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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-16421
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PROVIDENT BANKSHARES CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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MARYLAND 52-1518642
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
114 EAST LEXINGTON STREET, BALTIMORE, MARYLAND 21202
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(410) 277-7000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No |_|
At August 4, 2005, the Registrant had 32,912,014 shares of $1.00 par value
common stock outstanding.
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TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Statements of Condition
June 30, 2005 and 2004 and December 31, 2004 3
Consolidated Statements of Income - Unaudited
Three and six month periods ended June 30, 2005 and 2004 4
Consolidated Statements of Cash Flows - Unaudited
Six month periods ended June 30, 2005 and 2004 5
Notes to Consolidated Financial Statements - Unaudited 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 36
Item 4. Controls and Procedures 36
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 37
Item 3. Defaults upon Senior Securities 37
Item 4. Submission of Matters to a Vote of Security Holders 37
Item 5. Other Information 38
Item 6. Exhibits 38
SIGNATURES 39
FORWARD-LOOKING STATEMENTS
This report, as well as other written communications made from time to time by
Provident Bankshares Corporation and its subsidiaries (the "Corporation")
(including, without limitation, the Corporation's 2004 Annual Report to
Stockholders) and oral communications made from time to time by authorized
officers of the Corporation, may contain statements relating to the future
results of the Corporation (including certain projections and business trends)
that are considered "forward-looking statements" as defined in the Private
Securities Litigation Reform Act of 1995 (the "PSLRA"). Such forward-looking
statements may be identified by the use of such words as "believe," "expect,"
"anticipate," "should," "planned," "estimated," "intend" and "potential."
Examples of forward-looking statements include, but are not limited to, possible
or assumed estimates with respect to the financial condition, expected or
anticipated revenue, and results of operations and business of the Corporation,
including earnings growth determined using U.S. generally accepted accounting
principles ("GAAP"); revenue growth in retail banking, lending and other areas;
1
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, 2004 under the headings "Forward-Looking Statements" and "Risk
Factors," prevailing economic conditions, either nationally or locally in some
or all areas in which the Corporation conducts business or conditions in the
securities markets or the banking industry; changes in interest rates, deposit
flows, loan demand, real estate values and competition, which can materially
affect, among other things, consumer banking revenues, revenues from sales on
non-deposit investment products, origination levels in the Corporation's lending
businesses and the level of defaults, losses and prepayments on loans made by
the Corporation, whether held in portfolio or sold in the secondary markets;
changes in the quality or composition of the loan or investment portfolios; the
Corporation's ability to successfully integrate any assets, liabilities,
customers, systems and management personnel the Corporation may acquire into its
operations and its ability to realize related revenue synergies and cost savings
within expected time frames; the Corporation's timely development of new and
competitive products or services in a changing environment, and the acceptance
of such products or services by customers; operational issues and/or capital
spending necessitated by the potential need to adapt to industry changes in
information technology systems, on which it is highly dependent; changes in
accounting principles, policies, and guidelines; changes in any applicable law,
rule, regulation or practice with respect to tax or legal issues; risks and
uncertainties related to mergers and related integration and restructuring
activities; and other economic, competitive, governmental, regulatory and
technological factors affecting the Corporation's operations, pricing, products
and services. Readers are cautioned not to place undue reliance on these
forward-looking statements which are made as of the date of this report, and,
except as may be required by applicable law or regulation, the Corporation
assumes no obligation to update the forward-looking statements or to update the
reasons why actual results could differ from those projected in the
forward-looking statements.
In the event that any non-GAAP financial information is described in any written
communication, please refer to the supplemental financial tables included within
and on the Corporation's website for the GAAP reconciliation of this
information.
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
June 30, December 31, June 30,
(dollars in thousands, except per share and share amounts) 2005 2004 2004
-------------- ------------- --------------
(Unaudited) (Unaudited)
ASSETS:
Cash and due from banks $ 150,487 $ 124,664 $ 179,624
Short-term investments 5,973 9,658 7,884
Mortgage loans held for sale 5,595 6,520 6,406
Securities available for sale 1,945,625 2,186,395 2,175,961
Securities held to maturity 112,449 114,671 -
Loans 3,623,791 3,559,880 3,519,519
Less allowance for loan losses 46,583 46,169 47,687
-------------- ------------- --------------
Net loans 3,577,208 3,513,711 3,471,832
-------------- ------------- --------------
Premises and equipment, net 63,770 63,413 70,457
Accrued interest receivable 28,935 28,669 27,936
Goodwill 256,190 256,241 247,776
Intangible assets 11,685 12,649 13,613
Other assets 249,471 255,569 221,563
-------------- ------------- --------------
Total assets $ 6,407,388 $ 6,572,160 $ 6,423,052
============== ============= ==============
LIABILITIES:
Deposits:
Noninterest-bearing $ 931,421 $ 811,917 $ 924,096
Interest-bearing 3,106,407 2,970,083 3,206,406
-------------- ------------- --------------
Total deposits 4,037,828 3,782,000 4,130,502
-------------- ------------- --------------
Short-term borrowings 677,241 917,893 511,796
Long-term debt 1,031,884 1,205,548 1,168,572
Accrued expenses and other liabilities 33,889 49,280 29,305
-------------- ------------- --------------
Total liabilities 5,780,842 5,954,721 5,840,175
-------------- ------------- --------------
STOCKHOLDERS' EQUITY:
Common stock (par value $1.00) authorized 100,000,000 shares;
issued 41,040,258, 40,870,602 and 40,649,190 shares at June 30,
2005, December 31, 2004 and June 30, 2004, respectively 41,040 40,871 40,649
Additional paid-in capital 556,229 552,671 547,089
Retained earnings 201,470 182,414 162,647
Net accumulated other comprehensive loss (1,490) (964) (14,175)
Treasury stock at cost - 8,174,441, 7,768,217 and 7,651,317
shares at June 30, 2005, December 31, 2004 and
June 30, 2004, respectively (170,703) (157,553) (153,333)
------------- ------------ --------------
Total stockholders' equity 626,546 617,439 582,877
------------- ------------ --------------
Total liabilities and stockholders' equity $ 6,407,388 $ 6,572,160 $ 6,423,052
============= ============ ==============
The accompanying notes are an integral part of these statements.
3
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
(dollars in thousands, except per share data) 2005 2004 2005 2004
------------- -------------- -------------- -------------
INTEREST INCOME:
Loans, including fees $ 52,514 $ 43,608 $ 103,018 $ 80,593
Investment securities 24,360 22,871 48,681 45,405
Tax-advantaged loans and securities 335 332 654 674
Short-term investments 64 48 107 50
------------- -------------- -------------- -------------
Total interest income 77,273 66,859 152,460 126,722
------------- -------------- -------------- -------------
INTEREST EXPENSE:
Deposits 11,812 9,544 21,939 18,158
Short-term borrowings 4,819 1,365 9,292 2,943
Long-term debt 9,887 10,601 20,153 21,549
------------- -------------- -------------- -------------
Total interest expense 26,518 21,510 51,384 42,650
------------- -------------- -------------- -------------
Net interest income 50,755 45,349 101,076 84,072
Less provision for loan losses 2,222 1,530 3,797 3,922
------------- -------------- -------------- -------------
Net interest income after provision for loan losses 48,533 43,819 97,279 80,150
------------- -------------- -------------- -------------
NON-INTEREST INCOME:
Service charges on deposit accounts 21,761 21,052 41,110 39,583
Commissions and fees 1,314 1,142 2,524 2,366
Net gains (losses) 706 (7,877) (70) (7,061)
Other non-interest income 4,408 3,259 9,910 6,271
------------- -------------- -------------- -------------
Total non-interest income 28,189 17,576 53,474 41,159
------------- -------------- -------------- -------------
NON-INTEREST EXPENSE:
Salaries and employee benefits 24,588 22,048 47,286 42,469
Occupancy expense, net 6,289 4,430 11,563 8,480
Furniture and equipment expense 3,612 3,471 7,076 6,614
External processing fees 5,125 6,066 10,322 11,361
Merger expenses - 1,972 - 2,156
Other non-interest expense 10,212 8,174 21,053 15,690
------------- -------------- -------------- -------------
Total non-interest expense 49,826 46,161 97,300 86,770
------------- -------------- -------------- -------------
Income before income taxes 26,896 15,234 53,453 34,539
Income tax expense 8,458 4,734 16,907 11,164
------------- -------------- -------------- -------------
Net income $ 18,438 $ 10,500 $ 36,546 $ 23,375
============= ============== ============== =============
NET INCOME PER SHARE AMOUNTS:
Basic $ 0.56 $ 0.35 $ 1.11 $ 0.85
Diluted 0.55 0.34 1.09 0.83
The accompanying notes are an integral part of these statements.
4
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
Six Months Ended
June 30,
----------------------------------
(in thousands) 2005 2004
-------------- ---------------
OPERATING ACTIVITIES:
Net income $ 36,546 $ 23,375
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 12,766 15,454
Provision for loan losses 3,797 3,922
Provision for deferred income tax (benefit) 255 (3,771)
Net losses 70 7,061
Originated loans held for sale (32,963) (35,229)
Proceeds from sales of loans held for sale 34,167 34,025
Net decrease (increase) in accrued interest receivable and other assets 4,190 (2,815)
Net increase (decrease) in accrued expenses and other liabilities (4,641) 94
-------------- ---------------
Total adjustments 17,641 18,741
-------------- ---------------
Net cash provided by operating activities 54,187 42,116
-------------- ---------------
INVESTING ACTIVITIES:
Principal collections and maturities of securities available for sale 173,995 253,864
Principal collections and maturities of securities held to maturity 1,026 -
Proceeds from sales of securities available for sale 263,383 816,335
Purchases of securities available for sale (210,694) (623,692)
Loan originations and purchases less principal collections (67,946) (64,811)
Net cash received from business acquisition - 27,872
Purchases of premises and equipment (6,477) (7,146)
-------------- ---------------
Net cash provided by investing activities 153,287 402,422
-------------- ---------------
FINANCING ACTIVITIES:
Net increase in deposits 256,082 28,713
Net decrease in short-term borrowings (240,652) (352,293)
Proceeds from long-term debt 30,000 99,987
Payments and maturities of long-term debt (203,853) (152,583)
Proceeds from issuance of stock 3,727 5,234
Purchase of treasury stock (13,150) -
Cash dividends paid on common stock (17,490) (14,273)
-------------- ---------------
Net cash used by financing activities (185,336) (385,215)
-------------- ---------------
Increase in cash and cash equivalents 22,138 59,323
Cash and cash equivalents at beginning of period 134,322 128,185
-------------- ---------------
Cash and cash equivalents at end of period $ 156,460 $ 187,508
============== ===============
SUPPLEMENTAL DISCLOSURES:
Interest paid, net of amount credited to deposit accounts $ 35,349 $ 30,405
Income taxes paid 6,100 10,135
Stock issued for acquired company - 251,363
The accompanying notes are an integral part of these statements.
5
PROVIDENT BANKSHARES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
JUNE 30, 2005
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Provident Bankshares Corporation ("the Corporation"), a Maryland corporation, is
the bank holding company for Provident Bank ("the Bank"), a Maryland chartered
stock commercial bank. The Bank serves individuals and businesses through a
network of banking offices and ATMs in Maryland, Virginia, and southern York
County, Pennsylvania. Related financial services are offered through its wholly
owned subsidiaries. Securities brokerage, investment management and related
insurance services are available through Provident Investment Company and leases
through Court Square Leasing and Provident Lease Corporation.
The accounting and reporting policies of the Corporation conform with U.S.
generally accepted accounting principles ("GAAP") and prevailing practices
within the banking industry for interim financial information and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
notes required for complete financial statements and prevailing practices within
the banking industry. The following summary of significant accounting policies
of the Corporation is presented to assist the reader in understanding the
financial and other data presented in this report. Operating results for the
three month period ended June 30, 2005 are not necessarily indicative of the
results that may be expected for any future quarters or for the year ending
December 31, 2005. For further information, refer to the consolidated financial
statements and notes thereto included in the Corporation's Annual Report on Form
10-K for the year ended December 31, 2004 as filed with the Securities and
Exchange Commission ("SEC") on March 16, 2005.
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The unaudited Consolidated Financial Statements include the accounts of the
Corporation and its wholly owned subsidiary, Provident Bank and its
subsidiaries. All significant inter-company accounts and transactions have been
eliminated in consolidation. Results of operations from purchased companies are
included from the date of merger. Assets and liabilities of purchased companies
are stated at estimated fair values at the date of merger.
Certain prior years' amounts in the unaudited Consolidated Financial Statements
have been reclassified to conform to the presentation used for the current
period. These reclassifications have no effect on stockholders' equity or net
income as previously reported.
USE OF ESTIMATES
The Consolidated Financial Statements of the Corporation are prepared in
accordance with GAAP. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities for the reporting periods. Management bases its estimates
on historical experience and various other factors and assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Management evaluates estimates
on an on-going basis, including those related to the allowance for loan losses,
non-accrual loans, other real estate owned, goodwill and intangible assets,
other than temporary impairment of investment securities, pension and
post-retirement benefits, asset prepayment rates, stock-based compensation,
derivative positions, recourse liabilities, litigation and income taxes.
Management believes the following critical accounting policies affect its more
significant judgments and estimates used in preparation of its consolidated
financial statements: allowance for loan losses, other than temporary impairment
of investment securities, goodwill and intangible assets, asset prepayment rates
and income taxes. Each estimate and its financial impact, to the extent
significant to financial results, is discussed in the unaudited Consolidated
Financial Statements. It is at least reasonably possible that each of the
Corporation's estimates could change in the near term or that actual results may
differ from these estimates under different assumptions or conditions, resulting
in a change that could be material to the unaudited Consolidated Financial
Statements.
6
CHANGES IN ACCOUNTING PRINCIPLES
In December 2003, the Accounting Standards Executive Committee ("AcSEC") issued
Statement of Position 03-3, "Accounting for Certain Loans or Debt Securities
Acquired in a Transfer" ("SOP 03-3"). SOP 03-3 is effective for loans acquired
in fiscal years beginning after December 15, 2004. The SOP addresses accounting
for differences between contractual cash flows and cash flows expected to be
collected from an investor's initial investment in loans or debt securities
acquired in a transfer if those differences are attributable, at least in part,
to credit quality. The SOP does not apply to loans originated by the Bank. The
Corporation did not acquire any assets in 2005 that were within the scope of SOP
03-3.
In December 2004, the FASB issued SFAS No. 123R (a revision of SFAS No. 123)
"Accounting for Stock-Based Compensation" ("SFAS No. 123R") effective for
interim and annual periods beginning after June 15, 2005. In April 2005, the SEC
deferred the effective date of the provisions of SFAS No. 123R until the
beginning of the first annual period beginning after June 15, 2005. SFAS No.
123R requires companies to recognize the grant-date fair value of stock options
and other equity-based compensation issued to employees as a cost of employee
services in the Consolidated Statements of Income. The cost will be recognized
over the period during which an employee is required to provide service in
exchange for the award (usually the vesting period). As of the required
effective date, the Corporation intends to use the modified prospective method
as defined in SFAS No. 123R. Under this method, awards that are granted,
modified or settled after the date of adoption should be measured and accounted
for in accordance with SFAS No. 123R. Unvested awards that were granted prior to
the effective date should be valued in accordance with SFAS No. 123R.
Compensation expense must be recognized in the Consolidated Statements of Income
subsequent to the effective date of SFAS No. 123R. Management has evaluated the
potential impact of SFAS No. 123R and determined that it would result in
additional compensation expense of approximately $1.2 million in 2006 for
options granted in 2005.
In May 2005, the FASB issued Statement of Financial Accounting Standard No. 154,
"Accounting Changes and Error Corrections" ("SFAS No. 154"), which is effective
for accounting changes and corrections of errors made in years beginning after
December 15, 2005. SFAS No. 154 provides guidance on the accounting for and
reporting of accounting changes and error corrections. The adoption of SFAS No.
154 will not have any impact on the results of operations of the Corporation.
STOCK-BASED COMPENSATION
The Corporation may grant employees and/or directors stock-based compensation in
the form of stock options or restricted stock priced at the fair market value on
the grant date.
The Corporation recognized pre-tax compensation expense of $324 thousand
relating to restricted stock grants for the six months ended June 30, 2005. The
Corporation uses the intrinsic value method of accounting for stock options
granted to employees and accordingly does not recognize compensation expense for
its stock options in the Consolidated Statements of Income.
The following table illustrates the pro forma effect on net income and earnings
per share if the Corporation had applied the fair value provisions of SFAS No.
123 "Accounting for Stock-Based Compensation" ("SFAS No. 123") to stock-based
compensation for the periods indicated.
7
Six Months Ended
June 30,
---------------------------------
(in thousands, except per share data) 2005 2004
-------------- ---------------
NET INCOME:
Net income as reported $ 36,546 $ 23,375
Addition for total stock-based compensation expense determined
under fair value based method for restricted stock awards, net of tax 211 -
Deduction for total stock-based compensation expense determined
under fair value based method for all awards, net of tax (1,188) (570)
-------------- ---------------
Pro forma net income $ 35,569 $ 22,805
============== ===============
BASIC EARNINGS PER SHARE:
As reported $ 1.11 $ 0.85
Pro forma 1.08 0.83
DILUTED EARNINGS PER SHARE:
As reported $ 1.09 $ 0.83
Pro forma 1.06 0.81
Pro forma amounts may not be representative of future expense since the
estimated fair value of stock options is amortized to expense over the various
vesting periods and additional options may be granted in future periods.
The weighted average fair value of all of the options granted during the periods
indicated have been estimated using the Black-Scholes option-pricing model with
the following assumptions:
Six Months Ended
June 30,
---------------------------------
2005 2004
-------------- ---------------
Dividend yield 3.49% 3.33%
Weighted average risk-free interest rate 4.29% 3.20%
Weighted average expected volatility 23.58% 25.86%
Weighted average expected life in years 5.50 7.00
Beginning in 2006, under SFAS No. 123R the Corporation will be required to
recognize compensation expense related to stock options as they vest, which will
reduce net income. Effective April 1, 2005, the Board of Directors approved the
acceleration, by one year, of the vesting of all the currently outstanding
options to purchase 766,575 shares of the Corporation's common stock granted
prior to 2005 including those options held by certain members of senior
management. This effectively reduces the three year vesting period on these
options from three to two years. Stock options granted in 2005 have an eight
year life and vest over a four year period. The acceleration of the vesting will
result in an aggregate compensation expense of $135,000 over the modified
vesting periods (i.e. 2006). The amount that would have been expensed for the
unvested options granted prior to 2005 had the Corporation not accelerated the
vesting would have been approximately $600,000 over the original vesting periods
(i.e. 2006 and 2007). The other terms of each of the option grants remained
unchanged.
8
NOTE 2--BUSINESS COMBINATION
On April 30, 2004, the Corporation acquired 100 percent of the outstanding
common shares of Southern Financial Bancorp, Inc. ("Southern Financial"),
headquartered in Warrenton, Virginia, which was the holding company for Southern
Financial Bank. Southern Financial had previously completed the acquisition of
Essex Bancorp, Inc., based in Norfolk, Virginia. Southern Financial operated 33
banking offices in the northern Virginia counties of Fairfax, Loudoun and Prince
William; as well as Richmond, Charlottesville and the Tidewater areas.
Southern Financial was merged with and into the Corporation. Southern Financial
shareholders received 1.0875 shares of the Corporation's common stock and
$11.125 in cash for each Southern Financial share outstanding. As a result,
Southern Financial's shareholders received 8.2 million shares of the
Corporation's common stock amounting to $251.3 million and $83.8 million in
cash, for an aggregate purchase price of $335.1 million. The value of the shares
issued was based on the average market closing price of the Corporation's common
stock from October 29, 2003 through November 6, 2003.
The following table summarizes the fair values of the assets acquired and
liabilities assumed of Southern Financial at the merger date. Adjustments to the
initial allocation of the purchase price were due to final settlement of asset
dispositions, evaluation of tax matters and receipt of other information
relating to the valuation of contingencies.
April 30,
(in thousands) 2004
----------------
ASSETS:
Cash $ 47,142
Short-term investments 64,544
Investment securities 565,014
Net loans 664,489
Other assets 71,836
Goodwill 248,513
Deposit-based intangible 12,829
----------------
Total assets acquired $ 1,674,367
================
LIABILITIES:
Deposits $ 1,022,271
Borrowings 300,308
Other liabilities 16,698
----------------
Total liabilities assumed $ 1,339,277
================
Net assets acquired $ 335,090
================
The merger with Southern Financial resulted in the recognition of $261.3 million
of intangible assets, of which $12.8 million was allocated to a deposit-based
intangible. The remaining intangible was allocated to goodwill.
The results of operations from Southern Financial have been included in the
Consolidated Financial Statements since the date of merger.
9
NOTE 3--INVESTMENT SECURITIES
The following table presents the aggregate amortized cost and fair values of the
investment securities portfolio as of the dates indicated:
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gains Losses Value
-------------- ------------- ------------- --------------
JUNE 30, 2005
Securities available for sale:
U.S. Treasury and government agencies and corporations $ 85,544 $ - $ 886 $ 84,658
Mortgage-backed securities 1,303,419 6,059 10,804 1,298,674
Municipal securities 12,555 264 - 12,819
Other debt securities 547,645 2,200 371 549,474
-------------- ------------- ------------- --------------
Total securities available for sale 1,949,163 8,523 12,061 1,945,625
-------------- ------------- ------------- --------------
Securities held to maturity:
Other debt securities 112,449 360 733 112,076
-------------- ------------- ------------- --------------
Total securities held to maturity 112,449 360 733 112,076
-------------- ------------- ------------- --------------
Total investment securities $ 2,061,612 $ 8,883 $ 12,794 $ 2,057,701
============== ============= ============= ==============
DECEMBER 31, 2004
Securities available for sale:
U.S. Treasury and government agencies and corporations $ 118,018 $ - $ 3,637 $ 114,381
Mortgage-backed securities 1,647,047 10,754 11,523 1,646,278
Municipal securities 13,608 434 - 14,042
Other debt securities 411,169 1,020 495 411,694
-------------- ------------- ------------- --------------
Total securities available for sale 2,189,842 12,208 15,655 2,186,395
-------------- ------------- ------------- --------------
Securities held to maturity:
Other debt securities 114,671 482 686 114,467
-------------- ------------- ------------- --------------
Total securities held to maturity 114,671 482 686 114,467
-------------- ------------- ------------- --------------
Total investment securities $ 2,304,513 $ 12,690 $ 16,341 $ 2,300,862
============== ============= ============= ==============
JUNE 30, 2004
Securities available for sale:
U.S. Treasury and government agencies and corporations $ 104,631 $ - $ 6,362 $ 98,269
Mortgage-backed securities 1,683,036 4,649 27,413 1,660,272
Municipal securities 16,416 587 - 17,003
Other debt securities 392,822 8,071 476 400,417
-------------- ------------- ------------- --------------
Total securities available for sale $ 2,196,905 $ 13,307 $ 34,251 $ 2,175,961
============== ============= ============= ==============
At June 30, 2005, a net unrealized after-tax loss of $1.5 million on the
securities portfolio was reflected in net accumulated other comprehensive loss.
This compared to a net unrealized after-tax loss of $13.6 million and a net
unrealized after-tax gain of $2.2 million at June 30, 2004 and December 31,
2004, respectively.
During the third quarter of 2004, the Corporation transferred $108 million in
securities available for sale to securities held to maturity. The unrealized
gains of $7.4 million associated with these securities included in net
accumulated other comprehensive loss at the date of transfer will continue to be
reflected in stockholders' equity and be reflected as a premium. Both the
premium and the amount reflected in net accumulated other comprehensive loss are
amortized over the remaining life of the transferred securities. The
amortization is determined using the interest method and results in equal and
offsetting amounts being recorded in interest income, resulting in no impact to
net income.
10
Management reviews the investment portfolio on a periodic basis to determine the
cause of declines in the fair value of each security. Thorough evaluations of
the causes of the unrealized losses are performed to determine whether the
impairment is temporary or other than temporary in nature. Considerations such
as recoverability of invested amount over a reasonable period of time, the
length of time the security is in a loss position and receipt of amounts
contractually due, for example, are applied in determining other than temporary
impairment. At June 30, 2005, the unrealized losses contained within the
Corporation's investment portfolio were considered temporary because the
declines in fair value were due to changes in market interest rates, not in
estimated cash flows of the underlying debt securities.
For further details regarding investment securities at December 31, 2004, refer
to Notes 1 and 4 of the Consolidated Financial Statements in the Corporation's
Form 10-K as of and for the year ended December 31, 2004.
NOTE 4--LOANS
A summary of loans outstanding as of the dates indicated is shown in the table
below.
June 30, December 31, June 30,
(in thousands) 2005 2004 2004
--------------- -------------- ---------------
Residential real estate:
Originated residential mortgage $ 81,345 $ 100,909 $ 123,216
Home equity 798,461 705,126 604,096
Acquired residential 489,506 560,040 625,857
Other consumer:
Marine 426,155 436,262 445,833
Other 33,677 42,121 51,595
--------------- -------------- ---------------
Total consumer 1,829,144 1,844,458 1,850,597
--------------- -------------- ---------------
Commercial real estate:
Commercial mortgage 491,768 483,636 492,856
Residential construction 320,918 242,246 217,138
Commercial construction 310,511 279,347 281,044
Commercial business 671,450 710,193 677,884
--------------- -------------- ---------------
Total commercial 1,794,647 1,715,422 1,668,922
--------------- -------------- ---------------
Total loans $ 3,623,791 $ 3,559,880 $ 3,519,519
=============== ============== ===============
11
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
The following table reflects the activity in the allowance for loan losses for
the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------- --------------------------------
(in thousands) 2005 2004 2005 2004
-------------- --------------- -------------- ---------------
Balance at beginning of period $ 45,639 $ 36,126 $ 46,169 $ 35,539
Provision for loan losses 2,222 1,530 3,797 3,922
Allowance of acquired bank - 12,085 - 12,085
Less loans charged-off, net of recoveries:
Originated residential mortgage and home equity 71 29 83 38
Acquired residential 55 1,234 683 2,470
Marine and other consumer 262 234 252 487
Commercial mortgage - 207 - 207
Commercial construction (67) - (67) -
Commercial business 957 350 2,432 657
-------------- --------------- -------------- ---------------
Net charge-offs 1,278 2,054 3,383 3,859
-------------- --------------- -------------- ---------------
Balance at end of period $ 46,583 $ 47,687 $ 46,583 $ 47,687
============== =============== ============== ===============
NOTE 6--INTANGIBLE ASSETS
The table below presents an analysis of the goodwill and deposit-based
intangible activity for the six months ended June 30, 2005.
Accumulated Net
(in thousands) Goodwill Amortization Goodwill
---------------- --------------- ----------------
Balance at December 31, 2004 $ 256,863 $ (622) $ 256,241
Adjustment of intangible related to 2004
merger with Southern Financial Bancorp (51) - (51)
---------------- --------------- ----------------
Balance at June 30, 2005 $ 256,812 $ (622) $ 256,190
================ =============== ================
Deposit-based Accumulated
(in thousands) Intangible Amortization Total
---------------- --------------- ----------------
Balance at December 31, 2004 $ 15,429 $ (2,780) $ 12,649
Amortization expense - (964) (964)
---------------- --------------- ----------------
Balance at June 30, 2005 $ 15,429 $ (3,744) $ 11,685
================ =============== ================
12
NOTE 7--DEPOSITS
The table below presents a summary of deposits as of the dates indicated:
June 30, December 31, June 30,
(in thousands) 2005 2004 2004
------------- ------------- -------------
Interest-bearing deposits:
Interest-bearing demand $ 587,796 $ 531,622 $ 514,461
Money market 601,836 525,744 660,307
Savings 750,991 743,937 772,564
Direct time certificates of deposit 795,478 812,904 902,942
Brokered certificates of deposit 370,306 355,876 356,132
------------- ------------- -------------
Total interest-bearing deposits 3,106,407 2,970,083 3,206,406
Noninterest-bearing deposits 931,421 811,917 924,096
------------- ------------- -------------
Total deposits $ 4,037,828 $ 3,782,000 $ 4,130,502
============= ============= =============
NOTE 8--SHORT-TERM BORROWINGS
The table below presents a summary of short-term borrowings as of the dates
indicated:
June 30, December 31, June 30,
(in thousands) 2005 2004 2004
------------- ------------ -------------
Securities sold under repurchase agreements $ 355,065 $ 396,263 $ 264,704
Federal funds purchased 180,000 329,500 245,000
Federal Home Loan Bank advances - variable rate 140,000 190,000 -
Other short-term borrowings 2,176 2,130 2,092
------------- ------------ -------------
Total short-term borrowings $ 677,241 $ 917,893 $ 511,796
============= ============ =============
NOTE 9--LONG-TERM DEBT
The table below presents a summary of long-term debt as of the dates indicated:
June 30, December 31, June 30,
(in thousands) 2005 2004 2004
-------------- -------------- --------------
Federal Home Loan Bank advances - fixed rate $ 163,117 $ 169,833 $ 171,105
Federal Home Loan Bank advances - variable rate 715,000 834,555 780,699
Trust preferred securities 141,892 173,035 172,393
Term repurchase agreements 11,875 28,125 44,375
-------------- -------------- --------------
Total long-term debt $ 1,031,884 $ 1,205,548 $ 1,168,572
============== ============== ==============
On March 31, 2005, the Corporation redeemed $30.0 million in aggregate principal
amount of 10% trust preferred securities of Provident Trust II. The trust
preferred securities had a final stated maturity of March 31, 2030, but were
callable at par beginning on March 31, 2005. On July 15, 2005, the Corporation
redeemed $5.0 million in aggregate principal amount of 11% trust preferred
securities of Southern Trust I. The securities were callable beginning July 15,
2005.
13
NOTE 10--DERIVATIVE FINANCIAL INSTRUMENTS
Fair value hedges that meet the criteria for effectiveness have changes in the
fair value of the derivative and the designated hedged item recognized in
earnings. At and during all periods presented, the derivatives designated as
fair value hedges were determined to be effective. Accordingly, the designated
hedges and the associated hedged items were marked to fair value by an equal and
offsetting amount of $3.3 million and $6.3 million for the six months ended June
30, 2005 and 2004, respectively. Cash flow hedges have the effective portion of
changes in the fair value of the derivative recorded in accumulated other
comprehensive loss. At June 30, 2005 and 2004, the Corporation recorded a
cumulative decline in the fair value of derivatives of $1.6 million and $561
thousand, respectively, net of taxes, in accumulated other comprehensive loss to
reflect the effective portion of cash flow hedges. Amounts recorded in
accumulated other comprehensive loss are recognized into earnings concurrent
with the impact of the hedged item on earnings. For the six months ended June
30, 2005 and 2004, the Corporation had no ineffective hedges.
The table below presents the Corporation's open derivative positions as of the
dates indicated:
(in thousands) Notional Credit Risk Market
Derivative Type Hedge Objective Amount Amount Risk
- ------------------------------ ------------------------- --------------- --------------- --------------
JUNE 30, 2005
Interest rate swaps:
Pay fixed/receive variable Borrowing cost $ 155,000 $ 1,638 $ 1,067
Pay fixed/receive variable Loan rate risk 30,044 363 (198)
Receive fixed/pay variable Borrowing cost 426,400 5,814 3,458
Interest rate caps/corridors Borrowing cost 300,000 1,490 1,490
--------------- --------------- --------------
$ 911,444 $ 9,305 $ 5,817
=============== =============== ==============
DECEMBER 31, 2004
Interest rate swaps:
Pay fixed/receive variable Borrowing cost $ 245,000 $ 1,527 $ 1,527
Pay fixed/receive variable Loan rate risk 59,776 - (167)
Receive fixed/pay variable Borrowing cost 357,500 5,506 3,655
Interest rate caps/corridors Borrowing cost 300,000 2,778 2,778
--------------- --------------- --------------
$ 962,276 $ 9,811 $ 7,793
=============== =============== ==============
JUNE 30, 2004
Interest rate swaps:
Pay fixed/receive variable Borrowing cost $ 350,000 $ 1,922 $ 1,922
Pay fixed/receive variable Loan rate risk 66,132 1,086 1,086
Receive fixed/pay variable Borrowing cost 287,500 5,411 1,792
Interest rate caps/corridors Borrowing cost 300,000 5,955 5,955
--------------- --------------- --------------
$ 1,003,632 $ 14,374 $ 10,755
=============== =============== ==============
14
NOTE 11--OFF BALANCE SHEET RISK
Commitments to extend credit in the form of consumer, commercial real estate and
business loans at the date indicated were as follows:
June 30,
(in thousands) 2005
--------------
Commercial business and real estate $ 828,732
Consumer revolving credit 610,612
Residential mortgage credit 17,624
Performance standby letters of credit 97,576
Commercial letters of credit 315
--------------
Total loan commitments $ 1,554,859
==============
Historically, many of the commitments expire without being fully drawn;
therefore, the total commitment amounts do not necessarily represent future cash
requirements.
NOTE 12--NET GAINS (LOSSES)
Net gains (losses) include the following components for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ -------------------------------
(in thousands) 2005 2004 2005 2004
------------- ------------- ------------- --------------
Net gains (losses):
Securities sales $ 659 $ (7,660) $ (217) $ (6,706)
Asset sales 47 (217) 198 (355)
Debt extinguishment - - (51) -
------------- ------------- ------------- --------------
Net gains (losses) $ 706 $ (7,877) $ (70) $ (7,061)
============= ============= ============= ==============
NOTE 13--EARNINGS PER SHARE
The following table presents a summary of per share data and amounts for the
periods indicated.
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
(in thousands, except per share data) 2005 2004 2005 2004
------------- ------------- ------------- -------------
Net income $ 18,438 $ 10,500 $ 36,546 $ 23,375
Basic EPS shares 32,939 30,264 32,984 27,466
Basic EPS $ 0.56 $ 0.35 $ 1.11 $ 0.85
Dilutive shares 586 549 632 620
Diluted EPS shares 33,525 30,813 33,616 28,086
Diluted EPS $ 0.55 $ 0.34 $ 1.09 $ 0.83
Antidilutive shares 863 453 434 451
15
NOTE 14--COMPREHENSIVE INCOME (LOSS)
Presented below is a reconciliation of net income to comprehensive income (loss)
including the components of other comprehensive income (loss) for the periods
indicated:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
(in thousands) 2005 2004 2005 2004
-------------- -------------- -------------- -------------
Net income $ 18,438 $ 10,500 $ 36,546 $ 23,375
Other comprehensive income (loss):
Net unrealized gains (losses) on derivatives (2,398) 11,951 256 4,608
Net unrealized holding gains (losses) on debt securities 18,380 (44,431) (1,181) (22,984)
Less reclassification adjustment for gains (losses)
realized in net income 641 (7,660) (116) (6,706)
-------------- -------------- -------------- -------------
Other comprehensive income (loss) before tax 15,341 (24,820) (809) (11,670)
Related income tax expense (benefit) 5,370 (8,685) (283) (4,084)
-------------- -------------- -------------- -------------
Other comprehensive income (loss) after tax 9,971 (16,135) (526) (7,586)
-------------- -------------- -------------- -------------
Comprehensive income (loss) $ 28,409 $ (5,635) $ 36,020 $ 15,789
============== ============== ============== =============
NOTE 15--EMPLOYEE BENEFIT PLANS
The actuarially estimated net benefit cost includes the following components for the periods indicated:
Qualified Non-qualified
Pension Plan Postretirement Benefits Pension Plan
---------------------------- -------------------------- -------------------------
Three Months Ended Three Months Ended Three Months Ended
June 30, June 30, June 30,
---------------------------- -------------------------- -------------------------
(in thousands) 2005 2004 2005 2004 2005 2004
------------ ------------- ------------ ------------ ------------- ----------
Service cost - benefits earned during the period $ 271 $ 292 $ 11 $ 26 $ 89 $ 37
Interest cost on projected benefit obligation 346 372 7 18 249 105
Expected return on plan assets (398) (428) - - - -
Net amortization and deferral of loss 44 48 3 8 105 45
------------ ------------- ------------ ------------ ------------- ----------
Net pension cost included in employee
benefits expense $ 263 $ 284 $ 21 $ 52 $ 443 $ 187
============ ============= ============ ============ ============= ==========
Qualified Non-qualified
Pension Plan Postretirement Benefits Pension Plan
---------------------------- -------------------------- -------------------------
Six Months Ended Six Months Ended Six Months Ended
June 30, June 30, June 30,
---------------------------- -------------------------- -------------------------
(in thousands) 2005 2004 2005 2004 2005 2004
------------ ------------- ------------ ------------ ------------- ----------
Service cost - benefits earned during the period $ 575 $ 585 $ 50 $ 52 $ 164 $ 70
Interest cost on projected benefit obligation 733 746 34 36 458 196
Expected return on plan assets (843) (858) - - - -
Net amortization and deferral of loss 94 96 16 17 193 83
------------ ------------- ------------ ------------ ------------- ----------
Subtotal 559 569 100 105 815 349
Reversal of liability - - (1,641) - - -
------------ ------------- ------------ ------------ ------------- ----------
Net pension cost included in employee
benefits expense $ 559 $ 569 $ (1,541) $ 105 $ 815 $ 349
============ ============= ============ ============ ============= ==========
On March 31, 2005, the Corporation announced that the pension plan will be
frozen for new entrants. Employees who are already participants in the plan will
not be affected by this change. Also on March 31, 2005, the Corporation
communicated to retirees currently receiving postretirement benefits that these
benefits will be eliminated and no longer offered, effective January 1, 2006.
This action resulted in the reversal of the actuarially determined liability of
$1.6 million at March 31, 2005.
No contributions were made to the qualified pension plan in the six months ended
June 30, 2005. For the six months ended June 30, 2004 the Corporation
contributed $5.0 million to the qualified pension plan. The minimum required
16
contribution in 2005 for the qualified plan is estimated to be zero. At June 30,
2005, the maximum deductible contribution under the Internal Revenue Code was
$4.9 million. The decision to contribute the maximum amount is dependent on
other factors including the actual investment performance of plan assets. Given
these uncertainties, the Corporation is not able to reliably estimate the
maximum deductible contribution or the amount that will be contributed in 2005
to the qualified plan. For the unfunded non-qualified pension and postretirement
benefit plans, the Corporation will contribute the minimum required amount in
2005, which is equal to the benefits paid under the plans.
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 June 30, 2005, the Bank was the second
largest independent commercial bank, in asset size, headquartered in Maryland,
with $6.4 billion in assets. Provident is a regional bank serving Maryland and
Virginia, with emphasis on the key urban centers within these states - the
Baltimore, Washington, 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 Bank offers consumer and commercial banking products and
services through the Consumer and Commercial Banking groups. Provident also
offers related financial services through wholly owned subsidiaries. Securities
brokerage, investment management and related insurance services are available
through Provident Investment Company ("PIC") and leases through Court Square
Leasing and Provident Lease Corporation.
Provident's key business strategies provide it with a unique opportunity in its
marketplace. An overview of these strategies are discussed below:
o MAXIMIZE PROVIDENT'S POSITION AS THE RIGHT SIZE BANK IN THE
MARKETPLACE. Provident's position as the second largest bank headquartered
in Maryland provides a unique opportunity as the "right size" bank in its
footprint. The Bank provides the service of a community bank combined with
the convenience and wide array of products and services that a strong
regional bank offers. In addition, the 62 in-store banking offices
throughout its footprint reinforce its right size strategy through
convenient hours and full product service. Provident currently has 152
banking offices concentrated in the Baltimore-Washington, D.C. corridor and
beyond to Richmond, Virginia. Of the 152 banking offices, 45% are located
in the Baltimore metropolitan region and 55% are located in the metro
Washington, D.C. and Virginia regions, reflecting the successful
development of the Bank into a highly competitive regional commercial bank.
Provident also offers its customers 24-hour banking services through ATMs,
telephone banking and the Internet. The network of 244 ATMs enhances the
banking office network by providing customers increased opportunities to
access their funds.
o GROW AND DEEPEN CONSUMER AND SMALL BUSINESS RELATIONSHIPS IN MARYLAND
AND VIRGINIA. Consumer banking continues to be an important component of
the Bank's business strategy. Consumer banking services include a broad
array of consumer and small business loan, lease, deposit and investment
products offered to consumer and commercial customers through Provident's
banking office network and ProvidentDirect, the Bank's direct channel sales
center. The small business segment is further supported by relationship
managers who provide comprehensive business product and sales support to
expand existing customer relationships and acquire new clients.
o GROW AND DEEPEN COMMERCIAL AND REAL ESTATE RELATIONSHIPS IN MARYLAND AND
VIRGINIA. Commercial banking is the other key component to the
Corporation's regional presence in its market area. The Commercial Banking
group provides customized banking solutions to middle market commercial and
real estate customers. The Bank has an experienced team of loan officers
with expertise in real estate and business lending to companies in various
industries in the region. It also has a suite of cash management products
managed by responsive account teams that deepen customer relationships
through consistently priced deposit based services, responsive service and
maintenance of frequent personal contact with each customer.
17
o MOVE FROM A PRODUCT DRIVEN ORGANIZATION TO A CUSTOMER RELATIONSHIP
FOCUSED SALES CULTURE. The Corporation's transition to a customer
relationship driven sales culture requires deepening relationships through
cross-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 strategy 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 strong regional bank
offers.
o CREATE A HIGH PERFORMANCE CULTURE THAT FOCUSES ON EMPLOYEE DEVELOPMENT
AND RETENTION. Provident has always placed a high priority on its
employees and has approached employee development and training with
renewed emphasis. Employee development is viewed as a critical part of
executing Provident's strategy as the right size bank and transforming the
Company's sales culture with a focus on the employee's development and
approach with Provident's customers.
FINANCIAL REVIEW
The principal objective of this Financial Review is to provide an overview of
the financial condition and results of operations of Provident Bankshares
Corporation and its subsidiaries for the periods indicated. This discussion and
tabular presentations should be read in conjunction with the accompanying
unaudited Consolidated Financial Statements and Notes as well as the other
information herein.
Discussion and analysis of the financial condition and results of operations are
based on the consolidated financial statements of the Corporation, which are
prepared in accordance with U.S. generally accepted accounting principles
("GAAP"). The preparation of these financial statements requires management to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. Management evaluates estimates on an on-going basis, including
those related to the allowance for loan losses, non-accrual loans, asset
prepayment rates, other real estate owned, other than temporary impairment of
investment securities, goodwill and intangible assets, pension and
post-retirement benefits, stock-based compensation, derivative positions,
recourse liabilities, litigation and income taxes. Management bases its
estimates on historical experience and various other factors and assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
Management believes the following critical accounting policies affect its more
significant judgments and estimates used in preparation of its consolidated
financial statements: allowance for loan losses, other than temporary impairment
of investment securities, goodwill and intangible assets, asset prepayment rates
and income taxes. Each estimate and its financial impact, to the extent
significant to financial results, is discussed in the applicable sections of
Management's Discussion and Analysis. It is at least reasonably possible that
each of the Corporation's estimates could change in the near term and the effect
of the change could be material to the unaudited Consolidated Financial
Statements.
FINANCIAL CONDITION
The financial condition of the Corporation reflects the continued balance sheet
transition towards growing loans and deposits in the Bank's core business
segments. The expanded market, as a direct result of the merger, has augmented
the number of banking relationship opportunities in the Corporation's key
markets of Baltimore, Washington, D.C. and Richmond. The expansion led to
increases in average loans and deposits of 9% and 3%, respectively, over the
second quarter of 2004. At June 30, 2005, total assets were $6.4 billion as
compared to $6.6 billion at December 31, 2004. The basis for financial
comparison includes the impact of the Southern Financial merger for two months
of the second quarter of 2004 and the entire second quarter of 2005.
18
LENDING
Total average loan balances increased to $3.6 billion in second quarter 2005, an
increase of $282 million, or 9%, from second quarter 2004 ("prior year
quarter"). The following table summarizes the composition of the Bank's average
loans for the periods indicated.
Three Months Ended
June 30,
------------------------------- $ %
(dollars in thousands) 2005 2004 Variance Variance
-------------- ------------- -------------- -------------
Residential real estate:
Originated residential mortgage $ 88,228 $ 108,155 $ (19,927) (18.4) %
Home equity 772,541 572,716 199,825 34.9
Acquired residential 515,747 625,145 (109,398) (17.5)
Other consumer:
Marine 427,921 450,148 (22,227) (4.9)
Other 34,847 49,193 (14,346) (29.2)
-------------- ------------- --------------
Total consumer 1,839,284 1,805,357 33,927 1.9
-------------- ------------- --------------
Commercial real estate:
Commercial mortgage 478,535 429,279 49,256 11.5
Residential construction 287,238 204,964 82,274 40.1
Commercial construction 293,357 259,088 34,269 13.2
Commercial business 676,863 594,828 82,035 13.8
-------------- ------------- --------------
Total commercial 1,735,993 1,488,159 247,834 16.7
-------------- ------------- --------------
Total loans $ 3,575,277 $ 3,293,516 $ 281,761 8.6
============== ============= ==============
The 9% increase in average loans was driven by an increase of $200 million in
average home equity loans that more than offset planned reductions in acquired
residential and marine loans of $109 million and $22 million, respectively, and
reductions in originated residential mortgage and other consumer loans of $20
million and $14 million, respectively. The home equity loan suite of products
has been a key component of the Bank's strategy to deepen its consumer
relationships. This sales focus resulted in the $200 million, or 35%, increase
in home equity average balances, continuing the growth of $185 million, or 48%,
that occurred in second quarter 2004. Commercial banking is the other key
component to the Corporation's regional presence in its market area. Average
commercial business and real estate loans increased 14% and 19%, respectively,
compared to the 2004 quarter. All of the real estate categories, including
commercial mortgage loans and commercial and residential construction loans,
posted increases during the quarter, reflecting strong regional demand. The
increase in the commercial loan portfolios over the 2004 second quarter also
reflects the benefits derived from Southern Financial's focus on commercial
banking in Virginia. The result is a balanced mix of revenue sources between the
two business segments with $1.8 billion, or 51%, in consumer loans, and $1.7
billion, or 49%, in commercial loans. Geographically, average loan balances of
$1.3 billion originated in the Washington, D.C. and Richmond metropolitan
regions represented 36% of total average loans in second quarter 2005.
19
ASSET QUALITY
The following table presents information with respect to non-performing assets and 90-day delinquencies as of the dates
indicated.
June 30, December 31,
(dollars in thousands) 2005 2004
--------------- --------------
NON-PERFORMING ASSETS:
Originated residential mortgage $ 709 $ 1,934
Home equity 105 103
Acquired residential 8,449 8,393
Other consumer 146 147
Commercial mortgage 1,598 1,612
Commercial real estate construction - 1,063
Commercial business 11,525 12,461
--------------- --------------
Total non-accrual loans 22,532 25,713
Total renegotiated loans - -
--------------- --------------
Total non-performing loans 22,532 25,713
Total other assets and real estate owned 1,676 1,616
--------------- --------------
Total non-performing assets $ 24,208 $ 27,329
=============== ==============
90-DAY DELINQUENCIES:
Originated residential mortgage $ 2,557 $ 5,442
Home equity 365 126
Acquired residential 2,121 3,655
Other consumer 738 1,108
Commercial business 1,288 1,883
--------------- --------------
Total 90-day delinquencies $ 7,069 $ 12,214
=============== ==============
ASSET QUALITY RATIOS:
Non-performing loans to loans 0.62% 0.72%
Non-performing assets to loans 0.67% 0.77%
Allowance for loan losses to loans 1.29% 1.30%
Net charge-offs in quarter to average loans 0.14% 0.28%
Allowance for loan losses to non-performing loans 206.74% 179.56%
Credit conditions in second quarter 2005 reflect continuation of the asset
quality within the Corporation's loan portfolios. Non-performing assets were
$24.2 million at June 30, 2005, a decline of $3.1 million from the level at
December 31, 2004. The decline in non-performing assets was due to the
resolution of non-performing commercial business, commercial real estate
construction and originated residential loans during the quarter. Non-performing
commercial business loans include $1.2 million of loans that have U.S.
government guarantees.
The level of non-performing assets to total loans was 0.67% at June 30, 2005
compared to 0.77% at December 31, 2004. The level of 90-day delinquent loans
also declined during the quarter, decreasing $5.1 million, or 42%, to $7.1
million from the level at December 31, 2004. No assurance can be given regarding
the level of non-performing assets in the future.
The Corporation maintains an allowance for loan losses ("the allowance"), which
is intended to be management's best estimate of probable inherent losses in the
outstanding loan portfolio. The allowance is reduced by actual credit losses and
is increased by the provision for loan losses and recoveries of previous losses.
The provisions for loan losses are charges to earnings to bring the total
allowance to a level considered necessary by management.
20
The allowance is based on management's continuing review and evaluation of the
loan portfolio. This process provides an allowance consisting of two components,
allocated and unallocated. To arrive at the allocated component of the
allowance, the Corporation combines estimates of the allowances needed for loans
analyzed individually and on a pooled basis. The allocated component of the
allowance is supplemented by an unallocated component.
The portion of the allowance that is allocated to individual internally
criticized and non-accrual loans is determined by estimating the inherent loss
on each problem credit after giving consideration to the value of underlying
collateral. Management emphasizes loan quality and close monitoring of potential
problem credits. Credit risk identification and review processes are utilized in
order to assess and monitor the degree of risk in the loan portfolio. The
Corporation's lending and credit administration staff are charged with reviewing
the loan portfolio and identifying changes in the economy or in a borrower's
circumstances which may affect the ability to repay debt or the value of pledged
collateral. A loan classification and review system exists that identifies those
loans with a higher than normal risk of uncollectibility. Each commercial loan
is assigned a grade based upon an assessment of the borrower's financial
capacity to service the debt and the presence and value of collateral for the
loan.
In addition to being used to categorize risk, the Bank's internal ten-point risk
rating system is used to determine the allocated allowance for the commercial
portfolio. Reserve factors, based on the actual loss history for a 5-year period
for criticized loans, are assigned. If the factor, based on loss history for
classified credits is lower than the minimum established factor, the higher
factor is applied. For 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 unallocated component of the allowance exists 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 Board of Directors. Such reviews also assist management in
establishing the level of the allowance.
Management believes that it uses the best information available to make
determinations about the allowance and that it has established its existing
allowance in accordance with GAAP. If circumstances differ substantially from
the assumptions used in making determinations, adjustments to the allowance may
be necessary and results of operations could be affected. Because events
affecting borrowers and collateral cannot be predicted with certainty, there can
be no assurance that increases to the allowance will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed above.
21
The FDIC examines the Bank periodically and, accordingly, as part of this exam,
the allowance is reviewed for adequacy utilizing specific guidelines. Based upon
their review, the regulators may from time to time require reserves in addition
to those previously provided.
At June 30, 2005, the allowance was $46.6 million, or 1.29% as a percentage of
total loans outstanding, compared to an allowance at December 31, 2004 of $46.2
million, or 1.30% as a percentage of total loans outstanding. The allowance
coverage increased to 207% of non-performing loans at June 30, 2005 compared to
180% at December 31, 2004. Portfolio-wide net charge-offs represented 0.14% of
average loans in second quarter 2005, an improvement from 0.25% in second
quarter 2004 and 0.24% in first quarter 2005. Net charge-offs for the quarter
were favorably impacted by a single commercial recovery of approximately $600
thousand. Exclusive of this recovery, net charge-offs were 0.21% of average
loans, which remains consistent with historical levels.
DEPOSITS
The following table summarizes the composition of the Corporation's average deposit balances for the periods indicated.
Three Months Ended
June 30,
------------------------------ $ %
(dollars in thousands) 2005 2004 Variance Variance
-------------- ------------- ------------- ------------
Transaction accounts:
Noninterest-bearing $ 817,408 $ 752,198 $ 65,210 8.7 %
Interest-bearing 578,274 504,110 74,164 14.7
Savings/money market:
Savings 760,314 771,270 (10,956) (1.4)
Money market 596,023 600,844 (4,821) (0.8)
Certificates of deposit:
Direct 788,218 852,525 (64,307) (7.5)
Brokered 391,977 338,392 53,585 15.8
-------------- ------------- -------------
Total deposits $ 3,932,214 $ 3,819,339 $ 112,875 3.0
============== ============= =============
Deposits by source:
Consumer $ 2,720,895 $ 2,707,743 $ 13,152 0.5
Commercial 819,342 773,204 46,138 6.0
Brokered 391,977 338,392 53,585 15.8
-------------- ------------- -------------
Total deposits $ 3,932,214 $ 3,819,339 $ 112,875 3.0
============== ============= =============
Average deposits increased $113 million, or 3%, in second quarter 2005 over the
same quarter last year. Demand accounts represented the largest increase of $139
million, or 11%, over the prior year's quarter. Average brokered deposits
increased 15.8% over the 2004 second quarter, driven by an increase in callable
brokered deposits acquired in the merger, as well as brokered deposits issued
during the year as a less expensive alternative to borrowing.
Provident's Virginia franchise continues to be a significant component of its
business focus. For the quarter, average deposits in the Washington metropolitan
and Virginia markets represented 38% of customer deposits. The 30 banking
offices added from the Southern Financial merger facilitated the growth in the
Washington, D.C. metropolitan area franchise to 84 banking offices, or 55% of
total banking offices.
Total average consumer deposits remained flat in second quarter 2005 over second
quarter 2004. Average consumer demand account balances increased 8%, from $746
million in the 2004 second quarter, to $814 million in 2005. Average consumer
certificates of deposit decreased 7% and average consumer savings deposits
decreased 2% from the prior year
22
quarter. Commercial deposits increased 6% over the prior year quarter with
average demand account balances representing the areas of growth.
TREASURY ACTIVITIES
The Treasury Division manages the wholesale segments of the balance sheet,
including investments, purchased funds, long-term debt and derivatives.
Management's objective is to achieve the maximum level of stable earnings over
the long term, while controlling the level of interest rate and liquidity risk,
and optimizing capital utilization.
At June 30, 2005, the investment securities portfolio was $2.1 billion, or 32%
of total assets. The Bank's investment portfolio declined $243 million from
December 31, 2004 to June 30, 2005, reflecting management's strategy to
de-emphasize wholesale investments while growing originated loans. The reduction
in balances occurred in the fixed rate mortgage-backed securities portfolio,
which was reduced from $1.6 billion to $1.3 billion during 2005. The portfolio
objective is to obtain the maximum sustainable interest margin over match-funded
borrowings, subject to liquidity, credit and interest rate risk, as well as
capital, regulatory and economic considerations. Typically, management
classifies securities as available for sale to maximize management flexibility,
although securities may be purchased with the intention of holding to maturity.
To achieve its stated objective, the Corporation invests predominately in U.S.
Treasury and Agency securities, mortgage-backed securities ("MBS"), corporate
bonds and asset-backed securities ("ABS"). At June 30, 2005, 63% of the
investment portfolio was invested in MBS. The ABS portfolio, representing 26% of
the total portfolio, consists predominately of Aaa and single A rated tranches
of pooled trust preferred securities. Other debt securities primarily include
investments in single issuer corporate bonds rated investment-grade by Moody's
or S&P, singe or double 'A' rated home equity ABS, and U.S. Treasury, Agency,
and municipal securities.
The primary risk in the investment portfolio is duration risk. Duration measures
the expected change in the market value of an investment for a 100 basis point
(or 1%) change in interest rates. The higher an investment's duration, the
longer the time until its rate is reset to current market rates. The Bank's risk
tolerance, as measured by the duration of the investment portfolio, is typically
between 2% and 3.5%. In the current economic environment, the duration is
targeted for the lower half of that range. Another risk in the investment
portfolio is credit risk. At June 30, 2005, over 74% of the entire investment
portfolio was rated AAA, 25% was investment grade below AAA, and 1% was rated
below investment grade or was not rated. The allocation to floating rate ABS and
corporate bonds was increased to 30%, in anticipation of rising short-term
interest rates.
Investment securities are evaluated periodically to determine whether a decline
in their value is other than temporary. Management utilizes criteria such as the
magnitude and duration of the decline, in addition to the reasons underlying the
decline, to determine whether the loss in value is other than temporary. If a
decline in value is determined to be other than temporary, the value of the
security is reduced and a corresponding charge to earnings is recognized. The
Corporation had a limited number of securities in a continuous loss position for
12 months or more at June 30, 2005. Because the declines in fair value were due
to changes in market interest rates, not in estimated cash flows, no other than
temporary impairment was recorded at June 30, 2005.
Provident's funds management objectives are as follows: to minimize the cost of
borrowings while assuring sufficient funding availability to meet current and
future borrowing requirements, and to contribute to interest rate risk
management goals through match-funding loan and investment activity. Management
utilizes a variety of sources to raise borrowed funds at competitive rates,
including federal funds purchased ("fed funds"), Federal Home Loan Bank ("FHLB")
borrowings, securities sold under repurchase agreements ("repos"), and brokered
and jumbo certificates of deposit ("CDs"). FHLB borrowings and repos typically
are borrowed at rates approximating the LIBOR rate for the equivalent term
because they are secured with investments or high quality real estate loans. Fed
funds, which are generally overnight borrowings, are typically purchased at the
Federal Reserve target rate. Brokered CDs are generally added when market
conditions permit issuance at rates favorable to other funding sources.
23
The Corporation formed wholly owned statutory business trusts in 1998, 2000 and
2003. In 2004, the Corporation acquired three wholly owned statutory business
trusts from Southern Financial as part of the merger. In all cases, the trusts
issued trust preferred securities that were sold to outside third parties. The
trust preferred securities are presented net of unamortized issuance costs as
Long-Term Debt in the Consolidated Statements of Condition and are includable in
Tier 1 capital for regulatory capital purposes, subject to certain limitations.
Any of the trust preferred securities are redeemable at any time in whole, but
not in part, from the date of issuance on the occurrence of certain events. On
March 31, 2005, the Corporation redeemed $30 million aggregate value of capital
securities issued by Provident Trust II at an annual rate of 10%. On July 15,
2005, the Corporation redeemed $5 million aggregate value of capital securities
issued by Southern Capital Trust I at an annual rate of 11%.
Treasury borrowings declined from December 2004 to June 2005, reflecting the
transition of the Bank's balance sheet from wholesale to core funding sources.
Comparing monthly average balances, June 2005 borrowings declined $275 million
from December 2004, from $2.09 billion to $1.82 billion. The reductions in
balance were widespread: short-term borrowings declined $115 million, long-term
borrowings were reduced $135 million, and management redeemed $30 million of
trust preferred securities in the first half of 2005.
LIQUIDITY
An important component of the Bank's asset/liability structure is the level of
liquidity available to meet the needs of customers and creditors. Traditional
sources of bank liquidity include deposit growth, loan repayments, investment
maturities, asset sales, borrowings and interest received. Management believes
the Bank has sufficient liquidity to meet funding needs in the foreseeable
future.
The Bank's primary source of liquidity beyond the traditional sources is the
assets it possesses, which can either be pledged as collateral for secured
borrowings or sold outright. The Bank's primary sources for raising secured
borrowings are the FHLB and securities broker/dealers. At June 30, 2005, $1.4
billion of secured borrowings were employed, with sufficient collateral
available to immediately raise an additional $793 million. An excess liquidity
position of $543 million remains after covering $250 million of unsecured funds
that mature in the next three months. Additionally, over $300 million of assets
are maintained as collateral with the Federal Reserve that is available as a
contingent funding source.
The Bank also has several unsecured funding sources available should the need
arise. At June 30, 2005, the Bank possessed over $900 million of overnight
borrowing capacity, of which $180 million was in use at period-end. The brokered
CD and unsecured debt markets, which generally are more expensive than secured
funds of similar maturity, are also viable funding alternatives. In second
quarter 2005, the Bank did not issue brokered CDs.
As an alternative to raising secured funds, the Bank can raise liquidity through
asset sales. At June 30, 2005, over $500 million of the Bank's investment
portfolio was immediately saleable at a market value equaling or exceeding its
amortized cost basis. Additionally, over a 90-day time frame, a majority of the
Bank's $1.8 billion consumer loan portfolio is saleable in an efficient market.
A significant use of the Corporation's liquidity is the dividends it pays to
shareholders. The Corporation is a one-bank holding company that relies upon the
Bank's performance to generate capital growth through Bank earnings. A portion
of the Bank's earnings is passed to the Corporation in the form of cash
dividends. As a commercial bank under the Maryland Financial Institution Law,
the Bank may declare cash dividends from undivided profits or, with the prior
approval of the Commissioner of Financial Regulation, out of paid-in capital in
excess of 100% of its required capital stock, and after providing for due or
accrued expenses, losses, interest and taxes. These dividends paid to the
holding company are utilized to pay dividends to stockholders, repurchase shares
and pay interest on trust preferred securities. The Corporation and the Bank, in
declaring and paying dividends, are also limited insofar as minimum capital
requirements of regulatory authorities must be maintained. The Corporation and
the Bank comply with such capital requirements. If the Corporation or the Bank
were unable to comply with the minimum capital requirements, it could result in
regulatory actions that could have a material impact on the Corporation.
24
CONTRACTUAL OBLIGATIONS, COMMITMENTS AND OFF BALANCE SHEET ARRANGEMENTS
The Corporation has various contractual obligations, such as long-term
borrowings, that are recorded as liabilities in the Consolidated Financial
Statements. Other items, such as certain minimum lease payments for the use of
banking and operations offices under operating lease agreements, are not
recognized as liabilities in the Consolidated Financial Statements, but are
required to be disclosed. Each of these arrangements affects the Corporation's
determination of sufficient liquidity.
The following table summarizes significant contractual obligations at June 30,
2005 and the future periods in which such obligations are expected to be settled
in cash. In addition, the table reflects the timing of principal payments on
outstanding borrowings.
Contractual Payments Due by Period
---------------------------------------------------------------------------------------
(in thousands) Less
than 1 1-3 4-5 After 5
Year Years Years Years Total
-------------- -------------- -------------- --------------- ----------------
Lease obligations $ 12,880 $ 22,762 $ 19,413 $ 28,038 $ 83,093
Long-term debt 402,790 363,627 110,691 154,776 1,031,884
---------------------------------------------------------------------------------------
Total $ 415,670 $ 386,389 $ 130,104 $ 182,814 $ 1,114,977
=======================================================================================
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 June 30, 2005 were as follows:
June 30,
(in thousands) 2005
--------------
Commercial business and real estate $ 828,732
Consumer revolving credit 610,612
Residential mortgage credit 17,624
Performance standby letters of credit 97,576
Commercial letters of credit 315
--------------
Total loan commitments $ 1,554,859
==============
Historically, many of the commitments expire without being fully drawn;
therefore, the total commitment amounts do not necessarily represent future cash
requirements.
25
RISK MANAGEMENT
The nature of the banking business, which involves paying interest on deposits
at varying rates and terms and charging interest on loans at other rates and
terms, creates interest rate risk. As a result, earnings and the market value of
assets and liabilities are subject to fluctuations, which arise due to changes
in the level and directions of interest rates. Management's objective is to
minimize the fluctuation in the net interest margin caused by changes in
interest rates using cost-effective strategies and tools. The Bank manages
several forms of interest rate risk, including asset/liability mismatch, basis
and prepayment risk.
The Corporation purchases amortizing loan pools and investment securities in
which the underlying assets are residential mortgage loans subject to
prepayments. The actual principal reduction on these assets varies from the
expected contractual principal reduction due to principal prepayments resulting
from borrowers' elections to refinance the underlying mortgages based on market
and other conditions. Prepayment rate projections utilize actual prepayment
speed experience and available market information on like-kind instruments. The
prepayment rates form the basis for income recognition of premiums or discounts
on the related assets. Changes in prepayment estimates may cause the earnings
recognized on these assets to vary over the term that the assets are held,
creating volatility in the net interest margin. Prepayment rate assumptions are
monitored and updated monthly to reflect actual activity and the most recent
market projections. Basis risk exists as a result of having much of the Bank's
earning assets priced using either the Prime rate or the U.S. Treasury yield
curve, while much of the liability portfolio, which finances earning assets, is
priced using the CD yield curve or LIBOR yield curve. These different yield
curves typically do not move in lock-step with one another.
Measuring and managing interest rate risk is a dynamic process that management
performs continually to meet the objective of maintaining a stable net interest
margin. This process relies chiefly on simulation modeling of shocks to the
balance sheet under a variety of interest rate scenarios, including parallel and
non-parallel rate shifts, such as the forward yield curves for both short and
long term interest rates. The results of these shocks are measured in two forms:
first, the impact on the net interest margin and earnings over one and two year
time frames; and second, the impact on the market value of equity. In addition
to measuring the basis risks and prepayment risks noted above, simulations also
quantify the earnings impact of rate changes and the cost / benefit of hedging
strategies.
The following table shows the anticipated effect on net interest income in
parallel shift (up or down) interest rate scenarios. These shifts are assumed to
begin on July 1, 2005 for the June 30, 2005 data and on January 1, 2005 for the
December 31, 2004 data and evenly ramp-up or down over a six-month period. The
effect on net interest income would be for the next twelve months. Given the
interest environment in the periods presented, a 200 basis point drop in rate is
unlikely and has not been shown.
At June 30, 2005 At December 31, 2004
Projected Projected
Percentage Change in Percentage Change in
Interest Rate Scenario Net Interest Income Net Interest Income
--------------------------------- ---------------------------------- ---------------------------------
-100 basis points -4.80% -3.40%
No change -- --
+100 basis points +1.60% +1.40%
+200 basis points +2.20% +1.60%
The isolated modeling environment, assuming no action by management, shows that
the Corporation's net interest income volatility is less than 4.9% under
probable single direction scenarios. The Corporation's one-year forward earnings
are slightly asset sensitive, which will result in net interest income moving in
the same direction as future interest rates. Management pays close attention to
the risk of continued flattening of the yield curve. Short-term interest rates,
such as the Fed Funds rate, have increased approximately 225 basis points over
the past year while long-term rates have declined.
26
Further yield curve flattening may be possible, either through further increases
in short-term rates, further decreases in long-term rates, or both. Management
routinely models several yield curve flattening scenarios as part of its
interest rate risk management function, and believes this risk is minor under
most yield curve flattening scenarios.
Management employs the investment, purchased funds, and derivatives portfolios
in implementing the Bank's interest rate strategy. As noted above, mitigating
yield curve flattening risk has been a significant element of interest rate risk
management. To protect the Bank from rising short-term interest rates, over $600
million of the investment portfolio reprices semiannually or more frequently. In
the purchase funds portfolio, over $300 million of funds reset their rates with
long-term interest rates, such as the 10 year constant maturity swap rate, to
protect net interest margin from falling long-term interest rates. The interest
expense associated with these borrowings declines when long-term interest rates
decline. Additionally, $611 million of interest rates swaps were in force to
reduce interest rate risk, and $300 million of interest rate caps were employed
specifically to protect against rising interest rates.
In addition to managing interest rate risk, which applies to both assets and
liabilities, the Corporation must understand and manage risks specific to
lending. Much of the fundamental lending business of Provident is based upon
understanding, measuring and controlling credit risk. Credit risk entails both
general risks, which are inherent in the process of lending, and risk specific
to individual borrowers. Each consumer and residential lending product has a
generally predictable level of credit loss based on historical loss experience.
Home mortgage and home equity loans and lines generally have the lowest credit
loss experience. Loans with medium credit loss experience are primarily secured
products such as auto and marine loans. Unsecured loan products such as personal
revolving credit have the highest credit loss experience, therefore the Bank has
chosen not to engage in a significant amount of this type of lending. Credit
risk in commercial lending varies significantly, as losses as a percentage of
outstanding loans can shift widely from period to period and are particularly
sensitive to changing economic conditions. Generally improving economic
conditions result in improved operating results on the part of commercial
customers, enhancing their ability to meet debt service requirements. However,
this improvement in operating cash flow is often at least partially offset by
rising interest rates often seen in an improving economic environment. In
addition, changing economic conditions often impact various business segments
differently, giving rise to the need to manage industry concentrations within
the loan portfolio. Further discussion relating to asset quality was presented
on page 21.
Other lending risks include liquidity risk and specific risk. The liquidity risk
of the Corporation arises from its obligation to make payment in the event of a
customer's contractual default. The evaluation of specific risk is a basic
function of underwriting and loan administration, involving analysis of the
borrower's ability to service debt as well as the value of pledged collateral.
In addition to impacting individual lending decisions, this analysis may also
determine the aggregate level of commitments the Corporation is willing to
extend to an individual customer or a group of related customers.
CAPITAL RESOURCES
Total stockholders' equity was $627 million at June 30, 2005, an increase of $9
million from December 31, 2004. The change in stockholders' equity for the
period was attributable to $36.5 million in earnings that was partially offset
by dividends paid of $17.5 million, or $0.535 per share, and a decrease of $526
thousand in net accumulated other comprehensive income loss. Capital was also
reduced by $13.1 million from the repurchase of 406 thousand shares of the
Corporation's common stock at an average price of $32.40. In June 2005, the
Corporation approved the repurchase of an additional 1.3 million shares under
its stock repurchase program, bringing the maximum authorized remainder to
1,516,603 shares.
27
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.
June 30, December 31,
(dollars in thousands) 2005 2004
-------------- --------------
Total equity capital per consolidated financial statements $ 626,546 $ 617,439
Qualifying trust preferred securities 134,000 164,000
Minimum pension liablity (1,365) (1,365)
Accumulated other comprehensive loss 1,490 964
-------------- --------------
Adjusted capital 760,671 781,038
Adjustments for tier 1 capital:
Goodwill and disallowed intangible assets (268,061) (269,078)
-------------- --------------
Total tier 1 capital 492,610 511,960
-------------- --------------
Adjustments for tier 2 capital:
Allowance for loan losses 46,583 46,169
Allowance for letter of credit losses 439 474
-------------- --------------
Total tier 2 capital adjustments 47,022 46,643
-------------- --------------
Total regulatory capital $ 539,632 $ 558,603
============== ==============
Risk-weighted assets $ 4,487,869 $ 4,346,973
Quarterly regulatory average assets 6,173,720 6,198,284
Minimum
Regulatory To be "Well
Ratios: Requirements Capitalized"
------------------------------------
Tier 1 leverage 7.98% 8.26% 4.00% 5.00%
Tier 1 capital to risk-weighted assets 10.98 11.78 4.00 6.00
Total regulatory capital to risk-weighted assets 12.02 12.85 8.00 10.00
On March 31, 2005, the Corporation redeemed $30.0 million in aggregate principal
amount of 10% trust preferred securities of Provident Trust II. The trust
preferred securities had a final stated maturity of March 31, 2030, but were
callable at par beginning on March 31, 2005. Additionally, on July 15, 2005, the
Corporation redeemed $5.0 million in aggregate principal amount of 11% trust
preferred securities of Southern Trust I which were callable beginning July 15,
2005.
28
RESULTS OF OPERATIONS
OVERVIEW
The Corporation recorded net income of $18.4 million or $0.55 per diluted share
in the quarter ended June 30, 2005 compared to $10.5 million and $0.34 per
diluted share in second quarter 2004, representing increases over second quarter
2004 of 76% and 62%, respectively.
Solid loan growth in key business segments and the effects of the Southern
Financial merger augmented second quarter results. Improved earnings included an
increase of $5.4 million in net interest income, a $700 thousand increase in the
provision for loan losses and a $10.6 million increase in non-interest income,
which were partially offset by a $3.7 million increase in non-interest expense
and a $3.8 million increase in income tax expense, resulting in a $7.9 million
increase in net income from second quarter 2004.
Results for the quarter included a one-time after-tax adjustment of $699,000, or
$0.02 per diluted share, to reflect the cumulative impact of a modification of
the Corporation's accounting practices related to leased facilities. Like many
other publicly-traded companies that have a significant number of leased
facilities, the Corporation is conforming its method of accounting for rent
expense for leases that contain fixed escalations in rent payments, in order to
be consistent with accounting guidance. As the adjustment was not material to
any prior period financial statements, the full lease accounting adjustment was
recorded in the second quarter of 2005 in occupancy expense. While the lease
accounting adjustment accelerates rent expense from future periods, it does not
affect historical or future cash flows or the timing or amounts of rent
payments.
The financial results reflect the continued balance sheet transition toward
growing loans and deposits in core business segments. An overview of the
strategies is discussed on pages 17 and 18 of Management's Discussion and
Analysis of Financial Condition and Results of Operations. The net interest
margin was 3.58%, as compared to 3.31% for the same quarter last year. Return on
assets was 1.15%, and return on common equity was 11.82%. The efficiency ratio
improved to 62.2% for the quarter. Asset quality remained strong, as
non-performing assets to loans were 0.67% and charge-offs to average loans were
0.14% for the quarter.
The basis for financial comparison includes the impact of the Southern Financial
Bancorp, Inc. merger for two months of the second quarter of 2004 and the entire
second quarter of 2005.
NET INTEREST INCOME
The Corporation's principal source of revenue is net interest income, which is
the difference between interest income on earning assets and interest expense on
deposits and borrowings. Interest income is presented on a tax-equivalent basis
to recognize associated tax benefits in order to provide a basis for comparison
of yields with taxable earning assets. The table on the following pages analyzes
the reasons for the changes from period-to-period in the principal elements that
comprise net interest income. Rate and volume variances presented for each
component will not total the variances presented on totals of interest income
and interest expense because of shifts from period-to-period in the relative mix
of interest-earning assets and interest-bearing liabilities.
29
CONSOLIDATED AVERAGE BALANCES AND ANALYSIS OF CHANGES IN TAX EQUIVALENT NET INTEREST INCOME
THREE MONTHS ENDED JUNE 30, 2005 AND 2004
-----------------------------------------------------------------------------
Three Months Ended Three Months Ended
June 30, 2005 June 30, 2004
-----------------------------------------------------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
(tax-equivalent basis) Balance Expense Rate Balance Expense Rate
------------- ----------- -------- ------------- ------------ ----------
ASSETS:
Interest-earning assets:
Originated residential $ 88,228 $ 1,456 6.62% $ 108,155 $ 1,910 7.10%
Home equity 772,541 10,578 5.49 572,716 6,513 4.57
Acquired residential 515,747 7,372 5.73 625,145 8,884 5.72
Marine 427,921 5,410 5.07 450,148 5,682 5.08
Other consumer 34,847 752 8.66 49,193 917 7.50
Commercial mortgage 478,535 7,288 6.11 429,279 5,626 5.27
Residential construction 287,238 4,714 6.58 204,964 2,242 4.40
Commercial construction 293,357 4,424 6.05 259,088 2,326 3.61
Commercial business 676,863 10,721 6.35 594,828 9,615 6.50
------------- ----------- -------------- -----------
Total loans 3,575,277 52,715 5.91 3,293,516 43,715 5.34
------------- ----------- -------------- -----------
Loans held for sale 5,888 87 5.93 7,644 109 5.74
Short-term investments 9,952 64 2.58 16,316 48 1.18
Taxable investment securities 2,106,576 24,360 4.64 2,207,444 22,871 4.17
Tax-advantaged investment securities 12,564 245 7.82 16,508 313 7.63
------------- ----------- -------------- -----------
Total investment securities 2,119,140 24,605 4.66 2,223,952 23,184 4.19
------------- ----------- -------------- -----------
Total interest-earning assets 5,710,257 77,471 5.44 5,541,428 67,056 4.87
------------- ----------- -------------- -----------
Less: allowance for loan losses (45,582) (44,102)
Cash and due from banks 142,561 141,652
Other assets 613,810 474,942
------------- --------------
Total assets $ 6,421,046 $ 6,113,920
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand/money market deposits $ 1,176,127 2,940 1.00 $ 1,106,812 1,722 0.63
Savings deposits 760,314 546 0.29 771,270 573 0.30
Direct time deposits 786,388 4,896 2.50 850,667 3,941 1.86
Brokered time deposits 391,977 3,430 3.51 338,392 3,308 3.93
Short-term borrowings 754,225 4,819 2.56 589,075 1,365 0.93
Long-term debt 1,085,186 9,887 3.65 1,171,125 10,601 3.64
------------- ----------- -------------- -----------
Total interest-bearing liabilities 4,954,217 26,518 2.15 4,827,341 21,510 1.79
------------- ----------- -------------- -----------
Noninterest-bearing demand deposits 817,408 752,198
Other liabilities 23,728 25,489
Stockholders' equity 625,693 508,892
------------- --------------
Total liabilities and stockholders'
equity $ 6,421,046 $ 6,113,920
============= ==============
Net interest-earning assets $ 756,040 $ 714,087
============= ==============
Net interest income (tax-equivalent) 50,953 45,546
Less: tax-equivalent adjustment (198) (197)
----------- -----------
Net interest income $ 50,755 $ 45,349
=========== ===========
Net yield on interest-earning assets 3.58% 3.31%
30
CONSOLIDATED AVERAGE BALANCES AND ANALYSIS OF CHANGES IN TAX EQUIVALENT NET INTEREST INCOME (CONTINUED)
THREE MONTHS ENDED JUNE 30, 2005 AND 2004
-----------------------------
2005/2004
----------------------------------------------------- Income/Expense Variance
2005/2004 Increase/(Decrease) Due to Change In
----------------------------------------------------- -----------------------------
(dollars in thousands) Average % Income/ % Average Average
(tax-equivalent basis) Balance Change Expense Change Rate Volume
------------- --------- ----------- ------------- ------------- --------------
ASSETS:
Interest-earning assets:
Originated residential $ (19,927) (18.4)% $ (454) (23.8)% $ (123) $ (331)
Home equity 199,825 34.9 4,065 62.4 1,485 2,580
Acquired residential (109,398) (17.5) (1,512) (17.0) 28 (1,540)
Marine (22,227) (4.9) (272) (4.8) (6) (266)
Other consumer (14,346) (29.2) (165) (18.0) 129 (294)
Commercial mortgage 49,256 11.5 1,662 29.5 965 697
Residential construction 82,274 40.1 2,472 110.3 1,367 1,105
Commercial construction 34,269 13.2 2,098 90.2 1,754 344
Commercial business 82,035 13.8 1,106 11.5 (220) 1,326
------------- -----------
Total loans 281,761 8.6 9,000 20.6
------------- -----------
Loans held for sale (1,756) (23.0) (22) (20.2) 4 (26)
Short-term investments (6,364) (39.0) 16 33.3 40 (24)
Taxable investment securities (100,868) (4.6) 1,489 6.5 2,553 (1,064)
Tax-advantaged investment securities (3,944) (23.9) (68) (21.7) 8 (76)
------------- -----------
Total investment securities (104,812) (4.7) 1,421 6.1
------------- -----------
Total interest-earning assets 168,829 3.0 10,415 15.5 8,279 2,136
------------- -----------
Less: allowance for loan losses (1,480) 3.4
Cash and due from banks 909 0.6
Other assets 138,868 29.2
-------------
Total assets $ 307,126 5.0
=============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand/money market deposits $ 69,315 6.3 1,218 70.7 1,103 115
Savings deposits (10,956) (1.4) (27) (4.7) (19) (8)
Direct time deposits (64,279) (7.6) 955 24.2 1,270 (315)
Brokered time deposits 53,585 15.8 122 3.7 (375) 497
Short-term borrowings 165,150 28.0 3,454 253.0 2,977 477
Long-term debt (85,939) (7.3) (714) (6.7) 41 (755)
------------- -----------
Total interest-bearing liabilities 126,876 2.6 5,008 23.3 4,421 587
------------- -----------
Noninterest-bearing demand deposits 65,210 8.7
Other liabilities (1,761) (6.9)
Stockholders' equity 116,801 23.0
-------------
Total liabilities and stockholders'
equity $ 307,126 5.0
=============
Net interest-earning assets $ 41,953 5.9
=============
Net interest income (tax-equivalent) 5,407 11.9 $ 3,858 $ 1,549
Less: tax-equivalent adjustment (1) 0.5
-----------
Net interest income $ 5,406 11.9
===========
31
The net interest margin, on a tax-equivalent basis, increased 27 basis points to
3.58% and was driven by continued solid growth in lending activities. Earning
assets grew $169 million to $5.7 billion fueled by loan growth of $282 million
which was partially offset by a $100 million reduction in investment securities.
The yields on loans and investments grew 57 and 47 basis points, respectively.
The yield increase in the portfolio was the result of the restructuring program
initiated last year which placed greater emphasis on variable rate securities,
as well as a decline in prepayments. Interest-bearing liabilities grew $127
million while the average rate paid increased 36 basis points. The increase in
the average rate paid was primarily due to an increase in short-term borrowings
which replaced direct CDs and long-term debt. Interest expense benefited further
from a $65 million increase in average noninterest-bearing deposit balances
during the quarter.
The 5.44% yield on earning assets correspondingly increased as a result of the
loan growth which more than offset the increase in funding costs of 2.15%. Net
interest income on a tax-equivalent basis was $51.0 million in second quarter
2005, compared to $45.5 million in second quarter 2004. Total interest income
increased $10.4 million and total interest expense increased $5.0 million
resulting in the growth in net interest income of $5.4 million.
As a result of derivative transactions undertaken to mitigate the affect of
interest rate risk on the Corporation, interest income decreased by $187
thousand and interest expense decreased by $1.0 million, for a total increase of
$850 thousand in net interest income relating to derivative transactions for the
quarter ended June 30, 2005.
Future growth in net interest income will depend upon consumer and commercial
loan demand, growth in deposits and the general level of interest rates.
PROVISION FOR LOAN LOSSES
The Corporation's underwriting and collection efforts, as well as aggressive
management of potential problem loans resulted in a provision for loan losses of
$2.2 million in second quarter 2005 compared to $1.5 million in second quarter
2004. Net charge-offs were $1.3 million, or 0.14% of average loans, in second
quarter 2005 compared to $2.1 million, or 0.25% of average loans, in second
quarter 2004. Acquired residential loan net charge-offs as a percentage of
average acquired residential loans continued to decline during the period, from
0.79% in second quarter 2004 to 0.04% in second quarter 2005.
NON-INTEREST INCOME
Non-interest income grew to $28.2 million from $17.6 million in second quarter
2004. Non-interest income, excluding net gains (losses) of $706 thousand, grew
$2 million, or 8% from 2004.(1) Deposit fee income increased 3%, reflecting
increases in consumer and commercial deposit fees. Virtually all of the increase
in consumer deposit fees was from the addition of the Southern Financial account
base, as well as debit card fee income, which increased 8%. As with many of the
Bank's peers, consumer deposit fees are being negatively impacted by decreases
in checking transactions and decreases in NSF activity. The Bank took actions
during the second quarter that involved implementing a number of fundamental
processing changes. Management believes these changes will not alter its
competitive position, but will deliver sustainable revenue recovery in the
future, given expected account and transaction volumes. Other non-interest
income benefited from increases in mortgage banking income and income associated
with bank owned life insurance.
Net gains were $706 thousand in second quarter 2005, compared to net losses of
$7.9 million in second quarter 2004. Second quarter 2005 included
investment/borrowing transactions that were focused on reducing fixed rate
mortgage-backed securities to reduce interest rate risk. These transactions
generated net losses of $659 thousand. These losses were more than offset by a
$1.4 million gain realized from the liquidation of an equity investment held by
the Corporation, resulting from the acquisition of the issuer. Prior year's
losses were primarily the result of the investment portfolio restructuring
program, the objective of which was to improve the overall yield of the
portfolio. The second quarter of 2005 also included net gains of $142 thousand
from the sale of mortgage loans. The disposition of loans and foreclosed
properties, which occur in the ordinary course of business, generated net losses
of $96 thousand in the second quarter of 2005.
- ----------------
(1) For the purposes of providing more meaningful discussion, the aforementioned
items were excluded to provide comparability of the results from period to
period. The items were excluded due to their infrequent nature.
32
NON-INTEREST EXPENSE
Non-interest expense of $49.8 million for second quarter 2005 was $3.7 million
higher than second quarter 2004. Exclusive of the one-time $1.0 million
adjustment to account for escalating lease payments recorded as occupancy
expense and $2.0 million for merger expenses incurred in the second quarter of
2005 and 2004, respectively, non-interest expense increased $4.6 million, or
10%(1). Of this increase, $2.5 million was attributable to salary and employee
benefit expense associated with internal or acquired branch expansion, in
addition to increases in employee benefit costs. Another contributing factor to
rising compensation cost was the competition in the employment market that has
resulted in increased relative labor costs. Non-interest expense also included
the impact of an additional $700 thousand of professional fees, primarily
relating to the cost of compliance with the Sarbanes-Oxley Act of 2002. The
remaining $1.4 million increase represented costs associated with expanding the
Bank's footprint and the related infrastructure.
INCOME TAXES
The Corporation accounts for income taxes under the asset/liability method.
Deferred tax assets and liabilities are recognized for the future consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases, as well as
operating loss and tax credit carryforwards. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period indicated by the enactment date. A
valuation allowance is established against deferred tax assets when in the
judgment of management, it is more likely than not that such deferred tax assets
will not become realizable. The judgment about the level of future taxable
income is dependent to a great extent on matters that may at least in part, be
beyond the Bank's control. It is at least reasonably possible that management's
judgment about the need for a valuation allowance for deferred taxes could
change in the near term. The valuation allowance was $1.9 million at June 30,
2005 versus $1.7 million at December 31, 2004.
The Corporation recorded income tax expense of $8.5 million based on pre-tax
income of $26.9 million, representing an effective tax rate of 31.4% in second
quarter 2005. In second quarter 2004, the Corporation recorded a tax expense of
$4.7 million on pre-tax income of $15.2 million, an effective tax rate of 31.1%.
FOR SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004
The Corporation recorded net income of $36.5 million or $1.09 per diluted share
for the six months ended June 30, 2005, compared to $23.4 million or $0.83 per
diluted share in the prior year.
NET INTEREST INCOME
Tax-equivalent net interest income for the six months of 2005 increased $17
million to $101.5 million compared to 2004, a 20% increase from period to
period. Interest income increased $25.7 million and interest expense increased
$8.7 million. Growth of $492 million in interest-earning assets accompanied by a
50 basis point yield increase more than offset the $406 million increase in
interest-bearing liabilities whose rate increased 20 basis points. This resulted
in the net yield on earning assets increasing to 3.58% in 2005 from 3.25% in
2004. The growth in the net yield further benefited from the $141 million growth
in non-interest bearing deposits.
33
CONSOLIDATED AVERAGE BALANCES AND ANALYSIS OF CHANGES IN TAX EQUIVALENT NET INTEREST INCOME
SIX MONTHS ENDED JUNE 30, 2005 AND 2004
----------------------------------------------------------------------------
Six Months Ended Six Months Ended
June 30, 2005 June 30, 2004
----------------------------------------------------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
(tax-equivalent basis) Balance Expense Rate Balance Expense Rate
------------- ----------- --------- -------------- ----------- ---------
ASSETS:
Interest-earning assets:
Originated residential $ 92,863 $ 3,150 6.84% $ 91,544 $ 3,220 7.07%
Home equity 748,764 19,930 5.37 545,868 12,645 4.66
Acquired residential 528,948 15,163 5.78 614,604 17,891 5.85
Marine 430,392 10,993 5.15 456,927 11,729 5.16
Other consumer 36,539 1,523 8.41 46,776 1,788 7.69
Commercial mortgage 481,581 14,460 6.05 375,611 9,965 5.34
Residential construction 273,664 8,600 6.34 187,366 4,268 4.58
Commercial construction 287,563 8,338 5.85 237,868 4,342 3.67
Commercial business 677,519 21,250 6.32 495,221 15,035 6.11
------------- ----------- -------------- -----------
Total loans 3,557,833 103,407 5.86 3,051,785 80,883 5.33
------------- ----------- -------------- -----------
Loans held for sale 5,990 175 5.89 5,897 173 5.90
Short-term investments 9,315 107 2.32 8,954 50 1.12
Taxable investment securities 2,131,641 48,681 4.61 2,141,981 45,405 4.26
Tax-advantaged investment securities 12,778 476 7.51 16,654 611 7.38
------------- ----------- -------------- -----------
Total investment securities 2,144,419 49,157 4.62 2,158,635 46,016 4.29
------------- ----------- -------------- -----------
Total interest-earning assets 5,717,557 152,846 5.39 5,225,271 127,122 4.89
------------- ----------- -------------- -----------
Less: allowance for loan losses (45,815) (39,839)
Cash and due from banks 135,202 130,162
Other assets 616,440 356,761
------------- --------------
Total assets $ 6,423,384 $ 5,672,355
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand/money market deposits $ 1,119,012 5,160 0.93 $ 1,012,042 3,052 0.61
Savings deposits 754,728 1,086 0.29 743,268 1,083 0.29
Direct time deposits 790,340 9,299 2.37 751,473 7,263 1.94
Brokered time deposits 382,943 6,394 3.37 278,627 6,760 4.88
Short-term borrowings 795,854 9,292 2.35 629,636 2,943 0.94
Long-term debt 1,132,045 20,153 3.59 1,153,554 21,549 3.76
------------- ----------- -------------- -----------
Total interest-bearing liabilities 4,974,922 51,384 2.08 4,568,600 42,650 1.88
------------- ----------- -------------- -----------
Noninterest-bearing demand deposits 800,634 659,865
Other liabilities 25,563 23,230
Stockholders' equity 622,265 420,660
------------- --------------
Total liabilities and stockholders'
equity $ 6,423,384 $ 5,672,355
============= ==============
Net interest-earning assets $ 742,635 $ 656,671
============= ==============
Net interest income (tax-equivalent) 101,462 84,472
Less: tax-equivalent adjustment (386) (400)
----------- -----------
Net interest income $ 101,076 $ 84,072
=========== ===========
Net yield on interest-earning assets 3.58% 3.25%
34
CONSOLIDATED AVERAGE BALANCES AND ANALYSIS OF CHANGES IN TAX EQUIVALENT NET INTEREST INCOME (CONTINUED)
SIX MONTHS ENDED JUNE 30, 2005 AND 2004
-----------------------------
2005/2004
----------------------------------------------------- Income/Expense Variance
2005/2004 Increase/(Decrease) Due to Change In
----------------------------------------------------- -----------------------------
(dollars in thousands) Average % Income/ % Average Average
(tax-equivalent basis) Balance Change Expense Change Rate Volume
------------- --------- ----------- ------------- ------------- --------------
ASSETS:
Interest-earning assets:
Originated residential $ 1,319 1.4% $ (70) (2.2)% $ (113) $ 43
Home equity 202,896 37.2 7,285 57.6 2,117 5,168
Acquired residential (85,656) (13.9) (2,728) (15.2) (225) (2,503)
Marine (26,535) (5.8) (736) (6.3) (27) (709)
Other consumer (10,237) (21.9) (265) (14.8) 154 (419)
Commercial mortgage 105,970 28.2 4,495 45.1 1,454 3,041
Residential construction 86,298 46.1 4,332 101.5 1,968 2,364
Commercial construction 49,695 20.9 3,996 92.0 2,955 1,041
Commercial business 182,298 36.8 6,215 41.3 553 5,662
------------- -----------
Total loans 506,048 16.6 22,524 27.8
------------- -----------
Loans held for sale 93 1.6 2 1.2 - 2
Short-term investments 361 4.0 57 114.0 55 2
Taxable investment securities (10,340) (0.5) 3,276 7.2 3,503 (227)
Tax-advantaged investment securities (3,876) (23.3) (135) (22.1) 11 (146)
------------- -----------
Total investment securities (14,216) (0.7) 3,141 6.8
------------- -----------
Total interest-earning assets 492,286 9.4 25,724 20.2 13,365 12,359
------------- -----------
Less: allowance for loan losses (5,976) 15.0
Cash and due from banks 5,040 3.9
Other assets 259,679 72.8
-------------
Total assets $ 751,029 13.2
=============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand/money market deposits $ 106,970 10.6 2,108 69.1 1,759 349
Savings deposits 11,460 1.5 3 0.3 (12) 15
Direct time deposits 38,867 5.2 2,036 28.0 1,650 386
Brokered time deposits 104,316 37.4 (366) (5.4) (2,452) 2,086
Short-term borrowings 166,218 26.4 6,349 215.7 5,402 947
Long-term debt (21,509) (1.9) (1,396) (6.5) (983) (413)
------------- -----------
Total interest-bearing liabilities 406,322 8.9 8,734 20.5 4,819 3,915
------------- -----------
Noninterest-bearing demand deposits 140,769 21.3
Other liabilities 2,333 10.0
Stockholders' equity 201,605 47.9
-------------
Total liabilities and stockholders'
equity $ 751,029 13.2
=============
Net interest-earning assets $ 85,964 13.1
=============
Net interest income (tax-equivalent) 16,990 20.1 $ 8,546 $ 8,444
Less: tax-equivalent adjustment 14 (3.5)
-----------
Net interest income $ 17,004 20.2
===========
35
PROVISION FOR LOAN LOSSES
The provision for loan losses for the first six months of 2005 was $3.8 million,
level with the first six months of 2004. Net charge-offs were $3.3 million in
2005 compared to $3.5 million in 2004. Net charge-offs as a percentage of
average loans were 0.19% in 2005 compared to 0.22% in 2004.
NON-INTEREST INCOME
Total non-interest income increased to $53.5 million for the six months ended
June 30, 2005 from $41.2 million for the six months ended June 30, 2004.
Excluding net losses of $70 thousand, non-interest income increased 11% to $53.5
million for the six months in 2005(1). The majority of this increase was due to
a $1.5 million increase in deposit service charges and $2.4 million in income
associated with bank owned life insurance policies maintained by the
Corporation.
Net losses were $70 thousand for the six months ended June 30, 2005, compared to
net losses of $7.1 million for the six months ended June 30, 2004. In 2004, net
losses from the sales of securities were $6.7 million, driven by the $8.1
million loss from balance sheet restructuring transactions associated with the
prior year's merger with Southern Financial.
NON-INTEREST EXPENSE
Non-interest expense of $97.3 million for the six months ended June 30, 2005
increased $10.5 million, or 12%, compared to the same period one year ago. The
six months ended June 30, 2005 included a reduction to non-interest expense of
$1.6 million related to the Corporation's termination of the post-retirement
benefit plan and a one-time charge for occupancy expense of $1.0 million. The
same period for 2004 included merger expense of $2.2 million. Exclusive of these
items, non-interest expense increased $13.4 million or 16%(1). The increase from
year to year is primarily attributable to the merger, which had two months of
expense included in the 2004 results versus 2005 which had a full six months
expense. Additional items contributing to this increase were employee benefit
costs, labor and the associated recruiting costs and cost of compliance with the
Sarbanes-Oxley Act of 2002.
INCOME TAXES
The Corporation recorded income tax expense of $16.9 million in the first six
months of 2005 based on pre-tax income of $53.5 million, a 31.6% effective tax
rate as compared to pre-tax income of $34.5 million and an effective tax rate of
32.3% for 2004.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding market risk at December 31, 2004, see "Interest
Sensitivity Management" and Note 9 to the Consolidated Financial Statements in
the Corporation's Form 10-K filed with the Securities and Exchange Commission on
March 16, 2005. The market risk of the Corporation has not experienced any
material changes as of June 30, 2005 from December 31, 2004. Additionally, refer
to Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations for additional quantitative and qualitative discussions
about market risk at June 30, 2005.
ITEM 4. CONTROLS AND PROCEDURES
The Corporation's management, including the Corporation's principal executive
officer and principal financial officer, have evaluated the effectiveness of the
Corporation's "disclosure controls and procedures," as such term is defined in
Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended, (the "Exchange Act"). Based upon their evaluation, the principal
executive officer and principal financial officer concluded that, as of the end
of the period covered by this report, the Corporation's disclosure controls and
procedures were effective for the purpose of ensuring that the information
required to be disclosed in the reports that the Corporation files or submits
under the Exchange Act with the Securities and Exchange Commission (the "SEC")
(1) is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and (2) is accumulated and communicated
to the Corporation's management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required
disclosure. In addition, based on that evaluation, no change in the
Corporation's internal control over financial reporting occurred during the
quarter ended June 30, 2005 that has materially affected, or is reasonably
likely to materially affect, the Corporation's internal control over financial
reporting.
36
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Corporation is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business.
Management believes such routine legal proceedings, in the aggregate, will not
have a material adverse affect on the Corporation's financial condition or
results of operation.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During 1998, the Corporation initiated a stock repurchase program for its
outstanding stock. Under this plan the Corporation approved the repurchase of
specific additional amounts of shares without any specific expiration date. As
the Corporation fulfilled each specified repurchase amount, additional amounts
were approved. Most recently, on June 17, 2005, the Corporation approved an
additional stock repurchase of up to 1.3 million shares from time to time
subject to market conditions. Currently, the maximum number of shares remaining
to be purchased under this plan is 1,516,603. 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 June 30, 2005. The Corporation has no plans that it
elected to terminate prior to expiration or under which it does not intend to
make further purchases.
The following table provides certain information with regard to shares
repurchased by the Corporation in the second quarter of 2005.
Maximum Number
Total Number Average Total Number of of Shares Remaining
of Shares Price Paid Shares Purchased to be Purchased
Period Purchased per Share Under Plan Under Plan
- ------------------------------- ---------------- ------------- ----------------- ------------------
April 1 - April 30 110,000 $ 30.84 110,000 362,891
May 1 - May 31 99,900 30.88 99,900 262,991
June 1 - June 30 60,000 32.07 60,000 1,516,603
---------------- ------------- ----------------- -----------------
Total 269,900 $ 31.13 269,900 1,516,603
---------------- ------------- ----------------- -----------------
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company held its Annual Meeting of Shareholders on May 18, 2005. Proxies
were solicited with respect to such meeting under regulation 14A of the
Securities and Exchange Act of 1934, as amended, pursuant to proxy materials
dated April 13, 2005. Of the shares eligible to vote at the annual meeting,
30,126,611 were represented in person or by proxy.
(b) There was no solicitation in opposition to the Board nominees for directors
and all of such nominees were elected as follows:
No. of Votes No. of Votes Broker
Director For % Withheld % Non-Votes %
- -------- --- --- -------- --- --------- ---
Thomas S. Bozzuto 29,736,689 98.7 389,922 1.3 0 0.0
Charles W. Cole, Jr. 29,738,305 98.7 388,306 1.3 0 0.0
Barbara B. Lucas 29,737,103 98.7 389,508 1.3 0 0.0
Francis G. Riggs 29,345,924 97.4 780,687 2.6 0 0.0
Enos K. Fry 29,458,838 97.8 667,773 2.2 0 0.0
37
(c) Additional proposal submitted for a vote, with the following result:
No. of Votes No. of Votes No. of Votes Broker
Proposal For Against Abstaining Non-Votes
- -------- --- ------- ---------- ---------
Ratification of the
appointment of KPMG LLP
as independent registered
public accounting firm
for the fiscal year
ending December 31, 2005 29,583,473 500,011 43,127 -
ITEM 5. OTHER INFORMATION
On June 27, 2005, Richard J. Oppitz, Jr. and Provident Bank entered into a
memorandum regarding Mr. Oppitz' separation of employment. This was brought
about as a result of the elimination of his position as Executive Vice President
of the Bank. The memorandum contemplates that he will be paid 24 months of
severance pay, aggregating $580,726 and receive continuing benefits for 24
months. His change in control agreement is terminated.
ITEM 6. EXHIBITS
The exhibits and financial statements filed as a part of this report are as
follows:
(2.0) Agreement and Plan of Reorganization between Provident Bankshares
Corporation and Southern Financial Bancorp, Inc. (1)
(3.1) Articles of Incorporation of Provident Bankshares Corporation (2)
(3.2) Articles of Amendment to the Articles of Incorporation of Provident
Bankshares Corporation (2)
(3.3) Fifth Amended and Restated By-Laws of Provident Bankshares
Corporation (3)
(10.1) Form of Change in Control Agreement (4)
(10.2) Memorandum of Separation of Employment regarding Richard J. Oppitz,
Jr.
(11.0) Statement re: Computation of Per Share Earnings (5)
(31.1) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
(31.2) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
(32.1) Section 1350 Certification of Chief Executive Officer
(32.2) Section 1350 Certification of Chief Financial Officer
- ---------------------------
(1) Incorporated by reference from Registrant's Form 8-K (File No. 0-16421)
filed with the Commission on November 4, 2003.
(2) Incorporated by reference from Registrant's Registration Statement on
Form S-8 (File No. 33-58881) filed with the Commission on July 10, 1998.
(3) Incorporated by reference from Registrant's Annual Report on Form 10-K
(File No. 0-16421) for the year ended December 31, 2004, filed with the
Commission on March 16, 2005.
(4) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q (File No. 0-16421) for the quarter ended March 31, 2005, filed with
the Commission on May 10, 2005.
(5) Included in Note 13 to the Unaudited Consolidated Financial Statements on
page 15 hereof.
38
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:
August 9, 2005 By /s/ GARY N. GEISEL
--------------------------------------
Gary N. Geisel
Chairman of the Board
and Chief Executive Officer
Principal Financial Officer:
August 9, 2005 By /s/ DENNIS A. STARLIPER
--------------------------------------
Dennis A. Starliper
Executive Vice President and
Chief Financial Officer
39
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------------ -----------------------------------------------------------------------
10.2 Memorandum of Separation of Employment regarding Richard J. Oppitz, Jr.
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