UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-31708

CAPITOL BANCORP LTD.

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: 14,742,591 shares outstanding as of October 20, 2004.

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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.

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CAPITOL BANCORP LIMITED

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CAPITOL BANCORP LIMITED

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CAPITOL BANCORP LTD.

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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, 2004 are not necessarily indicative of the results to be expected for the year ending December 31, 2004.

     The consolidated balance sheet as of December 31, 2003 was derived from audited consolidated financial statements as of that date. Certain 2003 amounts have been reclassified to conform to the 2004 presentation.

Note B – Implementation of New Accounting Standard

     FASB Interpretation No. 46, Consolidation of Variable Interest Entities, (as revised December 2003—FIN 46(R)), clarifies when some entities previously not consolidated under prior accounting guidance, should be. In some instances, it also requires certain previously consolidated entities to be deconsolidated. FIN 46(R) is effective for periods ending after December 15, 2003 for special purpose entities and for periods ending after March 15, 2004 for other types of variable interest entities that are not defined as special purpose entities. Implementation of this new guidance required Capitol to deconsolidate (or exclude) its trusts which issued trust-preferred securities effective March 31, 2004 and report the underlying subordinated debentures as debt obligations on Capitol’s consolidated balance sheet at that date and thereafter.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - Continued

     Note C – Stock Options

     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:

     Stock option activity for the interim 2004 period is summarized as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - Continued

Note C – Stock Options – Continued

     As of September 30, 2004, 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:

Note D – Net Income Per Share

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - Continued

Note E – Acquisition of Bank

     Effective April 1, 2004, Capitol acquired First Carolina State Bank (First Carolina) located in Rocky Mount, North Carolina, in a purchase transaction with total consideration approximating $10 million. Approximately half of the consideration was paid in cash and the remainder consisted of approximately 183,000 previously unissued shares of Capitol’s common stock. At March 31, 2004, First Carolina’s total assets approximated $61.7 million. Capitol’s acquisition of First Carolina was accounted for under the purchase-method of accounting and its results of operations are included in Capitol’s consolidated financial statements for periods after the effective date of the acquisition. Goodwill of approximately $4 million was recorded in conjunction with this transaction and will not be amortized, but will be reviewed at least annually for impairment. Had this transaction occurred at the beginning of the periods presented, net income would have approximated $18.4 million ($1.23 per diluted share) and $17.3 million ($1.32 per diluted share) for the nine months ended September 30, 2004 and 2003, respectively.

Note F – Share Exchange Transactions

     A share exchange transaction regarding First California Northern Bancorp was completed effective August 31, 2004. A similar share exchange transaction regarding Sunrise Bank of San Diego was completed effective May 31, 2004. In each transaction, the shares acquired from shareholders other than Capitol were exchanged for Capitol’s common stock according to a fixed, but differing, exchange ratio. In total, Capitol issued approximately 347,000 shares of previously unissued common stock resulting from these share exchanges (for aggregate consideration approximating $8.7 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 $19.0 million ($1.25 per diluted share) and $17.2 million ($1.30 per diluted share) for the nine months ended September 30, 2004 and 2003, respectively.

     Sunrise Bank of San Diego and First California Northern Bancorp were previously included in Capitol’s consolidated financial statements. The carrying value of assets and liabilities of the entities closely approximated the fair value at the date of the share exchanges. Additionally, goodwill of approximately $4 million was recorded in conjunction with the share exchanges and will not be amortized, but will be reviewed at least annually for impairment.

Note G – New Bank and Bank Development Activities

     Point Loma Community Bank, located in Point Loma (San Diego County), California opened in August 2004. It is majority-owned by First California Southern Bancorp, which is a majority-owned subsidiary of Capitol.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - Continued

Note G – New Bank and Bank Development Activities – Continued

     Bank development efforts are currently under consideration at September 30, 2004 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. During March 2004, Capitol completed the capitalization of Capitol Development Bancorp Limited II (CDBL II); CDBL II is substantially similar in structure and purpose to CDBL I which was formed in late 2003.

Note H – Impact of New Accounting Standards

     AICPA Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3), addresses the accounting for differences between contractual cash flows and cash flows expected to be collected from the initial investment in loans acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes such loans acquired in purchase business combinations and does not apply to loans originated by the entity. The SOP prohibits carrying over or creation of valuation allowances in the initial accounting for loans acquired in a transfer. It is effective for loans acquired in fiscal years beginning after December 15, 2004. The effects of this new guidance on Capitol’s consolidated financial statements will depend on future loan or debt securities acquisition activity, thus, its impact is not readily determinable.

     On March 31, 2004, the Financial Accounting Standards Board (FASB) issued a proposed statement, Share-Based Payment, that addresses the accounting for share-based payment transactions (for example, stock options and awards of restricted stock) in which an employer receives employee-services in exchange for equity securities of the company or liabilities that are based on the fair value of the company’s equity securities. This proposal, when finalized, would eliminate use of APB Opinion No. 25, Accounting for Stock Issued to Employees, and generally would require such transactions be accounted for using a fair-value-based method and recording compensation expense rather than optional pro forma disclosure of what expense amounts might be. The proposal, when approved, would substantially amend FASB Statement No. 123, Accounting for Stock-Based Compensation. Legislation has been introduced to substantially limit the FASB proposal. Uncertainty continues as to whether the proposal will be finalized and the FASB has recently announced some major proposed revisions to it, including material changes to the fair-value methodology, among other things. Currently, the most recent announcements suggest that this guidance may become effective for periods beginning after June 15, 2005 for public companies. Management has not completed its review of the proposal or assessed its potential impact on Capitol.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - Continued

Note H – Impact of New Accounting Standards – Continued

     In 2003, the Emerging Issues Task Force of the FASB (EITF) addressed an issue regarding how companies should account for longer-term declines in value (below cost) of investment securities which are classified as available-for-sale. In the EITF’s consensus, expanded disclosures of declines in market value (below cost) of one year or more are required. Further, this new guidance sought to define “other than temporary declines” in market value, as applied to available-for-sale investment securities, including when such declines should be recognized as if they are realized losses. In October 2004, the effective dates for the definitional guidance (and related loss recognition guidance) were postponed. Based on Capitol’s current investment portfolio, management does not expect this guidance will have a significant effect on Capitol’s financial statements upon implementation.

     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 $3.1 billion at September 30, 2004, an increase of $321 million from the December 31, 2003 level of $2.7 billion. The balance sheet includes Capitol and its consolidated subsidiaries:

(1)		Acquired effective April 1, 2004.
(2)		Commenced operations in August 2004 and is 51%-owned by First California Southern Bancorp, a majority-owned subsidiary of Capitol.

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     Portfolio loans increased during the nine-month 2004 period by approximately $361 million, compared to net loan growth of about $145 million during the corresponding period of 2003. Year-to-date loan growth includes the acquisition of First Carolina State Bank, effective April 1, 2004, which had portfolio loans totaling approximately $50 million at the acquisition date. Loan growth in the first quarter of 2004 approximated $100 million ($60 million in 2003). Second and third quarter 2004 loan growth approximated $114 million and $97 million, respectively, (excluding the second quarter impact of the First Carolina acquisition) compared to $32 million and $53 million in 2003. 2004 loan growth has been significant due to higher loan demand. The majority of portfolio loan growth occurred in commercial loans, consistent with the banks’ emphasis on commercial lending activities.

     The allowance for loan losses at September 30, 2004 approximated $37 million or 1.42% of total portfolio loans, which was slightly higher than the year-end 2003 ratio of 1.40%.

     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):

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     Net charge-offs of loans in the nine-month interim 2004 period decreased by approximately $350,000, compared to the corresponding 2003 period. The decrease was mainly due to less installment loan charge-offs and higher recoveries associated with commercial loans.

     The amounts of the allowance for loan losses allocated in the following table (in thousands) are based on management’s estimate of losses inherent in the portfolio at the balance-sheet date, 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) and other nonperforming assets are summarized below (in thousands):

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     Nonperforming loans at September 30, 2004 were 1.10% of total portfolio loans, a significant improvement from the corresponding period in 2003 of 1.48%. Nonperforming loans increased 7.2% or $1.9 million during the nine-month period ended September 30, 2004. Of the nonperforming loans at September 30, 2004, about 67% were 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 were generally secured by other business assets. Nonperforming loans at September 30, 2004 were 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 internal 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, 2004, potential problem loans (including the previously mentioned nonperforming loans) approximated $119 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 identified 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 provisions for loan losses in the interim 2004 period.

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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):