Edgar Filing: FIRST CITIZENS BANCSHARES INC /DE/

First Citizens Bancshares, Inc.

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, 2006

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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.


Large accelerated filer x		Accelerated filer ¨		Non-accelerated filer ¨

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 $1,205,145,350.

On February 27, 2007, 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 2007 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	35
	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
	Item 6	Selected Financial Data	10
	Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations	8-37
	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	38
		Management’s Annual Report on Internal Control over Financial Reporting	39
		Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting	40
		Consolidated Balance Sheets at December 31, 2006 and 2005	41
		Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2006	42
		Consolidated Statements of Changes in Shareholders’ Equity for each of the years in the three-year period ended December 31, 2006	43
		Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2006	44
		Notes to Consolidated Financial Statements	45-69
		Quarterly Financial Summary for 2006 and 2005	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 2007 Annual Meeting of Shareholders (2007 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 2007 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 2007 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 2007 Proxy Statement.

Information required by Item 14 is incorporated by reference to the information that appears under the caption ‘Services and Fees During 2006 and 2005’ of the 2007 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, 2006, FCB operated 340 offices in North Carolina, Virginia, West Virginia, Maryland and Tennessee.

On April 28, 1997, BancShares launched Atlantic States Bank (ASB), a federally chartered thrift institution. During 2004, ASB changed its name to IronStone Bank (ISB). ISB branches were initially concentrated within the metropolitan Atlanta, Georgia market. In 1999, ISB expanded its presence into Florida, focusing initially on selected markets in southwest Florida. The targeted market areas within Florida have grown to now include Jacksonville, West Palm Beach and Fort Lauderdale. During 2002, ISB continued its expansion into high-growth markets by opening offices in Austin, Texas.

During 2003, ISB opened offices in Scottsdale, Arizona, the San Diego, Newport Beach and LaJolla communities in Southern California and Sacramento in Northern California. ISB continued its expansion in 2004 and 2005 by opening branch facilities in Denver, Colorado; Albuquerque, New Mexico; Santa Fe, New Mexico; Portland, Oregon; and Seattle, Washington. These markets have been selected based on their strong anticipated economic growth rates and the desire to bring a bank with a focus on customer service in these communities. At December 31, 2006, ISB had 56 offices. During 2006, ISB received approval to expand into Houston, Texas. During early 2007, ISB requested regulatory approval to open branch offices in Dallas, Texas; Oklahoma City, Oklahoma; Kansas City, Missouri; and Kansas City, Kansas.

BancShares’ executive offices are located at 4300 Six Forks Road, Raleigh, North Carolina 27609, and its telephone number is (919) 716-7000. Although BancShares does not maintain a dedicated website, information regarding BancShares is available at FCB’s website, www.firstcitizens.com. At December 31, 2006, BancShares and its subsidiaries employed a full-time staff of 3,942 and a part-time staff of 822 for a total of 4,764 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 normal 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.

First Citizens Bank, National Association, which was the issuing and processing bank for retail credit cards and provided processing services for merchants, was merged into FCB during 2006. On January 1, 2007, American Guaranty Insurance Company, a wholly-owned subsidiary of BancShares that provides property and casualty insurance, and Triangle Life Insurance Company, a wholly-owned subsidiary of FCB that provides credit-related life insurance, were sold to a third party.

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.

The various regulatory authorities supervise all areas of the banking subsidiaries, including their reserves, loans, mergers, the payment of dividends, 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 this new legislation on public companies, including BancShares, have been and will continue to be significant in terms of the time, resources and costs associated with complying with the new law.

FCIS and ISS are registered broker-dealers and investment advisers. Broker-dealer activities are subject to regulation by the National Association of Securities Dealers (NASD), 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 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.

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 over the past ten years, 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, 2006, BancShares’ subsidiary financial institutions operated branch offices at 396 locations in North Carolina, Virginia, West Virginia, Maryland, Tennessee, Florida, Georgia, Texas, Arizona, California, New Mexico, Colorado, Oregon and Washington. BancShares owns many of the buildings and leases other facilities from third parties. In early 2007, ISB announced plans to expand into four new markets: Dallas, Texas; Oklahoma City, Oklahoma; Kansas City, Missouri; and Kansas City, Kansas.

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’ 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, 2006, there were 2,240 holders of record of the Class A common stock, and 412 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 2006 and 2005 are set forth in Table 16 under the caption ‘Per Share of Stock’ of this report. A cash dividend of 27.5 cents per share was declared by the Board of Directors on January 22, 2007, payable April 2, 2007, to holders of record as of March 19, 2007. 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 2006, 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, 2001, 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 in enabling it 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 39 of this Report. The attestation report of BancShares’ independent accountants regarding management’s assessment of BancShares’ internal control over financial reporting is included on page 40 of this Report.

No change in BancShares’ internal control over financial reporting occurred during our fourth quarter of 2006 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 38 through 69 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 2006, 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 North Carolina, Virginia, Maryland, Tennessee and West Virginia. ISB operates branches in Florida, Georgia, Texas, New Mexico, Arizona, California, Colorado, Oregon and Washington.

BancShares’ earnings and cash flows are primarily derived from the commercial banking activities conducted by its banking subsidiaries. These activities include commercial and consumer lending, deposit and cash management products, cardholder, merchant, wealth management services as well as various other products and services incidental to commercial banking. FCB and ISB gather interest-bearing and noninterest-bearing 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 various types of 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 and deposit products. In an effort to stimulate and control the rate of economic growth, monetary actions by the Federal Reserve are significant to the interest rate environment in which we operate. At any point in time, both the existing level and anticipated movement of interest rates have a profound impact on customer demand for our products and on our profitability. During 2006, the Federal Reserve increased the discount rate and the federal funds rate by 100 basis points, compared to increases totaling 200 basis points during 2005. As the nation’s economy continued to expand, the Federal Reserve decisions to increase these major indices had a significant impact on demand for and pricing of loan, deposit and cash management products.

In addition to the interest rate environment, the general strength of the economy influences demand as well as the quality and collectibility of our loan portfolio. External economic indicators such as consumer bankruptcy rates and business debt service capacity closely follow trends in the economic cycle. Demand for our deposit and cash management products is highly dependent on interest rates and, to some extent, the volatility of alternative investment markets.

Although we are unable to control the external factors that influence our business, through the utilization of various liquidity, interest rate and credit risk management tools, 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 frequently focus their strategic and operating emphasis on maximizing profitability, and therefore measure their relative 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. BancShares has placed primary emphasis upon asset quality, balance sheet liquidity and capital conservation, even when those priorities may be detrimental to short-term profitability.

Based on our organization’s strengths, competitive position and strategic focus within the financial services industry, we believe opportunities for significant growth and expansion exist. We operate in diverse and growing geographic markets and believe that through focused strategic emphasis, competitive products and superior customer service, we can increase our business volumes and profitability. In recent years, we have concentrated our efforts on customers who own their own businesses, medical and other professionals and individuals who are financially active. We seek to increase fee income in areas such as merchant processing, working capital finance, insurance, cash management, wealth management

and private banking services. We also focus on opportunities to generate income by providing various processing services to other banks.

We attempt to mitigate certain of the risks that can endanger our profitability and growth prospects. While we are attentive to all areas of risk, economic risk is especially problematic due to the lack of control and the likelihood of a material impact on our financial results. Specific economic risks include recession, rapid movements in interest rates, changes in the yield curve and significant shifts in inflation expectations. Compared to our larger competitors, our relatively small asset size and limited capital resources create a level of economic risk that requires constant and focused management attention.

PERFORMANCE SUMMARY

BancShares reported net income of $126.5 million during 2006, compared to $112.9 million in 2005 and $74.8 million in 2004. Net income for 2006 represented a 12.1 percent increase when compared to 2005. Return on assets and shareholders’ equity were 0.83 percent and 10.19 percent, respectively, for 2006 compared to 0.81 percent and 9.98 percent for 2005. Net income per share for 2006 totaled $12.12, compared to $10.82 and $7.17 for 2005 and 2004, respectively.

Significant items contributing to the $13.6 million increase in 2006 net income included improved levels of net interest and noninterest income and lower provision for credit losses, partially offset by higher noninterest expense. The $38.0 million increase in net income in 2005 when compared to 2004 was the primary result of higher net interest income and noninterest income, partially offset by higher noninterest expense and income tax expense.

Average interest-earning assets increased $1.12 billion for 2006, including a $596.7 million increase in average loans and leases and a $495.2 million increase in investment securities. Much of the loan growth was focused in the commercial and industrial and commercial mortgage loan portfolios. Growth in average interest-earning assets was funded primarily through a $1.15 billion increase in average interest-bearing liabilities. Average interest-bearing deposits increased $669.8 million while short-term borrowings increased $382.3 million. The majority of the deposit increase came in time deposits. The net yield on interest-earning assets for 2006 equaled 3.48 percent, down 12 basis points from 2005 due to the adverse impact of a prolonged flat yield curve.

Net charge-offs as a percentage of average loans and leases equaled 0.18 percent for 2006, down from 0.28 percent for 2005. Nonperforming assets equaled 0.20 percent of total loans and leases and other real estate as of December 31, 2006, down from 0.27 percent as of December 31, 2005.

Noninterest income totaled $279.3 million during 2006. Healthy increases were noted in cardholder and merchant services income, commission-based income and fees from processing services. Deposit service charges declined $4.8 million, or 6.2 percent.

Noninterest expenses increased $34.2 million or 6.8 percent compared with 2005 primarily due to increases in personnel costs and occupancy expenses. Continued expansion of our branch network caused a substantial amount of the increase.

Table 1

FINANCIAL SUMMARY AND SELECTED AVERAGE BALANCES AND RATIOS


	2006			2005			2004			2003			2002
	(thousands, except share data and ratios)
SUMMARY OF OPERATIONS
Interest income	$	825,252		$	665,934		$	521,117		$	510,477		$	596,169
Interest expense		353,737			218,151			133,826			148,537			214,018

Net interest income		471,515			447,783			387,291			361,940			382,151
Provision for credit losses		20,906			33,109			34,473			24,187			26,550

Net interest income after provision for credit losses		450,609			414,674			352,818			337,753			355,601
Noninterest income		279,344			263,779			251,271			244,176			220,475
Noninterest expense		534,007			499,783			479,894			465,328			432,533

Income before income taxes		195,946			178,670			124,195			116,601			143,543
Income taxes		69,455			65,808			49,352			41,414			50,787

Net income	$	126,491		$	112,862		$	74,843		$	75,187		$	92,756

Net interest income, taxable equivalent	$	473,316		$	449,256		$	388,556		$	362,991		$	383,494

SELECTED AVERAGE BALANCES
Total assets	$	15,240,327		$	13,905,260		$	12,856,102		$	12,245,840		$	11,843,239
Investment securities		3,028,384			2,533,161			2,157,367			2,585,376			2,610,622
Loans and leases		9,961,032			9,364,327			8,892,317			7,886,948			7,379,607
Interest-earning assets		13,608,663			12,492,955			11,483,694			10,932,853			10,553,574
Deposits		12,452,955			11,714,569			10,961,380			10,433,781			10,007,398
Interest-bearing liabilities		11,262,423			10,113,999			9,327,436			9,163,960			9,129,168
Long-term obligations		450,272			353,885			287,333			255,379			263,291
Shareholders’ equity	$	1,241,254		$	1,131,066		$	1,053,860		$	996,578		$	924,877
Shares outstanding		10,434,453			10,434,453			10,435,247			10,452,523			10,478,843

SELECTED PERIOD-END BALANCES
Total assets	$	15,729,697		$	14,639,392		$	13,265,711		$	12,566,961		$	12,237,534
Investment securities		3,221,048			2,929,516			2,125,524			2,469,447			2,539,236
Loans and leases		10,239,551			9,642,994			9,354,387			8,326,598			7,620,263
Interest-earning assets		13,809,196			13,053,522			11,863,654			11,090,450			10,783,069
Deposits		12,743,324			12,173,858			11,350,798			10,711,332			10,439,620
Interest-bearing liabilities		11,612,372			10,745,696			9,641,368			9,251,903			9,298,080
Long-term obligations		401,198			408,987			285,943			289,277			253,409
Shareholders’ equity	$	1,310,819		$	1,181,059		$	1,086,310		$	1,029,305		$	967,291
Shares outstanding		10,434,453			10,434,453			10,434,453			10,436,345			10,473,294

PROFITABILITY RATIOS (averages)
Rate of return on:
Total assets		0.83	%		0.81	%		0.58	%		0.61	%		0.78	%
Shareholders’ equity		10.19			9.98			7.10			7.54			10.03
Dividend payout ratio		9.08			10.17			15.34			15.30			11.30

LIQUIDITY AND CAPITAL RATIOS (averages)
Loans and leases to deposits		79.99	%		79.94	%		81.12	%		75.59	%		73.74	%
Shareholders’ equity to total assets		8.14			8.13			8.20			8.14			7.81
Time certificates of $100,000 or more to total deposits		15.34			12.57			11.05			10.33			10.87

PER SHARE OF STOCK
Net income	$	12.12		$	10.82		$	7.17		$	7.19		$	8.85
Cash dividends		1.10			1.10			1.10			1.10			1.00
Market price at December 31 (Class A)		202.64			174.42			148.25			120.50			96.60
Book value at December 31		125.62			113.19			104.11			98.63			92.36
Tangible book value at December 31		115.02			102.35			93.12			87.56			81.73

Table 2 details acquisitions and divestitures during 2006, 2005 and 2004. All of the acquisitions were accounted for as purchases, with the results of operations included with BancShares’ consolidated financial statements since the respective acquisition date. There were no material purchase transactions during the three-year period presented.

Table 2

ACQUISITIONS AND DIVESTITURES


Year	Transaction	Total Loans			Total Deposits
		(thousands)
2006	Sale of one branch by First Citizens Bank	$	(36	)	$	(20,553	)
2005	Securitization and sale of revolving mortgage loans		(256,232	)		—
2005	Purchase of one branch by First Citizens Bank		11			20,957
2004	Purchase of one branch by First Citizens Bank		2,288			11,565
2004	Sale of one branch by IronStone Bank		—			(12,156	)

CRITICAL ACCOUNTING POLICIES

The preparation of our audited financial statements and the information included in management’s discussion and analysis is governed by policies that are based on accounting principles generally accepted in the United States of America and general practices within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial condition, results of operations and disclosures can be affected by these estimates and assumptions, which are integral 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, and require that management make estimates that are subjective or complex. Those accounting policies considered by Management to be critical accounting policies are described below.

BancShares periodically evaluates its estimates, 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 that will result from the inability of our customers to make required payments. The allowance for credit losses results from 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, 2006, 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 obligation, future plan asset value 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 pension plan assets and liabilities are subject to management judgment and may differ significantly depending upon the

assumption used. The discount rate assumption used to determine the present value of the benefits to be paid under the pension plan reflects the interest rate that could be obtained by a suitable investment used to fund the obligation. The assumed discount rate equaled 5.75 percent at December 31, 2006, compared to 5.50 percent at December 31, 2005 and 5.75 percent at December 31, 2004. Assuming other variables remain unchanged, a reduction in the assumed discount rate would cause an increase in obligations, thereby resulting in higher employee benefits expense. Conversely, an increase in the assumed discount rate would reduce the calculated benefit obligations, which would result in reduced expense.

We also select an expected 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 assets and projections of future returns on various asset classes. Based on these factors, we estimated the expected long-term return on plan assets to be 8.50 percent for 2006, 2005 and 2004. Assuming other variables remain unchanged, an increase in the long-term rate of return on plan assets reduces pension expense.

The assumed rate of future compensation increases is reviewed annually based on actual experience and future salary expectations. The compensation increase assumption was 4.25 percent during 2006 and 2005 compared to 4.75 percent during 2004. Assuming other variables remain unchanged, a reduction in the rate of future compensation increases results in lower 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 financial statement amount of assets and liabilities and their respective tax bases. In estimating the liabilities and related 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 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.

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 the investor to potentially higher levels of default. We have historically focused on maintaining high asset quality, which results in a loan portfolio subjected to strenuous underwriting and monitoring procedures. That focus on asset quality also influences our investment securities portfolio. At December 31, 2006, United States Treasury and government agency securities represented 97.6 percent of our investment securities 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 cash management products. Ultimately, the size of the investment securities portfolio changes based on trends noted among loans, deposits and short-term borrowings. When demand for deposit and cash management products exceeds loan demand, we invest excess funds in the securities portfolio. Conversely, when loan demand exceeds growth in deposits and short-term borrowings generated by cash management products, we use proceeds from maturing securities to fund loan demand.

Interest-earning assets averaged $13.61 billion during 2006, an increase of $1.12 billion or 8.9 percent over 2005 levels, compared to a $1.01 billion or 8.8 percent increase in 2005 over 2004 levels. The increase among interest-earning assets during 2006 and 2005 resulted from growth in loans, leases and investment securities.

Loans and leases. As of December 31, 2006, loans and leases outstanding were $10.24 billion, a 6.2 percent increase over the December 31, 2005 balance of $9.64 billion. The $596.6 million increase in loans and leases during 2006 resulted from growth among commercial and industrial loans and commercial mortgage loans. FCB loans and leases increased $406.6 million or 5.1 percent, while ISB loans and leases increased $190.0 million or 11.3 percent during 2006. Loan growth during 2005 was affected by FCB’s securitization and sale of $256.2 million of revolving mortgage loans. Including the impact of the securitization and sale, FCB loans and leases declined $17.2 million or 0.2 percent during 2005. ISB loans and leases increased $305.8 million or 22.3 percent during 2005. Loan balances for the last five years are presented in Table 3.

Table 3

LOANS AND LEASES


	December 31
	2006		2005		2004		2003		2002
	(thousands)
Real estate:
Construction and land development	$	783,680	$	766,945	$	588,092	$	509,578	$	433,123
Commercial mortgage		3,725,752		3,518,563		3,279,729		2,654,414		2,366,149
Residential mortgage		1,025,235		1,016,677		979,663		929,096		1,077,937
Revolving mortgage		1,326,403		1,368,729		1,714,032		1,598,603		1,335,024
Other mortgage		165,223		172,712		171,700		173,489		166,023

Total real estate loans		7,026,293		6,843,626		6,733,216		5,865,180		5,378,256
Commercial and industrial		1,493,326		1,193,349		969,729		929,039		925,775
Consumer		1,360,524		1,318,971		1,397,820		1,303,718		1,154,280
Lease financing		294,366		233,499		192,164		160,390		141,372
Other		65,042		53,549		61,458		68,271		20,580

Total loans and leases		10,239,551		9,642,994		9,354,387		8,326,598		7,620,263
Less allowance for loan and lease losses		132,004		128,847		123,861		112,304		106,888

Net loans and leases	$	10,107,547	$	9,514,147	$	9,230,526	$	8,214,294	$	7,513,375

All information presented in this table relates to domestic loans and leases. There were no foreign loans or leases in any period.

Loans secured by real estate totaled $7.03 billion at December 31, 2006, compared to $6.84 billion at December 31, 2005 and $6.73 billion at December 31, 2004. Loans secured by commercial mortgages totaled $3.73 billion at December 31, 2006, a $207.2 million or 5.9 percent increase from December 31, 2005. Although we continued to see growth in commercial mortgage lending during 2006, the rate of growth slowed from 2005 and 2004, when we achieved growth rates of 7.3 percent and 23.6 percent, respectively. The sustained growth reflects the continued focus on small business customers targeted by our banking subsidiaries. As a percentage of total loans and leases, loans secured by commercial mortgages represent 36.4 percent at December 31, 2006, compared to 36.5 percent and 35.1 percent at December 31, 2005 and 2004, respectively. A large percentage of our commercial mortgage portfolio is secured by owner-occupied facilities, rather than investment property. 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, revolving loans secured by real estate totaled $1.33 billion in 2006, $1.37 billion in 2005, and $1.71 billion in 2004, respectively. The $42.3 million or 3.1 percent reduction in 2006 reflects a continuing migration by customers to fixed-rate lending alternatives. This trend results from rising short-term rates, which have caused the rates on variable rate revolving mortgage products to increase compared to generally stable rates on longer-term fixed-rate products. The $345.3 million or 20.1 percent reduction in 2005 resulted from the securitization and sale of $256.2 million of revolving mortgage loans and increased customer preference for fixed-rate loans. At December 31, 2006, revolving mortgage loans represented 13.0 percent of loans and leases, compared to 14.2 percent and 18.3 percent, respectively, at December 31, 2005 and 2004.

Commercial and industrial loans were $1.49 billion at December 31, 2006, compared to $1.19 billion at December 31, 2005 and $969.7 million at December 31, 2004. Commercial and industrial loans realized growth of $300.0 million or 25.1 percent during 2006 after an increase of $223.6 million or 23.1 percent between 2004 and 2005. Growth among these loans in 2006 results from continuing focus on business owners and medical professionals and new opportunities arising from our geographic expansion. Commercial and industrial loans represented 14.6 percent, 12.4 percent and 10.4 percent of loans and leases, respectively, as of December 31, 2006, 2005 and 2004.

Consumer loans totaled $1.36 billion at December 31, 2006, an increase of $41.6 million or 3.2 percent during 2006. During 2005, consumer loans decreased $78.8 million or 5.6 percent. At December 31, 2006, 2005 and 2004, consumer loans represented 13.3 percent, 13.7 percent and 14.9 percent of the total portfolio, respectively.

We anticipate continued growth in commercial mortgage and commercial and industrial loans in 2007. Our growth and expansion into new markets and stability in general economic conditions will likely translate into modestly higher levels of loan and lease demand among our business customers. All growth projections are subject to change as a result of further economic deterioration or improvement and other external factors.

Table 4

INVESTMENT SECURITIES


	December 31
	2006							2005				2004
	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	$	1,514,194	$	1,503,970	0/5	3.66	%	$	1,159,556	$	1,140,602	$	927,250	$	916,427
One to five years		1,367,029		1,363,571	1/8	4.84			1,055,472		1,044,913		253,120		250,317
Five to ten years		6,337		6,095	6/7	4.88			115		109		159		156
Over ten years		53,250		52,054	27/2	5.34			29,721		29,097		21,300		21,166

Total		2,940,810		2,925,690	1/6	4.24			2,244,864		2,214,721		1,201,829		1,188,066

State, county and municipal:
Within one year		875		873	0/5	2.96			954		947		838		835
One to five years		2,734		2,696	2/9	3.99			3,013		2,977		4,059		4,065
Five to ten years		470		477	6/2	4.92			1,115		1,110		1,301		1,305
Over ten years		211		211	24/7	3.46			145		145		145		145

Total		4,290		4,257	3/8	3.85			5,227		5,179		6,343		6,350

Other:
Within one year		—		—					—		—		—		—
One to five years		—		—					—		—		—
Five to ten years		—		—					—		—		—
Over ten years		10,173		10,240	11/4	11.08			11,902		11,902		—		—

Total		10,173		10,240	11/4	11.08			11,902		11,902

Equity securities		35,171		61,703					34,409		61,218		32,447		53,629

Total investment securities available for sale		2,990,444		3,001,890					2,296,402		2,293,020		1,240,619		1,248,045

Investment securities held to maturity:
U. S. Government:
Within one year		210,232		209,296	0/4	3.67			416,172		413,289		511,421		509,932
One to five years		3		3	3/2	8.00			209,207		207,234		351,264		349,425
Five to ten years		46		46	9/5	6.76			—		—		21		22
Over ten years		7,049		7,031	11/4	5.60			9,294		9,385		12,790		13,255

Total		217,330		216,376	0/8	3.73			634,673		629,908		875,496		872,634

State, county and municipal:
Within one year		—		—	—	—			—		—		165		168
One to five years		148		154	2/4	5.88			147		155		146		155
Five to ten years		—		—	—	—			—		—		—		—
Over ten years		1,430		1,553	11/4	6.02			1,426		1,563		1,422		1,572

Total		1,578		1,707	10/6	6.01			1,573		1,718		1,733		1,895

Other:
Within one year		—		—					—		—		—		—
One to five years		250		250	1/7	3.25			250		250		250		250
Five to ten years		—		—					—		—		—		—

Total		250		250	1/7	3.25			250		250		250		250

Total investment securities held to maturity		219,158		218,333	0/9	3.75			636,496		631,876		877,479		874,779

Total investment securities	$	3,209,602	$	3,220,223				$	2,932,898	$	2,924,896	$	2,118,098	$	2,122,824

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% for federal income taxes and 6.90% for state income taxes for all periods.

Investment Securities. At December 31, 2006, and 2005, the investment securities portfolio totaled $3.22 billion and $2.93 billion, respectively. Investment securities available for sale at December 31, 2006 and 2005 totaled $3.00 billion and $2.29 billion, respectively, a $708.9 million increase. Available-for-sale securities are reported at their aggregate fair value. The growth in investment securities available for sale during 2006 resulted from deposit and short-term borrowings growth that exceeded loan and lease demand, and the reinvestment of proceeds from maturing held-to-maturity securities into newly-purchased securities classified as available-for-sale. Unrealized gains and losses on available-for-sale securities are included as a component of shareholders’ equity, net of deferred taxes.

Investment securities held to maturity totaled $219.2 million and $636.5 million, respectively, at December 31, 2006 and 2005. The $417.3 million reduction in investment securities held to maturity during 2006 resulted from the continued migration of investments to the available-for-sale portfolio. 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 $825.3 million during 2006, a $159.3 million or 23.9 percent increase from 2005, compared to a $144.8 million or 27.8 percent increase from 2004 to 2005. The increase in interest income during 2006 resulted from higher yields and higher average assets.

Table 5 analyzes interest-earning assets and interest-bearing liabilities for the five years ending December 31, 2006. To assess the impact of the tax-exempt status of income earned on certain loans, leases and municipal securities, Table 5 is prepared on a taxable-equivalent basis. The taxable-equivalent yield on interest-earning assets was 6.08 percent during 2006, a 74 basis point increase from the 5.34 percent reported in 2005. The taxable-equivalent yield on interest-earning assets was 4.55 percent in 2004.

The taxable-equivalent yield on the loan and lease portfolio increased from 6.11 percent in 2005 to 6.83 percent in 2006. The combination of the 72 basis point yield increase, and the $596.7 million or 6.4 percent growth in average loans and leases contributed to an increase in loan interest income of $107.6 million or 18.8 percent over 2005. This followed an increase of $104.5 million or 22.4 percent in loan interest income in 2005 over 2004, the combined result of a $472.0 million increase in average loans and leases and an 85 basis point loan yield increase. The higher yields during both 2006 and 2005 reflect the impact of Federal Reserve actions to increase market interest rates.

We believe that additional interest rate increases by the Federal Reserve are unlikely during 2007 and that the yield on interest-earning assets will increase marginally compared to the end of 2006. However, due to uncertainty about interest rates, we continue to encourage variable rate lending to allow interest-sensitive assets to reprice as interest rates increase, thereby reducing the interest rate risk imbedded in the balance sheet.

Interest income earned on the investment securities portfolio amounted to $116.0 million, $75.9 million and $48.9 million during 2006, 2005 and 2004, respectively. The taxable-equivalent yield on the investment securities portfolio was 3.83 percent, 3.00 percent and 2.27 percent, respectively, for 2006, 2005 and 2004. The $40.1 million increase in investment interest income during 2006 reflected the 83 basis points increase in the taxable-equivalent yield and a $495.2 million increase in average investment securities. The $104.5 million increase in interest income earned on investment securities during 2005 resulted from a 73 basis point increase in the taxable-equivalent yield and a $375.8 million increase in average investment securities.

Table 5

AVERAGE BALANCE SHEETS


	2006							2005
	Average Balance			Interest Income/Expense		Yield/ Rate		Average Balance			Interest Income/Expense		Yield/ Rate
	(thousands, taxable equivalent)
Assets
Loans and leases	$	9,961,032		$	680,051	6.83	%	$	9,364,327		$	572,129	6.11	%
Investment securities:
U. S. Government		2,949,201			112,461	3.81			2,463,545			73,472	2.98
State, county and municipal		6,174			334	5.41			7,238			374	5.17
Other		73,009			3,304	4.53			62,378			2,224	3.57

Total investment securities		3,028,384			116,099	3.83			2,533,161			76,070	3.00
Overnight investments		619,247			30,903	4.99			595,467			19,208	3.23

Total interest-earning assets		13,608,663		$	827,053	6.08	%		12,492,955		$	667,407	5.34	%
Cash and due from banks		757,428							654,821
Premises and equipment		669,748							608,668
Allowance for loan and lease losses		(131,077	)						(127,968	)
Other assets		335,565							276,784

Total assets	$	15,240,327						$	13,905,260

Liabilities and shareholders’ equity
Interest-bearing deposits:
Checking With Interest	$	1,522,439		$	1,875	0.12	%	$	1,570,010		$	1,923	0.12	%
Savings		649,619			1,382	0.21			737,830			1,521	0.21
Money market accounts		2,691,292			79,522	2.95			2,643,330			50,171	1.90
Time deposits		4,967,591			197,399	3.97			4,209,996			123,016	2.92

Total interest-bearing deposits		9,830,941			280,178	2.85			9,161,166			176,631	1.93
Short-term borrowings		981,210			41,431	4.22			598,948			14,966	2.50
Long-term obligations		450,272			32,128	7.14			353,885			26,554	7.50

Total interest-bearing liabilities		11,262,423		$	353,737	3.14	%		10,113,999		$	218,151	2.16	%
Demand deposits		2,622,014							2,553,403
Other liabilities		114,636							106,792
Shareholders’ equity		1,241,254							1,131,066

Total liabilities and shareholders’ equity	$	15,240,327						$	13,905,260

Interest rate spread						2.94	%						3.18	%
Net interest income and net yield on interest-earning assets				$	473,316	3.48	%				$	449,256	3.60	%

Loans and leases include nonaccrual accounts. 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.

Table 5

AVERAGE BALANCE SHEETS (continued)


2004					2003							2002
Average Balance	Interest Income/Expense		Yield/ Rate		Average Balance			Interest Income/Expense		Yield/ Rate		Average Balance			Interest Income/Expense		Yield/ Rate
					(thousands, taxable equivalent)

$8,892,317	$	467,429	5.26	%	$	7,886,948		$	445,639	5.65	%	$	7,379,607		$	491,770	6.66	%

2,096,869		47,515	2.27			2,525,007			59,350	2.35			2,550,835			94,794	3.72
8,667		423	4.88			5,151			235	4.56			3,699			301	8.14
51,831		1,137	2.19			55,218			1,345	2.44			56,088			1,673	2.98

2,157,367		49,075	2.27			2,585,376			60,930	2.36			2,610,622			96,768	3.71
434,010		5,878	1.35			460,529			4,959	1.08			563,345			8,974	1.59

11,483,694	$	522,382	4.55	%		10,932,853		$	511,528	4.68	%		10,553,574		$	597,512	5.66	%
679,955						667,979							669,770
554,480						522,548							494,534
(124,834)						(115,737	)						(110,123	)
262,807						238,197							235,484

$12,856,102					$	12,245,840						$	11,843,239



$1,500,638	$	1,796	0.12	%	$	1,379,479		$	1,923	0.14	%	$	1,266,185		$	3,450	0.27	%
743,629		1,492	0.20			690,705			2,151	0.31			642,764			3,435	0.53
2,571,468		21,594	0.84			2,563,589			22,208	0.87			2,305,486			35,743	1.55
3,778,048		83,557	2.21			3,811,476			98,507	2.58			4,121,474			145,278	3.52

8,593,783		108,439	1.26			8,445,249			124,789	1.48			8,335,909			187,906	2.25
446,320		3,611	0.81			463,332			2,795	0.60			529,968			4,528	0.85
287,333		21,776	7.58			255,379			20,953	8.21			263,291			21,584	8.20

9,327,436	$	133,826	1.43	%		9,163,960		$	148,537	1.62	%		9,129,168		$	214,018	2.34	%
2,367,597						1,988,532							1,671,489
107,209						96,770							117,705
1,053,860						996,578							924,877

$12,856,102					$	12,245,840						$	11,843,239

			3.12	%						3.06	%						3.32	%
	$	388,556	3.38	%				$	362,991	3.32	%				$	383,494	3.63	%

Interest earned on overnight investments was $30.9 million during 2006, compared to $19.2 million during 2005 and $5.9 million during 2004. The $11.7 million increase during 2006 resulted from a 176 basis point yield increase and the $23.8 million increase in average overnight investments. During 2005, interest income earned from overnight investments increased $13.3 million over 2004, the combined result of a 188 basis point yield increase and a $161.5 million increase in average overnight investments.

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, in some cases, to fulfill commercial customer demand for cash management services. Certain of our long-term borrowings also currently qualify as capital under guidelines established by the Federal Reserve and other banking regulators.

At December 31, 2006 and 2005, interest-bearing liabilities totaled $11.61 billion and $10.75 billion, respectively, an increase of $866.7 million or 8.1 percent. The higher balances during 2006 result from increased levels of interest-bearing deposits and short-term borrowings. Interest-bearing liabilities averaged $11.26 billion during 2006, an increase of $1.15 billion or 11.4 percent over 2005 levels. During 2005, interest-bearing liabilities averaged $10.11 billion, an increase of $786.6 million or 8.4 percent over 2004.

Deposits. At December 31, 2006, deposits totaled $12.74 billion, an increase of $569.5 million or 4.7 percent from the $12.17 billion in deposits recorded as of December 31, 2005. Total deposits averaged $12.45 billion in 2006, an increase of $738.4 million or 6.3 percent over 2005, with a significant portion of that growth attributable to time deposits. During 2005, total deposits averaged $11.71 billion, an increase of $753.2 million or 6.9 percent over 2004.

Interest-bearing deposits averaged $9.83 billion during 2006, an increase of $669.8 million or 7.3 percent. Average interest-bearing deposits were $9.16 billion during 2005, an increase of $567.4 million or 6.6 percent over 2004. In 2006, the increase in average deposits resulted from growth in average time deposits, which increased $757.6 million or 18.0 percent. During 2005, average time deposits increased $431.9 million or 11.4 percent.

Table 6

MATURITIES OF TIME DEPOSITS OF $100,000 OR MORE


	December 31, 2006
	(thousands)
Less than three months	$	637,428
Three to six months		507,002
Six to 12 months		403,947
More than 12 months		513,299

Total	$	2,061,676

Competition for deposit business in our primary market areas is extremely intense. While we have access to non-deposit borrowing sources, we prefer to fund loan and lease demand with traditional bank deposits. Therefore, generating consistently solid deposit growth is a critical challenge for us, particularly during periods of strong loan demand.

Short-Term Borrowings. At December 31, 2006, short-term borrowings totaled $1.15 billion, compared to $779.0 million one year earlier, a 47.7 percent increase. For the year ended December 31, 2006, short-term borrowings averaged $981.2 million, compared to $598.9 million during 2005 and $446.3 million during 2004. The $382.3 million or 63.8 percent increase in short-term borrowings during 2006 was the result of significant growth in our commercial master note and repurchase agreement products. Customer interest in these commercial cash management products improved significantly due to more attractive rates on these sweep products. We continue to have access to various short-term borrowings, including the purchase of federal funds, overnight repurchase obligations and credit lines with various correspondent banks. At December 31, 2006, we had immediate access of up to $525.0 million on an unsecured basis and additional amounts under secured borrowing agreements with the Federal Home Loan Bank of Atlanta. Table 7 provides additional information regarding short-term borrowed funds.

Table 7

SHORT-TERM BORROWINGS


	2006				2005				2004
	Amount		Rate		Amount		Rate		Amount		Rate
	(thousands)
Master notes
At December 31	$	741,029	4.18	%	$	520,585	3.19	%	$	213,387	1.23	%
Average during year		643,926	4.28			353,871	2.61			197,268	0.82
Maximum month-end balance during year		776,734	—			520,585	—			213,387	—

Repurchase agreements
At December 31		251,135	3.68			150,054	2.69			131,367	0.73
Average during year		213,730	3.47			143,813	1.71			141,959	0.41
Maximum month-end balance during year		272,807	—			165,758	—			145,884	—

Federal funds purchased
At December 31		66,066	5.04			36,620	3.80			36,933	2.10
Average during year		47,662	4.84			45,595	3.10			46,676	1.23
Maximum month-end balance during year		68,620	—			59,139	—			66,125	—

Other
At December 31		92,617	4.56			71,769	3.43			65,999	1.90
Average during year		75,892	5.45			55,669	3.32			60,417	1.39
Maximum month-end balance during year		169,305	—			72,351	—			74,171	—

Long-Term Obligations. At December 31, 2006 and 2005, long-term obligations totaled $401.2 million and $409.0 million, respectively, a decrease of $7.8 million or 1.9 percent. During 2006, we issued $118.6 million in junior subordinated debentures as part of a trust preferred offering at a rate of LIBOR plus 1.75 percent. We also redeemed an 8.40 percent 2001 trust preferred issue in the amount of $103.1 million.

For 2006, long-term obligations includes $273.2 million in junior subordinated debentures representing obligations to two equity method subsidiaries, 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, 2006. 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.

As of December 31, 2005, long-term obligations include $257.7 million in junior subordinated debentures representing obligations to FCB/NC Capital Trust I and FCB/NC Capital Trust II, related to $250.0 million of trust preferred capital securities outstanding. The junior subordinated debenture and the related securities issued by FCB/NC Capital Trust II were redeemed during the fourth quarter of 2006.

Expense of Interest-Bearing Liabilities. Interest expense amounted to $353.7 million in 2006, a $135.6 million or 62.2 percent increase from 2005. This followed an $84.3 million or 63.0 percent increase in interest expense during 2005 compared to 2004. For both 2006 and 2005, the increase in interest expense was the result of higher interest rates and increased levels of interest-bearing liabilities. The blended rate on total interest-bearing liabilities equaled 3.14 percent during 2006, compared to 2.16 percent in 2005 and 1.43 percent in 2004. The rate increases during 2006 and 2005 were the result of higher market interest rates due to intense competition among banks for interest-bearing deposits combined with adjustments to index rates established by the Federal Reserve.

The aggregate rate on interest-bearing deposits was 2.85 percent during 2006, compared to 1.93 percent during 2005 and 1.26 percent during 2004. Coupled with the impact of growth in interest-bearing deposits, the higher rates caused interest expense on interest-bearing deposits to reach $280.2 million during 2006, a 58.6 percent increase from the $176.6

million recorded during 2005. A similar increase was noted in 2005 as compared to 2004. During both 2006 and 2005, increased rates and higher balances of time deposits and money market deposits caused the growth in interest expense on interest-bearing deposits.

Interest expense on short-term borrowings increased $26.5 million or 176.8 percent during 2006, the combined result of a 172 basis point rate increase and strong growth in balances, particularly among master note and repurchase obligations. During 2005, interest expense increased $11.4 million over 2004, the result of higher interest rates and growth in average short-term borrowings.

The interest expense recognized on long-term obligations increased $5.6 million during 2006 due to a $96.4 million or 27.2 percent increase in the average amount outstanding. This increase resulted from issuance of $125.0 million in subordinated notes during 2005 and the net impact of the issuance and redemption of junior subordinated debentures during 2006.

