**FORM 10-Q**

 

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**QUARTERLYREPORT UNDER SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the quarter ended June 30, 2005**

 

**Commission file number:  33-850626**

 

**FULTONBANCSHARES CORPORATION**

(Exact name of registrant as specified in itscharter)

 
| **Commonwealth of Pennsylvania**         | ** ** | **25-1598464**      |
|------------------------------------------|------------|---------------------|
| (State or other jurisdiction of          |       | (I.R.S. Employer    |
| incorporation or organization)           |       | Identification No.) |
|                                     |       |                |
| **100 Lincoln Way East**                 | ** ** | ** **          |
| **McConnellsburg, Pennsylvania**         | ** ** | **17233**           |
| (Address of principal executive offices) |       | (Zip Code)          |

 

Registrant’stelephone number, including area code: **(717) 485-3144**

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. 

 

Yes   ý    No   o

 

Indicate by checkmark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act) 

 

Yes   o    No   ý

 

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

 
| **Class**                      | ** ** | **Outstanding  at August 10, 2005** |
|--------------------------------|------------|-------------------------------------|
| (Common stock, .625 par value) |       | 492,790                             |

 

 

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FULTON BANCSHARES CORPORATION

INDEX

 
| PART I - FINANCIAL INFORMATION                                                                         |   |
|--------------------------------------------------------------------------------------------------------|--------|
|                                                                                                   |   |
| Item 1 - Consolidated Financial Statements                                                             |   |
|                                                                                                   |   |
| Condensed  consolidated balance sheets - June 30, 2005 and December 31, 2004                           |   |
|                                                                                                   |   |
| Condensed consolidated statements of income - three months ended June  30, 2005 and 2004               |   |
|                                                                                                   |   |
| Condensed consolidated statements of comprehensive income - three  months ended June 30, 2005 and 2004 |   |
|                                                                                                   |   |
| Condensed consolidated statements of income - six months ended June  30, 2005 and 2004                 |   |
|                                                                                                   |   |
| Condensed consolidated statements of comprehensive income six months  ended June 30, 2005 and 2004     |   |
|                                                                                                   |   |
| Condensed  consolidated statements of cash flows - six months ended June 30, 2005 and  2004            |   |
|                                                                                                   |   |
| Notes to condensed consolidated financial statements                                                   |   |
|                                                                                                   |   |
| 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                                                                       |   |

 

2

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| PART  II - OTHER INFORMATION                                         |   |
|----------------------------------------------------------------------|--------|
|                                                                 |   |
| Item  1 - Legal proceedings                                          |   |
|                                                                 |   |
| Item 2 - Unregistered sales of equity securities and use of proceeds |   |
|                                                                 |   |
| Item 3 - Defaults upon senior securities                             |   |
|                                                                 |   |
| Item 4 - Submission of matters to a vote of security holders         |   |
|                                                                 |   |
| Item  5 - Other information                                          |   |
|                                                                 |   |
| Item 6 -  Exhibits                                                   |   |
|                                                                 |   |
| Signatures                                                           |   |
|                                                                 |   |
| Exhibits                                                             |   |

 

3

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PART I - FINANCIAL INFORMATION

 

FULTONBANCSHARES CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCESHEETS

($000 omitted )

 
| ** **                                                                                   | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                   | ** ** | **(Unaudited)**         | ** ** | **(Audited)**               | ** ** |
| **ASSETS**                                                                                   |       |                    |       |                        |       |
| Cash and due from banks                                                                      |       | $                       | 3,781      |                        | $          | 12,809 |   |
| Interest-bearing deposits in other banks                                                     |       | 396                     |       | 55                          |       |
| Federal funds sold                                                                           |       | 4,800                   |       | 3,500                       |       |
| Cash and cash equivalents                                                                    |       | 8,977                   |       | 16,364                      |       |
|                                                                                         |       |                    |       |                        |       |
| Investment securities available for sale                                                     |       | 32,875                  |       | 18,985                      |       |
| Federal Reserve, Atlantic Central Bankers  Bank and Federal Home Loan Bank stocks            |       | 993                     |       | 1,207                       |       |
| Loans, net of reserve for loan losses 2005-$1,905;  2004-$1,821                              |       | 83,642                  |       | 92,649                      |       |
|                                                                                         |       |                    |       |                        |       |
| Premises and equipment                                                                       |       | 3,591                   |       | 3,596                       |       |
| Cash surrender value of life insurance                                                       |       | 5,524                   |       | 5,430                       |       |
| Accrued interest receivable                                                                  |       | 551                     |       | 660                         |       |
| Real estate owned other than premises                                                        |       | 700                     |       | 1,534                       |       |
| Other assets                                                                                 |       | 1,430                   |       | 1,332                       |       |
|                                                                                         |       |                    |       |                        |       |
| Total assets                                                                                 |       | $                       | 138,283    |                        | $          | 141,757 |   |
|                                                                                         |       |                    |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                |       |                    |       |                        |       |
| Deposits                                                                                     |       |                    |       |                        |       |
| Noninterest bearing                                                                          |       | $                       | 16,333     |                        | $          | 16,524 |   |
| Interest bearing                                                                             |       | 89,793                  |       | 93,097                      |       |
|                                                                                         |       | 106,126                 |       | 109,621                     |       |
|                                                                                         |       |                    |       |                        |       |
| Other borrowed funds                                                                         |       | 15,000                  |       | 15,000                      |       |
| Accrued interest payable                                                                     |       | 247                     |       | 243                         |       |
| Other liabilities                                                                            |       | 1,463                   |       | 1,375                       |       |
| Total liabilities                                                                            |       | 122,836                 |       | 126,239                     |       |
|                                                                                         |       |                    |       |                        |       |
| Stockholders’ Equity                                                                    |       |                    |       |                        |       |
| Common stock: par value $.625 per share;  4,000,000 shares authorized; 495,000 shares issued |       | 309                     |       | 309                         |       |
| Additional paid-in capital                                                                   |       | 2,051                   |       | 2,051                       |       |
| Retained earnings                                                                            |       | 13,211                  |       | 13,226                      |       |
| Accumulated other comprehensive income  (loss)                                               |       | (35                     | )          | 21                          |       |
| Treasury stock; shares at cost- 2005-  2,210; 2004 - 2,210                                   |       | (89                     | )          | (89                         | )          |
| Total stockholders’ equity                                                              |       | 15,447                  |       | 15,518                      |       |
| Total liabilities and stockholders’s equity                                             |       | $                       | 138,283    |                        | $          | 141,757 |   |

 

**The Notesto Condensed Consolidated Financial Statements are an integral part of thesestatements.**

 

4

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FULTON BANCSHARESCORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OFINCOME

Three Months Ended June 30,2005 and 2004

UNAUDITED

($ 000 omitted except pershare)

 
| ** **                                                                  | ** ** | **2005**   | ** ** | **2004**          | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                  | ** ** | ** ** | ** ** | **(As Restated)** | ** ** |
| **Interest Income**                                                         |       |       |       |              |       |
| Interest and fees on loans                                                  |       | $          | 1,466      |              | $          | 1,571 |   |
| Interest and dividends on investment  securities:                           |       |       |       |              |       |
| Other U.S. Government agencies                                              |       | 64         |       | 77                |       |
| Mortgage-backed securities                                                  |       | 151        |       | 19                |       |
| Oligations of state and political  subdivisions- tax exempt                 |       | 52         |       | 52                |       |
| FNMA and FHLMC preferred stock                                              |       | —     |       | 147               |       |
| Other interest and dividends                                                |       | 4          |       | 8                 |       |
| Interest on federal funds sold                                              |       | 42         |       | 4                 |       |
| Total interest income                                                       |       | 1,779      |       | 1,878             |       |
|                                                                        |       |       |       |              |       |
| **Interest Expense**                                                        |       |       |       |              |       |
| Interest on deposits                                                        |       | 486        |       | 504               |       |
| Interest on federal funds purchased                                         |       | —     |       | 1                 |       |
| Interest on other borrowed money                                            |       | 225        |       | 225               |       |
| Total interest expense                                                      |       | 711        |       | 730               |       |
|                                                                        |       |       |       |              |       |
| Net interest income before provision for  loan losses                       |       | 1,068      |       | 1,148             |       |
|                                                                        |       |       |       |              |       |
| **Provision for Loan Losses**                                               |       | 17         |       | 261               |       |
|                                                                        |       |       |       |              |       |
| Net interest income after provision for  loan losses                        |       | 1,051      |       | 887               |       |
|                                                                        |       |       |       |              |       |
| **Other Income**                                                            |       |       |       |              |       |
|                                                                        |       |       |       |              |       |
| Service charges on deposit accounts                                         |       | 41         |       | 45                |       |
| Other service charges and fees                                              |       | 42         |       | 40                |       |
| Earnings-Cash surrender value of life  insurance                            |       | 60         |       | 63                |       |
| Trust services                                                              |       | —     |       | 1                 |       |
| Gain (loss) on sale of investment  securities                               |       | —     |       | 6                 |       |
| Gain on sale of OREO property                                               |       | —     |       | 8                 |       |
| Gain on sale of assets                                                      |       | 9          |       | —            |       |
| Gain on sale of loans                                                       |       | —     |       | —            |       |
| Other income                                                                |       | 2          |       | 6                 |       |
| Total other income                                                          |       | 154        |       | 169               |       |
|                                                                        |       |       |       |              |       |
| **Other Expenses**                                                          |       |       |       |              |       |
| Salaries, fees and employee benefits                                        |       | 479        |       | 482               |       |
| Net occupancy expense of bank premises and furniture  and equipment expense |       | 197        |       | 205               |       |
| Professional and loan-related fees                                          |       | 302        |       | 70                |       |
| Data processing                                                             |       | 83         |       | 61                |       |
| FDIC insurance premiums                                                     |       | 48         |       | 4                 |       |
| Other expenses                                                              |       | 266        |       | 267               |       |
| Total other expenses                                                        |       | 1,375      |       | 1,089             |       |
|                                                                        |       |       |       |              |       |
| Income (loss) before income taxes                                           |       | (170       | )          | (33               | )          |
| Applicable income tax (benefit)                                             |       | (95        | )          | (7                | )          |
|                                                                        |       |       |       |              |       |
| Net income (loss)                                                           |       | $          | (75        | )                 | $          | (26 | ) |
|                                                                        |       |       |       |              |       |
| Earnings per common share                                                   |       | $          | (0.15      | )                 | $          | (0.05 | ) |
| Cash dividends declared per share                                           |       | $          | —     |              | $          | 0.23 | ** ** |

 

**The Notesto Condensed Consolidated Financial Statements are an integral part of thesestatements.**

 

5

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FULTONBANCSHARES CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTSOF COMPREHENSIVE INCOME

THREEMONTHS ENDED JUNE 30, 2005 AND 2004

(UNAUDITED)

 
| ** **                                                             | ** ** | **2005**   | ** ** | **2004**           | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|--------------------|------------|
| ** **                                                             | ** ** | ** ** | ** ** | **(As  Restated)** | ** ** |
| Net Income (Loss)                                                      |       | $          | (75        | )                  | $          | (26 | ) |
|                                                                   |       |       |       |               |       |
| Unrealized gain (loss) on investments available  for sale, net of tax  |       | 231        |       | (1,073             | )          |
|                                                                   |       |       |       |               |       |
| Reclassification adjustment for gains (losses)  included in net income |       | —     |       | 6                  |       |
|                                                                   |       |       |       |               |       |
| Comprehensive income (loss)                                            |       | $          | 156        |               | $          | (1,093 | ) |

 

**The Notes to Condensed Consolidated Financial Statements arean integral part of these statements.**

 

6

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FULTONBANCSHARES CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME

SixMonths Ended June 30, 2005 and 2004

UNAUDITED

($000 omitted except per share)

 
| ** **                                                                  | ** ** | **2005**   | ** ** | **2004**          | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                  | ** ** | ** ** | ** ** | **(As Restated)** | ** ** |
| **Interest Income**                                                         |       |       |       |              |       |
| Interest and fees on loans                                                  |       | $          | 2,973      |              | $          | 3,179 |   |
| Interest and dividends on investment  securities:                           |       |       |       |              |       |
| Other U.S. Government agencies                                              |       | 128        |       | 144               |       |
| Mortgage-backed securities                                                  |       | 283        |       | 41                |       |
| Oligations of state and political  subdivisions- tax exempt                 |       | 104        |       | 104               |       |
| FNMA and FHLMC preferred stock                                              |       | —     |       | 307               |       |
| Other interest and dividends                                                |       | 14         |       | 15                |       |
| Interest on federal funds sold                                              |       | 61         |       | 4                 |       |
| Total interest income                                                       |       | 3,563      |       | 3,794             |       |
|                                                                        |       |       |       |              |       |
| **Interest Expense**                                                        |       |       |       |              |       |
| Interest on deposits                                                        |       | 960        |       | 1,002             |       |
| Interest on federal funds purchased                                         |       | —     |       | 12                |       |
| Interest on other borrowed money                                            |       | 447        |       | 450               |       |
| Total interest expense                                                      |       | 1,407      |       | 1,464             |       |
|                                                                        |       |       |       |              |       |
| Net interest income before provision for  loan losses                       |       | 2,156      |       | 2,330             |       |
|                                                                        |       |       |       |              |       |
| **Provision for Loan Losses**                                               |       | 87         |       | 261               |       |
|                                                                        |       |       |       |              |       |
| Net interest income after provision for  loan losses                        |       | 2,069      |       | 2,069             |       |
|                                                                        |       |       |       |              |       |
| **Other Income**                                                            |       |       |       |              |       |
|                                                                        |       |       |       |              |       |
| Service charges on deposit accounts                                         |       | 79         |       | 90                |       |
| Other service charges and fees                                              |       | 94         |       | 71                |       |
| Earnings-Cash surrender value of life  insurance                            |       | 118        |       | 125               |       |
| Trust services                                                              |       | 2          |       | 1                 |       |
| Gain (loss) on sale of investment  securities                               |       | —     |       | 10                |       |
| Gain on sale of OREO property                                               |       | 19         |       | 12                |       |
| Gain on sale of assets                                                      |       | 9          |       | —            |       |
| Gain on sale of loans                                                       |       | 1          |       | 13                |       |
| Other income                                                                |       | 4          |       | 10                |       |
| Total other income                                                          |       | 326        |       | 332               |       |
|                                                                        |       |       |       |              |       |
| **Other Expenses**                                                          |       |       |       |              |       |
| Salaries, fees and employee benefits                                        |       | 917        |       | 913               |       |
| Net occupancy expense of bank premises and furniture  and equipment expense |       | 404        |       | 417               |       |
| Professional and loan-related fees                                          |       | 455        |       | 116               |       |
| Data processing                                                             |       | 157        |       | 136               |       |
| FDIC insurance premiums                                                     |       | 98         |       | 8                 |       |
| Other expenses                                                              |       | 491        |       | 513               |       |
| Total other expenses                                                        |       | 2,522      |       | 2,103             |       |
|                                                                        |       |       |       |              |       |
| Income (loss) before income taxes                                           |       | (127       | )          | 298               |       |
| Applicable income tax (benefit)                                             |       | (112       | )          | 41                |       |
|                                                                        |       |       |       |              |       |
| Net income (loss)                                                           |       | $          | (15        | )                 | $          | 257 |   |
|                                                                        |       |       |       |              |       |
| Earnings per common share                                                   |       | $          | (0.03      | )                 | $          | 0.52 |   |
| Cash dividends declared per share                                           | ** ** | $          | **—** |              | $          | 0.46 | ** ** |

