Annual Reports

  • 10-K (Feb 25, 2014)
  • 10-K (Feb 26, 2013)
  • 10-K (Oct 11, 2011)
  • 10-K (Feb 28, 2011)
  • 10-K (Feb 24, 2010)
  • 10-K (Feb 25, 2009)

 
Quarterly Reports

 
8-K

 
Other

Park National 10-K 2007
EX-13
 

Exhibit 13
FINANCIAL REVIEW
 
This financial review presents management’s discussion and analysis of the financial condition and results of operations for Park National Corporation (“Park” or the “Corporation”). This discussion should be read in conjunction with the consolidated financial statements and related notes and the five-year summary of selected financial data. Management’s discussion and analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. Forward-looking statements provide current expectations or forecasts of future events and are not guarantees of future performance. The forward-looking statements are based on management’s expectations and are subject to a number of risks and uncertainties. Although management believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from those expressed or implied in such statements. Risks and uncertainties that could cause actual results to differ materially include, without limitation, Park’s ability to execute its business plan, Park’s ability to successfully integrate acquisitions into Park’s operations, Park’s ability to achieve the anticipated cost savings and revenue synergies from acquisitions, changes in general economic and financial market conditions, changes in interest rates, changes in the competitive environment, changes in banking regulations or other regulatory or legislative requirements affecting the respective businesses of Park and its subsidiaries, changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or other regulatory agencies, demand for loans in the respective market areas served by Park and its subsidiaries, and other risk factors relating to our industry as detailed from time to time in Park’s reports filed with the Securities and Exchange Commission (“SEC”) including those described in “Item 1A. Risk Factors” of Park’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006. Undue reliance should not be placed on the forward-looking statements, which speak only as of the date hereof. Park does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions that may be made to update any forward-looking statement to reflect the events or circumstances after the date on which the forward-looking statement is made, or reflect the occurrence of unanticipated events, except to the extent required by law.
Park’s Board of Directors approved a 5% stock dividend in November 2004. The additional common shares resulting from the dividend were distributed on December 15, 2004 to stockholders of record as of December 1, 2004. The consolidated financial statements, notes and other references to share and per share data have been retroactively restated for the stock dividend.
CORRECTION REFLECTED IN 2006 FINANCIAL STATEMENTS
On January 26, 2007, Park filed a Form 8-K with the SEC announcing that management had discovered an error in its accounting for accrued interest income on loans. Management determined that accrued interest receivable on loans was overstated by $1.933 million and as a result interest income on loans was overstated by $1.933 million on a cumulative basis. Management discovered in late January 2007 that certain previously charged-off loans were incorrectly accruing interest income. On Park’s data processing system, a loan that is charged-off also needs to be coded as nonaccrual for the data processing system to not accrue interest income on these loans. Primarily, one of Park’s subsidiary banks did not follow this procedure on certain installment loans for approximately the past ten years. Management determined that interest income on loans was overstated by approximately $100,000 per quarter for the past several quarters. Park’s management concluded that the overstatement of accrued interest receivable on loans and the related overstatement of interest income on loans is not material to any previously issued financial statements. Accordingly, Park recorded a cumulative adjustment of $1.933 million in the fourth quarter of 2006 to reduce accrued interest receivable on loans and reduce interest income on loans. On an after-tax basis, this adjustment reduced Park’s net income by $1.256 million for the three and twelve months ended December 31, 2006 and reduced diluted earnings per share by $.09 for the three and twelve months ended December 31, 2006, as compared to net income and diluted earnings per share that was previously reported by Park on January 16, 2007 in a Form 8-K filing with the SEC.
This financial review is written comparing the corrected 2006 financial statements to the financial statements for 2005 and 2004.
OVERVIEW
Net income for 2006 decreased by $1.1 million or 1.2% to $94.1 million, compared to net income of $95.2 million for 2005. Diluted earnings per share increased by 1.5% to $6.74 for 2006 compared to $6.64 for 2005.
For 2006 compared to 2005, income before federal income taxes was negatively impacted by a $7.3 million reduction in net interest income and a $1.6 million increase in total operating expenses. Income before federal income taxes benefited from a decrease in the loan loss provision of $1.5 million and an increase in total other income of $5.1 million. The net impact to income before federal income taxes from the reduction in net interest income, the reduction in the provision for loan losses, the increase in total other income and the increase in total operating expenses was a decrease of $2.3 million. Federal income tax expense decreased by $1.2 million, which generated the decrease in net income of $1.1 million in 2006 compared to 2005.
Net income for 2005 increased by $3.7 million to $95.2 million, a 4.1% increase over net income of $91.5 million for 2004. Diluted earnings per share increased by 5.1% to $6.64 for 2005 compared to $6.32 for 2004.
For 2005 compared to 2004, income before federal income taxes benefited from an $8.3 million increase in net interest income, a $3.2 million decrease in the provision for loan losses and a $7.9 million increase in total other income. Total operating expenses increased by $13.1 million and federal income tax expense increased by $2.4 million in 2005 compared to 2004.
The primary reason for the increases in net interest income, total other income and operating expenses (in 2005 compared to 2004) was the acquisitions of First Federal Bancorp, Inc. (“First Federal”) on December 31, 2004 and First Clermont Bank (“First Clermont”) on January 3, 2005. First Federal had $253 million of assets at the time of its acquisition and First Clermont had $185 million of assets on January 3, 2005. Both acquisitions were accounted for as purchases and did not have any impact on the 2004 operating results for Park.
The reduction in the provision for loan losses contributed to earnings for both 2006 and 2005. The provision for loan losses was $3.9 million in 2006, $5.4 million in 2005 and $8.6 million in 2004. The reduction in the provision for loan losses was primarily due to a reduction in net loan charge-offs, which were $3.9 million in 2006, $5.9 million in 2005 and $7.9 million in 2004.
The annualized net income to average assets ratio (ROA) was 1.75% for 2006, 1.71% for 2005 and 1.81% for 2004. The annualized net income to average equity ratio (ROE) was 17.26% for 2006, 17.03% for 2005 and 17.00% for 2004.
Park has been active the past three years in purchasing treasury stock. Park’s common shares outstanding at December 31, 2003 were 14.455 million compared to 14.320 million at year-end 2004, 14.093 million at year-end 2005 and 13.922 million at year-end 2006. Park purchased 214,681 treasury shares in 2004, 281,360 treasury shares in 2005 and 302,786 treasury shares in 2006. The average balance of Park’s common shares outstanding was 14.345 million shares in 2004, 14.259 million shares in 2005 and 13.929 million shares in 2006. The reduction in Park’s common shares outstanding contributed to the increase in earnings per share compared to the change in net income for the past three years. For 2006 compared to 2005, net income decreased by 1.2% and diluted earnings per share increased by 1.5%. For 2005 compared to 2004, net income increased by 4.1% and diluted earnings per share increased by 5.1%. For 2004 compared to 2003, net income increased by 5.3% and diluted earnings per share increased by 5.9%.

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FINANCIAL REVIEW
 
Effective the fourth quarter of 2006, the quarterly cash dividend on common shares was increased to $.93 per share. The new annualized cash dividend of $3.72 per share is 1.1% greater than the sum of the cash dividends declared for the four previous quarters. Park has paid quarterly cash dividends since becoming a holding company in early 1987. The annual compound growth rate for Park’s dividend declared per share for the last five years is 6.0%. The dividend pay out ratio was 54.65% for 2006, 54.19% for 2005 and 53.54% for 2004.
ACQUISITIONS AND BRANCH SALE
On December 18, 2006, Park acquired Anderson Bank Company (“Anderson”) of Cincinnati, Ohio for $17.7 million in a cash and stock transaction. Park paid the shareholders of Anderson aggregate consideration consisting of $9.052 million and 86,137 common shares of Park valued at $8.665 million. Anderson merged with Park’s subsidiary bank, The Park National Bank (“PNB”), and Anderson’s two offices are being operated as part of the operating division of PNB known as The Park National Bank of Southwest Ohio & Northern Kentucky (“PSW”). The fair value of the acquired assets of Anderson was $69.7 million and the fair value of the liabilities assumed was $62.6 million at December 18, 2006. The goodwill recognized as a result of this acquisition was $10.6 million.
On January 3, 2005, Park acquired First Clermont Bank (“First Clermont”) of Milford, Ohio for $52.5 million in an all cash transaction. First Clermont merged with PNB and operated as a separate division of PNB (under the First Clermont name) until June 12, 2006, when First Clermont and three offices of PNB in southwest Ohio were combined to form PSW. The fair value of the acquired assets of First Clermont was $185.4 million and the fair value of the liabilities assumed was $161.3 million at January 3, 2005. The goodwill recognized as a result of this acquisition was $28.4 million.
On December 31, 2004, Park acquired First Federal Bancorp, Inc. (“First Federal”) for $46.6 million in an all cash transaction accounted for as a purchase. The savings and loan subsidiary of First Federal, First Federal Savings Bank of Eastern Ohio, merged with Park’s subsidiary bank, Century National Bank (“CNB”). The goodwill recognized as a result of this acquisition was $26.7 million. The fair value of the acquired assets of First Federal was $252.7 million and the fair value of the liabilities assumed was $232.7 million at December 31, 2004.
On February 11, 2005, CNB sold its Roseville, Ohio branch office. The Roseville branch office was acquired in connection with the acquisition of First Federal on December 31, 2004. The Federal Reserve Board required that the Roseville branch office be sold as a condition of their approval of the merger transactions involving Park and First Federal. The deposits sold with the Roseville branch office totaled $12.4 million and the loans sold with the branch office totaled $5.3 million. CNB received a premium of $1.2 million from the sale of deposits which reduced goodwill by $860,000 and core deposit intangibles by $324,000.
The three acquisitions were funded through the working capital of Park and its subsidiary banks.
PENDING ACQUISITION
On September 14, 2006, Park and Vision Bancshares, Inc. (“Vision”) jointly announced the signing of an agreement and plan of merger (the “Merger Agreement”) providing for the merger of Vision into Park. On or about January 11, 2007, a prospectus of Park/proxy statement of Vision was mailed to the shareholders of Vision in connection with the special meeting of shareholders to be held on February 20, 2007. The merger transaction is subject to the satisfaction of customary closing conditions in the Merger Agreement and the approval of appropriate regulatory authorities and of the shareholders of Vision. Park has filed all necessary regulatory applications and anticipates the transaction will close on or about March 9, 2007, assuming that all required approvals have been received and conditions to closing are satisfied.
Vision operates two bank affiliates, both named Vision Bank. One bank is headquartered in Gulf Shores, Alabama and the other in Panama City, Florida. These banks operate 15 offices. As of December 31, 2006, (on a consolidated basis), Vision had total assets of $691 million, total loans of $588 million and total deposits of $587 million.
Under the terms of the Merger Agreement, the shareholders of Vision are entitled to receive, in exchange for their shares of Vision common stock, either (a) cash, (b) Park common shares, or (c) a combination of cash and Park common shares, subject to the election and allocation procedures set forth in the Merger Agreement. Park will cause the requests of the Vision shareholders to be allocated on a pro-rata basis so that 50% of the shares of Vision common stock outstanding at the effective time of the merger will be exchanged for cash at the rate of $25.00 per share of Vision common stock and the other 50% of the outstanding shares of Vision common stock will be exchanged for Park common shares at the exchange rate of .2475 Park common shares for each share of Vision common stock. This allocation is subject to adjustment for cash paid in lieu of fractional Park common shares in accordance with the terms of the Merger Agreement.
As of January 8, 2007, 6,114,518 shares of Vision common stock were outstanding and 828,834 shares of Vision common stock were subject to outstanding stock options with a weighted average exercise price of $8.21 per share. Each outstanding stock option (that is not exercised prior to the election deadline specified in the Merger Agreement) granted under one of Vision’s equity-based compensation plans will be cancelled and extinguished and converted into the right to receive an amount of cash equal to (1)(a) $25.00 multiplied by (b) the number of shares of Vision common stock subject to the unexercised portion of the stock option minus (2) the aggregate exercise price for the shares of Vision common stock subject to the unexercised portion of the stock option.
The cash paid to the shareholders of Vision will be funded through the working capital of Park.
CRITICAL ACCOUNTING POLICIES
The significant accounting policies used in the development and presentation of Park’s financial statements are listed in Note 1 of the Notes to Consolidated Financial Statements. The accounting and reporting policies of Park conform with U.S. generally accepted accounting principles and general practices within the financial services industry. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
Park considers that the determination of the allowance for loan losses involves a higher degree of judgement and complexity than its other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb probable incurred credit losses in the loan portfolio. Management’s determination of the adequacy of the allowance for loan losses is based on periodic evaluations of the loan portfolio and of current economic conditions. However, this evaluation is inherently subjective as it requires material estimates, including expected default probabilities, loss given default, the amounts and timing of expected future cash flows on impaired loans, and estimated losses on consumer loans and residential mortgage loans based on historical loss experience and the current economic conditions. All of those factors may be susceptible to significant change. To the extent that actual results differ from management estimates, additional loan loss provisions may be required that would adversely impact earnings for future periods.
Management’s assessment of the adequacy of the allowance for loan losses considers individual impaired loans, pools of homogeneous loans with similar risk characteristics and other environmental risk factors. This assessment is updated on a quarterly basis. The allowance established for individual impaired loans reflects expected losses resulting from analyses developed through specific credit allocations for individual loans. The specific credit allocations are based on regular analyses of commercial, commercial real

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FINANCIAL REVIEW
 
estate and construction loans where the internal credit rating is at or below a predetermined classification. These analyses involve a high degree of judgement in estimating the amount of loss associated with specific impaired loans.
Pools of homogeneous loans with similar risk characteristics are also assessed for probable losses. A loss migration analysis is performed on certain commercial, commercial real estate loans and construction loans. These are loans above a fixed dollar amount that are assigned an internal credit rating. Generally, residential real estate loans and consumer loans are not individually graded. The amount of loan loss reserve assigned to these loans is dependent on their net charge-off history.
Management also evaluates the impact of environmental factors which pose additional risks. Such environmental factors include: national and local economic trends and conditions; experience, ability, and depth of lending management and staff; effects of any changes in lending policies and procedures; levels of, and trends in, consumer bankruptcies, delinquencies, impaired loans and charge-offs and recoveries. The determination of this component of the allowance for loan losses requires considerable management judgement.
Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgement than most other significant accounting policies. Statement of Financial Accounting Standards (SFAS) No. 142, “Accounting for Goodwill and Other Intangible Assets,” establishes standards for the amortization of acquired intangible assets and the impairment assessment of goodwill. At December 31, 2006, Park had core deposit intangibles of $5.7 million subject to amortization and $72.3 million of goodwill, which was not subject to periodic amortization. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. Park’s goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of Park’s banking subsidiaries to provide quality, cost effective banking services in a competitive marketplace. The goodwill value of $72.3 million is supported by revenue that is in part driven by the volume of business transacted. A decrease in earnings resulting from a decline in the customer base or the inability to deliver cost effective services over sustained periods can lead to impairment of goodwill that could adversely impact earnings in future periods. SFAS No. 142 requires an annual evaluation of goodwill for impairment. The fair value of the goodwill, which resides on the books of Park’s subsidiary banks, is estimated by reviewing the past and projected operating results for the Park subsidiary banks, deposit and loan totals for the Park subsidiary banks and banking industry comparable information. Park has concluded in each of the past three years that the recorded value of goodwill was not impaired.
ABOUT OUR BUSINESS
Through its banking subsidiaries, Park is engaged in the commercial banking and trust business, generally in small to medium population Ohio communities. Management believes there is a significant number of consumers and businesses which seek long-term relationships with community-based financial institutions of quality and strength. While not engaging in activities such as foreign lending, nationally syndicated loans and investment banking operations, Park attempts to meet the needs of its customers for commercial, real estate and consumer loans, consumer and commercial leases, and investment, fiduciary and deposit services. Familiarity with its local markets has allowed Park to achieve solid financial results even in periods when there have been weak economic conditions.
A subsidiary bank of Park, PNB has concentrated on further expanding its operations in three metropolitan areas in Ohio during the past two years. The metropolitan areas are Columbus, Cincinnati and Dayton. During 2005, PNB opened an office in Worthington (near Columbus), opened an office in West Chester (near Cincinnati) and relocated its downtown Dayton office to the Dayton suburb of Centerville. In 2006, PNB opened an office in Florence, Kentucky (in the greater Cincinnati market) and added two additional offices in the Cincinnati market through the acquisition of Anderson Bank on December 18, 2006. Management expects to continue to add to branch locations in the Columbus, Cincinnati and Dayton markets over the next two years.
Management expects to close on the acquisition of Vision on or about March 9, 2007. Vision operates 15 branch locations in Gulf Coast communities in Alabama and the Florida panhandle. These markets are expected to grow much faster than many of the non-metro markets in which Park’s subsidiary banks operate in Ohio. Management expects that the acquisition of Vision will improve the future growth rate for Park’s loans and deposits. Management will consider other acquisition opportunities in fast growing markets after the Vision acquisition has been integrated.
Park’s subsidiaries compete for deposits and loans with other banks, savings associations, credit unions and other types of financial institutions. At December 31, 2006, Park and its subsidiaries operated 138 offices and a network of 142 automatic teller machines in 29 Ohio counties and one county in northern Kentucky.
Park has produced performance ratios which compare favorably to peer bank holding companies in terms of equity and asset returns, capital adequacy and asset quality. Continued strong results are contingent upon economic conditions in Ohio and competitive factors, among other things.
A table of financial data of Park’s subsidiaries for 2006, 2005 and 2004 is shown below. See Note 20 of the Notes to Consolidated Financial Statements for additional information on the Corporation’s subsidiaries.
Table 1 — Park National Corporation Affiliate Financial Data
                                                 
 
    2006   2005   2004
    Average   Net   Average   Net   Average   Net
(In thousands)   Assets   Income   Assets   Income   Assets   Income
 
 
Park National Bank:
                                               
Park National Division
  $ 1,503,420     $ 26,577     $ 1,413,872     $ 23,026     $ 1,380,568     $ 21,569  
Fairfield National Division
    338,183       6,457       362,192       6,856       335,006       7,309  
Park National SW & N KY Division
    288,189       1,331       229,726       3,049              
Richland Trust Company
    496,481       7,987       515,749       8,842       546,710       9,753  
Century National Bank
    719,864       10,149       743,276       12,464       503,239       8,065  
 
First-Knox National Bank:
                                               
First-Knox National Division
    639,969       11,406       639,000       10,805       665,116       11,049  
Farmers & Savings Division
    132,222       2,308       126,939       2,544       79,442       2,799  
United Bank, N.A.
    218,358       2,537       241,277       3,026       240,988       3,523  
Second National Bank
    386,139       4,705       404,656       6,029       390,906       6,859  
 
Security National Bank:
                                               
Security National Division
    766,298       11,931       782,467       11,393       773,710       12,290  
Unity National Division
    190,751       986       184,234       1,404       170,829       1,159  
Citizens National Bank
    166,611       1,854       189,965       1,928       201,916       2,332  
Parent Company, including consolidating entries
    (465,862 )     5,863       (275,265 )     3,872       (239,349 )     4,800  
 
Consolidated Totals
  $ 5,380,623     $ 94,091     $ 5,558,088     $ 95,238     $ 5,049,081     $ 91,507  
 
RETURN ON EQUITY
Park’s primary financial goal is to achieve a superior long-term return on stockholders’ equity. The Corporation measures performance in its attempt to achieve this goal against its peers, defined as all U.S. bank holding companies between $3 billion and $10 billion in assets. At year-end 2006, there were approximately 94 bank holding companies in this peer group. The Corporation’s net income to average equity ratio (ROE) was 17.26%, 17.03% and 17.00% in 2006, 2005, and 2004, respectively. The return on equity ratio has averaged 17.11% over the past five years compared to 13.41% for the peer group.

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BALANCE SHEET COMPOSITION
Park functions as a commercial bank holding company. The following section discusses the balance sheet for the Corporation.
SOURCE OF FUNDS
Deposits: Park’s major source of funds is provided by core deposits from individuals, businesses and local government units. These core deposits consist of all noninterest bearing and interest bearing deposits, excluding certificates of deposit of $100,000 and over which were less than 12% of total deposits for each of the last three years.
In 2006, year-end total deposits increased by $6 million or .2% exclusive of the $61 million of deposits that were acquired in the Anderson acquisition.
In 2005, year-end total deposits decreased by $55 million or 1.5% exclusive of the $136 million of deposits that were acquired in the First Clermont acquisition and the $12 million in deposits that were included in the sale of the Roseville branch office.
Average total deposits were $3,825 million in 2006 compared to $3,830 million in 2005 and $3,521 million in 2004. Average noninterest bearing deposits were $662 million in 2006 compared to $643 million in 2005 and $575 million in 2004.
Management expects that average total deposits (excluding the Vision acquisition) will increase by a modest amount (1% to 2%) in 2007. Emphasis will continue to be placed on increasing noninterest bearing deposits. A year ago, management projected that average total deposits would increase by 1% to 2% in 2006. Average total deposits decreased by $5 million in 2006 instead of increasing by the modest growth rate that was projected. The slower than expected growth was primarily due to increased competition for interest bearing balances. Management continued to concentrate on controlling the cost of interest bearing deposit accounts in 2006. Additionally, one of Park’s affiliate banks (PNB) lost a large deposit customer during the fourth quarter of 2006, as the customer relocated its business outside of the state of Ohio. This customer had maintained average deposits of approximately $73 million during the first nine months of 2006 and all of these funds were withdrawn during the first few weeks of the fourth quarter of 2006.
The average interest rate paid on interest bearing deposit accounts was 2.60% in 2006 compared to 1.79% in 2005 and 1.36% in 2004. By comparison, the average federal funds rate was 4.97% in 2006, 3.21% in 2005 and 1.36% in 2004.
Maturities of time certificates of deposit and other time deposits of $100,000 and over as of December 31, 2006 were:
Table 2 — $100,000 and Over Maturity Schedule
         
 
December 31, 2006   Time Certificates
(In thousands)   of Deposit
 
3 months or less
  $ 157,817  
Over 3 months through 6 months
    89,523  
Over 6 months through 12 months
    127,495  
Over 12 months
    75,020  
 
Total
  $ 449,855  
 
Short-Term Borrowings: Short-term borrowings consist of securities sold under agreements to repurchase, Federal Home Loan Bank advances, federal funds purchased and other borrowings. These funds are used to manage the Corporation’s liquidity needs and interest rate sensitivity risk. The average rate paid on short-term borrowings generally moves closely with changes in market interest rates for short-term investments. The average rate paid on short-term borrowings was 4.18% in 2006 compared to 2.57% in 2005 and 1.33% in 2004.
The Federal Reserve Board increased the federal funds rate by 25 basis points at each Federal Open Market Committee meeting from June 2004 thru June 2006. The federal funds rate increased by 1.00% to 2.25% at year-end 2004, increased to 4.25% by year-end 2005 and increased to 5.25% by June 30, 2006. The federal funds rate remained at 5.25% throughout the second half of 2006. The average federal funds rate was 1.36% in 2004, 3.21% in 2005 and 4.97% in 2006.
Average short-term borrowings were $375 million in 2006 compared to $292 million in 2005 and $401 million in 2004.
Long-Term Debt: Long-term debt primarily consists of borrowings from the Federal Home Loan Bank and repurchase agreements with investment banking firms. The average rate paid on long-term debt was 4.22% for 2006 compared to 3.69% for 2005 and 2.57% for 2004. In 2006, average long-term debt was $553 million compared to $800 million in 2005 and $520 million in 2004. Average total debt (long-term and short-term) was $929 million in 2006 compared to $1,092 million in 2005 and $921 million in 2004. Average long-term debt was 60% of average total debt in 2006 compared to 73% in 2005 and 56% in 2004.
Stockholders’ Equity: Average stockholders’ equity to average total assets was 10.13% in 2006, 10.06% in 2005 and 10.66% in 2004.
The decrease in the average stockholders’ equity to average total assets ratio in 2005 was primarily due to the acquisitions of First Federal and First Clermont, which added assets totaling $438 million, but no equity since both acquisitions were all cash transactions.
In accordance with SFAS No. 115, Park reflects any unrealized holding gain or loss on available-for-sale securities, net of federal taxes, as accumulated other comprehensive income (loss) which is part of Park’s equity. While the effects of this accounting are not recognized for calculation of regulatory capital adequacy ratios, it does impact Park’s equity as reported in the audited financial statements. The unrealized holding loss on available-for-sale securities, net of federal taxes, was $(16.0) million at year-end 2006 and $(10.1) million at year-end 2005. The unrealized holding gain on available-for-sale securities, net of federal taxes, was $12.4 million at year-end 2004. Long-term interest rates increased during 2005 which caused the market value of Park’s investment securities to decline and produced the unrealized holding loss on available-for-sale securities.
Park recorded an additional decrease in accumulated other comprehensive income (loss), net of federal taxes, of $(6.8) million in 2006 related to the adoption of SFAS No. 158, which pertains to the accounting for Park’s defined benefit pension plan. See Note 1 of the Notes to Consolidated Financial Statements for additional information on the adoption of SFAS No. 158.
INVESTMENT OF FUNDS
Loans: Average loans, net of unearned income, were $3,357 million in 2006 compared to $3,278 million in 2005 and $2,813 million in 2004. The average yield on loans was 7.61% in 2006 compared to 6.84% in 2005 and 6.38% in 2004. The average prime lending rate in 2006 was 7.96% compared to 6.19% in 2005 and 4.35% in 2004. Approximately 62% of loan balances mature or reprice within one year (see Table 11). This results in the interest rate yield on the loan portfolio adjusting with changes in interest rates, but on a delayed basis. Management expects that the yield on the loan portfolio will continue to increase in 2007 as variable rate loans reprice at higher interest rates.
Year-end loan balances, net of unearned income, increased by $100 million or 3.0% in 2006 exclusive of $53 million of loans that were acquired in the Anderson acquisition. In 2005, loans increased by $52 million or 1.7% exclusive of $161 million of loans that were acquired in the First Clermont acquisition and $5 million of loans that were included in the sale of the Roseville branch office. In 2004, loans increased by $167 million or 6.1% exclusive of $223 million of loans that were acquired in the First Federal acquisition.
In summary, year-end loan balances (exclusive of the acquisitions) have increased by 3.0%, 1.7% and 6.1% for the years 2006, 2005 and 2004, respectively. The growth in loans in 2005 was negatively impacted by the decrease in the loan portfolios of First Federal and First Clermont. Their combined loan portfolios decreased by approximately $47 million in 2005.

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A year ago, management projected that year-end loan balances would grow between 3% to 5% during 2006. The actual increase in year-end loans was $100 million or 3.0% for 2006. However, $27 million of the growth in loans for 2006 resulted from the purchase of loan participations from Vision during the fourth quarter. Without the purchase of the loan participations from Vision, the growth in loans for 2006 would have been 2.2%. Management expects that loan growth for 2007 (exclusive of loans from the Vision acquisition) will be approximately 3% to 4%.
Year-end residential real estate loans were $1,300 million, $1,287 million and $1,190 million in 2006, 2005 and 2004, respectively. Residential real estate loans decreased by $15 million at year-end 2006 exclusive of the $28 million of loans from the Anderson acquisition. In 2005, residential real estate loans increased by $9 million exclusive of $88 million of loans from the First Clermont acquisition. In 2004, residential real estate loans increased by $78 million or 7.9% exclusive of $129 million of loans from the First Federal acquisition. Management expects no growth in residential real estate loans in 2007, exclusive of loans from the pending acquisition of Vision.
The long-term fixed rate mortgage loans that Park originates are sold in the secondary market and Park retains the servicing on these loans. The balance of sold fixed rate mortgage loans was $1,405 million at year-end 2006 compared to $1,403 million at year-end 2005 and $1,266 million at year-end 2004. Management expects that the balance of sold fixed rate mortgage loans would remain relatively stable during 2007.
Year-end consumer loans were $532 million, $495 million and $505 million in 2006, 2005 and 2004, respectively. Consumer loans increased by $35 million or 7.1% at year-end 2006 exclusive of $2 million of loans from the Anderson acquisition. In 2005, consumer loans decreased by $30 million or 5.9% exclusive of $20 million of loans from the First Clermont acquisition. Consumer loans increased by $3 million or .6% at year-end 2004 exclusive of $52 million of loans from the acquisition of First Federal. The increase in consumer loans in 2006 was primarily due to an increase in automobile loans originated through automobile dealers. Management expects that consumer loans will increase by approximately 5% in 2007, exclusive of loans from the pending acquisition of Vision.
The origination of construction loans, commercial loans and commercial real estate loans was positive in 2006. On a combined basis, these loans totaled $1,638 million, $1,529 million and $1,377 million at year-end 2006, 2005 and 2004, respectively. These combined loan totals increased by $86 million or 5.6% at year-end 2006 exclusive of $23 million of loans from the Anderson acquisition. In 2005, these combined loan totals increased by $96 million or 7.0% exclusive of $56 million of loans from the First Clermont acquisition. In 2004, these combined loan totals increased by $105 million or 8.5% exclusive of $40 million of loans from the acquisition of First Federal. Management expects that construction loans, commercial loans and commercial real estate loans will grow by approximately 6% in 2007, exclusive of loans from the pending acquisition of Vision.
Year-end lease balances were $10 million, $17 million and $48 million in 2006, 2005 and 2004, respectively. Management continues to de-emphasize automobile leasing and to a lesser extent commercial leasing. The year-end lease balances are expected to continue to decrease in 2007.
Table 3 reports year-end loan balances by type of loan for the past five years.
Table 3 — Loans by Type
                                         
 
December 31,                    
(In thousands)   2006   2005   2004   2003   2002
 
Commercial, financial and agricultural
  $ 548,254     $ 512,636     $ 469,382     $ 441,165     $ 440,030  
Real estate — construction
    234,988       193,185       155,326       121,160       99,102  
Real estate — residential
    1,300,294       1,287,438       1,190,275       983,702       998,202  
Real estate — commercial
    854,869       823,354       752,428       670,082       617,270  
Consumer, net of unearned income
    532,092       494,975       505,151       450,145       441,747  
Leases, net of unearned income
    10,205       16,524       48,046       64,549       95,836  
 
Total Loans
  $ 3,480,702     $ 3,328,112     $ 3,120,608     $ 2,730,803     $ 2,692,187  
 
Table 4 — Selected Loan Maturity Distribution
                                 
 
            Over One   Over    
December 31, 2006   One Year   Through   Five    
(In thousands)   or Less   Five Years   Years   Total
 
Commercial, financial and agricultural
  $ 254,874     $ 186,164     $ 107,216     $ 548,254  
Real estate — construction
    118,459       67,427       49,102       234,988  
 
Total
  $ 373,333     $ 253,591     $ 156,318     $ 783,242  
 
Total of these selected loans due after one year with:
                               
Fixed interest rate
                          $ 158,127  
Floating interest rate
                          $ 251,782  
 
Investment Securities: Park’s investment securities portfolio is structured to provide liquidity and contribute to earnings. Park’s investment strategy is dynamic. As conditions change over time, Park’s overall interest rate risk, liquidity needs and potential return on the investment portfolio will change. Management regularly evaluates the securities in the investment portfolio as circumstances evolve. Circumstances that may precipitate a sale of a security would be to better manage interest rate risk, meet liquidity needs or to improve the overall yield on the investment portfolio.
Park classifies most of its securities as available-for-sale (see Note 4 of the Notes to Consolidated Financial Statements). These securities are carried on the books at their estimated fair value with the unrealized holding gain or loss, net of federal taxes, accounted for as accumulated other comprehensive income (loss) which is part of the Corporation’s equity.
Management classified approximately 88% of the securities portfolio as available-for-sale at December 31, 2006. These securities are available to be sold in future periods in carrying out Park’s investment strategies. The remaining securities are classified as held-to-maturity and are accounted for at amortized cost.
Average taxable investment securities were $1,533 million in 2006 compared to $1,758 million in 2005 and $1,795 million in 2004. The average yield on taxable securities was 4.91% in 2006 compared to 4.87% in 2005 and 4.84% in 2004. Average tax-exempt investment securities were $77 million in 2006 compared to $94 million in 2005 and $107 million in 2004. The average tax-equivalent yield on tax-exempt investment securities was 6.84% in 2006 compared to 7.01% in 2005 and 7.17% in 2004. On a combined basis, the total of the average balance of taxable and tax-exempt securities was 29.9% of average total assets in 2006 compared to 33.3% in 2005 and 37.7% in 2004.
Year-end total investment securities (at amortized cost) were $1,538 million in 2006, $1,679 million in 2005 and $1,908 million in 2004. Management purchased investment securities totaling $167 million in 2006, $301 million in 2005 and $427 million in 2004. Proceeds from repayments and maturities of investment securities were $313 million in 2006, $410 million in 2005 and $437 million in 2004. Proceeds from sales of available-for-sale securities were $304,000 in 2006, $132 million in 2005 and $58 million in 2004. Park realized net security gains of $97,000 in 2006 and $96,000 in 2005, and net security losses of $793,000 in 2004.
Long-term interest rates are currently lower than short-term interest rates. The monthly average rate on a 5 year U.S. Treasury security was below the federal funds rate of 5.25% for each of the last 6 months of 2006. The investment securities that Park usually buys (U.S. Government Agency 15 year mortgage-backed securities) typically yield approximately 75 basis points above a 5 year U.S. Treasury security. With current interest rates, the yield on purchases of investment securities do not provide a sufficient spread above the federal funds rate for Park to increase the investment portfolio. Without an improvement in investment opportunities, management plans on using much of the cash flow from the maturities and repayments of investment securities (approximately $245 million) to repay borrowings in 2007 and provide funding for loans.

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FINANCIAL REVIEW
 
At year-end 2006 and 2005, the average tax-equivalent yield on the total investment portfolio was 5.01% and 4.93%, respectively. The weighted average remaining maturity was 4.4 years at December 31, 2006 and 4.6 years at December 31, 2005. U.S. Government Agency asset-backed securities were approximately 85% of the total investment portfolio at year-end 2006 and were approximately 91% of the total investment portfolio at year-end 2005. This segment of the investment portfolio consists of 15 year mortgage-backed securities and collateralized mortgage obligations.
The average maturity of the investment portfolio would lengthen if long-term interest rates would increase as the principal repayments from mortgage-backed securities and collateralized mortgage obligations would be reduced. At year-end 2006, management estimated that the average maturity of the investment portfolio would lengthen to 4.8 years with a 100 basis point increase in long-term interest rates and to 5.0 years with a 200 basis point increase in long-term interest rates.
The following table sets forth the carrying value of investment securities at year-end 2006, 2005 and 2004:
Table 5 — Investment Securities
                         
 
December 31,            
(In thousands)   2006   2005   2004
 
Obligations of U.S. Treasury and other U.S. Government agencies
  $ 90,709     $ 996     $ 15,206  
Obligations of states and political subdivisions
    70,090       85,336       103,739  
U.S. Government asset-backed securities and other asset-backed securities
    1,288,969       1,516,950       1,754,852  
Other securities
    63,730       60,060       52,985  
 
Total
  $ 1,513,498     $ 1,663,342     $ 1,926,782  
 
Included in “Other Securities” in Table 5, are Park’s investments in Federal Home Loan Bank stock and Federal Reserve Bank stock. Park owned $55.5 million of Federal Home Loan Bank stock and $6.4 million of Federal Reserve Bank stock at December 31, 2006. At December 31, 2005, Park owned $52.1 million of Federal Home Loan Bank stock and $5.9 million of Federal Reserve Bank stock. At December 31, 2004, Park owned $47.1 million of Federal Home Loan Bank stock and $4.4 million of Federal Reserve Bank stock. The fair values of these investments are the same as their amortized costs.
ANALYSIS OF EARNINGS
Park’s principal source of earnings is net interest income, the difference between total interest income and total interest expense. Net interest income results from average balances outstanding for interest earning assets and interest bearing liabilities in conjunction with the average rates earned and paid on them. (See Table 6 for three years of history on the average balances of the balance sheet categories and the average rates earned on interest earning assets and the average rates paid on interest bearing liabilities.)
Table 6 — Distribution of Assets, Liabilities and Stockholders’ Equity
                                                                             
             
    2006     2005     2004
December 31,   Daily           Average     Daily           Average     Daily           Average
(Dollars in thousands)   Average   Interest   Rate     Average   Interest   Rate     Average   Interest   Rate
             
ASSETS
                                                                           
Interest earning assets:
                                                                           
Loans (1) (2)
  $ 3,357,278     $ 255,641       7.61 %     $ 3,278,092     $ 224,346       6.84 %     $ 2,813,069     $ 179,458       6.38 %
Taxable investment securities
    1,533,310       75,300       4.91 %       1,757,853       85,664       4.87 %       1,794,544       86,806       4.84 %
Tax-exempt investment securities (3)
    77,329       5,288       6.84 %       93,745       6,571       7.01 %       106,585       7,637       7.17 %
Money market instruments
    8,723       469       5.38 %       12,258       441       3.60 %       9,366       219       2.34 %
             
Total interest earning assets
    4,976,640       336,698       6.77 %       5,141,948       317,022       6.17 %       4,723,564       274,120       5.80 %
             
Noninterest earning assets:
                                                                           
Allowance for possible loan losses
    (70,386 )                       (71,052 )                       (64,676 )                
Cash and due from banks
    142,794                         148,303                         142,102                  
Premises and equipment, net
    46,894                         46,418                         36,540                  
Other assets
    284,681                         292,471                         211,551                  
             
TOTAL
  $ 5,380,623                       $ 5,558,088                       $ 5,049,081                  
             
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                                                           
Interest bearing liabilities:
                                                                           
Transaction accounts
  $ 1,058,323     $ 22,508       2.13 %     $ 1,007,576     $ 11,763       1.17 %     $ 871,264     $ 4,458       0.51 %
Savings deposits
    573,067       3,362       0.59 %       633,545       3,328       0.53 %       598,181       2,437       0.41 %
Time deposits
    1,531,477       56,402       3.68 %       1,545,912       41,808       2.70 %       1,476,915       33,103       2.24 %
Total interest bearing deposits
    3,162,867       82,272       2.60 %       3,187,033       56,899       1.79 %       2,946,360       39,998       1.36 %
Short-term borrowings
    375,332       15,692       4.18 %       291,842       7,508       2.57 %       401,299       5,319       1.33 %
Long-term debt
    553,307       23,351       4.22 %       799,888       29,488       3.69 %       519,979       13,385       2.57 %
             
Total interest bearing liabilities
    4,091,506       121,315       2.97 %       4,278,763       93,895       2.19 %       3,867,638       58,702       1.52 %
             
Noninterest bearing liabilities:
                                                                           
Demand deposits
    662,077                         643,032                         574,560                  
Other
    81,966                         77,082                         68,608                  
             
Total noninterest bearing liabilities
    744,043                         720,114                         643,168                  
             
Stockholders’ equity
    545,074                         559,211                         538,275                  
             
TOTAL
  $ 5,380,623                       $ 5,558,088                       $ 5,049,081                  
             
Net interest earnings
          $ 215,383                       $ 223,127                       $ 215,418          
Net interest spread
                    3.80 %                       3.98 %                       4.28 %
Net yield on interest earning assets
                    4.33 %                       4.34 %                       4.56 %
             
(1)   Loan income includes loan related fee income of $4,340 in 2006, $3,809 in 2005 and $3,336 in 2004. Loan income also includes the effects of taxable equivalent adjustments using a 35% tax rate in 2006, 2005 and 2004. The taxable equivalent adjustment was $518 in 2006, $478 in 2005, and $605 in 2004.
 
(2)   For the purpose of the computation, nonaccrual loans are included in the daily average loans outstanding.
 
(3)   Interest income on tax-exempt investment securities includes the effects of taxable equivalent adjustments using a 35% tax rate in 2006, 2005 and 2004. The taxable equivalent adjustments were $1,621 in 2006, $2,085 in 2005, and $2,522 in 2004.

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FINANCIAL REVIEW
 
Park expects to close on the acquisition of Vision in March 2007. The following analysis of earnings ignores the impact of the pending acquisition of Vision. Park’s management will update projections for 2007 in the Form 10-Q filed after the completion of the Vision acquisition.
Net interest income decreased by $7.3 million or 3.3% to $213.2 million for 2006 compared to an increase of $8.3 million or 3.9% to $220.6 million for 2005. The net yield on interest earning assets was 4.33% for 2006 compared to 4.34% for 2005 and 4.56% for 2004. The net interest rate spread (the difference between rates received for interest earning assets and the rates paid for interest bearing liabilities) was 3.80% for 2006 compared to 3.98% for 2005 and 4.28% for 2004. The decrease in net interest income in 2006 was primarily due to a decrease in average interest earning assets of $165 million or 3.2%. The increase in net interest income in 2005 was primarily due to an increase in average interest earning assets of $418 million or 8.9%.
The average yield on interest earning assets was 6.77% in 2006 compared to 6.17% in 2005 and 5.80% in 2004. The Federal Reserve Board increased the federal funds rate from 1.00% at June 29, 2004 to 2.25% at year-end 2004 and to 4.25% at year-end 2005 and finally to 5.25% at June 30, 2006. The federal funds rate remained at 5.25% for the final 6 months of 2006. The average yield on interest earning assets on a quarterly basis in 2006 was 6.57% for the first quarter, 6.76% for the second quarter, 6.87% for the third quarter and 6.85% for the fourth quarter. The average yield on loans on a quarterly basis in 2006 was 7.35% for the first quarter, 7.61% for the second quarter, 7.77% for the third quarter and 7.71% for the fourth quarter. (The average yield on interest earning assets and the average yield on loans were negatively impacted in the fourth quarter as a result of the $1.933 million cumulative reduction in interest income on loans, due to the overstatement of accrued interest receivable on loans. Without the $1.933 million adjustment, the average yield on interest earnings assets was 7.01% for the fourth quarter and the average yield on loans was 7.93% for the fourth quarter.) Management expects that the average yield on interest earning assets and loans will gradually increase in 2007 as loans reprice at higher interest rates or mature and are replaced with higher yielding loans.
The average rate paid on interest bearing liabilities was 2.97% in 2006 compared to 2.19% in 2005 and 1.52% for 2004. The average rate paid on interest bearing deposits was 2.60% in 2006 compared to 1.79% in 2005 and 1.36% in 2004. The average rate paid on interest bearing liabilities on a quarterly basis in 2006 was 2.67% for the first quarter, 2.89% for the second quarter, 3.10% for the third quarter and 3.20% for the fourth quarter. The average rate paid on interest bearing deposits on a quarterly basis in 2006 was 2.25% for the first quarter, 2.49% for the second quarter, 2.77% for the third quarter and 2.88% for the fourth quarter. Management expects that the average cost of interest bearing liabilities and the average rate paid on interest bearing deposits will gradually increase in 2007.
Management expects that net interest income will increase modestly (2% to 3%) in 2007. Management expects that average interest earning assets will slightly decrease in 2007, but the net yield on interest earning assets is expected to improve to approximately 4.40%.
A year ago, management projected that the net yield on interest earning assets would be between 4.35% and 4.40% for 2006. The actual net yield on interest earning assets was 4.33% for 2006. Management also projected modest growth in average interest earning assets and a modest increase in net interest income. The actual results in 2006 were a decrease in average interest earning assets of 3.2% and a decrease in net interest income of 3.3%. (Without the $1.933 million cumulative reduction to interest income on loans, the net interest margin was 4.37% for 2006.)
The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of change in each.
Table 7 — Volume/Rate Variance Analysis
                                                 
 
    Change from 2005 to 2006   Change from 2004 to 2005
(In thousands)   Volume   Rate   Total   Volume   Rate   Total
 
Increase (decrease) in:
                                               
Interest income:
                                               
 
Total loans
  $ 5,529     $ 25,766     $ 31,295     $ 31,256     $ 13,632     $ 44,888  
 
Taxable investments
    (11,059 )     695       (10,364 )     (1,703 )     561       (1,142 )
Tax-exempt investments
    (1,127 )     (156 )     (1,283 )     (899 )     (167 )     (1,066 )
Money market instruments
    (153 )     181       28       81       141       222  
 
Total interest income
    (6,810 )     26,486       19,676       28,735       14,167       42,902  
 
Interest expense:
                                               
Transaction accounts
  $ 621     $ 10,124     $ 10,745     $ 788     $ 6,517     $ 7,305  
Savings accounts
    (332 )     366       34       150       741       891  
Time deposits
    (394 )     14,988       14,594       1,613       7,092       8,705  
Short-term borrowings
    2,566       5,618       8,184       (1,757 )     3,946       2,189  
Long-term debt
    (9,970 )     3,833       (6,137 )     8,899       7,204       16,103  
 
Total interest expense
    (7,509 )     34,929       27,420       9,693       25,500       35,193  
 
Net variance
  $ 699     $ (8,443 )   $ (7,744 )   $ 19,042     $ (11,333 )   $ 7,709  
 
Other Income: Total other income, exclusive of security gains or losses, increased by $5.1 million or 8.5% to $64.7 million in 2006 compared to an increase of $7.0 million or 13.2% to $59.6 million in 2005. The large increase in 2005 was primarily due to the additional customers and volume from the acquisitions of First Federal and First Clermont.
Income from fiduciary activities increased by $1.5 million or 12.6% to $13.5 million in 2006 and increased by $897,000 or 8.1% to $12.0 million in 2005. These increases are primarily due to growth in the number of customers being served. Additionally, the strong performance of the equity markets in 2006 contributed to an increase in the market value of assets being managed which contributed to the increase in fee income in 2006. Management expects an increase of 8% to 9% in fee income from fiduciary activities in 2007. First Federal and First Clermont did not have any fee income from fiduciary activities.
Service charges on deposit accounts increased by $2.1 million or 11.9% to $20.0 million in 2006 and increased by $2.3 million or 14.6% to $17.9 million in 2005. The primary reason for the relatively large increase in service charges on deposit accounts in 2006 was due to an increase in charges from Park’s courtesy overdraft program and to an increase in the number of checking account customers. The large increase in service charges on deposits in 2005 was due to the additional deposit customers from the First Federal and First Clermont acquisitions. Management expects that the increase in service charges on deposit accounts will be approximately 10% in 2007.
Fee income earned from the origination and sale into the secondary market of fixed rate mortgage loans is included with other non-yield related loan fees in the subcategory “other service income.” Other service income was $10.9 million in 2006 compared to $10.8 million in 2005 and $10.3 million in 2004. Management expects that the volume of mortgage loans originated and sold in the secondary market in 2007 will approximate 2006. Management projects that other service income will be approximately $11 million in 2007.
The subcategory of “other income” was $20.2 million in 2006 compared to $19.0 million in 2005 and $15.6 million in 2004. The percentage increase was 6.6% in 2006 compared to 21.6% in 2005. The large increase in other income in 2005 was primarily due to the additional customers from the First Federal and First Clermont acquisitions. This subcategory includes fees earned from check card and ATM services, fee income from bank owned life insurance, fee income earned from the sale of investment and insurance products, rental fee income from safety deposit boxes and fees earned from the sale of official checks and printed checks. Management expects that other income for 2007 will be approximately $20.5 million.

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FINANCIAL REVIEW
 
A year ago, management projected that total other income, exclusive of security gains or losses, would be approximately $61.5 million in 2006. The actual results of $64.7 million exceeded the projection by $3.2 million or 5.1%. This variance was due to fee income from fiduciary activities exceeding the projection by $600,000, service charges on deposits exceeding the projection by $1.0 million and other income exceeding the projection by $1.6 million. These positive variances were primarily due to an increase in volume. For 2007, management expects that total other income, exclusive of security gains or losses, will be approximately $68.3 million in 2007, a projected increase of 5.6%.
Other Expense: Total other expense increased by $1.6 million or 1.1% to $141.0 million in 2006 and increased by $13.1 million or 10.4% to $139.4 million in 2005. The large increase in total other expense in 2005 of 10.4% was primarily due to the acquisitions of First Federal and First Clermont.
Salaries and employee benefits expense increased by $1.7 million or 2.2% to $80.2 million in 2006 and increased by $7.0 million or 9.8% to $78.5 million in 2005. Full-time equivalent employees at year-end 2006 were 1,892 compared to 1,824 at year-end 2005, an increase of 3.7%. The small increase in salaries and employee benefits expense in 2006 was primarily due to the $1.4 million reduction in the officer incentive compensation pool in 2006 compared to 2005. A total of 123 employees were added from the First Federal and First Clermont acquisitions, which explains the large increase of 9.8% in salaries and employee benefits expense in 2005. None of the employees of First Federal and First Clermont were included in salaries and employee benefits expense in 2004, but were included for the entire year of 2005. A year ago, management projected that salaries and employee benefits expense would be approximately $82.4 million for 2006 compared to the actual expense of $80.2 million in 2006. This positive variance was primarily due to a $1.4 million reduction in the officer incentive compensation pool. Management expects that salaries and employee benefits expense will increase by approximately 8% in 2007, primarily due to the increase in full-time equivalent employees and the expected increase in health insurance costs.
Data processing expense increased by $1.2 million or 11.1% to $11.8 million in 2006 and increased by $1.7 million or 19.5% to $10.6 million in 2005. The increase in data processing expense in 2006 was primarily due to upgrades that management made to its data processing systems. In 2005, the large increase in data processing expense was primarily due to the acquisitions of First Federal and First Clermont. Data processing expense is expected to increase by approximately 5% in 2007.
The expense for state franchise taxes was $2.2 million in 2006, $2.9 million in 2005 and $2.5 million in 2004. The decrease in expense in 2006 was primarily due to the First Clermont acquisition closing on January 3, 2005. First Clermont had a franchise tax liability for calendar year 2005 and none for 2006. Management expects that state franchise tax expense will be approximately $2.4 million in 2007.
The subcategory “other expense” was $10.3 million in 2006, $12.0 million in 2005 and $10.9 million in 2004. The subcategory other expense includes expenses for supplies, travel, charitable contributions, sundry write-offs and other miscellaneous expenses. The decrease in other expense in 2006 was due to the decrease in charitable contributions of $1.7 million. Charitable contribution expense was $300,000 in 2006 compared to $2.0 million in 2005. In 2005, the increase in other expense was primarily due to an increase in charitable contributions of $1.1 million to $2.0 million in 2005 compared to $900,000 in 2004. Management expects that charitable contribution expense will be approximately $900,000 in 2007. Management expects that the subcategory other expense will total approximately $11.5 million in 2007.
The expense for amortization of intangibles was $2.5 million in 2006, $2.5 million in 2005 and $1.5 million in 2004. The increase in this expense in 2005 was due to the acquisitions of First Federal and First Clermont. Intangible amortization expense is expected to decrease to $2.0 million in 2007 as the core deposit premiums pertaining to certain branch acquisitions were fully amortized at the end of 2006.
A year ago, management projected that total other expense would be approximately $145.0 million in 2006 compared to actual results of $141.0 million. Most of the positive variance was due to salary and employee benefit expense being $2.2 million below the projected amount. Additionally, management estimated a year ago that the operating expense pertaining to the issuance of incentive stock options would be $1 million in 2006. Park did not issue stock options in 2006 and accordingly did not recognize any expense in connection with the adoption of SFAS No. 123R “Share-Based Payment.” Park anticipates that few, if any, stock options would be issued in 2007. For 2007, management expects that total other expense will increase by approximately 6.2% to approximately $150 million in 2007.
Federal Income Taxes: Federal income tax expense as a percentage of income before taxes was 29.3% in 2006, 29.7% in 2005 and 29.2% in 2004. A lower effective tax percentage rate than the statutory rate of 35% is primarily due to tax-exempt interest income from state and municipal investments and loans, low income housing tax credits and fee income from bank owned life insurance. Park and its subsidiary banks do not pay state income tax to the state of Ohio, but pay a franchise tax based on year-end equity. The franchise tax expense is included in “state taxes” on Park’s Consolidated Statements of Income.
CREDIT EXPERIENCE
Provision for Loan Losses: The provision for loan losses is the amount added to the allowance for loan losses to absorb future loan charge-offs. The amount of the loan loss provision is determined by management after reviewing the risk characteristics of the loan portfolio, historic and current loan loss experience and current economic conditions.
The provision for loan losses was $3.9 million in 2006, $5.4 million in 2005 and $8.6 million in 2004. Net loan charge-offs were $3.9 million in 2006, $5.9 million in 2005 and $7.9 million in 2004. The ratio of net loan charge-offs to average loans was .12% in 2006, .18% in 2005 and .28% in 2004.
At year-end 2006, the allowance for loan losses was $70.5 million or 2.03% of total loans outstanding, compared to $69.7 million or 2.09% of total loans outstanding at year-end 2005 and $68.3 million or 2.19% of total loans outstanding at year-end 2004. In each of the last three years, the loan loss reserve from an acquired bank was added to Park’s allowance for loan losses. The Anderson acquisition added $798,000 in 2006, the First Clermont acquisition added $1.8 million in 2005 and the First Federal acquisition added $4.5 million in 2004.
Management believes that the allowance for loan losses at year-end 2006 is adequate to absorb probable incurred credit losses in the loan portfolio. See Note 1 of the Notes to Consolidated Financial Statements and the discussion under the heading “Critical Accounting Policies” earlier in this Financial Review section for additional information on management’s evaluation of the adequacy of the allowance for loan losses.

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FINANCIAL REVIEW
 
The following table summarizes the activity in the allowance for loan losses for the past five years. The charge-offs and recoveries are listed by type of loan for each year.
Table 8 — Summary of Loan Loss Experience
                                         
 
(In thousands)   2006   2005   2004   2003   2002
 
Average loans (net of unearned interest)
  $ 3,357,278     $ 3,278,092     $ 2,813,069     $ 2,695,830     $ 2,719,805  
Allowance for loan losses:
                                       
Beginning balance
  $ 69,694     $ 68,328     $ 63,142     $ 62,028     $ 59,959  
Charge-offs:
                                       
Commercial, financial and agricultural
    853       3,154       2,557       4,698       7,210  
Real estate — construction
    718       46       613             317  
Real estate — residential
    1,915       1,006       1,476       1,173       1,208  
Real estate — commercial
    556       1,612       1,951       1,947       884  
Consumer
    6,673       7,255       8,111       9,233       8,606  
Lease financing
    57       316       465       985       1,602  
 
Total charge-offs
    10,772       13,389       15,173       18,036       19,827  
 
Recoveries:
                                       
Commercial, financial and agricultural
  $ 842     $ 2,707     $ 2,138     $ 1,543     $ 1,812  
Real estate — construction
          173       67       175        
Real estate — residential
    1,017       659       650       549       969  
Real estate — commercial
    1,646       517       292       407       565  
Consumer
    3,198       3,214       3,633       3,236       2,891  
Lease financing
    150       229       529       645       616  
 
Total recoveries
    6,853       7,499       7,309       6,555       6,853  
 
Net charge-offs
    3,919       5,890       7,864       11,481       12,974  
 
Provision charged to earnings
    3,927       5,407       8,600       12,595       15,043  
 
Allowance for loan losses of acquired bank
    798       1,849       4,450              
 
Ending balance
  $ 70,500     $ 69,694     $ 68,328     $ 63,142     $ 62,028  
 
Ratio of net charge-offs to average loans
    0.12 %     0.18 %     0.28 %     0.43 %     0.48 %
Ratio of allowance for loan losses to end of year loans, net of unearned interest
    2.03 %     2.09 %     2.19 %     2.31 %     2.30 %
 
The following table summarizes the allocation of the allowance for loan losses for the past five years:
Table 9 — Allocation of Allowance for Loan Losses
                                                                                           
                               
December 31,     2006     2005     2004     2003     2002
              Percent of             Percent of             Percent of             Percent of             Percent of
(Dollars in             Loans Per             Loans Per             Loans Per             Loans Per             Loans Per
thousands)     Allowance   Category     Allowance   Category     Allowance   Category     Allowance   Category     Allowance   Category
                               
Commercial, financial and agricultural
    $ 16,985       15.75 %     $ 17,942       15.40 %     $ 17,837       15.04 %     $ 17,117       16.16 %     $ 17,049       16.34 %
Real estate — construction
      4,425       6.75 %       3,864       5.80 %       3,107       4.98 %       2,423       4.44 %       1,982       3.68 %
Real estate — residential
      10,402       37.36 %       10,329       38.68 %       8,926       38.14 %       7,378       36.02 %       7,504       37.17 %
Real estate — commercial
      17,097       24.56 %       16,823       24.74 %       16,930       24.11 %       15,412       24.54 %       13,889       22.93 %
Consumer
      21,285       15.29 %       19,799       14.87 %       20,206       16.19 %       18,681       16.48 %       18,322       16.40 %
Leases
      306       0.29 %       937       0.51 %       1,322       1.54 %       2,131       2.36 %       3,282       3.48 %
                               
Total
    $ 70,500       100.00 %     $ 69,694       100.00 %     $ 68,328       100.00 %     $ 63,142       100.00 %     $ 62,028       100.00 %
                               
As of December 31, 2006, Park had no significant concentrations of loans to borrowers engaged in the same or similar industries nor did Park have any loans to foreign governments.
Nonperforming Assets: Nonperforming loans include: l) loans whose interest is accounted for on a nonaccrual basis; 2) loans whose terms have been renegotiated; and 3) loans which are contractually past due 90 days or more as to principal or interest payments but whose interest continues to accrue. Other real estate owned results from taking title to property used as collateral for a defaulted loan.
The percentage of nonperforming loans to total loans was .95% at year-end 2006, .90% at year-end 2005 and .92% at year-end 2004. The percentage of nonperforming assets to total loans was 1.04% at year-end 2006, .97% at year-end 2005 and 1.01% at year-end 2004.
Park had $176.8 million of loans included on the Corporation’s watch list of potential problem loans at December 31, 2006 compared to $130.8 million at year-end 2005 and $131.8 million at year-end 2004. The existing conditions of these loans do not warrant classification as nonaccrual. Management performs additional analyses regarding a borrower’s ability to comply with payment terms for watch list loans. As a percentage of year-end total loans, the Corporation’s watch list of potential problem loans was 5.1% in 2006, 3.9% in 2005 and 4.2% in 2004.
Management does not expect that the increase in watch list loans in 2006 of $46 million will lead to a significant increase in nonperforming loans and assets in 2007. Park’s lending management will work with the additional watch list loan borrowers to prevent these loans from becoming nonperforming.
The following is a summary of the nonaccrual, past due and renegotiated loans and other real estate owned for the last five years:
Table 10 — Nonperforming Assets
                                         
 
December 31,                    
(Dollars in thousands)   2006   2005   2004   2003   2002
 
Nonaccrual loans
  $ 16,004     $ 14,922     $ 17,873     $ 15,921     $ 17,579  
Renegotiated loans
    9,113       7,441       5,461       5,452       2,599  
Loans past due 90 days or more
    7,832       7,661       5,439       4,367       6,290  
 
Total nonperforming loans
    32,949       30,024       28,773       25,740       26,468  
 
Other real estate owned
    3,351       2,368       2,680       2,319       3,206  
 
Total nonperforming assets
  $ 36,300     $ 32,392     $ 31,453     $ 28,059     $ 29,674  
 
Percentage of nonperforming loans to loans, net of unearned interest
    0.95 %     0.90 %     0.92 %     0.94 %     0.98 %
Percentage of nonperforming assets to loans, net of unearned interest
    1.04 %     0.97 %     1.01 %     1.03 %     1.10 %
Percentage of nonperforming assets to total assets
    0.66 %     0.60 %     0.58 %     0.56 %     0.67 %
 
Tax equivalent interest income from loans of $255.6 million for 2006 would have increased by $2.1 million if all loans had been current in accordance with their original terms. Interest income for the year ended December 31, 2006 in the approximate amount of $619,000 is included in interest income for those loans in accordance with their original terms.
CAPITAL RESOURCES
Liquidity and Interest Rate Sensitivity Management: The Corporation’s objective in managing its liquidity is to maintain the ability to continuously meet the cash flow needs of customers, such as borrowings or deposit withdrawals, while at the same time seeking higher yields from longer-term lending and investing activities.

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FINANCIAL REVIEW
 
Cash and cash equivalents increased by $12.3 million during 2006 to $186.3 million at year end. Cash provided by operating activities was $85.3 million in 2006, $78.5 million in 2005, and $85.0 million in 2004. Net income was the primary source of cash for operating activities during each year.
Cash provided by investing activities was $47.8 million in 2006 and $145.1 million in 2005. Cash used in investing activities was $146.2 million in 2004. Security transactions are the major use or source of cash in investing activities. Proceeds from the sale, repayment or maturity of securities provide cash and purchases of securities use cash. Net security transactions provided $145.9 million of cash in 2006, $239.0 million in 2005 and $66.3 million in 2004. The other major use or source of cash in investing activities is the net increase or decrease in the loan portfolio. Cash used by the net increase in the loan portfolio was $99.3 million in 2006, $53.6 million in 2005 and $171.8 million in 2004.
Cash used by financing activities was $120.7 million in 2006 and $211.4 million in 2005. Cash provided by financing activities was $53.2 million in 2004. A major source of cash for financing activities is the net change in deposits. Cash provided by the net increase in deposits was $6.3 million in 2006 and $103.3 million in 2004. Cash used by the net decrease in deposits was $55.5 million in 2005.
Changes in short-term borrowings or long-term debt is another major source or use of cash for financing activities. The net increase in short-term borrowings provided cash of $61.7 million in 2006 and $35.8 million in 2005. The net decrease in short-term borrowings used cash of $256.8 million in 2004. Cash was used by the net decrease in long-term debt of $110.6 million in 2006 and $102.6 million in 2005. Cash was provided by the net increase in long-term debt of $271.4 million in 2004.
Funds are available from a number of sources, including the securities portfolio, the core deposit base, Federal Home Loan Bank borrowings, and the capability to securitize or package loans for sale. The present funding sources provide more than adequate liquidity for the Corporation to meet its cash flow needs.
The increase or decrease in the investment portfolio and short-term borrowings and long-term debt is greatly dependent upon the growth in loans and deposits. The primary objective of management is to grow loan and deposit totals. To the extent that management is unable to grow loan totals at a desired growth rate, additional investment securities may be added to the balance sheet. Likewise, short-term borrowings and long-term debt are utilized to fund the growth in earning assets if the growth in deposits and the cash flow from operations is not sufficient to do so.
Liquidity is enhanced by assets maturing or repricing within one year. Assets maturing or repricing within one year were $2,452 million or 49.0% of interest earning assets at year-end 2006. Liquidity is also enhanced by a significant amount of stable core deposits from a variety of customers in several Ohio markets served by the Corporation.
An asset/liability committee monitors and forecasts rate-sensitive assets and rate-sensitive liabilities and develops strategies and pricing policies to influence the acquisition of certain assets and liabilities. The purpose of these efforts is to guard the Corporation from adverse impacts of unforeseen swings in interest rates and to enhance the net income of the Corporation by accepting a limited amount of interest rate risk, based on interest rate projections.
The following table shows interest rate sensitivity data for five different time intervals as of December 31, 2006:
Table 11 — Interest Rate Sensitivity
                                                 
 
(Dollars   0-3   3-12   1-3   3-5   Over 5    
in thousands)   Months   Months   Years   Years   Years   Total
 
Interest earning assets:
                                               
Investment securities (1)
  $ 119,755     $ 177,071     $ 356,913     $ 258,081     $ 601,679     $ 1,513,499  
Money market instruments
    8,266                               8,266  
Loans (1)
    1,195,740       950,797       1,180,733       138,463       14,969       3,480,702  
 
Total interest earning assets
    1,323,761       1,127,868       1,537,646       396,544       616,648       5,002,467  
 
Interest bearing liabilities:
                                               
Interest bearing transaction accounts
    545,592             488,278                   1,033,870  
Savings accounts (2)
    271,862             271,862                   543,724  
Time deposits
    402,581       834,223       261,121       81,492       1,703       1,581,120  
Other
    1,858                               1,858  
 
Total deposits
    1,221,893       834,223       1,021,261       81,492       1,703       3,160,572  
 
Short-term borrowings
    375,773                               375,773  
Long-term debt
    127,700       288,476       165,783       18,920       3,261       604,140  
 
Total interest bearing liabilities
    1,725,366       1,122,699       1,187,044       100,412       4,964       4,140,485  
 
Interest rate sensitivity gap
    (401,605 )     5,169       350,602       296,132       611,684       861,982  
Cumulative rate sensitivity gap
    (401,605 )     (396,436 )     (45,834 )     250,298       861,982        
Cumulative gap as a percentage of total interest earning assets
    -8.03 %     -7.92 %     -0.92 %     5.00 %     17.23 %      
 
(1)   Investment securities and loans that are subject to prepayment are shown in the table by the earlier of their repricing date or their expected repayment dates and not by their contractual maturity. The totals for investment securities include interest bearing deposits with other banks.
 
(2)   Management considers interest bearing transaction accounts and savings accounts to be core deposits and therefore, not as rate sensitive as other deposit accounts and borrowed money. Accordingly, only 53% of interest bearing transaction accounts and 50% of savings accounts are considered to reprice within one year. If all of the interest bearing checking accounts and savings accounts were considered to reprice within one year, the one year cumulative gap would change from a negative 7.92% to a negative 23.12%.
The interest rate sensitivity gap analysis provides a good overall picture of the Corporation’s static interest rate risk position. The Corporation’s policy is that the twelve month cumulative gap position should not exceed fifteen percent of interest earning assets for three consecutive quarters. At December 31, 2006, the cumulative interest earning assets maturing or repricing within twelve months were $2,452 million compared to the cumulative interest bearing liabilities maturing or repricing within twelve months of $2,848 million. For the twelve-month cumulative gap position, rate sensitive liabilities exceed rate sensitive assets by $396 million or 7.9% of interest earning assets.
A negative twelve month cumulative rate sensitivity gap (liabilities exceeding assets) would suggest that the Corporation’s net interest margin would decrease if interest rates were to rise. However, the usefulness of the interest sensitivity gap analysis as a forecasting tool in projecting net interest income is limited. The gap analysis does not consider the magnitude by which assets or liabilities will reprice during a period and also contains assumptions as to the repricing of transaction and savings accounts that may not prove to be correct.
The cumulative twelve month interest rate sensitivity gap position at December 31, 2005, was a negative $64 million or a negative 1.3% of interest earning assets compared to a negative $396 million or a negative 7.9% of interest earning assets at December 31, 2006. This change in the cumulative twelve month interest rate sensitivity gap of a negative $332 million was primarily due to an increase in time deposits maturing or repricing within one year.

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FINANCIAL REVIEW
 
The amount of time deposits maturing or repricing within one year increased by $269 million to $1,237 million or 78.2% of the total time deposits at December 31, 2006 compared to $968 million or 64.3% of the total time deposits at December 31, 2005.
Management supplements the interest rate sensitivity gap analysis with periodic simulations of balance sheet sensitivity under various interest rate and what-if scenarios to better forecast and manage the net interest margin. The Corporation uses an earnings simulation model to analyze net interest income sensitivity to movements in interest rates. This model is based on actual cash flows and repricing characteristics for balance sheet instruments and incorporates market-based assumptions regarding the impact of changing interest rates on the prepayment rate of certain assets and liabilities. This model also includes management’s projections for activity levels of various balance sheet instruments and noninterest fee income and operating expense. Assumptions based on the historical behavior of deposit rates and balances in relation to changes in interest rates are also incorporated into this earnings simulation model. These assumptions are inherently uncertain and as a result, the model cannot precisely measure net interest income and net income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies.
Management uses a 50 basis point change in market interest rates per quarter for a total of 200 basis points per year in evaluating the impact of changing interest rates on net interest income and net income over a twelve month horizon. At December 31, 2006, the earnings simulation model projected that net income would increase by .1% using a rising interest rate scenario and decrease by .7% using a declining interest rate scenario over the next year. At December 31, 2005, the earnings simulation model projected that net income would decrease by .2% using a rising interest rate scenario and increase by .9% using a declining interest rate scenario over the next year and at December 31, 2004, the earnings simulation model projected that net income would increase by .9% using a rising interest rate scenario and decrease by .9% using a declining interest rate scenario over the next year. Consistently, over the past several years the earnings simulation model has projected that changes in interest rates would have only a small impact on net income and the net interest margin. The net interest margin has been relatively stable over the past four years at 4.33% in 2006, 4.34% in 2005, 4.56% in 2004 and 4.60% in 2003. A major goal of the asset/liability committee is to have a relatively stable net interest margin regardless of the level of interest rates. Management expects that the net interest margin will be approximately 4.40% in 2007. The decrease in the net interest margin for 2005 was largely due to the cash acquisitions of First Federal and First Clermont.
CONTRACTUAL OBLIGATIONS
In the ordinary course of operations, Park enters into certain contractual obligations. Such obligations include the funding of operations through debt issuances as well as leases for premises. The following table summarizes Park’s significant and determinable obligations by payment date at December 31, 2006.
Further discussion of the nature of each specified obligation is included in the referenced Note to the Consolidated Financial Statements or referenced Table in the Financial Review section.
Table 12 — Contractual Obligations
                                             
 
December 31, 2006   Payments Due In
 
(Dollars   Table /   0-1   1-3   3-5   Over 5    
in thousands)   Note   Years   Years   Years   Years   Total
 
Deposits without stated maturity
      $ 2,244,414     $     $     $     $ 2,244,414  
Certificates of deposit
  11     1,236,804       261,121       81,492       1,703       1,581,120  
Short-term borrowings
  11     375,773                         375,773  
Long-term debt
  10     66,289       115,808       18,845       403,198       604,140  
Operating leases
  8     1,727       2,778       1,023       579       6,107  
Purchase obligations
        90,932                         90,932  
 
Total contractual obligations
      $ 4,015,939     $ 379,707     $ 101,360     $ 405,480     $ 4,902,486  
 
The Corporation’s operating lease obligations represent short-term and long-term lease and rental payments for facilities and equipment. Purchase obligations represent obligations under agreements to purchase goods or services that are enforceable and legally binding on the Corporation. Purchase obligations in Table 12 include $90.4 million for the cash portion of the total consideration that could be paid to the Vision shareholders in connection with the pending acquisition.
Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements: In order to meet the financing needs of its customers, the Corporation issues loan commitments and standby letters of credit. At December 31, 2006, the Corporation had $824 million of loan commitments for commercial, commercial real estate, and residential real estate loans and had $140 million of commitments for revolving home equity and credit card lines. Standby letters of credit totaled $20 million at December 31, 2006.
Commitments to extend credit for loan commitments and standby letters of credit do not necessarily represent future cash requirements. These commitments often expire without being drawn upon. However, all of the loan commitments and standby letters of credit are permitted to be drawn upon in 2007. See Note 17 of the Notes to Consolidated Financial Statements for additional information on loan commitments and standby letters of credit.
The Corporation did not have any significant contingent liabilities at December 31, 2006, and did not have any off-balance sheet arrangements at year-end 2006.
Capital: Park’s primary means of maintaining capital adequacy is through net retained earnings. At December 31, 2006, the Corporation’s equity capital was $570.4 million, compared to $558.4 million at December 31, 2005. Stockholders’ equity at December 31, 2006 was 10.43% of total assets compared to 10.27% of total assets at December 31, 2005.
Net income for 2006 was $94.1 million, $95.2 million in 2005 and $91.5 million in 2004. The cash dividends declared were $51.4 million in 2006, $51.6 million in 2005 and $49.0 million 2004.
In 2006, Park purchased 302,786 shares of treasury stock totaling $30.5 million at a weighted average cost of $100.76 per share. In 2005, Park purchased 281,360 shares of treasury stock totaling $30.0 million at a weighted average cost of $106.55 per share. Treasury stock had a balance in stockholders’ equity of $143.4 million at December 31, 2006 compared to $116.7 million at December 31, 2005 and $91.4 million at December 31, 2004.
Accumulated other comprehensive income (loss) was $(22.8) million at December 31, 2006 compared to $(10.1) million at December 31, 2005 and $12.4 million at December 31, 2004. Long-term interest rates increased during 2005 and the market value of Park’s investment securities decreased causing the large decrease in accumulated other comprehensive income (loss) in 2005. Park adopted SFAS No. 158 concerning the accounting for its pension plan in 2006. This new accounting standard caused Park to charge accumulated other comprehensive income (loss) by $6.8 million.

36


 

FINANCIAL REVIEW
 
Financial institution regulators have established guidelines for minimum capital ratios for banks, thrifts and bank holding companies. Park’s accumulated other comprehensive income (loss) is not included in computing regulatory capital. The capital standard of risk-based capital to risk-based assets is 8.00% at December 31, 2006. At year-end 2006, the Corporation had a risk-based capital ratio of 15.98% or capital above the minimum required by $286 million. The capital standard of tier l capital to risk-based assets is 4.00% at December 31, 2006. Tier l capital includes stockholders’ equity net of goodwill and other intangible assets. At year-end 2006, the Corporation had a tier l capital to risk-based assets ratio of 14.72% or capital above the minimum required by $384 million. Bank regulators have also established a leverage capital ratio of 4%, consisting of tier 1 capital to total assets, not risk adjusted. At year-end 2006, the Corporation had a leverage capital ratio of 9.96% or capital above the minimum required by $316 million. Regulatory guidelines also establish capital ratio requirements for “well capitalized” bank holding companies. The capital ratios are 10% for risk-based capital, 6% for tier 1 capital to risk-based assets and 5% for tier 1 capital to total assets. The Corporation exceeds these higher capital standards and therefore is classified as “well capitalized.”
The financial institution subsidiaries of the Corporation each met the well capitalized ratio guidelines at December 31, 2006. See Note 19 of the Notes to Consolidated Financial Statements for the capital ratios for the Corporation and its financial institution subsidiaries.
Effects of Inflation: Balance sheets of financial institutions typically contain assets and liabilities that are monetary in nature and therefore, differ greatly from most commercial and industrial companies which have significant investments in premises, equipment and inventory. During periods of inflation, financial institutions that are in a net positive monetary position will experience a decline in purchasing power, which does have an impact on growth. Another significant effect on internal equity growth is other expenses, which tend to rise during periods of inflation.
Management believes the most significant impact on financial results is the Corporation’s ability to align its asset/liability management program to react to changes in interest rates.
The following table summarizes five-year financial information. All per share data have been retroactively restated for the 5% stock dividend paid on December 15, 2004.
Table 13 — Consolidated Five-Year Selected Financial Data
                                         
 
December 31,                    
(Dollars in thousands,                    
except per share data)   2006   2005   2004   2003   2002
 
Results of Operations:
                                       
Interest income
  $ 334,559     $ 314,459     $ 270,993     $ 264,629     $ 287,920  
Interest expense
    121,315       93,895       58,702       61,992       82,588  
Net interest income
    213,244       220,564       212,291       202,637       205,332  
Provision for loan losses
    3,927       5,407       8,600       12,595       15,043  
Net interest income after provision for loan losses
    209,317       215,157       203,691       190,042       190,289  
Net gains (losses) on sale of securities
    97       96       (793 )     (6,060 )     (182 )
Noninterest income
    64,665       59,609       52,641       61,583       51,032  
Noninterest expense
    141,002       139,438       126,290       122,376       119,964  
Net income
    94,091       95,238       91,507       86,878       85,579  
Per share:
                                       
Net income — basic
    6.75       6.68       6.38       6.01       5.87  
Net income — diluted
    6.74       6.64       6.32       5.97       5.86  
Cash dividends declared
    3.690       3.620       3.414       3.209       2.962  
Average Balances:
                                       
Loans
  $ 3,357,278     $ 3,278,092     $ 2,813,069     $ 2,695,830     $ 2,719,805  
Investment securities
    1,610,639       1,851,598       1,901,129       1,759,816       1,384,750  
Money market instruments and other
    8,723       12,258       9,366       35,768       36,679  
 
Total earning assets
    4,976,640       5,141,948       4,723,564       4,491,414       4,141,234  
 
Table 13 — Consolidated Five-Year Selected Financial Data continued
                                         
 
December 31,                    
(Dollars in thousands,                    
except per share data)   2006   2005   2004   2003   2002
 
Noninterest bearing deposits
    662,077       643,032       574,560       522,456       502,400  
Interest bearing deposits
    3,162,867       3,187,033       2,946,360       2,901,835       2,901,456  
 
Total deposits
    3,824,944       3,830,065       3,520,920       3,424,291       3,403,856  
 
Short-term borrowings
    375,332       291,842       401,299       515,328       226,238  
Long-term debt
    553,307       799,888       519,979       281,599       252,834  
Stockholders’ equity
    545,074       559,211       538,275       520,391       487,316  
Total assets
    5,380,623       5,558,088       5,049,081       4,803,263       4,435,162  
Ratios:
                                       
Return on average assets
    1.75 %     1.71 %     1.81 %     1.81 %     1.93 %
Return on average equity
    17.26 %     17.03 %     17.00 %     16.69 %     17.56 %
Net interest margin (1)
    4.33 %     4.34 %     4.56 %     4.60 %     5.06 %
Noninterest expense to net revenue (1)
    50.35 %     49.32 %     47.11 %     45.66 %     46.02 %
Dividend payout ratio
    54.65 %     54.19 %     53.54 %     53.42 %     50.42 %
Average stockholders’ equity to average total assets
    10.13 %     10.06 %     10.66 %     10.83 %     10.99 %
Leverage capital
    9.96 %     9.27 %     10.10 %     10.79 %     10.72 %
Tier 1 capital
    14.72 %     14.17 %     15.16 %     16.51 %     16.51 %
Risk-based capital
    15.98 %     15.43 %     16.43 %     17.78 %     17.78 %
 
(1)   Computed on a fully taxable equivalent basis
The following table is a summary of selected quarterly results of operations for the years ended December 31, 2006 and 2005. Certain quarterly amounts have been reclassified to conform to the year-end financial statement presentation.
Table 14 — Quarterly Financial Data
                                 
 
(Dollars in thousands,   Three Months Ended
except per share data)   March 31   June 30   Sept. 30   Dec. 31
 
2006:
                               
Interest income
  $ 80,596     $ 83,298     $ 85,290     $ 85,375  
Interest expense
    27,177       29,476       31,728       32,934  
Net interest income
    53,419       53,822       53,562       52,441  
Provision for loan losses
          1,467       935       1,525  
Gain (loss) on sale of securities
                97        
Income before income taxes
    33,800       33,827       33,589       31,861  
Net income
    23,807       23,886       23,805       22,593  
Per share data:
                               
Net income — basic
    1.70       1.71       1.72       1.63  
Net income — diluted
    1.69       1.70       1.71       1.63  
Weighted-average common stock outstanding — basic
    14,034,360       13,977,432       13,859,498       13,845,071  
Weighted-average common stock equivalent — diluted
    14,095,895       14,010,407       13,888,458       13,872,586  
 
2005:
                               
Interest income
  $ 74,959     $ 78,928     $ 79,768     $ 80,804  
Interest expense
    20,514       23,516       24,217       25,648  
Net interest income
    54,445       55,412       55,551       55,156  
Provision for loan losses
    1,082       1,325       1,600       1,400  
Gain (loss) on sale of securities
          96              
Income before income taxes
    33,071       35,303       34,763       32,287  
Net income
    23,342       24,770       24,295       22,831  
Per share data:
                               
Net income — basic
    1.63       1.73       1.70       1.62  
Net income — diluted
    1.61       1.72       1.69       1.61  
Weighted-average common stock outstanding — basic
    14,331,261       14,312,032       14,256,723       14,134,058  
Weighted-average common stock equivalent — diluted
    14,475,634       14,379,463       14,338,418       14,199,455  
 

37


 

FINANCIAL REVIEW
 
The Corporation’s common stock (symbol: PRK) is traded on the American Stock Exchange (AMEX). At December 31, 2006, the Corporation had 4,994 stockholders of record. The following table sets forth the high, low and closing sale prices of, and dividends declared on the common stock for each quarterly period for the years ended December 31, 2006 and 2005, as reported by AMEX.
Table 15 — Market and Dividend Information
                                 
 
                            Cash
                            Dividend
                    Last   Declared
    High   Low   Price   Per Share
 
2006:
                               
First Quarter
  $ 117.21     $ 103.00     $ 106.50     $ 0.92  
Second Quarter
    105.42       92.36       98.81       0.92  
Third Quarter
    105.00       93.72       100.09       0.92  
Fourth Quarter
    103.95       98.14       99.00       0.93  
 
2005:
                               
First Quarter
  $ 133.30     $ 108.40     $ 112.50     $ 0.90  
Second Quarter
    113.01       99.04       110.50       0.90  
Third Quarter
    118.20       104.55       108.27       0.90  
Fourth Quarter
    112.91       101.00       102.64       0.92  
 
PERFORMANCE GRAPH
Table 16 compares the total return performance for Park common shares with the AMEX Composite Index, the NASDAQ Bank Stocks Index and with the SNL Financial Bank and Thrift Index for the five year period from December 31, 2001 to December 31, 2006. The AMEX Composite Index is a market capitalization-weighted index of the stocks listed on the American Stock Exchange. The NASDAQ Bank Stock Index is comprised of all depository institutions and holding and other investment companies that are traded on The NASDAQ Global Select and Global Markets. Park considers a number of bank holding companies traded on The NASDAQ to be within its peer group. The SNL Financial Bank and Thrift Index is comprised of all publicly traded bank and thrift stocks researched by SNL Financial.
The AMEX Financial Stocks Index includes the stocks of banks, thrifts, finance companies and securities broker-dealers. Park believes that The NASDAQ Bank Stock Index and the SNL Financial Bank and Thrift Index are more appropriate industry indices for Park to use for the five year total return performance comparison.
Table 16 — Total Return Performance
(TOTAL RETURN PERFORMANCE GRAPH)
                                                         
            PERIOD ENDING  
        Index   12/31/01     12/31/02     12/31/03     12/31/04     12/31/05     12/31/06  
         
      
Park National Corporation
    100.00       110.00       130.01       168.28       131.73       131.77  
      
Amex Composite
    100.00       99.37       145.77       183.03       230.95       277.00  
      
NASDAQ Bank Stocks
    100.00       106.95       142.29       161.73       158.61       180.53  
      
SNL Bank and Thrift Index
    100.00       93.96       127.39       142.66       144.89       169.30  
The total return performance for Park’s common shares has lagged behind the total return performance on the three indices used in the five year comparison as indicated in Table 16. The annual compound total return on Park’s common shares for the past five years is 5.7%. The annual compound growth rate in Park’s diluted earnings per share for the past five years is 4.9%. Park’s performance ratios (such as return on average assets and return on average equity) continue to be strong compared to other financial institutions. However, Park has had difficulty in growing loans since 2000, and as a result diluted earnings per share have not grown faster than the 4.9% annual compound growth rate for the past five years.

38


 

MANAGEMENT’S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
 
To the Board of Directors and Stockholders
Park National Corporation
The management of Park National Corporation (the “Corporation”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a—15(f) and 15d—15(f) under the Securities Exchange Act of 1934. The Corporation’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in conformity with U.S. generally accepted accounting principles. The Corporation’s internal control over financial reporting includes those policies and procedures that:
  a.)   pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Corporation and its consolidated subsidiaries;
 
  b.)   provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in conformity with U.S. generally accepted accounting principles, and that receipts and expenditures of the Corporation and its consolidated subsidiaries are being made only in accordance with authorizations of management and directors of the Corporation; and
 
  c.)   provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the assets of the Corporation and its consolidated subsidiaries that could have a material effect on the financial statements.
The Corporation’s internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability through a program of internal audits. Actions are taken to correct potential deficiencies as they are identified.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluations 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. Accordingly, even an effective system of internal control over financial reporting will provide only reasonable assurance with respect to financial statement preparation.
With the supervision and participation of our Chairman and Chief Executive Officer, our President and our Chief Financial Officer, management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth for effective internal control over financial reporting by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on our assessment and those criteria, management concluded that the Corporation maintained effective internal control over financial reporting as of December 31, 2006.
Park’s independent registered public accounting firm (Crowe Chizek and Company LLC) has issued an attestation report on management’s assessment of the Corporation’s internal control over financial reporting which follows this report.
         
(-s- C. Daniel DeLawder)
  (-s- David L. Trautman )   (-s- John W. Kozak)
 
       
C. Daniel DeLawder
  David L. Trautman   John W. Kozak
Chairman and Chief Executive Officer
  President   Chief Financial Officer
February 23, 2007

39


 

REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders
Park National Corporation
Newark, Ohio
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Park National Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Park National 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.
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.
In our opinion, management’s assessment that Park National Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in COSO. Also in our opinion, Park National Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Park National Corporation as of December 31, 2006, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the year then ended, and our report dated February 23, 2007 expressed an unqualified opinion on those consolidated financial statements.
Crowe Chizek and Company LLC
Columbus, Ohio
February 23, 2007

40


 

REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders
Park National Corporation
Newark, Ohio
We have audited the accompanying consolidated balance sheet of Park National Corporation as of December 31, 2006, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The consolidated balance sheet of Park National Corporation as of December 31, 2005 and the consolidated statements of income, changes in stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2005, were audited by other auditors whose report dated February 21, 2006, expressed an unqualified opinion on those statements.
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 the consolidated 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 audit provides a reasonable basis for our opinion.
In our opinion, the 2006 financial statements referred to above present fairly, in all material respects, the financial position of Park National Corporation as of December 31, 2006, and the results of its operations and its cash flows for the year then ended, 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 Park National Corporation’s internal control over financial reporting as of December 31, 2006, 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 23, 2007, expressed an unqualified opinion thereon.
/s/ Crowe Chizek and Company LLC
Columbus, Ohio
February 23, 2007

41


 

CONSOLIDATED BALANCE SHEETS
 
PARK NATIONAL CORPORATION AND SUBSIDIARIES
at December 31, 2006 and 2005 (Dollars in thousands)
                 
 
ASSETS
    2006   2005
 
Cash and due from banks
  $ 177,990     $ 169,690  
Money market instruments
    8,266       4,283  
 
Cash and cash equivalents
    186,256       173,973  
 
Interest bearing deposits with other banks
    1       300  
Investment securities:
               
Securities available-for-sale, at fair value (amortized cost of $1,299,686 and $1,424,955 at December 31, 2006 and 2005, respectively)
    1,275,079       1,409,351  
Securities held-to-maturity, at amortized cost (fair value of $169,786 and $190,425 at December 31, 2006 and 2005, respectively)
    176,485       195,953  
Other investment securities
    61,934       58,038  
 
Total investment securities
    1,513,498       1,663,342  
 
Loans
    3,485,994       3,333,713  
Unearned loan interest
    (5,292 )     (5,601 )
 
Total loans
    3,480,702       3,328,112  
 
Allowance for loan losses
    (70,500 )     (69,694 )
 
Net loans
    3,410,202       3,258,418  
 
Other assets:
               
Bank owned life insurance
    113,101       109,600  
Goodwill and other intangible assets
    78,003       69,188  
Premises and equipment, net
    47,554       47,172  
Accrued interest receivable
    26,122       23,306  
Mortgage loan servicing rights
    10,371       10,665  
Other
    85,768       80,084  
 
Total other assets
    360,919       340,015  
 
Total assets
  $ 5,470,876     $ 5,436,048  
 
The accompanying notes are an integral part of the financial statements.

42


 

     
CONSOLIDATED BALANCE SHEETS
  (CONTINUED)
 
PARK NATIONAL CORPORATION AND SUBSIDIARIES
at December 31, 2006 and 2005 (Dollars in thousands)
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
    2006   2005
 
Deposits:
               
Noninterest bearing
  $ 664,962     $ 667,328  
Interest bearing
    3,160,572       3,090,429  
 
Total deposits
    3,825,534       3,757,757  
 
Short-term borrowings
    375,773       314,074  
Long-term debt
    604,140       714,784  
 
Total borrowings
    979,913       1,028,858  
 
Other liabilities:
               
Accrued interest payable
    13,076       8,943  
Other
    81,914       82,060  
 
Total other liabilities
    94,990       91,003  
 
Total liabilities
    4,900,437       4,877,618  
 
 
               
COMMITMENTS AND CONTINGENCIES
               
Stockholders’ equity:
               
Common stock, no par value (20,000,000 shares authorized; 15,358,323 shares issued in 2006 and 15,271,574 issued in 2005)
    217,067       208,365  
Accumulated other comprehensive income (loss), net
    (22,820 )     (10,143 )
Retained earnings
    519,563       476,889  
Less: Treasury stock (1,436,794 shares in 2006 and 1,178,948 shares in 2005)
    (143,371 )     (116,681 )
 
Total stockholders’ equity
    570,439       558,430  
 
Total liabilities and stockholders’ equity
  $ 5,470,876     $ 5,436,048  
 
The accompanying notes are an integral part of the financial statements.

43


 

CONSOLIDATED STATEMENTS OF INCOME
 
PARK NATIONAL CORPORATION AND SUBSIDIARIES
for the years ended December 31, 2006, 2005 and 2004 (Dollars in thousands, except per share data)
                         
 
    2006   2005   2004
 
Interest and dividend income:
                       
Interest and fees on loans
  $ 255,123     $ 223,868     $ 178,853  
Interest and dividends on:
                       
Obligations of U.S. Government, its agencies and other securities
    75,300       85,664       86,806  
Obligations of states and political subdivisions
    3,667       4,486       5,115  
Other interest income
    469       441       219  
 
Total interest and dividend income
    334,559       314,459       270,993  
 
Interest expense:
                       
Interest on deposits:
                       
Demand and savings deposits
    25,870       15,091       6,895  
Time deposits
    56,402       41,808       33,103  
Interest on short-term borrowings
    15,692       7,508       5,319  
Interest on long-term debt
    23,351       29,488       13,385  
 
Total interest expense
    121,315       93,895       58,702  
 
Net interest income
    213,244       220,564       212,291  
 
Provision for loan losses
    3,927       5,407       8,600  
 
Net interest income after provision for loan losses
    209,317       215,157       203,691  
 
Other income:
                       
Income from fiduciary activities
    13,548       12,034       11,137  
Service charges on deposit accounts
    19,969       17,853       15,585  
Net gains (losses) on sales of securities
    97       96       (793 )
Other service income
    10,920       10,753       10,325  
Other
    20,228       18,969       15,594  
 
Total other income
  $ 64,762     $ 59,705     $ 51,848  
 
The accompanying notes are an integral part of the financial statements.

44


 

     
CONSOLIDATED STATEMENTS OF INCOME
  (CONTINUED)
 
PARK NATIONAL CORPORATION AND SUBSIDIARIES
for the years ended December 31, 2006, 2005 and 2004 (Dollars in thousands, except per share data)
                         
 
    2006   2005   2004
 
Other expense:
                       
Salaries and employee benefits
  $ 80,227     $ 78,498     $ 71,464  
Data processing fees
    11,812       10,636       8,900  
Fees and service charges
    9,218       8,723       8,784  
Net occupancy expense of bank premises
    9,066       8,641       7,024  
Amortization of intangibles
    2,470       2,548       1,479  
Furniture and equipment expense
    5,166       5,278       5,749  
Insurance
    1,136       1,243       1,030  
Marketing
    4,438       4,197       3,972  
Postage and telephone
    4,890       4,827       4,482  
State taxes
    2,232       2,893       2,468  
Other
    10,347       11,954       10,938  
 
Total other expense
    141,002       139,438       126,290  
 
Income before federal income taxes
    133,077       135,424       129,249  
Federal income taxes
    38,986       40,186       37,742  
 
Net income
  $ 94,091     $ 95,238     $ 91,507  
 
Earnings per share:
                       
Basic
  $ 6.75     $ 6.68     $ 6.38  
Diluted
  $ 6.74     $ 6.64     $ 6.32  
 
The accompanying notes are an integral part of the financial statements.

45


 

CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS’ EQUITY
 
PARK NATIONAL CORPORATION AND SUBSIDIARIES
for the years ended December 31, 2006, 2005 and 2004 (Dollars in thousands, except per share data)
                                                         
 
                        Accumulated            
    Common Stock                   Other            
    Shares           Retained   Treasury   Comprehensive           Comprehensive
    Outstanding   Amount   Earnings   Stock   Income (Loss)   Total   Income
 
Balance, January 1, 2004
    14,455,027     $ 105,895     $ 486,769     $ (68,577 )   $ 18,954     $ 543,041          
 
Net income
                91,507                   91,507       91,507  
Other comprehensive income, net of tax:
                                                       
Unrealized net holding loss on securities available-for-sale, net of income taxes of $(3,506)
                                    (6,512 )     (6,512 )     (6,512 )
 
Total comprehensive income
                                                    84,995  
 
Cash dividends:
                                                       
Corporation at $3.414 per share
                (48,991 )                 (48,991 )        
Stock dividend at 5%
            102,464       (96,025 )     (6,439 )                      
Cash payment for fractional shares for 5% stock dividend
    (1,772 )     (249 )                             (249 )        
Cash payment for fractional shares in dividend reinvestment plan
    (25 )     (3 )                       (3 )        
Shares issued for stock options
    2,052       144                         144          
Treasury stock purchased
    (214,681 )                 (23,699 )           (23,699 )        
Treasury stock reissued primarily for stock options exercised
    79,626                   7,323             7,323          
 
Balance, December 31, 2004
    14,320,227     $ 208,251     $ 433,260     $ (91,392 )   $ 12,442     $ 562,561          
 
Net income
                95,238                   95,238       95,238  
Other comprehensive income, net of tax:
                                                       
Unrealized net holding loss on securities available-for-sale, net of income taxes of $(12,161)
                                    (22,585 )     (22,585 )     (22,585 )
 
 
                                                    72,653  
 
Cash dividends:
                                                       
Corporation at $3.62 per share
                (51,609 )                 (51,609 )        
Cash payment for fractional shares in dividend reinvestment plan
    (50 )     (3 )                       (3 )        
Shares issued for stock options
    1,917       117                               117          
Treasury stock purchased
    (281,360 )                 (29,978 )           (29,978 )        
Treasury stock reissued primarily for stock options exercised
    51,892                   4,689             4,689          
 
Balance, December 31, 2005
    14,092,626     $ 208,365     $ 476,889     $ (116,681 )   $ (10,143 )   $ 558,430          
 
Net income
                94,091                   94,091       94,091  
Other comprehensive income (loss), net of tax:
                                                       
Unrealized net holding loss on securities available-for-sale, net of income taxes of $(3,151)
                                    (5,851 )     (5,851 )     (5,851 )
 
Total comprehensive income
                                                    88,240  
 
Adjustment to initially apply SFAS No. 158, net of income taxes of $(3,675)
                                    (6,826 )     (6,826 )        
Cash dividends:
                                                       
Corporation at $3.69 per share
                (51,417 )                 (51,417 )        
Cash payment for fractional shares in dividend reinvestment plan
    (72 )     (5 )                       (5 )        
Shares issued for stock options
    684       42                         42          
Treasury stock purchased
    (302,786 )                 (30,508 )           (30,508 )        
Treasury stock reissued primarily for stock options exercised
    44,940                   3,818             3,818          
Shares issued for Anderson bank purchase
    86,137       8,665                         8,665          
 
Balance, December 31, 2006
    13,921,529     $ 217,067     $ 519,563     $ (143,371 )   $ (22,820 )   $ 570,439          
 
The accompanying notes are an integral part of the financial statements.

46


 

CONSOLIDATED STATEMENTS OF CASH FLOWS
 
PARK NATIONAL CORPORATION AND SUBSIDIARIES
for the years ended December 31, 2006, 2005 and 2004 (Dollars in thousands)
                         
 
    2006   2005   2004
 
Operating activities:
                       
Net income
  $ 94,091     $ 95,238     $ 91,507  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Provision for loan losses
    3,927       5,407       8,600  
Amortization of loan fees and costs, net
    (4,340 )     (3,809 )     (3,336 )
Provision for depreciation and amortization
    5,522       5,641       5,436  
Amortization of intangible assets
    2,470       2,548       1,479  
Accretion of investment securities
    (1,630 )     (2,444 )     (1,756 )
Deferred income tax expense (benefit)
    156       1,990       (2,542 )
Realized net investment security (gains) losses
    (97 )     (96 )     793  
Stock dividends on Federal Home Loan Bank stock
    (3,101 )     (2,525 )     (1,665 )
Changes in assets and liabilities:
                       
Increase in other assets
    (14,606 )     (24,431 )     (20,219 )
Increase in other liabilities
    2,858       958       6,750  
 
Net cash provided by operating activities
    85,250       78,477       85,047  
 
Investing activities:
                       
Proceeds from sales of available-for-sale securities
    304       131,794       58,438  
Proceeds from maturities of securities:
                       
Held-to-maturity
    19,471       63,914       52,741  
Available-for-sale
    293,207       345,660       384,087  
Purchase of securities:
                       
Held-to-maturity
          (187,420 )     (62,659 )
Available-for-sale
    (166,518 )     (113,198 )     (364,215 )
Net increase in other investments
    (532 )     (1,743 )     (2,094 )
Net decrease in interest bearing deposits with other banks
    299       1,796       50  
Net increase in loans
    (99,316 )     (53,600 )     (171,784 )
Proceeds from loans sold with branch office
          5,273        
Cash received (paid) for acquisition, net
    5,177       (39,227 )     (34,693 )
Purchases of premises and equipment, net
    (4,311 )     (8,193 )     (6,047 )
 
Net cash provided by (used in) investing activities
    47,781       145,056       (146,176 )
 
Financing activities:
                       
Net increase (decrease) in deposits
    6,320       (55,491 )     103,273  
Deposits sold with branch office
          (12,419 )      
Net increase (decrease) in short-term borrowings
    61,699       35,843       (256,756 )
Cash payment for fractional shares of common stock
    (5 )     (3 )     (252 )
Exercise of stock options, including tax benefits
    42       117       144  
Purchase of treasury stock, net
    (26,690 )     (25,289 )     (16,376 )
Proceeds from long-term debt
    300,000       326,040       477,915  
Repayment of long-term debt
    (410,644 )     (428,689 )     (206,541 )
Cash dividends paid
    (51,470 )     (51,498 )     (48,231 )
 
Net cash (used in) provided by financing activities
    (120,748 )     (211,389 )     53,176  
 
Increase (decrease) in cash and cash equivalents
    12,283       12,144       (7,953 )
Cash and cash equivalents at beginning of year
    173,973       161,829       169,782  
 
Cash and cash equivalents at end of year
  $ 186,256     $ 173,973     $ 161,829  
 
Supplemental disclosure
                       
Summary of business acquisition:
                       
Fair value of assets acquired
  $ 69,717     $ 185,372     $ 252,687  
Cash paid for the purchase of financial institutions
    (9,052 )     (52,500 )     (46,638 )
Stock issued for the purchase of financial institutions
    (8,665 )            
Fair value of liabilities assumed
    (62,638 )     (161,241 )     (232,707 )
 
Goodwill recognized
  $ (10,638 )   $ (28,369 )   $ (26,658 )
 
The accompanying notes are an integral part of the financial statements.

47


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements:
Principles of Consolidation
The consolidated financial statements include the accounts of Park National Corporation (“Park” or the “Corporation”) and all of its subsidiaries. Material intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. The allowance for loan losses and the accounting for goodwill are particularly subject to change.
Reclassifications
Certain prior year amounts have been reclassified to conform with current year presentation.
Investment Securities
Investment securities are classified upon acquisition into one of three categories: Held-to-maturity, available-for-sale, or trading (see Note 4).
Held-to-maturity securities are those securities that the Corporation has the positive intent and ability to hold to maturity and are recorded at amortized cost. Available-for-sale securities are those securities that would be available to be sold in the future in response to the Corporation’s liquidity needs, changes in market interest rates, and asset-liability management strategies, among others. Available-for-sale securities are reported at fair value, with unrealized holding gains and losses excluded from earnings but included in other comprehensive income, net of applicable taxes. At December 31, 2006 and 2005, the Corporation did not hold any trading securities.
Available-for-sale and held-to-maturity securities are evaluated quarterly for potential other-than-temporary impairment. Management considers the facts of each security including the nature of the security, the amount and duration of the loss, credit quality of the issuer, the expectations for that security’s performance and Park’s intent and ability to hold the security until recovery. A decline in value that is considered to be other-than-temporary is recorded as a charge to earnings in the Consolidated Statements of Income.
Other investment securities (as shown on the balance sheet) consist of stock investments in the Federal Home Loan Bank and the Federal Reserve Bank. The fair values of these investments are the same as their amortized costs.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated.
Gains and losses realized on the sale of investment securities have been accounted for on the trade date in the year of sale on a specific identification basis.
Federal Home Loan Bank (FHLB) Stock
Park’s subsidiary banks are members of the FHLB system. Members are required to own a certain amount of stock based on their level of borrowings and other factors and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on the ultimate recovery of the par value. Both cash and stock dividends are reported as income.
Bank Owned Life Insurance
Park has purchased life insurance policies on certain key officers and directors. Bank owned life insurance is recorded at its cash surrender value (or the amount that can be realized).
Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at the lower of cost or fair value, determined using an aggregate basis. Write-downs to fair value are recognized as a charge to earnings at the time the decline in value occurs. Mortgage loans held for sale were $5.1 million at December 31, 2006 and $5.8 million at December 31, 2005. These amounts are included in loans on the balance sheet. The Corporation enters into forward commitments to sell mortgage loans to reduce market risk on mortgage loans in the process of origination and mortgage loans held for sale. Gains and losses resulting from sales of mortgage loans are recognized when the respective loans are sold to investors. Gains and losses are determined by the difference between the selling price and the carrying amount of the loans sold, net of discounts collected or paid and considering a normal servicing rate. Fees received from borrowers to guarantee the funding of mortgage loans held for sale and fees paid to investors to ensure the ultimate sale of such mortgage loans are recognized as income or expense when the loans are sold or when it becomes evident that the commitment will not be used.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are reported at their outstanding principal balances adjusted for any charge-offs, any deferred fees or costs on originated loans, and any unamortized premiums or discounts on purchased loans. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Generally, loans are placed on nonaccrual status at 90 days past due and interest is considered a loss, unless the loan is well-secured and in the process of collection. Consumer loans are generally charged-off when they are 120 days past due. For loans which are on nonaccrual status, it is Park’s policy to reverse interest previously accrued on the loan against interest income. Interest on such loans is thereafter recorded on a cash basis and is included in earnings only when actually received in cash and when full payment of principal is no longer doubtful.
The delinquency status of a loan is based on contractual terms and not on how recently payments have been received. Loans are removed from non-accrual status when loan payments have been received to cure the delinquency status and the loan is deemed to be well-secured by management.
Allowance for Loan Losses
The allowance for loan losses is that amount believed adequate to absorb probable incurred credit losses in the loan portfolio based on management’s evaluation of various factors, including overall growth in the loan portfolio, an analysis of individual loans, prior and current loss experience and current economic conditions. A provision for loan losses is charged to operations based on management’s periodic evaluation of these and other pertinent factors.
Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure” requires an allowance to be established as a component of the allowance for loan losses for certain loans when it is probable that all amounts due pursuant to the contractual terms of the loan will not be collected, and the recorded investment in the loan exceeds the fair value. Fair value is measured using either the present value of expected future cash flows based upon the initial effective interest rate on the loan, the observable market price of the loan or the fair value of the collateral, if the loan is collateral dependent.
Commercial loans are individually risk graded. Where appropriate, reserves are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral and other sources of cash flow. Homogenous loans, such as consumer installment loans, residential mortgage loans and automobile leases are not individually risk graded. Reserves are established for each pool of loans based on historical loan loss experience, current economic conditions and loan delinquency.
Income Recognition
Income earned by the Corporation and its subsidiaries is recognized on the accrual basis of accounting, except for late charges on loans which are recognized as income when they are collected.

48


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is generally provided on the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized over the lives of the respective leases or the estimated useful lives of the improvements, whichever are the shorter periods. Upon the sale or other disposal of the assets, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is recognized. Maintenance and repairs are charged to expense as incurred while renewals and improvements are capitalized.
The range of depreciable lives that premises and equipment are being depreciated over are:
     
 
Buildings
  5 to 50 Years
Equipment, furniture and fixtures
  3 to 20 Years
Leasehold improvements
  1 to 10 Years
 
Buildings that are currently placed in service are depreciated over 30 years. Equipment, furniture and fixtures that are currently placed in service are depreciated over 3 to 12 years. Leasehold improvements are depreciated over the life of the leases which range from 1 to 10 years.
Other Real Estate Owned
Other real estate owned is recorded at the lower of cost or fair market value (which is not in excess of estimated net realizable value) and consists of property acquired through foreclosure, and real estate held for sale. Subsequent to acquisition, allowances for losses are established if carrying values exceed fair value less estimated costs to sell. Costs relating to development and improvement of such properties are capitalized (not in excess of fair value less estimated costs to sell), whereas, costs relating to holding the properties are charged to expense.
Mortgage Loan Servicing Rights
When Park sells mortgage loans with servicing rights retained, the total cost of the mortgage loan is allocated to the servicing rights and the loans based on their relative fair values. The servicing rights capitalized are amortized in proportion to and over the period of estimated servicing income. Capitalized mortgage servicing rights totaled $10.4 million at December 31, 2006 and $10.7 million at December 31, 2005. The estimated fair values of capitalized mortgage servicing rights are $11.6 million and $12.2 million at December 31, 2006 and 2005, respectively. The fair value of mortgage servicing rights is determined by discounting estimated future cash flows from the servicing assets, using market discount rates, and using expected future prepayment rates. Park capitalized $1.6 million in mortgage servicing rights in 2006 and capitalized $2.0 million in both 2005 and 2004. In 2006, 2005 and 2004, Park’s amortization of mortgage servicing rights was $1.9 million, $2.1 million and $2.0 million, respectively. Generally, mortgage servicing rights are capitalized and amortized on an individual sold loan basis. When a sold mortgage loan is paid off, the related mortgage servicing rights are fully amortized. Mortgage servicing rights increased by $1.3 million in 2005 as a result of the acquisition of First Clermont Bank on January 3, 2005 and also increased by $315,000 in 2004 as a result of the acquisition of First Federal Bancorp, Inc. on December 31, 2004. Mortgage servicing rights are assessed for impairment periodically, based on fair value, with any impairment recognized through a valuation allowance. Fees received for servicing mortgage loans owned by investors are based on a percentage of the outstanding monthly principal balance of such loans and are included in income as loan payments are received. The cost of servicing loans is charged to expense as incurred.
Park serviced sold mortgage loans of $1,405 million at December 31, 2006 compared to $1,403 million at December 31, 2005, and $1,266 million at December 31, 2004. At December 31, 2006, $77 million of the sold mortgage loans were sold with recourse compared to $87 million at December 31, 2005. Management closely monitors the delinquency rates on the mortgage loans sold with recourse. At December 31, 2006, management determined that no liability was deemed necessary for these loans.
Lease Financing
Leases of equipment, automobiles and aircraft to customers generally are direct leases in which the Corporation’s subsidiaries have acquired the equipment, automobiles or aircraft with no outside financing.
Such leases are accounted for as direct financing leases for financial reporting purposes. Under the direct financing method, a receivable is recorded for the total amount of the lease payments to be received.
Unearned lease income, representing the excess of the sum of the aggregate rentals of the equipment, automobiles or aircraft over its cost is included in income over the term of the lease under the interest method.
The estimated residual values of leases are established at inception by determining the estimated residual value for the equipment, automobiles or aircraft from the particular industry leasing guide. Management re-evaluates the estimated residual values of leases on a quarterly basis from review of the leasing guides and charges operating expense for any write-down of the estimated residual values of leases.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over net identifiable tangible and intangible assets acquired in a purchase business combination. Other intangible assets represent purchased assets that have no physical property but represent some future economic benefit to its owner and are capable of being sold or exchanged on their own or in combination with a related asset or liability.
Goodwill and indefinite-lived intangible assets are not amortized to expense, but are subject to annual impairment tests. Intangible assets with definitive useful lives (such as core deposit intangibles) are amortized to expense over their estimated useful life.
Management considers several factors when performing the annual impairment tests on goodwill. The factors considered include the operating results for the particular Park subsidiary bank for the past year and the operating results budgeted for the current year, the purchase prices being paid for financial institutions in the Midwest, the deposit and loan totals of the Park subsidiary bank and the economic conditions in the markets served by the Park subsidiary bank.
The following table reflects the activity in goodwill and other intangible assets for the years 2006, 2005 and 2004. (See Note 2 of the Notes to Consolidated Financial Statements for details on the acquisitions of Anderson Bank Company (“Anderson”), First Federal Bancorp, Inc. (“First Federal”) and First Clermont Bank (“First Clermont”) and the sale of the Roseville branch office.)
                         
 
            Core Deposit    
(In thousands)   Goodwill   Intangibles   Total
 
January 1, 2004
  $ 7,529     $ 5,429     $ 12,958  
 
Amortization
          (1,479 )     (1,479 )
First Federal acquisition
    26,658       2,750       29,408  
 
December 31, 2004
  $ 34,187     $ 6,700     $ 40,887  
 
First Clermont acquisition
    28,369       3,664       32,033  
Sale of branch office
    (860 )     (324 )     (1,184 )
Amortization
          (2,548 )     (2,548 )
 
December 31, 2005
  $ 61,696     $ 7,492     $ 69,188  
 
Amortization
          (2,470 )     (2,470 )
Anderson acquisition
    10,638       647       11,285  
 
December 31, 2006
  $ 72,334     $ 5,669     $ 78,003  
 

49


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Park evaluates goodwill for impairment during the first quarter of each year. A determination has been made each year that goodwill was not impaired.
The balance of goodwill was $72.3 million at December 31, 2006. This goodwill balance is located at three subsidiary banks of Park. The subsidiary banks are The Park National Bank ($39.0 million), Century National Bank ($25.8 million) and The Security National Bank and Trust Co. ($7.5 million).
Goodwill and other intangible assets (as shown on the balance sheet) totaled $78.0 million at December 31, 2006 and $69.2 million at December 31, 2005.
The core deposit intangibles are being amortized to expense principally on the straight-line method, over periods ranging from six to ten years. The amortization period for each of the First Federal, First Clermont and Anderson acquisitions is six years. Core deposit intangible amortization expense was $2.5 million in both 2006 and 2005 and was $1.5 million in 2004.
The accumulated amortization of core deposit intangibles was $9.0 million at December 31, 2006 and $11.1 million at December 31, 2005. Park’s subsidiary banks had two branch offices in 2006 for which the core deposit intangibles were fully amortized. These intangibles totaled $4.6 million. The expected core deposit intangible amortization expense for each of the next five years is as follows:
         
 
(In thousands)        
 
2007
  $ 1,968  
2008
    1,456  
2009
    1,177  
2010
    853  
2011
    108  
 
Total
  $ 5,562  
 
Consolidated Statement of Cash Flows
Cash and cash equivalents include cash and cash items, amounts due from banks and money market instruments. Generally money market instruments are purchased and sold for one day periods.
Net cash provided by operating activities reflects cash payments as follows:
                         
 
December 31,   2006   2005   2004
(Dollars in thousands)                        
 
Interest paid on deposits and other borrowings
  $ 118,589     $ 91,408     $ 58,986  
Income taxes paid
  $ 34,633     $ 37,146     $ 41,884  
 
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
Income Taxes
The Corporation accounts for income taxes using the asset and liability approach. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
Stock Dividend
Park’s Board of Directors approved a 5% stock dividend in November 2004. The additional shares resulting from the dividend were distributed on December 15, 2004 to stockholders of record as of December 1, 2004. The consolidated financial statements, notes and other references to share and per share data have been retroactively restated for the stock dividend.
Treasury Stock
The purchase of Park’s common stock is recorded at cost. At the date of retirement or subsequent reissuance, the treasury stock account is reduced by the cost of such stock.
Stock Options
Effective January 1, 2006, Park adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment,” using the modified prospective method and accordingly did not restate prior period results. The modified prospective method recognizes compensation expense beginning with the effective date of January 1, 2006, for all stock options granted after January 1, 2006, and for all stock options that became vested after January 1, 2006. Park did not grant any stock options in 2006. Additionally, no stock options became vested in 2006. The adoption of SFAS No. 123R on January 1, 2006, had no impact on Park’s net income in 2006.
Prior to January 1, 2006, Park accounted for its stock option plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (APB 25) and related interpretations. Under APB 25, no stock based employee compensation cost was reflected in net income, as all options granted under Park’s plans had an exercise price equal to the market value of the underlying common stock on the grant date.
Park granted 228,150 incentive stock options in 2005 and 232,178 incentive stock options in 2004. Generally, these options vested immediately at the time of grant. The following table illustrates the effect on net income and earnings per share if compensation expense was measured using the fair value recognition provisions of SFAS No. 123R for 2005 and 2004.
                 
 
December 31,   2005   2004
(Dollars in thousands, except per share data)                
 
Net income as reported
  $ 95,238     $ 91,507  
 
Deduct: Stock-based compensation expense determined under fair value
    (3,664 )     (3,223 )
Pro-forma net income
    91,574       88,284  
 
Basic earnings per share as reported
  $ 6.68     $ 6.38  
Pro-forma basic earnings per share
    6.42       6.15  
 
Diluted earnings per share as reported
    6.64       6.32  
Pro-forma diluted earnings per share
    6.38       6.09  
 
Derivative Instruments
Park did not use any derivative instruments (such as interest rate swaps) in 2006, 2005 and 2004.
Accounting for Defined Benefit Pension Plan
In September 2006, the Financial Accounting Standards Board issued SFAS No. 158, “Employers Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132R.” This statement requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multi-employer plan) as an asset or liability in its balance sheet, beginning with year-end 2006, and to recognize changes in the funded status in the year in which the changes occur through comprehensive income beginning in 2007. Additionally, defined benefit plan assets and obligations are to be measured as of the date of the employer’s fiscal year-end, starting in 2008. The adoption of SFAS No. 158 had the following effect on individual line items in the 2006 balance sheet:
                         
 
    Before application           After application
(In thousands)   of SFAS No. 158   Adjustments   of SFAS No. 158
 
Prepaid pension benefit cost
  $ 16,342     $ (10,501 )   $ 5,841  
 
Deferred income tax asset
    18,715       3,675       22,390  
 
Total assets
    5,477,702       (6,826 )     5,470,876  
 
Accumulated other comprehensive income (loss), net
    (15,994 )     (6,826 )     (22,820 )
 
Total stockholders’ equity
  $ 577,265     $ (6,826 )   $ 570,439  
 

50


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Prior Year Misstatements
In September 2006, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108),” which is effective for fiscal years ending on or after November 15, 2006. SAB 108 provides guidance on how the effects of prior-year uncorrected financial statement misstatements should be considered in quantifying a current year misstatement. SAB 108 requires public companies to quantify misstatements using both an income statement (rollover) and balance sheet (iron curtain) approach and evaluate whether either approach results in misstatement that when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. Park had no items that required posting an adjustment to beginning retained earnings.
On January 26, 2007, Park filed a Form 8-K with the SEC announcing that management had discovered an error in its accounting for accrued interest income on loans. Management determined that accrued interest receivable on loans was overstated by $1.933 million and as a result interest income on loans was overstated by $1.933 million on a cumulative basis. Management discovered in late January 2007 that certain previously charged-off loans were incorrectly accruing interest income. On Park’s data processing system, a loan that is charged-off also needs to be coded as nonaccrual for the data processing system to not accrue interest income on these loans. Primarily, one of Park’s subsidiary banks did not follow this procedure on certain installment loans for approximately the past ten years. Management determined that interest income on loans was overstated by approximately $100,000 per quarter for the past several quarters. Park’s management concluded that the overstatement of accrued interest receivable on loans and the related overstatement of interest income on loans is not material to any previously issued financial statements. Accordingly, Park recorded a cumulative adjustment of $1.933 million in the fourth quarter of 2006 to reduce accrued interest receivable on loans and reduce interest income on loans. On an after-tax basis, this adjustment reduced Park’s net income by $1.256 million for the three and twelve months ended December 31, 2006 and reduced diluted earnings per share by $.09 for the three and twelve months ended December 31, 2006, as compared to net income and diluted earnings per share that was previously reported by Park on January 16, 2007, in a Form 8-K filing with the SEC.
Recently Issued but not yet Effective Accounting Pronouncements Accounting for Certain Hybrid Financial Instruments: In February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—an amendment to SFAS No. 133 and 140.” This statement permits fair value re-measurement for any hybrid financial instruments, clarifies which instruments are subject to the requirements of SFAS No. 133, and establishes a requirement to evaluate interests in securitized financial assets and other items. This Statement is effective for all financial instruments acquired, issued, or subject to a remeasurement (new basis) event occurring after January 1, 2007. Management does not expect that the adoption of this Statement will have a material impact on Park’s financial statements.
Accounting for Servicing of Financial Assets: In March 2006, FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets—an amendment of SFAS No. 140.” This Statement provides the following: 1.) revised guidance on when a servicing asset and servicing liability should be recognized; 2.) requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; 3.) permits an entity to elect to measure servicing assets and servicing liabilities at fair value each reporting date and report changes in fair value in earnings in the period in which the changes occur; 4.) upon initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities for securities which are identified as offsetting the entity’s exposure to changes in the fair value of servicing assets or liabilities that a servicer elects to subsequently measure at fair value; and 5.) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial condition and additional footnote disclosures. For Park, this Statement is effective January 1, 2007, with the effects of initial adoption being reported as a cumulative-effect adjustment to retained earnings. Management does not expect the adoption of this Statement will have a material impact on its financial statements.
Accounting for Income Taxes: In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of SFAS No. 109 (FIN 48),” which prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. For Park, FIN 48 is effective January 1, 2007. Management does not expect that the adoption of FIN 48 will have a material impact on its financial statements.
Accounting for Postretirement Benefits Pertaining to Life Insurance Arrangements: In September 2006, the FASB Emerging Issues Task Force (EITF) finalized Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” EITF Issue No. 06-4 requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after the participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. For Park, Issue No. 06-4 is effective on January 1, 2008.
At December 31, 2006, Park and its subsidiary banks owned $113 million of bank owned life insurance. These life insurance policies are generally subject to endorsement split-dollar life insurance agreements. These arrangements were designed to provide a pre-retirement and post-retirement benefit for senior officers and directors of Park and its subsidiary banks. Park’s management has not completed its evaluation of the impact of adoption of EITF Issue No. 06-4 on Park’s financial statements. Without an adjustment to the post-retirement benefits provided by the endorsement split-dollar life insurance agreements, Park’s management has concluded that the adoption of EITF Issue No. 06-4 may have a material impact on Park’s financial statements.
Accounting for Purchases of Life Insurance: In September 2006, the FASB EITF finalized Issue No. 06-5, “Accounting for Purchases of Life Insurance—Determining the Amount That Could be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life Insurance).” EITF Issue No. 06-5 requires that a policyholder consider contractual terms of a life insurance policy in determining the amount that could be realized under the insurance contract. It also requires that if the contract provides for a greater surrender value if all individual policies in a group are surrendered at the same time, that the surrender value be determined based on the assumption that policies will be surrendered on an individual basis. Lastly, EITF Issue No. 06-5 discusses whether the cash surrender value should be discounted when the policyholder is contractually limited in its ability to surrender a policy. For Park, EITF Issue No. 06-5 is effective January 1, 2007. Park does not expect that this Issue will have a material impact on its financial statements.
Fair Value Measurements: In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective on January 1, 2008 for Park. Management does not expect that the adoption of SFAS No. 157 will have a material impact on Park’s financial statements.

51


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
2. ORGANIZATION, ACQUISITIONS, BRANCH SALE AND PENDING ACQUISITION
Park National Corporation is a multi-bank holding company headquartered in Newark, Ohio. Through its banking subsidiaries, The Park National Bank (PNB), The Richland Trust Company (RTC), Century National Bank (CNB), The First-Knox National Bank of Mount Vernon (FKNB), United Bank, N.A. (UB), Second National Bank (SNB), The Security National Bank and Trust Co. (SEC), and The Citizens National Bank of Urbana (CIT), Park is engaged in a general commercial banking and trust business, primarily in Ohio. A wholly owned subsidiary of Park, Guardian Finance Company (GFC) began operating in May 1999. GFC is a consumer finance company located in Central Ohio. PNB operates through three banking divisions with the Park National Division headquartered in Newark, Ohio, the Fairfield National Division headquartered in Lancaster, Ohio and The Park National Bank of Southwest Ohio & Northern Kentucky Division headquartered in Milford, Ohio. FKNB operates through two banking divisions with the First-Knox National Division headquartered in Mount Vernon, Ohio and the Farmers and Savings Division headquartered in Loudonville, Ohio. SEC also operates through two banking divisions with the Security National Division headquartered in Springfield, Ohio and The Unity National Division (formerly The Third Savings and Loan Company) headquartered in Piqua, Ohio. All of the banking subsidiaries and their respective divisions provide the following principal services: the acceptance of deposits for demand, savings and time accounts; commercial, industrial, consumer and real estate lending, including installment loans, credit cards, home equity lines of credit, commercial and auto leasing; trust services; cash management; safe deposit operations; electronic funds transfers and a variety of additional banking-related services. See Note 20 for financial information on the Corporation’s banking subsidiaries.
On December 18, 2006, Park acquired all of the stock of Anderson Bank of Cincinnati, Ohio for $9.052 million in cash and 86,137 shares of Park common stock valued at $8.665 million or $100.60 per share. Immediately following Park’s acquisition, Anderson merged with Park’s subsidiary, The Park National Bank and is being operated as part of PNB’s operating division, The Park National Bank of Southwest Ohio & Northern Kentucky. The goodwill recognized as a result of this acquisition was $10.638 million. The fair value of the acquired assets of Anderson was $69.717 million and the fair value of the liabilities assumed was $62.638 million at December 18, 2006.
On January 3, 2005, Park acquired all of the stock of First Clermont Bank of Milford, Ohio for $52.5 million in an all cash transaction accounted for as a purchase. Immediately following Park’s stock acquisition, First Clermont merged with Park’s subsidiary, The Park National Bank. The goodwill recognized as a result of this acquisition was $28.369 million. The fair value of the acquired assets of First Clermont was $185.372 million and the fair value of the liabilities assumed was $161.241 million at January 3, 2005. During 2006, the First Clermont Division of PNB combined with three of PNB’s branches to form the operating division known as The Park National Bank of Southwest Ohio & Northern Kentucky.
On December 31, 2004, Park acquired First Federal Bancorp, Inc., a savings and loan holding company headquartered in Zanesville, Ohio, in an all cash transaction accounted for as a purchase. The stockholders of First Federal received $13.25 in cash for each outstanding common share of First Federal common stock. Park paid a total of $46.638 million to the stockholders of First Federal. The savings and loan subsidiary of First Federal, First Federal Savings Bank of Eastern Ohio, merged with Century National Bank. The goodwill recognized as a result of this acquisition was $26.658 million. The fair value of the acquired assets of First Federal was $252.687 million and the fair value of the liabilities assumed was $232.707 million at December 31, 2004.
On February 11, 2005, Park’s subsidiary Century National Bank, sold its Roseville, Ohio branch office. The Roseville branch office was acquired in connection with the acquisition of First Federal on December 31, 2004.
The Federal Reserve Board required that the Roseville branch office be sold as a condition of their approval of the merger transactions involving Park and First Federal. The deposits sold with the Roseville branch office totaled $12.419 million and the loans sold with the branch office totaled $5.273 million. Century National Bank received a premium of $1.184 million from the sale of the deposits.
Pending Acquisition
On September 14, 2006, Park and Vision Bancshares, Inc. (“Vision”) jointly announced the signing of an agreement and plan of merger (the “Merger Agreement”) providing for the merger of Vision into Park. This merger transaction is subject to the satisfaction of customary closing conditions in the Merger Agreement and the approval of appropriate regulatory authorities and of the shareholders of Vision. Park has filed all necessary regulatory applications and anticipates the transaction will close on or about March 9, 2007, assuming that all required approvals have been received and conditions to closing satisfied. Vision’s special shareholders meeting is scheduled to be held on February 20, 2007.
Vision operates two bank subsidiaries, both named Vision Bank. One bank is headquartered in Gulf Shores, Alabama and the other in Panama City, Florida. These banks operate fifteen offices. As of December 31, 2006, (on a consolidated basis) Vision had total assets of $691 million, total loans of $588 million and total deposits of $587 million.
Under the terms of the Merger Agreement, the shareholders of Vision are entitled to receive, in exchange for their shares of Vision common stock, either (a) cash, (b) Park common shares, or (c) a combination of cash and Park common shares, subject to the election and allocation procedures set forth in the Merger Agreement. Park will cause the requests of the Vision shareholders to be allocated on a pro-rata basis so that 50% of the shares of Vision common stock outstanding at the effective time of the merger will be exchanged for cash at the rate of $25.00 per share of Vision common stock and the other 50% of the outstanding shares of Vision common stock will be exchanged for Park common shares at the exchange rate of .2475 Park common shares for each share of Vision common stock. This allocation is subject to adjustment for cash paid in lieu of fractional Park common shares in accordance with the terms of the Merger Agreement.
As of January 8, 2007, 6,114,518 shares of Vision common stock were outstanding and 828,834 shares of Vision common stock were subject to outstanding stock options with a weighted average exercise price of $8.21 per share. Each outstanding stock option (that is not exercised prior to the election deadline specified in the Merger Agreement) granted under one of Vision’s equity-based compensation plans will be cancelled and extinguished and converted into the right to receive an amount of cash equal to (1)(a) $25.00 multiplied by (b) the number of shares of Vision common stock subject to the unexercised portion of the stock option minus (2) the aggregate exercise price for the shares of Vision common stock subject to the unexercised portion of the stock option.
3. RESTRICTIONS ON CASH AND DUE FROM BANKS
The Corporation’s banking subsidiaries are required to maintain average reserve balances with the Federal Reserve Bank. The average required reserve balance was approximately $30.9 million at December 31, 2006 and $37.7 million at December 31, 2005. No other compensating balance arrangements were in existence at year-end.
4. INVESTMENT SECURITIES
The amortized cost and fair value of investment securities are shown in the following table. Management evaluates the investment securities on a quarterly basis for permanent impairment. No impairment charges have been deemed necessary in 2006 and 2005.

52


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Investment securities at December 31, 2006, were as follows:
                                 
 
            Gross   Gross    
            Unrealized   Unrealized    
    Amortized   Holding   Holding   Estimated
(In thousands)   Cost   Gains   Losses   Fair Value
 
2006:
                               
Securities Available-for-Sale
                               
Obligations of U.S. Treasury and other U.S. Government agencies
  $ 90,988     $ 140     $ 419     $ 90,709  
Obligations of states and political subdivisions
    53,947       1,006       3       54,950  
U.S. Government agencies’ asset-backed securities and other asset-backed securities
    1,153,515       932       26,823       1,127,624  
Other equity securities
    1,236       595       35       1,796  
 
Total
  $ 1,299,686     $ 2,673     $ 27,280     $ 1,275,079  
 
2006:
                               
Securities Held-to-Maturity
                               
Obligations of states and political subdivisions
  $ 15,140     $ 169     $     $ 15,309  
U.S. Government agencies’ asset-backed securities and other asset-backed securities
    161,345       1       6,869       154,477  
 
Total
  $ 176,485     $ 170     $ 6,869     $ 169,786  
 
Other investment securities (as shown on the balance sheet) consist of stock investments in the Federal Home Loan Bank and the Federal Reserve Bank. Park owned $55.5 million of Federal Home Loan Bank stock and $6.4 million of Federal Reserve stock at December 31, 2006. Park owned $52.1 million of Federal Home Loan Bank stock and $5.9 million of Federal Reserve Bank stock at December 31, 2005. The fair values of these investments are the same as their amortized costs.
Management does not believe any individual unrealized loss as of December 31, 2006 and December 31, 2005, represents an other-than-temporary impairment. The unrealized losses relate primarily to the impact of increases in market interest rates on U.S. Government agencies’ asset-backed securities. The fair value is expected to recover as payments are received on these securities and they approach maturity.
Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.
Securities with unrealized losses at December 31, 2006, were as follows:
                                                             
                 
    Less than 12 Months     12 Months or Longer     Total        
                 
    Fair   Unrealized     Fair   Unrealized     Fair   Unrealized        
(In thousands)   Value   Losses     Value   Losses     Value   Losses        
                 
2006:
                                                           
Securities Available-for-Sale
                                                           
Obligations of U.S. Treasury and other U.S. Government agencies
  $ 60,577     $ 419       $     $       $ 60,577     $ 419          
Obligations of states and political subdivisions
    131       1         120       2         251       3          
U.S. Government agencies’ asset-backed securities and other asset-backed securities
    17,266       116         1,064,607       26,707         1,081,873       26,823          
Other equity securities
                  165       35         165       35          
                 
Total
  $ 77,974     $ 536       $ 1,064,892     $ 26,744       $ 1,142,866     $ 27,280          
                 
2006:
                                                           
Securities Held-to-Maturity
                                                           
U.S. Government agencies’ asset-backed securities and other asset-backed securities
  $     $       $ 154,286     $ 6,869       $ 154,286     $ 6,869          
 
Investment securities at December 31, 2005, were as follows:
                                 
 
            Gross   Gross    
            Unrealized   Unrealized    
    Amortized   Holding   Holding   Estimated
(In thousands)   Cost   Gains   Losses   Fair Value
 
2005:
                               
Securities Available-for-Sale
                               
Obligations of U.S. Treasury and other U.S. Government agencies
  $ 998     $     $ 2     $ 996  
Obligations of states and political subdivisions
    66,181       1,740       15       67,906  
U.S. Government agencies’ asset-backed securities and other asset-backed securities
    1,356,233       1,823       19,629       1,338,427  
Other equity securities
    1,543       527       48       2,022  
 
Total
  $ 1,424,955     $ 4,090     $ 19,694     $ 1,409,351  
 
2005:
                               
Securities Held-to-Maturity
                               
Obligations of states and political subdivisions
  $ 17,430     $ 308     $     $ 17,738  
U.S. Government agencies’ asset-backed securities and other asset-backed securities
    178,523       2       5,838       172,687  
 
Total
  $ 195,953     $ 310     $ 5,838     $ 190,425  
 
Securities with unrealized losses at December 31, 2005, were as follows:
                                                             
                   
    Less than 12 Months     12 Months or Longer     Total        
                     
    Fair   Unrealized     Fair   Unrealized     Fair   Unrealized        
(In thousands)   Value   Losses     Value   Losses     Value   Losses        
                   
2005:
                                                   
Securities Available-for-Sale
                                                   
Obligations of U.S. Treasury and other U.S. Government agencies
  $ 996     $ 2       $     $       $ 996     $ 2  
Obligations of states and political subdivisions
    346       4         474       11         820       15  
U.S. Government agencies’ asset-backed securities and other asset-backed securities
    1,244,306       19,272         4,338       357         1,248,644       19,629  
Other equity securities
                  152       48         152       48  
             
Total
  $ 1,245,648     $ 19,278       $ 4,964     $ 416       $ 1,250,612     $ 19,694  
             
2005:
                                                   
Securities Held-to-Maturity
                                                   
U.S. Government agencies’ asset-backed securities and other asset-backed securities
  $ 172,591     $ 5,838       $     $       $ 172,591     $ 5,838  
             
The amortized cost and estimated fair value of investments in debt securities at December 31, 2006, are shown in the following table by contractual maturity or the expected call date, except for asset-backed securities which are shown based on expected principal repayments. The average yield is computed on a tax equivalent basis using a thirty-five percent tax rate and is based on the amortized cost of the securities.

53


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                                 
 
                    Weighted    
    Amortized   Estimated   Average   Average
(Dollars in thousands)   Cost   Fair Value   Maturity   Yield
 
Securities Available-for-Sale
                               
U.S. Treasury and agencies’ notes:
                               
Due within one year
  $ 996     $ 995     0.21 years     4.92 %
Due five through ten years
    89,992       89,714     9.34 years     5.97 %
 
Total
  $ 90,988     $ 90,709     9.24 years     5.96 %
 
Obligations of states and political subdivisions:
                               
Due within one year
  $ 22,700     $ 22,889     0.50 years     7.21 %
Due one through five years
    30,635       31,414     1.96 years     7.18 %
Due five through ten years
    612       647     6.57 years     6.86 %
 
Total
  $ 53,947     $ 54,950     1.40 years     7.19 %
 
U.S. Government agencies’ asset-backed securities and other asset-backed securities:
                               
Due within one year
  $ 193,432     $ 189,103     0.53 years     4.85 %
Due one through five years
    553,790       541,321     2.85 years     4.83 %
Due five through ten years
    358,802       350,772     7.24 years     4.76 %
Due over ten years
    47,491       46,428     10.62 years     4.70 %
 
Total
  $ 1,153,515     $ 1,127,624     4.16 years     4.81 %
 
Securities Held-to-Maturity
                               
Obligations of states and political subdivisions:
                               
Due within one year
  $ 7,761     $ 7,792     0.43 years     6.57 %
Due one through five years
    6,879       7,007     2.05 years     6.59 %
Due five through ten years
    500       510     7.50 years     6.60 %
 
Total
  $ 15,140     $ 15,309     1.40 years     6.58 %
 
U.S. Government agencies’ asset-backed securities and other asset-backed securities:
                               
Due within one year
  $ 20,555     $ 19,681     0.51 years     4.76 %
Due one through five years
    35,380       33,876     3.07 years     4.72 %
Due five through ten years
    88,954       85,164     7.59 years     4.73 %
Due over ten years
    16,456       15,756     10.58 years     4.73 %
 
Total
  $ 161,345     $ 154,477     6.00 years     4.73 %
 
Investment securities having a book value of $1,448 million and $1,503 million at December 31, 2006 and 2005, respectively, were pledged to collateralize government and trust department deposits in accordance with federal and state requirements and to secure repurchase agreements sold, and as collateral for Federal Home Loan Bank (FHLB) advance borrowings.
At December 31, 2006, $781 million was pledged for government and trust department deposits, $661 million was pledged to secure repurchase agreements and $6 million was pledged as collateral for FHLB advance borrowings. At December 31, 2005, $699 million was pledged for government and trust department deposits, $659 million was pledged to secure repurchase agreements and $145 million was pledged as collateral for FHLB advance borrowings.
In 2006, 2005 and 2004, gross gains of $106,000, $97,000 and $140,000, and gross losses of $9,000, $1,000 and $933,000 were realized, respectively. The tax expense related to the net securities gains was $34,000 in both 2006 and 2005 and the tax benefit related to net securities losses was $278,000 in 2004.
5. LOANS
The composition of the loan portfolio is as follows:
                 
 
December 31 (Dollars in thousands)   2006   2005
 
Commercial, financial and agricultural
  $ 548,254     $ 512,636  
Real estate:
               
Construction
    234,988       193,185  
Residential
    1,300,294       1,287,438  
Commercial
    854,869       823,354  
Consumer, net
    532,092       494,975  
Leases, net
    10,205       16,524  
 
Total loans
  $ 3,480,702     $ 3,328,112  
 
Under the Corporation’s credit policies and practices, all nonaccrual and restructured commercial, financial, agricultural, construction and commercial real estate loans meet the definition of impaired loans under SFAS No. 114 and 118. Impaired loans as defined by SFAS No. 114 and 118 exclude certain consumer loans, residential real estate loans and lease financing classified as nonaccrual. The majority of the loans deemed impaired were evaluated using the fair value of the collateral as the measurement method.
Nonaccrual and restructured loans are summarized as follows:
                 
 
December 31 (Dollars in thousands)   2006   2005
 
Impaired loans:
               
Nonaccrual
  $ 10,367     $ 9,308  
Restructured
    9,113       7,441  
Total impaired loans
    19,480       16,749  
Other nonaccrual loans
    5,637       5,614  
 
Total nonaccrual and restructured loans
  $ 25,117     $ 22,363  
 
The allowance for credit losses related to impaired loans at December 31, 2006 and 2005, was $2,002,000 and $1,988,000, respectively. All impaired loans for both periods were subject to a related allowance for credit losses.
The average balance of impaired loans was $21,976,000, $19,557,000 and $21,003,000 for 2006, 2005 and 2004, respectively.
Interest income on impaired loans is recognized after all past due and current principal payments have been made, and collectibility is no longer doubtful. For the years ended December 31, 2006, 2005 and 2004, the Corporation recognized $450,000, $490,000 and $721,000, respectively, of interest income on impaired loans, which included $471,000, $553,000 and $752,000, respectively, of interest income recognized using the cash basis method of income recognition.
Certain of Park’s and its affiliate banks’ executive officers, directors and their affiliates are loan customers of the Corporation’s banking subsidiaries. As of December 31, 2006 and 2005, loans aggregating approximately $112,486,000 and $130,116,000, respectively, were outstanding to such parties. During 2006, $17,870,000 of new loans were made and repayments totaled $35,500,000.
6. ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses is summarized as follows:
                         
 
(Dollars in thousands)   2006   2005   2004
 
Balance, January 1
  $ 69,694     $ 68,328     $ 63,142  
Allowance for loan losses of acquired bank
    798       1,849       4,450  
Provision for loan losses
    3,927       5,407       8,600  
Losses charged to the reserve
    (10,772 )     (13,389 )     (15,173 )
Recoveries
    6,853       7,499       7,309  
 
Balance, December 31
  $ 70,500     $ 69,694     $ 68,328  
 
7. INVESTMENT IN FINANCING LEASES
The following is a summary of the components of the Corporation’s affiliates’ net investment in direct financing leases:
                 
 
December 31 (Dollars in thousands)   2006   2005
 
Total minimum payments to be received
  $ 9,458     $ 12,987  
Estimated unguaranteed residual value of leased property
    1,702       4,562  
Less unearned income
    (955 )     (1,025 )
 
Total
  $ 10,205     $ 16,524  
 

54


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Minimum lease payments to be received as of December 31, 2006 are:
         
 
(In thousands)        
 
2007
    2,242  
2008
    1,666  
2009
    2,769  
2010
    999  
2011
    459  
Thereafter
    1,323  
 
Total
  $ 9,458  
 
8. PREMISES AND EQUIPMENT
The major categories of premises and equipment and accumulated depreciation are summarized as follows:
                 
 
December 31 (Dollars in thousands)   2006   2005
 
Land
  $ 16,220     $ 14,292  
Buildings
    59,917       58,308  
Equipment, furniture and fixtures
    55,377       53,630  
Leasehold improvements
    3,951       3,624  
 
Total
    135,465       129,854  
 
Less accumulated depreciation and amortization
    (87,911 )     (82,682 )
 
Premises and equipment, net
  $ 47,554     $ 47,172  
 
Depreciation and amortization expense amounted to $5,522,000, $5,641,000 and $5,436,000 for the three years ended December 31, 2006, 2005 and 2004, respectively.
The Corporation and its subsidiaries lease certain premises and equipment accounted for as operating leases. The following is a schedule of the future minimum rental payments required for the next five years under such leases with initial terms in excess of one year:
         
 
(In thousands)        
 
2007
    1,727  
2008
    1,544  
2009
    1,234  
2010
    697  
2011
    326  
Thereafter
    579  
 
Total
  $ 6,107  
 
Rent expense amounted to $2,107,000, $1,915,000 and $1,362,000, for the three years ended December 31, 2006, 2005 and 2004, respectively.
9. SHORT-TERM BORROWINGS
Short-term borrowings are as follows:
                 
 
December 31 (Dollars in thousands)   2006   2005
 
Securities sold under agreements to repurchase and federal funds purchased
  $ 225,356     $ 246,502  
Federal Home Loan Bank advances
    142,000       60,000  
Other short-term borrowings
    8,417       7,572  
 
Total short-term borrowings
  $ 375,773     $ 314,074  
 
The outstanding balances for all short-term borrowings as of December 31, 2006, 2005 and 2004 (in thousands) and the weighted-average interest rates as of and paid during each of the years then ended are as follows:
                         
 
    Repurchase           Demand
    Agreements   Federal   Notes
    and Federal   Home Loan   Due U.S.
    Funds   Bank   Treasury
(Dollars in thousands)   Purchased   Advances   and Other
 
2006:
                       
Ending balance
  $ 225,356     $ 142,000     $ 8,417  
Highest month-end balance
    240,924       246,000       11,290  
Average daily balance
    224,662       147,145       3,525  
Weighted-average interest rate:
                       
As of year-end
    3.73 %     5.24 %     5.06 %
Paid during the year
    3.54 %     5.15 %     4.62 %
 
2005:
                       
Ending balance
  $ 246,502     $ 60,000     $ 7,572  
Highest month-end balance
    246,502       170,000       8,583  
Average daily balance
    194,157       94,264       3,421  
Weighted-average interest rate:
                       
As of year-end
    2.94 %     4.20 %     4.16 %
Paid during the year
    2.14 %     3.46 %     2.93 %
 
2004:
                       
Ending balance
  $ 192,483     $ 78,228     $ 7,520  
Highest month-end balance
    354,195       160,050       7,520  
Average daily balance
    323,978       74,043       3,278  
Weighted-average interest rate:
                       
As of year-end
    1.29 %     2.31 %     2.25 %
Paid during the year
    1.17 %     2.01 %     1.13 %
 
At December 31, 2006 and 2005, Federal Home Loan Bank (FHLB) advances were collateralized by investment securities owned by the Corporation’s subsidiary banks and by various loans pledged under a blanket agreement by the Corporation’s subsidiary banks.
See Note 4 of the Notes to Consolidated Financial Statements for the amount of investment securities that are pledged. At December 31, 2006, $1,770 million of commercial real estate and residential mortgage loans were pledged under a blanket agreement to the FHLB by Park’s subsidiary banks. At December 31, 2005, $867 million of residential mortgage loans were pledged to the FHLB.
10. LONG-TERM DEBT
Long-term debt is listed below:
                                 
 
December 31 (Dollars in thousands)   2006   2005
    Outstanding   Average   Outstanding   Average
    Balance   Rate   Balance   Rate
 
Total Federal Home Loan Bank advances by year of maturity:
                               
2006
  $           $ 113,268       4.17 %
2007
    41,289       4.01 %     41,243       4.02 %
2008
    84,726       4.83 %     122,110       4.20 %
2009
    6,082       3.92 %     6,115       3.93 %
2010
    17,416       5.72 %     17,404       5.72 %
2011
    1,429       4.01 %     6,422       4.59 %
Thereafter
    103,198       4.15 %     73,222       4.53 %
 
Total
  $ 254,140       4.46 %   $ 379,784       4.31 %
 
Total broker repurchase agreements by year of maturity:
                               
2007
  $ 25,000       3.84 %   $ 25,000       3.84 %
2009
    25,000       3.79 %     85,000       3.94 %
2010
                75,000       3.83 %
Thereafter
    300,000       4.00 %     150,000       3.87 %
 
Total
  $ 350,000       3.97 %   $ 335,000       3.88 %
 
Total combined long-term debt by year of maturity:
                               
2006
  $           $ 113,268       4.17 %
2007
    66,289       3.95 %     66,243       3.95 %
2008
    84,726       4.83 %     122,110       4.20 %
2009
    31,082       3.81 %     91,115       3.94 %
2010
    17,416       5.72 %     92,404       4.19 %
2011
    1,429       4.01 %     6,422       4.59 %
Thereafter
    403,198       4.04 %     223,222       4.09 %
 
Total
  $ 604,140       4.18 %   $ 714,784       4.11 %
 

55


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Park had approximately $403 million of long-term debt at December 31, 2006 with a contractual maturity longer than five years. However, approximately $303 million of this debt is callable by the issuer in 2007 and the remaining $100 million is callable by the issuer in 2008.
At December 31, 2006 and 2005, Federal Home Loan Bank (FHLB) advances were collateralized by investment securities owned by the Corporation’s subsidiary banks and by various loans pledged under a blanket agreement by the Corporation’s subsidiary banks.
See Note 4 of the Notes to Consolidated Financial Statements for the amount of investment securities that are pledged. See Note 9 of the Notes to Consolidated Financial Statements for the amount of residential mortgage loans that are pledged to the FHLB.
11. STOCK OPTION PLANS
The Park National Corporation 2005 Incentive Stock Option Plan (the “2005 Plan”) was adopted by the Board of Directors of Park on January 18, 2005, and was approved by the shareholders at the Annual Meeting of Shareholders on April 18, 2005. Under the 2005 Plan, 1,500,000 common shares are authorized for delivery upon the exercise of incentive stock options. All of the common shares delivered upon the exercise of incentive stock options granted under the 2005 Plan are to be treasury shares. At December 31, 2006, 1,285,175 options were available for future grants under the 2005 Plan. Under the terms of the 2005 Plan, incentive stock options may be granted at a price not less than the fair market value at the date of the grant, and for an option term of up to five years. No additional incentive stock options may be granted under the 2005 Plan after January 17, 2015.
The Park National Corporation 1995 Incentive Stock Option Plan (the “1995 Plan”) was adopted April 17, 1995, and amended, April 20, 1998 and April 16, 2001. Pursuant to the terms of the 1995 Plan, all of the common shares delivered upon exercise of incentive stock options are to be treasury shares. No incentive stock options may be granted under the 1995 Plan after January 16, 2005.
The fair value of each incentive stock option granted is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical volatilities of Park’s common stock. The Corporation uses historical data to estimate option exercise behavior. The expected term of incentive stock options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the incentive stock option is based on the U.S. Treasury yield curve in effect at the time of the grant.
The fair value of incentive stock options granted was determined using the following weighted-average assumptions as of the grant date. Park did not grant any options in 2006.
                 
 
    2005   2004
 
Risk-free interest rate
    3.77 %     3.36 %
Expected term (years)
    4.0       4.0  
Expected stock price volatility
    19.8 %     17.5 %
Dividend yield
    3.00 %     3.00 %
 
The activity in Park’s stock option plans is listed in the following table for 2006:
                 
 
    Stock Options
            Weighted
            Average
            Exercise
            Price per
    Number   Share
 
January 1, 2006
    818,182     $ 99.78  
Granted
           
Exercised
    (39,444 )     81.81  
Forfeited/Expired
    (92,714 )     91.76  
 
December 31, 2006
    686,024     $ 101.89  
 
Exercisable at year end:     686,024  
Weighted-average remaining contractual life:
  2.1 Years
Aggregate intrinsic value:   $ 2,398,466  
 
Information related to Park’s stock option plans for the past three years is listed in the following table for 2006:
                         
 
(Dollars in thousands)   2006   2005   2004
 
Intrinsic value of options exercised
  $ 692     $ 1,213     $ 2,255  
Cash received from option exercises
    3,227       4,077       6,617  
Tax benefit realized from option exercises
    18       57       63  
Weighted-average fair value of options granted per share
  $     $ 16.14     $ 13.88  
 
12. BENEFIT PLANS
The Corporation has a noncontributory defined benefit pension plan covering substantially all of the employees of the Corporation and its subsidiaries. The plan provides benefits based on an employee’s years of service and compensation.
The Corporation’s funding policy is to contribute annually an amount that can be deducted for federal income tax purposes using a different actuarial cost method and different assumptions from those used for financial reporting purposes. Management does not expect to make a contribution to the defined benefit pension plan in 2007.
Using an accrual measurement date of September 30, plan assets for the pension plan are listed below:
                 
 
(Dollars in thousands)   2006   2005
 
Change in fair value of plan assets:
               
Fair value at beginning of measurement period
  $ 46,331     $ 37,341  
Actual return on plan assets
    4,336       4,303  
Company contributions
    9,117       9,688  
Benefits paid
    (4,243 )     (5,001 )
 
Fair value at end of measurement period
  $ 55,541     $ 46,331  
 
The asset allocation for the defined benefit pension plan as of the measurement date, by asset category, is as follows:
                     
 
        Percentage of Plan Assets
Asset Category   Target Allocation   2006   2005
 
Equity securities
  50% - 100%     81 %     82 %
Fixed income and cash equivalents
  remaining balance     19 %     18 %
Other
             
 
Total
      100 %     100 %
 
The investment policy, as established by the Retirement Plan Committee, is to invest assets per the target allocation stated above. Assets will be reallocated periodically based on the investment strategy of the Retirement Plan Committee. The investment policy is reviewed periodically.
The expected long-term rate of return on plan assets is 7.75% in 2006 and 2005. This return is based on the expected return of each of the asset categories, weighted based on the median of the target allocation for each class.

56


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Using an actuarial measurement date of September 30, benefit obligation activity is listed as follows:
                 
 
(Dollars in thousands)   2006   2005
 
Change in benefit obligation:
               
Projected benefit obligation at beginning of measurement period
  $ 46,641     $ 45,169  
Service cost
    3,179       2,682  
Interest cost
    2,886       2,756  
Actuarial loss or (gain)
    1,237       1,035  
Benefits paid
    (4,243 )     (5,001 )
 
Projected benefit obligation at the end of measurement period
  $ 49,700     $ 46,641  
 
The accumulated benefit obligation for the defined benefit pension plan was $40.5 million at September 30, 2006 and $38.3 million at September 30, 2005.
The weighted average assumptions used to determine benefit obligations at September 30, were as follows:
                 
 
    2006   2005
 
Discount rate
    6.08 %     5.96 %
Rate of compensation increase
    3.50 %     3.50 %
 
The estimated future pension benefit payments reflecting expected future service for the next ten years are shown below in thousands:
         
 
2007
  $ 1,156  
2008
    1,309  
2009
    1,470  
2010
    1,686  
2011
    2,028  
2012 - 2015
    17,987  
 
Total
  $ 25,636  
 
The following table displays the funded status of the defined benefit pension plan which is computed by taking the difference between the fair value of the plan assets and the projected benefit obligation at the measurement date of September 30. Park adopted SFAS No. 158 in 2006. SFAS No. 158 requires that the funded status of the defined benefit pension plan be shown in Park’s financial statements as the prepaid benefit cost at September 30, 2006. The prepaid benefit cost at September 30, 2005 includes the unrecognized prior service cost and the unrecognized net actuarial loss. The following table provides information on the prepaid benefit cost at September 30.
                 
 
(Dollars in thousands)   2006   2005
 
Funded status
  $ 5,841     $ (310 )
Unrecognized prior service cost
          238  
Unrecognized net actuarial loss
          9,956  
 
Prepaid benefit cost
  $ 5,841     $ 9,884  
 
In 2006, Park recorded the unrecognized prior service cost and the unrecognized net actuarial loss as a reduction to prepaid benefit cost and an adjustment to accumulated other comprehensive income (loss).
         
 
(Dollars in thousands)   2006
 
Unrecognized prior service cost
  $ (224 )
Unrecognized net actuarial loss
    (10,277 )
 
Reduction to prepaid benefit cost
    (10,501 )
 
Impact on deferred taxes
    3,675  
 
Adjustment to accumulated other comprehensive income (loss)
  $ (6,826 )
 
Using an actuarial measurement date of September 30, components of net periodic benefit cost are as follows:
                         
 
(Dollars in thousands)   2006   2005   2004
 
Components of net periodic benefit cost:
                       
Service cost
  $ 3,179     $ 2,682     $ 2,502  
Interest cost
    2,886       2,756       2,577  
Expected return on plan assets
    (3,975 )     (3,334 )     (2,789 )
Amortization of prior service cost
    14       12       12  
Recognized net actuarial loss/(gain)
    555       545       497  
 
Benefit cost
  $ 2,659     $ 2,661     $ 2,799  
 
The estimated net loss and prior service costs for the defined benefit pension plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $363,000 and $34,000, respectively.
The weighted average assumptions used to determine net periodic benefit cost for the years ended December 31, are listed below:
                 
 
    2006   2005
 
Discount rate
    5.96 %     6.00 %
Rate of compensation increase
    3.50 %     3.75 %
Expected long-term return on plan assets
    7.75 %     7.75 %
 
The Corporation has a voluntary salary deferral plan covering substantially all of its employees. Eligible employees may contribute a portion of their compensation subject to a maximum statutory limitation. The Corporation provides a matching contribution established annually by the Corporation. Contribution expense for the Corporation was $1,672,000, $1,763,000 and $1,452,000 for 2006, 2005 and 2004, respectively.
The Corporation has a Supplemental Executive Retirement Plan (SERP) covering certain key officers of the Corporation and its subsidiaries with defined pension benefits in excess of limits imposed by federal tax law. At December 31, 2006 and 2005, the accrued benefit cost for this plan totaled $5,946,000 and $5,620,000, respectively. The expense for the Corporation was $620,000, $744,000, and $636,000 for 2006, 2005, and 2004, respectively.
13.   FEDERAL INCOME TAXES
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 the Corporation’s deferred tax assets and liabilities are as follows:
                 
 
December 31 (Dollars in thousands)   2006   2005
 
Deferred tax assets:
               
Allowance for loan losses
  $ 24,675     $ 24,393  
Accumulated other comprehensive loss — SFAS No. 115
    8,612       5,461  
Accumulated other comprehensive loss — SFAS No. 158
    3,675        
Intangible assets
    3,209       3,465  
Deferred compensation
    3,678       3,545  
Other
    3,973       3,628  
 
Total deferred tax assets
  $ 47,822     $ 40,492  
 
Deferred tax liabilities:
               
Lease revenue reporting
  $ 2,096     $ 3,830  
Deferred investment income
    12,319       12,170  
Pension plan
    5,625       3,400  
Mortgage servicing rights
    3,630       3,733  
Other
    1,762       1,804  
 
Total deferred tax liabilities
  $ 25,432     $ 24,937  
 
Net deferred tax assets
  $ 22,390     $ 15,555  
 
The components of the provision for federal income taxes are shown below:
                         
 
(Dollars in thousands)   2006   2005   2004
 
Currently payable
  $ 38,830     $ 38,196     $ 40,284  
Deferred
    156       1,990       (2,542 )
 
Total
  $ 38,986     $ 40,186     $ 37,742  
 

57


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
The following is a reconcilement of federal income tax expense to the amount computed at the statutory rate of 35% for the years ended December 31, 2006, 2005 and 2004.
                         
 
December 31   2006   2005   2004
 
Statutory corporate tax rate
    35.0 %     35.0 %     35.0 %
Changes in rates resulting from:
                       
Tax-exempt interest, net of disallowed interest
    (1.2 %)     (1.3 %)     (1.7 %)
Bank owned life insurance
    (1.0 %)     (.9 %)     (1.0 %)
Tax credits (low income housing)
    (2.9 %)     (2.5 %)     (2.2 %)
Other
    (.6 %)     (.6 %)     (.9 %)
 
Effective tax rate
    29.3 %     29.7 %     29.2 %
 
Park and its subsidiary banks do not pay state income tax to the State of Ohio, but pay a franchise tax based on their year-end equity. The franchise tax expense is included in state tax expense and was $2.2 million in 2006, $2.9 million in 2005 and $2.5 million in 2004.
14.   OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes are shown in the following table for the years ended December 31, 2006, 2005 and 2004.
                         
 
Year ended December 31   Before-Tax   Tax   Net-of-Tax
(Dollars in thousands)   Amount   Expense   Amount
 
2006:
                       
Unrealized losses on available-for-sale securities
  $ (8,905 )   $ (3,117 )   $ (5,788 )
Reclassification adjustment for gains realized in net income
    (97 )     (34 )     (63 )
 
Other comprehensive loss
  $ (9,002 )   $ (3,151 )   $ (5,851 )
 
2005:
                       
Unrealized losses on available-for-sale securities
  $ (34,650 )   $ (12,127 )   $ (22,523 )
Reclassification adjustment for gains realized in net income
    (96 )     (34 )     (62 )
 
Other comprehensive loss
  $ (34,746 )   $ (12,161 )   $ (22,585 )
 
2004:
                       
Unrealized losses on available-for-sale securities
  $ (10,811 )   $ (3,784 )   $ (7,027 )
Reclassification adjustment for losses realized in net income
    793       278       515  
 
Other comprehensive loss
  $ (10,018 )   $ (3,506 )   $ (6,512 )
 
15.   EARNINGS PER SHARE
SFAS No. 128, “Earnings Per Share” requires the reporting of basic and diluted earnings per share. Basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share.
The following table sets forth the computation of basic and diluted earnings per share:
                         
 
Year ended December 31            
(Dollars in thousands,            
except per share data)   2006   2005   2004
 
Numerator:
                       
Net income
  $ 94,091     $ 95,238     $ 91,507  
Denominator:
                       
Basic earnings per share:
                       
Weighted-average shares
    13,929,090       14,258,519       14,344,771  
Effect of dilutive securities — stock options
    37,746       89,724       141,556  
Diluted earnings per share:
                       
Adjusted weighted-average shares and assumed conversions
    13,966,836       14,348,243       14,486,327  
Earnings per share:
                       
Basic earnings per share
  $ 6.75     $ 6.68     $ 6.38  
Diluted earnings per share
  $ 6.74     $ 6.64     $ 6.32  
 
16.   DIVIDEND RESTRICTIONS
Bank regulators limit the amount of dividends a subsidiary bank can declare in any calendar year without obtaining prior approval. At December 31, 2006, approximately $2.4 million of the total stockholders’ equity of the bank subsidiaries is available for the payment of dividends to the Corporation, without approval by the applicable regulatory authorities.
17.   FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK
The Corporation is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include loan commitments and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements.
The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.
The total amounts of off-balance sheet financial instruments with credit risk are as follows:
                 
 
December 31 (Dollars in thousands)   2006   2005
 
Loan commitments
  $ 824,412     $ 667,074  
Unused credit card limits
    140,100       132,591  
Standby letters of credit
    19,687       20,872  
 
The loan commitments are generally for variable rates of interest.
The Corporation grants retail, commercial and commercial real estate loans to customers primarily located in Ohio. The Corporation evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Although the Corporation has a diversified loan portfolio, a substantial portion of the borrowers’ ability to honor their contracts is dependent upon the economic conditions in each borrower’s geographic location.
18.   FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.
Interest bearing deposits with other banks: The carrying amounts reported in the balance sheet for interest bearing deposits with other banks approximate those assets’ fair values.
Investment securities: Fair values for investment 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.
Bank owned life insurance: The carrying amounts reported in the balance sheet for bank owned life insurance approximate those assets’ fair values.

58


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for certain mortgage loans (e.g., one-to-four family residential) are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.
Off-balance sheet instruments: Fair values for the Corporation’s loan commitments and standby letters of credit are based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counter parties’ credit standing.
Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable-rate, fixed-term certificates of deposit approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities of time deposits.
Short-term borrowings: The carrying amounts of federal funds purchased, borrowings under repurchase agreements and other short-term borrowings approximate their fair values.
Long-term debt: Fair values for long-term debt are estimated using a discounted cash flow calculation that applies interest rates currently being offered on long-term debt to a schedule of monthly maturities.
The fair value of financial instruments at December 31, 2006 and 2005, is as follows:
                                 
 
    2006   2005
December 31,   Carrying   Fair   Carrying   Fair
(In thousands)   Amount   Value   Amount   Value
 
Financial assets:
                               
Cash and money market instruments
  $ 186,256     $ 186,256     $ 173,973     $ 173,973  
Interest bearing deposits with other banks
    1       1       300       300  
Investment securities
    1,513,498       1,506,799       1,663,342       1,657,814  
Bank owned life insurance
    113,101       113,101       109,600       109,600  
Loans:
                               
Commercial, financial and agricultural
    548,254       548,254       512,636       512,636  
Real estate:
                               
Construction
    234,988       234,988       193,185       193,185  
Residential
    1,300,294       1,294,157       1,287,438       1,281,657  
Commercial
    854,869       843,251       823,354       815,022  
Consumer, net
    532,092       527,128       494,975       494,064  
 
Total loans
    3,470,497       3,447,778       3,311,588       3,296,564  
 
Allowance for loan losses
    (70,500 )           (69,694 )      
 
Loans receivable, net
  $ 3,399,997     $ 3,447,778     $ 3,241,894     $ 3,296,564  
 
Financial liabilities:
                               
Noninterest bearing checking
  $ 664,962     $ 664,962     $ 667,328     $ 667,328  
Interest bearing transaction accounts
    1,033,870       1,033,870       987,954       987,954  
Savings
    543,724       543,724       594,706       594,706  
Time deposits
    1,581,120       1,575,713       1,505,903       1,486,989  
Other
    1,858       1,858       1,866       1,866  
 
Total deposits
  $ 3,825,534     $ 3,820,127     $ 3,757,757     $ 3,738,843  
 
Short-term borrowings
    375,773       375,773       314,074       314,074  
Long-term debt
    604,140       603,516       714,784       718,384  
Unrecognized financial instruments:
                               
Loan commitments
          (824 )           (667 )
Standby letters of credit
          (98 )           (104 )
 
19.   CAPITAL RATIOS
The following table reflects various measures of capital at December 31, 2006 and December 31, 2005:
                                 
 
December 31,   2006   2005
(Dollars in thousands)   Amount   Ratio   Amount   Ratio
 
Total equity (1)
  $ 570,439       10.43 %   $ 558,430       10.27 %
Tier 1 capital (2)
    528,019       14.72 %     498,502       14.17 %
Total risk-based capital (3)
    573,216       15.98 %     543,000       15.43 %
Leverage (4)
    528,019       9.96 %     498,502       9.27 %
 
(1)   Stockholders’ equity including accumulated other comprehensive income (loss); computed as a ratio to total assets.
 
(2)   Stockholders’ equity less certain intangibles and accumulated other comprehensive income (loss); computed as a ratio to risk-adjusted assets as defined.
 
(3)   Tier 1 capital plus qualifying loan loss allowance; computed as a ratio to risk-adjusted assets, as defined.
 
(4)   Tier 1 capital computed as a ratio to average total assets less certain intangibles.
At December 31, 2006 and 2005, the Corporation’s tier 1 capital, total risk-based capital and leverage ratios were well above both the required minimum levels of 4.00%, 8.00% and 4.00%, respectively and the well-capitalized levels of 6.00%, 10.00% and 5.00%, respectively.
At December 31, 2006 and 2005, all of the Corporation’s subsidiary financial institutions met the well-capitalized levels under the capital definitions prescribed in the FDIC Improvement Act of 1991. The following table indicates the capital ratios for each subsidiary at December 31, 2006 and December 31, 2005.
                                                 
 
December 31   2006   2005
    Tier 1   Total           Tier 1   Total    
    Risk-   Risk-           Risk-   Risk-    
    Based   Based   Leverage   Based   Based   Leverage
 
Park National Bank
    8.11 %     10.76 %     5.84 %     7.65 %     10.41 %     5.44 %
Richland Trust Company
    9.44 %     10.70 %     5.47 %     9.76 %     11.02 %     5.76 %
Century National Bank
    8.69 %     10.44 %     5.57 %     8.91 %     11.36 %     5.65 %
First-Knox National Bank
    8.01 %     10.61 %     5.27 %     8.87 %     12.23 %     5.80 %
United Bank, N.A.
    10.89 %     12.15 %     5.37 %     10.82 %     12.07 %     5.64 %
Second National Bank
    8.39 %     10.64 %     5.39 %     9.27 %     12.64 %     5.63 %
Security National Bank
    9.18 %     10.76 %     5.45 %     9.42 %     13.78 %     5.35 %
Citizens National Bank
    14.58 %     15.83 %     7.24 %     11.86 %     17.29 %     5.60 %
 

59


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
20. SEGMENT INFORMATION
The Corporation’s segments are its banking subsidiaries. The operating results of the banking subsidiaries are monitored closely by senior management and each president of the subsidiary and division are held accountable for their results. Information about reportable segments follows. See Note 2 for a detailed description of individual banking subsidiaries.
                                                                                 
 
Operating Results for the year ended December 31, 2006 (In thousands)                                                                
                                                                    All    
    PNB   RTC   CNB   FKNB   UB   SNB   SEC   CIT   Others   Total
 
Net interest income
  $ 72,526     $ 18,493     $ 23,361     $ 30,755     $ 7,727     $ 12,034     $ 30,479     $ 5,383     $ 12,486     $ 213,244  
Provision for loan losses
    1,713       220       180       630       (130 )     155       235       125       799       3,927  
Other income
    27,858       4,672       8,498       7,772       2,218       2,333       9,051       1,709       651       64,762  
Depreciation and amortization
    1,790       433       866       689       245       299       779       221       200       5,522  
Other expense
    46,030       10,402       15,519       16,484       6,103       7,181       19,308       4,053       10,400       135,480  
 
Income before taxes
    50,851       12,110       15,294       20,724       3,727       6,732       19,208       2,693       1,738       133,077  
 
Federal income taxes
    16,486       4,123       5,145       7,010       1,190       2,027       6,291       839       (4,125 )     38,986  
 
Net income
  $ 34,365     $ 7,987     $ 10,149     $ 13,714     $ 2,537     $ 4,705     $ 12,917     $ 1,854     $ 5,863     $ 94,091  
 
Balances at December 31, 2006:
                                                                               
Assets
  $ 1,970,072     $ 534,142     $ 745,168     $ 778,864     $ 220,701     $ 397,602     $ 860,995     $ 162,498     $ (199,166 )   $ 5,470,876  
Loans
    1,368,125       245,694       511,684       521,111       92,843       227,337       446,110       58,254       9,544       3,480,702  
Deposits
    1,367,942       377,356       493,218       499,199       194,834       248,985       572,269       122,358       (50,627 )     3,825,534  
 
 
                                                                               
Operating Results for the year ended December 31, 2005 (In thousands)                                                        
Net interest income
  $ 71,227     $ 20,273     $ 27,599     $ 30,855     $ 8,606     $ 13,592     $ 30,811     $ 6,140     $ 11,461     $ 220,564  
Provision for loan losses
    2,611       700       150       1,127       (160 )     (510 )     1,005       (100 )     584       5,407  
Other income
    25,566       4,442       7,439       7,191       1,968       2,154       8,880       1,518       547       59,705  
Depreciation and amortization
    1,705       394       913       675       233       315       993       200       213       5,641  
Other expense
    43,622       10,226       15,155       16,156       6,026       7,238       18,665       4,701       12,008       133,797  
 
Income before taxes
    48,855       13,395       18,820       20,088       4,475       8,703       19,028       2,857       (797 )     135,424  
 
Federal income taxes
    15,924       4,553       6,356       6,739       1,449       2,674       6,231       929       (4,669 )     40,186  
 
Net income
  $ 32,931     $ 8,842     $ 12,464     $ 13,349     $ 3,026     $ 6,029     $ 12,797     $ 1,928     $ 3,872     $ 95,238  
 
Balances at December 31, 2005:
                                                                               
Assets
  $ 1,999,102     $ 506,198     $ 711,804     $ 753,288     $ 228,716     $ 392,257     $ 924,484     $ 173,190     $ (252,991 )   $ 5,436,048  
Loans
    1,247,105       266,293       503,278       507,148       96,232       203,638       439,698       58,611       6,109       3,328,112  
Deposits
    1,343,180       373,398       469,333       476,257       180,274       250,553       578,404       123,555       (37,197 )     3,757,757  
 
 
                                                                               
Operating Results for the year ended December 31, 2004 (In thousands)                                                        
Net interest income
  $ 63,050     $ 21,992     $ 19,725     $ 32,329     $ 10,074     $ 15,477     $ 31,939     $ 7,252     $ 10,453     $ 212,291  
Provision for loan losses
    3,230       735       965       1,695       320       (15 )     430       580       660       8,600  
Other income
    21,401       4,339       5,210       6,766       1,722       2,079       8,257       1,253       821       51,848  
Depreciation and amortization
    1,708       388       520       693       197       334       1,183       197       216       5,436  
Other expense
    36,827       10,549       11,413       15,995       6,071       7,282       18,649       4,284       9,784       120,854  
 
Income before taxes
    42,686       14,659       12,037       20,712       5,208       9,955       19,934       3,444       614       129,249  
 
Federal income taxes
    13,808       4,906       3,972       6,864       1,685       3,096       6,485       1,112       (4,186 )     37,742  
 
Net income
  $ 28,878     $ 9,753     $ 8,065     $ 13,848     $ 3,523     $ 6,859     $ 13,449     $ 2,332     $ 4,800     $ 91,507  
 
Balances at December 31, 2004:
                                                                               
Assets
  $ 1,662,200     $ 511,681     $ 782,393     $ 756,454     $ 236,658     $ 445,158     $ 917,084     $ 200,795     $ (99,839 )   $ 5,412,584  
Loans
    1,011,912       277,812       540,607       479,348       101,628       196,577       436,718       69,830       6,176       3,120,608  
Deposits
    1,182,804       386,652       530,082       488,748       182,578       262,271       571,580       131,873       (46,727 )     3,689,861  
 

60


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Reconciliation of financial information for the reportable segments to the Corporation’s consolidated totals.
 
                                                 
 
    Net Interest   Depreciation   Other   Income        
(In thousands)   Income   Expense   Expense   Taxes   Assets   Deposits
 
2006:
                                               
Totals for reportable segments
  $ 200,758     $ 5,322     $ 125,080     $ 43,111     $ 5,670,042     $ 3,876,161  
Elimination of intersegment items
                            (290,163 )     (50,627 )
Parent Co. and GFC totals — not eliminated
    12,486       49       10,400       (4,125 )     90,997        
Other items
          151                          
 
Totals
  $ 213,244     $ 5,522     $ 135,480     $ 38,986     $ 5,470,876     $ 3,825,534  
 
2005:
                                               
Totals for reportable segments
  $ 209,103     $ 5,428     $ 121,789     $ 44,855     $ 5,689,039     $ 3,794,954  
Elimination of intersegment items
                            (337,393 )     (37,197 )
Parent Co. and GFC totals — not eliminated
    11,461       62       12,008       (4,669 )     84,402        
Other items
          151                          
 
Totals
  $ 220,564     $ 5,641     $ 133,797     $ 40,186     $ 5,436,048     $ 3,757,757  
 
2004:
                                               
Totals for reportable segments
  $ 201,838     $ 5,220     $ 111,070     $ 41,928     $ 5,512,423     $ 3,736,588  
Elimination of intersegment items
                            (173,856 )     (46,727 )
Parent Co. and GFC totals — not eliminated
    10,453       65       9,784       (4,186 )     74,017        
Other items
          151                          
 
Totals
  $ 212,291     $ 5,436     $ 120,854     $ 37,742     $ 5,412,584     $ 3,689,861  
 
21. PARENT COMPANY STATEMENTS
The Parent Company statements should be read in conjunction with the consolidated financial statements and the information set forth below.
Investments in subsidiaries are accounted for using the equity method of accounting.
The effective tax rate for the Parent Company is substantially less than the statutory rate due principally to tax-exempt dividends from subsidiaries.
Cash represents noninterest bearing deposits with a bank subsidiary.
Net cash provided by operating activities reflects cash payments (received from subsidiaries) for income taxes of $5.345 million, $5.492 million and $4.386 million in 2006, 2005 and 2004, respectively.
At December 31, 2006 and 2005, stockholders’ equity reflected in the Parent Company balance sheet includes $127.1 million and $120.1 million, respectively, of undistributed earnings of the Corporation’s subsidiaries which are restricted from transfer as dividends to the Corporation.
Balance Sheets
at December 31, 2006 and 2005
                 
 
(In thousands)   2006   2005
 
Assets:
               
Cash
  $ 150,954     $ 45,043  
Investment in subsidiaries
    382,620       375,454  
Debentures receivable from subsidiary banks
    27,500       56,000  
Other investments
    1,504       1,738  
Dividends receivable from subsidiaries
          75,075  
Other assets
    56,259       52,195  
 
Total assets
  $ 618,837     $ 605,505  
 
Liabilities:
               
Dividends payable
  $ 12,947     $ 13,000  
Other liabilities
    35,451       34,075  
Total liabilities
    48,398       47,075  
Total stockholders’ equity
    570,439       558,430  
 
Total liabilities and stockholders’ equity
  $ 618,837     $ 605,505  
 
Statements of Income
for the years ended December 31, 2006, 2005 and 2004
                         
 
(In thousands)   2006   2005   2004
 
Income:
                       
Dividends from subsidiaries
  $ 89,500     $ 109,250     $ 83,000  
Interest and dividends
    7,107       6,553       6,461  
Other
    632       514       774  
 
Total income
    97,239       116,317       90,235  
 
Expense:
                       
Other, net
    8,307       10,096       8,199  
 
Total expense
    8,307       10,096       8,199  
 
Income before federal taxes and equity in undistributed earnings of subsidiaries
    88,932       106,221       82,036  
Federal income tax benefit
    4,985       5,503       4,791  
 
Income before equity in undistributed earnings of subsidiaries
    93,917       111,724       86,827  
 
Equity in undistributed earnings (losses) of subsidiaries
    174       (16,486 )     4,680  
 
Net income
  $ 94,091     $ 95,238     $ 91,507  
 

61


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Statements of Cash Flows
for the years ended December 31, 2006, 2005 and 2004
                         
 
(In thousands)   2006   2005   2004
 
Operating activities:
                       
Net income
  $ 94,091     $ 95,238     $ 91,507  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Undistributed (earnings) losses of subsidiaries
    (174 )     16,486       (4,680 )
Realized net investment security (gains) losses
    (97 )            
(Increase) decrease in dividends receivable from subsidiaries
    75,075       (48,675 )     25,500  
Increase in other assets
    (4,090 )     (5,138 )     (3,833 )
Increase in other liabilities
    1,378       1,408       3,689  
 
Net cash provided by operating activities
    166,183       59,319       112,183  
 
Investing activities:
                       
Cash paid for acquisition, net
    (9,052 )     (52,500 )     (43,645 )
Sales (purchases) of investment securities
    403       (521 )     277  
Capital contribution to subsidiary
    (2,000 )     (8,000 )      
Repayment of debentures receivable from subsidiaries
    28,500              
 
Net cash provided by (used in) investing activities
    17,851       (61,021 )     (43,368 )
 
Financing activities:
                       
Cash dividends paid
    (51,470 )     (51,498 )     (48,231 )
Proceeds from issuance of common stock
    42       117       144  
Cash payment for fractional shares
    (5 )     (3 )     (252 )
Purchase of treasury stock, net
    (26,690 )     (25,289 )     (16,376 )
 
Net cash used in financing activities
    (78,123 )     (76,673 )     (64,715 )
 
Increase (decrease) in cash
    105,911       (78,375 )     4,100  
Cash at beginning of year
    45,043       123,418       119,318  
 
Cash at end of year
  $ 150,954     $ 45,043     $ 123,418  
 

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