SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d) of
the Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File
March 31, 2003 No. 1-8019
PROVIDENT FINANCIAL GROUP, INC.
Incorporated under IRS Employer I.D.
the Laws of Ohio No. 31-0982792
One East Fourth Street, Cincinnati, Ohio 45202
Phone: 513-579-2000
Indicate by check whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: Common stock, without par
value, outstanding at April 30, 2003 is 48,765,906.
Please address all correspondence to:
Christopher J. Carey
Executive Vice President and Chief Financial Officer
Provident Financial Group, Inc.
One East Fourth Street
Cincinnati, Ohio 45202
-1-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT
ON FORM 10-Q
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Income . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Changes in Shareholders' Equity . . . . 5
Consolidated Statements of Cash Flows . . . . . . . . . . . . . . . 6
Notes to the Consolidated Financial Statements . . . . . . . . . . 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS . . . . . . . . . . . . . . . . . . 15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK . . 40
ITEM 4. CONTROLS AND PROCEDURES . . . . . . . . . . . . . . . . . . . 41
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . . . . 42
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . . . 42
SIGNATURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
CERTIFICATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2003 2002
(Dollars in Thousands) (Unaudited)
- -------------------------------------------------------------------------------------
ASSETS
Cash and Due from Banks $ 340,141 $ 351,994
Federal Funds Sold and Reverse Repurchase Agreements 561,446 188,925
Trading Account Securities 111,516 127,848
Loans Held for Sale 255,593 436,884
Investment Securities Available for Sale
(amortized cost - $4,303,774 and $4,158,511) 4,320,723 4,215,238
Loans and Leases (Net of Unearned Income):
Corporate Lending:
Commercial 4,515,888 4,482,373
Mortgage 947,205 960,636
Construction 528,824 510,331
Lease Financing 1,233,533 1,273,901
Consumer Lending:
Installment 1,362,896 1,306,761
Residential 519,632 599,793
Lease Financing 43,522 -
------------ ------------
Total Loans and Leases 9,151,500 9,133,795
Reserve for Loan and Lease Losses (201,020) (201,051)
------------ ------------
Net Loans and Leases 8,950,480 8,932,744
Leased Equipment 2,181,823 2,350,356
Premises and Equipment 98,853 101,513
Goodwill 82,651 82,651
Other Assets 823,194 751,856
------------ ------------
TOTAL ASSETS $ 17,726,420 $ 17,540,009
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Noninterest Bearing $ 1,163,209 $ 1,141,990
Interest Bearing 9,502,086 8,706,989
------------ ------------
Total Deposits 10,665,295 9,848,979
Short-Term Debt 1,506,797 1,925,005
Long-Term Debt 3,661,219 3,842,657
Guaranteed Preferred Beneficial Interests in
Company's Junior Subordinated Debentures 451,179 451,074
Minority Interest 160,966 160,966
Accrued Interest and Other Liabilities 401,981 430,957
------------ ------------
Total Liabilities 16,847,437 16,659,638
Shareholders' Equity:
Preferred Stock, 5,000,000 Shares Authorized,
Series D, 70,272 Issued 7,000 7,000
Common Stock, No Par Value, 110,000,000 Shares
Authorized, 48,759,156 and 48,760,462 Issued 14,454 14,454
Capital Surplus 298,498 298,025
Retained Earnings 619,444 604,013
Accumulated Other Comprehensive Loss, Net (60,413) (43,121)
------------ ------------
Total Shareholders' Equity 878,983 880,371
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 17,726,420 $ 17,540,009
============ ============
See notes to consolidated financial statements.
-3-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
March 31,
------------------------
(In Thousands, Except Per Share Data) 2003 2002
- -----------------------------------------------------------------------
Interest Income:
Interest and Fees on Loans and Leases $141,636 $155,001
Interest on Investment Securities 51,815 53,348
Other Interest Income 8,291 5,067
-------- --------
Total Interest Income 201,742 213,416
Interest Expense:
Interest on Deposits:
Savings and Demand Deposits 9,868 9,052
Time Deposits 47,068 58,403
-------- --------
Total Interest on Deposits 56,936 67,455
Interest on Short-Term Debt 8,840 10,310
Interest on Long-Term Debt 48,308 51,418
Interest on Junior Subordinated Debentures 4,699 5,938
-------- --------
Total Interest Expense 118,783 135,121
-------- --------
Net Interest Income 82,959 78,295
Provision for Loan and Lease Losses 16,521 24,205
-------- --------
Net Interest Income After Provision
for Loan and Lease Losses 66,438 54,090
Noninterest Income:
Service Charges on Deposit Accounts 12,332 10,449
Loan Servicing Fees 10,660 7,998
Commercial Mortgage Banking Revenue 10,297 5,746
Other Service Charges and Fees 11,736 9,899
Leasing Income 138,861 154,981
Cash Gains on Sale of Loans 4,942 2,640
Warrant Gains 328 -
Net Security Gains 1,500 -
Other 3,518 4,517
-------- --------
Total Noninterest Income 194,174 196,230
Noninterest Expense:
Salaries, Wages and Benefits 61,984 56,389
Charges and Fees 7,822 7,651
Occupancy 6,228 6,018
Leasing Expense 95,760 106,865
Equipment Expense 6,949 6,207
Professional Services 8,398 6,085
Minority Interest Expense 3,197 -
Other 31,745 27,397
-------- --------
Total Noninterest Expense 222,083 216,612
-------- --------
Income Before Income Taxes 38,529 33,708
Applicable Income Taxes 12,715 12,092
-------- --------
Net Income $ 25,814 $ 21,616
======== ========
Per Common Share:
Basic Earnings Per Share $ 0.52 $ 0.43
Diluted Earnings Per Share 0.51 0.43
Cash Dividends Paid 0.24 0.24
See notes to consolidated financial statements.
-4-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Accumulated
Other
Preferred Common Capital Retained Comprehensive
(In Thousands) Stock Stock Surplus Earnings Loss, Net Total
- --------------------------------------------------------------------------------------------------------
Balance at January 1, 2002 $ 7,000 $14,587 $322,024 $556,918 $ (98,696) $801,833
Net Income 21,616 21,616
Other Comprehensive Income,
Net of Tax:
Change in Unrealized
Gains (Losses) on:
Hedging Instruments 22,690 22,690
Marketable Securities (8,900) (8,900)
--------
Total Comprehensive Income 35,406
Dividends Paid on:
Preferred Stock (237) (237)
Common Stock (11,816) (11,816)
Exercise of Stock Options and
Accompanying Tax Benefits 16 826 842
Other (14) (14)
------- ------- -------- -------- --------- --------
Balance at March 31, 2002 $ 7,000 $14,603 $322,836 $566,481 $ (84,906) $826,014
======= ======= ======== ======== ========= ========
Balance at January 1, 2003 $ 7,000 $14,454 $298,025 $604,013 $ (43,121) $880,371
Net Income 25,814 25,814
Other Comprehensive Income,
Net of Tax:
Change in Unrealized
Gains (Losses) on:
Hedging Instruments 8,562 8,562
Marketable Securities (25,854) (25,854)
--------
Total Comprehensive Income 8,522
Dividends Paid on:
Preferred Stock (237) (237)
Common Stock (11,895) (11,895)
Exercise of Stock Options and
Accompanying Tax Benefits 9 991 1,000
Benefit Plan Assets in
Provident Stock (9) (518) (51) (578)
Other 1,800 1,800
------- ------- -------- -------- --------- --------
Balance at March 31, 2003 $ 7,000 $14,454 $298,498 $619,444 $ (60,413) $878,983
======= ======= ======== ======== ========= ========
See notes to consolidated financial statements.
-5-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended March 31,
---------------------------
(In Thousands) 2003 2002
- ------------------------------------------------------------------------------------
Operating Activities:
Net Income $ 25,814 $ 21,616
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Provision for Loan and Lease Losses 16,521 24,205
Other Amortization and Accretion 13,869 1,880
Depreciation of Leased Equipment 99,653 107,928
Depreciation of Premises and Equipment 6,193 5,583
Tax Benefit Received from Exercise of Stock Options 616 266
Realized Investment Security Gains (1,500) -
Proceeds from Sale of Loans Held for Sale 1,109,898 521,175
Origination of Loans Held for Sale (925,509) (427,197)
Realized Gains on Loans Held for Sale (3,098) (1,485)
Net Purchases of Trading Account Securities 16,332 1,154
Increase in Interest Receivable (7,752) (3,931)
Increase in Other Assets (74,478) (10,511)
Increase in Interest Payable 1,009 5,467
Increase (Decrease) in Other Liabilities (406) 30,599
----------- -----------
Net Cash Provided By Operating Activities 277,162 276,749
----------- -----------
Investing Activities:
Investment Securities Available for Sale:
Proceeds from Sales 1,200,358 420,524
Proceeds from Maturities and Prepayments 479,290 209,190
Purchases (1,822,695) (1,052,077)
(Increase) Decrease in Loans and Leases (34,341) 276,413
(Increase) Decrease in Operating Lease Equipment 68,880 (16,114)
Increase in Premises and Equipment (3,533) (4,292)
----------- -----------
Net Cash Used In Investing Activities (112,041) (166,356)
----------- -----------
Financing Activities:
Increase in Deposits 805,772 52,656
Decrease in Short-Term Debt (418,208) (216,949)
Principal Payments on Long-Term Debt (182,403) (113,775)
Proceeds From Issuance of Long-Term Debt 334 1,393
Cash Dividends Paid (12,132) (12,053)
Proceeds from Exercise of Stock Options 384 576
Net Increase (Decrease) in Other Equity Items 1,800 (14)
----------- -----------
Net Cash Provided By (Used In) Financing Activities 195,547 (288,166)
----------- -----------
Increase (Decrease) in Cash and Cash Equivalents 360,668 (177,773)
Cash and Cash Equivalents at Beginning of Period 540,919 501,223
----------- -----------
Cash and Cash Equivalents at End of Period $ 901,587 $ 323,450
=========== ===========
Supplemental Disclosures of Cash Flow Information:
Cash Paid for:
Interest $ 117,775 $ 112,484
Income Taxes 2,077 -
Non-Cash Activity:
Transfer of Loans and Leases to
Other Real Estate and Equipment 7,761 6,293
See notes to consolidated financial statements.
-6-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
- ------------------------------
The accompanying unaudited financial statements reflect all adjustments,
consisting of normal recurring accruals, which are, in the opinion of
management, necessary for a fair presentation of the financial position, the
results of operations, changes in shareholders' equity and cash flows for
the periods presented. These financial statements have been prepared
according to the rules and regulations of the Securities and Exchange
Commission and, therefore, certain information and footnote disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States (GAAP) have
been omitted. The results of operations for interim periods are not
necessarily indicative of the results to be expected for the full year.
The consolidated financial statements include the accounts of Provident
Financial Group, Inc. (Provident) and its subsidiaries. Investment in
companies in which Provident has significant influence over operating and
financing decisions (principally defined as owning a voting or economic
interest of 20% to 50%) are accounted for by the equity method of
accounting. All significant intercompany balances and transactions have been
eliminated. Certain reclassifications have been made to conform to the
current year presentation. These reclassifications had no effect on net
income.
The financial statements and notes thereto appearing in Provident's 2002
annual report on Form 10-K, which include descriptions of significant
accounting policies, should be read in conjunction with these interim
financial statements.
NOTE 2. EARNINGS PER SHARE
- ---------------------------
Basic earnings per share is calculated by dividing net income, less dividend
requirements on convertible preferred stock, by the weighted average number
of common shares outstanding for the period. Diluted earnings per share
takes into consideration the pro forma dilution assuming the convertible
preferred shares and the in-the-money outstanding stock options were
converted or exercised into common shares. It also takes into consideration
the dilutive impact of shares held in benefit plans and of forward purchase
contracts required to be settled in Provident Stock. Net income is not
adjusted for preferred dividend requirements.
Stock options to purchase approximately 5.6 million and 4.6 million shares
of Common Stock were outstanding at March 31, 2003 and 2002, respectively,
but were not included in the computation of diluted earnings per share
because the options' exercise price was not in-the-money and, therefore, the
effect would be anti-dilutive. The PRIDES units were not included in the
computation of dilutive earnings per share as these instruments had no
dilutive impact.
-7-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the computation of basic and diluted earnings
per common share:
Three Months Ended
March 31,
-----------------------
(In Thousands, Except Per Share Data) 2003 2002
- -------------------------------------------------------------------------
Basic:
Net Income $ 25,814 $ 21,616
Less Preferred Stock Dividends (237) (237)
-------- --------
Income Available to Common Shareholders 25,577 21,379
Weighted-Average Common Shares Outstanding 48,776 49,228
-------- --------
Basic Earnings Per Share $ 0.52 $ 0.43
======== ========
Diluted:
Net Income $ 25,814 $ 21,616
Weighted-Average Common Shares Outstanding 48,776 49,228
Benefit Plans Common Shares 680 -
Assumed Conversion of:
Convertible Preferred Stock 988 988
Dilutive Stock Options 322 372
-------- --------
Dilutive Potential Common Shares 50,766 50,588
-------- --------
Diluted Earnings Per Share $ 0.51 $ 0.43
======== ========
NOTE 3. GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S JUNIOR
- ----------------------------------------------------------------------------
SUBORDINATED DEBENTURES
- -----------------------
Wholly-owned subsidiary trusts of Provident have issued $462.5 million of
preferred securities and, in turn, purchased $462.5 million of
newly-authorized Provident junior subordinated debentures. The debentures
provide interest and principal payments to fund the trusts' obligations.
Provident fully and unconditionally guarantees the preferred securities.
Approximately $367 million of the preferred securities qualify as Tier 1
capital and the remainder qualifies as Tier 2 capital for bank regulatory
purposes. The sole assets of the trusts are the debentures. The junior
subordinated debentures consisted of the following at March 31, 2003:
Stated Effective Maturity
(Dollars in Thousands) Rate Rate(1) Date Amount
- ----------------------------------------------------------------------------
November 1996 Issuance 8.60% 8.67% 12/01/26 $ 99,013
June 1999 Issuance 8.75% 2.62% 06/30/29 121,555
November 2000 Issuance 10.25% 3.99% 12/31/30 109,286
March 2001 Issuance 9.45% 4.27% 03/30/31 121,325
--------
Total $451,179
========
(1) Effective rate reflects interest rate after adjustment for notes issued
at discount or premium, capitalized fees associated with the issuance of
the debt and interest rate swap agreements entered to alter the payment
characteristics.
-8-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. COMPREHENSIVE INCOME
- -----------------------------
Comprehensive income represents the changes in equity during a period except
those resulting from investments by shareholders and distributions to
shareholders. For Provident, components of comprehensive income include the
unrealized gains/losses on securities available for sale and unrealized
gains/losses on cash flow hedging derivatives (collectively known as other
comprehensive income), as well as net income. A summary of activity in
accumulated other comprehensive income (loss) follows:
Three Months Ended
March 31,
--------------------
(In Thousands) 2003 2002
- -------------------------------------------------------------------------------------
Accumulated Unrealized Gains (Losses) on Securities Available
for Sale at January 1, Net of Tax $ 36,809 $(15,953)
Net Unrealized Losses for the Period, Net of Tax
Benefit of $4,471 in 2003 and $4,792 in 2002 (8,304) (8,900)
Reclassification Adjustment for Gains Included in Net Income,
Net of Tax Expense of $9,450 in 2003 (17,550) -
-------- --------
Effect on Other Comprehensive Income (Loss) for the Year (25,854) (8,900)
-------- --------
Accumulated Unrealized Gains (Losses) on Securities Available
for Sale at March 31, Net of Tax $ 10,955 $(24,853)
======== ========
Accumulated Unrealized Losses on Derivatives Used in Cash
Flow Hedging Relationships at January 1, Net of Tax $(79,930) $(82,743)
Net Unrealized Gains (Losses) for the Period, Net of Tax
Expense (Benefit) of ($2,459) in 2003 and $2,527 in 2002 (4,567) 4,693
Reclassification Adjustment for Losses Included in Net Income,
Net of Tax Benefit of $7,070 in 2003 and $9,691 in 2002 13,129 17,997
-------- --------
Effect on Other Comprehensive Income (Loss) for the Year 8,562 22,690
-------- --------
Accumulated Unrealized Losses on Derivatives Used in Cash
Flow Hedging Relationships at March 31, Net of Tax $(71,368) $(60,053)
======== ========
Accumulated Other Comprehensive Loss at January 1, Net of Tax $(43,121) $(98,696)
Other Comprehensive Income (Loss), Net of Tax (17,292) 13,790
-------- --------
Accumulated Other Comprehensive Loss at March 31, Net of Tax $(60,413) $(84,906)
======== ========
NOTE 5. LINE OF BUSINESS REPORTING
- -----------------------------------
Provident's three major business lines, referred to as Commercial Banking,
Retail Banking and Mortgage Banking, are based on the products and services
offered, and its management structure. Commercial Banking offers a broad
range of commercial lending and financial products and services to corporate
businesses. Retail Banking provides consumer lending, deposit accounts,
trust, brokerage and investment products and services to consumers and small
businesses. Mortgage Banking offers conforming and nonconforming residential
mortgage loans to consumers, and also provides fee-based loan processing,
loan warehousing and servicing for third party originators.
-9-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial results are determined based on an assignment of balance sheet and
income statement items to each business line. Equity allocations are made
based on various risk measurements of the business line. A matched funded
transfer pricing process is used to allocate interest income and expense
among the business lines. Provision for loan and lease losses are charged to
business lines based on its level of net charge-offs and the size and risk
of its lending portfolio. Activity-based costing is used to allocate
expenses for centrally provided services.
Condensed income statements and total assets are provided below for
Provident's three major lines of business for the three-month period ended
March 31, 2003 and 2002. Corporate Center represents income and expenses not
related to the major business lines, and gain/loss on the sale of investment
securities.
Commercial Retail Mortgage Corporate
(Dollars in Millions) Banking Banking Banking Center Total
- --------------------------------------------------------------------------------------------
Three Months Ended March 31 2003:
Net Interest Income $ 49.8 $ 14.0 $ 19.1 $ - $ 82.9
Provision for Loan Losses (12.0) (2.0) (2.5) - (16.5)
Noninterest Income 41.5 139.4 11.8 1.5 194.2
Noninterest Expense (58.1) (142.8) (21.2) - (222.1)
Income Taxes (7.0) (2.8) (2.4) (0.5) (12.7)
-------- -------- -------- ------- -------
Net Income $ 14.2 $ 5.8 $ 4.8 $ 1.0 $ 25.8
======== ======== ======== ======= =======
Total Assets $ 7,430 $ 4,794 $ 1,561 $ 3,941 $17,726
======== ======== ======== ======= =======
Three Months Ended March 31 2002:
Net Interest Income $ 55.5 $ 7.5 $ 15.3 $ - $ 78.3
Provision for Loan Losses (18.7) (3.8) (1.7) - (24.2)
Noninterest Income 36.3 153.4 6.5 - 196.2
Noninterest Expense (53.7) (146.2) (16.7) - (216.6)
Income Taxes (6.9) (4.0) (1.2) - (12.1)
-------- -------- -------- ------- -------
Net Income $ 12.5 $ 6.9 $ 2.2 $ - $ 21.6
======== ======== ======== ======= =======
Total Assets $ 6,976 $ 4,608 $ 1,624 $ 3,097 $16,305
======== ======== ======== ======= =======
NOTE 6. GOODWILL AND OTHER INTANGIBLE ASSETS
- ---------------------------------------------
Provident adopted the provisions of Statements of Financial Accounting
Standards No. 141, "Business Combinations", and No. 142, "Goodwill and Other
Intangible Assets", on January 1 2002. Under the new rules, goodwill and
intangible assets deemed to have indefinite lives are no longer amortized
but are subject to annual impairment tests in accordance with Statement 142.
Other intangible assets deemed to have limited lives continue to be
amortized over their useful lives. Management performed an impairment test
on its goodwill assets as of January 1, 2003 and determined that no
impairment existed as of that date.
-10-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in the carrying amount of goodwill by business line for the three
months ended March 31, 2003 and 2002, are as follows:
Commercial Retail
(In Thousands) Banking Banking Total
- ----------------------------------------------------------------------------
Balance at January 1, 2002 $39,825 $40,824 $80,649
Goodwill Acquired During the Year - 189 189
Goodwill Recorded as a Result of Contingent
Consideration being Recognized 1,594 - 1,594
------- ------- -------
Balance at March 31, 2002 $41,419 $41,013 $82,432
======= ======= =======
Balance at January 1, 2003 $41,419 $41,232 $82,651
Goodwill Acquired During the Year - - -
------- ------- -------
Balance at March 31, 2003 $41,419 $41,232 $82,651
======= ======= =======
As all of Provident's other intangible assets have been determined to have
limited lives, these assets have continued to be amortized as in the past.
Intangible assets, along with accumulated amortization, is provided below:
Gross Net
Carrying Accumulated Carrying
(In Thousands) Value Amortization Value
- ----------------------------------------------------------------------------
Non-Contractual Customer Relationships $21,997 $ 9,934 $12,063
Purchased Core Deposits 1,429 1,161 268
------- -------- -------
Balance at March 31, 2003 $23,426 $ 11,095 $12,331
======= ======== =======
The estimated amortization of intangible assets for the next five years, is
$3.6 million for the remainder of 2003; $4.4 million for 2004; $3.1 million
for 2005; $0.7 million for 2006; and $0.2 million for 2007.
NOTE 7. MORTGAGE SERVICING ASSETS
- ----------------------------------
Provident recognizes the rights to service mortgage loans it does not own
but services for others within Other Assets of its Balance Sheets. Mortgage
servicing assets may be recognized (1) when mortgage loans are sold with
servicing retained or (2) when mortgage loan servicing is purchased. When
mortgage loans are sold, the carrying value of the loans is allocated
between the loans sold and servicing assets retained based on the relative
fair values of each. Mortgage servicing assets, when purchased, are
initially recorded at cost. Mortgage servicing assets are carried at the
lower of the initial carrying value, adjusted for amortization, or estimated
fair value. Mortgage servicing assets are evaluated quarterly for impairment
based on the fair value of those assets, using a disaggregated approach. The
fair value of the mortgage servicing assets is determined by estimating the
present value of future net cash flows, taking into consideration loan
prepayments speeds, discount rates, servicing costs and other economic
factors.
-11-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in the carrying value of mortgage servicing assets follows:
Three Months Ended
March 31
----------------------
(In Thousands) 2003 2002
- ----------------------------------------------------------------------------
Balance at Beginning of Period $ 111,690 $ 84,267
Additions 24,790 7,546
Amortization (5,612) (2,856)
Impairment Charges - -
--------- ---------
Balance at End of Period $ 130,868 $ 88,957
========= =========
As of March 31, 2003, mortgage servicing assets relating to commercial real
estate loans and residential loans totaled $65.8 million and $65.1 million,
respectively. Total mortgage loans serviced for others included $9.7 billion
on commercial real estate property and $9.0 billion on residential property
as of March 31, 2003. No impairment charges were incurred on the commercial
real estate servicing assets as most of the underlying loans have lockout
and prepayment penalties generally ranging from 5 to 9 years. Regarding the
residential servicing rights, no impairment charges were recognized as the
majority of the servicing assets were acquired under the current interest
rate environment.
NOTE 8. EQUITY INVESTMENTS
- ---------------------------
Provident invests in low income housing partnerships, equity funds and
directly in equity securities, which are collectively referred to herein as
equity investments. Equity investments, which are reported within Investment
Securities Available for Sale and Other Assets, are carried at estimated
fair value with changes in fair value recognized in noninterest income. The
fair value of publicly traded investments are determined using quoted market
prices less liquidity discounts. Liquidity discounts take into account the
fact that Provident may not immediately realize such market prices due to
regulatory, corporate and contractual sales restrictions. The estimated fair
value of equity investments that are not publicly traded approximates cost
including other than temporary valuation adjustments considered appropriate
by management. During the first quarter of 2003, certain equity investments
were determined to have incurred a total of $11.0 million of other than
temporary impairment in their valuation based upon information received from
the general partners of the equity funds and Provident's internal analyses.
This impairment charge was offset against other realized security gains. As
of March 31, 2003 and 2002, Provident held equity investments with a
carrying value of $60.6 million and $83.0 million, respectively.
NOTE 9. STOCK OPTIONS
- ----------------------
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" encourages, but does not require, adoption of a
fair value-based accounting method for stock-based employee compensation
plans. Provident adopted the provisions of Statement 123 as of January 1,
2003. Under these rules, compensation expense is recognized over the vesting
period equal to the fair value of stock-based compensation as of the date of
grant. As Provident has elected to use the Prospective Method of expense
recognition according to the transition rules of Statement No. 148,
-12-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
"Accounting for Stock-Based Compensation - Transition and Disclosure," the
adoption of Statement 123 applies only to options granted after December 31,
2002. Prior to January 1, 2003, Provident accounted for stock-based employee
compensation plans in accordance with Accounting Principles Bulletin (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees", whereby no
compensation expense is recognized for the granting of stock options when
the exercise price of the option equals the market price of the underlying
stock at the date of grant.
For purposes of providing pro forma disclosures as if Statement 123 had been
adopted as of its effective date (grants issued in fiscal years that begin
after December 15, 1994), the fair value of stock options was estimated at
the date of grant using a Black-Scholes option pricing model. The
Black-Scholes option pricing model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of
subjective assumptions including the expected stock price volatility.
Provident recorded $225,000 ($189,000 after-tax) of stock-based compensation
during the first three months of 2003 while no compensation cost was
recognized for stock option grants during 2002. Had compensation cost been
determined for stock option awards based on the fair values at grant dates
as discussed above, Provident's net income and earnings per share would have
been as follows:
Three Months Ended
March 31
------------------------
(In Thousands, Except Per Share Data) 2003 2002
- ----------------------------------------------------------------------------------
Net Income as Reported $ 25,814 $ 21,616
Plus Stock-Based Compensation Recognized for Options
Granted in 2003, Net of Related Tax 189 -
Less Total Stock-Based Compensation for Options Granted
Since 1994, Net of Related Tax (2,289) (2,352)
---------- ----------
Pro-forma Net Income $ 23,714 $ 19,264
========== ==========
Earnings Per Share:
Basic - As Reported $ 0.52 $ 0.43
Basic - Pro Forma 0.48 0.39
Diluted - As Reported 0.51 0.43
Diluted - Pro Forma 0.48 0.38
NOTE 10. RESTRICTED ASSETS
- ---------------------------
Provident formed the subsidiaries listed below to account for and support
the process of transferring, securitizing and/or selling vehicle and
equipment leases. These subsidiaries are separate legal entities and each
maintains books and records with respect to its assets and liabilities. The
assets of these subsidiaries, which are included in the consolidated
financial statements, are not available to secure financing or otherwise
satisfy claims of creditors of Provident or any of its other subsidiaries.
-13-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The subsidiaries and their total assets as of March 31, 2003 follow:
(In Thousands) Total Assets
- ----------------------------------------------------------------------------
Provident Auto Rental LLC 1999-1 $706,261
Provident Auto Leasing Company 485,076
Provident Auto Rental LLC 2000-1 349,638
Provident Auto Rental LLC 2001-1 308,435
Provident Auto Rental LLC 2000-2 151,036
Provident Auto Rental Company LLC 1998-2 149,302
Provident Auto Rental Company LLC 1998-1 138,079
Provident Lease Receivables Company LLC 102,769
The above amounts include items which are eliminated in the Consolidated
Financial Statements.
NOTE 11. CONSOLIDATION OF VARIABLE INTEREST ENTITIES
- -----------------------------------------------------
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities". This
Interpretation of Accounting Research Bulletin No. 51 (ARB 51), Consolidated
Financial Statements, addresses consolidation by business enterprises where
ownership interests in an entity may vary over time or, in many cases,
special-purpose entities (SPEs). To be consolidated for financial reporting,
these entities must have certain characteristics. ARB 51 requires that an
enterprise's consolidated financial statements include subsidiaries in which
the enterprise has a controlling financial interest. This Interpretation
requires existing unconsolidated variable interest entities to be
consolidated by their primary beneficiaries if the entities do not
effectively disperse risks among parties involved. An enterprise that holds
significant variable interests in such an entity, but is not the primary
beneficiary, is required to disclose certain information regarding its
interests in that entity. This Interpretation applies in the first fiscal
year or interim period beginning after June 15, 2003, to variable interest
entities in which an enterprise holds an interest that it acquired before
February 1, 2003. It also applies immediately to variable interest entities
created after January 31, 2003, and to variable interest entities in which
an enterprise obtains an interest after that date. As management has
determined that the SPEs used in the securitization of its nonconforming
residential, prime home equities and equipment leases effectively disperse
risks among parties involved, these securitization entities will continue to
be excluded from consolidation.
-14-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ----------------------------------------------------------------------------
RESULTS OF OPERATIONS
- ---------------------
INTRODUCTION
- ------------
Provident is a bank holding company headquartered in Cincinnati, Ohio.
Provident operates bank and other financial service subsidiaries principally
in Ohio, northern Kentucky and southwest Florida. Principal products and
services provided by Provident include commercial lending, lease financing,
cash management, retail lending, deposit accounts, mortgage banking,
brokerage services, investment products and trust services.
On March 5, 2003, Provident announced a restatement of its operating results
for years 1997 through 2001 and the interim periods for 2002. The
restatement was a result of unintentional errors in the accounting for nine
auto lease financing transactions originated between 1997 and 1999, and the
return to the balance sheet of the associated consumer auto leases which had
been previously accounted for as off-balance sheet. These errors were
discovered by Provident's finance staff in connection with the testing and
installation of a financial model that identified differences in income from
that originally recorded, compared with the income generated by the
financial model for auto lease transactions.
Subsequent to this announcement, Provident determined that its auto leases
should be classified as operating leases instead of finance leases. As a
result, Provident accounted for its auto lease portfolio as operating leases
resulting in the recognition of rental income and depreciation expense
rather than interest income as reported in earlier periods. Also, amounts
previously reported as direct financing leases and included in the loan
category, were reclassified to leased equipment.
The results of these restatements are reflected for all periods reported
upon in Provident's 2002 Form 10-K and this filing of Provident's March 31,
2003 Form 10-Q.
Forward-Looking Statements
- --------------------------
This Form 10-Q contains certain forward-looking statements that are subject
to numerous assumptions, risks or uncertainties. The Private Securities
Litigation Reform Act of 1995 provides a safe harbor for forward-looking
statements. Actual results could differ materially from those contained in
or implied by such forward-looking statements for a variety of factors
including: sharp and/or rapid changes in interest rates; significant changes
in the anticipated economic scenario which could materially change
anticipated credit quality trends; the ability to generate loans and leases;
significant cost, delay in, or inability to execute strategic initiatives
designed to increase revenues and/or manage expenses; consummation of
significant business combinations or divestitures; and significant changes
in accounting, tax, or regulatory practices or requirements and factors
noted in connection with forward-looking statements. Additionally, borrowers
could suffer unanticipated losses without regard to general economic
conditions. The result of these and other factors could cause differences
from expectations in the level of defaults, changes in risk characteristics
-15-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
of the loan and lease portfolio, and changes in the provision for loan and
lease losses. Forward-looking statements speak only as of the date made.
Provident undertakes no obligations to update any forward-looking statements
to reflect events or circumstances arising after the date on which they are
made.
RESULTS OF OPERATIONS
- ---------------------
Summary
- -------
The following table summarizes earnings components, earnings per share and
key financial ratios:
Three Months Ended
March 31,
(Dollars in Thousands, --------------------------------
Except Per Share Data) 2003 2002 Change
- ----------------------------------------------------------------------------
Income Statement Summary:
Net Interest Income $ 82,959 $ 78,295 6%
Noninterest Income 194,174 196,230 (1)
Total Revenue 277,133 274,525 1
Provision for Loan and Lease Losses 16,521 24,205 (32)
Noninterest Expense 222,083 216,612 3
Net Income 25,814 21,616 19
Diluted Earnings Per Common Share 0.51 0.43 19
Ratios Analysis:
Return on Average Equity 11.76% 10.45%
Return on Average Assets 0.59% 0.53%
First quarter 2003 earnings per diluted share and net income were $0.51 and
$25.8 million, respectively, compared with $0.43 and $21.6 million in the
first quarter of 2002. Returns on average equity and assets were 11.76% and
0.59%, respectively, for the first three months of 2003 compared with 10.45%
and 0.53% for the same period during 2002.
Net interest income increased 6% to $83.0 million for the first quarter of
2003 from $78.3 million reported for the first quarter of 2002. The increase
was due to interest earning assets growing at a higher rate than
interest-bearing liabilities. The net interest margin for the first three
months of 2003 and 2002 was 2.37% and 2.47%, respectively. The lower net
interest margin for 2003 was the result of the lower interest rate
environment and a change in the mix of interest earning assets as the
company continues to reduce its overall credit risk.
The provision for loan and lease losses declined from $24.2 million for the
first quarter of 2002 to $16.5 million for the first quarter of 2003. The
annualized net charge-off to average loans and leases ratio was 0.73% for
the first three months of 2003 compared to 1.02% for the same period in
2002. The annualized charge-off ratio in 2003 was the lowest ratio
experienced by Provident during the past two years. Nonperforming assets at
March 31, 2003 was $203.4 million compared to $182.2 million at December 31,
2002 and $211.5 million at March 31, 2002. Reserve for loan losses to total
loans and leases was 2.20% as of March 31, 2003, compared to 2.20% and 2.81%
as of December 31, 2002 and March 31, 2002, respectively.
-16-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Noninterest income remained relatively flat for the first three months of
2003 as compared to the same period in 2002. Increases in nearly every
noninterest income category offset a decrease in leasing income. The
decrease in leasing income was a result of Provident's decision to
de-emphasize its auto leasing activity and because auto leases originated
since February, 2003 have been classified as finance leases rather than
operating leases. In February 2003, Provident changed the structure of the
residual insurance it obtains on its auto leases resulting in this type of
lending being classified as a direct financing lease in the loan category
and income being recorded as interest income.
Noninterest expense increased $5.5 million, or 3%, for the first quarter of
2003 as compared to the same period in 2002. The increase in noninterest
expense was primarily in the areas of payroll, professional services and
minority interest expense and was partially offset by a decrease in leasing
expense. The minority interest expense relates to dividends paid on $165
million of Preferred Stock of PFGI Capital Corporation, a real estate
investment trust that was formed late in the second quarter of 2002. Similar
to leasing income, leasing expense decreased due to the decrease in auto
leasing activity, as well as auto leases originated since February 2003
being classified as finance leases rather than operating leases.
Total assets increased $186 million from December 31, 2002 to March 31, 2003
primarily as a result of an increase in federal funds, investment securities
and home equity loans. Partially offsetting these increases were reductions
in nonconforming residential loans, structured finance loans and auto
leases. The fluctuations in the loan and lease balances reflect management's
decision to lower the risk profile of its loan and lease portfolio. Total
deposits increased $816 million during the first three months of 2003.
Average core deposits have increased 8% since the first quarter of 2002.
Regulatory capital ratios have improved significantly since March 2002, due
primarily to the issuance of $165 million of Real Estate Investment Trust
(REIT) PRIDES and a lower regulatory risk-weighting composition of on and
off-balance sheet assets.
Business Lines
- --------------
Provident's major business lines are Commercial Banking, Retail Banking and
Mortgage Banking. The following table summarizes net income by major lines
of business for the three-month periods ended March 31, 2003 and 2002.
Condensed income statements and total assets are provided in Note 5 of the
"Notes to Consolidated Financial Statements".
Three Months Ended
March 31,
----------------------
(Dollars in Millions) 2003 2002
- ----------------------------------------------------------------------------
Commercial Banking $ 14.2 $ 12.5
Retail Banking 5.8 6.9
Mortgage Banking 4.8 2.2
Corporate Center 1.0 -
------ ------
$ 25.8 $ 21.6
====== ======
-17-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Key components of the management reporting process follows:
o Risk-Based Equity Allocations: Provident uses a comprehensive approach
for measuring risk and making risk-based equity allocations. Risk
measurements are applied to credit, operational and other corporate-level
risks.
o Transfer Pricing: Provident utilizes a matched funded transfer pricing
methodology that in most cases isolates the business units from
fluctuations in interest rates, and provides management with the ability
to measure business unit, product and customer level profitability based
on the financial characteristics of the products rather than the level of
interest rates.
o Provision for Loan and Lease Losses: Business lines are charged for
provision based upon their level of net charge-offs as well as the size
and composition of their lending portfolio.
o Costs Allocation: Provident applies a detailed approach to allocating
costs at the business unit, product and customer levels. Allocations are
generally based on volume/activity and are reviewed and updated
regularly.
o Corporate Center: Corporate Center includes balance sheet and income
statement items not allocated to the primary business lines, and
gain/loss on the sale of investment securities.
Business line descriptions and fluctuation analysis follows:
o Commercial Banking provides a broad range of commercial banking and
commercial real estate products, services and solutions. Areas of focus
and expertise include regional middle-market lending, equipment leasing
and financing, treasury management, and loan servicing, transaction
structuring and various capital solutions for the multi-family housing
industry. Primary operating groups within Commercial Banking are Regional
Middle-Market Commercial Banking, Commercial Real Estate, Middle Market
Equipment Leasing and Financing and Corporate Services.
Net income for Commercial Banking for the quarters ending March 31, 2003
and 2002 was $14.2 million and $12.5 million, respectively. The
fluctuation in net income can be primarily attributed to an increase in
noninterest income between the first quarter 2003 and first quarter 2002
of $5.2 million, all primarily attributed to Commercial Mortgage Banking.
Both Red Capital Group and Capstone recognized a significant increase in
revenue while utilizing lower levels of capital. The favorable rate
environment during the past quarter provided for an increased demand for
their services.
Average balances for the first three months of 2003 increased $459
million or 7% compared to the same time period in 2002. However, net
interest income for the first three months of 2003 failed to keep pace
with asset growth due to a modest spread compression. Furthermore,
provision expense decreased in the first three months of 2003 primarily
due to an overall improvement in credit quality of the commercial loan
portfolio.
-18-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management continues to reposition this business line in order to develop
and grow more predictable earnings. Management has de-emphasized its
higher credit risk areas of structured finance lending and large
equipment leasing while growing its lower credit risk areas of middle
market leasing and regional middle market commercial lending units.
o Retail Banking provides a variety of deposit, credit and investment
products, services and solutions to consumers and small businesses
through various delivery channels including: branches, call center, ATMs
and the internet. Consumer lending primarily focuses on offering home
equity loans to high credit-quality borrowers. Primary operating groups
within Retail Banking include Branch Banking, Business Banking and
Consumer Lending/Prime Home Equity. Retail Banking also includes
Provident Financial Advisors, which provides an extensive range of
investment, insurance and financial products, services and solutions to
individuals, businesses and government agencies.
Net income was $5.8 million and $6.9 million for the three-month periods
ended March 31, 2003 and 2002, respectively. The decrease in net income
for 2003 was primarily the result of a decrease in noninterest income,
principally leasing income, which was partially offset by an increase in
net interest income. The improvement in net interest income was primarily
due to the growth in the home equity lending portfolio.
Retail Banking continues to alter the composition of its consumer lending
portfolio. Management believes that growing its home equity portfolio
while slowing auto lease originations will result in lower credit risk
exposure.
Retail Banking has experienced growth in transaction deposits of 7% in
the first quarter of 2003 as compared to the first quarter of 2002. Total
retail deposit growth has been flat over the same time period, however,
due to less aggressive pricing on retail certificates of deposit.
Provident plans to further enhance its distribution system to improve
customer acquisition and market penetration.
o Mortgage Banking offers conforming and nonconforming residential mortgage
loans to consumers, and also provides fee-based loan processing, loan
warehousing and servicing for third-party originators. Loans are
originated through retail and broker channels and are sold on a
whole-loan basis. Whole-loan sales refer to the transfer of credit risk
along with the payment stream of the loan. Primary operating groups
within Mortgage Banking include Residential Mortgage Origination and
Sales, Third-Party Loan Servicing and Warehouse Lending Services.
-19-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Net income for the first quarter of 2003 was $4.8 million as compared to
net income of $2.2 million for the first quarter of 2002. Net income for
the first quarter of 2003 rose primarily from higher warehouse lending
production, growth in the sub-servicing portfolio, and from the execution
of the whole-loan sale strategy. Warehouse lending production has
benefited from a favorable rate environment, which has stimulated loan
refinancing. Sub-servicing has also experienced significant growth as
loans serviced for others (excluding securitized mortgages) increased
from $1.6 billion at March of 2002 to $7.7 billion at the end of this
quarter. Gains on the sale of nonconforming residential loans increased
from $1.5 million in the first quarter of 2002 to $2.9 million in the
first quarter of 2003.
Mortgage Banking, consistent with the overall company strategy of risk
reduction, continues to implement strategic initiatives to reduce the
business' risk profile. Nonconforming loan originations have been sold to
investors on a whole-loan basis. Mortgage Banking has also developed new
businesses to create a diverse array of product offerings in the mortgage
market. Mortgage Banking is continuing with its strategy of building
national mortgage alliances in order to generate qualified leads for home
mortgage loans on a nationwide basis and sell them to investors.
Net Interest Income
- -------------------
Net interest income for the three months ended March 31, 2003, increased
$4.7 million, or 6%, compared to the first three months of 2002. The
increase in interest income was due to an increase in average earning assets
of $1.3 billion, or 10%. The increase in average earning assets resulted
primarily from the growth of home equity loans and investment securities.
The growth in earning assets was primarily funded by a corresponding growth
in interest bearing liabilities. The largest increases in interest bearing
liabilities were demand and time deposits.
-20-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Net interest margin represents net interest income as a percentage of total
interest earning assets. For the first three months of 2003, the net
interest margin, on a tax-equivalent basis, was 2.37% compared to 2.47% for
the same period in 2002. This increase was driven by changes in rates and
volumes of earning assets and the corresponding funding sources. The
following table details the components of the change in net interest income
(on a tax-equivalent basis) by major category of interest earning assets and
interest bearing liabilities for the three-month period ended March 31, 2003
and 2002.
Three Months Ended
-------------------------------------------
March 31, 2003 March 31, 2002
-------------------------------------------
Average Average Average Average
(Dollars in Millions) Balance Rate Balance Rate
- --------------------------------------------------------------------------------------------------
Assets:
Loans and Leases:
Corporate Lending:
Commercial $ 4,446 5.66% $ 4,386 6.55%
Mortgage 934 5.83 882 6.54
Construction 522 4.19 567 4.82
Lease Financing 1,246 8.85 1,117 9.84
------- ----- ------- -----
Total Corporate Lending 7,148 6.13 6,952 6.94
Consumer Lending:
Installment 1,352 5.12 937 6.99
Residential 552 11.68 869 9.30
Lease Financing 33 7.92 - -
------- ----- ------- -----
Total Consumer Lending 1,937 7.04 1,806 8.11
------- ----- ------- -----
Total Loans and Leases 9,085 6.32 8,758 7.18
Investment Securities 4,292 4.90 3,721 5.82
Federal Funds Sold and Reverse
Repurchase Agreements 313 2.13 109 2.79
Other Short Term Investments 504 5.35 285 6.15
------- ----- ------- -----
Total Earning Assets 14,194 5.76 12,873 6.72
Cash and Due From Banks 311 238
Leased Equipment 2,242 2,606
Other Assets 787 644
------- -------
Total Assets $17,534 $16,361
======= =======
Liabilities and Shareholders' Equity:
Deposits:
Demand Deposits $ 1,053 1.43 $ 512 1.01
Savings Deposits 1,419 1.76 1,535 2.05
Time Deposits 6,498 2.94 5,920 4.00
------- ----- ------- -----
Total Deposits 8,970 2.57 7,967 3.43
Short-Term Debt:
Federal Funds Purchased and
Repurchase Agreements 1,488 2.11 1,481 2.47
Commercial Paper 300 1.47 273 1.92
------- ----- ------- -----
Total Short-Term Debt 1,788 2.00 1,754 2.38
Long-Term Debt 3,769 5.20 4,022 5.18
Junior Subordinated Debentures 451 4.22 451 5.34
------- ----- ------- -----
Total Interest Bearing Liabilities 14,978 3.22 14,194 3.86
Noninterest Bearing Deposits 1,137 847
Minority Interest 161 -
Other Liabilities 380 493
Shareholders' Equity 878 827
------- -------
Total Liabilities and Shareholders' Equity $17,534 $16,361
======= =======
Net Interest Spread 2.54% 2.86%
===== =====
Net Interest Margin 2.37% 2.47%
===== =====
-21-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Provision and Reserve for Loan and Lease Losses and Credit Quality
- ------------------------------------------------------------------
Over the past year, Provident has significantly enhanced its Credit and Risk
Management function through additional experienced staff, new processes and
enhanced information and analytics. This coupled with clear business and
portfolio strategies allow for focused business development and aggressive
management of both non-strategic portfolios and problem loans.
Provident has expanded and improved its analytical and reporting capacity,
which in turn has improved the timeliness and value of portfolio
information. Loans and leases are primarily monitored by closely following
changes and trends in risk characteristics. The characteristics are analyzed
using various techniques; including, credit scoring models for consumer and
small business loans and leases and risk ratings for larger commercial,
commercial mortgage and commercial construction loans. These risk ratings
are assigned based upon individual credit analysis and are aggregated for
reporting to senior management on a regular basis. These same analytics
serve as the basis for refining the rating system, and establishing
portfolio wide targets and caution levels. Early trends and thresholds
trigger changes in strategy and tactics including the use of secondary
market alternatives to liquidate and mitigate problem exposures and
portfolio segments.
Provident maintains a reserve for loan and lease losses to absorb losses
from current outstandings and potential usage of unfunded commitments.
Discussion and analysis of the reserves as well as the overall credit
quality of the off-balance sheet lending portfolio is provided in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Asset Securitization Activity" and "Fannie Mae DUS Program."
The following paragraphs provide information concerning its on-balance sheet
credit portfolio and unused commitments.
The reserve for loan and lease losses is maintained at a level which
management considers adequate to absorb loan and lease losses given the
conditions at the time. The reserve is increased by the provision for loan
and lease losses. Loans and leases deemed uncollectible are charged off and
deducted from the reserve while recoveries on loans and leases previously
charged off are added back to the reserve.
The adequacy of the reserve for loan and lease losses is monitored on a
regular basis and reflects management's evaluation of numerous factors.
These factors include the quality of the current loan portfolio, the trend
in the loan portfolio's risk ratings, current economic conditions, specific
industry trends, loan concentrations, evaluation of specific loss estimates
for all significant problem loans, payment histories, collateral valuations,
historic charge-off and recovery experience, estimates of charge-offs for
the upcoming year and other pertinent information. Provident lowered its
loan loss reserve to total loans by 61 basis points to 2.20% during the past
twelve months.
The provision for loan and lease losses was $16.5 million and $24.2 million
for the first three months of 2003 and 2002, respectively. As credit-related
volatility declined during 2002 and 2003, the provision has decreased. The
-22-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ratio of reserve for loan and lease losses to total loans and leases was
2.20% and 2.81% at March 31, 2003 and 2002, respectively.
The reserve methodology considers potential losses in the commercial airline
portfolio as well as all other loan and lease types. Risks in the commercial
airline portfolio arise from principal reliance on borrower credit quality
and secondarily on equipment value. Based upon previous peak outstandings,
the majority of commercial airline loans and leases are to borrowers
considered to have better credit quality. Even within this segment, shorter
maturities have left Provident exposed to residual equipment values. Most of
the charge-offs and valuation adjustments have dealt with transactions
related to borrowers with weaker credit quality, which exposed Provident to
depressed equipment values. Future events could occur that may negatively
impact our assessment of borrowers' credit quality and/or equipment values
leading to higher reserves and potential future losses.
The following table shows the progression of the reserve for loan and lease
losses and selected reserve ratios:
Three Months Ended
March 31,
-----------------------
(Dollars in Thousands) 2003 2002
- ----------------------------------------------------------------------------
Balance at Beginning of Period $ 201,051 $ 241,143
Provision for Loan and Lease Losses 16,521 24,205
Loans and Leases Charged Off (22,429) (28,241)
Recoveries 5,877 5,912
--------- ---------
Balance at End of Period $ 201,020 $ 243,019
========= =========
Reserve for Loan and Lease Losses as a Percent of:
Nonaccrual Loans 110.91% 132.51%
Nonperforming Assets 98.82% 114.90%
Total Loans and Leases 2.20% 2.81%
Based upon the analysis of the adequacy of the reserve and the continuing
change in composition of the loan and lease portfolio, the reserve for loan
and lease losses has been allowed to decline over the past twelve months. As
a result of the lower reserve balance, the reserve to nonaccrual loans,
nonperforming assets and total loans and leases ratios have also declined.
-23-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following table presents the distribution of net loan charge-offs by
loan type for the three-month period ended March 31, 2003 and 2002:
Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
--------------------------------- ----------------------------------
Pctg of Pctg of Pctg of Pctg of
Average Total Average Total
Net Total Net Net Total Net
Charge- Loans Charge- Charge- Loans Charge-
(Dollars in Thousands) Offs (annualized) Offs Offs (annualized) Offs
- ---------------------------------------------------------------------------------------------------
Corporate Lending:
Commercial $ 8,093 0.73% 48.9% $ 13,937 1.27% 62.4%
Mortgage 46 0.02 0.3 24 0.01 0.1
Construction 65 0.05 0.4 300 0.21 1.3
Lease Financing 3,294 1.06 19.9 4,324 1.55 19.4
-------- ----- -------- -----
Net Corporate Lending 11,498 0.64 69.5 18,585 1.07 83.2
Consumer Lending:
Installment 576 0.17 3.5 727 0.31 3.3
Residential 4,478 3.25 27.0 3,017 1.39 13.5
Lease Financing - - - - - -
-------- ----- -------- -----
Net Consumer Lending 5,054 1.04 30.5 3,744 0.83 16.8
-------- ----- -------- -----
Net Charge-Offs $ 16,552 0.73 100.0 $ 22,329 1.02 100.0
======== ===== ======== =====
The decrease in net charge-offs for commercial loans was due primarily to a
decrease in charge-offs in the regional commercial banking area. A decrease
in charge-offs in the middle-market equipment leasing area was the primary
reason for the decrease in charge-offs in commercial lease financing. The
weak economic environment was the primary reason for the increase in
residential mortgage net charge-offs.
-24-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Nonperforming assets at March 31, 2003 were $203.4 million compared to
$182.2 million and $211.5 million as of December 31, 2002 and March 31,
2002, respectively. While there is typical flow of charge-offs, collections,
and new non-accruals during a quarter, the increase in commercial nonaccrual
loans in the first quarter of 2003 was principally driven by one large
addition late in the period. The decrease in nonaccrual commercial mortgage
loans during the first quarter of 2003 was due primarily to one loan coming
off nonaccrual status. The increase in other nonperforming assets during the
first quarter of 2003 is primarily due to an increase in foreclosed
residential properties. The composition of nonperforming assets over the
past five quarters is provided in the following table.
2003 2002
-------- --------------------------------------------
First Fourth Third Second First
(Dollars in Thousands) Quarter Quarter Quarter Quarter Quarter
- ---------------------------------------------------------------------------------------
Nonaccrual Loans:
Corporate Lending:
Commercial $123,912 $ 99,805 $117,571 $108,330 $111,727
Mortgage 7,298 11,783 10,619 5,546 1,938
Construction 1,321 1,746 2,243 7,268 1,984
Lease Financing 2,792 4,008 3,952 3,497 5,223
-------- -------- -------- -------- --------
Total Corporate Lending 135,323 117,342 134,385 124,641 120,872
Consumer Lending:
Installment - - - - -
Residential 45,927 49,091 44,548 35,920 62,530
Lease Financing - - - - -
-------- -------- -------- -------- --------
Total Consumer Lending 45,927 49,091 44,548 35,920 62,530
-------- -------- -------- -------- --------
Total Nonaccrual Loans 181,250 166,433 178,933 160,561 183,402
Other Nonperforming Assets 22,172 15,780 14,579 25,471 28,098
-------- -------- -------- -------- --------
Total Nonperforming Assets $203,422 $182,213 $193,512 $186,032 $211,500
======== ======== ======== ======== ========
Loans 90 Days Past Due
Still Accruing $ 36,038 $ 29,918 $ 30,482 $ 29,186 $ 29,390
Nonaccrual Loans to
Total Loans and Leases 1.98% 1.82% 1.99% 1.84% 2.12%
Nonperforming Assets to:
Total Loans, Leases and
Other Nonperforming Assets 2.22% 1.99% 2.15% 2.12% 2.44%
Total Assets 1.15% 1.04% 1.13% 1.12% 1.30%
Nonaccrual loans have increased $14.8 million while other nonperforming
assets have increased $6.4 million during the first quarter of 2003. The
following table shows the progression of nonaccrual loans and other
nonperforming assets during this time period:
Corporate Lending
------------------------------------ Consumer Total Other Total
Real Lease Residential Nonaccrual Nonperforming Nonperforming
(In Thousands) Commercial Estate Financing Mortgages Loans Assets Assets
- -------------------------------------------------------------------------------------------------------------------
Balance at
Beginning of Year $ 99,805 $ 13,529 $ 4,008 $ 49,091 $ 166,433 $ 15,780 $ 182,213
Additions 44,317 309 2,436 17,022 64,084 2,669 66,753
Payments / Sales (9,707) (4,880) (1,297) (8,950) (24,834) (4,131) (28,965)
Charge-Offs (10,503) (111) (955) (3,701) (15,270) (1,309) (16,579)
Transfers to Other
Nonperforming Assets - (228) (1,400) (7,535) (9,163) 9,163 -
--------- --------- --------- --------- --------- --------- ---------
Balance at
March 31, 2003 $ 123,912 $ 8,619 $ 2,792 $ 45,927 $ 181,250 $ 22,172 $ 203,422
========= ========= ========= ========= ========= ========= =========
-25-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Noninterest Income
- ------------------
The following table details the components of noninterest income and their
change for the three-month period ended March 31, 2003 and 2002:
Three Months Ended
March 31,
------------------- Pctg
(Dollars in Thousands) 2003 2002 Change
- ----------------------------------------------------------------------------
Service Charges on Deposit Accounts $ 12,332 $ 10,449 18%
Loan Servicing Fees 10,660 7,998 33
Commercial Mortgage Banking Revenue 10,297 5,746 79
Other Service Charges and Fees 11,736 9,899 19
Leasing Income 138,861 154,981 (10)
Cash Gains on Sale of Loans 4,942 2,640 87
Warrant Gains 328 - -
Security Gains 1,500 - -
Other 3,518 4,517 (22)
-------- --------
Total Noninterest Income $194,174 $196,230 (1)
======== ========
Explanations for significant changes in noninterest income by category
follow:
o Service charges on deposit accounts increased $1.9 million primarily as a
result of growth in deposit transaction accounts and increases in
overdraft fees.
o Loan servicing fees increased $2.7 million as an increase in fees from
servicing residential mortgage portfolios more than offset the decrease
from servicing equipment leasing portfolios.
o An increase in commercial mortgage banking fees from Red Capital Group
was the primary reason for the increase in commercial mortgage banking
revenue.
o Other service charges and fees increased $1.8 million due primarily to
increases in other fee income generated by Mortgage Banking and Red
Capital Group.
o Leasing income decreased $16.1 million primarily as a result of the
decrease in size of the lease portfolio. The decrease in the auto lease
portfolio is reflective of management's decision to de-emphasize the auto
lease business and because auto leases originated since February, 2003
have been classified as finance leases rather than operating leases.
o The increase of $2.3 million in gain on sale of loans is due primarily to
gains recognized from the sale of nonconforming residential mortgage
loans on a whole-loan basis, a strategy that Provident implemented during
the third quarter of 2001.
o A decrease in income from equity investments was the primary reason for
the $1.0 million decrease in other income.
-26-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Noninterest Expense
- -------------------
The following table details the components of noninterest expense and their
change for the three-month period ended March 31, 2003 and 2002:
Three Months Ended
March 31,
------------------- Pctg
(Dollars in Thousands) 2003 2002 Change
- ----------------------------------------------------------------------------
Salaries, Wages and Benefits $ 61,984 $ 56,389 10%
Charges and Fees 7,822 7,651 2
Occupancy 6,228 6,018 3
Leasing Expense 95,760 106,865 (10)
Equipment Expense 6,949 6,207 12
Professional Services 8,398 6,085 38
Minority Interest Expense 3,197 - -
Other 31,745 27,397 16
-------- --------
Total Noninterest Expense $222,083 $216,612 3
======== ========
Explanations for significant changes in noninterest expense by category
follow:
o Salaries, wages and benefits increased $5.6 million in the first quarter
of 2003 due primarily to increased commissions and staffing expenses
associated with the Commercial Banking business line.
o The decrease in leasing expense is a result of the decrease in size of
the auto lease portfolio.
o Equipment expense increased due primarily to increases in depreciation
and equipment rental expense.
o Professional services increased $2.3 million primarily as a result of
increases in legal fees for loan collection activity and professional
fees associated with the restatements of operating results.
o Minority interest expense relates to dividends payable on $165 million of
Preferred Stock of PFGI Capital Corporation, a real estate investment
trust that was formed late in the second quarter of 2002. The dividends
are payable at an annualized rate of 7.75%.
o The three largest expenses within other noninterest expense were
marketing expense ($2.9 million in 2003 and $2.7 million in 2002), travel
($2.5 million in 2003 and $1.9 million in 2002) and data processing
expense ($2.3 million in 2003 and $1.7 million in 2002).
-27-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
- -------------------
Short-Term Investments and Investment Securities
- ------------------------------------------------
Federal funds sold and reverse repurchase agreements increased $373 million
since December 31, 2002. Due to the restatement of earnings announced on
March 5, 2003 and the potential impact this could have had on its funding,
management decided to enhance its balance sheet liquidity position. This
excess liquidity was placed in overnight federal funds.
Trading account securities were $112 million and $128 million as of March
31, 2003 and December 31, 2002, respectively. Provident trades investment
securities with the intention of recognizing short-term profits. These
securities are carried at fair value with realized and unrealized gains and
losses reported in noninterest income.
Provident had $256 million of loans classified as held for sale at March 31,
2003. This is a decrease of $181 million from the amount reported at
December 31, 2002. These loans consist of $142 million of multifamily loans,
$104 million of nonconforming residential mortgage loans and $10 million of
conforming residential loans. The multifamily loans are either insured by
the Federal Housing Association or subject to purchase contracts from Fannie
Mae or Freddie Mac. These loans are usually outstanding for sixty days or
less. Activities related to the multifamily loans held for sale are part of
the operations of Red Capital Group. Nonconforming residential mortgage
loans are being sold on a whole-loan basis. This is part of the initiative
started during 2001 to reduce the risk profile of the Mortgage Banking
business line.
Securities purchased with the intention of being held for indefinite periods
of time are classified as investment securities available for sale. These
securities increased $105 million during the first three months of 2003.
U.S. government agency mortgage-backed securities accounted for the majority
of the increase, as funds obtained from loan payments and the sale of other
debt securities were deployed into investment securities with higher credit
quality, increased liquidity and an improved interest rate risk profile.
Loans and Leases
- ----------------
As of March 31, 2003 total loans and leases were $9.2 billion compared to
$9.1 billion at December 31, 2002. Provident had an additional $1.9 billion
and $2.1 billion of off-balance sheet securitized loans and leases as of
March 31, 2003 and December 31, 2002, respectively. As a result of recent
earnings volatility, management has re-evaluated the risk/reward
relationships of its lending portfolio. During the second half of 2001,
Provident implemented a whole-loan sale strategy for its nonconforming
residential loans. Also, management has decided to de-emphasize its
structured finance lending and large equipment leasing while placing a
greater focus on its regional middle-market commercial lending and
middle-market equipment leasing. As a result of these actions, Provident's
lending portfolio has a lower concentration of residential loans, higher
concentrations of middle-market corporate leases, and a lower risk profile
-28-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
of commercial loans. Provident does not have a material exposure to foreign
loans.
The following table shows the composition of the commercial loan category by
industry type at March 31, 2003:
Amount on
(Dollars in Millions) Amount % Nonaccrual
- -------------------------------------------------------------------------------------
Mortgage Warehousing Lines $ 597.0 13 $ 4.5
Real Estate Operators/Developers/General Contractors 585.6 13 0.7
Banking and Finance 225.0 5 12.6
Healthcare 196.8 4 0.6
Transportation 191.3 4 7.5
Retailing 190.4 4 6.1
Tourism and Entertainment 161.5 4 0.3
Machinery and Equipment 153.0 3 10.6
Business Services 150.2 3 13.0
Metals 147.5 3 11.8
Automobile Dealers 135.9 3 -
Construction 129.6 3 3.0
Commercial Aviation Related (1) 121.2 3 23.8
Eating and Drinking Establishments 110.6 3 1.4
Financial Services 102.9 2 2.0
Automotive Services/Parts 86.2 2 0.1
Technology 83.5 2 17.1
Energy Production and Distribution 72.0 2 -
Other (includes 20 industry types) 1,075.7 24 8.8
---------- --- --------
Total $ 4,515.9 100 $ 123.9
========== === ========
(1) Includes $25 million of loans related to the commercial airline
industry, and aircraft used in private, charter and corporate markets.
Mortgage warehousing lines decreased $43 million during the first quarter to
$597 million. All loans are underwritten to Provident and secondary market
standards as part of Provident's control processes related to this activity.
At March 31, 2003, Provident had loans and leases of $176 million to
commercial airline carriers, including $25 million of commercial loans and
$151 million of finance and operating leases. As the events of September 11,
2001 have had a significant financial impact upon the airline industry and
the re-sale value of aircraft, Provident recorded credit costs and other
expenses of $34 million during 2002, which were related to secured
commercial airline loans and leases. No additional credit charges were
incurred during the first quarter of 2003.
At March 31, 2003, Provident had approximately $826 million of commercial
loans that are to borrowers who have shared national credit loans.
Generally, shared national credit loans are loans that have a commitment
amount of at least $20 million and involve three or more supervised
financial institutions. In an on-going effort to diversify its portfolio,
the shared national credit loans in which Provident participates are
distributed across thirty-one industry types, with the largest industry
concentration (real estate) accounting for approximately 15% of its total
shared national credit loans. The real estate category is comprised of loans
to borrowers with different risk characteristics, including single family
home developers, commercial property owner/operators and commercial realtors
-29-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
and property managers. The average outstanding balance of a shared national
credit loan was $3.9 million.
The composition of the mortgage and construction loan categories by property
type at March 31, 2003 follows:
Amount on
(Dollars in Millions) Amount % Nonaccrual
- ----------------------------------------------------------------------------
Office/Warehouse $ 247.8 17 $ 2.7
Residential Development 238.6 16 1.9
Shopping/Retail 237.5 16 -
Apartments 230.1 16 2.3
Hotels/Motels 106.1 7 0.1
Health Facilities 93.9 6 -
Land 90.1 6 0.4
Industrial Plants 29.5 2 -
Other Commercial Properties 202.4 14 1.2
-------- --- -----
Total $1,476.0 100 $ 8.6
======== === =====
As of March 31, 2003, Provident had $1.2 billion in commercial lease
financing. These leases were comprised of $1.0 billion of small to mid-size
equipment leases and $.2 billion of large equipment leases.
The following table shows the composition of the installment loan category
by loan type at March 31, 2003:
(Dollars in Millions) Amount %
- ---------------------------------------------------------------------------
Home Equity $1,174.1 86
Indirect Installment 116.8 9
Direct Installment 56.2 4
Other Consumer Loans 15.8 1
-------- ---
Total $1,362.9 100
======== ===
Noninterest Earning Assets
- --------------------------
Leased equipment consisted of $1.9 billion of auto leases and $0.3 billion
of equipment leases. Total leased equipment decreased $169 million, or 7%,
during the first three months of 2003 due primarily to a reduction in the
size of the automobile leasing portfolio. The decrease in auto leases is
reflective of management's decision to de-emphasize the auto lease business
due to its overall complexity and thin margin. Also, auto leases originated
since February 2003 are classified as direct financing leases in the loan
category as Provident changed the structure of the residual insurance it
obtains on its auto leases.
Other assets increased $71 million, or 9%, during the first three months of
2003. The increase was primarily due to increases in mortgage servicing
rights and unsettled security trades.
-30-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Deposits
- --------
Total deposits increased $816 million during the first three months of 2003.
Since March 31, 2002, average core deposits have grown 8% with significant
contribution coming from commercial deposits. The following table presents a
summary of deposit types:
March 31,
----------------------------
(In Millions) 2003 2002
- ----------------------------------------------------------------------------
Noninterest Bearing Deposits $ 1,163.2 $ 849.7
Interest Bearing Demand Deposits 1,141.9 509.7
Savings Deposits 1,395.8 1,517.2
Certificates of Deposit 6,964.4 6,029.8
--------- ---------
Total Deposits $10,665.3 $ 8,906.4
========= =========
Borrowed Funds
- --------------
Short-term debt decreased $418 million during the first three months of
2003. Decreases in federal funds purchased and repurchase agreements were
the primary reason for the decrease in short-term debt.
Long-term debt decreased $181 million, or 5%, during the first three months
of 2003 due primarily to payments on subordinated notes and secured
financings.
Minority Interest
- -----------------
During June 2002, Provident and its consolidated subsidiary, PFGI Capital
Corporation (PFGI Capital), issued 6.6 million of equity units (PRIDES) to
outside investors for $165 million. The Provident Bank (the Bank),
Provident's most significant subsidiary, owns all of the $165 million
of Common Stock of PFGI Capital. The principal business objective of PFGI
Capital is to hold and manage commercial mortgage loan assets and other
authorized investments acquired from the Bank that will generate net income
for distribution to its stockholders. PFGI Capital has elected to be treated
as a real estate investment trust (REIT) for federal income tax purposes.
Each PRIDES has a stated amount of $25 per unit and is comprised of two
components - a 3-year forward purchase commitment (Purchase Contract) and
PFGI Capital Preferred Stock.
Each Purchase Contract obligates the holder to buy, on August 17, 2005, for
$25, a number of newly issued shares of Provident Common Stock equal to the
"settlement rate." The settlement rate will be calculated as follows:
o if the market value of Provident Common Stock is equal to or greater than
$29.0598, the settlement rate will be .8603;
o if the market value of Provident Common Stock is between $29.0598 and
$24.42, the settlement rate will be equal to the $25 stated amount
divided by the applicable market value; and
o if the applicable market value is less than or equal to $24.42, the
settlement rate will be 1.0238.
-31-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Under the Purchase Contract, Provident will also make quarterly contract
adjustment payments to the PRIDES holders at the rate of 1.25% of the stated
amount per year. The present value of this obligation has been recorded as a
liability and as a reduction to shareholders' equity.
The PFGI Capital Preferred Stock has a liquidation preference of $25 and an
initial non-cumulative dividend rate of 7.75%.
Other Noninterest Earning Liabilities
- -------------------------------------
Other liabilities decreased $29 million, or 7%, during the first three
months of 2003 due primarily to a reduction in the amount of market value
adjustments recorded in relation to derivative transactions accounted for in
accordance with Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities."
Transactions with Affiliates
- ----------------------------
Provident has had certain transactions with various executive officers,
directors and principal holders of equity securities of Provident and its
subsidiaries and entities in which these individuals are principal owners. A
summary of significant transactions and the indebtedness of these related
parties can be found in Note 24 to Provident's 2002 Annual Report as filed
on Form 10-K.
ASSET SECURITIZATION ACTIVITY
- -----------------------------
From 1996 through the second quarter of 2000, the structure of some of
Provident's securitizations resulted in the transactions being accounted for
as sales through the use of special purpose entities. As such, gains or
losses were recognized, loans and leases were removed from the balance sheet
and residual assets, representing the present value of future cash flows,
were recorded. During the third quarter of 2000, management decided to
structure all future securitizations as secured financings thereby
eliminating the use of gain-on-sale accounting and leaving all debt on the
balance sheet.
The securitization and sale of loans and leases, during the period from 1996
through the first half of 2000, continues to impact the current presentation
of Provident's financial condition, results of operations and off-balance
sheet market risks. The areas most significantly affected are loans and
leases, retained interest in securitized assets, credit enhancements and
credit risk.
-32-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Securitized Loans and Leases
- ----------------------------
Securitized loans and leases that have been treated as sales have been
removed from the balance sheet. The following table provides a summary of
the outstanding balances of these off-balance sheet managed assets:
March 31,
-------------------------------
(In Thousands) 2003 2002
- ----------------------------------------------------------------------------
Nonconforming Residential $1,618,742 $2,412,274
Prime Home Equity 178,035 269,260
Equipment Leases 79,798 179,239
---------- ----------
$1,876,575 $2,860,773
========== ==========
Retained Interest in Securitized Assets
- ---------------------------------------
In connection with the recognition of non-cash gains on securitizations
accounted for as sales, the present value of future cash flows, referred to
as retained interest in securitized assets (RISAs), were recorded as assets
within the investment securities line item of the consolidated balance
sheets. Components of the RISAs, based on current models, as of March 31,
2003 follow:
Nonconforming Prime
(In Thousands) Residential Home Equity
- ----------------------------------------------------------------------------
Estimated Cash Flows of Underlying Loans,
Net of Payments to Certificate Holders $ 161,068 $ 12,087
Less:
Estimated Credit Loss (7,871) -
Servicing and Insurance Expense (24,565) (2,166)
Discount to Present Value (31,330) (979)
--------- --------
Carrying Value of Retained Interest in
Securitized Assets $ 97,302 (1) $ 8,942
========= ========
(1) The carrying value for nonconforming retained interest in securitized
assets, net of all loss reserves, was $85.9 million.
-33-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Securitization Credit Enhancements
- ----------------------------------
Provident has provided for credit enhancements to its securitizations
structured as sales in the form of cash, loans and an unfunded secured
demand note. The credit enhancements are maintained at a significantly
higher balance than the level of estimated credit losses to improve the
credit grade of the securitization and thereby reduce the rate paid to
investors of the securitization trust. Provident had reserves of $13.8
million as of March 31, 2003 to offset future losses. Estimated credit
losses are based upon loan credit grades, collateral, market conditions and
other pertinent factors. Detail of the credit enhancements along with their
loss reserves are provided below as of March 31, 2003:
Type of Credit Value of Credit Loss
(In Thousands) Enhancements Enhancements Reserves
- -------------------------------------------------------------------------------------------
Nonconforming Residential Unfunded Demand Note(1)/Loans $ 250,786 $11,354
Prime Home Equity Cash 26,600 842
Equipment Leases Cash 28,727 1,620
--------- -------
$ 306,113 $13,816
========= =======
(1) During the fourth quarter of 2001, Provident reached an agreement with
the securitization insurer to release the cash credit enhancement for
the nonconforming residential loan securitizations and substitute an
unfunded demand note backed by a AAA rated standby letter of credit.
Actual losses are submitted on a monthly basis to Provident by the
trustee. Should Provident fail to reimburse the trustee for these
monthly losses, the letter of credit can only be drawn upon monthly.
As discussed in Management's Discussion and Analysis of Financial Condition
and Results of Operations - Critical Accounting Policies," future period
cash flow realizations may differ from current projections as a result of
timing differences in credit related charge-offs in any given period.
Although these variances may not change the life-time loss assumptions, they
may result in temporary negative cash flows and the possibility of a charge
to earnings. To minimize the potential impact of this timing difference,
Provident increased its reserves for RISAs by $14.5 million during the first
quarter of 2003 which was offset against other realized security gains.
Management's estimate of the present value of expected future excess cash
flows above projected losses is $40 million. At March 31, 2003, management
believes the current carrying value of the RISA asset is properly stated.
-34-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Securitization Credit Risk
- --------------------------
The following table presents a summary of various indicators of the credit
quality of off-balance sheet securitized loans and leases as of and for the
three months ended March 31, 2003:
Nonconforming Prime Home Equipment
(Dollars in Thousands) Residential Equity Leases
- -----------------------------------------------------------------------------------
For the Three Months Ended March 31, 2003:
Average Securitized Assets $1,699,407 $ 186,361 $ 87,380
Net Charge-Offs 26,711 422 1,528
Net Charge-Offs to Average
Securitized Assets (Annualized) 6.29% 0.91% 6.99%
As of March 31, 2003:
Securitized Assets $1,618,742 $ 178,035 $ 79,798
Established Contingent Loss Liability 19,225 842 1,620
Delinquency Rates:
30 to 89 Days 10.27% 0.16% 2.15%
90 or More 22.00% 0.93% 1.93%
FANNIE MAE DUS PROGRAM
- ----------------------
Red Mortgage Capital, Inc. (Red Mortgage), a member of Red Capital Group, is
an approved Fannie Mae Delegated Underwriting and Servicing (DUS) mortgage
lender. Under the Fannie Mae DUS program, Red Mortgage underwrites, funds
and sells mortgage loans on multifamily rental projects. Red Mortgage then
services these mortgage loans on Fannie Mae's behalf. Participation in the
Fannie Mae DUS program requires Red Mortgage to share the risk of loan
losses with Fannie Mae. The substance of this loss sharing arrangement is
that Red Mortgage and Fannie Mae split losses with one-third of all losses
assumed by Red Mortgage and two-thirds of all losses assumed by Fannie Mae.
Red Mortgage services multifamily mortgage loans under the DUS program with
outstanding principal balances aggregating $3.3 billion at March 31, 2003.
At March 31, 2003, no DUS loans in Red Mortgage's loan servicing portfolio
were in default. Red Mortgage has established reserves of $9.5 million for
possible losses under this program. The reserve is determined by evaluating
pools of homogenous loans and includes information based upon industry and
historical loss experience, as well as each project's recent operating
performance. Management believes the reserve is maintained at a level that
adequately provides for the inherent losses within Red Mortgage's portfolio
of DUS loans. The employees and management team of Red Mortgage have
originated and serviced the existing Fannie Mae DUS loan servicing portfolio
since 1995 without any charge-offs relating to the DUS loans.
-35-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
DERIVATIVE AND OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
- ------------------------------------------------------
In the normal course of business, Provident uses derivative and off-balance
sheet financial instruments to manage its interest rate risk and to meet the
financing needs of its customers. At March 31, 2003, these financial
instruments consisted of standby letters of credit of $268 million,
commitments to extend credit of $3.8 billion, and interest rate swaps and
caps with a notional amount of $6.8 billion and $5.4 billion, respectively.
In order to mitigate credit risk within the auto lease portfolio, Provident
entered into credit risk transfer arrangements during 2001 and 2000. Under
the 2001 transaction, Provident transferred 97 1/2% of the credit risk on an
auto lease portfolio, while retaining a 2 1/2% first-loss position. Under
the 2000 transaction, Provident transferred 98% of the credit risk on an
auto lease portfolio, while retaining a 2% first-loss position. As a result
of these transactions, Provident was able to lower its credit concentration
in auto leasing while reducing its regulatory capital requirements. As of
March 31, 2003, the remaining unpaid auto lease balances on the 2001 and
2000 transactions were $0.5 billion and $0.9 billion, respectively.
Capital Resources and Adequacy
- ------------------------------
Total shareholders' equity at March 31, 2003 was $879 million compared to
$880 million at December 31, 2002. The change in the equity balance relates
primarily to net income exceeding dividends by $13.7 million, an increase in
the market value of cash flow hedging instruments of $8.6 million (net of
deferred taxes) and a decrease in the market value of investment securities
of $25.9 million (net of deferred taxes).
Capital expenditures planned by Provident in 2003 for premises and equipment
are currently estimated to be approximately $30 million. Included in this
amount are projected capital expenditures for the purchase of data
processing hardware and software, branch additions, renovations and
enhancements, facility renovations and ATMs. Through March 31, 2003,
approximately $6 million of these expenditures had been made.
The following table of ratios is important for an analysis of capital
adequacy:
Three Months Ended Year Ended
March 31, 2003 December 31, 2002
- ---------------------------------------------------------------------------------------
Average Shareholders' Equity to Average Assets 5.01% 5.12%
Average Tangible Shareholders' Equity to
Average Tangible Assets 4.48 4.55
Period End Shareholders' Equity to
Period End Assets 4.96 5.02
Period End Tangible Shareholders' Equity to
Period End Tangible Assets 4.45 4.49
Dividend Payout to Net Earnings 47.00 50.64
Tier 1 Capital to Risk-Weighted Assets 9.78 9.40
Total Risk-Based Capital To Risk-Weighted Assets 11.65 11.42
Tier 1 Leverage Ratio 7.76 7.81
-36-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Risk-based capital guidelines established by the Federal Reserve Board set
minimum capital requirements and require institutions to calculate
risk-based capital ratios by assigning risk weightings to assets and
off-balance sheet items. Provident is required to maintain minimum ratios of
4.00% for Tier 1 capital to risk-weighted assets, 8.00% for total risk-based
capital to risk-weighted assets, and 4.00% for Tier 1 capital to average
assets. These guidelines further define "well-capitalized" levels for Tier
1, total risk-based capital, and leverage ratio purposes at 6.00%, 10.00%
and 5.00%, respectively. As of March 31, 2003, both Provident and the Bank
were categorized as well-capitalized for regulatory purposes.
LIQUIDITY
- ---------
Adequate liquidity is necessary to meet the borrowing needs and deposit
withdrawal requirements of customers as well as to satisfy liabilities, fund
operations and support asset growth. Management forecasts that the largest
liquidity needs for the next twelve months will come from growth in the
lending portfolio, maturing of retail and brokered certificates of deposit,
and scheduled principal payments on long-term debt. Provident has a variety
of sources to meet these liquidity demands. First, management expects to
issue new certificates of deposit along with renewing many of its maturing
certificates of deposit. Management also projects growth within retail
transactional deposits. Additional sources of liquidity include the
availability to borrow both short-term and long-term funds.
Consistent with Provident's contingent funding plan, management monitors the
potential impact of changes in its corporate ratings on existing and new
business transactions. Ratings related liquidity events may include reduced
availability of short-term federal funds, reduced availability to the surety
bond market that supports the bank's Public Funds program and other
commitments provided to third parties in related business transactions. If
such ratings events are anticipated, management will take actions to enhance
balance sheet liquidity positions to meet liquidity needs. Such actions to
enhance liquidity positions were taken in connection with Provident's March
5, 2003 announcement related to the restatement of its earnings. In
anticipation of potential ratings downgrades, management took actions to
enhance liquidity positions, including issuance of additional brokered
certificates of deposits. Additional term liquidity reduces reliance on
short-term funding and increases the availability of collateral in the
investment portfolio. Management will continue to monitor events as the need
may arise for further liquidity enhancements in the future.
The major source of liquidity for Provident on a parent-only basis is
dividends paid to it by its subsidiaries. Pursuant to Federal Reserve and
state banking regulations, the maximum amount available for dividend
distribution to the Parent at March 31, 2003 by its banking subsidiary was
approximately $46.4 million. The Parent has received $15 million in
dividends from its banking subsidiary during the current year. During 2001,
higher credit costs had an unfavorable impact on net income. While credit
costs have declined substantially in 2002 and 2003, if these costs were to
rise again, this could impact Provident's ability to maintain the payment of
its quarterly dividend at current rates.
-37-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
- ----------------------------
Note 1 to Provident's 2002 annual report on Form 10-K lists significant
accounting policies used in the development and presentation of Provident's
financial statements. However, four of these accounting policies are
considered to be critical due to the level of sensitivity and subjectivity
of their underlying accounting estimates. These critical accounting policies
concern the adequacy of the reserve for loan and lease losses; the valuation
of retained interest in securitized assets (RISAs) and securitized credit
enhancements; the valuation of mortgage servicing assets; and the valuation
of derivatives.
Reserve for Loan and Lease Losses: Provident maintains a reserve to absorb
potential loan and lease losses inherent in its lending portfolio.
Management's determination of the adequacy of the loan loss reserve is based
on an assessment of the potential losses given the conditions at the time.
This assessment consists of certain loans and leases being evaluated on an
individual basis, as well as all loans and leases being categorized based on
common credit risk attributes and being evaluated as a group. Management
evaluates numerous factors including the credit quality of the current loan
portfolio, the trend in the loan portfolio's risk ratings, current economic
conditions, specific industry trends, loan concentrations, evaluation of
specific loss estimates for all significant problem loans, payment
histories, collateral valuations, historical charge-off and recovery
experience, estimates of charge-offs for the upcoming year and other
relevant information.
Loans and leases that have been placed on classified and/or nonaccrual
status are further evaluated for potential losses based upon review and
discussion among Credit, Portfolio Risk Review, lending officers, collection
associates, and senior management. Factors considered include the market
value of collateral or real estate associated with a specific loan or lease,
cash flows generated by the borrower, third-party guarantees, the general
economic climate and any specific industry trends that may affect an
individual loan or lease.
Additional loss estimates associated with securitized assets and loans sold
under the Fannie Mae DUS Program are provided for separately from the
reserve for loan and lease losses. For more information on credit exposures
on these off-balance sheet assets, see "Management Discussion and Analysis
of Financial Condition and Results of Operations - Asset Securitization
Activity" and "Fannie Mae DUS Program."
RISAs and Securitized Credit Enhancements: Prior to July 2000, Provident
structured its securitization transactions as sales. As such, Provident
retained (a) future cash flows of the underlying loans, net of payments due
to investors of the securitization trust, servicing fees and other fees
(RISAs), (b) servicing rights on the loans and leases, and (c) credit
enhancement accounts used to absorb credit losses on the loans securitized.
Gain or loss on the sale of the loans depended in part on the previous
carrying amount of the financial assets involved in the transfer, allocated
between the assets sold and the assets retained based on their relative fair
value at the date of transfer. However, quotes are generally not available
-38-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
for assets retained, so Provident estimates the fair value based on key
assumptions, including prepayment speeds, credit losses, forward yield
curves, and discount rates commensurate with the risks involved.
Provident monitors the valuation of the RISAs on a monthly basis. The
valuation centers primarily around two estimates, total life-time credit
losses and the constant prepayment rate (CPR). During 2002, both of these
factors trended upward which had an unfavorable impact on the nonconforming
residential RISA valuation. Additionally, the CPR was impacted by
management's decision to accelerate the liquidation of other real estate
associated with the securitized nonconforming residential portfolio.
Provident models a CPR range from 26% to 35% with the actual CPR currently
running at 30%. If the CPR stays at its current level, management estimates
that there would be sufficient cash flows to absorb lifetime losses up to
6.3%. If the CPR rises to 35%, there would be sufficient cash flows to
absorb lifetime losses up to 5.9%. Cumulative incurred losses through March
31, 2003 are 4.2%, with estimated total lifetime losses expected to be 5.6%.
On a worst case basis, management currently estimates that lifetime losses
should not exceed 6.1% assuming real estate values remain relatively stable.
From an earnings sensitivity standpoint, above certain loss thresholds, 5
basis points in losses represent a $1.8 million unfavorable after-tax
impact. Should both the estimated life-time credit losses and CPR continue
to rise, impairment of the RISA value could occur. Future period cash flow
realizations may differ from current projections as a result of timing
differences in credit related charge-offs in any given period. Although
these variances may not change the life-time loss assumptions, they may
result in temporary negative cash flows and the possibility of a charge to
earnings. At March 31, 2003, management believes the current carrying value
of the RISA asset is properly stated.
Valuation of Mortgage Servicing Rights: Provident recognizes the rights to
service mortgage loans it does not own but services for others within Other
Assets of its balance sheets. Mortgage servicing assets are carried at the
lower of the initial carrying value, adjusted for amortization, or estimated
fair value. Estimated fair value is based on projected discounted cash flows
which takes into consideration estimated servicing fees, prepayment speeds,
discount rates, earnings on deposit of escrow funds and other assumptions.
These estimates have a significant impact on the valuation of the mortgage
servicing assets. Mortgage servicing rights are tested quarterly to verify
the market value equals or exceeds its carrying value.
Valuation of Derivatives: In accordance with Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities," Provident carries the fair value of derivative
instruments on its consolidated balance sheets with changes in value
recorded in the income statement or as other comprehensive income. Although
the value of the derivatives are determined using third-party valuations,
these valuations use discounted cash flow modeling techniques, which require
the use of assumptions concerning the amount and timing of future cash
flows. These estimates have a significant impact on the valuation of the
derivatives.
-39-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
The responsibility of monitoring and managing market and liquidity risk is
assigned to the Asset Liability Committee (ALCO). The main component of
market risk is the risk of loss in the value of financial instruments that
may result from the changes in interest rates. ALCO is bound to guidelines
stated in the relevant policies approved by the Board of Directors.
In addition to the natural balance sheet hedges, ALCO utilizes derivative
instruments to manage interest rate risk on and off its balance sheet.
Interest rate swaps and caps are the most widely used tools to manage
interest rate risk.
Provident uses an earnings simulation model to analyze net interest income
sensitivity to movements in interest rates. The model evaluates the effect
of changes in interest rates on net interest income by running various
interest rate scenarios up and down from a flat rate scenario. As a basis
for strategic interest rate risk management, the ALCO group regularly
analyzes the impact of four to six additional interest rate scenarios on net
interest income in addition to the standard scenarios used for policy
measurement. These rate scenarios are established by ALCO and incorporate
changes to the slope of the yield curve. The balance sheet assumptions,
including loan growth, funding mix, and prepayment speeds primarily on
mortgage related products, are adjusted for each rate scenario. Market-based
prepayment speeds are incorporated into the analysis, particularly for
mortgage related products, including investment portfolio securities. Faster
prepayments during low interest rate environments such as the current levels
negatively impact interest rate margins due to lower reinvestment yields.
Provident's policy limit stipulates that the negative impact on net interest
income from a +/-200 basis points, 12 month gradual parallel ramp rate
scenario as compared to the flat rate scenario cannot exceed 10 percent over
the next 12 month period. These tests are performed on a monthly basis, and
the results are presented to the Board of Directors. Based on the results of
the simulation model, net interest income would change by the following over
the next 12-month period: decrease 0.90% for a 100 basis point decrease;
decrease 0.07% for a 100 basis point increase; and decrease 1.24% for a 200
basis point increase. Due to the current interest rate environment, nothing
beyond a 100 basis point decrease was simulated.
Although primarily classified as leased equipment, Provident continues to
include all of its auto leases in its interest sensitivity analysis.
ALCO regularly incorporates discussions and analyses of market risk embedded
in off-balance sheet activities as well as on non-interest income items such
as loan sale premiums. ALCO actively monitors the impact of related market
risk since these premiums are sensitive to changes in interest rates.
-40-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
All transaction accounts are regularly analyzed for embedded market risk.
These accounts are evaluated with respect to their repricing characteristics
as well as their expected average lives. Provident offers a diverse set of
managed transaction accounts including some that reprice according to a
third party index and some with managed rates. ALCO actively monitors the
behavioral characteristics of these products. Although indexed account rates
move parallel to movements in short term rates, managed account rates adjust
slower and at smaller increments due to the competitive environment. During
the current low rate environment, such price rigidities negatively impact
interest rate margins in the short run; however, the long-term profitability
and liquidity characteristics of these accounts are very attractive.
ITEM 4. CONTROLS AND PROCEDURES
- -------------------------------
An evaluation was performed under the supervision and with the participation
of management, including the principal executive and financial officers, of
the effectiveness of the design and operation of Provident's disclosure
controls and procedures within 90 days prior to the filing of this Form
10-Q. Based on that evaluation, management, including the principal
executive and financial officers, concluded that Provident's disclosure
controls and procedures were effective with no significant weaknesses noted
except that Provident's disclosure controls and procedures did not detect
until early 2003 certain unintentional errors that had occurred in the
accounting and classification of auto lease transactions. This weakness has
been addressed and the financial statements and related financial
information included in this Form 10-Q have been appropriately revised.
There have been no significant changes in Provident's internal controls or
in other factors that could significantly affect these internal controls
after the date of their evaluation. Provident is reviewing its disclosure
controls and procedures in all areas involving financial models previously
established for lease and other transactions to improve the ability of its
disclosure controls and procedures to detect such problems of the nature
discovered in early 2003. Provident's Audit Committee, through legal
counsel, engaged the accounting firm of PricewaterhouseCoopers LLP, which is
not the auditor of Provident's financial statements, to undertake a review
of its internal controls in certain areas. The scope of this review is
currently being determined.
-41-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS
- -------------------------
In addition to litigation filed in the first quarter of 2003, which was
reported in the Form 10-K for 2002, a similar purported class action was
filed April 22, 2003 in the U.S. District Court for the Southern District of
Ohio by shareholder Marzoff, IRA against Provident, its President, Robert L.
Hoverson and its Chief Financial Officer, Christopher J. Carey. Also, on May
3, 2003 shareholder Silverback Master Ltd. filed a purported class action
against those same defendants plus PFGI Capital Corporation, a Provident
subsidiary, and former officers, Allen L. Davis and John R. Farrenkopf on
behalf of all purchasers of PRIDES in or traceable to a June 6, 2002
offering of those securities registered with the Securities and Exchange
Commission and extending to March 5, 2003. This action is based upon
circumstances involved in a restatement of earnings announced by Provident
on March 5, 2003. It alleges violations of securities laws by the defendants
in Provident's financial disclosures during the period from March 30, 1998
through March 5, 2003 and in the June 2002 offering. The suit seeks an
unspecified amount of compensatory damages and/or rescission of purchases of
those securities. In addition, on April 16, 2003 a derivative action was
filed by shareholder Mays on behalf of Provident versus Provident's
directors, a former director, Philip R. Myers, and Ernst & Young, LLP in the
Court of Common Pleas of Hamilton County, Ohio. This suit is also concerned
with the restatement of earnings and alleges that the individual defendants
breached fiduciary duties owed to Provident and are responsible for the
conditions that led to the restatement and its consequences. It alleges that
Ernst & Young did not meet its accounting obligations with regard to its
audit of Provident's financial statements. It seeks an unspecified amount of
damages, and return of all bonuses and options received by Hoverson.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ----------------------------------------
(a) Exhibits filed:
Exhibit 99.1 - Section 906 of the Sarbanes-Oxley Act of 2002,
Certification of Chief Executive Officer
Exhibit 99.2 - Section 906 of the Sarbanes-Oxley Act of 2002,
Certification of Chief Financial Officer
(b) Reports on Form 8-K:
Form 8-K (Items 5 and 7) filed on March 5, 2003.
Form 8-K (Item 9) filed on April 15, 2003.
Form 8-K (Items 7 and 9) filed on April 18, 2003.
Form 8-K (Items 7 and 9) filed on April 30, 2003.
All other items required in Part II of this form have been omitted since
they are not applicable or not required.
-42-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Provident Financial Group, Inc.
-------------------------------
Registrant
Date: May 15, 2003 /s/Christopher J. Carey
-----------------------
Christopher J. Carey
Executive Vice President and
Chief Financial Officer
-43-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Certification of Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
and Securities and Exchange Commission Release 34-46427
I, Robert L. Hoverson, the principal executive officer of Provident
Financial Group, Inc. ("Provident"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of Provident;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;
4. The registrant's other certifying officer 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
we 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 quarterly
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 quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly 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 officer 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 officer and I have indicated in this
quarterly report whether or not 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.
Date: May 15, 2003 /s/Robert L. Hoverson
---------------------
Robert L. Hoverson
Chief Executive Officer
(Principal Executive Officer)
-44-
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Certification of Principal Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
and Securities and Exchange Commission Release 34-46427
I, Christopher J. Carey, the principal financial officer of Provident
Financial Group, Inc. ("Provident"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of Provident;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;
4. The registrant's other certifying officer 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
we 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 quarterly
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 quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly 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 officer 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 officer and I have indicated in this
quarterly report whether or not 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.
Date: May 15, 2003 /s/ Christopher J. Carey
------------------------
Christopher J. Carey
Chief Financial Officer
(Principal Financial Officer)
-45-
