================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-16421
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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)
(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 |_|
At April 30, 2004, the Registrant had 24,768,989 shares of $1.00 par value
common stock outstanding.
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2
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page
Item 1. Financial Statements
Consolidated Statements of Condition - Unaudited
March 31, 2004 and 2003 and December 31, 2003 3
Consolidated Statements of Income - Unaudited Three month periods ended
March 31, 2004 and 2003 4
Consolidated Statements of Cash Flows - Unaudited Three month periods
ended March 31, 2004 and 2003 5
Notes to Consolidated Financial Statements - Unaudited 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 30
Item 4. Controls and Procedures 30
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 2. Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities 31
Item 3. Defaults upon Senior Securities 31
Item 4. Submission of Matters to a Vote of Security Holders 31
Item 5. Other Information 32
Item 6. Exhibits and Reports on Form 8-K 32
SIGNATURES 34
1
3
This report, as well as other written communications made from time to time by
Provident Bankshares Corporation and its subsidiaries (the "Corporation")
(including, without limitation, the Corporation's 2003 Annual Report to
Stockholders) and oral communications made from time to time by authorized
officers of the Corporation, may contain statements relating to the future
results of the Corporation (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 Corporation,
including earnings growth determined using accounting principles generally
accepted in the United States of America ("GAAP"); revenue growth in retail
banking, lending and other areas; origination volume in the Corporation'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 Corporation claims the
protection of the safe harbor for forward-looking statements contained in the
PSLRA.
The Corporation 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,
consumer banking revenues, revenues from sales on non-deposit investment
products, origination levels in the Corporation's lending businesses and the
level of defaults, losses and prepayments on loans made by the Corporation,
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 Corporation's operations, pricing, products
and services. The following factors, among others, could cause the actual
results of the Southern Financial Bancorp, Inc. ("Southern Financial")
acquisition to differ materially from the expectations stated in this release,
the associated conference call and web cast and prior statements: the ability to
successfully integrate the companies following the acquisition; the ability to
fully realize the expected cost savings and revenues; and the ability to realize
the expected cost savings and revenues on a timely basis. Readers are cautioned
not to place undue reliance on these forward-looking statements which are made
as of the date of this report, and, except as may be required by applicable law
or regulation, the Corporation 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.
In the event that any non-GAAP financial information is described in any written
communication, please refer to the supplemental financial tables included within
and on our website for the GAAP reconciliation of this information.
2
4
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CONDITION - UNAUDITED
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
March 31, December 31, March 31,
(dollars in thousands, except share amounts) 2004 2003 2003
-------------- ------------- --------------
ASSETS:
Cash and due from banks $ 116,006 $ 127,048 $ 132,005
Short-term investments 1,903 1,137 2,250
Mortgage loans held for sale 5,456 5,016 11,892
Securities available for sale 2,127,047 2,086,510 2,229,246
Loans 2,829,936 2,784,546 2,462,022
Less allowance for loan losses 36,126 35,539 32,562
-------------- ------------- --------------
Net loans 2,793,810 2,749,007 2,429,460
-------------- ------------- --------------
Premises and equipment, net 49,481 49,575 47,461
Accrued interest receivable 25,202 25,413 27,726
Intangible assets 8,830 8,932 9,238
Other assets 141,008 155,210 124,214
-------------- ------------- --------------
Total assets $ 5,268,743 $ 5,207,848 $ 5,013,492
============== ============= ==============
LIABILITIES:
Deposits:
Noninterest-bearing $ 646,765 $ 579,058 $ 560,749
Interest-bearing 2,555,553 2,500,491 2,712,268
-------------- ------------- --------------
Total deposits 3,202,318 3,079,549 3,273,017
-------------- ------------- --------------
Short-term borrowings 555,637 627,861 287,318
Long-term debt 1,136,121 1,153,301 1,098,670
Accrued expenses and other liabilities 30,197 22,372 30,499
-------------- ------------- --------------
Total liabilities 4,924,273 4,883,083 4,689,504
-------------- ------------- --------------
STOCKHOLDERS' EQUITY:
Common stock (par value $1.00) authorized 100,000,000 shares;
issued 32,410,354, 32,213,590 and 31,782,375 shares at March 31,
2004, December 31, 2003 and March 31, 2003, respectively 32,410 32,214 31,782
Additional paid-in capital 303,049 298,928 290,499
Retained earnings 160,385 153,545 131,164
Net accumulated other comprehensive income (loss) 1,959 (6,589) 16,126
Treasury stock at cost - 7,651,317, 7,651,317 and 7,373,601
shares at March 31, 2004, December 31, 2003 and
March 31, 2003, respectively (153,333) (153,333) (145,583)
-------------- ------------- --------------
Total stockholders' equity 344,470 324,765 323,988
-------------- ------------- --------------
Total liabilities and stockholders' equity $ 5,268,743 $ 5,207,848 $ 5,013,492
============== ============= ==============
The accompanying notes are an integral part of these statements.
3
5
CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
Three Months Ended
March 31,
------------------------------
(dollars in thousands, except per share data) 2004 2003
-------------- -------------
INTEREST INCOME:
Loans, including fees $ 36,985 $ 36,826
Investment securities 22,534 24,049
Tax-advantaged loans and securities 342 400
Short-term investments 2 8
-------------- -------------
Total interest income 59,863 61,283
-------------- -------------
INTEREST EXPENSE:
Deposits 8,614 14,373
Short-term borrowings 1,578 1,266
Long-term debt 10,948 10,017
-------------- -------------
Total interest expense 21,140 25,656
-------------- -------------
Net interest income 38,723 35,627
Less provision for loan losses 2,174 1,760
-------------- -------------
Net interest income, after provision for loan losses 36,549 33,867
-------------- -------------
NON-INTEREST INCOME:
Service charges on deposit accounts 18,531 17,321
Commissions and fees 1,224 1,310
Net gains 816 1,247
Other non-interest income 3,012 2,713
-------------- -------------
Total non-interest income 23,583 22,591
-------------- -------------
NON-INTEREST EXPENSE:
Salaries and employee benefits 20,421 18,984
Occupancy expense, net 4,050 4,016
Furniture and equipment expense 3,144 2,866
External processing fees 5,302 5,092
Other non-interest expense 7,910 8,092
-------------- -------------
Total non-interest expense 40,827 39,050
-------------- -------------
Income before income taxes 19,305 17,408
Income tax expense 6,430 5,623
-------------- -------------
Net income $ 12,875 $ 11,785
============== =============
NET INCOME PER SHARE AMOUNTS:
Basic $ 0.52 $ 0.48
Diluted 0.51 0.47
The accompanying notes are an integral part of these statements.
4
6
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
Three Months Ended
March 31,
---------------------------------
(in thousands) 2004 2003
-------------- --------------
OPERATING ACTIVITIES:
Net income $ 12,875 $ 11,785
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 7,246 9,668
Provision for loan losses 2,174 1,760
Provision for deferred income tax (benefit) (917) 3,967
Net gains (816) (1,247)
Loans originated and held for sale (12,497) (26,479)
Proceeds from sales of loans held for sale 12,111 23,645
Net decrease (increase) in accrued interest receivable and other assets 2,339 (150)
Net increase (decrease) in accrued expenses and other liabilities 7,825 (4,409)
-------------- --------------
Total adjustments 17,465 6,755
-------------- --------------
Net cash provided by operating activities 30,340 18,540
-------------- --------------
INVESTING ACTIVITIES:
Principal collections and maturities of securities available for sale 92,899 204,520
Proceeds from sales of securities available for sale 113,042 48,296
Purchases of securities available for sale (227,720) (488,996)
Loan originations and purchases less principal collections (48,090) 94,406
Purchases of premises and equipment (2,532) (2,843)
-------------- --------------
Net cash used by investing activities (72,401) (144,617)
-------------- --------------
FINANCING ACTIVITIES:
Net increase in deposits 122,769 85,051
Net decrease in short-term borrowings (72,224) (252,440)
Proceeds from long-term debt - 295,000
Payments and maturities of long-term debt (17,042) (10,833)
Proceeds from issuance of stock 4,317 846
Cash dividends paid on common stock (6,035) (5,484)
-------------- --------------
Net cash provided by financing activities 31,785 112,140
-------------- --------------
Decrease in cash and cash equivalents (10,276) (13,937)
Cash and cash equivalents at beginning of year 128,185 148,192
-------------- --------------
Cash and cash equivalents at end of period $ 117,909 $ 134,255
============== ==============
SUPPLEMENTAL DISCLOSURES:
Interest paid, net of amount credited to deposit accounts $ 15,518 $ 17,487
Income taxes paid 96 56
The accompanying notes are an integral part of these statements.
5
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
MARCH 31, 2004
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Provident Bankshares Corporation ("the Corporation"), a Maryland corporation, is
the bank holding company for Provident Bank ("the Bank"), a Maryland chartered
stock commercial bank. The Bank serves individuals and businesses in Maryland
and Virginia through a network of banking offices and ATMs in Maryland,
Virginia, and southern York County, Pennsylvania. Related financial services are
offered through its wholly owned subsidiaries. Securities brokerage, investment
management and related insurance services are available through Provident
Investment Company and leases through Court Square Leasing 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 month period ended
March 31, 2004 are not necessarily indicative of the results that may be
expected for any future quarters or for the year ending December 31, 2004. For
further information, refer to the consolidated financial statements and notes
thereto included in the Corporation's Annual Report on Form 10-K for the year
ended December 31, 2003 as filed with the Securities and Exchange Commission.
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The 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 unaudited Consolidated Financial Statements
have been reclassified to conform to the presentation used for the current
period. 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
The Corporation may grant employees and/or directors stock options priced at the
fair market value on the grant date. The granting of these options is considered
stock-based compensation.
6
8
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.
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 compensation for the periods indicated.
Three Months Ended
March 31,
-------------------------------
(in thousands, except per share data) 2004 2003
-------------- --------------
NET INCOME:
Net income as reported $ 12,875 $ 11,785
Deduction for total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax effects 250 239
-------------- --------------
Pro forma net income $ 12,625 $ 11,546
============== ==============
BASIC EARNINGS PER SHARE:
As reported $ 0.52 $ 0.48
Pro forma 0.51 0.47
DILUTED EARNINGS PER SHARE:
As reported $ 0.51 $ 0.47
Pro forma 0.50 0.46
The weighted average fair value of all of the options granted during the periods
indicated have been estimated using the Black-Scholes option-pricing model with
the following assumptions:
Three Months Ended
March 31,
--------------------------------
2004 2003
-------------- --------------
Dividend yield 3.33% 3.63%
Weighted average risk-free interest rate 3.20% 3.14%
Weighted average expected volatility 25.86% 25.31%
Weighted average expected life in years 7.00 7.02
RECENTLY ADOPTED ACCOUNTING PRINCIPLES
In December 2003, the FASB issued Statement of Financial Accounting Standards
No. 132 (revised 2003), "Employer's Disclosures about Pensions and Other
Postretirement Benefits" ("SFAS No. 132") effective for fiscal years ending
after December 15, 2003. SFAS No. 132 revises annual and interim disclosures
about pension plans and other postretirement benefit plans. It does not change
the measurement or recognition of those plans. SFAS No. 132 requires additional
disclosures about plan assets, obligations, cash flows and net periodic benefit
cost of deferred benefit plans. The adoption of SFAS No. 132 did not have any
impact on the Corporation's earnings, financial condition or equity. The
required interim disclosures are included in Note 13 in this 10-Q.
7
9
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which addresses how a business
enterprise should evaluate whether it has a controlling financial interest in an
entity through means other than voting rights and accordingly should consolidate
the entity. FIN 46 Revised ("FIN 46R"), issued in December 2003, replaces FIN
46. FIN 46R requires public entities to apply FIN 46 or FIN 46R to all entities
that are considered special-purpose entities in practice and under the FASB
literature that was applied before the issuance of FIN 46 by the end of the
first reporting period that ends after December 15, 2003. For any variable
interest entities ("VIE") that must be consolidated under FIN 46R, the assets,
liabilities and noncontrolling interests of the VIE initially would be measured
at their carrying amounts with any difference between the net amount added to
the statement of condition and any previously recognized interest being
recognized as the cumulative effect of an accounting change. If determining the
carrying amounts is not practicable, fair value at the date FIN 46R first
applies may be used to measure the assets, liabilities and noncontrolling
interest of the VIE. The adoption of FIN 46R did not have a material impact on
the Corporation's consolidated earnings, financial condition, or equity, nor has
there been any additional requirement for disclosure.
In November 2003, the Emerging Issues Task Force ("EITF") of the FASB issued
EITF Abstract 03-1, "The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments" ("EITF 03-1") effective for fiscal years
ending after December 15, 2003. This abstract provides guidelines on the meaning
of other-than-temporary impairment and its application to investments, in
addition to requiring quantitative and qualitative disclosures in the financial
statements. In March 2004, the EITF issued a Consensus on Issue 03-1 (the
"Consensus") requiring that the provisions of EITF 03-1 be applied to
cost-method investments for annual periods ending after June 30, 2004. The
Consensus also requires several additional disclosures for cost-method
investments. The Corporation has not yet determined the impact that this
Consensus will have on its financial statements.
FUTURE CHANGES IN ACCOUNTING PRINCIPLES
In December 2003, the Accounting Standards Executive Committee ("AcSEC") issued
Statement of Position 03-3, "Accounting for Certain Loans or Debt Securities
Acquired in a Transfer" ("SOP 03-3"). SOP 03-3 is effective for loans acquired
in fiscal years beginning after December 15, 2004. The SOP addresses accounting
for differences between contractual cash flows and cash flows expected to be
collected from an investor's initial investment in loans or debt securities
acquired in a transfer if those differences are attributable, at least in part,
to credit quality. The SOP does not apply to loans originated by the Bank. The
Corporation is evaluating the operational requirements of implementation and
plans to adopt the provisions beginning January 1, 2005.
In December 2003, The Medicare Prescription Drug, Improvement and Modernization
Act of 2003 (the "Act") was passed by Congress and signed into law. The Act
introduces a prescription drug benefit under Medicare as well as a federal
subsidy to sponsors of retiree health care benefit plans that is at least
actuarially equivalent to Medicare. At the same time, the FASB issued FASB Staff
Position 106-1 ("FSP 106-1") regarding Accounting and Disclosure Requirements
Related to the Act, which is effective for financial statements of fiscal years
ending after December 7, 2003. FSP 106-1 provides that the sponsor of a
post-retirement health care plan that provides a prescription drug benefit may
make a one-time election to defer accounting for the effects of the Act. The
Corporation made this election. Once authoritative guidance is issued,
management will evaluate the impact on the Corporation.
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NOTE 2--INVESTMENT SECURITIES
The following table presents the aggregate amortized cost and fair values of the
available for sale securities portfolio as of the dates indicated:
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gains Losses Value
-------------- ------------- ------------- --------------
MARCH 31, 2004
Securities available for sale:
U.S. Treasury and government agencies and corporations $ 115,270 $ 1 $ 3,184 $ 112,087
Mortgage-backed securities 1,712,373 14,534 7,605 1,719,302
Municipal securities 16,412 851 - 17,263
Other debt securities 267,164 11,396 165 278,395
-------------- ------------- ------------- --------------
Total securities available for sale $ 2,111,219 $ 26,782 $ 10,954 $2,127,047
============== ============= ============= ==============
DECEMBER 31, 2003
Securities available for sale:
U.S. Treasury and government agencies and corporations $ 115,837 $ 1 $ 5,206 $ 110,632
Mortgage-backed securities 1,746,373 9,893 19,226 1,737,040
Municipal securities 17,326 900 - 18,226
Other debt securities 211,640 9,699 727 220,612
-------------- ------------- ------------- --------------
Total securities available for sale $ 2,091,176 $ 20,493 $ 25,159 $2,086,510
============== ============= ============= ==============
MARCH 31, 2003
Securities available for sale:
U.S. Treasury and government agencies and corporations $ 68,310 $ 219 $ 64 $ 68,465
Mortgage-backed securities 1,981,418 28,625 354 2,009,689
Municipal securities 19,245 1,205 - 20,450
Other debt securities 126,058 6,515 1,931 130,642
-------------- ------------- ------------- --------------
Total securities available for sale $ 2,195,031 $ 36,564 $ 2,349 $2,229,246
============== ============= ============= ==============
At March 31, 2004, a net unrealized after-tax gain of $10.3 million on the
securities portfolio was reflected in Net Accumulated Other Comprehensive Income
("OCI"). This compared to a net unrealized after-tax gain of $22.2 million at
March 31, 2003 and a net unrealized after-tax loss of $3.0 million at December
31, 2003. For further details regarding investment securities at December 31,
2003, 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 $954 thousand for the quarter
ended March 31, 2004 compared to net realized gains of $1.1 million for the same
quarter of 2003. The net gains are included in Net Gains in the Consolidated
Statements of Income.
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NOTE 3--LOANS AND ALLOWANCE FOR LOAN LOSSES
A summary of loans outstanding as of the dates indicated is shown in the table
below.
March 31, December 31, March 31,
(in thousands) 2004 2003 2003
--------------- -------------- ---------------
Acquired residential mortgage $ 598,517 $ 611,157 $ 500,487
Residential real estate mortgage 71,854 78,164 140,208
Other consumer:
Home equity 536,244 505,465 376,795
Marine 461,200 464,474 429,689
Other 40,766 49,721 68,221
--------------- -------------- ---------------
Total consumer 1,708,581 1,708,981 1,515,400
Commercial business 407,599 386,603 364,403
Residential real estate construction 171,864 161,932 131,872
Commercial real estate construction 219,287 208,594 196,247
Commercial real estate mortgage 322,605 318,436 254,100
--------------- -------------- ---------------
Total loans $ 2,829,936 $ 2,784,546 $ 2,462,022
=============== ============== ===============
The following table reflects the activity in the allowance for loan losses for the periods indicated:
Three Months Ended
March 31,
--------------------------------
(in thousands) 2004 2003
-------------- ---------------
Balance at beginning of period $ 35,539 $ 33,425
Provision for loan losses 2,174 1,760
Transfer to other liabilities - (262)
Less loans charged-off, net of recoveries:
Acquired residential mortgage 1,236 1,898
Residential real estate mortgage - (49)
Other consumer 44 390
Commercial business 307 122
-------------- ---------------
Net charge-offs 1,587 2,361
-------------- ---------------
Balance at end of period $ 36,126 $ 32,562
============== ===============
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. Under the provisions of SFAS No.
142 which the Corporation adopted in 2002, the Corporation ceased amortization
of goodwill. 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.
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12
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, 2003 $ 8,314 $ (622) $ 2,600 $ (1,360) $ 8,932
Amortization expense for the three
months ended March 31, 2004 - - - (102) (102)
------------- -------------- ---------------- --------------- -------------
Balance at March 31, 2004 $ 8,314 $ (622) $ 2,600 $ (1,462) $ 8,830
============= ============== ================ =============== =============
NOTE 5--DEPOSITS
The table below presents a summary of deposits as of the dates indicated:
March 31, December 31, March 31,
(in thousands) 2004 2003 2003
------------- ------------- -------------
Noninterest-bearing $ 646,765 $ 579,058 $ 560,749
Money market/demand 948,298 912,247 893,179
Savings 731,248 701,524 697,492
Direct time certificates of deposit 663,488 655,563 743,757
Brokered certificates of deposit 212,519 231,157 377,840
------------- ------------- -------------
Total deposits $3,202,318 $3,079,549 $3,273,017
============= ============= =============
NOTE 6--SHORT-TERM BORROWINGS
The table below presents a summary of short-term borrowings as of the dates indicated:
March 31, December 31, March 31,
(in thousands) 2004 2003 2003
------------- ------------ -------------
Securities sold under repurchase agreements $ 273,561 $ 240,798 $ 224,725
Federal funds purchased 140,000 245,000 60,575
Federal Home Loan Bank advances-variable rate 140,000 140,000 -
Other short-term borrowings 2,076 2,063 2,018
------------- ------------ -------------
Total short-term borrowings $ 555,637 $ 627,861 $ 287,318
============= ============ =============
11
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NOTE 7--LONG-TERM DEBT
The table below presents a summary of long-term debt as of the dates indicated:
March 31, December 31, March 31,
(in thousands) 2004 2003 2003
-------------- -------------- --------------
Federal Home Loan Bank advances-fixed rate $ 127,038 $ 138,540 $ 288,894
Federal Home Loan Bank advances-variable rate 810,000 809,517 646,893
Trust preferred securities 145,725 144,619 77,883
Term repurchase agreements 53,358 60,625 85,000
-------------- -------------- --------------
Total long-term debt $1,136,121 $1,153,301 $1,098,670
============== ============== ==============
NOTE 8--DERIVATIVE FINANCIAL INSTRUMENTS
Fair value hedges that 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 $7.6 million and $13.4 million for the three month periods
ended March 31, 2004 and 2003, respectively. Cash flow hedges have the effective
portion of changes in the fair value of the derivative recorded in other
comprehensive income. At March 31, 2004 and 2003, the Corporation recorded a
cumulative decline in the fair value of derivatives of $8.3 million and $3.6
million, respectively, net of taxes, in accumulated other comprehensive income
to reflect the effective portion of cash flow hedges. Amounts recorded in other
comprehensive income are recognized into earnings concurrent with the impact of
the hedged item on earnings. For the three months ended March 31, 2004 and 2003,
the Corporation had no ineffective portions of hedges.
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The table below presents the Corporation's open derivative positions as of the dates indicated:
(in thousands) Notional Credit Risk Market
Derivative Type Hedge Objective Amount Amount Risk
- ------------------------------------ --------------------------- ----------------- ---------------- ----------------
MARCH 31, 2004
Interest rate swaps:
Pay fixed/receive variable Borrowing cost $ 510,000 $ - $ (8,087)
Pay fixed/receive variable Loan rate risk 47,438 - (956)
Receive fixed/pay variable Borrowing cost 70,000 8,597 8,597
Interest rate caps/corridors Borrowing cost 400,000 4,215 4,215
----------------- ---------------- ----------------
$ 1,027,438 $ 12,812 $ 3,769
================= ================ ================
December 31, 2003
Interest rate swaps:
Pay fixed/receive variable Borrowing cost $ 510,000 $ - $ (2,455)
Pay fixed/receive variable Loan rate risk 50,442 148 148
Receive fixed/pay variable Borrowing cost 70,000 6,667 6,667
Interest rate caps/corridors Borrowing cost 400,000 6,472 6,472
----------------- ---------------- ----------------
$ 1,030,442 $ 13,287 $ 10,832
================= ================ ================
MARCH 31, 2003
Interest rate swaps:
Pay fixed/receive variable Deposit/Borrowing cost $ 320,000 $ - $ (5,718)
Receive fixed/pay variable Borrowing cost 157,750 13,401 13,401
Interest rate caps/corridors Borrowing cost 162,000 13 13
----------------- ---------------- ----------------
$ 639,750 $ 13,414 $ 7,696
================= ================ ================
NOTE 9--OFF BALANCE SHEET RISK
Commitments to extend credit in the form of consumer, commercial real estate and
business loans at the date indicated were as follows:
March 31,
(in thousands) 2004
-------------
Commercial business and real estate $ 474,899
Consumer revolving credit 388,295
Residential mortgage credit 17,286
Performance standby letters of credit 72,923
Commercial letters of credit 414
------------
Total loan commitments $ 953,817
============
Historically, many of the commitments expire without being fully drawn;
therefore, the total commitment amounts do not necessarily represent future cash
requirements.
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NOTE 10--NET GAINS
Net gains include the following components for the periods indicated:
Three Months Ended
March 31,
-------------------------------
(in thousands) 2004 2003
------------- --------------
Net gains:
Securities $ 954 $ 1,125
Asset sales (138) 122
------------- --------------
Net gains $ 816 $ 1,247
============= ==============
NOTE 11--EARNINGS PER SHARE
The following table presents a summary of per share data and amounts for the
periods indicated.
Three Months Ended
March 31,
-----------------------------
(in thousands, except per share data) 2004 2003
------------- -------------
Qualifying net income $ 12,875 $ 11,785
Basic EPS shares 24,664 24,384
Basic EPS $ 0.52 $ 0.48
Dilutive shares 686 670
Diluted EPS shares 25,350 25,054
Diluted EPS $ 0.51 $ 0.47
NOTE 12--OTHER COMPREHENSIVE INCOME
Presented below is a reconciliation of net income to comprehensive income
including the components of other comprehensive income for the periods
indicated.
Three Months Ended
March 31,
-----------------------------
(in thousands) 2004 2003
------------- -------------
Net income $ 12,875 $ 11,875
Other comprehensive income (loss):
Net unrealized loss on derivatives (7,343) (1,829)
Net unrealized holding gain on debt securities 21,447 4,809
Less reclassification adjustment for gains realized in net income 954 1,125
------------- -------------
Other comprehensive income before tax 13,150 1,855
Related income tax expense 4,602 649
------------- -------------
Other comprehensive income, after tax 8,548 1,206
------------- -------------
Comprehensive income $ 21,423 $ 13,081
============= =============
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NOTE 13--EMPLOYEE BENEFIT PLANS
The actuarially estimated net benefit cost includes the following components for
the periods indicated:
Pension Plan Postretirement Benefits
---------------------------- ---------------------------
Three Months Ended Three Months Ended
March 31, March 31,
---------------------------- ---------------------------
(in thousands) 2004 2003 2004 2003
------------- ------------- ------------- ------------
Service cost - benefits earned during the period $ 293 $ 523 $ 26 $ 57
Interest cost on projected benefit obligation 374 666 18 39
Expected return on plan assets (430) (767) - -
Net amortization and deferral of loss 48 86 9 19
------------- ------------- ------------- ------------
Net pension cost included in employee benefits expense $ 285 $ 508 $ 53 $ 115
============= ============= ============= ============
During 2003, the Corporation contributed $11.1 million to the pension plan.
Management meets periodically with the trustees of the plan to review asset
values, performance of the plan's investments and the assessment of the benefit
obligation. Combining these factors in addition to the expected future
performance of the plan assets, management may determine that additional funding
of the plan would be prudent. Future contributions may occur based upon the
value of the plan assets as compared to the projected benefit obligation. The
Corporation currently can contribute an additional $6.4 million under ERISA
guidelines.
NOTE 14--RECENT DEVELOPMENTS
Effective May 1, 2004, the Corporation completed its acquisition of Southern
Financial Bancorp, Inc. ("Southern Financial"). Southern Financial was the
holding company for Southern Financial Bank and Essex Savings Bank, F.S.B.
Southern Financial had approximately $1.5 billion in assets and operated 33
offices in the northern Virginia counties of Fairfax, Loudoun and Prince
William; as well as Richmond, Charlottesville and the Tidewater areas.
Shareholders of Southern Financial received 1.0875 shares of Corporation common
stock and $11.125 in cash for each Southern Financial share outstanding. The
Corporation issued approximately 8.2 million shares and paid $83.8 million to
the former shareholders of Southern Financial.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Provident Bankshares Corporation ("the Corporation"), a Maryland corporation, is
the bank holding company for Provident Bank ("Provident" or "the Bank"), a
Maryland chartered stock commercial bank. At March 31, 2004, the Bank was the
second largest independent commercial bank, in asset size, headquartered in
Maryland, with $5.3 billion in assets.
Provident's principal business is to acquire deposits from individuals and
businesses and to use these deposits to fund loans to individuals and
businesses. Provident focuses on providing its products and services to three
segments of customers - individuals, small businesses and middle market
businesses. The Corporation offers consumer and commercial banking products and
services through the Retail Banking group and the Commercial Banking group.
Provident also offers related financial services through wholly owned
subsidiaries. Securities brokerage, investment management and related insurance
services are available through Provident Investment Company ("PIC") and leases
through Court Square Leasing and Provident Lease Corporation.
Retail banking services include a broad array of consumer and small business
loan, lease, deposit and investment products offered to retail and commercial
customers through Provident's banking office network and ProvidentDirect, the
Bank's direct channel sales center that serves consumers via the Internet and
in-bound and out-bound telephone operations. The small business segment is
further supported by relationship managers who provide comprehensive business
product and sales support to expand existing customer relationships and acquire
new clients.
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Commercial Banking provides an array of commercial financial services to middle
market commercial customers. The Bank has an experienced team of loan officers
with expertise in real estate and business lending to companies in various
industries in the region. The Bank has a highly regarded suite of cash
management products managed by responsive account teams that deepen customer
relationships through consistently priced deposit based services.
The cornerstone of the Bank's ability to serve its customers is its banking
office network, which consists of 59 traditional banking office locations and 59
in-store banking offices at March 31, 2004. Of the 118 banking offices, 57% are
located in the Baltimore metropolitan region and 43% are located in the
Virginia/Washington D.C. metropolitan region, reflecting the successful
migration of the Bank from a Baltimore-based thrift to a highly competitive
regional commercial bank.
Provident also offers its customers 24-hour banking services through ATMs,
telephone banking and the Internet. The network of 192 ATMs enhances the banking
office network by providing customers increased opportunities to access their
funds. In first quarter 2004, the ATM network continued its expansion into new
markets by adding 9 new locations.
With banking offices and ATMs throughout most of Maryland and a growing presence
in Virginia, Provident serves one of the most vibrant regions in the country.
Maryland's economy is performing at or above national levels, based on the most
current data on unemployment and office space absorption. To complement its
presence in the attractive Maryland market, Provident has expanded into
Virginia, particularly northern Virginia, which is the fastest growing area in
Virginia and is home to nearly two million people.
Provident is well positioned in its region to provide the products and services
of its largest competitors, while delivering the level of service provided by
the best community banks. Over the past three years the Corporation's focus has
been on the consistent execution of a group of fundamental business strategies:
o to broaden presence and customer base in the Virginia and metropolitan
Washington markets;
o to grow commercial business in all of its markets;
o to focus resources in core business lines; and
o to improve financial fundamentals.
Supporting Provident's key business strategy to increase its presence and market
share in the Virginia and metropolitan Washington markets, in late 2003, the
Corporation announced a strategic acquisition of Southern Financial Bancorp,
Inc. of Warrenton, Virginia ("Southern Financial"). The acquisition of Southern
Financial will add 33 well-located branches in the Northern and Central Virginia
markets. It will also fulfill the Bank's strategy to enhance its consumer and
commercial business lines, as Southern Financial's commercial banking strength
will be combined with Provident's proven ability to attract consumer loans and
low cost deposits. All required regulatory approvals were received and the
transaction closed on April 30, 2004. The Corporation expects to convert
Southern's customer base to Provident's operating systems in late May.
FINANCIAL REVIEW AND CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The principal objective of this Financial Review is to provide an overview of
the financial condition and results of operations of Provident Bankshares
Corporation and its subsidiaries for the periods indicated. This discussion and
tabular presentations should be read in conjunction with the accompanying
Unaudited Consolidated Financial Statements and Notes as well as the other
information herein.
Discussion and analysis of the financial condition and results of operations are
based on the consolidated financial statements of the Corporation, which are
prepared in accordance with 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 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. Management evaluates estimates on an
on-going basis and believes the following critical accounting policies affect
its more significant judgments and estimates used in preparation of its
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consolidated financial statements: allowance for loan losses, other than
temporary impairment of investment securities, asset prepayment rates and income
taxes. Each estimate and its financial impact, 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 or that actual results may
differ from these estimates under different assumptions or conditions, resulting
in a change that could be material to the Corporation's Consolidated Financial
Statements.
FINANCIAL CONDITION
At March 31, 2004, total assets were $5.3 billion, up from $5.0 billion at March
31, 2003. The Corporation continued to evolve 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, while non-core loan and deposit
balances continued to decline. In first quarter 2004, average core loans
represented 74% of total average loans and average core deposits represented 93%
of total average deposits, evidencing the substantial progress made in the
transition to a core-based balance sheet.
LENDING
Total average loan balances increased to $2.8 billion, driven by a $345 million
increase in average core loan balances in first quarter 2004 compared to first
quarter 2003. The following table summarizes the composition of the Bank's
average loans for the periods indicated.
Three Months Ended
March 31,
------------------------------- $ %
(dollars in thousands) 2004 2003 Variance Variance
------------- -------------- -------------- -------------
Core loans:
Consumer $ 1,017,510 $ 845,071 $ 172,439 20.4
Commercial business 386,264 342,097 44,167 12.9
Real estate 689,700 561,086 128,614 22.9
------------- -------------- --------------
Total core loans (1) 2,093,474 1,748,254 345,220 19.7
------------- -------------- --------------
Non-core loans:
Consumer 688,572 701,449 (12,877) (1.8)
National syndicated loans 28,008 49,845 (21,837) (43.8)
------------- -------------- --------------
Total non-core loans 716,580 751,294 (34,714) (4.6)
------------- -------------- --------------
Total avearge loans $ 2,810,054 $ 2,499,548 $ 310,506 12.4
============= ============== ==============
Core loans as a % of total loans 74% 70%
(1)Management defines core loans as all currently marketed loans originated by
the Bank and participations within the Bank's defined market area.
The Corporation has focused its lending efforts on the generation of core loans
that are of higher, more predictable credit quality at higher spreads.
Management believes this leads to customers who are more likely to utilize the
Bank's other products and services, resulting in longer term, more profitable
relationships.
Provident's expanded presence in the Baltimore-Washington metropolitan regions
helped achieve the 20% growth in average core loans. The average core loan
growth of $345 million was evenly split between consumer and commercial loans,
maintaining the balanced mix between the two product segments.
Average core consumer loans, comprised of direct consumer and marine loans,
increased $172 million, or 20%, in first quarter 2004 versus the same quarter of
the prior year. Strong production of direct consumer loans, primarily home
equity loans and lines generated by the Bank's retail banking offices, phone
center and Internet unit in the past twelve months resulted in a $138 million,
or 33%, net increase in direct consumer loans to $554 million. Marine loans,
which are originated indirectly through brokers but underwritten individually by
the Bank, also had strong performance in the
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quarter, with average marine loan balances up 8% to $464 million compared to
March 31, 2003 balances. Average core consumer loan balances from the Washington
market grew 72% in first quarter 2004 versus 2003, reflecting the Bank's
continued expansion into that market.
Average core commercial business, real estate construction and commercial
mortgage loans also continued to show steady growth, evidenced by an increase of
$173 million, or 19%, in first quarter 2004 compared to first quarter 2003.
During the same time period, the growth in average core commercial loans was
evenly balanced by region, with growth of 16% in the Washington market and 21%
in the Baltimore market.
Consistent with the execution of its key strategies, the Corporation's average
non-core loan balances continued to represent a smaller percentage of total
loans, falling to 26% of total average loans in first quarter 2004. The largest
component of non-core loans is the portfolio of acquired residential mortgage
loans (consisting of first mortgages, home equity loans and lines), that had an
average balance of $604 million in the first quarter 2004. Over the past several
years, for new acquisitions the Bank has increased its credit quality
requirements and shifted its lien position focus from predominantly second lien
position to entirely first lien position. All of the purchases in 2002 and 2003
were in first lien position and at March 31, 2004, 75% of the acquired portfolio
was in first lien position. Although the Corporation did not purchase any loans
in first quarter 2004, management intends to continue to purchase residential
loans to maintain an average acquired portfolio size between $500 million and
$600 million.
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ASSET QUALITY
The following table presents information with respect to non-performing assets
and 90-day delinquencies as of the dates indicated.
March 31, December 31, March 31,
(dollars in thousands) 2004 2003 2003
--------------- -------------- ----------------
NON-PERFORMING ASSETS:
Acquired residential mortgage $ 15,463 $ 16,401 $ 17,510
Residential real estate mortgage 2,474 2,560 3,141
Other consumer 172 136 493
Commercial business 680 3,085 493
Residential real estate construction 134 135 -
--------------- -------------- ----------------
Total non-accrual loans 18,923 22,317 21,637
Total renegotiated loans - - -
--------------- -------------- ----------------
Total non-performing loans 18,923 22,317 21,637
Total other assets and real estate owned 2,855 3,243 4,155
--------------- -------------- ----------------
Total non-performing assets $ 21,778 $ 25,560 $ 25,792
=============== ============== ================
90-DAY DELINQUENCIES:
Acquired residential mortgage $ 3,248 $ 4,181 $ 6,229
Residential real estate mortgage 4,394 4,669 5,466
Other consumer 1,177 498 430
Commercial business 469 544 407
Residential real estate construction - - 136
--------------- -------------- ----------------
Total 90-day delinquencies $ 9,288 $ 9,892 $ 12,668
=============== ============== ================
Asset Quality Ratios:
Non-performing loans to loans 0.67% 0.80% 0.88%
Non-performing assets to loans 0.77% 0.92% 1.05%
Allowance for loan losses to loans 1.28% 1.28% 1.32%
Net charge-offs in quarter to average loans 0.23% 0.21% 0.38%
Allowance for loan losses to non-performing loans 190.91% 159.25% 150.49%
The asset quality within the Corporation's loan portfolios continued to remain
strong in first quarter 2004. Non-performing assets were $21.8 million at March
31, 2004, down $4.0 million from the level at March 31, 2003. Of the total,
$18.1 million are in the consumer and residential mortgage loan portfolios,
which are collateralized by 1 to 4 family residences. With the vast majority of
non-performing loans already written down to net fair value, management expects
little further loss. Commercial non-performing assets decreased $2.4 million in
first quarter 2004 from December 31, 2003, primarily due to the liquidation of
two credits without any additional material charge-off. Although no assurances
can be given, management believes that non-performing assets will remain
relatively stable in the near term.
Total 90-day delinquencies decreased slightly in first quarter 2004 from
December 31, 2003 due to a decrease in delinquent residential mortgages.
Delinquencies have declined consistently in the acquired mortgage portfolio
reaching their lowest level in several years. The increase in delinquencies in
the other consumer portfolio was due to one specific marine credit which was
brought current subsequent to March 31, 2004.
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 based on management's continuing
review and evaluation of the loan portfolio. This process provides an allowance
consisting of two components, allocated and unallocated. A portion of the
allowance is allocated to individual internally criticized and non-accrual loans
and is determined by estimating the inherent loss on each problem credit after
giving consideration to the value of
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underlying collateral. Management emphasizes loan quality and close monitoring
of potential problem credits. The determination of the remainder of the
allocated allowance is conducted at an aggregate, or pooled, level for
portfolios such as consumer loans, commercial business loans and loans secured
by real estate. An 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. Although management has
allocated the majority of the allowance to specific loan categories, the
evaluation of the allowance is considered in its entirety.
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.
The level of the allowance remained relatively constant at March 31, 2004
compared to the level at December 31, 2003. At $36.1 million, the allowance
represented 1.28% of total loans outstanding and 191% of non-performing loans at
March 31, 2004. Portfolio-wide net charge-offs represented 0.23% of average
loans in first quarter 2004, down from 0.38% in first quarter 2003. For
portfolios that experienced losses, the twelve-month rolling loss rates in each
of the portfolios were at their lowest levels in several years, reflecting both
the favorable levels of delinquencies and management's attention to collection
efforts.
DEPOSITS
The following table summarizes the composition of the Corporation's average
deposit balances for the periods indicated.
Three Months Ended
March 31,
--------------------------------- $ %
(dollars in thousands) 2004 2003 Variance Variance
--------------- --------------- ------------- -------------
Core deposits:
Consumer non-time $ 1,742,278 $ 1,618,624 $ 123,654 7.6 %
Consumer time 616,625 725,863 (109,238) (15.0)
Commercial 493,444 404,663 88,781 21.9
--------------- --------------- -------------
Total core deposits 2,852,347 2,749,150 103,197 3.8
Non-core deposits 218,863 398,018 (179,155) (45.0)
--------------- --------------- -------------
Total average deposits $ 3,071,210 $ 3,147,168 $ (75,958) (2.4)%
=============== =============== =============
Core deposits as a % of total deposits 93% 87%
Deposits obtained from individuals and businesses represented 93% of the Bank's
deposit balances in first quarter 2004, compared to 87% in first quarter 2003
and 71% in 2001. This virtually completes a portion of management's strategic
goals to shift the mix of deposits away from non-core higher-cost brokered
deposits to core lower-cost customer deposits. The customer deposits are
generated through the Bank's increasingly expansive banking office locations and
commercial cash management cross sales and calling efforts. As a result of the
banking office expansion efforts, approximately 23% of average customer deposit
balances in first quarter 2004 were from the Virginia and Washington
metropolitan areas. Further, the percentage of commercial deposits continued to
improve, with average commercial deposit growth of 22% in first quarter 2004
compared to first quarter 2003 resulting in commercial deposit balances
representing 16% of average customer deposits.
Transaction accounts comprise 35% of the Bank's customer deposit balances, and
remain a key part of the Bank's retail deposit-gathering strategy. Transaction
accounts not only serve as an important cross-sell tool in terms of deepening
customer relationships, but also are an important source of fee income to the
Bank. Management believes its checking account products, combined with the
Bank's service options available through both traditional and in-store banking
offices, has given Provident a competitive advantage in the customer deposit
gathering process.
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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 in first quarter 2004 from first quarter 2003,
replacing $103 million of the $179 million brokered CD runoff. Excluding average
consumer time deposits, core deposit balances increased $212 million, or 11%, in
first quarter 2004 compared to 2003. Average balances from consumer transaction
accounts increased $81 million, or 14%, in first quarter 2004 versus first
quarter 2003, as a result of the Bank's success in marketing this product.
Deposit growth from the commercial sector was also particularly favorable, with
a net increase in average balances of $89 million, or 22%, of which $56 million
was in transaction accounts. Average consumer time deposit balances decreased
$109 million from first quarter 2003 to 2004, reflecting customer aversion to
locking in longer term deposit rates in the current low interest rate
environment.
TREASURY ACTIVITIES
The Treasury Division manages the wholesale segments of the balance sheet,
including investments, purchased funds, long-term debt and derivatives.
Management's objective is to achieve the maximum level of stable earnings over
the long term, while controlling the level of interest rate and liquidity risk,
and optimizing capital utilization.
At March 31, 2004, the investment securities portfolio was $2.1 billion. The
portfolio objective is to obtain the maximum sustainable interest margin over
match-funded borrowings, subject to liquidity, credit and interest rate risk; as
well as capital, regulatory and economic considerations. Although securities may
be purchased with the intention of holding to maturity, all securities are
currently classified as available for sale to maximize management flexibility.
The Corporation invests predominately in U.S. Treasury and Agency securities,
mortgage-backed securities ("MBS") and other debt securities, which include
corporate bonds and asset-backed securities. At March 31, 2004, 81% of the
investment portfolio was invested in MBS. The asset-backed securities portfolio,
representing 7% of the total portfolio, consisted predominately of Aaa and
single A rated tranches of pooled trust preferred securities. The corporate bond
portfolio, representing 6% of the portfolio at March 31, 2004, is chiefly
invested in securities rated investment grade by Moody's and S&P rating
agencies.
The primary risk in the investment portfolio is duration risk. Duration is a
measure of the market value volatility of an investment for a 100 basis point
(or 1%) change in interest rates. The higher an investment's duration, the
longer the time until its rate is reset to current market rates. The Bank's risk
tolerance, as measured by the duration of the investment portfolio, is typically
between 2% and 4%. In the current economic environment, the duration is targeted
for the middle of that range.
Investment 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. At
March 31, 2004, there were no investment securities determined to be other than
temporarily impaired.
Provident's funds management objectives are two-fold: to minimize the cost of
borrowings while assuring sufficient funding availability to meet current and
future borrowing requirements; and to contribute to interest rate risk
management goals through match-funding loan or investment activity. Management
utilizes a variety of sources to raise borrowed funds at competitive rates,
including federal funds purchased ("fed funds"), Federal Home Loan Bank ("FHLB")
borrowings, securities sold under repurchase agreements ("repos"), and brokered
and jumbo certificates of deposit ("CDs"). FHLB borrowings and repos typically
are borrowed at rates below the LIBOR rate for the equivalent term because they
are secured with investments or high quality real estate loans. Fed funds, which
are generally overnight borrowings, are typically purchased at the Federal
Reserve target rate.
Average borrowings increased $305 million in first quarter 2004 from first
quarter 2003. Average fed funds increased $80 million, reflecting management's
intentions to match fund more of the Bank's prime-based loan portfolio with
these borrowings. Average FHLB borrowings increased $141 million, offsetting
runoff of higher cost brokered CDs. In
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December 2003, the Corporation issued $71 million of floating rate trust
preferred securities in contemplation of its settlement of the pending Southern
Financial acquisition.
The Provident / Southern Financial merger closed on April 30, 2004. Initially,
the post-merger tangible capital ratio is projected to decline from the current
6.2% to 5.1%. Other measures of capital adequacy, such as the leverage ratio and
risk-based capital ratios, are projected to decline as well. Provident plans to
rebuild its capital ratios throughout 2004 and 2005. Specifically, Provident
intends to sell approximately $420 million of its investment portfolio in the
second quarter of 2004, with a loss of approximately $8.2 million projected on
this transaction. Additionally, investment portfolio purchases are targeted to
decline throughout the third and fourth quarters of 2004 and all of 2005. As a
result of these balance reductions, capital is projected to grow at a faster
rate than assets throughout this period, allowing the tangible capital ratio as
well as the leverage and risk-based capital ratios to increase to pre-merger
levels by the end of 2005.
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. Management believes
the Bank has sufficient liquidity to meet funding needs in the foreseeable
future.
The Bank's primary source of liquidity beyond the traditional sources is the
assets it possesses, which can be either pledged as collateral for secured
borrowings or sold outright. The Bank's primary sources for raising secured
borrowings are the FHLB and securities broker/dealers. At March 31, 2004, $1.4
billion of secured borrowings were employed, with sufficient collateral
available to immediately raise an additional $585 million. After covering $230
million of unsecured funds that mature in the next three months, the excess
liquidity position of $356 million is well in excess of projected liquidity
requirements for the next 12 months. Additionally, over $300 million of assets
are maintained as collateral with the Federal Reserve that is available as a
contingent funding source.
The Bank also has several unsecured funding sources available should the need
arise. At March 31, 2004, the Bank possessed over $725 million of overnight
borrowing capacity, of which only $140 million were in use at March 31, 2004.
Brokered CDs, which typically are more expensive 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, and is allowing the existing brokered CD average balances to run off.
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 March 31, 2004, over $500 million of the Bank's investment
portfolio was immediately saleable at a market value equaling or exceeding its
amortized cost basis. Additionally, over a 90-day time frame, a majority of the
Bank's $1.7 billion consumer loan portfolio is saleable in an efficient market.
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. As a
commercial bank under the Maryland Financial Institution Law, the Bank may
declare cash dividends from undivided profits or, with the prior approval of the
Commissioner of Financial Regulation, out of paid-in capital in excess of 100%
of its required capital stock, and after providing for due or accrued expenses,
losses, interest and taxes. 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 that could
have a material impact on the Corporation.
RISK MANAGEMENT
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 directions of interest rates. Management's
22
24
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, that 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.
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. Prepayment rate projections utilize actual prepayment
speed experience and available market information on like-kind instruments. The
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.
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 the net interest margin and earnings over one and two year
time frames; and second, the impact on the market value of equity. 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.
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 April 1, 2004 and evenly ramp-up or down over a six-month period. The
effect on net interest income would be for the next twelve months. Given the
interest environment at March 31, 2004, a 200 basis point drop in rate is
unlikely and has not been shown.
Projected
Percentage Change in
Interest Rate Scenario Net Interest Income
- ------------------------------------------------- -------------------------
- -100 basis points -4.3%
No change --
+100 basis points +1.0%
+200 basis points +1.0%
This isolated modeling environment, assuming no action by management, shows that
the Corporation's net interest income volatility is less than 4.5% 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. 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
23
25
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,
$700 million notional amount in interest rate swaps were in force to reduce
interest rate risk, and over $400 million of interest rate caps were employed to
protect the interest margin from rising interest rates in the future.
In addition to managing interest rate risk, which applies to both assets and
liabilities, the Corporation must understand and manage risks specific to
lending. Much of the fundamental lending business of Provident is based upon
understanding, measuring and controlling credit risk. Credit risk entails both
general risks, which are inherent in the process of lending, and risk specific
to individual borrowers. Each consumer and residential lending product has a
generally predictable level of credit loss based on historical loss experience.
Home mortgage and home equity loans and lines generally have the lowest credit
loss experience. Loans with medium credit loss experience are primarily secured
products such as auto and marine loans. Unsecured loan products such as personal
revolving credit have the highest credit loss experience. Credit risk in
commercial lending varies significantly, as losses as a percentage of
outstanding loans can shift widely from period to period and are particularly
sensitive to changing economic conditions. Other lending risks include liquidity
risk and specific risk. The liquidity risk of the Corporation arises from its
obligation to make payment in the event of a customer's contractual default. The
evaluation of specific risk is a basic function of underwriting and loan
administration, involving analysis of the borrower's ability to service debt as
well as the value of pledged collateral.
CAPITAL RESOURCES
Total stockholders' equity was $344 million at March 31, 2004, an increase of
$19.7 million from December 31, 2003. The change in stockholders' equity for the
three months ended March 31, 2004 was attributable to $12.9 million in earnings,
$4.3 million from the issuance of common stock relating primarily to the
exercise of stock options and an increase of $8.5 million in net accumulated
OCI. This was partially offset by dividends paid of $6.0 million, or $0.245 per
share. In first quarter 2004, OCI increased due primarily to an increase in
market value of available for sale securities. No shares of common stock were
repurchased in first quarter 2004; however the Corporation has remaining
authority to repurchase an additional 730,331 shares under its stock repurchase
program.
24
26
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:
March 31, December 31,
(dollars in thousands) 2004 2003
-------------- --------------
Total equity capital per consolidated financial statements $ 344,470 $ 324,765
Qualifying issued trust preferred securities 114,056 110,341
Accumulated other comprehensive (income) loss (1,959) 6,589
-------------- --------------
Adjusted capital 456,567 441,695
Adjustments for tier 1 capital:
Goodwill and disallowed intangible assets (8,830) (8,932)
-------------- --------------
Total tier 1 capital 447,737 432,763
-------------- --------------
Adjustments for tier 2 capital:
Qualifying issued trust preferred securities in excess
of tier 1 capital limitations 26,944 30,659
Allowance for loan losses 36,126 35,539
Allowance for letter of credit losses 365 343
-------------- --------------
Total tier 2 capital adjustments 63,435 66,541
-------------- --------------
Total regulatory capital $ 511,172 $ 499,304
============== ==============
Risk-weighted assets $ 3,322,834 $ 3,258,851
Quarterly regulatory average assets 5,231,835 5,094,719
Minimum
Regulatory To be "Well
Ratios: Requirements Capitalized"
---------------------------------
Tier 1 leverage 8.56 % 8.49 % 4.00 % 5.00 %
Tier 1 capital to risk-weighted assets 13.47 13.28 4.00 6.00
Total regulatory capital to risk-weighted assets 15.38 15.32 8.00 10.00
The trust preferred securities issued by the Corporation in December 2003 had
the effect of increasing Tier 1 capital by $44 million and total regulatory
capital by $71 million at March 31, 2004. Without the transaction, which was
executed in contemplation of the acquisition of Southern Financial, the
Corporation's leverage and total regulatory capital to risk-weighted assets
ratios would have been 7.72% and 13.25%, respectively, at March 31, 2004,
compared to 7.70% and 13.14% at December 31, 2003, respectively.
RESULTS OF OPERATIONS
OVERVIEW
The Corporation recorded net income of $12.9 million or $0.51 per diluted share
in the quarter ended March 31, 2004. The financial results for the 2004 quarter
versus 2003, represented by increases of 9.2% in net income and 8.5% in diluted
earnings per share, demonstrate stability and continued growth in the
Corporation's core businesses, as well as strong asset quality. The Corporation
continued to show improvement in its financial fundamentals with two of its key
performance measures showing improvement over first quarter 2003. Return on
assets and the efficiency ratio were 0.99% and 66.18%, respectively, in first
quarter 2004, compared to 0.98% and 68.33%, respectively, in first quarter 2003.
An increase of $3.1 million in the net interest margin and a $1.0 million
increase in non-interest income more than offset an increase in income tax
expense of $807 thousand, a $1.8 million increase in non-interest expense and a
$400 thousand increase in the provision for loan losses, resulting in a $1.1
million increase in net income over 2003. These items are discussed in more
detail, as follows.
25
27
NET INTEREST INCOME
The Corporation's principal source of revenue is net interest income, which is
the difference between interest income on earning assets and interest expense on
deposits and borrowings. Interest income is presented on a tax-equivalent basis
to recognize associated tax benefits in order to provide a basis for comparison
of yields with taxable earning assets. The table on the following pages 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.
26
28
CONSOLIDATED AVERAGE BALANCES AND ANALYSIS OF CHANGES IN TAX EQUIVALENT NET INTEREST INCOME
----------------------------------------------------------------
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
----------------------------------------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
(tax-equivalent basis) Balance Expense Rate Balance Expense Rate
----------- --------- -------------------- --------- ---------
ASSETS:
Interest-earning assets:
Acquired residential mortgage $ 604,064 $ 9,008 6.00 % $ 515,256 $ 8,578 6.75 %
Residential mortgage 74,932 1,310 7.03 153,770 2,803 7.39
Home equity 519,019 6,132 4.75 374,534 5,009 5.42
Marine 463,706 6,047 5.24 428,833 6,264 5.92
Other direct consumer 34,785 671 7.76 41,703 842 8.19
Other indirect consumer 9,576 199 8.36 32,424 614 7.68
----------- --------- ----------- ---------
Total consumer 1,706,082 23,367 5.51 1,546,520 24,110 6.32
Commercial business 386,264 5,321 5.54 342,097 5,133 6.09
Real estate-construction 367,757 3,881 4.24 314,064 3,455 4.46
Commercial mortgage 321,943 4,340 5.42 247,022 3,785 6.21
Non-core syndicated loans 28,008 259 3.72 49,845 457 3.72
----------- --------- ----------- ---------
Total loans 2,810,054 37,168 5.32 2,499,548 36,940 5.99
----------- --------- ----------- ---------
Loans held for sale 4,149 64 6.20 8,651 121 5.67
Short-term investments 1,592 2 0.51 2,297 8 1.41
Taxable investment securities 2,076,697 22,534 4.36 2,030,410 24,049 4.80
Tax-advantaged investment securities 16,617 298 7.21 19,541 339 7.04
----------- --------- ----------- ---------
Total investment securities 2,093,314 22,832 4.39 2,049,951 24,388 4.82
----------- --------- ----------- ---------
Total interest-earning assets 4,909,109 60,066 4.92 4,560,447 61,457 5.47
----------- --------- ----------- ---------
Less: allowance for loan losses (35,576) (32,766)
Cash and due from banks 118,671 103,084
Other assets 238,582 253,062
----------- -----------
Total assets $5,230,786 $4,883,827
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand/money market deposits $ 917,272 1,330 0.58 $ 844,448 1,723 0.83
Savings deposits 715,265 510 0.29 677,776 1,090 0.65
Direct time deposits 652,280 3,322 2.05 757,250 5,558 2.98
Brokered time deposits 218,863 3,452 6.34 398,018 6,002 6.12
Short-term borrowings 670,195 1,578 0.95 439,184 1,266 1.17
Long-term debt 1,135,984 10,948 3.88 970,656 10,017 4.19
----------- --------- ----------- ---------
Total interest-bearing liabilities 4,309,859 21,140 1.97 4,087,332 25,656 2.55
----------- --------- ----------- ---------
Noninterest-bearing demand deposits 567,530 469,676
Other liabilities 20,974 24,439
Stockholders' equity 332,423 302,380
----------- -----------
Total liabilities and stockholders'
equity $5,230,786 $4,883,827
=========== ===========
Net interest-earning assets $ 599,250 $ 473,115
=========== ===========
Net interest income (tax-equivalent) 38,926 35,801
Less: tax-equivalent adjustment (203) (174)
--------- ---------
Net interest income $ 38,723 $35,627
========= =========
Net yield on interest-earning assets 3.19 % 3.18 %
27
29
CONSOLIDATED AVERAGE BALANCES AND ANALYSIS OF CHANGES IN TAX EQUIVALENT NET INTEREST INCOME (CONTINUED)
2004/2003
--------------------------------------------- Income/Expense Variance
2004/2003 Increase/(Decrease) Due to Change In
--------------------------------------------- -------------------------
Average % Income/ % Average Average
Balance Change Expense Change Rate Volume
----------- ------- ---------- ----------- ------------ ------------
ASSETS:
Interest-earning assets:
Acquired residential mortgage $ 88,808 17.2 % $ 430 5.0 % $ (1,006) $ 1,436
Residential mortgage (78,838) (51.3) (1,493) (53.3) (130) (1,363)
Home equity 144,485 38.6 1,123 22.4 (677) 1,800
Marine 34,873 8.1 (217) (3.5) (730) 513
Other direct consumer (6,918) (16.6) (171) (20.3) (41) (130)
Other indirect consumer (22,848) (70.5) (415) (67.6) 51 (466)
----------- ----------
Total consumer 159,562 10.3 (743) (3.1)
Commercial business 44,167 12.9 188 3.7 (472) 660
Real estate-construction 53,693 17.1 426 12.3 (170) 596
Commercial mortgage 74,921 30.3 555 14.7 (523) 1,078
Non-core syndicated loans (21,837) (43.8) (198) (43.3) - (198)
----------- ----------
Total loans 310,506 12.4 228 0.6
----------- ----------
Loans held for sale (4,502) (52.0) (57) (47.1) 11 (68)
Short-term investments (705) (30.7) (6) (75.0) (4) (2)
Taxable investment securities 46,287 2.3 (1,515) (6.3) (2,100) 585
Tax-advantaged investment securities (2,924) (15.0) (41) (12.1) 9 (50)
----------- ----------
Total investment securities 43,363 2.1 (1,556) (6.4)
----------- ----------
Total interest-earning assets 348,662 7.6 (1,391) (2.3) (6,161) 4,770
----------- ----------
Less: allowance for loan losses (2,810) 8.6
Cash and due from banks 15,587 15.1
Other assets (14,480) (5.7)
-----------
Total assets $ 346,959 7.1
===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand/money market deposits $ 72,824 8.6 (393) (22.8) (537) 144
Savings deposits 37,489 5.5 (580) (53.2) (639) 59
Direct time deposits (104,970) (13.9) (2,236) (40.2) (1,548) (688)
Brokered time deposits (179,155) (45.0) (2,550) (42.5) 223 (2,773)
Short-term borrowings 231,011 52.6 312 24.6 (274) 586
Long-term debt 165,328 17.0 931 9.3 (762) 1,693
----------- ----------
Total interest-bearing liabilities 222,527 5.4 (4,516) (17.6) (5,911) 1,395
----------- ----------
Noninterest-bearing demand deposits 97,854 20.8
Other liabilities (3,465) (14.2)
Stockholders' equity 30,043 9.9
-----------
Total liabilities and stockholders' equity $ 346,959 7.1
===========
Net interest-earning assets $ 126,135 26.7
===========
Net interest income (tax-equivalent) 3,125 8.7 $ (250) $ 3,375
Less: tax-equivalent adjustment (29) 16.7
----------
Net interest income $ 3,096 8.7
==========
28
30
Net interest income on a tax-equivalent basis totaled $38.9 million in first
quarter 2004, compared to $35.8 million in first quarter 2003, while the net
interest margin grew slightly to 3.19%. A decline of $1.4 million in total
interest income was more than offset by a decline in total interest expense of
$4.5 million. Generally, favorable changes in the mix of interest-bearing
liabilities lowered interest costs which offset lower yields on the growth in
earning assets.
The yield on earning assets was 4.92% in first quarter 2004, compared to 5.47%
in first quarter 2003, a decline of 55 basis points, reflecting the low interest
rate environment in first quarter 2004. The $1.4 million decrease in total
interest income was primarily attributable to prepayments in the loan and
investment portfolios, as higher yielding assets in those portfolios were
replaced with lower yielding assets. Interest income from loans increased only
$228 thousand, despite an additional $311 million in loan average balances, and
interest income from investments decreased $1.6 million.
The average rate paid on interest-bearing liabilities declined 58 basis points
to 1.97% in first quarter 2004, versus 2.55% in first quarter 2003. The deposit
mix shifted favorably from higher rate CDs into lower rate demand and savings
deposits, resulting in a favorable impact on interest expense of $5.8 million.
Interest expense benefited further from a $98 million increase in average
noninterest-bearing deposit balances during the quarter.
As a result of derivative transactions undertaken to mitigate the affect of
interest rate risk on the Bank, interest income decreased by $377 thousand and
interest expense increased by $1.2 million, for a total decrease of $1.6 million
in net interest income relating to derivative transactions for the quarter ended
March 31, 2004.
Future growth in net interest income will depend upon consumer and commercial
loan demand, growth in deposits and the general level of interest rates.
PROVISION FOR LOAN LOSSES
The Corporation continued to emphasize quality underwriting as well as
aggressive management of charge-offs and potential problem loans. As a result,
the provision for loan losses was $2.2 million in first quarter 2004, exceeding
net charge-offs by $587 thousand. Net charge-offs were $1.6 million in first
quarter 2004 compared to $2.4 million in first quarter 2003. Of the $774
thousand decrease in net charge-offs, $662 thousand related to the acquired
consumer loan portfolio and an increase of $185 thousand related to commercial
business loans. Both portfolios experienced an improvement in net charge-offs as
a percentage of average loans in their respective portfolios. Consumer loan net
charge-offs as a percentage of average consumer loans were 0.29% in first
quarter 2004 compared to 0.48% in first quarter 2003. On an overall basis, net
charge-offs as a percentage of average loans were 0.23% in first quarter 2004
compared to 0.38% in first quarter 2003.
NON-INTEREST INCOME
Compared to first quarter 2003, total non-interest income increased $1.0 million
to $23.6 million in first quarter 2004. Excluding net gains, non-interest income
increased 6.7% to $22.8 million in first quarter 2004 versus 2003. Exclusive of
the net gains, non-interest income, as a percentage of combined net interest
income and non-interest income, was 37% in both 2004 and 2003 quarters. This
demonstrates both the importance and stability of non-interest income to the
Bank's strategic profile, as well as the diversity in its sources of revenue.
The improvement in non-interest income continued to be driven by deposit service
charges, which increased $1.2 million from first quarter 2003, or 7.0%, to $18.5
million in first quarter 2004. The increase in deposit fees was primarily the
result of continued strong retail and commercial deposit account growth.
Additionally, the growth in deposit service fees was in spite of a $789
thousand, or 30%, decrease in fees from its retail customers' use of Bank-issued
debit cards, resulting from an August 2003 downward revision to the retail debit
card interchange fee structure from MasterCard. An upward revision to the debit
card interchange fee structure effective in April 2004 is expected to have a
favorable impact to this revenue source in future periods.
Net gains are composed of security gains and losses, and gains and losses on
sales of loans, foreclosed property and fixed assets, which occur in the
ordinary course of business. The Corporation recorded $816 thousand in net gains
in first quarter 2004, compared to $1.2 million in first quarter 2003. The net
gains in first quarter 2004 were composed of $954 thousand in net gains on the
sales of securities, partially offset by $138 thousand in net losses relating to
the disposition of
29
31
certain assets. The majority of net gains on the sales of securities were the
result of re-balancing the investment portfolio, predominately to reduce
prepayment volatility related to changes in interest rates.
NON-INTEREST EXPENSE
Non-interest expense of $40.8 million for first quarter 2004 was $1.8 million,
or 4.6%, greater than first quarter 2003. Over $400 thousand of the increase was
directly attributable to the Bank's network expansion, 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 and
expenses relating to the pending acquisition of Southern Financial, was
contained to a growth rate of less than 3%. Increases in external processing
fees were related to volume increases and additional outsourced services. Other
non-interest expense decreased $182 thousand from first quarter 2003, due
primarily to the elimination of a recourse reserve established in 2001 related
to securitized loans.
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. A 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. 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. The valuation allowance was approximately $1.5 million at March 31, 2004
versus $1.4 million at December 31, 2003.
Provident recorded income tax expense of $6.4 million based on pre-tax income of
$19.3 million, representing an effective tax rate of 33.3%, compared to an
effective tax rate of 32.3% in first quarter 2003. During the second quarter of
2003, the Corporation recognized state tax benefits associated with net
operating loss carryforwards. The recognition of these state tax benefits in
2003 resulted in a greater state tax expense in 2004, forming the primary cause
of the increase in the effective tax rate in the period.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding market risk at December 31, 2003, 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 12, 2004. The market risk of the Corporation has not experienced any
material changes as of March 31, 2004 from December 31, 2003. 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 March 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
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 March 31, 2004 that has materially affected, or is reasonably
likely to materially affect, the Corporation's internal control over financial
reporting.
30
32
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Corporation is not involved in any pending legal proceedings
other than routine legal proceedings occurring in the ordinary
course of business. Management believes such routine legal
proceedings, in the aggregate, will not have a material adverse
affect on the Corporation's financial condition or results of
operation.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
On January 15, 2003 the board of directors approved the
repurchase of 1 million shares. During 2003, 273,885 shares were
purchased under this authorization, leaving 730,331 remaining.
There were no shares repurchased in the first quarter of 2004.
Maximum Number
Total Number Average Total Number of of Shares Remaining
of Shares Price Paid Shares Purchased to be Purchased
Period Purchased per Share Under Plan Under Plan
- ------------------------- ---------------- -------------- --------------------- ----------------------
January 1
through
March 31 2004 - - - 730,331
---------------- -------------- --------------------- ----------------------
Total - - - 730,331
---------------- -------------- --------------------- ----------------------
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company held its Annual Meeting of Shareholders on April
21, 2004. Proxies were solicited with respect to such meeting
under regulation 14A of the Securities and Exchange Act of 1934,
as amended, pursuant to proxy materials dated March 12, 2004. Of
the shares eligible to vote at the annual meeting, 21,534,471
were represented in person or by proxy.
(b) There was no solicitation in opposition to the Board nominees
for directors and all of such nominees were elected as follows:
No. of Votes No. of Votes Broker
Director For % Withheld % Non-Votes %
-------- --- - -------- - --------- -
Melvin A. Bilal 20,357,080 94.5 1,177,391 5.5 0 0.0
Ward B. Coe 15,270,348 70.9 6,264,123 29.1 0 0.0
William J. Crowley Jr. 20,419,648 94.8 1,114,823 5.2 0 0.0
Gary N. Geisel 20,468,188 95.0 1,066,283 5.0 0 0.0
Bryan J. Logan 20,491,582 95.2 1,042,889 4.8 0 0.0
Frederick W. Meier, Jr. 20,429,211 94.9 1,105,260 5.1 0 0.0
31
33
The following directors are serving terms of office that continue
through 2005 and 2006, as noted:
Director Year Term Expires
-------- -----------------
Thomas S. Bozzuto 2005
Charles W. Cole, Jr. 2005
Barbara B. Lucas 2005
Francis G. Riggs 2005
Enos K. Fry 2005
Pierce B. Dunn 2006
Mark K. Joseph 2006
Peter M. Martin 2006
Sheila K. Riggs 2006
Kevin G. Byrnes 2006
Donald E. Wilson 2006
(c) Three additional proposals were submitted for a vote, with the following results:
Broker
No. of Votes No. of Votes No. of Votes Non-
Proposal For Against Abstaining Votes
-------- --- ------- ---------- -----
Approval and Adoption of
the Agreement and Plan of
Reorganization pursuant to which
Southern Financial Bancorp
will merge with and into
Provident Bankshares 17,962,949 86,807 59,178 3,425,537
Approval of the
Provident Bankshares
Corporation 2004 Equity
Compensation Plan 13,630,715 4,278,254 199,960 3,425,542
Ratification of the
appointment of KPMG LLP
as independent auditors
for the fiscal year
ending December 31, 2004 21,336,484 148,042 49,945 -
ITEM 5. OTHER INFORMATION - NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The exhibits and financial statements filed as a part of this report are as
follows:
(2.0) Agreement and Plan of Reorganization between Provident Bankshares
Corporation and Southern Financial Bancorp, Inc. (1)
(3.1) Articles of Incorporation of Provident Bankshares Corporation (2)
(3.3) Fourth Amended and Restated By-Laws of Provident Bankshares
Corporation(3)
(4.1) Amendment No. 1 to Stockholder Protection Rights Agreement (4)
(11.0) Statement re: Computation of Per Share Earnings (5)
(31.1) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
32
34
(31.2) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
(32.1) Section 1350 Certification of Chief Executive Officer
(32.2) Section 1350 Certification of Chief Financial Officer
(b) Reports on Form 8-K were filed with the Securities and Exchange Commission
in the first quarter of 2004 as follows:
On January 21, 2004, the Company furnished a Form 8-K related to a
press release announcing its financial results for the year ended
December 31, 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
December 31, 2003 versus three months ended December 31, 2002), the
Company's unaudited Consolidated Statement of Income for the three and
twelve months ended December 31, 2003 and the Company's unaudited
Consolidated Statement of Condition at December 31, 2003.
------------
(1) Incorporated by reference from Registrant's Form 8-K (File No. 0-16421)
filed with the Commission on November 4, 2003.
(2) Incorporated by reference from Registrant's Registration Statement on
Form S-8 (File No. 33-58881) filed with the Commission on July 10, 1998.
(3) Incorporated by reference from Registrant's Quarterly Report on Form
10-Q (File No. 0-16421) for the quarter ended March 31, 2000 (File No.
0-16421), filed with the Commission on May 10, 2000.
(4) Incorporated by reference from Registrant's 1994 Annual Report on Form
10-K (File No. 0-16421) filed with the Commission on February 17, 1995.
(5) Included in Note 11 to the Unaudited Consolidated Financial Statements on
page 14 hereof.
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35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Principal Executive Officer:
May 7, 2004 By /s/ GARY N. GEISEL
----------------------------------
Gary N. Geisel
Chairman of the Board
and Chief Executive Officer
Principal Financial Officer:
May 7, 2004 By /s/ DENNIS A. STARLIPER
----------------------------------
Dennis A. Starliper
Executive Vice President and
Chief Financial Officer
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36
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------------ ---------------------------------------------------------------------------
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
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer