Edgar Filing: FIRST CITIZENS BANCSHARES INC /DE/

Form 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008

Commission File Number 0-16471

FIRST CITIZENS BANCSHARES, INC.

(Exact name of Registrant as specified in the charter)


Delaware		56-1528994
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification Number)

4300 Six Forks Road

Raleigh, North Carolina 27609

(Address of Principal Executive Offices, Zip Code)

(919) 716-7000

(Registrant’s Telephone Number, including Area Code)


		Securities registered pursuant to:
		Section 12(b) of the Act:		Class A Common Stock, Par Value $1
		Section 12(g) of the Act:		Class B Common Stock, Par Value $1
				(Title of Class)

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

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

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 twelve 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 ninety days. Yes x No ¨

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. ¨

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 definition of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer x		Accelerated filer ¨		Non-accelerated filer ¨		Smaller reporting company ¨

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

The aggregate market value of the Registrant’s common equity held by nonaffiliates computed by reference to the price at which the common equity was last sold as of the last business day of the Registrant’s most recently completed second fiscal quarter was $718,318,286.

On February 27, 2009, there were 8,756,778 outstanding shares of the Registrant’s Class A Common Stock and 1,677,675 outstanding shares of the Registrant’s Class B Common Stock.

Portions of the Registrant’s definitive Proxy Statement for the 2009 Annual Meeting of Shareholders are incorporated in Part III of this report.

CROSS REFERENCE INDEX


			Page
PART 1	Item 1	Business	3
	Item 1A	Risk Factors	6
	Item 1B	Unresolved Staff Comments	None
	Item 2	Properties	6
	Item 3	Legal Proceedings	36
	Item 4	Submission of Matters to a Vote of Security Holders	None
PART II	Item 5	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	6-7
	Item 6	Selected Financial Data	12
	Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations	8-38
	Item 7A	Quantitative and Qualitative Disclosures about Market Risk	29-30
	Item 8	Financial Statements and Supplementary Data
		Report of Independent Registered Public Accounting Firm	39
		Management’s Annual Report on Internal Control over Financial Reporting	40
		Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting	41
		Consolidated Balance Sheets at December 31, 2008 and 2007	42
		Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2008	43
		Consolidated Statements of Changes in Shareholders’ Equity for each of the years in the three-year period ended December 31, 2008	44
		Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2008	45
		Notes to Consolidated Financial Statements	46-71
		Quarterly Financial Summary for 2008 and 2007	33
	Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	None
	Item 9A	Controls and Procedures	7
	Item 9B	Other Information	None
PART III	Item 10	Directors and Executive Officers and Corporate Governance	*
	Item 11	Executive Compensation	*
	Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	*
	Item 13	Certain Relationships and Related Transactions and Director Independence	*
	Item 14	Principal Accounting Fees and Services	*
PART IV	Item 15	Exhibits, Financial Statement Schedules
	(1)	Financial Statements (see Item 8 for reference)
	(2)	All Financial Statement Schedules normally required on Form 10-K are omitted since they are not applicable, except as referred to in Item 8.
	(3)	The Exhibits listed on the Exhibit Index contained in this Form 10-K are filed with or furnished to the Commission or incorporated by reference into this report and are available upon written request.

Information required by Item 10 is incorporated herein by reference to the information that appears under the headings or captions ‘Proposal 1: Election of Directors,’ ‘Code of Ethics,’ ‘Committees of our Board—General,’ and ‘—Audit and Compliance Committee’, ‘Executive Officers’ and ‘Section 16(a) Beneficial Ownership Reporting Compliance’ from the Registrant’s Proxy Statement for the 2009 Annual Meeting of Shareholders (2009 Proxy Statement) .

Information required by Item 11 is incorporated herein by reference to the information that appears under the headings or captions ‘Compensation Discussion and Analysis,’ ‘Compensation Committee Report,’ ‘Executive Compensation,’ and ‘Director Compensation,’ of the 2009 Proxy Statement.

Information required by Item 12 is incorporated herein by reference to the information that appears under the heading ‘Beneficial Ownership of Our Common Stock’ of the 2009 Proxy Statement.

Information required by Item 13 is incorporated herein by reference to the information that appears under the headings or captions ‘Corporate Governance—Director Independence’ and ‘Transactions with Related Persons’ of the 2009 Proxy Statement.

Information required by Item 14 is incorporated by reference to the information that appears under the caption ‘Services and Fees During 2008 and 2007 of the 2009 Proxy Statement.

Business

First Citizens BancShares, Inc. (BancShares) was incorporated under the laws of Delaware on August 7, 1986, to become the holding company of First-Citizens Bank & Trust Company (First Citizens Bank or FCB), its banking subsidiary. FCB opened in 1898 as the Bank of Smithfield, Smithfield, North Carolina, and through a series of mergers and name changes, it later became First-Citizens Bank & Trust Company. As of December 31, 2008, FCB operated 343 offices in North Carolina, Virginia, West Virginia, Maryland and Tennessee. During 2008, FCB announced plans to establish a new branch office in Washington, D.C.

On April 28, 1997, BancShares launched IronStone Bank (ISB), a federally-chartered thrift institution that originally operated under the name Atlantic States Bank. Initially, ISB operated in the counties surrounding Atlanta, Georgia, but gradually expanded into other high-growth markets in urban areas. At December 31, 2008, ISB had 58 offices in Georgia, Florida, Texas, Arizona, New Mexico, California, Oregon, Washington, Colorado, Oklahoma, Kansas and Missouri.

BancShares’ executive offices are located at 4300 Six Forks Road, Raleigh, North Carolina 27609, and its telephone number is (919) 716-7000. At December 31, 2008, BancShares and its subsidiaries employed a full-time staff of 4,044 and a part-time staff of 799 for a total of 4,843 employees.

BancShares’ subsidiary banks seek to meet the needs of both consumers and commercial entities in their respective market areas. These services, offered at most offices, include taking of deposits, cashing of checks, and providing for individual and commercial cash needs; numerous checking and savings plans; commercial, business and consumer lending; a full-service trust department; and other activities incidental to commercial banking. First Citizens Investor Services, Inc. (FCIS) and IronStone Securities (ISS) provide various investment products, including annuities, discount brokerage services and third-party mutual funds to customers. Various other subsidiaries are not material to BancShares’ consolidated financial position or to consolidated net income.

The business and operations of BancShares and its subsidiary banks are subject to significant federal and state governmental regulation and supervision. BancShares is a financial holding company registered with the Federal Reserve Board (FRB) under the Bank Holding Company Act of 1956, as amended. It is subject to supervision and examination by, and the regulations and reporting requirements of, the FRB.

FCB is a state-chartered bank, subject to supervision and examination by, and the regulations and reporting requirements of, the Federal Deposit Insurance Corporation (FDIC) and the North Carolina Commissioner of Banks. ISB is a federally-chartered thrift institution supervised by the Office of Thrift Supervision. Deposit obligations of FCB and ISB are insured by the FDIC to the maximum legal limits.

The various regulatory authorities supervise all areas of the banking subsidiaries, including their reserves, loans, mergers, the payment of dividends, various compliance matters and other aspects of their operations. The regulators conduct regular examinations, and the banking subsidiaries must furnish periodic reports to their regulators containing detailed financial and other information regarding their affairs.

There are many statutes and regulations that apply to and restrict the activities of the banking subsidiaries, including limitations on the ability to pay dividends, capital requirements, reserve requirements, deposit insurance requirements and restrictions on transactions with related parties. The impact of these statutes and regulations is discussed below and in the accompanying audited consolidated financial statements.

The Gramm-Leach-Bliley Act (GLB Act) adopted by Congress during 1999 expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. The GLB Act permits bank holding companies to become “financial holding companies” and expands activities in which banks and bank holding companies may participate, including opportunities to affiliate with securities firms and insurance companies. During 2000, BancShares became a financial holding company. The GLB Act also contains extensive customer privacy protection provisions which require banks to adopt and implement policies and procedures for the protection of the financial privacy of their customers, including procedures that allow customers to elect that certain financial information not be disclosed to certain persons.

Under Delaware law, BancShares is authorized to pay dividends declared by its Board of Directors, provided that no distribution results in its insolvency on a going concern or balance sheet basis. The ability of the banking subsidiaries to pay dividends to BancShares is governed by statutes of each entity’s chartering jurisdiction and rules and regulations issued by each entity’s respective regulatory authority. Under federal law, and as insured banks, each of the banking subsidiaries is prohibited from making any capital distributions, including paying a cash dividend, if it is, or after making the distribution it would become, “undercapitalized” as that term is defined in the Federal Deposit Insurance Act (FDIA).

BancShares is required to comply with the capital adequacy standards established by the FRB, and the banking subsidiaries are required to comply with the capital adequacy standards established by the FDIC. The FRB and FDIC have promulgated risk-based capital and leverage capital guidelines for determining the adequacy of the capital of a bank holding company or a bank, and all applicable capital standards must be satisfied for a bank holding company or a bank to be considered in compliance with these capital requirements.

Current federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized banks. Under this system, the FDIC has established five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”), and it is required to take certain mandatory supervisory actions, and is authorized to take other discretionary actions, with respect to banks in the three undercapitalized categories.

Under the FDIC’s rules implementing the prompt corrective action provisions, an insured, state-chartered bank that has a Total Capital Ratio of 10.0% or greater, a Tier 1 Capital Ratio of 6.0% or greater, a Leverage Ratio of 5.0% or greater, and is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the FDIC, is considered to be “well-capitalized.” Each of BancShares’ banking subsidiaries is well-capitalized.

Under regulations of the FRB, all FDIC-insured banks must maintain average daily reserves against their transaction accounts. Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the Banks’ interest-earning assets.

Under the Federal Deposit Insurance Reform Act of 2005 (FDIRA), the FDIC uses a risk-based assessment system to determine the amount of a bank’s deposit insurance assessment based on an evaluation of the probability that the deposit insurance fund (DIF) will incur a loss with respect to that bank. The evaluation considers risks attributable to different categories and concentrations of the bank’s assets and liabilities and other factors the FDIC considers to be relevant, including information obtained from the bank’s federal and state banking regulators.

The FDIC is responsible for maintaining the adequacy of the DIF, and the amount paid by a bank for deposit insurance is influenced not only by the assessment of the risk it poses to the DIF, but also by the adequacy of the insurance fund to cover the risk posed by all insured institutions. FDIC insurance assessments could be increased substantially in the future if the FDIC finds such an increase to be necessary in order to adequately maintain the DIF. Additionally, under the FDIA, the FDIC may terminate a bank’s deposit insurance if it finds that the bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated applicable laws, regulations, rules, or orders.

Each of the banking subsidiaries is subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of certain transactions with affiliate entities. The total amount of the transactions by any of the banking subsidiaries with a single affiliate is limited to 10% of the banking subsidiary’s capital and surplus and, for all affiliates, to 20% of the banking subsidiary’s capital and surplus. Each of the transactions among affiliates must also meet specified collateral requirements and must comply with other provisions of Section 23A designed to avoid transfers of low-quality assets between affiliates. The banking subsidiaries are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibits the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the banking subsidiary or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

The USA Patriot Act of 2001 (Patriot Act) is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The Patriot Act contains sweeping anti-money laundering and financial transparency laws which require various new regulations, including standards for verifying

customer identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. The Patriot Act has required financial institutions to adopt new policies and procedures to combat money laundering, and it grants the Secretary of the Treasury broad authority to establish regulations and impose requirements and restrictions on financial institutions’ operations.

Under the Community Reinvestment Act, as implemented by regulations of the federal bank regulatory agencies, an insured bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods.

The Sarbanes-Oxley Act of 2002 (SOX Act) mandated important new corporate governance, financial reporting and disclosure requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It established new responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process, and it created a new regulatory body to oversee auditors of public companies. The SOX Act also mandated new enforcement tools, increased criminal penalties for federal mail, wire and securities fraud, and created new criminal penalties for document and record destruction in connection with federal investigations. Additionally, the SOX Act increased the opportunity for private litigation by lengthening the statute of limitations for securities fraud claims and providing new federal corporate whistleblower protection.

The SOX Act requires various securities exchanges, including The Nasdaq Stock Market, to prohibit the listing of the stock of an issuer unless that issuer maintains an independent audit committee. In addition, the securities exchanges have imposed various corporate governance requirements, including the requirement that various corporate matters (including executive compensation and board nominations) be approved, or recommended for approval by the issuer’s full board of directors, by directors of the issuer who are “independent” as defined by the exchanges’ rules or by committees made up of “independent” directors. Since BancShares’ Class A common stock is a listed stock, BancShares is subject to those provisions of the Act and to corporate governance requirements of The Nasdaq Stock Market. The economic and operational effects of the SOX Act on public companies, including BancShares, have been and will continue to be significant in terms of the time, resources and costs required to achieve compliance.

During 2008, in response to the widespread consumer concern about weakness within the banking industry, the Emergency Economic Stabilization Act was enacted, providing expanded insurance protection to depositors. In addition, the U.S. Treasury created the TARP Capital Purchase Program to provide qualifying banks with additional capital. The FDIC created the Temporary Liquidity Guarantee Program (TLGP), which allowed banks to purchase a guarantee for newly-issued senior unsecured debt and provided expanded deposit insurance benefits to certain noninterest bearing accounts. Due to our strong capital ratios, we did not apply for additional capital under the TARP Capital Purchase Program. We did not participate in the TLGP debt guarantee program but did elect to participate in the TLGP expansion of deposit insurance.

FCIS and ISS are registered broker-dealers and investment advisers. Broker-dealer activities are subject to regulation by the Financial Industry Regulatory Authority (FINRA), a self-regulatory organization to which the Securities and Exchange Commission (SEC) has delegated regulatory authority for broker-dealers, as well as by the state securities authorities of the various states in which FCIS and ISS operate. Investment advisory activities are subject to direct regulation by the SEC, and investment advisory representatives must register with the state securities authorities of the various states in which they operate.

FCIS and ISS are also licensed as insurance agencies in connection with various investment products, such as annuities, that are regulated as insurance products. FCIS’ and ISS’ insurance sales activities are subject to concurrent regulation by securities regulators and by the insurance regulators of the various states in which FCIS and ISS do business.

