**FORM 10-Q**

 

**QUARTERLYREPORT 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 30,2004**

 

**or**

 

**o****Transition Report Pursuant to Section 13 or15(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  its charter)                             |
|                                                                                |   |   |
| **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 Actof 1934 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 90 days.

 
|   | 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 INBANKRUPTCYPROCEEDINGS 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** |   | **7,707,998**                            |
|--------------------------------|--------|------------------------------------------|
| Class                          |   | Outstanding Shares At July 30, 2004 |

 

 

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SUN BANCORP, INC.

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2004

 

CONTENTS

 
| PART I -  FINANCIAL INFORMATION                                                                       |                                                                                                                        |
|-------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------|
|                                                                                                  |                                                                                                                        |
| Item 1 -  Financial Statements:                                                                       |                                                                                                                        |
|                                                                                                  |                                                                                                                        |
|                                                                                                  | Consolidated Balance Sheet as of June 30, 2004 (Unaudited) and  December 31, 2003                                 |   |
|                                                                                                  | Consolidated Statement of Income for the  Three and Six Months Ended June 30, 2004 and June 30, 2003  (Unaudited) |   |
|                                                                                                  | Consolidated Statement of Cash Flows for  the Six Months Ended June 30, 2004 and June 30, 2003 (Unaudited)        |   |
|                                                                                                  |                                                                                                                        |   |
|                                                                                                  | Notes to the  Consolidated Financial Statements (Unaudited)                                                                 |   |
|                                                                                                  |                                                                                                                        |   |
| Item 2 -  Management’s Discussion and Analysis of Financial Condition and Results of  Operations |                                                                                                                        |
|                                                                                                  |                                                                                                                        |   |
| Item 3 – Quantitative and  Qualitative Disclosures about Market Risk                             |                                                                                                                        |
|                                                                                                  |                                                                                                                        |   |
| 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

 
|                                                             |   | **(Unaudited)**         |      |                        |   |
|------------------------------------------------------------------|--------|-------------------------|-----------|-----------------------------|--------|
| **(In Thousands, Except Share Data)**                            |   | **June 30,  2004** |      | **December 31,  2003** |   |
|                                                             |   |                    |      |                        |   |
| ASSETS                                                           |   |                    |      |                        |   |
|                                                             |   |                    |      |                        |   |
| Cash and due from other financial  institutions                  |   | $                       | 22,482    |                        | $      | 27,021 |   |
| Interest-bearing deposits in other  financial institutions       |   | 2,263                   |      | 1,400                       |   |
| Total cash and cash equivalents                                  |   | 24,745                  |      | 28,421                      |   |
|                                                             |   |                    |      |                        |   |
| Investment securities, available for sale,  at fair market value |   | 229,601                 |      | 223,209                     |   |
|                                                             |   |                    |      |                        |   |
| Loans and leases, net of unearned income                         |   | 675,197                 |      | 679,977                     |   |
| Less: allowance for loan and lease losses                        |   | 8,734                   |      | 7,754                       |   |
| Loans and leases, net                                            |   | 666,463                 |      | 672,223                     |   |
|                                                             |   |                    |      |                        |   |
| Bank premises and equipment, net                                 |   | 32,413                  |      | 27,256                      |   |
| Goodwill                                                         |   | 36,163                  |      | 29,848                      |   |
| Intangibles with finite lives                                    |   | 5,484                   |      | 3,690                       |   |
| Intangibles, other                                               |   | 147                     |      | —                      |   |
| Accrued interest                                                 |   | 3,352                   |      | 3,378                       |   |
| Bank-owned life insurance                                        |   | 33,817                  |      | 33,174                      |   |
| Other assets                                                     |   | 13,492                  |      | 7,054                       |   |
| Total assets                                                     |   | $                       | 1,045,677 |                        | $      | 1,028,253 |   |

 

3

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|                                                                                                                           |   | **(Unaudited)**         |      |                        |   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|-----------|-----------------------------|--------|
| **(In Thousands, Except Share Data)**                                                                                          |   | **June 30,  2004** |      | **December 31,  2003** |   |
|                                                                                                                           |   |                    |      |                        |   |
| LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                    |   |                    |      |                        |   |
|                                                                                                                           |   |                    |      |                        |   |
| Deposits                                                                                                                       |   |                    |      |                        |   |
| Non-interest-bearing                                                                                                           |   | $                       | 67,195    |                        | $      | 69,640 |   |
| Interest-bearing                                                                                                               |   | 577,242                 |      | 544,910                     |   |
| Total deposits                                                                                                                 |   | 644,437                 |      | 614,550                     |   |
|                                                                                                                           |   |                    |      |                        |   |
| Short-term borrowings                                                                                                          |   | 43,633                  |      | 65,388                      |   |
| Long-term borrowings, Federal Home Loan  Bank                                                                                  |   | 224,110                 |      | 226,236                     |   |
| Long-term borrowings, other                                                                                                    |   | 11,900                  |      | 11,900                      |   |
| Subordinated debentures                                                                                                        |   | 18,078                  |      | 18,866                      |   |
| Accrued interest and other liabilities                                                                                         |   | 17,786                  |      | 12,131                      |   |
| Total liabilities                                                                                                              |   | 959,944                 |      | 949,071                     |   |
|                                                                                                                           |   |                    |      |                        |   |
| Commitments and contingencies (note 10)                                                                                        |   |                    |      |                        |   |
|                                                                                                                           |   |                    |      |                        |   |
| Shareholders’ equity:                                                                                                     |   |                    |      |                        |   |
|                                                                                                                           |   |                    |      |                        |   |
| Common stock, no par value; 50,000,000  authorized shares: issued  7,704,826  shares in 2004 and 7,320,225 shares in 2003 |   | 92,413                  |      | 85,386                      |   |
| Retained earnings (deficit)                                                                                                    |   | (3,784                  | )         | (3,728                      | )      |
| Accumulated other comprehensive income, net  of taxes                                                                          |   | (2,896                  | )         | 29                          |   |
| Less: Treasury stock, at cost,                                                                                                 |   |                    |      |                        |   |
| 140,922 shares in 2003                                                                                                         |   | —                  |      | (2,505                      | )      |
| Total shareholders’ equity                                                                                                |   | 85,733                  |      | 79,182                      |   |
| Total liabilities and shareholders’ equity                                                                                |   | $                       | 1,045,677 |                        | $      | 1,028,253 |   |

 

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)**                             |   | **2004**                                      |   | **2003**                                    |   | **2004** |   | **2003** |   |
| Interest and dividend income:                                     |   |                                          |   |                                        |   |   |   |   |   |
| Loans and leases, including fees                                  |   | $                                             | 9,733  |                                        | $      | 10,347 |   | $ | 19,625 |   | $ | 20,042 |   |
| Investment securities                                             |   |                                          |   |                                        |   |   |   |   |   |
| Taxable                                                           |   | 1,718                                         |   | 2,251                                       |   | 3,447 |   | 4,550 |   |
| Tax-exempt                                                        |   | 179                                           |   | 214                                         |   | 382 |   | 445 |   |
| Dividends                                                         |   | 44                                            |   | 95                                          |   | 90 |   | 206 |   |
| Deposits in other financial institutions                          |   | 20                                            |   | 39                                          |   | 33 |   | 91 |   |
|                                                              |   |                                          |   |                                        |   |   |   |   |   |
| Total interest and dividend income                                |   | 11,694                                        |   | 12,946                                      |   | 23,577 |   | 25,334 |   |
|                                                              |   |                                          |   |                                        |   |   |   |   |   |
| Interest expense:                                                 |   |                                          |   |                                        |   |   |   |   |   |
| Deposits                                                          |   | 2,465                                         |   | 3,071                                       |   | 4,812 |   | 6,198 |   |
| Short-term borrowings                                             |   | 60                                            |   | 140                                         |   | 150 |   | 247 |   |
| Long-term borrowings                                              |   | 2,899                                         |   | 3,346                                       |   | 5,800 |   | 6,484 |   |
| Subordinated debentures                                           |   | 453                                           |   | 465                                         |   | 909 |   | 933 |   |
|                                                              |   |                                          |   |                                        |   |   |   |   |   |
| Total interest expense                                            |   | 5,877                                         |   | 7,022                                       |   | 11,671 |   | 13,862 |   |
|                                                              |   |                                          |   |                                        |   |   |   |   |   |
| Net interest income                                               |   | 5,817                                         |   | 5,924                                       |   | 11,906 |   | 11,472 |   |
|                                                              |   |                                          |   |                                        |   |   |   |   |   |
| Provision for loan and lease losses                               |   | 450                                           |   | 405                                         |   | 885 |   | 810 |   |
|                                                              |   |                                          |   |                                        |   |   |   |   |   |
| Net interest income, after provision for  loan & lease losses |   | $                                             | 5,367  |                                        | $      | 5,519 |   | $ | 11,021 |   | $ | 10,662 |   |

 

5

----

 
|                                           |   | **For The  Three Months  Ended June 30** |   | **For the  Six Months  Ended June 30** |   |
|------------------------------------------------|--------|-----------------------------------------------|--------|---------------------------------------------|--------|
| **(In Thousands, Except Share Data)**          |   | **2004**                                      |   | **2003**                                    |   | **2004** |   | **2003** |   |
| Non-interest income:                           |   |                                          |   |                                        |   |   |   |   |   |
| Service charges on deposit accounts            |   | $                                             | 1,057  |                                        | $      | 983 |   | $ | 2,096 |   | $ | 1,828 |   |
| Trust income                                   |   | 564                                           |   | 203                                         |   | 896 |   | 422 |   |
| Net security gains                             |   | 502                                           |   | 1,001                                       |   | 611 |   | 2,497 |   |
| Investment product sales                       |   | 246                                           |   | 78                                          |   | 411 |   | 102 |   |
| Bank-owned life insurance                      |   | 331                                           |   | 317                                         |   | 643 |   | 642 |   |
| Insurance subsidiary                           |   | 469                                           |   | 340                                         |   | 1,130 |   | 363 |   |
| Net gain on sale of loans                      |   | 62                                            |   | 43                                          |   | 96 |   | 304 |   |
| Leasing fees                                   |   | 253                                           |   | 262                                         |   | 525 |   | 563 |   |
| Other income                                   |   | 798                                           |   | 320                                         |   | 1,469 |   | 716 |   |
|                                           |   |                                          |   |                                        |   |   |   |   |   |
| Total non-interest income                      |   | 4,282                                         |   | 3,547                                       |   | 7,877 |   | 7,437 |   |
|                                           |   |                                          |   |                                        |   |   |   |   |   |
| Non-interest expense:                          |   |                                          |   |                                        |   |   |   |   |   |
| Salaries and employee benefits                 |   | 3,677                                         |   | 3,415                                       |   | 7,170 |   | 6,581 |   |
| Net occupancy expenses                         |   | 442                                           |   | 332                                         |   | 880 |   | 715 |   |
| Furniture and equipment expenses               |   | 547                                           |   | 503                                         |   | 1,077 |   | 990 |   |
| Amortization of intangibles with finite  lives |   | 126                                           |   | 38                                          |   | 234 |   | 38 |   |
| Other expenses                                 |   | 3,452                                         |   | 2,853                                       |   | 6,402 |   | 5,380 |   |
|                                           |   |                                          |   |                                        |   |   |   |   |   |
| Total non-interest expense                     |   | 8,244                                         |   | 7,141                                       |   | 15,763 |   | 13,704 |   |
|                                           |   |                                          |   |                                        |   |   |   |   |   |
| Income before income tax provision             |   | 1,405                                         |   | 1,925                                       |   | 3,135 |   | 4,395 |   |
|                                           |   |                                          |   |                                        |   |   |   |   |   |
| Income tax provision                           |   | 179                                           |   | 235                                         |   | 400 |   | 671 |   |
|                                           |   |                                          |   |                                        |   |   |   |   |   |
| Net income                                     |   | $                                             | 1,226  |                                        | $      | 1,690 |   | $ | 2,735 |   | $ | 3,724 |   |
|                                           |   |                                          |   |                                        |   |   |   |   |   |
| Net income per share – Basic              |   | $                                             | 0.16   |                                        | $      | 0.23 |   | $ | 0.36 |   | $ | 0.52 |   |
| Net income per share – Diluted            |   | $                                             | 0.16   |                                        | $      | 0.23 |   | $ | 0.36 |   | $ | 0.52 |   |
| Dividends declared                             |   | $                                             | 0.1815 |                                        | $      | 0.1815 |   | $ | 0.3630 |   | $ | 0.3465 |   |
| Weighted average shares outstanding - basic    |   | 7,689,708                                     |   | 7,210,518                                   |   | 7,511,383 |   | 7,196,333 |   |
| Weighted average shares outstanding -  diluted |   | 7,721,239                                     |   | 7,241,897                                   |   | 7,533,030 |   | 7,219,243 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

6

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SUN BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES INSHAREHOLDERS’ EQUITY

(UNAUDITED)

 
|                                                                                                               |   | **Common Stock** |       | **Retained  Earnings  (Deficit)** |       | **Accumulated  Other  Comprehensive  Income(Loss)** |       | **Treasury  Stock** |       | **Total  Shareholders’  Equity** |       |
|--------------------------------------------------------------------------------------------------------------------|--------|------------------|------------|-----------------------------------|------------|-----------------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
| **(In Thousands, Except Per Share  Data)**                                                                         |   | **Shares**       |       | **Amount**                        |       |
| **Balance,  December 31, 2003**                                                                               |   | **7,320**        | ** ** | **$**                             | **85,386** | ** **                                          | **$**      | **(3,728**          | **)**      | **$**                                 | **29**     | ** ** | **$** | **(2,505** | **)** | **$** | **79,182** | ** ** |
| **Comprehensive  income:**                                                                                         |   |             |       |                              |       |                                                |       |                |       |                                  |       |   |   |
| Net income                                                                                                         |   | **—**       | ** ** | **—**                        | ** ** | **2,735**                                           | ** ** | **—**          | ** ** | **—**                            | ** ** | **2,735** | ** ** |
| Unrealized gains and losses on securities  available for sale, net of reclassification adjustments and tax effects |   | **—**       | ** ** | **—**                        | ** ** | **—**                                          | ** ** | **(2,925**          | **)**      | **—**                            | ** ** | **(2,925** | **)** |
| **Total comprehensive  income**                                                                                    |   |             |       |                              | ** ** |                                                | ** ** |                | ** ** |                                  | ** ** | **(190** | **)** |
|                                                                                                               |   |             |       |                              |       |                                                |       |                |       |                                  |       |   |   |
| Stock issued:                                                                                                      |   |             |       |                              |       |                                                |       |                |       |                                  |       |   |   |
| Employee benefit plans                                                                                             |   | **26**           | ** ** | **242**                           | ** ** | **—**                                          | ** ** | **—**          | ** ** | **—**                            | ** ** | **242** | ** ** |
| Purchase of Sentry Trust Company (141  treasury shares)                                                            |   | **359**          | ** ** | **6,785**                         | ** ** | **—**                                          | ** ** | **—**          | ** ** | **2,505**                             | ** ** | **9,290** | ** ** |
| Cash dividends declared, $.3630 per share                                                                          |   | **—**       | ** ** | **—**                        | ** ** | **(2,791**                                          | **)**      | **—**          | ** ** | **—**                            | ** ** | **(2,791** | **)** |
| **Balance,  June 30, 2004**                                                                                   |   | **7,705**        | ** ** | **$**                             | **92,413** | ** **                                          | **$**      | **(3,784**          | **)**      | **$**                                 | **(2,896** | **)** | **$** | **—** | ** ** | **$** | **85,733** | ** ** |
|                                                                                                                    |        |                  |            |                                   |            |                                                     |            |                     |            |                                       |            |  |  |  |  |  |  |  |  |

 
|                                                                                                               |   | **Common Stock** |       | **Retained  Earnings  (Deficit)** |       | **Accumulated  Other  Comprehensive  Income(Loss)** |       | **Treasury  Stock** |       | **Total  Shareholders’  Equity** |       |
|--------------------------------------------------------------------------------------------------------------------|--------|------------------|------------|-----------------------------------|------------|-----------------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                                                                                               |   | **Shares**       |       | **Amount**                        |       |
| 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 and losses 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** | ** ** |

 

7

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SUN BANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED) 

 
|                                                                                             |   | **For the  Six Months  Ended June 30,** |   |
|--------------------------------------------------------------------------------------------------|--------|----------------------------------------------|--------|
| **(In Thousands)**                                                                               |   | **2004**                                     |   | **2003** |   |
| Cash flows from operating activities:                                                            |   |                                         |   |   |   |
| Net income                                                                                       |   | $                                            | 2,735  |   | $ | 3,724 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities:     |   |                                         |   |   |   |
| Provision for loan and lease losses                                                              |   | 885                                          |   | 810 |   |
| Depreciation                                                                                     |   | 786                                          |   | 512 |   |
| Amortization of intangibles                                                                      |   | 234                                          |   | 38 |   |
| Accretion of discount on acquired  liabilities                                                   |   | (102                                         | )      | — |   |
| Amortization and accretion of premium and  discounts on investment securities available for sale |   | 769                                          |   | 669 |   |
| Net gain on sale of investment securities  available for sale                                    |   | (611                                         | )      | (2,497 | ) |
| Proceeds from loan sales                                                                         |   | 6,453                                        |   | 13,135 |   |
| Mortgage loans originated for resale                                                             |   | (6,713                                       | )      | (12,870 | ) |
| Net gain on sale of loans                                                                        |   | (96                                          | )      | (304 | ) |
| Decrease in other assets and liabilities,  net                                                   |   | (2,365                                       | )      | (9,952 | ) |
| Net cash provided by (used in) operating  activities                                             |   | 1,975                                        |   | (6,735 | ) |
|                                                                                             |   |                                         |   |   |   |
| Cash flows from investing activities:                                                            |   |                                         |   |   |   |
| Proceeds from sales of investment  securities available for sale                                 |   | 49,486                                       |   | 73,985 |   |
| Proceeds from maturities, calls, and  prepayments of investment securities available for sale    |   | 27,306                                       |   | 63,929 |   |
| Purchases of investment securities  available for sale                                           |   | (83,188                                      | )      | (135,061 | ) |
| Net cash used in acquisitions                                                                    |   | (5,888                                       | )      | (131 | ) |
| Net decrease (increase) in loans and leases                                                      |   | 5,231                                        |   | (14,120 | ) |
| Capital expenditures                                                                             |   | (3,393                                       | )      | (1,957 | ) |
| Net cash used in investing activities                                                            |   | (10,446                                      | )      | (13,355 | ) |
|                                                                                             |   |                                         |   |   |   |
| Cash flows from financing activities:                                                            |   |                                         |   |   |   |
| Net increase in deposits                                                                         |   | 29,887                                       |   | 24,452 |   |
| Net decrease in short-term borrowings                                                            |   | (21,755                                      | )      | (5,404 | ) |
| Proceeds from long-term borrowings, other                                                        |   | —                                       |   | 11,900 |   |
| Repayment of long term borrowings, FHLB                                                          |   | —                                       |   | (1,137 | ) |
| Repayment of subordinated debentures                                                             |   | (788                                         | )      | (789 | ) |
| Cash dividends paid                                                                              |   | (2,791                                       | )      | (2,496 | ) |
| Proceeds from sale of stock for employee  benefits program                                       |   | 242                                          |   | 259 |   |
| Purchase of treasury stock                                                                       |   | —                                       |   | (1,841 | ) |
| Net cash (used in) provided by financing  activities                                             |   | 4,795                                        |   | 24,944 |   |
|                                                                                             |   |                                         |   |   |   |
| Net (decrease) increase in cash and cash  equivalents                                            |   | (3,676                                       | )      | 4,854 |   |
| Cash and cash equivalents at beginning of  period                                                |   | 28,421                                       |   | 41,569 |   |
| Cash and cash equivalents at end of period                                                       |   | $                                            | 24,745 |   | $ | 46,423 |   |
| Supplemental disclosure of cash flow  information:                                               |   |                                         |   |   |   |
|                                                                                             |   |                                         |   |   |   |
| Cash paid during the period for:                                                                 |   |                                         |   |   |   |
|                                                                                             |   |                                         |   |   |   |
| Interest expense on deposits and borrowings                                                      |   | $                                            | 12,468 |   | $ | 14,245 |   |
|                                                                                             |   |                                         |   |   |   |
| Income taxes                                                                                     |   | —                                       |   | — |   |

 

Loans with an estimated value of $424 were reclassified to foreclosed assets held for sale during thesix-month period ended June 30, 2003 with no loans reclassified during thesix-month period ended June 30, 2004

 

Theaccompanying notes are an integral part of these financial statements.

 

8

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SUN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1 — Basis of Interim Presentation

 

The consolidated financial statements include the accounts of SunBancorp, Inc. (“Sun”), the parent company, and its wholly-owned subsidiaries:SunBank, Mid-Penn Insurance Associates, Inc., SUBI Investment Company, andBeacon Life Insurance Company.  Sun alsoholds thirty percent ownership in Sun Abstract and Settlement Services.  SunBank’s wholly owned subsidiaries are SentryTrust Company, Sun Investment Services, Inc., SUBI Services LLC, and Bank CapitalServices Corporation.  The transactionsof Beacon Life Insurance Company and Sun Abstract and Settlement Services arenot material to the consolidated financial statements.  The parent and subsidiaries are reported asone unit within the financial statements. All significant intercompany balances and transactions have beeneliminated 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 theaudited financial statements contained in the 2003 Annual Report toShareholders.  However, in the opinionof management, all adjustments necessary for a fair presentation of the resultsof the interim period have been included. Operating results for the three and six months ended June 30, 2004are not necessarily indicative of the results that may be expected for the yearended December 31, 2004.

 

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 18through 21 of the 2003 Annual Report to Shareholders.

 

9

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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 restricted 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 a price per share not less than 85% of the marketvalue 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 does not recognizecompensation expense under these plans when the options are granted.  Had compensation expense been determinedbased on fair values at the grant dates (pursuant to SFAS 123), Sun’s netincome and basic earnings per share for the three and six months endedJune 30, 2004 and 2003 would have been:

 
|                                       |   | **For the  Three Months Ended  June 30** |   | **For the  Six Months Ended  June 30** |   |
|--------------------------------------------|--------|-----------------------------------------------|--------|---------------------------------------------|--------|
| **(In Thousands, Except per Share  Data)** |   | **2004**                                      |   | **2003**                                    |   | **2004** |   | **2003** |   |
| Net income:                                |   |                                          |   |                                        |   |   |   |   |   |
| As reported                                |   | $                                             | 1,226  |                                        | $      | 1,690 |   | $ | 2,735 |   | $ | 3,724 |   |
| Pro forma                                  |   | $                                             | 1,254  |                                        | $      | 1,836 |   | $ | 3,030 |   | $ | 3,867 |   |
|                                       |   |                                          |   |                                        |   |   |   |   |   |
| Earnings per share - Basic                 |   |                                          |   |                                        |   |   |   |   |   |
| As reported                                |   | $                                             | 0.16   |                                        | $      | 0.23 |   | $ | 0.36 |   | $ | 0.52 |   |
| Pro forma                                  |   | $                                             | 0.16   |                                        | $      | 0.25 |   | $ | 0.40 |   | $ | 0.54 |   |

 

10

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Note 3 – Investment Securities

 

SunBank holds one bond within other corporate obligations that hasexperienced an 11% unrealized loss at June 30, 2004 and a 12% unrealizedloss at December 31, 2003.  Theamortized cost of the bond was $208 and $236 at June 30, 2004 andDecember 31, 2003, respectively. Management believes this unrealized loss is temporary in nature and willnot effect the performance of the bond. There are no other investments with an unrealized loss greater than oneyear as of June 30, 2004.

 

The amortized cost and fair value of investment securities availablefor sale, at June 30, 2004 and December 31, 2003, were as follows:

 
| **(In Thousands)**                                |   | **June 30, 2004** |    |
|---------------------------------------------------|--------|------------------------|---------|
|                                              |   | **Amortized  Cost**    |    | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair Value** | ** ** |
|                                              |   |                   |    |   |   |   |   |   |   |
| Debt Securities:                                  |   |                   |    |   |   |   |   |   |   |
| Mortgage - Pass through                           |   | $                      | 79,351  |   | $ | 216 |   | $ | (1,916 | ) | $ | 77,651 |   |
| Mortgage - Other                                  |   | 82,413                 |    | 88 |   | (1,767 | ) | 80,734 |   |
| Agency obligations                                |   | 41,943                 |    | — |   | (517 | ) | 41,426 |   |
| Obligations of states and political  subdivisions |   | 7,579                  |    | 54 |   | (147 | ) | 7,486 |   |
| Other corporate                                   |   | 9,361                  |    | 13 |   | (410 | ) | 8,964 |   |
| Total debt securities                             |   | 220,647                |    | 371 |   | (4,757 | ) | 216,261 |   |
|                                              |   |                   |    |   |   |   |   |   |   |
| Equity securities:                                |   |                   |    |   |   |   |   |   |   |
| Marketable equity securities                      |   | 330                    |    | — |   | — |   | 330 |   |
| Restricted equity securities                      |   | 13,010                 |    | — |   | — |   | 13,010 |   |
| Total equity securities                           |   | 13,340                 |    | — |   | — |   | 13,340 |   |
|                                              |   |                   |    |   |   |   |   |   |   |
| Total                                             |   | $                      | 233,987 |   | $ | 371 |   | $ | (4,757 | ) | $ | 229,601 |   |

 
|                                              |   | **December 31,  2003** |    |
|---------------------------------------------------|--------|-----------------------------|---------|
|                                              |   | **Amortized  Cost**         |    | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair Value** |   |
|                                              |   |                        |    |   |   |   |   |   |   |
| Debt Securities:                                  |   |                        |    |   |   |   |   |   |   |
| Mortgage - Pass through                           |   | $                           | 84,935  |   | $ | 407 |   | $ | (559 | ) | $ | 84,783 |   |
| Mortgage - Other                                  |   | 101,393                     |    | 263 |   | (992 | ) | 100,664 |   |
| Agency obligations                                |   | 3,190                       |    | 11 |   | (73 | ) | 3,128 |   |
| Obligations of states and political  subdivisions |   | 17,654                      |    | 1,030 |   | (62 | ) | 18,622 |   |
| Other corporate                                   |   | 1,206                       |    | 48 |   | (29 | ) | 1,225 |   |
| Total debt securities                             |   | 208,378                     |    | 1,759 |   | (1,715 | ) | 208,422 |   |
|                                              |   |                        |    |   |   |   |   |   |   |
| Equity securities:                                |   |                        |    |   |   |   |   |   |   |
| Marketable equity securities                      |   | 330                         |    | — |   | — |   | 330 |   |
| Restricted equity securities                      |   | 14,457                      |    | — |   | — |   | 14,457 |   |
| Total equity securities                           |   | 14,787                      |    | — |   | — |   | 14,787 |   |
|                                              |   |                        |    |   |   |   |   |   |   |
| Total                                             |   | $                           | 223,165 |   | $ | 1,759 |   | $ | (1,715 | ) | $ | 223,209 |   |

 

11

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Note 4 – Loans

 

The balances for principalloan categories were as follows:

 
| **(In Thousands)**                                   |   | **June 30,  2004** |    | **December 31,  2003** |   |
|------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                                 |   |                    |    |                        |   |
| Real estate – mortgage                          |   | $                       | 313,232 |                        | $      | 373,068 |   |
| Real estate - construction                           |   | 11,160                  |    | 32,157                      |   |
| Agricultural                                         |   | 93                      |    | 268                         |   |
| Commercial and industrial                            |   | 156,979                 |    | 96,028                      |   |
| Lease – auto                                    |   | 89,218                  |    | 80,582                      |   |
| Lease – equipment                               |   | 10,768                  |    | 9,404                       |   |
| Individual                                           |   | 103,779                 |    | 98,193                      |   |
| Other                                                |   | 231                     |    | 321                         |   |
| Total                                                |   | 685,460                 |    | 690,021                     |   |
|                                                 |   |                    |    |                        |   |
| Less:                                                |   |                    |    |                        |   |
| Unearned income & deferred loan fees             |   | (10,759                 | )       | (10,541                     | )      |
| Unamortized net discount/premium on  purchased loans |   | 496                     |    | 497                         |   |
| ALLL                                                 |   | (8,734                  | )       | (7,754                      | )      |
| Net Loans                                            |   | $                       | 666,463 |                        | $      | 672,223 |   |

 

Net Investmentin Direct Financing Leases:

(In Thousands)

 
|                                  |   | **June 30,  2004** |   | **December 31,  2003** |   |
|---------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
| Minimum lease payments receivable     |   | $                       | 60,355 |                        | $      | 55,684 |   |
| Residual values                       |   | 39,631                  |   | 34,301                      |   |
| Unearned income under lease contracts |   | (10,672                 | )      | (10,488                     | )      |
| Net Investment                        |   | $                       | 89,314 |                        | $      | 79,497 |   |

 

12

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Note 5 – 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 number of shares of commonstock which would be issued, assuming the exercise of stock options during eachperiod using the treasury method.

 

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, 2004 and 2003:

 
| **(In Thousands, Except Share Data)**                                                           |   | **For the  Three Months Ended  June 30** |   | **For the  Six Months Ended  June 30** |   |
|-------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|---------------------------------------------|--------|
|                                                                                            |   | **2004**                                      |   | **2003**                                    |   | **2004** |   | **2003** |   |
| Net income                                                                                      |   | $                                             | 1,226  |                                        | $      | 1,690 |   | $ | 2,735 |   | $ | 3,724 |   |
| Average number of common shares oustanding                                                      |   | 7,689,708                                     |   | 7,210,518                                   |   | 7,511,383 |   | 7,196,333 |   |
| Effect of dilutive options                                                                      |   | 31,531                                        |   | 31,379                                      |   | 21,647 |   | 22,910 |   |
| Average number of common shares oustanding  used to calculate diluted earnings per common share |   | 7,721,239                                     |   | 7,241,897                                   |   | 7,533,030 |   | 7,219,243 |   |
|                                                                                                 |        |                                               |        |                                             |        |  |  |  |  |  |  |  |  |

 

Note 6 – Bank Premises and Equipment 

 
| **(In Thousands)**               |   | **June 30  2004** |   | **December 31,  2003** |   |
|----------------------------------|--------|------------------------|--------|-----------------------------|--------|
|                             |   |                   |   |                        |   |
| Land                             |   | $                      | 3,801  |                        | $      | 3,631 |   |
| Buildings                        |   | 17,507                 |   | 15,033                      |   |
| Furniture and equipment          |   | 9,931                  |   | 9,455                       |   |
| Autos under operating lease      |   | 10,603                 |   | 7,195                       |   |
| Total cost                       |   | 41,842                 |   | 35,314                      |   |
|                             |   |                   |   |                        |   |
| Less: Accumulated deprecation    |   | (9,429                 | )      | (8,058                      | )      |
| Bank premises and equipment, net |   | $                      | 32,413 |                        | $      | 27,256 |   |

 

13

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Note 7 – Goodwill and Core Deposit Intangible

 

In February 2004, Sun acquired Sentry Trust Company.  The acquisition of Sentry includedidentifiable intangible assets in the form of a trade name intangible andcustomer relationship intangible which were valued by a third party.  Assumptions used in the valuation of thecustomer relationship intangible included, but were not limited to (1) anattrition rate of 5.0%, (2) a discount rate of 15.0%, and (3) an effective taxrate of 35%.  Assumptions used in thevaluation of the trade name intangible included, but were not limited to (1) aroyalty rate of 1.5%, (2) a growth rate of 3.0%, and (3) a discount rate of20%.  The customer relationship wasclassified as an identifiable intangible of $2,028, while the trade name was classifiedas an identifiable intangible of $147. The annual amortization for the customer relationship intangible amountsto $107 using a 19-year amortization, while the trade name intangible has beendetermined to have an indefinite life.

 

Thefollowing is a schedule of intangibles acquired and associatedamortization for the six months ended June 30, 2004.

 
|                    |   |                        |   | **Acquired** |   |       |   |   |   |
|-------------------------|--------|-----------------------------|--------|--------------|--------|------------|--------|--------|--------|
| **(In Thousands)**      |   | **December 31,  2003** |   |         |   | **Sentry** |   |   |   |   |   | **Amortization** |   | **June 30,  2004** |   |
| Goodwill                |   | $                           | 29,848 |         | — |       | $      | 6,315  |   | — |   | — |   | $ | — |   | $ | 36,163 |   |
| Core Deposit Intangible |   | 1,912                       |   | —       |   | —     |   | — |   | — |   | (137 | ) | 1,775 |   |
| Customer Relationship   |   | 1,778                       |   | —       |   | 2,028      |   | — |   | — |   | (97 | ) | 3,709 |   |
| Trade Name              |   | —                      |   | —       |   | 147        |   | — |   | — |   | — |   | 147 |   |
| Total                   |   | $                           | 33,538 |         | — |       | $      | 8,490  |   | — |   | — |   | $ | (234 | ) | $ | 41,794 |   |

 
|                    |   |                       |   | **Acquired**     |   |    |   |         |   |            |   |
|-------------------------|--------|----------------------------|--------|------------------|--------|---------|--------|--------------|--------|-----------------|--------|
|                    |   | **December 31, 2002** |   | **Bank Capital** |   | **MPI** |   | **Steelton** |   | **CDI Reclass** |   | **Amortization** |   | **December 31, 2003** |   |
| Goodwill                |   | $                          | 22,924 |             | $      | 421     |   | $            | 1,453  |            | $      | 6,616 |   | $ | (1,566 | ) | $ | — |   | $ | 29,848 |   |
| Core Deposit Intangible |   | —                     |   | —           |   | —  |   | 791          |   | 1,566           |   | (445 | ) | 1,912 |   |
| Customer Relationship   |   | —                     |   | —           |   | 1,864   |   | —       |   | —          |   | (86 | ) | 1,778 |   |
| Total                   |   | $                          | 22,924 |             | $      | 421     |   | $            | 3,317  |            | $      | 7,407 |   | $ | — |   | $ | (531 | ) | $ | 33,538 |   |

 

14

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Note 8 – Borrowed Funds

 
| **(In Thousands)**                              |   | **June 30,  2004** |    | **December 31,  2003** |   |
|-------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                            |   |                    |    |                        |   |
| Short-term Borrowings:                          |   |                    |    |                        |   |
| FHLB repurchase agreements                      |   | $                       | 23,910  |                        | $      | 17,570 |   |
| FHLB advances                                   |   | —                  |    | 20,000                      |   |
| Securities sold under agreements to  repurchase |   | 19,601                  |    | 27,693                      |   |
| Treasury Tax and Loan Note Option               |   | 122                     |    | 125                         |   |
| Total Short-term Borrowings                     |   | 43,633                  |    | 65,388                      |   |
|                                            |   |                    |    |                        |   |
| Long-term Borrowings:                           |   |                    |    |                        |   |
| FHLB advances                                   |   | 224,110                 |    | 226,236                     |   |
| Subordinated debentures                         |   | 18,078                  |    | 18,866                      |   |
| Other borrowings                                |   | 11,900                  |    | 11,900                      |   |
| Total Long-term Borrowings                      |   | 254,088                 |    | 257,002                     |   |
| Total Borrowed Funds                            |   | $                       | 297,721 |                        | $      | 322,390 |   |

 

The long-term Federal Home Loan Bank (“FHLB”) advances carrysignificant prepayment penalties that limit the ability of Sun to reduce itsdebt level.  As of June 30, 2004,prepayment penalties totaled $19,387 as compared to $29,418 atDecember 31, 2003.

