ITEM 1. BUSINESS ----------------
Provident Financial Group, Inc.
Provident Financial Group, Inc. ("Provident") is a Cincinnati-based commercial banking and financial services company. At December 31, 2002, Provident had total assets of $17.5 billion, loans and leases of $9.1 billion, deposits of $9.8 billion and shareholders' equity of $880 million. Additionally, Provident services loans and leases for other entities including $2.1 billion which have been securitized (off-balance sheet managed assets); $3.0 billion which have been sold by a wholly-owned subsidiary through the Fannie Mae DUS program as an approved seller/servicer; and $12.4 billion which have no recourse to Provident.
Provident's executive offices are located at One East Fourth Street, Cincinnati, Ohio 45202 and its Investor Relations telephone number is (513) 345-7102 or (800) 851-9521. The Annual Report, on Form 10-K, is filed with the Securities and Exchange Commission ("SEC"). Copies of this document and all other SEC filings by Provident may be obtained, without charge, by contacting Investor Relations. These reports may also be obtained via the Internet at the web sites of Provident at http://www.providentbank.com, or the SEC at http://www.sec.gov.
Provident has 78 full service branch banking centers located in Ohio, Kentucky and southwestern Florida. Provident also provides commercial financing, equipment leasing and mortgage lending at a national level with commercial lending offices located in eleven states.
Provident conducts its banking operations through The Provident Bank. Major business lines are Commercial Banking, Retail Banking and Mortgage Banking. See ITEM 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Lines" and Note 23 included in "Notes to Consolidated Financial Statements" for details as to the types of financial products and services offered by these business lines.
On March 5, 2003, Provident announced a restatement of its operating results for years 1997 through 2001 and the interim periods for 2002. The restatement was a result of unintentional errors in the accounting for nine auto lease financing transactions originated between 1997 and 1999, and the return to the balance sheet of the associated consumer auto leases which had been previously accounted for as off-balance sheet. These errors were discovered by Provident's finance staff in connection with the testing and installation of a financial model that identified differences in income from that originally recorded, compared with the income generated by the financial model for auto lease transactions.
Subsequent to this announcement, Provident has determined that its auto leases should be classified as operating leases instead of finance leases. As a result, Provident will account for its auto lease portfolio as operating leases resulting in the recognition of rental income and depreciation expense rather than interest income as reported in earlier periods. Also, amounts previously reported as direct financing leases and included in the loan category, have been reclassified to leased equipment.
The results of these restatements are reflected in the Consolidated Financial Statements, Notes to Consolidated Financial Statements, Management's
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Discussion and Analysis of Financial Condition and Results of Operations, and Selected Financial Data for all periods reported upon in this Form 10-K. See Note 3 included in "Notes to Consolidated Financial Statements" for additional information concerning the restatement.
At December 31, 2002, Provident and its subsidiaries employed approximately 3,300 full-time-equivalent employees.
Competition
The financial services business is highly competitive with many products and services priced on a commodity basis. Provident competes actively with both national and state chartered banks, savings and loan associations, securities dealers, mortgage bankers, finance companies and other financial service entities.
Supervision and Regulation
Provident is registered as a bank holding company, and is subject to regulations of the Board of Governors of the Federal Reserve System ("Federal Reserve") under the Bank Holding Company Act of 1956 (the "BHC Act"), as amended. Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve. The BHC Act requires Federal Reserve approval of acquisitions of control of more than 5% of the voting stock or substantially all of the assets of any bank or bank holding company. The BHC Act authorizes interstate bank acquisitions anywhere in the country and allows interstate branching by acquisition and consolidation in those states that have not opted out. Ohio, Kentucky and Florida did not opt out of interstate branching.
Provident is prohibited by the BHC Act from engaging in nonbanking activities, unless such activities are determined by the Federal Reserve to be financial in nature, incidental to such financial activity, or complementary to a financial activity. The BHC Act does not place territorial restrictions on such nonbanking-related activities.
The Gramm-Leach-Bliley Act, which was enacted on November 12, 1999, imposes new privacy disclosure and "opt out" requirements on virtually all regulated financial services organizations.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989 provides that a holding company's controlled insured depository institutions can be held liable for any loss incurred by, or reasonably expected to be incurred by, the Federal Deposit Insurance Corporation ("FDIC") in connection with the default of an affiliated insured bank or savings association.
Provident's subsidiary bank, The Provident Bank, an Ohio state-chartered member bank of the Federal Reserve System, and its subsidiaries are subject to supervision and examination by applicable federal and state banking agencies, including the Federal Reserve, FDIC and the Ohio Division of Financial Institutions. One aspect of this supervision is that there are various legal and regulatory limits on the extent to which The Provident Bank may pay dividends or otherwise supply funds to Provident. In addition, federal and state regulatory agencies also have the authority to prevent a bank or bank holding company from paying a dividend or engaging in any other activity that, in the opinion of the agency, would constitute an unsafe or unsound practice. See ITEM 7 "Management's Discussion and Analysis of
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Financial Condition and Results of Operations - Liquidity" and Note 26 included in "Notes to Consolidated Financial Statements."
Federal and state laws regulate other aspects of the operations of The Provident Bank, including requiring the maintenance of cash balances against deposits, limiting the nature of loans and interest that may be charged thereon, and restricting investments and other activities.
As a regulated financial services firm, Provident's relationships and good standing with its regulators are of fundamental importance to the continuation and growth of Provident's businesses. The Federal Reserve, the FDIC, the Ohio Division of Financial Institutions, and other regulators have broad enforcement powers, and powers to approve, deny, or refuse to act upon applications or notices of Provident or its subsidiaries to conduct new activities, acquire or divest businesses or assets or reconfigure existing operations. Provident and its subsidiaries are subject to examination by various regulators which results in examination reports and ratings (which are not publicly available pursuant to regulatory rules) that can impact the conduct and growth of Provident's businesses. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. The ratings are largely at the discretion of the regulator and involve many qualitative judgments that are not as a practical matter subject to review or appeal.
State and federal banking agencies possess broad powers to take corrective action as deemed appropriate for an insured depository institution and its holding company. The extent of these powers depends upon whether the institution in question is considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Generally, as an institution is deemed to be less than well capitalized, the scope and severity of the agencies' powers increase, ultimately permitting the agency to appoint a receiver for the institution. Business activities may also be influenced by an institution's capital classification. As of December 31, 2002, Provident and The Provident Bank were deemed to be well capitalized for the above purposes. See Note 15 included in "Notes to Consolidated Financial Statements."
The monetary policies of regulatory authorities, including the Federal Reserve, have a significant effect on the operating results of banks and bank holding companies. The nature of future monetary policies and the effect of such policies on the future business and income of Provident and its subsidiaries cannot be predicted.
Red Capital Markets, Inc., a Provident Bank subsidiary, is licensed as a securities broker-dealer and is subject to regulation by the Securities and Exchange Commission, state securities authorities and the National Association of Securities Dealers, Inc. Provident Insurance Agency, Inc., a subsidiary of Red Capital Markets, is subject to regulation by state insurance authorities. Provident Investment Advisors, Inc., a Provident subsidiary, is a registered investment advisor, subject to regulation by the Securities and Exchange Commission and state securities authorities.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 2.
ITEM 2. PROPERTIES ------------------
Provident and its significant subsidiaries occupy their headquarters located at One East Fourth Street, Cincinnati, Ohio under long-term leases. Additional operation centers are leased in Cincinnati, Columbus, Cleveland, Atlanta and Sarasota. Provident owns buildings in Greater Cincinnati that contain approximately 300,000 square feet which are used for offices, data processing and warehouse facilities. Provident owns forty-one of its full-service banking center locations and leases thirty-seven. For information concerning rental obligations, see Note 7 included in "Notes to Consolidated Financial Statements."
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS -------------------------
Provident and its subsidiaries are not parties to any pending legal proceedings other than routine litigation incidental to their business except for the following matters related to the restatement announced March 5, 2003.
On March 6, 6, 11, 26 and 31 and April 3, 2003, respectively, purported class-actions were filed in the U.S. District Court for the Southern District of Ohio by shareholders Waldbaum, Merzin, McKay, Nicci, Koot (as a Provident Capital Trust holder) and Spitz, respectively against Provident, its President, Robert L. Hoverson, its Chief Financial Officer, Christopher J. Carey, and, in the Merzin, Koot, and Spitz cases, their predecessors in those positions, on behalf of all purchasers of Provident securities from March 30, 1998 through March 5, 2003. These actions are based upon circumstances involved in the restatement of earnings announced by Provident on March 5, 2003 and allege violations of federal securities laws by the defendants in Provident's financial disclosures during the period from March 30, 1998 through March 5, 2003. They seek an unspecified amount of damages and, in the cases filed by Waldbaum and McKay, reimbursement of all executive bonuses received during that period.
On March 7 and 18, 2003, respectively, derivative actions were filed by the Plumbers and Pipefitters Location 572 Pension Fund and shareholder Berg on behalf of Provident versus Provident's directors in the same court. These suits were also concerned with the restatement of earnings and allege that the defendants breached fiduciary duties owed to Provident and are responsible for the conditions that led to the restatement and its consequences and sales of stock and other actions by certain officers and directors and seek recovery from the defendants of an unspecified amount of damages. A similar action was filed in the Court of Common Pleas of Hamilton County, Ohio on March 26, 2003 by shareholder Weinstein against the directors and two officers.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ------------------------------------------------------------
None in the fourth quarter.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS -----------------------------------------------------------------------------
The Common Stock is traded on the NASDAQ Stock Market under the symbol "PFGI". The following table sets forth, for the periods indicated, the high, low and period end closing sales prices as reported on NASDAQ and the quarterly dividends paid by Provident.
2002 2001 ------------------------------------- ------------------------------------- Fourth Third Second First Fourth Third Second First Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter ----------------------------------------------------------------------------- High Close $28.05 $29.51 $31.35 $29.97 $26.29 $35.09 $33.37 $37.38 Low Close 21.48 24.28 24.42 22.17 21.41 24.90 27.06 25.88 Period End Close 26.03 25.09 29.01 28.80 26.28 25.25 32.92 28.13 Cash Dividends .24 .24 .24 .24 .24 .24 .24 .24
At March 31, 2003, there were 4,942 holders of record and an additional 11,413 non-registered or "street name" holders of Provident's Common Stock.
Provident paid dividends on its Common Stock of $47.4 million and $47.1 million during 2002 and 2001, respectively, and $0.9 million on its Preferred Stock for both years. Provident's quarterly dividend rate per share was $.24 for 2002 and 2001. It is expected that in the next several years, Provident's (Parent's) revenues will consist principally of dividends paid to it by its subsidiaries and interest generated from investing activities. A discussion of limitations and restrictions on the payment of dividends by subsidiaries to Provident is contained under ITEM 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity" and Note 26 included in "Notes to Consolidated Financial Statements."
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA --------------------------------
For Year Ended December 31, (Dollars In Millions ------------------------------------------------------------ Except Per Share Amounts) 2002 2001 2000 1999 1998 ------------------------------------------------------------------------------------------------------ Earnings: Total Interest Income $ 841 $ 973 $ 906 $ 680 $ 657 Total Interest Expense (526) (703) (662) (430) (403) -------- -------- -------- -------- -------- Net Interest Income 315 270 244 250 254 Provision for Loan and Lease Losses (99) (216) (133) (46) (29) Noninterest Income 805 757 660 537 279 Noninterest Expense (876) (813) (680) (544) (323) -------- -------- -------- -------- -------- Income (Loss) Before Income Taxes 145 (2) 91 197 181 Applicable Income Taxes (50) 1 (34) (70) (63) -------- -------- -------- -------- -------- Net Income (Loss) $ 95 $ (1) $ 57 $ 127 $ 118 ======== ======== ======== ======== ======== Per Common Share Data: Basic Earnings (Loss) $ 1.94 $ (0.04) $ 1.14 $ 2.66 $ 2.47 Diluted Earnings (Loss) 1.88 (0.04) 1.12 2.58 2.38 Dividends Paid .96 .96 .96 .88 .80 Book Value 17.91 16.15 18.79 17.89 16.30
Selected Balances at December 31: Total Investment Securities 4,215 3,486 3,014 2,111 1,598 Total Loans and Leases 9,134 8,950 7,996 6,634 5,879 Reserve for Loan and Lease Losses 201 241 159 95 80 Leased Equipment 2,350 2,651 2,386 1,807 1,207 Total Assets 17,540 16,561 14,997 11,849 9,576 Noninterest Bearing Deposits 1,142 995 1,293 1,185 679 Interest Bearing Deposits 8,707 7,859 7,536 6,045 5,277 Long-Term Debt and Junior Subordinated Debentures 4,294 4,532 4,353 2,515 1,764 Total Shareholders' Equity 880 802 924 877 777 Off-Balance Sheet Managed Assets 2,068 3,138 4,621 4,641 2,571
Other Statistical Information: Return on Average Assets 0.58% -0.01% 0.42% 1.20% 1.29% Return on Average Equity 11.27 (0.11) 6.32 16.20 15.45 Dividend Payout Ratio 50.64 n/m 84.43 32.36 32.19
Capital Ratios at December 31: Total Equity to Total Assets 5.02% 4.84% 6.16% 7.40% 8.12% Tier 1 Leverage Ratio 7.81 6.65 8.21 9.67 8.43 Tier 1 Capital to Risk-Weighted Assets 9.40 7.95 8.56 8.57 8.24 Total Risk-Based Capital to Risk-Weighted Assets 11.43 10.71 10.60 10.82 10.85
Loan Quality Ratios at December 31: Reserve for Loan and Lease Losses to Total Loans and Leases 2.20% 2.69% 1.99% 1.43% 1.36% Reserve for Loan and Lease Losses to Nonaccrual Loans 120.80 136.35 165.71 170.98 178.09 Nonaccrual Loans to Total Loans and Leases 1.82 1.98 1.20 0.84 0.77 Net Charge-Offs to Average Total Loans and Leases 1.59 1.63 1.04 0.51 0.42
-------------------- n/m - not meaningful
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ----------------------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------
Introduction
Provident Financial Group, Inc. ("Provident") is a holding company for The Provident Bank (the "Bank"), an FDIC member bank. Major business lines are: Commercial Banking, a provider of credit products and cash management services to commercial customers; Retail Banking, a provider of consumer loans and leases, deposit accounts, trust, brokerage and investment products and services; and Mortgage Banking, an originator and servicer of conforming and nonconforming residential loans to consumers and short-term financing to mortgage originators and brokers.
RESTATEMENT OF FINANCIAL RESULTS
On March 5, 2003, Provident announced that it would restate its operating results for the years 1997 through 2001 and the interim periods for 2002. The restatement of previously reported operating results were attributed to unintentional errors in the accounting for nine auto lease financing transactions originated between 1997 and 1999. The errors that existed in the accounting for these transactions were first discovered by internal finance staff in connection with the testing and installation of a financial model that identified differences in income that was originally recorded, compared with the income generated by the financial model.
A review of the accounting for the nine transactions also concluded that none of the transactions should have been reported as off-balance sheet leases. The appropriate accounting was to report the transactions as on-balance sheet leases with all assets and related liabilities included on the balance sheet.
Provident's audit committee, through legal counsel, engaged the accounting firm of PricewaterhouseCoopers LLP on March 12, 2003 for the purpose of conducting a review of the company's restatement. Provident's management affirmed, based upon the review of its advisors, its prior conclusion that the accounting errors that led to the restatement were unintentional.
However, another issue surfaced as a result of the independent review. Provident has historically recorded its auto leases as direct finance leases. This matches interest income with interest expense and is similar to how Provident records all of its loans. Provident has now determined that its auto leases do not meet the requirements for direct finance lease classification under Financial Accounting Standards No. 13, titled "Accounting for Leases."
Since 1994, an important factor Provident has relied upon in determining the classification of its auto lease portfolio has been its residual value insurance. In general, Provident has obtained residual value insurance for its auto leases on a pool basis by year of origination. Its insurance is commonly referred to as "capped" insurance. Provident has now determined that this type of insurance coverage, while effective in removing residual risk, does not result in direct finance lease classification for its auto leases.
As a result, Provident has reclassified all of the auto leases on its balance sheet as operating leases and reported them as leased equipment, instead of
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
finance leases, which were previously reported in the loan category. The reclassification will affect auto leases originated from 1994 through 2002. During this period, the company's auto lease originations totaled $4.7 billion and had a remaining balance of $2.1 billion at December 31, 2002. Income to be recognized in future years, beginning with 2003, will be increased by an aggregate amount substantially similar to the additional restatement. In addition, this restatement has no impact on Provident's cash flows.
The results of the restatement are reflected in the Consolidated Financial Statements, Notes to Consolidated Financial Statements, this Management's Discussion and Analysis of Financial Condition and Results of Operations, and Selected Financial Data for all periods reported upon in this Form 10-K. See Note 3 included in "Notes to Consolidated Financial Statements" for additional information concerning the restatement.
RESULTS OF OPERATIONS
Performance Summary
The following table summarizes three-year financial data for Provident, along with calculated variances from the prior year:
Percentage Year Ended December 31, Increase (Decrease) (Dollars in Millions ---------------------------------------------------------- Except Per Share Data) 2002 2001 2000 2002/01 2001/00 --------------------------------------------------------------------------------------------------- Net Interest Income $ 315 $ 270 $ 244 17% 11% Noninterest Income 805 757 660 6 15 Total Revenue 1,120 1,027 904 9 14 Provision for Loan and Lease Losses 99 216 133 (54) 62 Noninterest Expense 876 813 680 8 20 Net Income 95 (1) 57 - (102) Total Loans and Leases 9,134 8,950 7,996 2 12 Leased Equipment 2,350 2,651 2,386 (11) 11 Total Assets 17,540 16,561 14,997 6 10 Total Off-Balance Sheet Managed Assets 2,068 3,138 4,621 (34) (32) Total Deposits 9,849 8,854 8,829 11 0 Long-Term Debt and Junior Subordinated Debentures 4,294 4,532 4,353 (5) 4 Stockholders' Equity 880 802 924 10 (13) Per Common Share: Book Value 17.91 16.15 18.79 11 (14) Diluted Earnings (Loss) 1.88 (0.04) 1.12 - - Ratio Analysis: Net Interest Margin 2.41% 2.19% 2.40% Return on Average Equity 11.27% -0.11% 6.32% Return on Average Assets 0.58% -0.01% 0.42% Average Equity to Average Assets 5.12% 5.59% 6.70% Dividend Payout to Net Earnings 50.64% n/m 84.43%
-------------------- n/m - not meaningful
Provident reported net income (loss) of $95.5 million, ($1.0) million and $56.5 million for 2002, 2001 and 2000, respectively. Earnings (loss) per diluted share was $1.88 for 2002, compared to ($0.04) for 2001 and $1.12 for 2000. Return on average equity was 11.27%, (0.11%) and 6.32% and return on average assets was 0.58%, (0.01)% and 0.42% for the three years ended 2002, 2001 and 2000, respectively.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net income and financial performance ratios improved for 2002 as compared to 2001 due primarily to lower credit charges. The provision for loan and lease losses decreased $116.0 million, while other credit costs (included in noninterest expense) representing charges for the write-down of foreclosed property and leased equipment decreased $17.4 million. The higher than normal provision and credit-related costs in 2001 were due primarily to the weakened economy and the events of September 11, 2001. Although the economy remained sluggish during 2002, credit-related volatility began to stabilize. As a result of the improved loan quality outlook and the charge-off of several loans and leases that had been part of the year-end 2001 loan loss reserve, Provident lowered its loan loss reserve ratio from 2.69% to 2.20% during 2002.
The lower net income and financial performance ratios for 2001 as compared to 2000 were principally the result of two factors. First, earnings were affected by adverse economic conditions as well as the negative impact the September 11 events had on the airline industry. During the second half of 2001, Provident recorded additional credit costs and other expenses of $81 million related to the events of September 11 of which $66 million were for secured commercial airline loans and leases and $15 million were for other industry loans and leases. In light of Provident's analyses of its lending portfolio and changes in asset quality indicators, as reflected by higher charge-offs, declining credit quality ratios and the uncertain economic environment, Provident increased its loan loss reserve ratio from 1.99% to 2.69% during 2001.
A second reason for lower earnings in 2001 was management's decision to change the structure of its securitizations to secured financings, eliminating the use of gain-on-sale accounting. The switch to secured financing structures, which was made during the third quarter of 2000, does not affect the total profit Provident will recognize over the life of a loan, but rather impacts the timing of income recognition. Secured financing transactions, on a comparative basis, cause reported earnings from securitized loans to be lower in the initial periods and higher in later periods, as interest is earned on the loans. No gains were recognized from securitization transactions during 2001 while $44 million was recognized during 2000.
Revenue (net interest income plus noninterest income) increased 9% during 2002 over 2001 and 14% during 2001 over 2000. Net interest income increased $45 million, or 17%, for 2002 compared to 2001, after increasing $27 million, or 11%, in 2001 compared to 2000. Higher net interest income was primarily the result of growth in the investment portfolio for 2002 and in the lending portfolio for 2001. Noninterest income increased $49 million in 2002 while increasing $96 million in 2001. The increase in noninterest income during 2002 and 2001 was primarily the result of an increase in leasing income in both years. Gain on sales of loans and leases, a component of noninterest income, was $15.7 million, $6.3 million and $44.9 million for 2002, 2001 and 2000, respectively. The increase for 2002 was primarily the result of gains recognized from whole-loan sales (without recourse) of residential loans, while the decrease for 2001 resulted from management's decision to restructure securitizations as secure financings and thereby eliminate the use of gain-on-sale accounting as was employed in 2000.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Total noninterest expense was $876 million, $813 million and $680 million for 2002, 2001 and 2000, respectively. Included in 2000 is $39.3 million for merger and restructuring charges related to the acquisition of Fidelity Financial of Ohio and other post-merger business line restructurings. The increase in noninterest expense during 2002 was primarily the result of three activities. First, Provident is investing in businesses where strong growth opportunities exist, including middle market commercial lending, middle market equipment leasing and mortgage servicing. Also, significant investments continue to be made within the credit and risk management functions. Offsetting these increases were lower write-downs of foreclosed properties and leased equipment. The increase in noninterest expense during 2001 was primarily the result of an increase in leasing expense. Noninterest expense during 2001 was also impacted by activities of Red Capital Group, which was acquired in the second half of 2000, and additional investments being made within existing businesses where growth opportunities exist.
Total assets at December 31, 2002, 2001 and 2000 were $17.5 billion, $16.6 billion and $15.0 billion, respectively. Total assets increased during 2002 primarily as a result of an increase in investment securities, middle market equipment lease financing and home equity loans. Partially offsetting these increases were reductions in nonconforming residential loans, structured finance loans, large equipment leases and auto leases. The fluctuations in these loan and lease balances reflect management's decision to lower the risk profile of its loan and lease portfolio. The growth for 2001 was primarily the result of the decision to hold loans and leases originated during the first half of 2001 on the balance sheet.
Nonperforming assets at December 31, 2002 decreased from year-end 2001, while year-end 2001 significantly increased from year-end 2000. The ratio of nonperforming assets to total assets was 1.04%, 1.19% and 0.70% as of December 31, 2002, 2001 and 2000, respectively. The changes in nonperforming asset levels and other asset quality indicators resulted in decisions to lower the ratio of reserve for loan and lease losses to total loans and leases by 49 basis points to 2.20% as of December 31, 2002, and increase the ratio by 70 basis points to 2.69% as of year-end 2001.
Total deposits for 2002, 2001 and 2000 were $9.8 billion, $8.9 billion and $8.8 billion, respectively. Commercial deposits increased 68% to $1.1 billion during 2002 while retail deposits increased 16% to $5.6 billion during 2001. Offsetting the increase in retail deposits was a decrease in securitization trust deposits held as credit enhancements, which were released during 2001.
Shareholders' equity at December 31, 2002, 2001 and 2000 was $880 million, $802 million and $924 million, respectively. The increase in shareholders' equity during 2002 was due principally to earnings exceeding dividends paid and an increase in the mark-to-market on investment securities. The decrease in shareholders' equity during 2001 was primarily the result of the adoption of the provisions of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" and dividends paid.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Business Initiatives
During the past two years, Provident's profitability has been significantly impacted by the downturn in the nation's economy and the resulting credit deterioration of its lending portfolio. In order to compete effectively in today's economy and grow shareholder value, Provident's goal is to become a lower risk company engaged in achieving predictable and profitable long-term earnings growth. Examples of how this goal is being achieved follows:
o Discontinued or De-emphasized Higher Risk Lending Products: Provident is reducing or exiting businesses with higher credit risk and where the benefits received do not justify the risks taken. Provident has de-emphasized both its Structured Finance business unit and its Nonconforming Residential Lending Portfolio. Structured Finance provided senior debt to support leveraged financings including management buyouts, recapitalizations, acquisitions and business expansions. While Provident continues to originate nonconforming residential loans, these loans are no longer being held, but are sold with no retained recourse (credit risk). These loans are being sold to third-parties whereby Provident recognizes a gain on the sale and sometimes ongoing loan servicing fees.
Lending businesses where originations have been significantly reduced include Large Equipment Leasing and Auto Leasing business units. Large Equipment Leasing is the financing of assets such as corporate and commercial aircraft, construction, distribution, manufacturing and mining equipment, as well as transportation equipment including trucks, tractors and freight containers. Auto lease originations have also been significantly reduced due to the overall complexity of the business and its thin margins. Management believes that capital could be better deployed elsewhere.
o Expansion of Lower Risk Lending Products: Funding formerly used in the higher risk areas noted above is being re-deployed toward lending products which have lower credit risk and less volatile earnings. Provident is currently expanding its Regional Commercial Banking, Middle Market Equipment Leasing, and Prime Home Equity business units. Each of these business units are viewed by management as being areas of expertise for Provident with lower risk profiles and where growth opportunities exist.
o Monitoring of Risk: Over the past year, Provident has significantly enhanced its monitoring of risk within the company. The Credit and Risk Management Group is responsible for establishing the framework for managing and overseeing Provident's credit, operational and compliance risks. Accomplishments within this area include improved and expanded credit policies, implementation of an expanded risk rating system and updated credit risk factors, as well as the addition of portfolio and information specialists, retail analytics staff and centralized risk management operation units. This has resulted in the timely resolution of credit issues, improved credit quality and improved reporting, analysis and forecasting of the credit quality of the lending portfolio.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
o Expansion of Fee Revenue Businesses: Provident is also investing in businesses that generate fee income. These businesses provide Provident with a steady stream of income, with lower risk, while utilizing lower levels of capital. Businesses which fit this description include Red Capital Group, Capstone and Mortgage Banking. Each of these businesses provide a platform to generate fee income from originating, selling and servicing of commercial and residential mortgage loans.
o Higher Concentration of Transaction Deposits: Stronger efforts are being made to obtain low-cost transaction deposits. Included in these efforts is the offering of a no fee deposit account product, improved service and delivery processes, the use of "Vista", a state-of-the-art contact management and relationship building software tool, in all branches, increased training and enhanced incentive plans for branch associates, expanded focus on commercial lending relationships to include their deposit business, and improved internet banking capabilities.
Business Lines
The following table provides selected financial information by lines of business for the past three years:
Percentage Increase (Decrease) ------------------- (Dollars in Millions) 2002 2001 2000 2002/01 2001/00 ------------------------------------------------------------------------------ Total Revenue: Commercial Banking $ 366.7 $ 373.5 $ 301.1 (2)% 24 % Retail Banking 636.2 566.9 506.5 12 12 Mortgage Banking 107.4 86.5 96.4 24 (10) Corporate Center 10.8 - .2 - (100) --------- ----------- --------- $ 1,121.1 $ 1,026.9 $ 904.2 9 % 14 % ========= =========== ========= Net Income: Commercial Banking $ 57.7 $ (0.8) $ 60.8 - % - % Retail Banking 27.1 6.0 19.9 352 (70) Mortgage Banking 9.5 (6.2) 2.7 - - Corporate Center 1.2 - (26.9) - - --------- ----------- --------- $ 95.5 $ (1.0) $ 56.5 - % - % ========= =========== ========= Average Assets: Commercial Banking $ 7,039 $ 6,896 $ 5,457 2 % 26 % Retail Banking 4,694 4,389 3,618 7 21 Mortgage Banking 1,597 2,075 1,248 (23) 66 Corporate Center 3,208 2,688 3,042 19 (12) --------- ----------- --------- $ 16,538 $ 16,048 $ 13,365 3 % 20 % ========= =========== =========
Key components of the management reporting process follow: o Risk-Based Equity Allocations: Provident uses a comprehensive approach for measuring risk and making risk-based equity allocations. Risk measurements are applied to credit, operational and other corporate-level risks. o Transfer Pricing: Provident utilizes a matched funded transfer pricing methodology that in most cases isolates the business units from fluctuations in interest rates, and provides management with the ability to measure business unit, product and customer level profitability based on the financial characteristics of the products rather than the level of interest rates.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
o Provision for Loan and Lease Losses: Business lines are charged for provision based upon its level of net charge-offs as well as the size and composition of its lending portfolio. o Cost Allocations: Provident applies a detailed approach to allocating costs at the business unit, product and customer levels. Allocations are generally based on volume/activity and are reviewed and updated regularly. o "Corporate Center": Corporate Center includes balance sheet and income statement items not related to the primary business lines, and gain/loss on the sale of investment securities.
Business line descriptions and analyses follow:
o Commercial Banking provides a broad range of commercial banking and commercial real estate products and services. Areas of focus and expertise include regional middle market lending, equipment leasing and financing, cash management, and loan servicing, transaction structuring and commercial mortgage banking services for the multi-family housing industry.
Net income for Commercial Banking for the years ending December 31, 2002, 2001 and 2000 was $57.7 million, ($0.8) and $60.8 million, respectively. The fluctuation in net income can be primarily attributed to provision and other credit-related charges. Commercial Banking performed well during the first three quarters of 2000. Asset growth was strong and income benefited from gains recognized from the securitization of equipment leases. However, during the fourth quarter of 2000, Commercial Banking began to feel the impact of a slowing economy. During that quarter, Commercial Banking took several large charge-offs and placed additional loans on nonaccrual which significantly reduced income. The condition of the economy continued to decline during 2001 which was accentuated by the impact of the events of September 11, 2001. The majority of the decline in income during 2001 was related to credit write-offs and residual impairments from loans and leases to the commercial airline industry. In addition, net income was reduced as a result of a higher level of loan loss reserve to total loans and the change in securitization structures which eliminated gain-on-sale accounting. Although the economy has not recovered, credit related volatility declined during 2002. Commercial Banking benefited from lower provision and other credit related charges during 2002 as compared to 2001.
As a result of earnings volatility, management is repositioning this business line so it can grow with a more predictable earnings pattern. Management is de-emphasizing its higher credit risk areas of structured finance lending and large equipment leasing while growing its lower credit risk areas of middle market leasing and regional middle market commercial lending units.
Provident is also investing in businesses that generate fee income. These businesses provide a steady stream of income with reduced risk while utilizing lower levels of capital. One such business, Red Capital Group, provides a platform to generate fee income from originating, selling and servicing commercial mortgage loans. Red Capital's revenue has increased 30% and net income has increased 40% in 2002 compared to 2001.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
o Retail Banking provides a variety of banking and investment products and services to retail consumers and businesses. Services are delivered through various delivery channels including Financial Centers, ATMs, telephone and the internet. Primary operating areas include Consumer and Small Business Banking, Home Equity Lending, and Provident Financial Advisors.
Net income for Retail Banking was $27.1 million, $6.0 million and $19.9 million for the years ended December 31, 2002, 2001 and 2000, respectively. Net income increased during 2002 primarily as a result of increased net interest income on deposits and lower provision for loan and lease losses. The lower provision was due to slower loan growth and a lower level of loan loss reserves as compared to 2001. The decrease in net income for 2001 was related primarily to higher loan loss provision and lower gain on sales of loans revenue. The higher provision was due to higher loan growth and a higher level of loan loss reserves as compared to 2000.
Loans and auto leases for Retail Banking were flat during 2002 and increased 19% during 2001. An increase in home equity loans was offset by a decrease in auto leases during 2002. Both home equity loans and auto leases increased in 2001. Retail Banking is expanding its home equity product line to lower the overall risk profile of its lending portfolio. Auto leasing is being de-emphasized as it is a complex business with thin margins.
Retail Banking has experienced growth in deposits during both 2002 and 2001. Average retail deposits grew by 7% during 2002 and 14% during 2001. Deposit growth in 2002 came primarily from growth in transaction accounts. Overall, the growth during 2002 was slower than 2001 because of less aggressive pricing on retail certificates of deposit. Provident plans to further enhance its distribution system to improve customer acquisition and market penetration.
o Mortgage Banking offers traditional and non-traditional residential mortgage loans to consumers, and also provides fee-based loan processing, loan warehousing and servicing for third party originators. Loans are originated through retail and broker channels and are sold on a whole-loan basis. Whole-loan sales refer to the transfer of credit risk along with the payment stream of the loan. Primary operating areas include Mortgage Services, Warehouse Lending Services and the National Servicing Center.
Net income for 2002 was $9.5 million as compared to a net loss of $6.2 million for 2001 and net income of $2.7 million for 2000. Net income for 2002 rose primarily from increased activity in warehouse lending production, the sub-servicing portfolio, and whole-loan sales. Loans serviced for others increased from $0.4 billion at December 31, 2001 to $5.1 billion at December 31, 2002 as Mortgage Banking added significant levels of servicing portfolios during 2002. Gains of $13.7 million were recognized from nonconforming residential whole-loan sales during 2002 compared to $3.2 million during 2001. The net loss reported for 2001 was driven by the decision to change the structure of securitizations resulting in the elimination of gain-on-sale accounting. This decision resulted in no gain on sales of securitized loans being recognized during 2001 as compared to pre-tax gains of $30.3 million being recognized during 2000. Partially offsetting the lack of gain on sales was an increase in net interest income as loans originated during the first half of 2001 remained on the balance sheet.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Mortgage Banking, in following the overall company strategy of risk reduction, continues to implement strategic initiatives to reduce the business' risk profile. Nonconforming loan originations have been sold to investors on a whole-loan basis. Mortgage Banking has also developed new businesses to create a diverse array of product offerings in the mortgage market. Mortgage Banking is continuing with its strategy of building national mortgage alliances in order to generate qualified leads for home mortgage loans on a nationwide basis and sell them to investors.
Related Party Transactions
Provident, in its normal course of business, has had transactions with its directors, officers, principal shareholders and affiliates including American Financial Group, Inc. and its subsidiaries. All such transactions are on terms no less favorable to Provident than those which could be obtained with non-affiliated parties. These transactions include the leasing of its corporate headquarters and additional office space, insurance coverage, record retention services, guard services, extensions of credit, and maintaining investments of commercial paper, repurchase agreements and deposit accounts. For details concerning these transactions, see Note 24 of the "Notes to Consolidated Financial Statements."
Net Interest Income
Net interest income equals the difference between interest earned on loans, leases and investments and interest incurred on deposits and other borrowed funds. Net interest income is affected by changes in both interest rates and the amounts of interest earning assets and interest bearing liabilities outstanding.
Net interest income represents a principal source of income for Provident. In 2002, 2001 and 2000, net interest income on a taxable equivalent basis was $315.7 million, $270.6 million and $243.7 million, respectively.
Net interest margin represents net interest income as a percentage of average interest earning assets. The net interest margin was 2.41%, 2.19% and 2.40% for 2002, 2001 and 2000, respectively.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table provides an analysis of net interest income and illustrates the interest income earned and interest expense charged for each major component of interest earning assets and interest bearing liabilities. The net interest spread is the difference between the average yield earned on assets and the average rate incurred on liabilities. For comparative purposes, the table has been adjusted to reflect tax-exempt income on a fully taxable equivalent basis assuming an income tax rate of 35%. Nonaccrual loans are included in the loans and lease categories.
Year Ended December 31, -------------------------------------------------------------------------------------------- 2002 2001 2000 ----------------------------- ---------------------------- ----------------------------- Average Income/ Avg. Average Income/ Avg. Average Income/ Avg. (Dollars in Millions) Balance Expense Rate Balance Expense Rate Balance Expense Rate --------------------------------------------------------------------------------------------------------------------------- ASSETS Interest Earning Assets: Loans/Leases: Corporate Lending: Commercial $ 4,312 $ 273.4 6.34% $ 4,655 $ 377.2 8.10% $ 4,345 $ 426.7 9.82% Mortgage 909 56.5 6.22 864 69.2 8.02 667 61.1 9.17 Construction 546 24.6 4.51 570 40.5 7.10 601 54.3 9.03 Lease Financing 1,199 109.9 9.16 958 92.4 9.65 378 37.5 9.92 Consumer Lending: Installment 1,054 65.4 6.21 774 68.7 8.87 515 51.6 10.02 Residential 737 70.6 9.59 1,008 99.9 9.91 388 42.3 10.90 -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Loans/Leases 8,757 600.4 6.86 8,829 747.9 8.47 6,894 673.5 9.77 Investment Securities 3,882 217.7 5.61 3,158 204.5 6.47 3,217 227.8 7.08 Federal Funds Sold and Reverse Repurchase Agreements 125 3.4 2.71 92 4.2 4.59 23 1.5 6.51 Other Short-Term Investments 341 20.0 5.85 297 16.8 5.66 30 2.8 9.28 -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Earning Assets 13,105 841.5 6.42% 12,376 973.4 7.86% 10,164 905.6 8.91% Cash and Noninterest Bearing Deposits 255 255 241 Leased Equipment 2,477 2,491 2,040 Other Assets 701 926 920 -------- -------- -------- Total Assets $ 16,538 $ 16,048 $ 13,365 ======== ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Interest Bearing Liabilities: Deposits: Demand Deposits $ 696 9.8 1.40% $ 484 12.1 2.50% $ 370 9.9 2.68% Savings Deposits 1,472 29.0 1.97 1,548 56.5 3.65 1,379 68.5 4.97 Time Deposits 6,134 223.4 3.64 5,828 317.8 5.45 4,838 301.9 6.24 -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Deposits 8,302 262.2 3.16 7,860 386.4 4.92 6,587 380.3 5.77 Short-Term Debt: Federal Funds Purchased and Repurchase Agreements 1,182 30.3 2.56 1,156 46.8 4.05 1,208 74.5 6.17 Commercial Paper 280 5.3 1.91 229 9.0 3.92 203 12.3 6.04 -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Short-Term Debt 1,462 35.6 2.44 1,385 55.8 4.03 1,411 86.8 6.15 Long-Term Debt 3,990 204.7 5.13 3,877 230.1 5.93 2,789 174.8 6.27 Junior Subordinated Debentures 451 23.3 5.16 422 30.5 7.24 235 20.0 8.53 -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Interest Bearing Liabilities 14,205 525.8 3.70% 13,544 702.8 5.19% 11,022 661.9 6.01% Noninterest Bearing Deposits 945 1,220 1,215 Other Liabilities 541 387 233 Shareholders' Equity 847 897 895 -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Liabilities and Shareholders' Equity $ 16,538 $ 16,048 $ 13,365 ======== ======== ======== Net Interest Income $ 315.7 $ 270.6 $ 243.7 ======= ======= ======= Net Interest Margin 2.41% 2.19% 2.40% ==== ==== ==== Net Interest Spread 2.72% 2.67% 2.90% ==== ==== ====
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table shows the changes in net interest income on a tax equivalent basis resulting from changes in volume and changes in rates. Changes not solely due to volume or rate have been allocated proportionately.
Year Ended December 31, ------------------------------------------------ 2002 Changes from 2001 Changes from 2001 Due to 2000 Due to ---------------------- ---------------------- (In Thousands) Volume Rate Volume Rate ---------------------------------------------------------------------------------- Interest Earned On: Loans and Leases: Corporate Lending: Commercial $ (26,271) $ (77,508) $ 28,921 $ (78,502) Mortgage 3,449 (16,189) 16,463 (8,364) Construction (1,681) (14,192) (2,684) (11,087) Lease Financing 22,311 (4,845) 55,989 (1,064) Consumer Lending: Installment 20,724 (23,977) 23,526 (6,504) Residential (26,138) (3,179) 61,856 (4,179) --------- --------- --------- --------- Net Loans and Leases (7,606) (139,890) 184,071 (109,700) Investment Securities 42,933 (29,647) (4,109) (19,239) Federal Funds Sold and Reverse Repurchase Agreements 1,217 (2,068) 3,309 (554) Short-Term Investments 2,529 594 15,514 (1,514) --------- --------- --------- --------- Total 39,073 (171,011) 198,785 (131,007) --------- --------- --------- --------- Interest Paid On: Demand Deposits 4,136 (6,441) 2,882 (708) Savings Deposits (2,643) (24,864) 7,691 (19,727) Time Deposits 15,968 (110,354) 56,971 (41,079) --------- --------- --------- --------- Total Deposits 17,461 (141,659) 67,544 (61,514) Short-Term Debt: Federal Funds Purchased and Repurchase Agreements 1,016 (17,567) (3,107) (24,555) Commercial Paper 1,695 (5,321) 1,392 (4,708) --------- --------- --------- --------- Total Short-Term Debt 2,711 (22,888) (1,715) (29,263) Long-Term Debt 6,560 (31,879) 64,954 (9,654) Junior Subordinated Debentures 1,974 (9,251) 13,944 (3,426) --------- --------- --------- --------- Total 28,706 (205,677) 144,727 (103,857) --------- --------- --------- --------- Net Interest Income $ 10,367 $ 34,666 $ 54,058 $ (27,150) ========= ========= ========= =========
Noninterest Income
The following table details the components of noninterest income and their change since 2000:
Percentage Increase (Decrease) -------------------- (Dollars in Thousands) 2002 2001 2000 2002/01 2001/00 -------------------------------------------------------------------------------------------- Service Charges on Deposit Accounts $ 45,184 $ 39,924 $ 35,138 13% 14% Loan Servicing Fees 33,835 33,026 37,849 2 (13) Commercial Mortgage Banking Revenue 25,354 29,490 5,674 (14) 420 Other Service Charges and Fees 48,563 38,833 49,108 25 (21) Leasing Income 605,887 584,065 461,209 4 27 Gain on Sales of Loans and Leases: Non-Cash - - 34,447 - (100) Cash 15,691 6,311 10,452 149 (40) Warrant Gains 8,186 412 7,500 1,887 (95) Security Gains 2,596 - 155 - (100) Other 20,196 24,375 19,084 (17) 28 -------- -------- -------- Total Noninterest Income $805,492 $756,436 $660,616 7% 15% ======== ======== ========
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Explanations for significant changes in noninterest income by category follow:
o Service Charges on Deposit Accounts: Increases in overdraft fees and service charges on corporate deposit accounts were the primary reasons for the increase in service charges on deposit accounts in 2002. The increase in 2001 was primarily the result of pricing and volume increases on corporate and consumer deposit accounts and higher ATM interchange fees.
o Loan Servicing Fees: Loan servicing fees were stable during 2002 as decreases in fees from servicing securitized residential mortgage and credit card portfolios were offset by increases in fees from servicing multi-family loans by Red Capital Group and residential mortgage loans by Mortgage Banking. Loan servicing fees decreased during 2001 due primarily to a decrease in fees from warehouse lending and the servicing of securitized residential mortgages, which more than offset an increase in the servicing of multi-family loans. Total loans serviced for others at December 31, 2002, 2001 and 2000 were $17.5 billion, $12.5 billion and $10.1 billion.
o Commercial Mortgage Banking Fees: A decrease in commercial mortgage banking fees from Red Capital Group was the primary reason for the decrease in 2002. The increase in 2001 was due primarily to an increase in fees from Red Capital Group, which was acquired in September of 2000.
o Other Service Charges and Fees: Other service charges and fees increased during 2002 due primarily to an increase in other fee income generated from Mortgage Banking and funds management fees, more than offsetting a decrease in credit card fees. Other service charges and fees decreased during 2001 due primarily to decreases in credit card fees, funds management fees and other miscellaneous fees.
o Leasing Income: Leasing income increased during 2002 and 2001 due primarily to increases in income from auto leases. Income from auto leases increased $26 million during 2002 and $123 million during 2001 and accounted for more than 92% of leasing income during 2002, 2001 and 2000. Income from auto leasing has increased primarily because of the increase in size of the auto lease portfolio since 1999.
o Warrant Gains: Provident's Commercial Banking business line from time to time acquires equity warrants as a part of the lending fee structure established with customers. Warrant gains totaled $8.2 million for 2002 as compared to $0.4 million and $7.5 million for years 2001 and 2000, respectively.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
o Gain on Sales of Loans and Leases: Gain on sales of loans and leases increased $9.4 million in 2002, due primarily to gains recognized from the sale of nonconforming residential mortgage loans on a whole-loan basis, a strategy that Provident implemented during the third quarter of 2001. The $38.6 million decrease in 2001 was a result of the third quarter of 2000 decision to change the structure of securitizations resulting in the elimination of gain-on-sale accounting. The following table provides detail of the gain on sales recognized during the past three years.
(In Thousands) 2002 2001 2000 ------------------------------------------------------------------------------ Non-Cash Gains -- Loan and Lease Sales: Nonconforming Residential Loan Securitizations $ - $ - $30,291 Prime Consumer Home Equity Securitizations - - 4,156 ------- ------- ------- - - 34,447 ------- ------- ------- Cash Gains -- Loan and Lease Sales: Equipment Lease Securitizations - - 9,083 Nonconforming Residential Whole-Loan Sales 13,698 3,177 - Conforming Residential Whole-Loan Sales 712 1,544 729 Other Loan Sales 1,281 1,590 640 ------- ------- ------- 15,691 6,311 10,452 ------- ------- ------- $15,691 $ 6,311 $44,899 ======= ======= =======
A detailed discussion of the various securitizations of loans and leases is provided under the "Management's Discussion and Analysis of Financial Condition and Results of Operations - Off-Balance Sheet and Derivative Arrangements" and in Note 20 included in "Notes to Consolidated Financial Statements."
o Other: The decrease in other income during 2002 was due primarily to a decrease in income from equity investments. The increase in 2001 was due primarily to increases in income from equity investments and trading account activity.
Noninterest Expense
The following table details the components of noninterest expense and their change since 2000:
Percentage Increase (Decrease) ------------------ (Dollars in Thousands) 2002 2001 2000 2002/01 2001/00 --------------------------------------------------------------------------------------- Salaries, Wages and Benefits $233,178 $201,715 $172,903 16% 17% Charges and Fees 30,531 31,888 22,099 (4) 44 Occupancy 23,637 22,605 20,631 5 10 Leasing Expense 416,508 402,372 300,711 4 34 Equipment Expense 24,345 25,234 26,045 (4) (3) Professional Fees 25,990 24,507 21,735 6 13 Minority Interest Expense 7,069 - - - - Merger and Restructuring Charges - - 39,300 - (100) Other 114,770 104,663 76,977 10 36 -------- -------- -------- Total Noninterest Expense $876,028 $812,984 $680,401 8% 20% ======== ======== ========
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Components of noninterest expense, along with an explanation as to their fluctuations, follow:
o Salaries, Wages and Benefits: Compensation increased in 2002 due primarily to increased staffing and incentive pay in areas where opportunities for growth exist, such as middle market commercial lending, middle market equipment leasing and mortgage servicing. Expense also increased within the Credit and Risk Management Group as staff was added to better monitor and control the overall risk of Provident, particularly credit risk within the lending portfolio. Compensation increased in 2001 due to increased commissions and staffing expenses associated with growth in the Commercial Banking business line, primarily Red Capital Group.
o Charges and Fees: Charges and fees decreased in 2002 as the decrease in goodwill amortization expense more than offset the increase in expenses related to credit risk transfer transactions. Charges and fees increased in 2001 due primarily to expenses related to credit risk transfer transactions. Details concerning goodwill amortization and credit transfer transactions are provided in Notes 7 and 21, respectively, included in "Notes to Consolidated Financial Statements."
o Occupancy: Increases in depreciation expense, guard services and utilities were the primary reasons for higher occupancy expense in 2002. An increase in rent expense, reflecting the geographic expansion of Commercial Banking, was the primary reason for higher occupancy expense in 2001.
o Leasing Expense: An increase in depreciation expense was the primary reason for the increase in leasing expense for both 2002 and 2001. Depreciation on auto leases is the primary component of depreciation expense. Depreciation expense has increased primarily because of the increase in size of the auto lease portfolio since 1999. Included in lease expense was a $20 million write-down in residual values related to aircraft leases that occurred in the third quarter of 2001 and a $5.7 million impairment charge on uninsured auto lease residual values in the fourth quarter of 2001. The deterioration in residual values of aircraft was a result of the terrorist actions of September 11, 2001 and its financial impact on the airline industry.
o Equipment Expense: Equipment expense decreased in 2002 due primarily to a reduction in depreciation expense. The decrease in equipment expense in 2001 was due primarily to reductions in maintenance and equipment rental expenses.
o Professional Fees: Professional fees increased in both 2002 and 2001 due primarily to legal, consulting and other professional fees related to loan collections.
o Minority Interest Expense: Minority interest expense relates to dividends payable on $165 million of Preferred Stock of PFGI Capital Corporation, a real estate investment trust that was formed late in the second quarter of 2002. The dividends are payable at an annualized rate of 7.75%. Additional information on minority interest may be found on Note 13 of "Notes to Consolidated Financial Statements."
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
o Merger and Restructuring Charges: In connection with Provident's acquisition of Fidelity Financial of Ohio, Inc., direct-merger related and other post-merger business line restructuring charges of $39.3 million were recorded during the first quarter of 2000.
o Other: Larger expenses included within other noninterest expense include marketing ($11.0 million, $9.2 million and $9.1 million in 2002, 2001, and 2000, respectively), travel ($8.9 million, $9.0 million and $8.2 million in 2002, 2001 and 2000, respectively), franchise taxes ($7.0 million, $8.5 million and $8.1 million in 2002, 2001 and 2000, respectively), data processing expense ($7.8 million, $5.6 million and $5.7 million in 2002, 2001 and 2000, respectively), insurance expense ($13.1 million, $10.4 million and $8.3 million in 2002, 2001 and 2000, respectively), and the write-down in value of repossessed aircraft ($4.0 million in 2001).
FINANCIAL CONDITION
Short-Term Investments and Investment Securities
As of December 31, 2002 and 2001, federal funds sold and reverse repurchase agreements outstanding were $188.9 million and $123.0 million, respectively. The amount of federal funds sold changes daily as cash is managed to meet reserve requirements and customer needs. After funds have been allocated to meet lending and investment demands, any remainder is placed in overnight federal funds.
As of December 31, 2002 and 2001, Provident held $127.8 million and $101.2, respectively, in trading account securities. Provident trades investment securities with the intention of recognizing short-term profits. These securities are carried at fair value with realized and unrealized gains and losses reported in other noninterest income.
Provident classified $436.9 million and $217.9 million of loans as held for sale at December 31, 2002 and 2001, respectively. At year-end 2002, these loans consisted of $344.8 million of multifamily loans, $82.5 million of nonconforming residential mortgage loans and $9.6 million of conforming residential mortgage loans. The multifamily loans are either insured by the Federal Housing Association or subject to purchase contracts from Fannie Mae or Freddie Mac. These loans are usually outstanding for sixty days or less. Activities related to the multifamily loans held for sale are part of the operations of Red Capital Group. Nonconforming residential mortgage loans are being sold on a whole-loan basis. This is part of an initiative started during 2001 to reduce the risk profile of the Mortgage Banking business line.
Investment securities purchased with the intention of being held for indefinite periods of time are classified as available for sale. These securities totaled $4.2 billion and $3.5 billion as of December 31, 2002 and 2001, respectively. U.S. government agency mortgage-backed securities accounted for the majority of the increase.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The amortized cost and market value of investment securities available for sale at the dates indicated are summarized in the following table:
Amortized Cost at December 31, ------------------------------------ (In Thousands) 2002 2001 2000 ---------------------------------------------------------------------------------- U.S. Treasury and Federal Agency Debentures $ 310,244 $ 302,912 $ 326,721 State and Political Subdivisions 1,838 3,185 3,317 Mortgage-Backed Securities 3,240,192 2,700,620 1,938,546 Asset-Backed Securities - - 44,257 Other Securities 606,237 503,884 728,363 ---------- ---------- ---------- Total Securities $4,158,511 $3,510,601 $3,041,204 ========== ========== ==========
Market Value at December 31, ------------------------------------ (In Thousands) 2002 2001 2000 ---------------------------------------------------------------------------------- U.S. Treasury and Federal Agency Debentures $ 316,143 $ 306,556 $ 325,457 State and Political Subdivisions 1,875 3,199 3,301 Mortgage-Backed Securities 3,291,512 2,673,174 1,915,602 Asset-Backed Securities - - 42,061 Other Securities 605,708 503,129 727,200 ---------- ---------- ---------- Total Securities $4,215,238 $3,486,058 $3,013,621 ========== ========== ==========
The following table shows the December 31, 2002 maturities and weighted average yields for investment securities. Yields on equity securities that comprise the fixed rate, due after 10 years classification of other securities have been omitted from the table. A 35% tax rate was used in computing the tax equivalent yield adjustment. The yields shown are calculated based on amortized cost and effective yields weighted for the scheduled maturity of each security. Securities are assigned to maturity categories based on their estimated average lives.
Fixed Rate Floating Rate -------------------------- ------------------------- Weighted Weighted Average Average Yield On Amortized Yield To Amortized Current (Dollars in Thousands) Cost Maturity Cost Coupon Rates -------------------------------------------------------------------------------------------- U.S. Treasury and Federal Agency Debentures: Due in one year or less $ 110,331 4.94% $ 749 1.67% Due after 1 through 5 years 199,164 4.78 - - ---------- ---- -------- ---- Total $ 309,495 4.83% $ 749 1.67% ========== ==== ======== ==== State and Political Subdivisions: Due after 5 through 10 years $ 403 5.91% $ - -% Due after 10 years 1,435 7.66 - - ---------- ---- -------- ---- Total $ 1,838 7.28% $ - -% ========== ==== ======== ==== Mortgage-Backed Securities: Due in one year or less $ 125,569 6.43% $ 59 2.28% Due after 1 through 5 years 2,855,012 6.23 112,601 3.33 Due after 5 through 10 years 85,800 6.03 18,457 3.52 Due after 10 years 42,694 6.80 - - ---------- ---- -------- ---- Total $3,109,075 6.24% $131,117 3.36% ========== ==== ======== ==== Other Securities: Due in one year or less $ - -% $ 54,567 1.08% Due after 1 through 5 years 250 6.75 195,928 1.08 Due after 5 through 10 years - - 246,837 1.76 Due after 10 years 108,655 - - - ---------- ---- -------- ---- Total $ 108,905 6.75% $497,332 1.42% ========== ==== ======== ====
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Loans and Leases
As of December 31, 2002 and 2001, total on-balance sheet loans and leases were $9.1 billion and $9.0 billion, respectively. Provident had an additional $2.1 billion and $3.1 billion of off-balance sheet loans and leases as of year-end 2002 and 2001, respectively. As a result of recent earnings volatility, management has re-evaluated the risk/reward relationships of its lending portfolio. During the second half of 2001, Provident implemented a whole-loan sale strategy for its nonconforming residential loans. Also, management has decided to de-emphasize its structured finance lending and large equipment leasing while placing a greater focus on its regional middle market commercial lending and middle market equipment leasing. As a result of these actions, Provident's lending portfolio has a lower concentration of residential loans, higher concentrations of middle market corporate leases, and a lower risk profile of commercial loans. Provident does not have a material exposure to foreign, energy or agricultural loans. The following table shows on-balance sheet loans and leases outstanding at period end by type of loan:
December 31, ---------------------------------------------------------- (Dollars in Millions) 2002 2001 2000 1999 1998 -------------------------------------------------------------------------------------- Dollar: Corporate Lending: Commercial $ 4,482.4 $ 4,540.1 $ 4,580.2 $ 3,990.9 $ 3,278.0 Mortgage 960.6 939.8 823.5 576.6 546.5 Construction 510.3 528.0 610.5 559.8 450.6 Lease Financing 1,273.9 1,106.1 566.1 376.6 243.7 Consumer Lending: Installment 1,306.8 913.4 580.1 476.5 650.1 Residential 599.8 922.7 835.5 653.7 710.3 ---------- ---------- ---------- ---------- ---------- Total Loans and Leases $ 9,133.8 $ 8,950.1 $ 7,995.9 $ 6,634.1 $ 5,879.2 ========== ========== ========== ========== ========== Percentage: Corporate Lending: Commercial 49.1% 50.7% 57.3% 60.1% 55.7% Mortgage 10.5 10.5 10.3 8.7 9.3 Construction 5.6 5.9 7.6 8.4 7.7 Lease Financing 13.9 12.4 7.1 5.7 4.1 Consumer Lending: Installment 14.3 10.2 7.3 7.2 11.1 Residential 6.6 10.3 10.4 9.9 12.1 ---------- ---------- ---------- ---------- ---------- Total Loans and Leases 100.0% 100.0% 100.0% 100.0% 100.0% ========== ========== ========== ========== ==========
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table shows the composition of the commercial loan category by industry type at December 31, 2002, including loan amounts on which interest is not being accrued:
Amount on (Dollars in Millions) Amount % Nonaccrual ---------------------------------------------------------------------------------- Mortgage Warehousing Lines $ 639.7 14 $ 3.5 Real Estate Operators/Developers/General Contractors 541.2 12 0.8 Transportation 209.1 5 0.7 Banking and Finance 200.9 4 6.0 Healthcare 193.5 4 0.6 Retailing 171.9 4 5.9 Tourism and Entertainment 155.0 3 0.4 Metals 150.4 3 12.0 Machinery and Equipment 146.2 3 11.4 Eating and Drinking Establishments 129.3 3 4.0 Automobile Dealers 129.1 3 - Business Services 127.1 3 14.2 Commercial Aviation Related (1) 118.3 3 24.1 Construction 117.5 3 3.3 Financial Services 105.9 2 0.1 Technology 87.3 2 3.0 Automotive Services/Parts 79.4 2 0.1 Plastics, Ceramics, Rubber and Other Products 68.3 2 3.0 Other (includes 20 industry types) 1,112.3 25 6.7 ---------- --- ------- Total $ 4,482.4 100 $ 99.8 ========== === =======
(1) Includes $27 million of loans related to the commercial airline industry, and aircraft used in private, charter and corporate markets.
Mortgage warehousing lines increased significantly in the fourth quarter to $640 million, reflecting Provident's continuing shift to origination and sale activity in its mortgage business, as well as a surge in fourth quarter volume. All loans are underwritten to Provident and secondary market standards as part of Provident's control processes related to this activity.
At December 31, 2002, Provident had loans and leases of $178 million to commercial airline carriers, including $27 million of commercial loans and $151 million of finance and operating leases. As the events of September 11, 2001 have had a significant financial impact upon the airline industry and the resale value of aircraft, Provident recorded credit costs and other expenses of $34 million and $66 million during 2002 and 2001, respectively, which were related to secured commercial airline loans and leases.
At December 31, 2002, Provident had approximately $802 million of commercial loans that are to borrowers who have shared national credit loans. Generally, shared national credit loans are loans that have a commitment amount of at least $20 million and involve three or more supervised financial institutions. In an on-going effort to diversify its portfolio, the shared national credit loans in which Provident participates are distributed across thirty-two industry types, with the largest industry concentration (real estate) accounting for approximately 13% of its total shared national credit loans. The real estate category is comprised of loans to borrowers with different risks characteristics, including single family home developers, commercial property owner/operators, and commercial realtors and property managers. The average outstanding balance of a shared national credit loan was $3.8 million.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table shows the composition of commercial mortgage and construction loans by property type at December 31, 2002:
Commercial Commercial Amount on (Dollars in Millions) Mortgage Construction Total Percentage Nonaccrual --------------------------------------------------------------------------------------------- Residential Development $ 142.0 $ 107.9 $ 249.9 17.0% $ 6.6 Shopping / Retail 138.6 105.5 244.1 16.6 - Office / Warehouse 153.7 85.3 239.0 16.3 2.9 Apartments 135.6 50.2 185.8 12.6 2.0 Healthcare Facilities 118.0 6.5 124.5 8.5 - Hotel / Motel 97.1 9.2 106.3 7.2 .1 Land 45.2 45.0 90.2 6.1 .6 Industrial Plants 18.9 10.2 29.1 2.0 - Other Commercial Properties 111.5 90.5 202.0 13.7 1.3 ------- ------- -------- ----- ------ $ 960.6 $ 510.3 $1,470.9 100.0% $ 13.5 ======= ======= ======== ===== ======
As of December 31, 2002, Provident had $1.3 billion in commercial lease financing. These leases were comprised of $1.1 billion of small and middle market equipment leases and $0.2 billion of large equipment leases.
Commercial and real estate construction loans outstanding at December 31, 2002 are shown in the following table by maturity, based on remaining scheduled repayments of principal:
After 1 Within but Through After (In Millions) 1 Year 5 Years 5 Years Total ---------------------------------------------------------------------- Commercial $1,886.7 $2,116.6 $479.1 $4,482.4 Commercial Construction 213.2 263.9 33.2 510.3 Residential Construction - - 0.2 0.2 -------- -------- ------ -------- Total $2,099.9 $2,380.5 $512.5 $4,992.9 ======== ======== ====== ======== Loans Due After One Year: At predetermined interest rates $ 312.4 At floating interest rates 2,580.6
The following table shows the composition of the installment loan category by loan type at December 31, 2002:
(Dollars in Millions) Amount Percentage ---------------------------------------------------------------------- Home Equity $1,110.7 85.0% Indirect Installment 120.3 9.2 Direct Installment 60.1 4.6 Other Consumer Loans 15.7 1.2 -------- ----- $1,306.8 100.0% ======== =====
Credit Risk Management
Over the past year, Provident has significantly enhanced its Credit and Risk Management function through additional experienced staff, new processes and enhanced information and analytics. Provident's new tactics include a strategic approach to the portfolio, balanced with valuing our key relationship customers. Clear business and portfolio strategies allow for focused marketing of new accounts, and aggressive management of both non-strategic portfolios and problem loans.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
A significant change in the portfolio composition has and will continue to occur as a result of these strategic decisions. Risk and return, volatility and portfolio suitability have all been important considerations in this change. These initiatives include de-emphasizing the structured finance lending as well as originating the nonconforming residential loans only for sale on a whole-loan basis. Regional middle market commercial lending, middle market leasing and prime home equity loans are businesses which management believes can be grown while generating more predictable future earnings streams.
Enhanced processes have improved our understanding of publicly-identified exit portfolios and the value of our continuing businesses and relationships. More active use of an independent Special Assets Division, a revamped internal Portfolio Risk Review unit, and an expanded Credit Officer network allow Provident to ensure independent oversight and improved communication of issues and problems throughout the portfolio. In addition, Credit and Risk Management is responsible for the establishment and oversight of Provident's credit risk policies addressing underwriting standards, internal lending limits and methodologies for monitoring credit risk within the various loan and lease portfolios. Changes to these policies enhance Provident's initial and ongoing risk management and monitoring capabilities.
Provident has expanded and improved its analytical and reporting capacity, which in turn has improved the timeliness and value of portfolio information. Loans and leases are primarily monitored by closely following changes and trends in risk characteristics. The characteristics are analyzed using various techniques; including, credit scoring models for consumer and small business loans and leases and risk ratings for larger commercial, commercial mortgage and commercial construction loans. These risk ratings are assigned based upon individual credit analysis and are aggregated for reporting to senior management on a regular basis. These same analytics serve as the basis for refining the rating system, and establishing portfolio wide targets and caution levels. Early trends and thresholds trigger changes in strategy and tactics including the use of secondary market alternatives to liquidate and mitigate problem exposures and portfolio segments.
Provident maintains a reserve for loan and lease losses to absorb losses from current outstandings and potential usage of unfunded commitments. Discussion and analysis of the reserves as well as the overall credit quality of the off-balance sheet lending portfolio is provided in Note 20 of the "Notes to Consolidated Financial Statements." The following paragraphs provide information concerning its on-balance sheet credit portfolio and unused commitments.
The reserve for loan and lease losses is maintained at a level which management considers adequate to absorb loan and lease losses given the conditions at the time. The reserve is increased by the provision for loan and lease losses. Loans and leases deemed uncollectible are charged off and deducted from the reserve while recoveries on loans and leases previously charged off are added back to the reserve.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The adequacy of the reserve for loan and lease losses is monitored on a regular basis and reflects management's evaluation of numerous factors. These factors include the quality of the current loan portfolio, the trend in the loan portfolio's risk ratings, current economic conditions, specific industry trends, loan concentrations, evaluation of specific loss estimates for all significant problem loans, payment histories, collateral valuations, historic charge-off and recovery experience, estimates of charge-offs for the upcoming year and other pertinent information. Based upon the analyses, Provident lowered its loan loss reserve to total loans by 49 basis points to 2.20% during 2002 after raising the reserve ratio by 70 basis points in 2001.
Unfavorable business conditions and difficulties experienced by the airline industry have caused Provident to take large loan loss provisions during the past three years. Late in the fourth quarter of 2000, Provident placed three large loans, totaling $52 million, on nonaccrual status. Additionally, several large commercial loan charge-offs were recorded at that time. Nonaccrual loans and charge-offs increased during 2001 as the economic climate continued to deteriorate, particularly with regard to the airline industry. During 2001, Provident recorded charge-offs, write-downs and additional provision of $66 million on commercial airline loans and leases. Another $15 million of provision was recorded for industries other than commercial airlines that were related to the events of September 11, 2001. During 2002, Provident recorded an additional $34 million of credit costs related to the airline industry. Although the economy remained sluggish during 2002, credit-related volatility began to stabilize. Corporate nonaccrual loans have declined $11.9 million since year-end 2001.
The reserve methodology considers potential losses in the commercial airline portfolio as well as all other loan and lease types. Risks in the commercial airline portfolio arise from principal reliance on borrower credit quality and secondarily on equipment value. Based upon previous peak outstandings, the majority of commercial airline loans and leases are to borrowers considered to have better credit quality. Even within this segment, shorter maturities have left Provident exposed to residual equipment values resulting in modest charge-offs. Most of the prior charge-offs and valuation adjustments dealt with transactions related to borrowers with weaker credit quality, which exposed Provident to weaker equipment values. However, future events could occur that may negatively impact our assessment of borrowers' credit quality and equipment values leading to higher reserves and potential future losses.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table shows selected information relating to Provident's reserve for loan and lease losses:
December 31, ---------------------------------------------------- (In Thousands) 2002 2001 2000 1999 1998 ------------------------------------------------------------------------------------- Reserve for Loan and Lease Losses at Beginning of Period $241,143 $159,118 $ 95,181 $ 80,179 $ 75,669 Provision Charged to Expense 99,549 215,545 133,477 46,110 29,348 Acquired Reserves - 10,003 2,377 1,263 - Loans and Leases Charged Off: Corporate Lending: Commercial 81,371 105,711 63,497 25,145 14,403 Mortgage 183 844 96 247 3 Construction 850 - - - - Lease Financing 48,501 26,622 2,892 6,736 5,173 Consumer Lending: Installment 7,727 7,557 7,535 10,159 12,856 Residential 27,229 14,846 8,022 759 900 -------- -------- -------- -------- -------- Total Charge-Offs 165,861 155,580 82,042 43,046 33,335 -------- -------- -------- -------- -------- Recoveries: Corporate Lending: Commercial 10,274 2,675 3,406 2,742 836 Mortgage 137 8 20 42 1,344 Construction 21 - - - - Lease Financing 9,821 3,068 1,290 3,102 226 Consumer Lending: Installment 4,615 4,990 5,282 4,523 5,901 Residential 1,352 1,316 127 266 190 -------- -------- -------- -------- -------- Total Recoveries 26,220 12,057 10,125 10,675 8,497 -------- -------- -------- -------- -------- Net Loans and Leases Charged Off 139,641 143,523 71,917 32,371 24,838 -------- -------- -------- -------- -------- Reserve for Loan and Lease Losses at End of Period $201,051 $241,143 $159,118 $ 95,181 $ 80,179 ======== ======== ======== ======== ========
On a percentage basis, the following table provides annual net charge-offs to average total loans and leases by category:
December 31, ------------------------------------------------ 2002 2001 2000 1999 1998 ------------------------------------------------ Corporate Lending: Commercial 1.65% 2.21% 1.38% .63% .43% Mortgage .01 .10 .01 .04 (.24) Construction .15 - - - - Lease Financing 3.23 2.46 .42 1.29 1.56 Consumer Lending: Installment .30 .33 .44 .96 .98 Residential 3.51 1.34 2.04 .05 .09 ---- ---- ---- --- --- Net Charge-Offs to Average Total Loans and Leases 1.59% 1.63% 1.04% .51% .42% ==== ==== ==== === ===
Explanation as to significant changes in charge-offs between 2000 and 2002 follows:
o Commercial: Net charge-offs to average loans were 1.65%, 2.21% and 1.38% for 2002, 2001 and 2000, respectively. The decrease in charge-offs in 2002 was due primarily to a decrease in net charge-offs in the structured finance area, which is being de-emphasized. The increase in charge-offs for 2001 was due primarily to the overall deterioration in the economy, particularly in the airline industry. The increase in charge-offs in 2000
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
was due primarily to the decline in asset quality indicators combined with the uncertain economic environment.
o Commercial Lease Financings: Net charge-offs to average leases were 3.23%, 2.46% and 0.42% for 2002, 2001 and 2000, respectively. The increase in the net charge-off percentage during 2001 to 2002 was due primarily to an increase in charge-offs related to aircraft exposures.
o Installment: Net charge-offs to average loans were .30%, .33% and .44% for 2002, 2001 and 2000, respectively. The decrease in the charge-offs for 2000 as compared to 1999 was a result of lower charge-offs in home equity and credit card loans. The reduction in home equity charge-offs was due to continued focus on credit quality standards on the origination of these loans and improved technology of collection systems.
o Residential: Net charge-offs to average loans were 3.51%, 1.34% and 2.04% for 2002, 2001 and 2000, respectively. The increase in charge-offs for 2002 was due primarily to the $9.1 million charge-off taken in conjunction with the sale of $27 million of nonperforming residential mortgage loans that took place during the second quarter of 2002. The increase in charge-offs for 2001 and 2000 was a result of nonconforming residential loans originated during the second half of 2000 and the first half of 2001 being kept on the balance sheet.
The following table shows the dollar amount of the reserve for loan and lease losses, using management's estimate, by principal loan and lease category. While amounts are allocated to various portfolio categories, the total reserve, less the portion attributable to reserves as prescribed under provisions of Statement No. 114, "Accounting by Creditors for Impairment of a Loan," is available to absorb losses from any loan or lease category.
December 31, ---------------------------------------------------- (In Thousands) 2002 2001 2000 1999 1998 ------------------------------------------------------------------------- Corporate Lending: Commercial $132,286 $168,248 $107,713 $ 73,992 $ 53,624 Mortgage 12,337 5,837 8,291 4,645 5,428 Construction 5,393 7,430 5,622 2,192 3,556 Lease Financing 28,690 26,303 13,407 4,344 3,928 -------- -------- -------- -------- -------- 178,706 207,818 135,033 85,173 66,536 Consumer Lending: Installment 1,490 5,696 9,089 8,245 11,003 Residential 20,855 27,629 14,996 1,763 2,640 -------- -------- -------- -------- -------- 22,345 33,325 24,085 10,008 13,643 -------- -------- -------- -------- -------- $201,051 $241,143 $159,118 $ 95,181 $ 80,179 ======== ======== ======== ======== ========
The changes in the corporate lending reserves and their distribution between 2001 and 2002 resulted from numerous factors, including: (1) the anticipated use of the reserves established as of December 31, 2001 to absorb potential charge-offs in the commercial portfolio stemming from the commercial airline industry as well as several unrelated potential charge-offs in other industries; (2) the implementation of an enhanced commercial-related reserve methodology; and (3) the transfer of several commercial construction loans to commercial mortgage loan status. Additionally, the reserves related to consumer lending declined due to the sale of higher risk assets.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The reserve levels are tested under various scenarios, primarily reflecting different portfolio migration and roll rates. The rates used reflect those experienced during periods of varied economic conditions. As would be expected, the results indicate additional provision may be required to maintain adequate reserves if the downside scenarios were to materialize.
The following table presents a summary of various indicators of credit quality:
December 31, -------------------------------------------------------- (Dollars In Thousands) 2002 2001 2000 1999 1998 ------------------------------------------------------------------------------------------ Nonaccrual Loans: Corporate Lending: Commercial $ 99,805 $116,663 $ 74,401 $ 43,452 $ 34,544 Mortgage 11,783 1,929 1,712 3,003 933 Construction 1,746 2,699 - 216 - Lease Financing 4,008 7,986 6,503 1,309 4,002 -------- -------- -------- -------- -------- 117,342 129,277 82,616 47,980 39,479 Consumer Lending: Installment - - - 48 38 Residential 49,091 47,579 13,404 7,640 5,504 -------- -------- -------- -------- -------- 49,091 47,579 13,404 7,688 5,542 -------- -------- -------- -------- -------- Total Nonaccrual Loans 166,433 176,856 96,020 55,668 45,021 Other Nonperforming Assets 15,780 20,907 8,805 3,870 2,767 -------- -------- -------- -------- -------- Total Nonperforming Assets $182,213 $197,763 $104,825 $ 59,538 $ 47,788 ======== ======== ======== ======== ======== Loans 90 Days Past Due - Still Accruing $ 29,918 $ 30,326 $ 28,203 $ 14,943 $ 10,356 Loan and Lease Loss Reserve to: Total Loans and Leases 2.20% 2.69% 1.99% 1.43% 1.36% Nonaccrual Loans 120.80 136.35 165.71 170.98 178.09 Nonperforming Assets 110.34 121.94 151.79 159.87 167.78 Nonaccrual Loans to Total Loans and Leases 1.82 1.98 1.20 .84 .77 Nonperforming Assets to: Total Loans, Leases and Other Nonperforming Assets 1.99 2.20 1.31 .90 .81 Total Assets 1.04 1.19 .70 .50 .50
Loans and leases are generally placed on nonaccrual status when the payment of principal and/or interest is past due 90 days or more. However, installment loans are not placed on nonaccrual status because they are charged off in the month the loans and leases reach 120 days past due. In addition, loans that are well secured and in the process of collection are not placed on nonaccrual status. When a loan is placed on nonaccrual status, any interest income previously recognized that has not been received is reversed from income. Future interest income is recorded only when a payment is received and collection of principal is considered reasonably assured.
Although loans and leases may be classified as nonaccrual, many continue to pay interest irregularly or at less than the original contractual rates. The gross amount of interest income recognized during 2002 with respect to these loans and leases was $1.7 million compared to $16.2 million that would have been recognized had the loans and leases remained current in accordance with their original terms.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Loans and leases that have been placed on nonaccrual status are further evaluated for potential losses based upon review and discussion among Credit, Portfolio Risk Review, lending officers, collection associates, and senior management. Factors considered include the market value of collateral associated with a specific loan or lease, cash flows generated by the borrower, third-party guarantees, the general economic climate and any specific industry trends that may affect an individual loan or lease. Total nonaccrual loans at December 31, 2002 were $166.4 million. In addition, $73.1 million of performing loans were being closely monitored due to possible credit problems.
Nonaccrual loans decreased $10.4 million and other nonperforming assets decreased $5.1 million during 2002 while nonaccrual loans increased $80.8 million and other nonperforming assets increased $12.1 million during 2001. The following table shows the progression of nonaccrual loans and other nonperforming assets during these time periods:
Corporate Lending ------------------------------------ Consumer Total Other Total Real Lease Residential Nonaccrual Nonperforming Nonperforming (In Thousands) Commercial Estate Financing Mortgages Loans Assets Assets ------------------------------------------------------------------------------------------------------------------- Balance at January 1, 2001 $ 74,401 $ 1,712 $ 6,503 $ 13,404 $ 96,020 $ 8,805 $ 104,825 Additions 197,149 4,224 19,912 57,525 278,810 2,026 280,836 Payments / Sales (43,218) (464) (3,872) (2,966) (50,520) (5,722) (56,242) Charge-Offs (97,352) (844) (14,557) (12,257) (125,010) (6,646) (131,656) Transfers to Other Nonperforming Assets (14,317) - - (8,127) (22,444) 22,444 - --------- --------- --------- --------- --------- --------- --------- Balance at December 31, 2001 116,663 4,628 7,986 47,579 176,856 20,907 197,763
Additions 108,021 12,147 15,757 75,133 211,058 4,012 215,070 Payments / Sales (51,503) (2,023) (5,136) (27,376) (86,038) (20,345) (106,383) Charge-Offs (73,076) (1,033) (14,599) (23,055) (111,763) (4,481) (116,244) Transfers to Other Nonperforming Assets (300) (190) - (23,190) (23,680) 23,680 - Write-Downs - - - - - (7,993) (7,993) --------- --------- --------- --------- --------- --------- --------- Balance at December 31, 2002 $ 99,805 $ 13,529 $ 4,008 $ 49,091 $ 166,433 $ 15,780 $ 182,213 ========= ========= ========= ========= ========= ========= =========
Credit Outlook and Operating Implications
In 2001, Provident's total credit costs (loan loss provision and aircraft lease residual write-offs) increased 76% or $102 million over the prior year's amount. These higher credit costs had a materially unfavorable impact on net income. To address asset quality issues and related credit costs that arose during 2001, management worked to improve its internal credit processes and resolve asset quality concerns in its loan and lease portfolios. Credit costs declined substantially in 2002. However, if credit costs should substantially increase again, this could impact Provident's ability to maintain the payment of its quarterly dividend rate at current levels.
Noninterest Earning Assets
Leased equipment includes the leasing of automobiles to consumers and equipment to commercial customers. As of December 31, 2002 and 2001, the cost of automobiles, net of depreciation, was $2.1 billion and $2.4 billion, respectively, and the cost of equipment, net of depreciation, was $266 million for both years. The decrease in auto leases is reflective of management's decision to provide fewer resources to this business due to its overall complexity and thin margin.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Goodwill totaled $83 million and $81 million as of December 31, 2002 and 2001, respectively. Goodwill represents the excess of the purchase price over net identifiable tangible and intangible assets acquired in a purchase business combination. During 2001, the Financial Accounting Standards Board issued Statement No. 141, "Business Combinations," and Statement No. 142, "Goodwill and Other Intangible Assets." Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets continue to be amortized over their useful lives. These rules became effective as of January 1, 2002 for Provident. Additional information on goodwill and other intangibles is provided in Note 8 of the "Notes to Consolidated Financial Statements."
Other assets increased $41 million during 2002 and decreased $244 million during 2001. The increase in 2002 was primarily due to an increase in mortgage servicing rights and an increase in the amount of market value adjustments recorded in relation to Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities." The decrease in 2001 was due primarily to the decrease in receivables from securitization trusts.
Deposits
Deposits increased $995 million and $25 million during 2002 and 2001, respectively. During 2002, commercial deposits increased 68% to $1.1 billion at December 31, 2002 from $637 million at December 31, 2001. During 2001, retail deposits increased 16% to $5.6 billion at December 31, 2001 from $4.8 billion at December 31, 2000, with significant contribution from internet deposit-gathering initiatives. Offsetting this increase was a $469 million decrease in deposits from securitization trusts held at Provident. The following table presents a summary of period end deposit balances:
December 31, ------------------------ (In Millions) 2002 2001 2000 -------------------------------------------------------------------------------- Noninterest Bearing Deposits of Securitization Trusts $ 48 $ 27 $ 496 Other Noninterest Bearing Deposits 1,094 968 797 Interest Bearing Demand Deposits 1,017 523 464 Savings Deposits 1,460 1,544 1,458 Certificates of Deposit Less than $100,000 2,621 2,551 2,239 Certificates of Deposit of $100,000 or More 3,609 3,241 3,375 ------ ------ ------ $9,849 $8,854 $8,829 ====== ====== ======
At December 31, 2002, maturities on certificates of deposit of $100,000 or more were as follows (in millions):
3 months or less $ 255 Over 3 through 6 months 213 Over 6 through 12 months 228 Over 12 months 2,913 ------ Total $3,609 ======
Included in certificates of deposit of $100,000 or more at December 31, 2002, 2001 and 2000 were brokered deposits of $2.7 billion, $2.0 billion and $2.2 billion, respectively.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Provident issues brokered certificates of deposit with embedded call options combined with interest rate swaps with matching call dates as part of its certificate of deposit program. Provident has the right to redeem the certificates of deposit on specific dates prior to their stated maturity while the interest rate swaps are callable at the option of the swap counterparty. The terms and conditions of the call options embedded in the interest rate swaps match those of the certificates of deposit, offsetting any option risk exposure to Provident. At December 31, 2002, Provident had $1.4 billion of brokered callable certificates of deposit.
Borrowed Funds
Borrowed funds are an important component of total funds necessary to support earning assets. In 2002, short-term debt increased $40 million (2%) while long-term debt decreased $239 million (6%). An increase in commercial paper borrowing was the primary reason for the increase in short-term debt. Payments on medium-term notes and debt issued as secured financings were the primary reasons for the decrease in long-term debt. In 2001, short-term debt increased $1.2 billion (195%) and long-term debt increased $57 million (1%). Increases in federal funds purchased and repurchase agreements were the primary reasons for the increase in short-term debt. The primary reason for the increase in long-term debt was an increase in debt issued as secured financings.
During the first quarter of 2001, Provident established Provident Capital Trust IV. Capital Trust IV issued capital securities of $125 million of preferred stock to the public and $3.9 million of common stock to Provident. Proceeds from the issuance of the capital securities were invested in Provident's 9.45% junior subordinated debentures due 2031.
Minority Interest
During June 2002, Provident and its consolidated subsidiary, PFGI Capital Corporation ("PFGI Capital"), issued 6.6 million of equity units ("PRIDES") to outside investors for $165 million. The Bank owns all of the $165 million of Common Stock of PFGI Capital. The principal business objective of PFGI Capital is to hold and manage commercial mortgage loan assets and other authorized investments acquired from the Bank that will generate net income for distribution to its stockholders. PFGI Capital has elected to be treated as a real estate investment trust ("REIT") for federal income tax purposes.
Each PRIDES is comprised of two components - a 3-year forward purchase commitment ("Purchase Contract") and PFGI Capital Preferred Stock. Each Purchase Contract obligates the holder to buy, on August 17, 2005, for $25, a number of newly issued shares of Provident Common Stock equal to the "settlement rate." The PRIDES qualify as Tier 1 Capital for regulatory capital purposes. Additional information concerning the PRIDES instruments is provided in Note 13 of the "Notes to Consolidated Financial Statements."
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Other Noninterest Bearing Liabilities
Accrued interest and other liabilities decreased $56 million, or 12%, during 2002 after increasing $236 million, or 94%, during 2001. The decrease during 2002 was due primarily to a reduction in the amount of market value adjustments recorded in relation to Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." The increase during 2001 was due primarily to the adoption of the provisions of Statement 133. For further details concerning Statement 133, see Note 21 of "Notes to Consolidated Financial Statements."
OFF-BALANCE SHEET AND DERIVATIVE ARRANGEMENTS
Asset Securitization Activity
From 1996 through the second quarter of 2000, the structure of some of Provident's securitizations resulted in the transactions being accounted for as sales through the use of special purpose entities. As such, gains or losses were recognized, loans and leases were removed from the balance sheet and residual assets, representing the present value of future cash flows, were recorded. During the third quarter of 2000, management decided to structure all future securitizations as secured financings thereby eliminating the use of gain-on-sale accounting and leaving all debt on the balance sheet. The switch to a secured financing structure does not affect the total profit Provident will recognize over the life of the asset, but rather impacts the timing of income recognition. Secured financing transactions, as compared to transactions accounted for as sales, cause reported earnings from securitized assets to be lower in the initial periods and higher in later periods, as interest is earned on the assets.
The securitization and sale of loans and leases from 1996 through the first half of 2000 continues to impact the current presentation of Provident's financial condition, results of operations and off-balance sheet market risks. The following discusses this impact on the Consolidated Statements of Income and Consolidated Balance Sheets.
Impact on Consolidated Statements of Income: During 2000, gains were recognized from the securitization and sale of loans and leases. No such gains were recognized during 2002 and 2001. The following table provides a summary of principal securitized and gains recognized:
----------------------- (In Thousands) Principal Gain --------------------------------------------------------- Non-Cash Gains: Nonconforming Residential $1,030,000 $ 30,291 Prime Home Equity 158,598 4,156 ---------- ---------- Total Non-Cash Gains 1,188,598 34,447 Cash Gains - Equipment Leases 223,705 9,083 ---------- ---------- Total Securitization Sales $1,412,303 $ 43,530 ========== ==========
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The securitization and sale of nonconforming residential and prime home equity loans have resulted in the recognition of non-cash gains. Gains recognized under this structure are referred to as non-cash gains as Provident receives cash equal to the amount of loans sold. The gains or losses are determined based on a present value calculation of future cash flows of the underlying loans, net of interest payments to security holders, loan loss and prepayment assumptions and normal servicing revenue. These net cash flows, which are represented by retained interests on securitized assets ("RISAs"), are included in investment securities. No RISAs have been recorded since June 2000.
Cash gains have been recognized from the securitization and sale of equipment leases. Under the structure of these securitizations, Provident sells the lease payments under the lease contract but retains ownership of the underlying equipment. The cash received from these sales exceeds the present value of the lease payments and generates the cash gain.
Provident retains the servicing of the loans and leases it securitizes. As a result, a significant level of assets is serviced by Provident, which do not appear on its balance sheet. These off-balance sheet assets contributed to the generation of approximately $9 million in loan servicing fees during 2002.
Impact on Consolidated Balance Sheets: Securitized loans and leases that have been treated as sales have been removed from the balance sheet. The following table provides a summary of the outstanding balances of these off-balance sheet managed assets:
December 31, ------------------------------------ (In Thousands) 2002 2001 2000 ---------------------------------------------------------------- Nonconforming Residential $1,779,127 $2,627,332 $3,625,033 Prime Home Equity 194,775 303,527 471,873 Equipment Leases 94,408 207,131 359,457 Credit Card - - 165,000 ---------- ---------- ---------- $2,068,310 $3,137,990 $4,621,363 ========== ========== ==========
In connection with the sale of these loans and leases, Provident recorded RISAs, established credit enhancing collateral accounts and has issued an unfunded secured demand note. As noted earlier, RISAs represent the rights to future cash flows arising after the investors of the securitization trusts have received the return for which they contracted. RISAs are subordinate to investors of the securitization trust with its value subject to prepayment risks, interest rate risks and, in certain cases, credit risks on the transferred assets. As of December 31, 2002, Provident had RISAs totaling $121.5 million.
Provident has provided collateral to its securitizations structured as sales in the form of cash, loans and an unfunded secured demand note. The collateral is maintained at a significantly higher balance than the level of estimated credit losses to improve the credit grade of the securitization and thereby reduce the rate paid to investors of the securitization trust. As of December 31, 2002, collateral consisted of $57.4 million of cash, $5.1 million of loans and a secured demand note that could be drawn up to $270 million. Provident had reserves of $20.9 million as of year-end 2002 to offset future losses. Nonconforming residential RISAs net of its loss reserves totaled $93.3 million. Information concerning the credit quality of the managed loans, cash flows of the securitization trust and valuation analyses of the RISAs, may be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" and Note 20 included in "Notes to Consolidated Financial Statements."
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
New Accounting Pronouncement: In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" that addresses consolidation by business enterprises of variable interest entities (VIEs). Under this Interpretation, special purpose entities (SPEs) having certain attributes will now be consolidated where, in the past, they have not. The Interpretation does not impact qualifying special purpose entities (QSPEs), as described in Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," and other SPEs with similar characteristics. As management has determined that the SPEs used in the securitization of its nonconforming residential, prime home equities and equipment leases have the characteristics of a QSPE, these securitization entities will continue to be excluded from consolidation.
Fannie Mae DUS Program
Red Mortgage Capital, Inc. ("Red Mortgage"), a member of Red Capital Group, is an approved Fannie Mae Delegated Underwriting and Servicing ("DUS") mortgage lender. Under the Fannie Mae DUS program, Red Mortgage underwrites, funds and sells mortgage loans on multifamily rental projects. Red Mortgage then services these mortgage loans on Fannie Mae's behalf. Participation in the Fannie Mae DUS program requires Red Mortgage to share the risk of loan losses with Fannie Mae. The substance of this loss sharing arrangement is that Red Mortgage and Fannie Mae split losses with one-third of all losses assumed by Red Mortgage and two-thirds of all losses assumed by Fannie Mae.
Red Mortgage services multifamily mortgage loans under the DUS program with outstanding principal balances aggregating approximately $3.0 billion at December 31, 2002. At December 31, 2002, no DUS loans in Red Mortgage's loan servicing portfolio were in default. Red Mortgage has established reserves of approximately $8.7 million for possible losses under this program. The reserve is determined by evaluating pools of homogenous loans and includes information based upon industry and historical loss experience, as well as each project's recent operating performance. Management believes the reserve is maintained at a level that adequately provides for the inherent losses within Red Mortgage's portfolio of DUS loans. The employees and management team of Red Mortgage have originated and serviced the existing Fannie Mae DUS loan servicing portfolio since 1995 without any charge-offs relating to the DUS loans.
Interest Rate Swaps and Caps
At December 31, 2002, Provident held $3.8 billion in interest rate swaps on which it receives payments at fixed interest rates while making payments at variable interest rates. These instruments are used primarily as a hedge to offset time deposit accounts and debt where Provident must pay interest at fixed rates. As funds received on these interest rate swaps match the fixed rate payments required of the time deposits and debt, these derivatives
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
essentially convert long-term fixed rate instruments into shorter repricing instruments.
Provident also had $2.2 billion in interest rate swaps that it receives payments at floating interest rates while making payments at fixed interest rates. The primary use of these instruments is for off-balance sheet securitizations. Provident is required to pay investors of these securitizations interest at a floating rate, however, many of the underlying loans pay interest to Provident at fixed or longer-term adjustable rates. The use of these interest rate swaps allows Provident to offset the floating interest rate payments to the investors with floating interest rates payments received from the interest rate swaps. The fixed or longer-term adjustable interest rate payments received from the underlying loans are used to offset the fixed rate interest payments required on these interest rate swaps.
Provident has approximately $2.75 billion in purchased interest rate caps. Interest rate caps protect against the impact of rising interest rates on interest-bearing financial instruments. When interest rates go above a cap's strike rate, the cap provides for receipt of payments based on its notional amounts. Risks involved in these purchased interest rate caps have been mitigated by selling $2.75 billion in interest rate caps.
The fair value of these interest rate swaps and caps are recorded on the consolidated balance sheet as either other assets (derivatives with a positive fair value) or as other liabilities (derivatives with a negative fair value) as prescribed by Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." For further details concerning Provident's interest rate swaps and caps, see Note 21 of "Notes to Consolidated Financial Statements."
Forward Delivery Commitments
Provident enters into forward delivery contracts for the future delivery of commercial real estate and residential mortgage loans at a specified interest rate to reduce the interest rate risk associated with loans held for sale. As of December 31, 2002, Provident had $172 million in forward delivery contracts.
Credit Risk Transfer Instruments
In order to mitigate credit risk within the auto lease portfolio, Provident has entered into credit risk transfer arrangements during 2001 and 2000. Under the 2001 transaction, Provident transferred 97 1/2% of the credit risk on an auto lease portfolio, while retaining a 2 1/2% first-loss position. Under the 2000 transaction, Provident transferred 98% of the credit risk on an auto lease portfolio, while retaining a 2% first-loss position. As a result of these transactions, Provident was able to lower its credit concentration in auto leasing while reducing its regulatory capital requirements. As of December 31, 2002, the remaining unpaid auto lease balances on the 2001 and 2000 transactions were $0.4 billion and $1.0 billion, respectively.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Credit Commitments, Standby Letters of Credit and Guarantees
Commitments to extend credit are financial instruments in which Provident agrees to provide financing to customers based on predetermined terms and conditions. Since many of the commitments to extend credit are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. As of December 31, 2002 and 2001, credit commitments totaled $2.9 billion and $2.2 billion, respectively.
Standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Provident had $274 million and $193 million in standby letters of credit as of December 31, 2002 and 2001, respectively.
Provident (Parent) has issued a guarantee for a subsidiary to assist in its business activities. This guarantee was made to Fannie Mae for the benefit of Red Mortgage Capital, Inc. Red Mortgage is an approved Fannie Mae Delegated Underwriting and Servicing (DUS) mortgage lender. Participation in the Fannie Mae DUS program requires Red Mortgage to share the risk of loan losses with Fannie Mae. For Red Mortgage to participate in the loss sharing agreement, the Parent provided a guarantee to Fannie Mae that it would fulfill all payments required of Red Mortgage under the loss sharing arrangement and for servicing advances of these loans if Red Mortgage fails to meet its obligations. The guarantee will continue until such time as the loss sharing agreement is amended or that Red Mortgage no longer participates in the Fannie Mae DUS program. No liability is carried on the Parent's balance sheet for this guarantee as a liability has been established for estimated losses on Red Mortgage's balance sheet. Additional information concerning the Fannie Mae DUS program may be found under "Management Discussion and Analysis of Financial Condition and Results of Operations - Fannie Mae DUS Program."
CAPITAL RESOURCES AND LIQUIDITY
Capital Resources
Total stockholders' equity at December 31, 2002 and 2001 was $880 million and $802 million, respectively. The change in the equity balance relates primarily to net income exceeding dividends by $47 million and an increase in the market value of investment securities of $53 million, (net of deferred taxes).
Provident's capital expenditure program typically includes the purchase of computer equipment and software, branch additions and enhancements, ATM additions and office building renovations. Capital expenditures for 2003 are estimated to be approximately $30 million and include the purchase of data processing hardware and software, branch additions, renovations and enhancements, facility renovations, and ATMs. Management believes that currently available funds and funds provided by normal operations will be sufficient to meet these capital expenditure requirements.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table of ratios is important for an analysis of capital adequacy:
Year Ended December 31, ------------------------ 2002 2001 2000 ------------------------ Average Shareholders' Equity to Average Assets 5.12% 5.59% 6.70% Average Tangible Shareholders' Equity to Average Tangible Assets 4.55 5.00 6.11 Period End Shareholders' Equity to Period End Assets 5.02 4.84 6.16 Period End Tangible Shareholders' Equity to Period End Tangible Assets 4.49 4.26 5.72 Dividend Payout to Net Earnings 50.64 n/m 84.43 Tier 1 Capital to Risk-Weighted Assets 9.40 7.95 8.56 Total Risk-Based Capital To Risk-Weighted Assets 11.43 10.71 10.60 Tier 1 Leverage Ratio 7.81 6.65 8.21
-------------------- n/m - not meaningful
Risk-based capital guidelines established by the Federal Reserve Board set minimum capital requirements and require institutions to calculate risk-based capital ratios by assigning risk weightings to assets and off-balance sheet items. Provident is required to maintain minimum ratios of 4.00% for Tier 1 capital to average assets, 4.00% for Tier 1 capital to risk-weighted assets, and 8.00% for total risk-based capital to risk-weighted assets. These guidelines further define "well-capitalized" levels for Tier 1, total risk-based capital, and leverage ratio purposes at 6%, 10% and 5%, respectively. Provident has consistently maintained regulatory capital ratios at or above the well-capitalized standards. For further detail on capital ratios, see Note 15 of the "Notes to Consolidated Financial Statements."
As noted in earlier sections of this report, during the second quarter of 2002, Provident issued $165 million of PRIDES in connection with the formation of PFGI Capital. These equity units qualify as Tier 1 Capital in Provident's calculation of regulatory capital ratios.
Liquidity
Adequate liquidity is necessary to meet the borrowing needs and deposit withdrawal requirements of customers as well as to satisfy liabilities, fund operations and support asset growth. Management forecasts that the largest liquidity needs during 2003 will come from growth in the lending portfolio, maturing of retail and brokered certificates of deposit, and scheduled principal payments on long-term debt. Provident has a variety of sources to meet these liquidity demands. First, management expects to issue new certificates of deposit along with renewing many of its maturing certificates of deposit. Management also projects growth within retail transactional deposits. Additional sources of liquidity include the secured financing of commercial and consumer loans and leases, whole-loan sales of nonconforming residential loans and the availability to borrow both short-term and long-term funds.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table represents Provident's estimated contractual obligations, excluding short-term obligations, at December 31, 2002:
Less Than From 1 to From 3 to More Than (In Millions) 1 Year 3 Years 5 Years 5 Years Total ----------------------------------------------------------------------------------- Certificates of Deposit $ 1,499 $ 1,676 $ 1,289 $ 1,766 $ 6,230 Long-Term Debt 445 1,736 831 831 3,843 Junior Subordinated Debentures - - - 451 451 Rental Obligations 16 26 19 44 105 ------- ------- ------- ------- ------- $ 1,960 $ 3,438 $ 2,139 $ 3,092 $10,629 ======= ======= ======= ======= =======
Consistent with Provident's contingent funding plan, management monitors the potential impact of changes in its corporate ratings on existing and new business transactions. Ratings related liquidity events may include reduced availability of short-term federal funds, reduced availability to the surety bond market that supports the bank's Public Funds program and other commitments provided to third parties in related business transactions. If such ratings events are anticipated, management will take actions to enhance balance sheet liquidity positions to meet liquidity needs. Such actions to enhance liquidity positions were taken in connection with Provident's March 5, 2003 announcement related to the restatement of its earnings. In anticipation of potential ratings downgrades, management took actions to enhance liquidity positions, including issuance of additional brokered certificates of deposits. Additional term liquidity reduces reliance on short-term funding and increases the availability of collateral in the investment portfolio. Management will continue to monitor events as the need may arise for further liquidity enhancements in the future.
The parent company's primary liquidity needs during 2003 will be the payment of dividends to its preferred and common shareholders, funds for activity of the commercial paper operations and interest payments on junior subordinated debentures. The major source of liquidity for the parent company is dividends and interest paid to it by its subsidiaries. Provident received dividends of $45 million, $15 million and $37 million in 2002, 2001 and 2000, respectively. The amount of dividends available for payment in 2003 by The Provident Bank, Provident's banking subsidiary, is approximately $30.2 million, plus 2003 net income. It is unlikely, however, that the Bank would pay annual dividends to the parent company that exceeds $60 million.
The parent company also received interest payments of $25.4 million, $24.9 million and $13.2 million for the years ended December 31, 2002, 2001 and 2000, respectively, from its subsidiaries. These interest payments were primarily the result of $249.5 million of subordinated debt loaned to the Bank. The subordinated debt matures during 2009 and 2010. Management believes that dividends and interest payments from the Bank will be sufficient to meet the parent company's liquidity requirements in 2003.
At December 31, 2002, the parent company had $170 million in general purpose lines of credit with unaffiliated banks. The principal purpose of these lines was to provide a backup facility for its commercial paper program. In July 2002, the parent company issued $75 million of long-term senior notes to improve its overall liquidity position. Proceeds from these notes have provided sufficient incremental liquidity to meet its short-term obligations and have eliminated the primary use of the lines. The lines were not renewed at their March 27, 2003 expiration date. The lines of credit had not been drawn upon during the past three years.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
Note 1 to the "Notes to Consolidated Financial Statements" lists significant accounting policies used in the development and presentation of Provident's financial statements. However, four of these accounting policies are considered to be critical due to the level of sensitivity and subjectivity of their underlying accounting estimates. These critical accounting policies concern the adequacy of the reserve for loan and lease losses; the valuation of retained interest in securitized assets (RISAs) and securitized credit enhancements; the valuation of mortgage servicing assets; and the valuation of derivatives.
Reserve for Loan and Lease Losses: Provident maintains a reserve to absorb potential loan and lease losses inherent in its lending portfolio. Management's determination of the adequacy of the loan loss reserve is based on an assessment of the potential losses given the conditions at the time. This assessment consists of certain loans and leases being evaluated on an individual basis, as well as all loans and leases being categorized based on common credit risk attributes and being evaluated as a group. Management evaluates numerous factors including the credit quality of the current loan portfolio, the trend in the loan portfolio's risk ratings, current economic conditions, specific industry trends, loan concentrations, evaluation of specific loss estimates for all significant problem loans, payment histories, collateral valuations, historical charge-off and recovery experience, estimates of charge-offs for the upcoming year and other relevant information.
Loans and leases that have been placed on classified and/or nonaccrual status are further evaluated for potential losses based upon review and discussion among Credit, Portfolio Risk Review, lending officers, collection associates, and senior management. Factors considered include the market value of collateral or real estate associated with a specific loan or lease, cash flows generated by the borrower, third-party guarantees, the general economic climate and any specific industry trends that may affect an individual loan or lease.
Additional loss estimates associated with securitized assets and loans sold under the Fannie Mae DUS Program are provided for separately from the reserve for loan and lease losses. For more information on credit exposures on these off-balance sheet assets, see "Management Discussion and Analysis of Financial Condition and Results of Operations - Off-Balance Sheet and Derivative Arrangements" and Note 20 of the "Notes to Consolidated Financial Statements."
RISAs and Securitized Credit Enhancements: Prior to July 2000, Provident structured its securitization transactions as sales. As such, Provident retained (a) future cash flows of the underlying loans, net of payments due to investors of the securitization trust, servicing fees and other fees (RISAs), (b) servicing rights on the loans and leases, and (c) credit enhancement accounts used to absorb credit losses on the loans securitized. Gain or loss on the sale of the loans depended in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the assets retained based on their relative fair value at the date of transfer. However, quotes are generally not available
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
for assets retained, so Provident estimates the fair value based on key assumptions, including prepayment speeds, credit losses, forward yield curves, and discount rates commensurate with the risks involved.
Provident monitors the valuation of the RISAs on a monthly basis. The valuation centers primarily around two estimates, total life-time credit losses and the constant prepayment rate (CPR). During the current year, both of these factors have trended upward which has had an unfavorable impact on the nonconforming residential RISA valuation. Additionally, the CPR has also been impacted by management's decision to accelerate the liquidation of other real estate associated with the securitized nonconforming residential portfolio. Provident models a CPR range from 26% to 35% with the actual CPR currently running at 30%. If the CPR stays at its current level, management estimates that there would be sufficient cash flows to absorb lifetime losses up to 6.3%. If the CPR rises to 35%, there would be sufficient cash flows to absorb lifetime losses up to 5.4%. Cumulative incurred losses through December 31, 2002 are 3.6%, with estimated total lifetime losses expected to be 5.6%. On a worst case basis, management currently estimates that lifetime losses should not exceed 6.1% assuming real estate values remain relatively stable. From an earnings sensitivity standpoint, above certain loss thresholds, 5 basis points in losses represent a $1.8 million unfavorable after-tax impact. Should both the estimated life-time credit losses and CPR continue to rise, impairment of the RISA value could occur. Future period cash flow realizations may differ from current projections as a result of timing differences in credit related charge-offs in any given period. Although these variances may not change the life-time loss assumptions, they may result in temporary negative cash flows and the possibility of a charge to earnings. At December 31, 2002, management believes the current carrying value of the RISA asset is properly stated. Additional sensitivity analyses is provided in Note 20 of the "Notes to Consolidated Financial Statements."
Valuation of Mortgage Servicing Rights: Provident recognizes the rights to service mortgage loans it does not own but services for others within Other Assets of its balance sheets. Mortgage servicing assets are carried at the lower of the initial carrying value, adjusted for amortization, or estimated fair value. Estimated fair value is based on projected discounted cash flows which takes into consideration estimated servicing fees, prepayment speeds, discount rates, earnings on deposit of escrow funds and other assumptions. These estimates have a significant impact on the valuation of the mortgage servicing assets. Mortgage servicing rights are tested quarterly to verify the market value equals or exceeds its carrying value.
Valuation of Derivatives: In accordance with Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," Provident carries the fair value of derivative instruments on its consolidated balance sheets with changes in value recorded in the income statement or as other comprehensive income. Although the value of the derivatives are determined using third-party valuations, these valuations use discounted cash flow modeling techniques, which require the use of assumptions concerning the amount and timing of future cash flows. These estimates have a significant impact on the valuation of the derivatives.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK --------------------------------------------------------------------
The responsibility of monitoring and managing market and liquidity risk is assigned to the Asset Liability Committee (ALCO). The main component of market risk is the risk of loss in the value of financial instruments that may result from the changes in interest rates. ALCO is bound to guidelines stated in the relevant policies approved by the Board of Directors.
In addition to the natural balance sheet hedges, ALCO utilizes derivative instruments to manage interest rate risk on and off its balance sheet. Interest rate swaps and caps are the most widely used tools to manage interest rate risk.
Provident uses an earnings simulation model to analyze net interest income sensitivity to movements in interest rates. The model evaluates the effect of changes in interest rates on net interest income by running various interest rate scenarios up and down from a flat rate scenario. As a basis for strategic interest rate risk management, the ALCO group regularly analyzes the impact of four to six additional interest rate scenarios on net interest income in addition to the standard scenarios used for policy measurement. These rate scenarios are established by ALCO and incorporate changes to the slope of the yield curve. The balance sheet assumptions, including loan growth, funding mix, and prepayment speeds primarily on mortgage related products, are adjusted for each rate scenario. Market-based prepayment speeds are incorporated into the analysis, particularly for mortgage related products, including investment portfolio securities. Faster prepayments during low interest rate environments such as the current levels negatively impact interest rate margins due to lower reinvestment yields.
Provident's policy limit stipulates that the negative impact on net interest income from a +/-200 basis points, 12 month gradual parallel ramp rate scenario as compared to the flat rate scenario cannot exceed 10 percent over the next 12 month period. These tests are performed on a monthly basis, and the results are presented to the Board of Directors. Based on the results of the simulation model, net interest income would change by the following over the next 12-month period:
2002 2001 ------------------ 100 Basis Points Decrease (3.92%) 0.24% 100 Basis Points Increase 0.55% (0.33%)
200 Basis Points Decrease n/a n/a 200 Basis Points Increase (0.52%) (0.74%)
Due to the current low interest rate environment, nothing beyond a 100 basis point decrease was simulated for 2002.
Although classified as leased equipment, Provident continues to include auto leases in its interest sensitivity analysis.
ALCO regularly incorporates discussions and analyses of market risk embedded in off-balance sheet activities as well as on non-interest income items such as loan sale premiums. ALCO actively monitors the impact of related market risk since these premiums are sensitive to changes in interest rates.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
All transaction accounts are regularly analyzed for embedded market risk. These accounts are evaluated with respect to their repricing characteristics as well as their expected average lives. Provident offers a diverse set of managed transaction accounts including some that reprice according to a third party index and some with managed rates. ALCO actively monitors the behavioral characteristics of these products. Although indexed account rates move parallel to movements in short term rates, managed account rates adjust slower and at smaller increments due to the competitive environment. During the current low rate environment, such price rigidities negatively impact interest rate margins in the short run; however, the long-term profitability and liquidity characteristics of these accounts are very attractive.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ----------------------------------------------------
Report of Ernst & Young LLP, Independent Auditors ........................ 45
Financial Statements:
Provident Financial Group, Inc. and Subsidiaries Consolidated Balance Sheets .......................................... 46 Consolidated Statements of Income .................................... 47 Consolidated Statements of Changes in Shareholders' Equity ........... 48 Consolidated Statements of Cash Flows ................................ 49 Notes to Consolidated Financial Statements ........................... 50
Supplementary Data:
Quarterly Consolidated Results of Operations (unaudited) ................. 89
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Shareholders Provident Financial Group, Inc.
We have audited the accompanying consolidated balance sheets of Provident Financial Group, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Provident Financial Group, Inc. and subsidiaries at December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 3 to the consolidated financial statements, Provident Financial Group, Inc. has restated previously issued 2000 and 2001 consolidated financial statements.
As discussed in Note 8 to the consolidated financial statements, in 2002 Provident Financial Group, Inc. changed its method of accounting for goodwill in accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."
/s/ ERNST & YOUNG LLP
Cincinnati, Ohio April 11, 2003
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, ---------------------------- As Restated (Dollars in Thousands) 2002 See Note 3 ------------------------------------------------------------------------------------- ASSETS Cash and Due from Banks $ 351,994 $ 378,257 Federal Funds Sold and Reverse Repurchase Agreements 188,925 122,966 Trading Account Securities 127,848 101,156 Loans Held for Sale 436,884 217,914 Investment Securities Available for Sale (amortized cost - $4,158,511 and $3,510,601) 4,215,238 3,486,058 Loans and Leases: Corporate Lending: Commercial 4,482,373 4,540,088 Mortgage 960,636 939,824 Construction 510,331 528,008 Lease Financing 1,273,901 1,106,144 Consumer Lending: Installment 1,306,761 913,312 Residential 599,793 922,747 ------------ ------------ Total Loans and Leases 9,133,795 8,950,123 Reserve for Loan and Lease Losses (201,051) (241,143) ------------ ------------ Net Loans and Leases 8,932,744 8,708,980 Leased Equipment 2,350,356 2,651,394 Premises and Equipment 101,513 103,085 Goodwill 82,651 80,649 Other Assets 751,856 710,372 ------------ ------------ TOTAL ASSETS $ 17,540,009 $ 16,560,831 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Deposits: Noninterest Bearing $ 1,141,990 $ 994,978 Interest Bearing 8,706,989 7,859,272 ------------ ------------ Total Deposits 9,848,979 8,854,250 Short-Term Debt 1,925,005 1,885,309 Long-Term Debt 3,842,657 4,081,414 Guaranteed Preferred Beneficial Interests in Company's Junior Subordinated Debentures 451,074 450,759 Minority Interest 160,966 - Accrued Interest and Other Liabilities 430,957 487,266 ------------ ------------ Total Liabilities 16,659,638 15,758,998 Shareholders' Equity: Preferred Stock, 5,000,000 Shares Authorized: Series D, 70,272 Issued 7,000 7,000 Common Stock, No Par Value, 110,000,000 Shares Authorized, 48,760,462 and 49,205,897 Issued 14,454 14,587 Capital Surplus 298,025 322,024 Retained Earnings 604,013 556,918 Accumulated Other Comprehensive Loss (43,121) (98,696) ------------ ------------ Total Shareholders' Equity 880,371 801,833 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 17,540,009 $ 16,560,831 ============ ============
See notes to consolidated financial statements.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31, ---------------------------------- 2001 2000 As Restated As Restated (In Thousands, Except Per Share Data) 2002 See Note 3 See Note 3 -------------------------------------------------------------------------------- Interest Income: Interest and Fees on Loans and Leases $ 600,460 $ 747,930 $ 673,561 Interest on Investment Securities 217,595 204,304 227,701 Other Interest Income 23,333 21,061 4,306 --------- --------- --------- Total Interest Income 841,388 973,295 905,568 Interest Expense: Interest on Deposits: Savings and Demand Deposits 38,748 68,559 78,421 Time Deposits 223,424 317,810 301,918 --------- --------- --------- Total Interest on Deposits 262,172 386,369 380,339 Interest on Short-Term Debt 35,642 55,819 86,797 Interest on Long-Term Debt 204,742 230,061 174,761 Interest on Junior Subordinated Debentures 23,274 30,551 20,033 --------- --------- --------- Total Interest Expense 525,830 702,800 661,930 --------- --------- --------- Net Interest Income 315,558 270,495 243,638 Provision for Loan and Lease Losses 99,549 215,545 133,477 --------- --------- --------- Net Interest Income After Provision for Loan and Lease Losses 216,009 54,950 110,161 Noninterest Income: Service Charges on Deposit Accounts 45,184 39,924 35,138 Loan Servicing Fees 33,835 33,026 37,849 Commercial Mortgage Banking Revenue 25,354 29,490 5,674 Other Service Charges and Fees 48,563 38,833 49,108 Leasing Income 605,887 584,065 461,209 Non-Cash Gain on Sales of Loans and Leases - - 34,447 Cash Gain on Sales of Loans and Leases 15,691 6,311 10,452 Warrant Gains 8,186 412 7,500 Security Gains 2,596 - 155 Other 20,196 24,375 19,084 --------- --------- --------- Total Noninterest Income 805,492 756,436 660,616 Noninterest Expense: Salaries, Wages and Benefits 233,178 201,715 172,903 Charges and Fees 30,531 31,888 22,099 Occupancy 23,637 22,605 20,631 Leasing Expense 416,508 402,372 300,711 Equipment Expense 24,345 25,234 26,045 Professional Fees 25,990 24,507 21,735 Minority Interest Expense 7,069 - - Merger and Restructuring Charges - - 39,300 Other 114,770 104,663 76,977 --------- --------- --------- Total Noninterest Expenses 876,028 812,984 680,401 --------- --------- --------- Income (Loss) Before Income Taxes 145,473 (1,598) 90,376 Applicable Income Taxes 50,022 (595) 33,835 --------- --------- --------- Net Income (Loss) $ 95,451 $ (1,003) $ 56,541 ========= ========= =========
Basic Earnings (Loss) Per Common Share $ 1.94 $ (.04) $ 1.14 Diluted Earnings (Loss) Per Common Share 1.88 (.04) 1.12 Cash Dividends Paid Per Common Share .96 .96 .96
See notes to consolidated financial statements.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Retained Accumulated Earnings Other (In Thousands, Preferred Common Capital As Restated Comprehensive Except Per Share Data) Stock Shares Stock Surplus See Note 3 Loss, Net Total ------------------------------------------------------------------------------------------------------------------------ Balance at January 1, 2000 as Previously Reported $ 7,000 48,619 $ 14,410 $ 308,237 $ 646,472 $ (49,897) $ 926,222
Accumulative Adjustment for Restatement of Prior Years (49,352) (49,352) ------- ------ -------- --------- --------- --------- ---------
Balance at January 1, 2000 as Restated 7,000 48,619 14,410 308,237 597,120 (49,897) 876,870
Net Income 56,541 56,541 Change in Unrealized Gains (Losses) on Marketable Securities 31,968 31,968 --------- Comprehensive Income 88,509 Cash Dividends Declared on: Common Stock ($.96/share) (46,789) (46,789) Preferred Stock ($13.50/share) (949) (949) Principal Payments on Loans/ Amortization of Expense Related to Employee Stock Benefit Plans 780 780 Liquidation of Employee Stock Benefit Plans 1,469 1,469 Exercise of Stock Options and Accompanying Tax Benefits 195 59 3,842 3,901 Deferred Compensation Tax Adjustment 567 567 ------- ------ -------- --------- --------- --------- --------- Balance at December 31, 2000 7,000 48,814 14,469 314,895 605,923 (17,929) 924,358
Net Loss (1,003) (1,003) Other Comprehensive Income, Net of Tax: Cumulative Effect of a Change in Accounting Principle (28,332) (28,332) Change in Unrealized Gains (Losses) on: Hedging Instruments (54,411) (54,411) Marketable Securities 1,976 1,976 --------- Total Comprehensive Loss (81,770) Cash Dividends Declared on: Common Stock ($.96/share) (47,053) (47,053) Preferred Stock ($13.50/share) (949) (949) Exercise of Stock Options and Accompanying Tax Benefits 375 113 6,477 6,590 Distribution of Contingent Shares for Prior Year Acquisition 28 8 822 830 Stock Purchased and Cancelled (11) (3) (243) (246) Other 73 73 ------- ------ -------- --------- --------- --------- --------- Balance at December 31, 2001 7,000 49,206 14,587 322,024 556,918 (98,696) 801,833
Net Income 95,451 95,451 Other Comprehensive Income, Net of Tax: Change in Unrealized Gains (Losses) on: Hedging Instruments 2,813 2,813 Marketable Securities 52,762 52,762 --------- Total Comprehensive Income 151,026 Cash Dividends Declared on: Common Stock ($.96/share) (47,385) (47,385) Preferred Stock ($13.50/share) (949) (949) Exercise of Stock Options and Accompanying Tax Benefits 336 101 5,200 5,301 Benefit Plan Assets in Provident Stock (781) (234) (22,258) (22) (22,514) Costs and Present Value of Contract Payments of PRIDES Securities (6,917) (6,917) Stock Purchased and Cancelled (1) (24) (24) ------- ------ -------- --------- --------- --------- --------- Balance at December 31, 2002 $ 7,000 48,760 $ 14,454 $ 298,025 $ 604,013 $ (43,121) $ 880,371 ======= ====== ======== ========= ========= ========= =========
See notes to consolidated financial statements.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, ----------------------------------------- 2001 2000 As Restated As Restated (In Thousands) 2002 See Note 3 See Note 3 -------------------------------------------------------------------------------------------------- Operating Activities: Net Income (Loss) $ 95,451 $ (1,003) $ 56,541 Adjustments to Reconcile Net Income to Net Cash Provided by (Used in) Operating Activities: Provision for Loan and Lease Losses 99,549 215,545 133,477 Amortization of Goodwill - 4,317 3,718 Other Amortization and Accretion 26,654 83 (28,158) Depreciation of Leased Equipment 419,438 387,235 296,997 Depreciation of Premises and Equipment 22,088 22,482 21,743 Tax Benefit Received from Exercise of Stock Options 1,069 2,706 513 Realized Investment Security Gains (2,596) - (155) Proceeds From Sale of Loans Held for Sale 3,065,139 2,825,184 1,049,470 Origination of Loans Held for Sale (3,270,407) (2,834,074) (1,192,804) Realized Gains on Loans Held for Sale (13,702) (2,856) (30,607) (Increase) Decrease in Trading Account Securities (11,368) (59,207) 32,767 (Increase) Decrease in Interest Receivable 1,171 4,402 (23,635) Increase in Other Assets (5,711) (144,760) (4,699) Increase (Decrease) in Interest Payable (4,745) (4,099) 22,209 Deferred Income Taxes 24,957 (11,915) 10,808 Increase (Decrease) in Other Liabilities (65,135) 57,596 (70,616) ----------- ----------- ----------- Net Cash Provided by Operating Activities 381,852 461,636 277,569 ----------- ----------- ----------- Investing Activities: Investment Securities Available for Sale: Proceeds from Sales 1,423,825 2,264,759 2,229,586 Proceeds from Maturities and Prepayments 1,282,271 1,120,965 485,028 Purchases (3,346,950) (3,833,511) (2,885,170) (Increase) Decrease in Receivables Due From Securitization Trusts (962) 466,268 (91,134) Net Increase in Loans and Leases (320,208) (1,085,819) (1,874,728) Net Increase in Leased Equipment (118,400) (652,695) (875,601) Net Increase in Premises and Equipment (20,516) (21,648) (23,863) Acquisitions - - (129,190) ----------- ----------- ----------- Net Cash Used in Investing Activities (1,100,940) (1,741,681) (3,165,072) ----------- ----------- ----------- Financing Activities: Net Increase in Deposits 882,968 43,254 1,529,122 Net Increase (Decrease) in Short-Term Debt 39,696 1,246,286 (436,107) Principal Payments on Long-Term Debt (366,959) (259,041) (587,307) Proceeds from Issuance of Long-Term Debt and Junior Subordinated Debentures 86,239 426,032 2,416,214 Proceeds from Issuance of Minority Interest 160,966 - - Cash Dividends Paid (48,334) (48,002) (47,738) Repurchase of Common Stock (24) (246) - Proceeds from Exercise of Stock Options 4,232 3,884 3,388 Net Increase in Other Equity Items - 73 2,816 ----------- ----------- ----------- Net Cash Provided by Financing Activities 758,784 1,412,240 2,880,388 ----------- ----------- ----------- Increase (Decrease) in Cash and Cash Equivalents 39,696 132,195 (7,115) Cash and Cash Equivalents at Beginning of Period 501,223 369,028 376,143 ----------- ----------- ----------- Cash and Cash Equivalents at End of Period $ 540,919 $ 501,223 $ 369,028 =========== =========== ===========
Supplemental Disclosures of Cash Flow Information: Cash Paid for: Interest $ 464,821 $ 634,239 $ 560,801 Income Taxes 6,318 20,044 58,883 Non-Cash Activity: Transfer of Loans and Premises and Equipment to Other Real Estate 23,680 22,444 14,365 Residual Interest in Securitized Assets Created from the Sale of Loans - - 106,098
See notes to consolidated financial statements.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ACCOUNTING POLICIES: ------------------------------- The following is a summary of significant accounting policies:
NATURE OF OPERATIONS: Provident Financial Group, Inc. ("Provident") is a bank holding company headquartered in Cincinnati, Ohio. Provident operates bank and other financial service subsidiaries principally in Ohio, northern Kentucky and southwest Florida. Principal products and services provided by Provident include commercial lending, lease financing, cash management, retail lending, deposit accounts, mortgage banking, brokerage services, investment products and trust services.
BASIS OF PRESENTATION: The accounting and reporting policies of Provident conform with accounting principles generally accepted in the United States. Certain estimates are required to be made by management in the preparation of the consolidated financial statements. Actual results may differ from those estimates. All significant intercompany balances and transactions have been eliminated. Certain reclassifications have been made to conform to the current year presentation.
The consolidated financial statements include the accounts of Provident and its subsidiaries. Investments in companies in which Provident has significant influence over operating and financing decisions (principally defined as owning a voting or economic interest of 20% to 50%) are accounted for by the equity method of accounting.
Special purpose entities (SPEs) have been formed for many of Provident's securitization transactions. These SPEs are not operating entities, have no employees, and have a limited life. The basic SPE structure involves Provident transferring loans or leases to the SPE. The SPE funds the purchase of these assets by issuing debt securities to investors. The legal documents governing the SPE transactions describe how the cash earned on the assets held in the SPE must be allocated to the investors and other parties that have rights to these cash flows. SPEs can be structured to be bankruptcy remote, thereby insulating investors from the impact of the creditors of other entities, including the seller of the assets. SPEs are critical to the functioning of several significant markets, including, asset-backed securities, mortgage-backed securities and commercial paper markets.
Generally, Provident's securitization transactions from 1996 through the second quarter of 2000 involved loans and equipment leases being transferred to SPEs. Loans and equipment leases sold to these SPEs are no longer recorded on Provident's balance sheet and the SPEs are not consolidated. Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," provides specific criteria for determining when an SPE meets the definition of a qualifying special-purpose entity (QSPE). Provident's nonconforming residential, prime home equity and equipment lease transactions meet the applicable QSPE criteria under Statement 140 and are not consolidated on Provident's balance sheet.
STATEMENTS OF CASH FLOWS: For cash flow purposes, cash equivalents include amounts due from banks and federal funds sold and reverse repurchase agreements. Generally, federal funds sold and reverse repurchase agreements are purchased and sold for one-day periods.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REVERSE REPURCHASE AGREEMENTS AND REPURCHASE AGREEMENTS: Securities purchased under agreements to resell ("reverse repurchase agreements") and securities sold under agreements to repurchase ("repurchase agreements") are treated as collateralized financing transactions and are recorded at the amounts at which the securities were acquired or sold plus accrued interest. Securities, generally U.S. government, federal agency and agency mortgage-backed securities, pledged as collateral under these financing arrangements cannot be sold or repledged by the secured party. The fair value of collateral either received from or provided to a third party is continually monitored by Provident.
SECURITIES: Securities are classified as available for sale or trading. Securities classified as available for sale are intended to be held for indefinite periods of time. These securities are stated at fair value with unrealized gains and losses (net of taxes) reported as a separate component of shareholders' equity.
Securities purchased with the intention of selling them in the near term are classified as trading. These securities are carried at fair value with unrealized gains and losses included in noninterest income. The specific identification method is used for determining gains and losses from securities transactions.
LOANS AND LEASES: Loans are generally stated at the principal amount outstanding. Loans that are intended to be sold within a short period of time are classified as held for sale. Loans held for sale are reported at the lower of aggregate cost or market value. Interest on loans is computed on the outstanding principal balance. The portion of loan fees which exceeds the direct costs to originate the loan is deferred and recognized as interest income over the estimated lives of the related loans using the interest method. Any premium or discount applicable to specific loans purchased is amortized over the remaining lives of such loans using the interest method. Loans are generally placed on nonaccrual status when the payment of principal or interest is past due 90 days or more. However, installment loans are not placed on nonaccrual status because they are charged off in the month the loans reach 120 days past due. In addition, loans that are well secured and in the process of collection are not placed on nonaccrual status. When a loan is placed on nonaccrual status, any interest income previously recognized that has not been received is reversed. Future interest income is recorded only when a payment is received and collection of principal is considered reasonably assured. Income on impaired loans is generally recognized on a cash basis.
Unearned income on direct financing leases is amortized over the terms of the leases resulting in an approximate level rate of return on the net investment in the leases. Income from leveraged lease transactions is recognized using a method that yields a level rate of return in relation to Provident's net investment in the lease. The investment includes the sum of the aggregate rentals receivable and the estimated residual value of leased equipment less unearned income and third party debt on leveraged leases. Commercial leases are generally placed on nonaccrual status when payments are past due 90 days or more.
RESERVE FOR LOAN AND LEASE LOSSES: The reserve for loan and lease losses is maintained at a level necessary to absorb losses in the lending portfolio. The reserve is increased by charges to earnings, as provisions for loan and lease losses. Loans and leases deemed uncollectible are charged off and
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
deducted from the reserve and recoveries on loans and leases previously charged off are added back to the reserve.
Management's determination of the adequacy of the reserve is based on an assessment of potential losses given the conditions at the time. This assessment consists of certain loans and leases being evaluated on an individual basis, as well as all loans and leases being categorized based on common characteristics related to the reserve factors and being evaluated as a group. Loans and leases reviewed on an individual basis include large non-homogeneous credits where their internal credit rating is at or below a predetermined classification. Corporate loans and leases not individually reviewed are segmented by the characteristics related to the reserve factors while consumer loans are segmented by retail product. Analyses are performed on each segment of the portfolio based upon trends in delinquencies, charge-offs, economic factors and business strategies. Adequacy factors are adjusted based on changes in expected losses in the segment.
Provident considers a corporate loan to be an impaired loan when it is probable that all amounts due will not be collected according to the contractual terms of the loan agreement. Provident measures the value of an impaired loan based on the present value of expected future cash flows discounted at the loan's effective interest rate or, if more practical, at the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent.
LOAN AND LEASE SECURITIZATIONS: Provident has securitized loans and leases it originated or purchased. Securitizations have provided Provident with immediate cash flows to fund additional loan and lease originations and purchases. Prior to June 30, 2000, Provident's securitizations were generally structured as sales, resulting in the removal of the loans and leases from the balance sheet and the recognition of gains or losses on the income statement. Since June 30, 2000, Provident's securitizations have been structured as secured financings, resulting in additional debt on the balance sheet and no recognition of gains or losses on the income statement. The switch to a secured financing structure does not affect the total profit Provident will recognize over the life of a loan, but rather impacts the timing of income recognition. Secured financing transactions, on a comparative basis, cause reported earnings from securitized loans to be lower in the initial periods and higher in later periods, as interest is earned on the loans.
Generally, when Provident structured its mortgage related securitization transactions as sales, it retained (a) future cash flows of the underlying loans, net of payments due to investors of the securitization trust, servicing fees and other fees (referred to as Retained Interests in Securitized Assets or "RISAs"), (b) servicing rights on the loans and leases, and (c) reserve accounts used to absorb credit losses on the loans securitized. Gain or loss on the sale of the loans depended in portion on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the assets retained based on their relative fair value at the date of transfer. To obtain fair values, quoted market prices are used if available. However, quotes are generally not available for assets retained, so Provident generally estimates fair value based on the present value of future expected cash flows estimated using management's best estimates of the key assumptions, including credit losses, prepayment speeds, forward yield curves, and discount rates commensurate with the risks involved.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
LEASED EQUIPMENT: Rental income for leased equipment is recognized on a straight-line basis as scheduled. Related depreciation expense is recorded on the straight line basis over the life of the lease based upon the estimated residual value. On a periodic basis, a review is undertaken to determine if the leased equipment is impaired. An impairment loss is recognized if the carrying amount of the leased equipment is not recoverable and exceeds its fair value. The carrying amount of the leased equipment is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the lease payments and the eventual disposition of the assets. Auto lease receivables are written off in the month the leases reach 120 days past due while equipment leases are written off when deemed uncollectible.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost less depreciation and amortization that are computed principally on the straight-line method over the estimated useful lives of the assets.
GOODWILL: Goodwill is the excess of the purchase price over net identifiable tangible and intangible assets acquired in a purchase business combination. Provident adopted the provisions of Statement of Financial Accounting Standards No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets determined to have limited lives continue to be amortized over their useful lives.
MORTGAGE SERVICING ASSETS: Provident recognizes the rights to service mortgage loans it does not own but services for others within Other Assets of its balance sheets. Mortgage servicing assets may be recognized (1) when mortgage loans are sold with servicing retained or (2) when mortgage loan servicing is purchased. When mortgage loans are sold, the carrying value of the loans is allocated between the loans sold and servicing assets retained based on the relative fair values of each. Mortgage servicing assets, when purchased, are initially recorded at cost. Mortgage servicing assets are carried at the lower of the initial carrying value, adjusted for amortization, or estimated fair value.
EQUITY INVESTMENTS: Provident invests in low income housing partnerships, equity funds and directly in equity securities, which are collectively referred to herein as equity investments. Equity investments, which are reported within Investment Securities Available for Sale and Other Assets, are carried at estimated fair value with changes in fair value recognized in other noninterest income. The fair value of publicly traded investments are determined using quoted market prices less liquidity discounts. Liquidity discounts take into account the fact that Provident may not immediately realize such market prices due to regulatory, corporate and contractual sales restrictions. The estimated fair value of equity investments that are not publicly traded approximates cost including other than temporary valuation adjustments considered appropriate by management. As of December 31, 2002 and 2001, Provident held equity investments with a carrying value of $72.1 million and $79.4 million, respectively.
OTHER REAL ESTATE AND EQUIPMENT: Other real estate and equipment acquired through partial or total satisfaction of loans is recorded at the lower of cost or fair value and is included in Other Assets of the consolidated balance sheets. Provident's policy is to include the unpaid balance of
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
applicable loans in the cost of other real estate and equipment. However, in no case is the carrying value of other real estate and equipment greater than fair value. At December 31, 2002 and 2001, the carrying value of other real estate and equipment owned was $15.8 million and $20.9 million, respectively.
STOCK-BASED COMPENSATION: Statement No. 123, "Accounting for Stock-Based Compensation" encourages, but does not require, adoption of a fair value-based accounting method for stock-based employee compensation plans. For the years reported, Provident has elected to continue its accounting in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," whereby no compensation expense is recognized for the granting of stock options when the exercise price of the option equals the market price of the underlying stock at date of grant.
For purposes of providing the pro forma disclosures required under Statement 123, the fair value of stock options granted in 2002, 2001 and 2000 was estimated at the date of grant using a Black-Scholes option pricing model. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of subjective assumptions including the expected stock price volatility.
The following weighted-average assumptions were used in the option pricing model for 2002, 2001 and 2000 respectively: risk-free interest rates of 4.50%, 4.72% and 6.13%; dividend yields of 3.50%, 3.00% and 3.00%; volatility factors of the expected market price of Provident's Common Stock of 29.1%, 28.8% and 26.9% and an expected life of the option of 7 years for each year. Based on these assumptions, the weighted-average fair value of options granted in 2002, 2001 and 2000 was $5.89, $8.35 and $8.78, respectively.
No compensation cost has been recognized for stock option grants. Had compensation cost been expensed for stock option awards based on the fair values at grant dates, Provident's net income and earnings per share would have been as follows:
Year Ended December 31, ------------------------------------- (In Thousands, Except Per Share Data) 2002 2001 2000 --------------------------------------------------------------------------------------- Net Income as Reported $ 95,451 $ (1,003) $ 56,541 Less Total Stock-Based Compensation Determined under Fair Value Based Methods, Net of Related Tax Effects (9,662) (7,181) (5,289) ---------- --------- ---------- Pro-forma Net Income $ 85,789 $ (8,184) $ 51,252 ========== ========= ========== Earnings Per Share: Basic - As Reported $ 1.94 $ (0.04) $ 1.14 Basic - Pro Forma 1.74 (0.19) 1.03 Diluted - As Reported 1.88 (0.04) 1.12 Diluted - Pro Forma 1.72 (0.19) 1.03
As of January 1, 2003, Provident adopted the provisions of Statement 123. Under these rules, compensation expense will be recognized over the vesting period equal to the fair value of stock-based compensation as of the date of grant. As Provident has elected to use the Prospective Method of expense recognition according to the transition rules of Statement No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," the adoption of Statement 123 applies only to options granted after December 31, 2002. Options granted prior to January 1, 2003 will continue to be accounted for under APB 25.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INCOME TAXES: Provident files a consolidated federal income tax return that includes all of its subsidiaries. Subsidiaries provide for income taxes on a separate-return basis and remit to Provident amounts determined to be currently payable.
DERIVATIVE FINANCIAL INSTRUMENTS: Provident employs derivatives such as interest rate swaps, caps and floors to manage the interest sensitivity of certain on and off-balance sheet assets and liabilities. The net interest income or expense on interest rate swaps, caps and floors is accrued and recognized as an adjustment to the interest income or expense of the associated on and off-balance sheet asset or liability.
Provident adopted the provisions of Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, on January 1, 2001. Statement 133 requires that derivatives be recognized as either assets or liabilities in the balance sheet and that those instruments be measured at fair value. The accounting for the gain or loss resulting from the change in fair value depends on the intended use of the derivative. For a derivative used to hedge changes in fair value of a recognized asset or liability, or an unrecognized firm commitment, the gain or loss on the derivative will be recognized in earnings together with the offsetting loss or gain on the hedged item. This results in earnings recognition only to the extent that the hedge is ineffective in achieving offsetting changes in fair value. For a derivative used to hedge changes in cash flows associated with forecasted transactions, the gain or loss on the effective portion of the derivative will be deferred, and reported as accumulated other comprehensive income, a component of shareholders' equity, until such time the hedged transaction affects earnings. For derivative instruments not accounted for as hedges, changes in fair value are required to be recognized in earnings. Note 21 provides additional detail on the accounting for derivative instruments and hedging activities held by Provident.
NOTE 2 - ACCOUNTING PRONOUNCEMENTS EFFECTIVE FOR FUTURE PERIODS: -------------------------------------------------------------------- In June 2001, Statement No. 143, "Accounting for Asset Retirement Obligations" was issued. Statement 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. The adoption of Statement 143, which becomes effective January 1, 2003, is not expected to have a material impact on Provident's financial position or results of operations.
In April 2002, the Financial Accounting Standards Board issued Statement No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment No. 13, and Technical Corrections." Under Statement 4, all gains and losses from extinguishment of debt were required to be aggregated and classified as an extraordinary item, net of related income tax effect. As a result of the elimination of Statement 4, gains and losses from extinguishment of debt will be classified as extraordinary items only if they meet the criteria in APB Opinion No. 30. Applying the provisions of APB 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification of an extraordinary item. Additionally, Statement 13 is amended to require sale-leaseback accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The adoption of Statement 145, which becomes effective January 1, 2003, is not expected to have a material impact on Provident's results of operations or financial condition.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In June 2002, Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" was issued. Statement 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue 94-3. Statement 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. The adoption of Statement 146, which becomes effective January 1, 2003, is not expected to have a material impact on Provident's results of operations or financial condition.
In October 2002, the Financial Accounting Standards Board issued Statement No. 147, "Acquisitions of Certain Financial Institutions an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9." Statement 147 provides guidance on the accounting for the acquisition of a financial institution and applies to all acquisitions except those between two or more mutual enterprises. The excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as a business combination represents goodwill and will no longer be amortized, but rather, be subject to impairment tests as prescribed by Statement No. 142, "Goodwill and Other Intangible Assets." Statement 147, which became effective on October 1, 2002, did not have a material impact on Provident's results of operations or financial condition.
In December 2002, Statement No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," was issued. Statement 148 amends Statement No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition to Statement 123's fair value based method of accounting for stock-based employee compensation. Statement 148 also amends the disclosure provisions of Statement 123 and APB Opinion No. 28, "Interim Financial Reporting," to require disclosure in the summary of significant accounting policies of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While Statement 148 does not amend Statement 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of Statement 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of Statement 123 or the intrinsic value method of APB Opinion No. 25. Provident elected to adopt the provisions of Statement 123 using the Prospective Method of expense recognition according to the transition rules of Statement 148. The full-year 2003 impact on net income and diluted earnings per share are estimated to be $1.4 million and $.02, respectively, for options granted after December 31, 2002. Note 1 provides pro forma information had Statement 123 been adopted for earlier periods.
In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This Interpretation also incorporates, without change, the guidance in FASB Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness of
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Others," which is being superseded. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The provisions of this Interpretation is not expected to have a material impact on Provident's results of operations or financial condition.
In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" that addresses consolidation by business enterprises of variable interest entities (VIEs). Under this Interpretation, special purpose entities (SPEs) having certain attributes will now be consolidated where, in the past, they have not. The Interpretation does not impact qualifying special purpose entities (QSPEs), as described in Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," and other SPEs with similar characteristics. As management has determined that the SPEs used in the securitization of its nonconforming residential, prime home equities and equipment leases have the characteristics of a QSPE, these securitization entities will continue to be excluded from consolidation.
NOTE 3 - RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS: ---------------------------------------------------------------- On March 5, 2003, Provident announced that it would restate its annual financial statements for the years 1997 through 2001 and the interim periods for 2002. The restated financial statements reflect both the correction of an error that resulted in an overstatement of operating results and the return to the balance sheet of consumer auto leases which, as a result of nine financing transactions, had been previously accounted for as off-balance sheet.
The restatement of previously reported operating results was a result of unintentional errors in the accounting for nine auto lease financing transactions originated between 1997 and 1999. These errors were first discovered by Provident in connection with the testing and installation of a financial model that identified differences in income that was previously recorded, compared with income generated by the financial model. The original amortization model was designed to match revenue and expense in an operating lease framework.
Provident has also determined that its auto leases do not meet the requirements for direct finance lease classification under Financial Accounting Standards No. 13, titled "Accounting for Leases." Provident has reclassified all of the auto leases on its balance sheet as operating leases and reported them as leased equipment, instead of finance leases, which were previously reported in the loan category. The reclassification will affect auto leases originated from 1994 through 2002. During this period, Provident's auto lease originations totaled $4.7 billion and had a remaining balance of $2.1 billion at December 31, 2002. Income to be recognized in future years, beginning with 2003, will be increased by an aggregate amount substantially similar to the additional restatement. In addition, this restatement has no impact on Provident's cash flows.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables reconcile the effects of the restatement for the years ended December 31, 2001, and 2000, the first three quarters of 2002 and all quarters of 2001. The effects of the restatement on the Consolidated Statements of Operations are as follows:
Year Ended December 31, -------------------------- (In Thousands, Except Per Share Data) 2001 2000 ---------------------------------------------------------------------- Total Interest Income: Prior to Restatement $ 1,103,244 $ 970,981 Subsequent to Restatement 973,295 905,568 Total Interest Expense: Prior to Restatement 630,141 583,008 Subsequent to Restatement 702,800 661,930 Net Interest Income: Prior to Restatement 473,103 387,973 Subsequent to Restatement 270,495 243,638 Provision for Loan and Lease Losses: Prior to Restatement 225,748 131,281 Subsequent to Restatement 215,545 133,477 Total Noninterest Income: Prior to Restatement 226,379 254,162 Subsequent to Restatement 756,436 660,616 Total Noninterest Expense: Prior to Restatement 437,298 392,909 Subsequent to Restatement 812,984 680,401 Net Income (Loss): Prior to Restatement 23,329 73,614 Subsequent to Restatement (1,003) 56,541 Diluted Earnings (Loss) Per Common Share: Prior to Restatement 0.46 1.46 Subsequent to Restatement (0.04) 1.12
Quarter Ended (Unaudited) ---------------------------------- September 30, June 30, March 31, (In Thousands, Except Per Share Data) 2002 2002 2002 -------------------------------------------------------------------------- Total Interest Income: Prior to Restatement $239,715 $242,494 $244,362 Subsequent to Restatement 208,250 211,331 213,416 Total Interest Expense: Prior to Restatement 114,427 116,101 117,951 Subsequent to Restatement 130,624 132,603 135,121 Net Interest Income: Prior to Restatement 125,288 126,393 126,411 Subsequent to Restatement 77,626 78,728 78,295 Provision for Loan and Lease Losses: Prior to Restatement 25,100 33,119 23,990 Subsequent to Restatement 23,532 33,575 24,205 Total Noninterest Income: Prior to Restatement 59,909 65,316 53,584 Subsequent to Restatement 196,397 204,578 194,230 Total Noninterest Expense: Prior to Restatement 113,981 113,501 113,543 Subsequent to Restatement 214,079 214,637 214,612 Net Income (Loss): Prior to Restatement 30,436 29,759 27,388 Subsequent to Restatement 24,036 23,170 21,616 Diluted Earnings (Loss) Per Common Share: Prior to Restatement 0.60 0.58 0.54 Subsequent to Restatement 0.47 0.46 0.43
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Quarter Ended (Unaudited) --------------------------------------------------- December 31, September 30, June 30, March 31, (In Thousands, Except Per Share Data) 2001 2001 2001 2001 --------------------------------------------------------------------------------------------- Total Interest Income: Prior to Restatement $ 256,146 $ 280,061 $ 282,019 $ 285,018 Subsequent to Restatement 221,768 245,459 250,450 255,618 Total Interest Expense: Prior to Restatement 131,231 156,389 166,380 176,141 Subsequent to Restatement 148,894 174,336 184,606 194,964 Net Interest Income: Prior to Restatement 124,915 123,672 115,639 108,877 Subsequent to Restatement 72,874 71,123 65,844 60,654 Provision for Loan and Lease Losses: Prior to Restatement 111,151 66,010 24,900 23,687 Subsequent to Restatement 108,787 60,886 23,548 22,324 Total Noninterest Income: Prior to Restatement 51,521 57,103 64,383 53,372 Subsequent to Restatement 195,712 192,917 193,534 174,273 Total Noninterest Expense: Prior to Restatement 110,077 125,863 105,902 95,456 Subsequent to Restatement 218,399 222,476 194,701 177,408 Net Income (Loss): Prior to Restatement (28,891) (7,435) 31,852 27,803 Subsequent to Restatement (37,519) (12,782) 26,632 22,666 Diluted Earnings (Loss) Per Common Share: Prior to Restatement (0.59) (0.16) 0.63 0.55 Subsequent to Restatement (0.77) (0.27) 0.53 0.45
The effects of the restatement on the Consolidated Balance sheets are as follows:
(Unaudited) ---------------------------------------- December 31, September 30, June 30, March 31, ------------------------- (In Thousands) 2002 2002 2002 2001 2000 -------------------------------------------------------------------------------------------------------- Total Loans and Leases: Prior to Restatement $10,425,250 $10,219,359 $10,158,640 $10,495,956 $ 9,076,906 Subsequent to Restatement 8,999,430 8,740,060 8,650,866 8,950,123 7,995,906 Reserve for Loan and Lease Losses: Prior to Restatement 201,056 211,262 240,663 240,653 154,300 Subsequent to Restatement 205,073 215,119 243,099 241,143 159,118 Leased Equipment: Prior to Restatement 179,195 166,515 178,393 185,863 215,227 Subsequent to Restatement 2,397,967 2,479,125 2,559,580 2,651,394 2,385,934 Total Assets: Prior to Restatement 16,237,999 15,673,874 15,358,476 15,573,554 13,857,385 Subsequent to Restatement 17,097,115 16,575,333 16,305,291 16,560,831 14,996,847 Long-Term Debt: Prior to Restatement 2,977,236 2,914,945 2,881,313 2,941,165 2,774,493 Subsequent to Restatement 4,017,644 3,976,155 3,962,991 4,081,414 4,024,109 Total Shareholders' Equity: Prior to Restatement 964,833 948,201 922,545 892,590 990,783 Subsequent to Restatement 855,316 845,081 826,014 801,833 924,358
The results of the restatement are reflected in the Consolidated Financial Statements and Notes to Consolidated Financial Statements for all periods reported upon.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - INVESTMENT SECURITIES: -------------------------------- The amortized cost and estimated market values of securities available for sale at December 31 were as follows:
Gross Gross Estimated Amortized Unrealized Unrealized Market (In Thousands) Cost Gains Losses Value -------------------------------------------------------------------------------------------- 2002: U.S. Treasury and Federal Agency Debentures $ 310,244 $ 5,974 $ (75) $ 316,143 State and Political Subdivisions 1,838 40 (3) 1,875 Mortgage-Backed Securities 3,240,192 70,043 (18,723) 3,291,512 Other Securities 606,237 10 (539) 605,708 ----------- ----------- ----------- ----------- $ 4,158,511 $ 76,067 $ (19,340) $ 4,215,238 =========== =========== =========== =========== 2001: U.S. Treasury and Federal Agency Debentures $ 302,912 $ 4,046 $ (402) $ 306,556 State and Political Subdivisions 3,185 28 (14) 3,199 Mortgage-Backed Securities 2,700,620 10,544 (37,990) 2,673,174 Other Securities 503,884 10 (765) 503,129 ----------- ----------- ----------- ----------- $ 3,510,601 $ 14,628 $ (39,171) $ 3,486,058 =========== =========== =========== ===========
Investment securities with a carrying value of approximately $2.6 billion and $1.9 billion at December 31, 2002 and 2001, respectively, were pledged as collateral to secure public and trust deposits, repurchase agreements, extensions of credit by the Federal Home Loan Bank, interest rate derivatives and for other purposes.
In 2002, 2001 and 2000 gross gains of $9.2 million, $10.3 million and $4.2 million and gross losses of $6.6 million, $10.3 million and $4.0 million, respectively, were realized on the sale of securities available for sale.
Securities are shown below based on their estimated average lives at December 31, 2002. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Estimated (In Thousands) Cost Market Value -------------------------------------------------------- Due in one year or less $ 291,275 $ 294,507 Due after 1 through 5 years 3,362,955 3,433,104 Due after 5 through 10 years 351,497 351,641 Due after 10 years 152,784 135,986 ---------- ---------- Total $4,158,511 $4,215,238 ========== ==========
NOTE 5 - LEASING: ----------------- Provident originates leases which are classified as either finance leases or operating leases, based on the terms of the lease arrangement. When a lease is classified as a finance lease, the future lease payments, net of unearned income, and the estimated residual value of the leased property at the end of the lease term are recorded as an asset under Loans and Leases. The amortization of the unearned income is recorded as interest income. When a lease is classified as an operating lease, the costs of the leased property, net of depreciation, is recorded as Leased Equipment. Rental income is recorded as noninterest income while the depreciation on the leased property is recorded as noninterest expense. At the expiration of a lease, the leased property is sold or another lease agreement is initiated.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Lease Financing: Lease financing includes the leasing of transportation, manufacturing, construction, communication, data processing and office equipment. These leases are classified as direct financing leases, with expiration dates over the next 1 to 9 years. Rentals receivable at December 31, 2002 and 2001 include $81 million and $118 million, respectively, for leveraged leases, which is net of principal and interest on the nonrecourse debt. The residual values on the leveraged leases that were entered into are estimated to be approximately $110 million and $112 million in total at December 31, 2002 and 2001, respectively.
The components of the net investment in lease financing at December 31 were as follows:
(In Thousands) 2002 2001 --------------------------------------------------------------- Rentals Receivable $ 1,322,470 $ 1,172,818 Leases in Process - 15,961 Estimated Residual Values 171,482 167,005 ----------- ----------- 1,493,952 1,355,784 Less: Unearned Income (220,051) (249,640) ----------- ----------- Net Investment in Lease Financing $ 1,273,901 $ 1,106,144 =========== ===========
Future minimum lease payments, by year, to be received on lease financing are $477.1 million for 2003; $341.6 million for 2004; $207.0 million for 2005; $112.9 million for 2006; $65.2 million for 2007 and $118.6 million thereafter.
Leased Equipment: Leased equipment includes assets which are subject to operating leases. Operating leases are comprised of transportation equipment, manufacturing equipment, data processing and office equipment to commercial clients and vehicles, some of which are accounted for as assets under a capital lease.
Provident, utilizing its auto leases, has entered into sale-leaseback transactions. At December 31, 2002 and 2001, respectively, approximately $1.5 billion and $1.7 billion of auto leases which were utilized in these transactions were outstanding and represent assets under capital leases included in Leased Equipment.
A summary of leased equipment at December 31 follows:
(In Thousands) 2002 2001 ------------------------------------------------------------------------- Costs of Automobiles $ 2,905,969 $ 3,059,187 Accumulated Depreciation - Automobiles (821,710) (673,799) ----------- ----------- Carrying Value of Automobile Leases 2,084,259 2,385,388 ----------- ----------- Costs of Equipment 366,982 367,431 Accumulated Depreciation - Equipment (100,885) (101,425) ----------- ----------- Carrying Value of Equipment Leases 266,097 266,006 ----------- ----------- Total Carrying Value of Leased Equipment $ 2,350,356 $ 2,651,394 =========== ===========
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The future gross minimum rentals, by year, under noncancelable leases for the rental of leased equipment follows:
Automobile Equipment (In Thousands) Leases Leases -------------------------------------------------------- 2003 $ 431,405 $ 56,184 2004 346,681 46,136 2005 237,221 30,869 2006 122,312 15,878 2007 38,294 6,105 Thereafter 4,003 3,930 ---------- -------- Total $1,179,916 $159,102 ========== ========
In 2002, 2001 and 2000, respectively, Provident incurred impairment charges of $1.9 million, $5.7 million and $1.3 million on uninsured auto residuals. Impairment is determined on an individual unit basis. Since 1994, except for a five-month period during 1998, when it self-insured, Provident has maintained insurance on its auto lease residuals in amounts necessary to effectively remove residual risk.
NOTE 6 - RESERVE FOR LOAN AND LEASE LOSSES: -------------------------------------------- The changes in the loan and lease loss reserve for the years ended December 31 were as follows:
(In Thousands) 2002 2001 2000 ------------------------------------------------------------------------- Balance at Beginning of Period $ 241,143 $ 159,118 $ 95,181 Provision for Loan and Lease Losses Charged to Earnings 99,549 215,545 133,477 Acquired Reserves - 10,003 2,377 Recoveries Credited to the Reserve 26,220 12,057 10,125 --------- --------- --------- 366,912 396,723 241,160 Losses Charged to the Reserve (165,861) (155,580) (82,042) --------- --------- --------- Balance at End of Period $ 201,051 $ 241,143 $ 159,118 ========= ========= =========
The following table shows Provident's investment in impaired loans as defined under Statement 114 as amended by Statement 118:
(In Thousands) 2002 2001 ------------------------------------------------------------------------ Impaired Loans Requiring a Valuation Allowance of $29.4 Million in 2002 and $18.2 Million in 2001 $ 91,053 $ 64,245 Impaired Loans Not Requiring a Valuation Allowance 8,272 - -------- -------- Total Impaired Loans $ 99,325 $ 64,245 ======== ======== Average Balance of Impaired Loans for the Year $102,241 $ 52,367 ======== ========
The increase in impaired loans partially reflects the implementation of more conservative criteria to identify impaired loans. The largest impaired loan relates to the commercial airline industry. The remaining impaired loans are distributed among 19 industries. Impaired loans are reviewed on an individual basis to estimate potential future losses. Given the circumstances as of December 31, 2002, reserves established for impaired loans are believed to be sufficient to absorb future potential losses.
Interest income recognized on impaired loans during 2002 or 2001 was $0.2 million and $0, respectively. The valuation allowance recorded on impaired loans is included in the reserve for loan losses.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loans and leases on nonaccrual status at December 31, 2002, 2001 and 2000 were $166.4 million, $176.9 million and $96.0 million, respectively. Loans and leases which were ninety days or more past due and still accruing totaled $29.9 million, $30.3 million and $28.2 million at December 31, 2002, 2001 and 2000, respectively. No loans or leases had been renegotiated to provide a reduction or deferral of interest or principal as of December 31, 2002, 2001 and 2000.
NOTE 7 - PREMISES AND EQUIPMENT: -------------------------------- The following is a summary of premises and equipment at December 31:
(In Thousands) 2002 2001 ----------------------------------------------------------- Land $ 11,921 $ 11,921 Buildings 40,698 40,802 Leasehold Improvements 19,092 17,889 Furniture and Fixtures 179,016 163,101 --------- --------- 250,727 233,713 Less Depreciation and Amortization (149,214) (130,628) --------- --------- Total $ 101,513 $ 103,085 ========= =========
Rent expense for all bank premises and equipment leases was $15.2 million, $15.1 million and $14.1 million in 2002, 2001 and 2000, respectively. The future gross minimum rentals, by year, under noncancelable leases for the rental of premises and equipment are $16.1 million in 2003, $14.1 million in 2004, $12.1 million in 2005, $10.5 million in 2006, $8.9 million in 2007 and $43.6 million thereafter.
NOTE 8 GOODWILL AND OTHER INTANGIBLE ASSETS: ---------------------------------------------- Provident adopted the provisions of Statements of Financial Accounting Standards No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with Statement 142. Other intangible assets determined to have limited lives continue to be amortized over their useful lives. Management performed a transitional impairment test on its goodwill assets as of January 1, 2002 and determined that no impairment existed as of that date.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As a result of adopting Statement 142, Provident did not incur any goodwill amortization during 2002, whereas during prior years, Provident recorded goodwill amortization. The following table provides net income and earnings per share for the years ended December 31, 2001 and 2000 on a pro forma basis excluding goodwill amortization.
Year Ended December 31, ----------------------- (In Thousands, Except Per Share Amounts) 2001 2000 -------------------------------------------------------------------------- Net Income (Loss): As Reported $(1,003) $56,541 Add Back: After-Tax Goodwill Amortization 2,806 2,417 ------- ------- Pro-Forma Net Income $ 1,803 $58,958 ======= ======= Basic Earnings (Loss) Per Common Share: As Reported $ (0.04) $ 1.14 Add Back: After-Tax Goodwill Amortization 0.06 0.05 ------- ------- Pro-Forma Basic Earnings Per Common Share $ 0.02 $ 1.19 ======= ======= Diluted Earnings (Loss) Per Common Share: As Reported $ (0.04) $ 1.12 Add Back: After-Tax Goodwill Amortization 0.06 0.05 ------- ------- Pro-Forma Diluted Earnings Per Common Share $ 0.02 $ 1.17 ======= =======
Changes in the carrying amount of goodwill by business line for the years ended December 31, 2002 and 2001, are as follows:
Commercial Retail (In Thousands) Banking Banking Total ------------------------------------------------------------------------------ Balance at January 1, 2001 $ 40,899 $ 43,060 $ 83,959 Goodwill Recorded as a Result of Contingent Consideration being Recognized 1,007 - 1,007 Amortization of Goodwill (2,081) (2,236) (4,317) -------- -------- -------- Balance at December 31, 2001 39,825 40,824 80,649
Goodwill Acquired During the Year - 189 189 Goodwill Recorded as a Result of Contingent Consideration being Recognized 1,594 219 1,813 -------- -------- -------- Balance at December 31, 2002 $ 41,419 $ 41,232 $ 82,651 ======== ======== ========
As all of Provident's other intangible assets have been determined to have limited lives, these assets have continued to be amortized as in the past. Intangible assets, along with accumulated amortization, is provided below:
Gross Net Carrying Accumulated Carrying (In Thousands) Value Amortization Value --------------------------------------------------------------------------------- Non-Contractual Customer Relationships $21,996 $ 7,837 $14,159 Purchased Core Deposits 1,429 1,072 357 ------- ------- ------- Balance at December 31, 2002 $23,425 $ 8,909 $14,516 ======= ======= =======
Amortization of intangible assets was $4.7 million, $3.4 million and $0.9 million for the years ended December 31, 2002, 2001 and 2000. The estimated amortization of intangible assets for the next five years is $4.7 million for 2003; $4.4 million for 2004; $3.3 million for 2005; $1.5 million for 2006; and $0.2 million for 2007.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - MORTGAGE SERVICING ASSETS: ------------------------------------ Provident recognizes the rights to service mortgage loans it does not own but services for others within Other Assets of its balance sheet. Mortgage servicing assets may be recognized (1) when mortgage loans are sold with servicing retained or (2) when mortgage loan servicing is purchased. When mortgage loans are sold, the carrying value of the loans is allocated between the loans sold and servicing assets retained based on the relative fair values of each. Mortgage servicing assets, when purchased, are initially recorded at cost. Mortgage servicing assets are carried at the lower of the initial carrying value, adjusted for amortization, or estimated fair value. Mortgage servicing assets are evaluated for impairment based on the fair value of those assets, using a desegregated approach. The fair value of the mortgage servicing assets is determined by estimating the present value of future net cash flows, taking into consideration loan prepayments speeds, discount rates, servicing costs and other economic factors.
Changes in the carrying value of mortgage servicing assets follows:
December 31, ---------------------- (In Thousands) 2002 2001 ------------------------------------------------------- Balance at Beginning of Period $ 84,267 $ 76,649 Additions 44,957 16,821 Amortization (17,534) (9,203) Impairment Charges - - --------- --------- Balance at End of Period $ 111,690 $ 84,267 ========= =========
As of December 31, 2002, mortgage servicing assets relating to commercial real estate loans and residential loans totaled $61.0 million and $50.7 million, respectively. Total mortgage loans serviced for others included $6.5 billion on commercial real estate property and $7.1 billion on residential property as of at December 31, 2002. No impairment charges were incurred on the commercial real estate servicing assets as most of the underlying loans have lockout and prepayment penalties generally ranging from 5 to 9 years. Regarding the residential servicing rights, no impairment charges were recognized as the majority of the servicing assets were acquired under the current interest rate environment.
NOTE 10 - SHORT-TERM DEBT: -------------------------- Short-term debt was as follows:
(Dollars in Thousands) 2002 2001 2000 -------------------------------------------------------------------------------------------- Year End Balance: Federal Funds Purchased and Repurchase Agreements $1,653,736 $1,644,738 $ 451,933 Commercial Paper 271,269 240,571 187,090 Weighted Average Interest Rate at Year End: Federal Funds Purchased and Repurchase Agreements 1.98% 2.28% 5.99% Commercial Paper 1.49 1.67 6.02 Maximum Amount Outstanding at Any Month End: Federal Funds Purchased and Repurchase Agreements $1,701,716 $1,925,001 $1,821,278 Commercial Paper 310,029 273,898 209,393
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - LONG-TERM DEBT: Long-term debt consisted of the following:
December 31, Stated Effective Maturity ---------------------- (Dollars in Thousands) Rate (1) Rate (2) Date 2002 2001 -------------------------------------------------------------------------------------------------- Provident (Parent Company): Fixed Rate Senior 8.38% 4.19% 2032 $ 75,000 $ - Miscellaneous Notes Various Various Various 239 359 ---------- ---------- 75,239 359 ---------- ---------- Subsidiaries: $1.5 Billion Bank Notes Program: Fixed Rate Senior n/a n/a n/a - 99,892 Notes Payable to Federal Home Loan Bank: Fixed Rate 5.84 5.84 2009 253,076 253,210 Fixed Rate 5.98 5.98 2010 420,000 420,000 Fixed Rate Various Various Various 55,589 57,915 Subordinated Notes: Fixed Rate 7.13 2.38 2003 74,998 74,986 Fixed Rate 6.38 2.11 2004 99,932 99,867 Secured Debt Financings: Secured by Auto Leases (3) 6.00 6.00 2003 125,354 152,909 Secured by Auto Leases (3) 5.62 5.62 2003 42,325 49,644 Secured by Auto Leases (3) 5.77 .71 2004 55,029 69,884 Secured by Auto Leases (3) 5.06 5.06 2004 244,585 273,792 Secured by Auto Leases (3) 5.97 5.97 2005 24,515 29,496 Secured by Auto Leases (3) 6.09 6.09 2005 130,263 143,232 Secured by Auto Leases (3) 6.39 6.39 2006 474,504 520,672 Secured by Auto Leases (3) 5.39 5.39 2007 26,700 29,775 Secured by Auto Leases (3) 6.84 6.84 2007 388,869 430,141 Secured by Auto Leases (3) 5.13 7.33 2007 249,020 287,158 Secured by Residential Properties 1.78 3.11 2005 986,536 985,456 Secured by Equipment Leases 7.27 7.27 2005 43,073 83,665 Miscellaneous Notes Various Various Various 73,050 19,361 ---------- ---------- 3,767,418 4,081,055 ---------- ---------- Total $3,842,657 $4,081,414 ========== ========== (1) Stated rate reflects interest rate on notes as of December 31, 2002. (2) Effective rate reflects interest rate paid as of December 31, 2002 after adjustments for notes issued at discount or premium, capitalized fees associated with the issuance of the debt and interest rate swap agreements entered to alter the payment characteristics. (3) Capital lease obligations incurred under sale-leaseback arrangement.
During the third quarter of 2002, Provident issued $75 million of senior unsecured notes. These notes mature on July 15, 2032, however, they may be called in whole or in part at any time on or after July 15, 2007.
The notes payable to the Federal Home Loan Bank are collateralized by investment securities and residential loans with a book value of $1.5 billion. They are subordinated to the claims of depositors and other creditors of Provident and are not insured by the FDIC.
At December 31, 2002, $175 million of subordinated notes were outstanding. For regulatory capital purposes, $20 million of these notes qualify as Tier 2 capital as of year-end 2002. These notes are subordinated to the claims of depositors and other creditors of Provident and are not insured by the FDIC.
Many of Provident's securitizations of loans and leases have been structured to account for the transactions as secured financings. In connection with these transactions, Provident has pledged $1.6 billion in auto leases, $1.1 billion in residential and home equity loans, $212 million in cash and $68 million in equipment leases.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2002, scheduled principal payments on long-term debt for the following five years were as follows:
(In Thousands) 2003 2004 2005 2006 2007 -------------------------------------------------------------------------------- Provident (Parent Company) $ 120 $ 119 $ - $ - $ - Subsidiaries 445,278 501,795 1,234,571 347,034 484,098
NOTE 12 - GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S JUNIOR ----------------------------------------------------------------------------- SUBORDINATED DEBENTURES: ------------------------ Wholly-owned subsidiary trusts of Provident have issued $462.5 million of preferred securities and, in turn, purchased $462.5 million of newly-authorized Provident junior subordinated debentures. The debentures provide interest and principal payments to fund the trusts' obligations. Provident fully and unconditionally guarantees the preferred securities. The preferred securities qualify as either Tier 1 or Tier 2 capital for bank regulatory purposes. The sole assets of the trusts are the debentures. The junior subordinated debentures consisted of the following at December 31:
December 31, Stated Effective Maturity ------------------- (Dollars in Thousands) Rate Rate (1) Date 2002 2001 ------------------------------------------------------------------------------ November 1996 Issuance 8.60% 8.55% 12/01/26 $ 99,003 $ 99,066 June 1999 Issuance 8.75% 3.13% 06/30/29 121,522 121,391 November 2000 Issuance 10.25% 4.49% 12/31/30 109,257 109,141 March 2001 Issuance 9.45% 4.77% 03/30/31 121,292 121,161 -------- -------- Total $451,074 $450,759 ======== ======== (1) Effective rate reflects interest rate paid as of December 31, 2002 after adjustments for notes issued at discount or premium, capitalized fees associated with the issuance of the debt and interest rate swap agreements entered to alter the payment characteristics.
NOTE 13 - MINORITY INTEREST: ---------------------------- During June 2002, Provident and its consolidated subsidiary, PFGI Capital Corporation ("PFGI Capital"), issued 6.6 million equity units ("PRIDES") to outside investors for $165 million. The Provident Bank (the "Bank"), Provident's most significant subsidiary, owns all of the $165 million of Common Stock of PFGI Capital. The principal business objective of PFGI Capital is to hold and manage commercial mortgage loan assets and other authorized investments acquired from the Bank that will generate net income for distribution to its stockholders. PFGI Capital has elected to be treated as a real estate investment trust ("REIT") for federal income tax purposes.
Each PRIDES has a stated amount of $25 per unit and is comprised of two components - a 3-year forward purchase commitment ("Purchase Contract") and PFGI Capital Preferred Stock.
Each Purchase Contract obligates the holder to buy, on August 17, 2005, for $25, a number of newly issued shares of Provident Common Stock equal to the "settlement rate." The settlement rate will be calculated as follows: o if the market value of Provident Common Stock is equal to or greater than the $29.0598, the settlement rate will be 0.8603; o if the market value of Provident Common Stock is between $29.0598 and $24.42, the settlement rate will be equal to the $25 stated amount divided by the applicable market value; and o if the applicable market value is less than or equal to $24.42, the settlement rate will be 1.0238.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
"Applicable market value" is defined as the average of the closing price per share of Provident Common Stock on each of the twenty consecutive trading days ending on the fifth trading day immediately preceding August 17, 2005.
The following table illustrates how the settlement rate impacts the total number of shares of Provident Common Stock that will be issued under the Purchase Contract and the calculated price per share:
Applicable Market Value Less Than Greater Than of Provident Common Stock $24.42 $25.00 $28.00 $29.0598 --------------------------------------------------------------------------------------------- Settlement Rate (25.00/24.42) (25.00/25.00) (25.00/28.00) (25.00/29.0598) 1.0238 1.0000 0.8929 0.8603 Total Purchased Contracts Outstanding 6,600,000 6,600,000 6,600,000 6,600,000 ------------ ------------ ------------ ------------- Shares of Provident Common Stock Purchased 6,757,080 6,600,000 5,893,140 5,677,980 ============ ============ ============ ============= Total Proceeds Received From PFGI Preferred Stock Issuance $165,000,000 $165,000,000 $165,000,000 $ 165,000,000 Shares of Provident Common Stock Purchased 6,757,080 6,600,000 5,893,140 5,677,980 ------------ ------------ ------------ ------------- Price Paid Per Share of Provident Common Stock $ 24.42 $ 25.00 $ 28.00 $ 29.06 ============ ============ ============ =============
Under the Purchase Contract, Provident will also make quarterly contract adjustment payments to the PRIDES holders at the rate of 1.25% of the stated amount per year. The present value of this obligation has been recorded as a liability and as a reduction to shareholders' equity.
The PFGI Capital Preferred Stock has a liquidation preference of $25 and an initial non-cumulative dividend rate of 7.75%. Under certain regulatory circumstances, the PFGI Capital Preferred Stock will be automatically exchanged for the Bank Preferred Stock.
Concurrent with the fulfillment of the Purchase Contract, Provident has engaged a remarketing agent to remarket the PFGI Capital Preferred Stock on behalf of the holders, at which time the PFGI Capital Preferred Stock is permanently detached from the Purchase Contract. Once the Purchase Contract is fulfilled, there will be two separate and distinct securities outstanding: PFGI Capital Preferred Stock and Provident Common Stock. The number of common shares to be issued will be from 5,677,980 to 6,757,080, depending on the market value of the Common Stock. The proceeds received from the remarketing will be used by the holders of PFGI Capital Preferred Stock to fulfill their commitment under the terms of the Purchase Contract. Provident intends to use such proceeds for the redemption of the remarketed PFGI Capital Preferred Stock ninety days after the remarketing.
NOTE 14 - STOCKHOLDERS' EQUITY: --------------------------------- In 1991, Provident issued 371,418 shares of Non-Voting Convertible Preferred Stock to American Financial Group as partial consideration for the acquisition of Hunter Savings Association. During 1995, 301,146 shares of the Preferred Stock were converted into 4,234,865 shares of Common Stock. As of December 31, 2002 and 2001, 70,272 shares of Preferred Stock remain outstanding. These shares have a stated value and liquidation value of $100 per share and a conversion ratio of 14.0625 shares of Provident's Common Stock for each share of Convertible Preferred Stock.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On January 1, 2001, Provident recorded an after-tax transitional loss of $28.3 million in connection with the adoption of Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." A description of Statement 133 is provided in Note 1. The transitional loss was recorded in accumulated other comprehensive income (loss) of shareholders' equity of which a summary of activity follows:
(In Thousands) 2002 2001 ------------------------------------------------------------------------------------- Accumulated Unrealized Losses on Securities Available for Sale at January 1, Net of Tax $(15,953) $(17,929) Net Unrealized Gains for the Period, Net of Tax Expense of $29,319 in 2002 and $1,064 in 2001 54,449 1,976 Reclassification Adjustment for Gains Included in Net Income, Net of Tax Expense of $909 in 2002 (1,687) - -------- -------- Effect on Other Comprehensive Income (Loss) for the Year 52,762 1,976 -------- -------- Accumulated Unrealized Gains (Losses) on Securities Available for Sale at December 31, Net of Tax $ 36,809 $(15,953) ======== ======== Accumulated Unrealized Losses on Derivatives Used in Cash Flow Hedging Relationships at January 1, Net of Tax $(82,743) $ - Cumulative Effect of Change in Accounting Principle, Net of Tax Benefit of $15,256 in 2001 - (28,332) Net Unrealized Losses for the Period, Net of Tax Benefit of $13,117 in 2002 and $48,648 in 2001 (24,360) (90,347) Reclassification Adjustment for Losses Included in Net Income, Net of Tax Benefit of $14,632 in 2002 and $19,350 in 2001 27,173 35,936 -------- -------- Effect on Other Comprehensive Income (Loss) for the Year 2,813 (82,743) -------- -------- Accumulated Unrealized Losses on Derivatives Used in Cash Flow Hedging Relationships at December 31, Net of Tax $(79,930) $(82,743) ======== ======== Accumulated Other Comprehensive Income (Loss) at January 1, Net of Tax $(98,696) $(17,929) Other Comprehensive Income (Loss), Net of Tax 55,575 (80,767) -------- -------- Accumulated Other Comprehensive Income (Loss) at December 31, Net of Tax $(43,121) $(98,696) ======== ========
NOTE 15 - REGULATORY CAPITAL REQUIREMENTS: ------------------------------------------ Provident and its banking subsidiary, The Provident Bank, are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Provident's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Provident and the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require Provident and the Bank to maintain minimum ratios of 4.00% for Tier 1 capital to average assets, 4.00% for Tier 1 capital to risk-weighted assets, and 8.00% for total risk-based capital to risk-weighted assets. As of December 31, 2002, Provident and the Bank meet all capital requirements to which it is subject.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2002, Provident and the Bank's capital ratios were categorized as "well capitalized" for regulatory purposes. To be categorized as well capitalized, Provident and the Bank must maintain minimum ratios of 5.00% for Tier 1 capital to average assets, 6.00% for Tier 1 capital to risk-weighted assets, and 10.00% for total risk-based capital to risk-weighted assets. There have been no subsequent conditions or events which management believes have changed the institutions' status.
The following table presents Provident and the Bank's regulatory capital information at December 31:
2002 2001 -------------------------------------------------------- Provident Provident (Dollars in Thousands) Provident Bank Provident Bank ------------------------------------------------------------------------------------------- Tier 1 Capital $ 1,337,160 $ 1,151,078 $ 1,091,141 $ 938,402 Average Assets 17,113,302 16,990,504 16,414,480 16,287,008 Tier 1 Leverage Ratio 7.81% 6.77% 6.65% 5.76%
Tier 1 Capital $ 1,337,160 $ 1,151,078 $ 1,091,141 $ 938,402 Risk-Weighted Assets 14,221,099 14,055,619 13,727,270 13,597,229 Tier 1 Capital Ratio 9.40% 8.19% 7.95% 6.90%
Total Risk-Based Capital $ 1,625,263 $ 1,596,938 $ 1,470,511 $ 1,414,786 Risk-Weighted Assets 14,221,099 14,055,619 13,727,270 13,597,229 Total Risk-Based Capital Ratio 11.43% 11.36% 10.71% 10.40%
Provident's Tier 1 capital is comprised of total shareholders' equity plus qualifying minority interest and junior subordinated debentures, less unrealized gains and losses within accumulated other comprehensive loss, intangible assets, and a valuation related to mortgage servicing rights. Total risk-based capital consists of Tier 1 capital plus qualifying reserves for loan and lease losses, qualifying subordinated debentures and junior subordinated debentures which did not qualify for Tier 1 treatment.
For purposes of computing the leverage ratio, average assets represents average assets for the fourth quarter less assets not qualifying for total risk-based capital including intangibles and non-qualifying mortgage servicing assets and reserve for loan and lease losses.
NOTE 16 - BENEFIT PLANS: ------------------------- Provident has a Retirement Plan for the benefit of its employees. Included under this plan is a Profit Sharing Plan and a Personal Investment Election Plan ("PIE Plan"). Provident also maintains a Deferred Compensation Plan ("DCP") and stock option plans.
The Profit Sharing Plan covers all employees who are qualified as to age and length of service. It is a trusteed plan with the entire cost borne by Provident. All fund assets are allocated to the participants. Provident's contributions are discretionary by the directors of Provident. Provident contributed approximately $4.6 million for 2002. Contributions of $4.1 million and $5.9 million were made to an Employee Stock Ownership Plan ("ESOP") for 2001 and 2000, respectively. The Profit Sharing Plan, which replaced the ESOP, differs from the ESOP in that participants may diversify contributions, which were formerly in Provident Stock, to other kinds of investments. In addition, participants may diversify up to 25% of their year-end 2002 ESOP balance each year into other investment options.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The PIE Plan, a tax deferred retirement plan, covers all employees who are qualified as to age and length of service. Employees who wish to participate in the PIE Plan may contribute from 1% to 10% (15% beginning in 2003) of their pre-tax salaries (to a maximum prescribed by the Internal Revenue Service) to the plan as voluntary contributions. Provident will make a matching contribution equal to 25% of the pre-tax voluntary contributions made by the employees on the first 8% of their pre-tax salaries during the plan year. The contribution made by Provident is charged against earnings as the employees' contributions are made. Provident incurred expense of $1.7 million, $1.5 million and $1.4 million for this retirement plan for 2002, 2001 and 2000, respectively.
The DCP permits participants, selected by the Compensation Committee of the Board of Directors, to defer compensation in a manner that aligns their interests with those of Provident shareholders through the investment of deferred compensation in Provident Common Stock. The DCP allows participants to postpone the receipt of 5% to 50% of compensation until retirement. Amounts deferred are invested in a Bank Stock Account or a Self-Directed Account. Provident will credit the Bank Stock Account with an amount dependent upon Provident's pre-tax earnings per share, for each share of Provident Common Stock in the account. The calculated credit is charged against earnings by Provident annually. Under the DCP, Provident paid $195,000 for 2002 and $0 for both 2001 and 2000.
Provident has Employee Stock Option Plans, an Advisory Directors' Stock Option Plan and Outside Directors' Stock Option Plans. During 2000, Provident established an Employee Stock Option Plan for the benefit of all Provident associates not participating in other stock option plans. The other stock option plans are for the benefit of its key employees and directors. The Employee Stock Option Plans made 12.3 million options available for grant. The options are to be granted, with exercise prices at market value, as of the date of grant. Options become exercisable beginning one year from date of grant generally at the rate of 20% per year. The Advisory Directors' Stock Option Plan and Outside Directors' Stock Option Plans authorized the issuance of 427,500 and 193,750 options, respectively. As of December 31, 2002, the number of options remaining available for future issuance under all of the stock option plans is 2.5 million.
The following table summarizes option activity for the three years ended December 31, 2002:
2002 2001 2000 -------------------- --------------------- -------------------- Weighted Weighted Weighted Average Average Average Exercise Number of Exercise Number of Exercise Number of Price Options Price Options Price Options ------------------------------------------------------------------- Outstanding at Beginning of Year $29.92 6,143,359 $28.84 5,480,365 $30.00 4,205,113 Granted 23.08 1,660,200 29.17 1,407,432 27.29 2,079,600 Exercised 12.59 (336,295) 10.37 (374,567) 17.27 (196,130) Canceled 30.33 (340,029) 30.82 (369,871) 35.30 (608,218) --------- --------- ---------- Outstanding at End of Year $29.12 7,127,235 $29.92 6,143,359 $28.84 5,480,365 ========= ========= =========
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2002, 2001 and 2000, there were 3,297,934, 2,825,462 and 2,396,315 options exercisable, respectively, having a weighted average option price per share of $31.27, $28.61 and $24.26, respectively. The following table summarizes information about stock options outstanding at December 31, 2002:
Options Outstanding Options Exercisable ---------------------------------------- ----------------------- Weighted Average Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life in Years Price Exercisable Price -------------------------------------------------------------------------------------- $10.45 - $12.00 33,488 0.2 $10.87 33,488 $10.87 $12.01 - $18.00 451,872 2.1 14.74 451,872 14.74 $18.01 - $27.00 2,982,890 7.7 23.93 889,027 24.84 $27.01 - $40.00 2,741,470 7.1 31.68 1,121,297 33.24 $40.01 - $54.47 917,515 5.0 46.10 802,250 45.79
No compensation cost has been recognized for stock option grants. Pro forma net income and earnings per share information is provided in Note 1 as if compensation cost had been determined for stock awards based on the fair values at grant dates.
Beginning with the first quarter of 2003, Provident has elected to adopt the provisions of Statement No. 123, "Accounting for Stock-Based Compensation" using the Prospective Method of expense recognition according to the transition rules of Statement No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." Under Statement 123, compensation expense is recognized over the vesting period equal to the fair value of stock-based compensation as of the date of grant. The full-year 2003 impact on net income and diluted earnings per share are estimated to be $1.4 million and $.02, respectively, for options granted after December 31, 2002.
NOTE 17 - MERGERS AND RESTRUCTURING CHARGES: ---------------------------------------------- In September 2000, Provident purchased Bank One Corporation's Housing and Health Care Capital business, including the operations and substantially all of the assets of Banc One Capital Funding Corporation, a wholly-owned subsidiary of Bank One. The business, which was renamed Red Capital Group, engages in the financing and loan servicing of multi-family facilities. Provident paid $129 million for the net assets with $11 million of goodwill. As the acquisition was recorded under the purchase accounting method, the assets acquired and liabilities assumed were recorded at estimated fair value and the accounts and operations of Red Capital Group have been included in the consolidated financial statements from the date of acquisition only.
In February 2000, Provident acquired Fidelity Financial of Ohio, Inc., a holding company for Centennial Bank. Centennial operated fifteen banking centers in the greater Cincinnati metropolitan area and held deposits of $588 million. Provident issued 4.6 million shares of its common stock for the acquisition. The merger was accounted for as a pooling-of-interests. Accordingly, the assets acquired and liabilities assumed were recorded at historical value. The consolidated financial statements and other financial information for periods prior to the merger date include the accounts and operations of Fidelity Financial.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In connection with Provident's acquisition of Fidelity Financial, direct-merger related and other post-merger business line restructuring charges of $39.3 million were recorded during the first quarter of 2000. These charges included non-cash write-downs of assets totaling $26.7 million. A charge of $5.1 million was taken on the write-down of fixed assets, primarily from the closing and consolidation of banking centers. Balance sheet restructuring, consisting primarily of the sale and write-down of acquired residential loans and investment securities, accounted for the remaining $21.6 million of these non-cash charges.
The merger and restructuring charges also included cash outlays totaling $12.6 million. The largest of the cash outlays was for severance costs totaling $8.6 million. Additionally, contract termination charges, primarily from lease buyout agreements on rented facilities, of $2.3 million were expensed. Finally, professional fees in connection with the acquisition of Fidelity Financial of $1.7 million were incurred. All cash outlays have been paid.
NOTE 18 - INCOME TAXES: ----------------------- The composition of income tax expense follows:
(In Thousands) 2002 2001 2000 ------------------------------------------------ Current: Federal $ 2,686 $ (50) $ 346 State 24,786 11,704 22,681 -------- -------- -------- 27,472 11,654 23,027 Deferred 22,550 (12,249) 10,808 -------- -------- -------- Total $ 50,022 $ (595) $ 33,835 ======== ======== ========
The effective tax rate differs from the statutory rate applicable to corporations as a result of permanent differences between accounting and taxable income. The reconciliation between income tax expense and the amount computed by applying the statutory federal income tax rate was as follows:
(In Thousands) 2002 2001 2000 ------------------------------------------------------------------------------- Tax at Statutory Rate (35%) $ 50,915 $ (557) $ 31,631 State Income Tax, Net of Federal Tax Benefit 1,746 (32) 225 Tax Effect of: Non-Taxable Interest Income (3,388) (512) (289) Non-Deductible Amortization of Goodwill - 1,257 1,273 Tax Credits (2,638) (1,113) (1,063) Other - Net 3,387 362 2,058 -------- -------- -------- Applicable Income Taxes $ 50,022 $ (595) $ 33,835 ======== ======== ========
At December 31, 2002, for income tax purposes, Provident had a federal net operating loss carryforward of $312.8 million available, which $167.9 million and $144.9 million expires in the years 2021 and 2022, respectively.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of Provident's deferred tax liabilities and assets as of December 31 are as follows:
(In Thousands) 2002 2001 2000 --------------------------------------------------------------------------- Deferred Tax Liabilities: Excess Lease and Partnership Income $194,679 $143,267 $112,052 Securitizations 109,585 58,433 34,752 Deferred Loan Costs 23,308 30,485 26,600 Other 23,829 19,225 13,599 -------- -------- -------- Total Deferred Tax Liabilities 351,401 251,410 187,003 -------- -------- -------- Deferred Tax Assets: Federal Net Operating Loss Carryforward 109,482 36,044 - Reserve for Loan and Lease Losses 94,462 87,769 57,957 Unrealized Loss on Investment Securities 23,414 53,150 9,654 Deferred Compensation 10,808 9,210 7,555 Other 20,020 24,335 15,190 -------- -------- -------- Total Deferred Tax Assets 258,186 210,508 90,356 -------- -------- -------- Net Deferred Tax Liabilities $ 93,215 $ 40,902 $ 96,647 ======== ======== ========
NOTE 19 - EARNINGS PER SHARE: ----------------------------- Basic earnings per share is calculated by dividing net income, less dividend requirements on convertible preferred stock, by the weighted average number of common shares outstanding for the period. Diluted earnings per share takes into consideration the pro forma dilution assuming the convertible preferred shares and the in-the-money outstanding stock options were converted or exercised into common shares. It also takes into consideration the dilutive impact of shares held in benefit plans and of forward purchase contracts required to be settled in Provident Stock. Net income is not adjusted for preferred dividend requirements.
Stock options to purchase approximately 4.6 million, 5.1 million and 2.0 million shares of Common Stock were outstanding at December 31, 2002, 2001 and 2000, respectively, but were not included in the computation of diluted earnings per share because the options' exercise price was not in-the-money and, therefore, the effect would be anti-dilutive. The PRIDES units were not included in the computation of dilutive earnings per share as these instruments had no dilutive impact.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the computation of basic and diluted earnings per common share:
Year Ended December 31, -------------------------------- (In Thousands Except Per Share Data) 2002 2001 2000 ------------------------------------------------------------------------------- Basic: Net Income (Loss) $ 95,451 $ (1,003) $ 56,541 Less Preferred Stock Dividends (949) (949) (949) -------- -------- -------- Income Available to Common Shareholders 94,502 (1,952) 55,592 Weighted-Average Common Shares Outstanding 48,806 49,011 48,744 -------- -------- -------- Basic Earnings (Loss) Per Share $ 1.94 $ (0.04) $ 1.14 ======== ======== ======== Diluted: Net Income (Loss) $ 95,451 $ (1,003) $ 56,541 Less Preferred Stock Dividends (1) n/a (949) n/a -------- -------- -------- 95,451 (1,952) 56,541 Weighted-Average Common Shares Outstanding 48,806 49,011 48,744 Benefit Plans Common Shares 497 - - Assumed Conversion of: Convertible Preferred Stock (1) 988 n/a 988 Dilutive Stock Options (1) 452 n/a 608 -------- -------- -------- Dilutive Potential Common Shares 50,743 49,011 50,340 -------- -------- -------- Diluted Earnings (Loss) Per Share $ 1.88 $ (0.04) $ 1.12 ======== ======== ======== (1) The conversion of preferred securities and stock options were not included in the diluted earnings (loss) per share calculation for 2001 as these are anti-dilutive.
NOTE 20 - ASSET SECURITIZATION SALES: -------------------------------------- Since June 2000, Provident has structured its securitization transactions as secured financings. Prior to this time, the structure of many of its securitizations resulted in the transactions being treated as sales. During 2000 Provident sold $1.4 billion of loans and equipment leases in securitization transactions resulting in the recognition of $43.5 million in gains. For securitizations structured as sales, Provident retained servicing responsibilities and subordinated interests. Provident receives annual servicing fees approximating 0.50% (for nonconforming residential and prime home equity loans) and 0.75% (for equipment leases) of the outstanding balance. Provident also possesses the rights to future cash flows arising after the investors of the securitization trusts have received the return for which they contracted, referred to as retained interests in securitized assets ("RISAs"). RISAs are subordinate to investors of the securitization trust with its value subject to prepayment risks, interest rate risks and credit risks (1996 and 1997 securitizations only) on the transferred assets.
Securitization transactions that have been accounted for as sales have resulted in loans and leases being removed from the balance sheet. The following table provides a summary of the outstanding balances of these off-balance sheet loans and leases:
December 31, ----------------------- (In Thousands) 2002 2001 --------------------------------------------------- Nonconforming Residential $1,779,127 $2,627,332 Prime Home Equity 194,775 303,527 Equipment Leases 94,408 207,131 ---------- ---------- $2,068,310 $3,137,990 ========== ==========
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RISA balances have been established for nonconforming residential loans and prime home equity loans. No RISAs have been established for equipment leases as cash gains were recognized at the time of securitization. Components of the nonconforming residential and prime home equity RISAs, which are included within Investment Securities on the balance sheet, as of December 31, 2002 follow:
Nonconforming Prime (In Thousands) Residential Home Equity -------------------------------------------------------------------------------- Estimated Cash Flows of Underlying Loans, Net of Payments to Certificate Holders $ 161,259 $13,677 Less: Estimated Credit Loss (6,960) - Servicing and Insurance Expense (21,105) (2,597) Discount to Present Value (21,177) (1,555) --------- ------- Carrying Value of RISA $ 112,017 (1) $ 9,525 ========= ======= (1) Carrying value of Retained Interest in Securitized Assets, net of all loss reserves, was $93.3 million at December 31, 2002.
Provident had provided for credit enhancements to its securitizations structured as sales in the form of cash, loans and an unfunded secured demand note. The credit enhancements are maintained at a significantly higher balance than the level of estimated credit losses to improve the credit grade of the securitization and thereby reduce the rate paid to investors of the securitization trust. Provident had reserves of $20.9 million as of year-end 2002 to offset future losses. Estimated credit losses are based upon loan credit grades, collateral, market conditions and other pertinent factors. Detail of the credit enhancements along with their loss reserves are provided below as of December 31, 2002:
Type of Credit Value of Credit Loss (In Thousands) Enhancements Enhancements Reserves --------------------------------------------------------------------------------------------- Nonconforming Residential (1) Unfunded Demand Deposit/Loans $ 275,075 $18,756 Prime Home Equity Cash 27,080 502 Equipment Leases Cash 30,352 1,672 --------- ------- $ 332,507 $20,930 ========= ======= (1) During the fourth quarter of 2001, Provident reached an agreement with the securitization insurer to release the cash accounts for the nonconforming residential loan securitizations and substitute an unfunded secured demand note backed by a AAA rated standby letter of credit. Actual losses are submitted on a monthly basis to Provident by the trustee. Should Provident fail to reimburse the trustee for these monthly losses, the letter of credit can be drawn upon. There are no conditions that can accelerate this monthly process.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Various economic assumptions are used in the measurement of RISAs and loss estimates. The following key assumptions were used as of the date of the securitization during 2000:
Nonconforming Prime Equipment Residential Home Equity Leasing --------------------------------------------------- Prepayment Speed: Initial Rate 13.73% 10.00% n/a Peak Rate 35.00% 30.00% n/a Weighted Average Life (in years) 2.4 2.1 n/a Estimated Credit Losses: Annual Basis 1.14% 0.20% 1.00% Percentage of Original Balance 2.84% 0.47% 2.00% Discount Rate 12.00% 12.00% 8.00%
The following sensitivity table provides the effects of an immediate 10% and 20% adverse change to key economic assumptions on RISAs and loss estimates as of December 31, 2002:
Nonconforming Prime Equipment (Dollars in Millions) Residential Home Equity Leasing ---------------------------------------------------------------------------------------------- Peak Prepayment Speed Assumption (Annual Rate)(1) 30% CPR 30% CPR n/a Impact on Fair Value of 10% Adverse Change $ (17.6) $ (1.4) n/a Impact on Fair Value of 20% Adverse Change $ (35.2) $ (2.6) n/a
Estimated Credit Loss Assumption(1) (Percentage of Original Balance) 4.83% 0.20% 6.00% Impact on Fair Value of 10% Adverse Change $ (6.5) $ (0.1) $(0.4) Impact on Fair Value of 20% Adverse Change $ (12.9) $ (0.2) $(0.8)
RISA Discount Rate(1) 12.00% 10.89% n/a Impact on Fair Value of 10% Adverse Change $ (3.0) $ (0.2) n/a Impact on Fair Value of 20% Adverse Change $ (5.9) $ (0.4) n/a
(1) The assumptions used at the time of securitization and the assumptions used in subsequently measuring the carrying amount / fair value of the RISA and cash reserve accounts, while not the same, are conservative estimates at different points in time.
These sensitivities are hypothetical and should be used with caution. The effect of a variation in a particular assumption on the fair value of the RISA and loss estimates is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.
The table below summarizes certain cash flows received from and paid to securitization trusts:
Year Ended December 31, -------------------------------------- (In Thousands) 2002 2001 2000 ------------------------------------------------------------------------------------- Proceeds From New Securitizations $ - $ - $1,412,303 Cash Flows Received from Interests Retained 175,828 193,357 130,720 Servicing Fees Received 14,384 21,766 24,450 Prepayment and Late Fees Received 11,941 17,662 13,365 Net Servicing Advances (58,535) (61,749) (44,246)
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents quantitative information about delinquencies, net credit losses and components of securitized and portfolio loans and leases:
2002 2001 ---------------------------------------------- -------------------------------------------- Middle Market Middle Market Nonconforming Prime Home Equipment Nonconforming Prime Home Equipment (Dollars in Thousands) Residential Equity Leases Residential Equity Leases -------------------------------------------------------------------------------------------------------------------------- Average Assets: Securitized and Sold $ 2,190,684 $ 246,163 $ 150,562 $ 3,086,984 $ 383,157 $ 276,895 Portfolio 808,822 853,860 957,835 993,436 510,812 671,951 ----------- ----------- ----------- ----------- --------- ----------- Total Managed Assets $ 2,999,506 $ 1,100,023 $ 1,108,397 $ 4,080,420 $ 893,969 $ 948,846 =========== =========== =========== =========== ========= =========== Year-End Assets: Securitized and Sold $ 1,779,127 $ 194,775 $ 94,408 $ 2,627,332 $ 303,527 $ 207,131 Portfolio 657,204 1,110,728 1,046,640 918,458 688,798 844,096 ----------- ----------- ----------- ----------- --------- ----------- Total Managed Assets $ 2,436,331 $ 1,305,503 $ 1,141,048 $ 3,545,790 $ 992,325 $ 1,051,227 =========== =========== =========== =========== ========= =========== Net Charge-Offs: Total Managed Assets $ 131,462 $ 3,422 $ 20,184 $ 63,651 $ 2,816 $ 17,430 =========== =========== =========== =========== ========= =========== Net Charge-Offs to Average Assets: Total Managed Assets 4.38% 0.31% 1.82% 1.56% 0.31% 1.84% =========== =========== =========== =========== ========= =========== 90 Days or More Delinquencies to Year-End Assets: Total Managed Assets 17.85% 0.19% 0.38% 13.85% 0.21% 1.17% =========== =========== =========== =========== ========= ===========
NOTE 21 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: --------------------------------------------------------- Provident uses derivative instruments to manage its interest rate risk. These instruments include interest rate swaps and interest rate caps. In addition, forward delivery commitments are entered to assist with the issuance of mortgage-backed securities.
Interest rate swaps are agreements between two parties to exchange periodic interest payments that are calculated on a notional principal amount. Provident enters into swaps to synthetically alter the repricing characteristics of specific assets, liabilities and off-balance sheet loan securitizations. As only interest payments are exchanged, cash requirements and credit risk are significantly less than the notional amounts.
Interest rate caps protect against the impact of rising interest rates on interest-bearing financial instruments. When interest rates go above a cap's strike rate, the cap provides for receipt of payments based on its notional amount.
Interest rate derivative instruments have a credit risk component based on the ability of a counterparty to meet the obligations to Provident under the terms of the instruments. Notional principal amounts express the volume of the transactions, but Provident's potential exposure to credit risk is limited only to the market value of the instruments. Provident manages its credit risk in these instruments through counterparty credit policies. At December 31, 2002, Provident had bilateral collateral agreements in place with its counterparties, against which Provident has pledged investment securities with a carrying value of $50 million as collateral. There were no past due amounts on any instruments as of December 31, 2002. Provident has never experienced a credit loss related to these instruments.
Provident adopted the provisions of Statements of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," on January 1, 2001. Pursuant to Statement 133, derivatives are carried at fair value and are recorded within Other Assets or Accrued Interest and Other Liabilities in the balance sheets. The accounting for the
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
gain or loss resulting from the change in fair value depends on the intended use of the derivative. For a derivative used to hedge changes in fair value of a recognized asset or liability, or an unrecognized firm commitment, the gain or loss on the derivative will be recognized in earnings together with the offsetting loss or gain on the hedged item. This results in earnings recognition only to the extent that the hedge is ineffective in achieving offsetting changes in fair value. For a derivative used to hedge changes in cash flows associated with forecasted transactions, the gain or loss on the effective portion of the derivative will be deferred, and reported as accumulated other comprehensive income, a component of shareholders' equity, until such time the hedged transaction affects earnings. For derivative instruments not accounted for as hedges, changes in fair value are required to be recognized in earnings.
Fair Value Hedging Strategy: Provident uses interest rate swaps to assist in the management of its interest rate risk. The interest rate swaps effectively modify Provident's exposure to interest risk by converting fixed rate liabilities, generally time deposits and long-term debt, to a floating rate. These interest rate swaps involve the receipt of fixed rate amounts in exchange for floating rate interest payments over the life of the agreements without an exchange of the underlying principal amounts.
As the changes in fair value of the hedged items offset the changes in fair value of the derivatives, no material gain or loss was recognized at the time of adoption of Statement 133 or for the years ended December 31, 2002 and 2001.
Cash Flow Hedging Strategy: Provident has also entered into interest rate swap agreements to reduce the impact of interest rate changes on future interest payments of on and off-balance sheet financing. These interest rate swaps convert floating rate debt to a fixed rate basis. These interest rate swaps have generally been used to hedge interest payments involving floating rate debt and off-balance sheet securitization transactions with maturities up to December 2014.
Upon the adoption of Statement 133 and for the year ended December 31, 2001, Provident recorded reductions of $28.3 million and $54.4 million, respectively, and for the year ended December 31, 2002, Provident recorded a gain of $2.8 million in accumulated other comprehensive income. No gain or loss was recognized at the time of adoption or for the full years of 2002 and 2001 as a result of ineffective cash flow hedges. During the next twelve months, management expects to reclassify $51.6 million of net losses on derivative instruments from accumulated other comprehensive income to earnings which it believes will be offset by improved cash flows of the hedged items associated with these derivative instruments.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the notional amount of the interest rate derivatives at December 31 is as follows:
Interest Rate Swaps ------------------- Interest Rate Caps Receive Pay ------------------ (In Millions) Fixed Fixed Purchased Sold -------------------------------------------------------------------------- At December 31, 2002: Off-Balance Sheet Securitizations $ 139 $1,265 $1,736 $1,736 Certificates of Deposit 2,812 - - - Long-Term / Subordinated Debt 838 622 1,010 1,010 Premium Index Deposits - 195 - - Loans - 51 - - For Customers' Purposes - 37 13 - ------ ------ ------ ------ Totals $3,789 $2,170 $2,759 $2,746 ====== ====== ====== ====== At December 31, 2001: Off-Balance Sheet Securitizations $ 270 $2,317 $1,944 $1,944 Certificates of Deposit 2,472 - - - Long-Term / Subordinated Debt 718 547 1,010 1,010 Premium Index Deposits - 195 - - Loans - 45 - - For Customers' Purposes - - 48 - ------ ------ ------ ------ Totals $3,460 $3,104 $3,002 $2,954 ====== ====== ====== ======
Summary information with respect to the interest rate derivatives used to manage Provident's interest rate sensitivity at December 31, 2002 follows:
Interest Rate Swaps ------------------- Interest Rate Caps Receive Pay ------------------- (Dollars in Millions) Fixed Fixed Purchased Sold ----------------------------------------------------------------------------- Notional Amount $ 3,789 $ 2,170 $ 2,759 $ 2,746 Positive Fair Value Adjustment 161 - 29 - Negative Fair Value Adjustment (1) (152) - (29) Weighted Average: Receive Rate 5.86% 1.50% n/a n/a Pay Rate 1.75% 5.96% n/a n/a Strike Rate n/a n/a 8.97% 8.97% Life (in years) 10.5 6.4 12.2 12.3
The expected notional maturities of Provident's interest rate derivative portfolio at December 31, 2002 are as follows:
Interest Rate Swaps ------------------- Interest Rate Caps Receive Pay ------------------- (In Millions) Fixed Fixed Purchased Sold Total -------------------------------------------------------------------------- Less than 1 Year $ 387 $ 178 $ - $ - $ 565 From 1 to 5 Years 1,084 432 13 - 1,529 From 5 to 10 Years 627 1,354 - - 1,981 From 10 to 15 Years 717 191 2,746 2,746 6,400 More than 15 Years 974 15 - - 989 ------- ------- ------- ------ ------- Total $ 3,789 $ 2,170 $ 2,759 $2,746 $11,464 ======= ======= ======= ====== =======
Provident also enters into forward delivery contracts for the future delivery of commercial real estate and residential mortgage loans at a specified interest rate to reduce the interest rate risk associated with loans held for sale. As of December 31, 2002, Provident had $172 million in forward delivery contracts.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 22 - CREDIT RISK TRANSFER INSTRUMENTS, CREDIT COMMITMENTS AND GUARANTEES: ------------------------------------------------------------------------------ During 2001 and 2000, Provident entered into credit risk transfer transactions. Under the 2001 transaction, Provident transferred 97 1/2% of the credit risk on an auto lease portfolio, while retaining a 2 1/2% first-loss position. Under the 2000 transaction, Provident transferred 98% of the credit risk on an auto lease portfolio, while retaining a 2% first-loss position. As a result of these transactions, Provident was able to lower its credit concentration in auto leasing while reducing its regulatory capital requirements. As of December 31, 2002, the remaining unpaid auto lease balances on the 2001 and 2000 credit risk transfer transactions were $0.4 billion and $1.0 billion, respectively.
Commitments to extend credit are financial instruments in which Provident agrees to provide financing to customers based on predetermined terms and conditions. Since many of the commitments to extend credit are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Provident evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by Provident upon extension of credit is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
A standby letter of credit is an irrevocable guarantee whereby Provident guarantees the performance of a customer to a third party in a borrowing arrangement. They are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral is obtained based on management's credit assessment of the customer. Generally, Provident issues standby letters of credit for terms from six months to three years.
Provident's commitments to extend credit and letters of credit which are not reflected in the balance sheet at December 31 are as follows:
(In Millions) 2002 2001 ---------------------------------------------- Commitments to Extend Credit $2,887 $2,153 Standby Letters of Credit 274 193 Commercial Letters of Credit 11 -
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Provident (Parent) has issued a guarantee for a subsidiary to assist in its business activities. This guarantee was made to Fannie Mae for the benefit of Red Mortgage Capital, Inc. Red Mortgage is an approved Fannie Mae Delegated Underwriting and Servicing (DUS) mortgage lender. Under the Fannie Mae DUS program, Red Mortgage underwrites, funds and sells mortgage loans on multifamily rental projects. Red Mortgage then services these mortgage loans on Fannie Mae's behalf. Participation in the Fannie Mae DUS program requires Red Mortgage to share the risk of loan losses with Fannie Mae. Under the loss sharing arrangement, Red Mortgage and Fannie Mae split losses with one-third of all losses assumed by Red Mortgage and two-thirds of all losses assumed by Fannie Mae. For Red Mortgage to participate in the loss sharing agreement, the Parent provided a guarantee to Fannie Mae that it would fulfill all payments required of Red Mortgage under the loss sharing arrangement and for servicing advances of these loans if Red Mortgage fails to meet its obligations. As of December 31, 2002, Red Mortgage serviced loans with outstanding principal balances aggregating $3.0 billion under the DUS program. The guarantee will continue until such time as the loss sharing agreement is amended or that Red Mortgage no longer participates in the Fannie Mae DUS program. No liability is carried on the Parent's balance sheet for this guarantee as a liability has been established for estimated losses on Red Mortgage's balance sheet.
NOTE 23 - LINE OF BUSINESS REPORTING: -------------------------------------- Provident's three major business lines, referred to as Commercial Banking, Retail Banking and Mortgage Banking, are based on the products and services offered, and its management structure. Commercial Banking offers a full range of commercial lending and financial products and services to corporate businesses. Retail Banking provides consumer loans and leases, deposit accounts, trust, brokerage and investment products and services to consumers and small businesses. Mortgage Banking originates and services conforming and nonconforming residential loans to consumers and provides short-term financing to mortgage originators and brokers.
Financial results are determined based on an assignment of balance sheet and income statement items to each business line. Equity allocations are made based on various risk measurements of the business line. A matched funded transfer pricing process is used to allocate interest income and expense among the business lines. Provision for loan and lease losses are charged to business lines based on its level of net charge-offs and the size and risk of its lending portfolio. Activity-based costing is used to allocate expenses for centrally provided services.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed income statements and total assets are provided below for Provident's three major lines of business for the past three years. Corporate Center represents income and expenses not related to the major business lines, and gain/loss on the sale of investment securities.
Commercial Retail Mortgage Corporate (In Millions) Banking Banking Banking Center Total ----------------------------------------------------------------------------------------- Year Ended December 31, 2002: Net Interest Income $ 216.7 $ 32.6 $ 66.3 $ - $ 315.6 Provision for Loan Losses (62.0) (8.0) (20.6) (9.0) (99.6) Noninterest Income 150.0 603.6 41.1 10.8 805.5 Noninterest Expense (216.9) (586.8) (72.3) - (876.0) Income Taxes (30.1) (14.3) (5.0) (.6) (50.0) -------- -------- -------- -------- --------- Net Income $ 57.7 $ 27.1 $ 9.5 $ 1.2 $ 95.5 ======== ======== ======== ======== ========= Total Assets $ 7,554 $ 4,854 $ 1,646 $ 3,486 $ 17,540 ======== ======== ======== ======== ========= Year Ended December 31, 2001: Net Interest Income $ 206.7 $ 3.4 $ 60.4 $ - $ 270.5 Provision for Loan Losses (155.9) (27.9) (31.7) - (215.5) Noninterest Income 166.8 563.5 26.1 - 756.4 Noninterest Expense (218.9) (529.4) (64.7) - (813.0) Income Taxes .5 (3.6) 3.7 - .6 -------- -------- -------- -------- --------- Net Income $ (0.8) $ 6.0 $ (6.2) $ - $ (1.0) ======== ======== ======== ======== ========= Total Assets $ 7,115 $ 4,785 $ 1,799 $ 2,862 $ 16,561 ======== ======== ======== ======== ========= Year Ended December 31, 2000: Net Interest Income $ 186.4 $ 20.2 $ 37.0 $ - $ 243.6 Provision for Loan Losses (79.2) (25.0) (29.3) - (133.5) Noninterest Income 114.7 486.3 59.4 .2 660.6 Noninterest Expense (127.9) (450.2) (63.0) (39.3) (680.4) Income Taxes (33.2) (11.4) (1.4) 12.2 (33.8) -------- -------- -------- -------- --------- Net Income $ 60.8 $ 19.9 $ 2.7 $ (26.9) $ 56.5 ======== ======== ======== ======== ========= Total Assets $ 6,242 $ 4,161 $ 1,824 $ 2,770 $ 14,997 ======== ======== ======== ======== =========
NOTE 24 - TRANSACTIONS WITH AFFILIATES: --------------------------------------- At December 31, 2002, Carl H. Lindner, Jr., members of his immediate family and trusts for their benefit, owned 44% of American Financial Group's Common Stock. This group, along with Carl H. Lindner's siblings and entities controlled by them, or established for their benefit, owned 44% of Provident's Common Stock at year-end 2002. Provident leases its home office space and other office space from a trust, for the benefit of a subsidiary of American Financial Group. Rentals and renovations charged by American Financial Group and affiliates for the years ended December 31, 2002, 2001 and 2000 amounted to $3.8 million, $3.1 million and $3.0 million, respectively. Provident paid $612,000, $0 and $0 to a subsidiary of American Financial Group for insurance coverage during 2002, 2001, and 2000, respectively. Payments of $114,000, $28,000 and $0 were made to American Financial Group and affiliates for record retention services for the years ended December 31, 2002, 2001 and 2000, respectively. Approximately $100,000 was also paid to American Financial Group for guard services in each of the past three years.
Provident has had certain transactions with various executive officers, directors and principal holders of equity securities of Provident and its subsidiaries and entities in which these individuals are principal owners. Various loans and leases have been made as well as the sale of commercial paper and repurchase agreements to these persons. Such loans and leases to these persons aggregated approximately $25.6 million and $42.8 million at
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001, respectively. During 2002, new loans and leases aggregating $2.6 million were made to such parties and loans and leases aggregating $19.8 million were repaid. All of the loans and leases were made at market interest rates and, in the opinion of management, all amounts are fully collectible. At December 31, 2002 and 2001, these persons held Provident's commercial paper amounting to $17.3 million and $17.5 million, respectively. Additionally, repurchase agreements in the amount of $5.8 million and $7.7 million had been sold to these persons at December 31, 2002 and 2001, respectively. All of these transactions were at market interest rates.
NOTE 25 - FAIR VALUE OF FINANCIAL INSTRUMENTS: ---------------------------------------------- Carrying values and estimated fair values for certain financial instruments as of December 31 are shown in the following table. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Because no secondary market exists for many of Provident's assets and liabilities, the derived fair values are calculated estimates, and the fair values provided herein do not necessarily represent the actual values which may be realized in the disposition of these instruments. The aggregate fair value amounts presented do not represent the underlying value of Provident. What is presented below is a point-in-time valuation that is affected, in part, by unrealized gains and losses resulting from management's implementation of its program to manage overall interest rate risk. It is not management's intention to immediately dispose of a significant portion of its financial instruments. As a result, the following fair value information should not be interpreted as a forecast of future earnings and cash flows.
2002 2001 ------------------------------------------------------- Carrying Fair Carrying Fair (In Thousands) Value Value Value Value -------------------------------------------------------------------------------------- Financial Assets: Cash and Cash Equivalents $ 540,919 $ 540,919 $ 501,223 $ 501,223 Trading Account Securities 127,848 127,848 101,156 101,156 Loans Held for Sale 436,884 436,884 217,914 217,914 Investment Securities 4,215,238 4,215,238 3,486,058 3,486,058 Loans and Leases 9,133,795 9,184,892 8,950,123 8,992,407 Less: Reserve for Losses (201,051) - (241,143) - --------- --------- --------- --------- Net Loans and Leases 8,932,744 9,184,892 8,708,980 8,992,407 Financial Liabilities: Deposits 9,848,979 9,818,970 8,854,250 8,867,237 Short-Term Debt 1,925,005 1,925,005 1,885,309 1,885,309 Long-Term Debt and Junior Subordinated Debentures 4,293,731 4,447,041 4,532,173 4,745,430 Derivative Instruments: Interest Rate Swaps 7,985 7,985 (132,664) (132,664) Interest Rate Caps - - - - Interest Rate Floors - - - -
The following methods and assumptions were used by Provident in estimating its fair value disclosures for financial instruments: o Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair values. o Trading account securities and investment securities: Fair values for trading account securities and investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Retained interests in securitized assets are valued using discounted cash
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
flow techniques. Significant assumptions used in the valuation are presented in Note 20. o Loans and leases: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for certain residential mortgage loans and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair values for other loans and leases are estimated using discounted cash flow analyses and interest rates currently being offered for loans and leases with similar terms to borrowers of similar credit quality. The fair values disclosed for loans held for sale are equal to their carrying amounts. o Deposits: The fair values disclosed for demand deposits are equal to their carrying amounts. The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. o Short-term debt: The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings approximate their fair values. o Long-term debt and junior subordinated debentures: The fair values of long-term borrowings that are traded in the markets are equal to their quoted market prices. The fair values of other long-term borrowings (other than deposits) are estimated using discounted cash flow analyses, based on Provident's current incremental borrowing rates for similar types of borrowing arrangements. o Derivative instruments: The fair value of derivative instruments has been recognized as either assets or liabilities in the balance sheet in accordance to Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." The fair value of derivative instruments is based upon current market quotes.
NOTE 26 - ADDITIONAL INFORMATION: ---------------------------------
LEGAL MATTERS: Provident and its subsidiaries are not parties to any pending legal proceedings other than routine litigation incidental to their business except for the following matters related to the restatement announced March 5, 2003.
On March 6, 6, 11, 26 and 31 and April 3, 2003, respectively, purported class-actions were filed in the U.S. District Court for the Southern District of Ohio by shareholders Waldbaum, Merzin, McKay, Nicci, Koot (as a Provident Capital Trust holder) and Spitz, respectively against Provident, its President, Robert L. Hoverson, its Chief Financial Officer, Christopher J. Carey, and, in the Merzin, Koot, and Spitz cases, their predecessors in those positions, on behalf of all purchasers of Provident securities from March 30, 1998 through March 5, 2003. These actions are based upon circumstances involved in the restatement of earnings announced by Provident on March 5, 2003 and allege violations of federal securities laws by the defendants in Provident's financial disclosures during the period from March 30, 1998 through March 5, 2003. They seek an unspecified amount of damages and, in the cases filed by Waldbaum and McKay, reimbursement of all executive bonuses received during that period.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On March 7 and 18, 2003, respectively, derivative actions were filed by the Plumbers and Pipefitters Location 572 Pension Fund and shareholder Berg on behalf of Provident versus Provident's directors in the same court. These suits were also concerned with the restatement of earnings and allege that the defendants breached fiduciary duties owed to Provident and are responsible for the conditions that led to the restatement and its consequences and sales of stock and other actions by certain officers and directors and seek recovery from the defendants of an unspecified amount of damages. A similar action was filed in the Court of Common Pleas of Hamilton County, Ohio on March 26, 2003 by shareholder Weinstein against the directors and two officers.
RESTRICTIONS ON CASH AND NONINTEREST BEARING DEPOSITS: Federal Reserve Board regulations require that The Provident Bank maintain certain minimum reserve balances. The average amount of those reserve balances for the year ended December 31, 2002, was approximately $57.8 million.
RESTRICTED ASSETS: Provident formed the subsidiaries listed below to account for and support the process of transferring, securitizing and/or selling of vehicle and equipment leases. These subsidiaries are separate legal entities and each maintains books and records with respect to its assets and liabilities. The assets of these subsidiaries, which are included in the consolidated financial statements, are not available to secure financing or otherwise satisfy claims of creditors of Provident or any of its other subsidiaries.
The subsidiaries and their total assets as of December 31, 2002 and 2001 follow (in thousands):
December 31, ------------------- Subsidiary 2002 2001 ----------------------------------------------------------------------- Provident Auto Rental LLC 1999-1 $723,901 $801,373 Provident Auto Leasing Company 617,371 717,239 Provident Auto Rental LLC 2000-1 350,500 374,242 Provident Auto Rental LLC 2001-1 314,339 345,432 Provident Auto Rental Company LLC 1998-2 152,986 171,112 Provident Auto Rental LLC 2000-2 150,401 159,537 Provident Auto Rental Company LLC 1998-1 141,300 157,498 Provident Lease Receivables Company LLC 115,460 193,139
The above amounts include items which are eliminated in the Consolidated Financial Statements.
RESTRICTIONS ON TRANSFER OF FUNDS FROM SUBSIDIARIES TO PARENT: The transfer of funds by The Provident Bank to the parent as dividends, loans or advances is subject to various laws and regulations that limit the amount of such transfers. The amount of dividends available for payment in 2003 by the Bank to the parent company is approximately $30.2 million, plus 2003 net income. Pursuant to Federal Reserve and State regulations, the maximum amount available to be loaned to affiliates (as defined), including its Parent, by the Bank, was approximately $165.1 million to any single affiliate, and $330.2 million to all affiliates combined of which $43.6 million was loaned at December 31, 2002.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PARENT COMPANY FINANCIAL INFORMATION: Parent Company only condensed financial information for Provident Financial Group, Inc. is as follows:
BALANCE SHEETS (PARENT ONLY)
December 31, ----------------------- (In Thousands) 2002 2001 ------------------------------------------------------------------------- ASSETS Cash and Cash Equivalents $ 243,000 $ 157,168 Trading Account Securities 10,470 - Investment Securities Available for Sale 299,024 315,018 Investment in Subsidiaries: Banking 1,056,278 948,949 Non-Banking 18,287 18,782 Accounts Receivable from Banking Subsidiaries 18,552 - Other Assets 103,222 99,005 ---------- ---------- TOTAL ASSETS $1,748,833 $1,538,922 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Accounts Payable to Banking Subsidiaries $ - $ 12,459 Other Accounts Payable and Accrued Expenses 56,575 18,636 Commercial Paper 271,269 240,571 Long-Term Debt and Junior Subordinated Debentures 540,618 465,423 ---------- ---------- Total Liabilities 868,462 737,089 Shareholders' Equity 880,371 801,833 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,748,833 $1,538,922 ========== ==========
STATEMENTS OF INCOME (PARENT ONLY)
Year Ended December 31, ------------------------------- (In Thousands) 2002 2001 2000 ------------------------------------------------------------------------------------ Income: Dividends from Banking Subsidiaries $ 45,000 $ 15,000 $ 37,000 Interest Income from Banking Subsidiaries 25,394 24,944 13,232 Other Interest Income 1,261 1,469 4,951 Noninterest Income 1,080 7,492 5,712 -------- -------- -------- 72,735 48,905 60,895 Expenses: Interest Expense 32,125 40,762 34,795 Noninterest Expense 1,705 2,842 2,668 -------- -------- -------- 33,830 43,604 37,463 -------- -------- -------- Income Before Taxes and Equity in Undistributed Net Income of Subsidiaries 38,905 5,301 23,432 Applicable Income Tax Credits 5,571 7,936 6,624 -------- -------- -------- Income Before Equity in Undistributed Net Income of Subsidiaries 44,476 13,237 30,056 Equity in Undistributed Net Income of Subsidiaries 50,975 (14,240) 26,485 -------- -------- -------- Net Income (Loss) $ 95,451 $ (1,003) $ 56,541 ======== ======== ========
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
STATEMENTS OF CASH FLOWS (PARENT ONLY)
Year Ended December 31, ----------------------------------- (In Thousands) 2002 2001 2000 ------------------------------------------------------------------------------------- Operating Activities: Net Income (Loss) $ 95,451 $ (1,003) $ 56,541 Adjustment to Reconcile Net Income to Net Cash Provided by (Used in) Operating Activities: Equity in Undistributed Net Income of Subsidiaries (50,975) 14,240 (26,485) Amortization and Accretion 453 1,066 805 Tax Benefit Received from Exercise of Stock Options 1,069 2,706 513 Realized Investment Security (Gains) Losses 11 (72) 493 (Increase) Decrease in Interest Receivable (48) 177 39 (Increase) Decrease in Other Assets (22,754) 3,783 (40,026) Increase (Decrease) in Interest Payable 1,163 (261) 76 Increase (Decrease) in Other Liabilities (15,584) (20,821) 10,193 --------- --------- --------- Net Cash Provided by (Used In) Operating Activities 8,786 (185) 2,149 --------- --------- --------- Investing Activities: Investment Securities Available for Sale: Proceeds from Sales 24,159 19,379 129,648 Proceeds from Maturities and Prepayments 11,664 15,234 87,358 Purchases (19,883) (50,671) (330,583) --------- --------- --------- Net Cash Provided by (Used In) Investing Activities 15,940 (16,058) (113,577) --------- --------- --------- Financing Activities: Net Increase (Decrease) in Commercial Paper 30,698 53,481 (14,694) Principal Payments on Long-Term Debt (120) (391) (74,764) Proceeds from Issuance of Long-Term Debt and Junior Subordinated Debentures 75,000 124,432 186,706 Cash Dividends Paid (48,334) (48,002) (47,738) Repurchase of Common Stock (24) (246) - Proceeds from Exercise of Stock Options 4,232 3,884 3,388 Contribution to Subsidiaries (346) (54,986) (3,480) Net Increase in Other Equity Items - 903 2,816 --------- --------- --------- Net Cash Provided by Financing Activities 61,106 79,075 52,234 --------- --------- --------- Increase (Decrease) in Cash and Cash Equivalents 85,832 62,832 (59,194) Cash and Cash Equivalents at Beginning of Year 157,168 94,336 153,530 --------- --------- --------- Cash and Cash Equivalents at End of Year $ 243,000 $ 157,168 $ 94,336 ========= ========= =========
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUPPLEMENTARY DATA
Quarterly Consolidated Results of Operations - (Unaudited) ----------------------------------------------------------
The following are quarterly consolidated results of operations for the two years ended December 31, 2002.
As Restated, See Note 3 ----------------------------------- Fourth Third Second First (In Thousands Except Per Share Data) Quarter Quarter Quarter Quarter ---------------------------------------------------------------------------------------- 2002: Total Interest Income $ 208,391 $ 208,250 $ 211,331 $ 213,416 Total Interest Expense (127,482) (130,624) (132,603) (135,121) --------- --------- --------- --------- Net Interest Income 80,909 77,626 78,728 78,295 Provision for Loan and Lease Losses (18,237) (23,532) (33,575) (24,205) --------- --------- --------- --------- Net Interest Income After Provision for Loan and Lease Losses 62,672 54,094 45,153 54,090 Noninterest Income 210,287 196,397 204,578 194,230 Noninterest Expense (232,700) (214,079) (214,637) (214,612) --------- --------- --------- --------- Income Before Income Taxes 40,259 36,412 35,094 33,708 Applicable Income Taxes (13,630) (12,376) (11,924) (12,092) --------- --------- --------- --------- Net Income $ 26,629 $ 24,036 $ 23,170 $ 21,616 ========= ========= ========= ========= Net Earnings Per Common Share: Basic $ .54 $ .49 $ .47 $ .43 Diluted .52 .47 .46 .43 Cash Dividends .24 .24 .24 .24
As Restated, See Note 3 ------------------------------------------------ Fourth Third Second First 2001: Quarter Quarter Quarter Quarter ----------------------------------------------------------------------------------------- Total Interest Income $ 221,768 $ 245,459 $ 250,450 $ 255,618 Total Interest Expense (148,894) (174,336) (184,606) (194,964) --------- --------- --------- --------- Net Interest Income 72,874 71,123 65,844 60,654 Provision for Loan and Lease Losses (108,787) (60,886) (23,548) (22,324) --------- --------- --------- --------- Net Interest Income After Provision for Loan and Lease Losses (35,913) 10,237 42,296 38,330 Noninterest Income 195,712 192,917 193,534 174,273 Noninterest Expense (218,399) (222,476) (194,701) (177,408) --------- --------- --------- --------- Income (Loss) Before Income Taxes (58,600) (19,322) 41,129 35,195 Applicable Income Taxes 21,081 6,540 (14,497) (12,529) --------- --------- --------- --------- Net Income (Loss) $ (37,519) $ (12,782) $ 26,632 $ 22,666 ========= ========= ========= ========= Net Earnings (Loss) Per Common Share: Basic $ (.77) $ (.27) $ .54 $ .46 Diluted (.77) (.27) .53 .45 Cash Dividends .24 .24 .24 .24
Quarterly earnings per share numbers do not necessarily add to the year-to-date amounts due to the treasury stock method of calculating earnings per share and to rounding.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND ----------------------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------
None
PART III
Items 10 through 13 are incorporated by reference to Provident's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A within 120 days after the close of Provident's fiscal year ending December 31, 2002:
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT -----------------------------------------------------------
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION -------------------------------
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND ----------------------------------------------------------------------------- RELATED STOCKHOLDER MATTERS ---------------------------
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -------------------------------------------------------
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES ---------------------------------
An evaluation was performed under the supervision and with the participation of management, including the principal executive and financial officers, of the effectiveness of the design and operation of Provident's disclosure controls and procedures within 90 days prior to the filing of this Form 10-K. Based on that evaluation, management, including the principal executive and financial officers, concluded that Provident's disclosure controls and procedures were effective with no significant weaknesses noted except that Provident's disclosure controls and procedures did not detect until early 2003 certain unintentional errors that had occurred in the accounting and classification of auto lease transactions. This weakness has been addressed and the financial statements and related financial information included in this Form 10-K have been appropriately revised. There have been no significant changes in Provident's internal controls or in other factors that could significantly affect these internal controls after the date of their evaluation. Provident is reviewing its disclosure controls and procedures in all areas involving financial models previously established for lease and other transactions to improve the ability of its disclosure controls and procedures to detect such problems of the nature discovered in early 2003. Provident's Audit Committee engaged PricewaterhouseCoopers LLP, which is not the auditor of Provident's financial statements, to undertake a review of its internal controls. PricewaterhouseCoopers is to provide an assessment of Provident's existing internal controls in certain areas. The scope of this review is currently being determined.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ------------------------------------------------------------------------
(a) 1. See Index to Financial Statements on page 44 for a list of all financial statements filed as a part of this report.
2. Schedules to the consolidated financial statements required by Article 9 of Regulation S-X have been omitted as they are not required, not applicable or the information required thereby is set forth in the related financial statements.
3. Exhibits:
Number Exhibit Description Filing Status ------ ------------------- -------------
3.1 Articles of Incorporation Incorporated by reference to Form 10-Q for quarter ending June 30, 1997.
3.2 Code of Regulations Incorporated by reference to Proxy Statement for the 1994 Annual Meeting of Shareholders.
4.1 Instruments defining the Provident has no outstanding rights of security issue of indebtedness exceeding holders 10% of the assets of Provident Financial and Consolidated Subsidiaries. A copy of the instruments defining the rights of security holders will be furnished to the Commission upon request.
4.2 Plan of Reorganization Incorporated by reference to Form relating to Series D, 10-K for 1995. Non-Voting Convertible Preferred Stock
10.1 Junior Subordinated Incorporated by reference to Indenture, dated as of Exhibit 4.1 on Form 8-K dated November 27, 1996, between November 27, 1996. Provident and the Bank of New York, as Indenture Trustee
10.2 Amended and Restated Incorporated by reference to Declaration of Trust of Exhibit 4.3 on Form 8-K dated Provident Capital Trust I, November 27, 1996. dated as of November 27,
10.3 Form of Guarantee Agreement Incorporated by reference to entered into by Provident registration statement number and The Bank of New York, 333-20769. as Guarantee Trustee
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Number Exhibit Description Filing Status ------ ------------------- -------------
10.4 Provident 1990 Employee Incorporated by reference to Stock Purchase Plan(1) Post-Effective Amendment No. 1 to Form S-8 (File No. 33-34904).
10.5 Provident Retirement Plan Incorporated by reference to (As amended)(1) Form S-8 (File No. 33-90792).
10.6 Provident 1992 Advisory Incorporated by reference to Form Directors' Stock Option Plan 8-K filed October 22, 1992, and (As amended)(1) Form S-8 (File No. 33-62707).
10.7 Provident 1992 Outside Incorporated by reference to Form Directors' Stock Option S-8 (File No. 33-51230). Plan(1)
10.8 Provident Restricted Incorporated by reference to Form Stock Plan(1) S-2 (File No. 33-44641).
10.9 Registration of Preferred Incorporated by reference to Form Capital Securities, between S-3 (File No. 333-80231). Provident Capital Trust II, Provident and Chase Manhattan Bank
10.10 Agreement and Plan of Incorporated by reference to Form Reorganization between S-4 (File No. 333-88723). Provident and Fidelity Financial of Ohio, Inc.
10.11 Registration of Preferred Incorporated by reference to Form Capital Securities of S-3 as amended by Form S-3/A File Provident Capital Trust No. 333-93603). III and IV
10.12 Registration of Glenway Incorporated by reference to Form Financial Corporation 1990 S-8 (File No. 333-96503) and Form Stock Option and Incentive S-8 (File No. 333-55698). Plan, Fidelity Federal Savings Bank 1992 Stock Incentive Plan, Fidelity Financial of Ohio, Inc. 1997 Stock Option Plan, and OHSL Financial Corp. 1992 Stock Option and Incentive Plan
10.13 Separation agreement between Incorporated by reference to Form Provident and Philip R. Myers Form 10-Q for the second quarter (1) of 2001.
10.14 Provident Dividend Incorporated by reference to Form Reinvestment Plan S-3 (File No. 333-67754).
10.15 Employment agreement between Incorporated by reference to Form Provident and James L. Gertie 8-K (File No. 02672034). (1)
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Number Exhibit Description Filing Status ------ ------------------- -------------
10.16 Employment agreement between Filed herewith. Provident and Christopher J. Carey(1)
10.17 Employment agreement between Filed herewith. Provident and James R. Whitaker(1)
10.18 Provident 1988 Stock Option Filed herewith. Plan (As amended)(1)
10.19 Provident 1996 Non-Executive Filed herewith. Officer Stock Option Plan (As amended)(1)
10.20 Provident 1997 Stock Option Filed herewith. Plan (As amended)(1)
10.21 Provident 2000 Stock Option Filed herewith. Plan (As amended)(1)
10.22 Provident Deferred Filed herewith. Compensation Plan (As Amended)(1)
10.23 Provident 2002 Outside Filed herewith. Directors Stock Option Plan(1)
10.24 Provident Outside Directors Filed herewith. Deferred Compensation Plan (As Amended)(1)
10.25 Provident Supplemental Filed herewith. Executive Retirement Plan (As Amended)(1)
21 Subsidiaries of Provident Filed herewith.
23 Consent of Independent Filed herewith. Auditors
(1) Management Compensatory Agreements
(b) Reports on Form 8-K:
Form 8-K (Items 5 and 7) filed on March 5, 2003.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Signatures
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, Provident Financial Group, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Provident Financial Group, Inc.
/s/Robert L. Hoverson --------------------- Robert L. Hoverson President April 11, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Provident Financial Group, Inc. and in the capacities and on the dates indicated.
Signature Capacity Date --------- -------- ----
/s/Robert L. Hoverson Director and President April 11, 2003 ----------------------- (Principal Executive Officer) Robert L. Hoverson
/s/Jack M. Cook Director April 11, 2003 ----------------------- Jack M. Cook
/s/Thomas D. Grote, Jr. Director April 11, 2003 ----------------------- Thomas D. Grote, Jr.
/s/Joseph A. Pedoto Director April 11, 2003 ----------------------- Joseph A. Pedoto
/s/Sidney A. Peerless Director April 11, 2003 ----------------------- Sidney A. Peerless
/s/Joseph A. Steger Director April 11, 2003 ----------------------- Joseph A. Steger
/s/Christopher J. Carey Executive Vice President April 11, 2003 ------------------------ and Chief Financial Officer Christopher J. Carey
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 and Securities and Exchange Commission Release 34-46427
I, Robert L. Hoverson, the principal executive officer of Provident Financial Group, Inc. ("Provident"), certify that:
1. I have reviewed this annual report on Form 10-K of Provident; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: April 10, 2003 /s/Robert L. Hoverson --------------------- Robert L. Hoverson Chief Executive Officer (Principal Executive Officer)
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 and Securities and Exchange Commission Release 34-46427
I, Christopher J. Carey, the principal financial officer of Provident Financial Group, Inc. ("Provident"), certify that:
1. I have reviewed this annual report on Form 10-K of Provident; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: April 10, 2003 /s/Christopher J. Carey ----------------------- Christopher J. Carey Chief Financial Officer (Principal Financial Officer)
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CERTIFICATION OF CHIEF EXECUTIVE OFFICER Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the filing with the Securities and Exchange Commission of the Annual Report of Provident Financial Group, Inc. ("Provident") on Form 10-K for the period ending December 31, 2002 (the "Report"), I, Robert L. Hoverson, Chief Executive Officer of Provident, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Provident.
/s/Robert L. Hoverson --------------------- Robert L. Hoverson Chief Executive Officer
April 10, 2003
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CERTIFICATION OF CHIEF FINANCIAL OFFICER Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the filing with the Securities and Exchange Commission of the Annual Report of Provident Financial Group, Inc. ("Provident") on Form 10-K for the period ending December 31, 2002 (the "Report"), I, Christopher J. Carey, Chief Financial Officer of Provident, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Provident.
/s/Christopher J. Carey ----------------------- Christopher J. Carey Chief Financial Officer
April 10, 2003