UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

For the quarterly period ended June 30, 2004

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

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 x No o

          Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o

          As of August 4, 2004 the Registrant had outstanding 29,778,832 shares of Common Stock, no par value.

First Charter Corporation

Form 10-Q for the Quarterly Period Ended June 30, 2004

INDEX

PART 1. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

First Charter Corporation and Subsidiaries

See accompanying notes to consolidated financial statements.

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First Charter Corporation and Subsidiaries

See accompanying notes to consolidated financial statements.

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First Charter Corporation and Subsidiaries

See accompanying notes to consolidated financial statements.

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First Charter Corporation and Subsidiaries

See accompanying notes to consolidated financial statements.

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FIRST CHARTER CORPORATION AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Three Months Ended June 30, 2004 and 2003

     First Charter Corporation (the “Corporation”) is a regional financial services company with assets of approximately $4.3 billion and is the holding company for First Charter Bank (“FCB” or the “Bank”). FCB is a full-service bank and trust company with 54 financial centers and six insurance offices located in 18 counties throughout the piedmont and western half of North Carolina. FCB also operates one mortgage origination office in Virginia. FCB provides businesses and individuals with a broad range of financial services, including banking, comprehensive financial planning, funds management, investments, insurance, mortgages and a full array of employee benefit programs.

Note One — Accounting Policies

     The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiary, FCB. In consolidation, all intercompany accounts and transactions have been eliminated.

     The information contained in the consolidated financial statements, excluding information as of the fiscal year ended December 31, 2003, is unaudited. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements, as well as the amounts of income and expenses during the reporting period. Actual results could differ from those estimates.

     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. Certain amounts reported in prior periods have been reclassified to conform to the current period presentation. Such reclassifications have no effect on net income or shareholders’ equity as previously reported.

     Accounting policies followed by the Corporation are presented on pages 53 to 61 of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003. With the exception of the Corporation’s policy regarding derivative instruments, these policies have not materially changed from the year ended December 31, 2003.

Derivative Instruments

     The Corporation enters into interest rate swap agreements as business conditions warrant. These interest rate swap agreements provide an exchange of interest payments computed on notional amounts that will offset any undesirable change in fair value resulting from market rate changes on designated hedged items. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. The interest rate swap agreements utilized by the Corporation qualify for hedge accounting as fair value hedges.

     The Corporation accounts for these interest rate swaps as a hedge of the fair value of the related Federal Home Loan Bank (“FHLB”) advances. Accordingly, the Corporation records on a quarterly basis, in noninterest income, the net change in the fair value of the interest rate swap and the related FHLB advances (ineffectiveness), provided the criteria for hedge accounting continue to be met. In the event such criteria are not met in a future period, the Corporation will only record changes in the fair value on the interest rate swap. The derivative hedging instruments are recorded at fair value in other assets or other liabilities.

     Interest rate swaps assist the Corporation’s Asset Liability Management (“ALM”) process. The Corporation’s interest rate risk management strategy includes the use of interest rate contracts to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. The Corporation’s goal is to manage interest rate sensitivity so that movements in interest rates do not have significant adverse effects on net interest income. As a result of interest rate fluctuations, hedged fixed-rate liabilities appreciate or depreciate in market value. Gains or

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losses on the derivative instruments that are linked to the hedged fixed-rate liabilities are expected to substantially offset this unrealized appreciation or depreciation.

     Interest rate contracts, which are generally non-leveraged interest rate swaps, allow the Corporation to effectively manage its interest rate risk position. Non-leveraged interest rate swaps involve the exchange of fixed-rate and variable-rate interest payments based on the contractual underlying notional amount. Exposure to loss on these contracts will increase or decrease over their respective lives as interest rates fluctuate.

     Credit risk associated with derivatives is measured as the net replacement cost should the counter-parties with contracts in a gain position to the Corporation completely fail to perform under the terms of those contracts assuming no recoveries of underlying collateral. In managing derivative credit risk, both the current exposure, which is the replacement cost of contracts on the measurement date, as well as an estimate of the potential change in value of contracts over their remaining lives are considered. In managing credit risk associated with its derivative activities, the Corporation deals primarily with commercial banks, broker-dealers and corporations. To minimize credit risk, the Corporation enters into legally enforceable master netting agreements, which reduce risk by permitting the closeout and netting of transactions with the same counter-party upon the occurrence of certain events.

Accrued Taxes

     The Corporation estimates tax expense based on the amount it is expected to owe various tax jurisdictions. The estimate of tax expense is reported in the Consolidated Statements of Income. Accrued taxes represent the net estimated amount due or to be received from taxing jurisdictions either currently or in the future and are reported as a component of accrued expenses and other liabilities on the Consolidated Balance Sheet. In estimating accrued taxes, the Corporation assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial and regulatory guidance in the context of the Corporation’s tax position.

     Changes to the estimate of accrued taxes occur periodically due to changes in the tax rates, implementation of new tax planning strategies, resolution with taxing authorities of issues with previously taken tax positions and newly enacted statutory, judicial and regulatory guidance. These changes, which are often driven by the Corporation’s judgments, affect accrued taxes and can be material to the Corporation’s operating results for any particular quarter.

Recently Adopted Accounting Pronouncements

     In January 2003, the Financial Accounting Standards Board (“FASB”) issued Financial Accounting Standards Board Interpretation No. 46, (“FIN 46”), “Consolidation of Variable Interest Entities,” which addresses consolidation of variable interest entities by business enterprises. Variable interest entities are entities with equity interests that do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. An enterprise shall consolidate a variable interest entity if that enterprise has a variable interest (or combination of variable interests) that will absorb a majority of expected losses if they occur, receive a majority of the entity’s residual returns if they occur, or both. The enterprise that consolidates the variable interest entity is called the primary beneficiary of that entity. Under FIN 46 an enterprise that holds significant variable interests in a variable interest entity, but is not the primary beneficiary, is required to disclose the nature, purpose, size, and activities of the variable interest entity, its exposure to loss as a result of the variable interest holder’s involvement with the entity, and the nature of its involvement with the entity and date when the involvement began. The primary beneficiary of a variable interest entity is required to disclose the nature, purpose, size, and activities of the variable interest entity, the carrying amount and classification of consolidated assets that are collateral for the variable interest entity’s obligations, and any lack of recourse by creditors (or beneficial interest holders) of a consolidated variable interest entity to the general credit of the primary beneficiary. In December 2003, the FASB issued a revision to FIN 46 (“FIN 46 R”), which clarifies and interprets certain provisions of FIN 46, without changing the basic accounting model of FIN 46. The Corporation adopted the provisions of FIN 46 and FIN 46 R effective March 2004 with no material effect on its consolidated financial statements. At June 30, 2004, the Corporation did not have any significant investments in variable interest entities.

     In March 2004, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 105 (SAB 105), which contains specific guidance on the inputs to a valuation-recognition model to measure loan

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commitments accounted for at fair value. SAB 105 requires that fair-value measurement include only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any expected future cash flows related to the customer relationship or loan servicing. SAB 105 is effective for mortgage-loan commitments that are accounted for as derivatives and are entered into after June 30, 2004. The Corporation adopted SAB 105 on June 30, 2004, with no effect on its 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.

Note Two - Net income Per Share

     Basic net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding for the three months and six months ended June 30, 2004 and 2003, respectively. Diluted net income per share reflects the potential dilution that could occur if the Corporation’s potential common stock and contingently issuable shares, which consist of dilutive stock options, were issued. The numerators of the basic net income per share computations are the same as the numerators of the diluted net income per share computations for all periods presented.

     A reconciliation of the basic average common shares outstanding to the diluted average common shares outstanding is as follows:

     The effects of outstanding antidilutive stock options are excluded from the computation of diluted earnings per common share. These amounts were 1.0 million shares and 0.9 million shares for the three and six months ended June 30, 2004, respectively, and 1.7 million shares and 1.6 million shares for the comparable 2003 periods.

     The Corporation paid cash dividends of $0.185 per share for both the three months ended June 30, 2004 and 2003, respectively, and paid cash dividends of $0.37 per share for both the six months ended June 30, 2004 and 2003, respectively.

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Note Three — Business Segment Information

     Refer to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003 for information with respect to the Corporation’s policies for defining and accounting for its segments. Financial information by segment for the six months ended June 30, 2004 and 2003 is as follows:

June 30, 2004

June 30, 2003

(1)

Included in Other Operating Segments are revenues, expenses and assets of insurance services, brokerage, mortgage and financial management.

(2)

Included in Other are revenues, expenses and assets of the parent company and eliminations.

Note Four - Acquisitions

     (a) Insurance Agencies. In July and October of 2003, the Corporation, through a subsidiary of FCB, acquired Piedmont Insurance Agency, Inc. and Robertson Insurance Agency, Inc., respectively. The purchase price for both agencies totaled $1.1 million in cash and were accounted for as purchases. The purchase agreements also contemplate additional cash payments based on the post-closing performance of the acquired businesses. The year over year increases in insurance services income is due to the organic growth of our insurance agencies as well as the insurance agencies and customer lists acquired. Pro forma financial information reflecting the effect of these acquisitions on periods prior to the combination is not considered material.

     (b) Third Party Benefits Administrator. In July of 2003, the Corporation, through a subsidiary of FCB, purchased a third party benefits administrator in a stock transaction. The purchase price delivered at closing consisted of First Charter common stock valued at $1.32 million, and the agreement contemplates additional common stock payments based on the post closing performance of the business. The value of such additional payments, if earned, is expected to total approximately $880,000. This acquisition was accounted for as a purchase. Accordingly, the results of operations of this entity are included in the consolidated results of operations of the Corporation from the

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date of the acquisition. The year over year increases in financial management income is mainly due to the third party benefits administrator acquired. Pro forma financial information reflecting the effect of this acquisition on periods prior to the combination is not considered material. Intangible assets amounted to $1.1 million from the acquisition.

Note Five - 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 as of June 30, 2004 and December 31, 2003:

(1) Noncompete agreements, customer lists, mortgage servicing rights and other intangibles are recorded in the Other Operating Segments as described in the 2003 Annual Report on Form 10-K.

(2) Branch acquisition intangible assets are recorded in the FCB segment as described in the 2003 Annual Report on Form 10-K.

(3) Other intangibles include trade name and proprietary software.

(4) Goodwill of $6,278 is recorded in the Other Operating Segments and $12,944 is recorded on FCB as described in the 2003 Annual Report on Form 10-K.

     Amortization expense, excluding amortization of mortgage servicing rights, totaled $96,000 and $214,000 for the three and six months ended June 30, 2004, respectively, and $77,000 and $162,000 for the comparable 2003 periods.

     The following table presents the estimated amortization expense for intangible assets for the years ended December 31, 2004, 2005, 2006, 2007, 2008 and 2009 and thereafter:

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Note Six - Comprehensive Income (Loss)

     Comprehensive income (loss) includes net income and all non-owner changes to the Corporation’s equity. The Corporation’s only component of other comprehensive income (loss) is the change in unrealized gains and losses on available for sale securities.

     The Corporation’s total comprehensive loss for the six months ended June 30, 2004 was $5.5 million compared to total comprehensive income for the six months ended June 30, 2003 of $6.3 million. The after-tax unrealized loss on securities available for sale at June 30, 2004 was $18.8 million compared to an after-tax unrealized gain of $6.2 million at December 31, 2003. This decrease was due to an increase in interest rates across the yield curve. Information concerning the Corporation’s other comprehensive income for the six months ended June 30, 2004 and 2003 is as follows:

Note Seven - Trading Activity

     The Corporation engages in writing over-the-counter covered call options on specific fixed income securities in the available for sale portfolio. Under these agreements, the Corporation agrees to sell, upon election by the optionholder, a fixed income security at a fixed price. The Corporation receives a premium from the optionholder in exchange for writing the option contract. In addition, the Corporation records the write up or write down in the market value of the First Charter Option Plan Trust (the “OPT Plan”) as a trading gain or loss. The OPT Plan is a tax-deferred capital accumulation plan. For more information concerning the OPT Plan, see Note Fourteen of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003. For the three and six months ended June 30, 2004, the Corporation recognized trading losses of $5,000 and trading income of $0.1 million, respectively, which primarily consisted of the mark to market of the investments in the OPT Plan. There were no written covered call options outstanding at June 30, 2004 or at any time during the three and six months ended June 30, 2004. For the three and six months ended June 30, 2003, the Corporation recognized trading gains of $0.4 million and $1.6 million, respectively, primarily from writing covered call options. There were no written covered call options outstanding at June 30, 2003. The highest written covered call options outstanding at any time during the six months ended June 30, 2003 were $125.0 million.

Note Eight - Derivatives

     The Corporation utilizes interest rate swap agreements to provide an exchange of interest payments computed on notional amounts that will offset any undesirable change in fair value resulting from market rate changes on designated hedged items. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. The interest rate swap agreements utilized by the Corporation qualify for hedge accounting as fair value hedges.

     The Corporation accounts for these interest rate swaps as a hedge of the fair value of the related FHLB advances. Accordingly, the Corporation records on a quarterly basis, in noninterest income, the net change in the fair value of the interest rate swap and the related FHLB advances (ineffectiveness), provided the criteria for hedge

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accounting continues to be met. In the event such criteria are not met in a future period, the Corporation will only record changes in the fair value on the interest rate swap. For the six months ended June 30, 2004, the Corporation recognized a net gain of $18,000 for the ineffective portion of the interest rate swaps. At June 30, 2004, the derivative hedging instruments were recorded at fair value in other assets. These instruments had a gross unrealized loss of $5.8 million at June 30, 2004.

     Information concerning the Corporation’s derivative instruments for the six months ended June 30, 2004 is as follows:

     According to the provisions of SFAS No. 133, the “short cut” method assumes that the change in the fair value of the derivative hedging instrument and the hedged debt obligation is one hundred percent correlated, which results in no ineffectiveness and no income statement effect. Of the $222.0 million aggregate notional amount of interest rate swap agreements entered into during the first half of 2004, three of those agreements totaling $90.0 million qualify for the “short cut method” assumption of no ineffectiveness; therefore, there was no impact on earnings during the six months ended June 30, 2004 from those interest rate swap agreements.

Note Nine - Securities Available for Sale

     Securities available for sale at June 30, 2004 and December 31, 2003 are summarized as follows:

     Securities with an aggregate carrying value of $1.2 billion at June 30, 2004 were pledged to secure public deposits, securities sold under agreements to repurchase and FHLB borrowings. Proceeds from the sale of securities available for sale were $38.0 million and $846.5 million for the six months ended June 30, 2004 and 2003, respectively. Gross gains of $1.1 million and gross losses of $0.3 million were realized in the six months ended June 30, 2004. Gross gains of $9.5 million were realized in the six months ended June 30, 2003.

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     At June 30, 2004, US government agency obligations of $478.8 million were considered temporarily impaired. US government agency obligations are interest-bearing debt securities of the US government and US government agencies. Mortgage-backed securities of $704.3 million were considered temporarily impaired at June 30, 2004. Mortgage-backed securities are investment grade securities backed by a pool of mortgages or trust deeds. Principal and interest payments on the underlying mortgages are used to pay monthly interest and principal on the securities. Cash flow from the principal and interest payments on the underlying mortgages is used to pay off the bonds. Because some mortgage pools will pay off faster than others, mortgaged-backed securities are typically issued as a series of several different bonds, each having a different maturity date. US government obligations of $38.7 million were considered temporarily impaired at June 30, 2004. These obligations are securities issued by the US Treasury. State, county and municipal obligations of $16.2 million were considered temporarily impaired at June 30, 2004. These obligations are debt instruments that are obligations of a state, county or municipality.

     The unrealized losses shown in the following table resulted primarily from an increase in interest rates across the yield curve.

Temporarily Impaired Investments
As of June 30, 2004

     Investments that are in a gross unrealized loss position include five US government obligations, thirty-five US agency securities, fifty-seven mortgage-backed securities and fourteen municipal obligations. The unrealized losses associated with these securities are not considered to be other-than-temporary, because they are related to changes in interest rates and do not affect the expected cash flows of the underlying collateral or the issuer. In addition, investments that have been in an unrealized loss position for longer than 1 year have an external credit rating of AAA.

Note Ten - Loans and Loans Held for Sale

     The Corporation’s primary market area includes North Carolina, and predominately centers around the metropolitan (“metro”) region of Charlotte, North Carolina. From time to time, the Corporation purchases construction loans in other market areas through a correspondent relationship. At June 30, 2004, the majority of the total loan portfolio, as well as a substantial portion of the commercial and real estate loan portfolios, was to borrowers within this region. 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 economic diversity of the borrowers.

     The following is a summary of the loan portfolio at June 30, 2004 and December 31, 2003:

     Loans held for sale consists primarily of 15 and 30 year mortgages which the Corporation intends to sell as whole loans or to securitize to improve its liquidity position. Loans held for sale are carried at the lower of aggregate

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cost or market. Loans held for sale were $26.8 million and $5.1 million at June 30, 2004 and December 31, 2003, respectively. Loans held for sale was impacted by originations, sales activity and securitizations, which is reflected in the Consolidated Statement of Cash Flows. No valuation allowance to reduce these loans to lower of cost or market was required at June 30, 2004 and December 31, 2003.

     The following is a summary of the changes in the allowance for loan losses for the three and six months ended June 30, 2004 and 2003:

     The allowance for loan losses was $26.1 million or 1.11 percent of gross loans at June 30, 2004 compared to $25.6 million or 1.14 percent of gross loans at December 31, 2003. The allowance for loan losses as a percentage of loans decreased primarily due to the impact of improved asset quality trends on the historical loss factors used in the loan loss migration model. In addition, the allowance for loan losses was reduced by $0.5 million due to the sale of nonaccruing and accruing higher risk mortgage loans and by net charge-offs of $4.0 million. Net charge-offs were impacted by one $0.6 million commercial loan recovery during the second quarter of 2004. These reductions were offset by an additional provision expense of $5.0 million.

     The table below summarizes the Corporation’s nonperforming assets and loans 90 days or more past due and still accruing interest as of the dates indicated.

     The recorded investment in individually impaired loans was $6.5 million (all of which were on nonaccrual status) and $4.7 million (all of which were on nonaccrual status) at June 30, 2004 and December 31, 2003, respectively. The related allowance for loan losses on these loans was $1.9 million and $0.9 million at June 30, 2004 and December 31, 2003, respectively. The average recorded investment in impaired loans for the six months ended June 30, 2004 and 2003 was $6.1 million and $17.7 million, respectively.

Note Eleven — Stock Repurchase Program

     On January 23, 2002, the Corporation’s Board of Directors authorized the repurchase of up to 1.5 million shares of the Corporation’s common stock. As of June 30, 2004, the Corporation had repurchased a total of 1.4 million shares of its common stock at an average per-share price of $17.52 under this authorization, which has reduced shareholders’ equity by $24.5 million. No shares were repurchased under this authorization during the six months ended June 30, 2004.

     On October 24, 2003, the Corporation’s Board of Directors authorized the repurchase of up to 1.5 million additional shares of the Corporation’s common stock. At June 30, 2004, no shares had been repurchased under this authorization.

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Note Twelve - Stock-Based Compensation

     The Corporation accounts for stock-based compensation under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” The pro forma impact on net income per share as if the fair value of stock-based compensation plans had been recorded as a component of compensation expense in the consolidated financial statements as of the date of grant of awards related to such plans, pursuant to the provisions of the Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” and Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure an amendment to FASB Statement No. 123”, is disclosed as follows: