Back to GetFilings.com
1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission file number
December 31, 1997 0-16421
-----------------
PROVIDENT BANKSHARES CORPORATION
--------------------------------
(Exact name of Registrant as specified in its charter)
MARYLAND 52-1518642
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
114 EAST LEXINGTON STREET
BALTIMORE, MARYLAND 21202
(Address of principal executive offices) (zip code)
(410) 277-7000
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Title of each class
None
Name of each exchange on which registered
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, par value $1.00 per share
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 and 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
Yes /X/ No / /
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of January 30, 1998 was $725,616,271.
At January 30, 1998, the Registrant had 23,073,790 shares of $1.00 par
value common stock outstanding adjusted for a 2 for 1 stock split which occurred
on February 13, 1998 for stockholders of record at the close of business on
February 2, 1998.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
1
2
TABLE OF CONTENTS
PART I. Page
----
Item 1. Business 3
Item 2. Properties 4
Item 3. Legal Proceedings 4
Item 4. Submission of Matters to a Vote of
Security Holders 4
PART II.
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters 4
Item 6. Selected Financial Data 5
Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations 6
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk 24
Item 8. Financial Statements and Supplementary Data 24
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 47
PART III.
Item 10. Directors and Executive Officers of the
Registrant* 47
Item 11. Executive Compensation* 47
Item 12. Security Ownership of Certain Beneficial
Owners and Management* 47
Item 13. Certain Relationships and Related
Transactions* 47
PART IV.
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K 47
Signatures 48
*Incorporated by reference from Registrant's definitive Proxy Statement for the
Annual Meeting of Stockholders to be held April 15, 1998, for which a Proxy
Statement will be filed not later than 120 days after the end of the fiscal year
covered by this Annual Report on Form 10-K.
2
3
PART I
ITEM 1. BUSINESS
Provident Bankshares Corporation ("the Corporation"), a Maryland corporation,
was organized in 1987 by the management of Provident Bank of Maryland ("the
Bank"), and registered as a bank holding company under the Bank Holding Company
Act of 1956. Through a reorganization dated December 22, 1987, the Corporation
became the sole stockholder of the Bank. The reorganization allowed the Bank to
convert from a Maryland chartered mutual savings bank, the form in which it had
operated since 1886, to a Maryland chartered stock commercial bank. At December
31, 1997, the Bank was the second largest commercial bank chartered under the
laws of the State of Maryland in terms of assets. For the discussion regarding
lending and investment activities as well as sources of funds of the
Corporation, see pages 13 through 19.
MORTGAGE BANKING ACTIVITIES
Provident Mortgage Corp. ("PMC"), a subsidiary of the Bank, was formed in 1992
to offer a broad range of mortgage lending products to consumers and thereby
enhance the Corporation's mortgage banking operations.
BANKING SERVICES ACTIVITIES
Provident Investment Center, Inc. ("PIC"), a subsidiary of the Bank, provides
consumers a competitive range of banking products, such as purchased annuities
and mutual funds.
INSURANCE ACTIVITIES
BankSure Insurance Corporation ("BankSure"), a subsidiary of the Bank, offers
insurance products to its loan customers and thereby enhances the Bank's lending
product lines.
REAL ESTATE ACTIVITIES
The Bank owns approximately 49,000 square feet of real estate adjacent to the
Corporation's headquarters building. Management plans to utilize this real
estate to meet future space requirements of the Corporation.
EMPLOYEES
At December 31, 1997, the Corporation and its subsidiaries had 1,235 employees.
The Corporation currently maintains what management considers to be a
comprehensive, competitive employee benefits program. Employees are not
represented by a collective bargaining unit and management considers its
relationship with its employees to be good.
COMPETITION
The Corporation encounters substantial competition in all areas of its business.
There are three commercial banks based in Maryland with deposits in excess of $1
billion. Additionally, there are three banks with deposits in excess of $1
billion operating in Maryland which have headquarters in other states. The Bank
also faces competition from savings and loan associations, savings banks,
mortgage banking companies, credit unions, insurance companies, consumer finance
companies, money market and mutual funds and various other financial services
firms.
Current federal law allows acquisitions of bank holding companies
nationwide. Further, Maryland law in some instances allows acquisitions among
banks in Maryland with banks in other states, provided that the other
jurisdiction has approved reciprocal interstate banking legislation. As a
consequence of these developments, competition in the Bank's principal market
may increase, and a consolidation of financial institutions in Maryland may
occur.
REGULATION
The Corporation is registered as a bank holding company, under the Bank Holding
Company Act of 1956. As such, the Corporation is subject to regulation and
examination by the Federal Reserve Board, and is required to file periodic
reports and any additional information that the Federal Reserve Board may
require. The Bank Holding Company Act imposes certain restrictions upon the
Corporation regarding the acquisition of substantially all of the assets of or
direct or indirect ownership or control of any bank of which it is not already
the majority owner; or, with certain exceptions, of any company engaged in
nonbanking activities.
The Bank is subject to supervision, regulation and examination by the Bank
Commissioner of the State of Maryland and the Federal Deposit Insurance
Corporation. Asset growth, deposits, reserves, investments, loans, consumer law
compliance, issuance of securities, payment of dividends, establishment of
branches, mergers and consolidations, changes in control, electronic funds
transfer, management practices and other aspects of operations are subject to
regulation by the appropriate federal and state supervisory authorities. The
Bank is also subject to various regulatory requirements of the Federal Reserve
Board applicable to FDIC insured depository institutions.
MONETARY POLICY
The Corporation and the Bank are affected by fiscal and monetary
policies of the federal government, including those of the Federal Reserve
Board, which regulates the national money supply in order to mitigate
recessionary and inflationary pressures. Among the techniques available to the
Federal Reserve Board are engaging in open market transactions of U.S.
Government securities, changing the discount rate and changing reserve
requirements against bank deposits. These techniques are used in varying
combinations to influence the overall growth of bank loans, investments and
deposits. Their use may also affect interest rates charged on loans and paid on
deposits. The effect of governmental policies on the earnings of the Corporation
and the Bank cannot be predicted.
3
4
ITEM 2. PROPERTIES
In December 1990, the Bank sold its corporate headquarters located at 114 East
Lexington Street, Baltimore, Maryland, and simultaneously leased back these
facilities for an initial twelve year lease term.
The majority of the Bank's 81 offices are located in the
Baltimore/Washington metropolitan area and southern Pennsylvania. The Bank owns
12 and leases 69 of its offices. Most of these leases provide for the payment of
property taxes and other costs by the Bank and include one or more renewal
options ranging from five to ten years. Some of the leases also contain a
purchase option.
In 1993, the Bank renewed a long-term agreement to lease a one-story
building large enough to consolidate operations and support functions. The Bank
currently leases all of the building's 80,000 square feet of space.
ITEM 3. LEGAL PROCEEDINGS
Refer to Note 13 of Item 8. -- "Financial Statements and Supplementary Data" on
page 43.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None
PART II.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The common stock of Provident Bankshares Corporation is traded over-the-counter
and is quoted in the NASDAQ Stock Market. Such over-the-counter market
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions. The NASDAQ
symbol is PBKS. The trading range of Provident's common stock for the years 1997
and 1996 is shown in the table of Consolidated Quarterly Results of Operations,
Market Prices and Dividends contained on page 12 of Management's Discussion and
Analysis (Item 7). At January 30, 1998, there were approximately 3,300 holders
of record of the Corporation's common stock.
For the year 1997, the Corporation declared and paid dividends of $.44 per
share of common stock outstanding. See Note 11 of Notes to Consolidated
Financial Statements of Provident Bankshares Corporation and Subsidiaries for a
discussion of the effect of the liquidation account of the Bank on the ability
of the Corporation to pay dividends. Certain provisions of Maryland banking law
impose limitations on the amount of dividends payable by the Corporation, but
none is as restrictive as the liquidation account.
4
5
ITEM 6. SELECTED FINANCIAL DATA
Table 1
Year Ended December 31,
- ---------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data) 1997 1996 1995 1994 1993
=================================================================================================================================
Interest Income (tax-equivalent) $ 280,167 $ 248,311 $ 224,236 $ 172,351 $ 156,717
Interest Expense 156,718 137,354 122,819 82,254 74,981
- ---------------------------------------------------------------------------------------------------------------------------------
Net Interest Income (tax-equivalent) 123,449 110,957 101,417 90,097 81,736
Provision for Loan Losses 9,953 10,011 1,517 (678) 2,845
- ---------------------------------------------------------------------------------------------------------------------------------
Net Interest Income After Provision for Loan Losses 113,496 100,946 99,900 90,775 78,891
Non-Interest Income 41,672 44,509 34,573 29,122 28,097
Net Securities Gains (Losses) 2,337 5,556 (2,683) 695 2,951
Merger Related Expenses (1) 10,047 -- -- -- --
Non-Interest Expense 107,816 110,323 97,416 95,164 89,843
- ---------------------------------------------------------------------------------------------------------------------------------
Income Before Taxes and Cumulative
Effect of Change in Accounting Principle 39,642 40,688 34,374 25,428 20,096
Income Tax Expense (tax-equivalent) 14,683 14,500 12,242 9,263 6,863
Cumulative Effect of Change in Accounting Principle (2) -- -- -- -- 777
- ---------------------------------------------------------------------------------------------------------------------------------
Net Income $ 24,959 $ 26,188 $ 22,132 $ 16,165 $ 14,010
=================================================================================================================================
Per Share Amounts:
Net Income Before Cumulative Effect of
Change in Accounting Principle $ 1.10 $ 1.18 $ 1.02 $ .82 $ .69
Cumulative Effect of Change in Accounting Principle (2) -- -- -- -- .04
- ---------------------------------------------------------------------------------------------------------------------------------
Net Income-- Basic $ 1.10 $ 1.18 $ 1.02 $ .82 $ .73
Net Income-- Diluted 1.06 1.12 .97 .77 .69
=================================================================================================================================
Cash Dividends Paid $ .44 $ .35 $ .26 $ .18 $ .13
=================================================================================================================================
Tax-Equivalent Adjustment (3) $ 1,055 $ 832 $ 754 $ 417 $ 317
=================================================================================================================================
Total Assets $3,926,739 $3,485,618 $3,170,390 $2,842,050 $2,366,199
Total Stockholders' Equity 270,182 238,798 223,048 184,358 164,915
Return on Average Assets .68% .79% .75% .66% .62%
Return on Average Equity 9.91 11.41 10.88 9.55 9.38
Stockholders' Equity to Assets 6.88 6.85 7.04 6.49 6.97
Average Equity to Average Assets 6.89 6.91 6.85 6.95 6.65
Dividend Payout Ratio 41.51 31.25 26.80 23.38 18.84
- ---------------------------------------------------------------------------------------------------------------------------------
(1) Merger Related Expenses -- Exclusive of after tax merger related expenses incurred during 1997, net income would have been
$33.6 million. Return on average assets and return on average equity for 1997 would have been .92% and 13.34%, respectively.
Basic earnings per share and diluted earnings per share would have been $1.48 and $1.43, respectively.
(2) In 1993 the cumulative effect of change in accounting principle included an $1,510 ($.08 per share) income tax benefit and
a $733 ($.04 per share) cost of purchased mortgage servicing rights.
(3) Tax-advantaged income has been adjusted to a tax-equivalent basis using the combined statutory federal and state income tax
rate in effect of 39.55% in 1997-1994 and 38.62% in 1993.
5
6
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 and its subsidiaries for the three years ended December 31, 1997.
The outlook for the Corporation based upon current trends and actions taken
during the year is also included. This discussion and tabular presentations
should be read in conjunction with the accompanying financial statements and
notes.
Provident Bankshares Corporation ("the Corporation"), through its wholly
owned subsidiary, Provident Bank of Maryland ("the Bank"), offers consumer and
commercial banking services throughout central Maryland. The Bank offers related
financial services through its wholly owned subsidiaries, including mortgages
through Provident Mortgage Corp. (PMC), and mutual funds and annuities through
Provident Investment Center (PIC). During 1997, the Corporation acquired First
Citizens Financial Corporation and the acquisition was accounted for as a
pooling-of-interest, accordingly, results for the reporting periods have been
restated.
Before merger related costs, the Corporation recorded operating results in
1997 of $33.6 million or $1.43 per share-diluted, a 27% increase over the $26.2
million or $1.12 (adjusted for the 1997 5% stock dividend and 2 for 1 stock
split in February 1998) per share-diluted earned in 1996. The growth in net
earnings was attributable to a $12.3 million rise in net interest income, lower
provision for loan losses and a $2.5 million decrease in operating costs, net of
merger expenses. These were partially offset by a $6.1 million decrease in
non-interest income. These variances are discussed in more detail beginning on
the following pages.
FINANCIAL TRENDS
The graphs below illustrate Provident's performance during the past five years.
The amounts and ratios for 1997 exclude the $8.7 million after-tax impact of
merger related expenses.
[GRAPHS APPEAR HERE]
- --------------------------------------------------------------------------------
RETURN ON AVERAGE ASSETS
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
.62% .66% .75% .79% .92%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
RETURN ON AVERAGE EQUITY
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
9.38% 9.55% 10.88% 11.41% 13.34%
- ------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ASSETS (in billions)
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
$2.25 $2.43 $2.97 $3.32 $3.66
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE EQUITY (in millions)
1993 1994 1995 1996 1997
------ ------ ------ ------ ------
$149.4 $169.2 $203.5 $229.5 $252.0
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NET INCOME (in millions)
1993 1994 1995 1996 1997
------- ------- ------- ------- -------
$14.010 $16.165 $22.132 $26.188 $33.610
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
CASH DIVIDENDS PER SHARE (in dollars)
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
$.13 $.18 $.26 $.35 $.44
Cash Dividends Per Share
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
EARNINGS PER SHARE (in dollars)
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
$.69 $.77 $.97 $1.12 $1.43
Diluted Earnings Per Share
RESULTS OF OPERATIONS
- ---------------------
NET INTEREST INCOME
The Corporation's principal source of revenue is net interest income, the
difference between interest income on earning assets and interest expense on
deposits and borrowings. Interest income, for purposes of analysis, is presented
on a tax-equivalent basis to recognize associated tax benefits as this
presentation provides a basis for comparison of yields with taxable earning
assets. The discussion on net interest income should be read in conjunction with
Table 2 -- "Analysis of Changes in Net Interest Income" and Table 3 --
"Consolidated Average Balances, Interest Income and Expense and Yields and
Rates."
Tax-equivalent net interest income for 1997 increased $12.5 million or
11.3% from 1996 as average earning assets grew $341 million over the prior year.
Net interest margin grew by 2 basis points primarily caused by an $18 million
increase in non-interest bearing liabilities.
Provident's interest income increased $31.9 million or 12.8% during the
year primarily due to the growth in average earning assets plus a 15 basis point
increase in yield. The increase in yield was mainly due to a continued shift out
of investments into higher yielding loans. The increase in average earning
assets resulted from a $422 million increase in the loan portfolios offset by a
decline of $50 million in investments and $30 million in loans held for sale.
Consumer loans grew $349 million while the commercial business and real estate
mortgage portfolios also experienced growth of $25 million and $47 million,
respectively. Interest income earned on the loan portfolio increased $35.1
million reflecting higher loan outstandings. The yield on investments and loans
increased 23 basis points and 1 basis point, respectively. Interest lost from
non-accruing loans was $523 thousand compared to $440 thousand in 1996.
Interest expense increased $19.4 million from 1996 resulting from a $292
million growth in average interest bearing liabilities. The overall cost of
funds increased 14 basis points during 1997 as costs on total interest bearing
liabilities increased 17 basis points. Excluding the effect of off-balance sheet
positions in each year, total costs of interest bearing liabilities would have
increased 9 basis points. The average rate paid on borrowed funds increased 16
basis points during 1997.
The increase in average interest bearing liabilities reflects a $298
million rise in interest bearing deposits, $201 million of which is associated
with matched maturity brokered deposits and $62 million with money market
certificates of deposit. Non-interest bearing demand deposit accounts grew by
$18 million or 11%. The Corporation experienced a $6 million drop in borrowed
funds.
Future growth in net interest income will depend upon consumer and
commercial loan demand and the general level of interest rates. Please refer to
the section entitled "Interest Sensitivity Management" on page 21 for further
discussion of the impact of current trends on net interest income in 1997.
6
7
ANALYSIS OF CHANGES IN NET INTEREST INCOME
Table 2
1997/1996 1996/1995
------------------------------------------ -------------------------------------------
Variance Due To Change In Variance Due To Change In
---------------------------------- ------------------------------------
(in thousands) Net Increase/ Average Average Average Net Increase/ Average Average Average
(tax-equivalent basis) (Decrease) Rate Volume Rate/Volume (Decrease) Rate Volume Rate/Volume
========================================================================================================================
INTEREST INCOME FROM:
Loans:
Consumer $28,447 $ 195 $28,187 $ 65 $ 28,483 $(1,760) $ 31,214 $(971)
Commercial Business 1,800 (354) 2,187 (33) 5,154 (1,421) 7,117 (542)
Real Estate - Construction 394 293 99 2 3,277 (690) 4,285 (318)
Real Estate - Mortgage 4,414 627 3,736 51 (21,473) 1,321 (22,355) (439)
Mortgage Loans Held for Sale (2,099) 206 (2,213) (92) (278) (220) (61) 3
Other Short-Term Investments (175) (47) (143) 15 17 (54) 81 (10)
U.S. Treasury and Government
Agencies and Corporations (995) 258 (1,211) (42) 2,152 240 1,829 83
Mortgage-Backed Securities 1,127 2,227 (1,063) (37) 10,902 (1,088) 12,244 (254)
Municipal Securities 514 (43) 582 (25) 255 (20) 283 (8)
Other Debt Securities (1,287) 175 (1,394) (68) (4,698) 154 (4,763) (89)
Equity Securities (284) - (284) - 284 - 284 -
- ------------------------------------------------------------------------------------------------------------------------
Total Interest Income 31,856 4,873 26,464 519 24,075 (2,942) 27,376 (359)
- ------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE ON:
Demand/Money Market Deposits 338 (287) 642 (17) (109) (1,759) 1,960 (310)
Savings Deposits 3,350 3,407 (48) (9) 1,658 2,068 (362) (48)
Certificates of Deposit 14,424 (1,022) 15,747 (301) 8,221 (275) 8,548 (52)
Individual Retirement Accounts 156 (159) 323 (8) (250) (210) (41) 1
Short-Term Borrowings (865) 999 (1,803) (61) 33 (2,168) 2,375 (174)
Long-Term Debt 1,961 332 1,602 27 4,982 619 4,190 173
- ------------------------------------------------------------------------------------------------------------------------
Total Interest Expense 19,364 5,063 13,793 508 14,535 304 14,196 35
- ------------------------------------------------------------------------------------------------------------------------
Net Interest Income $12,492 $ (190) $12,671 $ 11 $ 9,540 $(3,246) $ 13,180 $(394)
========================================================================================================================
The table above analyzes the reasons for the changes from year-to-year in the principal elements that comprise net interest
income. The calculation of rate, volume and rate/volume variances is based upon a procedure established for banks by the
Securities and Exchange Commission. Rate, volume and rate/volume variances presented for each component will not total to
the variances presented on totals of interest income and interest expense because of shifts from year-to-year in the
relative mix of interest-earning assets and interest-bearing liabilities.
