UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934

 

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2007

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ­ ­ to ­ ­

 

Commission File Number 0-15829

 

FIRST CHARTER CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

 

Registrant’s telephone number, including area code (704) 688-4300

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

Title of Each Class

 

Common stock, no par value

 

Series X Junior Participating Preferred Stock Purchase Rights

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o No þ

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o No þ

 

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant as of June 30, 2007, determined using a per share closing sale price on that date of $19.47, as quoted on the NASDAQ Global Select Market, was $627,711,000.

 

As of February 15, 2008, the registrant had outstanding 35,004,515 shares of common stock, no par value.

 

Documents Incorporated by Reference

 

PART III: The registrant has incorporated by reference into Part III of this Annual Report on Form 10-K portions of its definitive proxy statement or an amendment on Form 10-K/A to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year covered by this Annual Report. (With the exception of those portions which are specifically incorporated by reference in this Annual Report on Form 10-K, the Proxy Statement is not deemed to be filed or incorporated by reference as part of this Annual Report.)

 

 

First Charter Corporation
FORM 10-K
FISCAL YEAR ENDED DECEMBER 31, 2007

 

All reports filed electronically by First Charter Corporation with the United States Securities and Exchange Commission (“SEC”), including its annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, as well as any amendments to those reports, are accessible at no cost on the Corporation’s Web site at www.firstcharter.com. These filings are also accessible on the SEC’s Web site at www.sec.gov.

 

 

TABLE OF CONTENTS

 

 

 

General

 

First Charter Corporation (hereinafter referred to as the “Registrant,” “First Charter,” or the “Corporation”) is a bank holding company established as a North Carolina corporation in 1983 and is registered under the Bank Holding Company Act of 1956, as amended (“BHCA”). Its principal asset is the stock of its banking subsidiary, First Charter Bank (“Bank”). The principal executive offices of the Corporation and the Bank are located at 10200 David Taylor Drive, Charlotte, North Carolina 28262. The telephone number is (704) 688-4300.

 

First Charter Bank, a North Carolina state bank, is the successor entity to The Concord National Bank, which was established in 1888. On November 1, 2006, the Corporation completed its acquisition of GBC Bancorp, Inc. (“GBC”), parent of Gwinnett Banking Company (“Gwinnett Bank”), its banking subsidiary, headquartered in Lawrenceville, Georgia (“GBC Merger”). Gwinnett Bank operated two financial centers located in Lawrenceville, Georgia and Alpharetta, Georgia. On March 1, 2007, Gwinnett Bank was merged into the Bank.

 

On August 15, 2007, First Charter and Fifth Third Bancorp (“Fifth Third”) entered into an Agreement and Plan of Merger, as amended by the Amended and Restated Agreement and Plan of Merger, dated September 14, 2007, (“Merger Agreement”) by and among First Charter, Fifth Third, and Fifth Third Financial Corporation (“Fifth Third Financial”). Under the terms of the Merger Agreement, First Charter will be merged with and into Fifth Third Financial. The Merger Agreement has been approved by the Board of Directors of First Charter, Fifth Third and Fifth Third Financial. On January 18, 2008, First Charter shareholders approved the Merger Agreement. The Merger Agreement is subject to customary closing conditions, including regulatory approval. First Charter is planning for closing in the second quarter of 2008, although no assurance can be given in this regard.

 

As of December 31, 2007, First Charter operated 60 financial centers, four insurance offices, and 137 automated teller machines (“ATMs”) throughout North Carolina and Georgia and also operated loan origination offices in Asheville, North Carolina and Reston, Virginia.

 

The Corporation’s primary market area is located within North Carolina and is centered primarily around the Charlotte Metro region, including Mecklenburg County and its surrounding counties. Charlotte is the twentieth largest city in the United States and has a diverse economic base. Primary business sectors in the Charlotte Metro region include banking and finance, insurance, manufacturing, health care, transportation, retail, telecommunications, government services, and education. Beginning in October 2005, the Corporation expanded into the Raleigh, North Carolina market, and currently operates five financial centers. Raleigh has an economic base similar to that found in Charlotte. Since the North Carolina economy has historically relied on the manufacturing and transportation sectors, it has been significantly impacted by global competition and rising energy prices. As a result, the North Carolina economy is transitioning to a more service-oriented economy. Recently, the education, healthcare, financial and business services industries have shown the most growth.

 

As a result of the GBC Merger, the Corporation entered the Atlanta, Georgia market in the fourth quarter of 2006. The two financial centers in the Atlanta area are located in Gwinnett and Fulton counties. These two counties have a diverse economic base and primary business sectors include education, government, health and social services, retail trade, manufacturing, financial and other professional services.

 

Through its financial centers, the Bank provides a wide range of banking products, including interest-bearing and noninterest-bearing checking accounts, money market accounts, certificates of deposit, individual retirement accounts, full service and discount brokerage services including annuity sales, overdraft protection, financial planning services, personal and corporate trust services, safe deposit boxes, and online banking. It also provides commercial, consumer, real estate, residential mortgage, and home equity loans.

In addition, the Bank also operates two subsidiaries: First Charter Insurance Services, Inc. (“First Charter Insurance”) and First Charter Leasing and Investments, Inc. (“First Charter Leasing”). First Charter Insurance is a North Carolina corporation formed to meet the insurance needs of businesses and individuals. First Charter Leasing is a North Carolina corporation which manages investment securities and acts as the holding company for First Charter of Virginia Realty Investments, Inc., a Virginia corporation (“First Charter Virginia”). First Charter Virginia is engaged in the mortgage origination business and also acts as the holding company for First Charter Realty Investments, Inc., a Delaware real estate investment trust (“First Charter Realty”). First Charter Realty is the holding company for FCB Real Estate, Inc., a North Carolina real estate investment trust, and First Charter Real Estate Holdings, LLC, a North Carolina limited liability company, which owns and maintains the real estate property and assets of the Corporation. FCB Real Estate, Inc. primarily invests in commercial and 1-4 family residential real estate loans. First Charter Bank also has a majority ownership in Lincoln Center at Mallard Creek, LLC (“LCMC”), a North Carolina limited liability company, which is currently being dissolved. LCMC sold Lincoln Center, a three-story office building, and its principal asset, during 2006. First Charter Insurance and one of the Bank’s financial centers continue to lease a portion of Lincoln Center.

 

At December 31, 2007, the Corporation and its subsidiaries had 1,073 full-time equivalent employees. Substantially all of the Corporation’s employees are also employees of the Bank. The Corporation considers its relations with its employees to be satisfactory.

 

Due to the diverse economic base of the markets in which it operates, the Corporation believes it is not dependent on any one or a few customers or types of commerce whose loss would have a material adverse effect on the Corporation.

 

The Corporation operates one reportable segment, the Bank. See Note 25 of the consolidated financial statements.

 

Competition

 

The Corporation’s primary market area is located within North Carolina and Atlanta, Georgia. Banking activities in these areas are highly competitive, and the Corporation has active competition in all areas in which it presently engages in business. Within these areas are numerous branches of national, regional, and local institutions. In its market area, the Corporation faces competition from other banks, including four of the largest banks in the country, savings and loan associations, savings banks, credit unions, finance companies, brokerage firms, insurance companies and major retail stores that offer competing financial services. Many of these competitors have greater resources, broader geographic coverage and higher lending limits than the Bank. The Bank’s primary method of competition is to provide its clients with a broad array of financial products and solutions, delivered with exceptional service and convenience at a fair price.

 

Government Supervision and Regulation

 

General. As a registered bank holding company, the Corporation is subject to the supervision of, and regular inspection by, the Board of Governors of the Federal Reserve System (“Federal Reserve”). The Bank is a North Carolina chartered-banking corporation and a Federal Reserve member bank, with deposits insured by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is subject to extensive regulation and examination by the Federal Reserve, the Office of the Commissioner of Banks of the State of North Carolina (“NC Commissioner”) under the direction and supervision of the North Carolina Banking Commission (“NC Banking Commission”) and the FDIC, which insures deposits to the maximum extent permitted by law.

 

The federal and state laws and regulations applicable to the Bank deal with required reserves against deposits, allowable investments, loans, mergers, consolidations, issuance of securities, payment of dividends, establishment of branches, limitations on credit to subsidiaries and other aspects of the business of such subsidiaries. The federal and state banking agencies have broad authority and discretion in connection with their supervisory and enforcement activities and examination policies, including policies involving the classification of assets and the establishment of loan loss reserves for regulatory purposes.

Such actions by the regulators prohibit member banks from engaging in unsafe or unsound banking practices. The Bank is also subject to certain reserve requirements established by the Federal Reserve Board. The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Atlanta, which is one of the 12 regional banks comprising the FHLB System.

 

In addition to state and federal banking laws, regulations and regulatory agencies, the Corporation and the Bank are subject to various other laws, regulation, and supervision and examination by other regulatory agencies, all of which directly or indirectly affect the Corporation’s operations, management and ability to make distributions. The following discussion summarizes certain aspects of those laws and regulations that affect the Corporation.

 

Gramm-Leach-Bliley Financial Modernization Act of 1999. The Gramm-Leach-Bliley Financial Modernization Act of 1999 (“GLB Act”) eliminated certain legal barriers separating the conduct of various types of financial service businesses, such as commercial banking, investment banking and insurance, in addition to substantially revamping the regulatory scheme within which the Corporation operates. Under the GLB Act, bank holding companies meeting management, capital and Community Reinvestment Act standards, and that have elected to become a financial holding company, may engage in a substantially broader range of traditionally nonbanking activities than was permissible before enactment, including insurance underwriting and making merchant banking investments in commercial and financial companies. The Corporation has not elected to become a financial holding company. The GLB Act also allows insurers and other financial services companies to acquire banks, removes various restrictions that currently apply to bank holding company ownership of securities firms and mutual fund advisory companies, and establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations.

 

Restrictions on Bank Holding Companies. The Federal Reserve is authorized to adopt regulations affecting various aspects of bank holding companies. Under the BHCA, the Corporation’s activities and those of companies that it controls or holds more than five percent of the voting stock, are limited to certain activities including banking, managing or controlling banks, furnishing or performing services for subsidiaries, or any other activity which the Federal Reserve determines to be so closely related to banking, managing or controlling banks that it is also considered a covered activity. In making those determinations, the Federal Reserve is required to consider whether the performance of such activities by a bank holding company or its subsidiaries can be expected to reasonably produce benefits to the public such as greater convenience, increased competition or gains in efficiency that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The BHCA, as amended by the GLB Act, generally limits the activities of a bank holding company (unless the bank holding company has elected to become a financial holding company) to activities that are closely related to banking and a proper incident thereto.

 

Generally, bank holding companies are required to obtain prior approval of the Federal Reserve to engage in any new activity not previously approved by the Federal Reserve or when acquiring more than five percent of any class of voting stock of any company. The BHCA also requires bank holding companies to obtain the prior approval of the Federal Reserve before acquiring more than five percent of any class of voting stock of any bank which is not already majority-owned by the bank holding company.

 

The Corporation is also subject to the North Carolina Bank Holding Company Act of 1984. This state legislation requires the Corporation, by virtue of its ownership of the Bank, to register as a bank holding company with the NC Commissioner. In addition, as a result of its acquisition of GBC, the Corporation is required to register as a bank holding company with the Georgia Department of Banking and Finance.

 

Interstate Banking and Branching Legislation. Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Interstate Banking and Branching Act”), a bank holding company may acquire banks in states other than its home state, without regard to the permissibility of those acquisitions under state law, but subject to any state requirement where the bank has been organized and operating for a minimum period of time, not to exceed five years, and other conditions, including deposit concentration limits.

The Interstate Banking and Branching Act also authorized banks to merge across state lines, thereby creating interstate branches. Under this legislation, each state had the opportunity either to “opt out” of this provision, thereby prohibiting interstate branching in such states, or to “opt in.” The State of North Carolina elected to “opt in” to such legislation. Furthermore, pursuant to the Interstate Banking and Branching Act, a bank is now able to open new branches in a state in which it does not already have banking operations, if the laws of such state permit such de novo branching.

 

Consumer Protection. In connection with its lending and leasing activities, the Bank and its subsidiaries are subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, as well as state law counterparts.

 

Title V of the GLB Act, along with other provisions of federal law, currently contains extensive consumer privacy protection provisions. Under these provisions, a financial institution must provide its customers, at the inception of the customer relationship and annually thereafter, the financial institution’s policies and procedures for collecting, disclosing, and protecting nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, a financial institution may not provide nonpublic personal information to nonaffiliated third parties, unless the financial institution discloses to the customer that the information may be provided and the customer is given the opportunity to opt out of that disclosure. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.

 

The Community Reinvestment Act of 1977 requires the Bank’s primary federal regulatory agency, in this case the Federal Reserve, to assess its ability to meet the credit needs of low- and moderate-income persons. Financial institutions are assigned one of four ratings: “Outstanding,” “Satisfactory,” “Needs to Improve,” or “Substantial Noncompliance.” As of the Bank’s latest examination, it had a “Satisfactory” rating.

 

The USA PATRIOT Act. After the September 11, 2001 terrorist attacks in New York and Washington, D.C., the United States government attempted to tighten control on activities perceived to be connected to money laundering and terrorist funding. A series of orders were issued which attempt to identify terrorists and terrorist organizations and require the blocking of property and assets of, as well as prohibiting all transactions or dealings with, such terrorists, terrorist organizations and those that assist or sponsor them. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”) substantially broadened existing anti-money laundering legislation and the extraterritorial jurisdiction of the United States, imposed new compliance and due diligence obligations, created new crimes and penalties, compelled the production of documents located both inside and outside the United States, including those of foreign institutions that have a correspondent relationship in the United States, and clarified the safe harbor from civil liability to customers. Originally passed into law in October 2001, the USA PATRIOT Act was renewed in March 2006. In addition, the United States Treasury Department issued regulations in cooperation with the federal banking agencies, the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Department of Justice that require customer identification and verification, expand the money-laundering program requirement to the major financial services sectors including insurance and unregistered investment companies such as hedge funds, and facilitate and permit the sharing of information between law enforcement and financial institutions and among financial institutions. The United States Treasury Department also has created the Treasury USA PATRIOT Act Task Force to work with other financial regulators, the regulated community, law enforcement and consumers to continually improve regulation.

 

Sarbanes-Oxley Act of 2002. On July 30, 2002, the Sarbanes-Oxley Act was enacted which addressed corporate governance and securities reporting requirements for companies with securities registered under the Securities Exchange Act of 1934, as amended (“Exchange Act”). Among its requirements are changes in auditing and accounting and the inclusion of certifications of certain securities filings by principal executive officers and principal financial officers. It also expanded reporting of information in

current reports filed with the Securities and Exchange Commission and requires more detailed reporting information in securities disclosure documents in a more timely manner. The NASDAQ Global Select Market has also modified its corporate governance rules with an intent to allow shareholders to more easily and efficiently monitor the performance and activities of companies and their executive officers and directors.

 

Capital and Operational Requirements

 

The Corporation and the Bank must comply with the minimum capital adequacy standards set by the Federal Reserve and the FDIC which are substantially similar. The risk-based guidelines define a three-tier capital framework, under which the Corporation and the Bank are required to maintain a minimum ratio of Tier 1 Capital (as defined) to total risk-weighted assets of 4.00 percent and a minimum ratio of Total Capital (as defined) to risk-weighted assets of 8.00 percent. Tier 1 Capital includes common shareholders’ equity, qualifying trust preferred securities, qualifying minority interests, and qualifying perpetual preferred stock, less goodwill and other adjustments. Tier 2 Capital includes, among other items, perpetual or long-term preferred stock, certain intermediate-term preferred stock, hybrid capital instruments, perpetual debt and mandatorily convertible debt securities, qualifying subordinated debt, and the allowance for credit losses up to 1.25 percent of risk-weighted assets. Tier 3 Capital includes subordinated debt that is unsecured, fully paid up, has an original maturity of at least two years, is not redeemable before maturity without prior approval of the Federal Reserve and includes a lock-in clause precluding payment of either interest or principal if the payment would cause the issuing bank’s risk-based capital ratio to fall or remain below the required minimum. The sum of Tier 1 and Tier 2 Capital less investments in unconsolidated subsidiaries is equal to qualifying total capital. Risk-based capital ratios are calculated by dividing Tier 1 Capital and Total Risk-Based Capital by risk-weighted assets. Risk-weighted assets refer to the on- and off-balance sheet exposures of the Corporation and the Bank, as adjusted for one of four categories of applicable risk-weights established in Federal Reserve regulations, based primarily on relative credit risk. At December 31, 2007, the Corporation and the Bank were in compliance with the risk-based capital requirements. The Corporation’s Tier 1 Capital and Total Risk-Based Capital Ratios at December 31, 2007, were 11.17 percent and 12.24 percent, respectively. The Corporation did not have any subordinated debt that qualified as Tier 3 Capital at December 31, 2007. The leverage ratio is calculated by dividing Tier 1 Capital by adjusted total assets. The Corporation’s leverage ratio at December 31, 2007, was 9.43 percent. The Corporation meets its leverage ratio requirement.

 

In addition to the above described capital requirements, the federal regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels due to the organization’s financial condition or actual or anticipated growth.

 

Prompt Corrective Action under FDICIA. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective federal regulatory agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. In addition, pursuant to FDICIA, the various regulatory agencies have prescribed certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation, and such agencies may take action against a financial institution that does not meet the applicable standards.

 

The various regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the Total Risk-Based Capital, Tier 1 Risk-Based Capital and Leverage Capital Ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered undercapitalized. Under the regulations, a “well capitalized” institution must have (i) a Tier 1 Capital ratio of at least 6.00 percent, (ii) a Total Capital

ratio of at least 10.00 percent, (iii) a Leverage ratio of at least 5.00 percent and (iv) not be subject to a capital directive order. An “adequately capitalized” institution must have a Tier 1 Capital ratio of at least 4.00 percent, a Total Capital ratio of at least 8.00 percent and a leverage ratio of at least 4.00 percent, or 3.00 percent in some cases. Under these guidelines, the Bank was considered well capitalized as of December 31, 2007. See Note 23 of the consolidated financial statements.

 

Banking agencies have also adopted regulations which mandate that regulators take into consideration (i) concentrations of credit risk, (ii) interest rate risk and (iii) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation is made as a part of the institution’s regular safety and soundness examination. In addition, the banking agencies have amended their regulatory capital guidelines to incorporate a measure for market risk. In accordance with amended guidelines, a corporation or bank with significant trading activity (as defined in the amendment) must incorporate a measure for market risk in its regulatory capital calculations. The revised guidelines do not materially impact the Corporation’s or the Bank’s regulatory capital ratios or the Bank’s well-capitalized status.

 

Distributions. The Corporation is a legal entity separate and distinct from its subsidiaries. The primary source of funds for distributions paid by the Corporation to its shareholders is dividends received from the Bank, and the Bank is subject to laws and regulations that limit the amount of dividends it can pay. The Federal Reserve regulates the amount of dividends the Bank can pay to the Corporation based on net profits for the current year combined with the undivided profits for the last two years, less dividends already paid. See Note 23 of the consolidated financial statements. North Carolina laws provide that, subject to certain capital requirements, a board of directors of a North Carolina bank may declare a dividend of as much of the bank’s undivided profits as it deems expedient.

 

In addition to the foregoing, the ability of the Corporation and the Bank to pay dividends may be affected by the various minimum capital requirements and the capital and non-capital standards established under FDICIA, as described above. Furthermore, if in the opinion of a federal regulatory agency, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), such agency may require, after notice and hearing, that such bank cease and desist from such practice. The right of the Corporation, its shareholders, and its creditors to participate in any distribution of assets or earnings of the Bank is further subject to the prior claims of creditors against the Bank.

 

Deposit Insurance. The deposits of the Bank are insured by the Deposit Insurance Fund (“DIF”) of the FDIC, up to applicable limits. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against banking institutions, after giving the institution’s primary regulator an opportunity to take such action.

 

In addition, the Bank is subject to the deposit premium assessments of the DIF. The FDIC imposes a risk-based deposit premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 (“Reform Act”). Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category, the FDIC further determines the institution’s assessment rate based on certain specified financial ratios or, if applicable, its long-term debt ratings. Beginning January 1, 2007, assessments can range from 5 to 43 basis points per $100 of assessable deposits, depending on the insured institution’s risk category as described above. This assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. Under the current system, premiums are assessed quarterly.

 

The Reform Act also provides for a one-time premium assessment credit for eligible insured depository institutions, including those institutions in existence and paying deposit insurance premiums on

December 31, 1996, or certain successors to any such institution. The assessment credit is determined based on the eligible institution’s deposits at December 31, 1996, and is applied automatically to reduce the institution’s quarterly premium assessments to the maximum extent allowed, until the credit is exhausted. In addition, insured deposits have been required to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation (“FICO”) to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation.

 

Source of Strength. According to Federal Reserve policy, bank holding companies are expected to act as a source of financial strength to subsidiary banks and to commit resources to support each such subsidiary. This support may be required at times when a bank holding company may not be able to provide such support. Similarly, under the cross-guarantee provisions of the Federal Deposit Insurance Act, in the event of a loss suffered or anticipated by the FDIC, either as a result of default of a banking or thrift subsidiary of the Corporation or related to FDIC assistance provided to a subsidiary in danger of default, the other banking subsidiaries of the Corporation may be assessed for the FDIC’s loss, subject to certain exceptions.

 

Future Legislation. Proposals to change the laws and regulations governing the banking industry are frequently introduced in Congress, in the state legislatures and before the various bank regulatory agencies. The likelihood and timing of any such proposals or bills being enacted and the impact they might have on the Corporation and the Bank cannot be determined at this time.

 

Regulatory Recommendations. The Corporation and the Bank are subject to federal and state banking regulatory reviews from time to time. As a result of these reviews, the Corporation and the Bank receive various observations and recommendations from their respective regulators. Observations are matters that are informative, advisory, or that suggest a means of improving the performance or management of the operations of the Corporation. Recommendations are provided to enhance oversight of, or to improve or strengthen, the Corporation’s or the Bank’s processes. The Corporation does not believe that these observations and recommendations are material to the Corporation. In addition, neither the Corporation nor the Bank is currently subject to any formal or informal corrective action with respect to any of their regulators.

 

Other Considerations

 

There are particular risks and uncertainties that are applicable to an investment in the Corporation’s common stock. Specifically, there are risks and uncertainties that bear on the Corporation’s future financial results that may adversely affect its future earnings and financial condition. Some of these risks and uncertainties relate to economic conditions generally and would affect other financial institutions in similar ways. See Item 1A. Risk Factors, and Factors that May Affect Future Results in the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations for a discussion of the particular risks and uncertainties that are specific to the Corporation’s business.

 

Available Information

 

The Corporation’s Internet address is www.firstcharter.com. The Corporation makes available, free of charge, on or through its website, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, and beneficial ownership reports on Forms 3, 4 and 5, as soon as reasonably practicable after electronically filing such material with, or furnishing it to, the SEC. The Corporation’s website also includes the charters of its Audit Committee, Compensation Committee, and Governance and Nominating Committee, its Code of Business Conduct and Ethics applicable to its directors and employees (including its Chief Executive Officer and principal financial officer) and those of its subsidiaries, and its Corporate Governance Guidelines.

 

 

An investment in the Corporation’s common stock is subject to risks inherent in the Corporation’s business. The material risks and uncertainties that management believes affect the Corporation are described

below. Before making an investment decision, you should carefully consider these risks and uncertainties, together with all of the other information included or incorporated by reference in this report. These risks and uncertainties are not the only ones facing the Corporation. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Corporation’s business operations. This report is qualified in its entirety by these risk factors.

 

The Corporation entered into the Merger Agreement with Fifth Third and Fifth Third Financial pursuant to which the Corporation would be merged with and into Fifth Third Financial. The Merger Agreement is subject to customary closing conditions, including regulatory approval. Failure to satisfy such conditions could adversely affect the Corporation.

 

If any of the following risks actually occur, the Corporation’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Corporation’s common stock could decline significantly, and you could lose all or part of your investment.

 

Risks Related to the Merger Agreement

 

The Merger Agreement with Fifth Third Limits the Corporation’s Ability to Pursue Alternatives.

 

The Merger Agreement with Fifth Third contains terms and conditions that make it more difficult for the Corporation to be sold to a party other than Fifth Third. These provisions impose restrictions that prevent the Corporation from seeking another acquisition proposal and that, subject to certain exceptions, limit the Corporation’s ability to discuss, facilitate or commit to competing third-party proposals to acquire all or a significant part of the Corporation.

 

Fifth Third required the Corporation to agree to these provisions as a condition to Fifth Third’s willingness to enter into the Merger Agreement. These provisions, however, might discourage a third party that might have an interest in acquiring all or a significant part of the Corporation from considering or proposing that acquisition even if it were prepared to pay consideration with a higher per share market price than the current proposed merger consideration, and the termination fee provided in the Merger Agreement might result in a potential competing acquirer proposing to pay a lower per share price to acquire First Charter than it might otherwise have proposed to pay.

 

The Corporation’s Business and Common Stock Price May be Adversely Affected if the Proposed Merger with Fifth Third is not Completed.

 

The Corporation’s business and common stock price could be adversely affected if the proposed merger with Fifth Third is not completed as a result of several factors, including, but not limited to, the following:

 

 

Risks Related to the Corporation’s Internal Controls and the Failure to Timely File its 2006 Form 10-K with the SEC

 

The Corporation May be Subjected to Negative Publicity That May Adversely Affect its Business.

 

As a result of the delay in filing its 2006 Annual Report on Form 10-K with the SEC and the existence of material weaknesses identified in 2006 in the Corporation’s internal controls over financial reporting, the Corporation has been subject to negative publicity. Although the Corporation is now current with its SEC filings and the material weaknesses have been remediated, the Corporation may continue to be subject to negative publicity. This negative publicity could have a material impact on the Corporation’s ability to attract new clients or the terms under which some clients are willing to continue to do business with the Corporation.

 

The Corporation Could Face Additional Adverse Consequences as a Result of its Late SEC Filing.

 

While the Corporation is now current with its SEC filings, the Corporation was late filing its 2006 Annual Report on Form 10-K and, as a result, First Charter will not be eligible to use a “short form” registration statement on Form S-3 and the Corporation may not be eligible to use a short form registration statement in the future if it fails to satisfy the conditions required to use short form registration. The Corporation’s inability to use a short form registration statement may impair its ability or increase the costs and complexity of efforts to raise funds in the public markets or use its stock as consideration in acquisitions should the Corporation desire to do so during this one year period. The Merger Agreement referred to above would also limit the Corporation’s ability to engage in such activity.

 

Risks Related to the Corporation’s Business

 

The Corporation is Subject to Interest Rate Risk.

 

The Corporation’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Corporation’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Corporation receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Corporation’s ability to originate loans and obtain deposits, (ii) the fair value of the Corporation’s financial assets and liabilities, and (iii) the average duration of certain of the Corporation’s interest-rate sensitive assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Corporation’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

 

Although management believes it has implemented effective asset-liability management strategies, including the potential use of derivatives as hedging instruments, to reduce the potential effects of changes in interest rates on the Corporation’s results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the Corporation’s financial condition and results of operations. See Market Risk Management — Asset-Liability Management and Interest Rate Risk in the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Corporation’s management of interest rate risk.

The Corporation is Subject to Lending Risk.

 

There are inherent risks associated with the Corporation’s lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions of the markets where the Corporation operates as well as those across the States of North Carolina, Georgia, and the United States. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. The Corporation is also subject to various laws and regulations that affect its lending activities. Failure to comply with applicable laws and regulations could subject the Corporation to regulatory enforcement action that could result in the assessment of significant civil money penalties.

 

As of December 31, 2007, approximately 64 percent of the Corporation’s loan portfolio consisted of commercial non-real estate, construction, and commercial real estate loans. These types of loans are generally viewed as having more risk of default than residential real estate loans or consumer loans. They are also typically larger than residential real estate loans and consumer loans. Because the Corporation’s loan portfolio contains a significant number of commercial non-real estate, construction, and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in nonperforming loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses, and an increase in loan charge-offs, all of which could have a material adverse effect on the Corporation’s financial condition and results of operations. See Balance Sheet Analysis - Loan Portfolio in the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Corporation’s loan portfolio.

 

The Corporation’s Allowance for Loan Losses May be Insufficient.

 

The Corporation maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense that represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Corporation’s control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review the Corporation’s allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, the Corporation will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Corporation’s financial condition and results of operations. See Credit Risk Management — Allowance for Loan Losses in the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Corporation’s process for determining the appropriate level of the allowance for possible loan losses.

 

The Corporation is Subject to Environmental Liability Risk Associated with Lending Activities.

 

A significant portion of the Corporation’s loan portfolio is secured by real property. During the ordinary course of business, the Corporation may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Corporation may be liable for remediation costs, as well as

for personal injury and property damage. Environmental laws may require the Corporation to incur substantial expenses and may materially reduce the affected property’s value or limit the Corporation’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations of enforcement policies with respect to existing laws may increase the Corporation’s exposure to environmental liability. Although the Corporation has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

The Corporation’s Profitability Depends Significantly on Economic Conditions in its Markets of Operation.

 

The Corporation’s success depends primarily on the general economic conditions of the Carolinas, Georgia and the specific local markets in which the Corporation operates. Unlike larger national or other regional banks that are more geographically diversified, the Corporation provides banking and financial services to customers primarily in the metropolitan areas of Charlotte-Gastonia-Concord, Lincolnton, Statesville-Mooresville, Shelby, Forest City, Salisbury, Asheville, Brevard and Raleigh-Cary, all in the State of North Carolina. In 2006, the Corporation commenced banking operations in the Atlanta, Georgia metropolitan area. The local economic conditions in these areas have a significant impact on the demand for the Corporation’s products and services as well as the ability of the Corporation’s customers to repay loans, the value of the collateral securing loans, and the stability of the Corporation’s deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, or unemployment in the Corporation’s primary markets, or changes in securities markets or other factors, could impact these local economic conditions and, in turn, have a material adverse effect on the Corporation’s financial condition and results of operations.

 

The Corporation Operates in a Highly Competitive Industry and Market Areas.

 

The Corporation faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and may have more financial resources than the Corporation. Such competitors primarily include national, regional and local financial institutions within the various markets the Corporation operates. Additionally, various out-of-state banks have begun to enter or have announced plans to enter the market areas in which the Corporation currently operates. The Corporation also faces competition from many other types of financial institutions, including, without limitation, savings and loan associations, savings banks, credit unions, finance companies, brokerage firms, insurance companies, and major retail stores that offer competing financial services. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of these competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than the Corporation can.

 

The Corporation’s ability to compete successfully depends on a number of factors, including, among other things:

 

 

 

Failure to perform in any of these areas could significantly weaken the Corporation’s competitive position, which could adversely affect the Corporation’s growth and profitability, which, in turn, could have a material adverse effect on the Corporation’s financial condition and results of operation.

 

The Corporation Is Subject to Extensive Government Regulation and Supervision.

 

The Corporation, primarily through its banking and certain non-banking subsidiaries, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect the Corporation’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Corporation in substantial and unpredictable ways. Such changes could subject the Corporation to additional costs, limit the types of financial services and products the Corporation may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with these laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputational damage, which could have a material adverse effect on the Corporation’s business, financial condition and results of operations. While the Corporation has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See Government Supervision and Regulation in the accompanying Business section and Note 23 of the consolidated financial statements.

 

New Lines of Business or New Products and Services May Subject the Corporation to Additional Risks.

 

From time to time, the Corporation may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services the Corporation may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Corporation’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on the Corporation’s business, results of operations and financial condition.

 

The Corporation Relies on Dividends from the Bank for Most of its Revenue.

 

First Charter Corporation is a separate and distinct legal entity from the Bank. It receives substantially all of its revenue from dividends received from the Bank. These dividends are the principal source of funds to pay dividends on the Corporation’s common stock and interest and principal on its outstanding debt securities. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to the Corporation. In the event the Bank is unable to pay dividends to the Corporation, the Corporation may not be able to service debt, pay obligations, or pay dividends on the Corporation’s

common stock. The inability to receive dividends from the Bank could have a material adverse effect on the Corporation’s business, financial condition, and results of operations. See Government Supervision and Regulation in the accompanying Business section and Note 23 of the consolidated financial statements.

 

Potential Acquisitions May Disrupt the Corporation’s Business and Dilute Shareholder Value.

 

From time to time the Corporation may seek merger or acquisition partners that are culturally similar, have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale or expanded services. Acquiring other banks, businesses, or financial centers involves risks commonly associated with acquisitions, including, among other things:

 

 

The Merger Agreement limits the Corporation’s ability to pursue merger and acquisition activity. The Corporation historically evaluated merger and acquisition opportunities and conducted due diligence activities related to possible transactions with other financial institutions and financial services companies.

 

As a result, merger or acquisition discussions and, in some cases, negotiations could take place and future mergers or acquisitions involving cash, debt or equity securities could occur at any time. Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of the Corporation’s tangible book value and net income per common share may occur in connection with any future transaction. Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

The Corporation May Not Be Able to Attract and Retain Skilled Personnel.

 

The Corporation’s success depends, in large part, on its ability to attract and retain key personnel. Competition for these individuals in most businesses engaged in by the Corporation can be intense and the Corporation may not be able to hire or retain them. The pending merger with Fifth Third could result in the departure of employees who do not expect to be retained by Fifth Third or employees who do not wish to be employed by Fifth Third. The unexpected loss of services of one or more of the Corporation’s key personnel could have a material adverse impact on the Corporation’s business because of their skills, institutional knowledge of the Corporation’s business and market, years of financial services experience, and the difficulty of promptly finding qualified replacement personnel. The Corporation has employment agreements or non-competition agreements with several of its senior and executive officers in an attempt to partially mitigate this risk.

 

The Corporation’s Information Systems May Experience a Failure, Interruption, or Breach in Security.

 

The Corporation relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Corporation’s customer relationship management, general ledger, deposit, loan and other systems. While the Corporation has policies and procedures designed to prevent or limit the effect of a failure, interruption or security breach of its information systems, there can be no assurance that any such failures,

interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of the Corporation’s information systems could damage the Corporation’s reputation, result in a loss of customer business, subject the Corporation to additional regulatory scrutiny, or expose the Corporation to civil litigation and possible financial liability, any of which could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

The Corporation Continually Encounters Technological Advancements.

 

The financial services industry is continually undergoing rapid technological advancements with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Corporation’s future success depends, in large part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Corporation’s operations. Many of the Corporation’s competitors have substantially greater resources to invest in technological improvements. The Corporation may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological advancements affecting the financial services industry could have a material adverse impact on the Corporation’s business and, in turn, the Corporation’s financial condition and results of operations.

 

The Corporation is Subject to Claims and Litigation Pertaining to Fiduciary Responsibility.

 

From time to time, customers make claims and take legal action pertaining to the Corporation’s performance of its fiduciary responsibilities. Whether or not customer claims and legal action related to the Corporation’s performance of its fiduciary responsibilities are founded, if such claims and legal actions are not resolved in a manner favorable to the Corporation, they may result in significant financial liability and/or adversely affect the market perception of the Corporation and its products and services, as well as impact customer demand for those products and services. Any financial liability or reputational damage could have a material adverse effect on the Corporation’s business, which, in turn, could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

The Corporation May Need Additional Capital Resources in the Future Which May Not Be Available When Needed or At All.

 

The Corporation may need to obtain additional debt or equity financing in the future for growth, investment or strategic acquisitions. There can be no assurance that such financing will be available to the Corporation on acceptable terms or at all. If the Corporation is unable to obtain such additional financing, the Corporation may not be able to grow or make strategic acquisitions or investments when desired, which could have a material adverse impact on the Corporation’s business and, in turn, the Corporation’s financial condition and results of operations.

 

Severe Weather, Natural Disasters and Other Adverse External Events Could Significantly Impact the Corporation’s Business.

 

Severe weather, natural disasters, and other adverse external events could have a significant impact on the Corporation’s ability to conduct business. Such events could affect the stability of the Corporation’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause the Corporation to incur additional expenses. The Southeast region of the United States is periodically impacted by hurricanes. For example, during 1989, Hurricane Hugo made landfall along the South Carolina coast and subsequently caused extensive flooding and destruction in the metropolitan area of Charlotte, North Carolina and other communities where the Corporation conducts business. While the impact of hurricanes may not significantly affect the Corporation, other severe weather or natural disasters, acts of war or terrorism or other adverse external events may occur in the future. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse

effect on the Corporation’s business, which, in turn, could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

Risks Associated With The Corporation’s Common Stock

 

The Corporation’s Common Stock Price Can Be Volatile.

 

Stock price volatility may make it more difficult for a shareholder to resell the Corporation’s common stock when desired and at favorable prices. The Corporation’s common stock price can fluctuate significantly in response to a variety of factors including, among other things:

 

 

General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause the Corporation’s stock price to decrease regardless of operating results.

 

The Trading Volume in the Corporation’s Common Stock is Less Than That of Other Larger Financial Services Companies.

 

Although the Corporation’s common stock is listed for trading on the NASDAQ Global Select Market, the trading volume in its common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of the Corporation’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which the Corporation has no control. Given the lower trading volume of the Corporation’s common stock, significant sales of the Corporation’s common stock, or the expectation of these sales, could cause the Corporation’s stock price to fall.

 

An Investment in the Corporation’s Common Stock is Not an Insured Deposit.

 

The Corporation’s common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in the Corporation’s common stock is inherently risky for the reasons described in this Risk Factors section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire the Corporation’s common stock, you may lose some or all of your investment.

The Corporation’s Articles of Incorporation, Bylaws and Stockholder Protection Rights Agreement, as well as Certain Banking Laws, May Have an Anti-Takeover Effect.

 

Provisions of the Corporation’s articles of incorporation and bylaws, federal banking laws, including regulatory approval requirements, and the Corporation’s Stockholder Protection Rights Agreement could make it more difficult for a third party to acquire the Corporation, even if doing so would be perceived to be beneficial to the Corporation’s shareholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of the Corporation’s common stock. The Corporation satisfied the various requirements in the articles of incorporation and bylaws in connection with the Merger Agreement. There can be no assurance that such requirements would be satisfied in connection with any other transaction. The merger with Fifth Third has not yet received all required regulatory approvals.

 

Risks Associated With The Corporation’s Industry

 

The Earnings of Financial Services Companies Are Significantly Affected by General Business and Economic Conditions.

 

The Corporation’s operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, and the strength of the U.S. economy and the local economies in which the Corporation operates, all of which are beyond the Corporation’s control. A deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for the Corporation’s products and services, among other things, any of which could have a material adverse impact on the Corporation’s financial condition and results of operations.

 

Financial Services Companies Depend on the Accuracy and Completeness of Information About Customers and Counterparties.

 

In deciding whether to extend credit or enter into other transactions, the Corporation may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports and other financial information. The Corporation may also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on the Corporation’s business and, in turn, the Corporation’s financial condition and results of operations.

 

Consumers May Decide Not to Use Banks to Complete Their Financial Transactions.

 

Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on the Corporation’s financial condition and results of operations.

 

 

None.

 

The principal offices of the Corporation are contained within the First Charter Center, located at 10200 David Taylor Drive in Charlotte, North Carolina, which is owned by the Bank through its subsidiaries. The First Charter Center contains the corporate offices of the Corporation, as well as the operations, mortgage loan, and data processing departments of the Bank.

 

At December 31, 2007, the Bank operated 60 financial centers, four insurance offices, and 137 ATMs located in North Carolina and Georgia. As of that time, the Corporation and its subsidiaries owned 35 financial center locations and leased 25 financial center locations and its four insurance offices. The Corporation also leased facilities in Reston, Virginia and Asheville, North Carolina for loan origination.

 

 

The Corporation and its subsidiaries are defendants in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated operations, liquidity, or financial position of the Corporation or its subsidiaries.

 

 

There were no matters submitted to a vote of shareholders during the quarter ended December 31, 2007.

 

The following table sets forth certain information about each of the current executive officers of the Registrant, including his or her name, age, positions and offices held with the Registrant and the Bank, the period served in such positions or offices and, if such person has served in such position and office for less than five years, the prior employment of such person. No executive officer has a family relationship as close as first cousin with any other executive officer or director.

 

 

Market Information, Holders, and Dividends

 

The principal market on which the Corporation’s common stock (“common stock”) is traded is the NASDAQ Global Select Market under the ticker symbol “FCTR”. The following table sets forth the high and low sales prices of the common stock for the periods indicated, as reported on the NASDAQ Global Select Market:

 

 

As of February 15, 2008, there were 6,839 record holders of the common stock.

 

During 2007 and 2006, the Corporation paid dividends on the common stock on a quarterly basis. The following table sets forth dividends declared per share of common stock for the periods indicated:

 

 

For additional information regarding the Corporation’s ability to pay dividends, see Management’s Discussion and Analysis of Financial Condition and Results of Operations - Capital Management and Note 23 of the consolidated financial statements.

 

Equity Compensation Plan Information

 

The following table provides information as of December 31, 2007, regarding the number of shares of the common stock that may be issued under the Corporation’s equity compensation plans:

 

 

Recent Sales of Unregistered Securities

 

None.

 

Issuer Purchases of Equity Securities

 

The following table summarizes the Corporation’s repurchases of common stock during the quarter ended December 31, 2007:

 

 

On January 23, 2002, the Corporation’s Board of Directors authorized a stock repurchase plan to acquire up to 1.5 million shares of the Corporation’s common stock from time to time. As of December 31, 2007, the Corporation had repurchased all shares under this authorization.

 

On October 24, 2003, the Corporation’s Board of Directors authorized a stock repurchase plan to acquire up to an additional 1.5 million shares of the Corporation’s common stock from time to time. As of December 31, 2007, the Corporation had repurchased 374,600 shares under this authorization.

 

There were no repurchases of the Corporation’s common stock during the three months ended December 31, 2007. There were 500,000 shares repurchased of the Corporation’s common stock during the twelve months ended December 31, 2007. The maximum number of shares that may yet be purchased under the October 24, 2003 plan was 1,125,400 at December 31, 2007 and this stock repurchase authorization has no set expiration or termination date.

 

The Corporation does not anticipate repurchasing any additional shares due to the proposed merger with Fifth Third. For additional information on the proposed merger with Fifth Third, see Item 1 Business - General of this Form 10-K.

 

Five-Year Total Return Performance Graph

 

The following graph compares the Corporation’s five-year cumulative total shareholder return with the cumulative total return of the NASDAQ Composite Index and the SNL Southeast Bank Index. The cumulative total shareholder return for each of these groups assumes the reinvestment of dividends and is expressed in dollars based on an assumed initial investment of $100.

 

Total Return Performance

 

 

 

Source: SNL Financial LC

 

 

See Table One in Item 7 for Selected Financial Data.

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements of the Corporation and the notes thereto.

Factors that May Affect Future Results

 

The following discussion contains certain forward-looking statements about the Corporation’s financial condition and results of operations, which are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s judgment only as of the date hereof. The Corporation undertakes no obligation to publicly revise these forward-looking statements to reflect events and circumstances that arise after the date hereof.

 

Factors that may cause actual results to differ materially from those contemplated by such forward- looking statements, and which may be beyond the Corporation’s control, include, among others, the following possibilities: (i) projected results in connection with management’s implementation of, or changes in, the Corporation’s business plan and strategic initiatives, including the Corporation’s balance sheet initiatives; (ii) competitive pressure among financial services companies increases significantly; (iii) costs or difficulties related to the integration of acquisitions, including deposit attrition, customer retention and revenue loss, or expenses in general are greater than expected; (iv) general economic conditions, in the markets in which the Corporation does business, are less favorable than expected; (v) risks inherent in making loans, including repayment risks and risks associated with collateral values, are greater than expected, including the Penland loans described herein; (vi) changes in the interest rate environment, or interest rate policies of the Board of Governors of the Federal Reserve System, may reduce interest margins and affect funding sources; (vii) changes in market rates and prices may adversely affect the value of financial products; (viii) legislation or regulatory requirements or changes thereto, including changes in accounting standards, may adversely affect the businesses in which the Corporation is engaged; (ix) regulatory compliance cost increases are greater than expected; (x) the passage of future tax legislation, or any negative regulatory, administrative or judicial position, may adversely impact the Corporation; (xi) the Corporation’s competitors may have greater financial resources and may develop products that enable them to compete more successfully in the markets in which the Corporation operates; (xii) changes in the securities markets, including changes in interest rates, may adversely affect the Corporation’s ability to raise capital from time to time; and (xiii) costs and difficulties related to the consummation of the proposed merger with Fifth Third may be greater than expected and the consummation remains subject to the satisfaction of various required conditions that may be delayed or may not be satisfied at all.

 

Overview

 

First Charter Corporation (NASDAQ: FCTR) (hereinafter referred to as “First Charter,” the “Corporation,” or the “Registrant”), headquartered in Charlotte, North Carolina, is a regional financial services company with assets of $4.9 billion and is the holding company for First Charter Bank (“Bank”). As of December 31, 2007, First Charter operated 60 financial centers, four insurance offices, and 137 ATMs throughout North Carolina and Georgia, and also operated loan origination offices in Asheville, North Carolina and Reston, Virginia. First Charter provides businesses and individuals with a broad range of financial services, including banking, financial planning, wealth management, investments, insurance, and mortgages. The results of operations of the Bank constitute the substantial majority of the consolidated net income, revenue, and assets of the Corporation.

 

The Corporation’s principal source of earnings is derived from net interest income. Net interest income is the interest earned on securities, loans, and other interest-earning assets less the interest paid for deposits and short-and long-term debt.

 

Another source of earnings for the Corporation is noninterest income. Noninterest income is derived largely from service charges on deposit accounts and other fee or commission-based services and products, including mortgage, wealth management, brokerage, and insurance. Other sources of noninterest income include securities gains or losses, gains from Small Business Administration loan sales, transactions involving bank-owned property, and income from Bank Owned Life Insurance (“BOLI”) policies.

Noninterest expense is the primary component of expense for the Corporation. Noninterest expense is primarily composed of corporate operating expenses, including salaries and benefits, occupancy and equipment, professional fees, and other operating expense. The provisions for loan losses and income taxes are also considered material expenses.

 

Proposed Merger with Fifth Third

 

On August 15, 2007, First Charter and Fifth Third Bancorp entered into an Agreement and Plan of Merger, as amended by the Amended and Restated Plan of Merger, dated September 14, 2007 by and among First Charter, Fifth Third, and Fifth Third Financial. Under the terms of the Merger Agreement, First Charter will be merged with and into Fifth Third Financial. The Merger Agreement has been approved by the Board of Directors of First Charter, Fifth Third and Fifth Third Financial. On January 18, 2008, First Charter shareholders approved the Merger Agreement. The Merger Agreement is subject to customary closing conditions, including regulatory approval. First Charter is planning for a closing in the second quarter of 2008, although no assurance can be given in this regard.

 

Pursuant to the Merger Agreement, at the effective time of the merger, each common share of First Charter issued and outstanding immediately prior to the effective time (other than common shares held directly or indirectly by First Charter or Fifth Third) will be converted, at the election of the owner of the common share, into either $31.00 cash or shares of Fifth Third common stock with a value of $31.00 per share, or both. Under the terms of the Merger Agreement, approximately 30 percent of First Charter shares will be converted to cash and approximately 70 percent will be converted to Fifth Third common stock.

 

The Merger Agreement contains customary representations and warranties between First Charter and Fifth Third. The Merger Agreement also contains customary covenants and agreements, including (a) covenants related to the conduct of First Charter’s business between the date of the signing of the Merger Agreement and the closing of the merger, (b) covenants prohibiting solicitation of competing merger proposals, and (c) agreements regarding efforts of the parties to cause the Merger Agreement to be completed.

 

The Merger Agreement contains certain termination rights and provides that, upon or following the termination of the Merger Agreement, under specified circumstances involving a competing merger transaction, First Charter may be required to pay Fifth Third a termination fee of $32.5 million.

 

In connection with the proposed merger with Fifth Third, the Corporation has incurred expenses of approximately $1.3 million of merger-related costs for 2007.

 

As previously disclosed, First Charter has been informed by Fifth Third that in February 2008 a shareholder of Fifth Third filed a derivative suit in the Court of Common Pleas for Hamilton County, Ohio, against the members of Fifth Third’s board of directors and, nominally, Fifth Third, alleging breach of fiduciary duty and waste of corporate assets, among other charges, in relation to the approval of Fifth Third’s acquisition of First Charter. The suit seeks, with respect to the completion of the acquisition, an injunction to stop the acquisition of First Charter and an independent valuation of First Charter as to its worth. The suit also seeks unspecified compensatory damages to be paid to Fifth Third by its directors as well as costs and attorneys fees to the plaintiff. The suit is in its earliest stage and Fifth Third has stated that the impact of the final disposition cannot be assessed at this time. First Charter and its legal counsel are reviewing the complaint carefully and intend to take such action as is appropriate and necessary to protect First Charter’s interests in the Merger Agreement with Fifth Third.

 

The Community-Banking Model

 

The Bank operates a community-banking model. The community-banking model is focused on delivering a broad array of financial products and solutions to our clients with exceptional service and convenience at a fair price. It emphasizes local market decision-making and management whenever possible. Management believes this model works well against larger competitors that may have less flexibility, as well as local competition that may not have the array of products and services nor the number of convenient locations

that the Bank offers and are challenged to provide exceptional customer service. The Bank competes against four of the largest banks in the country, as well as other local banks, savings and loan associations, credit unions, and finance companies.

 

Existing Markets and Expansion

 

During 2005, First Charter implemented a growth strategy intended to both expand the First Charter footprint into high growth markets and to optimize existing locations through attracting new customers and retaining existing customers. As part of the strategic growth strategy, First Charter expanded operations into the Raleigh, North Carolina, metro area. The Raleigh metro area is expected to have at or above average household income and growth rates relative to the North Carolina and national averages. First Charter operates five financial centers and 26 ATMs in the Raleigh market.

 

In November 2006, the Corporation entered the greater Atlanta, Georgia metropolitan market with the acquisition of GBC and its banking subsidiary, Gwinnett Bank, with financial centers located in Lawrenceville and Alpharetta, Georgia. By expanding into the Atlanta metropolitan market, the Corporation has been able to spread its credit risk over multiple market areas and states, as well as gain access to another large market area as a source for core deposits. The Georgia counties in which First Charter operates boast some of the strongest demographic growth trends in the nation, and the median household income in these counties is significantly higher than the median income for Georgia and the southeastern United States. First Charter has two financial centers and operates three ATMs in the Atlanta market.

 

During the first quarter of 2007, the Corporation opened its fifth financial center in the Raleigh market and during the third quarter of 2007, the Corporation opened its Renaissance Square financial center, to bring its total financial centers to 60 at December 31, 2007. The Renaissance Square financial center is located in a rapidly expanding growth area in the northern section of Cabarrus County, North Carolina, adjacent to the Mecklenburg County line and the town of Davidson, North Carolina.

 

Recent Challenges

 

During the fourth quarter of 2006, the Corporation closed two significant transactions, the acquisition of GBC and the sale of Southeastern Employee Benefits Services (“SEBS”), its employee benefits administration business. In addition, the Corporation was faced with several new accounting standards. The numerous challenges that these events posed for the Corporation were compounded by a key vacancy in the leadership of its accounting area and turnover within other key finance positions, and exposed certain material weaknesses in the Corporation’s internal control over financial reporting. During 2007, management implemented a remediation plan to address these material weaknesses. As of December 31, 2007, the Corporation has concluded that these previously identified material weaknesses have been remediated and that the Corporation’s internal controls over financial reporting were effective. See Item 9A. Controls and Procedures.

 

During the second quarter of 2007, the North Carolina Attorney General obtained a court order to appoint a receiver to take control of the Village of Penland and related development projects (“Penland”) located in western North Carolina. The Attorney General’s complaint alleges that various defendants, including real estate development companies, individuals, and an appraiser engaged in deceptive practices to induce consumers to obtain loans to purchase lots in Penland in the Spruce Pine, North Carolina area. These lots were allegedly priced based upon inflated appraisals. Several financial institutions, including First Charter, made loans in connection with these residential developments.

 

As of December 31, 2007, the Corporation had an aggregate outstanding balance of $3.7 million to individual lot purchasers related to Penland, net of $10.4 million charged off during the year. Based on management’s assessment of probable incurred losses associated with the Penland loan portfolio, the Corporation recorded an allowance for loan losses of $1.3 million as of December 31, 2007. Additionally, based on management’s assessment of the individual borrowers, $1.1 million of the Penland loans were on nonaccrual status as of December 31, 2007 and all of the previously recognized interest income related to these nonaccrual loans was reversed.

On July 31, 2007, the General Assembly of North Carolina passed House Bill 1473 which includes a provision that disallows the deduction of dividends paid by captive real estate investment trusts (“REITs”) for the purposes of determining North Carolina taxable income. First Charter, through its subsidiaries, participates in two entities classified as captive REITs from which First Charter has historically received dividends which resulted in certain tax benefits taken within First Charter’s tax returns and consolidated financial statements. This legislation is effective for taxable years beginning on or after January 1, 2007.

 

As a result of this legislation, during the third quarter of 2007, First Charter recorded $1.0 million, net of reserve, of additional income tax expense as it eliminated the dividend received deduction previously recorded during 2007. This increased First Charter’s effective tax rate for 2007, and it is expected to increase the effective tax rate for future periods. Additionally, tax expense was reduced by $0.4 million as a result of the expiration of the relevant Federal statute of limitations. The net impact of these two events was a $0.6 million increase to income tax expense for the year ended December 31, 2007.

 

On December 31, 2007, the Superior Court of North Carolina ruled in favor of the State of North Carolina in the Wal-Mart Stores East Inc. v Reginald S. Hinton, Secretary of Revenue of State of North Carolina case (“Wal-Mart case”). This ruling was made available to the public on January 4, 2008 and the case has been appealed by the taxpayer to the North Carolina Court of Appeals. The Corporation’s REIT position has certain facts that are similar as those in the above-mentioned Wal-Mart case.

 

The Corporation is currently evaluating its reserves for uncertain tax positions in accordance with FIN 48 which requires remeasurement of uncertain tax positions to be based on the information that became available during the first quarter of 2008. The Corporation has yet to quantify the impact that the Wal-Mart case ruling will have on its consolidated financial statements, but believes the amount could be material. The Corporation’s maximum exposure related to this matter is approximately $13.5 million. The Corporation will record the remeasurement of its uncertain tax position related to the Wal-Mart case in the first quarter of 2008.

 

Financial Summary

 

The Corporation’s net income was $41.3 million, or $1.18 per diluted share, a $6.1 million decrease from net income of $47.4 million in 2006. Return on average assets and return on average equity was 0.85 percent and 9.07 percent for 2007, respectively, compared to 1.08 percent and 13.45 percent for 2006, respectively. Fiscal year 2007 includes a full-year’s impact of the GBC acquisition, while 2006 includes two months of GBC results.

 

For 2007, the provision for loan losses was $19.9 million, a $14.6 million increase, from a $5.3 million provision for loan losses in 2006. The increase in provision for loan losses included $11.7 million related to Penland. The allowance for loan losses as a percentage of portfolio loans was 1.21 percent and 1.00 percent as of December 31, 2007 and 2006, respectively.

 

During 2007 and 2006, several material transactions occurred, which impacted noninterest income and noninterest expense. In 2007, the Corporation incurred costs related to the potential merger with Fifth Third, recognized distributions from the Corporation’s equity method investments, and recorded gains on the sales of certain properties. In 2006, material transactions included the sale of the Corporation’s employee benefits administration business, the sale of two financial centers, distributions received from the Corporation’s equity method investments, the further repositioning of the Corporation’s securities portfolio, the restructuring of the Corporation’s BOLI investment, the acceleration of vesting on all stock options granted from 2003 to 2005, the separation expense of certain employees, and the merger costs associated with the GBC acquisition.

 

Earnings Analysis for Fourth Quarter 2007 versus Fourth Quarter 2006

 

For the fourth quarter of 2007, net income was $8.9 million, or $0.25 per diluted share, compared to net income of $12.0 million, or $0.36 per diluted share, for the 2006 fourth quarter. The fourth quarter of 2007 was impacted by continued higher provision for loan losses expense, largely due to the Penland

development, and ongoing merger expenses caused by the pending merger with Fifth Third. These items were partially offset by property sale gains that were recognized in the fourth quarter of 2007.

 

The net interest margin, on a tax-equivalent basis, decreased 15 basis points to 3.25 percent in the fourth quarter of 2007 from 3.40 percent in the fourth quarter of 2006. The margin was negatively impacted by the Corporation’s interest earning assets repricing faster than interest bearing liabilities, and by unusually high competitive pricing for time deposits. Net interest income declined to $35.4 million, representing a $0.6 million, or 1.8 percent, decline over the fourth quarter of 2006.

 

Compared to the fourth quarter of 2006, earning-asset yields decreased 9 basis points to 6.87 percent. The decline was driven by a 28 basis point decline in loan yields to 7.28 percent, partially mitigated by a 45 basis point increase in securities yields to 5.29 percent. This decrease in loan yields was a direct result of lower short-term interest rates to the year-ago quarter. The Federal Reserve lowered the rate that banks can lend to each other (“federal funds rate”) by 100 basis points from year-end 2006 to year-end 2007. The ending federal funds rate was 4.25 percent as of December 31, 2007.

 

On the liability side of the balance sheet, the cost of interest-bearing liabilities increased 8 basis points during the fourth quarter of 2007, compared to the fourth quarter of 2006. This was comprised of an 8 basis point increase in interest-bearing deposit costs to 3.81 percent, while other borrowing costs increased 7 basis points to 4.97 percent.

 

Provision for loan losses expense totaled $6.1 million, compared to $1.5 million in the fourth quarter of 2006. Provision for the Penland development resulted in $2.5 million of additional expense during the fourth quarter of 2007. Net charge-offs during the fourth quarter 2007 totaled $6.7 million, with $5.2 million attributable to Penland, compared to total net charge-offs of $0.7 million during the fourth quarter 2006.

 

Noninterest income from continuing operations totaled $20.1 million, compared to $17.4 million for the fourth quarter of 2006. Of this increase, $1.4 million was attributable to property sale gains that were realized in the fourth quarter of 2007. Additionally, deposit service charges, ATM, debit card, and merchant fees, mortgage services, and wealth management revenue were all contributors to growth in the Corporation’s noninterest income. Partially offsetting the growth in these key areas was $0.2 million less in insurance revenue in the 2007 fourth quarter, compared to the 2006 fourth quarter.

 

Noninterest expense from continuing operations for the 2007 fourth quarter increased $1.9 million to $35.8 million, compared to $33.9 million for the fourth quarter of 2006. The most significant driver of the increase was professional fees, with total fourth quarter 2007 expense of $3.8 million, or $1.6 million higher than the year-ago quarter. Approximately $0.6 million of the increase resulted from expenses related to the pending merger with Fifth Third. Marketing expense increased $0.4 million as a result of a greater number of marketing campaigns in the fourth quarter 2007 compared to the year-ago quarter. During the fourth quarter 2007, charitable contribution expense increased $0.4 million, compared to the fourth quarter 2006. Data processing, foreclosed properties, and occupancy and equipment were also higher. These increases were partially offset by decreases in salaries and benefits, postage and supplies, telecommunications, and other noninterest expense.

 

The effective tax rate for the fourth quarter of 2007 was 33.9 percent, compared with 33.0 percent in the fourth quarter of 2006. The effective tax rate excludes the effects of discontinued operations in the fourth quarter of 2006. The higher effective tax rate for 2007 reflects the impact of the previously mentioned loss of the state dividend received deduction.

 

Average fully diluted shares increased 1.5 million to 35.1 million shares in the fourth quarter of 2007. The most significant drivers of the increase were a full quarter’s impact resulting from the merger with GBC, which occurred on November 1, 2006, and the decease in the number of anti-dilutive shares. Partially offsetting these increases was the share repurchases which occurred in the second quarter of 2007.

Table One
Selected Financial Data

 

Critical Accounting Estimates and Policies

 

The Corporation’s significant accounting policies are described in Note 1 of the consolidated financial statements and are essential in understanding management’s discussion and analysis of financial condition and results of operations. Some of the Corporation’s accounting policies require significant judgment to estimate values of either assets or liabilities. In addition, certain accounting principles require significant judgment with respect to their application to complicated transactions to determine the most appropriate treatment.

 

The following is a summary of three accounting policies that the Corporation has identified as being critical in terms of judgments and the extent to which estimates are used. In many cases, there are numerous alternative judgments that could be used in the process of estimating values of assets or liabilities. Where alternatives exist, the Corporation has used the factors that it believes represent the most reasonable value in developing the inputs for the valuation. Actual performance that differs from the Corporation’s estimates of the key variables could affect net income.

 

Allowance for Loan Losses

 

The Corporation considers its policy regarding the allowance for loan losses to be one of its most critical accounting policies, as it requires some of management’s most subjective and complex judgments. The allowance for loan losses is maintained at a level the Corporation believes is adequate to absorb probable losses inherent in the loan portfolio as of the date of the consolidated financial statements. The Corporation has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses that reflect its evaluation of credit risk considering all information available to it.

 

The determination of the level of the allowance and, correspondingly, the provision for loan losses, rests upon various judgments and assumptions, including: (i) general economic conditions, (ii) loan portfolio composition, (iii) prior loan loss experience, (iv) management’s evaluation of credit risk related to both individual borrowers and pools of loans and (v) observations derived from the Corporation’s ongoing internal credit review and examination processes and those of its regulators. Depending on changes in circumstances, future assessments of credit risk may yield materially different results, which may require an increase or decrease in the allowance for loan losses.

 

The Corporation employs a variety of statistical modeling and estimation tools in developing the appropriate allowance. The following provides a description of each of the components involved in the allowance for loan losses, the techniques the Corporation uses, and the estimates and judgments inherent to each component.

 

The first component of the allowance for loan losses, the valuation allowance for impaired loans, is computed based on documented reviews performed by the Corporation’s Credit Risk Management for impaired relationships greater than $150,000. Credit Risk Management typically estimates these valuation allowances by considering the fair value of the underlying collateral for each impaired loan using current appraisals. The results of these estimates are updated quarterly or periodically as circumstances change. Changes in the dollar amount of impaired loans or in the estimates of the fair value of the underlying collateral can impact the valuation allowance on impaired loans and, therefore, the overall allowance for loan losses.

 

The second component of the allowance for loan losses, the portion attributable to all other loans without specific reserve amounts, is determined by applying reserve factors to the outstanding balance of loans. The portfolio is segmented into two major categories: commercial loans and consumer loans. Commercial loans are segmented further by risk grade, so that separate reserve factors are applied to each pool of commercial loans. The reserve factors applied to the commercial segments are determined using a migration analysis that computes current loss estimates by credit grade using a 60-month trailing loss history. Since the migration analysis is based on trailing data, the reserve factors are changed based on actual losses and other judgmentally determined factors. Changes in commercial loan credit grades can also impact this component of the allowance for loan losses from period to period. Consumer loans which include mortgage, general consumer, consumer real estate, home equity and consumer unsecured loans are segmented by homogeneous pools in order to apply separate reserve factors to each pool of consumer

loans. The reserve factors applied to the consumer segments are a 36-month rolling average of losses. Since the reserve factors are based on historical loss data, the percentage loss estimates can change period-to-period based on actual losses.

 

The third component of the allowance for loan losses is intended to capture the various risk elements of the loan portfolio which may not be sufficiently captured in the historical loss rates. These factors include intrinsic risk, operational risk, concentration risk and model risk. Intrinsic risk relates to the impact of current economic conditions on the Corporation’s borrower base, the effects of which may not be realized by the Corporation in the form of charge-offs for several periods. The Corporation monitors and documents various local, regional and national economic data, and makes subjective estimates of the impact of changes in economic conditions on the allowance for loan losses. Operational risk includes factors such as the likelihood of loss on a loan due to procedural error. Historically, the Corporation has made additional loss estimates for certain types of loans that were either acquired from other institutions in mergers or were underwritten using policies that are no longer in effect at the Corporation. These identified loans are considered to have higher risk of loss than currently reflected in historical loss rates of the Corporation, so additional estimates of loss are made by management. Concentration risk includes the risk of loss due to extensions of credit to a particular industry, loan type or borrower that may be troubled. The Corporation monitors its portfolio for any excessive concentrations of loans during each period, and if any excessive concentrations are noted, additional estimates of loss are made. Model risk reflects the inherent uncertainty of estimates within the allowance for loan losses model. Changes in the allowance for loan losses for these subjective factors can arise from changes in the balance and types of outstanding loans, as well as changes in the underlying conditions which drive a change in the percentage used. As more fully discussed below, the Corporation continually monitors the portfolio in an effort to identify any other factors which may have an impact on loss estimates within the portfolio.

 

All estimates of the loan portfolio risk, including the adequacy of the allowance for loan losses, are subject to general and local economic conditions, among other factors, which are unpredictable and beyond the Corporation’s control. Since a significant portion of the loan portfolio is comprised of real estate loans and loans to area businesses, the Corporation is subject to continued risk that the real estate market and economic conditions in general could change and therefore result in additional losses and require increases in the provision for loan losses. If management had made different assumptions about probable loan losses, the Corporation’s financial position and results of operations could have differed materially.

 

As previously disclosed, the Corporation has recorded a provision for loan losses related to Penland. The Corporation continues to evaluate the Penland lot loan portfolio. Subsequent developments related to the Penland loans may have a significant impact on the provision for loan losses.

 

For additional discussion concerning the Corporation’s allowance for loan losses and related matters, see Credit Risk Management — Allowance for Loan Losses.

 

Income Taxes

 

Calculating the Corporation’s income tax expense requires significant judgment and the use of estimates. The Corporation periodically assesses its tax positions based on current tax developments, including enacted statutory, judicial and regulatory guidance. In analyzing the Corporation’s overall tax position, consideration is given to the amount and timing of recognizing income tax liabilities and benefits. In applying the tax and accounting guidance to the facts and circumstances, income tax balances are adjusted appropriately through the income tax provision.

 

Reserves for income tax uncertainties are determined using a two-step process in accordance with FASB Interpretation No. 48, Accounting for Uncertainties in Income Taxes, and requires significant management judgment. In the first step of the process, the Corporation determines whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. If the Corporation determines that a tax position has met the more-likely-than-not threshold, the Corporation then determines the amount that would be recognized in its financial statements. In calculating the amount recognized in the financial statements, the Corporation considers the amounts and probabilities that could be recognized upon ultimate settlement using the facts, circumstances, and information available at the reporting date.

Identified Intangible Assets and Goodwill

 

The Corporation records all assets and liabilities acquired in purchase acquisitions, including goodwill, indefinite-lived intangibles, and other intangibles, at fair value as required by SFAS 141, Business Combinations. The initial recording of goodwill and other intangibles requires subjective judgments concerning estimates of the fair value of the acquired assets and liabilities. During 2007, the Corporation finalized the valuations of certain of its acquired assets and liabilities related to GBC. This refinement impacted the allocation of the GBC purchase price and the resulting goodwill. Goodwill and indefinite-lived intangible assets are not amortized but are subject to annual tests for impairment or more often if events or circumstances indicate they may be impaired. Other identified intangible assets are amortized over their estimated useful lives and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount.

 

The ongoing value of goodwill is ultimately supported by revenue from the Corporation’s businesses and its ability to deliver cost-effective services over future periods. Any decline in revenue resulting from a lack of growth or the inability to effectively provide services could potentially create an impairment of goodwill.

 

Earnings Performance

 

First Charter Corporation’s net income was $41.3 million for 2007, compared to $47.4 million for 2006. Earnings were $1.18 per diluted share, a decrease of $0.31 per diluted share from $1.49 a year ago. Total revenue increased 11.8 percent to $225.1 million, compared to $201.4 million a year ago. The increase in revenue was primarily driven by two factors. First, net interest income increased $13.2 million to $146.9 million. This increase is attributable to a full year of GBC results in 2007, compared to two months of GBC results in 2006 and the Corporation’s net interest margin expanding 3 basis points to 3.40 percent. Second, noninterest income from continuing operations, excluding securities losses in both 2007 and 2006, increased $4.5 million, or 6.2 percent, primarily due to higher deposit service charges, ATM, debit card, and merchant fees, wealth management and BOLI revenue, and the gain on property sales. Partially offsetting these revenue increases was a $17.6 million increase of noninterest expense from continuing operations.

 

Net charge-offs as a percentage of average portfolio loans has increased from 0.11 in 2006 to 0.36 percent in 2007.

 

Net Interest Income and Margin

 

Net interest income, the difference between total interest income and total interest expense, is the Corporation’s principal source of earnings. An analysis of the Corporation’s net interest income on a taxable-equivalent basis and average balance sheets for the last three years is presented in Table Two. Net interest income on a taxable-equivalent basis (“FTE”) is a non-GAAP (Generally Accepted Accounting Principles) performance measure used by management in operating the business which management believes provides investors with a more accurate picture of the interest margin for comparative purposes. The changes in net interest income, on a taxable-equivalent basis, from year to year are analyzed in Table Three. The discussion below is based on net interest income computed under accounting principles generally accepted in the United States of America. For 2007, net interest income was $146.9 million, an increase of $13.2 million, or 9.9 percent, from net interest income of $133.7 million in 2006.

 

Compared to 2006, earning-asset yields increased 39 basis points to 7.02 percent. This increase was driven by several factors. First, loan yields increased 27 basis points to 7.53 percent. Second, securities yields increased 59 basis points to 5.11 percent. Third, the mix of higher-yielding (loan) assets continued to improve as the Corporation continues to focus on generating higher-yielding commercial loans, partially funded by runoff in its lower yielding mortgage loan portfolio. Lastly, the percentage of investment security average balances (which, on average, have lower yields than loans) to total earning asset average balances fell from 22.8 percent to 20.6 percent over the past year.

Earning-asset average balances increased $413.9 million to $4.4 billion at December 31, 2007, compared to $4.0 billion for 2006. The increase was primarily due to the GBC acquisition and also some organic loan growth.

 

On the liability side of the balance sheet, the cost of interest-bearing liabilities increased 49 basis points, compared to 2006. This increase was comprised of a 53 basis point increase in interest-bearing deposit costs to 3.84 percent, while other borrowing costs increased 42 basis points to 5.07 percent. During the first half of 2006, the Federal Reserve raised the federal funds rate by 100 basis points. The Federal Reserve lowered the federal funds rate by 50 basis points in third quarter 2007 and by an additional 50 basis points in the fourth quarter 2007.

 

Net interest income and yields on earning-asset average balances and interest expense and rates paid on interest-bearing liability average balances, and the net interest margin follow:

 

Table Two
Average Balances and Net Interest Income Analysis

 

The following table shows changes in tax-equivalent interest income, interest expense, and tax-equivalent net interest income arising from volume and rate changes for major categories of earning assets and interest-bearing liabilities. The change in interest not solely due to changes in volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each.

 

Table Three

Volume and Rate Variance Analysis

 

Noninterest Income

 

The major components of noninterest income are derived from service charges on deposit accounts, ATM, debit and merchant fees, and mortgage, brokerage, insurance, and wealth management revenue. In addition, the Corporation realizes gains and losses on securities, equity investments, Small Business Administration (“SBA”) loan sales, bank-owned property sales, and income from its BOLI policies.

 

Historical noninterest income and expense amounts have been restated to reflect the effect of reporting the previously announced sale of Southeastern Employee Benefits Services (“SEBS”) in the fourth quarter of 2006 as discontinued operations and to reflect the implementation of SAB 108 at year-end 2006.

 

Details of noninterest income follow:

 

Table Four
Noninterest Income

 

Selected items included in noninterest income follow:

 

Table Five
Selected Items Included in Noninterest Income

Noninterest income from continuing operations for 2007 was $78.3 million, an increase of $10.6 million, or 15.6 percent, from $67.7 million for 2006. The primary factors for this increase include the following:

 

 

Noninterest Expense

 

Details of noninterest expense follow:

 

Table Six
Noninterest Expense

 

⁽¹⁾ Noninterest expense divided by the sum of taxable-equivalent net interest income plus noninterest income less securities gains (losses), net. Excludes the results of discontinued operations and the impact of the debt extinguishment and derivative termination charges related to the balance sheet repositioning in 2005.

 

Selected items included in noninterest expense follow:

 

Table Seven
Selected Items Included in Noninterest Expense