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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 THE QUARTERLY PERIOD
ENDED SEPTEMBER 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 November 4, 2003, the Registrant had 24,527,039 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
September 30, 2003 and 2002 and December 31, 2002 4
Consolidated Statement of Income - Unaudited
Three and nine month periods ended September 30, 2003 and 2002 5
Consolidated Statement of Cash Flows - Unaudited
Nine month periods ended September 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 16
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 29
Item 4. Required Disclosure 29
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 2. Changes in Securities and Use of Proceeds 30
Item 3. Defaults upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits and Reports on Form 8-K 30
SIGNATURES 32
FORWARD-LOOKING STATEMENTS
This report, as well as other written communications made from time to time by
Provident Bankshares Corporation and its 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
Item 1. Financial Statements
CONSOLIDATED STATEMENT OF CONDITION - UNAUDITED
Provident Bankshares Corporation and Subsidiaries
September 30, December 31, September 30,
(dollars in thousands, except share amounts) 2003 2002 2002
-------------- ------------- --------------
ASSETS:
Cash and due from banks $ 111,659 $ 145,063 $ 158,571
Short-term investments 2,213 3,129 1,964
Mortgage loans held for sale 13,157 8,899 7,421
Securities available for sale 1,970,618 1,993,229 1,916,868
Loans 2,702,255 2,560,563 2,635,325
Less allowance for loan losses 35,006 33,425 34,615
-------------- ------------- --------------
Net loans 2,667,249 2,527,138 2,600,710
-------------- ------------- --------------
Premises and equipment, net 47,975 47,031 45,494
Accrued interest receivable 24,988 28,101 30,520
Intangible assets 9,034 9,340 10,463
Other assets 138,552 128,792 127,161
-------------- ------------- --------------
Total assets $4,985,445 $4,890,722 $4,899,172
============== ============= ==============
LIABILITIES:
Deposits:
Noninterest-bearing $ 576,482 $ 492,661 $ 488,674
Interest-bearing 2,511,424 2,695,305 2,744,741
-------------- ------------- --------------
Total deposits 3,087,906 3,187,966 3,233,415
-------------- ------------- --------------
Short-term borrowings 511,838 539,758 487,485
Long-term debt 1,047,612 814,546 835,141
Accrued expenses and other liabilities 21,428 32,817 31,751
-------------- ------------- --------------
Total liabilities 4,668,784 4,575,087 4,587,792
-------------- ------------- --------------
STOCKHOLDERS' EQUITY:
Common stock (par value $1.00) authorized 100,000,000 shares; issued 32,134,460,
31,737,237 and 31,717,319 shares at September 30,
2003, December 31, 2002 and September 30, 2002, respectively 32,134 31,737 31,717
Additional paid-in capital 297,284 289,698 289,348
Retained earnings 145,265 124,862 116,990
Net accumulated other comprehensive income (loss) (4,689) 14,920 10,438
Treasury stock at cost - 7,651,317, 7,373,601 and 6,983,601
shares at September 30, 2003, December 31, 2002 and
September 30, 2002, respectively (153,333) (145,582) (137,113)
-------------- ------------- --------------
Total stockholders' equity 316,661 315,635 311,380
-------------- ------------- --------------
Total liabilities and stockholders' equity $4,985,445 $4,890,722 $4,899,172
============== ============= ==============
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 Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
(dollars in thousands, except per share data) 2003 2002 2003 2002
------------- -------------- -------------- -------------
INTEREST INCOME:
Loans, including fees $ 37,202 $ 43,309 $ 110,534 $ 135,407
Investment securities 21,187 23,451 68,729 77,723
Tax-advantaged loans and securities 367 469 1,146 1,351
Short-term investments 7 16 20 81
------------- -------------- -------------- -------------
Total interest income 58,763 67,245 180,429 214,562
------------- -------------- -------------- -------------
INTEREST EXPENSE:
Deposits 10,980 19,572 38,252 66,265
Short-term borrowings 1,169 1,911 3,512 4,616
Long-term debt 8,577 10,998 28,202 36,395
------------- -------------- -------------- -------------
Total interest expense 20,726 32,481 69,966 107,276
------------- -------------- -------------- -------------
Net interest income 38,037 34,764 110,463 107,286
Less provision for loan losses 2,950 2,150 7,961 8,400
------------- -------------- -------------- -------------
Net interest income, after provision for loan losses 35,087 32,614 102,502 98,886
------------- -------------- -------------- -------------
NON-INTEREST INCOME:
Service charges on deposit accounts 19,453 18,358 56,018 51,890
Commissions and fees 1,085 1,142 3,545 3,742
Net gains (losses) 746 1,997 (4,899) 186
Other non-interest income 3,339 2,529 8,910 7,843
------------- -------------- -------------- -------------
Total non-interest income 24,623 24,026 63,574 63,661
------------- -------------- -------------- -------------
NON-INTEREST EXPENSE:
Salaries and employee benefits 19,441 18,709 58,003 54,533
Occupancy expense, net 4,023 3,722 11,997 10,776
Furniture and equipment expense 2,988 2,806 8,809 8,144
External processing fees 5,358 5,138 15,901 15,133
Other non-interest expense 7,520 7,096 23,970 23,048
------------- -------------- -------------- -------------
Total non-interest expense 39,330 37,471 118,680 111,634
------------- -------------- -------------- -------------
Income before income taxes 20,380 19,169 47,396 50,913
Income tax expense 7,072 6,029 10,108 15,893
------------- -------------- -------------- -------------
Net income $ 13,308 $ 13,140 $ 37,288 $ 35,020
============= ============== ============== =============
NET INCOME PER SHARE AMOUNTS:
Basic $ 0.54 $ 0.53 $ 1.52 $ 1.40
Diluted 0.53 0.52 1.48 1.36
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
Nine Months Ended
September 30,
---------------------------------
(in thousands) 2003 2002
-------------- --------------
OPERATING ACTIVITIES:
Net income $ 37,288 $ 35,020
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 27,442 26,607
Provision for loan losses 7,961 8,400
Provision for deferred income tax benefit (633) (2,736)
Net losses (gains) 4,899 (186)
Loans originated and held for sale (98,594) (47,536)
Proceeds from sales of loans held for sale 94,939 47,321
Net decrease (increase) in accrued interest receivable and other assets (250) 12,509
Net increase (decrease) in accrued expenses and other liabilities (11,651) 790
-------------- --------------
Total adjustments 24,113 45,169
-------------- --------------
Net cash provided by operating activities 61,401 80,189
-------------- --------------
INVESTING ACTIVITIES:
Principal collections and maturities of securities available for sale 687,232 549,229
Proceeds from sales of securities available for sale 1,027,452 966,669
Purchases of securities available for sale (1,724,512) (1,620,546)
Loan principal collections less originations and purchases (150,980) 129,410
Purchases of premises and equipment (8,326) (6,755)
-------------- --------------
Net cash provided (used) by investing activities (169,134) 18,007
-------------- --------------
FINANCING ACTIVITIES:
Net decrease in deposits (100,060) (122,632)
Net increase (decrease) in short-term borrowings (27,920) 121,164
Proceeds from long-term debt 415,000 95,000
Payments and maturities of long-term debt (196,954) (122,159)
Proceeds from issuance of stock 7,983 5,202
Purchase of treasury stock (7,751) (16,241)
Cash dividends paid on common stock (16,885) (15,779)
-------------- --------------
Net cash provided (used) by financing activities 73,413 (55,445)
-------------- --------------
Increase (decrease) in cash and cash equivalents (34,320) 42,751
Cash and cash equivalents at beginning of period 148,192 117,784
-------------- --------------
Cash and cash equivalents at end of period $ 113,872 $ 160,535
============== ==============
SUPPLEMENTAL DISCLOSURES:
Interest paid, net of amount credited to deposit accounts $ 51,554 $ 77,488
Income taxes paid 6,120 23,283
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
SEPTEMBER 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 nine month periods
ended September 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.
