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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 [FEE REQUIRED]
For the Fiscal Year Ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the transaction period from ______________ to ______________
Commission File Number: 1-31566
PROVIDENT FINANCIAL SERVICES, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 42-1547151
--------------------------------- ---------------------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
830 Bergen Avenue, Jersey City, New Jersey 07306-4599
------------------------------------------ ----------
(Address of Principal Executive Offices) (Zip Code)
(201) 333-1000
---------------------------------------------------
(Registrant's Telephone Number including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 per share
--------------------------------------
(Title of Class)
Securities Registered Pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file reports) and (2) has been subject to such
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
amendments to this Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
YES ___ NO X
As of March 1, 2003, there were issued and outstanding 61,538,300
shares of the Registrant's Common Stock. The aggregate value of the voting stock
held by non-affiliates of the Registrant, computed by reference to the average
bid and asked prices of the Common Stock as of March 1, 2003 was $908.6 million.
PART I
ITEM 1. BUSINESS
GENERAL
PROVIDENT FINANCIAL SERVICES, INC.
Provident Financial Services, Inc. is a Delaware corporation which, on
January 15, 2003, became the holding company for The Provident Bank, following
the completion of the conversion of The Provident Bank to a stock chartered
savings bank. On January 15, 2003, Provident Financial Services, Inc. issued an
aggregate of 59,618,300 shares of its common stock, par value $0.01 per share in
a subscription offering and contributed cash and 1,920,000 shares of its common
stock to The Provident Bank Foundation, a charitable foundation established by
The Provident Bank. As a result of the conversion and our related stock
offering, we raised $586.2 million in net proceeds, of which $293.1 million was
infused into The Provident Bank and $293.1 million was retained by us. At
December 31, 2002, Provident Financial Services, Inc. had no assets or
liabilities and had no business operations. As of the completion of the
conversion on January 15, 2003, Provident Financial Services, Inc. owned all of
the outstanding common stock of The Provident Bank. Currently, Provident
Financial Services, Inc.'s activities consist solely of managing the Bank and
investing its portion of the net proceeds received in the subscription offering.
Accordingly, the following discussion addresses the operations of The Provident
Bank and its subsidiaries.
Provident Financial Services, Inc. maintains a website at
www.providentbanknj.com and makes available, free of charge, through this
website its annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and all amendments to those reports as soon as reasonably
practicable after such material is electronically filed with or furnished to the
Securities and Exchange Commission ("SEC"). These forms can be accessed within
the Investor Relations portion of the website by clicking on "SEC Filings."
THE PROVIDENT BANK
Originally established in 1839, The Provident Bank is a New Jersey
chartered capital stock savings bank headquartered in Jersey City, New Jersey.
The Provident Bank is a community- and customer-oriented bank operating 49
full-service branch offices in the New Jersey counties of Hudson, Bergen, Essex,
Mercer, Middlesex, Monmouth, Morris, Ocean, Somerset and Union, which we
consider our primary market area. As part of our "Customer-Centric Strategy,"
The Provident Bank emphasizes personal service and customer convenience in
serving the financial needs of the individuals, families and businesses residing
in our markets. The Provident Bank attracts deposits from the general public in
the areas surrounding its banking offices and uses those funds, together with
funds generated from operations and borrowings, to originate commercial real
estate loans, residential mortgage loans, mortgage warehouse loans, commercial
business loans and consumer loans. The Provident Bank also invests in
mortgage-backed securities and other permissible investments. At December 31,
2002, The Provident Bank had total assets of $3.92 billion, net loans of $2.03
billion, total deposits of $3.24 billion, and equity of $326.0 million. Our
mailing address is 830 Bergen Avenue, Jersey City, New Jersey 07306-4599, and
our telephone number is (201) 333-1000.
The following are highlights of The Provident Bank's operations:
. Diversified Loan Portfolio. In order to improve asset yields and
reduce our exposure to interest rate risk, The Provident Bank
diversified its loan portfolio by emphasizing the origination of
commercial mortgage, commercial business and mortgage warehouse
loans. These loans generally have adjustable interest rates that
initially are higher than the rates applicable to one- to
four-family residential mortgage loans. However, these loans also
generally have a higher risk of loss than single-family
residential mortgage loans. Residential mortgage loans as a
percentage of our loan portfolio have declined from 50.19% at
December 31, 1998 to 34.43% at December 31, 2002.
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. Asset Quality. As of December 31, 2002, non-performing assets
were $8.5 million or 0.22% of total assets compared to $5.7
million or 0.23% of total assets at December 31, 1998. The
Provident Bank's asset quality reflects our focus on underwriting
criteria and our aggressive collection and charge-off efforts.
However, the increased levels of commercial mortgage, commercial
business and mortgage warehouse loans, the limited seasoning of
these portfolios and the relatively large credit concentrations,
increase The Provident Bank's credit risk.
. Emphasis on Relationship Banking and Core Deposits. The Provident
Bank has emphasized growth in core deposit accounts, such as
checking and savings accounts and expanding customer
relationships. Core deposit accounts totaled $2.19 billion at
December 31, 2002, representing 67.58% of total deposits. The
Provident Bank has also focused on increasing the number of
households and businesses served and the number of bank products
per customer through our commitment to our brand promise --
"Hassle-Free Banking for Busy People."
. Increasing Non-Interest Income. The Provident Bank's emphasis on
transaction accounts and expanded products and services has
enabled the Bank to increase non-interest income. A primary
source of our non-interest income is derived from fees on our
core deposit accounts. Non-interest income increased to $24.1
million for the year ended December 31, 2002 from $21.2 million
for the year ended December 31, 2001. We have also focused on
expanding our products and services to generate additional
non-interest income. In addition to offering investment products
and estate management and trust services, we entered into a joint
venture in 2001 to sell title insurance and we acquired a
mortgage banking company in July 2001.
. Expense Management. During 2001, The Provident Bank hired a
significant number of lending and marketing professionals as part
of our business strategy of increasing business lending and
deposit relationships and developing and implementing our
Customer Relationship Management strategy. Non-interest expense
to average assets decreased to 2.90% for the year ended December
31, 2002 from 2.94% for the year ended December 31, 2001.
. Managing Interest Rate Risk. Although The Provident Bank's
liabilities are more sensitive to changes in interest rates than
its assets, The Provident Bank seeks to manage its exposure to
interest rate risk by emphasizing the origination and retention
of adjustable rate and shorter term loans. In addition, The
Provident Bank uses its investments in securities to manage
interest rate risk. At December 31, 2002, 22.8% of our loan
portfolio had a term to maturity of one year or less or had an
adjustable interest rate. Moreover, at December 31, 2002, The
Provident Bank's securities portfolio totaled $1.46 billion and
had an average expected life of 1.86 years (excluding equity
securities).
. Expansion of Retail Banking Franchise. During the last several
years, The Provident Bank has expanded its retail banking
franchise by acquiring branches and a whole bank. The Provident
Bank has also closed branch offices that did not meet its
performance criteria. The Provident Bank anticipates continued
expansion through the establishment of two to four de novo branch
offices annually during the next three years, although no
assurance can be given that it will be able to establish these
branches as intended. The Provident Bank will consider other
expansion opportunities that may arise and that complement or
enhance our market presence.
Certain statements contained herein are not based on historical facts
and are "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Such forward-looking statements may be identified by reference to a future
period or periods, or by the use of forward-looking terminology, such as "may,"
"will," "believe," "expect," "estimate," "anticipate," "continue," or similar
terms or variations on those terms, or the negative of those terms.
Forward-looking statements are subject to numerous risks and uncertainties,
including, but not limited to, those related to the economic environment,
particularly in the market areas in which the company operates, competitive
products and pricing, fiscal and monetary policies of the U.S. Government,
changes in government regulations affecting financial institutions, including
regulatory fees and capital requirements, changes in prevailing interest rates,
acquisitions and the
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integration of acquired businesses, credit risk management, asset-liability
management, the financial and securities markets and the availability of and
costs associated with sources of liquidity.
The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made. The
Company wishes to advise readers that the factors listed above could affect the
Company's financial performance and could cause the Company's actual results for
future periods to differ materially from any opinions or statements expressed
with respect to future periods in any current statements. The Company does not
undertake and specifically declines any obligation to publicly release the
result of any revisions which may be made to any forward-looking statements to
reflect events or circumstances after the date of such statements or to reflect
the occurrence of anticipated or unanticipated events.
MARKET AREA
We are headquartered in Jersey City, which is located in Hudson County,
New Jersey. In addition to our banking offices throughout Hudson County, we
operate offices in nine additional counties in northern and central New Jersey,
namely, Bergen, Essex, Mercer, Middlesex, Monmouth, Morris, Ocean, Somerset and
Union. The Provident Bank's lending activities, though concentrated in the
communities surrounding its offices, extend predominately throughout the State
of New Jersey.
The Provident Bank's 10-county primary market area includes a mix of
urban and suburban communities. Hudson County is an urban area situated across
the Hudson River from New York City. Extensive development of new office space
has been a primary source of economic growth in Hudson County. The Provident
Bank's ten-county market area has a diversified mix of industries including
pharmaceutical and other manufacturing companies, network communications,
insurance and financial services, and retail. Major employers in the area
include several prominent companies such as AT&T, Prudential Insurance Co. and
Johnson & Johnson. New Jersey has the highest population density of any state in
the United States, and our ten-county market area has a population of 5.8
million, which is 69.0% of the state's total population. Population growth in
our market area between 1990 and 2000 was 9.6% compared to the state average of
8.6% and the national average of 13.10%. Median household income in our market
area is among the highest in the United States at $51,500, compared to $47,900
for New Jersey as a whole and $37,000 nationally.
Within its ten-county market area The Provident Bank has an approximate
1.75% share of bank deposits as of June 30, 2002, the latest date for which
statistics are available, and an approximate 1.40% deposit share of the New
Jersey market statewide. Our market share in each of Hudson and Essex Counties
was in excess of 4.0% at that period. Of the 181 FDIC insured institutions
operating within New Jersey as of June 30, 2002, The Provident Bank was 15th in
total deposits within the state.
Because of the diversity of industries in The Provident Bank's market
area and, to a lesser extent, because of its proximity to the New York City
financial markets, the area's economy can be significantly affected by changes
in national and international economies. While the growth rate of New Jersey's
gross domestic product over the last several years has been less than the
national rate, the state's overall unemployment rate has been significantly
below the national average. This gap has recently narrowed, particularly in the
manufacturing sector, due to the recent recession.
COMPETITION
We face intense competition within our market both in originating loans
and attracting deposits. The Northern and Central New Jersey market area has a
high concentration of financial institutions, including large money center and
regional banks, community banks, credit unions, investment brokerage firms and
insurance companies. We face direct competition for loans from each of these
institutions as well as from the mortgage companies, mortgage brokers and other
loan origination firms operating in our market area. The Provident Bank's most
direct competition for deposits has come from the several commercial banks and
savings banks in our market area, especially large regional banks which have
obtained a major share of the available deposit market due in part to
acquisitions and consolidations. Many of these banks have substantially greater
financial resources than The Provident Bank and offer services, such as private
banking, that we do not provide. In addition, we face significant
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competition for deposits from the mutual fund industry and from investors'
direct purchase of short-term money market securities and other corporate and
government securities.
The Provident Bank expects to compete in this environment by
maintaining a diversified product line, including mutual funds, annuities and
other investment services made available through our investment subsidiary.
Relationships with our customers are built and maintained through The Provident
Bank's branch network, its deployment of branch and off-site ATMs, and
continuing development of its telephone and web-based banking services.
RISK FACTORS
In addition to factors discussed in the description of our business and
elsewhere in this report, the following are risk factors that could aversely
affect our future results of operations and our financial condition.
Our Commercial Real Estate, Multi-Family, Mortgage Warehouse and Commercial
Loans Expose Us to Increased Lending Risks
We have significantly increased our construction loans, commercial
mortgage loans, mortgage warehouse loans and commercial loans. Our strategy is
to continue to grow our portfolios of these types of loans. These loans are
generally regarded to have a higher risk of default and loss than single-family
residential mortgage loans. Our construction loans have increased from an
aggregate of $25.5 million or 1.52% of our total loan portfolio at December 31,
1998 to $96.0 million or 4.73% of our total loan portfolio at December 31, 2002,
while our commercial loans have increased from an aggregate of $68.6 million or
4.08% of our total loan portfolio at December 31, 1998 to $183.4 million or
9.03% of our total loan portfolio at December 31, 2002. Our commercial mortgage
loans have increased from $300.5 million or 17.88% of our total loan portfolio
at December 31, 1998 to $444.2 million or 21.86% of our total loan portfolio at
December 31, 2002, while our mortgage warehouse loans have increased from $85.5
million at December 31, 1998 or 5.09% of our total loan portfolio to $276.4
million or 13.60% of our total loan portfolio at December 31, 2002. At the same
time, while the dollar amount of our single-family residential mortgage loans
has remained relatively level in recent years, the percentage of our
single-family residential mortgage loans in our portfolio has significantly
decreased. Single-family residential mortgage loans have decreased from 50.19%
of our total loan portfolio at December 31, 1998 to 34.43% at December 31, 2002.
Construction loans, commercial mortgage loans, multi-family mortgage
loans, mortgage warehouse loans, marine loans and commercial loans all generally
have a higher risk of loss than single-family residential mortgage loans,
because repayment of the loans often depends on the successful operation of a
business or of the underlying property. In addition, our construction loans,
commercial mortgage loans, multi-family mortgage loans, mortgage warehouse loans
and commercial loans have significantly larger average loan balances compared to
our single-family residential mortgage loans. Also, many of our borrowers of
these types of loans have more than one loan outstanding with us. Consequently,
any adverse development with respect to one loan or one credit relationship can
expose us to a significantly greater risk of loss compared to an adverse
development with respect to one single-family residential mortgage loan.
Additionally, mortgage warehouse lending subjects The Provident Bank to risk of
fraud. Such fraud may consist of a mortgage warehouse borrower pledging the same
collateral to more than one mortgage warehouse line. Detection of such fraud is
generally very difficult. During the quarter ended September 30, 2002, we
recorded an $11.1 million provision for loan losses due to the reclassification
of a $20.6 million mortgage warehouse line to a mortgage warehouse borrower that
has ceased doing business under allegations of fraud. During the fourth quarter
we sold loans totaling $1.4 million to investors and charged off an additional
$718,000 in loans related to the $20.6 million mortgage warehouse loan. We have
placed the remaining loans in our portfolio, established contact with the
borrowers and subsequently moved these loans into performing status as payment
histories were established.
In addition, at December 31, 2002, the aggregate principal balance of
loans to our fifty largest lending relationships was $568.9 million, or 27.73%
of our total loan portfolio. At December 31, 2002, the average loan size for a
construction loan was $1.5 million, for a commercial real estate loan was
$942,825, for a multi-family loan was $452,649, for a mortgage warehouse loan
was $7.3 million, and for a commercial loan was $184,708, compared to an average
loan size of $113,963 for a single-family residential mortgage loan.
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Our Continuing Concentration of Loans in Our Primary Market Area May Increase
Our Risk
Our success depends primarily on the general economic conditions in
northern-central New Jersey. Unlike larger banks that are more geographically
diversified, we provide banking and financial services to customers primarily in
northern-central New Jersey. The local economic conditions in northern-central
New Jersey have a significant impact on our commercial, real estate, mortgage
warehouse and construction loans, the ability of the borrowers to repay these
loans and the value of the collateral securing these loans. A significant
decline in general economic conditions caused by inflation, recession,
unemployment or other factors beyond our control would impact these local
economic conditions and could negatively affect the financial results of our
banking operations. Additionally, because we have a significant amount of real
estate loans, decreases in real estate values may also have a negative effect on
the ability of many of our borrowers to make timely repayments of their loans,
which would have an adverse impact on our earnings.
We target our business development and marketing strategy for loans to
serve primarily the banking and financial services needs of small- to
medium-sized businesses in northern-central New Jersey. These small-to
medium-sized businesses generally have fewer financial resources in terms of
capital or borrowing capacity than larger entities. If general economic
conditions negatively impact these businesses, our results of operations and
financial condition may be adversely affected.
If Our Allowance for Loan Losses is Not Sufficient to Cover Actual Loan Losses,
Our Earnings Could Decrease
Our loan customers may not repay their loans according to the terms of
the loans, and the collateral securing the payment of these loans may be
insufficient to pay any remaining loan balance. We may experience significant
loan losses, which could have a material adverse effect on our operating
results. We make various assumptions and judgments about the collectibility of
our loan portfolio, including the creditworthiness of our borrowers and the
value of the real estate and other assets serving as collateral for the
repayment of many of our loans. In determining the amount of the allowance for
loan losses, we rely on our loan quality reviews, our experience and our
evaluation of economic conditions, among other factors. If our assumptions prove
to be incorrect, our allowance for loan losses may not be sufficient to cover
losses inherent in our loan portfolio, resulting in additions to our allowance.
Material additions to our allowance would materially decrease our net income.
Our emphasis on continued diversification of our loan portfolio through
the origination of construction loans, commercial mortgage loans, mortgage
warehouse loans and commercial loans has been one of the more significant
factors we have taken into account in evaluating our allowance for loan losses
and provision for loan losses. In the event we were to further increase the
amount of such types of loans in our portfolio, we may determine to make
additional or increased provisions for loans losses, which could adversely
affect our earnings.
In addition, bank regulators periodically review our allowance for loan
losses and may require us to increase our provision for loan losses or recognize
further loan charge-offs. Any increase in our allowance for loan losses or loan
charge-offs as required by these regulatory authorities could have a material
adverse effect on our results of operations and financial condition.
Changes in Interest Rates Could Adversely Affect Our Results of Operations and
Financial Condition
Our results of operations and financial condition are significantly
affected by changes in interest rates. Our results of operations are affected
substantially by our net interest income, which is the difference between the
interest income earned on our interest-earning assets and the interest expense
paid on our interest-bearing liabilities. Changes in interest rates could have
an adverse affect on net interest income because, as a general matter, our
interest-bearing liabilities reprice or mature more quickly than our
interest-earning assets, an increase in interest rates generally would result in
a decrease in our average interest rate spread and net interest income, which
would have a negative effect on our profitability. In the event of an immediate
and sustained 200 basis point increase in interest rates and assuming management
took no actions to mitigate the effect of such change, we are projecting that
our net interest income would decrease 8.43% or $12.1 million.
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Changes in interest rates also affect the value of our interest-earning
assets, and in particular our securities portfolio. Generally, the value of
securities fluctuates inversely with changes in interest rates. At December 31,
2002, our available for sale securities portfolio totaled $1.24 billion.
Unrealized gains and losses on securities available for sale are reported as a
separate component of equity. Decreases in the fair value of securities
available for sale resulting from increases in interest rates therefore could
have an adverse effect on stockholders' equity.
We are also subject to prepayment and reinvestment risk related to
interest rate movements. Changes in interest rates can affect the average life
of loans and mortgage related securities. Decreases in interest rates can result
in increased prepayments of loans and mortgage related securities, as borrowers
refinance to reduce borrowing costs. Under these circumstances, we are subject
to reinvestment risk to the extent that we are unable to reinvest such
prepayments at rates that are comparable to the rates on existing loans or
securities.
We Operate in a Highly Regulated Environment and May be Adversely Affected by
Changes in Laws and Regulations
We are subject to extensive regulation, supervision and examination by
the New Jersey Department of Banking and Insurance, our chartering authority,
and by the Federal Deposit Insurance Corporation, as insurer of our deposits. As
a bank holding company, Provident Financial Services, Inc. is subject to
regulation and oversight by the Board of Governors of the Federal Reserve
System. Such regulation and supervision govern the activities in which a bank
and its holding company may engage and are intended primarily for the protection
of the insurance fund and depositors. These regulatory authorities have
extensive discretion in connection with their supervisory and enforcement
activities, including the imposition of restrictions on our operations, the
classification of our assets and the adequacy of our allowance for loan losses.
Any change in such regulation and oversight, whether in the form of regulatory
policy, regulations, or legislation, could have a material impact on The
Provident Bank, Provident Financial Services, Inc., and our operations.
We May Enter Into an Agreement With The FDIC Regarding Compliance With Federal
Banking Regulations; The Failure To Comply May Restrict Our Activities
The FDIC recently conducted an examination relating to our compliance
with various federal banking regulations, which examination was unrelated to
safety and soundness. The FDIC noted weaknesses and failures relating to our
compliance with the reporting requirements of the Home Mortgage Disclosure Act.
The Home Mortgage Disclosure Act imposes on financial institutions reporting
obligations relating to home purchase and home improvement loans originated or
purchased, or for which the financial institution receives applications. This
loan data is used by regulatory agencies to help determine whether a financial
institution is serving the housing needs of the communities it serves, to assist
public officials in the distribution of public sector investments where it is
needed, and to assist federal bank regulators in identifying possible
discriminatory lending patterns.
We have taken action and implemented procedures to redress the FDIC's
concerns and findings, including the refiling with the FDIC of our Home Mortgage
Disclosure Act data for 2000 and 2001. The FDIC has issued a final report of
examination and we anticipate that the FDIC will require us to implement
corrective actions and may also require a memorandum of understanding with The
Provident Bank to ensure that corrective actions are taken and continue in the
future and may impose civil money penalties in connection with our refiling of
Home Mortgage Disclosure Act data. If we are required to enter into a memorandum
of understanding with the FDIC and in the future fail to comply with any such
agreement, we could be subject to further regulatory action, including
restrictions on our ability to expand through bank and branch acquisitions, and
possible monetary penalties.
Strong Competition Within Our Market Area May Limit Our Growth and Profitability
Competition in the banking and financial services industry is intense.
In our market area, we compete with commercial banks, savings institutions,
mortgage brokerage firms, credit unions, finance companies, mutual funds,
insurance companies, and brokerage and investment banking firms operating
locally and elsewhere. In particular, over the past decade, New Jersey has
experienced the effects of substantial banking consolidation. In the early
1990's, certain out-of-state banks acquired New Jersey financial institutions
and, later in the decade, such acquirers became subject to mergers themselves.
In the northern New Jersey market, for example, large out-of-state competitors
have grown significantly. There are also a number of strong locally-based
competitors in our market.
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Many of these competitors (whether regional or national institutions) have
substantially greater resources and lending limits than we do, and may offer
certain services that we do not or cannot provide. Our profitability depends
upon our continued ability to successfully compete in our market area.
Our Return on Equity Will be Low Compared to Other Companies. This Could Lower
the Trading Price of Our Common Stock
Net income divided by average equity, known as "return on equity," is a
ratio many investors use to compare the performance of a financial institution
to its peers. We expect our return on equity to decrease as compared to our
performance in recent years until we are able to leverage our increased equity
from the offering. Our return on equity also will be reduced due to the costs of
being a public company, added expenses associated with our employee stock
ownership plan, and, later on, our recognition and retention plan, assuming this
plan is approved by our stockholders. Until we can increase our net interest
income and non-interest income, we expect our return on equity to be below the
industry average, which may negatively affect the value of our common stock. Our
return on equity is projected to be significantly lower than our peer group due
to the projected higher pro forma capital levels resulting from the infusion of
conversion proceeds.
Our Stock Benefit Plans Will Increase Our Costs, Which Will Reduce Our Income
and Stockholders' Equity
Our employee stock ownership plan purchased 0.97% of the common stock
sold in the offering with funds borrowed from Provident Financial Services, Inc.
The cost of acquiring the employee stock ownership plan shares has been
$18,368,024 through March 1, 2003. The aggregate cost will continue to increase
as the employee stock ownership plan continues to purchase shares in the open
market. We will record annual employee stock ownership plan expenses in an
amount equal to the fair value of shares committed to be released to employees.
If shares of common stock appreciate in value over time, compensation expense
relating to the employee stock ownership plan will increase.
We also intend to implement a recognition and retention plan after the
conversion. Under this plan, our officers and directors could be awarded, at no
cost to them, shares of common stock in an aggregate amount equal to 4% of the
shares sold in the offering. The recognition and retention plan cannot be
implemented until at least six months after the conversion, and if it is adopted
within 12 months after the conversion, it is subject to regulatory restrictions.
The recognition and retention plan must be approved by our shareholders. If
shares of our common stock appreciate in value over time, the net after-tax
expense relating to the recognition and retention plan will increase. In the
event that a portion of the shares used to (i) fund the recognition and
retention plan or (ii) satisfy the exercise of options from our stock option
plan, is obtained from authorized but unissued shares, the issuance of
additional shares will decrease our net income per share and stockholders'
equity per share.
The Implementation of Stock-Based Benefit Plans May Dilute Your Ownership
Interest
We intend to adopt a stock option plan and a recognition and retention
plan now that we have converted. These stock benefit plans will be funded
through either open market purchases, if permitted, or from the issuance of
authorized but unissued shares. Stockholders will experience a reduction in
ownership interest in the event newly issued shares are used to fund stock
options and awards made under these plans.
Our Stock Value May Suffer Due to Our Ability to Impede Potential Takeovers
Provisions in our corporate documents and in Delaware corporate law, as
well as certain banking regulations, make it difficult and expensive for an
outsider to pursue a tender offer, change in control or takeover attempt that
our Board of Directors opposes. For example, our corporate documents require a
supermajority vote of stockholders to amend or repeal specific sections of
Provident Financial Services, Inc.'s certificate of incorporation and bylaws. As
a result, you may not have an opportunity to participate in this type of
transaction, and the trading price of our common stock may not rise to the level
of other institutions that are more vulnerable to hostile takeovers.
These provisions also will make it more difficult for an outsider to
remove our current Board of Directors or management.
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Potential Voting Control by Management and Employees Could Make a Takeover
Attempt More Difficult to Achieve
The shares of common stock that our directors and officers purchased in
the conversion, when combined with the shares that may be awarded to
participants under our employee stock ownership plan and other stock benefit
plans, could result in management and employees controlling a significant
percentage of our common stock. The shares owned by our directors, officers and
employees, when combined with our employee stock ownership plan and our other
stock benefit plans, assuming they are implemented as proposed, could result in
the control of up to 23% of the outstanding shares of our common stock on a
fully diluted basis. If these individuals were to act together, they could have
significant influence over the outcome of any stockholder vote. This voting
power may discourage takeover attempts that other stockholders may desire.
LENDING ACTIVITIES
General. Historically, our principal lending activity has been the
origination of fixed-rate and adjustable-rate mortgage loans collateralized by
one- to four-family residential real estate located within our primary market
area. Since 1997, we have taken a more balanced approach to the composition of
our loan portfolio by increasing our emphasis on originating commercial real
estate loans, commercial business loans and mortgage warehouse loans. A
substantial majority of our borrowers are located in the State of New Jersey.
Residential mortgage loans are primarily underwritten to standards that
allow the sale of the loans to the secondary markets, primarily to Fannie Mae
and Freddie Mac. To manage interest rate risk, we generally sell the 20 year and
30 year fixed-rate residential mortgages that we originate. We retain the
majority of the originated adjustable rate mortgages for our portfolio.
The Provident Bank originates commercial real estate loans that are
secured by income-producing properties such as multi-family residences, office
buildings, and retail and industrial properties. In order to limit exposure to
interest rate risk, The Provident Bank adjusts the rate following the initial
five-year period in the majority of the real estate loans it originates.
We provide construction loans for both single family and condominium
projects intended for sale and projects that will be retained as investments of
the borrower. The Provident Bank underwrites most construction loans for a term
of three years or less. The majority of these loans are underwritten on a
floating rate basis. The Provident Bank recognizes that there is higher risk in
construction lending than permanent lending. As such, we take certain
precautions to mitigate this risk, including the retention of an outside
engineering firm to review all construction advances made against work in place
and a limitation on how and when loan proceeds are advanced. In most cases, for
the single family/condominium projects we manage our exposure against houses or
units that are not under contract. Similarly, commercial construction loans
usually have commitments for significant pre-leasing, or funds are held back
until the leases are finalized.
The Provident Bank originates consumer loans that are secured in most
cases by the individual's assets. Home equity loans and home equity lines of
credit that are primarily secured by a second mortgage lien on the borrower's
residence comprise the largest category of our consumer loan portfolio. Our
consumer loan portfolio also includes marine loans that are secured by a first
lien on recreation boats. The marine loans we finance are generated by boat
dealers located on the Atlantic Coast of the United States. To a lesser extent,
The Provident Bank originates personal unsecured loans, primarily as an
accommodation to customers. All loans, whether originated directly or purchased,
are underwritten to The Provident Bank's lending standards.
Commercial loans are loans to businesses of varying size and type to
borrowers in our market. The Provident Bank's underwriting standards for
commercial loans less than $150,000, utilize an industry recognized automated
credit scoring system. The Provident Bank lends to established businesses, and
the loans are generally secured by business assets such as equipment,
receivables, inventory, real estate or marketable securities. On occasion we
make unsecured commercial loans. Most commercial loans are made on a floating
interest rate basis and fixed interest rates are rarely offered for more than
five years.
9
The Provident Bank provides lines of credit for working capital to
mortgage bankers conducting business primarily in New Jersey. These loans are
secured by mortgages originated by the mortgage banker with the proceeds of our
warehouse loan that will be sold to a recognized lender under a firm takeout
commitment. Mortgage warehouse loans are made on a floating interest rate basis
tied to the prime rate, federal funds or similar index.
10
Loan Portfolio Composition. Set forth below is selected information
concerning the composition of our loan portfolio in dollar amounts and in
percentages (before deductions for deferred fees and costs, unearned discounts
and premiums and allowances for losses) as of the dates indicated.
AT DECEMBER 31,
----------------------------------------------------------------------------------------------
2002 2001 2000
---------------------------- ---------------------------- ----------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------------ ------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
Residential mortgage loans ... $ 699,469 34.43% $ 795,442 39.88% $ 905,825 46.33%
Commercial mortgage loans .... 444,249 21.86 412,280 20.67 380,237 19.45
Multi-family mortgage loans .. 77,006 3.79 95,456 4.78 95,387 4.88
Construction loans ........... 96,028 4.73 80,717 4.05 75,980 3.89
------------ ------------ ------------ ------------ ------------ ------------
Total mortgage loans ...... 1,316,752 64.81 1,383,895 69.38 1,457,429 74.55
------------ ------------ ------------ ------------ ------------ ------------
Mortgage warehouse loans ..... 276,383 13.60 167,905 8.42 66,949 3.42
Commercial loans ............. 183,410 9.03 141,491 7.09 121,540 6.22
Consumer loans ............... 275,812 13.57 322,219 16.15 328,831 16.82
------------ ------------ ------------ ------------ ------------ ------------
Total other loans ......... 735,605 36.20 631,615 31.66 517,320 26.46
------------ ------------ ------------ ------------ ------------ ------------
Premium on purchased loans ... 2,123 0.10 2,566 0.13 3,264 0.17
Less net deferred fees ....... (1,625) (0.08) (1,531) (0.07) (2,823) (0.15)
Less: Allowance Loan Loss .... (20,986) (1.03) (21,909) (1.10) (20,198) (1.03)
------------ ------------ ------------ ------------ ------------ ------------
Total loans, net .......... $ 2,031,869 100.0% $ 1,994,636 100.00% $ 1,954,992 100.00%
============ ============ ============ ============ ============ ============
AT DECEMBER 31,
-------------------------------------------------------------
1999 1998
---------------------------- ----------------------------
AMOUNT PERCENT AMOUNT PERCENT
------------ ------------ ------------ ------------
(Dollars in thousands)
Residential mortgage loans.... $ 884,680 47.15% $ 843,210 50.19%
Commercial mortgage loans .... 387,435 20.64 300,478 17.88
Multi-family mortgage loans .. 96,476 5.14 88,598 5.27
Construction loans ........... 69,946 3.73 25,510 1.52
------------ ------------ ------------ ------------
Total mortgage loans ...... 1,438,537 76.66 1,257,796 74.86
------------ ------------ ------------ ------------
Mortgage warehouse loans ..... 47,719 2.54 85,477 5.09
Commercial loans ............. 85,357 4.55 68,556 4.08
Consumer loans ............... 324,431 17.29 287,531 17.11
------------ ------------ ------------ ------------
Total other loans ......... 457,507 24.38 441,564 26.28
------------ ------------ ------------ ------------
Premium on purchased loans ... 2,925 0.16 1,109 0.07
Less net deferred fees ....... (3,742) (0.20) (2,997) (0.18)
Less: Allowance Loan Loss .... (18,794) (1.00) (17,381) (1.03)
------------ ------------ ------------ ------------
Total loans, net .......... $ 1,876,433 100.00% $ 1,680,091 100.00%
============ ============ ============ ============
11
Loan Maturity Schedule. The following table sets forth certain
information as of December 31, 2002, regarding the maturities of loans in our
loan portfolio. Demand loans having no stated schedule of repayment and no
stated maturity, and overdrafts are reported as due in one year or less. Due to
prepayments, actual cash flows may differ from the maturities stated below.
ONE TEN
THROUGH THREE FIVE THROUGH BEYOND
WITHIN THREE THROUGH THROUGH TWENTY TWENTY
ONE YEAR YEARS FIVE YEARS TEN YEARS YEARS YEARS TOTAL
---------- ---------- ---------- ---------- ---------- ---------- ------------
(In thousands)
Residential mortgage loans .. $ 84,558 $ 64,377 $ 105,093 $ 137,043 $ 217,669 $ 90,729 $ 699,469
Commercial mortgage loans ... 23,580 92,285 165,529 138,761 21,944 2,150 444,249
Multi-family mortgage loans.. 15,429 15,808 34,617 8,280 2,393 479 77,006
Construction loans .......... 64,740 26,040 4,803 445 -- -- 96,028
---------- ---------- ---------- ---------- ---------- ---------- ------------
Total mortgage loans .... 188,307 198,510 310,042 284,529 242,006 93,358 1,316,752
Mortgage warehouse loans .... 276,383 -- -- -- -- -- 276,383
Commercial loans ............ 76,282 25,319 28,665 33,527 19,197 420 183,410
Consumer loans .............. 35,878 12,088 18,917 52,355 156,574 -- 275,812
---------- ---------- ---------- ---------- ---------- ---------- ------------
Total loans ............. $ 576,850 $ 235,917 $ 357,624 $ 370,411 $ 417,777 $ 93,778 $ 2,052,357
========== ========== ========== ========== ========== ========== ============
Fixed- and Adjustable-Rate Loan Schedule. The following table sets
forth at December 31, 2002, the dollar amount of all fixed-rate and
adjustment-rate loans due after December 31, 2003. Adjustable and floating rate
loans are included based on contractual maturities.
DUE AFTER DECEMBER 31, 2003
--------------------------------------------
FIXED ADJUSTABLE TOTAL
------------ ------------ ------------
(In thousands)
Residential mortgage loans...... $ 385,314 $ 229,597 $ 614,911
Commercial mortgage loans....... 91,162 329,507 420,669
Multi-family mortgage loans..... 18,112 43,465 61,577
Construction loans.............. -- 31,288 31,288
------------ ------------ ------------
Total mortgage loans......... 494,588 633,857 1,128,445
------------ ------------ ------------
Mortgage warehouse loans........ -- -- --
Commercial loans................ 71,223 35,905 107,128
Consumer loans.................. 239,934 -- 239,934
------------ ------------ ------------
Total loans.................. $ 805,745 $ 669,762 $ 1,475,507
============ ============ ============
Residential Mortgage Lending. A principal lending activity of The
Provident Bank is to originate loans secured by first mortgages on one- to
four-family residences in the State of New Jersey. We originate residential
mortgages primarily through commissioned mortgage representatives and our branch
offices. The Provident Bank originates both fixed-rate and adjustable-rate
mortgages. Residential lending, while declining as a percentage of the loan
portfolio, represents the largest single component of our total portfolio. As of
December 31, 2002, $699.5 million or 34.43% of the total portfolio consisted of
one- to four-family real estate loans. Of the one- to four-family loans at that
date, 55.17% were fixed-rate and 44.83% were adjustable rate loans.
The Provident Bank originates fixed-rate fully amortizing residential
mortgage loans, with the principal and interest due each month that have
maturities ranging from 10 to 30 years. We also originate fixed-rate residential
mortgage loans with maturities of 15, 20 and 30 years that require the payment
of principal and interest on a bi-weekly basis. Fixed-rate jumbo residential
mortgage loans (loans over the maximum that one of the government-sponsored
agencies will purchase) are originated with maturities of up to 30 years.
Adjustable rate mortgage loans are offered with a fixed-rate period of 1, 3, 5,
7 or 10 years prior to the first annual interest rate adjustment. The standard
adjustment formula is the one-year constant maturity Treasury rate plus 2 3/4%,
adjusting annually with a 2% maximum annual adjustment and a 6% maximum
adjustment over the life of the loan.
The residential mortgage portfolio is primarily underwritten to Federal
Home Loan Mortgage Corporation ("Freddie Mac") and Federal National Mortgage
Association ("Fannie Mae") standards. The Provident Bank's
12
standard loan to value ratio is 80%. However, working through mortgage insurance
companies, we underwrite loans for sale to Freddie Mac or Fannie Mae programs
that will finance up to 100% of the value of the residence. Generally all
fixed-rate loans with terms of 20 years or more, as well as loans with a loan to
value ratio of 97% or more, are sold into the secondary market with servicing
rights retained. Fixed-rate residential mortgage loans retained in our portfolio
generally include loans with a term of 15 years or less and biweekly payment
loans with a term of 20 years or less. We retain the majority of the originated
adjustable rate mortgages for our portfolio.
The percentage of loans sold into the secondary market will vary
depending upon interest rates and our strategies for reducing our exposure to
interest rate risk. In 2002, approximately $79.1 million or 26.72% of
residential real estate loans originated were sold into the secondary market.
All of the loans sold in 2002 were long term fixed-rate mortgages. Generally it
is our policy to retain all adjustable-rate mortgages and 10 and 15 year
fixed-rate loans in portfolio and sell all 20 and 30 year fixed-rate mortgages.
For loans that are sold, they are sold without recourse and we usually retain
servicing on these loans.
The retention of adjustable rate mortgages, as opposed to longer term,
fixed-rate residential mortgage loans, in our loan portfolio helps reduce our
exposure to interest rate risk. However, adjustable rate mortgages generally
pose credit risks different from the credit risks inherent in fixed-rate loans
primarily because as interest rates rise, the underlying debt service payments
of the borrowers rise, thereby increasing the potential for default. In order to
minimize this risk, borrowers of one- to four-family one year adjustable-rate
loans are qualified at the maximum rate which would be in effect after the first
interest rate adjustment, if that rate is higher than the initial rate. We
believe that these risks, which have not had a material adverse effect on The
Provident Bank to date, generally are less onerous than the interest rate risks
associated with holding 20-30 year fixed-rate loans in our loan portfolio.
The Provident Bank has for many years offered discounted rates for low-
to moderate-income individuals. Loans originated in this category over the last
five years have totaled $59.6 million. We also offer a special rate program for
first time homebuyers and this activity has totaled over $73.0 million for the
past five years.