7
8
CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME AND EXPENSE AND YIELDS AND RATES
Provident Bankshares Corporation and Subsidiaries
Table 3
1997 1996
------------------------------- ------------------------------------
(dollars in thousands) Average Yield/ Income/ Average Yield/ Income/
(tax-equivalent basis) Balance Rate Expense Balance Rate Expense
=================================================================================================================
ASSETS
INTEREST-EARNING ASSETS:
Loans: (2)
Consumer $1,402,359 8.09% $113,496 $1,053,279 8.07% $ 85,049
Commercial Business 292,788 8.75 25,607 268,158 8.88 23,807
Real Estate-- Construction 125,565 10.33 12,968 124,584 10.09 12,574
Real Estate-- Mortgage 624,604 8.04 50,227 577,515 7.93 45,813
---------- -------- ---------- --------
Total Loans (1) 2,445,316 8.27 202,298 2,023,536 8.26 167,243
---------- -------- ---------- --------
Mortgage Loans Held for Sale 37,662 7.57 2,851 68,112 7.27 4,950
Federal Funds Sold and Securities
Purchased Under Resale Agreements -- -- -- -- -- --
Other Short-Term Investments 6,023 4.37 263 8,949 4.89 438
U.S. Treasury and Government
Agencies and Corporations 90,709 7.10 6,437 108,368 6.86 7,432
Corporate Securities -- -- -- -- -- --
Mortgage-Backed Securities 914,196 7.06 64,531 929,786 6.82 63,404
Municipal Securities 18,875 8.01 1,512 11,917 8.37 998
Other Debt Securities 28,174 8.07 2,275 46,277 7.70 3,562
Equity Securities -- -- -- 2,983 9.52 284
---------- -------- ---------- --------
Total Investment Securities (2) 1,051,954 7.11 74,755 1,099,331 6.88 75,680
---------- -------- ---------- --------
Trading Account Securities -- -- -- -- -- --
---------- -------- ---------- --------
Total Interest-Earning Assets 3,540,955 7.91 280,167 3,199,928 7.76 248,311
---------- -------- ---------- --------
Less: Allowance for Loan Losses (33,017) (27,985)
Cash and Due From Banks 57,923 55,568
Other Assets 89,650 92,621
---------- ----------
Total Assets $3,655,511 $3,320,132
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
INTEREST-BEARING LIABILITIES:
Demand/Money Market Deposits $ 403,128 2.81 11,347 $ 380,913 2.89 11,009
Savings Deposits 620,267 3.30 20,450 621,995 2.75 17,100
Certificates of Deposit 1,194,202 5.69 67,917 922,616 5.80 53,493
Individual Retirement Accounts 111,252 5.65 6,290 105,680 5.80 6,134
Short-Term Borrowings 505,640 5.68 28,737 538,434 5.50 29,602
Long-Term Debt 360,862 6.09 21,977 334,120 5.99 20,016
---------- -------- ---------- --------
Total Interest-Bearing Liabilities 3,195,351 4.90 156,718 2,903,758 4.73 137,354
---------- -------- ---------- --------
Noninterest-Bearing Demand Deposits 176,645 158,635
Other Liabilities 31,555 28,253
Stockholders' Equity 251,960 229,486
---------- ----------
Total Liabilities and Stockholders'
Equity $3,655,511 $3,320,132
---------- ----------
Net Interest-Earning Assets $ 345,604 $ 296,170
---------- ----------
Net Interest Income (tax-equivalent) 123,449 110,957
Less: Tax-Equivalent Adjustment (1,055) (832)
-------- --------
Net Interest Income $122,394 $110,125
-------- --------
Net Yield on Interest-Earning
Assets (tax-equivalent) 3.49% 3.47%
(1) Average loan balances include non-accrual loans.
(2) Tax-advantaged income has been adjusted to a tax-equivalent basis using the combined statutory
federal and state income tax rate in effect of 39.55% in 1997 - 1994 and 38.62% in 1993.
8
9
1995 1994 1993
------------------------------- ------------------------------------ ---------------------------------
Average Yield/ Income/ Average Yield/ Income/ Average Yield/ Income/
Balance Rate Expense Balance Rate Expense Balance Rate Expense
===================================================================================================================
$ 678,734 8.33% $ 56,566 $ 525,796 7.78% $ 40,925 $ 442,822 8.00% $ 35,412
194,094 9.61 18,653 176,511 8.56 15,109 163,974 7.75 12,706
85,277 10.90 9,297 91,299 9.23 8,430 107,055 8.43 9,029
864,852 7.78 67,286 806,403 7.50 60,475 518,754 7.92 41,067
---------- --------- ---------- -------- ---------- ---------
1,822,957 8.33 151,802 1,600,009 7.81 124,939 1,232,605 7.97 98,214
---------- --------- ---------- -------- ---------- ---------
68,920 7.59 5,228 93,133 6.97 6,489 122,311 6.74 8,248
-- -- -- 565 3.19 18 367 2.72 10
7,496 5.62 421 323 5.26 17 -- -- --
80,488 6.56 5,280 67,555 6.35 4,292 58,727 6.85 4,025
-- -- -- 19,961 7.08 1,414 123,692 5.36 6,631
753,963 6.96 52,502 534,685 6.53 34,914 582,595 6.80 39,589
8,634 8.61 743 3,371 7.95 268 -- -- --
109,308 7.56 8,260 -- -- -- -- -- --
-- -- -- -- -- -- -- -- --
---------- --------- ---------- -------- ---------- ---------
952,393 7.01 66,785 625,572 6.54 40,888 765,014 6.57 50,245
---------- --------- ---------- -------- ---------- ---------
-- -- -- -- -- -- 14,188 -- --
---------- --------- ---------- -------- ---------- ---------
2,851,766 7.86 224,236 2,319,602 7.43 172,351 2,134,485 7.34 156,717
---------- --------- ---------- -------- ---------- ---------
(27,299) (28,753) (28,984)
53,379 44,797 36,741
90,322 97,784 102,966
---------- ---------- ----------
$2,968,168 $2,433,430 $2,245,208
========== ========== ==========
$ 323,836 3.43 11,118 $ 356,642 2.81 10,011 $ 334,848 2.82 9,426
636,908 2.42 15,442 646,063 2.88 18,618 598,713 3.17 19,005
776,089 5.83 45,272 553,399 4.59 25,402 555,084 4.71 26,118
106,370 6.00 6,384 103,671 5.45 5,655 106,136 5.60 5,948
498,399 5.93 29,569 269,968 4.69 12,663 290,521 3.60 10,454
261,295 5.75 15,034 205,795 4.81 9,905 87,165 4.62 4,030
---------- --------- ---------- -------- ---------- ---------
2,602,897 4.72 122,819 2,135,538 3.85 82,254 1,972,467 3.80 74,981
---------- --------- ---------- -------- ---------- ---------
129,740 107,112 93,342
32,064 21,549 30,013
203,467 169,231 149,386
---------- ---------- ----------
$2,968,168 $2,433,430 $2,245,208
========== ========== ==========
$ 248,869 $ 184,064 $ 162,018
========== ========== ==========
101,417 90,097 81,736
(754) (417) (317)
--------- -------- ---------
$ 100,663 $ 89,680 $ 81,419
========= ======== =========
3.56% 3.88% 3.83%
9
10
PROVISION FOR LOAN LOSSES
The provision for loan losses, net of the merger related portion, decreased $2.7
million to $7.4 million in 1997. During 1996 the Corporation incurred a $5
million write-off attributed to a single commercial credit. Without this
write-off, the provision in 1996 would have been approximately $5.0 million.
Total loans outstanding grew by $453 million. The Corporation continues to
emphasize quality underwriting as well as aggressive management of prior
charge-offs and potential problem loans.
Net charge-offs were $3.5 million in 1997 compared to $7.2 million in 1996.
The decrease is mainly associated with the single commercial credit in 1996
noted above. Net charge-offs as a percentage of average loans was .14% in 1997.
Non-accrual loans ended the year at $9.9 million, a decrease of $5.0 million
from December 31, 1996. This decrease is mainly associated with the change in
policy to no longer place consumer loans on non-accrual status but to charge-off
such loans at 120 days and 180 days delinquent for installment loans and
revolving credits, respectively. This change in policy was made to conform with
standard industry practice.
A further discussion of the allowance for loan losses, net charge-offs and
non-performing assets appears on pages 15-18.
NON-INTEREST INCOME
Non-interest income is principally derived from fee-based services, mortgage
banking activities and gains on investment securities sales. Total non-interest
income decreased 12.1% to $44.0 million. Excluding net securities gains
(losses), non-interest income decreased $2.8 million or 6.4%. Table 4 presents a
comparative analysis of the major components of non-interest income.
NON-INTEREST INCOME SUMMARY
Table 4
(in thousands) 1997 1996 1995 1994 1993
=====================================================================================================
Service Charges on Deposit Accounts $24,432 $19,262 $13,685 $ 8,734 $ 6,254
Mortgage Banking Activities 6,845 14,895 9,806 14,696 11,763
Commissions and Fees 3,705 3,229 2,101 3,223 1,738
Trading Account Profits - - - - 416
Credit Card Fees - - - - 426
Other Loan Fees 2,147 1,872 1,208 1,261 1,443
Interest Income on Tax Refund - - 5,796 - -
Gain on Sale of Credit Card Portfolio - - - - 4,389
Other Non-Interest Income 4,543 5,251 1,977 1,208 1,668
- -----------------------------------------------------------------------------------------------------
Subtotal 41,672 44,509 34,573 29,122 28,097
Net Securities Gains (Losses) 2,337 5,556 (2,683) 695 2,951
- -----------------------------------------------------------------------------------------------------
Total Non-Interest Income $44,009 $50,065 $31,890 $29,817 $31,048
=====================================================================================================
Deposit service charges rose 27% over the prior year due to a $3.3 million
increase in retail demand deposit service fees, $1.1 million increase in ATM
fees and a $588 thousand increase in commercial deposit fees. Interest-bearing
demand/money market deposits grew $27 million or 6.8% over last year while
noninterest-bearing deposits increased $27 million or 15.2%. These increases are
the result of continued promotion and sales efforts of retail deposit products.
Income from mortgage banking activities decreased $8.0 million, $1.5
million due to lower gains on the sale of mortgage servicing rights, $3.0
million in lower gains from sale of mortgage loans and $2.0 million from lower
origination income. Mortgage originations during the year declined $68 million
to $396 million. The changes resulted primarily from the interruptions of
closing sales offices and shifting to a more indirect origination business.
Provident Investment Center (PIC), a wholly owned subsidiary of the Bank
offers annuities and mutual funds through an affiliation with a securities
broker-dealer. For the year 1997, income associated with these products
increased by $384 thousand to $2.2 million. This increase is attributed to
concentrated sales efforts towards these products.
Loan fees increased $275 thousand from 1996, all associated with retail
loan fees. This increase is tied to an increase in loan volume.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards (SFAS) No. 125/127 -- "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" which became
effective for the Corporation in 1997. The Statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. This Statement did not have any material affect
on the results of the Corporation.
NON-INTEREST EXPENSE
Non-interest expense is composed primarily of costs associated with employees'
salaries and benefits, bank facilities, external data processing and regulatory
fees. Provident's non-interest expense of $108 million (net of merger expenses)
represented a 2% decrease from 1996. Table 5 presents a comparative summary of
the major components of non-interest expense.
10
11
NON-INTEREST EXPENSE SUMMARY
Table 5
(in thousands) 1997 1996 1995 1994 1993
===================================================================================================
Salaries and Employee Benefits $ 54,107 $ 55,406 $50,875 $51,149 $50,040
Occupancy Expense, Net 10,018 9,317 8,914 8,305 7,877
Furniture & Equipment 7,354 7,036 6,625 5,486 5,068
External Processing Fees 12,374 10,929 7,784 6,729 5,152
Advertising and Promotion 5,678 5,986 5,562 5,042 4,635
Communication & Postage 3,693 3,861 3,050 2,702 2,051
Printing & Supplies 2,277 2,351 2,032 1,586 1,552
Federal Insurance Fund Recapitalization - 3,029 - - -
Regulatory Fees 1,016 1,699 3,095 4,357 4,223
Professional Services 2,762 3,000 2,621 2,590 2,287
Merger Related Expenses 10,047 - - - -
Other Non-Interest Expense 8,537 7,709 6,858 6,675 6,958
- ---------------------------------------------------------------------------------------------------
Total Non-Interest Expense $117,863 $110,323 $97,416 $94,621 $89,843
===================================================================================================
Salaries and benefits decreased $1.3 million during the year. Compensation
decreased $729 thousand while benefits were down $570 thousand. The decline in
these categories is attributable to the change in the mortgage banking business
from predominately retail to wholesale and savings associated with the merger.
Full time equivalent employees for the year were 1,235 compared to 1,459 last
year. Occupancy costs grew $701 thousand or 7.5% over last year. This increase
is mainly due to additional rent and leasehold improvements as the branch
network increased to 66 branches in 1997, with five new in-store locations.
Total furniture and equipment expense increased $318 thousand due to upgrading
of technology in the Bank's office automation and branch platform systems.
External processing increased $1.4 million or 13%, associated with increased
account volume. Regulatory fees declined $3.9 million, mainly associated with a
one-time SAIF special assessment of $3.0 million paid by Citizens Saving Bank in
the third quarter of 1996.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs using two digits rather
than four to define the applicable year. Any of the Corporation's computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions.
The Corporation utilizes a third party processor for the majority of its
data processing requirements. Provident is working with this servicer as well as
with all of the Corporation's other significant suppliers of data processing
software and hardware. The Corporation presently believes that timely
modifications to existing software and or hardware will neutralize the Year 2000
Issue.
The Corporation will utilize both internal and external resources to
reprogram, or replace, and test the software for Year 2000 modifications. The
Corporation plans to complete the Year 2000 project by December 31, 1998. The
total cost of the Year 2000 project is not expected to exceed $1.0 million and
is not expected to have a material effect on the results of operations.
The costs of the project and the date on which the Corporation plans to
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, and similar uncertainties.
INCOME TAXES
Provident recorded income tax expense of $13.6 million on pre-tax income of
$38.6 million for an effective tax rate of 35.3%. This compares with a 34.3%
effective tax rate for 1996. This increase is related to permanent tax
differences associated with the merger of First Citizens Financial Corporation
offset in part by a lower effective state income tax rate.
FOURTH QUARTER RESULTS
Provident recorded net income of $9.0 million, or $.37 per share on a diluted
basis, in the fourth quarter of 1997, an increase of $1.4 million, or 18%, over
the $7.7 million, or $.33 per share on a diluted basis, recorded in the same
period last year. The higher earnings are principally due to a 7.5% increase in
net interest income, higher non-interest income and lower operating expenses. A
higher loan loss provision as a result of loan growth and a rise in the
effective tax rate partially offset these increases.
Tax-equivalent net interest income in the fourth quarter rose $2.2 million
to $31.1 million as the net interest margin declined 6 basis points to 3.39% and
average earning assets grew $311 million to $3.64 billion. The decrease in the
net interest margin primarily
11
12
reflected a higher cost of borrowed funds as well as the effect of the
amortization of closed off-balance sheet transactions.
The Corporation recorded a provision for loan losses of $2.7 million during
the quarter to provide for loan growth in the portfolio.
Non-interest income increased 4.5 percent to $12.1 million. The increase is
derived from fee-based services as a result of higher account volumes, security
gains and increased fees and commissions. Fee income from deposit accounts
increased $1.2 million and net security gains increased $1.3 million. These
increases were partially offset by lower mortgage banking income and lower other
non-interest income mainly associated with the successful settlement of
litigation during the fourth quarter of 1996.
Non-interest expense decreased $427 thousand to $27.1 million mainly
because of lower salaries and benefits expense of $664 thousand. External
processing costs rose $230 thousand due to increased account volume and
occupancy expense increased $289 thousand.
Table 6 presents quarterly trend data for 1997 and 1996.
CONSOLIDATED QUARTERLY RESULTS OF OPERATIONS, MARKET PRICES AND DIVIDENDS
(UNAUDITED)
Table 6
1997 1996
-------------------------------------- -----------------------------------
Fourth Third Second First Fourth Third Second First
(in thousands, except per share data) Quarter Quarter (1) Quarter Quarter Quarter Quarter Quarter Quarter
==========================================================================================================================
Interest Income $72,043 $71,475 $69,106 $66,488 $65,263 $63,354 $60,459 $58,403
Interest Expense 41,250 39,912 38,623 36,933 36,617 35,197 33,214 32,326
- --------------------------------------------------------------------------------------------------------------------------
Net Interest Income 30,793 31,563 30,483 29,555 28,646 28,157 27,245 26,077
Provision for Loan Losses 2,736 4,330 2,053 834 2,250 1,705 509 5,547
- --------------------------------------------------------------------------------------------------------------------------
Net Interest Income After Provision
for Loan Losses 28,057 27,233 28,430 28,721 26,396 26,452 26,736 20,530
Non-Interest Income 10,328 10,479 10,598 10,267 11,094 12,363 10,729 10,323
Net Securities Gains (Losses) 1,769 230 267 71 478 42 (38) 5,074
Merger Related Expenses (1) - 10,047 - - - - - -
Non-Interest Expense 27,118 26,987 26,909 26,802 27,545 30,216 26,514 26,048
- --------------------------------------------------------------------------------------------------------------------------
Income Before Taxes 13,036 908 12,386 12,257 10,423 8,641 10,913 9,879
Income Tax Expense 4,026 882 4,392 4,328 2,772 3,241 4,161 3,494
- --------------------------------------------------------------------------------------------------------------------------
Net Income $ 9,010 $ 26 $ 7,994 $ 7,929 $ 7,651 $ 5,400 $ 6,752 $ 6,385
==========================================================================================================================
Per Share Amounts: (1)
Net Income - Basic $ .39 $ .00 $ .35 $ .35 $ .34 $ .24 $ .30 $ .29
Net Income - Diluted $ .37 $ .00 $ .34 $ .34 $ .33 $ .23 $ .29 $ .28
Market Prices: High 32.13 29.82 20.82 20.42 18.64 16.85 16.07 15.25
Low 24.00 20.69 17.00 18.34 16.05 15.12 14.74 12.53
Cash Dividends Paid .12 .11 .11 .10 .10 .09 .08 .08
==========================================================================================================================
(1) Merger Related Expenses - Exclusive of $8.6 million after-tax merger related expenses incurred during the third
quarter of 1997, net income would have been $8.7 million. Third quarter basic and diluted earnings per share would
have been $.38.
12
13
FINANCIAL CONDITION
- -------------------
SOURCE AND USE OF FUNDS
DEPOSITS
This graph reflects the steady growth in deposits over the respective years.
[GRAPH APPEARS HERE]
- --------------------------------------------------------------------------------
DEPOSITS (in billions)
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
$1.72 $1.91 $2.06 $2.29 $2.75
- --------------------------------------------------------------------------------
A major portion of Provident's funding comes from core deposits which
consists of consumer and commercial transaction accounts and consumer savings
and time deposits. These deposits are generated through the Bank's 66 branch
banking locations. At December 31, 1997, core deposits represented 73% of total
deposits and 55% of total liabilities. Provident's future funding growth is
expected to be generated from deposit growth through strategies outlined below.
The branch network strategy includes traditional full service branch
locations supplemented with in-store branches. In-store branch locations are
comprised of supermarket locations and national retail superstores. Provident
Bank of Maryland as of December 31, 1997 had 51 traditional branch locations and
15 in-store branches. The Corporation has an agreement with FOODARAMA
Corporation to operate branches in their Metro and Basic supermarkets in the
Baltimore metropolitan area. Provident will selectively look for additional
branch opportunities complementary to existing locations when the cost of entry
is reasonable. The Corporation has seven in-store branches planned for 1998.
Provident continues to attract increased commercial and retail deposits.
Interest bearing demand/money market deposit balances at December 31, 1997 were
up $26.7 million or 6.8% compared to year end 1996. The Bank also operates seven
Fast'n Friendly Check Cashing centers. The purpose of the check cashing centers
is to offer alternative banking services to a segment of our market place that
does not utilize traditional banking services. The Corporation has two new
centers planned for 1998.
This table presents the average deposit balances and rates paid for the five
years ended December 31, 1997.