Nine Months Ended
September 30,
---------------------------------
(in thousands, except per share data) 2003 2002
--------------- --------------
NET INCOME:
Net income as reported $ 37,288 $ 35,020
Deduction for total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax effects 801 1,072
--------------- --------------
Pro forma net income $ 36,487 $ 33,948
=============== ==============
BASIC EARNINGS PER SHARE:
As reported $ 1.52 $ 1.40
Pro forma 1.49 1.36
DILUTED EARNINGS PER SHARE:
As reported $ 1.48 $ 1.36
Pro forma 1.45 1.32
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:
Nine Months Ended
September 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 September 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 September 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 September 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.
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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
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 $32 thousand at September 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. In October of 2003, the FASB
deferred the effective date for applying the provisions of Interpretation No. 46
for variable interest entities created before February 1, 2003 or for public
entities which did not previously issue financial statements reporting variable
interest entity in accordance with Interpretation No. 46. The Corporation holds
no significant variable interests in any entities which would require disclosure
or consolidation.
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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
-------------- ------------- ------------- --------------
SEPTEMBER 30, 2003
Securities available for sale:
U.S. Treasury and government
agencies and corporations $ 106,657 $ 2 $ 4,182 $ 102,477
Mortgage-backed securities 1,659,851 11,896 14,827 1,656,920
Municipal securities 18,965 1,063 - 20,028
Other debt securities 181,765 10,216 788 191,193
-------------- ------------- ------------- --------------
Total securities available for sale $1,967,238 $ 23,177 $ 19,797 $1,970,618
============== ============= ============= ==============
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
============== ============= ============= ==============
SEPTEMBER 30, 2002
Securities available for sale:
U.S. Treasury and government
agencies and corporations $ 82,155 $ 1,306 $ - $ 83,461
Mortgage-backed securities 1,645,790 23,362 1,604 1,667,548
Municipal securities 20,692 1,710 - 22,402
Other debt securities 148,016 455 5,014 143,457
-------------- ------------- ------------- --------------
Total securities available for sale $1,896,653 $ 26,833 $ 6,618 $1,916,868
============== ============= ============= ==============
At September 30, 2003, net unrealized gains on securities available for sale,
net of taxes, of $2.2 million were reflected as a component of Net Accumulated
Other Comprehensive Income ("OCI"). This compared to net unrealized gains, net
of taxes, of $12.9 million at September 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
incorporated by reference from the Corporation's 10-K.
Net realized gains on investment securities were $341 thousand for the quarter
ended September 30, 2003 compared to net realized gains of $3.1 million for the
same quarter of 2002. For the nine months ended September 30, 2003, net realized
gains were $8.6 million compared to net realized gains of $2.1 million for the
same period of 2002. These net gains (losses) on investment securities are
included in net gains (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.
September 30, December 31, September 30,
(in thousands) 2003 2002 2002
--------------- -------------- ---------------
Acquired residential mortgage $ 584,886 $ 545,323 $ 599,010
Other consumer 977,758 881,151 873,607
--------------- -------------- ---------------
Total consumer 1,562,644 1,426,474 1,472,617
Commercial business 374,888 376,065 373,646
Residential real estate construction 160,519 119,732 112,438
Commercial real estate construction 201,906 238,344 237,055
Residential real estate mortgage 90,268 168,869 208,304
Commercial real estate mortgage 312,030 231,079 231,265
--------------- -------------- ---------------
Total loans $ 2,702,255 $ 2,560,563 $ 2,635,325
=============== ============== ===============
The following table reflects the activity in the allowance for loan losses for
the periods indicated.
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------------
(in thousands) 2003 2002 2003 2002
-------------- --------------- -------------- ---------------
Balance at beginning of period $ 34,047 $ 34,719 $ 33,425 $ 34,611
Provision for loan losses 2,950 2,150 7,961 8,400
Transfer to other liabilities - - (262) -
Less loans charged-off, net of recoveries:
Acquired residential mortgage 1,346 2,394 4,739 6,862
Other consumer 440 264 963 957
Commercial business 195 (331) 455 635
Residential real estate mortgage 10 65 (39) 97
Commercial real estate mortgage - (138) - (155)
-------------- --------------- -------------- ---------------
Net charge-offs 1,991 2,254 6,118 8,396
-------------- --------------- -------------- ---------------
Balance at end of period $ 35,006 $ 34,615 $ 35,006 $ 34,615
============== =============== ============== ===============
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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 for the period indicated.
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 nine
months ended September 30, 2003 - - - (306) (306)
------------- -------------- ---------------- --------------- -------------
Balance at September 30, 2003 $ 8,314 $ (622) $ 2,600 $ (1,258) $ 9,034
============= ============== ================ =============== =============
NOTE 5 - DEPOSITS
The table below presents deposits as of the periods indicated.
September 30, December 31, September 30,
(in thousands) 2003 2002 2002
------------- ------------- -------------
Noninterest-bearing $ 576,482 $ 492,661 $ 488,674
Money market/demand 889,170 847,966 829,390
Savings 703,318 662,021 654,453
Direct time certificates of deposit 678,504 775,546 805,423
Brokered certificates of deposit 240,432 409,772 455,475
------------- ------------- -------------
Total deposits $3,087,906 $3,187,966 $3,233,415
============= ============= =============
NOTE 6 - SHORT-TERM BORROWINGS
The table below presents short-term borrowings as of the periods indicated.
September 30, December 31, September 30,
(in thousands) 2003 2002 2002
------------- ------------ -------------
Securities sold under repurchase agreements $ 242,790 $ 233,748 $ 305,889
Federal funds purchased 267,000 304,000 179,525
Other short-term borrowings 2,048 2,010 2,071
------------- ------------ -------------
Total short-term borrowings $ 511,838 $ 539,758 $ 487,485
============= ============ =============
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NOTE 7 - LONG-TERM DEBT
The table below presents long-term debt as of the periods indicated.