 

The following is a schedule of the rates and maturities for thelong-term borrowings identified above. The variable rate borrowings listedconsist entirely of FHLB advances that are fixed until the FHLB exercises theiroption to increase the rate charged when the then current rate surpasses therate set at contract inception.  Thefixed rate debt listed below also consists of subordinated debentures andreverse repurchase agreements.

 
| **(In Thousands)**                                     |   | **June 30,  2004** |    | **December 31,  2003** |   |
|--------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
| Variable rate of 1.99%, maturity 2005                  |   | $                       | 2,037   |                        | $      | 2,044 |   |
| Variable rates between 4.63% and 5.04%,  maturity 2008 |   | 26,053                  |    | 26,063                      |   |
| Variable rates between 4.93% and 5.88%,  maturity 2009 |   | 51,846                  |    | 49,360                      |   |
| Variable rates between 5.86% and 6.36%, maturity  2010 |   | 94,705                  |    | 99,258                      |   |
| Variable rate of 5.24%, maturity 2011                  |   | 3,220                   |    | 3,261                       |   |
| Variable rates between 5.08% and 5.15%,  maturity 2013 |   | 46,250                  |    | 46,250                      |   |
| Fixed rate of 6.00%, maturity 2004                     |   | —                  |    | 789                         |   |
| Fixed rates between 1.90% and 6.00%,  maturity 2005    |   | 5,489                   |    | 5,489                       |   |
| Fixed rates between 2.42% and 6.00%,  maturity 2006    |   | 4,388                   |    | 4,388                       |   |
| Fixed rate of 2.84%, maturity 2007                     |   | 3,600                   |    | 3,600                       |   |
| Fixed rate of 10.20%, maturity 2031                    |   | 16,500                  |    | 16,500                      |   |
| Total                                                  |   | $                       | 254,088 |                        | $      | 257,002 |   |

 

15

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Note 9 – Employee Benefit Plans

 

Sun provides a defined contribution pension plan that coverssubstantially all employees. Sun’s contributions are based on employeecontributions and compensation. The contributions are accrued and funded to theemployee’s account once a year with the employee maintaining control over theallocation of the funds between stocks and bonds.

 

In addition to the defined contribution plan, Sun also has a definedbenefit plan, which provides supplemental payments to certain key employeesupon retirement. The supplemental payment expense included interest of $1 foreach of the three-month periods and $2 for each of the six-month periods endedJune 30, 2004 and 2003, respectively. With the Guaranty Bank acquisitionin 2001 and the Steelton Bancorp acquisition in 2003, Sun will also providesupplemental payments to certain former directors. Life insurance contracts arebeing used to fund this supplemental payment to the former directors. Expensesrelated to these plans and the carrying value of the defined benefit plan forthe three and six-month periods ended June 30, 2004 and 2003 were:

 
| **(In Thousands)**                                     |   | **For the  Three Months Ended  June 30** |   | **For the  Six Months Ended  June 30** |   |
|--------------------------------------------------------|--------|-----------------------------------------------|--------|---------------------------------------------|--------|
|                                                   |   | **2004**                                      |   | **2003**                                    |   | **2004** |   | **2003** |   |
| Defined pension contributions                          |   | $                                             | 253    |                                        | $      | 210 |   | $ | 474 |   | $ | 448 |   |
| Supplemental payment expense for defined  benefit plan |   | $                                             | 3      |                                        | $      | 9 |   | $ | 6 |   | $ | 18 |   |
| Defined benefit plan, carrying value                   |   | $                                             | 133    |                                        | $      | 309 |   | $ | 133 |   | $ | 309 |   |

 

The estimated payments under the defined contribution pension plan anddefined benefit plan for each of the next five years ended December 31 areas follows:

 
| **(In Thousands)  December 31,** |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **2008** |   |
|---------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
| Defined pension                       |   | $        | 595    |     | $      | 613      |   | $        | 632    |     | $      | 651 |   | $ | 670 |   |
| Defined benefit                       |   | $        | 12     |     | $      | 12       |   | $        | 12     |     | $      | 12 |   | $ | 12 |   |

 

16

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Note 10 – Off –Balance Sheet Risk

 

Inthe normal course of business, Sun is a party to financial instruments withoff-balance sheet risk. These financial instruments include commitments toextend credit and standby letters of credit containing, in varying degrees,credit and interest rate risk exceeding the amount recognized in the balancesheet.  There were no material losscontingencies at June 30, 2004 or December 31, 2003.

 

Creditrisk from nonperformance by counterparties to commitments to extend credit andstandby letters of credit is represented by the contractual amount of thoseinstruments. Sun uses the same credit policies to guide commitments andconditional obligations as it does for direct, funded loans.

 

Commitmentsto extend credit are agreements to lend to a customer as long as no contractconditions are violated. Commitments generally include fixed expiration datesor other termination clauses and certain fee payments. Since many commitmentsare expected to expire without being drawn upon, the total commitment amountsdo not necessarily represent future cash requirements. Each customer’screditworthiness is evaluated on a case-by-case basis. The collateral amountobtained, if deemed necessary, is based on management’s credit evaluation ofthe customer. Collateral types vary but may include accounts receivable,inventory, property, equipment, and income-producing commercial properties.

 

Standbyletters of credit are conditional commitments that guarantee a customer’sperformance to a third party. Those guarantees are primarily issued to supportborrowing arrangements and related transactions. Terms vary from one month to24 months and may have renewal features. Credit risk differs little from direct loans to customers.  When warranted, Sun holds collateral againstthose commitments.  Sun recognizes aliability for financial guarantees at the inception of the contract.  This liability is equivalent to the premium receivedand is amortized over the life of the guarantee.

 

Thefollowing represents outstanding commitments to extend credit and standbyletters of credit as of June 30, 2004 and December 31, 2003:

 
| **(In Thousands)**                                 |   | **June 30,  2004** |    | **December 31,  2003** |   |
|----------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
| Commitments to extend credit                       |   | $                       | 140,267 |                        | $      | 158,291 |   |
| Standy letters of credit and financial  guarantees |   | 11,582                  |    | 11,356                      |   |
| Total credit extension commitments                 |   | $                       | 151,849 |                        | $      | 169,647 |   |

 

17

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Note 11 – Hedging Activities

 

Sunmaintains an overall interest rate risk-management strategy that incorporatesthe use of derivative instruments to minimize significant unplannedfluctuations in earnings that are caused by interest rate volatility. Sun’sgoal is to manage interest rate sensitivity by modifying the repricing ormaturity characteristics of certain balance sheet liabilities so that movementsin interest rates do not, on a material basis, adversely affect the fair valuesof these liabilities. As a result of interest rate fluctuations, hedgedfixed-rate liabilities will appreciate or depreciate in market value. Theeffect of this unrealized appreciation or depreciation is expected to besubstantially offset by Sun’s gains or losses on the derivative instruments thatare linked to these hedged liabilities. Another result of interest ratefluctuations is that the interest expense of hedged variable-rate liabilitieswill increase or decrease. The effect of this variability in earnings isexpected to be substantially offset by Sun’s derivative instruments linked tothese hedged liabilities. Sun considers its strategic use of derivatives to bea prudent method of managing interest-rate sensitivity, as it reduces theexposure to earnings from undue risk posed by changes in interest rates.

 

Sun uses interest rate swaps as part of the interest raterisk-management strategy. These interest rate swaps have indices related to thepricing of specific balance sheet liabilities. As a matter of policy, Sun doesnot use highly leveraged derivative instruments for interest rate riskmanagement. 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. The derivative instruments entered into bySun gives Sun the right to enter into additional interest rate swaps with thewriter of the option in the event the liabilities are repriced by the issuer.

 

Byusing derivative instruments, Sun exposes itself to credit and market risk. Ifa counterparty fails to fulfill its performance obligations under a derivativecontract, Sun’s credit risk will equal the fair value gain in a derivative.Generally, when the fair value of a derivative contract is positive, thisindicates that the counterparty owes Sun, thus creating a credit risk for Sun.When the fair value of a derivative contract is negative, Sun owes thecounterparty and, therefore, assumes no credit risk. Sun minimizes the credit(or repayment) risk in derivative instruments by entering into transactionswith high quality counterparties that are reviewed periodically by SunAsset/Liability Committee.

 

Market risk is the adverse effect that a change in interest rates,currency, or implied volatility might have on the value of a financialinstrument. Sun manages the market risk associated with interest rate contractsby establishing and monitoring limits for the types and degree of risk that maybe undertaken. Sun’s derivative activities are monitored by its Asset/LiabilityCommittee as part of the committee’s oversight of Sun’s asset/liabilityposition. The Asset/Liability Committee is responsible for approving hedgingstrategies that are developed through its analysis of data derived fromfinancial simulation models and other internal and industry sources. Theresulting hedging strategies are then incorporated into Sun’s overall interestrate risk-management strategy.

 

As of June 30, 2004, Sun has used four pay-variable, receive-fixedinterest rate swaps with a $100,000 total notional amount to hedge changes inthe fair value of certain Federal Home Loan Bank (FHLB) long-term borrowings.The swaps also contain an embedded option to enter into an interest rate swapwith opposite terms in the event the FHLB long-term borrowings convert to a

 

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variable rate. This occurrence would effectively fix the rate beingpaid on the borrowings at approximately the original coupon and would reducethe net interest volatility caused in a rising interest rate environment. Sunincludes all components of each derivative gain or loss in the assessment ofhedge effectiveness. Sun recognizes the change in fair value of the hedge andassociated borrowings through the income statement within other income. Thecost of the swaption is embedded within the rate of its host, the fixed tovariable swap. The cost of the swaption will increase interest expense.Premiums/discounts are reflected in the rates received/paid and thus reflectedin interest expense. Because this swaption is a fair value hedge, Sun reportschanges in the fair value of the swaption in other income/other expense duringthe applicable period. For the six months ended June 30, 2004, there was achange in fair value recognized in the hedge and designated long-term FHLBborrowings of $2,024 to $7,180 at June 30, 2004 from $5,156 atDecember 31, 2003 due to the change in interest rates. Sun also recognizeda reduction of $370 and $742 in interest expense on long-term FHLB borrowings asa result of the hedge transaction during the three and six-month periods endedJune 30, 2004, respectively.  Therewas no interest expense reduction during the six months ended June 30,2003.  A summary of Sun’s fair valuehedges at June 30, 2004 is as follows:

 
| **(In Thousands)**                                |   |                 |    |      |   |          |   | **Weighted  Average** |   |
|---------------------------------------------------|--------|----------------------|---------|-----------|--------|---------------|--------|-----------------------|--------|
| **June 30, 2004**                            |   | **Notional  Amount** |    | **Asset** |   | **Liability** |   | **Receive  Rate**     |   | **Pay  Rate** |   | **Life  (Years)** |   |
| Fair Value Hedges:                                |   |                 |    |      |   |          |   |                  |   |   |   |   |   |
| Receive fixed - pay variable interest rate  swaps |   | $                    | 100,000 |      | $      | —        |   | $                     | 7,180  |   | 2.65 | % | 1.17 | % | 5.8 |   |
|                                                   |        |                      |         |           |        |               |        |                       |        |  |  |  |  |  |  |  |

 
|                                              |   |                 |    |      |   |          |   | **Weighted Average** |   |
|---------------------------------------------------|--------|----------------------|---------|-----------|--------|---------------|--------|----------------------|--------|
| **December 31,  2003**                       |   | **Notional  Amount** |    | **Asset** |   | **Liability** |   | **Receive  Rate**    |   | **Pay  Rate** |   | **Life  (Years)** |   |
| Fair Value Hedges:                                |   |                 |    |      |   |          |   |                 |   |   |   |   |   |
| Receive fixed - pay  variable interest rate swaps |   | $                    | 100,000 |      | $      | —        |   | $                    | 5,156  |   | 2.65 | % | 1.13 | % | 6.3 |   |
|                                                   |        |                      |         |           |        |               |        |                      |        |  |  |  |  |  |  |  |

 

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Note 12 – Acquisitions

 

During February 2004 Sun completed the acquisition of Sentry TrustCompany.  Sentry provides Sun an entryinto south central Pennsylvania and further diversifying Sun’s revenuestream.  As of March 31, 2004,Sentry had approximately $460,162 in assets under management.  Based on the guidance provided by FASB 141,Business Combinations, management believes that this transaction did not have amaterial effect on consolidated financial results and, therefore, does notrequire pro-forma presentation at this time.

 

The following is a summary of the purchase:

 
| **(In Thousands)**             |   | **Sentry  Trust** |   |
|--------------------------------|--------|-------------------|--------|
| Assets acquired                |   | $                 | 7,661  |   |
| Identifiable intangible assets |   | 2,175             |   |
| Less: liabilities assumed      |   | 186               |   |
| Net assets acquired            |   | 9,650             |   |
| Less: purchase price           |   | 15,965            |   |
| Goodwill                       |   | $                 | 6,315  |   |
|                           |   |              |   |
| Consideration paid:            |   |              |   |
| Cash                           |   | $                 | 6,674  |   |
| Stock                          |   | $                 | 9,291  |   |

 

Note 13 – Merger Agreement

 

OnApril 20, 2004, Sun announced that a definitive merger agreement wasunanimously approved by the Boards of Directors of both Sun and Omega FinancialCorporation (Omega).  The agreementprovides that Sun be merged with and into Omega (which would survive the mergeras the surviving corporation).  Pursuantto this agreement, each share of Sun common stock would be converted intoeither .664 shares of Omega common stock or cash in the amount of $23.25.  Holders of Sun common stock will be entitledto elect their preference, subject to the limitations set forth in the mergeragreement that 20% of the total deal consideration will be paid in cash, and80% will be paid in the form of Omega common stock. The transaction isanticipated to close late in the third quarter or early in the fourth quarterof 2004.

 

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Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

(in thousands, except per share amounts)

 

Forward Looking Statements 

 

In addition to historical information, thisreport and the reports and documents incorporated by reference in this reportcontain statements relating to future events and Sun’s future results. Thesestatements are “forward-looking” within the meaning of the Private SecuritiesLitigation Reform Act of 1995 and include, but are not limited to, statementsthat relate to projections of future results of operations, liquidity, capitalexpenditures or other financial items, discussions of estimated future revenueenhancements and cost savings, and potential exposure to various types ofmarket risk, including interest rate risk and credit risk.  These statements may also relate to Sun’sbusiness strategy, goals and expectations concerning its market position,future operations, margins, profitability, liquidity and capital resources.Generally, words such as “anticipate”, “believe”, “continue”, “could”,“estimate”, “expect”, “intend”, “may”, “plan”, “predict”, “project”, “should”,“will” and similar terms and phrases are used to identify forward-lookingstatements in this report and in the documents incorporated in this report byreference.   These forward-lookingstatements are made as of the date of this report.

 

Readers should note that many factors, someof which are discussed elsewhere in this report and in the documentsincorporated by reference in this report, could affect the future financialresults of Sun and its subsidiaries, both individually and collectively, andcould cause those results to differ materially from those expressed in theforward-looking statements contained or incorporated by reference in this Form10-Q. These factors 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.

 

Sun undertakes no obligation to publiclyrevise or update these forward-looking statements to reflect events orcircumstances that arise after the date of this report. Readers shouldcarefully review the risk factors described in other documents that Sun filesperiodically with the Securities and Exchange Commission.

 

The following is management’s discussion and analysis of the significantchanges in the results of operations, capital resources, and liquiditypresented in its accompanying consolidated financial statements for Sun, afinancial holding company, and its wholly-owned subsidiaries, SunBank, Mid-PennInsurance Associates, Inc., Sentry Trust Company, Beacon Life InsuranceCompany, and SUBI Investment Company. Sun Bancorp, Inc. also holds thirty percent ownership in Sun Abstractand Settlement Services.  SunBank’swholly owned subsidiaries are Sentry Trust Company, Sun Investment Services,Inc., SUBI Services LLC, and Bank Capital Services Corporation.  Sun Bancorp, Inc.’s consolidated financialcondition and results of operations consist almost entirely of SunBank’sfinancial condition and results of operations. This discussion should be read in conjunction with Sun’s 2003 AnnualReport. Current performance does not guarantee or assure similar performance inthe future, and may not be indicative of future results.

 

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Results of Operations – Three Months Ended June 30, 2004 and 2003

 

Sun’s earnings of $1,226 or$0.16 per share basic and diluted for the three months ended June 30, 2004were $464 or $0.07 per share basic and diluted lower than the three monthsended June 30, 2003.  Excludingsecurity gains, net income for the three months ended June 30, 2004 wouldhave decreased $134 from the three months ended June 30, 2003.

 

Annualized return on average assets for thethree months ended June 30, 2004 was 0.47% compared to 0.66% for the sameperiod in 2003.  Annualized return onaverage equity for the three months ended June 30, 2004 was 5.60% comparedto 8.30% for the three months ended June 30, 2003.

 

Comparativeinformation for the three months ended June 30, 2004 and 2003 is impactedby the acquisitions of Mid-Penn Insurance Associates, Inc. in April 2003,Steelton Bancorp in April 2003, and Sentry Trust Company inFebruary 2004.

 

Net interest income decreased 1.8% to $5,817for the three months ended June 30, 2004 compared to $5,924 for the sameperiod of 2003.  Total interest anddividend income decreased $1,252 to $11,694 for the three months endedJune 30, 2004 as compared to the corresponding period of 2003.  Interest and fees on loans and leasesdecreased 5.9% to $9,733 for the three months ended June 30, 2004 comparedto the corresponding period of 2003 despite average loan and lease growth of$34,319 for the same time periods.  Thedecline in interest and fees on loans reflects the impact of significant loanprepayments with higher coupons and the scheduled principal payments,principally in the Bank’s residential mortgage loan portfolio.  Interest and dividends on available for salesecurities decreased $619 or 24.2% to $1,941 for the three months endedJune 30, 2004 due in part to accelerated amortization of premiumson mortgage backed securities caused by prepayments on the underlying assetsand a decrease of $42,056 in the average outstanding balance for the threemonths ended June 30, 2004 as compared to 2003.  Interest on deposits in banksdecreased $19 or 48.7% to $20 for the three months ended June 30, 2004, asa lower cash level was maintained during the second quarter of 2004, coupledwith lower interest rates. Total interest expense decreased 16.3% or $1,145 forthe three months ended June 30, 2004, compared to the same period of2003.  This overall decrease correspondsto a general decline in market rates and the maturity of certificates ofdeposits, which were written during a period of higher interest rates.  Interest on deposits decreased 19.7%, or $606primarily due to lower offered rates for the three months ended June 30,2004 in comparison to rates offered during the three months ended June 30,2003.  Interest on long-term borrowingsdecreased 13.4% or $447 as the weighted average cost declined to 4.84% for thethree months ended June 30, 2004 as compared to 5.53% for 2003.  The decrease was the result of the SunBankentering into $100,000 total notional value interest rate swap agreements inJune of 2003. The effect of these swap agreements was a decrease ininterest expense of $370 for the three months ended June 30, 2004 ascompared to 2003.

 

Non-interest income, excluding security gains, increased $1,234 or48.5% to $3,780 for the three months ended June 30, 2004 as compared tothe corresponding period of 2003. Service charges on

 

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deposits increased 7.5% or $74. The increase in service charges was primarily the result of improvedperformance related to SunBank’s overdraft protection program, which providesoverdraft protection.  Income from Sun’sinsurance subsidiary increased 37.9% or $129 reflecting the acquisition ofMid-Penn Insurance in April 2003. The acquisition of Sentry Trust Company in February of 2004 andSun’s focus on increasing fee income resulted in growth of $361 in trust incomeand $168 in investment product sales. Other income increased $478, due torental income from automobile operating leases which generated $422 of the increase.  Gains on the sale of loans increased $19 to$62 for the three months ended June 30, 2004 as Sun continues to sellnearly all new residential mortgages within 7 days of origination.  Sun recognized security gains of $502 for thethree months ended June 30, 2004, compared to $1,001 for the correspondingperiod of 2003 as Sun continued to restructure the investment portfoliocomposition.

 

Non-interest expenses increased $1,103 or 15.5% to $8,244 for the threemonths ended June 30, 2004 compared to the corresponding period of2003.  All categories of non-interestexpense have been impacted by the acquisitions of Mid-Penn InsuranceAssociates, Inc. and Steelton Bancorp in April 2003 and Sentry TrustCompany during 2004.  Salaries andemployee benefits increased $262 or 7.7% primarily due to the acquisitions andincreased employee benefit costs.  Netoccupancy expense and furniture and equipment expenses increased $154 or 18.4%due to acquisitions and, to a lesser extent, infrastructure improvements.  Other expenses increased 21.0% or $599 due toincreases in normal business expenses, acquisitions, and depreciation relatedto operating leases.  The depreciationrelated to the operating leases accounted for $329 or 45.1% of the increase inother expenses.  Amortization ofintangibles increased $88 due to the amortization of customer relationshipintangibles from the Mid Penn Insurance and Sentry acquisitions and theamortization of core deposit intangibles from the Steelton and Mellon branchacquisition.  Refer to Note 7 foradditional information regarding intangibles.

 

Results of Operations – Six Months Ended June 30, 2004 and 2003

 

Sun’s earnings of $2,735 or $0.36 per share basic and diluted for thesix months ended June 30, 2004 were $989 or $0.16 per share basic anddiluted lower than the six months ended June 30, 2003.  Excluding security gains, net income for thesix months ended June 30, 2004 would have increased $256 from the sixmonths ended June 30, 2003.

 

Annualized return on average assets for thesix months ended June 30, 2004 was 0.53% compared to 0.75% for the sameperiod in 2003.  Annualized return onaverage equity for the six months ended June 30, 2004 was 6.23% comparedto 9.09% for the six months ended June 30, 2003.

 

Comparativeinformation for the six months ended June 30, 2004 and 2003 is impacted bythe acquisitions of Mid-Penn Insurance Associates, Inc. in April 2003,Steelton Bancorp in April 2003, and Sentry Trust Company inFebruary 2004.

 

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Net interest income decreased 3.8% to $11,906for the six months ended June 30, 2004 compared to $11,472 for the sameperiod of 2003.  Over the same timeperiod, taxable equivalent net interest income increased 3.6% to $12,370.  Total interest and dividend income decreased$1,757 to $23,577 for the six months ended June 30, 2004 as compared tothe corresponding period of 2003. Interest and fees on loans and leases decreased 2.1% to $19,625 for thesix months ended June 30, 2004 compared to the corresponding period of2003 despite average loan and lease growth of $54,029 for the same timeperiods.  The additional interest incomefrom the significant average loan growth partially offset the impact ofsignificant loan prepayments with higher coupons and the scheduled principalpayments.  Interest and dividends onavailable for sale securities decreased $1,282 or 24.7% to $3,919 for the sixmonths ended June 30, 2004 due to accelerated amortization ofpremiums on mortgage backed securities caused by prepayments on the underlyingassets and a decrease of $37,180 in average outstanding balance for the sixmonths ended June 30, 2004 as compared to 2003.  Interest on deposits in banksdecreased 63.7% to $33 for the six months ended June 30, 2004, as thelevel of cash was reduced by approximately 50% to fund the average loan growthfor the six month periods ended June 30, 2004 and 2003. Total interestexpense decreased 15.8% or $2,191 for the six months ended June 30, 2004,compared to the same period of 2003.  Thedecrease was driven by lower rates paid on deposits and the maturity of higherrate certificates of deposits resulting in a 22.4%, or $1,386 decline indeposit interest expense.  Interest onlong-term borrowings decreased 10.5% or $684 as the weighted average cost wasreduced to 4.87% for the six months ended June 30, 2004 compared to 5.60%for 2003.  The reduction in cost was theresult of the Bank entering into $100,000 total notional value interest rateswap agreements in June of 2003, which decreased interest expense by $742for the six months ended June 30, 2004 as compared to 2003.

 

Non-interest income, excluding security gains, increased $2,326 or47.1% to $7,266 for the six months ended June 30, 2004 compared to thecorresponding period of 2003.  Servicecharges on deposits increased 14.7% or $268 as continued growth in SunBank’soverdraft honor program, which provides overdraft protection, led theincrease.  Income from Sun’s insurancesubsidiary increased $767 due to the full period impact of the acquisition ofMid-Penn Insurance in April 2003. The acquisition of Sentry Trust Company, in 2004, and Sun’s focus onincreasing fee income resulted in growth of $474 in trust income and $309 ininvestment product sales. Rental income from Sun entering into operating leaseagreements with its customers increased $775 resulting in an other incomeincrease of 105.2% or $753.  Gains on thesale of loans decreased $208 as the six months ended June 30, 2003included $160 from a pooled sale of SBA loans. Security gains decreased $1,886 as the six months ended June 30,2003 included a significant investment portfolio restructuring resulting in netgains of $2,497.

 

Non-interest expenses increased $2,059 or 15.0% to $13,704 for the sixmonths ended June 30, 2004 compared to the corresponding period of2003.  All categories of non-interestexpense have been impacted by the acquisitions of Mid-Penn InsuranceAssociates, Inc. and Steelton Bancorp in April 2003 and Sentry TrustCompany during 2004.  Salaries andemployee benefits increased $589 or 9.0% due to the acquisitions and increasedemployee benefit costs as average full time equivalent

 

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employees increased from 293 to 314 for the six months endedJune 30, 2003 and 2004.  Netoccupancy expense and furniture and equipment expenses increased $252 or 14.8%primarily due to acquisitions.  Otherexpenses increased 19.0% or $1,022 due to increases in normal businessexpenses, acquisitions, and depreciation related to operating leases.  Depreciation related to operating leasesaccounted for $616 or 65.9% of the increase in other expenses.  Amortization of intangibles increased $196due to the amortization of customer relationship intangibles from the Mid-PennInsurance and Sentry Trust Company acquisitions and also the amortization ofcore deposit intangibles from the Steelton Bancorp and Mellon branchacquisitions.  Refer to Note 7 foradditional information regarding intangibles.

 

Balance Sheet – June 30, 2004 and December 31, 2003

 

Total assets increased $17,424 to $1,045,677 at June 30, 2004 from$1,028,253 at December 31, 2003. Cash and cash equivalents decreased $3,676, or 12.9% from $28,421 atDecember 31, 2003 as cash was utilized as a component of the considerationpaid for Sentry Trust Company (cash $6,674, stock $9,291).  The investment portfolio increased $6,392 or2.9%, as cash flows from net loan repayments were reallocated to the investmentportfolio.  The decline in net loansoutstanding of $5,760 was the result of continued prepayments, a decline inoverall loan demand, and the selling of residential mortgages at origination.The allowance for loan and lease losses increased $980 and is discussed ingreater detail in the Allowance for Loan and Lease Losses section ofManagement’s Discussion and Analysis. The increases in fixed assets, intangibles, and other assets areprimarily the result of the previously mentioned acquisitions.

 

Totalliabilities increased $10,873 to $959,944 at June 30, 2004 fromDecember 31, 2003.  Total depositsincreased $29,887 to $644,437, with core deposits (non-time deposits)contributing $20,951 to the increase. Since December 31, 2003, money market accounts have increased$21,416 or 95.3%.  The increase in moneymarket accounts is the result of a deposit gathering campaign that placesparticular emphasis on money market accounts. Time deposits increased $8,936 from December 31, 2003 as Sun hasplaced emphasis on gathering time deposit with a maturity greater than twoyears.  Since December 31, 2003,non-interest-bearing deposits have decreased 3.5% to $67,195.  Short-term borrowings decreased $21,755 fromDecember 31, 2003, due to the payoff of short-term FHLB borrowings.  The funds used to payoff the short-termborrowings were from the increase in deposits..

 

Sun’s total shareholders’ equity increased $6,551 or 8.3% to $85,733from December 31, 2003 to June 30, 2004.  The increase is primarily the net result ofthe acquisition of Sentry Trust Company offset by a change in accumulated othercomprehensive income.  The acquisition ofSentry Trust Company resulted in an increase of $9,291 as Sun issuedapproximately a half million shares from authorized, non-issued, and treasuryas a component of the purchase price. Accumulated other comprehensive income decreased $2,925 to $(2,896) atJune 30, 2004 due to a decrease in the market value of Sun’s investmentportfolio.  Net income of $2,735increased shareholders’ equity, however,

 

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the increase was offset by the payment of $2,791 in dividends toshareholders during the six months ended June 30, 2004.

 

Allowance for Loan and Lease Losses 

 

Sun maintains anAllowance for Loan and Lease Losses (ALLL) in an effort to provide for lossesinherent in its loan and lease portfolio. Loan and lease losses are chargedagainst the ALLL in the period in which they have been determineduncollectible. Recoveries of previously charged-off loans and leases arecredited to the ALLL when received. Management believes the ALLL is adequate asof June 30, 2004.

 

Sun’s methodology for calculating its ALLLconsists of three components:

• specificallocations for loans evaluated by management and deemed to have an increasedlevel of inherent risks;

• a generalallocation, which varies for each type of homogenous loan pool within theportfolio;

•and qualitative factors which are discussed below.

 

Specific reserves are established for loansof all types that management deems to be risk-rated as Other Assets EspeciallyMentioned (OAEM) or lower. The allocation based on specific risk-rated creditsis calculated by applying a risk factor (from 3% to 100%) against the loanbased on the severity of risk-rating. All loans are risk-rated; however, consumer loans and residentialmortgages generally receive a favorable rating unless and until a history ofdelinquency becomes evident. Commercial loans are continuously reviewed and aspecific reserve is allocated once a loan has fallen to OAEM or lower status.

 

Loans of all types, for which there are nospecific reserves, are evaluated as a homogeneous group based on commoncharacteristics. Management determines the general allocation by applying afactor primarily based on Sun’s loss experience over the previous five completeyears and the current partial year.

 

Sun’s assessment of the ALLL also considersadditional qualitative factors reflective of economic conditions, management’slending policies, the nature and volume of loan portfolio changes, creditmanagement, credit review, risk profile, classified assets, historic collectionand charge-off practices, portfolio concentrations, and external factors suchas competition, legal and regulatory requirements.

 

Sun’s loan review and underwriting processincludes risk-based pricing in the loan structuring process.  Sun also utilizes a loan quality committee,comprised of members of senior management and representatives of the Board ofDirectors, that meets monthly overseeing overall credit quality.

 

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Management continued to closely monitor credit quality during the sixmonths ended June 30, 2004. The ALLL, as a percentage of total loans andleases, increased to 1.29% at June 30, 2004 from 1.14% of total loans atDecember 31, 2003. The increase was due to the changing mix of loanswithin the portfolio and an increase in specific reserve for several watch listloans.  A significant improvement in netcharge-offs compared to prior periods limited the increase in the provision forloan and lease losses.  Changes in thecomposition of the loan and lease portfolio affected the allocation withinALLL. Most notably, commercial and industrial loans and real estatecollateralized commercial loans, included within the real estate category, havebecome an increasing percentage of the overall loan portfolio as Sun has beenselling new residential mortgages on the secondary market within seven days ofthe loan closing. Accordingly, because commercial and industrial loans and realestate collateralized commercial loans are generally associated with a higherelement of risk compared to residential mortgages, a higher percentage of theALLL is directed toward commercial and industrial loans. Moreover, increases inauto leases have required a higher general allocation in the ALLL because ofthe historically higher industry wide loss rates on this type of asset.

 

Sun’s ALLL reflects periodic provisions forloan and lease losses determined through the application of Sun’s ALLLmethodology discussed above. The provision for loan and lease losses is theexpense necessary to maintain the ALLL at a level adequate to encompassmanagement’s best estimate of probable losses in the loan and lease portfolio.Management increased the provision for loan and lease losses to $450 and $885for the three and six-month periods ended June 30, 2004 compared to $405and $810 for the same periods in 2003. The provision was increased in 2004based on a larger loan portfolio, in part due to a merger with Steelton Bancorpduring 2003, due to the changing mix of loans within the portfolio as discussedabove, and several watch list loans requiring a higher specific reserve.

 

Determining the level of the ALLL at anygiven period is difficult, particularly during deteriorating or uncertaineconomic periods. Management must make estimates using information andassumptions that are often subjective and rapidly changing. Managementcontinues to review the loan and lease portfolios in light of a changingeconomy and the dynamics of the banking and regulatory environment.

 

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 managementto increase the ALLL. Such developments could include changing economicconditions or negative developments with borrowers. In addition, bankregulators periodically assess Sun’s ALLL and may, consistent with examinationguidelines and current information, require an increased ALLL. As a result, anynumber of factors may materially change management’s analysis in the future.

 

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Deposits

 

Sun’stotal deposits increased $29,887 or 4.9%, to $644,437 at June 30, 2004,compared to $614,550, at December 31, 2003.  This increase is the result of Sun’s focus ongrowing low cost core deposits (all deposits excluding time deposits) andbuilding relationships with local municipalities, colleges, andbusinesses.  The focus on obtaining coredeposits resulted in a core deposit increase of 6.2% or $20,951, to $360,271 atJune 30, 2004, compared to $339,320, at December 31, 2003.  As part of this process, Sun began amarketing and pricing program to attract money market accounts during the firstsix months of 2004.  The result was a$21,416 or 95.3% increase in money market accounts since December 31,2003.  Time deposits have increased$8,936 or 3.2% since December 31, 2003 as emphasis has been placed onattracting time deposits having a maturity greater than two years.  Over the same time period, demand deposit,savings, and NOW accounts have remained constant with each category having lessthan a $2,500 balance fluctuation.

 
| ** **          | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** | **Change** | ** ** |
|---------------------|------------|------------------------|------------|----------------------------|------------|------------|------------|
| **(In  Thousands)** | ** ** | **Amount**             | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Demand deposits     |       | $                      | 67,195     |                       | 10.4       | %          | $          | 69,640 |   | 11.3 | % | $ | (2,445 | ) | (3.5 | )% |
| NOW accounts        |       | 164,476                |       | 25.5                       |       | 164,803    |       | 26.8 |   | (327 | ) | (0.2 | ) |
| Insured MMDA        |       | 43,877                 |       | 6.8                        |       | 22,461     |       | 3.7 |   | 21,416 |   | 95.3 |   |
| Savings deposits    |       | 84,723                 |       | 13.1                       |       | 82,416     |       | 13.4 |   | 2,307 |   | 2.8 |   |
| Time deposits       |       | 284,166                |       | 44.2                       |       | 275,230    |       | 44.8 |   | 8,936 |   | 3.2 |   |
| Total deposits      |       | $                      | 644,437    |                       | 100.0      | %          | $          | 614,550 |   | 100.0 | % | $ | 29,887 |   | 4.9 | % |
|                |       |                   |       |                       |       |       |       |   |   |   |   |   |   |
| Core deposits*      |       | $                      | 360,271    |                       | 55.9       | %          | $          | 339,320 |   | 55.2 | % | $ | 20,951 |   | 6.2 | % |

 

Time deposit totals above include certificates of deposit and othertime deposits issued in amounts of $100,000 or more.  These deposits and their remainingmaturities, at June 30, 2004 and December 31, 2003, are listed below:

 
| ** **                | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** | **Change** | ** ** |
|---------------------------|------------|------------------------|------------|----------------------------|------------|------------|------------|
| **(In  Thousands)**       | ** ** | **Amount**             | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Three months or less      |       | $                      | 18,114     |                       | 28.4       | %          | $          | 20,487 |   | 35.6 | % | $ | (2,373 | ) | (37.3 | )% |
| Three through six months  |       | 4,053                  |       | 6.3                        |       | 12,818     |       | 22.2 |   | (8,765 | ) | (137.7 | ) |
| Six through twelve months |       | 25,310                 |       | 39.5                       |       | 8,515      |       | 14.8 |   | 16,795 |   | 263.9 |   |
| Over twelve months        |       | 16,525                 |       | 25.8                       |       | 15,817     |       | 27.4 |   | 708 |   | 11.1 |   |
| Total                     |       | $                      | 64,002     |                       | 100.0      | %          | $          | 57,637 |   | 100.0 | % | $ | 6,365 |   | 11.0 | % |

 

28

----

 

Other Funding

 

Suncontinued using borrowings as a supplemental source of funding during 2004 and2003.  At June 30, 2004, Sun had$254,088 in outstanding long-term debt. This funding consisted primarily of $224,110 in variable rate FHLBborrowings with maturities between 2005 and 2013.  Sun also had $11,900 in long-term repurchaseagreements at June 30, 2004.  Inaddition, Sun had $18,078 in long term subordinated debentures at June 30,2004, that consisted of $16,500 in trust preferred securities with a maturityof February 22, 2031 and an initial call of February 22, 2011.  The remaining $1,578 was the result of a noteissued for the purchase of Guaranty Bank, N.A., during 2001 and carries a rateof 6% and matures in 2006.

 

Other short-term funding sources include deposit customers’ cashmanagement accounts (classified as securities sold under agreements torepurchase), Treasury Tax and Loan Note Option, repurchase agreements, and FHLBovernight borrowings.  At June 30,2004, Sun’s short-term borrowings consisted primarily of cash managementaccounts in the amount of $19,601 and FHLB overnight borrowings of $23,910.

 

29

----

 

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

 

Netinterest income, the difference between interest income and interest expense,is the largest component of Sun’s earnings. Net interest margin (NIM) measures the difference between the yield oninterest earning assets and the aggregate funding cost.  NIM is calculated as taxable equivalent netinterest income divided by average interest earning assets.

 

Sun’sNIM decreased by 1 basis point to 2.68% and increased by 6 basis points to2.77% for the three and six-month periods ended June 30, 2004, compared to2.69% and 2.71%, for the same periods of 2003. The increase is primarily the result of two actions.  The first action was the entering into offour swap contracts on June 30, 2003, involving the long-term FHLBadvances.  The second action centeredaround Sun’s change in pricing strategy resulting in a decrease in rates paidon deposit accounts.  These actionscoupled, with a core deposit gathering campaign focused on money marketaccounts, countered the continued decline in loan and investment portfolioyields related due to prepayments and scheduled payments of higher coupon loansand investments.

 

The previously mentioned swaps were entered into to reduce net interestincome volatility due to changes in market interest rates.  The contracts, which involve the long-termFHLB advances, increased net interest income by $370 and $742 and the NIM by 16and 17 basis points for the three and six-months ended June 30, 2004,respectively, compared to the three and six-months ended June 30, 2003.  Embedded in each swap is an option to reversethe original swap (receive fixed-pay variable), at any time, to payfixed-receive variable if the FHLB notifies the Bank that it is going toexercise the option to increase the Bank’s interest rate on the debt.  Thus, in a rising rate environment the Bankhas locked in a fixed rate.  Despitebeing able to lock in a fixed rate, an upward movement in the 90-day LIBOR ratewill reduce the positive NIM impact of the swap and will cause a negative NIMimpact during the period that 90-day LIBOR is above 2.65% and the point atwhich the FHLB would reprice the debt. Readers are encouraged to refer to Note 11 to the Financial Statementsunder Item 1for further information on Sun’s hedging activities.

 

30

----

 

The following table sets forth comparativeyields and rates paid for interest bearing assets and liabilities:

 
| ** **                                                          | ** ** | **For the Three Months Ended** | ** **    |
|---------------------------------------------------------------------|------------|--------------------------------|---------------|
| ** **                                                          | ** ** | **June 30, 2004**         | ** **    | **June 30, 2003** | ** ** |
| **(In  Thousands)**                                                 | ** ** | **Average  Balance**           | ** **    | **Interest** | ** ** | **Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **ASSETS**                                                          |       |                           |          |   |   |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                                           |       |                           |          |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits                                          | ** ** | **$**                          | **8,603**     | ** ** | **$** | **20** | ** ** | **0.93** | **%** | $ | 11,528 |   | $ | 39 |   | 1.36 | % |
| Loans  (net of unearned income)                                     | ** ** | **676,904**                    | ** **    | **9,866** | ** ** | **5.86** |   | 642,585 |   | 10,463 |   | 6.53 |   |
| Investments:                                                        |       |                           |          |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                             | ** ** | **205,066**                    | ** **    | **1,762** | ** ** | **3.46** |   | 243,753 |   | 2,346 |   | 3.85 |   |
| Tax-exempt                                                          | ** ** | **16,228**                     | ** **    | **272** | ** ** | **6.74** |   | 19,597 |   | 324 |   | 6.62 |   |
| **Total interest-earning assets**                                   | ** ** | **906,801**                    | ** **    | **11,920** | ** ** | **5.28** |   | 917,463 |   | 13,172 |   | 5.76 |   |
|                                                                |       |                           |          |   |   |   |   |   |   |   |   |   |   |
| **Noninterest-earning assets:**                                     |       |                           |          |   |   |   |   |   |   |   |   |   |   |
| Cash  and due from banks                                            | ** ** | **23,708**                     |          |   |   |   |   | 22,245 |   |   |   |   |   |
| Bank  premises & equipment                                      | ** ** | **32,259**                     |          |   |   |   |   | 18,723 |   |   |   |   |   |
|                                                                |       |                           |          |   |   |   |   |   |   |   |   |   |   |
| Accrued  interest and other assets                                  | ** ** | **85,808**                     |          |   |   |   |   | 76,932 |   |   |   |   |   |
| Less:  Allowance for loan losses                                    | ** ** | **(8,584**                     | **)**         |   |   |   |   | (7,101 | ) |   |   |   |   |
| Unamortized  loan fees                                              | ** ** | **322**                        |          |   |   |   |   | 218 |   |   |   |   |   |
| Total  assets                                                       | ** ** | **$**                          | **1,040,314** |   |   |   |   |   | $ | 1,028,480 |   |   |   |   |   |
|                                                                | ** ** | ** **                     |          |   |   |   |   |   |   |   |   |   |   |
|                                                                | ** ** | ** **                     |          |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                       | ** ** | ** **                     |          |   |   |   |   |   |   |   |   |   |   |
| ** **                                                          | ** ** | ** **                     |          |   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing liabilities:**                                   | ** ** | ** **                     |          |   |   |   |   |   |   |   |   |   |   |
| ** **                                                          | ** ** | ** **                     |          |   |   |   |   |   |   |   |   |   |   |
| NOW Accounts                                                        |       | **$**                          | **170,215**   | ** ** | **$** | **230** | ** ** | **0.54** | **%** | $ | 165,746 |   | $ | 350 |   | 0.85 | % |
| Insured Money Market Accounts                                       |       | **39,428**                     | ** **    | **135** | ** ** | **1.38** | ** ** | 28,369 |   | 98 |   | 1.39 |   |
| Savings deposits                                                    |       | **84,735**                     | ** **    | **69** | ** ** | **0.33** | ** ** | 87,172 |   | 201 |   | 0.93 |   |
| Time deposits                                                       |       | **296,870**                    | ** **    | **2,031** | ** ** | **2.75** | ** ** | 291,711 |   | 2,422 |   | 3.34 |   |
| Short-term borrowings                                               |       | **24,356**                     | ** **    | **60** | ** ** | **0.99** | ** ** | 48,081 |   | 140 |   | 1.17 |   |
| Subordinated debentures                                             |       | **18,606**                     | ** **    | **453** | ** ** | **9.79** | ** ** | 19,646 |   | 465 |   | 9.52 |   |
| Long-term borrowings                                                |       | **240,824**                    | ** **    | **2,899** | ** ** | **4.84** | ** ** | 243,318 |   | 3,346 |   | 5.53 |   |
| **Total  interest-bearing liabilities**                             |       | **875,034**                    | ** **    | **5,877** | ** ** | **2.70** | ** ** | 884,043 |   | 7,022 |   | 3.19 |   |
| ** **                                                          |       | ** **                     | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **Noninterest-bearing  liabilities and shareholders’ equity:** |       | ** **                     | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| ** **                                                          |       | ** **                     | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Demand deposits                                                     |       | **69,872**                     | ** **    | ** ** | ** ** | ** ** | ** ** | 60,180 |   |   |   |   |   |
| Accrued interest and other                                          |       | ** **                     | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| liabilities                                                         |       | **7,824**                      | ** **    | ** ** | ** ** | ** ** | ** ** | 2,798 |   |   |   |   |   |
| Shareholders’ equity                                           |       | **87,584**                     | ** **    | ** ** | ** ** | ** ** | ** ** | 81,459 |   |   |   |   |   |
| Total liabilities and shareholders’ equity                     |       | **$**                          | **1,040,314** | ** ** | ** ** | ** ** | ** ** | ** ** | $ | 1,028,480 |   |   |   |   |   |
|                                                                |       | ** **                     | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Interest rate spread                                                |       | ** **                     | ** **    | ** ** | ** ** | **2.58** | **%** |   |   |   |   | 2.57 | % |
|                                                                |       | ** **                     | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Net interest income/margin                                          |       | ** **                     | ** **    | **$** | **6,043** | ** ** | **2.68** | **%** |   |   | $ | 6,150 |   | 2.69 | % |

 

----

(1)  Average loan balances include non-accrualloans.  Interest income includes fees onloans.

(2) Interest income and yields on tax-exempt loans and investments have beenadjusted to a fully taxable equivalent basis using a 34% federal income taxrate.

 

31

----

 

 

The following table sets forth comparativeyields and rates paid for interest bearing assets and liabilities:

 
| ** **                                                          | ** ** | **For the Six Months Ended** | ** **    |
|---------------------------------------------------------------------|------------|------------------------------|---------------|
| ** **                                                          | ** ** | **June 30, 2004**       | ** **    | **June 30, 2003** | ** ** |
| **(In  Thousands)**                                                 | ** ** | **Average  Balance**         | ** **    | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Average  Interest** | ** ** | **Rate** | ** ** |
| **ASSETS**                                                          |       |                         |          |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                            |       |                         |          |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits                                           |       | **$**                        | **7,300**     | ** ** | **$** | **33** | ** ** | **0.91** | **%** | $ | 14,486 |   | $ | 91 |   | 1.27 | % |
| Loans (net of unearned income)                                      |       | **678,162**                  | ** **    | **19,892** | ** ** | **5.90** | ** ** | 624,133 |   | 20,285 |   | 6.55 |   |
| Investments:                                                        |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Taxable                                                             |       | **196,354**                  | ** **    | **3,537** | ** ** | **3.60** | ** ** | 231,458 |   | 4,756 |   | 4.11 |   |
| Tax-exempt                                                          |       | **17,376**                   | ** **    | **579** | ** ** | **6.66** | ** ** | 19,452 |   | 675 |   | 6.94 |   |
| **Total  interest-earning assets**                                  |       | **899,192**                  | ** **    | **24,041** | ** ** | **5.36** | ** ** | 889,529 |   | 25,807 |   | 5.84 |   |
|                                                                |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **Noninterest-earning  assets:**                                    |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| ** **                                                          |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Cash and due from banks                                             |       | **24,127**                   | ** **    | ** ** | ** ** | ** ** | ** ** | 20,761 |   |   |   |   |   |
| Bank premises & equipment                                       |       | **30,731**                   | ** **    | ** ** | ** ** | ** ** | ** ** | 17,442 |   |   |   |   |   |
|                                                                |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Accrued interest and other assets                                   |       | **85,376**                   | ** **    | ** ** | ** ** | ** ** | ** ** | 73,614 |   |   |   |   |   |
| Less: Allowance for loan losses                                     |       | **(8,268**                   | **)**         | ** ** | ** ** | ** ** | ** ** | (6,737 | ) |   |   |   |   |
| Unamortized loan fees                                               |       | **330**                      | ** **    | ** ** | ** ** | ** ** | ** ** | 212 |   |   |   |   |   |
| Total assets                                                        |       | **$**                        | **1,031,488** | ** ** | ** ** | ** ** | ** ** | ** ** | $ | 994,821 |   |   |   |   |   |
|                                                                |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                       |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| ** **                                                          |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **Interest-bearing  liabilities:**                                  |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| ** **                                                          |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| NOW Accounts                                                        |       | **$**                        | **166,263**   | ** ** | **$** | **428** | ** ** | **0.52** | **%** | $ | 161,147 |   | $ | 728 |   | 0.91 | % |
| Insured Money Market Accounts                                       |       | **32,961**                   | ** **    | **198** | ** ** | **1.21** | ** ** | 27,072 |   | 197 |   | 1.47 |   |
| Savings deposits                                                    |       | **84,008**                   | ** **    | **149** | ** ** | **0.36** | ** ** | 83,069 |   | 393 |   | 0.95 |   |
| Time deposits                                                       |       | **292,058**                  | ** **    | **4,037** | ** ** | **2.78** | ** ** | 283,880 |   | 4,880 |   | 3.47 |   |
| Short-term borrowings                                               |       | **32,576**                   | ** **    | **150** | ** ** | **0.93** | ** ** | 40,704 |   | 247 |   | 1.22 |   |
| Subordinated debentures                                             |       | **18,736**                   | ** **    | **909** | ** ** | **9.70** | ** ** | 19,651 |   | 933 |   | 9.50 |   |
| Other borrowed funds                                                |       | **239,490**                  | ** **    | **5,800** | ** ** | **4.87** | ** ** | 233,564 |   | 6,484 |   | 5.60 |   |
| **Total  interest-bearing liabilities**                             |       | **866,092**                  | ** **    | **11,671** | ** ** | **2.71** | ** ** | 849,087 |   | 13,862 |   | 3.29 |   |
|                                                                |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **Noninterest-bearing  liabilities and shareholders’ equity:** |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| ** **                                                          |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Demand deposits                                                     |       | **68,459**                   | ** **    | ** ** | ** ** | ** ** | ** ** | 58,203 |   |   |   |   |   |
| Accrued interest and other liabilities                              |       | **9,151**                    | ** **    | ** ** | ** ** | ** ** | ** ** | 5,603 |   |   |   |   |   |
| Shareholders’ equity                                           |       | **87,786**                   | ** **    | ** ** | ** ** | ** ** | ** ** | 81,928 |   |   |   |   |   |
| Total liabilities and shareholders’ equity                     |       | **$**                        | **1,031,488** | ** ** | ** ** | ** ** | ** ** | ** ** | $ | 994,821 |   |   |   |   |   |
|                                                                |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Interest rate spread                                                |       | ** **                   | ** **    | ** ** | ** ** | **2.65** | **%** |   |   |   |   | 2.55 | % |
|                                                                |       | ** **                   | ** **    | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Net interest income/margin                                          |       | ** **                   | ** **    | **$** | **12,370** | ** ** | **2.77** | **%** |   |   | $ | 11,945 |   | 2.71 | % |

 

----

(1)   Average loan balances include non-accrualloans.  Interest income includes fees onloans.

