**FORM 10-Q**

 

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C.  20549**

 

**QUARTERLY REPORT UNDER SECTION 13OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For thequarter ended September 30, 2005**

**Commissionfile number:  33-850626**

 

**FULTON BANCSHARES CORPORATION**

(Exactname of registrant as specified in its charter)

 

| **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’s  telephone number, including area code: |       | **(717) 485-3144**   |

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for shorterperiod that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes ý No o

 

Indicate by checkmark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes o No ý

 

Indicate by check markwhether registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o No ý

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practicabledate.

 

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

 

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FULTONBANCSHARES CORPORATION

INDEX
| PART I -  FINANCIAL INFORMATION                                                                      |
|------------------------------------------------------------------------------------------------------|
| Item  1 - Consolidated Financial Statements                                                          |
|                                                                                                 | Condensed consolidated balance sheets - September 30,  2005 and December 31, 2004 |
|                                                                                                 | Condensed consolidated statements of income - three  months ended September 30, 2005 and 2004 |
|                                                                                                 | Condensed consolidated statements of comprehensive  income - three months ended September 30, 2005 and 2004 |
|                                                                                                 | Condensed consolidated statements of income - nine  months ended September 30, 2005 and 2004 |
|                                                                                                 | Condensed consolidated statements of comprehensive  income nine months ended September 30, 2005 and 2004 |
|                                                                                                 | Condensed consolidated statements of cash flows - nine  months ended September 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                                                                     |
| 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                                                                                             |

 

2

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PARTI - FINANCIAL INFORMATION

 

 

FULTON BANCSHARESCORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATEDBALANCE SHEETS

($ 000 omitted )

 

 
| ** **                                                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                   | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| ** **                                                                                   | ** ** | **(Unaudited)**   | ** ** | **(Audited)**    | ** ** |
| **ASSETS**                                                                                   |       |              |       |             |       |
| Cash and due from banks                                                                      |       | $                 | 3,739      |             | $          | 12,809 |   |
| Interest-bearing deposits in other banks                                                     |       | 364               |       | 55               |       |
| Federal funds sold                                                                           |       | 8,250             |       | 3,500            |       |
| Cash and cash equivalents                                                                    |       | 12,353            |       | 16,364           |       |
|                                                                                         |       |              |       |             |       |
| Investment securities available for sale                                                     |       | 32,405            |       | 18,985           |       |
| Federal Reserve, Atlantic Central Bankers Bank and Federal Home Loan  Bank stocks            |       | 1,052             |       | 1,207            |       |
| Loans, net of reserve for loan losses 2005-$1,903; 2004-$1,828                               |       | 81,617            |       | 92,649           |       |
|                                                                                         |       |              |       |             |       |
| Premises and equipment                                                                       |       | 3,522             |       | 3,596            |       |
| Cash surrender value of life insurance                                                       |       | 5,572             |       | 5,430            |       |
| Accrued interest receivable                                                                  |       | 566               |       | 660              |       |
| Real estate owned other than premises                                                        |       | 700               |       | 1,534            |       |
| Other assets                                                                                 |       | 1,570             |       | 1,332            |       |
|                                                                                         |       |              |       |             |       |
| Total assets                                                                                 |       | $                 | 139,357    |             | $          | 141,757 |   |
|                                                                                         |       |              |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                               |       |              |       |             |       |
| Deposits                                                                                     |       |              |       |             |       |
| Noninterest bearing                                                                          |       | $                 | 17,740     |             | $          | 16,524 |   |
| Interest bearing                                                                             |       | 89,769            |       | 93,097           |       |
|                                                                                         |       | 107,509           |       | 109,621          |       |
|                                                                                         |       |              |       |             |       |
| Other borrowed funds                                                                         |       | 15,000            |       | 15,000           |       |
| Accrued interest payable                                                                     |       | 247               |       | 243              |       |
| Other liabilities                                                                            |       | 1,456             |       | 1,375            |       |
| Total liabilities                                                                            |       | 124,212           |       | 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                                                                            |       | 13,112            |       | 13,226           |       |
| Accumulated other comprehensive income (loss)                                                |       | (238              | )          | 21               |       |
| Treasury stock; shares at cost- 2,210                                                        |       | (89               | )          | (89              | )          |
| Total stockholders’ equity                                                              |       | 15,145            |       | 15,518           |       |
| Total liabilities and stockholders’s equity                                             |       | $                 | 139,357    |             | $          | 141,757 |   |
|                                                                                              |            |                   |            |                  |            |  |  |  |  |

 

**The Notes to Condensed Consolidated FinancialStatements are an integral part of these statements.**

 

3

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FULTON BANCSHARES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME

Three Months EndedSeptember 30, 2005 and 2004

UNAUDITED

($ 000 omitted except pershare)

 

