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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, 2005
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
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COMMISSION FILE NUMBER 0-16421
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PROVIDENT BANKSHARES CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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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 May 6, 2005, the Registrant had 32,962,067 shares of $1.00 par value common
stock outstanding.
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TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Statements of Condition
March 31, 2005 and 2004 and December 31, 2004 3
Consolidated Statements of Income - Unaudited
Three month periods ended March 31, 2005 and 2004 4
Consolidated Statements of Cash Flows - Unaudited
Three month periods ended March 31, 2005 and 2004 5
Notes to Consolidated Financial Statements - Unaudited 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 33
Item 4. Controls and Procedures 33
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 34
Item 3. Defaults upon Senior Securities 34
Item 4. Submission of Matters to a Vote of Security Holders 34
Item 5. Other Information 34
Item 6. Exhibits 35
SIGNATURES 36
FORWARD-LOOKING STATEMENTS
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 2004 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 U.S. generally accepted accounting
principles ("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;
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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: the
factors identified in the Corporation's Form 10-K for the fiscal year ended
December 31, 2004 under the headings "Forward-Looking Statements" and "Risk
Factors," prevailing economic conditions, either nationally or locally in some
or all areas in which the Corporation conducts business or conditions in the
securities markets or the banking industry; changes in interest rates, deposit
flows, 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 the quality or composition of the loan or investment portfolios; the
Corporation's ability to successfully integrate any assets, liabilities,
customers, systems and management personnel the Corporation may acquire into its
operations and its ability to realize related revenue synergies and cost savings
within expected time frames; the Corporation's timely development of new and
competitive products or services in a changing environment, and the acceptance
of such products or services by customers; operational issues and/or capital
spending necessitated by the potential need to adapt to industry changes in
information technology systems, on which it is highly dependent; 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 mergers and related integration and restructuring
activities; and other economic, competitive, governmental, regulatory and
technological factors affecting the Corporation's operations, pricing, products
and services. 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 the Corporation's website for the GAAP reconciliation of this
information.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
March 31, December 31, March 31,
2005 2004 2004
(dollars in thousands, except share amounts) -------------- --------------- --------------
(Unaudited) (Unaudited)
ASSETS:
Cash and due from banks $ 155,562 $ 124,664 $ 116,006
Short-term investments 5,347 9,658 1,903
Mortgage loans held for sale 4,441 6,520 5,456
Securities available for sale 2,031,290 2,186,395 2,127,047
Securities held to maturity 114,091 114,671 -
Loans 3,546,286 3,559,880 2,829,936
Less allowance for loan losses 45,639 46,169 36,126
-------------- --------------- --------------
Net loans 3,500,647 3,513,711 2,793,810
-------------- --------------- --------------
Premises and equipment, net 63,379 63,413 49,481
Accrued interest receivable 29,627 28,669 25,202
Goodwill 255,973 256,241 7,692
Intangible assets 12,167 12,649 1,138
Other assets 256,305 255,569 141,008
-------------- --------------- --------------
Total assets $ 6,428,829 $ 6,572,160 $ 5,268,743
============== =============== ==============
LIABILITIES:
Deposits:
Noninterest-bearing $ 884,840 $ 811,917 $ 646,765
Interest-bearing 3,047,348 2,970,083 2,555,553
-------------- --------------- --------------
Total deposits 3,932,188 3,782,000 3,202,318
-------------- --------------- --------------
Short-term borrowings 719,228 917,893 555,637
Long-term debt 1,124,530 1,205,548 1,136,121
Accrued expenses and other liabilities 39,504 49,280 30,197
-------------- --------------- --------------
Total liabilities 5,815,450 5,954,721 4,924,273
-------------- --------------- --------------
STOCKHOLDERS' EQUITY:
Common stock (par value $1.00) authorized 100,000,000 shares;
issued 40,966,829, 40,870,602, and 32,410,354 shares at March 31,
2005, December 31, 2004 and March 31, 2004, respectively 40,967 40,871 32,410
Additional paid-in capital 554,244 552,671 303,049
Retained earnings 191,929 182,414 160,385
Net accumulated other comprehensive income (loss) (11,461) (964) 1,959
Treasury stock at cost - 7,904,541, 7,768,217 and 7,651,317
shares at March 31, 2005, December 31, 2004 and
March 31, 2004, respectively (162,300) (157,553) (153,333)
-------------- --------------- --------------
Total stockholders' equity 613,379 617,439 344,470
-------------- --------------- --------------
Total liabilities and stockholders' equity $ 6,428,829 $ 6,572,160 $ 5,268,743
============== =============== ==============
The accompanying notes are an integral part of these statements.
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PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED
Three Months Ended
March 31
-------------------------------
2005 2004
(dollars in thousands, except per share data) -------------- --------------
INTEREST INCOME:
Loans, including fees $ 50,565 $ 36,985
Investment securities 24,321 22,534
Tax-advantaged loans and securities 319 342
Short-term investments 43 2
-------------- --------------
Total interest income 75,248 59,863
-------------- --------------
INTEREST EXPENSE:
Deposits 10,188 8,614
Short-term borrowings 4,473 1,578
Long-term debt 10,266 10,948
-------------- --------------
Total interest expense 24,927 21,140
-------------- --------------
Net interest income 50,321 38,723
Less provision for loan losses 1,575 2,391
-------------- --------------
Net interest income, after provision for loan losses 48,746 36,332
-------------- --------------
NON-INTEREST INCOME:
Service charges on deposit accounts 19,349 18,531
Commissions and fees 1,210 1,224
Net gains (losses) (776) 816
Other non-interest income 5,502 3,012
-------------- --------------
Total non-interest income 25,285 23,583
-------------- --------------
NON-INTEREST EXPENSE:
Salaries and employee benefits 22,698 20,421
Occupancy expense, net 5,274 4,050
Furniture and equipment expense 3,464 3,144
External processing fees 5,197 5,302
Merger expenses - 184
Other non-interest expense 10,841 7,509
-------------- --------------
Total non-interest expense 47,474 40,610
-------------- --------------
Income before income taxes 26,557 19,305
Income tax expense 8,449 6,430
-------------- --------------
Net income $ 18,108 $ 12,875
============== ==============
NET INCOME PER SHARE AMOUNTS:
Basic $ 0.55 $ 0.52
Diluted 0.54 0.51
The accompanying notes are an integral part of these statements.
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PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
Three Months Ended
March 31,
----------------------------------
(in thousands) 2005 2004
-------------- ---------------
OPERATING ACTIVITIES:
Net income $ 18,108 $ 12,875
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 6,543 7,246
Provision for loan losses 1,575 2,391
Provision for deferred income tax (benefit) 171 (917)
Net (gains) losses 776 (816)
Originated loans held for sale (15,880) (12,497)
Proceeds from sales of loans held for sale 18,097 12,111
Net decrease in accrued interest receivable and other assets 4,611 2,339
Net increase (decrease) in accrued expenses and other liabilities (1,534) 7,825
-------------- ---------------
Total adjustments 14,359 17,682
-------------- ---------------
Net cash provided by operating activities 32,467 30,557
-------------- ---------------
INVESTING ACTIVITIES:
Principal collections and maturities of securities available for sale 83,480 92,899
Proceeds from sales of securities available for sale 129,900 113,042
Purchases of securities available for sale (87,235) (227,720)
Loan principal collections less originations and purchases 11,206 (48,307)
Purchases of premises and equipment (3,007) (2,532)
-------------- ---------------
Net cash provided (used) by investing activities 134,344 (72,618)
-------------- ---------------
FINANCING ACTIVITIES:
Net increase in deposits 150,315 122,769
Net decrease in short-term borrowings (198,665) (72,224)
Proceeds from long-term debt 30,000 -
Payments and maturities of long-term debt (110,203) (17,042)
Proceeds from issuance of stock 1,669 4,317
Purchase of treasury stock (4,747) -
Cash dividends paid on common stock (8,593) (6,035)
-------------- ---------------
Net cash provided (used) by financing activities (140,224) 31,785
-------------- ---------------
Increase (decrease) in cash and cash equivalents 26,587 (10,276)
Cash and cash equivalents at beginning of period 134,322 128,185
-------------- ---------------
Cash and cash equivalents at end of period $ 160,909 $ 117,909
============== ===============
SUPPLEMENTAL DISCLOSURES:
Interest paid, net of amount credited to deposit accounts $ 18,338 $ 15,518
Income taxes paid 27,893 96
The accompanying notes are an integral part of these statements.
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PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
MARCH 31, 2005
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 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 U.S.
generally accepted accounting principles ("GAAP") and prevailing practices
within the banking industry 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, 2005 are not necessarily indicative of the
results that may be expected for any future quarters or for the year ending
December 31, 2005. 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, 2004 as filed with the Securities and
Exchange Commission ("SEC").
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 purchased companies are
included from the date of merger. Assets and liabilities of purchased companies
are stated at estimated fair values at the date of merger.
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
The consolidated financial statements of the Corporation 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 for the reporting periods. 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, including those related to the allowance for loan losses,
non-accrual loans, other real estate owned, goodwill and intangible assets,
other than temporary impairment of investment securities, pension and
post-retirement benefits, asset prepayment rates, 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, goodwill and intangible assets, asset prepayment rates
and income taxes. Each estimate and its financial impact, to the extent
significant to financial results, is discussed in the unaudited Consolidated
Financial Statements. 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 unaudited Consolidated Financial
Statements.
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STOCK-BASED COMPENSATION
The Corporation may grant employees and/or directors stock-based compensation in
the form of stock options or restricted stock priced at the fair market value on
the grant date.
The Corporation recognized pre-tax compensation expense of $46 thousand relating
to restricted stock grants for the three months ended March 31, 2005. The
Corporation uses the intrinsic value method of accounting for stock options
granted to employees and accordingly does not recognize compensation expense for
its stock options in the Consolidated Statements of Income.
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 "Accounting for Stock-Based Compensation" ("SFAS No. 123") to stock-based
compensation for the periods indicated.
Three Months Ended
March 31,
----------------------------------
(in thousands, except per share data) 2005 2004
--------------- ---------------
NET INCOME:
Net income as reported $ 18,108 $ 12,875
Addition for total stock-based compensation expense determined
under fair value based method for restricted stock awards, net of tax 30 -
Deduction for total stock-based compensation expense determined
under fair value based method for all awards, net of tax (508) (250)
--------------- ---------------
Pro forma net income $ 17,630 $ 12,625
=============== ===============
BASIC EARNINGS PER SHARE:
As reported $ 0.55 $ 0.52
Pro forma 0.53 0.51
DILUTED EARNINGS PER SHARE:
As reported $ 0.54 $ 0.51
Pro forma 0.52 0.50
Stock options granted in February, 2005 have an eight year life and vest over a
four period. Options granted in 2004 have a ten year life and vest over a three
year period. These pro forma amounts may not be representative of future expense
since the estimated fair value of stock options is amortized to expense over the
various vesting periods and additional options may be granted in future periods.
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,
---------------------------------
2005 2004
-------------- ---------------
Dividend yield 3.49% 3.33%
Weighted average risk-free interest rate 4.29% 3.20%
Weighted average expected volatility 23.59% 25.86%
Weighted average expected life in years 5.50 7.00
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Effective April 1, 2005, the Board of Directors approved the acceleration, by
one year, of the vesting of all the currently outstanding options granted prior
to 2005 to purchase the Corporation's common stock, including those options held
by certain members of senior management. Under recently issued accounting
pronouncement as discussed below, the Corporation will be required to recognize
compensation expense related to stock options as they vest, which will reduce
net income. The acceleration of the vesting of options to purchase 766,575
shares of the Corporation's common stock will result in an aggregate
compensation expense of $135,000 over the modified vesting periods (i.e. 2006).
The amount that would have been expensed for the unvested options granted prior
to 2005 had the Corporation not accelerated the vesting in this manner would
have been approximately $600,000 over the original vesting periods (i.e. 2006
and 2007). The other terms of each of the option grants will remain unchanged.
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 did not acquire any assets in the first quarter of 2005 that where
within the scope of SOP 03-3.
In December 2004, the FASB issued SFAS No. 123R (a revision of SFAS No. 123)
"Accounting for Stock-Based Compensation" ("SFAS No. 123R") effective for
interim and annual periods beginning after June 15, In April 2005, the SEC
deferred the effective date of the provisions of SFAS No. 123R until the
beginning of the first annual period beginning after June 15, 2005. SFAS No.
123R requires companies to recognize the grant-date fair value of stock options
and other equity-based compensation issued to employees as a cost of employee
services in the Consolidated Statements of Income. The cost will be recognized
over the period during which an employee is required to provide service in
exchange for the award (usually the vesting period). As of the required
effective date, the Corporation intends to use the modified prospective method
as defined in SFAS No. 123R. Under this method, awards that are granted,
modified or settled after the date of adoption should be measured and accounted
for in accordance with SFAS No. 123R. Unvested awards that were granted prior to
the effective date should be valued in accordance with SFAS No. 123R.
Compensation expense must be recognized in the Consolidated Statements of Income
subsequent to the effective date of SFAS No. 123R.
NOTE 2--BUSINESS COMBINATION
On April 30, 2004, the Corporation acquired 100 percent of the outstanding
common shares of Southern Financial Bancorp, Inc. ("Southern Financial"),
headquartered in Warrenton, Virginia, which was the holding company for Southern
Financial Bank. Southern Financial had previously completed the acquisition of
Essex Bancorp, Inc., based in Norfolk, Virginia. Southern Financial operated 33
banking offices in the northern Virginia counties of Fairfax, Loudoun and Prince
William; as well as Richmond, Charlottesville and the Tidewater areas.
Southern Financial was merged with and into the Corporation. Southern Financial
shareholders received 1.0875 shares of the Corporation's common stock and
$11.125 in cash for each Southern Financial share outstanding. As a result,
Southern Financial's shareholders received 8.2 million shares of the
Corporation's common stock amounting to $251.2 million and $83.8 million in
cash, for an aggregate purchase price of $335.1 million. The cash portion of the
purchase price was substantially funded by $71 million in trust preferred
securities which were issued in the fourth quarter of 2003. The value of the
shares issued was based on the average market closing price of the Corporation's
common stock from October 29, 2003 through November 6, 2003.
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The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed for Southern Financial at the merger date. A significant
portion of the purchase price allocation has been finalized. Certain assets and
liabilities are still pending analysis and valuation. Adjustments to the initial
allocation of the purchase price were due to final settlement of asset
dispositions, evaluation of tax matters and settlement of contingencies. Pending
valuation matters will not affect operating results of the Corporation.
April 30,
(in thousands) 2004
----------------
ASSETS:
Cash $ 47,142
Short-term investments 64,544
Investment securities 564,964
Net loans 664,489
Other assets 72,201
Goodwill 248,296
Deposit-based intangible 12,829
----------------
Total assets acquired $ 1,674,465
================
LIABILITIES:
Deposits $ 1,022,271
Borrowings 300,308
Other liabilities 16,796
----------------
Total liabilities assumed 1,339,375
----------------
Net assets acquired $ 335,090
================
The merger with Southern Financial resulted in the recognition of $261.1 million
of intangible assets, of which $12.8 million was allocated to a deposit-based
intangible. The remaining intangible was allocated to goodwill.
The results of operations from Southern Financial have been included in the
Consolidated Financial Statements since the date of merger.
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NOTE 3--INVESTMENT SECURITIES
The following table presents the aggregate amortized cost and fair values of the
investment securities portfolio as of the dates indicated:
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gains Losses Value
-------------- ------------- ------------- -------------
MARCH 31, 2005
Securities available for sale:
U.S. Treasury and government agencies and corporations $ 102,781 $ - $ 2,754 $ 100,027
Mortgage-backed securities 1,473,870 2,910 23,663 1,453,117
Municipal securities 12,568 302 - 12,870
Other debt securities 463,857 1,925 506 465,276
-------------- ------------- ------------- -------------
Total securities available for sale 2,053,076 5,137 26,923 2,031,290
-------------- ------------- ------------- -------------
Securities held to maturity:
Other debt securities 114,091 383 1,421 113,053
-------------- ------------- ------------- -------------
Total securities held to maturity 114,091 383 1,421 113,053
-------------- ------------- ------------- -------------
Total investment securities $ 2,167,167 $ 5,520 $ 28,344 $ 2,144,343
============== ============= ============= =============
DECEMBER 31, 2004
Securities available for sale:
U.S. Treasury and government agencies and corporations $ 118,018 $ - $ 3,637 $ 114,381
Mortgage-backed securities 1,647,047 10,754 11,523 1,646,278
Municipal securities 13,608 434 - 14,042
Other debt securities 411,169 1,020 495 411,694
-------------- ------------- ------------- -------------
Total securities available for sale 2,189,842 12,208 15,655 2,186,395
-------------- ------------- ------------- -------------
Securities held to maturity:
Other debt securities 114,671 482 686 114,467
-------------- ------------- ------------- -------------
Total securities held to maturity 114,671 482 686 114,467
-------------- ------------- ------------- -------------
Total investment securities $ 2,304,513 $ 12,690 $ 16,341 $ 2,300,862
============== ============= ============= =============
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
============== ============= ============= =============
At March 31, 2005, a net unrealized after-tax loss of $14.2 million on the
securities portfolio was reflected in net accumulated other comprehensive income
(loss). This compared to net unrealized after-tax gains of $10.3 million and
$2.2 million at March 31, 2004 and December 31, 2004, respectively.
During the third quarter of 2004, the Corporation transferred $108 million in
securities available for sale to securities held to maturity. The unrealized
gains of $7.4 million associated with these securities included in net
accumulated other comprehensive income at the date of transfer will continue to
be reflected in stockholders' equity and be reflected as a premium. The premium
and amount reflected in net accumulated other comprehensive income are amortized
over the
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remaining life of the securities using the interest method. These amortization
amounts will offset with no net income impact on the Corporation.
Management reviews the investment portfolio on a periodic basis to determine the
cause of declines in the fair value of each security. Thorough evaluations of
the causes of the unrealized losses are performed to determine whether the
impairment is temporary or other than temporary in nature. Considerations such
as recoverability of invested amount over a reasonable period of time, the
length of time the security is in a loss position and receipt of amounts
contractually due, for example, are applied in determining other than temporary
impairment. At March 31, 2005, the unrealized losses contained within the
Corporation's investment portfolio were considered temporary because the
declines in fair value were due to changes in market interest rates, not in
estimated cash flows.
For further details regarding investment securities at December 31, 2004, refer
to Notes 1 and 4 of the Consolidated Financial Statements in the Corporation's
Form 10-K as of and for the year ended December 31, 2004.
NOTE 4--LOANS
A summary of loans outstanding as of the dates indicated is shown in the table
below.
March 31, December 31, March 31,
(in thousands) 2005 2004 2004
--------------- -------------- ---------------
Residential real estate:
Originated residential mortgage $ 90,355 $ 100,909 $ 71,854
Home equity 745,996 705,126 536,244
Acquired residential 536,597 560,040 598,517
Other consumer:
Marine 431,381 436,262 461,200
Other 35,482 42,121 40,766
--------------- -------------- ---------------
Total consumer 1,839,811 1,844,458 1,708,581
--------------- -------------- ---------------
Commercial real estate:
Commercial mortgage 483,256 483,636 322,605
Residential construction 264,906 242,246 171,864
Commercial construction 282,092 279,347 219,287
Commercial business 676,221 710,193 407,599
--------------- -------------- ---------------
Total commercial 1,706,475 1,715,422 1,121,355
--------------- -------------- ---------------
Total loans $ 3,546,286 $ 3,559,880 $ 2,829,936
=============== ============== ===============
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NOTE 5 - ALLOWANCE FOR LOAN LOSSES
The following table reflects the activity in the allowance for loan losses for
the periods indicated:
Three Months Ended
March 31,
--------------------------------
(in thousands) 2005 2004
-------------- ---------------
Balance at beginning of period $ 46,169 $ 35,539
Provision for loan losses 1,575 2,391
Less loans charged-off, net of recoveries:
Originated residential mortgage and home equity 12 9
Acquired residential 628 1,236
Marine and other consumer (10) 252
Commercial business 1,475 307
-------------- ---------------
Net charge-offs 2,105 1,804
-------------- ---------------
Balance at end of period $ 45,639 $ 36,126
============== ===============
NOTE 6--INTANGIBLE ASSETS
The table below presents an analysis of the goodwill and deposit-based
intangible activity for the three months ended March 31, 2005.
Accumulated Net
(in thousands) Goodwill Amortization Goodwill
----------------- ---------------- ---------------
Balance at December 31, 2004 $ 256,863 $ (622) $ 256,241
Adjustment of intangible related to 2004 merger (268) - (268)
----------------- ---------------- ---------------
Balance at March 31, 2005 $ 256,595 $ (622) $ 255,973
================= ================ ===============
Deposit-based Accumulated
(in thousands) Intangible Amortization Total
----------------- ---------------- ---------------
Balance at December 31, 2004 $ 15,429 $ (2,780) $ 12,649
Amortization expense - (482) (482)
----------------- ---------------- ---------------
Balance at March 31, 2005 $ 15,429 $ (3,262) $ 12,167
================= ================ ===============
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NOTE 7--DEPOSITS
The table below presents a summary of deposits as of the dates indicated:
March 31, December 31, March 31,
(in thousands) 2005 2004 2004
------------- ------------- -------------
Interest-bearing deposits:
Interest-bearing demand $ 523,308 $ 531,622 $ 482,620
Money market 580,038 525,744 465,678
Savings 760,165 743,937 731,248
Direct time certificates of deposit 793,000 812,904 665,001
Brokered certificates of deposit 390,837 355,876 211,006
------------- ------------- -------------
Total interest-bearing deposits 3,047,348 2,970,083 2,555,553
Noninterest-bearing deposits 884,840 811,917 646,765
------------- ------------- -------------
Total deposits $ 3,932,188 $ 3,782,000 $ 3,202,318
============= ============= =============
NOTE 8--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) 2005 2004 2004
------------- ------------ -------------
Securities sold under repurchase agreements $ 412,071 $ 396,263 $ 273,561
Federal funds purchased 140,000 329,500 140,000
Federal Home Loan Bank advances - variable rate 165,000 190,000 140,000
Other short-term borrowings 2,157 2,130 2,076
------------- ------------ -------------
Total short-term borrowings $ 719,228 $ 917,893 $ 555,637
============= ============ =============
NOTE 9--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) 2005 2004 2004
-------------- -------------- --------------
Federal Home Loan Bank advances - fixed rate $ 163,228 $ 169,833 $ 127,038
Federal Home Loan Bank advances - variable rate 800,000 834,555 810,000
Trust preferred securities 141,302 173,035 145,725
Term repurchase agreements 20,000 28,125 53,358
-------------- -------------- --------------
Total long-term debt $ 1,124,530 $ 1,205,548 $ 1,136,121
============== ============== ==============
On March 31, 2005, the Corporation redeemed $30.0 million in aggregate principal
amount of 10% trust preferred securities of Provident Trust II. The trust
preferred securities had a final stated maturity of March 31, 2030, but were
callable at par beginning on March 31, 2005.
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15
NOTE 10--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 determined to be effective. Accordingly, the designated
hedges and the associated hedged items were marked to fair value by an equal and
offsetting amount of $6.4 million and $7.6 million for the three months ended
March 31, 2005 and 2004, respectively. Cash flow hedges have the effective
portion of changes in the fair value of the derivative recorded in accumulated
other comprehensive income (loss). At March 31, 2005 and 2004, the Corporation
recorded a cumulative decline in the fair value of derivatives of $55 thousand
and $8.3 million, respectively, net of taxes, in accumulated other comprehensive
income (loss) to reflect the effective portion of cash flow hedges. Amounts
recorded in accumulated other comprehensive income (loss) are recognized into
earnings concurrent with the impact of the hedged item on earnings. For the
three months ended March 31, 2005 and 2004, the Corporation had no ineffective
hedges.
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, 2005
Interest rate swaps:
Pay fixed/receive variable Borrowing cost $ 125,000 $ 2,324 $ 2,224
Pay fixed/receive variable Loan rate risk 55,985 1,255 1,255
Receive fixed/pay variable Borrowing cost 368,500 5,347 (1,313)
Interest rate caps/corridors Borrowing cost 300,000 3,008 3,008
--------------- --------------- --------------
$ 849,485 $ 11,934 $ 5,174
=============== =============== ==============
DECEMBER 31, 2004
Interest rate swaps:
Pay fixed/receive variable Borrowing cost $ 245,000 $ 1,527 $ 1,527
Pay fixed/receive variable Loan rate risk 59,776 - (167)
Receive fixed/pay variable Borrowing cost 357,500 5,506 3,655
Interest rate caps/corridors Borrowing cost 300,000 2,778 2,778
--------------- --------------- --------------
$ 962,276 $ 9,811 $ 7,793
=============== =============== ==============
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
=============== =============== ==============
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NOTE 11--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) 2005
--------------
Commercial business and real estate $ 773,919
Consumer revolving credit 544,030
Residential mortgage credit 23,756
Performance standby letters of credit 103,035
Commercial letters of credit 1,262
--------------
Total loan commitments $ 1,446,002
==============
Historically, many of the commitments expire without being fully drawn;
therefore, the total commitment amounts do not necessarily represent future cash
requirements.
NOTE 12--NET GAINS (LOSSES)
Net gains (losses) include the following components for the periods indicated:
Three Months Ended
March 31,
------------------------------
(in thousands) 2005 2004
------------- -------------
Net gains (losses):
Securities sales $ (876) $ 954
Asset sales 151 (138)
Debt extinguishment (51) -
------------- -------------
Net gains (losses) $ (776) $ 816
============= =============
NOTE 13--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) 2005 2004
------------- -------------
Qualifying net income $ 18,108 $ 12,875
Basic EPS shares 33,029 24,664
Basic EPS $ 0.55 $ 0.52
Dilutive shares 691 686
Diluted EPS shares 33,720 25,350
Diluted EPS $ 0.54 $ 0.51
Antidilutive shares 2 205
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NOTE 14--COMPREHENSIVE INCOME
Presented below is a reconciliation of net income to comprehensive income
including the components of other comprehensive income (loss) for the periods
indicated:
Three Months Ended
March 31,
-------------------------------
(in thousands) 2005 2004
-------------- --------------
Net income $ 18,108 $ 12,875
Other comprehensive income (loss):
Net unrealized gains (losses) on derivatives 2,654 (7,343)
Net unrealized holding gains (losses) on debt securities (19,561) 21,447
Less reclassification adjustment for gains (losses)
realized in net income (757) 954
-------------- --------------
Other comprehensive income (loss) before tax (16,150) 13,150
Related income tax expense (benefit) (5,653) 4,602
-------------- --------------
Other comprehensive income (loss) after tax (10,497) 8,548
-------------- --------------
Comprehensive income $ 7,611 $ 21,423
============== ==============
NOTE 15--EMPLOYEE BENEFIT PLANS
The actuarially estimated net benefit cost includes the following components for
the periods indicated:
Qualified Non-qualified
Pension Plan Postretirement Benefits Pension Plan
-------------------------- ------------------------ ------------------------
Three Months Ended Three Months Ended Three Months Ended
March 31, March 31, March 31,
-------------------------- ------------------------ ------------------------
(in thousands) 2005 2004 2005 2004 2005 2004
---------- ----------- ---------- ------------ ----------- -----------
Service cost - benefits earned during the period $ 304 $ 293 $ 39 $ 26 $ 75 $ 33
Interest cost on projected benefit obligation 387 374 27 18 209 91
Expected return on plan assets (445) (430) - - - -
Net amortization and deferral of loss 50 48 13 9 88 38
--------- ------------- ---------- ------------ ---------- -----------
Subtotal 296 285 79 53 372 162
Reversal of liability - - (1,641) - - -
--------- ------------- ---------- ------------ ---------- -----------
Net pension cost included in employee
benefits expense $ 296 $ 285 $ (1,562) $ 53 $ 372 $ 162
========= ============= ========== ============ ========== ===========
On March 31, 2005, the Corporation announced that the pension plan will be
frozen for new entrants. Employees who are already participants in the plan will
not be affected by this change. Also on March 31, 2005, the Corporation
communicated to retirees currently receiving postretirement benefits that these
benefits will be eliminated and no longer offered, effective January 1, 2006.
This action resulted in the reversal of the actuarially determined liability of
$1.6 million at March 31, 2005.
No contributions were made to the qualified pension plan in the three months
ended March 31, 2005 and 2004, respectively. The minimum required contribution
in 2005 for the qualified plan is estimated to be zero. The maximum contribution
amount for the qualified plan is the maximum deductible contribution under the
Internal Revenue Code, which is dependent on several factors including proposed
legislation that will affect the interest rate used to determine the current
liability. In addition, the decision to contribute the maximum amount is
dependent on other factors including the actual investment performance of plan
assets. Given these uncertainties, the Corporation is not able to reliably
estimate the maximum deductible contribution or the amount that will be
contributed in 2005 to the qualified plan. For the unfunded non-qualified
pension and postretirement benefit plans, the Corporation will contribute the
minimum required amount in 2005, which is equal to the benefits paid under the
plans.
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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, 2005, the Bank was the
second largest independent commercial bank, in asset size, headquartered in
Maryland, with $6.4 billion in assets. Provident is a regional bank serving
Maryland and Virginia, with emphasis on the key urban centers within these
states - the Baltimore, Washington and Richmond metropolitan areas.
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 Bank offers consumer and commercial banking products and
services through the Consumer 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.
Provident's key business strategies provide it with a unique opportunity in its
marketplace. An overview of these strategies are discussed below:
o MAXIMIZE PROVIDENT'S POSITION AS THE RIGHT SIZE BANK IN THE MARKETPLACE.
Provident's position as the second largest bank headquartered in Maryland
provides a unique opportunity as the "right size" bank in its footprint.
The Bank seeks to provide the service of a small institution combined with
the convenience and wide array of products and services that a strong
regional bank offers. In addition, the 60 in-store branches throughout its
footprint reinforce its right size strategy through convenient hours and
full product service. Provident currently has 149 branches concentrated in
the Baltimore-Washington corridor and beyond to Richmond, Virginia. Of the
149 banking offices, 44% are located in the Baltimore metropolitan region
and 56% are located in the metro Washington and Virginia regions,
reflecting the successful development of the Bank into 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 242 ATMs enhances the banking office network by providing
customers increased opportunities to access their funds.
o GROW AND DEEPEN CONSUMER AND SMALL BUSINESS RELATIONSHIPS IN MARYLAND
AND VIRGINIA. Consumer banking continues to be an important component of
the Bank's business strategy. Consumer banking services include a broad
array of consumer and small business loan, lease, deposit and investment
products offered to consumer 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.
o GROW AND DEEPEN COMMERCIAL AND REAL ESTATE RELATIONSHIPS IN MARYLAND AND
VIRGINIA. Commercial banking is the other key component to the
Corporation's regional presence in its market area. The Commercial Banking
group 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. It also has a suite of cash management products
managed by responsive account teams that deepen customer relationships
through consistently priced deposit based services. The Bank's increased
commercial loan and deposit portfolios reflect the benefits derived from
Southern Financial's focus on commercial banking in Virginia.
o MOVE FROM A PRODUCT DRIVEN ORGANIZATION TO A CUSTOMER RELATIONSHIP FOCUSED
SALES CULTURE. The Corporation's transition to a customer relationship
driven sales culture requires deepening relationships through cross-sell
and the continuing emphasis on retention of valued customers. The Bank has
segmented its customers to better understand and anticipate their financial
needs and provide Provident's sales force with a targeted approach to
customers and prospects. The successful execution of this strategy will be
centered on the right size bank commitment - providing the service of a
small institution combined with the convenience and wide array of products
and services that a strong regional bank offers.
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19
o CREATE A HIGH PERFORMANCE CULTURE THAT FOCUSES ON EMPLOYEE DEVELOPMENT
AND RETENTION. Provident has always placed a high priority on its
employees and has approached employee development and training with
renewed emphasis. Their development is viewed as a critical part of
executing its strategy as the right size bank and transforming the
Company's sales culture. The focus is on the employee's development and
their approach with Provident's customers.
FINANCIAL REVIEW
The principal objective of this Financial Review is to provide an overview of
the financial condition and results of operations of Provident Bankshares
Corporation ("the 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 U.S. generally accepted accounting principles
("GAAP"). The preparation of these financial statements requires management to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. Management evaluates estimates on an on-going basis, including
those related to the allowance for loan losses, non-accrual loans, asset
prepayment rates, other real estate owned, other than temporary impairment of
investment securities, goodwill and intangible assets, pension and
post-retirement benefits, stock-based compensation, derivative positions,
recourse liabilities, litigation and income taxes. Management bases its
estimates on historical experience and various other factors and assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
Management believes the following critical accounting policies affect its more
significant judgments and estimates used in preparation of its consolidated
financial statements: allowance for loan losses, other than temporary impairment
of investment securities, goodwill and intangible assets, 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 and the effect
of the change could be material to the unaudited Consolidated Financial
Statements.
FINANCIAL CONDITION
The financial condition of the Corporation reflects the continued balance sheet
transition towards growing loans and deposits in the Bank's business segments.
The Bank's commitment to its business strategies in the key markets of
Baltimore, Washington and Richmond, coupled with the impact of the Southern
Financial merger, led to increases in average loans and deposits of 26% and 23%,
respectively, over the first quarter of 2004. The April 30, 2004 strategic
merger with Southern Financial Bancorp, Inc. added 30 branches in the Northern
Virginia, Richmond, Charlottesville and Washington D.C. areas. At March 31,
2005, total assets were $6.4 billion as compared to $6.6 billion at December 31,
2004. The basis for financial comparison for the first quarter of 2005 includes
the impact of the Southern Financial merger.
18
20
LENDING
Total average loan balances increased to $3.5 billion in first quarter 2005, an
increase of $733 million, or 26%, from first quarter 2004 ("prior year
quarter"). While commercial loans acquired with the Southern Financial merger
contributed to the increase, organic loan production from existing Provident
units continued to grow at a double digit pace. The following table summarizes
the composition of the Bank's average loans for the periods indicated.
Three Months Ended
March 31,
------------------------------- $ %
(dollars in thousands) 2005 2004 Variance Variance
-------------- ------------- -------------- -------------
Residential real estate:
Originated residential mortgage $ 97,550 $ 74,932 $ 22,618 30.2 %
Home equity 724,721 519,019 205,702 39.6
Acquired residential 542,295 604,064 (61,769) (10.2)
Other consumer:
Marine 432,891 463,706 (30,815) (6.6)
Other 38,250 44,361 (6,111) (13.8)
-------------- ------------- --------------
Total consumer 1,835,707 1,706,082 129,625 7.6
-------------- ------------- --------------
Commercial real estate:
Commercial mortgage 484,661 321,943 162,718 50.5
Residential construction 259,940 169,767 90,173 53.1
Commercial construction 281,705 216,648 65,057 30.0
Commercial business 680,837 395,614 285,223 72.1
-------------- ------------- --------------
Total commercial 1,707,143 1,103,972 603,171 54.6
-------------- ------------- --------------
Total loans $ 3,542,850 $ 2,810,054 $ 732,796 26.1
============== ============= ==============
Provident's expanded presence in the Washington and Richmond metropolitan
regions was the primary contributor to the achievement of the 26% growth in
average loans. The average loan growth of $733 million in the last twelve months
is comprised of $130 million, or 8%, in consumer loans and $603 million, or 55%,
in commercial loans. The result is a balanced mix of revenue sources between the
two business segments with $1.8 billion, or 52%, in consumer loans, and $1.7
billion, or 48%, in commercial loans. Geographically, average loan balances of
$1.3 billion originated in the Washington and Richmond metropolitan regions were
more than twice the level in first quarter 2004 and represented 36% of total
average loans in first quarter 2005. This growth emphasizes the Corporation's
commitment to the Virginia market as well as the benefits of the merger.
Consumer banking continues to be an important component of the Bank's business
strategy. Average consumer loan balances increased $130 million, or 8%, over the
prior year quarter. Home equity loans averaged $725 million, and increased 40%
over the prior year. The strong growth in home equity lending was partially
offset by managed declines in marine loans and purchased residential loans
totaling $93 million. This shift indicates the Bank's focus on its key business
segments. Average residential mortgage loans also increased $23 million over the
prior year quarter as a result of loans acquired from Southern Financial.
Commercial banking is the other key component to the Corporation's regional
presence in its market area. Average commercial and real estate loans increased
72% and 45%, respectively. Commercial mortgage loans and commercial and
residential construction loans each posted increases during the quarter. The
increase in the commercial loan portfolios over the 2004 first quarter also
reflects the benefits derived from Southern Financial's focus on commercial
banking in Virginia.
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21
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,
2005 2004
--------------- -------------
(dollars in thousands)
NON-PERFORMING ASSETS:
Originated residential mortgage $ 1,230 $ 1,934
Home equity 275 103
Acquired residential 8,900 8,393
Other consumer - 147
Commercial mortgage 1,598 1,612
Residential real estate construction - -
Commercial real estate construction 195 1,063
Commercial business 11,008 12,461
--------------- -------------
Total non-accrual loans 23,206 25,713
Total renegotiated loans - -
--------------- -------------
Total non-performing loans 23,206 25,713
Total other assets and real estate owned 1,578 1,616
--------------- -------------
Total non-performing assets $ 24,784 $ 27,329
=============== =============
90-DAY DELINQUENCIES:
Originated residential mortgage $ 3,315 $ 5,442
Home equity 348 126
Acquired residential 4,834 3,655
Other consumer 1,033 1,108
Commercial business 1,244 1,883
--------------- -------------
Total 90-day delinquencies $ 10,774 $ 12,214
=============== =============
ASSET QUALITY RATIOS:
Non-performing loans to loans 0.65% 0.72%
Non-performing assets to loans 0.70% 0.77%
Allowance for loan losses to loans 1.29% 1.30%
Net charge-offs in quarter to average loans 0.24% 0.28%
Allowance for loan losses to non-performing loans 196.67% 179.56%
Credit conditions in first quarter 2005 reflect continuation of the asset
quality within the Corporation's loan portfolios. Non-performing assets were
$24.8 million at March 31, 2005, a decline of $2.5 million from the level at
December 31, 2004. The decline in non-performing assets was due to the
resolution of non-performing commercial business and commercial real estate
construction loans during the quarter. Non-performing commercial business loans
include $1.3 million of loans that have U.S. government guarantees.
The level of non-performing assets to total loans was 0.70% at March 31, 2005
compared to 0.77% at December 31, 2004. The level of 90-day delinquent loans
also declined during the quarter, decreasing $1.4 million, or 12%, to $10.8
million. No assurance can be given regarding the level of non-performing assets
in the future.
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22
The Corporation maintains an allowance for loan losses ("the allowance"), which
is intended to be management's best estimate of probable inherent losses in the
outstanding loan portfolio. The allowance is reduced by actual credit losses and
is increased by the provision for loan losses and recoveries of previous losses.
The provisions for loan losses are charges to earnings to bring the total
allowance to a level considered necessary by management.
The allowance is based on management's continuing review and evaluation of the
loan portfolio. This process provides an allowance consisting of two components,
allocated and unallocated. To arrive at the allocated component of the
allowance, the Corporation combines estimates of the allowances needed for loans
analyzed individually and on a pooled basis. The allocated component of the
allowance is supplemented by an unallocated component.
The portion of the allowance that is allocated to individual internally
criticized and non-accrual loans is determined by estimating the inherent loss
on each problem credit after giving consideration to the value of underlying
collateral. Management emphasizes loan quality and close monitoring of potential
problem credits. Credit risk identification and review processes are utilized in
order to assess and monitor the degree of risk in the loan portfolio. The
Corporation's lending and credit administration staff are charged with reviewing
the loan portfolio and identifying changes in the economy or in a borrower's
circumstances which may affect the ability to repay debt or the value of pledged
collateral. A loan classification and review system exists that identifies those
loans with a higher than normal risk of uncollectibility. Each commercial loan
is assigned a grade based upon an assessment of the borrower's financial
capacity to service the debt and the presence and value of collateral for the
loan.
In addition to being used to categorize risk, the Bank's internal ten-point risk
rating system is used to determine the allocated allowance for the commercial
portfolio. Reserve factors, based on the actual loss history for a 5-year period
for criticized loans, are assigned. If the factor, based on loss history for
classified credits is lower than the minimum established factor, the higher
factor is applied. For pass rated credits, the factors are based on the rating
profile of the portfolio and the consequent historic losses of bonds with
equivalent ratings.
For the consumer portfolios, the determination of the allocated allowance is
conducted at an aggregate, or pooled, level. Each quarter, historical rolling
loss rates for homogenous pools of loans in these portfolios provide the basis
for the allocated reserve. For any portfolio where the Bank lacks sufficient
historic experience, industry loss rates are used. If recent history is not
deemed to reflect the inherent losses existing within a portfolio, older
historic loss rates during a period of similar economic or market conditions are
used.
The Bank's credit administration group adjusts the indicated loss rates based on
qualitative factors. Factors that are considered in adjusting loss rates include
risk characteristics, credit concentration trends and general economic
conditions, including job growth and unemployment rates. For commercial and real
estate portfolios, additional factors include the level and trend of watched and
criticized credits within those portfolios; historic loss rates, commercial real
estate vacancy, absorption and rental rates; and the number and volume of
syndicated credits, construction loans, or other portfolio segments deemed to
carry higher levels of risk. Upon completion of the qualitative adjustments, the
overall allowance is allocated to the components of the portfolio based on the
adjusted loss factors.
The unallocated component of the allowance exists to mitigate the imprecision
inherent in management's estimates of expected credit losses and includes its
judgmental determination of the amounts necessary for concentrations, economic
uncertainties and other subjective factors that may not have been fully
considered in the allocated allowance. The relationship of the unallocated
component to the total allowance may fluctuate from period to period. Although
management has allocated the majority of the allowance to specific loan
categories, the evaluation of the allowance is considered in its entirety.
Lending management meets at least quarterly with executive management to review
the credit quality of the loan portfolios and to evaluate the allowance. The
Corporation has an internal risk analysis and review staff that continuously
reviews loan quality and reports the results of its reviews to executive
management and the Board of Directors. Such reviews also assist management in
establishing the level of the allowance.
Management believes that it uses the best information available to make
determinations about the allowance and that it has established its existing
allowance in accordance with GAAP. If circumstances differ substantially from
21
23
the assumptions used in making determinations, adjustments to the allowance may
be necessary and results of operations could be affected. Because events
affecting borrowers and collateral cannot be predicted with certainty, there can
be no assurance that increases to the allowance will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed above.
The FDIC examines the Bank periodically and, accordingly, as part of this exam,
the allowance is reviewed for adequacy utilizing specific guidelines. Based upon
their review, the regulators may from time to time require reserves in addition
to those previously provided.
At March 31, 2005, the allowance was $45.6 million, or 1.29% as a percentage of
total loans outstanding, compared to an allowance at December 31, 2004 of $46.2
million, or 1.30% as a percentage of total loans outstanding. The allowance
coverage increased to 197% of non-performing loans at March 31, 2005 compared to
180% at December 31, 2004. Portfolio-wide net charge-offs represented 0.24% of
average loans in first quarter 2005, down from 0.26% in first quarter 2004 and
0.28% in fourth quarter 2004.
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) 2005 2004 Variance Variance
-------------- ------------- ------------- ------------
Transaction accounts:
Noninterest-bearing $ 791,747 $ 567,530 $ 224,217 39.5 %
Interest-bearing 520,013 449,735 70,278 15.6
Savings/money market:
Savings 749,080 715,265 33,815 4.7
Money market 533,176 467,537 65,639 14.0
Certificates of deposit:
Direct 798,065 652,280 145,785 22.4
Brokered 373,809 218,863 154,946 70.8
-------------- ------------- -------------
Total deposits $ 3,765,890 $ 3,071,210 $ 694,680 22.6
============== ============= =============
Deposits by source:
Consumer $ 2,660,397 $ 2,358,903 $ 301,494 12.8
Commercial 731,684 493,444 238,240 48.3
Brokered 373,809 218,863 154,946 70.8
-------------- ------------- -------------
Total deposits $ 3,765,890 $ 3,071,210 $ 694,680 22.6
============== ============= =============
Average deposits increased $695 million, or 23%, in first quarter 2005 over the
same quarter last year. Demand accounts represented the largest increase of $294
million, or 29%. Average money market, savings, and time deposits accounts
represented the remaining increase over the prior year's quarter. Average
brokered deposits also increased over the 2004 first quarter, driven by an
increase in callable brokered deposits acquired in the merger, as well as
brokered deposits issued during the year as a less expensive alternative to
borrowing.
22
24
Provident's Virginia franchise continues to be a significant component of its
business focus. For the quarter, consumer and commercial deposits in the
Washington metropolitan and Virginia markets increased 54% and 104%,
respectively, representing increases in all deposit categories. The 30 branches
added from the Southern Financial merger facilitated the growth in deposits for
the year. The Virginia franchise has grown to 83 branches, or 56% of total
branches, in the key metropolitan markets of Washington and Richmond.
Total average consumer deposits increased 13% in first quarter 2005 over first
quarter 2004. Average consumer demand account balances increased 18%, from $670
million in the 2004 first quarter, to $793 million in 2005. Average consumer
certificates of deposit increased 18% and average consumer money market and
savings deposits increased 6% over the prior year quarter. Commercial deposits
increased 48% over the prior year quarter with average demand account balances,
money market balances and certificates of deposit representing the areas of
growth. The increase in the commercial deposit portfolios over the 2004 first
quarter also reflects the benefits derived from Southern Financial's focus on
commercial banking in Virginia.
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, 2005, the investment securities portfolio was $2.2 billion, or 33%
of total assets. 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.
Typically, management classifies securities as available for sale to maximize
management flexibility, although securities may be purchased with the intention
of holding to maturity.
To achieve its stated objective, 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
("ABS"). At March 31, 2005, 68% of the investment portfolio was invested in MBS.
The ABS portfolio, representing 20% of the total portfolio, consists
predominately of Aaa and single A rated tranches of pooled trust preferred
securities. Other debt securities primarily include investments in single issuer
corporate bonds rated investment-grade by Moody's or S&P, and U.S. Treasury,
Agency, and municipal securities.
The primary risk in the investment portfolio is duration risk. Duration measures
the expected change in the market value 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. Another risk in the investment portfolio is credit
risk. At March 31, 2005, over 78% of the entire investment portfolio was rated
AAA, 21% was investment grade below AAA, and 1% was rated below investment grade
or was not rated. The allocation to single A rated floating rate ABS was
increased by 3%, or $61 million, in anticipation of rising short-term interest
rates.
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. If 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. The
Corporation had a limited number of securities in a continuous loss position for
12 months or more at March 31, 2005. Because the declines in fair value were due
to changes in market interest rates, not in estimated cash flows, no other than
temporary impairment was recorded at March 31, 2005.
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 and 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")
23
25
borrowings, securities sold under repurchase agreements ("repos"), and brokered
and jumbo certificates of deposit ("CDs"). FHLB borrowings and repos typically
are borrowed at rates approximating 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. Brokered CDs are generally added when market
conditions permit issuance at rates favorable to other funding sources.
The Corporation formed wholly owned statutory business trusts in 1998, 2000 and
2003. In 2004, the Corporation acquired three wholly owned statutory business
trusts from Southern Financial as part of the merger. In all cases, the trusts
issued trust preferred securities that were sold to outside third parties. The
trust preferred securities are presented net of unamortized issuance costs as
Long-Term Debt in the Consolidated Statements of Condition and are includable in
Tier 1 capital for regulatory capital purposes, subject to certain limitations.
Any of the trust preferred securities are redeemable at any time in whole, but
not in part, from the date of issuance on the occurrence of certain events. On
March 31, 2005, the Corporation redeemed $30 million aggregate value of capital
securities issued by Provident Trust II at an annual rate of 10%.
Average borrowings increased $207 million in first quarter 2005 from first
quarter 2004. Average repo balances increased $149 million, representing
commercial customer cash management products. Average trust preferred balances
increased $23 million due to trust preferred securities acquired as part of the
merger. Average fed funds decreased $27 million, reflecting management's
intentions to match fund more of the Bank's prime-based loan portfolio with
these borrowings. Average FHLB borrowings increased $92 million; offsetting
runoff of higher cost pre-merger brokered CDs. During first quarter 2005, the
Bank restructured $36 million of debt, extinguishing FHLB borrowings. A loss of
$51 thousand was incurred in connection with the transactions.
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 either be 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, 2005, $1.6
billion of secured borrowings were employed, with sufficient collateral
available to immediately raise an additional $655 million. An excess liquidity
position of $464 million remains after covering $191 million of unsecured funds
that mature in the next three 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, 2005, the Bank possessed over $880 million of overnight
borrowing capacity, of which only $140 million was in use at period-end. The
brokered CD and unsecured debt markets, which generally are more expensive than
secured funds of similar maturity, are also viable funding alternatives. In
first quarter 2005, the Bank issued $41 million of brokered CDs at favorable
pricing levels.
As an alternative to raising secured funds, the Bank can raise liquidity through
asset sales. At March 31, 2005, 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 $1.8 billion consumer loan portfolio is saleable in an efficient market.
A significant use of the Corporation's liquidity is the dividends it pays to
shareholders. 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
24
26
stock, and after providing for due or accrued expenses, losses, interest and
taxes. These dividends paid to the holding company 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.
CONTRACTUAL OBLIGATIONS, COMMITMENTS AND OFF BALANCE SHEET ARRANGEMENTS
The Corporation has various contractual obligations, such as long-term
borrowings, that are recorded as liabilities in the Consolidated Financial
Statements. Other items, such as certain minimum lease payments for the use of
banking and operations offices under operating lease agreements, are not
recognized as liabilities in the Consolidated Financial Statements, but are
required to be disclosed. Each of these arrangements affects the Corporation's
determination of sufficient liquidity.
The following table summarizes significant contractual obligations at March 31,
2005 and the future periods in which such obligations are expected to be settled
in cash. In addition, the table reflects the timing of principal payments on
outstanding borrowings.
Contractual Payments Due by Period
-----------------------------------------------------------------------------------------
(in thousands) Less
than 1 1-3 4-5 After 5
Year Years Years Years Total
--------------- -------------- -------------- -------------- ----------------
Lease obligations $ 13,266 $ 23,488 $ 18,910 $ 30,842 $ 86,506
Long-term debt 365,128 493,173 111,977 154,252 1,124,530
-----------------------------------------------------------------------------------------
Total $ 378,394 $ 516,661 $ 130,887 $ 185,094 $ 1,211,036
=========================================================================================
Arrangements to fund credit products or guarantee financing take the form of
loan commitments (including lines of credit on revolving credit structures) and
letters of credit. Approvals for these arrangements are obtained in the same
manner as loans. Generally, cash flows, collateral value and a risk assessment
are considered when determining the amount and structure of credit arrangements.
Commitments to extend credit in the form of consumer, commercial real estate and
business loans at March 31, 2005 were as follows:
March 31,
(in thousands) 2005
--------------
Commercial business and real estate $ 773,919
Consumer revolving credit 544,030
Residential mortgage credit 23,756
Performance standby letters of credit 103,035
Commercial letters of credit 1,262
--------------
Total loan commitments $ 1,446,002
==============
Historically, many of the commitments expire without being fully drawn;
therefore, the total commitment amounts do not necessarily represent future cash
requirements.
25
27
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 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, including asset/liability mismatch, basis
and prepayment risk.
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. 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.
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 both short and
long term interest rates. 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, 2005 for the March 31, 2005 data and on January 1, 2005 for
the December 31, 2004 data 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 in the periods presented, a 200 basis point drop in rate is
unlikely and has not been shown.
At March 31, 2005 At December 31, 2004
Projected Projected
Percentage Change in Percentage Change in
Interest Rate Scenario Net Interest Income Net Interest Income
--------------------------------- ---------------------------------- ---------------------------------
-100 basis points -4.0% -3.4%
No change -- --
+100 basis points +3.0% +1.4%
+200 basis points +4.0% +1.6%
The isolated modeling environment, assuming no action by management, shows that
the Corporation's net interest income volatility is less than 4.1% 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.
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The Corporation increased its asset sensitivity position slightly from year-end
2004 by replacing fixed rate mortgage backed securities with floating rate ABS.
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 $400 million have been employed
which reset their rates monthly or quarterly based on the level of long-term
interest rates - specifically, the 10-year constant maturity swap rate - rather
than short-term rates, to offset the effect of mortgage prepayments on asset
yields. There is a high correlation between changes in the 10-year constant
maturity swap rate and the 30-year mortgage rate. Additionally, $549 million
notional amount in interest rate swaps were in force to reduce interest rate
risk, and $300 million of interest rate caps were employed to protect the
interest margin from rising interest rates.
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, therefore the Bank has
chosen not to engage in a significant amount of this type of lending. 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. Generally improving economic
conditions result in improved operating results on the part of commercial
customers, enhancing their ability to meet debt service requirements. However,
this improvement in operating cash flow is often at least partially offset by
rising interest rates often seen in an improving economic environment. In
addition, changing economic conditions often impact various business segments
differently, giving rise to the need to manage industry concentrations within
the loan portfolio.
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.
In addition to impacting individual lending decisions, this analysis may also
determine the aggregate level of commitments the Corporation is willing to
extend to an individual customer or a group of related customers.
CAPITAL RESOURCES
Total stockholders' equity was $613 million at March 31, 2005, a decline of $4
million from December 31, 2004. The change in stockholders' equity for the
period was attributable to $18.1 million in earnings that was more than offset
by dividends paid of $8.6 million, or $0.265 per share and a decrease of $10.5
million in net accumulated other comprehensive income (loss). Net accumulated
other comprehensive income (loss) decreased due primarily to a decrease in
market value of available for sale securities. Capital was also reduced by $4.7
million from the repurchase of 136,324 shares of the Corporation's common stock
at an average price of $34.77. The Corporation is authorized to repurchase an
additional 472,891 shares under its stock repurchase program.
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29
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) 2005 2004
--------------- --------------
Total equity capital per consolidated financial statements $ 613,379 $ 617,439
Qualifying trust preferred securities 134,000 164,000
Minimum pension liablity (1,365) (1,365)
Accumulated other comprehensive loss 11,461 964
--------------- --------------
Adjusted capital 757,475 781,038
Adjustments for tier 1 capital:
Goodwill and disallowed intangible assets (268,315) (269,078)
--------------- --------------
Total tier 1 capital 489,160 511,960
--------------- --------------
Adjustments for tier 2 capital:
Allowance for loan losses 45,639 46,169
Allowance for letter of credit losses 514 474
--------------- --------------
Total tier 2 capital adjustments 46,153 46,643
--------------- --------------
Total regulatory capital $ 535,313 $ 558,603
=============== ==============
Risk-weighted assets $ 4,353,188 $ 4,346,973
Quarterly regulatory average assets 6,171,886 6,198,284
Minimum
Regulatory To be "Well
Ratios: Requirements Capitalized"
------------------------------------------
Tier 1 leverage 7.93 % 8.26 % 4.00 % 5.00 %
Tier 1 capital to risk-weighted assets 11.24 11.78 4.00 6.00
Total regulatory capital to risk-weighted assets 12.30 12.85 8.00 10.00
On April 30, 2004, as a result of the Southern Financial merger, regulatory
capital increased as a result of the $251 million of equity capital issued as
part of the merger transaction, the inclusion of $23 million of Southern
Financial's trust preferred securities and the increased allowance for loan
losses. These additions were partially offset by the $261 million of additional
goodwill and other intangible assets arising from the merger that are deducted
from regulatory capital.
On March 31, 2005, the Corporation redeemed $30.0 million in aggregate principal
amount of 10% trust preferred securities of Provident Trust II. The trust
preferred securities had a final stated maturity of March 31, 2030, but were
callable at par beginning on March 31, 2005.
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RESULTS OF OPERATIONS
OVERVIEW
Provident's continued focus on financial fundamentals produced strong results
for the quarter. The Corporation recorded net income of $18.1 million or $0.54
per diluted share in the quarter ended March 31, 2005 compared to $12.9 million
and $0.51 per diluted share in first quarter 2004, representing increases over
first quarter 2004 of 41% and 6%, respectively. Provident continued to show
improvement in its financial fundamentals with key performance measures showing
improvement over first quarter 2004. Return on assets was 1.14% and the
efficiency ratio was 62.00% in first quarter 2005 compared to 0.99% and 65.53%,
respectively, in first quarter 2004. Operating results from the merger with
Southern Financial have been included for the entire first quarter 2005.
Solid loan growth in key business segments and the effects of the Southern
Financial merger augmented first quarter results. Improved earnings included an
increase of $11.6 million in the net interest margin, a $0.8 million decrease in
the provision for loan losses and a $1.7 million increase in non-interest
income, which were partially offset by a $6.9 million increase in non-interest
expense and a $2.0 million increase in income tax expense, resulting in a $5.2
million increase in net income from first quarter 2004.
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.
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31
CONSOLIDATED AVERAGE BALANCES AND ANALYSIS OF CHANGES IN TAX EQUIVALENT NET INTEREST INCOME
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
---------------------------------------------------------------------------
Three Months Ended Three Months Ended
March 31, 2005 March 31, 2004
----------------------------------- -----------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
(tax-equivalent basis) Balance Expense Rate Balance Expense Rate
------------ ---------- ------- ----------- ---------- --------
ASSETS:
Interest-earning assets:
Originated residential $ 97,550 $ 1,694 7.04 % $ 74,932 $ 1,310 7.03 %
Home equity 724,721 9,352 5.23 519,019 6,132 4.75
Acquired residential 542,295 7,791 5.83 604,064 9,008 6.00
Marine 432,891 5,583 5.23 463,706 6,047 5.24
Other consumer 38,250 771 8.17 44,361 870 7.89
Commercial mortgage 484,661 7,172 6.00 321,943 4,340 5.42
Residential construction 259,940 3,886 6.06 169,767 2,026 4.80
Commercial construction 281,705 3,914 5.63 216,648 2,015 3.74
Commercial business 680,837 10,590 6.31 395,614 5,420 5.51
------------ ----------- ----------- ----------
Total loans 3,542,850 50,753 5.81 2,810,054 37,168 5.32
------------ ----------- ----------- ----------
Loans held for sale 6,093 88 5.86 4,149 64 6.20
Short-term investments 8,671 43 2.01 1,592 2 0.51
Taxable investment securities 2,156,984 24,321 4.57 2,076,515 22,534 4.36
Tax-advantaged investment securities 12,995 231 7.21 16,799 298 7.13
------------ ----------- ----------- ----------
Total investment securities 2,169,979 24,552 4.59 2,093,314 22,832 4.39
------------ ----------- ----------- ----------
Total interest-earning assets 5,727,593 75,436 5.34 4,909,109 60,066 4.92
------------ ----------- ----------- ----------
Less: allowance for loan losses (46,051) (35,576)
Cash and due from banks 127,760 118,671
Other assets 616,048 238,582
------------ -----------
Total assets $ 6,425,350 $ 5,230,786
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand/money market deposits $ 1,053,189 2,208 0.85 $ 917,272 1,330 0.58
Savings deposits 749,080 540 0.29 715,265 510 0.29
Direct time deposits 798,065 4,476 2.27 652,280 3,322 2.05
Brokered time deposits 373,809 2,964 3.22 218,863 3,452 6.34
Short-term borrowings 837,946 4,473 2.16 670,195 1,578 0.95
Long-term debt 1,174,439 10,266 3.55 1,135,984 10,948 3.88
------------ ----------- ----------- ----------
Total interest-bearing liabilities 4,986,528 24,927 2.03 4,309,859 21,140 1.97
------------ ----------- ----------- ----------
Noninterest-bearing demand deposits 791,747 567,530
Other liabilities 27,336 20,974
Stockholders' equity 619,739 332,423
------------ -----------
Total liabilities and stockholders'
equity $ 6,425,350 $ 5,230,786
============ ===========
Net interest-earning assets $ 741,065 $ 599,250
============ ===========
Net interest income (tax-equivalent) 50,509 38,926
Less: tax-equivalent adjustment (188) (203)
----------- ----------
Net interest income $ 50,321 $ 38,723
=========== ==========
Net yield on interest-earning assets 3.58 % 3.19 %
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32
CONSOLIDATED AVERAGE BALANCES AND ANALYSIS OF CHANGES IN TAX EQUIVALENT NET INTEREST INCOME (CONTINUED)
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
-----------------------------
2005/2004
----------------------------------------------------- Income/Expense Variance
2005/2004 Increase/(Decrease) Due to Change In
----------------------------------------------------- -----------------------------
(dollars in thousands) Average % Income/ % Average Average
(tax-equivalent basis) Balance Change Expense Change Rate Volume
-------------- --------- ------------ ------------- --------------- ------------
ASSETS:
Interest-earning assets:
Originated residential $ 22,618 30.2 % $ 384 29.3 % $ 2 $ 382
Home equity 205,702 39.6 3,220 52.5 656 2,564
Acquired residential (61,769) (10.2) (1,217) (13.5) (266) (951)
Marine (30,815) (6.6) (464) (7.7) (18) (446)
Other consumer (6,111) (13.8) (99) (11.4) 30 (129)
Commercial mortgage 162,718 50.5 2,832 65.3 494 2,338
Residential construction 90,173 53.1 1,860 91.8 616 1,244
Commercial construction 65,057 30.0 1,899 94.2 1,192 707
Commercial business 285,223 72.1 5,170 95.4 865 4,305
-------------- ------------
Total loans 732,796 26.1 13,585 36.6
-------------- ------------
Loans held for sale 1,944 46.9 24 37.5 (4) 28
Short-term investments 7,079 444.7 41 2,050.0 16 25
Taxable investment securities 80,469 3.9 1,787 7.9 986 801
Tax-advantaged investment securities (3,804) (22.6) (67) (22.5) 3 (70)
-------------- ------------
Total investment securities 76,665 3.7 1,720 7.5
-------------- ------------
Total interest-earning assets 818,484 16.7 15,370 25.6 5,206 10,164
-------------- ------------
Less: allowance for loan losses (10,475) 29.4
Cash and due from banks 9,089 7.7
Other assets 377,466 158.2
--------------
Total assets $ 1,194,564 22.8
==============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand/money market deposits $ 135,917 14.8 878 66.0 663 215
Savings deposits 33,815 4.7 30 5.9 9 21
Direct time deposits 145,785 22.4 1,154 34.7 382 772
Brokered time deposits 154,946 70.8 (488) (14.1) (2,229) 1,741
Short-term borrowings 167,751 25.0 2,895 183.5 2,423 472
Long-term debt 38,455 3.4 (682) (6.2) (1,025) 343
-------------- ------------
Total interest-bearing liabilities 676,669 15.7 3,787 17.9 567 3,220
-------------- ------------
Noninterest-bearing demand deposits 224,217 39.5
Other liabilities 6,362 30.3
Stockholders' equity 287,316 86.4
--------------
Total liabilities and stockholders'
equity $ 1,194,564 22.8
==============
Net interest-earning assets $ 141,815 23.7
==============
Net interest income (tax-equivalent) 11,583 29.8 $ 4,639 $ 6,944
Less: tax-equivalent adjustment 15 (7.4)
------------
Net interest income $ 11,598 30.0
============
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33
The net interest margin, on a tax-equivalent basis, increased 39 basis points to
3.58% and was driven by continued solid growth in lending activities. Average
loan growth of $733 million drove average earning assets up to $5.7 billion
during the quarter. The yield on earning assets correspondingly increased as a
result of the loan growth which more than offset the increase in funding costs.
In addition, higher yielding investment securities were purchased with proceeds
from sales of investment securities during the quarter.
Net interest income on a tax-equivalent basis was $50.5 million in first quarter
2005, compared to $38.9 million in first quarter 2004. Total interest income
increased $15.4 million and total interest expense increased $3.8 million. The
overall improvement in net interest income and the net yield is partially a
result of the addition of Southern Financial's assets and liabilities for first
quarter 2005.
The yield on earning assets was 5.34% in first quarter 2005, a 42 basis point
increase from 4.92% in first quarter 2004. A higher ratio of average loans to
investment securities and the benefits derived from the addition of the Southern
Financial loan portfolio resulted in the higher interest income.
The average rate paid on interest-bearing liabilities increased 6 basis points
to 2.03% in first quarter 2005, from 1.97% in first quarter 2004. The decline in
the average rate paid was primarily due to lower rate callable brokered CDs
acquired in the merger that replaced higher rate brokered CDs that matured
during the period. Interest expense benefited further from a $224 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 Corporation, interest income decreased by $287
thousand and interest expense decreased by $1.1 million, for a total increase of
$863 thousand in net interest income relating to derivative transactions for the
quarter ended March 31, 2005.
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's underwriting and collection efforts, as well as aggressive
management of potential problem loans resulted in a provision for loan losses of
$1.6 million in first quarter 2005 compared to $2.4 million in first quarter
2004. Net charge-offs were $2.1 million, or 0.24% of average loans, in first
quarter 2005 compared to $1.8 million, or 0.26% of average loans, in first
quarter 2004. Acquired residential loan net charge-offs as a percentage of
average acquired residential loans continued to decline during the period, from
0.83% in first quarter 2004 to 0.47% in first quarter 2005.
NON-INTEREST INCOME
Non-interest income grew 7% to $25.3 million, up from $23.6 million in the first
quarter 2004. Deposit fee income increased 4%, reflecting increases in consumer
and commercial deposit fees. Virtually all of the increase in consumer deposit
fees was from the addition of the Southern Financial account base, as well as
debit card fee income, which increased 39%. As with many of the Bank's peers,
consumer deposit fees are being negatively impacted by decreases in checking
transactions and decreases in NSF activity during the quarter. Other
non-interest income also included $1.5 million of proceeds related to cash
surrender value insurance policies maintained by the Corporation.
Net losses were $776 thousand in first quarter 2005, compared to net gains of
$816 thousand in first quarter 2004. First quarter 2005 included
investment/borrowing transactions that were focused on improving future interest
yield performance. These transactions generated net losses of $876 thousand from
the sales of securities and net losses of $51 thousand from the extinguishment
of $36 million of FHLB borrowings. The proceeds from the sales were used to
purchase investment securities at higher yields. The disposition of loans and
foreclosed properties, which occur in the ordinary course of business, generated
net gains of $151 thousand in 2005.
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NON-INTEREST EXPENSE
Non-interest expense of $47.5 million for first quarter 2005 was $6.9 million
higher than first quarter 2004. Of this increase, approximately $4.4 million was
attributable to the Corporation's expansion activities, including its merger
with Southern Financial. The growth in non-interest expense, other than that
which was impacted by expenses relating to expansion, was $2.5 million.
Non-interest expense included the impact of $1.4 million in professional fees
for services rendered in first quarter 2005 relating to 2004 compliance with the
Sarbanes-Oxley Act of 2002. Also included in non-interest expense was a
reduction of $1.6 million related to the termination of the Corporation's
postretirement benefits plan, which was communicated to participants in March
2005.
INCOME TAXES
The Corporation accounts for income taxes under the asset/liability method.
Deferred tax assets and liabilities are recognized for the future consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases, as well as
operating loss and tax credit carryforwards. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period indicated by the enactment date. A
valuation allowance is established against deferred tax assets when in the
judgment of management, it is more likely than not that such deferred tax assets
will not become realizable. The judgment about the level of future taxable
income is dependent to a great extent on matters that may at least in part, be
beyond the Bank's control. It is at least reasonably possible that management's
judgment about the need for a valuation allowance for deferred taxes could
change in the near term. The valuation allowance was $1.8 million at March 31,
2005 versus $1.7 million at December 31, 2004.
The Corporation recorded income tax expense of $8.4 million based on pre-tax
income of $26.6 million, representing an effective tax rate of 31.8% in first
quarter 2005. In first quarter 2004, the Corporation recorded a tax expense of
$6.4 million on pre-tax income of $19.3 million, an effective tax rate of 33.3%.
The effective tax rate declined due primarily to the impact of the Corporation's
increased investments in affordable housing credits and bank-owned life
insurance and its proceeds, as well as a decrease in state income tax expense.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding market risk at December 31, 2004, see "Interest
Sensitivity Management" and Note 9 to the Consolidated Financial Statements in
the Corporation's Form 10-K filed with the Securities and Exchange Commission on
March 16, 2005. The market risk of the Corporation has not experienced any
material changes as of March 31, 2005 from December 31, 2004. 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, 2005.
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, 2005 that has materially affected, or is reasonably
likely to materially affect, the Corporation's internal control over financial
reporting.
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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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During 1998, the Corporation initiated a stock repurchase program for its
outstanding stock. Under this plan the Corporation approved the repurchase of
specific additional amounts of shares without any specific expiration date. As
the Corporation fulfilled each specified repurchase amount, additional amounts
were approved. Most recently, on January 15, 2003, the Corporation approved an
additional stock repurchase of 1.0 million shares. Currently the maximum number
of shares remaining to be purchased under this plan is 472,891. All shares have
been repurchased pursuant to the publicly announced plan.
The following table provides certain information with regard to shares
repurchased by the Corporation in the first quarter of 2005.
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 - January 31 136,324 $ 34.77 136,324 472,891
February 1 - February 28 - - - 472,891
March 1 - March 31 - - - 472,891
---------------- ------------- ----------------- -----------------
Total 136,324 $ 34.77 136,324 472,891
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - NONE
ITEM 5. OTHER INFORMATION
The following disclosure would otherwise have been filed on Form 8-K under the
heading: "Item 1.01. Entry into a Material Definitive Agreement":
The Corporation has entered into change in control agreements with the following
executive officers: Gary N. Geisel, Kevin G. Byrnes, Richard J. Oppitz and
Dennis A. Starliper. These agreements, as modified on May 5, 2005, replace the
former agreements between the executives and the Corporation and the Bank. As in
the former agreements, following a change in control, if the executives are
involuntarily terminated other than for just cause (as defined in the
agreements) or if they terminate voluntarily under circumstances constituting
constructive termination (as defined in the agreements), they become entitled to
a cash payment equal to three times their average annual taxable compensation
for the five (5) consecutive taxable years preceding their termination date, as
reported on Box 1 of Form W-2, as well as continued life and medical insurance
for thirty-six months following termination. As modified, however, the
agreements exclude from the above definition of average annual compensation any
taxable compensation realized upon the vesting of restricted stock and the
exercise of stock options. The modified agreements also provide that the
executives may resign for any
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reason within one year after a change in control and receive a sum equal to one
half their base salary and continued life and medical coverage for six months
(or the cash equivalent).
ITEM 6. EXHIBITS
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 Amendment to the Articles of Incorporation of Provident
Bankshares Corporation (2)
(3.2) Fifth Amended and Restated By-Laws of Provident Bankshares
Corporation (3)
(10.1) Form of Change in Control Agreement between Provident Bankshares
Corporation and Gary N. Geisel, Kevin G. Byrnes, Richard J. Oppitz
and Dennis A. Starliper
(11.0) Statement re: Computation of Per Share Earnings (4)
(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
(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 Annual Report on Form 10-K
(File No. 0-16421) for the year ended December 31, 2004, filed with the
Commission on March 16, 2005.
(4) Included in Note 13 to the Unaudited Consolidated Financial Statements on
page 15 hereof.
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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 10, 2005 By /s/ GARY N. GEISEL
---------------------------------
Gary N. Geisel
Chairman of the Board
and Chief Executive Officer
Principal Financial Officer:
May 10, 2005 By /s/ DENNIS A. STARLIPER
---------------------------------
Dennis A. Starliper
Executive Vice President and
Chief Financial Officer
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EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------------ -----------------------------------------------------------------
10.1 Form of Change in Control Agreement
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