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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d) of
the Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File
June 30, 2002 No. 1-8019
PROVIDENT FINANCIAL GROUP, INC.
Incorporated under IRS Employer I.D.
the Laws of Ohio No. 31-0982792
One East Fourth Street, Cincinnati, Ohio 45202
Phone: 513-579-2000
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 X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: Common stock, without par
value, outstanding at July 31, 2002 is 48,716,991.
Please address all correspondence to:
Christopher J. Carey
Executive Vice President and Chief Financial Officer
Provident Financial Group, Inc.
One East Fourth Street
Cincinnati, Ohio 45202
-1-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT
ON FORM 10-Q
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Income . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Changes in Shareholders' Equity . . . . 5
Consolidated Statements of Cash Flows . . . . . . . . . . . . . . . 6
Notes to the Consolidated Financial Statements . . . . . . . . . . 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS . . . . . . . . . . . . . . . . . . 14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK . . 36
PART II. OTHER INFORMATION . . . . . . . . . . . . . . . . . . . . . . . 37
SIGNATURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
(Dollars in Thousands) (Unaudited)
- -------------------------------------------------------------------------------------
ASSETS
Cash and Due from Banks $ 244,147 $ 378,257
Federal Funds Sold and Reverse Repurchase Agreements 56,337 122,966
Trading Account Securities 81,739 101,156
Loans Held for Sale 328,453 217,914
Investment Securities Available for Sale
(amortized cost - $3,797,095 and $3,510,601) 3,815,609 3,486,058
Loans and Leases (Net of Unearned Income):
Corporate Lending:
Commercial 4,289,690 4,540,088
Mortgage 873,726 939,824
Construction 575,655 528,008
Lease Financing 1,313,785 1,188,319
Consumer Lending:
Residential 750,045 922,747
Installment 1,008,386 913,312
Lease Financing 1,408,072 1,463,658
------------ ------------
Total Loans and Leases 10,219,359 10,495,956
Reserve for Loan and Lease Losses (211,262) (240,653)
------------ ------------
Net Loans and Leases 10,008,097 10,255,303
Leased Equipment 166,515 185,863
Premises and Equipment 101,230 103,085
Goodwill 82,432 80,649
Other Assets 789,315 642,303
------------ ------------
TOTAL ASSETS $ 15,673,874 $ 15,573,554
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Noninterest Bearing $ 844,256 $ 994,978
Interest Bearing 8,548,319 7,859,272
------------ ------------
Total Deposits 9,392,575 8,854,250
Short-Term Debt 1,314,980 1,885,309
Long-Term Debt 2,914,945 2,941,165
Guaranteed Preferred Beneficial Interests in
Company's Junior Subordinated Debentures 450,864 450,759
Minority Interest 161,213 -
Accrued Interest and Other Liabilities 491,096 549,481
------------ ------------
Total Liabilities 14,725,673 14,680,964
Shareholders' Equity:
Preferred Stock, 5,000,000 Shares Authorized,
Series D, 70,272 Issued 7,000 7,000
Common Stock, No Par Value, 110,000,000 Shares
Authorized, 48,671,668 and 49,205,897 Issued 14,427 14,587
Capital Surplus 298,898 322,024
Retained Earnings 680,699 647,675
Accumulated Other Comprehensive Loss, Net (52,823) (98,696)
------------ ------------
Total Shareholders' Equity 948,201 892,590
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 15,673,874 $ 15,573,554
============ ============
See notes to consolidated financial statements.
-3-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -------------------
(In Thousands, Except Per Share Data) 2002 2001 2002 2001
- -----------------------------------------------------------------------------------
Interest Income:
Interest and Fees on Loans and Leases $179,863 $225,925 $365,811 $449,023
Interest on Investment Securities 56,840 51,941 110,188 108,785
Other Interest Income 5,791 4,153 10,857 9,229
-------- -------- -------- --------
Total Interest Income 242,494 282,019 486,856 567,037
Interest Expense:
Interest on Deposits:
Savings and Demand Deposits 8,770 18,800 17,821 40,559
Time Deposits 58,804 82,020 117,207 171,996
-------- -------- -------- --------
Total Interest on Deposits 67,574 100,820 135,028 212,555
Interest on Short-Term Debt 7,931 16,312 18,242 29,227
Interest on Long-Term Debt 34,446 40,323 68,694 84,577
Interest on Junior Subordinated
Debentures 6,150 8,925 12,088 16,162
-------- -------- -------- --------
Total Interest Expense 116,101 166,380 234,052 342,521
-------- -------- -------- --------
Net Interest Income 126,393 115,639 252,804 224,516
Provision for Loan and Lease Losses 33,119 24,900 57,109 48,587
-------- -------- -------- --------
Net Interest Income After Provision
for Loan and Lease Losses 93,274 90,739 195,695 175,929
Noninterest Income:
Service Charges on Deposit Accounts 10,915 10,131 21,364 19,239
Loan Servicing Fees 10,126 11,692 20,081 23,270
Other Service Charges and Fees 12,657 10,293 23,020 19,785
Leasing Income 9,054 11,410 18,968 22,831
Cash Gains on Sale of Loans 4,494 857 7,134 1,236
Warrant Gains 8,186 412 8,186 412
Security Gains 654 - 654 -
Other 9,230 19,588 19,493 30,982
-------- -------- -------- --------
Total Noninterest Income 65,316 64,383 118,900 117,755
Noninterest Expense:
Salaries, Wages and Benefits 58,730 53,036 115,119 101,168
Charges and Fees 8,099 8,584 15,750 15,228
Occupancy 5,950 5,541 11,968 11,149
Leasing Expense 6,534 7,642 16,980 14,841
Equipment Expense 5,975 6,359 12,182 13,017
Professional Services 6,219 7,344 12,304 12,767
Minority Interest Expense 666 - 666 -
Other 21,328 17,396 42,075 33,188
-------- -------- -------- --------
Total Noninterest Expense 113,501 105,902 227,044 201,358
-------- -------- -------- --------
Income Before Income Taxes 45,089 49,220 87,551 92,326
Applicable Income Taxes 15,330 17,368 30,404 32,671
-------- -------- -------- --------
Net Income $ 29,759 $ 31,852 $ 57,147 $ 59,655
======== ======== ======== ========
Per Common Share:
Basic Earnings Per Share $ 0.61 $ 0.65 $ 1.16 $ 1.21
Diluted Earnings Per Share 0.58 0.63 1.13 1.18
Cash Dividends Paid 0.24 0.24 0.48 0.48
See notes to consolidated financial statements.
-4-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Accumulated
Other
Preferred Common Capital Retained Comprehensive
(In Thousands) Stock Stock Surplus Earnings Loss, Net Total
- ------------------------------------------------------------------------------------------------------
Balance at January 1, 2001 $ 7,000 $ 14,469 $ 314,895 $ 672,348 $ (17,929) $ 990,783
Net Income 59,655 59,655
Other Comprehensive Income,
Net of Tax:
Cumulative Effect of a Change
in Accounting Principle (28,332) (28,332)
Change in Unrealized
Gains (Losses) on:
Hedging Instruments (18,769) (18,769)
Marketable Securities 986 986
---------
Total Comprehensive Income 13,540
Dividends Paid on:
Preferred Stock (474) (474)
Common Stock (23,460) (23,460)
Exercise of Stock Options and
Accompanying Tax Benefits 22 1,437 1,459
Distribution of Contingent
Shares for Prior Year
Acquisition 8 822 830
------- -------- --------- --------- ---------- ---------
Balance at June 30, 2001 $ 7,000 $ 14,499 $ 317,154 $ 708,069 $ (64,044) $ 982,678
======= ======== ========= ========= ========== =========
Balance at January 1, 2002 $ 7,000 $ 14,587 $ 322,024 $ 647,675 $ (98,696) $ 892,590
Net Income 57,147 57,147
Other Comprehensive Income,
Net of Tax:
Change in Unrealized
Gains (Losses) on:
Hedging Instruments 17,887 17,887
Marketable Securities 27,986 27,986
---------
Total Comprehensive Income 103,020
Dividends Paid on:
Preferred Stock (474) (474)
Common Stock (23,649) (23,649)
Exercise of Stock Options and
Accompanying Tax Benefits 35 2,311 2,346
Benefit Plan Assets in
Provident Stock (195) (18,701) (18,896)
Costs Associated with issuance
of PRIDES Securities (6,722) (6,722)
Stock Repurchased and Cancelled (14) (14)
------- -------- --------- --------- ---------- ---------
Balance at June 30, 2002 $ 7,000 $ 14,427 $ 298,898 $ 680,699 $ (52,823) $ 948,201
======= ======== ========= ========= ========== =========
See notes to consolidated financial statements.
-5-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended June 30,
-------------------------
(In Thousands) 2002 2001
- ------------------------------------------------------------------------------------
Operating Activities:
Net Income $ 57,147 $ 59,655
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Provision for Loan and Lease Losses 57,109 48,587
Amortization of Goodwill - 2,238
Other Amortization and Accretion 6,416 (7,501)
Depreciation of Leased Equipment and
Premises and Equipment 21,853 24,611
Tax Benefit Received from Exercise of Stock Options 508 453
Realized Investment Security Gains (654) -
Proceeds from Sale of Loans Held for Sale 1,216,436 976,603
Origination of Loans Held for Sale (1,321,641) (925,117)
Realized Gains on Loans Held for Sale (5,334) -
(Increase) Decrease in Trading Account Securities 19,417 (45,799)
(Increase) Decrease in Interest Receivable (9,699) 1,795
Decrease in Other Assets 31,297 50,337
Increase in Interest Payable 12,220 11,567
Increase (Decrease) in Other Liabilities (30,180) 49,489
----------- -----------
Net Cash Provided By Operating Activities 54,895 246,918
----------- -----------
Investing Activities:
Investment Securities Available for Sale:
Proceeds from Sales 735,979 1,368,361
Proceeds from Maturities and Prepayments 456,764 598,224
Purchases (1,607,553) (1,976,374)
(Increase) Decrease in Loans and Leases 191,327 (1,368,864)
Decrease in Operating Lease Equipment 8,484 10,465
Increase in Premises and Equipment (9,134) (10,518)
----------- -----------
Net Cash Used In Investing Activities (224,133) (1,378,706)
----------- -----------
Financing Activities:
Increase (Decrease) in Deposits 445,323 (22,504)
Increase (Decrease) in Short-Term Debt (570,329) 1,100,228
Principal Payments on Long-Term Debt (83,723) (106,142)
Proceeds From Issuance of Long-Term Debt and
Company's Junior Subordinated Debentures 38,314 128,665
Proceeds From Issuance of Minority Interest,
Net of Transaction Costs 161,213 -
Cash Dividends Paid (24,123) (23,934)
Proceeds from Exercise of Stock Options 1,838 1,006
Common Stock Repurchased and Cancelled (14) -
----------- -----------
Net Cash Provided By (Used In) Financing Activities (31,501) 1,077,319
----------- -----------
Decrease in Cash and Cash Equivalents (200,739) (54,469)
Cash and Cash Equivalents at Beginning of Period 501,223 369,028
----------- -----------
Cash and Cash Equivalents at End of Period $ 300,484 $ 314,559
=========== ===========
Supplemental Disclosures of Cash Flow Information:
Cash Paid for:
Interest $ 221,832 $ 330,954
Income Taxes 5,534 14,634
Non-Cash Activity:
Transfer of Loans and Leases to Other Real Estate 12,519 12,033
See notes to consolidated financial statements.
-6-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
- ------------------------------
The accompanying unaudited financial statements reflect all adjustments,
consisting of normal recurring accruals, which are, in the opinion of
management, necessary for a fair presentation of the financial position, the
results of operations, changes in shareholders' equity and cash flows for
the periods presented. These financial statements have been prepared
according to the rules and regulations of the Securities and Exchange
Commission and, therefore, certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles ("GAAP") have been omitted. The
results of operations for interim periods are not necessarily indicative of
the results to be expected for the full year.
The consolidated financial statements include the accounts of Provident
Financial Group, Inc. ("Provident") and its subsidiaries. All significant
intercompany balances and transactions have been eliminated. Certain
reclassifications have been made to conform to the current year
presentation. These reclassifications had no effect on net income.
The financial statements and notes thereto appearing in Provident's 2001
annual report on Form 10-K, which include descriptions of significant
accounting policies, should be read in conjunction with these interim
financial statements.
NOTE 2. EARNINGS PER SHARE
- ---------------------------
Basic earnings per share is calculated by dividing net income, less dividend
requirements on convertible preferred stock by the weighted average number
of common shares outstanding for the period. Diluted earnings per share
takes into consideration the pro forma dilution assuming the convertible
preferred shares and the in-the-money outstanding stock options were
converted or exercised into common shares. It also takes into consideration
the dilutive impact of shares held in benefit plans and of forward purchase
contracts required to be settled in Provident Stock. Net income is not
adjusted for preferred dividend requirements.
Stock options to purchase approximately 3.0 million and 2.0 million shares
of Common Stock were outstanding at June 30, 2002 and 2001, respectively,
but were not included in the computation of diluted earnings per share
because the options' exercise price was not in-the-money and, therefore, the
effect would be anti-dilutive. The PRIDES units were not included in the
computation of dilutive earnings per share as the average market price did
not equal or exceed $29.06 and, thus, had no dilutive impact. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Minority Interest" for additional information.
-7-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the computation of basic and diluted earnings
per common share:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
(In Thousands, Except Per Share Data) 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------
Basic:
Net Income $ 29,759 $ 31,852 $ 57,147 $ 59,655
Less Preferred Stock Dividends (237) (237) (474) (474)
-------- -------- -------- --------
Income Available to Common Shareholders 29,522 31,615 56,673 59,181
Weighted-Average Common Shares Outstanding 48,646 48,897 48,936 48,881
-------- -------- -------- --------
Basic Earnings Per Share $ 0.61 $ 0.65 $ 1.16 $ 1.21
======== ======== ======== ========
Diluted:
Net Income $ 29,759 $ 31,852 $ 57,147 $ 59,655
Weighted-Average Common Shares Outstanding 48,646 48,897 48,936 48,881
Benefit Plans Common Shares 651 - 327 -
Assumed Conversion of:
Convertible Preferred Stock 988 988 988 988
Dilutive Stock Options
(Treasury Stock Method) 630 689 501 686
-------- -------- -------- --------
Dilutive Potential Common Shares 50,915 50,574 50,752 50,555
-------- -------- -------- --------
Diluted Earnings Per Share $ 0.58 $ 0.63 $ 1.13 $ 1.18
======== ======== ======== ========
NOTE 3. GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S JUNIOR
- ----------------------------------------------------------------------------
SUBORDINATED DEBENTURES
- -----------------------
Wholly-owned subsidiary trusts of Provident have issued $462.5 million of
preferred securities and, in turn, purchased $462.5 million of
newly-authorized Provident junior subordinated debentures. The debentures
provide interest and principal payments to fund the trusts' obligations.
Provident fully and unconditionally guarantees the preferred securities.
Approximately $385 million of the preferred securities qualify as Tier 1
capital and the remainder qualifies as Tier 2 capital for bank regulatory
purposes. The sole assets of the trusts are the debentures. The junior
subordinated debentures consisted of the following at June 30, 2002:
Stated Effective Maturity
(Dollars in Thousands) Rate Rate (1) Date Amount
- -----------------------------------------------------------------------
November 1996 Issuance 8.60% 8.66% 12/01/26 $ 98,982
June 1999 Issuance 8.75% 3.18% 06/30/29 121,456
November 2000 Issuance 10.25% 4.55% 12/31/30 109,199
March 2001 Issuance 9.45% 4.83% 03/30/31 121,227
--------
Total $450,864
========
(1)Effective rate reflects interest rate after adjustment for notes issued
at discount or premium, capitalized fees associated with the issuance of
the debt and interest rate swap agreements entered to alter the payment
characteristics.
-8-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. COMPREHENSIVE INCOME
- -----------------------------
Comprehensive income represents the changes in equity during a period except
those resulting from investments by shareholders and distributions to
shareholders. For Provident, components of comprehensive income include the
unrealized gains/losses on securities available for sale and unrealized
gains/losses on cash flow hedging derivatives (collectively known as other
comprehensive income), as well as net income. A summary of activity in
accumulated other comprehensive income (loss) follows:
Six Months Ended
June 30,
--------------------
(In Thousands) 2002 2001
- -------------------------------------------------------------------------------------
Accumulated Unrealized Losses on Securities Available
for Sale at January 1, Net of Tax $(15,953) $(17,929)
Net Unrealized Gains for the Period, Net of Tax
Expense of $15,299 in 2002 and $531 in 2001 28,411 986
Reclassification Adjustment for Gains Included in Net Income,
Net of Tax Expense of $229 in 2002 (425) -
-------- --------
Effect on Other Comprehensive Income (Loss) for the Year 27,986 986
-------- --------
Accumulated Unrealized Gains (Losses) on Securities Available
for Sale at June 30, Net of Tax $ 12,033 $(16,943)
======== ========
Accumulated Unrealized Losses on Derivatives Used in Cash
Flow Hedging Relationships at January 1, Net of Tax $(82,743) $ -
Cumulative Effect of Change in Accounting Principle, Net of
Tax Benefit of $15,256 in 2001 - (28,332)
Net Unrealized Gains (Losses) for the Period, Net of Tax
Expense (Benefit) of $22,561 in 2002 and $(7,360) in 2001 41,900 (13,667)
Reclassification Adjustment for Losses Included in Net Income,
Net of Tax Benefit of $12,930 in 2002 and $2,748 in 2001 (24,013) (5,102)
-------- --------
Effect on Other Comprehensive Income (Loss) for the Year 17,887 (47,101)
-------- --------
Accumulated Unrealized Losses on Derivatives Used in Cash
Flow Hedging Relationships at June 30, Net of Tax $(64,856) $(47,101)
======== ========
Accumulated Other Comprehensive Loss at January 1, Net of Tax $(98,696) $(17,929)
Other Comprehensive Income (Loss), Net of Tax 45,873 (46,115)
-------- --------
Accumulated Other Comprehensive Loss at June 30, Net of Tax $(52,823) $(64,044)
======== ========
NOTE 5. LINE OF BUSINESS REPORTING
- -----------------------------------
Provident's three major business lines, referred to as Commercial Banking,
Retail Banking and Mortgage Banking, are based on the products and services
offered, and its management structure. Commercial Banking offers a full
range of commercial lending and financial products and services to corporate
businesses. Retail Banking provides consumer lending, deposit accounts,
trust, brokerage and investment products and services to consumers and small
businesses. Mortgage Banking offers traditional and non-traditional
residential mortgage loans to consumers, and also provides fee-based loan
processing, loan warehousing and servicing for third party originators.
-9-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed income statements and average assets are provided below for
Provident's three major lines of business for the three-month and six-month
periods ended June 30, 2002 and 2001.
Commercial Retail Mortgage Corporate
(Dollars in Millions) Banking Banking Banking Center Total
- ----------------------------------------------------------------------------------------------
Three Months Ended June 30 2002:
Net Interest Income $ 55.7 $ 55.0 $ 15.7 $ - $ 126.4
Provision for Loan Losses (13.4) (3.0) (7.7) (9.0) (33.1)
Noninterest Income 29.5 17.8 9.2 8.8 65.3
Noninterest Expense (45.4) (50.4) (17.7) - (113.5)
Income Taxes (9.0) (6.6) 0.2 0.1 (15.3)
-------- -------- -------- -------- ---------
Net Income $ 17.4 $ 12.8 $ (0.3) $ (0.1) $ 29.8
======== ======== ======== ======== =========
Average Assets $ 7,004 $ 3,679 $ 1,555 $ 3,145 $ 15,383
======== ======== ======== ======== =========
Three Months Ended June 30 2001:
Net Interest Income $ 51.3 $ 47.6 $ 16.7 $ - $ 115.6
Provision for Loan Losses (14.9) (4.7) (5.3) - (24.9)
Noninterest Income 41.2 16.8 6.4 - 64.4
Noninterest Expense (44.0) (45.3) (16.6) - (105.9)
Income Taxes (11.8) (5.1) (0.4) - (17.3)
-------- -------- -------- -------- ---------
Net Income $ 21.8 $ 9.3 $ 0.8 $ - $ 31.9
======== ======== ======== ======== =========
Average Assets $ 6,949 $ 3,154 $ 2,126 $ 2,764 $ 14,993
======== ======== ======== ======== =========
Six Months Ended June 30 2002:
Net Interest Income $ 112.3 $ 109.7 $ 30.8 $ - $ 252.8
Provision for Loan Losses (32.1) (6.7) (9.3) (9.0) (57.1)
Noninterest Income 57.6 36.8 15.7 8.8 118.9
Noninterest Expense (93.3) (99.0) (34.8) - (227.1)
Income Taxes (15.4) (14.2) (0.9) 0.1 (30.4)
-------- -------- -------- -------- ---------
Net Income $ 29.1 $ 26.6 $ 1.5 $ (0.1) $ 57.1
======== ======== ======== ======== =========
Average Assets $ 6,953 $ 3,702 $ 1,620 $ 3,114 $ 15,389
======== ======== ======== ======== =========
Six Months Ended June 30 2001:
Net Interest Income $ 101.0 $ 91.8 $ 31.7 $ - $ 224.5
Provision for Loan Losses (27.5) (10.3) (10.8) - (48.6)
Noninterest Income 71.8 33.0 13.0 - 117.8
Noninterest Expense (81.2) (87.3) (32.9) - (201.4)
Income Taxes (22.7) (9.6) (0.3) - (32.6)
-------- -------- -------- -------- ---------
Net Income $ 41.4 $ 17.6 $ 0.7 $ - $ 59.7
======== ======== ======== ======== =========
Average Assets $ 6,696 $ 3,114 $ 2,052 $ 2,788 $ 14,650
======== ======== ======== ======== =========
Key components of the management reporting process follows:
o Risk-Based Equity Allocations: Provident uses a comprehensive approach
for measuring risk and making risk-based equity allocations. Risk
measurements are applied to credit, operational and other corporate-level
risks.
o Transfer Pricing: Provident utilizes a matched funded transfer pricing
methodology that isolates the business units from fluctuations in
interest rates, and provides management with the ability to measure
business unit, product and customer level profitability based on the
financial characteristics of the products rather than the level of
interest rates.
o Provision for Loan and Lease Losses: Business lines are charged for
provision based upon its level of net charge-offs as well as the size and
composition of its loan/lease portfolio.
-10-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
o Costs Allocation: Provident applies a detailed approach to allocating
costs at the business unit, product and customer levels. Allocations are
generally based on volume/activity and are reviewed and updated
regularly.
o "Corporate Center": Corporate Center includes balance sheet and income
statement items not allocated to the primary business lines, gain/loss on
the sale of investment securities, and any unusual business revenues and
expenses.
NOTE 6. GOODWILL AND OTHER INTANGIBLES
- ---------------------------------------
Provident adopted the provisions of Statement of Financial Accounting
Standards ("FAS") No. 141, "Business Combinations", and No. 142, "Goodwill
and Other Intangible Assets", on January 1 2002. Under the new rules,
goodwill and intangible assets deemed to have indefinite lives will no
longer be amortized but will be subject to annual impairment tests in
accordance with the Statements. Other intangible assets continue to be
amortized over their useful lives. Management performed a transitional
impairment test on its goodwill assets as of January 1, 2002 and determined
that no impairment existed as of that date.
As a result of adopting FAS No. 142, Provident did not incur any goodwill
amortization during 2002, whereas during 2001 Provident recorded goodwill
amortization. The follow table provides net income and earnings per share
for the three-month and six-month periods ended June 30, 2001 on a pro forma
basis excluding goodwill amortization.
Three Months Six Months
Ended Ended
(In Thousands, Except Per Share Amounts) June 30, 2001 June 30, 2001
- ----------------------------------------------------------------------------
Net Income:
As Reported $ 31,852 $ 59,655
Add Back: After-Tax Goodwill Amortization 733 1,455
---------- ----------
Pro-Forma Net Income $ 32,585 $ 61,110
========== ==========
Basic Earnings Per Common Share:
As Reported $ 0.65 $ 1.21
Add Back: After-Tax Goodwill Amortization 0.01 0.03
---------- ----------
Pro-Forma Basic Earnings Per Common Share $ 0.66 $ 1.24
========== ==========
Diluted Earnings Per Common Share:
As Reported $ 0.63 $ 1.18
Add Back: After-Tax Goodwill Amortization 0.01 0.03
---------- ----------
Pro-Forma Diluted Earnings Per Common Share $ 0.64 $ 1.21
========== ==========
Changes in the carrying amount of goodwill for the six months ended June 30,
2002, are as follows:
Commercial Retail
(In Thousands) Banking Banking Total
- ----------------------------------------------------------------------------
Balance at January 1, 2002 $39,825 $40,824 $80,649
Goodwill Acquired During the Year - 189 189
Goodwill Recorded as a Result of Contingent
Consideration being Recognized 1,594 - 1,594
------- ------- -------
Balance at June 30, 2002 $41,419 $41,013 $82,432
======= ======= =======
-11-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As all of Provident's other intangible assets have been determined to have
limited lives, these assets have continued to be amortized as in the past.
Intangible assets, along with accumulated amortization, is provided below as
of June 30, 2002:
Gross Net
Carrying Accumulated Carrying
(In Thousands) Value Amortization Value
- ----------------------------------------------------------------------------
Non-Contractual Customer Relationships $21,997 $ 5,685 $16,312
Purchased Core Deposits 1,429 893 536
------- ------- -------
Balance at June 30, 2002 $23,426 $ 6,578 $16,848
======= ======= =======
The estimated amortization of intangible assets for the next five years, is
$2.3 million for the remainder of 2002; $4.7 million for 2003; $4.4 million
for 2004; $3.3 million for 2005; and $1.5 million for 2006.
NOTE 7. MORTGAGE SERVICING ASSETS
- ----------------------------------
Provident recognizes the rights to service mortgage loans it does not own
but services for others within Other Assets of its Balance Sheets. Mortgage
servicing assets may be recognized (1) when mortgage loans are sold with
servicing retained or (2) when mortgage loan servicing is purchased. When
mortgage loans are sold, the carrying value of the loans is allocated
between the loans sold and servicing assets retained based on the relative
fair values of each. Mortgage servicing assets, when purchased, are
initially recorded at cost. Mortgage servicing assets are carried at the
lower of the initial carrying value, adjusted for amortization, or estimated
fair value. At June 30, 2002 and 2001, Provident had $96.4 million and $82.4
million, respectively, of mortgage servicing assets.
NOTE 8. RESTRICTED ASSETS
- --------------------------
Provident formed the subsidiaries listed below to account for and support
the process of transferring, securitizing and/or selling vehicle and
equipment leases. These subsidiaries are separate legal entities and each
maintains books and records with respect to its assets and liabilities. The
assets of these subsidiaries, which are included in the consolidated
financial statements, are not available to secure financing or otherwise
satisfy claims of creditors of Provident or any of its other subsidiaries.
The subsidiaries and their total assets as of June 30, 2002 follow:
(In Thousands) Total Assets
- ----------------------------------------------------------------------------
Provident Auto Leasing Company $515,517
Provident Auto Rental LLC 2000-1 362,327
Provident Auto Rental LLC 2001-1 331,889
Provident Auto Rental LLC 1999-1 205,068
Provident Lease Receivables Company LLC 163,532
Provident Auto Rental LLC 2000-2 154,754
Provident Auto Rental Company LLC 1998-2 42,352
Provident Auto Rental Company LLC 1998-1 41,247
The above amounts include items which are eliminated in the Consolidated
Financial Statements.
-12-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ----------------------------------------------------------------------------
RESULTS OF OPERATIONS
- ---------------------
INTRODUCTION
- ------------
Provident is a bank holding company headquartered in Cincinnati, Ohio.
Provident operates bank and other financial service subsidiaries principally
in Ohio, northern Kentucky and southwest Florida. Principal products and
services provided by Provident include commercial lending, lease financing,
cash management, retail lending, deposit accounts, mortgage banking,
brokerage services, investment products and trust services.
Forward-Looking Statements
- --------------------------
This Form 10-Q contains certain forward-looking statements that are subject
to numerous assumptions, risks or uncertainties. The Private Securities
Litigation Reform Act of 1995 provides a safe harbor for forward-looking
statements. Actual results could differ materially from those contained in
or implied by such forward-looking statements for a variety of factors
including: sharp and/or rapid changes in interest rates; significant changes
in the anticipated economic scenario which could materially change
anticipated credit quality trends; the ability to generate loans and leases;
significant cost, delay in, or inability to execute strategic initiatives
designed to increase revenues and/or manage expenses; consummation of
significant business combinations or divestitures; and significant changes
in accounting, tax, or regulatory practices or requirements and factors
noted in connection with forward-looking statements. Additionally, borrowers
could suffer unanticipated losses without regard to general economic
conditions. The result of these and other factors could cause differences
from expectations in the level of defaults, changes in risk characteristics
of the loan and lease portfolio, and changes in the provision for loan and
lease losses. Forward-looking statements speak only as of the date made.
Provident undertakes no obligations to update any forward-looking statements
to reflect events or circumstances arising after the date on which they are
made.
Accounting Policies
- -------------------
Note 1 to Provident's consolidated financial statements included in the 2001
Annual Report filed on Form 10-K lists significant accounting policies used
in the development and presentation of its financial statements. These
accounting policies, along with discussion and analysis included in this
report, are necessary for an understanding and evaluation of Provident and
its results of operations.
-13-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
- ---------------------
Summary
- -------
The following table summarizes earnings components, earnings per share and
key financial ratios:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in Thousands, -------------------------------- ---------------------------------
Except Per Share Data) 2002 2001 Change 2002 2001 Change
- -----------------------------------------------------------------------------------------------------------
Net Interest Income $126,393 $115,639 9% $252,804 $224,516 13%
Noninterest Income 65,316 64,383 1 118,900 117,755 1
Total Revenue 191,709 180,022 6 371,704 342,271 9
Provision for Loan and Lease Losses 33,119 24,900 33 57,109 48,587 18
Noninterest Expense 113,501 105,902 7 227,044 201,358 13
Net Income 29,759 31,852 (7) 57,147 59,655 (4)
Diluted Earnings per Share 0.58 0.63 (8) 1.13 1.18 (4)
Return on Average Equity 12.53% 13.06% 12.21% 12.27%
Return on Average Assets 0.77% 0.85% 0.74% 0.81%
Efficiency Ratio (Excludes Unusual
Credit Charges, Minority Interest
Expense and Warrant Gains 61.58% 58.96% 61.37% 58.90%
Second quarter 2002 earnings per diluted share and net income were $.58 and
$29.8 million, respectively, compared with $.63 and $31.9 million in the
second quarter of 2001. First half 2002 earnings per diluted share and net
income were $1.13 and $57.1 million, respectively, compared with $1.18 and
$59.7 million for the first half of 2001. Although down slightly from those
reported a year ago, current earnings did increase significantly from the
third and fourth quarters of 2001, which posted net losses of $7.4 million
and $28.9 million, respectively. The losses were primarily the result of
large credit-related charges during the final two quarters of 2001.
The provision for loan and lease losses was $57.1 million for the first half
of 2002 as compared to $48.6 million during the same time period of 2001.
Additionally, Provident recorded $3.7 million of credit-related charges for
the write-down of foreclosed property and leased equipment (included with
noninterest expense) during the first half of 2002. During the third and
fourth quarters of 2001, Provident recorded provision and other
credit-related charges of $86.0 million and $115.2 million, respectively.
The higher than normal expenses incurred for provision and other
credit-related charges were due primarily to the weakened economy and the
events of September 11, 2001. As credit-related volatility declined during
2002, the provision returned to a more normal level as compared to the third
and fourth quarters of 2001. The increase in provision during the first half
of 2002 as compared to the same period of 2001 was a result of the sale of
$27 million of nonperforming loans from Provident's residential mortgage
portfolio at a $9.1 million discount. This increase was substantially offset
in net income by an $8.2 million cash gain recognized from a warrant
transaction. During the second quarter of 2002 the loss reserve was allowed
to decline as $29.4 million of commercial airline loans and leases were
charged off. These charge-offs did not impact the current period provision
as last year's increase in the loss reserve was deemed adequate to absorb
these charge-offs. Although encouraged by the reduced credit-related
volatility during 2002, management continues to work diligently to resolve
any remaining credit issues in the lending portfolio.
-14-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Provident's total revenue (net interest income plus noninterest income)
increased $29.4 million, or 9%, during the first half of 2002 as compared to
the first half of 2001. Net interest income increased by $28.3 million, or
13%, as a result of growth in earning assets, primarily small to mid-size
equipment lease financing and investment securities, and an improved net
interest margin which increased from 3.40% to 3.54%. Noninterest income
increased $1.1 million, or 1%, from that reported in last year's first two
quarters.
Noninterest expense increased $25.7 million, or 13%, for the first half of
2002 as compared to the first half of 2001. The increase in noninterest
expense was primarily the result of three activities. First, Provident is
investing in businesses where strong growth opportunities exist, including
middle market commercial lending, middle market equipment leasing and
mortgage servicing. Also, significant investments continue to be made within
the credit and risk administration functions. Finally, as noted earlier in
this section, the first six months of 2002 noninterest expense included $3.7
million of credit-related charges for the write-down of foreclosed
properties and leased equipment. The ratio of noninterest expense to tax
equivalent revenue ("efficiency ratio"), excluding unusual credit charges,
minority interest expense and warrant gains, increased to 61.37% for the
first half of 2002 as compared to 58.90% during 2001.
Total assets increased $100 million from December 31, 2001 to June 30, 2002
primarily as a result of an increase in small to mid-size equipment lease
financing and investment securities. Partially offsetting these increases
was a decrease in commercial loans. The decrease in commercial loans is due
to a softness in commercial loan demand and management's decision to
de-emphasize its structured finance and large equipment leasing businesses.
Total deposits increased $538 million during the first half of 2002. Average
core deposits increased at an annualized rate of 8%. Regulatory capital
ratios improved significantly during the first half of 2002 due to the
issuance of $165 million of Real Estate Investment Trust (REIT) preferred
securities.
Business Lines
- --------------
Provident's major business lines are Commercial Banking, Retail Banking and
Mortgage Banking. The following table summarized net income by major lines
of business for the three-month and six-month periods ended June 30, 2002
and 2001. Condensed income statements and average balances are provided in
Note 5 of the "Notes to Consolidated Financial Statements".
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -----------------------
(Dollars in Millions) 2002 2001 2002 2001
- ----------------------------------------------------------------------------
Commercial Banking $ 17.4 $ 21.8 $ 29.1 $ 41.4
Retail Banking 12.8 9.3 26.6 17.6
Mortgage Banking (0.3) 0.8 1.5 0.7
Corporate Center (0.1) - (0.1) -
--------- --------- --------- ---------
$ 29.8 $ 31.9 $ 57.1 $ 59.7
========= ========= ========= =========
-15-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Business line descriptions and fluctuation analysis follows:
o Commercial Banking provides a broad range of commercial banking and
commercial real estate products and services. Areas of focus and
expertise include regional middle-market lending, equipment leasing and
financing, cash management, and loan servicing, structuring and
investment banking services for the multi-family housing and healthcare
industries.
Net income for the second quarter and first half of 2002 was $17.4
million and $29.1 million, respectively, compared to $21.8 million and
$41.4 million for the same periods in 2001. Total revenues decreased
during the first six months of 2002 as a result of slower asset growth
and lower fee-based transaction activity. Both provision and noninterest
expense increased during the first half of 2002 due to credit write-offs
and residual write-downs resulting from the extended economic softness.
Management continues to re-position this business line so it can grow
with a more predictable earnings pattern. Management is de-emphasizing
its higher credit risk areas of structured finance lending and large
equipment leasing while growing its lower credit risk areas of
middle-market leasing and regional middle-market commercial lending
units.
Red Capital Group, a business unit within Commercial Banking, continued
to make significant contributions to revenue growth in the first half of
2002. Total revenues have increased 23% and net income has increased 25%
in the first six months of 2002 compared to 2001. Red Capital provides a
platform to generate fee income from originating, selling and servicing
commercial mortgage loans which improves Provident's balance between
interest spread and fee-based revenues.
o Retail Banking provides a variety of banking and investment products and
services to retail consumers and businesses. Services are delivered
through various delivery channels including Financial Centers, telephone,
ATMs and the internet. Primary operating areas include Retail and
Business Banking, Consumer Lending and Provident Financial Advisors.
Net income increased $3.5 million and $9.0 million for the three-month
and six-month periods ended June 30, 2002 as compared to the same periods
in 2001. The primary driver for the increase was an increase in net
interest income on deposits. Average total retail deposits grew by 8%
during the second quarter of 2002 compared to the second quarter of 2001.
This largely occurred as a result of internet deposit-gathering
initiatives. In addition to an increase in deposit volume, the rate
environment has had a positive impact on the net interest margin.
o Mortgage Banking offers traditional and non-traditional residential
mortgage loans to consumers, and also provides fee-based loan processing,
loan warehousing and servicing for third party originators. Loans are
originated through retail and broker channels and are sold on a
whole-loan basis. Whole-loan sales refer to the transfer of credit risk
along with the payment stream of the loan. Primary operating areas
include Mortgage Services, Warehouse Lending Services and the National
Servicing Center.
-16-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Mortgage Banking had net income (loss) of ($.3) million and $1.5 million
for the second quarter and six months of 2002. The net loss for the
second quarter was primarily the result of higher loan loss provision.
Mortgage Banking has continued to implement strategic initiatives
designed to reduce its risk profile, the largest initiative being the
transition from portfolio lending to whole-loan sales. Since the third
quarter of 2001, nonconforming loan originations have been sold on a
whole-loan basis to investors. During the second quarter of 2002, the net
sales premium on nonconforming loan sales averaged approximately 205
basis points as compared to 130 basis points reported for the first
quarter of 2002. These sales provided Mortgage Banking with $3.8 million
of gains that were not present in the second quarter of 2001. Through
associations with other companies, a new direct retail marketing loan
division and a new mortgage services company, management continues to
seek and cultivate new opportunities for diverse cash flow streams within
the mortgage business.
During the second quarter of 2002, $27 million of nonperforming mortgage
loans were sold. Primarily as a result of this transaction, total
nonperforming loans within Mortgage Banking decreased from $71 million at
March 31, 2002 to $43 million as of June 30, 2002.
o Corporate Center includes revenue and expenses not allocated to the
primary business lines, including any unusual revenues and expenses. Net
income for Corporate Center included warrant gains of $8.2 million,
security gains of $.7 million and a loss of $9.1 million from the sale of
$27 million of non-performing loans from the residential mortgage
portfolio.
Net Interest Income
- -------------------
Net interest income for the six months ended June 30, 2002, increased $28.3
million, or 13%, compared to the first six months of 2001. The increase in
interest income was due to an increase in average earning assets of $1.1
billion, or 8%, and an increase in the net interest margin. The increase in
average earning assets resulted primarily from the growth of the lending
portfolio, principally equipment lease financing, and the investment
security portfolio. The growth in earning assets were primarily supported by
a corresponding growth in interest bearing liabilities. The largest
increases in interest bearing liabilities was time deposits and long-term
debt.
-17-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Net interest margin represents net interest income as a percentage of total
interest earning assets. For the first six months of 2002, the net interest
margin, on a tax-equivalent basis, was 3.54% compared to 3.40% for the same
period in 2001. This increase was driven by changes in rates and volumes of
earning assets and the corresponding funding sources. The following table
details the components of the change in net interest income (on a
tax-equivalent basis) by major category of interest earning assets and
interest bearing liabilities for the three-month and six-month periods ended
June 30, 2002 and 2001.
Three Months Ended Six Months Ended
--------------------------------------- ---------------------------------------
June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001
------------------ ------------------ ------------------ ------------------
Average Average Average Average Average Average Average Average
(Dollars in Millions) Balance Rate Balance Rate Balance Rate Balance Rate
- -------------------------------------------------------------------------------------------------------------------
Assets:
Loans and Leases:
Corporate Lending:
Commercial $ 4,231 5.99% $ 4,825 7.75% $ 4,308 6.04% $ 4,713 8.26%
Mortgage 878 6.17 856 8.20 880 6.35 635 8.90
Construction 560 4.38 587 7.49 563 4.60 812 7.95
Lease Financing 1,268 9.25 1,020 10.74 1,232 9.72 836 11.06
------- ----- ------- ----- ------- ----- ------- -----
Total Corporate Lending 6,937 6.48 7,288 8.20 6,983 6.61 6,996 8.62
Consumer Lending:
Residential 791 11.21 1,067 10.91 830 11.00 1,004 11.23
Installment 965 6.88 719 10.38 951 7.12 691 10.56
Lease Financing 1,407 8.31 1,152 10.21 1,427 8.20 1,115 10.48
------- ----- ------- ----- ------- ----- ------- -----
Total Consumer Lending 3,163 8.60 2,938 10.51 3,208 8.60 2,810 10.77
------- ----- ------- ----- ------- ----- ------- -----
Total Loans and Leases 10,100 7.14 10,226 8.86 10,191 7.24 9,806 9.23
Investment Securities 3,866 5.90 3,113 6.69 3,794 5.86 3,195 6.87
Federal Funds Sold and Reverse
Repurchase Agreements 127 2.85 112 5.46 118 2.82 104 5.60
Other Short Term Investments 299 6.55 236 4.48 292 6.36 205 6.26
------- ----- ------- ----- ------- ----- ------- -----
Total Earning Assets 14,392 6.76 13,687 8.26 14,395 6.82 13,310 8.59
Cash and Due From Banks 212 239 225 268
Other Assets 779 1,067 769 1,072
------- ------- ------- -------
Total Assets $15,383 $14,993 $15,389 $14,650
======= ======= ======= =======
Liabilities and
Shareholders' Equity:
Deposits:
Demand Deposits $ 546 1.12 $ 486 2.87 $ 529 1.07 $ 475 3.13
Savings Deposits 1,475 1.97 1,550 3.97 1,505 2.01 1,526 4.39
Time Deposits 6,446 3.66 5,698 5.77 6,184 3.82 5,712 6.07
------- ----- ------- ----- ------- ----- ------- -----
Total Deposits 8,467 3.20 7,734 5.23 8,218 3.31 7,713 5.56
Short-Term Debt:
Federal Funds Purchased and
Repurchase Agreements 904 2.91 1,297 4.32 1,190 2.64 1,032 4.65
Commercial Paper 284 1.93 221 4.24 278 1.93 220 4.92
Short-Term Notes Payable 3 1.58 2 3.74 2 1.59 2 4.30
------- ----- ------- ----- ------- ----- ------- -----
Total Short-Term Debt 1,191 2.67 1,520 4.31 1,470 2.50 1,254 4.70
Long-Term Debt 2,902 4.76 2,685 6.02 2,907 4.76 2,708 6.30
Junior Subordinated Debentures 451 5.47 450 7.95 451 5.41 393 8.29
------- ----- ------- ----- ------- ----- ------- -----
Total Interest Bearing
Liabilities 13,011 3.58 12,389 5.39 13,046 3.62 12,068 5.72
Noninterest Bearing Deposits 881 1,212 864 1,236
Minority Interest 34 - 17 -
Other Liabilities 507 416 526 374
Shareholders' Equity 950 976 936 972
------- ------- ------- -------
Total Liabilities and
Shareholders' Equity $15,383 $14,993 $15,389 $14,650
======= ======= ======= =======
Net Interest Spread 3.18% 2.87% 3.20% 2.87%
==== ==== ==== ====
Net Interest Margin 3.52% 3.39% 3.54% 3.40%
==== ==== ==== ====
-18-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Provision and Reserve for Loan and Lease Losses and Credit Quality
- ------------------------------------------------------------------
Management's determination of the adequacy of the loan loss reserve is based
on an assessment of the losses given the conditions at the time. This
assessment consists of certain loans and leases being evaluated on an
individual basis, as well as all loans and leases being categorized based on
common credit risk attributes and being evaluated as a group.
Provident's Credit and Risk Management Group is responsible for the
establishment and oversight of Provident's credit risk policies. The credit
risk policies address underwriting standards, internal lending limits and
methodologies for the monitoring of credit risk within the various loan and
lease portfolios. Loans and leases are primarily monitored by closely
following changes and trends in assigned risk ratings. Credit scoring models
are used for consumer and small business loans and leases, while larger
commercial, commercial mortgage and commercial construction loans are
assigned individual risk ratings. These ratings are assigned based upon
individual credit analysis and are reported to senior management on a
regular basis.
Loans and leases that have been placed on classified and/or nonaccrual
status are further evaluated for potential losses based upon review and
discussion among lending officers, Credit, Loan Review, collection
associates, and senior management. Factors considered include the market
value of collateral or real estate associated with a specific loan or lease,
cash flows generated by the borrower, third-party guarantees, the general
economic climate and any specific industry trends that may affect an
individual loan or lease.
The adequacy of the reserve for loan and lease losses is monitored on a
continual basis and is based upon management's evaluation of numerous
factors. These factors include the quality of the current loan portfolio,
the trend in the loan portfolio's risk ratings, current economic conditions,
loan concentrations, evaluation of specific loss estimates for all
significant problem loans, payment histories, collateral valuations,
historical charge-off and recovery experience, estimates of charge-offs for
the upcoming year and other pertinent information.
Additional loss estimates associated with securitized assets and loans sold
under the Fannie Mae DUS Program are provided for separately from the
reserve for loan and lease losses. For more information on credit exposures
for these off-balance sheet assets, see "Management Discussion and Analysis
of Financial Condition and Results of Operations - Asset Securitization
Activity" and "Fannie Mae DUS Program." The following paragraphs provide
information concerning its on-balance sheet credit portfolio.
-19-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The provision for loan and lease losses was $57.1 million and $48.6 million
for the first six months of 2002 and 2001, respectively. During the third
and fourth quarters of 2001, Provident recorded $66.0 and $111.2 million of
provision expense. The higher than normal provision was due primarily to the
weakened economy and the events of September 11, 2001. As the credit-related
volatility declined during 2002, the provision returned to a more normal
level. The $8.2 million increase in provision in the second quarter of 2002
as compared to 2001 was a result of the sale of $27 million of nonperforming
loans from the residential mortgage portfolio at a $9.1 million discount.
The ratio of reserve for loan and lease losses to total loans and leases was
2.07% and 1.70% at June 30, 2002 and 2001, respectively. The ratio of
reserve for loan and lease losses to total loans and leases was raised
during the second half of 2001 based on analyses of the lending portfolio,
deterioration of asset quality indicators and the uncertain economic
environment. During the second quarter of 2002, the loss reserve was allowed
to decline as $29.4 million of commercial airline loans and leases were
charged off, which did not impact the provision as last year's increase in
the loss reserve was adequate to absorb these charge-offs without increasing
provision expense.
Management continues to remain focused on resolving its credit issues.
Provident has initiated various steps to enhance its credit review function
including the hiring of a Chief Credit and Risk Officer, enlarging its
Credit and Risk Management department and improving internal policies and
procedures. Additionally, Provident is implementing several strategic
changes to improve its credit quality metrics, portfolio diversification and
loan concentrations. These initiatives include de-emphasizing its structured
finance lending and auto leasing, as well as originating its nonconforming
residential loans for sale on a whole-loan basis. Regional middle-market
commercial lending, middle-market leasing and prime home equity loans are
businesses which management believes it can grow with more predictable
future earnings streams.
-20-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following table shows the progression of the reserve for loan and lease
losses and selected reserve ratios:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- -----------------------
(Dollars in Thousands) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------
Balance at Beginning of Period $ 240,663 $ 163,682 $ 240,653 $ 154,300
Acquired Reserves - 8,728 - 10,003
Provision for Loan and Lease Losses 33,119 24,900 57,109 48,587
Loans and Leases Charged Off (70,583) (24,470) (102,546) (43,796)
Recoveries 8,063 4,135 16,046 7,881
--------- --------- --------- ---------
Balance at End of Period $ 211,262 $ 176,975 $ 211,262 $ 176,975
========= ========= ========= =========
Reserve for Loan and Lease Losses
as a Percent of:
Nonaccrual Loans 131.58% 160.05%
Nonperforming Assets 113.56% 139.51%
Total Loans and Leases 2.07% 1.70%
The following table presents the distribution of net loan charge-offs by
loan type for the three-month and six-month periods ended June 30, 2002 and
2001:
Three Months Ended Three Months Ended
June 30, 2002 June 30, 2001
--------------------------------- -----------------------------------
Pctg of Pctg of Pctg of Pctg of
Average Total Average Total
Net Total Net Net Total Net
Charge- Loans Charge- Charge- Loans Charge-
(Dollars in Thousands) Offs (annualized) Offs Offs (annualized) Offs
- --------------------------------------------------------------------------------------------------
Corporate Lending:
Commercial $ 25,057 2.37% 40.1% $ 12,491 1.04% 61.4%
Mortgage - - - - - -
Construction - - - - - -
Lease Financing 21,635 6.82 34.6 3,810 1.49 18.7
-------- ----- -------- -----
Net Corporate Lending 46,692 2.69 74.7 16,301 0.89 80.1
Consumer Lending:
Residential 14,260 7.21 22.8 2,958 1.11 14.6
Installment 782 0.32 1.2 144 0.08 0.7
Lease Financing 786 0.22 1.3 932 0.32 4.6
-------- ----- -------- -----
Net Consumer Lending 15,828 2.00 25.3 4,034 0.55 19.9
-------- ----- -------- -----
Net Charge-Off's $ 62,520 2.48 100.0 $ 20,335 0.79 100.0
======== ===== ======== =====
Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
--------------------------------- -----------------------------------
Pctg of Pctg of Pctg of Pctg of
Average Total Average Total
Net Total Net Net Total Net
Charge- Loans Charge- Charge- Loans Charge-
(Dollars in Thousands) Offs (annualized) Offs Offs (annualized) Offs
- --------------------------------------------------------------------------------------------------
Corporate Lending:
Commercial $ 38,994 1.81% 45.1% $ 22,283 0.95% 62.0%
Mortgage 24 0.01 - 25 0.01 0.1
Construction 300 0.11 0.4 - - -
Lease Financing 25,959 4.21 30.0 4,435 1.06 12.4
-------- ----- -------- -----
Net Corporate Lending 65,277 1.87 75.5 26,743 0.76 74.5
Consumer Lending:
Residential 17,277 4.16 20.0 6,253 1.25 17.4
Installment 1,509 0.32 1.7 1,000 0.29 2.8
Lease Financing 2,437 0.34 2.8 1,919 0.34 5.3
-------- ----- -------- -----
Net Consumer Lending 21,223 1.32 24.5 9,172 0.65 25.5
-------- ----- -------- -----
Net Charge-Off's $ 86,500 1.70 100.0 $ 35,915 0.73 100.0
======== ===== ======== =====
-21-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The increase in net charge-offs for both commercial loans and corporate
lease financing was due primarily to the $29.4 million charge-off of
commercial airline loans and leases combined with the weak economic
environment. The charge-off was comprised of $10.6 million of commercial
airline loans and $18.8 million of commercial airline leases. The increase
in net charge-offs for residential was due primarily to the $9.1 million
charge-off taken in conjunction with the sale of $27 million of
nonperforming residential mortgage loans that took place during the second
quarter of 2002.
Nonperforming assets at June 30, 2002 were $186.0 million compared to $197.8
million and $126.9 million as of December 31, 2001 and June 30, 2001,
respectively. The increase in nonperforming assets over the past twelve
months was due primarily to the overall weak economic environment,
particularly in the airline industry. However, since year-end 2001,
nonaccrual loans in the corporate lending portfolio have decreased $4.6
million. The decrease in nonaccrual residential mortgage loans during the
second quarter of 2002 is primarily due to the sale of $27 million of
nonaccrual loans from the residential mortgage portfolio. The composition of
nonperforming assets over the past five quarters is provided in the
following table.
2002 2001
-------------------- --------------------------------
Second First Fourth Third Second
(Dollars in Thousands) Quarter Quarter Quarter Quarter Quarter
- ---------------------------------------------------------------------------------------
Nonaccrual Loans:
Corporate Lending:
Commercial $108,330 $111,727 $116,663 $ 84,700 $ 74,098
Mortgage 5,546 1,938 1,929 1,984 1,944
Construction 7,268 1,984 2,699 2,213 4,585
Lease Financing 3,497 5,223 7,986 5,977 6,079
-------- -------- -------- -------- --------
Total Corporate Lending 124,641 120,872 129,277 94,874 86,706
Consumer Lending:
Residential 35,920 62,530 47,579 36,792 23,868
Installment - - - - -
Lease Financing - - - - -
-------- -------- -------- -------- --------
Total Consumer Lending 35,920 62,530 47,579 36,792 23,868
-------- -------- -------- -------- --------
Total Nonaccrual Loans 160,561 183,402 176,856 131,666 110,574
Other Nonperforming Assets 25,471 28,098 20,907 15,758 16,279
-------- -------- -------- -------- --------
Total Nonperforming Assets $186,032 $211,500 $197,763 $147,424 $126,853
======== ======== ======== ======== ========
Loans 90 Days Past Due
Still Accruing $ 31,626 $ 30,115 $ 31,219 $ 34,929 $ 22,830
Nonaccrual Loans to
Total Loans and Leases 1.57% 1.81% 1.68% 1.27% 1.06%
Nonperforming Assets to:
Total Loans, Leases and
Other Nonperforming Assets 1.82% 2.08% 1.88% 1.42% 1.22%
Total Assets 1.19% 1.38% 1.27% 0.97% 0.84%
-22-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Nonaccrual loans decreased $16.3 million during the first half of 2002. The
decrease was composed of $104.1 million of additions to nonaccrual loans,
less $47.3 million of payments on nonaccrual loans, $60.4 million of
nonaccrual loans charged off and $12.7 million transferred to other
nonperforming assets. The decrease in nonaccrual residential mortgage loans
was the primary reason for the decrease in nonaccrual loans. Other
nonperforming assets increased $4.6 million during the first half of 2002,
due primarily to an increase in foreclosed residential properties. The
increase was composed of $12.7 million of transfers from nonaccrual loans
and $5.7 million of other additions less $7.0 million of payments and $6.8
million of charge-offs and write-downs of nonperforming assets.
Noninterest Income
- ------------------
The following table details the components of noninterest income and their
change for the second quarter and six-month periods of 2002 and 2001:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ Pctg ------------------- Pctg
(Dollars in Thousands) 2002 2001 Change 2002 2001 Change
- -------------------------------------------------------------------------------------------------
Service Charges on Deposit Accounts $ 10,915 $ 10,131 7.7% $ 21,364 $ 19,239 11.0%
Loan Servicing Fees 10,126 11,692 (13.4) 20,081 23,270 (13.7)
Other Service Charges and Fees 12,657 10,293 23.0 23,020 19,785 16.4
Leasing Income 9,054 11,410 (20.6) 18,968 22,831 (16.9)
Cash Gains on Sale of Loans 4,494 857 - 7,134 1,236 -
Warrant Gains 8,186 412 - 8,186 412 -
Security Gains 654 - - 654 - -
Other 9,230 19,588 (52.9) 19,493 30,982 (37.1)
-------- -------- -------- --------
Total Noninterest Income $ 65,316 $ 64,383 1.4 $118,900 $117,755 1.0
======== ======== ======== ========
Explanations for significant changes in noninterest income by category
follow:
o Service charges on deposit accounts increased $.8 million and $2.1
million in the quarterly and six month comparisons. Increases in
overdraft fees and service charges on corporate deposit accounts were the
primary reasons for the increase in the comparisons.
o Decreases in fees from servicing securitized residential mortgage and
credit card portfolios, which more than offset increases from servicing
multi-family loans by Red Capital Group and residential mortgage loans by
Mortgage Banking, were the primary reasons for the decrease in loan
servicing fees for both the quarterly and six-month comparisons.
o Other service charges and fees increased $2.4 million and $3.2 million in
the quarterly and six-month comparisons. The increase for both periods
was due primarily to an increase in other fee income generated from the
residential mortgage portfolio and funds management fees, more than
offsetting a decrease in credit card fees.
o Leasing income decreased in both the quarterly and six-month comparisons.
The decrease for both periods was due primarily to the reduction in size
of the leasing portfolio of Provident Commercial Group, a national lessor
of large equipment.
-23-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
o The increase of $3.6 million and $5.9 million in gain on sales of loans
in the quarterly and six-month comparisons is due primarily to gains
recognized from the sale of nonconforming residential mortgage loans on a
whole-loan basis, a strategy that Provident implemented during the third
quarter of 2001. During the first six months of 2002, over $300 million
of residential loans were sold on a whole-loan basis providing gains of
$5.3 million.
o Provident's Commercial Banking business line from time to time acquires
equity warrants as a part of the lending fee structure established with
customers. Warrant gains of $8.2 million and $.4 million were recognized
during the first six months of 2002 and 2001, respectively.
o Decreases in income from equity investments and miscellaneous fees earned
by Red Capital Group were the primary reasons for the $10.4 million and
$11.5 million decrease in other income in the quarterly and six-month
comparisons.
Noninterest Expense
- -------------------
The following table details the components of noninterest expense and their
change for the second quarter and six-month periods of 2002 and 2001:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ Pctg ------------------- Pctg
(Dollars in Thousands) 2002 2001 Change 2002 2001 Change
- ------------------------------------------------------------------------------------------
Salaries, Wages and Benefits $ 58,730 $ 53,036 10.7% $115,119 $101,168 13.8%
Charges and Fees 8,099 8,584 (5.7) 15,750 15,228 3.4
Occupancy 5,950 5,541 7.4 11,968 11,149 7.3
Leasing Expense 6,534 7,642 (14.5) 16,980 14,841 14.4
Equipment Expense 5,975 6,359 (6.0) 12,182 13,017 (6.4)
Professional Services 6,219 7,344 (15.3) 12,304 12,767 (3.6)
Minority Interest Expense 666 - - 666 - -
Other 21,328 17,396 22.6 42,075 33,188 26.8
-------- -------- -------- --------
Total Noninterest Expense $113,501 $105,902 7.2 $227,044 $201,358 12.8
======== ======== ======== ========
Explanations for significant changes in noninterest expense by category
follow:
o Salaries, wages and benefits increased $5.7 million and $14.0 million in
the quarterly and six-month comparisons due primarily to increased
staffing and incentive pay in areas where opportunities for growth exist,
such as middle market commercial lending, middle market equipment leasing
and mortgage servicing. Staffing expense also increased within the Credit
and Risk Management Group in order to better monitor and control the
overall risk of the company, particularly credit risk within the lending
portfolio.
o Charges and fees decreased $.5 million in the quarterly comparison due
primarily to a decrease in goodwill amortization expense. Charges and
fees increased $.5 million in the six-month comparison due primarily to
credit risk transfer agreements. Details concerning these transactions
are provided in the "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Derivative and Off-Balance Sheet
Financial Instruments" section of this report.
-24-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
o Increases in rent expense, repair and maintenance, and guard services
were the primary reasons for the increase in occupancy expense.
o A reduction in the size of the large equipment leasing portfolio and a
partial recovery on write-downs of residual values were the primary
reasons for the reduction in leasing expense in the quarterly comparison.
A valuation adjustment and other disposal costs related to leased
equipment were the primary reasons for the increase in leasing expense in
the six-month comparison.
o Equipment expense decreased in the quarterly and six-month comparisons
due to decreases in depreciation and equipment rental expense.
o A decrease in legal fees was the primary reason for the decrease in
professional services.
o Minority interest expense relates to dividends payable on $165 million of
Preferred Stock of PFGI Capital Corporation, a real estate investment
trust that was formed late in the second quarter of 2002. The dividends
are payable at an annualized rate of 7.75%.
o Increases in marketing expense and expenses related to foreclosed
properties were the primary reasons for the increase in other expense in
both the quarterly and six-month comparisons.
FINANCIAL CONDITION
- -------------------
Short-Term Investments and Investment Securities
- ------------------------------------------------
Federal funds sold and reverse repurchase agreements decreased $67 million
since December 31, 2001. The amount of federal funds sold changes daily as
cash is managed to meet reserve requirements and customer needs. After funds
have been allocated to meet lending and investment requirements, any
remainder is placed in overnight federal funds.
Trading account securities were $82 million and $101 million as of June 30,
2002 and December 31, 2001, respectively. Provident trades investment
securities with the intention of recognizing short-term profits. These
securities are carried at fair value with realized and unrealized gains and
losses reported in noninterest income.
Provident classified $328 million of loans as held for sale at June 30,
2002. This is an increase of $111 million from the amount reported at
December 31, 2001. These loans consist of $270 million of multifamily loans
and $58 million of nonconforming residential mortgage loans. The multifamily
loans are generally insured by either the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation or the Federal
Housing Association. These loans are usually outstanding for sixty days or
less. Activities related to the multifamily loans held for sale are part of
the operations of Red Capital Group. Nonconforming residential mortgage
-25-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
loans are being sold on a whole-loan basis. This is part of the initiative
to transition the Mortgage Banking business to a lower risk profile.
Securities purchased with the intention of being held for indefinite periods
of time are classified as investment securities available for sale. These
securities increased $330 million during the first six months of 2002. U.S.
government agency mortgage-backed securities accounted for the majority of
the increase, as funds obtained from loan payments and the sale of other
debt securities were deployed into investment securities with higher credit
quality, increased liquidity and an improved interest rate risk profile.
Loans and Leases
- ----------------
As of June 30, 2002 total loans and leases were $10.2 billion compared to
$10.5 billion at December 31, 2001. Provident had an additional $3.4 billion
and $4.1 billion of off-balance sheet loans and leases as of June 30, 2002
and December 31, 2001, respectively. As a result of recent earnings
volatility, management has re-evaluated the risk/reward relationships of its
lending portfolio. During the second half of 2001, Provident implemented a
whole-loan sale strategy for its nonconforming residential loans. Also,
management has decided to de-emphasize its structured finance lending while
placing a greater focus on its regional middle-market commercial lending and
middle-market equipment leasing. Provident is also providing fewer resources
to its auto leasing business as management has determined that this is a
thin margin business and that capital can be better deployed elsewhere. As a
result of these actions, Provident's lending portfolio in future periods
should have lower concentrations of residential loans and consumer leases,
higher concentrations of middle-market corporate leases, and a lower risk
profile of commercial loans. Provident does not have a material exposure to
foreign, energy or agricultural loans.
The following table shows the composition of the commercial loan category by
industry type at June 30, 2002:
Amount on
(Dollars in Millions) Amount % Nonaccrual
- ----------------------------------------------------------------------------
Manufacturing $ 692.9 16 $ 31.9
Service Industries 654.5 15 28.6
Real Estate Operators/Investment 436.1 10 0.4
Retail Trade 343.2 8 2.3
Finance and Insurance 319.6 8 18.4
Wholesale Trade 260.1 6 0.5
Transportation/Utilities 299.1 7 8.6
Construction 218.6 5 6.2
Automobile Dealers 109.8 3 -
Other 955.8 22 11.4
---------- --- --------
Total $ 4,289.7 100 $ 108.3
========== === ========
-26-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
At June 30, 2002, Provident had loans and leases of $193 million to the
commercial airline carriers, including $39 million of commercial loans and
$154 million of finance and operating leases. As the tragic events of
September 11, 2001 have had a significant financial impact upon the airline
industry and the re-sale value of aircraft, Provident recorded credit costs
and other expenses of $66 million and $27 million during the second half of
2001 and first half of 2002, respectively, which were related to secured
commercial airline loans and leases.
At June 30, 2002, Provident had approximately $794 million of commercial
loans that are to borrowers who have shared national credit loans.
Generally, shared national credit loans are loans that have a commitment
amount of at least $20 million and involve three or more supervised
financial institutions. In an on-going effort to diversify its portfolio,
the shared national credit loans in which Provident participates are
distributed across sixteen business segments, with the largest segment
concentration (real estate) accounting for approximately 17% of its total
shared national credit loans. The average outstanding balance of a shared
national credit loan was $4.8 million.
The composition of the corporate mortgage and construction loan categories
by property type at June 30, 2002 follows:
Amount on
(Dollars in Millions) Amount % Nonaccrual
- ----------------------------------------------------------------------------
Residential Development $ 269.4 18 $ 4.5
Shopping/Retail 233.6 16 -
Apartments 221.8 15 3.0
Office/Warehouse 200.8 14 0.2
Health Facilities 103.7 7 -
Land 70.3 5 3.7
Hotels/Motels 70.1 5 0.1
Industrial Plants 30.1 2 -
Churches 10.0 1 -
Auto Sales and Service 9.3 1 -
Other Commercial Properties 230.3 16 1.3
---------- --- -------
Total $ 1,449.4 100 $ 12.8
========== === =======
As of June 30, 2002, Provident had $1.3 billion in commercial lease
financing. These leases were comprised of $1.1 billion from Information
Leasing Corporation, Provident's small to mid-size equipment leasing
business unit, and $.2 billion from Provident Commercial Group, Provident's
large equipment leasing business unit.
The following table shows the composition of the installment loan category
by loan type at June 30, 2002:
(Dollars in Millions) Amount %
- --------------------------------------------------------------------------
Home Equity $810.9 80
Indirect Installment 120.4 12
Direct Installment 59.7 6
Other Consumer Loans 17.4 2
-------- ---
Total $1,008.4 100
======== ===
-27-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Noninterest Earning Assets
- --------------------------
Leased equipment decreased $19 million, or 10%, during the first half of
2002 due primarily to a reduction in the size of the leasing portfolio of
Provident Commercial Group, a national lessor of large equipment.
Other assets increased $147 million, or 23%, during the first half of 2002.
The increase was primarily due to a receivable resulting from the sale of
investment securities that did not settle until the first week of July.
Deposits
- --------
Total deposits increased $538 million during the first half of 2002. Average
core deposits grew at an annualized rate of 8% during the first half of
2002, with significant contribution coming from internet deposit-gathering
initiatives.
Borrowed Funds
- --------------
Short-term debt decreased $570 million, or 30%, during the first half of
2002. A decrease in federal funds purchased was the primary reason for the
decrease in short-term debt.
Long-term debt decreased $26 million, or 1%, during the first half of 2002
due primarily to scheduled principal payments on long-term debt. During July
2002, Provident issued $75 million of senior unsecured long-term notes. The
notes have an annual interest rate of 8.375% and mature on July 15, 2032.
The notes may be called in whole or in part at any time on or after July 15,
2007.
Minority Interest
- -----------------
During June 2002, Provident and its consolidated subsidiary, PFGI Capital
Corporation ("PFGI Capital"), issued 6.6 million equity units ("PRIDES") for
$165 million. The Provident Bank (the "Bank"), Provident's most significant
subsidiary, owns all of the $165 million of Common Stock of PFGI Capital.
The principle business objective of PFGI Capital is to acquire, hold and
manage commercial mortgage loan assets and other authorized investments from
the Bank that will generate net income for distribution to its stockholders.
PFGI Capital has elected to be treated as a real estate investment trust
(REIT) for federal income tax purposes.
Each PRIDES has a stated amount of $25 per unit and is comprised of two
components - a 3-year forward purchase commitment (the "Purchase Contract")
and PFGI Capital Preferred Stock.
Each Purchase Contract obligates the holder to buy, on August 17, 2005, for
$25, a number of newly issued shares of Provident Common Stock equal to the
"settlement rate." The settlement rate will be calculated as follows:
o if the market value of Provident Common Stock is equal to or greater than
the $29.0598, the settlement rate will be .8603;
-28-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
o if the market value of Provident Common Stock is between $29.0598 and
$24.42, the settlement rate will be equal to the $25 stated amount
divided by the applicable market value; and
o if the applicable market value is less than or equal to $24.42, the
settlement rate will be 1.0238.
"Applicable market value" is defined as the average of the closing price per
share of Provident Common Stock on each of the twenty consecutive trading
days ending on the fifth trading day immediately preceding August 17, 2005.
The following table illustrates how the settlement rate impacts the total
number of shares of Provident Common Stock that will be issued under the
Purchase Contract and the calculated price per share:
Applicable Market Value Less Than Greater Than
of Provident Common Stock $24.42 $25.00 $28.00 $29.0598
- ---------------------------------------------------------------------------------------
Settlement Rate (25.00/24.42) (25.00/25.00) (25.00/28.00) (25.00/29.0598)
1.0238 1.0000 0.8929 0.8603
Total Purchased Contracts
Outstanding 6,600,000 6,600,000 6,600,000 6,600,000
------------ ------------ ------------ ------------
Shares of Provident
Common Stock Purchased 6,757,080 6,600,000 5,893,140 5,677,980
========= ========= ========= =========
Total Proceeds Received
From PFGI Preferred
Stock Issuance $165,000,000 $165,000,000 $165,000,000 $165,000,000
Shares of Provident
Common Stock Purchased 6,757,080 6,600,000 5,893,140 5,677,980
------------ ------------ ------------ ------------
Price Paid Per Share of
Provident Common Stock $ 24.42 $ 25.00 $ 28.00 $ 29.06
============ ============ ============ ============
Under the Purchase Contract, Provident will also make quarterly contract
adjustment payments to the PRIDES holders at the rate of 1.25% of the stated
amount per year. The present value of this obligation has been recorded as a
liability and as a reduction to shareholders' equity.
The PFGI Capital Preferred Stock has a liquidation preference of $25 and an
initial non-cumulative dividend rate of 7.75%. Under certain circumstances,
the PFGI Capital Preferred Stock will be automatically exchanged for the
Bank Preferred Stock.
Concurrent with the fulfillment of the Purchase Contract, Provident has
engaged a remarketing agent to remarket the PFGI Capital Preferred Stock on
behalf of the holders, at which time the PFGI Preferred Stock is permanently
detached from the Purchase Contract. Once the Purchase Contract is
fulfilled, there will be two separate and distinct securities outstanding:
PFGI Capital Preferred Stock and Provident Common Stock. The number of
common shares to be issued will be from 5,677,980 to 6,757,080, depending on
the market value of the Common Stock. The proceeds received from the
remarketing will be used by the holders of Preferred Stock to fulfill their
commitment under the terms of the Purchase Contract.
-29-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Other Noninterest Earning Liabilities
- -------------------------------------
Other liabilities decreased $58 million, or 11%, during the first half of
2002 due primarily to a reduction in the amount of market value adjustments
recorded in relation to Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities."
Capital Resources and Adequacy
- ------------------------------
Total shareholders' equity at June 30, 2002 was $948 million compared to
$893 million at December 31, 2001. The change in the equity balance relates
primarily to net income exceeding dividends by $33 million (quarterly common
dividend rate of $.24), an increase in the market value of cash flow hedging
instruments of $18 million (net of deferred taxes) and an increase in the
market value of investment securities of $28 million (net of deferred
taxes).
The following table of ratios is important for an analysis of capital
adequacy:
Six Months Ended Year Ended
June 30, 2002 December 31, 2001
-------------------------------------
Average Shareholders' Equity to Average Assets 6.08% 6.51%
Dividend Payout to Net Earnings 42.21 205.76
Tier 1 Capital to Risk-Weighted Assets 10.64 8.86
Total Risk-Based Capital To Risk-Weighted Assets 12.54 11.41
Tier 1 Leverage Ratio 9.34 7.87
Risk-based capital guidelines established by the Federal Reserve Board set
minimum capital requirements and require institutions to calculate
risk-based capital ratios by assigning risk weightings to assets and
off-balance sheet items. These guidelines further define "well-capitalized"
levels for Tier 1, total risk-based capital, and leverage ratio purposes at
6%, 10% and 5%, respectively. As of June 30, 2002, both Provident and the
Bank were categorized as well capitalized for regulatory purposes.
As noted in earlier sections of this report, Provident issued $165 million
of PRIDES in connection with the formation of PFGI Capital during the second
quarter of 2002. These equity units qualify as Tier 1 Capital in Provident's
calculation of regulatory capital ratios.
Capital expenditures planned by Provident in 2002 for premises and equipment
are currently estimated to be approximately $37 million. Included in this
amount are projected capital expenditures for the purchase of data
processing hardware and software, office/facility additions, renovations and
enhancements, and ATMs. Through June 30, 2002, approximately $9 million of
these expenditures had been made.
Stock Options
- -------------
Options to purchase approximately 1.5 million shares of Provident common
securities were granted during the first six months of 2002. The options
have exercise prices ranging from $21.73 to $30.38.
-30-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Transactions with Affiliates
- ----------------------------
Provident has had certain transactions with various executive officers,
directors and principal holders of equity securities of Provident and its
subsidiaries and entities in which these individuals are principal owners. A
summary of significant transactions and the indebtedness of these related
parties can be found in Note 20 to Provident's 2001 Annual Report as filed
on Form 10-K.
ASSET SECURITIZATION ACTIVITY
- -----------------------------
From 1996 through the second quarter of 2000, the structure of many of
Provident's securitizations resulted in the transactions being treated as
sales. As such, gains or losses were recognized, loans and leases were
removed from the balance sheet and residual assets, representing the present
value of future cash flows, were recorded. While the performance of
Provident's residual assets have generally been better than or consistent
with their initial estimates, other companies utilizing securitization
structures requiring gain-on-sale accounting have experienced valuation
problems and consequently, the market penalized all companies using
gain-on-sale accounting. Although gain-on-sale accounting is in compliance
with Generally Accepted Accounting Principles, the investment community
clearly signaled its dissatisfaction with this accounting method and
management believed this sentiment had been factored into Provident's stock
price. Additionally, newly-issued regulatory guidelines regarding
securitization activity discourage the use of gain-on-sale accounting by
limiting the amount of residual assets that can be included as part of
regulatory capital.
As a result of these factors, Provident decided that securitizations during
the third quarter of 2000 and thereafter would be structured to allow for
the transactions to be treated as secured financings which eliminates the
use of gain-on-sale accounting. The switch to a secured financing structure
does not affect the total profit Provident will recognize over the life of
the asset, but rather impacts the timing of income recognition. Secured
financing transactions cause reported earnings from securitized assets to be
lower in the initial periods and higher in later periods, as interest is
earned on the assets. As a result, moving away from transaction structures
that use gain-on-sale accounting caused Provident's earnings to be lower
over the short term, particularly in 2000 and 2001.
The securitization and sale of loans and leases, during the period from 1996
through the first half of 2000, continues to impact the current presentation
of Provident's financial condition, results of operations and off-balance
sheet market risks. The areas most significantly affected are loans and
leases, retained interest in securitized assets, credit enhancements
accounts and credit risk.
-31-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Securitized Loans and Leases
- ----------------------------
Securitized loans and leases that have been treated as sales have been
removed from the balance sheet. The following table provides a summary of
the outstanding balances of these off-balance sheet managed assets:
June 30
-------------------------------
(In Thousands) 2002 2001
- ----------------------------------------------------------------------------
Nonconforming Residential $2,180,788 $3,115,224
Auto Leases 900,045 1,053,332
Prime Home Equity 244,270 387,480
Equipment Leases 115,663 284,854
Credit Card - 155,000
---------- ----------
$3,440,766 $4,995,890
========== ==========
In June 2002, the Financial Accounting Standards Board ("FASB") issued a
draft of a proposed interpretation that would establish accounting guidance
for consolidation of special-purpose entities ("SPEs"). Although this
interpretation is in the process of being further developed, it is expected
that if this proposal is implemented, more SPEs will be consolidated than in
the past. As the proposal is currently written, qualifying SPEs, as
described in FAS Statement No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," and other SPEs with
similar characteristics would continue to be excluded from consolidation.
Management is in the process of determining the impact of the proposal, if
any, on its earnings and financial position.
Provident retains the servicing of the loans and leases it securitizes. As a
result, a significant level of assets is serviced by Provident, which do not
appear on its balance sheet. These off-balance sheet assets significantly
contributed to the generation of $20.1 million and $23.3 million in loan
servicing fees during the first six months of 2002 and 2001, respectively.
-32-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Retained Interest in Securitized Assets
- ---------------------------------------
In connection with the recognition of non-cash gains on securitizations
accounted for as sales, the present value of future cash flows, referred to
as retained interest in securitized assets ("RISAs"), were recorded as
assets within the investment securities line item of the consolidated
balance sheets. Components of the RISAs, based on current models, as of June
30, 2002 follow:
Nonconforming Prime
(In Thousands) Residential Home Equity
- ----------------------------------------------------------------------------
Estimated Cash Flows of Underlying Loans,
Net of Payments to Certificate Holders $ 198,506 $ 9,294
Less:
Estimated Credit Loss (6,847) (50)
Servicing and Insurance Expense (30,970) (773)
Discount to Present Value (25,092) (1,421)
--------- -------
Carrying Value of Retained Interest in
Securitized Assets $ 135,597 (1) $ 7,050
========= =======
(1)Carrying value of Retained Interest in Securitized Assets, net of
reserves carried as other liabilities, was $87,350 at June 30, 2002.
Securitization Credit Enhancements
- ----------------------------------
Provident has provided for credit enhancements to its securitizations
structured as sales in the form of reserve accounts. The reserve accounts
are maintained at a significantly higher balance than the level of estimated
credit losses to improve the credit grade of the securitization and thereby
reduce the rate paid to investors of the securitization trust. Credit losses
are absorbed directly into these reserve accounts. Provident estimates the
amount of all credit losses based upon loan credit grades, collateral,
market conditions and other pertinent factors.
During the fourth quarter of 2001, Provident reached an agreement with the
securitization insurer to release the reserve accounts for the nonconforming
residential loan securitizations and substitute an unfunded demand note
backed by a AAA rated standby letter of credit. Actual losses, which $48.2
million have been reserved for, are submitted on a monthly basis to
Provident by the trustee. Should Provident fail to reimburse the trustee for
these monthly losses, the letter of credit can be drawn upon. There are no
conditions that can accelerate this monthly process.
As of June 30, 2002, Provident had $54.8 million and $28.5 million in credit
enhancement accounts for securitized equipment leases and prime home equity
loans, respectively.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Securitization Credit Risk
- --------------------------
The following table presents a summary of various indicators of the credit
quality of off-balance sheet loans and leases as of and for the six months
ended June 30, 2002:
Nonconforming Prime Home Equipment
(Dollars in Thousands) Residential Equity Leases
- ------------------------------------------------------------------------------
For the Six Months Ended June 30, 2002:
Average Securitized Assets $ 2,369,013 $ 266,588 $ 160,882
Net Charge-Offs 40,044 1,147 3,505
Net Charge-Offs to Average
Securitized Assets (Annualized) 3.38% 0.86% 4.36%
As of June 30, 2002:
Securitized Assets $ 2,180,788 $ 244,270 $ 115,663
Established Contingent Loss Liability 55,094 823 1,499
Estimated Credit Losses to
Period-End Securitized Assets 2.53% 0.34% 1.30%
Estimated Credit Loss Rates:
Annual Basis 1.09% 0.20% 1.00%
Percentage of Original Balance 2.94% 0.42% 1.97%
Delinquency Rates:
30 to 89 Days 7.69% 0.24% 2.82%
90 or More 18.31% 0.74% 2.96%
Management does not believe that future losses on off-balance sheet loans
and leases will exceed the established contingent loss liability.
FANNIE MAE DUS PROGRAM
- ----------------------
Red Capital Group, a business unit within the Commercial Banking business
line, is an approved Fannie Mae Delegated Underwriting and Servicing ("DUS")
mortgage lender. Under the Fannie Mae DUS program, Red Capital underwrites,
funds and sells mortgage loans on multifamily rental projects. Red Capital
then services these mortgage loans on Fannie Mae's behalf. Participation in
the Fannie Mae DUS program requires Red Capital to share the risk of loan
losses with Fannie Mae. Red Capital's share of any losses is limited to 20%
of the original principal balance of each loan. The substance of the loss
sharing is that Red Capital assumes the initial loss up to 5% of the unpaid
principal balance, after which Red Capital and Fannie Mae split additional
losses 25% to Red Capital and 75% to Fannie Mae until such additional losses
total 20% of the unpaid principal balance. From that point, losses are split
10% to Red Capital and 90% to Fannie Mae with the total loss to Red Capital
capped at 20% of the original principal balance of the loan.
Red Capital services multifamily mortgage loans under the DUS program with
outstanding principal balances aggregating approximately $2.8 billion at
June 30, 2002. At June 30, 2002, no DUS loans in Red Capital's loan
servicing portfolio were delinquent or in default. Red Capital has
established reserves of approximately $8.4 million for possible loan losses
under this program. The reserve is determined by evaluating pools of
homogenous loans and includes information based upon industry and historical
loss experience, as well as each project's recent operating performance.
Management believes the reserve is maintained at a level that adequately
provides for the inherent losses within Red Capital's portfolio of DUS
-34-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
loans. The employees and management team of Red Capital have originated and
serviced the existing Fannie Mae DUS loan servicing portfolio since 1995
without any charge-offs relating to the DUS loans.
DERIVATIVE AND OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
- ------------------------------------------------------
In the normal course of business, Provident uses derivative and off-balance
sheet financial instruments to manage its interest rate risk and to meet the
financing needs of its customers. At June 30, 2002, these financial
instruments consisted of standby letters of credit of $277 million,
commitments to extend credit of $2.9 billion, and interest rate swaps and
caps with a notional amount of $7.0 billion and $5.7 billion, respectively.
During 2001 and 2000, Provident entered into two credit risk transfer
transactions. Under the 2001 transaction, Provident transferred 97 1/2% of
the credit risk on a $.8 billion auto lease portfolio, while retaining a 2
1/2% first-loss position. Under the 2000 transaction, Provident transferred
98% of the credit risk on a $1.8 billion auto lease portfolio, while
retaining a 2% first-loss position. As a result of these transactions,
Provident was able to lower its credit concentration in auto leasing while
reducing its regulatory capital requirements. As of June 30, 2002, the
remaining unpaid auto lease balances on the 2001 and 2000 credit risk
transfer transactions were $.7 billion and $1.3 billion, respectively.
LIQUIDITY
- ---------
Adequate liquidity is necessary to meet the borrowing needs and deposit
withdrawal requirements of customers as well as to satisfy liabilities, fund
operations and support asset growth. Provident has a number of sources to
provide for liquidity needs. First, liquidity needs can be met by the liquid
assets on its balance sheet such as cash, deposits with other banks and
federal funds sold. Additional sources of liquidity include the sale of
securities, the sale or secured financing of corporate and consumer loans
and leases and the generation of new deposits. Provident may also borrow
both short-term and long-term funds. Provident has an additional $1.4
billion available for borrowing under a $1.5 billion bank notes program.
Approximately $120 million of long-term debt is due to be repaid during the
remainder of 2002.
The major source of liquidity for Provident on a parent-only basis is
dividends paid to it by its subsidiaries. Pursuant to Federal Reserve and
state banking regulations, the maximum amount available for dividend
distribution to the Parent at June 30, 2002 by its banking subsidiary was
approximately $92.1 million. The Parent has received $15 million in
dividends from its banking subsidiary during the current year. During 2001,
higher credit costs had an unfavorable impact on net income. While credit
costs have declined substantially during the first half of 2002, if these
costs were to rise again, this could impact Provident's ability to maintain
the payment of its quarterly dividend at current rates.
During 2002, the Parent has not drawn on any of its $170 million in general
purpose lines of credit with unaffiliated banks. Additionally the Parent had
approximately $198 million in cash and interest earning deposits to meet its
liquidity needs.
-35-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
The responsibility of monitoring and managing market and liquidity risk is
assigned to the Asset Liability Committee ("ALCO"). The main component of
market risk is the risk of loss in the value of financial instruments that
may result from the changes in interest rates. ALCO is bound to guidelines
stated in the relevant policies approved by the Board of Directors.
In addition to the natural balance sheet hedges, ALCO utilizes derivative
instruments to manage interest rate risk on and off its balance sheet.
Interest rate swaps are the most widely used tools to manage interest rate
risk. Provident has used derivative instruments effectively for a number of
years and believes it has developed the appropriate expertise and knowledge
to achieve a sound interest rate risk management process.
Provident uses an earnings simulation model to analyze net interest income
sensitivity to movements in interest rates. Given an instantaneous and
permanent change in the pricing of all interest rate sensitive assets,
liabilities and off-balance sheet financial agreements of Provident, net
interest income would change by the following over the next 12-month period:
increase .38% for a 100 basis point decrease; decrease .84% for a 100 basis
point increase; and decrease 3.01% for a 200 basis point increase. Due to
the current interest rate environment, nothing beyond a 100 basis point
decrease was simulated. The effects of these interest rate fluctuations are
considered extreme case scenarios, as the analysis does not give
consideration to any management of any new interest rate environment. These
tests are performed on a monthly basis, and the results, which are in
compliance with policy, are presented to the Board of Directors.
-36-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
---------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
Registrant's annual meeting of shareholders was held on April 25, 2002.
Proxies were solicited pursuant to Regulation 14 under the Securities
Exchange Act of 1934 and the following matters were voted upon and approved
by the shareholders as indicated below.
Votes Votes
For Withheld
- ----------------------------------------------------------------------------
Election of the following directors:
(a) Jack M. Cook 42,803,917 483,156
(b) Thomas D. Grote, Jr. 42,880,160 406,913
(c) Robert L. Hoverson 39,818,157 3,468,916
(d) Joseph A. Pedoto 42,934,921 352,152
(e) Sidney A. Peerless 42,918,402 368,671
(f) Joseph A. Steger 42,797,935 489,138
Votes Votes
For Against Abstained
- -------------------------------------------------------------------------------
Approval of Ernst and Young LLP as Provident's
independent public accountants for 2002 42,277,549 959,940 49,584
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ----------------------------------------
(a) Exhibits filed:
Exhibit 10 - Management Agreement and Master Participation and Servicing
Agreement between the Bank and PFGI Capital incorporated by reference
to Form S-3, as amended (File No. 333-88446 and No. 333-88446-01).
Exhibit 99.1 - Certification of Chief Executive Officer.
Exhibit 99.2 - Certification of Chief Financial Officer.
Exhibit 99.3 - Pro forma net income and earnings per share for years
ending December 31, 2001, 2000 and 1999 as if FAS No. 142, "Goodwill
and Other Intangible Assets" had been in effect for those years.
(b) Reports on Form 8-K:
Form 8-K (Items 5 and 7) filed on June 6, 2002.
Form 8-K (Items 5 and 7) filed on June 7, 2002.
Form 8-K (Items 5 and 7) filed on July 16, 2002.
Form 8-K (Items 7 and 9) filed on August 9, 2002.
All other items required in Part II of this form have been omitted since
they are not applicable or not required.
-37-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Provident Financial Group, Inc.
-------------------------------
Registrant
Date: August 14, 2002 \s\ Christopher J. Carey
------------------------
Christopher J. Carey
Executive Vice President and
Chief Financial Officer
-38-