[Provident Bankshares Corporation Letterhead]
August 29, 2007
Ms. Sharon Blume
Reviewing Accountant
United States Securities and
Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
RE: PROVIDENT BANKSHARES CORPORATION
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
FORM 10-Q FOR THE FISCAL QUARTERS ENDED MARCH 31, 2007 AND
JUNE 30, 2007
FILE NO. 0-16421
Dear Ms. Blume:
On behalf of Provident Bankshares Corporation, Baltimore, Maryland (the
"Corporation") this letter responds to your August 16, 2007 comment letter with
respect to the Corporation's Form 10-K for the fiscal year ended December 31,
2006 and Form 10-Q for the fiscal quarters ended March 31, 2007 and June 30,
2007. For your convenience, each comment is transcribed below, followed by the
response.
Item 8. Financial Statements and Supplementary Data, page 37
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Consolidated Statement of Changes in Stockholders' Equity and Comprehensive
- ---------------------------------------------------------------------------
Income, page 42
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COMMENT NO. 1
IT APPEARS YOU HAVE INCLUDED THE SFAS 158 TRANSITION ADJUSTMENT REQUIRED BY
PARAGRAPH 16(A) OF SFAS 158 IN OTHER COMPREHENSIVE INCOME AND NET ACCUMULATED
OTHER COMPREHENSIVE INCOME (LOSS). PLEASE REVISE FUTURE FILINGS TO PRESENT THE
TRANSITION ADJUSTMENT SOLELY IN ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS),
CONSISTENT WITH PARAGRAPH A7 OF SFAS 158.
RESPONSE TO COMMENT NO. 1
The Corporation has reviewed the technical requirements under paragraph A7 of
SFAS No. 158 and agrees with your comment. The Corporation will comply with this
comment in future filings.
Notes to Consolidated Financial Statements, page 44
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Note - Summary of Significant Accounting Policies, page 44
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Derivative Financial Instruments, page 48
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Ms. Sharon Blume
August 29, 2007
Page 2
COMMENT NO. 2
PLEASE TELL US THE FOLLOWING RELATED TO YOUR HEDGING RELATIONSHIPS INVOLVING THE
USE OF THE SHORT-CUT METHOD FOR ASSUMING NO INEFFECTIVENESS:
o THE NATURE AND SPECIFIC TERMS OF THE HEDGED ITEMS;
o THE NATURE AND SPECIFIC TERMS OF THE DERIVATIVE INSTRUMENTS AND HOW YOU
DETERMINE THOSE TERMS MATCH THE TERMS OF THE HEDGED ITEMS;
o THE SPECIFIC DOCUMENTED RISK BEING HEDGED;
o THE TYPE OF SFAS 133 HEDGE (FAIR VALUE, CASH FLOW, ETC.); AND
o HOW YOU DETERMINE THESE HEDGING RELATIONSHIPS MEET EACH OF THE
CONDITIONS IN PARAGRAPH 68 OF SFAS 133 TO QUALIFY FOR USE OF THE SHORT
CUT METHOD.
RESPONSE TO COMMENT NO. 2
On December 31, 2006, the Corporation had three fixed rate FHLB borrowings
outstanding totaling $29,900,000 that were being hedged with three LIBOR
interest rate swaps with the same notional amounts. The hedge objective was to
convert fixed rate borrowings to variable rate borrowings. The critical terms of
both the underlying hedged item and the swap matched. All three interest rate
swaps were accounted for as fair value hedges using the short-cut method of
accounting as permitted by SFAS No. 133.
Prior to entering into an interest rate swap agreement that meets the
requirements under SFAS No. 133 for the short-cut method, a hedge documentation
checklist "Documentation Requirement for (Cash Flow Hedge or Fair Value Hedge)
and Checklist for Obtaining Short-cut Accounting Treatment" is prepared by the
Corporation's Treasury Department. The documentation of the hedging relationship
includes the following:
o Identifies the type of hedge
o States the risk management objective and strategy for undertaking
the hedge
o Identifies the hedging instrument
o Identifies the nature of the risk being hedged, and
o States how the hedging instrument's effectiveness in offsetting
the exposure to the hedged item's cash flows will be assessed
Additionally, the interest rate swaps are tested and documented using the
criteria stated in paragraph 68 of SFAS No. 133 for the assumption of no hedge
ineffectiveness. If the accounting criteria for using the short-cut method is
met, the Corporation enters into the interest rate swap. Subsequent to entering
into the swap, the terms of the interest rate swap and the hedged item are
reviewed and verified on a quarterly basis to determine if any changes had
occurred that might invalidate the application of short-cut treatment. This
review is documented on a quarterly basis. At no time during the hedge was a
mismatch noted which would invalidate the short-cut treatment.
Ms. Sharon Blume
August 29, 2007
Page 3
THE NATURE AND SPECIFIC TERMS OF THE HEDGE ITEMS WERE AS FOLLOWS:
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HOST (HEDGED ITEMS):
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MATURITY FIXED HOST IS NOT
HOST # PRINCIPAL DATE RATE PREPAYABLE
- ------------------------------------------------------------------------------------------
FHLB Borrowing 331 $25,000,000 May 10, 2007 3.98% Yes
FHLB Borrowing 256 3,000,000 June 15, 2009 4.25% Yes
FHLB Borrowing 295 1,900,000 July 18, 2011 4.40% Yes
-----------
$29,900,000
THE NATURE AND SPECIFIC TERMS OF THE DERIVATIVE INSTRUMENTS WERE AS FOLLOWS:
- ----------------------
DERIVATIVE INSTRUMENT:
- -------------------------------------------------------------------------------------------------------------------------------
CAP OR
FAIR VALUE FLOOR ON
MATURITY OF SWAP VARIABLE RATE REPRICING
HEDGE POSITION # PRINCIPAL DATE RATE AT INCEPTION ON SWAP FREQUENCY
- -------------------------------------------------------------------------------------------------------------------------------
Libor Interest Rate Swap 470 $25,000,000 May 10, 2007 90 Day Libor Zero None Quarterly
Libor Interest Rate Swap 473 3,000,000 June 15, 2009 30 Day Libor Zero None Monthly
Libor Interest Rate Swap 474 1,900,000 July 18, 2011 30 Day Libor Zero None Monthly
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$29,900,000
The specific terms of the derivative instruments were reviewed at inception to
make sure they match the terms of the hedged item.
TYPE OF SFAS NO. 133 HEDGE AND SPECIFIC RISK BEING HEDGED.
All three derivatives that used the short-cut method were accounted for as fair
value hedges. The specific documented risk being hedged was the change in fair
value of the hedged item due to changes in market interest rates. Market
interest rates are considered a benchmark under SFAS No.133.
TO DETERMINE IF THE HEDGING RELATIONSHIPS MEET EACH OF THE CONDITIONS IN
PARAGRAPH 68 OF SFAS NO. 133 TO QUALIFY FOR USE OF THE SHORT-CUT METHOD, THE
CORPORATION REVIEWS THE FOLLOWING CRITERIA.
Criteria to qualify for short-cut treatment for interest rate swaps designated
as fair value hedges:
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Does the notional amount of the swap match the principal amount
of the asset or liability? (68a)
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Is the fair value of swap at inception zero? (68b)
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Is the formula for computing net settlements the same for each
settlement (fixed rate is the same throughout the term, and the
variable rate is based on the same index and includes the same
constant adjustment or no adjustment)? (68c)
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Is the hedged asset or liability not pre-payable? (68d)
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Ms. Sharon Blume
August 29, 2007
Page 4
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Are the other terms of the instruments typical and do not
invalidate the assumption of no effectiveness? (68e)
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Does the expiration date of the swap match the maturity date of
the asset or liability? (68f)
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Is the swap free from a floor or ceiling on the variable
interest rate of the swap? (68g)
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Is the interval between resets of the variable rate in the swap
3 to 6 months or less? (68h)
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If the answers to all the above questions are "yes," the swap qualifies for
short-cut accounting treatment and there is an assumption of no hedge
ineffectiveness. On a quarterly basis, the terms of the swap and the hedged item
are reviewed for any changes that might invalidate the application of short-cut
treatment.
As of June 30, 2007, the Corporation did not have any outstanding interest rate
swaps that were accounted for using the short-cut accounting treatment. During
the six months of 2007, swap number 470 matured while swaps numbered 473 and 474
were terminated.
Note 3 - Investment Securities, page 53
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COMMENT NO. 3
WE NOTE YOUR DISCLOSURE ON PAGE 32 IN MD&A IN WHICH YOU STATE THAT YOU SOLD
$182.9 MILLION FIXED RATE MORTGAGE-BACKED SECURITIES IN THE FOURTH QUARTER AT A
LOSS OF $6.9 MILLION TO IMPROVE FUTURE PROFITABILITY AND REDUCE THE
CORPORATION'S WHOLESALE ASSETS. PLEASE TELL US THE FOLLOWING CONCERNING THIS
ASSET SALE:
o A TIMELINE OF THE FACTS AND CIRCUMSTANCES RELATED TO YOUR DECISION TO
SELL THESE SECURITIES; AND
o HOW YOU CAN CONSIDER WHETHER YOU WERE REQUIRED TO RECORD AN OTHER THAN
TEMPORARY IMPAIRMENT CHARGE TO INCOME RELATED TO AVAILABLE-FOR-SALE
SECURITIES IN AN UNREALIZED LOSS POSITION AS OF SEPTEMBER 30, 2006.
SPECIFICALLY TELL US THE BASIS FOR YOUR CONCLUSION THAT YOU HAD THE
INTENT AND ABILITY TO HOLD THESE SECURITIES TO THE EARLIER OF LOSSES OR
MATURITY AT SEPTEMBER 30, 2006.
