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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
September 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 October 31, 2002 is 48,735,426.
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 . . . . . . . . . . . . . . . . . . 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK . . 41
ITEM 4. CONTROLS AND PROCEDURES . . . . . . . . . . . . . . . . . . . 42
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . . . 43
SIGNATURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
CERTIFICATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2002 2001
(Dollars in Thousands) (Unaudited)
- -------------------------------------------------------------------------------------
ASSETS
Cash and Due from Banks $ 327,467 $ 378,257
Federal Funds Sold and Reverse Repurchase Agreements 119,464 122,966
Trading Account Securities 204,202 101,156
Loans Held for Sale 189,581 217,914
Investment Securities Available for Sale
(amortized cost - $4,088,833 and $3,510,601) 4,138,464 3,486,058
Loans and Leases (Net of Unearned Income):
Corporate Lending:
Commercial 4,418,133 4,540,088
Mortgage 973,833 939,824
Construction 510,410 528,008
Lease Financing 1,317,133 1,188,319
Consumer Lending:
Residential 676,971 922,747
Installment 1,164,509 913,312
Lease Financing 1,364,261 1,463,658
------------ ------------
Total Loans and Leases 10,425,250 10,495,956
Reserve for Loan and Lease Losses (201,056) (240,653)
------------ ------------
Net Loans and Leases 10,224,194 10,255,303
Leased Equipment 179,195 185,863
Premises and Equipment 101,003 103,085
Goodwill 82,651 80,649
Other Assets 671,778 642,303
------------ ------------
TOTAL ASSETS $ 16,237,999 $ 15,573,554
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Noninterest Bearing $ 988,508 $ 994,978
Interest Bearing 8,284,737 7,859,272
------------ ------------
Total Deposits 9,273,245 8,854,250
Short-Term Debt 1,886,715 1,885,309
Long-Term Debt 2,977,236 2,941,165
Guaranteed Preferred Beneficial Interests in
Company's Junior Subordinated Debentures 450,969 450,759
Minority Interest 163,337 -
Accrued Interest and Other Liabilities 521,664 549,481
------------ ------------
Total Liabilities 15,273,166 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, 48,611,426 and 49,205,897 Issued 14,409 14,587
Capital Surplus 298,731 322,024
Retained Earnings 699,050 647,675
Accumulated Other Comprehensive Loss, Net (54,357) (98,696)
------------ ------------
Total Shareholders' Equity 964,833 892,590
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 16,237,999 $ 15,573,554
============ ============
See notes to consolidated financial statements.
-3-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
(In Thousands, Except Per Share Data) 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------
Interest Income:
Interest and Fees on Loans and Leases $ 181,208 $ 224,155 $ 547,019 $ 673,178
Interest on Investment Securities 52,401 49,306 162,589 158,091
Other Interest Income 6,106 6,600 16,963 15,829
--------- --------- --------- ---------
Total Interest Income 239,715 280,061 726,571 847,098
Interest Expense:
Interest on Deposits:
Savings and Demand Deposits 10,405 16,230 28,226 56,789
Time Deposits 54,664 77,643 171,871 249,639
--------- --------- --------- ---------
Total Interest on Deposits 65,069 93,873 200,097 306,428
Interest on Short-Term Debt 7,542 16,356 25,784 45,583
Interest on Long-Term Debt 35,817 38,321 104,511 122,898
Interest on Junior Subordinated
Debentures 5,999 7,839 18,087 24,001
--------- --------- --------- ---------
Total Interest Expense 114,427 156,389 348,479 498,910
--------- --------- --------- ---------
Net Interest Income 125,288 123,672 378,092 348,188
Provision for Loan and Lease Losses 25,100 66,010 82,209 114,597
--------- --------- --------- ---------
Net Interest Income After Provision
for Loan and Lease Losses 100,188 57,662 295,883 233,591
Noninterest Income:
Service Charges on Deposit Accounts 11,681 10,312 33,045 29,551
Loan Servicing Fees 10,325 10,329 30,406 33,599
Other Service Charges and Fees 11,687 9,017 34,707 28,802
Leasing Income 9,397 10,500 28,365 33,331
Cash Gains on Sale of Loans 5,001 3,254 12,135 4,490
Warrant Gains - - 8,186 412
Security Gains 633 - 1,287 -
Other 11,185 13,691 30,678 44,673
--------- --------- --------- ---------
Total Noninterest Income 59,909 57,103 178,809 174,858
Noninterest Expense:
Salaries, Wages and Benefits 57,141 52,783 172,260 153,951
Charges and Fees 7,029 8,321 22,779 23,549
Occupancy 5,861 5,634 17,829 16,783
Leasing Expense 6,285 28,123 23,265 42,964
Equipment Expense 5,680 6,209 17,862 19,226
Professional Services 6,007 5,476 18,311 18,243
Minority Interest Expense 3,223 - 3,889 -
Other 22,755 19,317 64,830 52,505
--------- --------- --------- ---------
Total Noninterest Expense 113,981 125,863 341,025 327,221
--------- --------- --------- ---------
Income Before Income Taxes 46,116 (11,098) 133,667 81,228
Applicable Income Taxes 15,680 (3,663) 46,084 29,008
--------- --------- --------- ---------
Net Income $ 30,436 $ (7,435) $ 87,583 $ 52,220
========= ========= ========= =========
Per Common Share:
Basic Earnings Per Share $ 0.62 $ (0.16) $ 1.78 $ 1.05
Diluted Earnings Per Share 0.60 (0.16) 1.73 1.03
Cash Dividends Paid 0.24 0.24 0.72 0.72
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 52,220 52,220
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 (71,676) (71,676)
Marketable Securities 33,239 33,239
---------
Total Comprehensive Income (14,549)
Dividends Paid on:
Preferred Stock (712) (712)
Common Stock (35,246) (35,246)
Exercise of Stock Options and
Accompanying Tax Benefits 100 5,913 6,013
Distribution of Contingent
Shares for Prior Year
Acquisition 8 822 830
Other 73 73
---------- -------- --------- --------- -------------- ---------
Balance at September 30, 2001 $ 7,000 $ 14,577 $ 321,703 $ 688,610 $ (84,698) $ 947,192
========== ======== ========= ========= ============== =========
Balance at January 1, 2002 $ 7,000 $ 14,587 $ 322,024 $ 647,675 $ (98,696) $ 892,590
Net Income 87,583 87,583
Other Comprehensive Income,
Net of Tax:
Change in Unrealized
Gains (Losses) on:
Hedging Instruments (3,873) (3,873)
Marketable Securities 48,212 48,212
---------
Total Comprehensive Income 131,922
Dividends Paid on:
Preferred Stock (712) (712)
Common Stock (35,496) (35,496)
Exercise of Stock Options and
Accompanying Tax Benefits 54 3,190 3,244
Benefit Plan Assets in
Provident Stock (232) (19,540) (19,772)
Costs Associated with issuance
of PRIDES Securities (6,919) (6,919)
Other (24) (24)
---------- -------- --------- --------- -------------- ---------
Balance at September 30, 2002 $ 7,000 $ 14,409 $ 298,731 $ 699,050 $ (54,357) $ 964,833
========== ======== ========= ========= ============== =========
See notes to consolidated financial statements.
-5-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
-------------------------------
(In Thousands) 2002 2001
- -----------------------------------------------------------------------------------
Operating Activities:
Net Income $ 87,583 $ 52,220
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Provision for Loan and Lease Losses 82,209 114,597
Amortization of Goodwill - 3,363
Other Amortization and Accretion 15,282 (4,900)
Depreciation of Leased Equipment and
Premises and Equipment 32,014 36,084
Tax Benefit Received from Exercise of Stock Options 844 2,504
Realized Investment Security Gains (1,287) -
Proceeds from Sale of Loans Held for Sale 2,175,191 1,892,462
Origination of Loans Held for Sale (2,136,513) (1,914,805)
Realized Gains on Loans Held for Sale (10,345) (1,519)
Net Purchases of Trading Account Securities (88,702) (36,462)
(Increase) Decrease in Interest Receivable 306 (5,022)
Decrease in Other Assets 18,379 63,681
Increase (Decrease) in Interest Payable (1,337) 15,778
Increase in Other Liabilities 27,613 66,692
----------- -----------
Net Cash Provided By Operating Activities 201,237 284,673
----------- -----------
Investing Activities:
Investment Securities Available for Sale:
Proceeds from Sales 1,022,535 1,895,947
Proceeds from Maturities and Prepayments 818,741 901,360
Purchases (2,411,298) (2,705,559)
Increase in Loans and Leases (48,200) (1,351,578)
(Increase) Decrease in Operating Lease Equipment (9,445) 13,411
Increase in Premises and Equipment (13,819) (14,703)
----------- -----------
Net Cash Used In Investing Activities (641,486) (1,261,122)
----------- -----------
Financing Activities:
Increase in Deposits 262,023 432,603
Increase in Short-Term Debt 1,406 689,698
Principal Payments on Long-Term Debt (113,803) (125,563)
Proceeds From Issuance of Long-Term Debt and
Company's Junior Subordinated Debentures 106,826 136,264
Proceeds From Issuance of Minority Interest,
Net of Transaction Costs 163,337 -
Cash Dividends Paid (36,208) (35,958)
Proceeds from Exercise of Stock Options 2,400 3,509
Net Increase (Decrease) in Other Equity Items (24) 73
----------- -----------
Net Cash Provided By Financing Activities 385,957 1,100,626
----------- -----------
Increase (Decrease) in Cash and Cash Equivalents (54,292) 124,177
Cash and Cash Equivalents at Beginning of Period 501,223 369,028
----------- -----------
Cash and Cash Equivalents at End of Period $ 446,931 $ 493,205
=========== ===========
Supplemental Disclosures of Cash Flow Information:
Cash Paid for:
Interest $ 349,817 $ 330,954
Income Taxes 5,000 14,634
Non-Cash Activity:
Transfer of Loans and Leases to
Other Real Estate and Equipment 22,509 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
accounting principles generally accepted in the United States (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 3.7 million and 2.0 million shares
of Common Stock were outstanding at September 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 Nine Months Ended
September 30, September 30,
-------------------- --------------------
(In Thousands, Except Per Share Data) 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------
Basic:
Net Income $ 30,436 $ (7,435) $ 87,583 $ 52,220
Less Preferred Stock Dividends (237) (237) (712) (712)
-------- -------- -------- --------
Income Available to Common Shareholders 30,199 (7,672) 86,871 51,508
Weighted-Average Common Shares Outstanding 48,616 49,081 48,828 48,949
-------- -------- -------- --------
Basic Earnings Per Share $ 0.62 $ (0.16) $ 1.78 $ 1.05
======== ======== ======== ========
Diluted:
Net Income $ 30,436 $ (7,435) $ 87,583 $ 52,220
Less Preferred Stock Dividends n/a (237)(1) n/a n/a
-------- -------- -------- --------
Income Available to Common Shareholders 30,436 (7,672) 87,583 52,220
Weighted-Average Common Shares Outstanding 48,616 49,081 48,828 48,949
Benefit Plans Common Shares 652 - 437 -
Assumed Conversion of:
Convertible Preferred Stock 988 n/a (1) 988 988
Dilutive Stock Options
(Treasury Stock Method) 471 n/a (1) 491 656
-------- -------- -------- --------
Dilutive Potential Common Shares 50,727 49,081 50,744 50,593
-------- -------- -------- --------
Diluted Earnings Per Share $ 0.60 $ (0.16) $ 1.73 $ 1.03
======== ======== ======== ========
(1) Assumed conversion of preferred stock and stock options are
anti-dilutive and thus, are not included in the calculation of diluted
earnings per share for the three months ended September 30, 2001.
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 $394 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 September 30, 2002:
Stated Effective Maturity
(Dollars in Thousands) Rate Rate (1) Date Amount
- ----------------------------------------------------------------------------
November 1996 Issuance 8.60% 8.66% 12/01/26 $ 98,992
June 1999 Issuance 8.75% 3.12% 06/30/29 121,489
November 2000 Issuance 10.25% 4.49% 12/31/30 109,229
March 2001 Issuance 9.45% 4.77% 03/30/31 121,259
--------
Total $450,969
========
(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:
Nine Months Ended
September 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 $26,411 in 2002 and $17,898 in 2001 49,049 33,239
Reclassification Adjustment for Gains Included in Net Income,
Net of Tax Expense of $450 in 2002 (837) -
--------- ---------
Effect on Other Comprehensive Income (Loss) for the Year 48,212 33,239
--------- ---------
Accumulated Unrealized Gains on Securities Available
for Sale at September 30, Net of Tax $ 32,259 $ 15,310
========= =========
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 Losses for the Period, Net of Tax
Benefit of $18,475 in 2002 and $46,150 in 2001 (34,310) (85,707)
Reclassification Adjustment for Losses Included in Net Income,
Net of Tax Benefit of $16,389 in 2002 and $7,555 in 2001 30,437 14,031
--------- ---------
Effect on Other Comprehensive Income (Loss) for the Year (3,873) (100,008)
--------- ---------
Accumulated Unrealized Losses on Derivatives Used in Cash
Flow Hedging Relationships at September 30, Net of Tax $ (86,616) $(100,008)
========= =========
Accumulated Other Comprehensive Loss at January 1, Net of Tax $ (98,696) $ (17,929)
Other Comprehensive Income (Loss), Net of Tax 44,339 (66,769)
--------- ---------
Accumulated Other Comprehensive Loss at September 30, Net of Tax $ (54,357) $ (84,698)
========= =========
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 broad
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 nine-month
periods ended September 30, 2002 and 2001.
` Commercial Retail Mortgage Corporate
(Dollars in Millions) Banking Banking Banking Center Total
- ---------------------------------------------------------------------------------------------
Three Months Ended September 30 2002:
Net Interest Income $ 56.9 $ 52.8 $ 15.6 $ - $ 125.3
Provision for Loan Losses (17.2) (3.3) (4.6) - (25.1)
Noninterest Income 28.9 18.5 11.9 0.6 59.9
Noninterest Expense (48.0) (48.2) (17.8) - (114.0)
Income Taxes (7.0) (6.8) (1.7) (0.2) (15.7)
-------- -------- -------- -------- ---------
Net Income $ 13.6 $ 13.0 $ 3.4 $ 0.4 $ 30.4
======== ======== ======== ======== =========
Average Assets $ 7,074 $ 3,790 $ 1,533 $ 3,087 $ 15,484
======== ======== ======== ======== =========
Three Months Ended September 30 2001:
Net Interest Income $ 56.9 $ 51.1 $ 15.7 $ - $ 123.7
Provision for Loan Losses (54.2) (9.8) (2.0) - (66.0)
Noninterest Income 32.3 18.3 6.5 - 57.1
Noninterest Expense (62.4) (48.2) (15.3) - (125.9)
Income Taxes 9.1 (3.8) (1.6) - 3.7
-------- -------- -------- -------- ---------
Net Income $ (18.3) $ 7.6 $ 3.3 $ - $ (7.4)
======== ======== ======== ======== =========
Average Assets $ 7,152 $ 3,426 $ 2,119 $ 2,626 $ 15,323
======== ======== ======== ======== =========
Nine Months Ended September 30 2002:
Net Interest Income $ 169.2 $ 162.5 $ 46.4 $ - $ 378.1
Provision for Loan Losses (49.3) (9.9) (14.0) (9.0) (82.2)
Noninterest Income 86.5 55.2 27.6 9.5 178.8
Noninterest Expense (141.3) (147.2) (52.5) - (341.0)
Income Taxes (22.4) (20.9) (2.6) (0.2) (46.1)
-------- -------- -------- -------- ---------
Net Income $ 42.7 $ 39.7 $ 4.9 $ 0.3 $ 87.6
======== ======== ======== ======== =========
Average Assets $ 6,994 $ 3,731 $ 1,591 $ 3,105 $ 15,421
======== ======== ======== ======== =========
Nine Months Ended September 30 2001:
Net Interest Income $ 157.9 $ 142.8 $ 47.5 $ - $ 348.2
Provision for Loan Losses (81.7) (20.1) (12.8) - (114.6)
Noninterest Income 104.0 51.3 19.5 - 174.8
Noninterest Expense (143.5) (135.4) (48.3) - (327.2)
Income Taxes (13.6) (13.4) (2.0) - (29.0)
-------- -------- -------- -------- ---------
Net Income $ 23.1 $ 25.2 $ 3.9 $ - $ 52.2
======== ======== ======== ======== =========
Average Assets $ 6,851 $ 3,219 $ 2,075 $ 2,732 $ 14,877
======== ======== ======== ======== =========
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 INTANGIBLE ASSETS
- ---------------------------------------------
Provident adopted the provisions of Statement of Financial Accounting
Standards 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 Statement 142, Provident did not incur any goodwill
amortization during 2002, whereas during 2001 Provident recorded goodwill
amortization. The following table provides net income and earnings per share
for the three-month and nine-month periods ended September 30, 2001 on a pro
forma basis excluding goodwill amortization.
Three Months Nine Months
Ended Ended
(In Thousands, Except Per Share Amounts) September 30, 2001 September 30, 2001
- ----------------------------------------------------------------------------------------
Net Income:
As Reported $ (7,435) $ 52,220
Add Back: After-Tax Goodwill Amortization 731 2,186
-------- --------
Pro-Forma Net Income $ (6,704) $ 54,406
======== ========
Basic Earnings Per Common Share:
As Reported $ (0.16) $ 1.05
Add Back: After-Tax Goodwill Amortization 0.02 0.05
-------- --------
Pro-Forma Basic Earnings Per Common Share $ (0.14) $ 1.10
======== ========
Diluted Earnings Per Common Share:
As Reported $ (0.16) $ 1.03
Add Back: After-Tax Goodwill Amortization 0.02 0.05
-------- --------
Pro-Forma Diluted Earnings Per Common Share $ (0.14) $ 1.08
======== ========
Changes in the carrying amount of goodwill by business line for the nine
months ended September 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 1,594 219 1,813
------- ------- -------
Balance at September 30, 2002 $41,419 $41,232 $82,651
======= ======= =======
-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 September 30, 2002:
Gross Net
Carrying Accumulated Carrying
(In Thousands) Value Amortization Value
- ----------------------------------------------------------------------------
Non-Contractual Customer Relationships $21,997 $ 6,761 $15,236
Purchased Core Deposits 1,429 983 446
------- ------- -------
Balance at September 30, 2002 $23,426 $ 7,744 $15,682
======= ======= =======
The estimated amortization of intangible assets for the next five years, is
$1.2 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 September 30, 2002 and 2001, Provident had $107.7 million and
$83.2 million, respectively, of mortgage servicing assets.
NOTE 8. EQUITY INVESTMENTS
- ---------------------------
Provident invests in low income housing partnerships, equity funds and
directly in equity securities, which are collectively referred to herein as
equity investments. Equity investments, which are reported within Investment
Securities Available for Sale and Other Assets, are carried at estimated
fair value with changes in fair value recognized in other noninterest
income. The fair value of publicly traded investments are determined using
quoted market prices less liquidity discounts. Liquidity discounts take into
account the fact that Provident may not immediately realize such market
prices due to regulatory, corporate and contractual sales restrictions. The
estimated fair value of equity investments that are not publicly traded
approximates cost including other than temporary valuation adjustments
considered appropriate by management. As of September 30, 2002, Provident
held equity investments with a carrying value of $73.7 million.
-12-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9. STOCK OPTIONS
- ----------------------
Financial Accounting Standards Board (FASB) Statement No. 123, "Accounting
for Stock-Based Compensation" encourages, but does not require, adoption of
a fair value-based accounting method for stock-based employee compensation
plans. Provident has elected to continue its accounting in accordance with
Accounting Principles Bulletin (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees", whereby no compensation expense is recognized for the
granting of stock options when the exercise price of the option equals the
market price of the underlying stock at the date of grant.
For purposes of providing pro forma disclosures as if Statement 123 had been
adopted as of its effective date (grants issued in fiscal years that begin
after December 15, 1994), the fair value of stock options was estimated at
the date of grant using a Black-Scholes option pricing model. The
Black-Scholes option pricing model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because Provident's stock options have characteristics significantly
different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate,
management believes that the Black-Scholes model may not necessarily provide
a reliable single measure of the fair value of its stock options.
Options to purchase approximately 1.6 million and 1.3 million shares of
Provident Common Stock were granted during the first nine months of 2002 and
2001, respectively. The following weighted-average assumptions were used in
the option pricing model for the first nine months of 2002 and 2001,
respectively: risk-free interest rates of 4.50% and 4.72%; dividend yields
of 3.5% and 3.0%; volatility factors of the expected market price of
Provident's Common Stock of 29.1% and 28.8%; and an expected life of the
option of 7 years for each period. Based on these assumptions, the
weighted-average fair value of options granted during the first nine months
of 2002 and 2001 was $5.85 and $8.44, respectively.
No compensation cost has been recognized for stock option grants. Had
compensation cost been determined for stock option awards based on the fair
values at grant dates as discussed above, Provident's net income and
earnings per share would have been as follows:
Nine Months Ended
September 30,
-------------------------
(In Thousands, Except Per Share Data) 2002 2001
- ----------------------------------------------------------------------------
Pro Forma Net Income $ 80,398 $ 45,208
Pro Forma Basic Earnings Per Share 1.63 0.91
Pro Forma Diluted Earnings Per Share 1.62 0.91
-13-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. 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 September 30, 2002 follow:
(In Thousands) Total Assets
- ----------------------------------------------------------------------------
Provident Auto Leasing Company $510,600
Provident Auto Rental LLC 2000-1 355,609
Provident Auto Rental LLC 2001-1 323,045
Provident Auto Rental LLC 1999-1 207,815
Provident Lease Receivables Company LLC 154,161
Provident Auto Rental LLC 2000-2 152,478
Provident Auto Rental Company LLC 1998-2 43,698
Provident Auto Rental Company LLC 1998-1 40,936
The above amounts include items which are eliminated in the Consolidated
Financial Statements.
NOTE 11. RECENT ACCOUNTING PRONOUNCEMENTS
- ------------------------------------------
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment No. 13, and Technical Corrections."
Under Statement 4, all gains and losses from extinguishment of debt were
required to be aggregated and classified as an extraordinary item, net of
related income tax effect. As a result of the elimination of Statement 4,
gains and losses from extinguishment of debt will be classified as
extraordinary items only if they meet the criteria in APB Opinion No. 30.
Applying the provisions of APB 30 will distinguish transactions that are
part of an entity's recurring operations from those that are unusual or
infrequent or that meet the criteria for classification of an extraordinary
item. Additionally, Statement 13 is amended to require sale-leaseback
accounting for certain lease modifications that have economic effects that
are similar to sale-leaseback transactions. Statement 145 becomes effective
January 1, 2003.
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force (EITF) Issue
94-3. Statement 146 requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred.
Under EITF 94-3, a liability for an exit cost was recognized at the date of
an entity's commitment to an exit plan. Statement 146 becomes effective
January 1, 2003.
-14-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In October 2002, the FASB issued Statement No. 147, "Acquisitions of Certain
Financial Institutions an amendment of FASB Statements No. 72 and 144 and
FASB Interpretation No. 9." Statement 147 provides guidance on the
accounting for the acquisition of a financial institution and applies to all
acquisitions except those between two or more mutual enterprises. The excess
of the fair value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired as a business combination represents
goodwill and will no longer be amortized, but rather, be subject to
impairment tests as prescribed by FASB Statement No. 142, "Goodwill and
Other Intangible Assets." Statement 147 became effective on October 1, 2002.
The adoption of Statements No. 145, 146 and 147 are not expected to have a
material impact on Provident's results of operations or financial condition.
-15-
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.
-16-
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 Nine Months Ended
September 30, September 30,
(Dollars in Thousands, ------------------------------------ -----------------------------------
Except Per Share Data) 2002 2001 Change 2002 2001 Change
-----------------------------------------------------------------------------------------------------------------
Net Interest Income $ 125,288 $ 123,672 1% $ 378,092 $ 348,188 9%
Noninterest Income 59,909 57,103 5 178,809 174,858 2
Total Revenue 185,197 180,775 2 556,901 523,046 6
Provision for Loan and Lease Losses 25,100 66,010 (62) 82,209 114,597 (28)
Noninterest Expense 113,981 125,863 (9) 341,025 327,221 4
Net Income 30,436 (7,435) n/m 87,583 52,220 68
Diluted Earnings per Share 0.60 (0.16) n/m 1.73 1.03 68
Return on Average Equity 12.73% (2.99%) 12.39% 7.11%
Return on Average Assets 0.79% (0.19%) 0.76% 0.47%
Efficiency Ratio (Excludes Unusual
Credit Charges, Minority Interest
Expense and Warrant Gains 58.45% 58.54% 60.37% 58.77%
n/m - not meaningful
Third quarter 2002 earnings per diluted share and net income were $.60 and
$30.4 million, respectively, compared with ($.16) and ($7.4) million in the
third quarter of 2001. The first nine months of 2002 earnings per diluted
share and net income were $1.73 and $87.6 million, respectively, compared
with $1.03 and $52.2 million for the same period in 2001. The loss recorded
in the third quarter of 2001 was primarily the result of large
credit-related charges taken during that period.
The provision for loan and lease losses was $82.2 million for the first
three quarters of 2002 as compared to $114.6 million during the same time
period of 2001. Additionally, Provident recorded $6.6 million and $20.0
million of credit-related charges for the write-down of foreclosed property
and leased equipment (included with noninterest expense) during the first
nine months of 2002 and 2001, respectively. The higher than normal provision
and credit-related charges in 2001 were due primarily to the weakened
economy and the events of September 11, 2001. Although the economy remains
sluggish, credit-related volatility has begun to stabilize during 2002.
Beginning with the third quarter of 2001 and continuing through the third
quarter of 2002, the quarterly provision for loan and leases has been $66.0
million, $111.2 million, $24.0 million, $33.1 million and $25.1 million. The
higher provision for the second quarter of 2002 as compared to the first and
third quarters of 2002 was a result of the sale of $27 million of
nonperforming loans from Provident's residential mortgage portfolio at a
$9.1 million discount. During the second and third quarters of 2002, the
allowance for loan and lease losses was allowed to decline from $240.7
million to $201.1 million as $29.4 million of commercial airline loans and
leases were charged off during the second quarter and a large nonaccrual
commercial loan was partially charged-off during the third quarter. These
charge-offs did not impact the second or third quarter 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.
-17-
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 $33.9 million, or 6%, during the first nine months of 2002 as
compared to the first nine months of 2001. Net interest income increased by
$29.9 million, or 9%, as a result of growth in earning assets, primarily
investment securities and small to mid-size equipment lease financing, and
an improved net interest margin which increased from 3.44% to 3.51%.
Noninterest income increased $4.0 million, or 2%, from that reported in last
year's first nine months.
Noninterest expense increased $13.8 million, or 4%, for the first three
quarters of 2002 as compared to the same period in 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. Offsetting these
increases were lower write-downs of foreclosed properties and leased
equipment which totaled $6.6 million and $20.0 million for the nine months
ended September 30, 2002 and 2001, respectively. The ratio of noninterest
expense to tax equivalent revenue (efficiency ratio), excluding unusual
credit charges, minority interest expense and warrant gains, increased to
60.37% for the first three quarters of 2002 as compared to 58.77% for the
same period during 2001.
Total assets increased $664 million from December 31, 2001 to September 30,
2002 primarily as a result of an increase in investment securities, small to
mid-size equipment lease financing and home equity loans. Partially
offsetting these increases were reductions in nonconforming residential
loans, structured finance loans and auto leases. The fluctuations in these
loan and lease balances reflect management's decision to lower the risk
profile of its loan and lease portfolio. Total deposits increased $419
million during the first nine months of 2002. Average retail and commercial
core deposits increased from $6,076 million to $6,400 million during this
time period. Regulatory capital ratios improved significantly during the
first nine months of 2002 due primarily to the issuance of $165 million of
Real Estate Investment Trust (REIT) PRIDES during the second quarter of
2002.
-18-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Business Lines
- --------------
Provident's major business lines are Commercial Banking, Retail Banking and
Mortgage Banking. The following table summarizes net income by major lines
of business for the three-month and nine-month periods ended September 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 Nine Months Ended
September 30, September 30,
--------------------- ---------------------
(Dollars in Millions) 2002 2001 2002 2001
- ----------------------------------------------------------------------------
Commercial Banking $ 13.6 $ (18.3) $ 42.7 $ 23.1
Retail Banking 13.0 7.6 39.7 25.2
Mortgage Banking 3.4 3.3 4.9 3.9
Corporate Center 0.4 - 0.3 -
--------- --------- --------- ---------
$ 30.4 $ (7.4) $ 87.6 $ 52.2
========= ========= ========= =========
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, transaction structuring
and investment banking services for the multi-family housing and
healthcare industries.
Net income for the third quarter and first nine months of 2002 was $13.6
million and $42.7 million, respectively, compared to ($18.3) million and
$23.1 million for the same periods in 2001. During the third quarter of
2001, Commercial Banking recognized significantly higher than normal
provision and credit-related charges attributable to the weakened
economy and the events of September 11. Although the economy has not
recovered, credit-related volatility has declined during 2002.
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 during 2002. Total
revenues have increased 23% and net income has increased 28% in the
first nine 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.
-19-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Net income increased $5.4 million and $14.5 million for the three-month
and nine-month periods ended September 30, 2002 as compared to the same
periods in 2001. The primary drivers for the increase was an increase in
net interest income on deposits and lower provision for loan and lease
losses. Average total retail deposits grew by 6% during the third
quarter of 2002 compared to the third quarter of 2001. This largely
occurred as a result of internet deposit-gathering initiatives.
Retail Banking is in the process of altering the composition of its
consumer lending portfolio. Management believes that growing its home
equity portfolio while slowing auto lease originations will result in an
improved interest rate margin and a lower risk exposure.
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.
Mortgage Banking had net income of $3.4 million and $4.9 million for the
third quarter and nine months of 2002. Net income for the third quarter
was primarily the result of its warehouse lending division and continued
success in the whole-loan sale market. Mortgage Banking has continued to
implement strategic initiatives designed to reduce its risk profile, the
largest of these initiatives being the transition from portfolio lending
to whole-loan sales which has significantly reduced the business line's
loan default risk. Since the third quarter of 2001, nonconforming loan
originations have been sold on a whole-loan basis to investors. During
the third quarter of 2002, the net sales gain premium averaged 224 basis
points on nonconforming loan sales of $223 million compared to the
second quarter of 2002 which averaged 207 basis points on sales of $186
million. Additionally, third-party mortgage loan servicing increased
from $2.3 billion to $4.4 billion during the third quarter of 2002.
Management has continued to search for new ventures in the mortgage
market. Through their direct retail marketing division which went into
operation in February and a year-old mortgage services venture,
management continues to seek and cultivate new opportunities for diverse
cash flow streams within the mortgage business.
o Corporate Center includes revenue and expenses not allocated to the
primary business lines, including any unusual revenues and expenses. Net
income for the first nine months of 2002 included warrant gains of $8.2
million, security gains of $1.3 million and a loss of $9.1 million from
the sale of $27 million of non-performing loans from the residential
mortgage portfolio.
-20-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Net Interest Income
- -------------------
Net interest income for the nine months ended September 30, 2002, increased
$29.9 million, or 9%, compared to the first nine months of 2001. The
increase in interest income was due to an increase in average earning assets
of $858 million, or 6%, and an increase in the net interest margin. The
increase in average earning assets resulted primarily from the growth of the
investment security portfolio. The growth in earning assets was primarily
funded by a corresponding growth in interest bearing liabilities. The
largest increases in interest bearing liabilities were time deposits and
long-term debt.
Net interest margin represents net interest income as a percentage of total
interest earning assets. For the first nine months of 2002, the net interest
margin, on a tax-equivalent basis, was 3.51% compared to 3.44% 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 nine-month periods
ended September 30, 2002 and 2001.
Three Months Ended Nine Months Ended
-------------------------------------- --------------------------------------
September 30, 2002 September 30, 2001 September 30, 2002 September 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 $ 4,227 6.36% $ 4,640 7.90% $ 4,281 6.41% $ 4,688 8.50%
Mortgage 930 6.08 855 7.93 897 6.34 850 8.41
Construction 533 4.56 549 6.73 553 4.59 583 7.57
Lease Financing 1,300 9.06 1,200 9.66 1,255 9.36 958 9.96
------- ---- ------- ---- ------- ---- ------- ----
Total Corporate Lending 6,990 6.69 7,244 8.11 6,986 6.79 7,079 8.61
Consumer Lending:
Residential 685 9.64 1,064 9.82 781 9.50 1,024 10.10
Installment 1,080 6.16 821 8.63 994 6.50 735 9.17
Lease Financing 1,383 8.59 1,277 9.94 1,412 8.37 1,170 10.22
------- ---- ------- ---- ------- ---- ------- ----
Total Consumer Lending 3,148 7.98 3,162 9.56 3,187 8.06 2,929 9.92
------- ---- ------- ---- ------- ---- ------- ----
Total Loans and Leases 10,138 7.09 10,406 8.55 10,173 7.19 10,008 8.99
Investment Securities 3,789 5.49 3,105 6.30 3,792 5.73 3,164 6.68
Federal Funds Sold and Reverse
Repurchase Agreements 102 2.66 102 3.53 113 2.77 103 4.91
Other Short Term Investments 407 5.28 416 5.43 331 5.91 276 5.84
------- ---- ------- ---- ------- ---- ------- ----
Total Earning Assets 14,436 6.59 14,029 7.92 14,409 6.74 13,551 8.36
Cash and Due From Banks 245 241 232 259
Other Assets 803 1,053 780 1,067
------- ------- ------- -------
Total Assets $15,484 $15,323 $15,421 $14,877
======= ======= ======= =======
Liabilities and
Shareholders' Equity:
Deposits:
Demand Deposits $ 778 1.61 $ 487 2.32 $ 613 1.30 $ 479 2.85
Savings Deposits 1,417 2.03 1,581 3.36 1,475 2.02 1,544 4.03
Time Deposits 6,211 3.49 5,832 5.28 6,193 3.71 5,753 5.80
------- ---- ------- ---- ------- ---- ------- ----
Total Deposits 8,406 3.07 7,900 4.71 8,281 3.23 7,776 5.27
Short-Term Debt:
Federal Funds Purchased and
Repurchase Agreements 849 2.90 1,435 3.97 1,076 2.71 1,170 4.37
Commercial Paper 268 1.97 209 3.79 275 1.94 216 4.55
------- ---- ------- ---- ------- ---- ------- ----
Total Short-Term Debt 1,117 2.68 1,644 3.95 1,351 2.55 1,386 4.40
Long-Term Debt 2,968 4.79 2,670 5.69 2,928 4.77 2,695 6.10
Junior Subordinated Debentures 451 5.28 451 6.90 451 5.36 412 7.78
------- ---- ------- ---- ------- ---- ------- ----
Total Interest Bearing
Liabilities 12,942 3.51 12,665 4.90 13,011 3.58 12,269 5.44
Noninterest Bearing Deposits 934 1,203 888 1,225
Minority Interest 162 - 66 -
Other Liabilities 490 460 513 403
Shareholders' Equity 956 995 943 980
------- ------- ------- -------
Total Liabilities and
Shareholders' Equity $15,484 $15,323 $15,421 $14,877
======= ======= ======= =======
Net Interest Spread 3.08% 3.02% 3.16% 2.92%
==== ==== ==== ====
Net Interest Margin 3.44% 3.50% 3.51% 3.44%
==== ==== ==== ====
-21-
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,
specific industry trends, loan concentrations, evaluation of specific loss
estimates for all significant problem loans, payment histories, collateral
valuations, historic 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 Provident's on-balance sheet credit portfolio.
-22-
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 $82.2 million and $114.6 million
for the first nine 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
1.93% and 1.99% at September 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 and third quarters of 2002, the loss reserve
was allowed to decline. During the second quarter of 2002, $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. During the
third quarter of 2002, net charge-offs were higher than initially
anticipated due to a partial charge-off of a large nonaccrual commercial
loan that occurred sooner than anticipated. Management expects to maintain
the loss reserve at its present level throughout the remainder of 2002.
The reserve methodology considers potential losses in the commercial airline
portfolio as well as all other loan and lease types. Risks in the commercial
airline portfolio arise from our principal reliance on borrower credit
quality and secondarily on equipment value. Based upon previous peak
outstandings, the majority of these commercial airline loans and leases are
to borrowers designated as having better credit quality. Even within this
segment, shorter maturities have left Provident exposed to residual
equipment values resulting in modest losses. Most of the prior charge-offs
and valuation adjustments have dealt with transactions related to borrowers
with weaker credit quality, which exposes us to weaker equipment values.
Approximately 22% of the remaining outstandings relate to borrowers with
weaker credit quality of which more than half are covered by current
reasonable-sale equipment values. However, future events could occur that
may negatively impact our assessment of borrowers' credit quality and
equipment values leading to higher reserves and potential future losses.
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 Group 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 businesses, 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.
-23-
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 Nine Months Ended
September 30, September 30,
---------------------- -----------------------
(Dollars in Thousands) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------
Balance at Beginning of Period $ 211,262 $ 176,975 $ 240,653 $ 154,300
Acquired Reserves - - - 10,003
Provision for Loan and Lease Losses 25,100 66,010 82,209 114,597
Loans and Leases Charged Off (42,912) (40,735) (145,459) (84,531)
Recoveries 7,606 4,596 23,653 12,477
--------- --------- --------- ---------
Balance at End of Period $ 201,056 $ 206,846 $ 201,056 $ 206,846
========= ========= ========= =========
Reserve for Loan and Lease Losses
as a Percent of:
Nonaccrual Loans 112.36% 157.10%
Nonperforming Assets 103.90% 140.31%
Total Loans and Leases 1.93% 1.99%
The following table presents the distribution of net loan charge-offs by
loan type for the three-month and nine-month periods ended September 30,
2002 and 2001:
Three Months Ended Three Months Ended
September 30, 2002 September 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 $ 24,859 2.35% 70.4% $ 27,900 2.41% 77.2%
Mortgage 22 0.01 0.1 483 0.32 1.4
Construction 379 0.28 1.1 - - -
Lease Financing 2,620 0.81 7.4 3,081 1.03 8.5
-------- ----- -------- -----
Net Corporate Lending 27,880 1.60 79.0 31,464 1.74 87.1
Consumer Lending:
Residential 4,853 2.83 13.7 2,179 0.82 6.0
Installment 850 0.31 2.4 834 0.41 2.3
Lease Financing 1,723 0.50 4.9 1,662 0.52 4.6
-------- ----- -------- -----
Net Consumer Lending 7,426 0.94 21.0 4,675 0.59 12.9
-------- ----- -------- -----
Net Charge-Offs $ 35,306 1.39 100.0 $ 36,139 1.39 100.0
======== ===== ======== =====
Nine Months Ended Nine Months Ended
September 30, 2002 September 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 $ 63,853 1.99% 52.4% $ 50,183 1.43% 69.7%
Mortgage 46 0.01 - 508 0.11 0.7
Construction 679 0.16 0.6 - - -
Lease Financing 28,579 3.04 23.5 7,516 1.05 10.4
-------- ----- -------- -----
Net Corporate Lending 93,157 1.78 76.5 58,207 1.10 80.8
Consumer Lending:
Residential 22,130 3.78 18.2 8,432 1.10 11.7
Installment 2,359 0.32 1.9 1,834 0.33 2.5
Lease Financing 4,160 0.39 3.4 3,581 0.41 5.0
-------- ----- -------- -----
Net Consumer Lending 28,649 1.20 23.5 13,847 0.63 19.2
-------- ----- -------- -----
Net Charge-Offs $121,806 1.60 100.0 $ 72,054 0.96 100.0
======== ===== ======== =====
-24-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The increase in net charge-offs during the first nine months of 2002 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 year-to-date 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 September 30, 2002 were $193.5 million compared to
$197.8 million and $147.4 million as of December 31, 2001 and September 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. The decrease in nonaccrual residential
mortgage loans during the second quarter of 2002 was due primarily to the
sale of $27 million of nonaccrual residential loans. The decrease in other
nonperforming assets during the third quarter of 2002 is due primarily to
the sale of commercial properties. The composition of nonperforming assets
over the past five quarters is provided in the following table.
2002 2001
-------------------------------- --------------------
Third Second First Fourth Third
(Dollars in Thousands) Quarter Quarter Quarter Quarter Quarter
- ---------------------------------------------------------------------------------------
Nonaccrual Loans:
Corporate Lending:
Commercial $117,571 $108,330 $111,727 $116,663 $ 84,700
Mortgage 10,619 5,546 1,938 1,929 1,984
Construction 2,243 7,268 1,984 2,699 2,213
Lease Financing 3,952 3,497 5,223 7,986 5,977
-------- -------- -------- -------- --------
Total Corporate Lending 134,385 124,641 120,872 129,277 94,874
Consumer Lending:
Residential 44,548 35,920 62,530 47,579 36,792
Installment - - - - -
Lease Financing - - - - -
-------- -------- -------- -------- --------
Total Consumer Lending 44,548 35,920 62,530 47,579 36,792
-------- -------- -------- -------- --------
Total Nonaccrual Loans 178,933 160,561 183,402 176,856 131,666
Other Nonperforming Assets 14,579 25,471 28,098 20,907 15,758
-------- -------- -------- -------- --------
Total Nonperforming Assets $193,512 $186,032 $211,500 $197,763 $147,424
======== ======== ======== ======== ========
Loans 90 Days Past Due
Still Accruing $ 32,811 $ 31,626 $ 30,115 $ 31,219 $ 34,929
Nonaccrual Loans to
Total Loans and Leases 1.72% 1.57% 1.81% 1.68% 1.27%
Nonperforming Assets to:
Total Loans, Leases and
Other Nonperforming Assets 1.85% 1.82% 2.08% 1.88% 1.42%
Total Assets 1.19% 1.19% 1.38% 1.27% 0.97%
-25-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Nonaccrual loans have increased $2.1 million while other nonperforming
assets have decreased $6.3 million during the first nine months of 2002. The
following table shows the progression of nonaccrual loans and other
nonperforming assets during this time period:
Corporate Lending
----------------------------------- Consumer Total Other Total
Real Lease Residential Nonaccrual Nonperforming Nonperforming
(In Thousands) Commercial Estate Financing Mortgages Loans Assets Assets
- ----------------------------------------------------------------------------------------------------------------
Balance at
Beginning of Year $ 116,663 $ 4,628 $ 7,986 $ 47,579 $ 176,856 $ 20,907 $ 197,763
Additions 112,363 10,921 8,465 62,122 193,871 3,120 196,991
Payments / Sales (46,983) (1,614) (4,509) (27,376) (80,482) (16,696) (97,178)
Charge-Offs (64,172) (883) (7,990) (19,738) (92,783) (3,288) (96,071)
Transfers to Other
Nonperforming Assets (300) (190) - (18,039) (18,529) 18,529 -
Write-Downs - - - - - (7,993) (7,993)
--------- --------- --------- --------- --------- --------- ---------
Balance at
September 30, 2002 $ 117,571 $ 12,862 $ 3,952 $ 44,548 $ 178,933 $ 14,579 $ 193,512
========= ========= ========= ========= ========= ========= =========
Noninterest Income
- ------------------
The following table details the components of noninterest income and their
change for the third quarter and nine-month periods of 2002 and 2001:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- Pctg ------------------- Pctg
(Dollars in Thousands) 2002 2001 Change 2002 2001 Change
- -------------------------------------------------------------------------------------------------------
Service Charges on Deposit Accounts $ 11,681 $ 10,312 13% $ 33,045 $ 29,551 12%
Loan Servicing Fees 10,325 10,329 (0) 30,406 33,599 (10)
Other Service Charges and Fees 11,687 9,017 30 34,707 28,802 21
Leasing Income 9,397 10,500 (11) 28,365 33,331 (15)
Cash Gains on Sale of Loans 5,001 3,254 54 12,135 4,490 170
Warrant Gains - - - 8,186 412 -
Security Gains 633 - - 1,287 - -
Other 11,185 13,691 (18) 30,678 44,673 (31)
-------- -------- -------- --------
Total Noninterest Income $ 59,909 $ 57,103 5 $178,809 $174,858 2
======== ======== ======== ========
Explanations for significant changes in noninterest income by category
follow:
o Service charges on deposit accounts increased $1.4 million and $3.5
million in the quarterly and nine-month comparisons. An increase in
overdraft fees was the primary reason for the increase in the quarterly
comparison. Increases in overdraft fees and service charges on corporate
deposit accounts were the primary reasons for the increase in the
nine-month comparison.
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 the nine-month comparison.
o Other service charges and fees increased $2.7 million and $5.9 million
in the quarterly and nine-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.
-26-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
o Leasing income decreased $1.1 million and $5.0 million in the quarterly
and nine-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.
o The increase of $1.7 million and $7.6 million in gain on sales of loans
in the quarterly and nine-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 nine months of 2002, over $500
million of residential loans were sold on a whole-loan basis providing
gains of $10.3 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 nine 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 $2.5
million and $14.0 million decrease in other income in the quarterly and
nine-month comparisons.
Noninterest Expense
- -------------------
The following table details the components of noninterest expense and their
change for the third quarter and nine-month periods of 2002 and 2001:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- Pctg ------------------- Pctg
(Dollars in Thousands) 2002 2001 Change 2002 2001 Change
- ------------------------------------------------------------------------------------------------
Salaries, Wages and Benefits $ 57,141 $ 52,783 8% $172,260 $153,951 12%
Charges and Fees 7,029 8,321 (16) 22,779 23,549 (3)
Occupancy 5,861 5,634 4 17,829 16,783 6
Leasing Expense 6,285 28,123 (78) 23,265 42,964 (46)
Equipment Expense 5,680 6,209 (9) 17,862 19,226 (7)
Professional Services 6,007 5,476 10 18,311 18,243 0
Minority Interest Expense 3,223 - - 3,889 - -
Other 22,755 19,317 18 64,830 52,505 23
-------- -------- -------- --------
Total Noninterest Expense $113,981 $125,863 (9) $341,025 $327,221 4
======== ======== ======== ========
Explanations for significant changes in noninterest expense by category
follow:
o Salaries, wages and benefits increased $4.4 million and $18.3 million in
the quarterly and nine-month comparisons due primarily to increased
staffing in areas where opportunities for growth exist, such as middle
market commercial lending, middle market equipment leasing and mortgage
servicing, and incentive pay. 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.
-27-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
o Charges and fees decreased $1.3 million in the quarterly comparison due
primarily to a decrease in goodwill amortization expense. Charges and
fees decreased $.8 million in the nine-month comparison as the decrease
in goodwill amortization expense more than offset the increase in
expenses related 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.
o Increases in rent expense, repairs and maintenance were the primary
reasons for the increase in occupancy expense.
o The decrease in leasing expense for both the quarterly and nine-month
comparisons was attributable to a $20.0 million write-down in residual
values related to aircraft leases that occurred in the third quarter of
2001 with no corresponding write-down during 2002.
o Equipment expense decreased in the quarterly and nine-month comparisons
due to a decrease in depreciation expense.
o An increase in legal fees related to loan collections was the primary
reason for the increase in professional services in the quarterly
comparison.
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 expenses related to repossessed properties was the primary
reason for the increase in other expense in the quarterly comparison.
Increases in marketing expense as well as expenses related to
repossessed properties were the primary reasons for the increase in
other expense in the nine-month comparison.
FINANCIAL CONDITION
- -------------------
Short-Term Investments and Investment Securities
- ------------------------------------------------
Federal funds sold and reverse repurchase agreements decreased $4 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 $204 million and $101 million as of
September 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.
-28-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Provident classified $190 million of loans as held for sale at September 30,
2002. This is a decrease of $28 million from the amount reported at December
31, 2001. These loans consist of $116 million of multifamily loans and $74
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 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 $652 million during the first nine 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 September 30, 2002 total loans and leases were $10.4 billion compared
to $10.5 billion at December 31, 2001. Provident had an additional $3.2
billion and $4.1 billion of off-balance sheet loans and leases as of
September 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 has 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.
-29-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following table shows the composition of the commercial loan category by
industry type at September 30, 2002:
Amount on
(Dollars in Millions) Amount % Nonaccrual
- ----------------------------------------------------------------------------------
Real Estate Operators/Developers/General Contractors $ 555.2 13 $ 1.3
Mortgage Warehousing Lines 491.4 11 5.1
Transportation 207.9 5 2.5
Retailing 195.1 4 6.5
Healthcare 187.6 4 1.0
Banking and Finance 181.5 4 0.8
Tourism and Entertainment 152.0 3 1.3
Metals 149.8 3 12.6
Machinery and Equipment 144.4 3 13.2
Eating and Drinking Establishments 137.9 3 4.2
Commercial Aviation Related (1) 129.3 3 25.6
Construction 122.2 3 3.6
Business Services 121.0 3 10.4
Financial Services 110.3 3 0.1
Automobile Dealers 94.6 2 -
Technology 88.9 2 3.7
Automotive Services/Parts 85.8 2 13.6
Media 66.8 2 0.1
Other (includes 20 industry types) 1,196.4 27 12.0
-------- --- ------
Total $4,418.1 100 $117.6
======== === ======
(1) Includes loans related to the commercial airline industry, and aircraft
used in private, charter and corporate markets.
At September 30, 2002, Provident had loans and leases of $185 million to the
commercial airline carriers, including $31 million of commercial loans and
$154 million of finance and operating leases. As the 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 $30 million during the second half of 2001 and
first nine months of 2002, respectively, which were related to secured
commercial airline loans and leases.
At September 30, 2002, Provident had approximately $869 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 thirty-one industry types, with the largest industry
concentration (real estate) accounting for approximately 15% of its total
shared national credit loans. The average outstanding balance of a shared
national credit loan was $3.9 million.
-30-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The composition of the corporate mortgage and construction loan categories
by property type at September 30, 2002 follows:
Amount on
(Dollars in Millions) Amount % Nonaccrual
- ----------------------------------------------------------------------------
Residential Development $ 275.0 18 $ 6.1
Shopping/Retail 246.6 17 -
Office/Warehouse 237.3 16 3.0
Apartments 232.5 16 2.1
Health Facilities 112.9 7 -
Hotels/Motels 105.5 7 0.1
Land 71.0 5 0.8
Industrial Plants 28.7 2 -
Auto Sales and Service 16.5 1 -
Churches 9.8 1 -
Other Commercial Properties 148.4 10 0.8
---------- --- -------
Total $ 1,484.2 100 $ 12.9
========== === =======
As of September 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 September 30, 2002:
(Dollars in Millions) Amount %
- ----------------------------------------------------------------------------
Home Equity $962.4 83
Indirect Installment 123.1 10
Direct Installment 59.4 5
Other Consumer Loans 19.6 2
-------- ---
Total $1,164.5 100
======== ===
Noninterest Earning Assets
- --------------------------
Leased equipment decreased $7 million, or 4%, during the first nine months
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 $29 million, or 5%, during the first nine months of
2002. The increase was primarily due to an increase in mortgage servicing
rights.
Deposits
- --------
Total deposits increased $419 million during the first nine months of 2002.
Average core deposits grew at an annualized rate of 7% during the first nine
months of 2002, with significant contribution coming from internet
deposit-gathering initiatives.
-31-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Borrowed Funds
- --------------
Short-term debt remained relatively flat during the first nine months of
2002. A decrease in federal funds purchased was offset by an increase in
commercial paper.
Long-term debt increased $36 million, or 1%, during the first nine months of
2002 due primarily to the issuance of $75 million of senior unsecured notes.
These 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 (Bank), Provident's most significant
subsidiary, owns all of the $165 million of Common Stock of PFGI Capital.
The principal 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 (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;
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.
-32-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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. On November 17, 2002,
Provident will make an adjustment payment of approximately $894,000.
The PFGI Capital Preferred Stock has a liquidation preference of $25 and an
initial non-cumulative dividend rate of 7.75%. Under certain regulatory
circumstances, the PFGI Capital Preferred Stock will be automatically
exchanged for the Bank Preferred Stock. On November 17, 2002, PFGI Capital
will make a dividend payment of approximately $5,541,000.
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 Capital 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 PFGI Capital Preferred
Stock to fulfill their commitment under the terms of the Purchase Contract.
Provident intends to use such proceeds for the redemption of the remarketed
PFGI Capital Preferred Stock ninety days after the remarketing.
Other Noninterest Earning Liabilities
- -------------------------------------
Other liabilities decreased $28 million, or 5%, during the first nine months
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."
-33-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Capital Resources and Adequacy
- ------------------------------
Total shareholders' equity at September 30, 2002 was $965 million compared
to $893 million at December 31, 2001. The change in the equity balance
relates primarily to net income exceeding dividends by $51 million
(quarterly common dividend rate of $.24), a decrease in the market value of
cash flow hedging instruments of $4 million (net of deferred taxes) and an
increase in the market value of investment securities of $48 million (net of
deferred taxes).
Capital expenditures planned by Provident in 2002 for premises and equipment
are currently estimated to be approximately $25 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 September 30, 2002, approximately $14
million of these expenditures had been made.
The following table of ratios is important for an analysis of capital
adequacy:
Nine Months Ended Year Ended
September 30, 2002 December 31, 2001
- -------------------------------------------------------------------------------------------
Average Shareholders' Equity to Average Assets 6.11% 6.51%
Average Tangible Shareholders' Equity to
Average Tangible Assets 5.50 5.89
Period End Shareholders' Equity to
Period End Assets 5.94 5.73
Period End Tangible Shareholders' Equity to
Period End Tangible Assets 5.37 5.12
Dividend Payout to Net Earnings 41.34 205.76
Tier 1 Capital to Risk-Weighted Assets 10.56 8.86
Total Risk-Based Capital To Risk-Weighted Assets 12.37 11.41
Tier 1 Leverage Ratio 9.50 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 September 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.
-34-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Federal banking agencies have adopted revised regulatory capital rules
regarding the treatment of certain recourse obligations, direct credit
substitutes and residual interests in asset securitizations. Requirements of
the revised rules include (1) deducting from Tier 1 capital the amount of
credit-enhancing interest-only strips (a type of residual interests) that
exceeds 25% of Tier 1 capital; (2) requiring a dollar in risk-based capital
for each dollar of residual interests not deducted from Tier 1 capital,
except those qualifying under the ratings-based approach; and (3) requiring
that the gross-up treatment of assets sold with recourse, along with the
low-level recourse rule, be applied to direct credit substitutes. The
revised rules became effective on January 1, 2002, for new residual
interests related to transactions that settled after December 31, 2001. For
transactions settled before January 1, 2002, application of the new capital
treatment to the residuals created will be delayed until December 31, 2002.
These rules apply to Provident's securitization transactions structured as
sales and utilizing gain on sale accounting, and to its Fannie Mae DUS
program. However, the impact of the revised rules have been significantly
reduced due to Provident's third quarter of 2000 decision to structure
future securitizations in the form of secured financings rather than sales.
Management is also taking steps to reduce the overall recourse within its
Fannie Mae DUS program in order to lessen the impact of the direct credit
substitute rule change. Management does not believe that the revised rules
will prevent Provident or the Bank from being classified as well
capitalized.
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 GAAP, 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.
-35-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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.
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:
September 30,
----------------------------
(In Thousands) 2002 2001
- ----------------------------------------------------------------------------
Nonconforming Residential $1,973,471 $2,871,850
Auto Leases 862,514 1,013,057
Prime Home Equity 219,958 347,241
Equipment Leases 113,821 243,476
---------- ----------
$3,169,764 $4,475,624
========== ==========
In June 2002, the 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 FASB Statement 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 contributed to
the generation of $30.4 million and $33.6 million in loan servicing fees
during the first nine months of 2002 and 2001, respectively.
-36-
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 (RISA), were recorded as assets
within the investment securities line item of the consolidated balance
sheets. Components of the RISA, based on current models, as of September 30,
2002 follow:
Nonconforming Prime
(In Thousands) Residential Home Equity
- ----------------------------------------------------------------------------
Estimated Cash Flows of Underlying Loans,
Net of Payments to Certificate Holders $ 183,903 $ 15,065
Less:
Estimated Credit Loss (7,576) (50)
Servicing and Insurance Expense (23,254) (2,879)
Discount to Present Value (25,181) (1,732)
--------- --------
Carrying Value of Retained Interest in
Securitized Assets $ 127,892 (1) $ 10,404
========= ========
(1) Carrying value of Retained Interest in Securitized Assets, net of
reserves carried as other liabilities, was $90.3 million at September
30, 2002. Provident monitors the valuation of the RISA on a monthly
basis. The valuation centers primarily around two estimates, total
life-time losses and the constant prepayment rate (CPR). During the
current year, both of these factors have trended upward which has had an
unfavorable impact on the RISA valuation. Additionally, the CPR has also
been impacted by management's decision to accelerate the liquidation of
other real estate associated with the securitized nonconforming
residential portfolio. Provident models a CPR range from 25% to 35% with
the actual CPR in the third quarter running at 30%. If the CPR stays at
its current level, management estimates that there would be sufficient
cash flows to absorb lifetime losses up to 5.3%. If the CPR rises to
35%, there would be sufficient cash flows to absorb lifetime losses up
to 4.8%. Cumulative incurred losses through September 30, 2002 are 3.0%,
with estimated total lifetime losses expected to be 4.6%. On a worst
case basis, management currently estimates that lifetime losses should
not exceed 5.0%, assuming real estate values remain stable. From an
earnings sensitivity standpoint, above certain loss thresholds, 5 basis
points in losses represent a $1.8 million unfavorable after-tax impact.
Should both the estimated life-time losses and CPR continue to rise,
impairment of the RISA value could occur. At September 30, 2002,
management believes the current carrying value of the RISA asset is
properly stated.
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.
-37-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 $37.6
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 September 30, 2002, Provident had $56.5 million and $27.6 million in
credit enhancement accounts for securitized equipment leases and prime home
equity loans, respectively.
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 nine months
ended September 30, 2002:
Nonconforming Prime Home Equipment
(Dollars in Thousands) Residential Equity Leases
- ----------------------------------------------------------------------------------------
For the Nine Months Ended September 30, 2002:
Average Securitized Assets $2,259,501 $ 254,489 $ 150,537
Net Charge-Offs 75,412 1,724 4,184
Net Charge-Offs to Average
Securitized Assets (Annualized) 4.45% 0.90% 3.71%
As of September 30, 2002:
Securitized Assets $1,973,471 $ 219,958 $ 113,821
Established Contingent Loss Liability 45,165 (1) 1,009 1,565
Delinquency Rates:
30 to 89 Days 10.88% 0.31% 2.78%
90 or More 19.37% 0.77% 2.57%
(1) As actual prepayment speeds have been lower than what was used to record
the original RISA balance, it is projected that there will be a
significant level of excess cash flows available to absorb a much higher
level of charge-offs.
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.
-38-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Red Capital services multifamily mortgage loans under the DUS program with
outstanding principal balances aggregating approximately $2.8 billion at
September 30, 2002. At September 30, 2002, no DUS loans in Red Capital's
loan servicing portfolio were 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 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 September 30, 2002, these financial
instruments consisted of standby letters of credit of $294 million,
commitments to extend credit of $2.6 billion, and interest rate swaps and
caps with a notional amount of $5.8 billion and $5.6 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 September 30, 2002, the
remaining unpaid auto lease balances on the 2001 and 2000 credit risk
transfer transactions were $.7 billion and $1.1 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. Approximately $110 million of long-term
debt is due to be repaid during the remainder of 2002.
-39-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 September 30, 2002 by its banking subsidiary
was approximately $107.7 million. The Parent has received $30 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 nine months 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 $223 million in cash and interest earning deposits to meet its
liquidity needs.
-40-
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 and caps 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. The model evaluates the effect
on net interest income by running various interest rate shock scenarios up
and down from a baseline scenario which utilizes implied forward market
rates. Market-based prepayment speeds are incorporated into the analysis
particularly for mortgage related products. Provident's policy limit
stipulates that the negative impact on net interest income from an
instantaneous 200 basis point increase or decrease to spot market rates as
compared to the baseline scenario cannot exceed 10 percent over the next 12
month period. Based on the results of the simulation model as of September
30, 2002, net interest income would change by the following over the next
12-month period: decrease 3.11% for a 100 basis point decrease; decrease
1.43% for a 100 basis point increase; and decrease 2.45% 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 shock tests do
not give consideration to any management action in the new interest rate
environments. These tests are performed on a monthly basis, and the results,
which are in compliance with policy, are presented to the Board of
Directors.
As a basis for strategic interest rate risk management, the ALCO group
regularly analyzes the impact of four to six additional interest rate
scenarios on net interest income in addition to the standard scenarios used
for policy measurement. These rate scenarios are established by ALCO and
incorporate changes to the slope of the yield curve or gradual rate changes.
The balance sheet assumptions including loan growth, funding mix, and
prepayment speeds primarily on mortgage related products are adjusted for
each rate scenario.
ALCO regularly incorporates discussions and analysis of market risk embedded
in off-balance sheet activities as well as on non-interest income items such
as loan sale premiums. ALCO actively monitors the impact of related market
risk since these premiums are sensitive to changes in interest rates.
-41-
All transaction accounts are regularly analyzed for embedded market risk.
These accounts are evaluated with respect to their repricing characteristics
as well as their expected average lives. Provident offers a diverse set of
managed transaction accounts including some that reprice according to a
third party index and some with managed rates. ALCO actively monitors the
behavioral characteristics of these products.
ITEM 4. CONTROLS AND PROCEDURES
- -------------------------------
An evaluation was performed under the supervision and with the participation
of management, including the principal executive and financial officers, of
the effectiveness of the design and operation of Provident's disclosure
controls and procedures as of September 30, 2002. Based on that evaluation,
management, including the principal executive and financial officers,
concluded that Provident's disclosure controls and procedures were effective
with no significant weaknesses noted. There have been no significant changes
in Provident's internal controls or in other factors that could
significantly affect these internal controls after the date of their
evaluation.
-42-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
---------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ----------------------------------------
(b) Reports on Form 8-K:
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.
-43-
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: November 14, 2002 /s/Christopher J. Carey
-----------------------
Christopher J. Carey
Executive Vice President and
Chief Financial Officer
-44-
Certification of Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
and Securities and Exchange Commission Release 34-46427
I, Robert L. Hoverson, the principal executive officer of Provident
Financial Group, Inc. ("Provident"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of Provident;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date");
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 14, 2002 /s/Robert L. Hoverson
---------------------
Robert L. Hoverson
Chief Executive Officer
(Principal Executive Officer)
-45-
Certification of Principal Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
and Securities and Exchange Commission Release 34-46427
I, Christopher J. Carey, the principal financial officer of Provident
Financial Group, Inc. ("Provident"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of Provident;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 14, 2002 /s/Christopher J. Carey
-----------------------
Christopher J. Carey
Chief Financial Officer
(Principal Financial Officer)
-46-
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the filing with the Securities and Exchange Commission of
the Quarterly Report of Provident Financial Group, Inc. ("Provident") on
Form 10-Q for the period ending September 30, 2002 (the "Report"), I, Robert
L. Hoverson, Chief Executive Officer of Provident, certify, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of
Provident.
/s/Robert L. Hoverson
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Robert L. Hoverson
Chief Executive Officer
November 14, 2002
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CERTIFICATION OF CHIEF FINANCIAL OFFICER
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the filing with the Securities and Exchange Commission of
the Quarterly Report of Provident Financial Group, Inc. ("Provident") on
Form 10-Q for the period ending September 30, 2002 (the "Report"), I,
Christopher J. Carey, Chief Financial Officer of Provident, certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of
Provident.
/s/Christopher J. Carey
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Christopher J. Carey
Chief Financial Officer
November 14, 2002
-48-