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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 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, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
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
(Address of Principal Executive Offices)
Not Applicable
(Former Name, Former Address and Former Fiscal Year
if Changed Since Last Report)
(410) 277-7000
(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 |_|
Indicate by check mark 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:
At August 6, 2003, the Registrant had 24,600,006 shares of $1.00 par value
common stock outstanding.
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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, 2003 and 2002 and December 31, 2002 4
Consolidated Statement of Income - Unaudited
Three and six month periods ended June 30, 2003 and 2002 5
Consolidated Statement of Cash Flows - Unaudited
Six month periods ended June 30, 2003 and 2002 6
Notes to Consolidated Financial Statements - Unaudited 7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 28
Item 4. Controls and Procedures 28
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2. Changes in Securities and Use of Proceeds 29
Item 3. Defaults upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29
SIGNATURES 31
FORWARD-LOOKING STATEMENTS
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 2002 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 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, except
as may be required by applicable law or regulation, 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) 2003 2002 2002
=============== =============== ==============
ASSETS:
Cash and Due From Banks $ 144,251 $ 145,063 $ 138,480
Short-Term Investments 1,694 3,129 2,150
Mortgage Loans Held for Sale 8,091 8,899 5,352
Securities Available for Sale 2,126,758 1,993,229 1,920,191
Loans 2,579,365 2,560,563 2,652,210
Less Allowance for Loan Losses 34,047 33,425 34,719
--------------- --------------- --------------
Net Loans 2,545,318 2,527,138 2,617,491
--------------- --------------- --------------
Premises and Equipment, Net 47,083 47,031 45,136
Accrued Interest Receivable 26,296 28,101 31,477
Intangible Assets 9,136 9,340 10,565
Other Assets 187,669 128,792 372,934
--------------- --------------- --------------
Total Assets $ 5,096,296 $ 4,890,722 $ 5,143,776
=============== =============== ==============
LIABILITIES:
Deposits:
Noninterest-Bearing $ 672,459 $ 492,661 $ 479,024
Interest-Bearing 2,675,515 2,695,305 2,871,437
--------------- --------------- --------------
Total Deposits 3,347,974 3,187,966 3,350,461
--------------- --------------- --------------
Short-Term Borrowings 369,173 539,758 344,460
Long-Term Debt 975,280 814,546 858,614
Accrued Expenses and Other Liabilities 73,053 32,817 288,580
--------------- --------------- --------------
Total Liabilities 4,765,480 4,575,087 4,842,115
=============== =============== ==============
STOCKHOLDERS' EQUITY:
Common Stock (par value $1.00) authorized 100,000,000 shares; issued
31,938,838, 31,737,237 and 31,688,048 shares at
June 30, 2003, December 31, 2002 and June 30, 2002, respectively 31,939 31,737 31,688
Additional Paid-in Capital 293,832 289,698 289,573
Retained Earnings 137,737 124,862 109,194
Net Accumulated Other Comprehensive Income (Loss) 12,890 14,920 (584)
Treasury Stock at Cost - 7,373,601, 7,373,601 and 6,585,701 shares at
June 30, 2003, December 31, 2002 and June 30, 2002, respectively (145,582) (145,582) (128,210)
--------------- --------------- --------------
Total Stockholders' Equity 330,816 315,635 301,661
--------------- --------------- --------------
Total Liabilities and Stockholders' Equity $ 5,096,296 $ 4,890,722 $ 5,143,776
=============== =============== ==============
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) 2003 2002 2003 2002
=============== ============= ============= =============
INTEREST INCOME:
Loans, including fees $ 36,506 $ 45,057 $ 73,332 $ 92,098
Investment Securities 23,493 26,775 47,542 54,272
Tax-Advantaged Loans and Securities 379 432 779 882
Short-Term Investments 5 15 13 65
--------------- ------------- ------------- -------------
Total Interest Income 60,383 72,279 121,666 147,317
--------------- ------------- ------------- -------------
INTEREST EXPENSE:
Deposits 12,899 22,205 27,272 46,693
Short-Term Borrowings 1,077 1,374 2,343 2,705
Long-Term Borrowings 9,608 12,830 19,625 25,397
--------------- ------------- ------------- -------------
Total Interest Expense 23,584 36,409 49,240 74,795
--------------- ------------- ------------- -------------
Net Interest Income 36,799 35,870 72,426 72,522
Less: Provision for Loan Losses 3,251 2,650 5,011 6,250
--------------- ------------- ------------- -------------
Net Interest Income after Provision for Loan Losses 33,548 33,220 67,415 66,272
--------------- ------------- ------------- -------------
NON-INTEREST INCOME:
Service Charges on Deposit Accounts 19,244 17,789 36,565 33,532
Commissions and Fees 1,150 1,266 2,460 2,600
Net Losses (6,892) (2,242) (5,645) (1,811)
Other Non-Interest Income 2,858 2,622 5,571 5,314
--------------- ------------- ------------- -------------
Total Non-Interest Income 16,360 19,435 38,951 39,635
--------------- ------------- ------------- -------------
NON-INTEREST EXPENSE:
Salaries and Employee Benefits 19,578 17,804 38,562 35,824
Occupancy Expense, Net 3,894 3,553 7,974 7,054
Furniture and Equipment Expense 2,955 2,704 5,821 5,338
External Processing Fees 5,451 5,142 10,543 9,995
Other Non-Interest Expense 8,422 8,577 16,450 15,952
--------------- ------------- ------------- -------------
Total Non-Interest Expense 40,300 37,780 79,350 74,163
--------------- ------------- ------------- -------------
Income before Income Taxes 9,608 14,875 27,016 31,744
Income Tax Expense (Benefit) (2,587) 4,470 3,036 9,864
--------------- ------------- ------------- -------------
Net Income $ 12,195 $ 10,405 $ 23,980 $ 21,880
=============== ============= ============= =============
NET INCOME PER SHARE AMOUNTS:
Basic $ 0.50 $ 0.41 $ 0.98 $ 0.87
Diluted 0.49 0.40 0.96 0.84
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,
-------------------------------------
(in thousands) 2003 2002
================ ===============
OPERATING ACTIVITIES:
Net Income $ 23,980 $ 21,880
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Depreciation and Amortization 19,284 15,110
Provision for Loan Losses 5,011 6,250
Provision for Deferred Income Tax (Benefit) (2,378) 1,013
Net Losses 5,645 1,811
Loans Originated and Held for Sale (60,833) (26,151)
Proceeds from Sales of Loans Held for Sale 62,056 27,890
Net (Increase) Decrease in Accrued Interest
Receivable and Other Assets (11,549) 1,708
Net Increase (Decrease) in Accrued
Expenses and Other Liabilities (4,447) 288
---------------- ---------------
Total Adjustments 12,789 27,919
---------------- ---------------
Net Cash Provided by Operating Activities 36,769 49,799
---------------- ---------------
INVESTING ACTIVITIES:
Principal Collections and Maturities of Securities Available for Sale 469,213 414,205
Proceeds from Sales of Securities Available for Sale 771,882 183,290
Purchases of Securities Available for Sale (1,377,485) (694,578)
Loan Principal Collections Less Originations and Purchases (25,998) 116,359
Purchases of Premises and Equipment (4,918) (4,037)
---------------- ---------------
Net Cash Provided (Used) by Investing Activities (167,306) 15,239
---------------- ---------------
FINANCING ACTIVITIES:
Net Decrease (Increase) in Deposits 160,008 (5,586)
Net Decrease in Short-Term Borrowings (170,585) (21,861)
Proceeds from Long-Term Debt 320,000 95,000
Payments and Maturities of Long-Term Debt (174,364) (97,370)
Proceeds from Issuance of Stock 4,336 5,398
Purchase of Treasury Stock - (7,338)
Cash Dividends Paid on Common Stock (11,105) (10,435)
---------------- ---------------
Net Cash Provided (Used) by Financing Activities 128,290 (42,192)
---------------- ---------------
Increase (Decrease) in Cash and Cash Equivalents (2,247) 22,846
Cash and Cash Equivalents at Beginning of Period 148,192 117,784
---------------- ---------------
Cash and Cash Equivalents at End of Period $ 145,945 $ 140,630
================ ===============
SUPPLEMENTAL DISCLOSURES:
Interest Paid, Net of Amount Credited to Deposit Accounts $ 36,509 $ 53,146
Income Taxes Paid 4,569 13,561
Net Investment Securities Purchased and not Settled 44,421 257,331
Net Investment Securities Sold and not Delivered 45,880 240,285
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, 2003
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Provident Bankshares Corporation ("the Corporation"), a Maryland corporation,
was organized as a bank holding company in 1987, and is the sole stockholder of
Provident Bank ("the Bank"), a Maryland chartered stock commercial bank. The
Bank offers consumer and commercial banking services through a network of branch
offices and ATMs in the Baltimore-Washington corridor of Maryland, Northern
Virginia, and southern York County, Pennsylvania. Related financial services are
offered through its wholly owned subsidiaries. Mutual funds, annuities and
insurance products are offered through Provident Investment Company and leases
through Court Square Leasing Corporation and Provident Lease Corporation.
The accounting and reporting policies of the Corporation conform with accounting
principles generally accepted in the United States of America ("GAAP") for
interim financial information and Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and notes required for complete
financial statements and prevailing practices within the banking industry. The
following summary of significant accounting policies of the Corporation is
presented to assist the reader in understanding the financial and other data
presented in this report. Operating results for the three and six month periods
ended June 30, 2003 are not necessarily indicative of the results that may be
expected for any future quarters or for the year ending December 31, 2003. For
further information, refer to the consolidated financial statements and notes
thereto included in the Provident Bankshares Corporation's Annual Report on Form
10-K for the year ended December 31, 2002 as filed with the Securities and
Exchange Commission.
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying unaudited Consolidated Financial Statements include the
accounts of the Corporation and its wholly owned subsidiary, Provident Bank and
its subsidiaries. All significant inter-company accounts and transactions have
been eliminated in consolidation. Results of operations from entities purchased,
if any, are included from the date of acquisition. Assets and liabilities of
purchased companies are stated at estimated fair values at the date of
acquisition.
Certain prior years' amounts in the accompanying unaudited Consolidated
Financial Statements have been reclassified to conform to the presentation used
for the current year. These reclassifications have no effect on Stockholders'
Equity or Net Income as previously reported.
USE OF ESTIMATES
In preparation of the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the dates of the financial statements and accompanying notes
and the reported amounts of income and expense during the reporting periods.
Estimates and assumptions are utilized in the determination of the allowance for
loan losses, non-accrual loans, asset prepayment rates, other real estate owned,
other than temporary impairment of investment securities, intangible assets,
pension and post-retirement benefits, fair value of financial instruments
disclosures, stock-based compensation, derivative positions, recourse
liabilities, litigation and income taxes. Management believes the following
critical accounting policies affect its more significant judgments and estimates
used in preparation of its consolidated financial statements: allowance for loan
losses, other than temporary impairment of investment securities, asset
prepayment rates and income taxes. It is at least reasonably possible that each
of the Corporation's estimates could change in the near term and the effect of
the change could be material to the Corporation's Consolidated Financial
Statements.
STOCK-BASED COMPENSATION
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure" ("SFAS No. 148"), an amendment of SFAS
No. 123, "Accounting for Stock-Based Compensation" (collectively, "SFAS No.
123"). The provisions of SFAS No. 123 provide the Corporation with the option of
accruing stock-based employee compensation expense, or applying the provisions
of APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No.
25"), which does not require compensation expense to be recognized. The
Corporation has elected to continue to apply APB No. 25 to account for
stock-based employee compensation. Accordingly, no compensation expense has been
recognized.
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The following table illustrates the pro forma effect on net income and earnings
per share if the Corporation had applied the fair value provisions of SFAS No.
123 to stock-based employee compensation.
Six Months Ended June 30,
-------------------------------
2003 2002
------------ -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NET INCOME:
Net Income As Reported $ 23,980 $ 21,880
Deduction for Total Stock-Based Employee
Compensation Expense Determined under
Fair Value Based Method for all Awards,
Net of Related Tax Effects 517 710
------------ -------------
Pro Forma Net Income $ 23,463 $ 21,170
============ =============
BASIC EARNINGS PER SHARE:
As Reported $ 0.98 $ 0.87
Pro Forma 0.96 0.84
DILUTED EARNINGS PER SHARE:
As Reported $ 0.96 $ 0.84
Pro Forma 0.94 0.82
The weighted average fair value of all of the options granted during the periods
presented have been estimated using the Black-Scholes option-pricing model with
the following assumptions:
Six Months Ended June 30,
-------------------------------
2003 2002
------------ -------------
Dividend Yield 3.62% 3.72%
Weighted Average Risk-Free Interest Rate 3.12% 3.11%
Weighted Average Expected Volatility 25.33% 25.68%
Weighted Average Expected Life in Years 7.02 6.75
RECENTLY ADOPTED 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 15, 2002. SFAS No. 143 establishes
standards for recognition and measurement of liabilities for asset retirement
obligations and retirement cost. SFAS No. 143 did not have a significant impact
on the Corporation's earnings, financial condition or equity.
In July 2002, the FASB issued Statement of Financial Accounting Standards 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. SFAS No. 143 did not have a significant impact on
the Corporation's earnings, financial condition or equity.
In April 2003, the FASB issued Statement of Financial Accounting Standard No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" ("SFAS No. 149"), which is generally effective for contracts entered
into or modified after June 30, 2003. This Statement amends and clarifies
financial accounting and reporting for derivative instruments embedded in other
contracts, collectively referred to as "derivatives" and hedging activities
under SFAS No. 133. The adoption of SFAS No. 149 did not have a significant
impact on the Corporation's earnings, financial condition or equity.
In May 2003, the FASB issued Statement of Financial Accounting Standards No.
150, "Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity" ("SFAS No. 150") effective for financial instruments
entered into or modified after May 31, 2003. This statement establishes
standards for classifying and measuring certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within the scope of the statement (such
as obligations that a reporting entity can or must settle by issuing its own
equity shares) as a liability rather than equity. SFAS No. 150 did not have an
impact on the Corporation's earnings, financial condition or equity.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("Interpretation No. 45"), which addresses the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees. Interpretation No. 45 also
requires the recognition of a liability by a guarantor at the inception of
certain guarantees. The liability is recognized for the non-contingent component
of the guarantee, which is the obligation to stand ready to perform in the event
that specified triggering events or conditions occur. The initial measurement of
this liability is the fair value of the guarantee at inception. The recognition
of the liability is required even if it is not probable that payments will be
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required under the guarantee, or if the guarantee was issued with a premium
payment, or as part of a transaction with multiple elements. The Corporation
adopted the recognition and measurement provisions for all guarantees entered
into or modified after December 31, 2002. The liability associated with these
guarantees amounted to $48 thousand at June 30, 2003, which will be amortized
over the period covered by the guarantees.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("Interpretation No. 46") which explains
identification of variable interest entities and the assessment of whether to
consolidate those entities. Interpretation No. 46 requires existing
unconsolidated variable interest entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risks among the
involved parties. The provisions of Interpretation No. 46 are effective for all
financial statements issued after January 1, 2003. The Corporation holds no
significant variable interests in any entities which would require disclosure or
consolidation.
NOTE 2 - INVESTMENT SECURITIES
The aggregate amortized cost and market values of the investment securities
portfolio were as follows at the periods indicated.
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gains Losses Value
--------------- --------------- -------------- ----------------
JUNE 30, 2003
- -------------
SECURITIES AVAILABLE FOR SALE:
U.S. Treasury and Government
Agencies and Corporations $ 126,289 $ 894 $ 1,812 $ 125,371
Mortgage-Backed Securities 1,794,490 23,597 2,943 1,815,144
Municipal Securities 19,210 1,229 - 20,439
Other Debt Securities 155,929 10,563 688 165,804
--------------- --------------- -------------- ----------------
Total Securities Available for Sale $ 2,095,918 $ 36,283 $ 5,443 $ 2,126,758
--------------- --------------- -------------- ----------------
DECEMBER 31, 2002
- -----------------
SECURITIES AVAILABLE FOR SALE:
U.S. Treasury and Government
Agencies and Corporations $ 54,074 $ 199 $ - $ 54,273
Mortgage-Backed Securities 1,767,095 28,258 570 1,794,783
Municipal Securities 19,547 1,580 - 21,127
Other Debt Securities 121,656 3,353 1,963 123,046
--------------- --------------- -------------- ----------------
Total Securities Available for Sale $ 1,962,372 $ 33,390 $ 2,533 $ 1,993,229
--------------- --------------- -------------- ----------------
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
--------------- --------------- -------------- ----------------
At June 30, 2003, net unrealized gains on securities available for sale, net of
taxes, of $20.0 million were reflected as a component of Net Accumulated Other
Comprehensive Income ("OCI"). This compared to net unrealized gains, net of
taxes, of $864 thousand at June 30, 2002 and $19.8 million at December 31, 2002.
For further details regarding investment securities at December 31, 2002, refer
to Notes 1 and 3 of the Consolidated Financial Statements.
Net realized gains on investment securities were $7.2 million for the quarter
ended June 30, 2003 compared to net realized losses of $1.1 million for the same
quarter of 2002. For the six months ended June 30, 2003, net realized gains were
$8.3 million compared to net realized losses of $944 thousand for the same
period of 2002. These net gains (losses) on investment securities are included
in net losses in the Consolidated Statement of Income.
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NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES
A summary of loans outstanding is shown in the table below as of the periods indicated.
(IN THOUSANDS) 6/30/2003 12/31/2002 6/30/2002
---------------- --------------- ---------------
Acquired Residential Mortgage $ 541,166 $ 545,323 $ 640,262
Other Consumer 913,838 881,151 852,128
---------------- --------------- ---------------
Total Consumer 1,455,004 1,426,474 1,492,390
Commercial Business 379,920 376,065 384,799
Real Estate - Construction - Residential 136,996 119,732 109,627
- Commercial 208,286 238,344 208,209
Real Estate - Mortgage - Residential 111,486 168,869 244,482
- Commercial 287,673 231,079 212,703
---------------- --------------- ---------------
Total Loans $ 2,579,365 $ 2,560,563 $ 2,652,210
================ =============== ===============
The following table reflects the activity in the allowance for loan losses for
the periods indicated.
Three Months Ended June 30, Six Months Ended June 30,
----------------------------------- ----------------------------------
(IN THOUSANDS) 2003 2002 2003 2002
-------------- ----------------- --------------- -------------
Balance at Beginning of Period $ 32,562 $ 35,164 $ 33,425 $ 34,611
Provision for Loan Losses 3,251 2,650 5,011 6,250
Transfer to Other Liabilities - - (262) -
Less: Loans Charged-Off, Net of Recoveries
Acquired Residential Mortgage 1,497 2,565 3,395 4,468
Other Consumer 132 346 522 693
Commercial Business 137 177 259 966
Real Estate - Mortgage - Residential - 18 (49) 32
- Commercial - (11) - (17)
-------------- ----------------- --------------- -------------
Net Charge-Offs 1,766 3,095 4,127 6,142
-------------- ----------------- --------------- -------------
Balance at End of Period $ 34,047 $ 34,719 $ 34,047 $ 34,719
-------------- ----------------- --------------- -------------
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NOTE 4 - INTANGIBLE ASSETS
In September 2000, the Corporation acquired Harbor Federal Bancorp using the
purchase method of accounting and allocated the purchase price to the fair value
of the net assets acquired. This allocation resulted in $8.3 million of goodwill
and $2.6 million of deposit-based intangibles. Effective January 1, 2002, the
Corporation adopted Statement of Financial Accounting Standards 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 amortization of goodwill, however, the Corporation continues
to amortize the deposit-based intangible over seven years. Testing of goodwill
balances was completed at the time of the implementation of SFAS No. 142 and no
impairment of goodwill existed at that date. The Corporation continues to
periodically monitor the balances for any indication of potential impairment in
addition to annual impairment testing of the goodwill balances.
The table below presents an analysis of the goodwill and deposit-based
intangible activity.
Accumulated Deposit-Based Accumulated
(IN THOUSANDS) Goodwill Amortization Intangible Amortization Total
============ ================ ================= ================== ==============
Balance at December 31, 2002 $ 8,314 $ (622) $ 2,600 $ (952) $ 9,340
Amortization Expense for the Six
Months Ended June 30, 2003 - - - (204) (204)
------------ ---------------- ----------------- ----------------- --------------
Balance at June 30, 2003 $ 8,314 $ (622) $ 2,600 $ (1,156) $ 9,136
============ ================ ================= ================== ==============
NOTE 5 - DEPOSITS
The table below presents deposits as of the periods indicated.
(IN THOUSANDS) 6/30/2003 12/31/2002 6/30/2002
=============== ================ ==============
Noninterest-Bearing $ 672,459 $ 492,661 $ 479,024
Money Market/Demand 916,486 847,966 808,687
Savings 711,930 662,021 660,709
Direct Time Certificates of Deposit 709,548 775,546 836,318
Broker Certificates of Deposit 337,551 409,772 565,723
--------------- --------------- --------------
Total Deposits $ 3,347,974 $ 3,187,966 $ 3,350,461
=============== ================ ==============
NOTE 6 - SHORT-TERM BORROWINGS
The table below presents short-term borrowings as of the periods indicated.