AVERAGE DEPOSITS
Table 7
1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------------------------
Average Average Average Average Average Average Average Average Average Average
(dollars in thousands) Balance Rate Balance Rate Balance Rate Balance Rate Balance Rate
===================================================================================================================================
Noninterest-Bearing $ 176,645 __% $ 158,635 __% $ 129,740 __% $ 107,112 __% $ 93,342 __%
Money Market/Demand 403,128 2.81 380,913 2.89 323,836 3.43 356,642 2.81 334,848 2.82
Savings 620,267 3.30 621,995 2.75 636,908 2.42 646,063 2.88 598,713 3.17
Time:
Certificates of Deposit 1,194,202 5.69 922,616 5.80 776,089 5.83 553,399 4.59 555,084 4.71
Individual Retirement Accounts 111,252 5.65 105,680 5.80 106,370 6.00 103,671 5.45 106,136 5.60
---------- ---------- ---------- --------- ----------
Total Average Balance/Rate $2,505,494 4.23% $2,189,839 4.01% $1,972,943 3.96% $1,766,887 3.38% $1,688,123 3.58%
========== ========== ========== ========== ==========
Total Year-End Balance $2,754,515 $2,286,144 $2,056,436 $1,905,584 $1,719,148
========== ========== ========== ========== ==========
As the table above indicates, Provident has a stable base of consumer
savings deposits. During 1997, average deposits grew $316 million or 14.4%
compared to 1996. Average money market/demand deposits and non-interest bearing
deposits increased $40.2 million or 7.5%. This growth reflects Provident's
emphasis on full banking relationships with its retail and commercial customers.
Average time deposits increased $277 million or 27%, $201 million of which is
attributable to matched maturity brokered deposits and $62 million in money
market certificates of deposit. Brokered deposits are utilized as a cheaper
source of funds compared to other available sources of borrowed money.
The table below presents information at December 31, 1997, with respect to the
maturity of Certificates of Deposit of $100,000 or more.
DEPOSIT MATURITIES
Table 8
Maturities
------------------------------------------------------------
Three Months Over Three Months Over Six Months Over 12
(dollars in thousands) or Less to Six Months to 12 Months Months Total
======================================================================================================
Balance $53,980 $26,308 $34,297 $41,842 $156,427
Percent of Total 34.5% 16.8% 21.9% 26.8% 100.0%
13
14
CREDIT RISK MANAGEMENT
Much of the fundamental business of Provident is based upon understanding,
measuring and controlling credit risk. Credit risk entails both general risk,
which is 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. For example, loans with generally low credit
loss experience include home mortgage and home equity loans. Loans with medium
credit loss experience are primarily secured products such as auto and marine
loans. The category with high credit loss experience includes unsecured products
such as personal revolving credit. In commercial lending, losses as a percentage
of outstanding loans can vary widely from period to period and are particularly
sensitive to changing economic conditions. 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.
Policies and procedures have been developed which specify the appropriate
credit approval and monitoring for the various types of credit offered. The Bank
employs prudent lending practices and adheres to regulatory requirements
including loan to value ratios and legal lending limits. These procedures are
modified periodically in order to reflect changing conditions and new products.
The Bank's lending and loan administration staffs are charged with reviewing the
loan portfolio, 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. In order to assess and monitor the degree of risk in the loan
portfolio, credit risk identification and review processes are utilized. Credit
risk analysis assigns a grade to each commercial loan based upon an assessment
of the borrower's financial capacity to service the debt and the presence and
value of collateral for the loan. An independent loan review function tests risk
assessment and determines the adequacy of the allowance for loan losses.
Financial Accounting Standards require creditors to evaluate the
collectibility of contractually due principal and interest on commercial credits
to assess the need for providing for losses. The Corporation's credit procedures
require monitoring of commercial credits to determine the collectibility of such
credits. If a loan is identified as impaired, it will be placed on non-accrual
status and recorded according to accounting guidelines. As of December 31, 1997,
there were $2.9 million in commercial loans considered to be impaired.
LOANS
Provident offers a diversified mix of residential and commercial real estate,
business and consumer loans. As shown in table 9, the mix of loans outstanding
has shifted to more consumer orientation over the past five years.
[GRAPH APPEARS HERE]
- --------------------------------------------------------------------------------
LOANS (in billions)
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
$1.52 $1.71 $1.75 $2.25 $2.70
- --------------------------------------------------------------------------------
Provident's residential mortgage lending includes the origination, sale and
servicing of fixed and variable rate mortgage loans. Loans are originated
through the loan production offices of Provident Mortgage Corp. Financial
Accounting Standards for mortgage banking enterprises that acquire mortgage
servicing rights, and sells or securitizes those loans with servicing retained,
require the allocation of the cost of the mortgage loans to the mortgage
servicing rights and the loans. Mortgage origination activity in 1997 showed a
slightly lower volume as originations totaled $376 million in 1997 compared to
$413 million in 1996. In 1998, originations are projected to exceed 1997's
production as more emphasis is being placed on the wholesale segment of the
business. During 1997, income from the sale of loans was $3.2 million while $3.8
million was recognized from the sale of servicing assets. The mortgage servicing
portfolio ended the year at $656 million. The residential real estate mortgage
loan balance at December 31, 1997 was $362 million compared to $356 million at
the end of the prior year.
The following table sets forth information concerning the Bank's loan portfolio
by type of loan at December 31.
LOAN PORTFOLIO SUMMARY
Table 9
(dollars in thousands) 1997 % 1996 % 1995 % 1994 % 1993 %
====================================================================================================================================
Consumer $1,667,094 61.7% $1,211,971 54.0% $ 852,605 48.6% $ 540,141 31.6% $ 516,356 33.9%
Commercial Business 288,289 10.7 294,844 13.1 238,667 13.6 199,469 11.7 155,101 10.2
Real Estate -- Construction:
Residential 99,926 3.7 112,072 5.0 76,092 4.3 61,104 3.6 53,090 3.5
Commercial 25,154 .9 9,470 .4 19,444 1.1 26,869 1.6 52,491 3.4
Real Estate -- Mortgage:
Residential 362,012 13.4 355,566 15.8 332,940 19.1 655,052 38.3 529,367 34.7
Commercial 258,593 9.6 263,950 11.7 233,103 13.3 224,754 13.2 218,455 14.3
- ------------------------------------------------------------------------------------------------------------------------------------
Total Loans $2,701,068 100.0% $2,247,873 100.0% $1,752,851 100.0% $1,707,389 100.0% $1,524,860 100.0%
====================================================================================================================================
14
15
Provident offers a wide range of loans to consumers including installment
loans, home equity loans, and personal lines of credit. In addition, the Bank
may purchase portfolios of quality consumer loans from other financial
institutions. All purchased portfolios go through a thorough due diligence
process prior to a purchase commitment. Provident's portfolio of acquired loans
increased $245 million on average, ending the year at $861 million, and is
predominately comprised of second mortgages.
Consumer credit originated by Provident increased $104 million on average
during 1997, ending the year with a balance of $806 million. The majority of the
increase is from automobile and marine loans. Most of the automobile loans are
made through a network of auto dealerships in Maryland, Delaware, Pennsylvania
and Virginia. Average auto loans made through this network of dealerships grew
$60 million ending the year at $306 million. Average marine loan balances grew
$21 million during 1997 totaling $172 million at year-end, and were produced
primarily through correspondent brokers. Average home equity lines of credit
increased $13 million during the year and totaled $210 million at the end of
1997 while average direct second mortgage loans increased $13 million and ended
the year at $69 million.
Provident's focus in commercial real estate lending has been on financing
commercial and residential construction, as well as on intermediate-term
commercial mortgages. Properties securing the loans include office buildings,
shopping centers, apartment complexes, warehouses, residential building lots and
developments. Average commercial real estate mortgage loans increased $27
million or 11.4% while average commercial construction loans decreased $6
million or 31%. Average residential construction loans increased $7 million or
7% to end the year at $100 million.
Provident's commercial loan portfolio consists of general business loans,
including asset-based loans, primarily to small and medium sized businesses in
the Baltimore, Maryland and Washington, D.C. metropolitan areas. The Bank
stresses the importance of asset quality as well as the development of new
marketing programs. Average commercial loans grew by $25 million or 9% ending
the year at $288 million. Provident has minimal exposure to highly leveraged
transactions. HLTs totaled $33.3 million as of year-end, and all are performing
in accordance with their contractual terms.
NON-PERFORMING ASSETS AND PAST DUE LOANS
Non-performing assets include loans on which interest is no longer accrued,
renegotiated loans and real estate and other assets that have been acquired
through foreclosure or repossession. Past due loans are loans that are 90 days
or more past due as of December 31 and still accruing interest because they are
well secured and in the process of collection. Beginning in 1997, the
Corporation no longer places consumer loans on non-accrual status to better
conform to standard industry practice. Delinquent consumer loan outstandings and
any uncollected interest are generally charged-off at 120 days and 180 days,
respectively. Information with respect to non-performing assets and past due
loans is presented in Table 10 for the years indicated. As shown in the table,
total non-accrual loans decreased $5.0 million, mainly in the consumer loan
portfolio due to the change in policy as noted above, partially offset by
increases of $2.4 million and $2.6 million in the commercial business and
residential mortgage portfolios, respectively. The increase in past due consumer
loans is a result of a $455 million or 38% growth in the consumer loan
portfolio. As of December 31, 1997, non-performing assets and past due loans
ended the year at $12.7 million and $25.3 million, respectively. (See the
discussion under Loans) The $10.6 million in past due residential mortgage loans
are guaranteed or insured by an agency of United States government and no
significant loss is anticipated. The increase in non-performing commercial loans
was primarily the result of one commercial credit.
[GRAPH APPEARS HERE]
- --------------------------------------------------------------------------------
NON-PERFORMING LOANS (as a percentage of period-end loans)
Non-Performing Loans
-----------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
2.28% 1.12% .90% .84% .36%
Allowance for Loan Losses
-----------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
1.96% 1.59% 1.57% 1.35% 1.36%
- --------------------------------------------------------------------------------
The ratio of total non-performing loans to year-end loans declined from
.84% to .36% at the end of 1997. The decrease is mainly attributable to the
change in the consumer loan non-accrual policy.
Presented below is interest income that would have been recorded on all
non-accrual loans if such loans had been paid in accordance with their original
terms and the interest income on such loans that was actually collected for the
year.
Year Ended
(in thousands) December 31, 1997
- --------------------------------------------------------------------------------
Gross interest income that would have been
recorded had such loans been paid in
accordance with original terms $685
Interest income actually recorded 162
15
16
NON-PERFORMING ASSETS AND PAST DUE LOANS
Table 10
December 31,
- -----------------------------------------------------------------------------------------------
(dollars in thousands) 1997 1996 1995 1994 1993
===============================================================================================
Non-Accrual Loans:
Consumer $ -- $ 9,809 $ 4,868 $ 1,533 $ 1,300
Commercial Business 2,917 539 246 1,450 194
Real Estate -- Construction:
Residential -- 37 -- -- 2,069
Commercial -- -- 80 9,349 7,700
Real Estate -- Mortgage:
Residential 6,937 4,372 3,785 4,054 3,714
Commercial -- 125 1,327 -- --
- -----------------------------------------------------------------------------------------------
Total Non-Accrual Loans 9,854 14,882 10,306 16,386 14,977
- -----------------------------------------------------------------------------------------------
Renegotiated Loans:
Real Estate -- Construction:
Residential -- -- -- -- 1,452
Commercial -- -- 2,575 -- 9,182
Real Estate -- Mortgage:
Residential -- -- -- -- 2,198
Commercial -- 3,942 2,900 2,813 7,008
- -----------------------------------------------------------------------------------------------
Total Renegotiated Loans -- 3,942 5,475 2,813 19,840
- -----------------------------------------------------------------------------------------------
Other Non-Performing Assets:
Real Estate -- Construction:
Residential 454 132 6,580 11,824 16,322
Commercial -- 9,571 7,122 4,223 3,862
Real Estate -- Mortgage:
Residential 2,367 903 246 116 2,017
Commercial -- -- 939 177 5,797
- -----------------------------------------------------------------------------------------------
Total Other Non-Performing Assets 2,821 10,606 14,887 16,340 27,998
- -----------------------------------------------------------------------------------------------
Total Non-Performing Assets $12,675 $29,430 $30,668 $35,539 $62,815
===============================================================================================
Past Due Loans:
Consumer $14,371 $ 237 $ 559 $ 270 $ 121
Commercial Business 126 -- -- -- --
Real Estate -- Construction:
Residential 133 -- -- -- --
Commercial -- -- -- -- --
Real Estate -- Mortgage:
Residential 10,646 7,823 5,072 424 368
Commercial -- -- -- -- 3,087
- -----------------------------------------------------------------------------------------------
Total Past Due Loans $25,276 $ 8,060 $ 5,631 $ 694 $ 3,576
===============================================================================================
Ratios:
Total Non-Performing
Loans to Year-End Loans .36% .84% .90% 1.12% 2.28%
Total Non-Performing Assets
to Year-End Assets .32% .84% .97% 1.25% 2.65%
- -----------------------------------------------------------------------------------------------
16
17
ALLOWANCE FOR LOAN LOSSES
Provident maintains an allowance for loan losses which is available to absorb
potential losses. The allowance is reduced by actual credit losses and is
increased by the provision for loan losses and recoveries of previous losses.
Determination of the adequacy of the allowance, which is performed quarterly, is
accomplished by assigning specific reserves to individually identified problem
credits and general reserves, based on historic and anticipated loss experience,
to all other loans.
The following table reflects the allowance for possible loan losses and the
activity during each of the respective years.
LOAN LOSS EXPERIENCE SUMMARY
Table 11
(dollars in thousands) 1997 1996 1995 1994 1993
=============================================================================================================
Balance at Beginning of Year $ 30,361 $ 27,524 $ 27,137 $ 29,825 $ 28,210
Provision for Loan Losses 9,953 10,011 1,517 (678) 2,845
Loans Charged-Off:
Consumer 3,641 2,888 1,642 1,485 3,064
Commercial Business 143 5,170 310 204 325
Real Estate - Construction:
Residential 305 37 33 - -
Commercial 37 8 - 1,167 -
Real Estate - Mortgage:
Residential 289 360 73 53 15
Commercial 798 399 76 1,088 1,001
- -------------------------------------------------------------------------------------------------------------
Total Charge-Offs 5,213 8,862 2,134 3,997 4,405
- -------------------------------------------------------------------------------------------------------------
Recoveries:
Consumer 871 826 917 1,225 1,556
Commercial Business 882 801 72 376 1,214
Real Estate - Construction:
Residential - - - - 96
Commercial 1 16 - 385 277
Real Estate - Mortgage:
Residential 1 45 13 1 -
Commercial 5 - 2 - 32
- -------------------------------------------------------------------------------------------------------------
Total Recoveries 1,760 1,688 1,004 1,987 3,175
- -------------------------------------------------------------------------------------------------------------
Net Loans Charged-Off 3,453 7,174 1,130 2,010 1,230
=============================================================================================================
Balance at End of Year $ 36,861 $ 30,361 $ 27,524 $ 27,137 $ 29,825
=============================================================================================================
Balances:
Loans - Year-End $2,701,068 $2,247,873 $1,752,851 $1,707,389 $1,524,860
Loans - Average 2,445,316 2,023,536 1,822,957 1,600,009 1,232,605
Ratios:
Net Loans Charged-Off to Average Loans .14% .35% .06% .13% .10%
Allowance for Loan Losses
to Year-End Loans 1.36 1.35 1.57 1.59 1.96
- -------------------------------------------------------------------------------------------------------------
The continued emphasis on loan quality and close monitoring of potential
problem credits has resulted in a strong credit portfolio. Senior managers meet
at least monthly to review the credit quality of the loan portfolios and at
least quarterly with executive management to review the adequacy of the
allowance for loan losses. The allowance is determined by management's
evaluation of the composition and risk characteristics of the loan portfolio.
Based upon the evaluation of credit risk, provisions, in the form of charges to
operations, are made to bring the allowance up to a level management believes is
adequate.
An analysis of the loan portfolio was performed at December 31, 1997, and
expected losses have been provided for in the allowance for loan losses. During
1997 the loan loss allowance increased $6.5 million to $36.9 million at
year-end. The allowance as a percentage of total loans was 1.36% at December 31,
1997 compared to 1.35% at December 31, 1996. The allowance for loan losses as a
percentage of non-accrual loans was 374% at December 31, 1997, compared to 204%
the prior year. This increase is primarily attributable to the change in the
consumer loan accrual policy offset partially by increases in non-accrual loans
for commercial business and residential mortgage. The portion of the allowance
which is allocated to non-accrual loans is determined by estimating the
potential loss on each credit after giving consideration to the value of
underlying collateral.
17
18
Provident maintains a loan classification and review system to identify
those loans with a higher than normal risk of uncollectibility. Estimated
potential losses from internally criticized loans have been provided for in
determining the allowance for loan losses.
Table 12 reflects the allocation of the allowance for loan losses to the
various loan categories. The entire allowance for loan losses is available to
absorb losses from any type of loan.
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
Table 12
December 31,
- -----------------------------------------------------------------------------------------------
(dollars in thousands) 1997 1996 1995 1994 1993
===============================================================================================
Consumer $ 3,390 $ 4,572 $ 1,995 $ 708 $ 1,770
Commercial Business 8,376 3,120 2,527 2,579 2,693
Real Estate - Construction:
Residential 1,585 1,408 2,697 2,305 2,867
Commercial 384 883 545 3,143 5,479
Real Estate - Mortgage:
Residential 592 998 1,390 1,048 1,258
Commercial 2,486 2,704 3,803 3,054 2,905
Unallocated 20,048 16,676 14,567 14,300 12,853
- -----------------------------------------------------------------------------------------------
Total Allowance for Loan Losses $36,861 $30,361 $27,524 $27,137 $29,825
===============================================================================================
INVESTMENT SECURITIES
Provident's investment activities include management of the $983 million
investment securities portfolio. The investment securities portfolio includes
mortgage-backed securities, U.S. Government securities, municipal securities and
asset-backed securities. In addition to investment securities, the Corporation
invests in federal funds sold, reverse repos, mortgage loans held for sale and
other short-term investments (referred to in total as the investment portfolio).
The strategies employed in the management of these portfolios depend upon the
liquidity, interest sensitivity and capital objectives and requirements of the
Corporation. The Treasury Division executes these strategies.
The following table sets forth information concerning the Bank's investment
securities portfolio at December 31.
INVESTMENT SECURITIES SUMMARY
Table 13
(dollars in thousands) 1997 % 1996 % 1995 % 1994 % 1993 %
====================================================================================================================================
SECURITIES AVAILABLE FOR SALE
U.S. Treasury and Government
Agencies and Corporations $ 55,576 5.7% $ 71,882 6.8% $ 67,833 5.8% $ 33,156 3.5% $ 39,783 7.2%
Corporate Notes -- -- -- -- -- -- -- -- 54,907 9.9
Mortgage-Backed Securities 885,491 90.0 847,194 80.4 939,382 80.4 296,382 31.2 383,762 69.2
Municipal Securities 19,391 2.0 19,091 1.8 11,981 1.0 -- -- -- --
Other Debt Securities 22,783 2.3 29,987 2.8 76,073 6.5 100,531 10.6 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Securities Available
for Sale 983,241 100.0 968,154 91.8 1,095,269 93.7 430,069 45.3 478,452 86.3
- ------------------------------------------------------------------------------------------------------------------------------------
SECURITIES HELD TO MATURITY
U.S. Treasury and Government
Agencies and Corporations -- -- 32,395 3.1 13,397 1.2 34,569 3.6 8,679 1.6
Mortgage-Backed Securities -- -- 53,842 5.1 60,106 5.1 477,886 50.3 67,201 12.1
Municipal Securities -- -- -- -- -- -- 7,186 .8 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Securities Held to Maturity -- -- 86,237 8.2 73,503 6.3 519,641 54.7 75,880 13.7
- ------------------------------------------------------------------------------------------------------------------------------------
Total Investment
Securities Portfolio $983,241 100.0% $1,054,391 100.0% $1,168,772 100.0% $949,710 100.0% $554,332 100.0%
====================================================================================================================================
Total Portfolio Yield 7.0% 6.9% 6.9% 6.7% 6.5%
- ------------------------------------------------------------------------------------------------------------------------------------
18
19
During 1997, Provident continued to enjoy a strong capital position, a high
degree of liquidity, and a substantial level of core deposits. Management's
principal objectives for the investment portfolio during 1997 were to maintain
an appropriate level of quality, to ensure sufficient liquidity in various
interest rate environments while maximizing yield and to increase net income by
utilizing excess capital. To successfully achieve these objectives, the
Corporation employs off-balance sheet and on balance sheet strategies. Total
investment securities decreased $71 million during 1997 as a result of shifting
funds into higher yielding loan portfolios.
The Corporation applies the provisions of Statement of Financial Accounting
Standards No. 115 which requires investment securities to be segregated into
three categories: 1) held to maturity, 2) trading, and 3) available for sale.
All securities in the available for sale category must be measured at fair
market value. The resulting gain or loss is excluded from revenue but is
reflected as a change in stockholders' equity. Trading securities must be
measured at fair value and changes included in income for the period. As of
December 31, 1997, the Corporation had no investments classified as trading
securities. Securities designated as held to maturity are carried at amortized
cost. Subsequent to the merger of First Citizens Financial Corporation,
Provident disposed of certain securities classified as held to maturity by First
Citizens. As a result of these transactions, all of the Corporation's investment
securities portfolio has been classified as available for sale. Additionally,
all future purchases of securities will be classified as available for sale in
the forseeable future. At December 31, 1997, the available for sale portfolio
included net unrealized gains of approximately $7.8 million, compared to net
unrealized losses of $2.2 million at December 31, 1996.
In addition to unrealized gains and losses, Provident realized $3.45
million in gains and $1.11 million in losses from the sale of securities from
the available for sale portfolio in 1997. These sales were the result of
management's continuous monitoring of the investment securities portfolio in
terms of both credit quality and interest sensitivity.
LIQUIDITY AND SENSITIVITY TO INTEREST RATES
- -------------------------------------------
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.
Provident's Asset/Liability Management Committee has established general
guidelines for the maintenance of prudent levels of liquidity. The committee
continually monitors the amount and source of available liquidity, the time
required to obtain it and its cost. Management believes the Bank has sufficient
liquidity to meet funding needs in the foreseeable future.
The primary source of liquidity at December 31, 1997 was loans held for
sale and investment securities available for sale, which totaled $1.05 billion.
This represents 29% of total liabilities compared to 31% at December 31, 1996.
Maturities of investment securities, as table 14 indicates, is expected to
generate $159 million in funds in 1998 and $678 million, or 69%, of the
portfolio within the next five years.
The following table presents the expected cash flows and interest yields of the
Bank's investment securities portfolio at December 31, 1997.
MATURITIES OF INVESTMENT SECURITIES PORTFOLIO
Table 14
In One Year After One Year After Five Years Over Unrealized
or Less Through Five Years Through Ten Years Ten Years Gain (Loss)
- ------------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Total Yield
====================================================================================================================================
SECURITIES AVAILABLE FOR SALE
U.S. Treasury and Government
Agencies and Corporations $ 1,677 6.2% $ 26,258 6.4% $ 2,056 6.1% $ 25,633 7.2% $ (48) $ 55,576 6.8%
Mortgage-Backed Securities 148,607 7.0 473,593 7.0 149,211 7.0 106,551 7.0 7,529 885,491 7.0
Municipal Securities -- -- 5,121 7.8 12,564 8.0 1,183 8.1 523 19,391 8.0
Other Debt Securities 8,732 7.9 14,226 7.9 -- -- -- -- (175) 22,783 7.9
- ------------------------------------------------------------------------------------------------------------------------------------
Total Investment
Securities Portfolio $159,016 7.0% $519,198 7.0% $163,831 7.1% $133,367 7.0% $7,829 $983,241 7.0%
====================================================================================================================================
19
20
Another source of liquidity is scheduled loan repayments within one year,
which totaled $436 million or 16% of loans.
Table 15 presents contractual loan maturities and interest rate sensitivity
at December 31, 1997.
LOAN MATURITIES AND RATE SENSITIVITY
Table 15
In One Year After One Year After Five
(dollars in thousands) or Less Through Five Years Years Total Percent
======================================================================================================
Consumer $178,036 $602,466 $ 886,592 $1,667,094 61.7%
Commercial Business 86,026 139,605 62,658 288,289 10.7
Real Estate - Construction:
Residential 77,876 20,775 1,275 99,926 3.7
Commercial 11,227 7,049 6,878 25,154 .9
Real Estate - Mortgage:
Residential 32,305 74,569 255,138 362,012 13.4
Commercial 50,157 126,822 81,614 258,593 9.6
- ------------------------------------------------------------------------------------------------------
Total Loans $435,627 $971,286 $1,294,155 $2,701,068 100.0%
======================================================================================================
Rate Sensitivity:
Fixed Rate $260,050 $594,078 $ 912,849 $1,766,977 65.4%
Variable or Adjustable Rate 175,577 377,208 381,306 934,091 34.6
- ------------------------------------------------------------------------------------------------------
Total Loans $435,627 $971,286 $1,294,155 $2,701,068 100.0%
======================================================================================================
Core deposits are valuable in assessing liquidity needs because they tend
to be stable with little net short or intermediate-term withdrawal demands by
customers. At year-end, core deposits represented $2.0 billion, or 55%, of total
liabilities and 52% of total assets.
An important element in liquidity management is the availability of
borrowed funds. At December 31, 1997, short-term borrowings totaled $347
million, or 9.5%, of liabilities in contrast to $602 million, or 18.6%, of
liabilities at December 31, 1996. This decrease was the result of greater
utilization of the broker CD market and the implementation of the money market
CD product to match fund assets. Brokered CDs at December 31, 1997 amounted to
$660 million, a $338 million increase from the same period last year. Money
market CDs totaled $94 million at December 31, 1997. The average maturity of
short-term borrowings at the end of the current year was 48 days. These
borrowings are fully collateralized by U.S. Government or mortgage-backed
securities owned by the Bank. Long-term borrowings consisted of variable and
fixed-rate advances from the Federal Home Loan Bank and totaled $469 million as
of December 31, 1997. It is anticipated that Provident will continue to have
access to the repurchase market and federal fund lines as well as short and
long-term variable and fixed-rate funds from the Federal Home Loan Bank.
20
21
INTEREST SENSITIVITY 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 are subject to
fluctuations which arise due to changes in the level and directions of interest
rates. Management's objective is to minimize this risk.
Measuring and managing interest rate risk is a dynamic process which is
performed regularly as an important component of management's analysis of the
impact of changes in asset and liability portfolios. Control of Provident's
interest sensitivity position is accomplished through the structuring of the
investment and funding portfolios, securitizing loans for possible sale, the use
of variable rate loan products and off-balance sheet derivatives.
Management does not try to anticipate changes in interest rates. Its
principal objective is to maintain interest margins in periods of both rising
and falling rates. Traditional interest sensitivity gap analyses alone do not
adequately measure an institution's exposure to changes in interest rates
because gap models are not sensitive to changes in the relationship between
interest rates charged or paid and do not incorporate balance sheet trends and
management actions. Each of these factors can affect an institution's earnings.
Accordingly, in addition to performing gap analysis, management also evaluates
the impact of differing interest rates on net interest income using an earnings
simulation model. The model incorporates the factors not captured by gap
analysis by projecting income over a twelve month horizon under a variety of
interest rate scenarios.
As of December 31, 1997, Provident's interest sensitive liabilities
exceeded interest sensitive assets within a one year period by $747 million or
20% of assets. The Bank's savings products are structured to give management the
ability to reset the rates paid on a monthly basis. This causes the Bank to
become more liability sensitive. If interest rates rise, the rate paid on
savings deposits may follow, and the Corporation's net interest margin may
decline. Management continues to take steps to protect the Bank from possible
increases in interest rates. In 1997 these steps included lengthening the
maturities on purchased funds and certificates of deposits and shortening asset
maturities with interest rate swaps and caps. Management monitors the interest
rate environment and employs appropriate off-balance sheet strategies to address
potential changes in interest rates. These strategies lower the net interest
margin but are designed to maintain an acceptable margin in a changing rate
environment. As a result, interest income has been decreased by $13 thousand and
interest expense has been increased by $2.4 million, for a total decrease of
$2.4 million in net interest income for the year ending December 31, 1997.
Included in this net interest income decrease was the amortization of closed
positions which reduced interest income by $402 thousand and increased interest
expense by $3.0 million (a net decrease of $3.39 million in net interest income)
for the year ending December 31, 1997. Without this, off-balance sheet positions
increased net interest income $965 thousand for the year. The forward yield
curve indicates that short-term and long-term rates will each increase 5 basis
points over the next twelve months. The Corporation's analysis indicates that if
management does not adjust its December 31, 1997 off-balance sheet positions and
the forward yield curve assumptions occur, off-balance sheet positions would
increase net interest income by $820 thousand over the next twelve months. This
compares to an increase in net interest income of $908 thousand should interest
rates remain unchanged. Amortization of closed positions will reduce net
interest income $2.4 million over the next twelve months. Thus, without
amortization of closed positions, net interest income would increase $3.2
million over the next twelve months if the forward yield curve assumptions occur
and $3.3 million if rates remain unchanged as a result of these off-balance
sheet positions.
21
22
STOCKHOLDERS' EQUITY
- --------------------
It is necessary for banks to maintain a sufficient level of capital in order to
sustain growth, absorb unforeseen losses and meet regulatory requirements. In
addition, the current economic and regulatory climate places an increased
emphasis on capital strength. In this environment, Provident continues to
maintain a strong capital position. At December 31, 1997 total stockholders'
equity was $270 million, a $31 million increase over the prior year. In addition
to the ordinary adjustments to stockholders' equity of net income and dividends
paid, additional capital was raised through the dividend reinvestment plan of
$443 thousand, $8.4 million from the exercise of stock options, while capital
increased by $6.1 million during 1997 as a result of Statement of Financial
Accounting Standards No. 115. This statement requires changes in market value,
net of applicable income taxes, of the available for sale investment portfolio
to be accounted for through equity. During the second quarter of 1997, the
Corporation issued a 5% stock dividend and all earnings per share figures have
been adjusted for this dividend and the 2 for 1 stock split in February 1998.
Provident exceeds all regulatory capital requirements as of December 31,
1997. The standards used by federal bank regulators to evaluate capital adequacy
are the risk-based capital and leverage ratio guidelines. Equity for regulatory
purposes does not include market value adjustments as required by SFAS No. 115.
Risk-based capital ratios measure core and total stockholders' equity against
risk-weighted assets. Provident's core capital is equal to its common stock,
capital surplus and retained earnings less treasury stock. The calculation of
Provident's total stockholders' equity, for these purposes, is equal to the
above plus the allowance for loan losses subject to certain limitations.
Risk-weighted assets are determined by applying a weighting to asset categories
and certain off-balance sheet commitments based on the level of credit risk
inherent in the assets. At December 31, 1997, Provident's total capital ratio
was 10.24% compared to the minimum regulatory guideline of 8%. In addition, core
common stockholders' equity (Tier 1 Capital) must be at least 4% of
risk-weighted assets. At year-end, Provident's Tier 1 Capital ratio was 8.99%.
The leverage ratio represents core capital, as defined above, divided by
average total assets. Guidelines for the leverage ratio require the ratio of
core stockholders' equity to average total assets to be 100 to 200 basis points
above a 3% minimum, depending on risk profiles and other factors. Provident's
leverage ratio of 7.06% at December 31, 1997 was well in excess of this
requirement.
CAPITAL COMPONENTS AND RATIOS
Table 16
December 31,
- --------------------------------------------------------------------
(dollars in thousands) 1997 1996
====================================================================
QUALIFYING CAPITAL
Tier 1 Capital $ 265,199 $ 240,077
Total Capital 302,060 270,438
Risk-Weighted Assets 2,949,890 2,584,260
Quarterly Average Assets 3,756,348 3,449,616
RATIOS
Leverage Capital 7.06% 6.96%
Tier 1 Capital 8.99 9.29
Total Capital 10.24 10.46
22
23
FINANCIAL REVIEW 1996/1995
- --------------------------
For the year ended December 31, 1996, Provident recorded net income of $26.2
million or $1.12 per share-diluted basis, compared to $22.1 million or $.97 per
share-diluted basis in 1995. The per share amounts have been adjusted for stock
dividends and the 2 for 1 stock split in February. This improvement in earnings
was attributable to a $9.5 million rise in tax-equivalent net interest income
and a $9.9 million increase in non-interest income net of securities gains.
These increases more than offset a $12.9 million increase in operating expense.
Net interest income on a tax-equivalent basis for 1996 increased $9.5
million or 9.4% from 1995 as average earning assets grew $348 million over the
prior year. Net interest margin dropped by 9 basis points primarily caused by
lower yields on interest earning assets.
The provision for loan losses increased $8.5 million to $10.0 million in
1996. The increase was the result of overall loan growth in the loan portfolios
of $495 million as total average loans outstanding grew by $201 million.
Non-interest income increased 57% to $50.1 million. Excluding net
securities gains (losses) and interest income on the tax refund, non-interest
income increased $15.7 million or 55%. Deposit service charges rose 45% over the
prior year to $19.3 million, mortgage banking activities were up $5.1 million to
$14.9 million, and commissions and fees were up 54% to $3.2 million.
Provident's non-interest expense rose 13.2% in 1996 over 1995. Salaries and
employee benefits increased $4.5 million attributable to merit increases, new
branches and staffing of our new Fast `n Friendly Check Cashing centers.
Commissions were up associated with increased activity within Provident
Investment Center, Inc. while maintaining Saturday hours at most of our branches
also contributed to increased compensation expense. Occupancy costs grew $403
thousand or 4.5% over 1995. Much of this increase was due to additional mortgage
and supermarket branches as well as additional space requirements at our
headquarters and operations buildings. Total furniture and equipment expense
increased $411 thousand due to upgrading of technology in the Bank's office
automation and branch platform systems. External processing increased $3.1
million due to increased account volumes. Regulatory fees increased $1.6 million
mainly associated with a special one-time assessment on SAIF deposits held by
Citizens Savings Bank as of March 31, 1995.
Provident recorded an income tax expense of $13.7 million in 1996 based on
pre-tax income of $39.9 million, which represented an effective tax rate of
34.3%. This compares with a 34.2% effective tax rate for 1995.
23
24
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Interest Sensitivity Management" and Note 13 to the Consolidated Financial
Statements herein.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Provident Bankshares Corporation and Subsidiaries
- --------------------------------------------------------------------------------
Page
Report of Independent Accountants 25
For the Three Years Ended December 31, 1997, 1996 and 1995
Consolidated Statement of Income 26
Consolidated Statement of Changes in Stockholders' Equity 28
Consolidated Statement of Cash Flows 29
Consolidated Statement of Condition at December 31, 1997 and 1996 27
Notes to Consolidated Financial Statements 30-46
- --------------------------------------------------------------------------------
FINANCIAL REPORTING RESPONSIBILITY
CONSOLIDATED FINANCIAL STATEMENTS
Provident Bankshares Corporation (the "Corporation") is responsible for the
preparation, integrity and fair presentation of its published consolidated
financial statements as of December 31, 1997, and the year then ended. The
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and, as such, include amounts, some of
which are based on judgments and estimates of management.
INTERNAL CONTROL STRUCTURE OVER FINANCIAL REPORTING
Management maintains a system of internal control over financial reporting,
including controls over safeguarding of assets against unauthorized acquisition,
use or disposition which is designed to provide reasonable assurance to the
Corporation's management and board of directors regarding the preparation of
reliable published financial statements and such asset safeguarding. The system
contains self-monitoring mechanisms, and actions are taken to correct
deficiencies as they are identified. This system encompasses activities that
control the preparation of the Corporation's Annual Report/10-K financial
statements prepared in accordance with generally accepted accounting principles.
There are inherent limitations in the effectiveness of any system of
internal control, including the possibility of human error and the circumvention
or overriding of controls. Accordingly, even an effective internal control
system can provide only reasonable assurance with respect to financial statement
preparation. Further, because of changes in conditions, the effectiveness of an
internal control system may vary over time.
Management assessed its internal control structure over financial reporting
as of December 31, 1997. This assessment was based on criteria for effective
internal control over financial reporting described in "Internal
Control--Integrated Framework" issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, management
believes that Provident Bankshares Corporation maintained an effective internal
control structure over financial reporting as of December 31, 1997.
COMPLIANCE WITH LAWS AND REGULATIONS
Management is also responsible for compliance with the federal and state laws
and regulations concerning dividend restrictions and federal laws and
regulations concerning loans to insiders designated by the FDIC as safety and
soundness laws and regulations.
Management assessed its compliance with the designated laws and regulations
relating to safety and soundness. Based on this assessment, management believes
that Provident Bank of Maryland, the wholly owned subsidiary of Provident
Bankshares Corporation complied, in all significant respects, with the
designated laws and regulations related to safety and soundness for the year
ended December 31, 1997.
24
25
REPORT OF COOPERS & LYBRAND L.L.P.,
INDEPENDENT ACCOUNTANTS
To the Board of Directors
Provident Bankshares Corporation
Baltimore, Maryland
We have audited the accompanying consolidated balance sheets of Provident
Bankshares Corporation and subsidiaries as of December 31, 1997, and 1996 and
the related consolidated statement of income, cash flows and changes in
stockholders' equity for each of the three years in the period ended December
31, 1997. These consolidated financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an opinion on these
financial statements based on our audits. We did not audit the consolidated
financial statements of First Citizens Financial Corporation, acquired during
1997 in a pooling of interests, as of December 31, 1996 and for each of the two
years in the period then ended which statements reflect total assets
constituting 20% of the related consolidated totals at December 31, 1996, and
total interest income constituting 19% in 1996 and 19% in 1995 of the related
consolidated totals. Those statements were audited by other auditors whose
report has been furnished to us, and in our opinion, insofar as it relates to
the amounts included for First Citizens Financial Corporation, is based solely
on the report of other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Provident Bankshares Corporation
and subsidiaries as of December 31, 1997 and 1996, and the consolidated results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Coopers & Lybrand L.L.P.
Coopers & Lybrand L.L.P.
Baltimore, Maryland
January 21, 1998
25
25a
ARTHUR ANDERSEN LLP
Report of Independent Public Accountants
The Board of Directors and Stockholders
First Citizens Financial Corporation
Gaithersburg, Maryland
We have audited the accompanying consolidated statements of financial condition
of First Citizens Financial Corporation (a Delaware Corporation) and subsidiary
as of December 31, 1996 and 1995, and the related consolidated statements of
income, stockholders' equity and cash flows for each of the years then ended.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Citizens
Financial Corporation and subsidiary as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the years then
ended in conformity with generally accepted accounting principles.
As disclosed in Note 1, effective January 1, 1995, the Company changed its
method of accounting for impaired loans.
/s/ Arthur Andersen LLP
Washington, D.C.
January 22, 1997, except with respect
Note 19 as to which the date is March 10, 1997
26
CONSOLIDATED STATEMENT OF INCOME
Provident Bankshares Corporation and Subsidiaries
Year Ended December 31,
- ---------------------------------------------------------------------------------------------------
(in thousands, except per share data) 1997 1996 1995
===================================================================================================
INTEREST INCOME
Interest and Fees on Loans $203,899 $171,267 $155,686
Interest on Securities 68,294 73,186 65,762
Tax-Advantaged Interest 6,656 2,588 1,613
Interest on Short-Term Investments 263 438 421
- ---------------------------------------------------------------------------------------------------
Total Interest Income 279,112 247,479 223,482
- ---------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on Deposits 106,004 87,736 78,216
Interest on Short-Term Borrowings 28,737 29,602 29,569
Interest on Long-Term Debt 21,977 20,016 15,034
- ---------------------------------------------------------------------------------------------------
TOTAL INTEREST EXPENSE 156,718 137,354 122,819
- ---------------------------------------------------------------------------------------------------
NET INTEREST INCOME 122,394 110,125 100,663
Less: Provision for Loan Losses 9,953 10,011 1,517
- ---------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 112,441 100,114 99,146
- ---------------------------------------------------------------------------------------------------
NON-INTEREST INCOME
Service Charges on Deposit Accounts 24,432 19,262 13,685
Mortgage Banking Activities 6,845 14,895 9,806
Commissions and Fees 3,705 3,229 2,101
Net Securities Gains (Losses) 2,337 5,556 (2,683)
Other Non-Interest Income 6,690 7,123 8,981
- ---------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST INCOME 44,009 50,065 31,890
- ---------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSE
Salaries and Employee Benefits 54,107 55,406 50,875
Occupancy Expense, Net 10,018 9,317 8,914
Furniture and Equipment Expense 7,354 7,036 6,625
External Processing Fees 12,374 10,929 7,784
Federal Deposit Insurance Assessment -- 3,029 --
Merger Related Expenses 10,047 -- --
Other Non-Interest Expense 23,963 24,606 23,218
- ---------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST EXPENSE 117,863 110,323 97,416
- ---------------------------------------------------------------------------------------------------
Income Before Taxes 38,587 39,856 33,620
Income Tax Expense 13,628 13,668 11,488
- ---------------------------------------------------------------------------------------------------
NET INCOME $ 24,959 $ 26,188 $ 22,132
===================================================================================================
Per Share Amounts:
Net Income -- Basic $ 1.10 $ 1.18 $ 1.02
Net Income -- Diluted $ 1.06 $ 1.12 $ .97
===================================================================================================
The accompanying notes are an integral part of these statements.
26
27
CONSOLIDATED STATEMENT OF CONDITION
Provident Bankshares Corporation and Subsidiaries
December 31,
- ------------------------------------------------------------------------------------------------------------------
(dollars in thousands) 1997 1996
==================================================================================================================
ASSETS
Cash and Due From Banks $ 68,580 $ 70,132
Short-Term Investments 350 11,366
Mortgage Loans Held for Sale 66,925 35,356
Securities Available for Sale 983,241 968,154
Securities Held to Maturity (Market Value $86,464 at December 31, 1996) -- 86,237
Loans:
Consumer 1,667,094 1,211,971
Commercial Business 288,289 294,844
Real Estate -- Construction 125,080 121,542
Real Estate -- Mortgage 620,605 619,516
- ------------------------------------------------------------------------------------------------------------------
Total Loans 2,701,068 2,247,873
Less: Allowance for Loan Losses 36,861 30,361
- ------------------------------------------------------------------------------------------------------------------
Net Loans 2,664,207 2,217,512
- ------------------------------------------------------------------------------------------------------------------
Premises and Equipment, Net 37,402 36,481
Accrued Interest Receivable 31,032 23,485
Other Assets 75,002 36,895
- ------------------------------------------------------------------------------------------------------------------
Total Assets $3,926,739 $3,485,618
==================================================================================================================
LIABILITIES
Deposits:
Noninterest-Bearing $ 196,178 $ 169,000
Interest-Bearing 2,558,337 2,117,144
- ------------------------------------------------------------------------------------------------------------------
Total Deposits 2,754,515 2,286,144
- ------------------------------------------------------------------------------------------------------------------
Short-Term Borrowings 347,291 602,435
Long-Term Debt 469,077 328,517
Other Liabilities 85,674 29,724
- ------------------------------------------------------------------------------------------------------------------
Total Liabilities 3,656,557 3,246,820
- ------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Common Stock (Par Value $1.00) Authorized 30,000,000 Shares,
Issued 1997 - 23,512,962 Shares; 1996 - 21,914,530 Shares 23,513 21,915
Capital Surplus 130,963 109,132
Retained Earnings 113,463 111,614
Net Unrealized Gain (Loss) on Debt Securities 4,733 (1,373)
Treasury Stock at Cost -- 456,132 Shares (2,490) (2,490)
- ------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 270,182 238,798
- ------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $3,926,739 $3,485,618
==================================================================================================================
The accompanying notes are an integral part of these statements.
27
28
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Provident Bankshares Corporation and Subsidiaries
Unrealized Treasury Total
Common Capital Retained Gain (Loss) on Stock Stockholders'
(dollars in thousands, except per share data) Stock Surplus Earnings Debt Securities at Cost Equity
==============================================================================================================================
Balance at January 1, 1995 $18,628 $ 73,398 $103,321 $ (8,499) $(2,490) $184,358
Net Income -- 1995 -- -- 22,132 -- -- 22,132
Dividends Paid ($.26 per share) -- -- (4,301) -- -- (4,301)
Adjustment for 1994 Private Offering -- 114 -- -- -- 114
Exercise of Stock Options (324,060 shares) 324 1,543 -- -- -- 1,867
Common Stock Issued under Dividend
Reinvestment Plan (234,290 shares) 234 3,006 -- -- -- 3,240
Unrealized Gain on Debt Securities -- -- -- 15,638 -- 15,638
Stock Dividend (1,098,210 shares) 1,098 11,052 (12,150) -- -- --
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 20,284 89,113 109,002 7,139 (2,490) 223,048
Net Income -- 1996 -- -- 26,188 -- -- 26,188
Dividends Paid ($.35 per share) -- -- (6,281) -- -- (6,281)
Exercise of Stock Options (346,896 shares) 347 2,495 -- -- -- 2,842
Common Stock Issued under Dividend
Reinvestment Plan (83,496 shares) 84 1,429 -- -- -- 1,513
Unrealized Loss on Debt Securities -- -- -- (8,512) -- (8,512)
Stock Dividend (1,200,432 shares) 1,200 16,095 (17,295) -- -- --
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 21,915 109,132 111,614 (1,373) (2,490) 238,798
Net Income -- 1997 -- -- 24,959 -- -- 24,959
Dividends Paid ($.44 per share) -- -- (8,505) -- -- (8,505)
Exercise of Stock Options (720,638 shares) 720 7,661 -- -- -- 8,381
Common Stock Issued under Dividend
Reinvestment Plan (20,312 shares) 20 423 -- -- -- 443
Unrealized Gain on Debt Securities -- -- -- 6,106 -- 6,106
Stock Dividend (858,376 shares) 858 13,747 (14,605) -- -- --
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $23,513 $130,963 $113,463 $ 4,733 $(2,490) $270,182
=============================================================================================================================
The accompanying notes are an integral part of these statements.
28
29
CONSOLIDATED STATEMENT OF CASH FLOWS
Provident Bankshares Corporation and Subsidiaries
Year Ended December 31,
- --------------------------------------------------------------------------------------------------------------------
(in thousands) 1997 1996 1995
====================================================================================================================
OPERATING ACTIVITIES:
Net Income $ 24,959 $ 26,188 $ 22,132
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Depreciation and Amortization 8,235 6,308 4,849
Provision for Loan Losses 9,953 10,011 1,517
Provision for Deferred Income Tax (Benefit) (5,139) (750) 6,787
Realized Net Securities (Gains) Losses (2,337) (5,556) 2,683
Loans Originated or Acquired and Held for Sale (344,587) (559,717) (419,493)
Proceeds from Sales of Loans 315,650 649,363 378,591
Gain on Sales of Loans (2,632) (5,681) (295)
Other Operating Activities 8,930 (5,296) 4,161
- --------------------------------------------------------------------------------------------------------------------
Total Adjustments (11,927) 88,682 (21,200)
- --------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 13,032 114,870 932
- --------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Principal Collections and Maturities of Securities Available for Sale 169,288 196,039 110,340
Principal Collections and Maturities of Securities Held to Maturity 13,130 13,353 67,583
Proceeds on Sales of Securities Available for Sale 395,803 297,336 208,202
Purchases of Securities Held to Maturity (15,259) (26,108) (31,526)
Purchases of Securities Available for Sale (481,343) (375,667) (269,915)
Loan Originations and Purchases Less Principal Collections (454,026) (495,697) (349,569)
Purchases of Premises and Equipment (7,299) (6,282) (8,615)
- --------------------------------------------------------------------------------------------------------------------
NET CASH USED BY INVESTING ACTIVITIES (379,706) (397,026) (273,500)
- --------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net Increase in Deposits 468,371 248,686 150,852
Net Increase (Decrease) in Short-Term Borrowings (255,144) 60,570 38,391
Proceeds from Long-Term Debt 194,000 308,650 300,490
Payments and Maturities of Long-Term Debt (53,440) (320,638) (204,975)
Issuance of Common Stock 8,824 4,355 5,221
Cash Dividends on Common Stock (8,505) (6,281) (4,301)
- --------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 354,106 295,342 285,678
- --------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (12,568) 13,186 13,110
Cash and Cash Equivalents at Beginning of Year 81,498 68,312 55,202
- --------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 68,930 $ 81,498 $ 68,312
====================================================================================================================
SUPPLEMENTAL DISCLOSURES
- --------------------------------------------------------------------------------------------------------------------
Interest Paid, Net of Amount Capitalized $71,711 $ 70,337 $ 61,184
Income Taxes Paid (Received) 13,114 15,374 (370)
Stock Dividend 14,605 17,295 12,150
Transfer of Securities Held to Maturity to Securities Available for Sale 88,318 -- 419,821
Mortgage Loans Securitized in Investment Portfolio -- -- 281,246
The accompanying notes are an integral part of these statements.
29
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Provident Bankshares Corporation and Subsidiaries
NOTE 1 -- SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Provident Bankshares Corporation ("the Corporation") offers a wide range of
banking services through its wholly owned subsidiary, Provident Bank of Maryland
and its subsidiaries ("the Bank") including various types of deposit accounts,
commercial and personal investment products. These services are provided through
a network of 81 offices and 80 ATMs located in the greater Baltimore/ Washington
metropolitan area and southern Pennsylvania.
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.
The accounting and reporting policies of the Corporation are in accordance
with generally accepted accounting principles and conform to general practice
within the banking industry. Certain prior years' amounts in the Consolidated
Financial Statements have been reclassified to conform with the presentation
used for the current year. These reclassifications have no effect on
stockholders' equity or net income as previously reported.
CONSOLIDATION POLICIES
The Consolidated Financial Statements include the accounts of Provident
Bankshares Corporation and its wholly owned subsidiary, Provident Bank of
Maryland (the "Bank") and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Prior period financial statements have been restated to include the
accounts and results of operations for the acquisition of First Citizens
Financial Corporation during 1997 which was accounted for using the
pooling-of-interest accounting method.
In preparation of financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the dates of the financial statements and accompanying notes
and the reported amounts of income and expense during the reporting periods.
Actual results could differ from these estimates.
INVESTMENT SECURITIES
The Corporation divides the investment portfolio among three categories:
securities held to maturity, securities available for sale and, if applicable,
trading account securities. Securities that the Corporation has the intent and
ability to hold to maturity are included in securities held to maturity and,
accordingly, are carried at cost adjusted for amortization of premiums and
accretion of discounts using the interest method. Securities available for sale
are securities the Corporation does not have the intent and ability to hold to
maturity nor does it intend to trade actively as part of any trading account
activity. Available for sale securities are reported at fair value with any
unrealized appreciation or depreciation in value reported directly as a separate
component of stockholders' equity as unrealized gain (loss) on debt securities
which is reflected net of applicable taxes, and therefore, have had no effect on
the reported earnings of the Corporation. Gains and losses from sales of
securities available for sale are recognized by the specific identification
method and are reported in non-interest income.
LOANS AND ALLOWANCE FOR LOAN LOSSES
Interest on loans is accrued at the contractual rate and credited to income
based upon the principal amount outstanding. It is the policy of management to
place a loan in non-accrual status and discontinue the accrual of interest and
reverse previously accrued but unpaid interest when the quality of a commercial
credit has deteriorated to the extent that collectibility of all interest and/or
principal cannot be reasonably expected or when it is 90 days past due unless
the loan is well secured and in the process of collection. Beginning in 1997,
consumer loans are not placed in non-accrual status but are generally
charged-off at 120 days past due for installment loans and 180 days for
revolving loans. This was done to conform to standard industry practice. Prior
to 1997, consumer loans were generally placed into non-accrual status at 90 days
past due and subsequently charged off.
The Corporation adopted the provisions of Statements of Financial
Accounting Standards No. 114/118 "Accounting by Creditors for Impairment of a
Loan" ("SFAS No. 114/118") on January 1, 1995. Under SFAS No. 114/118, the
Corporation considers a loan impaired when, based on available information, it
is probable that the Corporation will be unable to collect principal and
interest when due in accordance with the contractual terms of the loan
agreement. All non-accrual loans and troubled debt restructurings are considered
impaired loans. The measurement of impaired loans may be based on the present
value of expected future cash flows discounted at the historical effective
interest rate or based on the fair value of the underlying collateral.
Impairment criteria are applied to the loan portfolio exclusive of smaller
balance homogeneous loans such as residential mortgage and consumer loans which
are evaluated collectively for impairment. Restructured loans are considered
impaired in the year of restructuring. In subsequent years each restructured
loan is evaluated for impairment. The allowance for loan losses includes
reserves for these loans. Collections of interest and principal on loans in
non-accrual status and considered impaired are generally applied as a reduction
to the outstanding principal. Once future collectibility has been established,
interest income may be recognized on a cash basis.
The Corporation defers and amortizes loan origination fees and related
costs over the life of the loan using the interest method. Net amortization of
fees and costs are recognized in interest income as a yield adjustment and are,
accordingly, reported as Interest and Fees on Loans in the Consolidated
Statement of Income. Unearned income on loans at December 31, 1997 and 1996 was
not material with respect to the respective financial statements.
30
31
The Corporation's allowance for loan losses is based upon management's
continuing review and evaluation of the loan portfolio and is intended to
maintain an allowance adequate to absorb potential losses on loans outstanding.
The level of the allowance is based on an evaluation of the risk characteristics
of the loan portfolio and considers such factors as past and expected future
loan loss experience, the financial condition of the borrower, current economic
conditions and other relevant factors.
Adjustments to the allowance due to changes in measurement of impaired
loans are incorporated in the provision for loan losses. The adoption of SFAS
No. 114/118 has not resulted in any additional provision for loan losses for the
years ended December 31, 1997 and 1996.
PREMISES AND EQUIPMENT
Premises, equipment and leasehold improvements are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization are
computed on the straight-line method over the estimated useful lives of the
assets or, for leasehold improvements, the lives of the related leases, if
shorter. Major improvements are capitalized while maintenance and repairs are
charged to expense as incurred.
STOCKHOLDERS' EQUITY
During 1997 and 1996, the Corporation declared five percent stock dividends for
each year to the stockholders of record as of April 28, 1997 and April 29, 1996,
respectively. The 1997 stock dividend was paid on May 9, 1997 resulting in the
distribution of 858,376 common shares with a par value of $1.00 per share.
Accordingly, $858 thousand and $13.7 million was transferred from retained
earnings to common stock and capital surplus, respectively. The 1996 stock
dividend was paid May 10, 1996 with the distribution of 1,200,432 common shares
with a $1.00 par value per share. This dividend resulted in the transfer of $1.2
million to common stock and $16.1 million to capital surplus from retained
earnings. The cumulative impact of these stock dividends has been reflected in
the restatement of earnings and dividends per share and stock option data in the
financial statements and accompanying notes.
Subsequent to December 31, 1997, the Corporation declared a two for one
stock split. The split occurred after the dividend payment on February 13, 1998
for stockholders of record at the close of business on February 2, 1998. All
earnings per share and common stock related information has been given
retroactive effect to this transaction at December 31, 1997.
INCOME TAXES
The Corporation uses the liability method to determine deferred tax amounts and
the related income tax expense or benefit. Using this method, deferred taxes are
calculated by applying enacted statutory tax rates to temporary differences
consisting of items of income and expense that are accounted for in financial
reporting periods which differ from income tax reporting periods. The resultant
deferred tax assets and liabilities represent future taxes to be recovered or
remitted when the related assets and liabilities are recovered or settled. The
deferred tax assets are reduced by a valuation allowance for that portion of the
tax deferred assets which are unlikely to be realized.
DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation uses a variety of derivative financial instruments as part of
its interest rate risk management strategy and the Corporation does not hold or
issue derivative financial instruments for trading purposes. The derivative
products used are interest rate swaps and caps or floors, used separately or in
combination to suit the hedge objective. All are currently classified as hedges.
To qualify as a hedge, 1) the asset or liability to be hedged exposes the
Corporation to interest rate risk, 2) the derivatives act to move the
Corporation to a rate insensitive position should interest rates change, and 3)
the derivative is designated and is effective as a hedge of a balance sheet
item.
Interest rate swaps are agreements between two parties which agree to
exchange fixed and floating rates on a notional principal amount without the
actual exchange of principal for a specified period of time. The notional
amounts are not reflected on the Consolidated Statement of Condition because
they are merely a unit of measure to determine the effect of the swap. Income
and expense on interest rate swaps associated with designated balance sheet
items is recognized using the accrual method over the life of the agreement(s)
as an adjustment to the income or expense on the designated balance sheet item.
Premiums associated with interest rate floor/cap/corridor arrangements are
reflected in the Consolidated Statement of Condition and amortized over their
life using the straight-line method and included as an adjustment to interest
income/expense associated with the balance sheet item. Payments due to or from
counterparties under these agreements are accrued as an adjustment to interest
income or expense associated with the designated balance sheet item.
The Corporation continually monitors each derivative position to ensure the
proper relationship such as risk reduction, correlation or effectiveness between
the designated balance sheet item hedged and the derivative position. Any
significant divergence between this relationship which results in interest
income or expense exceeding projected parameters results in the hedge being
marked-to-market with the resultant gain or loss included in earnings.
Terminated derivative positions with the designated assets or liabilities
retained have the resulting gain or loss deferred and amortized over the
estimated remaining life of the hedge into interest income/expense associated
with the balance sheet item. Derivatives associated with liquidated hedged
assets or liabilities are marked-to-market and have subsequent changes in their
fair value reflected in earnings as the derivative is considered speculative in
nature.
Accounting treatment of derivative positions is consistent with the
accounting treatment of the underlying asset or liability. Interest rate swaps
used to hedge available for sale debt securities have their fair value included
in stockholders' equity which is
31
32
consistent with the fair value treatment of the available for sale securities.
Interest accruals associated with the swap are included as an adjustment to
interest income on the associated securities. Derivative products terminated
prior to the sale of the related security have the respective gain or loss
deferred and amortized into interest income as yield adjustments to the
designated asset over the shorter of the remaining life of the agreement or the
designated asset. Upon sale of the security, the deferred gain or loss on the
derivative is reflected in income at the time of sale.
PENSION PLAN
The Corporation has a defined benefit pension plan which covers substantially
all employees. The cost of this noncontributory pension plan was computed and
accrued using the projected unit credit method.
Prior service cost is amortized on a straight-line method over the average
remaining service period of employees expected to receive benefits under the
plan. Annual contributions are made to the plan in an amount at least to equal
the maximum requirements and no greater than the maximum allowed by regulatory
authorities.
STATEMENT OF CASH FLOWS
For purposes of reporting cash flows, cash equivalents are composed of cash and
due from banks and short-term investments.
FUTURE ACCOUNTING DISCLOSURE REQUIREMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting
Comprehensive Income." The statement establishes requirements for the disclosure
and presentation of comprehensive income and its components in full sets of
financial statements. Comprehensive income is defined as transactions and other
occurrences which are the result of nonowner changes in equity. Nonowner equity
changes, such as unrealized gains or losses on debt securities for example, will
be accumulated with net income in determining comprehensive income. This
statement will not impact the historical financial results of the Corporation's
operations. This statement is effective for years beginning after December 15,
1997 and reclassification of financial statements for earlier periods provided
for comparative purposes is required.
The FASB also issued Statement of Financial Accounting Standards No. 131
("SFAS No. 131"), "Disclosures about Segments of an Enterprise and Related
Information" during June 1997 which becomes effective for all periods beginning
after December 15, 1997. This statement provides standards for reporting
information on the operating segments of public businesses in their annual and
interim reports to shareholders. SFAS No. 131 requires that selected financial
information be provided for segments meeting specific criteria. This statement
will not impact the presentation of the Corporation's financial results as no
segments meet the specific reporting criteria.
NOTE 2 -- ACQUISITION
On August 22, 1997, the Corporation completed its acquisition of First Citizens
Financial Corporation ("First Citizens"), a savings and holding company based in
Montgomery County, Maryland. This acquisition was accounted for as a
pooling-of-interest business combination. Historical financial information for
years prior to the acquisition have been restated to reflect the combined
results of Provident Bankshares Corporation and First Citizens Financial
Corporation for those periods. Provident issued approximately 4,522,000 shares
of common stock to the former stockholders of First Citizens at an exchange
ratio of .7665 shares of Provident for each share of First Citizens. At the date
of acquisition, First Citizens had total assets of $674 million.
Exclusive of $8.6 million in post-tax merger related charges incurred by
both entities, net income of the combined entities would be $33.6 million on a
pre-merger basis for the year ended December 31, 1997. The majority of these
charges incurred include severance pay and benefits for terminated employees,
professional fees which include investment banking, accounting and legal fees,
write-down of real estate owned properties, writedowns for facilities which were
consolidated and asset write-offs for unusable equipment. These charges included
only identified direct and incremental cost associated with the acquisition.
Presented below are the combined results of operations based on the audited
consolidated financial statements of Provident and First Citizens for the two
years ended December 31:
(dollars in thousands, except per share data) 1996 1995
======================================================================
Net Interest Income:
Provident $ 91,287 $ 82,940
First Citizens 18,838 17,723
- ----------------------------------------------------------------------
Combined $110,125 $100,663
- ----------------------------------------------------------------------
Net Income:
Provident $ 23,020 $ 18,025
First Citizens 3,168 4,107
- ----------------------------------------------------------------------
Combined $ 26,188 $ 22,132
======================================================================
Diluted Net Income Per Share:
Provident $ 1.25 $ 1.00
First Citizens .50 .65
- ----------------------------------------------------------------------
Combined $ 1.12 $ .97
======================================================================
The combined results of operations are not necessarily indicative of the
results that would have occurred had the acquisition been consummated prior to
1997 or that may be achieved in the future.
NOTE 3 -- RESTRICTIONS ON CASH AND DUE FROM BANKS
The Federal Reserve requires banks to maintain cash reserves against certain
categories of deposit liabilities. Such reserves averaged approximately $18.6
million and $18.5 million during the years ended December 31, 1997 and 1996,
respectively.
32
33
In order to cover the costs of services provided by correspondent banks,
the Corporation maintains compensating balance arrangements at these
correspondent banks or elects to pay a fee in lieu of such arrangements. During
1997 and 1996, the Corporation maintained average compensating balances of
approximately $2.5 million and $2.6 million, respectively. In addition, the
Corporation paid fees totaling $311 thousand in 1997, $397 thousand in 1996 and
$317 thousand in 1995 in lieu of maintaining compensating balances.
NOTE 4 - INVESTMENT SECURITIES
The aggregate amortized cost and market values of the investment securities
portfolio at December 31 were as follows:
1997 1996
------------------------------------------- -------------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Market Amortized Unrealized Unrealized Market
(in thousands) Cost Gains Losses Value Cost Gains Losses Value
====================================================================================================================================
SECURITIES AVAILABLE FOR SALE
U.S. Treasury and Government
Agencies and Corporations $ 55,624 $ 36 $ 84 $ 55,576 $ 72,363 $ 60 $ 541 $ 71,882
Mortgage-Backed Securities 877,962 8,870 1,341 885,491 849,126 4,893 6,825 847,194
Municipal Securities 18,868 523 - 19,391 18,881 327 117 19,091
Other Debt Securities 22,958 - 175 22,783 30,029 77 119 29,987
- ------------------------------------------------------------------------------------------------------------------------------------
Total Securities Available for Sale 975,412 9,429 1,600 983,241 970,399 5,357 7,602 968,154
- ------------------------------------------------------------------------------------------------------------------------------------
SECURITIES HELD TO MATURITY
U.S. Treasury and Government
Agencies and Corporations 32,395 257 - 32,652
Mortgage-Backed Securities 53,842 542 572 53,812
- ------------------------------------------------------------------------------------------------------------------------------------
Total Securities Held to Maturity - - - - 86,237 799 572 86,464
- ------------------------------------------------------------------------------------------------------------------------------------
Total Investment Securities Portfolio $975,412 $9,429 $1,600 $983,241 $1,056,636 $6,156 $8,174 $1,054,618
====================================================================================================================================
The aggregate amortized cost and market values of the investment securities
portfolio by contractual maturity at December 31, 1997 and 1996, are shown
below. Expected maturities on mortgage-backed securities may differ from the
contractual maturities as borrowers have the right to prepay the obligation
without prepayment penalties.
1997 1996
---------------------- ----------------------
Amortized Market Amortized Market
(in thousands) Cost Value Cost Value
=========================================================================================
SECURITIES AVAILABLE FOR SALE
In One Year or Less $ 550 $ 514 $ 5,010 $ 5,065
After One Year Through Five Years 16,975 16,737 29,183 29,145
After Five Years Through Ten Years 24,762 25,081 48,118 47,944
Over Ten Years 55,163 55,418 38,962 38,806
Mortgage-Backed Securities 877,962 885,491 849,126 847,194
- -----------------------------------------------------------------------------------------
Total Securities Available for Sale 975,412 983,241 970,399 968,154
- -----------------------------------------------------------------------------------------
SECURITIES HELD TO MATURITY
In One Year or Less - - - -
After One Year Through Five Years - - 2,964 3,025
After Five Years Through Ten Years - - 15,120 15,316
Over Ten Years - - 14,311 14,311
Mortgage-Backed Securities - - 53,842 53,812
- -----------------------------------------------------------------------------------------
Total Securities Held to Maturity - - 86,237 86,464
- -----------------------------------------------------------------------------------------
Total Investment Securities Portfolio $975,412 $983,241 $1,056,636 $1,054,618
=========================================================================================
33
34
Proceeds from sales of securities available for sale during 1997 were $395.8
million resulting in the realization of gross gains of $3.4 million and gross
losses of $1.1 million on such sales. For 1996, sales of securities yielded
proceeds of $297.3 million which resulted in gross realized gains of $6.1
million and gross losses of $525 thousand. Securities sold in 1995 produced
proceeds of $208.2 million resulting in gross gains of $846 thousand and gross
losses of $3.5 million.
In conjunction with the acquisition of First Citizens in 1997, the
Corporation reclassified $88.3 million in held to maturity securities of the
combined entity to the available for sale portfolio. These securities were
transferred by the Corporation to provide additional liquidity and financial
flexibility. All securities were transferred at fair value. Unrealized gains of
$355 thousand were recognized separately in stockholders' equity. As a result of
the transfer, all securities will be classified as available for sale in the
foreseeable future.
During 1995, the Financial Accounting Standards Board issued a special
report on SFAS No. 115 which provided an opportunity to reclassify from
securities held to maturity to securities available for sale. The permitted
reclassification resulting from this one-time assessment does not call into
question the intent of the Corporation's future investment classifications. On
December 31, 1995, the Corporation transferred $419.8 million of securities from
Securities Held to Maturity to Securities Available for Sale. The transfer was
the result of management's intention to maximize its flexibility to take
advantage of future business opportunities. These securities were transferred at
fair value and the respective holding gains of $7.4 million were recognized as a
separate component of stockholders' equity.
At December 31, 1997, a net unrealized gain of $4.7 million on the
securities portfolio was reflected as a separate component of stockholders'
equity in the Consolidated Statement of Condition as compared to a net
unrealized loss of $1.4 million at December 31, 1996.
The aggregate book and estimated market values of investment securities by
issuer which exceed ten percent of capital at December 31, 1997, are indicated
below. All of these securities represent senior debt securities with AAA bond
ratings.
Estimated
(in thousands) Book Value Market Value
=======================================================================
Issuer:
Mortgage-Backed Securities:
Residential Funding Corporation $39,927 $40,223
Headlands Mortgage Securities, Inc. 43,265 43,313
Indy Mac, Inc. 70,393 70,634
=======================================================================
Securities with a market value of $611.2 million and $827.1 million at
December 31, 1997 and 1996, respectively, were pledged as collateral for public
funds, certain short-term borrowings and for other purposes required by law.
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
A summary of the activity in the allowance for loan losses for the three years
ended December 31 is presented below:
(in thousands) 1997 1996 1995
=========================================================================
Balance at Beginning of the Year $30,361 $27,524 $27,137
Provision for Loan Losses 9,953 10,011 1,517
Loans Charged-Off (5,213) (8,862) (2,134)
Less: Recoveries of Loans
Previously Charged-Off 1,760 1,688 1,004
- -------------------------------------------------------------------------
Net Loans Charged-Off (3,453) (7,174) (1,130)
- -------------------------------------------------------------------------
Balance at End of the Year $36,861 $30,361 $27,524
=========================================================================
At December 31, 1997, 1996 and 1995, the recorded investment in loans which
are in non-accrual status and therefore considered impaired totaled $2.9
million, $4.6 million and $7.1 million, respectively. There was no additional
allowance required for these loans under the provisions of SFAS No. 114/118. Had
these loans performed in accordance with their original terms, interest income
of $178 thousand in 1997, $603 thousand in 1996 and $1.0 million in 1995 would
have been recorded. During 1997 no interest income was recognized on these
loans, but during 1996 and 1995 interest income of $411 and $477, respectively
was recognized on these loans. The average recorded investment in impaired loans
was approximately $2.1 million in 1997 and $3.1 million in 1996.
NOTE 6 - PREMISES AND EQUIPMENT
Real estate and equipment holdings at December 31 are presented in the table
below. Real estate owned and used by the Corporation consists of twelve branches
and other facilities in the Baltimore/ Washington metropolitan area which are
used primarily for the operations of the Bank.
(in thousands) 1997 1996
========================================================================
Land $ 851 $ 851
Buildings and Leasehold Improvements 23,227 21,453
Furniture and Equipment 37,921 34,586
Property Held for Future Expansion 7,177 7,143
- ------------------------------------------------------------------------
Total Premises and Equipment 69,176 64,033
Less: Accumulated Depreciation
and Amortization 31,774 27,552
- ------------------------------------------------------------------------
Net Premises and Equipment $37,402 $36,481
========================================================================
Property Held for Future Expansion represents approximately 49,000 square
feet of real estate adjacent to the Corporation's headquarters building which is
currently being used for employee and public parking. Following an assessment of
occupancy requirements, management determined that this property would be
necessary to meet the Corporation's growing office and parking requirements.
In December 1990, the Corporation entered into a sale and leaseback
agreement whereby its headquarters building was sold to
34
35
an unrelated third party which then leased the building back to the Corporation.
In association with the sale, the Corporation financed $6.0 million of this
arrangement with a market rate note which has recourse to other assets of the
acquiror. The lease has five years remaining on the term. The remaining
associated deferred gain of $1.3 million from the sale will be recognized in
proportion to the gross rental expense incurred over the outstanding term of the
lease. The associated lease payments and sublease rental income are included in
the table below.
The Corporation also maintains non-cancelable operating leases associated
with Bank premises. Most of these leases provide for the payment of property
taxes and other costs by the Bank and include one or more renewal options
ranging up to ten years. Some of the leases also contain purchase options at
market value. Annual rental commitments under all long-term non-cancelable
operating lease agreements consisted of the following at December 31, 1997.
Real
Property Sublease Equipment
(in thousands) Leases Income Leases Total
====================================================================
1998 $ 5,749 $ 93 $551 $ 6,207
1999 5,168 56 234 5,346
2000 4,485 19 25 4,491
2001 3,680 19 10 3,671
2002 3,269 18 - 3,251
2002 and Thereafter 2,961 5 - 2,956
- --------------------------------------------------------------------
Total $25,312 $210 $820 $25,922
====================================================================
Rental expense for premises and equipment was $6.6 million in 1997, $6.3
million in 1996 and $5.7 million in 1995.
NOTE 7 - MORTGAGE BANKING ACTIVITIES
The Corporation engages in sales of mortgage loans, which are originated
internally or purchased from third parties. Mortgage loans held for sale are
carried at the aggregate lower of cost or market value. Gains or losses on sales
of these mortgage loans are recorded as a component of Non-Interest Income in
the Consolidated Statement of Income.
Unpaid principal balances of loans serviced for others not included in the
accompanying Consolidated Statement of Condition were $229 million and $419
million at December 31, 1997 and 1996, respectively.
Effective January 1, 1997, the Corporation adopted the provisions of
Statement of Financial Accounting Standards No. 125 - "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No.
125"). This new statement supersedes SFAS No. 122 - "Accounting for Mortgage
Servicing Rights," which was adopted on January 1 of the prior year. The
adoption of SFAS No. 125 has had no significant impact on the earnings or
financial condition of the Corporation. SFAS No. 125 requires the Corporation to
carry any retained interest in a transferred asset on the Statement of Condition
as a servicing asset. In the case of the Corporation, the servicing assets
represent the fair value of the servicing contracts associated with the purchase
or origination and subsequent securitization of the mortgage loans. Servicing
assets are amortized in proportion to and over the period of estimated net
servicing income. Servicing assets are evaluated periodically for impairment
based on their fair value and impairment, if any, is recognized through a
valuation allowance and a charge to operations. At December 31, 1997 no
valuation allowance was required.
The following is an analysis of servicing asset balance, net of accumulated
amortization, during each of the respective years.
December 31,
- --------------------------------------------------------------------------
(in thousands) 1997 1996 1995
==========================================================================
Balance at the Beginning
of the Year $ 2,155 $ 981 $1,597
Additions 1,785 3,338 93
Amortization (359) (458) (360)
Sales of Servicing Rights (1,597) (1,706) (349)
- -------------------------------------------------------------------------
Balance at the End of the Year $ 1,984 $ 2,155 $ 981
==========================================================================
NOTE 8 - SHORT-TERM BORROWINGS
At December 31, short-term borrowings were as follows:
(in thousands) 1997 1996
==============================================================
Securities Sold Under
Repurchase Agreements
and Federal Funds Purchased $345,430 $568,592
Other Short-Term Borrowings 1,861 33,843
- --------------------------------------------------------------
Total $347,291 $602,435
==============================================================
The following table sets forth various data on securities sold under
repurchase agreements and federal funds purchased.
(dollars in thousands) 1997 1996 1995
================================================================
Balance at December 31 $345,430 $568,592 $525,240
Average Balance During
the Year 464,662 496,117 450,243
Maximum Month-End Balance 515,937 583,499 531,788
Weighted Average Rate
During the Year 5.68% 5.59% 5.62%
Weighted Average Rate
at December 31 5.72% 5.73% 5.19%
================================================================
35
36
Securities sold under repurchase agreements at December 31, 1997, are detailed
below by due date:
(dollars in thousands) Overnight Less than 30 days 30-90 days Over 90 days Demand Total
=================================================================================================================
Mortgage-Backed Securities:
Securities Sold:
Carrying Value $68,153 $91,250 $112,965 $14,480 $ - $286,848
Market Value 69,119 92,064 113,469 14,602 - 289,254
Repurchase Borrowings 69,094 89,553 107,603 14,680 - 280,930
Average Borrowing Interest Rate 4.97% 5.87% 5.78% 6.15% -% 5.63%
=================================================================================================================
NOTE 9 -LONG-TERM DEBT
Long-term debt consisted of Federal Home Loan Bank Advances of $469.1 million
and $328.5 million at December 31, 1997 and 1996, respectively. The principal
maturities of long-term debt at December 31, 1997, are presented below.
(in thousands)
=========================================
1998 $163,500
1999 93,950
2000 49,250
2001 24,000
2002 61,000
After 2002 77,377
- -----------------------------------------
Total $469,077
=========================================
The Federal Home Loan Bank Advances to the Bank mature in varying amounts
through 2016. These advances are composed of $319.1 million fixed rate advances
with an average interest rate of 6.35% and $150.0 million variable rate advances
with an average rate of 5.78%. These advances are collateralized by investment
securities and certain real estate loans with carrying values of $257.2 million
and $246.7 million, respectively, at December 31, 1997.
NOTE 10 - INCOME TAXES
The components of income tax expense and the sources of deferred income taxes
for the three years ended December 31 are presented below.
(in thousands) 1997 1996 1995
=======================================================================
Current Income Tax Expense (Benefit):
Federal $19,121 $12,527 $ 2,627
State (354) 391 2,074
- -----------------------------------------------------------------------
Total Current 18,767 12,918 4,701
Deferred Income Tax Expense (Benefit) (5,139) 750 6,787
- -----------------------------------------------------------------------
Total Income Tax Expense $13,628 $13,668 $11,488
=======================================================================
Tax expense (benefit) associated with investment securities gains/(losses)
was $927 thousand in 1997, $2.2 million in 1996 and $(1.1) million in 1995.
The primary sources of temporary differences that give rise to significant
portions of the deferred tax asset and liability at December 31, 1997 and 1996,
are presented below.
Deferred Deferred
(in thousands) Assets Liabilities
=======================================================================
1997:
Loan Loss Reserve Recapture $ - $ 9,877
Reserve for Loan Loss 12,901 -
Write-down of Property Held for Sale 1,453 -
Employee Benefits 2,289 -
Deferred Gain on Sale/Leaseback 437 -
Deferred State Tax Receivable 2,820 -
Depreciation - 113
Deferred Federal Tax Liability for
State Receivable - 987
Deferred Tax Liability on Unrealized
Gains in Debt Securities - 3,096
Deferred Tax Liability on
Security Transactions - 768
Mortgage Servicing Rights - 549
Capitalized Real Estate Owned Costs 516 -
Deferred Loan Fees - 1,154
All Other 682 1,807
- -----------------------------------------------------------------------
Total $21,098 $18,351
=======================================================================
1996:
Loan Loss Reserve Recapture $ - $ 9,998
Reserve for Loan Loss 10,626 -
Write-down of Property Held for Sale 1,371 -
Employee Benefits 2,373 -
Deferred Gain on Sale/Leaseback 512 -
Deferred State Tax Receivable 2,148 -
Depreciation - 301
Deferred Federal Tax Liability for
State Receivable - 750
Deferred Tax Asset on Unrealized
Losses in Debt Securities 896 -
Deferred Tax Liability on
Security Transactions - 1,933
Mortgage Servicing Rights - 491
Capitalized Real Estate Owned Costs 137 -
Deferred Loan Fees - 1,237
All Other 513 2,220
- -----------------------------------------------------------------------
Total $18,576 $16,930
=======================================================================
At December 31, 1997 and 1996, no valuation allowance was required with
respect to deferred tax assets.
36
37
The combined federal and state effective tax rate for each year is
different than the statutory federal income tax rate. The reasons for these
differences are set forth below:
1997 1996 1995
=============================================================
Statutory Federal Income Tax Rate 35.0% 35.0% 35.0%
Increases (Decreases) in Tax Rate
Resulting from:
State and Local Income Taxes, Net
of Federal Income Tax Benefit - 2.4 3.8
Tax Benefit of State Refund Claim - (1.3) -
Tax-Advantaged Income (1.6) (1.2) (1.4)
Resolution of State Tax Issue - - (1.3)
Federal Benefit Due to Change
in Deferred Tax Rate - - (.7)
Disallowed Interest Expense - - .1
Employee Benefits (.4) (.1) (.1)
Non-Deductible Merger Expenses 2.3 - -
Other - (.5) (1.2)
- -------------------------------------------------------------
Total Combined Effective Tax Rate 35.3% 34.3% 34.2%
=============================================================
NOTE 11 - STOCKHOLDERS' EQUITY
The Corporation's Stock Option Plan (the "Option Plan") covers a maximum of 2.6
million shares of common stock that has been reserved for issuance under the
Option Plan described below. Under the provisions of Statement of Financial
Accounting Standards No. 123 - "Accounting for Stock-Based Compensation" ("SFAS
No. 123"), the Corporation had the option of accruing a compensation expense for
stock options granted to employees, or applying the provisions of APB Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") which does not
require compensation expense to be recognized. In 1996, the Corporation elected
to continue to apply APB No. 25 to account for the Option Plan. Under the Option
Plan, stock options are granted at an exercise price not less than the market
value of the underlying shares of common stock on the date of the grant, as
such, the Option Plan is classified as a fixed stock option plan. Accordingly,
no compensation expense has been recognized from 1997 through 1995.
The Option Plan provides for the granting of nonqualified stock options to
certain key employees and directors of Bankshares and the Bank, as designated by
the Corporation's board of directors. All options have a maximum duration of ten
years from the date of grant. Vesting in the majority of options usually occurs
immediately in 50% of the options granted with the remainder vesting in the
subsequent year. The vesting provisions on the remaining options may be
accelerated on the attainment of specific benchmarks related to the
Corporation's performance.
The following table presents a summarization of the activity related to
the options for the periods indicated:
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
Common Weighted Avg. Common Weighted Avg. Common Weighted Avg.
Shares Exercise Price Shares Exercise Price Shares Exercise Price
==================================================================================================================================
Outstanding, January 1, 2,263,614 $ 6.90 2,114,158 $ 4.63 2,191,798 $ 3.69
Granted 166,798 19.81 514,154 15.16 248,624 11.08
Exercised (720,638) 3.78 (346,896) 5.13 (324,060) 3.17
Cancelled or Expired (6,446) 16.86 (17,802) 8.83 (2,204) 9.47
- ----------------------------------------------------------------------------------------------------------------------------------
Outstanding, December 31, 1,703,328 $ 9.43 2,263,614 $ 6.90 2,114,158 $ 4.63
==================================================================================================================================
Options Exercisable at Year-end 1,273,480 1,251,708 1,402,646
Weighted Average Fair Value of Options Granted
During the Year $ 2.83 $ 4.25 $ 3.42
Options Available for Granting under the Option Plan 278,308 1,492,766 1,894,860
- ----------------------------------------------------------------------------------------------------------------------------------
37
38
The table below provides information on the stock options outstanding at
December 31, 1997:
Options Outstanding Options Exercisable
----------------------------------------- -------------------------------
Weighted Weighted Average Weighted
Exercise Price Common Average Remaining Common Average
Range Shares Exercise Price Contractual Life Shares Exercise Price
- ---------------------------------------------------------------------------------------------------
$ 1.72 - $ 9.68 616,006 $ 2.84 4.4 606,860 $ 2.72
12.19 - 20.87 389,802 8.79 6.9 389,802 8.81
21.12 - 25.93 136,174 12.05 8.4 136,174 12.13
26.09 - 30.38 335,346 15.02 8.2 7,244 13.48
31.66 - 38.51 210,400 18.23 9.0 126,400 17.89
43.94 - 61.63 15,600 23.91 9.6 7,000 23.74
- ---------------------------------------------------------------------------------------------------
1,703,328 $ 9.43 6.6 1,273,480 $ 7.27
===================================================================================================
The weighted average fair value of all of the options granted during 1997,
1996 and 1995 has been estimated using the Black-Scholes option-pricing model
with the following weighted average assumptions:
1997 1996 1995
- ---------------------------------------------------------------------
Dividend Yield 38.47% 14.64% 14.64%
Weighted Average Risk-free Interest Rate 5.72 6.31 5.47
Weighted Average Expected Volatility 22.18 21.18 21.18
Weighted Average Expected Life in Years 7 7 7
- ---------------------------------------------------------------------
The provisions of SFAS No. 123 require pro forma disclosure of compensation
expense for the Corporation based on the fair value of the awards at the date of
grant. Under those provisions, the Corporation's net income and earnings per
share would have been reduced to the following pro forma amounts below:
(in thousands, except per share data) 1997 1996 1995
=========================================================================
Net Income:
As Reported $24,959 $26,188 $22,132
Pro forma 24,473 25,361 21,541
Basic Earnings Per Share:
As Reported $ 1.10 $ 1.18 $ 1.02
Pro forma 1.08 1.15 1.00
Diluted Earnings Per Share:
As Reported $ 1.06 $ 1.12 $ .97
Pro forma 1.04 1.09 .94
=========================================================================
At the time of the Corporation's reorganization, a liquidation account was
established by the Bank for the benefit of all eligible deposit account holders
as of December 31, 1986 who maintain their accounts in the Bank subsequent to
the reorganization. The liquidation account provides these deposit account
holders with an interest in the retained earnings of the Bank prior to any
distribution to stockholders in the sole event of a complete liquidation. The
deposit account holders' interest in the liquidation account decreases as the
related deposit account decreases and will never increase. The liquidation
account does not restrict the use or application of stockholders' equity of the
Bank except that the Bank may not declare or pay a cash dividend on, or
repurchase any of its capital stock if, as the result of such dividend or
repurchase, the Bank's stockholders' equity would be less than the amount then
required for the liquidation account. At December 31, 1997, the balance of the
liquidation account was $11.2 million.
NOTE 12 - EMPLOYEE BENEFIT PLANS
PENSION PLAN
The Corporation's non-contributory defined benefit pension plan covers
substantially all full-time employees with at least one year of service and
provides monthly benefits upon retirement to participants based on average
career earnings and length of service. During 1996 the Plan was amended
effective January 1, 1996 to change the Plan into a Cash Balance Plan. Accrued
benefits were converted to cash balances as of January 1, 1996 for the Plan
participants. This change resulted in a reduction in the Plan expense during
1997 and 1996. The pension liability decreased accordingly at December 31, 1997
and 1996 as a result of the Plan change. The Corporation's policy is to
contribute amounts to the plan sufficient to meet the minimum funding
requirements set forth in the Employee Retirement Income Security Act of 1974,
as amended, plus such additional amounts as the Corporation deems appropriate.
During 1996, the Corporation contributed $1.3 million to the plan assets.
38
39
The following table sets forth the defined benefit plan's funded status at
January 1:
(in thousands) 1998 1997 1996
=========================================================================
Actuarial Present Value of Benefit
Obligations:
Accumulated Benefit Obligation,
Including Vested Benefits of
$18,321 - 1998; $16,268 - 1997;
$15,391 - 1996 $(20,729) $(18,903) $(17,610)
=========================================================================
Projected Benefit Obligation for
Service Rendered to Date $(21,965) $(19,861) $(20,119)
Plan Assets at Fair Value 26,825 23,353 19,560
- -------------------------------------------------------------------------
Plan Assets in Excess of (Less than)
Projected Benefit Obligation 4,860 3,492 (559)
Unrecognized Net Gain from
Past Experience Different from
that Assumed (3,547) (2,340) (695)
Unrecognized Net Asset Arising at
Transition at January 1, 1988 (695) (835) (1,516)
Unrecognized Prior Service Cost (1,713) (1,902) (248)
- -------------------------------------------------------------------------
Accrued Pension Cost Included in
Other Liabilities $ (1,095) $ (1,585) $ (3,018)
=========================================================================
The actuarially estimated net pension cost for the year ended December 31
includes the following components:
(in thousands) 1997 1996 1995
=========================================================================
Service Cost - Benefits Earned
During the Year $ 839 $ 650 $ 1,115
Interest Cost on Projected Benefit
Obligation 1,502 1,447 1,407
Actual Return on Plan Assets (4,666) (3,693) (4,529)
Net Amortization and
Deferral of Loss 1,987 1,492 2,825
Net Pension Cost (Benefit) Included
in Employee Benefits Expense $ (338) $ (104) $ 818
=========================================================================
The Corporation revises the rates applied in the determination of the
actuarial present value of the projected benefit obligation to reflect the
anticipated performance of the plan and changes in compensation levels.
1998 1997 1996
=========================================================================
Rates Used in Determining
Actuarial Present Value of Projected
Benefit Obligation:
Weighted Average Discount Rate 7.5% 8.0% 8.0%
Expected Rate of Increase in
Future Compensation Levels 4.0% 4.0% 4.0%
Expected Long-Term Rate of Return
on Plan Assets 10.0% 10.0% 10.0%
=========================================================================
Plan assets are primarily comprised of equity securities, and short-term
and long-term debt securities. The unrecognized net asset arising at transition
is being amortized over 15.6 years. The plan held no shares of the Corporation's
common stock at December 31, 1997, 1996 and 1995.
RETIREMENT SAVINGS PLAN
The Retirement Savings Plan is a defined contribution plan which is qualified
under Section 401(a) of the Internal Revenue Code of 1986. The plan generally
allows all employees who complete 500 hours of employment during a six month
period and elect to participate, to receive matching funds from the Corporation
for pre-tax retirement contributions made by the employee. The annual
contribution to this plan is at the discretion of and determined by the Board of
Directors of the Corporation. During 1996, the Corporation raised the maximum
contribution of 50% of an employee's contribution up to 2% of the individual's
salary to 75% and 4.5%, respectively. Contributions to this plan amounted to
$1.1 million, $1.2 million and $548 thousand for the years ended December 31,
1997, 1996 and 1995, respectively.
POSTRETIREMENT BENEFITS
In addition to providing pension benefits, the Corporation provides certain
health care and life insurance benefits to retired employees. Substantially all
employees of the Corporation that reach retirement age may become eligible for
these benefits, generally contingent upon the completion of twenty years of
service. The health care plan is contributory where the retiree is responsible
for all premiums in excess of the Corporation's contribution. The Corporation's
contribution is capped at a growth rate of 4% per year. Under the prospective
transition approach, the transition obligation is amortized over a twenty-year
period. The cost of life insurance benefits provided to the retiree is borne by
the Corporation. At December 31, 1997 and 1996, this plan is unfunded.
39
40
The following tables set forth the plan's funded status reconciled with
amounts reported in the Corporation's financial statements at December 31:
(in thousands) 1997 1996
=========================================================================
Actuarial Present Value of Benefit
Obligations (APBO):
Accumulated Postretirement Benefit Obligation:
Retirees $ (642) $ (761)
Fully Eligible Active Plan Participants (50) (103)
Other Active Plan Participants (368) (338)
=========================================================================
Total (APBO) (1,060) (1,202)
Plan Assets at Fair Value - -
- -------------------------------------------------------------------------
Accumulated Postretirement Benefit
Obligation in Excess of Plan Assets (1,060) (1,202)
Unrecognized Net Gain (317) (129)
Less: Unrecognized Transition Obligation 811 864
- -------------------------------------------------------------------------
Accrued Postretirement Benefit Liability $ (566) $ (467)
=========================================================================
The actuarially estimated net postretirement benefit cost for the year
ended December 31:
(dollars in thousands) 1997 1996 1995
=============================================================================
Service Cost-Benefits Earned During Year $ 51 $ 58 $ 42
Interest Cost on Projected Benefit Obligation 75 88 85
Amortization of Transition Obligation 54 55 53
Amortization of Unrecognized Gain (17) - (8)
- -----------------------------------------------------------------------------
Net Postretirement Benefit Cost
Included in Employee Benefit Expense $163 $201 $172
- -----------------------------------------------------------------------------
Discount Rate Used in Determining the
Actual Present Value of Accumulated
Postretirement Benefit Obligation 8.0% 8.0% 8.0%
- -----------------------------------------------------------------------------
NOTE 13 - OFF-BALANCE SHEET RISK
In the normal course of business, the Bank offers various financial products to
its customers to meet their credit and liquidity needs. These instruments
involve, to varying degrees, elements of credit and market risk which may exceed
any amount recognized in the financial statements. Risks that are inherent in
normal banking services also exist in some of these financial instruments.
Contract amounts of the instruments indicate the maximum exposure the Bank has
in each class of financial instruments discussed in the following paragraphs.
These commitments and contingencies are not reflected in the accompanying
financial statements. Unless noted otherwise, the Bank does not require
collateral or other securities to support financial instruments with credit
risk.
Subject to its normal credit standards and risk monitoring procedures, the
Bank makes contractual commitments to extend credit. Commitments to extend
credit in the form of consumer, commercial real estate and commercial business
loans amounted to $467.7 million and $396.1 million at December 31, 1997 and
1996, respectively. Commitments typically have fixed expiration dates or other
termination clauses. The total of commitments does not necessarily represent
future cash requirements as many commitments may expire without being exercised.
Collateral and amounts thereof are obtained, if necessary, based upon
management's evaluation of each borrower's financial condition. Required
collateral may be in the form of cash, accounts receivable, inventory, property,
plant and equipment and income generating commercial properties and residential
properties.
The Bank is obligated under various recourse provisions related to sales of
residential mortgage loans. The maximum potential recourse obligation was $13.3
million and $20.5 million at December 31, 1997 and 1996, respectively. No losses
have been incurred under these recourse provisions. Conditional commitments are
issued by the Bank in the form of performance stand-by letters of credit which
guarantee the performance of a customer to a third party. These letters of
credit are typically included in the amount of funds committed by the Bank to
complete associated construction projects. At December 31, commitments under
outstanding performance stand-by letters of credit aggregated $32.9 million in
1997 and $38.7 million in 1996. The credit risk of issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Bank enters into agreements for the delivery of securitized mortgage
pools at a future date at a specified price or yield. The inability of
counterparties to meet the terms of these contracts and movements in the value
of securities and interest rates imposes risk on the Bank. Forward contracts
aggregated $89.3 million and $46.4 million at December 31, 1997 and 1996,
respectively. However management does not feel that any significant amounts are
at risk with regard to these contracts.
The Bank enters into various derivative financial instruments to manage its
interest rate risk exposure (see Note 1). The two major types used are interest
rate swaps and interest rate floor/cap/ corridor arrangements. These derivative
financial instruments use notional amounts to represent a unit of measure but
not the amount subject to accounting loss, which is much smaller. Risks in these
transactions involve nonperformance by counterparties under the terms of the
contract (counterparty credit risk) and, for interest rate swaps, the
possibility that interest rate movements or general market volatility could
result in losses on open off-balance sheet positions (market risk). Credit risk
is controlled by dealing with
40
41
well-established brokers which are highly rated by independent sources. Market
risk on interest rate swaps is minimized by using these instruments as hedges,
actively managing interest rate risk and by continually monitoring these
positions. Market risk associated with the interest rate floor/cap/corridor
arrangements only exist when premiums are amortized into interest expense
without receiving any compensation from third parties. Unamortized premiums paid
and outstanding for floor/cap/corridor arrangements were $523 thousand at
December 31, 1997, and $1.3 million at December 31, 1996.
Notional amounts of interest rate swaps and interest rate
floor/cap/corridor arrangements are detailed below by amounts outstanding,
average interest rates/fees and market values at December 31, 1997 and 1996.
Average Interest Rate/Fee
Notional Maturity ------------------------------------- Market
(dollars in thousands) Amount Date Paid Received Value
=============================================================================================================================
1997
Interest Rate Swaps:
$ 20,000 1998 5.29% 3 month LIBOR (5.77%) $ 25
15,000 1998 6.96% 3 month LIBOR (5.91%) (39)
20,000 1998 6.47% 3 month LIBOR (5.75%) 131
12,000 1998 6.49% 3 month LIBOR (5.75%) 87
20,000 1999 6.52% 3 month LIBOR (5.75%) 160
20,000 1999 6.52% 3 month LIBOR (5.75%) 168
9,583 1999 5.34% 3 month LIBOR (5.88%) 36
20,000 1999 6.58% 3 month LIBOR (5.91%) 172
9,167 1999 5.78% 3 month LIBOR (5.91%) 6
5,250 1999 6.84% 3 month LIBOR (5.81%) (46)
20,000 1999 6.60% 3 month LIBOR (5.78%) 221
20,000 1999 6.61% 3 month LIBOR (5.78%) 234
20,000 1999 6.62% 3 month LIBOR (5.72%) 268
12,385 1999 6.01% 3 month LIBOR (5.81%) (20)
20,000 1999 6.65% 3 month LIBOR (5.88%) 262
12,385 1999 6.14% 3 month LIBOR (5.88%) (33)
20,000 1999 6.68% 3 month LIBOR (5.91%) 270
9,962 1999 6.35% 3 month LIBOR (5.78%) (65)
20,000 1999 6.68% 3 month LIBOR (5.78%) 317
9,846 1999 6.45% 3 month LIBOR (5.78%) (65)
11,076 1999 6.21% 3 month LIBOR (5.88%) (40)
11,076 1999 6.31% 3 month LIBOR (5.91%) (52)
20,000 1999 6.70% 3 month LIBOR (5.91%) 302
12,461 2000 6.01% 3 month LIBOR (5.72%) (27)
10,385 2000 5.83% 3 month LIBOR (5.75%) 3
7,615 2000 5.95% 3 month LIBOR (5.91%) (6)
15,000 2000 7.08% 3 month LIBOR (5.91%) (371)
9,000 2000 7.19% 3 month LIBOR (5.91%) (278)
8,461 2000 6.17% 3 month LIBOR (5.72%) (36)
8,000 2002 6.08% 3 month LIBOR (5.91%) (32)
15,000 2002 6.03% 3 month LIBOR (5.91%) (31)
10,000 2002 6.25% 3 month LIBOR (5.90%) (67)
10,000 2002 6.30% 3 month LIBOR (5.90%) (88)
Interest Rate Floor/Cap/Corridor Arrangements:
Corridor $ 50,000 1998 $ 80 3 month LIBOR (5.81%)> 6.63%, capped at 8.63% $ 14
Corridor 100,000 1999 260 3 month LIBOR (5.81%)> 6.63%, capped at 8.63% 95
Floor 100,000 1999 182 4 year Treasury Notes (5.80%), Strike Price of 6.8% 1,080
- -------------------------------------------------------------------------------------------------------------------------------
41
42
Average Interest Rate/Fee
Notional Maturity ------------------------------------- Market
(dollars in thousands) Amount Date Paid Received Value
=============================================================================================================================
1996
Interest Rate Swaps:
$ 8,000 1998 5.38% 3 month LIBOR (5.50%) $ 33
8,000 1998 6.47% 3 month LIBOR (5.62%) (93)
15,000 1998 6.96% 3 month LIBOR (5.62%) (216)
20,000 1998 5.29% 3 month LIBOR (5.62%) 96
8,750 1999 6.84% 3 month LIBOR (5.53%) (121)
14,769 1999 6.45% 3 month LIBOR (5.53%) (131)
15,654 1999 6.35% 3 month LIBOR (5.62%) (131)
16,501 1999 5.42% 3 month LIBOR (5.50%) 75
16,501 1999 5.78% 3 month LIBOR (5.94%) 12
16,615 1999 6.21% 3 month LIBOR (5.50%) (79)
16,615 1999 6.31% 3 month LIBOR (5.94%) (96)
17,249 1999 5.34% 3 month LIBOR (5.50%) 95
19,462 1999 6.01% 3 month LIBOR (5.53%) (49)
19,462 1999 6.14% 3 month LIBOR (5.50%) (79)
7,000 2000 5.90% 3 month LIBOR (5.50%) 6
9,000 2000 7.19% 3 month LIBOR (5.62%) (310)
11,000 2000 5.95% 3 month LIBOR (5.62%) 19
15,000 2000 7.08% 3 month LIBOR (5.59%) (408)
15,000 2000 6.45% 3 month LIBOR (5.50%) (138)
15,000 2000 5.83% 3 month LIBOR (5.53%) 20
18,000 2000 6.01% 3 month LIBOR (5.63%) (34)
10,000 2000 6.56% 3 month LIBOR (5.50%) (105)
Interest Rate Floor/Cap/Corridor Arrangements:
Corridor $ 50,000 1997 $850 3 month LIBOR (5.50%)> 4%, capped at 6% $ 129
Corridor 50,000 1997 760 3 month LIBOR (5.59%)> 4%, capped at 6% 192
Corridor 50,000 1998 315 3 month LIBOR (5.63%)> 6.62%, capped at 8.62% 138
Corridor 100,000 1999 768 3 month LIBOR (5.63%)> 6.62%, capped at 8.62% 437
Floor 100,000 1997 390 4 year Treasury Notes (6.03%), Strike Price of 6.8% 649
Floor 100,000 1999 780 4 year Treasury Notes (6.03%), Strike Price of 6.8% 1,410
- -----------------------------------------------------------------------------------------------------------------------------
For the year ended December 31, 1997, $39.0 million of the interest rate
swaps hedged the exposure that the securities available for sale had to
declining market values as a result of increasing interest rates. Additionally,
remaining swaps of $149.7 million and $275.0 million were utilized to hedge the
interest rate risk inherent in short-term borrowings and callable brokered
certificates of deposit, respectively. The interest rate corridors protect the
net interest margin from the impact of increases in savings deposit rates during
periods of rising interest rates. The interest rate floors were purchased to
hedge the impact of loan repricing on net interest income in future years.
The following is an analysis of the activity with regards to interest rate
swaps and interest rate floor/cap/corridor arrangements for the years ended
December 31, 1997, 1996 and 1995, respectively.
Notional Amount
-------------------------------------
Interest Rate
Interest Rate Floor/Cap/Corridor
(in thousands) Swaps Arrangements
====================================================================
Balance, January 1, 1995 $ 184,000 $ 490,000
New Contracts 134,500 150,000
Expired Contracts (1,750) (100,000)
Terminated Contracts (161,500) -
- --------------------------------------------------------------------
Balance, December 31, 1995 155,250 540,000
New Contracts 295,500 -
Expired Contracts (104,172) (90,000)
Terminated Contracts (34,000) -
- --------------------------------------------------------------------
Balance, December 31, 1996 312,578 450,000
New Contracts 748,500 -
Expired Contracts (72,759) (200,000)
Terminated Contracts (524,667) -
- --------------------------------------------------------------------
Balance, December 31, 1997 $ 463,652 $ 250,000
====================================================================
42
43
At December 31, 1997, the Corporation had deferred gains of $1.4 million
and deferred losses of $2.8 million related to terminated contracts. These
deferred gains and losses will be amortized over 3.3 and 1.5 years,
respectively.
The Corporation had deferred gains of $324 thousand and deferred losses of
$6.0 million related to terminated contracts which were amortized as a yield
adjustment over .3 and 1.6 years, respectively, at December 31, 1996.
The notional maturities of the interest rate swaps and interest rate
floor/cap/corridor arrangements at December 31, 1997, are presented below.
Notional Amount
-----------------------------------
Interest Rate
Interest Rate Floor/Cap/Corridor
(in thousands) Swaps Arrangements
======================================================================
1998 $ 67,000 $ 50,000
1999 290,730 200,000
2000 62,922 -
2001 - -
2002 43,000 -
- -----------------------------------------------------------------------
Total $463,652 $250,000
=======================================================================
In April of 1997, a judgment stemming from a lawsuit alleging that
Provident Bank of Maryland had failed to fully honor a letter of credit was
entered against Provident in the amount of $5.2 million. This decision reversed
an earlier court holding in favor of Provident. The Bank has appealed the
decision. Management, in consultation with legal counsel, is of the opinion that
there exists a significant possibility that the award will be reversed or
substantially altered at the appellate level. The ultimate outcome of the case
will not have a material adverse effect on the Corporation's financial
statements.
NOTE 14 - CONCENTRATIONS OF CREDIT RISK
The Corporation's investment portfolio contains mortgage-backed securities
amounting to $885.5 million and $901.0 million at December 31, 1997 and 1996,
respectively. The underlying collateral for these securities is in the form of
pools of mortgages on residential properties. The majority of the securities are
either directly or indirectly guaranteed by U.S. Government agencies or
corporations. Management is of the opinion that credit risk is minimal.
Construction and mortgage loan receivables from real estate developers
represent $321.9 million and $398.8 million of the total loan portfolio at
December 31, 1997 and 1996, respectively. Substantially all loans are
collateralized by real property or other assets. These loans are expected to be
repaid from the proceeds received by the borrowers from the retail sales or
rentals of these properties to third parties.
NOTE 15 - OTHER NON-INTEREST INCOME AND EXPENSE
The components of other non-interest income and other non-interest expense for
the three years ended December 31 were as follows:
(in thousands) 1997 1996 1995
=======================================================================
Other Non-Interest Income:
Other Loan Fees $ 2,147 $ 1,872 $ 1,208
Interest Income on Tax Refund - - 5,796
Other Non-Interest Income 4,543 5,251 1,977
- -----------------------------------------------------------------------
Total Other Non-Interest Income $ 6,690 $ 7,123 $ 8,981
=======================================================================
Other Non-Interest Expense:
Advertising and Promotion $ 5,678 $ 5,986 $ 5,562
Communication and Postage 3,693 3,861 3,050
Printing and Supplies 2,277 2,351 2,032
Regulatory Fees 1,016 1,699 3,095
Professional Services 2,762 3,000 2,621
Other Non-Interest Expense 8,537 7,709 6,858
- -----------------------------------------------------------------------
Total Other Non-Interest Expense $23,963 $24,606 $23,218
=======================================================================
NOTE 16 - EARNINGS PER SHARE
The Corporation adopted Statement of Financial Accounting Standards No. 128 -
"Earnings Per Share" ("SFAS No. 128") on December 31, 1997. SFAS No. 128
requires the Corporation to change the method of computing, presenting and
disclosing earnings per share information. Accordingly, all prior period data
presented has been restated to conform to the provisions of SFAS No. 128. Under
the revised provisions of the new standard, primary earnings per share has been
replaced with basic earnings per share. Basic earnings per share is computed by
dividing net income by the weighted average number of common shares outstanding
for the period. Basic earnings per share does not include the effect of any
potentially dilutive transactions or conversions. Additionally, under the
standard, diluted earnings per share replaces fully diluted earnings per share
from prior years. This computation reflects the potential dilution of earnings
per share under the treasury stock method which could occur if contracts to
issue common stock were exercised, such as stock options, and shared in
corporate earnings. In addition to the data being restated to conform to the
provisions of SFAS No. 128, all prior period data has also been restated to
provide for the effects of the stock dividend issued and the 2 for 1 stock
split, the acquisition consummated during 1997 and the split in February, 1998.
The following table presents a summary of per share data and amounts for
the periods indicated:
(dollars in thousands, except per share data)
- ------------------------------------------------------------------------------------------------------
Qualifying Basic Basic Dilutive Diluted Diluted
Year Ended December 31, Net Income EPS Shares EPS Shares EPS Shares EPS
======================================================================================================
1995 $22,132 21,670 $1.02 1,186 22,856 $0.97
1996 $26,188 22,188 $1.18 1,140 23,328 $1.12
1997 $24,959 22,664 $1.10 906 23,570 $1.06
======================================================================================================
43
44
NOTE 17 - REGULATORY CAPITAL
The Corporation is subject to various capital adequacy guidelines imposed by
federal and state regulatory agencies. Under these guidelines, the Corporation
must meet specific capital adequacy requirements which are quantitative measures
of the Corporation's assets, liabilities and certain off-balance sheet items
calculated under regulatory accounting practices. Additionally, the
Corporation's capital amounts and classifications are subject to qualitative
judgments by these agencies about components, risk weightings and other factors.
The quantitative measures established by regulation to ensure capital adequacy
require the Corporation to maintain amounts and ratios of total and tier 1
capital to risk-weighted assets and tier 1 capital to average assets, known as
the leverage ratio. The Corporation's tier 1 capital is equal to its common
stock, capital surplus and retained earnings less treasury stock. Equity for
regulatory purposes does not include market value adjustments for available for
sale securities. The calculation of the Corporation's total capital is equal to
tier 1 capital plus the allowance for loan losses subject to certain
limitations. Risk-weighted assets are determined by applying weighting to asset
categories and certain off-balance sheet commitments based on the level of
credit risk inherent in the assets. At December 31, 1997, the Corporation
exceeds all regulatory capital requirements. The most recent notification from
the Corporation's primary regulators categorized the Corporation as well
capitalized under the regulatory framework for prompt corrective action. There
are no conditions or events since that notification that management believes
have changed the Corporation's category. If the Corporation is unable to comply
with the minimum capital requirements, it would result in regulatory actions
which could have a material impact on the Corporation.
The minimum regulatory guidelines for total capital and tier 1 capital to
risk-weighted assets are 8% and 4%, respectively. Guidelines for the leverage
ratio require the ratio of tier 1 capital to average assets to be 100 to 200
basis points above a 3% minimum, depending on risk profiles and other factors.
The table below presents the various components used to calculate the capital
adequacy ratios.
December 31,
- ---------------------------------------------------------
(dollars in thousands) 1997 1996
=========================================================
Qualifying Capital
Tier 1 Capital $ 265,199 $ 240,077
Total Capital 302,060 270,438
Risk-Weighted Assets 2,949,890 2,584,260
Quarterly Average Assets 3,756,348 3,449,616
RATIOS
Leverage Capital 7.06% 6.96%
Tier 1 Capital 8.99 9.29
Total Capital 10.24 10.46
NOTE 18 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosure about Fair
Value of Financial Instruments," requires all entities to disclose the fair
value of recognized and unrecognized financial instruments on a prospective
basis, where practicable, in an effort to provide financial statement users with
information in making rational investment and credit decisions.
To estimate the fair value of each class of financial instrument the
Corporation applied the following methods using the indicated assumptions:
CASH AND DUE FROM BANKS AND
SHORT-TERM INVESTMENTS
Carrying amount of those investments is used to estimate fair value.
MORTGAGE LOANS HELD FOR SALE
Fair value for mortgage loans held for trading or sale was determined using
forward contract commitment pricing for the majority of these loans. Loans not
specifically allocated to a forward commitment have been priced using quoted
prices for commitments into which these mortgages would be placed in the future.
SECURITIES AVAILABLE FOR SALE AND SECURITIES
HELD TO MATURITY
The fair values of the securities are based on quoted market prices or dealer
quotes for those investments.
LOANS
Fair value of loans which have homogeneous characteristics, such as residential
mortgages and installment loans, was estimated using discounted cash flows. All
other loans were valued using discount rates which reflected credit risks of the
borrower, types of collateral and remaining maturities.
DEPOSIT LIABILITIES
Fair value of demand deposits, savings accounts and money market deposits is the
amount payable on demand at the reporting date. The fair value of certificates
of deposit is estimated using the rates currently offered for deposits of
similar remaining maturities.
SHORT-TERM BORROWINGS AND LONG-TERM DEBT
Rates currently available to the Corporation for borrowings and debt with
similar terms and remaining maturities are used to estimate fair value of the
existing debt.
44
45
INTEREST RATE ARRANGEMENTS
The fair value of interest rate swaps and floor/cap/corridor arrangements, which
the Corporation uses for hedging purposes, is the estimated amount the
Corporation would receive or pay to terminate the arrangements at the reporting
date, taking into account the current interest rates and the current credit
worthiness of the counterparties.
COMMITMENTS TO EXTEND CREDIT
The fair value of commitments is estimated using the fees currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the credit worthiness of the borrowers. Fixed-rate loan
commitments also take into account the difference between current levels of
interest rates and committed rates.
The estimated fair values of the Corporation's financial instruments at December
31 are as follows:
1997 1996
- --------------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
(in thousands) Amount Value Amount Value
==================================================================================================
Assets:
Cash and Due From Banks $ 68,580 $ 68,580 $ 70,132 $ 70,132
Short-Term Investments 350 350 11,366 11,366
Mortgage Loans Held for Sale 66,925 67,024 35,356 35,378
Securities Available for Sale 983,241 983,241 968,154 968,154
Securities Held to Maturity 86,237 86,464
Loans, Net of Allowance 2,664,207 2,764,821 2,217,512 2,260,124
Liabilities:
Deposits $2,754,515 $2,761,008 $2,286,144 $2,295,814
Short-Term Borrowings 347,291 347,511 602,435 602,957
Long-Term Debt 469,077 471,406 328,517 330,809
Recognized Derivative Financial Instruments:
Interest Rate Floors $ 182 $ 1,080 $ 483 $ 2,059
Interest Rate Corridors 340 109 768 896
Unrecognized Financial Instruments:
Interest Rate Swaps -- 1,366 -- (1,634)
Commitments to Extend Credit $ -- $ 41 $ -- $ 175
==================================================================================================
These fair value disclosures are made solely to comply with the requirements of SFAS No. 107.
The calculations represent estimates and do not represent the underlying value of the Corporation.
The information presented is based on fair value calculations and market quotes as of December 31,
1997 and 1996. These amounts are based on the relative economic environment at the respective
year-ends, therefore, the valuations may have been affected by economic movements since year-end.
45
46
NOTE 19 -- PARENT COMPANY FINANCIAL INFORMATION
The condensed statements of income, financial condition and cash flows for
Provident Bankshares Corporation (parent only) are presented below.
STATEMENT OF INCOME
Year Ended December 31,
- --------------------------------------------------------------------
(in thousands) 1997 1996 1995
====================================================================
Interest Income From
Bank Subsidiary $ 225 $ 81 $ 105
Dividend Income From
Bank Subsidiary 8,460 6,060 4,410
- --------------------------------------------------------------------
Total Income 8,685 6,141 4,515
- --------------------------------------------------------------------
Operating Expenses 2,863 505 970
- --------------------------------------------------------------------
Income Before Income Taxes
and Equity in Undistributed
Income of Bank Subsidiary 5,822 5,636 3,545
Income Tax Benefit (43) (144) (297)
- --------------------------------------------------------------------
5,865 5,780 3,842
Equity in Undistributed Income
of Bank Subsidiary 19,094 20,408 18,290
- --------------------------------------------------------------------
Net Income $24,959 $26,188 $22,132
====================================================================
STATEMENT OF CONDITION
December 31,
- --------------------------------------------------------------------------------
(in thousands) 1997 1996
================================================================================
ASSETS
Interest-Bearing Deposit with Bank Subsidiary $ 254 $ 2,153
Investment in Bank Subsidiary 266,071 236,372
Other Assets 4,325 716
- --------------------------------------------------------------------------------
Total Assets $270,650 $239,241
================================================================================
LIABILITIES
Other Liabilities $ 468 $ 443
- --------------------------------------------------------------------------------
Total Liabilities 468 443
- --------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Common Stock 23,513 21,915
Capital Surplus 130,963 109,132
Retained Earnings 113,463 111,614
Unrealized Gain (Loss) on Debt Securities
of Bank Subsidiary 4,733 (1,373)
Treasury Stock at Cost (2,490) (2,490)
- --------------------------------------------------------------------------------
Total Stockholders' Equity 270,182 238,798
- --------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $270,650 $239,241
================================================================================
STATEMENT OF CASH FLOWS
Year Ended December 31,
- --------------------------------------------------------------------------
(in thousands) 1997 1996 1995
==========================================================================
Operating Activities:
Net Income $ 24,959 $ 26,188 $ 22,132
Adjustments to Reconcile
Net Income to Net Cash
Provided (Used) by
Operating Activities:
Equity in Undistributed
Income from
Bank Subsidiary (19,094) (20,408) (18,290)
Other Operating Activities (3,583) 7 (316)
- --------------------------------------------------------------------------
Total Adjustments (22,677) (20,401) (18,606)
- --------------------------------------------------------------------------
Net Cash Provided by
Operating Activities 2,282 5,787 3,526
- --------------------------------------------------------------------------
Investing Activities:
Investment in Bank Subsidiary (4,500) (4,000) (3,800)
- --------------------------------------------------------------------------
Net Cash Used by
Investing Activities (4,500) (4,000) (3,800)
- --------------------------------------------------------------------------
Financing Activities:
Issuance of Common Stock 8,824 4,355 5,221
Cash Dividends on Common Stock (8,505) (6,281) (4,301)
- --------------------------------------------------------------------------
Net Cash Provided (Used) by
Financing Activities 319 (1,926) 920
- --------------------------------------------------------------------------
Increase (Decrease) in Cash
and Cash Equivalents (1,899) (139) 646
Cash and Cash Equivalents
at Beginning of Year 2,153 2,292 1,646
- --------------------------------------------------------------------------
Cash and Cash Equivalents
at End of Year $ 254 $ 2,153 $ 2,292
==========================================================================
Supplemental Disclosures
- --------------------------------------------------------------------------
Income Taxes Paid (Received) $ 187 $ (158) $ (209)
Stock Dividend 14,605 17,295 12,150
46
47
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The text and tables under "Election of Directors" in the Corporation's 1998
Proxy Statement is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The text and tables under "Compensation of Officers and Directors" in the
Corporation's 1998 Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The text and tables under "Voting Securities and Principal Holders Thereof" and
"Election of Directors" in the Corporation's 1998 Proxy Statement are
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The text under "Certain Transactions with Management" in the Corporation's 1998
Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) The Consolidated Financial Statements of Provident
Bankshares Corporation and Subsidiaries are included
in Item 8.
(a) (2) Financial statement schedules--none applicable
or required.
(a) (3) Exhibits
The following is an index of the exhibits included in this report:
(3.1) Articles of Incorporation of Provident Bankshares
Corporation.(1)
(3.2) By-Laws of Provident Bankshares Corporation, as amended.(3)
(4.1) Stockholder Protection Right Agreement.(3)
(10.1) 1994 Supplemental Executive Incentive Plan of Provident
Bank of Maryland.(3)
(10.2) Supplemental Executive Retirement Income Plan of Provident
Bank of Maryland.(4)
(10.3) Amended and restated Stock Option and Appreciation Rights
Plan of Provident Bankshares Corporation.(5)
(10.4) Form of Change in Control Agreement between Provident
Bankshares Corporation and Certain Executive Officers.(2)
(10.5) Form of Change in Control Agreement between Provident Bank
of Maryland and Certain Executive Officers.(2)
(11) Statement re: Computation of Per Share Earnings.(6)
(21) Subsidiaries of Provident Bankshares Corporation.(6)
(23) Consents of Independent Accountants.(6)
(24) Power of Attorney.(6)
(27) Financial Data Schedule.(6)
(b) No reports on Form 8-K were filed by the Corporation in the last quarter
of 1997.
(1) Incorporated by reference from Registrant's Registration Statement on Form
S-3 (File No. 33-73162) filed with the Commission on August 18, 1994.
(2) Incorporated by reference from Registrant's 1995 Form 10-K (File No.
0-16421) filed with the Commission on March 18, 1996.
(3) Incorporated by reference from the Registrant's 1994 Annual Report on Form
10-K (File No. 0-16421) filed with the Commission on February 17, 1995.
(4) Incorporated by reference from Registrant's 1993 Form 10-K (File No.
0-16421) filed with the Commission on March 14, 1994.
(5) Incorporated by reference from the Registrant's definitive 1995 Proxy
Statement for the Annual Meeting of Stockholders held on April 19, 1995.
(6) Filed herewith.
47
48
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.
PROVIDENT BANKSHARES CORPORATION
(Registrant)
January 30, 1998 BY: /s/Carl W. Stearn
-----------------------------------
Carl W. Stearn
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacity and on the dates indicated.
Principal Executive Officer:
January 30, 1998 BY:/s/Carl W. Stearn
-----------------------------------
Carl W. Stearn
Chairman of the Board and
Chief Executive Officer
Principal Financial Officer:
January 30, 1998 BY:/s/James R. Wallis
-----------------------------------
James R. Wallis
Executive Vice President
January 30, 1998 Principal Accounting Officer
BY: /s/ R. Wayne Hall
----------------------------------
R. Wayne Hall
Treasurer
A Majority of the Board of Directors*
Robert B. Barnhill, Jr., Melvin A. Bilal,
Dr. Calvin W. Burnett, Ward B. Coe, III,
Charles W. Cole, Jr., M. Jenkins Cromwell, Jr.,
Pierce B. Dunn, Enos K. Fry,
Herbert W. Jorgensen, Mark K. Joseph,
Barbara B. Lucas, Peter M. Martin,
Frederick W. Meier, Jr.,
Sister Rosemarie Nassif, Francis G. Riggs,
Sheila K. Riggs, Carl W. Stearn
January 30, 1998 *BY /s/ R. Wayne Hall
----------------------------------
R. Wayne Hall
Attorney-in-fact
48