Statistical information regarding our business activities is found in Management’s Discussion and Analysis.

Risk Factors

Certain risk factors that we believe apply to our business and to an investment in our common stock are described below. In addition to those risk factors and investment risks that apply to any financial institution, our business, financial condition and operating results could be harmed by other risks, including risks we have not yet identified or that we may currently believe are immaterial or unlikely.

As a publicly-traded security, the value of our stock moves up and down based on trends or market expectations that may affect a broad range of equity investments, specific industries, or individual securities. These movements may result from external disclosures about various topics such as economic growth, interest rates, employment or inflation. During 2008, economic pressures have adversely affected bank stocks, including BancShares.

Movements in our stock price may also result from our own activities, by our earnings or by changes in strategies or management. In conjunction with our investment in ISB, we have entered new markets that are not adjacent to our existing footprint. Losses generated by ISB as it continues its de novo growth have adversely impacted net income. In addition to the impact on net income, the geographic dispersion of these markets represents additional shareholder risk.

In addition to the capital requirements mandated by regulatory authorities, our ability to grow is limited by the amount of capital we generate. In recent years, we have focused on earnings retention and have used non-equity capital sources to support our growth. We have not traditionally issued capital stock to support balance sheet growth. Capital adequacy is therefore a significant risk factor.

To the extent that we are dependent on our banking subsidiaries’ lending and deposit gathering functions to generate income, shareholders are also exposed to credit risk, interest rate risk and liquidity risk.

Properties

As of December 31, 2008, BancShares’ subsidiary financial institutions operated branch offices at 401 locations in North Carolina, Virginia, West Virginia, Maryland, Tennessee, Florida, Georgia, Texas, Arizona, California, New Mexico, Colorado, Oregon, Washington, Oklahoma, Kansas and Missouri. BancShares owns many of the buildings and leases other facilities from third parties.

Additional information relating to premises, equipment and lease commitments is set forth in Note E of BancShares’ consolidated financial statements.

Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

BancShares has two classes of common stock – Class A common and Class B common. Shares of Class A common have one vote per share, while shares of Class B common have 16 votes per share. BancShares’ Class A and Class B common stock is traded in the over-the-counter market, and the Class A common stock is listed on the NASDAQ Global Select Market under the symbol FCNCA. The Class B common stock is quoted on the OTC Bulletin Board under the symbol FCNCB. As of December 31, 2008, there were 2,044 holders of record of the Class A common stock, and 372 holders of record of the Class B common stock.

The per share cash dividends declared by BancShares and the high and low sales prices for each quarterly period during 2008 and 2007 are set forth in the following table.


	2008								2007
	Fourth Quarter		Third Quarter		Second Quarter		First Quarter		Fourth Quarter		Third Quarter		Second Quarter		First Quarter
Cash dividends	$	0.275	$	0.275	$	0.275	$	0.275	$	0.275	$	0.275	$	0.275	$	0.275

Class A sales price
High		179.09		198.44		164.63		153.48		181.91		195.66		209.01		214.59
Low		124.09		125.79		131.00		117.75		143.00		152.47		182.10		199.41
Class B sales price
High		174.00		177.00		192.00		204.75		205.00		211.50		213.00		214.95
Low		146.00		172.00		166.00		181.00		200.00		204.00		207.50		205.50

Sales prices for Class A common were obtained from the NASDAQ Global Select Market. Sales prices for Class B common were obtained from the OTC Bulletin Board.

A cash dividend of 30.0 cents per share was declared by the Board of Directors on January 26, 2009, payable April 6, 2009, to holders of record as of March 16, 2009. Payment of dividends is made at the discretion of the Board of Directors and is contingent upon satisfactory earnings as well as projected future capital needs. BancShares’ principal source of liquidity for payment of shareholder dividends is the dividend it receives from FCB. FCB is subject to various requirements under federal and state banking laws that restrict the payment of dividends and its ability to lend to BancShares. Subject to the foregoing, it is currently management’s expectation that comparable cash dividends will continue to be paid in the future.

During the fourth quarter of 2008, BancShares did not issue, sell or repurchase any Class A or Class B common stock.

The following graph compares the cumulative total shareholder return (CTSR) of our Class A common stock during the previous five years with the CTSR over the same measurement period of the Nasdaq-U.S. index and the Nasdaq Banks index. Each trend line assumes that $100 was invested on December 31, 2003, and that dividends were reinvested for additional shares.

LOGO

Controls and Procedures

BancShares’ management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of BancShares’ disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (Exchange Act). Based on their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, BancShares’ disclosure controls and procedures were effective to provide reasonable assurance that it is able to record, process, summarize and report in a timely manner the information required to be disclosed in reports it files under the Exchange Act.

Management’s Annual Report on Internal Control Over Financial Reporting is included on page 41 of this Report. The report of BancShares’ independent accountants regarding BancShares’ internal control over financial reporting is included on page 42 of this Report.

No change in BancShares’ internal control over financial reporting was identified during the evaluation that occurred during the fourth quarter of 2008 that has materially affected, or is reasonably likely to materially affect, BancShares’ internal control over financial reporting.

Available Information

BancShares does not have its own separate Internet website. However, FCB’s Internet website (www.firstcitizens.com) includes a hyperlink to the SEC’s website where the public may obtain copies of BancShares’ annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Interested parties may also directly access the SEC’s Internet website that contains reports and other information that BancShares files electronically with the SEC. The address of the SEC’s website is www.sec.gov.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion and related financial data should be read in conjunction with the audited consolidated financial statements and related footnotes of First Citizens BancShares, Inc. (BancShares), presented on pages 40 through 72 of this report. Intercompany accounts and transactions have been eliminated. Although certain amounts for prior years have been reclassified to conform to statement presentations for 2008, the reclassifications have no effect on shareholders' equity or net income as previously reported.

OVERVIEW

BancShares is a financial holding company headquartered in Raleigh, North Carolina that offers full-service banking through two wholly-owned banking subsidiaries, First-Citizens Bank & Trust Company (FCB), a North Carolina-chartered bank, and IronStone Bank (ISB), a federally-chartered thrift institution. FCB operates branches in five states and has announced plans to open an office in Washington, D.C. ISB operates branches in urban areas of twelve states. Beyond the traditional branch network, we offer customer sales and service through telephone, online banking and our extensive ATM network.

BancShares’ earnings and cash flows are primarily derived from the commercial banking activities conducted by its banking subsidiaries. We offer commercial and consumer loans, deposit and treasury services products, cardholder and merchant services, wealth management services as well as various other products and services typically offered by commercial banks. FCB and ISB gather deposits from retail and commercial customers. BancShares and its subsidiaries also secure funding through various non-deposit sources. We invest the liquidity generated from these funding sources in interest-earning assets such as loans and leases, investment securities and overnight investments. We also invest in the bank premises, furniture and equipment used to conduct the subsidiaries’ commercial banking business.

Various external factors influence customer demand for our loan, lease and deposit products and ultimately affect the quality of our assets and our profitability. Recessionary economic conditions have caused higher rates of unemployment, and a growing inability for some businesses and consumers to meet their debt service obligations. In addition, real estate demand in many of our markets remains weak, resulting in a decline in real estate values that has adversely affected collateral values for certain of our loans. Further, the current and anticipated instability in alternative investment markets has influenced demand for our deposit and cash management products.

Economic conditions during 2008 have had a significant impact on virtually all financial institutions in the United States, including BancShares. The widespread non-availability of capital has created significant disruptions, causing financial institutions to curtail growth and in some cases to seek merger partners under distressed conditions. As a result of the inter-connectivity of the global financial markets, the failure and acquisition of troubled entities have created challenges throughout the industry.

In response to the challenges facing the financial services sector, several regulatory and governmental actions were taken during 2008, including:

•

The Emergency Economic Stabilization Act, approved by Congress and signed by President Bush on October 3, 2008, which, among other provisions, allowed the U.S. Treasury to purchase troubled assets from banks, authorized the Securities and Exchange Commission to suspend the application of mark-to-market accounting, and temporarily raised the limit of FDIC deposit insurance from $100,000 to $250,000; as currently written, the deposit insurance limit will return to $100,000 after December 31, 2009;

•

On October 7, 2008, the FDIC approved a restoration plan to increase the rates banks pay for deposit insurance;

•

On October 14, 2008, the U.S. Treasury announced the creation of a new program, the TARP Capital Purchase Program that encourages and allows financial institutions to build capital through the sale of senior preferred shares to the U.S. Treasury on terms that are non-negotiable; due to the adequacy of our existing capital, we did not apply for TARP funding;

•

On October 14, 2008, the FDIC announced the creation of the Temporary Liquidity Guarantee Program (TLGP), which seeks to strengthen confidence and encourage liquidity in the banking system; the TLGP has two primary components that are available on a voluntary basis to financial institutions:

•

Guarantee of newly-issued senior unsecured debt; the guarantee would apply to new debt issued on or before June 30, 2009 and would provide protection until June 30, 2012; issuers electing to participate pay a 75 basis point fee for the guarantee; we did not participate in the debt guarantee program;

•

Unlimited deposit insurance for non-interest bearing deposit transaction accounts; financial institutions electing to participate pay a 10 basis point premium in addition to the insurance premiums paid for standard deposit insurance; we elected to participate in the expanded deposit insurance program;

It is likely that further regulatory actions will arise as the Federal government attempts to provide liquidity and capital to strengthen the financial service sector.

In addition to the various regulatory efforts to stabilize the economic turbulence during 2008, ongoing management of monetary policy and interest rates by the Federal Reserve has significantly impacted the pricing of and demand for loan, deposit and treasury services products. During the fourth quarter of 2008, the Federal Reserve dropped the federal funds rate to near zero percent.

Although we are unable to control the external factors that influence our business, by maintaining high levels of balance sheet liquidity, managing our interest rate exposures and by actively monitoring asset quality, we seek to minimize the potentially adverse risks of unforeseen and unfavorable economic trends and take advantage of favorable economic conditions when appropriate.

Financial institutions have typically focused their strategic and operating emphasis on maximizing profitability, and therefore have measured their success by reference to profitability measures such as return on average assets or return on average shareholders’ equity. BancShares’ return on average assets and return on average equity have historically compared unfavorably to the returns of similar-sized financial holding companies. We have consistently placed primary strategic emphasis upon balance sheet liquidity, asset quality and capital conservation, even when those priorities may be detrimental to short-term profitability. While we have not been immune from adverse influences arising from economic weaknesses, our long-standing focus on balance sheet strength served us well during 2008.

Once economic conditions begin to improve, we will be well-positioned to resume favorable growth and profitability trends. We operate in diverse geographic markets and can increase our business volumes and profitability by offering competitive products and superior customer service. We continue to concentrate our marketing efforts on business owners, medical and other professionals and financially-active individuals. We seek to increase fee income in areas such as wealth management, cardholder and merchant services, insurance and treasury services. Leveraging on our investments in technology, we also focus on opportunities to generate income by providing various processing services to other banks.

PERFORMANCE SUMMARY

BancShares reported net income of $91.1 million during 2008, compared to $108.6 million in 2007. Net income for 2008 declined 16.2 percent when compared to 2007. Return on average assets was 0.56 percent for 2008 compared to 0.68 percent for 2007. Return on average shareholders’ equity equaled 6.13 percent and 7.92 percent for 2008 and 2007, respectively. Net income per share for 2008 totaled $8.73, compared to $10.41 for 2007.

Contributing to the $17.6 million decrease in net income during 2008 were significantly higher levels of provision for credit losses and increased noninterest expense, partially offset by improved net interest and noninterest income. Net interest income during 2008 increased $19.4 million, or 4.0 percent versus 2007 due to the favorable impact of growth in

interest-earning assets. Despite weak economic conditions, loans grew $755.4 million or 6.9 percent. The taxable-equivalent net yield on interest-earning assets equaled 3.40 percent during 2008, down only one basis point from 2007. However, after showing marginal improvements during the first three quarters of 2008, the fourth quarter taxable-equivalent net yield on interest-earning assets declined 20 basis points from the third quarter.

The provision for credit losses increased $32.2 million or 95.9 percent during 2008, primarily the result of significant deterioration in the residential construction loan portfolio. Net charge-offs for 2008 totaled $45.3 million, compared to $28.0 million recorded during 2007. The ratio of net charge-offs to average loans and leases in 2008 equaled 0.40 percent, compared to 0.27 percent for the prior year. Nonperforming assets totaled $71.7 million or 0.61 percent of loans plus other real estate owned as of December 31, 2008, compared to $19.9 million or 0.18 percent as of December 31, 2007. The increase in nonperforming assets is primarily attributable to the residential construction loan portfolio.

Noninterest income increased $16.6 million or 5.6 percent during 2008, with favorable variances in service charges on deposit accounts, fees from processing services and other service charges and fees. In addition, securities gains increased $6.8 million due to gains recognized on the redemption of Visa stock. Wealth management services income declined.

Noninterest expense increased $31.8 million or 5.5 percent during 2008. Salaries and benefits accounted for $21.5 million of the added expense due to costs from new branch locations, merit increases and higher health and executive retirement costs. Occupancy costs grew $3.9 million or 6.9 percent due to new branches and expenses related to the new headquarters building.

CRITICAL ACCOUNTING POLICIES

Information included in our audited financial statements and management’s discussion and analysis is derived from our accounting records, which are maintained in accordance with accounting principles generally accepted in the United States of America and general practices within the banking industry. While much of the information is definitive, certain accounting issues are highly dependent upon estimates and assumptions made by management. An understanding of these estimates and assumptions is vital to understanding BancShares’ financial statements. Critical accounting policies are those policies that are most important to the determination of our financial condition and results of operations or that require management to make assumptions and estimates that are subjective or complex.

We periodically evaluate our critical accounting policies, including those related to the allowance for credit losses, pension plan assumptions and income taxes. While we base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, actual results may differ from these estimates under different assumptions or outcomes.