 

**The Notes to Condensed Consolidated Financial Statements arean integral part of these statements.**

 

7

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FULTONBANCSHARES CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTSOF COMPREHENSIVE INCOME

SIX  MONTHS ENDED JUNE 30, 2005 AND 2004

(UNAUDITED)

 
| ** **                                                             | ** ** | **2005**   | ** ** | **2004**          | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                             | ** ** | ** ** | ** ** | **(As Restated)** | ** ** |
| Net Income (Loss)                                                      |       | $          | (15        | )                 | $          | 257 |   |
|                                                                   |       |       |       |              |       |
| Unrealized gain (loss) on investments available  for sale, net of tax  |       | (56        | )          | (608              | )          |
|                                                                   |       |       |       |              |       |
| Reclassification adjustment for gains (losses)  included in net income |       | —     |       | 10                |       |
|                                                                   |       |       |       |              |       |
| Comprehensive income (loss)                                            |       | $          | (71        | )                 | $          | (341 | ) |

 

**The Notes to Condensed Consolidated Financial Statements arean integral part of these statements.**

 

8

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FULTONBANCSHARES, CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS

SixMonths Ended June 30, 2005 and 2004

(UNAUDITED)

 
| ** **                                                                               | ** ** | **2005**   | ** ** | **2004**          | ** ** |
|------------------------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                               | ** ** | ** ** | ** ** | **(As Restated)** | ** ** |
| Cash flows from operating activities:                                                    |       |       |       |              |       |
| Net Income (Loss)                                                                        |       | $          | (15        | )                 | $          | 257 |   |
| Adjustments to reconcile net income to net  cash                                         |       |       |       |              |       |
| Provided by operating activities:                                                        |       |       |       |              |       |
| Depreciation and amortization                                                            |       | 172        |       | 197               |       |
| Provision for loan losses                                                                |       | 87         |       | 261               |       |
| (Increase) decrease in accrued interest  receivable                                      |       | 108        |       | (12               | )          |
| Increase (decrease) in accrued interest  payable                                         |       | 3          |       | (8                | )          |
| Increase in CSV-Life Insurance                                                           |       | (95        | )          | (104              | )          |
| Gain on sale - securities                                                                |       | —     |       | (10               | )          |
| Gain on sale - OREO                                                                      |       | (19        | )          | (12               | )          |
| Gain on sale - land                                                                      |       | (9         | )          |              |       |
| Gain on sale -loans                                                                      |       | —     |       | (13               | )          |
| Other - Net                                                                              |       | 26         |       | 137               |       |
|                                                                                     |       |       |       |              |       |
| Net cash provided by operating activities                                                |       | 258        |       | 693               |       |
|                                                                                     |       |       |       |              |       |
| Cash flows from investing activities:                                                    |       |       |       |              |       |
| Purchase of investment securities -  Available-for-sale                                  |       | (15,053    | )          | (3,523            | )          |
| Net redemption of Federal Home Loan Bank  Stock                                          |       | 215        |       | 343               |       |
| Sales of available-for-sale securities                                                   |       | —     |       | 1,080             |       |
| Maturities of available-for-sale securities                                              |       | 1,071      |       | 3,451             |       |
| Net decrease in loans                                                                    |       | 8,921      |       | 3,602             |       |
| Proceeds from sale of OREO                                                               |       | 853        |       | (1,398            | )          |
| Proceeds from sale of land                                                               |       | 25         |       | —            |       |
| Purchases of & deposits on bank  premises and equipment - net                   |       | (182       | )          | (160              | )          |
|                                                                                     |       |       |       |              |       |
| Net cash provided (used) by investing  activities                                        |       | (4,150     | )          | 3,395             |       |
|                                                                                     |       |       |       |              |       |
| Cash flows from financing activities:                                                    |       |       |       |              |       |
| Net increase (decrease) in deposits                                                      |       | (3,495     | )          | 1,752             |       |
| Purchase of treasury stock                                                               |       | —     |       | (1                | )          |
| Dividends paid                                                                           |       | —     |       | (227              | )          |
| Net increase (decrease) in other borrowed  money                                         |       | —     |       | (3,825            | )          |
|                                                                                     |       |       |       |              |       |
| Net cash provided (used) by financing  activities                                        |       | (3,495     | )          | (2,301            | )          |
|                                                                                     |       |       |       |              |       |
| Net increase (decrease) in cash and cash  equivalents                                    |       | (7,387     | )          | 1,787             |       |
|                                                                                     |       |       |       |              |       |
| Cash and cash equivalents, beginning  balance                                            |       | 16,364     |       | 3,853             |       |
|                                                                                     |       |       |       |              |       |
| Cash and cash equivalents, ending balance                                                |       | $          | 8,977      |              | $          | 5,640 |   |
|                                                                                     |       |       |       |              |       |
| Supplemental disclosure of cash flows  information:                                      |       |       |       |              |       |
| Cash paid during the period for:                                                         |       |       |       |              |       |
| Interest                                                                                 |       | $          | 1,404      |              | $          | 1,552 |   |
| Income taxes                                                                             |       | 17         |       | —            |       |
|                                                                                     |       |       |       |              |       |
| Supplemental schedule of noncash  investing and financing activities:               |       |       |       |              |       |
| Change in net unrealized gain on  investments available for sale (net of deferred taxes) |       | (56        | )          | (608              | )          |

 

**The Notes to Condensed Consolidated Financial Statements arean integral part of these statements.**

 

9

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2005

(UNAUDITED)

 

Review ofInterim Financial Statements

 

The condensedconsolidated financial statements as of and for the six months ended June 30,2005 and 2004 have been reviewed by independent certified public accountants.Their report on the review is attached as Exhibit 99.1 to the 10-Q filing.

 

Note 1.Restatement and Basis of Presentation

 

Restatement

 

The Office of the Comptroller of the Currency Report of Examination onthe Corporation’s wholly-owned bank subsidiary which commenced August 10, 2004and was delivered to the Bank in final form in February, 2005 included afinding that the Bank must add at least a $250,000 provision to the Reserve forPossible Loan Losses at June 30, 2004. The Bank’s calculation of the necessary provision was $261,000. TheCondensed Consolidated Statements of Income for the three months and six monthsended June 30, 2004, the Condensed Consolidated Statements of ComprehensiveIncome for the three months and six months ended June 30, 2004 and theCondensed Consolidated Statements of Cash Flows for the six months ended June30, 2004 were amended to reflect the additional $261,000 provision expense andthe related reduction of applicable income taxes.

 

Basis of Presentation

 

The financialinformation presented at and for the six months ended June 30, 2005 and 2004 isunaudited. Information presented at December 31, 2004 is condensed from auditedyear-end financial statements. However, unaudited information reflects alladjustments (consisting solely of normal recurring adjustments) that are, inthe opinion of management, necessary for a fair presentation of the financialposition, results of operations and cash flows for the interim period.

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with generally accepted accounting principles in the United Statesof America for interim financial information. Accordingly, they do not includeall of the information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, alladjustments considered necessary for a fair presentation have been included andare of a normal, recurring nature. Operating results for the six month periodended June 30, 2005, are not necessarily indicative of the results that may beexpected for the year ending December 31, 2005. These statements should be readin conjunction with notes to the financial statements contained in the 2004Annual Report to Stockholders.

 

In addition tohistorical information, this Form 10-Q Report contains forward-lookingstatements. The forward-looking statements contained herein are subject tocertain risks and uncertainties that could cause actual results to differmaterially from those projected in the forward-looking statements. Importantfactors that might cause such differences include, but are not limited to,those discussed in the section entitled “Management’s Discussion and Analysisof Financial Condition and Results of Operations”. Readers are cautioned not toplace undue reliance on these forward-looking statements, which reflectmanagement’s analysis only as of the date hereof. Readers should carefullyreview the risk factors described in other documents the Fulton BancsharesCorporation files from time to time with the Securities and Exchange Commission.

 

10

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Note 2. Principles ofConsolidation

 

Theconsolidated financial statements include the accounts of the Fulton BancsharesCorporation and its wholly-owned subsidiaries, Fulton County National Bank& Trust Company and the Fulton County Community Development Corporation(together, the “Corporation”). All significant intercompany transactions andaccounts have been eliminated.

 

Note 3. CashFlows

 

For purposesof the statements of cash flows, the corporation has defined cash and cashequivalents as those amounts included in the balance sheet captions “cash anddue from banks” and “federal funds sold”. As permitted by Statement ofFinancial Accounting Standards No. 104, the corporation has elected to presentthe net increase or decrease in deposits in banks, loans and time deposits inthe statements of cash flows.

 

Note 4.Federal Income Taxes

 

For financialreporting purposes the provision for loan losses charged to operating expenseis based on management’s judgment, whereas for federal income tax purposes, theamount allowable under present tax law is deducted. Additionally, certainexpenses are charged to operating expense in the period the liability isincurred for financial reporting purposes, whereas for federal income taxpurposes, these expenses are deducted when paid. As a result of these timingdifferences, deferred income taxes are provided in the financial statements.Federal income taxes were computed after reducing pretax accounting income fornontaxable municipal and loan income.

 

Note 5. OtherCommitments

 

In the normalcourse of business, the Corporation makes various commitments and incurscertain contingent liabilities which are not reflected in the accompanyingfinancial statements. These commitments include various guarantees andcommitments to extend credit and the Corporation does not anticipate any lossesas a result of these transactions.

 

Note 6.Investment Securities

 

The carryingamounts of investment securities and their approximate fair values at June 30,2005 were as follows:

 
| ** **                                | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| **($ 000 omitted)**                  | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
|                                      |       |          |       |           |       |           |       |       |       |
| Investment securities available for sale: |       |          |       |           |       |           |       |       |       |
|                                      |       |          |       |           |       |           |       |       |       |
| State & Municipal Securities          |       | $             | 5,394      |           | $          | 76             |       | $          | 0          |   | $ | 5,470 |   |
|                                      |       |          |       |           |       |           |       |       |       |
| U.S. Government Treasury Securities       |       | 4,998         |       | 0              |       | 0              |       | 4,998      |       |
|                                      |       |          |       |           |       |           |       |       |       |
| U.S. Government Agency Securities         |       | 8,237         |       | 0              |       | (85            | )          | 8,152      |       |
|                                      |       |          |       |           |       |           |       |       |       |
| Mortgage-backed Securities                |       | 14,242        |       | 15             |       | (60            | )          | 14,197     |       |
|                                      |       |          |       |           |       |           |       |       |       |
| Equity Securities                         |       | 59            |       | 0              |       | (1             | )          | 58         |       |
|                                      |       |          |       |           |       |           |       |       |       |
|                                      |       | $             | 32,930     |           | $          | 91             |       | $          | (146       | ) | $ | 32,875 |   |
|                                           |            |               |            |                |            |                |            |            |            |  |  |  |  |  |

 

There were nosecurities categorized “Held-to-maturity” or “Trading” at June 30, 2005.

 

11

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Note 7.Comprehensive Income

 

Comprehensiveincome is defined as the change in equity from transactions and other eventsfrom nonowner sources. It includes all changes in equity except those resultingfrom investments by owners and distributions to owners. Consequently, a “Statementof Comprehensive Income” has been included in this filing.

 

Note 8.  Earnings Per Share

 

Earnings percommon share were computed based on the weighted average of shares of commonstock outstanding, which was 492,790 shares.

 

Note 9.Regulatory Matters and Settlement with Former President

 

Fulton CountyNational Bank and Trust Company, as a National Bank, is subject to the dividendrestrictions set forth by the Comptroller of the Currency.  The Corporation is also subject to variousregulatory capital requirements administered by federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory, and possibly additional discretionary actionsby regulators that, if undertaken, could have a direct material effect on theCorporation’s financial statements.

 

On March 23,2005, the Bank’s Board of Directors entered into a “Stipulation and Consent tothe Issuance of a Consent Order” (the “Consent Order”) with the Office of theComptroller of the Currency (OCC).  TheConsent Order includes 24 articles that commence by requiring the Bank to forma Compliance Committee and develop an action plan (“Plan”) to comply with theremaining articles.  The Plan requiresthe development of a strategic plan, the appointment of certain management andofficers and the commission of a management and board supervision study. ThePlan also requires the development of a three-year profit plan and capitalplan, the requirement to maintain certain capital ratios, improvement ininterest rate risk management, a consultant study of compliance withTruth-In-Lending and RESPA, and a review of the methodology of determiningALLL.  The Plan further requires the Bankto engage and retain a qualified third-party loan review, to develop a criticizedassets improvement program, to implement a loan portfolio managementimprovement program and to implement improved reporting and information systemsfor the loan portfolio.  Further articlesof the Plan require a qualified, independent consultant to assess compliancewith the Bank Secrecy Act (“BSA”), Money Laundering Control Act, suspiciousactivities, and the rules and regulations of the Office of Foreign Assets andControl, the development of a BSA compliance program, a study of the auditfunction with emphasis on BSA compliance, and a written program on SuspiciousActivity Reports.  Other articles of thePlan require the development of a customer information security program, adisaster recovery plan, and a liquidity contingency plan.  Finally, an article requires the Board totake all necessary steps to ensure that the Bank corrects each violation oflaw, rule or regulation cited in Reports of Examination.  The remaining articles are administrative innature.

 

Under the Consent Order, the Bank must obtain OCC approval before anyexecutive officers or directors can be added to the Bank’s management.  The payment of dividends has also beentemporarily suspended without prior OCC approval.

 

Similarrestrictions have been placed on the holding company, Fulton BancsharesCorporation, by the Federal Reserve Bank. The Corporation is considered to be in “troubled” condition, as thatterm is defined in Regulation Y, 12 C.F.R.225.71(d).  The designation was due to serious concernsin a Federal Reserve Inspection Report commenced January 31, 2005 and concludedFebruary 17, 2005 and the Office of the Comptroller of the Currency (OCC)Report of Examination on the Corporation’s wholly-owned bank subsidiarycommenced August 10, 2004 and received in the final form in February, 2005. TheOCC, the Bank’s primary regulator, provided a letter of concern based on thepreliminary findings of the Examination dated

 

12

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November 23,2004.  The concerns in the OCC Report ofExamination were reflected in the Consent Order referenced above.

 

On May 9, 2005the Board of Directors of the Corporation signed a Memorandum of Understanding(“MOU”) dated May 9, 2005 issued by Federal Reserve Bank (“Reserve Bank”).  The principle elements of the MOU are asfollows:  The Corporation may not issuedividends nor incur debt not in the ordinary course of business withoutapproval of the Reserve Bank, the Corporation may not repurchase its own stockwithout approval of the Reserve Bank, the Corporation must appoint a compliancecommittee and conduct an assessment of the external audit firm’s ability toaudit an organization, such as the Corporation, which is subject to theSarbanes Oxley Act and the Corporation is required to ensure that its whollyowned subsidiary, The Fulton County National Bank & Trust Company, complieswith the supervisory actions imposed by the Office of the Comptroller of theCurrency.

 

The OCC hasalso informed the Bank of possible violations of laws and regulations withregard to the Bank Secrecy Act, the Truth-In-Lending Act, and the Real EstateSettlement Procedures Act which could result in future fines and penalties tothe Bank and possible reimbursements. The amount of any future fines or reimbursements cannot be reasonablyestimated at June 30, 2005.

 

Because of thepossible regulatory violations and other OCC scrutiny, the Bank’s FDICinsurance premiums and OCC assessment fees will increase by approximately $168,000 in 2005.

 

Becausecompliance with the Order will require reallocation and increases in internalresources and the engagement of various vendors and consultants, the cost ofcompliance and the effect on results of operations is expected to be material;however the cost of compliance with the Order cannot be reasonably estimated atthis time.

 

The Bankintends to take actions required by the Order to remediate the identifiedweaknesses by forming a Board Compliance Committee that will direct and monitorthe completion of the specific requirements of Order by use of internalresources and the retention of qualified vendors and consultants.

 

In addition,on March 4, 2005, the Bank terminated its President.  The Boards of Directors of Fulton BancsharesCorporation and The Fulton National Bank and Trust Company entered into aSettlement Agreement and General Release with its former President which becameeffective on June 15, 2005. The terms of the Settlement Agreement aresummarized as follows.

 

The formerPresident’s termination on March 4, 2005 from employment as an officer oremployee of the Bank remained in effect. The former President resigned as amember of the Boards of Directors and any other officer or employment positionhe held with the Corporation and the Bank, effective June 15, 2005. The formerPresident acknowledged his March 4, 2005 separation from employment by theCorporation and the Bank and agreed that he will not challenge the legalvalidity of that separation. The former President agreed not to seek employmentwith the Corporation or the Bank.

 

The principalbalances of a loan to the former President and two other loans in the aggregateapproximate amount of $185,000 were required to be paid in full with interestand other charges as required by the applicable loan documents to the Bankwithin thirty days of the effective date. In addition, the former President was required to assign PittsburghSteelers ticket licensing rights for six seats to the Bank.

 

The Bankagreed to no longer take the position under the Salary Continuation Agreementknown generically as a Supplemental Employee Retirement Plan dated September 1,1995 and subsequently amended (together, “SERP”) that the former President’stermination was for cause,

 

13

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therebyallowing the former President to apply to the OCC and the Federal DepositInsurance Corporation (“FDIC”) for permission to obtain such part of his SERPas the regulators or the courts determine that the Bank must pay. If the SERPpayments are not approved by the OCC and FDIC, and such regulatory disapprovalis upheld by any subsequent judicial review, then the Bank agreed to pay theformer President only one year of severance pay at his final annual salary, ifauthorized by the regulators to do so. The former President agreed to not challenge the legal validity of theBank’s payment under the SERP of the amount determined by the regulators or afinal valid court order. The Bank agreed to not file a civil action requestingthe return by the former President of monies paid to him under the Bank’s401(k) plan or the SERP.

 

The Directorsas individuals and shareholders released the former President from liabilityrelated to his employment with the Corporation and the Bank.  The former President released theCorporation, Bank, and Directors from any liability related to termination ofhis employment with the Corporation and the Bank.

 

14

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FULTONBANCSHARES CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

 

RESTATEMENT

 

The Office of the Comptroller of the Currency Report of Examination onthe Corporation’s wholly-owned bank subsidiary, which commenced August 10, 2004and was delivered to the Bank in final form in February, 2005, included afinding that the Bank must add at least a $250,000 provision to the Reserve forPossible Loan Losses at June 30, 2004. The Bank’s calculation of the necessary provision was $261,000. TheCondensed Consolidated Statements of Income for the three months and six monthsended June 30, 2004, the Condensed Consolidated Statements of ComprehensiveIncome for the three months and six months ended June 30, 2004 and theCondensed Consolidated Statements of Cash Flows for the six months ended June30, 2004 were amended to reflect the additional $261,000 provision expense andthe related reduction of applicable income taxes.  All discussion that follows is based on therestated amounts for the three months and six months periods ended June, 30,2004.

 

OVERVIEW

 

Net after taxloss for the first six months of 2005 was ($15,000) compared to net income of$257,000 for the same period in 2004, representing a decrease of $272,000, or106%. Net loss on an adjusted per share basis for the first six months of 2005was ($.03) compared to $.52 income per share realized during the first sixmonths ended June 30, 2004.

 

RESULTS OFOPERATIONS

 

Second Quarter2005 vs. Second Quarter 2004

 

Interestincome for the second quarter of 2005 was $1,779,000 compared to $1,878,000earned during the same period in 2004, for a decrease of $99,000, or 5%. Thedecrease was due primarily to a decrease in the average balance of loans andinvestments in 2005.  Loans declined onaverage by 11% as the Bank focused on work out of problem credits.  Interest income also decreased due to a highermix of liquid assets being held to allow for lowered overnight borrowingcapacity at Federal Home Loan Bank of Pittsburgh.  Interest expense for the second quarter of2005 was $711,000, a decrease of $19,000, or 3% compared to the second quarterof 2004. The decrease was due primarily to a decrease in the average balance ofdeposits and borrowings that offset higher deposit rates paid in 2005.  Due to higher Bank capital ratio requirementsin the OCC Consent Order signed on March 23, 2005 and related borrowingrestrictions, asset growth is constrained and more liquid assets are beingmaintained. Net interest income before the provision for loan losses for thesecond quarter of 2005 totaled $1,068,000, down $80,000, or 7%, from the secondquarter of 2004.

 

Six Months2005 vs. Six Months 2004

 

Interestincome for the first six months of 2005 was $3,563,000 compared to $3,794,000earned during the same period in 2004, for a decrease of $231,000, or 6%. Thedecrease was due primarily to a decrease in the average balance of loans andinvestments in 2005.  Loans declined onaverage by 10% as a focus was to work out of problem credits.  Interest income also decreased due to ahigher mix of liquid assets being held to allow for lowered overnight borrowingcapacity at Federal Home Loan Bank of Pittsburgh.  Interest expense for the first six months of2005 was $1,407,000, a decrease of $57,000, or 4% compared to the first sixmonths

 

15

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of 2004. Thedecrease was due primarily to a decrease in the average balance of deposits andborrowings that offset higher deposit rates paid in 2005.  Due to higher Bank capital ratio requirementsin the OCC Consent Order signed on March 23, 2005 and related borrowingrestrictions, asset growth is constrained and more liquid assets are beingmaintained. Net interest income before the provision for loan losses for thefirst six months of 2005 totaled $2,156,000, down $174,000, or 8%, from thefirst six months of 2004.

 

Net interestincome is the difference between total interest income and total interestexpense. Interest income is generated through earning assets, which includeloans, deposits with other banks, and investments. Interest income is dependenton many factors including the volume of earning assets; level of interestrates; changes in interest rates; and volumes of nonperforming loans. The costof funds varies with the volume of funds necessary to support earning assets;rates paid to maintain deposits; rates paid on borrowed funds; and level ofinterest-free deposits.

 

NET INTERESTMARGIN

 

The netinterest margin for the first six months of 2005 was 3.47% compared to 3.56%for the first six months of 2004.The net interest margin declined mainly due tothe change in mix of earning assets to more liquid assets and lowerhigher-earning loans in 2005 compared to 2004. Liquidity and interest rate riskare monitored through asset liability management modeling. Management protectsits net interest margin by competitively pricing its loans and deposits and bystructuring interest-earning assets and liabilities so they can be repriced inresponse to changes in market interest rates.

 

NONINTERESTINCOME

 

Second Quarter2005 vs. Second Quarter 2004

 

Second quarter2005 noninterest income decreased $15,000 to $154,000, or 9% from $169,000 inthe second quarter of 2004. Service charges on deposits decreased $4,000, or9%, primarily due to a decrease in the number of overdraft charges. Other feesand other income decreased $6,000, or 6%, primarily due to lower earnings onbank owned life insurance and rental income in 2005.  Net gains on sales of various assetsdecreased $5,000 in 2005 primarily because of nonrecurring investment portfoliogains taken in 2004.

 

Six Months2005 vs. Six Months 2004

 

Noninterestincome for the first six months of 2005 decreased $6,000 to $326,000, or 2%from $332,000 in the first half of 2004. Service charges on deposits decreased$11,000, or 12%, primarily due to a decrease in the number of overdraft chargescollected (the fee was unchanged year-over-year). Other fees and other incomeincreased $11,000, or 5%, primarily due to miscellaneous income and recoveriesand higher debit card income offsetting lower earnings on bank owned lifeinsurance and the lack of secondary market fees earned in the previousyear.   The Company is not currentlyselling residential mortgages into the secondary market. Net gains on sales ofvarious assets decreased $6,000 in 2005 primarily because of nonrecurringinvestment portfolio and loan sale gains taken in 2004.

 

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NONINTERESTEXPENSE

 

Second Quarterof 2005 vs. Second Quarter 2004

 

Second quarter2005 noninterest expenses totaled $1,375,000, an increase of $286,000, or 26%,over the $1,089,000 for the second quarter of 2004. Salaries andemployee-related expenses decreased $3,000, or 1%, primarily due to a reductionin profit-sharing and supplemental retirement plan expenses offsettingincreased other personnel expenditures. The second quarter also had a vacancy in the CEO position. Fixed assetexpenses decreased $8,000, or 4%, primarily due to lower equipment/buildingmaintenance and supplies costs.

 

Professionalexpenses increased by $232,000 or 331% due to consultant and legal engagementsnecessitated by compliance with the Consent Order and other regulatoryrequirements.  In addition, during thesecond quarter, legal and consultant expenses were incurred to arrive at asettlement with the former President and CEO. FDIC insurance premiums increased 11 fold to $48,000 for the secondquarter of 2005 due to the regulatory ratings. Data processing expensesincreased $22,000 or 36% due to higher electronic delivery costs. Othernoninterest expenses decreased by $1,000, primarily due to lower discretionaryspending offsetting higher costs associated with the stock transfer servicewhich was outsourced in 2005 and other holding company expenditures.

 

Six Months2005 vs. Six Months 2004

 

Noninterestexpenses for the first six months of 2005 totaled $2,522,000, an increase of$419,000, or 20%, over the $2,103,000 for the same period in 2004. Salaries andemployee-related expenses increased $4,000 primarily due higher salary expensesin 2005 in the first quarter. Fixed asset expenses decreased $13,000, or 3%,primarily due to lower rental, maintenance and supplies costs.

 

Professionalexpenses increased by $339,000 or 292% due to consultant and professionalengagements necessitated by compliance with the Consent Order and otherregulatory requirements.  In addition,during the second quarter, legal and consultant expenses were incurred toarrive at a settlement with the former President and CEO.  FDIC insurance premiums increased 11 fold to$98,000 for the first six months of 2005 due to the regulatory ratings.  Other noninterest expenses decreased by$22,000, or 4%, primarily due to lower discretionary spending.

 

INCOME TAXES

 

The income taxbenefit for the second quarter of 2005 was ($95,000) compared to a benefit of($7,000) for the second quarter of 2004. The income tax benefit for the firstsix months of 2005 was $(112,000) compared to a provision expense of $41,000for the first six months of 2004. Effective tax rates (compared to the marginalfederal income tax bracket of 34% applicable to each period) were different foreach period primarily due to the relationship of non taxable investmentsecurity income to total taxable income.

 

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PROVISION FORLOAN LOSSES

 

Provision forloan losses was $17,000 for the second quarter of 2005 compared with $261,000for the second quarter of 2004. Provision for loan losses was $87,000 for thefirst six months of 2005 compared with $261,000 for the first six months of2004. Provisions were based on management’s evaluation of the adequacy of thereserve for possible loan losses at June 30, 2005 and 2004 and representsamounts deemed necessary to maintain the reserve at the appropriate level basedon size, mix, and quality of the loan portfolio, and considering economicconditions and other relevant risk factors. A summary of the allowance for loanlosses is as follows: 

 
| ** **                                       | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|
| ** **                                       | ** ** | **June 30,**         | ** ** | **June 30,** | ** ** |
| ** **                                       | ** ** | **2005**             | ** ** | **2004** | ** ** |
|                                             |       |                 |       |   |   |
| Beginning of period                              |       | $                    | 1,821      |   | $ | 1,900 |   |
|                                             |       |                 |       |   |   |
| Loans charged-off during the period:             |       |                 |       |   |   |
| Real estate loans                                |       | —               |       | — |   |
| Installment loans                                |       | 8                    |       | 12 |   |
| Commercial and all other loans                   |       | —               |       | 343 |   |
| Total charge-offs                                |       | 8                    |       | 355 |   |
|                                             |       |                 |       |   |   |
| Recoveries of Loans previously charged-off:      |       |                 |       |   |   |
| Real estate loans                                |       | 2                    |       | — |   |
| Installment loans                                |       | 3                    |       | 14 |   |
| Commercial and all other loans                   |       | —               |       | 7 |   |
| Total charge-offs                                |       | 5                    |       | 21 |   |
|                                             |       |                 |       |   |   |
| Net loans (charged off) recovered                |       | (3                   | )          | (344 | ) |
|                                             |       |                 |       |   |   |
| Provision for loan losses charged to  operations |       | 87                   |       | 261 |   |
|                                             |       |                 |       |   |   |
| Allowance for loan losses- end of period         |       | $                    | 1,905      |   | $ | 1,827 |   |

 

Loans 90 daysor more past due (still accruing interest) and those on nonaccrual status wereas follows at June 30: 

 
| ** **                   | ** ** | **90 Days or More Past Due** | ** ** | **Nonaccrual Status** | ** ** |
|------------------------------|------------|------------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2005**                     | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Loans secured by real estate |       | $                            | —     |                  | $          | — |   | $ | 538 |   | $ | 1,400 |   |
|                         |       |                         |       |                  |       |   |   |   |   |
| Personal loans               |       | 1                            |       | 5                     |       | 0 |   | 0 |   |
|                         |       |                         |       |                  |       |   |   |   |   |
| Commercial and other loans   |       | —                       |       | —                |       | 1,531 |   | 106 |   |
| Total                        |       | $                            | 1          |                  | $          | 5 |   | $ | 2,069 |   | $ | 1,506 |   |

 

The Corporation utilizes asystematic review of its loan portfolio on a quarterly basis in order todetermine the adequacy of the allowance for loan losses.  The allowance for loan losses consists of acomponent for individual loan impairment primarily based on the loan’scollateral fair value and other observable data.   A watch list of loans is identified forevaluation based on regulatory examinations and internal and external loangrading and reviews.  Loans other thanthose determined to be impaired are grouped into pools of loans with similarcredit risk characteristics.  These loansare evaluated as groups with allocations made to the allowance based onhistorical loss experience adjusted for current trends in delinquencies, trendsin underwriting and oversight, concentrations of credit and general economicconditions within the Corporation’s trading area.

 

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The decrease in the provisionfor loan losses expense for 2005 compared to 2004 was a result of lower netcharge-offs experienced in 2005.  Theprovision expense in 2004 was mandated by an examination by the Bank’s primaryregulator.

 

FINANCIALCONDITION

 

Assets

 

Total assetson June 30, 2005 were $138,283,000 compared to $141,757,000 at December 31,2004, a decrease of $3,474,000 or 2%. Net loans on June 30, 2005 stood at $83,642,000,a decrease of 10% from $92,649,000 on December 31, 2004. The loan decrease wasdue to payoffs from workouts of classified loans and loan refinancing elsewheredue to competitive rate and structure factors. Investments securities increased and cash decreased from December 31,2004 as proceeds from a late 2004 security sale were reemployed in investmentsecurities in early 2005. Investments also increased from temporary deploymentof proceeds of loan payoffs at quarter end.

 

Liabilities

 

Total depositsdecreased $3,495,000 or 3% to $106,126,000 as of June 30, 2005 compared with$109,621,000 at December 31, 2004. Noninterest-bearing demand depositsdecreased 1% mainly due to the varying cash flow needs of business customersbetween the two dates.   Interest-bearingdeposits decreased $3,304,000 or 4% due to conservative rate positions due tolack of loan demand.

 

Off-BalanceSheet Items

 

TheCorporation is a party to financial instruments with off-balance-sheet risk inthe normal course of business to meet the financial needs of its customers.These financial instruments include commitments to extend credit and standbyletters of credit. Those instruments involve, to varying degrees, elements ofcredit and interest rate risk in excess of the amount recognized in the balancesheet. The contract amounts of those instruments reflect the extent ofinvolvement the corporation has in particular classes of financial instruments.The Corporation’s exposure to credit loss in the event of nonperformance by theother party to the financial instrument for commitments to extend credit andstandby letters of credit and financial guarantees written is represented bythe contractual amounts of those instruments. The Corporation uses the samecredit policies in making commitments and conditional obligations as it doesfor on- balance-sheet instruments.

 

Contract or Notional Amount June 30, 2005

 

FinancialInstruments whose contract amounts represent credit risk at June 30:

 
| Commitments to extend credit                                |   | $      | 10,101,000 |   |
|-------------------------------------------------------------|--------|--------|------------|--------|
|                                                        |   |   |       |
| Standby letters of credit and financial  guarantees written |   | $      | 40,000     |   |

 

Commitments toextend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract. Commitments generallyhave fixed expiration dates or other termination clauses and may requirepayment of a fee. Since many of the commitments are expected to expire withoutbeing drawn upon, the total commitment amounts do not necessarily representfuture cash requirements. The Corporation evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, ifdeemed necessary by the Corporation upon extension of credit, is based onmanagement’s credit evaluation of the customer. Collateral held varies but mayinclude accounts receivable,

 

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inventory,real estate, equipment, and income- producing commercial properties. Standbyletters of credit and financial guarantees written are conditional commitmentsissued by the Corporation to guarantee the performance of a customer to asecond party. Those guarantees are primarily issued to support public andprivate borrowing arrangements. The credit risk involved in issuing letters ofcredit is essentially the same as that involved in extending loans tocustomers. The Corporation holds collateral supporting those commitments whendeemed necessary by management.

 

Liquidity andInterest Rate Sensitivity

 

Liquidity andinterest rate sensitivity are related to, but distinctly different from oneanother. Liquidity involves the bank’s ability to meet cash withdrawal needs ofcustomers and their credit needs in the form of loans. Liquidity is provided bycash on hand and transaction balances held at correspondent banks. Adequateliquidity to meet credit demands and/or adverse deposit flows is also madeavailable from sales or maturities of short-term assets. Additional sources offunds to meet credit needs have traditionally been provided by access to themarketplace to obtain interest-bearing deposits and other borrowings, includingsignificant borrowing capacity available through Federal Home Loan Bank. AtJune 30, 2005, the Bank had borrowings of $15,000,000 at Federal Home LoanBank, representing no change from December 31, 2004. On March 29, 2005, theBank was requested to identify and deliver specific investment securities andloans to collateralize this borrowing. Because of rules on collateral eligibility, this requirement significantlyreduced additional borrowing capacity at the Federal Home Loan Bank for thetime being.  The bank responded byestablishing new unsecured and collateralized borrowing lines of credit atother banks totaling $4,000,000. Management measures liquidity ratios and balance sheet trends on afrequent basis to measure and control liquidity risk.

 

Interest ratesensitivity is the matching or mismatching of the maturity and rate structureof the interest-bearing assets and liabilities. It is the objective ofmanagement to control the difference in the timing of the rate changes forthese assets and liabilities to preserve a satisfactory net interest margin.Management models net interest income at risk in various interest rateenvironments as its primary method of measuring interest rate risk anddeveloping balance sheet management strategies to minimize this risk.

 

Capital

 

Stockholders’equity was $15,447,000 at June 30, 2005 compared with $15,518,000 atDecember 31, 2004, a decrease of $71,000. Accumulated net loss of $15,000and a $56,000 net unrealized loss on available-for-sale securities (net of taxeffect) accounted for the decrease. Total stockholders’ equity represented11.17% of total assets at June 30, 2005. In compliance with regulatoryrestrictions, no cash dividends were paid in 2005, $.23 per share were paid for the second quarter of 2004 and atotal of $.46 per share were paid in the first six months of 2004. On July 20,2000, the Board of Directors announced the approval of a plan to purchase, inopen market and privately negotiated transactions, up to 2% of its shares ofoutstanding common stock. Additionally, on December 18, 2003, the Corporationannounced the approval of a plan to purchase, in open market and privatelynegotiated transactions, up to 1,000 shares of outstanding common stock. As ofDecember 31, 2004, the Corporation had repurchased 2,210 shares, representing0.45% of its shares of outstanding common stock. As a condition of the March23, 2005 Consent Order and the May 9, 2005 Memorandum of Understanding with theFederal Reserve Bank, the Company has agreed to not declare dividends withoutthe prior written approval of these regulators and to terminate the stockrepurchase plans.

 

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REGULATORYCAPITAL

 

The Consent Orderrequires the Bank to maintain capital ratios that are well above the capitallevels normally required by federal regulatory authorities, includingrisk-based capital guidelines. A comparison of Fulton Bancshares Corporation’scapital ratios to regulatory minimum requirements at June 30, 2005 is asfollows:

 
| ** **                                                                 | ** ** | **Fulton**      | ** ** | **Regulatory**   | ** ** | **Increased Regulatory**     | ** ** |
|----------------------------------------------------------------------------|------------|-----------------|------------|------------------|------------|------------------------------|------------|
| ** **                                                                 | ** ** | **Bancshares**  | ** ** | **Minimum**      | ** ** | **Bank Minimum Requirement** | ** ** |
| ** **                                                                 | ** ** | **Corporation** | ** ** | **Requirements** | ** ** | **By Consent Order**         | ** ** |
|                                                                       |       |            |       |             |       |                         |       |
| Leverage ratio                                                             |       | 11.15           | %          | 4.00             | %          | 10.00                        | %          |
|                                                                       |       |            |       |             |       |                         |       |
| Risk-based capital ratios:                                                 |       |            |       |             |       |                         |       |
|                                                                       |       |            |       |             |       |                         |       |
| Tier I (core capital)                                                      |       | 18.36           | %          | 4.00             | %          | 14.00                        | %          |
|                                                                       |       |            |       |             |       |                         |       |
| Combined Tier I and Tier II (core capital  plus allowance for loan losses) |       | 19.62           | %          | 8.00             | %          |                         |       |

 

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BALANCE SHEETANALYSIS

 

The followingtable highlights the changes in the balance sheet. Because quarter end balancescan be distorted by one-day fluctuations, an analysis of changes in thequarterly averages is provided to show balance sheet trends.

 

BALANCE SHEET ANALYSIS

(in 000’s)

Balance Sheets Condensed

Average

 
| ** **                                        | ** ** | **Second**       | ** ** | **Second**       | ** ** |
|---------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                        | ** ** | **Quarter 2005** | ** ** | **Quarter 2004** | ** ** |
|                                              |       |             |       |             |       |
| ASSETS                                            |       |             |       |             |       |
| Federal Funds Sold                                |       | $                | 6,226      |             | $          | 625 |   |
| Securities Available for Sale /Other  Investments |       | 29,421           |       | 30,284           |       |
| Loans                                             |       | 89,388           |       | 100,595          |       |
| Total interest-earning assets                     |       | 125,035          |       | 131,504          |       |
|                                              |       |             |       |             |       |
| Cash and Due from Banks                           |       | 3,826            |       | 4,820            |       |
| Bank Premises and Equipment                       |       | 3,589            |       | 3,715            |       |
| All Other Assets                                  |       | 8,276            |       | 8,445            |       |
| Allowance for Loan Losses                         |       | (1,896           | )          | (1,730           | )          |
| Total Assets                                      |       | $                | 138,830    |             | $          | 146,754 |   |
|                                              |       |             |       |             |       |
| LIABILITIES                                       |       |             |       |             |       |
| Interest-bearing deposits                         |       | $                | 90,661     |             | $          | 97,356 |   |
| Federal Funds Purchased                           |       | 2                |       | —           |       |
| Other Short-term Borrowings                       |       | 15,000           |       | 16,075           |       |
| Total interest-bearing liabilities                |       | 105,663          |       | 113,431          |       |
|                                              |       |             |       |             |       |
| Non-interest bearing deposits                     |       | 15,949           |       | 15,559           |       |
| All Other Liabilities                             |       | 1,696            |       | 1,544            |       |
| Total Liabilities                                 |       | 123,308          |       | 130,534          |       |
|                                              |       |             |       |             |       |
| STOCKHOLDERS’  EQUITY                        |       |             |       |             |       |
| Common Stockholders’ Equity                  |       | 15,522           |       | 16,220           |       |
| Total Stockholders’ Equity                   |       | 15,522           |       | 16,220           |       |
|                                              |       |             |       |             |       |
| Total Liabilities and Stockholders’ Equity   |       | $                | 138,830    |             | $          | 146,754 |   |

 

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ITEM 3 - QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

There havebeen no material changes to the quantitative and qualitative disclosures madein the Corporation’s Annual Report on Form 10-K for the year ended December 31,2004. See Management’s Discussion and Analysis for further discussion of marketrisk.

 

ITEM 4 - CONTROLS AND PROCEDURES

 

The Corporation’sChief Executive Officer and Chief Financial Officer have evaluated theeffectiveness of the Corporation’s disclosure controls and procedures (as suchterm is defined in Rules 13a-14(c) under the Securities Exchange Act of 1934,as amended (the “Exchange Act”)) as of June 30, 2005. Based on such evaluation,such officers have concluded that, as of June 30, 2005, the Corporation’sdisclosure controls and procedures are effective in alerting them on a timelybasis to material information relating to the Corporation (including itsconsolidated subsidiaries) required to be included in the Corporation’speriodic filings under the Exchange Act. There have not been any significantchanges in the Corporation’s internal control over financial reporting or inother factors that could significantly affect such control during the secondquarter of 2005.

 

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PART II -OTHER INFORMATION

 

Item 1 - Legal Proceedings

 

In the opinionof the management of the Corporation, there are no material pending legalproceedings other than ordinary routine litigation incidental to the business,to which the corporation or its subsidiary are a party to or to which theirproperty is subject.

 

Item 2 - Unregistered Sales of Equity Securitiesand Use of Proceeds

 

Not applicable

 

Item 3 - Defaults Upon Senior Securities

 

Not applicable

 

Item 4 - Submission of Matters to a Vote ofSecurity Holders

 

The annualmeeting of the Board of Directors of Fulton Bancshares Corporation was held onMonday, May 9, 2005.  Directors werere-appointed for 3 year terms expiring in 2008 based on the following votescast:

 

| ** **       | ** ** | **For** | ** ** | **Withhold  Authority** | ** ** |
|------------------|------------|---------|------------|-------------------------|------------|
| Martin R. Brown  |       | 332,855 |       | 39,292                  |       |
| David L. Seiders |       | 285,523 |       | 86,624                  |       |
| Robert L. Thomas |       | 330,359 |       | 41,788                  |       |

 

Otherdirectors and the year their respective terms expire are as follows:

 

| Cecil B. Mellott  |   | 2006 |   |
|-------------------|--------|------|--------|
| Clair R. Miller   |   | 2006 |   |
| Robert C. Snyder  |   | 2007 |   |
| Ellis L. Yingling |   | 2007 |   |

Item 5 – Other Information

 

TheCorporation has issued a letter to shareholders that reviews the state of theBank and the Corporation’s second quarter results of operations.  The letter is attached to the 10-Q asExhibit 99.2.

 

Item 6 – Exhibits

 

(a)          Exhibits:

 

Exhibit NumberReferred to Item 601 of Regulation S-K: Description of Exhibit:

 

3(i) Articlesof Incorporation. Incorporated by reference to registrant’s Form 10-K filedwith the Securities and Exchange Commission on December 31, 2004.

 

3(ii) By-laws.Incorporated by reference to registrant’s Form 10-K filed with the Securitiesand Exchange Commission on December 31, 2004.

 

10.1 SalaryContinuation Agreement and Second Amendment - Chief Executive Officer.Incorporated by reference to registrant’s Form 10-K filed with the Securitiesand Exchange Commission on December 31, 2002.

 

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10.2 DirectorDeferred Compensation Plan Incorporated by reference to registrant’s Form 10-Kfiled with the Securities and Exchange Commission on December 31, 2002.

 

10.3 DirectorEmeritus Retirement Agreement Incorporated by reference to registrant’s Form10-K filed with the Securities and Exchange Commission on December 31, 2002.

 

31.1Certification of Chief Executive Officer pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

 

31.2 Certificationof Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

 

32.1Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350

 

32.2Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350

 

99.1 Report ofIndependent Accountant on Interim Financial Statements

 

99.2 Letter toShareholders dated August 15, 2005.

 

SIGNATURES Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 
| Date: August  10, 2005 | By:                                            | /s/George W.  Millward |   |
|------------------------|------------------------------------------------|------------------------|--------|
|                   | George W.  Millward,                           |
|                   | Interim  President and Chief Executive Officer |
|                   |                                           |
| Date: August  10, 2005 | By:                                            | /s/David W.  Cathel    |   |
|                   | David W.  Cathell,                             |
|                   | Senior Vice  President and                     |
|                   | Chief  Financial Officer                       |
|                        |                                                |                        |        |  |

 

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