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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003

OR

( ) TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from                   to                  

Commission file number 33-24728C

CAPITOL BANCORP LTD.
(Exact name of registrant as specified in its charter)

Capitol Bancorp Center
200 Washington Square North, Lansing, Michigan
(Address of principal executive offices)
48933
(Zip Code)
(517) 487-6555
(Registrant’s telephone number)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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

         Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b of the Act). Yes   X   No        

APPLICABLE ONLY TO CORPORATE ISSUERS:

        Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

       Common stock, No par value: 13,674,401 shares outstanding as of October 31, 2003.

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INDEX

PART I. FINANCIAL INFORMATION

Forward-Looking Statements

Certain of the statements contained in this document, including Capitol’s consolidated financial statements, Management’s Discussion and Analysis of Financial Condition and Results of Operations and in documents incorporated into this document by reference that are not historical facts, including, without limitation, statements of future expectations, projections of results of operations and financial condition, statements of future economic performance and other forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, are subject to known and unknown risks, uncertainties and other factors which may cause the actual future results, performance or achievements of Capitol and/or its subsidiaries and other operating units to differ materially from those contemplated in such forward-looking statements. The words “intend”, “expect”, “project”, “estimate”, “predict”, “anticipate”, “should”, “believe”, and similar expressions also are intended to identify forward-looking statements. Important factors which may cause actual results to differ from those contemplated in such forward-looking statements include, but are not limited to: (i) the results of Capitol’s efforts to implement its business strategy, (ii) changes in interest rates, (iii) legislation or regulatory requirements adversely impacting Capitol’s banking business and/or expansion strategy, (iv) adverse changes in business conditions or inflation, (v) general economic conditions, either nationally or regionally, which are less favorable than expected and that result in, among other things, a deterioration in credit quality and/or loan performance and collectability, (vi) competitive pressures among financial institutions, (vii) changes in securities markets, (viii) actions of competitors of Capitol’s banks and Capitol’s ability to respond to such actions, (ix) the cost of capital, which may depend in part on Capitol’s asset quality, prospects and outlook, (x) changes in governmental regulation, tax rates and similar matters, and (xi) other risks detailed in Capitol’s other filings with the Securities and Exchange Commission. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated. All subsequent written or oral forward-looking statements attributable to Capitol or persons acting on its behalf are expressly qualified in their entirety by the foregoing factors. Investors and other interested parties are cautioned not to place undue reliance on such statements, which speak as of the date of such statements. Capitol undertakes no obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of unanticipated events.

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PART I, ITEM I

CAPITOL BANCORP LTD.
Consolidated Balance Sheets
As of September 30, 2003 and December 31, 2002

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CAPITOL BANCORP LIMITED
Consolidated Statements of Income (Unaudited)
For the Three Months and Nine Months Ended September 30, 2003 and 2002
(in thousands, except per share data)

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CAPITOL BANCORP LIMITED
Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
For the Nine Months Ended September 30, 2003 and 2002
(in thousands except share data)

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CAPITOL BANCORP LTD.
Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2003 and 2002

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD.

Note A – Basis of Presentation

        The accompanying unaudited condensed consolidated financial statements of Capitol Bancorp Ltd. (“Capitol”) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q. Accordingly, they do not include all information and footnotes necessary for a fair presentation of consolidated financial position, results of operations and cash flows in conformity with generally accepted accounting principles.

        The statements do, however, include all adjustments of a normal recurring nature (in accordance with Rule 10-01(b)(8) of Regulation S-X) which Capitol considers necessary for a fair presentation of the interim periods.

        The results of operations for the period ended September 30, 2003 are not necessarily indicative of the results to be expected for the year ending December 31, 2003.

        The consolidated balance sheet as of December 31, 2002 was derived from audited consolidated financial statements as of that date. Certain 2002 amounts have been reclassified to conform to the 2003 presentation.