 
| ** **                                                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Interest Income**                                                              |       |     |       |     |       |
| Interest and fees on loans                                                       |       | $        | 1,423      |     | $          | 1,590 |   |
| Interest and dividends on investment securities:                                 |       |     |       |     |       |
| Other U.S. Government agencies                                                   |       | 66       |       | 70       |       |
| Mortgage-backed securities                                                       |       | 147      |       | 18       |       |
| Obligations of state and political subdivisions- tax exempt                      |       | 52       |       | 52       |       |
| FNMA and FHLMC preferred stock                                                   |       | 0        |       | 152      |       |
| Other interest and dividends                                                     |       | 12       |       | (7       | )          |
| Interest on federal funds sold                                                   |       | 93       |       | 5        |       |
| Total interest income                                                            |       | 1,793    |       | 1,880    |       |
|                                                                             |       |     |       |     |       |
| **Interest Expense**                                                             |       |     |       |     |       |
| Interest on deposits                                                             |       | 508      |       | 489      |       |
| Interest on federal funds purchased                                              |       | 0        |       | 0        |       |
| Interest on other borrowed money                                                 |       | 227      |       | 228      |       |
| Total interest expense                                                           |       | 735      |       | 717      |       |
|                                                                             |       |     |       |     |       |
| Net interest income before provision for loan losses                             |       | 1,058    |       | 1,163    |       |
|                                                                             |       |     |       |     |       |
| **Provision for Loan Losses**                                                    |       | 80       |       | 0        |       |
|                                                                             |       |     |       |     |       |
| Net interest income after provision for loan losses                              |       | 978      |       | 1,163    |       |
|                                                                             |       |     |       |     |       |
| **Other Income**                                                                 |       |     |       |     |       |
| Service charges on deposit accounts                                              |       | 46       |       | 40       |       |
| Other service charges and fees                                                   |       | 42       |       | 44       |       |
| Earnings-Cash surrender value of life insurance                                  |       | 59       |       | 59       |       |
| Trust services                                                                   |       | 1        |       | 3        |       |
| Gain (loss) on sale of investment securities                                     |       | 0        |       | (6       | )          |
| Gain (loss) on sale of OREO property                                             |       | 0        |       | (7       | )          |
| Other income                                                                     |       | 2        |       | 1        |       |
| Total other income                                                               |       | 150      |       | 134      |       |
|                                                                             |       |     |       |     |       |
| **Other Expenses**                                                               |       |     |       |     |       |
| Salaries, fees, and employee benefits                                            |       | 486      |       | 354      |       |
| Net occupancy expense of bank premises and furniture and  equipment expense |       | 214      |       | 207      |       |
| Professional and loan-related fees                                               |       | 267      |       | 84       |       |
| Data processing                                                                  |       | 69       |       | 70       |       |
| FDIC insurance premiums                                                          |       | 49       |       | 12       |       |
| Other expenses                                                                   |       | 244      |       | 277      |       |
| Total other expenses                                                             |       | 1,329    |       | 1,004    |       |
|                                                                             |       |     |       |     |       |
| Income (loss) before income taxes                                                |       | (201     | )          | 293      |       |
| Applicable income tax (benefit)                                                  |       | (102     | )          | (13      | )          |
|                                                                             |       |     |       |     |       |
| Net income (loss)                                                                |       | $        | (99        | )        | $          | 306 |   |
|                                                                             |       |     |       |     |       |
| Earnings (loss) per common  share                                                |       | $        | (.20       | )        | $          | .62 |   |
| Cash dividends declared  per share                                               |       | $        | 0          |     | $          | .27 |   |
|                                                                                  |            |          |            |          |            |  |  |  |

** **

**The Notes to Condensed Consolidated FinancialStatements are an integral part of these statements.**

 

4

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FULTON BANCSHARESCORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME

THREE MONTHS ENDEDSEPTEMBER 30, 2005 AND 2004

 (UNAUDITED)

 
| ** **                                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                   |       |     |       |     |       |
| Net Income (Loss)                                                      |       | $        | (99        | )        | $          | 306 |   |
|                                                                   |       |     |       |     |       |
| Unrealized gain (loss) on  investments available for sale, net of tax  |       | (203     | )          | 258      |       |
|                                                                   |       |     |       |     |       |
| Reclassification  adjustment for gains (losses) included in net income |       | 0        |       | (6       | )          |
|                                                                   |       |     |       |     |       |
| Comprehensive income  (loss)                                           |       | $        | (302       | )        | $          | 558 |   |

 

**The Notes to Condensed Consolidated FinancialStatements are an integral part of these statements.**

 

5

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FULTON BANCSHARESCORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME

Nine Months EndedSeptember 30, 2005 and 2004

UNAUDITED

($ 000 omitted except pershare)

 

 
| ** **                                                                  | ** ** | **2005**   | ** ** | **2004**          | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                  | ** ** | ** ** | ** ** | **(As Restated)** | ** ** |
| **Interest Income**                                                         |       |       |       |              |       |
| Interest and fees on loans                                                  |       | $          | 4,396      |              | $          | 4,769 |   |
| Interest and dividends on investment securities:                            |       |       |       |              |       |
| Other U.S. Government agencies                                              |       | 194        |       | 214               |       |
| Mortgage-backed securities                                                  |       | 430        |       | 59                |       |
| Obligations of state and political subdivisions- tax exempt                 |       | 156        |       | 156               |       |
| FNMA and FHLMC preferred stock                                              |       | 0          |       | 463               |       |
| Other interest and dividends                                                |       | 26         |       | 8                 |       |
| Interest on federal funds sold                                              |       | 154        |       | 5                 |       |
| Total interest income                                                       |       | 5,356      |       | 5,674             |       |
|                                                                        |       |       |       |              |       |
| **Interest Expense**                                                        |       |       |       |              |       |
| Interest on deposits                                                        |       | 1,468      |       | 1,503             |       |
| Interest on federal funds purchased                                         |       | 0          |       | 0                 |       |
| Interest on other borrowed money                                            |       | 674        |       | 678               |       |
| Total interest expense                                                      |       | 2,142      |       | 2,181             |       |
|                                                                        |       |       |       |              |       |
| Net interest income before provision for loan losses                        |       | 3,214      |       | 3,493             |       |
|                                                                        |       |       |       |              |       |
| **Provision for Loan Losses**                                               |       | 167        |       | 261               |       |
| Net interest income after provision for loan losses                         |       | 3,047      |       | 3,232             |       |
|                                                                        |       |       |       |              |       |
| **Other Income**                                                            |       |       |       |              |       |
| Service charges on deposit accounts                                         |       | 125        |       | 130               |       |
| Other service charges and fees                                              |       | 136        |       | 115               |       |
| Earnings-Cash surrender value of life insurance                             |       | 177        |       | 184               |       |
| Trust services                                                              |       | 3          |       | 4                 |       |
| Gain on sale of investment securities                                       |       | 0          |       | 4                 |       |
| Gain on sale of OREO property                                               |       | 19         |       | 5                 |       |
| Gain on sale of assets                                                      |       | 9          |       | 0                 |       |
| Gain on sale of loans                                                       |       | 1          |       | 13                |       |
| Other income                                                                |       | 6          |       | 11                |       |
| Total other income                                                          |       | 476        |       | 466               |       |
|                                                                        |       |       |       |              |       |
| **Other Expenses**                                                          |       |       |       |              |       |
| Salaries, fees and employee benefits                                        |       | 1,403      |       | 1,267             |       |
| Net occupancy expense of bank premises and furniture and equipment  expense |       | 618        |       | 624               |       |
| Professional and loan-related fees                                          |       | 722        |       | 200               |       |
| Data processing                                                             |       | 226        |       | 206               |       |
| FDIC insurance premiums                                                     |       | 147        |       | 20                |       |
| Other expenses                                                              |       | 735        |       | 790               |       |
| Total other expenses                                                        |       | 3,851      |       | 3,107             |       |
|                                                                        |       |       |       |              |       |
| Income (loss) before income taxes                                           |       | (328       | )          | 591               |       |
| Applicable income tax (benefit)                                             |       | (214       | )          | 28                |       |
|                                                                        |       |       |       |              |       |
| Net income (loss)                                                           |       | $          | (114       | )                 | $          | 563 |   |
|                                                                        |       |       |       |              |       |
| Earnings (loss) per common  share                                           |       | $          | (0.23      | )                 | $          | 1.14 |   |
| Cash dividends declared  per share                                          |       | $          | 0          |              | $          | 0.73 |   |

