Provident Bankshares (PBKS) 10-Q 2007 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2007

Commission File Number 0-16421

PROVIDENT BANKSHARES CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Maryland	52-1518642
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)

114 East Lexington Street, Baltimore, Maryland 21202

(Address of Principal Executive Offices)

(410) 277-7000

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filed, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

At November 6, 2007, the Registrant had 31,875,605 shares of $1.00 par value common stock outstanding.

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements
Condensed Consolidated Statements of Condition – Unaudited September 30, 2007 and 2006 and December 31, 2006		4
Condensed Consolidated Statements of Income – Unaudited three and nine month periods ended September 30, 2007 and 2006		5
Condensed Consolidated Statements of Cash Flows – Unaudited nine month periods ended September 30, 2007 and 2006		6
Notes to Condensed Consolidated Financial Statements – Unaudited		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46
Item 4.	Controls and Procedures	46
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults upon Senior Securities	48
Item 4.	Submission of Matters to a Vote of Security Holders	48
Item 5.	Other Information	48
Item 6.	Exhibits	48
SIGNATURES		49

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Forward-looking Statements

This report, as well as other written communications made from time to time by Provident Bankshares Corporation and its subsidiaries (the “Corporation”) (including, without limitation, the Corporation’s 2006 Annual Report to Stockholders) and oral communications made from time to time by authorized officers of the Corporation, may contain statements relating to the future results of the Corporation (including certain projections and business trends) that are considered “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). Such forward-looking statements may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “intend” and “potential.” Examples of forward-looking statements include, but are not limited to, possible or assumed estimates with respect to the financial condition, expected or anticipated revenue, and results of operations and business of the Corporation, including earnings growth determined using U.S. generally accepted accounting principles (“GAAP”); revenue growth in retail banking, lending and other areas; origination volume in the Corporation’s consumer, commercial and other lending businesses; asset quality and levels of non-performing assets; current and future capital management programs; non-interest income levels, including fees from services and product sales; tangible capital generation; market share; expense levels; and other business operations and strategies. For these statements, the Corporation claims the protection of the safe harbor for forward-looking statements contained in the PSLRA.

The Corporation cautions you that a number of important factors could cause actual results to differ materially from those currently anticipated in any forward-looking statement. Such factors include, but are not limited to: the factors identified in the Corporation’s Form 10-K for the fiscal year ended December 31, 2006 under the headings “Forward-Looking Statements” and “Item 1A. Risk Factors,” prevailing economic conditions, either nationally or locally in some or all areas in which the Corporation conducts business or conditions in the securities markets or the banking industry; changes in interest rates, deposit flows, loan demand, real estate values and competition, which can materially affect, among other things, consumer banking revenues, revenues from sales on non-deposit investment products, origination levels in the Corporation’s lending businesses and the level of defaults, losses and prepayments on loans made by the Corporation, whether held in portfolio or sold in the secondary markets; changes in the quality or composition of the loan or investment portfolios; the Corporation’s ability to successfully integrate any assets, liabilities, customers, systems and management personnel the Corporation may acquire into its operations and its ability to realize related revenue synergies and cost savings within expected time frames; the Corporation’s timely development of new and competitive products or services in a changing environment, and the acceptance of such products or services by customers; operational issues and/or capital spending necessitated by the potential need to adapt to industry changes in information technology systems, on which it is highly dependent; changes in accounting principles, policies, and guidelines; changes in any applicable law, rule, regulation or practice with respect to tax or legal issues; risks and uncertainties related to mergers and related integration and restructuring activities; conditions in the securities markets or the banking industry; changes in the quality or composition of the investment portfolio; litigation liabilities, including costs, expenses, settlements and judgments; or the outcome of other matters before regulatory agencies, whether pending or commencing in the future; and other economic, competitive, governmental, regulatory and technological factors affecting the Corporation’s operations, pricing, products and services. Additionally, the timing and occurrence or non-occurrence of events may be subject to circumstances beyond the Corporation’s control. Readers are cautioned not to place undue reliance on these forward-looking statements which are made as of the date of this report, and, except as may be required by applicable law or regulation, the Corporation assumes no obligation to update the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements.

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Provident Bankshares Corporation and Subsidiaries

Condensed Consolidated Statements of Condition

(dollars in thousands, except per share and share amounts)	September 30, 2007			December 31, 2006			September 30, 2006
Assets:		(Unaudited	)					(Unaudited	)
Cash and due from banks	$	123,417		$	142,794		$	142,173
Short-term investments		2,822			7,118			9,937
Mortgage loans held for sale		10,571			10,615			9,223
Securities available for sale		1,511,945			1,582,736			1,761,424
Securities held to maturity		47,654			101,867			128,530
Loans		4,047,715			3,865,492			3,768,027
Less allowance for loan losses		51,244			45,203			44,703
Net loans		3,996,471			3,820,289			3,723,324
Premises and equipment, net		60,630			67,936			66,492
Accrued interest receivable		36,091			37,084			37,336
Goodwill		253,906			254,543			254,855
Intangible assets		6,474			8,965			9,415
Other assets		314,029			261,946			267,582
Total assets	$	6,364,010		$	6,295,893		$	6,410,291
Liabilities:
Deposits:
Noninterest-bearing	$	715,224		$	761,830		$	774,574
Interest-bearing		3,491,517			3,378,282			3,357,128
Total deposits		4,206,741			4,140,112			4,131,702
Short-term borrowings		734,748			658,887			634,645
Long-term debt		771,726			828,079			955,599
Accrued expenses and other liabilities		40,074			35,184			41,459
Total liabilities		5,753,289			5,662,262			5,763,405
Stockholders’ Equity:
Common stock (par value $1.00) authorized 100,000,000 shares; issued 31,974,520, 32,433,387 and 32,680,266 shares at September 30, 2007, December 31, 2006 and September 30, 2006, respectively		31,975			32,433			32,680
Additional paid-in capital		354,836			370,425			379,673
Retained earnings		270,475			252,880			251,405
Net accumulated other comprehensive loss		(46,565	)		(22,107	)		(16,872	)
Total stockholders’ equity		610,721			633,631			646,886
Total liabilities and stockholders’ equity	$	6,364,010		$	6,295,893		$	6,410,291

The accompanying notes are an integral part of these statements.

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Provident Bankshares Corporation and Subsidiaries

Condensed Consolidated Statements of Income—Unaudited

	Three Months Ended September 30,				Nine Months Ended September 30,
(dollars in thousands, except per share data)	2007		2006		2007			2006
Interest Income:
Loans, including fees	$	72,363	$	68,376	$	211,895		$	194,354
Investment securities		20,832		25,234		64,631			73,918
Tax-advantaged loans and securities		1,640		1,110		4,323			2,820
Short-term investments		39		92		181			282
Total interest income		94,874		94,812		281,030			271,374
Interest Expense:
Deposits		27,242		22,018		79,511			57,885
Short-term borrowings		8,774		8,661		23,345			27,243
Long-term debt		11,021		12,919		32,854			31,211
Total interest expense		47,037		43,598		135,710			116,339
Net interest income		47,837		51,214		145,320			155,035
Less provision for loan losses		7,494		954		13,338			2,096
Net interest income after provision for loan losses		40,343		50,260		131,982			152,939
Non-Interest Income:
Service charges on deposit accounts		23,910		24,450		70,591			70,258
Commissions and fees		1,616		1,492		5,122			4,770
Net gains		4,902		373		6,525			1,116
Net derivative gains (losses) on swaps		204		643		(416	)		(514	)
Net cash settlement on swaps		193		186		599			714
Other non-interest income		4,478		4,356		13,836			14,600
Total non-interest income		35,303		31,500		96,257			90,944
Non-Interest Expense:
Salaries and employee benefits		26,390		27,353		81,018			82,153
Occupancy expense, net		5,978		5,845		17,973			17,233
Furniture and equipment expense		3,875		3,838		11,671			11,608
External processing fees		5,083		5,272		15,214			15,373
Restructuring activities		111		—		1,459			—
Other non-interest expense		11,248		10,306		32,746			32,833
Total non-interest expense		52,685		52,614		160,081			159,200
Income before income taxes		22,961		29,146		68,158			84,683
Income tax expense		6,993		8,707		20,554			25,963
Net income	$	15,968	$	20,439	$	47,604		$	58,720
Net Income Per Share Amounts:
Basic	$	0.50	$	0.63	$	1.48		$	1.79
Diluted		0.50		0.62		1.48			1.77

The accompanying notes are an integral part of these statements.

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Provident Bankshares Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows – Unaudited

	Nine Months Ended September 30,
(in thousands)	2007			2006
Operating Activities:
Net income	$	47,604		$	58,720
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		14,619			17,140
Provision for loan losses		13,338			2,096
Provision for deferred income tax benefit		(7,190	)		(2,014	)
Net gains		(848	)		(1,116	)
Gain on sale of branches and deposits		(5,677	)		—
Net derivative losses on swaps		416			514
Originated loans held for sale		(90,166	)		(78,720	)
Proceeds from sales of loans held for sale		90,728			78,122
Restructuring activities		1,459			—
Cash payments for restructuring activities		(877	)		—
Net decrease in accrued interest receivable and other assets		(25,369	)		(9,218	)
Net increase in accrued expenses and other liabilities		4,427			8,269
Total adjustments		(5,140	)		15,073
Net cash provided by operating activities		42,464			73,793
Investing Activities:
Principal collections and maturities of securities available for sale		115,923			164,851
Principal collections and maturities of securities held to maturity		52,048			—
Proceeds from sales of securities available for sale		82,938			195,258
Purchases of securities available for sale		(171,654	)		(327,030	)
Purchases of securities held to maturity		—			(19,016	)
Loan originations and purchases less principal collections		(189,012	)		(77,211	)
Purchases of premises and equipment		(6,156	)		(10,956	)
Sale of branch facilities		3,867			—
Net cash used by investing activities		(112,046	)		(74,104	)
Financing Activities:
Net increase in deposits		72,475			7,567
Net increase (decrease) in short-term borrowings		75,861			(13,107	)
Proceeds from long-term debt		220,000			505,000
Payments and maturities of long-term debt		(276,649	)		(470,217	)
Proceeds from issuance of stock		5,094			13,141
Tax benefits associated with share based payments		278			2,452
Purchase of treasury stock		(21,141	)		(27,276	)
Cash dividends paid on common stock		(30,009	)		(28,605	)
Net cash provided (used) by financing activities		45,909			(11,045	)
Decrease in cash and cash equivalents		(23,673	)		(11,356	)
Cash and cash equivalents at beginning of period		149,912			163,466
Cash and cash equivalents at end of period	$	126,239		$	152,110
Supplemental Disclosures:
Interest paid, net of amount credited to deposit accounts	$	78,150		$	74,168
Income taxes paid		19,759			22,617

The accompanying notes are an integral part of these statements.

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Provident Bankshares Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements—Unaudited

September 30, 2007

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Provident Bankshares Corporation (“the Corporation”), a Maryland corporation, is the bank holding company for Provident Bank (“the Bank”), a Maryland chartered stock commercial bank. The Bank serves individuals and businesses through a network of banking offices and ATMs in Maryland, Virginia, and southern York County, Pennsylvania. Related financial services are offered through its wholly owned subsidiaries. Securities brokerage, investment management and related insurance services are available through Provident Investment Center and leases through Court Square Leasing.

The accounting and reporting policies of the Corporation conform with U.S. generally accepted accounting principles (“GAAP”) and prevailing practices within the banking industry for interim financial information and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required for complete financial statements and prevailing practices within the banking industry. The following summary of significant accounting policies of the Corporation is presented to assist the reader in understanding the financial and other data presented in this report. Operating results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for any future quarters or for the year ending December 31, 2007. For further information, refer to the Consolidated Financial Statements and notes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2006 as filed with the Securities and Exchange Commission (“SEC”) on March 1, 2007.

Principles of Consolidation and Basis of Presentation

The unaudited Condensed Consolidated Financial Statements include the accounts of the Corporation and its wholly owned subsidiary, Provident Bank and its subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. These unaudited Condensed Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States and reflect all adjustments which are, in the opinion of management, necessary to a fair statement of our results for the interim periods presented. All such adjustments are of a normal recurring nature.

Certain prior periods and prior years’ amounts in the unaudited Condensed Consolidated Financial Statements have been reclassified to conform to the presentation used for the current period. These reclassifications have no effect on stockholders’ equity or net income as previously reported.

Use of Estimates

The Condensed Consolidated Financial Statements of the Corporation are prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities for the reporting periods. Management evaluates estimates on an on-going basis and believes the following represent its more significant judgments and estimates used in preparation of its consolidated financial statements: allowance for loan losses, non-accrual loans, other real estate owned, estimates of fair value and intangible assets associated with mergers, other than temporary impairment of investment securities, pension and post-retirement benefits, asset prepayment rates, goodwill and intangible assets, share-based payment, derivative financial instruments, litigation and income taxes. Management bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Each estimate and its financial impact, to the extent significant to financial results, is discussed in the audited Consolidated Financial Statements or in the notes to the audited Consolidated Financial Statements as included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2006. It is at least reasonably possible that each of the Corporation’s estimates could change in the near term or that actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could be material to the Corporation’s unaudited Condensed Consolidated Financial Statements.

Derivative Financial Instruments

The Corporation uses various derivative financial instruments as part of its interest rate risk management strategy to mitigate the exposure to changes in market interest rates. The derivative financial instruments used separately or in combination are interest rate swaps and caps. Derivative financial instruments are required to be measured at fair value and recognized as either assets or liabilities in the financial statements. Fair value represents the payment the Corporation would receive or pay if the item were sold or bought in a current transaction. Fair values are generally based on market quotes. The accounting for changes in fair value (gains or losses) of a derivative is dependent on whether the derivative is designated and qualifies for

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hedge accounting. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), the Corporation assigns derivatives to one of these categories at the purchase date: fair value hedge, cash flow hedge or non-designated derivative. SFAS No. 133 requires an assessment of the expected and ongoing hedge effectiveness of any derivative designated a fair value hedge or cash flow hedge. Derivatives are included in other assets and other liabilities in the Condensed Consolidated Statements of Condition.

Fair Value Hedges—For derivatives designated as fair value hedges, the derivative instrument and related hedge item are marked-to-market through the related interest income or expense, as applicable, except for the ineffective portion which is recorded in non-interest income.

Cash Flow Hedges—For derivatives designated as cash flow hedges, marked-to-market adjustments are recorded net of income taxes as a component of other comprehensive income (“OCI”) in stockholders’ equity, except for the ineffective portion which is recorded in non-interest income. Amounts recorded in OCI are recognized into earnings concurrent with the hedged items’ impact on earnings.

Non-Designated Derivatives—Certain economic hedges are not designated as cash flow or as fair value hedges for accounting purposes. As a result, changes in the fair value are recorded in non-interest income in the Condensed Consolidated Statements of Income. Interest income or expense related to non-designated derivatives is also recorded in non-interest income.

All qualifying relationships between hedging instruments and hedged items are fully documented by the Corporation. Risk management objectives, strategies and the projected effectiveness of the chosen derivatives to hedge specific risks are also documented. At inception of the hedging relationship and periodically as required under SFAS No. 133, the Corporation evaluates the effectiveness of its hedging instruments. For hedges qualifying for “short-cut” treatment at inception, the ongoing effectiveness testing includes a review of the hedge and the hedged item to determine if the hedge continues to qualify for short-cut treatment. An assumption of no hedge ineffectiveness is allowed for derivatives qualifying for short-cut treatment. For all other derivatives qualifying for hedge accounting, a quantitative assessment of the effectiveness of the hedge is required at each reporting date. The Corporation performs effectiveness testing quarterly for all of its hedges. The Corporation uses benchmark interest rates such as LIBOR to hedge the interest rate risk associated with interest-earning assets or interest-bearing liabilities. Using benchmark rates and complying with specific criteria set forth in SFAS No.133, the Corporation has concluded that, for qualifying hedges, changes in fair value or cash flows that are attributable to risks being hedged will be highly effective at the hedge’s inception and on an ongoing basis.

When it is determined that a derivative is not, or ceases to be effective as a hedge, the Corporation discontinues hedge accounting prospectively. When a fair value hedge is discontinued due to ineffectiveness, the Corporation continues to carry the derivative on the Condensed Consolidated Statements of Condition at its fair value as a non-designated derivative, but discontinues marking-to-market the hedged asset or liability for changes in fair value. Any previous marked-to-market adjustments recorded to the hedged item are amortized over the remaining life of the asset or liability. All ineffective portions of fair value hedges are reported in and affect net income immediately. When a cash flow hedge is discontinued due to termination of the derivative, the Corporation continues to carry the previous marked-to-market adjustments in accumulated OCI and recognizes the amount into earnings in the same period or periods during which the hedged item affects earnings. If the cash flow hedge is discontinued due to ineffectiveness, the derivative is considered a non-designated derivative and continues to be marked-to-market in the Condensed Consolidated Statements of Condition as an asset or liability, and marked-to-market through current period earnings in the Condensed Consolidated Statements of Income and not through OCI.

Counter-party credit risk associated with derivatives is controlled by dealing with well-established brokers that are highly rated by credit rating agencies and by establishing exposure limits for individual counter-parties. Market risk on interest rate swaps is minimized by using these instruments as hedges and by continually monitoring the positions to ensure ongoing effectiveness. For significant derivative positions, credit risk is controlled by entering into bilateral collateral agreements with brokers, in which the parties pledge collateral to indemnify the counter-party in the case of default. The Corporation’s hedging activities and strategies are monitored by the Bank’s Asset / Liability Committee (“ALCO”) as part of its oversight of the treasury function.

Share-Based Payment

Effective January 1, 2006, the Corporation adopted SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123R”) which requires companies to recognize the grant-date fair value of stock options and other equity-based compensation issued to employees and non-employees in the Condensed Consolidated Statements of Income.

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Compensation cost for stock options granted after January 1, 2006 and restricted stock grants is recognized as non-interest expense in the Condensed Consolidated Statements of Income on a straight-line basis over the vesting period of each stock option and restricted share grant. Compensation cost for stock options includes the impact of an estimated forfeiture rate. The impact of forfeitures on the restricted stock grants is recorded as they occur.

At September 30, 2007 and 2006, respectively, no stock options had vesting conditions linked to the performance of the Corporation. The tax benefits associated with tax deductions in excess of compensation costs are recognized as a financing activity in the Condensed Consolidated Statements of Cash Flows.

Income Taxes

Effective January 1, 2007, the Corporation adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”), which prescribes the recognition and measurement of tax positions taken or expected to be taken in a tax return. FIN No. 48 provides guidance for derecognition and classification of previously recognized tax positions that did not meet certain recognition criteria in addition to recognition of interest and penalties, if necessary.

Other Changes in Accounting Principles

Effective December 31, 2006, the Corporation adopted SFAS No. 158, “Employers’ Accounting Defined Benefit Pension and other Postretirement Plans.” Upon adoption, the Corporation recorded a $10.0 million reduction in comprehensive income on the Corporation’s Consolidated Statements of Changes in Stockholder’s Equity and Comprehensive Income as of December 31, 2006. However, the cumulative effect of change in accounting, net of tax, should have been recorded as a separate component of accumulated other comprehensive income. As of December 31, 2006, total comprehensive income was reported as $65.2 million. With this revised presentation, total comprehensive income would have been $75.2 million as of December 31, 2006. The revised presentation will be reflected in the Corporation’s Annual Report on Form 10-K as of December 31, 2007.

In September 2006, the Emerging Issues Task Force (“EITF”) issued EITF No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefits Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (“EITF 06-4”), which will be effective for fiscal years beginning after December 15, 2007. The issue addresses the accounting for the liability and related compensation costs for endorsement split-dollar life insurance arrangements that provide benefits to employees that extend to postretirement periods. The Corporation has split-dollar arrangements that provide certain postretirement death benefits to certain employees. Under the provisions of EITF 06-4, the application of this guidance can be recognized through a cumulative adjustment to beginning retained earnings. Accordingly, this treatment will not have any impact on the Corporation’s results of operations. The Corporation is currently evaluating the impact on the financial condition of the Corporation from the application of this guidance.

In September 2006, the EITF issued EITF No. 06-5, “Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4” (“EITF 06-5”), which was effective for fiscal years beginning after December 15, 2006. The issue addresses the determination of which amounts must be included in the contractual terms of insurance policies, other than cash surrender values, and whether the impact of the contractual ability to surrender all of the policies at the same time should affect the amounts. The Corporation currently owns various cash surrender and bank-owned life insurance policies. Under the provisions of EITF 06-5, the application of this guidance can be recognized through a cumulative adjustment to beginning retained earnings. If it is determined that certain amounts are not to be included as part of the life insurance policies or if surrender charges exist, these amounts should be deducted from the cash surrender values and an adjustment will be necessary. Accordingly, this treatment will not have any impact on the Corporation’s results of operations. The Corporation adopted the provisions as of January 1, 2007 and evaluated the terms of each policy and determined that there was no impact on the financial condition of the Corporation.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which will be effective for an entity’s financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. The statement provides enhanced guidance on the definition of fair value, the methods to measure fair value and the expanded disclosures about fair value measurements. The statement emphasizes that fair value is a market-based measurement and should be based on assumptions that market participants would use in pricing assets or liabilities. The Corporation is currently evaluating the implications of this guidance on the operations of the Corporation.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which will be effective for an entity’s financial statements issued for fiscal years beginning after November 15, 2007. Early adoption of the provisions of SFAS No. 159 is permitted for certain eligible items as of the

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beginning of the fiscal year that begins on or before November 15, 2007, if certain conditions are met. The statement permits entities to elect, at specific dates, to measure certain eligible items at fair value. Once fair value is elected for any items, changes in unrealized gains and losses must be reported in earnings at each subsequent reporting date. This guidance may be applied to specific financial assets or liabilities, is irrevocable once elected and must be applied to the entire instrument, not only to specific risks, cash flows or portions of an instrument. The Corporation is currently evaluating the implications of this guidance on the operations of the Corporation.

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NOTE 2—INVESTMENT SECURITIES

The following table presents the aggregate amortized cost and fair values of the investment securities portfolio as of the dates indicated:

(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
September 30, 2007
Securities available for sale:
U.S. Treasury and government agencies and corporations	$	67,807	$	17	$	1,326	$	66,498
Mortgage-backed securities		697,715		616		22,153		676,178
Municipal securities		153,369		923		470		153,822
Other debt securities		652,221		1,331		38,105		615,447
Total securities available for sale		1,571,112		2,887		62,054		1,511,945
Securities held to maturity:
Other debt securities		47,654		793		75		48,372
Total securities held to maturity		47,654		793		75		48,372
Total investment securities	$	1,618,766	$	3,680	$	62,129	$	1,560,317
December 31, 2006
Securities available for sale:
U.S. Treasury and government agencies and corporations	$	73,105	$	—	$	1,694	$	71,411
Mortgage-backed securities		718,697		1,105		18,947		700,855
Municipal securities		100,973		693		293		101,373
Other debt securities		706,748		3,619		1,270		709,097
Total securities available for sale		1,599,523		5,417		22,204		1,582,736
Securities held to maturity:
Other debt securities		101,867		2,223		1,140		102,950
Total securities held to maturity		101,867		2,223		1,140		102,950
Total investment securities	$	1,701,390	$	7,640	$	23,344	$	1,685,686
September 30, 2006
Securities available for sale:
U.S. Treasury and government agencies and corporations	$	78,880	$	—	$	1,686	$	77,194
Mortgage-backed securities		950,404		1,527		28,242		923,689
Municipal securities		101,362		974		162		102,174
Other debt securities		656,261		2,967		861		658,367
Total securities available for sale		1,786,907		5,468		30,951		1,761,424
Securities held to maturity:
Other debt securities		128,530		1,438		1,755		128,213
Total securities held to maturity		128,530		1,438		1,755		128,213
Total investment securities	$	1,915,437	$	6,906	$	32,706	$	1,889,637

11

At September 30, 2007, a net unrealized after-tax loss of $35.8 million on the investment securities portfolio was reflected in net accumulated other comprehensive loss, an element of the Corporation’s capital. This compared to a net unrealized after-tax loss of $13.9 million at September 30, 2006 and a net unrealized after-tax loss of $9.1 million at December 31, 2006.

Management reviews the investment securities portfolio on a periodic basis to determine the cause of declines in the fair value of each security. Thorough evaluations of the causes of the unrealized losses are performed to determine whether the impairment is temporary or other than temporary in nature. Considerations such as the Corporation’s intent and ability to hold securities, recoverability of invested amount over a reasonable period of time, the length of time the security is in a loss position and receipt of amounts contractually due, for example, are applied in determining whether a security is other than temporarily impaired. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized. At September 30, 2007, the unrealized losses contained within the Corporation’s investment securities portfolio were considered temporary because the declines in fair value were due to changes in market interest rates and from the recent illiquid market conditions and not from a decline in estimated cash flows of the underlying debt securities. Management currently has the intent and ability to retain investment securities with unrealized losses until the decline in value has been recovered.

For further details regarding investment securities at December 31, 2006, refer to Notes 1 and 3 of the Consolidated Financial Statements in the Corporation’s Form 10-K for the year ended December 31, 2006.

NOTE 3—LOANS

A summary of loans outstanding as of the dates indicated is shown in the table below.

(in thousands)	September 30, 2007		December 31, 2006		September 30, 2006
Residential real estate:
Originated and acquired residential mortgage	$	292,129	$	333,568	$	356,179
Home equity		1,060,882		991,327		993,994
Other consumer:
Marine		355,267		374,652		387,671
Other		28,933		28,427		31,015
Total consumer		1,737,211		1,727,974		1,768,859
Commercial real estate:
Commercial mortgage		440,472		445,563		434,484
Residential construction		618,669		599,275		554,794
Commercial construction		405,249		357,594		302,953
Commercial business		846,114		735,086		706,937
Total commercial		2,310,504		2,137,518		1,999,168
Total loans	$	4,047,715	$	3,865,492	$	3,768,027

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NOTE 4—ALLOWANCE FOR LOAN LOSSES

The following table reflects the activity in the allowance for loan losses for the periods indicated:

	Three Months Ended September 30,					Nine Months Ended September 30,
(in thousands)	2007		2006			2007		2006
Balance at beginning of period	$	45,769	$	44,700		$	45,203	$	45,639
Provision for loan losses		7,494		954			13,338		2,096
Less loans charged-off, net of recoveries:
Originated and acquired residential mortgage		175		197			493		617
Home equity		274		(19	)		418		93
Marine and other consumer		961		720			1,932		1,281
Residential construction		368		—			368		—
Commercial business		241		53			4,086		1,041
Net charge-offs		2,019		951			7,297		3,032
Balance at end of period	$	51,244	$	44,703		$	51,244	$	44,703

NOTE 5—INTANGIBLE ASSETS

The table below presents an analysis of the goodwill and deposit-based intangible activity for the nine months ended September 30, 2007.

(in thousands)	Goodwill			Accumulated Amortization			Net Goodwill
Balance at December 31, 2006	$	255,165		$	(622	)	$	254,543
Adjustment of intangible related to 2004 merger with Southern Financial Bancorp		(637	)		—			(637	)
Balance at September 30, 2007	$	254,528		$	(622	)	$	253,906

The adjustment to goodwill in 2007 was due to the resolution of income tax uncertainties related to the Corporation’s merger with Southern Financial on April 30, 2004.

(in thousands)	Deposit-based Intangible		Accumulated Amortization			Total
Balance at December 31, 2006	$	15,429	$	(6,464	)	$	8,965
Amortization expense		—		(1,307	)		(1,307	)
Reduction of deposit-based intangible due to sale of branches				(1,184	)		(1,184	)
Balance at September 30, 2007	$	15,429	$	(8,955	)	$	6,474

On September 7, 2007, the deposits and facilities of six branches were sold to Union Bankshares. As a result of the sale, $1.2 million of the deposit-based intangible associated with the deposits sold was reduced and included in net gains.

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NOTE 6—DEPOSITS

The table below presents a summary of deposits as of the dates indicated:

(in thousands)	September 30, 2007		December 31, 2006		September 30, 2006
Interest-bearing deposits:
Interest-bearing demand	$	491,362	$	559,682	$	553,415
Money market		607,812		545,584		544,262
Savings		536,172		596,434		625,073
Direct time certificates of deposit		1,192,522		1,156,709		1,040,078
Brokered certificates of deposit		663,649		519,873		594,300
Total interest-bearing deposits		3,491,517		3,378,282		3,357,128
Noninterest-bearing deposits		715,224		761,830		774,574
Total deposits	$	4,206,741	$	4,140,112	$	4,131,702

NOTE 7—SHORT-TERM BORROWINGS

The table below presents a summary of short-term borrowings as of the dates indicated:

(in thousands)	September 30, 2007		December 31, 2006		September 30, 2006
Securities sold under repurchase agreements	$	312,116	$	306,437	$	318,251
Federal funds purchased		420,000		320,000		284,000
Federal Home Loan Bank advances - variable rate		—		30,000		30,000
Other short-term borrowings		2,632		2,450		2,394
Total short-term borrowings	$	734,748	$	658,887	$	634,645

NOTE 8—LONG-TERM DEBT

The table below presents a summary of long-term debt as of the dates indicated:

(in thousands)	September 30, 2007		December 31, 2006		September 30, 2006
Federal Home Loan Bank advances - fixed rate	$	90,000	$	30,795	$	63,698
Federal Home Loan Bank advances - variable rate		545,000		660,427		755,000
Junior Subordinated Debentures		136,726		136,857		136,901
Total long-term debt	$	771,726	$	828,079	$	955,599

NOTE 9—STOCKHOLDERS’ EQUITY

Share-Based Payment Plan Description

The Corporation issues nonqualified stock options and restricted stock grants to certain of its employees and directors pursuant to the 2004 Equity Compensation Plan (“the Plan”), which has been approved by the Corporation’s shareholders. The Plan allows for a maximum of 12.5 million shares of common stock to be issued. At September 30, 2007, 4.4 million shares were available to be granted by the Corporation pursuant to the plan.

Stock Option Awards

Stock options (“options”) are granted with an exercise price equal to the market price of the Corporation’s shares at the date of the grant. Options granted subsequent to January 1, 2005 vest based on four years of continuous service and have eight-year contractual terms. All options issued prior to January 1, 2005 have contractual terms of ten years and are vested.

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All options provide for accelerated vesting upon a change in control (as defined in the Plan). Stock options exercised result in the issuance of new shares.

On the date of each grant, the fair value of each award is estimated using the Black-Scholes option pricing model based on assumptions made by the Corporation as follows:

• Dividend yield is based on the dividend rate of the Corporation’s stock at the date of the grant

• Risk-free interest rate is based on the U.S. Treasury zero-coupon bond rate with a term equaling the expected life of the granted options

• Expected volatility is based on the historical volatility of the Corporation’s stock price

• Expected life represents the period of time that granted options are expected to be outstanding based on historical trends

Below is a tabular presentation of the option pricing assumptions and the estimated fair value of the options granted during the periods indicated using these assumptions.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
Weighted average dividend yield		4.96	%		3.14	%		3.64	%		3.14	%
Weighted average risk-free interest rate		4.39	%		4.89	%		4.67	%		4.61	%
Weighted average expected volatility		17.40	%		17.86	%		16.80	%		19.78	%
Weighted average expected life		5.25 years			5.25 years			5.25 years			5.25 years
Weighted average fair value of options granted	$	3.68		$	6.21		$	5.18		$	6.47

The Corporation recognized compensation expense related to options of $217 thousand and $142 thousand for the three months ended September 30, 2007 and 2006, respectively. For the nine months ended September 30, 2007, compensation expense related to options was $642 thousand compared to $315 thousand for the same period in 2006. The intrinsic value of options exercised for the three months ended September 30, 2007 and 2006 was $61 thousand and $3.0 million, respectively. For the nine months ended September 30, 2007 and 2006, the intrinsic value of options exercised was $1.1 million and $6.5 million, respectively. Unrecognized compensation cost related to non-vested options was $2.7 million and $1.7 million at September 30, 2007 and 2006, respectively, and is expected to be recognized over a weighted average period of 3.0 years and 3.4 years, respectively.

The following table presents a summary of the activity related to options for the period indicated:

	Common Shares		Weighted Average Exercise Price		Weighted Average Contractual Remaining Life (in years)	Aggregate Intrinsic Value (in thousands)
Options outstanding at December 31, 2006	2,113,371		$	28.21
Granted	373,575		$	35.26
Exercised	(121,807	)	$	24.94
Cancelled or expired	(49,076	)	$	34.37
Options outstanding at September 30, 2007	2,316,063		$	29.39	5.40	$	8,375
Options exercisable at September 30, 2007	1,741,737		$	27.66	4.83	$	8,375

Restricted Stock Awards

The Corporation issues restricted stock grants, in the form of new shares, to its directors and certain key employees. The restricted stock grants are issued at the fair market value of the common shares on the date of each grant. The Corporation grants shares of restricted stock to directors of the Corporation as part of director compensation, and as such, those restricted stock grants vest immediately. The restricted stock grants to the directors may not be sold or otherwise divested until six months subsequent to their departure from the board of directors. The restricted stock grants to employees vest ratably over four years.

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Expense recorded relating to restricted stock grants to directors and employees is presented in the following table:

	Three Months Ended September 30,				Nine Months Ended September 30,
(in thousands)	2007		2006		2007		2006
Grants to directors	$	—	$	15	$	320	$	233
Grants to employees	$	341	$	191	$	841	$	499

The following table presents a summary of the activity related to restricted stock grants for the period indicated:

	Common Shares		Weighted Average Grant Fair Value
Unvested at December 31, 2006	78,641		$	35.33
Granted	68,224		$	35.28
Vested	(30,596	)	$	34.61
Cancelled	(4,055	)	$	35.54
Unvested at September 30, 2007	112,214		$	35.49

At September 30, 2007, unrecognized compensation cost related to non-vested restricted stock grants was $3.5 million and is expected to be recognized over a weighted average period of 2.8 years.

NOTE 10—DERIVATIVE FINANCIAL INSTRUMENTS

Fair value hedges that meet the criteria for effectiveness have changes in the fair value of the derivative and the designated hedged item recognized in earnings. During all periods presented, the derivatives designated as fair value hedges were determined to be effective. Accordingly, the designated hedges and the associated hedged items were marked to fair value by equal and offsetting amounts. At September 30, 2007, there were no derivatives designated as fair value hedges. Cash flow hedges have the effective portion of changes in the fair value of the derivative, net of taxes, recorded in net accumulated other comprehensive loss. For the nine months ended September 30, 2007, the Corporation recorded an increase in the value of derivatives of $2.2 million compared to a decrease of $612 thousand for the same period in 2006, net of taxes, in net accumulated other comprehensive loss to reflect the effective portion of cash flow hedges. Amounts recorded in net accumulated other comprehensive loss are recognized into earnings concurrent with the impact of the hedged item on earnings. For the three and nine months ended September 30, 2007 and 2006, respectively, the impact of the ineffectiveness portions of cash flow hedges was immaterial.

The interest rate swaps that are classified as non-designated derivatives are marked-to-market and the gains or losses are recorded in non-interest income at the end of each reporting period. These non-designated derivatives represent interest rate protection on the Corporation’s net interest income but do not meet the requirements to receive hedge accounting treatment. For the three months ended September 30, 2007 and 2006, the Corporation recorded net gains of $200 thousand and $645 thousand, respectively, to reflect the change in value of the non-designated interest rate swaps. For the nine months ended September 30, 2007 and 2006, the Corporation recorded net losses of $415 thousand and $507 thousand, respectively, to reflect the change in value of the non-designated interest rate swaps. The net cash settlements on these interest rate swaps are recorded in non-interest income. The net cash benefit from these interest rate swaps was $193 thousand and $186 thousand for the three months ended September 30, 2007 and 2006, respectively. For the nine months ended September 30, 2007 and 2006, the net cash benefit from these interest rate swaps was $599 thousand and $714 thousand, respectively.

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The table below presents the Corporation’s open derivative positions as of the dates indicated:

(in thousands) Derivative Type	Objective	Notional Amount		Credit Risk Amount		Market Risk
September 30, 2007
Designated Derivatives
Interest rate swaps:
Receive fixed/pay variable	Hedge investment rate risk	$	277,450	$	1,232	$	1,084
Interest rate caps/corridors	Hedge borrowing cost		75,000		321		321
Total designated derivatives			352,450		1,553		1,405
Non-designated Derivatives
Interest rate swaps:
Receive fixed/pay variable			40,000		2,880		2,880
Total non-designated derivatives			40,000		2,880		2,880
Total derivatives		$	392,450	$	4,433	$	4,285
December 31, 2006
Designated Derivatives
Interest rate swaps:
Receive fixed/pay variable	Hedge investment rate risk	$	293,450	$	471	$	(1,410	)
Receive fixed/pay variable	Hedge borrowing cost		29,900		—		(280	)
Interest rate caps/corridors	Hedge borrowing cost		140,000		615		615
Total designated derivatives			463,350		1,086		(1,075	)
Non-designated Derivatives
Interest rate swaps:
Receive fixed/pay variable			40,000		2,465		2,465
Total non-designated derivatives			40,000		2,465		2,465
Total derivatives		$	503,350	$	3,551	$	1,390
September 30, 2006
Designated Derivatives
Interest rate swaps:
Pay fixed/receive variable	Hedge borrowing cost	$	25,000	$	170	$	170
Receive fixed/pay variable	Hedge investment rate risk		293,450		621		(1,146	)
Receive fixed/pay variable	Hedge borrowing cost		29,900		—		(366	)
Interest rate caps/corridors	Hedge borrowing cost		140,000		922		922
Total designated derivatives			488,350		1,713		(420	)
Non-designated Derivatives
Interest rate swaps:
Receive fixed/pay variable			40,000		3,282		3,282
Total non-designated derivatives			40,000		3,282		3,282
Total derivatives		$	528,350	$	4,995	$	2,862

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NOTE 11—CONTINGENCIES AND OFF-BALANCE SHEET RISK

Commitments

Commitments to extend credit in the form of consumer, commercial real estate and business loans at the date indicated were as follows:

(in thousands)	September 30, 2007
Commercial business and real estate	$	1,054,669
Consumer revolving credit		840,518
Residential mortgage credit		15,158
Performance standby letters of credit		114,908
Total loan commitments	$	2,025,253

Historically, many of the commitments expire without being fully drawn; therefore, the total commitment amounts do not necessarily represent realizable future cash requirements.

Litigation

The Corporation is involved in various legal actions that arise in the ordinary course of its business. All active lawsuits entail amounts which management believes, individually and in the aggregate, are immaterial to the financial condition and the results of operations of the Corporation.

During the third quarter of 2007, the Corporation received a court decision requiring that it pay the legal expenses of former officers and directors of Southern Financial as a result of a provision for indemnification under the terms of the 2004 merger agreement with Southern Financial Bancorp in April 2004. This amounted to $756 thousand in legal expenses for the three and nine months ended September 30, 2007. At September 30, 2007, this is an ongoing obligation and the Corporation is unable to estimate the cost impact, if any, on future periods.

NOTE 12—NET GAINS

Net gains include the following components for the periods indicated:

	Three Months Ended September 30,					Nine Months Ended September 30,
(in thousands)	2007			2006		2007		2006
Net gains:
Securities sales	$	—		$	202	$	399	$	491
Asset sales		(8	)		171		1,063		551
Sale of branches		4,910			—		4,910		—
Debt extinguishment		—			—		153		74
Net gains	$	4,902		$	373	$	6,525	$	1,116

NOTE 13—RESTRUCTURING ACTIVITIES

Costs associated with restructuring activities are recorded in the Condensed Consolidated Statements of Income as they are incurred. The costs include incremental expenses associated with corporate-wide efficiency and infrastructure initiatives focused on the rationalization of the branch network, the composition and execution of fee generation activities and the creation of efficiencies in the Corporation’s business model.

As part of the rationalization of the branch network, the Corporation closed seven branches and sold deposits and facilities of six branches during the nine months ending September 30, 2007. During the first quarter of 2007, the restructuring costs related to the branch closures were composed of contract termination costs and the write-down of premises and equipment values. The Corporation does not anticipate incurring any further costs relating to these previously announced branch closures. In addition, the branch closure initiative resulted in a $767 thousand realized gain associated with the sale of a branch facility. This gain is reflected in net gains from asset sales in Note 12. In the third quarter of 2007, the Corporation also completed the sale of the deposits and facilities of six branches in western and central Virginia to Union Bankshares of Bowling Green, Virginia. The transaction closed in early September 2007 with an associated $4.9 million gain reflected in net gains from sales of branches in Note 12. There are no restructuring costs associated with the sale of these branches. The sale of the six branches was consistent with the Corporation’s strategy to rationalize the branch network by focusing on the Corporation’s core markets—the high growth, metropolitan areas of Baltimore, Washington and Richmond.

For the second and third quarters of 2007, restructuring activities costs related to the corporate-wide efficiency and infrastructure initiatives. All expenses accrued in the second and third quarters of 2007 are directly related to staff reductions associated with an ongoing corporate efficiency and process re-engineering project initiated by management. The costs represent salaries, benefits, severance payments and outplacement services for the affected employees.

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All amounts accrued with respect to the initiatives discussed above have been recognized in the Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2007.

The incurred costs for all restructuring activities are reflected in the following tables:

	For the three months ended September 30, 2007
(in thousands)	Branch Closures		Efficiency Initiatives		Total
Severance and employee-related charges	$	—	$	111	$	111
Contract terminations		—		—		—
Impairment of fixed assets		—		—		—
Other related costs		—		—		—
Total restructuring activities	$	—	$	111	$	111

	For the nine months ended September 30, 2007
(in thousands)	Branch Closures			Efficiency Initiatives			Total
Severance and employee-related charges	$	—		$	592		$	592
Contract terminations		473			—			473
Impairment of fixed assets		357			—			357
Other related costs		37			—			37
Total restructuring activities	$	867		$	592		$	1,459
The following table reflects a rollforward of the accrued liability associated with the restructuring activities:
	At September 30, 2007
(in thousands)	Branch Closures			Efficiency Initiatives			Total
Balance December 31, 2006	$	—		$	—		$	—
Branch closure costs		510						510
Efficiency initiatives costs		—			592			592
Cash payments		(510	)		(367	)		(877	)
Balance at September 30, 2007	$	—		$	225		$	225

Future costs associated with efficiency initiatives have not been incurred or estimated at this time and have not been recognized as liabilities at September 30, 2007. The expected completion date of the restructuring activities is early 2008.

NOTE 14—INCOME TAXES

In April 2007, the State of Maryland passed legislation eliminating a dividends paid deduction for captive real estate investment trusts. The law was effective July 1, 2007 and was retroactive to January 1, 2007. The Corporation, which maintains a trust to which the new law is applicable, has evaluated the impact of this change in the tax regulations and has concluded that the overall tax impact is immaterial to the financial condition of the Corporation.

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Effective January 1, 2007, the Corporation adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”), which prescribes the recognition and measurement of tax positions taken or expected to be taken in a tax return. FIN No. 48 provides guidance for derecognition and classification of previously recognized tax positions that did not meet the certain recognition criteria in addition to recognition of interest and penalties, if necessary. The Corporation did not have any material unrecognized tax benefits as of the date of adoption. The Corporation’s policy is to recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense on the Condensed Consolidated Statements of Income. At January 1, 2007, no interest and penalties were required to be recognized. At September 30, 2007, the tax years that remain subject to examination are 2004 through 2006 for both the Federal and State of Maryland tax authorities.

NOTE 15—EARNINGS PER SHARE

The following table presents a summary of per share data and amounts for the periods indicated.

	Three Months Ended September 30,				Nine Months Ended September 30,
(in thousands, except per share data)	2007		2006		2007		2006
Net income	$	15,968	$	20,439	$	47,604	$	58,720
Basic EPS shares		31,932		32,633		32,063		32,791
Basic EPS	$	0.50	$	0.63	$	1.48	$	1.79
Dilutive shares		160		404		196		404
Diluted EPS shares		32,092		33,037		32,259		33,195
Diluted EPS	$	0.50	$	0.62	$	1.48	$	1.77
Antidilutive shares		1,372		12		936		24

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NOTE 16—COMPREHENSIVE INCOME (LOSS)

Presented below is a reconciliation of net income to comprehensive income including the components of other comprehensive income (loss) for the periods indicated.

	Three Months Ended September 30,
	2007									2006
(in thousands)	Before Income Tax			Tax Expense (Benefit)			Net of Tax			Before Income Tax			Tax Expense (Benefit)			Net of Tax
Securities available for sale:
Net unrealized gains (losses) arising during the year	$	(22,536	)	$	(9,172	)	$	(13,364	)	$	24,037		$	9,052		$	14,985
Reclassification of net gains realized in net income		—			—			—			(202	)		(79	)		(123	)
Net unrealized gains (losses) on securities arising during the year		(22,536	)		(9,172	)		(13,364	)		23,835			8,973			14,862
Net unrealized gains from derivative activities arising during the year		4,110			1,626			2,484			4,106			1,625			2,481
Other comprehensive income (loss)	$	(18,426	)	$	(7,546	)		(10,880	)	$	27,941		$	10,598			17,343
Net income								15,968									20,439
Comprehensive income							$	5,088								$	37,782
	Nine Months Ended September 30,
	2007									2006
(in thousands)	Before Income Tax			Tax Expense (Benefit)			Net of Tax			Before Income Tax			Tax Expense (Benefit)			Net of Tax
Securities available for sale:
Net unrealized gains (losses) arising during the year	$	(44,027	)	$	(17,643	)	$	(26,384	)	$	1,427		$	110		$	1,317
Reclassification of net gains realized in net income		(399	)		(157	)		(242	)		(491	)		(194	)		(297	)
Net unrealized gains (losses) on securities arising during the year		(44,426	)		(17,800	)		(26,626	)		936			(84	)		1,020
Net unrealized gains (losses) from derivative activities arising during the year		3,286			1,118			2,168			(839	)		(230	)		(609	)
Other comprehensive income (loss)	$	(41,140	)	$	(16,682	)		(24,458	)	$	97		$	(314	)		411
Net income								47,604									58,720
Comprehensive income							$	23,146								$	59,131

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NOTE 17—EMPLOYEE BENEFIT PLANS

The actuarially estimated net benefit cost includes the following components for the periods indicated:

	Three Months Ended September 30,
	Qualified Pension Plan						Non-qualified Pension Plan				Postretirement Benefit Plan
(in thousands)	2007			2006			2007		2006		2007			2006
Service cost - benefits earned during the period	$	558		$	792		$	258	$	36	$	1		$	72
Interest cost on projected benefit obligation		639			855			215		153		5			58
Expected return on plan assets		(977	)		(1,359	)		—		—		—			—
Net amortization and deferral of loss (gain)		186			110			67		182		(2	)		(107	)
Net pension cost included in employee benefits expense	$	406		$	398		$	540	$	371	$	4		$	23
	Nine Months Ended September 30,
	Qualified Pension Plan						Non-qualified Pension Plan				Postretirement Benefit Plan
(in thousands)	2007			2006			2007		2006		2007			2006
Service cost - benefits earned during the period	$	1,823		$	2,475		$	771	$	109	$	4		$	216
Interest cost on projected benefit obligation		2,087			2,672			645		458		16			173
Expected return on plan assets		(3,191	)		(4,248	)		—		—		—			—
Net amortization and deferral of loss (gain)		607			345			203		546		(6	)		(320	)
Net pension cost included in employee benefits expense	$	1,326		$	1,244		$	1,619	$	1,113	$	14		$	69

During the second quarter of 2007, the Corporation made a $3.5 million contribution to the defined pension plan to offset the impact to the plan assets resulting from lump sum payments made to retired employees. The minimum required contribution in 2007 for the qualified plan is estimated to be zero. The decision to contribute further amounts is dependent on other factors, including the actual investment performance of the plan assets and the requirements of the Internal Revenue Code. Given these uncertainties and the lack of available data at this time, the Corporation is not able to reliably estimate the maximum deductible contribution or the future amounts that may be contributed in 2007 to the qualified plan. No contributions were made to the qualified pension plan during the nine months ending September 30, 2006.

For the unfunded non-qualified pension and postretirement benefit plans, the Corporation will contribute the minimum required amount in 2007, which is equal to the benefits paid under the plans.

NOTE 18—BUSINESS SEGMENT INFORMATION

The Corporation’s lines of business are structured according to the channels through which its products and services are delivered to its customers. For management purposes the lines are divided into the following segments: Consumer Banking, Commercial Banking, and Treasury and Administration.

The Corporation offers consumer and commercial banking products and services through its wholly owned subsidiary, Provident Bank. The Bank offers its services to customers in the key metropolitan areas of Baltimore, Washington D.C. and Richmond, Virginia, through 80 traditional and 62 in-store banking offices in Maryland, Virginia and southern York County, Pennsylvania. Additionally, the Bank offers its customers 24-hour banking services through 238 bank owned ATMs, telephone banking and the Internet. The Bank is also a member of the MoneyPass network which provides customers with free access to more than 11,000 ATMs nationwide. Consumer banking services include a broad array of small business and consumer loan, deposit and investment products offered to retail and commercial customers through the retail branch network and direct channel sales center. Commercial Banking provides an array of commercial financial services including asset-based lending, equipment leasing, real estate financing, cash management and structured financing to middle market commercial customers. Treasury and Administration is comprised of balance sheet management activities that include managing the investment portfolio, discretionary funding, utilization of derivative financial instruments and optimizing the Corporation’s equity position.

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The financial performance of each business segment is monitored using an internal profitability measurement system. This system utilizes policies that ensure the results reflect the economics for each segment compiled on a consistent basis. Line of business information is based on management accounting practices that support the current management structure and is not necessarily comparable with similar information for other financial institutions. This profitability measurement system uses internal management accounting policies that generally follow the policies described in Note 1. The Corporation’s funds transfer pricing system utilizes a matched maturity methodology that assigns a cost of funds to earning assets and a value to the liabilities of each business segment with an offset in the Treasury and Administration business segment. The provision for loan losses is charged to the consumer and commercial segments based on actual charge-offs with the balance to the Treasury and Administration segment. Operating expense is charged on a fully absorbed basis. Income tax expense is calculated based on the segment’s fully taxable equivalent income and the Corporation’s effective tax rate. Revenues from no individual customer exceeded 10% of consolidated total revenues.

The table below summarizes results by each business segment for the periods indicated.

Three Months Ended September 30,	2007									2006
(in thousands)	Commercial Banking		Consumer Banking		Treasury and Administration			Total		Commercial Banking		Consumer Banking		Treasury and Administration			Total
Net interest income	$	16,228	$	25,300	$	6,309		$	47,837	$	15,637	$	27,831	$	7,746		$	51,214
Provision for loan losses		615		1,261		5,618			7,494		47		707		200			954
Net interest income after provision for loan losses		15,613		24,039		691			40,343		15,590		27,124		7,546			50,260
Non-interest income – other		5,112		25,710		(429	)		30,393		4,180		26,420		900			31,500
Gain on sale of branches and deposits		—		4,910		—			4,910		—		—		—			—
Total non-interest income		5,112		30,620		(429	)		35,303		4,180		26,420		900			31,500
Non-interest expense		6,530		37,499		8,656			52,685		6,133		37,944		8,537			52,614
Income (loss) before income taxes		14,195		17,160		(8,394	)		22,961		13,637		15,600		(91	)		29,146
Income tax expense (benefit)		4,323		5,226		(2,556	)		6,993		4,074		4,660		(27	)		8,707
Net income (loss)	$	9,872	$	11,934	$	(5,838	)	$	15,968	$	9,563	$	10,940	$	(64	)	$	20,439
Total assets	$	2,298,379	$	3,012,101	$	1,053,530		$	6,364,010	$	2,020,658	$	3,023,680	$	1,365,953		$	6,410,291
Nine Months Ended September 30,	2007									2006
	Commercial Banking		Consumer Banking		Treasury and Administration			Total		Commercial Banking		Consumer Banking		Treasury and Administration			Total
Net interest income	$	47,611	$	75,727	$	21,982		$	145,320	$	45,885	$	84,082	$	25,068		$	155,035
Provision for loan losses		4,381		2,523		6,434			13,338		909		1,506		(319	)		2,096
Net interest income after provision for loan losses		43,230		73,204		15,548			131,982		44,976		82,576		25,387			152,939
Non-interest income – other		15,124		76,721		(1,265	)		90,580		14,018		76,228		698			90,944
Gain on sale of branches and deposits		—		5,677		—			5,677		—		—		—			—
Total non-interest income		15,124		82,398		(1,265	)		96,257		14,018		76,228		698			90,944
Non-interest expense		20,164		114,771		25,146			160,081		18,791		113,110		27,299			159,200
Income (loss) before income taxes		38,190		40,831		(10,863	)		68,158		40,203		45,694		(1,214	)		84,683
Income tax expense (benefit)		11,517		12,313		(3,276	)		20,554		12,326		14,009		(372	)		25,963
Net income (loss)	$	26,673	$	28,518	$	(7,587	)	$	47,604	$	27,877	$	31,685	$	(842	)	$	58,720
Total assets	$	2,298,379	$	3,012,101	$	1,053,530		$	6,364,010	$	2,020,658	$	3,023,680	$	1,365,953		$	6,410,291

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

GENERAL

Provident Bankshares Corporation (“the Corporation”), a Maryland corporation, is the holding company for Provident Bank (“Provident” or the “Bank”), a Maryland chartered stock commercial bank. At September 30, 2007, the Bank is the largest independent commercial bank, in asset size, headquartered in Maryland, with $6.4 billion in assets. Provident is a regional bank serving Maryland, Virginia and Southern York County, PA, with emphasis on the key urban centers within these states – the Baltimore, Washington, D.C. and Richmond metropolitan areas.

Provident’s principal business is to acquire deposits from individuals and businesses and to use these deposits to fund loans to individuals and businesses. Provident focuses on providing its products and services to three segments of customers – individuals, small businesses and middle market businesses. The Corporation offers consumer and commercial lending products and services through the Consumer Banking group and the Commercial Banking group. Provident also offers related financial services through wholly-owned subsidiaries. Securities brokerage, investment management and related insurance services are available through Provident Investment Center (“PIC”) and leases through Court Square Leasing.

Provident’s mission is to exceed customer expectations by delivering superior service, products and banking convenience. Every employee’s commitment to serve the Bank’s customers in this fashion will assist in establishing Provident as the primary bank of choice of individuals, families, small businesses and middle market businesses throughout its chosen markets. To achieve this mission and to improve financial fundamentals, the strategic priorities of the organization are to:

Maximize Provident’s position as the right size bank in the marketplace. Provident’s position as the largest bank headquartered in Maryland provides a unique opportunity as the “right size” bank in its market areas, or footprint. The Bank provides the service of a community bank combined with the convenience and wide array of products and services that a major regional bank offers. In addition, the 62 in-store banking offices throughout its footprint reinforce its right size strategy through convenient locations, hours and a full line of products and services. Provident currently has 142 banking offices concentrated in the Baltimore-Washington, D.C. corridor and beyond to Richmond, Virginia. Of the 142 banking offices, 49% are located in the Greater Baltimore region and 51% are located in the Greater Washington, D.C. and Central Virginia regions, reflecting the successful development of the Bank into a highly competitive regional commercial bank. Provident also offers its customers 24-hour banking services through ATMs, telephone banking and the Internet. The Bank’s network of 238 ATMs enhances the banking office network by providing customers increased opportunities to access their funds. In addition, the Bank is a member of the MoneyPass network which provides free access to more than 11,000 ATMs nationwide for its customers.

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Profitably grow and deepen customer relationships in all four key market segments: Commercial, Commercial Real Estate, Consumer and Business Banking. Consumer banking continues to be an important component of the Bank’s strategic priorities. Consumer banking services include a broad array of consumer loan, lease, deposit and investment products offered to consumer and commercial customers through Provident’s banking office network and ProvidentDirect, the Bank’s direct channel sales center. The business banking segment is further supported by relationship managers who provide comprehensive business product and sales support to expand existing customer relationships and acquire new clients. Commercial banking is the other key component to the Corporation’s regional presence in its market area. Commercial Banking provides lending services through its commercial business division and its commercial real estate division. Commercial business division provides customized banking solutions to middle market commercial customers while the commercial real estate division provides the lending expertise and financing options to real estate customers. The Bank has an experienced team of relationship managers with expertise in business and real estate lending to companies in various industries in the region. It also has a suite of cash management products managed by responsive account teams that deepen customer relationships through competitively priced deposit based services, responsive service and frequent personal contact with each customer. Recently, management has introduced a remote deposit product, which allows a customer to electronically post their deposits directly from the workplace. This product was designed to attract and retain commercial deposits. Business clients have enthusiastically embraced this convenience based product.

Consistently execute a higher-performance, customer relationship-focused sales culture.The Corporation’s transition to a customer relationship driven sales culture requires deepening relationships through cross-selling and the continuing emphasis on retention of valued customers. The Bank has segmented its customers to better understand and anticipate their financial needs and provide Provident’s sales force with a targeted approach to customers and prospects. The successful execution of this strategic priority will be centered on the right size bank commitment—providing the service of a community bank combined with the convenience and wide array of products and services that a major regional bank offers. This strategy is measured and monitored by a number of actions such as the utilization of individual performance and incentive plans.

Sustain a culture that attracts and retains employees who provide the differentiating “Provident Way” customer experience.Provident has always placed a high priority on its employees and has approached employee development and training with renewed emphasis. Employee development is viewed as a critical part of executing Provident’s strategic priority as the right size bank and transforming the Corporation’s sales culture with a focus on the employee’s development and approach with Provident’s customers. This strategy is measured and monitored by a number of actions, such as utilization of individual development plans for every employee and tracking individual employee learning activities through our learning management system.

Expand delivery (branch and non-branch) within the market Provident serves; supplement with acquisitions within pricing discipline. Provident supplements organic growth opportunities with acquisitions if they are a strategic fit and are within the Corporation’s pricing model. Over the past five years, Provident has expanded its branch network by 42 in-store or traditional branches.

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Restructuring Activities

During the fourth quarter of 2006, management initiated a corporate-wide efficiency and infrastructure initiative program that focused on three major areas: the rationalization of the branch network; the composition and execution of fee generation activities, and the third and largest focus, the fundamental efficiency of loan and deposit operational support activities. As part of the efficiency initiative program, management established four internal efficiency and infrastructure teams to identify revenue and efficiency opportunities. These cross-functional teams worked with outside consultants to analyze expense and revenue opportunities based on industry best practices. The identified financial objective is to reduce operating expenses and increase fee income for a total pre-tax impact of $10 million in 2007.

Increased revenue is expected to come from a combination of both loan and deposit product sources and will include increased pricing and new fees where both are competitively available. Revenues are also expected to increase from improved collection of currently generated but waived or uncollected fees. With respect to operating expenses, reductions will almost entirely be provided by staff reductions, the bulk of which is expected to be achieved via attrition. The attrition method renders expense reduction that is less immediate but more favorable to stability and business continuity. Reduced staffing will be realized primarily from the: (1) rationalization of the branch network and composition of branch and branch operations support personnel and (2) improved efficiency in the loan, credit and customer support functions.

The initial phase of this program was an extensive internal review of the branch network locations to consider each location’s profitability, opportunity for growth and proximity to other branches. The review work was completed in the first quarter of 2007 and implementation of the efficiency initiatives plans have been put in place or are currently in process. In the first quarter of 2007, the Corporation closed one branch in Maryland and six branches in Virginia, transferring $76 million in deposits to other nearby Provident branches.

On September 7, 2007, the Corporation completed a sale of the deposits and facilities of six branches in western and central Virginia to Union Bankshares of Bowling Green, Virginia with an associated gain of $4.9 million. The sale of the six branches is consistent with the Corporation’s strategy to rationalize the branch network and to focus on the Corporation’s core markets – the high growth, metropolitan areas of Baltimore, Washington and Richmond.

The Corporation’s restructuring activities eliminated approximately $15 million in annualized compensation and benefits costs relating to positions that have been removed from the Corporation’s base cost structure. Management currently believes that it will achieve the financial objective of the restructuring activities in 2007. The costs associated with the restructuring activities are currently being reported separately in the Condensed Consolidated Statements of Income.

FINANCIAL REVIEW

The principal objective of this Financial Review is to provide an overview of the financial condition and results of operations of Provident Bankshares Corporation and its subsidiaries for the periods indicated. This discussion and tabular presentations should be read in conjunction with the accompanying unaudited Condensed Consolidated Financial Statements and Notes as well as the other information herein.

Overview of Income and Expenses

Income

The Corporation has two primary sources of pre-tax income. The first is net interest income. Net interest income is the difference between interest income—which is the income that the Corporation earns on its loans and investments—and interest expense—which is the interest that is paid on its deposits and borrowings.

The second principal source of pre-tax income is non-interest income—the compensation received from providing products and services. The majority of the non-interest income comes from service charges on deposit accounts. The Corporation also earns income from insurance commissions, mortgage banking fees and other fees and charges.

The Corporation recognizes gains or losses as a result of sales of investment securities or the disposition of loans, foreclosed property or fixed assets. In addition, the Corporation also recognizes gains or losses on its outstanding derivative financial instruments. Gains and losses are not a regular part of the Corporation’s primary source of income.

Expenses

The expenses the Corporation incurs in operating its business consist of salaries and employee benefits expense, occupancy expense, furniture and equipment expense, external processing fees, deposit insurance premiums, advertising expenses, and other miscellaneous expenses.

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Salaries and employee benefits expense consists primarily of the salaries and wages paid to employees, payroll taxes, and expenses for health care, retirement and other employee benefits.

Occupancy expenses, which are fixed or variable costs associated with premises and equipment, consist primarily of lease payments, real estate taxes, depreciation charges, maintenance and cost of utilities.

Furniture and equipment include expenses and depreciation charges related to office and banking equipment. Depreciation of furniture and equipment is computed using the straight-line method based on the useful lives of related assets. Estimated lives are 5 to 15 years for building and leasehold improvements, and 3 to 10 years for furniture and equipment.

External processing fees are fees paid to third parties for data processing services.

Restructuring activities are incremental expenses associated with corporate efficiency and infrastructure initiatives implemented to simplify the Corporation’s business model as discussed in Note 13 to the unaudited Condensed Consolidated Financial Statements.

Other expenses include expenses for attorneys, accountants and consultants, fees paid to directors, franchise taxes, charitable contributions, insurance, office supplies, postage, telephone and other miscellaneous operating expenses.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The unaudited Condensed Consolidated Financial Statements of the Corporation are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities for the reporting periods. Management evaluates estimates on an on-going basis, and believes the following represent its more significant judgments and estimates used in preparation of its consolidated financial statements: allowance for loan losses, non-accrual loans, other real estate owned, estimates of fair value and intangible assets associated with mergers, other than temporary impairment of investment securities, pension and post-retirement benefits, asset prepayment rates, goodwill and intangible assets, share-based payment, derivative financial instruments, litigation and income taxes. Management bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Management believes the following critical accounting policies affect its more significant judgments and estimates used in preparation of its unaudited Condensed Consolidated Financial Statements: allowance for loan losses, other than temporary impairment of investment securities, derivative financial instruments, goodwill and intangible assets, asset prepayment rates, and income taxes. Each estimate and its financial impact, to the extent significant to financial results, is discussed in the notes to the unaudited Condensed Consolidated Financial Statements. It is at least reasonably possible that each of the Corporation’s estimates could change in the near term or that actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could be material to the unaudited Condensed Consolidated Financial Statements.

FINANCIAL CONDITION

The financial condition of the Corporation reflects the strong focus on business development and the execution of the Corporation’s strategic priorities and strengthening of the balance sheet by growing loans and customer deposits in the Corporation’s core business segments and key major markets of Greater Baltimore, Greater Washington, D.C. and Central Virginia. Solid growth in relationship-based loan portfolios (loans other than the Corporation’s originated and acquired residential mortgage loans) was a reflection of the Corporation’s ability to grow the loan portfolio in these key markets through its lending expertise and focus on its premier loan programs – home equity, commercial real estate, and commercial business. The Corporation was also successful in retaining and growing customer deposits over the past 12 months. These successful efforts have led to growth in average relationship-based loans of $274.7 million, or 8.1%, and average customer deposits of $52.6 million, or 1.5%, over the third quarter of 2006. At September 30, 2007, total assets were $6.4 billion, while total loans and deposits were $4.0 billion and $4.2 billion, respectively.

Based upon the Corporation’s strategy, growth in internally generated loan portfolios continues to replace the decline in wholesale assets (originated and acquired residential mortgages and investment securities) as the Corporation strengthens the balance sheet by growing relationship-based portfolios and de-emphasizing wholesale assets. Over the past few years, capital growth has been a specific focus for the Corporation. Going forward, management will continue to focus on the level of tangible common equity ratio to maximize the returns to the investors. Tangible common equity as a percentage of tangible assets was 6.50% at September 30, 2007 and is consistent with the ratios reported for December 31, 2006 and September 30, 2006. The tangible common equity ratio is a non-GAAP measure used by management to evaluate capital adequacy. Tangible common equity is total equity less net accumulated other comprehensive income (“OCI”), goodwill and deposit-based

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intangibles. Tangible assets are total assets less goodwill and deposit-based intangibles. The tangible common equity ratio is calculated by removing the impact of OCI and certain intangible assets from total equity and total assets. Management and many stock analysts use the tangible common equity ratio in conjunction with more traditional bank capital ratios to compare the capital adequacy of banking organizations with significant amounts of goodwill or other intangible assets, typically stemming from the use of the purchase accounting method accounting for mergers and acquisitions. Management believes this is an important benchmark for the Corporation and for investors. Neither tangible common equity, tangible assets nor the related measures should be considered in isolation or as a substitute for stockholders’ equity, total assets or any other measure calculated in accordance with GAAP. Moreover, the manner in which the Corporation calculates its tangible common equity, tangible assets and the related measures may differ from that of other companies reporting measures with similar names. The following table is a reconciliation of the Corporation’s tangible common equity and tangible assets for the periods ended September 30, 2007, December 31, 2006 and September 30, 2006, respectively.

(dollars in thousands)	September 30, 2007			December 31, 2006			September 30, 2006
Total equity capital per consolidated financial statements	$	610,721		$	633,631		$	646,886
Accumulated other comprehensive loss		46,565			22,107			16,872
Goodwill		(253,906	)		(254,543	)		(254,855	)
Deposit-based intangible		(6,474	)		(8,965	)		(9,415	)
Tangible common equity	$	396,906		$	392,230		$	399,488
Total assets per consolidated financial statements	$	6,364,010		$	6,295,893		$	6,410,291
Goodwill		(253,906	)		(254,543	)		(254,855	)
Deposit-based intangible		(6,474	)		(8,965	)		(9,415	)
Tangible assets	$	6,103,630		$	6,032,385		$	6,146,021
Tangible common equity ratio		6.50	%		6.50	%		6.50	%

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Lending

Total average loan balances increased to $4.0 billion in the third quarter of 2007, an increase of $199.1 million, or 5.3%, from the third quarter of 2006. The following table summarizes the composition of the Bank’s average loans for the periods indicated.

	Three Months Ended September 30,				$ Variance			% Variance
(dollars in thousands)	2007		2006
Residential real estate:
Originated and acquired residential mortgage	$	298,019	$	373,568	$	(75,549	)	(20.2	)%
Home equity		1,050,442		983,288		67,154		6.8
Other consumer:
Marine		357,217		389,760		(32,543	)	(8.3	)
Other		29,533		32,334		(2,801	)	(8.7	)
Total consumer		1,735,211		1,778,950		(43,739	)	(2.5	)
Commercial real estate:
Commercial mortgage		441,685		449,305		(7,620	)	(1.7	)
Residential construction		609,537		535,183		74,354		13.9
Commercial construction		383,775		307,655		76,120		24.7
Commercial business		803,537		703,523		100,014		14.2
Total commercial		2,238,534		1,995,666		242,868		12.2
Total loans	$	3,973,745	$	3,774,616	$	199,129		5.3

The Corporation continues to produce strong loan growth in its internally generated loan portfolios. Relationship-based loans increased in the aggregate $274.7 million, or 8.1%, over the same quarter in 2006. The Corporation’s focus on business development and developing lending relationships that are provided by the market opportunity, combined with the experience of lending officers in the market, has been demonstrated by the strong growth in the commercial real estate and commercial business loan portfolios. Total average loans increased by 5.3%, primarily due to an increase of $67.2 million, or 6.8%, in average home equity loans, $74.4 million, or 13.9%, in average residential construction loans, $76.1 million, or 24.7%, in commercial construction loans and $100.0 million, or 14.2%, in average commercial business loans. These increases more than offset the planned reductions in marine lending of $32.5 million and $75.5 million in the originated and acquired residential portfolios. These positive results reflect the effectiveness of the Corporation’s strategy to profitably grow and deepen customer relationships in all four key market segments: commercial, commercial real estate, consumer and small business.

The variety of home equity loan products, along with the Corporation’s relationship sales approach and competitive pricing have proven to be successful in the markets of Maryland, Washington, D.C. and Virginia. This marketing strategy resulted in the $67.2 million, or 6.8%, increase in average home equity loan balances. The production of direct consumer loans, primarily home equity loans and lines, is generated through the Bank’s retail banking offices, phone center and internet channels. The solid growth in home equity lending was partially offset by a decline in marine and other consumer loans. Currently, management has chosen to limit marine lending loan growth due to low pricing margins in the industry.

Commercial Banking is the other key component to the Corporation’s regional presence in its market area. Average total commercial loans increased $242.9 million, or 12.2%, compared to the third quarter of 2006. Residential and commercial construction loans posted increases compared to the same quarter of 2006 of $74.4 million and $76.1 million, respectively, reflecting the balanced growth in the regional real estate construction markets. During this same period, commercial business loans increased by $100.0 million, or 14.2%. This growth has occurred within the Corporation’s market footprint and is a reflection of the strength in the Corporation’s markets and the group’s ability to deepen historical lending relationships with seasoned borrowers in familiar markets. These expanded relationships and associated risks are managed through an effective level of loan administration and credit monitoring by an experienced credit management staff.

The overall result is a relatively balanced mix of lending revenue sources between consumer and commercial loan products with $1.7 billion, or 43.7%, in consumer loans, and $2.2 billion, or 56.3%, in commercial loans. The diversity of lending products should provide the Corporation with opportunities to emphasize certain product lines as market conditions change. In the third quarter of 2007, average loan balances in the Greater Washington and Central Virginia regions represented 38.4% of total average loan balances while 61.6% were in the Greater Baltimore region.

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Asset Quality

The following table presents information with respect to non-performing assets and 90-day delinquencies as of the dates indicated.

(dollars in thousands)	September 30, 2007			December 31, 2006
Non-Performing Assets:
Originated and acquired residential mortgage	$	6,706		$	7,202
Home equity		2,103			421
Other consumer		—			351
Commercial mortgage		1,335			1,335
Commercial business		12,486			10,417
Total non-accrual loans		22,630			19,726
Total renegotiated loans		—			—
Total non-performing loans		22,630			19,726
Total other assets and real estate owned		4,305			2,483
Total non-performing assets	$	26,935		$	22,209
90-Day Delinquencies:
Originated and acquired residential mortgage	$	2,291		$	3,030
Home equity		1,406			1,234
Other consumer		272			827
Commercial business		165			97
Total 90-day delinquencies	$	4,134		$	5,188
Asset Quality Ratios:
Non-performing loans to loans		0.56	%		0.51	%
Non-performing assets to loans		0.67	%		0.57	%
Allowance for loan losses to loans		1.27	%		1.17	%
Net charge-offs in quarter to average loans		0.20	%		0.14	%
Allowance for loan losses to non-performing loans		226.44	%		229.15	%

Regional credit conditions appear to be moving towards historical credit cost levels from the extraordinary low cost levels over the past couple of years. During the third quarter of 2007, the Bank placed a $4.1 million commercial business loan on non-performing status and provided a specific reserve for the full amount of the loan. The amount of this specific reserve is expected to be the Bank’s maximum loss exposure in this matter. Despite the addition to the non-performing loan status associated with this commercial loan, the overall credit quality is considered sound as evidenced by the net charge-offs to average loans ratio of 0.20%, an allowance for loan losses to total loans of 1.27%, and the relatively stable non-performing assets and 90-day delinquencies levels when compared to December 31, 2006. During the current quarter, the Corporation did not experience any broad-based deterioration within its loan portfolios. The diversification of the commercial real estate portfolio between commercial mortgages, commercial construction and residential construction along with the geographically different markets of Baltimore, suburban Washington, D.C. and Richmond, Virginia supports these results. In addition, the home equity portfolio has performed fairly well under the current market conditions, as a large percentage of the loan portfolio are not piggyback type loans but standard home equity loan products. The success within the Corporation’s loan portfolio is a reflection of management’s high credit standards, in-house administration and strong oversight procedures along with the strategy of shifting the balance sheet away from wholesale loans to relationship-based loan portfolios. In addition, the regional economy remained favorable for the third quarter of 2007.

The level of non-performing assets to total loans was 0.67% at September 30, 2007, a slight increase compared to 0.57% at December 31, 2006. The level of 90-day delinquent loans declined during the same period, decreasing $1.1 million, or 20.3%, to $4.1 million from the $5.2 million level at December 31, 2006. The decline in 90-day delinquent loans was

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primarily in the originated and acquired residential mortgage portfolio along with the decline in other consumer loans. In addition, net charge-offs in the quarter as a percentage of average loans increased from 0.14% in the fourth quarter of 2006 to 0.20%. The increase in the net-charge-off percentage for the third quarter of 2007 is the result of slightly higher net charge-offs in all loan portfolio types.

Overall, the asset quality ratios of the Corporation are considered favorable despite the $4.1 million commercial business loan placed on non-performing status. Non-performing assets were $26.9 million at September 30, 2007, a 21.3% increase from the level at December 31, 2006. The increase in non-performing assets also included a $1.7 million increase in home equity loans, and a $1.8 million increase in other assets and real estate owned. Non-performing commercial business loans include $1.8 million of loans that have U.S. government guarantees.

Allowance for Loan Losses

The Corporation maintains an allowance for loan losses (“the allowance”), which is management’s best estimate of inherent losses in the outstanding loan portfolio. The allowance is reduced by actual credit losses and is increased by the provision for loan losses and recoveries of previous loan losses. The provisions for loan losses are charges to earnings to bring the total allowance to a level considered necessary by management.

The allowance is based on management’s continuing review and evaluation of the loan portfolio. This process provides an allowance consisting of two components, allocated and unallocated. To arrive at the allocated component of the allowance, the Corporation combines estimates of the allowances needed for loans analyzed individually and on a pooled basis. The allocated component of the allowance is supplemented by an unallocated component.

The portion of the allowance that is allocated to individual internally criticized and non-accrual loans is determined by estimating the inherent loss on each problem credit after giving consideration to the value of underlying collateral. Management emphasizes loan quality and close monitoring of potential problem credits. Credit risk identification and review processes are utilized in order to assess and monitor the degree of risk in the loan portfolio. The Corporation’s lending and credit administration staff are charged with reviewing the loan portfolio and identifying changes in the economy or in a borrower’s circumstances that may affect the ability to repay debt or the value of pledged collateral. The loan classification and review system identifies those loans with a higher than normal risk of uncollectibility. Each commercial loan is assigned a risk rating based upon an assessment of the borrower’s financial capacity to service the debt and the presence and value of collateral for the loan.

In addition to being used to categorize risk, the Bank’s internal ten-point risk rating system is used to determine the allocated allowance for the commercial portfolio. Reserve factors, based on the actual loss history for a 5-year period for criticized loans, are assigned. If the factor, based on loss history, for classified credits is lower than the minimum established factor, the higher factor is applied. For loans with satisfactory risk profiles, the factors are based on the rating profile of the portfolio and the consequent historic losses of bonds with equivalent ratings.

For the consumer portfolios, the determination of the allocated allowance is conducted at an aggregate, or pooled, level. Each quarter, historical rolling loss rates for homogenous pools of loans in these portfolios provide the basis for the allocated reserve. For any portfolio where the Bank lacks sufficient historic experience, industry loss rates are used. If recent history is not deemed to reflect the inherent losses existing within a portfolio, older historic loss rates during a period of similar economic or market conditions are used.

The Bank’s credit administration group adjusts the indicated loss rates based on qualitative factors. Factors that are considered in adjusting loss rates include risk characteristics, credit concentration trends and general economic conditions, including job growth and unemployment rates. For commercial and real estate portfolios, additional factors include the level and trend of watched and criticized credits within those portfolios; historic loss rates, commercial real estate vacancy, absorption and rental rates; and the number and volume of syndicated credits, construction loans, or other portfolio segments deemed to carry higher levels of risk. Upon completion of the qualitative adjustments, the overall allowance is allocated to the components of the portfolio based on the adjusted loss factors.

The purpose of the unallocated component of the allowance is to mitigate the imprecision inherent in management’s estimates of expected credit losses and includes its determination of the amounts necessary for concentrations, economic uncertainties and other subjective factors that may not have been fully considered in the allocated allowance. The relationship of the unallocated component to the total allowance may fluctuate from period to period. Although management has allocated the majority of the allowance to specific loan categories, the evaluation of the allowance is considered in its entirety.

Lending management meets at least quarterly with executive management to review the credit quality of the loan portfolios and to evaluate the allowance. The Corporation has an internal risk analysis and review staff that continuously reviews loan quality and reports the results of its reviews to executive management and the Audit Committee of the Board of Directors. Such reviews also assist management in establishing the level of the allowance.

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Management believes that it uses the relevant information available to make determinations about the allowance and that it has established its existing allowance in accordance with GAAP. If circumstances differ substantially from the assumptions used in making determinations, adjustments to the allowance may be necessary and results of operations could be affected. Because events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that increases to the allowance will not be necessary should the quality of any loans deteriorate.

The FDIC examines the Bank periodically and, accordingly, as part of this examination, the allowance is reviewed for adequacy utilizing specific guidelines. Based upon their review, the regulators may from time to time require reserves in addition to those previously provided.

At September 30, 2007, the allowance was $51.2 million, or 1.27% of total loans outstanding, compared to an allowance at December 31, 2006 of $45.2 million, or 1.17% of total loans outstanding. The additional $4.1 million specific reserve discussed in “Asset Quality” was the main reason for the increase in loan loss percentage from 1.17% to 1.27%. The allowance coverage was 226.4% of non-performing loans at September 30, 2007 compared to 229.2% at December 31, 2006. Portfolio-wide, net charge-offs represented 0.20% of average loans in third quarter of 2007, compared to 0.10% in third quarter of 2006 and 0.47% in the second quarter of 2007.

Deposits

The following table summarizes the composition of the Corporation’s average deposit balances for the periods indicated.

	Three Months Ended September 30,				$ Variance			% Variance
(dollars in thousands)	2007		2006
Transaction accounts:
Noninterest-bearing	$	709,492	$	759,874	$	(50,382	)	(6.6	)%
Interest-bearing		487,435		539,858		(52,423	)	(9.7	)
Savings/money market:
Savings		557,239		645,666		(88,427	)	(13.7	)
Money market		583,856		576,136		7,720		1.3
Certificates of deposit:
Direct		1,218,368		982,228		236,140		24.0
Brokered		528,841		520,367		8,474		1.6
Total deposits	$	4,085,231	$	4,024,129	$	61,102		1.5
Deposits by source:
Consumer	$	2,769,227	$	2,669,835	$	99,392		3.7
Commercial		787,163		833,927		(46,764	)	(5.6	)
Brokered		528,841		520,367		8,474		1.6
Total deposits	$	4,085,231	$	4,024,129	$	61,102		1.5

Average total deposits increased $61.1 million, or 1.5%, in the third quarter of 2007 over the third quarter of 2006. Consumer deposits grew by 3.7%, or $99.4 million to $2.8 billion, while commercial deposits driven by market conditions experienced a decline of $46.8 million, or 5.6%. Consumer certificates of deposit increased by $207.0 million and money market deposits by $25.1 million from a year ago and were offset by a $132.7 million net decline in all other sources of consumer deposits. Commercial certificates of deposit also increased over the same period a year ago, growing by $29.1 million, or 21.7%, while all other sources of commercial deposits declined by $75.9 million. The decline in commercial deposits is mainly attributed to lower title company activity, repo sweeps and the increase in customer utilization of their deposits versus obtaining financing. Over the past year, consumer and commercial customers have been shifting their deposits away from low yielding checking and savings accounts to higher yielding certificates of deposit or moving their deposits to alternative markets. This change in deposit mix is a result of the current rate environment and the intense level of competition and was the primary reason for the decline in net interest income as compared to the prior year. In addition, the use of brokered deposits increased from $520.4 million to $528.8 million as it provided an economic alternative to fund loan growth for the quarter ending September 30, 2007.

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Treasury Activities

The Treasury Division manages the wholesale segments of the balance sheet, including investments, purchased funds, long-term debt and derivatives. Management’s objective is to achieve the maximum level of stable earnings over the long term, while controlling the level of interest rate and liquidity risk, and optimizing capital utilization. In managing the investment portfolio to achieve its stated objective, the Corporation invests predominately in U.S. Treasury and Agency securities, mortgage-backed securities (“MBS”), asset-backed securities (“ABS”), corporate bonds and municipal bonds. Treasury strategies and activities are overseen by the Bank’s Asset / Liability Committee (“the ALCO”), which also reviews all investment and funding transactions. ALCO activities are summarized and reviewed monthly with the Corporation’s Board of Directors.

At September 30, 2007, the investment securities portfolio totaled $1.6 billion, or 24.5% of total assets, compared to 26.8% of total assets at year-end 2006. The portfolio declined $125.0 million from the level at year-end 2006, reflecting management’s continued execution of the strategy to de-emphasize wholesale assets and the impact from the decline in fair value of the investment securities portfolio. In 2007 management has invested primarily in fixed rate mortgage-backed securities and municipal bonds to diversify investment portfolio risks, maximize stable earnings, and manage the Bank’s interest rate sensitivity. In the first nine months of 2007, $54.3 million of AAA rated municipal bonds and $90.8 million of AAA or AA rated non-agency MBS were purchased, reinvesting proceeds of MBS sales, ABS sales, and prepayments.

Investment Portfolio Credit Quality

Investment allocations as of September 30, 2007 include MBS (43.3%), ABS (36.4%), municipal (9.9%), corporate (6.1%), and U.S. Government securities (4.3%). The MBS portfolio includes $549.6 million of agency-backed securities, $69.9 million of Aaa rated non-agency MBS, and $56.6 million of Aa rated non-agency MBS. All of the non-agency MBS are backed by high credit quality 30-year fixed rate loans. There have been no credit downgrades in the Corporation’s non-agency MBS portfolio, and there are no securities in the investment portfolio backed by sub-prime mortgage loans. The Corporation’s ABS portfolio consists of Aaa, Aa, single A, and BBB rated pooled trust preferred securities. In the third quarter of 2007, pooled trust preferred securities totaling $30 million were downgraded by S&P from single A to BBB, and an additional $5 million of similar securities were downgraded to BBB by Fitch. The downgraded securities are a component of the Corporation’s $95 million portfolio of pooled trust preferred securities backed by REITs. Of the remaining $60 million of securities in this portfolio, $25 million are AAA rated, $9 million are AA rated, and $26 million remain single-A rated. Several mortgage REITs are facing a challenging operating environment due to the well-publicized liquidity crunch facing the mortgage origination sector. While most REITs in this securitized portfolio continue to make timely dividend payments, a few are currently in default.

The Corporation’s municipal bond portfolio consists of geographically diversified Aaa rated securities. Other debt securities primarily include investments in single issuer corporate bonds rated investment-grade by Moody’s or S&P, and U.S. Treasury and Agency securities.

The chart below summarizes the credit quality of the Corporation’s investment portfolio, as rated by Standard & Poors.

(dollars in thousands)	Amount		% of Portfolio
U.S. Treasury	$	2,514	0.2	%
U.S. Govt Agency (Incl Agency MBS)		613,629	39.4
AAA		321,929	20.6
AA		131,053	8.4
A		439,769	28.2
BBB		47,299	3.0
BB and below		—	—
Not Rated		3,406	0.2
Total portfolio	$	1,559,599	100.0	%

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In addition to credit risk, the other significant risk in the investment portfolio is duration risk. Duration measures the expected change in the market value of an investment for a 100 basis point (or 1%) change in interest rates. The higher an investment’s duration, the longer the time until its rate is reset to current market rates. The Bank’s risk tolerance, as measured by the duration of the investment portfolio, is typically between 2.5% and 3.5%. The portfolio duration is currently 3.4%.

Investment securities are evaluated periodically to determine whether a decline in their value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. As of September 30, 2007 Provident’s investment portfolio had unrealized losses of $59.2 million, or 3.7%, up from $37.2 million, or 2.3% at June 30, 2007. The increased loss position stemmed primarily from deterioration in the market valuations of pooled trust preferred securities and non-agency MBS. The pricing for these securities has been distressed by the sub-prime mortgage crisis, which has caused a liquidity contagion in both the mortgage and asset-backed securities markets.

Provident had a limited number of securities in a continuous loss position for 12 months or more at September 30, 2007. Because the declines in fair value were due to changes in market interest rates or liquidity, not in estimated cash flows, no other than temporary impairment was recorded at September 30, 2007. Management currently has the intent and ability to retain investment securities with unrealized losses until the decline in value has been recovered or until maturity.

Treasury funding, representing brokered certificates of deposit, short-term borrowings excluding repurchase agreements (“repo”), long-term debt and junior subordinated debentures, totaled $1.9 billion at September 30, 2007, up $157.6 million from year-end 2006. The increase offset core deposit outflow of $77.1 million and a $68.1 million increase in total assets over that time period.

Provident’s funds management objectives are two-fold: to minimize the cost of borrowings while assuring sufficient funding availability to meet current and future customer requirements, and to contribute to interest rate risk management goals through match-funding loan and investment activity. Management utilizes a variety of sources to raise borrowed funds at competitive rates, including federal funds purchased (“fed funds”), Federal Home Loan Bank (“FHLB”) borrowings, securities sold under repo agreements, and brokered and jumbo certificates of deposit (“CDs”). FHLB borrowings and repos typically are borrowed at rates approximating the LIBOR rate for the equivalent term because they are secured with investments or high quality real estate loans. Fed funds, which are generally overnight borrowings, are typically purchased at the Federal Reserve target rate. Brokered CDs are generally added when market conditions permit issuance at rates favorable to other funding sources.

The Corporation formed wholly owned statutory business trusts in 1998, 2000 and 2003. In 2004, the Corporation also acquired three wholly owned statutory business trusts from Southern Financial as part of the merger. In all cases, the trusts issued trust preferred securities that were sold to outside third parties. The junior subordinated debentures issued by the Corporation to the trusts are presented net of unamortized issuance costs as long-term debt in the Condensed Consolidated Statements of Condition and are includable in Tier 1 capital for regulatory capital purposes, subject to certain limitations. Any of the junior subordinated debentures are redeemable at any time in whole, but not in part, from the date of issuance on the occurrence of certain events. There are $50 million of issuances callable within the next twelve months.

Liquidity

An important component of the Corporation’s asset/liability structure is the level of liquidity available to meet the needs of customers and creditors. Traditional sources of bank liquidity include deposit growth, loan repayments, investment maturities, asset sales, borrowings and interest received. Management believes the Corporation has sufficient liquidity to meet future funding needs.

The Corporation’s chief source of liquidity is the assets it possesses, which can either be pledged as collateral for secured borrowings or sold outright. At September 30, 2007, over $500 million of the Corporation’s investment portfolio was immediately saleable at a market value equaling or exceeding its amortized cost basis. Additionally, over a 90-day time frame, a majority of the Corporation’s $1.7 billion consumer and residential loan portfolios is saleable under normal conditions.

As an alternative to asset sales, the Corporation has the ability to pledge assets to raise secured borrowings. The primary sources for raising secured borrowings are the FHLB and securities broker/dealers. At September 30, 2007, $947.1 million of secured borrowings were employed, with sufficient collateral available immediately to raise an additional $587.9 million. In an illiquid market, the Corporation could replace unsecured funds with secured funds. Total unsecured funds maturing in the next 90 days include $420 million of fed funds purchased, $110.3 million of brokered CDs, and $88.9 million of relationship Jumbo CDs. Additionally, over $300.0 million of assets are maintained as collateral with the Federal Reserve and available as a contingent funding source.

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The Corporation also has several sources of unsecured funding that it uses routinely. At September 30, 2007, the Corporation possessed $1.3 billion of overnight borrowing capacity, of which only $420.0 million was in use at quarter-end. The brokered certificates of deposit and unsecured debt markets, which are at times more expensive than secured funds of similar maturity, are also vital funding alternatives. As of September 30, 2007, the Corporation’s brokered CDs totaled $663.6 million.

A significant use of the Corporation’s liquidity is the dividends it pays to shareholders. The Corporation is a one-bank holding company that relies upon the Bank’s performance to generate capital growth through Bank earnings. A portion of the Bank’s earnings is passed to the Corporation in the form of cash dividends. As a commercial bank under the Maryland Financial Institution Law, the Bank may declare cash dividends from undivided profits or, with the prior approval of the Commissioner of Financial Regulation, out of paid-in capital in excess of 100% of its required capital stock, and after providing for due or accrued expenses, losses, interest and taxes. These dividends paid to the Corporation are utilized to pay dividends to stockholders, repurchase shares and pay interest on junior subordinated debentures. The Corporation and the Bank, in declaring and paying dividends, are also limited insofar as minimum capital requirements of regulatory authorities must be maintained. The Corporation and the Bank comply with such capital requirements. If the Corporation or the Bank were unable to comply with the minimum capital requirements, it could result in regulatory actions that could have a material impact on the Corporation.

Contractual Obligations, Commitments and Off Balance Sheet Arrangements

The Corporation has various contractual obligations, such as long-term borrowings, that are recorded as liabilities in the Condensed Consolidated Financial Statements. Other items, such as certain minimum lease payments for the use of banking and operations offices under operating lease agreements, are not recognized as liabilities in the Condensed Consolidated Financial Statements, but are required to be disclosed. Each of these arrangements affects the Corporation’s determination of sufficient liquidity.

The following table summarizes significant contractual obligations at September 30, 2007 and the future periods in which such obligations are expected to be settled in cash. In addition, the table reflects the timing of principal payments on outstanding borrowings.

	Contractual Payments Due by Period								Total
(in thousands)	Less than 1 Year		1-3 Years		4-5 Years		After 5 Years
Lease obligations	$	12,163	$	22,418	$	18,388	$	21,484	$	74,453
Long-term debt		180,000		390,000		65,000		136,726		771,726
Total	$	192,163	$	412,418	$	83,388	$	158,210	$	846,179

Arrangements to fund credit products or guarantee financing take the form of loan commitments (including lines of credit on revolving credit structures) and letters of credit. Approvals for these arrangements are obtained in the same manner as loans. Generally, cash flows, collateral value and a risk assessment are considered when determining the amount and structure of credit arrangements. Commitments to extend credit in the form of consumer, commercial real estate and business loans at September 30, 2007 were as follows:

(in thousands)	September 30, 2007
Commercial business and real estate	$	1,054,669
Consumer revolving credit		840,518
Residential mortgage credit		15,158
Performance standby letters of credit		114,908
Total loan commitments	$	2,025,253

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Historically, many of the commitments expire without being fully drawn; therefore, the total commitment amounts do not necessarily represent future cash requirements. Obligations also take the form of commitments to purchase loans. At September 30, 2007, the Corporation did not have any firm commitments to purchase loans.

Risk Management

Interest Rate Risk

The nature of the banking business, which involves paying interest on deposits at varying rates and terms and charging interest on loans at other rates and terms, creates interest rate risk. As a result, earnings and the market value of assets and liabilities are subject to fluctuations, which arise due to changes in the level and directions of interest rates. Management’s objective is to minimize the fluctuation in the net interest margin caused by changes in interest rates using cost-effective strategies and tools. The Bank manages several forms of interest rate risk, including asset/liability mismatch, basis risk, and prepayment risk.

Management continually monitors each of these interest rate risks. Asset / Liability mismatch is caused by offering loan products and deposit products with differing maturity and rate reset characteristics, to meet customers needs. The Treasury Division rebalances this risk through the investment and wholesale borrowing portfolios. Basis risk exists as a result of having a significant amount of earning assets priced using either the prime rate or the U.S. Treasury yield curve, while much of the liability portfolio, which finances earning assets, is priced using the certificates of deposit yield curve or LIBOR yield curve. These different yield curves typically do not move in lock-step with one another.

The Corporation both purchases and originates amortizing loan pools and investment securities in which the underlying assets are residential mortgage loans subject to prepayments. The actual principal reduction on these assets varies from the expected contractual principal reduction due to principal prepayments resulting from borrowers’ elections to refinance the underlying mortgages based on market and other conditions. Prepayment rate projections utilize actual prepayment speed experience and available market information on like-kind instruments. The prepayment rates form the basis for income recognition of premiums or discounts on the related assets. Changes in prepayment estimates may cause the earnings recognized on these assets to vary over the term that the assets are held, creating volatility in the net interest margin. Prepayment rate assumptions are monitored and updated monthly to reflect actual activity and the most recent market projections.

Measuring and managing interest rate risk is a dynamic process that management performs continually to meet the objective of maintaining a stable net interest margin. This process relies chiefly on simulation modeling of shocks to the balance sheet under a variety of interest rate scenarios, including parallel and non-parallel rate shifts, such as the forward yield curves for both short and long term interest rates. The results of these shocks are measured in two forms: first, the impact on the net interest margin and earnings over one and two year time frames; and second, the impact on the market value of equity. In addition to measuring the basis risks and prepayment risks noted above, simulations also quantify the earnings impact of rate changes and the cost / benefit of hedging strategies.

The following table shows the anticipated effect on net interest income in parallel shift (up or down) interest rate scenarios. These shifts are assumed to begin on October 1, 2007 for the September 30, 2007 data and on January 1, 2007 for the December 31, 2006 data and evenly increase or decrease over a 6-month period. The effect on net interest income would be for the next twelve months.

Interest Rate Scenario	At September 30, 2007 Projected Percentage Change in Net Interest Income		At December 31, 2006 Projected Percentage Change in Net Interest Income
-200 basis points	-1.80	%	-3.20	%
-100 basis points	-1.10	%	-2.30	%
No change	—		—
+100 basis points	0.10	%	0.30	%
+200 basis points	0.00	%	1.00	%

The percentage changes displayed in the table above relate to the Corporation’s projected net interest income. Management’s intent is for derivative interest income to mitigate risk to the Corporation’s net interest income stemming from changes in interest rates. For comparison purposes, these projections include all interest earned on derivatives in net interest income. The analysis includes the interest income and expense relating to non-designated interest rate swaps that is classified in non-interest income as net cash settlement on swaps.

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The isolated modeling environment, assuming no action by management, shows that the Corporation’s net interest income volatility is less than 2.0% under the assumed single direction scenarios. Management routinely models several yield curve flattening and steepening scenarios as part of its interest rate risk management function, and this modeling discloses little risk under most yield curve twisting scenarios. The current economic environment includes concerns about elevated inflation on one hand and a slowing housing market on the other. At this point in time there is no clear direction for the path of future interest rate changes, or changes in the shape of the yield curve. Management is currently employing strategies to reduce the exposure to net interest margin from rising or falling interest rates.

Management employs the investment, borrowings, and derivatives portfolios in implementing the Bank’s interest rate strategies. To protect the Bank from rising short-term interest rates, over $450 million of the investment portfolio reprices semiannually or more frequently. In the borrowings portfolio, $260.0 million of funds reset their rates quarterly with long-term interest rates, and $90 million are fixed rate and callable at Provident’s option, to mitigate the impact on the net interest margin from falling long-term interest rates. The interest expense associated with these borrowings declines when long-term interest rates decline, either through the rate reset or the exercise of the call option. Additionally, $317.5 million of interest rate swaps were in force to reduce interest rate risk, and $75.0 million of interest rate caps were employed specifically to protect against rising interest rates in the future.

Credit Risk

Much of the fundamental lending business of Provident is based upon understanding, measuring and controlling credit risk. In addition to managing interest rate risk, which applies to both assets and liabilities, the Corporation must understand and manage risks specific to lending. Much of the fundamental lending business of Provident is based upon understanding, measuring and controlling credit risk. Credit risk entails both general risks, which are inherent in the process of lending, and risk specific to individual borrowers. Each consumer and residential lending product has a generally predictable level of credit loss based on historical loss experience. Home mortgage and home equity loans and lines generally have the lowest credit loss experience. Loans with medium credit loss experience are primarily secured products such as auto and marine loans. Unsecured loan products such as personal revolving credit have the highest credit loss experience; therefore the Bank has chosen not to engage in a significant amount of this type of lending. Credit risk in commercial lending varies significantly, as losses as a percentage of outstanding loans can shift widely from period to period and are particularly sensitive to changing economic conditions. Generally improving economic conditions result in improved operating results on the part of commercial customers, enhancing their ability to meet debt service requirements. However, this improvement in operating cash flow is often at least partially offset by rising interest rates often seen in an improving economic environment. In addition, changing economic conditions often impact various business segments differently, giving rise to the need to manage industry concentrations within the loan portfolio.

To control and manage credit risk, management has set high credit standards along with an in-house administration and strong oversight procedures along with a cautious approach to adopting products before they have been sufficiently tested in the market place. In addition, the Corporation maintains a fairly balanced portfolio concentration between home equity, commercial and residential real estate and commercial business loans. The Corporation’s assessment of the loan portfolio’s credit risk and asset quality is measured by its levels of delinquencies, non-performing asset levels and charge-offs. For the quarter ending September 30, 2007, the 90-day delinquency level was $4.1 million, or 0.10% of loans, down by $1.1 million, or 20.3% from December 31, 2006. Non-performing assets were $26.9 million, or 0.67% of loans compared to 0.57% as of December 31, 2006. Net charge-offs as a percentage of average loans for the quarter ending September 30, 2007 were 0.20% compared to 0.14% for the fourth quarter of last year. Overall, the asset quality of the Corporation’s loan portfolio remains sound while the market conditions appear to be moving towards historical credit levels from the extraordinary low levels over the past couple of years. Further discussion relating to asset quality is presented in “Financial Condition – Asset Quality” and on page 32 in “Investment Portfolio Credit Quality.”

Other Lending Risks

Other lending risks include liquidity risk and specific risk. The liquidity risk of the Corporation arises from its obligation to make payment in the event of a customer’s contractual default. The evaluation of specific risk is a basic function of underwriting and loan administration, involving analysis of the borrower’s ability to service debt as well as the value of pledged collateral. In addition to impacting individual lending decisions, this analysis may also determine the aggregate level of commitments the Corporation is willing to extend to an individual customer or a group of related customers.

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Capital Resources

Total stockholders’ equity was $610.7 million at September 30, 2007, a decrease of $22.9 million from December 31, 2006. The overall change in stockholders’ equity for the period was attributable to $47.6 million in earnings that was partially offset by dividends paid of $30.0 million. Net accumulated other comprehensive loss increased by $24.5 million during the period primarily due to the impact on the market value of the debt securities portfolio from the current illiquid market. Capital was also increased by $5.1 million associated with the exercise of vested stock options and was reduced by $21.1 million from the repurchase of 646 thousand shares of the Corporation’s common stock at an average price of $32.74. The Corporation is authorized to repurchase up to an additional 1.1 million shares under its stock repurchase program.

The Corporation is required to maintain minimum amounts and ratios of core capital to adjusted quarterly average assets (“leverage ratio”) and of tier 1 and total regulatory capital to risk-weighted assets. The actual regulatory capital ratios and required ratios for capital adequacy purposes under FIRREA and the ratios to be categorized as “well capitalized” under prompt corrective action regulations are summarized in the following table.

(dollars in thousands)	September 30, 2007			December 31, 2006
Total equity capital per consolidated financial statements	$	610,721		$	633,631
Qualifying trust preferred securities		129,000			129,000
Accumulated other comprehensive loss		46,565			22,107
Adjusted capital		786,286			784,738
Adjustments for tier 1 capital:
Goodwill and disallowed intangible assets		(260,518	)		(263,665	)
Total tier 1 capital		525,768			521,073
Adjustments for tier 2 capital:
Allowance for loan losses		51,244			45,203
Allowance for letter of credit losses		575			534
Total tier 2 capital adjustments		51,819			45,737
Total regulatory capital	$	577,587		$	566,810
Risk-weighted assets	$	4,887,076		$	4,781,982
Quarterly regulatory average assets		6,018,560			6,108,492

					Minimum Regulatory Requirements		To be “Well Capitalized”
Ratios:
Tier 1 leverage	8.74	%	8.53	%	4.00	%	5.00	%
Tier 1 capital to risk-weighted assets	10.76		10.90		4.00		6.00
Total regulatory capital to risk-weighted assets	11.82		11.85		8.00		10.00

As of September 30, 2007, the Corporation is considered “well capitalized” for regulatory purposes.

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RESULTS OF OPERATIONS

For Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006

Financial Highlights

Provident reported net income of $16.0 million, or $0.50 per diluted share, for the quarter ended September 30, 2007 compared to $20.4 million, or $0.62 per diluted share in the third quarter of 2006. The third quarter 2007 included a $4.9 million gain associated with the sale of six branches and associated deposits to Union Bankshares and also included $111 thousand in costs associated with restructuring activities along with $733 thousand in consulting costs relating to this program. Additionally, the Corporation incurred a $954 thousand expense associated with higher legal costs and two legal settlements. During the quarter ending September 30, 2007, the provision for loan losses increased by $6.5 million over the same quarter of 2006 due to overall loan growth and a $4.1 million specific reserve for a non-performing commercial business loan. The decline in year over year net income was also driven by lower net interest income that resulted mainly from depositors shifting their deposits from low yielding checking and savings accounts to higher yielding certificates of deposit. The Corporation’s key performance measurements such as return on assets, return on common equity and net interest margin were 1.00%, 9.82% and 3.45%, respectively, for the quarter ended September 30, 2007 compared to 1.26%, 12.34%, and 3.61%, respectively, for the third quarter of 2006.

Despite the decline in year over year net income, the third quarter of 2007 reflects the Corporation’s continued commitment to produce positive loan and customer deposit growth by executing the basic strategies of broadening its presence and customer base in the Greater Washington and Central Virginia regions, and by growing commercial business and enhancing business results in all markets. In addition, excluding the one commercial loan discussed above, asset quality continued to be sound and management’s focus on expense control has contributed to maintaining operating expenses at levels similar to prior periods. Solid growth in average relationship-based loans of $274.7 million in the Corporation’s business segments enabled the Corporation to continue to strengthen the balance sheet by replacing wholesale assets with internally generated loan portfolios.

Earnings for the third quarter of 2007 include a decrease of $3.4 million in net interest income, a $6.5 million increase in provision for loan losses, an increase in non-interest income of $3.8 million, an increase of $71 thousand in non-interest expense and a $1.7 million decrease in income tax expense, resulting in a decrease of $4.5 million in net income from third quarter of 2006. The quarter ending September 30, 2007 reflects strong growth in relationship-based loans, growth in customer deposit balances in a challenging banking environment, while controlling operating expenses. An overview of the Corporation’s strategies is discussed on pages 23-24 of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Net Interest Income

The Corporation’s principal source of revenue is net interest income, the difference between interest income on earning assets and interest expense on deposits and borrowings. Interest income is presented on a tax-equivalent basis to recognize associated tax benefits in order to provide a basis for comparison of yields with taxable earning assets. The following table presents information regarding the average balance of assets and liabilities, as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing annualized income or expense by the average balances of assets or liabilities, respectively, for the periods presented. Nonaccrual loans are included in average loan balances, however, accrued interest income has been excluded from these loans. The tables on the following pages also analyze the reasons for the changes from year-to-year in the principal elements that comprise net interest income. Rate and volume variances presented for each component will not total the variances presented on totals of interest income and interest expense because of shifts from year-to-year in the relative mix of interest-earning assets and interest-bearing liabilities.

38

Consolidated Average Balances and Analysis of Changes in Tax Equivalent Net Interest Income

Three Months Ended September 30, 2007 and 2006

	Three Months Ended September 30, 2007						Three Months Ended September 30, 2006
(dollars in thousands) (tax-equivalent basis)	Average Balance		Income/ Expense		Yield/ Rate		Average Balance		Income/ Expense		Yield/ Rate
Assets:
Interest-earning assets:
Originated and acquired residential	$	298,019	$	4,571	6.09	%	$	373,568	$	6,023	6.40	%
Home equity		1,050,442		18,076	6.83			983,288		17,307	6.98
Marine		357,217		4,988	5.54			389,760		5,284	5.38
Other consumer		29,533		546	7.33			32,334		594	7.29
Commercial mortgage		441,685		7,938	7.13			449,305		7,963	7.03
Residential construction		609,537		13,400	8.72			535,183		11,905	8.83
Commercial construction		383,775		7,685	7.94			307,655		6,058	7.81
Commercial business		803,537		15,155	7.48			703,523		13,286	7.49
Total loans		3,973,745		72,359	7.22			3,774,616		68,420	7.19
Loans held for sale		11,318		203	7.12			10,866		197	7.19
Short-term investments		1,905		39	8.12			7,898		92	4.62
Taxable investment securities		1,493,579		20,832	5.53			1,811,500		25,234	5.53
Tax-advantaged investment securities		116,187		2,261	7.72			97,066		1,470	6.01
Total investment securities		1,609,766		23,093	5.69			1,908,566		26,704	5.55
Total interest-earning assets		5,596,734		95,694	6.78			5,701,946		95,413	6.64
Less: allowance for loan losses		46,147						44,749
Cash and due from banks		110,954						122,805
Other assets		617,812						626,770
Total assets	$	6,279,353					$	6,406,772
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Interest-bearing demand deposits	$	487,435		637	0.52		$	539,858		722	0.53
Money market deposits		583,856		5,016	3.41			576,136		4,385	3.02
Savings deposits		557,239		538	0.38			645,666		734	0.45
Direct time deposits		1,218,368		14,148	4.61			982,228		9,929	4.01
Brokered time deposits		528,841		6,903	5.18			520,367		6,248	4.76
Short-term borrowings		748,807		8,774	4.65			722,043		8,661	4.76
Long-term debt		758,878		11,021	5.76			963,669		12,919	5.32
Total interest-bearing liabilities		4,883,424		47,037	3.82			4,949,967		43,598	3.49
Noninterest-bearing demand deposits		709,492						759,874
Other liabilities		41,541						39,773
Stockholders’ equity		644,896						657,158
Total liabilities and stockholders’ equity	$	6,279,353					$	6,406,772
Net interest-earning assets	$	713,310					$	751,979
Net interest income (tax-equivalent)				48,657						51,815
Less: tax-equivalent adjustment				820						601
Net interest income			$	47,837					$	51,214
Net yield on interest-earning assets on a tax-equivalent basis					3.45	%					3.61	%

39

Consolidated Average Balances and Analysis of Changes in Tax Equivalent Net Interest Income (Continued)

Three Months Ended September 30, 2007 and 2006

	2007 Quarter to 2006 Quarter Increase/(Decrease)										2007/2006 Income/Expense Variance Due to Change In
(dollars in thousands) (tax-equivalent basis)	Average Balance			% Change		Income/ Expense			% Change		Average Rate			Average Volume
Assets:
Interest-earning assets:
Originated and acquired residential	$	(75,549	)	(20.2	)%	$	(1,452	)	(24.1	)%	$	(282	)	$	(1,170	)
Home equity		67,154		6.8			769		4.4			(393	)		1,162
Marine		(32,543	)	(8.3	)		(296	)	(5.6	)		155			(451	)
Other consumer		(2,801	)	(8.7	)		(48	)	(8.1	)		4			(52	)
Commercial mortgage		(7,620	)	(1.7	)		(25	)	(0.3	)		111			(136	)
Residential construction		74,354		13.9			1,495		12.6			(141	)		1,636
Commercial construction		76,120		24.7			1,627		26.9			104			1,523
Commercial business		100,014		14.2			1,869		14.1			(17	)		1,886
Total loans		199,129		5.3			3,939		5.8
Loans held for sale		452		4.2			6		3.0			(2	)		8
Short-term investments		(5,993	)	(75.9	)		(53	)	(57.6	)		43			(96	)
Taxable investment securities		(317,921	)	(17.6	)		(4,402	)	(17.4	)		32			(4,434	)
Tax-advantaged investment securities		19,121		19.7			791		53.8			468			323
Total investment securities		(298,800	)	(15.7	)		(3,611	)	(13.5	)
Total interest-earning assets		(105,212	)	(1.8	)		281		0.3			2,059			(1,778	)
Less: allowance for loan losses		1,398		3.1
Cash and due from banks		(11,851	)	(9.7	)
Other assets		(8,958	)	(1.4	)
Total assets	$	(127,419	)	(2.0	)
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Interest-bearing demand deposits	$	(52,423	)	(9.7	)		(85	)	(11.8	)		(16	)		(69	)
Money market deposits		7,720		1.3			631		14.4			572			59
Savings deposits		(88,427	)	(13.7	)		(196	)	(26.7	)		(103	)		(93	)
Direct time deposits		236,140		24.0			4,219		42.5			1,613			2,606
Brokered time deposits		8,474		1.6			655		10.5			552			103
Short-term borrowings		26,764		3.7			113		1.3			(204	)		317
Long-term debt		(204,791	)	(21.3	)		(1,898	)	(14.7	)		1,012			(2,910	)
Total interest-bearing liabilities		(66,543	)	(1.3	)		3,439		7.9			4,032			(593	)
Noninterest-bearing demand deposits		(50,382	)	(6.6	)
Other liabilities		1,768		4.4
Stockholders’ equity		(12,262	)	(1.9	)
Total liabilities and stockholders’ equity	$	(127,419	)	(2.0	)
Net interest-earning assets	$	(38,669	)	(5.1	)
Net interest income (tax-equivalent)							(3,158	)	(6.1	)	$	(1,973	)	$	(1,185	)
Less: tax-equivalent adjustment							219		36.4
Net interest income						$	(3,377	)	(6.6	)

40

The net interest margin, on a tax-equivalent basis, decreased 16 basis points to 3.45% for the quarter ending September 30, 2007 compared to September 30, 2006. The decline was primarily caused by the shift in deposit mix as customers have been moving balances away from lower yielding checking and savings accounts to higher yielding certificates of deposit. The deposit mix change is mainly a result of the current yield curve environment. Over the past twelve months, the Corporation’s customers have been taking advantage of the higher deposit rates associated with certificates of deposit. The favorable yield impact of replacing lower yielding net interest-earning wholesale assets with higher yielding net interest-earning assets has been offset by the negative impact from the change in the deposit mix. The securities and debt restructuring transaction that occurred in December 2006 has mitigated some of the impact on the net interest margin caused by the shift in deposit mix.

During the quarter ending September 30, 2007, the Corporation experienced loan growth in its home equity and residential and commercial construction loan portfolios as well as commercial business from the same period a year ago. Growth in these loan portfolios was slightly offset by strategically planned declines in wholesale assets (investment securities and originated and acquired residential portfolios). Overall, average-earning assets declined $105.2 million to $5.6 billion, which was mainly attributable to the $298.8 million reduction in average investment securities that resulted primarily from the securities and debt restructuring transaction in 2006. This decline was partially offset by the $199.1 million increase in average loans. The yields on loans and investments grew 3 and 14 basis points, respectively. The yield increase in loan and investment portfolios resulted from the year over year increase in market interest rates and the composition mix of loan and investment products. Interest-bearing liabilities decreased $66.5 million while the average rate paid increased 33 basis points. The increase in the average rate paid was primarily due to the shift in deposit in addition to the rise in year over year interest rates that impacted money market deposits, time deposits and long-term debt. Interest expense was also negatively impacted from the $50.4 million decline in average noninterest-bearing demand deposit balances during the third quarter of 2007 compared to same quarter a year ago as a result of the current interest rate environment.

The 6.78% yield on earning assets in the third quarter 2007 increased 14 basis points from the third quarter 2006, as a result of the year over year slight increase in interest rates, but was more than offset by the increased cost on interest-bearing liabilities of 33 basis points to 3.82%. Net interest income on a tax-equivalent basis was $48.7 million in the third quarter of 2007, compared to $51.8 million in third quarter of 2006. Total interest income increased $281 thousand and total interest expense increased $3.4 million resulting in the decline in net interest income of $3.2 million on a tax-equivalent basis. Growth in commercial and home equity consumer loans offset by the decline in the originated and acquired residential mortgage portfolio, marine loans and the significant decline in the investment portfolios, along with the impact from the slight rise in year over year interest rates, were the primary drivers behind the $281 thousand increase in total interest income. The impact from rising interest rates along with the change in deposit mix towards higher yielding certificates of deposit from lower yielding checking and savings accounts were the primary causes of the increase in interest expense of $3.4 million.

Future growth in net interest income will depend upon several factors including loan demand, growth in deposits, deposit mix and the general level of interest rates.

Provision for Loan Losses

The Corporation continues to emphasize quality underwriting as well as portfolio management of potential problem loans. Net charge-offs in the third quarter of 2007 were $2.0 million, or 0.20% of average loans compared to $951 thousand, or 0.10% of average loans, in the third quarter of 2006. The $1.1 million increase in net charge-offs was not concentrated in one loan portfolio but spread relatively evenly throughout the home equity, residential real estate construction, commercial business and other consumer loan portfolios. The charge-off rate for the quarter is considered favorable compared to historical credit conditions. This performance is a reflection of management’s credit policies and strategy of shifting the balance sheet to relationship-based loan portfolios. As a result of the overall loan growth and a $4.1 million specific reserve on a commercial business loan placed on nonaccural status within the current quarter, the provision for loan losses increased by $6.5 million over the same period a year ago. The allowance for loan losses to total loans was 1.27% as of September 30, 2007.

Non-Interest Income

Non-interest income for the current quarter increased $3.8 million, or 12.1%, to $35.3 million compared to the third quarter of 2006. The third quarter of 2007 included a $4.9 million gain on the sale of the deposits and facilities of six branches. The decline in non-interest income adjusted for net gains was $726 thousand and was mainly driven by a decline in deposit fee income of $540 thousand, a decline in derivative gains of $439 thousand offset by increases in commissions and fees of $124 thousand and the increase in other non-interest income of $122 thousand.

41

Deposit fee income decreased $540 thousand, or 2.2%, from the third quarter of 2006, reflecting decreases in consumer deposit fees of $640 thousand offset by an increase in commercial accounts activity by $100 thousand. The decline in consumer deposit fees was mainly associated with lower NSF fees.

Commissions and fees increased 8.3% to $1.6 million for the three months ended September 30, 2007 over the same period a year ago. This increase is mainly from the improved sales performance in Provident Investment Company activities. During the third quarter 2007, net gains associated with the sale of securities, asset sales and debt extinguishments increased by $4.5 million over the same period a year ago to $4.9 million. The third quarter of 2007 included the sale of the deposits and facilities of six branches with a $4.9 million gain. The third quarter of 2006 included investment/borrowing transactions that were focused on reducing sensitivity to changes in short-term interest rates. These transactions generated net gains of $202 thousand. The third quarter of 2006 also included net gains of $171 thousand primarily from the sale of mortgage loans.

Net derivative gains on swaps were $204 thousand in the third quarter of 2007, compared to a $643 thousand gain in the third quarter of 2006. These non-cash amounts represent the change in the value of certain derivatives that are used to mitigate the impact of changing interest rates. Non-interest income is impacted by changing interest rates and market volatility on the fair value of the non-designated interest rate swaps.

Net cash settlement on swaps, representing interest income and expense on non-designated interest rate swaps, increased $7 thousand from third quarter of 2006. Provident’s non-designated interest rate swaps are receive fixed/pay LIBOR positions and are used strictly for hedging activities.

Other non-interest income for the third quarter of 2007 benefited from an increase in bank owned life insurance income of $142 thousand.

Non-Interest Expense

Non-interest expense increased by $71 thousand or less than 1% from the same period a year ago. In the third quarter of 2007, total non-interest expense included $111 thousand in restructuring costs associated with the corporate-wide efficiency initiatives program along with consulting costs of $733 thousand relating to this program. In addition, the third quarter of 2007 includes $954 thousand associated with additional legal costs and two legal settlements.

Salaries and employee benefits decreased $963 thousand, or 3.5%, from the same period a year ago. This decline is mainly attributable to decreased labor costs of $1.7 million from a lower number of employees that resulted from the restructuring activities that were partially offset by annual merit increases and new staffing positions relating to new business initiatives. The decrease in salaries and employee benefits expense was also offset by the increase of $224 thousand relating to share-based payments, $604 thousand in employee incentive and commission payments and $202 thousand in pension benefits. In addition, salary and employee benefit expense was positively impacted by the decrease in payroll taxes of $136 and healthcare costs by $101 thousand. Occupancy expense increased $133 thousand over the third quarter of 2006 mainly due to the expiration of a sublease arrangement. Furniture and equipment increased 1.0% from the third quarter of 2006 while external processing fees decreased by $189 thousand, or 3.6%. The restructuring costs of $111 thousand for the third quarter of 2007 are composed of severance costs and associated employee termination costs. Other non-interest expense increased by $942 thousand from the same period a year ago. The increase was mainly from $954 thousand in additional legal costs relating to indemnification obligations assumed in connection with the acquisition of Southern Financial Bancorp in April 2004 and two legal settlements that occurred in the third quarter of 2007. Included in other non-interest expense is a decline in professional fees of $268 thousand that relates to the annual audit and regulatory compliance costs. In addition, consulting costs increased by $733 thousand, which relates to the ongoing corporate efficiency infrastructure initiatives.

Income Taxes

The Corporation accounts for income taxes under the asset/liability method. Deferred tax assets and liabilities are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carry forwards. It is at least reasonably possible that management’s judgment about the need for a valuation allowance for deferred taxes could change in the near term. The valuation allowance was $3.0 million at September 30, 2007 versus $2.6 million at September 30, 2006. The valuation allowance relates to state operating losses that are unlikely to be realized in the foreseeable future.

The Corporation recorded income tax expense of $7.0 million based on pre-tax income of $23.0 million, representing an effective tax rate of 30.5% in third quarter of 2007, compared to the 29.9% rate for the same period a year ago. The current quarter reflects the increased state tax expense associated with the recent state tax law change associated with captive real estate investment trusts that was partially offset by the impact from the increase in average tax-advantaged investment income and the impact of permanent tax differences in proportion to lower pre-tax earnings in 2007. In the third quarter of 2006, the Corporation recorded a tax expense of $8.7 million on pre-tax income of $29.1 million.

42

For Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

Financial Highlights

The Corporation recorded net income of $47.6 million, or $1.48 per diluted share, for the nine months ended September 30, 2007, compared to $58.7 million, or $1.77 per diluted share, for the nine months ended September 30, 2006. The decline in year over year net income was primarily due to lower net interest income driven by the change in deposit mix and the additional provision for loan loss of $11.2 million recorded in 2007 that was mainly associated with loan growth, a $3.5 million charge-off of a commercial business loan in the second quarter of 2007 and a $4.1 million specific reserve placed on a commercial business loan in the third quarter of 2007. Year-to-date 2007 pre-tax results included a $1.5 million expense associated with restructuring activities and $2.2 million in consulting costs associated with these activities. In addition, non-interest income included a $767 thousand gain from the sale of a branch facility that was completed as part of the branch rationalization effort and a $4.9 million gain on sale of the deposits and facilities of six branches. Year-to-date 2006 pre-tax income included a legal settlement expense of $1.3 million and a bank owned life insurance death benefit of $1.3 million.

For the nine months ending September 30, 2007 and 2006, the Corporation’s key performance measurements of return on assets, return on common equity and net interest margin were 1.02%, 9.9% and 3.55%, compared to 1.23%, 12.03% and 3.69%, respectively.

Net Interest Income

Tax equivalent net interest income for the nine months of 2007 decreased $9.1 million to $147.4 million compared to 2006, a 5.8% decrease from period to period. Tax equivalent interest income increased $10.3 million and interest expense increased $19.4 million. The decline in net interest income is mainly a result of the change in deposit mix as customers shifted their deposits away from low yielding checking and savings deposits to higher yielding certificates of deposit. Year over year, interest-earning assets declined by $112.1 million which is mainly a result of the Corporation’s securities and debt restructuring transaction that occurred in December 2006 and was partially mitigated by the increase in average loans. The yield on earning assets increased 38 basis points and was offset by the impact from the 58 basis point increase in rates paid on interest-bearing liabilities. Interest-bearing liabilities declined by $67.0 million over the same period a year ago. The overall impact on the net yield on earning assets was a decrease of 14 basis points to 3.55% in 2007 from 3.69% in 2006.

43

Consolidated Average Balances and Analysis of Changes in Tax Equivalent Net Interest Income

Nine Months Ended September 30, 2007 and 2006

	Nine Months Ended September 30, 2007						Nine Months Ended September 30, 2006
(dollars in thousands) (tax-equivalent basis)	Average Balance		Income/ Expense		Yield/ Rate		Average Balance		Income/ Expense		Yield/ Rate
Assets:
Interest-earning assets:
Originated and acquired residential	$	311,406	$	14,527	6.24	%	$	405,214	$	19,060	6.29	%
Home equity		1,020,822		52,537	6.88			948,202		47,457	6.69
Marine		366,064		14,919	5.45			396,462		15,672	5.29
Other consumer		27,987		1,622	7.75			30,272		1,753	7.74
Commercial mortgage		446,297		23,878	7.15			461,976		24,006	6.95
Residential construction		593,501		38,742	8.73			497,421		31,589	8.49
Commercial construction		377,122		22,366	7.93			304,167		17,204	7.56
Commercial business		773,392		43,345	7.49			691,325		37,631	7.28
Total loans		3,916,591		211,936	7.23			3,735,039		194,372	6.96
Loans held for sale		11,678		572	6.55			9,578		494	6.90
Short-term investments		2,802		181	8.64			8,195		282	4.60
Taxable investment securities		1,507,167		64,631	5.73			1,833,084		73,918	5.39
Tax-advantaged investment securities		120,221		5,832	6.49			84,613		3,833	6.06
Total investment securities		1,627,388		70,463	5.79			1,917,697		77,751	5.42
Total interest-earning assets		5,558,459		283,152	6.81			5,670,509		272,899	6.43
Less: allowance for loan losses		45,610						44,963
Cash and due from banks		113,552						122,649
Other assets		616,778						624,351
Total assets	$	6,243,179					$	6,372,546
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Interest-bearing demand deposits	$	511,594		2,095	0.55		$	562,619		2,038	0.48
Money market deposits		575,200		14,704	3.42			603,217		12,072	2.68
Savings deposits		584,305		1,692	0.39			673,506		1,874	0.37
Direct time deposits		1,200,980		41,232	4.59			933,644		25,217	3.61
Brokered time deposits		518,678		19,788	5.10			476,701		16,684	4.68
Short-term borrowings		668,091		23,345	4.67			811,605		27,243	4.49
Long-term debt		773,690		32,854	5.68			838,255		31,211	4.98
Total interest-bearing liabilities		4,832,538		135,710	3.75			4,899,547		116,339	3.17
Noninterest-bearing demand deposits		725,771						783,774
Other liabilities		41,862						36,404
Stockholders’ equity		643,008						652,821
Total liabilities and stockholders’ equity	$	6,243,179					$	6,372,546
Net interest-earning assets	$	725,921					$	770,962
Net interest income (tax-equivalent)				147,442						156,560
Less: tax-equivalent adjustment				2,122						1,525
Net interest income			$	145,320					$	155,035
Net yield on interest-earning assets on a tax-equivalent basis					3.55	%					3.69	%

44

Consolidated Average Balances and Analysis of Changes in Tax Equivalent Net Interest Income (Continued)

Nine Months Ended September 30, 2007 and 2006

	YTD 2007 to YTD 2006 Increase/(Decrease)										2007/2006 Income/Expense Variance Due to Change In
(dollars in thousands) (tax-equivalent basis)	Average Balance			% Change		Income/ Expense			% Change		Average Rate			Average Volume
Assets:
Interest-earning assets:
Originated and acquired residential	$	(93,808	)	(23.2	)%	$	(4,533	)	(23.8	)%	$	(156	)	$	(4,377	)
Home equity		72,620		7.7			5,080		10.7			1,370			3,710
Marine		(30,398	)	(7.7	)		(753	)	(4.8	)		475			(1,228	)
Other consumer		(2,285	)	(7.5	)		(131	)	(7.5	)		1			(132	)
Commercial mortgage		(15,679	)	(3.4	)		(128	)	(0.5	)		699			(827	)
Residential construction		96,080		19.3			7,153		22.6			903			6,250
Commercial construction		72,955		24.0			5,162		30.0			869			4,293
Commercial business		82,067		11.9			5,714		15.2			1,141			4,573
Total loans		181,552		4.9			17,564		9.0
Loans held for sale		2,100		21.9			78		15.8			(26	)		104
Short-term investments		(5,393	)	(65.8	)		(101	)	(35.8	)		154			(255	)
Taxable investment securities		(325,917	)	(17.8	)		(9,287	)	(12.6	)		4,470			(13,757	)
Tax-advantaged investment securities		35,608		42.1			1,999		52.2			288			1,711
Total investment securities		(290,309	)	(15.1	)		(7,288	)	(9.4	)
Total interest-earning assets		(112,050	)	(2.0	)		10,253		3.8			15,725			(5,472	)
Less: allowance for loan losses		647		1.4
Cash and due from banks		(9,097	)	(7.4	)
Other assets		(7,573	)	(1.2	)
Total assets	$	(129,367	)	(2.0	)
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Interest-bearing demand deposits	$	(51,025	)	(9.1	)		57		2.8			252			(195	)
Money market deposits		(28,017	)	(4.6	)		2,632		21.8			3,215			(583	)
Savings deposits		(89,201	)	(13.2	)		(182	)	(9.7	)		74			(256	)
Direct time deposits		267,336		28.6			16,015		63.5			7,789			8,226
Brokered time deposits		41,977		8.8			3,104		18.6			1,570			1,534
Short-term borrowings		(143,514	)	(17.7	)		(3,898	)	(14.3	)		1,080			(4,978	)
Long-term debt		(64,565	)	(7.7	)		1,643		5.3			4,166			(2,523	)
Total interest-bearing liabilities		(67,009	)	(1.4	)		19,371		16.7			20,982			(1,611	)
Noninterest-bearing demand deposits		(58,003	)	(7.4	)
Other liabilities		5,458		15.0
Stockholders’ equity		(9,813	)	(1.5	)
Total liabilities and stockholders’ equity	$	(129,367	)	(2.0	)
Net interest-earning assets	$	(45,041	)	(5.8	)
Net interest income (tax-equivalent)							(9,118	)	(5.8	)	$	(5,257	)	$	(3,861	)
Less: tax-equivalent adjustment							597		39.1
Net interest income						$	(9,715	)	(6.3	)

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Provision for Loan Losses

The provision for loan losses for the first nine months of 2007 was $13.3 million compared to $2.1 million for the nine months of 2006. Net charge-offs were $7.3 million, or 0.25% of average loans, in the first nine months of 2007 compared to $3.0 million, or 0.11% of average loans, for the nine months of 2006. During the first nine months of 2007 management increased the provision for loan losses by $11.2 million to provide for the increase in loan growth, net charge-offs and a specific reserve on a commercial business loan. The allowance for loan losses to total loans was 1.27% at September 30, 2007.

Non-Interest Income

Total non-interest income increased to $96.3 million for the nine months ended September 30, 2007 from $90.9 million for the nine months ended September 30, 2006. Deposit fee income increased $333 thousand, or 0.5%, reflecting increases in consumer and commercial deposit fees. Net cash settlement on swaps, representing interest income and expense on non-designated interest rate swaps, decreased $115 thousand from the nine months ending September 30, 2006, as a result of a change in interest rates. Non-interest income benefited from increases in commissions and fees of $352 thousand mainly from insurance and investment fees. Net gains were $6.5 million for the nine months ended September 30, 2007, compared to $1.1 million for the nine months ended September 30, 2006. The nine months ended September 30, 2007 includes a $767 thousand gain from the sale of a branch facility and a $4.9 million gain from the sale of deposits and facilities of six branches. Derivative losses on swaps decreased by $98 thousand, from a net loss of $514 thousand for the nine months ending September 30, 2006 to a net loss of $416 thousand for the nine months ending September 30, 2007. This decrease resulted from the impact of the changing interest rates and market volatility. In addition, the nine months ended September 30, 2006 included a $1.3 million insurance death benefit.

Non-Interest Expense

Non-interest expense increased by $881 thousand, or 0.6%, over year-to-date 2006. Year-to-date 2007 included a $1.5 million expense associated with restructuring activities and $2.2 million in consulting costs associated with these activities. Year-to-date 2006 included a legal settlement of $1.3 million. Salaries and employee benefits declined by $1.1 million, or 1.4%, from the same period a year ago. This decline is mainly attributable to decreased labor costs of $1.9 million from the decline in the number of employees resulting from the restructuring activities offset by annual merit increases and severance related expenses. Salaries and employee benefits included an increase in incentives and commissions of $397 thousand and an additional $498 thousand in deferred origination costs. Healthcare costs declined by $657 thousand, payroll taxes by $202 thousand while pension expense increased by $684 thousand and the Corporation’s 401k plan expense increased by $197 thousand due to increased employee participation. Stock compensation expense also increased by $668 thousand relating to share based payments. Occupancy and furniture and equipment expense increased $803 thousand reflecting increased rent expense, depreciation expense and a termination of a sublease agreement. Non-interest expense also includes $1.5 million in restructuring costs and $2.2 million in consulting fees relating to the restructuring activities. Professional fees relating to the annual audit and regulatory compliance activities declined by $1.0 million.

Income Taxes

The Corporation recorded income tax expense of $20.6 million in the first nine months of 2007 based on pre-tax income of $68.2 million, a 30.2% effective tax rate, compared to pre-tax income of $84.7 million and an effective tax rate of 30.7% for 2006. The decline in the effective tax rate is due to the impact from the increase in average tax-advantage investments and the impact of permanent tax differences on the effective tax rate due to lower pre-tax earnings in 2007, offset by an increase in state tax expense related to the recent law change associated with captive real estate investment trusts.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

For information regarding market risk at December 31, 2006, see “Interest Sensitivity Management” and Note 14 to the Consolidated Financial Statements in the Corporation’s Form 10-K filed with the Securities and Exchange Commission on March 1, 2007. The market risk of the Corporation has not experienced any material changes as of September 30, 2007 from December 31, 2006. Additionally, refer to Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional quantitative and qualitative discussions about market risk at September 30, 2007.

Item 4. Controls and Procedures

The Corporation’s management, including the Corporation’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Corporation’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their

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evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Corporation’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Corporation files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Corporation’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Corporation’s internal control over financial reporting occurred during the quarter ended September 30, 2007 that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

The Corporation is involved in various legal actions that arise in the ordinary course of its business. All active lawsuits entail amounts which management believes, individually and in the aggregate, are immaterial to the financial condition and the results of operations of the Corporation.

Item 1A. Risk Factors

In early April 2007, the State of Maryland passed legislation eliminating a previously legal dividend deduction for captive real estate investment trusts. The new legislation was signed by the Governor into law in May 2007. The law was effective July 1, 2007 and was retroactive to January 1, 2007. The Corporation, which maintains a trust to which the new law is applicable, has evaluated the impact of this change in the tax regulations on the Corporation’s operations and has concluded that the overall tax impact is immaterial to the financial condition of the Corporation.

In addition to the other information set forth in this report, the reader should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2006, which could materially affect the Corporation’s business, financial condition or future results. The risks described in the Corporation’s Annual Report on Form 10-K are not the only risks that the Corporation faces. Additional risks and uncertainties not currently known to the Corporation or that the Corporation currently deems to be immaterial also may materially adversely affect the Corporation’s business, financial condition and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During 1998, the Corporation initiated a stock repurchase program for its outstanding stock. Under this plan, the Corporation approved the repurchase of specific additional amounts of shares without any specific expiration date. As the Corporation fulfilled each specified repurchase amount, additional amounts were approved. On June 17, 2005, and on January 17, 2007 the Corporation approved an additional stock repurchase of up to 1.3 million and 1.6 million shares, respectively. Currently, the maximum number of shares remaining to be purchased under this plan is 1,100,039. All shares have been repurchased pursuant to the publicly announced plan. The repurchase plan will continue until it is completed or terminated by the Board of Directors. No plans expired during the three months ended September 30, 2007. The Corporation currently has no plan to terminate the stock repurchase plan.

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The following table provides certain information with regard to shares repurchased by the Corporation in the third quarter of 2007.

Period	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased Under Plan	Maximum Number of Shares Remaining to be Purchased Under Plan
July 1 - July 31	250,000	$	30.77	250,000	1,150,039
August 1 - August 31	50,000		28.87	50,000	1,100,039
September 1 - September 30	—		—	—	1,100,039
Total	300,000	$	30.45	300,000	1,100,039

For information regarding limitations on the payment of dividends, see “Item 2 – Management’s Discussion and Analysis of Financial Condition – Liquidity.”

Item 3. Defaults Upon Senior Securities – None

Item 4. Submission of Matters to a Vote of Security Holders – None

Item 5. Other Information – None

Item 6. Exhibits

The exhibits and financial statements filed as a part of this report are as follows:

(3.1)	Articles of Incorporation of Provident Bankshares Corporation (1)
(3.2)	Articles of Amendment to the Articles of Incorporation of Provident Bankshares Corporation (1)
(3.3)	Seventh Amended and Restated By-Laws of Provident Bankshares Corporation (2)
(11.0)	Statement re: Computation of Per Share Earnings (3)
(31.1)	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
(31.2)	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
(32.1)	Section 1350 Certification of Chief Executive Officer
(32.2)	Section 1350 Certification of Chief Financial Officer

(1) Incorporated by reference from Registrant’s Registration Statement on Form S-8 (File No. 33-58881) filed with the Commission on July 10, 1998.

(2) Incorporated by reference from Registrant’s Current Report on Form 8-K (File No. 0-16421) filed with the Commission on October 18, 2007.

(3) Included in Note 15 to the Unaudited Condensed Consolidated Financial Statements.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Principal Executive Officer:
November 9, 2007	By	/s/ Gary N. Geisel
		Gary N. Geisel
		Chairman of the Board and Chief Executive Officer
	Principal Financial Officer:
November 9, 2007	By	/s/ Dennis A. Starliper
		Dennis A. Starliper
		Executive Vice President and Chief Financial Officer

EXHIBIT	DESCRIPTION
31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.1	Section 1350 Certification of Chief Executive Officer
32.2	Section 1350 Certification of Chief Financial Officer

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