(IN THOUSANDS) 6/30/2003 12/31/2002 6/30/2002
=============== ================ ================
Securities Sold Under Repurchase Agreements $ 237,135 $ 233,748 $ 267,402
Federal Funds Purchased 130,000 304,000 75,000
Other Short-Term Borrowings 2,038 2,010 2,058
--------------- ---------------- ----------------
Total Short-Term Borrowings $ 369,173 $ 539,758 $ 344,460
=============== ================ ================
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NOTE 7 - LONG-TERM DEBT
The table below presents long-term debt as of the periods indicated.
(IN THOUSANDS) 6/30/2003 12/31/2002 6/30/2002
=============== ============== ===============
Federal Home Loan Bank Advances - Fixed Rate $ 148,593 $ 292,609 $ 327,037
Federal Home Loan Bank Advances - Variable Rate 672,293 351,826 350,167
Trust Preferred Securities 77,519 76,986 72,035
Term Repurchase Agreements 76,875 93,125 109,375
--------------- -------------- ---------------
Total Long-Term Debt $ 975,280 $ 814,546 $ 858,614
=============== ============== ===============
NOTE 8 - DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation uses derivatives to hedge the interest rate risks inherent with
its funding costs. Fair value hedges which meet the criteria 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 $14.2 million and $4.0 million for the six
months ended June 30, 2003 and 2002, respectively. Cash flow hedges have the
effective portion of changes in the fair value of the derivative recorded in
OCI. At June 30, 2003 and 2002, the Corporation had recorded a cumulative
decline in the fair value of derivatives of $4.7 million and $1.4 million,
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 ended June 30, 2003
and 2002, the Corporation had no ineffective portions of hedges.
The table below presents the Corporation's open derivative positions for the
periods indicated.
(IN THOUSANDS) NOTIONAL CREDIT RISK FAIR UNAMORTIZED
DERIVATIVE TYPE HEDGE OBJECTIVE AMOUNT AMOUNT VALUE PREMIUM
- --------------- ---------------------------- --------------- -------------- --------------- --------------
JUNE 30, 2003
- -------------
INTEREST RATE SWAPS:
PAY FIXED/RECEIVE VARIABLE DEPOSIT/BORROWING COST $ 215,000 $ - $ (6,000) $ -
PAY FIXED/RECEIVE VARIABLE LOAN RATE RISK 10,000 - (91) -
RECEIVE FIXED/PAY VARIABLE BORROWING COST 157,750 14,124 14,124 -
INTEREST RATE CAPS/CORRIDORS BORROWING COST 162,000 2 2 179
--------------- -------------- --------------- --------------
$ 544,750 $ 14,126 $ 8,035 $ 179
--------------- -------------- --------------- --------------
DECEMBER 31, 2002
- -----------------
Interest Rate Swaps:
Pay Fixed/Receive Variable Borrowing Cost $ 45,000 $ - $ (3,396) $ -
Receive Fixed/Pay Variable Borrowing Cost 157,750 12,368 12,368 -
Interest Rate Caps/Corridors Borrowing Cost 162,000 37 37 415
--------------- -------------- --------------- -------------
$ 364,750 $ 12,405 $ 9,009 $ 415
--------------- -------------- --------------- -------------
JUNE 30, 2002
- -------------
Interest Rate Swaps:
Pay Fixed/Receive Variable Deposit/Borrowing Cost $ 125,000 $ - $ (1,992) $ -
Pay Fixed/Receive Variable Asset Values/Rate Risk 16,687 - (809) -
Receive Fixed/Pay Variable Borrowing Cost 70,000 4,770 4,770 -
Interest Rate Caps/Corridors Borrowing Cost 162,000 273 273 693
--------------- -------------- --------------- -------------
$ 373,687 $ 5,043 $ 2,242 $ 693
--------------- -------------- --------------- -------------
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NOTE 9 - OTHER COMPREHENSIVE INCOME
Presented below is a reconciliation of net income to comprehensive income indicating the components of
other comprehensive income for the periods indicated.
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
(IN THOUSANDS) 2003 2002 2003 2002
---------- ----------- ----------- ----------
Net Income $ 12,195 $ 10,405 $ 23,980 $ 21,880
Other Comprehensive Income (Loss):
Gain (Loss) on Derivatives Recognized in Other Comprehensive Income (1,603) (1,474) (3,432) (1,280)
Unrealized Holding Gain (Loss) on Debt Securities 3,779 23,714 8,588 9,372
Less: Reclassification Adjustment for Gains (Losses) Included in Net Income 7,154 (1,111) 8,279 (944)
---------- ----------- ----------- ----------
Other Comprehensive Income (Loss), Before Tax (4,978) 23,351 (3,123) 9,036
Income Tax (Benefit) Related to Items of Other Comprehensive Income (1,742) 8,173 (1,093) 3,162
---------- ----------- ----------- ----------
Other Comprehensive Income (Loss), After Tax (3,236) 15,178 (2,030) 5,874
---------- ----------- ----------- ----------
Comprehensive Income $ 8,959 $ 25,583 $ 21,950 $ 27,754
========== =========== =========== ==========
NOTE 10- NET LOSSES
Net losses include the following components for the periods indicated.
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- ---------------------------
(IN THOUSANDS) 2003 2002 2003 2002
------------ ---------- ------------ -----------
Net Gains (Losses):
Securities $ 7,154 $ (1,111) $ 8,279 $ (944)
Asset Sales 1,252 (158) 1,374 106
Debt Extinguishment (15,298) (973) (15,298) (973)
------------ ---------- ------------ -----------
Net Losses $ (6,892) $ (2,242) $ (5,645) $ (1,811)
------------ ---------- ------------ -----------
NOTE 11 - 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,
-------------------------- ---------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2003 2002
------------ ---------- ------------ -----------
Qualifying Net Income $ 12,195 $ 10,405 $ 23,980 $ 21,880
Basic EPS Shares 24,501 25,151 24,443 25,134
Basic EPS $0.50 $0.41 $0.98 $0.87
Dilutive Shares 585 824 624 837
Diluted EPS Shares 25,086 25,975 25,067 25,971
Diluted EPS $0.49 $0.40 $0.96 $0.84
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NOTE 12 - COMMITMENTS AND CONTINGENCIES
COMMITMENTS
Commitments to extend credit in the form of consumer, commercial real estate
and business loans were as follows at June 30, 2003.
(IN THOUSANDS) 6/30/2003
============
Commercial Business and Real Estate $ 371,328
Consumer Revolving Credit 275,457
Residential Mortgage Credit 33,765
Performance Standby Letters of Credit 52,871
Commercial Letters of Credit 433
Forward Loan Purchase Commitment 55,100
-------------
Total Loan Commitments $ 788,954
=============
Historically, many of the commitments expire without being fully drawn;
therefore, the total commitment amounts do not necessarily represent future cash
requirements.
SECURITIZATIONS AND RECOURSE PROVISION
From 1999 through 2001, the Corporation securitized a total of $946 million of
its acquired residential mortgage loan portfolio. These loans were securitized
with Fannie Mae and the respective securities were placed into the Corporation's
investment portfolio.
The loans underlying the securities were securitized with full recourse to the
Corporation for any losses. The maximum potential recourse obligation was $88.9
million and $256.2 million at June 30, 2003 and 2002, respectively. A recourse
liability was established by the Corporation based upon management's current
assessment of the credit risk inherent in the loans. The recourse liability
amounted to $1.8 million and $3.1 million at June 30, 2003 and 2002,
respectively. The recourse liability is evaluated periodically for adequacy. Net
charges to the recourse liability amounted to $1.4 million and $469 thousand for
the six months ended June 30, 2003 and 2002, respectively. At June 30, 2003,
$1.4 million of loans with potential recourse were 90 days or more past due.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL REVIEW
Provident Bankshares Corporation ("the Corporation"), a Maryland corporation,
was organized as a bank holding company in 1987, and is the sole stockholder of
Provident Bank ("the Bank"), a Maryland chartered stock commercial bank. The
Bank offers consumer and commercial banking services through a network of 114
banking offices and 164 ATMs in the Baltimore-Washington corridor of Maryland,
Northern Virginia, and southern York County, Pennsylvania. At June 30, 2003, the
branch network consisted of 59 traditional full service branch locations, 51
in-store branches and 4 ATM Plus banking offices. The in-store and ATM Plus
offices are located in supermarkets and national retail superstores. Of the 114
banking offices, 61% are located in the Baltimore region and 39% are located in
the metropolitan Washington D.C. region. The Bank offers related financial
services through its wholly owned subsidiaries. Mutual funds, annuities and
insurance products are offered through Provident Investment Company and leases
through Court Square Leasing Corporation and Provident Lease Corporation.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Discussion and analysis of 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 of America ("GAAP"). The preparation of these financial statements
requires management to make estimates and judgments 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
impairment of investment securities, intangible assets, pension and
post-retirement benefits, stock-based compensation, derivative positions,
recourse liabilities, litigation 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 judgments 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 judgments and estimates used in preparation of its consolidated
financial statements: allowance for loan losses, other than temporary impairment
of investment securities, asset prepayment rates and income taxes. Each estimate
is discussed below. The financial impact of each estimate, to the extent
significant to financial results, is discussed in the applicable sections of
Management's Discussion and Analysis. It is at least reasonably possible that
each of the Corporation's estimates could change in the near term and the affect
of the change could be material to the Corporation's consolidated financial
statements.
ALLOWANCE FOR LOAN LOSSES
The Corporation maintains an allowance for loan losses ("the allowance"), which
is intended to be management's best estimate of probable inherent losses in the
outstanding loan portfolio. The allowance is reduced by actual credit losses and
is increased by the provision for loan losses and recoveries of previous losses.
The provisions for loan losses are charges to earnings to bring the total
allowance to a level considered necessary by management.
The allowance is based on management's continuing review and evaluation of the
loan portfolio. This process provides an allowance consisting of two components,
allocated and unallocated. To arrive at the allocated component of the
allowance, the Corporation combines estimates of the allowances needed for loans
analyzed individually and on a pooled basis. The allocated component of the
allowance is supplemented by an unallocated component.
The portion of the allowance that is allocated to individual internally
criticized and non-accrual loans is determined by estimating the inherent loss
on each problem credit after giving consideration to the value of underlying
collateral. 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 credit 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.
For portfolios such as consumer loans, commercial business loans and loans
secured by real estate, the determination of the allocated allowance is
conducted at an aggregate, or pooled, level. Each quarter, twelve-month rolling
loss rates for homogenous pools of loans in the consumer portfolio provide the
basis for the allocated reserve. Historical loss rates also provide the basis
for reserves allocated to pools within the commercial portfolios. For any
portfolio where the Bank lacks sufficient historic experience, industry loss
rates are used. If recent history is
15
16
not deemed to reflect the inherent losses existing within a portfolio, older
historic loss rates during a period of similar economic or market conditions are
used.
The Bank's credit administration group adjusts the indicated loss rates based on
qualitative factors. Factors that are considered in adjusting loss rates include
risk characteristics, credit concentration trends and general economic
conditions, including job growth and unemployment rates. For commercial and real
estate portfolios, additional factors include the level and trend of watched and
criticized credits within those portfolios; commercial real estate vacancy,
absorption and rental rates; and the number and volume of syndicated credits,
construction loans, speculative construction loans or other portfolio segments
deemed to carry higher levels of risk. Upon completion of the qualitative
adjustments, the overall allowance is allocated to the components of the
portfolio based on the adjusted loss factors.
The unallocated component of the allowance exists to mitigate the imprecision
inherent in management's estimates of expected credit losses and includes its
judgmental determination of the amounts necessary for concentrations, economic
uncertainties and other subjective factors that may not have been fully
considered in the allocated allowance. The relationship of the unallocated
component to the total allowance may fluctuate from period to period. Although
management has allocated the majority of the allowance to specific loan
categories, the evaluation of the allowance is considered in its entirety.
Lending management meets at least monthly to review the credit quality of the
loan portfolios and at least quarterly with executive management to evaluate the
allowance. The Corporation has an internal risk analysis and review staff that
continuously reviews loan quality and reports the results of its reviews to
executive management, the Audit Committee and the Board of Directors. Such
reviews also assist management in establishing the level of the allowance.
Management believes that it uses the best information available to make
determinations about the allowance and that it has established its existing
allowance in accordance with GAAP. If circumstances differ substantially from
the assumptions used in making determinations, adjustments to the allowance may
be necessary and results of operations could be affected. Because 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.
The Bank is examined periodically by the Federal Deposit Insurance Corporation
and, accordingly, as part of this exam, the allowance is reviewed for adequacy
utilizing specific guidelines. Based upon their review, the regulators may from
time to time require reserves in addition to those previously provided.
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. It indicates that the prospects for a near term recovery of value are
not necessarily favorable, or that there is a lack of evidence to support fair
values 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 loan pools and investment securities in
which the underlying assets are residential mortgage loans subject to
prepayments. The actual principal reduction on these assets varies from the
expected contractual principal reduction due to principal prepayments resulting
from borrowers elections to refinance the underlying mortgages based on market
and other 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 estimated life is calculated by projecting future
prepayments and the resulting principal cash flows until maturity. Management
makes prepayment rate projections by utilizing actual prepayment speed
experience and 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 cause the
earnings recognized on these assets to vary over the term that the assets are
held, creating volatility in the net interest margin. Prepayment rate
assumptions are monitored and updated monthly to reflect actual activity and the
most recent market projections.
INCOME TAXES
The Corporation accounts for income taxes under the asset/liability method.
Deferred tax assets and liabilities are recognized for the future consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases, as well as
operating loss and tax credit carryforwards. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period indicated by the enactment date. A
valuation
16
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allowance is established against deferred tax assets when, in the judgment of
management, it is more likely than not that such deferred tax assets will not
become realizable. The judgment about the level of future taxable income is
dependent to a great extent on matters that may, at least in part, be beyond the
Bank's control. It is at least reasonably possible that management's judgment
about the need for a valuation allowance for deferred taxes could change in the
near term.
FINANCIAL CONDITION
At June 30, 2003, total assets were $5.1 billion, up slightly from $4.9 billion
at December 31, 2002. The Corporation continued to migrate the composition of
the balance sheet by focusing resources on growth in core business lines,
resulting in a higher percentage of core loans and deposits on the balance
sheet, while non-core loan and deposit balances continued to decline. The
Corporation experienced growth in all of its markets, opening one in-store
branch in the Washington metropolitan area during the quarter.
ASSET COMPOSITION
The following table summarizes the composition of the Bank's average earning
assets for the periods indicated.
AVERAGE EARNING ASSETS SUMMARY
Three Months Ended
June 30, $ %
----------------------------------
(DOLLARS IN THOUSANDS) 2003 2002 Variance Variance
--------------- -------------- ------------ -----------
Investments $ 2,132,288 $ 1,890,814 $ 241,474 12.8 %
Other earning assets 14,350 7,548 6,802 90.1
Core loans:
Consumer 866,789 784,134 82,655 10.5
Commercial business 352,095 334,796 17,299 5.2
Real estate 579,714 497,669 82,045 16.5
--------------- -------------- ------------
Total core loans 1,798,598 1,616,599 181,999 11.3
--------------- -------------- ------------
Non-core loans:
Consumer 674,381 978,204 (303,823) (31.1)
National syndicated loans 38,232 72,073 (33,841) (47.0)
--------------- -------------- ------------
Total non-core loans 712,613 1,050,277 (337,664) (32.1)
--------------- -------------- ------------
Total loans 2,511,211 2,666,876 (155,665) (5.8)
--------------- -------------- ------------
Total earning assets $ 4,657,849 $ 4,565,238 $ 92,611 2.0 %
--------------- -------------- ------------
Total average earning assets increased by $93 million to $4.7 billion in the
second quarter of 2003 ("the 2003 quarter") compared to the second quarter of
2002 ("the 2002 quarter"). A $241 million increase in average investment
portfolio balances and a $182 million increase in average core loan balances
offset the $338 million decrease in average non-core loan balances. Management
defines core loans as those loans originated by the Bank, as well as purchases
of participations in syndicated loans in the Bank's defined market area.
Non-core loans are defined as purchased loans, participations in syndicated
loans outside the Bank's defined market area, and Bank-originated loans from
discontinued product lines.
The growth in the investment portfolio average balances in the 2003 quarter
occurred as the excess cash flow generated by the non-core loan portfolio
payments, net of core loan funding requirements, was reinvested into the
investment portfolio. Cashflows were predominately invested in a combination of
15, 20, and 30 year conventional MBS, as well as 5/1 and 7/1 hybrid ARMs, and 7
year balloon mortgages. These purchases lengthened the duration of the portfolio
and mitigated prepayment risk associated with the falling interest rate
environment.
The Corporation's expanded presence in the Baltimore-Washington metropolitan
region facilitated the robust 11.3% growth in average core loans, which comprise
71.6% of total average loans in the 2003 quarter. Average core consumer loans,
comprised of direct consumer and marine loans, increased $83 million, or 10.5%,
in the 2003 quarter compared to the 2002 quarter. Production of direct consumer
loans, primarily home equity loans, totaling $109 million in the 2003 quarter
exceeded production in the 2002 quarter by $50 million, or 87%. Production from
the internet-based home equity product referral network continued to supplement
lending activity from the Bank's branch and call center network, contributing
$13 million to the direct consumer loan production in the current quarter.
Marine loans, which are originated indirectly through brokers but underwritten
individually by the Bank, also had strong performance, with average marine loan
balances up 17.9% to $439 million in the 2003 quarter. Average core commercial
business, real estate construction and commercial mortgage loans also continued
to show steady growth, evidenced by an increase of $99 million, or 11.9%, in the
2003 quarter compared to the 2002 quarter. Both the Washington and Baltimore
markets experienced 12% average core commercial loan growth for the 2003 quarter
compared to the 2002 quarter.
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The Corporation's average non-core loan balances continued to decline at a rapid
pace as the low interest rate environment continued in 2003, decreasing $338
million in the 2003 quarter, or 32.1%, due to continued prepayment activity. The
largest component of non-core consumer loans is the portfolio of acquired
residential mortgage loans, which declined by $129 million to an average balance
for the quarter of $525 million. The decline was a result of the level of
payoffs and resultant amortization of loan purchase premiums, partially offset
by additional purchases. In the 2003 quarter, the Corporation purchased $104
million in loans secured by residential real estate, all of which are in a first
lien position. Management intends to continue to purchase such loans to maintain
an average acquired portfolio size between $500 million and $600 million. The
other non-core consumer portfolios, relating to residential mortgage and
indirect auto loan product lines that are no longer offered by the Bank,
declined by $175 million. The non-core syndicated portfolio average balances
declined $34 million, or 47.0%, in the 2003 quarter. The remaining $38 million
of non-core syndicated loans represent a diversified portfolio of loans which
are performing as agreed and amortizing according to their terms and conditions.
ASSET QUALITY
Non-performing assets were $24.6 million at June 30, 2003, or 0.95% of loans
outstanding, showing continued improvement from the December 31, 2002 level of
$24.9 million, or 0.97% and the June 30, 2002 level of $26.8 million, or 1.01%.
Of total non-performing loans at June 30, 2003, $18.1 million are in the
consumer and residential mortgage loan portfolios, which are collateralized by 1
to 4 family residences. With the vast majority of non-performing loans already
written down to net fair value, management expects little further loss.
Commercial and real estate non-performing loans remained at historically low
levels. Total 90-day delinquent loans decreased $2.3 million at June 30, 2003
from the level at December 31, 2002. In the acquired mortgage portfolio
(comprised of 70% first lien loans), delinquencies have declined consistently,
reaching their lowest level in three years.
As a result of the growth and mix in the commercial and consumer loan
portfolios, the Corporation increased the level of the allowance $622 thousand
from December 31, 2002 to $34.0 million at June 30, 2003. At June 30, 2003, the
allowance represents 1.32% of total loans outstanding and 175% of non-performing
loans. Portfolio-wide net charge-offs represented 0.28% of average loans for the
2003 quarter, continuing to improve from 0.40% in the December 2002 quarter and
0.47% in the June 2002 quarter.
Although no assurances can be given, management believes that non-performing
assets will remain relatively stable in the near term. Management believes that
the allowance at June 30, 2003 represents its best estimate of probable losses
inherent in the portfolio.
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ASSET QUALITY SUMMARY
(DOLLARS IN THOUSANDS)
6/30/2003 12/31/2002 6/30/2002
-------------- -------------- ---------------
NON-PERFORMING ASSETS:
- ----------------------
Acquired Residential Mortgage $ 15,507 $ 18,070 $ 17,823
Other Consumer 420 460 664
Commercial Business 533 514 93
Real Estate - Construction - Residential 135 136 215
- Commercial - - -
Real Estate - Mortgage - Residential 2,104 1,953 3,906
- Commercial 735 - -
-------------- -------------- ---------------
Total Non-Accrual Loans 19,434 21,133 22,701
Total Renegotiated Loans - - -
-------------- -------------- ---------------
Total Non-Performing Loans 19,434 21,133 22,701
Total Other Assets and Real Estate Owned 5,132 3,796 4,060
-------------- -------------- ---------------
Total Non-Performing Assets $ 24,566 $ 24,929 $ 26,761
============== ============== ===============
90-DAY DELINQUENCIES:
- ---------------------
Acquired Residential Mortgage $ 5,353 $ 5,108 $ 4,710
Other Consumer 373 1,023 977
Commercial Business 380 320 204
Real Estate - Construction - Residential - - -
- Commercial - - -
Real Estate - Mortgage - Residential 6,414 8,377 6,711
- Commercial - - -
-------------- -------------- ---------------
Total 90-Day Delinquencies $ 12,520 $ 14,828 $ 12,602
============== ============== ===============
ASSET QUALITY RATIOS:
- ---------------------
Non-Performing Loans to Loans 0.75% 0.83% 0.86%
Non-Performing Assets to Loans 0.95% 0.97% 1.01%
Allowance for Loan Losses to Loans 1.32% 1.31% 1.31%
Net Charge-Offs in Quarter to Average Loans 0.28% 0.40% 0.47%
Allowance for Loan Losses to Non-Performing Loans 175.19% 158.16% 152.94%
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SOURCES OF FUNDS
DEPOSITS AND BORROWINGS
The following table summarizes the composition of the Bank's average deposit and
borrowing balances for the periods indicated.
AVERAGE DEPOSITS AND BORROWINGS
Three Months Ended
June 30, $ %
--------------------------------
(DOLLARS IN THOUSANDS) 2003 2002 Variance Variance
-------------- ------------- ------------ -----------
Core Deposits:
Consumer $ 2,395,159 $ 2,363,093 $ 32,066 1.4 %
Commercial 460,845 341,345 119,500 35.0
-------------- ------------- ------------
Total Core Deposits 2,856,004 2,704,438 151,566 5.6
Non-core Deposits 356,908 630,611 (273,703) (43.4)
-------------- ------------- ------------
Total Deposits 3,212,912 3,335,049 (122,137) (3.7)
-------------- ------------- ------------
Borrowings:
Federal Funds Purchased 185,863 127,158 58,705 46.2
FHLB Advances 915,155 692,054 223,101 32.2
Repurchase Agreements and Other 287,995 316,787 (28,792) (9.1)
Trust Preferred Securities 68,141 68,069 72 0.1
-------------- ------------- ------------
Total Borrowings 1,457,154 1,204,068 253,086 21.0
-------------- ------------- ------------
Total Deposits and Borrowings $ 4,670,066 $ 4,539,117 $ 130,949 2.9 %
============== ============= ============
Total average deposit balances decreased $122 million in the 2003 quarter
compared to the 2002 quarter due to the $274 million decrease in average
non-core deposits (composed of brokered CDs), that matured but were not
replaced. Due to the Corporation's focus on its core business lines, average
core deposits generated from the Bank's consumer and commercial customer base
continued to grow steadily, replacing $152 million of the brokered CD runoff.
Excluding average retail CDs, which decreased $111 million from the 2002 quarter
to the 2003 quarter, average consumer deposit balances increased $143 million,
or 9.2%, from the 2002 quarter to the 2003 quarter. Deposit growth from the
commercial sector was particularly strong during the same period, with a net
increase in average balances of $120 million, or 35%, in the 2003 quarter, of
which $92 million was in non-interest-bearing accounts. In the 2003 quarter,
average core deposits comprised 88.9% of average total deposits.
Average borrowings increased $253 million in the second quarter of 2003 compared
to the 2002 quarter. Average Federal Funds Purchased ("Fed Funds") increased $59
million, reflecting management's desire to match fund more of the Bank's
prime-based loan portfolio with these borrowings. Average Federal Home Loan Bank
("FHLB") borrowings increased $223 million over 12 months; however FHLB
borrowings declined $101 million from March 31, 2003 to June 30, 2003. In the
second quarter of 2003, management took advantage of the opportunity to
extinguish $140 million of term FHLB borrowings with above market rates. The
debt was replaced with lower rate FHLB borrowings and Fed Funds, which is
expected to have a favorable impact on interest expense in the second half of
2003, as well as 2004-2006.
LIQUIDITY
An important component of the Bank's asset/liability structure is the level of
liquidity available to meet the needs of customers and creditors. Traditional
sources of bank liquidity include deposit growth, loan repayments, investment
maturities, asset sales, borrowings and interest received. The Bank's
Asset/Liability Management Committee has established general guidelines for
maintaining prudent levels of liquidity. The committee continually monitors the
amount and sources of available liquidity, and the time and cost required for
obtaining it. Management believes the Bank has sufficient liquidity to meet
funding needs in the foreseeable future.
The Bank's primary source of liquidity is the assets it possesses, which can be
pledged as collateral for secured borrowings or alternatively sold to raise cash
levels. An objective of liquidity management is to optimize the use of this
collateral to minimize funding costs. The Bank's primary sources for raising
secured borrowings are the FHLB and securities broker/dealers. At June 30, 2003,
$1.1 billion of secured borrowings were employed, with sufficient collateral
available to immediately raise an additional $843 million. After covering $245
million of unsecured funds that mature in the next three months, the excess
liquidity position of $598 million is well in excess of projected liquidity
requirements for the next 12 months. Additionally, over $300 million of assets
are maintained as collateral with the Federal Reserve which is available as a
contingent funding source.
20
21
The Bank also has several unsecured funding sources available. At June 30, 2003,
the Bank possessed over $700 million of Fed Funds lines, of which only $130
million were in use at quarter-end. Brokered CDs, which typically cost 10 - 25
basis points more than secured funds of a similar maturity, remain a viable
funding alternative, however management has not used this source since 2001 in
accordance with its strategy to reduce non-core funding. Existing brokered CD
average balances declined by $41 million in the second quarter of 2003 from the
first quarter of 2003. The unsecured debt markets are also a potential
alternative to raise funds but have not been employed since 2001 given the
Bank's ability to raise funds at lower interest rates in the secured funds
markets.
As an alternative to raising secured funds, the Bank can raise liquidity through
asset sales. At June 30, 2003, over $500 million of the Bank's investment
portfolio is not pledged as collateral for borrowings, and is immediately
saleable at a market value equaling or exceeding its amortized cost basis.
Additionally, over a 90-day time frame, much of the Bank's $1.5 billion consumer
loan portfolio is saleable in an efficient market.
Commitments to lend funds to customers affect the Bank's determination of
sufficient liquidity. The borrowing requirements of customers include
commitments to extend credit and unused availability of lines of credit, which
totaled $789 million at June 30, 2003 (see Note 12 to the unaudited consolidated
financial statements). Historically, many of the commitments expire without
being fully drawn; therefore, the total commitment amounts do not necessarily
represent future cash requirements.
The Corporation is a one-bank holding company which relies upon the Bank's
performance to generate capital growth through Bank earnings. A portion of the
Bank's earnings are passed to the Corporation in the form of cash dividends.
These dividends are utilized to pay dividends to stockholders, repurchase shares
and pay interest on trust preferred securities. The Corporation and the Bank, in
declaring and paying dividends, are also limited insofar as minimum capital
requirements of regulatory authorities must be maintained. The Corporation and
the Bank comply with such capital requirements. If the Corporation or the Bank
were unable to comply with the minimum capital requirements, it could result in
regulatory actions which could have a material impact on the Corporation.
MARKET RISK AND INTEREST RATE SENSITIVITY
The nature of the banking business, which involves paying interest on deposits
at varying rates and terms and charging interest on loans at other rates and
terms, creates interest rate risk. As a result, earnings and the market value of
assets and liabilities are subject to fluctuations, which arise due to changes
in the level and direction of interest rates. Management's objective is to
minimize the fluctuation in the net interest margin caused by changes in
interest rates using cost-effective strategies and tools.
The Bank manages several forms of interest rate risk. The simplest involves the
mismatch of maturities between fixed rate assets and liabilities. A second risk,
basis risk, exists as a result of having much of the Bank's earning assets
priced using either the Prime rate or the U.S. Treasury yield curve, while much
of the liability portfolio is priced using the CD yield curve or LIBOR yield
curve. These different yield curves typically do not move in lock-step with one
another. A third risk, options risk, exists in the form of prepayment volatility
in residential mortgage loans and other consumer loans. Prepayment risk
increases when long-term interest rates, such as the 10 year Treasury Note rate
or the 30 year mortgage rate, decline substantially. Prepayment volatility
complicates funding strategies in which the goal is to maintain a stable spread
between asset yields and borrowing rates.
Measuring and managing interest rate risk is a dynamic process that management
performs continually to meet the objective of maintaining a stable net interest
margin. This process relies chiefly on simulation modeling of shocks to the
balance sheet under a variety of interest rate scenarios, including parallel and
non-parallel rate shifts, such as the forward yield curves for U.S. Treasuries
and Interest Rate Swaps. The results of these shocks are measured in two forms:
first, the impact on net interest margin and earnings over one and two year time
frames; and second, the impact on the market value of equity. There are several
advantages of simulation analysis over traditional gap analysis. In addition to
measuring the basis risks and prepayment risks noted above, simulations also
quantify the earnings impact of rate changes and the cost/benefit of hedging
strategies.
21
22
The following table shows the anticipated effect on net interest income in
parallel shift (up or down) interest rate scenarios. These shifts are assumed to
begin on July 1, 2003 and evenly ramp-up or down over a six-month period. The
effect on net interest income would be for the next 12 months. Given the
interest environment at June 30, 2003, a 200 basis point drop in rate is
unlikely and has not been shown.
PROJECTED PERCENTAGE
INTEREST RATE SCENARIO CHANGE IN NET INTEREST INCOME
---------------------- -----------------------------
-100 basis points -5.4%
No Change ---
+100 basis points +2.2%
+200 basis points +1.8%
The isolated modeling environment, assuming no action by management, shows that
the Corporation's net interest income volatility is less than 6% under probable
single direction scenarios. The Corporation's one year forward earnings are
slightly asset sensitive, which will result in net interest income moving in the
same direction as future interest rates.
The Corporation maintains an overall interest rate management strategy that
incorporates structuring of investments, purchased funds, variable rate loan
products, and derivatives in order to minimize significant fluctuations in
earnings or market values (see Note 8 to unaudited financial statements). The
Bank continues to employ hedges to mitigate interest rate risk. Borrowings
totaling over $500 million have been employed which reset their rates monthly or
quarterly based on the level of long-term interest rates - specifically, the
10-year constant maturity swap rate - rather than short-term rates, to offset
the effect of mortgage prepayments on asset yields. Both the 10-year swap rate
and the 30-year mortgage rate fell by 60-65 basis points from January 2, 2003 to
June 30, 2003. Additionally, $383 million notional amount in interest rate swaps
were in force to reduce maturity mismatches, and $162 million of interest rate
caps were employed to protect the interest margin from rising interest rates in
the future.
CAPITAL RESOURCES
Total stockholder's equity was $331 million at June 30, 2003, an increase of
$15.2 million, or 4.8%, from December 31, 2002. The growth in stockholder's
equity for the six months ended June 30, 2003 was attributable to $24.0 million
in earnings and $4.3 million from the issuance of common stock relating to the
exercise of stock options. This was partially offset by dividends declared of
$11.1 million and a decrease of $2.0 million in accumulated other comprehensive
income ("OCI"). OCI decreased due primarily to the realization of $7.2 million
previously unrealized gains in available-for-sale securities. The Corporation
approved an extension of its repurchase program in early 2003 to authorize
repurchases of an additional 1.0 million shares, but did not repurchase any
shares during the quarter ended June 30, 2003.
The Corporation is required to maintain minimum amounts and ratios of core
capital to adjusted quarterly average assets ("leverage ratio") and of tier 1
and total regulatory capital to risk-weighted assets. The actual regulatory
capital ratios and required ratios for capital adequacy purposes under FIRREA
and the ratios to be categorized as "well capitalized" under prompt corrective
action regulations are summarized in the following table:
MINIMUM
JUNE 30, DECEMBER 31, REGULATORY TO BE "WELL
2003 2002 REQUIREMENTS CAPITALIZED"
------------- ---------------- ----------------- ---------------
Tier 1 leverage ratio 7.51% 7.47% 4.00% 5.00%
Tier 1 capital to risk-weighted assets 12.01% 11.62% 4.00% 6.00%
Total regulatory capital to risk-weighted assets 13.09% 12.70% 8.00% 10.00%
22
23
RESULTS OF OPERATIONS
FOR THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED
JUNE 30, 2002
OVERVIEW
The Corporation recorded net income for the quarter ended June 30, 2003 of $12.2
million or $.49 per diluted share. The Corporation's two key performance
measures, return on average common equity and return on assets, were 15.88% and
0.98%, respectively, compared to 13.87% and 0.86%, respectively, for the 2002
quarter. The financial results for the 2003 quarter, represented by increases of
17.2% in net income and 22.5% in diluted earnings per share, demonstrated margin
stability, continued growth in all of the Corporation's core loan and deposit
businesses and continued progress in asset quality.
Net income increased $1.8 million from the prior year's second quarter. Net
interest income after the provision for loan losses was stable, and a $7.1
million decrease in tax expense offset a $3.1 million decrease in non-interest
income and a $2.5 million increase in non-interest expense. In the 2003 second
quarter, when it became apparent that the Corporation would be required to
recognize one-time tax benefits of $8.9 million, management elected to reset a
portion of its borrowing cost at beneficial rates by extinguishing $59 million
of debt at a corresponding loss of $8.9 million. These items are discussed in
more detail, as follows.
NET INTEREST INCOME
The Corporation's principal source of revenue is net interest income, the
difference between interest income on earning assets and interest expense on
deposits and borrowings. Interest income, for purposes of analysis, is presented
on a tax-equivalent basis to recognize associated tax benefits. This
presentation provides a basis for comparison of yields with taxable earning
assets. The discussion of net interest income should be read in conjunction with
the table on the following pages. The table analyzes the reasons for the changes
from period-to-period in the principal elements that comprise net interest
income. Rate and volume variances presented for each component will not total
the variances presented on totals of interest income and interest expense
because of shifts from period-to-period in the relative mix of interest-earning
assets and interest-bearing liabilities.
23
24
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
COMPARATIVE ANALYSIS OF AVERAGE BALANCES, INTEREST INCOME AND EXPENSE AND INTEREST YIELDS AND RATES
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended
June 30, 2003 June 30, 2002 2003/2002 Increase/(Decrease)
--------------------------------------------------------- ---------------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/ Average % Income/ %
(tax-equivalent basis) Balance Expense Rate Balance Expense Rate Balance Change Expense Change
----------- --------- ------ ---------- -------- ------- ---------- -------- ---------- --------
ASSETS
- ------
Interest-Earning Assets:
Home Equity--Direct $ 387,317 $ 5,048 5.23% $ 365,241 $ 5,625 6.18% $ 22,076 6.0 % $ (577) (10.3)%
Marine 439,310 6,280 5.73 372,664 6,413 6.90 66,646 17.9 (133) (2.1)
Acquired Residential Mortgage 525,282 8,512 6.50 654,113 12,784 7.84 (128,831) (19.7) (4,272) (33.4)
Other Direct Consumer 40,162 795 7.94 46,229 912 7.91 (6,067) (13.1) (117) (12.8)
Other Indirect Consumer 23,786 482 8.13 66,111 1,247 7.57 (42,325) (64.0) (765) (61.3)
Residential Mortgage 125,313 2,434 7.79 257,980 4,937 7.68 (132,667) (51.4) (2,503) (50.7)
----------- -------- ---------- -------- ---------- --------
Total Consumer 1,541,170 23,551 6.13 1,762,338 31,918 7.26 (221,168) (12.5) (8,367) (26.2)
Commercial Business 352,095 5,200 5.92 334,796 5,528 6.62 17,299 5.2 (328) (5.9)
Real Estate-Construction 316,603 3,466 4.39 274,415 3,302 4.83 42,188 15.4 164 5.0
Commercial Mortgage 263,111 3,982 6.07 223,254 3,660 6.58 39,857 17.9 322 8.8
Non-Core Syndicated Loans 38,232 362 3.80 72,073 865 4.81 (33,841) (47.0) (503) (58.2)
----------- -------- ---------- -------- ---------- --------
Total Loans 2,511,211 36,561 5.84 2,666,876 45,273 6.81 (155,665) (5.8) (8,712) (19.2)
----------- -------- ---------- -------- ---------- --------
Loans Held for Sale 11,871 165 5.58 4,897 81 6.63 6,974 142.4 84 103.7
Short-Term Investments 2,479 5 0.81 2,651 15 2.27 (172) (6.5) (10) (66.7)
Taxable Investment Securities 2,113,055 23,493 4.46 1,869,922 26,705 5.73 243,133 13.0 (3,212) (12.0)
Tax-Advantaged Investment
Securities 19,233 331 6.90 20,892 405 7.78 (1,659) (7.9) (74) (18.3)
----------- -------- ---------- -------- ---------- --------
Total Investment Securities 2,132,288 23,824 4.48 1,890,814 27,110 5.75 241,474 12.8 (3,286) (12.1)
----------- -------- ---------- -------- ---------- --------
Total Interest-Earning
Assets 4,657,849 60,555 5.21 4,565,238 72,479 6.37 92,611 2.0 (11,924) (16.5)
----------- -------- ---------- -------- ---------- --------
Less: Allowance for Loan Losses (32,741) (34,710) 1,969 (5.7)
Cash and Due From Banks 113,397 97,474 15,923 16.3
Other Assets 260,343 242,141 18,202 7.5
----------- ---------- ----------
Total Assets $ 4,998,848 $4,870,143 $ 128,705 2.6
=========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Liabilities:
Demand/Money Market Deposits $ 884,984 1,673 0.76 $ 785,628 2,383 1.22 $ 99,356 12.6 (710) (29.8)
Savings Deposits 709,444 966 0.55 658,555 1,878 1.14 50,889 7.7 (912) (48.6)
Direct Time Deposits 722,802 4,787 2.66 835,176 7,687 3.69 (112,374) (13.5) (2,900) (37.7)
Brokered Time Deposits 356,908 5,471 6.15 630,611 10,257 6.52 (273,703) (43.4) (4,786) (46.7)
Short-Term Borrowings 393,325 1,077 1.10 330,915 1,374 1.67 62,410 18.9 (297) (21.6)
Long-Term Debt 1,063,829 9,608 3.62 873,153 12,830 5.89 190,676 21.8 (3,222) (25.1)
----------- -------- ---------- -------- ---------- --------
Total Interest-Bearing
Liabilities 4,131,292 23,582 2.29 4,114,038 36,409 3.55 17,254 0.4 (12,827) (35.2)
----------- -------- ---------- -------- ---------- --------
Noninterest-Bearing Demand Deposits 538,774 425,079 113,695 26.7
Other Liabilities 20,762 30,135 (9,373) (31.1)
Common Stockholders' Equity 308,020 300,891 7,129 2.4
----------- ---------- ----------
Total Liabilities and
Stockholders' Equity $ 4,998,848 $4,870,143 $ 128,705 2.6
=========== ========== ==========
Net Interest-Earning Assets $ 526,557 $ 451,200 $ 75,357 16.7
=========== ========== ==========
Net Interest Income (tax-equivalent) 36,973 36,070 903 2.5
Less: Tax-Equivalent Adjustment (174) (200) 26 (13.0)
-------- -------- --------
Net Interest Income $ 36,799 $ 35,870 $ 929 2.6
======== ======== ========
Net Yield on Interest-Earning Assets 3.18% 3.17%
2003/2002
INCOME/EXPENSE VARIANCE
DUE TO CHANGE IN
----------------------------
(dollars in thousands) AVERAGE AVERAGE
(tax-equivalent basis) RATE VOLUME
----------- -----------
ASSETS
- ------
Interest-Earning Assets:
Home Equity--Direct $ (902) $ 325
Marine (1,180) 1,047
Acquired Residential Mortgage (1,984) (2,288)
Other Direct Consumer 3 (120)
Other Indirect Consumer 87 (852)
Residential Mortgage 73 (2,576)
Total Consumer
Commercial Business (604) 276
Real Estate-Construction (315) 479
Commercial Mortgage (296) 618
Non-Core Syndicated Loans (156) (347)
Total Loans
Loans Held for Sale (15) 99
Short-Term Investments (9) (1)
Taxable Investment Securities (6,400) 3,188
Tax-Advantaged Investment Securities (43) (31)
Total Investment Securities
Total Interest-Earning Assets (13,367) 1,443
Less: Allowance for Loan Losses
Cash and Due From Banks
Other Assets
Total Assets
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Liabilities:
Demand/Money Market Deposits (983) 273
Savings Deposits (1,047) 135
Direct Time Deposits (1,960) (940)
Brokered Time Deposits (560) (4,226)
Short-Term Borrowings (525) 228
Long-Term Debt (5,633) 2,411
Total Interest-Bearing Liabilities (12,979) 152
Noninterest-Bearing Demand Deposits
Other Liabilities
Common Stockholders' Equity
Total Liabilities and Stockholders' Equity
Net Interest-Earning Assets
Net Interest Income (tax-equivalent) $ (388) $ 1,291
Less: Tax-Equivalent Adjustment
Net Interest Income
Net Yield on Interest-Earning Assets
24
25
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
COMPARATIVE ANALYSIS OF AVERAGE BALANCES, INTEREST INCOME AND EXPENSE AND INTEREST YIELDS AND RATES
- ------------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED Six Months Ended
JUNE 30, 2003 June 30, 2002 2003/2002 INCREASE/(DECREASE)
------------------------------------------------------------ ---------------------------------------
(DOLLARS IN THOUSANDS) AVERAGE INCOME/ YIELD/ Average Income/ Yield/ AVERAGE % INCOME/ %
(TAX-EQUIVALENT BASIS) BALANCE EXPENSE RATE Balance Expense Rate BALANCE CHANGE EXPENSE CHANGE
---------- --------- -------- --------- --------- -------- --------- ---------- --------- -------
Assets
Interest-Earning Assets:
Home Equity--Direct $ 380,961 $ 10,056 5.32 % $ 360,373 $ 11,158 6.24 % $ 20,588 5.7 % $ (1,102) (9.9)%
Marine 434,100 12,545 5.83 363,334 12,507 6.94 70,766 19.5 38 0.3
