UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

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

For the transition period from ________________ to __________________

Commission file Number 000-10535

CITIZENS BANKING CORPORATION

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

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

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

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

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ Noo

The aggregate market value of the voting common stock held by non-affiliates of the Registrant as of June 30, 2004 was $1,315,664,541. For purposes of this computation, all officers, directors and 10% beneficial owners of the Registrant are assumed to be affiliates. Such determination should not be deemed an admission that such officers, directors and beneficial owners are, in fact, affiliates of the Registrant.

The number of shares outstanding of the Registrant’s no par value Common Stock as of February 28, 2005 was 43,250,191.

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DOCUMENTS INCORPORATED BY REFERENCE

Portions of Citizens Banking Corporation’s Proxy Statement for its annual meeting of shareholders to be held May 17, 2005 are incorporated by reference into Part III of this Annual Report on Form 10-K.

CITIZENS BANKING CORPORATION
2004 Annual Report on Form 10-K

TABLE OF CONTENTS

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PART I

ITEM 1. BUSINESS

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

GENERAL

Citizens Banking Corporation, incorporated in the State of Michigan in 1980, is a diversified banking and financial services company that is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Citizens provides a full range of banking and financial services to individuals and businesses through its subsidiaries Citizens Bank and F&M Bank. These services include checking, savings, and money market deposit accounts, business, personal, educational, residential, and commercial mortgage loans, other consumer-oriented financial services, such as IRA and Keogh accounts, lease financing for a variety of capital equipment for commerce and industry, and safe deposit and night depository facilities. Automated Teller Machines (“ATMs”), which provide 24-hour banking services to customers, are installed in many locations in the Corporation’s service areas. The Corporation participates in an interstate and international shared ATM network, which allows its customers to perform banking transactions from their checking, savings, or credit card accounts at ATMs in a multi-state and international environment. Among the services designed specifically to meet the needs of businesses are various types of specialized financing, treasury management services, and transfer/collection facilities. Citizens also provides wealth management services through Citizens Bank Wealth Management, N.A., and through affiliate trust departments of F&M Bank — Wisconsin and F&M Bank — Iowa.

Citizens operates in the following three principal business lines: Commercial Banking, Consumer Banking, and Wealth Management. A brief description of each follows:

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

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

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

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All three major business lines are involved in some form of lending activity. Lending involves credit risk which is controlled and monitored through active asset quality management, the use of lending standards, thorough review of potential borrowers. Active asset quality administration, including early problem loan identification and timely resolution of problems, further ensures appropriate management of credit risk and minimization of loan losses. The allowance for loan losses represents Citizens’ estimate of an amount adequate to provide for probable losses inherent in the loan portfolio. Citizens’ evaluation of the adequacy of the allowance for loan losses is based on management’s ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various loan classifications, current economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect potential credit losses. Credit risk management is discussed in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the captions “Critical Accounting Policies,” “Loan Portfolio” and “Nonperforming Assets” and under Notes 1 and 6 to the Consolidated Financial Statements.

During 2004, Citizens continued to focus on the expansion initiative in Oakland County, Michigan, one of the wealthiest counties in the nation, which it announced in the fourth quarter of 2003. In 2004, this initiative significantly added to Citizens’ Oakland County presence with the opening of two regional hub locations and four branch facilities and the hiring of 42 employees. As of December 31, 2004, Citizens has two regional hub locations, ten branches, four financial centers and 124 employees in Oakland County. The Oakland County expansion initiative has shown great success since being launched, as evidenced by a $203.7 million or 49.2% increase in total loans to $617.9 million as of December 31, 2004. Core deposits increased $65.5 million or 43.9% to $214.7 million for the same period. The Corporation intends to invest up to $22 to $32 million and may open as many as 7 to 10 branches over the next three years.

The Corporation is not dependent upon any single or limited number of customers, the loss of which would have a material adverse effect on the Corporation. No material portion of the business of the Corporation is seasonal.

GEOGRAPHIC LOCATIONS

As of December 31, 2004, Citizens conducts operations through 181 banking offices, private banking and financial center locations, and 185 ATM locations throughout Michigan, Wisconsin, and Iowa with 2,215 full-time equivalent employees. In Michigan, the primary market includes much of the lower peninsula of the state. In Wisconsin, the primary market areas are the Fox Valley region, extending from Green Bay to Appleton to Oshkosh, as well as northeastern and southwestern Wisconsin. In Iowa, the primary market area is the central region of the state.

RECENT TRANSACTIONS

Illinois Bank Sale

On August 5, 2004, Citizens completed the sale of its subsidiary bank, Citizens Bank-Illinois, N.A. (the “Illinois Bank”), to Metropolitan Bank Group, Inc. in a cash transaction valued at $26.3 million. The Illinois Bank was comprised of three branches with $173.2 million of assets, $78.5 million of loans and $155.3 million of deposits as of August 5, 2004. Citizens realized a pre-tax gain of $11.7 million on the transaction. The sale of the Illinois Bank generated a tax loss benefit because Citizens’ tax basis in the stock of the Illinois Bank was greater than the Illinois Bank’s sale price.

Prepayment of FHLB Advances and Issuance of New FHLB Debt

Citizens prepaid $235 million of high cost Federal Home Loan Bank (“FHLB”) advances during the third quarter of 2004. The after-tax effect of the prepayment penalties on the debt largely offset the gain on the sale of the Illinois Bank, resulting in a relatively neutral effect on earnings per share for the third quarter. Additionally, during the third quarter of 2004, Citizens issued $275 million of new FHLB fixed rate advances at approximately 150 basis points less than the retired debt. The improved structure and lower cost is expected to improve Citizens’ net interest margin and interest rate sensitivity and to offset the negative impact on future results of operations from the sale of the Illinois Bank.

Consolidation of Charters

On July 9, 2004, Citizens Banking Corporation announced that it had filed applications with the Federal Reserve Bank of Chicago and the State of Michigan Office of Financial and Insurance Services to consolidate its Michigan and Wisconsin subsidiary banks. Upon completion of the consolidation, F&M Bank – Wisconsin will become part of Citizens’ Michigan subsidiary bank. The resulting bank will be regulated as a State of Michigan, Federal Reserve member bank. Although the

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consolidation is not expected to have a significant effect on Citizens’ financial results, the consolidation of the charters will create a more efficient banking franchise by allowing the combined banks to operate as a single entity. The consolidation will eliminate the need for separate regulatory reporting and separate accounting and financial tracking by the two banks as well as allow the Corporation to make more efficient use of its capital due to having one less legal entity. The Federal Reserve Bank and State of Michigan approved the consolidation in October 2004 and agreed to extend the approval 90 days to February 2005. The consolidation date is planned for April 25, 2005 so Citizens has applied for another 90 day extension, which is expected to be approved. In January 2005, Citizens began notifying its Wisconsin clients of the consolidation and the rebranding of all 53 F&M Bank – Wisconsin locations to Citizens Bank. The F&M Bank – Iowa franchise was not included in the consolidation at this time because of several complex legal and regulatory issues that exist in the State of Iowa. The Corporation intends to re-brand F&M Bank – Iowa to Citizens Bank either in late 2005 or in 2006.

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

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

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

At December 31, 2004, Citizens directly or indirectly owned the following subsidiaries:

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

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

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FHLMC and FNMA are done under terms that do not provide for any material recourse to Citizens by the investor. Citizens does not retain any interest in these securitized mortgage loans.

PRINCIPAL SOURCES OF REVENUE

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

LINES OF BUSINESS

Citizens’ performance is monitored by an internal profitability measurement system that provides line of business results and key performance measures. Citizens operates along three major business lines: Commercial Banking, Consumer Banking and Wealth Management. Additional information regarding the business lines is incorporated herein by reference from “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations — Line of Business Results” and in Note 20 of the Consolidated Financial Statements..

COMPETITION

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

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

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

Other factors such as employee relations and environmental laws also impact the Corporation’s competitiveness. Citizens maintains a favorable relationship with its employees and none of the employees are represented by a collective bargaining group. The impact of environmental laws is further discussed in “Item 3. Legal Proceedings” of this document.

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SUPERVISION AND REGULATION

General

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

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

Citizens’ subsidiary banks are subject to the provisions of the banking laws of their respective states of organization or the National Bank Act. They are under the supervision of, and are subject to periodic examination by, their respective state banking departments (in the case of state-chartered banks) or the Office of the Comptroller of the Currency (“OCC”) (in the case of national banks), and are subject to the rules and regulations of the OCC, the Federal Reserve Board and the Federal Deposit Insurance Corporation (“FDIC”). Citizens Bank (the Corporation’s principal bank subsidiary), F&M Bank-Wisconsin and F&M Bank-Iowa are state-chartered banks and are therefore subject to supervision, regulation and examination by the Michigan Office of Financial and Insurance Services, the Wisconsin Department of Financial Institutions and the Iowa Division of Banking, respectively, as well as by the Federal Reserve Board. Citizens Bank Wealth Management, N.A., a national non-depository trust bank, is subject to supervision, regulation and examination by the OCC. All of the depository banks are subject to supervision and examination by the FDIC, because the FDIC insures their deposits to the extent provided by law. In addition, all of the banks are members of the Federal Reserve System. The non-bank subsidiaries are supervised and examined by the Federal Reserve Board and various other federal and state agencies.

Consistent with the requirements of the Bank Holding Company Act, the Corporation’s only lines of business consist of providing its customers with banking, trust and other financial services and products. These services include commercial banking through three subsidiary banks, as well as trust services, mortgage origination and servicing, equipment leasing, brokerage and investment advisory services, property and casualty insurance brokerage services, life insurance and annuity products, title insurance, and portfolio management services for the majority of F&M Bank - Wisconsin’s investment portfolio all through subsidiary banks and other subsidiaries.

Regulations governing the Corporation and its subsidiary depository institutions restrict extensions of credit by such institutions to the Holding Company and, with some exceptions, to other affiliates. For these purposes, extensions of credit include loans and advances to and guarantees and letters of credit on behalf of Citizens and such affiliates. These regulations also restrict investments by the Corporation’s depository institution subsidiaries in the stock or other securities of the Holding Company and the covered affiliates, as well as the acceptance of such stock or other securities as collateral for loans to any borrower, whether or not related to Citizens.

Citizens insured depository institution subsidiaries are subject to comprehensive federal and state regulations dealing with a wide variety of subjects, including capital and reserve requirements, loan limitations, restrictions as to interest rates on loans and deposits, restrictions as to dividend payments, requirements governing the establishment of branches and numerous other aspects of their operations. These regulations generally have been adopted to protect depositors and creditors rather than shareholders or holders of subordinated debt. Information concerning capital adequacy guidelines for Citizens and its banking subsidiaries including their regulatory capital position at December 31, 2004 and maintenance of minimum average reserve balances by the banking subsidiaries with the Federal Reserve Bank is incorporated herein by reference from “Item 7

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- Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the captions “Capital Resources” and “Liquidity and Debt Capacity” and Note 21 to the Consolidated Financial Statements.

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

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

Payment of Dividends

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

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

In each of the years ended December 31, 2004, 2003 and 2002, Citizens’ subsidiaries paid cash dividends of $49.0 million, $24.0 million and $90.5 million, respectively. As of January 1, 2005, Citizens’ banking subsidiaries were able to distribute dividends of $64.0 million without further regulatory approval.

FDICIA

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

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

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

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

•	prohibiting the payment of principal and interest on subordinated debt;

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

•	placing limits on asset growth and restrictions on activities;

•	placing additional restrictions on transactions with affiliates;

•	restricting the interest rate the institution may pay on deposits;

•	prohibiting the institution from accepting deposits from correspondent banks; and

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

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

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

At December 31, 2004 and 2003, the most recent notification from the Federal Reserve Board categorized Citizens and all of its depository institution subsidiaries as “well capitalized” under the regulatory framework for prompt corrective action.

FDIC Insurance Assessments

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

The adjusted assessment rates for FDIC-insured institutions currently range from 0.00% to 0.27% depending on the assessment category into which a bank is placed. Citizens did not pay any regular insurance assessments to the FDIC in 2002. However, beginning July 1, 2003 and continuing throughout 2004, the Wisconsin bank subsidiary was required to pay an annualized assessment rate of ..03% to the FDIC for deposit insurance. Effective January 1, 2005, the Wisconsin bank is no longer required to pay the assessment. Additionally, Citizens does not expect that any other of its bank subsidiaries will pay significant insurance assessments in 2005. However, the FDIC retains the ability to increase regular insurance assessments and to levy special additional assessments.

Interstate Banking

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

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Transactions with Affiliates

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

Loans to Insiders

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

Community Reinvestment Act

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

Fair Lending and Consumer Laws

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

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

Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act, require compliance by depository

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institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of certain loans to customers.

Gramm-Leach-Bliley Act of 1999

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

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

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

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

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

USA Patriot Act of 2001

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

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laundering compliance and due diligence programs that include, among other things, the designation of a compliance officer, employee training programs and an independent audit function to review and test the program.

ECONOMIC FACTORS AND MONETARY POLICY

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

ENVIRONMENTAL MATTERS

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

Directors and Executive Officers of the Holding Company

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

Board of Directors

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Executive Officers

ITEM 2. PROPERTIES

Citizens’ executive offices are located at 328 South Saginaw Street, Flint, Michigan in the main office building of Citizens Bank, the largest bank subsidiary. The bank subsidiaries operate through 181 branch and financial banking offices. Of these, 45 are leased and the remainder are owned and not subject to any material liens. Rent expense on the leased properties totaled $2.8 million in 2004. The banking offices are located in various communities throughout the states of Michigan, Wisconsin, and in parts of Iowa. At certain Citizens Bank locations a portion of the office buildings are leased to tenants. Additional information related to the property and equipment owned or leased by Citizens and its subsidiaries is incorporated herein by reference from Note 9 to the Consolidated Financial Statements.

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ITEM 3. LEGAL PROCEEDINGS

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

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

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

No matters were submitted during the fourth quarter of 2004 to a vote of security holders through the solicitation of proxies or otherwise.

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PART II

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

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

As of December 31, 2004, the approximate number of shareholders of the Holding Company’s common stock was 14,847. This number includes an estimate for individual participants in the security positions of certain shareholders of record. Record shareholders at December 31, 2004 totaled 6,349.

Information regarding cash dividends that the Holding Company has declared during the last two fiscal years is incorporated herein by reference from Item 8 — “Selected Quarterly Information.” Restrictions on the Holding Company’s ability to pay dividends are incorporated herein by reference from Note 21 to the Consolidated Financial Statements.

Equity Compensation Plan Information

Citizens’ has two stock option plans pursuant to which it grants performance-based stock options to employees, officers and directors. The Stock Compensation Plan (the “2002 Plan”) was approved by Citizens shareholders in 2002. The All-Employee Stock Option Plan (the “All-Employee Plan”) was not submitted to Citizens shareholders for approval. The 2002 Plan replaced the Third Amended Stock Option Plan which has expired and Citizens Stock Option Plan for Directors which was terminated. Both of these plans were approved by Citizens shareholders and there continue to be options outstanding that were granted under these plans. The following table sets forth, with respect to all of the option plans, (i) the number of shares of common stock to be issued upon the exercise of outstanding options, (ii) the weighted average exercise price of outstanding options, and (iii) the number of shares remaining available for future issuance, as of December 31, 2004.

(1)

Issued under the All-Employee Plan. Under this plan, on May 18, 2000, Citizens granted stock options to all employees who did not receive grants under the then existing but since expired Third Amended Stock Option Plan. Each full-time employee received options for 200 shares of common stock and each part-time employee received options for 100 shares. The $16.66 exercise price of the grant was the market price of the common stock on the grant date. The options became exercisable three years after the date of grant. The options expire ten years from the date of grant. Options for a total of 550,700 shares were granted of which options for 103,400 shares were outstanding as of December 31, 2004. The plan provides that no further grants may be made under the plan.

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Issuer Repurchases of Equity Securities

(a) In October 2001, the Board of Directors approved the repurchase of up to 3,000,000 shares of common stock and in October 2003, the Board approved the repurchase of an additional 3,000,000 shares. There is no expiration date for the repurchase program. The stock repurchase program announced in October 2001 was completed on August 12, 2004. Citizens repurchased the shares at an overall average price of $28.56. As of December 31, 2004, 2,850,200 shares remain to be purchased under the current program. The purchase of shares is subject to limitations that may be imposed by applicable securities laws and regulations and the rules of the Nasdaq Stock Market. The timing of the purchases and the number of shares to be bought at any one time depend on market conditions and capital requirements. There can be no assurance that Citizens will repurchase the remaining shares authorized to be repurchased, or that any additional repurchases will be authorized by the Board of Directors.

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ITEM 6. SELECTED FINANCIAL DATA

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

The following presents management’s discussion and analysis of Citizens Banking Corporation’s financial condition and results of operations for each of the past three years and should be read in conjunction with the accompanying Consolidated Financial Statements and Notes. The discussion highlights the principal factors affecting earnings for the years 2004, 2003, and 2002 and the significant changes in balance sheet items from December 31, 2003 to December 31, 2004 and is intended to help the reader understand, from management’s perspective, the consolidated financial statements, notes to financial statements, and the accompanying tables, charts and financial statistics appearing elsewhere in this report. Where applicable, this discussion also reflects management’s insights regarding known events and trends that have or may reasonably be expected to have a material effect on the Corporation’s operations and financial condition.

Forward–Looking Statements

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

	•	Citizens faces the risk that loan losses, including unanticipated loan losses due to changes in loan portfolios, fraud and economic factors, will exceed the allowance for loan losses and that additional increases in the allowance will be required. Additions to the allowance would cause net income to decline and could have a negative impact on capital and financial position.
	•	While Citizens attempts to manage the risk from changes in market interest rates, interest rate risk management techniques are not exact. In addition, Citizens may not be able to economically hedge its interest rate risk. A rapid or substantial increase or decrease in interest rates could adversely affect net interest income and results of operations.
	•	An economic downturn, and the negative economic effects caused by terrorist attacks, potential attacks and other destabilizing events, would likely contribute to the deterioration of the quality of the loan portfolio and could reduce Citizens customer base, level of deposits, and demand for financial products such as loans.
	•	If Citizens is unable to continue to attract core deposits, cost of funds will increase, adversely affecting the ability to generate the funds necessary for lending operations, reducing net interest margin and negatively affecting results of operations.
	•	Increased competition with other financial institutions could reduce Citizens’ net income by decreasing the number and size of loans originated, the interest rates charged on these loans and the fees charged for services to customers.
	•	The financial services industry is undergoing rapid technological changes. If Citizens is unable to adequately invest in and implement new technology-driven products and services, it may not be able to compete effectively, or the cost to provide products and services may increase significantly.
	•	Citizens business may be adversely affected by the highly regulated environment in which it operates. Changes in banking or tax laws, regulations and regulatory practices at either the federal or state level may adversely affect the Corporation, including its ability to offer new products and services, obtain financing, dividend funds from the subsidiaries to the Holding Company, attract deposits, make loans and leases and achieve satisfactory spreads, and may also result in the imposition of additional costs.
	•	The products and services offered by the banking industry and customer expectations regarding them are subject to change. Citizens attempts to respond to perceived customer needs and expectations by offering new products and services, such as new wealth management capabilities, which are often costly to develop and market initially. A lack of market acceptance of these products and services would have a negative effect on Citizens’ results of operations.

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	•	New accounting pronouncements may be issued by the accounting profession, regulators or other government bodies which could change existing accounting methods. Changes in accounting methods could negatively impact Citizens’ results of operations and financial position.
	•	Citizens’ business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in or disruption to Citizens’ business and a negative impact on the results of operations.
	•	Citizens’ vendors could fail to fulfill their contractual obligations, resulting in a material interruption in, or disruption to, Citizens’ business and negatively impacting the results of operations.
	•	Citizens’ potential inability to integrate acquired operations or complete any restructuring could have a negative effect on Citizens’ expenses and results of operations.
	•	Citizens could face unanticipated environmental liabilities or costs related to real property owned or acquired through foreclosure. Compliance with federal, state and local environmental laws and regulations, including those related to investigation and clean-up of contaminated sites, may increase the Corporation’s capital costs and operating expenses.
	•	As a bank holding company that conducts substantially all of its operations through its subsidiaries, the ability of the Holding Company to pay dividends, repurchase its shares or to repay its indebtedness depends upon the results of operations of its subsidiaries and their ability to pay dividends to the Holding Company. Dividends paid by these subsidiaries are subject to limits imposed by federal and state law.

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

OVERVIEW

Nature of Citizens’ Business

Citizens is a diversified banking and financial services company that provides a full range of banking and financial services to individuals and businesses through its subsidiaries Citizens Bank and F&M Bank. The Corporation also provides wealth management services through Citizens Bank Wealth Management, N.A., and through affiliate trust departments of F&M Bank – Wisconsin and F&M Bank — Iowa. Citizens conducts operations through 181 banking offices, private banking and financial center locations, and 185 ATM locations throughout Michigan, Wisconsin, and Iowa.

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

The Corporation’s primary source of revenue is net interest income, which is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities, including interest-bearing deposits and borrowings used to fund those assets. Net interest income is affected by fluctuations in the amount and composition of earning assets and funding sources and in the yields earned and rates paid, respectively, on these assets and liabilities. The Corporation measures the level of interest income relative to earning assets and interest bearing liabilities through two statistics — interest spread and net interest margin. The interest spread represents the difference between yields on earning assets and the rates paid for interest-bearing liabilities. The net interest margin is expressed as the percentage of net interest income to average earning assets. A low interest rate environment, such as experienced in 2003 and 2004, has the effect of reducing the interest spread and net interest margin.

Proper management of the volume and composition of the Corporation’s earning assets and funding sources is essential for ensuring strong and consistent earnings performance, maintaining adequate liquidity and limiting exposure to risks caused by

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changing market conditions. Citizens’ investment securities portfolio is structured to provide a source of liquidity principally through the maturity of the securities held in the portfolio and to generate an income stream with relatively low levels of principal risk. Loans comprise the largest component of earning assets and are the highest yielding assets. Client deposits are the primary source of funding for earning assets while short-term debt and other managed sources of funds are utilized as market conditions and liquidity needs change.

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

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

Citizens net income can also be significantly affected by additions or reductions to the allowance for loan losses. Extending credit to businesses and consumers exposes Citizens to the risk that the principal balance of a loan and any related interest will not be collected. Citizens mitigates this credit risk through portfolio diversification that limits exposure to any single industry or customer and by establishing a comprehensive system of internal controls. The allowance for credit losses represents the estimate of probable losses inherent in the loan portfolio. The allowance is based on ongoing quarterly assessments of historical data and general economic factors, among other things, and is maintained at a level the Corporation considers adequate to absorb probable loan losses identified with specific customer relationships and probable losses believed to be inherent in the loan portfolio which have not been specifically identified. This evaluation process is inherently subjective, as it requires estimates that may be susceptible to significant change and have the potential to materially affect net income. In the event that Citizens overestimates future cash flows or underestimates losses on loan pools, the Corporation may be required to increase the provision for loan losses, which would have a negative impact on results of operations in the period in which the increase occurred. Certain economic indicators suggest that business spending has begun to increase and that business and consumer financial positions are improving in line with recent economic developments. While uncertainty exists as to how robust or sustainable this trend may be, the impact of such improvements would likely be positive to the Corporation’s credit quality indicators and could lead to a lower provision for loan losses in 2005 than in 2004.

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Performance Summary
An analysis of the major components of net income in 2004, 2003 and 2002 is presented below.

A comparative summary of key performance measures for 2004 versus 2003 follows.

Citizens recorded net income of $76.1 million or $1.74 per diluted share compared with net income of $66.0 million or $1.51 per diluted share for the same period of 2003, an increase of 15.4% in net income and 15.2% in diluted net income per share. Return on average assets and return on average equity for 2004 were 0.99% and 11.90%, respectively, compared to 0.86% and 10.43%, respectively, for 2003. Key factors behind these results were:

	•	Net interest income declined in 2004 $10.9 million to $275.3 million compared with the full year 2003 due to the decline in net interest margin percentage from 4.15% to 3.99%. Interest income decreased $23.0 million or 5.7% while interest expense decreased $12.1 million or 10.1%. The margin compression was due to Citizens slightly liability sensitive interest rate risk position, deposit mix shift toward products offering promotional rates and pricing spread compression on commercial loans. The commercial loan spread compression was due to competitive pressures, improved credit underwriting driving better credit quality than maturing loans booked prior to 2003 and continued reduction of exposure on credits not meeting Citizens risk parameters.
	•	Total average earning assets remained relatively unchanged for 2004 at $7.2 billion. Average total portfolio loans were also stable at $5.3 billion, with the strong growth in consumer loans throughout the entire year nearly offset the impact of the sale of the Illinois Bank and the decline in commercial loans. Although commercial loans declined for the first nine months, they displayed growth in the fourth quarter of 2004, substantially due to demand in the Oakland County market. Citizens retired $235 million of high cost FHLB debt during the third quarter of 2004 and replaced it with $275 million in lower-cost fixed rate debt. Total average deposits declined $289.9 million to $5.4 billion for 2004. The decline occurred largely within time deposits, reflecting Citizens’ less aggressive pricing

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		posture during the low interest rate environment. Core deposits, which exclude time deposits, grew by $94.5 million as a result of increases in noninterest bearing deposits and a new market rate savings product introduced in the fourth quarter of 2003.
	•	Loan loss provision expense decreased $41.9 million from 2003 due to a decline in nonperforming assets, lower net charge-offs, and fewer risk rating downgrades within the commercial loan portfolio. The decrease in nonperforming assets was the result of aggressive collection efforts, risk mitigation through reduction of exposure on credits not meeting Citizens’ risk parameters and, to a lesser extent, continued charge-off of nonperforming loans. Nonperforming assets decreased $26.2 million to $50.8 million or 0.94% of portfolio loans plus other repossessed assets acquired (“ORAA”) at December 31, 2004 from a year-end 2003 level of $77.0 million or 1.47% of portfolio loans plus ORAA. Total net charge-offs decreased $25.4 million in 2004 to $20.8 million or 0.40% of average portfolio loans outstanding compared to $46.2 million or 0.88% for 2003.
	•	Noninterest income increased $9.2 million or 9.7% to $104.1 million during the twelve month period ended December 31, 2004 compared with the same period of 2003. This increase was due to the $11.7 million pre-tax gain from the sale of the Illinois Bank, increased deposit service charge income, and gains on sale of closed bank premises, venture capital distributions, which partially offset lower mortgage income. Deposit service charges increased $5.2 million or 17.4% to $35.1 million compared with 2003 as a result of initiatives implemented over the last six quarters that improved fee waiver management as well as slight increases in certain fees. Remaining noninterest income categories increased $1.5 million for 2004 driven by gains on sale of closed bank premises and a venture capital investment distribution of $0.8 million related to investments made beginning in 1998. Mortgage and other loan income declined $8.4 million or 46.7% to $9.6 million compared with 2003. The decline in mortgage fees reflects the decrease in mortgage origination volume as compared to 2003, due to the increased refinance activity that occurred during 2003.
	•	Noninterest expense increased $29.8 million or 12.8% to $262.8 million compared with 2003 reflecting the impact of the $18.0 million prepayment penalty on $235 million of high cost FHLB advances and higher staff compensation and advertising expense. Salaries and benefits increased $6.8 million or 5.5% to $129.1 million compared with 2003 as a result of the Oakland County initiative and filling key staff positions during late 2003. Employee benefits increased due to higher pension and medical expenses. Advertising increased $3.4 million or 58.7% to $9.2 million compared with 2003 as a result of advertising to support the Oakland County initiative, deposit focused promotions, and the new brand introduction.
	•	Income tax expense remained relatively flat at $19.4 million in 2004 as compared to $19.2 million in 2003 even though pretax income increased $10.4 million. The 2004 effective tax rate was 20.3% compared to the 2003 effective tax rate of 22.5%. The key factors in this improvement were due to the sale of the Illinois Bank and the penalties related to the prepayment of FHLB advances. The sale of the Illinois Bank generated a tax loss benefit because Citizens tax basis in the stock of the Illinois Bank was greater than the Illinois Bank’s sale price.

CRITICAL ACCOUNTING POLICIES

Citizens’ Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles and follow general practices within the industry in which the Corporation operates. Application of these principles requires management to make estimates, assumptions, and complex judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Actual results could differ significantly from those estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates that are particularly susceptible to significant change include the determination of the allowance for loan losses, the benefit obligation and net periodic pension expense for employee pension and postretirement benefit plans, derivative financial instruments and hedging activities, and income taxes. Citizens believes that these estimates and the related policies discussed below are important to the portrayal of the Corporation’s financial condition and results. Therefore, management considers them to be critical accounting policies and discusses them directly with the Audit Committee of the Board of Directors. Citizens’ significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements.

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Allowance for Loan Losses

The allowance for loan losses represents Citizens’ estimate of probable losses inherent in the loan portfolio, the largest asset category on the consolidated balance sheet. Determining the amount of the allowance for loan losses is considered a critical accounting policy because it requires significant judgment and the evaluation of several factors: the ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, the size and diversity of individual large credits, and other qualitative and quantitative factors which could affect probable credit losses. These factors along with the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and allocation of reserves for special situations that are unique to the measurement period with consideration of current economic trends and conditions, all of which are susceptible to significant change, determine the amount of the allowance for loan losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly.

The Corporation’s allowance for possible loan loss methodology is based on guidance provided in SEC Staff Accounting Bulletin No. 102, “Selected Loan Loss Allowance Methodology and Documentation Issues” and includes allowance allocations calculated in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS 118, and allowance allocations determined in accordance with SFAS No. 5, “Accounting for Contingencies.” Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Corporation’s control, including the performance of the Corporation’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. See the section captioned “Allowance for Loan Losses” elsewhere in this discussion for further details of the risk factors considered by management in estimating the necessary level of the allowance for loan losses.

The Corporation’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with SFAS 114 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with SFAS 5 based on historical loan loss experience for similar loans with similar characteristics and trends; and (iii) general valuation allowances determined in accordance with SFAS 5 based on general economic conditions and other qualitative risk factors both internal and external to the Corporation.

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

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans at the time they were charged-off. The Corporation calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool.

The general valuation allowances are based on economic conditions and other qualitative risk factors both internal and external to the Corporation. Such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of Citizens’ lending management and staff; (ii) the effectiveness of the Corporation’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Citizens evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. The results are then input into a “general allocation matrix” to determine the appropriate range of general valuation allowances. Included in the general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits. Concentration risk guidelines have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships, and loans originated with policy exceptions. The general valuation allowances may also include estimates of inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information

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about a borrower’s financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors. In addition, the general valuation allowances include a component that explicitly accounts for the inherent imprecision in loan loss projection models. Many changes have occurred in the loan portfolio mix in recent years and as a result, historical loss experience data used to establish allocation estimates may not precisely correspond to the current portfolio. The uncertainty surrounding the strength and timing of economic cycles, including concerns over the effects of the prolonged economic downturn in the current cycle, also affects the allocation model’s estimates of loss. The historical losses used may not be representative of actual losses inherent in the portfolio that have not yet been realized.

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

In the event that management overestimates future cash flows or underestimates losses on loan pools, the Corporation may be required to increase the provision for loan losses, which would have a negative impact on the results of operations in the period in which the increase occurred. In the third quarter of 2002, Citizens experienced a significant increase in the allowance for loan losses due to elevated past-due and nonperforming loan levels, a weakened economy and enhancements to the loan loss allocation model, including the incorporation of more recent historical loss data in the determination of projected loss rates for pools of loans evaluated collectively and refinements to the internal risk rating system for commercial loans, which led to an increase in risk rating downgrades. Note 1 to the Consolidated Financial Statements describes the methodology used to determine the allowance for loan losses, and a discussion of the factors driving changes in the amount of the allowance for loan losses is included under “Provision and Allowance for Loan Losses.”

Pension and Postretirement Benefits

Pension liabilities are established and pension costs are charged to current operations based on actuarially determined present value calculations. The valuation of the pension obligation and net periodic pension expense is considered critical as it requires management to make estimates regarding the amount and timing of expected future cash outflows including assumptions about employee mortality, expected employee service periods, rate of employee compensation increases, assumed discount rate and the long-term return on plan assets. If Citizens were to determine that more conservative assumptions were necessary, costs would likely increase and have a negative impact on results of operations in the period in which the increase occurred. Note 13 to the Consolidated Financial Statements provides further discussion on the accounting for Citizens’ employee benefit plans and the estimates used in determining the actuarial present value of the benefit obligations and the net periodic pension expense. In 2004 and 2003, Citizens modified assumptions regarding the expected long-term rate of return and the assumed discount rate under its defined benefit pension plan, which will have a negative impact on future results. For a discussion of these changes and their expected impact on 2005 results, refer to “Noninterest Expense.” The expected rate of return was determined using long-term historical returns of the various investment categories weighted by target asset allocations. For more information on pension and postretirement benefits, see Note 13 of the Consolidated Financial Statements. The discount rate was derived from current market yields on long-term corporate bonds. The assumed discount rate is likely to change each year with fluctuations in market yields for long-term corporate bonds, while the expected long-term rate of return will likely exhibit less volatility.

Derivative Financial Instruments and Hedge Accounting

In various aspects of its business, the Corporation uses derivative financial instruments to modify its exposure to changes in interest rates and market prices for other financial instruments. Many of these derivative financial instruments are designated as hedges for financial accounting purposes. The application of Citizens’ hedge accounting policy requires judgment in the assessment of hedge effectiveness, identification of similar hedged item groupings, and measurement of changes in the fair value of hedged items. If in the future the derivative financial instruments identified as hedges no longer qualify for hedge accounting treatment, changes in the fair value of these hedged items would be recognized in current period earnings, and the impact on the consolidated results of operations and reported earnings could be significant. The Corporation believes hedge effectiveness is evaluated properly in the consolidated financial statements. For more information on derivative financial instruments and hedge accounting, see Notes 1 and 18 to the Consolidated Financial Statements.

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Stock-based Compensation

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

SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS 148, requires pro forma disclosures of net income and earnings per share for companies not adopting its fair value accounting method for stock-based employee compensation. The pro forma disclosures presented in Note 16 to the consolidated financial statements use the fair value method under SFAS 123 to measure compensation expense for stock-based employee compensation plans.

The Corporation expects to adopt the provisions of SFAS No. 123R, “Share-Based Payment (Revised 2004),” on July 1, 2005. Among other things, SFAS 123R eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the date of the grant. The Corporation will transition to fair value based accounting for stock-based compensation using a modified version of prospective application (“modified prospective application”). Under modified prospective application, as it is applicable to the Corporation, SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after July 1, 2005. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered (generally referring to non-vested awards) that are outstanding as of July 1, 2005 must be recognized as the remaining requisite service is rendered during the period of and/or the periods after the adoption of SFAS 123R. The attribution of compensation cost for those earlier awards will be based on the same method and on the same grant-date fair values previously determined for the pro forma disclosures required for companies that did not adopt the fair value accounting method for stock-based employee compensation. Based on the stock-based compensation awards outstanding as of December 31, 2004 for which the requisite service is not expected to be fully rendered prior to July 1, 2005, the Corporation expects to recognize additional pre-tax, quarterly compensation cost of approximately $1.0 million beginning in the third quarter of 2005 as a result of the adoption of SFAS 123R. Future levels of compensation cost recognized related to stock-based compensation awards (including the aforementioned expected costs during the period of adoption) may be impacted by new awards and/or modifications, repurchases and cancellations of existing awards before and after the adoption of this standard. See Note 2 to the consolidated financial statements for additional information.

Income Tax Accounting

Income tax liabilities or assets are established for the amount of taxes payable or refundable for the current year. Deferred tax liabilities and assets are also established for the future tax consequences of events that have been recognized in the Corporation’s financial statements or tax returns. A deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and carry forwards. The valuation of current and deferred tax liabilities and assets is considered critical as it requires management to make estimates based on provisions of the enacted tax laws. The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings. The Corporation believes its tax assets and liabilities are adequate and properly recorded in the consolidated financial statements. For more information regarding income tax accounting, see Notes 1 and 14 to the Consolidated Financial Statements.

RECENT ACCOUNTING PRONOUNCEMENTS

Note 2 to the Consolidated Financial Statements discusses new accounting policies adopted by Citizens during 2004 and 2003 and the expected impact of accounting policies recently issued or proposed but not yet required to be adopted. To the extent the adoption of new accounting standards materially affects Citizens’ financial condition, results of operations or liquidity, the impact is discussed elsewhere in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Notes 1, 2 and 7 to the Consolidated Financial Statements.

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RECENT DEVELOPMENTS

Oakland County Initiative

During 2004, Citizens continued to focus on the expansion initiative in Oakland County, Michigan, one of the wealthiest counties in the nation, which it announced in the fourth quarter of 2003. In 2004, this initiative significantly added to Citizens’ Oakland County presence with the opening of two regional hub locations and four branch facilities and the hiring of 42 employees. As of December 31, 2004, Citizens has 2 regional hub locations, ten branches, four financial centers and 124 employees in Oakland County. The Oakland County expansion initiative has shown great success since being launched, as evidenced by a $203.7 million or 49.2% increase in total loans to $617.9 million as of December 31, 2004. Core deposits increased $65.5 million or 43.9% to $214.7 million for the same period. The Corporation intends to invest up to $22 to $32 million and may open as many as 7 to 10 branches over the next three years.

Illinois Bank Sale

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

Prepayment of FHLB Advances and Issuance of New FHLB Debt

Citizens prepaid $235 million of high cost FHLB advances during the third quarter of 2004. The after-tax effect of the prepayment penalties on the debt largely offset the gain on the sale of the Illinois Bank, resulting in a relatively neutral effect on earnings per share for the third quarter. Additionally, during the third quarter of 2004, Citizens issued $275 million of new FHLB fixed rate advances at approximately 150 basis points less than the retired debt. The improved structure and lower cost is expected to improve Citizens’ net interest margin and interest rate sensitivity and to offset the negative impact on future results of operations from the sale of the Illinois Bank. The tax loss from the Illinois Bank sale along with lower pretax earnings resulting from the prepayment penalties of FHLB advances contributed toward reducing income tax expense for 2004.

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

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

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

Sale of Credit Card Portfolio

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

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Significant Developments in 2003 and 2002

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

During the fourth quarter of 2002 and the first quarter of 2003, Citizens experienced two unanticipated loan losses of $8.5 million and $11.5 million, respectively, resulting from collateral value shortfalls due to falsified borrowing base reports by the borrower. To reduce the risk of further unforeseen losses from similar collateral issues, the Corporation hired outside collateral auditors in 2003 to conduct field audits on all loans in excess of specific dollar thresholds. Citizens has since instituted regular audits of receivable and inventory collateral as a standard practice going forward. Refer to “Loan Origination/Risk Management” for further discussion.

In 2002, Citizens recorded a special charge of $13.4 million ($8.7 million after-tax) that included restructuring and impairment costs associated with reorganization of the Corporation’s consumer, commercial and wealth management lines of business. The reorganization resulted from a detailed review of consumer banking, commercial banking and wealth management areas by key members of management with assistance from industry consultants. This review revealed opportunities for process change, staff reassignment, reporting structure changes, branch closures, expense reduction and business growth. As a result of the reorganization, Citizens displaced 133 employees (157 employees less employees subsequently rehired for other available positions). Displaced employees were offered severance packages and outplacement assistance. As part of the restructuring initiatives, Citizens recognized a pension curtailment related to the early termination of certain officers’ employment earlier than expected. These pension benefits were provided under unfunded supplemental benefit plans. The curtailment resulted in a charge of $0.9 million for the accelerated recognition of their prior service cost and was recorded as a component of the $13.4 million special charge. Also, twelve banking offices were closed in the fourth quarter of 2002 and six additional offices were closed during the second quarter of 2003.

In the third quarter of 2002, Citizens also charged to earnings $9.4 million ($6.1 million after-tax) of other significant items considered unusual in nature. Net interest income was charged $0.7 million for premium amortization on mortgage-backed securities. Noninterest income was charged $1.6 million, which included market value adjustments of $0.7 million in an equity investment and $0.7 million to life insurance cash surrender values, and write-offs of $0.2 million for obsolete assets and $0.1 million for cash management fees accrued but not collectable. Noninterest expense was charged $7.1 million, comprised of a $3.3 million prepayment penalty on high cost FHLB debt, a $2.0 million contribution to Citizens charitable trust, a $1.0 million market valuation adjustment in other real estate, $0.4 million in additional depreciation on equipment to be retired early and $0.5 million in other items.

The aforementioned $0.7 million adjustment of the premium amortization on mortgage-backed securities in the third quarter of 2002 was the result of the Corporation’s quarterly review of prepayment assumptions. Low mortgage interest rate levels in 2002 resulted in an increase in prepayments and shortened the expected average life of these securities. Because the increase in prepayments was inconsistent with historical norms, the adjustment was determined to be unusual in nature.

The aforementioned equity investment market value write-down in 2002 relates to a venture capital partnership that specializes in financing technology companies. In the third quarter of 2002, Citizens received an accounting from the partnership showing significant write-downs in the carrying value of some of the investments in technology companies within the partnership due to their poor financial performance and the poor prospects of recovering some of these investments given the unfavorable market conditions for technology companies. As a result of these factors, Citizens reduced the book value of its investment in the partnership by $0.7 million from $1.1 million to $0.4 million and, because of the broad scope and degree of decline in the technology sector, determined the adjustment to be unusual in nature. This venture capital partnership has pursued a number of early stage investment opportunities in technology-driven businesses located in the Midwestern United States. One of the underlying business investments was sold to a New York-based buyout fund in 2004. As a result of this action, Citizens received a distribution of $0.8 million and recognized it as income during the third quarter of 2004.

The cash surrender value of separate-account life insurance policies is determined based upon the value of the underlying securities held in the policies. During the third quarter of 2002, the value of the underlying securities experienced a swift and

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significant decline due to the decrease in values in the equity markets. As a result, Citizens reduced the book value on these policies by $0.6 million from $2.2 million to $1.6 million, and considered the adjustment unusual due to the sharp and significant amount of the decline as a percent of the total cash surrender value of the policies.

In the second quarter of 2002, Citizens realized gains of $5.4 million on the sale of the merchant services business and $2.4 million on the sale of securitized mortgages.

RESULTS OF OPERATIONS

NET INTEREST INCOME

Table 2 presents net interest income, interest spread and net interest margin with average balances and related interest rates for the past three years.

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Net interest income was $275.3 million in 2004, down from $286.3 million in 2003 and $301.8 million in 2002. The decline in net interest income in 2004 was attributable to a 16 basis point decline in the net interest margin to 3.99% in 2004 compared with 4.15% in 2003. Average earning assets were nearly unchanged year over year as consumer loan growth offset the impact of the sale of the Illinois Bank, and declines in commercial and mortgage loans. Net interest margin declined in 2004, although at a slower rate than in 2003. As intermediate and long-term rates remained low throughout 2004, fixed rate asset portfolio yields continue to decline pushing earning asset yields lower. Overall, liability yields declined, but at a slower pace as growth in the high rate savings product and increases in short-term borrowing costs partially offset yield declines in the remaining interest-bearing liability categories.

The decline in net interest income in 2003 was attributable to a 30 basis point decline in the net interest margin to 4.15% in 2003 compared with 4.45% in 2002 partially offset by a $118.5 million increase in average earning assets. The net interest margin declined due to the combined effects of the low interest rate environment and accelerated prepayments in both the fixed rate commercial loan portfolio and the mortgage-related securities portfolio. Net premium amortization on investment securities totaled $10.0 million in 2003 compared with $1.9 million in 2002. The increase in 2003 is the result of accelerated premium amortization due to prepayments on the existing mortgage-related securities portfolio and additional on-going premium amortization on new purchases of mortgage-related securities. The decline in the net interest margin was also due, in part, to the expansion of the investment portfolio the first and second quarters of 2003. The investment portfolio was expanded by approximately $500 million in the first half of 2003 to offset the effect of weak loan demand and net interest margin pressure from continued low interest rates. Citizens purchased mortgage backed securities and collateralized mortgage obligations with average lives of three to five years and an average duration of two to four years, resulting in interest spreads of up to 250 basis points over funding sources. As this expansion generated a 250 basis point spread to funding costs, it had a dilutive effect on net interest margin.

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

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2004 compared to 2003

Interest income declined $23.0 million in 2004 compared with 2003 due to lower yields across almost all categories with a small volume offset. The continuation of low intermediate and long-term interest rates resulted in continued declines in yields on fixed rate asset portfolios. Yield increases on variable rate commercial loans resulting from increases in short-term market interest rate increases in the second half of 2004 offset the impact of fixed rate yield declines in the commercial loan category. Direct and indirect consumer loan growth combined with investment securities portfolio growth more than offset unfavorable volume variances in the remaining categories driven by declines in the outstanding amounts of commercial, commercial real estate, and mortgage loans held for sale as well as the effect of the sale of the Illinois Bank. The growth in the investment securities portfolios was the result of the portfolio expansion program implemented in the first half of 2003. The decline in mortgage loans held for sale was the result of lower mortgage volumes in 2004.

Interest expense decreased $12.1 million in 2004 due to overall favorable rate variances and favorable volume variances. Continued low intermediate-term interest rates resulted in lower costs for time deposits. The prepayment of higher cost FHLB debt in August 2004 resulted in a favorable rate variance on long term debt. Increases in short-term market rates drove the unfavorable rate variance on short-term borrowings, and the combination of short-term market rate increases and growth in promotional rate savings products resulted in the unfavorable rate variance in the savings category. The favorable volume variance in total interest expense was driven by lower volume in time deposits, slightly lower interest bearing demand volumes, and the impact of the sale of the Illinois Bank, partially offset by growth in the savings, short-term borrowings, and long-term debt.

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While net interest income is expected to decrease in the first quarter of 2005 when compared to the fourth quarter of 2004 due to anticipated slight margin compression and having two fewer days in the quarter, it is expected to be greater in the remaining quarters of 2005 as average portfolio loans are expected to increase.

2003 compared to 2002

Interest income declined $57.4 million in 2003 compared with 2002 due to lower yields on all asset categories. Yields declined due to the overall lower interest rate environment in 2003. Declining interest rates had a particularly significant impact on the yields on short-term and variable rate assets. In addition, accelerated prepayments in both the fixed-rate commercial and mortgage loan portfolios and the mortgage-related securities portfolio, as well as normal loan repayments and new origination in the lower interest rate environment, also led to the decline in earning asset yields. The unfavorable rate-related variances in interest income were partially offset by net favorable volume-related variances. The expansion of the taxable investment securities portfolio in the first half of 2003, growth in the consumer loan portfolio, particularly home equity loans, and higher average mortgage loans held for sale offset significant declines in the commercial and real estate loan portfolios and led to the favorable volume-related variances in 2003.

Interest expense decreased $41.9 million in 2003 due to favorable rate-related variances as the cost of all categories of interest bearing liabilities declined in 2003 compared with 2002, due to the low interest rate environment. Net unfavorable volume-related variances of $0.7 million partially offset the favorable rate-related variances. Average time deposits declined $405.2 million in 2003 from the prior year as a result of less aggressive pricing and concentrated efforts to grow core demand deposits. Higher average balances for interest bearing demand deposits, short-term borrowings and long term debt offset the decline in time deposits. The increase in short-term borrowings and long term debt funded the aforementioned growth in the investment portfolio and offset the decline in time deposits. The increase in long term debt also resulted from the issuance of $125 million of subordinated debt in January 2003 and the issuance of approximately $25 million of trust preferred securities in June 2003 to provide liquidity and increase capital levels at the Holding Company.

NONINTEREST INCOME

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

2004 compared to 2003

Noninterest income increased $9.2 million in 2004 due mostly to the gain from the sale of the Illinois Bank and increased deposit service charge income, partially offset by lower mortgage income and a net loss on the sale of investment securities. The increase in deposit service charges was the result of initiatives implemented over the last six quarters to improve fee waiver management and was also attributable to slight increases in certain fees. Trust fees increased due to stronger financial

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markets and Citizens’ sales management processes implemented during the first quarter of 2004. Total assets under administration were $2.7 billion at December 31, 2004 compared to $2.9 billion at December 31, 2003. The decrease in mortgage and other loan income in 2004 reflected an $850.7 million decrease in closed mortgage loan volume as compared to 2003, due to the decreased refinance and wholesale activity. Citizens continues to sell most new production into the secondary market, so the decline in volume also affects servicing release premiums received at time of sale. The net loss on the sale of investment securities was the result of a $2.1 million loss during the second quarter of 2004 when some investment securities were designated for sale partially offset by a $0.5 million gain when those securities were traded during the third quarter of 2004.

Other noninterest income increased in 2004 as a result of the profit on the sale of closed bank premises of $1.6 million and a distribution of $0.8 million received in the third quarter of 2004 related to venture capital investments made in prior years, in a limited partnership pursuing early stage investment opportunities in technology driven businesses located in the Midwest region of the United States.

Excluding the effects of the Illinois Bank sale, Citizens anticipates noninterest income levels in 2005 to be slightly lower than 2004 levels based on anticipated lower mortgage activity, fewer gains on the sale of closed branches, and not expecting any distributions from the venture capital investments previously mentioned.

2003 compared to 2002

The decline in noninterest income in 2003 was due mostly to gains of $7.8 million recorded in 2002 from the sale of securitized mortgages and the sale of the merchant services business, partially offset by $1.6 million of other charges recorded in 2002 and described above under the caption “Recent Developments”. The securitized mortgage sales were part of Citizens’ strategy to restructure the balance sheet to decrease reliance on wholesale funding and minimize interest rate risk. The remainder of the decline in 2003 was due to decreases in bankcard fees, trust fees and brokerage and investment fees, which were nearly offset by increases in deposit service charges, mortgage banking revenue and other revenue.

Bankcard fees declined in 2003 due to the sale of the merchant services business in the second quarter of 2002. Brokerage and investment fees declined in 2003 due to slower retail sales of fixed annuity products. Trust fees declined in 2003 due to lower average asset levels resulting from the decline in the financial markets during the latter half of 2002 and the first quarter of 2003 and from client attrition. Total assets under administration were $2.9 billion at December 31, 2003 compared to $2.6 billion at December 31, 2002.

Citizens made a number of changes in its service charge policies in 2003 that resulted in additional overdraft fees, a new overdraft monitoring system and fewer waived fees. The increase in mortgage and other loan income in 2003 reflected higher mortgage banking revenue from higher gains on sales of mortgages and the related servicing rights, as well as higher commercial line of credit fees and new home equity prepayment fee income. Other noninterest income increased in 2003 due to a $2.2 million increase in life insurance income, partially offset by a decrease of $0.6 million in gains recorded on the sale of branches and equipment. The increase in life insurance income resulted from increases in policy cash surrender values as the equity markets improved in the second half of 2003 and from the purchase of $78 million of separate account, bank owned life insurance in the third quarter of 2002. The policies, on which Citizens is the beneficiary, insure the lives of its officers and are designed as a funding source for payment of employee benefits and deferred compensation.

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NONINTEREST EXPENSE

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