RESPONSE TO COMMENT NO. 3
Over the past several years, the Corporation has articulated its wholesale asset
reduction strategy in its annual and quarterly reports. This strategy would
gradually reduce the total level of investment securities to be less than 25% of
total assets, produced through continuous run-off of the monthly amortizing
mortgage-backed securities ("MBS") portfolio. In the 4th Quarter 2006,
management entered into a balance sheet restructuring transaction that sold $183
million of MBS, extinguished $32 million of long-term debt, retired $120 million
of short-term borrowings and reinvested $36 million in securities at current
market rates. At the time of the securities sale, the MBS market provided the
Corporation with the opportunity to achieve this wholesale asset reduction
strategy sooner than management planned while significantly benefiting the
interest margin. The $183 million security sale was not for liquidity reasons,
but a discretionary business decision based on a strategic opportunity that
existed at this time due to the extended term of the flat yield curve and
narrowing yield spreads for MBS relative to the Corporation's funding costs.
Ms. Sharon Blume
August 29, 2007
Page 5
TIMELINE OF THE FACTS AND CIRCUMSTANCES:
----------------------------------------
o Throughout the 3rd quarter of 2006, depositors significantly reduced
their balances of low cost savings and checking accounts, replacing
them generally with much higher cost certificates of deposit, lowering
the Corporation's net interest margin by 11 basis points versus the 2nd
quarter of 2006.
o During the third week of October 2006, the magnitude of the net
interest income decline was determined and communicated to Executive
Management. Forecasts of the impact on the full year 2006 earnings and
on 2007 earnings were calculated for the October 19, 2007 Asset and
Liability Committee ("ALCO") meeting.
o By mid-October, the Treasury Division considered the impact of a
securities trade involving accelerated shrinking of the securities
portfolio to improve the net interest margin after reading of another
bank's 3rd quarter shrinkage / repositioning trade in that company's
earnings announcement.
o On October 19, 2006, the concept was discussed with Executive
Management at the bi-weekly ALCO meeting. The Executives expressed
interest in exploring this initiative, and the Treasury Division began
working on a viable trade shortly thereafter.
o By mid-November: After developing several scenarios, the Treasury
Division developed a securities trade that would improve the net
interest margin by 14 basis points by shrinking the balance sheet via a
sale of low yielding securities combined with a small amount of stock
repurchase. The trade was presented to the CFO on November 17, 2006 for
approval and the CEO and the President approved it on November 21,
2007.
o On November 27th and 28th, the Securities were sold.
QUESTION CONCERNING OTHER THAN TEMPORARY IMPAIRMENT, SPECIFICALLY WITH RESPECT
TO ABILITY AND INTENT TO HOLD THE SECURITIES ON SEPTEMBER 30, 2006 THAT WERE
SUBSEQUENTLY SOLD IN THE FOURTH QUARTER:
As of September 30, 2006 and as of the filing of the 10-Q on November 9, 2006,
the Corporation had no firm intention of selling any of the investment
securities in its available-for-sale portfolio. Selling securities was not
contemplated in the Corporation's annual budget, monthly forecasts, or in the
weekly Treasury Management liquidity meetings held in September 2006. The
Corporation did not begin to consider any sales until mid-October, and did not
identify any securities to sell until mid-November.
With respect to ability to hold the securities, the Corporation has, and had
throughout all of 2006, the ability and sufficient liquidity to hold all of its
securities to maturity. As of September 30, 2006, the Corporation, a $6.4
billion asset institution, had the ability to raise over $900 million in secured
funding from the broker repo markets and the FHLB Atlanta, over $800 million of
unused Fed Funds lines, and had ample ability to raise funds in the brokered CD
market. Additionally, all of the securities that were sold were pledgeable to
the FHLB Atlanta or in the mortgage repo market, so they were effectively
self-financing. In other words, the Corporation could raise essentially the same
level of liquidity through pledging these assets to raise secured funding as an
alternative to selling the securities.
Ms. Sharon Blume
August 29, 2007
Page 6
In conclusion, on September 30, 2006, the Corporation possessed both the intent
and the ability to hold to recovery the securities subsequently sold in the
fourth quarter, and should not have considered these securities to be other than
temporarily impaired.
* * * *
The Corporation hereby acknowledges that:
o The Corporation is responsible for the adequacy and accuracy of the
disclosure in its filings;
o Staff comments or changes to disclosure in response to staff comments
do not foreclose the Commission from taking any action with respect to
the filings; and
o The Corporation may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under federal
securities laws of the United States.
We trust that the responses provided herein appropriately address the
concerns expressed in your letter. If you should require and additional
information, please contact me at 410-277-2705.
Very truly yours,
/s/ Dennis A. Starliper
Dennis A. Starliper
Chief Financial Officer
cc: Robert L. Davis, Esq.
Edward G. Olifer, Esq.