First Charter Corporation
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2008
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-15829
FIRST CHARTER CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
     
North Carolina
(State or Other Jurisdiction of
Incorporation or Organization)
  56-1355866
(I.R.S. Employer
Identification No.)
     
10200 David Taylor Drive, Charlotte, NC
(Address of Principal Executive Offices)
  28262-2373
(Zip Code)
Registrant’s telephone number, including area code: (704) 688-4300
Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ  No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
       
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
    (Do not check if a smaller  
    reporting company)  
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No þ
As of May 1, 2008, the registrant had outstanding 35,082,601 shares of common stock, no par value.
 
 

 


 

FIRST CHARTER CORPORATION
FORM 10-Q
For the Quarter ended March 31, 2008
All reports filed electronically by First Charter Corporation (the “Corporation”) with the United States Securities and Exchange Commission (the “SEC”), including its annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, as well as any amendments to those reports, are accessible at no cost on the Corporation’s website at www.firstcharter.com. These filings are also accessible on the SEC’s website at www.sec.gov.
 
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 Exhibit 12.1
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

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PART 1. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
First Charter Corporation

Consolidated Balance Sheets
(Unaudited)
                 
 
    March 31   December 31
(Dollars in thousands, except share data)   2008   2007
 
Assets
               
Cash and due from banks
  $ 74,763     $ 85,562  
Federal funds sold
    8,653       10,926  
Interest-bearing bank deposits
    13,335       5,710  
 
Cash and cash equivalents
    96,751       102,198  
Securities available for sale (cost of $831,036 and $863,049 at March 31, 2008 and December 31, 2007, respectively)
    821,518       860,671  
Federal Home Loan Bank and Federal Reserve Bank stock
    52,123       48,990  
Loans held for sale
    17,544       14,145  
Portfolio loans:
               
Commercial and construction
    2,219,719       2,254,354  
Mortgage
    587,240       582,398  
Consumer
    670,829       666,255  
 
Total portfolio loans
    3,477,788       3,503,007  
Allowance for loan losses
    (45,022 )     (42,414 )
 
Portfolio loans, net
    3,432,766       3,460,593  
Premises and equipment, net
    110,283       110,763  
Goodwill and other intangible assets
    82,599       82,871  
Other assets
    182,277       182,186  
 
Total Assets
  $ 4,795,861     $ 4,862,417  
 
Liabilities
               
Deposits:
               
Noninterest-bearing demand
  $ 446,623     $ 438,313  
Demand
    510,604       478,186  
Money market
    532,864       564,053  
Savings
    104,615       101,234  
Certificates of deposit
    1,346,172       1,313,482  
Brokered certificates of deposit
    278,461       326,351  
 
Total deposits
    3,219,339       3,221,619  
Federal funds purchased and securities sold under agreements to repurchase
    208,816       268,232  
Commercial paper and other short-term borrowings
    248,827       284,180  
Long-term debt
    617,712       567,729  
Accrued expenses and other liabilities
    37,641       52,313  
 
Total Liabilities
    4,332,335       4,394,073  
Shareholders’ Equity
               
Preferred stock — no par value; authorized 2,000,000 shares; no shares issued and outstanding
           
Common stock — no par value; authorized 100,000,000 shares; issued and outstanding 35,003,721 and 34,978,847 shares at March 31, 2008 and December 31, 2007, respectively
    235,480       233,974  
Common stock held in Rabbi Trust for deferred compensation
    (1,720 )     (1,687 )
Deferred compensation payable in common stock
    1,720       1,687  
Retained earnings
    233,809       235,812  
Accumulated other comprehensive loss, net of tax
    (5,763 )     (1,442 )
 
Total Shareholders’ Equity
    463,526       468,344  
 
Total Liabilities and Shareholders’ Equity
  $ 4,795,861     $ 4,862,417  
 
 
See notes to consolidated financial statements.

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First Charter Corporation

Consolidated Statements of Income
(Unaudited)
                 
 
    Three Months Ended
    March 31
(Dollars in thousands, except per share amounts)   2008   2007
 
Interest income
               
Loans
  $ 57,109     $ 66,118  
Securities
    11,394       10,918  
Federal funds sold
    55       128  
Interest-bearing bank deposits
    26       50  
 
Total interest income
    68,584       77,214  
Interest expense
               
Deposits
    24,751       26,540  
Borrowings
    11,082       13,939  
 
Total interest expense
    35,833       40,479  
 
Net interest income
    32,751       36,735  
Provision for loan losses
    4,707       1,366  
 
Net interest income after provision for loan losses
    28,044       35,369  
Noninterest income
               
Service charges on deposits
    7,365       7,390  
ATM, debit, and merchant fees
    2,631       2,444  
Wealth management
    779       716  
Equity method investments gains, net
    627       1,127  
Mortgage services
    1,012       901  
Gain on sale of Small Business Administration loans
    98       377  
Brokerage services
    733       1,081  
Insurance services
    4,150       3,634  
Bank owned life insurance
    1,165       1,139  
Property sale gains, net
    59       63  
Securities gains (losses), net
    1,229       (11 )
Other
    570       705  
 
Total noninterest income
    20,418       19,566  
Noninterest expense
               
Salaries and employee benefits
    18,498       19,587  
Occupancy and equipment
    4,725       4,612  
Data processing
    1,515       1,790  
Marketing
    454       1,351  
Postage and supplies
    1,096       1,172  
Legal and professional services
    2,700       3,586  
Telecommunications
    625       671  
Amortization of intangibles
    159       223  
Foreclosed properties
    (128 )     153  
Other
    4,219       2,775  
 
Total noninterest expense
    33,863       35,920  
 
Income before income tax expense
    14,599       19,015  
Income tax expense
    9,057       6,659  
 
Net Income
  $ 5,542     $ 12,356  
Net income per common share
               
Basic
  $ 0.16     $ 0.36  
Diluted
    0.16       0.35  
Average common shares outstanding
               
Basic
    34,739       34,770  
Diluted
    35,121       35,085  
Dividends declared per common share
  $ 0.195     $ 0.195  
 
 
See notes to consolidated financial statements.

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First Charter Corporation
Consolidated Statements of Shareholders’ Equity
(Unaudited)
                                                         
 
                    Common Stock                    
                    in Rabbi   Deferred           Accumulated    
                    Trust for   Compensation           Other    
    Common Stock   Deferred   Payable in   Retained   Comprehensive    
(Dollars in thousands, except share and per share amounts)   Shares   Amount   Compensation   Common Stock   Earnings   Loss   Total
 
Balance, December 31, 2007
    34,978,847     $ 233,974     $ (1,687 )   $ 1,687     $ 235,812     $ (1,442 )   $ 468,344  
Comprehensive income:
                                                       
Net income
                            5,542             5,542  
Change in unrealized gains and losses on securities, net of reclassification adjustment for net losses included in net income, net of income tax
                                  (4,321 )     (4,321 )
 
                                                       
Total comprehensive income
                                                    1,221  
Adjustment to initially apply EITF 06-4
                            (680 )           (680 )
Common stock purchased by Rabbi Trust for deferred compensation
                (33 )                       (33 )
Deferred compensation payable in common stock
                      33                   33  
Cash dividends declared, $0.195 per share
                            (6,865 )           (6,865 )
Issuance of shares under stock-based compensation plans, including related tax effects
    24,874       1,506                               1,506  
 
Balance, March 31, 2008
    35,003,721     $ 235,480     $ (1,720 )   $ 1,720     $ 233,809     $ (5,763 )   $ 463,526  
 
 
See notes to consolidated financial statements.

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First Charter Corporation
Consolidated Statements of Cash Flows
(Unaudited)
                 
 
    Three Months Ended
    March 31
(In thousands)   2008   2007
 
Operating activities
               
Net income
  $ 5,542     $ 12,356  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    4,707       1,366  
Depreciation
    1,959       1,814  
Amortization of intangibles
    159       223  
Amortization of servicing rights
    79       81  
Stock-based compensation expense
    787       786  
Tax benefits from stock-based compensation plans
    (212 )     (116 )
Premium amortization and discount accretion, net
    84       89  
Securities (gains) losses, net
    (1,229 )     11  
Net gains on sales of other real estate owned
    (80 )     (51 )
Write-downs on other real estate owned
    15       74  
Equity method investment gains, net
    (627 )     (1,127 )
Gains on sales of loans held for sale
    (691 )     (701 )
Gains on sale of Small Business Administration loans
    (98 )     (377 )
Property sale gains, net
    (59 )     (63 )
Origination of loans held for sale
    (96,990 )     (67,080 )
Proceeds from sale of loans held for sale
    94,282       66,382  
Change in cash surrender value of life insurance
    (1,154 )     (1,158 )
Change in other assets
    4,130       7,591  
Change in other liabilities
    (15,184 )     1,055  
 
Net cash provided by (used in) operating activities
    (4,580 )     21,155  
 
Investing activities
               
Proceeds from sales of securities available for sale
          17,367  
Proceeds from sales of FHLB and Federal Reserve Bank stock
    676       7,813  
Proceeds from maturities, calls and paydowns of securities available for sale
    115,059       62,347  
Purchases of securities available for sale
    (82,752 )     (71,138 )
Purchases of FHLB and Federal Reserve Bank stock
    (3,809 )     (6,863 )
Net change in loans
    22,512       (45,667 )
Proceeds from sales of other real estate owned
    1,248       498  
Net purchases of premises and equipment
    (1,420 )     (2,371 )
 
Net cash provided by (used in) investing activities
    51,514       (38,014 )
 
Financing activities
               
Net change in deposits
    (2,280 )     73,238  
Net change in federal funds purchased and securities sold under repurchase agreements
    (59,416 )     (23,923 )
Net change in commercial paper and other short-term borrowings
    (35,353 )     (70,530 )
Proceeds from issuance of long-term debt and trust preferred securities
    50,000       150,000  
Retirement of long-term debt
    (17 )     (110,016 )
Proceeds from issuance of common stock
    1,294       2,813  
Tax benefits from stock-based compensation plans
    212       116  
Cash dividends paid
    (6,821 )     (6,811 )
 
Net cash provided by (used in) financing activities
    (52,381 )     14,887  
 
Net decrease in cash and cash equivalents
    (5,447 )     (1,972 )
Cash and cash equivalents at beginning of period
    102,198       102,827  
 
Cash and cash equivalents at end of period
  $ 96,751     $ 100,855  
 
Supplemental information for continuing operations
               
Cash paid for:
               
Interest
  $ 40,894     $ 40,561  
Income taxes
    14,770       3,200  
Non-cash items:
               
Transfer of loans to other real estate owned
    608       373  
Unrealized gains (losses) on securities available for sale (net of tax expense (benefit) of $(2,819), and $378, respectively)
    (4,321 )     578  
 
 
See notes to consolidated financial statements.

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First Charter Corporation
Notes to Consolidated Financial Statements
(Unaudited)
First Charter Corporation (“First Charter” or the “Corporation”), headquartered in Charlotte, North Carolina, is a regional financial services company with assets of $4.8 billion and is the holding company for First Charter Bank (the “Bank”). As of March 31, 2008, First Charter operated 60 financial centers, four insurance offices, and 136 ATMs throughout North Carolina and Georgia. First Charter also operates loan origination offices in Asheville, North Carolina and Reston, Virginia. First Charter provides businesses and individuals with a broad range of financial services, including banking, financial planning, wealth management, investments, insurance, and mortgages. The results of operations of the Bank constitute the substantial majority of the consolidated net income, revenue, and assets of the Corporation.
1. Accounting Policies
The consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiary, the Bank, and variable interest entities where the Corporation is the primary beneficiary. All significant intercompany transactions and balances have been eliminated.
The information contained in these interim consolidated financial statements, excluding the consolidated balance sheet as of December 31, 2007, is unaudited. The information furnished has been prepared pursuant to United States Securities and Exchange Commission (“SEC”) Rule 10-01 of Regulation S-X and does not include all the information and note disclosures required to be included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States of America.
The accompanying unaudited consolidated financial statements should be read in conjunction with the Corporation’s audited financial statements and accompanying notes in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on February 29, 2008.
The unaudited results of operations for the interim periods shown in these financial statements are not necessarily indicative of operating results for the entire year. The information furnished in this report reflects all adjustments, which are, in the opinion of management, necessary to present a fair statement of the financial condition and the results of operations for interim periods. All such adjustments are of a normal and recurring nature.
The significant accounting policies followed by the Corporation are presented in Note 1 of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007. With the exception of the Corporation’s adoption of certain of the accounting pronouncements discussed in Note 2, these policies have not materially changed from the disclosure in that report.
2. Recent Accounting Pronouncements
In March 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Accounting Standard (“SFAS”) No. 161, Disclosures About Derivative Instruments and Hedging Activities – An Amendment of FASB Statement No. 133. This standard requires companies to provide enhanced disclosures regarding derivative instruments and hedging activities. It requires companies to better convey the purpose of derivative use in terms of the risks that the company is intending to manage. SFAS 161 retains the same scope as SFAS 133 and is effective for fiscal years and interim periods beginning after November 15, 2008. The Corporation will adopt SFAS 161 beginning January 1, 2009 and is currently evaluating the impact, if any, SFAS 161 will have on the Corporation’s consolidated financial statements.
In February 2008, the FASB issued FASB Staff Position (“FSP”) 140-3, Accounting for Transfers of Financial Assets and Repurchase Financing Transactions. FSP 140-3 addresses the issue of whether or

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not these transactions should be viewed as two separate transactions or as one “linked” transaction. The FSP includes a rebuttable presumption that presumes linkage of the two transactions unless the presumption can be overcome by meeting certain criteria. FSP 140-3 is effective for fiscal years beginning after November 15, 2008. The Corporation will adopt this FSP beginning January 1, 2009 and is currently evaluating the impact, if any, FSP 140-3 will have on the Corporation’s consolidated financial statements.
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115. This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. This option is available to all entities. Most of the provisions in SFAS 159 are elective; however, the amendment to SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Corporation did not elect the fair value option as of January 1, 2008 for any of its financial assets or financial liabilities and, accordingly, the adoption of SFAS 159 did not have a material impact on the Corporation’s consolidated financial statements.
In September 2006, the FASB issued SFAS 157, Fair Value Measurements, which replaces the different definitions of fair value in existing accounting literature with a single definition, sets out a framework for measuring fair value, and requires additional disclosures about fair value measurements. SFAS 157 is required to be applied whenever another financial accounting standard requires or permits an asset or liability to be measured at fair value. The Corporation adopted the guidance of SFAS 157 beginning January 1, 2008, and the adoption of the statement did not have a material impact on the Corporation’s consolidated financial statements.
In September 2006, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) on Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements. EITF 06-4 requires the recognition of a liability and related compensation expense for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to post-retirement periods. Under EITF 06-4, life insurance policies purchased for the purpose of providing such benefits do not effectively settle an entity’s obligation to the employee. Accordingly, the entity must recognize a liability and related compensation expense during the employee’s active service period based on the future cost of insurance to be incurred during the employee’s retirement. If the entity has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized by following the guidance in SFAS 106, Employer’s Accounting for Postretirement Benefits Other Than Pensions. The Corporation adopted EITF 06-4 effective as of January 1, 2008 as a change in accounting principle, and reduced retained earnings by $0.7 million through a cumulative-effect adjustment.
In November 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings, (“SAB 109”). SAB 109 supersedes guidance provided by SAB 105, Loan Commitments Accounted for as Derivative Instruments, (“SAB 105”) and provides guidance on written loan commitments accounted for at fair value through earnings. Specifically, SAB 109 addresses the inclusion of expected net future cash flows related to the associated servicing of a loan in the measurement of all written loan commitments accounted for at fair value through earnings. In addition, SAB 109 retains the SEC’s position on the exclusion of internally-developed intangible assets as part of the fair value of a derivative loan commitment originally established in SAB 105. The Corporation adopted SAB 109 as of January 1, 2008 and the adoption of SAB 109 did not have a material impact on the Corporation’s consolidated financial statements.
3. Proposed Merger with Fifth Third
On August 15, 2007, First Charter and Fifth Third Bancorp (“Fifth Third”) entered into an Agreement and Plan of Merger, as amended by the Amended and Restated Agreement and Plan of Merger, dated September 14, 2007, (“Merger Agreement”) by and among First Charter, Fifth Third, and Fifth Third

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Financial Corporation (“Fifth Third Financial”). Under the terms of the Merger Agreement, First Charter will be merged with and into Fifth Third Financial. The Merger Agreement has been approved by the Board of Directors of First Charter, Fifth Third and Fifth Third Financial. First Charter’s shareholders have approved the Merger Agreement and the merger has been approved by all necessary state and federal regulatory agencies. The Merger Agreement is subject to customary closing conditions. The merger is currently anticipated to close on Friday, June 6, 2008.
In connection with the proposed merger with Fifth Third, the Corporation has incurred expenses of approximately $0.6 million of merger-related costs, principally legal and professional services, for the three months ended March 31, 2008.
4. Net Income Per Share
Basic net income per share is computed by dividing net income by the weighted average number of shares of the Corporation’s common stock outstanding for the three months ended March 31, 2008 and 2007, respectively. Diluted net income per share reflects the potential dilution that could occur if the Corporation’s potential common stock equivalents and contingently issuable shares, which consist of dilutive stock options, restricted stock, and performance shares, were issued.
A reconciliation of the basic average common shares outstanding to the diluted average common shares outstanding follows:
                 
