ITEM 1. Business - ----------------
Provident Bancorp, Inc.
Provident Bancorp, Inc. ("Provident Bancorp" or the "Company") is a Delaware corporation that owns all of the outstanding shares of common stock of Provident Bank (the "Bank"). At September 30, 2004, Provident Bancorp had consolidated assets of $1.8 billion, deposits of $1.2 billion and stockholders' equity of $ 349.5 million. As of September 30, 2004, Provident Bancorp had 39,618,373 shares of common stock outstanding.
Second Step Common Stock Offering and Acquisition of E.N.B. Holding Company, Inc.
On January 14, 2004 the Company completed its stock offering in connection with the second-step conversion of Provident Bancorp, MHC, the former mutual holding company for the Bank. As part of the conversion, the Company succeeded to Provident Bancorp, Inc., a federal corporation ("Provident Federal") as the stock holding company of the Bank. In the stock offering, shares representing Provident Bancorp, MHC's ownership interest in Provident Federal were sold to investors. The Company sold 19,573,000 shares of common stock at $10.00 per share to depositors of the Bank as of June 30, 2002 and September 30, 2003. The Company also issued 400,000 shares of common stock and contributed $1.0 million in cash to the Provident Bank Charitable Foundation. In addition, each outstanding share of common stock of Provident Federal as of January 14, 2004 was converted into 4.4323 new shares of the Company's common stock.
In addition, the Company simultaneously completed its acquisition of E.N.B. Holding Company, Inc., ("ENB"), headquartered in Ellenville, New York. Shareholders of ENB as of the close of business on January 14, 2004 received total merger consideration of approximately $76.47 million, consisting of 3,969,676 shares of common stock of the Company and approximately $36.77 million in cash. ENB had total assets of $349.7 million, total loans of $213.5 million and total deposits of $326.8 million. ENB had five offices in Orange County, two offices in Ulster County and two offices in Sullivan County, all in New York State.
As a result of the above transactions, the Company had 39,608,586 issued and outstanding shares at January 14, 2004.
Financial statements as of September 30, 2004, reflect the effect of the conversion of existing common shares, the stock offering, the acquisition of ENB and the issuance of shares and contribution of cash to the charitable foundation. Goodwill recorded in the ENB acquisition ($51.8 million) is not amortized to expense, but instead is reviewed for impairment at least annually, with impairment losses charged to expense, if and when they occur. The core deposit intangible asset ($4.9 million at September 30, 2004), is recognized apart from goodwill and amortized to expense over its estimated useful life and evaluated for impairment.
Provident Bank
Provident Bank is a full-service, community-oriented savings bank that provides financial services to individuals, families and businesses through 27 branch offices and 50 ATMs throughout Rockland, Orange, Ulster and Sullivan Counties, New York.
Provident Bank's business consists primarily of accepting deposits from the general public and investing those deposits, together with funds generated from operations and borrowings, in one- to four-family residential, multi-family residential and commercial real estate loans, commercial business loans and leases, consumer loans and in investment securities and mortgage-backed securities.
Originally organized in 1888 as a New York State-chartered mutual savings and loan association, in January 1999 Provident Bank reorganized into the mutual holding company structure as the wholly-owned subsidiary of Provident Federal, which simultaneously conducted an initial public offering. We have increased our number of branch offices from 11 branch offices at September 30, 1998 to 27 branch offices at September 30, 2004. Subsequent to our mutual holding company reorganization and initial stock offering, we have broadened our market reach through de novo branching and our acquisitions of The National Bank of Florida ("NBF") in April 2002 and ENB, discussed above.
Provident Bank's website (www.providentbanking.com) contains a direct link to the Company's filings with the Securities and Exchange Commission, including copies of annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these filings. Copies may also be obtained, without charge, by written request to Investor Relations, attn. Roberta Lenett, 400 Rella Boulevard, Montebello, New York 10901.
Provident Municipal Bank
In April 2002, Provident Bank organized Provident Municipal Bank as a wholly-owned subsidiary. Provident Municipal Bank is a New York State-chartered commercial bank that is engaged in the business of accepting deposits from municipalities in our market area, as New York State law requires municipalities located in the State of New York to deposit funds with commercial banks, effectively forbidding these municipalities from depositing funds with savings institutions, including federally chartered savings associations, such as Provident Bank.
Subsequent Event
On October 1, 2004 the Company completed the acquisition of Warwick Community Bancorp, Inc. ("Warwick"). The Company paid $72.6 million in cash and issued approximately 6,258,000 shares of its common stock in connection with the acquisition. Warwick had nine branch locations: six in Orange County, New York, one in Putnam County, New York and two office locations in Bergen County, New Jersey. Warwick had approximately $700 million in consolidated assets, $285 million in loans and $480 million in deposits.
Forward-Looking Statements
In addition to historical information, this annual report contains forward-looking statements. For this purpose, any statements contained herein (including documents incorporated herein by reference) that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believe", "anticipates", "plans", "expects" and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause Provident Bancorp's actual results to differ materially from those contemplated by such forward-looking statements. These important factors include, without limitation, Provident Bancorp's continued ability to originate quality loans, fluctuations in interest rates, real estate conditions in Provident Bancorp's lending areas, general and local economic conditions, Provident Bancorp's continued ability to attract and retain deposits, Provident Bancorp's ability to control costs, effect of new accounting pronouncements and changing regulatory requirements, and Provident Bancorp's ability to complete its announced acquisition and related systems conversions. Provident Bancorp undertakes no obligation to publicly release the results of any revisions to those forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Market Area
Provident Bank is an independent community bank offering a broad range of financial services to businesses and individuals as an alternative to money centers and large regional banks in our market area. At September 30, 2004, our 27 full-service banking offices consisted of 13 offices in Rockland County, New York, 10 offices in Orange County, New York, and four offices in contiguous Ulster and Sullivan Counties, New York. We acquired two of the Orange County offices as part of our acquisition of NBF, located in Florida, New York, which was completed in April 2002, and five offices as a result of our acquisition of ENB, which was headquartered in Ellenville, Ulster County, New York. Our primary market for deposits is currently concentrated around the areas where our full-service banking offices are located. Our primary lending area consists of Rockland and Orange Counties as well as contiguous counties.
Rockland and Orange counties constitute a suburban market with a broad employment base. They also serve as bedroom communities for nearby New York City and other suburban areas including Westchester County and northern New Jersey. Orange County is one of the two fastest growing counties in New York State. The economic environment in Rockland, Orange and contiguous counties continues to be favorable and has supported increased commercial and residential activity in recent years.
Lending Activities
General. We originate commercial real estate loans, commercial business loans and construction loans (collectively referred to as the "commercial loan portfolio"). We also originate in our market area fixed-rate and adjustable-rate ("ARM") residential mortgage loans collateralized by one- to four-family residential real estate, and consumer loans such as home equity lines of credit, homeowner loans and personal loans. We retain most of the loans we originate, although we may sell longer-term one- to four-family residential loans and participations in some commercial loans.
Commercial Real Estate Lending. We originate real estate loans secured predominantly by first liens on commercial real estate. The commercial properties are predominantly non-residential properties such as offices buildings, shopping centers, retail strip centers, industrial and warehouse properties and, to a lesser extent, more specialized properties such as churches, mobile home parks, restaurants and motel/hotels. We may, from time to time, purchase commercial real estate loan participations. We target commercial real estate loans with initial principal balances between $1.0 million and $5.0 million. Loans secured by commercial real estate totaled $327.4 million, or 32.8% of our total loan portfolio at September 30, 2004, and consisted of 738 loans outstanding with an average loan balance of approximately $444,000 although there are a large number of loans with balances substantially greater than this average. Substantially all of our commercial real estate loans are secured by properties located in our primary market area.
Most of our commercial real estate loans are written as five-year adjustable-rate or ten-year fixed-rate mortgages and typically have balloon maturities of ten years. Amortization on these loans is typically based on 10- to 20-year payout schedules. We also originate some 15- to 20-year fixed-rate, fully amortizing loans. Margins generally range from 175 basis points to 300 basis points above the applicable Federal Home Loan Bank advance rate.
In the underwriting of commercial real estate loans, we generally lend up to 75% of the property's appraised value. Decisions to lend are based on the economic viability of the property and the creditworthiness of the borrower. In evaluating a proposed commercial real estate loan, we emphasize primarily the ratio of the property's projected net cash flow to the loan's debt service requirement (generally targeting a ratio of 120%), computed after deduction for a vacancy factor and property expenses we deem appropriate. In addition, a personal guarantee of the loan or a portion of thereof is generally required from the principal(s) of the borrower. We require title insurance insuring the priority of our lien, fire and extended coverage casualty insurance, and flood insurance, if appropriate, in order to protect our security interest in the underlying property. In addition, business interruption insurance or other insurance may be required.
Commercial real estate loans generally carry higher interest rates and have shorter terms than those on one- to four-family residential mortgage loans. Commercial real estate loans, however, entail significant additional credit risks compared to one- to four-family residential mortgage loans, as they typically involve large loan balances concentrated
with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. For commercial real estate loans in which the borrower is the primary occupant, repayment experience also depends on the successful operation of the borrower's underlying business.
Commercial Business Loans. We make various types of secured and unsecured commercial loans to customers in our market area for the purpose of financing equipment acquisition, expansion, working capital and other general business purposes. The terms of these loans generally range from less than one year to seven years. The loans are either negotiated on a fixed-rate basis or carry adjustable interest rates indexed to (i) a lending rate that is determined internally, or (ii) a short-term market rate index. At September 30, 2004, we had 1,327 commercial business loans outstanding with an aggregate balance of $105.2 million, or 10.5% of the total loan portfolio. As of September 30, 2004, the average commercial business loan balance was approximately $80,000, although there are a large number of loans with balances substantially greater than this average.
Commercial credit decisions are based upon a credit assessment of the loan applicant. A determination is made as to the applicant's ability to repay in accordance with the proposed terms as well as an overall assessment of the risks involved. An evaluation is made of the applicant to determine character and capacity to manage. Personal guarantees of the principals are generally required, except in the case of not-for-profit corporations. In addition to an evaluation of the loan applicant's financial statements, a determination is made of the probable adequacy of the primary and secondary sources of repayment to be relied upon in the transaction. Credit agency reports of the applicant's credit history supplement the analysis of the applicant's creditworthiness. Checking with other banks and trade investigations also may be conducted. Collateral supporting a secured transaction also is analyzed to determine its marketability. For small business loans and lines of credit, generally those not exceeding $250,000, we use a credit scoring system that enables us to process the loan requests quickly and efficiently. Commercial business loans generally bear higher interest rates than residential loans of like duration because they involve a higher risk of default since their repayment is generally dependent on the successful operation of the borrower's business and the sufficiency of collateral, if any.
One- to Four-Family Real Estate Lending. We offer conforming and non-conforming, fixed-rate and adjustable-rate residential mortgage loans with maturities of up to 30 years and maximum loan amounts generally up to $1.1 million. This portfolio totaled $380.7 million, or 38.2% of our total loan portfolio at September 30, 2004.
We currently offer both fixed- and adjustable-rate conventional mortgage loans with terms of 10 to 30 years that are fully amortizing with monthly or bi-weekly loan payments. One- to four-family residential mortgage loans are generally underwritten according to Fannie Mae and Freddie Mac guidelines, and loans that conform to such guidelines are referred to as "conforming loans." We generally originate both fixed-rate and ARM loans in amounts up to the maximum conforming loan limits as established by Fannie Mae and Freddie Mac, which are currently $333,700 for single-family homes. Private mortgage insurance is generally required for loans with loan-to-value ratios in excess of 80%. We also originate loans above conforming limits, referred to as "jumbo loans," that have been underwritten to the credit standards of Fannie Mae or Freddie Mac. These loans are generally eligible for sale to various firms that specialize in the purchase of such non-conforming loans, although we retained in our portfolio all such loans originated in fiscal 2004, totaling $11.9 million. In our market area, due to our proximity to New York City, such larger residential loans are not uncommon. We also originate loans at higher rates that do not meet the credit standards of Fannie Mae or Freddie Mac, but are deemed to be acceptable risks. The amount of such loans originated for fiscal 2004 was $3.8 million, all of which were retained in our loan portfolio.
We actively monitor our interest rate risk position to determine the desirable level of investment in fixed-rate mortgages. Depending on market interest rates and our capital and liquidity position, we may retain all of our newly originated longer term fixed-rate, residential mortgage loans, or from time to time we may decide to sell all or a portion of such loans in the secondary mortgage market to government sponsored entities such as Fannie Mae and Freddie Mac or other purchasers. Our bi-weekly one- to four-family residential mortgage loans that are retained in our portfolio result in shorter repayment schedules than conventional monthly mortgage loans, and are repaid through an automatic
deduction from the borrower's savings or checking account. As of September 30, 2004, bi-weekly loans totaled $154.1 million, or 40.5 % of our residential loan portfolio. We retain the servicing rights on a large majority of loans sold to generate fee income and reinforce our commitment to customer service, although we may also sell non-conforming loans to mortgage banking companies, generally on a servicing-released basis. As of September 30, 2004, loans serviced for others totaled $84.9 million.
We currently offer several ARM loan products secured by residential properties with rates that are fixed for a period ranging from six months to ten years. After the initial term, the interest rate on these loans is generally reset every year based upon a contractual spread or margin above the average yield on U.S. Treasury securities, adjusted to a constant maturity of one year, as published weekly by the Federal Reserve Board and subject to certain periodic and lifetime limitations on interest rate changes. Many of the borrowers who select these loans have shorter-term credit needs than those who select long-term, fixed-rate loans. ARM loans generally pose different credit risks than fixed-rate loans primarily because the underlying debt service payments of the borrowers rise as interest rates rise, thereby increasing the potential for default. At September 30, 2004, our ARM portfolio included $5.3 million in loans that re-price every six months, $19.3 million in loans that re-price once a year and $27.7 million in loans that reprice periodically after an initial fixed-rate period of three years or more.
We require title insurance on all of our one- to four-family mortgage loans, and we also require that borrowers maintain fire and extended coverage or all risk casualty insurance (and, if appropriate, flood insurance) in an amount at least equal to the lesser of the loan balance or the replacement cost of the improvements but in any event in an amount calculated to avoid the effect of any coinsurance clause. Loans with initial loan-to-value ratios in excess of 80% must have private mortgage insurance, although occasional exceptions may be made. Nearly all residential loans must have a mortgage escrow account from which disbursements are made for real estate taxes and for hazard and flood insurance.
Construction Loans. We originate land acquisition, development and construction loans to builders in our market area. These loans totaled $54.3 million, or 5.4% of our total loan portfolio at September 30, 2004.
Acquisition loans help finance the purchase of land intended for further development, including single-family houses, multi-family housing, and commercial income property. In some cases, we may make an acquisition loan before the borrower has received approval to develop the land as planned. In general, the maximum loan-to-value ratio for a land acquisition loan is 60% of the appraised value of the property. We also make development loans to builders in our market area to finance improvements to real estate, consisting mostly of single-family subdivisions, typically to finance the cost of utilities, roads, sewers and other development costs. Builders generally rely on the sale of single-family homes to repay development loans, although in some cases the improved building lots may be sold to another builder. The maximum amount loaned is generally limited to the cost of the improvements plus an interest reserve, if one is required. Advances are made in accordance with a schedule reflecting the cost of the improvements.
We also grant construction loans to area builders, often in conjunction with development loans. In the case of residential subdivisions, these loans finance the cost of completing homes on the improved property. Advances on construction loans are made in accordance with a schedule reflecting the cost of construction. Repayment of construction loans on residential subdivisions is normally expected from the sale of units to individual purchasers. In the case of income-producing property, repayment is usually expected from permanent financing upon completion of construction. We commit to provide the permanent mortgage financing on most of our construction loans on income-producing property.
Land acquisition, development and construction lending exposes us to greater credit risk than permanent mortgage financing. The repayment of land acquisition, development and construction loans depends upon the sale of the property to third parties or the availability of permanent financing upon completion of all improvements. In the event we make an acquisition loan on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. These events may adversely affect the borrower and the collateral value of the property. Development and construction loans also expose us to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the property may not occur as anticipated.
Consumer Loans. We originate a variety of consumer and other loans, including homeowner loans, home equity lines of credit, new and used automobile loans, and personal unsecured loans, including fixed-rate installment loans and variable lines of credit. As of September 30, 2004, consumer loans totaled $130.0 million, or 13.0% of the total loan portfolio.
At September 30, 2004, the largest group of consumer loans consisted of $106.9 million of loans secured by junior liens on residential properties. We offer fixed-rate, fixed-term second mortgage loans, referred to as homeowner loans, and we also offer adjustable-rate home equity lines of credit. As of September 30, 2004, homeowner loans totaled $26.9 million or 2.7% of our total loan portfolio. The disbursed portion of home equity lines of credit totaled $80.0 million, or 8.0% of our total loan portfolio at September 30, 2004, with $47.4 million remaining undisbursed.
Other consumer loans include personal loans and loans secured by new or used automobiles. As of September 30, 2004, these loans totaled $23.0 million, or 2.3% of our total loan portfolio. We originate consumer loans directly to our customers or on an indirect basis through selected dealerships. We require borrowers to maintain collision insurance on automobiles securing consumer loans, with us listed as loss payee. Personal loans also include secured and unsecured installment loans for other purposes. Unsecured installment loans generally have shorter terms than secured consumer loans, and generally have higher interest rates than rates charged on secured installment loans with comparable terms. Personal loans are generally unsecured and carry higher interest rates and shorter terms than homeowner loans or automobile loans.
Our procedures for underwriting consumer loans include an assessment of an applicant's credit history and the ability to meet existing obligations and payments on the proposed loan. Although an applicant's creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral security, if any, to the proposed loan amount.
Consumer loans generally entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that tend to depreciate rapidly, such as automobiles. In addition, the repayment of consumer loans depends on the borrowers' continued financial stability, as repayment is more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy than a single family mortgage loan.
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio, excluding loans held for sale, by type of loan at the dates indicated.
Loan Portfolio Maturities and Yields. The following table summarizes the scheduled repayments of our loan portfolio at September 30, 2004. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.
- ---------- (1) Includes demand loans, loans having no stated repayment schedule or maturity, and overdraft loans.
(2) Includes land acquisition loans.
The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at September 30, 2004 that are contractually due after September 30, 2005.
Loan Originations, Purchases, Sales and Servicing. While we originate both fixed-rate and adjustable-rate loans, our ability to generate each type of loan depends upon borrower demand, market interest rates, borrower preference for fixed- versus adjustable-rate loans, and the interest rates offered on each type of loan by other lenders in our market area. These include competing banks, savings banks, credit unions, mortgage banking companies, life insurance companies and similar financial services firms. Loan originations are derived from a number of sources, including branch office personnel, existing customers, borrowers, builders, attorneys, real estate broker referrals and walk-in customers.
Our loan origination and sales activity may be adversely affected by a rising interest rate environment that typically results in decreased loan demand, while declining interest rates may stimulate increased loan demand. Accordingly, the volume of loan origination, the mix of fixed and adjustable-rate loans, and the profitability of this activity can vary from period to period. One- to four-family residential mortgage loans are generally underwritten to current Fannie Mae and Freddie Mac seller/servicer guidelines, and closed on standard Fannie Mae/Freddie Mac documents. If such loans are sold, the sales are conducted using standard Fannie Mae/Freddie Mac purchase contracts and master commitments as applicable. One- to four-family mortgage loans may be sold both to Fannie Mae or Freddie Mac on a non-recourse basis whereby foreclosure losses are generally the responsibility of the purchaser and not Provident Bank.
We are a qualified loan servicer for both Fannie Mae and Freddie Mac. Our policy has been to retain the servicing rights for all conforming loans sold. We therefore continue to collect payments on the loans, maintain tax escrows and applicable fire and flood insurance coverage, and supervise foreclosure proceedings if necessary. We retain a portion of the interest paid by the borrower on the loans as consideration for our servicing activities.
Loan Approval Authority and Underwriting. We have four levels of lending authority beginning with the Board of Directors. The Board grants lending authority to the Director Loan Committee, the members of which are Directors. The Director Loan Committee, in turn, may grant authority to the Management Loan Committee and individual loan officers. In addition, designated members of management may grant authority to individual loan officers up to specified limits. Our lending activities are subject to written policies established by the Board. These policies are reviewed periodically.
The Director Loan Committee may approve loans in accordance with applicable loan policies, up to the limits established in our policy governing loans to one borrower. This policy places limits on the aggregate dollar amount of credit that may be extended to any one borrower and related entities. Loans exceeding the maximum loan-to-one borrower limit described below require approval by the Board of Directors. The Management Loan Committee may approve loans of up to an aggregate of $2 million to any one borrower and group of related borrowers. Two loan officers with sufficient loan authority acting together may approve loans up to $1,000,000. The maximum individual authority to approve an unsecured loan is $50,000, however, for credit-scored small business loans; the maximum individual authority is $150,000.
We have established a risk rating system for our commercial business loans, commercial and multi-family real estate loans, and acquisition, development and construction loans to builders. The risk rating system assesses a variety of factors to rank the risk of default and risk of loss associated with the loan. These ratings are performed by commercial credit personnel who do not have responsibility for loan originations. We determine our maximum loan-to-one-borrower limits based upon the rating of the loan. The large majority of loans fall into three categories. The maximum for the best-rated borrowers is $15 million, for the next group of borrowers is $12 million, and for the third group is $6 million. Sublimits apply based on reliance on any single property, and for commercial business loans. However, for loans that fall into the best rated group or the next best group, the limits may be increased by 20% in certain cases if the loans are secured by mortgages on three or more properties.
In connection with our residential and commercial real estate loans, we generally require property appraisals to be performed by independent appraisers who are approved by the Board. Appraisals are then reviewed by the appropriate loan underwriting areas. Under certain conditions, appraisals may not be required for loans under $250,000 or in other limited circumstances. We also require title insurance, hazard insurance and, if indicated, flood insurance on property securing mortgage loans. Title insurance is not required for consumer loans under $100,000, such as home equity lines of credit and homeowner loans.
Loan Origination Fees and Costs. In addition to interest earned on loans, we also receive loan origination fees. Such fees vary with the volume and type of loans and commitments made, and competitive conditions in the mortgage markets, which in turn respond to the demand and availability of money. We defer loan origination fees and costs, and amortize such amounts as an adjustment to yield over the term of the loan by use of the level-yield method. Deferred loan origination costs (net of deferred fees) were $1,263,000 at September 30, 2004.
To the extent that originated loans are sold with servicing retained, we capitalize a mortgage servicing asset at the time of the sale in accordance with applicable accounting standards (Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"). The capitalized amount is amortized thereafter (over the period of estimated net servicing income) as a reduction of servicing fee income. The unamortized amount is fully charged to income when loans are prepaid. Originated mortgage servicing rights with an amortized cost of $746,000 are included in other assets at September 30, 2004. See also Notes 3 and 6 of the Notes to Consolidated Financial Statements.
Loans to One Borrower. At September 30, 2004, our five largest aggregate amounts loaned to any one borrower and certain related interests (including any unused lines of credit) consisted of secured and unsecured financing of $13.3 million, $10.1 million, $8.6 million, $8.4 million and $7.3 million. See "Regulation--Federal Banking Regulation--Loans to One Borrower" for a discussion of applicable regulatory limitations.
Delinquent Loans, Other Real Estate Owned and Classified Assets
Collection Procedures for Residential and Commercial Mortgage Loans and Consumer Loans. Computer-generated late notice is sent by the 16th day after the payment due date on a loan requesting the payment due plus any late charge that was assessed. Accounts are distributed to a collector or account officer to contact borrowers, determine the reason for delinquency and arrange for payment, and accounts are monitored electronically for receipt of payments. If payments are not received within 30 days of the original due date, a letter demanding payment of all arrearages is sent and contact efforts are continued. If payment is not received within 60 days of the due date, loans are generally accelerated and payment in full is demanded. Failure to pay within 90 days of the original due date generally results in legal action, notwithstanding ongoing collection efforts. Unsecured consumer loans are generally charged-off after 120 days. For other commercial loans, procedures vary depending upon individual circumstances.
Loans Past Due and Non-performing Assets. Loans are reviewed on a regular basis, and are placed on non-accrual status when either principal or interest is 90 days or more past due. In addition, loans are placed on non-accrual status when, in the opinion of management, there is sufficient reason to question the borrower's ability to continue to meet principal or interest payment obligations. Interest accrued and unpaid at the time a loan is placed on non-accrual status is reversed from interest income. Interest payments received on non-accrual loans are not recognized as income unless warranted based on the borrower's financial condition and payment record. At September 30, 2004, we had non-accrual loans of $2.7 million.
Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned ("REO") until such time as it is sold. When real estate is acquired through foreclosure or by deed in lieu of foreclosure, it is recorded at its fair value, less estimated costs of disposal. If the fair value of the property is less than the loan balance, the difference is charged against the allowance for loan losses. At September 30, 2004 we had no REO.
The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated.
Non-Performing Assets. The table below sets forth the amounts and categories of our non-performing assets at the dates indicated. At each date presented, we had no troubled debt restructurings (loans for which a portion of interest or principal has been forgiven and loans modified at interest rates materially less than current market rates).
For the year ended September 30, 2004, gross interest income that would have been recorded had the non-accrual loans at the end of the year remained on accrual status throughout the year amounted to $163,000. Interest income actually recognized on such loans totaled $119,000.
Classification of Assets. Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as substandard, doubtful, or loss assets. An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that the savings institution will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all of the
weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets is not warranted. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are required to be designated as special mention. As of September 30, 2004, we had $4.7 million of assets designated as special mention.
When we classify assets as either substandard or doubtful, we allocate a portion of the related general loss allowances to such assets as deemed prudent by management. The allowance for loan losses represents amounts that have been established to recognize losses inherent in the loan portfolio that are both probable and reasonably estimable at the date of the financial statements. When we classify problem assets as loss, we charge-off such amount. Our determination as to the classification of our assets and the amount of our loss allowances are subject to review by our regulatory agencies, which can order the establishment of additional loss allowances. Management regularly reviews our asset portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management's review of our assets at September 30, 2004, classified assets consisted of substandard assets of $3.7 million and $260,000 doubtful assets (loans).
Allowance for Loan Losses. We provide for loan losses based on the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to it. Additions to the allowance for loan losses are provided by charges to income based on various factors which, in management's judgment, deserve current recognition in estimating probable losses. Management regularly reviews the loan portfolio and makes provisions for loan losses in order to maintain the allowance for loan losses in accordance with accounting principles generally accepted in the United States of America. The allowance for loan losses consists of amounts specifically allocated to non-performing loans and other criticized or classified loans (if any) as well as allowances determined for each major loan category. After we establish a provision for loans that are known to be non-performing, criticized or classified, we calculate a percentage to apply to the remaining loan portfolio to estimate the probable losses inherent in that portion of the portfolio. When the loan portfolio increases, therefore, the percentage calculation results in a higher dollar amount of estimated probable losses than would be the case without the increase, and when the loan portfolio decreases, the percentage calculation results in a lower dollar amount of estimated probable losses than would be the case without the decrease. These percentages are determined by management based on historical loss experience for the applicable loan category, which are adjusted to reflect our evaluation of:
o levels of, and trends in, delinquencies and non-accruals;
o trends in volume and terms of loans;
o effects of any changes in lending policies and procedures;
o experience, ability, and depth of lending management and staff;
o national and local economic trends and conditions;
o concentrations of credit by such factors as location, industry, inter-relationships, and borrower; and
o for commercial loans, trends in risk ratings.
We consider commercial real estate loans, commercial business loans, and land acquisition, development and construction loans to be riskier than one-to four-family residential mortgage loans. Commercial real estate loans entail significant additional credit risks compared to one- to four-family residential mortgage loans, as they involve large loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related real estate project (business operation of the borrower who is also the primary occupant), and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. Commercial business loans involve a
higher risk of default than residential loans of like duration since their repayment is generally dependent on the successful operation of the borrower's business and the sufficiency of collateral, if any. Land acquisition, development and construction lending exposes us to greater credit risk than permanent mortgage financing. The repayment of land acquisition, development and construction loans depends upon the sale of the property to third parties or the availability of permanent financing upon completion of all improvements. In the event we make an acquisition loan on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. These events may adversely affect the borrower and the collateral value of the property. Development and construction loans also expose us to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the property may not occur as anticipated.
The carrying value of loans is periodically evaluated and the allowance is adjusted accordingly. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, our regulatory agencies periodically review the allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
The following table sets forth activity in our allowance for loan losses for the years indicated.
Allocation of Allowance for Loan Losses. The following tables set forth the allowance for loan losses allocated by loan category, the total loan balances by category (excluding loans held for sale), and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
Securities Activities
Our securities investment policy is established by our Board of Directors. This policy dictates that investment decisions be made based on the safety of the investment, liquidity requirements, potential returns, cash flow targets, and consistency with our interest rate risk management strategy. The Board's asset/liability committee oversees our investment program and evaluates on an ongoing basis our investment policy and objectives. Our chief financial officer, or our chief financial officer acting with our chief executive officer, is responsible for making securities portfolio decisions in accordance with established policies. Our chief financial officer, chief executive officer and certain other executive officers have the authority to purchase and sell securities within specific guidelines established by the investment policy. In addition, all transactions are reviewed by the Board's asset/liability committee at least quarterly.
Our current investment policy generally permits securities investments in debt securities issued by the U.S. Government and U.S. Agencies, municipal bonds, and corporate debt obligations, as well as investments in preferred and common stock of government agencies and government sponsored enterprises such as Fannie Mae, Freddie Mac and the Federal Home Loan Bank of New York (federal agency securities) and, to a lesser extent, other equity securities. Securities in these categories are classified as "investment securities" for financial reporting purposes. The policy also permits investments in mortgage-backed securities, including pass-through securities issued and guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae as well as collateralized mortgage obligations ("CMOs") issued or backed by securities issued by these government agencies. Also permitted are investments in securities issued or backed by the Small Business Administration, privately issued mortgage-backed securities and asset-backed securities collateralized by auto loans, credit card receivables, and home equity and home improvement loans. Our current investment strategy uses a risk management approach of diversified investing in fixed-rate securities with short- to intermediate-term maturities, as well as adjustable-rate securities, which may have a longer term to maturity. The emphasis of this approach is to increase overall investment securities yields while managing interest rate risk.
SFAS No. 115 requires that, at the time of purchase, we designate a security as held to maturity, available for sale, or trading, depending on our ability and intent. Securities available for sale are reported at fair value, while securities held to maturity are reported at amortized cost. We do not have a trading portfolio.
Government Securities. At September 30, 2004, we held government securities available for sale with a fair value of $192.3 million, consisting primarily of U.S. Treasury and Agency obligations with short- to medium-term maturities (one to five years). While these securities generally provide lower yields than other investments such as mortgage-backed securities, our current investment strategy is to maintain investments in such instruments to the extent appropriate for liquidity purposes, as collateral for borrowings, and for prepayment protection.
Corporate and Municipal Bonds. At September 30, 2004, we held no corporate debt securities. Although corporate bonds may offer a higher yield than that of a U.S. Treasury or Agency security of comparable duration, corporate bonds also have a higher risk of default due to adverse changes in the creditworthiness of the issuer. In recognition of this potential risk, our policy limits investments in corporate bonds to securities with maturities of ten years or less and rated "A" or better by at least one nationally recognized rating agency, and to a total investment of no more than $5.0 million per issuer and a total corporate bond portfolio limit of $40.0 million. The policy also limits investments in municipal bonds to securities with maturities of 20 years or less and rated AA or better by at least one nationally recognized rating agency, and favors issues that are insured unless the issuer is a local government entity within our service area. Such local entity obligations generally are not rated, and are subject to internal credit reviews. In addition, the policy imposes an investment limitation of $5.0 million per municipal issuer and a total municipal bond portfolio limit of 5% of assets. At September 30, 2004, we held $50.5 million in bonds issued by states and political subdivisions, $29.9 million of which were classified as held to maturity at amortized cost and $20.6 million of which were classified as available for sale at fair value.
Equity Securities. At September 30, 2004, our equity securities available for sale had a fair value of $1.2 million and consisted of stock issued by Freddie Mac and Fannie Mae, and certain other equity investments. We also held $10.2 million (at cost) of Federal Home Loan Bank of New York ("FHLBNY") common stock, a portion of which must be held as a condition of membership in the Federal Home Loan Bank System, with the remainder held as a condition to our borrowing under the Federal Home Loan Bank advance program. Dividends recorded in the year ended September 30, 2004 amounted to $141,000.
Mortgage-Backed Securities. We purchase mortgage-backed securities in order to: (i) generate positive interest rate spreads with minimal administrative expense; (ii) lower credit risk as a result of the guarantees provided by Freddie Mac, Fannie Mae and Ginnie Mae; and (iii) increase liquidity. We invest primarily in mortgage-backed securities issued or sponsored by Fannie Mae, Freddie Mac, and Ginnie Mae. To a lesser extent, we also invest in securities backed by agencies of the U.S. Government. At September 30, 2004, our mortgage-backed securities portfolio totaled $359.1 million, consisting of $320.2 million available for sale at fair value and $38.9 million held to maturity at amortized cost. The total mortgage-backed securities portfolio includes CMOs of $12.4 million, consisting of $9.6 million available for sale at fair value and $2.8 million held to maturity at amortized cost. The remaining mortgage-backed securities of $346.7 million were pass-through securities, consisting of $310.6 million available for sale at fair value and $36.1 million held to maturity at amortized cost.
Mortgage-backed securities are created by pooling mortgages and issuing a security collateralized by the pool of mortgages with an interest rate that is less than the interest rate on the underlying mortgages. Mortgage-backed securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although most of our mortgage-backed securities are collateralized by single-family mortgages. The issuers of such securities (generally U.S. Government agencies and government sponsored enterprises, including Fannie Mae, Freddie Mac and Ginnie Mae) pool and resell the participation interests in the form of securities to investors, such as us, and guarantee the payment of principal and interest to these investors. Investments in mortgage-backed securities involve a risk that actual prepayments will be greater or less than the prepayment rate estimated at the time of purchase, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby affecting the net yield on such securities. We review prepayment estimates for our mortgage-backed securities at purchase to ensure that prepayment assumptions are reasonable considering the underlying collateral for the securities at issue and current interest rates, and to determine the yield and estimated maturity of the mortgage-backed securities portfolio. Periodic reviews of current prepayment speeds are performed in order to ascertain whether prepayment estimates require modification that would cause amortization or accretion adjustments.
A portion of our mortgage-backed securities portfolio is invested in CMOs or collateralized mortgage obligations, including Real Estate Mortgage Investment Conduits ("REMICs"), backed by Fannie Mae and Freddie Mac. CMOs and REMICs are types of debt securities issued by a special-purpose entity that aggregates pools of mortgages and mortgage-backed securities and creates different classes of securities with varying maturities and amortization schedules, as well as a residual interest, with each class possessing different risk characteristics. The cash flows from the underlying collateral are generally divided into "tranches" or classes that have descending priorities with respect to the distribution of principal and interest cash flows, while cash flows on pass-through mortgage-backed securities are distributed pro rata to all security holders. Our practice is to limit fixed-rate CMO investments primarily to the early-to-intermediate tranches, which have the greatest cash flow stability. Floating rate CMOs are purchased with emphasis on the relative trade-offs between lifetime rate caps, prepayment risk, and interest rates.
Available for Sale Portfolio. The following table sets forth the composition of our available for sale portfolio at the dates indicated.
At September 30, 2004, our available for sale U. S. Treasury securities portfolio, at fair value, totaled $5.0 million, or 0.3% of total assets, and the federal agency securities portfolio, at fair value, totaled $187.3 million, or 10.3% of total assets. Of the combined U.S. Government and agency portfolio, based on amortized cost, $10.2 million had maturities of one year or less and a weighted average yield of 2.63%, and $182.6 million had maturities of between one and five years and a weighted average yield of 2.95%. The agency securities portfolio includes both non-callable and callable debentures. The agency debentures may be callable on a quarterly or one time basis depending on the security's individual terms following an initial holding period of from twelve to twenty-four months.
Equity securities available for sale at September 30, 2004 had a fair value of $1.2 million.
At September 30, 2004, $310.6 million of our available for sale mortgage-backed securities, at fair value, consisted of pass-through securities, which totaled 17.0% of total assets. At the same date, the fair value of our available for sale CMO portfolio totaled $9.6 million, or 0.5% of total assets, and consisted of CMOs issued by government sponsored agencies such as Fannie Mae and Freddie Mac with a weighted average yield of 3.7%. We own both fixed-rate and floating-rate CMOs. The underlying mortgage collateral for our portfolio of CMOs available for sale at September 30, 2004 had contractual maturities of over ten years. However, as with mortgage-backed pass-through securities, the actual maturity of a CMO may be less than its stated contractual maturity due to prepayments of the underlying mortgages and the terms of the CMO tranche owned.
Held to Maturity Portfolio. The following table sets forth the composition of our held to maturity portfolio at the dates indicated.
At September 30, 2004, our held to maturity mortgage-backed securities portfolio totaled $38.9 million at amortized cost, consisting of: $16.8 million with a weighted average yield of 5.01% and contractual maturities of one year or less and $22.1 million with a weighted average yield of 4.96% and contractual maturities within five years; CMOs of $2.8 million are included in this portfolio. While the contractual maturity of the CMOs underlying collateral is greater than ten years, the actual period to maturity of the CMOs may be shorter due to prepayments on the underlying mortgages and the terms of the CMO tranche owned.
Portfolio Maturities and Yields. The composition and maturities of the investment debt securities portfolio and the mortgage-backed securities portfolio at September 30, 2004 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. State and municipal securities yields have not been adjusted to a tax-equivalent basis.
Sources of Funds
General. Deposits, borrowings, repayments and prepayments of loans and securities, proceeds from sales of loans and securities, proceeds from maturing securities and cash flows from operations are the primary sources of our funds for use in lending, investing and for other general purposes.
Deposits. We offer a variety of deposit accounts with a range of interest rates and terms. Our deposit accounts consist of savings accounts, NOW accounts, checking accounts, money market accounts, club accounts, certificates of deposit and IRAs and other qualified plan accounts. We provide commercial checking accounts for businesses. In addition, we provide low-cost checking account services for low-income customers.
At September 30, 2004, our deposits totaled $1.2 billion. Interest-bearing deposits totaled $950.2 million, and non-interest-bearing demand deposits totaled $289.4 million. NOW, savings and money market deposits totaled $616.8 million at September 30, 2004. Also at that date, we had a total of $333.3 million in certificates of deposit, of which $277.8 million had maturities of one year or less. Although we have a significant portion of our deposits in shorter-term certificates of deposit, management monitors activity on these accounts and, based on historical experience and our current pricing strategy we believe we will retain a large portion of such accounts upon maturity.
