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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d) of
the Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File
June 30, 2003 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 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 by check whether the registrant is an accelerated filer (as defined in
Rule 12b-2 of the Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: Common stock, without par
value, outstanding at July 31, 2003 is 48,796,597.
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 . . . . . . . . . . . . . . . . . . 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK . . 44
ITEM 4. CONTROLS AND PROCEDURES . . . . . . . . . . . . . . . . . . . 45
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . . . 46
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . . . 46
SIGNATURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2003 2002
(Dollars in Thousands) (Unaudited)
- -------------------------------------------------------------------------------------
ASSETS
Cash and Due from Banks $ 352,241 $ 351,994
Federal Funds Sold and Reverse Repurchase Agreements 337,006 188,925
Trading Account Securities 105,877 127,848
Loans Held for Sale 447,039 436,884
Investment Securities Available for Sale
(amortized cost - $4,742,549 and $4,158,511) 4,760,894 4,215,238
Loans and Leases (Net of Unearned Income):
Corporate Lending:
Commercial 4,459,612 4,482,373
Mortgage 1,017,061 960,636
Construction 516,348 510,331
Lease Financing 1,253,851 1,273,901
Consumer Lending:
Installment 1,424,207 1,306,761
Residential 37,741 599,793
Lease Financing 155,577 -
------------ ------------
Total Loans and Leases 8,864,397 9,133,795
Reserve for Loan and Lease Losses (185,019) (201,051)
------------ ------------
Net Loans and Leases 8,679,378 8,932,744
Leased Equipment 2,006,999 2,350,356
Premises and Equipment 97,070 101,513
Goodwill 83,979 82,651
Other Assets 923,516 751,856
------------ ------------
TOTAL ASSETS $ 17,793,999 $ 17,540,009
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Noninterest Bearing $ 1,357,468 $ 1,141,990
Interest Bearing 9,598,344 8,706,989
------------ ------------
Total Deposits 10,955,812 9,848,979
Short-Term Debt 1,268,198 1,925,005
Long-Term Debt 3,624,262 3,842,657
Guaranteed Preferred Beneficial Interests in
Company's Junior Subordinated Debentures 451,284 451,074
Minority Interest 160,966 160,966
Accrued Interest and Other Liabilities 442,883 430,957
------------ ------------
Total Liabilities 16,903,405 16,659,638
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, 48,782,947 and 48,760,462 Issued 14,461 14,454
Capital Surplus 298,838 298,025
Retained Earnings 618,712 604,013
Accumulated Other Comprehensive Loss, Net (48,417) (43,121)
------------ ------------
Total Shareholders' Equity 890,594 880,371
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 17,793,999 $ 17,540,009
============ ============
See notes to consolidated financial statements.
-3-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------------
(In Thousands, Except Per Share Data) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------
Interest Income:
Interest and Fees on Loans and Leases $140,983 $148,701 $282,619 $303,702
Interest on Investment Securities 48,112 56,840 99,927 110,188
Other Interest Income 9,158 5,790 17,449 10,857
-------- -------- -------- --------
Total Interest Income 198,253 211,331 399,995 424,747
Interest Expense:
Interest on Deposits:
Savings and Demand Deposits 11,079 8,769 20,947 17,821
Time Deposits 46,629 58,804 93,697 117,207
-------- -------- -------- --------
Total Interest on Deposits 57,708 67,573 114,644 135,028
Interest on Short-Term Debt 7,493 7,931 16,333 18,241
Interest on Long-Term Debt 43,961 50,949 92,269 102,367
Interest on Junior Subordinated Debentures 4,597 6,150 9,296 12,088
-------- -------- -------- --------
Total Interest Expense 113,759 132,603 232,542 267,724
-------- -------- -------- --------
Net Interest Income 84,494 78,728 167,453 157,023
Provision for Loan and Lease Losses 52,469 33,575 68,990 57,780
-------- -------- -------- --------
Net Interest Income After Provision
for Loan and Lease Losses 32,025 45,153 98,463 99,243
Noninterest Income:
Service Charges on Deposit Accounts 12,391 10,915 24,723 21,364
Loan Servicing Fees 9,428 8,414 20,088 16,412
Commercial Mortgage Banking Revenue 10,849 6,021 21,146 11,767
Other Service Charges and Fees 12,921 12,021 24,657 21,920
Leasing Income 132,238 152,664 271,099 307,645
Cash Gains on Sale of Loans 7,124 4,494 12,066 7,134
Warrant Gains 1,308 8,186 1,636 8,186
Net Security Gains 858 654 2,358 654
Net Gain on Merchant Services Business 19,000 - 19,000 -
Other 7,636 3,209 11,154 7,726
-------- -------- -------- --------
Total Noninterest Income 213,753 206,578 407,927 402,808
Noninterest Expense:
Salaries, Wages and Benefits 65,823 58,730 127,807 115,119
Charges and Fees 7,867 8,099 15,689 15,750
Occupancy 6,464 5,950 12,692 11,968
Leasing Expense 90,750 104,537 186,510 211,402
Equipment Expense 6,824 5,975 13,773 12,182
Professional Services 8,418 6,219 16,816 12,304
Minority Interest Expense 3,197 666 6,394 666
Disposition Cost of Subprime Loans 6,914 - 6,914 -
Other 29,816 26,461 61,561 53,858
-------- -------- -------- --------
Total Noninterest Expense 226,073 216,637 448,156 433,249
-------- -------- -------- --------
Income Before Income Taxes 19,705 35,094 58,234 68,802
Applicable Income Taxes 6,502 11,924 19,217 24,016
-------- -------- -------- --------
Net Income $ 13,203 $ 23,170 $ 39,017 $ 44,786
======== ======== ======== ========
Per Common Share:
Basic Earnings Per Share $ 0.27 $ 0.47 $ 0.79 $ 0.91
Diluted Earnings Per Share 0.26 0.46 0.77 0.88
Cash Dividends Paid 0.24 0.24 0.48 0.48
See notes to consolidated financial statements.
-4-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Accumulated
Other
Preferred Common Capital Retained Comprehensive
(In Thousands) Stock Stock Surplus Earnings Loss, Net Total
- ------------------------------------------------------------------------------------------------------------
Balance at January 1, 2002 $ 7,000 $ 14,587 $ 322,024 $ 556,918 $ (98,696) $ 801,833
Net Income 44,786 44,786
Other Comprehensive Income,
Net of Tax:
Change in Unrealized
Gains (Losses) on:
Hedging Instruments 17,887 17,887
Marketable Securities 27,986 27,986
---------
Total Comprehensive Income 90,659
Dividends Paid on:
Preferred Stock (474) (474)
Common Stock (23,649) (23,649)
Exercise of Stock Options and
Accompanying Tax Benefits 35 2,311 2,346
Benefit Plan Assets in
Provident Stock (195) (18,701) (18,896)
Costs Associated with issuance
of PRIDES Securities (6,722) (6,722)
Other (14) (2) (16)
--------- --------- --------- --------- --------- ---------
Balance at June 30, 2002 $ 7,000 $ 14,427 $ 298,898 $ 577,579 $ (52,823) $ 845,081
========= ========= ========= ========= ========= =========
Balance at January 1, 2003 $ 7,000 $ 14,454 $ 298,025 $ 604,013 $ (43,121) $ 880,371
Net Income 39,017 39,017
Other Comprehensive Income,
Net of Tax:
Change in Unrealized
Gains (Losses) on:
Hedging Instruments 19,647 19,647
Marketable Securities (24,943) (24,943)
---------
Total Comprehensive Income 33,721
Dividends Paid on:
Preferred Stock (474) (474)
Common Stock (23,797) (23,797)
Exercise of Stock Options and
Accompanying Tax Benefits 18 1,513 1,531
Benefit Plan Assets in
Provident Stock (11) (700) (47) (758)
--------- --------- --------- --------- --------- ---------
Balance at June 30, 2003 $ 7,000 $ 14,461 $ 298,838 $ 618,712 $ (48,417) $ 890,594
========= ========= ========= ========= ========= =========
See notes to consolidated financial statements.
-5-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended June 30,
---------------------------
(In Thousands) 2003 2002
- ------------------------------------------------------------------------------------
Operating Activities:
Net Income $ 39,017 $ 44,786
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Provision for Loan and Lease Losses 68,990 57,780
Other Amortization and Accretion 31,022 6,416
Depreciation of Leased Equipment 194,583 209,508
Depreciation of Premises and Equipment 12,246 10,989
Tax Benefit Received from Exercise of Stock Options 730 508
Realized Investment Security Gains (2,358) (654)
Proceeds from Sale of Loans Held for Sale 2,013,900 1,216,436
Origination of Loans Held for Sale (2,016,045) (1,321,641)
Realized Gains on Loans Held for Sale (8,010) (5,334)
Decrease in Trading Account Securities 21,971 19,417
Increase in Interest Receivable (43,345) (9,699)
(Increase) Decrease in Other Assets (152,158) 27,620
Increase (Decrease) in Interest Payable (5,709) 12,220
Increase (Decrease) in Other Liabilities 76,356 (24,596)
----------- -----------
Net Cash Provided By Operating Activities 231,190 243,756
----------- -----------
Investing Activities:
Investment Securities Available for Sale:
Proceeds from Sales 1,902,379 735,979
Proceeds from Maturities and Prepayments 859,842 456,764
Purchases (3,323,184) (1,607,553)
Decrease in Loans and Leases 184,896 127,230
(Increase) Decrease in Operating Lease Equipment 148,774 (37,239)
Increase in Premises and Equipment (7,803) (9,134)
----------- -----------
Net Cash Used In Investing Activities (235,096) (333,953)
----------- -----------
Financing Activities:
Increase in Deposits 1,065,669 445,323
Decrease in Short-Term Debt (656,807) (570,329)
Principal Payments on Long-Term Debt (233,844) (162,762)
Proceeds From Issuance of Long-Term Debt 686 38,314
Proceeds From Issuance of Minority Interest,
Net of Transaction Costs - 161,213
Cash Dividends Paid (24,271) (24,123)
Proceeds from Exercise of Stock Options 801 1,838
Net Decrease in Other Equity Items - (16)
----------- -----------
Net Cash Provided By (Used In) Financing Activities 152,234 (110,542)
----------- -----------
Increase (Decrease) in Cash and Cash Equivalents 148,328 (200,739)
Cash and Cash Equivalents at Beginning of Period 540,919 501,223
----------- -----------
Cash and Cash Equivalents at End of Period $ 689,247 $ 300,484
=========== ===========
Supplemental Disclosures of Cash Flow Information:
Cash Paid for:
Interest $ 238,251 $ 221,832
Income Taxes 2,174 5,534
Non-Cash Activity:
Transfer of Loans and Leases to
Other Real Estate and Equipment 18,420 12,519
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. Investment in companies
in which Provident has significant influence over operating and financing
decisions (principally defined as owning a voting or economic interest of 20% to
50%) are accounted for by the equity method of accounting. 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 2002 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 5.6 million and 3.0 million shares of
Common Stock were outstanding at June 30, 2003 and 2002, 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 these instruments had no dilutive impact.
-7-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the computation of basic and diluted earnings per
common share:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
(In Thousands, Except Per Share Data) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------
Basic:
Net Income $ 13,203 $ 23,170 $ 39,017 $ 44,786
Less Preferred Stock Dividends (237) (237) (474) (474)
-------- -------- -------- --------
Income Available to Common Shareholders 12,966 22,933 38,543 44,312
Weighted-Average Common Shares Outstanding 48,770 48,646 48,773 48,936
-------- -------- -------- --------
Basic Earnings Per Share $ 0.27 $ 0.47 $ 0.79 $ 0.91
======== ======== ======== ========
Diluted:
Net Income $ 13,203 $ 23,170 $ 39,017 $ 44,786
Weighted-Average Common Shares Outstanding 48,770 48,646 48,773 48,936
Benefit Plans Common Shares 711 651 695 327
Assumed Conversion of:
Convertible Preferred Stock 988 988 988 988
Dilutive Stock Options 199 630 260 501
-------- -------- -------- --------
Dilutive Potential Common Shares 50,668 50,915 50,716 50,752
-------- -------- -------- --------
Diluted Earnings Per Share $ 0.26 $ 0.46 $ 0.77 $ 0.88
======== ======== ======== ========
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 $367 million
of the preferred securities qualify as Tier 1 capital and the remainder
qualifies as Tier 2 capital for bank regulatory purposes. The sole assets of the
trusts are the debentures. The junior subordinated debentures consisted of the
following at June 30, 2003:
Stated Effective Maturity
(Dollars in Thousands) Rate Rate (1) Date Amount
- ------------------------------------------------------------------------------
November 1996 Issuance 8.60% 8.64% 12/01/26 $ 99,023
June 1999 Issuance 8.75% 2.37% 06/30/29 121,588
November 2000 Issuance 10.25% 3.73% 12/31/30 109,315
March 2001 Issuance 9.45% 4.02% 03/30/31 121,358
--------
Total $451,284
========
(1)Effective rate reflects interest rate after adjustment for notes issued at
discount or premium, capitalized fees associated with the issuance of the
debt and interest rate swap agreements entered to alter the payment
characteristics.
-8-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. COMPREHENSIVE INCOME
- -----------------------------
Comprehensive income represents the changes in equity during a period except
those resulting from investments by shareholders and distributions to
shareholders. For Provident, components of comprehensive income include the
unrealized gains/losses on securities available for sale and unrealized
gains/losses on cash flow hedging derivatives (collectively known as other
comprehensive income), as well as net income. A summary of activity in
accumulated other comprehensive income (loss) follows:
Six Months Ended
June 30,
-----------------------
(In Thousands) 2003 2002
- ------------------------------------------------------------------------------------------
Accumulated Unrealized Gains (Losses) on Securities Available
for Sale at January 1, Net of Tax $ 36,809 $ (15,953)
Net Unrealized Gains for the Period, Net of Tax
Expense of $111 in 2003 and $15,298 in 2002 207 28,411
Reclassification Adjustment for Gains Included in Net Income,
Net of Tax Expense of $13,543 in 2003 and $229 in 2002 (25,150) (425)
-------- --------
Effect on Other Comprehensive Income (Loss) for the Year (24,943) 27,986
-------- --------
Accumulated Unrealized Gains on Securities Available
for Sale at June 30, Net of Tax $ 11,866 $ 12,033
======== ========
Accumulated Unrealized Losses on Derivatives Used in Cash
Flow Hedging Relationships at January 1, Net of Tax $ (79,930) $ (82,743)
Net Unrealized Losses for the Period, Net of Tax
Expense of $2,949 in 2003 and $3,299 in 2002 (5,477) (6,126)
Reclassification Adjustment for Losses Included in Net Income,
Net of Tax Benefit of $13,529 in 2003 and $12,930 in 2002 25,124 24,013
-------- --------
Effect on Other Comprehensive Income (Loss) for the Year 19,647 17,887
-------- --------
Accumulated Unrealized Losses on Derivatives Used in Cash
Flow Hedging Relationships at June 30, Net of Tax $ (60,283) $ (64,856)
========= =========
Accumulated Other Comprehensive Loss at January 1, Net of Tax $ (43,121) $ (98,696)
Other Comprehensive Income (Loss), Net of Tax (5,296) 45,873
-------- --------
Accumulated Other Comprehensive Loss at June 30, Net of Tax $ (48,417) $ (52,823)
========= =========
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 conforming and nonconforming 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
Financial results are determined based on an assignment of balance sheet and
income statement items to each business line. Equity allocations are made based
on various risk measurements of the business line. A matched funded transfer
pricing process is used to allocate interest income and expense among the
business lines. Provision for loan and lease losses are charged to each business
line based on its level of net charge-offs and the size and risk of its lending
portfolio. Activity-based costing is used to allocate expenses for centrally
provided services.
Condensed income statements and total assets are provided below for Provident's
three major lines of business for the three-month and six-month periods ended
June 30, 2003 and 2002. Corporate Center represents income and expenses not
related to the major business lines operational activities, and gain/loss on the
sale of investment securities.
Commercial Retail Mortgage Corporate
(Dollars in Millions) Banking Banking Banking Center Total
- ----------------------------------------------------------------------------------------------
Three Months Ended June 30 2003:
Net Interest Income $ 51.2 $ 15.6 $ 17.7 $ - $ 84.5
Provision for Loan Losses (8.7) (3.0) (7.6) (33.2) (52.5)
Noninterest Income 45.7 135.5 12.7 19.9 213.8
Noninterest Expense (60.4) (137.8) (21.0) (6.9) (226.1)
Income Taxes (9.2) (3.4) (0.6) 6.7 (6.5)
---------- ---------- ---------- ---------- -----------
Net Income $ 18.6 $ 6.9 $ 1.2 $ (13.5) $ 13.2
========== ========== ========== ========== ===========
Three Months Ended June 30 2002:
Net Interest Income $ 55.2 $ 7.4 $ 16.1 $ - $ 78.7
Provision for Loan Losses (13.2) (3.8) (7.6) (9.0) (33.6)
Noninterest Income 37.7 150.6 9.4 8.9 206.6
Noninterest Expense (50.5) (148.8) (17.3) - (216.6)
Income Taxes (9.9) (1.8) (0.2) - (11.9)
---------- ---------- ---------- ---------- -----------
Net Income $ 19.3 $ 3.6 $ 0.4 $ (0.1) $ 23.2
========== ========== ========== ========== ===========
Six Months Ended June 30 2003:
Net Interest Income $ 101.0 $ 29.7 $ 36.8 $ - $ 167.5
Provision for Loan Losses (20.7) (5.0) (10.1) (33.2) (69.0)
Noninterest Income 87.2 274.9 24.4 21.4 407.9
Noninterest Expense (118.5) (280.6) (42.2) (6.9) (448.2)
Income Taxes (16.2) (6.3) (2.9) 6.2 (19.2)
---------- ---------- ---------- ---------- -----------
Net Income $ 32.8 $ 12.7 $ 6.0 $ (12.5) $ 39.0
========== ========== ========== ========== ===========
Total Assets $ 7,559 $ 4,768 $ 1,276 $ 4,191 $ 17,794
========== ========== ========== ========== ===========
Six Months Ended June 30 2002:
Net Interest Income $ 110.8 $ 14.8 $ 31.4 $ - $ 157.0
Provision for Loan Losses (32.0) (7.6) (9.2) (9.0) (57.8)
Noninterest Income 74.0 304.1 15.8 8.9 402.8
Noninterest Expense (104.2) (295.0) (34.0) - (433.2)
Income Taxes (16.8) (5.8) (1.4) - (24.0)
---------- ---------- ---------- ---------- -----------
Net Income $ 31.8 $ 10.5 $ 2.6 $ (0.1) $ 44.8
========== ========== ========== ========== ===========
Total Assets $ 7,259 $ 4,624 $ 1,479 $ 3,213 $ 16,575
========== ========== ========== ========== ===========
-10-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. GOODWILL AND OTHER INTANGIBLE ASSETS
- ---------------------------------------------
Provident adopted the provisions of Statements 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 are no longer amortized but are subject to
annual impairment tests in accordance with Statement 142. Other intangible
assets deemed to have limited lives continue to be amortized over their useful
lives. Management performed an impairment test on its goodwill assets as of
January 1, 2003 and determined that no impairment existed as of that date.
Changes in the carrying amount of goodwill by business line for the six months
ended June 30, 2003 and 2002, are as follows:
Commercial Retail
(In Thousands) Banking Banking Total
- ----------------------------------------------------------------------------------
Balance at January 1, 2002 $ 39,825 $ 40,824 $ 80,649
Goodwill Acquired During the Year 189 189
Goodwill Recorded as a Result of Contingent
Consideration being Recognized 1,594 - 1,594
-------- -------- --------
Balance at June 30, 2002 $ 41,419 $ 41,013 $ 82,432
======== ======== ========
Balance at January 1, 2003 $ 41,419 $ 41,232 $ 82,651
Goodwill Recorded as a Result of Contingent
Consideration being Recognized 1,328 - 1,328
-------- -------- --------
Balance at June 30, 2003 $ 42,747 $ 41,232 $ 83,979
======== ======== ========
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:
Gross Net
Carrying Accumulated Carrying
(In Thousands) Value Amortization Value
- -------------------------------------------------------------------------------
Non-Contractual Customer Relationships $21,997 $ 11,029 $ 10,968
Purchased Core Deposits 1,429 1,251 178
------- -------- --------
Balance at June 30, 2003 $23,426 $ 12,280 $ 11,146
======= ======== ========
The estimated amortization of intangible assets for the next five years, is $2.4
million for the remainder of 2003; $4.4 million for 2004; $3.1 million for 2005;
$0.7 million for 2006; and $0.2 million for 2007.
-11-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 with servicing retained, 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. Mortgage servicing assets are evaluated quarterly for impairment based on
the fair value of those assets, using a disaggregated approach. The fair value
of the mortgage servicing assets is determined by estimating the present value
of future net cash flows, taking into consideration loan prepayments speeds,
discount rates, servicing costs and other economic factors.
Changes in the carrying value of mortgage servicing assets follows:
Six Months Ended
June 30
----------------------
(In Thousands) 2003 2002
- -------------------------------------------------------
Balance at Beginning of Period $ 111,690 $ 84,267
Additions 33,664 18,763
Amortization (14,794) (6,617)
Impairment Charges - -
--------- ---------
Balance at End of Period $ 130,560 $ 96,413
========= =========
As of June 30, 2003, mortgage servicing assets relating to commercial real
estate loans and residential loans totaled $66.4 million and $64.2 million,
respectively. Total mortgage loans serviced for others included $10.2 billion on
commercial real estate property and $9.1 billion on residential property as of
June 30, 2003. No impairment charges were incurred on the commercial real estate
servicing assets as most of the underlying loans have lockout and prepayment
penalties generally ranging from 5 to 9 years. Regarding the residential
servicing rights, no impairment charges were recognized as the majority of the
servicing assets were acquired under the current interest rate environment.
-12-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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. During the
first quarter of 2003, certain equity investments were determined to have
incurred a total of $11.0 million of other than temporary impairment in their
valuation based upon information received from the general partners of the
equity funds and Provident's internal analyses. This impairment charge was
offset against other realized security gains. As of June 30, 2003 and 2002,
Provident held equity investments with a carrying value of $60.6 million and
$74.6 million, respectively.
NOTE 9. STOCK OPTIONS
- ----------------------
Statement of Financial Accounting Standards 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 adopted
the provisions of Statement 123 as of January 1, 2003. Under these rules,
compensation expense is recognized over the vesting period equal to the fair
value of stock-based compensation as of the date of grant. As Provident has
elected to use the Prospective Method of expense recognition according to the
transition rules of Statement No. 148, "Accounting for Stock-Based Compensation
- - Transition and Disclosure," the adoption of Statement 123 applies only to
options granted after December 31, 2002. Prior to January 1, 2003, Provident
accounted for stock-based employee compensation plans 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 subjective assumptions
including the expected stock price volatility.
-13-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Provident recorded $471,000 ($393,000 after-tax) of stock-based compensation
during the first six months of 2003 while no compensation cost was recognized
for stock option grants during 2002. 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:
Three Months Ended Six Months Ended
June 30 June 30
------------------------ ------------------------
(In Thousands, Except Per Share Data) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------
Net Income as Reported $ 13,203 $ 23,170 $ 39,017 $ 44,786
Plus Stock-Based Compensation Recognized for
Options Granted in 2003, Net of Related Tax 204 - 393 -
Less Total Stock-Based Compensation for Options
Granted Since 1994, Net of Related Tax (1,778) (1,640) (3,689) (3,764)
---------- ---------- ---------- ----------
Pro-forma Net Income $ 11,629 $ 21,530 $ 35,721 $ 41,022
========== ========== ========== ==========
Earnings Per Share:
Basic - As Reported $ 0.27 $ 0.47 $ 0.79 $ 0.91
Basic - Pro Forma 0.23 0.44 0.72 0.83
Diluted - As Reported 0.26 0.46 0.77 0.88
Diluted - Pro Forma 0.23 0.43 0.72 0.81
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 June 30, 2003 follow:
(In Thousands) Total Assets
- -------------------------------------------------------------------------------
Provident Auto Rental LLC 1999-1 $697,806
Provident Auto Leasing Company 517,517
Provident Auto Rental LLC 2000-1 358,503
Provident Auto Rental LLC 2001-1 300,550
Provident Auto Rental LLC 2000-2 147,017
Provident Auto Rental Company LLC 1998-2 143,904
Provident Auto Rental Company LLC 1998-1 131,680
Provident Lease Receivables Company LLC 89,800
The above amounts include items which are eliminated in the Consolidated
Financial Statements.
NOTE 11. SALE OF LOANS AND BUSINESS UNIT
- -----------------------------------------
During the second quarter of 2003, Provident completed the sale of $471 million
of subprime residential mortgage loans and related assets, and also sold its
Merchant Services business, a payment solutions provider for credit and debit
card acceptance programs. The loans were sold at a $40 million net discount, of
which $6.9 million was recorded as disposition cost in noninterest expense. The
sale of the Merchant Services business resulted in a gain of $19 million.
-14-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. COMMITMENTS AND CONTINGENCIES
- ---------------------------------------
Commitments to extend credit are financial instruments in which Provident agrees
to provide financing to customers based on predetermined terms and conditions.
Since many of the commitments to extend credit are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. Provident evaluates each customer's creditworthiness
on a case-by-case basis.
A standby letter of credit is an irrevocable guarantee whereby Provident
guarantees the performance of a customer to a third party in a borrowing
arrangement. They are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing, and similar
transactions. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
Generally, Provident issues standby letters of credit for terms from six months
to three years.
Provident's commitments to extend credit and letters of credit which are not
reflected in the balance sheet are as follows:
June 30 December 31
(In Millions) 2003 2002
- ----------------------------------------------------------------
Commitments to Extend Credit $3,952 $2,887
Standby Letters of Credit 256 274
Commercial Letters of Credit 7 11
Provident (Parent) has issued a guarantee for a subsidiary to assist in its
business activities. This guarantee was made to Fannie Mae for the benefit of
Red Mortgage Capital, Inc. Red Mortgage is an approved Fannie Mae Delegated
Underwriting and Servicing (DUS) mortgage lender. Under the Fannie Mae DUS
program, Red Mortgage underwrites, funds and sells mortgage loans on multifamily
rental projects. Red Mortgage then services these mortgage loans on Fannie Mae's
behalf. Participation in the Fannie Mae DUS program requires Red Mortgage to
share the risk of loan losses with Fannie Mae. Under the loss sharing
arrangement, Red Mortgage and Fannie Mae split losses with one-third of all
losses assumed by Red Mortgage and two-thirds of all losses assumed by Fannie
Mae. For Red Mortgage to participate in the loss sharing agreement, the Parent
provided a guarantee to Fannie Mae that it would fulfill all payments required
of Red Mortgage under the loss sharing arrangement and for servicing advances of
these loans if Red Mortgage fails to meet its obligations. As of June 30, 2003,
Red Mortgage serviced loans with outstanding principal balances aggregating $3.4
billion under the DUS program. The guarantee will continue until such time as
the loss sharing agreement is amended or that Red Mortgage no longer
participates in the Fannie Mae DUS program. No liability is carried on the
Parent's balance sheet for this guarantee as a liability has been established
for estimated losses on Red Mortgage's balance sheet.
Provident and its subsidiaries are not parties to any pending legal proceedings
other than routine litigation incidental to their business except for the
following matters related to the restatements announced March 5, 2003, and April
15, 2003.
-15-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Several purported class-actions have been filed against Provident, its
President, Robert L. Hoverson, its Chief Financial Officer, Christopher J.
Carey, and their predecessors in those positions, on behalf of all purchasers of
Provident securities from March 30, 1998 through March 5, 2003. Litigation has
also been filed against Provident, its President, Robert L. Hoverson and its
Chief Financial Officer, Christopher J. Carey plus PFGI Capital Corporation, a
Provident subsidiary, and others on behalf of all purchasers of PRIDES in or
traceable to a June 6, 2002 offering of those securities registered with the
Securities and Exchange Commission and extending to March 5, 2003. That action
alleges violations of securities laws by the defendants in Provident's financial
disclosures during the period from March 30, 1998 through March 5, 2003 and in
the June 2002 offering and seeks an unspecified amount of compensatory damages
and/or rescission of purchases of the PRIDES securities. These actions are based
upon circumstances involved in the restatement of earnings announced by
Provident on March 5, 2003 and allege violations of federal securities laws by
the defendants in Provident's financial disclosures during the period from March
30, 1998 through March 5, 2003. They seek an unspecified amount of damages and,
in two cases, reimbursement of all executive bonuses received during that
period.
Several derivative actions have also been filed on behalf of Provident versus
Provident's directors and others. These suits were also concerned with the
restatements of earnings and allege that the defendants breached fiduciary
duties owed to Provident and are responsible for the conditions that led to the
restatements and their consequences and sales of stock and other actions by
certain officers and directors and seek recovery from the defendants of an
unspecified amount of damages.
NOTE 13. ACCOUNTING PRONOUNCEMENTS EFFECTIVE FOR FUTURE PERIODS
- ----------------------------------------------------------------
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities". This
Interpretation of Accounting Research Bulletin No. 51 (ARB 51), "Consolidated
Financial Statements," addresses consolidation by business enterprises where
ownership interests in an entity may vary over time or, in many cases,
consolidation of special-purpose entities (SPEs). To be consolidated for
financial reporting, these entities must have certain characteristics. ARB 51
requires that an enterprise's consolidated financial statements include
subsidiaries in which the enterprise has a controlling financial interest. This
Interpretation requires existing unconsolidated variable interest entities to be
consolidated by their primary beneficiaries if the entities do not effectively
disperse risks among parties involved. An enterprise that holds significant
variable interests in such an entity, but is not the primary beneficiary, is
required to disclose certain information regarding its interests in that entity.
This Interpretation applies in the first fiscal year or interim period beginning
after June 15, 2003, to variable interest entities in which an enterprise holds
an interest that it acquired before February 1, 2003. It also applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. As the securitization of its nonconforming residential, prime home
equities and equipment leases involve the use of qualified special purpose
-16-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
entities as defined by Statement 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities," which is excluded from
Interpretation 46, these securitization entities will continue to be excluded
from consolidation. Other equity investments held by Provident are currently
being reviewed for any possible impact. The adoption of this Interpretation is
not expected to have a material impact on Provident's results of operations or
financial condition.
In April 2003, FASB issued Statement of Financial Accounting Standards No. 149
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities."
Statement 149 amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities under Statement 133 "Accounting for
Derivative Instruments and Hedging Activities." Statement 149 amends Statement
133 for decisions made (1) as part of the Derivatives Implementation Group
process that effectively required amendments to Statement 133, (2) in connection
with other FASB projects dealing with financial instruments, and (3) in
connection with implementation issues raised in relation to the application of
the definition of a derivative. Statement 149 is effective for contracts entered
into or modified after June 30, 2003, and hedging relationships designated after
June 30, 2003. However, the provisions of Statement 149 that merely represent
the codification of previous Derivatives Implementation Group decisions, are
already effective and should continue to be applied in accordance with their
prior respective effective dates. The adoption of Statement 149 is not expected
to have a material impact on Provident's results of operations or financial
condition.
In May 2003, FASB issued Statement 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." Statement 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability. Many of those instruments were previously classified as equity.
Statement 150 is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. Restatement is not permitted. The
adoption of Statement 150 is not expected to have a material impact on
Provident's results of operations or financial condition.
-17-
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.
On July 10, 2003 Provident announced a number of strategic actions taken late in
the second quarter to further align its core businesses with its corporate
operating strategy. The company further reduced its risk profile through the
sale of $471 million of subprime residential mortgage loans, and also sold its
Merchant Services business, a payment solutions provider for credit and debit
card acceptance programs. The company has also agreed to sell its Florida
franchise including 13 branches to RBC Centura Bank, a wholly owned subsidiary
of Royal Bank of Canada. The transaction, which is subject to regulatory
approval, is expected to close in the third quarter or early fourth quarter of
this year.
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.
Forward-looking statements may be identified by words such as estimates,
anticipates, projects, plans, expects, intends, believes, should and similar
expressions and by the context in which they are used. Such statements are based
upon current expectations of the company and speak only as of the date made.
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;
changes by rating agencies in Provident's debt rating; 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. Provident
undertakes no obligations to update any forward-looking statements to reflect
events or circumstances arising after the date on which they are made.
-18-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
- ---------------------
Summary
- -------
The following table summarizes earnings components, earnings per share and key
financial ratios:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in Thousands, -------------------------------- -------------------------------
Except Per Share Data) 2003 2002 Change 2003 2002 Change
-----------------------------------------------------------------------------------------------------------
Income Statement Summary:
Net Interest Income $ 84,494 $ 78,728 7% $167,453 $157,023 7%
Noninterest Income 213,753 206,578 3 407,927 402,808 1
Total Revenue 298,247 285,306 5 575,380 559,831 3
Provision for Loan and Lease Losses 52,469 33,575 56 68,990 57,780 19
Noninterest Expense 226,073 216,637 4 448,156 433,249 3
Net Income 13,203 23,170 (43) 39,017 44,786 (13)
Diluted Earnings Per Common Share 0.26 0.46 (43) 0.77 0.88 (13)
Ratios Analysis:
Return on Average Equity 5.85% 10.91% 8.76% 10.69%
Return on Average Assets 0.30% 0.57% 0.44% 0.55%
Second quarter 2003 earnings per diluted share and net income were $0.26 and
$13.2 million, respectively, compared with $0.46 and $23.2 million in the second
quarter of 2002. For the first six months of 2003 earnings per diluted share and
net income were $0.77 and $39.0 million, respectively, compared with $0.88 and
$44.8 million for the same period in 2002. Returns on average equity and assets
were 8.76% and 0.44%, respectively, for the first six months of 2003 compared
with 10.69% and 0.55% for the same period during 2002.
-19-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
As noted earlier, during the second quarter Provident completed the sale of
subprime residential mortgage loans that had been held in portfolio, and also
sold its Merchant Services business. Management believes presenting financial
information excluding these sales might be beneficial to the reader as it
provides data that is more comparable to earlier periods contained in this
document. Excluding both sales, Provident's net income and earnings per share
would have been $27.4 million and $0.54 for the second quarter and $53.2 million
and $1.05 for the first six months of 2003, respectively. The following table
presents financial information removing the impact of the sales.
Impact from Sale of
As ---------------------------------- Excluding
Reported Subprime Loans Merchant Services Sales
---------------------------------------------------------------
For the Three Months Ended June 30, 2003:
Condensed Income Statement (In Thousands):
Net Interest Income $ 84,494 $ - $ - $ 84,494
Provision for Loan and Leases Losses (52,469) (33,225) - (19,244)
Noninterest Income 213,753 - 19,000 194,753
Noninterest Expense (226,073) (6,914) - (219,159)
-------- --------- -------- --------
Income Before Income Taxes 19,705 (40,139) 19,000 40,844
Applicable Income Taxes (6,502) 13,246 (6,270) (13,478)
-------- --------- -------- --------
Net Income $ 13,203 $ (26,893) $ 12,730 $ 27,366
======== ========= ======== ========
Other Data:
Earnings Per Common Share - Diluted $ 0.26 $ (0.53) $ 0.25 $ 0.54
Return on Assets 0.30% (0.60)% 0.28% 0.61%
Return on Equity 5.85% (11.91)% 5.64% 12.12%
Net Charge Offs $ 68,470 $ 49,225 n/a $ 19,245
Net Charge Offs to Average
Loans and Leases (annualized) 2.98% n/a n/a 0.84%
For the Six Months Ended June 30, 2003:
Condensed Income Statement (In Thousands):
Net Interest Income $167,453 $ - $ - $167,453
Provision for Loan and Leases Losses (68,990) (33,225) - (35,765)
Noninterest Income 407,927 - 19,000 388,927
Noninterest Expense (448,156) (6,914) - (441,242)
-------- --------- -------- --------
Income Before Income Taxes 58,234 (40,139) 19,000 79,373
Applicable Income Taxes (19,217) 13,246 (6,270) (26,193)
-------- --------- -------- --------
Net Income $ 39,017 $ (26,893) $ 12,730 $ 53,180
======== ========= ======== ========
Other Data:
Earnings Per Common Share - Diluted $ 0.77 $ (0.53) $ 0.25 $ 1.05
Return on Assets 0.44% (0.30)% 0.14% 0.60%
Return on Equity 8.76% (6.04)% 2.86% 11.94%
Net Charge Offs $ 85,022 $ 49,225 n/a $ 35,797
Net Charge Offs to Average
Loans and Leases (annualized) 1.86% n/a n/a 0.78%
Net interest income for the six months ended June 30, 2003, increased $10.4
million, or 7%, compared to the first six months of 2002. The increase in
interest income was due to an increase in average earning assets of $1.5
billion, or 12%. The increase in average earning assets resulted primarily from
the growth of home equity loans and investment securities. The growth in earning
assets was primarily funded by a corresponding growth in interest bearing
liabilities. The largest increases in interest bearing liabilities were demand
and time deposits.
-20-
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 $69.0 million and $57.8 million for
the first six months of 2003 and 2002, respectively. Included in the provision
for 2003 was approximately $33.2 million of provision related to the sale of
subprime residential mortgage loans that occurred in the second quarter of 2003.
The annualized net charge-off to average loans and leases ratio was 1.86% for
the first six months of 2003 compared to 1.94% for the same period in 2002. If
the $49.2 million charge-off related to the residential mortgage loan sale were
excluded, the net charge-off ratio for the first six months of 2003 would have
been 0.78%. Nonperforming assets at June 30, 2003 were $147.2 million compared
to $182.2 million and $186.0 million as of December 31, 2002 and June 30, 2002,
respectively. Nonperforming assets are at their lowest level in nearly two years
due to management actions and to the sale of the subprime residential mortgages.
Reserve for loan losses to nonperforming assets was 125.73% as of June 30, 2003
compared to 110.34% and 115.50% as of December 31, 2002 and June 30, 2002,
respectively.
Noninterest income increased $5.1 million for the first six months of 2003 as
compared to the same period in 2002. Increases in nearly every noninterest
income category along with a gain on the sale of the Merchant Servicing
business, more than offset a decrease in leasing income. The decrease in leasing
income was a result of amortization of the portfolio and because auto leases
originated since February, 2003 have been classified as finance leases rather
than operating leases. In February 2003, Provident changed the structure of the
residual insurance it obtains on its auto leases resulting in this type of
lending being classified as a direct financing lease in the loan category and
income being recorded as interest income.
Noninterest expense increased $14.9 million, or 3%, for the first six months of
2003 as compared to the same period in 2002. The increase in noninterest expense
was primarily in the areas of payroll, professional services, minority interest
expense, and expenses related to the disposal of the subprime residential
mortgage loans. These increases were partially offset by decreases in leasing
and other real estate expenses. The minority interest expense relates to
dividends paid 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.
Similar to leasing income, leasing expense decreased due to the decrease in auto
leasing activity, as well as auto leases originated since February 2003 being
classified as finance leases rather than operating leases.
Total assets increased $254 million from December 31, 2002 to June 30, 2003
primarily as a result of an increase in federal funds, investment securities and
home equity loans. Partially offsetting these increases were reductions in
nonconforming residential loans and auto leases. The fluctuations in the loan
and lease balances reflect management's decision to lower the risk profile of
its loan and lease portfolio. Total deposits increased $1.1 billion during the
first six months of 2003. Average core deposits have increased 9% since the
second quarter of 2002.
-21-
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 six-month periods ended June 30, 2003 and 2002.
Condensed income statements and total assets are provided in Note 5 of the
"Notes to Consolidated Financial Statements".
Key components of the management reporting process follows:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
(Dollars in Millions) 2003 2002 2003 2002
- --------------------------------------------------------------------
Commercial Banking $ 18.6 $ 19.3 $ 32.8 $ 31.8
Retail Banking 6.9 3.6 12.7 10.5
Mortgage Banking 1.2 0.4 6.0 2.6
Corporate Center (13.5) (0.1) (12.5) (0.1)
--------- --------- --------- ---------
$ 13.2 $ 23.2 $ 39.0 $ 44.8
========= ========= ========= =========
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 in most cases 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 their level of net charge-offs as well as the size and composition
of their lending portfolio.
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, and gain/loss on
the sale of investment securities.
Business line descriptions and fluctuation analysis follows:
o Commercial Banking provides a broad range of commercial banking and
commercial real estate products, services and solutions. Areas of focus and
expertise include regional middle-market lending, equipment leasing and
financing, treasury management, and loan servicing, transaction structuring
and various capital solutions for the multi-family housing industry. Primary
operating groups within Commercial Banking are Regional Middle-Market
Commercial Banking, Commercial Real Estate, Middle Market Equipment Leasing
and Financing and Corporate Services.
Net income for Commercial Banking for the second quarters of 2003 and 2002
was $18.6 million and $19.3 million, respectively, and for the first half of
-22-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
2003 and 2002 was $32.8 million and $31.8 million, respectively. Contributing
to the higher six-month net income for 2003 was an increase in noninterest
income and lower provision expense, which was partially offset by lower
interest income and higher operating expenses.
The growth in noninterest income came primarily from its fee-based commercial
real estate businesses, Red Capital Group and Capstone Realty Advisors. Both
Red Capital Group and Capstone recognized a significant increase in revenue
while utilizing lower levels of capital. The favorable rate environment
during the past quarter provided for an increased demand for their services.
Average asset balances for the first half of 2003 increased $432 million or
6% compared to the same time period in 2002. However, net interest income for
the first six months of 2003 failed to keep pace with asset growth due to
modest spread compression. Furthermore, provision expense decreased in the
first half of 2003 primarily due to an overall improvement in credit quality
of the commercial loan portfolio.
In cash management, technology-driven solutions and competitive product
offerings contributed to an increase in deposits for the second quarter of
2003. Average commercial deposits for the second quarter of 2003 increased by
$416 million, or 68% as compared to the second quarter of 2002. The product
offerings have attracted new relationships and generated more business from
the existing commercial customer base.
Management continues to reposition this business line in order to develop and
grow more predictable earnings. Management has de-emphasized 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.
o Retail Banking provides a variety of deposit, credit and investment products,
services and solutions to consumers and small businesses through various
delivery channels including: branches, call center, ATMs and the internet.
Consumer lending primarily focuses on offering home equity loans to high
credit-quality borrowers. Primary operating groups within Retail Banking
include Branch Banking, Business Banking and Consumer Lending/Prime Home
Equity. Retail Banking also includes Provident Financial Advisors, which
provides an extensive range of investment, insurance and financial products,
services and solutions to individuals, businesses and government agencies.
Net income increased $3.3 million and $2.2 million for the three-month and
six-month periods ended June 30, 2003 as compared to the same periods in
2002. The increase in net income for 2003 was primarily the result of growth
within Retail's lending business units.
Retail Banking continues to alter the composition of its consumer lending
portfolio. Management believes that growing its home equity portfolio while
slowing auto lease originations will result in lower credit risk exposure.
-23-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Retail Banking has experienced growth in transaction deposits of 21% in the
second quarter of 2003 as compared to the second quarter of 2002. Total
retail deposit growth has been flat over the same time period, however, due
to less aggressive pricing on retail certificates of deposit. Provident plans
to further enhance its distribution system to improve customer acquisition
and market penetration.
o Mortgage Banking offers conforming and nonconforming 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 groups within Mortgage Banking include
Residential Mortgage Origination and Sales, Third-Party Loan Servicing and
Warehouse Lending Services.
Net income for the second quarter of 2003 was $1.2 million as compared to
$0.4 million for the second quarter of 2002. For the first six months of
2003, net income was $6.0 million compared to $2.6 million for the same
period in 2002. Net income for 2003 rose primarily from higher warehouse
lending production, growth in the sub-servicing portfolio, and from the
execution of the whole-loan sale strategy. Warehouse lending production has
benefited from a favorable rate environment, which continues to generate loan
refinancing. Sub-servicing has also experienced significant growth as loans
serviced for others (excluding securitized mortgages) increased from $2.4
billion at June of 2002 to $7.5 billion at the end of this quarter. Gains on
the sale of nonconforming residential loans increased from $4.0 million in
the second quarter of 2002 to $4.7 million in the second quarter of 2003.
Mortgage Banking, consistent with the overall company strategy of risk
reduction, continues to implement strategic initiatives to reduce the
business' risk profile. Nonconforming loan originations have been sold to
investors on a whole-loan basis. Mortgage Banking has also developed new
businesses to create a diverse array of product offerings in the mortgage
market. Mortgage Banking is continuing with its strategy of building national
mortgage alliances in order to generate qualified leads for home mortgage
loans on a nationwide basis and sell them to investors.
o Corporate Center includes revenues and expenses not allocated to the primary
business lines, including any item not related to their operating activity.
The net loss of $12.5 million for the first six months of 2003 resulted from
an after-tax loss of $26.9 million from the sale of subprime residential
loans, net of after-tax gains of $12.7 million from the sale of the Merchant
Services business and $1.7 million from security sales. The net loss of $0.1
million for the first half of 2002 was from an after-tax loss of $5.9 million
from the sale of subprime loans, net of after-tax gains of $5.4 million from
the sale of warrants and $0.4 million from security sales.
-24-
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 six months ended June 30, 2003, increased $10.4
million, or 7%, compared to the first six months of 2002. The increase in
interest income was due to an increase in average earning assets of $1.5
billion, or 12%. The increase in average earning assets resulted primarily from
the growth of home equity loans and investment securities. The growth in earning
assets was primarily funded by a corresponding growth in interest bearing
liabilities. The largest increases in interest bearing liabilities were demand
and time deposits.
Net interest margin represents net interest income as a percentage of total
interest earning assets. For the first six months of 2003, the net interest
margin, on a tax-equivalent basis, was 2.35% compared to 2.46% for the same
period in 2002. This decrease was driven by changes in rates and volumes of
earning assets and the corresponding funding sources. The following table
details the components of the change in net interest income (on a tax-equivalent
basis) by major category of interest earning assets and interest bearing
liabilities for the three-month and six-month periods ended June 30, 2003 and
2002.
Three Months Ended Six Months Ended
---------------------------------- -----------------------------------
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
--------------- --------------- ---------------- ---------------
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 $ 4,518 5.73% $ 4,231 6.33% $ 4,482 5.70% $ 4,308 6.44%
Mortgage 909 5.59 878 6.42 921 5.71 880 6.48
Construction 539 4.34 560 4.38 531 4.26 563 4.60
Lease Financing 1,227 8.72 1,194 9.22 1,236 8.79 1,156 9.52
------- ---- ------- ---- ------- ---- ------- ----
Total Corporate Lending 7,193 6.12 6,863 6.68 7,170 6.12 6,907 6.81
Consumer Lending:
Installment 1,407 4.78 965 6.41 1,380 4.95 950 6.70
Residential 486 10.17 791 9.60 519 10.97 830 9.45
Lease Financing 97 8.91 0 0.00 65 8.65 0 0.00
------- ---- ------- ---- ------- ---- ------- ----
Total Consumer Lending 1,990 6.29 1,756 7.85 1,964 6.66 1,780 7.98
------- ---- ------- ---- ------- ---- ------- ----
Total Loans and Leases 9,183 6.16 8,619 6.92 9,134 6.24 8,687 7.05
Investment Securities 4,471 4.32 3,866 5.90 4,382 4.60 3,794 5.86
Federal Funds Sold and Reverse
Repurchase Agreements 441 1.90 127 2.85 378 1.99 118 2.82
Other Short Term Investments 498 5.70 299 6.55 501 5.52 292 6.36
------- ---- ------- ---- ------- ---- ------- ----
Total Earning Assets 14,593 5.45 12,911 6.57 14,395 5.60 12,891 6.65
Cash and Due From Banks 310 212 310 225
Leased Equipment 2,101 2,505 2,174 2,556
Other Assets 868 678 826 661
------- ------- ------- -------
Total Assets $17,872 $16,306 $17,705 $16,333
======= ======= ======= =======
Liabilities and
Shareholders' Equity:
Deposits:
Demand Deposits $ 1,204 1.51 $ 546 1.12 $ 1,129 1.47 $ 529 1.07
Savings Deposits 1,460 1.80 1,475 1.97 1,440 1.78 1,505 2.01
Time Deposits 6,990 2.68 6,446 3.66 6,745 2.80 6,184 3.82
------- ---- ------- ---- ------- ---- ------- ----
Total Deposits 9,654 2.40 8,467 3.20 9,314 2.48 8,218 3.31
Short-Term Debt:
Federal Funds Purchased and
Repurchase Agreements 1,129 2.37 906 2.90 1,308 2.22 1,192 2.64
Commercial Paper 265 1.24 284 1.93 283 1.36 278 1.93
------- ---- ------- ---- ------- ---- ------- ----
Total Short-Term Debt 1,394 2.16 1,190 2.67 1,591 2.07 1,470 2.50
Long-Term Debt 3,638 4.85 3,974 5.14 3,703 5.02 3,998 5.16
Junior Subordinated Debentures 451 4.09 451 5.47 451 4.15 451 5.41
------- ---- ------- ---- ------- ---- ------- ----
Total Interest Bearing
Liabilities 15,137 3.01 14,082 3.78 15,059 3.11 14,137 3.82
Noninterest Bearing Deposits 1,264 881 1,200 864
Minority Interest 162 34 161
Other Liabilities 406 460 394 494
Shareholders' Equity 903 849 891 838
------- ------- ------- -------
Total Liabilities and
and Shareholders' Equity $17,872 $16,306 $17,705 $16,333
======= ======= ======= =======
Net Interest Spread 2.44% 2.79% 2.49% 2.83%
==== ==== ==== ====
Net Interest Margin 2.32% 2.45% 2.35% 2.46%
==== ==== ==== ====
-25-
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
- ------------------------------------------------------------------
Provident continues to benefit from the significantly enhanced Credit and Risk
Management processes developed over the past 18 months. This coupled with clear
business and portfolio strategies allow for focused business development and
aggressive management of both non-strategic portfolios and problem loans.
Provident expanded and improved its analytical and reporting capacity, which in
turn improved the timeliness and value of portfolio information. Loans and
leases are primarily monitored by closely following changes and trends in risk
characteristics. The characteristics are analyzed using various techniques;
including, credit scoring models for consumer and small business loans and
leases and risk ratings for larger commercial, commercial mortgage and
commercial construction loans. These risk ratings are assigned based upon
individual credit analysis and are aggregated for reporting to senior management
on a regular basis. These same analytics serve as the basis for refining the
rating system, and establishing portfolio wide targets and caution levels. Early
trends and thresholds trigger changes in strategy and tactics including the use
of secondary market alternatives to liquidate and mitigate problem exposures and
portfolio segments.
Provident maintains a reserve for loan and lease losses to absorb losses from
current outstandings and potential usage of unfunded commitments. Discussion and
analysis of the reserves as well as the overall credit quality of the
off-balance sheet lending portfolio is provided in "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Asset Securitization
Activity" and "Fannie Mae DUS Program." The following paragraphs provide
information concerning its on-balance sheet credit portfolio and unused
commitments.
The reserve for loan and lease losses is maintained at a level which management
considers adequate to absorb loan and lease losses given the conditions at the
time. The reserve is increased by the provision for loan and lease losses. Loans
and leases deemed uncollectible are charged off and deducted from the reserve
while recoveries on loans and leases previously charged off are added back to
the reserve.
The adequacy of the reserve for loan and lease losses is monitored on a regular
basis and reflects 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.
Provident lowered its loan loss reserve to total loans by 37 basis points to
2.09% during the past twelve months. The provision for loan and lease losses was
$69.0 million and $57.8 million for the first six months of 2003 and 2002,
respectively. The increase in provision in the second quarter of 2003 as
compared to 2002 was a result of the sale of subprime residential mortgage
loans. Included in the provision for the second quarter of 2003 was
-26-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
approximately $33.2 million of provision related to the residential mortgage
loan sale. Nonperforming assets decreased by $56.3 million during the second
quarter of 2003, with approximately $53 million of the decrease attributable to
the subprime residential mortgage loan sale. The sale of the subprime
residential mortgage loans and the decrease in nonperforming assets has lowered
the level of problem loans. The ratio of reserve for loan and lease losses to
total loans was 2.09% and 2.46% at June 30, 2003 and 2002, respectively.
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 principal reliance on borrower credit quality and
secondarily on equipment value. Based upon previous peak outstandings, the
majority of commercial airline loans and leases are to borrowers considered to
have better credit quality. Even within this segment, shorter maturities have
left Provident exposed to residual equipment values. Most of the charge-offs and
valuation adjustments have dealt with transactions related to borrowers with
weaker credit quality, which exposed Provident to depressed equipment values.
Future events could occur that may negatively impact our assessment of
borrowers' credit quality and/or equipment values leading to higher reserves and
potential future losses.
The following table shows the progression of the reserve for loan and lease
losses and selected reserve ratios:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
(Dollars in Thousands) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------
Balance at Beginning of Period $ 201,020 $ 243,019 $ 201,051 $ 241,143
Provision for Loan and Lease Losses 52,469 33,575 68,990 57,780
Loans and Leases Charged Off (72,623) (68,145) (95,051) (96,386)
Recoveries 4,153 6,411 10,029 12,323
--------- --------- --------- ---------
Balance at End of Period $ 185,019 $ 214,860 $ 185,019 $ 214,860
========= ========= ========= =========
Reserve for Loan and Lease Losses
as a Percent of:
Nonaccrual Loans 138.80% 133.82%
Nonperforming Assets 125.73% 115.50%
Total Loans and Leases 2.09% 2.46%
Based upon the analysis of the adequacy of the reserve and the continuing change
in composition of the loan and lease portfolio, the reserve for loan and lease
losses has been allowed to decline over the past twelve months. However, as a
result of the decrease in nonperforming assets, both the reserve to nonaccrual
loans and nonperforming assets ratios improved during the second quarter of
2003.
-27-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following table presents the distribution of net loan charge-offs by loan
type for the three-month and six-month periods ended June 30, 2003 and 2002:
Three Months Ended Three Months Ended
June 30, 2003 June 30, 2002
--------------------------------------- -------------------------------------
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 $ 11,147 0.99% 16.3% $ 25,057 2.37% 40.6%
Mortgage 54 0.02 0.1 - - -
Construction (241) (0.18) (0.4) - - -
Lease Financing 1,714 0.56 2.5 21,635 7.25 35.0
-------- ----- -------- -----
Net Corporate Lending 12,674 0.70 18.5 46,692 2.72 75.6
Consumer Lending:
Installment 1,467 0.42 2.2 782 0.32 1.3
Residential 54,320 44.70 79.3 14,260 7.21 23.1
Lease Financing 9 0.04 - - - -
-------- ----- -------- -----
Net Consumer Lending 55,796 11.21 81.5 15,042 3.43 24.4
-------- ----- -------- -----
Net Charge-Offs $ 68,470 2.98 100.0 $ 61,734 2.87 100.0
======== ===== ======== =====
Six Months Ended Six Months Ended
June 30, 2003 June 30, 2002
--------------------------------------- -------------------------------------
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 $ 19,240 0.86% 22.6% $ 38,994 1.81% 46.4%
Mortgage 100 0.02 0.1 24 0.01 -
Construction (176) (0.07) (0.2) 300 0.11 0.3
Lease Financing 5,008 0.81 5.9 25,959 4.49 30.9
-------- ----- -------- -----
Net Corporate Lending 24,172 0.67 28.4 65,277 1.89 77.6
Consumer Lending:
Installment 2,043 0.30 2.4 1,509 0.32 1.8
Residential 58,798 22.67 69.2 17,277 4.16 20.6
Lease Financing 9 - - - - -
-------- ----- -------- -----
Net Consumer Lending 60,850 6.20 71.6 18,786 2.11 22.4
-------- ----- -------- -----
Net Charge-Offs $ 85,022 1.86 100.0 $ 84,063 1.94 100.0
======== ===== ======== =====
The decrease in net charge-offs for both commercial loans and corporate lease
financing was due primarily to the $29.4 million charge-off of commercial
airline loans and leases that occurred during the second quarter of 2002 with no
corresponding charge-off in 2003. The charge-off was comprised of $10.6 million
of commercial airline loans and $18.8 million of commercial airline leases. The
increase in the net charge-offs for residential was due primarily to the $49.2
million charge-off taken in conjunction with the sale of subprime residential
mortgage loans that occurred during the second quarter of 2003. During the
second quarter of 2002, a charge-off of $9.1 million was taken in conjunction
with the sale of $27 million of nonperforming subprime residential mortgage
loans. If the $49.2 million charge-off related to the subprime residential
mortgage loan sale were excluded, the net charge-off to average loans ratio for
the second quarter and six months of 2003 would have been .84% and .78%,
respectively.
-28-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Nonperforming assets at June 30, 2003 were $147.2 million compared to $182.2
million and $186.0 million as of December 31, 2002 and June 30, 2002,
respectively. The decrease in nonaccrual commercial loans during the second
quarter of 2003 was due primarily to one large charge off. The decrease in
nonaccrual residential mortgage loans and other nonperforming assets during the
second quarter of 2003 was due primarily to the sale of subprime residential
mortgage loans, which included loans that were on nonaccrual status and
foreclosed residential properties. The composition of nonperforming assets over
the past five quarters is provided in the following table.
2003 2002
-------------------- --------------------------------
Second First Fourth Third Second
(Dollars in Thousands) Quarter Quarter Quarter Quarter Quarter
- ---------------------------------------------------------------------------------------
Nonaccrual Loans:
Corporate Lending:
Commercial $116,926 $123,912 $ 99,805 $117,571 $108,330
Mortgage 6,307 7,298 11,783 10,619 5,546
Construction 3,792 1,321 1,746 2,243 7,268
Lease Financing 2,267 2,792 4,008 3,952 3,497
-------- -------- -------- -------- --------
Total Corporate Lending 129,292 135,323 117,342 134,385 124,641
Consumer Lending:
Installment - - - - -
Residential 4,011 45,927 49,091 44,548 35,920
Lease Financing - - - - -
-------- -------- -------- -------- --------
Total Consumer Lending 4,011 45,927 49,091 44,548 35,920
-------- -------- -------- -------- --------
Total Nonaccrual Loans 133,303 181,250 166,433 178,933 160,561
Other Nonperforming Assets 13,858 22,172 15,780 14,579 25,471
-------- -------- -------- -------- --------
Total Nonperforming Assets $147,161 $203,422 $182,213 $193,512 $186,032
======== ======== ======== ======== ========
Loans 90 Days Past Due
Still Accruing $ 5,971 $ 36,038 $ 29,918 $ 30,482 $ 29,186
Nonaccrual Loans to
Total Loans and Leases 1.50% 1.98% 1.82% 1.99% 1.84%
Nonperforming Assets to:
Total Loans, Leases and
Other Nonperforming Assets 1.66% 2.22% 1.99% 2.15% 2.12%
Total Assets 0.83% 1.15% 1.04% 1.13% 1.12%
Nonaccrual loans have decreased $33.1 million while other nonperforming assets
have decreased $1.9 million during the first half of 2003. The following table
shows the progression of nonperforming assets during the first six months of
2003:
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 $ 99,805 $ 13,529 $ 4,008 $ 49,091 $ 166,433 $ 15,780 $ 182,213
Additions 54,541 3,502 2,540 29,150 89,733 8,167 97,900
Payments / Sales (16,061) (6,539) (1,676) (50,161) (74,437) (25,801) (100,238)
Charge-Offs (21,359) (165) (1,205) (7,277) (30,006) (2,253) (32,259)
Transfers to Other
Nonperforming Assets - (228) (1,400) (16,792) (18,420) 18,420 -
Writedowns - - - - - (455) (455)
--------- --------- --------- --------- --------- --------- ---------
Balance at
June 30, 2003 $ 116,926 $ 10,099 $ 2,267 $ 4,011 $ 133,303 $ 13,858 $ 147,161
========= ========= ========= ========= ========= ========= =========
-29-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Noninterest Income
- ------------------
The following table details the components of noninterest income and their
change for the second quarter and six-month periods ended June 30, 2003 and
2002:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
(Dollars in Thousands) 2003 2002 Change 2003 2002 Change
- ----------------------------------------------------------------------------------------------------------
Service Charges on Deposit Accounts $ 12,391 $ 10,915 14% $ 24,723 $ 21,364 16%
Loan Servicing Fees 9,428 8,414 12 20,088 16,412 22
Commercial Mortgage Banking Revenue 10,849 6,021 80 21,146 11,767 80
Other Service Charges and Fees 12,921 12,021 7 24,657 21,920 12
Leasing Income 132,238 152,664 (13) 271,099 307,645 (12)
Cash Gains on Sale of Loans 7,124 4,494 59 12,066 7,134 69
Warrant Gains 1,308 8,186 (84) 1,636 8,186 (80)
Security Gains 858 654 31 2,358 654 261
Net Gain on Merchant Services Business 19,000 - n/a 19,000 - n/a
Other 7,636 3,209 138 11,154 7,726 44
-------- -------- -------- --------
Total Noninterest Income $213,753 $206,578 3 $407,927 $402,808 1
======== ======== ======== ========
Explanations for significant changes in noninterest income by category follow:
o Service charges on deposit accounts increased $1.5 million and $3.4 million
in the quarterly and six-month comparisons due primarily to increases in
service charges on corporate accounts and overdraft fees.
o Loan servicing fees increased $1.0 million and $3.7 million in the quarterly
and six-month comparisons as an increase in fees from servicing residential
mortgage portfolios more than offset the decrease in fees from the declining
off-balance sheet securitized portfolios.
o Increases in fees from both Red Capital Group and Capstone resulted in higher
commercial mortgage banking revenue for the three-month and six-month
comparisons.
o Other service charges and fees increased $0.9 million and $2.7 million in the
quarterly and six-month comparisons. The quarterly increase was due primarily
to increased fee income generated by Commercial Banking. The six-month
increase also included an increase in warehouse lending fees.
o Leasing income decreased $20.4 million and $36.5 million in the quarterly and
six-month comparisons due primarily to the decrease in size of the auto lease
portfolio. Auto leases originated since February, 2003 have been classified
as finance leases in the loan category rather than operating leases.
o The increase in gain on sale of loans of $2.6 million for the second quarter
and $4.9 million for six months of 2003 is due primarily to gains recognized
from the sale of nonconforming residential mortgage loans. Provident
implemented this strategy during the third quarter of 2001.
-30-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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. Warrants gains of $1.6 million were recognized in the first six
months of 2003 compared to gains of $8.2 million in the first six months of
2002.
o As part of its strategic repositioning, Provident sold its Merchant Services
business in the second quarter of 2003. This sale resulted in a gain of $19
million.
o An increase in fees associated with investment portfolio management and other
trading related activities was the primary reason for the increase in other
income for both the three-month and six-month comparisons.
Noninterest Expense
- -------------------
The following table details the components of noninterest expense and their
change for the second quarter and six-month periods ended June 30, 2003 and
2002:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
(Dollars in Thousands) 2003 2002 Change 2003 2002 Change
- ------------------------------------------------------------------------------------------------------
Salaries, Wages and Benefits $ 65,823 $ 58,730 12% $127,807 $115,119 11%
Charges and Fees 7,867 8,099 (3) 15,689 15,750 (0)
Occupancy 6,464 5,950 9 12,692 11,968 6
Leasing Expense 90,750 104,537 (13) 186,510 211,402 (12)
Equipment Expense 6,824 5,975 14 13,773 12,182 13
Professional Services 8,418 6,219 35 16,816 12,304 37
Minority Interest Expense 3,197 666 380 6,394 666 860
Disposition Cost of Subprime Loans 6,914 - n/a 6,914 - n/a
Other 29,816 26,461 13 61,561 53,858 14
-------- -------- -------- --------
Total Noninterest Expense $226,073 $216,637 4 $448,156 $433,249 3
======== ======== ======== ========
Explanations for significant changes in noninterest expense by category follow:
o Salaries, wages and benefits increased $7.1 million and $12.7 million in the
quarterly and six-month comparisons due primarily to increased commissions
for commercial mortgage banking activities and staffing increases in loan
servicing, risk management and retail.
o The decrease in leasing expense is a result of the decrease in size of the
auto lease portfolio.
o Equipment expense increased due primarily to increases in depreciation and
equipment rental expense.
o Professional services increased $2.2 million and $4.5 million in the
quarterly and six-month comparisons primarily as a result of increases in
professional fees associated with the restatements of operating results and
an increase in legal fees for the Commercial Banking area.
-31-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 Provident sold subprime residential mortgage loans and foreclosed properties
during the second quarter of 2003. Disposition cost of $6.9 million was
recorded from the loss on sale of other real estate and other contingencies
associated with the sale.
o The three largest expenses within other noninterest expense for the
three-month and six-month periods were marketing expense ($3.2 million and
$6.1 million in 2003 and $3.7 million and $6.3 million in 2002), expenses
incurred in the disposal of autos coming off lease ($3.3 million and $9.9
million in 2003 and $2.3 million and $5.1 million in 2002) and other taxes
and insurance ($2.7 million and $5.7 million in 2003 and $2.6 million and
$5.2 million in 2002).
FINANCIAL CONDITION
- -------------------
Short-Term Investments and Investment Securities
- ------------------------------------------------
Federal funds sold and reverse repurchase agreements increased $148 million
since December 31, 2002 primarily as a result of the sale of the subprime
residential mortgages and the Merchant Services business late in the second
quarter.
Trading account securities were $106 million and $128 million as of June 30,
2003 and December 31, 2002, respectively. Provident trades investment securities
with the intention of recognizing short-term profits. These securities are
carried at fair value with realized and unrealized gains and losses reported in
noninterest income.
Provident had $447 million of loans classified as held for sale at June 30,
2003. This is an increase of $10 million from the amount reported at December
31, 2002. These loans consist of $342 million of multifamily loans, $99 million
of nonconforming residential mortgage loans and $6 million of conforming
residential mortgage loans. Activities related to the multifamily loans held for
sale are predominately a part of the operations of Red Capital Group. The
multifamily loans are either insured by the Federal Housing Association or
subject to purchase contracts from Fannie Mae or Freddie Mac. These loans are
usually outstanding for sixty days or less. The remainder of the activities
related to the multifamily loans held for sale are part of the operations of
Capstone Realty Advisors, whose loans are insured by the Federal Housing
Association. Nonconforming residential mortgage loans are being sold on a
whole-loan basis. This is part of an initiative started during 2001 to reduce
the risk profile of the Mortgage Banking business line.
-32-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Securities purchased with the intention of being held for indefinite periods of
time are classified as investment securities available for sale. These
securities increased $546 million during the first six months of 2003. U.S.
government agency mortgage-backed securities accounted for the majority of the
increase, as funds obtained from loan payments and the sale of other debt
securities were deployed into investment securities with higher credit quality,
increased liquidity and an improved interest rate risk profile.
Loans and Leases
- ----------------
As of June 30, 2003 total loans and leases were $8.9 billion compared to $9.1
billion at December 31, 2002. Provident had an additional $1.7 billion and $2.1
billion of off-balance sheet securitized loans and leases as of June 30, 2003
and December 31, 2002, respectively. As a result of 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. During the second quarter
of 2003, Provident sold nearly all of its portfolio of subprime residential
mortgage loans. Also, management has decided to de-emphasize its structured
finance lending and large equipment leasing while placing a greater focus on its
regional middle-market commercial lending and middle-market equipment leasing.
As a result of these actions, Provident's lending portfolio has a much lower
concentration of subprime residential loans, a higher concentration of
middle-market corporate leases, and a lower risk profile of commercial loans.
Provident does not have a material exposure to foreign loans.
The following table shows the composition of the commercial loan category by
industry type at June 30, 2003:
Amount on
(Dollars in Millions) Amount % Nonaccrual
- --------------------------------------------------------------------------------------
Mortgage Warehousing Lines $ 701.3 16 $ 4.4
Real Estate Operators/Developers/General Contractors 522.0 12 0.4
Transportation 193.6 4 7.5
Retailing 187.0 4 6.0
Banking and Finance 183.6 4 12.2
Healthcare 177.2 4 1.1
Metals 168.3 4 12.4
Tourism and Entertainment 161.4 3 0.4
Machinery and Equipment 149.5 3 9.3
Business Services 145.5 3 13.0
Automobile Dealers 128.7 3 -
Commercial Aviation Related (1) 117.1 3 22.3
Construction 110.9 2 3.4
Eating and Drinking Establishments 110.6 2 1.4
Automotive Services/Parts 84.4 2 1.5
Financial Services 78.6 2 2.0
Technology 66.9 2 6.3
Chemicals 66.9 2 -
Other (includes 20 industry types) 1,106.1 25 13.3
---------- --- --------
Total $ 4,459.6 100 $ 116.9
========== === ========
(1) Includes $25 million of loans related to the commercial airline industry, and
aircraft used in private, charter and corporate markets.
-33-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Mortgage warehousing lines increased $62 million during the first six months to
$701 million. All loans are underwritten to Provident and secondary market
standards as part of Provident's control processes related to this activity.
At June 30, 2003, Provident had loans and leases of $173 million to commercial
airline carriers, including $25 million of commercial loans and $148 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 $34 million
during 2002, which were related to secured commercial airline loans and leases.
No additional credit charges were incurred during the first half of 2003.
At June 30, 2003, Provident had approximately $779 million of commercial loans
to borrowers who have shared national credit loans as compared to $802 million
at December 31, 2002. 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 17% of its total shared
national credit loans. The real estate category is comprised of loans to
borrowers with different risk characteristics, including single family home
developers, commercial property owner/operators and commercial realtors and
property managers. The average outstanding balance of a shared national credit
loan was $3.8 million.
The composition of the mortgage and construction loan categories by property
type at June 30, 2003 follows:
Amount on
(Dollars in Millions) Amount % Nonaccrual
- -------------------------------------------------------------
Office/Warehouse $ 271.7 18 $ 2.5
Residential Development 254.7 17 4.4
Shopping/Retail 218.0 14 -
Apartments 155.5 10 2.0
Health Facilities 143.7 9 -
Land 100.1 6 -
Hotels/Motels 86.0 6 -
Industrial Plants 28.6 2 -
Other Commercial Properties 275.1 18 1.2
---------- --- -------
Total $ 1,533.4 100 $ 10.1
========== === =======
As of June 30, 2003, Provident had $1.3 billion in commercial lease financing.
These leases were comprised of $1.1 billion of small to mid-size equipment
leases and $0.2 billion of large equipment leases.
Residential mortgage loans decreased $562 million during the first six months of
2003, due primarily to the sale of subprime residential mortgage loans that
occurred in the second quarter of 2003. Prior to the loan sale, residential
mortgage loans had been declining due to Provident implementing a whole-loan
sale strategy for its nonconforming residential loans during the second half of
2001. The loan sale, which also lowered the level of nonperforming assets, gives
-34-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Provident a lower concentration of residential loans and allows it to
concentrate more of its resources on its strategic initiatives such as home
equity, regional lending and mid-ticket leasing portfolios.
The following table shows the composition of the installment loan category by
loan type at June 30, 2003:
(Dollars in Millions) Amount %
- ----------------------------------------------------
Home Equity $ 1,227.2 86
Indirect Installment 121.6 9
Direct Installment 57.2 4
Other Consumer Loans 18.2 1
---------- ---
Total $ 1,424.2 100
========== ===
Noninterest Earning Assets
- --------------------------
Leased equipment consists of $1.7 billion of auto leases and $0.3 billion of
equipment leases. Total leased equipment decreased $343 million, or 15%, during
the first six months of 2003 due primarily to a reduction in the size of the
automobile leasing portfolio. This decrease is due to the amortization of the
portfolio. Also, auto leases originated since February 2003 are classified as
direct financing leases in the loan category as Provident changed the structure
of the residual insurance it obtains on its auto leases.
Other assets increased $172 million, or 23%, during the first six months of
2003. The increase was primarily due to increases in mortgage servicing rights
and unsettled security trades. These trades settled early in the third quarter.
Deposits
- --------
Total deposits increased $1.1 billion during the first six months of 2003. Since
June 30, 2002, average core deposits have grown 9% with significant contribution
coming from commercial deposits. The following table presents a summary of
deposit types:
June 30,
-----------------------------
(In Millions) 2003 2002
- -----------------------------------------------------------------------
Noninterest Bearing Deposits $ 1,357.5 $ 844.3
Interest Bearing Demand Deposits 1,253.9 610.2
Savings Deposits 1,515.5 1,421.4
Certificates of Deposit 6,828.9 6,516.7
----------- ----------
Total Deposits $ 10,955.8 $ 9,392.6
=========== ==========
Borrowed Funds
- --------------
Short-term debt decreased $657 million during the first six months of 2003.
Decreases in federal funds purchased and repurchase agreements were the primary
reason for the decrease in short-term debt.
-35-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Long-term debt decreased $218 million, or 6%, during the first six months of
2003 due primarily to payments on subordinated notes and secured financings.
Minority Interest
- -----------------
During June 2002, Provident and its consolidated subsidiary, PFGI Capital
Corporation (PFGI Capital), issued 6.6 million of equity units (PRIDES) to
outside investors for $165 million. The Provident Bank (the Bank), Provident's
most significant subsidiary, owns all of the $165 million of Common Stock of
PFGI Capital. The principal business objective of PFGI Capital is to hold and
manage commercial mortgage loan assets and other authorized investments acquired
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
$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.
Under the Purchase Contract, Provident will also make quarterly contract
adjustment payments to the PRIDES holders at the rate of 1.25% of the stated
amount per year. The present value of this obligation has been recorded as a
liability and as a reduction to shareholders' equity.
The PFGI Capital Preferred Stock has a liquidation preference of $25 and an
initial non-cumulative dividend rate of 7.75%.
Other Noninterest Earning Liabilities
- -------------------------------------
Other liabilities increased $12 million, or 3%, during the first six months of
2003 due primarily to an increase in amounts related to unsettled security
trades.
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 may be found in Note 24 to Provident's 2002 Annual Report as filed on
Form 10-K.
-36-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ASSET SECURITIZATION ACTIVITY
- -----------------------------
From 1996 through the second quarter of 2000, the structure of some of
Provident's securitizations resulted in the transactions being accounted for as
sales through the use of special purpose entities. 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.
During the third quarter of 2000, management decided to structure all future
securitizations as secured financings thereby eliminating the use of
gain-on-sale accounting and leaving all debt on the balance sheet.
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 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:
June 30,
------------------------------
(In Thousands) 2003 2002
- -----------------------------------------------------------------
Nonconforming Residential $1,468,358 $2,180,772
Prime Home Equity 163,323 245,046
Equipment Leases 64,185 151,326
---------- ----------
$1,695,866 $2,577,144
========== ==========
Retained Interest in Securitized Assets
- ---------------------------------------
In connection with the recognition of non-cash gains on securitizations
accounted for as sales, the present value of future cash flows, referred to as
retained interest in securitized assets (RISAs), were recorded as assets within
the investment securities line item of the consolidated balance sheets.
Components of the RISAs, based on current models, as of June 30, 2003 follow:
Nonconforming Prime
(In Thousands) Residential Home Equity
- --------------------------------------------------------------------------------
Estimated Cash Flows of Underlying Loans,
Net of Payments to Certificate Holders $ 149,088 $ 12,093
Less:
Estimated Credit Loss (4,015) -
Servicing and Insurance Expense (22,157) (2,464)
Discount to Present Value (32,857) (1,710)
--------- ---------
Carrying Value of Retained Interest in
Securitized Assets $ 90,059 (1) $ 7,919
========= =========
(1)The carrying value for nonconforming residential retained interest in
securitized assets, net of all loss reserves, was $81.9 million.
-37-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Securitization Credit Enhancements
- ----------------------------------
Provident has provided for credit enhancements to its securitizations structured
as sales in the form of cash, loans and an unfunded secured demand note. The
credit enhancements 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. Provident had reserves of $10.1 million as of June 30,
2003 to offset future losses. Estimated credit losses are based upon credit
scores, payment status, collateral, market conditions and other pertinent
factors. Detail of the credit enhancements along with their loss reserves are
provided below as of June 30, 2003:
Type of Credit Value of Credit Loss
(In Thousands) Enhancements Enhancements Reserves
- -----------------------------------------------------------------------------------------
Nonconforming Residential Unfunded Demand Note(1)/Loans $227,951 $ 8,123
Prime Home Equity Cash 26,495 753
Equipment Leases Cash 28,898 1,217
-------- --------
$283,344 $ 10,093
======== ========
(1)During the fourth quarter of 2001, Provident reached an agreement with the
securitization insurer to release the cash credit enhancement for the nonconforming
residential loan securitizations and substitute an unfunded demand note backed by a
AAA rated standby letter of credit. Actual losses 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 only be drawn upon monthly.
As discussed in "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Critical Accounting Policies," future period cash flow
realizations may differ from current projections as a result of timing
differences in credit related charge-offs in any given period. Although these
variances may not change the life-time loss assumptions, they may result in
temporary negative cash flows and the possibility of a charge to earnings. To
minimize the potential impact of this timing difference, Provident increased its
reserves for RISAs by $24.3 million during the first half of 2003 which was
offset against other realized security gains. Management's estimate of the
present value of expected future excess cash flows above projected losses is $38
million. At June 30, 2003, management believes the current carrying value of the
RISA asset is properly stated.
-38-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Securitization Credit Risk
- --------------------------
The following table presents a summary of various indicators of the credit
quality of off-balance sheet securitized loans and leases as of and for the six
months ended June 30, 2003:
Nonconforming Prime Home Equipment
(Dollars in Thousands) Residential Equity Leases
- --------------------------------------------------------------------------------------
For the Six Months Ended June 30, 2003:
Average Securitized Assets $1,621,796 $ 178,312 $ 79,734
Net Charge-Offs 48,661 606 3,035
Net Charge-Offs to Average
Securitized Assets (Annualized) 6.00% 0.68% 7.61%
As of June 30, 2003:
Securitized Assets $1,468,358 $ 163,323 $ 64,185
Established Contingent Loss Liability 12,138 753 1,217
Delinquency Rates:
30 to 89 Days 12.06% 0.37% 1.06%
90 or More 23.91% 0.97% 0.69%
FANNIE MAE DUS PROGRAM
- ----------------------
Red Mortgage Capital, Inc. (Red Mortgage), a member of Red Capital Group, is an
approved Fannie Mae Delegated Underwriting and Servicing (DUS) mortgage lender.
Under the Fannie Mae DUS program, Red Mortgage underwrites, funds and sells
mortgage loans on multifamily rental projects. Red Mortgage then services these
mortgage loans on Fannie Mae's behalf. Participation in the Fannie Mae DUS
program requires Red Mortgage to share the risk of loan losses with Fannie Mae.
The substance of this loss sharing arrangement is that Red Mortgage and Fannie
Mae split losses with one-third of all losses assumed by Red Mortgage and
two-thirds of all losses assumed by Fannie Mae.
Red Mortgage services multifamily mortgage loans under the DUS program with
outstanding principal balances aggregating $3.4 billion at June 30, 2003. At
June 30, 2003, two DUS loans totaling $18.5 million in Red Mortgage's loan
servicing portfolio were in default. Red Mortgage has established reserves of
$9.8 million for possible losses under this program. The reserve is determined
by evaluating pools of homogeneous 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 Mortgage's portfolio
of DUS loans. The employees and management team of Red Mortgage have originated
and serviced the existing Fannie Mae DUS loan servicing portfolio since 1995
without any charge-offs relating to the DUS loans.
DERIVATIVE AND OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
- ------------------------------------------------------
In the normal course of business, Provident uses derivative and off-balance
sheet financial instruments to manage its interest rate risk and to meet the
financing needs of its customers. At June 30, 2003, these financial instruments
consisted of letters of credit of $263 million, commitments to extend credit of
$4.0 billion, and interest rate swaps and caps with a notional amount of $6.4
billion and $5.3 billion, respectively.
-39-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In order to mitigate credit risk within the auto lease portfolio, Provident
entered into credit risk transfer arrangements during 2001 and 2000. Under the
2001 transaction, Provident transferred 97 1/2% of the credit risk on an auto
lease portfolio, while retaining a 2 1/2% first-loss position. Under the 2000
transaction, Provident transferred 98% of the credit risk on an auto lease
portfolio, while retaining a 2% first-loss position. As a result of these
transactions, Provident was able to lower its credit concentration in auto
leasing while reducing its regulatory capital requirements. As of June 30, 2003,
the remaining unpaid auto lease balances on the 2001 and 2000 transactions were
$0.5 billion and $0.8 billion, respectively.
Capital Resources and Adequacy
- ------------------------------
Total shareholders' equity at June 30, 2003 was $891 million compared to $880
million at December 31, 2002. The change in the equity balance relates primarily
to net income exceeding dividends by $14.7 million, an increase in the market
value of cash flow hedging instruments of $19.6 million (net of deferred taxes)
and a decrease in the market value of investment securities of $24.9 million
(net of deferred taxes).
Capital expenditures planned by Provident in 2003 for premises and equipment are
currently estimated to be approximately $30 million. Included in this amount are
projected capital expenditures for the purchase of data processing hardware and
software, branch additions, renovations and enhancements, facility renovations
and ATMs. Through June 30, 2003, approximately $12 million of these expenditures
had been made.
The following table of ratios is important for an analysis of capital adequacy:
Six Months Ended Year Ended
June 30, 2003 December 31, 2002
-------------------------------------
Average Shareholders' Equity to Average Assets 5.03% 5.12%
Average Tangible Shareholders' Equity to
Average Tangible Assets 4.51 4.55
Period End Shareholders' Equity to
Period End Assets 5.01 5.02
Period End Tangible Shareholders' Equity to
Period End Tangible Assets 4.49 4.49
Dividend Payout to Net Earnings 62.21 50.64
Tier 1 Capital to Risk-Weighted Assets 9.84 9.40
Total Risk-Based Capital To Risk-Weighted Assets 11.77 11.42
Tier 1 Leverage Ratio 7.62 7.81
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. Provident is required to maintain minimum ratios of 4.00% for Tier 1
capital to risk-weighted assets, 8.00% for total risk-based capital to
risk-weighted assets, and 4.00% for Tier 1 capital to average assets. These
guidelines further define "well-capitalized" levels for Tier 1, total risk-based
capital, and leverage ratio purposes at 6.00%, 10.00% and 5.00%, respectively.
As of June 30, 2003, both Provident and the Bank were categorized as
well-capitalized for regulatory purposes.
-40-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
LIQUIDITY
- ---------
Adequate liquidity is necessary to meet the borrowing needs and deposit
withdrawal requirements of customers as well as to satisfy liabilities, fund
operations, support asset growth and pay dividends to shareholders. Management
forecasts that the largest liquidity needs for the next twelve months will come
from growth in the lending portfolio, maturing of retail and brokered
certificates of deposit, and scheduled principal payments on long-term debt.
Provident has a variety of sources to meet these liquidity demands. First,
management expects to issue new certificates of deposit along with renewing many
of its maturing certificates of deposit. Management also projects growth within
retail transactional deposits and a decrease in the size of the investment
securities portfolio. Additional sources of liquidity include the availability
to borrow both short-term and long-term funds.
Consistent with Provident's contingent funding plan, management monitors the
potential impact of changes in its corporate ratings on existing and new
business transactions. Ratings related liquidity events may include reduced
availability of short-term federal funds, reduced availability to the surety
bond market that supports the bank's Public Funds program and other commitments
provided to third parties in related business transactions. If such ratings
events are anticipated, management will take actions to enhance balance sheet
liquidity positions to meet liquidity needs. Such actions to enhance liquidity
positions were taken in connection with Provident's March 5, 2003 announcement
related to the restatement of its earnings. In anticipation of potential ratings
downgrades, management took actions to enhance liquidity positions, including
issuance of additional brokered certificates of deposits. Additional term
liquidity reduces reliance on short-term funding and increases the availability
of collateral in the investment portfolio. Management will continue to monitor
events as the need may arise for further liquidity enhancements in the future.
The major source of liquidity for Provident on a parent-only basis is dividends
paid to it by its subsidiaries. Pursuant to Federal Reserve and state banking
regulations, the maximum amount available for dividend distribution to the
Parent at June 30, 2003 by its banking subsidiary was approximately $56.1
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
in 2002 and 2003, if these costs were to rise again, this could impact
Provident's ability to maintain the payment of its quarterly dividend at current
rates.
-41-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
- ----------------------------
Note 1 to Provident's 2002 annual report on Form 10-K lists significant
accounting policies used in the development and presentation of Provident's
financial statements. However, four of these accounting policies are considered
to be critical due to the level of sensitivity and subjectivity of their
underlying accounting estimates. These critical accounting policies concern the
adequacy of the reserve for loan and lease losses; the valuation of retained
interest in securitized assets (RISAs) and securitized credit enhancements; the
valuation of mortgage servicing assets; and the valuation of derivatives.
Reserve for Loan and Lease Losses: Provident maintains a reserve to absorb
potential loan and lease losses inherent in its lending portfolio. Management's
determination of the adequacy of the loan loss reserve is based on an assessment
of the potential 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. Management evaluates numerous factors
including the credit 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, historical
charge-off and recovery experience, estimates of charge-offs for the upcoming
year and other relevant information.
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 Credit, Portfolio Risk Review, lending officers, 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.
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 on 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."
RISAs and Securitized Credit Enhancements: Prior to July 2000, Provident
structured its securitization transactions as sales. As such, Provident retained
(a) future cash flows of the underlying loans, net of payments due to investors
of the securitization trust, servicing fees and other fees (RISAs), (b)
servicing rights on the loans and leases, and (c) credit enhancement accounts
used to absorb credit losses on the loans securitized. Gain or loss on the sale
of the loans depended in part on the previous carrying amount of the financial
assets involved in the transfer, allocated between the assets sold and the
assets retained based on their relative fair value at the date of transfer.
-42-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
However, quotes are generally not available for assets retained, so Provident
estimates the fair value based on key assumptions, including prepayment speeds,
credit losses, forward yield curves, and discount rates commensurate with the
risks involved.
Provident monitors the valuation of the RISAs on a monthly basis. The valuation
centers primarily around two estimates: total life-time credit losses and the
constant prepayment rate (CPR). During 2002 and 2003, both of these factors
trended upward which had an unfavorable impact on the nonconforming residential
RISA valuation. Additionally, the CPR was 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 26% to
35% with the actual CPR currently running at 31.5%. If the CPR stays at its
current level, management estimates that there would be sufficient cash flows to
absorb lifetime losses up to 6.4%. If the CPR rises to 35%, there would be
sufficient cash flows to absorb lifetime losses up to 6.1%. Cumulative incurred
losses through June 30, 2003 are 4.5%, with estimated total lifetime losses
expected to be 5.7%. On a worst case basis, management currently estimates that
lifetime losses should not exceed 6.1% assuming real estate values remain
relatively 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 credit losses and CPR
continue to rise, impairment of the RISA value could occur. Future period cash
flow realizations may differ from current projections as a result of timing
differences in credit related charge-offs in any given period. Although these
variances may not change the life-time loss assumptions, they may result in
temporary negative cash flows and the possibility of a charge to earnings. At
June 30, 2003, management believes the current carrying value of the RISA asset
is properly stated.
Valuation of Mortgage Servicing Rights: Provident recognizes the rights to
service mortgage loans it does not own but services for others within Other
Assets of its balance sheet. Mortgage servicing assets are carried at the lower
of the initial carrying value, adjusted for amortization, or estimated fair
value. Estimated fair value is based on projected discounted cash flows which
takes into consideration estimated servicing fees, prepayment speeds, discount
rates, earnings on deposit of escrow funds and other assumptions. These
estimates have a significant impact on the valuation of the mortgage servicing
assets. Mortgage servicing rights are tested quarterly to verify the market
value equals or exceeds its carrying value.
Valuation of Derivatives: In accordance with Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," Provident carries the fair value of derivative instruments on its
consolidated balance sheets with changes in value recorded in the income
statement or as other comprehensive income. Although the value of the
derivatives are determined using third-party valuations, these valuations use
discounted cash flow modeling techniques, which require the use of assumptions
concerning the amount and timing of future cash flows. These estimates have a
significant impact on the valuation of the derivatives.
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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 uses an earnings simulation model to analyze net interest income
sensitivity to movements in interest rates. The model evaluates the effect of
changes in interest rates on net interest income by running various interest
rate scenarios up and down from a flat rate scenario. As a basis for strategic
interest rate risk management, the ALCO group periodically analyzes the impact
of 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. The
balance sheet assumptions, including loan growth, funding mix, and prepayment
speeds primarily on mortgage related products, are adjusted for each rate
scenario. Market-based prepayment speeds are incorporated into the analysis,
particularly for mortgage related products, including investment portfolio
securities. Faster prepayments during low interest rate environments such as the
current levels negatively impact interest rate margins due to lower reinvestment
yields.
Provident's policy limit stipulates that the negative impact on net interest
income from a +/-200 basis points, 12 month gradual parallel ramp rate scenario
as compared to the flat rate scenario cannot exceed 10 percent over the next 12
month period. These tests are performed on a monthly basis, and the results are
presented to the Board of Directors. Based on the results of the simulation
model, net interest income would change by the following over the next 12-month
period: decrease 1.82% for a 100 basis point decrease; increase 0.47% for a 100
basis point increase; and decrease 0.19% for a 200 basis point increase. Due to
the current interest rate environment, nothing beyond a 100 basis point decrease
was simulated.
Although primarily classified as leased equipment, Provident continues to
include all of its auto leases in its interest sensitivity analysis.
ALCO regularly incorporates discussions and analyses 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.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
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. ALCO actively monitors the behavioral
characteristics of these products. Managed account rates adjust slower and at
smaller increments than short-term rates due to the competitive environment.
During the current low rate environment, such price rigidities negatively impact
interest rate margins in the short run; however, the long-term profitability and
liquidity characteristics of these accounts are very attractive.
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 June 30, 2003. 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 has been no change in Provident's internal control over financial
reporting that occurred during Provident's quarter ended June 30, 2003 that has
materially affected, or is reasonably likely to materially affect, Provident's
internal control over financial reporting.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
---------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
Registrant's annual meeting of shareholders was held on June 19, 2003. Proxies
were solicited pursuant to Regulation 14 under the Securities Exchange Act of
1934 and the following matters were voted on and approved by the shareholders as
indicated below.
Votes Votes
For Withheld
-------------------------
Election of the following directors:
(a) Jack M. Cook 41,782,348 2,026,563
(b) Thomas D. Grote, Jr. 41,562,597 2,246,314
(c) Robert L. Hoverson 39,359,171 4,449,740
(d) Joseph A. Pedoto 41,725,529 2,083,382
(e) Sidney A. Peerless 41,127,498 2,681,413
(f) Joseph A. Steger 41,762,927 2,045,984
Votes Votes
For Against Abstained
---------------------------------
Increase in shares authorized under
Provident's 1997 Stock Option Plan from
7,000,000 shares to 8,000,000 shares 39,267,011 4,274,219 267,681
Approval of Ernst & Young LLP as
Provident's independent public
accountants for 2003 41,905,194 1,773,914 129,803
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ----------------------------------------
(a) Exhibits filed:
Exhibit 31.1 - Section 302 of the Sarbanes-Oxley Act of 2002,
Certification of Principal Executive Officer
Exhibit 31.2 - Section 302 of the Sarbanes-Oxley Act of 2002,
Certification of Principal Financial Officer
Exhibit 32.1 - Section 906 of the Sarbanes-Oxley Act of 2002,
Certification of Principal Executive Officer
Exhibit 32.2 - Section 906 of the Sarbanes-Oxley Act of 2002,
Certification of Principal Financial Officer
(b) Reports on Form 8-K:
Form 8-K (Item 9) filed on April 15, 2003.
Form 8-K (Items 7 and 9) filed on April 18, 2003.
Form 8-K (Items 7 and 9) filed on April 30, 2003.
Form 8-K (Items 7 and 9) filed on June 11, 2003.
Form 8-K (Items 7 and 9) filed on July 10, 2003.
Form 8-K (Items 7 and 9) filed on July 16, 2003.
Form 8-K (Items 7 and 9) filed on July 17, 2003.
All other items required in Part II of this form have been omitted since they
are not applicable or not required.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Provident Financial Group, Inc.
-------------------------------
Registrant
Date: August 14, 2003 /s/Christopher J. Carey
-----------------------
Christopher J. Carey
Executive Vice President and
Chief Financial Officer
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