Acquired Residential Mortgage 520,297 17,092 6.62 682,456 27,052 7.99 (162,159) (23.8) (9,960) (36.8)
Other Direct Consumer 40,927 1,637 8.07 46,949 1,854 7.96 (6,022) (12.8) (217) (11.7)
Other Indirect Consumer 28,081 1,096 7.87 74,309 2,774 7.53 (46,228) (62.2) (1,678) (60.5)
Residential Mortgage 139,463 5,237 7.57 274,046 10,609 7.81 (134,583) (49.1) (5,372) (50.6)
---------- -------- ---------- -------- ---------- ---------
Total Consumer 1,543,829 47,663 6.23 1,801,467 65,954 7.38 (257,638) (14.3) (18,291) (27.7)
Commercial Business 347,124 10,333 6.00 328,545 10,981 6.74 18,579 5.7 (648) (5.9)
Real Estate-Construction 315,339 6,921 4.43 276,104 6,615 4.83 39,235 14.2 306 4.6
Commercial Mortgage 255,111 7,767 6.14 222,690 7,288 6.60 32,421 14.6 479 6.6
Non-Core Syndicated Loans 44,006 819 3.75 73,781 1,716 4.69 (29,775) (40.4) (897) (52.3)
---------- -------- ---------- -------- ---------- ---------
Total Loans 2,505,409 73,503 5.92 2,702,587 92,554 6.91 (197,178) (7.3) (19,051) (20.6)
---------- -------- ---------- -------- ---------- ---------
Loans Held for Sale 10,270 286 5.62 4,523 146 6.51 5,747 127.1 140 95.9
Short-Term Investments 2,389 13 1.10 6,664 65 1.97 (4,275) (64.2) (52) (80.0)
Taxable Investment Securities 2,072,256 47,471 4.62 1,812,666 54,133 6.02 259,590 14.3 (6,662) (12.3)
Tax-Advantaged Investment
Securities 19,089 741 7.83 21,422 830 7.81 (2,333) (10.9) (89) (10.7)
---------- -------- ---------- -------- ---------- ---------
Total Investment
Securities 2,091,345 48,212 4.65 1,834,088 54,963 6.04 257,257 14.0 (6,751) (12.3)
---------- -------- ---------- -------- ---------- ---------
Total Interest-Earning
Assets 4,609,413 122,014 5.34 4,547,862 147,728 6.55 61,551 1.4 (25,714) (17.4)
---------- -------- ---------- -------- ---------- ---------
Less: Allowance for Loan Losses (32,754) (34,303) 1,549 (4.5)
Cash and Due From Banks 108,269 90,857 17,412 19.2
Other Assets 256,722 250,858 5,864 2.3
---------- ---------- ----------
Total Assets $4,941,650 $4,855,274 $ 86,376 1.8
========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Liabilities:
Demand/Money Market Deposits $ 864,829 3,397 0.79 $ 764,346 4,674 1.23 $ 100,483 13.1 (1,277) (27.3)
Savings Deposits 693,698 2,057 0.60 641,045 3,655 1.15 52,653 8.2 (1,598) (43.7)
Direct Time Deposits 739,932 10,345 2.82 845,909 16,423 3.92 (105,977) (12.5) (6,078) (37.0)
Brokered Time Deposits 377,349 11,473 6.13 676,610 21,941 6.54 (299,261) (44.2) (10,468) (47.7)
Short-Term Borrowings 416,127 2,343 1.14 327,961 2,706 1.66 88,166 26.9 (363) (13.4)
Long-Term Debt 1,017,500 19,625 3.89 866,786 25,396 5.91 150,714 17.4 (5,771) (22.7)
---------- -------- ---------- -------- ---------- ---------
Total Interest-Bearing
Liabilities 4,109,435 49,240 2.42 4,122,657 74,795 3.66 (13,222) (0.3) (25,555) (34.2)
---------- -------- ---------- -------- ---------- ---------
Noninterest-Bearing Demand
Deposits 504,417 403,978 100,439 24.9
Other Liabilities 22,590 30,524 (7,934) (26.0)
Common Stockholders' Equity 305,208 298,115 7,093 2.4
---------- ---------- ----------
Total Liabilities and
Stockholders' Equity $4,941,650 $4,855,274 $ 86,376 1.8
========== ========== ==========
Net Interest-Earning Assets $ 499,978 $ 425,205 $ 74,773 17.6
========== ========== ==========
Net Interest Income (tax-equivalent) 72,774 72,933 (159) (0.2)
Less: Tax-Equivalent Adjustment (348) (411) 63 (15.3)
-------- -------- ---------
Net Interest Income $ 72,426 $ 72,522 $ (96) (0.1)
======== ======== =========
Net Yield on Interest-Earning Assets 3.18 % 3.23 %
2003/2002
INCOME/EXPENSE VARIANCE
DUE TO CHANGE IN
----------------------------
(dollars in thousands) AVERAGE AVERAGE
(tax-equivalent basis) RATE VOLUME
----------- -----------
ASSETS
- ------
Interest-Earning Assets:
Home Equity--Direct $ (1,713) $ 611
Marine (2,183) 2,221
Acquired Residential Mortgage (4,172) (5,788)
Other Direct Consumer 24 (241)
Other Indirect Consumer 121 (1,799)
Residential Mortgage (309) (5,063)
Total Consumer
Commercial Business (1,246) 598
Real Estate-Construction (584) 890
Commercial Mortgage (532) 1,011
Non-Core Syndicated Loans (297) (600)
Total Loans
Loans Held for Sale (22) 162
Short-Term Investments (21) (31)
Taxable Investment Securities (13,727) 7,065
Tax-Advantaged Investment Securities 1 (90)
Total Investment Securities
Total Interest-Earning Assets (27,688) 1,974
Less: Allowance for Loan Losses
Cash and Due From Banks
Other Assets
Total Assets
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Liabilities:
Demand/Money Market Deposits (1,832) 555
Savings Deposits (1,877) 279
Direct Time Deposits (4,199) (1,879)
Brokered Time Deposits (1,294) (9,174)
Short-Term Borrowings (985) 622
Long-Term Debt (9,678) 3,907
Total Interest-Bearing Liabilities (25,316) (239)
Noninterest-Bearing Demand Deposits
Other Liabilities
Common Stockholders' Equity
Total Liabilities and Stockholders' Equity
Net Interest-Earning Assets
Net Interest Income (tax-equivalent) $ (2,372) $ 2,213
Less: Tax-Equivalent Adjustment
Net Interest Income
Net Yield on Interest-Earning Assets
25
26
Net interest income on a tax-equivalent basis totaled $37.0 million in the 2003
quarter, compared to $36.1 million in the 2002 quarter. The net interest margin
increased slightly to 3.18% from 3.17% for the prior year. Total interest income
declined $11.9 million, offsetting a corresponding decline in total interest
expense of $12.8 million. Generally, favorable changes in the mix of
interest-bearing liabilities were offset by less than favorable changes in the
mix of interest-earning assets resulting from higher levels of investment
portfolio balances at lower rates.
The yield on earning assets was 5.21% in the 2003 quarter, compared to 6.37% in
the 2002 quarter, a decline of 116 basis points, reflecting the general decline
in interest rates during the period. The $11.9 million decrease in total
interest income was primarily attributable to two factors. First, higher
yielding home equity loans, investments, and marine loans prepaid substantially,
and were replaced with like product at lower yields. Additionally, $261 million
(average balance) of non-core residential mortgages with higher yields prepaid
and were replaced with investment securities at lower yields.
The average rate paid on interest-bearing liabilities declined 126 basis points
to 2.29% in the 2003 quarter, versus 3.55% in the 2002 quarter. The favorable
changes in deposit mix, from higher rate non-core and consumer CDs into lower
rate demand and savings deposits, had a positive impact on interest expense of
$9.3 million. Interest expense on borrowings decreased $3.5 million in the 2003
quarter from the prior year quarter, primarily resulting from the repricing of
floating rate FHLB borrowings throughout the period.
Future growth in net interest income will depend upon consumer and commercial
loan demand, growth in deposits and the general level of interest rates.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $3.3 million for the 2003 quarter, up from
$2.7 million in the 2002 quarter. Loan balances in the 2003 quarter increased
$61 million more than loan balances increased in the 2002 quarter, resulting in
an increased provision. This was partially offset by lower net charge-offs of
$1.8 million in the 2003 quarter compared to $3.1 million in the 2002 quarter.
Net charge-offs declined as a result of a 44% reduction in net charge-offs on
the acquired residential loan portfolio for the current quarter versus the prior
year quarter. On an overall basis, net charge-offs as a percentage of average
loans were 0.28% in the 2003 quarter compared to 0.47% in the 2002 quarter.
NON-INTEREST INCOME
Total non-interest income decreased $3.1 million to $16.4 million in the 2003
quarter compared to the 2002 quarter. Comparing the 2003 quarter to the 2002
quarter, total non-interest income, excluding the net losses described below,
was $23.3 million and $21.7 million, respectively, which represents a 7%
increase from period to period. Exclusive of the net losses, non-interest
income, as a percentage of combined net interest margin and non-interest income,
was 39% and 38% for the 2003 quarter versus the 2002 quarter, respectively.
The improvement in non-interest income continued to be driven by deposit service
charges, which increased $1.5 million, or 8%, to $19.2 million from the 2002
quarter to the 2003 quarter. The increase in deposit fees was primarily the
result of strong consumer and commercial deposit account growth.
A settlement was announced in April 2003 and is in process relating to
litigation between merchants and VISA and MasterCard regarding debit card
interchange reimbursement fees. MasterCard, the Bank's debit card issuer,
announced new debit and credit interchange fees in June 2003. After reviewing
the implications of the new fee schedule, management expects the new interchange
schedule to reduce fee income from retail debit cards by approximately one
third, beginning in August 2003. Based on projected card activation, utilization
and customer purchase volumes, the announced reduction in interchange income
will result in an approximate $2.2 million reduction in debit card income for
the remainder of 2003. To overcome this development, management specifically
identified increases in other fee income, pricing opportunities and expense
reductions that will offset this shortfall. As a result, management expects
little impact to the bottom line in 2003 as a result of the debit card
interchange restructure. The card companies have not yet announced their
interchange structures for 2004. Management continues to assess communications
and projections from Master Card, and is developing strategies and projections
for future periods to address several possible scenarios.
Commissions and fees and other non-interest income were level with the amounts
in the prior year quarter. Commissions and fees were primarily generated from
Provident Investment Company, Inc., which offers annuities and mutual funds
through an affiliation with a securities broker-dealer, as well as property and
casualty insurance products as an agent. Other non-interest income is composed
primarily of prepayment fees generated on early loan payoffs, cash surrender
value income associated with bank-owned life insurance and operating lease
income.
Net losses are composed of security gains and losses, losses from the
extinguishment of debt and gains and losses on sales of loans, foreclosed
property and fixed assets, which occur in the ordinary course of business. The
Corporation recorded $6.9 million in net losses for the 2003 quarter, compared
to net losses of $2.2 million in the same period in 2002. The net losses in 2003
were primarily composed of $15.3 million in losses on the early extinguishment
of $140 million of FHLB borrowings that were partially offset by $7.2 million in
net gains on the sales of
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investment securities and $1.2 million in net gains relating to the favorable
disposition of certain loans, fixed assets and foreclosed property. The net
gains on the sales of securities in the 2003 quarter were the result of
re-balancing the investment portfolio due to the heavy prepayments of
mortgage-backed securities. These net gains, as well as the one-time tax
benefit, discussed below, enabled higher rate FHLB borrowings to be
extinguished.
NON-INTEREST EXPENSE
Non-interest expense increased $2.5 million, or 6.7%, in the 2003 quarter
compared to the comparable 2002 quarter. Approximately 50% of the increase was
directly attributable to the opening of 15 new branches during the last twelve
months, impacting salaries and employee benefits, occupancy and furniture and
fixture expense. The growth in non-interest expense, other than that which was
impacted by branch expansion, was contained to an annual growth rate of less
than 4%. External processing fees increased $309 thousand, or 6.0%, due to
increases in the volume of processing.
INCOME TAXES
Provident recorded a net income tax benefit of $2.6 million on pre-tax income of
$9.6 million for the 2003 quarter. Included in tax expense for the 2003 quarter
is a one-time net benefit of $5.8 million associated with the realization of
accumulated state income tax benefits of $8.9 million. Based on the actual and
projected level of assets and earnings in PB Investment Corporation, a Delaware
subsidiary, relative to projected earnings in the Bank, it has become more
likely than not that the accumulated deferred benefits will be utilized in the
foreseeable future. SFAS No. 109, "Accounting for Income Taxes" provides that,
given the likelihood of utilization, the valuation allowance associated with the
deferred tax benefit is no longer appropriate, resulting in the recognition of
the $5.8 million net tax benefit. This incremental benefit was partially offset
by an additional $325 thousand in state tax expense for the six month
year-to-date period. Without these non-recurring items, the effective tax rate
for the 2003 quarter would have been approximately 32.6%. In future periods the
accrual of additional state tax expense is expected to add approximately 2.5% to
the Corporation's effective tax rate.
In the 2002 quarter, the Corporation recorded $4.5 million of income tax expense
on pre-tax income of $14.9 million, resulting in an effective tax rate of 30.1%.
FOR SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
The Corporation recorded net income of $24.0 million or $.96 per diluted share
for the six months ended June 30, 2003, compared to $21.9 million or $.84 per
diluted share in the prior year.
Tax-equivalent net interest income for the six months of 2003 remained
relatively flat compared to 2002, reflecting a $0.2 million decrease from period
to period. Interest income declined $25.7 million, but was offset by a decline
in interest expense of $25.5 million. Continued implementation of the
Corporation's strategy to reduce non-core assets and liabilities, and focus on
growth in its core banking business, resulted in an increase of $61 million in
average interest-earning assets and a decrease of $13 million average
interest-bearing liabilities during the past year. These shifts, in addition to
the general decline in interest rates, had the effect of maintaining the level
of net interest income while decreasing the net interest margin by 5 basis
points to 3.18% in 2003 from 3.23% in 2002.
The provision for loan losses for the first six months of 2003 was $5.0 million,
a decrease of $1.2 million from the first six months of 2002. Net charge-offs
were $4.1 million in 2003 compared to $6.1 million in 2002, with the majority of
the improvement in the acquired residential loan portfolio. Net charge-offs as a
percentage of average loans were 0.33% in 2003 compared to 0.46% in 2002.
Total non-interest income declined slightly, from $39.6 million for the six
months ended June 30, 2002 to $39.0 million for the six months ended June 30,
2003. Excluding net losses, non-interest income increased 8% to $44.6 million
for the six months in 2003. The major contributor to this increase was deposit
service charges that rose $3.0 million, or 9%, due to increases in the Bank's
retail and commercial deposit customer base. Commissions, loan fees and other
non-interest income were flat for the same periods.
Net losses were $5.6 million for the six months ended June 30, 2003, compared to
net losses of $1.8 million for the six months ended June 30, 2002. Losses of
$15.3 million from the extinguishment of $140 million of FHLB borrowings were
partially offset by net gains on the sales of investment securities of $8.3
million and $1.4 million of net gains on the disposition of loans, fixed assets
and foreclosed property, which occur in the ordinary course of business. The
prior year's net losses were composed primarily of $0.9 million in net security
losses and $1.0 million in losses from the extinguishment of $80 million of
debt.
Non-interest expense of $79.4 million for the six months ended June 30, 2003
increased $5.2 million, or 7%, compared to the same period one year ago,
reflecting the Bank's efforts to contain costs while pursuing its branch
expansion efforts. The majority of the increase was in salaries and employee
benefits, which increased by $2.7 million, or 8%, due primarily to increased
staffing from branch expansion efforts. The remaining $2.5 million of increase
was spread among all categories, and reflects primarily the incremental impacts
of the branch expansion efforts.
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The Corporation recorded income tax expense of $3.0 million in the first six
months of 2003 based on pre-tax income of $27.0 million. Because of the
realization of the state tax benefit in the current year the effective tax rate
of 11.2% is not comparable to the effective tax rate of 31.1% for the same
period of 2002. Exclusive of the tax benefit realized in the current year, the
effective tax rate would have been 32.5%.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding market risk at December 31, 2002, see "Interest
Sensitivity Management" and Note 11 to the Consolidated Financial Statements in
the Corporation's Form 10-K filed with the Securities and Exchange Commission on
March 7, 2003. The market risk of the Corporation has not experienced any
material changes as of June 30, 2003 from December 31, 2002. Additionally, refer
to Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations for additional quantitative and qualitative discussions
about market risk at June 30, 2003.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
------------------------------------------------
The Corporation maintains controls and procedures designed to ensure that
information required to be disclosed in the reports that the Corporation files
or submits under the Securities and Exchange Act of 1934 is recorded, processed,
summarized, and reported within the time periods specified in the rules and
forms of the Securities and Exchange Commission. Under the supervision and with
the participation of the Corporation's management, including the Corporation's
Chief Executive Officer and Chief Financial Officer, the Corporation has
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures within 90 days of the filing date of this quarterly
report, and, based on their evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that these disclosure controls and procedures
are effective.
(b) Changes in Internal Controls
----------------------------
The Corporation made no significant changes in its internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Corporation is involved in various legal actions arising in
the ordinary course of business. All such actions, in the
aggregate, involve amounts that are believed by management to be
immaterial to the financial condition and results of operations
of the Corporation.
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
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 (1)
(3.3) Fourth Amended and Restated By-Laws of Provident
Bankshares Corporation (2)
(3.4) Form of Stock Certificate of Provident Bankshares
Corporation (3)
(4.1) Stockholder Protection Rights Agreement, as amended (4)
(4.2) Indenture of Provident Trust I, relating to the Junior
Subordinated Debentures (5)
(4.3) Amended and Restated Trust Agreement of Provident
Trust I (5)
(4.4) Form of Exchange Capital Security Certificate for
Provident Trust I (5)
(4.5) Form of Exchange Guarantee Agreement of Provident Trust
I, relating to the Exchange of Capital Securities (5)
(4.6) Form of Indenture of Provident Bankshares Corporation
of Provident Trust II, relating to the Junior
Subordinated Debentures (6)
(4.7) Form of Amended and Restated Trust Agreement of
Provident Trust II (6)
(4.8) Form of Guarantee Agreement of Provident Trust II (6)
(11.0) Statement Re: Computation of Per Share Earnings (7)
(31.1) Rule 13a-14(a)/15d-14(a) Certification of Chief
Executive Officer
(31.2) Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer
(32.0) Section 1350 Certifications
(b) Reports on Form 8-K filed with the Securities and Exchange
Commission
On June 4, 2003, the Company furnished a Form 8-K to file a press
release announcing the availability and distribution to analysts of a
slide presentation summarizing certain information regarding the
Company's operating strategies, financial results and results of
operations.
On June 25, 2003, the Company furnished a Form 8-K to communicate
earnings guidance confirming that the Company expected to exceed
consensus analysts earnings estimates of $2.00 per share for the year
2003.
On July 17, 2003, the Company furnished a Form 8-K related to a
press release announcing its financial results for the quarter ended
June 30, 2003, and to file supplemental financial information,
including a comparative analysis of average balances, interest income
and expenses, and interest yields and rates (three months ended June
30, 2003 versus three months ended June 30, 2002), the Company's
unaudited Consolidated Statement of Income for the three and six
months ended June 30, 2003 and the Company's unaudited Consolidated
Statement of Condition at June 30, 2003.
(1) Incorporated by reference from Provident's Registration Statement on
Form S-8 (File No. 333-58881) filed with the Commission on July 10,
1998.
(2) Incorporated by reference from Provident's Quarterly Report on Form
10-Q (File No. 0-16421) for the quarter ended June 30, 2000, filed
with the Commission on May 10, 2000.
(3) Incorporated by reference from Provident's Registration Statement on
Form S-1 (File No. 3315873) filed with the Commission on
July 17, 1987.
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(4) Incorporated by reference from Provident's Form 10-Q (File No.
0-16421) for the quarter ended June 30, 1998, filed with the
Commission on August 14, 1998.
(5) Incorporated by reference from Provident's Registration Statement on
Form S-4 (File No. 333-58959) filed with the Commission on July 13,
1998.
(6) Incorporated by reference from Provident's Registration Statement on
Form S-3 (File No. 333-30678) filed with the Commission on February
18, 2000.
(7) Included in Note 11 to the Unaudited Consolidated Financial Statements
on Page 13 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, 2003 /s/ Gary N. Geisel
------------------
Gary N. Geisel
Chairman and Chief Executive Officer
August 13, 2003 /s/ Dennis A. Starliper
-----------------------
Dennis A. Starliper
Chief Financial Officer
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EXHIBIT INDEX
EXHIBIT DESCRIPTION SEQUENTIAL PAGE NUMBER
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(31.1) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer 33
(31.2) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer 34
(32.0) Section 1350 Certifications 35
32