(2)  Interest income and yields on tax-exempt loans and investments have beenadjusted to a fully taxable equivalent basis using a 34% federal income taxrate.

 

32

----

 

The following rate/volume analysis representsthe portions of the net change in interest income due to changes in volume orrate on a tax equivalent basis using a federal income tax rate of 34%.  Changes in net interest income, for the threeand six-month periods ended June 30, 2004 compared to the same periods in2003, due to rate and volume have been allocated to changes due to volume andrate in proportion to the absolute amount of change in each.

 
| ** **                         | ** ** | **Three Months Ended June 30, 2004 Compared to 2003  Increase (Decrease)** | ** ** | **Six Months Ended June 30, 2004 Compared to 2003  Increase (Decrease)** | ** ** |
|------------------------------------|------------|---------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| **(In  Thousands)**                | ** ** | **Volume**                                                                      | ** ** | **Rate**                                                                      | ** ** | **Net Change** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net Change** | ** ** |
| Interest earned on:                |       |                                                                            |       |                                                                          |       |   |   |   |   |   |   |   |   |
| Interest -bearing deposits         |       | $                                                                               | (10        | )                                                                             | $          | (9 | ) | $ | (19 | ) | $ | (45 | ) | $ | (13 | ) | $ | (58 | ) |
| Loans                              |       | 557                                                                             |       | (1,154                                                                        | )          | (597 | ) | 1,817 |   | (2,210 | ) | (393 | ) |
| Investments:                       |       |                                                                            |       |                                                                          |       |   |   |   |   |   |   |   |   |
| Taxable                            |       | (378                                                                            | )          | (206                                                                          | )          | (584 | ) | (743 | ) | (476 | ) | (1,219 | ) |
| Tax exempt                         |       | (56                                                                             | )          | 4                                                                             |       | (52 | ) | (75 | ) | (21 | ) | (96 | ) |
| Total interest-earning assets      |       | 113                                                                             |       | (1,365                                                                        | )          | (1,252 | ) | 954 |   | (2,720 | ) | (1,766 | ) |
|                               |       |                                                                            |       |                                                                          |       |   |   |   |   |   |   |   |   |
| Interest paid on:                  |       |                                                                            |       |                                                                          |       |   |   |   |   |   |   |   |   |
| NOW Accounts                       |       | 10                                                                              |       | (130                                                                          | )          | (120 | ) | 25 |   | (325 | ) | (300 | ) |
| Insured Money Market Accounts      |       | 38                                                                              |       | (1                                                                            | )          | 37 |   | 44 |   | (43 | ) | 1 |   |
| Savings deposits                   |       | (7                                                                              | )          | (125                                                                          | )          | (132 | ) | 6 |   | (250 | ) | (244 | ) |
| Time deposits                      |       | 43                                                                              |       | (434                                                                          | )          | (391 | ) | 155 |   | (998 | ) | (843 | ) |
| Short-term borrowings              |       | (68                                                                             | )          | (12                                                                           | )          | (80 | ) | (49 | ) | (48 | ) | (97 | ) |
| Subordinated debentures            |       | (6                                                                              | )          | (6                                                                            | )          | (12 | ) | (48 | ) | 24 |   | (24 | ) |
| Other borrowed funds               |       | (14                                                                             | )          | (433                                                                          | )          | (447 | ) | 183 |   | (867 | ) | (684 | ) |
| Total interest-bearing liabilities |       | (4                                                                              | )          | (1,141                                                                        | )          | (1,145 | ) | 316 |   | (2,507 | ) | (2,191 | ) |
| Net interest income                |       | $                                                                               | 117        |                                                                          | $          | (224 | ) | $ | (107 | ) | $ | 638 |   | $ | (213 | ) | $ | 425 |   |

 

33

----

 

 

Income and Expense Changes

 

The table below presents consolidated comparative changes in income andexpense, and also presents changes in average asset and liability volumes.  Tax-exempt income is not shown on a taxequivalent basis.   The following tablerepresents the three and six-month periods ended June 30, 2004 andJune 30, 2003:

 
| ** **                                                     | ** ** | **Three Months Ended June 30, 2004 Compared to 2003** | ** ** | **Six Months Ended June 30, 2004 Compared to 2003** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                     | ** ** | **Average**                                                | ** ** | **Volume**                                               | ** ** | **Income/Expense** | ** ** | **Average** | ** ** | **Volume** | ** ** | **Income/Expense** | ** ** |
| **(In  Thousands)**                                            | ** ** | **$ Change**                                          | ** ** | **% Change**                                             | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Loans, net                                                     |       | $                                                          | 34,319     |                                                     | 5.34       | % | $ | (614 | ) | (5.93 | )% | $ | 54,029 |   | 8.66 | % | $ | (417 | ) | (2.08 | )% |
| Investment securities                                          |       | (42,056                                                    | )          | (15.97                                                   | )          | (619 | ) | (24.18 | ) | (37,180 | ) | (14.82 | ) | (1,282 | ) | (24.65 | ) |
| Interest-bearing deposits                                      |       | (2,925                                                     | )          | (25.37                                                   | )          | (19 | ) | (48.72 | ) | (7,186 | ) | (49.61 | ) | (58 | ) | (63.74 | ) |
| Total interest-earning assets                                  |       | $                                                          | (10,662    | )                                                        | (1.16      | )% | $ | (1,252 | ) | (9.51 | )% | $ | 9,663 |   | 1.09 | % | $ | (1,757 | ) | (6.94 | )% |
|                                                           |       |                                                       |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW Accounts                                                   |       | $                                                          | 4,469      |                                                     | 2.70       | % | $ | (120 | ) | (34.29 | )% | $ | 5,116 |   | 3.17 | % | $ | (300 | ) | (41.21 | )% |
| Insured Money Market Accounts                                  |       | 11,059                                                     |       | 38.98                                                    |       | 37 |   | 37.76 |   | 5,889 |   | 21.75 |   | 1 |   | 0.51 |   |
| Savings deposits                                               |       | (2,437                                                     | )          | (2.80                                                    | )          | (132 | ) | (65.67 | ) | 939 |   | 1.13 |   | (244 | ) | (62.09 | ) |
| Time deposits                                                  |       | 5,159                                                      |       | 1.77                                                     |       | (391 | ) | (16.14 | ) | 8,178 |   | 2.88 |   | (843 | ) | (17.27 | ) |
| Short-term borrowings                                          |       | (23,725                                                    | )          | (49.34                                                   | )          | (80 | ) | (57.14 | ) | (8,128 | ) | (19.97 | ) | (97 | ) | (39.27 | ) |
| Subordinated debentures                                        |       | (1,040                                                     | )          | (5.29                                                    | )          | (12 | ) | (2.58 | ) | (915 | ) | (4.66 | ) | (24 | ) | (2.57 | ) |
| Other borrowed funds                                           |       | (2,494                                                     | )          | (1.02                                                    | )          | (447 | ) | (13.36 | ) | 5,926 |   | 2.54 |   | (684 | ) | (10.55 | ) |
| Total interest-bearing liabilities                             |       | $                                                          | (9,009     | )                                                        | (1.02      | )% | $ | (1,145 | ) | (16.31 | )% | $ | 17,005 |   | 2.00 | % | $ | (2,191 | ) | (15.81 | )% |
|                                                           |       |                                                       |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                            |       |                                                       |       |                                                     |       | $ | (107 | ) | (1.81 | )% |   |   |   |   | $ | 434 |   | 3.78 | % |
| Provision for loan and lease losses                            |       |                                                       |       |                                                     |       | 45 |   | 11.11 |   |   |   |   |   | 75 |   | 9.26 |   |
| Net interest income after provision for loan and  lease losses |       |                                                       |       |                                                     |       | (152 | ) | (2.75 | ) |   |   |   |   | 359 |   | 3.37 |   |
| Service charges on deposit accounts                            |       |                                                       |       |                                                     |       | 74 |   | 7.53 |   |   |   |   |   | 268 |   | 14.66 |   |
| Trust income                                                   |       |                                                       |       |                                                     |       | 361 |   | 177.83 |   |   |   |   |   | 474 |   | 112.32 |   |
| Net securities gains                                           |       |                                                       |       |                                                     |       | (499 | ) | (49.85 | ) |   |   |   |   | (1,886 | ) | (75.53 | ) |
| Investment sales                                               |       |                                                       |       |                                                     |       | 168 |   | 215.38 |   |   |   |   |   | 309 |   | 302.94 |   |
| Bank owned life insurance                                      |       |                                                       |       |                                                     |       | 14 |   | 4.42 |   |   |   |   |   | 1 |   | 0.16 |   |
| Insurance subsidiary                                           |       |                                                       |       |                                                     |       | 129 |   | 37.94 |   |   |   |   |   | 767 |   | 211.29 |   |
| Gain on sale of loans                                          |       |                                                       |       |                                                     |       | 19 |   | 44.19 |   |   |   |   |   | (208 | ) | (68.42 | ) |
| Leasing subsidiary                                             |       |                                                       |       |                                                     |       | (9 | ) | (3.44 | ) |   |   |   |   | (38 | ) | (6.75 | ) |
| Other income                                                   |       |                                                       |       |                                                     |       | 478 |   | 149.38 |   |   |   |   |   | 753 |   | 105.17 |   |
| Total other non-interest income                                |       |                                                       |       |                                                     |       | 735 |   | 20.72 |   |   |   |   |   | 440 |   | 5.92 |   |
|                                                           |       |                                                       |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                                 |       |                                                       |       |                                                     |       | 262 |   | 7.67 |   |   |   |   |   | 589 |   | 8.95 |   |
| Net occupancy expense                                          |       |                                                       |       |                                                     |       | 110 |   | 33.13 |   |   |   |   |   | 165 |   | 23.08 |   |
| Net furniture and equipment expenses                           |       |                                                       |       |                                                     |       | 45 |   | 8.95 |   |   |   |   |   | 88 |   | 8.89 |   |
| Amortization of intangibles                                    |       |                                                       |       |                                                     |       | 87 |   | 228.95 |   |   |   |   |   | 195 |   | 513.16 |   |
| Other expenses                                                 |       |                                                       |       |                                                     |       | 599 |   | 21.00 |   |   |   |   |   | 1,022 |   | 19.00 |   |
| Total other non-interest expense                               |       |                                                       |       |                                                     |       | 1,103 |   | 15.45 |   |   |   |   |   | 2,059 |   | 15.02 |   |
| Income before income tax provision                             |       |                                                       |       |                                                     |       | (520 | ) | (27.01 | ) |   |   |   |   | (1,260 | ) | (28.67 | ) |
| Income tax provision                                           |       |                                                       |       |                                                     |       | (56 | ) | (23.83 | ) |   |   |   |   | (271 | ) | (40.39 | ) |
| Net income                                                     |       |                                                       |       |                                                     |       | $ | (464 | ) | (27.46 | )% |   |   |   |   | $ | (989 | ) | (26.56 | )% |

 

34

----

 

#### **Non-interestIncome**

 

Non-interestincome, excluding security gains, increased $1,234 or 48.5% to $3,780, for thethree months ended June 30, 2004 compared to the corresponding period of2003.  Increased service charges ondeposits accounted for $74 of the increase which was due, in part, to theApril 2003 Steelton Bancorp acquisition and also to the continued growthin Sun’s overdraft honor program.  Income from insurance fees increased $129 primarily as the result ofSun’s acquisition of Mid-Penn Insurance in April 2003.  Income from investment product sales and trustincome increased $168 and $361, respectively due in part to the acquisition ofSentry Trust Company during the first quarter of 2004 and the continuedimprovement in the company’s delivery of brokerage services.  Other income increased $478 principally dueto a $422 increase in rental income from operating leases.  Net security gains decreased $499, comparedto the three months ended June 30, 2003. During 2003, Sun realigned its portfolio to better serve its needs inthe then current interest rate environment resulting in significant gains onsales during that period.

 

Non-interestincome, excluding security gains, increased $2,326 or 47.1% to $7,266, for thesix months ended June 30, 2004 compared to the corresponding period of2003.  The increase in non-interestincome was primarily driven by the impact of the Sentry Trust Company and MidPenn Insurance acquisitions during 2004 and 2003, respectively, in addition toincreases in rental income from operating leases.

 

 
| ** **                            | ** ** | **For The Three Months Ended** | ** ** |
|---------------------------------------|------------|--------------------------------|------------|
| ** **                            | ** ** | **June 30, 2004**         | ** ** | **June 30, 2003** | ** ** | **Change** | ** ** |
| **(In Thousands)**                    | ** ** | **Amount**                     | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Service charge on  deposit accounts   |       | $                              | 1,057      |   | 24.8 | % | $ | 983 |   | 27.8 | % | $ | 74 |   | 7.5 | % |
| Trust income                          |       | 564                            |       | 13.2 |   | 203 |   | 5.7 |   | 361 |   | 177.8 |   |
| Net security gains                    |       | 502                            |       | 11.7 |   | 1,001 |   | 28.2 |   | (499 | ) | (49.9 | ) |
| Income from investment  product sales |       | 246                            |       | 5.7 |   | 78 |   | 2.2 |   | 168 |   | 215.4 |   |
| Bank owned life  insurance            |       | 331                            |       | 7.7 |   | 317 |   | 8.9 |   | 14 |   | 4.4 |   |
| Income from insurance  subsidiary     |       | 469                            |       | 11.0 |   | 340 |   | 9.6 |   | 129 |   | 37.9 |   |
| Gain on sale of loans                 |       | 62                             |       | 1.4 |   | 43 |   | 1.2 |   | 19 |   | 44.2 |   |
| Income from leasing  subsidiary       |       | 253                            |       | 5.9 |   | 262 |   | 7.4 |   | (9 | ) | (3.4 | ) |
| Other income                          |       | 798                            |       | 18.6 |   | 320 |   | 9.0 |   | 478 |   | 149.4 |   |
| Total non-interest  income            |       | $                              | 4,282      |   | 100.0 | % | $ | 3,547 |   | 100.0 | % | $ | 735 |   | 20.7 | % |

 
| ** **                           | ** ** | **For The Six Months Ended** | ** ** |
|--------------------------------------|------------|------------------------------|------------|
| ** **                           | ** ** | **June 30, 2004**       | ** ** | **June 30, 2003** | ** ** | **Change** | ** ** |
| ** **                           | ** ** | **Amount**                   | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Service charge on deposit accounts   |       | $                            | 2,096      |   | 26.6 | % | $ | 1,828 |   | 24.6 | % | $ | 268 |   | 14.7 | % |
| Trust income                         |       | 896                          |       | 11.4 |   | 422 |   | 5.7 |   | 474 |   | 112.3 |   |
| Net security gains                   |       | 611                          |       | 7.8 |   | 2,497 |   | 33.5 |   | (1,886 | ) | (75.5 | ) |
| Income from investment product sales |       | 411                          |       | 5.2 |   | 102 |   | 1.4 |   | 309 |   | 302.9 |   |
| Bank owned life insurance            |       | 643                          |       | 8.2 |   | 642 |   | 8.6 |   | 1 |   | 0.2 |   |
| Income from insurance subsidiary     |       | 1,130                        |       | 14.3 |   | 363 |   | 4.9 |   | 767 |   | 211.3 |   |
| Gain on sale of loans                |       | 96                           |       | 1.2 |   | 304 |   | 4.1 |   | (208 | ) | (68.4 | ) |
| Income from leasing subsidiary       |       | 525                          |       | 6.7 |   | 563 |   | 7.6 |   | (38 | ) | (6.7 | ) |
| Other income                         |       | 1,469                        |       | 18.6 |   | 716 |   | 9.6 |   | 753 |   | 105.2 |   |
| Total non-interest income            |       | $                            | 7,877      |   | 100.0 | % | $ | 7,437 |   | 100.0 | % | $ | 440 |   | 5.9 | % |

 

35

----

 

#### **Non-interestExpense**

 

Non-interest expense increased $1,103 or 15.5% to $8,244, for the threemonths ended June 30, 2004 compared to the corresponding period of 2003.  The acquisitions of Mid-Penn Insurance,Steelton Bancorp, and Sentry Trust significantly impacted all categories ofnon-interest expense for the three months ended June 30, 2004 compared to2003.  Salaries and employee benefitsincreased $262 or 7.7%, primarily due to the acquisitions and increasedemployee benefit costs.  Net occupancyexpense and furniture and equipment expenses increased $154 or 18.4% due to theacquisitions and certain infrastructure improvements.  Other expenses increased $599 or 21.0% asdepreciation expense related to Sun’s auto lease program increased $329.  The remaining increase is the result ofnormal business expenses and acquisitions. Intangible amortization increased $88 or 231.6% due to the creation ofcustomer relationship intangibles and core deposit intangibles related to theacquisitions (Refer to Note 7 for additional information).

 

Non-interestexpense increased $2,059 or 15.0% to $15,763, for the six months endedJune 30, 2004 compared to the corresponding period of 2003.  The increase in non-interest expense wasprimarily driven by the impact of the Sentry Trust Company and Mid PennInsurance acquisitions during 2004 and 2003, respectively, in addition to a$616 increase in operating lease depreciation (included within other expenses).

 
| ** **                       | ** ** | **For The Three Months Ended** | ** ** |
|----------------------------------|------------|--------------------------------|------------|
| ** **                       | ** ** | **June 30, 2004**         | ** ** | **June 30, 2003** | ** ** | **Change** | ** ** |
| **(In  Thousands)**              | ** ** | **Amount**                     | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and employee benefits   |       | $                              | 3,677      |   | 44.6 | % | $ | 3,415 |   | 47.8 | % | $ | 262 |   | 7.7 | % |
| Net occupancy expenses           |       | 442                            |       | 5.4 |   | 332 |   | 4.7 |   | 110 |   | 33.1 |   |
| Furniture and equipment expenses |       | 547                            |       | 6.6 |   | 503 |   | 7.0 |   | 44 |   | 8.8 |   |
| Amortization of intangibles      |       | 126                            |       | 1.5 |   | 38 |   | 0.5 |   | 88 |   | 231.6 |   |
| Other expenses                   |       | 3,452                          |       | 41.9 |   | 2,853 |   | 40.0 |   | 599 |   | 21.0 |   |
| Total non-interest expense       |       | $                              | 8,244      |   | 100.0 | % | $ | 7,141 |   | 100.0 | % | $ | 1,103 |   | 15.5 | % |

 
| ** **                       | ** ** | **For The Six Months Ended** | ** ** |
|----------------------------------|------------|------------------------------|------------|
| ** **                       | ** ** | **June 30, 2004**       | ** ** | **June 30, 2003** | ** ** | **Change** | ** ** |
| ** **                       | ** ** | **Amount**                   | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and employee benefits   |       | $                            | 7,170      |   | 45.5 | % | $ | 6,581 |   | 48.0 | % | $ | 589 |   | 9.0 | **%** |
| Net occupancy expenses           |       | 880                          |       | 5.6 |   | 715 |   | 5.2 |   | 165 |   | 23.1 |   |
| Furniture and equipment expenses |       | 1,077                        |       | 6.8 |   | 990 |   | 7.2 |   | 87 |   | 8.8 |   |
| Amortization of intangibles      |       | 234                          |       | 1.5 |   | 38 |   | 0.3 |   | 196 |   | 515.8 |   |
| Other expenses                   |       | 6,402                        |       | 40.6 |   | 5,380 |   | 39.3 |   | 1,022 |   | 19.0 |   |
| Total non-interest expense       |       | $                            | 15,763     |   | 100.0 | % | $ | 13,704 |   | 100.0 | % | $ | 2,059 |   | 15.0 | % |

 

36

----

 

CapitalAdequacy

 

Sun and SunBank are subject to various regulatorycapital requirements administered by federal banking agencies.  Failure to meet minimum capital requirementscould prompt regulatory action that, if undertaken, might materially affectSun’s financial statements.  Underregulatory capital adequacy guidelines, Sun 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.

 

Quantitative measures established by regulation toensure capital adequacy require SunBank to maintain minimum amounts and ratios(set forth in the table below) of total and Tier 1 capital (as defined in theregulations) to risk-weighted assets (as defined), and of Tier 1 capital (asdefined) to average assets (as defined). Management believes, as of June 30, 2004, that Sun and SunBank meetall applicable capital adequacy requirements.

 

Sun is currently, and has been in the past,designated as a well-capitalized institution. Shareholders’ equity increased $6,551 to $85,733, at June 30, 2004,from $79,182, at December 31, 2003. This increase is attributable to the acquisition of Sentry Trust Companywhich resulted in an increase of $9,291 as Sun issued approximately a halfmillion shares from treasury and authorized shares as a component of thepurchase.

 
| ** **                    | ** ** | **Actual** | ** ** | **To Be Well Capitalized  Ratio** | ** ** |
|-------------------------------|------------|------------|------------|-----------------------------------|------------|
| **(Dollars  in thousands)**   | ** ** | **Amount** | ** ** | **Ratio**                         | ** ** | ** ** |
| As of June 30, 2004:     |       |       |       |                              |       |   |   |
| Total Risk-Based Capital      |       |       |       |                              |       |   |   |
| Sun Bancorp                   |       | $          | 73,646     |                              | 9.7        | % | N/A |   |
| SunBank                       |       | $          | 85,231     |                              | 11.1       | % | 10.0 | % |
| Tier I Risk-Based Capital     |       |       |       |                              |       |   |   |
| Sun Bancorp                   |       | $          | 63,334     |                              | 8.4        | % | N/A |   |
| SunBank                       |       | $          | 76,497     |                              | 10.0       | % | 6.0 | % |
| Leverage Ratio                |       |       |       |                              |       |   |   |
| Sun                           |       | $          | 63,334     |                              | 6.3        | % | N/A |   |
| SunBank                       |       | $          | 76,497     |                              | 7.6        | % | 5.0 | % |
|                          |       |       |       |                              |       |   |   |
| As of December 31, 2003: |       |       |       |                              |       |   |   |
| Total Risk-Based Capital      |       |       |       |                              |       |   |   |
| Sun Bancorp                   |       | $          | 73,984     |                              | 9.9        | % | N/A |   |
| SunBank                       |       | $          | 76,880     |                              | 10.3       | % | 10.0 | % |
| Tier I Risk-Based Capital     |       |       |       |                              |       |   |   |
| Sun Bancorp                   |       | $          | 63,864     |                              | 8.5        | % | N/A |   |
| SunBank                       |       | $          | 69,126     |                              | 9.2        | % | 6.0 | % |
| Leverage Ratio                |       |       |       |                              |       |   |   |
| Sun Bancorp                   |       | $          | 63,864     |                              | 6.4        | % | N/A |   |
| SunBank                       |       | $          | 69,126     |                              | 6.9        | % | 5.0 | % |

 

37

----

 

Liquidity

 

Management must ensure sufficientliquidity to meet current and future business needs, including customer cashwithdrawals and loan fundings. In addition, management must maintain additionalcontingency liquidity sources to meet unexpected needs. Sun’s liquidity dependson its ability to acquire funds or convert assets to cash without materialloss. Sun’s primary liquidity sources include regular principal and interestpayments on loans and securities, short-term securities, and various borrowingsources. Supplemental liquidity sources include longer-term securities, linesof credit, and additional sources for new deposits. Notably, management doesnot consider cash and due from banks amounts to be liquidity sources. Thoseamounts are typically needed by banks for daily operations.

 

Management believes that Sun hasadequate financial resources to meet its ongoing cash requirements foroperations and capital expenditures, as well as its other financialobligations.

 

Regulatory and Industry Merger Activity

 

From time to time, various types of federaland state legislation have been proposed that could result in additionalregulation of, and restrictions on, the business of Sun and SunBank.  It cannot be predicted whether suchlegislation will be adopted or, if adopted, how such legislation would affectthe business of Sun.  As a consequence ofthe extensive regulation of commercial banking activities in the United States,Sun’s business is particularly susceptible to being affected by federallegislation and regulations that may increase the costs of doing business.  Future legislation, rules or regulations ifimplemented, could have a material adverse effect upon the liquidity, capitalresources, or results of operations. The general cost of compliance withnumerous and multiple federal and state laws and regulations does have, and inthe future may have, a negative impact on Sun’s results of operations.

 

Further, the business of Sun is also affectedby the state of the financial services industry in general.  As a result of legal and industry changes,management expects the industry to continue to experience an increase inconsolidation as the financial services industry strives for greater costefficiencies and firms seek to gain market share.  Management also expects the financialservices industry including Sun to increase diversification of financialproducts and services offered. Management believes that industry consolidationand product and service diversification present opportunities for Sun toenhance its competitive position.

 

On April 20, 2004, Sun announced that adefinitive merger agreement was unanimously approved by the Boards of Directorsof both Sun and Omega Financial Corporation. Please refer to Note 13 to the Financial Statements under Item 1forfurther information on Sun’s merger with Omega Financial Corporation.

 

38

----

 

Thefollowing tables set forth Selected Financial Data for each of the past fivequarters:

 
| ** **                                          | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------------|------------|-------------------|------------|
| **(Dollars  in Thousands, Except Per Share Data)**  | ** ** | **6/30/2004**     | ** ** | **3/31/2004** | ** ** | **12/31/2003** | ** ** | **9/30/2003** | ** ** | **6/30/2003** | ** ** |
| **Financial Condition  Data:**                      |       |              |       |   |   |   |   |   |   |   |   |
| **General**                                         |       |              |       |   |   |   |   |   |   |   |   |
| Total assets                                        |       | $                 | 1,045,677  |   | $ | 1,037,218 |   | $ | 1,028,253 |   | $ | 1,033,917 |   | $ | 1,027,414 |   |
| Loans, net                                          |       | 666,463           |       | 675,791 |   | 672,223 |   | 663,339 |   | 646,604 |   |
| Intangibles                                         |       | 41,794            |       | 41,920 |   | 33,538 |   | 33,981 |   | 34,032 |   |
| Total deposits                                      |       | 644,437           |       | 647,605 |   | 614,550 |   | 651,512 |   | 648,429 |   |
| Non interest bearing                                |       | 67,195            |       | 69,794 |   | 69,640 |   | 66,118 |   | 64,671 |   |
|                                                |       |              |       |   |   |   |   |   |   |   |   |
| Savings                                             |       | 84,723            |       | 84,578 |   | 82,416 |   | 88,106 |   | 89,806 |   |
| NOW                                                 |       | 164,476           |       | 161,376 |   | 164,803 |   | 170,001 |   | 163,018 |   |
| Money Market                                        |       | 43,877            |       | 34,472 |   | 22,461 |   | 26,726 |   | 27,887 |   |
| Time Deposits                                       |       | 284,166           |       | 297,385 |   | 275,230 |   | 300,561 |   | 303,047 |   |
| Total interest bearing deposits                     |       | 577,242           |       | 577,811 |   | 544,910 |   | 585,394 |   | 583,758 |   |
|                                                |       |              |       |   |   |   |   |   |   |   |   |
| Core deposits*                                      |       | 360,271           |       | 350,220 |   | 339,320 |   | 350,951 |   | 345,382 |   |
| Trust preferred securities &  subordinated debt |       | 18,078            |       | 18,866 |   | 18,866 |   | 18,866 |   | 18,866 |   |
| Shareholders’ equity                           |       | 85,733            |       | 89,539 |   | 79,182 |   | 79,015 |   | 81,037 |   |
| Trust assets under management                       |       | 578,048           |       | 588,642 |   | 162,150 |   | 148,144 |   | 148,156 |   |
|                                                |       |              |       |   |   |   |   |   |   |   |   |
| **Asset Quality**                                   |       |              |       |   |   |   |   |   |   |   |   |
|                                                |       |              |       |   |   |   |   |   |   |   |   |
| Non-performing assets                               |       | $                 | 4,586      |   | $ | 6,033 |   | $ | 5,203 |   | $ | 4,596 |   | $ | 4,592 |   |
| Non-performing assets to total assets               |       | 0.44              | %          | 0.58 | % | 0.51 | % | 0.44 | % | 0.45 | % |
| Allowance for loan losses                           |       | 8,734             |       | 8,435 |   | 7,754 |   | 7,229 |   | 7,342 |   |
| Allowance for loan losses to total loans            |       | 1.29              | %          | 1.23 | % | 1.14 | % | 1.08 | % | 1.12 | % |
| Allowance for loan losses to non-performing  loans  |       | 245.34            | %          | 175.77 | % | 194.97 | % | 201.48 | % | 204.57 | % |
| Non-performing loans to total loans                 |       | 0.53              | %          | 0.70 | % | 0.58 | % | 0.54 | % | 0.55 | % |
|                                                |       |              |       |   |   |   |   |   |   |   |   |
| **Capitalization -  Bancorp**                       |       |              |       |   |   |   |   |   |   |   |   |
|                                                |       |              |       |   |   |   |   |   |   |   |   |
| Shareholders’ equity to total assets           |       | 8.20              | %          | 8.63 | % | 7.70 | % | 7.64 | % | 7.89 | % |

 

----

* Core deposits are defined as total deposits less time deposits

 

39

----

 
| ** **                                         | ** ** | **Quarter Ended** | ** ** |
|----------------------------------------------------|------------|-------------------|------------|
| **(Dollars  in Thousands, Except Per Share Data)** | ** ** | **6/30/2004**     | ** ** | **3/31/2004** | ** ** | **12/31/2003** | ** ** | **9/30/2003** | ** ** | **6/30/2003** | ** ** |
|                                               |       |              |       |   |   |   |   |   |   |   |   |
| **Operating Data**                                 |       |              |       |   |   |   |   |   |   |   |   |
|                                               |       |              |       |   |   |   |   |   |   |   |   |
| Net income                                         |       | $                 | 1,226      |   | $ | 1,509 |   | $ | 983 |   | $ | 1,821 |   | $ | 1,690 |   |
| Net interest income                                |       | 5,817             |       | 6,089 |   | 5,829 |   | 5,973 |   | 5,924 |   |
| Provision for loan losses                          |       | 450               |       | 435 |   | 405 |   | 405 |   | 405 |   |
| Non-interest income                                |       | 4,282             |       | 3,595 |   | 3,065 |   | 3,728 |   | 3,547 |   |
| Non-interest expense                               |       | 8,244             |       | 7,519 |   | 7,634 |   | 7,155 |   | 7,141 |   |
|                                               |       |              |       |   |   |   |   |   |   |   |   |
| **Performance Statistics**                         |       |              |       |   |   |   |   |   |   |   |   |
|                                               |       |              |       |   |   |   |   |   |   |   |   |
| Net interest margin                                |       | 2.68              | %          | 2.85 | % | 2.69 | % | 2.70 | % | 2.69 | % |
| Annualized return on average assets                |       | 0.47              | %          | 0.59 | % | 0.38 | % | 0.70 | % | 0.66 | % |
| Annualized return on average equity                |       | 5.60              | %          | 6.87 | % | 4.99 | % | 9.15 | % | 8.30 | % |
| Annualized net loan charge-offs to avg loans       |       | 0.09              | %          | -0.14 | % | -0.07 | % | 0.31 | % | 0.15 | % |
| Net charge-offs (recoveries)                       |       | 151               |       | (246 | ) | (120 | ) | 517 |   | 234 |   |
| Efficiency ratio                                   |       | 84.6              |       | 77.4 |   | 80.9 |   | 78.9 |   | 83.7 |   |
| Net income per employee                            |       | 4                 |       | 5 |   | 3 |   | 6 |   | 6 |   |
|                                               |       |              |       |   |   |   |   |   |   |   |   |
| **Per Share Data**                                 |       |              |       |   |   |   |   |   |   |   |   |
|                                               |       |              |       |   |   |   |   |   |   |   |   |
| Basic earnings per share                           |       | $                 | 0.16       |   | $ | 0.21 |   | $ | 0.14 |   | $ | 0.25 |   | $ | 0.23 |   |
| Diluted earnings per share                         |       | 0.16              |       | 0.21 |   | 0.14 |   | 0.25 |   | 0.23 |   |
| Dividend declared per share                        |       | 0.1815            |       | 0.1815 |   | 0.1815 |   | 0.1815 |   | 0.1815 |   |
| Book value                                         |       | 11.13             |       | 11.66 |   | 11.03 |   | 11.01 |   | 11.24 |   |
| Common stock price:                                |       |              |       |   |   |   |   |   |   |   |   |
| High                                               |       | 23.15             |       | 20.28 |   | 21.29 |   | 22.14 |   | 22.48 |   |
| Low                                                |       | 18.79             |       | 17.87 |   | 18.36 |   | 17.80 |   | 19.60 |   |
| Close                                              |       | 22.39             |       | 19.50 |   | 18.96 |   | 18.22 |   | 20.13 |   |
| Weighted average common shares:                    |       |              |       |   |   |   |   |   |   |   |   |
| Basic                                              |       | 7,690             |       | 7,333 |   | 7,179 |   | 7,189 |   | 7,211 |   |
| Fully Diluted                                      |       | 7,721             |       | 7,357 |   | 7,203 |   | 7,214 |   | 7,242 |   |
| End-of-period common shares:                       |       |              |       |   |   |   |   |   |   |   |   |
| Issued                                             |       | 7,705             |       | 7,679 |   | 7,320 |   | 7,319 |   | 7,319 |   |
| Treasury                                           |       | —            |       | — |   | 141 |   | 141 |   | 111 |   |

 

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Item 3 – Quantitative and Qualitative Disclosures about Market Risk

 

Market Risk

 

For Sun, market risk results predominantly from interest rate risk andequity price risk. Although Sun’s market risks may change in the future,management currently focuses its risk management efforts on those twocomponents.

 

Interest Rate Risk (IRR)

 

IRR represents the potential current or futureearnings and capital volatility due to interest rate changes. Interest ratefluctuations affect earnings by changing net interest income and otherinterest-sensitive income and expense levels. Interest rate changes affect capitalby altering banks’ economic value of equity (EVE). EVE represents the netpresent value of all asset, liability, and off-balance sheet cash flows.Interest rate fluctuations change the present values of those cash flows.

 

As financial intermediaries, banks cannotcompletely avoid IRR. However, excessive IRR can threaten earnings, capital,liquidity, and solvency. IRR has many components, including repricing risk,basis risk, yield curve risk, option risk, and price risk. Sun’s primary, butnot sole, IRR source is balance sheet optionality from residential mortgagesand mortgage-backed securities. Those assets may prepay principal at changingspeeds depending on interest rate levels and other factors beyond Sun’scontrol. When prepayments occur, management must reinvest those cash flows atcurrent market rates (in loans or securities). Thus, future interest levels andpaths may negatively (or positively) affect Sun’s net interest income.

 

Sun seeks to minimize netinterest income volatility by carefully measuring, monitoring, and controllingIRR. Sun has implemented a comprehensive market risk management program todramatically enhance management’s ability to measure, monitor, and controlrisk. Market risk can result in fluctuating net interest income due to interestrate and other economic changes. Using simulation models, Sun can measuremarket risk by forecasting net interest income volatility under variousinterest rate scenarios. However, these models depend on many significantassumptions that may not accurately reflect future conditions.

 

To minimize interest income volatility, on June 30, 2003 Sunentered into four pay-variable receive-fixed interest rate swaps ($100,000notional total) to hedge changes in fair value of certain FHLB long-term borrowings(other borrowed funds).  The swaps alsocontain an embedded option to reverse the swap to pay-fixed receive-variable inthe event that the FHLB long-term borrowings reprice and become variable rate.  The exercise of the option would effectivelyfix the rate Sun pays on the borrowings at approximately the original couponand would reduce the net interest income volatility caused in an increasinginterest rate environment.  Sun includesall components of each derivatives gain or loss in the assessment of hedgeeffectiveness.  Sun recognizes the changein fair value of the hedge and associated borrowings through the incomestatement.  There was a change in valuerecognized in the hedge and associated long-term FHLB borrowings of $2,024 to$7,180 at June 30, 2004 from $5,156 at December 31, 2003, due to themark to market adjustment. The change in value of the FHLB borrowings isincluded within long-term borrowings, while the change in the swap value isincluded within accrued interest and other liabilities.   Sun also

 

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recognizeda reduction of $370 and $742 in interest expense on long-term FHLB borrowingsduring the three and six-months ended June 30, 2004, respectively, as aresult of the hedge transaction.  Asummary of Sun’s fair value hedges appears below:

 
| **(In  Thousands)**                               | ** ** | ** **           | ** ** | ** ** | ** ** | ** **    | ** ** | **Weighted Average** | ** ** |
|---------------------------------------------------|------------|----------------------|------------|------------|------------|---------------|------------|----------------------|------------|
| **June 30,  2004**                           | ** ** | **Notional  Amount** | ** ** | **Asset**  | ** ** | **Liability** | ** ** | **Receive  Rate**    | ** ** | **Pay  Rate** | ** ** | **Life  (Years)** | ** ** |
| Fair Value Hedges:                                |       |                 |       |       |       |          |       |                 |       |   |   |   |   |
| Receive fixed - pay variable interest rate  swaps |       | $                    | 100,000    |       | $          | —        |       | $                    | 7,180      |   | 2.65 | % | 1.17 | % | 5.8 |   |
|                                                   |            |                      |            |            |            |               |            |                      |            |  |  |  |  |  |  |  |

 
| ** **                                        | ** ** | ** **           | ** ** | ** ** | ** ** | ** **    | ** ** | **Weighted Average** | ** ** |
|---------------------------------------------------|------------|----------------------|------------|------------|------------|---------------|------------|----------------------|------------|
| **December 31,  2003**                       | ** ** | **Notional  Amount** | ** ** | **Asset**  | ** ** | **Liability** | ** ** | **Receive  Rate**    | ** ** | **Pay  Rate** | ** ** | **Life  (Years)** | ** ** |
| Fair Value Hedges:                                |       |                 |       |       |       |          |       |                 |       |   |   |   |   |
| Receive fixed - pay variable interest rate  swaps |       | $                    | 100,000    |       | $          | —        |       | $                    | 5,156      |   | 2.65 | % | 1.13 | % | 6.3 |   |
|                                                   |            |                      |            |            |            |               |            |                      |            |  |  |  |  |  |  |  |

 

 

Rate Shock at June 30, 2004 for the NextTwelve Months:

 
| ** **          | ** ** | **Parallel rate shock in basis points (bp)** | ** ** |
|---------------------|------------|----------------------------------------------|------------|
| **(In  Thousands)** | ** ** | **-100bp**                                   | ** ** | **0bp** | ** ** | **+100bp** | ** ** | **+200bp** | ** ** | **+300bp** | ** ** |
| Net interest income |       | $                                            | 20,911     |   | $ | 22,373 |   | $ | 22,832 |   | $ | 23,089 |   | $ | 23,297 |   |
| Percent change      |       | -6.53                                        | %          | 0.00 | % | 2.05 | % | 3.20 | % | 4.13 | % |
|                     |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

Rate Shock at December 31, 2003 for theNext Twelve Months:

 
| ** **          | ** ** | **Parallel rate shock in basis points (bp)** | ** ** |
|---------------------|------------|----------------------------------------------|------------|
| **(In  Thousands)** | ** ** | **-100bp**                                   | ** ** | **0bp** | ** ** | **+100bp** | ** ** | **+200bp** | ** ** | **+300bp** | ** ** |
| Net interest income |       | $                                            | 19,695     |   | $ | 21,947 |   | $ | 22,520 |   | $ | 22,561 |   | $ | 22,475 |   |
| Percent change      |       | -10.26                                       | %          | 0.00 | % | 2.61 | % | 2.80 | % | 2.41 | % |
|                     |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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#### **EquitySecurities Risk**

 

Sun’s equity securities consist of marketableequities and restricted stock. Marketable equities consist entirely of common stock of bank andfinancial holding companies.   BecauseFederal Home Loan Bank stock is redeemable at par, Sun carries it at cost andperiodically evaluates the stock for impairment.  Possible impairment factors include potentialdramatic changes to the housing and residential mortgage industry or therelated regulatory environment.  Managementcurrently does not believe any factors exist to suggest potential impairment.

 

Bank and financial holding company stocks aresubject to general industry risks, including competition from non-bankentities, credit risk, interest rate risk, and other factors.  Individual stocks could suffer pricedecreases due to circumstances at specific banks.  In addition, Sun’s bank stock investments areconcentrated in Pennsylvania entities, so these investments could decline invalue if there were a downturn in the state’s economy.

 

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Reference is also made to Item 7A. Quantitative and QualitativeDisclosure About Market Risk in Sun’s Annual Report on Form 10-K for the year2003.

 

Item 4 – Controls and Procedures

 

Management maintains a system of controls andprocedures designed to provide reasonable assurance as to the reliability ofthe financial statements and other disclosures included in this report, as wellas to safeguard assets from unauthorized use or disposition.  An evaluation was carried out under thesupervision and with the participation of the Sun’s management, including thePrincipal Executive Officer and Principal Financial Officer of theeffectiveness of Sun’s disclosure controls and procedures as of the end of theperiod covered by this report.  Based on that evaluation, Sun’smanagement, including the Principal Executive Officer and Principal FinancialOfficer has concluded that Sun’s disclosure controls and procedures areeffective.  No significant changes weremade to Sun’s internal controls or other factors that have materially affectedor is reasonably likely to materially affect these controls subsequent to thedate of their evaluation.

 

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SUN BANCORP, INC.

FORM 10-Q

PART II

 

Item 1 – Legal Proceedings

 

Neither Sun nor SunBank is a party to any material legal proceedings at this time. From time to time Sun or SunBank is involved in various claims and legal actions arising in the ordinary course of business.

 

Item 2 – Changes in Securities, Use of Proceeds and Issuer Purchases ofEquity Securities

 

There were no purchases of Sun’s common stock conducted by Sun duringthe three months ended June 30, 2004.

 

Item 3 – Defaults upon Senior Securities

 

None

 

Item 4 – Submission of matters to a vote ofsecurity holders

 

OnApril 22, 2004 the annual meeting of Sun Bancorp, Inc. was held with theresults of the items voted on at the meeting listed in the attached exhibit99.1.

 

Item 5 – Other Information

 

There were no material changes to theprocedures by which a shareholder may recommend nominees to Sun’s Board ofDirectors.

 

Item 6 – Exhibits andReports on Form 8-K

 

a.                                 OnApril 16, 2004, Sun Bancorp, Inc. filed a Current Report on Form 8-Kannouncing the declarationof the second quarter cash dividend of $0.1815 per share.

 

b.                                On April 19,2004, Sun Bancorp, Inc. filed a Current Report on Form 8-K announcing the operating results for thethree months ended March 31, 2004.

 

c.                                 OnApril 22, 2004, Sun Bancorp, Inc. filed a Current Report on Form 8-Kannouncing the signing of a merger agreement with Omega Financial Corporationon April 20, 2004.

 

d.                                Exhibits

 

2                                    Agreementand Plan of Merger by and between Omega Financial Corporation and Sun Bancorp,Inc. dated April 20, 2004 is incorporated by reference to Exhibit 2.1 tothe Form 8-K filed April 22, 2004 (Commission File Number 0-14745)

 

3(i)                         TheArticles of Incorporation of the Registrant are incorporated herein byreference to Exhibit 3(i) to the Form 8-K filed July 1, 2003 (CommissionFile Number 0-14745).

 

3(ii)                      TheBy-Laws, as amended and restated are incorporated herein by reference toExhibit 3 (iii) to the Form 8-K filed March 20, 2003 (Commission FileNumber 0-14745).

 

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10.1               EmploymentAgreement between Robert J. McCormack, the Registrant and SunBank datedOctober 31, 2002 is incorporated by reference to Form 8-K filedMarch 20, 2003 (Commission File Number 0-14745).

 

10.2               EmploymentAgreement between Thomas W. Bixler, the Registrant and SunBank datedNovember 3, 2002 is incorporated by reference to Form 8-K filedMarch 20, 2003 (Commission File Number 0-14745).

 

10.3               EmploymentAgreement between Sandra Miller, the Registrant and SunBank datedOctober 24, 2002 is incorporated by reference to Form 8-K filedMarch 20, 2003 (Commission File Number 0-14745).

 

10.4               EmploymentAgreement between Maureen M. Bufalino, the Registrant, SunBank, and SUBIServices, LLC dated January 12, 2004 is incorporated by reference to Form8-K filed March 26, 2004 (Commission File Number 0-14745).

 

10.5               Generalrelease between Wilmer D. Leinbach, the Registrant, SunBank, and SUBI Services,LLC dated July 31, 2004 is incorporated by reference to Form 8-K filedAugust 5, 2004 (Commission File Number 0-14745).

 

10.6               EmploymentAgreement between David M. Diffenderffer, the Registrant, SunBank, and SUBIServices, LLC dated January 12, 2004 is incorporated by reference to Form10-K filed March 15, 2004 (Commission File Number 0-14745).

 

10.7               EmploymentAgreement between James P. Radick, the Registrant, SunBank, and SUBI Services,LLC dated January 12, 2004 is incorporated by reference to Form 10-K filedMarch 15, 2004 (Commission File Number 0-14745).

 

10.8               EmploymentAgreement between Byron M. Mertz III, the Registrant, SunBank, and SUBIServices, LLC dated January 12, 2004 is incorporated by reference to Form10-K filed March 15, 2004 (Commission File Number 0-14745).

 

10.9               EmploymentAgreement between Gary Cook, the Registrant, SunBank, and Bank Capital ServicesCorporation dated December 17, 2002 is incorporated by reference to Form10-K filed March 15, 2004 (Commission File Number 0-14745).

 

10.10               EmploymentAgreement between Carol Phillips, the Registrant, SunBank, and Bank CapitalServices Corporation dated December 17, 2002 is incorporated by referenceto Form 10-K filed March 15, 2004 (Commission File Number 0-14745).

 

10.11               EmploymentAgreement between Christopher J. Fellon, the Registrant, SunBank, and Mid-PennInsurance Associates dated December 23, 2002 is incorporated by referenceto Form 10-K filed March 15, 2004 (Commission File Number 0-14745).

 

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10.12               EmploymentAgreement between Cheryl A. Zellers, the Registrant, SunBank, and Mid-PennInsurance Associates dated December 23, 2002 is incorporated by referenceto Form 10-K filed March 15, 2004 (Commission File Number 0-14745).

 

10.13               EmploymentAgreement between Daniel R. Geise, the Registrant, SunBank, and Mid-PennInsurance Associates dated December 23, 2002 is incorporated by referenceto Form 10-K filed March 15, 2004 (Commission File Number 0-14745).

 

10.14               EmploymentAgreement between Charles E. Nelson, the Registrant, SunBank, SUBI Services,LLC, and Sentry Trust Company dated April 23, 2003 is incorporated byreference to Exhibit 2 to Appendix A to the proxy statement prospectus on Sun’sRegistration Statement on Form S-4 filed January 23, 2004 (RegistrationStatement no. 333-107944).

 

10.15               EmploymentAgreement between Carole L. Crist, the Registrant, SunBank, SUBI Services, LLC,and Sentry Trust Company dated April 23, 2003 is incorporated by referenceto Exhibit 3 to Appendix A of the proxy statement prospectus on Sun’sRegistration Statement on Form S-4 filed January 23, 2004 (RegistrationStatement no. 333-107944).

 

10.16               EmploymentAgreement between Randy L. Martin, the Registrant, SunBank, SUBI Services, LLC,and Sentry Trust Company dated April 23, 2003 is incorporated by referenceto Exhibit 4 to Appendix A of the proxy statement prospectus on Sun’sRegistration Statement on Form S-4 filed January 23, 2004 (RegistrationStatement no. 333-107944).

 

10.17               1998Stock Incentive Plan is incorporated by reference to Exhibit 4.3 of Sun’sRegistration Statement on Form S-8 filed on August 12, 1998 (RegistrationStatement No. 333-61237).

 

10.18               1998Independent Directors Stock Option Plan is incorporated by reference to Exhibit4.3 of Sun’s Registration Statement on Form S-8 filed on August 12, 1998(Registration Statement No. 333-61241).

 

10.19               1998EmployeeStock Purchase Plan is incorporated by reference to Exhibit 4.3 of Sun’sRegistration Statement on Form S-8 filed on August 12, 1998 (RegistrationStatement No. 333-61249).

 

10.20               Consulting Agreementbetween Sun Bancorp, Inc. and Sidney M Palmer is incorporated by reference toAppendix B to the proxy statement prospectus on Sun’s Registration Statement onForm S-4 filed on January 23, 2004 (Registration Statement No. 333-107944)

 

11                              Statementre: Computation of Earnings Per Share can be referenced in Note 5 of theConsolidated Statements in this Report

 

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31.1               Certificationpursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2               Certificationpursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1               Certification of principalexecutive officer or principal financial officer pursuant to 18U.S.C.Section 1350.

 

32.2               Certificationof principal executive officer or principal financial officer pursuant to18U.S.C. Section 1350.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|   |                | Sun Bancorp, Inc.                     |                           |
|--------|---------------------|---------------------------------------|--------------------------------|
|   |                |                                  |                           |
| Date   | August 6, 2004 |                                  | /s/   Robert J. McCormack |   |
|   |                | Robert J. McCormack                   |                           |
|   |                | President and Chief Executive Officer |                           |
|   |                | (Principal Executive Officer)         |                           |
|   |                |                                  |                           |
|   |                |                                  |                           |
|   |                | /s/   James P. Radick            |                           |
|   |                | James P. Radick                       |                           |
|   |                | Senior Vice President of Finance      |                           |
|   |                | (Principal Financial Officer)         |                           |
|        |                     |                                       |                                |  |

 

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