September 30, December 31, September 30,
(in thousands) 2003 2002 2002
-------------- ------------- -------------
Fixed rate Federal Home Loan Bank advances $ 137,038 $ 292,609 $ 306,323
Varible rate Federal Home Loan Bank advances 766,231 351,826 351,639
Trust preferred securities 75,593 76,986 75,929
Term repurchase agreements 68,750 93,125 101,250
-------------- ------------- -------------
Total long-term debt $1,047,612 $ 814,546 $ 835,141
============== ============= =============
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 $8.5 million and $11.7 million for the nine
months ended September 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 September 30, 2003 and 2002, the Corporation recorded a cumulative
decline in the fair value of derivatives of $4.4 million and $2.5 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 nine months ended September 30,
2003 the Corporation had an ineffective portion of a hedge which resulted in a
$97 thousand charge to earnings. For the nine months ended September 30, 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
- ------------------------------ ------------------------ --------------- --------------- -------------- --------------
SEPTEMBER 30, 2003
Interest rate swaps:
Pay fixed/receive variable Borrowing cost $ 430,000 $ - $ (3,644) $ -
Pay fixed/receive variable Loan rate risk 43,909 - (296) -
Receive fixed/pay variable Borrowing cost 70,000 8,783 8,783 -
Interest rate caps/corridors Borrowing cost 202,000 1,405 1,405 1,503
--------------- --------------- -------------- --------------
$ 745,909 $ 10,188 $ 6,248 $ 1,503
=============== =============== ============== ==============
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
=============== =============== ============== ==============
SEPTEMBER 30, 2002
Interest rate swaps:
Pay fixed/receive variable Deposit/borrowing cost $ 45,000 $ - $ (3,401) $ -
Receive fixed/pay variable Borrowing cost 157,750 11,690 11,690 -
Interest rate caps/corridors Borrowing cost 162,000 - 81 553
--------------- --------------- -------------- --------------
$ 364,750 $ 11,690 $ 8,370 $ 553
=============== =============== ============== ==============
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NOTE 9 - OTHER COMPREHENSIVE INCOME (LOSS)
Presented below is a reconciliation of net income to comprehensive income (loss)
indicating the components of other comprehensive income for the periods
indicated.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -----------------------------
(in thousands) 2003 2002 2003 2002
-------------- -------------- ------------- -------------
Net income $ 13,308 $ 13,140 $ 37,288 $ 35,020
Other comprehensive income (loss):
Gain (loss) on derivatives recognized in
other comprehensive income 415 (1,561) (3,017) (2,842)
Unrealized holding gain (loss) on debt securities (27,119) 21,580 (18,531) 30,952
Less reclassification adjustment for
gains included in net income 341 3,063 8,620 2,118
-------------- -------------- ------------- -------------
Other comprehensive income (loss) before tax (27,045) 16,956 (30,168) 25,992
Income tax (benefit) related to items
of other comprehensive income (9,466) 5,935 (10,559) 9,097
-------------- -------------- ------------- -------------
Other comprehensive income (loss), after tax (17,579) 11,021 (19,609) 16,895
-------------- -------------- ------------- -------------
Comprehensive income (loss) $ (4,271) $ 24,161 $ 17,679 $ 51,915
============== ============== ============= =============
NOTE 10- NET GAINS (LOSSES)
Net gains (losses) include the following components for the periods indicated.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ -------------------------------
(in thousands) 2003 2002 2003 2002
------------- ------------- ------------- --------------
Net gains (losses):
Securities $ 341 $ 3,063 $ 8,620 $ 2,118
Asset sales 405 275 1,779 382
Debt extinguishment - (1,341) (15,298) (2,314)
------------- ------------- ------------- --------------
Net gains (losses) $ 746 $ 1,997 $ (4,899) $ 186
============= ============= ============= ==============
NOTE 11 - PER SHARE INFORMATION
The following table presents a summary of per share data and amounts for the periods indicated.
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
(in thousands, except per share data) 2003 2002 2003 2002
------------- ------------- ------------- -------------
Qualifying net income $ 13,308 $ 13,140 $ 37,288 $ 35,020
Basic EPS shares 24,556 24,840 24,483 25,035
Basic EPS $ 0.54 $ 0.53 $ 1.52 $ 1.40
Dilutive shares 649 653 629 772
Diluted EPS shares 25,205 25,493 25,112 25,807
Diluted EPS $ 0.53 $ 0.52 $ 1.48 $ 1.36
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NOTE 12 - COMMITMENTS AND CONTINGENCIES
COMMITMENTS
The table below presents commitments to extend credit in the form of consumer,
commercial real estate and business loans for the period indicated.
September 30,
(in thousands) 2003
--------------
Commercial business and real estate $ 393,538
Consumer revolving credit 290,112
Residential mortgage credit 16,162
Performance standby letters of credit 53,730
Commercial letters of credit 52
--------------
Total loan commitments $ 753,594
==============
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 $65.8
million and $159.1 million at September 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 $1.5 million and $2.8 million at September 30, 2003 and
2002, respectively. The recourse liability is evaluated periodically for
adequacy. Net charge-offs to the recourse liability amounted to $1.1 million and
$850 thousand for the nine months ended September 30, 2003 and 2002,
respectively. At September 30, 2003, $1.0 million of loans with potential
recourse were 90 days or more past due.
NOTE 13 - RECENT DEVELOPMENTS
On November 3, 2003, the Corporation announced it had reached a definitive
agreement to acquire Southern Financial Bancorp, Inc. ("Southern Financial").
Southern Financial is headquartered in Warrenton Virginia and is the holding
company for Southern Financial Bank. Following its pending acquisition of Essex
Bancorp, Inc., Southern Financial will have approximately $1.5 billion in assets
and operate 33 offices in the Northern Virginia areas of Fairfax, Loudoun and
Prince William Counties as well as Richmond, Charlottesville and the Tidewater
areas. Pursuant to the agreement, Southern Financial will be merged with and
into the Corporation. Shareholders of Southern Financial will receive 1.0875
shares of Corporation common stock and $11.125 in cash for each Southern
Financial share outstanding, subject to possible adjustment under certain
circumstances. The transaction is valued at approximately $330 million, or
$44.50 per common share of the Southern Financial common stock. The transaction,
which is subject to approval by regulatory authorities and the Corporation's and
Southern Financial's shareholders, is expected to close in the second quarter of
calendar year 2004.
The Corporation and Southern Financial will be filing a joint proxy
statement/prospectus and other relevant documents concerning the merger with the
United States Securities and Exchange Commission. The Corporation urges
investors to read the joint proxy statement/prospectus and any other relevant
documents to be filed with the SEC, because they contain important information.
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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 183 ATMs in the Baltimore-Washington corridor of Maryland,
Northern Virginia, and southern York County, Pennsylvania. At September 30,
2003, the branch network consisted of 58 traditional full service branch
locations, 52 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, 58% are located in the Baltimore region and 42% 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
16
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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 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
17
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valuation 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 September 30, 2003, total assets were $5.0 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, and opened
one in-store branch and closed one traditional 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.
Three Months Ended
September 30, $ %
-------------------------------
(dollars in thousands) 2003 2002 Variance Variance
-------------- -------------- ------------- -------------
Investments $ 1,993,040 $ 1,914,305 $ 78,735 4.1 %
Other earning assets 15,404 8,672 6,732 77.6
Core loans:
Consumer 928,730 811,417 117,313 14.5
Commercial business 355,002 343,577 11,425 3.3
Real estate 630,095 524,259 105,836 20.2
-------------- -------------- -------------
Total core loans 1,913,827 1,679,253 234,574 14.0
-------------- -------------- -------------
Non-core loans:
Consumer 694,637 895,848 (201,211) (22.5)
National syndicated loans 31,499 67,103 (35,604) (53.1)
-------------- -------------- -------------
Total non-core loans 726,136 962,951 (236,815) (24.6)
-------------- -------------- -------------
Total loans 2,639,963 2,642,204 (2,241) (0.1)
-------------- -------------- -------------
Total average earning assets $ 4,648,407 $ 4,565,181 $ 83,226 1.8 %
============== ============== =============
Total average earning assets increased by $83 million to $4.6 billion in the
third quarter of 2003 ("the 2003 quarter") compared to the third quarter of 2002
("the 2002 quarter"). While total average loan balances remained flat at $2.6
billion, the mix changed favorably, with a $235 million increase in average core
loan balances offsetting a $237 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 Corporation's expanded presence in the Baltimore-Washington metropolitan
region facilitated the robust 14% growth in average core loans, which comprise
72% of total average loans in the 2003 quarter. The core loan growth of $235
million was evenly split between consumer and commercial loans. Average core
consumer loans, comprised of direct consumer and marine loans, increased $117
million, or 14%, in the 2003 quarter compared to the 2002 quarter. Production of
direct consumer loans, primarily home equity loans and lines generated by the
Bank's retail branches, phone center and Internet unit, totaled $141 million in
the 2003 quarter. This was more than double the production in the 2002 quarter
of $60 million, and was 29% higher than production in the second 2003 quarter.
Average core consumer loan balances from the Washington market grew 33% in the
2003 quarter compared to the 2002 quarter, reflecting the Bank's continued
expansion into that market. The strong production in the current year resulted
in average home equity loan and line balances of $433 million in the 2003
quarter, a $64 million increase from the comparable 2002 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 15%
to $456 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 $117 million, or 14%, in the 2003 quarter
compared to the 2002 quarter. The growth in average core commercial loans
continued to be evenly balanced by region, with growth of 17% in the Washington
market and 11% in the Baltimore market for the 2003 quarter compared to the 2002
quarter.
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Consistent with the execution of its key strategies, the Corporation's average
non-core loan balances continued to decline significantly, decreasing $237
million, or 25%, in the 2003 quarter. The largest component of non-core consumer
loans is the portfolio of acquired residential mortgage loans (consisting of
home equity loans and lines), which declined by $40 million to an average
balance for the quarter of $573 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
$96 million in loans secured by residential real estate, all of which are in
first lien position. Purchases for the current quarter included $24 million in
loans to borrowers residing in the Bank's footprint. Provident will service
these loans and will cultivate additional relationships with the borrowers.
Management intends to continue to purchase residential loans to maintain an
average acquired portfolio size between $500 million and $600 million. The
average balances of other non-core consumer portfolios, consisting of
residential mortgage and indirect auto loan product lines that are no longer
offered by the Bank, declined by $161 million from the 2002 quarter. The
non-core syndicated portfolio average balances declined $36 million, or 53%, in
the 2003 quarter. The remaining $31 million average balances of non-core
syndicated loans represent a diversified portfolio of loans which are performing
as agreed and amortizing according to their terms and conditions.
The growth in the investment portfolio average balances of $79 million in the
2003 quarter compared to the 2002 quarter occurred as excess cash flows were
reinvested into the investment portfolio. Cashflows were predominately invested
in a combination of 15 year conventional MBS and 7/1 hybrid ARMs, as well as
floating rate asset backed securities. Investment portfolio average balances
declined $139 million from the second 2003 quarter to the third 2003 quarter.
ASSET QUALITY
Non-performing assets were $24.2 million at September 30, 2003, or 0.90% of
loans outstanding, slightly improved from the December 31, 2002 level of $24.9
million, or 0.97% and the September 30, 2002 level of $24.5 million, or 0.93%.
At September 30, 2003, $18.5 million of the $20.3 million of total
non-performing loans were 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 in the 2003 quarter.
Total 90-day delinquent loans decreased $3.6 million at September 30, 2003 from
the level at December 31, 2002. In the acquired mortgage portfolio (comprised of
nearly 80% first lien loans), delinquencies have declined consistently, reaching
their lowest level in several years.
As a result of the growth and mix in the commercial and consumer loan
portfolios, the Corporation increased the level of the allowance by $1.6 million
from the December 31, 2002 level to $35.0 million at September 30, 2003. At
September 30, 2003, the allowance represents 1.30% of total loans outstanding
and 172% of non-performing loans. Portfolio-wide net charge-offs represented
0.30% of average loans for the 2003 quarter, continuing to improve from 0.41% in
the December 2002 quarter and 0.34% in the September 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 September 30, 2003 represents its best estimate of probable
losses inherent in the portfolio.
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ASSET QUALITY SUMMARY
September 30, December 31, September 30,
(dollars in thousands) 2003 2002 2002
--------------- -------------- --------------
NON-PERFORMING ASSETS:
Acquired residential mortgage $ 16,122 $ 18,070 $ 16,626
Other consumer 266 460 642
Commercial business 1,810 514 88
Residential real estate construction 134 136 213
Residential real estate mortgage 2,002 1,953 2,776
--------------- -------------- ----------------
Total non-accrual loans 20,334 21,133 20,345
Total renegotiated loans - - -
--------------- -------------- ----------------
Total non-performing loans 20,334 21,133 20,345
Total other assets and real estate owned 3,916 3,796 4,105
--------------- -------------- ----------------
Total non-performing assets $ 24,250 $ 24,929 $ 24,450
=============== ============== ================
90-DAY DELINQUENCIES:
Acquired residential mortgage $ 4,276 $ 5,108 $ 5,601
Other consumer 723 1,023 1,391
Commercial business 380 320 648
Residential real estate mortgage 5,899 8,377 8,099
--------------- -------------- ----------------
Total 90-day delinquencies $ 11,278 $ 14,828 $ 15,739
=============== ============== ================
ASSET QUALITY RATIOS:
Non-performing loans to loans 0.75% 0.83% 0.77%
Non-performing assets to loans 0.90% 0.97% 0.93%
Allowance for loan losses to loans 1.30% 1.31% 1.31%
Net charge-offs in quarter to average loans 0.30% 0.41% 0.34%
Allowance for loan losses to non-performing loans 172.16% 158.16% 170.14%
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21
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.
Three Months Ended
September 30, $ %
------------------------------
(dollars in thousands) 2003 2002 Variance Variance
------------- -------------- ------------- -------------
Core deposits:
Consumer $ 2,365,441 $ 2,333,725 $ 31,716 1.4 %
Commercial 504,287 384,197 120,090 31.3
------------- -------------- -------------
Total core deposits 2,869,728 2,717,922 151,806 5.6
Non-core deposits 282,405 519,125 (236,720) (45.6)
------------- -------------- -------------
Total deposits 3,152,133 3,237,047 (84,914) (2.6)
------------- -------------- -------------
Borrowings:
Federal funds purchased 284,987 199,190 85,797 43.1
FHLB advances 842,317 672,566 169,751 25.2
Repurchase agreements and other 302,489 358,497 (56,008) (15.6)
Trust preferred securities 68,159 68,087 72 0.1
------------- -------------- -------------
Total borrowings 1,497,952 1,298,340 199,612 15.4
------------- -------------- -------------
Total average deposits and borrowings $ 4,650,085 $ 4,535,387 $ 114,698 2.5 %
============= ============== =============
Total average deposit balances decreased $85 million in the 2003 quarter
compared to the 2002 quarter. Average non-core deposits (composed of brokered
CDs) decreased $237 million, or 46%, from matured CDs that were not replaced
with non-core funding. As a result of 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 direct time deposits, which decreased
$132 million from the 2002 quarter to the 2003 quarter, average deposit balances
increased $284 million, or 10%, 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 31%, in
the 2003 quarter, of which $102 million was in non-interest-bearing accounts.
Regionally, core deposits in the Washington market increased 14% and core
deposits in the Baltimore market increased 3%. In the 2003 quarter, average core
deposits comprised 91% of average total deposits.
Average borrowings increased $200 million in the third quarter of 2003 compared
to the 2002 quarter. Average federal funds purchased ("fed funds") increased $86
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 $170 million over 12 months, however FHLB
borrowings declined $73 million from June 30, 2003 to September 30, 2003.
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 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 September 30,
2003, $1.2 billion of secured borrowings were employed, with sufficient
collateral available to immediately raise an additional $619 million. After
covering $303 million of unsecured funds that mature in the next three months,
the excess liquidity position of $316 million is well in excess of projected
liquidity requirements for the next 12 months. Additionally, over $400 million
of assets are maintained as collateral with the Federal Reserve that is
available as a contingent funding source.
21
22
The Bank also has several unsecured funding sources available. At September 30,
2003, the Bank possessed over $800 million of fed funds lines, of which only
$267 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 $75 million in the third quarter of 2003 from the
second quarter of 2003. The unsecured debt markets are also a potential
alternative to raise funds but have not been employed since 2000 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 September 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 $1.6 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 $754 million at September 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 that relies upon the Bank's
performance to generate capital growth through Bank earnings. A portion of the
Bank's earnings is 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.
22
23
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 October 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 September 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 -5.1%
No change -
+100 basis points +1.7%
+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. There is a high correlation
between changes in the 10 year constant maturity swap rate and the 30 year
mortgage rate. Additionally, $544 million notional amount in interest rate swaps
were in force to reduce interest rate risk, and $202 million of interest rate
caps were employed to protect the interest margin from rising interest rates in
the future.
CAPITAL RESOURCES
Total stockholders' equity was $317 million at September 30, 2003, an increase
of $1.0 million from December 31, 2002. The change in stockholders' equity for
the nine months ended September 30, 2003 was attributable to $37.3 million in
earnings and $8.0 million from the issuance of common stock relating to the
exercise of stock options. This was partially offset by dividends paid of $16.9
million and a decrease of $19.6 million in accumulated other comprehensive
income ("OCI"). OCI decreased due primarily to a decline in market value of
available-for-sale securities. Capital was also reduced by $7.8 million from the
repurchase of 277,716 shares of the Corporation's common stock at an average
price of $28.75. The Corporation is authorized to repurchase an additional
722,284 shares under its current authorization.
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
September 30, December 31, Regulatory To be "Well
2003 2002 Requirements Capitalized"
----------------- --------------- ----------------- ---------------
Tier 1 leverage ratio 7.61% 7.47% 4.00% 5.00%
Tier 1 capital to risk-weighted assets 11.99% 11.62% 4.00% 6.00%
Total regulatory capital to risk-weighted assets 13.11% 12.70% 8.00% 10.00%
23
24
RESULTS OF OPERATIONS
FOR THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2002
OVERVIEW
The Corporation recorded net income for the quarter ended September 30, 2003 of
$13.3 million or $.53 per diluted share, with return on average common equity of
16.63% and return on assets of 1.06%. The financial results for the 2003 quarter
compared to the 2002 quarter, represented by increases of 1.3% in net income and
1.9% 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 was comparable to the prior year's third quarter. Increases of $3.3
million in net interest income and a $0.6 million increase in non-interest
income offset increases in provision, non-interest expense and income tax
expense of $0.8 million, $1.9 million and $1.0 million, respectively, compared
to the 2002 quarter. 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.
24
25
Comparative Analysis of Average Balances, Interest Income and Expense and Interest Yields and Rates
----------------------------------------------------------------
Three Months Ended Three Months Ended
September 30, 2003 September 30, 2002
----------------------------------------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
(tax-equivalent basis) Balance Expense Rate Balance Expense Rate
----------- --------- -------------------- --------- ---------
ASSETS
Interest-earning assets:
Home equity $ 433,193 $ 5,395 4.94 % $ 369,341 $ 5,665 6.09 %
Marine 455,867 6,287 5.47 397,002 6,813 6.81
Acquired residential mortgage 573,449 8,972 6.21 613,457 10,967 7.09
Other direct consumer 39,670 773 7.73 45,074 869 7.65
Other indirect consumer 20,085 382 7.55 54,980 1,028 7.42
Residential mortgage 101,103 2,110 8.28 227,411 4,349 7.59
----------- --------- ----------- ---------
Total consumer 1,623,367 23,919 5.85 1,707,265 29,691 6.90
Commercial business 355,002 5,150 5.76 343,577 5,802 6.70
Real estate construction 334,702 3,567 4.23 296,668 3,568 4.77
Commercial mortgage 295,393 4,320 5.80 227,591 3,672 6.40
Non-core SNCs 31,499 278 3.50 67,103 778 4.60
----------- --------- ----------- ---------
Total loans 2,639,963 37,234 5.60 2,642,204 43,511 6.53
----------- --------- ----------- ---------
Loans held for sale 11,912 172 5.73 6,340 107 6.70
Short-term investments 3,492 7 0.80 2,332 16 2.72
Taxable investment securities 1,974,264 21,187 4.26 1,893,581 23,427 4.91
Tax-advantaged investment securities 18,776 331 6.99 20,724 375 7.18
----------- --------- ----------- ---------
Total investment securities 1,993,040 21,518 4.28 1,914,305 23,802 4.93
----------- --------- ----------- ---------
Total interest-earning assets 4,648,407 58,931 5.03 4,565,181 67,436 5.86
----------- --------- ----------- ---------
Less allowance for loan losses (34,472) (34,385)
Cash and due from banks 116,487 97,755
Other assets 254,537 232,236
----------- -----------
Total assets $4,984,959 $4,860,787
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Demand/money market deposits $ 895,396 1,797 0.80 $ 804,225 2,282 1.13
Savings deposits 708,493 680 0.38 657,405 1,772 1.07
Direct time deposits 691,228 4,116 2.36 822,964 7,193 3.47
Brokered time deposits 282,405 4,387 6.16 519,125 8,325 6.36
Short-term borrowings 515,080 1,142 0.88 452,750 1,911 1.67
Long-term debt 982,872 8,604 3.47 845,590 10,998 5.16
----------- --------- ----------- ---------
Total interest-bearing
liabilities 4,075,474 20,726 2.02 4,102,059 32,481 3.14
----------- ---------- ----------- ---------
Noninterest-bearing demand deposits 574,611 433,328
Other liabilities 17,296 28,120
Common stockholders' equity 317,578 297,280
----------- -----------
Total liabilities and
stockholders' equity $4,984,959 $4,860,787
=========== ===========
Net interest-earning assets $ 572,933 $ 463,122
=========== ===========
Net interest income (tax-equivalent) 38,205 34,955
Less tax-equivalent adjustment (168) (191)
--------- ---------
Net interest income $38,037 $ 34,764
========= =========
Net yield on interest-earning assets 3.26 % 3.04 %
2003/2002
Income/Expense Variance
2003/2002 Increase/(Decrease) Due to Change In
---------------------------------------------- -------------------------
(dollars in thousands) Average % Income/ % Average Average
(tax-equivalent basis) Balance Change Expense Change Rate Volume
------------ ------- --------- ----------- ------------ ------------
ASSETS
Interest-earning assets:
Home equity $ 63,852 17.3 % $ (270) (4.8)% $ (1,161) $ 891
Marine 58,865 14.8 (526) (7.7) (1,451) 925
Acquired residential mortgage (40,008) (6.5) (1,995) (18.2) (1,310) (685)
Other direct consumer (5,404) (12.0) (96) (11.0) 9 (105)
Other indirect consumer (34,895) (63.5) (646) (62.8) 17 (663)
Residential mortgage (126,308) (55.5) (2,239) (51.5) 366 (2,605)
------------ ---------
Total consumer (83,898) (4.9) (5,772) (19.4)
Commercial business 11,425 3.3 (652) (11.2) (840) 188
Real estate construction 38,034 12.8 (1) (0.0) (431) 430
Commercial mortgage 67,802 29.8 648 17.6 (368) 1,016
Non-core SNCs (35,604) (53.1) (500) (64.3) (155) (345)
------------ ---------
Total loans (2,241) (0.1) (6,277) (14.4)
------------ ---------
Loans held for sale 5,572 87.9 65 60.7 (17) 82
Short-term investments 1,160 49.7 (9) (56.3) (15) 6
Taxable investment securities 80,683 4.3 (2,240) (9.6) (3,206) 966
Tax-advantaged investment securities (1,948) (9.4) (44) (11.7) (9) (35)
------------ ---------
Total investment securities 78,735 4.1 (2,284) (9.6)
------------ ---------
Total interest-earning assets 83,226 1.8 (8,505) (12.6) (9,715) 1,210
------------ ---------
Less allowance for loan losses (87) 0.3
Cash and due from banks 18,732 19.2
Other assets 22,301 9.6
------------
Total assets $ 124,172 2.6
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Demand/money market deposits $ 91,171 11.3 (485) (21.3) (722) 237
Savings deposits 51,088 7.8 (1,092) (61.6) (1,220) 128
Direct time deposits (131,736) (16.0) (3,077) (42.8) (2,048) (1,029)
Brokered time deposits (236,720) (45.6) (3,938) (47.3) (253) (3,685)
Short-term borrowings 62,330 13.8 (769) (40.2) (1,004) 235
Long-term debt 137,282 16.2 (2,394) (21.8) (3,986) 1,592
------------ ---------
Total interest-bearing liabilities (26,585) (0.6) (11,755) (36.2) (11,546) (209)
------------ ---------
Noninterest-bearing demand deposits 141,283 32.6
Other liabilities (10,824) (38.5)
Common stockholders' equity 20,298 6.8
------------
Total liabilities and
stockholders' equity $ 124,172 2.6
============
Net interest-earning assets $ 109,811 23.7
============
Net interest income (tax-equivalent) 3,250 9.3 $ 1,831 $ 1,419
Less tax-equivalent adjustment 23 (12.0)
---------
Net interest income $ 3,273 9.4
=========
25
26
Net interest income on a tax-equivalent basis totaled $38.2 million in the 2003
quarter, compared to $35.0 million in the 2002 quarter, while the net interest
margin expanded to 3.26% from 3.04%. A decline of $8.5 million in total interest
income was more than offset by a decline in total interest expense of $11.8
million. Generally, favorable changes in the mix of interest-bearing liabilities
offset growth in earning assets at lower yields, primarily in the investment
portfolio. The margin benefited further from a $141 million increase in
noninterest-bearing deposits during the period.
The yield on earning assets was 5.03% in the 2003 quarter, compared to 5.86% in
the 2002 quarter, a decline of 83 basis points, reflecting the general decline
in interest rates during the period. The $8.5 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, $161 million (average
balance) of residential mortgages and indirect consumer loans with higher yields
prepaid and were replaced with investment securities at lower yields.
The average rate paid on interest-bearing liabilities declined 112 basis points
to 2.02% in the 2003 quarter, versus 3.14% in the 2002 quarter. The favorable
changes in deposit mix, from higher rate non-core and retail CDs into lower rate
demand and savings deposits, had a positive impact on deposit interest expense
of $8.6 million. Interest expense on borrowings decreased $3.2 million in the
2003 quarter from the prior year quarter, primarily resulting from the
extinguishment of $140 million of higher rate FHLB borrowings in the second 2003
quarter, and the repricing of floating rate FHLB borrowings throughout the
period.
Future growth in net interest income will primarily 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 $2.9 million for the 2003 quarter, up from
$2.1 million in the 2002 quarter. Loan balances in the 2003 quarter increased
$105 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
$2.0 million in the 2003 quarter compared to $2.3 million in the 2002 quarter.
The 12% decline in net charge-offs resulted from 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 0.30% in the 2003 quarter compared to 0.34% in
the 2002 quarter.
NON-INTEREST INCOME
Total non-interest income increased to $24.6 million in the 2003 quarter from
$24.0 million in the 2002 quarter. Comparing the 2003 quarter to the 2002
quarter, total non-interest income, excluding the net gains described below, was
$23.9 million and $22.0 million, respectively, which represents a 8% increase
from period to period. Exclusive of the net gains, non-interest income, as a
percentage of combined net interest margin and non-interest income, was 39% for
both quarters.
The improvement in non-interest income continued to be driven by deposit service
charges, which increased $1.1 million, or 6%, to $19.5 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. As a result of
the new retail debit card interchange structure, per transaction interchange
revenue was cut by 33% beginning on August 1, 2003. Strong increases in the
average number of active cards and average purchases per card mitigated the
reduced per transaction revenue, and as a result, debit card revenues decreased
only slightly from $2.4 million in the 2002 quarter to $2.2 million for the 2003
quarter.
Commissions and fees of $1.1 million were level with the amounts in the prior
year quarter. Commissions and fees are 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. While the volume of investment sales has
increased, the commission level has decreased, resulting in flat period over
period results. Other non-interest income increased 32% to $3.3 million in the
2003 quarter. Other non-interest income is composed primarily of loan fees (25%
increase), cash surrender value income associated with bank-owned life insurance
(5% decrease) and operating lease income ($172 thousand or 48% increase).
Additionally, the Corporation received $300 thousand in additional income in the
2003 quarter relating to a change in the relationship associated with its
affinity credit card program.
Net gains (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 $746 thousand in net gains for the 2003 quarter, compared
to net gains of $2.0 million in the same period in 2002. The net gains in 2003
were composed of $341 thousand in net gains on the sales of investment
securities and $405 thousand in net gains relating to the favorable disposition
of certain loans, fixed assets and foreclosed property.
26
27
NON-INTEREST EXPENSE
Non-interest expense increased $1.9 million, or 5.0%, in the 2003 quarter
compared to the comparable 2002 quarter. $1.3 million of the increase was
directly attributable to the opening of 13 new branches and 4 ATM Plus locations
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 2%. External processing fees increased $220
thousand, or 4.3%, due to increases in the volume of processing. The expense
associated with the recourse reserve on securitized loans, which is included in
other non-interest expense, increased $191 thousand in the 2003 quarter,
reflecting chargeoff activity in the quarter.
INCOME TAXES
In the 2003 quarter, the Corporation recorded $7.1 million of income tax expense
on pre-tax income of $20.4 million, resulting in an effective tax rate of 34.7%.
In the 2002 quarter, the Corporation recorded $6.0 million of income tax expense
on pre-tax income of $19.2 million, resulting in an effective tax rate of 31.5%.
The change in the effective tax rate in the 2003 quarter is primarily due to
state tax expense which added approximately 2.8% to the Corporation's effective
tax rate.
FOR NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2002
The Corporation recorded net income of $37.3 million or $1.48 per diluted share
for the nine months ended September 30, 2003, compared to $35.0 million or $1.36
per diluted share in the prior year.
Tax-equivalent net interest income for the nine months of 2003 increased 2.9% to
$111.0 million compared to the 2002 period, reflecting a $3.1 million increase
from period to period. Interest income declined $34.2 million, but was offset by
a decline in interest expense of $37.3 million. Average interest-earning assets
increased $69 million while average interest-bearing liabilities decreased $18
million during the past year. The margin benefited further from a $114 million
increase in noninterest-bearing deposits during the period. These shifts, in
addition to the general decline in interest rates, had the effect of increasing
the level of net interest income as well as increasing the net interest margin
by 4 basis points to 3.21% in 2003 from 3.17% in 2002.
27
28
Comparative Analysis of Average Balances, Interest Income and Expense and Interest Yields and Rates
Nine Months Ended Nine Months Ended
September 30, 2003 September 30, 2002
----------------------------------------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
(tax-equivalent basis) Balance Expense Rate Balance Expense Rate
----------- ---------- -------------------- ---------- ---------
ASSETS
Interest-earning assets:
Home equity $ 398,564 $ 15,450 5.18 % $ 363,395 $ 16,866 6.21 %
Marine 441,435 18,832 5.70 374,679 19,320 6.89
Acquired residential mortgage 538,208 26,064 6.47 659,203 38,019 7.71
Other direct consumer 40,504 2,411 7.96 46,318 2,680 7.74
Other indirect consumer 25,386 1,478 7.78 67,795 3,802 7.50
Residential mortgage 126,536 7,347 7.76 258,330 14,958 7.74
----------- ---------- ----------- ----------
Total consumer 1,570,633 71,582 6.09 1,769,720 95,645 7.23
Commercial business 350,167 15,495 5.92 333,611 16,783 6.73
Real estate construction 321,865 10,489 4.36 283,034 10,183 4.81
Commercial mortgage 268,686 12,086 6.01 224,341 10,960 6.53
Non-core SNCs 39,403 1,085 3.68 71,530 2,494 4.66
----------- ---------- ----------- ----------
Total loans 2,550,754 110,737 5.80 2,682,236 136,065 6.78
----------- ---------- ----------- ----------
Loans held for sale 10,823 458 5.66 5,135 253 6.59
Short-term investments 2,760 20 0.97 5,204 81 2.08
Taxable investment securities 2,039,235 68,729 4.51 1,839,933 77,724 5.65
Tax-advantaged investment securities 18,983 1,001 7.05 21,187 1,041 6.57
----------- ---------- ----------- ----------
Total investment securities 2,058,218 69,730 4.53 1,861,120 78,765 5.66
----------- ---------- ----------- ----------
Total interest-earning assets 4,622,555 180,945 5.23 4,553,695 215,164 6.32
----------- ---------- ----------- ----------
Less allowance for loan losses (33,333) (34,331)
Cash and due from banks 111,038 93,181
Other assets 255,987 244,581
----------- -----------
Total assets $4,956,247 $4,857,126
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Demand/money market deposits $ 875,129 5,194 0.79 $ 777,785 6,956 1.20
Savings deposits 698,685 2,737 0.52 646,559 5,427 1.12
Direct time deposits 723,518 14,461 2.67 838,177 23,616 3.77
Brokered time deposits 345,355 15,860 6.14 623,538 30,266 6.49
Short-term borrowings 449,475 3,385 1.01 370,015 4,617 1.67
Long-term debt 1,005,830 28,329 3.77 859,642 36,394 5.66
----------- ---------- ----------- ----------
Total interest-bearing
liabilities 4,097,992 69,966 2.28 4,115,716 107,276 3.48
----------- ---------- ----------- ----------
Noninterest-bearing demand deposits 528,071 413,868
Other liabilities 20,806 29,714
Common stockholders' equity 309,378 297,828
----------- -----------
Total liabilities and
stockholders' equity $4,956,247 $ 4,857,126
=========== ===========
Net interest-earning assets $ 524,563 $ 437,979
=========== ===========
Net interest income
(tax-equivalent) 110,979 107,888
Less tax-equivalent adjustment (516) (602)
---------- ----------
Net interest income $110,463 $107,286
========== ==========
Net yield on interest-earning assets 3.21 % 3.17 %
2003/2002
Income/Expense Variance
2003/2002 Increase/(Decrease) Due to Change In
--------------------------------------------- -------------------------
(dollars in thousands) Average % Income/ % Average Average
(tax-equivalent basis) Balance Change Expense Change Rate Volume
----------- ------- --------- ----------- ------------ ------------
ASSETS
Interest-earning assets:
Home equity $ 35,169 9.7 % $ (1,416) (8.4)% $ (2,949) $ 1,533
Marine 66,756 17.8 (488) (2.5) (3,628) 3,140
Acquired residential mortgage (120,995) (18.4) (11,955) (31.4) (5,574) (6,381)
Other direct consumer (5,814) (12.6) (269) (10.0) 75 (344)
Other indirect consumer (42,409) (62.6) (2,324) (61.1) 140 (2,464)
Residential mortgage (131,794) (51.0) (7,611) (50.9) 41 (7,652)
----------- ---------
Total consumer (199,087) (11.2) (24,063) (25.2)
Commercial business 16,556 5.0 (1,288) (7.7) (2,092) 804
Real estate construction 38,831 13.7 306 3.0 (1,013) 1,319
Commercial mortgage 44,345 19.8 1,126 10.3 (918) 2,044
Non-core SNCs (32,127) (44.9) (1,409) (56.5) (449) (960)
----------- ---------
Total loans (131,482) (4.9) (25,328) (18.6)
Loans held for sale 5,688 110.8 205 81.0 (40) 245
Short-term investments (2,444) (47.0) (61) (75.3) (32) (29)
Taxable investment securities 199,302 10.8 (8,995) (11.6) (16,820) 7,825
Tax-advantaged investment securitie (2,204) (10.4) (40) (3.8) 73 (113)
----------- ---------
Total investment securities 197,098 10.6 (9,035) (11.5)
----------- ---------
Total interest-earning assets 68,860 1.5 (34,219) (15.9) (37,427) 3,208
----------- ---------
Less allowance for loan losses 998 (2.9)
Cash and due from banks 17,857 19.2
Other assets 11,406 4.7
-----------
Total assets $ 99,121 2.0
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Demand/money market deposits $ 97,344 12.5 (1,762) (25.3) (2,553) 791
Savings deposits 52,126 8.1 (2,690) (49.6) (3,097) 407
Direct time deposits (114,659) (13.7) (9,155) (38.8) (6,225) (2,930)
Brokered time deposits (278,183) (44.6) (14,406) (47.6) (1,552) (12,854)
Short-term borrowings 79,460 21.5 (1,232) (26.7) (2,085) 853
Long-term debt 146,188 17.0 (8,065) (22.2) (13,556) 5,491
----------- ---------
Total interest-bearing
liabilities (17,724) (0.4) (37,310) (34.8) (36,850) (460)
----------- ---------
Noninterest-bearing demand deposits 114,203 27.6
Other liabilities (8,908) (30.0)
Common stockholders' equity 11,550 3.9
-----------
Total liabilities and
stockholders' equity $ 99,121 2.0
===========
Net interest-earning assets $ 86,584 19.8
===========
Net interest income
(tax-equivalent) 3,091 2.9 $ (577) $ 3,668
Less tax-equivalent adjustment 86 (14.3)
---------
Net interest income $ 3,177 3.0
=========
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The provision for loan losses for the first nine months of 2003 was $8.0
million, a decrease of $439 thousand from the first nine months of 2002.
Increases in loan balances in 2003 relative to 2002 resulted in an increased
provision, which was more than offset by a reduction of $2.3 million in net
charge-offs. The reduced net charge-offs of $6.1 million in 2003 were
attributable to improvement in the acquired residential loan portfolio. Net
charge-offs as a percentage of average loans were 0.32% in 2003 compared to
0.42% in 2002.
Total non-interest income of $63.6 million for the nine months ended September
30, 2003 was flat to the nine months ended September 30, 2002. However,
excluding net gains (losses), non-interest income increased 8% to $68.5 million
for the nine months in 2003. This increase was primarily the result of deposit
service charges that rose $4.1 million, or 8%, due to increases in the Bank's
retail and commercial deposit customer base. Other non-interest income was $1.1
million higher in 2003 due to increases in loan fees, operating lease income and
mortgage banking fees.
Net losses were $4.9 million for the nine months ended September 30, 2003,
compared to net gains of $200 thousand for the nine months ended September 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 $8.6 million and $1.8 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 gains were composed of $2.1 million in net
security gains and $400 thousand in gains from asset sales partially offset by
$2.3 million in losses from the extinguishment of $90 million of debt.
Non-interest expense of $118.7 million for the nine months ended September 30,
2003 increased $7.0 million, or 6%, 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 $3.5 million, or 6%, due primarily to increased
staffing from branch expansion efforts. The remaining $3.5 million of increase
was spread among all categories, and reflects primarily the incremental impacts
of the branch expansion efforts.
The Corporation recorded income tax expense of $10.1 million in the first nine
months of 2003 based on pre-tax income of $47.4 million. Because of the
realization of the one-time net benefit of $5.8 million associated with the
realization of accumulated state income tax benefits of $8.9 million in the
second quarter of 2003, the effective tax rate of 21.3% is not comparable to the
effective tax rate of 31.2% for the same period of 2002. Exclusive of the tax
benefit realized in the current year, the effective tax rate would have been
32.6%.
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 September 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 September 30, 2003.
Item 4. Required Disclosure
The Corporation's management, including the Corporation's principal executive
officer and principal financial officer, have evaluated the effectiveness of the
Corporation's "disclosure controls and procedures," as such term is defined in
Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended, (the "Exchange Act"). Based upon their evaluation, the principal
executive officer and principal financial officer concluded that, as of the end
of the period covered by this report, the Corporation's disclosure controls and
procedures were effective for the purpose of ensuring that the information
required to be disclosed in the reports that the Corporation files or submits
under the Exchange Act with the Securities and Exchange Commission (the "SEC")
(1) is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and (2) is accumulated and communicated
to the Corporation's management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required
disclosure. In addition, based on that evaluation, no change in the
Corporation's internal control over financial reporting occurred during the
quarter ended September 30, 2003 that has materially affected, or is reasonably
likely to materially affect, the Corporation's internal control over financial
reporting.
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30
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 Securities 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 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.
On September 4, 2003, the Company furnished a Form 8-K related to
a slide presentation. The presentation materials summarize certain
information regarding the Corporation's operating strategies,
financial results and results of operations posted to the
Corporation's website on September 4, 2003.
On October 17, 2003, the Company furnished a Form 8-K related to
a press release announcing its financial results for the quarter ended
September 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
September 30, 2003 versus three months ended September 30, 2002), the
Company's unaudited Consolidated Statement of Income for the three and
nine months ended September 30, 2003 and the Company's unaudited
Consolidated Statement of Condition at September 30, 2003.
On November 4, 2003, the Company furnished a Form 8-K containing
the Agreement and Plan of Reorganization dated November 3, 2003, by
and between Provident Bankshares Corporation ("Provident Bankshares")
and Southern Financial Bancorp, Inc. ("Southern Financial") pursuant
to which Southern Financial will merge with Provident Bankshares.
(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.
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31
(2) Incorporated by reference from Provident's Quarterly Report on Form 10-Q
(File No. 0-16421) for the quarter ended March 31, 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.
(4) Incorporated by reference from Provident's Quarterly Report on 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 14 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
November 12, 2003 /s/ Gary N. Geisel
------------------
Gary N. Geisel
Chairman and Chief Executive Officer
November 12, 2003 /s/ Dennis A. Starliper
-----------------------
Dennis A. Starliper
Chief Financial Officer
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EXHIBIT INDEX
Exhibit Description Sequential Page Number
------- ----------- ----------------------
(31.1) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer 34
(31.2) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer 35
(32.0) Section 1350 Certifications 36
33