NET INTEREST INCOME

Net interest income was $471.5 million during 2006, a $23.7 million or 5.3 percent increase over 2005. During 2005, net interest income equaled $447.8 million, a $60.5 million or 15.6 percent increase from 2004. For both 2006 and 2005, the impact of higher interest rates had a favorable impact on net interest income, as the rate-influenced growth in interest income exceeded the growth in interest expense for each period. The impact of balance sheet growth was also favorable in both periods, as interest income resulting from growth among interest-earning assets exceeded the interest expense that resulted from higher interest-bearing liabilities.

However, the net yield on interest-earning assets declined 12 basis points from 3.60 percent during 2005 to 3.48 percent during 2006. This reduction resulted from the unfavorable impact of the flat yield curve which persisted during the entire year and the shrinking net short-term asset sensitivity of our balance sheet. The net yield on interest-earning assets increased 22 basis points in 2005 compared to 2004 due to the favorable impact of rate changes among interest-earning assets and interest-bearing liabilities.

Table 8 presents the annual changes in net interest income due to changes in volume and interest rates. Like Table 5, this table is presented on a taxable-equivalent basis to adjust for the tax-exempt status of income earned on certain loans, leases and municipal securities.

Table 8

CHANGES IN CONSOLIDATED TAXABLE EQUIVALENT NET INTEREST INCOME


	2006									2005
	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	$	38,478		$	69,444		$	107,922		$	26,971		$	77,729		$	104,700
Investment securities:
U. S. Government		16,507			22,482			38,989			9,696			16,261			25,957
State, county and municipal		(57	)		17			(40	)		(72	)		23			(49	)
Other		430			650			1,080			301			786			1,087

Total investment securities		16,880			23,149			40,029			9,925			17,070			26,995
Overnight investments		991			10,704			11,695			3,675			9,655			13,330

Total interest-earning assets	$	56,349		$	103,297		$	159,646		$	40,571		$	104,454		$	145,025

Liabilities
Interest-bearing deposits:
Checking With Interest	$	(53	)	$	5		$	(48	)	$	105		$	22		$	127
Savings		(163	)		24			(139	)		(29	)		58			29
Money market accounts		1,253			28,098			29,351			961			27,616			28,577
Time deposits		26,149			48,234			74,383			11,090			28,369			39,459

Total interest-bearing deposits		27,186			76,361			103,547			12,127			56,065			68,192
Short-term borrowings		12,859			13,606			26,465			2,524			8,831			11,355
Long-term obligations		7,038			(1,464	)		5,574			5,026			(248	)		4,778

Total interest-bearing liabilities	$	47,083		$	88,503		$	135,586		$	19,677		$	64,648		$	84,325

Change in net interest income	$	9,266		$	14,794		$	24,060		$	20,894		$	39,806		$	60,700

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 $1,801, $1,473 and $1,265 for the years 2006, 2005 and 2004 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.

NONINTEREST INCOME

The 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 service income, service charges generated from deposit accounts, various types of commission-based income including sales of investments by our broker-dealer subsidiaries, fees from processing services for client banks and various types of revenues derived from wealth management services, including trust and asset management income. Total noninterest income was $279.3 million during 2006, an increase of $15.6 million or 5.9 percent from 2005. Noninterest income during 2005 was $263.8 million, a $12.5 million or 5.0 percent increase from 2004. Table 9 presents the major components of noninterest income for the past five years.

The increase in noninterest income during 2006 can be attributed to increases in cardholder and merchant services income, commission-based income, trust and asset management fees and fees from processing services. These increases were partially offset by reductions in service charges on deposit accounts. Cardholder and merchant services income amounted to $86.1 million in 2006, compared to $75.3 million in 2005 and $64.1 million in 2004. The growth in 2006 represents a $10.8 million or 14.3 percent increase, the result of higher credit card merchant discount and higher interchange fees for debit and credit card transactions. Although processing costs and other expenses for cardholder and merchant services similarly grew at a rapid pace, we continue to view this source of noninterest income as a key growth area.

Commission-based income increased $6.5 million to $32.5 million in 2006 from $26.0 million in 2005. In 2004, commission-based income was $24.6 million. The 24.8 percent increase in 2006 resulted from a $4.3 million or 28.6 percent increase in broker-dealer commissions and a $1.5 million or 40.4 percent increase in revenue generated by our working capital finance group, much of which relates to services offered in the medical market.

Table 9

NONINTEREST INCOME


	Year ended December 31
	2006			2005			2004		2003		2002
	(thousands)
Cardholder and merchant services	$	86,103		$	75,298		$	65,903	$	56,432	$	50,174
Service charges on deposit accounts		72,561			77,376			81,478		78,273		75,870
Commission-based income:
Broker-dealer		19,436			15,119			14,719		15,387		14,000
Insurance		8,003			7,318			7,008		6,180		5,930
Working capital finance		5,063			3,606			2,896		2,380		2,037

Total commission-based income		32,502			26,043			24,623		23,947		21,967
Fees from processing services		29,631			25,598			23,888		20,590		18,929
Trust and asset management fees		21,586			18,588			16,913		15,005		14,897
Mortgage income		8,408			7,868			8,352		15,469		11,605
ATM income		6,803			7,843			8,416		7,894		8,418
Other service charges and fees		16,062			16,507			13,688		14,463		14,744
Securities (losses) gains		(659	)		(492	)		1,852		309		(1,081	)
Gain on sale of branches		826			—			426		5,710		—
Other		5,521			9,150			5,732		6,084		4,952

Total	$	279,344		$	263,779		$	251,271	$	244,176	$	220,475

During 2006, fees from processing services totaled $29.6 million, an increase of $4.0 million or 15.8 percent over 2005. During 2005, BancShares recognized $25.6 million in fees from processing services, an increase of $1.7 million or 7.2 percent over the $23.9 million recognized during 2004. Growth in the number of transactions and types of services provided to client banks and the addition of new clients created a favorable volume variance during 2006. In each year, a substantial portion of the income resulted from services provided to financial institutions controlled by related persons. During 2006, 2005 and 2004, fees from processing services provided to banks controlled by related persons totaled $26.1 million, $24.0 million, and $23.0 million, respectively, while the fees generated by the largest individual institution totaled $16.9 million, $14.4 million and $13.5 million, respectively. We continue to seek opportunities to provide processing services to unrelated persons.

During 2006, trust and asset management fees totaled $21.6 million, compared to $18.6 million during 2005 and $16.9 million in 2004. Improvements in capital market conditions and our emphasis on expanding wealth management services have resulted in higher income.

Service charges on deposit accounts equaled $72.6 million during 2006, compared to $77.4 million in 2005 and $81.5 million in 2004. The $4.8 million or 6.2 percent decrease in service charge income during 2006 reflects the result of lower service charge and overdraft fees when compared to 2005. Personal service charge income decreased during 2006 due to the growth of low-cost and free checking accounts. Commercial service charge income declined due to the higher interest rates, which resulted in reduced service charges for commercial customers.

The securitization and sale of $256.2 million in revolving mortgage loans generated a gain of $2.9 million during 2005. This gain is included in other noninterest income. No such gain resulting from securitization activities was recorded in any other period.

We anticipate continued growth during 2006 among cardholder and merchant services income, processing services, trust and asset management fees and selected commission-based income sources. We anticipate continued reductions in deposit service charge income.

Table 10

NONINTEREST EXPENSE


	Year ended December 31
	2006		2005		2004		2003		2002
	(thousands)
Salaries and wages	$	231,386	$	215,504	$	207,088	$	199,703	$	186,756
Employee benefits		50,445		51,517		48,624		45,958		42,199
Equipment expense		52,490		50,291		50,125		50,436		45,406
Occupancy expense		52,153		46,912		43,997		42,430		38,316
Cardholder and merchant services expense		37,286		32,067		28,290		24,119		22,123
Telecommunication expense		9,844		9,873		10,461		11,455		10,753
Cardholder reward programs		9,228		5,878		5,763		5,458		5,604
Postage expense		8,926		8,045		8,639		8,826		8,242
Advertising expense		7,212		7,206		7,981		7,566		7,520
Legal expense		5,244		4,124		5,978		5,851		5,063
Consultant expense		2,254		3,362		2,980		3,747		2,543
Amortization of intangibles		2,318		2,453		2,360		2,583		2,803
Other		65,221		62,551		57,608		57,196		55,205

Total	$	534,007	$	499,783	$	479,894	$	465,328	$	432,533

NONINTEREST EXPENSE

The primary components of noninterest expense are salaries and related employee benefit costs, equipment and software costs related to branch offices and technology, and occupancy costs related to branch offices and support facilities. Noninterest expense for 2006 amounted to $534.0 million, a $34.2 million or 6.8 percent increase over 2005. Noninterest expense in 2005 was $499.8 million, a $19.9 million or 4.1 percent increase over 2004. Table 10 presents the major components of noninterest expense for the past five years. For 2006 and 2005, $6.2 million and $12.9 million of the respective increases in total noninterest expense are attributable to the continued growth and expansion of ISB.

Salary expense was $231.4 million during 2006, compared to $215.5 million during 2005, an increase of $15.9 million or 7.4 percent, following an $8.4 million or 4.1 percent increase in 2005 over 2004. The increase in 2006 is attributable to higher incentive-based compensation, which increased $4.2 million or 29.3 percent, incremental staff costs for new branch offices and merit increases. ISB’s salary costs increased by $2.8 million or 10.6 percent in 2006, primarily related to additional staff for expansion and growth in new markets. Our continued focus on branch expansion and wealth management activities will result in incremental salary costs in 2007

Employee benefits expense equaled $50.4 million during 2006, a decrease of $1.1 million or 2.1 percent from 2005 due to the favorable impact of reduced pension costs in 2006 and the $1.8 million cost recorded in 2005 related to an accrual for executive post-employment benefits available for separation from service at specified ages. Pension expense decreased $2.4 million or 17.7 percent due to the benefit of substantial cash infusions into the plan over the last three years and strong investment returns on plan assets. However, health and disability expense increased $2.6 million or 17.3 percent in 2006 when compared to 2005 due to higher claims cost.

Equipment expense for 2006 was $52.5 million for 2006 and $50.3 million in 2005. The $2.2 million increase during 2006 resulted primarily from higher costs for depreciation expense and maintenance costs for equipment and software.

BancShares recorded occupancy expense of $52.2 million during 2006, an increase of $5.2 million or 11.2 percent during 2006. Occupancy expense during 2005 was $46.9 million, an increase of $2.9 million or 6.6 percent over 2004. The increase in occupancy expense in each period resulted from higher depreciation expense attributable to newly constructed branches. The growth during 2006 also reflected the impact of increased depreciation and operating expenses recognized for our corporate headquarters building. ISB’s occupancy expense increased $1.6 million or 14.4 percent during 2006.

Expenses related to cardholder and merchant processing amounted to $37.3 million in 2006 and $32.1 million in 2005. This increase of $5.2 million or 16.3 percent is primarily due to growth in credit and debit card transactions and

higher levels of merchant volume. In 2005, card processing expense increased $3.8 million or 13.4 percent from 2004, likewise due to volume increases. We anticipate this volume-based expense will continue to increase during 2007.

Cardholder reward program expense surged $3.4 million or 57.0 percent during 2006 due to the introduction of expanded reward programs for cardholders to augment an existing air travel reward program.

Courier services increased $1.5 million or 30.5 percent during 2006, due to costs related to additional client banks and higher fuel costs. As a result a recent renegotiation of our courier contract, we anticipate this cost will stabilize during 2007. Postage costs increased $881,000 or 11.0 percent during 2006 due to increased mail volume and higher postage rates. Legal expense increased $1.1 million or 27.2 percent primarily due to collection efforts on nonaccrual loans and defense costs related to various litigation matters in which we have been named as a defendant.

INCOME TAXES

During 2006, BancShares recorded total income tax expense of $69.5 million, compared to $65.8 million during 2005 and $49.4 million in 2004. BancShares’ effective tax rate was 35.4 percent in 2006, 36.8 in 2005 and 39.7 percent in 2004. The lower effective tax rate during 2006 resulted from the benefit of credits earned for low-income housing investments and changes to the deferred tax asset valuation allowance and blended state tax rates. The $1.0 million reduction in the deferred tax asset valuation allowance during 2006 related to the taxable income generated by ISB.

During 2004, in conjunction with our ongoing review of the adequacy of our income tax obligations, we identified unallocated income tax liabilities that were no longer needed and were therefore reversed. Also during 2004, the North Carolina Department of Revenue conducted an examination of BancShares’ North Carolina tax returns for 2000, 2001 and 2002. Including interest and net of federal benefit, the net additional amount of tax expense recorded for these items amounted to $2.7 million.

SHAREHOLDERS’ EQUITY

Management regularly monitors the capital levels and capital ratios for BancShares and the subsidiary banks to ensure they are adequate to exceed the minimum capital requirements imposed by their respective regulatory authorities, and to ensure that the subsidiary banks’ capital is appropriate given each bank’s growth projections 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, 2006, 2005 and 2004.

Table 11

ANALYSIS OF CAPITAL ADEQUACY


	December 31									Regulatory Minimum
	2006			2005			2004			Regulatory Minimum
	(dollars in thousands)
First Citizens BancShares, Inc.
Tier 1 capital	$	1,456,947		$	1,320,152		$	1,217,149
Tier 2 capital		275,079			267,989			134,386

Total capital	$	1,732,026		$	1,588,141		$	1,351,535

Risk-adjusted assets	$	11,266,342		$	10,510,254		$	10,023,469

Risk-based capital ratios
Tier 1 capital		12.93	%		12.56	%		12.14	%	4.00	%
Total capital		15.37	%		15.11	%		13.48	%	8.00	%
Tier 1 leverage ratio		9.39	%		9.17	%		9.26	%	3.00	%

First-Citizens Bank & Trust Company
Tier 1 capital	$	1,104,132		$	998,152		$	900,183
Tier 2 capital		240,070			234,311			107,467

Total capital	$	1,344,202		$	1,232,463		$	1,007,650

Risk-adjusted assets	$	9,238,512		$	8,739,531		$	8,590,360
Average total assets		13,250,610			12,523,144			11,622,295
Risk-based capital ratios
Tier 1 capital		11.95	%		11.42	%		10.48	%	4.00	%
Total capital		14.55	%		14.10	%		11.73	%	8.00	%
Tier 1 leverage ratio		8.33	%		7.97	%		7.75	%	3.00	%

IronStone Bank
Tier 1 capital	$	245,402		$	215,263		$	199,577
Tier 2 capital		23,576			21,101			16,397

Total capital	$	268,978		$	236,364		$	215,974

Risk-adjusted assets	$	1,953,178		$	1,821,048		$	1,441,487
Adjusted total assets		2,130,770			1,849,828			1,495,250
Risk-based capital ratios
Tier 1 capital		12.56	%		11.82	%		13.85	%	4.00	%
Total capital		13.77	%		12.98	%		14.98	%	8.00	%
Tangible equity ratio		11.52	%		11.64	%		13.35	%	3.00	%

BancShares continues to exceed minimum capital standards and the banking subsidiaries remain well-capitalized. The continued de novo growth of ISB has required BancShares to infuse significant amounts of capital into ISB to support its rapidly expanding balance sheet. Infusions totaled $30.0 million in 2006, $20 million in 2005, and $30.0 million in 2004. Since ISB was formed in 1997, BancShares has provided $280.0 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 source for capital infusions into ISB to fund its continuing growth and expansion. These dividends also fund BancShares’ payment of shareholder dividends and interest payments on its long-term obligations. During 2006, FCB declared dividends to BancShares in the amount of $40.0 million, compared to $32.2 million in 2005 and $50.2 million in 2004.

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.

The 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. The maintenance of excellent asset quality is one of our key performance measures. 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, and much of the credit decision process is centralized. 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 sectors within the banking subsidiaries. BancShares strives 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.

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 recent expansion of our branch network has allowed us to mitigate our historic exposure to geographic risk concentration in North Carolina and Virginia.

In recent years, we have aggressively 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 $1.26 billion as of December 31, 2006, which represents 12.4 percent of total loans and leases outstanding, compared to $1.32 billion or 13.7 percent of loans and leases at December 31, 2005. Except for this single concentration, no other industry represented more than 10 percent of total loans and leases outstanding at December 31, 2006.

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, 2006, we had $1.08 billion or 10.6 percent of loans and leases that exceeded the loan-to-value ratios recommended by the guidelines. At December 31, 2005, loan-to-value exceptions totaled $1.08 billion or 11.2 percent of loans and leases. 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.

Table 12

NONPERFORMING ASSETS


	December 31,
	2006			2005			2004			2003			2002
	(thousands, except ratios)
Nonaccrual loans and leases	$	14,882		$	18,969		$	14,266		$	18,190		$	15,521
Other real estate		6,028			6,753			9,020			5,949			7,330

Total nonperforming assets	$	20,910		$	25,722		$	23,286		$	24,139		$	22,851

Accruing loans and leases 90 days or more past due	$	5,185		$	9,180		$	12,192		$	11,492		$	9,566
Loans and leases at December 31	$	10,239,551		$	9,642,994		$	9,354,387		$	8,326,598		$	7,620,263
Ratio of nonperforming assets to total loans and leases plus other real estate		0.20	%		0.27	%		0.25	%		0.29	%		0.30	%

Interest income that would have been earned on nonperforming loans and leases had they been performing	$	1,271		$	551		$	773		$	1,182		$	1,190
Interest income earned on nonperforming loans and leases		226			821			281			356			753

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

Nonperforming assets include nonaccrual loans and leases and other real estate. 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 an 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 as well as branch facilities that we have closed but not sold. Nonperforming asset balances for the past five years are presented in Table 12.

BancShares’ nonperforming assets at December 31, 2006 totaled $20.9 million, compared to $25.7 million at December 31, 2005 and $23.3 million at December 31, 2004. A portion of the reduction experienced in during 2006 is attributable to write downs taken on a single relationship that was classified as non-accrual as of December 31, 2005. As a percentage of total loans, leases and other real estate, nonperforming assets represented 0.20 percent, 0.27 percent and 0.25 percent as of December 31, 2006, 2005 and 2004. These ratios are low by industry standards, evidence of our strong focus on asset quality. We continue to closely monitor past due accounts to identify any loans and leases that should be classified as impaired or non-accrual.

At December 31, 2006, BancShares’ allowance for credit losses was $138.6 million or 1.35 percent of loans and leases outstanding. This compares to $135.8 million or 1.41 percent at December 31, 2005, and $130.8 million or 1.40 percent at December 31, 2004.

The provision for credit losses charged to operations was $20.9 million during 2006 compared to $33.1 million during 2005 and $34.5 million during 2004. The $12.2 million or 36.9 percent decrease in provision for credit losses from 2005 to 2006 resulted primarily from a reduction in net charge-offs during 2006.

Table 13

ALLOWANCE FOR CREDIT LOSSES


	2006			2005			2004			2003			2002
	(thousands, except ratios)
Allowance for credit losses at beginning of period	$	135,770		$	130,832		$	119,357		$	112,533		$	107,087
Adjustment for sale of loans		—			(1,585	)		—			—			—
Acquired allowance for credit losses		—			—			—			409			—
Provision for credit losses		20,906			33,109			34,473			24,187			26,550
Charge-offs:
Real estate:
Construction and land development		—			(1	)		(13	)		(16	)		(580	)
Commercial mortgage		(124	)		(551	)		(804	)		(318	)		(1,186	)
Residential mortgage		(1,717	)		(1,912	)		(2,351	)		(1,594	)		(2,916	)
Revolving mortgage		(1,475	)		(951	)		(1,384	)		(1,392	)		(902	)
Other mortgage		—			—			—			—			—

Total real estate loans		(3,316	)		(3,415	)		(4,552	)		(3,320	)		(5,584	)
Commercial and industrial		(10,362	)		(18,319	)		(9,583	)		(7,101	)		(7,654	)
Consumer		(9,171	)		(10,425	)		(12,238	)		(10,481	)		(10,117	)
Lease financing		(1,488	)		(347	)		(173	)		(756	)		(1,585	)

Total charge-offs		(24,337	)		(32,506	)		(26,546	)		(21,658	)		(24,940	)

Recoveries:
Real estate:
Construction and land development		—			—			34			10			—
Commercial mortgage		182			409			236			164			954
Residential mortgage		290			432			244			631			239
Revolving mortgage		182			155			103			63			15
Other mortgage		—			—			—			—			—

Total real estate loans		654			996			617			868			1,208
Commercial and industrial		1,358			2,164			1,084			1,428			1,212
Consumer		4,140			2,672			1,761			1,590			1,413
Lease financing		155			88			86			—			3

Total recoveries		6,307			5,920			3,548			3,886			3,836

Net charge-offs		(18,030	)		(26,586	)		(22,998	)		(17,772	)		(21,104	)

Allowance for credit losses at end of period	$	138,646		$	135,770		$	130,832		$	119,357		$	112,533

Allowance for credit losses includes:
Allowance for loan and lease losses	$	132,004		$	128,847		$	123,861		$	112,304		$	106,889
Reserve for unfunded commitments		6,642			6,923			6,971			7,053			5,644

Allowance for credit losses at end of period	$	138,646		$	135,770		$	130,832		$	119,357		$	112,533

Average loans and leases	$	9,961,032		$	9,364,327		$	8,892,317		$	7,886,948		$	7,379,607
Loans and leases at year-end		10,239,551			9,642,994			9,354,387			8,326,598			7,620,263
Ratios
Net charge-offs to average loans and leases		0.18	%		0.28	%		0.26	%		0.23	%		0.29	%
Percent of loans and leases at period-end:
Allowance for loan and lease losses		1.29			1.34			1.32			1.35			1.40
Reserve for unfunded commitments		0.06			0.07			0.07			0.08			0.07
Allowance for credit losses		1.35			1.41			1.40			1.43			1.48

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

Net charge-offs for 2006 totaled $18.0 million, compared to $26.6 million during 2005, and $23.0 million during 2004. The ratio of net charge-offs to average loans and leases outstanding equaled 0.18 percent during 2006, 0.28 percent during 2005 and 0.26 percent during 2004. These low loss ratios reflect the quality of BancShares’ loan and lease portfolio and are a key indicator that we closely monitor to evaluate our operational performance. Table 13 provides details concerning the allowance for credit losses and provision for credit losses for the past five years.

Gross charge-offs for 2006 were $24.3 million, compared to $32.5 million in 2005, a decrease of $8.2 million or 25.1 percent. Gross charge-offs in 2005 represented a $6.0 million or 22.5 percent increase over the $26.5 million recorded in 2004. During 2006, charge-offs of commercial and industrial loans declined $8.0 million, primarily the result of losses on a single relationship recorded during 2005. Consumer loan charge-offs decreased $1.3 million, while lease financing charge-offs increased $1.1 million.

Table 14

ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES


	December 31
	2006				2005				2004				2003				2002
	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
	(thousands)
Real estate:
Construction and land development	$	9,351	7.65	%	$	8,985	7.95	%	$	7,704	6.29	%	$	7,806	10.26	%	$	7,911	10.49	%
Commercial mortgage		41,626	36.39			39,356	36.49			37,769	35.06			33,054	28.20			31,380	26.71
Residential mortgage		6,954	10.01			6,822	10.54			6,387	10.47			5,577	10.86			5,581	13.89
Revolving mortgage		8,848	12.95			9,094	14.19			11,992	18.32			9,725	19.20			7,519	17.52
Other mortgage		2,145	1.61			2,242	1.79			2,249	1.84			2,113	1.92			1,863	1.97

Total real estate loans		68,924	68.61			66,499	70.96			66,101	71.98			58,275	70.44			54,254	70.58
Commercial and industrial		35,883	14.58			32,834	12.38			29,191	10.37			26,921	11.16			23,705	12.15
Consumer		24,333	13.29			24,519	13.68			25,845	14.94			24,564	15.65			25,326	15.14
Lease financing		3,562	2.87			2,389	2.42			2,229	2.05			2,518	1.93			2,036	1.86
Other		723	0.65			576	0.56			743	0.66			901	0.82			255	0.27
Unallocated		5,221				8,953				6,723				6,178				6,957

Total	$	138,646	100.00	%	$	135,770	100.00	%	$	130,832	100.00	%	$	119,357	100.00	%	$	112,533	100.00	%

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. Generally, loans and leases to commercial customers are evaluated individually and assigned a credit grade, while loans to retail customers are evaluated among groups of loans with similar characteristics. Loans and leases evaluated individually are assigned a credit grade using such factors as the borrower’s cash flow, the value of any underlying collateral and the strength of any guarantee. The rating becomes the basis for the allowance allocation for that individual loan or lease. Groups of loans are aggregated over their remaining estimated behavioral lives and probable loss projections for each period become the basis for the allowance allocation. The loss projections are based on historical loss patterns and current economic conditions.

The amount of the allowance for credit losses not allocated through these loss models represents the unallocated portion of the allowance. The decrease in the unallocated allowance during 2006 results from refinements to the allowance model.

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 may also have a direct or indirect 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 net interest income simulations are prepared over a 12-month and 24-month forecast horizon. As of December 31, 2006, net interest income for the subsequent 12-month period under both a gradual 200-basis point rate reduction and an immediate 200-basis point rate reduction increased by less than 2.0 percent as compared to the stable rate scenario. Similarly, net interest income for the ensuing 12-month period under both a gradual 200-basis point rate increase and an immediate 200-basis point rate increase declined by less than 2.0 percent as compared to the stable rate scenario.

We also utilize the market value of equity as a measurement tool in measuring and managing 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, 2006, the market value of equity is estimated to increase by 8.8 percent given a 200-basis point immediate decrease in interest rates, and decline by 6.1 percent when interest rates immediately increase by 200 basis points. 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 than for interest-bearing liabilities.

As our largest single asset, the impact of maturities and repricings within our loan and lease portfolio has a significant impact on our interest rate risk. Table 15 provides a loan maturity distribution and information regarding the sensitivity of loans and leases to changes in interest rates.

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.

Table 15

LOAN MATURITY DISTRIBUTION AND INTEREST RATE SENSITIVITY


	December 31, 2006
	Within One Year		One to Five Years		After Five Years		Total
	(thousands)
Real estate:
Construction and land development	$	416,376	$	245,671	$	121,633	$	783,680
Commercial mortgage		1,411,908		1,534,899		778,945		3,725,752
Residential mortgage		315,401		373,633		336,201		1,025,235
Revolving mortgage		185,696		318,337		822,370		1,326,403
Other mortgage		62,280		68,865		34,078		165,223

Total real estate loans		2,391,661		2,541,405		2,093,227		7,026,293
Commercial and industrial		514,016		570,486		408,824		1,493,326
Consumer		288,904		913,949		157,671		1,360,524
Lease financing		73,592		220,774		—		294,366
Other		26,825		24,224		13,993		65,042

Total	$	3,294,998	$	4,270,838	$	2,673,715	$	10,239,551

Loans maturing after one year with:
Fixed interest rates			$	2,960,931	$	1,568,673	$	4,529,604
Floating or adjustable rates				1,309,907		1,105,040		2,414,947

Total			$	4,270,838	$	2,673,713	$	6,944,551

Liquidity Risk. Liquidity risk results from the mismatching of asset and liability cash flows. 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 our deposit base represents our primary liquidity source. The rate of growth in average deposits was 6.3 percent during 2006, 6.9 percent during 2005 and 5.1 percent during 2004. Through our deposit pricing strategies, we have the ability to stimulate or curtail deposit growth. In addition to deposits, BancShares maintains additional sources for borrowed funds through federal funds lines of credit and other borrowing facilities. At December 31, 2006, BancShares had access to $525.0 million in unfunded borrowings through its various sources.

Once we have generated the needed liquidity and have satisfied our loan demand, residual liquidity is invested in overnight and longer-term investment products. Investment securities available for sale provide immediate liquidity as needed. At December 31, 2006, investment securities available for sale totaled $3.00 billion compared to $2.29 billion at December 31, 2005. At December 31, 2006 and 2005, the sum of cash and due from banks, overnight investments and investment securities available for sale represent 27.7 percent and 24.3 percent of total assets, respectively.

In addition, investment securities held to maturity provide an ongoing liquidity source based on the scheduled maturity dates of the securities. These securities totaled $219.2 million at December 31, 2006 compared to $636.5 million at December 31, 2005. Investment securities held to maturity had an average maturity of nine months at December 31, 2006, compared to eleven months at December 31, 2005.

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 markets, throughout its history, much of its expansion has been accomplished on a de novo basis. However, because of FCB’s relative size, the costs associated with de novo branching at its current rate of expansion are not material to FCB’s financial performance. Since it first opened in 1997, ISB has followed a similar business model for growth and expansion. However, due to the number of branch offices that have yet to attain sufficient size for 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 offset by revenues until the third year of operation. ISB’s rapid growth in new markets in recent years has continued to adversely impact its financial performance. Losses incurred since ISB’s inception total $27.0 million.

IronStone Bank. At December 31, 2006, ISB operated 56 facilities in Florida, Georgia, Texas, New Mexico, Arizona, California, Colorado, Oregon and Washington. ISB continues to focus on markets with favorable growth prospects. Our business model for these new markets has two pivotal 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. Both of these are costly goals, but we believe that they are critical to establishing a solid foundation for future success in these new markets.

As a result of expansion into new markets and growth in existing markets, ISB’s total assets increased from $1.86 billion at December 31, 2005 to $2.14 billion at December 31, 2006, an increase of $280.7 million or 15.1 percent. ISB’s net interest income increased $5.1 million or 8.3 percent during 2006, the result of balance sheet growth. Loans and leases increased $190.0 million or 11.3 percent from $1.68 billion at December 31, 2005 to $1.87 billion at December 31, 2006.

Provision for credit losses decreased $4.5 million or 55.8 percent during 2006, due to lower net charge offs and slower loan growth. Net charge-offs amounted to $1.1 million during 2006, compared to $3.7 million in 2005, a decrease of $2.6 million.

ISB’s noninterest income increased $3.5 million or 44.9 percent during 2006, primarily the result of higher cardholder and merchant services income and commissions generated by the working capital finance group.

Noninterest expense increased $6.2 million or 9.5 percent during 2006, the result of higher personnel and occupancy costs incurred in conjunction with the opening of new branch offices as well as higher cardholder processing costs.

ISB recorded net income of $2.2 million during 2006 compared to net losses of $2.9 million during 2005 and $3.0 million in 2004.

During the first quarter of 2007, ISB announced plans to expand its Texas franchise into the Dallas area and to establish new branches in Oklahoma City and Kansas City. As its growth continues, ISB will continue to incur incremental operating costs, particularly in the areas of personnel, occupancy and equipment. As a result of the anticipated expansion of its franchise, ISB will operate at a near breakeven level during 2007.

First-Citizens Bank & Trust Company. At December 31, 2006, FCB operated 340 branches, compared to 339 branches at December 31, 2005. In addition to its established franchise in North Carolina, Virginia and West Virginia, FCB opened new offices in Maryland and Tennessee during 2005.

FCB’s total assets increased from $12.71 billion at December 31, 2005 to $13.33 billion at December 31, 2006, an increase of $622.1 million or 4.9 percent. FCB’s net interest income increased $21.4 million or 5.3 percent during 2006, benefiting from growth in interest-earning assets. Provision for credit losses decreased $7.7 million or 30.8 percent during 2006 due to lower net charge-offs and slower loan growth.

FCB’s noninterest income increased $13.3 million or 5.1 percent during 2006, primarily the result of higher cardholder and merchant services income, commission-based income and client bank income.

Noninterest expense increased $29.0 million or 6.6 percent during 2006, due to higher personnel, credit card processing and occupancy expense. FCB recorded net income of $139.1 million during 2006 compared to $128.5 million during 2005. This represents a $10.6 million or 8.3 percent increase in net income.

FOURTH QUARTER ANALYSIS

BancShares reported net income of $33.2 million for the quarter ended December 31, 2006, compared to $27.8 million for the corresponding period of 2005, an increase of 19.3 percent. Per share income for the fourth quarter 2006 totaled $3.18 compared to $2.67 for the same period of 2005. BancShares’ results generated an annualized return on average assets of 0.84 percent for the fourth quarter of 2006, compared to 0.76 percent for the same period of 2005. The annualized return on average equity equaled 10.19 percent during the fourth quarter of 2006, compared to 9.45 percent for the same period of 2005. In the fourth quarter, higher noninterest income and lower provision for credit losses contributed to the improvement in net income. These benefits were partially offset by higher noninterest expense and lower net interest income.

Net interest income decreased $331,000 or 0.3 percent in the fourth quarter of 2006, compared to the same period of 2005. The taxable-equivalent net yield on interest-earning assets decreased from 3.58 percent in the fourth quarter of 2005 to 3.34 percent for the fourth quarter of 2006.

Average interest-earning assets increased $926.3 million to $13.95 billion from the fourth quarter of 2005 to the fourth quarter of 2006. Average loans and leases outstanding during the fourth quarter of 2006 were $10.13 billion, an increase of $678.4 million or 7.2 percent over 2005. The yield on interest-earning assets increased 60 basis points from 5.62 percent in 2005 to 6.22 percent in 2006. The yield on average loans and leases improved 50 basis points to 6.94 percent while the taxable-equivalent yield on investment securities increased 78 basis points to 4.11 percent.

Average interest-bearing liabilities increased $980.4 million to $11.60 billion. Average time deposits increased $654.8 million or 14.6 percent to $5.13 billion while average short-term borrowings increased $421.6 million or 55.4 percent to $1.18 billion due to strong growth among master note borrowings and repurchase obligations. The rate on average interest-bearing liabilities increased 97 basis points to 3.46 percent in 2006.

The provision for credit losses decreased $6.2 million or 45.6 percent in the fourth quarter of 2006, compared to the same period of 2005 due to lower net charge-offs, primarily the result of losses sustained on a single relationship during the fourth quarter of 2005. Net charge-offs were $7.0 million during the fourth quarter of 2006, compared to $11.0 million during the same period of 2005.

Noninterest income increased $5.8 million or 8.8 percent during the fourth quarter. Cardholder and merchant services income increased $3.2 million or 16.9 percent due to favorable volume growth, while trust and asset management fees increased $1.4 million or 30.5 percent due to improved market returns. Deposit service charge income declined by $1.4 million.

Table 16

SELECTED QUARTERLY DATA


	2006												2005
	Fourth Quarter			Third Quarter			Second Quarter			First Quarter			Fourth Quarter			Third Quarter			Second Quarter			First Quarter
	(thousands, except per share data and ratios)
SUMMARY OF OPERATIONS
Interest income	$	218,102		$	214,650		$	202,499		$	190,001		$	183,949		$	173,534		$	160,206		$	148,245
Interest expense		101,215			96,773			83,566			72,183			66,731			59,306			49,536			42,578

Net interest income		116,887			117,877			118,933			117,818			117,218			114,228			110,670			105,667
Provision for credit losses		7,383			3,813			2,973			6,737			13,578			7,211			6,994			5,326

Net interest income after provision for credit losses		109,504			114,064			115,960			111,081			103,640			107,017			103,676			100,341
Noninterest income		71,381			72,605			69,609			65,749			65,589			68,220			68,699			61,271
Noninterest expense		132,223			134,865			135,207			131,712			125,527			128,779			124,084			121,393

Income before income taxes		48,662			51,804			50,362			45,118			43,702			46,458			48,291			40,219
Income taxes		15,467			18,877			18,650			16,461			15,866			16,505			18,215			15,222

Net income	$	33,195		$	32,927		$	31,712		$	28,657		$	27,836		$	29,953		$	30,076		$	24,997

Net interest income, taxable equivalent	$	117,394		$	118,345		$	119,351		$	118,226		$	117,601		$	114,603		$	111,038		$	106,014

SELECTED QUARTERLY AVERAGES
Total assets	$	15,628,835		$	15,477,992		$	15,322,373		$	14,699,290		$	14,516,620		$	14,160,391		$	13,618,161		$	13,309,802
Investment securities		3,176,845			3,072,113			2,964,308			2,896,711			2,938,833			2,764,377			2,345,056			2,072,316
Loans and leases		10,133,502			10,075,016			9,924,208			9,705,443			9,455,059			9,323,115			9,324,200			9,357,480
Interest-earning assets		13,951,134			13,820,610			13,522,235			13,129,313			13,024,871			12,750,494			12,255,663			11,929,086
Deposits		12,601,708			12,571,525			12,440,125			12,192,664			12,071,673			11,836,193			11,562,349			11,379,079
Interest-bearing liabilities		11,601,752			11,485,378			11,156,821			10,794,420			10,621,384			10,312,675			9,867,227			9,640,417
Long-term obligations		424,597			500,564			466,259			408,946			409,612			409,825			308,461			285,666
Shareholders’ equity	$	1,292,771		$	1,254,551		$	1,219,835		$	1,196,174		$	1,169,113		$	1,143,391		$	1,118,122		$	1,094,213
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	$	15,729,697		$	15,633,597		$	15,530,846		$	15,099,564		$	14,639,392		$	14,484,919		$	14,023,066		$	13,592,675
Investment securities		3,221,048			3,118,025			3,024,780			2,896,962			2,929,516			2,871,731			2,644,335			2,187,374
Loans and leases		10,239,551			10,129,423			10,029,045			9,810,088			9,642,994			9,359,540			9,300,984			9,404,742
Interest-earning assets		13,809,196			13,818,528			13,685,530			13,455,968			13,053,522			12,996,027			12,579,346			12,234,577
Deposits		12,743,324			12,681,150			12,717,219			12,512,557			12,173,858			12,123,491			11,758,089			11,629,382
Interest-bearing liabilities		11,612,372			11,510,073			11,395,473			11,038,192			10,745,696			10,544,543			10,156,552			9,818,651
Long-term obligations		401,198			424,351			527,478			408,954			408,987			409,742			409,964			285,312
Shareholders’ equity	$	1,310,819		$	1,276,608		$	1,232,933		$	1,207,720		$	1,181,059		$	1,158,885		$	1,134,242		$	1,102,568
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

PROFITABILITY RATIOS (averages)
Rate of return (annualized) on:
Total assets		0.84	%		0.84	%		0.84	%		0.79	%		0.76	%		0.84	%		0.89	%		0.76	%
Shareholders’ equity		10.19			10.41			10.43			9.72			9.45			10.39			10.79			9.26
Dividend payout ratio		8.65			8.70			9.05			10.00			10.30			9.58			9.55			11.46

LIQUIDITY AND CAPITAL RATIOS (averages)
Loans and leases to deposits		80.41	%		80.14	%		79.78	%		79.60	%		78.32	%		78.77	%		80.64	%		82.23	%
Shareholders’ equity to total assets		8.27			8.11			7.96			8.14			8.05			8.07			8.21			8.22
Time certificates of $100,000 or more to total deposits		16.17			15.74			15.04			14.44			13.45			12.59			12.24			11.90

PER SHARE OF STOCK
Net income	$	3.18		$	3.16		$	3.04		$	2.75		$	2.67		$	2.87		$	2.88		$	2.40
Cash dividends (Class A and Class B)		0.275			0.275			0.275			0.275			0.275			0.275			0.275			0.275
Class A sales price
High		202.64			217.79

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