Allowance for credit losses. The allowance for credit losses, which consists of the allowance for loan and lease losses and the reserve for unfunded commitments, reflects the estimated losses resulting from the inability of our customers to make required loan and lease payments. The allowance for credit losses reflects management’s evaluation of the risk characteristics of the loan and lease portfolio under current economic conditions and considers such factors as the financial condition of the borrower, fair market value of collateral and other items that, in our opinion, deserve current recognition in estimating possible loan and lease losses. Our evaluation process is based on historical evidence and current trends among delinquencies, defaults and nonperforming assets.

Management considers the established allowance adequate to absorb losses that relate to loans and leases as well as unfunded loan commitments outstanding at December 31, 2008, although future additions may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for credit losses. These agencies may require the recognition of additions to the allowance based on their judgments of information available to them at the time of their examination. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, our estimates would be updated, and additions to the allowance may be required.

Pension plan assumptions. BancShares offers a defined benefit pension plan to qualifying employees. The calculation of the benefit obligation, the future value of plan assets, funded status and related pension expense under the

pension plan requires the use of actuarial valuation methods and assumptions. The valuations and assumptions used to determine the future value of plan assets and liabilities are subject to management judgment and may differ significantly depending upon the assumption used. The discount rate used to estimate the present value of the benefits to be paid under the pension plan reflects the interest rate that could be obtained for a suitable investment used to fund the benefit obligations. The assumed discount rate equaled 6.00 percent at December 31, 2008, compared to 6.25 percent at December 31, 2007 due to declines in relevant market interest rates. Assuming other variables remain unchanged, a reduction in the assumed discount rate would increase the calculated benefit obligations, which would result in higher pension expense. Conversely, an increase in the assumed discount rate would cause a reduction in obligations, thereby resulting in lower pension expense.

We also estimate a long-term rate of return on pension plan assets that is used to calculate the value of plan assets over time. We consider such factors as the actual return earned on plan assets, historical returns on the various asset classes in the plan and projections of future returns on various asset classes. We used an assumed long-term rate of return on pension assets of 8.00 percent to calculate the funded status of the pension plan as of December 31, 2008 compared to 8.50 percent at December 31, 2007. The calculation of pension expense during 2008 and 2007 was based on an assumed expected long-term return on plan assets of 8.50 percent. Assuming other variables remain unchanged, a reduction in the long-term rate of return on plan assets increases pension expense.

The assumed rate of future compensation increases is reviewed annually based on actual experience and future salary expectations. We used an assumed rate of compensation increase of 4.50 percent to calculate the funded status of the pension plan as of December 31, 2008 compared to 4.25 percent at December 31, 2007. The compensation increase assumption used to calculate pension expense was 4.25 percent during 2008 and 2007. Assuming other variables remain unchanged, an increase in the rate of future compensation increases results in higher pension expense.

Income taxes. Management estimates income tax expense using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the amount of assets and liabilities reported in the consolidated financial statements and their respective tax bases. In estimating the liabilities and corresponding expense related to income taxes, management assesses the relative merits and risks of various tax positions considering statutory, judicial and regulatory guidance. Because of the complexity of tax laws and regulations, interpretation is difficult and subject to differing judgments.

Changes in the estimate of income tax liabilities occur periodically due to changes in actual or estimated future tax rates and projections of taxable income, interpretations of tax laws, the complexities of multi-state income tax reporting, the status of examinations being conducted by various taxing authorities and the impact of newly enacted legislation or guidance as well as income tax accounting pronouncements.

Table 1

FINANCIAL SUMMARY AND SELECTED AVERAGE BALANCES AND RATIOS


	2008			2007			2006			2005			2004
	(thousands, except share data and ratios)
SUMMARY OF OPERATIONS
Interest income	$	814,716		$	904,056		$	830,315		$	669,540		$	524,013
Interest expense		314,945			423,714			353,737			218,151			133,826

Net interest income		499,771			480,342			476,578			451,389			390,187
Provision for credit losses		65,805			33,594			20,922			33,514			34,690

Net interest income after provision for credit losses		433,966			446,748			455,656			417,875			355,497
Noninterest income		312,119			295,470			271,367			257,666			245,884
Noninterest expense		606,481			574,664			531,077			496,871			477,186

Income before income taxes		139,604			167,554			195,946			178,670			124,195
Income taxes		48,546			58,937			69,455			65,808			49,352

Net income	$	91,058		$	108,617		$	126,491		$	112,862		$	74,843

Net interest income, taxable equivalent	$	506,516		$	488,019		$	482,927		$	455,687		$	392,242

PER SHARE DATA
Net income	$	8.73		$	10.41		$	12.12		$	10.82		$	7.17
Cash dividends		1.10			1.10			1.10			1.10			1.10
Market price at December 31 (Class A)		152.80			145.85			202.64			174.42			148.25
Book value at December 31		138.33			138.12			125.62			113.19			104.11
Tangible book value at December 31		128.13			127.72			115.02			102.35			93.12

SELECTED AVERAGE BALANCES
Total assets	$	16,403,717		$	15,919,222		$	15,240,327		$	13,905,260		$	12,856,102
Investment securities		3,153,121			3,144,052			3,028,384			2,533,161			2,157,367
Loans and leases		11,306,900			10,513,599			9,989,757			9,375,249			8,901,628
Interest-earning assets		14,910,905			14,292,322			13,637,388			12,503,877			11,493,005
Deposits		13,108,246			12,659,236			12,452,955			11,714,569			10,961,380
Interest-bearing liabilities		12,312,499			11,883,421			11,262,423			10,113,999			9,327,436
Long-term obligations		607,463			405,758			450,272			353,885			287,333
Shareholders’ equity	$	1,484,605		$	1,370,617		$	1,241,254		$	1,131,066		$	1,053,860
Shares outstanding		10,434,453			10,434,453			10,434,453			10,434,453			10,435,247

SELECTED PERIOD-END BALANCES
Total assets	$	16,745,662		$	16,212,107		$	15,729,697		$	14,639,392		$	13,265,711
Investment securities		3,271,650			3,236,835			3,221,048			2,929,516			2,125,524
Loans and leases		11,719,285			10,963,904			10,273,043			9,656,230			9,364,822
Interest-earning assets		15,165,551			14,466,948			13,842,688			13,066,758			11,874,089
Deposits		13,713,763			12,928,544			12,743,324			12,173,858			11,350,798
Interest-bearing liabilities		12,441,025			12,118,967			11,612,372			10,745,696			9,641,368
Long-term obligations		733,132			404,392			401,198			408,987			285,943
Shareholders’ equity	$	1,443,375		$	1,441,208		$	1,310,819		$	1,181,059		$	1,086,310
Shares outstanding		10,434,453			10,434,453			10,434,453			10,434,453			10,434,453

SELECTED RATIOS AND OTHER DATA
Rate of return on average assets		0.56	%		0.68	%		0.83	%		0.81	%		0.58	%
Rate of return on average shareholders’ equity		6.13			7.92			10.19			9.98			7.10
Net yield on interest-earning assets (taxable equivalent)		3.40			3.41			3.54			3.64			3.41
Allowance for loan and lease losses to total loans and leases at year-end		1.34			1.25			1.28			1.33			1.32
Nonperforming assets to total loans and leases plus other real estate at year-end		0.61			0.18			0.20			0.27			0.25
Tier 1 risk-based capital ratio		13.20			13.02			12.93			12.56			12.14
Total risk-based capital ratio		15.49			15.36			15.37			15.11			13.48
Leverage capital ratio		9.88			9.63			9.39			9.17			9.26
Dividend payout ratio		12.60			10.57			9.08			10.17			15.34
Average loans and leases to average deposits		86.26			83.05			80.22			80.03			81.21

Table 2

BUSINESS COMBINATIONS


Year	Description of transaction	Total Loans			Total Deposits
		(thousands)
2007	Sale of American Guaranty Insurance Company, a property and casualty insurance company	$	—		$	—
2007	Sale of Triangle Life Insurance Company, an accident and life insurance company		—			—
2006	Sale of T-TECH, Inc., a check processing company		—			—
2006	Sale of one branch by First Citizens Bank		(36	)		(20,553	)

INTEREST-EARNING ASSETS

Interest-earning assets include loans and leases, investment securities and overnight investments, all of which reflect varying interest rates based on the risk level and repricing characteristics of the underlying asset. Riskier investments typically carry a higher interest rate, but expose us to potentially higher levels of default.

We have historically focused on maintaining high asset quality, which results in a loan and lease portfolio subjected to strenuous underwriting and monitoring procedures. That focus on asset quality also influences the composition of our investment securities portfolio. At December 31, 2008, United States Treasury and government agency securities represented 95.0 percent of our investment securities portfolio. Mortgage-backed securities comprise only 2.6 percent of the total portfolio. Overnight investments are selectively made with other financial institutions that are within our risk tolerance.

Changes in our interest-earning assets reflect the impact of liquidity generated by deposits and short-term borrowings, the majority of which arises from various treasury services products. The size of the investment securities portfolio changes principally based on trends among loans, deposits and short-term borrowings. When inflows arising from deposit and treasury services products exceed loan and lease demand, we invest excess funds in the securities portfolio. Conversely, when loan demand exceeds growth in deposits and short-term borrowings, we allow overnight investments to decline and use proceeds from maturing securities to fund loan demand.

Table 3

LOANS AND LEASES


	December 31
	2008		2007		2006		2005		2004
	(thousands)
Real estate:
Construction and land development	$	778,315	$	810,818	$	783,680	$	766,945	$	588,092
Commercial mortgage		4,343,809		3,982,496		3,725,752		3,518,563		3,279,729
Residential mortgage		964,201		1,029,030		1,025,235		1,016,677		979,663
Revolving mortgage		1,911,852		1,494,431		1,326,403		1,368,729		1,714,032
Other mortgage		149,478		145,552		165,223		172,712		171,700

Total real estate loans		8,147,655		7,462,327		7,026,293		6,843,626		6,733,216
Commercial and industrial		1,885,358		1,707,394		1,526,818		1,206,585		980,164
Consumer		1,233,075		1,368,228		1,360,524		1,318,971		1,397,820
Lease financing		353,933		340,601		294,366		233,499		192,164
Other		99,264		85,354		65,042		53,549		61,458

Total loans and leases		11,719,285		10,963,904		10,273,043		9,656,230		9,364,822
Less allowance for loan and lease losses		157,569		136,974		132,004		128,847		123,861

Net loans and leases	$	11,561,716	$	10,826,930	$	10,141,039	$	9,527,383	$	9,240,961

There were no foreign loans or leases in any period.

Loans and leases. As of December 31, 2008, loans and leases outstanding equaled $11.72 billion, a 6.9 percent increase over the December 31, 2007 balance of $10.96 billion. The $755.4 million increase in loans and leases during 2008 resulted from growth among revolving mortgage, commercial mortgage and commercial and industrial loans. Loan balances for the last five years are presented in Table 3.

Loans secured by commercial mortgages totaled $4.34 billion at December 31, 2008, a $361.3 million or 9.1 percent increase from December 31, 2007. In 2007 commercial mortgage loans increased 6.9 percent over 2006. The sustained growth reflects our continued focus on small business customers, particularly among medical-related and other professional customers targeted by our banking subsidiaries. As a percentage of total loans and leases, commercial mortgage loans represent 37.1 percent at December 31, 2008 and 36.3 percent at December 31, 2007. At December 31, 2008, among construction and land development and commercial mortgage loans, 76.9 percent of the outstanding balance was secured by owner-occupied facilities. These loans are underwritten based primarily upon the cash flow from the operation of the business rather than the value of the real estate collateral.

At December 31, 2008, revolving loans secured by real estate totaled $1.91 billion, compared to $1.49 billion at December 31, 2007. The $417.4 million or 27.9 percent increase in revolving mortgage loans in 2008 resulted from robust origination of new credit lines and attractive rates stimulating line utilization. At December 31, 2008, revolving mortgage loans represented 16.3 percent of gross loans and leases, compared to 13.6 percent at December 31, 2007.

Commercial and industrial loans equaled $1.89 billion at December 31, 2008, compared to $1.71 billion at December 31, 2007. Commercial and industrial loans realized growth of $178.0 million or 10.4 percent during 2008 following an increase of $180.6 million or 11.8 percent from 2006 to 2007. Growth among these loans in 2008 and 2007 results from continuing focus on business owners and medical professionals and new opportunities arising from our geographic expansion. Commercial and industrial loans represented 16.1 percent and 15.6 percent of loans and leases, respectively, as of December 31, 2008 and 2007.

Consumer loans totaled $1.23 billion at December 31, 2008, a decrease of $135.2 million from the prior year. This decline results from our decision during 2008 to discontinue originations of sales finance loans through our dealer network. At December 31, 2008 and 2007, consumer loans represented 10.5 percent and 12.5 percent of the total portfolio, respectively.

Construction and land development loans equaled $778.3 million at December 31, 2008, a reduction of $32.5 million or 4.0 percent from December 31, 2007. Of the $778.3 million outstanding as of December 31, 2008, $105.1 million was in the Atlanta, Georgia and southwest Florida markets. Both of these market areas experienced significant reductions in real estate values during 2008. The majority of the remaining $673.2 million of construction and land development loans are in North Carolina and Virginia.

Due to the generally weak demand for loans in our market areas and our ongoing challenge to provide liquidity to fund loan growth, our projections for 2009 anticipate a modest increase in our loan portfolio. Commercial and industrial and real estate secured loans will continue to grow, but at a much reduced rate. However, projected economic instability could constrain customer demand for loans and lender support for increased debt levels. All growth projections are subject to change due to further economic deterioration or improvement and other external factors.

Investment securities. Investment securities available for sale at December 31, 2008 and 2007 totaled $3.27 billion and $3.23 billion, respectively, a $36.5 million or 1.1 percent increase. Available-for-sale securities are reported at their aggregate fair value, and unrealized gains and losses are included as a component of other comprehensive income, net of deferred taxes.

Investment securities held to maturity equaled $5.9 million and $7.6 million, respectively, at December 31, 2008 and 2007. Securities that are classified as held-to-maturity reflect BancShares’ ability and positive intent to hold those investments until maturity.

Table 4 presents detailed information relating to the investment securities portfolio.

Income on interest-earning assets. Interest income amounted to $814.7 million during 2008, an $89.3 million or 9.9 percent decrease from 2007, compared to a $73.7 million or 8.9 percent increase from 2006 to 2007. The decrease in interest income during 2008 resulted from lower yields, partially offset by growth in interest-earning assets.

Table 4

INVESTMENT SECURITIES


	December 31
	2008							2007				2006
	Cost		Fair Value		Average Maturity (Yrs./Mos.)	Taxable Equivalent Yield		Cost		Fair Value		Cost		Fair Value
	(thousands, except maturity and yield information)
Investment securities available for sale:
U. S. Government:
Within one year	$	1,349,114	$	1,374,022	0/6	4.41	%	$	1,667,530	$	1,675,309	$	1,514,138	$	1,503,915
One to five years		1,704,326		1,738,406	1/8	1.86			1,377,715		1,399,434		1,366,945		1,363,491
Five to ten years		—		—					6,300		6,287		6,269		6,059

Total		3,053,440		3,112,428	1/10	2.98			3,051,545		3,081,030		2,887,352		2,873,465

Mortgage-backed securities:
Within one year		—		—					—		—		56		55
One to five years		32		30	2/7	5.39			51		48		84		80
Five to ten years		789		791	9/3	4.55			135		132		68		36
Over ten years		80,288		82,131	27/6	5.36			78,012		77,632		53,250		52,054

Total		81,109		82,952	26/10	5.35			78,198		77,812		53,458		52,225

State, county and municipal:
Within one year		1,682		1,687	0/4	3.90			709		708		875		873
One to five years		1,416		1,356	2/11	4.69			2,246		2,236		2,734		2,696
Five to ten years		—		—	—	—			356		363		470		477
Over ten years		10		10	11/11	4.97			66		65		211		211

Total		3,108		3,053	1/6	4.26			3,377		3,372		4,290		4,257

Other:
Over ten years		3,691		5,427	9/5	11.05			7,771		9,390		10,173		10,240

Equity securities		49,747		61,917					33,614		57,637		35,171		61,703

Total investment securities available for sale		3,191,095		3,265,777					3,174,505		3,229,241		2,990,444		3,001,890

Investment securities held to maturity:
U. S. Government:
Within one year		—		—	—	—			—		—		210,232		209,296

Mortgage-backed securities:
One to five years		—		—	—	—			—		—		3		3
Five to ten years		4,117		4,289	8/3	5.54			5,563		5,612		46		46
Over ten years		165		198	18/10	6.43			197		231		7,049		7,031

Total		4,282		4,487	8/8	5.57			5,760		5,843		7,098		7,080

State, county and municipal:
Within one year		151		151	0/4	5.88			—		—		—		—
One to five years		—		—					149		153		148		154
Five to ten years		1,440		1,472	9/4	6.02			—		—		—		—
Over ten years		—		—					1,435		1,530		1,430		1,553

Total		1,591		1,623	8/6	6.01			1,584		1,683		1,578		1,707

Other:
Within one year		—		—		—			250		250		—		—
One to five years		—		—		—			—		—		250		250

Total		—		—		—			250		250		250		250

Total investment securities held to maturity		5,873		6,110	8/8	5.69			7,594		7,776		219,158		218,333

Total investment securities	$	3,196,968	$	3,271,887				$	3,182,099	$	3,237,017	$	3,209,602	$	3,220,223

The average maturity assumes callable securities mature on their earliest call date; yields are based on amortized cost; yields related to securities that are exempt from federal and/or state income taxes are stated on a taxable-equivalent basis assuming statutory rates of 35.0 percent for federal income taxes and 6.9 percent for state income taxes for all periods.

Table 5

AVERAGE BALANCE SHEETS


	2008							2007
	Average Balance			Interest Income/Expense		Yield/ Rate		Average Balance			Interest Income Expense		Yield/ Rate
	(dollars in thousands, taxable equivalent)
Assets
Loans and leases	$	11,306,900		$	683,943	6.05	%	$	10,513,599		$	729,635	6.94	%
Investment securities:
U. S. Government		3,075,049			126,114	4.10			3,068,477			146,483	4.77
State, county and municipal		4,828			322	6.67			5,321			346	6.50
Other		73,244			2,327	3.18			70,254			3,100	4.41

Total investment securities		3,153,121			128,763	4.08			3,144,052			149,929	4.77
Overnight investments		450,884			8,755	1.94			634,671			32,169	5.07

Total interest-earning assets		14,910,905		$	821,461	5.51	%		14,292,322		$	911,733	6.38	%
Cash and due from banks		591,032							705,864
Premises and equipment		781,149							735,465
Allowance for loan and lease losses		(145,523	)						(132,530	)
Other assets		266,154							318,101

Total assets	$	16,403,717						$	15,919,222

Liabilities and shareholders’ equity
Interest-bearing deposits:
Checking With Interest	$	1,440,908		$	1,414	0.10	%	$	1,431,085		$	1,971	0.14	%
Savings		545,048			1,103	0.20			573,286			1,235	0.22
Money market accounts		3,187,012			59,298	1.86			2,835,255			94,541	3.33
Time deposits		5,402,505			201,723	3.73			5,283,782			243,489	4.61

Total interest-bearing deposits		10,575,473			263,538	2.49			10,123,408			341,236	3.37
Short-term borrowings		1,129,563			17,502	1.55			1,354,255			55,126	4.07
Long-term obligations		607,463			33,905	5.58			405,758			27,352	6.74

Total interest-bearing liabilities		12,312,499		$	314,945	2.56	%		11,883,421		$	423,714	3.57	%
Demand deposits		2,532,773							2,535,828
Other liabilities		73,840							129,356
Shareholders’ equity		1,484,605							1,370,617

Total liabilities and shareholders’ equity	$	16,403,717						$	15,919,222

Interest rate spread						2.95	%						2.81	%
Net interest income and net yield on interest-earning assets				$	506,516	3.40	%				$	488,019	3.41	%

Loans and leases include nonaccrual loans. Yields related to loans, leases and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only, are stated on a taxable-equivalent basis assuming a statutory federal income tax rate of 35.0% and a state income tax rate of 6.9% for all periods. Loan fees, which are not material for any period shown, are included in the yield calculation.

Table 5 analyzes taxable-equivalent yields and rates on interest-earning assets and interest-bearing liabilities for the five years ended December 31, 2008. The taxable-equivalent yield on interest-earning assets was 5.51 percent during 2008, an 87 basis point drop from the 6.38 percent reported in 2007 caused primarily by significant reductions in market interest rates during the course of 2008. The taxable-equivalent yield on interest-earning assets equaled 6.14 percent in 2006.

Table 5

AVERAGE BALANCE SHEETS (continued)


2006							2005							2004
Average Balance			Interest Income/Expense		Yield/ Rate		Average Balance			Interest Income/Expense		Yield/ Rate		Average Balance			Interest Income/Expense		Yield/ Rate
(dollars in thousands, taxable equivalent)
$	9,989,757		$	685,114	6.86	%	$	9,375,249		$	575,735	6.14	%	$	8,901,628		$	470,325	5.28	%

	2,949,201			116,969	3.97			2,463,545			76,267	3.10			2,096,869			48,304	2.30
	6,174			374	6.06			7,238			404	5.58			8,667			424	4.89
	73,009			3,304	4.53			62,378			2,224	3.57			51,831			1,137	2.19

	3,028,384			120,647	3.98			2,533,161			78,895	3.11			2,157,367			49,865	2.31
	619,247			30,903	4.99			595,467			19,208	3.23			434,010			5,878	1.35

	13,637,388		$	836,664	6.14	%		12,503,877		$	673,838	5.39	%		11,493,005		$	526,068	4.58	%
	757,428							654,821							679,955
	669,748							608,668							554,480
	(131,077	)						(127,968	)						(124,834	)
	306,840							265,862							253,496

$	15,240,327						$	13,905,260						$	12,856,102


$	1,522,439		$	1,875	0.12	%	$	1,570,010		$	1,923	0.12	%	$	1,500,638		$	1,796	0.12	%
	649,619			1,382	0.21			737,830			1,521	0.21			743,629			1,492	0.20
	2,691,292			79,522	2.95			2,643,330			50,171	1.90			2,571,468			21,594	0.84
	4,967,591			197,399	3.97			4,209,996			123,016	2.92			3,778,048			83,557	2.21

	9,830,941			280,178	2.85			9,161,166			176,631	1.93			8,593,783			108,439	1.26
	981,210			41,431	4.22			598,948			14,966	2.50			446,320			3,611	0.81
	450,272			32,128	7.14			353,885			26,554	7.50			287,333			21,776	7.58

	11,262,423		$	353,737	3.14	%		10,113,999		$	218,151	2.16	%		9,327,436		$	133,826	1.43	%
	2,622,014							2,553,403							2,367,597
	114,636							106,792							107,209
	1,241,254							1,131,066							1,053,860

$	15,240,327						$	13,905,260						$	12,856,102

					3.00	%						3.23	%						3.15	%

			$	482,927	3.54	%				$	455,687	3.64	%				$	392,242	3.41	%

The taxable-equivalent yield on the loan and lease portfolio decreased from 6.94 percent in 2007 to 6.05 percent in 2008. The combination of the 89 basis point yield drop, and the $793.3 million or 7.5 percent growth in average loans and leases contributed to a decrease in loan interest income of $45.7 million or 6.3 percent over 2007. This followed an increase of $44.2 million or 6.5 percent in loan interest income in 2007 over 2006, the combined result of a $523.8 million increase in average loans and leases and an 8 basis point yield increase.

Interest income earned on the investment securities portfolio amounted to $124.1 million and $144.3 million during 2008 and 2007. The taxable-equivalent yield on the investment securities portfolio was 4.08 percent and 4.77 percent, respectively, for 2008 and 2007. The $20.2 million decrease in investment interest income during 2008 reflected the 69 basis points decrease in the taxable-equivalent yield. The $28.3 million increase in interest income earned on investment securities during 2007 resulted from a 79 basis point increase in the taxable-equivalent yield and a $115.7 million increase in average investment securities.

Interest earned on overnight investments equaled $8.8 million during 2008, compared to $32.2 million during 2007. The $23.4 million decrease during 2008 resulted from the 313 basis point yield decline and a $183.8 million decrease in average overnight investments. The decline in the yield on overnight investments resulted from actions by the Federal Reserve to significantly reduce short-term interest rates. During 2007, interest income earned from overnight investments increased marginally as compared to 2006.

INTEREST-BEARING LIABILITIES

Interest-bearing liabilities include interest-bearing deposits as well as short-term borrowings and long-term obligations. Deposits are our primary funding source, although we also utilize non-deposit borrowings to stabilize our liquidity base and to fulfill commercial customer demand for treasury services. Certain of our long-term borrowings also currently qualify as capital under guidelines established by the Federal Reserve and other banking regulators.

Deposits. At December 31, 2008, deposits totaled $13.71 billion, an increase of $785.2 million or 6.1 percent from the $12.93 billion in deposits recorded as of December 31, 2007. Money market accounts increased $584.9 million or 19.7 percent from December 31, 2007 to December 31, 2008, while demand deposits increased $133.6 million or 5.3 percent. Time deposits increased marginally, up $37.9 million or 0.7 percent. As a result of the substantial decline in interest rates during 2008, depositors elected to place available liquidity in money market and transaction accounts rather than time deposits.

During 2008, competition and pricing for deposit business in our market areas remained intense, particularly from larger bank competitors confronting funding and other financial challenges. During the third and fourth quarters of 2008, we experienced a surge in deposit growth directly attributable to business acquired from competitor institutions.

Due to the ongoing industry-wide liquidity challenges that intensified during 2008 and our historic commitment to maintaining a liquid balance sheet, we are focused on deposit attraction and retention as a key business objective for 2009. Our ability to satisfy customer loan demand could potentially be constrained unless we are able to continue to generate new deposits at a reasonable cost.

Table 6

MATURITIES OF TIME DEPOSITS OF $100,000 OR MORE


	December 31, 2008
	(thousands)
Less than three months	$	530,767
Three to six months		417,814
Six to 12 months		948,406
More than 12 months		572,846

Total	$	2,469,833

Short-term borrowings. At December 31, 2008, short-term borrowings totaled $647.0 million, compared to $1.31 billion one year earlier, a 50.4 percent decrease. The $658.3 million reduction resulted from a $450.9 million decline in outstanding obligations under our commercial master note program and a $182.2 million reduction in repurchase obligations during 2008. Both of these commercial treasury products are highly rate-sensitive, and the sharp reduction in interest rates during 2008 triggered a significant runoff in these funding sources. A portion of the decline in short-term borrowings was invested by customers in money market accounts and other deposit instruments.

We continue to maintain access to various short-term borrowings, including the purchase of federal funds, overnight repurchase obligations and credit arrangements with various correspondent banks. At December 31, 2008, we had immediate access of up to $500.0 million on an unsecured basis. At December 31, 2008, we also had access to $1.22 billion under secured borrowing agreements with the Federal Home Loan Bank of Atlanta. Table 7 provides additional information regarding short-term borrowings.

Table7

SHORT-TERM BORROWINGS


	2008				2007				2006
	Amount		Rate		Amount		Rate		Amount		Rate
	(dollars in thousands)
Master notes
At December 31	$	472,573	0.25	%	$	923,424	3.02	%	$	741,029	4.18	%
Average during year		819,209	1.52			910,389	4.19			643,926	4.28
Maximum month-end balance during year		929,613	—			1,035,278	—			776,734	—

Repurchase agreements
At December 31		103,878	0.15			286,090	2.27			251,135	3.68
Average during year		211,853	0.82			303,862	3.38			213,730	3.47
Maximum month-end balance during year		293,703	—			325,790	—			272,807	—

Federal funds purchased
At December 31		10,551	0.10			23,893	3.60			66,066	5.04
Average during year		40,079	1.69			59,050	5.07			47,662	4.84
Maximum month-end balance during year		96,551	—			101,753	—			68,620	—

Other
At December 31		60,026	4.13			71,880	4.54			92,617	4.56
Average during year		58,422	4.53			80,954	4.57			75,892	5.45
Maximum month-end balance during year		71,286	—			96,785	—			169,305	—

Long-term obligations. At December 31, 2008 and 2007, long-term obligations totaled $733.1 million and $404.4 million, respectively, an increase of $328.7 million or 81.3 percent. The increase during 2008 results from $330.0 million borrowed from the Federal Home Loan Bank of Atlanta under varying terms and at varying rates. The additional borrowings were funded to augment balance sheet liquidity at rates that management believes are attractive given the terms of the individual obligations.

Table 8

CHANGES IN CONSOLIDATED TAXABLE EQUIVALENT NET INTEREST INCOME


	2008									2007
	Change from previous year due to:									Change from previous year due to:
	Volume			Yield/ Rate			Total Change			Volume			Yield/ Rate			Total Change
	(thousands)
Assets
Loans and leases	$	51,467		$	(97,159	)	$	(45,692	)	$	36,232		$	8,289		$	44,521
Investment securities:
U. S. Government		251			(20,620	)		(20,369	)		5,327			24,187			29,514
State, county and municipal		(33	)		9			(24	)		(54	)		26			(28	)
Other		111			(884	)		(773	)		(121	)		(83	)		(204	)

Total investment securities		329			(21,495	)		(21,166	)		5,152			24,130			29,282
Overnight investments		(6,434	)		(16,980	)		(23,414	)		770			496			1,266

Total interest-earning assets	$	45,362		$	(135,634	)	$	(90,272	)	$	42,154		$	32,915		$	75,069

Liabilities
Interest-bearing deposits:
Checking With Interest	$	11		$	(568	)	$	(557	)	$	(120	)	$	216		$	96
Savings		(59	)		(73	)		(132	)		(164	)		17			(147	)
Money market accounts		9,137			(44,380	)		(35,243	)		4,527			10,492			15,019
Time deposits		4,952			(46,718	)		(41,766	)		13,567			32,523			46,090

Total interest-bearing deposits		14,041			(91,739	)		(77,698	)		17,810			43,248			61,058
Short-term borrowings		(6,314	)		(31,310	)		(37,624	)		15,468			(1,773	)		13,695
Long-term obligations		12,427			(5,874	)		6,553			(3,077	)		(1,699	)		(4,776	)

Total interest-bearing liabilities	$	20,154		$	(128,923	)	$	(108,769	)	$	30,201		$	39,776		$	69,977

Change in net interest income	$	25,208		$	(6,711	)	$	18,497		$	11,953		$	(6,861	)	$	5,092

Changes in income relating to certain loans, leases and investment securities are stated on a fully tax-equivalent basis at a rate that approximates BancShares’ marginal tax rate. The taxable equivalent adjustment was $6,745, $7,677 and $6,349 for the years 2008, 2007 and 2006 respectively. Table 5 provides detailed information on average balances, income/expense, yield/rate by category and the relevant income tax rates. The rate/volume variance is allocated equally between the changes in volume and rate.

For 2008 and 2007, long-term obligations included $273.2 million in junior subordinated debentures representing obligations to two special purpose entities, FCB/NC Capital Trust I and FCB/NC Capital Trust III (the Capital Trusts). The Capital Trusts are the grantor trusts for $265.0 million of trust preferred capital securities outstanding as of December 31, 2008. The proceeds from the trust preferred capital securities were used to purchase the junior subordinated debentures issued by BancShares. Under current regulatory standards, these trust preferred capital securities qualify as capital for BancShares. The $150.0 million in trust preferred capital securities issued by FCB/NC Capital Trust I mature in 2028 and may be redeemed in whole or in part on or after March 1, 2008 at a premium that declines until 2018, when the redemption price equals the par value of the securities. The $115.0 million in trust preferred capital securities issued by FCB/NC Capital Trust III mature in 2036 and may be redeemed at par in whole or in part on or after June 30, 2011. BancShares has guaranteed all obligations of the Capital Trusts.

Expense of interest-bearing liabilities. Interest expense amounted to $314.9 million in 2008, a $108.8 million or 25.7 percent decrease from 2007. This followed a $70.0 million or 19.8 percent increase in interest expense during 2007 compared to 2006. For 2008, the decrease in interest expense was the net result of lower interest rates offset in part by increased levels of interest-bearing liabilities. In 2007, both average interest-bearing liabilities and rates increased from the prior year. The blended rate on total interest-bearing liabilities equaled 2.56 percent during 2008, compared to 3.57 percent in 2007 and 3.14 percent in 2006. Interest-bearing liabilities averaged $12.31 billion during 2008, an increase of $429.1 million or 3.6 percent over 2007 levels. During 2007, interest-bearing liabilities averaged $11.88 billion, an increase of $621.0 million or 5.5 percent over 2006.

Interest expense on interest-bearing deposits equaled $263.5 million during 2008, down $77.7 million or 22.8 percent from 2007. The impact of lower interest rates more than offset added expense from higher deposit balances. Lower market interest rates caused the aggregate rate on interest-bearing deposits to decline to 2.49 percent during 2008, down 88 basis points from 2007. Interest-bearing deposits averaged $10.58 billion during 2008, an increase of $452.1 million or 4.5 percent. Average money market balances increased $351.8 million or 12.4 percent while average time deposits increased $118.7 million or 2.2 percent. During 2007, average time deposits increased $316.2 million or 6.4 percent.

Interest expense on short-term borrowings decreased $37.6 million or 68.3 percent during 2008, the result of decreases in the balances of both master note and repurchase obligations as well as lower rates. The rate on average short-term borrowings decreased 252 basis points from 4.07 percent in 2007 to 1.55 percent in 2008 due to reductions in the federal funds rate during 2008. During 2007, interest expense increased $13.7 million over 2006, the result of growth in average short-term borrowings partially offset by a 15 basis point rate reduction.

Interest expense on long-term obligations increased $6.6 million or 24.0 percent during 2008 due to new borrowings from the Federal Home Loan Bank of Atlanta. The rate on average long-term obligations decreased 116 basis points from 6.74 percent in 2007 to 5.58 percent in 2008.

NET INTEREST INCOME

Net interest income amounted to $499.8 million during 2008, a $19.4 million or 4.0 percent increase over 2007. The increase from 2008 resulted from balance sheet growth as the taxable-equivalent net yield on interest-earning assets declined by only one basis point from the prior year to 3.40 percent during 2008.

During 2007, net interest income equaled $480.3 million, a $3.8 million or 0.8 percent increase over 2006. The marginal increase from 2006 resulted from balance sheet growth, the impact of which offset the unfavorable influence of a lower net yield on interest-earning assets. The taxable-equivalent net yield on interest-earning assets declined 13 basis points from 3.54 percent during 2006. This reduction resulted from the impact of a flat yield curve and extremely competitive pricing for both loan and deposit products.

A net short-term liability-sensitive balance sheet such as that maintained by BancShares would typically provide improved net interest income following reductions in interest rates such as those implemented by the Federal Reserve during 2007 and 2008. However, intense competition for deposits by institutions struggling to overcome liquidity challenges caused interest rates on these products to remain artificially high through much of 2008 while asset yields continued to decline. Table 8 isolates the changes in taxable-equivalent net interest income due to changes in volume and interest rates for 2008 and 2007.

Table 9

NONINTEREST INCOME


	Year ended December 31
	2008		2007		2006			2005			2004
	(thousands)
Cardholder and merchant services	$	97,577	$	97,070	$	86,103		$	75,298		$	65,903
Service charges on deposit accounts		82,349		77,827		72,561			77,376			81,478
Wealth management services
Trust and asset management fees		23,216		25,262		21,586			18,588			16,913
Broker-dealer activities		24,982		24,043		20,627			16,138			15,541

Total wealth management services		48,198		49,305		42,213			34,726			32,454
Fees from processing services		35,585		32,531		29,631			25,598			23,888
Insurance commissions		8,277		7,735		6,942			6,390			6,186
Mortgage income		6,564		6,305		5,494			5,361			5,861
ATM income		7,003		6,515		6,803			7,843			8,416
Other service charges and fees		17,598		15,318		15,996			16,902			13,926
Securities gains (losses)		8,128		1,376		(659	)		(492	)		1,852
Other		840		1,488		6,283			8,664			5,920

Total	$	312,119	$	295,470	$	271,367		$	257,666		$	245,884

NONINTEREST INCOME

Growth of noninterest income is essential to our ability to sustain adequate levels of profitability. The primary sources of noninterest income are cardholder and merchant services income, service charges on deposit accounts, revenues derived from wealth management services and fees from processing services. Noninterest income totaled $312.1 million during 2008, an increase of $16.6 million or 5.6 percent. Noninterest income during 2007 equaled $295.5 million, a $24.1 million or 8.9 percent increase over 2006. Table 9 presents the major components of noninterest income for the past five years.

The increase in noninterest income during 2008 can be primarily attributed to gains in securities transaction, improvements in service charges on deposits accounts, fees from processing services and other service charges and fees.

Gains on securities transactions amounted to $8.1 million in 2008, compared to the $1.4 million earned in 2007. During 2008, Visa completed its initial public offering resulting in a conversion of our former member-bank equity investment to a new class of restricted stock. Immediately thereafter, a portion of our new Visa stock was redeemed for cash, an event that triggered the recognition of an $8.1 million gain.

Service charges on deposit accounts equaled $82.3 million during 2008, compared to $77.8 million in 2007, a $4.5 million or 5.8 percent increase. Commercial service charge income benefited from lower interest rates during 2008, which generated reduced earnings credit for commercial customers. Individual service charge income declined due to continued growth in free checking products. Insufficient funds and overdraft income improved due to refinements in the methodology used to process customer transactions.

During 2008, fees from processing services totaled $35.6 million, an increase of $3.1 million or 9.4 percent over 2007. During 2007, BancShares recognized $32.5 million in fees from processing services, an increase of $2.9 million or 9.8 percent over the $29.6 million recognized during 2006. Growth in the number of processed banks and transaction volumes led to the favorable trend.

Cardholder and merchant services income amounted to $97.6 million in 2008 up slightly over 2007. Interchange income earned on debit and credit card transactions increased during 2008, although transaction volumes softened during the last quarter. Merchant income declined during 2008 due to weaker sales activity by merchant customers.

Fees from wealth management services decreased $1.1 million to $48.2 million in 2008 from $49.3 million in 2007. The 2.2 percent decrease in 2008 resulted from lower trust and asset management fees caused by significant market declines in assets under management. Despite the general weakness in the economy, fees generated through the broker-dealer subsidiaries increased during 2008.

Insurance commissions totaled $8.3 million during 2008, a 7.0 percent increase over 2007, primarily a result of higher bonus commissions. Mortgage income during 2008 equaled $6.6 million, a 4.1 percent improvement over 2007 with most of the income resulting from sales of newly-originated residential mortgage loans and the related servicing rights to various investors.

Other service charges and fees totaled $17.6 million during 2008, an increase of $2.3 million or 14.9 percent over 2007 due to higher international fees and processing fees for commercial loan modifications.

Table 10

NONINTEREST EXPENSE


	Year ended December 31
	2008		2007		2006		2005		2004
	(thousands)
Salaries and wages	$	259,250	$	243,871	$	228,472	$	212,997	$	204,597
Employee benefits		58,899		52,733		50,445		51,517		48,624
Equipment expense		57,715		56,404		52,490		50,291		50,125
Occupancy expense		60,839		56,922		52,153		46,912		43,997
Cardholder and merchant processing		42,071		41,882		37,286		32,067		28,290
Cardholder reward programs		9,323		12,529		9,228		5,878		5,763
Telecommunications		12,061		10,501		9,844		9,873		10,461
Postage		10,427		9,614		8,926		8,045		8,639
Processing fees paid to third parties		8,985		7,004		5,845		4,332		3,826
Advertising		8,098		7,499		7,212		7,206		7,981
Legal		6,308		6,410		5,244		4,124		5,978
Consultant		2,514		3,324		2,254		3,362		2,980
Amortization of intangibles		2,048		2,142		2,318		2,453		2,360
Other		67,943		63,829		59,360		57,814		53,565

Total	$	606,481	$	574,664	$	531,077	$	496,871	$	477,186

NONINTEREST EXPENSE

The primary components of noninterest expense are salaries and related employee benefits, occupancy costs for branch offices and support facilities and equipment and software costs related to branch offices and technology. Noninterest expense for 2008 amounted to $606.5 million, a $31.8 million or 5.5 percent increase over 2007. Noninterest expense in 2007 was $574.7 million, a $43.6 million or 8.2 percent increase over 2006. Table 10 presents the major components of noninterest expense for the past five years. For 2008 and 2007, $7.7 million and $8.4 million of the respective increases in total noninterest expense are attributable to the continued growth and expansion of ISB.

Salary expense totaled $259.3 million during 2008, compared to $243.9 million during 2007, an increase of $15.4 million or 6.3 percent, following a $15.4 million or 6.7 percent increase in 2007 over 2006. The increase in 2008 is attributable to staff costs for new branch offices, headcount additions in support functions and merit increases.

Employee benefits expense equaled $58.9 million during 2008, an increase of $6.2 million or 11.7 percent from 2007. The 2008 increase results from a $2.8 million increase in health care expense and a $2.7 million increase in executive retirement costs. The aggregate cost of all qualified retirement plans declined $516,000 or 3.1 percent during 2008, the net result of lower pension expense and higher employer contributions to 401(k) benefit plans.

As a result of earnings and funding volatility associated with providing a defined benefit plan, BancShares discontinued offering traditional pension benefits to newly-hired employees during 2007. Instead, employees hired after March 31, 2007 may elect to participate in an enhanced 401(k) benefit plan. Employees hired on or before March 31, 2007 were allowed the option of continued participation in the defined benefit plan and the existing 401(k) plan or enrollment in an enhanced 401(k) benefit plan. Employees who elected to enroll in the enhanced 401(k) benefit plan discontinued the accrual of future years of service benefit under the defined benefit plan. Based on the elections made by participants, a curtailment charge of $763,000 was included in employee benefit expense during 2007.

BancShares recorded occupancy expense of $60.8 million during 2008, an increase of $3.9 million or 6.9 percent during 2008. Occupancy expense during 2007 equaled $56.9 million, an increase of $4.8 million or 9.1 percent over 2006. The increase in occupancy expense in each period resulted from higher depreciation and rent expense attributable to newly constructed branches and our corporate headquarters building and significant increases in building repairs.

Equipment expense was $57.7 million for 2008 and $56.4 million in 2007. The $1.3 million increase during 2008 resulted primarily from increased software and hardware costs and additional depreciation expense from the corporate headquarters building and new branch offices.

Costs associated with various cardholder reward programs totaled $9.3 million during 2008 compared to $12.5 million during 2007. The $3.2 million reduction resulted from the termination of a program for debit cardholders. Processing fees paid to third parties increased $2.0 million or 28.3 percent during 2008, the result of greater utilization of outsourced technology.

Telecommunications expense totaled $12.1 million during 2008, an increase of $1.6 million or 14.9 percent over 2007 related to network upgrades to our branch offices. Losses sustained on the disposition of assets increased $1.6 million during 2008, primarily due to losses realized on sales of foreclosed property.

Other expense increased $4.1 million or 6.4 percent during 2008, primarily due to current litigation accruals, partially offset by the reversal of a $3.3 million accrual established in 2007 for litigation matters resulting from our Visa member bank status. The 2007 accrual related to two separate claims against Visa, the exposure for which was shared by member banks. Upon completion of its initial public offering in early 2008, Visa retained proceeds to fund the anticipated litigation claims, and the previously-estimated member claims were relieved.

INCOME TAXES

During 2008, BancShares recorded income tax expense of $48.5 million, compared to $58.9 million during 2007 and $69.5 million in 2006. BancShares' effective tax rate equaled 34.8 percent in 2008, 35.2 percent in 2007 and 35.4 percent in 2006.

Table 11

ANALYSIS OF CAPITAL ADEQUACY


	December 31									Regulatory Minimum
	2008			2007			2006			Regulatory Minimum
	(dollars in thousands)
First Citizens BancShares, Inc.
Tier 1 capital	$	1,649,675		$	1,557,190		$	1,456,947
Tier 2 capital		286,318			279,573			275,079

Total capital	$	1,935,993		$	1,836,763		$	1,732,026

Risk-adjusted assets	$	12,499,545		$	11,961,124		$	11,266,342
Risk-based capital ratios
Tier 1 capital		13.20	%		13.02	%		12.93	%	4.00	%
Total capital		15.49	%		15.36	%		15.37	%	8.00	%
Tier 1 leverage ratio		9.88	%		9.63	%		9.39	%	3.00	%

First-Citizens Bank & Trust Company
Tier 1 capital	$	1,262,950		$	1,188,599		$	1,104,132
Tier 2 capital		250,095			244,470			240,070

Total capital	$	1,513,045		$	1,433,069		$	1,344,202

Risk-adjusted assets	$	10,006,171		$	9,716,423		$	9,238,512
Risk-based capital ratios
Tier 1 capital		12.62	%		12.23	%		11.95	%	4.00	%
Total capital		15.12	%		14.75	%		14.55	%	8.00	%

Tier 1 leverage ratio		9.17	%		8.81	%		8.33	%	3.00	%

IronStone Bank
Tier 1 capital	$	273,637		$	261,500		$	245,402
Tier 2 capital		38,250			24,801			23,576

Total capital	$	311,887		$	286,301		$	268,978

Risk-adjusted assets	$	2,369,415		$	2,190,348		$	1,953,178
Risk-based capital ratios
Tier 1 capital		11.55	%		11.94	%		12.56	%	4.00	%
Total capital		13.16	%		13.07	%		13.77	%	8.00	%
Tangible equity ratio		10.71	%		11.21	%		11.52	%	3.00	%

SHAREHOLDERS’ EQUITY

We continually monitor the capital levels and ratios for BancShares and the subsidiary banks to ensure that they comfortably exceed the minimum requirements imposed by their respective regulatory authorities and to ensure that the subsidiary banks’ capital is appropriate given each bank’s growth projection and risk profile. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material effect on the financial statements. Table 11 provides information on capital adequacy for BancShares, FCB and ISB as of December 31, 2008, 2007 and 2006.

BancShares continues to exceed minimum capital standards and the banking subsidiaries remain well-capitalized. The sustained growth of ISB has required BancShares to infuse significant amounts of capital into ISB to support its expanding balance sheet and continuing operating losses. Infusions totaled $45.8 million in 2008, $24.0 million in 2007 and $30.0 million in 2006. Since ISB was formed in 1997, BancShares has provided $349.8 million in capital. BancShares’ prospective capacity to provide capital to support the future growth and expansion of ISB is highly dependent upon FCB’s ability to return capital through dividends to BancShares.

Dividends from FCB to BancShares provide the sole source for capital infusions into ISB to fund its growth and expansion. These dividends also fund BancShares’ payment of shareholder dividends and interest payments on a portion

of its long-term obligations. During 2008, FCB declared dividends to BancShares in the amount of $54.8 million, compared to $43.8 million in 2007 and $40.0 million in 2006. At December 31, 2008, based on limitations imposed by North Carolina General Statutes, FCB had the ability to declare dividends totaling $1.03 billion. However, any dividends declared in excess of $512.4 million would have caused FCB to lose its well-capitalized designation.

RISK MANAGEMENT

In the normal course of business, BancShares is exposed to various risks. To manage the major risks that are inherent in the operation of a financial holding company and to provide reasonable assurance that our long-term business objectives will be attained, various policies and risk management processes identify, monitor and manage risk within acceptable tolerances. Management continually refines and enhances its risk management policies and procedures to maintain effective risk management programs and processes.

Our most prominent risk exposures are credit, interest rate and liquidity risk. Credit risk is the risk of not collecting the amount of a loan or investment when it is contractually due. Interest rate risk is the potential reduction of net interest income as a result of changes in market interest rates. Liquidity risk is the possible inability to fund obligations to depositors, creditors, investors or borrowers.

Credit Risk. BancShares manages and monitors extensions of credit and the quality of the loan and lease portfolio through rigorous initial underwriting processes and periodic ongoing reviews. Underwriting standards reflect credit policies and procedures administered through our highly centralized credit decision process. We maintain a credit review function that conducts independent risk reviews and analyses for the purpose of ensuring compliance with credit policies and to monitor asset quality trends. The independent risk reviews include portfolio analysis by geographic location and horizontal reviews across industry and collateral sectors within the banking subsidiaries. We strive to identify potential credit problems as early as possible, to take charge-offs or write-downs as appropriate and to maintain adequate allowances for credit losses that are inherent in the loan and lease portfolio. The maintenance of excellent asset quality is one of our key performance measures.

We maintain a well-diversified loan and lease portfolio, and seek to avoid the risk associated with large concentrations within specific geographic areas or industries. The ongoing expansion of our branch network has allowed us to mitigate our historic exposure to geographic risk concentration in North Carolina and Virginia.

We have historically carried a significant concentration of real estate-secured loans, although our underwriting policies principally rely on adequate borrower cash flow rather than underlying collateral values. When we do rely on underlying real property values, we favor financing secured by owner-occupied real property and as a result a large percentage of our real estate secured loans are owner-occupied. At December 31, 2008, loans secured by real estate totaled $8.15 billion or 69.5 percent of total loans compared to $7.46 billion or 68.1 percent at December 31, 2007.

Table 12

NONPERFORMING ASSETS


	December 31,
	2008			2007			2006			2005			2004
	(thousands, except ratios)
Nonaccrual loans and leases	$	39,361		$	13,021		$	14,882		$	18,969		$	14,266
Other real estate		29,956			6,893			6,028			6,753			9,020
Restructured loans		2,349			—			—			—			—

Total nonperforming assets	$	71,666		$	19,914		$	20,910		$	25,722		$	23,286

Accruing loans and leases 90 days or more past due and in process of collection	$	22,459		$	7,124		$	5,185		$	9,180		$	12,192
Loans and leases at December 31	$	11,719,285		$	10,963,904		$	10,273,043		$	9,656,230		$	9,364,822
Ratio of nonperforming assets to total loans and leases plus other real estate		0.61	%		0.18	%		0.20	%		0.27	%		0.25	%

Interest income that would have been earned on nonperforming loans and leases had they been performing	$	1,275		$	1,200		$	1,271		$	551		$	773
Interest income earned on nonperforming loans and leases		797			465			226			821			281

There were no foreign loans or leases outstanding in any period.

In recent years, we have sought opportunities to provide financial services to businesses associated with and professionals within the medical community. Due to strong loan growth within this industry, our loans to borrowers in medical, dental or related fields totaled $2.74 billion as of December 31, 2008 and $2.26 billion as of December 31, 2007, representing 23.4 percent and 20.6 percent of total loans and leases as of the respective dates. Except for this single concentration, no other industry represented more than 10 percent of total loans and leases outstanding at December 31, 2008.

In addition to geographic and industry concentrations, we monitor our loan and lease portfolio for other risk characteristics. Among the key indicators of credit risk are loan-to-value ratios, which measure a lender’s exposure as compared to the value of the underlying collateral. Regulatory agencies have established guidelines that define high loan-to-value loans as those real estate loans that exceed 65 percent to 85 percent of the collateral value depending upon the type of collateral. At December 31, 2008, we had $919.2 million or 7.8 percent of loans and leases that exceeded the loan-to-value ratios recommended by the guidelines compared to $969.1 million or 8.8 percent at December 31, 2007. While we continuously strive to limit our high loan-to-value loans, we believe that the inherent risk within these loans is lessened by mitigating factors, such as our strict underwriting criteria and the high rate of owner-occupied properties.

Nonperforming assets include nonaccrual loans and leases, other real estate and restructured loans. With the exception of certain residential mortgage loans, the accrual of interest on loans and leases is discontinued when we deem that collection of additional principal or interest is doubtful. Loans and leases are returned to accrual status when both principal and interest are current and the asset is determined to be performing in accordance with the terms of the loan instrument. The accrual of interest on certain residential mortgage loans is discontinued when a loan is more than three monthly payments past due, and the accrual of interest resumes when the loan is less than three monthly payments past due. Other real estate includes foreclosed property, branch facilities that we have closed but not sold and land that we have elected to sell that was originally acquired for future branches. Restructured loans include accruing loans that we have modified in order to enable a financially-distressed borrower an opportunity to continue making payments under terms more favorable than we would normally extend. Nonperforming asset balances for the past five years are presented in Table 12.

BancShares’ nonperforming assets at December 31, 2008 totaled $71.7 million, compared to $19.9 million at December 31, 2007 and $20.9 million at December 31, 2006. As a percentage of total loans, leases and other real estate, nonperforming assets represented 0.61 percent, 0.18 percent and 0.20 percent as of December 31, 2008, 2007 and 2006.

The $51.8 million surge in nonperforming assets during 2008 was primarily due to deterioration of our residential construction loans located in the counties surrounding Atlanta, Georgia, and in southwest Florida. Both markets have experienced significant over-development that has resulted in extremely weak sales of new residential units and significant declines in property values. As of December 31, 2008, $21.9 million and $18.1 million of other real estate and nonaccrual loans respectively relate to the Atlanta, Georgia and southwest Florida markets. All of the $2.3 million of restructured loans relate to these markets. Thus, $42.3 million of the $71.7 million total nonperforming assets arose from the residential construction loan portfolio in Atlanta, Georgia and southwest Florida. Total nonperforming assets in these markets as of December 31, 2007 amounted to $1.1 million.

Residential construction loans in these markets equaled $105.1 million as of December 31, 2008. Of that total, $24.2 million was already classified as nonperforming, and $67.4 million were identified as potential problem loans due to concerns about borrowers’ abilities to comply with existing loan repayment terms. It is likely that additional residential construction loans will be placed on nonaccrual during 2009. We continue to closely monitor past due and problem accounts to identify any loans and leases that should be classified as impaired or nonaccrual.

The allowance for credit losses reflects the estimated losses resulting from the inability of our customers to make required payments. In calculating the allowance, we employ a variety of modeling and estimation tools for measuring credit risk. Generally, loans and leases to commercial customers are evaluated individually and assigned a credit grade, while consumer loans are evaluated collectively. The individual credit grades for commercial loans are assigned based upon factors such as the borrower’s cash flow, the value of any underlying collateral and the strength of any guarantee. Relying on historical data of credit grade losses and migration patterns among credit grades, we calculate a loss estimate for each credit grade. As loans to borrowers experiencing financial stress are moved to higher-risk credit grades, increased allowances are assigned to that exposure.

Groups of consumer loans are aggregated over their remaining estimated behavioral lives and probable loss projections for each period become the basis for the allowance amount. The loss projections are based on historical losses, delinquency patterns and various other credit risk indicators. During 2008, based on deepening economic weaknesses indicated by higher unemployment and personal bankruptcy rates, we increased loss estimates for the affected retail loans types.

When needed, we also establish specific allowances for impaired loans. Commercial purpose loans are considered to be impaired if they are classified as nonaccrual. The allowance for impaired loans in excess of $1.0 million is the difference between its carrying value and the estimated collateral value or the present value of anticipated cash flows. For smaller impaired loans, the allowance is calculated based on the credit grade.

At December 31, 2008, impaired loans total $38.9 million compared to $10.6 million at December 31, 2007. Allowances established for impaired loans totaled $6.7 million and $2.1 million, respectively. The calculation of allowances for impaired loans is highly dependent on collateral valuations. Since all of our impaired loans are secured by real estate, we are relying on appraisals. However, given the significant instability in real estate markets, particularly in the Atlanta, Georgia area and in Southwest Florida, the valuations are subject to significant variation based on further reductions or recoveries of property values.

The allowance for credit losses also includes an amount that is not specifically allocated to individual loan types. This unallocated allowance is based upon factors such as changes in business and economic conditions, recent loss, delinquency and asset quality issues both within BancShares and the banking industry, exposures resulting from loan concentrations or specific industry risks and other judgmental factors. As of December 31, 2008, the unallocated portion of the allowance equaled $11.7 million or 7.1 percent of the total allowance for credit losses. This compares to $11.5 million or 8.0 percent as of December 31, 2007.

Table 13

ALLOWANCE FOR CREDIT LOSSES


	2008			2007			2006			2005			2004
	(thousands, except ratios)
Allowance for credit losses at beginning of period	$	144,271		$	138,646		$	135,770		$	130,832		$	119,357
Adjustment for sale of loans		—			—			—			(1,585	)		—
Provision for credit losses		65,805			33,594			20,922			33,514			34,690
Charge-offs:
Real estate:
Construction and land development		(17,559	)		(1,683	)		—			(1	)		(13	)
Commercial mortgage		(696	)		(49	)		(124	)		(551	)		(804	)
Residential mortgage		(1,165	)		(194	)		(1,717	)		(1,912	)		(2,351	)
Revolving mortgage		(3,249	)		(1,363	)		(1,475	)		(951	)		(1,384	)
Other mortgage loans		—			—			—			—			—

Total real estate loans		(22,669	)		(3,289	)		(3,316	)		(3,415	)		(4,552	)
Commercial and industrial		(13,593	)		(13,106	)		(10,378	)		(18,724	)		(9,800	)
Consumer		(12,695	)		(13,203	)		(9,171	)		(10,425	)		(12,238	)
Lease financing		(1,124	)		(3,092	)		(1,488	)		(347	)		(173	)

Total charge-offs		(50,081	)		(32,690	)		(24,353	)		(32,911	)		(26,763	)

Recoveries:
Real estate:
Construction and land development		227			21			—			—			34
Commercial mortgage		55			8			182			409			236
Residential mortgage		121			261			290			432			244
Revolving mortgage		215			96			182			155			103
Other mortgage loans		—			—			—			—			—

Total real estate loans		618			386			654			996			617
Commercial and industrial		1,645			1,282			1,358			2,164			1,084
Consumer		2,173			2,883			4,140			2,672			1,761
Lease financing		314			170			155			88			86

Total recoveries		4,750			4,721			6,307			5,920			3,548

Net charge-offs		(45,331	)		(27,969	)		(18,046	)		(26,991	)		(23,215	)

Allowance for credit losses at end of period	$	164,745		$	144,271		$	138,646		$	135,770		$	130,832

Allowance for credit losses includes:
Allowance for loan and lease losses	$	157,569		$	136,974		$	132,004		$	128,847		$	123,861
Reserve for unfunded commitments		7,176			7,297			6,642			6,923			6,971

Allowance for credit losses at end of period	$	164,745		$	144,271		$	138,646		$	135,770		$	130,832

Average loans and leases	$	11,306,900		$	10,513,599		$	9,989,757		$	9,375,249		$	8,901,628
Loans and leases at year-end		11,719,285			10,963,904			10,273,043			9,656,230			9,364,822
Ratios
Net charge-offs to average loans and leases		0.40	%		0.27	%		0.18	%		0.29	%		0.26	%
Percent of total loans and leases at period-end:
Allowance for loan and lease losses		1.34			1.25			1.28			1.33			1.32
Reserve for unfunded commitments		0.06			0.07			0.06			0.07			0.07
Allowance for credit losses		1.41			1.32			1.35			1.41			1.40

All information presented in this table relates to domestic loans and leases as BancShares makes no foreign loans and leases.

At December 31, 2008, BancShares' allowance for credit losses totaled $164.7 million or 1.41 percent of loans and leases outstanding, compared to $144.3 million or 1.32 percent at December 31, 2007. The allowance equaled $138.6 million or 1.35 percent at December 31, 2006. The $20.4 million increase during 2008 was primarily due to higher anticipated losses within the residential construction loan portfolio and in consumer loans.

The provision for credit losses equaled $65.8 million during 2008 compared to $33.6 million during 2007 and $20.9 million during 2006. The $32.2 million or 95.9 percent increase in provision for credit losses from 2007 to 2008 resulted primarily from losses and provisions in the residential construction loan portfolio as well as certain consumer loan portfolios.

Net charge-offs for 2008 totaled $45.3 million, compared to $28.0 million during 2007, and $18.0 million during 2006. The ratio of net charge-offs to average loans and leases outstanding equaled 0.40 percent during 2008, 0.27 percent during 2007 and 0.18 percent during 2006. Despite the increase in the 2008 loss ratio, these net charge-off rates remain low when compared to industry data. Table 13 provides details concerning the allowance for credit losses and provision for credit losses for the past five years.

Table 14 details the allocation of the allowance for credit losses among the various loan types. The process used to allocate the allowance considers, among other factors, whether the borrower is a retail or commercial customer, whether the loan is secured or unsecured, and whether the loan is an open or closed-end agreement.

Table 14

ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES


	December 31
	2008				2007				2006				2005				2004
	Allowance for Credit Losses		Percent of Loans to Total Loans		Allowance for Credit Losses		Percent of Loans to Total Loans		Allowance for Credit Losses		Percent of Loans to Total Loans		Allowance for Credit Losses		Percent of Loans to Total Loans		Allowance for Credit Losses		Percent of Loans to Total Loans
	(dollars in thousands)
Allowance for loan and lease losses:
Real estate:
Construction and land development	$	13,948	6.64	%	$	9,918	7.40	%	$	9,351	7.63	%	$	8,985	7.94	%	$	7,704	6.28	%
Commercial mortgage		43,222	37.06			35,760	36.31			38,463	36.27			37,185	36.44			35,373	35.03
Residential mortgage		8,006	8.23			7,011	9.39			6,954	9.98			6,822	10.53			6,387	10.46
Revolving mortgage		6,821	16.31			5,735	13.63			8,425	12.91			8,712	14.17			11,587	18.30
Other mortgage		5,231	1.28			2,323	1.33			2,145	1.61			2,242	1.79			2,249	1.83

Total real estate		77,228	69.52			60,747	68.06			65,338	68.40			63,946	70.87			63,300	71.90
Commercial and industrial		35,896	16.09			32,743	15.57			34,846	14.86			30,663	12.50			26,794	10.47
Consumer		27,045	10.52			26,925	12.48			22,396	13.24			22,695	13.66			24,072	14.92
Lease financing		5,091	3.02			4,649	3.11			3,562	2.87			2,389	2.42			2,229	2.05
Other		632	0.85			412	0.78			723	0.63			576	0.55			743	0.66
Unallocated		11,677				11,498				5,139				8,578				6,723

Total allowance for loan and lease losses		157,569				136,974				132,004				128,847				123,861
Reserve for unfunded commitments		7,176				7,297				6,642				6,923				6,971

Total allowance for credit losses	$	164,745	100.00	%	$	144,271	100.00	%	$	138,646	100.00	%	$	135,770	100.00	%	$	130,832	100.00	%

Interest Rate Risk. Interest rate risk results principally from assets and liabilities maturing or repricing at different points in time, from assets and liabilities repricing at the same point in time but in different amounts and from short-term and long-term interest rates changing in different magnitudes, an event frequently described by the resulting impact on the shape of the yield curve. Market interest rates also have an impact on the interest rate and repricing characteristics of loans and leases that are originated as well as the rate characteristics of our interest-bearing liabilities.

We assess our interest rate risk by simulating future amounts of net interest income using various interest rate scenarios and comparing those results to forecasted net interest income assuming stable rates. The December 31, 2008

simulations project very modest changes in net interest income in all scenarios, the result of limited ability to adjust rates on many interest-earning assets and interest-bearing liabilities, due to the presence of contractual or effective rate floors. Certain deposit and short-term borrowing liabilities can price down only marginally from current interest rate levels, and it is anticipated that the prime interest rate cannot move below the 3.25% rate as of December 31, 2008. Table 15 provides the impact on net interest income resulting from various interest rate scenarios as of December 31, 2008 and 2007.

Table 15

INTEREST RATE RISK ANALYSIS


	Favorable (unfavorable) impact on net interest income compared to stable rate scenario over the 12-month period following:
Assumed rate change	December 31, 2008		December 31, 2007
Most likely	-0.37	%	-0.52	%
Immediate 200 basis point increase	2.06	%	-5.65	%
Gradual 200 basis point increase	0.19	%	-2.22	%
Immediate 200 basis point decrease	-0.58	%	2.45	%
Gradual 200 basis point decrease	1.29	%	3.05	%

We also utilize the market value of equity as a tool to measure and manage interest rate risk. The market value of equity measures the degree to which the market values of our assets and liabilities will change given a specific degree of movement in interest rates. Our calculation methodology for the market value of equity utilizes a 200-basis point parallel rate shock. As of December 31, 2008, the market value of equity calculated with a 200-basis point immediate decrease in interest rates equals 8.08 percent of assets, up from 7.40 percent when calculated with stable rates. The market value of equity calculated with a 200-basis point immediate increase in interest rates equals 6.14 percent of assets. The estimated amounts for the market value of equity are highly influenced by the relatively longer maturity of the commercial loan component of interest-earning assets when compared to the maturity characteristics of interest-bearing liabilities.

The maturity distribution and repricing opportunities of interest-earning assets and interest-bearing liabilities have a significant impact on our interest rate risk. Our strategy is to reduce overall interest rate risk by maintaining relatively short maturities. Table 16 provides a loan maturity distribution and information regarding the sensitivity of loans and leases to changes in interest rates. Table 4 includes maturity information for our investment securities. Table 6 displays maturity information for time deposits with balances in excess of $100,000.

Table 16

LOAN MATURITY DISTRIBUTION AND INTEREST RATE SENSITIVITY


	December 31, 2008
	Within One Year		One to Five Years		After Five Years		Total
	(thousands)
Real estate	$	2,428,898	$	3,832,926	$	1,885,831	$	8,147,655
Commercial and industrial		486,258		779,066		620,034		1,885,358
Other		408,857		1,104,970		172,445		1,686,272

Total	$	3,324,013	$	5,716,962	$	2,678,310	$	11,719,285

Loans maturing after one year with:
Fixed interest rates			$	3,579,124	$	2,324,689	$	5,903,813
Floating or adjustable rates				2,137,838		353,621		2,491,459

Total			$	5,716,962	$	2,678,310	$	8,395,272

We do not typically utilize interest rate swaps, floors, collars or other derivative financial instruments to attempt to hedge our rate sensitivity and interest rate risk. However, during the second quarter of 2006, in conjunction with the

issuance of $115.0 million in trust preferred securities, we entered into an interest rate swap to synthetically convert the variable rate coupon on the securities to a fixed rate of 7.125 percent for a period of five years. The interest rate swap is a cash flow derivative under Statement of Financial Accounting Standards No. 133. The derivative is valued each quarter, and changes in the fair value are recorded on the consolidated balance sheet with an offset to other comprehensive income for the effective portion and an offset to the consolidated statements of income for any ineffective portion. The determination of effectiveness is made under the long-haul method.

Liquidity Risk. Liquidity risk results from the mismatching of asset and liability cash flows and the potential inability to secure adequate amounts of funding from traditional sources of liquidity. BancShares manages this risk by structuring its balance sheet prudently and by maintaining various borrowing resources to fund potential cash needs. BancShares has historically maintained a strong focus on liquidity, and we have traditionally relied on our deposit base as our primary liquidity source. Short-term borrowings resulting from commercial treasury customers have also emerged as an important source of liquidity in recent years, although some of those borrowings must be collateralized thereby potentially restricting the use of the resulting liquidity. Through our deposit and treasury product pricing strategies, we have the ability to stimulate or curtail liability growth.

During 2008, economic conditions created significant disruptions to the normal availability of liquidity to lenders, a trend that was amplified in some institutions by deposit withdrawals. We achieved growth in average deposits of 3.5 percent during 2008, compared to 1.7 percent during 2007 and 6.3 percent during 2006. The majority of the 2008 growth was achieved in the fourth quarter, as financial conditions within the banking industry deteriorated. We attribute this growth to recognition of the safety and financial strength of our company. This growth in deposits occurred despite falling interest rates. Lower interest rates did significantly impact the balances of short-term borrowings during 2008. Master notes and overnight repurchase obligations experienced a $633.1 million reduction due to lower interest rates.

We utilize borrowings from the Federal Home Loan Bank of Atlanta as an alternative source of liquidity, and to assist in matching the maturities of longer dated interest-earning assets. At December 31, 2008, we had sufficient collateral pledged to provide access to $1.22 billion of additional borrowings. Additionally, we maintain federal funds lines of credit and other borrowing facilities. At December 31, 2008, BancShares had access to $500.0 million in unsecured borrowings through its various sources.

Once we have satisfied our loan demand and other funding needs, residual liquidity is held in cash or invested in overnight investment and investment securities available for sale. At December 31, 2008, these highly-liquid assets totaled $4.03 billion or 24.1 percent of total assets, compared to $4.29 billion or 26.5 percent of total assets at December 31, 2007.

SEGMENT REPORTING

BancShares conducts its banking operations through its two wholly owned subsidiaries, FCB and ISB. Although FCB and ISB offer similar products and services to customers, each entity operates in distinct geographic markets and has separate management groups. We monitor growth and financial results in these institutions separately and, within each institution, by further geographic segregation.

Although FCB has grown through acquisition in certain of its markets, throughout its history the majority of its expansion has been accomplished on a de novo basis. Because of its size, the costs associated with FCB’s current rate of expansion are not material to its financial performance. Since ISB began operations in 1997, it has followed a similar business model for growth and expansion. However, due to the rapid pace of its growth and the number of branch offices that have not attained sufficient size to achieve profitability, the financial results and trends of ISB are significantly affected by its current and continuing growth. Each new market ISB enters creates additional operating costs that are typically not fully offset by operating revenues until three to four years of operation. Losses incurred since ISB’s inception total $63.7 million.

IronStone Bank. At December 31, 2008, ISB operated 61 facilities in twelve states, with a focus on markets with favorable growth prospects. ISB continued its expansion during 2008, establishing facilities in Kansas, Oklahoma and Dallas, Texas. Our business model for new markets has two requirements. First, we hire experienced bankers who are established in the markets we are entering and who are focused on delivering high quality customer service while maintaining strong asset quality. Second, we occupy attractive and accessible branch facilities. While these are costly goals, we believe that they are critical to establishing a solid foundation for future success in new markets.

ISB’s total assets increased from $2.34 billion at December 31, 2007 to $2.56 billion at December 31, 2008, an increase of $222.7 million or 9.5 percent. ISB’s total assets represented 15.3 percent of consolidated assets at December 31, 2008 compared to 14.4 percent at December 31, 2007.

ISB recorded a net loss of $28.9 million during 2008 compared to a net loss of $7.7 million during 2007 and net income of $2.2 million in 2006. The $21.2 million increase in the net loss resulted from significantly higher provision for credit losses on residential construction loans and higher noninterest expense. While we believe that the provision for credit losses will decline when compared to 2008, we project that ISB will operate at a loss at least through 2009.

ISB’s net interest income increased $3.7 million or 5.8 percent during 2008 due to asset growth and lower funding costs. Loans and leases increased $148.8 million or 7.2 percent from $2.07 billion at December 31, 2007 to $2.22 billion at December 31, 2008.

Provision for credit losses increased $27.2 million during 2008, due to higher net charge offs and deterioration of the residential construction loan portfolio. Net charge-offs amounted to $23.1 million or 1.06 percent of loans and leases during 2008, compared to $6.7 million or 0.34 percent of loans and leases in 2007. During 2008, $16.8 million or 72.7 percent of net charge-offs relate to residential construction loans. Nonperforming assets totaled $32.6 million at December 31, 2008, compared to $6.2 million at December 31, 2007.

ISB’s noninterest income fell $1.3 million or 9.7 percent during 2008, primarily the result of lower working capital finance fees and mortgage income. Deposit service charges increased $668,000 or 24.3 percent due to higher commercial service charges. Cardholder and merchant service fees increased $1.0 million from $6.4 million in 2007 to $7.5 million in 2008 as merchant discount and Visa interchange income were both higher.

Noninterest expense increased $7.7 million or 9.6 percent during 2008, the result of costs incurred in conjunction with the opening of new branch offices and higher cardholder processing expenses.

First-Citizens Bank & Trust Company. At December 31, 2008, FCB operated 343 branches in five states. During 2009, FCB plans to establish a new office in Washington, DC.

FCB’s total assets increased from $13.58 billion at December 31, 2007 to $13.88 billion at December 31, 2008, an increase of $297.6 million or 2.2 percent. FCB’s total assets represented 82.9 percent and 83.8 percent of consolidated assets at December 31, 2008 and 2007, respectively.

FCB recorded net income of $127.1 million during 2008 compared to $125.2 million during 2007, an increase of $1.9 million or 1.5 percent. The favorable variance in net income is attributable to improved net interest income and noninterest income, partially offset by higher noninterest expense and provision for credit losses.

FCB’s net interest income increased $11.9 million or 2.8 percent during 2008 due to higher average assets. Total FCB loans increased $606.6 million in 2008 from $8.89 billion to $9.50 billion. Provision for credit losses increased $5.0 million or 20.5 percent during 2008 caused by higher net charge-offs on consumer loans and continued loan growth. Net charge-offs increased $961,000 or 4.5 percent from $21.3 million in 2007 to $22.2 million in 2008.

FCB’s noninterest income increased $18.5 million or 6.4 percent during 2008, the result of higher securities gains, service charge income and fees from processing services. Noninterest expense increased $23.4 million or 4.6 percent during 2008, due to higher personnel, occupancy and telecommunications expense.

FOURTH QUARTER ANALYSIS

BancShares reported net income of $12.9 million for the quarter ended December 31, 2008, compared to $26.2 million for the corresponding period of 2007, a decrease of 50.7 percent. Per share income for the fourth quarter 2008 totaled $1.24 compared to $2.51 for the same period of 2007. BancShares’ results generated an annualized return on average assets of 0.31 percent for the fourth quarter of 2008, compared to 0.64 percent for the same period of 2007. The annualized return on average equity equaled 3.43 percent during the fourth quarter of 2008, compared to 7.31 percent for the same period of 2007. In the fourth quarter, higher noninterest expense and higher provision for credit losses contributed to the decline in net income. These added costs were partially offset by higher net interest income.

Table 17

SELECTED QUARTERLY DATA


	2008												2007
	Fourth Quarter			Third Quarter			Second Quarter			First Quarter			Fourth Quarter			Third Quarter			Second Quarter			First Quarter
	(thousands, except share data and ratios)
SUMMARY OF OPERATIONS
Interest income	$	195,366		$	199,372		$	202,575		$	217,403		$	230,826		$	232,120		$	223,473		$	217,637
Interest expense		71,211			71,761			77,147			94,826			109,197			111,185			103,884			99,448

Net interest income		124,155			127,611			125,428			122,577			121,629			120,935			119,589			118,189
Provision for credit losses		22,142			20,195			13,350			10,118			11,795			17,333			934			3,532

Net interest income after provision for credit losses		102,013			107,416			112,078			112,459			109,834			103,602			118,655			114,657
Noninterest income		72,182			77,244			79,025			83,668			76,534			77,285			72,620			69,031
Noninterest expense		155,800			155,559			149,481			145,641			146,285			146,906			142,878			138,595

Income before income taxes		18,395			29,101			41,622			50,486			40,083			33,981			48,397			45,093
Income taxes		5,502			9,547			15,396			18,101			13,920			11,362			17,546			16,109

Net income	$	12,893		$	19,554		$	26,226		$	32,385		$	26,163		$	22,619		$	30,851		$	28,984

Net interest income, taxable equivalent	$	125,779		$	129,164		$	127,143		$	124,430		$	123,666		$	122,980		$	121,409		$	119,964

PER SHARE DATA
Net income	$	1.24		$	1.87		$	2.51		$	3.10		$	2.51		$	2.17		$	2.96		$	2.78
Cash dividends		0.275			0.275			0.275			0.275			0.275			0.275			0.275			0.275
Market price at period end (Class A)		152.80			179.00			139.49			139.35			145.85			174.40			194.40			201.00
Book value at period end		138.33			144.17			142.54			142.42			138.12			134.32			131.10			128.64
Tangible book value at period end		128.13			133.92			132.24			132.07			127.72			123.88			120.61			118.10

SELECTED QUARTERLY AVERAGE BALANCES
Total assets	$	16,741,696		$	16,377,570		$	16,396,288		$	16,302,994		$	16,276,649		$	16,092,009		$	15,725,976		$	15,572,613
Investment securities		3,193,703			2,998,370			3,238,028			3,183,636			3,272,015			3,162,011			3,047,753			3,092,261
Loans and leases		11,665,522			11,440,563			11,154,400			10,961,706			10,831,571			10,623,247			10,360,913			10,230,858
Interest-earning assets		15,293,442			14,814,463			14,841,431			14,691,141			14,655,309			14,476,247			14,118,884			13,908,622
Deposits		13,544,762			13,003,821			12,969,423			12,905,651			12,876,549			12,728,527			12,524,786			12,502,206
Interest-bearing liabilities		12,471,757			12,187,085			12,281,649			12,309,132			12,216,067			12,052,307			11,698,285			11,557,940
Long-term obligations		730,360			613,046			609,301			475,732			404,367			405,101			405,339			408,277
Shareholders’ equity	$	1,497,619		$	1,496,573		$	1,484,143		$	1,466,411		$	1,420,348		$	1,385,284		$	1,353,739		$	1,323,327
Shares outstanding		10,434,453			10,434,453			10,434,453			10,434,453			10,434,453			10,434,453			10,434,453			10,434,453

SELECTED QUARTER-END BALANCES
Total assets	$	16,745,662		$	16,665,605		$	16,422,674		$	16,746,518		$	16,212,107		$	16,311,870		$	16,008,605		$	15,853,778
Investment securities		3,271,650			2,977,565			3,013,432			3,206,137			3,236,835			3,266,150			3,023,799			3,031,798
Loans and leases		11,719,285			11,627,635			11,313,155			11,029,937			10,963,904			10,763,158			10,513,041			10,262,356
Interest-earning assets		15,165,551			14,933,906			14,722,037			15,039,574			14,466,948			14,542,241			14,232,802			14,094,002
Deposits		13,713,763			13,372,468			13,075,411			13,226,991			12,928,544			12,980,447			12,772,322			12,722,532
Interest-bearing liabilities		12,441,025			12,383,450			12,147,269			12,566,799			12,118,967			12,170,559			11,830,904			11,671,127
Long-term obligations		733,132			649,214			609,277			609,335			404,392			404,266			405,314			405,356
Shareholders’ equity		1,443,375			1,504,334		$	1,487,282		$	1,486,034		$	1,441,208		$	1,401,575		$	1,367,980		$	1,342,327
Shares outstanding		10,434,453			10,434,453			10,434,453			10,434,453			10,434,453			10,434,453			10,434,453			10,434,453

SELECTED RATIOS AND OTHER DATA
Rate of return on average assets		0.31	%		0.64	%		0.64	%		0.80	%		0.64	%		0.56	%		0.79	%		0.75	%
Rate of return on average shareholders’ equity		3.43			7.11			7.11			8.88			7.31			6.48			9.14			8.88
Net yield on interest-earning assets (taxable equivalent)		3.27			3.47			3.45			3.41			3.35			3.37			3.45			3.50
Allowance for loan and lease losses to total loans and leases at period end		1.34			1.32			1.28			1.28			1.25			1.24			1.23			1.29
Nonperforming assets to total loans and leases plus other real estate at period end		0.61			0.53			0.42			0.39			0.18			0.22			0.18			0.21
Tier 1 risk-based capital ratio		13.20			13.01			13.14			13.12			13.02			12.96			13.05			13.09
Total risk-based capital ratio		15.49			15.33			15.48			15.47			15.36			15.30			15.40			15.52
Leverage capital ratio		9.88			10.01			9.89			9.80			9.63			9.59			9.75			9.60
Dividend payout ratio		22.18			14.71			10.96			8.87			10.96			12.67			9.29			9.89
Average loans and leases to average deposits		86.13			87.98			86.01			84.94			84.12			83.46			82.72			81.83

Average loan and lease balances include nonaccrual loans and leases.

Net interest income increased $2.5 million or 2.1 percent in the fourth quarter of 2008, compared to the same period of 2007. The taxable-equivalent net yield on interest-earning assets decreased from 3.35 percent in the fourth quarter of 2007 to 3.27 percent for the fourth quarter of 2008.

Average interest-earning assets increased $638.1 million to $15.29 billion from the fourth quarter of 2007 to the fourth quarter of 2008. Average loans and leases outstanding during the fourth quarter of 2008 equaled $11.67 billion, an increase of $834.0 million or 7.7 percent over 2007. The yield on interest-earning assets decreased 119 basis points from 6.31 percent in 2007 to 5.12 percent in 2008.

Average interest-bearing liabilities increased $255.7 million to $12.47 billion. Average money market deposits increased $439.5 million or 14.8 percent to $3.40 billion while average short-term borrowings decreased $561.0 million or 39.0 percent due to reductions in master note borrowings and repurchase obligations. The rate on average interest-bearing liabilities decreased 128 basis points from 3.55 percent in 2007 to 2.27 percent in 2008.

The provision for credit losses increased $10.3 million or 87.7 percent in the fourth quarter of 2008, compared to the same period of 2007 due to higher net charge-offs and loan growth. Net charge-offs were $18.0 million during the fourth quarter of 2008, compared to $8.4 million during the same period of 2007.

Noninterest income decreased $4.4 million or 5.7 percent during the fourth quarter. Fees from wealth management services decreased $3.0 million or 23.0 percent for the fourth quarter of 2008, due to the lower value of assets under management. Cardholder and merchant services income decreased $1.5 million or 6.0 percent due to lower merchant and interchange fees. Deposit service charges declined $931,000 or 4.4 percent in the quarter.

Noninterest expense increased $9.5 million or 6.5 percent during the fourth quarter of 2008, when compared to the same period of 2007. Salaries increased $3.4 million or 5.5 percent from the fourth quarter of 2007 to the fourth quarter of 2008. Benefits were up $2.5 million or 21.9 percent as life and health insurance costs continue to escalate. Occupancy costs increased $706,000 or 4.8 percent from $14.7 million during the fourth quarter of 2007 to $15.4 million during the fourth quarter of 2008. Higher personnel and occupancy costs are primarily related to the continued expansion of the branch network. FDIC insurance expense increased $2.2 million or 310.8 percent.

Losses resulting from the sales of assets increased $2.6 million or 521.2 percent from $503,000 in 2007 to $3.1 million in 2008 primarily due to losses on foreclosed property. Advertising costs increased $3.4 million in the fourth quarter of 2008.

Table 17 provides quarterly information for each of the quarters in 2008 and 2007. Table 18 analyzes the components of changes in net interest income between the fourth quarter of 2008 and 2007.

Table 18

CONSOLIDATED TAXABLE EQUIVALENT RATE/VOLUME VARIANCE ANALYSIS—FOURTH QUARTER


	2008						2007						Increase (decrease) due to:
	Average Balance		Interest Income/ Expense		Yield/ Rate		Average Balance		Interest Income/ Expense		Yield/ Rate		Volume			Yield/ Rate			Total Change
	(dollars in thousands)
Assets
Loans and leases	$	11,665,522	$	169,249	5.77	%	$	10,831,571	$	186,426	6.83	%	$	13,001		$	(30,178	)	$	(17,177	)
Investment securities:
U. S. Government		3,114,125		26,870	3.43			3,197,797		39,178	4.89			(836	)		(11,472	)		(12,308	)
State, county and municipal		4,675		79	6.72			4,949		83	6.65			(5	)		1			(4	)
Other		74,903		199	1.06			69,269		773	4.43			38			(612	)		(574	)

Total investment securities		3,193,703		27,148	3.38			3,272,015		40,034	4.88			(803	)		(12,083	)		(12,886	)
Overnight investments		434,217		592	0.54			551,723		6,403	4.60			(770	)		(5,041	)		(5,811	)

Total interest-earning assets	$	15,293,442	$	196,989	5.12	%	$	14,655,309	$	232,863	6.31	%	$	11,428		$	(47,302	)	$	(35,874	)

Liabilities
Deposits:
Checking With Interest	$	1,433,261	$	458	0.13	%	$	1,384,226	$	536	0.15	%	$	5		$	(83	)	$	(78	)
Savings		538,992		263	0.19			546,410		299	0.22			1			(37	)		(36	)
Money market accounts		3,403,985		12,239	1.43			2,964,472		24,181	3.24			2,563			(14,505	)		(11,942	)
Time deposits		5,486,405		46,903

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents