1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR QUARTERLY PERIOD ENDED JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD
COMMISSION FILE NUMBER 0-16421
PROVIDENT BANKSHARES CORPORATION
--------------------------------
(Exact Name of Registrant as Specified in its Charter)
MARYLAND 52-1518642
- --------------------------------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
114 EAST LEXINGTON STREET, BALTIMORE, MARYLAND 21202
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(Address of Principal Executive Offices)
Not Applicable
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(Former Name, Former Address and Former Fiscal Year
if Changed Since Last Report)
(410) 277-7000
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(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock, par value $1.00 per share, 24,866,217 shares outstanding at July
29, 2002.
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PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statement of Condition - Unaudited
June 30, 2002 and 2001 and December 31, 2001 4
Consolidated Statement of Income - Unaudited
Three month and six month periods
ended June 30, 2002 and 2001 5
Consolidated Statement of Cash Flows - Unaudited
Six month periods ended June 30, 2002 and 2001 6
Notes to Consolidated Financial Statements - Unaudited 7
Item 2. Management's Discussion and Analysis
of Results of Operations and Financial Condition 12
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 20
PART II - OTHER INFORMATION 20
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES 22
This report, as well as other written communications made from time to time by
Provident Bankshares Corporation and subsidiaries (the Company) (including,
without limitation, the Company's 2001 Annual Report to Stockholders) and oral
communications made from time to time by authorized officers of the Company, may
contain statements relating to the future results of the Company (including
certain projections and business trends) that are considered "forward-looking
statements" as defined in the Private Securities Litigation Reform Act of 1995
(the PSLRA). Such forward-looking statements may be identified by the use of
such words as "believe," "expect," "anticipate," "should," "planned,"
"estimated," "intend" and "potential." Examples of forward-looking statements
include, but are not limited to, possible or assumed estimates with respect to
the financial condition, expected or anticipated revenue, and results of
operations and business of the Company, including with respect to earnings
growth (on both accounting principles generally accepted in the United States of
America (GAAP) and cash basis); revenue growth in retail banking, lending and
other areas; origination volume in the Company's consumer, commercial and other
lending businesses; asset quality and levels of non-performing assets; current
and future capital management programs; non-interest income levels, including
fees from services and product sales; tangible capital generation; market share;
expense levels; and other business operations and strategies. For these
statements, the Company claims the protection of the safe harbor for
forward-looking statements contained in the PSLRA.
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The Company cautions you that a number of important factors could cause actual
results to differ materially from those currently anticipated in any
forward-looking statement. Such factors include, but are not limited to:
prevailing economic conditions; changes in interest rates, loan demand, real
estate values and competition, which can materially affect, among other things,
retail banking revenues, revenues from sales on non-deposit investment products,
origination levels in the Company's mortgage lending businesses and the level of
defaults, losses and prepayments on loans made by the Company, whether held in
portfolio or sold in the secondary markets; changes in accounting principles,
policies, and guidelines; changes in any applicable law, rule, regulation or
practice with respect to tax or legal issues; risks and uncertainties related to
acquisitions and related integration and restructuring activities; and other
economic, competitive, governmental, regulatory and technological factors
affecting the Company's operations, pricing, products and services. The
forward-looking statements are made as of the date of this report, and the
Company assumes no obligation to update the forward-looking statements or to
update the reasons why actual results could differ from those projected in the
forward-looking statements.
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PART I - FINANCIAL INFORMATION
CONSOLIDATED STATEMENT OF CONDITION - UNAUDITED
Provident Bankshares Corporation and Subsidiaries
JUNE 30, December 31, June 30,
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS) 2002 2001 2001
====================================================================================================================================
ASSETS
Cash and Due From Banks $ 138,480 $ 105,986 $ 90,820
Short-Term Investments 2,150 11,798 7,919
Mortgage Loans Held for Sale 5,352 6,932 4,571
Securities Available for Sale 1,920,191 1,804,234 1,803,242
Loans:
Consumer 1,492,390 1,561,717 1,679,289
Commercial Business 384,799 379,616 351,596
Real Estate -- Construction 317,836 308,568 289,294
Real Estate -- Mortgage 457,185 526,992 650,914
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LOANS 2,652,210 2,776,893 2,971,093
Less: Allowance for Loan Losses 34,719 34,611 35,310
- ------------------------------------------------------------------------------------------------------------------------------------
NET LOANS 2,617,491 2,742,282 2,935,783
- ------------------------------------------------------------------------------------------------------------------------------------
Premises and Equipment, Net 45,136 45,687 45,713
Accrued Interest Receivable 31,477 34,057 40,084
Other Assets 383,499 148,741 242,538
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 5,143,776 $ 4,899,717 $ 5,170,670
====================================================================================================================================
LIABILITIES
Deposits:
Noninterest-Bearing $ 479,024 $ 384,009 $ 365,425
Interest-Bearing 2,871,437 2,972,038 3,215,377
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL DEPOSITS 3,350,461 3,356,047 3,580,802
- ------------------------------------------------------------------------------------------------------------------------------------
Short-Term Borrowings 344,460 366,321 311,493
Long-Term Debt 858,614 860,106 866,208
Other Liabilities 288,580 30,961 126,412
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 4,842,115 4,613,435 4,884,915
- ------------------------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Common Stock (Par Value $1.00) Authorized 100,000,000 Shares; Issued 31,688,048,
31,405,793 and 31,322,737 Shares at June 30, 2002,
December 31, 2001 and June 30, 2001, respectively 31,688 31,406 31,323
Capital Surplus 289,573 284,457 283,146
Retained Earnings 109,194 97,749 84,593
Net Accumulated Other Comprehensive Income (Loss) (584) (6,458) (7,248)
Treasury Stock at Cost - 6,585,701, 6,294,201 and 5,626,926 Shares
at June 30, 2002, December 31, 2001 and June 30, 2001, respectively (128,210) (120,872) (106,059)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 301,661 286,282 285,755
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,143,776 $ 4,899,717 $ 5,170,670
====================================================================================================================================
These financial statements should be read in conjunction with the accompanying notes.
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CONSOLIDATED STATEMENT OF INCOME - UNAUDITED
Provident Bankshares Corporation and Subsidiaries
Three Months Ended Six Months Ended
June 30, June 30,
- -----------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Interest and Fees on Loans $ 45,057 $ 60,484 $ 92,098 $ 127,401
Interest on Securities 26,775 27,670 54,272 58,010
Tax-Advantaged Interest 432 576 882 1,128
Interest on Short-Term Investments 15 92 65 177
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST INCOME 72,279 88,822 147,317 186,716
- -----------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on Deposits 22,205 37,935 46,693 80,265
Interest on Borrowings 14,204 16,378 28,102 34,702
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST EXPENSE 36,409 54,313 74,795 114,967
- -----------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 35,870 34,509 72,522 71,749
Less: Provision for Loan Losses 2,650 4,895 6,250 13,070
- -----------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 33,220 29,614 66,272 58,679
- -----------------------------------------------------------------------------------------------------------------------
NON-INTEREST INCOME
Service Charges on Deposit Accounts 17,789 15,007 33,532 28,357
Commissions and Fees 1,266 1,166 2,600 2,370
Net Gains (Losses) (2,242) 1,812 (1,811) 7,810
Other Non-Interest Income 2,622 2,219 5,314 4,696
- -----------------------------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST INCOME 19,435 20,204 39,635 43,233
- -----------------------------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSE
Salaries and Employee Benefits 17,804 18,047 35,824 35,999
Occupancy Expense, Net 3,553 3,254 7,054 6,677
Furniture and Equipment Expense 2,704 2,559 5,338 5,143
External Processing Fees 5,142 3,571 9,995 7,789
Other Non-Interest Expense 8,577 10,712 15,952 17,905
- -----------------------------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST EXPENSE 37,780 38,143 74,163 73,513
- -----------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 14,875 11,675 31,744 28,399
Income Tax Expense 4,470 3,640 9,864 9,039
- -----------------------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE 10,405 8,035 21,880 19,360
Cumulative Effect of Change
in Accounting Principle, Net - - - (1,160)
- -----------------------------------------------------------------------------------------------------------------------
NET INCOME $ 10,405 $ 8,035 $ 21,880 $ 18,200
=======================================================================================================================
BASIC EARNINGS PER SHARE
Income before Cumulative Effect of
Change in Accounting Principle $ 0.41 $ 0.31 $ 0.87 $ 0.74
Cumulative Effect of Change
in Accounting Principle, Net - - - (0.04)
- -----------------------------------------------------------------------------------------------------------------------
Net Income $ 0.41 $ 0.31 $ 0.87 $ 0.70
=======================================================================================================================
DILUTED EARNINGS PER SHARE
Income before Cumulative Effect of
Change in Accounting Principle $ 0.40 $ 0.30 $ 0.84 $ 0.71
Cumulative Effect of Change
in Accounting Principle, Net - - - (0.04)
- -----------------------------------------------------------------------------------------------------------------------
Net Income $ 0.40 $ 0.30 $ 0.84 $ 0.67
=======================================================================================================================
These financial statements should be read in conjunction with the accompanying notes.
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CONSOLIDATED STATEMENT OF CASH FLOWS - UNAUDITED
Provident Bankshares Corporation and Subsidiaries
Six Months Ended June 30,
(DOLLARS IN THOUSANDS) 2002 2001
===========================================================================================================================
OPERATING ACTIVITIES
Net Income $ 21,880 $ 18,200
Adjustments to Reconcile Net Income to
Net Cash Provided (Used) by Operating Activities:
Depreciation and Amortization 15,110 18,535
Provision for Loan Losses 6,250 13,070
Provision for Deferred Income Tax (Benefit) 1,013 (1,095)
Realized Net Losses (Gains) 1,811 (7,810)
Loans Originated or Acquired and Held for Sale (26,151) (18,520)
Proceeds from Sales of Loans Held for Sale 27,890 22,393
Net (Increase) Decrease in Accrued Interest Receivable,
Accrued Receivables and Other Assets 1,708 (2,262)
Net Increase (Decrease) in Accrued Interest Payable,
Accrued Expenses and Other Liabilities 288 (6,430)
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL ADJUSTMENTS 27,919 17,881
- ---------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 49,799 36,081
- ---------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Principal Collections and Maturities of Securities Available for Sale 414,205 234,426
Proceeds on Sales of Securities Available for Sale 183,290 454,775
Purchases of Securities Available for Sale (694,578) (366,683)
Loan Principal Collections Less Originations and Purchases 116,359 81,466
Purchases of Premises and Equipment (4,037) (4,785)
- ---------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 15,239 399,199
- ---------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net Decrease in Deposits (5,586) (373,968)
Net Decrease in Short-Term Borrowings (21,861) (86,340)
Proceeds from Long-Term Debt 95,000 90,000
Payments and Maturities of Long-Term Debt (97,370) (16,579)
Issuance of Stock 5,398 4,917
Purchase of Treasury Stock (7,338) (41,679)
Cash Dividends on Common Stock (10,435) (9,436)
- ---------------------------------------------------------------------------------------------------------------------------
NET CASH USED BY FINANCING ACTIVITIES (42,192) (433,085)
- ---------------------------------------------------------------------------------------------------------------------------
INCREASE IN CASH AND CASH EQUIVALENTS 22,846 2,195
Cash and Cash Equivalents at Beginning of Year 117,784 96,544
- ---------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 140,630 $ 98,739
===========================================================================================================================
SUPPLEMENTAL DISCLOSURES
- ---------------------------------------------------------------------------------------------------------------------------
Interest Paid, Net of Amount Credited to Deposit Accounts $ 53,146 $ 86,193
Income Taxes Paid 13,561 12,501
Investment Securities Purchased and not Received 257,331 -
Investment Securities Sold and not Delivered 240,285 -
Loans Securitized and Converted to Securities Available for Sale - 238,874
Stock Dividend - 28,659
These financial statements should be read in conjunction with the accompanying notes.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
JUNE 30, 2002
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
notes required by accounting principles generally accepted in the United States
of America for complete financial statements. In the opinion of management, all
adjustments (consisting of only normal recurring accruals) considered necessary
for a fair presentation have been included. Certain prior years' amounts in the
Consolidated Financial Statements have been reclassified to conform with the
presentation used for the current year. These reclassifications have no effect
on stockholders' equity or net income as previously reported. Operating results
for the three month and six month periods ended June 30, 2002 are not
necessarily indicative of the results that may be expected for any future
quarters or for the year ending December 31, 2002. For further information,
refer to the consolidated financial statements and notes thereto included in the
Provident Bankshares Corporation's ("the Corporation") Annual Report on Form
10-K for the year ended December 31, 2001 as filed with the Securities and
Exchange Commission on March 8, 2002.
NOTE B - ADOPTED ACCOUNTING PRINCIPLES
In October 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144
provides new guidance on recognition of impairment losses on long-lived assets
to be held and used. The standard broadens the definition of what constitutes a
discontinued operation and how the results of discontinued operations are to be
measured. The provisions of SFAS No. 144 were effective for the Corporation on
January 1, 2002. To date no charges have been required for impairment.
In April 2002, the FASB issued SFAS No. 145, "Recission of FASB
Statements No. 4, 44 and 64, amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS 145"). SFAS 145, among other things, restricts the
classification of gains and losses from extinguishment of debt as extraordinary
to only those transactions that are unusual and infrequent in nature as defined
by generally accepted accounting principles. SFAS No. 145 is effective January
1, 2003, although earlier adoption was encouraged. The Corporation adopted this
statement for 2002 and earlier periods. Accordingly, any previous extinguishment
of debt recorded as an extraordinary item would be reclassified to pre-tax
income before extraordinary items. Gains and losses on future qualifying debt
extinguishment will likewise be recorded in pre-tax income. During the second
quarter of 2002, the Corporation extinguished debt resulting in a $973 thousand
loss that is included in net gains (losses) on the Consolidated Statement of
Income.
NOTE C - ACCOUNTING FOR DERIVATIVES
Effective January 1, 2001, the Corporation adopted Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"), as amended by SFAS Nos. 137 and 138
(collectively, "SFAS No. 133"). The statement established the accounting and
reporting standards for derivative instruments embedded in other contracts and
for hedging activities. The adoption of SFAS No. 133 on January 1, 2001 resulted
in a reduction of net earnings of $1.2 million after-tax. This represented the
difference between the derivatives previous carrying amount and the fair value
of the derivatives at January 1, 2001. At adoption of SFAS No. 133, other
comprehensive income ("OCI") reflected a $452 thousand loss, net of tax, to
recognize the net fair value of the derivatives used in the Corporation's cash
flow hedges on that date.
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The Corporation uses derivatives to hedge the interest rate risks
inherent with its funding costs. Fair value hedges which meet the criteria of
SFAS No. 133 for effectiveness have changes in the fair value of the derivative
and the designated hedged item recognized in earnings. At and during all periods
presented, the derivatives designated as fair value hedges were proven to be
effective. Accordingly, the designated hedges and the associated hedged items
were marked to fair value by an equal and offsetting amount of $3.2 million and
$2.0 million for the six months ended June 30, 2002 and 2001, respectively. Cash
flow hedges have the effective portion of changes in the fair value of the
derivative recorded in OCI. At June 30, 2002 and 2001, the Corporation had an
unrealized loss in the value of derivatives of $1.4 million and $521 thousand,
respectively, net of taxes, in OCI to reflect the effective portion of cash flow
hedges. Amounts recorded in OCI are recognized into earnings concurrent with the
impact of the hedged item on earnings. For the six months ending June 30, 2002
and 2001, the Corporation had no ineffective portions of hedges.
NOTE D - PER SHARE INFORMATION
The following table presents a summary of per share data and amounts
for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
- ---------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------
Net Income Before Extraordinary Item $ 10,405 $ 8,035 $ 21,880 $ 19,360
Cumulative Effect of Change in Accounting Principle, Net - - - (1,160)
- ---------------------------------------------------------------------------------------------------------------------------
Net Income $ 10,405 $ 8,035 $ 21,880 $ 18,200
- ---------------------------------------------------------------------------------------------------------------------------
BASIC
Basic EPS Shares 25,151 25,546 25,134 25,989
Net Income Before Extraordinary Item $ 0.41 $ 0.31 $ 0.87 $ 0.74
Cumulative Effect of Change in Accounting Principle, Net - - - (0.04)
- ---------------------------------------------------------------------------------------------------------------------------
Net Income Per Share $ 0.41 $ 0.31 $ 0.87 $ 0.70
- ---------------------------------------------------------------------------------------------------------------------------
DILUTED
Dilutive Shares (principally stock options) 824 961 837 1,001
Diluted EPS Shares 25,975 26,507 25,971 26,990
Net Income Before Extraordinary Item $ 0.40 $ 0.30 $ 0.84 $ 0.71
Cumulative Effect of Change in Accounting Principle, Net - - - (0.04)
- ---------------------------------------------------------------------------------------------------------------------------
Net Income Per Share $ 0.40 $ 0.30 $ 0.84 $ 0.67
===========================================================================================================================
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NOTE E- INVESTMENT SECURITIES
The aggregate amortized cost and market values of the investment securities portfolio were as follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
(IN THOUSANDS) COST GAINS LOSSES VALUE
- ------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2002
SECURITIES AVAILABLE FOR SALE
U.S. Treasury and Government
Agencies and Corporations $ 99,788 $ 1 $ 1,572 $ 98,217
Mortgage-Backed Securities 1,643,262 11,054 1,994 1,652,322
Municipal Securities 20,891 1,022 - 21,913
Other Debt Securities 154,622 345 7,228 147,739
- ------------------------------------------------------------------------------------------------------------------------
Total Securities Available for Sale $ 1,918,563 $ 12,422 $ 10,794 $ 1,920,191
- ------------------------------------------------------------------------------------------------------------------------
June 30, 2001
SECURITIES AVAILABLE FOR SALE
U.S. Treasury and Government
Agencies and Corporations $ 83,948 $ 1 $ 1,767 $ 82,182
Mortgage-Backed Securities 1,570,232 11,581 8,644 1,573,169
Municipal Securities 24,669 700 1 25,368
Other Debt Securities 134,743 77 12,297 122,523
- ------------------------------------------------------------------------------------------------------------------------
Total Securities Available for Sale $ 1,813,592 $ 12,359 $ 22,709 $ 1,803,242
- ------------------------------------------------------------------------------------------------------------------------
At June 30, 2002 and 2001, a net unrealized gain on securities available
for sale of $864 thousand and $6.7 million unrealized loss, respectively, was
reflected as a component of Net Accumulated Other Comprehensive Income, which is
reflected separately as a component of Stockholders' Equity in the Consolidated
Statement of Condition and therefore has no effect on the financial results of
the Corporation's operations. For details regarding investment securities at
December 31, 2001, refer to Notes 1 and 6 of the Consolidated Financial
Statements incorporated by reference from the Corporation's 10-K filed March 8,
2002.
Net realized losses on investment securities were $1.1 million for the
quarter ended June 30, 2002. This compares to net realized gains of $1.6 million
for the second quarter of 2001. For the six months ended June 30, 2002 and 2001,
the Corporation had net realized losses of $944 thousand and net realized gains
of $7.6 million, respectively. These net gains (losses) on investment securities
are included in net gains (losses) in the Consolidated Statement of Income.
During the second quarter of 2002, debt securities amounting to $10.4
million were determined to be other than temporarily impaired. Included in net
realized losses on investment securities for the current quarter is a pre-tax
charge of $8.7 million that reduced the basis of the security to its fair value.
Accrued interest of $189 thousand was reversed from interest income.
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NOTE F - COMPREHENSIVE INCOME
Comprehensive income is defined as net income plus transactions and
other occurrences which are the result of nonowner changes in equity. For
financial statements presented for the Corporation, nonowner equity changes are
comprised of unrealized gains or losses on available for sale debt securities
and recorded gains or losses on derivatives utilized in cash flow hedges. These
nonowner equity changes are accumulated with net income from operations to
determine comprehensive income. This change does not have an impact on the
Corporation's results of operations.
Presented below is a reconciliation of net income to comprehensive
income indicating the components of other comprehensive income.
Three Months Ended Six Months Ended
June 30, June 30,
- ------------------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income $ 10,405 $ 8,035 $ 21,880 $ 18,200
Other Comprehensive Income (Loss):
Loss on Derivatives Due to SFAS No. 133 Transition - - - (696)
Gain (Loss) on Derivatives Recognized in Other Comprehensive Income (1,474) 188 (1,280) (349)
Unrealized Holding Gain (Loss) on Debt Securities 23,714 (3,722) 9,372 13,693
Less: Reclassification Adjustment for Gains (Losses) Included in Net Income (1,111) 1,622 (944) 7,589
- ------------------------------------------------------------------------------------------------------------------------------------
Other Comprehensive Income (Loss), Before Tax 23,351 (5,156) 9,036 5,059
Income Tax (Benefit) Related to Items of Other Comprehensive Income 8,173 (1,804) 3,162 1,612
- ------------------------------------------------------------------------------------------------------------------------------------
Other Comprehensive Income (Loss), After Tax 15,178 (3,352) 5,874 3,447
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 25,583 $ 4,683 $ 27,754 $ 21,647
- ------------------------------------------------------------------------------------------------------------------------------------
NOTE G-SECURITIZATION OF ASSETS
During 2001 and 2000 the Corporation securitized $239 million and $324
million of its acquired loan portfolio. These loans were securitized with FNMA
and the respective securities were placed into the Corporation's investment
portfolio. Accordingly, no gain or loss was recorded on these transactions.
These securities are valued at fair market value along with the Corporation's
investment securities.
The loans underlying the securities were securitized with full recourse
to the Corporation for any credit losses. The maximum potential recourse
obligation was $256.2 million and $659.3 million at June 30, 2002 and 2001,
respectively. A recourse liability was established by the Corporation based upon
management's current assessment of the credit risk inherent in these loans. This
recourse liability amounted to $3.1 million and $4.2 million at June 30, 2002
and 2001, respectively. This recourse liability is evaluated periodically for
adequacy. Net charges to the recourse liability amounted to $469 thousand and
$434 thousand for the six month periods ended June 30, 2002 and 2001,
respectively. At June 30, 2002, $2.4 million of loans with potential recourse
were 90 days or more past due.
NOTE H - INTANGIBLE ASSETS
Effective January 1, 2002 the Corporation adopted Statements of
Financial Accounting Standards No. 141 "Business Combinations" ("SFAS No. 141")
which requires the mandatory application of purchase accounting for future
business combinations and No. 142 "Goodwill and Other Intangible Assets" ("SFAS
No. 142") which provides guidance on accounting for goodwill. Under the
provisions of SFAS No. 142, the Corporation ceased the amortization of goodwill.
Testing of goodwill balances was completed at the time of implementation and no
impairment of goodwill existed at that date. In future periods, goodwill will be
evaluated for possible impairment on at least an annual basis.
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The following table presents the impact of the adoption of SFAS No. 142.
Three Months Ended Six Months Ended
June 30, June 30,
- ----------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------
Reported Net Income 10,405 8,035 21,880 18,200
Add Back: Goodwill Amortization - 106 - 214
- ----------------------------------------------------------------------------------------------------------------
Adjusted Net Income $ 10,405 $ 8,141 $ 21,880 $ 18,414
- ----------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Reported Net Income $ 0.41 $ 0.31 $ 0.87 $ 0.70
Add Back: Goodwill Amortization - 0.01 - 0.01
- ----------------------------------------------------------------------------------------------------------------
Adjusted Net Income $ 0.41 $ 0.32 $ 0.87 $ 0.71
- ----------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE
Reported Net Income $ 0.40 $ 0.30 $ 0.84 $ 0.67
Add Back: Goodwill Amortization - 0.01 - 0.01
- ----------------------------------------------------------------------------------------------------------------
Adjusted Net Income $ 0.40 $ 0.31 $ 0.84 $ 0.68
- ----------------------------------------------------------------------------------------------------------------
NOTE I - NET GAINS (LOSSES)
Net Gains(Losses) on the Consolidated Statement of Income are composed of the following components:
Three Months Ended Six Months Ended
June 30, June 30,
- ----------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------
Securities:
Writedown for Other Than Temporary Impairment $ (8,660) $ - $ (8,660) $ -
Sales 7,549 1,622 7,716 7,589
- ----------------------------------------------------------------------------------------------------------------
Total Securities (1,111) 1,622 (944) 7,589
Debt Extinguishment (973) - (973) -
Asset Sales (158) 190 106 221
- ----------------------------------------------------------------------------------------------------------------
Net Gain (Loss) $ (2,242) $ 1,812 $ (1,811) $ 7,810
================================================================================================================
NOTE J - FUTURE CHANGES IN ACCOUNTING PRINCIPLES
In June 2001, the FASB issued Statement of Financial Accounting
Standards No. 143 "Accounting for Asset Retirement Obligations" ("SFAS No. 143")
effective for fiscal years beginning after June 30, 2002. SFAS No. 143
establishes standards for recognition and measurement of liabilities for asset
retirement obligations and retirement cost. Management does not expect SFAS No.
143 to have a significant impact on the Corporation.
In July 2002, the FASB issued Statement of Financial Standard No. 146
"Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No.
146"). The requirements of SFAS No. 146 are effective prospectively for
qualifying activities initiated after December 31, 2002. SFAS No. 146 applies to
costs associated with an exit activity, including restructuring, or with a
disposal of long-lived assets. Management is unable to determine the impact of
this standard due to its prospective application.
11
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
FINANCIAL REVIEW
PERFORMANCE OVERVIEW
Provident Bankshares reported net income of $10.4 million or $.40 per
diluted share for the quarter ended June 30, 2002 compared to $8.0 million or
$.30 per diluted share for the same quarter of the prior year. Net income for
the six months ended June 30, 2002 was $21.9 million or $.84 per diluted share,
compared to $18.2 million or $.67 per diluted share for the six months ended
June 30, 2001. This quarter continued to reflect management's focus on the
Corporation's strategic business plans which resulted in strong performance from
core business lines as well as marked deposit and loan growth, solid asset
quality and improved capital from the second quarter of 2001. Return on assets
for the quarter improved to .86% from .63% posted in the prior year. This
improvement was the result of improved profitability and the shift in
asset/liability mix from wholesale to core components. Average assets declined
$255 million during the quarter due to the planned run-off in non-core loans,
primarily portfolio acquisition loans, which decreased $689 million. This was
partially offset by a $177 million or 12.3% increase in average core loan
balances resulting in a net decrease in average loans of $512 million. Total
average deposits decreased $356 million from the 2001 second quarter to the 2002
second quarter to $3.3 billion, reflecting a planned decrease in brokered and
national money market CD balances of $501 million. Led by a 25% increase in
average non-interest bearing demand deposits, average core deposits increased
$148 million, or 6%, from the same quarter last year.
Return on average common equity was 13.87% for the quarter ending June
30, 2002 compared to 11.16% for the second quarter of 2001. The return on
average common equity was driven by increased net income for the period as
average common equity increased 4.2% from the prior year. The net interest
margin improved to 3.17% for the period ending June 30, 2002 compared to 2.89% a
year ago.
During the period, due to WorldCom's disclosure of accounting
irregularities in June, the Corporation wrote down $10.4 million in WorldCom
bonds currently held in its investment portfolio to their market value of $1.7
million, thereby realizing a loss of $8.7 million. This loss was partially
offset by net securities gains of $7.5 million recognized on the sales of
investment securities during the quarter. In the second quarter, exclusive of
net gains(losses), non-interest income grew 18% from the comparable quarter of
2001 driven by increased fee income.
Asset quality continues to improve as non-performing loans declined 19%
to $22.7 million from June 30, 2001. Net charge-offs declined 62% from last
year's second quarter while the allowance for loan losses improved from 1.19% in
2001 to 1.31% at current quarter end.
RESULTS OF OPERATIONS
FOR THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED
JUNE 30, 2001
OVERVIEW
The Corporation recorded net income of $10.4 million for the three
months ended June 30, 2002 compared to net income of $8.0 million for the
corresponding period of 2001. The increase from period to period was
characterized by increased net interest income, a lower provision for loan
losses, significant growth in core non-interest income and the stabilization of
non-interest expense. All of these events are the product of management's
efforts to reduce the wholesale portion of the balance sheet, focus resources on
growth of core product lines, broaden the Corporation's presence in growing and
vibrant markets and improve efficiencies.
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NET INTEREST INCOME
The discussion on net interest income should be read in conjunction with
a review of Tables 1 and 2 - "Analysis of Changes in Net Interest Income" and
"Consolidated Average Balances, Interest Income and Expense and Yields and
Rates", presented on the following pages. For the quarter ended June 30, 2002,
interest income declined $16.6 million, offset by a decline in interest expense
of $17.9 million compared to the prior year's second quarter, for a net increase
of $1.3 million or a 3.8% increase. During this period, the net margin increased
to 3.17% from 2.89% in 2001. The change in net interest income and the margin
continue to reflect management's strategy to focus on core product growth, while
decreasing its emphasis on wholesale assets and liabilities, such as acquired
loans and brokered deposits. The reductions in the non-core portfolios resulted
in decreases of $689 million and $503 million for loans and deposits,
respectively. These overall declines, however, were offset by core loan and
deposit growth of $177 million (12%) and $148 million (6%), respectively, over
the past twelve months. Core consumer loans increased 21% while commercial
business loans increased 12%. Core deposit increases occurred mainly in
interest-bearing and noninterest-bearing demand deposits. These increases were
primarily due to the robust growth in the Washington metro area where commercial
deposit growth increased 99% compared to the same period of last year. Continued
focus on the Baltimore-Washington corridor resulted in average core commercial
deposits growing 38% during the quarter. These increases reflect the
Corporation's commitment to produce positive core results by executing the
business strategies of broadening its presence and customer base in the
Washington metro area and growing commercial business in the
Baltimore-Washington corridor.
The $177 million growth in average core loans in comparison to the
second quarter of 2001 was driven by the $135 million (21%) growth in consumer
loans and $32 million (12%) in commercial business loans. The growth in the
consumer portfolio was due to the demand for marine loans which increased $87
million (31%) from the prior year, supplemented by $35 million and $14 million
growth in the home equity and direct lending products, respectively. Average
investment securities increased $257 million from June 30, 2001 due to cash
flows received from both the investment and non-core loan portfolios. The yield
on earning assets ended the second quarter of 2002 at 6.37% compared to 7.40%
for the first quarter of 2001, reflecting the general decline in interest rates
from the prior year. This general rate decline coupled with the planned decline
in non-core loan balances, resulted in interest income decreasing $16.6 million
from the prior year.
The decline in interest income was more than offset by the $17.9 million
decrease in interest expense. This decrease was the product of the decline in
interest rates and the planned run-off of $450 million in brokered deposits.
While total average deposits decreased due to the run-off of brokered deposits,
average core deposits, primarily demand deposits, increased $148 million or 6%
from June of last year. In addition to the growth of demand deposits, the
migration of $79 million in high rate retail CDs into lower priced deposit
products resulted in reducing interest expense for the quarter. The growth in
deposits is the result of the continued expansion of branch network in the
Washington metro area and successful focus on commercial deposit relationships.
Average borrowings increased $97 million from last year due to the relative low
cost of borrowings when compared to purchased deposits. The combination of this
aforementioned movement in rates and the associated changes in average volumes
had the effect of reducing the average rate paid on interest-bearing liabilities
to 3.55% for the three months ending June 30, 2002 versus 4.89% for the same
period in 2001.
Although the net interest margin improved to 3.17% for the current
quarter as compared to the prior year's 2.89%, the margin declined from the
seasonally high first quarter margin of 3.30%. The effect of three items
negatively impacted the current quarter's margin compared to the margin for the
first quarter of 2002. The first was the reversal of the accrued interest
associated with the WorldCom investment. The second was the higher than expected
level of prepayments on the securitized portion of the acquired loan portfolio
necessitating the amortization of related premium. Lastly, the addition of $100
million to the average investment portfolio at current rates had the effect of
increasing net interest income but decreasing the margin. The 28 basis point
increase in the margin from the second quarter of 2002 to the corresponding
quarter of 2001 was the result of non-core loan runoff combined with core loan
growth that improved the margin 20 basis points. Additionally, core deposit
growth had a 6 basis points favorable impact on the margin.
The Corporation maintains an overall interest rate management strategy
that incorporates the use of derivative instruments to minimize significant
fluctuations in earnings that are caused by interest rate volatility (see Note C
to unaudited financial statements). Management monitors the level of earnings at
risk due to interest rate volatility through the simulation of multiple interest
rate scenarios. Modeling shows that the Corporation's earnings may improve when
the forward yield curve steepens and decline with the flattening or inversion of
the yield curve. The forward yield curve currently predicts significantly
13
14
rising short-term rates and slightly rising long-term rates. If this scenario
were to be realized, the Corporation's net interest income would not be impacted
significantly in the next year, but could be reduced 3% in the following year
within this isolated modeling environment, assuming no action by management.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
TABLE 1
FOR THE THREE MONTHS ENDED JUNE 30, 2002/2001
--------------------------------------------------------
VARIANCE DUE
TO CHANGE IN
---------------------------------------
(IN THOUSANDS) NET INCREASE/ AVERAGE AVERAGE
(TAX-EQUIVALENT BASIS) (DECREASE) RATE VOLUME
- ------------------------------------------------------------------------------------------------------------
INTEREST INCOME FROM:
Loans:
Consumer Loans $ (8,582) $ (1,780) $ (6,802)
Commercial Business Loans (970) (1,438) 468
Real Estate-Construction Loans-Commercial (722) (1,242) 520
Real Estate-Construction Loans-Residential (813) (732) (81)
Real Estate-Mortgage Loans-Commercial (1,046) (665) (381)
Real Estate-Mortgage Loans-Residential (3,326) (47) (3,279)
Mortgage Loans Held for Sale (16) (10) (6)
Other Short-Term Investments (77) (34) (43)
US Government and Agency Securities (78) (261) 183
Mortgage-Backed Securities (1,064) (4,425) 3,361
Municipal Securities (142) (75) (67)
Other Debt Securities 248 (339) 587
---------
Total Interest Income $(16,588) (11,956) (4,632)
---------
INTEREST EXPENSE ON:
Demand/Money Market Deposits (1,979) (2,551) 572
Savings Deposits (642) (809) 167
Certificates of Deposit (12,653) (4,857) (7,796)
Individual Retirement Accounts (456) (367) (89)
Short-Term Borrowings (1,126) (1,865) 739
Long-Term Debt (1,048) (1,130) 82
---------
Total Interest Expense $(17,904) (13,958) (3,946)
- ------------------------------------------------------------------------------------------------------------
Net Interest Income $ 1,316 $ 2,002 $ (686)
============================================================================================================
The table above analyzes the reasons for the changes from year-to-year in the
principal elements that comprise net interest income. The calculation of rate
and volume variances is based upon a procedure established for banks by the
Securities and Exchange Commission. Rate and volume variances presented for each
component will not sum to the variances presented on totals of interest income
and interest expense because of shifts from year-to-year in the relative mix of
interest-earning assets and interest-bearing liabilities.
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CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME AND EXPENSE AND YIELDS AND RATES
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
TABLE 2
THREE MONTHS ENDED THREE MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2001
----------------------------------- ----------------------------------
(dollars in thousands) AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
(tax-equivalent basis) BALANCE EXPENSE RATE BALANCE EXPENSE RATE
===============================================================================================================
ASSETS
- ------
Interest-Earning Assets:
Loans:
Consumer $ 1,504,358 $ 26,981 7.19 % $ 1,879,329 $ 35,563 7.59 %
Commercial Business 371,756 5,979 6.45 347,098 6,949 8.03
Real Estate-Construction:
Commercial 203,480 2,218 4.37 169,066 2,940 6.97
Residential 106,049 1,498 5.67 110,055 2,311 8.42
Real Estate-Mortgage:
Commercial 223,254 3,660 6.58 244,146 4,706 7.73
Residential 257,980 4,937 7.68 429,301 8,263 7.72
------------------------ -----------------------
Total Loans 2,666,877 45,273 6.81 3,178,995 60,732 7.66
------------------------ -----------------------
Loans Held for Sale 4,897 81 6.63 5,230 97 7.44
Other Short-Term Investments 2,651 15 2.27 7,888 92 4.68
US Governments & Agency Securities 99,794 1,251 5.03 86,767 1,329 6.14
Mortgage Backed Securities 1,601,584 22,722 5.69 1,388,086 23,786 6.87
Municipal Securities 20,892 334 6.41 24,670 476 7.74
Other Debt Securities 168,544 2,803 6.67 134,780 2,555 7.60
------------------------ -----------------------
Total Investment Securities 1,890,814 27,110 5.75 1,634,303 28,146 6.91
------------------------ -----------------------
Total Interest-Earning Assets 4,565,239 72,479 6.37 4,826,416 89,067 7.40
------------------------ -----------------------
Less: Allowance for Loan Losses (34,710) (36,685)
Cash and Due From Banks 97,474 79,000
Other Assets 242,140 256,584
------------- ------------
Total Assets $ 4,870,143 $ 5,125,315
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Liabilities:
Demand/Money Market Deposits $ 785,628 2,383 1.22 $ 684,262 4,362 2.56
Savings Deposits 658,555 1,878 1.14 615,348 2,520 1.64
Certificates of Deposit 1,327,601 16,374 4.95 1,907,701 29,027 6.10
Individual Retirement Accounts 138,186 1,570 4.56 144,803 2,026 5.61
Short-Term Borrowings 330,915 1,374 1.67 238,614 2,500 4.20
Long-Term Debt 873,153 12,830 5.89 867,988 13,878 6.41
------------------------ -----------------------
Total Interest-Bearing Liabilities 4,114,038 36,409 3.55 4,458,716 54,313 4.89
------------------------ -----------------------
Noninterest-Bearing Demand Deposits 425,079 338,711
Other Liabilities 30,135 39,074
Stockholders' Equity 300,891 288,814
------------- ------------
Total Liabilities and Stockholders'
Equity $ 4,870,143 $ 5,125,315
============= ============
Net Interest-Earning Assets $ 451,201 $ 367,700
============= ============
Net Interest Income (tax-equivalent) 36,070 34,754
Less: Tax-Equivalent Adjustment (200) (245)
----------- ---------
Net Interest Income $ 35,870 $ 34,509
=========== =========
Net Yield on Interest-Earning Assets
(tax-equivalent) 3.17 % 2.89 %
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2001
-----------------------------------------------------------------------
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
-----------------------------------------------------------------------
ASSETS
- ------
Interest-Earning Assets:
Loans:
Consumer $ 1,527,420 $ 55,345 7.31 % $ 1,969,169 $ 75,154 7.70 %
Commercial Business 368,083 11,902 6.52 348,129 14,310 8.29
Real Estate-Construction:
Commercial 207,354 4,485 4.36 162,176 6,233 7.75
Residential 102,993 2,925 5.73 110,301 4,964 9.08
Real Estate-Mortgage:
Commercial 222,690 7,288 6.60 243,220 9,719 8.06
Residential 274,047 10,609 7.81 446,917 17,450 7.87
------------------------ ----------------------
Total Loans 2,702,587 92,554 6.91 3,279,912 127,830 7.86
------------------------ ----------------------
Loans Held for Sale 4,523 146 6.51 6,150 230 7.54
Other Short-Term Investments 6,664 65 1.97 7,011 177 5.09
US Governments & Agency Securities 100,031 2,551 5.14 86,176 2,706 6.33
Mortgage Backed Securities 1,539,341 45,729 5.99 1,447,838 49,999 6.96
Municipal Securities 21,422 690 6.50 25,143 969 7.77
Other Debt Securities 173,294 5,993 6.97 140,440 5,305 7.62
------------------------ ----------------------
Total Investment Securities 1,834,088 54,963 6.04 1,699,597 58,979 7.00
------------------------ ----------------------
Total Interest-Earning Assets 4,547,862 147,728 6.55 4,992,670 187,216 7.56
------------------------ ----------------------
Less: Allowance for Loan Losses (34,303) (37,645)
Cash and Due From Banks 90,857 80,158
Other Assets 250,858 215,499
------------- ------------
Total Assets $ 4,855,274 $ 5,250,682
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Liabilities:
Demand/Money Market Deposits $ 764,346 4,674 1.23 $ 663,644 8,855 2.69
Savings Deposits 641,045 3,655 1.15 610,145 5,213 1.72
Certificates of Deposit 1,383,971 35,115 5.12 2,019,227 62,097 6.20
Individual Retirement Accounts 138,548 3,249 4.73 146,229 4,100 5.65
Short-Term Borrowings 327,961 2,705 1.66 277,212 6,964 5.07
Long-Term Debt 866,786 25,397 5.91 868,678 27,738 6.44
------------------------ ----------------------
Total Interest-Bearing Liabilities 4,122,657 74,795 3.66 4,585,135 114,967 5.06
------------------------ ----------------------
Noninterest-Bearing Demand Deposits 403,978 327,052
Other Liabilities 30,524 41,665
Stockholders' Equity 298,115 296,830
------------- ------------
Total Liabilities and Stockholders'
Equity $ 4,855,274 $ 5,250,682
============= ============
Net Interest-Earning Assets $ 425,205 $ 407,535
============= ============
Net Interest Income (tax-equivalent) 72,933 72,249
Less: Tax-Equivalent Adjustment (411) (500)
----------- ---------
Net Interest Income $ 72,522 $ 71,749
=========== =========
Net Yield on Interest-Earning Assets
(tax-equivalent) 3.23 % 2.92 %
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PROVISION FOR LOAN LOSSES
The provision for loan losses was $2.7 million for the second quarter of
2002 compared to $4.9 million recorded in 2001. The reduction in the provision
for loan losses from last year was due to lower charge-offs in the current
quarter compared to the prior year as charge-offs declined 62% to $3.1 million
in the second quarter of 2002 compared to $8.2 million for the same period last
year. The elevated amount of the prior year charge-offs was related to a review
of the acquired loan portfolio in addition to the write down of the
Corporation's last remaining non-performing health care credit. Non-performing
loans declined 19% or $5.4 million from June 30, 2001 to end the second quarter
of 2002 at $22.7 million, of which $22.4 million were collateralized by
residential real estate. The improvement in these credit quality indicators was
the result of increased response and reaction to delinquency trends.
The allowance for loan losses at June 30, 2002 was $34.7 million,
compared to $35.3 million at June 30, 2001. The current allowance represents
1.31% of total loans outstanding or 153% of non-performing loans versus 1.19%
and 126%, respectively, of a year ago. At June 30, 2002, non-performing loans as
a percentage of loans outstanding were .86% compared to .95% in 2001. Management
believes that non-performing loans should remain relatively stable for the
balance of the year.
NON-INTEREST INCOME
Non-interest income, excluding net gains and losses, was $21.7 million
compared to $18.4 million for the previous year. This represents a $3.3 million
or 18% increase from the second quarter of 2002. At $21.7 million, non-interest
income represents 38% of total quarterly revenue versus 35% for the prior year's
second quarter. Improvements in non-interest income continue to be driven
primarily by increases in deposit service charges which increased 18.5% from the
prior year. The increase in deposit fees is the result of the aforementioned
increase in core deposits due to strong retail and commercial checking account
growth, notably in the Washington metro area. Branch banking fee income
generated in the Washington region increased 32% over the same quarter last
year. Commission and fee income increased 9% as a result of increased insurance
commissions and annuity sales. Other non-interest income posted an 18% increase
as a result of loan fee income from commercial products and property leasing.
Net gains(losses) are comprised primarily of security gains or losses
with smaller portions being attributable to the extinguishment of debt and the
net gains(losses) on sales of loans, foreclosed property and fixed assets. For
the quarter ended June 30, 2002, the Corporation recorded a $2.2 million net
loss as compared to net gains of $1.8 million a year ago. For the quarter ended
June 30, 2002, the majority of net losses were attributable to $1.1 million in
net security losses and a $973 thousand loss incurred on the early liquidation
of FHLB borrowings. Included in the $1.1 million in net securities losses was an
$8.7 million loss resulting from the write down of $10.4 million in WorldCom
bonds held in the Corporation's investment portfolio to $1.7 million. This loss
was partially offset by net gains of $7.5 million on sales of investment
securities during the quarter. The FHLB borrowings were liquidated as part of a
strategy that will positively impact the net interest margin by taking advantage
of lower future funding costs. Last year's net gains of $1.8 million included
$1.6 million of net security gains.
NON-INTEREST EXPENSE
Non-interest expense for the second quarter of 2002 was $37.8 million
versus $38.1 million for the prior year, a 1% decrease. External processing
increased 44% from the prior year due to the combination of the cost of
outsourcing the item processing function in late 2001 and the increase in
deposit accounts serviced. Outsourcing had the impact of lowering salary and
benefit expense; however, this decline in salary and benefit cost was offset by
the cost associated with the continued expansion of the branch network in the
Washington suburbs. Other non-interest expense declined $2.1 million when
comparing the second quarter of 2002 to the second quarter of 2001. The previous
year included a $1.9 million charge to increase the existing recourse reserve
related to securitized acquired second mortgages. Exclusive of this charge,
other non-interest expense declined $249 thousand.
INCOME TAXES
Tax expense of $4.5 million on income before taxes of $14.9 million was
recorded in the second quarter of 2002, for an effective tax rate of 30.1%. This
is an increase of $830 thousand from the prior year reflecting the increase in
income before taxes from year to year.
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RESULTS OF OPERATIONS
FOR SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
The Corporation recorded net income of $21.9 million or $.84 per diluted
share for the six months ending June 30, 2002. The six months ended June 30,
2001 had net income of $18.2 million or $.67 per diluted share, including a $1.2
million charge for the cumulative effect of change in accounting principle. The
prior year's charge for the change in accounting principle was the result of the
required adoption of SFAS No. 133 (see Note C to unaudited financial
statements).
Tax-equivalent net interest income for the first six months of 2002
remained relatively flat compared to 2001 reflecting only a $684 thousand
increase from period to period. Interest income declined $39.5 million, offset
by a decline in interest expense of $40.2 million. This change in net interest
income reflected management's strategy to focus on organic growth. The
implementation of the Corporation's strategy to reduce wholesale assets and
liabilities, such as purchased loans and brokered deposits, and focus on growing
core banking business resulted in reductions of $445 million in interest-earning
assets and $462 million interest-bearing liabilities, respectively, over the
past year. These reductions, in addition to the general decline in interest
rates, had the effect of maintaining the level of net interest income while
improving the net interest margin to 3.23% in 2002 versus 2.92% in 2001.
The provision for loan losses for the first half of 2002 was $6.3
million, a decrease of $6.8 million from the first half of 2001. The decline
in the provision was due primarily to lower charge-off activity related to
health care credits and the acquired loan portfolio. At June 30, 2002 the
allowance for loan losses was $34.7 million or 1.31% of loans outstanding.
Non-interest income, excluding net gains or losses, increased 17% to
$41.4 million. The major contributor to the increase in non-interest income was
deposit service charges that rose $5.2 million or 18% due to increases in
deposits and branch expansion. Commissions and fees rose 10% due to sales of
annuity products. Other non-interest income increased 13% from the prior year
primarily due to increased fee income on commercial products and leasing income.
Net losses were $1.8 million for the six months ended June 30, 2002 compared to
net gains of $7.8 million for the six months ended June 30, 2001. The net losses
for 2002 were primarily the net result of the write-down of the WorldCom bonds
and the extinguishment of debt, partially offset by net gains on the sales of
investment securities. The prior year's net gains of $7.8 million contained $7.6
million in net security gains. Non-interest expense was relatively stable at
$74.2 million when compared to the same period one year ago. Salary and benefit
expense decreased modestly by $175 thousand during this period. This decrease
occurred despite the impact of the Corporation's branch expansion strategy due
to the impact of the decision to outsource the item processing function at the
beginning of the year. The effect of the reduction in compensation expense was
offset in part by the increase in external processing fees which increased $2.2
million. A major contributor to the increase in external processing cost was the
increase in deposit account volume associated with the $134 million average core
deposit growth that occurred from the first half of 2001 to 2002. Branch
expansion was also the cause of the growth in occupancy expense and furniture
and fixture expense which grew by 5.6% and 3.8%, respectively. Other
non-interest expense decreased $2.0 million from the prior year as last year's
other non-interest expense contained a $1.9 million increase to an existing
recourse reserve related to securitized loans.
The Corporation recorded an income tax expense of $9.9 million in the
first half of 2002 based on pre-tax income of $31.7 million, which represented
an effective tax rate of 31.1%. This compares with an effective tax rate of
31.8% for the same period of 2001.
FINANCIAL CONDITION
Total assets of the Corporation increased $244 million from December 31,
2001 to June 30, 2002. This increase is due primarily to a temporary increase in
other assets of $240 million which represented receivables from brokers for the
previously mentioned securities sales that occurred in late June 2002. These
amounts were settled and collected in July as is customary in the financial
markets. During this period of time, the Corporation continued its planned
reduction of non-core assets and associated non-core funding while concentrating
on accreting core lending and deposit balances. Additionally the Corporation
continued to exercise its stock repurchasing authority to repurchase 292,000
shares of common stock. As a result of the runoff of non-core loans exceeding
new core loan production, the lending portfolio declined $125 million. Net funds
derived from this activity were re-deployed to the investment securities
portfolio which grew $116 million. The investment securities portfolio is
composed of a diversified group of investments of which 91% is invested in
agency or AAA rated mortgage-backed securities.
17
18
The remaining 9% of the portfolio represents a diversified group of generally
small issues. Within the lending portfolio, consumer loans declined $69 million
net of core production as a result of the run-off experienced in the portfolio
acquisition loans. Mortgage loans also declined a net of $70 million as a result
of the activity in the retail refinancing market.
Total deposits at June 30, 2002 were $3.35 billion, which was
approximately the same amount at year end despite the planned reduction in
brokered CDs. During the period, non-interest bearing deposits increased $95
million, savings accounts $56 million, interest-bearing demand $49 million and
money market accounts increased $20 million. Some of the increases in these
deposit products were the result of a $43 million decline in retail CDs. The
decline in retail CDs was driven by the behavior of customers who felt the need
to remain liquid to take advantage of potential rising rates in a period where
deposit rates paid on other deposit products had narrowed.
LIQUIDITY
The primary sources of liquidity at June 30, 2002 were loans held for
sale, short-term investments and investments held for sale, which totaled $1.93
billion or 40% of total liabilities, including deposits. The coverage of total
liabilities has remained constant compared to December 31, 2001. At June 30,
2002 the Corporation had $566 million in brokered deposits as compared to $747
million at December 31, 2001. Brokered deposits maturing within the next 3
months amount to $111 million or 20% of total brokered CDs, with $119 million
maturing in the following nine months and $190 million in the twelve months
thereafter. Cash flows used to meet the liquidity demands of these maturities
will be provided by run-off of the acquired loan portfolio.
CAPITAL
Total stockholders' equity at June 30, 2002 was $302 million, a $15
million increase from December 31, 2001. Ordinary adjustments to capital include
net income, dividends paid, dividend reinvestment and the exercise of stock
options. During the first half of the year, capital increased $5.9 million as a
result of mark-to-market adjustments for unrealized gains contained in the
investment portfolio. The Corporation also repurchased shares totaling $7.3
million during the first half of 2002. At June 30, 2002, the leverage ratio was
7.44% and total regulatory capital represented 12.13% of risk adjusted assets.
These ratios exceed the minimum requirements of the current leverage capital and
risk-based capital standards under FIRREA, and exceeded the ratios established
for "well-capitalized" institutions under prompt corrective action regulations.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Discussion and analysis of the financial condition and results of
operations are based on the consolidated financial statements of the
Corporation, which are prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires management to make estimates and judgements that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. Management evaluates estimates
on an on-going basis; including those related to the allowance for loan losses,
non-accrual loans, asset prepayment rates, other real estate owned,
other-than-temporary investment impairments, intangible assets, pension and
post-retirement benefits, stock option plan, recourse liabilities and income
taxes. Management bases its estimates on historical experience and various other
factors and assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgements about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
Management believes the following critical accounting policies affect
its more significant judgements and estimates used in preparation of its
consolidated financial statements: allowance for loan losses,
other-than-temporary investment security impairment and asset prepayment rates.
Each estimate is discussed below. The financial impact of each estimate if
significant to financial results was discussed in the applicable sections of
Management's Discussion and Analysis.
ALLOWANCE FOR LOAN LOSSES
The Corporation maintains an allowance for loan losses, which is
intended to be adequate to absorb probable inherent losses in the outstanding
loan portfolio. The allowance is reduced by actual credit losses and is
increased by the provision
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for loan losses and recoveries of previous losses. The provisions for loan
losses are charges to earnings to bring the total allowance for loan losses to a
level considered by management as adequate.
The allowance for loan losses is based on management's continuing review
and evaluation of the loan portfolio. The level of the allowance is determined
by assigning specific reserves to individually identified problem credits and
general reserves to all other loans. The portion of the allowance that is
allocated to internally criticized and non-accrual loans is determined by
estimating the inherent loss on each credit after giving consideration to the
value of underlying collateral. The general reserves are based on the
composition and risk characteristics of the loan portfolio; including the nature
of the loan portfolio, credit concentration trends, historic and anticipated
delinquency and loss experience, as well as other qualitative factors such as
current economic conditions.
Management emphasizes loan quality and close monitoring of potential
problem credits. Credit risk identification and review processes are utilized in
order to assess and monitor the degree of risk in the loan portfolio. The
Corporation's lending and loan administration staff are charged with reviewing
the loan portfolio and identifying changes in the economy or in a borrower's
circumstances which may affect the ability to repay debt or the value of pledged
collateral. A loan classification and review system exists that identifies those
loans with a higher than normal risk of uncollectibility. Each commercial loan
is assigned a grade based upon an assessment of the borrower's financial
capacity to service the debt and the presence and value of collateral for the
loan. An independent loan review group tests risk assessments and evaluates the
adequacy of the allowance for loan losses. Senior managers meet at least monthly
to review the credit quality of the loan portfolios and at least quarterly with
executive management to review the adequacy of the allowance for loan losses.
Management believes that it uses the best information available to make
determinations about the adequacy of the allowance and that it has established
its existing allowance for loan losses in accordance with GAAP. If circumstances
differ substantially from the assumptions used in making determinations, future
adjustments to the allowance for loan losses may be necessary and results of
operations could be affected. Because future events affecting borrowers and
collateral cannot be predicted with certainty, there can be no assurance that
increases to the allowance will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed above.
OTHER THAN TEMPORARY IMPAIRMENT OF INVESTMENT SECURITIES
Securities are evaluated periodically to determine whether a decline in
their value is other than temporary. Management utilizes criteria such as the
magnitude and duration of the decline, in addition to the reasons underlying the
decline, to determine whether the loss in value is other than temporary. The
term "other than temporary" is not intended to indicate that the decline is
permanent, but indicates that the prospects for a near term recovery of value is
not necessarily favorable, or that there is a lack of evidence to support
realizable value equal to or greater than the carrying value of the investment.
Once a decline in value is determined to be other than temporary, the value of
the security is reduced and a corresponding charge to earnings is recognized.
ASSET PREPAYMENT RATES
The Corporation purchases amortizing loans and investment securities.
The actual principal reduction on these assets exceeds the contractual principal
reduction due to principal prepayments that fluctuate based on market
conditions. The purchase premiums and discounts associated with these assets are
amortized or accreted to interest income over the estimated life of the related
assets. The Corporation funds these assets with matched maturity funds utilizing
the estimated life of the assets. Management makes prepayment rate assumptions
by utilizing available market information on like-kind instruments. The assumed
prepayment rates form the basis for income recognition of premiums or discounts
on the related assets. Changes in prepayment estimates may accordingly cause the
earnings recognized on these assets to vary over the term that the assets are
held. Because the funding costs are fixed, changes in actual prepayments of the
related assets may cause volatility in the net interest margin. These prepayment
rates are monitored and updated monthly to reflect actual activity and the most
recent market projections.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding market risk at December 31, 2001, see
"Interest Sensitivity Management" and Note 13 to the Consolidated Financial
Statements in the Corporation's Form 10-K filed with the Commission on March 8,
2002. The market risk of the Corporation has not experienced any material
changes as of June 30, 2002 from December 31, 2001. Additionally, refer to "Net
Interest Income" in Item 2 - Management's Discussion and Analysis of Results of
Operations and Financial Condition for additional quantitative and qualitative
discussions about market risk at June 30, 2002.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities and Use of Proceeds - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
The Annual Meeting of Stockholders of Provident Bankshares Corporation
was held on April 17, 2002.
PROPOSAL I
Election of Directors.
The following persons were elected as directors at the 2002
Annual Meeting of Stockholders. The corresponding votes for each
director and their terms of office which continue until the 2005
Annual Meeting of Stockholders is reflected below.
For % Withheld %
--- - -------- -
Thomas S. Bozzuto 22,255,734 99.0 224,919 1.0
Charles W. Cole, Jr. 22,248,179 99.0 232,474 1.0
Barbara B. Lucas 22,232,540 98.9 248,113 1.1
Francis G. Riggs 21,965,137 97.7 515,516 2.3
Carl W. Stearn 22,227,239 98.9 253,414 1.1
Enos K. Fry 22,242,100 98.9 238,553 1.1
The following persons continue to serve as directors until the
2003 Annual Meeting of Stockholders: Pierce B. Dunn, Mark K.
Joseph, Peter M. Martin, Sheila K. Riggs.; until the 2004 Annual
Meeting of Stockholders: Melvin A. Bilal, Ward B. Coe, III,
Fredrick W. Meier, Jr., Sister Rosemarie Nassif, Gary N. Geisel.
PROPOSAL 2.
The stockholders ratified the selection of KPMG LLP as
independent auditors for 2002, with 22,035,992 (98.0%) shares
cast in favor, 381,813 (1.7%) shares cast against and 62,848
(.3%) abstaining.
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) The exhibits filed as part of this report are listed below:
(3.1) Articles of Incorporation of Provident Bankshares
Corporation (1)
(3.2) Articles of Amendment to Articles of Incorporation of
Provident Bankshares Corporation (2)
(3.3) Fourth Amended and Restated By-Laws of Provident
Bankshares Corporation (3)
(4.1) Stockholder Protection Rights Plan, as amended (4)
(11.0) Statement Re: Computation of Per Share Earnings (5)
(b) Reports on Form 8-K were filed with the Securities and Exchange
Commission as follows:
April 23, 2002 - Transcript of telephone conference call
on April 18, 2002 relating to the Corporation's April 18,
2002 earnings release.
June 28, 2002 - Company press release announcing
write-down of WorldCom Inc. securities.
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(1) Incorporated by reference from Provident's Registration Statement on
Form S-3 (File No. 33-73162) filed with the Commission on August 18, 1994.
(2) Incorporated by reference from Provident's Registration Statement on
Form S-8 (File No. 333-58881) filed with the Commission on July 10, 1998.
(3) Incorporated by reference from Providents's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2000, filed with the Commission on
May 10, 2000.
(4) Incorporated by reference from Provident's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998, filed with the Commission on
August 14, 1998.
(5) Included in Note D to the Unaudited Consolidated Financial Statements on
Page 8 hereof.
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SIGNATURES
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 BANKSHARES CORPORATION
--------------------------------
Registrant
August 13, 2002 /s/ Peter M. Martin
------------------------------------
Peter M. Martin
Chairman and Chief Executive Officer
August 13, 2002 /s/ Dennis A. Starliper
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Dennis A. Starliper
Chief Financial Officer
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