** **

**The Notes to Condensed Consolidated FinancialStatements are an integral part of these statements.**

 

6

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FULTON BANCSHARESCORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME

NINE  MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

(UNAUDITED)

 
| ** **                                                             | ** ** | **2005**   | ** ** | **2004**          | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                             | ** ** | ** ** | ** ** | **(As Restated)** | ** ** |
| Net Income (Loss)                                                      |       | $          | (114       | )                 | $          | 563 |   |
|                                                                   |       |       |       |              |       |
| Unrealized gain (loss) on  investments available for sale, net of tax  |       | (259       | )          | (350              | )          |
|                                                                   |       |       |       |              |       |
| Reclassification  adjustment for gains (losses) included in net income |       | 0          |       | 4                 |       |
|                                                                   |       |       |       |              |       |
| Comprehensive income  (loss)                                           |       | $          | (373       | )                 | $          | 219 |   |
|                                                                        |            |            |            |                   |            |  |  |  |  |

 

**The Notes to Condensed Consolidated FinancialStatements are an integral part of these statements.**

 

7

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FULTON BANCSHARES,CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARIES

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

Nine Months EndedSeptember 30, 2005 and 2004

(UNAUDITED)

 
| ** **                                                                               | ** ** | **2005**   | ** ** | **2004**          | ** ** |
|------------------------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                               | ** ** | ** ** | ** ** | **(As Restated)** | ** ** |
| Cash flows from operating  activities:                                                   |       |       |       |              |       |
| Net Income (Loss)                                                                        |       | $          | (114       | )                 | $          | 563 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities:       |       |       |       |              |       |
| Depreciation and amortization                                                            |       | 266        |       | 294               |       |
| Provision for loan losses                                                                |       | 167        |       | 261               |       |
| (Increase) decrease in accrued interest receivable                                       |       | 94         |       | (4                | )          |
| Increase (decrease) in accrued interest payable                                          |       | 4          |       | (93               | )          |
| Increase in CSV-Life Insurance                                                           |       | (142       | )          | (152              | )          |
| Gain on sale - securities                                                                |       | 0          |       | (4                | )          |
| Gain on sale - OREO                                                                      |       | (19        | )          | (5                | )          |
| Gain on sale - land                                                                      |       | (9         | )          | 0                 |       |
| Gain on sale -loans                                                                      |       | (1         | )          | (13               | )          |
| Other - Net                                                                              |       | (23        | )          | 178               |       |
|                                                                                     |       |       |       |              |       |
| Net cash provided by operating activities                                                |       | 223        |       | 1,039             |       |
|                                                                                     |       |       |       |              |       |
| Cash flows from investing  activities:                                                   |       |       |       |              |       |
| Purchase of investment securities - Available-for-sale                                   |       | (20,549    | )          | (3,527            | )          |
| Net redemption of Federal Home Loan Bank Stock                                           |       | 155        |       | 237               |       |
| Sales of available-for-sale securities                                                   |       | 0          |       | 1,075             |       |
| Maturities of available-for-sale securities                                              |       | 6,728      |       | 3,711             |       |
| Net decrease in loans                                                                    |       | 10,866     |       | 4,671             |       |
| Proceeds from sale of OREO                                                               |       | 853        |       | (1,323            | )          |
| Proceeds from sale of land                                                               |       | 25         |       | 0                 |       |
| Purchases of & deposits on bank premises and equipment - net                         |       | (200       | )          | (160              | )          |
|                                                                                     |       |       |       |              |       |
| Net cash provided (used)  by investing activities                                        |       | (2,122     | )          | 4,684             |       |
|                                                                                     |       |       |       |              |       |
| Cash flows from financing  activities:                                                   |       |       |       |              |       |
| Net increase (decrease) in deposits                                                      |       | (2,112     | )          | 68                |       |
| Purchase of treasury stock                                                               |       | 0          |       | (1                | )          |
| Dividends paid                                                                           |       | 0          |       | (360              | )          |
| Net increase (decrease) in other borrowed money                                          |       | 0          |       | (3,825            | )          |
|                                                                                     |       |       |       |              |       |
| Net cash provided (used)  by financing activities                                        |       | (2,112     | )          | (4,118            | )          |
|                                                                                     |       |       |       |              |       |
| Net increase (decrease) in  cash and cash equivalents                                    |       | (4,011     | )          | 1,605             |       |
|                                                                                     |       |       |       |              |       |
| Cash and cash equivalents,  beginning balance                                            |       | 16,364     |       | 3,853             |       |
|                                                                                     |       |       |       |              |       |
| Cash and cash equivalents,  ending balance                                               |       | $          | 12,353     |              | $          | 5,458 |   |
|                                                                                     |       |       |       |              |       |
| Supplemental disclosure of  cash flows information:                                      |       |       |       |              |       |
| Cash paid during the  period for:                                                        |       |       |       |              |       |
| Interest                                                                                 |       | $          | 2,138      |              | $          | 2,274 |   |
| Income taxes                                                                             |       | 17         |       | 0                 |       |
|                                                                                     |       |       |       |              |       |
| Supplemental schedule of  noncash investing and financing activities:                    |       |       |       |              |       |
| Change in net unrealized gain on investments available for sale (net  of deferred taxes) |       | (259       | )          | (350              | )          |
|                                                                                          |            |            |            |                   |            |  |  |  |  |

 

**The Notes to Condensed Consolidated FinancialStatements are an integral part of these statements.**

 

8

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NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)

Reviewof Interim Financial Statements

Thecondensed consolidated financial statements as of and for the nine months endedSeptember 30, 2005 and 2004 have been reviewed by independent certifiedpublic accountants. Their report on the review is attached as Exhibit 99.1 tothe 10-Q filing.

Note1. Restatement and Basis of Presentation

Restatement

The Officeof the Comptroller of the Currency Report of Examination on theCorporation’s wholly-owned bank subsidiary which commenced August 10, 2004 andwas delivered to the Bank in final form in February, 2005 included a findingthat 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, Comprehensive Income, and CashFlows for the nine months ended September 30, 2004 were amended to reflect theadditional $261,000 provision expense and the related reduction of applicableincome taxes.

Basis of Presentation

Thefinancial information presented at and for the nine months ended September 30,2005 and 2004 is unaudited. Information presented at December 31, 2004 iscondensed from audited year-end financial statements. However, unauditedinformation reflects all adjustments (consisting solely of normal recurringadjustments) that are, in the opinion of management, necessary for a fairpresentation of the financial position, results of operations and cash flowsfor 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 nine month periodended September 30, 2005, are not necessarily indicative of the results thatmay be expected for the year ending December 31, 2005. These statements shouldbe read in conjunction with notes to the financial statements contained in the2004 Annual Report to Stockholders.

 In addition to historical information, thisForm 10-Q Report contains forward-looking statements. The forward-lookingstatements contained herein are subject to certain risks and uncertainties thatcould cause actual results to differ materially from those projected in theforward-looking statements. Important factors that might cause such differencesinclude, but are not limited to, those discussed in the section entitled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”.Readers are cautioned not to place undue reliance on these forward-lookingstatements, which reflect management’s analysis only as of the date hereof.Readers should carefully review the risk factors described in other documentsthe Fulton Bancshares Corporation files from time to time with the Securitiesand Exchange Commission.

 

9

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Note2. Principles of Consolidation

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.

Note3. Cash Flows

Forpurposes of the statements of cash flows, the corporation has defined cash andcash equivalents as those amounts included in the balance sheet captions “cashand due 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.

Note4. Federal Income Taxes

Forfinancial reporting purposes the provision for loan losses charged to operatingexpense is based on management’s judgment, whereas for federal income taxpurposes, the amount allowable under present tax law is deducted. Additionally,certain expenses are charged to operating expense in the period the liabilityis incurred 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.

Note5. Other Commitments

Inthe normal course of business, the Corporation makes various commitments andincurs certain contingent liabilities which are not reflected in theaccompanying financial statements. These commitments include various guaranteesand commitments to extend credit and the Corporation does not anticipate anylosses as a result of these transactions.

Note6. Investment Securities

Thecarrying amounts of investment securities and their approximate fair values atSeptember 30, 2005 were as follows:

 
| ** **                                | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| ** **                                | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
| **($ 000 omitted)**                  | ** ** | ** **    | ** ** |
|                                      |       |          |       |           |       |           |       |       |       |
| INVESTMENT SECURITIES AVAILABLE FOR SALE: |       |          |       |           |       |           |       |       |       |
|                                      |       |          |       |           |       |           |       |       |       |
| State and Municipal  Securities           |       | $             | 5,394      |           | $          | 34             |       | $          | (19        | ) | $ | 5,409 |   |
|                                      |       |          |       |           |       |           |       |       |       |
| U.S. Government Treasury  Securities      |       | 0             |       | 0              |       | 0              |       | 0          |       |
|                                      |       |          |       |           |       |           |       |       |       |
| U.S. Government Agency  Securities        |       | 13,735        |       | 1              |       | (141           | )          | 13,595     |       |
|                                      |       |          |       |           |       |           |       |       |       |
| Mortgage-backed Securities                |       | 13,579        |       | 5              |       | (255           | )          | 13,329     |       |
|                                      |       |          |       |           |       |           |       |       |       |
| Equity Securities                         |       | 59            |       | 13             |       | 0              |       | 72         |       |
|                                      |       |          |       |           |       |           |       |       |       |
|                                      |       | $             | 32,767     |           | $          | 53             |       | $          | (415       | ) | $ | 32,405 |   |

 

Therewere no securities categorized “Held-to-maturity” or “Trading” at September 30,2005.

 

10

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Note7. 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.

Note8.  Earnings Per Share

Earningsper common share were computed based on the weighted average of shares ofcommon stock outstanding, which was 492,790 shares.

Note9. Regulatory Matters and Settlement with Former President

Fulton County National Bank and Trust Company, as a National Bank, issubject to the dividend restrictions set forth by the Comptroller of theCurrency.  The Corporation is alsosubject to various regulatory capital requirements administered by federalbanking agencies.  Failure to meetminimum capital requirements can initiate certain mandatory, and possiblyadditional discretionary actions by regulators that, if undertaken, could havea direct material effect on the Corporation’s financial statements.

OnMarch 23, 2005, the Bank’s Board of Directors entered into a “Stipulation andConsent to the Issuance of a Consent Order” (the “Consent Order”) with the Officeof the Comptroller of the Currency (OCC). The Consent Order includes 24 articles that commence by requiring theBank to form a Compliance Committee and develop an action plan (“Plan”) tocomply with the remaining articles.  ThePlan requires the development of a strategic plan, the appointment of certainmanagement and officers and the commission of a management and boardsupervision study. The Plan also requires the development of a three-yearprofit plan and capital plan, the requirement to maintain certain capitalratios, improvement in interest rate risk management, a consultant study ofcompliance with Truth-In-Lending and RESPA, and a review of  the methodology of determining ALLL.  The Plan further requires the Bank to engageand retain a qualified third-party loan review, to develop a criticized assetsimprovement program, to implement a loan portfolio management improvementprogram and to implement improved reporting and information systems for theloan portfolio.  Further articles of thePlan require a qualified, independent consultant to assess compliance with theBank Secrecy Act (“BSA”), Money Laundering Control Act, suspicious activities,and the rules and regulations of the Office of Foreign Assets and Control, thedevelopment of a BSA compliance program, a study of the audit function withemphasis on BSA compliance, and a written program on Suspicious ActivityReports.  Other articles of the Planrequire the development of a customer information security program, a disasterrecovery 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 OCCapproval before any executive officers or directors can be added to the Bank’smanagement.  The payment of dividends hasalso been temporarily 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

 

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November23, 2004.  The concerns in the OCC Reportof Examination were reflected in the Consent Order referenced above.

OnMay 9, 2005 the Board of Directors of the Corporation signed a Memorandum ofUnderstanding (“MOU”) dated May 9, 2005 issued by Federal Reserve Bank (“ReserveBank”).  The principle elements of theMOU are as follows:  The Corporation maynot issue dividends nor incur debt not in the ordinary course of businesswithout approval of the Reserve Bank, the Corporation may not repurchase itsown stock without approval of the Reserve Bank, the Corporation must appoint acompliance committee and conduct an assessment of the external audit firm’sability to audit an organization, such as the Corporation, which is subject tothe Sarbanes Oxley Act and the Corporation is required to ensure that itswholly owned subsidiary, The Fulton County National Bank & Trust Company,complies with the supervisory actions imposed by the Office of the Comptrollerof the Currency.

TheOCC has also informed the Bank of possible violations of laws and regulationswith regard to the Bank Secrecy Act, the Truth-In-Lending Act, and the RealEstate Settlement Procedures Act which could result in future fines andpenalties to the Bank and possible reimbursements.  The amount of any future fines orreimbursements cannot be reasonably estimated at September 30, 2005.

Becauseof the possible regulatory violations and other OCC scrutiny, the Bank’s FDICinsurance premiums and OCC assessment fees will increase by approximately$165,000 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.

TheBank intends 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 itsPresident.  The Boards of Directors ofFulton Bancshares Corporation and The Fulton National Bank and Trust Companyentered into a Settlement Agreement and General Release with its formerPresident which became effective on June 15, 2005. The terms of the SettlementAgreement are summarized as follows.

Theformer President’s termination on March 4, 2005 from employment as an officeror employee 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.

Theprincipal balances of a loan to the former President and two other loans in theaggregate approximate amount of $185,000 were paid to the Bank in full withinterest and other charges as required by the applicable loan documents.  In addition, the former President assignedPittsburgh Steelers ticket licensing rights for six seats to the Bank.

TheBank agreed to no longer take the position under the Salary ContinuationAgreement known generically as a Supplemental Employee Retirement Plan datedSeptember 1, 1995 and subsequently amended (together, “SERP”) that the formerPresident’s termination was for cause,

 

12

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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.

TheDirectors as individuals and shareholders released the former President fromliability related 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.

 

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

RESTATEMENT

The Officeof the Comptroller of the Currency Report of Examination on theCorporation’s wholly-owned bank subsidiary, which commenced August 10, 2004 andwas delivered to the Bank in final form in February, 2005, included a findingthat the Bank must add  at least a$250,000 provision to the Reserve for Possible Loan Losses at June 30, 2004.  The Bank’s calculation of the necessaryprovision was $261,000. The Condensed Consolidated Statements of Income,Comprehensive Income, and Cash Flows for the nine months ended September 30,2004 were amended to reflect the additional $261,000 provision expense and therelated reduction of applicable income taxes. All discussion that follows is based on the restated amounts for thenine month period ended September, 30, 2004.

OVERVIEW

Netafter tax loss for the first nine months of 2005 was $114,000 compared to netincome of $563,000 for the same period in 2004, representing a decrease of$677,000, or 120%. Net loss on an adjusted per share basis for the first ninemonths of 2005 was $.23 compared to $1.14 income per share realized during thefirst nine months ended September 30, 2004.

RESULTSOF OPERATIONS

ThirdQuarter 2005 vs. Third Quarter 2004

Interestincome for the third quarter of 2005 was $1,793,000 compared to $1,880,000earned during the same period in 2004, for a decrease of $87,000, or 5%. Thedecrease was due primarily to a change in the mix of earning assets in2005.  Loans declined on average by 16%as the Bank focused on work out of problem credits.  The average balance of Federal Funds Soldincreased $10,948,000 as the Bank held a higher mix of liquid assets inanticipation of reinvestment into the securities portfolio during the fourthquarter of 2005.  Due to higher Bankcapital ratio requirements in the OCC Consent Order signed on March 23, 2005and related borrowing restrictions, asset growth is constrained and more liquidassets are being maintained.

Interestexpense for the third quarter of 2005 was $735,000, a decrease of $18,000, or3% compared to the third quarter of 2004. The decrease was due primarily to adecrease in the average balance of deposits and borrowings that offset higherdeposit rates paid in 2005.  Net interestincome before the provision for loan losses for the third quarter of 2005totaled $1,058,000, down $105,000, or 9%, from the third quarter of 2004.

NineMonths 2005 vs. Nine Months 2004

Interestincome for the first nine months of 2005 was $5,356,000 compared to $5,674,000earned during the same period in 2004, for a decrease of $318,000, or 6%. Thedecrease was due primarily to a decrease in the average balance of loans andinvestments in 2005.  Loans declined onaverage by 10% as management focused on working out problem credits.  Interest income also decreased due to ahigher mix of liquid assets being held to accommodate overnight borrowingcapacity at Federal Home Loan Bank of Pittsburgh.  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.  Interest expense for thefirst nine months of 2005 was $2,142,000, a decrease of $39,000, or 2%

 

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comparedto the first nine months of 2004. The decrease was due primarily to a decreasein the average balance of deposits and borrowings that offset higher depositrates paid in 2005.  Net interest incomebefore the provision for loan losses for the first nine months of 2005 totaled$3,214,000, down $279,000, or 8%, from the first nine months of 2004.

Netinterest income is the difference between total interest income and totalinterest expense. Interest income is generated through earning assets, whichinclude loans, deposits with other banks, and investments. Interest income isdependent on many factors including the volume of earning assets; level ofinterest rates; changes in interest rates; and volumes of nonperforming loans.The cost of funds varies with the volume of funds necessary to support earningassets; rates paid to maintain deposits; rates paid on borrowed funds; andlevel of interest-free deposits.

NETINTEREST MARGIN

Thenet interest margin for the first nine months of 2005 was 3.43% compared to 3.60%for the first nine months of 2004.The net interest margin declined mainly dueto a change in the mix of earning assets to more liquid assets and less higher-earningloans in 2005 compared to 2004. Liquidity and interest rate risk are monitoredthrough asset liability management modeling to evaluate the impact of risingand falling rates. Management protects its net interest margin  by structuring the maturities and cash flowof interest-earning assets and liabilities so they can be repriced in responseto changes in market interest rates.

NONINTERESTINCOME

ThirdQuarter 2005 vs. Third Quarter 2004

Thirdquarter 2005 noninterest income increased $16,000 to $150,000, up 12% from$134,000 in the third quarter of 2004. Service charges on deposits increased$6,000, or 15%. Other fees and other income increased $10,000, or 11%,primarily due to the lack of losses on sales of investment securities and OREOin 2005.

NineMonths 2005 vs. Nine Months 2004

Noninterestincome for the first nine months of 2005 increased $10,000 to $476,000, or 2%from $466,000 in the first nine months of 2004. Service charges on depositsdecreased $5,000, or 4%, primarily due to a decrease in the number of overdraftcharges collected (the fee was unchanged year-over-year). Other fees and otherincome increased $15,000, or 4%, primarily due to miscellaneous income andrecoveries and higher debit card income offsetting lower earnings on bank ownedlife insurance and lower rental income earned in the previous year.   Net gains on sales of investment securities,OREO, loans and other assets increased $7,000, or 32% over the previous year.

NONINTERESTEXPENSE

ThirdQuarter of 2005 vs. Third Quarter 2004

Thirdquarter 2005 noninterest expenses totaled $1,329,000, an increase of $325,000,or 32%, over the $1,004,000 for the third quarter of 2004. Salaries andemployee-related expenses increased $132,000, or 37%, primarily due toincreases in benefit costs of $ 14,000 over the same period in 2004 andthe employment of additional compliance staff and interim resources to complywith the terms of the Consent Order.

 

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Fixedasset expenses increased $7,000. Professional expenses increased by $183,000 or 217% due to consultantand legal engagements necessitated by compliance with the Consent Order andother regulatory requirements.  FDICinsurance premiums increased 308% to $49,000 for the third quarter of 2005 dueto the regulatory ratings. Other noninterest expenses declined $33,000, or 12%,primarily due to lower discretionary spending.

NineMonths 2005 vs. Nine Months 2004

Noninterestexpenses for the first nine months of 2005 totaled $3,851,000, an increase of$744,000, or 24%, over the $3,107,000 for the same period in 2004. Salaries andemployee-related expenses increased $136,000 primarily due to increases inbenefit costs of $ 25,000 over the same period in 2004 and to theemployment of additional compliance staff and interim resources to comply withthe terms of the Consent Order. Professional expenses increased by $522,000, or 261%, due to consultantand professional engagements necessitated by compliance with the Consent Orderand other regulatory requirements.  Inaddition, during the second quarter, legal and consultant expenses wereincurred to arrive at a settlement with the former President and CEO.  FDIC insurance premiums increased 6 fold to$147,000 for the first nine months of 2005 due to the regulatory ratings.  Other noninterest expenses decreased $55,000,or 7%, primarily due to lower discretionary spending.

INCOMETAXES

Theincome tax benefit for the third quarter of 2005 was ($102,000) compared to abenefit of ($13,000) for the third quarter of 2004. The income tax benefit forthe first nine months of 2005 was ($214,000) compared to a provision expense of$28,000 for the first nine months of 2004. Effective tax rates (compared to themarginal federal income tax bracket of 34% applicable to each period) weredifferent for each period primarily due to the relationship of non taxableincome to total taxable loss.  Noallowance for deferred tax assets, including net operating loss carryovers, aredeemed necessary by management.

 

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PROVISIONFOR LOAN LOSSES

Provision for loan losseswas $80,000 for the third quarter of 2005 compared with $0 for the thirdquarter of 2004. Provision for loan losses was $167,000 for the first ninemonths of 2005 compared with $261,000 for the first nine months of 2004.Provisions were based on management’s evaluation of the adequacy of the reservefor possible loan losses at September 30, 2005 and 2004 and represent amountsdeemed necessary to maintain the reserve at the appropriate level based onsize, 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: 

 
| ** **                                       | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **Sept. 30,**         | ** ** | **Sept. 30,** | ** ** |
| ** **                                       | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                             |       |                  |       |   |   |
| Beginning of period                              |       | $                     | 1,821      |   | $ | 1,900 |   |
|                                             |       |                  |       |   |   |
| Loans charged-off during  the period:            |       |                  |       |   |   |
| Real estate loans                                |       | 0                     |       | 0 |   |
| Installment loans                                |       | 11                    |       | 13 |   |
| Commercial and all other  loans                  |       | 80                    |       | 343 |   |
| Total charge-offs                                |       | 91                    |       | 356 |   |
|                                             |       |                  |       |   |   |
| Recoveries of Loans  previously charged-off:     |       |                  |       |   |   |
| Real estate loans                                |       | 0                     |       | 0 |   |
| Installment loans                                |       | 3                     |       | 14 |   |
| Commercial and all other  loans                  |       | 3                     |       | 9 |   |
| Total charge-offs                                |       | 6                     |       | 23 |   |
|                                             |       |                  |       |   |   |
| Net loans (charged off)  recovered               |       | (85                   | )          | (333 | ) |
|                                             |       |                  |       |   |   |
| Provision for loan losses  charged to operations |       | 167                   |       | 261 |   |
|                                             |       |                  |       |   |   |
| Allowance for loan losses-  end of period        |       | $                     | 1,903      |   | $ | 1,828 |   |
|                                                  |            |                       |            |  |  |  |  |  |  |

Loans90 days or more past due (still accruing interest) and those on nonaccrualstatus were as follows at September 30:
| ** **                    | ** ** | **90 Days or More Past Due** | ** ** | **Nonaccrual Status** | ** ** |
|-------------------------------|------------|------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2005**                     | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Loans secured by real  estate |       | $                            | 274        |                  | $          | 545 |   | $ | 794 |   | $ | 331 |   |
|                          |       |                         |       |                  |       |   |   |   |   |
| Personal loans                |       | 0                            |       | 17                    |       | 0 |   | 0 |   |
|                          |       |                         |       |                  |       |   |   |   |   |
| Commercial and other loans    |       | 123                          |       | 0                     |       | 1,462 |   | 0 |   |
| Total                         |       | $                            | 397        |                  | $          | 562 |   | $ | 2,256 |   | $ | 331 |   |

TheCorporation utilizes a systematic review of its loan portfolio on a quarterlybasis in order to determine 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 internal and external loan grading and reviews.  Loans other than those determined to be impairedare grouped into pools of loans with similar credit risk characteristics.  These loans are evaluated as groups withallocations made to the allowance based on historical loss experience adjustedfor current  trends in delinquencies,trends in  underwriting and oversight,concentrations of credit and general economic conditions within the Corporation’strading area.

 

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The decrease in the provision for loan lossesfor 2005 compared to 2004 was a result of lower net charge-offs experienced in2005.  The provision expense in 2004 wasmandated by an examination by the Bank’s primary regulator as detailed in thefootnote entitled “Restatement”.

FINANCIALCONDITION

Assets

Totalassets on September 30, 2005 were $139,357,000 compared to $141,757,000 atDecember 31, 2004, a decrease of $2,400,000 or 2%. Net loans on September30, 2005 stood at $81,617,000, a decrease of 12% from $92,649,000 on December31, 2004. The loan decrease was due to payoffs from workouts of classifiedloans and loan refinancing elsewhere due to competitive rate and structurefactors.  Investment securities increasedand cash decreased from December 31, 2004 as proceeds from a late 2004 securitysale were reemployed in investment securities in early 2005. Investments alsoincreased from deployment of proceeds of loan payoffs at quarter end.

Liabilities

Totaldeposits decreased $2,112,000 or 2% to $107,509,000 as of September 30, 2005compared with $109,621,000 at December 31, 2004. Noninterest-bearing demanddeposits increased 7% mainly due to the varying cash flow needs of businesscustomers.  Interest-bearing depositsdecreased $3,328,000 or 4% due to conservative rate offerings on deposits.

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 AmountSeptember 30, 2005

FinancialInstruments whose contract amounts represent credit risk at September 30:
| Commitments to extend credit                                |   | $ | 9,739,000 |   |
|-------------------------------------------------------------|--------|---|-----------|--------|
| Standby letters of credit  and financial guarantees written |   | $ | 8,000     |   |

Commitmentsto extend 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.

Liquidityand Interest Rate Sensitivity

Liquidityand interest 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. AtSeptember 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 requirementsignificantly reduced additional borrowing capacity at the Federal Home LoanBank.  The bank responded by establishingnew unsecured and collateralized borrowing lines of credit at othercorrespondent banks totaling $4,000,000. Management measures liquidity ratios and balance sheet trends on afrequent basis to measure and control liquidity risk.

Interestrate sensitivity is the matching or mismatching of the maturity and ratestructure of the interest-bearing assets and liabilities. It is the objectiveof management 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 $15,145,000 at September 30, 2005 compared with $15,518,000 at December 31,2004, a decrease of $373,000. Accumulated net loss of $114,000 for the ninemonths ended September 30, 2005 and a $238,000 net unrealized loss onavailable-for-sale securities (net of tax effect) accounted for the decrease.Total stockholders’ equity represented 10.86% of total assets at September 30,2005. In compliance with regulatory restrictions, no cash dividends were paidin  2005, $.27 per share were paid forthe third quarter of 2004 and a total of $.73 per share were paid in the firstnine months of 2004. On July 20, 2000, the Board of Directors announced theapproval of a plan to purchase, in open market and privately negotiatedtransactions, up to 2% of its shares of outstanding common stock. Additionally,on December 18, 2003, the Corporation announced the approval of a plan topurchase, in open market and privately negotiated transactions, up to 1,000shares of outstanding common stock. As of December 31, 2004, the Corporationhad repurchased 2,210 shares, representing 0.45% of its shares of outstandingcommon stock. As a condition of the March 23, 2005 Consent Order and the May 9,2005 Memorandum of Understanding with the Federal Reserve Bank, the Company hasagreed to not declare dividends without the prior written approval of these regulatorsand to terminate the stock repurchase plans.

 

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REGULATORYCAPITAL

TheConsent Order requires the Bank to maintain capital ratios that are well abovethe capital levels normally required by federal regulatory authorities,including risk-based capital guidelines. A comparison of Fulton BancsharesCorporation’s capital ratios to regulatory minimum requirements at September30, 2005 is as follows:
| ** **                                                                 | ** ** | **Fulton**      | ** ** | **Regulatory**   | ** ** | **Increased Regulatory**     | ** ** |
|----------------------------------------------------------------------------|------------|-----------------|------------|------------------|------------|------------------------------|------------|
| ** **                                                                 | ** ** | **Bancshares**  | ** ** | **Minimum**      | ** ** | **Bank Minimum Requirement** | ** ** |
| ** **                                                                 | ** ** | **Corporation** | ** ** | **Requirements** | ** ** | **By Consent Order**         | ** ** |
|                                                                       |       |            |       |             |       |                         |       |
| Leverage ratio                                                             |       | 11.05           | %          | 4.00             | %          | 10.00                        | %          |
|                                                                       |       |            |       |             |       |                         |       |
| Risk-based capital ratios:                                                 |       |            |       |             |       |                         |       |
|                                                                       |       |            |       |             |       |                         |       |
| Tier I (core capital)                                                      |       | 18.13           | %          | 4.00             | %          | 14.00                        | %          |
|                                                                       |       |            |       |             |       |                         |       |
| Combined Tier I and Tier II (core capital plus allowance for loan  losses) |       | 19.39           | %          | 8.00             | %          |                         |       |

 

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BALANCESHEET ANALYSIS

Thefollowing table highlights the changes in the balance sheet. Because quarterend balances can be distorted by one-day fluctuations, an analysis of changesin the quarterly averages is provided to show balance sheet trends.

 

 Balance SheetsCondensed

Average

 
| ** **                                        | ** ** | **Third**        | ** ** | **Third**        | ** ** |
|---------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                        | ** ** | **Quarter 2005** | ** ** | **Quarter 2004** | ** ** |
|                                              |       |             |       |             |       |
| ASSETS                                            |       |             |       |             |       |
| Federal Funds Sold                                |       | $                | 11,674     |             | $          | 726 |   |
| Securities Available for  Sale /Other Investments |       | 29,472           |       | 30,171           |       |
| Loans                                             |       | 84,459           |       | 100,639          |       |
| Total interest-earning  assets                    |       | 125,605          |       | 131,536          |       |
|                                              |       |             |       |             |       |
| Cash and Due from Banks                           |       | 4,387            |       | 4,334            |       |
| Bank Premises and  Equipment                      |       | 3,562            |       | 3,714            |       |
| All Other Assets                                  |       | 7,509            |       | 8,400            |       |
| Allowance for Loan Losses                         |       | (1,905           | )          | (2,006           | )          |
| Total Assets                                      |       | $                | 139,158    |             | $          | 145,978 |   |
|                                              |       |             |       |             |       |
| LIABILITIES                                       |       |             |       |             |       |
| Interest-bearing deposits                         |       | $                | 89,904     |             | $          | 97,261 |   |
| Federal Funds Purchased                           |       | —           |       | 204              |       |
| Other Short-term  Borrowings                      |       | 15,000           |       | 16,371           |       |
| Total interest-bearing  liabilities               |       | 104,904          |       | 113,836          |       |
|                                              |       |             |       |             |       |
| Non-interest bearing  deposits                    |       | 17,889           |       | 14,474           |       |
| All Other Liabilities                             |       | 862              |       | 1,551            |       |
| Total Liabilities                                 |       | 123,655          |       | 129,861          |       |
| STOCKHOLDERS’  EQUITY                        |       |             |       |             |       |
| Common Stockholders’  Equity                 |       | 15,503           |       | 16,117           |       |
|                                              |       | 15,503           |       | 16,117           |       |
|                                              |       |             |       |             |       |
| Total Liabilities and  Stockholders’ Equity  |       | $                | 139,158    |             | $          | 145,978 |   |
|                                                   |            |                  |            |                  |            |  |  |  |  |  |

 

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ITEM3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Therehave been no material changes to the quantitative and qualitative disclosuresmade in the Corporation’s Annual Report on Form 10-K for the year endedDecember 31, 2004. See Management’s Discussion and Analysis for furtherdiscussion of market risk.

ITEM4 - CONTROLS AND PROCEDURES

TheCorporation’s Chief Executive Officer and Chief Financial Officer 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 September 30, 2005. Based on suchevaluation, such officers have concluded that, as of September 30, 2005, theCorporation’s disclosure controls and procedures are effective in alerting themon a timely basis to material information relating to the Corporation(including its consolidated subsidiaries) required to be included in theCorporation’s periodic filings under the Exchange Act. There have not been anysignificant changes in the Corporation’s internal control over financialreporting or in other factors that materially affected or are reasonably likelyto materially affect such control during the third quarter of 2005.

 

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PART II - OTHER INFORMATION

 

Item1 - Legal Proceedings

Inthe opinion of the management of the Corporation, there are no material pendinglegal proceedings other than ordinary routine litigation incidental to thebusiness, to which the corporation or its subsidiary are a party or to whichtheir property is subject.

Item2 - Unregistered Sales of Equity Securities and Use of Proceeds

Notapplicable

Item3 - Defaults Upon Senior Securities

Notapplicable

Item4 - Submission of Matters to a Vote of Security Holders

Notapplicable

Item5 - Other Information

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

Item 6 — Exhibits

(a) Exhibits:

ExhibitNumber Referred to Item 601 of Regulation S-K: Description of Exhibit:

3(i)Articles of Incorporation. Incorporated by reference to registrant’s Form 10-Kfiled with the Securities and Exchange Commission on December 31, 2004.

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

10.1Salary Continuation 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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10.2Director Deferred Compensation Plan Incorporated by reference to registrant’sForm 10-K filed with the Securities and Exchange Commission on December 31,2002.

10.3Director Emeritus Retirement Agreement Incorporated by reference to registrant’sForm 10-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.

31.2Certification of Chief Financial Officer pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

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

99.1Report of Independent Accountant on Interim Financial Statements

99.2Letter to Shareholders dated November 14, 2005.

 

SIGNATURES

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
| Date: November 14, 2005 | By:                                           | /s/George W. Millward |
|-------------------------|-----------------------------------------------|-----------------------|
|                    | George W. Millward,                           |
|                    | Interim President and Chief Executive Officer |
|                    |                                          |
| Date: November 14, 2005 | By:                                           | /s/Debra A. Goodling  |
|                    | Debra A. Goodling,                            |
|                    | Interim Chief Financial Officer               |

 

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