Note B – Implementation of New Accounting Standard

        Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, clarifies how some instruments or securities should be classified on an issuer’s balance sheet and their related impact on income and results of operations. It is effective for Capitol’s consolidated financial statements beginning July 1, 2003. Implementation of this new standard resulted in the reclassification of Capitol’s trust-preferred securities from their prior “mezzanine” classification (between liabilities and equity) to part of debt obligations on Capitol’s consolidated balance sheet. Although trust-preferred securities are now classified for balance-sheet purposes as debt securities, they continue to be treated as an element of capital for regulatory purposes. Trust-preferred securities outstanding at December 31, 2002 have been similarly reclassified in the accompanying balance sheet for comparative purposes. This new standard had no impact on Capitol’s results of operations upon implementation.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. — Continued

Note C – Bank Development Activities

        Bank development efforts are currently under consideration at September 30, 2003 in several states including pre-development exploratory discussions, lease and employment negotiations and preparation of preliminary regulatory applications for formation and/or acquisition of community banks. On October 14, 2003, Capitol announced the opening of its 30^th bank affiliate, Bank of Escondido, located in San Diego County, California.

Note D – Share Exchange Transactions

        Share exchange transactions regarding Black Mountain Community Bank, Desert Community Bank, Elkhart Community Bank and Red Rock Community Bank were completed effective July 31, 2003. In each transaction, the shares acquired from shareholders other than Capitol were exchanged for Capitol’s common stock according to fixed, but differing, exchange ratios. Capitol issued approximately 982,000 shares of its common stock resulting from these share exchanges, for aggregate consideration approximating $20 million. These transactions have been recorded using the purchase-method of accounting. Had these transactions occurred at the beginning of the periods presented, net income would have approximated $17.4 million ($1.28 per diluted share) and $12.0 million ($1.08 per diluted share) for the nine months ended September 30, 2003 and 2002, respectively.

        Black Mountain, Desert, Elkhart and Red Rock were previously included in Capitol’s consolidated financial statements. The carrying value of assets and liabilities of those entities closely approximated their fair values at the date of the share exchanges. Additionally, goodwill of approximately $5.8 million was recorded in conjunction with the share exchanges and will not be amortized, but will be reviewed at least annually for impairment.

        As of September 30, 2003, potential share exchange transactions were in the proposal stage regarding the minority interests of Arrowhead Community Bank, Goshen Community Bank, Sunrise Bank of Albuquerque and Yuma Community Bank which, if completed, would result in Capitol issuing approximately 300,000 additional shares of common stock and those majority-owned subsidiaries becoming wholly-owned. Such proposed share exchanges are subject to the separate approval of the minority shareholders of those banks and other contingencies.

8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. — Continued

Note E – Net Income Per Share

        The computations of basic and diluted earnings per share were as follows:

Note F – Stock Options

        Stock option activity for the interim 2003 period is summarized as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. — Continued

Note F – Stock Options – Continued

        As of September 30, 2003, stock options outstanding had a weighted average remaining contractual life of 4.7 years. The following table summarizes stock options outstanding segregated by exercise price range:

        Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, establishes an alternative fair value method of accounting for stock options whereby compensation expense would be recognized based on the computed fair value of the options on the grant date. By not electing this alternative, certain pro forma disclosures of the expense recognition provisions of Statement No. 123 are required, which are as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. — Continued

Note G – Impact of New Accounting Standards

        The Financial Accounting Standards Board (FASB) recently issued Statements No. 146 (Accounting for Costs Associated With Exit or Disposal Activities) and No. 149 (Amendment of Statement 133 on Derivative Instruments and Hedging Activities). These new standards have varying effective dates in 2003 and had no material effect on Capitol’s financial statements, upon implementation.

        Statement No. 148, Accounting for Stock-Based Compensation–Transition and Disclosure, provides alternative methods of transition for a voluntary change to the fair-value based method of accounting for stock-based employee compensation and it amends the prior disclosure requirements of Statement No. 123 to require more prominent and frequent disclosures about the effects of stock-based compensation, including interim disclosures (such interim disclosures appear in Note F). As permitted, Capitol has retained its prior method of accounting for stock-based employee compensation.

        FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others, expands disclosures about obligations under certain guarantees and, in addition, requires recording a liability for the fair value of the obligations undertaken in issuing the guarantee, applicable to guarantees issued or modified after December 31, 2002. This new guidance had no material effect on Capitol’s consolidated financial position or results of operations upon implementation.

        FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46), clarifies when some entities previously not consolidated under prior accounting guidance, should be. FIN 46 applies immediately to variable interest entities created after January 31, 2003. The FASB deferred the implementation of FIN 46 relating to potential variable interest entities that existed prior to February 1, 2003 until the end of the first interim or annual period ending after December 15, 2003. Capitol is evaluating the impact of FIN 46 and believes that it will not have a material impact on its consolidated financial position or results of operations upon implementation. It is Capitol’s understanding that the issuance of Statement No. 150 (see Note B) and FIN 46 has resulted in the Federal Reserve Board announcing potential future reconsideration of trust-preferred securities as elements of regulatory capital.

        A variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to Capitol’s consolidated financial statements.

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PART I, ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

Financial Condition

        Total assets approximated $2.7 billion at September 30, 2003, an increase of $241 million from the December 31, 2002 level of $2.4 billion. The balance sheet includes Capitol and its consolidated subsidiaries:

        Effective July 31, 2003, four previously 51%-owned bank subsidiaries became wholly-owned as a result of share exchange transactions which are discussed later in this narrative. The acquisitions of these minority interests did not have a material impact on Capitol’s financial position or results of operations for the interim 2003 period.

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        Portfolio loans increased during the nine-month 2003 period by approximately $145 million. The majority of portfolio loan growth occurred in commercial loans, consistent with the banks’ emphasis on commercial lending activities. Portfolio loan growth in 2003 is net of about $59 million of commercial loans sold to other financial institutions.

        The allowance for loan losses at September 30, 2003 approximated $31 million or 1.43% of total portfolio loans, a decrease from the year-end 2002 ratio of 1.45%.

        The allowance for loan losses is maintained at a level believed adequate by management to absorb potential losses inherent in the loan portfolio at the balance sheet date. Management’s determination of the adequacy of the allowance is based on evaluation of the portfolio (including potential impairment of individual loans and concentrations of credit), past loss experience, current economic conditions, volume, amount and composition of the loan portfolio, loan commitments outstanding and other factors. The allowance is increased by provisions charged to operations and reduced by net charge-offs.

        The table below summarizes portfolio loan balances and activity in the allowance for loan losses for the interim periods (in thousands):

        Net charge-offs of loans in the interim 2003 period increased approximately $1 million, compared to the corresponding 2002 period. The increase was mainly due to losses associated with loans secured by business equipment and accounts receivable.

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        The amounts of the allowance for loan losses allocated in the following table (in thousands) include all loans for which, based on Capitol’s loan rating system, management has concerns, and should not be interpreted as an indication of future charge-offs.

        Nonperforming loans (i.e., loans which are 90 days or more past due and loans on nonaccrual status) are summarized below (in thousands):

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        Nonperforming loans increased approximately $9 million during the nine-month period ended September 30, 2003. Of the nonperforming loans at September 30, 2003, about 65% are real estate secured. Those loans, when originated, had appropriate loan-to-value ratios and, accordingly, have loss exposure which is expected to be minimal; however, underlying real estate values depend upon current economic conditions and liquidation strategies. Most other nonperforming loans are generally secured by other business assets. Nonperforming loans at September 30, 2003 are in various stages of resolution for which management believes such loans are adequately collateralized or otherwise appropriately considered in its determination of the adequacy of the allowance for loan losses.

        In addition to the identification of nonperforming loans involving borrowers with payment performance difficulties (i.e., nonaccrual loans and loans past-due 90 days or more), management utilizes an internal loan review process to identify other potential problem loans which may warrant additional monitoring or other attention. This loan review process is a continuous activity which periodically updates internal loan ratings. At inception, all loans are individually assigned a rating which grades the credits on a risk basis, based on the type and discounted value of collateral, financial strength of the borrower and guarantors and other factors such as nature of the borrower’s business climate, local economic conditions and other subjective factors. The loan rating process is fluid and subjective.

        Potential problem loans include loans which are generally performing as agreed; however, because of loan review’s and/or lending staff’s risk assessment, increased monitoring is deemed appropriate. In addition, some loans are assigned a more adverse classification, with specific performance issues or other risk factors requiring close management and development of specific remedial action plans.

        At September 30, 2003, potential problem loans (including the previously mentioned nonperforming loans) approximated $114 million, or about 5% of total consolidated portfolio loans. These potential problem loans do not necessarily have significant loss exposure (nor are they necessarily deemed ‘impaired’), but rather are classified by management in this manner to aid in loan administration and risk management. Management believes such loans to be adequately considered in its evaluation of the adequacy of the allowance for loan losses. Management believes, however, that current general economic conditions may result in higher levels of future loan losses, in comparison to previous years, as evidenced by higher loan losses in the interim 2003 period.

        Other real estate (included as a component of other assets), comprises properties acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure, approximated $3.8 million at September 30, 2003, a decrease of $800,000 from the beginning of the year level of $4.6 million.

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        The following comparative analysis summarizes each bank’s total portfolio loans, allowance for loan losses, nonperforming loans and ratio of the allowance as a percentage of portfolio loans (dollars in thousands):

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Results of Operations

        Net income for the nine months ended September 30, 2003 was $17 million, an increase of $5.7 million or 50% over the same period in 2002. Diluted earnings per share for the nine-month 2003 period were $1.33 compared to $1.12 for the prior year period. Third quarter 2003 earnings were a new record level, $6 million, an increase of $1.6 million over the same period in 2002; diluted earnings per share were $0.44 compared to $0.40 in 2002. The percentage increase in net income per share was less than the percentage increase in the amount of net income in 2003 because of the larger share base resulting primarily from Capitol’s share exchanges in 2003 and 2002.

        Net interest income for the first nine months of 2003 totaled $84.4 million, a 15% increase compared to $73.4 million in 2002. Net interest income for the third quarter of 2003 totaled $29.4 million, a 12% increase as compared to $26.2 million for the comparable period in 2002. This increase is attributable to the banks’ growth in size and a relatively stable interest rate environment.

        Noninterest income for the nine months ended September 30, 2003 was $15.2 million, an increase of $4.8 million, or 46%, over the same period in 2002. Noninterest income for the three months ended September 30, 2003 was $5.4 million, an increase of $1.3 million, or 31%, over the same period in 2002. Fees from origination of nonportfolio residential mortgage loans totaled $2.6 million for the third quarter of 2003, and were $7.5 million for the nine-month period, as compared to $2 million and $4.4 million for the comparable periods in 2002, respectively, due to continuing high volume of loan fees derived from residential mortgage loan refinance activity resulting from record low interest rates; however, interest rates have recently risen which may adversely impact this revenue source in future periods. Service charges on deposit accounts for the nine-month 2003 period increased by 8%, compared to 2002, due to growth in the size of banks.

        The provision for loan losses for the nine-month period in 2003 was $6.6 million, as compared to $8.7 million for the same period in 2002. The provision for loan losses for the quarter ended September 30, 2003 was $2.9 million as compared to $3.9 million during the corresponding 2002 period. The provisions for loan losses are based upon management’s analysis of the adequacy of the allowance for loan losses, as previously discussed.

        Noninterest expense totaled $65.5 million for the nine-month period and $22.4 million for the third quarter in 2003, as compared to $56.8 million and $18.9 million, respectively, for the comparable periods in 2002. The increase in noninterest expense is associated with growth in the size of the banks and increases in general operating costs. Increases in both occupancy and salaries and employee benefits relate primarily to the growth in the size of banks within the consolidated group. Other noninterest expense in the 2002 period included the preopening costs of two start-up banks which commenced operations in the first quarter of the year (none in the interim 2003 period).

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        Operating results (dollars in thousands) were as follows: