UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

Commission file number 001-31708

CAPITOL BANCORP LTD.

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

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

     Common stock, No par value: 14,922,284 shares outstanding as of April 15, 2005.

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INDEX

PART I. FINANCIAL INFORMATION

Forward-Looking Statements

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

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PART I. ITEM I

CAPITOL BANCORP LIMITED

See notes to condensed consolidated financial statements.

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CAPITOL BANCORP LIMITED

See notes to condensed consolidated financial statements.

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CAPITOL BANCORP LTD.

See notes to condensed consolidated financial statements.

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CAPITOL BANCORP LTD.

See notes to condensed consolidated financial statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD.

Note A – Basis of Presentation

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

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

     The results of operations for the period ended March 31, 2005 are not necessarily indicative of the results to be expected for the year ending December 31, 2005.

     The consolidated balance sheet as of December 31, 2004 was derived from audited consolidated financial statements as of that date. Certain 2004 amounts have been reclassified to conform to the 2005 presentation.

Note B – Implementation of New Accounting Standard

     AICPA Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3), addresses the accounting for differences between contractual cash flows and cash flows expected to be collected from the initial investment in loans acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes such loans acquired in purchase business combinations and does not apply to loans originated by the entity. The SOP prohibits carrying over or creation of valuation allowances in the initial accounting for loans acquired in a transfer. It is effective for loans acquired in fiscal years beginning after December 15, 2004. This new guidance had no effect on Capitol’s consolidated financial statements upon implementation.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - Continued

Note C – Stock Options

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

     Stock option activity for the interim 2005 period is summarized as follows:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - Continued

Note C – Stock Options – Continued

     As of March 31, 2005, stock options outstanding had a weighted average remaining contractual life of 4.3 years. The following table summarizes stock options outstanding segregated by exercise price range:

Note D – Net Income Per Share

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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - Continued

Note E – New Bank and Bank Development Activities

     Bank of Michigan, located in Farmington Hills, Michigan, opened in January 2005. It is majority-owned by Capitol Development Bancorp Limited I, which is a controlled subsidiary of Capitol.

     Bank development efforts are currently under consideration at March 31, 2005 in several states including pre-development exploratory discussions, lease and employment negotiations and preparation of preliminary regulatory applications for formation and/or acquisition of community banks. Currently, Capitol Bancorp has applications pending for additional de novo community banks in California, Colorado, Michigan and Washington.

Note F – Pending Share Exchange Proposal

     As of March 31, 2005, a potential share exchange transaction was in the proposal stage regarding Napa Community Bank which, if completed, would result in Capitol issuing approximately 280,000 additional shares of common stock and the bank becoming wholly-owned if all of the bank’s shareholders, other than Capitol, elect to exchange their shares of the bank’s common stock for shares of Capitol. Capitol anticipates concluding the proposed share exchange mid-year, 2005.

Note G – Subsequent Acquisition of Bank

     In early April 2005, Capitol acquired a 51% interest in Peoples State Bank (“Peoples”) located in Jeffersonville, Georgia, in a purchase transaction with total consideration approximating $2.2 million. At March 31, 2005, Peoples’ total assets approximated $21.2 million. Capitol’s acquisition of Peoples will be accounted for under the purchase method of accounting and its results of operations will be included in Capitol’s consolidated financial statements for periods after the effective date of the acquisition.

Note H – Impact of New Accounting Standards

     In December 2004, the Financial Accounting Standards Board (“FASB”) issued a revision of Statement No. 123. Statement No. 123(R), Share-Based Payment, is broader in scope than the original statement, which was more narrowly focused on stock-based compensation, and makes significant changes to accounting for “payments” involving employee compensation and “shares” or securities, in the form of stock options, restricted stock or other arrangements settled in the reporting entity’s securities. Most significant in the standard is the requirement that all stock options be measured at estimated fair value at the grant date and recorded as compensation expense over the requisite service period associated with the option, usually the vesting period. The revised standard was to become effective for interim periods beginning after June 30, 2005 and be applied prospectively to stock options granted after the effective date and any unvested stock options at that date; however, the SEC superseded the FASB’s implementation timetable in April 2005, changing the effective date to the beginning of 2006 for calendar-year public companies.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - Continued

Note H – Impact of New Accounting Standards – Continued

     Although Capitol’s management has not completed its analysis of the revised standard, the effect of the revised standard’s implementation will be recognition of compensation expense associated with stock options. Previously, Capitol has used the intrinsic-value method which did not result in expense recognition but, instead, required pro forma presentation of what compensation expense would have been recorded if the fair-value measurement and expense recognition provisions had been applied. Effective December 31, 2004, Capitol accelerated the vesting of all of its outstanding stock options in anticipation of implementation of Statement No. 123(R). Such acceleration of vesting, to make all such stock options vested as of December 31, 2004, was done for the purpose of avoiding future expense associated with any unvested stock options granted prior to the effective date of Statement No. 123(R).

     FASB’s Emerging Issues Task Force (“EITF”), reached consensus on “The Meaning of Other-Than-Temporary and Its Application to Certain Investments” in EITF Issue No. 03-1. The guidance included in the EITF largely consists of expanded disclosures and the guidance was intended to be fully effective in 2003, except for loss-recognition guidance which had a delayed effective date into 2004. In 2004, the FASB has further delayed the loss recognition provisions of Issue No. 03-1, pending additional deliberation in the future. Because of the inconclusive status of the EITF’s current position on the loss recognition aspects of Issue No. 03-1, Capitol’s management is unable to speculate on the potential impact of this matter on Capitol’s consolidated financial statements.

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

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PART I. ITEM 2

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

Financial Condition

     Total assets approximated $3.2 billion at March 31, 2005, an increase of $124 million from the December 31, 2004 level of $3.1 billion. The balance sheet includes Capitol and its consolidated subsidiaries:

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     Portfolio loans increased during the three-month 2005 period by approximately $67 million, compared to net loan growth of about $100 million during the corresponding period of 2004. 2005 loan growth represented a continuation of prior-period demand and growth at many of Capitol’s younger banks. The majority of portfolio loan growth occurred in commercial loans, consistent with the banks’ emphasis on commercial lending activities.

     The allowance for loan losses at March 31, 2005 approximated $38 million or 1.37% of total portfolio loans, which was slightly less than the year-end 2004 ratio of 1.40%. The allowance ratio at March 31, 2005 is lower than the beginning of the year, consistent with asset quality improvements discussed later in this narrative.

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

     The interim 2004 provision for loan losses was at a higher level due to unexpectedly strong loan growth in the first quarter of 2004 and a special provision of $1 million recorded for estimated losses on one lending relationship.

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     Net charge-offs of loans in the interim 2005 period increased marginally in amount compared to the corresponding 2004 period, however, the ratio of net charge-offs as a percentage of average loans decreased to .27% in 2005, compared to .31% in the 2004 period.

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

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

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     Nonperforming loans decreased 14% or $4 million during the three-month period ended March 31, 2005. Nonperforming loans as a percentage of portfolio loans outstanding at March 31, 2005 were 0.88%, a reduction from the beginning of year level of 1.06%. The significant early 2005 reduction in nonperforming loans came as a result of collection efforts and other resolution activities, such as charge-offs. Of the nonperforming loans at March 31, 2005, about 59% were real estate secured. Those loans, when originated, had appropriate loan-to-value ratios and, accordingly, have loss exposure which is expected to be minimal; however, underlying real estate values depend upon current economic conditions and liquidation strategies. Most other nonperforming loans were generally secured by other business assets. Nonperforming loans at March 31, 2005 were in various stages of resolution and management believes such loans are adequately collateralized or otherwise appropriately considered in its determination of the adequacy of the allowance for loan losses.

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

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

     At March 31, 2005, potential problem loans (including the previously mentioned nonperforming loans) approximated $108 million, or about 4% of total consolidated portfolio loans. These potential problem loans do not necessarily have significant loss exposure (nor are they necessarily deemed ‘impaired’), but rather are identified by management in this manner to aid in loan administration and risk management. Management believes such loans to be adequately considered in its evaluation of the adequacy of the allowance for loan losses. Management believes, however, that current general economic conditions may result in higher levels of future loan losses, in comparison to previous years, as evidenced by higher provisions for loan losses in recent periods.

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

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Results of Operations

     Net income for the three months ended March 31, 2005 was $8 million, an increase of $3.6 million or 81% over the same period in 2004. Diluted earnings per share for the three-month 2005 period were $0.52 compared to $0.30 for the prior year period.

     Net interest income for the first three months of 2005 totaled $35.8 million, an 18% increase compared to $30.2 million in 2004. This increase is attributable to the banks’ growth in size and a continued strong net interest margin despite an increasing interest rate environment.

     Noninterest income for the three months ended March 31, 2005 was $4.6 million, an increase of $435,000, or 11%, over the same period in 2004. The increase is due primarily to a nonrecurring loss on sale of investment securities available for sale accrued in the 2004 period as a result of management’s decision to exit mutual fund investments on an enterprise-wide basis. Other noninterest income in the 2005 period includes $456,000 of gains on sale of government guaranteed loans.

     The provision for loan losses for the three-month period in 2005 was $2 million, as compared to $3.5 million for the same period in 2004. Provisions for loan losses were lower than in the prior year due to a decrease in nonperforming loans in the first quarter of 2005. The interim 2004 provision for loan losses was at a higher level due to unexpectedly strong loan growth in the first quarter of 2004 and a special provision of $1 million recorded for estimated losses on one lending relationship. The provisions for loan losses are based upon management’s analysis of the adequacy of the allowance for loan losses, as previously discussed.

     Noninterest expense totaled $26.5 million for the first quarter in 2005, as compared to $23.6 million for the comparable period in 2004. The increase in noninterest expense is associated with growth in the size of the banks and increases in general operating costs. Increases in both occupancy and salaries and employee benefits relate primarily to the growth in the size of banks within the consolidated group, the addition of a bank in the first quarter of 2005 (none in the first quarter of 2004), and added regional bank development executives as part of Capitol’s 2005 expansion campaign.

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     Operating results (dollars in thousands) were as follows: