e10vk

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K


þ		Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2005.


o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission file Number 000-10535

CITIZENS BANKING CORPORATION

(Exact name of Registrant as specified in its charter)


MICHIGAN		38-2378932

(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

328 S. Saginaw Street, Flint, Michigan		48502

(Address of Principal Executive Offices)		(ZIP Code)

Registrant’s telephone number, including area code: (810) 766-7500

Securities registered pursuant to Section 12(b) of the Act: none

Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value


		Preferred Stock Purchase Rights

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

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

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

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one).
Large accelerated filer þ Accelerated filer o Non-accelerated filer o

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

The aggregate market value of the voting common stock held by non-affiliates of the Registrant as of June 30, 2005 was $1,287,503,910. For purposes of this computation, all officers, directors and 10% beneficial owners of the Registrant are assumed to be affiliates. Such determination should not be deemed an admission that such officers, directors and beneficial owners are, in fact, affiliates of the Registrant.

The number of shares outstanding of the Registrant’s no par value Common Stock as of February 28, 2006 was 42,878,476.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Citizens Banking Corporation’s Proxy Statement for its annual meeting of shareholders to be held April 20, 2006 are incorporated by reference into Part III of this Annual Report on Form 10-K.

EXPLANATORY NOTE — RESTATEMENT

On August 5, 2004, Citizens completed the sale of its subsidiary bank, Citizens Bank-Illinois, N.A., to Metropolitan Bank Group, Inc. The results of the Illinois Bank are presented as discontinued operations in a separate category following results from continuing operations on the Consolidated Statements of Income. The years 2004, 2003, 2002, and 2001 have been restated for all tables and notes to reflect continuing operations only, unless otherwise indicated. These changes do not affect Citizens’ reported financial condition or net income for any of the years mentioned. The following table displays a summary of the new presentation. Further discussion of this transaction is included in Note 1 to the Consolidated Financial Statements.


(in thousands, except per share amounts)	2005		2004		2003
			(Restated)		(Restated)
*Income from Continuing Operations Before Income Taxes*	$	112,106	$	81,269	$	82,884
Income tax provision		31,581		19,590		18,375

*Income from Continuing Operations*		80,525		61,679		64,509
*Discontinued operations*
Income from discontinued operations (net of income tax of $939 and $801)		—		1,659		1,442
Gain on sale of discontinued operations (including income tax benefit of $1,109)		—		12,759		—

Income from discontinued operations		—		14,418		1,442

*Net Income*	$	80,525	$	76,097	$	65,951

*Earnings Per Share from Continuing Operations*
Basic	$	1.87	$	1.43	$	1.49
Diluted		1.85		1.41		1.48
*Earnings Per Share from Discontinued Operations*
Basic	$	—	$	0.33	$	0.03
Diluted		—		0.33		0.03
*Net Income Per Common Share*
Basic	$	1.87	$	1.76	$	1.52
Diluted		1.85		1.74		1.51

PART I

ITEM 1. BUSINESS

Unless the context indicates otherwise, all references in this Form 10-K to “Citizens” or the “Corporation,” refer to Citizens Banking Corporation and its subsidiaries. References to the “Holding Company” refer to Citizens Banking Corporation alone. Citizens’ common stock is traded on the National Market tier of the Nasdaq Stock Market under the symbol “CBCF.” Citizens’ principal executive offices are located at 328 South Saginaw Street, Flint, Michigan 48502, and the telephone number is (810) 766-7500. Citizens maintains an internet website at www.citizensonline.com where the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports are available without charge, as soon as reasonably practicable after Citizens files each such report with, or furnishes it to, the U.S. Securities and Exchange Commission. The information on Citizens’ website does not constitute a part of this report.

GENERAL

industry, and safe deposit and night depository facilities. Automated Teller Machines (“ATMs”), which provide 24-hour banking services to customers, are installed in many locations in the Corporation’s service areas. The Corporation participates in an interstate and international shared ATM network, which allows its customers to perform banking transactions from their checking, savings, or credit card accounts at ATMs in a multi-state and international environment. Among the services designed specifically to meet the needs of businesses are various types of specialized financing, treasury management services, and transfer/collection facilities. Citizens also provides wealth management services through Citizens Bank Wealth Management, N.A., and through the affiliate trust department of F&M Bank-Iowa. The Corporation is not dependent upon any single or limited number of customers, the loss of which would have a material adverse effect on the Corporation. No material portion of the business of the Corporation is seasonal.

At December 31, 2005, Citizens directly or indirectly owned the following subsidiaries:

Total

Date

Principal

Number of

Assets

Acquired /

Subsidiary

Office

Offices

(in millions)

Established

Citizens Bank (a)

Flint, MI

172

7,350.3

01/01/82

F&M Bank – Iowa (a)

Marshalltown, IA

410.8

11/01/99

Citizens Bank Wealth Management, N.A.

Flint, MI

)

03/01/02


(a)		Consolidated totals include its non-bank subsidiaries.

(b)		Citizens Bank Wealth Management, N.A. conducts business at most Citizens Bank locations and had total assets under administration of $2.5 billion at December 31, 2005.

During 2004, Citizens filed applications with the Federal Reserve Bank of Chicago and the State of Michigan Office of Financial and Insurance Services to consolidate its Michigan and Wisconsin subsidiary banks. On April 25, 2005, F&M Bank – Wisconsin became part of Citizens Bank and all offices were re-branded with the Citizens name and logo, which has been positively received by clients and staff. The resulting bank is regulated as a State of Michigan, Federal Reserve member bank. Although the consolidation did not have a significant effect on financial results, it created a more efficient banking franchise by allowing the combined banks to operate as a single entity. The consolidation eliminated the need for separate regulatory reporting and separate accounting and financial tracking by the two banks as well as allowed the Corporation to make more efficient use of its capital due to having one less legal entity.

GEOGRAPHIC LOCATIONS

As of December 31, 2005, Citizens conducts operations through 183 banking offices, private banking and financial center locations, and 187 ATM locations throughout Michigan, Wisconsin, and Iowa with 2,123 full-time equivalent employees. In Michigan, the primary market includes much of the lower peninsula of the state. In Wisconsin, the primary market areas are the Fox Valley region, extending from Green Bay to Appleton to Oshkosh, as well as northeastern and southwestern Wisconsin. In Iowa, the primary market area is the central region of the state.

PRINCIPAL SOURCES OF REVENUE

The Corporation’s primary source of revenue is interest income. The table below shows the amount of total consolidated revenues resulting from interest and fees on loans, interest and dividends on investment securities and other interest and noninterest income for each of the last three years:


	Year Ended December 31,
(in thousands)	2005		2004		2003
			(Restated)		(Restated)
Interest and fees on loans	$	343,890	$	297,811	$	318,543
Interest and dividends on investment securities		79,303		80,456		79,068
Other interest and noninterest income		80,564		91,470		93,158

Total revenues from continuing operations	$	503,757	$	469,737	$	490,769

LINES OF BUSINESS

Citizens’ performance is monitored by an internal profitability measurement system that provides line of business results and key performance measures. Citizens operates along three major business lines: Commercial Banking, Consumer Banking and Wealth Management. A brief description of each follows:

•

Commercial Banking — Commercial Banking provides a full range of lending, depository, and related financial services to middle-market corporate, industrial, financial, small business, government and leasing clients. Products and services offered include commercial loans such as term loans, revolving credit arrangements, and inventory and accounts receivable financing, commercial mortgages, real estate construction lending, letters of credit, and small business loans. Noncredit services for commercial customers include deposit accounts, treasury management, corporate cash management, international banking services, advice and assistance in the placement of securities, and financial planning.

•

Consumer Banking - Consumer Banking includes consumer lending and deposit gathering, small business lending, branch banking, electronic banking and residential mortgage loan origination and servicing. This line of business offers a variety of retail financial products and services including direct and indirect installment loans, debit and credit cards, home equity loans and lines of credit, residential mortgage loans, deposit products, fixed and variable annuities and ATM network services. Consumer loans are composed of automobile, personal, marine, and recreational vehicle loans. Deposit products include checking, savings, money market accounts, and certificates of deposit.

•

Wealth Management - Wealth Management offers a broad array of asset management, private banking, financial planning, estate settlement and administration, credit and deposit products and services. Trust and investment services include personal trust and planning, investment management, estate settlement and administration services. Retirement plan services focus on investment management and fiduciary activities with special emphasis on 401(k) plans. Brokerage and insurance delivers retail mutual funds, other securities, variable and fixed annuities, personal disability and life insurance products and discounted brokerage services. Private banking provides credit, deposit and asset management solutions for affluent clients.

All three major business lines are involved in lending activity. Lending involves credit risk which is controlled and monitored through active asset quality management, the use of lending standards, and thorough review of potential borrowers. Active asset quality administration, including early problem loan identification and timely resolution of problems, further ensures appropriate management of credit risk and minimization of loan losses. The allowance for loan losses represents Citizens’ estimate of an amount adequate to provide for probable losses inherent in the loan portfolio. Citizens’ evaluation of the adequacy of the allowance for loan losses is based on management’s ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various loan classifications, current economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect potential credit losses. Credit risk management is discussed in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the captions “Critical Accounting Policies,” “Loan Portfolio” and “Nonperforming Assets” and under Notes 2, 7 and 9 to the Consolidated Financial Statements.

Additional information regarding the business lines is incorporated herein by reference from “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Line of Business Results” and in Note 21 of the Consolidated Financial Statements.

COMPETITION

The financial services industry is highly competitive. Citizens’ banking subsidiaries compete with other commercial banks, many of which are subsidiaries of other bank holding companies, for loans, deposits, trust accounts and other business on the basis of interest rates, fees, convenience and quality of service. Major competitors include banking subsidiaries of JP Morgan Chase and Company, Comerica Incorporated, National City Corporation, Fifth Third Bancorp, LaSalle Bank Corporation, Marshall and Ilsley Corporation and Associated Banc-Corp, among others. The Corporation also actively competes with a variety of other financial service organizations including community banks, savings associations, finance companies, mortgage banking companies, brokerage firms, credit unions and other organizations. The non-banking subsidiaries compete with other companies in related industries including title insurance companies, mortgage banking companies, insurance companies, consumer finance companies and other organizations.

Mergers between financial institutions and the expansion of financial institutions both within and outside of the primary Midwest banking markets have provided significant competitive pressure in those markets. In addition, the passage of Federal interstate banking legislation has expanded the banking market and heightened competitive forces. The effect of this legislation is further discussed under the caption “Supervision and Regulation.”

Many of Citizens’ offices are located in small cities and rural areas that have diverse economies and a mix of manufacturing, service, retailing and agricultural businesses. In many of these localities, Citizens is the largest bank, which is believed to be a competitive advantage. In other markets, Citizens’ competitors may enjoy a competitive advantage, including greater financial resources, more aggressive marketing campaigns, better brand recognition and more branch locations. Citizens’ competitors may also offer higher interest rates, which could decrease Citizens’ ability to attract deposits or require Citizens to increase its rates to attract new deposits.

Other factors such as employee relations and environmental laws also impact the Corporation’s competitiveness. Citizens maintains a favorable relationship with its employees and none of the employees are represented by a collective bargaining group.

SUPERVISION AND REGULATION

General

The banking industry is subject to extensive state and federal regulation and continues to undergo significant change. Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress, in state legislatures, and before the various bank regulatory agencies. The likelihood and timing of any changes and the impact such changes might have on Citizens are impossible to determine with any certainty. A change in applicable laws or regulation, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on the business, operations and earnings of Citizens. Although Congress in recent years has sought to reduce the regulatory burden on financial institutions with respect to the approval of specific transactions, Citizens expects that the financial services industry will remain heavily regulated and that additional laws or regulations may be adopted. The following discussion summarizes certain aspects of the banking laws and regulations that affect Citizens. To the extent that the following information describes statutory or regulatory provisions, it is qualified entirely by reference to the particular statutory or regulatory provision.

Citizens is a bank holding company registered with the Federal Reserve Board and is subject to regulation under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). The Bank Holding Company Act requires the Federal Reserve Board’s prior approval of an acquisition of assets or of ownership or control of voting shares of any bank or bank holding company if the acquisition would give the Corporation more than 5% of the voting shares of that bank or bank holding company. It also imposes restrictions, summarized below, on the assets or voting shares of non-banking companies that Citizens may acquire.

Consistent with the requirements of the Bank Holding Company Act, the Corporation’s lines of business provide its customers with banking, trust and other financial services and products. These services include commercial banking through two subsidiary banks, as well as trust services, mortgage origination and servicing, equipment leasing, brokerage and investment advisory services, property and casualty insurance, brokerage services, life insurance and annuity products, title insurance, and portfolio management services through subsidiary banks and other subsidiaries.

Under Federal Reserve Board policy, a bank holding company is expected to serve as a source of financial strength to each of its subsidiary banks and to stand prepared to commit resources to support each of them. There are no specific quantitative rules on the holding company’s potential liability. If one of Citizens’ subsidiary banks were to encounter financial difficulty, the Federal Reserve Board could invoke the doctrine and require a capital contribution from the Holding Company. In addition, and as a separate legal matter, a holding company is required to guarantee the capital plan of an undercapitalized subsidiary bank. See “Capital Adequacy and Prompt Corrective Action” below.

Citizens’ subsidiary banks are subject to the provisions of the banking laws of their respective states of organization or the National Bank Act. They are under the supervision of, and are subject to periodic examination by, their respective state banking departments (in the case of state-chartered banks) or the Office of the Comptroller of the Currency (“OCC”) (in the

case of national banks), and are subject to the rules and regulations of the OCC, the Federal Reserve Board and the Federal Deposit Insurance Corporation (“FDIC”). Citizens Bank (the Corporation’s principal bank subsidiary) and F&M Bank-Iowa are state-chartered banks and are therefore subject to supervision, regulation and examination by the Michigan Office of Financial and Insurance Services and the Iowa Division of Banking, respectively. Both of the depository banks are members of the Federal Reserve System so they are subject to supervision and examination by the Federal Reserve Board as well as the FDIC, because the FDIC insures their deposits to the extent provided by law. Citizens Bank Wealth Management, N.A., a national non-depository trust bank, is subject to supervision, regulation and examination by the OCC. Additionally, the non-bank subsidiaries are supervised and examined by the Federal Reserve Board and various other federal and state agencies.

Citizens’ insured depository institution subsidiaries are also subject to cross-guaranty liability under federal law. This means that if one FDIC-insured depository institution subsidiary of a multi-institution bank holding company fails or requires FDIC assistance, the FDIC may assess “commonly controlled” depository institutions for the estimated losses suffered by the FDIC. Such liability could have a material adverse effect on the financial condition of any assessed subsidiary institution and on Citizens as the common parent. While the FDIC’s cross-guaranty claim is generally junior to the claims of depositors, holders of secured liabilities, general creditors and subordinated creditors, it is generally superior to the claims of shareholders and affiliates.

Payment of Dividends

There are various statutory restrictions on the ability of Citizens’ banking subsidiaries to pay dividends or make other payments to their Holding Company. Each of the state-chartered banking subsidiaries is subject to dividend limits under the laws of the state in which it is chartered. In addition, all of the subsidiary banks are member banks of the Federal Reserve System, subject to the dividend limits of the Federal Reserve Board. The Federal Reserve Board allows a member bank to make dividends or other capital distributions in an amount not exceeding the current calendar year’s net income, plus retained net income of the preceding two years. Distributions in excess of this limit require prior approval of the Federal Reserve Board. Federal Reserve Board policy provides that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears to be consistent with the holding company’s capital needs, asset quality and overall financial condition.

Dividends from a national banking association may be declared only from the bank’s undivided profits, and until the bank’s surplus fund equals its common capital, no dividends may be declared unless at least 10% of the bank’s net income for a given time period has been carried to the surplus fund, depending on the frequency of dividend payments in a given year. The OCC’s approval is required if the total of all dividends declared in any calendar year exceeds the sum of the bank’s net income of that year combined with its retained net income of the preceding two years.

In each of the years ended December 31, 2005, 2004 and 2003, Citizens’ subsidiaries paid cash dividends of $63.2 million, $49.0 million and $24.0 million, respectively. As of January 1, 2006, Citizens’ banking subsidiaries were able to distribute dividends of $47.4 million without further regulatory approval.

Capital Adequacy and Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires federal regulators to take prompt corrective action against any undercapitalized institution. FDICIA establishes five capital categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. “Well capitalized” institutions significantly exceed the required minimum level for each capital measure (currently, risk-based and leverage). “Adequately capitalized” institutions include depository institutions that meet the required minimum level for each capital measure. “Undercapitalized” institutions consist of those that fail to meet the required minimum level for one or more relevant capital measures. “Significantly undercapitalized” characterizes depository institutions with capital levels significantly below the minimum requirements. “Critically undercapitalized” refers to depository institutions with minimal capital and at serious risk for government seizure.

Under certain circumstances, a well-capitalized, adequately capitalized or undercapitalized institution may be treated as if the institution were in the next lower capital category. A depository institution is generally prohibited from making capital distributions, including paying dividends, or paying management fees to a holding company if the institution would thereafter be undercapitalized. Institutions that are adequately but not well capitalized cannot accept, renew or rollover brokered

deposits except with a waiver from the FDIC and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew or rollover brokered deposits.

The banking regulatory agencies are permitted or, in certain cases, required to take certain actions with respect to institutions falling within one of the three undercapitalized categories. Depending on the level of an institution’s capital, the agencies’ corrective powers include, among other things:

•

prohibiting the payment of principal and interest on subordinated debt;

•

prohibiting the holding company from making distributions without prior regulatory approval;

•

placing limits on asset growth and restrictions on activities;

•

placing additional restrictions on transactions with affiliates;

•

restricting the interest rate the institution may pay on deposits;

•

prohibiting the institution from accepting deposits from correspondent banks; and

•

in the most severe cases, appointing a conservator or receiver for the institution.

A banking institution that is undercapitalized is required to submit a capital restoration plan, and such a plan will not be accepted unless, among other things, the banking institution’s holding company guarantees the plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy.

FDICIA also contains a variety of other provisions that may affect Citizens’ operations, including reporting requirements, regulatory standards for real estate lending, “truth in savings” provisions, and the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch.

At December 31, 2005 and 2004, the most recent notification from the Federal Reserve Board categorized Citizens and all of its depository institution subsidiaries as “well capitalized” under the regulatory framework for prompt corrective action. Information concerning capital adequacy guidelines for Citizens and its banking subsidiaries including their regulatory capital position at December 31, 2005 and maintenance of minimum average reserve balances by the banking subsidiaries with the Federal Reserve Bank is incorporated herein by reference from “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the captions “Capital Resources” and “Liquidity and Debt Capacity” and Note 22 to the Consolidated Financial Statements.

FDIC Insurance Assessments

The FDIC’s deposit insurance assessments currently are calculated under a risk-based system. The risk-based system places a bank in one of nine risk categories, principally on the basis of its capital level and an evaluation of the bank’s risk to the relevant deposit insurance fund, and bases premiums on the probability of loss to the FDIC with respect to each individual bank. Under the Federal Deposit Insurance Act, depository institutions such as Citizens’ subsidiary banks may not pay interest on indebtedness, if such interest is required to be paid out of net profits, or distribute any of its capital assets while it remains in default on any assessment due to the FDIC.

The adjusted assessment rates for FDIC-insured institutions currently range from 0.00% to 0.27% depending on the assessment category into which a bank is placed. Citizens did not pay any regular insurance assessments to the FDIC in 2002. However, beginning July 1, 2003 and continuing throughout 2004, the Wisconsin bank subsidiary was required to pay an annualized assessment rate of 0.03% to the FDIC for deposit insurance. Effective January 1, 2005, the Wisconsin bank was no longer required to pay the assessment. Additionally, Citizens does not expect that any other of its bank subsidiaries will pay significant insurance assessments in 2006. However, the FDIC retains the ability to increase regular insurance assessments and to levy special additional assessments.

Interstate Banking

Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Riegle-Neal Act”), as amended, a bank holding company may acquire banks in states other than its home state, subject to any state requirement that the bank has been organized and operating for a minimum period of time (not to exceed five years) and the requirement that the bank holding company not control, prior to or following the proposed acquisition, more than 10% of the total amount of deposits of insured depository institutions nationwide or, unless the acquisition is the bank holding company’s initial entry into the state, more than 30% of such deposits in the state, or such lesser or greater amount set by the state. The Riegle-Neal Act also

authorizes banks to merge across state lines, thereby creating interstate branches. Banks are also permitted to acquire and to establish de novo branches in other states where authorized under the laws of those states.

Transactions with Affiliates

Transactions between Citizens’ subsidiary banks and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. The affiliates of the banks include Citizens and any entity controlled by Citizens. Generally, Sections 23A and 23B (i) limit the extent to which the subsidiary banks may engage in “covered transactions” with any one affiliate to an amount equal to 10% of the Corporation’s capital stock and surplus, and maintain an aggregate limit on all such transactions with affiliates to an amount equal to 20% of the bank’s capital stock and surplus, (ii) require that a bank’s extensions of credit to such affiliates be fully collateralized (with 100% to 130% collateral coverage, depending on the type of collateral), (iii) prohibit the bank from purchasing or accepting as collateral from an affiliate any “low quality assets” (including non-performing loans) and (iv) require that all “covered transactions” be on terms substantially the same, or at least as favorable, to the bank or its subsidiary as those provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and other types of similar transactions.

Loans to Insiders

The Federal Reserve Act and related regulations impose specific restrictions on loans to directors, executive officers and principal stockholders of banks. Under Section 22(h) of the Federal Reserve Act and its implementing regulations, loans to a director, an executive officer and to a principal stockholder of a bank, and some affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the bank’s loan-to-one-borrower limit. Loans in the aggregate to insiders and their related interests as a class may not exceed the bank’s unimpaired capital and unimpaired surplus. Section 22(h) and its implementing regulations also prohibit loans, above amounts prescribed by the appropriate federal banking agency, to directors, executive officers and principal stockholders of a bank or bank holding company, and their respective affiliates, unless such loan is approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. Section 22(h) generally requires that loans to directors, executive officers and principal stockholders be made on terms and underwriting standards substantially the same as offered in comparable transactions to other persons.

Community Reinvestment Act

Under the Community Reinvestment Act (“CRA”) and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate income areas, consistent with safe and sound banking practice. The CRA requires the adoption by each institution of a CRA statement for each of its market areas describing the depository institution’s efforts to assist in its community’s credit needs. Depository institutions are periodically examined for compliance with CRA and are periodically assigned ratings in this regard. Banking regulators consider a depository institution’s CRA rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiary.

Citizens Bank was evaluated in 2005 and received an “outstanding” rating. F&M Bank-Iowa was evaluated in 2004 and received a “satisfactory” rating.

Fair Lending and Consumer Laws

In addition to the Community Reinvestment Act, other federal and state laws regulate various lending and consumer aspects of the banking business. Governmental agencies, including the Department of Housing and Urban Development, the Federal Trade Commission and the Department of Justice, have become concerned that in some cases prospective borrowers experience unlawful discrimination in their efforts to obtain loans from depository and other lending institutions. These agencies have brought litigation against some depository institutions alleging discrimination against borrowers. Many of these suits have been settled, in some cases for material sums, short of a full trial.

These governmental agencies have clarified what they consider to be lending discrimination and have specified various factors that they will use to determine the existence of lending discrimination under the Equal Credit Opportunity Act and the Fair Housing Act. These factors include evidence that a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently based on prohibited factors in the absence of evidence that the treatment was the result of prejudice or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral non-discriminatory policy uniformly to all applicants, but the practice had a discriminatory effect, unless the practice could be justified as a business necessity.

Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act, require compliance by depository institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of certain loans to customers.

Gramm-Leach-Bliley Act of 1999

The Gramm-Leach-Bliley Act of 1999 (the “GLBA”) was signed into law on November 12, 1999. The GLBA covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. The following description summarizes some of its significant provisions.

The GLBA repeals sections 20 and 32 of the Glass-Steagall Act, thus permitting unrestricted affiliations between banks and securities firms. It also permits bank holding companies to elect to become financial holding companies. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, investment, merchant banking, insurance underwriting, sales and brokerage activities. In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed and have at least a satisfactory Community Reinvestment Act rating. Citizens has determined not to become certified as a financial holding company at this time. The Corporation may reconsider this determination in the future.

The GLBA provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in specific areas identified under the law. The federal bank regulatory agencies adopted insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures.

The GLBA repeals the broad exemption of banks from the definitions of “broker” and “dealer” for purposes of the Securities Exchange Act of 1934, as amended. It also identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a “broker,” and a set of activities in which a bank may engage without being deemed a “dealer.” Additionally, the law makes conforming changes in the definitions of “broker” and “dealer” for purposes of the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended.

The GLBA also contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, both at the inception of the customer relationship and on an annual basis, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. The new law provides that, except for specific limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to “opt out” of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The GLBA also provides that the states may adopt customer privacy protections that are more strict than those contained in the GLBA.

Anti-Money Laundering and the USA Patriot Act of 2001

In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”). The Patriot Act is designed to deny terrorists and criminals the ability to obtain access to the United States’ financial system and has significant implications for depository institutions, brokers, dealers, and other businesses involved in the transfer of money. The Patriot Act mandates that financial services companies implement policies and procedures with respect to additional measures designed to address the following matters: money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, and currency crimes. The Patriot Act also substantially broadened existing anti-money laundering legislation, imposed new compliance and due diligence obligations, created new crimes and penalties, and compelled the production of documents located both inside and outside the United States. The U.S. Treasury Department has issued a number of regulations that apply some of these requirements to financial institutions such as Citizens’ banking subsidiaries. The regulations impose new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering

and terrorist financing. The Treasury Department is expected to issue a number of additional regulations which will further clarify these requirements. Pursuant to the Patriot Act and the related regulations Citizens has established anti-money laundering compliance and due diligence programs that include, among other things, the designation of a compliance officer, employee training programs and an independent audit function to review and test the program.

ECONOMIC FACTORS AND MONETARY POLICY

Citizens’ earnings and business are affected by the general economic and political conditions in the United States and abroad and by the monetary and fiscal policies of various federal regulatory authorities, including the Federal Reserve System. Through open market securities transactions, variations in the Federal Funds rate and the establishment of reserve requirements, the Board of Governors of the Federal Reserve System exerts considerable influence on interest rates and the supply of money and credit. The effect of fluctuating economic conditions and federal regulatory policies on Citizens’ future profitability cannot be predicted with any certainty. The effect of the economy and changes in interest rates on Citizens’ net interest margin and net interest income in 2005, 2004, and 2003 and their potential effect on future periods is discussed in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Net Interest Income” and is incorporated herein by reference. Citizens’ sensitivity to changes in interest rates and the potential effect of changes in interest rates on net interest income is presented in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations- — Interest Rate Risk” and incorporated herein by reference.

ENVIRONMENTAL MATTERS

Citizens’ primary exposure to environmental risk is through trust services and lending activities. In each instance, policies and procedures are in place to mitigate environmental risk exposures. With respect to lending activities, Citizens requires environmental site assessments at the time of loan origination to confirm collateral quality on commercial real estate parcels posing higher than normal potential for environmental impact, as determined by reference to present and past uses of the subject property and adjacent sites. Environmental assessments are also mandated prior to any foreclosure activity involving non-residential real estate collateral. In the case of trust services, Citizens utilizes various types of environmental transaction screening to identify actual and potential risks arising from any proposed holding of non-residential real estate for trust accounts. Consequently the Corporation does not anticipate any material effect on capital expenditures, earnings or the competitive position of Citizens or any of its subsidiaries with regard to compliance with federal, state or local environmental protection laws or regulations. Additional information is provided in “Item 3. Legal Proceedings.”

Directors and Executive Officers of the Holding Company

The following information is provided for the members of the Board of Directors of the Holding Company and those persons currently designated as executive officers of the Holding Company by its Board of Directors.

Board of Directors


Name		Occupation

William R. Hartman		Chairman of the Board, President and Chief Executive Officer, Citizens Banking Corporation
Edward P. Abbott		President and Chief Executive Officer, Abbott’s Meats, Inc.
Lizabeth A. Ardisana		Chief Executive Officer and Owner, ASG Renaissance
Joseph P. Day		President, Banner Engineering & Sales, Inc.
Richard J. Dolinski		President and Chief Executive Officer, Dolinski Associates, Inc. and President, The Legacy Center for Student Success
Benjamin W. Laird		Attorney at Law, Godfrey & Kahn, S.C.
Stephen J. Lazaroff		President, Diversified Precision Products, Inc.
William C. Shedd		Attorney at Law, Shedd, Frasier & Grossman, PLLC
Kendall B. Williams		Attorney at Law, The Williams Firm, P.C.
James L. Wolohan		Chairman of the Board, President and CEO, Wolohan Lumber Company

Executive Officers


Name		Title
William R. Hartman		Chairman, President and Chief Executive Officer
Marilyn K. Allor		Senior Vice President and Director of Human Resources
Charles D. Christy		Executive Vice President and Chief Financial Officer
Roy A. Eon		Executive Vice President and Manager of Operations and Technology
Steven V. Figliuolo		Executive Vice President and Corporate Risk Officer
Thomas W. Gallagher		General Counsel and Secretary
James A. Hawking		Senior Vice President and General Auditor
Wendy K. Hemingway		Senior Vice President and Director of Commercial Products and Sales
Judith L. Klawinski		Senior Vice President and Head of Retail Delivery
John J. Owens		Senior Vice President and Chief Marketing Officer
Randall J. Peterson		Executive Vice President and Regional Chairman – Wisconsin and Iowa
Jeffrey A. Powell		Senior Vice President, Controller and Principal Accounting Officer
Clinton A. Sampson		Executive Vice President and Regional Chairman – Michigan
James A. Schmelter		Executive Vice President for Wealth Management
John D. Schwab		Executive Vice President and Chief Credit Officer

ITEM 1A. RISK FACTORS

Unless the context indicates otherwise, all references in this Item to “we,” “us,” or “our,” refer to Citizens Banking Corporation and its subsidiaries. An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that we believe affect us are described below. The risks and uncertainties described below (in bold) are not the only ones we face. Additional risks and uncertainties that we are not aware of or focused on or currently deems immaterial may also impair business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and shareholders could lose all or part of their investment.

We face the risk that loan losses, including unanticipated loan losses due to changes in loan portfolios, fraud and economic factors, will exceed the allowance for loan losses and that additional increases in the allowance will be required which would cause our net income to decline and could have a negative impact on our capital and financial position.

Making loans is an essential element of our business, and we recognize there is a risk that customer loans will not be repaid. The risk of nonpayment is affected by a number of factors, including:

	•		the duration of the loan;

	•		credit risks of a particular borrower;

	•		changes in economic and industry conditions; and

	•		in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

We attempt to maintain an appropriate allowance for loan losses to provide for potential losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors including the ongoing review and grading of the loan portfolio, consideration of past loan loss experience as well as that of the banking industry, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, the size and diversity of individual large credits, and other qualitative and quantitative factors which could affect probable credit losses. We determine the amount of the allowance for loan losses by considering

these factors and by using estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on our historical loss experience as well as that of the banking industry with additional qualitative factors for various issues, and allocation of reserves for special situations that are unique to the measurement period with consideration of current economic trends and conditions, all of which are susceptible to significant change. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly.

There is no precise method of predicting loan losses, and therefore we always face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional increases in the allowance for loan losses will be required. Additions to the allowance for loan losses would cause net income to decline in the period(s) in which such additions occur and could also have a material adverse impact on capital and financial position.

While we attempt to manage the risk from changes in market interest rates, interest rate risk management techniques are not exact. In addition, we may not be able to economically hedge our interest rate risk. A rapid or substantial increase or decrease in interest rates could adversely affect our net interest income and results of operations.

Our net income depends primarily upon our net interest income. Net interest income is income that remains after deducting, from total income generated by earning assets, the interest expense attributable to the acquisition of the funds required to support earning assets. Income from earning assets includes income from loans, investment securities and short-term investments. The amount of interest income is dependent on many factors including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates and the levels of non-performing loans. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, rates paid on borrowed funds and the levels of non-interest-bearing demand deposits and equity capital.

Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities. That means either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest earning assets, or vice versa. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could reduce net interest income. We are unable to predict changes in market interest rates which are affected by many factors beyond our control including inflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets. As of December 31, 2005, we were a liability-sensitive financial institution (liabilities repricing within one year exceeded assets repricing within one year). Net interest income is not only affected by the level and direction of interest rates, but also by the shape of the yield curve, relationships between interest sensitive instruments and key driver rates, as well as balance sheet growth, client loan and deposit preferences and the timing of changes in these variables.

We attempt to manage risk from changes in market interest rates, in part, by controlling the mix of interest rate-sensitive assets and interest rate-sensitive liabilities. We continually review our interest rate risk position and modify our strategies based on projections to minimize the impact of future interest rate changes. We also use derivative financial instruments to modify our exposure to changes in interest rates. Holding residential mortgage loans for sale and committing to fund residential mortgage loan applications at specific rates may pose interest rate risk during the period from loan funding until sale. To minimize this risk, we enter into mandatory forward commitments to sell residential mortgage loans. However, interest rate risk management techniques are not exact. A rapid increase or decrease in interest rates could adversely affect results of operations and financial performance.

An economic downturn, and the negative economic effects caused by terrorist attacks, potential attacks and other destabilizing events, would likely contribute to the deterioration of the quality of our loan portfolio and could reduce our customer base, level of deposits, and demand for financial products such as loans.

High inflation, natural disasters, acts of terrorism, an escalation of hostilities or other international or domestic occurrences, increased unemployment, changes in securities markets and other factors could have a negative impact on the economy of the Upper Midwest regions in which we operate. A sustained economic downturn in our markets would likely contribute to the deterioration of the quality of our loan portfolio by impacting the ability of our customers to repay loans, the value of the collateral securing loans, and may reduce the level of deposits in our banking subsidiaries and the stability of our deposit

funding sources. A sustained economic downturn could also have a significant impact on the demand for our products and services. The cumulative effect of these matters on our results of operations and financial condition would likely be adverse and could be material.

If we are unable to continue to attract core deposits or continue to obtain third party financing on favorable terms, our cost of funds will increase, adversely affecting the ability to generate the funds necessary for lending operations, reducing net interest margin and negatively affecting results of operations.

Our subsidiary banks derive liquidity through core deposit growth, maturity of money market investments, and maturity and sale of investment securities and loans. Additionally, our subsidiary banks have access to financial market borrowing sources on an unsecured, as well as collateralized basis, for both short-term and long-term purposes including, but not limited to, the Federal Reserve and Federal Home Loan Banks of which the subsidiary banks are members. If these funding sources are not sufficient, we may have to acquire funds through higher-cost sources.

Our credit ratings were reviewed and affirmed by Moody’s Investor Service on January 27, 2005 and Dominion Bond Rating Service assigned ratings to us on April 21, 2005. Wholesale funding represents an important source of liquidity to us, and credit ratings affect the availability and cost of this funding. We currently have the ability to borrow funds on both a short-term and long-term basis as an additional source of liquidity. Our Holding Company maintains a $75 million short-term revolving credit facility with four unaffiliated banks. As of December 31, 2005, there was no outstanding balance on this credit facility. If our ratings were downgraded, our ability to borrow funds at favorable rates may be negatively impacted and could adversely affect our results of operations and financial condition.

Increased competition with other financial institutions or an adverse change in our relationship with a number of major customers could reduce our net interest margin and net income by decreasing the number and size of loans originated, the interest rates charged on these loans and the fees charged for services to customers. If we lend to customers who are less likely to pay in order to maintain historical origination levels, we may not be able to maintain current loan quality levels.

Our banking subsidiaries face substantial competition in originating commercial and consumer loans. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders. Many of our competitors have competitive advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income by decreasing the number and size of the loans that we originate and the interest rates we charge on these loans.

In attracting business and consumer deposits, we face substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns and better brand recognition and more branch locations. These competitors may offer higher interest rates, which could decrease the deposits that we attract or require us to increase rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations which could increase our cost of funds.

We also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance companies and governmental organizations which may offer more favorable terms. Some non-bank competitors are not subject to the same extensive regulations that govern banking operations. As a result, such non-bank competitors may have advantages over us in providing certain products and services. This competition may reduce or limit our margins on banking and non-banking services, reduce our market share and adversely affect our earnings and financial condition.

The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to

entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems.

We are party to various lawsuits incidental to our business. Litigation is subject to many uncertainties such that the expenses and ultimate exposure with respect to many of these matters cannot be ascertained.

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

The financial services industry is undergoing rapid technological changes. If we are unable to adequately invest in and implement new technology-driven products and services, we may not be able to compete effectively, or the cost to provide products and services may increase significantly.

The financial services industry is undergoing rapid technological changes with frequent introduction of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial service institutions to reduce costs. Our future success will depend, in part, upon our ability to address the customer needs by using technology to provide products and services to enhance customer convenience, as well as to create additional operational efficiencies. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services, which could reduce our ability to effectively compete and, in turn, have a material adverse effect on our financial condition and results of operations.

Our business may be adversely affected by the highly regulated environment in which we operate. We may be adversely affected by changes in banking or tax laws, regulations, and regulatory practices at either the federal or state level. Such changes would affect our ability to offer new products and services, obtain financing, pay dividends from the subsidiaries to the Holding Company, attract deposits, make loans and leases at satisfactory spreads. Such changes may also result in the imposition of additional costs.

The banking industry is heavily regulated, and such regulations are intended primarily for the protection of depositors and the federal deposit insurance funds, not shareholders or holders of subordinated debt. As a bank holding company, our Holding Company is subject to regulation by the Federal Reserve Board. Our bank subsidiaries each have their own federal regulator (the Federal Reserve Board or the OCC) and are also subject to regulation by the state banking departments of the state in which they are chartered. These regulations affect lending practices, capital structure, investment practices, dividend policy and growth. In addition, we have non-bank operating subsidiaries from which we derive income. Certain of these non-bank subsidiaries engage in providing investment management and insurance brokerage services, which industries are also heavily regulated on both a state and federal level. In addition, changes in laws, regulations and regulatory practices affecting the financial services industry could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.

The products and services offered by the banking industry and customer expectations regarding them are subject to change. We attempt to respond to perceived customer needs and expectations by offering new products and services, which are often costly to develop and market initially. A lack of market acceptance of these products and services would have a negative effect on financial condition and results of operations.

From time to time, we implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services we may invest

significant time and resources. We may not achieve initial timetables for the introduction and development of new lines of business and/or new products or services and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on business, results of operations and financial condition.

New accounting or tax pronouncements or interpretations may be issued by the accounting profession, regulators or other government bodies which could change existing accounting methods. Changes in accounting methods could negatively impact our results of operations and financial position.

Current accounting and tax rules, standards, policies, and interpretations influence the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. Events that may not have a direct impact on us, such as the bankruptcy of major U.S. companies, have resulted in legislators, regulators, and authoritative bodies, such as the Financial Accounting Standards Board, the Securities and Exchange Commission, the Public Company Accounting Oversight Board, and various taxing authorities responding by adopting and/or proposing substantive revision to laws, regulations, rules, standards, policies, and interpretations. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. A change in accounting standards may adversely affect reported financial condition and results of operations.

Our business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in, or disruption to, our business and a negative impact on the results of operations.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems, whether due to severe weather, natural disasters, acts of war or terrorism, criminal activity or other factors, could result in failures or disruptions in general ledger, deposit, loan, customer relationship management, and other systems. While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our results of operations.

Our vendors could fail to fulfill their contractual obligations, resulting in a material interruption in, or disruption to, our business and a negative impact on our results of operations.

We have entered into subcontracts for the supply of current and future services, such as data processing and certain property management functions. These services must be available on a continuous and timely basis and be in compliance with any regulatory requirements. Failure to do so could substantially harm our business.

We often purchase services from vendors under agreements that typically can be terminated on a periodic basis. There can be no assurance, however, that vendors will be able to meet their obligations under these agreements or that we will be able to compel them to do so. Risks of relying on vendors include the following.

	•		If an existing agreement expires or a certain service is discontinued by a vendor, then we may not be able to continue to offer our customers the same breadth of products and our operating results would likely suffer unless we are able to find an alternate supply of a similar service.

	•		Agreements we may negotiate in the future may commit us to certain minimum spending obligations. It is possible we will not be able to create the market demand to meet such obligations.

	•		If market demand for our products increase suddenly, our current vendors might not be able to fulfill our commercial needs, which would require us to seek new arrangements or new sources of supply, and may result in substantial delays in meeting market demand.

	•		We may not be able to control or adequately monitor the quality of services we receive from our vendors. Poor quality services could damage our reputation with our customers.

Potential problems with vendors such as those discussed above could have a significant adverse effect on our business, lead to higher costs and damage our reputation with our customers and, in turn, have a material adverse effect on our financial condition and results of operations.

Our potential inability to integrate acquired operations could have a negative effect on our expenses and results of operations.

In the past, we have grown through strategic acquisitions and we may engage in strategic acquisitions in the future to strengthen and expand our operating and marketing capabilities. The full benefits of these acquisitions, however, require integration of administrative, financial, sales, lending, collections, marketing approaches, and personnel. If we are unable to successfully integrate these acquisitions, we may not realize the benefits of the acquisitions, and our financial results may be negatively affected. A completed acquisition may adversely affect our financial condition and results of operations, including our capital requirements and the accounting treatment of these acquisitions. Completed acquisitions may also lead to significant unexpected liabilities after the consummation of these acquisitions.

We could face unanticipated environmental liabilities or costs related to real property owned or acquired through foreclosure. Compliance with federal, state and local environmental laws and regulations, including those related to investigation and clean-up of contaminated sites, could have a negative effect on expenses and results of operations.

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on results of operations.

As a bank holding company that conducts substantially all of our operations through our subsidiaries, the ability of the Holding Company to pay dividends, repurchase our shares or to repay our indebtedness depends upon the results of operations of our subsidiaries and their ability to pay dividends to the Holding Company. Dividends paid by these subsidiaries are subject to limits imposed by federal and state law.

The Holding Company is a separate and distinct legal entity from our subsidiaries and it receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on common stock and interest and principal on debt. Various federal and/or state laws and regulations limit the amount of dividends that our bank subsidiaries and certain non-bank subsidiaries may pay to the Holding Company. Also, the Holding Company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event its subsidiaries are unable to pay dividends to the Holding Company, the Holding Company may not be able to service debt, pay obligations or pay dividends on common stock.

Our controls and procedures may fail or be circumvented which could have a material adverse effect on our business, results of operations and financial condition.

We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.

Our articles of incorporation, bylaws and shareholder rights agreement as well as certain banking laws may have an anti-takeover effect.

Provisions of our articles of incorporation and bylaws, federal banking laws, including regulatory approval requirements, and the rights agreement, dated May 23, 2000, between the Holding Company and Citizens Bank, as rights agent, could make it more difficult for a third party to acquire the Holding Company, even if doing so would be perceived to be beneficial to shareholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None

ITEM 2. PROPERTIES

Citizens’ executive offices are located at 328 South Saginaw Street, Flint, Michigan in the main office building of Citizens Bank, the largest bank subsidiary. The bank subsidiaries operate through 183 branch and financial banking offices. Of these, 36 are leased and the remainder are owned and not subject to any material liens. Rent expense on the leased properties totaled $3.4 million in 2005. The banking offices are located in various communities throughout the states of Michigan, Wisconsin, and in parts of Iowa. At certain Citizens Bank locations a portion of the office buildings are leased to tenants. Additional information related to the property and equipment owned or leased by Citizens and its subsidiaries is incorporated herein by reference from Note 10 to the Consolidated Financial Statements.

ITEM 3. LEGAL PROCEEDINGS

Citizens and its subsidiaries are parties to a number of lawsuits incidental to its business. Although litigation is subject to many uncertainties and the ultimate exposure with respect to many of these matters cannot be ascertained, Citizens does not believe the ultimate outcome of these matters will have a material adverse effect on its financial condition or liquidity.

From time to time, certain of the Corporation’s subsidiaries are notified by applicable environmental regulatory agencies, pursuant to State or Federal environmental statutes or regulations, that they may be potentially responsible parties (“PRPs”) for environmental contamination on or emanating from properties currently or formerly owned. Typically, exact costs of remediating the contamination cannot be fully determined at the time of initial notification. While, as PRPs, these subsidiaries are potentially liable for the costs of remediation, in most cases, a number of other PRPs have been identified as being jointly and severally liable for remediation costs. Additionally, in certain cases, statutory defenses to liability for remediation costs may be asserted based on the subsidiaries’ status as lending institutions that acquired ownership of the contaminated property through foreclosure. Citizens is not presently aware of any environmental liabilities that pose a reasonable possibility of future material impact on its earnings. It is Citizens’ policy to establish and accrue appropriate reserves for all such identified exposures during the accounting period in which a loss is deemed to be probable and the amount is determinable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted during the fourth quarter of 2005 to a vote of security holders through the solicitation of proxies or otherwise.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Holding Company’s common stock is traded on the National Market tier of the Nasdaq Stock Market under the symbol “CBCF.” Information regarding the Holding Company’s stock prices during the last two years is incorporated herein by reference from “Item 8 – Financial Statements and Supplementary Data.”

As of December 31, 2005, the approximate number of shareholders of the Holding Company’s common stock was 15,094. This number includes an estimate for individual participants in the security positions of certain shareholders of record. Record shareholders at December 31, 2005 totaled 6,039.

Information regarding cash dividends that the Holding Company has declared during the last two fiscal years is incorporated herein by reference from “Item 8 – Financial Statements and Supplementary Data.” Restrictions on the Holding Company’s ability to pay dividends are incorporated herein by reference from Note 22 to the Consolidated Financial Statements.

Equity Compensation Plan Information

Citizens’ has two stock option plans pursuant to which it grants performance-based stock options to employees, officers and directors. The Stock Compensation Plan (the “2002 Plan”) was approved by Citizens shareholders in 2002. The All-Employee Stock Option Plan (the “All-Employee Plan”) was not submitted to Citizens shareholders for approval. The 2002 Plan replaced the Third Amended Stock Option Plan which has expired and Citizens Stock Option Plan for Directors which was terminated. Both of these plans were approved by Citizens shareholders and there continue to be options outstanding that were granted under these plans. The following table sets forth, with respect to all of the option plans, (i) the number of shares of common stock to be issued upon the exercise of outstanding options, (ii) the weighted average exercise price of outstanding options, and (iii) the number of shares remaining available for future issuance, as of December 31, 2005.


						Number of shares
						remaining available for
						future issuance under
	Number of shares to be			Weighted-average		equity compensation
	issued upon exercise of			exercise price of		plans (excluding shares
Plan Category	outstanding options			outstanding options		reflected in column (a))
	(a)			(b)		(c)
Equity compensation plans approved by shareholders		3,833,991		$	28.16		3,990,880

Equity compensation plans not approved by shareholders		83,900	(1)	$	16.66		0


Total		3,917,891		$	27.91		3,990,880

(1)

Issued under the All-Employee Plan. Under this plan, on May 18, 2000, Citizens granted stock options to all employees who did not receive grants under the then existing but since expired Third Amended Stock Option Plan. Each full-time employee received options for 200 shares of common stock and each part-time employee received options for 100 shares. The $16.66 exercise price of the grant was the market price of the common stock on the grant date. The options became exercisable three years after the date of grant. The options expire ten years from the date of grant. Options for a total of 550,700 shares were granted of which options for 83,900 shares were outstanding as of December 31, 2005. The plan provides that no further grants may be made under the plan.

Issuer Repurchases of Equity Securities


					Total Number of		Maximum Number of
					Shares Purchased as		Shares that May Yet
					Part of Publicly		Be Purchased Under
	Total Number of		Average Price Paid		Announced Plans or		The Plans or Programs
Period	Shares Purchased		Per Share		Programs		(a)
October 2005		—		—		—		2,376,200
November 2005		75,000		29.57		75,000		2,301,200
December 2005		60,000		29.29		60,000		2,241,200

Total		135,000		29.44		135,000		2,241,200


(a)		In October 2003, the Board approved the repurchase of up to 3,000,000 shares. There is no expiration date for the repurchase program. The purchase of shares is subject to limitations that may be imposed by applicable securities laws and regulations and the rules of the Nasdaq Stock Market. The timing of the purchases and the number of shares to be bought at any one time depend on market conditions and capital requirements. There can be no assurance that Citizens will repurchase the remaining shares authorized to be repurchased, or that any additional repurchases will be authorized by the Board of Directors.

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data presented below are derived from Citizens’ audited consolidated financial statements and should be read in conjunction with its Consolidated Financial Statements for the years ended December 31, 2005, 2004, and 2003, and notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this Annual Report. Certain amounts for prior periods have been reclassified to conform to the current presentation. In addition, as discussed in the Explanatory Note at the beginning of this Annual Report, the years 2004, 2003, 2002, and 2001 have been restated to reflect the sale of the Illinois Bank as discontinued operations. These changes do not affect Citizens’ reported financial condition or net income for any of the years mentioned. Further discussion is included in Note 1 to the Consolidated Financial Statements.

Five Year Summary of Selected Financial Data


(in thousands, except per share data)	2005			2004			2003		2002			2001
				(Restated)			(Restated)		(Restated)			(Restated)
*For The Year*
Net interest income	$	275,749		$	271,698		$	280,705	$	294,545		$	301,159
Provision for loan losses ⁽¹⁾		1,109			21,609			62,008		117,331			25,232
Noninterest income before securities gains (losses) ⁽²⁾		89,435			92,971			92,952		97,569			109,724
Investment securities gains (losses) ⁽³⁾		(8,927	)		(1,513	)		101		2,338			5,997
Noninterest expense ⁽⁴⁾		243,042			260,278			228,866		253,972			244,845
Income tax provision (benefit) from continuing operations		31,581			19,590			18,375		(1,346	)		42,451
Income from continuing operations		80,525			61,679			64,509		24,495			104,352
Discontinued operations (after tax) ⁽⁵⁾		—			14,418			1,442		543			305
Net income		80,525			76,097			65,951		25,038			104,657
Cash dividends		49,311			49,286			49,476		50,659			50,158
*Per Common Share Data*
Income from continuing operations
Basic	$	1.87		$	1.43		$	1.49	$	0.55		$	2.26
Diluted		1.85			1.41			1.48		0.55			2.24
Discontinued operations
Basic	$	—		$	0.33		$	0.03	$	0.01		$	0.01
Diluted		—			0.33			0.03		0.01			0.01
Net income
Basic	$	1.87		$	1.76		$	1.52	$	0.56		$	2.27
Diluted		1.85			1.74			1.51		0.56			2.25
Cash dividends		1.140			1.140			1.140		1.130			1.085
Book value, end of year		15.28			15.13			14.69		14.88			15.47
Market value, end of year		27.75			34.35			32.72		24.78			32.88
*At Year End, Continuing Operations*
Assets	$	7,751,883		$	7,706,033		$	7,544,903	$	7,320,958		$	7,494,272
Portfolio loans ⁽⁶⁾		5,616,119			5,393,365			5,164,416		5,342,669			5,669,755
Deposits		5,473,839			5,299,760			5,274,082		5,740,867			5,758,953
Long-term debt		1,006,109			949,921			936,859		599,313			629,099
Shareholders’ equity		656,463			654,302			635,162		650,469			697,464
*At Year End, Combined*
Assets	$	7,751,883		$	7,706,033		$	7,711,070	$	7,524,724		$	7,682,899
Portfolio loans ⁽⁶⁾		5,616,119			5,393,365			5,247,818		5,437,795			5,777,954
Deposits		5,473,839			5,299,760			5,442,267		5,936,913			5,965,126
Long-term debt		1,006,109			949,921			936,859		599,313			629,099
Shareholders’ equity		656,463			654,302			635,162		650,469			697,464
*Average For The Year, Continuing Operations*
Assets	$	7,777,818		$	7,585,479		$	7,510,870	$	7,360,405		$	7,731,553
Earning assets		7,348,168			7,164,365			7,097,607		6,959,160			7,316,131
Portfolio loans ⁽⁶⁾		5,493,280			5,210,817			5,140,450		5,467,139			5,851,694
Deposits		5,286,390			5,277,670			5,478,315		5,720,200			5,802,258
Interest-bearing deposits		4,355,337			4,379,150			4,626,593		4,877,101			4,950,672
Repurchase agreements and other short-term borrowings		812,642			653,442			454,339		242,614			528,525
Long-term debt		938,478			936,050			861,704		620,913			596,380
Shareholders’ equity		653,004			639,631			632,060		691,834			702,381
*Average For The Year, Combined*
Assets	$	7,777,818		$	7,684,834		$	7,693,931	$	7,569,341		$	7,935,843
Earning assets		7,348,168			7,259,660			7,272,887		7,160,596			7,510,332
Portfolio loans ⁽⁶⁾		5,493,280			5,259,303			5,234,246		5,569,432			5,983,971
Deposits		5,286,390			5,375,297			5,665,533		5,924,442			6,008,096
Interest-bearing deposits		4,355,337			4,460,391			4,787,594		5,054,743			5,126,928
Repurchase agreements and other short-term borrowings		812,642			655,472			458,673		251,315			538,673
Long-term debt		938,478			936,049			861,704		620,913			596,380
Shareholders’ equity		653,004			639,631			632,060		691,834			702,381

Five Year Summary of Selected Financial Data (Continued)


(in thousands, except per share data)	2005			2004			2003			2002			2001
				(Restated)			(Restated)			(Restated)			(Restated)
*Financial Ratios, Continuing Operations*
Return on average:
Shareholders’ equity		12.33	%		9.64	%		10.21	%		3.54	%		14.86	%
Earning assets		1.10			0.86			0.91			0.35			1.43
Assets		1.04			0.81			0.86			0.33			1.35
Average shareholders’ equity/avg. assets		8.40			8.43			8.42			9.40			9.08
Dividend payout ratio		61.24			79.91			76.70			206.82			48.07
Net interest margin (FTE)		3.94			3.99			4.17			4.47			4.34
Tier I leverage ratio		7.98			7.84			7.45			7.18			7.79
Tier I risk-based capital ratio		9.94			9.96			9.80			9.18			9.87
Total risk-based capital ratio		13.22			13.32			13.23			10.43			11.12
*Financial Ratios, Combined*
Return on average:
Shareholders’ equity		12.33	%		11.90	%		10.43	%		3.62	%		14.90	%
Earning assets		1.10			1.05			0.91			0.35			1.39
Assets		1.04			0.99			0.86			0.33			1.32
Average shareholders’ equity/avg. assets		8.40			8.32			8.22			9.14			8.85
Dividend payout ratio		61.24			64.77			75.02			202.33			47.93
Net interest margin (FTE)		3.94			3.99			4.15			4.45			4.32
Tier I leverage ratio		7.98			7.84			7.45			7.18			7.79
Tier I risk-based capital ratio		9.94			9.96			9.80			9.18			9.87
Total risk-based capital ratio		13.22			13.32			13.23			10.43			11.12


(1)		Provision for loan losses in 2005 includes a $9.1 million insurance settlement relating to a claim for recovery of fraud losses suffered in connection with two loans made by the Corporation and subsequently charged-off in 2002 and 2003.

(2)		Noninterest income in 2005 includes a charge of $3.6 million related to a fair value change in CD swap derivatives.

(3)		Investment securities gains (losses) in 2005 includes losses of $9.0 million on the sale of investment securities.

(4)		Citizens recorded special charges of $13.4 million in 2002 for restructurings and other initiatives. Additionally, the year 2003 included a special charge credit of ($0.7 million) related to accrual reversals primarily for employee benefits and severance, and professional fees. The special charges and the related credit were included in noninterest expense. Noninterest expense in 2004 included a $18.0 million prepayment penalty on the prepayment of FHLB debt.

(5)		Discontinued operations in 2004 includes an after-tax gain of $12.8 million for the sale of the Illinois bank subsidiary.

(6)		Balances exclude mortgage loans held for sale.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following presents management’s discussion and analysis of Citizens Banking Corporation’s financial condition and results of operations for each of the past three years and should be read in conjunction with the accompanying Consolidated Financial Statements and Notes. The discussion highlights the principal factors affecting earnings for the years 2005, 2004, and 2003 and the significant changes in balance sheet items from December 31, 2004 to December 31, 2005 and is intended to help the reader understand, from management’s perspective, the consolidated financial statements, notes to financial statements, and the accompanying tables, charts and financial statistics appearing elsewhere in this report. Where applicable, this discussion also reflects management’s insights regarding known events and trends that have or may reasonably be expected to have a material effect on the Corporation’s operations and financial condition.

Change in Presentation to Reflect Discontinued Operations

On August 5, 2004, Citizens completed the sale of its subsidiary bank, Citizens Bank-Illinois, N.A., to Metropolitan Bank Group, Inc. The results of the Illinois Bank are presented as discontinued operations in a separate category following results from continuing operations on the Consolidated Statements of Income. The years 2004, 2003, 2002, and 2001 have been restated for all tables and notes to reflect continuing operations only, unless otherwise indicated. These changes do not affect Citizens’ reported financial condition or net income for any of the years mentioned. Further discussion of this transaction is included in Note 1 to the Consolidated Financial Statements.

Forward–Looking Statements

Discussions in this report that are not statements of historical fact (including statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” and “plan”) are forward-looking statements that involve risks and uncertainties, and actual future results could materially differ from those discussed. Factors that could cause or contribute to such differences include, without limitation, risks and uncertainties detailed from time to time in the Holding Company’s filings with the Securities and Exchange Commission, including those listed in Item 1A of this report.

Other factors not currently anticipated may also materially and adversely affect Citizens’ results of operations and financial position. There can be no assurance that future results will meet expectations. While the Corporation believes that the forward-looking statements in this report are reasonable, the reader should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. Citizens does not undertake, and expressly disclaims, any obligation to update or alter any statements whether as a result of new information, future events or otherwise, except as may be required by applicable law.

OVERVIEW

Nature of Citizens’ Business

Citizens is a diversified banking and financial services company that provides a full range of banking and financial services to individuals and businesses through its subsidiaries Citizens Bank and F&M Bank-Iowa. The Corporation also provides wealth management services through Citizens Bank Wealth Management, N.A., and through the affiliate trust department of F&M Bank-Iowa. Citizens conducts operations through 183 banking offices, private banking and financial center locations, and 187 ATM locations throughout Michigan, Wisconsin, and Iowa.

Citizens operates in three major business lines: Commercial Banking, Consumer Banking and Wealth Management. Citizens’ performance is monitored by an internal profitability measurement system that provides line of business results and key performance measures including return on assets, return on equity, net interest margin, allowance for loan losses to portfolio loans, net loans charged off percentage and nonperforming assets as a percent of total assets. These key performance measures for the last five years are presented in Tables 6 and 8 below and in the table under “Item 6 – Selected Financial Data.”

The Corporation’s primary source of revenue is net interest income, which is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities, including interest-bearing deposits and borrowings used to fund those assets. Net interest income is affected by fluctuations in the amount and composition of earning assets and funding sources and in the yields earned and rates paid, respectively, on these assets and liabilities. The Corporation measures the level of interest income relative to earning assets and interest bearing liabilities through two statistics — interest spread and net interest margin. The interest spread represents the difference between yields on earning assets and the rates paid for interest-bearing liabilities. The net interest margin is expressed as the percentage of net interest income to average earning assets. Citizens’ sensitivity to changes in interest rates and the potential affect of changes in interest rates on net interest income is presented in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate Risk” and incorporated herein by reference.

Proper management of the volume and composition of the Corporation’s earning assets and funding sources is essential for ensuring strong and consistent earnings performance, maintaining adequate liquidity and limiting exposure to risks caused by changing market conditions. Citizens’ investment securities portfolio is structured to provide a source of liquidity principally through the maturity of the securities held in the portfolio and to generate an income stream with relatively low levels of principal risk. Loans comprise the largest component of earning assets and are the highest yielding assets. Client deposits are the primary source of funding for earning assets while short-term debt and other managed sources of funds are utilized as market conditions and liquidity needs change.

The Corporation monitors and manages its liquidity position so that funds will be available at a reasonable cost to meet client cash flow needs, while maintaining funds available for loan and investment opportunities as well as to pay dividends to shareholders, service debt, invest in subsidiaries, finance business expansion, satisfy other operating requirements and take advantage of unforeseen opportunities. Citizens derives its liquidity through core deposit growth, maturity of money market

investments, and maturity and sale of investment securities and loans. The Corporation also has access to market borrowing sources for both short-term and long-term purposes.

Citizens’ other principal source of revenue is noninterest income, particularly fees and other revenue from financial services provided to customers. Citizens’ noninterest income includes service charges on deposit accounts, fees charged for trust services related to personal, institutional and employee benefit products and services, revenue related to loan products, including commercial loan fees and mortgage banking revenue, and fees for various other services, such as brokerage and investment services, ATM network use, and financial services.

Citizens’ net income can also be significantly affected by additions or reductions to the allowance for loan losses. Extending credit to businesses and consumers exposes Citizens to the risk that the principal balance of a loan and any related interest will not be collected. Citizens mitigates this credit risk through portfolio diversification that limits exposure to any single industry or customer and by establishing a comprehensive system of internal controls. The allowance for credit losses represents the estimate of probable losses inherent in the loan portfolio. The allowance is based on ongoing quarterly assessments of historical data and general economic factors, among other things, and is maintained at a level the Corporation considers adequate to absorb probable loan losses identified with specific customer relationships and probable losses believed to be inherent in the loan portfolio which have not been specifically identified. This evaluation process is inherently subjective, as it requires estimates that may be susceptible to significant change and have the potential to materially affect net income. In the event that Citizens overestimates future cash flows or underestimates losses on loan pools, the Corporation may be required to increase the provision for loan losses, which would have a negative impact on results of operations in the period in which the increase occurred. Certain economic indicators suggest that business conditions are stable and improving, which could result in a lower provision for loan losses for the commercial banking segment in 2006. However, the lingering effects of the downturn in the Midwest automotive industry on consumer financial positions may result in higher provision for loan losses in 2006 for the consumer banking segment of Citizens’ business. Excluding the $9.1 million recovery for loan losses in the fourth quarter of 2005, the combined impact from both segments will likely be positive to the Corporation’s credit quality indicators and could lead to a lower provision for loan losses in 2006.

Performance Summary

An analysis of the major components of net income in 2005, 2004 and 2003 is presented below.

Table 1. Three Year Summary of Net Income Components


	Year Ended December 31,
(in thousands)	2005			2004			2003
				(Restated)			(Restated)
Interest income	$	423,249		$	378,279		$	397,716
Interest expense		147,500			106,581			117,011

Net interest income		275,749			271,698			280,705
Provision for loan losses ⁽¹⁾		1,109			21,609			62,008
Noninterest income ⁽¹⁾		80,508			91,458			93,053
Noninterest expense ⁽¹⁾		243,042			260,278			228,866
Income tax provision from continuing operations⁽¹⁾		31,581			19,590			18,375

Income from continuing operations		80,525			61,679			64,509
Discontinued operations:
Income from discontinued operations (net of income tax of $939 and $801)		—			1,659			1,442
Gain on sale of discontinued operations (including income tax benefit of $1,109)		—			12,759			—

Income from discontinued operations		—			14,418			1,442

Net income	$	80,525		$	76,097		$	65,951


⁽¹⁾Includes significant charges and/or gains as follows:
Provision for loan losses	$	9,125		$	—		$	—

Noninterest income
Losses from sale of investment securities		(8,976	)		—			—
Fair value change in CD swap derivatives		(3,604	)		—			—

Total losses and other charges recorded in noninterest income		(12,580	)		—			—

Noninterest expense
Prepayment penalty on FHLB advances		—			(17,959	)		—

Tax benefit (expense)		(1,209	)		6,286			—

Net increase (decrease) to income	$	(2,246	)	$	(11,673	)	$	—

A comparative summary of key performance measures for 2005 versus 2004 follows.

Citizens recorded net income of $80.5 million or $1.85 per diluted share compared with net income of $76.1 million or $1.74 per diluted share for the same period of 2004, an increase of 5.8% in net income and 6.3% in diluted net income per share. Return on average assets and return on average equity for 2005 were 1.04% and 12.33%, respectively, compared with 0.99% and 11.90%, respectively, for 2004. Key factors behind these results were:

	•		Net interest income for 2005 increased $4.1 million or 1.5% to $275.7 million compared with the full year 2004 while the net interest margin percentage decreased from 3.99% to 3.94% during the same period. Interest income increased $45.0 million or 11.9% and interest expense increased $40.9 million or 38.4%. The margin compression was due to shifts within the deposit portfolio from lower cost savings and transaction products to time deposits and continued pricing pressure on commercial loans, partially offset by growth in earning assets of 2.9% due to higher loan balances, a shift in asset mix from investment securities to higher yielding commercial loans and growth in noninterest-bearing sources of funds.

	•		Total average earning assets for 2005 increased $203.5 million or 2.9% to $7.3 billion. Average total portfolio loans increased $282.5 million or 5.4% to $5.5 billion, with the growth in all loan categories partially offset by a decline in taxable investment securities. Total average deposits remained relatively unchanged for 2005 at $5.3 billion. A decrease in interest-bearing demand was substantially offset by increases in savings deposits, time deposits, and

			noninterest-bearing demand. Core deposits, which exclude time deposits, decreased by $88.5 million or 2.5% due to clients migrating their funds into time deposits with higher yields and promotional rate products within the market.

	•		Loan loss provision expense decreased $20.5 million from 2004 due to lower net charge-offs, a decline in nonperforming assets, fewer risk rating downgrades within the commercial loan portfolio, and a fourth quarter 2005 reduction in the reserve of $1.5 million related to a previous mortgage recourse transaction. Total net charge-offs decreased $13.9 million in 2005 to $6.9 million or 0.13% of average portfolio loans outstanding compared to $20.8 million or 0.40% for 2004. The net charge-offs reflect a recovery of $9.1 million as a result of an insurance settlement. The reduction in nonperforming assets was the result of a sale of nonperforming commercial loans with a balance of $6.7 million during the third quarter of 2005, aggressive collection efforts, risk mitigation through reduction of exposure on credits not meeting Citizens’ risk parameters and, to a lesser extent, continued charge-off of nonperforming loans. Nonperforming assets decreased $11.0 million to $39.9 million or 0.71% of portfolio loans plus other repossessed assets acquired (“ORAA”) at December 31, 2005.

	•		Noninterest income decreased $11.0 million or 12.0% to $80.5 million compared with the full year of 2004. The decrease was the result of a $9.0 million net loss on the sale of securities as a result of restructuring the investment portfolio during the fourth quarter of 2005, a cumulative charge of $3.6 million on swaps related to brokered certificates during the fourth quarter of 2005, and lower mortgage, other loan income and other income, partially offset by increased service charges on deposit accounts, trust fees, ATM network user fees, bankcard fees, and financial services.

	•		Noninterest expense decreased $17.2 million or 6.6% to $243.0 million compared with the full year of 2004. The decrease was the result of the $18.0 million prepayment penalty on $235.0 million of high cost Federal Home Loan Bank (“FHLB”) advances during the third quarter of 2004, declines in advertising and public relations, other loan expenses, and other expenses, partially offset by increases in salaries and employee benefits, occupancy, and professional services.

	•		Income tax expense increased $12.0 million or 61.2% to $31.6 million compared with the full year of 2004. The 2005 effective tax rate was 28.17% compared with the 2004 effective tax rate of 24.11%. The increases were attributable to higher pre-tax income, a $1.3 million ($0.8 million after-tax) reduction in the deferred Wisconsin state income tax asset, higher ongoing state taxes as a result of the April 2005 merger of the Michigan and Wisconsin bank charters, and a fourth quarter 2005 adjustment in the reserve for taxes payable.

CRITICAL ACCOUNTING POLICIES

Citizens’ Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and follow general practices within the industry in which the Corporation operates. Application of these principles requires management to make estimates, assumptions, and complex judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Actual results could differ significantly from those estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates that are particularly susceptible to significant change include the determination of the allowance for loan losses, the benefit obligation and net periodic pension expense for employee pension and postretirement benefit plans, derivative financial instruments and hedging activities, and income taxes. Citizens believes that these estimates and the related policies discussed below are important to the portrayal of the Corporation’s financial condition and results. Therefore, management considers them to be critical accounting policies and discusses them directly with the Audit Committee of the Board of Directors. Citizens’ significant accounting policies are more fully described in Note 2 to the Consolidated Financial Statements.

Allowance for Loan Losses

The allowance for loan losses represents Citizens’ estimate of probable losses inherent in the loan portfolio, the largest asset category on the consolidated balance sheet. Determining the amount of the allowance for loan losses is considered a critical accounting policy because it requires significant judgment and the evaluation of several factors: the ongoing review and grading of the loan portfolio, consideration of past Citizens’ and banking industry loan loss experience, trends in past due and

nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, the size and diversity of individual large credits, and other qualitative and quantitative factors which could affect probable credit losses. Other considerations include the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical Citizens’ or banking industry loss experience and additional qualitative factors for various issues. Additionally, an allocation of reserves is established for special situations that are unique to the measurement period with consideration of current economic trends and conditions. All of these factors are susceptible to significant change, determine the amount of the allowance for loan losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly.

The Corporation’s allowance for possible loan loss methodology is based on guidance provided in SEC Staff Accounting Bulletin 102, “Selected Loan Loss Allowance Methodology and Documentation Issues” and includes allowance allocations calculated in accordance with SFAS 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures,” and allowance allocations determined in accordance with SFAS 5, “Accounting for Contingencies.” Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Corporation’s control, including the performance of the Corporation’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. See the section captioned “Provision and Allowance for Loan Losses” elsewhere in this discussion for further details of the risk factors considered by management in estimating the necessary level of the allowance for loan losses.

The Corporation’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with SFAS 114 based on probable losses on specific commercial loans; (ii) homogenous loan pools valuation allowances determined in accordance with SFAS 5 based on quantitative Citizens’ or banking industry loan loss experience for similar loans with similar risk characteristics, with additional qualitative risks upon the best judgment of management; and (iii) general valuation allowances based on existing regional and local economic factors, including the automotive industry, a macroeconomic adjustment factor used to calibrate for the current economic cycle the Corporation is experiencing, and other judgmental factors supported by qualitative documentation such as the inherent imprecision of loan loss projection models.

Specific valuation allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicate it is probable that a loss will be incurred. The specific credit allocations are based on a regular analysis of all commercial and commercial real estate loans over a fixed dollar amount where the internal credit rating is at or below a predetermined classification.

Citizens’ loan loss experience for homogenous loan pools is calculated based on historical data with additional qualitative risk based on the best judgment of management. Industry loan loss experience rather than Citizens’ own historical data, which for some portfolios is limited, is utilized when, in the judgment of management, the industry loan loss experience more comprehensively portrays the current loss environment for any loan pool. Qualitative factors, both internal and external to the Corporation, considered by management include, among other things: (i) the experience, ability and effectiveness of Citizens’ lending management and staff; (ii) the effectiveness of the Corporation’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Citizens evaluates the degree of risk that these components have on the quality of the loan portfolio on a quarterly basis. Based upon the Corporation’s analysis, appropriate estimates for qualitative risks are established. Included in the qualitative valuations are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits. Concentration risk guidelines have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships, and loans originated with policy exceptions. Qualitative allowances may also include estimates of inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors. The historical losses used may not be representative of actual losses inherent in the portfolio that have not yet been realized.

The general valuation qualitative allowance is based on management’s estimate of the effect of current general economic conditions on current loan pools and the inherent imprecision in loan loss projection models. The uncertainty surrounding the strength and timing of economic cycles, including concerns over the effects of the prolonged economic downturn for the Corporation’s business footprint in the current cycle, also affects the estimates of loss.

Continuous credit monitoring processes and the analysis of loss components are the principal methods relied upon by management to ensure that changes in estimated credit loss levels are reflected in Citizens’ allowance for credit losses on a timely basis. Citizens utilizes the experience of other banking institutions and regulatory guidance in addition to its own experience. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for credit losses. Such agencies may require additions to the allowance based on their judgment on information available to them at the time of their examination.

Actual loss ratios experienced in the future may vary from those projected. In the event that management overestimates future cash flows or underestimates losses on loan pools, the Corporation may be required to increase the provision for loan losses, which would have a negative impact on the results of operations in the period in which the increase occurred. In the third quarter of 2002, Citizens experienced a significant increase in the allowance for loan losses due to elevated past-due and nonperforming loan levels, a weakened economy and enhancements to the loan loss allocation model, including the incorporation of more recent historical loss data in the determination of projected loss rates for pools of loans evaluated collectively and refinements to the internal risk rating system for commercial loans, which led to an increase in risk rating downgrades. Note 2 to the Consolidated Financial Statements describes the methodology used to determine the allowance for loan losses, and a discussion of the factors driving changes in the amount of the allowance for loan losses is included under “Provision and Allowance for Loan Losses.”

Pension and Postretirement Benefits

Pension liabilities are established and pension costs are charged to current operations based on actuarially determined present value calculations. The valuation of the pension obligation and net periodic pension expense is considered critical as it requires management to make estimates regarding the amount and timing of expected future cash outflows including assumptions about employee mortality, expected employee service periods, rate of employee compensation increases, assumed discount rate and the long-term return on plan assets. If Citizens were to determine that more conservative assumptions were necessary, costs would likely increase and have a negative impact on results of operations in the period in which the increase occurred. Note 14 to the Consolidated Financial Statements provides further discussion on the accounting for Citizens’ employee benefit plans and the estimates used in determining the actuarial present value of the benefit obligations and the net periodic pension expense.

On an annual basis, Citizens determines an expected long-term rate of return on plan assets by analyzing historical returns, projected returns, target asset allocations, and projected plan expenses. The long term rate of return assumption was lowered for 2004 negatively impacting future results and remained unchanged for 2005. Effective December 31, 2005, Citizens updated its employee mortality assumptions using more recent actuarial tables with a net increase in life expectancy, which has a small unfavorable impact on future results. Assumed compensation increases were also changed to more appropriately reflect Citizens’ performance management process with little impact on future results. Additionally, the assumed future rate of earnings for the cash balance pension plans was lowered at December 31, 2005 to reflect the current rate environment, causing a slight decrease to the liability and positively impacting future results. The healthcare increase trend rate assumption was reset to match the scale used at December 31, 2004 and will have a slight negative impact on future results.

For 2005, the determination of the discount rate used for calculating pension benefit obligations was based on a cash flow matching method. A spot yield curve for high quality bonds rated AA- or better was converted to zero coupon equivalent bond rates. These zero coupon bond rates were matched to the actuarially determined benefit obligation annual cash flows. The resulting single discount rate was rounded to a 25 basis point increment. For 2004, the determination of the discount rate used for calculating pension benefit obligations was based on an index for high quality bonds rated AA- or better, and rounded to a 25 basis point increment. No adjustments were made to the index rate to account for timing and amount of pension benefit cash flows in 2004. The assumed discount rate is likely to change each year with fluctuations in market yields for long-term corporate bonds, while the expected long-term rate of return will likely exhibit less volatility. For a discussion of these changes and their expected impact on 2006 results, refer to “Noninterest Expense.” For more information on pension and postretirement benefits, see Note 14 of the Consolidated Financial Statements.

Derivative Financial Instruments and Hedge Accounting

In various aspects of its business, Citizens uses derivative financial instruments to modify its exposure to changes in interest rates and market prices for other financial instruments. Many of these derivative financial instruments are designated as hedges for financial accounting purposes. The application of Citizens’ hedge accounting policy requires judgment in the assessment of hedge effectiveness, identification of similar hedged item groupings, and measurement of changes in the fair value of hedged items. If in the future the derivative financial instruments identified as hedges no longer qualify for hedge accounting treatment, changes in the fair value of these hedged items would be recognized in current period earnings, and the impact on the consolidated results of operations and reported earnings could be significant.

For more information on derivative financial instruments and hedge accounting, see Notes 2 and 19 to the Consolidated Financial Statements.

Income Tax Accounting

Income tax liabilities or assets are established for the amount of taxes payable or refundable for the current year. Deferred tax liabilities and assets are also established for the future tax consequences of events that have been recognized in the Corporation’s financial statements or tax returns. A deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and deductions that can be carried forward (used) in future years. The valuation of current and deferred tax liabilities and assets is considered critical as it requires management to make estimates based on provisions of the enacted tax laws. The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings. The Corporation believes its tax assets and liabilities are adequate and properly recorded in the consolidated financial statements. For more information regarding income tax accounting, see Notes 2 and 15 to the Consolidated Financial Statements.

RECENT ACCOUNTING PRONOUNCEMENTS

Note 3 to the Consolidated Financial Statements discusses new accounting policies adopted by Citizens during 2005 and 2004 and the expected impact of accounting policies recently issued or proposed but not yet required to be adopted. To the extent the adoption of new accounting standards materially affects Citizens’ financial condition, results of operations or liquidity, the impact is discussed elsewhere in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Notes 2 and 3 to the Consolidated Financial Statements.

RECENT DEVELOPMENTS

Insurance Settlement

In 2002 and 2003, a total of $20.0 million was charged to the Allowance for Loan Losses after Citizens determined that two of its borrowers provided falsified reports detailing the value of collateral used for the borrowing base of their loans. Through collection efforts, loan loss recoveries were subsequently recorded to the Allowance for Loan Losses totaling $2.4 million over the course of 2003 and 2004. After exhausting efforts to obtain restitution from the borrowers on the remaining portion of these loans, Citizens filed a claim with one of its previous insurers who underwrote a financial institutions bond with a rider which protected Citizens from losses incurred resulting from reliance on false and fraudulent financial documentation. The claim was initially denied so Citizens filed a lawsuit against the insurer in early 2004.

On October 10, 2005, Citizens agreed to a settlement of $9.1 million with the insurer. The settlement agreement provided that the parties release each other from further liability and stipulated dismissal of the litigation with prejudice. It permits the Corporation to pursue claim against any other person or entity seeking recovery for the losses to which the litigation related. The settlement was accounted for as a loan loss recovery to the Allowance for Loan Losses.

Accounting for Derivative Instruments and Hedging Activities

accounting treatment under the “short-cut” method of SFAS 133. Further discussion of this charge is included in Note 19 to the Consolidated Financial Statements.

Securities Sale

During the fourth quarter of 2005, Citizens incurred a $9.0 million net loss on the sale of securities as the result of restructuring the investment portfolio. The Corporation sold $322.4 million of investment securities and purchased $209.4 million of higher yielding securities. The remaining $104.0 million, after netting the $9.0 million loss, was used to pay down short-term borrowings. The Corporation also entered into a notional amount of $100.0 million in receive-fixed swaps. The decision to sell the securities was based on significant changes in the asset/liability position of the Corporation. Recent increases in intermediate and long-term interest rates had extended the duration of the securities portfolio due to the effect on embedded options, and recent declines in core deposits had negatively impacted the duration of liabilities and increased the reliance on wholesale funding. Including the impact of the swaps, this transaction shortened the duration of the investment portfolio, reduced option risk related to callable securities and reduced wholesale borrowings. The transaction has had a beneficial impact on net interest margin and net interest income. Further discussion of this charge is included in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the captions “Noninterest Income,” and “Investment Securities and Money Market Investments” and under Note 4 to the Consolidated Financial Statements.

Southeast Michigan Initiative

During 2005, Citizens continued to focus on the expansion initiative in Southeast Michigan, which it announced in the fourth quarter of 2003. In 2005, three new branch facilities were opened, six additional commercial bankers added, and a third middle market commercial group was established. As of December 31, 2005, Citizens has two regional hub locations, 14 branch facilities and 163 employees. This initiative continues to show great success, as evidenced by a $194.1 million or 31.4% increase in total loans to $812.0 million as of December 31, 2005. Total deposits increased $4.7 million or 1.7% to $276.1 million and the wealth management business increased assets under management $37.7 million or 122% to $68.5 million for the same period. The Corporation intends to open two new branch locations in 2006.

Significant Developments in 2004 and 2003

Illinois Bank Sale

On August 5, 2004, Citizens completed the sale of its subsidiary bank, Citizens Bank-Illinois, N.A., to Metropolitan Bank Group, Inc. in a cash transaction valued at $26.3 million. The Illinois Bank was comprised of three branch locations with $173.2 million of assets, $78.5 million of loans and $155.3 million of deposits as of August 5, 2004. Citizens realized a pretax gain of $11.7 million on the transaction. The sale of the Illinois Bank generated a tax loss benefit because Citizens’ tax basis in the stock of the Illinois Bank was greater than the Illinois Bank’s sale price. The sale of the Illinois Bank has been reflected as a discontinued operation. Further discussion of this transaction is included in Note 1 to the Consolidated Financial Statements.

Prepayment of FHLB Advances and Issuance of New FHLB Debt

Citizens prepaid $235.0 million of high cost FHLB advances during the third quarter of 2004. The after-tax effect of the prepayment penalties on the debt largely offset the gain on the sale of the Illinois Bank, resulting in a relatively neutral effect on earnings per share for the third quarter. Additionally, during the third quarter of 2004, Citizens issued $275.0 million of new FHLB fixed rate advances at approximately 150 basis points less than the retired debt. The improved structure and lower cost improved Citizens’ net interest margin and interest rate sensitivity and offset the negative impact on future results of operations from the sale of the Illinois Bank. The tax loss from the Illinois Bank sale along with lower pretax earnings resulting from the prepayment penalties of FHLB advances contributed toward reducing income tax expense for 2004.

Replacement of Wealth Management’s Broker/Dealer and Reorganization of the Golden Oak Funds

On July 26, 2004, the brokerage and investment areas of the Wealth Management line implemented changes to better compete with national brokerage firms and in the local investment arena. The new program is marketed under the new names of Investment Center At Citizens Bank, and Investment Center at F&M Bank. In addition, Citizens replaced its broker/dealer services vendor with Independent Financial Marketing Group, Inc., an experienced and highly rated distributor of investment and insurance products. IFMG will provide Citizens with marketing support, advanced technology and improved processing capabilities that will help Citizens grow its brokerage business.

On September 29, 2004, the Wealth Management line completed its reorganization of the Golden Oak Funds into two leading fund groups: Goldman Sachs Asset Management and Federated Mutual Fund Services. The assets of the Golden Oak funds have been exchanged for shares of the acquiring funds. At the time of the reorganization, the Golden Oak mutual fund portfolios had approximately $450 million in assets under management.

Sale of Credit Card Portfolio

Effective May 28, 2004, F&M Bank-Wisconsin and F&M Bank-Iowa (the “F&M Banks”) entered into agreements with MBNA America Bank, N.A. (“MBNA”) to sell their respective credit card account portfolios to MBNA. Pursuant to such arrangements, MBNA paid to F&M Bank-Iowa a premium of $0.3 million for a portfolio totaling $2.5 million and paid to F&M Bank-Wisconsin a premium of $0.1 million for a portfolio totaling $1.1 million. Also in connection with the sale, each of the F&M Banks executed an addendum to a joint marketing agreement with MBNA that the Citizens Bank Michigan affiliate had previously entered into as of February 28, 2001. Under the joint marketing agreement, MBNA is licensed to issue its credit cards to clients of the F&M Banks and to utilize the F&M Banks’ names and logos. The F&M Banks in return receive a fee from MBNA for each new credit card account generated. Pursuant to such arrangement, the F&M Banks have no responsibility for credit, fraud or other types of losses associated with such credit card accounts.

Wealth Management Strategic Alliances

In the second quarter of 2003, Wealth Management formed strategic alliances with SEI Investments and EnvestnetPMC, Inc. The alliances enable Wealth Management to offer their clients a broader range of mutual fund family choices, access to separately managed accounts with specialized portfolio managers, state of the art research capabilities, and sophisticated client profiling and portfolio modeling tools. In addition, Wealth Management, through an arrangement with EPIC Advisors, Inc., provides retirement plan products and services by offering its clients advanced state-of-the-art online employee account access, online retirement plan design and consulting options, and access to industry experts.

RESULTS OF OPERATIONS

NET INTEREST INCOME

An analysis of net interest income, interest spread and net interest margin with average balances and related interest rates for the full years 2005, 2004, and 2003 is presented below.

Table 2. Average Balances/Net Interest Income/Average Rates


	2005								2004								2003
												(Restated)								(Restated)
Year Ended December 31	Average					Average			Average					Average			Average					Average
(in thousands)	Balance			Interest ⁽¹⁾		Rate ⁽²⁾			Balance			Interest ⁽¹⁾		Rate ⁽²⁾			Balance			Interest ⁽¹⁾		Rate ⁽²⁾

*Earning Assets*
Money market investments	$	2,348		$	56		2.38	%	$	2,088		$	12		0.57	%	$	11,204		$	105		0.94	%
Investment securities ⁽³⁾:
Taxable		1,380,868			58,514		4.24			1,470,490			59,794		4.07			1,333,123			58,944		4.42
Tax-exempt		426,811			20,789		7.49			418,829			20,662		7.59			397,541			20,124		7.79
Mortgage loans held for sale		35,061			1,901		5.42			32,646			1,782		5.46			170,083			8,568		5.04
Portfolio Loans ⁽⁴⁾:
Commercial		1,628,625			98,030		6.15			1,597,667			80,524		5.17			1,729,337			87,219		5.18
Commercial real estate		1,338,870			85,102		6.36			1,239,169			72,866		5.88			1,317,719			82,787		6.28
Residential mortgage loans		513,385			28,611		5.57			487,634			27,954		5.73			506,562			32,036		6.32
Direct consumer		1,171,567			74,798		6.38			1,094,441			61,454		5.62			898,499			57,525		6.40
Indirect consumer		840,833			55,448		6.59			791,906			53,231		6.72			688,333			50,408		7.32

Total portfolio loans		5,493,280			341,989		6.27			5,210,817			296,029		5.72			5,140,450			309,975		6.08

Total earning assets ⁽³⁾		7,338,368			423,249		5.95			7,134,870			378,279		5.49			7,052,401			397,716		5.83

*Nonearning Assets*
Cash and due from banks		158,826								160,937								165,778
Bank premises and equipment		121,277								115,723								111,059
Investment security fair value adjustment		9,801								29,495								45,206
Other nonearning assets		269,471								267,609								255,348
Assets of discontinued operations		—								99,355								183,061
Allowance for loan losses		(119,925	)							(123,155	)							(118,922	)

Total assets	$	7,777,818							$	7,684,834							$	7,693,931

*Interest-Bearing Liabilities*
Deposits:
Interest-bearing demand		1,035,579			6,968		0.67			1,264,941			9,452		0.75			1,284,903			11,434		0.89
Savings deposits		1,505,604			22,197		1.47			1,397,290			10,862		0.78			1,281,175			8,633		0.67
Time deposits		1,814,154			55,989		3.09			1,716,919			43,075		2.51			2,060,515			60,701		2.95
Short-term borrowings		812,642			25,929		3.19			653,442			9,574		1.47			454,339			4,933		1.09
Long-term debt		938,478			36,417		3.88			936,050			33,618		3.59			861,704			31,310		3.63

Total interest-bearing liabilities		6,106,457			147,500		2.42			5,968,642			106,581		1.79			5,942,636			117,011		1.97

*Noninterest-Bearing Liabilities and Shareholders’ Equity*
Noninterest-bearing demand		931,053								898,520								851,722
Other liabilities		87,304								78,018								75,990
Liabilities of discontinued operations		—								100,023								191,523
Shareholders’ equity		653,004								639,631								632,060

Total liabilities and shareholders’ equity	$	7,777,818							$	7,684,834							$	7,693,931


*Net Interest Income*				$	275,749							$	271,698							$	280,705


*Interest Spread* ⁽⁵⁾							3.53	%							3.70	%							3.86	%
Contribution of noninterest bearing sources of funds							0.41								0.29								0.31

*Net Interest Margin* ⁽⁵⁾⁽⁶⁾							3.94	%							3.99	%							4.17	%


⁽¹⁾		Interest income is shown on an unadjusted basis and therefore does not include taxable equivalent adjustments.

⁽²⁾		Average rates include taxable equivalent adjustments to interest income of $13.4 million, $13.2 million, and $13.3 million for the years ended December 31, 2005, 2004, based on a 35% tax rate.

⁽³⁾		For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of discounts.

⁽⁴⁾		Nonaccrual loans are included in average balances.

⁽⁵⁾		The interest spread and net interest margin are presented on a tax-equivalent basis.

⁽⁶⁾		Because noninterest-bearing funding sources, demand deposits, other liabilities and shareholders’ equity also support earning assets, the net interest margin exceeds the interest spread.

Unless stated otherwise, average interest rates, net interest margin and net interest spread are presented in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” on a fully taxable equivalent basis. This presentation is customary in the banking industry because it permits comparability of yields on both taxable and tax-exempt sources of interest income.

Net interest income was $275.7 million in 2005, up from $271.7 million in 2004 and down from $280.7 million in 2003. The increase in net interest income in 2005 was attributable to a $203.5 million increase in average earning assets, as growth in the consumer and commercial loan portfolios outpaced the decline in the balance of investment securities. The increase in

earning assets was substantially offset by a five basis point decline in the net interest margin to 3.94% in 2005 compared with 3.99% in 2004. This decrease was due to shifts within the deposit portfolio from lower cost savings and transaction products to higher cost time deposits and continued pricing pressure on commercial loans, partially offset by the shift in asset mix from investment securities to higher yielding loans and growth in noninterest-bearing sources of funds.

The decrease in net interest income in 2004 was attributable to an 18 basis point decline in the net interest margin to 3.99% in 2004 compared with 4.17% in 2003. The net interest margin decline was due to declines in yields on assets outpacing declines in yields on liabilities. As intermediate and long-term rates remained low throughout 2004, fixed rate asset portfolio yields declined, pushing earning asset yields lower. Overall liability yields also declined, but at a slower pace as growth in the high rate savings product and increases in short-term borrowing costs partially offset yield declines in the remaining interest-bearing categories. Average earning assets increased $82.5 million year over year as increases in consumer loan and investment securities balances offset declines in commercial and mortgage loan balances.

Table 3 below shows changes in interest income, interest expense and net interest income due to volume and rate variances for major categories of earning assets and interest-bearing liabilities.

Table 3. Analysis of Changes in Interest Income and Interest Expense


	2005 Compared to 2004									2004 Compared to 2003 (Restated)
				Increase (Decrease)									Increase (Decrease)
Year Ended December 31	Net			Due to Change in						Net			Due to Change in
(in thousands)	Change⁽¹⁾			Rate ⁽²⁾			Volume⁽²⁾			Change⁽¹⁾			Rate ⁽²⁾			Volume⁽²⁾
*Interest Income:*
Money market investments	$	44		$	42		$	2		$	(93	)	$	(30	)	$	(63	)
Investment securities:
Taxable		(1,280	)		2,455			(3,735	)		850			(4,949	)		5,799
Tax-exempt		127			(264	)		391			538			(521	)		1,059
Mortgage loans held for sale		119			(12	)		131			(6,786	)		662			(7,448	)
Loans:
Commercial		17,506			15,938			1,568			(6,695	)		(287	)		(6,408	)
Commercial real estate		12,236			6,238			5,998			(9,921	)		(5,242	)		(4,679	)
Residential mortgage loans		657			(792	)		1,449			(4,082	)		(2,917	)		(1,165	)
Direct consumer		13,344			8,871			4,473			3,929			(7,737	)		11,666
Indirect consumer		2,217			(907	)		3,124			2,823			(4,452	)		7,275

Total portfolio loans		45,960			29,348			16,612			(13,946	)		(20,635	)		6,689

Total		44,970			31,569			13,401			(19,437	)		(25,473	)		6,036


*Interest Expense:*
Deposits:
Interest-bearing demand		(2,484	)		(865	)		(1,619	)		(1,982	)		(1,810	)		(172	)
Savings		11,335			10,435			900			2,229			1,393			836
Time		12,914			10,388			2,526			(17,626	)		(8,379	)		(9,247	)
Short-term borrowings		16,355			13,557			2,798			4,641			2,050			2,591
Long-term debt		2,799			2,714			85			2,308			(440	)		2,748

Total		40,919			36,229			4,690			(10,430	)		(7,186	)		(3,244	)

*Net Interest Income*	$	4,051		$	(4,660	)	$	8,711		$	(9,007	)	$	(18,287	)	$	9,280


⁽¹⁾		Changes are based on actual interest income and do not reflect taxable equivalent adjustments.

⁽²⁾		The change in interest not solely due to changes in volume or rates has been allocated in proportion to the absolute dollar amounts of the change in each.

2005 compared to 2004

The increase in net interest income of $4.1 million in 2005 compared with 2004 reflects rate variances which were unfavorable in the aggregate and volume variances which were favorable in the aggregate.

Organic loan growth in all consumer and commercial loan categories more than offset a decrease in investment portfolio balances, creating favorable volume variances. Unfavorable volume variances in the investment portfolio were the result of maturing balances not having been fully reinvested and the restructuring of the portfolio in the fourth quarter of 2005.

Favorable volume variances in interest-bearing demand partially offset unfavorable volume variances in the remaining liability categories. The variances were the result of customers migrating funds from lower yielding deposit products into higher yielding deposit categories in response to increases in short-term interest rates, and increases in short-term borrowing to fund loan growth.

Favorable rate variances on assets partially offset unfavorable rate variances on liabilities. Favorable rate variances on assets and unfavorable rate variances on liabilities were the result of increases in short and intermediate-term market rates. The unfavorable rate variances for tax-exempt investment securities, residential mortgage, and indirect consumer loans were the result of yields on maturing balances being higher than yields on new volume due to continued low long-term interest rates.

For 2006, Citizens anticipates net interest income will be slightly lower than 2005 as a result of anticipated margin compression and slightly lower investment portfolio balances.

2004 compared to 2003

The decrease in net interest income of $9.0 million in 2004 compared with 2003 reflects rate variances which were unfavorable in the aggregate which were not completely offset by volume variances which were favorable in the aggregate.

Favorable consumer loan and investment portfolio volume variances more than offset unfavorable volume variances in the remaining categories driven by declines in the outstanding balances of commercial, commercial real estate, and residential mortgage loans, and mortgage loans held for sale. The favorable investment portfolio volume variance was the result of the portfolio expansion program implemented in the first half of 2003. The unfavorable mortgage loans held for sale volume variance was the result of lower mortgage origination volumes in 2004.

Favorable volume variances on time deposits and interest-bearing demand were partially offset by unfavorable volume variances on savings, short-term borrowings, and long-term debt. The unfavorable variance on savings deposits was the result of deposit campaigns focused on growing core deposits. The favorable volume variance on time deposits resulted from customers shifting funds from time deposits into savings products.

Favorable rate variances on most liability categories partially offset rate variances on asset categories that were unfavorable in the aggregate as a result of the continuation of low intermediate and long-term interest rates. The favorable rate variance on long-term debt was the result of the prepayment of higher cost FHLB debt in August, 2004. Continued low intermediate-term rates and less aggressive pricing resulted in favorable rate variances for time deposits. Increases in short-term market rates drove the unfavorable rate variance on short-term borrowings, and the combination of short-term market rate increases and growth in promotional rate savings products resulted in the unfavorable rate variance on savings deposits.

NONINTEREST INCOME

An analysis of the components of noninterest income is presented in the table below. To provide more meaningful trend analysis certain significant transactions not normally incurred are presented separately.

Noninterest Income


	Year Ended December 31,								$ Change						% Change
(dollars in thousands)	2005			2004			2003		2005-2004			2004-2003			2005-2004			2004-2003
				(Restated)			(Restated)
Service charges on deposit accounts	$	35,409		$	34,618		$	29,074	$	791		$	5,544			2.3	%		19.1	%
Trust fees		18,445			17,854			17,527		591			327			3.3			1.9
Mortgage and other loan income		8,983			9,547			17,817		(564	)		(8,270	)		(5.9	)		(46.4	)
Brokerage and investment fees		7,803			7,710			7,375		93			335			1.2			4.5
ATM network user fees		4,355			3,361			3,384		994			(23	)		29.6			(0.7	)
Bankcard fees		3,804			3,415			3,008		389			407			11.4			13.5
Financial services		2,723			2,357			2,412		366			(55	)		15.5			(2.3	)
Investment securities gains (losses)		(8,927	)		(1,513	)		101		(7,414	)		(1,614	)	NM				—
Fair value change in CD swap derivatives		(3,604	)		—			—		(3,604	)		—			—		NM
Other		11,517			14,109			12,355		(2,592	)		1,754			(18.4	)		14.2

Total noninterest income	$	80,508		$	91,458		$	93,053	$	(10,950	)	$	(1,595	)		(12.0	)		(1.7	)

NM — Not meaningful

2005 compared to 2004

Noninterest income totaled $80.5 million, a decrease of $11.0 million or 12.0% from the same period of 2004. The variance from the prior year was primarily the result of a $9.0 million net loss on the sales of securities in the fourth quarter of 2005, a $3.6 million pre-tax charge associated with the accounting for swaps hedging brokered certificates of deposit, and lower mortgage, other loan income, and other income, partially offset by increased service charges on deposit accounts, trust fees, ATM network user fees, bankcard fees, and financial services. During the fourth quarter of 2005, Citizens incurred a $9.0 million net loss on the sale of securities as the result of restructuring the investment portfolio. The Corporation sold $322.4 million of investment securities and purchased $209.4 million of higher yielding securities. The remaining $104.0 million, after netting the $9.0 million loss, was used to pay down short-term borrowings. The Corporation also entered into a notional amount of $100.0 million in receive-fixed swaps. Including the impact of the swaps, this transaction shortened the duration of the investment portfolio, reduced option risk and will have a beneficial impact on net interest margin and net interest income. Also during the fourth quarter of 2005, Citizens incurred a pre-tax cumulative charge to non-interest income of $3.6 million as a result of determining that the swaps related to brokered certificates of deposit did not qualify for fair value hedge accounting treatment under the “short-cut” method of SFAS 133. In January 2006, Citizens modified the interest rate swaps related to brokered certificates of deposits to establish fair value hedge accounting treatment for future periods. Further discussion of this charge and subsequent changes in the swap portfolio is included in Note 19 to the Consolidated Financial Statements.

Some of the variance between 2005 and 2004 was the result of core banking activities. Mortgage and other loan income decreased as a result of lower mortgage origination in 2005 and lower letter of credit and home equity annual fees. The other income category decreased due to net gains of $1.7 million from the sale of former branch and other bank premises during 2004. Increases in ATM network user fees and bankcard fees were the result of higher customer activity over electronic delivery channels.

Excluding the effects of the fourth quarter of 2005 investment loss and the fair value change in CD swap derivatives, Citizens anticipates noninterest income levels in 2006 to be slightly higher than 2005 levels due to modest increases in most categories.

2004 compared to 2003

Noninterest income decreased $1.6 million in 2004 due to lower mortgage income and a net loss on the sale of investment securities, partially offset by increased service charges on deposit accounts, trust fees, bankcard fees, and other income. The decrease in mortgage and other loan income in 2004 reflected an $850.7 million decrease in closed mortgage loan volume as compared to 2003, due to the decreased refinance and wholesale activity. Citizens continues to sell most new production into the secondary market, so the decline in volume also affects servicing release premiums received at time of sale. The net loss on the sale of investment securities was the result of a $2.1 million impairment charge incurred in the second quarter of 2004. Citizens identified $74.9 million of securities that would be sold to offset the negative impact on interest rate risk and

liquidity risk resulting from the sale of the Illinois Bank. The securities were sold in the third quarter of 2004 and a recovery of $0.5 million partially offset the impairment charge. The increase in service charges on deposit accounts was the result of initiatives implemented over the last six quarters to improve fee waiver management and was also attributable to slight increases in certain fees. Bankcard fees increased as a result of higher customer activity over electronic delivery channels. Other noninterest income increased in 2004 as a result of the profit on the sale of closed bank premises of $1.7 million and a distribution of $0.8 million received in the third quarter of 2004 related to venture capital investments made in prior years, in a limited partnership pursuing early stage investment opportunities in technology driven businesses located in the Midwest region of the United States.

NONINTEREST EXPENSE

An analysis of the components of noninterest expense is presented in the table below. In order to provide more meaningful trend analysis, special and certain other significant charges are presented separately.

Noninterest Expense


	Year Ended December 31,						$ Change						% Change
(dollars in thousands)	2005		2004		2003		2005-2004			2004-2003			2005-2004			2004-2003
			(Restated)		(Restated)
Salaries and employee benefits	$	132,153	$	127,958	$	120,538	$	4,195		$	7,420			3.3	%		6.2	%
Occupancy		22,131		19,865		17,865		2,266			2,000			11.4			11.2
Professional services		17,279		16,095		17,307		1,184			(1,212	)		7.4			(7.0	)
Equipment		14,634		14,252		16,222		382			(1,970	)		2.7			(12.1	)
Data processing services		13,800		13,131		12,513		669			618			5.1			4.9
Advertising and public relations		7,853		9,126		5,663		(1,273	)		3,463			(13.9	)		61.2
Postage and delivery		6,213		6,411		6,711		(198	)		(300	)		(3.1	)		(4.5	)
Telephone		5,481		5,940		4,704		(459	)		1,236			(7.7	)		26.3
Other loan expenses		2,655		3,964		4,758		(1,309	)		(794	)		(33.0	)		(16.7	)
Stationery and supplies		3,091		3,707		3,444		(616	)		263			(16.6	)		7.6
Intangible asset amortization		2,899		2,899		2,899		—			—			—			—
Prepayment penalty on FHLB advances		—		17,959		—		(17,959	)		17,959			(100.0	)		100.0
Other		14,853		18,971		16,242		(4,118	)		2,729			(21.7	)		16.8

Total noninterest expense	$	243,042	$	260,278	$	228,866	$	(17,236	)	$	31,412			(6.6	)		13.7

2005 compared to 2004

Noninterest expense totaled $243.0 million, a decrease of $17.2 million or 6.6% from the same period of 2004. This decrease was the result of the $18.0 million prepayment penalty on high cost FHLB debt incurred in the third quarter of 2004 and declines in advertising and public relations, other loan expenses, and in other expenses, partially offset by increases in salaries and employee benefits, occupancy, and professional services.

Salaries and employee benefits increased over 2004 due to higher incentive payouts, higher employee benefit costs related to pension and insurance expenses, and personnel increases in Citizens’ Southeast Michigan market, partially offset by a decrease in postretirement benefits for the Corporation. The Corporation accelerated the vesting of certain non-vested stock options during 2005 and 2004. The purpose of the vesting acceleration was to reduce compensation expense associated with these options in future periods. As a result of these accelerations, the Corporation recognized $0.1 million and $0.3 million in expense during 2005 and 2004, respectively. The expense related to those options that were accelerated, that would have occurred after the adoption of SFAS 123R, and will not be recognized as a result of the change, would have been $2.9 million in 2006, $2.5 million in 2007, $1.6 million in 2008 and $0.3 million in 2009. For further discussion of stock-based compensation, see Note 2 to the Consolidated Financial Statements.

Occupancy costs increased over 2004 due to rent and depreciation expenses related to the new branches and regional hubs opened in Southeast Michigan throughout 2004 and 2005 and the Michigan and Wisconsin re-branding projects. Professional services increased as a result of $2.3 million in consulting fees associated with several initiatives targeted at developing corporate strategies to produce enhanced profitability and revenue momentum, enhancing overall corporate risk

management, ensuring accounting and regulatory compliance, and enhancing information technology practices. Equipment costs increased over 2004 due to $1.5 million in additional depreciation during the second quarter of 2005 as a result of aligning the service life for these items with the current capitalization policy, partially offset by decreases in equipment maintenance and software maintenance. Advertising and public relations expenses decreased as the result of reduced advertising and marketing expenses associated with the Southeast Michigan initiative, partially offset by a fourth quarter 2005 deposit generation campaign. Other loan expenses decreased as a result of lower consumer loan volumes and process improvements implemented in the consumer loan processing department during the third quarter of 2004. The other expense category decreased as a result of certain tax related reconciliation items incurred in the third quarter of 2004 and a fourth quarter 2004 litigation settlement payment.

Citizens anticipates noninterest expense for 2006 to be consistent with 2005 experience.

2004 compared to 2003

Noninterest expense increased $31.4 million, or 13.7%, in 2004 reflecting the impact of the prepayment penalty on the FHLB debt and higher costs as a result of the Southeast Michigan initiative. Also contributing were increases in salaries and employee benefits, occupancy expense, advertising and public relations and telephone expense. These increases were partially offset by reductions in professional services, equipment expense and other loan fees.

Salaries and employee benefits increased due to the Southeast Michigan initiative and filling key staff positions in late 2003 and higher pension and medical expenses. Normal salary merit increases were partially offset by a reduction in staffing levels. Citizens had 2,215 full-time equivalent employees at December 31, 2004, down from 2,310 (excluding Illinois Bank employees) at December 31, 2003. The increase in pension expense in 2004 was due to a decrease in the expected return on assets in 2004 compared to 2003 and an increase in the amortization of unrealized net actuarial losses.

Occupancy expense increased in 2004 as a result of $0.9 million in costs related to the opening of new branches and two regional hubs in Oakland County and, to a lesser extent, higher building repair and maintenance costs.

Professional services decreased in 2004 as a result of lower executive recruiting and relocation costs and a decline in costs associated with banking industry consultants, partially offset by higher costs related to new internal control evaluation procedures to comply with Section 404 of the Sarbanes-Oxley Act.

Equipment related costs decreased in 2004 due to lower depreciation and amortization expense on equipment and software and the reclassification of data transmission costs from equipment expense to telephone expense in connection with a new services contract. These decreases were partially offset by increases in noncapitalized equipment purchases as a result of changes to Citizens’ capitalization policy in 2004.

Data processing services were up in 2004 compared to 2003 due to higher processing costs following the fourth quarter 2003 implementation of the new trust and investment accounting systems, partially offset by reduced processing costs on Citizens’ core loan and deposit systems.

Advertising and public relations expenses increased in 2004 as a result of advertising to support Citizens’ Oakland County initiative, deposit-focused promotions and the new brand introduction in the remaining locations in Michigan.

Other loan fee expense decreased in 2004 due to lower mortgage loan expenses as a result of lower mortgage origination volume and process efficiencies resulting in lower title fee expense.

Other noninterest expense increased in 2004 due to higher expenses for travel and training, certain tax related reconciliation items identified during the year, and losses from litigation settlements. Partially offsetting these increases were lower service fees due to implementation costs associated with strategic alliances with SEI Investments, EnvestnetPMC, Inc., and EPIC Advisors, Inc., which commenced in 2003. Additionally, other real estate expenses decreased $1.3 million due to reduced losses on property sales and lower carrying costs on properties under management.

FEDERAL AND STATE INCOME TAXES

Citizens recorded income tax expense of $31.6 million in 2005 compared to income tax expense of $19.6 million in 2004 and $18.4 million in 2003. The effective tax rate, computed by dividing the provision for income taxes by income before taxes, was 28.17% in 2005, compared to 24.11% in 2004 and 22.17% in 2003. The effective tax rate is lower than the statutory tax

rate due to tax-exempt interest income and, to a lesser extent, other permanent income tax differences. Citizens’ effective tax rate increased in 2005 compared to 2004 due to a $1.3 million ($0.8 million after-tax) reduction in the deferred Wisconsin state income tax asset and higher income taxes in other states. Citizens’ effective tax rate increased in 2004 compared to 2003 due to a reduction in tax-exempt income and an increase in permanent unfavorable differences.

Citizens anticipates that the effective income tax rate for 2006 will be slightly lower than the rate for 2005.

LINE OF BUSINESS RESULTS

Net income by line of business is presented in the table below. A description of each business line, important financial performance data and the methodologies used to measure financial performance are presented in Note 21 to the Consolidated Financial Statements.


	Net Income
(in thousands)	2005			2004			2003
				(Restated)			(Restated)
Commercial Banking	$	43,840		$	34,141		$	18,664
Consumer Banking		39,762			33,102			32,653
Wealth Management		2,165			1,028			227
Other		(5,242	)		(6,592	)		12,965

Income from continuing operations		80,525			61,679			64,509
Income from discontinued operations		—			14,418			1,442

Net income	$	80,525		$	76,097		$	65,951

2005 compared to 2004

Commercial Banking net income increased to $43.8 million in 2005 from $34.1 million in 2004. The increase in net income was due to an increase in net interest income and a decrease in the provision for loan losses, partially offset by lower noninterest income and higher noninterest expenses. The loan loss provision declined by $14.0 million due to a reduction in the level of net charge-offs primarily as a result of the $9.1 million insurance settlement and continued improvement in the overall risk of the commercial loan portfolio. Net interest income increased $6.0 million as a result of higher average commercial loan balances due to continued strong growth in the Southeast Michigan market, increased focus on the sales management process, and several new relationships in key Michigan and Wisconsin markets, which were partially offset by continued reduction of exposure on credits not meeting Citizens’ risk parameters, including the third quarter 2005 nonperforming loan sale, and normal competitive pressures. Higher average time deposit balances from municipalities and higher spreads on demand deposits due to the rising rate environment also contributed to the increase in net interest income. Noninterest income declined $0.8 million due to lower deposit service charges due to the rising rate environment, which resulted in higher customer earnings credits against commercial deposit service charges based on commercial deposit balances, and a change in procedures for recording letter of credit fees. Noninterest expense increased $4.2 million due to higher incentive compensation, and personnel increases in Citizens’ Southeast Michigan market. These increases were partially offset by lower professional services expense.

Consumer Banking net income increased to $39.8 million in 2005 from $33.1 million in 2004. The increase in net income was due to a decrease in the provision for loan losses and noninterest expense and an increase in net interest income, partially offset by a decline in noninterest income. The loan loss provision decreased by $6.6 million due to lower provision for losses due to portfolio growth in lower risk products, a continued conscientious focus on the underwriting process, and a reserve reduction of $1.5 million related to a previous mortgage recourse transaction. Noninterest expense for 2004, decreased by $2.8 million as a result of lower salary and incentive related compensation expense, and lower advertising and public relations expenses. Net interest income increased by $1.6 million as a result of increased spreads on consumer deposit products partially offset by spread compression in the consumer loan portfolio. Total noninterest income decreased by $0.8 million as a result of lower brokerage and mortgage related fee income, and net gains related to the sale of branch properties that occurred in 2004, these decreases were partially offset by higher deposit service charge income.

Wealth Management net income increased to $2.2 million in 2005 from $1.0 million in 2004. The increase in net income was due to increases in net interest income and noninterest income. Net interest income increased by $0.2 million due to an

increase in private banking loans and deposits. Noninterest income increased by $1.5 million as a result of higher trust fees, brokerage fees, a performance-related penalty of $0.3 million received from a third party vendor, and a full-year of third party vendor fees. These increases were partially offset by the gain on the reorganization of the Golden Oak Funds and a litigation settlement in 2004. Trust fees increased due to stronger financial markets, continued execution of the sales management process and improved pricing discipline, partially offset by attrition. Trust assets under administration were $2.5 billion at December 31, 2005 compared to $2.7 billion at December 31, 2004. The decline in trust assets was due to the reduction of an institutional relationship and the exit of custody assets during 2005. The effect of these exits was partially offset by stronger financial markets at December 31, 2005 and continued growth in personal investment management assets. Brokerage income increased due to more business being referred to financial consultants in Wealth Management from licensed personal bankers in Consumer Banking.

Activities that are not directly attributable to one of the above are included in the Other business line. Included in this category are the Holding Company; Citizens’ Treasury unit, including the securities portfolio, short-term borrowing and asset/liability management activities; inter-company eliminations; and the economic impact of certain assets, capital and support functions not specifically identifiable with the three primary lines of business. The Other business line net income increased $1.4 million resulting in a net loss of $5.2 million in 2005 compared to a net loss of $6.6 million in 2004. The increase in net income was due to lower noninterest expense, partially offset by lower net interest income and lower noninterest income. Noninterest expense decreased by $18.5 million, due largely to the $18.0 million prepayment penalty associated with the retirement of high cost FHLB advances that was incurred in the third quarter of 2004. Net interest income decreased by $3.6 million as a result of the internal profitability methodology utilized at Citizens, which insulates the other lines of business from interest-rate risk and assigns the risk to the asset/liability management function, which is a component of this segment. Noninterest income decreased by $10.9 million as a result of the $9.0 million net loss on the sale of securities and the $3.6 million charge associated with the accounting treatment of swaps hedging brokered CDs, both of which occurred in the fourth quarter of 2005.

2004 compared to 2003

Commercial Banking net income increased to $34.1 million in 2004 from $18.7 million in 2003. The increase in net income was due to a decrease in the provision for loan losses, partially offset by declines in net interest income and noninterest income and higher noninterest expenses. The loan loss provision decreased by $38.7 million in 2004 as a result of lower net charge-offs, fewer commercial loan risk-rating downgrades and improved nonperforming asset levels. Net interest income decreased by $5.8 million as a result of lower average commercial loan balances due to reduced demand for commercial credit, high repayment activity and continued reduction of exposure on credits not meeting Citizens’ risk parameters. The decline in loans occurred in most markets with the exception of Southeast Michigan, which experienced strong growth. Noninterest income declined by $0.9 million in 2004 as a result of lower deposit service charges and cash management fees as certain commercial account relationships were transferred from Commercial Banking to Consumer Banking beginning in the second quarter of 2003, based upon the client’s assigned officer. Noninterest expense increased by $9.5 million in 2004 due to higher staff compensation expense as a result of an increase in commercial banking staff, lower deferred origination-related compensation and higher recruiting-related incentives in Southeast Michigan and other markets, and a change in the methodology used to allocate intercompany operational costs, partially offset by decreases in loan fees and expenses related to maintaining repossessed commercial real estate.

Consumer Banking net income was relatively unchanged at $33.1 million in 2004 as compared to $32.7 million in 2003. During 2004 declines in net interest income and noninterest income and increases in noninterest expense were largely offset by declines in loan loss provision expense. Total net interest income was lower by $0.5 million as a result of declines in the mortgage loan and the held for sale portfolios which were partially offset by strong growth in the home equity and indirect loan portfolios. Non-interest income declined by $1.5 million due to lower mortgage income resulting from lower refinance activity, partially offset by increased deposit service charges and net gains related to the sale of branch properties. Noninterest expense increased by $1.6 million as a result of higher advertising and public relations costs, partially offset by lower staff compensation expense due to improved efficiency levels in the branches, and lower equipment costs. The provision for loan losses decreased by $1.7 million as a result of a lower provision for losses on the wholesale mortgage business which was partially offset by higher provision for the growth in home equity loans.

Wealth Management net income increased to $1.0 million in 2004 compared to $0.2 million in 2003. The increase in net income was due to increases in net interest income and noninterest income, partially offset by higher noninterest expenses. Net interest income increased by $0.5 million as a result of certain account relationships that were transferred from Commercial Banking and Consumer Banking to Wealth Management during 2004 based upon the client’s assigned officer.

Noninterest income increased by $1.2 million as a result of higher trust and brokerage fees related to stronger financial markets, successful brokerage sales campaigns, and Citizens new sales management process implemented during the first quarter of 2004. Furthermore, 2004 noninterest income included a gain from the reorganization of the Golden Oak Funds, a partial year of third party vendor fees, and a litigation settlement. Total trust assets under administration were $2.7 billion at December 31, 2004 compared to $2.9 billion at December 31, 2003. The decline in trust assets was due to the reduction of a large institutional relationship and a large custody account. Total noninterest expenses increased $0.4 million due to higher incentive-based compensation, and higher data processing costs as a result of the strategic alliances with SEI Investments, EnvestnetPMC, Inc., and EPIC Advisors, Inc., and a change in the methodology used to allocate intercompany operational costs. These increases were partially offset by decreases in salaries, equipment, and professional services related to the prior trust and investment accounting systems and operations, 2003 implementation costs associated with the new alliances, and a decline in losses related to a lawsuit settled in 2003.

The Other business line recorded a net loss of $6.6 million in 2004 compared to net income of $13.0 million in 2003, a decrease of $19.6 million. The decline in net income was the result of lower net interest income and lower noninterest income and higher noninterest expense. Net interest income declined by $3.2 million as a result of the internal profitability methodology utilized at Citizens, which insulates the other lines of business from interest-rate risk and assigns the risk to the asset/liability management function, which is a component of this segment. During 2004, noninterest expense increased by $20.6 million as a result of increases in employee benefits expense, reconciliation items including certain tax related items and the $18.0 million prepayment penalty associated with the retirement of high cost FHLB advances. Noninterest income decreased in 2004 by $0.4 million as a result of slightly higher losses on the sale of securities, partially offset by gains on the sale of vacant bank properties.

SUBSEQUENT EVENTS

Strategic Business Alliances for the Mortgage Operations, Secondary Marketing and Title Services Functions
On March 10, 2006, Citizens determined to form strategic business alliances for its mortgage operations, secondary marketing and title services functions. Citizens believes that these alliances will significantly increase its access to technology, improve its ability to originate loans by making more sales channels available, and eliminate certain fixed costs associated with maintaining the infrastructure of the title services function.

Citizens expects to fully implement the strategic business alliance concerning the mortgage operations and secondary marketing functions by the end of June 2006 and the title services function by the end of September 2006. In connection with this initiative, Citizens expects to reduce its workforce by 27 employees (approximately 1.2% of its workforce). This headcount reduction is anticipated to result in approximately $0.4 million in severance related costs. Citizens anticipates additional charges in 2006 of $0.3 million related to this restructuring.

The following table sets forth a summary of estimated costs to implement the above strategy by major category (in millions):


	Estimate of Charges – 2006
	First		Second		Third		Fourth
Major Cost Category	Quarter		Quarter		Quarter		Quarter		Total
Employee Separation	$	0.2	$	0.2		-0-		-0-	$	0.4
Other		-0-		-0-	$	0.1	$	0.2	$	0.3

Total	$	0.2	$	0.2	$	0.1	$	0.2	$	0.7

Citizens expects these charges will result in future cash expenditures of $0.7 million through 2007.

Consolidation of the Consumer and Commercial Loan Operations Functions
On March 10, 2006, Citizens determined to consolidate its consumer and commercial loan operations into a functional, centrally located operation. Citizens believes that the consolidation of these operations will improve workflows between the consumer and commercial loan operations, enhance management and employee productivity and efficiency, improve standardization and specialization, and serve as a more efficient means of deploying best practices.

Citizens expects to begin the consolidation process immediately, with full implementation by the end of the second quarter of 2006. In connection with this consolidation, Citizens expects to reduce its workforce by 17 employees (approximately 1.0% of its workforce) and will consolidate the loan operations function centrally at its Flint, Michigan headquarters. This headcount reduction is anticipated to result in approximately $0.4 million in severance related costs. Citizens anticipates additional charges in 2006 of $0.2 million related to the implementation of process improvement measures and technology enhancements as well as other restructuring activities.

The following table sets forth a summary of estimated costs of the consolidation by major category (in millions):


	Estimate of Charges – 2006
	First		Second		Third		Fourth
Major Cost Category	Quarter		Quarter		Quarter		Quarter		Total
Employee Separation	$	0.2	$	0.1		-0-	$	0.1	$	0.4
Other	$	0.1	$	0.1		-0-		-0-	$	0.2

Total	$	0.3	$	0.2		-0-	$	0.1	$	0.6

The Company expects these charges will result in future cash expenditures of $0.6 million through 2007.

FINANCIAL CONDITION

SUMMARY

The following table summarizes various indicators of Citizens’ financial condition for 2005, 2004 and 2003.


	2005			2004			2003

				(Restated)			(Restated)
Average total assets (in millions)	$	7,777.8		$	7,585.5		$	7,510.9
Average short term borrowings (in millions)		812.6			653.4			454.3
Average long term debt (in millions)		938.5			936.0			861.7
Average earning assets as a percent of average assets		94.5	%		94.4	%		94.5	%
Average investment securities and money market investments as a percent of average earning assets		24.8			26.8			25.2
Average portfolio loans as a percent of average earning assets		74.8			72.7			72.4
Interest-bearing deposits as a percent of average interest-bearing liabilities		71.3			73.4			77.9
Ratio of average noninterest bearing deposits to average deposits		17.6			17.0			15.5

These items are discussed in more detail below.

AVERAGE TOTAL ASSETS

Average total assets for 2005 increased $192.3 million or 2.5% to $7.8 billion as growth in all loan portfolios was offset by a decline in taxable investment securities.

INVESTMENT SECURITIES AND MONEY MARKET INVESTMENTS

Objectives in managing the securities portfolio are driven by the dynamics of the balance sheet, including growth, maturity, management of interest-rate risk and maximizing return. Securities are classified as available for sale or held to maturity. As of December 31, 2005, 91.6% of securities were classified as available for sale.

A summary of investment securities balances at December 31, 2005, 2004 and 2003 is provided below:


*Investment Securities*
December 31 (in thousands)	2005		2004		2003

					(Restated)
Available for Sale:
U.S. Treasury	$	—	$	—	$	—
Federal agencies
Mortgage-backed		811,898		1,056,208		1,130,696
Other agencies		310,408		291,991		256,727
State and municipal
Taxable		5,107		4,698		7,948
Tax-exempt		373,128		391,180		419,973
Mortgage and asset-backed		280		2,669		4,099
Other securities		1,176		388		6,021

Total	$	1,501,997	$	1,747,134	$	1,825,464


Held to Maturity:
State and municipal — tax exempt	$	82,431	$	54,035	$	19,857


Other Investments:
FHLB and Federal Reserve stock	$	55,911	$	67,390	$	64,884


Total Investments	$	1,640,339	$	1,868,559	$	1,910,205

Total investment securities decreased $228.2 million in 2005 after decreasing $41.6 million in 2004. Available for sale securities decreased $245.1 million or 14.0% in 2005. This compares with a decrease of $78.3 million or 4.3% in 2004. Agency-issued mortgage-backed securities decreased $244.3 million or 23.1% compared to a decrease of $74.5 million or 6.6% in 2004. Other agency-issued securities increased $18.4 million in 2005 or 6.3% compared to a $35.3 million increase or 13.7% in 2004. The overall decrease in available for sale securities has been a result of maturities, pre-payment of principal, sale of securities and the sale of the Illinois bank.

Citizens sold $322.4 million of securities in the fourth quarter of 2005 comprised of all callable agency, 10 year mortgage-backed, and hybrid-ARM mortgage-backed securities held by the Corporation. The primary objectives of the transaction were to shorten the duration of the investment portfolio, reduce prepayment option risk and improve liquidity by reducing short-term borrowings. The decision to sell securities was based on changes in Citizens’ asset/liability position resulting from increases in intermediate and long-term interest rates prior to the sales and recent declines in core deposit balances. Citizens used $209.4 million of the sale proceeds to purchase securities with shorter duration and no exposure to prepayment option risk. The remaining $104.0 million, after netting the $9.0 million loss, was used to reduce short-term borrowings.

Citizens had determined to sell $74.9 million of securities in the second quarter of 2004. The sale of securities was to offset the negative impact on interest rate risk and liquidity risk expected to result from the impending sale of Citizens Bank-Illinois, N.A. Since the fair values of the securities were below amortized cost, an impairment charge of $2.1 million was recognized in the second quarter of 2004. A recovery of $0.5 million partially offset the impairment charge when the securities were sold in the third quarter of 2004.

Purchases of municipal securities remain dependent on Citizens’ capacity to utilize tax-exempt income. Municipal securities increased $10.8 million or 2.4% in 2005, compared to an increase of $2.1 million or 0.5% in 2004.

Other securities increased $0.8 million in 2005 versus a $5.6 million decrease in 2004.

Other investments in Federal Reserve Bank and Federal Home Loan Bank stocks decreased $11.5 million in 2005 compared to an increase of $2.5 million in 2004. The decrease is a result of Federal Home Loan Bank stock having been redeemed, due to the merger of F&M Wisconsin into Citizens Bank in April 2005.

Money market investments are comprised of federal funds sold and government money market funds. Money market investments decreased $1.4 million in 2005 versus a decrease of $0.3 million in 2004. Funds invested in these assets are adjusted from time to time based on liquidity needs and asset/liability and investment objectives.

Maturities and average yields of investment securities at December 31, 2005 are presented in Table 4 below.

Table 4. Maturities and Average Yields of Securities At December 31, 2005


	U.S. Treasury and
	Federal Agency⁽¹⁾								State and Municipal^{(1), (2)}										Other⁽¹⁾								Total⁽⁴⁾
	Amortized		Fair						Amortized		Fair						Amortized		Fair						Amortized		Fair
(in thousands)	Cost		Value			Yield			Cost		Value			Yield			Cost		Value			Yield			Cost		Value			Yield

*Available for Sale:*
Due within one year	$	315,926	$	314,688			4.64	%	$	26,933	$	27,072			7.92	%	$	1,072	$	1,072			4.17	%	$	343,931	$	342,832			4.90	%
One to five years		702,145		691,592			4.62			124,791		130,467			7.92			3		4			5.88			826,939		822,063			5.12
Five to ten years		92,583		91,213			4.73			125,007		130,218			7.36			—		—			0.00			217,590		221,431			6.24
After ten years		24,960		24,813			4.98			88,122		90,478			6.81			277		380			5.80			113,359		115,671			6.40


		1,135,614		1,122,306			4.64			364,853		378,235			7.46			1,352		1,456			4.51		$	1,501,819	$	1,501,997			5.33


Average maturity⁽³⁾			3.20		yrs.						6.73		yrs.						3.06		yrs.						4.06		yrs.

*Held to Maturity:*
Due within one year									$	—	$	—			0.00	%									$	—	$	—			0.00	%
One to five years										—		—			0.00											—		—			0.00
Five to ten years										2,008		1,662			5.52											2,008		1,662			5.52
After ten years										80,423		80,702			6.25											80,423		80,702			6.25

										82,431		82,364			6.23											82,431		82,364			6.23


Average maturity⁽³⁾											13.25		yrs.															13.25	yrs.


⁽¹⁾		Maturities for collateralized mortgage obligations, mortgage-backed securities, and asset-backed securities are based upon a weighted average life basis. Maturities for state and municipal securities incorporate early call features, if applicable. Non-mortgage Federal Agency securities are based upon stated contractual maturity.

⁽²⁾		Yields are based on amortized cost and for state and municipal securities are calculated on a tax equivalent basis using a 35% tax rate.

⁽³⁾		Average maturity information excludes holdings of corporate stocks with no stated maturity.

⁽⁴⁾		This table excludes stock holdings of the Federal Home Loan Bank and Federal Reserve.

As of December 31, 2005, the estimated aggregate fair value of the investment securities portfolio was $0.1 million above amortized cost, consisting of gross unrealized gains of $18.1 million and gross unrealized losses of $18.0 million. A summary of estimated fair values and unrealized gains and losses for the major components of the investment securities portfolio is provided in Note 6 to the Consolidated Financial Statements. Citizens’ policies with respect to the classification of investments in debt and equity securities are discussed in Note 2 to the Consolidated Financial Statements.

LOAN PORTFOLIO

Citizens extends credit within the local markets of its banking subsidiaries located in Michigan, Wisconsin and Iowa. Citizens generally lends to consumers and small to mid-sized businesses and, consistent with its emphasis on relationship banking, most of these credits represent core, multi-relationship customers who also maintain deposit relationships and utilize other banking services such as treasury management. The loan portfolio is diversified by borrower and industry with no concentration within a single industry that exceeds 10% of total loans. Citizens has minimal loans to foreign debtors and does not actively solicit nationally syndicated loans or participate in highly leveraged transactions. Citizens seeks to limit its credit risk by establishing guidelines to review the aggregate outstanding commitments and loans to particular borrowers and industries. Citizens obtains and monitors collateral based on the nature of the credit and the risk assessment of the customer.

Portfolio Loans

Loan balances by category for the past five years and an analysis of the maturity and interest rate sensitivity of commercial, commercial real estate, and real estate construction loans at December 31, 2005 are presented below.

Table 5. Portfolio Loans ⁽¹⁾


(in millions)	2005		2004		2003		2002		2001

					(Restated)		(Restated)		(Restated)
*Portfolio Loans Outstanding at December 31*
Commercial	$	1,688.1	$	1,633.8	$	1,645.4	$	1,848.1	$	1,949.2
Commercial real estate		1,190.4		1,153.0		1,194.2		1,212.3		1,230.5
Real estate construction		211.7		102.9		89.9		168.4		132.2
Residential mortgage loans		539.8		508.2		492.7		622.2		889.7
Direct consumer		1,142.0		1,169.6		998.3		835.7		794.7
Indirect consumer		844.1		825.9		743.9		656.0		673.5

Total	$	5,616.1	$	5,393.4	$	5,164.4	$	5,342.7	$	5,669.8

Portfolio Loan Maturities and Interest Rate Sensitivity at December 31, 2005


	Within		One to		After
	One Year		Five Years		Five Years		Total

Commercial	$	921.7	$	666.6	$	99.8	$	1,688.1
Commercial real estate		248.5		885.1		56.8		1,190.4
Real estate construction		100.8		100.3		10.6		211.7

Total	$	1,271.0	$	1,652.0	$	167.2	$	3,090.2


Loans above:
With floating interest rates	$	907.2	$	665.0	$	96.2	$	1,668.4
With predetermined interest rates		363.8		987.0		71.0		1,421.8

Total	$	1,271.0	$	1,652.0	$	167.2	$	3,090.2


⁽¹⁾		Excludes mortgage loans held for sale

The 4.1% increase in total portfolio loans during 2005 was a result of increases in all loan categories except direct consumer, which declined as a result of weak consumer demand. The 2004 loan growth was primarily a result of increases in home equity and indirect consumer loans, which more than offset declines in commercial and commercial real estate loans. The decreases in total portfolio loans in 2003, 2002 and 2001 reflect declining commercial loan and residential mortgage loan balances, partially offset by growth in consumer loans. On an average basis, portfolio loans comprised 74.8% of total average earning assets during 2005, compared to 73.0% in 2004 and 72.4% in 2003.

Loan Origination/ Risk Management. Extending credit to businesses and consumers exposes the Corporation to credit risk which is the risk that the principal balance of a loan and any related interest will not be collected due to the inability or unwillingness of the borrower to repay the loan. The Corporation has a platform of lending policies and underwriting guidelines that are designed to maximize loan income within an acceptable level of risk. Credit risk is mitigated through the establishment of a comprehensive system of internal controls, which includes adherence to conservative lending practices, underwriting guidelines, collateral monitoring, and surveillance and evaluation by an independent internal loan review staff of the quality, trends, collectibility and collateral margins within the loan portfolio. Lending policies and guidelines are reviewed and modified on an ongoing basis as conditions change and new credit products are offered. Commercial and commercial real estate credit administration policies include a loan rating system that is validated by the internal loan review staff who verify credit ratings by sampling loans based upon select criteria, including loan size, delinquency status, loan officer coverage and other factors. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potentially problematic loans. Account officers are vested with the responsibility of monitoring their customers’ financial condition and initiating changes in the loan ratings on credits. In an ongoing effort to strengthen and monitor loan structuring and collateral position, collateral field audits are regularly performed on those credits that have a significant reliance on accounts receivable and inventory. Loans that have migrated within the loan rating system to a level that requires remediation are actively reviewed by senior management at quarterly meetings with the credit risk management staff and market account officers. At these meetings, action plans are developed to either remediate any emerging problem loans or

develop a specific plan for removing such loans from the portfolio. Credit risk associated with fluctuations in economic conditions is mitigated through portfolio diversification that limits exposure to any single industry or customer.

The Corporation maintains an independent loan review department that reviews and validates the credit risk profile on a regular basis. Results of these reviews are presented to management and to the Risk Committee of the Board of Directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel.

Commercial. The commercial loan category includes a diverse group of loans largely to in-market small business (less than $0.55 million) and lower-middle market ($0.5 to $5.0 million) companies in a variety of businesses across many industries. The purpose of these loans varies from supporting seasonal working capital needs to term financing of equipment purchases. While some short-term loans may be made on an unsecured basis, the large majority are secured by the assets being financed with collateral margins consistent with the Corporation’s loan underwriting guidelines. Commercial loans are evaluated for adequacy of repayment sources at the time of approval and are regularly reviewed for any possible deterioration in the ability of the borrower to repay on agreed terms. Credit risk in commercial loans arises due to fluctuations in borrowers’ financial condition, deterioration in collateral values, and changes in market conditions. Commercial loans at December 31, 2005 were higher than December 31, 2004 by $54.4 million or 3.3% due to higher demand for commercial credit in several of Citizens’ markets.

Commercial loans are underwritten after evaluating and understanding the borrower’s financial need and ability to repay any loans on a basis and within a timetable that makes sense for both the borrower and Citizens. Having determined that the borrower’s management possesses a sound business acumen, the Corporation’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Underwriting guidelines are designed to promote ongoing relationship banking which allows both the customer and the Corporation to make changes commensurate with current economic and performance results.

Commercial Real Estate. The majority of this portfolio consists of commercial real estate intermediate-term loans, to developers and owners of commercial real estate, for single and multiple family residential as well as multi-unit commercial properties. The Corporation’s primary focus for the commercial real estate portfolio has been growth in loans secured by owner-occupied properties. These loans are viewed first as cash-flow loans and secondarily as loans secured by real estate. Commercial real estate loans at December 31, 2005 were higher than December 31, 2004, by $37.4 million or 3.2% due to increased demand in many markets.

Commercial real estate loans are subject to underwriting standards and processes specific to the risks embedded in each of the geographic markets served by Citizens. As detailed in the discussion of real estate construction loans below, the properties securing the Corporation’s commercial real estate portfolio are diverse in both type and geographic location. This diversity reduces the Corporation’s exposure to adverse economic events that impact any individual market. Management monitors commercial real estate loans based on sustainable cash flow, collateral, geography, and risk rating criteria. As a general rule, the Corporation avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied “investment” real estate loans. At December 31, 2005, approximately 53% of the Corporation’s commercial real estate loans were secured by owner-occupied properties.

Real Estate Construction. Loans in this classification are short-term interim loans that provide financing for the acquisition or development of commercial real estate, such as multifamily or other commercial development projects. Real estate construction loans are made to developers and project managers who are well known to the Corporation, have prior successful project experience, and are well-capitalized. Projects undertaken by these developers are carefully reviewed by the Corporation to ensure that they are economically viable. Loans of this type are generally made to customers based in the Corporation’s markets in which the Corporation has a thorough knowledge of the local market economy. The credit risk associated with real estate construction loans is generally confined to specific geographic areas, but is also influenced by general economic conditions. The Corporation controls the credit risk on these types of loans by making loans in familiar markets to developers, underwriting the loans to meet the requirements of institutional investors in the secondary market, reviewing the merits of individual projects, controlling loan structure, and monitoring project progress and construction advances. These loans are typically refinanced at construction completion, as either income-producing investment or owner-occupied properties. Real estate construction loans increased 105.7% to $211.7 million at December 31, 2005. The increase in 2005 was a result of organic growth.

From time to time, the Corporation may originate loans to developers and builders secured by non-owner occupied investment properties. In such cases, the Corporation generally requires the borrower to have a proven record of success and to meet Citizens’ underwriting criteria for this type of credit risk. Real estate construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates, and financial analysis of the developers and property owners. Sources of repayment for these types of loans may be pre-committed permanent take out loans from long-term lenders, sales of developed property or an interim loan commitment from the Corporation until permanent financing is obtained. These loans are closely monitored through on-site inspections during construction, and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, general economic conditions, absorption dynamics, and the availability of long-term financing.

Residential Mortgage Loans. The residential mortgage loan category is predominately comprised of owner-occupied residential properties. Residential mortgage loans are evaluated for the adequacy of these repayment sources at the time of approval, including credit scores, debt-to-income ratios and loan-to-collateral value ratios. They are predominately originated through a subsidiary of the Corporation in accordance with underwriting standards set forth by the government-sponsored entities, FNMA, FHLMC and the Government National Mortgage Association (GNMA), who serve as the primary purchasers of loans sold in the secondary market by mortgage lenders. These underwriting standards generally require that the loans be collateralized by one-to-four family residential real estate, have loan-to-collateral value ratios of 80% or less, and are made to borrowers in good credit standing. Most residential mortgage loans are sold in the secondary mortgage market. The right to service the loans and receive servicing fee income is typically sold along with the underlying mortgages.

Portfolio residential mortgage loans were $539.8 million at December 31, 2005, an increase of $31.6 million or 6.2% compared with December 31, 2004. The lower refinance activity in 2005 helped maintain portfolio balances. Citizens continues to sell most new production into the secondary market. Closed mortgage loan volume declined to $491.9 million in 2005 compared with $589.9 million in 2004. The decrease was a result of lower refinance activity.

Mortgage loans held for sale represent the residential mortgage loans closed as of December 31, 2005 but not yet sold to the secondary market or placed in the Corporation’s portfolio. Mortgage loans held for sale were $16.3 million at December 31, 2005, a decrease of $11.8 million from December 31, 2004. The decrease was due to a decrease in residential mortgage loan closings to $105.0 million during the fourth quarter of 2005 compared with $140.1 million in the fourth quarter of 2004, as loans closed generally remain in loans held for sale for 30 to 60 days after closing.

Direct Consumer. The direct consumer loan category includes home equity loans, and direct installment loans to individuals used to purchase boats, recreational vehicles, automobiles, and other personal items. Home equity loans consist mainly of revolving lines of credit and fixed rate loans to consumers that are secured by residential real estate. These loans are originated through Citizens banking offices with loan-to-value ratios generally less than 90% of appraised collateral value. Citizens offers home equity loans to credit worthy customers above the 90% loan-to-value levels but does not underwrite home equity loans that exceed 100% of collateral value. Individual borrowers may be required to provide additional collateral or a satisfactory endorsement or guaranty from another person, depending on the creditworthiness of the borrower. Credit risks for these types of loans are influenced by general economic conditions, the financial strength of individual borrowers, and the value of the loan collateral. Credit risk in the direct consumer loan portfolio arises from the borrowers being unable to repay the loan on agreed terms, or by a shortfall in the collateral value in relation to the outstanding loan balance in the event of default and subsequent liquidation of collateral. Credit risk is generally controlled by evaluating the creditworthiness of the borrowers as well as taking appropriate collateral and guaranty positions.

The Corporation originates consumer loans utilizing a computer-based credit scoring model to supplement the underwriting process. To monitor and manage consumer loan risk, policies and underwriting guidelines are developed and modified as market conditions require. This monitoring activity, coupled with relatively small loan amounts spread across many individual borrowers, reduces risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting guidelines for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to loan-to-value considerations not to exceed 100%, credit scoring results, ability to service overall debt, and documentation requirements. During 2005 direct consumer loans decreased $27.6 million or 2.4% due to lower consumer demand.

Indirect Consumer. The indirect consumer loan category includes indirect installment loans used by customers to purchase boats, recreational vehicles, and automobiles. These loans are originated mainly within Citizens’ markets and through its

centralized underwriting group that has established relationships with certain dealers which meet Citizens’ underwriting guidelines and adhere to prudent business practices. The dealers are evaluated on their creditworthiness and business practices with performance monitored on a quarterly basis. The dealers refer customers to the centralized underwriting group which utilizes a computer-based credit scoring model to supplement the underwriting process, then complete the loans utilizing Citizens’ loan documents. Credit risks for these types of loans, as for direct consumer loans, are influenced by general economic conditions, the characteristics of individual borrowers, and the value of loan collateral. Additionally, credit risk may include the dealer’s ability to collect proper customer information, and adhere to appropriate lending guidelines including but not limited to, evaluating collateral value, proper capture of property identification numbers, and following related documentation guidelines. Credit risk in the indirect consumer loan portfolio can arise from borrower’s inability to repay the loan and by a shortfall in the collateral value in relation to the outstanding loan balance in the event of default and subsequent liquidation of collateral. Credit risk is generally controlled by reviewing the creditworthiness of the borrowers as well as taking appropriate collateral and guaranty positions.

During 2005, indirect loans increased $18.2 million or 2.2% due to growth in the recreational vehicle and marine segments from continued emphasis on service and maintaining strong relationships with existing dealers in Citizens’ markets.

Provision and Allowance for Loan Losses

The provision for loan losses represents a charge against income and a corresponding increase in the allowance for loan losses. Credit losses are charged against, and recoveries are credited to, the allowance for loan losses. The amount of the allowance for loan losses is based on a review of historical Citizens’ credit loss experience, banking industry credit loss experience and such factors that, in the Corporation’s judgment, deserve consideration under existing economic conditions in estimating probable credit losses. While the Corporation considers the allowance for loan losses to be adequate based on information currently available, future adjustments to the allowance may be necessary due to changes in economic conditions, delinquencies or loss rates. For further discussion, refer to “Critical Accounting Policies.”

A summary of Citizens’ loan loss experience for the past five years appears below.

Table 6. Summary of Loan Loss Experience


Year Ended December 31 (dollars in thousands)	2005			2004			2003			2002			2001

				(Restated)			(Restated)			(Restated)			(Restated)
Allowance for loan losses — January 1	$	122,184		$	121,350		$	104,859		$	74,355		$	73,211
Transfer to reserve for commitments		—			—			—			1,327			560
Provision for loan losses		1,109			21,609			62,008			117,331			25,232
*Charge-offs:*
Commercial ⁽³⁾		12,920			24,582			47,683			80,076			17,027
Residential mortgage		1,152			1,060			1,233			2,027			189
Direct consumer		5,290			5,864			6,414			7,346			6,565
Indirect consumer		9,485			7,565			9,243			8,710			7,512

Total charge-offs		28,847			39,071			64,573			98,159			31,293


*Recoveries:*
Commercial ⁽³⁾		17,721			13,960			14,094			5,283			1,903
Residential mortgage		69			70			35			11			47
Direct consumer		1,419			1,669			1,847			1,660			1,516
Indirect consumer		2,745			2,597			3,080			3,051			3,179

Total recoveries		21,954			18,296			19,056			10,005			6,645

Net charge-offs		6,893			20,775			45,517			88,154			24,648

Allowance for loan losses — December 31	$	116,400		$	122,184		$	121,350		$	104,859		$	74,355

Allowance for losses on lending-related commitments — December 31⁽²⁾	$	3,023		$	2,833		$	2,654		$	2,654		$	3,981

Portfolio loans outstanding at year-end ⁽¹⁾	$	5,616,119		$	5,393,365		$	5,164,416		$	5,342,669		$	5,669,755
Average portfolio loans outstanding ⁽¹⁾		5,493,280			5,210,817			5,140,450			5,467,139			5,851,694
Ratio of allowance for loan losses to loans outstanding at year-end		2.07	%		2.27	%		2.35	%		1.96	%		1.31	%
Ratio of net loans charged off as a percentage of average loans outstanding		0.13			0.40			0.89			1.61			0.42


⁽¹⁾		Balances exclude mortgage loans held for sale.

⁽²⁾		During the fourth quarter of 2003, Citizens reclassified $2.7 million from the allowance for loan losses related to unfunded loan commitments liabilities. Prior period amounts were restated to conform to the new presentation.

⁽³⁾		The Commercial category includes both commercial and commercial real estate loans.

The lower loan loss provision in 2005 resulted from a decline in nonperforming assets, lower net charge-offs, fewer risk rating downgrades within the commercial loan portfolio, and a $1.5 million reduction in the reserve related to a previous mortgage recourse transaction.

Commercial net charge-offs totaled $(4.8) million in 2005, compared with $10.6 million in 2004. Commercial net charge-offs reflect an insurance settlement of $9.1 million accounted for as a loan loss recovery. The commercial loan charge-offs in 2005 were smaller in size than the previous three years and represented a variety of industries.

The allowance for loan losses represents management’s estimate of an amount adequate to provide for probable credit losses inherent in the loan portfolio as of the balance sheet date. To assess the adequacy of the allowance for credit losses, an allocation methodology is applied that focuses on changes in the size and character of the loan portfolio, changes in the levels of impaired or other nonperforming loans, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing economic conditions, underlying collateral, historical losses on each portfolio category and other qualitative and quantitative factors which could affect probable credit losses. The evaluation process is inherently subjective, as it requires estimates that may be susceptible to significant change and have the potential to affect net income materially. Citizens did not substantively change its overall approach in the calculation of the allowance for loan losses in 2005 from

2004 and the allocation methods used at December 31, 2005 and December 31, 2004 were consistent. The methodology used for measuring the adequacy of the allowance relies on several key elements, which include specific allowances for identified problem loans, a formula-based risk-allocated allowance for the remainder of the portfolio and a general valuation allowance calculation. Management also considers overall portfolio indicators, including trends in historical charge-offs, a review of industry, geographic and portfolio performance, and other qualitative factors. This methodology is discussed in Note 2 to the Consolidated Financial Statements.

Internal risk ratings are assigned to each commercial and commercial real estate loan at the time of approval and are subject to subsequent periodic reviews by senior management. These ratings encompass ten categories that define a borrower’s estimated ability to repay their loan obligations. In the third quarter of 2002, the Corporation incorporated a new scoring methodology for certain larger balance watch list commercial credits that lowered the number of factors considered from eight to five and gave additional weight toward discounted service ability (cash flow capacity), financial condition and capitalization of the borrower, and less from collateral coverage and prior relationship history. As a result of these changes, a number of commercial credits were downgraded to higher risk ratings resulting in higher loss rates being applied to the same dollar of exposure.

Prior to the third quarter of 2002, Citizens had used a historical three-year rolling average of net charge-offs as the basis for developing loss factors for commercial credits. Beginning in the third quarter of 2002, in order to emphasize more recent loss trends in the methodology, the Corporation utilized an eighteen-month rolling average of net charge-offs. In 2004, Citizens further refined the use of loan loss averages by using 12 months for consumer, except home equity, and credit-card, while continuing to use 18 months for commercial, home equity, and mortgage loans. These changes did not affect the level of net charge-offs or the calculation of the specific allowances. In 2005, further enhancements to the methodology incorporate the use of quantitative Citizens’ or banking industry loan loss experience for homogenous loan pools with similar risk characteristics and qualitative risks based upon factors both internal and external to the Corporation.

Table 7 below summarizes the allocation of the allowance for loan losses for specific allocated, risk allocated, and general valuation allowances by loan type and the percentage of each loan type of total portfolio loans.

Table 7. Allocation of the Allowance for Loan Losses ⁽¹⁾


											2003					2002					2001
	2005					2004					(Restated)					(Restated)					(Restated)
			% of					% of					% of					% of					% of
December 31			Total					Total					Total					Total					Total
(dollars in millions)	Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans

Specific allocated allowance:
Commercial ⁽²⁾	$	5.1				$	15.3				$	18.0				$	18.6				$	8.8

Risk allocated allowances:
Commercial ⁽²⁾		55.2		55.1	%		59.2		53.6	%		68.3		56.7	%		62.0		60.4	%		28.5		58.4	%
Residential mortgage		6.3		9.6			6.2		9.4			4.7		9.6			2.3		11.7			3.3		15.7
Direct Consumer		12.4		20.3			6.9		21.7			6.3		19.3			7.1		15.6			6.9		14.0
Indirect Consumer		27.5		15.0			12.3		15.3			8.6		14.4			8.0		12.3			8.6		11.9

Total risk allocated allowance		101.4					84.6					87.9					79.4					47.3

Total allocated		106.5		100.0	%		99.9		100.0	%		105.9		100.0	%		98.0		100.0	%		56.1		100.0	%

General valuation allowances		9.9					22.3					15.4					6.8					18.2

Total	$	116.4				$	122.2				$	121.3				$	104.8				$	74.3


(1)		The allocation of the allowance for loan losses in the above table is based upon ranges of estimates and is not intended to imply either limitations on the usage of the allowance or precision of the specific amounts. Citizens and its subsidiaries do not view the allowance for loan losses as being divisible among the various categories of loans. The entire allowance is available to absorb any future losses without regard to the category or categories in which the charged-off loans are classified.

(2)		The commercial category includes both commercial and commercial real estate loans.

Specific Allocated Allowance. Classified credits, which include “doubtful”, “substandard” and “special mention” and are subject to specific reserves, decreased to $8.9 million and allocated a specific allowance of $5.1 million at December 31, 2005 compared to $35.0 million in classified credits with an allocated specific allowance of $15.3 million at December 31, 2004. The amount of the specific allowance, however, as a percent of outstanding loan balances subject to such specific reserves, increased to 56.9% at December 31, 2005 from 43.7% at December 31, 2004 as more substandard credits were assigned a specific reserve. Credits classified as “doubtful” have critical weaknesses that make full collection improbable. “Substandard” credits have well-defined weaknesses which, if not corrected, could jeopardize the full satisfaction of the debt. “Special mention” credits are potentially weak, as the borrower has begun to exhibit deteriorating trends that, if not corrected, could jeopardize repayment of the loan and result in further downgrade.

Risk Allocated Allowance. The amount allocated to commercial loans decreased in 2005, reflecting Citizens’ continued aggressive review and disposition of problematic credits in 2005. The increase in 2005 in the consumer direct and indirect portfolios reflects a combination of the growth and maturation of the home equity portfolio and economic weaknesses that are negatively impacting the portfolios.

General Valuation Allowances. The decrease in the general valuation reserve allowances reflects the refinement of a number of the portfolio specific reserves.

The general valuation reserve allowances are now based on existing regional and local economic factors, including the automotive industry, a macroeconomic adjustment factor used to calibrate for the current economic cycle the Corporation is experiencing, and other judgmental factors supported by qualitative documentation such as the inherent imprecision of the loan loss projection models. These factors could have a potentially negative impact on credit quality and result in future additional losses. These factors, coupled with an increase at December 31, 2005 in other credits that are current in terms of principal and interest payments, but which may deteriorate in quality if economic conditions change, indicate that additional undetected losses exist in the loan portfolios. Based on these factors and the possible imprecision in the loan loss allocation

models, management believes that the general valuation reserve allowances at December 31, 2005 appropriately reflect probable inherent but undetected losses in the portfolio.

NONPERFORMING ASSETS

Nonperforming assets are comprised of nonaccrual loans, restructured loans and repossessed assets. Although these assets have more than a normal risk of loss, they will not necessarily result in a higher level of losses in the future. A five-year history of nonperforming assets is presented below.

Table 8. Nonperforming Assets and Past Due Loans


December 31 (in thousands)	2005			2004			2003			2002			2001

							(Restated)			(Restated)			(Restated)
*Nonperforming Loans* ⁽¹⁾⁽²⁾
Nonaccrual
Less than 30 days past due	$	4,206		$	2,761		$	7,721		$	13,030		$	6,451
From 30 to 89 days past due		1,136			3,118			4,450			23,157			4,487
90 or more days past due		26,798			36,940			55,606			45,848			55,810

Total		32,140			42,819			67,777			82,035			66,748
90 days past due and still accruing		385			40			345			859			4,165
Restructured ⁽¹⁾		—			42			—			—			337

Total nonperforming loans		32,525			42,901			68,122			82,894			71,250
*Other Repossessed Assets Acquired*		7,351			7,946			7,771			7,918			5,836

Total nonperforming assets	$	39,876		$	50,847		$	75,893		$	90,812		$	77,086


Nonperforming assets as a percent of portfolio loans plus other repossessed assets acquired		0.71	%		0.94	%		1.47	%		1.70	%		1.36	%
Nonperforming assets as a percent of total assets		0.51			0.66			1.01			1.24			1.03

*Nonperforming Loans by Type*
Commercial	$	12,265		$	13,816		$	38,553		$	47,744		$	34,925
Commercial real estate		5,068			14,464			15,943			18,665			11,052
Residential mortgage		8,412			8,643			9,161			10,865			17,293
Direct Consumer		4,326			3,527			3,215			3,817			5,098
Indirect Consumer		2,454			2,451			1,250			1,803			2,882

Total	$	32,525		$	42,901		$	68,122		$	82,894		$	71,250


⁽¹⁾		Nonperforming loans include loans on which interest is not being recognized (nonaccrual), those on which interest has been renegotiated to lower than market rates because of the financial condition of the borrowers (restructured), and loans 90 days past due and still accruing.

⁽²⁾		Gross interest income that would have been recorded in 2005 for nonaccrual and restructured loans, as of December 31, 2005, assuming interest had been accrued throughout the year in accordance with original terms was $2.5 million. The comparable 2004 and 2003 totals were $3.8 million, and $6.1 million, respectively. Interest collected on these loans and included in income was $0.6 million in 2005, $2.0 million in 2004 and $3.9 million in 2003. Therefore, on a net basis, total income foregone due to these loans was $1.9 million in 2005, $1.8 million in 2004 and $2.2 million in 2003.

The decrease in nonperforming commercial and commercial real estate loans was the result of aggressive collection efforts, the third quarter 2005 sale of nonperforming commercial loans with a balance of $6.7 million and, to a lesser extent, continued charge-off of nonperforming loans. In addition, the decrease was attributable to a reduction of the inflow of new nonperforming loans due to proactive management and reduction of exposure on credits with the potential to deteriorate. Citizens believes the risk of loss for commercial real estate nonperforming loans is significantly less than the total principal balance, due to the nature of the underlying collateral and the value of such collateral in relation to the total credit exposure. These loans are generally for owner-occupied properties and the sources of repayment are not dependent on the performance of the real estate market.

Nonperforming residential mortgage loans decreased at December 31, 2005 compared with December 31, 2004, reflecting more aggressive collection and better loss mitigation efforts. The consumer portfolio non-performing loans increased at December 31, 2005 compared with December 31, 2004, reflecting the weakening economy in many Citizens’ markets, particularly Michigan.

The Corporation carefully monitors other credits that, while current in terms of principal and interest payments, have the potential to deteriorate in quality if economic conditions change. As of December 31, 2005, such loans amounted to $163.7 million or 2.9% of total portfolio loans compared with $155.6 million or 2.9% of total portfolio loans as of December 31, 2004. These loans are commercial and commercial real estate loans made in the normal course of business and do not represent a concentration in any one industry or geographic location.

Under the Corporation’s credit policies and practices, a loan is placed on nonaccrual status when there is doubt regarding collection of principal or interest, or when principal or interest is past due in excess of 90 days and the loan is not well secured and in the process of collection. Interest accrued but not collected is reversed and charged against income when the loan is placed on nonaccrual status.

Citizens conducts a periodic process on certain credits that utilize market and credit personnel to help evaluate and identify quantitative and qualitative factors within and surrounding these credits. These leading indicators help the Corporation track potential issues that may or may not arise with these credits. Some of these loans are transferred from the markets to Citizens’ special loans group. The special loans group then determines, using qualitative and quantitative factors, if there are specific conditions or circumstances that would indicate if it is probable that a loss will be incurred. A loan is considered impaired when Citizens determines that it is probable that all the principal and interest due under the loan may not be collected. In most instances, impairment is measured based on the fair value of the underlying collateral. Impairment may also be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate. The Corporation maintains a valuation allowance for impaired loans as a part of the specific allocated allowance. Cash collected on impaired nonaccrual loans is applied to outstanding principal. Interest income on all other impaired loans is recorded on an accrual basis.

Certain of the nonperforming loans included in Table 8 are considered to be impaired. Citizens measures impairment on all large balance nonaccrual commercial and commercial real estate loans. Certain large balance accruing loans rated substandard or lower are also measured for impairment. The policy does not apply to large groups of smaller balance homogeneous loans that are collectively evaluated for impairment, except for those loans restructured under a troubled debt restructuring. Loans collectively evaluated for impairment include certain smaller balance commercial loans. Consumer loans, both direct and indirect, and residential mortgage loans, are not included in the impaired loan data because they are smaller balance homogeneous loans. Total loans tracked by Citizens’ market and credit personnel considered impaired and their related reserve balances at December 31, 2005 and 2004, as well as their effect on net income in 2005 and 2004, are set forth in the following table.

Impaired Loan Information


					Valuation Reserve
(in thousands)	2005		2004		2005		2004
Balances — December 31
Impaired loans with valuation reserve	$	7,989	$	32,654	$	5,059	$	15,315
Impaired loans with no valuation reserve		908		2,389		—		—

Total impaired loans	$	8,897	$	35,043	$	5,059	$	15,315


Impaired loans on nonaccrual basis	$	4,728	$	13,010	$	2,747	$	4,541
Impaired loans on accrual basis		4,169		22,033		2,312		10,774

Total impaired loans	$	8,897	$	35,043	$	5,059	$	15,315


Average balance for the year	$	24,398	$	54,023
Interest income recognized for the year		1,057		2,144
Cash collected applied to outstanding principal		393		788

DEPOSITS

The following table provides a year-to-year comparison of average deposit balances over the last three years. Average, rather than period-end, balances are more meaningful in analyzing deposit funding sources because of inherent fluctuations that occur on a monthly basis with most deposit categories.

Table 9. Average Deposits


						2004					2003
	2005					(Restated)					(Restated)
Year Ended December 31	Average		Average			Average		Average			Average		Average
(dollars in thousands)	Balance		Rate			Balance		Rate			Balance		Rate
Noninterest-bearing demand	$	931,053		—	%	$	898,520		—	%	$	851,722		—	%
Interest-bearing demand		1,035,579		0.67			1,264,941		0.75			1,284,903		0.89
Savings		1,505,604		1.47			1,397,290		0.78			1,281,175		0.67
Time		1,814,154		3.09			1,716,919		2.51			2,060,515		2.95


Total	$	5,286,390		1.61		$	5,277,670		1.20		$	5,478,315		1.47

Total average deposits increased 0.2% in 2005. Average noninterest-bearing demand, savings, and time deposits increased 3.6%, 7.8%, and 5.7%, respectively, as a result of sales campaigns focused on growing deposits. These increases were largely offset by a decrease in interest-bearing demand of 18.1% as customers migrated balances to more rate sensitive product categories with the continued increases in short-term market interest rates. The increase in the average cost of the deposit portfolio was a result of the higher short and intermediate-term interest rate environment and a shift in deposit mix from lower cost interest-bearing demand deposits to higher cost savings and time deposits, partially offset by increases in noninterest-bearing demand deposits.

As of December 31, 2005, certificates of deposit of $100,000 or more accounted for 20.7% of total deposits. The maturities of these deposits are summarized below.

Table 10. Maturity of Time Certificates of Deposit of $100,000 or More At December 31, 2005


(in thousands)
Three months or less	$	427,679
After three but within six months		125,660
After six but within twelve months		314,124
After twelve months		224,948

Total	$	1,092,411

Citizens gathers deposits from the local markets of its banking subsidiaries and has used brokered deposits from time to time when cost effective. Brokered deposits and time deposits greater then $100,000 increased by $442.3 million at December 31, 2005 from the prior year-end as a result of a $175.8 million increase in brokered deposits and increased customer demand for time deposits as intermediate-term interest rates increased in 2005. The Corporation will continue to evaluate the use of alternative funding sources such as brokered deposits as funding needs change. Citizens continues to promote relationship driven core deposit growth and stability through focused marketing efforts and competitive pricing strategies.

BORROWED FUNDS

Short-term borrowings consist of federal funds purchased and securities sold under agreements to repurchase, FHLB borrowings, other bank borrowings, and Treasury Tax and Loan borrowings. Total short-term borrowings averaged $812.6 million in 2005, or 13.3%, of total average interest-bearing liabilities, compared with $653.4 million, or 10.9%, during 2004. The increase in short-term borrowings was due to little growth in deposit balances combined with loan growth that more than offset declining balances in the investment securities portfolio. See Note 12 to the Consolidated Financial Statements for additional information on short-term borrowings.

Long-term debt, comprised of FHLB notes, subordinated notes and other long-term debt, accounted for $938.5 million, or 15.4%, of average interest-bearing liabilities during 2005, compared to $936.1 million or 15.7% during 2004. On January 27, 2003, Citizens issued $125 million of 5.75% subordinated notes due in 2013. The notes qualify as Tier 2 capital for regulatory risk-based capital purposes and were issued to provide funding to support cash flow requirements at the Holding Company and to improve risk-based capital ratios. In June 2003, Citizens issued approximately $25 million of floating rate 30 year trust preferred securities through a special purpose trust with an initial interest rate of 4.16%. Interest only payments are due quarterly and full payment of the principal is due in June 2033. These securities qualify as Tier 1 capital for regulatory risk-based capital purposes and were issued to improve liquidity and risk-based capital ratios. FHLB advances increased $59.3 million to $859.5 million at December 31, 2005. A summary of long-term debt balances as of December 31, 2005 and 2004 appears in Note 13 to the Consolidated Financial Statements. Borrowed funds are expected to remain an important, reliable and cost-effective funding vehicle.

During the third quarter of 2004, Citizens prepaid $235.0 million of FHLB advances that were convertible to a floating rate at the option of the FHLB. Citizens issued $275.0 million of new fixed rate FHLB advances on August 5, 2004. The new advances have no conversion, put, or call options, and have an interest cost approximately 150 basis points below that of the prepaid advances.

CAPITAL RESOURCES

Citizens continues to maintain a strong capital position which supports current needs and provides a sound foundation to support further expansion. Regulatory capital ratios are consistently at or above the “well-capitalized” standards and all bank subsidiaries have sufficient capital to maintain a well-capitalized designation. The Corporation’s capital ratios for the past three years are presented below.


	Regulatory Minimum
				“Well-			December 31,
	Required			Capitalized”			2005			2004			2003

Risk based:
Tier 1 capital		4.00	%		6.00	%		9.94	%		9.96	%		9.80	%
Total capital		8.00			10.00			13.22			13.32			13.23

Tier 1 leverage		4.00			5.00			7.98			7.84			7.45

Average shareholders equity was $653.0 million, or 8.40% of average assets for 2005 compared with $639.6 million, or 8.32%, for 2004 and $632.1 million, or 8.22% for 2003. At December 31, 2005, shareholders’ equity was $656.5 million, compared with $654.3 million at December 31, 2004. Book value per common share at December 31, 2005 and 2004 was $15.28 and $15.13, respectively. Citizens declared and paid cash dividends of $1.14 per share in 2005, unchanged from $1.14 per share in 2004 and 2003. Shareholders’ equity increased in 2005 as net income more than offset cash dividends and capital used in share repurchase programs. The net income component of shareholders’ equity was also partially offset by a decline in other comprehensive net income as the net unrealized gain on available-for-sale securities decreased.

In October 2001, the Holding Company’s Board of Directors approved a plan to repurchase up to 3,000,000 shares of Citizens’ common stock for general corporate purposes. This plan was completed on August 12, 2004. The Holding Company repurchased the shares at an overall average price of $28.56. In October 2003, the Board of Directors approved a new plan to repurchase an additional 3,000,000 shares of common stock. There is no expiration date for the repurchase program. As of December 31, 2005, shares remaining to be purchased under the current program totaled 2,241,200. The repurchase of shares is subject to limitations that may be imposed by applicable securities laws and regulations and the rules of the Nasdaq Stock Market. The timing of the repurchases and the number of shares to be bought at any one time depend on market conditions and Citizens’ capital requirements. There can be no assurance that the Holding Company will repurchase the remaining shares authorized to be repurchased, or that any additional repurchases will be authorized by the Board of Directors.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

Contractual Obligations

In the ordinary course of business, Citizens has entered into certain contractual arrangements that require future cash payments and may impact liquidity. These obligations include issuance of debt to fund operations, purchase obligations to acquire goods or services, and property leases. The table below summarizes non-cancelable contractual obligations and future required minimum payments as of December 31, 2005. Refer to Notes 10, 11, and 13 to the Consolidated Financial Statements for a further discussion of these contractual obligations.

Table 11. Contractual Obligations


	Minimum Payments Due by Period
*Year Ended December 31, 2005*			Less than						More than
(in thousands)	Total		1 year		1-3 years		4-5 years		5 years

Deposits with stated maturities	$	2,172,888	$	1,593,454	$	395,197	$	123,122	$	61,115
Federal Home Loan Bank borrowings		859,483		255,927		471,820		27,623		104,113
Subordinated debt		146,626		—		—		—		146,626
Capital lease/mortgage debt		—		—		—		—		—
Purchase obligations		35,315		11,689		13,972		5,629		4,025
Operating leases and non-cancelable contracts		19,240		3,594		4,542		3,367		7,737

Total	$	3,233,552	$	1,864,664	$	885,531	$	159,741	$	323,616

Citizens has obligations not included in the above table under its retirement plans as described in Note 14 to the Consolidated Financial Statements.

Off-Balance Sheet Arrangements

In the normal course of business, in order to meet the financing needs of customers and to manage exposure to interest rate risk, Citizens has become a party to transactions involving financial instruments with off-balance sheet risk. These financial instruments, which are not reflected in the Consolidated Financial Statements, include commitments to extend credit, standby letters of credit, forward commitments to sell mortgage loans and interest rate swaps. The contractual amounts of these instruments express the extent of Citizens’ involvement in these transactions as of the balance sheet date. These instruments involve, to varying degrees, elements of credit risk, market risk and liquidity risk in excess of the amount recognized in the consolidated balance sheets, however, they do not represent unusual risks.

Commitments to extend credit are legally binding agreements to lend cash to a customer as long as there is no breach of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Commitments to fund loan applications with agreed-upon rates subject Citizens to market risk due to fluctuations in interest rates. At December 31, 2005, Citizens had commitments to extend credit totaling $1.8 billion.

Letters of credit guarantee the performance of a customer to a third party. These guarantees are normally issued to support public and private borrowing arrangements, real estate construction projects, bond financing and similar transactions. At December 31, 2005, Citizens had letters of credit outstanding totaling $279.6 million.

The credit risk associated with commitments to extend credit and letters of credit is essentially the same as that involved with direct lending. Therefore, these instruments are subject to loan review and approval procedures and credit policies. Based upon management’s credit evaluation of the counter-party, they may be required to provide collateral as security for the agreement, including real estate, accounts receivable, inventories, and investment securities. The maximum credit risk associated with these instruments equals their contractual amounts and assumes that the counter-party defaults and the collateral proves to be worthless. The total contractual amounts of commitments to extend credit and letters of credit do not necessarily represent future cash requirements, since many of these agreements may expire without being drawn upon. At December 31, 2005 and 2004, a liability of $3.0 million and $2.8 million, respectively had been recorded for possible losses on commitments to extend credit and as of December 31, 2005 and 2004, in accordance with FIN 45, a liability of $0.2 million and $0.8 million, respectively, has been recorded representing the value of the guarantee obligations associated with

certain letters of credit. The guarantee obligation liability will be amortized into income over the life of the commitments. Citizens’ commitments to extend credit and letters of credit are described in further detail in Note 18 to the Consolidated Financial Statements.

At December 31, 2005, Citizens had $17.9 million of commitments to fund residential real estate loan applications with agreed-upon rates (“Interest Rate Lock Commitments”). Interest Rate Lock Commitments and holding residential mortgage loans for sale to the secondary market exposes Citizens to interest rate risk during the period from application to when the loan is sold to the investors. To minimize this exposure to interest rate risk, forward commitments are entered into to sell such mortgage loans at specified future dates to various third parties.

At December 31, 2005, Citizens had outstanding mandatory forward commitments to sell $22.0 million of residential mortgage loans. These outstanding forward commitments to sell mortgage loans are expected to settle in the first quarter of 2006 without producing any material gains or losses. Citizens implemented SFAS 133, as amended which provides accounting guidance for derivative investments and hedging activities effective January 1, 2001. See Note 2 to the Consolidated Financial Statements for further explanation. For the year ended December 31, 2005, the impact of SFAS 133 on net income was immaterial.

Citizens is also contractually obligated to certain derivative instruments. At December 31, 2005, interest rate swap notional amounts totaled $887.1 million. Refer to Note 19 to the Consolidated Financial Statements for further discussion of interest rate lock commitments, mandatory forward commitments and derivative instruments.

The following table presents the total notional amounts and expected maturity of off-balance sheet financial instruments outstanding at December 31, 2005 and the notional amounts outstanding at December 31, 2004.

Table 12. Off Balance Sheet Financial Instruments


			Expected Expiration Dates by Period
	Total		Less than						More than		December 31,
(in thousands)	2005		1 year		1-3 years		4-5 years		5 years		2004

Financial instruments whose contract amounts represent credit risk:
Loan commitments to extend credit	$	1,762,259	$	1,118,354	$	163,115	$	18,906	$	461,884	$	1,769,968
Standby letters of credit		56,296		43,505		12,372		419		—		47,554
Commercial letters of credit		223,269		22,451		167,986		29,268		3,564		207,460
Financial instruments subject to interest rate risk:
Receive fixed and pay fixed swaps		654,000		205,000		214,000		40,000		195,000		289,000
Customer initiated swaps and corresponding offsets		233,104		—		—		182,086		51,018		142,674
Residential mortgage loan applications with agreed-upon rates		17,897		17,897		—		—		—		17,165
Forward commitments to sell residential mortgage loans		22,000		22,000		—		—		—		58,000

Total	$	2,968,825	$	1,429,207	$	557,473	$	270,679	$	711,466	$	2,531,821

During the ordinary course of business, Citizens also engages in other financial transactions that are not recorded on the consolidated balance sheets or are recorded on an equity or cost basis rather than being consolidated. Such transactions serve a variety of purposes including management of the liquidity, optimization of capital utilization, meeting the financial needs of its customers and fulfilling Community Reinvestment Act obligations.

Late in the second quarter of 2003, Citizens issued approximately $25 million of floating rate trust preferred securities through a special purpose trust which qualifies as a variable interest entity (“VIE”) under applicable accounting rules. Since Citizens is not the primary beneficiary of the VIE, consolidation is not required under the terms of Financial Accounting Standards Board Interpretation 46 “Consolidation of Variable Interest Entities” (“FIN 46”). As a result, the trust preferred securities were not recorded in the Consolidated Balance Sheets. Instead, a floating rate junior subordinated deferrable interest debenture (the “Debenture”) issued by Citizens to the VIE was recorded for the gross issuance proceeds. The Debenture is the sole asset of the trust and Citizens has guaranteed that interest payments on the Debenture made to the trust will be distributed by the trust to the holders of the trust preferred securities. The Debenture matures in thirty years, is

callable at par after five years and bears interest at an annual rate equal to the three-month LIBOR plus 3.10%, payable quarterly. The trust preferred securities issued by the trust have financial terms that are comparable to the Debenture.

Citizens has non-marketable equity investments that have not been consolidated in the Consolidated Financial Statements. At December 31, 2005, these investments included $1.7 million in limited partnerships, including a venture capital fund and an affordable housing tax credit fund that were reported under the equity method. Not included in the carrying amount were commitments to fund an additional $1.6 million at some future date. Consolidation of these investments is not required pursuant to FIN 46 since Citizens is not the primary beneficiary in the investments. The maximum exposure to loss for all non-marketable equity investments is the sum of the carrying amounts plus the additional commitments.

As of December 31, 2005, the unpaid principal balance of mortgage loans serviced for others was $51.1 million. These loans are not recorded on the Consolidated Financial Statements. Capitalized servicing rights relating to the serviced loans were fully reserved in June 2003.

Assets held in a fiduciary or agency capacity are not included in the Consolidated Financial Statements because they are not assets of Citizens. The total assets managed or administered by Citizens at December 31, 2005, in its fiduciary or agency capacity, were $2.5 billion.

LIQUIDITY AND DEBT CAPACITY

Citizens monitors and manages its liquidity position so that funds will be available at a reasonable cost to meet financial commitments, to finance business expansion and to take advantage of unforeseen opportunities. Citizens manages the liquidity of its Holding Company to pay dividends to shareholders, to service debt, to invest in subsidiaries and to satisfy other operating requirements. It also manages the liquidity of its subsidiary banks to meet client cash flow needs while maintaining funds available for loan and investment opportunities.

Citizens’ subsidiary banks derive liquidity through core deposit growth, maturity of money market investments, and maturity and sale of investment securities and loans. Additionally, its subsidiary banks have access to financial market borrowing sources on an unsecured, as well as a collateralized basis, for both short-term and long-term purposes including, but not limited to, the Federal Reserve and Federal Home Loan Banks of which the subsidiary banks are members.

The primary sources of liquidity for the Holding Company are dividends from and returns on investment in its subsidiaries. Each of the banking subsidiaries is subject to dividend limits under the laws of the state in which it is chartered and, as member banks of the Federal Reserve System, is subject to the dividend limits of the Federal Reserve Board. The Federal Reserve Board allows a member bank to make dividends or other capital distributions in an amount not exceeding the current calendar year’s net income, plus retained net income of the preceding two years. Distributions in excess of this limit require prior regulatory approval. During 2005, the Holding Company received $63.2 million in dividends from subsidiaries and paid $49.3 million in dividends to its shareholders. As discussed in Note 22 to the Consolidated Financial Statements, as of January 1, 2006, the subsidiary banks are able to pay dividends of $47.4 million to the Holding Company without prior regulatory approval.

The ability of the Holding Company to borrow funds on both a short-term and long-term basis provides an additional source of liquidity. The Holding Company maintains a $75 million short-term revolving credit facility with four unaffiliated banks. As of December 31, 2005, there was no outstanding balance on this credit facility. The current facility will mature in August 2006 and is expected to be renewed at that time. The credit agreement requires Citizens to maintain certain financial and non-financial covenants including capital adequacy, non-performing asset levels, and loan loss reserve adequacy. Citizens was in full compliance with all covenants as of December 31, 2005.

Citizens’ ongoing Southeast Michigan branch expansion may pose a challenge to liquidity as both the capital investment and loan growth will require incremental funding. Management anticipates that through a combination of wholesale funding and deposit generation from both the new Southeast Michigan branches and the existing branch network, the Corporation will be able to fund all aspects of the expansion plan.

Citizens also has contingent letter of credit commitments that may impact liquidity. Since many of these commitments have historically expired without being drawn upon, the total amount of these commitments does not necessarily represent the

Corporation’s future cash requirements in connection with them. Further information on these commitments is presented in Note 18 to the Consolidated Financial Statements in this report. Citizens has sufficient liquidity and capital resources to meet presently known short-term and long-term cash flow requirements.

Citizens’ long-term debt to equity ratio was 153.3% as of December 31, 2005 compared to 145.2% in 2004. Changes in short-term and long-term debt and deposit obligations during 2005 are further discussed in the sections titled “Deposits” and “Borrowed Funds.” Citizens believes that it has sufficient liquidity and capital sources to meet presently known short-term and long-term cash flow requirements arising from ongoing business transactions.

Wholesale funding represents an important source of liquidity to the Corporation, and credit ratings affect the availability and cost of this funding. Citizens’ credit ratings were reviewed and affirmed by Moody’s Investor Service on January 27, 2005. On April 21, 2005, Dominion Bond Rating Service (DBRS) assigned ratings to Citizens of R-2 (high) for short-term instruments, BBB (high) for issuer and senior debt and BBB for subordinated debt. DBRS defines short-term debt rated R-2 (high) to be at the upper end of its adequate credit quality classification. Long-term debt rated BBB is defined as adequate credit quality. Long-term debt categories are denoted by the subcategories “high” and “low.” The absence of a “high” or “low” designation indicates the rating is in the “middle” of the category. Credit ratings relate to the Corporation’s ability to issue long-term debt and should not be viewed as an indication of future stock performance.

INTEREST RATE RISK

The asset/liability management process includes monitoring contractual and expected repricing of assets and liabilities as well as forecasting earnings under different interest rate scenarios and balance sheet structures with the objective of insulating net interest income from large swings attributable to changes in market interest rates. Asset, liability, and off-balance sheet portfolios are monitored to ensure comprehensive management of interest rate risk. Interest rate risk results from a mismatch in the timing of the repricing of assets and liabilities, option risk, which can alter the expected timing of repricing of certain assets or liabilities, or basis risk. Many assets and liabilities contain embedded options which allow customers and entities associated with Citizens’ investments and wholesale funding to prepay loans or securities prior to maturity or to withdraw or reprice deposits or other funding instruments prior to maturity. Basis risk occurs when assets and liabilities reprice at the same time but based on different market rates which can change by different amounts. Citizens’ static interest rate sensitivity (GAP) as of December 31, 2005 and 2004 is presented in the following table.

Table 13. Interest Rate Sensitivity


										Total
	0 - 3			4 - 6			7 - 12			Within			1 - 5			Over
(dollars in millions)	Months			Months			Months			1 Year			Years			5 Years			Total

December 31, 2005
*Rate Sensitive Assets* ⁽¹⁾
Portfolio loans ⁽²⁾	$	2,623.7		$	240.4		$	432.7		$	3,296.8		$	1,915.8		$	403.5		$	5,616.1
Mortgage loans held for sale		16.3			—			—			16.3			—			—			16.3
Investment securities		58.8			67.1			133.0			258.9			952.0			429.4			1,640.3
Short-term investments		1.5			—			—			1.5			—			—			1.5

Total	$	2,700.3		$	307.5		$	565.7		$	3,573.5		$	2,867.8		$	832.9		$	7,274.2

*Rate Sensitive Liabilities*
Deposits ⁽³⁾	$	1,503.7		$	357.9		$	813.4		$	2,675.0		$	1,037.3		$	792.5		$	4,504.8
Other interest bearing liabilities		525.3			120.0			135.9			781.2			549.4			204.6			1,535.2

Total	$	2,029.0		$	477.9		$	949.3		$	3,456.2		$	1,586.7		$	997.1		$	6,040.0


*Derivatives*	$	(396.0	)	$	(15.0	)	$	170.0		$	(241.0	)	$	46.0		$	195.0		$	—


Period GAP ⁽⁴⁾	$	275.3		$	(185.4	)	$	(213.6	)	$	(123.7	)	$	1,327.1		$	30.8		$	1,234.2
Cumulative GAP		275.3			89.9			(123.7	)					1,203.4			1,234.2

December 31, 2004
*Rate Sensitive Assets* ⁽¹⁾
Portfolio loans ⁽²⁾	$	2,605.1		$	244.2		$	381.7		$	3,231.0		$	1,851.0		$	311.4		$	5,393.4
Mortgage loans held for sale		28.0			—			—			28.0			—			—			28.0
Investment securities		103.3			85.0			152.8			341.1			1,069.8			457.7			1,868.6
Short-term investments		2.2			—			—			2.2			—			—			2.2

Total	$	2,738.6		$	329.2		$	534.5		$	3,602.3		$	2,920.8		$	769.1		$	7,292.2


*Rate Sensitive Liabilities*
Deposits ⁽³⁾	$	1,850.9		$	250.9		$	407.1		$	2,508.9		$	1,094.2		$	797.8		$	4,400.9
Other interest bearing liabilities		819.9			145.0			0.6			965.5			529.3			179.9			1,674.7

Total	$	2,670.8		$	395.9		$	407.7		$	3,474.4		$	1,623.5		$	977.7		$	6,075.6


*Derivatives*	$	(71.0	)	$	(10.0	)	$	—		$	(81.0	)	$	(94.0	)	$	175.0		$	—


Period GAP ⁽⁴⁾	$	(3.2	)	$	(76.7	)	$	126.8		$	46.9		$	1,203.3		$	(33.6	)	$	1,216.6
Cumulative GAP		(3.2	)		(79.9	)		46.9						1,250.2			1,216.6


⁽¹⁾		Incorporates prepayment projections for certain assets which may shorten the time frame for repricing or maturity compared to contractual runoff.

⁽²⁾		Balances exclude mortgage loans held for sale.

⁽³⁾		Includes interest bearing deposits without contractual maturities of $1.1 billion in the less than one year category and $1.3 over one year category as of December 31, 2005. The same amounts as of December 31, 2004 were $1.5 billion and $1.3 respectively. These amounts reflect management’s assumptions regarding deposit repricing behavior and tenor.

⁽⁴⁾		GAP is the excess of rate sensitive assets (liabilities).

As of December 31, 2005 rate sensitive liabilities repricing within one year exceeded rate sensitive assets repricing within one year by $123.7 million or 1.6% of total assets, compared to rate sensitive assets repricing in one year exceeding rate sensitive liabilities repricing in one year by $46.9 million or 0.6% of total assets as of December 31, 2004. These results incorporate the impact of off-balance sheet derivatives and reflect interest rate environments consistent with December 31, 2005 and December 31, 2004, respectively. GAP analysis is limited in its ability to measure interest rate sensitivity, as embedded options can change the repricing characteristics of assets, liabilities, and off-balance sheet derivatives, thereby changing the repricing position from that outlined above. Further, basis risk is not captured by repricing GAP analysis. Since no single risk measurement approach satisfies all management objectives, a combination of techniques is used, including income simulation, repricing gap analysis, and economic value of equity analysis.

From time-to-time, derivative contracts are used to help manage or hedge exposure to interest rate risk and market value risk in conjunction with mortgage banking operations. These currently include interest rate swaps and forward mortgage loan

sales. Interest rate swaps are contracts with a third party (the “counter-party”) to exchange interest payment streams based upon an assumed principal amount (the “notional amount”). The notional amount is not advanced from the counter-party. Swap contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts and payments based on market interest rates as of the balance sheet date. The fair values of the contracts change daily as market interest rates change.

Holding residential mortgage loans for sale and committing to fund residential mortgage loan applications at specific rates exposes Citizens to market value risk caused by changes in interest rates during the period from rate commitment issuance until sale. To minimize this risk, Citizens enters into mandatory forward commitments to sell residential mortgage loans at the time a rate commitment is issued. These mandatory forward commitments are considered derivatives under SFAS 133. The practice of hedging mortgage loan-related market value risk with mandatory forward contracts has been effective and has not generated any material gains or losses. As of December 31, 2005, Citizens had forward contracts to sell mortgage loans of $22.0 million. Further discussion of derivative instruments is included in Notes 2 and 19 to the Consolidated Financial Statements.

Citizens uses income simulation modeling as its principal interest rate risk measurement technique. Key assumptions in the model include prepayment speeds on various loan and investment assets as customers repay loan principal prior to the due date or maturity date, cash flows and maturities of financial instruments, changes in market conditions, loan and deposit volumes, pricing, client preferences, and Citizens’ financial capital plans. These assumptions are inherently uncertain, subject to fluctuation and revision in a dynamic environment and, as a result, the model cannot precisely estimate net interest income nor exactly predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of balance sheet component and interest rate changes, and differences in client behavior, market conditions and management strategies, among other factors.

Simulations were performed as of December 31, 2005 to evaluate the impact of market rate changes on net interest income over the following 12 months assuming expected levels of balance sheet growth over that time period. If market interest rates were to increase immediately by 100 or 200 basis points (a parallel and immediate shift along the yield curve) net interest income would be expected to decline by 0.6% and 1.6%, respectively, from what it would be if rates were to remain at December 31, 2005 levels. An immediate 100 or 200 basis point parallel decline in market rates would be expected to reduce net interest income over the following twelve months by 0.7% and 2.4%, respectively, from what it would be if rates were to remain constant over the entire time period at December 31, 2005 levels. These results represent little change from prior year results. Net interest income is not only affected by the level and direction of interest rates, but also by the shape of the yield curve, pricing spreads in relation to market rates, balance sheet growth, the mix of different types of assets or liabilities, and the timing of changes in these variables. A further flattening or inversion of the yield curve would exacerbate the negative impact on net interest income. Scenarios different from those outlined above, whether different by only timing, level, or a combination of factors, could produce different results.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required by this item is incorporated by reference from “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Interest Rate Risk.”

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Consolidated Balance Sheets

Citizens Banking Corporation and Subsidiaries


	December 31,
(in thousands, except share amounts)	2005			2004

*Assets*
Cash and due from banks	$	194,748		$	153,474
Interest-bearing deposits with banks		380			1,769
Investment Securities:
Available-for-sale: (amortized cost $1,501,819 in 2005; $1,719,975 in 2004)
U.S. Treasury and federal agency securities		1,122,306			1,348,199
State and municipal securities		378,235			395,878
Other securities		1,456			3,057
Held-to-maturity:
State and municipal securities (fair value of $82,364 and $54,749, respectively)		82,431			54,035
FHLB and Federal Reserve stock		55,911			67,390

Total investment securities		1,640,339			1,868,559
Mortgage loans held for sale		16,252			28,038
Loans:
Commercial		1,688,079			1,633,698
Commercial real estate		1,402,128			1,255,913
Residential mortgage loans		539,824			508,234
Direct consumer		1,142,002			1,169,618
Indirect consumer		844,086			825,902

Total loans		5,616,119			5,393,365
Less: Allowance for loan losses		(116,400	)		(122,184	)

Net loans		5,499,719			5,271,181
Premises and equipment		121,730			117,944
Goodwill		54,527			54,527
Other intangible assets		11,133			14,033
Bank owned life insurance		84,435			82,613
Other assets		128,620			113,895

*Total assets*	$	7,751,883		$	7,706,033


*Liabilities*
Noninterest-bearing deposits	$	969,074		$	898,820
Interest-bearing demand deposits		891,313			1,150,332
Savings deposits		1,437,024			1,638,295
Time deposits		2,176,428			1,612,313

Total deposits		5,473,839			5,299,760
Federal funds purchased and securities sold under agreements to repurchase		505,879			671,660
Other short-term borrowings		23,242			53,114
Other liabilities		86,351			77,276
Long-term debt		1,006,109			949,921

Total liabilities		7,095,420			7,051,731

*Shareholders’ Equity*
Preferred stock — no par value:
Authorized - 5,000,000 shares; Issued — none		—			—
Common stock — no par value
Authorized - 100,000,000 shares
Issued and outstanding - 42,967,649 in 2005; 43,239,628 in 2004		85,526			97,180
Retained earnings		570,483			539,128
Accumulated other comprehensive income		454			17,994

Total shareholders’ equity		656,463			654,302

*Total liabilities and shareholders’ equity*	$	7,751,883		$	7,706,033

See notes to consolidated financial statements.

Consolidated Statements of Income

Citizens Banking Corporation and Subsidiaries


(in thousands, except per share amounts)	2005			2004			2003
				(Restated)			(Restated)
*Interest Income*
Interest and fees on loans	$	343,890		$	297,811		$	318,543
Interest and dividends on investment securities:
Taxable		58,514			59,794			58,944
Tax-exempt		20,789			20,662			20,124
Money market investments		56			12			105

Total interest income		423,249			378,279			397,716


*Interest Expense*
Deposits		85,154			63,389			80,768
Short-term borrowings		25,929			9,574			4,933
Long-term debt		36,417			33,618			31,310

Total interest expense		147,500			106,581			117,011

*Net Interest Income*		275,749			271,698			280,705
Provision for loan losses		1,109			21,609			62,008

Net interest income after provision for loan losses		274,640			250,089			218,697


*Noninterest Income*
Service charges on deposit accounts		35,409			34,618			29,074
Trust fees		18,445			17,854			17,527
Mortgage and other loan income		8,983			9,547			17,817
Brokerage and investment fees		7,803			7,710			7,375
ATM network user fees		4,355			3,361			3,384
Bankcard fees		3,804			3,415			3,008
Fair value change in CD swap derivatives		(3,604	)		—			—
Other		14,240			16,466			14,767

Total fees and other income		89,435			92,971			92,952
Investment securities gains (losses)		(8,927	)		(1,513	)		101

Total noninterest income		80,508			91,458			93,053

*Noninterest Expense*
Salaries and employee benefits		132,153			127,958			120,538
Occupancy		22,131			19,865			17,865
Professional services		17,279			16,095			17,307
Equipment		14,634			14,252			16,222
Data processing services		13,800			13,131			12,513
Advertising and public relations		7,853			9,126			5,663
Postage and delivery		6,213			6,411			6,711
Telephone		5,481			5,940			4,704
Other loan expenses		2,655			3,964			4,758
Stationery and supplies		3,091			3,707			3,444
Intangible asset amortization		2,899			2,899			2,899
Prepayment penalty on FHLB advances		—			17,959			—
Other		14,853			18,971			16,242

Total noninterest expense		243,042			260,278			228,866


*Income from Continuing Operations Before Income Taxes*		112,106			81,269			82,884
Income tax provision		31,581			19,590			18,375

*Income from Continuing Operations*		80,525			61,679			64,509
*Discontinued operations:*
Income from discontinued operations (net of income tax of $939 and $801)		—			1,659			1,442
Gain on sale of discontinued operations (including income tax benefit of $1,109)		—			12,759			—

Income from discontinued operations		—			14,418			1,442

*Net Income*	$	80,525		$	76,097		$	65,951


*Earnings Per Share from Continuing Operations*
Basic	$	1.87		$	1.43		$	1.49
Diluted		1.85			1.41			1.48

*Earnings Per Share from Discontinued Operations*
Basic	$	—		$	0.33		$	0.03
Diluted		—			0.33			0.03

*Net Income Per Common Share:*
Basic	$	1.87		$	1.76		$	1.52
Diluted		1.85			1.74			1.51

*Average Common Shares Outstanding:*
Basic		43,095,730			43,266,228			43,303,573
Diluted		43,412,247			43,762,966			43,609,148

See notes to consolidated financial statements.

Consolidated Statements of Changes in Shareholders’ Equity
Citizens Banking Corporation and Subsidiaries


										Accumulated
										Other
	Common Stock						Retained			Comprehensive
(in thousands, except per share amounts)	Shares			Amount			Earnings			Income (Loss)			Total
*Balance at January 1, 2003*		43,702		$	112,253		$	495,570		$	42,646		$	650,469
Comprehensive income, net of tax:
Net income								65,951						65,951
Other comprehensive income:
Net unrealized loss on securities available-for-sale, net of tax effect of ($11,023)											(20,472	)
Less: Reclassification adjustment for net gains included in net income, net of tax effect of $36											(67	)
Net change in unrealized gain on qualifying cash flow hedges, net of tax effect of $280											520
Minimum pension liability, net of tax effect of $95											176

Other comprehensive income total														(19,843	)

Total comprehensive income														46,108
Exercise of stock options		350			6,334									6,334
Tax benefit on non-qualified stock options					2,500									2,500
Net change in deferred compensation, net of tax					550									550
Cash dividends declared on common shares — $1.140 per share								(49,476	)					(49,476	)
Shares acquired for retirement		(810	)		(21,323	)								(21,323	)

*Balance at December 31, 2003*		43,242		$	100,314		$	512,045		$	22,803		$	635,162

Comprehensive income, net of tax:
Net income								76,097						76,097
Other comprehensive income:
Net unrealized loss on securities available-for-sale, net of tax effect of ($3,131)											(5,814	)
Less: Reclassification adjustment for net gains included in net income, net of tax effect of $528											981
Net change in unrealized gain on qualifying cash flow hedges, net of tax effect of ($38)											(70	)
Minimum pension liability, net of tax effect of $51											94

Other comprehensive income total														(4,809	)

Total comprehensive income														71,288
Exercise of stock options		402			8,267									8,267
Tax benefit on non-qualified stock options					1,370									1,370
Net change in deferred compensation, net of tax					193									193
Recognition of stock-based compensation								272						272
Cash dividends declared on common shares — $1.140 per share								(49,286	)					(49,286	)
Shares acquired for retirement		(404	)		(12,964	)								(12,964	)

*Balance — December 31, 2004*		43,240		$	97,180		$	539,128		$	17,994		$	654,302

Comprehensive income, net of tax:
Net income								80,525						80,525
Other comprehensive income:
Net unrealized loss on securities available-for-sale, net of tax effect of ($12,567)											(23,340	)
Less: Reclassification adjustment for net gains included in net income, net of tax effect of $3,125											5,802
Net change in unrealized gain on qualifying cash flow hedges, net of tax effect of $627											1,166
Minimum pension liability, net of tax effect of ($629)											(1,168	)

Other comprehensive income total														(17,540	)

Total comprehensive income														62,985
Exercise of stock options		337			5,061									5,061
Tax benefit on non-qualified stock options					783									783
Net change in deferred compensation, net of tax					691									691
Recognition of stock-based compensation								141						141
Cash dividends declared on common shares — $1.140 per share								(49,311	)					(49,311	)
Shares acquired for retirement		(609	)		(18,189	)								(18,189	)

*Balance — December 31, 2005*		42,968		$	85,526		$	570,483		$	454		$	656,463

See notes to consolidated financial statements.

Consolidated Statements of Cash Flows
Citizens Banking Corporation and Subsidiaries


	Year Ended December 31,
(in thousands)	2005			2004			2003
				(Restated)			(Restated)
*Operating Activities:*
Income from continuing operations	$	80,525		$	61,679		$	64,509
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
Provision for loan losses		1,109			21,609			62,008
Depreciation and amortization		14,005			11,871			13,550
Amortization of goodwill and other intangibles		2,899			2,899			2,899
Deferred income tax (credit)		(3,569	)		(417	)		1,619
Net amortization on investment securities		4,279			8,708			8,347
Investment securities (gains) losses		8,927			1,513			(101	)
Loans originated for sale		(320,938	)		(397,280	)		(1,204,506	)
Proceeds from sales of mortgage loans held for sale		337,473			416,098			1,326,152
Net gains from loan sales		(4,749	)		(4,757	)		(10,908	)
Net change in deferred compensation, net of tax effect		691			193			550
Recognition of Stock-based compensation expense		141			272			—
Other		3,224			(9,247	)		1,042

Net cash provided by operating activities from continuing operations		124,017			113,141			265,161
*Investing Activities:*
Net decrease in money market investments		1,389			292			69,268
Securities available-for-sale:
Proceeds from sales		313,318			77,829			1,440
Proceeds from maturities and payments		373,636			355,621			681,442
Purchases		(470,513	)		(374,334	)		(1,251,698	)
Securities held-to-maturity:
Purchases		(28,407	)		(34,321	)		(19,714	)
Proceeds from sale of discontinued operations		—			26,250			—
Net (increase) decrease in loans and leases		(229,647	)		(249,723	)		132,771
Net increase in properties and equipment		(17,791	)		(19,812	)		(8,885	)

Net cash used by investing activities from continuing operations		(58,015	)		(218,198	)		(395,376	)
*Financing Activities:*
Net (decrease) increase in demand and savings deposits		(390,036	)		304,660			(73,448	)
Net increase (decrease) in time deposits		564,115			(278,982	)		(393,337	)
Net increase (decrease) in short-term borrowings		(195,653	)		97,123			333,822
Proceeds from issuance of long-term debt		275,000			350,000			370,332
Principal reductions in long-term debt		(215,715	)		(337,825	)		(31,290	)
Cash dividends paid		(49,311	)		(49,286	)		(49,476	)
Proceeds from stock options exercised		5,061			8,267			6,334
Shares acquired for retirement		(18,189	)		(12,964	)		(21,323	)

Net cash provided (used) by financing activities from continuing operations		(24,728	)		80,993			141,614

Cash flows of discontinued operations:
Net cash provided by operating activities		—			9,011			1,411
Net cash provided by investing activities		—			158,186			30,235
Net cash used in financing activities		—			(172,204	)		(32,364	)

Net cash used in discontinued operations		—			(5,007	)		(718	)

Increase (decrease) in cash and cash equivalents		41,274			(29,071	)		10,681

Cash and cash equivalents at beginning of period, continuing operations		153,474			177,538			166,139
Cash and cash equivalents at beginning of period, discontinued operations		—			5,007			5,725

Cash and cash equivalents at beginning of period		153,474			182,545			171,864

Cash and cash equivalents at end of period, continuing operations		194,748			153,474			177,538
Cash and cash equivalents at end of period, discontinued operations		—			—			5,007


Cash and cash equivalents at end of period		194,748			153,474			182,545

Supplemental Cash Flow Information:
Interest paid from continuing operations	$	145,183		$	106,803		$	117,053
Income taxes paid from continuing operations		30,363			13,170			1,066

See notes to consolidated financial statements.

Citizens Banking Corporation

Notes To Consolidated Financial Statements

December 31, 2005, 2004, and 2003

Citizens Banking Corporation, incorporated in the State of Michigan in 1980, is a diversified banking and financial services company that is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Citizens provides a full range of banking and financial services to individuals and businesses through its subsidiaries, Citizens Bank and F&M Bank-Iowa. These services include deposit products such as checking, savings, and money market accounts, and loan products such as business, personal, educational, residential, and commercial mortgage loans, and other consumer-oriented financial services, such as IRA and Keogh accounts, lease financing for a variety of capital equipment for commerce and industry, and safe deposit and night depository facilities. Automated Teller Machines (“ATMs”), which provide 24-hour banking services to customers, are installed in many locations in the Corporation’s service areas. The Corporation participates in an interstate and international shared ATM network, which allows its customers to perform banking transactions from their checking, savings, or credit card accounts at ATMs in a multi-state and international environment. Among the services designed specifically to meet the needs of businesses are various types of specialized financing, treasury management services, and transfer/collection facilities. Citizens also provides wealth management services through Citizens Bank Wealth Management, N.A., and through the affiliate trust department of F&M Bank-Iowa. The Corporation is not dependent upon any single or limited number of customers, the loss of which would have a material adverse effect on the Corporation. No material portion of the business of the Corporation is seasonal.

Note 1. Restatement of Financial Statements

The information included in this Form 10-K sets forth the effects of Citizens’ restatement on the previously reported financial statements of operations for 2004 and 2003 to reflect the sale of the Illinois Bank as discontinued operations. These changes do not affect its reported financial condition or net income for any of the years mentioned.

On August 5, 2004, Citizens completed the sale of its subsidiary bank, Citizens Bank-Illinois, N.A., to Metropolitan Bank Group, Inc. in a cash transaction valued at $26.3 million. The Illinois Bank was comprised of three branch locations with $173.2 million of assets, $78.5 million of loans and $155.3 million of deposits as of August 5, 2004. Citizens realized a pretax gain of $11.7 million on the transaction. The sale of the Illinois Bank generated a tax loss benefit because Citizens’ tax basis in the stock of the Illinois Bank was greater than the Illinois Bank’s sale price. The results of the Illinois Bank are presented as discontinued operations in a separate category following results from continuing operations on the Consolidated Statements of Income.

This transaction does not affect the financial condition and results of operations for 2005 nor the December 31, 2004 consolidated balance sheets. The income from discontinued operations for the years ended December 31, 2004 and 2003 is presented below:


(in thousands)	2004			2003
Interest income	$	4,688		$	8,261
Interest expense		1,060			2,708
Net interest income		3,628			5,553
Provision for loan losses		(516	)		954
Noninterest income before securities gains		938			1,764
Investment securities gains		4			2
Gain on sale of discontinued operations		11,650			0
Noninterest expense		2,488			4,122

Income from discontinued operations before income tax		14,248			2,243

Income tax (benefit)		(170	)		801
Income from discontinued operations	$	14,418		$	1,442

Note 2. Summary of Significant Accounting Policies

The accounting and reporting policies of Citizens Banking Corporation and its subsidiaries (collectively, “Citizens” or “Corporation”) conform to U.S. generally accepted accounting principles (“GAAP”). References to the “Holding Company” refer to Citizens Banking Corporation alone. The following describes Citizens’ policies:

Basis of Financial Statement Presentation

The accompanying consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries. All material intercompany transactions have been eliminated in consolidation.

Additionally, the Corporation also determines whether it should consolidate other entities or account for them on the equity method of accounting depending on whether it has a controlling financial interest in an entity of less than 100% of the voting interest of that entity by considering the provisions of Accounting Research Bulletin 51 (ARB 51), “Consolidated Financial Statements,” or a controlling financial interest in a variable interest entity (“VIE”) by considering the provisions of FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” issued in January 2003, and FIN 46R issued in December 2003. The Corporation adopted the provisions of FIN 46 during the fourth quarter of 2003, and FIN 46R in the first quarter 2004. Under FIN 46, a VIE is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. Under FIN 46R, an entity that holds a variable interest in a VIE is required to consolidate the VIE if the entity is subject to a majority of the risk of loss from the VIE’s activities, is entitled to receive a majority of the entity’s residual returns or both. ARB 51 is considered for entities in which the total equity investment at risk is sufficient to enable the entity to finance itself independently and provides the equity holders with the obligation to absorb losses, the right to receive residual returns and the right to make financial and operating decisions.

The Corporation has one wholly owned trust formed for the purpose of issuing securities which qualify as regulatory capital and is considered a VIE. The Corporation is not the primary beneficiary, and consequently, the trust is not consolidated in the consolidated financial statements.

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are particularly susceptible to significant change include the determination of the allowance for loan losses, pension and postretirement benefits, derivative financial instruments and hedging activities, and income taxes.

Business Combinations

Since the issuance of Statement of Financial Accounting Standards, (“SFAS”) 141, “Business Combinations,” by the Financial Accounting Standards Board (FASB), business combinations initiated after June 30, 2001, are required to be accounted for by the purchase method. Under the purchase method, net assets of the business acquired are recorded at their estimated fair values as of the date of acquisition with any excess of the cost of the acquisition over the fair value of the net tangible and intangible assets acquired recorded as goodwill. Results of operations of the acquired business are included in the income statement from the date of acquisition.

Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase

Securities purchased under agreements to resell and securities sold under agreements to repurchase are generally accounted for as collateralized financing transactions and are recorded at the amounts at which the securities were acquired or sold plus accrued interest. Generally U.S. government and Federal agency securities are pledged as collateral under these financing arrangements and cannot be sold or repledged by the secured party. The fair value of collateral either received from or provided to a third party is continually monitored and additional collateral obtained or requested to be returned to Citizens as deemed appropriate.

Investment Securities

At the time of purchase, securities are classified as held to maturity, available for sale, or trading. Investment securities classified as held to maturity, which management has the positive intent and ability to hold to maturity, are reported at amortized cost, and adjusted for amortization of premiums and accretion of discounts, using a method that approximates level yield. The amortized cost of debt securities classified as held to maturity or available for sale is adjusted for amortization of premiums and accretion of discounts to the earlier of call or maturity date, or in the case of mortgage-related securities, over the estimated life of the security. Such amortization and accretion is included in interest income from the related security. Available for sale securities are reported at fair value with unrealized gains and losses, net of related deferred income taxes, included in shareholders’ equity as a separate component of other comprehensive income. The cost of securities sold is based on the specific identification method. Any security for which there has been an other-than-temporary impairment of value is written down to its estimated fair value through a charge to earnings and a new cost basis is established. Realized securities gains or losses and declines in value judged to be other-than-temporary are included in investment securities gains (losses), net, in the consolidated statements of income.

Loans

Loans are generally reported at the principal amount outstanding, net of unearned income. Interest income is recognized on an accrual basis. Loan origination fees, certain direct costs, unamortized premiums and unearned discounts are deferred and amortized into interest income as an adjustment to the yield over the term of the loan. Loan commitment fees are generally deferred and amortized into fee income on a straight-line basis over the commitment period. Other credit-related fees, including letter and line of credit fees, are amortized into fee income on a straight-line basis over their contractual life.

Loans are placed on nonaccrual status when the collection of principal or interest is considered doubtful, or payment of principal or interest is past due 90 days or more (which approximates three payments late) and the loan is not well secured and is in the process of collection. When these loans (including a loan impaired) are placed on nonaccrual status, all interest previously accrued but unpaid is reversed against current year interest income. Loans are normally restored to accrual status when interest and principal payments are current and it is believed that the financial condition of the borrower has improved to the extent that future principal and interest payments will be met on a timely basis.

Commercial and commercial real estate loans are generally charged off to the extent principal and interest due exceed the net realizable value of the collateral, with the charge-off occurring when the loss is reasonably quantifiable but not later than when the loan becomes 180 days past due. Residential mortgage loans are generally charged off after foreclosure to the extent principal and interest due exceed 75% of the current appraised value. Direct and indirect consumer loans (open and closed end) are generally charged off before the loan becomes 120 days past due.

Based on their internal credit rating, commercial and commercial real estate loans exceeding certain fixed dollar amounts are evaluated for impairment in accordance with the provisions of SFAS 114, “Accounting by Creditors for Impairment of a Loan,” which requires an allowance to be established as a component of the allowance for loan losses when it is probable all amounts due will not be collected pursuant to the contractual terms of the loan and the recorded investment in the loan exceeds its fair value. In most instances the fair value is measured based on the fair value of the collateral. Fair value may

also be measured using either the present value of expected future cash flows discounted at the loan’s effective interest rate or the observable market price of the loan.

Mortgage Loans Held for Sale

Mortgage loans held for sale are recorded at the lower of cost or market as determined on an aggregate basis and generally consist of current production of certain fixed-rate and variable-rate first mortgage loans. Holding costs are treated as period costs.

Gains and losses on the sales of loans are determined using the specific-identification method. Mortgage loans held for sale are valued on an aggregate basis at the lower of carrying amount or fair value. The majority of mortgage loans held for sale are sold within 60 days after closing. Citizens uses mandatory forward commitments, generally entered into at time of application, to protect the value of the mortgage loans from changes in interest rates during the period held. The cost basis of mortgage loans held for sale is adjusted, if material, by any gains or losses generated from mandatory forward commitments to sell the loans to investors in the secondary market. Citizens’ policy to hedge its market rate risk with mandatory forward commitments has been highly effective and has not generated any material gains or losses.

Allowance for Loan Losses

The allowance for loan losses is a reserve established through a provision for possible loan losses charged to expense, which represents management’s best estimate of probable losses that will be incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses inherent in the loan portfolio. The Corporation’s allowance for possible loan loss methodology is based on guidance provided in SEC Staff Accounting Bulletin No. 102, “Selected Loan Loss Allowance Methodology and Documentation Issues” and includes allowance allocations calculated in accordance with SFAS 114, as amended by SFAS 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures,” and allowance allocations determined in accordance with SFAS 5, “Accounting for Contingencies.” The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio, as well as trends in the foregoing. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Corporation’s control, including the performance of the Corporation’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The Corporation’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with SFAS 114 based on probable losses on specific commercial loans; (ii) homogenous loan pools valuation allowances determined in accordance with SFAS 5 based on quantitative Citizens’ or banking industry loan loss experience for similar loans with similar risk characteristics, with additional qualitative risks upon the best judgment of management; and (iii) general valuation allowances determined in accordance with SFAS 5 based on existing regional and local economic factors, including the automotive industry, a macroeconomic adjustment factor used to calibrate for the current economic cycle the bank is experiencing, and other judgmental factors supported by qualitative documentation such as the inherent imprecision of the loan loss projection models.

Premises and Equipment

Premises and equipment, including leasehold improvements, are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are computed principally on a straight-line basis and are charged to expense over the lesser of the estimated useful life of the assets or lease term. Maintenance and repairs are charged to expense as incurred. Gains and losses on dispositions are charged to income as incurred.

Long-lived depreciable assets are evaluated periodically for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. Impairment exists when the expected undiscounted future cash flows of a long-lived asset are less than its carrying value. In that event, Citizens recognizes a loss for the difference between the carrying amount and the estimated fair value of the asset based on a quoted market price, if applicable, or a discounted cash flow analysis.

Other Real Estate Owned

Other real estate owned is comprised of commercial and residential real estate properties acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure, and loans classified as in-substance foreclosure. These properties are carried at the lower of cost or fair value at the time of acquisition, net of estimated costs to sell, based upon current appraised value. Losses arising from the initial acquisition of such properties are charged against the allowance for loan losses at the time of transfer. Subsequent valuation adjustments to reflect current fair market value, as well as gains and losses on disposal of these properties are charged to other expenses as incurred.

Bank Owned Life Insurance

Bank Owned Life Insurance is recorded as an asset at the amount that could be realized under the insurance contracts as of the date of the consolidated balance sheets. The change in cash surrender value during the period is an adjustment of premiums paid in determining the expense or income to be recognized under the contracts for the period. This change is recorded in noninterest income as cash surrender value of life insurance revenue.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the cost of an acquisition over the fair value of net identifiable tangible and intangible assets acquired. Other intangible assets represent purchased assets that also lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. On January 1, 2002, Citizens adopted SFAS 142, “Goodwill and Other Intangible Assets.” Under the provisions of SFAS 142, goodwill is no longer ratably amortized into the income statement over an estimated life, but rather is tested at least annually for impairment. Impairment of goodwill is evaluated by line of business and geographic region and is based on a comparison of the recorded balance of goodwill to the applicable market value or discounted cash flows. To the extent that impairment may exist, the current carrying amount is reduced by the estimated shortfall. Therefore, any impairment of goodwill or intangibles will be recognized as an expense in the period of impairment. Intangible assets which have finite lives continue to be amortized over their estimated useful lives and also continue to be subject to impairment testing. All of Citizens’ other intangible assets have finite lives and are amortized on a straight-line basis over varying periods not exceeding 10 years. Prior to the adoption of SFAS 142, Citizens’ goodwill was amortized on a straight-line basis over varying periods not exceeding 20 years. Note 8 includes a summary of Citizens’ goodwill and other intangible assets as well as further detail about the impact of the adoption of SFAS 142.

Mortgage Servicing Rights

Citizens recognizes as a separate asset rights to service mortgage loans it does not own but services for others for a fee. This asset is included in other assets on the balance sheet and is carried at the lower of the initial carrying value, adjusted for amortization, or estimated fair value. Amortization is determined in proportion to and over the period of estimated net servicing income. Impairment of servicing assets is assessed based on the fair value of those rights. For purposes of measuring impairment, the rights are stratified by product type and interest rate.

The fair value of mortgage servicing assets is estimated by calculating the present value of estimated future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other economic factors. The expected and actual rates of mortgage loan prepayments are the most significant factors driving the value of mortgage servicing assets. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced.

Securitizations and Sales of Mortgage Loans

Citizens sells substantially all of the fixed-rate single-family mortgage loans originated, including adjustable-rate loans that convert to fixed-rate loans. These transactions are accomplished through cash sales to Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”) and other third-party investors, as well as through securitizations with FHLMC and FNMA. In general, mortgage-backed securities (“MBSs”) received from FHMLC or FNMA in exchange for fixed-rate mortgage loans are sold immediately in the securities market. From time to time, Citizens also exchanges fixed and variable rate mortgage loans held in portfolio for FHLMC or FNMA MBSs backed by the same loans. The resulting MBSs are sold to third party investors or classified as available for sale in the investment security portfolio.

If MBSs are retained in the investment portfolio, any gain or loss at time of sale is recorded as a security gain or loss. All other gains or losses associated with sales of single-family mortgage loans are recorded as a component of mortgage banking revenue. Typically, Citizens does not service the loans after they are sold or exchanged, but sells the mortgage servicing

rights, in a separate transaction, before or at the time of the securitization. Sales or securitizations of mortgage loans through FHLMC and FNMA are done under terms that do not provide for any material recourse to Citizens by the investor. Citizens does not retain any interest in these securitized mortgage loans.

Derivative Instruments

Citizens enters into derivative transactions from time to time to protect against the risk of adverse price or interest rate movements on the value of certain assets and liabilities and on future cash flows. Under the guidelines of SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, all derivative instruments are required to be carried at fair value on the balance sheet. SFAS 133 also provides special hedge accounting provisions. Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges under SFAS 133. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

Fair value hedges are accounted for by recording the fair value of the derivative instrument and the fair value related to the risk being hedged of the hedged asset or liability on the balance sheet with corresponding offsets recorded in the income statement. The adjustment to the hedged asset or liability is included in the basis of the hedged item, while the fair value of the derivative is recorded as a freestanding asset or liability. Actual cash receipts or payments and related amounts accrued during the period on derivatives included in a fair value hedge relationship are recorded as adjustments to the interest income or expense recorded on the hedged asset or liability.

Cash flow hedges are accounted for by recording the fair value of the derivative instrument on the balance sheet as either a freestanding asset or liability, with a corresponding offset recorded in other comprehensive income within shareholders’ equity, net of tax. Amounts are reclassified from other comprehensive income to the income statement in the period or periods the hedged forecasted transaction affects earnings.

Under both the fair value and cash flow hedge methods, derivative gains and losses not effective in hedging the change in fair value or expected cash flows of the hedged item are recognized immediately in the income statement.

Citizens utilizes mandatory forward commitments to protect against changes in interest rates and prices on its mortgage pipeline. These derivatives are marked to market through earnings. Citizens is also required to recognize certain contracts and commitments as derivatives when the characteristics of those contracts and commitments meet the definition of a derivative. In accordance with SFAS 133 and Staff Accounting Bulletion (SAB) 105, “Application of Accounting Principles to Loan Commitments,” Citizens also records as derivatives, residential loan commitments associated with loans held for sale. These derivatives are marked to market through earnings.

Citizens enters into various derivative agreements with customers desiring protection from possible adverse future fluctuations in interest rates. As an intermediary, Citizens generally maintains a portfolio of matched offsetting derivative agreements. These contracts are marked to market through earnings.

Stock-Based Compensation

Citizens’ stock-based compensation plans are accounted for based on the intrinsic value method set forth in Accounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees,” and related interpretations. Compensation expense for employee stock options is generally not recognized by Citizens because the exercise price of the stock option equals the market price of the underlying stock on the date of grant. Compensation expense for restricted share awards is ratably recognized over the period of service, usually the restricted period, based on the fair value of the stock on the date of grant.

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123R, “Share-Based Payment, (Revised 2004)” which must be adopted by January 1, 2006. Among other things, SFAS 123R eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be measured based on their fair values on the date of grant. The Corporation has selected the Black-Scholes option pricing model to determine the fair value of the stock options at the date of grant. Compensation expense will be recognized on a straight-line basis over the awards’ service periods using a modified prospective application.

During 2005 and 2004, the Board of Directors approved the acceleration of all the non-vested stock options previously awarded to employees, officers and directors. Consequently the majority of non-vested stock options were accelerated. The purpose of the vesting acceleration was to enable Citizens the opportunity to lower compensation expense associated with these options in future periods. As a result of these accelerations, the Corporation recognized $0.1 million and $0.3 million in expense during 2005 and 2004, respectively. The expense related to those options that were accelerated, that would have occurred after the adoption of SFAS 123R, and will not be recognized as a result of the change, would have been $2.9 million in 2006, $2.5 million in 2007, $1.6 million in 2008 and $0.3 million in 2009. Future levels of compensation cost recognized related to stock-based compensation awards will be impacted by new awards and/or modifications, repurchases and cancellations of existing awards after the adoption of this new standard.

The following table illustrates the effect on net income and earnings per share if Citizens had applied the fair value recognition provisions of SFAS 123R to its stock option awards. The increase in pro forma stock compensation expense for the 12 months ended December 31, 2005 was the result of the acceleration of certain options granted in prior years. As required by SFAS 123R, this modification was treated as the exchange of the original award for a new award. Consequently, $5.6 million of pre-tax additional pro forma stock compensation expense was recognized during the year.


	Year Ended December 31,
(in thousands, except per share amounts)	2005		2004		2003

Net income, as reported	$	80,525	$	76,097	$	65,951
Less pro forma expense related to options granted		5,554		2,855		2,261

Pro forma net income	$	74,971	$	73,242	$	63,690


Net income per share:
Basic — as reported	$	1.87	$	1.76	$	1.52
Basic — pro forma		1.74		1.69		1.47
Diluted — as reported		1.85		1.74		1.51
Diluted — pro forma		1.72		1.67		1.46

The fair values of stock options granted were estimated at the date of grant using a Black-Scholes option pricing model. The weighted-average assumptions used to determine the fair value of options granted are provided in Note 17 to the Consolidated Financial Statements.

Income Taxes

Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income taxes, which arise principally from temporary differences between the period in which certain income and expenses are recognized for financial accounting purposes and the period in which they affect taxable income, are included in the amounts provided for income taxes. In assessing the reliability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Citizens considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the period which the deferred tax assets are deductible, management believes it is more likely than not that the Corporation will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 2005.

The Corporation files a consolidated federal income tax return and individual Holding Company and subsidiary state income tax returns. When income and expenses are recognized in different periods for tax purposes, applicable deferred taxes are provided in the Consolidated Financial Statements. Accordingly, amounts equal to the tax benefits of those subsidiaries having taxable federal losses or credits are offset by other subsidiaries that incur federal tax liabilities.

Net Income per Share

Basic net income per share is based on net income divided by the weighted average number of shares outstanding in each period. Diluted net income per share shows the dilutive effect of additional common shares issuable upon the assumed exercise of stock options granted under Citizens’ stock option plans, using the treasury stock method.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents are considered to include cash and due from banks, interest-bearing deposits in other financial institutions, federal funds sold and securities purchased under agreements to resell.

Reclassifications

Certain amounts have been reclassified to conform to the current year presentation.

Note 3. Recent Accounting Pronouncements

Statements of Financial Accounting Standards

SFAS No. 154, “Accounting Changes and Error Corrections, a Replacement of APB Opinion No. 20 and FASB Statement No. 3” In May 2005, the FASB issued SFAS 154, which changes the accounting for and reporting of a change in accounting principle. This statement applies to all voluntary changes in accounting principle and changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impractical to determine either the period-specific or cumulative effect of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The adoption of this standard is not expected to have a material effect on financial condition, results of operations, or liquidity.

SFAS No. 123R, “Share-Based Payment (Revised 2004).” SFAS 123R establishes standards for the accounting for transactions in which an entity (i) exchanges its equity instruments for goods or services, or (ii) incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of the equity instruments. SFAS 123R eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the date of the grant. In 2005, the FASB issued further guidance on the classification and measurement of freestanding financial instruments originally issued for employee service and the application of grant date as defined in SFAS 123R. Citizens will adopt these statements on January 1, 2006 and will change its method of accounting for share-based awards to include estimated forfeitures in the initial estimate of compensation expense and to accelerate the recognition of compensation expense for retiree-eligible employees. The adoption of these standards is not expected to have a material effect on financial condition, results of operations, or liquidity.

Financial Accounting Standards Board (FASB) Staff Positions

FASB Staff Position (FSP) 115-1, ‘The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” In November 2005, the FASB issued FSP 115-1, which provides additional guidance on when an investment in a debt or equity security should be considered impaired and when that impairment should be considered other-than-temporary and recognized as a loss in earnings. Specifically, the guidance clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made. The FSP also required certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. This FSP is effective for years after December 15, 2005 and Citizens will apply this guidance in 2006. Citizens does not anticipate this to have a material impact on financial condition, results of operations, or liquidity.

Note 4. Recent Transactions

Insurance Settlement

Through collection efforts, loan loss recoveries were subsequently recorded to the Allowance for Loan Losses totaling $2.4 million over the course of 2003 and 2004. After exhausting efforts to obtain restitution from the borrowers on the remaining portion of these loans, Citizens filed a claim with one of its previous insurers who underwrote a financial institutions bond with a rider which protected Citizens from losses incurred resulting from reliance on false and fraudulent financial documentation. The claim was initially denied so Citizens filed a lawsuit against the insurer in early 2004.

On October 10, 2005, Citizens agreed to a settlement of $9.1 million with the insurer. The settlement agreement provides that the parties release each other from further liability and stipulated dismissal of the litigation with prejudice. It permits the Corporation to pursue claim against any other person or entity seeking recovery for the losses to which the litigation related. The settlement was accounted for as a loan loss recovery to the Allowance for Loan Losses.

Accounting for Derivative Instruments and Hedging Activities

Citizens incurred a pre-tax cumulative charge during the fourth quarter of 2005 to non-interest income of $3.6 million as a result of determining that the interest rate swaps related to brokered certificates of deposit did not qualify for fair value hedge accounting treatment under the “short-cut” method of SFAS 133. Further discussion of this charge is included in Note 19 to the Consolidated Financial Statements.

Securities Sale

Consolidation of Charters

During 2004, Citizens filed applications with the Federal Reserve Bank of Chicago and the State of Michigan Office of Financial and Insurance Services to consolidate its Michigan and Wisconsin subsidiary banks. On April 25, 2005, F&M Bank–Wisconsin became part of Citizens Bank and all offices were re-branded with the Citizens name and logo, which has been positively received by clients and staff. The resulting bank is regulated as a State of Michigan, Federal Reserve member bank. Although the consolidation did not have a significant effect on financial results, it created a more efficient banking franchise by allowing the combined banks to operate as a single entity. The consolidation eliminated the need for separate regulatory reporting and separate accounting and financial tracking by the two banks as well as allowed the Corporation to make more efficient use of its capital due to having one less legal entity.

Note5. Business Restructuring, Merger and Other Charges

In 2002, the Corporation recorded a net charge of $13.4 million ($8.7 million after-tax) for restructuring, impairment and other costs associated with reorganization of the consumer, commercial and wealth management lines of business.

The reorganization was the result of a detailed review of Citizens’ commercial banking, consumer banking, and wealth management areas by banking industry consultants and key members of management during the second and third quarters of 2002. This review revealed opportunities for process change, staff reassignment, reporting structure changes, branch closures, expense reduction and business growth. As a result of the reorganization, 133 employees were displaced (157 original employees less employees subsequently rehired for other available positions). Displaced employees are offered severance packages and outplacement assistance. Twelve banking offices were closed in the fourth quarter of 2002 and six additional offices were closed during the second quarter of 2003.

The reserve balance outstanding for business restructuring was $0.2 million at the end of 2005 and 2004. Total cash and non-cash charges were minimal for 2005 and $0.4 million for 2004. These charges against the reserve were primarily for severance and related benefit costs as well as facilities related contractual obligations.

Note 6. Investment Securities

The amortized cost, estimated fair value and gross unrealized gains and losses of investment securities follow:


	December 31, 2005								December 31, 2004
			Estimated								Estimated
	Amortized		Fair		Gross Unrealized				Amortized		Fair		Gross Unrealized
(in thousands)	Cost		Value		Gains		Losses		Cost		Value		Gains		Losses

*Available For Sale:*
U.S. Treasury	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Federal agencies:
Mortgage-backed		825,933		811,898		985		15,020		1,057,401		1,056,208		4,246		5,439
Other		309,681		310,408		2,046		1,319		287,044		291,991		5,269		322
State and municipal		364,853		378,235		14,391		1,009		372,602		395,878		23,628		352
Mortgage and asset-backed		280		280		1		1		2,633		2,669		37		1
Other		1,072		1,176		107		3		295		388		95		2

Total available for sale	$	1,501,819	$	1,501,997	$	17,530	$	17,352	$	1,719,975	$	1,747,134	$	33,275	$	6,116


*Held to Maturity:*
State and municipal
Total held to maturity	$	82,431	$	82,364	$	590	$	657	$	54,035	$	54,749	$	849	$	135


*Other Investment Securities:*
FHLB and Fed Reserve stock
Total Other Securities	$	55,911	$	55,911	$	—	$	—	$	67,390	$	67,390	$	—	$	—

The amortized cost, estimated fair value and weighted average yields of debt securities by maturity at December 31, 2005 are shown below. Maturities of mortgage-backed securities are based upon current industry prepayment schedules.

As of December 31, 2005


	Less than 12 Months				More than 12 Months				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses

*Available For Sale:*
U.S. Treasury	$	—	$	—	$	—	$	—	$	—	$	—
Federal agencies:
Mortgage-backed		320,048		3,669		440,599		11,351		760,647		15,020
Other		173,266		1,319		—		—		173,266		1,319
State and municipal		36,539		658		10,046		351		46,585		1,009
Mortgage and asset-backed		197		1		—		—		197		1
Other		—		—		6		3		6		3

Total available for sale		530,050		5,647		450,651		11,705		980,701		17,352


*Held to Maturity:*
State and municipal		41,471		544		3,660		113		45,131		657

Total held to maturity		41,471		544		3,660		113		45,131		657


Total	$	571,521	$	6,191	$	454,311	$	11,818	$	1,025,832	$	18,009

As of December 31, 2004


	Less than 12 Months				More than 12 Months				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses

*Available For Sale:*
U.S. Treasury	$	—	$	—	$	—	$	—	$	—	$	—
Federal agencies:
Mortgage-backed		263,928		2,142		381,676		3,297		645,604		5,439
Other		43,271		322		—		—		43,271		322
State and municipal		1,537		23		13,736		329		15,273		352
Mortgage and asset-backed		153		1		—		—		153		1
Other		—		—		9		2		9		2

Total available for sale		308,889		2,488		395,421		3,628		704,310		6,116


*Held to Maturity:*
State and municipal		9,230		126		1,595		9		10,825		135

Total held to maturity		9,230		126		1,595		9		10,825		135

Total	$	318,119	$	2,614	$	397,016	$	3,637	$	715,135	$	6,251

The unrealized losses are mostly due to increases in market interest rates over yields at the time the underlying securities were purchased. Recovery of fair value is expected as the securities approach their maturity date or re-pricing date or if valuations for such securities improve as market yields change. Management considers, among other things, the length of time and the extent to which fair value is less than cost, the credit worthiness and near-term prospects of the issuer, and the intent and ability of Citizens to retain the investment in the issuer for a period of time sufficient to allow for recovery of amortized cost. Factors considered in the determination of intent and ability include capital adequacy, interest rate risk profile, liquidity and business plans. As such, Citizens has the intent and ability to hold the impaired securities to anticipated recovery, but may change its intent in response to significant, unanticipated changes in policies, regulations, statutory legislation, or other afore-mentioned criteria.

As of December 31, 2005, management believes the impairments detailed in the previous table are temporary and no impairment loss has been realized in Citizens’ consolidated income statement.

Sales of investment securities resulted in realized gains and losses as follows:


				Year Ended December 31,
(in thousands)	2005			2004			2003

				(Restated)			(Restated)
Securities gains	$	49		$	639		$	180
Securities losses		(8,976	)		(2,152	)		(79	)

Net (Loss) Gain	$	(8,927	)	$	(1,513	)	$	101

Securities with amortized cost of $0.8 billion as December 31, 2005, and $1.3 billion at December 31, 2004, were pledged to secure public deposits, repurchase agreements, and other liabilities. Except for obligations of U.S. Government and its Agencies, no holdings of securities of any single issuer exceeded 10% of consolidated shareholders equity at December 31, 2005 or 2004.

Note 7. Loans and Nonperforming Assets

Citizens extends credit primarily within the Midwestern states of Michigan, Wisconsin and Iowa. In Michigan, the primary market includes most parts of the Lower Peninsula. In Wisconsin, the primary markets are the Fox Valley region extending from Green Bay to Appleton to Oshkosh as well as northeastern and southwestern Wisconsin. In Iowa, the primary market is central Iowa. Prior to the August 2004 sale of the Illinois subsidiary, Citizens had a presence in the western suburban market of Chicago, Illinois. Citizens seeks to limit its credit risk by using established guidelines to review its aggregate outstanding commitments and loans to particular borrowers, industries and geographic areas. Collateral is secured based on the nature of the credit and management’s credit assessment of the customer.

Citizens’ loan portfolio is widely diversified by borrowers with no concentration within a single industry that exceeds 10% of total loans. Citizens has minimal loans to foreign debtors. The majority of Citizens’ commercial real estate loans consist of mortgages on owner-occupied properties. Those borrowers are involved in business activities other than real estate, and the sources of repayment are not dependent on the performance of the real estate market.

A summary of nonperforming assets follows:


	December 31,
(in thousands)	2005		2004

Nonperforming loans:
Nonaccrual	$	32,140	$	42,819
Loans 90 days past due (still accruing)		385		40
Restructured		—		42

Total nonperforming loans		32,525		42,901
Other real estate		5,306		6,882
Other assets acquired by repossession		2,045		1,064

Total nonperforming assets	$	39,876	$	50,847

The effect of nonaccrual-nonperforming loans on interest income follows:


	Year Ended December 31,
(in thousands)	2005		2004		2003

					(Restated)
Interest income:
At original contract rates	$	2,545	$	3,819	$	6,071
As actually recognized		615		2,035		3,913

Interest foregone	$	1,930	$	1,784	$	2,158

There are no significant commitments outstanding to lend additional funds to clients whose loans were classified as nonaccrual or restructured at December 31, 2005.

A summary of impaired loans and their effect on interest income follows:


					Valuation Reserve
(in thousands)	2005		2004		2005		2004
Balances — December 31
Impaired loans with valuation reserve	$	7,989	$	32,654	$	5,059	$	15,315
Impaired loans with no valuation reserve		908		2,389		—		—

Total impaired loans	$	8,897	$	35,043	$	5,059	$	15,315


Impaired loans on nonaccrual basis	$	4,728	$	13,010	$	2,747	$	4,541
Impaired loans on accrual basis		4,169		22,033		2,312		10,774

Total impaired loans	$	8,897	$	35,043	$	5,059	$	15,315


Average balance for the year	$	24,398	$	54,023
Interest income recognized for the year		1,057		2,144
Cash collected applied to outstanding principal		393		788

Certain directors and executive officers of Citizens and its significant subsidiaries, including their families and entities in which they have 10% or more ownership, were clients of the banking subsidiaries. Total loans to these clients aggregated $3.0 million and $5.3 million at December 31, 2005 and 2004, respectively. During 2005, new loans of $1.1 million were made and repayments totaled $3.4 million.

The Consolidated Financial Statements do not include loans serviced for others, which totaled $51.1 million and $47.6 million at December 31, 2005 and 2004, respectively.

Note 8. Goodwill and Other Intangible Assets

SFAS 142, “Goodwill and Other Intangible Assets”, requires that goodwill be tested for impairment at least annually. Citizens performed its annual impairment testing as of September 30, 2005 and no impairment was identified. A summary of goodwill allocated to the lines of business as of December 31, 2005 and 2004 follows.


	December 31,
(in thousands)	2005			2004

Land	$	30,836		$	20,362
Buildings		150,882			148,299
Leasehold improvements		5,965			6,642
Furniture and equipment		119,641			117,464

Total Cost of Premises & Equipment		307,324			292,767
Accumulated depreciation and amortization		(185,594	)		(174,823	)

Net Book Value of Premises & Equipment	$	121,730		$	117,944

Certain branch facilities and equipment are leased under various operating contracts. Total rental expense, including expenses related to these operating leases, was $4.3 million in 2005, $3.8 million in 2004 and $4.5 million in 2003. The increase in total rental expense in 2005 was a result of business expansion in Southeast Michigan as Citizens added two new operating branches there in 2005. Future minimum rental commitments under non-cancelable operating leases are as follows at December 31, 2005: $3.6 million in 2006, $2.6 million in 2007, $2.0 million in 2008, $1.7 million in 2009, $1.7 million in 2010 and $7.7 million beyond 2010.

Note 11. Deposits

A summary of deposits follows:


	December 31,
(in thousands)	2005		2004

Noninterest-bearing demand	$	969,074	$	898,820
Interest-bearing demand		891,313		1,150,332
Savings		1,437,024		1,638,295
Time deposits over $100,000		1,092,411		650,145
Other time deposits		1,084,017		962,168

Total	$	5,473,839	$	5,299,760

Excluded from total deposits are demand deposit account overdrafts, which have been reclassified as loans. At December 31, 2005 and 2004, these overdrafts totaled $3.1 million and $5.1 million, respectively. Time deposits over $100,000 with remaining maturities of one year or more are $224.9 million at December 31, 2005. The maturities of these time deposits are as follows: $46.9 million in 2007, $42.6 million in 2008, $23.0 million in 2009, $33.2 million in 2010 and $79.2 million after 2010.

Note 12. Short-Term Borrowings

Short-term borrowings consist of federal funds purchased and securities sold under agreements to repurchase, Federal Home Loan Bank (FHLB) borrowings, other bank borrowings, and Treasury Tax and Loan borrowings. Federal funds purchased are overnight borrowings from other financial institutions. Securities sold under agreements to repurchase are secured transactions done principally with investment banks. Maturities of securities sold under agreements to repurchase are generally 90 days or less.

Information relating to federal funds purchased and securities sold under agreements to repurchase follows:


(in thousands)	2005			2004			2003

				(Restated)			(Restated)
At December 31:
Balance	$	505,879		$	671,660		$	586,131
Weighted average interest rate paid		4.13	%		2.19	%		1.01	%
During the year:
Maximum outstanding at any month-end	$	964,524		$	803,186		$	660,401
Daily average		802,554			643,327			441,668
Weighted average interest rate paid		3.21	%		1.40	%		1.09	%

Citizens did not have any significant short-term borrowings with the FHLB in 2005 or 2003. Information relating to short-term FHLB borrowings in 2004 follows:


(in thousands)	2004

At December 31:
Balance	$	25,000
Weighted average interest rate paid		2.41	%
During the year:
Maximum outstanding at any month-end	$	25,000
Daily average		1,025
Weighted average interest rate paid		2.41	%

Citizens’ Holding Company maintains a short-term line of credit with four unaffiliated banks totaling $75.0 million. As of December 31, 2005, there was no outstanding balance. The credit facility will mature in August 2006 and is expected to be extended at that time. The credit agreement requires Citizens to maintain certain financial covenants. Citizens was in full compliance with all debt covenants as of December 31, 2005.

Note 13. Long-Term Debt

A summary of long-term debt follows:


	December 31,
(in thousands)	2005		2004

Citizens (Parent only):
Subordinated debt:
Notes maturing February 2013	$	120,852	$	123,948
Deferrable interest debenture maturing June 2033		25,774		25,774
Subsidiaries:
Federal Home Loan Bank advances		859,483		800,161
Other borrowed funds		—		38

Total long-term debt	$	1,006,109	$	949,921

On January 27, 2003, Citizens issued $125.0 million of 5.75% subordinated notes maturing February 1, 2013. Citizens subsequently entered into an interest rate swap to hedge the interest rate risk on the subordinated debt. The carrying value of the subordinated notes has been adjusted to reflect the gain or loss attributable to the risk hedged. Issuance costs were capitalized and are included in other assets on the balance sheet. The issuance costs are being amortized over ten years as a component of interest expense. Under the risk-based capital guidelines, the subordinated debt qualifies as Tier 2 supplementary capital.

On June 26, 2003, Citizens issued approximately $25.0 million of floating rate, 30 year trust preferred securities through an unconsolidated special purpose trust to unrelated institutional investors. The gross proceeds from issuance were used to purchase a floating rate junior subordinated deferrable interest debenture (the “Debenture”) issued by Citizens, which is the sole asset of the trust. The Debenture matures in thirty years and bears interest at an annual rate equal to the three-month LIBOR plus 3.10%, payable quarterly beginning in September, 2003. Interest is adjusted on a quarterly basis provided that prior to May 2008, the interest rate shall not exceed 11.75%. The Debenture is an unsecured obligation of Citizens and is junior in the right of payment to all future senior indebtedness of Citizens. Citizens has guaranteed that interest payments on the Debenture made to the trust will be distributed by the trust to the holders of the trust preferred securities. Issuance costs of $0.5 million were capitalized and are included in other assets on the balance sheet. The trust preferred securities of the special purpose trust are callable after five years at par and must be redeemed in thirty years after issuance. In accordance with FASB Interpretation 46 and APB 21, the issuance costs are amortized to the call date over five years as a component of interest expense, as Citizens believes this is the most probable life of these securities. As of December 31, 2005, $0.3 million of the issuance costs have been amortized, with the remaining balance of $0.2 million. Under the risk-based capital guidelines, the trust preferred securities currently qualify as Tier 1 capital.

In August 2004, Citizens extinguished $235.0 million of FHLB advances maturing between July 2007 and February 2011. Subsequently, two new advances were issued: a $145.0 million amortizing advance with a 3.64% coupon that matures on August 11, 2008 and a $130.0 million amortizing advance with a 3.655% coupon that matures on November 10, 2008. Amortization on the $145.0 million advance begins in August 2006, and amortization on the $130.0 million advance begins in November 2006. Neither advance is subject to put, call, or conversion options.

Long-term advances from the FHLB are at fixed and variable rates ranging from 2.32% to 7.10% and mature from 2006 through 2021. Fixed and variable rate FHLB advances totaling $749.5 million are non-convertible and have neither put nor call options. FHLB advances totaling $60.0 million may be converted to a floating rate at the option of the FHLB, and advances totaling $50.0 million may be put back to Citizens prior to maturity at the option of the FHLB. Interest is paid monthly.

Long-term advances from the FHLB were collateralized at December 31, 2005 with $2.0 billion of residential and commercial loans secured by real estate, $227.8 million par value of investment securities, and FHLB stock. At December 31, 2004, $1.7 billion of residential and commercial loans secured by real estate, $467.7 million par value of investment securities, and FHLB stock collateralized long-term advances from the FHLB. The increase in the amount of loans and decrease in the amount of investment securities pledged as collateral at the FHLB in 2005 versus 2004 reflects the decision to make the investment securities available for alternative uses.

Maturities of long-term debt follows:


(in thousands)	Parent		Subsidiaries		Consolidated

2006	$	—	$	255,927	$	255,927
2007		—		190,780		190,780
2008		—		281,040		281,040
2009		—		1,509		1,509
2010		—		26,114		26,114
Over 5 Years		146,626		104,113		250,739

Total	$	146,626	$	859,483	$	1,006,109

Note 14. Employee Benefit Plans

Pension and Postretirement Benefits: Citizens maintains cash balance defined benefit pension plans covering the majority of its employees, and postretirement benefit plans for retirees that include health care benefits. Pension retirement benefits are based on the employee’s length of service and salary levels. Actuarially determined pension costs are charged to current operations. It is Citizens’ policy to fund pension costs in an amount sufficient to meet or exceed the minimum funding

requirements of applicable laws and regulations, plus such additional amounts as Citizens deems appropriate up to that allowable by federal tax regulations.

Citizens also maintains nonqualified supplemental benefit plans for certain key employees. These plans are provided for by charges to earnings sufficient to meet the projected benefit obligation under applicable accounting standards. The defined pension benefits provided under these plans are unfunded and any payments to plan participants are made by Citizens.

Effective January 1, 2002 the defined benefit plan for Citizens’ employees was amended to provide for a new cash balance pension benefit. Employees are eligible for early retirement at age 55 with at least 5 years service. Employees hired prior to January 1, 2002 will receive the greater of the benefit from the new formula or the old formula with the old formula continuing to run until December 31, 2006. The old formula is based, in part, on an employee’s final five-year average base pay. The defined benefit plan established for Citizens’ F&M employees in 2000 also provides for a cash balance pension benefit.

Citizens’ postretirement benefit plan, as amended, is available to full-time employees who retire at normal retirement age, were age 50 prior to January 1, 1993 and have at least 15 years of credited service under Citizens’ defined benefit pension plan. The medical portion of the plan is contributory to the participants. Those retired prior to January 1, 1993 receive benefits provided by the plan prior to its amendment. That plan included dental care, had some retiree contribution requirements, and had less restrictive eligibility requirements.

An actuarial measurement date of December 31 was utilized in the following table to determine the projected benefit obligations and fair value of plan assets.


	Pension						Postretirement
	Benefits						Benefits
(in thousands)	2005			2004			2005			2004

Change in Benefit Obligation
Projected benefit obligation, beginning of year	$	91,358			84,947		$	17,092		$	18,754
Service cost		5,040			4,249			4			8
Interest cost		5,196			5,171			535			999
Participant contribution		—			—			219			264
Actuarial (gains) losses		5,755			5,026			(3,805	)		(1,431	)
Plan amendments		—			—			(2,869	)		—
Benefits paid		(7,831	)		(8,035	)		(1,357	)		(1,502	)

Projected benefit obligation, end of year	$	99,518		$	91,358		$	9,819		$	17,092

Accumulated benefit obligation, end of year	$	96,380		$	89,122		$	9,819		$	17,092


Change in Plan Assets
Fair value of plan assets, beginning of year	$	86,938		$	85,040		$	—		$	—
Actual return on plan assets		6,503			8,257			—			—
Employer contribution		3,499			1,676			1,138			1,238
Participant contribution		—			—			219			264
Benefits paid		(7,831	)		(8,035	)		(1,357	)		(1,502	)

Fair value of plan assets, end of year	$	89,109		$	86,938		$	—		$	—


Reconciliation of Funded Status
(Under)/Over funded	$	(10,409	)	$	(4,420	)	$	(9,819	)	$	(17,092	)
Unrecognized:
Net transition asset		—			(5	)		—			—
Prior service cost (benefit)		1,289			1,485			(2,621	)		(23	)
Net actuarial (gain) loss		22,955			17,953			(1,262	)		2,452
Adjustment to recognize minimum liability		(1,965	)		(168	)		—			—

Net amount recognized in the consolidated balance sheets	$	11,870		$	14,845		$	(13,702	)	$	(14,663	)

The components of net periodic benefit cost charged to operations each year for all plans follow:


	Year Ended December 31,
(in thousands)	2005			2004			2003

Defined Benefit Pension Plans
Service cost	$	5,040		$	4,250		$	4,124
Interest cost		5,196			5,172			5,095
Expected return on plan assets		(7,018	)		(7,069	)		(7,901	)
Amortization of unrecognized:
Net transition asset		(6	)		(10	)		(10	)
Prior service cost		196			194			222
Net actuarial gain		1,269			732			61

Net pension cost		4,677			3,269			1,591

Postretirement Benefit Plans
Service cost		4			8			11
Interest cost		535			998			1,161
Amortization of unrecognized:
Prior service cost		(271	)		(5	)		(4	)
Net actuarial loss		(91	)		17			146

Net postretirement benefit cost		177			1,018			1,314

Defined contribution retirement and 401(k) plans
Employer contributions		3,170			3,158			3,033

Total periodic benefit cost	$	8,024		$	7,445		$	5,938

The assumptions used in determining the actuarial present value of the benefit obligations and the net periodic pension expense follow:


	Pension						Postretirement
	Benefits						Benefits
December 31,	2005			2004			2005			2004

Assumptions used to compute projected benefit obligation
Discount rate		5.50	%		5.75	%		5.50	%		5.75	%
Rate of compensation increase:								—			—
Cash balance defined benefit plans		5.00	%		⁽¹	⁾
Nonqualified supplemental benefit plans		6.00	%		6.00	%

Assumptions used to compute net benefit costs
Discount rate		5.75	%		6.25	%		5.75	%		6.25	%
Expected return on plan assets		8.75			8.75
Rate of compensation increase:								—			—
Cash balance defined benefit plans		5.00	%		⁽¹	⁾
Nonqualified supplemental benefit plans		6.00	%		6.00	%


⁽¹⁾ Scaled by age of plan participant — 9.0% at age 24 or under declining to 4.0% at age 50 or older.

At December 31, 2005, plan assets exceeded the accumulated plan benefits for all plans except the supplemental benefit plans. The projected benefit obligation and accumulated benefit obligation for these supplemental benefit plans were approximately $11.9 million and $10.3 million as of December 31, 2005 compared to $7.8 million and $7.1 million as of December 31, 2004, respectively.

At December 31, 2005, the projected benefit payments for the defined benefit pension plans and the postretirement benefit plan totaled $5.9 million and $0.9 million in 2006, $5.8 million and $0.9 million in 2007, $6.5 million and $0.9 million in 2008, $7.0 million and $0.9 million in 2009, $6.9 million and $0.9 million in 2010, and $41.1 million and $4.2 million in the

years 2011 through 2015, respectively. The projected payments were calculated using the same assumptions as those used to calculate the benefit obligations listed above.

Investment Policy and Strategy: Management’s investment policy and strategy for managing defined benefit plan assets is described as growth with income. The strategy provides for a target mix of 70% invested in equity securities and 30% invested in fixed income debt securities and in cash or short-term equivalents. Management analyzes the potential risks and rewards associated with the asset allocation strategies on a quarterly basis. Implementation of the strategies includes regular rebalancing to the target asset allocation. The plans’ target asset allocation and the actual asset allocation at December 31, 2005 and 2004 are presented below.


	Target			Percentage of Plan Assets
December 31,	Allocation			2005			2004

Asset Category:
Equity securities		70			69			71	%
Debt securities		29			23			26
Cash and Cash Equivalents		1			8			3

		100	%		100	%		100	%

Currently, Citizens does not anticipate making a contribution to the defined benefit pension plans in 2006. Citizens will review the funding of its plans during 2006 and will make a contribution, if appropriate. The Corporation anticipates making a contribution of $0.5 million to the nonqualified supplemental benefit plans during 2006. In addition, Citizens expects to pay $0.9 million in contributions to the postretirement healthcare benefit plan during 2006.

Prior service pension costs are amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits under the plans. For postretirement health care benefit plans, Citizens assumed a 10.0% annual health care cost trend rate in 2005, graded down to 5.0% over six years. This assumption can have a significant effect on the amounts reported. A one-percentage-point change in assumed health care cost trend rates would have the following effects:


	One Percentage		One Percentage
(in thousands)	Point Increase		Point Decrease

Effect on total of service and interest cost components	$	36	$	(32	)
Effect on the postretirement benefit obligation		688		(616	)

Defined Contribution Retirement and 401(k) Plans: Substantially all employees are eligible to contribute a portion of their pre-tax salary to a defined contribution 401(k) savings plan. Under the plan, employee contributions are partially matched by Citizens. The employer matching contribution is 75 percent of the first 6% (100 percent of the first 3% plus 50 percent of the next 3%) of each eligible employee’s qualifying salary contributed to the plan. In addition, one third of the match is intended to be used by the employees for purposes of retiree medical expenses.

Note 15. Income Taxes

Significant components of income taxes are as follows:


	Year Ended December 31,
(in thousands)	2005			2004			2003

				(Restated)			(Restated)
Current tax expense from continuing operations:
Federal	$	33,671		$	19,886		$	16,655
State		1,479			121			101

Total current tax expense		35,150			20,007			16,756
Deferred tax expense (benefit)		(3,569	)		(417	)		1,619

Total income tax expense from continuing operations		31,581			19,590			18,375
Discontinued Operations tax expense (benefit)		—			(170	)		801

Total income tax expense	$	31,581		$	19,420		$	19,176

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of Citizens’ deferred tax assets and liabilities as of December 31, 2005 and 2004 follow:


(in thousands)	2005		2004

Deferred tax assets:
Allowance for loan losses	$	41,675	$	45,173
Accrued postemployment benefits other than pensions		4,906		5,421
Deferred compensation		5,228		4,703
Accrued expenses		2,930		2,445
State net operating loss carryforwards		1,294		2,080
Minimum pension liability		688		59
Other deferred tax assets		2,929		341

Deferred tax assets		59,650		60,222

Deferred tax liabilities:
Pension		7,905		8,089
Acquisition premium on loans		2,929		5,170
Tax over book depreciation		1,640		4,570
Basis difference in FHLB stock		1,940		2,921
Purchase accounting adjustments		4,532		3,156
Unrealized gains on securities and derivatives		933		9,748
Other deferred tax liabilities		1,505		1,317

Deferred tax liabilities		21,384		34,971

Net deferred tax assets	$	38,266	$	25,251


	Year Ended December 31,
(in thousands)	2005		2004		2003

			(Restated)		(Restated)
*Continuing Operations*
*Numerator:*
Numerator for basic and dilutive earnings per share — income from continuing operations available to common shareholders	$	80,525	$	61,679	$	64,509

*Denominator:*
Denominator for basic earnings per share — weighted average shares		43,096		43,266		43,304
Effect of dilutive securities — potential conversion of employee stock options		316		497		305

Denominator for diluted earnings per share — adjusted weighted-average shares and assumed conversions		43,412		43,763		43,609

Basic earnings per share	$	1.87	$	1.43	$	1.49

Diluted earnings per share	$	1.85	$	1.41	$	1.48


*Discontinued Operations*
*Numerator:*
Numerator for basic and dilutive earnings per share — income from discontinued operations available to common shareholders	$	—	$	14,418	$	1,442

*Denominator:*
Denominator for basic earnings per share — weighted average shares		43,096		43,266		43,304
Effect of dilutive securities — potential conversion of employee stock options		316		497		305

Denominator for diluted earnings per share — adjusted weighted-average shares and assumed conversions		43,412		43,763		43,609

Basic earnings per share	$	—	$	0.33	$	0.03

Diluted earnings per share	$	—	$	0.33	$	0.03


*Combined*
*Numerator:*
Numerator for basic and dilutive earnings per share — net income available to common shareholders	$	80,525	$	76,097	$	65,951

*Denominator:*
Denominator for basic earnings per share — weighted average shares		43,096		43,266		43,304
Effect of dilutive securities — potential conversion of employee stock options		316		497		305

Denominator for diluted earnings per share — adjusted weighted-average shares and assumed conversions		43,412		43,763		43,609

Basic earnings per share	$	1.87	$	1.76	$	1.52

Diluted earnings per share	$	1.85	$	1.74	$	1.51

Basic net income per share is calculated by dividing net income by the weighted-average number of shares outstanding for the period. Diluted net income per share takes into consideration the pro forma dilution assuming all in-the-money outstanding stock options were exercised. The average price of Citizens’ stock for the period is used to determine the dilutive effect of outstanding stock options. See Note 17 for additional disclosures regarding employee stock options.

Note 17. Shareholders’ Equity

Rights Agreement: Citizens is a party to a Rights Agreement, dated May 23, 2000, designed to protect shareholders from unfair takeover offers by encouraging a potential buyer to negotiate with Citizens’ board prior to attempting a takeover. Owners of Citizens’ common shares have been granted rights under the Rights Agreement to purchase one one-thousandth of a share of Series B Preferred Stock at an exercise price of $65, subject to adjustment. The rights are not exercisable or separately tradable until after a public announcement that a person or group, without board approval, has acquired 15% or more of Citizens’ common shares or has commenced a tender offer to do so. If a person or group acquires 15% or more of the common shares, the rights (other than those held by the acquiror, which become void) become exercisable to purchase common shares having a fair value of $130 for $65, or the board may exchange one common share for each outstanding right (other than those held by the acquiror). If the acquiror merges Citizens into another entity, the rights become exercisable for common shares of the surviving entity having a fair value of $130 for $65. The rights are redeemable by the board at any time prior to May 23, 2010 for $.001 per right. The Rights Agreement may be amended by the board without shareholder or right holder approval at any time prior to the acquisition by a person or group of 15% or more of the common shares. The rights will cause substantial dilution to a person or group attempting to acquire Citizens without action by Citizens’ board to deactivate the rights.

Stock Repurchase Plans: Citizens purchased shares under a stock repurchase program initiated October 2003. This program authorizes Citizens to purchase up to 3,000,000 shares for treasury. During the year, a total of 609,000 shares were purchased under this plan at an average price of $29.89. The repurchased shares have been accorded the accounting treatment as if retired.

Stock Option Plan: Citizens’ Stock Compensation plan, effective January 18, 2002 and approved by shareholders on April 16, 2002, authorizes the granting of incentive and nonqualified stock options, restricted stock, restricted stock units and performance awards to employees and non-employee directors at any time prior to January 18, 2012. Aggregate grants under the plan may not exceed 7,000,000 shares, and grants other than stock options are further limited to 2,000,000 shares. The plan replaces the option plan for key employees that expired January 16, 2002 and the Stock Option Plan for Directors, which was terminated.

In 2005, as an enhancement to the current compensation plan, Citizens began rewarding a combination of stock options and restricted stock to employees. Options and restricted stock shares granted to employees expire ten years from the date of grant. During 2005 and 2004, the Compensation and Human Resources Committee of our Board of Directors approved the acceleration of all non-vested stock options previously awarded to employees, officers and directors. Consequently the majority of non-vested stock options were early vested. The purpose of the vesting acceleration was to reduce compensation expense associated with these options in future periods. As a result of these accelerations, the Corporation recognized $0.1 million and $0.3 million in expense during 2005 and 2004, respectively. The expense related to those options that were accelerated, that would have occurred after the adoption of SFAS 123R, and will not be recognized as a result of the change, would have been $2.9 million in 2006, $2.5 million in 2007, $1.6 million in 2008 and $0.3 million in 2009. At December 31, 2005, options outstanding under the plan to employees (including those issued under the expired plan) totaled 3,917,891 shares of which 3,879,330 shares are currently vested and exercisable. Canceled and expired options become available for future grants. A total of 129,180 restricted stock shares are outstanding and the majority become vested three years from date of grant. Recipients of restricted shares are entitled to receive dividends and have voting rights.

A total of 12,925 options to buy shares were granted to non-employee directors in 2005. The options granted in 2005 and 2004 are vested immediately and expire ten years from the date of grant. Options issued to directors in or before 2003 have a term of five years and are fully vested. As of December 31, 2005, there were 91,156 shares of options outstanding, including those issued under the previous plan.

Other Stock Options: On May 18, 2000, Citizens granted stock options to all employees who did not receive grants under the key employee stock option plan. Each full-time employee received 200 shares and each part-time employee received 100 shares. The $16.66 exercise price of the grant was the market price of Citizens’ stock on the grant date. The options became exercisable on May 18, 2003 and expire ten years from the date of grant. A total of 550,700 shares were granted, of which 83,900 shares were outstanding as of December 31, 2005.

Citizens has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock issued to Employees” (APB 25) and related Interpretations in accounting for its employee stock options as permitted by SFAS 123R. Under APB

25, no compensation expense is recognized by Citizens because the exercise price of the stock options equals the market price of the underlying stock on the date of grant.

SFAS 123R requires certain pro forma disclosures regarding net income and earnings per share as if Citizens had accounted for its stock options under the fair value method of that statement. The following table provides these disclosures along with significant assumptions used to estimate the fair value of these options:


(in thousands, except per share amounts)	2005			2004			2003

Pro forma amounts:
Net income, as reported	$	80,525		$	76,097		$	65,951
Less pro forma expense related to options granted		5,554			2,855			2,261

Pro format net income	$	74,971		$	73,242		$	63,690


Net income per share:
Basic — as reported		1.87			1.76			1.52
Basic — pro forma		1.74			1.69			1.47
Diluted — as reported		1.85			1.74			1.51
Diluted — pro forma		1.72			1.67			1.46
Weighted-average assumptions:
Dividend yield		3.5	%		3.5	%		3.5	%
Expected volatility		26.8	%		28.0	%		28.0	%
Risk-free interest rate		3.80	%		3.78	%		2.64	%
Expected lives		1.5	yrs.		5	yrs.		5	yrs.

The weighted average fair values of stock options granted during 2005, 2004 and 2003 were $3.48, $6.34 and $5.02, respectively. The weighted average fair value of restricted stock granted during 2005, 2004, and 2003 were $29.00, $32.91, and $25.20, respectively.

A summary of stock option transactions under the plans for 2005, 2004 and 2003 follows:


	Options						Option Price
	Available						Per Share
	for Grant			Outstanding			Range		Average

January 1, 2003		6,098,300			3,434,167			11.75-36.31	$	25.28
Granted		(1,255,200	)		1,255,200			23.10-33.66		26.27
Restricted Stock Granted		(8,862	)		—			—		—
Exercised		—			(341,485	)		11.75-30.50		18.55
Canceled		49,200			(174,654	)		16.66-36.31		25.90

December 31, 2003		4,883,438			4,173,228			15.10-35.63		26.10
Granted		(741,771	)		741,771			29.06-34.56		30.16
Restricted Stock Granted		(3,666	)		—			—		—
Exercised		—			(397,994	)		15.10-32.60		20.75
Canceled		140,480			(274,830	)		16.66-35.63		27.26

December 31, 2004		4,278,481			4,242,175			15.28-35.63	$	27.24

Granted		(344,007	)		344,007			26.99-33.80		29.31
Restricted Stock Granted		(117,735	)		—			—		—
Exercised		—			(223,964	)		15.28-30.50		22.59
Canceled		174,141			(444,327	)		16.66-35.63		25.19

December 31, 2005		3,990,880			3,917,891			16.66-36.31	$	27.91

The following table summarizes information on stock options outstanding as of December 31, 2005:


	Options Outstanding						Options Exercisable
			Weighted-						Weighted-
			Average		Weighted-				Average
			Remaining		Average				Exercise
Range	Amount		Life		Exercise Price		Amount		Price

$16.66-25.00		492,333	3.8 years		$	19.01		492,333	$	19.01
25.01-29.00		1,390,419		6.8		26.03		1,358,678		26.04
19.01-36.31		2,035,139		6.3		31.35		2,028,319		31.35

$16.66-36.31		3,917,891		6.2		27.91		3,879,330		27.92

Note 18. Commitments, Contingent Liabilities and Guarantees

Commitments: The Consolidated Financial Statements do not reflect various loan commitments (unfunded loans and unused lines of credit) and letters of credit originated in the normal course of business. Loan commitments are made to accommodate the financial needs of clients. Generally, new loan commitments do not extend beyond 90 days and unused lines of credit are reviewed at least annually. Letters of credit guarantee future payment of client financial obligations to third parties. They are normally issued for services provided or to facilitate the shipment of goods, and generally expire within one year. Both arrangements have essentially the same level of credit risk as that associated with extending loans to clients and are subject to Citizens’ normal credit policies. Inasmuch as these arrangements generally have fixed expiration dates or other termination clauses, most expire unfunded and do not necessarily represent future liquidity requirements. Collateral is obtained based on management’s assessment of the client and may include receivables, inventories, real property and equipment.

Amounts available to clients under loan commitments and letters of credit follow:


	December 31,		December 31,
(in thousands)	2005		2004

Loan commitments and letters of credit:
Commitments to extend credit	$	1,762,259	$	1,769,968
Financial standby letters of credit		44,739		41,356
Performance standby letters of credit		11,557		6,198
Commercial letters of credit		223,269		207,460

Total loan commitments and letters of credit	$	2,041,824	$	2,024,982

Commitments outstanding to extend home equity credit lines totaled $485.5 million and $440.0 million at December 31, 2005 and December 31, 2004, respectively.

Contingent Liabilities: Citizens and its subsidiaries are parties to litigation arising in the ordinary course of business. Management believes that the aggregate liability, if any, resulting from these proceedings would not have a material effect on Citizens’ consolidated financial position or results of operations.

Contingent Guarantees: Citizens has performance obligations upon the occurrence of certain events under financial guarantees provided in certain contractual arrangements. At December 31, 2005, Citizens had issued approximately $44.7 million of financial standby letters of credit and $11.6 million of performance standby letters of credit. The same amounts at December 31, 2004 were $41.4 million and $6.2 million, respectively.

Change in Control Agreements: The Corporation has change-in-control agreements with certain executive officers. Under these agreements, each covered person could receive, upon the effectiveness of a change-in-control, three times his or her base compensation plus the greater of the target bonus established for the year or the highest bonus paid to the executive in the last three years. Additionally, subject to certain conditions, the executive’s insurance benefits will continue three full years after the termination and all long-term incentive awards will immediately vest.

Note 19. Derivatives and Hedging Activities

SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS 138 and SFAS 149, “Accounting for Certain Derivative Instruments and Certain Hedging Activities,” (collectively referred to as “SFAS 133”) establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value.

Citizens designates its derivatives based upon criteria established by SFAS 133. For a derivative designated as a fair value hedge, the derivative is recorded at fair value on the consolidated balance sheet. Any difference between the fair value change of the hedge versus the fair value change of the hedged item is considered to be the “ineffective” portion of the hedge. The ineffectiveness of the hedge is recorded in current earnings. For a derivative designated as a cash flow hedge, the effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income (loss) and subsequently reclassified into earnings when the hedged exposure affects earnings.

Citizens may use derivative instruments to hedge the variability in interest payments or protect the value of certain assets and liabilities recorded in its balance sheet from changes in interest rates. Citizens uses interest rate contracts such as interest rate swaps to manage its interest rate risk. These contracts are designated as hedges of specific assets or liabilities. The net interest receivable or payable on swaps is accrued and recognized as an adjustment to the interest income or expense of the hedged asset or liability. The following table summarizes the derivative financial instruments held or issued by Citizens.

Derivative Financial Instruments:


	December 31,					December 31,
	2005					2004

	Notional		Fair			Notional		Fair
(dollars in thousands)	Amount		Value			Amount		Value

Receive fixed swaps	$	530,000	$	(7,429	)	$	185,000	$	(1,134	)
Pay fixed swaps		124,000		2,486			104,000		693
Customer initiated swaps and corresponding offsets		233,104		—			142,674		—
Interest rate lock commitments		17,897		37			17,165		108
Forward mortgage loan contracts		22,000		(66	)		58,000		(68	)

Total	$	927,001	$	(4,972	)	$	506,839	$	(401	)

Derivative Classifications and Hedging Relationships:


	December 31,					December 31,
	2005					2004

	Notional		Fair			Notional		Fair
(dollars in thousands)	Amount		Value			Amount		Value

Derivatives Designated as Cash Flow Hedges:
Hedging repurchase agreements	$	124,000	$	2,486		$	104,000	$	693

Derivatives Designated as Fair Value Hedges:
Hedging time deposits		25,000		(10	)		60,000		(456	)
Hedging long-term debt		225,000		(3,815	)		125,000		(678	)

Derivatives Not Designated as Hedges:
Receive fixed swaps		280,000		(3,604	)		—		—
Customer initiated swaps and corresponding offsets		233,104		—			142,674		—

Total	$	887,104	$	(4,943	)	$	431,674	$	(441	)

At December 31, 2005, Citizens had outstanding $654.0 million of interest rate swap agreements with an average receive rate of 4.32% and pay rate of 3.24%. At December 31, 2004, Citizens had outstanding $289.0 million of interest rate swap agreements with an average receive rate of 4.48% and pay rate of 3.18%. In addition, Citizens had $233.1 million and $142.7 million respectively of customer initiated swaps and corresponding offsets used specifically to manage their interest rate exposure. Interest rate lock commitments on mortgages held for sale were approximately $17.9 million at December 31, 2005 and $17.2 million at December 31, 2004. Citizens also had outstanding mandatory forward commitments to sell $22.0 million of residential mortgage loans at December 31, 2005, which hedged the year end balance of mortgage loans held for sale. These outstanding forward commitments to sell mortgage loans are expected to settle in the first quarter of 2006 with no material gain or loss. At December 31, 2004, outstanding forward commitments to sell mortgage loans were approximately $58.0 million. The practice of hedging interest rate lock commitments on mortgage loans with mandatory forward contracts has been highly effective and has not generated any material gains or losses.

Maturities and Interest Rates Exchanged on Swaps:


	Mature During
(dollars in thousands)	2006			2007			2008			2009			2010			After 2010			Total

Receive fixed swaps:
Notional amount	$	185,000		$	10,000		$	100,000		$	10,000		$	30,000		$	195,000		$	530,000
Receive fixed rate		4.18	%		4.10	%		4.10	%		4.00	%		4.57	%		4.56	%		4.32	%
Pay variable rate		4.23	%		4.02	%		3.64	%		4.42	%		4.33	%		4.07	%		4.07	%

Pay fixed swaps:
Notional amount	$	20,000		$	104,000		$	—		$	—		$	—		$	—		$	124,000
Pay fixed rate		2.86	%		3.31	%		0.00	%		0.00	%		0.00	%		0.00	%		3.24	%
Receive variable rate		4.41	%		4.36	%		0.00	%		0.00	%		0.00	%		0.00	%		4.37	%

Citizens incurred a pre-tax cumulative charge during the fourth quarter of 2005 to non-interest income of $3.6 million as a result of determining that the swaps related to brokered certificates of deposit did not qualify for fair value hedge accounting treatment under the “short-cut” method of SFAS 133. Fair value hedge accounting allows a company to record the change in fair value of the hedged item (in this case the brokered certificates of deposit) as an adjustment to income as an offset to the fair value adjustment on the related interest rate swap. Eliminating the application of fair value hedge accounting reverses the cumulative impact of the fair value adjustments that had been made to the brokered CDs, which resulted in the charge to non-interest income.

Since September of 2003, Citizens has entered into interest rate swap agreements to hedge the interest rate risk inherent in certain of its brokered certificates of deposit. From the inception of these transactions, Citizens has applied a method of fair value hedge accounting described under SFAS 133 as the “short-cut method.” Citizens has recently concluded that these swap transactions did not qualify for the “short-cut method.” Although Citizens believes these swaps would have qualified for fair value hedge accounting under the “long-haul method,” changes in hedge accounting method may not be applied retrospectively under SFAS 133, as the required “long-haul” documentation was not in place as of the inception of the hedge.

Based on a review of the quarterly and annual impacts of the changes in fair value of these instruments, and Staff Accounting Bulletin 99, “Materiality,” Citizens concluded that the impact to prior periods was not material, and reflected the cumulative change in fair value in the fourth quarter of 2005.

In January of 2006, Citizens terminated $160.0 million of receive fixed swaps and entered into $160.0 million of similar swap agreements which will be accounted for as fair value hedges against brokered certificates of deposit. Also in January 2006, Citizens terminated $120.0 million of receive fixed swaps. All remaining swaps with a balance sheet management purpose are expected to receive hedge accounting treatment.

Note 20. Fair Values of Financial Instruments

The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS 107, “Disclosure About Fair Value of Financial Instruments.” Where quoted market prices are not available, as is the case for a significant portion of Citizens’ financial instruments, the fair values are based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the derived fair value estimates presented herein cannot be substantiated by comparison to independent markets and are not necessarily indicative of the amounts Citizens could realize in a current market exchange.

In addition, the fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, Citizens has a substantial trust department that contributes net fee income annually. The trust department is not considered a financial instrument and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial assets or liabilities include Citizens’ brokerage

network, net deferred tax asset, premises and equipment, goodwill and deposit based intangibles. In addition, tax ramifications related to the recognition of unrealized gains and losses such as those within the investment securities portfolio can also have a significant effect on estimated fair values and have not been considered in the estimates. Accordingly, the aggregate fair value should not be considered an indication of the value of Citizens.

The estimated fair values of Citizens’ financial instruments follow:


	December 31, 2005					December 31, 2004
	Carrying		Estimated			Carrying		Estimated
(in millions)	Amount		Fair Value			Amount		Fair Value

Financial assets:
Cash and money market investments	$	195.1	$	195.1		$	155.2	$	155.2
Securities		1,640.3		1,640.3			1,868.6		1,869.3
Mortgage loans held for sale		16.3		16.3			28.0		28.1
Net loans		5,499.7		5,527.4			5,271.2		5,377.5
Cash surrender value of life insurance policies		84.4		84.4			82.6		82.6
Accrued interest receivable		39.1		39.1			35.5		35.5
Financial liabilities:
Deposits		5,473.8		5,455.7			5,299.8		5,292.3
Short-term borrowings		529.1		529.1			724.8		724.7
Long-term debt		1,006.1		1,006.1			949.9		960.2
Accrued interest payable		12.8		12.8			10.5		10.5
Off-balance sheet financial instrument liabilities:
Loan commitments to extend credit		—		1.2			—		1.1
Standby and commercial letters of credit		—		0.1			—		0.1
Interest rate swap agreements		—		(4.9	)		—		(0.4	)
Interest rate lock commitments		—		0.0			—		(0.0	)
Forward commitments to sell mortgage loans		—		(0.1	)		—		(0.1	)

Carrying value approximates fair value for cash, money market investments, accrued interest, and the cash surrender value of life insurance policies. Fair value estimates for other financial instruments are set forth below:

Investment Securities Available for Sale and Held to Maturity: The carrying amounts reported in the balance sheet for investment securities classified as available-for-sale approximate those assets’ fair values. SFAS 115 requires securities carried in the available for sale category to be carried at fair value — see Note 6. The securities classified as held-to-maturity are carried at amortized cost. The fair values of both available-for-sale and held-to-maturity securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Mortgage Loans Held For Sale: Fair values are based on quoted market prices, determined by the current market values of similar loans — see Net Loans below.

Net Loans: Fair value for the performing loan portfolio is estimated using discounted cash flow analysis reflecting repricing terms and assumptions for prepayment speeds where applicable. Discount rates are based on interest rates currently being offered for loans with similar terms and credit quality. Fair values for nonperforming loans are estimated after giving consideration to credit risk and estimated cash flows and discount rates based on available market and specific borrower information.

Deposit Liabilities: Under SFAS 107, the fair value of demand deposits (e.g., interest and noninterest checking, passbook savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for certificates of deposit are based on the discounted value of contractual cash flows at current interest rates.

Short-Term Borrowings: The carrying amounts of federal funds purchased, securities sold under agreement to repurchase and other short-term borrowings approximate their fair values.

Long-Term Debt: The fair value of long-term debt is estimated using a combination of discounted cash flow analyses based on Citizens current incremental wholesale borrowing rates and quoted market prices.

Loan Commitments and Letters Of Credit: The fair value of loan commitments and letter of credit guarantees is based on an estimate of the difference between fees currently charged to enter into similar agreements and fees paid to reduce or eliminate exposure to those agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.

Interest Rate Swap Agreements: Fair values are based on the estimated amount Citizens would receive or pay to terminate the swap agreements, taking into account the current interest rates and creditworthiness of the swap counterparties.

Interest Rate Lock Commitments and Forward Commitments to Sell Mortgages: The estimated fair values are based on quoted market prices.

Note 21. Lines of Business

The financial performance of Citizens is monitored by an internal profitability measurement system, which provides line of business results and key performance measures. The profitability measurement system is based on internal management methodologies designed to produce consistent results and reflect the underlying economics of the businesses. The development and application of these methodologies is a dynamic process. Accordingly, these measurement tools and assumptions may be revised periodically to reflect methodological, product, and/or management organizational changes. Further, these policies measure financial results that support the strategic objectives and internal organizational structure of Citizens. Consequently, the information presented is not necessarily comparable with similar information for other institutions.

A description of each business line, selected financial performance and the methodologies used to measure financial performance are presented below.

•		Commercial Banking — Commercial Banking provides a full range of lending, depository, and related financial services to middle-market corporate, industrial, financial, small business, government and leasing clients. Products and services offered include commercial loans such as term loans, revolving credit arrangements, inventory and accounts receivable financing, commercial mortgages, real estate construction lending, letters of credit, and small business loans. Noncredit services for commercial customers include deposit accounts, treasury management, corporate cash management, international banking services, advice and assistance in the placement of securities, and financial planning.

•		Consumer Banking — Consumer Banking includes consumer lending and deposit gathering, small business lending, branch banking, electronic banking and residential mortgage loan origination and servicing. This line of business offers a variety of retail financial products and services including direct and indirect installment loans, debit and credit cards, home equity loans and lines of credit, residential mortgage loans, deposit products, fixed and variable annuities and ATM network services. Consumer loans are composed of automobile, personal, marine, and recreational vehicle loans. Deposit products include checking, savings, money market accounts, and certificates of deposit.

•		Wealth Management — Wealth Management offers a broad array of asset management, private banking, financial planning, estate settlement and administration, credit and deposit products and services. Trust and investment services include personal trust and planning, investment management, estate settlement and administration services. Retirement plan services focus on investment management and fiduciary activities with special emphasis on 401(k) plans. Brokerage and insurance delivers retail mutual funds, other securities, variable and fixed annuities, personal disability and life insurance products and discounted brokerage services. Private banking provides credit, deposit and asset management solutions for affluent clients.

•

Other — The Other line of business includes activities that are not directly attributable to one of the three principal lines of business. Included in this category are the Holding Company; Citizens’ Treasury unit, including the securities portfolio, wholesale funding and asset liability management activities; inter-company eliminations; and the economic impact of certain assets, capital and support functions not specifically identifiable with the three primary lines of business.

The accounting policies of the individual business units are the same as those of Citizens described in Note 2 to the Consolidated Financial Statements. Funds transfer pricing is used in the determination of net interest income by assigning a cost for funds used or credit for funds provided to assets and liabilities within each business unit. Assets and liabilities are match-funded based on their maturity, prepayment and/or repricing characteristics. As a result, the Commercial, Consumer and Wealth Management units are largely insulated from changes in interest rates. Changes in net interest income due to changes in interest rates are reported in Citizens’ Treasury unit. The provision for loan losses is allocated based upon the actual net charge-offs of each respective line of business, adjusted for loan growth and changes in risk profile. Noninterest income and expenses directly attributable to a line of business are assigned to that business. Expenses for centrally provided services are allocated to the business lines as follows: product processing and technology expenditures are allocated based on standard unit costs applied to actual volume measurements; corporate overhead is allocated based on the ratio of a line of business’ noninterest expenses to total noninterest expenses incurred by all business lines. During the first quarter of 2005, Citizens implemented a new intercompany cost allocation system, which utilizes improved unit cost and statistical information for assigning operational costs from the Other business line to Commercial Banking, Consumer Banking, and Wealth Management. The implementation of this system included changes to the methodology used to allocate costs among lines of business. Prior period information has been restated to reflect this change. There are no significant intersegment revenues. Selected segment information is included in the following table.

Line of Business Information


	Commercial			Consumer		Wealth
(in thousands)	Banking			Banking		Mgmt			Other			Total

Earnings Summary — 2005

Net interest income (taxable equivalent)	$	121,653		$	151,255	$	975		$	15,258		$	289,141
Provision for loan losses		(6,406	)		7,522		(7	)		—			1,109

Net interest income after provision		128,059			143,733		982			15,258			288,032
Noninterest income		12,816			49,984		24,587			(6,879	)		80,508
Noninterest expense		73,185			132,545		22,209			15,103			243,042

Income before income taxes		67,690			61,172		3,360			(6,724	)		125,498
Income tax expense (taxable equivalent)		23,850			21,410		1,195			(1,482	)		44,973

Net income	$	43,840		$	39,762	$	2,165		$	(5,242	)	$	80,525

Average assets (in millions)	$	2,921		$	2,610	$	24		$	2,223		$	7,778



Earnings Summary — 2004 (Restated)

Net interest income (taxable equivalent)	$	115,675		$	149,608	$	811		$	18,836		$	284,930
Provision for loan losses		7,545			14,072		(8	)		—			21,609

Net interest income after provision		108,130			135,536		819			18,836			263,321
Noninterest income		13,620			50,741		23,074			4,023			91,458
Noninterest expense		69,012			135,350		22,285			33,631			260,278

Income from continuing operations before income taxes		52,738			50,927		1,608			(10,772	)		94,501
Income tax expense (taxable equivalent) from continuing operations		18,597			17,825		580			(4,180	)		32,822

Income from continuing operations		34,141			33,102		1,028			(6,592	)		61,679
Income from discontinued operations (net of tax)		1,040			1,080		44			(505	)		1,659
Gain from the sale of discontinued operations (net of tax)		—			—		—			12,759			12,759

Total income from discontinued operations (net of tax)		1,040			1,080		44			12,254			14,418

Net income	$	35,181		$	34,182	$	1,072		$	5,662		$	76,097

Average assets (in millions)	$	2,795		$	2,492	$	19		$	2,379		$	7,685



Earnings Summary — 2003 (Restated)
Net interest income (taxable equivalent)	$	121,488		$	150,100	$	308		$	22,066		$	293,962
Provision for loan losses		46,276			15,733		(1	)		—			62,008

Net interest income after provision		75,212			134,367		309			22,066			231,954
Noninterest income		14,505			52,246		21,836			4,466			93,053
Noninterest expense		59,496			134,642		21,736			12,992			228,866

Income from continuing operations before income taxes		30,221			51,971		409			13,540			96,141
Income tax expense (taxable equivalent) from continuing operations		11,557			19,318		182			575			31,632

Income from continuing operations		18,664			32,653		227			12,965			64,509
Income from discontinued operations (net of tax)		368			1,803		27			(756	)		1,442

Net income	$	19,032		$	34,456	$	254		$	12,209		$	65,951

Average assets (in millions)	$	3,035		$	2,416	$	8		$	2,235		$	7,694

Note 22. Regulatory Matters

Citizens banking subsidiaries are required to maintain a combination of cash on hand and non-interest-bearing deposits with the Federal Reserve Bank to meet regulatory reserve requirements. These reserve balances vary depending upon the level of client deposits in the subsidiary banks. During 2005 and 2004, the average reserve balances were $52.8 million and $40.0 million, respectively.

The banking subsidiaries are also subject to statutory limitations on extensions of credit to members of the affiliate group and on dividends that can be paid to the Holding Company. Generally, extensions of credit are limited to 10% to any one affiliate and 20% in aggregate to all affiliates of a subsidiary bank’s capital and surplus (net assets) as defined. Unless prior regulatory approval is obtained, dividends declared in any calendar year may not exceed the retained net profit, as defined, of that year plus the retained net profit of the preceding two years. As of January 1, 2006, the banking subsidiaries are able to distribute dividends of $47.4 million without prior regulatory approval. During 2006, net income of the banking subsidiaries will also become available for such dividends. Federal Reserve Board policy provides that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears to be consistent with the holding company’s capital needs, asset quality and overall financial condition.

The banking subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines must be met that involve quantitative measures of the assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification 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 banking subsidiaries to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital to risk-weighted assets (as defined in the regulations), and of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2005, that the banking subsidiaries meet all capital adequacy requirements to which they are subject.

As of December 31, 2005, the banking subsidiaries were well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized the banking subsidiaries must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since December 31, 2005 that management believes would cause Citizens to fall below the well-capitalized level.

Risk Based Capital Requirements

To Be Well Capitalized

For Capital

Under Prompt Corrective

Actual

Adequacy Purposes

Action Provisions

(in thousands)

Amount

Ratio

Amount

Ratio

Amount

Ratio

Citizens Banking Corporation

As of December 31, 2005:

Total Capital to risk weighted assets ⁽¹⁾

816,856

13.2

494,273

8.0

617,843

10.0

Tier 1 Capital to risk weighted assets ⁽¹⁾

614,072

9.9

247,137

4.0

370,706

6.0

Tier 1 Leverage ⁽²⁾

614,072

8.0

307,661

4.0

384,577

5.0

As of December 31, 2004:

Total Capital to risk weighted assets ⁽¹⁾

792,636

13.3

475,972

8.0

594,965

10.0

Tier 1 Capital to risk weighted assets ⁽¹⁾

592,640

10.0

237,986

4.0

356,979

6.0

Tier 1 Leverage ⁽²⁾

592,640

7.8

302,481

4.0

378,101

5.0

Citizens Bank

As of December 31, 2005:

Total Capital to risk weighted assets ⁽¹⁾

704,148

8.6

473,453

8.0

591,816

10.0

Tier 1 Capital to risk weighted assets ⁽¹⁾

629,667

10.6

236,726

4.0

355,090

6.0

Tier 1 Leverage ⁽²⁾

629,667

11.9

292,556

4.0

365,695

5.0

As of December 31, 2004:

Total Capital to risk weighted assets ⁽¹⁾

480,968

10.5

367,485

8.0

459,357

10.0

Tier 1 Capital to risk weighted assets ⁽¹⁾

423,318

9.2

183,743

4.0

275,614

6.0

Tier 1 Leverage ⁽²⁾

423,318

7.5

225,975

4.0

282,469

5.0

⁽¹⁾ Total Capital is comprised of Tier 1 Capital, a portion of the allowance for loan losses and qualifying subordinated debt. Tier 1 Capital consists of total equity and trust preferred securities less unrealized gains and losses accumulated in other comprehensive income, certain intangible assets and adjustments related to the valuation of mortgage servicing assets.

⁽²⁾ Tier 1 Capital to quarterly average assets

100

Note 23. Citizens Banking Corporation (Parent Only) Statements

Balance Sheets
Citizens Banking Corporation (Parent Only)


	December 31,
(in thousands)	2005		2004

*Assets*
Cash	$	5	$	5
Money market investments		65,359		65,436
Investment securities		167		113
Investment in subsidiaries — principally banks		744,016		734,195
Goodwill — net		15		—
Other assets		11,659		10,985

*Total assets*	$	821,221	$	810,734

*Liabilities and Shareholders’ Equity*
Long-term debt	$	146,448	$	149,723
Other liabilities		18,310		6,709

Total liabilities		164,758		156,432
Shareholders’ equity		656,463		654,302

*Total liabilities and shareholders’ equity*	$	821,221	$	810,734

Statements of Income
Citizens Banking Corporation (Parent Only)


	Year Ended December 31,
(in thousands)	2005		2004		2003

			(Restated)		(Restated)
*Income*
Dividends from subsidiaries — principally banks	$	63,200	$	49,000	$	24,000
Interest from bank subsidiary		1,998		839		624
Service fees from bank subsidiaries		11,459		11,076		10,520
Other		299		946		687

Total		76,956		61,861		35,831

*Expenses*
Interest		7,766		5,056		4,054
Salaries and employee benefits		16,054		12,443		12,104
Service fees paid to bank subsidiaries		2,768		2,782		2,883
Other noninterest expense		1,923		1,976		1,717

Total		28,511		22,257		20,758

Income before income taxes and equity in undistributed earnings of subsidiaries		48,445		39,604		15,073
Income tax benefit		5,693		4,977		4,508
Equity in undistributed earnings of subsidiaries		26,387		17,098		44,928

Income from continuing operations		80,525		61,679		64,509
Income from discontinued operations (net of income tax of $939 and $801)		—		1,659		1,442
Gain on sale of discontinued operations (including tax benefit of $1,109)		—		12,759		—

*Net Income*	$	80,525	$	76,097	$	65,951

101

Statements of Cash Flows
Citizens Banking Corporation (Parent Only)


	Year Ended December 31,
(in thousands)	2005			2004			2003

				(Restated)			(Restated)
*Operating Activities*

Net income from continuing operations	$	80,525		$	61,679		$	64,509
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of stock-based compensation expense		691			193			350
Stock-based compensation		—			—			200
Recognition of stock-based compensation expense		141			272			—
Dividends in excess of (equity in undistributed) earnings of subsidiaries		(26,386	)		(17,098	)		(44,928	)
Other		7,400			(545	)		(5,538	)

Net cash provided by operating activities from continuing operations		62,371			44,501			14,593

*Investing Activities*

Net (increase) decrease in money market investments		77			(16,772	)		(45,498	)
Proceeds from sales and maturities of investment securities		1			4			5
Purchases of investment securities		(10	)		—			—
Proceeds from sale of discontinued operations		—			26,250			—
Investments in and advances to subsidiaries		—			—			(25,000	)

Net cash provided (used) by investing activities from continuing operations		68			9,482			(70,493	)

*Financing Activities*

Principal reductions in short-term borrowings		—			—			(30,000	)
Proceeds from long-term borrowings		—			—			150,365
Cash dividends paid		(49,311	)		(49,286	)		(49,476	)
Proceeds from stock options exercised		5,062			8,267			6,334
Shares acquired for retirement		(18,190	)		(12,964	)		(21,323	)

Net cash used by financing activities from continuing operations		(62,439	)		(53,983	)		55,900


Net increase in cash		—			—			—
Cash at beginning of year		5			5			5

Cash at end of year	$	5		$	5		$	5

Note 24. Subsequent Events (unaudited)

Citizens entered into a contract with PHH Mortgage Corporation to perform mortgage operations loan processing, servicing, secondary marketing functions and other mortgage-related loan origination services. With respect to the title services function, Citizens has determined that such services will be provided by various third parties throughout its markets. In connection with this initiative, Citizens expects to reduce its workforce by 27 employees. This headcount reduction is anticipated to result in approximately $0.4 million in severance related costs. Citizens anticipates additional charges in 2006 of $0.3 million related to this restructuring. Implementation of these activities is expected to be completed by the end of the third quarter of 2006.

Citizens expects to begin the consolidation process immediately, with full implementation by the end of the second quarter of 2006. In connection with this consolidation, Citizens expects to reduce its workforce by 17 employees and will consolidate the loan operations function centrally at its Flint, Michigan headquarters. This headcount reduction is anticipated to result in approximately $0.4 million in severance related costs. Citizens anticipates additional charges in 2006 of $0.2 million related to the implementation of process improvement measures and technology enhancements as well as other restructuring activities.

102

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Citizens Banking Corporation

We have audited the accompanying consolidated balance sheets of Citizens Banking Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Citizens Banking Corporation and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Citizens Banking Corporation internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2006 expressed an unqualified opinion thereon.

As discussed in Note 1 of the consolidated financial statements, the Company has restated its consolidated financial statements for 2004 and 2003.

Detroit, Michigan
February 24, 2006

103

SELECTED QUARTERLY INFORMATION (unaudited)

Table 14 below sets forth selected quarterly financial information for each calendar quarter during 2005 and 2004.

Table 14. Selected Quarterly Information


(in thousands except,	2005									2004
per share data)	Fourth			Third		Second		First		Fourth		Third			Second			First
												(Restated)			(Restated)			(Restated)
Interest income	$	111,958		$	108,506	$	103,619	$	99,166	$	97,170	$	95,275		$	93,407		$	92,427
Interest expense		42,863			38,864		34,840		30,933		28,690		26,566			25,723			25,602
Net interest income		69,095			69,642		68,779		68,233		68,480		68,709			67,684			66,825
Provision for loan losses ⁽¹⁾		(7,287	)		4,000		1,396		3,000		4,609		6,506			3,544			6,950
Noninterest income before securities gains		19,930			23,941		23,109		22,455		23,644		22,746			24,438			22,143
Investment securities gains (losses) ⁽³⁾		(8,970	)		—		37		6		10		530			(2,053	)		—
Noninterest expense ⁽⁴⁾		60,901			60,550		60,990		60,601		61,117		78,433			61,206			59,522
Net income (loss) from continuing operations		18,888			20,992		20,565		20,080		20,286		5,787			18,686			16,920
Discontinued operations:
Income from discontinued operations (net of tax)		—			—		—		—		—		1,100			36			523
Gain on sale of discontinued operations (net of tax)		—			—		—		—		—		12,759			—			—
Total income from discontinued operations (net of tax)		—			—		—		—		—		13,859			36			523
Net income (loss)		18,888			20,992		20,565		20,080		20,286		19,646			18,722			17,443
*Discontinued operations*
Interest income	$	—		$	—	$	—	$	—	$	—	$	754		$	1,968		$	1,967
Interest expense		—			—		—		—		—		162			434			464
Net interest income		—			—		—		—		—		592			1,534			1,503
Provision for loan losses ⁽¹⁾		—			—		—		—		—		(1,521	)		956			50
Noninterest income before securities gains ⁽²⁾		—			—		—		—		—		11,802			418			369
Investment securities gains (losses) ⁽³⁾		—			—		—		—		—		4			—			—
Noninterest expense ⁽⁴⁾		—			—		—		—		—		540			937			1,012
Net income (loss) from discontinued operations		—			—		—		—		—		13,859			36			523
*Per Share of Common Stock*
Income from continuing operations:
Basic		0.44			0.49		0.48		0.46		0.47		0.14			0.43			0.39
Diluted		0.44			0.48		0.47		0.46		0.46		0.13			0.43			0.39
Income from discontinued operations:
Basic		—			—		—		—		—		0.32			—			0.01
Diluted		—			—		—		—		—		0.32			—			0.01
Net income (loss):
Basic		0.44			0.49		0.48		0.46		0.47		0.46			0.43			0.40
Diluted		0.44			0.48		0.47		0.46		0.46		0.45			0.43			0.40
Cash dividends declared		0.285			0.285		0.285		0.285		0.285		0.285			0.285			0.285
Market value:⁽⁵⁾
High		30.22			32.15		30.98		34.81		35.43		33.36			33.99			34.00
Low		26.67			28.20		26.35		29.02		32.01		29.42			28.31			31.55
Close		27.75			28.40		30.22		29.36		34.35		32.57			31.05			32.63


⁽¹⁾		Provision for loan losses includes, in the fourth quarter of 2005, a $9.1 million insurance settlement relating to a claim for recovery of fraud losses suffered in connection with two loans made by the Corporation and subsequently charged-off in 2002 and 2003.

⁽²⁾		Noninterest income includes, in the fourth quarter of 2005, a charge of $3.6 million related to a fair value change in CD swap derivatives.

⁽³⁾		Investment securities gains (losses) includes, in the fourth quarter of 2005, losses of $9.0 million on sale of investment securities.

⁽⁴⁾		Noninterest expense includes, in the third quarter of 2004, a prepayment penalty of $18.0 million on the prepayment of FHLB debt.

⁽⁵⁾		Citizens Banking Corporation common stock is traded on the National Market tier of the Nasdaq stock market (trading symbol: CBCF). At December 31, 2005, there were approximately 15,094 shareholders of the Corporation’s common stock.

104

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rule 13a-15 of the Securities Exchange Act of 1934, that are designed to cause the material information required to be disclosed by Citizens in the reports it files or submits under the Securities Exchange Act of 1934 to be recorded, processed, summarized, and reported to the extent applicable within the time periods required by the Securities and Exchange Commission’s rules and forms. In designing and evaluating the disclosure controls and procedures, management recognized that a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, with a company have been detected.

As of the end of the period covered by this report, Citizens performed an evaluation under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective at the reasonable assurance level.

Report on Management’s Assessment of Internal Control over Financial Reporting

The management of Citizens Banking Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined under applicable Securities and Exchange Commission rules as a process designed under the supervision of the Corporation’s Chief Executive Officer and Chief Financial Officer and effected by the Corporation’s Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Corporation’s financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The Corporation’s internal control over financial reporting includes those policies and procedures that:

	•		Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Corporation;

	•		Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of management and the directors of the Corporation; and

	•		Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Corporation’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As of December 31, 2005, management, with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Corporation’s internal control over financial reporting based on the criteria for effective internal control over financial reporting established in “Internal Control — Integrated Framework,” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on the assessment, management determined that the Corporation’s internal control over financial reporting was effective as of December 31, 2005.

105

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of Citizens Banking Corporation

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Citizens Banking Corporation maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Citizens Banking Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

In our opinion, management’s assessment that Citizens Banking Corporation maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Citizens Banking Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Citizens Banking Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2005 of Citizens Banking Corporation and our report dated February 24, 2006 expressed an unqualified opinion thereon.

Detroit, Michigan
February 24, 2006

107

ITEM 9B. OTHER INFORMATION

None.

Part III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item appears under the captions “Election of Directors” (excluding the information under the headings “Report of the Audit Committee” and “Compensation of Directors”), “Section 16(a) Beneficial Ownership Reporting Compliance” and “Shareholder Proposals and Nominees – Shareholder Communications with the Board of Directors” in Citizens’ proxy statement for its 2006 annual meeting of shareholders (the “Proxy Statement”) and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item appears under the caption “Compensation of Directors,” and under the caption “Executive Compensation” (excluding the information under the headings “Compensation and Human Resources Committee Report on Executive Compensation” and “Shareholder Return”) of the Proxy Statement, and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item appears under the captions “Security Ownership of Certain Beneficial Owners” and “Security Ownership of Management” of the Proxy Statement, and is incorporated herein by reference. In addition, the information under the caption “Equity Compensation Plan Information” under Item 5 of this Report is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item appears under the caption “Executive Compensation – Compensation Committee Interlocks and Certain Transactions and Relationships” of the Proxy Statement, and is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item appears under the caption “Independent Certified Public Accountants” of the Proxy Statement, and is incorporated herein by reference.

108

EXHIBIT INDEX

The following documents are filed as part of this report. Those exhibits previously filed and incorporated herein by reference are identified below. Exhibits not required for this report have been omitted. Citizens’ Commission file number is 000-10535.


Exhibit
No.		Exhibit

2.1		Stock Purchase Agreement by and between Metropolitan Bank Group, Inc., and Citizens Banking Corporation, Parent of Citizens Bank – Illinois, National Association, dated as of April 2, 2004 and Amendment No. 1 thereto, dated August 4, 2004 (incorporated by reference from Exhibit 2.1 of Citizens’ 2004 Second Quarter Report on Form 10-Q).

3.1		Restated Articles of Incorporation, as amended. (incorporated by reference from Exhibit 3(a) of Citizens’ 2002 Second Quarter Report on Form 10-Q).

3.2		Amended and Restated Bylaws dated March 28, 2003 (incorporated by reference from Exhibit 3.2 of Citizens’ December 31, 2002 Annual Report on Form 10-K).

4.1		Rights Agreement, dated May 23, 2000, between Citizens and Citizens Bank, as Rights Agent (incorporated by reference from Exhibit 4.1 of Citizens’ Current Report on Form 8-K filed June 8, 2000).

4.2		Indenture, dated as of January 27, 2003 among Citizens Banking Corporation and JP Morgan Chase Bank, as Trustee (filed as Exhibit 4.1 to Citizens Banking Corporation’s registration statement on Form S-4, registration no. 333-104472, and incorporated herein by reference).

4.3		Registration Rights Agreement, dated as of January 27, 2003 among Citizens Banking Corporation and Morgan Stanley, Keefe, Bruyette & Woods, Inc., Robert W. Baird & Co., Credit Suisse First Boston, Fahnestock & Co. Inc., Howe Barnes Investments, Inc. and McDonald Investments, as Initial Purchasers (filed as Exhibit 4.2 to Citizens Banking Corporation’s registration statement on Form S-4, registration no. 333-104472, and incorporated herein by reference).

4.4		Floating Rate Junior Subordinated Deferrable Interest Debentures dated as of June 26, 2003 (incorporated by reference from Exhibit 4.1 of Citizens’ 2003 Second Quarter Report on Form 10-Q).

10.1*		Citizens Banking Corporation Second Amended Stock Option Plan (incorporated by reference from Exhibit 4 of Citizens’ registration statement on Form S-8 filed May 5, 1992, Registration No. 33-47686).

10.2*		Citizens Banking Corporation Third Amended Stock Option Plan (incorporated by reference from Exhibit 10(r) of Citizens’ 1997 Second Quarter Report on Form 10-Q).

10.3*		First Amendment to Citizens Banking Corporation Third Amended Stock Option Plan (incorporated by reference from Exhibit 10.2 of Citizens’ 2000 Second Quarter Report on Form 10-Q).

10.4*		Citizens Banking Corporation All-Employee Stock Option Plan (incorporated by reference from Exhibit 99 of Citizens’ registration statement on Form S-8 filed June 26, 2000, Registration No. 333-40100).

10.5*		Citizens Banking Corporation Stock Option Plan for Directors (incorporated by reference from Exhibit 99 of Citizens’ registration statement on Form S-8 filed July 21, 1995, Registration No. 33-61197).

10.6*		First Amendment to Citizens Banking Corporation Stock Option Plan for Directors (incorporated by reference from Exhibit 10.3 of Citizens’ 2000 Second Quarter Report on Form 10-Q).

10.7*		Citizens Banking Corporation Stock Compensation Plan (incorporated by reference from exhibit 10.13 of Citizens’ 2001 Annual Report on Form 10-K).

112

EXHIBIT INDEX (continued)


Exhibit
No.		Exhibit

10.8*		Post Effective Amendment No. 1 to Form S-4 on Form S-8 pertaining to “F&M Bancorporation, Inc. 1993 Incentive Stock Option Plan” and “F&M Bancorporation, Inc. 1993 Stock Option Plan for Non-employee Directors” (incorporated by reference to Form S-8 filed December 22, 1999, file number 333-86569).

10.9*		Citizens Banking Corporation Amended and Restated Section 401(k) Plan (incorporated by reference from Exhibit 99.1 of Citizens’ registration statement on Form S-8 filed August 2, 1996 – Registration No. 333-09455).

10.11*		Citizens Banking Corporation Amended and Restated Director’s Deferred Compensation Plan (incorporated by reference from Exhibit 10.11 of Citizens’ 2002 Annual Report on Form 10-K).

10.13		Amended and Restated Declaration of Trust dated as of June 26, 2003 by and among U.S. Bank National Association, as institutional Trustee, Citizens Banking Corporation, as Sponsor, and William R. Hartman, Charles D. Christy and Thomas W. Gallagher as Administrators (incorporated by reference from Exhibit 10.1 of Citizens’ 2003 Second Quarter Report on Form 10-Q).

10.14		Placement Agreement, dated June 16, 2003, between Citizens, Citizens Michigan Statutory Trust I, FTN Financial Capital Markets and Keefe Bruyette & Woods, Inc. (incorporated by reference from Exhibit 10.2 of Citizens’ 2003 Second Quarter Report on Form 10-Q).

10.15		Guarantee Agreement dated as of June 26, 2003 by and between Citizens Banking Corporation and U.S. Bank National Association (incorporated by reference from Exhibit 10.3 of Citizens’ 2003 Second Quarter Report on Form 10-Q).

10.16*		Amended and Restated Employment Agreement by and between Citizens and William R. Hartman dated as of May 29, 2003 (incorporated by reference from Exhibit 10.4 of Citizens’ 2003 Second Quarter Report on Form 10-Q).

10.17*		Form of Change in Control Agreement by and between Citizens and certain executive officers (incorporated by reference from Exhibit 10.17 of Citizens’ 2003 Annual Report on Form 10-K.)

10.18*		Change in Control Agreement, dated as of April 7, 2003, by and between Citizens and Randall J. Peterson (incorporated by reference from Exhibit 10.18 of Citizens’ 2003 Annual Report on Form 10-K.)

10.20*		Form of Nonqualified Stock Option Agreement for Nonemployee Directors under the Citizens Banking Corporation Stock Compensation Plan (incorporated by reference from Exhibit 10.20 of Citizens’ 2004 Third Quarter Report on Form 10-Q).

10.21*		Form of Nonqualified Stock Option Agreement for Employees under the Citizens Banking Corporation Stock Compensation Plan (incorporated by reference from Exhibit 10.21 of Citizens’ 2004 Third Quarter Report on Form 10-Q).

10.22*		Form of Restricted Stock Agreement under the Citizens Banking Corporation Stock Compensation Plan (incorporated by reference from Exhibit 10.22 of Citizens’ 2004 Third Quarter Report on Form 10-Q).

10.23*		2005 Management Incentive Plan (incorporated by reference from Exhibit 10.19 of Citizens’ 2005 First Quarter Report on Form 10-Q¹

113

EXHIBIT INDEX (continued)


Exhibit
No.		Exhibit

10.24*		Form of Restricted Stock Agreement (Employee Version) (incorporated by reference from Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on June 7, 2005)

10.25*		Form of Restricted Stock Agreement (Director Version) (incorporated by reference from Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on June 7, 2005)

10.26*		Form of Stock Option Agreement (Employee Version) (incorporated by reference from Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on June 7, 2005)

10.27*		Form of Stock Option Agreement (Director Version) (incorporated by reference from Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the Commission on June 7, 2005)

21		Subsidiaries of the Registrant

23		Consent of Independent Registered Public Accounting Firm

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) under the Securities Exchange Act of 1934.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) under the Securities Exchange Act of 1934.


*		Current management contracts or compensatory plans or arrangements.

¹		Portions of this exhibit have been omitted pursuant to Citizens’ request to the Secretary of the Securities and Exchange Commission for confidential treatment pursuant to rule 24b-2 under the Securities Exchange Act of 1934, as amended

114


	Page
PART I
Item 1. Business		4
Item 1A. Risk Factors		13
Item 1B. Unresolved Staff Comments		19
Item 2. Properties		19
Item 3. Legal Proceedings		19
Item 4. Submission of Matters to a Vote of Security Holders		19

PART II
Item 5. Market for the Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities		20
Item 6. Selected Financial Data		21
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations		23
Overview		24
Critical Accounting Policies		27
Recent Accounting Pronouncements		30
Recent Developments		30
Results of Operations		32
Financial Condition		42
Liquidity and Debt Capacity		58
Interest Rate Risk		59
Item 7A. Quantitative and Qualitative Disclosures about Market Risk		61
Item 8. Financial Statements and Supplementary Data		61
Consolidated Balance Sheets		62
Consolidated Statements of Income		63
Consolidated Statements of Changes in Shareholders’ Equity		64
Consolidated Statements of Cash Flows		65
Notes to Consolidated Financial Statements		66
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		108
Item 9A. Controls and Procedures		108
Item 9B Other Information		111

PART III
Item 10. Directors and Executive Officers of the Registrant		111
Item 11. Executive Compensation		111
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		111
Item 13. Certain Relationships and Related Transactions		111
Item 14 Principal Accountant Fees and Services		111

PART IV
Item 15. Exhibits and Financial Statement Schedules		112

SIGNATURES		113

EXHIBIT INDEX		115
Subsidiaries of the Registrant
Consent of Independent Registered Public Accounting Firm
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)
Certification of Chief Executive Officer Pursuant to Section 1350
Certification of Chief Financial Officer Pursuant to Section 1350


																Weighted
	Within			1 to 5			5 to 10			After 10						Average
(in thousands)	1 Year			Years			Years			Years			Total			Yield

*Available for Sale:*
U.S. Treasury	$	—		$	—		$	—		$	—		$	—			—	%
Federal agencies:
Mortgage-backed		296,016			412,374			92,583			24,960		$	825,933			4.54
Other		19,910			289,771			—			—			309,681			4.90
State and municipal		26,933			124,791			125,007			88,122			364,853			7.46
Mortgage and asset-backed		64			3			—			213			280			5.89
Other		1,008			—			—			64			1,072			4.15

Amortized Cost	$	343,931		$	826,939		$	217,590		$	113,359		$	1,501,819

Fair Value	$	342,832		$	822,063		$	221,431		$	115,671		$	1,501,997

Weighted Average Yield		4.90	%		5.12	%		6.24	%		6.40	%		5.33	%

*Held to Maturity:*
State and Municipal	$	—		$	—		$	2,008		$	80,423		$	82,431			6.23	%

Amortized Cost	$	—		$	—		$	2,008		$	80,423		$	82,431

Fair Value	$	—		$	—		$	1,662		$	80,702		$	82,364

Weighted Average Yield		—			—			5.52	%		6.25	%		6.23	%


by	/s/ William R. Hartman	Date: March 10, 2006

William R. Hartman
Chairman, President and Chief Executive Officer


Signature	Capacity	Date

/s/ Charles D. Christy	Executive Vice President and Chief Financial Officer	March 10, 2006
Charles D. Christy	Executive Vice President and Chief Financial Officer

/s/ William R. Hartman	Chairman of the Board, President, Chief Executive Officer, and Director	March 10, 2006
William R. Hartman

/s/ Edward P. Abbott	Director	March 10, 2006
Edward P. Abbott

/s/ Lizabeth A. Ardisana	Director	March 10, 2006
Lizabeth A. Ardisana

/s/ Joseph P. Day	Director	March 10, 2006
Joseph P. Day

/s/ Richard J. Dolinski	Director	March 10, 2006
Richard J. Dolinski

/s/ Benjamin W. Laird	Director	March 10, 2006
Benjamin W. Laird

/s/ Stephen J. Lazaroff	Director	March 10, 2006
Stephen J. Lazaroff

/s/ William C. Shedd	Director	March 10, 2006
William C. Shedd