 
    Three Months Ended
    March 31
    2008   2007
 
Basic weighted-average number of common shares outstanding
    34,739,407       34,770,106  
Dilutive effect arising from potential common stock issuances
    381,660       314,534  
 
Diluted weighted-average number of common shares outstanding
    35,121,067       35,084,640  
 
The effects of outstanding anti-dilutive stock options are excluded from the computation of diluted net income per share. These amounts were 500 and 424,024 shares for the three months ended March 31, 2008 and 2007, respectively.
The Corporation declared dividends of $0.195 per share for the three months ended March 31, 2008 and 2007.
5. Goodwill and Other Intangible Assets
The following is a summary of the gross carrying amount and accumulated amortization of amortized intangible assets and the carrying amount of unamortized intangible assets:
                                                 
 
    March 31, 2008   December 31, 2007
    Gross           Net   Gross           Net
    Carrying   Accumulated   Carrying   Carrying   Accumulated   Carrying
(In thousands)   Amount   Amortization   Amount   Amount   Amortization   Amount
 
Amortized intangible assets:
                                               
Core deposits
  $ 3,560     $ 968     $ 2,592     $ 3,560     $ 808     $ 2,752  
Noncompete agreements
    90       90             90       90        
Customer lists
    2,615       1,752       863       2,615       1,640       975  
 
Total amortized intangible assets
    6,265       2,810       3,455       6,265       2,538       3,727  
Goodwill
    79,144       N/A       79,144       79,144       N/A       79,144  
 
Total goodwill and amortized intangible assets
  $ 85,409     $ 2,810     $ 82,599     $ 85,409     $ 2,538     $ 82,871  
 

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Amortization expense for the three months ended March 31, 2008 and 2007 was $0.3 million and $0.2 million, respectively.
As of March 31, 2008, expected future amortization expense for intangible assets follows:
 
                         
 
    Core   Customer    
(In thousands)   Deposits   Lists   Total
 
April - December 2008
  $ 449     $ 279     $ 728  
2009
    531       263       794  
2010
    453       142       595  
2011
    375       83       458  
2012
    297       48       345  
2013 and after
    487       48       535  
 
Total expected future intangible asset amortization
  $ 2,592     $ 863     $ 3,455  
 
6. Comprehensive Income
Comprehensive income is defined as the change in equity from all transactions other than those with shareholders, and it includes net income and other comprehensive income (loss). The Corporation’s only component of other comprehensive income is the change in unrealized gains and losses on available-for-sale securities.
The components of comprehensive income follow:
                 
 
    Three Months Ended
    March 31
(In thousands)   2008   2007
 
Comprehensive income
               
Net income
  $ 5,542     $ 12,356  
Other comprehensive income (loss)
               
Unrealized gains (losses) on available-for-sale securities, net
    (5,911 )     945  
Reclassification adjustment for gains (losses) included in net income
    1,229       (11 )
Income tax effect, net
    2,819       (378 )
 
Other comprehensive income (loss)
    (4,321 )     578  
 
Total comprehensive income
  $ 1,221     $ 12,934  
 

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7. Securities Available for Sale
Securities available for sale are summarized as follows:
                                 
 
    March 31, 2008
    Amortized   Unrealized   Unrealized   Fair
(In thousands)   Cost   Gains   Losses   Value
 
U.S. government agency obligations
  $ 97,257     $ 560     $ 5     $ 97,812  
Mortgage-backed securities
    583,797       4,325       7,881       580,241  
State, county, and municipal obligations
    90,959       1,024       2       91,981  
Asset-backed securities
    57,661             7,613       50,048  
Equity securities
    1,362       129       55       1,436  
 
Total securities
  $ 831,036     $ 6,038     $ 15,556     $ 821,518  
 
 
 
    December 31, 2007
    Amortized   Unrealized   Unrealized   Fair
(In thousands)   Cost   Gains   Losses   Value
 
U.S. government agency obligations
  $ 145,810     $ 814     $ 70     $ 146,554  
Mortgage-backed securities
    565,872       4,399       4,837       565,434  
State, county, and municipal obligations
    92,324       692       78       92,938  
Asset-backed securities
    57,681             3,452       54,229  
Equity securities
    1,362       193       39       1,516  
 
Total securities
  $ 863,049     $ 6,098     $ 8,476     $ 860,671  
 
The contractual maturity distribution and yields (computed on a taxable-equivalent basis) of the Corporation’s securities portfolio at March 31, 2008, are summarized below. Actual maturities may differ from contractual maturities shown below since borrowers may have the right to pre-pay these obligations without pre-payment penalties.
                                                                                 
 
                    Due after 1   Due after 5        
    Due in 1 year   through 5   through 10   Due after    
    or less   years   years   10 years   Total
(Dollars in thousands)   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield
 
Fair value of securities available for sale
                                                                               
U.S. government agency obligations
  $ 96,772       3.71 %   $       %   $ 1,040       5.20 %   $       %   $ 97,812       3.72 %
Mortgage-backed securities (1)
    8,952       5.65       274,670       4.82       244,123       5.46       52,496       5.67       580,241       5.18  
State and municipal obligations (2)
    32,826       6.76       20,399       5.01       4,110       5.99       34,646       2.62       91,981       4.78  
Asset-backed securities
                13,136       6.99       17,520       5.03       19,392       5.46       50,048       5.70  
Equity securities (3)
                                        1,436       6.10       1,436       6.10  
 
Total
  $ 138,550       4.56 %   $ 308,205       4.93 %   $ 266,793       5.43 %   $ 107,970       4.65 %   $ 821,518       4.99 %
 
Amortized cost of securities available for sale
  $ 137,446             $ 309,100             $ 271,953             $ 112,537             $ 831,036          
 
(1)  
Maturities estimated based on average life of security.
 
(2)  
Yields on tax-exempt securities are calculated on a tax-equivalent basis using the marginal Federal income tax rate of 35 percent.
 
(3)  
Although equity securities have no stated maturity, they are presented for illustrative purposes only. The 6.10% yield represents the expected dividend yield to be earned on equity securities.
Securities with an aggregate carrying value of $671.4 million and $655.0 million at March 31, 2008 and December 31, 2007, respectively, were pledged to secure public deposits, trust account deposits, securities sold under agreements to repurchase, and Federal Home Loan Bank (“FHLB”) borrowings.

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Gross gains and losses recognized on the sale of securities are summarized as follows:
                 
 
    Three Months Ended
    March 31
(In thousands)   2008   2007
 
Gross gains
  $ 1,229     $ 94  
Gross losses
          (105 )
 
Securities gains (losses), net
  $ 1,229     $ (11 )
 
In March 2008, the Corporation received 51,457 Class B common shares in connection with Visa Inc.’s (“Visa”) initial public offering (“IPO”), of which 19,894 shares were redeemed as part of Visa’s mandatory redemption of its Class B stock. The Corporation recognized a gain of $0.9 million related to this redemption. The Corporation did not recognize any gain on the remaining 31,563 unredeemed Visa Class B common shares. The unredeemed Visa Class B common shares are not reflected on the Corporation’s consolidated balance sheet at March 31, 2008 as the Corporation has no historical basis in these shares.
As of March 31, 2008, there were no issues of securities available for sale (excluding U.S. government agency obligations), which had carrying values that exceeded 10 percent of shareholders’ equity of the Corporation.
The unrealized losses at March 31, 2008, shown in the following table, resulted primarily from an increase in interest rate spreads among the various types of bond investments, market illiquidity and macro-economic recession fears.
                                                 
 
    Less than 12 months   12 months or longer   Total
    Fair   Unrealized   Fair   Unrealized   Fair   Unrealized
(In thousands)   Value   Losses   Value   Losses   Value   Losses
 
AAA/AA-RATED SECURITIES
                                               
U.S. government agency obligations
  $ 29,963     $ 5     $     $     $ 29,963     $ 5  
Mortgage-backed securities
    156,880       4,433       107,428       3,448       264,308       7,881  
 
Total AAA/AA-rated securities
    186,843       4,438       107,428       3,448       294,271       7,886  
 
A/BBB-RATED SECURITIES
                                               
Asset-backed securities
    41,833       5,826       8,215       1,787       50,048       7,613  
State, county, and municipal obligations
    1,168       2                   1,168       2  
 
Total A/BBB-rated securities
    43,001       5,828       8,215       1,787       51,216       7,615  
 
UNRATED SECURITIES
                                               
Equity securities
    397       55                   397       55  
 
Total unrated securities
    397       55                   397       55  
 
Total temporarily impaired securities
  $ 230,241     $ 10,321     $ 115,643     $ 5,235     $ 345,884     $ 15,556  
 
At March 31, 2008, investments in a gross unrealized loss position included one U.S. agency security, 38 mortgage-backed securities, one municipal obligation, and eight other asset-backed securities. The unrealized losses associated with these securities were not considered to be other-than-temporary because they were primarily related to changes in interest rates and interest rate spreads, and did not affect the expected cash flows of the underlying collateral or the issuer. At March 31, 2008, the Corporation had the ability and the intent to hold these investments to the recovery of par value. The Corporation’s available-for-sale securities portfolio also contains one equity security in an unrealized loss

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position. This equity security began trading publicly in the first quarter of 2007 and the stock price has decreased, resulting in an unrealized loss of approximately 12.2 percent as of March 31, 2008.
8. Loans and Allowance for Loan Losses
The Bank primarily makes commercial and installment loans to customers throughout its market areas. The Corporation’s primary market area includes the states of North Carolina, South Carolina, and Georgia, and predominately centers on the metropolitan regions of Charlotte and Raleigh, North Carolina, and Atlanta, Georgia. At March 31, 2008, the majority of the total loan portfolio was to borrowers within these regions. The real estate loan portfolio can be affected by the condition of the local real estate markets. The diversity of the region’s economic base provides a stable lending environment. No areas of significant concentrations of credit risk have been identified due to the diverse industrial bases in the regions.
Total portfolio loans are categorized as follows:
                                 
 
    March 31, 2008   December 31, 2007
(Dollars in thousands)   Amount   Percent   Amount   Percent
 
Commercial real estate
  $ 1,058,197       30.4 %   $ 1,073,983       30.7 %
Commercial non real estate
    299,555       8.6       308,792       8.8  
Construction
    861,967       24.8       871,579       24.9  
Mortgage
    587,240       16.9       582,398       16.6  
Home equity
    430,781       12.4       413,873       11.8  
Consumer
    240,048       6.9       252,382       7.2  
 
Total portfolio loans
  $ 3,477,788       100.0 %   $ 3,503,007       100.0 %
 
The following is a summary of the changes in the allowance for loan losses:
                 
 
    Three Months Ended March 31
(In thousands)   2008   2007
 
Balance, beginning of period
  $ 42,414     $ 34,966  
Charge-offs
    (2,458 )     (786 )
Recoveries
    359       308  
 
Net charge-offs
    (2,099 )     (478 )
Provision for loan losses
    4,707       1,366  
 
Balance, March 31
  $ 45,022     $ 35,854  
 
The table below summarizes the Corporation’s nonperforming assets.
                 
 
    March 31   December 31
(In thousands)   2008   2007
 
Nonaccrual loans
  $ 62,058     $ 28,695  
Loans 90 days or more past due and accruing interest
           
 
Total nonperforming loans
    62,058       28,695  
Other real estate
    9,481       10,056  
 
Total nonperforming assets
  $ 71,539     $ 38,751  
 
At March 31, 2008 and December 31, 2007, impaired loans amounted to $55.8 million and $23.2 million, respectively. Included in the allowance for loan losses was $7.6 million and $4.4 million related to the impaired loans at March 31, 2008 and December 31, 2007, respectively.

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9. Servicing Rights
As of March 31, 2008, the Corporation serviced $171.3 million of mortgage loans for other parties. The carrying value and aggregate estimated fair value of mortgage servicing rights (“MSR”) at March 31, 2008 were $0.6 million and $1.5 million, respectively, compared to a carrying value and estimated fair value of $0.6 million and $1.8 million, respectively, at December 31, 2007.
As of March 31, 2008, the Corporation serviced $34.0 million of Small Business Administration (“SBA”) loans that were originated by and sold by the Bank. The carrying value and aggregate estimated fair value of the SBA loan servicing rights (“SSR”) at March 31, 2008 were $0.8 million, compared to the carrying value and estimated fair value of $0.8 million and $0.9 million, respectively, at December 31, 2007.
Servicing rights are periodically evaluated for impairment based on their fair value. Impairment would be recognized as a reduction to the carrying value of the asset. Fair value is estimated based on market prices for similar assets and on the discounted estimated present value of future net cash flows based on market consensus loan prepayment estimates, historical prepayment rates, interest rates, and other economic factors. For purposes of impairment evaluation, the servicing assets are stratified based on predominant risk characteristics of the underlying loans, including loan type (conventional or government) and note rate.
The following is an analysis of capitalized servicing rights included in other assets in the consolidated balance sheets for the three months ending March 31, 2008 and 2007:
                                 
 
    2008   2007
(In thousands)   MSR   SSR   MSR   SSR
 
Balance, beginning of period
  $ 591     $ 792     $ 756     $ 1,137  
Servicing rights capitalized or acquired
          10             13  
Amortization expense
    (34 )     (48 )     (41 )     (40 )
Purchase accounting adjustment
                      (238 )
Valuation allowance
                       
 
Balance, March 31
  $ 557     $ 754     $ 715     $ 872  
 
Assumptions used to value the MSR included an average conditional prepayment rate (“CPR”) of 15.4 percent, an average discount rate of 12.2 percent, and a weighted-average life of 3.3 years. An increase in the prepayment rates of 10 percent and 20 percent may result in a decline in fair value of $57,000 and $110,000, respectively. An increase in the discount rate of 10 percent and 20 percent may result in a decline in fair value of $38,000 and $74,000, respectively. Changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the MSR is calculated independently without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, changes in mortgage interest rates, which drive changes in prepayment rate estimates, could result in changes in the discount rates), which may magnify or counteract the sensitivities.
Assumptions used to value the SSR included a CPR of 13.0 percent, a discount rate of 10.3 percent, and a weighted-average life of 4.1 years. An increase in the prepayment rates of 10 percent and 20 percent may result in a decline in fair value of $38,000 and $73,000, respectively. An increase in the discount rate of 10 percent and 20 percent may result in a decline in fair value of $20,000 and $40,000, respectively.
The MSR and SSR are expected to be amortized against other noninterest income over a weighted-average period of 3.0 years and 2.9 years, respectively. Expected future amortization expense for these capitalized servicing rights follows:

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(In thousands)   MSR   SSR   Total
 
April 1 - December 31, 2008
  $ 101     $ 132     $ 233  
2009
    111       152       263  
2010
    92       126       218  
2011
    74       104       178  
2012
    61       85       146  
2013 and after
    118       155       273  
 
Total amortization
  $ 557     $ 754     $ 1,311  
 
For the three months ended March 31, 2008 and 2007, contractual servicing fee revenue was $0.3 million and $0.4 million, respectively, and was included in the mortgage services line item of other noninterest income.
10. Other Borrowings
The following is a schedule of other borrowings:
                                 
 
    March 31, 2008   December 31, 2007
            Weighted-           Weighted-
            Average           Average
            Contractual           Contractual
(Dollars in thousands)   Balance   Rate   Balance   Rate
 
Federal funds purchased and securities sold under agreements to repurchase
  $ 208,816       3.18 %   $ 268,232       4.59 %
Commercial paper
    28,827       2.94       64,180       2.91  
Other short-term borrowings
    220,000       3.65       220,000       5.27  
Long-term debt
    617,712       4.77       567,729       5.26  
 
Total other borrowings
  $ 1,075,355       4.18 %   $ 1,120,141       4.97 %
 
Securities sold under agreements to repurchase represent short-term borrowings by the banking subsidiaries with maturities less than one year collateralized by a portion of the Corporation’s securities of the United States government or its agencies, which have been delivered to a third-party custodian for safekeeping. Securities with an aggregate carrying value of $114.1 million and $124.8 million at March 31, 2008 and December 31, 2007, respectively, were pledged to secure securities sold under agreements to repurchase.
Federal funds purchased represent unsecured overnight borrowings from other financial institutions. At March 31, 2008, the Bank had available federal funds lines of credit totaling $648.0 million, with $168.0 million outstanding, compared to similar lines of credit totaling $648.0 million, with $233.0 million outstanding at December 31, 2007.
First Charter Corporation issues commercial paper as another source of short-term funding. It is purchased primarily by the Bank’s commercial clients. Commercial paper outstanding at March 31, 2008 was $28.8 million, compared to $64.2 million at December 31, 2007.
Other short-term borrowings consist of the FHLB borrowings with an original maturity of one year or less. FHLB borrowings are collateralized by securities from the Corporation’s investment portfolio, and a blanket lien on certain qualifying commercial and single-family loans held in the Corporation’s loan portfolio. At March 31, 2008 and December 31, 2007, the Bank had $220.0 million of short-term FHLB borrowings.

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Long-term borrowings represent FHLB borrowings with original maturities greater than one year and subordinated debentures related to trust preferred securities. At March 31, 2008, the Bank had $555.8 million of long-term FHLB borrowings, compared to $505.8 million at December 31, 2007. In addition, the Corporation had $61.9 million of subordinated outstanding debentures at March 31, 2008 and December 31, 2007.
The Corporation formed First Charter Capital Trust I and First Charter Capital Trust II, in June 2005 and September 2005, respectively; both are wholly-owned business trusts. First Charter Capital Trust I and First Charter Capital Trust II issued $35.0 million and $25.0 million, respectively, of trust preferred securities that were sold to third parties. The proceeds of the sale of the trust preferred securities were used to purchase subordinated debentures (“Notes”) from the Corporation, which are presented as long-term borrowings in the consolidated balance sheets and qualify for inclusion in Tier 1 capital for regulatory capital purposes, subject to certain limitations.
The following is a summary of the Corporation’s outstanding trust preferred securities and Notes at March 31, 2008.
                                     
 
(Dollars in thousands)                        
 
        Aggregate                    
        Principal                    
        Amount of   Aggregate                
        Trust   Principal   Stated   Per Annum   Interest    
        Preferred   Amount of   Maturity of   Interest Rate   Payment   Redemption
Issuer   Issuance Date   Securities   the Notes   the Notes   of the Notes   Dates   Period
 
 
                      September   3 mo. LIBOR   3/15, 6/15,   On or after
Capital Trust I
  June 2005   $ 35,000     $ 36,083     2035   + 169 bps   9/15, 12/15   9/15/2010
                                     
 
                      December   3 mo. LIBOR   3/15, 6/15,   On or after
Capital Trust II
  September 2005     25,000       25,774     2035   + 142 bps   9/15, 12/15   12/15/2010
 
Total
      $ 60,000     $ 61,857                  
 
11. Income Tax
Income tax expense attributable to net income differed from the amounts computed by applying the U.S. federal statutory income tax rate of 35 percent to pretax income as follows:
                                 
 
    Three Months Ended March 31
(Dollars in thousands)   2008   2007
 
Tax at statutory federal rate
  $ 5,110       35.0 %   $ 6,655       35.0 %
Change in income taxes resulting from:
                               
Tax-exempt income
    (307 )     (2.1 )     (372 )     (2.0 )
Bank-owned life insurance
    (407 )     (2.8 )     (399 )     (2.1 )
State income tax, net of federal
    524       3.6       293       1.5  
Settlement with North Carolina DOR
    4,938       33.8              
Addition to or (release of) tax reserve
    (843 )     (5.8 )     226       1.2  
Other, net
    42       0.3       256       1.3  
 
Income tax expense
  $ 9,057       62.0 %   $ 6,659       34.9 %
 
The Corporation utilizes FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109. FIN 48 prescribes a more-likely-than-not threshold for the financial statement recognition of uncertain tax positions. The Corporation has a liability for unrecognized tax benefits relating to uncertain tax positions.

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As a result of various tax strategies of the Corporation, the amount of unrecognized tax benefits as of March 31, 2008 was $5.1 million, all of which would impact the Corporation’s effective tax rate, if recognized. The Corporation believes its current tax reserves are adequate. A reconciliation of the beginning and ending amount of unrecognized tax benefits for the three months ended March 31, 2008 follows:
         
 
(In thousands)        
 
Balance, beginning of period
  $ 10,833  
Expiration of statute
    (731 )
Reductions for tax positions of prior periods
    (4,981 )
 
Balance, March 31, 2008
  $ 5,121  
 
Consistent with prior reporting periods, the Corporation recognizes interest accrued in connection with unrecognized tax benefits, net of related tax benefits, and penalties in income tax expense in the consolidated statements of income. As of March 31, 2008, the Corporation had accrued approximately $0.1 million for the payment of interest and penalties.
The Corporation completed an examination by the North Carolina Department of Revenue (the “DOR”) for tax years 1999 through 2005. On March 31, 2008, the Corporation entered into a closing agreement with the DOR for years 1999 through and including 2006. As a result of this settlement, the Corporation paid $15.4 million in franchise and income taxes, interest and penalties. The closing agreement resulted in a reduction of unrecognized tax benefits of $4.2 million. The Corporation remains subject to examination by the DOR for tax years 2007 forward.
The Corporation was also under examination by the Internal Revenue Service for the 2004 and 2005 tax years. The examination was effectively concluded by March 31, 2008. The Corporation recognized $0.8 million of additional income tax expense in connection with the effective settlement of this examination.
12. Share-Based Payments
The Corporation has various stock-based compensation plans under which awards, including stock options and restricted stock, may be granted to employees and non-employee directors. These plans and the related accounting are described in Note 18 of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007.
Stock-based compensation costs totaled $0.8 million for the three months ended March 31, 2008, which consisted of $43,000 related to stock options, $573,000 related to service-based nonvested shares, and $172,000 related to performance-based nonvested shares. Stock-based compensation costs totaled $0.8 million for the three months ended March 31, 2007, which consisted of $50,000 related to stock options, $523,000 related to service-based nonvested shares, and $213,000 related to performance-based nonvested shares.

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The fair value of each stock option award is estimated at the date of grant using a Black-Scholes option-pricing model based on the following weighted-average assumptions:
             
 
    Three Months Ended
    March 31
    2008   2007
 
Expected volatility
  N/A     22.4 %
Expected dividend yield
  N/A     3.2  
Risk-free interest rate
  N/A     4.8  
Expected term (in years)
  N/A     8.0  
 
Stock option activity for the three months ended March 31, 2008, follows:
                                 
 
                    Weighted-    
                    Average    
            Weighted-   Remaining    
            Average   Contractual   Aggregate
            Exercise   Term   Intrinsic
    Shares   Price   (in years)   Value
 
Outstanding, beginning of period
    882,853     $ 19.98                  
Exercised
    (26,688 )     20.14             $ 187,093  
 
Outstanding, March 31, 2008
    856,165     $ 19.98       4.8     $ 5,765,413  
 
Exercisable, March 31, 2008
    782,505     $ 19.58       4.5     $ 5,577,166  
 
Nonvested share activity for the three months ended March 31, 2008 follows:
                                 
 
    Service-Based   Performance-Based
            Weighted-           Weighted-
            Average           Average
            Grant Date           Grant Date
    Shares   Fair Value   Shares   Fair Value
 
Outstanding, beginning of period
    263,168     $ 24.01       90,167     $ 22.31  
Exercised
    (5,196 )     23.68       (5,967 )     22.13  
Forfeited
    (1,000 )     20.04                
 
Outstanding, March 31, 2008
    256,972     $ 24.03       84,200     $ 22.32  
 
As of March 31, 2008, there was approximately $4.4 million of total unrecognized compensation cost related to service-based nonvested share-based compensation arrangements granted under the 2000 Omnibus Stock Option and Award Plan (“Omnibus Plan”) and the Restricted Stock Award Program. This cost is expected to be recognized over a remaining weighted-average period of 1.6 years. No share-based awards vested during the three months ended March 31, 2008.
As of March 31, 2008, there was $0.7 million of total unrecognized compensation cost related to performance-based nonvested share-based compensation arrangements granted under the Omnibus Plan. This cost is expected to be recognized over a remaining weighted-average period of 1.3 years.

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13. Financial Instruments Measured at Fair Value
As discussed in Note 2, the Corporation adopted SFAS 157 as of January 1, 2008. The following table presents the allocation of the Corporation’s assets recorded at fair value within the SFAS 157 fair value hierarchy as of March 31, 2008:
                                 
 
(In thousands)           Fair Value Measurements Using
            Quoted prices in           Significant
            active markets for   Significant other   unobservable
            identical assets   observable inputs   inputs
Description   Fair Value   (Level 1)   (Level 2)   (Level 3)
 
Securities at fair value
  $ 821,518     $ 1,436     $ 770,034     $ 50,048  
Loans recorded at collateral value
    48,246                   48,246  
 
The majority of the Corporation’s available-for-sale securities portfolio falls into Level 2 of the fair value hierarchy. The securities are generally priced through independent providers. In obtaining such valuation information, the Corporation has evaluated the valuation methodologies used to develop the fair values.
The Corporation has valued its asset-backed securities, which are trust preferred securities, using third-party dealer determined pricing models. Significant inputs to these dealer pricing models are not readily observable, thus the valuations of these securities are classified as Level 3 within the fair value hierarchy. The need to use unobservable inputs generally results from the lack of market liquidity of these securities, which has resulted in diminished observability of actual trades and observable market assumptions that would otherwise be used to value these instruments.
Impaired loans are recorded at the fair value of the underlying collateral. The fair value of the loan’s collateral is generally determined by third-party appraisals.
The following table shows a reconciliation for the three months ending March 31, 2008 of financial instruments measured using significant unobservable inputs and classified as Level 3 within the fair value hierarchy:
                 
 
    Fair Value of   Fair Value of
    Level 3   Level 3
(In thousands)   Securities   Loans
 
Balance, beginning of period
  $ 54,229     $ 18,787  
Losses included in earnings
          (3,169 )
Losses included in other comprehensive income
    (4,161 )      
Net transfers
    (20 )     32,628  
 
Balance, March 31, 2008
  $ 50,048     $ 48,246  
 
14. Commitments, Contingencies, and Off-Balance Sheet Risk
Commitments and Off-Balance Sheet Risk. The Corporation is party to various financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated financial statements. Commitments to extend credit are agreements to lend to a customer so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and may require collateral from the borrower if deemed necessary by the Corporation. Included in loan commitments are commitments of $83.6 million to cover customer deposit account overdrafts should they occur. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party up to a stipulated

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amount and with specified terms and conditions. Standby letters of credit are recorded as a liability by the Corporation at the fair value of the obligation undertaken in issuing the guarantee. The fair value and carrying value at March 31, 2008 of standby letters of credit issued or modified during 2008 was immaterial. Commitments to extend credit are not recorded as an asset or liability by the Corporation until the instrument is exercised. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for instruments reflected in the consolidated financial statements. The creditworthiness of each customer is evaluated on a case-by-case basis.
As of March 31, 2008, the Corporation’s maximum exposure is as follows:
                                                 
 
    Less than                           Timing not    
(In thousands)   1 year   1-3 Years   4-5 Years   Over 5 Years   determinable   Total
 
Loan commitments
  $ 570,313     $ 113,946     $ 16,922     $ 95,381     $     $ 796,562  
Lines of credit
    28,597       1,202       4,957       455,497             490,253  
Standby letters of credit
    23,016       2,849       4                   25,869  
Anticipated tax settlements
                            5,172       5,172  
 
Total commitments
  $ 621,926     $ 117,997     $ 21,883     $ 550,878     $ 5,172     $ 1,317,856  
 
Contingencies. The Corporation and the Bank are defendants in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated operations, liquidity, or financial position of the Corporation or the Bank.
During October 2007, Visa completed a restructuring and issued shares of Visa common stock to its financial institution members in contemplation of its IPO which occurred in March 2008. After the restructuring, member financial institutions became guarantors of certain Visa litigation liabilities based on the members’ proportionate share of the membership base. On November 7, 2007, Visa announced that it had reached a settlement in the amount of $2.065 billion to resolve certain restraint of trade litigation brought by American Express. The Corporation, as a member of the Visa network and a guarantor of its proportionate share of these liabilities, recognized a litigation liability of $0.6 million related to the American Express settlement and the remaining unsettled Discover, Interchange and Attridge litigation. Of this $0.6 million, $0.3 million is the Corporation’s proportionate share of the American Express Settlement and $0.3 million is the Corporation’s estimate of the fair value of the potential losses related to the remaining unsettled litigation. Charges related to these litigation matters is included in “Legal and professional services” on the Corporation’s consolidated statements of income.
The Corporation filed its Form 10-Q for the three months ended September 30, 2007 on November 9, 2007. As such, the Corporation should have recorded its $0.3 million proportionate share of Visa’s settlement with American Express in the third quarter of 2007. Additionally, the $0.3 million reserve related to the Discover, Interchange and Attridge litigation should have been recorded in the fourth quarter of 2007. The Corporation evaluated the impact of these errors, considering both qualitative and quantitative factors, and concluded the errors were immaterial to all periods affected. As such, the Corporation corrected the errors by recording the $0.6 million litigation reserve in the first quarter of 2008.
Visa funded an escrow account with a portion of the proceeds from the IPO. The escrow account will be used to pay settlements of Visa’s restraint of trade litigation. The Corporation’s proportionate share of this escrow account was $0.4 million and the Corporation recognized the benefit from the escrow account as a partial recapture of expenses incurred to establish the Visa litigation reserve liability. See Note 7 for further discussion of the Visa IPO transaction.
15. Regulatory Restrictions and Capital Ratios
The Corporation and the Bank are subject to various regulatory capital requirements administered by bank and bank holding company regulatory agencies (“regulators”). Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators

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that, if undertaken, could have a direct material effect on the Corporation’s financial position and operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to adjusted average assets (as defined). Management believes, as of March 31, 2008, that the Corporation and the Bank meet all capital adequacy requirements to which they are subject.
The Corporation’s and the Bank’s various regulators have issued regulatory capital guidelines for U.S. banking organizations. Failure to meet the capital requirements can initiate certain mandatory and discretionary actions by regulators that could have a material effect on the Corporation’s financial statements. At March 31, 2008, the Corporation and the Bank were classified as “well capitalized” under these regulatory frameworks. In the judgment of management, there have been no events or conditions since March 31, 2008, that would change the “well capitalized” status of the Corporation or the Bank.
The Corporation’s and the Bank’s actual capital amounts and ratios follow:
                                                 
 
                    For Capital    
                    Adequacy Purposes   To Be Well Capitalized
    Actual                   Minimum           Minimum
(Dollars in thousands)   Amount   Ratio   Amount   Ratio   Amount   Ratio
 
At March 31, 2008:
                                               
Leverage
                                               
First Charter Corporation
  $ 446,672       9.44 %   $ 189,249       4.00 %   None     None  
First Charter Bank
    424,710       8.99       189,030       4.00     $ 236,288       5.00 %
 
                                               
Tier I Capital
                                               
First Charter Corporation
  $ 446,672       11.25 %   $ 158,878       4.00 %   None     None  
First Charter Bank
    424,710       10.71       158,620       4.00     $ 237,930       6.00 %
 
                                               
Total Risk-Based Capital
                                               
First Charter Corporation
  $ 491,728       12.38 %   $ 317,757       8.00 %   None     None  
First Charter Bank
    469,732       11.85       317,240       8.00     $ 396,550       10.00 %
 
                                               
At December 31, 2007:
                                               
Leverage
                                               
First Charter Corporation
  $ 446,890       9.43 %   $ 189,630       4.00 %   None     None  
First Charter Bank
    417,979       8.83       189,252       4.00     $ 236,565       5.00 %
 
                                               
Tier I Capital
                                               
First Charter Corporation
  $ 446,890       11.17 %   $ 189,985       4.00 %   None     None  
First Charter Bank
    417,979       10.47       159,732       4.00     $ 239,598       6.00 %
 
                                               
Total Risk-Based Capital
                                               
First Charter Corporation
  $ 489,389       12.24 %   $ 319,970       8.00 %   None     None  
First Charter Bank
    460,393       11.53       319,464       8.00     $ 399,330       10.00 %
 
Tier 1 capital consists of total equity plus qualifying capital securities and minority interests, less unrealized gains and losses accumulated in other comprehensive income, certain intangible assets, and adjustments related to the valuation of servicing assets and certain equity investments in nonfinancial companies (equity method investments).
The leverage ratio reflects Tier 1 capital divided by average total assets for the period. Average assets used in the calculation exclude certain intangible and servicing assets.

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Total risk-based capital is comprised of Tier 1 capital plus qualifying subordinated debt and allowance for loan losses and a portion of unrealized gains on certain equity securities.
Both the Tier 1 and the total risk-based capital ratios are computed by dividing the respective capital amounts by risk-weighted assets, as defined.
The Corporation from time to time is required to maintain noninterest bearing reserve balances with the Federal Reserve Bank. The required reserve was $1.0 million at March 31, 2008.
Under current Federal Reserve regulations, a bank subsidiary is limited in the amount it may loan to its parent company and nonbank subsidiaries. Loans to a single affiliate may not exceed 10 percent and loans to all affiliates may not exceed 20 percent of the Bank’s capital stock, surplus, and undivided profits, plus the allowance for loan losses. Loans from the Bank to nonbank affiliates, including the parent company, are also required to be collateralized. As of March 31, 2008, the Bank did not have any loans to nonbank affiliates.
The primary source of funds available to the Corporation is the payment of dividends from the Bank. Dividends paid by a subsidiary bank to its parent company are also subject to certain legal and regulatory limitations. As of March 31, 2008, the Corporation and the Bank were in compliance with these limitations.
16. Business Segment Information
The Corporation operates one reportable segment, the Bank, representing the Corporation’s primary banking subsidiary. The Bank provides businesses and individuals with commercial, consumer and mortgage loans, deposit banking services, brokerage services, insurance products, and comprehensive financial planning solutions. The results of the Bank’s operations constitute a substantial majority of the consolidated net income, revenue, and assets of the Corporation. Intercompany transactions and the Corporation’s revenue, expenses, assets (including cash, investment securities, and investments in venture capital limited partnerships) and liabilities (including commercial paper and subordinated debentures) are included in the “Other” category.

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Information regarding the separate results of operations and assets for the Bank and Other follows:
                                 
 
    Three Months Ended March 31, 2008
                            Consolidated
(In thousands)   The Bank   Other   Eliminations   Total
 
Interest income
  $ 68,564     $ 20     $     $ 68,584  
Interest expense
    34,600       1,233             35,833  
 
Net interest income (expense)
    33,964       (1,213 )           32,751  
Provision for loan losses
    4,707                   4,707  
Noninterest income
    19,873       545             20,418  
Noninterest expense
    33,545       318             33,863  
 
Income (loss) before income tax expense
    15,585       (986 )           14,599  
Income tax expense (benefit)
    9,402       (345 )           9,057  
 
Net income (loss)
  $ 6,183     $ (641 )   $     $ 5,542  
 
Average portfolio loans
  $ 3,491,712     $     $     $ 3,491,712  
Average assets
    4,805,733       571,071       (561,507 )     4,815,297  
Total assets, March 31, 2008
    4,787,498       557,725       (549,362 )     4,795,861  
 
                                 
 
    Three Months Ended March 31, 2007
                            Consolidated
(In thousands)   The Bank   Other   Eliminations   Total
 
Interest income
  $ 77,132     $ 82     $     $ 77,214  
Interest expense
    39,222       1,257             40,479  
 
Net interest income (expense)
    37,910       (1,175 )           36,735  
Provision for loan losses
    1,366                   1,366  
Noninterest income
    19,458       108             19,566  
Noninterest expense
    35,710       210             35,920  
 
Income (loss) before income tax expense
    20,292       (1,277 )           19,015  
Income tax expense (benefit)
    7,106       (447 )           6,659  
 
Net income (loss)
  $ 13,186     $ (830 )   $     $ 12,356  
 
Average portfolio loans
  $ 3,510,437     $     $     $ 3,510,437  
Average assets
    4,856,050       540,699       (525,666 )     4,871,083  
Total assets, March 31, 2007
    4,866,281       540,302       (522,088 )     4,884,495  
 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the consolidated financial statements of the Corporation and the notes thereto.
Factors that May Affect Future Results
 
The following discussion contains certain forward-looking statements about the Corporation’s financial condition and results of operations, which are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s judgment only as of the date hereof. The Corporation undertakes no obligation to publicly revise these forward-looking statements to reflect events and circumstances that arise after the date hereof.
Factors that may cause actual results to differ materially from those contemplated by such forward- looking statements, and which may be beyond the Corporation’s control, include, among others, the following possibilities: (i) projected results in connection with management’s implementation of, or changes in, the Corporation’s business plan and strategic initiatives, including the Corporation’s balance sheet initiatives; (ii) competitive pressure among financial services companies increases significantly; (iii) costs or difficulties related to the integration of acquisitions, including deposit attrition, customer retention and revenue loss, or expenses in general are greater than expected; (iv) general economic conditions, in the markets in which the Corporation does business, are less favorable than expected; (v) risks inherent in making loans, including repayment risks and risks associated with collateral values, are greater than expected; (vi) changes in the interest rate environment, or interest rate policies of the Board of Governors of the Federal Reserve System, may reduce interest margins and affect funding sources; (vii) changes in market rates and prices may adversely affect the value of financial products; (viii) legislation or regulatory requirements or changes thereto, including changes in accounting standards, may adversely affect the businesses in which the Corporation is engaged; (ix) regulatory compliance cost increases are greater than expected; (x) the passage of future tax legislation, or any negative regulatory, administrative or judicial position, may adversely impact the Corporation; (xi) the Corporation’s competitors may have greater financial resources and may develop products that enable them to compete more successfully in the markets in which the Corporation operates; (xii) changes in the securities markets, including changes in interest rates, may adversely affect the Corporation’s ability to raise capital from time to time; and (xiii) costs and difficulties related to the consummation of the proposed merger with Fifth Third may be greater than expected and the consummation remains subject to the satisfaction of various required conditions that may be delayed or may not be satisfied at all.
Overview
 
First Charter Corporation (NASDAQ: FCTR) (hereinafter referred to as “First Charter,” the “Corporation,” or the “Registrant”), headquartered in Charlotte, North Carolina, is a regional financial services company with assets of $4.8 billion and is the holding company for First Charter Bank (“Bank”). As of March 31, 2008, First Charter operated 60 financial centers, four insurance offices, and 136 ATMs throughout North Carolina and Georgia, and also operated loan origination offices in Asheville, North Carolina and Reston, Virginia. First Charter provides businesses and individuals with a broad range of financial services, including banking, financial planning, wealth management, investments, insurance, and mortgages. The results of operations of the Bank constitute the substantial majority of the consolidated net income, revenue, and assets of the Corporation.
The Corporation’s principal source of earnings is derived from net interest income. Net interest income is the interest earned on securities, loans, and other interest-earning assets less the interest paid for deposits and short- and long-term debt.

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Another source of earnings for the Corporation is noninterest income. Noninterest income is derived largely from service charges on deposit accounts and other fee or commission-based services and products, including mortgage, wealth management, brokerage, and insurance. Other sources of noninterest income include securities gains or losses, gains from Small Business Administration loan sales, transactions involving bank-owned property, and income from Bank Owned Life Insurance (“BOLI”) policies.
Noninterest expense is the primary component of expense for the Corporation. Noninterest expense is primarily composed of corporate operating expenses, including salaries and benefits, occupancy and equipment, professional fees, and other operating expense. The provisions for loan losses and income taxes are also considered material expenses.
Proposed Merger with Fifth Third
On August 15, 2007, First Charter and Fifth Third Bancorp entered into an Agreement and Plan of Merger, as amended by the Amended and Restated Plan of Merger, dated September 14, 2007 by and among First Charter, Fifth Third, and Fifth Third Financial. Under the terms of the Merger Agreement, First Charter will be merged with and into Fifth Third Financial. The Merger Agreement has been approved by the Board of Directors of First Charter, Fifth Third and Fifth Third Financial. First Charter’s shareholders approved the Merger Agreement and the Merger has been approved by all necessary state and federal regulatory agencies. The Merger Agreement is subject to customary closing conditions. The merger is currently anticipated to close on Friday, June 6, 2008.
Pursuant to the Merger Agreement, at the effective time of the merger, each common share of First Charter issued and outstanding immediately prior to the effective time (other than common shares held directly or indirectly by First Charter or Fifth Third) will be converted, at the election of the owner of the common share, into either $31.00 cash or shares of Fifth Third common stock with a value of $31.00 per share, or both. Under the terms of the Merger Agreement, approximately 30 percent of First Charter shares will be converted to cash and approximately 70 percent will be converted to Fifth Third common stock.
The Merger Agreement contains customary representations and warranties between First Charter and Fifth Third. The Merger Agreement also contains customary covenants and agreements, including (a) covenants related to the conduct of First Charter’s business between the date of the signing of the Merger Agreement and the closing of the merger, (b) covenants prohibiting solicitation of competing merger proposals, and (c) agreements regarding efforts of the parties to cause the Merger Agreement to be completed.
The Merger Agreement contains certain termination rights and provides that, upon or following the termination of the Merger Agreement, under specified circumstances involving a competing merger transaction, First Charter may be required to pay Fifth Third a termination fee of $32.5 million.
As previously disclosed, First Charter has been informed by Fifth Third that in February 2008 a shareholder of Fifth Third filed a derivative suit in the Court of Common Pleas for Hamilton County, Ohio, against the members of Fifth Third’s board of directors and, nominally, Fifth Third, alleging breach of fiduciary duty and waste of corporate’s assets, among other charges, in relation to the approval of Fifth Third’s acquisition of First Charter. The suit seeks, with respect to the completion of the acquisition, an injunction to stop the acquisition of First Charter and an independent valuation of First Charter as to its worth. The suit also seeks unspecified compensatory damages to be paid to Fifth Third by its directors as well as costs and attorneys fees to the plaintiff. The suit is in its earliest state and Fifth Third has stated that the impact of the final disposition cannot be assessed at this time. First Charter and its legal counsel have carefully reviewed the complaint, are monitoring developments, and intend to take such action as is appropriate and necessary to protect First Charter’s interests in the Merger Agreement with Fifth Third.

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In connection with the proposed merger with Fifth Third, the Corporation has incurred expenses of approximately $0.6 million of merger-related costs, principally legal and professional services, for the three months ended March 31, 2008.
The Community-Banking Model
The Bank operates a community-banking model. The community-banking model is focused on delivering a broad array of financial products and solutions to our clients with exceptional service and convenience at a fair price. It emphasizes local market decision-making and management whenever possible. Management believes this model works well against larger competitors that may have less flexibility, as well as local competition that may not have the array of products and services nor the number of convenient locations that the Bank offers and are challenged to provide exceptional customer service. The Bank competes against four of the largest banks in the country, as well as other local banks, savings and loan associations, credit unions, and finance companies.
Financial Summary
Net interest income, the difference between total interest income and total interest expense, is the Corporation’s principal source of earnings. For the three months ended March 31, 2008, net interest income was $32.8 million, a decrease of $3.9 million, or 10.8 percent, from net interest income of $36.7 million for the three months ended March 31, 2007.
Income tax expense for the three months ended March 31, 2008, was $9.1 million, for an effective tax rate of 62.0 percent, compared with $6.7 million, for an effective tax rate of 35.0 percent in the first quarter of 2007. The effective tax rate increased for the three months ended March 31, 2008 primarily as a result of the closing agreement with the North Carolina Department of Revenue (“DOR”).
The Corporation’s first quarter 2008 net income was $5.5 million, or $0.16 per diluted share, a $6.9 million decrease from net income of $12.4 million in first quarter 2007. Return on average assets and return on average equity was 0.46 percent and 4.70 percent for the three months ended March 31, 2008, respectively, compared to 1.03 percent and 11.09 percent for the first quarter 2007, respectively.

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The table below presents the Corporation’s selected financial data by quarter:
Table One
Selected Financial Data
                                         
 
    Three Months Ended
    March 31   December 31   September 30   June 30   March 31
(Dollars in thousands, except share and per share amounts)   2008   2007   2007   2007   2007
 
Income statement
                                       
Interest income
  $ 68,584     $ 75,660     $ 78,727     $ 78,291     $ 77,214  
Interest expense
    35,833       40,284       41,496       40,747       40,479  
 
Net interest income
    32,751       35,376       37,231       37,544       36,735  
Provision for loan losses
    4,707       6,144       3,311       9,124       1,366  
Noninterest income
    20,418       20,120       18,427       20,141       19,566  
Noninterest expense
    33,863       35,845       35,556       35,207       35,920  
 
Income before income tax expense
    14,599       13,507       16,791       13,354       19,015  
Income tax expense
    9,057       4,576       5,724       4,404       6,659  
 
Net income
  $ 5,542     $ 8,931     $ 11,067     $ 8,950     $ 12,356  
 
Per common share
                                       
Net income per common share
                                       
Basic
  $ 0.16     $ 0.25     $ 0.32     $ 0.26     $ 0.36  
Diluted
    0.16       0.25       0.32       0.26       0.35  
Average shares
                                       
Basic
    34,739       34,562       34,423       34,698       34,770  
Diluted
    35,121       35,053       34,796       34,987       35,086  
Cash dividends declared
  $ 0.195     $ 0.195     $ 0.195     $ 0.195     $ 0.195  
Period-end book value
    13.24       13.39       13.16       12.85       12.97  
 
Ratios
                                       
Return on average equity
    4.70 %     7.67 %     9.72 %     7.86 %     11.09 %
Return on average assets
    0.46       0.74       0.91       0.74       1.03  
Net yield on earning assets
    3.03       3.25       3.39       3.42       3.38  
Average portfolio loans to average deposits
    108.41       108.72       109.37       109.50       107.98  
Average equity to average assets
    9.85       9.59       9.33       9.37       9.28  
Efficiency ratio (1)
    60.9       64.2       63.2       60.4       63.1  
 
Selected period-end balances
                                       
Portfolio loans, net
  $ 3,432,766     $ 3,460,593     $ 3,434,389     $ 3,509,047     $ 3,494,015  
Loans held for sale
    17,544       14,145       10,362       11,471       13,691  
Allowance for loan losses
    45,022       42,414       43,017       44,790       35,854  
Investment in securities (2)
    873,641       909,661       907,608       898,528       897,762  
Assets
    4,795,861       4,862,417       4,839,693       4,916,721       4,884,495  
Deposits
    3,219,339       3,221,619       3,208,026       3,230,346       3,321,366  
Other borrowings
    1,075,355       1,120,141       1,113,332       1,176,758       1,044,229  
Total liabilities
    4,332,335       4,394,073       4,382,205       4,470,893       4,429,123  
Shareholders’ equity
    463,526       468,344       457,488       445,828       455,372  
 
Selected average balances
                                       
Portfolio loans
  $ 3,491,712     $ 3,488,598     $ 3,514,699     $ 3,532,713     $ 3,510,437  
Loans held for sale
    13,373       10,028       9,345       11,127       11,431  
Investment in securities (2)
    905,045       901,068       914,569       914,606       926,970  
Earning assets
    4,419,298       4,412,038       4,445,923       4,467,031       4,463,161  
Assets
    4,815,297       4,819,264       4,846,399       4,874,742       4,871,083  
Deposits
    3,220,862       3,208,859       3,213,507       3,226,308       3,251,137  
Other borrowings
    1,079,188       1,103,585       1,124,021       1,131,599       1,113,191  
Shareholders’ equity
    474,114       461,972       451,946       456,634       451,835  
 
 
(1)  
Noninterest expense less debt extinguishment expense, Visa litigation expense, tax settlement and derivative termination costs, divided by the sum of taxable-equivalent net interest income plus noninterest income less gain (loss) on sale of securities, net.
 
(2)  
Includes available for sale securities and Federal Home Loan Bank and Federal Reserve Bank stock.
Critical Accounting Estimates and Policies
 
The Corporation’s significant accounting policies are described in Note 1 of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007. These policies are essential in understanding management’s discussion and analysis of financial condition and results of operations. Some of the Corporation’s accounting policies require significant judgment to estimate values of either assets or liabilities. In addition, certain accounting principles require significant judgment with respect to their application to complicated transactions to determine the most appropriate treatment.
The Corporation has identified four accounting policies as being critical in terms of judgments and the extent to which estimates are used: allowance for loan losses, income taxes, marketable securities valuation and identified intangible assets and goodwill. In many cases, there are numerous alternative judgments that could be used in the process of estimating values of assets or liabilities. Where alternatives exist, the Corporation has used the factors it believes represent the most reasonable value in

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developing the inputs for the valuation. Actual performance that differs from the Corporation’s estimates of the key variables could affect net income. A summary of these four accounting policies follows:
Allowance for Loan Losses
The Corporation considers its policy regarding the allowance for loan losses to be one of its most critical accounting policies, as it requires some of management’s most subjective and complex judgments. The allowance for loan losses is maintained at a level the Corporation believes is adequate to absorb probable losses inherent in the loan portfolio as of the date of the consolidated financial statements. The Corporation has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses that reflect its evaluation of credit risk considering all information available to it.
The determination of the level of the allowance and, correspondingly, the provision for loan losses, rests upon various judgments and assumptions, including: (i) general economic conditions, (ii) loan portfolio composition, (iii) prior loan loss experience, (iv) management’s evaluation of credit risk related to both individual borrowers and pools of loans and (v) observations derived from the Corporation’s ongoing internal credit review and examination processes and those of its regulators. Depending on changes in circumstances, future assessments of credit risk may yield materially different results, which may require an increase or decrease in the allowance for loan losses.
The Corporation employs a variety of statistical modeling and estimation tools in developing the appropriate allowance. The following provides a description of each of the components involved in the allowance for loan losses, the techniques the Corporation uses, and the estimates and judgments inherent to each component.
The first component of the allowance for loan losses, the valuation allowance for impaired loans, is computed based on documented reviews performed by the Corporation’s Credit Risk Management for impaired relationships greater than $150,000. Credit Risk Management typically estimates these valuation allowances by considering the fair value of the underlying collateral for each impaired loan using current appraisals. The results of these estimates are updated quarterly or periodically as circumstances change. Changes in the dollar amount of impaired loans or in the estimates of the fair value of the underlying collateral can impact the valuation allowance on impaired loans and, therefore, the overall allowance for loan losses.
The second component of the allowance for loan losses, the portion attributable to all other loans without specific reserve amounts, is determined by applying reserve factors to the outstanding balance of loans. The portfolio is segmented into two major categories: commercial loans and consumer loans. Commercial loans are segmented further by risk grade, so that separate reserve factors are applied to each pool of commercial loans. The reserve factors applied to the commercial segments are determined using a migration analysis that computes current loss estimates by credit grade using a 60-month trailing loss history. Since the migration analysis is based on trailing data, the reserve factors are changed based on actual losses and other judgmentally determined factors. Changes in commercial loan credit grades can also impact this component of the allowance for loan losses from period to period. Consumer loans which include mortgage, general consumer, consumer real estate, home equity and consumer unsecured loans are segmented by homogeneous pools in order to apply separate reserve factors to each pool of consumer loans. The reserve factors applied to the consumer segments are a 36-month rolling average of losses. Since the reserve factors are based on historical loss data, the percentage loss estimates can change period-to-period based on actual losses.
The third component of the allowance for loan losses is intended to capture the various risk elements of the loan portfolio which may not be sufficiently captured in the historical loss rates. These factors include intrinsic risk, operational risk, concentration risk and model risk. Intrinsic risk relates to the impact of current economic conditions on the Corporation’s borrower base, the effects of which may not be realized by the Corporation in the form of charge-offs for several periods. The Corporation monitors and documents various local, regional and national economic data, and makes subjective estimates of the

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impact of changes in economic conditions on the allowance for loan losses. Operational risk includes factors such as the likelihood of loss on a loan due to procedural error. Historically, the Corporation has made additional loss estimates for certain types of loans that were either acquired from other institutions in mergers or were underwritten using policies that are no longer in effect at the Corporation. These identified loans are considered to have higher risk of loss than currently reflected in historical loss rates of the Corporation, so additional estimates of loss are made by management. Concentration risk includes the risk of loss due to extensions of credit to a particular industry, loan type or borrower that may be troubled. The Corporation monitors its portfolio for any excessive concentrations of loans during each period, and if any excessive concentrations are noted, additional estimates of loss are made. Model risk reflects the inherent uncertainty of estimates within the allowance for loan losses model. Changes in the allowance for loan losses for these subjective factors can arise from changes in the balance and types of outstanding loans, as well as changes in the underlying conditions which drive a change in the percentage used. As more fully discussed below, the Corporation continually monitors the portfolio in an effort to identify any other factors which may have an impact on loss estimates within the portfolio.
All estimates of the loan portfolio risk, including the adequacy of the allowance for loan losses, are subject to general and local economic conditions, among other factors, which are unpredictable and beyond the Corporation’s control. Since a significant portion of the loan portfolio is comprised of real estate loans and loans to area businesses, the Corporation is subject to continued risk that the real estate market and economic conditions in general could change and therefore result in additional losses and require increases in the provision for loan losses. If management had made different assumptions about probable loan losses, the Corporation’s financial position and results of operations could have differed materially.
As previously disclosed, the Corporation has recorded a provision for loan losses related to Penland. The Corporation continues to evaluate the Penland lot loan portfolio.
Income Taxes
Calculating the Corporation’s income tax expense requires significant judgment and the use of estimates. The Corporation periodically assesses its tax positions based on current tax developments, including enacted statutory, judicial and regulatory guidance. In analyzing the Corporation’s overall tax position, consideration is given to the amount and timing of recognizing income tax liabilities and benefits. In applying the tax and accounting guidance to the facts and circumstances, income tax balances are adjusted appropriately through the income tax provision.
Reserves for income tax uncertainties are determined using a two-step process in accordance with FASB Interpretation No. 48, Accounting for Uncertainties in Income Taxes, and requires significant management judgment. In the first step of the process, the Corporation determines whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. If the Corporation determines that a tax position has met the more-likely-than-not threshold, the Corporation then determines the amount that would be recognized in its financial statements. In calculating the amount recognized in the financial statements, the Corporation considers the amounts and probabilities that could be recognized upon ultimate settlement using the facts, circumstances, and information available at the reporting date.
Marketable Securities Valuation
The Corporation holds fixed income and equity securities and substantially all of these assets are reflected at fair value on the Corporation’s consolidated balance sheets. SFAS 157, Fair Value Measurements, defines fair value and specifies a hierarchy of valuation techniques based on whether those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Corporation’s market assumptions. These two types of inputs create the following fair value hierarchy:

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Level 1 – Quoted market prices for identical instruments in active markets.
 
   
Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
 
   
Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
When available, the Corporation uses quoted market prices to determine fair value and classifies such items within Level 1 of the fair value hierarchy. If quoted market prices are not available, fair value is generally determined by using quoted prices for similar instruments or valuations using observable market inputs. If fair values can not be determined using active market data, a matrix pricing model is used. The matrix pricing model, which is classified as Level 2 within the fair value hierarchy, is populated using yield curve and other market data.
The recent credit crisis has caused some markets to be illiquid, thus reducing the availability of certain market data. As a result, the Corporation has valued its trust preferred securities using dealer determined prices. Significant inputs to these dealer pricing models are not readily observable, thus the valuations of these securities are classified as Level 3 within the fair value hierarchy. When or if the liquidity returns to these markets, the valuations of these securities will revert to using the related observable market inputs in determining fair value.
At the end of each reporting period, the Corporation reviews its securities portfolio for impairment. If a decline in the fair value of a security below its cost or amortized cost is judged by management to be other-than-temporary, the cost basis of the security is written down to fair value and the amount of the write down is included in noninterest income.
Identified Intangible Assets and Goodwill
The Corporation records all assets and liabilities acquired in purchase acquisitions, including goodwill, indefinite-lived intangibles, and other intangibles, at fair value as required by SFAS 141, Business Combinations. The initial recording of goodwill and other intangibles requires subjective judgments concerning estimates of the fair value of the acquired assets and liabilities. Goodwill and indefinite-lived intangible assets are not amortized but are subject to annual tests for impairment or more often if events or circumstances indicate they may be impaired. Other identified intangible assets are amortized over their estimated useful lives and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount.
The ongoing value of goodwill is ultimately supported by revenue from the Corporation’s businesses and its ability to deliver cost-effective services over future periods. Any decline in revenue resulting from a lack of growth or the inability to effectively provide services could potentially create an impairment of goodwill.
Earnings Performance
 
Net Interest Income and Margin
Net interest income, the difference between total interest income and total interest expense, is the Corporation’s principal source of earnings. An analysis of the Corporation’s net interest income on a taxable-equivalent basis and average balance sheets for three months ended March 31, 2008 and 2007 is presented in Table Two. Net interest income on a taxable-equivalent basis is a non-GAAP (Generally Accepted Accounting Principles) performance measure used by management in operating the business which management believes provides investors with a more accurate picture of the interest margin for comparative purposes. The changes in net interest income, on a taxable-equivalent basis, for the three months ended March 31, 2008 and 2007 are analyzed in Table Three. The discussion below is based on net interest income computed under accounting principles generally accepted in the United States of America.

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For the three months ended March 31, 2008, net interest income was $32.8 million, a decrease of $3.9 million, or 10.8 percent, from net interest income of $36.7 million for the three months ended March 31, 2007. The net interest margin (taxable-equivalent net interest income divided by average earning assets) for the first quarter of 2008 decreased 35 basis points to 3.03 percent compared to 3.38 percent for the first quarter of 2007.
Compared to first quarter 2007, earning-asset yields decreased 76 basis points to 6.29 percent. Loan yields decreased 105 basis points to 6.57 percent. This decrease is primarily the result of a reduction in the prime lending rate that followed the Federal Reserve lowering the federal funds rate by 300 basis points from September 2007 through March 2008. Loan yields were also negatively impacted by an increase in non accrual loans. The decrease in loan yields was partially offset by an increase in yields on the securities portfolio. Securities yields increased 28 basis points to 5.23 percent as maturities from lower yielding securities were reinvested in similar duration securities at higher yields. In addition, the percentage of investment security average balances (which, on average, have lower yields than loans) to total earning asset average balances fell from 20.8 percent to 20.4 percent over the past year. Earning-asset average balances decreased to $4.4 billion at March 31, 2008, compared to $4.5 billion at March 31, 2007.
On the liability side of the balance sheet, the cost of interest-bearing liabilities decreased 48 basis points, compared to March 31, 2007. This decrease was comprised of a 28 basis point decrease in interest-bearing deposit costs to 3.55 percent, while other borrowing costs decreased 95 basis points to 4.13 percent. While the Federal Reserve lowered the federal funds rate by 300 basis points from September 2007 through March 2008, the decline in rates on interest bearing liabilities trailed loan yields due to the short term fixed rate nature of CDs and external market liquidity concerns which kept deposit rates comparatively high.

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Net interest income and yields on earning-asset average balances and interest expense and rates paid on interest-bearing liability average balances, and the net interest margin follow:
Table Two
Average Balances and Net Interest Income Analysis
                                                 
 
    Three Months Ended March 31
    2008   2007
    Daily   Interest   Average   Daily   Interest   Average
    Average   Income/   Yield/Rate   Average   Income/   Yield/Rate
(Dollars in thousands)   Balance   Expense   Paid (6)   Balance   Expense   Paid (6)
 
Assets
                                               
Earning assets
                                               
Loans and loans held for sale (1) (2) (3) (4)
  $ 3,505,085     $ 57,298       6.57 %   $ 3,521,868     $ 66,239       7.62 %
Investment securities — taxable (4) (5)
    811,973       10,631       5.27       826,337       9,949       4.83  
Investment securities — tax-exempt
    91,610       1,174       5.13       100,633       1,491       5.92  
Federal funds sold
    7,056       55       3.19       9,073       128       5.70  
Interest-bearing bank deposits
    3,574       26       2.93       5,250       50       3.90  
 
Total earning assets
    4,419,298     $ 69,184       6.29 %     4,463,161     $ 77,857       7.05 %
Cash and due from banks
    70,406                       79,360                  
Other assets
    325,593                       328,562                  
 
Total assets
  $ 4,815,297                     $ 4,871,083                  
 
Liabilities and shareholders’ equity
                                               
Interest-bearing liabilities
                                               
Demand deposits
  $ 477,360     $ 1,468       1.24 %   $ 399,557     $ 1,058       1.07 %
Money market accounts
    541,779       3,456       2.57       642,383       5,551       3.50  
Savings deposits
    101,894       53       0.21       112,988       67       0.24  
Certificates of deposit
    1,679,341       19,774       4.74       1,649,408       19,865       4.88  
Retail other borrowings
    76,270       500       2.64       92,090       662       2.92  
Wholesale other borrowings
    1,002,918       10,582       4.24       1,021,101       13,276       5.27  
 
Total interest-bearing liabilities
    3,879,562       35,833       3.71 %     3,917,527       40,479       4.19 %
Noninterest-bearing deposits
    420,488                       446,801                  
Other liabilities
    41,133                       54,920                  
Shareholders’ equity
    474,114                       451,835                  
 
Total liabilities and shareholders’ equity
  $ 4,815,297                     $ 4,871,083                  
 
Net interest spread
                    2.58 %                     2.86 %
Contribution of noninterest bearing sources
                    0.45                       0.52  
 
Net interest income/ yield on earning assets
          $ 33,351       3.03 %           $ 37,378       3.38 %
 
 
(1)  
The preceding analysis takes into consideration the principal amount of nonaccruing loans and only income actually collected and recognized on such loans.
 
(2)  
Average loan balances are shown net of unearned income.
 
(3)  
Includes amortization of deferred loan fees of $960, and $829 for the three months ended March 2008 and 2007, respectively.
 
(4)  
Yields on tax-exempt securities and loans are stated on a taxable-equivalent basis, assuming a Federal tax rate of 35 percent and applicable state taxes for 2008 and 2007. The adjustments made to convert to a taxable-equivalent basis were $600 and $643 for the three months ended March 31, 2008 and 2007, respectively.
 
(5)  
Includes available for sale securities and Federal Home Loan Bank and Federal Reserve Bank stock.
 
(6)  
Annualized.
The following table shows changes in tax-equivalent interest income, interest expense, and tax-equivalent net interest income arising from volume and rate changes for major categories of earning assets and interest-bearing liabilities. The change in interest not solely due to changes in volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each.

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Table Three
Volume and Rate Variance Analysis
                         
 
    Three Months Ended March 31
    2008 vs 2007
    Due to Change in   Net
(In thousands)   Volume   Rate   Change
 
Increase (decrease) in tax-equivalent interest income
                       
Loans and loans held for sale (1)
  $ (297 )   $ (8,644 )   $ (8,941 )
Investment securities — taxable (1) (2)
    (181 )     863       682  
Investment securities — tax-exempt
    (127 )     (190 )     (317 )
Federal funds sold
    (24 )     (49 )     (73 )
Interest-bearing bank deposits
    (14 )     (10 )     (24 )
 
Total
  $ (643 )   $ (8,030 )   $ (8,673 )
 
Increase (decrease) in interest expense
                       
Deposits:
                       
Demand
  $ 227     $ 183     $ 410  
Money market
    (769 )     (1,326 )     (2,095 )
Savings
    (6 )     (8 )     (14 )
Certificates of deposit
    413       (504 )     (91 )
Retail other borrowings
    (103 )     (59 )     (162 )
Wholesale other borrowings
    (223 )     (2,471 )     (2,694 )
 
Total
  $ (463 )   $ (4,183 )   $ (4,646 )
 
Increase in tax-equivalent net interest income
                  $ (4,027 )
 
 
(1)  
Income on tax-exempt securities and loans are stated on a taxable-equivalent basis. Refer to Table Two for further details.
 
(2)  
Includes available for sale securities and Federal Home Loan Bank and Federal Reserve Bank stock.
Noninterest Income
The major components of noninterest income are derived from service charges on deposit accounts, ATM, debit and merchant fees, and mortgage, brokerage, insurance, and wealth management revenue. In addition, the Corporation realizes gains and losses on securities, equity investments, Small Business Administration (“SBA”) loan sales, bank-owned property sales, and income from its BOLI policies.

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Details of noninterest income follow:
Table Four
Noninterest Income
                                 
 
    Three Months Ended    
    March 31   Increase / (Decrease)
(In thousands)   2008   2007   Amount   Percent
 
Service charges on deposits
  $ 7,365     $ 7,390     $ (25 )     (0.3 )%
ATM, debit, and merchant fees
    2,631       2,444       187       7.7  
Wealth management
    779       716       63       8.8  
Equity method investment gains, net
    627       1,127       (500 )     (44.4 )
Mortgage services
    1,012       901       111       12.3  
Gain on sale of Small Business Administration loans
    98       377       (279 )     (74.0 )
Brokerage services
    733       1,081       (348 )     (32.2 )
Insurance services
    4,150       3,634       516       14.2  
Bank owned life insurance
    1,165       1,139       26       2.3  
Property sale gains, net
    59       63       (4 )     (6.3 )
Securities gains (losses), net
    1,229       (11 )     1,240        
Other
    570       705       (135 )     (19.1 )
 
Total noninterest income
  $ 20,418     $ 19,566     $ 852       4.4 %
 
Selected items included in noninterest income follow:
Table Five
Selected Items Included in Noninterest Income
                 
 
    Three Months Ended
    March 31
(In thousands)   2008   2007
 
Equity method investment gains, net
  $ 627     $ 1,127  
Securities gains (losses), net
    1,229       (11 )
 
Noninterest income for the three months ended March 31, 2008 was $20.4 million, an increase of $0.8 million, or 4.4 percent, from $19.6 million for the three months ended March 31, 2007.
The largest increase in noninterest income for the three months ended March 31, 2008 was from the gain recognized related to the redemption of Visa Inc. (“Visa”) common stock. In March 2008, the Corporation received 51,457 Visa Class B common shares in connection with Visa’s initial public offering (“IPO”), of which 19,894 shares were redeemed as part of Visa’s mandatory redemption of its Class B stock. The Corporation recognized a gain of $0.9 million related to this redemption. The Corporation did not recognize any gain on the remaining 31,563 unredeemed Visa Class B common shares.
Other factors for the increase in noninterest income included were:
   
Insurance service revenue increased $0.5 million due to greater contingency revenue recognized in the first quarter of 2008 compared with the first quarter of 2007.
 
   
ATM, debit and merchant card services revenue was $0.2 million higher, reflecting increased transactions.

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These increases were partially offset by the following items:
   
Equity method investment gains were $0.5 million lower for the three months ended March 31, 2008 as compared with the same period of 2007. The returns on the equity method investments vary from period to period and income is recorded when earned.
 
   
Brokerage revenue decreased $0.3 million from first quarter 2007 due to fewer brokers compared to prior year, in addition the recent uncertainty in the U.S. equity markets resulted in lower transaction volume.
 
   
Gains on SBA loan sales were $0.3 million lower for the three months ended March 31, 2008 compared to the same period in 2007 due to lower production and decreased spreads.
Noninterest Expense
Details of noninterest expense follow:
Table Six
Noninterest Expense
                                 
 
    Three Months Ended    
    March 31   Increase / (Decrease)
(Dollars in thousands)   2008   2007   Amount   Percent
 
Salaries and employee benefits
  $ 18,498     $ 19,587     $ (1,089 )     (5.6 )%
Occupancy and equipment
    4,725       4,612       113       2.5  
Data processing
    1,515       1,790       (275 )     (15.4 )
Marketing
    454       1,351       (897 )     (66.4 )
Postage and supplies
    1,096       1,172       (76 )     (6.5 )
Legal and professional services
    2,700       3,586       (886 )     (24.7 )
Telecommunications
    625       671       (46 )     (6.9 )
Amortization of intangibles
    159       223       (64 )     (28.7 )
Foreclosed properties
    (128 )     153       (281 )     (183.7 )
Other
    4,219       2,775       1,444       52.0  
 
Total noninterest expense
  $ 33,863     $ 35,920     $ (2,057 )     (5.7 )%
 
Full-time equivalent employees
    1,035       1,105       (70 )     (6.3 )%
 
Efficiency ratio (1)
    60.9 %     63.1 %     (2.2 )%     (3.5 )%
 
 
(1)  
Noninterest expense, less Visa litigation and tax settlements, divided by the sum of taxable-equivalent net interest income plus noninterest income less securities gains (losses), net.
Selected items included in noninterest expense follow:
Table Seven
Selected Items Included in Noninterest Expense
                 
 
    Three Months Ended
    March 31
(In thousands)   2008   2007
 
Separation agreements
  $     $ 58  
Merger-related costs
    607       200  
Visa litigation costs
    239        
Tax settlement costs
    1,604        
 
Noninterest expense for the first quarter of 2008 was $33.9 million, a $2.0 million, or 5.7 percent decrease from $35.9 million for the first quarter of 2007.
During October 2007, Visa completed a restructuring and issued shares of Visa common stock to its financial institution members in contemplation of its IPO which occurred in March 2008. After the

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restructuring, member financial institutions became guarantors of certain Visa’s litigation liabilities based on the members’ proportionate share of the membership base. On November 7, 2007, Visa announced that it had reached a settlement in the amount of $2.065 billion to resolve certain restraint of trade litigation brought by American Express. The Corporation recognized a litigation liability of $0.6 million related to the American Express settlement and the remaining unsettled Discover, Interchange and Attridge litigation. Of this $0.6 million, $0.3 million is the Corporation’s proportionate share of the American Express Settlement and $0.3 million is the Corporation’s estimate of the fair value of the potential losses related to the remaining unsettled litigation. Charges related to these litigation matters is included in “Legal and professional services” on the Corporation’s consolidated statements of income.
Additionally, Visa funded an escrow account with a portion of the proceeds from the IPO. The escrow account will be used to pay settlements of Visa’s restraint of trade litigation. The Corporation’s proportionate share of this escrow account was $0.4 million and the Corporation recognized the benefit from the escrow account as a partial recapture of expenses incurred to establish the Visa litigation reserve liability.
For the three months ended March 31, 2008, other noninterest expense increased $1.4 million. Other noninterest expense includes $1.6 million of expenses related to the payment of franchise taxes resulting from the North Carolina tax settlement.
The above increases were offset by the following decreases in expenses:
   
Salaries and employee benefits expense for the three months ended March 31, 2008 was $18.5 million, a $1.1 million decrease compared to the same period of 2007. The decrease in salaries and benefits expense was primarily due to a lower number of full-time equivalent employees.
 
   
Legal and professional services expense decreased $0.9 million compared to the same period of 2007. The first quarter of 2007 included the additional costs related to the delayed filing of the Corporation’s 2006 Form 10-K. The results for the three months ended March 31, 2008 included $0.6 million of legal costs related to the pending Fifth Third merger, compared to $0.2 million of legal costs related to the Gwinnett Banking Company (“GBC”) merger for the same period in 2007. As discussed above, legal and professional services include $0.2 million of net legal expense related to the establishment of the Visa reserves in 2008.
 
   
Data processing expense decreased $0.3 million as a result of improved vendor pricing.
 
   
Marketing expense decreased $0.9 million due to decreased spending in the first quarter of 2008.
The efficiency ratio, equal to noninterest expense as a percentage of tax-equivalent net interest income and total noninterest income, was 60.9 percent for the three months ended March 31, 2008, compared to 63.1 percent for the three months ended March 31, 2007. The calculation of the efficiency ratio excludes the impact of Visa transactions, North Carolina tax settlement expense and securities gains (losses).
Income Tax Expense
Income tax expense for the three months ended March 31, 2008, was $9.1 million, for an effective tax rate of 62.0 percent, compared with $6.7 million, for an effective tax rate of 35.0 percent in the first quarter of 2007. The effective tax rate increased for the three months ended March 31, 2008 primarily as a result of the closing agreement with the DOR. This closing agreement is discussed below and in Note 11 of the consolidated financial statements.
The Corporation, through its subsidiaries, participates in two entities classified as captive REITs from which the Corporation has historically received dividends eligible for certain tax benefits within the Corporation’s tax returns and consolidated financial statements. These entities were the primary focus of the examination of the Corporation by the DOR for tax years 1999 through and including 2005. On March 31, 2008,

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the Corporation entered into a closing agreement with the DOR for tax years 1999 through 2006. The Corporation remains subject to examination by the DOR for tax years 2007 forward.
The Corporation effectively settled the Internal Revenue Service examination of the 2004 and 2005 tax years during the quarter ended March 31, 2008. The Corporation’s tax years 2006 forward continue to be subject to examination by the Internal Revenue Service. For additional information regarding these examinations refer to Note 11 of the consolidated financial statements.
A reconciliation for the three months ending March 3, 2008 of the beginning and ending amount of unrecognized tax benefits is as follows:
Table Eight
Unrecognized Tax Benefits
         
 
(In thousands)        
 
Balance, beginning of period
  $ 10,833  
Expiration of statute
    (731 )
Addition for tax positions of prior periods
     
Reductions for tax positions of prior periods
    (4,981 )
 
Balance, March 31, 2008
  $ 5,121  
 
Balance Sheet Analysis
 
Securities Available for Sale
The securities portfolio, all of which is classified as available-for-sale, is a component of the Corporation’s Asset Liability Management (“ALM”) strategy. The decision to purchase or sell securities is based upon liquidity needs, changes in interest rates, changes in the Bank’s risk tolerance, the composition of the rest of the balance sheet, and other factors. Securities available-for-sale are accounted for at fair value, with unrealized gains and losses recorded net of tax as a component of other comprehensive income in shareholders’ equity, unless the unrealized losses are considered other-than-temporary.
The fair value of the securities portfolio is determined by various third-party sources. The valuation is determined as of a date within close proximity to the end of the reporting period based on available quoted market prices, quoted market prices for similar securities, or valuation models.
At March 31, 2008, securities available for sale were $821.5 million, compared to $860.7 million at December 31, 2007. Pretax unrealized net losses on securities available for sale were $9.5 million at March 31, 2008, compared to pretax unrealized net losses of $2.4 million at December 31, 2007. The increase in unrealized losses resulted primarily from an increase in credit spreads among the various types of bond investments, market illiquidity and recession fears.
During the first quarter of 2008, proceeds from the maturities, paydowns, and calls of $115.1 million of securities were used to purchase $82.8 million of securities, principally mortgage-backed and U.S. government agency securities.
In March 2008, the Corporation received 51,457 Class B common shares in connection with the Visa IPO, of which 19,894 shares were redeemed as part of Visa’s mandatory redemption of its Class B stock. The Corporation recognized a gain of approximately $0.9 million related to this redemption. The Corporation did not recognize any gain on the remaining 31,563 unredeemed Visa Class B common shares and the unconverted Visa Class B common shares are not reflected on the Corporation’s consolidated balance sheet at March 31, 2008 as the Corporation has no historical basis in these shares.

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The following table shows the carrying value of (i) U.S. government agency obligations, (ii) mortgage-backed securities, (iii) state, county, and municipal obligations, (iv) asset-backed securities, and (v) equity securities.
Table Nine
Investment Portfolio
                 
 
    March 31   December 31
(In thousands)   2008   2007
 
U.S. government agency obligations
  $ 97,812     $ 146,554  
Mortgage-backed securities
    580,241       565,434  
State, county, and municipal obligations
    91,981       92,938  
Asset-backed securities
    50,048       54,229  
Equity securities
    1,436       1,516  
 
Total Securities Available for Sale
  $ 821,518     $ 860,671  
 
The following is a summary of the credit ratings of the Corporation’s mortgage-backed securities as of March 31, 2008:
Table Ten
Mortgage-backed Securities
                         
 
    Amortized   AAA+ to   AA or
(In thousands)   Cost   AAA-   below
 
Government agency mortgages
  $ 437,040       100.0 %     %
Prime mortgages
    92,339       100.0        
Alt-A mortgages
    54,418       100.0        
Subprime mortgages
                 
 
Total Mortgage Backed Securities
  $ 583,797       100.0 %     %
 
The following is a summary of the Corporation’s state, county and municipal bond credit ratings, considering the effects with and without bond insurance as of March 31, 2008:
Table Eleven
Municipal Bond Obligations
                                 
 
    With Bond   Without Bond
(In thousands)   Insurance   Insurance
 
AAA
  $ 56,510       62.1 %   $ 37,451       41.2 %
AA
    11,977       13.2       18,899       20.8  
A
    20,435       22.5       28,104       30.9  
BBB
    1,715       1.9       2,834       3.1  
Below
    322       0.3       3,671       4.0  
 
Total Municipal Bond Obligations
  $ 90,959       100.0 %   $ 90,959       100.0 %
 
Industry exposure of the Corporation’s asset-backed securities is comprised of 63.9 percent bank, 35.0 percent insurance, and 1.1 percent REIT trust preferred securities. The following is a summary of the components and credit ratings of the Corporation’s asset-backed securities as of March 31, 2008:

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Table Twelve
Asset-backed Securities Ratings
                         
 
    Amortized   A   BBB
(In thousands)   Cost   Rated   Rated
 
Bank only trust preferred securities
  $ 5,000       %     100.0 %
Insurance only trust preferred securities
    10,002       100.0        
REIT only trust preferred securities
                 
Bank and insurance trust preferred securities
    23,744       42.1       57.9  
Bank, insurance and REIT trust preferred securities
    18,915       52.9       47.1  
 
Total Asset Backed Securities
  $ 57,661       52.0 %     48.0 %
 
Loan Portfolio
The Corporation’s loan portfolio at March 31, 2008, consisted of six major categories: Commercial Real Estate, Commercial Non Real Estate, Construction, Mortgage, Consumer, and Home Equity. Pricing is driven by quality, loan size, loan tenor, prepayment risk, the Corporation’s relationship with the customer, competition, and other factors. The Corporation is primarily a secured lender in all of these loan categories. The terms of the Corporation’s loans are generally five years or less with the exception of home equity lines and residential mortgages, for which the terms can range out to 30 years. In addition, the Corporation has a program in which it buys and sells portions of loans (primarily originated in the Southeastern region of the United States), both participations and syndications, from key strategic partner financial institutions with which the Corporation has established relationships. This strategic partners’ portfolio includes commercial real estate, commercial non real estate, and construction loans. This program enables the Corporation to diversify both its geographic risk and its total exposure risk. From time to time, the Corporation also sources commercial real estate, commercial non real estate, construction, and consumer loans through correspondent relationships. As of March 31, 2008, the Corporation’s total loan portfolio included $232.3 million of loans originated through the strategic partners’ program and correspondent relationships.
A summary of the loan portfolio follows:
Table Thirteen
Loan Portfolio Composition
                                 
 
    March 31   Percent of   December 31   Percent of
(In thousands)   2008   Total Loans   2007   Total Loans
 
Commercial real estate
  $ 1,058,197       30.4 %   $ 1,073,983       30.7 %
Commercial non real estate
    299,555       8.6       308,792       8.8  
Construction
    861,967       24.8       871,579       24.9  
Mortgage
    587,240       16.9       582,398       16.6  
Home equity
    430,781       12.4       413,873       11.8  
Consumer
    240,048       6.9       252,382       7.2  
 
Total portfolio loans
    3,477,788       100.0 %     3,503,007       100.0 %
Allowance for loan losses
    (45,022 )             (42,414 )        
 
Portfolio loans, net
  $ 3,432,766             $ 3,460,593          
 

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Deposits
A summary of deposits follows:
Table Fourteen
Deposits
                 
 
    March 31   December 31
(In thousands)   2008   2007
 
Noninterest bearing demand
  $ 446,623     $ 438,313  
Interest bearing demand
    510,604       478,186  
Money market accounts
    532,864       564,053  
Savings deposits
    104,615       101,234  
Certificates of deposit
    1,346,172       1,313,482  
Brokered certificates of deposit
    278,461       326,351  
 
Total deposits
  $ 3,219,339     $ 3,221,619  
 
Deposits totaled $3.2 billion at March 31, 2008 and December 31, 2007. Compared to March 31, 2007, deposits decreased $102.0 million from $3.3 billion, primarily as a result of a decline in money market balances and brokered certificates of deposits, partially offset by an increase in interest bearing demand accounts, certificates of deposit, and savings deposits.
For first quarter 2008, average core deposit balances (demand, money market and savings) decreased $67.5 million, or 4.2 percent, from the fourth quarter 2007. Growth in interest bearing checking of $37.0 million, or 8.4 percent was offset with a seasonal decline in noninterest bearing demand of $32.5 million, or 7.2 percent, driven by businesses holding fewer balances in these accounts. Average money market balances fell $70.5 million, or 11.5 percent, as customer preferences continued to migrate to certificates of deposits from money market deposits. This change in customer preferences is associated with the continued decline in interest rates during the first quarter of 2008. Average certificates of deposit increased $131.8 million, or 10.7 percent while average brokered certificates of deposits decreased $52.3 million, or 14.1 percent. Brokered certificates of deposits were lower due to unfavorable pricing of these deposits relative to other available funding sources.
Other Borrowings
Other borrowings consist of federal funds purchased, securities sold under agreement to repurchase, commercial paper, and other short- and long-term borrowings. Federal funds purchased represent unsecured overnight borrowings from other financial institutions by the Bank. At March 31, 2008, the Bank had federal funds back-up lines of credit totaling $648.0 million with $168.0 million outstanding, compared to similar lines of credit totaling $648.0 million with $233.0 million outstanding at December 31, 2007.
Securities sold under agreements to repurchase represent short-term borrowings by the banking subsidiaries with maturities less than one year collateralized by a portion of the Corporation’s United States government or agency securities. Securities with an aggregate carrying value of $114.1 million and $124.8 million at March 31, 2008 and December 31, 2007, respectively, were pledged to secure securities sold under agreements to repurchase. These borrowings are an important source of funding to the Corporation. Access to alternative short-term funding sources allows the Corporation to meet funding needs without relying on increasing deposits on a short-term basis.

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First Charter Corporation issues commercial paper as another source of short-term funding. It is purchased primarily by the Bank’s commercial deposit clients. Commercial paper outstanding at March 31, 2008 was $28.8 million, compared to $64.2 million at December 31, 2007.
Other short-term borrowings consist of the Federal Home Loan Bank (“FHLB”) borrowings with an original maturity of one year or less. FHLB borrowings are collateralized by securities from the Corporation’s investment portfolio and a blanket lien on certain qualifying commercial and single-family loans held in the Corporation’s loan portfolio. In addition, the Bank had $220.0 million of short-term FHLB borrowings at March 31, 2008 and December 31, 2007. The Corporation, in its overall management of interest-rate risk, is opportunistic in evaluating alternative funding sources. While balancing the funding needs of the Corporation, management considers the duration of available maturities, the relative attractiveness of funding costs, and the diversification of funding sources, among other factors, in order to maintain flexibility in the nature of deposits and borrowings the Corporation holds at any given time.
Long-term borrowings represent FHLB borrowings with original maturities greater than one year and subordinated debentures related to trust preferred securities. At March 31, 2008, the Bank had $555.8 million of long-term FHLB borrowings, compared to $505.8 million at December 31, 2007. In addition, the Corporation had $61.9 million of subordinated debentures at March 31, 2008 and December 31, 2007.
The Corporation formed First Charter Capital Trust I and First Charter Capital Trust II, in June 2005 and September 2005, respectively; both are wholly-owned business trusts. First Charter Capital Trust I and First Charter Capital Trust II issued $35.0 million and $25.0 million, respectively, of trust preferred securities that were sold to third parties. The proceeds of the sale of the trust preferred securities were used to purchase subordinated debentures from the Corporation, which are presented as long-term borrowings in the consolidated balance sheets and qualify for inclusion in Tier 1 Capital for regulatory capital purposes, subject to certain limitations.
Credit Risk Management
 
The Corporation’s credit risk policy and procedures are centralized for every loan type. In addition, all mortgage, consumer, and home equity loans are centrally decisioned. All loans generally flow through an independent closing unit to ensure proper documentation. Loans originated by the Corporation’s Atlanta-based lenders are currently being prepared and closed independently from the Corporation’s centralized credit structure. Finally, all known collection or problem loans are centrally managed by experienced workout personnel. To monitor the effectiveness of policies and procedures, management maintains a set of asset quality standards for past due, nonaccrual, and watchlist loans and monitors the trends of these standards over time. These standards are approved by the Board of Directors and reviewed quarterly with the Board of Directors for compliance.
Loan Administration and Underwriting
The Bank’s Chief Risk Officer is responsible for the continuous assessment of the Bank’s risk profile as well as making any necessary adjustments to policies and procedures. Commercial loan relationships of less than $750,000 may be approved by experienced commercial loan officers, within their loan authority. Commercial and commercial real estate loans are approved by signature authority requiring at least two experienced officers for relationships greater than $750,000. The exceptions to this include City Executives and certain Senior Loan Officers who are authorized to approve relationships up to $1.0 million. An independent Risk Manager is involved in the approval of commercial and commercial real estate relationships that exceed $1.0 million. All relationships greater than $2.0 million receive a comprehensive annual review by either the senior credit analysts or lending officers of the Bank, which is then reviewed by the independent Risk Managers and/or the final approval officer with the appropriate signature authority. Relationships totaling $5.0 million or more are further reviewed by senior lending officers of the Bank, the Chief Risk Officer, and the Credit Risk Management Committee comprised of certain executive and senior

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management. In addition, relationships totaling $10.0 million or more are reviewed by the Board of Directors’ Credit and Compliance Committee. These oversight committees provide policy, process, product and specific relationship direction to the lending personnel. As March 31, 2008, the Corporation had a legal lending limit of $70.5 million and a general target-lending limit of $10.0 million per relationship.
The Corporation’s loan portfolio consists of loans made for a variety of commercial and consumer purposes. Because commercial loans are made based to a great extent on the Corporation’s assessment of a borrower’s income, cash flow, character and ability to repay, such loans are viewed as involving a higher degree of credit risk than is the case with residential mortgage loans or consumer loans. To manage this risk, the Corporation’s commercial loan portfolio is managed under a defined process which includes underwriting standards and risk assessment, procedures for loan approvals, loan grading, ongoing identification and management of credit deterioration and portfolio reviews to assess loss exposure and to ascertain compliance with the Corporation’s credit policies and procedures.
The Corporation utilizes a consumer loan platform for servicing of its customers by providing loan officers with tools and real-time access to credit bureau information at the time of loan application. This platform also delivers reporting capabilities and credit risk management by having the Corporation’s policies embedded into the decision process while also managing approval authority limits for credit exposure and reporting.
In general, consumer loans (including mortgage and home equity) have a lower risk profile than commercial loans. Commercial loans (including commercial real estate, commercial non real estate and construction loans) are generally larger in size and more complex than consumer loans. Commercial real estate loans are deemed less risky than commercial non real estate and construction loans, because the collateral value of real estate generally maintains its value better than non real estate or construction collateral. Consumer loans, which are smaller in size and more geographically diverse across the Corporation’s entire primary market area, provide risk diversity across the portfolio. Because mortgage loans are secured by first liens on the consumer’s residential real estate, they are the Corporation’s lowest risk profile loan type. Home equity loans are deemed less risky than unsecured consumer loans, as home equity loans and lines are secured by first or second deeds of trust on the borrower’s residential real estate. A centralized decision-making process is in place to control the risk of the consumer, home equity, and mortgage loan portfolio. The consumer real estate appraisal process is also centralized relative to appraisal engagement, appraisal review, and appraiser quality assessment. These processes are detailed in the underwriting guidelines, which cover each retail loan product type from underwriting, servicing, compliance issues and closing procedures.
At March 31, 2008, the substantial majority of the total loan portfolio, including the commercial and real estate portfolio, represented loans to borrowers within the Charlotte and Raleigh, North Carolina and Atlanta, Georgia metropolitan regions. The diverse economic base of these regions tends to provide a stable lending environment; however, an economic downturn in the Charlotte region, the Corporation’s primary market area, could adversely affect its business.
Additionally, the Corporation’s loan portfolio consists of certain non-traditional loan products. Some of these products include interest-only loans, loans with initial interest rates that are below the market interest rate for the initial period of the loan-term and may increase when that period ends, and loans with a high loan-to-value ratio. Based on the Corporation’s assessment, these products do not give rise to a concentration of credit risk.
As disclosed in the Corporation’s 2007 Form 10-K, certain of the Corporation’s construction and real estate loans were originated through HomeBanc Corporation (“HomeBanc”). HomeBanc serviced the loans it originated on behalf of First Charter. On August 1, 2007, HomeBanc declared bankruptcy and, as a result, First Charter began servicing its loans that had been originated through HomeBanc. As of March 31, 2008, the Corporation’s balance of HomeBanc originated loans was $64.1 million. As of March 31, 2008, seven loans, approximating $2.9 million, were in dispute as a result of the HomeBanc bankruptcy.

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Based on the advice of counsel, the Corporation expects to be successful in resolving its dispute with HomeBanc and a secured lender to HomeBanc.
Derivatives
The Corporation enters into interest rate swap agreements or other derivative transactions as business conditions warrant. As of March 31, 2008 and December 31, 2007, the Corporation had no interest rate swap agreements or other derivative transactions outstanding.
Nonperforming Assets
Nonperforming assets are comprised of nonaccrual loans and other real estate owned (“OREO”). The nonaccrual status is determined after a loan is 90 days past due or when deemed not collectible in full as to principal or interest, unless in management’s opinion collection of both principal and interest is assured by way of collateralization, guarantees, or other security and the loan is in the process of collection. OREO represents real estate acquired through foreclosure or deed in lieu thereof and is generally carried at the lower of cost or fair value, less estimated costs to sell.
In management’s opinion, for any loan greater than 90 days past due, collection of all principal and interest is not probable. As such, these loans greater than 90 days past due are placed on nonaccrual status. Loans are returned to accrual status when management determines, based on an evaluation of the underlying collateral together with the borrower’s payment record and financial condition, that the borrower has the ability and intent to meet the contractual obligations of the loan agreement. As of March 31, 2008, no loans were 90 days or more past due and still accruing interest.
A summary of nonperforming assets follows:
Table Fifteen
Nonperforming Assets
                                         
 
    March 31   December 31   September 30   June 30   March 31
(In thousands)   2008   2007   2007   2007   2007
 
Nonaccrual loans
  $ 62,058     $ 28,695     $ 22,712     $ 17,387     $ 10,943  
Loans 90 days or more past due accruing interest
                             
 
Total nonperforming loans
    62,058       28,695       22,712       17,387       10,943  
Other real estate
    9,481       10,056       9,134       2,726       6,330  
 
Nonperforming assets
  $ 71,539     $ 38,751     $ 31,846     $ 20,113     $ 17,273  
 
Nonaccrual loans as a percentage of total portfolio loans
    1.78 %     0.82 %     0.65 %     0.49 %     0.31 %
Nonperforming assets as a percentage of:
                                       
Total assets
    1.49       0.80       0.66       0.41       0.35  
Total portfolio loans and other real estate owned
    2.05       1.10       0.91       0.57       0.49  
Net charge-offs to average portfolio loans
    0.24       0.36       0.57       0.02       0.06  
Allowance for loan losses to portfolio loans
    1.29       1.21       1.24       1.26       1.02  
Allowance for loan losses to net charge-offs
    5.33  x     3.39  x     2.13  x     59.40  x     18.50  x
Allowance for loan losses to nonperforming loans
    0.73       1.48       1.89       2.58       3.28  
 
Nonaccrual loans totaled $62.1 million, or 1.78 percent of total portfolio loans, at March 31, 2008. This represents a $33.4 million increase from $28.7 million, or 0.82 percent of total portfolio loans at December 31, 2007, and a $51.2 million increase from $10.9 million, or 0.31 percent, of total portfolio loans at March 31, 2007. Nonperforming assets as a percentage of total loans and other real estate owned increased to 2.05 percent at March 31, 2008, compared to 1.10 percent at December 31, 2007 and 0.49 percent at March 31, 2007.
The linked-quarter increase in nonaccrual loans was primarily driven by four residential condominium loans totaling $24.8 million, three of which were disclosed in the Corporation’s 2007 Form 10-K as potential problem loans. These loans are part of the Corporation’s strategic partner portfolio which buys and sells portions of loans (primarily originated in the Southeastern region of the United States) from key strategic partner financial institutions and are included in the Corporation’s

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construction loan portfolio. The remainder of the increase came from loans secured by residential real estate in the Raleigh, Charlotte, and Atlanta markets.
A summary of nonaccrual loans by loan group as of March 31, 2008 follows:
Table Sixteen
Nonaccrual Loans by Group
                                 
 
                    Nonaccrual    
                    Loans/   Nonaccrual
    Portfolio   Nonaccrual   Portfolio   Loans/ Total
(In thousands)   Loans   Loans   Loans   Nonaccruals
 
Commercial non real estate
  $ 299,555     $ 2,498       0.8 %     4.0 %
Commercial real estate
    1,058,197       2,572       0.2       4.1  
Construction
    861,967       46,314       5.4       74.6  
Mortgage
    587,240       5,398       0.9       8.7  
Home equity
    430,781       890       0.2       1.4  
Consumer
    240,048       4,386       1.8       7.1  
 
Total
  $ 3,477,788     $ 62,058       1.8 %     100.0 %
 
There were no other significant geographic or market segment concentrations. Nonaccrual loans primarily consisted of loans secured by real estate, including single-family residential and development construction loans. Nonaccrual loans as a percentage of loans may increase or decrease as economic conditions change. Management takes current and prospective economic conditions into consideration when estimating the allowance for loans losses. See Allowance for Loan Losses for a more detailed discussion.
Allowance for Loan Losses
The Corporation’s allowance for loan losses consists of three components: (i) valuation allowances computed on impaired loans in accordance with SFAS 114, Accounting by Creditors for Impairment of a Loan — an Amendment to FASB Statements No. 5 and No. 15; (ii) valuation allowances determined by applying historical loss rates to those loans not specifically identified as impaired; and (iii) valuation allowances for factors which management believes are not reflected in the historical loss rates or that otherwise need to be considered when estimating the allowance for loan losses. These three components are estimated at least quarterly and, along with a narrative analysis, comprise the Corporation’s allowance for loan losses model. The resulting components are used by management to determine the adequacy of the allowance for loan losses.
All estimates of loan portfolio risk, including the adequacy of the allowance for loan losses, are subject to general and local economic conditions, among other factors, which are unpredictable and beyond the Corporation’s control. Because a significant portion of the loan portfolio is comprised of real estate loans and loans to area businesses, the Corporation is subject to risk in the real estate market and changes in the economic conditions in its primary market areas. Changes in these areas can increase or decrease the provision for loan losses.
The Corporation monitors its loss estimate percentage attributable to economic factors in its allowance for loan loss model. As a part of its quarterly assessment of the allowance for loan losses, the Corporation reviews key local, regional and national economic information and assesses its impact on the allowance for loan losses. Given the recent trends in the national and local economic environment, including a slow-down in the national and local housing markets and moderate increases in the unemployment rate, the Corporation has increased its estimated loss percentages for economic factors for the quarter ended March 31, 2008.

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The Corporation continuously reviews its portfolio for any concentrations of loans to any one borrower or industry. To analyze its concentrations, the Corporation prepares various reports showing total risk concentrations to borrowers by industry, as well as reports showing total risk concentrations to one borrower. At the present time, the Corporation does not believe it has concentrations of risk in any one industry or specific borrower and, therefore, has made no allocations of allowances for loan losses for this factor for any of the periods presented.
The Corporation also monitors the amount of operational risk that exists in the portfolio. This would include the front-end underwriting, documentation and closing processes associated with the lending decision. During the quarter ended March 31, 2008, the Corporation increased its allocation for operational risk factors due to increased portfolio risks associated with areas exposed to residential real estate development and heightened potential employee attrition risks associated with the proposed merger with Fifth Third.
Changes in the allowance for loan losses follow:
Table Seventeen
Allowance For Loan Losses
                 
 
    Three Months Ended
    March 31
(In thousands)   2008   2007
 
Balance at beginning of period
  $ 42,414     $ 34,966  
 
Charge-offs
               
Commercial non real estate
    39       246  
Commercial real estate
    11       12  
Construction
    55        
Mortgage
    109       33  
Home equity
    142       130  
Consumer
    2,102       365  
 
Total charge-offs
    2,458       786  
 
Recoveries
               
Commercial non real estate
    47       88  
Commercial real estate
    52        
Construction
    2        
Mortgage
    3       25  
Consumer
    255       195  
Total recoveries
    359       308  
 
Net charge-offs
    2,099       478  
 
Provision for loan losses
    4,707       1,366  
Balance at end of period
  $ 45,022     $ 35,854  
 
Average portfolio loans
  $ 3,491,712     $ 3,510,437  
Net charge-offs to average portfolio loans (annualized)
    0.24 %     0.06 %
Allowance for loan losses to portfolio loans
    1.29       1.02  
 
The Corporation’s charge-off policy meets or exceeds regulatory minimums. Past-due status is based on contractual payment date. Losses on unsecured consumer debt are recognized at 90 days past due, compared to the regulatory loss criteria of 120 days. Secured consumer loans, including residential real estate, are typically charged-off between 120 and 180 days to the estimated collateral fair value, depending on the collateral type, in compliance with the Federal Financial Institutions Examination Council guidelines. Losses on commercial loans are recognized promptly upon determination that all or a portion of any loan balance is uncollectible. Any deficiency that exists after liquidation of collateral will be taken as a charge-off. Subsequent payment received will be treated as a recovery when collected.

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The allowance for loan losses was $45.0 million, or 1.29 percent of portfolio loans, at March 31, 2008, compared to $42.4 million, or 1.21 percent of portfolio loans, at December 31, 2007. The Corporation’s credit migration trends and an increase in economic and operational risk factors led to the higher allowance for loan loss ratio in 2008.
Management considers the allowance for loan losses adequate to cover inherent losses in the Corporation’s loan portfolio as of the date of the consolidated financial statements. Management believes it has established the allowance in consideration of the current and expected future economic environment. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary based on changes in economic and other conditions. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowances for loan losses. Such agencies may require the recognition of adjustments to the allowance based on their judgment of information available to them at the time of their examinations.
Provision for Loan Losses
The provision for loan losses is the amount charged to earnings, which is necessary to maintain an adequate and appropriate allowance for loan losses. Accordingly, the factors, which influence changes in the allowance for loan losses, have a direct effect on the provision for loan losses. The allowance for loan losses changes from period to period as a result of a number of factors, the most significant of which for the Corporation include the following: (i) changes in the amounts of loans outstanding, which are used to estimate current probable loan losses; (ii) current charge-offs and recoveries of loans; (iii) changes in impaired loan valuation allowances; (iv) changes in credit grades within the portfolio, which arise from a deterioration or an improvement in the performance of the borrower; (v) changes in loss percentages; and (vi) changes in the mix of types of loans. In addition, the Corporation considers other, more subjective factors, which impact the credit quality of the portfolio as a whole and estimates allocations of allowance for loan losses for these factors, as well. These factors include loan concentrations, economic conditions, operational risks, and model risk. Changes in these components of the allowance can arise from fluctuations in the underlying percentages used as related loss estimates for these factors, as well as variations in the portfolio balances to which they are applied. Changes in these factors provided approximately an additional $0.6 million for the three months ended March 31, 2008. The net change in the components of the allowance for loan losses results in the provision for loan losses. For a more detailed discussion of the Corporation’s process for estimating the allowance for loan losses, see Allowance for Loan Losses.
For the three months ended March 31, 2008, the provision for loan losses was $4.7 million, while net charge-offs were $2.1 million, or 0.24 percent of average portfolio loans. For the three months ended March 31, 2007, the provision for loan losses was $1.4 million and net charge-offs were $0.5 million, or 0.06 percent of average portfolio loans.
Market Risk Management
 
Asset-Liability Management and Interest Rate Risk
Interest rate risk is the exposure of earnings and capital to changes in interest rates. The objective of Asset-Liability Management (“ALM”) is to quantify and manage the change in interest rate risk associated with the Corporation’s balance sheet. The management of the ALM program includes oversight from the Board of Director’s Asset and Liability Committee (“Board ALCO”) and the Management Asset and Liability Committee (“Management ALCO”). Two primary metrics used in analyzing interest rate risk are earnings at risk (“EAR”) and economic value of equity (“EVE”). The Board of Directors has established limits on the EAR and EVE risk measures. Management ALCO, comprised of select members of executive and senior management, is charged with measuring performance relative to those limits and reporting the Bank’s performance to Board ALCO. Interest rate risk is measured and monitored through simulation modeling. The process is validated regularly by an independent third party.

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Both the EAR and the EVE risk measures were within policy guidelines as of March 31, 2008 and December 31, 2007.
Management considers EAR to be the best measure of short-term interest rate risk. This measure reflects the amount of net interest income that will be impacted by a change in interest rates over a 12- month time frame. A simulation model is used to run immediate and parallel changes in interest rates (rate shocks) from a base scenario using implied forward rates. At a minimum, rate shock scenarios are run at plus and minus 100, 200, and 300 basis points. From time to time, additional simulations are run to assess risk from changes in the slope of the yield curve. The simulation model projects the net interest income over the next 12 months for each scenario using consistent balance sheet growth projections and calculates the percentage change from the base scenario. Board ALCO has approved a policy limit for the change in EAR over a 12-month period of minus 10 percent to a plus or minus 200 basis point shock to interest rates. At March 31, 2008, the estimated EAR to a 200 basis point increase in rates was plus 3.3 percent while the estimated EAR to a 200 basis point decrease in rates was minus 4.6 percent. This compares with plus 2.1 percent and minus 4.7 percent, respectively, at December 31, 2007.
Management considers EVE to be the best measure of long-term interest rate risk. This measure reflects the amount of net equity that will be impacted by changes in interest rates. Through simulation modeling, the Corporation estimates the economic value of assets and the economic value of liabilities. The difference between these two measures is the EVE. The EVE is calculated for a series of scenarios in which current rates are shocked up and down by 100, 200, and 300 basis points and compared to a base scenario using the current yield curve. Board ALCO has approved a policy limit for the percentage change in EVE of minus 15 percent to a plus or minus 200 basis point shock to interest rates. At March 31, 2008, the estimated change in EVE to a 200 basis point increase in rates was minus 6.7 percent, while the estimated change in EVE to a 200 basis point decrease in rates was minus 3.6 percent. This compares with minus 10.9 percent and plus 0.3 percent, respectively at December 31, 2007. The variation in EVE risk from December 31, 2007 to March 31, 2008 is primarily attributable to the sharp decline in rates.
The result of any simulation is inherently uncertain and will not precisely estimate the impact of changes in rates on net interest income or the economic value of assets and liabilities. Actual results may differ from simulated results due to, but not limited to, the timing and magnitude of the change in interest rates, changes in management strategies, and changes in market conditions.
Table Eighteen summarizes, as of March 31, 2008, the expected maturities and weighted average effective yields and rates associated with certain of the Corporation’s significant non-trading financial instruments. Cash and cash equivalents, federal funds sold, and noninterest-bearing bank deposits are excluded from Table Eighteen as their respective carrying values approximate fair value. These financial instruments generally expose the Corporation to insignificant market risk as they have either no stated maturities or an average maturity of less than 30 days and interest rates that approximate market rates. However, these financial instruments could expose the Corporation to interest rate risk by requiring more or less reliance on alternative funding sources, such as long-term debt. The mortgage-backed securities are shown at their weighted-average expected life, obtained from an independent evaluation of the average remaining life of each security based on expected prepayment speeds of the underlying mortgages at March 31, 2008. These expected maturities, weighted-average effective yields, and fair values would change if interest rates change. Expected maturities for indeterminate demand, money market and savings deposits are estimated based on historical average lives.

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Table Eighteen
Market Risk
                                                         
 
            Expected Maturity
(Dollars in thousands)   Total   1 Year   2 Years   3 Years   4 Years   5 Years   Thereafter
 
Assets
                                                       
Debt securities
                                                       
Fixed rate
                                                       
Cost
  $ 526,565     $ 241,927     $ 108,189     $ 73,876     $ 45,457     $ 28,080     $ 29,036  
Weighted-average effective yield
    4.77 %                                                
Fair value
  $ 523,477                                                  
Variable rate
                                                       
Cost
  $ 304,471       55,779       45,509       35,904       26,239       20,538       120,502  
Weighted-average effective yield
    4.91 %                                                
Fair value
  $ 298,041                                                  
Loans and loans held for sale
                                                       
Fixed rate
                                                       
Book value
  $ 1,025,009       343,149       228,139       170,370       98,408       93,006       91,937  
Weighted-average effective yield
    6.79 %                                                
Fair value
  $ 1,062,895                                                  
Variable rate
                                                       
Book value
  $ 2,425,301       1,286,405       276,252       187,282       101,463       76,327       497,572  
Weighted-average effective yield
    5.83 %                                                
Fair value
  $ 2,458,280                                                  
 
                                                       
Liabilities
                                                       
Deposits
                                                       
Fixed rate
                                                       
Book value
  $ 1,624,633       1,557,179       42,616       14,098       3,963       5,330       1,447  
Weighted-average effective yield
    4.36 %                                                
Fair value
  $ 1,638,937                                                  
Variable rate
                                                       
Book value
  $ 1,148,083       277,025       276,774       276,496       136,268       84,919       96,601  
Weighted-average effective yield
    1.71 %                                                
Fair value
  $ 1,110,896                                                  
Long-term borrowings
                                                       
Fixed rate
                                                       
Book value
  $ 195,855       70,054       75,057       50,070       21       22       631  
Weighted-average effective yield
    4.79 %                                                
Fair value
  $ 199,075                                                  
Variable rate
                                                       
Book value
  $ 421,857       120,000       165,000       75,000                   61,857  
Weighted-average effective yield
    4.18 %                                                
Fair value
  $ 429,609                                                  
 
Off-Balance-Sheet Risk
The Corporation is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. Commitments to extend credit are agreements to lend to a customer so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and may require collateral from the borrower if deemed necessary by the Corporation. Included in loan commitments are commitments of $83.6 million to cover customer deposit account overdrafts should they occur. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party up to a stipulated amount and with specified terms and conditions. Standby letters of credit are recorded as a liability by the Corporation at the fair value of the obligation undertaken in issuing the guarantee. Commitments to extend credit are not recorded as an asset or liability by the Corporation until the instrument is exercised. Refer to Note 14 of the consolidated financial statements for further discussion of commitments. The Corporation does not have any off-balance-sheet financing arrangements, other than Trust Securities, refer to Note 10 of the consolidated financial statements.

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The following table presents aggregated information and expected maturities of commitments as of March 31, 2008.
Table Nineteen
Commitments
                                                 
 
    Less than                           Timing not    
(In thousands)   1 year   1-3 Years   4-5 Years   Over 5 Years   determinable   Total
 
Loan commitments
  $ 570,313     $ 113,946     $ 16,922     $ 95,381     $     $ 796,562  
Lines of credit
    28,597       1,202       4,957       455,497             490,253  
Standby letters of credit
    23,016       2,849       4                   25,869  
Anticipated tax settlements
                            5,172       5,172  
 
Total commitments
  $ 621,926     $ 117,997     $ 21,883     $ 550,878     $ 5,172     $ 1,317,856  
 
Commitments to extend credit, including loan commitments, standby letters of credit, and commercial letters of credit do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon.
Liquidity Risk
Liquidity is the ability to maintain cash flows adequate to fund operations and meet obligations and other commitments on a timely and cost-effective basis. Liquidity is provided by the ability to attract retail deposits, by current earnings, and by a strong capital base that enables the Corporation to use alternative funding sources that complement normal sources. The Corporation’s asset-liability management objectives include optimizing net interest income while continuing to provide adequate liquidity to meet continuing loan demand and deposit withdrawal requirements and to service normal operating expenses.
Liquidity is managed at two levels. The first is the liquidity of the Corporation. The second is the liquidity of the Bank. The management of liquidity at both levels is essential, because the Corporation and the Bank have different funding needs and sources, and each are subject to certain regulatory guidelines and requirements.
The primary source of funding for the Corporation includes dividends received from the Bank and proceeds from the issuance of common stock. In addition, the Corporation had commercial paper outstanding of $28.8 million at March 31, 2008. Primary uses of funds for the Corporation include repayment of commercial paper, share repurchases, and dividends paid to shareholders. During 2005, the Corporation issued trust preferred securities through specially formed trusts. These securities are presented as long-term borrowings in the consolidated balance sheets and are includable in Tier 1 Capital for regulatory capital purposes, subject to certain limitations.
Primary sources of funding for the Bank include customer deposits, wholesale deposits, other borrowings, loan repayments, and available-for-sale securities. The Bank has access to federal funds lines from various banks and borrowings from the Federal Reserve discount window. In addition to these sources, the Bank is a member of the FHLB, which provides access to FHLB lending sources. At March 31, 2008, the Bank had an available line of credit with the FHLB totaling $1.5 billion, with $775.9 million outstanding. At March 31, 2008, the Bank also had $648.0 million of federal funds lines of credit, with $168.0 million outstanding.
Management believes the Corporation’s and the Bank’s sources of liquidity are adequate to meet loan demand, operating needs, and deposit withdrawal requirements.

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Capital Management
 
The Corporation views capital as its most valuable and most expensive funding source. The objective of effective capital management is to generate above-market returns on equity to the Corporation’s shareholders while maintaining adequate regulatory capital ratios. Some of the Corporation’s primary uses of capital include funding growth, asset acquisition, dividend payments, and common stock repurchases.
Select capital measures follow:
Table Twenty
Capital Measures
                                 
 
    March 31   December 31
    2008   2007
(Dollars in thousands)   Amount   Ratio   Amount   Ratio
 
Total equity/total assets
                               
First Charter Corporation
  $ 463,526       9.66 %   $ 468,344       9.63 %
First Charter Bank
    501,540       10.48       499,322       10.30  
 
                               
Tangible equity/tangible assets (1)
                               
First Charter Corporation
  $ 380,927       8.08 %   $ 385,473       8.07 %
First Charter Bank
    418,941       8.90       416,450       8.74  
 
(1) The tangible equity ratio excludes goodwill and other intangible assets from both the numerator and the denominator.
Shareholders’ equity at March 31, 2008 decreased to $463.5 million, representing 9.7 percent of period-end total assets, compared to $468.3 million, or 9.6 percent, of period-end total assets at December 31, 2007. This decrease in shareholders’ equity resulted from a $0.7 million adjustment to initially apply EITF 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements, and cash dividends of $0.195 per common share, which resulted in cash dividend declarations of $6.9 million for the three months ended March 31, 2008. Additionally, accumulated other comprehensive loss (after-tax unrealized losses on available-for-sale securities) decreased $4.4 million to $5.8 million at March 31, 2008, compared to $1.4 million at December 31, 2007. This was partially offset with net income of $5.5 million.
The Corporation has remaining authority to repurchase 1.1 million shares of its common stock. The Corporation does not anticipate repurchasing any additional shares due to the proposed merger with Fifth Third.
During 2005, the Corporation issued trust preferred securities through specially formed trusts in an aggregate amount of $60.0 million. The proceeds from the sale of the trust preferred securities were used to purchase $61.9 million of subordinated debentures from the Corporation (“Notes”). The Notes are presented as long-term borrowings in the consolidated balance sheets and are includable in Tier 1 Capital for regulatory capital purposes, subject to certain limitations.
The Corporation’s and the Bank’s various regulators have issued regulatory capital guidelines for U.S. banking organizations. Failure to meet the capital requirements can initiate certain mandatory and discretionary actions by regulators that could have a material effect on the Corporation’s financial position and results of operations. At March 31, 2008 the Corporation and the Bank were classified as “well capitalized” under these regulatory frameworks.

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The principal asset of the Corporation is its investment in the Bank. Thus, the Corporation derives its principal source of income through dividends from the Bank. Certain regulatory and other requirements restrict the lending of funds by the subsidiary bank to the Corporation and the amount of dividends which can be paid to the Corporation. In addition, certain regulatory agencies may prohibit the payment of dividends by the Bank if they determine that such payment would constitute an unsafe or unsound practice. See Business — Government Supervision and Regulation, Business — Capital and Operational Requirements and Note 15 of notes to consolidated financial statements for additional discussion of these restrictions.
The Corporation and the Bank must comply with regulatory capital requirements established by the applicable federal regulatory agencies. Under the standards of the Federal Reserve Board, the Corporation and the Bank must maintain a minimum ratio of Tier I Capital (as defined) to total risk-weighted assets of 4.00 percent and a minimum ratio of Total Capital (as defined) to risk-weighted assets of 8.00 percent. Tier 1 Capital includes common shareholders’ equity, trust preferred securities, minority interests and qualifying preferred stock, less goodwill and other adjustments. Total Capital is comprised of Tier I Capital plus certain adjustments, the largest of which for the Corporation is the allowance for loan losses (up to 1.25 percent of risk-weighted assets).Total Capital must consist of at least 50 percent of Tier 1 Capital. Risk-weighted assets refer to the on- and off-balance sheet exposures of the Corporation adjusted for their related risk levels using amounts set forth in Federal Reserve standards.
In addition to the aforementioned risk-based capital requirements, the Corporation is subject to a leverage capital requirement, requiring a minimum ratio of Tier I Capital (as defined previously) to total adjusted average assets of 3.00 percent to 5.00 percent.
The Bank also has similar regulatory capital requirements imposed by the Federal Reserve Board. See Business — Government Supervision and Regulation, Business — Capital and Operational Requirements and Note 15 of notes to consolidated financial statements for additional discussion of these requirements.
At March 31, 2008, the Corporation and the Bank were in compliance with all existing capital requirements and were classified as “well capitalized” under regulatory capital guidelines. In the judgment of management, there have been no events or conditions since March 31, 2008, that would change the “well capitalized” status of the Corporation or the Bank. It is management’s intention for both the Corporation and the Bank to continue to be “well capitalized” for the foreseeable future. The capital requirements of the Corporation and the Bank are summarized in the table below as of March 31, 2008:
Table Twenty-One
Capital Ratios
                                                 
 
                    For Capital    
                    Adequacy Purposes   To Be Well Capitalized
    Actual                   Minimum           Minimum
(Dollars in thousands)   Amount   Ratio   Amount   Ratio   Amount   Ratio
 
Leverage
                                               
First Charter Corporation
  $ 446,672       9.44 %   $ 189,249       4.00 %   None     None  
First Charter Bank
    424,710       8.99       189,030       4.00     $ 236,288       5.00 %
 
                                               
Tier I Capital
                                               
First Charter Corporation
  $ 446,672       11.25 %   $ 158,878       4.00 %   None     None  
First Charter Bank
    424,710       10.71       158,620       4.00     $ 237,930       6.00 %
 
                                               
Total Risk-Based Capital
                                               
First Charter Corporation
  $ 491,728       12.38 %   $ 317,757       8.00 %   None     None  
First Charter Bank
    469,732       11.85       317,240       8.00     $ 396,550       10.00 %
 
Tier 1 Capital consists of total equity plus qualifying capital securities and minority interests, less unrealized gains and losses accumulated in other comprehensive income, certain intangible assets, and

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adjustments related to the valuation of servicing assets and certain equity investments in nonfinancial companies (principal investments).
The leverage ratio reflects Tier 1 Capital divided by average total assets for the period. Average assets used in the calculation exclude certain intangible and servicing assets.
Total Risk-Based Capital is comprised of Tier 1 Capital plus qualifying subordinated debt and allowance for loan losses and a portion of unrealized gains on certain equity securities.
Both the Tier 1 Capital and the Total Risk-Based Capital ratios are computed by dividing the respective capital amounts by risk-weighted assets, as defined.
Regulatory Recommendations
 
The Corporation and the Bank are subject to federal and state banking regulatory reviews from time to time. As a result of these reviews, the Corporation and the Bank receive various observations and recommendations from their respective regulators. Observations are matters that are informative, advisory, or that suggest a means of improving the performance or management of the operations of the Corporation. Recommendations are provided to enhance oversight of, or to improve or strengthen, the Corporation’s or the Bank’s processes. The Corporation does not believe that these observations and recommendations are material to the Corporation. In addition, neither the Corporation nor the Bank is currently subject to any formal or informal corrective action with respect to any of their regulators.
Recent Accounting Pronouncements
 
Note 2 to the consolidated financial statements discusses new accounting pronouncements adopted by the Corporation during 2008 and other recently issued pronouncements that have not yet been adopted by the Corporation. To the extent the adoption of new accounting pronouncements materially affects financial condition, results of operations, or liquidity, the effects are discussed in the applicable section of Management’s Discussion and Analysis of Financial Condition and Results of Operations and Notes to Consolidated Financial Statements.
From time to time, the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Corporation and monitors the status of changes to and proposed effective dates of exposure drafts.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
See Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Risk Management — Asset-Liability Management and Interest Rate Risk sections of this Report on Form 10-Q for Quantitative and Qualitative Disclosures about Market Risk.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of March 31, 2008, the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation of the effectiveness of the Registrant’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) was performed under the supervision and with the participation of the Registrant’s management, including the Chief Executive Officer and principal financial officer. Based on that evaluation, the

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Registrant’s Chief Executive Officer and principal financial officer have concluded that the Registrant’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Registrant in its reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission rules and forms and (ii) accumulated and communicated to the Registrant’s management, including the Chief Executive Officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
During the Registrant’s first fiscal quarter, there has been no change in the Registrant’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting.
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
The Corporation and its subsidiaries are defendants in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated operations, liquidity, or financial position of the Corporation or its subsidiaries.
Item 1A. Risk Factors
There have been no material changes from those risk factors previously disclosed in Item 1A Risk Factors of Part I of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c) Issuer Repurchases of Equity Securities
The following table summarizes the Corporation’s repurchases of its common stock during the quarter ended March 31, 2008.
                                 
 
                    Total Number of   Maximum Number
                    Shares Purchased   of Shares
    Total Number   Average Price   as Part of   That May Yet be
    of Shares   Paid   Publicly-Announced   Purchased under
Period   Purchased   Per Share   Plans or Programs   the Plans or Programs
 
January 1, 2008 - January 31, 2008
                      1,125,400  
February 1, 2008 - February 29, 2008
                      1,125,400  
March 1, 2008 - March 31, 2008
                      1,125,400  
 
Total
                      1,125,400  
 
On October 24, 2003, the Corporation’s Board of Directors authorized a stock repurchase plan to acquire up to an additional 1.5 million shares of the Corporation’s common stock from time to time. As of March 31, 2008, the Corporation had repurchased 374,600 shares under this authorization.
There were no shares of the Corporation’s common stock repurchased during the three months ended March 31, 2008. The maximum number of shares that may yet be repurchased under the plans or programs was 1,125,400 at March 31, 2008. The stock repurchase authorization has no set expiration or termination date. The Corporation does not anticipate repurchasing any additional shares due to the proposed merger with Fifth Third.

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Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
(a) First Charter Corporation’s Special Meeting of Shareholders was held on January 18, 2008.
(c) The following are the voting results on each matter (exclusive of procedural matters) submitted to the shareholders:
1. To approve the merger of First Charter with and into Fifth Third Financial Corporation, substantially on the terms set forth in the Amended and Restated Agreement and Plan of Merger dated as of September 14, 2007 by and among First Charter, Fifth Third Bancorp and Fifth Third Financial Corporation.
         
 
    Votes
 
For
    29,519,980  
Against
    202,324  
Abstain
    68,223  
 
Total
    29,790,527  
 
2. To approve the adjournment or postponement of the special meeting, if necessary or appropriate, to solicit additional proxies if there are insufficient votes at the time of the special meeting to adopt the merger agreement.
         
 
    Votes
 
For
    29,117,289  
Against
    542,115  
Abstain
    131,123  
 
Total
    29,790,527  
 
Item 5. Other Information
As discussed within this Form 10-Q, on August 15, 2007 the Corporation and Fifth Third entered into the Merger Agreement by and among the Corporation, Fifth Third, and Fifth Third Financial. Under the terms of the Merger Agreement, the Corporation will be merged with and into Fifth Third Financial. The Merger Agreement has been approved by the Board of Directors of the Corporation, Fifth Third, and Fifth Third Financial. The Corporation’s shareholders approved the Merger Agreement and the merger has been approved by all necessary state and federal regulatory agencies. The merger remains subject to customary closing conditions. The merger is currently anticipated to close on Friday, June 6, 2008. Pursuant to this plan, the Corporation does not intend to hold a 2008 annual meeting of shareholders. If First Charter were to schedule an annual meeting of shareholders, First Charter will provide notice of the date fixed for the annual meeting, as well as the deadline for submitting proposals for such meeting and have shareholder proposals included in the Corporation’s proxy statement.

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Item 6. Exhibits
     
Exhibit No.   Description of Exhibits
 
 
 
12.1
 
Computation of Ratio of Earnings to Fixed Charges.
 
 
 
31.1
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of principal financial officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1
 
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.2
 
Certification of the principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  FIRST CHARTER CORPORATION
(Registrant)
 
 
Date: May 6, 2008  /s/ Sheila A. Stoke    
  Sheila A. Stoke   
  Senior Vice President, Corporate Controller (Principal Financial Officer duly authorized to sign on behalf of the Registrant)   
 

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