Commercial Real Estate Loans. The Provident Bank originates loans
secured by mortgages on various commercial income producing properties,
including office buildings, retail and industrial properties. We have increased
our emphasis on commercial real estate lending. Commercial real estate and
construction loans have increased to 30.38% of the portfolio at December 31,
2002 from 24.67% at December 31, 1998. A substantial majority of our commercial
real estate loans are secured by properties located in the State of New Jersey.
The Provident Bank originates adjustable rate loans and loans with
fixed interest rates for a period that is generally five or fewer years, which
then adjust after the initial period. Typically the loans are written for
maturities of 10 years or less and have an amortization schedule of 20 or 25
years. As a result, the typical amortization schedule will result in a
substantial principal payment upon maturity. We generally underwrite commercial
real estate loans to a 75% advance against either the appraised value of the
property, or its purchase price (for loans to fund the acquisition of real
estate), whichever is less. We generally require minimum debt service coverage
of 1.20 times. There is a potential risk that the borrower may be unable to pay
off or refinance the outstanding balance at the loan maturity date. The
Provident Bank typically lends to experienced owners or developers who have
knowledge and contacts in the commercial real estate market.
Among the reasons for our continued emphasis on commercial real estate
lending is our desire to invest in assets bearing interest rates which are
generally higher than interest rates on residential mortgage loans, and are more
rate sensitive to changes in market interest rates. Commercial real estate
loans, however, entail significant additional credit risk as compared with one-
to four-family residential mortgage lending, as they typically involve larger
loan balances concentrated with single borrowers or groups of related borrowers.
In addition, the payment experience on commercial real estate loans secured by
income producing properties is typically dependent on the successful operation
of the related real estate project and thus may be more significantly impacted
by adverse conditions in the real estate market or in the economy generally.
The Provident Bank performs more extensive diligence in underwriting
commercial real estate loans than loans secured by owner occupied one- to
four-family residential properties due to the larger loan amounts and the
riskier nature of such loans. We attempt to understand and control the risk in
several ways including inspection of all such properties and the review of the
overall financial condition of the borrower, which may include, for
13
example, the review of the rent rolls and the verification of income. For
commercial real estate secured loans in excess of $750,000 and for all other
commercial real estate loans where it is appropriate, we employ environmental
experts to inspect the property and ascertain any environmental risks.
The Provident Bank requires a full independent appraisal for commercial
real estate. The appraiser must be selected from The Provident Bank's approved
list. The Provident Bank also employs an independent review appraiser to verify
that the appraisal meets our standards. The underwriting guidelines provide that
generally the loan to value ratio shall not exceed 75% of the appraised value
and the debt service coverage should be at least 1.20 times. In addition,
financial statements are required annually and reviewed by us. The Provident
Bank's policy also requires that a property inspection of commercial mortgages
over $1,000,000 be completed at least every 18 months.
Our largest commercial real estate loan at December 31, 2002 was a
$12.0 million loan secured by an office/research building in Cranbury, New
Jersey. The building was fully leased and the loan was performing in accordance
with its terms and conditions as of December 31, 2002.
Multi-family Lending. The Provident Bank underwrites loans secured by
apartment buildings that have five or more units. We classify multi-family
lending as a component of the commercial real estate lending portfolio. The
underwriting standards and procedures that are used to underwrite commercial
real estate loans are used to underwrite multi-family loans.
Mortgage Warehouse Loans. The Provident Bank's mortgage warehouse
financing provides the interim financing that allows the mortgage banker to fund
residential mortgage loans until the loan is delivered for sale to the ultimate
permanent investor of the mortgage loan. We lend to mortgage bankers that
underwrite loans insured by the Federal Housing Administration (FHA), loans
guaranteed by the Veterans Administration (VA), and other residential loans.
Each advance under a mortgage warehouse line is secured by the underlying
mortgage loan financed by the advance and by the purchase commitment of the
investor (which, in most cases, is a bank, other larger mortgage companies or
government agency). The underlying mortgage loans are underwritten by the
mortgage banker to the guidelines of the ultimate investor. Loans to mortgage
warehousing customers are made on a floating rate basis tied to the prime rate,
federal funds or similar indices and the maximum advance is generally 98% of the
value of the underlying loan. We generally require current audited annual
financial statements, an operations review by an outside specialized firm,
periodic interim financial statements prepared by the borrower, net worth
covenants and a maximum leverage ratio of 20:1 (assuming full usage of all of
the prospective borrower's outstanding lines of credit) as part of our
underwriting criteria. In addition, we generally require personal guarantees on
these loans, based upon a review of the guarantor's current financial statements
and tax returns. The Provident Bank will also conduct credit and reference
checks on prospective borrowers. Once we provide the financing, we monitor the
credit by having communications with the borrower, reviewing the activity on
these loans on a regular basis and preparing monthly reports on such activity,
hiring outside specialized firms on a periodic basis to conduct reviews of the
operations of the mortgage banker and keeping apprised of developments in this
market. In addition to the financial strength of the borrower and the
guarantors, The Provident Bank's analysis includes the number of days that
mortgage loans remain under the line of credit before delivery to the ultimate
investor and the types of loans that are originated. Our largest mortgage
banking relationship was $35.0 million, consisting of a $25.0 million mortgage
warehouse line of credit and a $10.0 million unsecured line of credit. This
credit relationship was performing in accordance with its terms and conditions
as of December 31, 2002.
In September 2002, management learned of an investigation by the
Federal Bureau of Investigation into alleged fraudulent activity involving one
of our mortgage warehouse borrowers. The borrower's business operations have
ceased and, upon our assessment of known facts, at September 30, 2002 the
outstanding mortgage warehouse line of $20.6 million was reclassified into the
following categories: $7.3 million as substandard, $1.5 million as doubtful and
$11.8 million as a loss. In accordance with our lending policies, on September
30, 2002, a charge of $11.8 million was taken against the allowance for loan
losses. In the fourth quarter, we sold loans totaling $1.4 million to investors
and charged off an additional $718,000 in loans related to the $20.6 million
mortgage warehouse loan. We have placed the remaining loans in our portfolio,
established contact with the borrowers and subsequently moved these loans into
performing status as payment histories were established.
Commercial Loans. The Provident Bank underwrites commercial loans to
corporations, partnerships and other businesses. The majority of our commercial
loan customers are local businesses with revenues of less than
14
$50.0 million. The Provident Bank offers commercial loans for equipment
purchases, lines of credit or letters of credit as well as loans where the
borrower is the sole occupant of the property. Most commercial loans are
originated on a floating rate basis and the majority of fixed-rate commercial
loans are fully amortized over a five-year period.
The Provident Bank also underwrites Small Business Administration
guaranteed loans and guaranteed or assisted loans through various state, county
and municipal programs. We typically utilize these governmental guarantees in
cases where the borrower requires additional credit support.
The underwriting of a commercial loan is based upon a review of the
financial statements of the prospective borrower and guarantors. In most cases
we obtain a general lien on accounts receivable and inventory, along with the
specific collateral such as real estate or equipment, as appropriate.
For commercial loans less than $150,000, we use an automated
underwriting system, which includes a nationally recognized credit scorecard to
assist in our decision-making process. For larger commercial loans a traditional
approach of reviewing all the financial information and collateral in greater
detail by seasoned lenders is utilized.
Commercial business loans generally bear higher interest rates than
residential loans, but they also involve a higher risk of default since their
repayment is generally dependent on the cash flow of the borrower's business. As
a result, the availability of funds for the repayment of commercial business
loans may be substantially dependent on the success of the business itself and
the general economic environment. Our largest commercial loan was a $7.5 million
term loan, with an assignment of mortgage as collateral.
Construction Loans. Over the last five years The Provident Bank has
expanded its activities in commercial construction lending. Commercial
construction lending includes both new construction of residential and
commercial real estate projects and the reconstruction of existing structures.
Our commercial construction financing takes two forms: projects for
sale (single family/condominiums) and projects that are constructed for
investment purposes (rental property). We attempt to mitigate the speculative
nature of construction loans by generally requiring significant pre-leases on
rental properties and a percentage of the single-family residences or
condominiums to be under contract to support construction loan advances.
The Provident Bank underwrites most construction loans for a term of
three years or less. The majority of The Provident Bank's construction loans are
floating rate loans and we utilize a procedure to attempt to insure that the
maximum 75% loan to value ratio of the completed project is not exceeded. We
employ professional engineering firms to assist in the review of construction
cost estimates and make site inspections to determine if the work has been
completed prior to the advance of funds for the project.
Construction lending generally involves a greater degree of risk than
other one- to four-family mortgage lending. Repayment of a construction loan is,
to a great degree, dependent upon the successful and timely completion of the
construction of the subject project and the successful marketing of the sale or
lease of the project. Construction delays or the financial impairment of the
builder may further impair the borrower's ability to repay the loan.
For all construction loans, we require an independent appraisal. For
construction loans in excess of $1.5 million, we require an independent
feasibility report to assist us in determining if the project is acceptable to
the market. The feasibility report reviews market rents, competing projects and
the absorption of new construction in a particular market for the type of
project to be financed. We also attempt to procure personal guarantees and
conduct environmental due diligence as appropriate.
The Provident Bank also attempts to control the risk of the
construction lending process by other means. For single family/condominium
financings, The Provident Bank generally requires payment for the release of a
unit that exceeds the amount of the loan advance attributable to such unit. On
commercial construction projects that the developer holds for rental, we
typically hold back funds for tenant improvements until a signed lease is
executed.
15
Our largest construction loan as of December 31, 2002 was a commitment
to loan $17.5 million for a residential project in Lopatcong, New Jersey. As of
December 31, 2002, $12.0 million of that loan was outstanding and the loan was
performing in accordance with its terms and conditions.
Consumer Loans. The Provident Bank offers a variety of consumer loans
to individuals. Home equity loans and home equity lines of credit constitute
61.38% of the portfolio as of December 31, 2002. Marine loans comprised 35.45%
of the consumer loan portfolio as of December 31, 2002. The remainder of the
consumer loan portfolio includes personal loans and unsecured lines of credit,
automobile loans and recreational vehicle loans.
Interest rates on our home equity loans are fixed for a term not to
exceed 15 years and the maximum loan amount is $350,000. A portion of the home
equity loan portfolio includes "first lien product loans," under which we have
offered special rates to borrowers who refinance first mortgage loans on the
home equity (first lien) basis. The Provident Bank's home equity lines are made
at floating interest rates, and we provide lines of credit up to $250,000. The
approved home equity lines and utilization amounts as of December 31, 2002 were
$84.2 million and $32.9 million respectively.
The Provident Bank originates a majority of its home equity and
automobile loans directly. We also originate loans through established
relationships with brokers, using our underwriting standards. The Provident Bank
purchases marine loans from established boat dealers and brokers. The maximum
loan for boats is $750,000, with a maximum advance of 80% against the appraised
value. All marine loans are collateralized by a first lien on the vessel. Marine
loans must be secured by a recreational boat that is maintained on the Atlantic
Coast of the United States.
The Provident Bank's consumer loan portfolio contains other type of
loans such as loans on motorcycles, recreational vehicles and personal loans,
which represents 3.17% of the portfolio. Personal unsecured loans are originated
primarily as an accommodation to existing customers.
Consumer loans generally entail greater credit risk than residential
mortgage loans, particularly in the case of consumer loans that are unsecured or
that are secured by assets that tend to depreciate, such as automobiles, boats,
recreational vehicles and mobile homes. Collateral repossessed by us for a
defaulted consumer loan may not provide an adequate source of repayment for the
outstanding loan and the remaining deficiency may warrant further substantial
collection efforts against the borrower. In addition, consumer loan collections
are dependent on the borrower's continued financial stability, and this is more
likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Furthermore, the application of various federal and state laws,
including bankruptcy and insolvency laws, may limit the amount which can be
recovered on such loans.
16
Loan Originations, Purchases, and Repayments. The following table sets
forth our loan origination, purchase and repayment activities for the periods
indicated.
YEAR ENDED DECEMBER 31,
----------------------------------------------
2002 2001 2000
------------- ------------- -------------
(In thousands)
Originations:
Residential mortgage....................... $ 296,161 $ 215,941 $ 153,383
Commercial mortgage........................ 113,687 90,316 38,927
Multi-family mortgage...................... 6,935 13,893 11,409
Construction............................... 80,514 96,344 75,201
Commercial................................. 125,114 70,760 36,242
Consumer................................... 101,946 106,081 98,049
------------- ------------- -------------
Subtotal of loans originated............. 724,357 593,335 413,211
Mortgage warehouse loans................... 2,620,210 1,641,316 844,151
------------- ------------- -------------
Total loans originated................... 3,344,567 2,234,651 1,257,362
------------- ------------- -------------
Loans sold or securitized.................... 79,129 80,652 25,264
Repayments:
Residential mortgage....................... 385,060 245,672 106,974
Commercial mortgage........................ 88,292 58,272 46,126
Multi-family mortgage...................... 25,448 13,824 12,498
Construction............................... 65,203 91,607 69,167
Commercial................................. 83,825 50,809 59
Consumer................................... 139,316 112,693 93,649
------------- ------------- -------------
Subtotal of loan repayments.............. 787,144 572,877 328,473
Mortgage warehouse loans................... 2,511,769 1,540,360 824,921
------------- ------------- -------------
Total repayments......................... 3,298,913 2,113,237 1,153,394
------------- ------------- -------------
Total reductions...................... 3,378,042 2,193,889 1,178,658
------------- ------------- -------------
Decrease other items, net(1)............ (15,418) (5,059) (7,896)
------------- ------------- -------------
Net increase (decrease)............... $ (48,893) $ 35,703 $ 70,808
============= ============= =============
----------
(1) Other items include charge-offs, deferred fees and expenses, and
discounts and premiums.
Loan Approval Procedures and Authority. The Provident Bank's Board of
Directors approves the Loan Policy and Procedures Manual on an annual basis as
well as on an interim basis as modifications warrant. The loan policy sets The
Provident Bank's lending authority for each type of loan. The Provident Bank's
individual lending officers are assigned dollar authority limits based upon
their experience and expertise.
The largest individual lending authority is $2.5 million, which only
our Chief Executive Officer and President, Executive Vice President, Customer
Management Group and Chief Lending Officer have. Loans in excess of $2.5 million
or when combined with existing credits of the borrower or related borrowers
exceeds $2.5 million are presented to the Credit Committee. The Credit Committee
consists of seven senior officers and requires a majority vote for approval of a
credit. The Credit Committee has a $7.5 million approval authority and the
Executive Committee of the Board of Directors has approval authority of up to
$15.0 million and, in certain limited cases, has approval authority of up to
$25.0 million. The Provident Bank's Board of Directors approves exposures
exceeding $15.0 million.
The Provident Bank has adopted a risk rating system as part of the risk
assessment of the loan portfolio. Our commercial real estate and commercial
lending officers are required to assign a risk rating to each loan in their
portfolio at origination. When the lender learns of important financial
developments, the risk rating is reviewed accordingly. Similarly, the Credit
Committee can adjust a risk rating. In addition, the Loan Review Department in
their periodic review of the loan portfolio may also change risk ratings. The
risk ratings play an important role in the establishment of the loan loss
provision and to confirm the adequacy of the allowance for loan losses.
Loans to One Borrower. The Provident Bank's regulatory limit on total
loans to any borrower or attributed to any one borrower is fifteen percent (15%)
of our unimpaired capital. As of December 31, 2002, our regulatory
17
lending limit was $50.3 million. Our internal policy limit on total loans to a
borrower or related borrowers that constitute a group exposure is up to $50.0
million for loans with a risk rating of 2 or better, $45.0 million for loans
with a risk rating of 3 and $35.0 million for loans with a risk rating of 4. We
review these group exposures on a quarterly basis. We also set additional limits
on size of loans by loan type. At December 31, 2002, our largest client
relationship with an individual borrower and related entities (excluding
mortgage warehouse loans) was $36.3 million, consisting of a variety of
construction and commercial loans to a real estate developer based in the State
of New Jersey. Each of these credit relationships was performing in accordance
with its terms and conditions as of December 31, 2002. Our largest client
relationship including mortgage warehouse lending was $35.0 million to a
mortgage banking client, consisting of a $25.0 million mortgage warehouse line
of credit and a $10.0 million unsecured line of credit. Each of these credit
relationships was performing in accordance with its terms and conditions as of
December 31, 2002.
As of December 31, 2002, The Provident Bank had $568.9 million in loans
outstanding to our 50 largest borrowers and their related entities.
ASSET QUALITY
General. One of our key objectives has been and continues to be to
maintain a high level of asset quality. In addition to maintaining sound credit
standards for new loan originations, we employ proactive collection and workout
processes in dealing with delinquent or problem loans. We actively market
properties that we may acquire through foreclosure or otherwise in the loan
collection process.
Collection Procedures. In the case of residential mortgage and consumer
loans the collections personnel in our Special Loan Department are responsible
for collection activities from the fifteenth day of delinquency. Collection
efforts include automated notices of delinquency generated by our system,
telephone calls, letters and other notices to the delinquent borrower.
Foreclosure proceedings and other appropriate collection activities such as
repossession of collateral are commenced within at least 90 to 120 days after
the loan is delinquent. Periodic inspections of real estate and other collateral
are conducted throughout the collection process. The collection procedures for
Federal Housing Association (FHA) and Veteran's Administration (VA) one- to
four-family mortgage loans follow the collection guidelines outlined by those
agencies.
Real estate taken by foreclosure or in connection with a loan workout
is held as other real estate owned. We carry other real estate owned at its fair
market value less estimated selling costs. We attempt to sell the property at
foreclosure sale or as soon as practicable after the foreclosure sale through a
proactive marketing effort.
The collection procedures for commercial real estate and commercial
loans include our sending periodic late notices and letters to a borrower once a
loan is past due. We attempt to make direct contact with a borrower once a loan
is 15 days past due, usually by telephone. The Chief Lending Officer reviews all
commercial real estate and commercial loan delinquencies on a weekly basis.
Delinquent commercial real estate and commercial loans will be transferred to
our Special Loan Department for further action if the delinquency is not cured
within a reasonable period of time, typically 30 to 90 days. Our Chief Lending
Officer has the authority to transfer performing commercial real estate or
commercial loans to the Special Loan Department if, in his opinion, a credit
problem exists or is likely to occur.
Loans deemed uncollectible are proposed for charge-off on a monthly
basis. The recommendation is then submitted to our Chief Lending Officer,
Executive Vice President - Customer Management Group and Chief Executive Officer
for approval.
Delinquent Loans and Non-performing Loans and Assets. Our policies
require that the Chief Lending Officer continuously monitor the status of the
loan portfolios and report to the Board of Directors on a monthly basis. These
reports include information on impaired loans, delinquent loans, criticized and
classified assets, and foreclosed real estate. An impaired loan is defined as a
loan for which it is probable, based on current information, that we will not
collect amounts due under the contractual terms of the loan agreement. We have
identified the population of impaired loans to be all commercial loans as well
as residential mortgage loans greater than $500,000 which meet the above
definition. Impaired loans are individually assessed to determine that each
loan's carrying
18
value is not in excess of the fair value of the related collateral or the
present value of the expected future cash flows. At December 31, 2002, the
impaired loan portfolio totaled $1.4 million.
With the exception of first mortgage loans insured or guaranteed by the
FHA or VA or for which the borrower has obtained private mortgage insurance,
accruing income is stopped on loans when interest or principal payments are 90
days in arrears or earlier when the timely collectibility of such interest or
principal is doubtful. When accruing has stopped, loans are designated as
non-accrual loans and the outstanding interest previously credited is reversed.
A non-accrual loan is returned to accrual status when factors indicating
doubtful collection no longer exist and the loan has been brought current.
Federal and state regulations as well as our policy require that we
utilize an internal asset classification system as a means of reporting problem
and potential problem assets. Under our internal risk rating system, we
currently classify problem and potential problem assets as "substandard,"
"doubtful" or "loss" assets. An asset is considered "substandard" if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. "Substandard" assets include those
characterized by the "distinct possibility" that we will sustain "some loss" if
the deficiencies are not corrected. Assets classified as "doubtful" have all of
the weaknesses inherent in those classified "substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted. Assets
which do not currently expose The Provident Bank to sufficient risk to warrant
classification in one of the aforementioned categories but which possess
weaknesses are required to be designated "special mention."
General valuation allowances represent loss allowances which have been
established to recognize the inherent risk associated with lending activities,
but which, unlike specific allowances, have not been allocated to particular
problem assets. When we classify one or more assets, or portions thereof, as
"substandard" or "doubtful," we determine that a specific allowance for loan
losses be established for loan losses in an amount deemed prudent by management.
When we classify one or more assets, or portions thereof, as "loss," we are
required either to establish a specific allowance for losses equal to 100% of
the amount of the asset so classified or to charge off such amount.
Our determination as to the classification of our assets and the amount
of our valuation allowances is subject to review by the FDIC and the New Jersey
Department of Banking and Insurance which can order the establishment of
additional general or specific loss allowances. The FDIC, in conjunction with
the other federal banking agencies, has adopted an interagency policy statement
on the allowance for loan and lease losses. The policy statement provides
guidance for financial institutions on both the responsibilities of management
for the assessment and establishment of adequate allowances and guidance for
banking agency examiners to use in determining the adequacy of general valuation
guidelines. Generally, the policy statement recommends that institutions have
effective systems and controls to identify, monitor and address asset quality
problems; that management has analyzed all significant factors that affect the
collectibility of the portfolio in a reasonable manner; and that management has
established acceptable allowance evaluation processes that meet the objectives
set forth in the policy statement. In July 2001, the SEC issued Staff Accounting
Bulleting, referred to as SAB, No. 102, "Selected Loan Loss Allowance
Methodology and Documentation Issues." The guidance contained in the SAB is
effective immediately and focuses on the documentation the SEC staff normally
expects registrants to prepare and maintain in support of the allowance for loan
and lease losses. Concurrent with the SEC's issuance of SAB No. 102, the federal
banking agencies, represented by the Federal Financial Institutions Examination
Council, referred to as FFIEC, issued an interagency policy statement entitled
"Allowance for Loan and Lease Losses Methodologies and Documentation for Bank
and Savings Institutions" ("Policy Statement"). The SAB and Policy Statement
were the result of an agreement between the SEC and the federal banking agencies
in March 1999 to provide guidance on allowance for loan and lease losses
methodologies and supporting documentation. There is no expected impact on
earnings, financial condition, or equity upon implementation of the SAB or FFIEC
pronouncement. We believe that our documentation relating to the allowance for
loan loss is consistent with these pronouncements. Although we believe that,
based on information currently available to us at this time, our allowance for
loans losses is adequate, actual losses are dependent upon future events and, as
such, further additions to the level of allowances for loan losses may become
necessary.
19
We classify assets in accordance with the management guidelines
described above. At December 31, 2002, we had $21.8 million of assets classified
as "substandard" which consisted of $4.1 million in residential loans, $3.9
million in commercial mortgage loans, $6.2 million in commercial loans, $5.6
million in mortgage warehouse loans, $1.7 million in consumer loans and $300,000
in multi-family loans. At that same date we had $766,000 in consumer loans
classified as "doubtful" and no loans classified as "loss." In addition, as of
December 31, 2002 we had $5.1 million of loans designated "special mention."
The following table sets forth delinquencies in our loan portfolio as
of the dates indicated.
AT DECEMBER 31, 2002 AT DECEMBER 31, 2001
------------------------------------------------ -----------------------------------------------
60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE
----------------------- ---------------------- ---------------------- ----------------------
PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL
NUMBER OF BALANCE NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE
LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
---------- ---------- --------- ---------- --------- ---------- --------- ----------
(Dollars in thousands)
Residential mortgage loans ... 25 $ 1,357 59 $ 4,073 27 $ 1,176 75 $ 4,171
Commercial mortgage loans .... -- -- 2 2,682 1 188 2 345
Multi-family mortgage loans .. -- -- -- -- -- -- -- --
Construction loans ........... -- -- -- -- -- -- 4 1,071
---------- ---------- --------- ---------- --------- ---------- --------- ----------
Total mortgage loans ..... 25 1,357 61 6,755 28 1,364 81 5,587
Mortgage warehouse loans ..... -- -- -- -- -- -- -- --
Commercial loans ............. 1 25 1 34 2 1,520 12 1,084
Multi-family mortgage loans .. -- -- -- -- -- -- -- --
Consumer loans ............... 119 1,515 141 1,723 34 444 82 1,413
---------- ---------- --------- ---------- --------- ---------- --------- ----------
Total loans .............. 145 $ 2,897 203 $ 8,512 64 $ 3,328 175 $ 8,084
========== ========== ========= ========== ========= ========== ========= ==========
AT DECEMBER 31, 2000
------------------------------------------------
60-89 DAYS 90 DAYS OR MORE
----------------------- ----------------------
PRINCIPAL PRINCIPAL
NUMBER BALANCE NUMBER BALANCE
OF LOANS OF LOANS OF LOANS OF LOANS
---------- ---------- --------- ----------
(Dollars in thousands)
Residential mortgage loans ... 27 $ 1,218 74 $ 2,413
Commercial mortgage loans .... -- -- 2 144
Multi-family mortgage loans .. -- -- 1 25
Construction loans ........... -- -- 1 5,166
---------- ---------- --------- ----------
Total mortgage loans ..... 27 1,218 78 7,748
Mortgage warehouse loans ..... -- -- -- --
Commercial loans ............. 2 138 3 274
Consumer loans ............... 30 377 60 1,458
---------- ---------- --------- ----------
Total loans .............. 59 $ 1,733 141 $ 9,480
========== ========== ========= ==========
20
Non-Accrual Loans and Non-Performing Assets. The following table sets
forth information regarding our non-accrual loans and other non-performing
assets. There were no troubled debt restructurings as defined in SFAS 15 at any
of the dates indicated.
AT DECEMBER 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
NON-ACCRUING LOANS:
Residential mortgage loans .......... $ 4,073 $ 4,171 $ 2,413 $ 3,466 $ 3,673
Commercial mortgage loans ........... 2,682 345 144 146 101
Multi-family mortgage loans ......... -- -- 25 -- --
Construction loans .................. -- 1,071 5,166 1,195 --
Mortgage warehouse loans ............ -- -- -- -- --
Commercial loans .................... 34 1,084 274 1,641 91
Consumer loans ...................... 1,723 1,413 1,458 1,586 1,619
------------ ------------ ------------ ------------ ------------
Total non-accruing loans .......... 8,512 8,084 9,480 8,034 5,484
Accruing loans delinquent 90 days or
more .................................. -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Total non-performing loans ........ 8,512 8,084 9,480 8,034 5,484
Other real estate owned ................ -- -- 204 40 251
------------ ------------ ------------ ------------ ------------
Total non-performing assets ....... $ 8,512 $ 8,084 $ 9,684 $ 8,074 $ 5,735
============ ============ ============ ============ ============
Total non-performing assets as a
percentage of total assets ....... 0.22% 0.28% 0.37% 0.31% 0.23%
============ ============ ============ ============ ============
Total non-performing loans to total
loans ............................ 0.41% 0.40% 0.48% 0.43% 0.33%
============ ============ ============ ============ ============
- ----------
(1) Loans generally are placed on non-accrual status when they become 90 days
or more past due or if they have been identified by us as presenting
uncertainty with respect to the collectibility of interest or principal.
If the non-accrual loans had performed in accordance with their
original terms, interest income would have increased by $651,000 during the year
ended December 31, 2002. At December 31, 2002, there were no commitments to lend
additional funds to borrowers whose loans were on non-accrual status.
Allowance for Loan Losses. The allowance for loan losses is a valuation
account that reflects our evaluation of the probable incurred losses in our loan
portfolio. We maintain the allowance for loan losses through provisions for loan
losses that are charged to income. Charge-offs against the allowance for loan
losses are taken on loans where we determine that the collection of loan
principal is unlikely. Recoveries made on loans that have been charged-off are
credited to the allowance for loan losses.
Our evaluation of the adequacy of the allowance for loan losses
includes the review of all loans on which the collectibility of principal may
not be reasonably assured. For residential mortgage and consumer loans this is
determined primarily by delinquency and collateral values. For commercial real
estate and commercial loans an extensive review of financial performance,
payment history and collateral values is conducted on a quarterly basis.
As part of our evaluation of the adequacy of our allowance for loan
losses, each quarter we prepare a worksheet. This worksheet categorizes the
entire loan portfolio by certain risk characteristics such as loan type
(residential mortgage, commercial mortgage, construction, commercial, etc.) and
loan risk rating. The factors we consider in assessing loan risk ratings include
the following:
. results of the routine loan quality reviews by our Loan Review
Department of the Risk Management Group and by third parties
retained by the Loan Review Department;
. general economic and business conditions affecting our key
lending areas;
. credit quality trends (including trends in non-performing loans,
including anticipated trends based on market conditions);
. collateral values;
21
. loan volumes and concentrations;
. seasoning of the loan portfolio;
. specific industry conditions within portfolio segments;
. recent loss experience in particular segments of the loan
portfolio; and
. duration of the current business cycle.
When assigning a risk rating to a loan, management utilizes The
Provident Bank's internal risk rating system which is a nine point rating
system. Loans deemed to be "acceptable quality" are rated one through four, with
a rating of one established for loans with minimal risk. Loans that are deemed
to be of "questionable quality" are rated five (watch) or six (special mention).
Loans with adverse classifications (substandard, doubtful or loss) are rated
seven, eight or nine, respectively. Commercial mortgage, commercial, mortgage
warehouse, multi-family and construction loans are rated individually, and each
lending officer is responsible for risk rating loans in his or her portfolio.
These risk ratings are then reviewed by the department manager and/or the Chief
Lending Officer and by the Credit Administration Department. The risk ratings
are then confirmed by the Loan Review Department of the Risk Management Group
and they are periodically reviewed by the Credit Committee in the credit renewal
or approval process.
Each quarter the lending groups prepare the PEWS Reports (Provident
Early Warning System) for the Credit Administration Department. These reports
review all commercial loans, commercial mortgage loans and mortgage warehouse
loans that have been determined to involve above average risk (risk rating of
five or worse). The PEWS reports contain the reason for the risk rating assigned
to each loan, status of the loan and any current developments. These reports are
submitted to a committee chaired by the Chief Lending Officer. Each loan officer
reviews the loan and the corresponding PEWS report with the committee and the
risk rating is evaluated for appropriateness.
Based upon market conditions and The Provident Bank's historical
experience dealing with problem credits, the reserve for each risk rating by
type of loan is established based on estimates of probable losses in the loan
portfolio. In addition reserves are established for unused lines and anticipated
closings and projected growth. We use a five-year moving average of charge-off
and recovery experience as a tool to assist in the development of the loan loss
factors in determining the provision for loan losses.
The loss factors applied to each loan risk rating are inherently
subjective in nature. Loan loss factors are assigned to each of the risk rating
categories. Our methodology permits adjustments to the allowance for loan losses
in the event that, in management's judgment, significant conditions impacting
the credit quality and collectibility of the loan portfolio as of the evaluation
date otherwise are not adequately reflected in the analysis.
We establish the provision for loan losses after considering the
allowance for loan loss worksheet, the amount of the allowance for loan losses
in relation to the total loan balance, loan portfolio growth, loan delinquency
trends and peer group analysis. As a result of this process, management has
established an unallocated portion of the allowance for loan losses. The
unallocated portion of the allowance for loan losses is warranted based on
factors such as the geographic concentration of our loan portfolio and the
losses inherent in commercial lending, as these types of loans are typically
riskier than residential mortgages.
The Loan Review Department of the Risk Management Group also uses a
historic model from the early 1990's when there were severe problems in the New
Jersey commercial real estate markets. This tool applies the problem loan
reserve percentages from our own portfolio for these prior years to the current
portfolio. The Loan Review Department of the Risk Management Group continuously
reviews the risk ratings.
Based on the composition of our loan portfolio, we believe the primary
risks inherent in our portfolio are possible increases in interest rates, a
possible decline in the economy and a possible decline in real estate market
values. Management will continue to review the entire loan portfolio to
determine the extent, if any, to which further additional loan loss provisions
may be deemed necessary. The allowance for loan losses is maintained at a
22
level that represents management's best estimate of inherent losses in the loan
portfolio. There can be no assurance that the allowance for loan losses will be
adequate to cover all losses that may in fact be realized in the future or that
additional provisions for loan losses will be required.
Analysis of the Allowance for Loan Losses. The following table sets
forth the analysis of the allowance for loan losses for the periods indicated.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
Balance at beginning of period ......... $ 21,909 $ 20,198 $ 18,794 $ 17,381 $ 15,036
Charge offs:
Residential mortgage loans .......... 228 411 770 1,475 1,541
Commercial mortgage loans ........... -- 208 -- -- --
Multi-family mortgage loans ......... -- -- -- -- --
Construction loans .................. -- -- -- -- --
Mortgage warehouse loans ............ 12,500 -- -- -- --
Commercial loans .................... 1,859 46 845 435 77
Consumer loans ...................... 156 297 194 442 322
------------ ------------ ------------ ------------ ------------
Total ............................. 14,743 962 1,809 2,352 1,940
------------ ------------ ------------ ------------ ------------
Recoveries:
Residential mortgage loans .......... 298 256 315 313 480
Commercial mortgage loans ........... -- 168 289 350 --
Multi-family mortgage loans ......... -- -- -- -- --
Construction loans .................. -- -- -- -- --
Mortgage warehouse loans ............ -- -- -- -- --
Commercial loans .................... 451 201 265 236 166
Consumer loans ...................... 271 148 284 766 325
------------ ------------ ------------ ------------ ------------
Total ............................. 1,020 773 1,153 1,665 971
------------ ------------ ------------ ------------ ------------
Net charge-offs ........................ 13,723 189 656 687 969
Provision for loan losses .............. 12,800 1,900 2,060 2,100 1,950
Acquisition-related allowance .......... -- -- -- -- 1,364
------------ ------------ ------------ ------------ ------------
Balance at end of period ............... $ 20,986 $ 21,909 $ 20,198 $ 18,794 $ 17,381
============ ============ ============ ============ ============
Ratio of net charge-offs during the
period to average loans outstanding
during the period ..................... 0.70% 0.01% 0.03% 0.04% 0.06%
============ ============ ============ ============ ============
Allowance for loan losses to total
loans ................................. 1.02% 1.09% 1.02% 0.99% 1.02%
============ ============ ============ ============ ============
Allowance for loan losses to
non-performing loans .................. 246.55% 271.02% 213.06% 233.93% 316.94%
============ ============ ============ ============ ============
23
Allocation of Allowance for Loan Losses. The following table sets forth
the allocation of the allowance for loan losses by loan category for the periods
indicated. This allocation is based on management's assessment, as of a given
point in time, of the risk characteristics of each of the component parts of the
total loan portfolio and is subject to changes as and when the risk factors of
each such component part change. The allocation is neither indicative of the
specific amounts or the loan categories in which future charge-offs may be taken
nor is it an indicator of future loss trends. The allocation of the allowance to
each category does not restrict the use of the allowance to absorb losses in any
category.
AT DECEMBER 31,
-----------------------------------------------------------------------------------------
2002 2001 2000
--------------------------- --------------------------- ---------------------------
PERCENT OF PERCENT OF PERCENT OF
AMOUNT OF LOANS IN AMOUNT OF LOANS IN AMOUNT OF LOANS IN
ALLOWANCE EACH ALLOWANCE EACH ALLOWANCE EACH
FOR LOAN CATEGORY TO FOR LOAN CATEGORY TO FOR LOAN CATEGORY TO
LOSSES TOTAL LOANS LOSSES TOTAL LOANS LOSSES TOTAL LOANS
------------ ------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
Residential mortgage loans $ 1,447 34.08% $ 1,598 39.43% $ 1,464 45.83%
Commercial mortgage loans.. 4,898 21.65 5,436 20.44 4,695 19.25
Multi-family mortgage
loans .................... 745 3.75 992 4.73 993 4.83
Construction loans ........ 1,247 4.68 1,528 4.00 1,981 3.85
Mortgage warehouse loans .. 3,408 13.47 2,612 8.33 1,155 3.39
Commercial loans .......... 2,708 8.94 2,281 7.02 1,744 6.15
Consumer loans ............ 3,507 13.43 3,615 16.05 3,805 16.70
Unallocated ............... 3,026 -- 3,847 -- 4,361 --
------------ ------------ ------------ ------------ ------------ ------------
Total ................... $ 20,986 100.00% $ 21,909 100.00% $ 20,198 100.00%
============ ============ ============ ============ ============ ============
AT DECEMBER 31,
----------------------------------------------------------
1999 1998
--------------------------- ---------------------------
PERCENT OF PERCENT OF
AMOUNT OF LOANS IN AMOUNT OF LOANS IN
ALLOWANCE EACH ALLOWANCE EACH
FOR LOAN CATEGORY TO FOR LOAN CATEGORY TO
LOSSES TOTAL LOANS LOSSES TOTAL LOANS
------------ ------------ ------------ ------------
(Dollars in thousands)
Residential mortgage loans $ 1,627 46.57% $ 2,329 49.51%
Commercial mortgage loans.. 4,795 20.44 3,918 17.70
Multi-family mortgage
loans .................... 1,047 5.09 864 5.22
Construction loans ........ 1,997 3.73 792 1.52
Mortgage warehouse loans .. 477 2.52 855 5.04
Commercial loans .......... 1,675 4.50 1,171 4.04
Consumer loans ............ 3,551 17.15 3,500 16.97
Unallocated ............... 3,625 -- 3,952 --
------------ ------------ ------------ ------------
Total ................... $ 18,794 100.00% $ 17,381 100.00%
============ ============ ============ ============
INVESTMENT ACTIVITIES
General. Our investment policy is approved annually by the Board of
Directors. The Chief Financial Officer and the Treasurer are authorized by the
Board to implement the investment policy and establish investment strategies.
The Chief Financial Officer, Treasurer and Assistant Treasurer are authorized to
make investment decisions consistent with the investment policy. Investment
transactions are reported to the Executive Committee of the Board of Directors
on a monthly basis.
Our investment policy is designed to generate a favorable rate of
return, consistent with established guidelines for liquidity, safety and
diversification, and to complement the lending activities of the bank.
Investment decisions are made in accordance with the policy and are based on
credit quality, interest rate risk, balance sheet composition, market
expectations, liquidity, income and collateral needs.
The investment policy does not permit participation in hedging
programs, interest rate swaps, options or futures transactions or the purchase
of any securities that are below investment grade.
24
Our investment strategy is to maximize the return on the investment
portfolio consistent with guidelines that have been established for liquidity,
safety, duration and diversification. Our investment strategy also considers our
interest rate risk position as well as our liquidity, loan demand and other
factors. Acceptable investment securities include U. S. Treasury and Agency
obligations, collateralized mortgage obligations issued by Fannie Mae and
Freddie Mac, corporate debt obligations, New Jersey municipal bonds,
mortgage-backed securities, commercial paper, mutual funds, bankers acceptances
and federal funds. Securities purchased for the investment portfolio require a
minimum credit rating of "A" by Moody's or Standard & Poor's.
Securities for the investment portfolio are classified as held to
maturity, available for sale or held for trading. Securities that are classified
as held to maturity are securities that we have the intent and ability to hold
until their contractual maturity date and are reported at cost. Securities that
are classified as available for sale are reported at fair value. Available for
sale securities include U.S. Treasury and Agency Obligations, U.S. Agency and
private collateralized mortgage obligations ("CMOs"), corporate debt obligations
and equities. Sales of securities may occur from time to time in response to
changes in market rates and to facilitate balance sheet reallocation to
effectively manage interest rate risk. At the present time there are no
securities that are classified as held for trading.
CMOs are a type of debt security issued by a special-purpose entity
that aggregates pools of mortgages and mortgage related securities and creates
different classes of CMO securities with varying maturities and amortization
schedules as well as a residual interest with each class possessing different
risk characteristics. In contrast to mortgage-backed securities from which cash
flow is received (and prepayment risk is shared) pro rata by all securities
holders, the cash flow from the mortgages or mortgage related securities
underlying CMOs is paid in accordance with predetermined priority to investors
holding various tranches of such securities or obligations. A particular tranche
of CMOs may therefore carry prepayment risk that differs from that of both the
underlying collateral and other tranches. Accordingly, CMOs attempt to moderate
risks associated with conventional mortgage related securities resulting from
unexpected prepayment activity. In declining interest rate environments, we try
to purchase CMOs with principal lock out periods, reducing prepayment risk in
the investment portfolio. During rising interest rate periods, our strategy is
to purchase CMOs that are receiving principal payments that can be reinvested at
higher current yields. Investments in CMOs involve a risk that actual
prepayments will differ from those estimated in pricing the security, which may
result in adjustments to the net yield on such securities. Additionally, the
market value of such securities may be adversely affected by changes in the
market interest rates. Management believes these securities may represent
attractive alternatives relative to other investments due to the wide variety of
maturity, repayment and interest rate options available. All CMOs in the
investment portfolio are rated "AAA."
Amortized Cost and Fair Value of Securities. The following tables set
forth certain information regarding the amortized cost and fair values of our
securities as of the dates indicated.
AT DECEMBER 31,
---------------------------------------------------------------------------------------
2002 2001 2000
--------------------------- --------------------------- ---------------------------
AMORTIZED AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
------------ ------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
HELD TO MATURITY:
U.S. Government & Agency
Collateralized Mortgage Obligations... $ 85,833 $ 86,785 $ 32,849 $ 33,615 $ 51,367 $ 51,280
State and municipal ................... 94,267 98,582 75,562 75,871 59,751 60,003
Corporate and other ................... 36,019 36,068 4,540 4,556 12,941 12,938
------------ ------------ ------------ ------------ ------------ ------------
Total held-to-maturity ............. $ 216,119 $ 221,435 $ 112,951 $ 114,042 $ 124,059 $ 124,221
============ ============ ============ ============ ============ ============
AVAILABLE FOR SALE:
U.S. Government & Agency obligations .. $ 515,193 $ 517,229 $ 76,111 $ 78,042 $ 80,994 $ 81,222
U.S. Government & Agency Pass Thru .... 40,491 42,319 35,106 35,225 38,970 38,499
U.S. Government & Agency
Collateralized Mortgage Obligations... 520,961 529,481 274,100 275,741 128,170 127,542
Corporate and other ................... 145,358 153,089 101,988 105,708 87,523 87,776
------------ ------------ ------------ ------------ ------------ ------------
Total available for sale ........... $ 1,222,003 $ 1,242,118 $ 487,305 $ 494,716 $ 335,657 $ 335,039
============ ============ ============ ============ ============ ============
Average expected life of securities(1).. 1.86 years 3.3 years 3.22 years
- ----------
(1) Average expected life is based on prepayment assumptions utilizing interest
rates as of the reporting dates and does not include Fannie Mae and FHLB
stock.
25
The following table sets forth certain information regarding the
carrying value, weighted average yields and contractual maturities of our
securities portfolio as of December 31, 2002. No tax equivalent adjustments were
made to the weighted average yields. Amounts are shown at amortized cost for
held to maturity securities and at fair value for available for sale securities.
AT DECEMBER 31, 2002
-----------------------------------------------------------------------------------------
MORE THAN ONE YEAR TO MORE THAN FIVE YEARS TO
ONE YEAR OR LESS FIVE YEARS TEN YEARS
--------------------------- --------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD
------------ ------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
HELD TO MATURITY:
U.S. Government & Agency
Collateralized Mortgage
Obligations ................... $ 3,420 5.62% $ 58,570 4.97% $ 23,784 4.94%
State and municipal ............ 3,167 3.51 27,803 4.23 43,147 4.40
Corporate and other ............ 773 5.14 33,161 4.99 237 6.42
------------ ------------ ------------ ------------ ------------ ------------
Total held-to-maturity ....... $ 7,360 4.66% $ 119,534 4.80% $ 67,168 4.60%
============ ============ ============ ============ ============ ============
AVAILABLE FOR SALE:
US Government & Agency
Obligations ................... $ 464,794 1.51% $ 52,435 3.38% $ -- --
U.S. Government Agency
Pass Thru ..................... 1,401 5.70 22,331 5.99 18,587 6.16
U.S. Government Agency
Collateralized Mortgage
Obligations ................... 55,104 5.49 398,939 4.96 38,957 5.62
Corporate and other ............ 6,924 5.49 139,037 5.64 2,735 5.98
------------ ------------ ------------ ------------ ------------ ------------
Total available for sale (2).. $ 528,223 1.99% $ 612,742 5.02% $ 60,279 5.80%
============ ============ ============ ============ ============ ============
AT DECEMBER 31, 2002
----------------------------------------------------------
AFTER TEN YEARS TOTAL
--------------------------- ----------------------------
WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD (1)
------------ ------------ ------------ ------------
(Dollars in thousands)
HELD TO MATURITY:
U.S. Government & Agency
Collateralized Mortgage
Obligations ................... $ 59 6.01% $ 85,833 4.99%
State and municipal ............ 20,150 4.49 94,267 4.34
Corporate and other ............ 1,848 7.43 36,019 5.13
------------ ------------ ------------ ------------
Total held-to-maturity ....... $ 22,057 4.74% $ 216,119 4.73%
============ ============ ============ ============
AVAILABLE FOR SALE:
US Government & Agency
Obligations ................... $ -- -- $ 517,229 1.70%
U.S. Government Agency
Pass Thru ..................... -- -- 42,319 6.06
U.S. Government Agency
Collateralized Mortgage
Obligations ................... 36,481 5.94 529,481 5.13
Corporate and other ............ 4,393 5.98 153,089 5.65
------------ ------------ ------------ ------------
Total available for sale (2).. $ 40,874 5.94% $ 1,242,118 3.80%
============ ============ ============ ============
- ----------
(1) Yields are not tax equivalent.
(2) Excludes FHLB stock.
26
SOURCES OF FUNDS
General. Sources of funds consist of principal and interest cash flows
received from loans and mortgage-backed securities, contractual maturities on
investments, deposits and Federal Home Loan Bank advances. These sources of
funds are for lending, investing and general corporate purposes.
Deposits. We offer a variety of deposits for retail and business
accounts. Deposit products include savings accounts, checking accounts, interest
bearing checking accounts, money market deposit accounts and certificate of
deposit accounts at varying interest rates and terms. We also offer IRA and
KEOGH accounts. For business customers we offer several checking account and
savings plans, cash management services, payroll origination service, escrow
account management and master card business cards. Our customer relationship
management strategy focuses on relationship banking for retail and business
customers to enhance the customer experience. Deposit activity is influenced by
state and local economic activity, changes in interest rates, internal pricing
decisions and competition. Deposits are primarily obtained from the areas
surrounding our branch locations. In order to attract and retain deposits we
offer competitive rates, quality customer service and we offer a wide variety of
products and services that meet the needs of our customers, including online
banking. We do not have any brokered deposits.
Deposit pricing strategy is monitored monthly by the Asset/Liability
Committee. Deposit pricing is set weekly by our Treasury Department. When
considering our deposit pricing, we consider competitive market rates, FHLB
advance rates and rates on other sources of funds. Core deposits, defined as
savings accounts, interest and non-interest bearing checking accounts and money
market deposit accounts represented 67.58% of total deposits at December 31,
2002 and 55.05% at December 31, 2001. As of December 31, 2002 and December 31,
2001, time deposits maturing in less than one year amounted to $870.3 million
and $881.7 million, respectively.
The following table indicates the amount of our certificates of deposit
by time remaining until maturity as of December 31, 2002.
MATURITY
---------------------------------------------------------
3 MONTHS OR OVER 3 TO 6 OVER 6 TO 12 OVER 12
LESS MONTHS MONTHS MONTHS TOTAL
------------ ------------ ------------ ------------ ------------
(In thousands)
Certificates of deposit less than
$100,000 ......................... $ 304,461 $ 226,853 $ 203,456 $ 155,872 $ 890,642
Certificates of deposit of $100,000
or more .......................... 69,778 32,952 32,785 25,352 160,867
------------ ------------ ------------ ------------ ------------
Total of certificates of deposit .. $ 374,239 $ 259,805 $ 236,241 $ 181,224 $ 1,051,509
============ ============ ============ ============ ============
Certificates of Deposit Maturities. The following table sets forth
certain information regarding our certificates of deposit.
PERIOD TO MATURITY FROM DECEMBER 31, 2002
---------------------------------------------------------------------------------------
LESS THAN ONE TO TWO TO THREE TO FOUR TO FIVE YEARS
ONE YEAR TWO YEARS THREE YEARS FOUR YEARS FIVE YEARS OR MORE
------------ ------------ ------------ ------------ ------------ ------------
(In thousands)
Rate:
1.00 to 2.00% ..................... $ 170,396 $ 2,256 $ -- $ -- $ 253 $ 83
2.01 to 3.00% ..................... 555,953 31,185 3,129 384 -- 70
3.01 to 4.00% ..................... 57,419 32,833 20,458 1,287 10,898 249
4.01 to 5.00% ..................... 43,859 13,549 9,646 8,033 21,454 979
5.01 to 6.00% ..................... 24,151 13,718 1,508 4,348 623 1,023
6.01 to 7.00% ..................... 18,507 132 3,084 14 -- --
Over 7.01% ...................... -- 23 2 -- -- 3
------------ ------------ ------------ ------------ ------------ ------------
Total .......................... $ 870,285 $ 93,696 $ 37,827 $ 14,066 $ 33,228 $ 2,407
============ ============ ============ ============ ============ ============
AT DECEMBER 31,
------------------------------------------
2002 2001 2000
------------ ------------ ------------
(In thousands)
Rate:
1.00 to 2.00% .................... $ 172,988 $ 2,913 $ 9
2.01 to 3.00% .................... 590,721 270,298 18
3.01 to 4.00% .................... 123,144 363,796 114
4.01 to 5.00% .................... 97,520 194,786 40,498
5.01 to 6.00% .................... 45,371 154,084 588,850
6.01 to 7.00% .................... 21,737 66,632 404,155
Over 7.01% ..................... 28 28 633
------------ ------------ ------------
Total ......................... $ 1,051,509 $ 1,052,537 $ 1,034,277
============ ============ ============
Borrowed Funds. At December 31, 2002, we had $323.1 million of borrowed
funds. Borrowed funds consist primarily of FHLB advances and repurchase
agreements with existing commercial customers. Repurchase agreements are
contracts for the sale of securities owned or borrowed by us, with an agreement
to repurchase those
27
securities at an agreed upon price and date. We use repurchase agreements as an
investment vehicle for our commercial sweep checking product. Our policies limit
the use of repurchase agreements to collateral consisting of U.S. Treasury
obligations, U.S. agency obligations or mortgage related securities. There were
$56.0 million of repurchase agreements outstanding as of December 31, 2002, and
we averaged approximately $47.6 million outstanding pursuant to such agreements
during the year ended December 31, 2002.
As a member of the Federal Home Loan Bank of New York, The Provident
Bank is eligible to obtain advances upon the security of the FHLB common stock
owned and certain residential mortgage loans, provided certain standards related
to credit-worthiness have been met. FHLB advances are available pursuant to
several credit programs, each of which has its own interest rate and range of
maturities. We had $267.1 million of FHLB advances outstanding as of December
31, 2002, and we averaged approximately $157.3 million of FHLB advances during
the year ended December 31, 2002.
The following table sets forth the maximum month-end balance and
average monthly balance of FHLB advances and securities sold under agreements to
repurchase for the periods indicated.
YEAR ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
(Dollars in thousands)
Maximum Balance:
FHLB advances ............................... $ 267,114 $ 144,664 $ 145,563
FHLB line of credit ......................... -- 26,900 82,000
Securities sold under agreements to
repurchase.................................. 55,967 51,103 47,784
Average Balance:
FHLB advances ............................... 157,300 132,756 139,650
FHLB line of credit ......................... -- 1,788 32,714
Securities sold under agreements to
repurchase.................................. 47,600 42,144 37,780
Weighted Average Interest Rate:
FHLB advances ............................... 3.88% 5.90% 6.11%
FHLB line of credit ......................... -- 5.50 6.93
Securities sold under agreements to
repurchase.................................. 1.50 3.07 4.21
The following table sets forth certain information as to our borrowings
at the dates indicated.
AT DECEMBER 31,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
(Dollars in thousands)
FHLB advances ............................... $ 267,114 $ 144,664 $ 132,240
FHLB line of credit ......................... -- -- 7,000
Securities sold under agreements to
repurchase.................................. 55,967 51,103 40,663
------------ ------------ ------------
Total borrowings ......................... $ 323,081 $ 195,767 $ 179,903
============ ============ ============
Weighted average interest rate of
FHLB advances............................... 3.88% 5.90% 6.11%
Weighted average interest rate of
FHLB line of credit ........................ -- 5.50% 6.93%
Weighted average interest rate of
securities sold under agreements to
repurchase ................................. 1.50% 3.07% 4.21%
FINANCIAL MANAGEMENT AND TRUST SERVICES
The Provident Bank offers a full range of trust and financial
management services primarily to individuals. These services include wealth
management services, such as investment management and investment advisory
accounts, as well as custody accounts. We also serve as trustee for living and
testamentary trusts. Our trust officers also provide estate settlement services
when The Provident Bank has been named executor or guardian of an estate. At
December 31, 2002 the book value of assets under administration was $186.3
million and the number of accounts under administration was 523.
28
SUBSIDIARY ACTIVITIES
Provident Mortgage Corporation is a wholly-owned subsidiary of The
Provident Bank. It was established as a New Jersey corporation to provide
mortgage banking services as a successor to Residential Home Funding Corp., a
mortgage company specializing in FHA-insured loans and VA-guaranteed loans and,
to a lesser extent, alternative residential loan products. We acquired
Residential Home Funding Corp. in July 2001. All loans originated by the
mortgage company are sold to established investors with the loan servicing
released.
Provident Investment Services, Inc. is a wholly-owned subsidiary of The
Provident Bank. It was established as a New Jersey corporation to provide life,
health, property and casualty insurance in the State of New Jersey and conducts
non-deposit investment product and insurance sales through a third party service
provider.
Provident Title, LLC is a joint venture in which The Provident Bank has
a 49% interest and Investor's Title Agency, Inc. has a 51% interest. Provident
Title, LLC is licensed to sell title insurance in the State of New Jersey. It
commenced business in October 2001.
Dudley Investment Corporation is a wholly-owned subsidiary of The
Provident Bank. On December 27, 2002, we received approval from the New Jersey
Department of Banking and Insurance for Dudley Investment Corporation to operate
as a New Jersey Investment Company. Dudley Investment Corporation owns all of
the outstanding common stock of PSB Funding Corporation.
The Provident Bank maintains several other wholly-owned subsidiaries,
including Beehive Investment, Inc. and Paulus Hook Corp., which currently
conduct no business and are inactive.
PSB Funding Corporation is a majority owned subsidiary of Dudley
Investment Corporation. It was established as a New Jersey corporation to engage
in real estate activities (including the acquisition of mortgage loans from The
Provident Bank) that enable it to be taxed as a real estate investment trust for
federal and New Jersey tax purposes.
PERSONNEL
As of December 31, 2002, we had 615 full-time and 82 part-time
employees. None of our employees is represented by a collective bargaining
group. We believe our relationship with our employees is good.
REGULATION
General
The Provident Bank is a New Jersey chartered savings bank, and its
deposit accounts are insured up to applicable limits by the Federal Deposit
Insurance Corporation ("FDIC") under the Bank Insurance Fund ("BIF") and the
Savings Association Insurance Fund ("SAIF"). The Provident Bank is subject to
extensive regulation, examination and supervision by the Commissioner of the New
Jersey Department of Banking and Insurance (the "Commissioner") as the issuer of
its certificate of incorporation, and by the FDIC as the deposit insurer. The
Provident Bank must file reports with the Commissioner and the FDIC concerning
its activities and financial condition, and it must obtain regulatory approval
prior to entering into certain transactions, such as mergers with, or
acquisitions of, other depository institutions and opening or acquiring branch
offices. The Commissioner and the FDIC conduct periodic examinations to assess
The Provident Bank's compliance with various regulatory requirements. This
regulation and supervision establishes a comprehensive framework of activities
in which a savings bank can engage and is intended primarily for the protection
of the deposit insurance fund and depositors. The regulatory structure also
gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes.
Provident Financial Services, Inc., as a bank holding company
controlling The Provident Bank, is subject to the Bank Holding Company Act of
1956, as amended ("BHCA"), and the rules and regulations of the Federal Reserve
Board under the BHCA and to the provisions of the New Jersey Banking Act of 1948
(the "New Jersey
29
Banking Act") and the regulations of the Commissioner under the New Jersey
Banking Act applicable to bank holding companies. The Provident Bank and
Provident Financial Services, Inc. are required to file reports with, and
otherwise comply with the rules and regulations of the Federal Reserve Board and
the Commissioner. Provident Financial Services, Inc. files certain reports with,
and otherwise complies with, the rules and regulations of the Securities and
Exchange Commission under the federal securities laws.
Any change in such laws and regulations, whether by the Commissioner,
the FDIC, the Federal Reserve Board or through legislation, could have a
material adverse impact on The Provident Bank and Provident Financial Services,
Inc. and their operations and stockholders.
New Jersey Banking Regulation
Activity Powers. The Provident Bank derives its lending, investment and
other activity powers primarily from the applicable provisions of the New Jersey
Banking Act and its related regulations. Under these laws and regulations,
savings banks, including The Provident Bank, generally may invest in:
(1) real estate mortgages;
(2) consumer and commercial loans;
(3) specific types of debt securities, including certain corporate
debt securities and obligations of federal, state and local
governments and agencies;
(4) certain types of corporate equity securities; and
(5) certain other assets.
A savings bank may also invest pursuant to a "leeway" power that
permits investments not otherwise permitted by the New Jersey Banking Act.
"Leeway" investments must comply with a number of limitations on the individual
and aggregate amounts of "leeway" investments. A savings bank may also exercise
trust powers upon approval of the Commissioner. New Jersey savings banks may
exercise those powers, rights, benefits or privileges authorized for national
banks or out-of-state banks or for federal or out-of-state savings banks or
savings associations, provided that before exercising any such power, right,
benefit or privilege, prior approval by the Commissioner by regulation or by
specific authorization is required. The exercise of these lending, investment
and activity powers are limited by federal law and the related regulations.
Loans-to-One-Borrower Limitations. With certain specified exceptions, a
New Jersey chartered savings bank may not make loans or extend credit to a
single borrower and to entities related to the borrower in an aggregate amount
that would exceed 15% of the bank's capital funds. A savings bank may lend an
additional 10% of the bank's capital funds if secured by collateral meeting the
requirements of the New Jersey Banking Act. The Provident Bank currently
complies with applicable loans-to-one-borrower limitations.
Dividends. Under the New Jersey Banking Act, a stock savings bank may
declare and pay a dividend on its capital stock only to the extent that the
payment of the dividend would not impair the capital stock of the savings bank.
In addition, a stock savings bank may not pay a dividend unless the savings bank
would, after the payment of the dividend, have a surplus of not less than 50% of
its capital stock, or the payment of the dividend would not reduce the surplus.
Federal law may also limit the amount of dividends that may be paid by The
Provident Bank.
Minimum Capital Requirements. Regulations of the Commissioner impose on
New Jersey chartered depository institutions, including The Provident Bank,
minimum capital requirements similar to those imposed by the FDIC on insured
state banks.
Examination and Enforcement. The New Jersey Department of Banking and
Insurance may examine The Provident Bank whenever it deems an examination
advisable. The Department examines The Provident Bank at least every two years.
The Commissioner may order any savings bank to discontinue any violation of law
or unsafe or unsound business practice and may direct any director, officer,
attorney or employee of a savings bank engaged in
30
an objectionable activity, after the Commissioner has ordered the activity to be
terminated, to show cause at a hearing before the Commissioner why such person
should not be removed.
Federal Banking Regulation
Capital Requirements. FDIC regulations require banks to maintain
minimum levels of capital. The FDIC regulations define two tiers, or classes, of
capital.
Tier 1 capital is comprised of the sum of:
. common stockholders' equity, excluding the unrealized
appreciation or depreciation, net of tax, from available for sale
securities;
. non-cumulative perpetual preferred stock, including any related
retained earnings; and
. minority interests in consolidated subsidiaries minus all
intangible assets, other than qualifying servicing rights and any
net unrealized loss on marketable equity securities.
The components of Tier 2 capital currently include:
. cumulative perpetual preferred stock;
. certain perpetual preferred stock for which the dividend rate may
be reset periodically;
. hybrid capital instruments, including mandatory convertible
securities;
. term subordinated debt;
. intermediate term preferred stock;
. allowance for possible loan losses; and
. up to 45% of pretax net unrealized holding gains on available for
sale equity securities with readily determinable fair market
values.
Allowance for possible loan losses includible in Tier 2 capital is limited to a
maximum of 1.25% of risk-weighted assets. Overall, the amount of Tier 2 capital
that may be included in total capital cannot exceed 100% of Tier 1 capital. The
FDIC regulations establish a minimum leverage capital requirement for banks in
the strongest financial and managerial condition, with a rating of 1 (the
highest examination rating of the FDIC for banks) under the Uniform Financial
Institutions Rating System, of not less than a ratio of 3.0% of Tier 1 capital
to total assets. For all other banks, the minimum leverage capital requirement
is 4.0%, unless a higher leverage capital ratio is warranted by the particular
circumstances or risk profile of the depository institution.
The FDIC regulations also require that banks meet a risk-based capital
standard. The risk-based capital standard requires the maintenance of a ratio of
total capital, which is defined as the sum of Tier 1 capital and Tier 2 capital,
to risk-weighted assets of at least 8% and a ratio of Tier 1 capital to
risk-weighted assets of at least 4%. In determining the amount of risk-weighted
assets, all assets, plus certain off balance sheet items, are multiplied by a
risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in
the type of asset or item.
The federal banking agencies, including the FDIC, have also adopted
regulations to require an assessment of an institution's exposure to declines in
the economic value of a bank's capital due to changes in interest rates when
assessing the bank's capital adequacy. Under such a risk assessment, examiners
will evaluate a bank's capital for interest rate risk on a case-by-case basis,
with consideration of both quantitative and qualitative factors. According to
the agencies, applicable considerations include:
. the quality of the bank's interest rate risk management process;
31
. the overall financial condition of the bank; and
. the level of other risks at the bank for which capital is needed.
Institutions with significant interest rate risk may be required to
hold additional capital. The agencies also issued a joint policy statement
providing guidance on interest rate risk management, including a discussion of
the critical factors affecting the agencies' evaluation of interest rate risk in
connection with capital adequacy.
The FDIC adopted regulations, effective April 1, 2002, establishing
minimum regulatory capital requirements for equity investments in non-financial
companies. The regulations apply a series of marginal capital charges that range
from 8% to 25% depending upon the size of the aggregate equity investment
portfolio of the banking organization relative to its Tier 1 capital. The
capital charge would be applied by making a deduction, which would be based on
the adjusted carrying value of the equity investment from the organization's
Tier 1 capital. We do not believe this new capital requirement will have a
material adverse effect upon our operations. However, we will have to take this
requirement into consideration should we, at some point in the future, decide to
invest in non-financial companies.
The following table shows our leverage ratio, our Tier 1 risk-based
capital ratio, and our total risk-based capital ratio, at December 31, 2002:
AS OF DECEMBER 31, 2002
-------------------------------------------------------------
PERCENT OF CAPITAL
CAPITAL ASSETS/(1)/ REQUIREMENTS/(1)/
------------------ ------------------ ------------------
(Dollars in thousands)
Regulatory Tier 1 leverage capital ..... $ 291,294 8.98% 4.0%
Tier 1 risk-based capital .............. 291,294 12.42 4.0
Total risk-based capital ............... 312,459 13.32 8.0
- ----------
(1) For purposes of calculating Regulatory Tier 1 leverage capital, assets are
based on adjusted total leverage assets. In calculating Tier 1 risk based
capital and total risk-based capital, assets are based on total
risk-weighted assets.
As the table shows, as of December 31, 2002, The Provident Bank was
considered "well capitalized" under FDIC guidelines.
Activity Restrictions on State-Chartered Banks. Section 24 of the
Federal Deposit Insurance Act, as amended, ("FDIA") which was added by the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDIC Improvement
Act"), generally limits the activities and investments of state-chartered FDIC
insured banks and their subsidiaries to those permissible for national banks and
their subsidiaries, unless such activities and investments are specifically
exempted by Section 24 or consented to by the FDIC.
Section 24 provides an exception for investments by a bank in common
and preferred stocks listed on a national securities exchange or the shares of
registered investment companies if:
. the bank held such types of investments during the 14 month
period from September 30, 1990 through November 26, 1991;
. the state in which the bank is chartered permitted such
investments as of September 30, 1991; and
. the bank notifies the FDIC and obtains approval from the FDIC to
make or retain such investments. Upon receiving such FDIC
approval, an institution's investment in such equity securities
will be subject to an aggregate limit up to the amount of its
Tier 1 capital.
Section 24 provides an exception for majority owned subsidiaries of a
bank, but Section 24 limits the activities of such subsidiaries to those
permissible for a national bank, permissible under Section 24 of the FDIA and
the related FDIC regulations, or as approved by the FDIC.
32
Before making a new investment or engaging in a new activity that is
not permissible for a national bank or otherwise permissible under Section 24 of
the FDIC regulations, an insured bank must seek approval from the FDIC to make
such investment or engage in such activity. The FDIC will not approve the
activity unless the bank meets its minimum capital requirements and the FDIC
determines that the activity does not present a significant risk to the FDIC
insurance funds. Certain activities of subsidiaries that are engaged in
activities permitted for national banks only through a "financial subsidiary"
are subject to additional restrictions.
The Gramm-Leach-Bliley Act ("Gramm-Leach") permits a state-chartered
savings bank to engage, through financial subsidiaries, in any activity in which
a national bank may engage through a financial subsidiary and on substantially
the same terms and conditions. In general, Gramm-Leach permits a national bank
that is well-capitalized and well-managed to conduct, through a financial
subsidiary, any activity permitted for a financial holding company other than
insurance underwriting, insurance investments, real estate investment or
development or merchant banking. The total assets of all such financial
subsidiaries may not exceed the lesser of 45% of the bank's total assets or $50
billion. The bank must have policies and procedures to assess the financial
subsidiary's risk and protect the bank from such risk and potential liability,
must not consolidate the financial subsidiary's assets with the bank's and must
exclude from its own assets and equity all equity investments, including
retained earnings, in the financial subsidiary. State chartered savings banks
may retain subsidiaries in existence as of March 11, 2000 and may engage in
activities that are not authorized under Gramm-Leach; otherwise, Gramm-Leach
will preempt all state laws regarding the permissibility of certain activities
for state chartered banks if such state law is in conflict with the provisions
of Gramm-Leach (with the exception of certain insurance activities), regardless
of whether the state law would authorize broader or more restrictive activities.
Although The Provident Bank meets all conditions necessary to establish and
engage in permitted activities through financial subsidiaries, it has not yet
determined whether or the extent to which it will seek to engage in such
activities.
Federal Home Loan Bank System. The Provident Bank is a member of the
FHLB system, which consists of twelve regional FHLBs, each subject to
supervision and regulation by the Federal Housing Finance Board ("FHFB"). The
FHLB provides a central credit facility primarily for member thrift institutions
as well as other entities involved in home mortgage lending. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLBs. It makes loans to members (i.e., advances) in accordance with policies
and procedures, including collateral requirements, established by the respective
boards of directors of the FHLBs. These policies and procedures are subject to
the regulation and oversight of the FHFB. All long term advances are required to
provide funds for residential home financing. The FHFB has also established
standards of community or investment service that members must meet to maintain
access to such long term advances. The Provident Bank, as a member of the FHLB
of New York, is required to purchase and hold shares of capital stock in that
FHLB in an amount at least equal to the greater of (i) 1% of the aggregate
principal amount of its unpaid mortgage loans, home purchase contracts and
similar obligations at the beginning of each year; (ii) 0.3% of its assets; or
(iii) 5% (or such greater fraction as established by the FHLB) of its advances
from the FHLB as of December 31, 2001. Pursuant to Gramm-Leach, the foregoing
minimum share ownership requirements will be replaced by regulations to be
promulgated by the FHFB. Gramm-Leach specifically provides that the minimum
requirements in existence immediately prior to adoption of Gramm-Leach shall
remain in effect until such regulations are adopted. The Provident Bank is in
compliance with these requirements.
Enforcement. The FDIC has extensive enforcement authority over insured
savings banks, including The Provident Bank. This enforcement authority
includes, among other things, the ability to assess civil money penalties, to
issue cease and desist orders and to remove directors and officers. In general,
these enforcement actions may be initiated in response to violations of laws and
regulations and to unsafe or unsound practices.
The FDIC is required, with some exceptions, to appoint a receiver or
conservator for an insured state bank if that bank is "critically
undercapitalized." For this purpose, "critically undercapitalized" means having
a ratio of tangible capital to total assets of less than 2%. The FDIC may also
appoint a conservator or receiver for a state bank on the basis of the
institution's financial condition or upon the occurrence of certain events,
including:
. insolvency, or when the assets of the bank are less than its
liabilities to depositors and others;
. substantial dissipation of assets or earnings through violations
of law or unsafe or unsound practices;
33
. existence of an unsafe or unsound condition to transact business;
. likelihood that the bank will be unable to meet the demands of
its depositors or to pay its obligations in the normal course of
business; and
. insufficient capital, or the incurring or likely incurring of
losses that will deplete substantially all of the institution's
capital with no reasonable prospect of replenishment of capital
without federal assistance.
Deposit Insurance. Pursuant to FDIC Improvement Act, the FDIC
established a system for setting deposit insurance premiums based upon the risks
a particular bank or savings association posed to its deposit insurance funds.
Under the risk-based deposit insurance assessment system, the FDIC assigns an
institution to one of three capital categories based on the institution's
financial information, as of the reporting period ending six months before the
assessment period. The three capital categories are (1) well capitalized, (2)
adequately capitalized and (3) undercapitalized. With respect to the capital
ratios, institutions are classified as well capitalized, adequately capitalized
or undercapitalized using ratios that are substantially similar to the prompt
corrective action capital ratios discussed below. The FDIC also assigns an
institution to supervisory subgroups based on a supervisory evaluation provided
to the FDIC by the institution's primary federal regulator and information that
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance funds, which may include information
provided by the institution's state supervisor.
An institution's assessment rate depends on the capital category and
supervisory category to which it is assigned. Under the final risk-based
assessment system, there are nine assessment risk classifications, or
combinations of capital groups and supervisory subgroups, to which different
assessment rates are applied. Assessment rates for deposit insurance currently
range from 0 basis points to 27 basis points. The capital and supervisory
subgroup to which an institution is assigned by the FDIC is confidential and may
not be disclosed. A bank's rate of deposit insurance assessments will depend
upon the category and subcategory to which the bank is assigned by the FDIC. Any
increase in insurance assessments could have an adverse effect on the earnings
of insured institutions, including The Provident Bank.
Under the Deposit Insurance Funds Act of 1996, the assessment base for
the payments on the bonds issued in the late 1980's by the Financing Corporation
to recapitalize the now defunct Federal Savings and Loan Insurance Corporation
was expanded to include, beginning January 1, 1997, the deposits of institutions
insured by the Bank Insurance Fund, such as The Provident Bank. The annual rate
of assessments for the payments on the Financing Corporation bonds for the
quarterly period beginning on January 1, 2002 was 0.0182% for both
BIF-assessable deposits and SAIF-assessable deposits.
Under the FDIA, the FDIC may terminate the insurance of an
institution's deposits upon a finding that the institution has engaged in unsafe
or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC. The management of The Provident Bank does not
know of any practice, condition or violation that might lead to termination of
deposit insurance.
Transactions with Affiliates of The Provident Bank. Transactions
between an insured bank, such as The Provident Bank, and any of its affiliates
is governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of
a bank is any company or entity that controls, is controlled by, or is under
common control with, the bank. Currently, a subsidiary of a bank that is not
also a depository institution generally is not treated as an affiliate of the
bank for purposes of Sections 23A and 23B, but the Federal Reserve Board has
proposed a comprehensive regulation implementing Sections 23A and 23B which
would establish certain exceptions to this policy.
Section 23A:
. limits the extent to which the bank or its subsidiaries may
engage in "covered transactions" with any one affiliate to an
amount equal to 10% of such bank's capital stock and retained
earnings, and limits all such transactions with all affiliates to
an amount equal to 20% of such capital stock and retained
earnings; and
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. requires that all such transactions be on terms that are
consistent with safe and sound banking practices.
The term "covered transaction" includes the making of loans, purchase
of assets, issuance of guarantees and other similar types of transactions.
Further, most loans by a bank to any of its affiliates must be secured by
collateral in amounts ranging from 100 to 130 percent of the loan amounts. In
addition, any covered transaction by a bank with an affiliate and any purchase
of assets or services by a bank from an affiliate must be on terms that are
substantially the same, or at least as favorable to the bank, as those that
would be provided to a non-affiliate.
In addition, provisions of the BHCA prohibit extensions of credit to a
bank's insiders and their related interests by any other institution that has a
correspondent banking relationship with the bank, unless such extension of
credit is on substantially the same terms as those prevailing at the time for
comparable transactions with other persons and does not involve more than the
normal risk of repayment or present other unfavorable features.
Prohibitions Against Tying Arrangements. Banks are subject to the
prohibitions of 12 U.S.C. Section 1972 on certain tying arrangements. A
depository institution is prohibited, subject to some exceptions, from extending
credit or offering any other service, or fixing or varying the consideration for
such extension of credit or service, on the condition that the customer obtain
some additional service from the institution or its affiliates or not obtain
services of a competitor of the institution.
Privacy Standards. Effective July 1, 2001, financial institutions,
including Provident Financial Services, Inc. and The Provident Bank, became
subject to FDIC regulations implementing the privacy protection provisions of
Gramm-Leach. These regulations require Provident Financial Services, Inc. and
The Provident Bank to disclose their privacy policy, including identifying with
whom they share "non-public personnel information" to customers at the time of
establishing the customer relationship and annually thereafter.
The regulations also require Provident Financial Services, Inc. and The
Provident Bank to provide their customers with initial and annual notices that
accurately reflect their privacy policies and practices. In addition, Provident
Financial Services, Inc. and The Provident Bank are required to provide their
customers with the ability to "opt-out" of having Provident Financial Services,
Inc. and The Provident Bank share their non-public personal information with
unaffiliated third parties before they can disclose such information, subject to
certain exceptions. The implementation of these regulations did not have a
material adverse effect on Provident Financial Services, Inc. or The Provident
Bank. Gramm-Leach also provides for the ability of each state to enact
legislation that is more protective of consumers' personal information.
Currently there are a number of privacy bills pending in the New Jersey
legislature. No action has been taken on any of these bills, and we cannot
predict whether any of them will become law or what impact, if any, these bills
will have if enacted into law.
On February 1, 2001, the FDIC and other federal banking agencies
adopted guidelines establishing standards for safeguarding customer information
to implement certain provisions of Gramm-Leach. The guidelines describe the
agencies' expectations for the creation, implementation and maintenance of an
information security program, which would include administrative, technical and
physical safeguards appropriate to the size and complexity of the institution
and the nature and scope of its activities. The standards set forth in the
guidelines are intended to ensure the security and confidentiality of customer
records and information, protect against any anticipated threats or hazards to
the security or integrity of such records and protect against unauthorized
access to or use of such records or information that could result in substantial
harm or inconvenience to any customer. We implemented the guidelines prior to
their effective date of July 1, 2001, and such implementation did not have a
material adverse effect on our operations.
Uniform Real Estate Lending Standards. Under the FDIA, the federal
banking agencies adopted uniform regulations prescribing standards for
extensions of credit that are secured by liens on interests in real estate or
made for the purpose of financing the construction of a building or other
improvements to real estate. Under the joint regulations adopted by the federal
banking agencies, all insured depository institutions must adopt and maintain
written policies that establish appropriate limits and standards for extensions
of credit that are secured by liens or interests in real estate or are made for
the purpose of financing permanent improvements to real estate. These policies
must establish loan portfolio diversification standards, prudent underwriting
standards, including loan-to-
35
value limits, that are clear and measurable, loan administration procedures, and
documentation, approval and reporting requirements. The real estate lending
policies must reflect consideration of the Interagency Guidelines for Real
Estate Lending Policies that have been adopted by the federal bank regulators.
The Interagency Guidelines, among other things, require a depository
institution to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits:
. for loans secured by raw land, the supervisory loan-to-value
limit is 65% of the value of the collateral;
. for land development loans, or loans for the purpose of improving
unimproved property prior to the erection of structures, the
supervisory limit is 75%;
. for loans for the construction of commercial, multi-family or
other non-residential property, the supervisory limit is 80%;
. for loans for the construction of one- to four-family residential
properties, the supervisory limit is 85%; and
. for loans secured by other improved property, for example,
farmland, completed commercial property and other
income-producing property including non-owner occupied, one-to
four-family property, the limit is 85%.
Although no supervisory loan-to-value limit has been established for
owner-occupied, one-to four-family and home equity loans, the Interagency
Guidelines state that for any such loan with a loan-to-value ratio that equals
or exceeds 90% at origination, an institution should require appropriate credit
enhancement in the form of either mortgage insurance or readily marketable
collateral.
The Provident Bank has established, however, internal loan-to-value
limits for real estate loans that are more stringent than the maximum limits
currently imposed under federal law.
Community Reinvestment Act and Fair Lending Laws. All FDIC insured
institutions have a responsibility under the Community Reinvestment Act and
related regulations to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In connection with its
examination of a state chartered savings bank, the FDIC is required to assess
the institution's record of compliance with the Community Reinvestment Act.
Among other things, the current Community Reinvestment Act regulations replace
the prior process-based assessment factors with a new evaluation system that
rates an institution based on its actual performance in meeting community needs.
In particular, the current evaluation system focuses on three tests:
. a lending test, to evaluate the institution's record of making
loans in its service areas;
. an investment test, to evaluate the institution's record of
investing in community development projects, affordable housing,
and programs benefiting low or moderate income individuals and
businesses; and
. a service test, to evaluate the institution's delivery of
services through its branches, ATMs and other offices.
An institution's failure to comply with the provisions of the Community
Reinvestment Act could, at a minimum, result in regulatory restrictions on its
activities. We received a satisfactory Community Reinvestment Act rating in our
most recently completed federal examination.
In addition, the Equal Credit Opportunity Act and the Fair Housing Act
prohibit lenders from discriminating in their lending practices on the basis of
characteristics specified in those statutes. The failure to comply with the
Equal Credit Opportunity Act and the Fair Housing Act could result in
enforcement actions by the FDIC, as well as other federal regulatory agencies
and the Department of Justice.
The FDIC recently conducted an examination relating to our compliance
with various federal banking regulations, which examination was unrelated to
safety and soundness. The FDIC noted weaknesses and failures to
36
comply with the reporting requirements of the Home Mortgage Disclosure Act. The
Home Mortgage Disclosure Act imposes on financial institutions reporting
obligations relating to home purchase and home improvement loans originated or
purchased, or for which the financial institution receives applications. This
loan data is used by regulatory agencies to help determine whether a financial
institution is serving the housing needs of the communities it serves, to assist
public officials in the distribution of public sector investments where it is
needed, and to assist federal bank regulators in identifying possible
discriminatory lending patterns. We have taken action and implemented procedures
to redress the FDIC's concerns and findings, including the refiling with the
FDIC of our Home Mortgage Disclosure Act data for 2000 and 2001.
In connection with the recent compliance examination, the FDIC informed
The Provident Bank that the FDIC made a preliminary finding that it had reason
to believe that The Provident Bank violated fair lending laws, including the
Equal Credit Opportunity Act and its implementing regulation, Regulation B of
the Federal Reserve Board. The FDIC's preliminary finding related to an
underwriting guideline on overdraft and personal loans that the FDIC alleged
could lead to disparate treatment of credit applicants on a prohibited basis.
The FDIC's preliminary finding also related to The Provident Bank's prior
practice of requesting reimbursement for appraisals purchased by The Provident
Bank from fixed-rate home equity loan applicants who paid no loan application
fee or other related costs and who requested copies of the appraisal. The Equal
Credit Opportunity Act and Regulation B promote the availability of credit to
all creditworthy applicants without regard to race, color, religion, national
origin, sex, marital status or age. Regulation B also requires creditors to
notify applicants of actions taken on their loan applications, to report credit
history in the names of both spouses on an account, to collect information about
the applicant's race or other personal characteristics in applications for
certain dwelling-related loans, and to provide applicants with copies of
appraisal reports used in credit transactions. The Provident Bank responded in
writing to the FDIC that it did not agree with the FDIC's finding and has
provided detailed information to the FDIC in support of its position. The
Provident Bank has been advised by the FDIC that this matter will not be
referred to the Department of Justice for further review or enforcement action.
The FDIC has issued a final report of examination and we anticipate that the
FDIC will require us to implement corrective actions, may impose civil money
penalties with respect to the refiling of Home Mortgage Disclosure Act data, and
may also require a memorandum of understanding with The Provident Bank to ensure
that corrective actions are taken and continue in the future. If we are required
to enter into a memorandum of understanding with the FDIC and in the future fail
to comply with any such agreement, we could be subject to further regulatory
action, including restrictions on our ability to expand through bank and branch
acquisitions, and possible monetary penalties. Management of The Provident Bank
has determined that the alleged failures and violations preliminarily found by
the FDIC to have occurred have not had a material adverse effect on its
operations or financial condition.
Safety and Soundness Standards. Pursuant to the requirements of the
FDIA, as amended by the Riegle Community Development and Regulatory Improvement
Act of 1994, each federal banking agency, including the FDIC, has adopted
guidelines establishing general standards relating to internal controls,
information and internal audit systems, loan documentation, credit underwriting,
interest rate exposure, asset growth, asset quality, earnings, compensation,
fees and benefits. In general, the guidelines require, among other things,
appropriate systems and practices to identify and manage the risks and exposures
specified in the guidelines. The guidelines prohibit excessive compensation as
an unsafe and unsound practice and describe compensation as excessive when the
amounts paid are unreasonable or disproportionate to the services performed by
an executive officer, employee, director, or principal stockholder.
In addition, the FDIC adopted regulations to require a bank that is
given notice by the FDIC that it is not satisfying any of such safety and
soundness standards to submit a compliance plan to the FDIC. If, after being so
notified, a bank fails to submit an acceptable compliance plan or fails in any
material respect to implement an accepted compliance plan, the FDIC may issue an
order directing corrective and other actions of the types to which a
significantly undercapitalized institution is subject under the "prompt
corrective action" provisions of FDIA. If a bank fails to comply with such an
order, the FDIC may seek to enforce such an order in judicial proceedings and to
impose civil monetary penalties.
Prompt Corrective Action. The FDIC Improvement Act also established a
system of prompt corrective action to resolve the problems of undercapitalized
institutions. The FDIC, as well as the other federal banking regulators, adopted
regulations governing the supervisory actions that may be taken against
undercapitalized institutions. The regulations establish five categories,
consisting of "well capitalized," "adequately capitalized,"
37
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." The FDIC's regulations define the five capital categories as
follows:
An institution will be treated as "well capitalized" if:
. its ratio of total capital to risk-weighted assets is at least
10%;
. its ratio of Tier 1 capital to risk-weighted assets is at least
6%; and
. its ratio of Tier 1 capital to total assets is at least 5%, and
it is not subject to any order or directive by the FDIC to meet a
specific capital level.
An institution will be treated as "adequately capitalized" if:
. its ratio of total capital to risk-weighted assets is at least
8%; and
. its ratio of Tier 1 capital to risk-weighted assets is at least
4%; and
. its ratio of Tier 1 capital to total assets is at least 4% (3% if
the bank receives the highest rating under the Uniform Financial
Institutions Rating System) and it is not a well-capitalized
institution.
An institution will be treated as "undercapitalized" if:
. its total risk-based capital is less than 8%; or
. its Tier 1 risk-based-capital is less than 4%; or
. its leverage ratio is less than 4% (or less than 3% if the
institution receives the highest rating under the Uniform
Financial Institutions Rating System).
An institution will be treated as "significantly undercapitalized" if:
. its total risk-based capital is less than 6%; or
. its Tier 1 capital is less than 3%; or
. its leverage ratio is less than 3%.
An institution that has a tangible capital to total assets ratio equal
to or less than 2% would be deemed to be "critically undercapitalized."
The severity of the action authorized or required to be taken under the
prompt corrective action regulations increases as a bank's capital decreases
within the three undercapitalized categories. All banks are prohibited from
paying dividends or other capital distributions or paying management fees to any
controlling person if, following such distribution, the bank would be
undercapitalized. The FDIC is required to monitor closely the condition of an
undercapitalized bank and to restrict the growth of its assets. An
undercapitalized bank is required to file a capital restoration plan within 45
days of the date the bank receives notice that it is within any of the three
undercapitalized categories, and the plan must be guaranteed by any parent
holding company. The aggregate liability of a parent holding company is limited
to the lesser of:
. an amount equal to five percent of the bank's total assets at the
time it became "undercapitalized," or
. the amount that is necessary (or would have been necessary) to
bring the bank into compliance with all capital standards
applicable with respect to such bank as of the time it fails to
comply with the plan.
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If a bank fails to submit an acceptable plan, it is treated as if it
were "significantly undercapitalized." Banks that are significantly or
critically undercapitalized are subject to a wider range of regulatory
requirements and restrictions.
The FDIC has a broad range of grounds under which it may appoint a
receiver or conservator for an insured depository bank. If one or more grounds
exist for appointing a conservator or receiver for a bank, the FDIC may require
the bank to issue additional debt or stock, sell assets, be acquired by a
depository bank holding company or combine with another depository bank. Under
the FDIA, the FDIC is required to appoint a receiver or a conservator for a
critically undercapitalized bank within 90 days after the bank becomes
critically undercapitalized or to take such other action that would better
achieve the purposes of the prompt corrective action provisions. Such
alternative action can be renewed for successive 90-day periods. However, if the
bank continues to be critically undercapitalized on average during the quarter
that begins 270 days after it first became critically undercapitalized, a
receiver must be appointed, unless the FDIC makes certain findings, including
that the bank is viable.
LOANS TO A BANK'S INSIDERS
Federal Regulation. A bank's loans to its executive officers,
directors, any owner of 10% or more of its stock (each, an insider) and any of
certain entities affiliated with any such person (an insider's related interest)
are subject to the conditions and limitations imposed by Section 22(h) of the
Federal Reserve Act and the Federal Reserve Board's Regulation O thereunder.
Under these restrictions, the aggregate amount of the loans to any insider and
the insider's related interests may not exceed the loans-to-one-borrower limit
applicable to national banks, which is comparable to the loans-to-one-borrower
limit applicable to The Provident Bank's loans. All loans by a bank to all
insiders and insiders' related interests in the aggregate may not exceed the
bank's unimpaired capital and unimpaired surplus. With certain exceptions, loans
to an executive officer, other than loans for the education of the officer's
children and certain loans secured by the officer's residence, may not exceed
the lesser of (1) $100,000 or (2) the greater of $25,000 or 2.5% of the bank's
unimpaired capital and surplus. Regulation O also requires that any proposed
loan to an insider or a related interest of that insider be approved in advance
by a majority of the board of directors of the bank, with any interested
directors not participating in the voting, if such loan, when aggregated with
any existing loans to that insider and the insider's related interests, would
exceed either (1) $500,000 or (2) the greater of $25,000 or 5% of the bank's
unimpaired capital and surplus. Generally, such loans must be made on
substantially the same terms as, and follow credit underwriting procedures that
are not less stringent than, those that are prevailing at the time for
comparable transactions with other persons.
An exception is made for extensions of credit made pursuant to a
benefit or compensation plan of a bank that is widely available to employees of
the bank and that does not give any preference to insiders of the bank over
other employees of the bank.
In addition, provisions of the BHCA prohibit extensions of credit to a
bank's insiders and their related interests by any other institution that has a
correspondent banking relationship with the bank, unless such extension of
credit is on substantially the same terms as those prevailing at the time for
comparable transactions with other persons and does not involve more than the
normal risk of repayment or present other unfavorable features.
New Jersey Regulation. Provisions of the New Jersey Banking Act impose
conditions and limitations on the liabilities to a savings bank of its directors
and executive officers and of corporations and partnerships controlled by such
persons that are comparable in many respects to the conditions and limitations
imposed on the loans and extensions of credit to insiders and their related
interests under Regulation O, as discussed above. The New Jersey Banking Act
also provides that a savings bank that is in compliance with Regulation O is
deemed to be in compliance with such provisions of the New Jersey Banking Act.
FEDERAL RESERVE SYSTEM
Under Federal Reserve Board regulations, The Provident Bank is required
to maintain noninterest-earning reserves against its transaction accounts. The
Federal Reserve Board regulations generally require that reserves of 3% must be
maintained against aggregate transaction accounts of $41.3 million or less,
subject to adjustment by the Federal Reserve Board, and an initial reserve of
$1.2 million plus 10%, subject to adjustment by the Federal Reserve Board
between 8% and 14%, against that portion of total transaction accounts in excess
of $41.3 million. The first
39
$5.7 million of otherwise reservable balances, subject to adjustments by the
Federal Reserve Board, are exempted from the reserve requirements. The Provident
Bank is in compliance with these requirements. Because required reserves must be
maintained in the form of either vault cash, a noninterest-bearing account at a
Federal Reserve Bank or a pass-through account as defined by the Federal Reserve
Board, the effect of this reserve requirement is to reduce The Provident Bank's
interest-earning assets.
INTERNET BANKING
Technological developments are significantly altering the ways in which
most companies, including financial institutions, conduct their business. The
growth of the Internet is prompting banks to reconsider business strategies and
adopt alternative distribution and marketing systems. The federal bank
regulatory agencies have conducted seminars and published materials targeted to
various aspects of internet banking, and have indicated their intention to
reevaluate their regulations to ensure that they encourage banks' efficiency and
competitiveness consistent with safe and sound banking practices. We cannot
assure you that the bank regulatory agencies will adopt new regulations that
will not materially affect our internet operations or restrict any such further
operations.
THE USA PATRIOT ACT
In response to the events of September 11, 2001, the Uniting and
Strengthening America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, was signed into law on
October 26, 2001. The USA PATRIOT Act gives the federal government new powers to
address terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing, and broadened anti-money
laundering requirements. By way of amendments to the Bank Secrecy Act, Title III
of the USA PATRIOT Act takes measures intended to encourage information sharing
among bank regulatory agencies and law enforcement bodies. Further, certain
provisions of Title III impose affirmative obligations on a broad range of
financial institutions, including banks, thrifts, brokers, dealers, credit
unions, money transfer agents and parties registered under the Commodity
Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the
following requirements with respect to financial institutions:
. Pursuant to Section 352, all financial institutions must
establish anti-money laundering programs that include, at
minimum: (i) internal policies, procedures, and controls; (ii)
specific designation of an anti-money laundering compliance
officer; (iii) ongoing employee training programs; and (iv) an
independent audit function to test the anti-money laundering
program.
. Section 326 of the Act authorizes the Secretary of the Department
of Treasury, in conjunction with other bank regulators, to issue
regulations that provide for minimum standards with respect to
customer identification at the time new accounts are opened.
. Section 312 of the Act requires financial institutions that
establish, maintain, administer, or manage private banking
accounts or correspondence accounts in the United States for
non-United States persons or their representatives (including
foreign individuals visiting the United States) to establish
appropriate, specific, and, where necessary, enhanced due
diligence policies, procedures, and controls designed to detect
and report money laundering.
. Effective December 25, 2001, financial institutions are
prohibited from establishing, maintaining, administering or
managing correspondent accounts for foreign shell banks (foreign
banks that do not have a physical presence in any country), and
will be subject to certain record keeping obligations with
respect to correspondent accounts of foreign banks.
. Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on
Federal Reserve Act and Bank Merger Act applications.
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The federal banking agencies have begun to propose and implement
regulations pursuant to the USA PATRIOT Act. These proposed and interim
regulations would require financial institutions to adopt the policies and
procedures contemplated by the USA PATRIOT Act.
HOLDING COMPANY REGULATION
Federal Regulation. Provident Financial Services, Inc. is regulated as
a bank holding company. Bank holding companies are subject to examination,
regulation and periodic reporting under the Bank Holding Company Act, as
administered by the Federal Reserve Board. The Federal Reserve Board has adopted
capital adequacy guidelines for bank holding companies on a consolidated basis
substantially similar to those of the FDIC for The Provident Bank. As of
December 31, 2002, Provident Financial Services, Inc.'s total capital and Tier 1
capital ratios would, on a pro forma basis, exceed these minimum capital
requirements.
Regulations of the Federal Reserve Board provide that a bank holding
company must serve as a source of strength to any of its subsidiary banks and
must not conduct its activities in an unsafe or unsound manner. Under the prompt
corrective action provisions of the FDIA, a bank holding company parent of an
undercapitalized subsidiary bank would be directed to guarantee, within
limitations, the capital restoration plan that is required of such an
undercapitalized bank. If the undercapitalized bank fails to file an acceptable
capital restoration plan or fails to implement an accepted plan, the Federal
Reserve Board may prohibit the bank holding company parent of the
undercapitalized bank from paying any dividend or making any other form of
capital distribution without the prior approval of the Federal Reserve Board.
As a bank holding company, Provident Financial Services, Inc. is
required to obtain the prior approval of the Federal Reserve Board to acquire
all, or substantially all, of the assets of any bank or bank holding company.
Prior Federal Reserve Board approval will be required for Provident Financial
Services, Inc. to acquire direct or indirect ownership or control of any voting
securities of any bank or bank holding company if, after giving effect to such
acquisition, it would, directly or indirectly, own or control more than 5% of
any class of voting shares of such bank or bank holding company.
A bank holding company is required to give the Federal Reserve Board
prior written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, will be equal to 10% or more of the company's
consolidated net worth. The Federal Reserve Board may disapprove such a purchase
or redemption if it determines that the proposal would constitute an unsafe and
unsound practice, or would violate any law, regulation, Federal Reserve Board
order or directive, or any condition imposed by, or written agreement with, the
Federal Reserve Board. Such notice and approval is not required for a bank
holding company that would be treated as "well capitalized" under applicable
regulations of the Federal Reserve Board, that has received a composite "1" or
"2" rating, as well as a "satisfactory" rating for management, at its most
recent bank holding company inspection by the Federal Reserve Board, and that is
not the subject of any unresolved supervisory issues.
In addition, a bank holding company which does not qualify as a
financial holding company under Gramm-Leach, is generally prohibited from
engaging in, or acquiring direct or indirect control of any company engaged in
non-banking activities. One of the principal exceptions to this prohibition is
for activities found by the Federal Reserve Board to be so closely related to
banking or managing or controlling banks as to be permissible. Some of the
principal activities that the Federal Reserve Board has determined by regulation
to be so closely related to banking as to be permissible are:
. making or servicing loans;
. performing certain data processing services;
. providing discount brokerage services; or acting as fiduciary,
investment or financial advisor;
. leasing personal or real property;
41
. making investments in corporations or projects designed primarily
to promote community welfare; and
. acquiring a savings and loan association.
Bank holding companies that do qualify as a financial holding company may engage
in activities that are financial in nature or incident to activities which are
financial in nature. Provident Financial Services, Inc. has not elected to
qualify as a financial holding company under Gramm-Leach, although it may seek
to do so in the future. Bank holding companies may qualify to become a financial
holding company if:
. each of its depository institution subsidiaries is "well
capitalized";
. each of its depository institution subsidiaries is "well
managed";
. each of its depository institution subsidiaries has at least a
"satisfactory" Community Reinvestment Act rating at its most
recent examination; and
. the bank holding company has filed a certification with the
Federal Reserve Board that it elects to become a financial
holding company.
Under the FDIA, depository institutions are liable to the FDIC for
losses suffered or anticipated by the FDIC in connection with the default of a
commonly controlled depository institution or any assistance provided by the
FDIC to such an institution in danger of default. This law would potentially be
applicable to Provident Financial Services, Inc. if it ever acquired as a
separate subsidiary a depository institution in addition to The Provident Bank.
New Jersey Regulation. Under the New Jersey Banking Act, a company
owning or controlling a savings bank is regulated as a bank holding company. The
New Jersey Banking Act defines the terms "company" and "bank holding company" as
such terms are defined under the BHCA. Each bank holding company controlling a
New Jersey chartered bank or savings bank must file certain reports with the
Commissioner and is subject to examination by the Commissioner.
Acquisition of Provident Financial Services, Inc. Under federal law and
under the New Jersey Banking Act, no person may acquire control of Provident
Financial Services, Inc. or The Provident Bank without first obtaining approval
of such acquisition of control by the Federal Reserve Board and the
Commissioner.
Federal Securities Laws. Provident Financial Services, Inc. common
stock is registered with the Securities and Exchange Commission under the
Securities Exchange Act of 1934, as amended. Provident Financial Services, Inc.
is subject to the information, proxy solicitation, insider trading restrictions
and other requirements under the Securities Exchange Act of 1934.
SARBANES-OXLEY ACT OF 2002
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act
of 2002 implementing legislative reforms intended to address corporate and
accounting irregularities. In addition to the establishment of a new accounting
oversight board which will enforce auditing, quality control and independence
standards and will be funded by fees from all publicly traded companies, the Act
restricts accounting companies from providing both auditing and consulting
services to an audit client. To ensure auditor independence, any non-audit
services being provided to an audit client will require preapproval by the
company's audit committee members. In addition, the audit partners must be
rotated. The Act requires chief executive officers and chief financial officers,
or their equivalent, to certify to the accuracy of periodic reports filed with
the SEC, subject to civil and criminal penalties if they knowingly or willfully
violate this certification requirement. In addition, under the Act, counsel will
be required to report evidence of a material violation of the securities laws or
a breach of fiduciary duty by a company to its chief executive officer or its
chief legal officer, and, if such officer does not appropriately respond, to
report such evidence to the audit committee or other similar committee of the
board of directors or the board itself.
The legislation accelerates the time frame for disclosures by public
companies, as they must immediately disclose any material changes in their
financial condition or operations. Directors and executive officers must also
42
provide information for most changes in ownership in a company's securities
within two business days of the change. The period during which certain types of
law suits can be instituted against a company or its officers has been extended,
and bonuses issued to top executives prior to restatement of a company's
financial statements are now subject to disgorgement if such restatement was due
to corporate misconduct. Executives are also prohibited from insider trading
during retirement plan "blackout" periods, and loans to company executives are
restricted. In addition, civil and criminal penalties have been enhanced.
The Act also increases the oversight of, and codifies certain
requirements relating to, audit committees of public companies and how they
interact with the company's "registered public accounting firm" ("RPAF"). Audit
Committee members must be independent and are barred from accepting consulting,
advisory or other compensatory fees from the issuer. In addition, companies must
disclose whether at least one member of the committee is a "financial expert"
(as such term will be defined by the SEC) and if not, why not. Under the Act, a
RPAF is prohibited from performing statutorily mandated audit services for a
company if such company's chief executive officer, chief financial officer,
comptroller, chief accounting officer or any person serving in equivalent
positions has been employed by such firm and participated in the audit of such
company during the one-year period preceding the audit initiation date. The Act
also prohibits any officer or director of a company or any other person acting
under their direction from taking any action to fraudulently influence, coerce,
manipulate or mislead any independent public or certified accountant engaged in
the audit of the company's financial statements for the purpose of rendering the
financial statement's materially misleading. In accordance with the Act, the SEC
proposed rules requiring inclusion of an internal control report and assessment
by management in the annual report to shareholders. The Act requires the RPAF
that issues the audit report to attest to and report on management's assessment
of the company's internal controls. In addition, the Act requires that each
financial report required to be prepared in accordance with (or reconciled to)
generally accepted accounting principles and filed with the SEC reflect all
material correcting adjustments that are identified by an RPAF in accordance
with generally accepted accounting principles and the rules and regulations of
the SEC.
TAXATION
FEDERAL TAXATION
General. Provident Financial Services, Inc. and The Provident Bank are
subject to federal income taxation in the same general manner as other
corporations, with some exceptions discussed below. The most recent tax period
audited by the Internal Revenue Service was December 31, 1996. The following
discussion of federal taxation is intended only to summarize certain pertinent
federal income tax matters and is not a comprehensive description of the tax
rules applicable to The Provident Bank.
Method of Accounting. For federal income tax purposes, The Provident
Bank currently reports its income and expenses on the accrual method of
accounting and uses a tax year ending December 31 for filing its consolidated
federal income tax returns.
Bad Debt Reserves. Prior to the Small Business Protection Act of 1996
(the "1996 Act"), The Provident Bank was permitted to establish a reserve for
bad debts and to make annual additions to the reserve. These additions could,
within specified formula limits, be deducted in arriving at our taxable income.
The Provident Bank was required to use the direct charge off method to compute
its bad debt deduction beginning with its 1996 federal tax return. Savings
institutions were required to recapture any excess reserves over those
established as of December 31, 1987 (base year reserve).
Taxable Distributions and Recapture. Prior to the 1996 Act, bad debt
reserves created prior to January 1, 1988 were subject to recapture into taxable
income should The Provident Bank fail to meet certain asset and definitional
tests. Federal legislation has eliminated these recapture rules.
Retained earnings at December 31, 2002 included approximately $33.7
million for which no provisions for income tax had been made. This amount
represents an allocation of income to bad debt deductions for tax purposes only.
Events that would result in taxation of these reserves include failure to
qualify as a bank for tax purposes, distributions in complete or partial
liquidation, stock redemptions and excess distributions to shareholders. At
43
December 31, 2002, The Provident Bank has an unrecognized tax liability of $13.9
million with respect to this reserve.
On January 15, 2003, the Company established a charitable foundation in
connection with the conversion. The Company made a contribution to the
charitable foundation valued at 6% of the gross proceeds received in the
offering in the form of $4.8 million in cash and 1,920,000 shares of common
stock.
Under the Internal Revenue Code, charitable donations are tax
deductible subject to a limitation based on 10% of the Company's annual taxable
income. The Company, however, is able to carry forward any unused portion of the
deduction for five years following the year in which the contribution is made.
Based on the Company's estimate of taxable income for 2003 and the carry forward
period, all of the charitable donation expense was considered tax deductible as
the Company will realize sufficient earnings over the six year period to take
the full deduction. As a result, the Company will record a tax benefit amounting
to $8.4 million relating to the charitable donation in the first quarter of
2003.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986,
as amended, which we refer to as the Code, imposes an alternative minimum tax
("AMT") at a rate of 20% on a base of regular taxable income plus certain tax
preferences (alternative minimum taxable income or AMTI). The AMT is payable to
the extent such AMTI is in excess of an exemption amount and the AMT exceeds the
regular income tax. Net operating losses can offset no more than 90% of AMTI.
Certain payments of alternative minimum tax may be used as credits against
regular tax liabilities in future years. The Provident Bank has not been subject
to the alternative minimum tax and has no such amounts available as credits for
carryover.
Net Operating Loss Carryovers. A financial institution may carry back
net operating losses to the preceding two taxable years and forward to the
succeeding 20 taxable years. At December 31, 2002, The Provident Bank had no net
operating loss carryforwards for federal income tax purposes.
Corporate Dividends-Received Deduction. Provident Financial Services,
Inc. may exclude from its income 100% of dividends received from The Provident
Bank as a member of the same affiliated group of corporations.
STATE TAXATION
New Jersey State Taxation. The Provident Bank has filed New Jersey
Savings Institution income tax returns. Generally, the income of savings
institutions in New Jersey, which is calculated based on federal taxable income,
subject to certain adjustments, is subject to New Jersey tax. The Provident Bank
is not currently under audit with respect to its New Jersey income tax returns
and The Provident Bank's state tax returns have not been audited for the past
five years.
On July 2, 2002, the State of New Jersey enacted income tax law changes
which will be retroactive to tax years beginning January 1, 2002. The more
relevant changes include an increase in the tax rate for savings banks from
three percent to nine percent and the establishment of an Alternative Minimum
Assessment ("AMA") tax. Under the new legislation, a taxpayer, including The
Provident Bank, will pay the greater of the corporate business ("CBT") tax (at
9% of taxable income) or the AMA tax. There are two methods for calculating the
AMA tax, the gross receipts method or the gross profits method. Under the gross
receipts method, the tax is calculated by multiplying the gross receipts by the
applicable factor, which ranges from 0.125% to 0.4%. Under the gross profits
method, the tax is calculated by multiplying the gross profits by the applicable
factor, which ranges from 0.25% to 0.8%. The taxpayer has the option of choosing
either the gross receipts or gross profits method, but once an election is made,
the taxpayer must use the same method for the next four tax years. The AMA tax
is creditable against the CBT in a year in which the CBT is higher, limited to
the AMA for that year, and limited to an amount such that the tax is not reduced
by more than 50% of the tax otherwise due and other statutory minimums. The AMA
tax for each taxpayer may not exceed $5.0 million per year and the sum of the
AMA for each member of an affiliated group may not exceed $20.0 million per year
for members of an affiliated group with five or more taxpayers. The AMA for tax
years beginning after June 30, 2006 shall be zero.
New Jersey tax law does not and has not allowed for a taxpayer to file
a tax return on a combined or consolidated basis with another member of the
affiliated group where there is common ownership. However, under
44
the new tax legislation, if the taxpayer cannot demonstrate by clear and
convincing evidence that the tax filing discloses the true earnings of the
taxpayer on its business carried on in the State of New Jersey, the New Jersey
Director of the Division of Taxation may, at the director's discretion, require
the taxpayer to file a consolidated return of the entire operations of the
affiliated group or controlled group, including its own operations and income.
Delaware State Taxation. As a Delaware holding company not earning
income in Delaware, Provident Financial Services, Inc. is exempted from Delaware
corporate income tax but is required to file annual returns and pay annual fees
and a franchise tax to the State of Delaware.
ITEM 2. PROPERTIES
At December 31, 2002, we conducted our business through 49 full-service
branch offices located in Hudson, Bergen, Essex, Mercer, Middlesex, Manmouth,
Morris, Ocean Somerset and Union Counties, New Jersey. The aggregate net book
value of our premises and equipment was $44.0 million at December 31, 2002.
ITEM 3. LEGAL PROCEEDINGS
There are various claims and lawsuits in which the Bank is periodically
involved incident to our business. We believe that these legal proceedings, in
the aggregate, are not material to our financial condition and results of
operations.
On December 17, 2002, certain depositor plaintiffs filed a lawsuit in
the United States District Court for the District of New Jersey against The
Provident Bank, the members of the Board of Directors and Provident Financial
Services, Inc., challenging the application of certain purchase limitations
contained in the Plan of Conversion. The lawsuit alleges that the Plan of
Conversion violated federal regulations and the New Jersey Law Against
Discrimination, and that the Board of Directors breached fiduciary duties. The
lawsuit sought temporary restraints and preliminary injunctive relief to enjoin
the application of purchase limitations provisions, alter the schedule of
closing of the stock offering and the meeting of depositors, and also sought
punitive damages for alleged violations of the New Jersey Law Against
Discrimination. The Company vigorously opposed the requested restraints and
injunctive relief. The District Court denied all requested injunctive relief in
its entirety. The Company plans to continue to vigorously defend this lawsuit.
On December 19, 2002, following the District Court of New Jersey's
denial of their requested temporary restraints and preliminary injunctive
relief, the depositor plaintiffs in the federal lawsuit referenced above filed a
Notice of Appeal in the Superior Court of New Jersey, Appellate Division
entitled In re the Decision and Order of the Commissioner, Department of Banking
and Insurance, dated November 8, 2002 Permitting The Provident Bank to Convert
from Mutual to Stock Savings Bank naming as respondents the Commissioner, New
Jersey Department of Banking and Insurance and The Provident Bank. The Notice of
Appeal seeks to overturn the Commissioner's Decision and Order dated November 8,
2002 approving The Provident Bank's Plan of Conversion. In addition, the
appellants filed a request with the Commissioner to stay her November 8, 2002
Decision and Order and, after that request was denied, then filed a stay request
with the Appellate Division pending appeal, which request was denied. The stay
requests alleged that certain provisions in the Plan of Conversion violated the
New Jersey Law Against Discrimination and constituted a breach of fiduciary duty
of the Board of Directors of The Provident Bank. The Company intends to defend
the appeal vigorously.
On January 22, 2003, after completion of the conversion of The
Provident Bank from mutual to stock form, certain depositors filed a Notice of
Appeal and a motion for an extension for time to file that appeal in the
Superior Court of New Jersey, Appellate Division naming as respondents the
Commissioner, Department of Banking and Insurance and The Provident Bank. These
appellants seek to appeal the Commissioner's Order and Decision approving the
conversion of The Provident Bank from a mutual to stock savings bank. In
particular they challenge the aggregate purchase limitations contained in the
Plan of Conversion. The Court has granted the appellants an extension of time to
pursue their appeal. The Company intends to defend this matter vigorously.
45
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the year ended
December 31, 2002 to a vote of securityholders. Depositors of The Provident Bank
approved the Plan of Conversion on January 7, 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Provident Financial Services, Inc. common stock began trading on the
New York Stock Exchange under the symbol "PFS" on January 16, 2003, and there is
an established market for such common stock.
The initial public offering price was $10.00 per share. For the period
of January 16, 2003 to March 1, 2003, the high and low sales prices were $16.00
and $14.80. As of March 1, 2003, there were 61,538,300 shares of Provident
Financial Services, Inc. common stock issued and outstanding and approximately
6,254 stockholders of record.
Provident Financial Services, Inc. will consider the payment of a cash
dividend no earlier than the completion of the first calendar quarter of 2003.
With the additional capital raised in the conversion, Provident Financial
Services, Inc. will have a significant dividend paying capacity. The payment of
dividends, if any, and the amount of any such dividend, will be subject to the
determination of our Board of Directors, which will take into account, among
other factors, our financial condition, results of operations, tax
considerations, industry standards, economic conditions and regulatory
restrictions that affect the payment of dividends by The Provident Bank to
Provident Financial Services, Inc. We cannot guarantee that we will pay
dividends or that, if paid, we will not reduce or eliminate dividends in the
future.
Provident Financial Services, Inc. is subject to the requirements of
Delaware law that generally limits dividends to an amount equal to the
difference between the amount by which total assets exceed total liabilities and
the amount equal to the aggregate par value of the outstanding shares of capital
stock. If there is no difference between these amounts, dividends are limited to
net income for the current and/or immediately preceding year.
ITEM 6. SELECTED FINANCIAL DATA
The summary information presented below at or for each of the periods
presented is derived in part from and should be read in conjunction with the
consolidated financial statements of The Provident Bank presented elsewhere.
Prior to January 15, 2003, Provident Financial Services, Inc. had no significant
assets, liabilities or operations, and accordingly, the data presented below
represents the financial condition and results of operation of The Provident
Bank. On January 15, 2003, The Provident Bank completed its conversion from a
mutual savings bank to a stock savings bank, and, in connection therewith,
Provident Financial Services, Inc. sold 59,618,300 shares of common stock which
resulted in $586.2 of net proceeds of which $293.1 was utilized to acquire all
of the outstanding common stock of The Provident Bank. In addition, Provident
Financial Services, Inc. contributed $4.8 million in cash and 1,920,000 shares
of its common stock to The Provident Bank Foundation. As part of the conversion,
The Provident Bank held $526.0 million of proceeds in escrow on behalf of
depositors and other individuals who submitted funds in anticipation of the
conversion.
AT DECEMBER 31,
------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
(In thousands)
SELECTED FINANCIAL CONDITION DATA:
Total assets .......................... $ 3,919,208 $ 2,869,717 $ 2,641,579 $ 2,578,249 $ 2,454,586
Loans, net(1) ......................... 2,031,869 1,994,636 1,954,992 1,876,433 1,680,091
Investment securities(2) .............. 216,119 112,951 124,059 162,680 233,099
Securities available for sale ......... 1,242,118 494,716 335,039 361,832 317,464
Deposits .............................. 3,243,334 2,341,723 2,168,336 2,096,604 2,056,053
Borrowings ............................ 323,081 195,767 179,903 216,641 146,620
Equity ................................ 326,009 292,130 263,072 236,664 224,019
46
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
(In thousands)
SELECTED OPERATIONS DATA:
Interest income .................................. $ 177,376 $ 180,979 $ 179,520 $ 166,046 $ 149,983
Interest expense ................................. 63,241 84,523 89,690 77,244 70,890
------------ ------------ ------------ ------------ ------------
Net interest income .............................. 114,135 96,456 89,830 88,802 79,093
Provision for loan losses ........................ 12,800 1,900 2,060 2,100 1,950
------------ ------------ ------------ ------------ ------------
Net interest income after provision for loan
losses .......................................... 101,335 94,556 87,770 86,702 77,143
------------ ------------ ------------ ------------ ------------
Non-interest income .............................. 24,078 21,236 18,276 15,688 15,005
------------ ------------ ------------ ------------ ------------
Non-interest expenses ............................ 89,087 80,629 75,865 71,853 60,985
------------ ------------ ------------ ------------ ------------
Income before income tax expense and the
cumulative effect of a change in accounting
principle ....................................... 36,326 35,163 30,181 30,537 31,163
Income tax expense ............................... 9,231 11,083 9,283 10,907 11,465
------------ ------------ ------------ ------------ ------------
Income before the cumulative effect of a change
in accounting principle ......................... 27,095 24,080 20,898 19,630 19,698
------------ ------------ ------------ ------------ ------------
Cumulative effect of change in accounting
principle(3) .................................... (519) -- -- -- --
------------ ------------ ------------ ------------ ------------
Net income ....................................... $ 26,576 $ 24,080 $ 20,898 $ 19,630 $ 19,698
============ ============ ============ ============ ============
- ----------
(1) Loans are shown net of allowance for loan losses, deferred fees and
unearned discount.
(2) Investment securities are held to maturity.
(3) In accordance with FASB Statement No. 142, we performed a goodwill
impairment test on the goodwill associated with the purchase of Provident
Mortgage Company. It was determined that the goodwill was impaired and a
charge of $519,000 was recorded as a cumulative effect of a change in
accounting principle.
AT OR FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
SELECTED FINANCIAL AND OTHER DATA(1)
PERFORMANCE RATIOS:
Return on average assets ....................... 0.86% 0.88% 0.80% 0.80% 0.92%
Return on average equity ....................... 8.71% 8.70 8.37 8.53 9.19
Interest rate spread information:
Average during period ......................... 3.61% 3.29 3.20 3.43 3.41
End of period ................................. 3.75% 3.85 3.05 3.55 3.72
Net interest margin(2) ......................... 3.98% 3.79 3.70 3.87 3.88
Average interest-earning assets to average
interest-bearing liabilities .................. 1.17 1.15 1.14 1.13 1.14
Non-interest income to average total assets..... 0.78 0.77 0.70 0.64 0.70
Non-interest expenses to average total assets... 2.90 2.94 2.90 2.92 2.84
Efficiency ratio(3) ............................ 64.46 68.51 70.18 68.77 64.81
ASSET QUALITY RATIOS:
Non-performing loans to total loans ............ 0.41% 0.40% 0.48% 0.43% 0.33%
Non-performing assets to total assets .......... 0.22 0.28 0.37 0.31 0.23
Allowance for loan losses to non-performing
loans ......................................... 246.55 271.02 213.06 233.93 316.94
Allowance for loan losses to total loans ....... 1.02 1.09 1.02 0.99 1.02
CAPITAL RATIOS:
Leverage capital(4) ............................ 8.98% 9.41% 9.12% 8.47% 8.23%
Total risk based capital(4) .................... 13.32 14.15 14.38 13.96 13.27
Average equity to average assets ............... 9.92 10.10 9.56 9.34 9.97
OTHER DATA:
Number of full-service offices(5) .............. 49 48 49 52 49
Full time equivalent employees ................. 656 688 613 604 604
- ----------
(1) Averages presented are daily averages.
(2) Net interest income divided by average interest-earning assets.
(3) Represents the ratio of non-interest expense divided by the sum of net
interest income and non-interest income.
(4) Leverage capital ratios are presented as a percentage of tangible assets.
Risk-based capital ratios are presented as a percentage of risk-weighted
assets.
47
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Critical Accounting Policies and Use of Estimates
The calculation of the allowance for loan losses is a critical
accounting policy of The Provident Bank. Provisions for loan losses will
continue to be based upon our assessment of the overall loan portfolio and the
underlying collateral, trends in non-performing loans, current economic
conditions and other relevant factors in order to maintain the allowance for
loan losses at adequate levels to provide for estimated losses. Although
management uses the best information available, the level of the allowance for
loan losses remains an estimate which is subject to significant judgment and
short-term change.
Analysis of Net Interest Income
Net interest income represents the difference between income on
interest-earning assets and expense on interest-bearing liabilities. Net
interest income depends on the relative amounts of interest-earning assets and
interest-bearing liabilities and the interest rates earned on such assets and
paid on such liabilities.
48
Average Balance Sheet. The following table sets forth certain
information for the years ended December 31, 2002, 2001 and 2000. For the
periods indicated, the total dollar amount of interest income from average
interest-earning assets and the resultant yields, as well as the interest
expense on average interest-bearing liabilities, is expressed both in dollars
and rates. No tax equivalent adjustments were made. Average balances are daily
averages.
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
2002 2001
-------------------------------------------- ------------------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
OUTSTANDING INTEREST YIELD/ OUTSTANDING INTEREST YIELD/
BALANCE EARNED/PAID RATE BALANCE EARNED/PAID RATE
------------ ------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
INTEREST-EARNING ASSETS:
Federal funds sold and
short-term investments .......... $ 93,572 $ 1,565 1.67% $ 32,558 $ 1,114 3.42%
Investment securities
(1) ............................. 114,878 5,321 4.63 112,659 5,784 5.13
Securities available
for sale ........................ 707,629 36,536 5.16 437,147 25,337 5.80
Net loans(2) ..................... 1,949,778 133,954 6.87 1,961,612 148,744 7.58
------------ ------------ ------------ ------------
Total interest-earning
assets ....................... 2,865,857 177,376 6.19 2,543,976 180,979 7.11
------------ ------------ ------------ ------------
Non-interest earning
assets .......................... 208,698 196,863
------------ ------------
Total assets .................. $ 3,074,555 $ 2,740,839
============ ============
INTEREST-BEARING
LIABILITIES:
Savings deposits ................. $ 823,752 14,459 1.76% $ 690,324 15,966 2.31
Money market accounts ............ 92,126 1,688 1.83 72,735 1,612 2.22
Interest-bearing
checking ........................ 268,049 3,209 1.20 213,441 3,091 1.45
Time accounts .................... 1,069,183 35,481 3.32 1,060,920 54,620 5.15
Borrowings ....................... 204,988 8,404 4.10 176,688 9,234 5.23
------------ ------------ ------------ ------------
Total interest-bearing
liabilities .................. 2,458,098 63,241 2.58 2,214,108 84,523 3.82
------------ ------------ ------------
Non-interest bearing
liabilities ..................... 311,494 249,913
------------ ------------
Total liabilities ............. 2,769,592 2,464,021
Equity ........................... 304,963 276,818
------------ ------------
Total liabilities
and equity .................. $ 3,074,555 $ 2,740,839
============ ============
Net interest income .............. $ 114,135 $ 96,456
============ ============
Net interest rate
spread .......................... 3.61% 3.29%
============ ============
Net interest earning
assets .......................... $ 407,759 $ 329,868
============ ============
Net interest margin(3) ........... 3.98% 3.79%
============ ============
Ratio of interest-earning assets
to total interest-bearing
liabilities ..................... 1.17x 1.15x
============ ============
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------
2000
-------------------------------------------
AVERAGE AVERAGE
OUTSTANDING INTEREST YIELD/
BALANCE EARNED/PAID RATE
------------ ------------ ------------
(Dollars in thousands)
INTEREST-EARNING ASSETS:
Federal funds sold and
short-term investments .......... $ 5,444 $ 325 5.97%
Investment securities
(1) ............................. 140,926 7,589 5.39
Securities available
for sale ........................ 351,439 21,577 6.14
Net loans(2) ..................... 1,933,075 150,029 7.76
------------ ------------
Total interest-earning
assets ....................... 2,430,884 179,520 7.39
------------ ------------
Non-interest earning
assets .......................... 182,705
------------
Total assets .................. $ 2,613,589
============
INTEREST-BEARING
LIABILITIES:
Savings deposits ................. $ 633,128 16,143 2.55
Money market accounts ............ 83,738 1,975 2.36
Interest-bearing
checking ........................ 195,258 2,932 1.50
Time accounts .................... 1,018,213 56,259 5.53
Borrowings ....................... 210,144 12,381 5.89
------------ ------------
Total interest-bearing
liabilities .................. 2,140,481 89,690 4.19
------------ -----------
Non-interest bearing
liabilities ..................... 223,339
------------
Total liabilities ............. 2,363,820
Equity ........................... 249,769
------------
Total liabilities
and equity .................. $ 2,613,589
============
Net interest income .............. $ 89,830
============
Net interest rate
spread .......................... 3.20%
============
Net interest earning
assets .......................... $ 290,403
============
Net interest margin(3) ........... 3.70%
============
Ratio of interest-earning assets
to total interest-bearing
liabilities ..................... 1.14x
============
- ----------
(1) Average outstanding balance amounts shown are amortized cost.
(2) Average outstanding balances shown net of the allowance for loan losses,
deferred loan fees and expenses, and loan premiums and discounts and include
non-accrual loans.
(3) Net interest income divided by average interest-earning assets.
49
Rate/Volume Analysis. The following table presents the extent to which
changes in interest rates and changes in the volume of interest-earning assets
and interest-bearing liabilities have affected our interest income and interest
expense during the periods indicated. Information is provided in each category
with respect to: (i) changes attributable to changes in volume (changes in
volume multiplied by prior rate); (ii) changes attributable to changes in rate
(changes in rate multiplied by prior volume); and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------
2002 VS. 2001 2001 VS. 2000
-------------------------------------------- --------------------------------------------
INCREASE/(DECREASE) INCREASE/(DECREASE)
DUE TO TOTAL DUE TO TOTAL
---------------------------- INCREASE/ ---------------------------- INCREASE/
VOLUME RATE (DECREASE) VOLUME RATE (DECREASE)
------------ ------------ ------------ ------------ ------------ ------------
(In thousands)
INTEREST-EARNING ASSETS:
Federal funds sold and short-term
investments ..................... $ 1,249 $ (798) $ 451 $ 982 $ (193) $ 789
Investment securities ............ 112 (575) (463) (1,465) (340) (1,805)
Securities available for sale .... 14,222 (3,023) 11,199 5,023 (1,262) 3,761
Loans ............................ (892) (13,898) (14,790) 2,195 (3,480) (1,285)
------------ ------------ ------------ ------------ ------------ ------------
Total interest-earning assets.. 14,691 (18,294) (3,603) 6,735 (5,275) 1,460
------------ ------------ ------------ ------------ ------------ ------------
INTEREST-BEARING LIABILITIES:
Savings deposits ................. 2,755 (4,262) (1,507) 1,392 (1,569) (177)
Money market accounts ............ 385 (309) 76 (249) (114) (363)
Interest-bearing checking ........ 709 (591) 118 267 (107) 160
Time accounts .................... 422 (19,561) (19,139) 2,298 (3,937) (1,639)
Borrowings ....................... 1,343 (2,173) (830) (1,841) (1,306) (3,147)
------------ ------------ ------------ ------------ ------------ ------------
Total interest-bearing
liabilities .................. 5,614 (26,896) (21,282) 1,867 (7,033) (5,166)
------------ ------------ ------------ ------------ ------------ ------------
Net interest income .............. $ 9,077 $ 8,602 $ 17,679 $ 4,868 $ 1,758 $ 6,626
============ ============ ============ ============ ============ ============
Comparison of Financial Condition at December 31, 2002 and December 31, 2001
Total assets at December 31, 2002 increased $1.05 billion or 36.57% to
$3.92 billion compared to $2.87 billion at December 31, 2001. At year-end 2002,
$526.0 million of funds received from depositors for stock purchase orders, in
connection with the conversion of The Provident Bank from a mutual to a stock
savings bank, were held in a separate escrow account. In December 2002, we
completed a $100.0 million leverage transaction.
Total loans increased by $36.3 million or 1.8% to $2.05 billion at
December 31, 2002 from $2.02 billion at December 31, 2001. Residential mortgage
loans decreased $96.0 million or 12.07% for the year ended December 31, 2002 to
$699.5 million compared to $795.4 million at December 31, 2001. Low interest
rates have contributed to the decline in residential mortgage loan balances as
borrowers continue to refinance residential mortgage loans. Consumer loans,
which consist primarily of home equity and marine loans, decreased $46.4 million
or 14.4% to $275.8 million at December 31, 2002 compared to $322.2 million at
December 31, 2001. Commercial real estate, multi-family and construction loans
increased $28.8 million or 4.90% to $617.3 million at December 31, 2002 from
$588.5 million at December 31, 2001, in spite of significant prepayment activity
in the commercial real estate and multi-family portfolios. Competitive pricing
based on long-standing relationships contributed to our ability to retain
existing customers and attract new customers. Mortgage warehouse loans increased
$108.5 million or 64.6% to $276.4 million at December 31, 2002 compared to
$167.9 million at December 31, 2001 due to the increased volume of business
experienced by our mortgage banking customers as a result of significant
refinance activity. Most of the refinance activity resulted in the origination
of long term fixed-rate mortgages. Commercial loans increased $41.9 million or
29.6% to $183.4 million at December 31, 2002 compared to $141.5 million at
December 31, 2001.
Investment securities increased $103.2 million or 91.3% to $216.1
million at December 31, 2002 compared to $113.0 million at December 31, 2001.
Securities available for sale increased $747.4 million or 151.1% to $1.2 billion
at December 31, 2002 from $494.7 million at December 31, 2001. These increases
were due primarily to the investment of conversion related funds, the
re-investment of prepayments on loans and mortgage-backed securities
50
and deposit inflows. In December 2002, we purchased $100.0 million in
mortgage-backed securities as part of a leverage strategy.
Total deposits for the year ended December 31, 2002 increased $901.6
million or 38.5% to $3.24 billion from $2.34 billion at December 31, 2001.
Excluding the funds in the conversion escrow account totaling $526.0 million,
total deposits grew $375.6 million or 16.04%. Our focus on the acquisition and
retention of core deposit accounts and customer relationship management resulted
in growth in our savings and demand deposit accounts. Core deposits (excluding
the conversion escrow account) grew $376.7 million or 29.22% for the year ended
December 31, 2002. Savings deposits increased $179.9 million or 24.22% to $922.4
million at December 31, 2002 compared to $742.5 million at December 31, 2001.
Demand deposit accounts (excluding the conversion escrow account) increased
$197.8 million or 36.06% to $743.4 million at December 31, 2002 compared to
$546.6 million at December 31, 2001. Time deposits with balances greater than
$100,000 grew $28.3 million or 21.3% to $160.9 million at December 31, 2002
compared to $132.6 million at December 31, 2001. Other time deposits decreased
$29.3 million or 3.18% to $890.6 million at December 31, 2002 compared to $919.9
million at December 31, 2001. Our strong deposit growth during 2002 can be
attributed to our focus on acquiring core deposits, the low interest rate
environment, stock market volatility and deposit inflows related to the stock
conversion.
Total borrowings increased $127.3 million or 65.03% to $323.1 million
for the year ended December 31, 2002 compared to $195.8 million at December 31,
2001. Within this category, balances in commercial sweep accounts increased $4.9
million or 9.52% to $56.0 million at December 31, 2002 compared to $51.1 million
at December 31, 2001. Borrowings from the Federal Home Loan Bank of New York
increased $122.5 million or 84.64% to $267.1 million at December 31, 2002
compared to $144.7 million at December 31, 2001. During the year we continued to
use FHLB advances to fund commercial real estate loans. In December we
implemented a leverage strategy that consisted of several FHLB advances totaling
$100.0 million with maturities ranging from one to five years and purchased
mortgage-backed securities with an average weighted life of 4.58 years. The
average weighted rate on the advances was 2.58% and the average yield on the
assets was 4.84% resulting in a spread of 2.26%.
Total equity increased $33.9 million or 11.6% to $326.0 million at
December 31, 2002 from $292.1 million at December 31, 2001. This increase is
attributable to net income of $26.6 million and an increase of $7.3 million in
net unrealized gains on available for sale securities, as a result of declining
interest rates.
Comparison of Operating Results for the Years Ended December 31, 2002 and
December 31, 2001
Net income for the year ended December 31, 2002 was $26.6 million, an
increase of $2.5 million or 10.4% compared to net income of $24.1 million for
the year ended December 31, 2001. Return on average assets for the year ended
December 31, 2002 was 0.86% compared to 0.88% for the year ended December 31,
2001. Return on average equity was 8.71% for the year ended December 31, 2002
compared to 8.70% for the year ended December 31, 2001.
Net interest income increased $17.7 million or 18.3% to $114.1 million
at December 31, 2002 from $96.5 million at December 31, 2001. Our average
interest rate spread improved 32 basis points to 3.61% at December 31, 2002 from
3.29% at December 31, 2001. Net interest margin improved 19 basis points to
3.98% at December 31, 2002 from 3.79% at December 31, 2001. The improvement in
net interest margin was due primarily to a 25.2% reduction in interest expense.
Interest income decreased $3.6 million or 2.0% to $177.4 million at
December 31, 2002 compared to $181.0 million at December 31, 2001. Average
interest earning assets increased $321.9 million or 12.65% to $2.87 billion in
2002 compared to $2.54 billion in 2001. Average outstanding loan balances
decreased $11.8 million or 0.60% to $1.95 billion at December 31, 2002 from
$1.96 billion at December 31, 2001. The average balance of investment securities
increased $2.2 million or 1.97% to $114.9 million in 2002 compared to $112.7
million in 2001. The average balance of securities available for sale increased
$270.5 million or 61.87% to $707.6 million at December 31, 2002 compared to
$437.1 million at December 31, 2001. Average federal funds sold and short term
investment balances increased $61.0 million or 187.4% to $93.6 million in 2002
from $32.6 million in 2001. The yield on interest earning assets decreased 92
basis points to 6.19% in 2002 from 7.11% in 2001. Interest expense decreased
$21.3 million or 25.2% to $63.2 million at December 31, 2002 from $84.5 million
at December 31, 2001. The reduction in interest expense is attributable to the
continued decline in short- term interest rates. The balance of
51
interest bearing liabilities increased $243.0 million or 11.02% to $2.46 billion
at December 31, 2002 compared to $2.21 billion at December 31, 2001. The balance
of average non-interest bearing liabilities increased $61.6 million or 24.6% to
$311.5 million in 2002 compared to $249.9 million in 2001. Rates paid on
interest bearing liabilities decreased 124 basis points to 2.58% in 2002 from
3.82% in 2001. Average outstanding borrowings increased $28.3 million or 16.02%
to $205.0 million for the year ended December 31, 2002 compared to $176.7
million for the year ended December 31, 2001. The average rate paid on
borrowings decreased to 4.10% for the year ended December 31, 2002 from 5.23%
for the year ended December 31, 2001.
Provision for Loan Losses. Provisions for loan losses are charged to
operations in order to maintain the allowance for loan losses at a level
management considers necessary to absorb probable incurred credit losses in the
loan portfolio. In determining the level of the allowance for loan losses,
management considers past and current loss experience, evaluations of real
estate collateral, current economic conditions, volume and type of lending,
adverse situations that may affect the borrower's ability to repay the loan and
the levels of non-performing and other classified loans. The amount of the
allowance is based on estimates and the ultimate losses may vary from such
estimates as more information becomes available or later events change.
Management assesses the allowance for loan losses on a quarterly basis and makes
provisions for loan losses in order to maintain the adequacy of the allowance.
Our emphasis on continued diversification of our loan portfolio through the
origination of construction loans, commercial mortgage loans, mortgage warehouse
loans and commercial loans has been one of the more significant factors we have
taken into account in evaluating our allowance for loan losses and provision for
loan losses. In the event we were to further increase the amount of such types
of loans in our portfolio, we may determine to make additional or increased
provisions for loan losses, which could adversely affect our earnings. During
2002, we charged off $12.5 million related to a $20.6 million warehouse loan,
resulting from an alleged fraud involving one of our mortgage warehouse
borrowers. In addition, we sold loans totaling $1.4 million to investors and
have placed the remaining loans in our portfolio, established contact with the
borrowers and subsequently moved these loans into performing status as payment
histories were established.
The provision for loan losses was $12.8 million in 2002 compared to
$1.9 million in 2001. This increase in our provision for loan losses was
primarily attributable to an $11.8 million charge off in the third quarter
related to a mortgage warehouse loan. The allowance for loan losses at December
31, 2002 was $21.0 million or 1.02% of total loans compared to $21.9 million or
1.09% of total loans at December 31, 2001. At December 31, 2002 the allowance
for loan losses as a percentage of non-performing loans was 246.55% compared to
271.02% at December 31, 2001.
Net charge offs for 2002 were $13.7 million compared to $189,000 for
2001. Total charge offs for the year ended December 31, 2002 were $14.7 million
compared to $962,000 for the year ended December 31, 2001. Recoveries for the
year ended December 31, 2002 were $1.0 million compared to $773,000 for the year
ended December 31, 2001.
At December 31, 2002, non-performing loans as a percentage of total
loans was 0.41% compared to 0.40% at December 31, 2001. Non-performing assets as
a percentage of total assets declined 6 basis points to 0.22% at December 31,
2002 compared to 0.28% at December 31, 2002. At December 31, 2002,
non-performing loans were $8.5 million compared to $8.1 at December 31, 2001.
Non-Interest Income. Total non-interest income increased $2.8 million
or 13.4% to $24.1 million at December 31, 2002 compared to $21.2 million at
December 31, 2001. Fee income from deposit accounts increased $912,000 or 6.41%
to $15.1 million at December 31, 2002 from $14.2 million at December 31, 2001.
This increase is attributable to our ongoing strategy to attract and retain core
deposit accounts. Other income increased $832,000 or 26.49% to $4.0 million in
2002 compared to $3.1 million in 2001. Other income consists of net gain on the
sale of loans, net gain on sales of other assets and other non-recurring income.
The net gain on the sale of fixed-rate mortgages increased $513,000 or 28.84% to
$2.2 million in 2002 from $1.7 million in 2001 and the net gain on other assets
increased $449,000 or 105.4% to $1.7 million in 2002 from $1.4 million in 2001.
Non-Interest Expense. For the year ended December 31, 2002,
non-interest expenses increased $8.5 million or 10.49% to $89.1 million at
December 31, 2002 compared to $80.6 million at December 31, 2001. Salary and
benefit expense increased $6.5 million or 15.97% in 2002 to $46.9 million from
$40.4 million in 2001. This increase is attributable to the addition of
experienced senior lending officers and staff at the end of 2001 and during
52
2002 as part of our business strategy to build and expand commercial
relationships. We have also added experienced market development professionals
to implement our Customer Relationship Management strategy. Other operating
expenses increased $2.6 million or 19.84% to $15.8 million in 2002 from $13.2
million in 2001.
As of December 31, 2001, the Bank had unamortized goodwill in the
amount of $20.0 million as a result of the acquisition of financial institutions
for which the amortization ceased upon the adoption of Statement No. 142 and
$0.5 million resulting from the acquisition of a mortgage banking company in
2001. During 2002, the Bank determined that the carrying amount of the $519,000
of goodwill related to the acquisition of the mortgage company was impaired, and
recognized the impairment as a cumulative effect of a change in accounting
principle in accordance with the transitional provisions of SFAS No. 142.
If SFAS No. 142 had been adopted on January 1, 2000, net income would
have increased as a result of ceasing the amortization of goodwill by $1,171,000
in each of the years ended December 31, 2001 and 2000.
Income Tax Expense. Income tax expense decreased $1.9 million or 16.71%
to $9.2 million on net income before taxes of $36.3 million resulting in an
effective tax rate of 25.4% in 2002 compared to income tax expense of $11.1
million on net income before taxes of $35.2 million in 2001 resulting in an
effective tax rate of 31.5%. The decline in the effective tax rate for the year
ended December 31, 2002 is attributable to lower taxable income as a result of
the charge off of $11.8 million in the third quarter related to a mortgage
warehouse borrower that ceased doing business under allegations of fraud and an
adjustment to deferred tax assets for state taxes to reflect the current New
Jersey corporate business tax rate of 9% from the previous tax rate of 3% which
gave rise to the reduction in the effective tax rate.
Change in Accounting Principle. In accordance with FASB Statement No.
142, we performed a goodwill impairment test on the goodwill associated with the
purchase of Provident Mortgage Company. It was determined that the goodwill was
impaired and we recorded a charge of $519,000 as a cumulative effect of a change
in accounting principle.
Comparison of Operating Results for the Years Ended December 31, 2001 and
December 31, 2000
General. Net income for the year ended December 31, 2001 was $24.1
million, an increase of $3.2 million from December 31, 2000. Return on average
assets for the year ended December 31, 2001 was 0.88% compared to 0.80% for the
year ended December 31, 2000. Return on average equity for the year ended
December 31, 2001 was 8.70% compared to 8.37% for the year ended December 31,
2000.
Net Interest Income. Net interest income increased $6.7 million or 7.4%
to $96.5 million at December 31, 2001 from $89.8 million at December 31, 2000.
Our average interest rate spread improved 9 basis points to 3.29% for the year
ended December 31, 2001 from 3.20% at December 31, 2000. Net interest margin
improved 9 basis points to 3.79% at December 31, 2001 from 3.70% at December 31,
2000. The improvement in net interest margin was attributable primarily to a
significant decline in interest expense as well as a slight increase in interest
income.
Interest income increased $1.5 million or 0.81% to $181.0 million at
December 31, 2001 from $179.5 million at December 31, 2000. Average interest
earning assets increased $113.1 million or 4.7% to $2.54 billion in 2001
compared to $2.43 billion in 2000. Average outstanding loan balances increased
$28.5 million or 1.5% to $1.96 billion in 2001 from $1.93 billion in 2000. The
average balance of securities increased $57.4 million or 11.7% to $549.8 million
in 2001 compared to $492.4 million in 2000. Average federal funds sold and
short-term investment balances increased $27.2 million to $32.6 million from
$5.4 million in 2000. The yield on interest earning assets decreased 28 basis
points to 7.11% in 2001 from 7.39% in 2000. Interest expense decreased $5.2
million or 5.8% to $84.5 million in 2001 compared to $89.7 million in 2000,
reflecting the rapid decline in interest rates during the year. The balance of
average interest-bearing liabilities increased to $2.21 billion for the year
ended December 31, 2001 from $2.14 billion for the year ended December 31, 2000
and the balance of average non-interest bearing liabilities increased to $249.9
million from $223.3 million during the comparative period. Rates paid on
interest bearing liabilities decreased 37 basis points to 3.82% in 2001 from
4.19% in 2000. Average outstanding borrowings decreased $33.5 million or 15.9%
to $176.7 million for the year ended December 31, 2001 compared to $210.1
million for the year ended December 31, 2000. The average rate paid on
borrowings decreased to 5.23% for the year ended December 31, 2001 from 5.89%
for the year ended December 31, 2000.
53
Provision For Loan Losses. We establish provisions for loan losses,
which are charged to operations, in order to maintain the allowance for loan
losses at a level management considers necessary to absorb probable incurred
credit losses in the loan portfolio. In determining the level of the allowance
for loan losses, management considers past and current loss experience,
evaluations of real estate collateral, current economic conditions, volume and
type of lending, adverse situations that may affect the borrower's ability to
repay the loan and the levels of non-performing and other classified loans. The
amount of the allowance is based on estimates and the ultimate losses may vary
from such estimates as more information becomes available or later events
change. Management assesses the allowance for loan losses on a quarterly basis
and makes provisions for loan losses in order to maintain the adequacy of the
allowance. Our emphasis on continued diversification of our loan portfolio
through the origination of construction loans, commercial mortgage loans,
mortgage warehouse loans and commercial loans has been one of the more
significant factors we have taken into account in evaluating our allowance for
loan losses and provision for loan losses. In the event we were to further
increase the amount of such types of loans in our portfolio, we may determine to
make additional or increased provisions for loan losses, which could adversely
affect our earnings.
Based on management's assessment of the above factors, the provision
for loan losses was $1.9 million in 2001 compared to $2.1 million in 2000. The
allowance for loan losses was $21.9 million or 1.09% of total loans at December
31, 2001 compared to $20.2 million or 1.02% of total loans at December 31, 2000.
Although there was a slight change in the concentration of the loan portfolio,
as residential mortgages declined during 2001 and commercial mortgages,
construction, mortgage warehouse and commercial loans increased, it did not have
a significant impact on the provision for loan losses as these factors were
offset by the increase in asset quality and reduced level of net charge offs.
At December 31, 2001, non-performing loans amounted to $8.1 million as
compared to $9.5 million at December 31, 2000. There were no significant changes
in the method or assumptions used in determining the provision for loan losses
for the year ended December 31, 2001.
Non-Interest Income. Non-interest income consists of fees on retail
accounts, investment services, loan servicing fees and increases in the cash
surrender value of bank owned life insurance. Non-interest income increased $2.9
million or 16.2% to $21.2 million at December 31, 2001 from $18.3 million at
December 31, 2000. This increase was attributable to an increase of $904,000 in
fees on deposit accounts pursuant to our strategy to increase core deposit
growth, and an increase of $722,000 in the cash surrender value of bank owned
life insurance. Gains on sales of loans, which are a component of non-interest
income, increased by $1.4 million to $1.7 million as a result of $80.7 million
in residential loan sales.
Non-Interest Expense. Non-interest expense increased $4.7 million or
6.3% to $80.6 million at December 31, 2001 from $75.9 million at the end of
December 31, 2000. This increase was the result of an increase of $5.8 million
or 16.8% in salaries and benefits as a result of a significant number of lending
and marketing professionals that were hired in 2001 as part of our strategy to
increase business lending and deposit relationships and customer relationship
management, an increase of $730,000 or 25.3% in marketing and advertising
expense and an increase of $453,000 or 3.9% in net occupancy expense offset in
part by a $3.7 million reduction in other operating expense at December 31,
2001. In 2000, we recorded a charge of $3.7 million related to the settlement of
outstanding litigation.
Income Tax Expense. Income tax expense increased $1.8 million or 19.4%
to $11.1 million on net income before taxes of $35.2 million in 2001, resulting
in an effective tax rate of 31.5% compared to income tax expense of $9.3 million
on net income before taxes of $30.2 million in 2000, resulting in an effective
tax rate of 30.8%.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to our ability to generate adequate amounts of cash to
meet our financial obligations to our depositors, to fund loans and securities
purchases, deposit outflows and operating expenses. Sources of funds include
scheduled amortization of loans, loan prepayments, scheduled maturities of
investments, cash flows from mortgage-backed securities and the ability to
borrow funds from the Federal Home Loan Bank of New York and approved broker
dealers. We have a $50.0 million overnight line of credit and a $50.0 million
one month overnight
54
repricing line of credit with the Federal Home Loan Bank of New York. As of
December 31, 2002, we had no outstanding borrowings against ether line of
credit.
Cash flows from loan payments and maturing investment securities are a
fairly predictable source of funds. Changes in interest rates, local economic
conditions and the competitive marketplace can influence loan prepayments,
prepayments on mortgaged-backed securities and deposit flows. As of December 31,
2002, loan prepayments, excluding mortgage warehouse activity, totaled $787.1
million compared to $572.9 million for the year ended December 31, 2001 due to
the high rate of loan prepayments resulting from significant refinance activity.
One- to four-family residential loans, commercial real estate loans,
multi-family loans and commercial and small business loans are our primary
investments. Purchasing securities for the investment portfolio is a secondary
use of funds and the investment portfolio is structured to complement and
facilitate our lending activities and ensure adequate liquidity. Loan
originations, excluding mortgage warehouse loans, totaled $724.4 million for the
year ended December 31, 2002 compared to $593.3 million for the year ended
December 31, 2001. Purchases for the investment portfolio totaled $1.0 billion
for the year ended December 31, 2002 compared to $323.2 million for the year
ended December 31, 2001.
At December 31, 2002, The Provident Bank had outstanding loan
commitments to borrowers of $368.2 million. Undisbursed mortgage warehouse loans
were $79.5 million at December 31, 2002. Undisbursed home equity lines and
personal credit lines were $51.7 million at December 31, 2002. Total deposits
increased $901.6 million or 38.5% to $3.24 billion at December 31, 2002 from
$2.34 billion at December 31, 2001. Excluding funds that were held in a
conversion escrow account in the amount of $526.0 million, total deposits
increased $375.6 million or 16.04% in 2002. Deposit inflows are affected by
changes in interest rates, competitive pricing and product offerings in our
marketplace, local economic conditions and other factors such as stock market
volatility. Certificate of deposit accounts that are scheduled to mature within
one year totaled $870.3 million at December 31, 2002. Based on our current
pricing strategy and customer retention experience we expect to retain a
significant share of these accounts. We manage our liquidity on a daily basis
and we expect to have sufficient funds to meet all of our funding requirements.
As of December 31, 2002, The Provident Bank exceeded all regulatory
capital requirements. At December 31, 2002, our leverage (Tier 1) capital ratio
was 8.98%. FDIC regulations currently require banks to maintain a minimum
leverage ratio of Tier 1 capital to adjusted total assets of 4.0%. At December
31, 2002, our total risk based capital ratio was 13.32%. Under current
regulations the minimum required ratio of total capital to risk-weighted assets
is 8.0%. A bank is considered to be well-capitalized if it has a leverage (Tier
1) capital ratio of at least 5.0% and a risk-based capital ratio of at least
10.0%. As of December 31, 2002, The Provident Bank exceeded the well-capitalized
capital requirements.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 141, "Business Combinations,"
which requires that all business combinations be accounted for under the
purchase method. Use of the pooling-of-interests method is no longer permitted.
SFAS No. 141 requires that the purchase method be used for business combinations
initiated after June 30, 2001. This pronouncement will have no effect on our
financial statements unless we enter into a business combination transaction.
On July 20, 2001, the FASB issued Statement No. 142, "Goodwill and
Other Intangible Assets." Statement No. 142 will require that goodwill and
intangible assets with indefinite useful lives no longer be amortized but
instead tested for impairment at least annually in accordance with the
provisions of Statement No. 142. Statement No. 142 also requires that intangible
assets with definite useful lives be amortized over their respective estimated
useful lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
long-lived Assets." The Provident Bank adopted Statement No. 142 effective
January 1, 2002. As of December 31, 2001, The Provident Bank had goodwill in the
amount of $20.0 million as a result of the acquisition of financial institutions
for which the amortization ceased upon the adoption of Statement No. 142 and
$519,000 resulting from the acquisition of a mortgage banking company in 2001.
At June 30, 2002, The Provident Bank determined that the carrying amount of
$519,000 of goodwill related to the acquisition of the mortgage company was
impaired and recognized the impairment charge as a cumulative effect of
55
a change in accounting principle in accordance with Statement No. 142. In
addition, at December 31, 2001, The Provident Bank had $3.3 million in
intangible assets with definite useful lives that continued to be amortized upon
the adoption of SFAS No. 142.
On October 3, 2001, the FASB issued SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses the financial
accounting and reporting for the impairment or disposal of long-lived assets.
While SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets to be Disposed Of," it retains many of the fundamental
provisions of the Statement. The Statement is effective for fiscal years
beginning after December 15, 2001. The initial adoption of this standard did not
have a significant impact on our financial statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This Statement rescinds FASB No. 4, "Reporting Gains and Losses
from Extinguishment of Debt," and an amendment of that Statement, SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." This
Statement also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor
Carriers." This Statement amends SFAS No. 13, "Accounting for Leases," to
eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback transactions. This
Statement also amends other existing authoritative pronouncements to make
various technical corrections, clarify meanings, or describe their applicability
under changing conditions. SFAS No. 145 is effective for fiscal years beginning
after May 15, 2002. Management does not anticipate that the initial adoption of
SFAS No. 145 will have a significant impact on the consolidated financial
statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." This Statement is to be
applied prospectively to exit or disposal activities initiated after December
31, 2002.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions - an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No 9." This Statement removes acquisitions of financial
institutions from the scope of both SFAS No. 72 and Interpretation 9 and
requires that those transactions be accounted for in accordance with SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." The provisions of SFAS No. 147 that relate to the application of the
purchase method of accounting apply to all acquisitions of financial
institutions, except transactions between two or more mutual enterprises. SFAS
No. 147 clarifies that a branch acquisition that meets the definition of a
business should be accounted for as a business combination, otherwise the
transaction should be accounted for as an acquisition of net assets that does
not result in the recognition of goodwill. The provisions of SFAS No. 147 are
effective October 1, 2002. This Statement will not have any impact on the
consolidated financial statements.
In December, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation, Transition and Disclosure." SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. SFAS No. 148 also
requires that disclosures of the pro forma effect of using the fair value method
of accounting for stock-based employee compensation be displayed more
prominently and in a tabular format. Additionally, SFAS No. 148 requires
disclosure of the pro forma effect in interim financial statements. The
additional disclosure requirements of SFAS No. 148 are effective for fiscal
years ended after December 15, 2002. As the Bank did not have any stock-based
employee compensation plans as of December 31, 2002, the initial adoption of
this statement did not have any impact on the consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Qualitative Analysis. Interest rate risk is the exposure of a bank's
current and future earnings and capital arising from adverse movements in
interest rates. Our most significant risk exposure is interest rate risk. The
guidelines of our interest rate risk policy seek to limit the exposure to
changes in interest rates that affect the underlying economic value of assets
and liabilities, earnings and capital. To minimize interest rate risk we
generally
56
sell all twenty and thirty year fixed-rate mortgage loans at origination. A
majority of residential loans that are in our portfolio are adjustable rate
mortgages. Commercial real estate loans generally have interest rates that reset
in five years and other commercial loans such as construction loans, commercial
lines of credit and mortgage warehouse loans reset with changes in the prime
rate or the federal funds rate. Investment securities purchases generally have
maturities of five years or less and mortgage-backed securities have weighted
average lives between three and five years.
The Asset/Liability Committee meets on a monthly basis to review the
impact of interest rate changes on net interest income, net interest margin, net
income and economic value of equity. Members of the Asset/Liability Committee
include our Chief Executive Officer and President and our Chief Operating
Officer as well as senior officers from our finance, lending and customer
management departments. The Asset/Liability Committee reviews a variety of
strategies that project changes in asset or liability mix and the impact of
those changes on projected net interest income and net income.
Our strategy for liabilities has been to maintain a stable core-funding
base by focusing on core deposit account acquisition and increasing products and
services per household. Our focus on core deposit accounts has led to a shift in
our funding base to less interest rate sensitive liabilities. Certificate of
deposit accounts as a percentage of total deposits have declined to 32.42% at
December 31, 2002 from 44.95% at December 31, 2001. Certificate of deposit
accounts are generally short term. As of December 31, 2002, 82.77% of all time
deposits had maturities of one year or less compared to 83.8% at December 31,
2001. Our ability to retain maturing certificate of deposit accounts is the
result of our strategy to remain competitively priced within our marketplace,
typically within the upper quartile of rates offered by our competitors. Our
pricing strategy may vary depending upon our funding needs and our ability to
fund operations through alternative sources, primarily by accessing our
short-term lines of credit with the Federal Home Loan Bank during periods of
pricing dislocation.
Quantitative Analysis. We measure our sensitivity to changes in
interest rates through the use of balance sheet and income simulation models.
The analyses capture changes in net interest income using flat rates as a base,
a most likely rate forecast and rising and declining interest rate forecasts. We
measure changes in net interest income and net income for the forecast period,
generally twelve to twenty-four months, within our limits for acceptable change.
The following sets forth the result of our net interest income model as
of December 31, 2002.
CHANGE IN NET INTEREST INCOME
INTEREST RATES ----------------------------------------------
IN BASIS POINTS AMOUNT($) CHANGE($) CHANGE(%)
(RATE SHOCK) ------------- ------------- ------------
--------------- (Dollars in thousands)
-100 $ 146,499 $ 3,548 2.48%
Static 142,951 -- --
+100 137,677 (5,274) (3.69)%
+200 130,894 (12,057) (8.43)%
+300 123,684 (19,267) (13.48)%
The above table indicates that as of December 31, 2002, in the event of
an immediate and sustained 200 basis point increase in interest rates, we would
experience an 8.43%, or $12.1 million decrease in net interest income. In the
event of a 100 basis point decrease in interest rates, we would experience a
2.48%, or $3.5 million increase in net interest income.
Another measure of interest rate sensitivity is to model changes in
economic value of equity through the use of immediate and sustained interest
rate shocks. The following table illustrates the result of our economic value of
equity model results as of December 31, 2002.
57
PRESENT VALUE OF EQUITY AS
PERCENT OF PRESENT VALUE OF
PRESENT VALUE OF EQUITY ASSETS
------------------------------------ ---------------------------
CHANGE IN DOLLAR DOLLAR PERCENT PRESENT VALUE PERCENT
INTEREST RATES AMOUNT CHANGE CHANGE RATIO CHANGE
-------------- ---------- ---------- ---------- ------------- -----------
(Basis Points) (Dollars in thousands)
-100 $ 542,933 $ 2,843 0.53% 13.16% 0.13%
Static 540,090 -- -- 13.14% --
+100 515,582 (24,508) (4.54)% 12.66% (3.66)%
+200 471,122 (68,968) (12.77)% 11.74% (10.71)%
+300 422,331 (117,759) (21.80)% 10.68% (18.72)%
The above table indicates that as of December 31, 2002, in the event of
an immediate and sustained 200 basis point increase in interest rates, we would
experience a 12.77% or $69.0 million reduction in the present value of equity.
If rates were to decrease 100 basis points, we would experience a 0.53% or $2.8
million increase in our present value of equity.
Certain shortcomings are inherent in the methodologies used in the
above interest rate risk measurement. Modeling changes in net interest income
requires the making of certain assumptions regarding prepayment and deposit
decay rates, which may or may not reflect the manner in which actual yields and
costs respond to changes in market interest rates. While we believe such
assumptions to be reasonable, there can be no assurance that assumed prepayment
rates and decay rates will approximate actual future loan prepayment and deposit
withdrawal activity. Moreover, the net interest income table presented assumes
that the composition of our interest sensitive assets and liabilities existing
at the beginning of a period remains constant over the period being measured and
also assumes that a particular change in interest rates is reflected uniformly
across the yield curve regardless of the duration to maturity or repricing of
specific assets and liabilities. Accordingly, although the net interest income
table provides an indication of our interest rate risk exposure at a particular
point in time, such measurement is not intended to and does not provide a
precise forecast of the effect of changes in market interest rates on our net
interest income and will differ from actual results.
58
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
THE PROVIDENT BANK AND SUBSIDIARIES
Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(With Independent Auditors' Report Thereon)
59
THE PROVIDENT BANK AND SUBSIDIARIES
Consolidated Financial Statements
CONTENTS
PAGE
----
Independent Auditors' Report 61
Consolidated Statements of Condition as of December 31, 2002 and 2001 62
Consolidated Statements of Income for the years ended December 31, 2002, 2001 and 2000 63
Consolidated Statements of Changes in Equity for the years ended December 31, 2002, 2001 and 2000 64
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 65
Notes to Consolidated Financial Statements 66
All schedules are omitted as the required information either is not applicable
or is included in the consolidated financial statements or related notes.
Separate financial statements for Provident Financial Services, Inc. have not
been included because Provident Financial Services, Inc., which has engaged in
only organizational activities to date, has no significant assets, contingent or
other liabilities, revenues or expenses.
60
[KPMG LLP LETTERHEAD]
INDEPENDENT AUDITORS' REPORT
The Audit Committee of the
Board of Directors
The Provident Bank:
We have audited the accompanying consolidated statements of condition of The
Provident Bank and subsidiaries as of December 31, 2002 and 2001, and the
related consolidated statements of income, changes in equity, and cash flows for
each of the years in the three-year period ended December 31, 2002. These
consolidated financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 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 The Provident Bank
and subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
As disclosed in Note 1 of the Notes to the Consolidated Financial Statements,
The Provident Bank adopted Statement of Financial Accounting Standards No. 142
"Goodwill and Other Intangible Assets" on January 1, 2002.
/s/ KPMG LLP
Short Hills, New Jersey
January 22, 2003
61
THE PROVIDENT BANK AND SUBSIDIARIES
Consolidated Statements of Condition
December 31, 2002 and 2001
(Dollars in Thousands)
2002 2001
------------------- -------------------
ASSETS
Cash and due from banks................................................ $ 101,352 $ 71,539
Federal funds sold..................................................... 73,000 35,000
Short-term investments................................................. 90,503 864
------------------- -------------------
Total cash and cash equivalents................................... 264,855 107,403
------------------- -------------------
Investment securities held to maturity (market value of $221,435 and
$114,042 at December 31, 2002 and 2001, respectively)................. 216,119 112,951
Securities available for sale, at fair value........................... 1,242,118 494,716
Federal Home Loan Bank stock........................................... 13,356 12,555
Loans.................................................................. 2,052,855 2,016,545
Less allowance for loan losses......................................... 20,986 21,909
------------------- -------------------
Net loans......................................................... 2,031,869 1,994,636
------------------- -------------------
Banking premises and equipment, net.................................... 44,005 42,213
Accrued interest receivable............................................ 15,842 15,331
Intangible assets...................................................... 25,405 27,781
Bank owned life insurance.............................................. 47,659 44,790
Other assets........................................................... 17,980 17,341
------------------- -------------------
Total assets...................................................... $ 3,919,208 $ 2,869,717
=================== ===================
LIABILITIES AND EQUITY
Deposits:
Demand deposits..................................................... $ 1,269,421 $ 546,639
Savings deposits.................................................... 922,404 742,547
Certificates of deposit of $100,000 or more......................... 160,867 132,614
Other time deposits................................................. 890,642 919,923
------------------- -------------------
Total deposits.................................................... 3,243,334 2,341,723
------------------- -------------------
Mortgage escrow deposits............................................... 9,582 13,753
Borrowed funds......................................................... 323,081 195,767
Other liabilities...................................................... 17,202 26,344
------------------- -------------------
Total liabilities................................................. 3,593,199 2,577,587
------------------- -------------------
Retained earnings...................................................... 314,111 287,535
Accumulated other comprehensive income................................. 11,898 4,595
------------------- -------------------
Total equity...................................................... 326,009 292,130
------------------- -------------------
Commitments and contingencies.......................................... -- --
------------------- -------------------
Total liabilities and equity...................................... $ 3,919,208 $ 2,869,717
=================== ===================
See accompanying notes to consolidated financial statements.
62
THE PROVIDENT BANK AND SUBSIDIARIES
Consolidated Statements of Income
Years Ended December 31, 2002, 2001 and 2000
(Dollars in Thousands)
YEARS ENDED DECEMBER 31
----------------------------------------------
2002 2001 2000
------------- ------------- -------------
Interest income:
Mortgage loans.................................................... $ 93,893 $ 105,659 $ 111,536
Commercial loans.................................................. 18,894 18,771 13,522
Consumer loans.................................................... 21,167 24,314 24,971
Investment securities............................................. 5,321 5,784 7,589
Securities available for sale..................................... 36,536 25,337 21,577
Other short-term investments...................................... 281 174 109
Federal funds..................................................... 1,284 940 216
------------- ------------- -------------
Total interest income.......................................... 177,376 180,979 179,520
------------- ------------- -------------
Interest expense:
Deposits.......................................................... 54,837 75,289 77,309
Borrowed funds.................................................... 8,404 9,234 12,381
------------- ------------- -------------
Total interest expense......................................... 63,241 84,523 89,690
------------- ------------- -------------
Net interest income............................................ 114,135 96,456 89,830
Provision for loan losses........................................... 12,800 1,900 2,060
------------- ------------- -------------
Net interest income after provision for loan losses............ 101,335 94,556 87,770
============= ============= =============
Non-interest income:
Fees.............................................................. 15,146 14,234 13,011
Net gain (loss) on securities transactions........................ 889 94 (325)
Commissions....................................................... 1,201 1,011 1,513
Bank owned life insurance......................................... 2,869 2,756 2,034
Other income...................................................... 3,973 3,141 2,043
------------- ------------- -------------
Total non-interest income...................................... 24,078 21,236 18,276
------------- ------------- -------------
Non-interest expense:
Salaries and employee benefits.................................... 46,862 40,407 34,604
Net occupancy expense............................................. 13,220 12,109 11,656
Federal deposit insurance......................................... 417 413 431
Data processing expense........................................... 6,080 6,496 5,784
Advertising and promotion expense................................. 3,003 3,620 2,890
Amortization of intangibles....................................... 3,677 4,376 3,570
Other operating expenses.......................................... 15,828 13,208 16,930
------------- ------------- -------------
Total non-interest expenses.................................... 89,087 80,629 75,865
------------- ------------- -------------
Income before income tax expense and the cumulative effect of a
change in accounting principle..................................... $ 36,326 $ 35,163 $ 30,181
Income tax expense.................................................. 9,231 11,083 9,283
------------- ------------- -------------
Income before the cumulative effect of a change in accounting
principle.......................................................... 27,095 24,080 20,898
Cumulative effect of a change in accounting principle, net of tax
of $0.............................................................. (519) -- --
------------- ------------- -------------
Net income..................................................... $ 26,576 $ 24,080 $ 20,898
============= ============= =============
See accompanying notes to consolidated financial statements.
63
THE PROVIDENT BANK AND SUBSIDIARIES
Consolidated Statements of Changes in Equity
Years Ended December 31, 2002, 2001 and 2000
(Dollars in Thousands)
ACCUMULATED
OTHER
RETAINED COMPREHENSIVE
EARNINGS INCOME (LOSS) TOTAL EQUITY
---------------- ---------------- ----------------
Balance at December 31, 1999................................ $ 242,557 $ (5,893) $ 236,664
---------------- ---------------- ----------------
Comprehensive income:
Net income................................................ 20,898 -- 20,898
Unrealized holding gains on securities arising during the
period (net of tax of $3,252)............................ -- 5,309 --
Less reclassification adjustment for losses included in
net income (net of tax of $124)......................... -- 201 --
Net unrealized holding losses on securities arising
during the period (net of tax of $3,376)................. -- 5,510 5,510
---------------- ---------------- ----------------
Total comprehensive income............................. -- -- 26,408
---------------- ---------------- ----------------
Balance at December 31, 2000................................ 263,455 (383) 263,072
---------------- ---------------- ----------------
Comprehensive Income:
Net income................................................ 24,080 -- 24,080
Unrealized holding gains on securities arising during the
period (net of tax of $3,087)............................ -- 5,036 --
Less reclassification adjustment for losses included in
net income (net of tax of $36).......................... -- (58) --
Net unrealized holding losses on securities arising
during the period (net of tax of $3,051)................. -- 4,978 4,978
---------------- ---------------- ----------------
Total comprehensive income............................. -- -- 29,058
---------------- ---------------- ----------------
Balance at December 31, 2001................................ 287,535 4,595 292,130
---------------- ---------------- ----------------
Comprehensive income:
Net income................................................ 26,576 -- 26,576
Unrealized holding gains on securities arising during the
period (net of tax of $5,401)............................ -- 7,828 --
Less reclassification adjustment for gains included in
net income (net of tax of $362)......................... -- 525 --
Net unrealized holding losses on securities arising
during the period (net of tax of $5,039)................. -- 7,303 7,303
---------------- ---------------- ----------------
Total comprehensive income................................ -- -- 33,879
---------------- ---------------- ----------------
Balance at December 31, 2002................................ $ 314,111 $ 11,898 $ 326,009
================ ================ ================
See accompanying notes to consolidated financial statements.
64
THE PROVIDENT BANK AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31, 2002, 2001 and 2000
(Dollars in Thousands)
YEARS ENDED DECEMBER 31
----------------------------------------------
2002 2001 2000
------------- ------------- -------------
Cash flows from operating activities:
Net income........................................................ $ 26,576 $ 24,080 $ 20,898
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of intangibles.................... 9,225 9,579 8,566
Provision for loan losses....................................... 12,800 1,900 2,060
Deferred tax benefit............................................ (1,537) (3,302) (801)
Increase in cash surrender value of bank owned life insurance... (2,869) (2,756) (2,034)
Net amortization of premiums and discount on securities......... (378) (368) (368)
Accretion of net deferred loan fees............................. (713) (1,538) (1,405)
Amortization of premiums on purchased loans..................... 905 1,386 1,255
Proceeds from sales of other real estate owned, net............. 299 204 154
Provision for losses on other real estate owned................. -- -- 47
Net gain on investment securities transactions.................. (2) (17) (114)
Net (gain) loss on sale of loans................................ (2,232) (1,719) (293)
Proceeds from sale of loans..................................... 79,129 80,652 25,264
Net (gain) loss on securities available for sale................ (887) (77) 439
Decrease (increase) in accrued interest receivable.............. (511) 3,816 (4,287)
Increase in other assets........................................ (7,859) (559) (3,757)
Increase (decrease) in mortgage escrow deposits................. (4,170) 2,176 (955)
Increase in other liabilities................................... (9,142) 7,653 2,883
------------- ------------- -------------
Net cash provided by operating activities.................... 98,634 121,110 47,552
------------- ------------- -------------
Cash flows from investing activities:
Proceeds from maturities, calls and paydowns of investment
securities....................................................... 31,635 59,014 72,202
Purchases of investment securities................................ (134,909) (47,951) (33,481)
Proceeds from sales of securities available for sale.............. 1,041 248 43,564
Proceeds from maturities and paydowns of securities available for
sale............................................................. 137,295 123,026 48,311
Purchases of securities available for sale........................ (871,822) (275,225) (51,204)
Purchase of Bank Owned Life Insurance............................. -- -- (40,000)
Net increase in loans............................................. (127,421) (121,416) (106,029)
Purchases of premises and equipment, net.......................... (5,926) (7,956) (2,800)
------------- ------------- -------------
Net cash used in investing activities........................ (970,107) (270,260) (69,437)
------------- ------------- -------------
Cash flows from financing activities:
Net increase in deposits.......................................... 901,611 173,387 71,732
Proceeds from FHLB Advances....................................... 166,150 77,240 68,441
Payments on FHLB Advances......................................... (43,700) (64,816) (81,471)
Net increase (decrease) in Retail................................. -- -- --
Repurchase Agreements and FHLB lines of credit.................... 4,864 3,440 (23,708)
------------- ------------- -------------
Net cash provided by financing activities.................... 1,028,925 189,251 34,994
------------- ------------- -------------
Net increase in cash and cash equivalents.................... 157,452 40,101 13,109
Cash and cash equivalents at beginning of period.................... 107,403 67,302 54,193
------------- ------------- -------------
Cash and cash equivalents at end of period.......................... $ 264,855 $ 107,403 $ 67,302
============= ============= =============
Cash paid during the period for:
Interest on deposits and borrowings................................ $ 63,242 $ 84,988 $ 89,149
============= ============= =============
Income taxes...................................................... $ 11,650 $ 12,100 $ 11,631
============= ============= =============
Non-cash investing activities - transfer of loans receivable to
other real estate owned............................................ $ 299 $ -- $ 539
============= ============= =============
See accompanying notes to consolidated financial statements.
65
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Provident
Bank and its wholly-owned subsidiaries (the Bank). All intercompany
balances and transactions have been eliminated in consolidation.
BUSINESS
The Bank provides a full range of banking services to individual and
corporate customers through branch offices in New Jersey. The Bank is
subject to competition from other financial institutions and to the
regulations of certain federal and state agencies, and undergoes
periodic examinations by those regulatory authorities.
BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements of the Bank have been prepared in
conformity with accounting principles generally accepted in the United
States of America. In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of the date of the
consolidated balance sheets and revenues and expenses for the periods
then ended. Actual results could differ from those estimates.
A material estimate that is particularly susceptible to change in the
near term relates to the determination of the allowance for loan
losses. In connection with the determination of the allowance for loan
losses, management generally obtains independent appraisals for
significant properties.
FEDERAL HOME LOAN BANK OF NEW YORK STOCK
The Bank, as a member of the Federal Home Loan Bank of New York (FHLB),
is required to hold shares of capital stock of the FHLB at cost based
on a specified formula. The Bank carries this investment at cost which
approximates market value.
SECURITIES
Securities include investment securities and securities available for
sale. Securities that an entity has the positive intent and ability to
hold to maturity are classified as "investment securities" and reported
at amortized cost. Securities to be held for indefinite periods of time
and not intended to be held to maturity are classified as "securities
available for sale" and are reported at fair value, with unrealized
gains and losses excluded from earnings and reported as a separate
component of equity, net of deferred taxes. Gains or losses on the sale
of securities are based upon the specific identification method.
LOANS
Mortgages on real estate and other loans are stated at the face amount
of the loans. Unearned income on discounted loans, principally lease
financing loans, is generally included in income based on the rule of
seventy-eights method, which approximates the level yield method.
Accrued interest on loans that are contractually 90 days or more past
due or when collection of interest appears doubtful is reversed and
charged against interest income. Income is subsequently recognized only
to the extent cash payments are received and the principal balance is
expected to be recovered. Such loans are restored to an accrual status
only if the loan is brought contractually current and the borrower has
demonstrated the ability to make future payments of principal and
interest.
An impaired loan is defined as a loan for which it is probable, based
on current information, that the lender will not collect amounts due
under the contractual terms of the loan agreement. The Bank has
identified the population of impaired loans to be all commercial loans
as well as residential mortgage loans greater
66
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
than $500,000 which meet the above definition. Impaired loans are
individually assessed to determine that each loan's carrying value is
not in excess of the fair value of the related collateral or the
present value of the expected future cash flows.
LOAN ORIGINATION AND COMMITMENT FEES AND RELATED COSTS
Loan fees and certain direct loan origination costs are deferred and
the net fee or cost is recognized in interest income using the
level-yield method over the contractual lives of the specifically
identified loans adjusted for prepayments.
ALLOWANCE FOR LOAN LOSSES
Losses on loans are charged to the allowance for loan losses. Additions
to this allowance are made by recoveries of loans previously charged
off and by a provision charged to expense. The determination of the
balance of the allowance for loan losses is based on an analysis of the
loan portfolio, economic conditions, historical loan loss experience
and other factors that warrant recognition in providing for an adequate
allowance.
Management believes that the allowance for loan losses is adequate.
While management uses available information to recognize losses on
loans and real estate, future additions to the allowance for loan
losses may be necessary based on changes in economic conditions in the
Bank's market area.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan
losses. Such agencies may require the Bank to recognize additions to
the allowance or additional write-downs based on their judgments about
information available to them at the time of their examination.
BANKING PREMISES AND EQUIPMENT
Land is carried at cost. Banking premises, furniture, fixtures and
equipment are carried at cost, less accumulated depreciation, computed
using the straight-line method based on their estimated useful lives
(generally 25 to 40 years for buildings and 3 to 5 years for furniture
and equipment). Leasehold improvements, carried at cost, net of
accumulated amortization, are amortized over the terms of the leases or
the estimated useful lives of the assets, whichever are shorter, using
the straight-line method. Maintenance and repairs are charged to
expense as incurred.
OTHER REAL ESTATE OWNED
Other real estate owned is property acquired through foreclosure or
deed in lieu of foreclosure. These properties are carried at fair
value, less estimated costs to sell. Fair market value is generally
based on recent appraisals. When a property is acquired, the excess of
the loan balance over fair value, less estimated costs to sell, is
charged to the allowance for loan losses. A reserve for real estate
owned has been established to provide for possible write-downs and
selling costs that occur subsequent to foreclosure. Real estate owned
is carried net of the related reserve. Operating results from real
estate owned, including rental income, operating expenses, and gains
and losses realized from the sales of real estate owned, are recorded
as incurred.
INCOME TAXES
The Bank uses the asset and liability method of accounting for income
taxes. Under this method, deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax
rates in effect for the year in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax
67
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
assets and liabilities of a change in tax rates is recognized in income
in the period that includes the enactment date.
TRUST DEPARTMENT
Trust assets consisting of securities and other property (other than
cash on deposit held by the Bank in fiduciary or agency capacities for
customers of the Trust Department) are not included in the accompanying
consolidated statements of condition because such properties are not
assets of the Bank.
INTANGIBLE ASSETS
Intangible assets of the Bank consist of goodwill, core deposit
premiums, and mortgage servicing rights. Goodwill represents the excess
of the purchase price over the estimated fair value of identifiable net
assets acquired through purchase acquisitions. The amortization of
goodwill was on a straight-line basis over a period of 20 years and was
included in other operating expenses prior to the adoption of Statement
No. 142, "Goodwill and Other Intangible Assets" on January 1, 2002.
After adoption of Statement No. 142, the amortization of goodwill with
an indefinite useful life has ceased, and the remaining balance is
evaluated for impairment on an annual basis.
Core deposit premiums represent the intangible value of depositor
relationships assumed in purchase acquisitions and are amortized on a
straight-line basis over a period of ten years. Mortgage servicing
rights are recorded when purchased or originated mortgage loans are
sold, with servicing rights retained. The amortization of the mortgage
servicing rights is on an accelerated basis, adjusted for prepayments.
Mortgage servicing rights are carried at fair value. The amortization
of the core deposit premiums and mortgage servicing rights is recorded
in other operating expenses.
EMPLOYEE BENEFIT PLANS
The Bank maintains a pension plan which covers substantially all
employees. The Bank's policy is to fund at least the minimum
contribution required by the Employee Retirement Income Security Act of
1974.
The Bank has a savings incentive plan covering substantially all
employees of the Bank. Contributions are currently made by the Bank in
an amount equal to 115% of employee contributions this amount was
effective until December 27, 2002. Effective December 30, 2002 the
match was reduced to 100%. The contribution percentage is determined
quarterly by the Board of Managers.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Bank provides postretirement health care and life insurance plans
to its employees. The medical and life insurance coverage is
noncontributory to the participants. The costs of such benefits are
accrued based on actuarial assumptions from the date of hire to the
date the employee is fully eligible to receive the benefits.
COMPREHENSIVE INCOME
Comprehensive income is divided into net income and other comprehensive
income. Other comprehensive income includes items previously recorded
directly to equity, such as unrealized gains and losses on securities
available for sale. Comprehensive income is presented in the statements
of changes in equity.
SEGMENT REPORTING
The Bank's operations are solely in the financial services industry and
include providing to its customers traditional banking and other
financial services. The Bank operates primarily in the geographical
regions of Northern and Central New Jersey. Management makes operating
decisions and assesses performance
68
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
based on an ongoing review of the Bank's consolidated financial
results. Therefore, the Bank has a single operating segment for
financial reporting purposes.
RECENT ACCOUNTING PRONOUNCEMENTS
On July 20, 2001, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) Statement No.
141, "Business Combinations," and Statement No. 142, "Goodwill and
Other Intangible Assets." Statement No. 141 requires that the purchase
method of accounting be used for all business combinations initiated
after June 30, 2001 as well as all purchase method business
combinations completed after June 30, 2001. Statement No. 141 also
specifies the criteria acquired intangible assets must meet to be
recognized and reported apart from goodwill. Statement No. 142 requires
that goodwill and intangible assets with indefinite useful lives no
longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of Statement No. 142.
Statement 142 also requires that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to
their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets and for Long-Lived Assets."
The Bank adopted the provisions of Statement No. 141 upon issuance. The
initial adoption of Statement 141 had no impact on the Bank's
consolidated financial statements. The Bank adopted Statement No. 142
effective January 1, 2002. In accordance with Statement No. 142, the
Bank tests its intangible assets with indefinite useful lives for
impairment annually on June 30. In accordance with the transitional
provisions of Statement No. 142, impairment is recognized as a
cumulative effect of a change in accounting principle.
On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses the
financial accounting and reporting for the impairment or disposal of
long-lived assets. While SFAS No. 144 supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," it retains many of the fundamental
provisions of the statement. The statement is effective for fiscal
years beginning after December 15, 2001. The initial adoption of SFAS
No. 144 did not have a significant impact on the Bank's financial
statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." This Statement rescinds FASB No. 4, "Reporting
Gains and Losses from Extinguishment of Debt," and an amendment of that
Statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements." This Statement also rescinds SFAS No. 44,
"Accounting for Intangible Assets of Motor Carriers." This Statement
amends SFAS No. 13, "Accounting for Leases," to eliminate an
inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease
modifications that have economic effects that are similar to
sale-leaseback transactions. This Statement also amends other existing
authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under change
conditions. SFAS No. 145 is effective for fiscal years beginning after
May 15, 2002. Management does not anticipate that the initial adoption
of SFAS No. 145 will have a significant impact on the consolidated
financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." This Statement is to be applied prospectively to
exit or disposal activities initiated after December 31, 2002.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions - an amendment of FASB Statements No. 72 and 144
and FASB Interpretation No 9." This Statement removes acquisitions of
financial institutions from the scope of both SFAS No. 72 and
Interpretation 9 and requires
69
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
that those transactions be accounted for in accordance with SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets." The provision of SFAS No. 147 that relate to the
application of the purchase method of accounting apply to all
acquisitions of financial institutions, except transactions between two
or more mutual enterprises.
SFAS No. 147 clarifies that a branch acquisition that meets the
definition of a business should be accounted for as a business
combination, otherwise the transaction should be accounted for as an
acquisition of net assets that does not result in the recognition of
goodwill. The provisions of SFAS No. 147 are effective October 1, 2002.
This Statement will not have any impact on the consolidated financial
statements.
In December, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation, Transition and Disclosure." SFAS No. 148
provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation. SFAS No. 148 also requires that disclosures of the pro
forma effect of using the fair value method of accounting for
stock-based employee compensation be displayed more prominently and in
a tabular format. Additionally, SFAS No. 148 requires disclosure of the
pro forma effect in interim financial statements. The additional
disclosure requirements of SFAS No. 148 are effective for fiscal years
ended after December 15, 2002. As the Bank did not have any stock-based
employee compensation plans as of December 31, 2002, the initial
adoption of this statement did not have any impact on the consolidated
financial statements.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks, federal funds sold and commercial paper.
BANK OWNED LIFE INSURANCE
Bank owned life insurance ("BOLI") is accounted for using the cash
surrender value method and is recorded at its realizable value. The
change in the net asset value is included in other assets and other
non-interest income.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2001 and 2000
consolidated financial statements to conform to the presentation
adopted in 2002.
(2) EQUITY
On April 26, 2002, the Board of Managers of the Bank approved a Plan of
Conversion ("the Plan"), which provided for the conversion of the Bank
from a New Jersey-chartered mutual savings bank to a New Jersey-
Chartered stock savings bank, pursuant to the rules and regulations of
the New Jersey Department of Banking and Insurance and the Federal
Deposit Insurance Corporation. As part of the conversion, the Plan
provided for the formation of the Holding Company, which would own 100%
of the common stock of the Bank following the conversion. The Bank
received approval of the Plan from the New Jersey Commissioner of
Banking and Insurance. The Federal Deposit Insurance Corporation, the
New Jersey Commissioner of Banking and Insurance and the Federal
Reserve Board have approved the establishment of the Holding Company.
The Plan was approved at a Special Meeting of Depositors on January 7,
2003.
On January 15, 2003 the Bank completed the Conversion, and the Bank
became a wholly owned subsidiary of Provident Financial Services, Inc.
(the "Company"). The Company sold 59.6 million shares (par value $0.01
per share) at $10.00 per share. The Company's common stock commenced
trading on January 16, 2003 on the New York Stock Exchange under the
symbol PFS. At December 31, 2002, The Company had no assets or
liabilities and had no business operations. Currently, the Company's
activities consist solely of managing the Bank and investing its
portion of the net proceeds received in the subscription offering
70
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
In connection with the Bank's commitment to its community, the Plan
provided for the establishment of a charitable foundation as part of
the conversion. Provident donated to the foundation cash of $4.8
million and 1.92 million of authorized but unissued shares of common
stock which amounted to $24 million in aggregate. The Company
recognized an expense, net of income tax benefit, equal to the cash and
fair value of the stock in the first quarter of 2003.
Conversion costs were deferred and deducted from the proceeds of the
shares sold in the offering. As of December 31, 2002, approximately
$2,193,000 of conversion costs had been deferred.
Upon completion of the Plan of Conversion, a "liquidation account" was
established in an amount equal to the total equity of the Bank as of
the latest practicable date prior to the Conversion. The liquidation
account was established to provide a limited priority claim to the
assets of the Bank to "eligible account holders" and "supplemental
eligible account holders", as defined in the Plan, who continue to
maintain deposits in the Bank after the Conversion. In the unlikely
event of a complete liquidation of the Bank, and only in such event,
each eligible account holder and supplemental eligible account holder
would receive a liquidation distribution, prior to any payment to the
holder of the Bank's common stock. This distribution would be based
upon each eligible account holder's and supplemental eligible account
holder's proportionate share of the then total remaining qualifying
deposits. At the time of the conversion, the liquidation account, which
is an off-balance sheet memorandum account, amounted to $302.6 million.
(3) CASH AND DUE FROM BANKS
Included in cash on hand and due from banks at December 31, 2002 and
2001 is $5,158,000 and $5,163,000, respectively, representing reserves
required by banking regulations.
(4) INVESTMENT SECURITIES HELD TO MATURITY
Investment securities held to maturity at December 31, 2002, and 2001
are summarized as follows (in thousands):
2002
---------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
-------------- -------------- -------------- --------------
U.S. Government Agency Collateralized
mortgage obligations................... $ 85,833 $ 952 $ -- $ 86,785
State and municipal..................... 94,267 4,356 41 98,582
Corporate and other..................... 36,019 90 41 36,068
-------------- -------------- -------------- --------------
$ 216,119 $ 5,398 $ 82 $ 221,435
============== ============== ============== ==============
2001
---------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
-------------- -------------- -------------- --------------
U.S. Government Agency Collateralized
mortgage obligations................... $ 32,849 $ 767 $ 1 $ 33,615
State and municipal..................... 75,562 782 473 75,871
Corporate and other..................... 4,540 59 43 4,556
-------------- -------------- -------------- --------------
$ 112,951 $ 1,608 $ 517 $ 114,042
============== ============== ============== ==============
71
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
The Bank generally purchases securities for long-term investment
purposes, and differences between carrying and market values may
fluctuate during the investment period. In the opinion of management,
the Bank expects to recover carrying values by retaining investment
securities until their maturity or until such recovery has taken place.
Investment securities having a carrying value of $6,001,000 and
$6,175,000 at December 31, 2002, and 2001, respectively, are pledged to
qualify for fiduciary powers to secure deposits as required by law.
The amortized cost and market value of investment securities at
December 31, 2002 by contractual maturity, are shown below (in
thousands). Expected maturities may differ from contractual maturities
due to prepayment or early call privileges of the issuer.
2002
-----------------------------------
AMORTIZED MARKET
COST VALUE
---------------- ----------------
Due in one year or less................... $ 7,360 $ 7,503
Due after one year through five years..... 119,534 121,625
Due after five years through ten years.... 67,168 69,431
Due after ten years....................... 22,057 22,876
---------------- ----------------
$ 216,119 $ 221,435
================ ================
During 2002, the Bank realized gains and losses on paydowns of
investment securities of $5,000 and $3,000, respectively. During 2001,
the Bank realized gains and losses on paydowns of investment securities
of $24,000 and $7,000, respectively. During 2000, the Bank realized
gains and losses on paydowns of investment securities of $127,000 and
$13,000, respectively.
(5) SECURITIES AVAILABLE FOR SALE
Securities available for sale at December 31, 2002, and 2001 are
summarized as follows (in thousands):
2002
-------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------ ------------ ------------ ------------
U.S. Government & agency obligations....... $ 515,193 $ 2,045 $ 9 $ 517,229
U.S. Government agency MBS................. 561,452 10,504 156 571,800
Corporate and other........................ 145,358 7,731 -- 153,089
------------ ------------ ------------ ------------
$ 1,222,003 $ 20,280 $ 165 $ 1,242,118
============ ============ ============ ============
2001
-------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------ ------------ ------------ ------------
U.S. Government & agency obligations....... $ 76,111 $ 1,931 $ -- $ 78,042
U.S. Government agency MBS................. 309,206 3,315 1,555 310,966
Corporate and other........................ 101,988 3,756 36 105,708
------------ ------------ ------------ ------------
$ 487,305 $ 9,002 $ 1,591 $ 494,716
============ ============ ============ ============
72
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Securities available for sale having a carrying value of $95,188,000
and $94,896,000 at December 31, 2002, and 2001, respectively, are
pledged to secure other borrowings and securities sold under repurchase
agreements.
The amortized cost and market value of securities available for sale at
December 31, 2002, by contractual maturity, are shown below (in
thousands). Expected maturities may differ from contractual maturities
due to prepayment or early call privileges of the issuer.
2002
-------------------------------------
AMORTIZED COST MARKET VALUE
----------------- -----------------
Due in one year or less.................. $ 526,376 $ 528,223
Due after one year through five years.... 596,771 612,742
Due after five years through ten years... 58,733 60,279
Due after ten years...................... 40,123 40,874
----------------- -----------------
$ 1,222,003 $ 1,242,118
================= =================
Proceeds from the sale of securities available for sale during 2002
were $1,041,000, resulting in gross gains and gross losses of
$1,072,000 and $185,000, respectively. During 2001, proceeds from the
sale of securities available for sale were $248,000, resulting in gross
gains and gross losses of $97,000 and $20,000, respectively. During
2000, proceeds from the sale of securities available for sale were
$43,564,000, resulting in gross gains and gross losses of $84,000 and
$523,000, respectively.
6) LOANS
Loans receivable at December 31, 2002, and 2001 are summarized as
follows (in thousands):
2002 2001
----------------- -----------------
Mortgage loans:
Residential........................ $ 699,469 $ 795,442
Commercial......................... 444,249 412,280
Multifamily........................ 77,006 95,456
Commercial construction............ 96,028 80,717
----------------- -----------------
Total mortgage loans........... 1,316,752 1,383,895
----------------- -----------------
Mortgage warehouse loans............... 276,383 167,905
Commercial loans....................... 183,410 141,491
Consumer loans......................... 275,812 322,219
----------------- -----------------
735,605 631,615
----------------- -----------------
Premium on purchased loans............. 2,123 2,566
Less net deferred fees................. 1,625 1,531
----------------- -----------------
$ 2,052,855 $ 2,016,545
================= =================
The premium on purchased loans is amortized using the effective
interest method as payments are received. Required reductions due to
loan prepayments are charged against operating expense. For the years
ended December 31, 2002, 2001 and 2000, $905,000 $1,386,000, and
$1,255,000, respectively, was charged to operating expense as a result
of prepayments and normal amortization.
Included in loans are loans for which the accrual of interest income
has been discontinued due to a deterioration in the financial condition
of the borrowers. The principal amount of these nonaccrual loans is
$8,512,000 and $8,084,000 at, December 31, 2002, and 2001,
respectively.
73
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
If the nonaccrual loans had performed in accordance with their original
terms, interest income would have increased by $651,000, $653,000,
$662,000 for years 2002, 2001 and 2000, respectively. At December 31,
2001, there are no commitments to lend additional funds to borrowers
whose loans are nonaccrual.
At December 31, 2002 and 2001, the impaired loan portfolio is primarily
collateral dependent and totals $1,366,000 and $1,402,000,
respectively, for which general and specific allocations to the
allowance for loan losses of $32,000 and $32,000, respectively, are
identified. The average balance of impaired loans during the years
ended December 31, 2002, 2001 and 2000 was $1,382,000, $1,417,000 and
$1,449,000, respectively. The amount of cash basis interest income that
was recognized on impaired loans during the years ended December 31,
2002 and 2001 was insignificant for the respective periods.
Loans serviced for others are not included in the accompanying
consolidated statements of condition. The unpaid principal balances of
loans serviced for others was approximately $334,342,000, $395,256,000
and $459,741,000, at December 31, 2002, 2001 and 2000, respectively.
The Bank, in the normal course of conducting its business, extends
credit to meet the financing needs of its customers through
commitments. Commitments and contingent liabilities, such as
commitments to extend credit (including loan commitments of
$368,211,000 and $341,754,000 at December 31, 2002 and 2001,
respectively, and undisbursed home equity and personal credit lines of
$51,721,000, and $31,411,000 December 31, 2002 and 2001, respectively),
exist which are not reflected in the accompanying consolidated
financial statements. These instruments involve elements of credit and
interest rate risk in excess of the amount recognized in the
consolidated financial statements. The Bank uses the same credit
policies and collateral requirements in making commitments and
conditional obligations as it does for on-balance-sheet loans.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since the commitments may
expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained if deemed necessary by the Bank upon extension of
credit is based on management's credit evaluation of the borrower.
The Bank grants residential real estate loans on single and
multi-family dwellings to borrowers throughout New Jersey. Its
borrowers' abilities to repay their obligations are dependent upon
various factors, including the borrowers' income and net worth, cash
flows generated by the underlying collateral, value of the underlying
collateral, and priority of the Bank's lien on the property. Such
factors are dependent upon various economic conditions and individual
circumstances beyond the Bank's control; the Bank is therefore subject
to risk of loss. The Bank believes that its lending policies and
procedures adequately minimize the potential exposure to such risks and
that adequate provisions for loan losses are provided for all known and
inherent risks. Collateral and/or guarantees are required for virtually
all loans.
(7) ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses for the years ended
December 31, 2002, 2001 and 2000 is as follows (in thousands):
YEARS ENDED DECEMBER 31
-----------------------------------------
2002 2001 2000
------------ ------------ ------------
Balance at beginning of period................ $ 21,909 $ 20,198 $ 18,794
Provision charged to operations............... 12,800 1,900 2,060
Recoveries of loans previously charged off.... 1,197 773 1,153
Loans charged off............................. (14,920) (962) (1,809)
------------ ------------ ------------
Balance at end of period...................... $ 20,986 $ 21,909 $ 20,198
============ ============ ============
During 2002, the Bank has charged off $12.5 million related to a $20.6
million warehouse loan, resulting from an alleged fraud involving a
mortgage warehouse borrower. An additional $1.4 million of these loans
74
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
were sold to investors and we have placed the remaining loans in our
portfolio, established contact with the borrowers and subsequently have
moved these loans into performing status as payment histories are
established.
(8) BANKING PREMISES AND EQUIPMENT
A summary of banking premises and equipment at December 31, 2002, and
2001 is as follows (in thousands):
2002 2001
--------------- ---------------
Land............................................... $ 6,394 $ 6,244
Banking premises................................... 38,632 36,820
Furniture, fixtures and equipment.................. 23,911 21,808
Leasehold improvements............................. 8,925 7,930
Construction in progress........................... 3,300 2,411
--------------- ---------------
81,162 75,213
Less accumulated depreciation and amortization..... 37,157 33,000
--------------- ---------------
$ 44,005 $ 42,213
=============== ===============
Depreciation expense for the years ended December 31, 2002, 2001 and
2000 amounted to $5,548,000, $5,203,000 and $4,996,000, respectively.
(9) INTANGIBLE ASSETS
Intangible assets at, December 31, 2002, and 2001, are summarized as
follows (in thousands):
2002 2001
--------------- ---------------
Goodwill................................ $ 19,908 $ 20,483
Core deposit premiums................... 2,702 3,260
Mortgage servicing rights............... 2,795 4,038
--------------- ---------------
$ 25,405 $ 27,781
=============== ===============
Amortization expense of intangible assets, for the years ended December
31, 2002, 2001 and 2000 is as follows (in thousands):
YEARS ENDED DECEMBER 31
-----------------------------------------
2002 2001 2000
------------ ------------ ------------
Goodwill amortization............. 55 1,340 1,410
Core deposit premiums............. 1,046 1,030 1,036
Mortgage servicing rights......... 2,576 2,006 1,124
------------ ------------ ------------
3,677 4,376 3,570
============ ============ ============
As of December 31, 2001, the Bank had unamortized goodwill in the
amount of $20.0 million as a result of the acquisition of financial
institutions for which the amortization ceased upon the adoption of
Statement No. 142 and $0.5 million resulting from the acquisition of a
mortgage banking company in 2001. During 2002, the Bank determined that
the carrying amount of the $519,000 of goodwill related to the
acquisition of the mortgage company was impaired, and recognized the
impairment as a cumulative effect of a change in accounting principle
in accordance with the transitional provisions of SFAS No. 142.
75
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
If SFAS No. 142 had been adopted on January 1, 2000, net income would
have increased as a result of ceasing the amortization of goodwill by
$1,171,000 in each of the years ended December 31, 2001 and 2000.
(10) DEPOSITS
Deposits at December 31, 2002 and 2001 are summarized as follows (in
thousands):
WEIGHTED WEIGHTED
AVERAGE AVERAGE
2002 INTEREST RATE 2001 INTEREST RATE
------------- ------------- ------------- -------------
Savings deposits $ 922,404 1.76% $ 742,547 2.52%
Money market accounts 101,489 1.83 79,482 2.22
NOW accounts 309,281 1.20 241,239 1.45
Non-interest bearing deposits 858,651 -- 225,918 --
Certificate of deposits 1,051,509 3.32 1,052,537 5.16
------------- -------------
$ 3,243,334 $ 2,341,723
============= =============
Scheduled maturities of certificates of deposit accounts at, December
31, 2002 and 2001 are as follows (in thousands):
2002 2001
------------------ ------------------
Within one year......................... $ 870,285 $ 881,656
One to three years...................... 131,523 149,306
Three to five years..................... 47,294 19,359
Five years and thereafter 2,407 2,216
------------------ ------------------
$ 1,051,509 $ 1,052,537
================== ==================
Interest expense on deposits for the years ended December 31, 2002,
2001 and 2000 is summarized as follows (in thousands):
YEARS ENDED DECEMBER 31
------------------------------------------
2002 2001 2000
------------ ------------ ------------
Savings deposits.................... $ 14,459 $ 15,966 $ 16,143
NOW and money market accounts....... 4,897 4,703 4,907
Certificates of deposits............ 35,481 54,620 56,259
------------ ------------ ------------
$ 54,837 $ 75,289 $ 77,309
============ ============ ============
(11) BORROWED FUNDS
Borrowed funds at, December 31, 2002, and 2001 is summarized as follows
(in thousands):
2002 2001
---------------- ----------------
Securities sold under repurchase agreements....... $ 55,967 $ 51,103
FHLB line of credit............................... -- --
FHLB advances..................................... 267,114 144,664
---------------- ----------------
$ 323,081 $ 195,767
================ ================
FHLB advances are at fixed rates and mature between March 11, 2003 and
November 13, 2018. These advances are secured by investment securities
and loans receivable under a blanket collateral agreement.
76
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Scheduled maturities of FHLB advances at December 31, 2002 are as
follows (in thousands):
2002
-----------------
Within one year................................... $ 71,419
Within two years.................................. 47,058
Within three years................................ 75,277
Within four years................................. 37,837
Within five years................................. 35,000
Thereafter........................................ 523
-----------------
$ 267,114
=================
The following tables set forth certain information as to borrowed funds
for the period ended December 31, 2002 and 2001 (in thousands):
WEIGHTED
MAXIMUM AVERAGE AVERAGE
BALANCE BALANCE INTEREST RATE
-------------- -------------- -------------
2002:
Securities sold under repurchase agreements... $ 55,967 $ 47,600 1.50%
FHLB advances................................. $ 267,114 $ 157,300 3.88%
============== ============== =============
WEIGHTED
MAXIMUM AVERAGE AVERAGE
BALANCE BALANCE INTEREST RATE
-------------- -------------- -------------
2001:
Securities sold under repurchase agreements... $ 51,103 $ 42,144 3.07%
FHLB Lines of credit.......................... 26,900 1,788 5.50%
FHLB advances................................. $ 144,664 $ 132,756 5.90%
============== ============== =============
Securities sold under repurchase agreements are arrangements with
deposit customers of the Bank to sweep funds into short-term
borrowings. The Bank uses securities available for sale to pledge as
collateral for the repurchase agreements. These securities are held at
and under the control of the Bank.
The securities sold under repurchase agreements have maturity dates
within 30 days.
At December 31, 2002 and 2001, the Bank has an unused line of credit
with the FHLB of $100,000,000.
(12) RETIREMENT PLANS
The Bank has a noncontributory defined benefit pension plan covering
all of its employees who have attained age 21 with at least one year of
service. The plan provides for 100% vesting after five years of
service. The plan's assets are invested in group annuity contracts and
investment funds managed by the Prudential Insurance Company and
AllAmerica Financial.
In addition to pension benefits, certain health care and life insurance
benefits are made available to retired employees. The costs of such
benefits are accrued based on actuarial assumptions from the date of
hire to the date the employee is fully eligible to receive the
benefits.
77
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
The following table shows the change in benefit obligation, the change
in plan assets and the funded status for the pension plan and
postretirement health care plan at December 31, 2002 and 2001 (in
thousands):
PENSION POSTRETIREMENT
--------------------------- ---------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Change in benefit obligation:
Benefit obligation at beginning of year........ $ 25,690 $ 19,035 $ 17,934 $ 14,361
Plan Amendment................................. 625 -- -- --
Service cost................................... 1,479 1,077 1,125 803
Interest cost.................................. 1,929 1,620 1,192 1,105
Actuarial loss (gain).......................... 1,470 1,452 (652) (325)
Benefits paid.................................. (1,171) (845) (359) (349)
Change in actuarial assumptions................ 1,126 3,351 722 2,339
------------ ------------ ------------ ------------
Benefit obligation at end of year........... $ 31,148 $ 25,690 $ 19,962 $ 17,934
------------ ------------ ------------ ------------
PENSION POSTRETIREMENT
--------------------------- ---------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Change in plan assets:
Fair value of plan assets at beginning of year. $ 16,714 $ 17,707 $ -- $ --
Actual return on plan assets................... (1,707) (1,116) -- --
Employer contributions......................... 6,674 968 358 349
Benefits paid.................................. (1,171) (845) (358) (349)
------------ ------------ ------------ ------------
Fair value of plan assets at end of year.... $ 20,510 $ 16,714 $ -- $ --
------------ ------------ ------------ ------------
Funded status...................................... $ (10,638) $ (8,976) $ (19,962) $ (17,934)
Unrecognized transition asset...................... -- -- 5,024 5,443
Unrecognized prior service cost.................... 533 (18) -- --
Unrecognized net actuarial (gain) loss............. 11,881 6,631 879 810
------------ ------------ ------------ ------------
Accrued benefit cost........................ $ 1,776 $ (2,363) $ (14,059) $ (11,681)
============ ============ ============ ============
Net periodic benefit cost for the years ending December 31, 2002, 2001
and 2000, included the following components (in thousands):
PENSION POSTRETIREMENT
----------------------------------- -----------------------------------
2002 2001 2000 2002 2001 2000
---------- ---------- ---------- ---------- ---------- ----------
Service cost......................... $ 1,480 $ 1,077 $ 990 $ 1,125 $ 803 $ 646
Interest cost........................ 1,929 1,620 1,374 1,192 1,105 1,025
Expected return on plan assets....... 1,707 1,117 (1,449) -- -- --
Amortization of:
Net (loss) gain.................... (2,655) (2,543) (67) -- -- --
Unrecognized prior service cost.... 74 27 30 -- -- --
Unrecognized remaining assets...... -- (61) (61) 419 410 419
---------- ---------- ---------- ---------- ---------- ----------
Net periodic pension cost....... $ 2,535 $ 1,237 $ 817 $ 2,736 $ 2,318 $ 2,090
========== ========== ========== ========== ========== ==========
78
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
The weighted average actuarial assumptions used in the plan
determinations at December 31, 2002 and 2001 were as follows:
2002 2001 2002 2001
--------- --------- --------- ---------
Discount rate.............................................. 6.75% 7.00% 6.75% 7.00%
Rate of compensation increase.............................. 5.50 5.50 5.50 5.50
Expected return on plan assets............................. 8.00 8.00 -- --
Medical and life insurance benefits cost rate of increase.. -- -- 8.50 9.00
========= ========= ========= =========
Assumed health care cost trend rates have a significant effect on the
amounts reported for health care plans. A 1% change in the assumed
health care cost trend rate would have the following effects on
postretirement benefits (in thousands):
1% INCREASE 1% DECREASE
---------------- ----------------
Effect on total service cost and interest cost.......... $ 405 $ (345)
Effect on postretirement benefits obligation............ 2,875 (2,495)
================ ================
The Bank has a savings incentive plan covering substantially all
employees of the Bank. Contributions were made by the Bank in an amount
equal to 115% of employee contributions, this amount was effective
until December 27, 2002. Effective December 30, 2002 the match was
reduced to 100%. The contribution percentage is determined quarterly by
the Board of Managers. Bank contributions for the years of 2002, 2001,
and 2000 were $1,264,964, $1,379,000, and $1,191,000, respectively.
The Bank also maintains a nonqualified supplemental retirement plan for
certain senior officers of the Bank. The plan, which is unfunded,
provides benefits in excess of that permitted to be paid by the pension
plan under provisions of the tax law. Amounts expensed under this
supplemental retirement plan amounted to $279,220, $122,000, and
$27,000 for the years 2002, 2001 and 2000, respectively. At December
31, 2002, 2001 and 2000, $1,142,299, $901,000 and $581,000,
respectively, is recorded in other liabilities on the consolidated
statements of condition for this supplemental retirement plan.
(13) INCOME TAXES
The current and deferred amounts of income tax expense (benefit) for
the years ended December 31, 2002, 2001 and 2000 are as follows (in
thousands):
YEARS ENDED DECEMBER 31
-------------------------------------------------
2002 2001 2000
-------------- -------------- --------------
Current:
Federal................................ $ 10,168 $ 14,362 $ 10,030
State.................................. 600 23 54
-------------- -------------- --------------
Total current....................... 10,768 14,385 10,084
-------------- -------------- --------------
Deferred:
Federal................................ 517 (3,302) (801)
State.................................. (1,023) -- --
Change in state deferred tax rate, net. (1,031) -- --
-------------- -------------- --------------
Total deferred...................... (1,537) (3,302) (801)
-------------- -------------- --------------
$ 9,231 $ 11,083 $ 9,283
============== ============== ==============
The Bank also recorded a deferred expense (benefit) of $5,401,000,
$3,051,000 and $3,376,000 during the years 2002, 2001 and 2000,
respectively, to reflect the tax effect of the unrealized (loss) gain
on securities available for sale
79
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
Reconciliation between the amount of reported total income tax expense
and the amount computed by multiplying the applicable statutory income
tax rate is as follows (in thousands):
YEARS ENDED DECEMBER 31
------------------------------------
2002 2001 2000
---------- ---------- ----------
Tax expense at statutory rate of 35%.................... $ 12,534 $ 12,308 $ 10,563
Increase (decrease) in taxes resulting from:
State tax, net of federal income tax benefit......... (275) 15 35
Tax-exempt income.................................... (1,180) (1,005) (873)
Goodwill............................................. -- 410 410
Bank-owned life insurance............................ (1,004) (965) (712)
Other, net........................................... 187 320 (140)
---------- ---------- ----------
$ 9,231 $ 11,083 $ 9,283
========== ========== ==========
The net deferred tax asset is included in other assets in the 2002, and
2001 consolidated statements of condition. The tax effects of temporary
differences that give rise to significant portions of the deferred tax
assets and deferred tax liabilities at December 31, 2002 and 2001 are
as follows (in thousands):
2002 2001
---------------- ----------------
Deferred tax assets:
Deferred fee income.......................... $ 407 $ 307
Allowance for loan losses.................... 8,487 8,326
Postretirement benefit....................... 5,799 4,467
Deferred compensation........................ 343 563
Pension expense.............................. -- 588
Intangibles.................................. 2,053 1,764
Depreciation................................. 2,119 1,995
SERP......................................... 467 349
Deferred gain................................ 267 311
Other........................................ 833 180
---------------- ----------------
Total gross deferred tax assets............ 20,775 18,850
---------------- ----------------
Deferred tax liabilities:
Tax reserves for loan losses................. $ 165 $ 306
Unrealized gain on securities................ 8,217 2,816
Investment securities, principally due to
accretion of discounts...................... 476 486
Prepaid pension.............................. 626 --
Originated mortgage servicing rights......... 486 512
Other........................................ 251 312
---------------- ----------------
Total gross deferred tax liabilities....... 10,221 4,432
---------------- ----------------
Net deferred tax asset..................... $ 10,554 $ 14,418
================ ================
Legislation was enacted in August 1996 which repealed for tax purposes
the reserve method for bad debts. As a result, the Bank must instead
use the direct charge-off method to compute its bad debt deduction. The
legislation requires the Bank to recapture its post-1987 net additions
to its tax bad debt reserves. The Bank has previously provided for this
liability in the consolidated financial statements.
Equity at December 31, 2002 includes approximately $33,700,000 for
which no provision for income tax has been made. This amount represents
an allocation of income to bad debt deductions for tax purposes
80
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
only. Events that would result in taxation of these reserves include
failure to qualify as a bank for tax purposes, distributions in
complete or partial liquidation, stock redemptions and excess
distributions to shareholders. At December 31, 2002 the Bank has an
unrecognized tax liability of $13,900,000 with respect to this reserve.
Management has determined that it is more likely than not that it will
realize the deferred tax assets based upon the nature and timing of the
items listed above. There can be no assurances, however, that there
will be no significant differences in the future between taxable income
and pretax book income if circumstances change. In order to fully
realize the net deferred tax asset, the Bank will need to generate
future taxable income. Management has projected that the Bank will
generate sufficient taxable income to utilize the net deferred tax
asset; however, there can be no assurance as to such levels of taxable
income generated.
(14) LEASE COMMITMENTS
On December 28, 2001, the Bank simultaneously sold its office building
at 895 Bergen Avenue, Jersey City, New Jersey and agreed in separate
lease contracts to lease back office space in this building. The
Company recorded a deferred gain of $818,000 on the sale of this
building. This gain is recognized as a reduction of rent expense over
the remaining lives of these lease contracts which has a term of five
years.
The approximate future minimum rental commitments for all significant
noncancellable operating leases at December 31, 2002 are summarized as
follows (in thousands):
Year ending December 31, 2002:
2003 $ 1,912
2004 1,928
2005 1,837
2006 1,858
Thereafter 22,303
$ 29,838
===================
Rental expense was $2,269,000, $1,812,000 and $1,807,000 and for the
years ended December 31, 2002, 2001 and 2000, respectively.
(15) COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF CREDIT RISK
In the normal course of business, various commitments and contingent
liabilities are outstanding which are not reflected in the accompanying
consolidated financial statements. In the opinion of management, the
consolidated financial position of the Bank will not be materially
affected by the outcome of such commitments or contingent liabilities.
During 2000, the Bank settled an outstanding litigation matter for
$3,675,000 and recorded such amount in other operating expenses in the
consolidated statements of income. In addition, during 2000, the Bank
entered into a merger agreement with another bank. Subsequent to the
merger agreement, the other bank rescinded the agreement and paid the
Bank a $1,000,000 break-up fee, which is recorded in other income in
the consolidated statements of income.
The Bank previously entered into a long-term data processing contract.
In exchange for certain data processing services, the Bank paid a fee
of $5,848,530, $6,257,000 and $5,237,000 the years ended December 31,
2002, 2001 and 2000, respectively.
A substantial portion of the Bank's loans are one- to four-family
residential first mortgage loans secured by real estate located in New
Jersey. Accordingly, the collectibility of a substantial portion of the
Bank's loan portfolio and the recovery of a substantial portion of the
carrying amount of other real estate owned are susceptible to changes
in real estate market conditions.
81
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
The Company has entered into employment agreements with three
executives upon completion of the Conversion. Each of these agreements
has a term of thirty-six months. The agreements renew for an additional
year beginning on the first anniversary date of the agreement, and on
each anniversary date thereafter, so that the remaining term is
thirty-six months. In the event the executive's employment is
terminated for reasons other than for cause, for retirement or for
disability or following a change in control the executive would be
entitled to a lump sum payment equivalent to the greater of: the
payments due for the remaining term of the employment agreement, or
three times the sum of (i) the highest annual rate of base salary and
(ii) the greater of the average bonus paid over the last three years or
the cash bonus paid in the last year, as well as continuation of life,
medical, dental and disability insurance coverage for three years. The
agreements generally provide that following a change in control (as
defined in the agreement), the executive will receive the severance
payments and insurance benefits described above if he resigns during
the one-year period following the change in control or if the executive
is terminated during the remaining term of the employment agreement
following the change in control. The executives would receive an
aggregate of $5.3 million pursuant to the employment agreements upon a
change of control of the Company based upon current levels of
compensation.
The FDIC recently conducted an examination relating to our compliance
with various federal banking regulations, which examination was
unrelated to safety and soundness. The FDIC noted weaknesses and
failures relating to our compliance with the reporting requirements of
the Home Mortgage Disclosure Act. The Home Mortgage Disclosure Act
imposes on financial institutions reporting obligations relating to
home purchase and home improvement loans originated or purchased, or
for which the financial institution receives applications. This loan
data is used by regulatory agencies to help determine whether a
financial institution is serving the housing needs of the communities
it serves, to assist public officials in the distribution of public
sector investments where it is needed, and to assist federal bank
regulators in identifying possible discriminatory lending patterns.
We have taken action and implemented procedures to redress the FDIC's
concerns and findings, including the refiling with the FDIC of our Home
Mortgage Disclosure Act data for 2000 and 2001. The FDIC has issued a
final report of examination and we anticipate that the FDIC will
require us to implement corrective actions and may also require a
memorandum of understanding with The Provident Bank to ensure that
corrective actions are taken and continue in the future and may impose
civil money penalties in connection with our refiling of Home Mortgage
Disclosure Act data. If we are required to enter into a memorandum of
understanding with the FDIC and in the future fail to comply with any
such agreement, we could be subject to further regulatory action,
including restrictions on our ability to expand through bank and branch
acquisitions and possible monetary penalties.
(16) REGULATORY CAPITAL REQUIREMENTS
FDIC regulations require banks to maintain minimum levels of regulatory
capital. Under the regulations in effect at December 31, 2002 and 2001,
the Bank is required to maintain (i) a minimum leverage ratio of Tier 1
capital to total adjusted assets of 4.0%, and (ii) minimum ratios of
Tier 1 and total capital to risk-weighted assets of 4.0% and 8.0%,
respectively.
Under its prompt corrective action regulations, the FDIC is required to
take certain supervisory actions (and may take additional discretionary
actions) with respect to an undercapitalized institution. Such actions
could have a direct material effect on the institution's financial
statements. The regulations establish a framework for the
classification of savings institutions into five categories: well
capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. Generally, an
institution is considered well capitalized if it has a leverage (Tier
1) capital ratio of at least 5.0%; a Tier 1 risk-based capital ratio of
at least 6.0%; and a total risk-based capital ratio of at least 10.0%.
The foregoing capital ratios are based in part on specific quantitative
measures of assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. Capital amounts and
82
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
classifications are also subject to qualitative judgments by the FDIC
about capital components, risk weightings and other factors.
Management believes that, as of December 31, 2002 and 2001, the Bank
meets all capital adequacy requirements to which it is subject.
Further, the most recent FDIC notification categorized the Bank as a
well-capitalized institution under the prompt corrective action
regulations. There have been no conditions or events since that
notification that management believes have changed the Bank's capital
classification.
The following is a summary of the Bank's actual capital amounts and
ratios as of December 31, 2002, and 2001, compared to the FDIC minimum
capital adequacy requirements and the FDIC requirements for
classification as a well-capitalized institution. The Bank's actual
capital amounts and ratios are also presented in the following table
(in thousands).
TO BE WELL CAPITALIZED
UNDER PROMPT
FOR CAPITAL ADEQUACY CORRECTIVE ACTION
ACTUAL PURPOSES PROVISIONS
----------------------- ----------------------- -----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------ ------- ------------ ------- ------------ -------
As of December 31, 2002:
Leverage (Tier 1)............ $ 291,294 8.98% $ 129,755 4.00% $ 162,194 5.00%
Risk-based capital:
Tier 1..................... 291,294 12.42 93,799 4.00 140,698 6.00
Total...................... 312,459 13.32 187,598 8.00 234,497 10.00
============ ======= ============ ======= ============ =======
TO BE WELL CAPITALIZED
UNDER PROMPT
FOR CAPITAL ADEQUACY CORRECTIVE ACTION
ACTUAL PURPOSES PROVISIONS
----------------------- ----------------------- -----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------ ------- ------------ ------- ------------ -------
As of December 31, 2001:
Leverage (Tier 1)............ $ 263,389 9.41% $ 112,057 4.00% $ 140,071 5.00%
Risk-based capital:
Tier 1..................... 263,389 13.06 77,838 4.00 116,756 6.00
Total...................... 285,298 14.15 155,675 8.00 194,594 10.00
============ ======= ============ ======= ============ =======
(17) FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments," requires that the Bank disclose
estimated fair values for its financial instruments. Fair value
estimates, methods and assumptions are set forth below for the Bank's
financial instruments.
CASH AND CASH EQUIVALENTS
For cash and due from banks, federal funds sold and short term
investments, the carrying amount approximates fair value.
INVESTMENT SECURITIES AND SECURITIES AVAILABLE FOR SALE
The fair value of investment securities and securities available for
sale is estimated based on bid quotations received from securities
dealers, if available. If a quoted market price is not available, fair
value is estimated using quoted market prices of similar instruments,
adjusted for differences between the quoted instruments and the
instruments being valued.
83
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
LOANS
Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as
residential mortgage, construction, land and consumer. Each loan
category is further segmented into fixed and adjustable rate interest
terms and into performing and nonperforming categories.
The fair value of performing loans is estimated using a combination of
techniques, including discounting estimated future cash flows and
quoted market prices of similar instruments, where available.
The fair value for significant nonperforming loans is based on recent
external appraisals of collateral securing such loans, adjusted for the
timing of anticipated cash flows.
DEPOSITS
The fair value of deposits with no stated maturity, such as
non-interest bearing demand deposits and savings deposits, is equal to
the amount payable on demand. The fair value of certificates of deposit
is based on the discounted value of contractual cash flows. The
discount rate is estimated using the rates currently offered for
deposits with similar remaining maturities.
BORROWED FUNDS
The fair value of borrowed funds is estimated by discounting future
cash flows using rates available for debt with similar terms and
maturities.
COMMITMENTS TO EXTEND CREDIT
The fair value of commitments to extend credit is estimated using the
fees currently charged to enter into similar agreements, taking into
account the remaining terms of the agreements and the present
creditworthiness of the counterparties. For fixed rate loan
commitments, fair value also considers the difference between current
levels of interest rates and the committed rates.
The estimated fair values of the Bank's financial instruments as of
December 31, 2002 and 2001 are presented in the following table (in
thousands). Since the fair value of off-balance-sheet commitments
approximates book value, these disclosures are not included.
2002 2001
---------------------------- ----------------------------
CARRYING CARRYING
VALUE FAIR VALUE VALUE FAIR VALUE
------------- ------------- ------------- -------------
Financial assets:
Cash and cash equivalents..... $ 264,855 $ 264,855 $ 107,403 $ 107,403
Securities available for sale. 1,242,118 1,242,118 494,716 494,716
Investment securities......... 216,119 221,435 112,951 114,042
FHLB stock.................... 13,356 13,356 12,555 12,555
Loans......................... 2,031,869 2,135,585 1,994,636 1,999,805
Financial liabilities:
Deposits...................... 3,243,334 3,250,663 2,341,723 2,348,411
Borrowed funds................ 323,081 328,664 195,767 197,047
============= ============= ============= =============
LIMITATIONS
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial
instrument. These estimates do not reflect any premium or discount that
could result from offering for sale at one time the Bank's entire
holdings of a particular financial instrument. Because no market exists
for a significant portion of the Bank's financial instruments, fair
value estimates are based on judgments regarding future expected loss
experience, current economic
84
THE PROVIDENT BANK AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2002, 2001 and 2000
conditions, risk characteristics of various financial instruments, and
other factors. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and, therefore,
cannot be determined with precision. Changes in assumptions could
significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance-sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities
that are not considered financial instruments. Significant assets and
liabilities that are not considered financial assets or liabilities
include the mortgage banking operation, deferred tax assets, and
premises and equipment. In addition, the tax ramifications related to
the realization of the unrealized gains and losses can have a
significant effect on fair value estimates and have not been considered
in the estimates.
(18) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables are a summary of certain quarterly financial data
for the years ended December 31, 2002 and 2001.
2002 QUARTER ENDED
-----------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------------- -------------- -------------- --------------
(In thousands)
Interest income............................... $ 43,693 $ 44,579 $ 45,028 $ 44,076
Interest expense.............................. 16,252 15,841 16,039 15,109
-------------- -------------- -------------- --------------
Net interest income.................... 27,441 28,738 28,989 28,967
Provision for loan losses..................... 600 600 11,050 550
-------------- -------------- -------------- --------------
Net interest income after provision
for loan losses....................... 26,841 28,138 17,939 28,417
Non-interest income........................... 6,035 5,943 5,722 6,378
Non-interest expense.......................... 21,532 23,094 20,993 23,468
-------------- -------------- -------------- --------------
Income before income tax expense (benefit)
and the cumulative effect of a change in
accounting principle....................... 11,344 10,987 2,668 11,327
Income tax expense (benefit).................. 3,382 3,404 (983) 3,428
-------------- -------------- -------------- --------------
Income before the cumulative effect of a
change in accounting principle............. 7,962 7,583 3,651 7,899
Cumulative effect of a change in accounting
principle, net of tax of $0................ (519) -- -- --
-------------- -------------- -------------- --------------
Net income............................. $ 7,443 $ 7,583 $ 3,651 $ 7,899
============== ============== ============== ==============
2001 QUARTER ENDED
-----------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------------- -------------- -------------- --------------
(In thousands)
Interest income............................ $ 45,128 $ 45,607 $ 45,536 $ 44,708
Interest expense........................... 22,831 22,486 20,996 18,210
-------------- -------------- -------------- --------------
Net interest income.................... 22,297 23,073 24,540 26,506
Provision for loan losses.................. 600 600 400 300
-------------- -------------- -------------- --------------
Net interest income after provision for
loan losses........................... 21,697 22,473 24,140 26,206
Non-interest income........................ 5,296 5,125 4,746 6,069
Non-interest expense....................... 18,584 19,532 20,172 22,341
-------------- -------------- -------------- --------------
Income before income tax expense....... 8,409 8,066 8,754 9,934
Income tax expense......................... 2,651 2,476 2,850 3,106
-------------- -------------- -------------- --------------
Net income............................. $ 5,758 $ 5,590 $ 5,904 $ 6,828
============== ============== ============== ==============
85
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
DIRECTORS
The Board of Directors of Provident Financial Services, Inc. is divided
into three classes and is elected by stockholders of Provident Financial
Services, Inc. for staggered three-year terms, or until their successors are
elected and qualified. No director shall serve beyond the annual meeting of
stockholders following his attaining the age of seventy-two, regardless of
whether or not his term has expired. The following table sets forth certain
information regarding the composition of the Board of Directors of Provident
Financial Services, Inc. as of December 31, 2002, including when each began
serving as a director of The Provident Bank and their terms of office:
BANK
DIRECTOR
DIRECTORS AGE POSITION SINCE TERM EXPIRES
- ------------------- ------- ------------------------------- ---------- ------------
Paul M. Pantozzi 58 Chairman of the Board, Chief 1989 2004
Executive Officer and President
J. Martin Comey 68 Director 1975 2003
Geoffrey M. Connor 56 Director 1996 2003
Frank L. Fekete 51 Director 1995 2004
Carlos Hernandez 53 Director 1996 2005
William T. Jackson 64 Director 1974 2005
David Leff 69 Director 1992 2004
Arthur R. McConnell 64 Director 1990 2005
Edward O'Donnell 52 Director 2002 2003
Daniel T. Scott 58 Director 1987 2004
Thomas E. Sheenan 67 Director 1990 2003
The Business Background of Our Directors. The business experience for
the past five years of each of our directors is as follows:
Paul M. Pantozzi. Mr. Pantozzi has been the Chief Executive Officer and
President of The Provident Bank since 1993 and Chairman since 1998.
J. Martin Comey. Mr. Comey is retired. He previously served as Vice
President of the Schering Plough Corp. of Madison, New Jersey.
Geoffrey M. Connor. Mr. Connor is a practicing attorney and Partner in
the Princeton, New Jersey office of the law firm of Reed Smith LLP.
Frank L. Fekete. Mr. Fekete is a certified public accountant and the
Managing Partner of the accounting firm of Mandel, Fekete & Bloom, CPAs, located
in Jersey City, New Jersey.
Carlos Hernandez. Mr. Hernandez is President of New Jersey City
University, located in Jersey City, New Jersey.
William T. Jackson. Mr. Jackson is Executive Director of Bayview/New
York Cemetery located in Jersey City, New Jersey.
86
David Leff. Mr. Leff is retired. He was previously a Partner in the law
firm of Eichenbaum, Kantrowitz, Leff & Gulko, located in Paramus, New Jersey.
Arthur R. McConnell. Mr. McConnell is the President of McConnell
Realty, located in Atlantic Highlands, New Jersey.
Edward O'Donnell. Mr. O'Donnell is President of Tradelinks Transport,
Inc., a transportation consulting company located in Westfield, New Jersey. From
March 1995 to July 1999, Mr. O'Donnell was a Director and Executive Vice
President of NPR, Inc. (Navieras), a transportation company located in Edison,
New Jersey.
Daniel T. Scott. Mr. Scott is the Chairman and Chief Executive Officer
of Scott Printing Corp., located in New Providence, New Jersey, and of Unz &
Co., Inc., Central Avenue Corporation and Scott On-Site, Inc.
Thomas E. Sheenan. Mr. Sheenan is the President of Sheenan Funeral Home
located in Dunellen, New Jersey.
EXECUTIVE OFFICERS OF PROVIDENT FINANCIAL SERVICES, INC. OR THE PROVIDENT BANK
WHO ARE NOT DIRECTORS
The business experience for the past five years of each of the
executive officers of Provident Financial Services, Inc. or The Provident Bank,
other than Mr. Pantozzi, is set forth below:
Kevin J. Ward. Mr. Ward has been Executive Vice President and Chief
Operating Officer of The Provident Bank since 2000. He served as Executive Vice
President, Chief Operating Officer and Chief Financial Officer of The Provident
Bank from January to November 2000. Prior to that time, he was Executive Vice
President and Chief Financial Officer of The Provident Bank.
Glenn H. Shell. Mr. Shell has been Executive Vice President of the
Customer Management Group of The Provident Bank since 2002. Prior to that time,
he served as Executive Vice President and Chief Lending Officer of The Provident
Bank.
Gregory French. Mr. French has been Senior Vice President of the Market
Development Group of The Provident Bank since February 2001. He was Vice
President of Marketing, eBusiness for American International Group in New York,
New York from January 2000 to February 2001. Prior to that time he served as
Vice President, Citibank National Director, Field Marketing of Citigroup in New
York, New York.
C. Gabriel Haagensen. Mr. Haagensen has served as Executive Vice
President - Human Capital Management of The Provident Bank since 2000. Prior to
that time he was Executive Vice President - Operations.
Kenneth J. Wagner. Mr. Wagner has been Senior Vice President of
Strategic Business Development of The Provident Bank since 2001. He served as
Senior Vice President of Customer Relationship Management of The Provident Bank
from 1998 to 2001. Prior to that time he was Senior Vice President and
Comptroller of The Provident Bank.
Linda A. Niro. Ms. Niro has served as Senior Vice President and Chief
Financial Officer of The Provident Bank since 2000. Prior to that time, she
served as Vice President and Treasurer of The Provident Bank.
John F. Kuntz. Mr. Kuntz has been Senior Vice President and General
Counsel of The Provident Bank since November 2002. Prior to that he was Vice
President and General Counsel of The Provident Bank since September 2001. He was
Vice President and Assistant General Counsel of Mellon Investor Services LLC in
Ridgefield Park, New Jersey from August 2000 to September 2001. Prior to that
time he was a Partner with the law firm of Bourne Noll & Kenyon P.C., Summit,
New Jersey.
MEETINGS OF THE BOARD OF DIRECTORS AND COMMITTEES
Provident Financial Services, Inc. did not begin its business
operations until January 15, 2003, the effective date of the conversion of The
Provident Bank from mutual to stock form. The Board of Directors of Provident
87
Financial Services, Inc. met once in 2002. The Board of Directors of Provident
Financial Services, Inc. will meet quarterly, or more often as may be necessary.
The Board of Directors maintains a compensation committee, audit committee and a
governance/nominating committee. Each of the compensation committee, audit
committee and governance/nominating committee will be comprised solely of
independent directors within the meaning of the rules of the New York Stock
Exchange. The Board of Directors may, by resolution, designate one or more
additional committees.
The Board of Directors of The Provident Bank meets on a monthly basis
and may hold additional special meetings. During 2002, the Board of Directors of
The Provident Bank held twelve regular meetings, two special meetings and one
annual meeting. The Board of Directors of The Provident Bank currently maintains
an Executive Committee and Directors Trust Committee. During 2002, The Board of
Directors of The Provident Bank also maintained an Examining Committee.
The Executive Committee consists of Directors Comey, Jackson, Pantozzi,
Scott and a fifth director that changes on a monthly basis, with Mr. Pantozzi
serving as Chair. The Executive Committee exercises general control and
supervision of all matters pertaining to The Provident Bank, subject at all
times to the direction of the Board of Directors. The Executive Committee met 27
times during the year ended December 31, 2002.
The Examining Committee (now the Audit Committee of the Board of
Directors of Provident Financial Services, Inc.) consists of Directors Fekete,
McConnell, O'Donnell and Sheenan, with Director Fekete serving as Chair. The
Examining Committee reviews the annual audit prepared by the independent
accountants, recommends the appointment of accountants, reviews the internal
audit function and reviews internal accounting controls. The Examining Committee
met 8 times during the year ended December 31, 2002.
The Directors Trust Committee consists of Directors Hernandez, Connor,
McConnell and Pantozzi, as well as the Executive Vice President, Customer
Management Group and the Vice President and Senior Trust Officer, with Director
Hernandez serving as Chair. The Directors Trust Committee oversees the
operations of the Trust Department of The Provident Bank. The Directors Trust
Committee met 4 times during the year ended December 31, 2002.
DIRECTOR COMPENSATION
Provident Financial Services, Inc. pays to each director a fee of
$1,000 per board meeting attended. The director members of the Audit Committee,
Compensation Committee, and the Governance/Nominating Committee receive $800 for
each committee meeting attended. The Chair of the Audit Committee receives
$1,500 for each committee meeting attended. The Chairs of the Compensation
Committee and the Governance/Nominating Committee each receive $1,200 for each
committee meeting attended.
The Provident Bank pays to each non-employee director an annual
retainer of $21,000 and a fee of $1,000 per board meeting attended. Non-employee
members of the Executive Committee receive an additional annual retainer of
$25,000. The non-employee rotating director of the Executive Committee, and the
non-employee director members of the Directors Trust Committee receive $800 for
each committee meeting attended. The Chair of the Directors Trust Committee
receives $1,200 for each committee meeting attended. The Provident Bank pays the
premiums for a life insurance policy, in the face amount of $10,000, for each
non-employee director, until the director attains the age of 72 or has received
such benefit for ten years, whichever occurs later.
Retirement Plan for the Board of Directors of The Provident Bank. The
Provident Bank maintains the Retirement Plan for the Board of Directors of The
Provident Bank, a non-qualified plan which provides cash payments for up to ten
years to eligible retired board members based on age and length of service
requirements. The maximum payment under this plan to a board member who
terminates service on or after the age of seventy with at least ten years of
service on the board, is forty quarterly payments of $1,250. The Provident Bank
may suspend payment if it does not meet FDIC or New Jersey Department of Banking
and Insurance minimum capital requirements. The Provident Bank may terminate
this plan at any time although such termination may not reduce or eliminate any
benefit previously accrued to a board member without his consent. The plan has
been amended to provide that, in the event of a change in control (as defined in
the plan), the undistributed balance of a director's
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accrued benefit will be distributed to him within 60 days of the change in
control. For the year ended December 31, 2002, The Provident Bank paid $7,750 to
former board members under this plan.
Voluntary Fee Deferral Plan for the Board of Directors. The Provident
Bank maintains the Board of Directors Voluntary Fee Deferral Plan, a
non-qualified plan which provides for the deferral of board fees by non-employee
members of The Provident Bank's Board of Directors. Provident Financial
Services, Inc. intends to adopt a Board of Directors Voluntary Fee Deferral
Plan, a non-qualified plan which will provide for the deferral of board fees by
non-employee members of Provident Financial Services, Inc.'s Board of Directors.
Board members may elect to defer board fees to a future year as determined by
that board member, so long as the distribution of such fees does not begin
beyond the year of the board member's normal retirement date. Deferred fees are
credited to an account established for the benefit of each participant which
receives interest at the prevailing prime rate. A participating board member may
receive the deferral payments pursuant to his election in a lump sum or over a
three year period, except in the event of a change in control, death or
disability, under which circumstances a lump sum payment shall be made. In
connection with the conversion and offering, The Provident Bank Voluntary Fee
Deferral Plan was amended to allow current board members a one-time election to
invest their account balances in shares of Provident Financial Services, Inc.
common stock. The amendment also provides that in the event of a change in
control (as defined in the plan), the undistributed balance of a participant's
separate account will be distributed within 60 days of the change in control. As
of December 31, 2002, The Provident Bank had accounts totaling $941,932.62 on
behalf of four present or former board members who participate in this plan.
ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE OFFICER COMPENSATION
Summary Compensation Table. The following table sets forth for the
years ended December 31, 2002 and 2001, certain information as to the total
remuneration paid by The Provident Bank to its Chief Executive Officer, as well
as to the four most highly compensated executive officers of The Provident Bank,
other than the Chief Executive Officer, who received total annual compensation
in excess of $100,000. Each of the individuals listed in the table below are
referred to as a Named Executive Officer.
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ANNUAL COMPENSATION
------------------------------------------------
OTHER ANNUAL ALL OTHER
COMPENSATION LTIP COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS (2) (3) PAYOUTS (4)
- --------------------------------- ------- --------- ---------- ------------ ------- ------------
Paul M. Pantozzi 2002 $ 560,000 $ 473,760 $ 66,693 $ 49,323
Chairman, Chief Executive 2001 $ 500,000 $ 375,000 $ 53,440 -- $ 51,503
Officer and President
Kevin J. Ward 2002 270,300 96,893 29,876
Executive Vice President 2001 255,000 99,450 -- -- 31,302
and Chief Operating
Officer
Glenn H. Shell 2002 238,500 71,704 26,047
Executive Vice President, 2001 225,000 92,250 -- -- 27,405
Customer Management Group
Gregory French 2002 223,000 57,466 24,236
Senior Vice President, 2001 177,692(1) 101,425 -- -- 27,202
Market Development
Group
C. Gabriel Haagensen 2002 196,100 42,112 21,320
Executive Vice President, 2001 185,000 50,413 -- -- 22,432
Human Capital
Management
- ----------
(1) Mr. French was initially employed as Senior Vice President in February 2001
at an annual salary of $210,000.
(2) Bonus payments earned pursuant to the Incentive Program for Senior
Executives of The Provident Bank. In addition, Mr. French received a
signing bonus of $40,000 in February 2001.
(3) The Provident Bank provides certain of its executive officers with non-cash
benefits and perquisites, such as the use of employer-owned automobiles,
club membership dues and certain other personnel benefits. Management
believes that the aggregate value of these benefits for 2001 and 2002 did
not, in the case of any Named Executive Officer, exceed $50,000 or 10% of
the aggregate salary and annual bonus reported for him in the Summary
Compensation Table except for Mr. Pantozzi, who had $53,440 in 2001 and
$66,693 in 2002 of such benefits including a stipend of $18,000 for 2001
and 2002, club membership dues of $17,500 in 2001 and $24,000 in 2002 and
automobile-related expenses of $17,940 in 2001 and $24,693 in 2002.
(4) Includes the following components: (i) employer payment of health insurance
premiums of $9,763, $8,444, $7,154, $9,763 and $5,700 for Messrs. Pantozzi,
Ward, Shell, French and Haagensen in 2001 and $10,383, $8,980, $7,564,
$10,383 and $6,055 in 2002, respectively and; (ii) employer payment of
dental insurance premiums of $380 in 2001 and 2002 each for Messrs.
Pantozzi, Ward, Shell, French and Haagensen, respectively; (iii) employer
payment of life insurance premiums of $4,560, $2,736, $2,451, $798 and
$2,029 in 2001 for Messrs. Pantozzi, Ward, Shell, French and Haagensen,
respectively and $4,560, $3,082, $2,719, $2,542 and $2,236 in 2002 for
Messrs. Pantozzi, Ward, Shell, French and Haagensen, respectively, and;
(iv) employer payment of long term disability insurance premiums of $1,800,
$1,892, $1,670, $1,561 and $1,373 in 2001 and 2002 for Messrs. Pantozzi,
Ward, Shell, French and Haagensen, respectively; (v) employer contributions
to the Savings Incentive Plan of $11,900 each for Messrs. Pantozzi, Ward,
Shell and Haagensen in 2001, respectively and a payment in lieu of first
year participation in the Savings Incentive Plan of $14,700 to Mr. French;
and in 2002 employer contributions to the Savings Incentive Plan of $9,775
each for Messrs. Pantozzi, Ward, Shell and Haagensen and 9,370 for Mr.
French; and (vi) employer contribution to the Supplemental Executive
Savings Plan of $23,100, $5,950, $3,850, $0 and $1,050 in 2001 for Messrs.
Pantozzi, Ward, Shell, French and Haagensen, respectively and employer
contribution to the Supplemental Executive Savings Plan of $22,425, $5,767,
$3,939, $0 and $1,501 in 2002 for Messrs. Pantozzi, Ward, Shell, French and
Haagensen, respectively.
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EMPLOYMENT AGREEMENTS
Provident Financial Services, Inc. entered into employment agreements
with Messrs. Pantozzi, Ward and Shell, which became effective upon completion of
the conversion. Each of these agreements has a term of thirty-six months. The
agreements renew for an additional year beginning on the first anniversary date
of the agreement, and on each anniversary date thereafter, so that the remaining
term is thirty-six months. However, if timely written notice of nonrenewal is
provided to the executive, the employment under the agreement ceases at the end
of thirty-six months following such anniversary date. On an annual basis, the
Board of Directors of Provident Financial Services, Inc. shall conduct a
performance review of the executive for purposes of determining whether to
provide a notice of nonrenewal. Under the agreements, the base salaries for
Messrs. Pantozzi, Ward and Shell are $600,000, $290,000 and $245,500,
respectively. In addition to the base salary, each agreement provides for, among
other things, participation in bonus programs, and other employee pension
benefit and fringe benefit plans applicable to executive employees. In addition,
the agreements provide for reasonable vacation and sick leave, reimbursement of
certain club membership fees incurred by each executive and the use of a
company-owned automobile. The agreements provide for termination by Provident
Financial Services, Inc. for cause at any time, in which event, the executive
would have no right to receive compensation or other benefits for any period
after termination. In the event the executive's employment is terminated for
reasons other than for cause, for retirement or for disability or following a
change in control the executive would be entitled to a lump sum payment
equivalent to the greater of: the payments due for the remaining term of the
employment agreement, or three times the sum of (i) the highest annual rate of
base salary and (ii) the greater of (x) the average cash bonus paid over the
last three years or (y) the cash bonus paid in the last year, as well as the
continuation of life, medical, dental and disability insurance coverage for
three years. The executive may resign from employment as a result of (i) a
material change in the nature or scope of the executive's function, duties or
responsibilities, (ii) a material reduction in benefits and perquisites,
including base salary, from those being provided as of the effective date of the
employment agreement, (iii) a relocation where the executive is required to
perform services at a location more than 25 miles from The Provident Bank's
principal executive offices, (iv) a failure to elect or reelect or to appoint or
reappoint executive to certain position(s) at Provident Financial Services, Inc.
or The Provident Bank, or to nominate or elect the Executive to the Board(s) of
Directors of Provident Financial Services, Inc. or The Provident Bank, (v) a
liquidation or dissolution of The Provident Bank or Provident Financial
Services, Inc., or (vi) a material breach of the employment agreement by The
Provident Bank or Provident Financial Services, Inc. as of the effective date of
the employment agreement and be entitled to the severance benefits described
above. The agreement generally provides that following a change in control (as
defined in the agreement), the executive will receive the severance payments and
insurance benefits described above if he resigns during the one-year period
following the change in control or if he is terminated during the remaining term
of the employment agreement following the change in control. Messrs. Pantozzi,
Ward and Shell would receive an aggregate of $3,221,304, $1,160,679 and
$951,612, respectively, pursuant to their employment agreements upon a change in
control of Provident Financial Services, Inc., based upon current levels of
compensation.
Under each employment agreement, if an executive becomes disabled or
incapacitated to the extent that the executive is unable to perform his duties,
he will be entitled to 75% of his base salary and all comparable insurance
benefits until the earlier of: (i) return to full-time employment; (ii)
employment by another employer; (iii) age 65; or (iv) death. Upon retirement at
age 65 or in accordance with any retirement policy established with his consent,
the executive is entitled to benefits under such retirement policy and other
plans to which he is a party but shall not be entitled to any benefit payments
specifically as a result of the employment agreement.
CHANGE IN CONTROL AGREEMENTS
Provident Financial Services, Inc. entered into change in control
agreements with six other officers including Messrs. Blum (the Chief Lending
Officer of The Provident Bank), Kuntz, French and Haagensen, Ms. Niro and Ms.
Hynes (First Vice President-Employee Relations, The Provident Bank), which
provide certain benefits in the event of a change in control of The Provident
Bank or Provident Financial Services, Inc. Each of the change in control
agreements provides for a term of 24 months. Commencing on the first anniversary
date of the change in control agreement, and on each anniversary date
thereafter, the term of the change in control agreement extends for an addition
12 months unless the Board of Directors of Provident Financial Services, Inc.
provides the executive timely notice of nonrenewal. In the event notice of
nonrenewal is provided to the executive, the change in
91
control agreement terminates 24 months following the applicable anniversary
date. On an annual basis the Board of Directors of Provident Financial Services,
Inc. shall conduct a performance review of the executive for purposes of
determining whether to provide a notice of nonrenewal. The change in control
agreements enable Provident Financial Services, Inc. to offer to designated
officers certain protections against termination without cause in the event of a
"change in control." For these purposes, a "change in control" is defined
generally to mean: (i) approval by shareholders of a plan of reorganization,
merger or consolidation of The Provident Bank or Provident Financial Services,
Inc. where The Provident Bank or Provident Financial Services, Inc. is not the
surviving entity; (ii) changes to the Board of Directors of The Provident Bank
or Provident Financial Services, Inc. whereby individuals who constitute the
current Board cease to constitute a majority of the Board, subject to certain
exceptions; (iii) the acquisition of all or substantially all of the assets of
Provident Financial Services, Inc. or the beneficial ownership of 20% or more of
the voting securities of Provident Financial Services, Inc.; or (iv) a complete
liquidation or dissolution of Provident Financial Services, Inc. or The
Provident Bank or approval by the shareholders of Provident Financial Services,
Inc. of a plan for such dissolution or liquidation. These protections against
termination without cause in the event of a change in control are frequently
offered by other financial institutions, and Provident Financial Services, Inc.
may be at a competitive disadvantage in attracting and retaining key employees
if it does not offer similar protections. Although the change in control
agreements may have the effect of making a takeover more expensive to an
acquiror, we believe that the benefits of enhancing our ability to attract and
retain qualified management persons by offering the change in control agreements
outweighs any disadvantage of such agreements.
Following a change in control of Provident Financial Services, Inc. or
The Provident Bank, an officer is entitled to a payment under the change in
control agreement if the officer's employment is terminated during the term of
such agreement by Provident Financial Services, Inc. or The Provident Bank,
other than for cause, disability or retirement, as defined, or if the officer
terminates employment during the term of such agreement for good reason. Good
reason is generally defined to include the assignment of duties materially
inconsistent with the officer's positions, duties or responsibilities as in
effect prior to the change in control, a reduction in his annual compensation or
benefits, or relocation of his principal place of employment by more than 25
miles from its location immediately prior to the change in control, or a failure
of Provident Financial Services, Inc. to obtain an assumption of the agreement
by its successor. In the event that an officer who is a party to a change in
control agreement is entitled to receive severance payments pursuant to the
agreement, he will receive a cash payment equal to two times the highest level
of aggregate annualized base salary and other cash compensation paid to the
officer during the calendar year in which he was terminated or either of the
immediately preceding two calendar years. In addition to the severance payment,
each covered officer is generally entitled to receive life, health, dental and
disability coverage for the remaining term of the agreement. Notwithstanding any
provision to the contrary in the change in control agreement, payments under the
change in control agreements are limited so that they will not constitute an
excess parachute payment under Section 280G of the Internal Revenue Code.
BENEFIT PLANS
Employee Savings Incentive Plan. The Provident Bank maintains The
Provident Bank Employee Savings Incentive Plan, a tax-qualified defined
contribution plan generally covering employees who have worked at The Provident
Bank for one year in which they have 1,000 or more hours of service. Currently,
participants may contribute up to 5% of their compensation to the Savings
Incentive Plan on an after-tax basis. As of April 1, 2003, the Bank intends to
change the Savings Incentive Plan to a 401(k) plan. As a 401(k) plan,
participants will be able to contribute up to the maximum compensation amount
permitted by IRS regulations each year to the Savings Incentive Plan on a
pre-tax basis. For this purpose, compensation includes wages, salaries,
commissions of dedicated salespeople and overtime. Participants are immediately
vested in their personal contributions. In 2002, The Provident Bank matched 115%
of the total amount contributed by the participants. For the first quarter of
2003, the Bank will match 100% of the total amount contributed by the
participants, and for the remainder of the year, the Bank will match 75% of the
first 6% contributed by the participants. The Provident Bank may from time to
time amend the Savings Incentive Plan to provide for a different matching
contribution. Until December 30, 2002, participants became vested in the
employer matching contributions as follows: 33% at the end of the first calendar
year following the end of the first year of plan participation, 66% at the end
of the second calendar year following the end of the first year of plan
participation and 100% at the end of the third calendar year following the end
of the first year of plan participation. As of the plan year beginning December
31, 2002, participants will become vested in employer matching contributions as
follows: 33% after the completion of one year of service; 66% after the
92
completion of two years of service and 100% after the completion of three years
of service. In addition, participants' accounts generally become fully vested in
the matching contributions in the event of termination of employment due to
retirement, disability or death.
The Savings Incentive Plan permits participants to direct the
investment of their accounts into various investment options set forth under the
plan. In connection with the stock offering, the Savings Incentive Plan was
amended to offer participants the opportunity to invest in an "Employer Stock
Fund" which intends to purchase stock of Provident Financial Services, Inc. in
the stock offering, and after the stock offering, in the open market. Each
participant who directs the trustee to invest all or part of his account in the
Employer Stock Fund will have assets in his account applied to the purchase of
shares of Provident Financial Services, Inc.
Upon termination of employment due to retirement at age 65 or older, a
participant is eligible to receive the vested value of his account either in a
single sum payment or in approximately equal annual installments, for a period
not to exceed 10 years or the participant's estimated life expectancy. For a
participant who terminates employment for reasons other than retirement at age
65 or older, the form of distribution of his vested account generally will be in
the form of a single sum payment. In the event of the participant's death, the
value of the plan account will be paid to the participant's beneficiary in a
single cash payment.
Pension Plan. The Provident Bank maintains The Provident Bank Pension
Plan, a tax-qualified plan generally covering employees age 21 or older who have
worked at The Provident Bank for at least one year in which they have accrued
1,000 or more hours of service. The Provident Bank intends to freeze the Pension
Plan as of April 1, 2003. Once it is frozen, employees will not be entitled to
accrue additional benefits. In addition, employees hired after the freeze date
will not be eligible to enter the Plan. Pension Plan participants generally
become entitled to retirement benefits upon the later of attainment of age 65 or
the fifth anniversary of participation in the plan, which is referred to as the
normal retirement date. The normal retirement benefit is equal to 1.35% of the
participant's average final compensation up to the Average Social Security Level
plus 2% of the participant's average final compensation in excess of the Average
Social Security Level multiplied by the participant's years of credited service
to a maximum of 30 years.
Participants who have completed at least 5 years of vested service
generally become 100% vested in their accrued retirement benefits. Vested
retirement benefits generally will be paid beginning on the participant's normal
retirement date.
A participant may elect to retire prior to age 65 and receive early
retirement benefits if retirement occurs after completion of at least 5
consecutive years of vested service and attainment of age 55. If such an early
retirement is made, retirement benefits will begin on the first day of any month
during the 10 year period preceding his normal retirement date, as directed by
the retiring participant. If a participant elects to retire prior to both
attaining age 65 and completing 25 years of credited service his accrued pension
benefit will be reduced 3% per year for the first five years prior to age 65 and
5% thereafter to age 55. If a participant elects to retire early after both
attaining age 60 and completing 25 years of credited service his accrued pension
benefit will be unreduced. Any participant who terminated employment prior to
January 1, 2002 will receive an early pension benefit equal to the actuarial
equivalent of the annual amount of the normal pension that would otherwise have
been payable to the participant had he not elected to receive an early pension.
If the termination of service occurs after the normal retirement date, the
participant's benefits will begin on the participant's postponed retirement
date.
The standard form of benefit payment for a married participant is a 50%
joint and survivor benefit that is reduced actuarially and the standard form of
benefit payment for a non-married participant is a straight life benefit. A
non-married participant or a participant who has complied with the spousal
consent requirements may elect to receive payment of benefits in the following
optional forms: (a) straight life benefit; (b) 100% joint and survivor benefit;
(c) 50% joint and survivor benefit; or (d) period certain and life benefit.
In the event a participant who is married for at least one year and is
vested in the Pension Plan dies prior to his termination of service and after
age 55, his or her spouse will be entitled to one-half of the amount payable to
the participant had the participant elected to retire the day before his death
with the 50% joint and survivor benefit. If the participant dies prior to age
55, the retirement benefits payable to the participant's spouse will commence at
the time the participant would have reached age 55.
93
In the event a non-married participant dies before his or her
termination of service after both attaining age 55 and completing 20 years of
service, a monthly pension shall be paid to his beneficiary. The non-married
participant's beneficiary will be entitled to a monthly pension benefit equal to
one-half of the amount payable to the participant as if the participant had
retired on the first day of the month following his or her death, had been
married, and the spouse had been born on the same day as the participant.
Payments made to beneficiaries of non-married participants cease upon the
earlier of the beneficiary's death or the receipt of the 120th monthly payment.
If the total value of a pension payable directly to a participant or to
any other beneficiary under the Pension Plan is less than $5,000, as determined
by the Pension Plan's actuary, payment of such value shall automatically be made
in a single sum in lieu of such pension.
The following table indicates the annual retirement benefit that would
have been payable under the Pension Plan and the Supplemental Executive
Retirement Plan upon retirement at or after a participant's normal retirement
date in calendar year 2002, considering the average annual earnings and credited
service classifications specified below.
AVERAGE FINAL EARNINGS 15 YEARS 20 YEARS 25 YEARS 30 YEARS 35 YEARS (1)
- -------------------------------- ---------- ---------- ---------- ---------- ------------
$ 125,000...................... $ 33,212 $ 44,283 $ 55,354 $ 66,424 $ 66,424
150,000...................... 40,712 54,283 67,854 81,424 81,424
175,000...................... 48,212 64,283 80,354 96,424 96,424
200,000...................... 55,712 74,283 92,854 111,424 111,424
225,000...................... 63,212 84,283 105,354 126,424 126,424
250,000...................... 70,712 94,283 117,854 141,424 141,424
300,000...................... 85,712 114,283 142,854 171,424 171,424
400,000...................... 115,712 154,283 192,854 231,424 231,424
450,000...................... 130,712 174,283 217,854 261,424 261,424
500,000...................... 145,712 194,283 242,854 291,424 291,424
600,000...................... 175,712 234,283 292,854 351,424 351,424
- ----------
(1) The Pension Plan and the Supplemental Executive Retirement Plan do not
count service in excess of 30 years in the benefit formula.
Average final earnings is the average base salary, as reported in the
"Salary" column of the Summary Compensation Table, for the highest five
consecutive years during the final 10 years of employment. Tax laws impose a
limit ($200,000 for individuals retiring in 2002) on average final earnings that
may be counted in computing benefits under the Pension Plan and on the annual
benefits ($160,000 in 2002). The Pension Plan may also pay benefits accrued as
of January 1, 1994 based on tax law limits then in effect. For Messrs. Pantozzi,
Ward, Shell, and Haagensen, benefits based on average final earnings in excess
of this limit are payable under the Supplemental Executive Retirement Plan.
The benefits shown in the preceding table are annual benefits payable
in the form of a single life annuity and are not subject to any deduction for
Social Security benefits or other offset amounts. As of December 31, 2002, Mr.
Pantozzi had 39 years of service; Mr. Ward had 30 years of service; Mr. Shell
had 8 years of service; Mr. French had 1 year of service; and Mr. Haagensen had
22 years of service.
Supplemental Executive Retirement Plan. In January 1990, The Provident
Bank established the Supplemental Executive Retirement Plan, a non-qualified
retirement plan. Participation in the SERP is limited to executive management or
highly compensated employees as designated by the Board of Directors and
currently consists of Messrs. Pantozzi, Ward, Shell and Haagensen. The SERP pays
to each participant an amount equal to the amount which would have been payable
under the terms of the Pension Plan but for the limitations under Sections
401(a)(17) and 415 of the Internal Revenue Code of 1986, as amended, less the
amount payable under the terms of the Pension Plan. The Provident Bank intends
to freeze the SERP as of April 1, 2003. Once the SERP is frozen, employees will
not be entitled to accrue additional benefits. Amounts due from this Plan will
be paid on a
94
monthly basis beginning within 90 days following termination of employment, but
in no event before age 60, in the form of a qualified joint and 100% survivor
annuity for married participants and a single life annuity for non-married
participants. The plan has been amended to provide that in the event of a change
in control (as defined in the plan), the undistributed balance of an employee's
accrued benefit will be paid to him within 60 days of the change in control. For
the year ended December 31, 2002, The Provident Bank expensed $242,328, $29,890,
$7,002 and $0 relating to the SERP on behalf of Messrs. Pantozzi, Ward, Shell
and Haagensen, respectively.
Supplemental Executive Savings Plan. In January 1990, The Provident
Bank established the Supplemental Executive Savings Plan, a non-qualified plan
that provides additional benefits to certain participants whose benefits under
the Employee Savings Incentive Plan are limited by tax law limitations
applicable to tax-qualified plans. Participation in the Executive Savings Plan
is limited to executive management or highly compensated employees as designated
by the Board of Directors and currently consists of Messrs. Pantozzi, Ward,
Shell and Haagensen. The Executive Savings Plan contributes for each participant
an amount equal to the amount which would have been contributed under the terms
of the Savings Incentive Plan but for the limitations under Section 401(a)(17),
401(m) and 415 of the Code, less the amount actually contributed under the
Savings Incentive Plan. For employees who are employed by The Provident Bank on
or after January 1, 1998, The Provident Bank established an investment fund to
provide for payments due under this plan and allows participants to choose, with
the plan administrator's consent, from a variety of investment options. In
connection with the conversion and offering, the Supplemental Executive Savings
Plan has been amended to allow current employees a one-time election to invest
their account balances in shares of Provident Financial Services, Inc. common
stock. Any benefits payable under the Executive Savings Plan attributable to The
Provident Bank's contributions and the earnings on these contributions shall be
vested under the terms and conditions of the Savings Incentive Plan. If there is
a change in control, as defined in the Executive Savings Plan, the unpaid
balance of the account shall become 100% vested and will be distributed within
60 days thereof. As of December 31, 2002, The Provident Bank expensed $22,425,
$5,767, $3,939 and $1,501 relating to the Executive Savings Plan on behalf of
Messrs. Pantozzi, Ward, Shell and Haagensen, respectively. In connection with
the stock offering and adoption of the ESOP, the Supplemental Executive Savings
Plan has been amended to include a feature that would require a contribution for
each participant who also participates in the ESOP equal to the amount which
would have been contributed under the terms of the ESOP but for the limitations
under Section 401(a)(17) and 415 of the Code, less the amount actually
contributed under the ESOP. The benefit payable under this portion of the
Supplemental Executive Savings Plan may be calculated as if the contribution was
applied to the repayment of a loan obtained to purchase shares in the stock
offering, in substantially the same manner as under the ESOP. The amendment also
requires the distribution of shares equal to the value of a participants'
account balance attributable to the ESOP component of the plan at the same time
and in the same manner as the participant receives a distribution from the ESOP.
In the event of a change in control (as defined in the amendment), the amendment
requires that the undistributed balance of a participant's account be paid to
him or her within 60 days.
Voluntary Bonus Deferral Plan for the Chairman. The Provident Bank
maintains the Voluntary Bonus Deferral Plan for Mr. Pantozzi, a non-qualified
plan which provides for the deferral of his bonus payments. Mr. Pantozzi may
defer one-quarter, one-half or all of his bonus award for a period of five years
or until the attainment of age 65. The Bank established an investment fund to
provide for the payment of the deferred bonus awards due under this plan and
allows Mr. Pantozzi to choose, with the plan administrator's consent, from a
variety of investment options. Mr. Pantozzi will receive a lump sum payment upon
a change in control, as defined in the plan, and is eligible to apply for a
hardship distribution of some or all of his separate account, in the event of a
financial hardship. Mr. Pantozzi has never deferred any bonus payments pursuant
to this plan.
Voluntary Bonus Deferral Plan. The Provident Bank maintains the
Voluntary Bonus Deferral Plan, a non-qualified plan which provides for the
deferral of some or all of any bonus payments awarded under our management
incentive bonus program. An eligible employee may defer either one-half or all
of a bonus award for a period of 5 years or 10 years, or until the attainment of
age 60 or 65, but in no event may any amount be deferred beyond the year in
which such employee attains age 65. Deferred bonus awards are invested by The
Provident Bank board, in its sole discretion, in a portfolio of assets
consisting of any combination of obligations of the United States with
maturities not exceeding five years in duration. An eligible employee will
receive a lump sum payment upon a change in control, as defined in this plan,
and is eligible to apply for a hardship distribution of some or all of his
separate accounts. As of December 31, 2002, The Provident Bank had accounts
totaling $343,479 on behalf of seven participants in this plan.
95
Employee Stock Ownership Plan and Trust. The Provident Bank implemented
an employee stock ownership plan in connection with the conversion and offering.
We intend that this plan will be a tax-qualified plan generally covering
employees who are at least 21 years old, who have at least one year of
employment with The Provident Bank or a designated affiliated corporation and
who have completed at least 1,000 hours of service. As part of the conversion
and offering, the employee stock ownership plan intends to borrow funds from
Provident Financial Services, Inc. and use those funds to purchase a number of
shares equal to up to 8% of the common stock sold in the stock offering.
Collateral for the loan will be the common stock purchased by the employee stock
ownership plan. The loan will be repaid principally from a participating
employers' discretionary contributions to the employee stock ownership plan over
a period of up to 30 years. The loan documents will provide that the loan may be
repaid over a shorter period, without penalty. It is anticipated that the
interest rate for the loan will be a floating-rate equal to the prime rate.
Shares purchased by the employee stock ownership plan will be held in a suspense
account for allocation among participants as the loan is repaid.
Contributions to the employee stock ownership plan and shares released
from the suspense account in an amount proportional to the repayment of the
employee stock ownership plan loan will be allocated among employee stock
ownership plan participants on the basis of compensation in the year of
allocation. Benefits under the plan will not vest at all in the first five years
of credited service but will vest entirely upon completion of five years of
credited service. In general, the employee stock ownership plan will credit
participants with up to five years of service for employment prior to adoption
of a plan. A participant's interest in his account under the plan will also
fully vest in the event of a termination of service due to a participant's early
or normal retirement, death, disability, or upon a change in control (as defined
in the plan). Vested benefits will be payable in the form of common stock and/or
cash. Contributions to the employee stock ownership plan are discretionary,
subject to the loan terms and tax law limits. Therefore, benefits payable under
the employee stock ownership plan cannot be estimated. Under generally accepted
accounting principles, a participating employer will be required to record
compensation expense each year in an amount equal to the fair market value of
the shares released from the suspense account. In the event of a change in
control, the employee stock ownership plan will terminate and participants will
become fully vested in their account balances.
FUTURE STOCK BENEFIT PLANS
Stock Option Plan. We intend to adopt a stock option plan for our
directors, officers and employees, subject to shareholder approval. Federal
regulations prohibit us from implementing this plan until six months after the
conversion and offering.
Provident Financial Services, Inc. expects that the stock option plan
will authorize a committee of non-employee directors or the full Board of
Directors, to grant options to purchase up to 10% of the shares sold in the
conversion. The stock option plan will have a term of 10 years. The committee
will decide which directors, officers and employees will receive options and the
terms of those options. Generally, no stock option will permit its recipient to
purchase shares at a price that is less than the fair market value of a share on
the date the option is granted, and no option will have a term that is longer
than 10 years. If we implement a stock option plan before the first anniversary
of the conversion, current regulations will require that:
. the total number of options available for grant to non-employee
directors be limited to 30% of the options authorized under the
plan;
. the number of options that may be granted to any one non-employee
director be limited to 5% of the options authorized under the
plan;
. the number of options that may be granted to any officer or
employee be limited to 25% of the options authorized for the plan;
. the options may not vest more rapidly than 20% per year, beginning
on the first anniversary of stockholder approval of the plan; and
. accelerated vesting not be permitted except for death, disability
or upon a change in control of The Provident Bank or Provident
Financial Services, Inc.
96
We may obtain the shares needed for this plan by issuing additional
shares or through stock repurchases.
Recognition and Retention Plan. We expect to implement a recognition
and retention plan for our directors and officers. Federal regulations prohibit
us from implementing this plan until six months after the conversion and
offering. If the recognition plan is implemented within the first 12 months
after the conversion and offering, federal regulations require that the plan be
approved by a majority of the outstanding shares of common stock of Provident
Financial Services, Inc.
In the event the recognition and retention plan is implemented within
12 months after the conversion and offering, Provident Financial Services, Inc.
expects that the plan will authorize a committee of non-employee directors or
the full Board of Directors of Provident Financial Services, Inc. to make
restricted stock awards of up to 4% of the shares sold in the offering. In the
event Provident Financial Services, Inc. implements the recognition and
retention plan more than 12 months after the conversion and offering, the
recognition and retention plan will not be subject to regulations limiting the
plan to no more than 4% of the shares sold in the offering. The committee will
decide which directors, officers and employees will receive restricted stock and
the terms of those awards. Provident Financial Services, Inc. may obtain the
shares needed for this plan by issuing additional shares or through stock
repurchases. If we implement a recognition and retention plan before the first
anniversary of the conversion and offering, current regulations will require
that:
. the total number of shares that are awarded to non-employee
directors be limited to 30% of the shares authorized under the
plan;
. the number of shares that are awarded to any one non-employee
director be limited to 5% of the shares authorized under the plan;
. the number of shares that are awarded to any officer or employee
be limited to 25% of the shares authorized under the plan;
. the awards may not vest more rapidly than 20% per year, beginning
on the first anniversary of stockholder approval of the plan; and
. accelerated vesting not be permitted except for death, disability
or upon a change in control of The Provident Bank or Provident
Financial Services, Inc.
Restricted stock awards under this plan may feature employment
restrictions that require continued employment for a period of time for the
award to be vested. Awards are not vested unless the specified employment
restrictions are met. However, pending vesting, the award recipient may have
voting and dividend rights. When an award becomes vested, the recipient must
include the current fair market value of the vested shares in his or her income
for federal income tax purposes. Generally, we will be allowed a federal income
tax deduction (subject to limitations discussed below, and subject to certain
reporting and withholding tax requirements) in the same amount and in the same
year as the recipient employee recognizes the taxable income. However, if the
stock award recipient elects under Code Section 83(b) to include in income the
fair market value of the shares at the grant date (e.g. before the recipient
vests in the property), then we will be allowed a federal income tax deduction
in the same amount at the time of the grant and not when the restrictions lapse.
Such deductions would also be subject to the deduction limitations of Code
Section 162(m) as described below.
LIMITATIONS ON FEDERAL TAX DEDUCTIONS FOR EXECUTIVE OFFICER COMPENSATION
As a private entity, The Provident Bank has been subject to federal tax
rules, which permit it to claim a federal income tax deduction for a reasonable
allowance for salaries or other compensation for personal services actually
rendered. Following the offering, federal tax laws may limit this deduction to
$1.0 million each tax year for each executive officer named in the summary
compensation table in Provident Financial Services, Inc.'s proxy statement for
that year. This limit will not apply to non-taxable compensation under various
broad-based retirement and fringe benefit plans, to compensation that is
"qualified performance-based compensation" under applicable law or to
compensation that is paid in satisfaction of commitments that arose before the
conversion. To the extent that compensation paid to any executive officer is not
deductible, the net after-tax cost of providing the compensation will be higher
and the net after-tax earnings of Provident Financial Services, Inc. will be
reduced.
97
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Persons and groups who beneficially own in excess of five percent of
the Common Stock are required to file certain reports with SEC regarding such
ownership pursuant to the Securities Exchange Act of 1934 (the "Exchange Act").
The following table sets forth, as of March 1, 2003, the shares of common stock
of Provident Financial Services, Inc., par value $0.01 per share ("Common
Stock"), beneficially owned by directors and named executive officers
individually, by executive officers and directors as a group. The Company is
unaware of any beneficial owner of more than five percent of the Company's
outstanding shares of Common Stock as of March 1, 2003. The business address of
each director and executive officer is 830 Bergen Avenue, Jersey City, New
Jersey 07306.
NUMBER OF SHARES OF
COMMON STOCK PERCENT OF ALL COMMON
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED/(1)/ STOCK OUTSTANDING/(1)/
- ------------------------------------------------------- ----------------------- ------------------------
DIRECTORS
J. Martin Comey 52,000/(2)/ *
Geoffrey M. Connor 30,000/(3)/ *
Frank L. Fekete 21,500/(4)/ *
Carlos Hernandez 6,870/(5)/ *
William T. Jackson 30,200/(6)/ *
David Leff 30,000 *
Arthur R. McConnell 25,000 *
Edward O'Donnell 20,000 *
Paul M. Pantozzi 55,100/(7)/ *
Daniel T. Scott 41,505/(8)/ *
Thomas E. Sheenan 35,389/(9)/ *
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
Donald Blum -- *
Angel Denis 5,750/(10)/ *
Charles Firestone 4,000/(11)/ *
Gregory French -- *
C. Gabriel Haagensen 20,000/(12)/ *
John F. Kuntz -- *
Linda A. Niro 8,150/(13)/ *
Giacomo Novielli 5,980/(14)/ *
Glenn H. Shell 42,000/(15)/ *
Kenneth J. Wagner 1,500/(16)/ *
Kevin J. Ward 41,700/(17)/ *
All directors and executive officers as a group (22) 476,644 *
- ----------
* Denotes less than 1%
/(1)/ Based upon 61,538,300 shares outstanding.
/(2)/ Includes 8,600 shares held in the Voluntary Fee Deferral Plan for the
Board of Directors.
/(3)/ Includes 7,500 shares held in an individual retirement account, 5,000
shares held as custodian for Mr. Connor's minor children and 1,000 shares
held by an adult child of Mr. Connor.
/(4)/ Includes 7,500 shares held by Mr. Fekete's spouse, 10,000 shares held by
a custodian for a retirement account for Mr. Fekete's benefit, 2,000
shares held by Mr. Fekete's spouse as custodian for Mr. Fekete's son and
2,000 shares held by Mr. Fekete's daughter.
/(5)/ Includes 1,450 shares held by Mr. Hernandez's spouse in an individual
retirement account.
/(6)/ Includes 200 shares held by Mr. Jackson's spouse.
(footnotes continued on following page)
98
/(7)/ Includes 1,000 shares held by Mr. Pantozzi as custodian for his
grandchildren, 2,000 shares held by Mr. Pantozzi's spouse, 22,000 shares
held by Mr. Pantozzi through the Supplemental Executive Retirement Plan
and 6,200 shares held by Mr. Pantozzi through the Employee Savings
Incentive Plan.
/(8)/ Includes 4,464, shares held by Mr. Scott in an individual retirement
account, 3,341 shares held by Mr. Scott's spouse in an individual
retirement account and 33,700 shares held in the Voluntary Fee Deferral
Plan for the Board of Directors.
/(9)/ Includes 2,000 shares held by Mr. Sheenan's spouse, 200 shares held by
Mr. Sheenan's daughter and 30,189 shares held in the Voluntary Fee
Deferral Plan for the Board of Directors.
/(10)/ Includes 5,000 shares held by Mr. Denis through the Employee Savings
Incentive Plan.
/(11)/ All of Mr. Firestone's shares are held through the Employee Savings
Incentive Plan.
/(12)/ All of Mr. Haagensen's shares are held through the Employee Savings
Incentive Plan.
/(13)/ Includes 6,000 shares held by Ms. Niro through the Employee Savings
Incentive Plan.
/(14)/ Includes 5,000 shares held by Mr. Novielli through the Employee Savings
Incentive Plan and 380 shares held by Mr. Novielli's spouse as custodian
for Mr. Novielli's children.
/(15)/ Includes 22,500 shares held by Mr. Shell in an individual retirement
account, 7,500 shares held by Mr. Shell's spouse, 10,000 shares held
through the Employee Savings Incentive Plan and 2,000 shares held in the
Supplemental Executive Retirement Plan.
/(16)/ All of Mr. Wagner's shares are held through the Employee Savings
Incentive Plan.
/(17)/ Includes 30,000 shares held by Mr. Ward through the Employee Savings
Incentive Plan, 2,400 shares held by Mr. Ward through the Supplemental
Executive Retirement Plan and 3,800 shares held by Mr. Ward's spouse.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Provident Bank does not originate loans for members of its Board of
Directors. There is one residential mortgage loan outstanding to a current Board
member that was originated prior to his service as a Board member.
The Provident Bank adheres to relevant federal and state law for loans
it makes to its executive officers. As of December 31, 2002, The Provident Bank
had loans and loan commitments totaling $876,900 to its executive officers.
The Provident Bank retains the law firm of Reed Smith LLP to perform
legal services from time to time. Director Connor is a partner at Reed Smith
LLP.
ITEM 14. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we evaluated
the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-14(c) and 15d-14(c) under the Exchange Act)
as of a date (the "Evaluation Date") within 90 days prior to the filing date of
this report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the Evaluation Date, our disclosure
controls and procedures are effective to ensure that information required to be
disclosed in the reports that Provident Financial Services, Inc. files or
submits under the Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the SEC's rules and forms. There have been
no significant changes in Provident Financial Services, Inc.'s internal controls
or in other factors that could significantly affect these controls subsequent to
the Evaluation Date.
99
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
The exhibits and financial statement schedules filed as a part of this
Form 10-K are as follows:
(a)(1) Financial Statements
. Independent Auditors' Report
. Consolidated Statements of Condition, December 31, 2002 and 2001
. Consolidated Statements of Income, Years Ended December 31, 2002,
2001 and 2000
. Consolidated Statements of Changes in Equity, Years Ended December
31, 2002, 2001 and 2000
. Consolidated Statements of Cash Flows, Years Ended December 31,
2002, 2001 and 2000
. Notes to Consolidated Financial Statements.
(a)(2) Financial Statement Schedules
No financial statement schedules are filed because the
required information is not applicable or is included in the
consolidated financial statements or related notes.
(a)(3) Exhibits
3.1 Certificate of Incorporation of Provident Financial
Services, Inc.*
3.2 Bylaws of Provident Financial Services, Inc.*
4.1 Form of Common Stock Certificate of Provident
Financial Services, Inc. *
10.1 Form of Employment Agreement between Provident
Financial Services, Inc. and certain executive
officers.*
10.2 Form of Change in Control Agreement between Provident
Financial Services, Inc. and certain executive
officers.*
10.3 Employee Savings Incentive Plan*
10.4 Employee Stock Ownership Plan*
10.5 Supplemental Executive Retirement Plan, as amended*
10.6 Supplemental Executive Savings Plan, as amended*
10.7 Retirement Plan for the Board of Directors of The
Provident Bank, as amended*
100
10.8 The Provident Bank Amended and Restated Board of
Directors Voluntary Fee Deferral Plan*
10.9 Voluntary Bonus Deferral Plan for the Chairman, as
amended*
10.10 Voluntary Bonus Deferral Plan, as amended*
21 Subsidiaries of the Registrant
23 Consent of KPMG LLP
99.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
----------
* Filed as exhibits to the Company's Registration
Statement on Form S-1, and any amendments thereto,
with the Securities and Exchange Commission.
(Registration No. 333-98241).
(b) Reports on Form 8-K:
On December 23, 2002, Provident Financial Services, Inc. filed
a report on Form 8-K relating to press releases issued on
litigation concerning The Provident Bank's Plan of Conversion.
(c) The exhibits listed under (a)(3) above are filed herewith.
(d) Not applicable.
101
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 FINANCIAL SERVICES, INC.
Date: March 26, 2003 By: /s/ Paul M. Pantozzi
-----------------------------------------------
Paul M. Pantozzi
Chairman, Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/ Paul M. Pantozzi By: /s/ Linda A. Niro
------------------------------------ -----------------------------
Paul M. Pantozzi, Chairman, Linda A. Niro, Senior Vice
Chief Executive Officer and President President and Chief Financial
(Principal Executive Officer) Officer (Principal Financial
and Accounting Officer)
Date: March 26, 2003 Date: March 26, 2003
By: /s/ J. Martin Comey By: /s/ Geoffrey M. Connor
------------------------------------ -----------------------------
J. Martin Comey, Director Geoffrey M. Connor, Director
Date: March 26, 2003 Date: March 26, 2003
By: /s/ Frank L. Fekete By: /s/ Carlos Hernandez
------------------------------------ -----------------------------
Frank L. Fekete, Director Carlos Hernandez, Director
Date: March 26, 2003 Date: March 26, 2003
By: /s/ William T. Jackson By: /s/ David Leff
------------------------------------ -----------------------------
William T. Jackson, Director David Leff, Director
Date: March 26, 2003 Date: March 26, 2003
By: /s/ Arthur M. McConnell By: /s/ Edward O'Donnell
------------------------------------ -----------------------------
Arthur M. McConnell, Director Edward O'Donnell, Director
Date: March 26, 2003 Date: March 26, 2003
By: /s/ Daniel T. Scott By: /s/ Thomas E. Sheenan
------------------------------------ -----------------------------
Daniel T. Scott, Director Thomas E. Sheenan, Director
Date: March 26, 2003 Date: March 26, 2003
102
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Paul M. Pantozzi, Chairman, Chief Executive Officer and President,
certify that:
1. I have reviewed this annual report on Form 10-K of Provident Financial
Services, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
March 26, 2003 /s/ Paul M. Pantozzi
- --------------------- -----------------------------------------------
Date Paul M. Pantozzi
Chairman, Chief Executive Officer and President
103
CERTIFICATION OF CHIEF FINANCIAL OFFICER
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Linda A. Niro, Senior Vice President and Chief Financial Officer,
certify that:
1. I have reviewed this annual report on Form 10-K of Provident Financial
Services, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
March 26, 2003 /s/ Linda A. Niro
- ---------------------- -------------------------------------------------
Date Linda A. Niro
Senior Vice President and Chief Financial Officer
104
EXHIBIT INDEX
3.1 Certificate of Incorporation of Provident Financial
Services, Inc.*
3.2 Bylaws of Provident Financial Services, Inc.*
4.1 Form of Common Stock Certificate of Provident
Financial Services, Inc. *
10.1 Form of Employment Agreement between Provident
Financial Services, Inc. and certain executive
officers.*
10.2 Form of Change in Control Agreement between Provident
Financial Services, Inc. and certain executive
officers.*
10.3 Employee Savings Incentive Plan*
10.4 Employee Stock Ownership Plan*
10.5 Supplemental Executive Retirement Plan, as amended*
10.6 Supplemental Executive Savings Plan, as amended*
10.7 Retirement Plan for the Board of Directors of The
Provident Bank, as amended*
10.8 The Provident Bank Amended and Restated Board of
Directors Voluntary Fee Deferral Plan*
10.9 Voluntary Bonus Deferral Plan for the Chairman, as
amended*
10.10 Voluntary Bonus Deferral Plan, as amended*
21 Subsidiaries of the Registrant
23 Consent of KPMG LLP
99.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
----------
* Filed as exhibits to the Company's Registration
Statement on Form S-1, and any amendments thereto,
with the Securities and Exchange Commission.
(Registration No. 333-98241).