**FORM10-Q—QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 
| ý   **Quarterly Report Pursuant to Section  13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                                                                                                                                            |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                  |
| **For the quarterly period ended   June 30, 2003**                                                                                                                                                                                                                                                                                                                                          |
|                                                                                                                                                                                                                                                                                                                                                                                                  |
| **or**                                                                                                                                                                                                                                                                                                                                                                                                |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |   |
| o   **Transition Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                                                                                                                                                |
|                                                                                                                                                                                                                                                                                                                                                                                                  |
| **For the transition period from                                 to                              ** |

 

**Commission File Number:  0-14745**

 

**Sun Bancorp, Inc.**

(Exact name of registrant as specified in itscharter)

 

| **Pennsylvania**                                                                    |   | **23-2233584**                        |
|-------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                     |   | (I.R.S. Employer  Identification No.) |
|                                                                                |   |                                  |
| **155 North 15th Street,  Lewisburg, PA**                                           |   | **17837**                             |
| (Address of principal executive offices)                                            |   | (Zip code)                            |
|                                                                                |   |                                  |
| **(570) 523-4300**                                                                  |
| (Registrant’s telephone number, including  area code)                          |
|                                                                                |   |                                  |
| **N/A**                                                                             |
| (Former name, former address and former  fiscal year, if changed since last report) |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90days.     Yes     ý    No     o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).        Yes     ý    No     o

 

APPLICABLE ONLY TO ISSUERS INVOLVED INBANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

 

Indicate by check mark whether the registrant has filed all documentsand reports required to be filed by Sections 12, 13 or 15(d) of the SecuritiesExchange Act of 1934 subsequent to the distribution of securities under a planconfirmed by a court.     Yes     o    No     o

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’sclasses of Common Stock, as of the latest practicable date.

 

| Common Stock, No Par Value |   | 7,203,165                           |
|----------------------------|--------|-------------------------------------|
| Class                      |   | Outstanding Shares At July 25, 2003 |

 

 

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SUN BANCORP, INC.

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2003

 
| CONTENTS                                                                                             |
|------------------------------------------------------------------------------------------------------|
|                                                                                                 |
| PART I  - FINANCIAL INFORMATION                                                                      |
|                                                                                                 |
| Item 1 - Financial Statements:                                                                       |
|                                                                                                 |
|                                                                                                 | Consolidated Balance Sheet as of June 30, 2003 (Unaudited) and  December 31, 2002 |
|                                                                                                 | Consolidated Statement of Income for the  Three and Six Months Ended June 30, 2003 and June 30, 2002 (Unaudited) |
|                                                                                                 | Consolidated Statement of Cash Flows for  the Six Months Ended June 30, 2003 and June 30, 2002 (Unaudited) |
|                                                                                                 |   |
|                                                                                                 | Notes to the Consolidated Financial  Statements (Unaudited) |
|                                                                                                 |
| Item 2 - Management’s Discussion and  Analysis of Financial Condition and Results of Operations |
|                                                                                                 |
| Item 4 – Controls and Procedures                                                                |
|                                                                                                 |
| PART  II - OTHER INFORMATION                                                                         |
|                                                                                                 |
| Item 4 – Submission of Matters to a Vote of  Security Holders                                   |
|                                                                                                 |
| Item 6 - Exhibits and Reports on Form 8-K                                                            |
|                                                                                                 |
| SIGNATURES                                                                                           |

 

2

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SUN BANCORP, INC.

FORM 10-Q

PART I

 

Item 1.  Financial Statements

 

SUN BANCORP, INC.

CONSOLIDATED BALANCE SHEET

 
| **(In Thousands, Except Share Data)**     |   | **June 30,  2003** |      | **December  31, 2002** |   |
|-------------------------------------------|--------|--------------------|-----------|------------------------|--------|
|                                      |   | **(Unaudited)**    |      |                   |   |
| ASSETS                                    |   |               |      |                   |   |
|                                      |   |               |      |                   |   |
| Cash and due from banks                   |   | $                  | 29,504    |                   | $      | 21,399 |   |
| Interest-bearing deposits in banks        |   | 16,919             |      | 20,170                 |   |
| Total cash and cash equivalents           |   | 46,423             |      | 41,569                 |   |
|                                      |   |               |      |                   |   |
| Investment securities                     |   | 235,212            |      | 219,438                |   |
| Loans and leases, net of unearned income  |   | 626,012            |      | 589,725                |   |
| Less: allowance for loan and lease losses |   | 7,342              |      | 6,206                  |   |
| Net loans and leases                      |   | 618,670            |      | 583,519                |   |
|                                      |   |               |      |                   |   |
| Bank premises and equipment, net          |   | 19,398             |      | 15,809                 |   |
| Goodwill and core deposit intangible      |   | 32,604             |      | 22,924                 |   |
| Accrued interest                          |   | 3,505              |      | 3,501                  |   |
| Bank owned life insurance                 |   | 32,604             |      | 30,800                 |   |
| Other assets                              |   | 38,374             |      | 33,614                 |   |
| Total assets                              |   | $                  | 1,026,790 |                   | $      | 951,174 |   |

 

3

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SUN BANCORP, INC.

CONSOLIDATED BALANCE SHEET

(Continued)

 
| **(In Thousands, Except Share Data)**                                                                                                     |   | **June 30,  2003** |      | **December  31, 2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|-----------|------------------------|--------|
|                                                                                                                                      |   | **(Unaudited)**    |      |                   |   |
|                                                                                                                                      |   |               |      |                   |   |
| LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                               |   |               |      |                   |   |
|                                                                                                                                      |   |               |      |                   |   |
| Deposits                                                                                                                                  |   |               |      |                   |   |
| Noninterest-bearing                                                                                                                       |   | $                  | 64,671    |                   | $      | 59,181 |   |
| Interest-bearing                                                                                                                          |   | 583,758            |      | 528,299                |   |
| Total deposits                                                                                                                            |   | 648,429            |      | 587,480                |   |
|                                                                                                                                      |   |               |      |                   |   |
| Short-term borrowings                                                                                                                     |   | 24,699             |      | 29,682                 |   |
| Other borrowed funds                                                                                                                      |   | 246,911            |      | 222,000                |   |
| Subordinated debentures                                                                                                                   |   | 18,866             |      | 19,655                 |   |
| Accrued interest and other liabilities                                                                                                    |   | 6,848              |      | 13,110                 |   |
| Total liabilities                                                                                                                         |   | 945,753            |      | 869,927                |   |
|                                                                                                                                      |   |               |      |                   |   |
| Shareholders’ equity                                                                                                                 |   |               |      |                   |   |
|                                                                                                                                      |   |               |      |                   |   |
| Preferred stock, no par value per share,  10,000,000 authorized shares:  no shares issued in 2003 and 2002                                |   | —             |      | —                 |   |
| Common stock, no par value per share;  50,000,000 authorized shares:  issued  7,319,087 shares in 2003 and  7,299,446 shares in 2002 |   | 85,367             |      | 84,591                 |   |
| Retained earnings (deficit)                                                                                                               |   | (3,931             | )         | (5,159                 | )      |
| Accumulated other comprehensive income                                                                                                    |   | 1,525              |      | 3,578                  |   |
| Less:   Treasury stock, at cost, 110,922 shares in 2003 and 126,717 shares in  2002                                                  |   | (1,924             | )         | (1,763                 | )      |
| Total shareholders’ equity                                                                                                           |   | 81,037             |      | 81,247                 |   |
| Total liabilities and shareholders’ equity                                                                                           |   | $                  | 1,026,790 |                   | $      | 951,174 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

4

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SUN BANCORP, INC.

CONSOLIDATED STATEMENT OF INCOME

(UNAUDITED)

 
|                                                                       |   | **For The  Three Months  Ended June 30** |   | **For the  Six Months  Ended June 30** |   |
|----------------------------------------------------------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
| **(In Thousands, Except Share Data)**                                      |   | **2003**                                 |   | **2002**                               |   | **2003** |   | **2002** |   |
| Interest income:                                                           |   |                                     |   |                                   |   |   |   |   |   |
| Interest and fees on loans and leases                                      |   | $                                        | 10,347 |                                   | $      | 10,204 |   | $ | 20,042 |   | $ | 19,898 |   |
| Income from available for sale securities                                  |   |                                     |   |                                   |   |   |   |   |   |
| Taxable                                                                    |   | 2,251                                    |   | 3,499                                  |   | 4,550 |   | 7,048 |   |
| Tax-exempt                                                                 |   | 214                                      |   | 258                                    |   | 445 |   | 518 |   |
| Dividends                                                                  |   | 95                                       |   | 112                                    |   | 206 |   | 246 |   |
| Interest on deposits in banks and other financial  institutions            |   | 39                                       |   | 71                                     |   | 91 |   | 175 |   |
|                                                                       |   |                                     |   |                                   |   |   |   |   |   |
| Total interest and dividend income                                         |   | 12,946                                   |   | 14,144                                 |   | 25,334 |   | 27,885 |   |
|                                                                       |   |                                     |   |                                   |   |   |   |   |   |
| Interest expense:                                                          |   |                                     |   |                                   |   |   |   |   |   |
| Interest on deposits                                                       |   | 3,071                                    |   | 3,684                                  |   | 6,198 |   | 7,684 |   |
| Interest on short-term borrowings                                          |   | 140                                      |   | 71                                     |   | 247 |   | 143 |   |
| Interest on other borrowed funds                                           |   | 3,346                                    |   | 3,180                                  |   | 6,484 |   | 6,333 |   |
| Interest on subordinated debentures                                        |   | 465                                      |   | 476                                    |   | 933 |   | 956 |   |
|                                                                       |   |                                     |   |                                   |   |   |   |   |   |
| Total interest expense                                                     |   | 7,022                                    |   | 7,411                                  |   | 13,862 |   | 15,116 |   |
|                                                                       |   |                                     |   |                                   |   |   |   |   |   |
| Net interest income                                                        |   | 5,924                                    |   | 6,733                                  |   | 11,472 |   | 12,769 |   |
|                                                                       |   |                                     |   |                                   |   |   |   |   |   |
| Provision for possible loan and lease losses                               |   | 405                                      |   | 405                                    |   | 810 |   | 810 |   |
|                                                                       |   |                                     |   |                                   |   |   |   |   |   |
| Net interest income, after provision for possible  loan & lease losses |   | $                                        | 5,519  |                                   | $      | 6,328 |   | $ | 10,662 |   | $ | 11,959 |   |

 

5

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|                                                     |   | **For The  Three Months  Ended June 30** |   | **For the  Six Months  Ended June 30** |   |
|----------------------------------------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
| **(In Thousands, Except Share Data)**                    |   | **2003**                                 |   | **2002**                               |   | **2003** |   | **2002** |   |
| Non-interest income:                                     |   |                                     |   |                                   |   |   |   |   |   |
| Service charges on deposit accounts                      |   | $                                        | 983    |                                   | $      | 708 |   | $ | 1,828 |   | $ | 1,228 |   |
| Trust income                                             |   | 203                                      |   | 187                                    |   | 422 |   | 341 |   |
| Net security gains                                       |   | 1,001                                    |   | 45                                     |   | 2,497 |   | 140 |   |
| Income from investment product sales                     |   | 78                                       |   | 155                                    |   | 102 |   | 260 |   |
| Bank owned life insurance                                |   | 317                                      |   | 161                                    |   | 642 |   | 206 |   |
| Income from insurance subsidiary                         |   | 340                                      |   | 19                                     |   | 363 |   | 49 |   |
| Gain on sale of loans                                    |   | 43                                       |   | 45                                     |   | 304 |   | 73 |   |
| Income from leasing fees                                 |   | 262                                      |   | —                                 |   | 563 |   | — |   |
| Other income                                             |   | 242                                      |   | 256                                    |   | 638 |   | 399 |   |
|                                                     |   |                                     |   |                                   |   |   |   |   |   |
| Total non-interest income                                |   | 3,469                                    |   | 1,576                                  |   | 7,359 |   | 2,696 |   |
|                                                     |   |                                     |   |                                   |   |   |   |   |   |
| Non-interest expense:                                    |   |                                     |   |                                   |   |   |   |   |   |
| Salaries and employee benefits                           |   | 3,415                                    |   | 2,829                                  |   | 6,581 |   | 5,633 |   |
| Net occupancy expense                                    |   | 332                                      |   | 251                                    |   | 715 |   | 525 |   |
| Furniture and equipment expenses                         |   | 503                                      |   | 418                                    |   | 990 |   | 815 |   |
| Amorization of intangibles                               |   | 38                                       |   | —                                 |   | 38 |   | — |   |
| Other expenses                                           |   | 2,775                                    |   | 1,930                                  |   | 5,302 |   | 3,355 |   |
|                                                     |   |                                     |   |                                   |   |   |   |   |   |
| Total non-interest expense                               |   | 7,063                                    |   | 5,428                                  |   | 13,626 |   | 10,328 |   |
|                                                     |   |                                     |   |                                   |   |   |   |   |   |
| Income before income tax provision                       |   | 1,925                                    |   | 2,476                                  |   | 4,395 |   | 4,327 |   |
|                                                     |   |                                     |   |                                   |   |   |   |   |   |
| Income tax provision                                     |   | 235                                      |   | 535                                    |   | 671 |   | 834 |   |
|                                                     |   |                                     |   |                                   |   |   |   |   |   |
| Net income                                               |   | $                                        | 1,690  |                                   | $      | 1,941 |   | $ | 3,724 |   | $ | 3,493 |   |
|                                                     |   |                                     |   |                                   |   |   |   |   |   |
| Net income per share - Basic                             |   | $                                        | 0.23   |                                   | $      | 0.27 |   | $ | 0.52 |   | $ | 0.49 |   |
| Weighted average number of shares outstanding  - Basic   |   | 7,210,518                                |   | 7,141,139                              |   | 7,196,333 |   | 7,141,897 |   |
| Net income per share - Diluted                           |   | $                                        | 0.23   |                                   | $      | 0.27 |   | $ | 0.52 |   | $ | 0.49 |   |
| Weighted average number of shares outstanding  - Diluted |   | 7,241,897                                |   | 7,163,965                              |   | 7,219,243 |   | 7,143,824 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

6

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SUN BANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 
|                                                                           |   | **For the  Six Months  Ended June 30,** |   |
|--------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
| **(In Thousands)**                                                             |   | **2003**                                |   | **2002** |   |
| Cash flows from operating activities:                                          |   |                                    |   |   |   |
| Net income                                                                     |   | $                                       | 3,724  |   | $ | 3,184 |   |
| Adjustments to reconcile net income to net  cash used in operating activities: |   |                                    |   |   |   |
| Provision for loan and lease losses                                            |   | 810                                     |   | 810 |   |
| Provision for depreciation                                                     |   | 512                                     |   | 512 |   |
| Amortization of intangibles                                                    |   | 38                                      |   | — |   |
| Amortization and accretion of securities,  net                                 |   | 669                                     |   | 578 |   |
| Net security gains                                                             |   | (2,497                                  | )      | (140 | ) |
| Decrease (increase) in accrued interest and  other assets                      |   | 282                                     |   | (23,594 | ) |
| Gain on sale of bank premises and equipment                                    |   | —                                  |   | (6 | ) |
| (Decrease) increase in accrued interest and  other liabilities                 |   | (10,234                                 | )      | 1,062 |   |
| Net cash used in operating activities                                          |   | (6,696                                  | )      | (17,594 | ) |
|                                                                           |   |                                    |   |   |   |
| Cash flows from investing activities:                                          |   |                                    |   |   |   |
| Proceeds from sales of investment securities                                   |   | 73,985                                  |   | 1,044 |   |
| Proceeds from maturities of investment  securities                             |   | 63,929                                  |   | 65,364 |   |
| Purchases of investment securities                                             |   | (135,061                                | )      | (5,979 | ) |
| Net cash paid for acquisitions                                                 |   | (131                                    | )      | — |   |
| Net increase in loans                                                          |   | (14,159                                 | )      | (61,248 | ) |
| Proceeds from sales of bank premises and  equipment                            |   | —                                  |   | 6 |   |
| Capital expenditures                                                           |   | (1,957                                  | )      | (398 | ) |
| Net cash used in investing activities                                          |   | (13,394                                 | )      | (1,211 | ) |
|                                                                           |   |                                    |   |   |   |
| Cash flows from financing activities:`                                         |   |                                    |   |   |   |
| Net increase (decrease) in deposits                                            |   | 24,452                                  |   | (2,506 | ) |
| Net (decrease) increase in short-term  borrowings                              |   | (5,404                                  | )      | 4,580 |   |
| Net increase (decrease) in long-term  borrowings                               |   | 10,763                                  |   | (2,000 | ) |
| Repayment of subordinated debt                                                 |   | (789                                    | )      | (789 | ) |
| Cash dividends paid                                                            |   | (2,496                                  | )      | (2,249 | ) |
| Proceeds from sale of stock for employee  benefits program                     |   | 259                                     |   | 431 |   |
| Purchase of treasury stock                                                     |   | (1,841                                  | )      | (313 | ) |
| Net cash provided by (used in) financing  activities                           |   | 24,944                                  |   | (2,846 | ) |
|                                                                           |   |                                    |   |   |   |
| Net increase (decrease) in cash and cash  equivalents                          |   | 4,854                                   |   | (21,651 | ) |
| Cash and cash equivalents at beginning of  period                              |   | 41,569                                  |   | 44,983 |   |
| Cash and cash equivalents at end of period                                     |   | $                                       | 46,423 |   | $ | 23,332 |   |

 

7

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|                                               |   | **For the Six Months  Ended June 30,** |   |
|----------------------------------------------------|--------|----------------------------------------|--------|
| **(In  Thousands)**                                |   | **2003**                               |   | **2002** |   |
|                                               |   |                                   |   |   |   |
| Supplemental disclosure of cash flow  information: |   |                                   |   |   |   |
|                                               |   |                                   |   |   |   |
| Cash paid during the period for:                   |   |                                   |   |   |   |
|                                               |   |                                   |   |   |   |
| Interest                                           |   | $                                      | 14,245 |   | $ | 14,983 |   |
|                                               |   |                                   |   |   |   |
| Income taxes                                       |   | $                                      | — |   | $ | 1,409 |   |

 

Loans with an estimated value of $424,000 and $342,000 were reclassified to foreclosed assets held forsale during the six-month periods ended June 30, 2003 and 2002, respectively.

 

The accompanying notes are an integral part of these financialstatements.

 

8

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SUN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Forward Looking Statements (FLSs)

 

Management has made forward-looking statements in this Form 10-Q. Theseforward-looking statements are subject to risks and uncertainties.  Forward-looking statements includeinformation concerning possible or assumed future results of operations of theCorporation and its subsidiaries. When words such as “believes,” “expects,”“anticipates” or similar expressions occur in the Form 10-Q, management ismaking forward-looking statements.

 

Readers should note that many factors, some of which are discussedelsewhere in this report and in the documents that management incorporates byreference, could affect the future financial results of the Corporation and itssubsidiaries, both individually and collectively, and could cause those results

to differ materially from those expressed in the forward-lookingstatements contained or incorporated by reference in this Form 10-Q. Thesefactors include:

 

•                       operating,legal and regulatory risks;

•                       economic,political and competitive forces affecting banking, securities, assetmanagement and credit services businesses; and

•                       therisk that management’s analysis of these risks and forces could be incorrectand/or that the strategies developed to address them could be unsuccessful.

 

The Corporation undertakes no obligation to publicly revise or updatethese forward-looking statements to reflect events or circumstances that ariseafter the date of this report. Readers should carefully review the risk factorsdescribed in other documents that Sun files periodically with the

Securities and Exchange Commission.

 

Note 1 — Basis of Interim Presentation

 

The consolidated financial statements include the accounts of SunBancorp, Inc., the parent company, and its wholly-owned subsidiaries: SunBank,Mid-Penn Insurance Associates, Inc., SUBI Investment Company, Beacon LifeInsurance Company, and Sun Bancorp Statutory Trust I.  Sun also holds thirty percent ownership in Sun Abstract andSettlement Services.  The transactionsof Beacon Life Insurance Company and Sun Abstract and Settlement Services arenot material to the consolidated financial statements.  All significant intercompany balances andtransactions have been eliminated in consolidation.

 

The accompanying unaudited consolidated financial statements for theinterim periods do not include all of the information and footnotes required bygenerally accepted accounting principles. These statements should be read in conjunction with the notes to the auditedfinancial statements contained in the 2002 Annual Report to Shareholders.  However, in the opinion of management, alladjustments necessary for a fair presentation of the results of the interimperiod have been included.  Operatingresults for the three and six months ended June 30, 2003 are not necessarilyindicative of the results that may be expected for the year ended December 31,2003.

 

9

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The accounting policies followed in the presentation of interimfinancial results are the same as those followed on an annual basis.  These policies are presented on pages 18thru 20 of the 2002 Annual Report to Shareholders.

 

Note 2 – Stock Options

 

Sun has three common stock plans for employees and directors.  The 1998 Stock Incentive Plan, administeredby a Board of Directors committee of independent directors, allows for 716,625shares of common stock to be issued for key officers and other managementemployees in the form of qualified options, non qualified options, stockappreciation rights, or restrictive stock. The 1998 Independent Directors Stock Option Plan allows 115,763 sharesof common stock to be issued for non-employee directors.  Options under those plans expire ten yearsafter the grant date.  Both of theseplans terminate in 2008.

 

The 1998 Employee Stock Purchase Plan, which permits all employees topurchase common stock at an option price per share not less than 85% of themarket value on the exercise date was allocated 248,063 shares.  Options granted to date have been awarded at90% of the market value on the exercise date. Each option under the 1998 Employee Stock Purchase Plan expires no laterthan five years from the grant date. This plan terminates in 2008.

 

Sun applies Accounting Principles Board Opinion Number 25 and relatedinterpretations to account for its common stock plans.  Accordingly, Sun has not recognizedcompensation expense for the plans.  Hadcompensation expense been determined based on fair values at the grant dates(pursuant to SFAS 123), Sun’s net income and basic earnings per share for thethree and six months ended June 30, 2003 and 2002 would have been:

 
|                                                                                            |   | **For the  Three Months Ended  June 30** |      | **For the  Six Months Ended  June 30** |
|-------------------------------------------------------------------------------------------------|--------|------------------------------------------|-----------|----------------------------------------|
|                                                                                            |   | **2003**                                 |      | **2002**                               |   | **2003** |   | **2002** |
| Net income                                                                                      |   | $                                        | 1,690,000 |                                   | $ | 1,941,000 |   | $ | 3,724,000 |   | $ | 3,493,000  |
| Average number of common shares oustanding                                                      |   | 7,210,518                                |      | 7,141,139                              |   | 7,196,333 |   | 7,141,897  |
| Effect of dilutive options                                                                      |   | 31,379                                   |      | 22,826                                 |   | 22,910 |   | 1,927 |
| Average number of common shares oustanding  used to calculate diluted earnings per common share |   | 7,241,897                                |      | 7,163,965                              |   | 7,219,243 |   | 7,143,824 |
|                                                                                                 |        |                                          |           |                                        |  |  |  |  |  |  |  |  |

 

10

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Note 3 – Consolidated Statement of Changes in Shareholder’s Equity

 

The purpose of reporting comprehensive income is to report a measure ofall changes in Sun Bancorp, Inc.’s equity resulting from economic events otherthan transactions with shareholders acting in their normal capacity asshareholders.  For Sun Bancorp, Inc.,“comprehensive income” includes traditional income statement amounts as well asunrealized gains and losses on certain investments in debt and equitysecurities (i.e. available-for-sale securities).  Unrealized gains and losses are part of comprehensive income,therefore comprehensive income may vary substantially between reporting periodsdue to fluctuations in the market prices of securities held.

 

**For theyears ended December 31, 2001, 2002 and the quarter ended June 30, 2003**

*(InThousands, Except for Share Data)*

 
|                                                                                                    |   | **Common Stock** |       | **Retained  Earnings  (Deficit)** |       | **Accumulated  Other  Comprehensive  Income(Loss)** |       | **Treasury  Stock** |       | **Total  Shareholders’  Equity** |       |
|---------------------------------------------------------------------------------------------------------|--------|------------------|------------|-----------------------------------|------------|-----------------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                                                                                    |   | **Shares**       |       | **Amount**                        |       |                                                |       |                |       |
| Balance, December 31, 2000                                                                              |   | 7,227            |       | 81,632                            |       | (11,177                                             | )          | (1,591              | )          | (6,337                                | )          | 62,527 |   |
| Comprehensive income:                                                                                   |   |             |       |                              |       |                                                |       |                |       |                                  |       |   |   |
| Net income                                                                                              |   | —           |       | —                            |       | 8,350                                               |       | —              |       | —                                |       | 8,350 |   |
| Unrealized gains on securities available  for sale, net of reclassification adjustments and tax effects |   | —           |       | —                            |       | —                                              |       | 3,660               |       | —                                |       | 3,660 |   |
| Total comprehensive income                                                                              |   |             |       |                              |       |                                                |       |                |       |                                  |       | 12,010 |   |
|                                                                                                    |   |             |       |                              |       |                                                |       |                |       |                                  |       |   |   |
| Stock issued:                                                                                           |   |             |       |                              |       |                                                |       |                |       |                                  |       |   |   |
| Employee benefit plans                                                                                  |   | 9                |       | 123                               |       | —                                              |       | —              |       | —                                |       | 123 |   |
| Purchase of Guaranty Bank, N.A. (553,558  treasury shares)                                              |   | —           |       | 1,810                             |       | —                                              |       | —              |       | 6,388                                 |       | 8,198 |   |
| Purchase of treasury stock (80,535 shares)                                                              |   | —           |       | —                            |       | —                                              |       | —              |       | (1,213                                | )          | (1,213 | ) |
| Cash dividends declared, $.60 per share                                                                 |   | —           |       | —                            |       | (4,134                                              | )          | —              |       | —                                |       | (4,134 | ) |
| Balance, December 31, 2001                                                                              |   | 7,236            |       | 83,565                            |       | (6,961                                              | )          | 2,069               |       | (1,162                                | )          | 77,511 |   |
| Comprehensive income:                                                                                   |   |             |       |                              |       |                                                |       |                |       |                                  |       |   |   |
| Net income                                                                                              |   | —           |       | —                            |       | 6,416                                               |       | —              |       | —                                |       | 6,416 |   |
| Unrealized gains on securities available  for sale, net of reclassification adjustments and tax effects |   | —           |       | —                            |       | —                                              |       | 1,509               |       | —                                |       | 1,509 |   |
| Total comprehensive income                                                                              |   |             |       |                              |       |                                                |       |                |       |                                  |       | 7,925 |   |
|                                                                                                    |   |             |       |                              |       |                                                |       |                |       |                                  |       |   |   |
| Stock issued:                                                                                           |   |             |       |                              |       |                                                |       |                |       |                                  |       |   |   |
| Employee benefit plans                                                                                  |   | 63               |       | 1,007                             |       | —                                              |       | —              |       | —                                |       | 1,007 |   |
| Purchase of treasury stock (33,300 shares)                                                              |   | —           |       | —                            |       | —                                              |       | —              |       | (601                                  | )          | (601 | ) |
| Cash dividends declared, $.66 per share                                                                 |   | —           |       | —                            |       | (4,614                                              | )          | —              |       | —                                |       | (4,614 | ) |
| Tax benefit of exercised stock options                                                                  |   | —           |       | 19                                |       | —                                              |       | —              |       | —                                |       | 19 |   |
| Balance, December 31, 2002                                                                              |   | 7,299            |       | 84,591                            |       | (5,159                                              | )          | 3,578               |       | (1,763                                | )          | 81,247 |   |
| **Comprehensive income:**                                                                               |   |             |       |                              |       |                                                |       |                |       |                                  |       |   |   |
| Net income                                                                                              |   | —           |       | —                            |       | **3,724**                                           |       | —              |       | —                                |       | **3,724** |   |
| Unrealized gains on securities available  for sale, net of reclassification adjustments and tax effects |   | **—**       | ** ** | **—**                        | ** ** | **—**                                          | ** ** | **(2,053**          | **)**      | **—**                            | ** ** | **(2,053** | **)** |
| **Total comprehensive income**                                                                          |   |             | ** ** |                              | ** ** |                                                | ** ** |                | ** ** |                                  | ** ** | **1,671** | ** ** |
|                                                                                                    |   |             | ** ** |                              | ** ** |                                                | ** ** |                | ** ** |                                  | ** ** |   | ** ** |
| Stock issued:                                                                                           |   |             | ** ** |                              | ** ** |                                                | ** ** |                | ** ** |                                  | ** ** |   | ** ** |
| Employee benefit plans                                                                                  |   | **20**           | ** ** | **259**                           | ** ** | **—**                                          | ** ** | **—**          | ** ** | **—**                            | ** ** | **259** | ** ** |
| Purchase of Bank Capital Services  Corporation (25,109 treasury shares)                                 |   | **—**       | ** ** | **121**                           | ** ** | **—**                                          | ** ** | **—**          | ** ** | **351**                               | ** ** | **472** | ** ** |
| Purchase of Mid-Penn Insurance Associates,  Inc. (85,936 treasury shares)                               |   | **—**       | ** ** | **396**                           | ** ** | **—**                                          | ** ** | **—**          | ** ** | **1,329**                             | ** ** | **1,725** | ** ** |
| Purchase of treasury stock (95,250 shares)                                                              |   | **—**       | ** ** | **—**                        | ** ** | **—**                                          | ** ** | **—**          | ** ** | **(1,841**                            | **)**      | **(1,841** | **)** |
| Cash dividends declared, $.3465 per share                                                               |   | **—**       | ** ** | **—**                        | ** ** | **(2,496**                                          | **)**      | **—**          | ** ** | **—**                            | ** ** | **(2,496** | **)** |
| **Balance, June 30, 2003**                                                                              |   | **7,319**        | ** ** | **85,367**                        | ** ** | **(3,931**                                          | **)**      | **1,525**           | ** ** | **(1,924**                            | **)**      | **81,037** | ** ** |

 

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Note 4 – Investment Securities

 

The amortized cost and fair value of investment securities at June 30,2003 and December 31, 2002 were as follows:

 
|                                              |   | **June 30,  2003**    |    |
|---------------------------------------------------|--------|-----------------------|---------|
| **(In Thousands)**                                |   | **Amortized  Cost**   |    | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair  Value** |   |
| Debt securities:                                  |   |                  |    |   |   |   |   |   |   |
| Obligations of U.S. government agencies           |   | $                     | 179,078 |   | $ | 1,688 |   | $ | (766 | ) | $ | 180,000 |   |
| Obligations of states and political  subdivisions |   | 18,642                |    | 1,324 |   | (46 | ) | 19,920 |   |
| Other corporate                                   |   | 17,591                |    | 52 |   | (108 | ) | 17,535 |   |
| Total debt securities                             |   | 215,311               |    | 3,064 |   | (920 | ) | 217,455 |   |
|                                              |   |                  |    |   |   |   |   |   |   |
| Equity securities:                                |   |                  |    |   |   |   |   |   |   |
| Marketable equity securities                      |   | 3,973                 |    | 279 |   | (113 | ) | 4,139 |   |
| Restricted equity securities                      |   | 13,618                |    | — |   | — |   | 13,618 |   |
| Total equity securities                           |   | 17,591                |    | 279 |   | (113 | ) | 17,757 |   |
|                                              |   |                  |    |   |   |   |   |   |   |
| Total                                             |   | $                     | 232,902 |   | $ | 3,343 |   | $ | (1,033 | ) | $ | 235,212 |   |
|                                              |   |                  |    |   |   |   |   |   |   |
|                                              |   | **December 31, 2002** |    |
|                                              |   | **Amortized  Cost**   |    | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair  Value** |   |
| Debt securities:                                  |   |                  |    |   |   |   |   |   |   |
| Obligations of U.S. government agencies           |   | $                     | 173,552 |   | $ | 4,584 |   | $ | (133 | ) | $ | 178,003 |   |
| Obligations of states and political  subdivisions |   | 19,767                |    | 836 |   | — |   | 20,603 |   |
| Other corporate                                   |   | 5,575                 |    | 388 |   | (75 | ) | 5,888 |   |
| Total debt securities                             |   | 198,894               |    | 5,808 |   | (208 | ) | 204,494 |   |
|                                              |   |                  |    |   |   |   |   |   |   |
| Equity securities:                                |   |                  |    |   |   |   |   |   |   |
| Marketable equity securities                      |   | 3,111                 |    | 136 |   | (315 | ) | 2,932 |   |
| Restricted equity securities                      |   | 12,012                |    | — |   | — |   | 12,012 |   |
| Total equity securities                           |   | 15,123                |    | 136 |   | (315 | ) | 14,944 |   |
|                                              |   |                  |    |   |   |   |   |   |   |
| Total                                             |   | $                     | 214,017 |   | $ | 5,944 |   | $ | (523 | ) | $ | 219,438 |   |

 

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Note 5 – Loans

 

The balances for principal loan categories are as follows:

 
|                                        |   | **June 30,  2003** |    | **December  31, 2002** |   |
|---------------------------------------------|--------|--------------------|---------|------------------------|--------|
|                                        |   |               |    |                   |   |
| Real estate – mortgage                 |   | $                  | 410,691 |                   | $      | 404,350 |   |
| Real estate – construction             |   | 20,530             |    | 17,721                 |   |
| Agricultural                                |   | 298                |    | 138                    |   |
| Commercial and industrial                   |   | 64,495             |    | 54,624                 |   |
| Lease – auto                           |   | 39,890             |    | 29,698                 |   |
| Lease – equipment                      |   | 6,949              |    | 4,955                  |   |
| Individual                                  |   | 92,988             |    | 85,920                 |   |
| Other                                       |   | 312                |    | 328                    |   |
| Total                                       |   | $                  | 636,153 |                   | $      | 597,734 |   |
|                                        |   |               |    |                   |   |
| Less:                                       |   |               |    |                   |   |
| Unearned income & deferred loan fees    |   | (9,704             | )       | (7,945                 | )      |
| Unamortized net discount on purchased loans |   | (437               | )       | (64                    | )      |
| ALLL                                        |   | (7,342             | )       | (6,206                 | )      |
| Net Loans                                   |   | $                  | 618,670 |                   | $      | 583,519 |   |

 

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Note 6 – Net Income Per Share

 

Net income per share is computed based on the weighted average numberof shares of stock outstanding for each period presented.  Statement of Financial Accounting StandardsNo. 128, “Earnings Per Share,” requires presentation of two amounts, basic anddiluted net income per share.  Basicearnings per share calculates net income divided by the average number ofshares outstanding for the period. Diluted earnings per share calculates net income divided by the sum ofthe average number of shares outstanding and the effect that, if all wereexercised, the granted stock options would have on the number of sharesoutstanding for the period.

 

The following data shows the amounts used in computing net income pershare and the weighted average number of shares of dilutive stock options forthe three and six-month periods ended June 30, 2003 and 2002:

 
|                       |   | **For the  Three Months Ended  June 30** |   | **For the  Six Months Ended  June 30** |   |
|----------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
| **(In Thousands)**         |   | **2003**                                 |   | **2002**                               |   | **2003** |   | **2002** |   |
| Net income:                |   |                                     |   |                                   |   |   |   |   |   |
| As reported                |   | $                                        | 1,690  |                                   | $      | 1,941 |   | $ | 3,724 |   | $ | 3,493 |   |
| Pro forma                  |   | $                                        | 1,836  |                                   | $      | 1,988 |   | $ | 3,867 |   | $ | 3,407 |   |
|                       |   |                                     |   |                                   |   |   |   |   |   |
| Earnings per share - Basic |   |                                     |   |                                   |   |   |   |   |   |
| As reported                |   | $                                        | 0.23   |                                   | $      | 0.27 |   | $ | 0.52 |   | $ | 0.49 |   |
| Pro forma                  |   | $                                        | 0.25   |                                   | $      | 0.28 |   | $ | 0.54 |   | $ | 0.48 |   |

 

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Note 7 – Off-Balance Sheet Risk

 

Sun is a party to financial instruments with off-balance sheet risk inthe normal course of business to meet customers’ financing needs.  These financial instruments includecommitments to extend credit and standby letters of credit containing, invarying degrees, credit and interest rate risk exceeding the amount recognizedin the balance sheet.

 

Credit risk from nonperformance by counterparties to commitments toextend credit and standby letters of credit is represented by the contractualamount of those instruments.  Sun usesthe same credit policies to guide commitments and conditional obligations as itdoes for direct, funded loans.

 

Commitments to extend credit are agreements to lend to a customer aslong as no contract conditions are violated. Commitments generally include fixed expiration dates or othertermination clauses and certain fee payments. Since many commitments are expected to expire without being drawn upon,the total commitment amounts do not necessarily represent future cashrequirements.  Each customer’screditworthiness is evaluated on a case-by-case basis.  The collateral amount obtained, if deemednecessary, is based on management’s credit evaluation of the customer.  Collateral types vary but may includeaccounts receivable, inventory, property, equipment, and income-producingcommercial properties.

 

Standby letters of credit are conditional commitments that guarantee acustomer’s performance to a third party. Those guarantees are primarily issued to support borrowing arrangementsand related transactions.  Terms varyfrom one month to 24 months and may have renewal features.  Credit risk differs little from direct loansto customers.  When warranted, Sun holdscollateral against those commitments.

 

 
|                                               |   |           |    |               |   |
|----------------------------------------------------|--------|----------------|---------|--------------------|--------|
| **(In Thousands)**                                 |   | **June  2003** |    | **December  2002** |   |
| Commitments to  extend credit (binding)            |   | $              | 140,215 |               | $      | 128,796 |   |
| Standy letters of  credit and financial guarantees |   | 9,452          |    | 10,577             |   |
| Total credit  extension commitments                |   | $              | 149,667 |               | $      | 139,373 |   |

 

 

Note 8 – Hedging Activities

 

On June 30, 2003 SunBank entered into $100,000 in notional valuederivative instruments as part of its interest rate risk management process tomanage risk associated with its Federal Home Loan Bank term borrowings (otherborrowings).   The derivativeinstruments are being accounted for as Fair Value Hedges in which SunBankreceives a fixed rate and pays a variable rate to the counter party.

 

Sun Bancorp, Inc. maintains an overall interest rate risk-managementstrategy that incorporates the use of derivative instruments to minimizesignificant unplanned fluctuations in earnings that are caused by interest ratevolatility.  Sun Bancorp, Inc.’s goal isto manage interest rate sensitivity by modifying the repricing or maturitycharacteristics of certain balance sheet assets and liabilities so that thenet-interest margin is not, on a material basis, adversely affected bymovements in interest rates.  As aresult of interest rate fluctuations, hedged fixed-rate liabilities willappreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation is expectedto be substantially offset by Sun Bancorp, Inc.’s gains or losses on thederivative instruments that are linked to these hedged liabilities.  Another result of interest rate fluctuationsis that the interest expense of hedged variable-rate liabilities will increaseor decrease.  The effect of thisvariability in earnings is expected to be substantially offset by Sun Bancorp,Inc.’s gains and losses on the derivative instruments that are linked to thesehedged liabilities.  Sun Bancorp, Inc.considers its strategic use of derivatives to be a prudent method of managinginterest-rate sensitivity, as it prevents earnings from being exposed to unduerisk posed by changes in interest rate.

 

Sun Bancorp, Inc. uses interest rate swaps as part of the interest raterisk-management strategy that have indices related to the pricing of specificbalance sheet liabilities.  As a matterof policy, Sun Bancorp, Inc. does not use highly leveraged derivativeinstruments for interest rate risk management. Interest rate swaps generally involve the exchange of fixed andvariable-rate interest payments between two parties, based on a common notionalprincipal amount and maturity date.  Thederivative instruments entered into by Sun Bancorp, Inc. give Sun Bancorp, Inc.the right to enter into additional interest rate swaps with the writer of theoption in the event that the Federal Home Loan Bank (FHLB) borrowings arerepriced by the FHLB.

 

By using derivative instruments, Sun Bancorp, Inc. exposes itself tocredit and market risk.   If acounterparty fails to fulfill its performance obligations under a derivativecontract, Sun Bancorp, Inc. credit risk will equal the fair value gain in a derivative.  Generally, when the fail value of aderivative contract is positive, this indicates that the counterparty owes SunBancorp, thus creating a credit risk for Sun Bancorp, Inc.  When the fair value of a derivative contractis negative, Sun Bancorp, Inc. owes the counterparty and, therefore, assumes norepayment risk.  Sun Bancorp, Inc.minimizes the credit (or repayment) risk in derivative instruments by enteringinto transactions with high quality counterparties that are reviewedperiodically by Sun Bancorp, Inc.’s Asset/Liability Committee.  Further, when the circumstances are deemedappropriate, Sun Bancorp, may request that collateral be provided by thecounterparty.

 

Market risk is the adverse effect that a change in interest rates,currency, or implied volatility rates might have on the value of a financialinstrument.  Sun Bancorp, Inc. managesthe market risk

 

15

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associated with interest rate contracts by establishing and monitoringlimits for the types and degree of risk that may be undertaken.

 

Sun Bancorp, Inc.’s derivative activities are monitored by itsAsset/Liability Committee as part of that committee’s oversight of Sun Bancorp,Inc.’s asset/liability position.  TheAsset/Liability Committee is responsible for approving hedging strategies thatare developed through its analysis of data derived from financial simulationmodels and other internal and industry sources.  The resulting hedging strategies are then incorporated into SunBancorp, Inc.’s overall interest rate risk-management strategy.

 

Sun Bancorp, Inc. on June 30, 2003 entered into four pay-variablereceive-fixed interest rate swaps ($100,000 notional) to hedge changes in fairvalue of certain FHLB long-term borrowing (other borrowed funds).  Sun Bancorp, Inc. includes all components ofeach derivatives gain or loss in the assessment of hedge effectiveness.  Sun Bancorp, Inc. recognizes the change infair value of the hedge and the associated borrowings through the incomestatement.  For the six months endedJune 30, 2003, there was no change in value recognized in the hedge orassociated borrowing as the deal closed on June 30, 2003.  A summary of Sun Bancorp, Inc.’s fair valueshedges appears below.

 
| **(In Thousands)**                                |   | **Notional  Amount** |    | **Asset** |              | **Liability** |          | **Weighted  Average** |              |
|---------------------------------------------------|--------|----------------------|---------|-----------|-------------------|---------------|---------------|-----------------------|-------------------|
|                                              |   |                 |    |      | **Receive  Rate** |          | **Pay  Rate** |                  | **Life  (Years)** |   |
| **June 30, 2003**                                 |   |                 |    |      |              |          |          |
| Fair Value Hedges:                                |   |                 |    |      |              |          |          |                  |              |   |   |   |   |
| Receive fixed - pay variable interest rate  swaps |   | $                    | 100,000 |      | —            |          | —        |                  | 2.65              | % | 1.10 | % | 6.8 |   |
|                                                   |        |                      |         |           |                   |               |               |                       |                   |  |  |  |  |  |

 

16

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Item 2.   Management’sDiscussion and Analysis of Financial Condition andResults of Operations (in thousands, except per share amounts)

 

The following is management’s discussion and analysis of thesignificant changes in the results of operations, capital resources, andliquidity presented in its accompanying consolidated financial statements forSun Bancorp, Inc., a financial holding company, and its wholly-ownedsubsidiaries, SunBank, Mid-Penn Insurance Associates, Inc., Beacon LifeInsurance Company, and Sun Bancorp Statutory Trust I.  Sun Bancorp, Inc. also holds thirty percent ownership in SunAbstract and Settlement Services.  SunBancorp, Inc.’s consolidated financial condition and results of operations consistalmost entirely of SunBank’s financial condition and results ofoperations.  This discussion should beread in conjunction with the 2002 Annual Report.  Current performance does not guarantee or assure similarperformance in the future, and may not be indicative of future results.

 

Results of Operations – Three Months Ended June 30, 2003 and 2002

 

Sun Bancorp, Inc.’s earnings of $1,690 ($0.23 per share basic anddiluted) for the three months ended June 30, 2003 were $251 ($0.04 per sharebasic and diluted) lower than the three months ended June 30, 2002.

 

The earnings resulted in annualized return on average assets for thethree months ended June 30, 2003 of 0.66% as compared to 0.85% for the same period in 2002.  Annualized return on average equity for thethree months ended June 30, 2003 was 8.30% as compared to 9.74% for the threemonths ended June 30, 2002.

 

Comparative information for the three months ended June 30, 2003 and2002 is impacted by the acquisition of Bank Capital Services Corporation inJanuary 2003, and the acquisitions of Mid-Penn Insurance Associates, Inc. andSteelton Bancorp in April 2003.

 

Net interest income decreased 12.0% to $5,924 for the three monthsended June 30, 2003 compared to $6,733 for the same period of 2002.  Total interest and dividend income decreased$1,198 to $12,946 for the three months ended June 30, 2003.  Interest and fees on loans and leasesremained relatively flat with a 1.4% increase to $10,347 for the three months endedJune 30, 2003 as compared to 2002 despite net loan and lease growth of $43,054over the same period.  Interest anddividends on available for sale securities decreased $1,309 to $2,560 for thethree months ended June 30, 2003 due to accelerated prepayments as a result ofthe current low interest rate environment. Interest on deposits in banks decreased 45.1% for the three months endedJune 30, 2003 primarily due to decreased interest rates. Total interest expensedecreased 5.2% for the three months ended June 30, 2003, as compared to2002.  The overall decrease is theresult of the rate reductions by the Federal Reserve during the past twoyears.  Interest on deposits decreased16.6%, or $613 as a result of the interest rate decreases when comparing thethree months ended June 30, 2003 to 2002. The decrease in the aggregate interest expense has not kept pace withthe decrease in interest income due to other borrowed funds that carried aweighted average cost of 5.5% for the three months ended June 2003.  To alleviate the impact of the Federal HomeLoan Bank term borrowings, Sun entered into $100,000  notional value swap arrangements on June 30, 2003.  At current interest rates, the impact of theswaps will reduce interest expense by approximately $120 per month.

 

17

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Non-interest income, excluding security gains, increased $937 or 61.2%to $2,468 for the three months ended June 30, 2003 as compared to 2002.  Increased service charges on depositsaccounted for $275 of the increase.  Theincrease in service charges was primarily the result of a program implementedduring 2002 involving charging fees for overdraft protection.  The addition of bank owned life insuranceduring March and October of 2002 represented $156 of the increase.  The bank owned life insurance was purchasedto supplement future increases in employee benefit plans and is generatingabove market returns.  Income fromleasing subsidiary, Bank Capital Services Corporation purchased in January 2003,generated $262 in additional fees. In addition, income from insurancesubsidiary increased $321 as the result of the acquisition of Mid-PennInsurance in April 2003.  Theacquisition of Steelton Bancorp in April 2003 also aided in the non-interestincome growth for the three months ended June 30, 2003 as compared to2002.  Income from investment productsales decreased $77 when comparing the three months ended June 30, 2003 to 2002as dollars have flowed out of the stock/bond markets and into banks.

 

Non-interest expenses increased $1,635 or 30.1% to $7,063 for the threemonths ended June 30, 2003 as compared to 2002.  All categories of other expenses have been impacted by theacquisitions of Bank Capital Services Corporation, Mid-Penn Insurance Associates,Inc., and Steelton Bancorp during 2003. Salaries and employee benefits increased $586 or 20.7% due to theacquisitions and increased employee benefit costs.  Net occupancy expense and furniture and equipment expensesincreased $166 or 24.8% due to the acquisitions and infrastructure improvements.  Other expenses increased 43.8% or $845 dueto increases in normal business expenses, acquisitions, and the outsourcing ofoperational processing and certain other support functions.  In aggregate, Bank Capital and MPIrepresented $527 or 32.2% of the total increase in other expense.  The outsourcing of operational processing,which increased our capabilities, increased expenses $341 or 20.9% of the totalincrease in other expense.

 

Results of Operations — Six Months Ended June 30, 2003 and 2002

 

Sun Bancorp, Inc.’s earnings of $3,724 ($0.52 per share basic anddiluted) for the six months ended June 30, 2003 were $231 ($0.03 per sharebasic and diluted) higher than the six months ended 2002.

 

The earnings resulted in annualized return on average assets for thesix months ended June 30, 2003 of  0.75%as compared to 0.76% for the six months ended June 30, 2002.  Annualized return on average equity for thesix months ended June 30, 2003 was 9.09% as compared to 8.85% for the sixmonths ended June 30, 2002.

 

Comparative information for the six months ended June 30, 2003 and 2002is impacted by the acquisition of Bank Capital Services Corporation, Mid-PennInsurance Associates, Inc. and Steelton Bancorp.

 

Net interest income decreased 10.2% to $11,472 for the six months endedJune 30, 2003 as compared to $12,769 for the same period of 2002.  Total interest and dividend income decreased$2,551 to $25,334 for the six months ended June 30, 2003.  Interest and fees on loans remained flat

 

18

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with a 0.7% increase to $20,042 for the six months ended June 30,2003.  Interest and dividends onavailable for sale securities decreased $2,611 to $5,201 for the six monthsended June 30, 2003 due to accelerated prepayments as a result of the currentlow interest rate environment.  Intereston deposits in banks decreased 48.0% for the six months ended June 30, 2003.Total interest expense decreased 8.3% for the six months ended June 30, 2003,as compared to 2002.  Interest ondeposits decreased 19.3%, or $1,486 as a result of the interest rate decreaseswhen comparing the six months ended June 30, 2003 to 2002.

 

Non-interest income, excluding security gains, increased $2,306 or90.2% to $4,862 for the six months ended June 30, 2003 as compared to2002.  Increased service charges ondeposits accounted for $600 of the increase. The addition of bank owned life insurance during March and October of2002 represented $436 of the increase. Income from leasing subsidiary, Bank Capital Services Corporationpurchased in January 2003, generated $563 in additional fees.  In addition, income from insurancesubsidiary increased $314 as the result of the acquisition of Mid-PennInsurance in April 2003.  Income frominvestment product sales decreased $158 when comparing the six months endedJune 30, 2003 to 2002 as dollars have flowed out of the stock/bond markets andinto banks.

 

Non-interest expenses increased $3,298 or 31.9% to $13,626 for the sixmonths ended June 30, 2003 as compared to 2002.  All categories of other expenses have been impacted by theacquisitions of Bank Capital Services Corporation, Mid-Penn InsuranceAssociates, Inc., and Steelton Bancorp during 2003.  Salaries and employee benefits increased $948 or 16.8% due to theacquisitions and increased employee benefit costs.  Net occupancy expense and furniture and equipment expensesincreased $365 or 27.2%.  Other expensesincreased 58.0% or $1,947 due to increases in normal business expenses,acquisitions, and the outsourcing of operational processing and certain othersupport functions.  In aggregate, BankCapital and MPI represented $769 or 23.3% of the total increase in otherexpense. The outsourcing of operational processing, which provided additionalcapabilities, increased expenses $683 or 20.7% of the total increase in otherexpense. Security gains of $2,497 were recognized for the six months ended Jun30, 2003, compared to $140 for 2002 as Sun Bancorp, Inc. realigned theinvestment portfolio to provide an even cash flow over the next thirty months.

 

Balance Sheet– June 30, 2003 and December 31, 2002

 

Total assets were $1,026,790 at June 30, 2003, an increase of $75,616from $951,174 at December 31, 2002. Cash and cash equivalents increased $4,854, or 11.7% from $41,569 atDecember 31, 2002.  The increase in cashand cash equivalents was the result of a cash build up as

 

19

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management evaluated the possibility of paying off debt and preparedfor upcoming loan closings.  Theinvestment growth was the result of the acquisition of Steelton Bancorp, Inc.in April 2003.  In addition, to theinvestment portfolio remaining constant, excluding acquisitions, the portfoliohas been realigned to provide an even cash flow over the next thirty months. A majority of the portfolio was projected to experience acceleratedprepayments, which would have resulted in excess of $100 million in principalpayments to Sun during 2003.  To combat the accelerated prepayments, Sunbegan a program, during late 2002, to sell bonds with a weightedaverage life of less than one year and which are experiencing acceleratedprepayments .  The reinvestment of the proceeds of the sales has beenprimarily in CMOs that have an average life of 3-4 years in a flat rateenvironment and extension of another 3 years in an upward rate environment of200bp, which should provide a constant level of cash flow, as interest ratesmove up.  A byproduct of this strategy to spread the future cash flows hasbeen the recognition of $2,497 in gains for the six months ended June 30, 2003.The growth in the loan portfolio of $35,151 has occurred in thecommercial/industrial category and residential mortgages. The residentialmortgage growth was a result of the Steelton Bancorp acquisition in which Sunacquired $22,231 in primarily residential loans.  Bank-owned life insurance of $32,604 was added to the balancesheet during 2002 as two separate $15,000 policies.  These policies are used to offset the future increases inemployee benefit costs and has increased in value as a result of earnings.

 

Total liabilities increased $75,826 to $945,753 at June 30, 2003.  Total deposits increased $60,949 to$648,429, as core deposits (non-time deposits) increased $24,548.  The acquisition of Steelton Bancorp provided$36,497 or 59.9% of the deposit increase. Since December 31, 2002, savings and NOW accounts have increased $13,094and $7,904 respectively, while money market accounts have decreased $1,940.  Since December 31, 2002, non-interest-bearingdeposits have increased $5,490 or 9.3%. Short-term borrowings decreased $4,983 from December 31, 2002, due tofluctuations in cash management accounts.

 

Sun Bancorp, Inc.’s total shareholders’ equity decreased $210 fromDecember 31, 2002 to June 30, 2003.  Thedecrease is the result of several factors. First, Sun Bancorp, Inc.’s accumulated other comprehensive income (66%of the change in the market value of Sun Bancorp, Inc.’s investment portfolio)decreased 57.4%, or $2,053, to $1,525 from $3,578, at December 31, 2002,because of changes in the market value of Sun Bancorp, Inc.’s investmentsecurities and the gain recognized on the sale of securities.  Second, net income of $3,724 increasedshareholders’ equity, however; this increase was offset by the payment of$2,496 in dividends to shareholders during the six months ended June 30,2003.  Treasury stock increased $161, asSun Bancorp, Inc. purchased 95,250 shares of treasury stock, at an average costof $19.33 per share, over the first six months of 2003 and issued 111,045shares from treasury for the purchase of Bank Capital Services Corporation andMid-Penn Insurance Associates, Inc.

 

20

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Allowance for Loan and Lease Losses 

 

SunBank’s allowance for loan and lease losses is increased throughperiodic provisions for loan and lease losses, and that provision is reportedas an expense in current income.  Loanlosses are charged against the allowance for loan and lease losses, in theperiod in which they are determined to be uncollectible.  Recoveries of previously charged off loansare credited to the allowance, as they are received.  Management maintains the allowance for loan and lease losses at alevel it believes will be adequate to absorb probable credit losses in theexisting loan portfolio.  Managementbelieves the allowance for loan and lease losses is adequate at June 30, 2003and December 31, 2002.

 

Management’s analysis incorporates many factors, including current andanticipated economic conditions, loss experience, loan portfolio composition,anticipated losses, and unfunded commitments. For significant real estate properties, management obtains independentappraisals.  SunBank also retainsconsultants to conduct independent, periodic loan quality reviews, whichmanagement incorporates into its allowance for loan and lease losses analysis.

 

Management determines the allowance for loan and lease losses based oncriteria and analysis developed to evaluate credit risk within each loancategory.  Each loan category’s uniquerisk characteristics guide management’s analysis and determination of anadequate specific reserve for that category. For real estate loans, management considers factors that include historicalloss rates, past due levels, collateral values, and anticipated economicconditions.  For commercial andindustrial loans, management evaluates several factors including historicalloss experience, current loan grades, expected future cash flows, individualloan reviews, internal and external analysis, and anticipated economicconditions.  For individual (consumer)loans, management evaluates factors such as historical and projected lossrates, past due levels, collateral values, and anticipated economic conditions.

 

SunBank’s allowance for loan and lease losses components is based onloss rates by loan grade, economic trends, and other risk factors.  Management determines estimated loss ratesby loan grade based on current loan grade, remaining term, loan type, periodicquantification of actual losses over a period of time, and other factors.  Management believes its methodologyreasonably measures the credit risk not captured in specific allocations andprovides for an adequate aggregate allowance for loan and lease losses.

 

As management continued to closely monitor the allowance for loan andlease losses, the provision for these losses remained constant at $405 and$810, for the three and six months ended June 30, 2003 and 2002,respectively.  The stability was theresult of 6.0% loan growth, since December 31, 2002, coupled with netcharge-offs of $367, for the six months ended June 30, 2003.  These factors resulted in an allowance forloan and lease losses of 1.17% of total loans and leases at June 30, 2003, ascompared to 1.17% at June 30, 2002, and 1.05% at December 31, 2002.

 

21

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Management continues to enhance its methodology for analyzing theallowance for loan and leases losses and for assigning reserves.  However, the allowance for loan and leaselosses still only represents management’s estimate of an amount adequate toabsorb probable loan losses due to credit quality.  Management cannot precisely quantify that amount due to manyuncertainties, including future global, national, and local economic conditionsand other factors.  As a result,unforeseen developments may require management to increase the allowance forloan and lease losses.  Such developmentscould include changing economic conditions or negative developments with borrowers.  In addition, bank regulators periodicallyassess SunBank’s allowance for loan and lease losses and may, consistent withexamination guidelines and current information, require an increased allowancefor loan and lease losses.  As a result,any number of factors may materially change management’s analysis in thefuture.

 

22

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Deposits

 

Sun Bancorp, Inc.’s total deposits increased $60,949 or 10.4%, to$648,429 at June 30, 2003, compared to $587,480, at December 31, 2002.  This increase is the result of Sun’s focuson growing low cost core deposits (all deposits excluding time deposits) andbuilding relationships with local municipalities, colleges, and businesses.  In addition, $36,497 of the deposit increase,$22,579 in time deposits, is the result of the Steelton Bancorp acquisitionthat occurred in April 2003.  Theacquisition and the focus on obtaining core deposits resulted in a core depositincrease of 7.7% or $24,548, to $345,382 at June 30, 2003, compared to$320,834, at December 31, 2002.  Amajority of the deposit growth is the result of savings accounts increasing$13,094 or 17.1%, and time deposits increasing $36,401 or 13.7% since December31, 2002.  Over the same time period,demand deposit accounts increased $5,490, or 9.3%, to $64,671.

 
|             |   | **June 30,  2003** |    | **December  31, 2002** |   | **Change** |   |
|------------------|--------|--------------------|---------|------------------------|--------|------------|--------|
|             |   | **Amount**         |    | **%****Total**         |   | **Amount** |   | **%****Total** |   | **Amount** |   | **%** |   |
| Demand deposits  |   | $                  | 64,671  |                   | 10.0   | %          | $      | 59,181 |   | 10.1 | % | $ | 5,490 |   | 9.3 | % |
| NOW accounts     |   | 163,018            |    | 25.1                   | %      | 155,114    |   | 26.4 | % | 7,904 |   | 5.1 | % |
| Insured MMDA     |   | 27,887             |    | 4.3                    | %      | 29,827     |   | 5.1 | % | (1,940 | ) | -6.5 | % |
| Savings deposits |   | 89,806             |    | 13.8                   | %      | 76,712     |   | 13.1 | % | 13,094 |   | 17.1 | % |
| Time deposits    |   | 303,047            |    | 46.8                   | %      | 266,646    |   | 45.3 | % | 36,401 |   | 13.7 | % |
| Total deposits   |   | $                  | 648,429 |                   | 100.0  | %          | $      | 587,480 |   | 100.0 | % | $ | 60,949 |   | 10.4 | % |
|             |   |               |    |                   |   |       |   |   |   |   |   |   |   |
| Core deposits*   |   | $                  | 345,382 |                   | 53.3   | %          | $      | 320,834 |   | 54.6 | % | $ | 24,548 |   | 7.7 | % |

 

----

* Core deposits are defined as total deposits less time deposits

 

Other Funding

 

Sun continued using borrowed funds to supplement deposits during 2003and 2002.  At June 30, 2003, Sun had$246,911 in long term debt funding. This funding consisted primarily of $230,750 in variable Federal HomeLoan Bank (FHLB) borrowings with maturities between 2005 and 2010.  Sun also had $11,900 in long-term repurchaseagreements at June 30, 2003.

 

Sun had $18,866 in long term subordinated debentures, at June 30, 2003,that consisted of $16,500 in trust preferred securities with a maturity ofFebruary 22, 2031 and an initial call of February 22, 2011.  The remaining $2,366 was the result of anote issued for the purchase of Guaranty Bank, N.A., during 2001.

 

Other funding sources for short-term money include deposit customers’cash management accounts (classified as securities sold under agreements torepurchase), Treasury Tax and Loan Note Option, repurchase agreements, and FHLBovernight borrowings.  At June 30, 2003,Sun’s short-term borrowings consisted primarily of cash management accounts inthe amount of $24,574.

 

23

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#### **NetInterest Income and Net Interest Margin**

 

Net interest income, the difference between interest income andinterest expense, is the largest component of Sun’s earnings.  Net interest margin (NIM) measures thedifference between the interest earning assets yield and the aggregate fundingcost.  NIM is calculated as taxableequivalent net interest income divided by average interest earning assets.

 

NIM decreased by 58 basis points to 2.77% for the three months endedJune 30, 2003, compared to 3.35%, for the same period of 2002.  The decrease was primarily the result ofdecreased yield on the loan and investment portfolios.  The decreased yield of 223 basis points ontaxable investments is the result of accelerated prepayments, coupled with lowreinvestment rates.  NIM has stabilizedfrom 2.86% for the fourth quarter of 2002. The stabilization of the NIM is the result of Sun lowering deposit ratesat approximately the same rate of decline seen in the yield on earning assets.

 

For the six months ended June 30, 2003, the NIM decreased by 40 basispoints to 2.78%, compared to 3.18% for the six months ended June 30, 2002.  The decrease was primarily the result ofdecreased yield on the loan and investment portfolios, which decreased greater thanthe cost of funds.  The decreased yieldof 162 basis points on taxable investments is the result of acceleratedprepayments coupled with low reinvestment rates. In addition, many of thehigher coupon bonds showing accelerated prepayments with a remaining averagelife of less than one year were sold and the proceeds reinvested in a manner tospread the cash flow over the next thirty months.

 

To alleviate the compression in the NIM and constrain the volatility innet interest income in an up or down interest rate environment, on June 30,2003, the Bank entered into $100 million in derivative contracts.  The contracts involve the high rate FederalHome Loan Bank advances (other borrowings) and will increase net interestincome by approximately $120 per month at current interest rates.

 

24

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The followingtable sets forth comparative yields and rates paid for interest bearing assetsand liabilities:

 
|                                                               |   | **For the  Three Months Ended** |          |
|--------------------------------------------------------------------|--------|---------------------------------|---------------|
|                                                               |   | **June 30,  2003**              |          | **June 30, 2002** |   |
| **(In Thousands)**                                                 |   | **Average  Balance**            |          | **Interest** |   | **Rate** |   | **Average  Balance** |   | **Interest** |   | **Rate** |   |
| **ASSETS**                                                         |   |                            |          |   |   |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                                          |   |                            |          |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits                                         |   | **$**                           | **11,529**    | ** ** | **$** | **39** | ** ** | **1.36** | **%** | $ | 12,613 |   | $ | 71 |   | 2.26 | % |
| Loans  (net of unearned income)                                    |   | **616,914**                     | ** **    | **10,463** | ** ** | **6.80** | **%** | 566,017 |   | 10,338 |   | 7.33 | % |
| Investments:                                                       |   |                            |          |   |   |   | ** ** |   |   |   |   |   |   |
| Taxable                                                            |   | **243,753**                     | ** **    | **2,346** | ** ** | **3.85** | **%** | 237,445 |   | 3,611 |   | 6.08 | % |
| Tax-exempt                                                         |   | **19,597**                      | ** **    | **324** | ** ** | **6.62** | **%** | 21,088 |   | 391 |   | 7.41 | % |
| **Total interest-earning assets**                                  |   | **891,792**                     | ** **    | **13,172** | ** ** | **5.92** | **%** | 837,163 |   | 14,411 |   | 6.90 | % |
|                                                               |   |                            |          |   |   |   |   |   |   |   |   |   |   |
| **Noninterest-earning assets:**                                    |   |                            |          |   |   |   |   |   |   |   |   |   |   |
|                                                               |   |                            |          |   |   |   |   |   |   |   |   |   |   |
| Cash  and due from banks                                           |   | **22,245**                      |          |   |   |   |   | 19,188 |   |   |   |   |   |
| Bank  premises & equipment                                     |   | **18,723**                      |          |   |   |   |   | 14,416 |   |   |   |   |   |
| Accrued  interest and other assets                                 |   | **102,603**                     |          |   |   |   |   | 61,799 |   |   |   |   |   |
| Less:  Allowance for loan losses                                   |   | **(7,101**                      | **)**         |   |   |   |   | (6,674 | ) |   |   |   |   |
| Unamortized  loan fees                                             |   | **218**                         |          |   |   |   |   | 195 |   |   |   |   |   |
|                                                               |   |                            |          |   |   |   |   |   |   |   |   |   |   |
| Total  assets                                                      |   | **$**                           | **1,028,479** |   |   |   |   |   | $ | 926,087 |   |   |   |   |   |
|                                                               |   |                            |          |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                      |   |                            |          |   |   |   |   |   |   |   |   |   |   |
|                                                               |   |                            |          |   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing liabilities:**                                  |   |                            |          |   |   |   |   |   |   |   |   |   |   |
|                                                               |   |                            |          |   |   |   |   |   |   |   |   |   |   |
| NOW  Accounts                                                      |   | **$**                           | **165,746**   | ** ** | **$** | **350** | ** ** | **0.85** | **%** | $ | 154,134 |   | $ | 513 |   | 1.33 | % |
| Insured  Money Market Accounts                                     |   | **28,369**                      | ** **    | **98** | ** ** | **1.39** | **%** | 22,079 |   | 102 |   | 1.85 | % |
| Savings  deposits                                                  |   | **87,172**                      | ** **    | **201** | ** ** | **0.92** | **%** | 78,111 |   | 304 |   | 1.56 | % |
| Time  deposits                                                     |   | **291,711**                     | ** **    | **2,422** | ** ** | **3.33** | **%** | 270,312 |   | 2,765 |   | 4.10 | % |
| Short-term  borrowings                                             |   | **48,081**                      | ** **    | **140** | ** ** | **1.17** | **%** | 20,324 |   | 71 |   | 1.40 | % |
| Subordinated  debentures                                           |   | **19,646**                      | ** **    | **465** | ** ** | **9.47** | **%** | 20,247 |   | 476 |   | 9.40 | % |
| Other  borrowed funds                                              |   | **243,318**                     | ** **    | **3,346** | ** ** | **5.52** | **%** | 221,429 |   | 3,180 |   | 5.76 | % |
| **Total interest-bearing liabilities**                             |   | **884,042**                     | ** **    | **7,022** | ** ** | **3.19** | **%** | 786,636 |   | 7,411 |   | 3.78 | % |
|                                                               |   |                            |          |   |   |   |   |   |   |   |   |   |   |
| **Noninterest-bearing liabilities and shareholders’ equity:** |   |                            |          |   |   |   |   |   |   |   |   |   |   |
|                                                               |   |                            |          |   |   |   |   |   |   |   |   |   |   |
| Demand  deposits                                                   |   | **60,180**                      |          |   |   |   |   | 57,962 |   |   |   |   |   |
| Accrued  interest and other liabilities                            |   | **2,798**                       |          |   |   |   |   | 1,703 |   |   |   |   |   |
| Shareholders’  equity                                         |   | **81,459**                      |          |   |   |   |   | 79,786 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity                   |   | **$**                           | **1,028,479** |   |   |   |   |   | $ | 926,087 |   |   |   |   |   |
| Interest  rate spread                                              |   |                            |          |   |   | **2.73** | **%** |   |   |   |   | 3.12 | % |
| Net  interest income/margin                                        |   |                            |          | **$** | **6,150** | ** ** | **2.77** | **%** |   |   | $ | 7,000 |   | 3.35 | % |

 

----

* Average loan balances include non-accrual loans and interest incomeincludes fees on loans

 

 

25

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* Yields on tax-exempt loans and investments have been adjusted to afully taxable equivalent basis using a 34% federal income tax rate

 

26

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The followingtable sets forth comparative yields and rates paid for interest bearing assetsand liabilities:

 
|                                                               |   | **For the  Six Months Ended** |        |
|--------------------------------------------------------------------|--------|-------------------------------|-------------|
|                                                               |   | **June 30,  2003**            |        | **June 30,  2002** |   |
| **(In Thousands)**                                                 |   | **Average  Balance**          |        | **Interest** |   | **Rate** |   | **Average****Balance** |   | **Interest** |   | **Rate** |   |
| **ASSETS**                                                         |   |                          | ** **  |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Interest-earning  assets:                                          |   |                          | ** **  |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Interest-bearing  deposits                                         |   | **$**                         | **14,486**  | ** ** | **$** | **91** | ** ** | **1.27** | **%** | $ | 14,514 |   | $ | 175 |   | 2.43 | % |
| Loans  (net of unearned income)                                    |   | **600,639**                   | ** **  | **20,285** | ** ** | **6.81** | **%** | 552,003 |   | 20,165 |   | 7.37 | % |
| Investments:                                                       |   |                          | ** **  |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Taxable                                                            |   | **231,458**                   | ** **  | **4,756** | ** ** | **4.11** | **%** | 254,789 |   | 7,294 |   | 5.73 | % |
| Tax-exempt                                                         |   | **19,452**                    | ** **  | **675** | ** ** | **6.94** | **%** | 21,194 |   | 785 |   | 7.41 | % |
| **Total interest-earning assets**                                  |   | **866,036**                   | ** **  | **25,807** | ** ** | **6.00** | **%** | 842,500 |   | 28,419 |   | 6.79 | % |
|                                                               |   |                          | ** **  |   | ** ** |   | ** ** |   |   |   |   |   |   |
| **Noninterest-earning assets:**                                    |   |                          | ** **  |   | ** ** |   | ** ** |   |   |   |   |   |   |
|                                                               |   |                          |        |   |   |   |   |   |   |   |   |   |   |
| Cash  and due from banks                                           |   | **20,761**                    | ** **  |   |   |   | ** ** | 19,869 |   |   |   |   |   |
| Bank  premises & equipment                                     |   | **17,442**                    | ** **  |   |   |   | ** ** | 14,432 |   |   |   |   |   |
| Accrued  interest and other assets                                 |   | **97,108**                    | ** **  |   |   |   | ** ** | 53,327 |   |   |   |   |   |
| Less:  Allowance for loan losses                                   |   | **(6,737**                    | **)**       |   |   |   | ** ** | (6,563 | ) |   |   |   |   |
| Unamortized  loan fees                                             |   | **212**                       | ** **  |   |   |   | ** ** | 58 |   |   |   |   |   |
|                                                               |   |                          | ** **  |   |   |   | ** ** |   |   |   |   |   |   |
| Total  assets                                                      |   | **$**                         | **994,821** | ** ** |   |   |   | ** ** | $ | 923,623 |   |   |   |   |   |
|                                                               |   |                          | ** **  |   | ** ** |   | ** ** |   |   |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                      |   |                          | ** **  |   | ** ** |   | ** ** |   |   |   |   |   |   |
|                                                               |   |                          |        |   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing liabilities:**                                  |   |                          | ** **  |   | ** ** |   | ** ** |   |   |   |   |   |   |
|                                                               |   |                          |        |   |   |   |   |   |   |   |   |   |   |
| NOW  Accounts                                                      |   | **$**                         | **161,147** | ** ** | **$** | **728** | ** ** | **0.91** | **%** | $ | 149,588 |   | $ | 1,009 |   | 1.36 | % |
| Insured  Money Market Accounts                                     |   | **27,072**                    | ** **  | **197** | ** ** | **1.47** | **%** | 21,197 |   | 201 |   | 1.91 | % |
| Savings  deposits                                                  |   | **83,069**                    | ** **  | **393** | ** ** | **0.95** | **%** | 75,583 |   | 633 |   | 1.69 | % |
| Time  deposits                                                     |   | **283,881**                   | ** **  | **4,880** | ** ** | **3.47** | **%** | 275,356 |   | 5,841 |   | 4.28 | % |
| Short-term  borrowings                                             |   | **40,704**                    | ** **  | **247** | ** ** | **1.22** | **%** | 20,815 |   | 143 |   | 1.39 | % |
| Subordinated  debentures                                           |   | **19,651**                    | ** **  | **933** | ** ** | **9.50** | **%** | 20,345 |   | 956 |   | 9.40 | % |
| Other  borrowed funds                                              |   | **233,564**                   | ** **  | **6,484** | ** ** | **5.60** | **%** | 221,713 |   | 6,333 |   | 5.76 | % |
| **Total interest-bearing liabilities**                             |   | **849,087**                   | ** **  | **13,862** | ** ** | **3.29** | **%** | 784,597 |   | 15,116 |   | 3.89 | % |
|                                                               |   |                          | ** **  |   | ** ** |   | ** ** |   |   |   |   |   |   |
| **Noninterest-bearing liabilities and shareholders’ equity:** |   |                          | ** **  |   | ** ** |   | ** ** |   |   |   |   |   |   |
|                                                               |   |                          |        |   |   |   |   |   |   |   |   |   |   |
| Demand  deposits                                                   |   | **58,203**                    | ** **  |   | ** ** |   | ** ** | 56,863 |   |   |   |   |   |
| Accrued  interest and other liabilities                            |   | **5,603**                     | ** **  |   | ** ** |   | ** ** | 3,264 |   |   |   |   |   |
| Shareholders’  equity                                         |   | **81,928**                    | ** **  |   | ** ** |   | ** ** | 78,899 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity                   |   | **$**                         | **994,821** | ** ** |   | ** ** |   | ** ** | $ | 923,623 |   |   |   |   |   |
| Interest  rate spread                                              |   |                          |        |   |   | **2.71** | **%** |   |   |   |   | 2.90 | % |
| Net  interest income/margin                                        |   |                          |        | **$** | **11,945** | ** ** | **2.78** | **%** |   |   | $ | 13,303 |   | 3.18 | % |

 

----

* Average loan balances include non-accrual loans and interest incomeincludes fees on loans

* Yields on tax-exempt loans and investments have been adjusted to afully taxable equivalent basisusing a 34% federal income tax rate.

 

27

----

 

Non-interestIncome

 

Non-interestincome, excluding security gains, increased $937 or 61.2% to $2,468, for thethree months ended June 30, 2003 compared to 2002.  Increased service charges on deposits accounted for $275 of theincrease.  The increase in servicecharges was primarily the result of a program implemented during 2002 involvingoverdraft protection.  The addition ofbank owned life insurance during 2002 represented $156 of the increase.  The bank owned life insurance was purchasedto supplement future increases in employee benefit plans.  Income from SunBank’s leasing subsidiary,Bank Capital Services Corporation, purchased in January 2003, generated $262 inadditional fees. In addition, income from insurance fees increased $321, as theresult of the acquisition of Mid-Penn Insurance, in April 2003.  The acquisition of Steelton Bancorp, inApril 2003, also increased non-interest income for the three months ended June2003, as compared to 2002.  Offsettingthe increases in other income was a decrease in income from investment productsales of $77, when comparing the three months ended June 30, 2003 to 2002, asdollars have flowed out of the stock/bond markets and into banks.

 

Non-interestincome, excluding security gains, increased $2,306 or 90.2% to $4,862 for thesix months ended June 30, 2003 compared to 2002.  The increases were driven by initiatives undertaken in 2002 andacquisitions in 2003, as noted in the above three-month discussion.

 
|                                 |   | **June 30,  2003** |   | **June 30,  2002** |   | **Change** |   |
|--------------------------------------|--------|--------------------|--------|--------------------|--------|------------|--------|
| **Three Months Ended**               |   | **Amount**         |   | **%****Total**     |   | **Amount** |   | **%****Total** |   | **Amount** |   | **%** |   |
| Service charges on deposit accounts  |   | $                  | 983    |               | 28.3   | %          | $      | 708 |   | 44.9 | % | $ | 275 |   | 38.8 | % |
| Trust income                         |   | 203                |   | 5.9                | %      | 187        |   | 11.9 | % | 16 |   | 8.6 | % |
| Net security gains                   |   | 1,001              |   | 28.9               | %      | 45         |   | 2.9 | % | 956 |   | 2124.4 | % |
| Income from investment product sales |   | 78                 |   | 2.2                | %      | 155        |   | 9.8 | % | (77 | ) | -49.7 | % |
| Bank owned life insurance            |   | 317                |   | 9.1                | %      | 161        |   | 10.2 | % | 156 |   | 96.9 | % |
| Income from insurance subsidiary     |   | 340                |   | 9.8                | %      | 19         |   | 1.2 | % | 321 |   | 1689.5 | % |
| Gain on sale of loans                |   | 43                 |   | 1.2                | %      | 45         |   | 2.9 | % | (2 | ) | -4.4 | % |
| Income from leasing subsidiary       |   | 262                |   | 7.6                | %      | —     |   | 0.0 | % | 262 |   | N/A |   |
| Other income                         |   | 242                |   | 7.0                | %      | 256        |   | 16.2 | % | (14 | ) | -5.5 | % |
| Total non-interest income            |   | $                  | 3,469  |               | 100.0  | %          | 1,576  |   | 100.0 | % | 1,893 |   | 120.1 | % |
|                                 |   |               |   |               |   |       |   |   |   |   |   |   |   |
|                                 |   | **June 30,  2003** |   | **June 30,  2002** |   | **Change** |   |
| **Six Months Ended**                 |   | **Amount**         |   | **%****Total**     |   | **Amount** |   | **%****Total** |   | **Amount** |   | **%** |   |
| Service charges on deposit accounts  |   | $                  | 1,828  |               | 24.8   | %          | $      | 1,228 |   | 45.7 | % | $ | 600 |   | 48.9 | % |
| Trust income                         |   | 422                |   | 5.7                | %      | 341        |   | 12.6 | % | 81 |   | 23.8 | % |
| Net security gains                   |   | 2,497              |   | 34.0               | %      | 140        |   | 5.2 | % | 2,357 |   | 1683.6 | % |
| Income from investment product sales |   | 102                |   | 1.4                | %      | 260        |   | 9.6 | % | (158 | ) | -60.8 | % |
| Bank owned life insurance            |   | 642                |   | 8.7                | %      | 206        |   | 7.6 | % | 436 |   | 211.7 | % |
| Income from insurance subsidiary     |   | 363                |   | 4.9                | %      | 49         |   | 1.8 | % | 314 |   | 640.8 | % |
| Gain on sale of loans                |   | 304                |   | 4.1                | %      | 73         |   | 2.7 | % | 231 |   | 316.4 | % |
| Income from leasing subsidiary       |   | 563                |   | 7.7                | %      | —     |   | 0.0 | % | 563 |   | N/A |   |
| Other income                         |   | 638                |   | 8.7                | %      | 399        |   | 14.8 | % | 239 |   | 59.9 | % |
| Total non-interest income            |   | $                  | 7,359  |               | 100.0  | %          | $      | 2,696 |   | 100.0 | % | $ | 4,663 |   | 173.0 | % |

 

28

----

 

Non-interestExpenses

 

Non-interestexpenses increased $1,635 or 30.1% to $7,063, for the three months ended June30, 2003 compared to 2002.  Theacquisitions of Bank Capital Services Corporation (Bank Capital), Mid-PennInsurance Associates, Inc (MPI), and Steelton Bancorp have impacted allcategories of other expenses during 2003. In the aggregate, Bank Capital and MPI represented $527 or 32.2% of thetotal increase.  The outsourcing ofoperational processing increased expenses $330 or 20.2% of the totalincrease.  Salaries and employeebenefits increased $586 or 20.7%, due to the acquisitions and increasedemployee benefit costs.  Net occupancyexpense and furniture and equipment expenses increased $166 or 24.8% due to theacquisitions and infrastructure improvements. Other expenses increased 43.8% or $845 due to increases in normalbusiness expenses, acquisitions, and the outsourcing of operational processingand certain other support functions.

 

Non-interestexpenses increased $3,298 or 31.9% to $13,626 for the six months ended June 30,2003 as compared to 2002.  The increaseswere driven by initiatives undertaken in 2002 and acquisitions in 2003, asnoted in the above three-month discussion.

 
|                             |   | **June 30,  2003** |   | **June 30,  2002** |   | **Change** |   |
|----------------------------------|--------|--------------------|--------|--------------------|--------|------------|--------|
| **Three Months Ended**           |   | **Amount**         |   | **%****Total**     |   | **Amount** |   | **%****Total** |   | **Amount** |   | **%** |   |
| Salaries and employee benefits   |   | $                  | 3,415  |               | 48.4   | %          | $      | 2,829 |   | 52.1 | % | $ | 586 |   | 20.7 | % |
| Net occupancy expenses           |   | 332                |   | 4.7                | %      | 251        |   | 4.6 | % | 81 |   | 32.3 | % |
| Furniture and equipment expenses |   | 503                |   | 7.1                | %      | 418        |   | 7.7 | % | 85 |   | 20.3 | % |
| Expenses of insurance subsidiary |   | 38                 |   | 0.5                | %      | —     |   | 0.0 | % | 38 |   | N/A |   |
| Other expenses                   |   | 2,775              |   | 39.3               | %      | 1,930      |   | 35.6 | % | 845 |   | 43.8 | % |
| Total non-interest expense       |   | $                  | 7,063  |               | 100.0  | %          | $      | 5,428 |   | 100.0 | % | $ | 1,635 |   | 30.1 | % |
|                             |   |               |   |               |   |       |   |   |   |   |   |   |   |
|                             |   | **June 30,  2003** |   | **June 30,  2002** |   | **Change** |   |
| **Six Months Ended**             |   | **Amount**         |   | **%****Total**     |   | **Amount** |   | **%****Total** |   | **Amount** |   | **%** |   |
| Salaries and employee benefits   |   | $                  | 6,581  |               | 48.3   | %          | $      | 5,633 |   | 54.5 | % | $ | 948 |   | 16.8 | % |
| Net occupancy expenses           |   | 715                |   | 5.2                | %      | 525        |   | 5.1 | % | 190 |   | 36.2 | % |
| Furniture and equipment expenses |   | 990                |   | 7.3                | %      | 815        |   | 7.9 | % | 175 |   | 21.5 | % |
| Expenses of insurance subsidiary |   | 38                 |   | 0.3                | %      | —     |   | 0.0 | % | 38 |   | N/A |   |
| Other expenses                   |   | 5,302              |   | 38.9               | %      | 3,355      |   | 32.5 | % | 1,947 |   | 58.0 | % |
| Total non-interest expense       |   | $                  | 13,626 |               | 100.0  | %          | $      | 10,328 |   | 100.0 | % | $ | 3,298 |   | 31.9 | % |

 

29

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EquitySecurities Risk

 

Sun Bancorp,Inc.’s equity securities consist of marketable equities and restrictedstock.  Marketable equities consistentirely of common stock, primarily of bank and bank and financial holdingcompanies.  Restricted stock consistsalmost entirely of Federal Home Loan Bank (FHLB) stock.  Because FHLB stock is redeemable at par,SunBank carries it at cost and periodically evaluates the stock forimpairment.  Possible impairment factorsinclude potential dramatic changes to the housing and residential mortgage industryor the related regulatory environment. Management currently does not believe any factors exist to suggestpotential impairment.

 

Bank andfinancial holding company stocks are subject to general industry risks,including competition from non-bank entities, credit risk, interest rate risk,and other factors.  Individual stockscould suffer price decreases due to circumstances at specific banks.  In addition, Sun Bancorp, Inc.’s bank stockinvestments are concentrated in Pennsylvania entities, so these investmentscould decline in value if there were a downturn in the state’s economy.  Other marketable stocks are comprised ofnon-bank, exchange-traded stocks that are subject to typical equity risks.

 
|                                            |   | **June 30,  2003**     |   |
|-------------------------------------------------|--------|------------------------|--------|
|                                            |   | **Book  Cost**         |   | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair  Value** |   |
| Banks and bank and financial holding  companies |   | $                      | 3,886  |   | $ | 279 |   | $ | (97 | ) | $ | 4,068 |   |
| FHLB stock                                      |   | 13,618                 |   | — |   | — |   | 13,618 |   |
| Non-bank companies                              |   | 87                     |   |   |   | (16 | ) | 71 |   |
| Total                                           |   | $                      | 17,591 |   | $ | 279 |   | $ | (113 | ) | $ | 17,757 |   |
|                                            |   |                   |   |   |   |   |   |   |   |
|                                            |   | **December  31, 2002** |   |
|                                            |   | **Book  Cost**         |   | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair  Value** |   |
|                                            |   |                   |   |   |   |   |   |   |   |
| Banks and bank and financial holding  companies |   | $                      | 3,024  |   | $ | 136 |   | $ | (293 | ) | $ | 2,867 |   |
| FHLB stock                                      |   | 12,012                 |   | — |   | — |   | 12,012 |   |
| Non-bank companies                              |   | 87                     |   |   |   | (22 | ) | 65 |   |
| Total                                           |   | $                      | 15,123 |   | $ | 136 |   | $ | (315 | ) | $ | 14,944 |   |

 

30

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CapitalAdequacy

 

Sun Bancorp,Inc. and SunBank are subject to various regulatory capital requirementsadministered by the federal banking agencies. Failure to meet minimum capital requirements could prompt regulatoryaction that, if undertaken, might materially affect Sun Bancorp, Inc.’sfinancial statements.  Under regulatorycapital adequacy guidelines, Sun Bancorp, Inc. and SunBank must meet specificcapital requirements involving quantitative measures of assets, liabilities,and certain off-balance sheet items (calculated using regulatory accountingpractices).  All related factors aresubject to qualitative judgments by the regulators.

 

Sun Bancorp,Inc. is currently, and has been in the past, designated a well-capitalizedinstitution.  Shareholders’ equitydecreased $210 to $81,037, at June 30, 2003, from $81,247, at December 31,2002.  Unrealized gains or losses, netof taxes on investment securities, are reported as accumulated othercomprehensive income within shareholders’ equity are the cause of this decreaseas accumulated other comprehensive income declined $2,053 to $1,525 from $3,578at December 31, 2002.

 

Management isnot aware of any events or regulatory restrictions that would have a materialeffect on Sun Bancorp, Inc.’s capital adequacy.

 

Sun Bancorp,Inc.’s strong capital position is evidenced by the following capital ratios,which are above the regulatory minimum levels.

 
|                       |   |       |       |      |       | **For  Capital  Adequacy Purposes  Ratio** |       |
|----------------------------|--------|------------|------------|-----------|------------|--------------------------------------------|------------|
|                       |   | **Actual** |       |      |
| **(Dollars in thousands)** |   | **Amount** |       | **Ratio** |       |                                       |
| As of June  30, 2003:      |   |       | ** ** |      | ** ** |                                       | ** ** |
| Total Capital              |   |       |       |      |       |                                       |       |
| Sun                        |   | $          | 73,188     |      | 10.4       | %                                          | 8.0        | % |
| Bank                       |   | $          | 69,250     |      | 9.9        | %                                          | 8.0        | % |
| Tier I Capital             |   |       |       |      |       |                                       |       |
| Sun                        |   | $          | 63,406     |      | 9.0        | %                                          | 4.0        | % |
| Bank                       |   | $          | 61,886     |      | 8.9        | %                                          | 4.0        | % |
| Leverage Ratio             |   |       |       |      |       |                                       |       |
| Sun                        |   | $          | 63,406     |      | 6.4        | %                                          | 4.0        | % |
| Bank                       |   | $          | 61,886     |      | 6.2        | %                                          | 4.0        | % |
|                       |   |       |       |      |       |                                       |       |
| As of December 31, 2002:   |   |       |       |      |       |                                       |       |
| Total Capital              |   |       |       |      |       |                                       |       |
| Sun                        |   | $          | 80,484     |      | 12.6       | %                                          | 8.0        | % |
| Bank                       |   | $          | 77,175     |      | 12.1       | %                                          | 8.0        | % |
| Tier I Capital             |   |       |       |      |       |                                       |       |
| Sun                        |   | $          | 71,123     |      | 11.1       | %                                          | 4.0        | % |
| Bank                       |   | $          | 70,969     |      | 11.1       | %                                          | 4.0        | % |
| Leverage Ratio             |   |       |       |      |       |                                       |       |
| Sun                        |   | $          | 71,123     |      | 7.8        | %                                          | 4.0        | % |
| Bank                       |   | $          | 70,969     |      | 7.9        | %                                          | 4.0        | % |

 

31

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Regulatory and Industry Merger Activity

 

From time totime, various types of federal and state legislation have been proposed thatcould result in additional regulation of, and restrictions on, the business ofSun Bancorp, Inc. and SunBank.  Itcannot be predicted whether such legislation will be adopted or, if adopted,how such legislation would affect the business of Sun Bancorp, Inc. andSunBank.  As a consequence of theextensive regulation of commercial banking activities in the United States, SunBancorp, Inc.’s and SunBank’s business is particularly susceptible to beingaffected by federal legislation and regulations that may increase the costs ofdoing business.  Except as specificallydescribed above, management believes the effect of the provisions of legislationon the liquidity, capital resources, and results of operations of Sun Bancorp,Inc. will be immaterial. Future recommendations by regulatory authorities orproposed legislation, which if they were implemented, would have a materialadverse effect upon the liquidity, capital resources, or results of operations,although the general cost of compliance with numerous and multiple federal andstate laws and regulations does have, and in the future may have, a negativeimpact on Sun Bancorp, Inc.’s results of operations.

 

Further, thebusiness of Sun Bancorp, Inc. is also affected by the state of the financialservices industry in general.  As aresult of legal and industry changes, management predicts the industry willcontinue to experience an increase in consolidations and mergers as the financialservices industry strives for greater cost efficiencies and market share.  Management also expects increaseddiversification of financial products and services offered by SunBank and itscompetitors.  Management believes suchconsolidations and mergers, and diversification of products and services mayenhance its competitive position as a community bank.

 

32

----

 

The following tables set forthSelected Financial Data for each of the past five quarters:

 
|                                                |   | **Quarter  Ended (A)** |      |
|-----------------------------------------------------|--------|------------------------|-----------|
| **(Dollars in  Thousands, Except Per Share Data)**  |   | **6/30/2003**          |      | **3/31/2003** |   | **12/31/2002** |   | **9/30/2002** |   | **6/30/2002** |   |
|                                                |   |                   |      |   |   |   |   |   |   |   |   |
| **Financial  Condition Data:**                      |   |                   |      |   |   |   |   |   |   |   |   |
| **General**                                         |   |                   |      |   |   |   |   |   |   |   |   |
| Total assets                                        |   | $                      | 1,026,790 |   | $ | 1,004,753 |   | $ | 951,174 |   | $ | 949,563 |   | $ | 924,091 |   |
| Loans, net                                          |   | 618,670                |      | 589,009 |   | 583,519 |   | 579,233 |   | 575,616 |   |
| Goodwill                                            |   | 32,604                 |      | 23,345 |   | 22,924 |   | 22,924 |   | 22,924 |   |
| Total deposits                                      |   | 648,429                |      | 598,067 |   | 587,480 |   | 601,843 |   | 571,371 |   |
| Non interest bearing                                |   | 64,671                 |      | 57,649 |   | 59,181 |   | 60,402 |   | 58,981 |   |
|                                                |   |                   |      |   |   |   |   |   |   |   |   |
| Savings                                             |   | 89,806                 |      | 81,321 |   | 76,712 |   | 79,588 |   | 79,375 |   |
| NOW                                                 |   | 163,018                |      | 156,649 |   | 155,114 |   | 157,806 |   | 143,144 |   |
| Money Market                                        |   | 27,887                 |      | 27,548 |   | 29,827 |   | 22,094 |   | 23,056 |   |
| Time Deposits                                       |   | 303,047                |      | 274,900 |   | 266,646 |   | 281,953 |   | 266,815 |   |
| Total interest bearing  deposits                    |   | 583,758                |      | 540,418 |   | 528,299 |   | 541,441 |   | 512,390 |   |
|                                                |   |                   |      |   |   |   |   |   |   |   |   |
| Core deposits*                                      |   | 345,382                |      | 323,167 |   | 320,834 |   | 319,890 |   | 304,556 |   |
| Trust preferred securities  & subordinated debt |   | 18,866                 |      | 19,655 |   | 19,655 |   | 19,655 |   | 19,655 |   |
| Shareholders’ equity                           |   | 81,037                 |      | 80,035 |   | 81,247 |   | 81,868 |   | 80,408 |   |
| Trust assets under  management                      |   | 140,119                |      | 144,014 |   | 151,173 |   | 152,434 |   | 147,682 |   |
|                                                |   |                   |      |   |   |   |   |   |   |   |   |
| **Asset  Quality**                                  |   |                   |      |   |   |   |   |   |   |   |   |
|                                                |   |                   |      |   |   |   |   |   |   |   |   |
| Non-performing assets                               |   | $                      | 4,592     |   | $ | 4,714 |   | $ | 4,115 |   | $ | 4,852 |   | $ | 4,461 |   |
| Non-performing assets to  total assets              |   | 0.45                   | %         | 0.47 | % | 0.43 | % | 0.51 | % | 0.48 | % |
| Allowance for loan losses                           |   | 7,342                  |      | 6,478 |   | 6,206 |   | 7,178 |   | 6,790 |   |
| Allowance for loan losses  to total loans           |   | 1.17                   | %         | 1.09 | % | 1.05 | % | 1.22 | % | 1.17 | % |
| Allowance for loan losses  to non-performing loans  |   | 204.57                 | %         | 167.04 | % | 183.56 | % | 170.70 | % | 184.81 | % |
| Non-performing loans to  total loans                |   | 0.57                   | %         | 0.65 | % | 0.57 | % | 0.72 | % | 0.63 | % |
|                                                |   |                   |      |   |   |   |   |   |   |   |   |
| **Capitalization  - Bancorp**                       |   |                   |      |   |   |   |   |   |   |   |   |
|                                                |   |                   |      |   |   |   |   |   |   |   |   |
| Shareholders’ equity to  total assets          |   | 7.89                   | %         | 7.97 | % | 8.54 | % | 8.62 | % | 8.70 | % |

 

----

* Core deposits are defined as total deposits less time deposits

(A) 2002 quarters have been adjusted for SFAS No. 147 impact.

 

33

----

 
|                                               |   | **Quarter  Ended (A)** |   |
|----------------------------------------------------|--------|------------------------|--------|
| **(Dollars in  Thousands, Except Per Share Data)** |   | **6/30/2003**          |   | **3/31/2003** |   | **12/31/2002** |   | **9/30/2002** |   | **6/30/2002** |   |
|                                               |   |                   |   |   |   |   |   |   |   |   |   |
| **Operating  Data**                                |   |                   |   |   |   |   |   |   |   |   |   |
|                                               |   |                   |   |   |   |   |   |   |   |   |   |
| Net income                                         |   | $                      | 1,690  |   | $ | 2,034 |   | $ | 1,228 |   | $ | 1,695 |   | $ | 1,941 |   |
| Net interest income                                |   | 5,924                  |   | 5,548 |   | 5,750 |   | 6,376 |   | 6,733 |   |
| Provision for loan losses                          |   | 405                    |   | 405 |   | 200 |   | 450 |   | 405 |   |
| Non-interest income                                |   | 3,469                  |   | 3,890 |   | 2,342 |   | 1,630 |   | 1,576 |   |
| Non-interest expense                               |   | 7,063                  |   | 6,563 |   | 6,643 |   | 5,651 |   | 5,428 |   |
|                                               |   |                   |   |   |   |   |   |   |   |   |   |
| **Performance  Statistics**                        |   |                   |   |   |   |   |   |   |   |   |   |
|                                               |   |                   |   |   |   |   |   |   |   |   |   |
| Net interest margin                                |   | 2.77                   | %      | 2.85 | % | 2.86 | % | 3.12 | % | 3.35 | % |
| Return on average assets                           |   | 0.66                   | %      | 0.84 | % | 0.51 | % | 0.73 | % | 0.85 | % |
| Return on average equity                           |   | 8.30                   | %      | 9.87 | % | 6.04 | % | 8.34 | % | 9.74 | % |
| Annualized net loan  charge-offs to avg loans      |   | 0.15                   | %      | 0.09 | % | 0.87 | % | 0.04 | % | 0.11 | % |
| Net charge-offs                                    |   | 234                    |   | 133 |   | 1,266 |   | 62 |   | 152 |   |
| Efficiency ratio                                   |   | 83.7                   |   | 82.6 |   | 87.2 |   | 70.6 |   | 65.7 |   |
| Net income per employee                            |   | 6                      |   | 7 |   | 4 |   | 6 |   | 7 |   |
|                                               |   |                   |   |   |   |   |   |   |   |   |   |
| **Per Share  Data**                                |   |                   |   |   |   |   |   |   |   |   |   |
|                                               |   |                   |   |   |   |   |   |   |   |   |   |
| Basic earnings per share                           |   | $                      | 0.23   |   | $ | 0.28 |   | $ | 0.17 |   | $ | 0.24 |   | $ | 0.27 |   |
| Diluted earnings per share                         |   | 0.23                   |   | 0.28 |   | 0.17 |   | 0.23 |   | 0.27 |   |
| Dividend declared per share                        |   | 0.1815                 |   | 0.1650 |   | 0.1650 |   | 0.1650 |   | 0.1650 |   |
| Book value                                         |   | 11.24                  |   | 11.17 |   | 11.33 |   | 11.43 |   | 11.24 |   |
| Common stock price:                                |   |                   |   |   |   |   |   |   |   |   |   |
| High                                               |   | 22.48                  |   | 20.50 |   | 23.20 |   | 23.98 |   | 24.49 |   |
| Low                                                |   | 19.60                  |   | 18.01 |   | 17.84 |   | 21.85 |   | 17.65 |   |
| Close                                              |   | 20.13                  |   | 19.51 |   | 18.26 |   | 22.48 |   | 24.49 |   |
| Weighted average common  shares:                   |   |                   |   |   |   |   |   |   |   |   |   |
| Basic                                              |   | 7,211                  |   | 7,182 |   | 7,168 |   | 7,165 |   | 7,141 |   |
| Fully Diluted                                      |   | 7,242                  |   | 7,201 |   | 7,238 |   | 7,248 |   | 7,164 |   |
| End-of-period common  shares:                      |   |                   |   |   |   |   |   |   |   |   |   |
| Issued                                             |   | 7,319                  |   | 7,317 |   | 7,299 |   | 7,276 |   | 7,266 |   |
| Treasury                                           |   | 111                    |   | 149 |   | 127 |   | 111 |   | 111 |   |

 

----

(A) 2002 quarters have beenadjusted for SFAS No. 147 impact.

 

34

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Item 4 —Controls and Procedures

 

Managementmaintains a system of controls and procedures designed to provide reasonableassurance as to the reliability of the financial statements and otherdisclosures included in this report, as well as to safeguard assets fromunauthorized use or disposition. Management evaluated the effectiveness of thedesign and operation of management’s disclosure controls and procedures underthe supervision and with the participation of management, including our ChiefExecutive Officer and Chief Financial Officer, within 90 days prior to thefiling date of this report. Based upon that evaluation, Sun Bancorp, Inc.’sChief Executive Officer and Chief Financial Officer concluded that management’sdisclosure controls and procedures are effective in timely alerting them tomaterial information required to be included in Sun Bancorp, Inc.’s periodicSecurities and Exchange Commission filings. No significant changes were made toSun Bancorp, Inc.’s internal controls or other factors that could significantlyaffect these controls subsequent to the date of their evaluation.

 

35

----

 

SUN BANCORP, INC.

FORM 10-Q

PART II

 

Items 1, 2, 3, and 5 — Omitted pursuant to instructions to Part II

 

Item 4 — Submission of matters to a vote of security holders

 

On April 24,2003 the annual meeting of Sun Bancorp, Inc. was held with the results of theitems voted on at the meeting listed in the attached exhibit 99.3.

 

Item 6 —Exhibits and Reports on Form 8-K

 
| a.     |   | On April 23, 2003, Sun filed a Current Report on Form 8-K announcing  the operating results for the three months ended March 31, 2003.                                                                                                                                                                |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                  |
| b.     |   | On April 23, 2003 Sun filed a Current Report on Form 8-K announcing  the completion of the acquisition of Mid-Penn Insurance Associates, Inc.                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                  |
| c.     |   | On April 25, 2003 Sun filed a Current Report on Form 8-K announcing  the entering into a definitive agreement for Sun to acquire Sentry  Trust Company.                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                  |
| d.     |   | On April 25, 2003 Sun filed a Current Report on Form 8-K announcing  the declaration of the second quarter cash dividend of $0.1815 per  share.                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                  |
| e.     |   | On May 29, 2003 Sun filed a Current Report on Form 8-K announcing that  Sun, as trustee for the Sun Bancorp, Inc. 401(k) Plan, disclosing that Beard  Miller Company, LLP has been engaged as the certified public accountant for  the Plan for the Plan’s fiscal year ending December 31, 2002. |
|   |   |                                                                                                                                                                                                                                                                                                  |
| f.     |   | Exhibits                                                                                                                                                                                                                                                                                              |
|   |   | 3(i)                                                                                                                                                                                                                                                                                                  | The Articles of  Incorporation of the Corporation (Incorporated herein by reference to Exhibit  3(i) to the Registrant’s Current Report on Form 8-K filed with the Commission  on July 1, 2003). |
|   |   |                                                                                                                                                                                                                                                                                                  |   |
|   |   | 3(ii)                                                                                                                                                                                                                                                                                                 | The By-Laws, as amended  and restated (Incorporated herein by reference to Exhibit 3 to the  Corporation’s Current Report on Form 8-K filed with the Securities and  Exchange Commission on March 20, 2003). |
|   |   |                                                                                                                                                                                                                                                                                                  |   |
|   |   | 10.1                                                                                                                                                                                                                                                                                                  | Employment Agreement  between Robert J. McCormack, the Registrant and Sun Bank dated October  31, 2002.  (Incorporated by reference  to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the  Commission on March 20, 2003). |
|   |   |                                                                                                                                                                                                                                                                                                  |   |
|   |   | 10.2                                                                                                                                                                                                                                                                                                  | Employment Agreement  between Thomas W. Bixler, the Registrant and Sun Bank dated November 3,  2002.  (Incorporated by reference to  Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed with the  Commission on March 20, 2003). |
|   |   |                                                                                                                                                                                                                                                                                                  |   |
|   |   | 10.3                                                                                                                                                                                                                                                                                                  | Employment Agreement  between Sandra Miller, the Registrant and Sun Bank dated October 24,  2002.  (Incorporated by reference to  Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed with the  Commission on March 20, 2003). |

 

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|   |   | 10.4   | Change of Control  Agreement between Maureen M. Bufalino, the Registrant and Sun Bank, dated May  31, 2001.  (Incorporated by reference  to Exhibit 10.4 to the Registrant’s Current Report on Form 8-K filed with the  Commission on March 20, 2003). |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                             |
|   |   | 10.5   | Employment Agreement  between Wilmer D. Leinbach, the Registrant and Sun Bank dated January 28,  2003.  (Incorporated by reference to  Exhibit 10.5 to the Registrant’s Current Report on Form 8-K filed with the  Commission on July 1, 2003).        |
|   |   |   |                                                                                                                                                                                                                                                             |
|   |   | 10.6   | 1998 Stock Incentive  Plan.  (Incorporated by reference to  Exhibit 4.3 of Registration Statement No. 333-61237 on Form S-8 filed with  the Commission on August 12, 1998).                                                                                 |
|   |   |   |                                                                                                                                                                                                                                                             |
|   |   | 10.7   | 1998 Independent  Directors Stock Option Plan.   (Incorporated by reference to Exhibit 4.3 of Registration Statement  No. 333-61241 on Form S-8 filed with the Commission on August 12, 1998).                                                              |
|   |   |   |                                                                                                                                                                                                                                                             |
|   |   | 10.8   | 1998 Employee Stock  Purchase Plan.  (Incorporated by  reference to Exhibit 4.3 of Registration Statement No. 333-61249 on Form S-8  filed with the Commission on August 12, 1998).                                                                         |
|   |   |   |                                                                                                                                                                                                                                                             |
|   |   | 11     | Statement re:  Computation of Earnings Per Share can be referenced in Note 2 of the  Consolidated Statements in this Report                                                                                                                                      |
|   |   |   |                                                                                                                                                                                                                                                             |
|   |   | 99.1   | Certification of  principal executive officer or principal financial officer pursuant to 18  U.S.C. Section 1350.                                                                                                                                                |
|   |   |   |                                                                                                                                                                                                                                                             |
|   |   | 99.2   | Certification of  principal executive officer or principal financial officer pursuant to 18  U.S.C. Section 1350.                                                                                                                                                |
|   |   |   |                                                                                                                                                                                                                                                             |
|   |   | 99.3   | Report of Inspector of  Election.                                                                                                                                                                                                                                |

 

37

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SIGNATURES

 

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|   |            | Sun Bancorp, Inc.                     |
|--------|-----------------|---------------------------------------|
|   |            |                                  |
| Date   | August 11, 2003 |                                  | /s/   Robert J. McCormack |
|   |            | Robert J. McCormack                   |
|   |            | President and Chief Executive Officer |
|   |            | (Principal Executive Officer)         |
|   |            |                                  |
|   |            |                                  |
|   |            | /s/   Wilmer D. Leinbach         |
|   |            | Wilmer D. Leinbach                    |
|   |            | Chief Financial Officer               |
|   |            | (Principal Financial Officer)         |
|        |                 |                                       |  |

 

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