Our deposits are obtained predominantly from the areas in which our branch offices are located. We rely on our favorable locations, customer service and competitive pricing to attract and retain these deposits. While we accept certificates of deposit in excess of $100,000 for which we may provide preferential rates, we do not actively solicit such deposits as they are more difficult to retain than core deposits. With the commencement of operations of our limited purpose commercial bank subsidiary, Provident Municipal Bank, in April 2002, we began accepting municipal deposits. Municipal time accounts (certificates of deposit) are generally obtained through a bidding process, and tend to carry higher average interest rates than retail certificates of deposit of similar term.
The following tables set forth the distribution of total deposit accounts, by account type, at the dates indicated.
The following table sets forth, by interest rate ranges, information concerning certificates of deposit at the dates indicated.
The following table sets forth certificates of deposit by time remaining until maturity as of September 30, 2004.
- ---------- (1) The weighted average interest rates for these accounts, by maturity period, are 1.76% for 3 months or less; 1.77% for 3 to 6 months; 1.94% for 6 to 12 months; and 2.15% for over 12 months. The overall weighted average interest rate for accounts of $100,000 or more was 1.84%.
Borrowings. Our borrowings consist of advances and repurchase agreements. At September 30, 2004, we had access to additional Federal Home Loan Bank advances of up to $228 million. The following table sets forth information concerning balances and interest rates on our Federal Home Loan Bank and other advances and repurchase agreements at the dates and for the years indicated.
Activities of Subsidiaries and Affiliated Entities
Provident Municipal Bank is a wholly-owned subsidiary of Provident Bank. Provident Municipal Bank is a New York State-chartered commercial bank whose purpose is limited to accepting municipal deposits and investing funds obtained into investment securities. New York State law requires municipalities located in the State of New York to deposit funds with commercial banks, effectively forbidding these municipalities from depositing funds with savings institutions, including federally chartered savings associations, such as Provident Bank. Provident Municipal Bank began operations on April 19, 2002, and at September 30, 2004 had $106.7 million in deposits from municipal entities in the communities served by Provident Bank.
Provest Services Corp. is a wholly-owned subsidiary of Provident Bank, holding an investment in a limited partnership that operates an assisted-living facility. A percentage of the units in the facility are for low-income individuals. Provest Services Corp. II is a wholly-owned subsidiary of Provident Bank that has engaged a third-party provider to sell annuities, mutual funds, life and health insurance products to Provident Bank's customers. Through September 30, 2004, the activities of these subsidiaries have had an insignificant effect on our consolidated financial condition and results of operations. During fiscal 1999, Provident Bank established Provident REIT, Inc., a wholly-owned subsidiary in the form of a real estate investment trust. Provident REIT, Inc. holds both residential and commercial real estate loans.
At the time of our initial public offering, 46.7% of our common stock was sold to the public, and the remaining 53.3% was retained by Provident Bancorp, MHC, the successor to our original mutual savings association. The accounts of Provident Bancorp, MHC are not included in our consolidated financial statements for the years ending September 30, 2003 and 2002.
Competition
We face significant competition in both originating loans and attracting deposits. The New York metropolitan area has a high concentration of financial institutions, many of which are significantly larger institutions with greater financial resources than us, and many of which are our competitors to varying degrees. Our competition for loans comes principally from commercial banks, savings banks, mortgage banking companies, credit unions, insurance companies and other financial service companies. Our most direct competition for deposits has historically come from commercial banks, savings banks and credit unions. We face additional competition for deposits from non-depository competitors such as the mutual fund industry, securities and brokerage firms and insurance companies. We have emphasized personalized banking and the advantage of local decision making in our banking business and this strategy appears to have been well received in our market area. We do not rely on any individual, group, or entity for a material portion of our deposits.
Employees
As of September 30, 2004, we had 396 full-time employees and 56 part-time employees. The employees are not represented by a collective bargaining unit and we consider our relationship with our employees to be good.
Regulation
General
As a federally chartered savings association, Provident Bank is regulated and supervised by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation. Provident Municipal Bank is regulated by the New York State Department of Banking and the Federal Deposit Insurance Corporation. This regulation and supervision establishes a comprehensive framework of activities in which a financial institution may engage and is intended primarily for the protection of the Federal Deposit Insurance Corporation's deposit insurance funds and depositors. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. After completing an examination, the federal agency critiques the financial institution's operations and assigns its rating (known as an institution's CAMELS). Under federal law, an institution may not disclose its CAMELS rating to the public. Provident Bank also is a member of, and owns stock in, the Federal Home Loan Bank of New York, which is one of the twelve regional banks in the Federal Home Loan Bank System. Provident Bank also is regulated to a lesser extent by the Board of Governors of the Federal Reserve System, governing reserves to be maintained against deposits and other matters. The Office of Thrift Supervision examines Provident Bank and prepares reports for the consideration of its board of directors on any operating deficiencies. Provident Bank's relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters concerning the ownership of deposit accounts and the form and content of Provident Bank's loan documents.
Any change in these laws or regulations, whether by the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the New York State Department of Banking or Congress, could have a material adverse impact on Provident Bancorp, Inc., Provident Bank, Provident Municipal Bank and their respective operations.
Federal Banking Regulation
Business Activities. A federal savings association derives its lending and investment powers from the Home Owners' Loan Act, as amended, and the regulations of the Office of Thrift Supervision. Under these laws and regulations, Provident Bank may invest in mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, certain types of debt securities and certain other loans and assets. Provident Bank also may establish subsidiaries that may engage in activities not otherwise permissible for Provident Bank directly, including real estate investment, securities brokerage and insurance agency.
Capital Requirements. Office of Thrift Supervision regulations require savings associations to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS rating system) and an 8% risk-based capital ratio. The prompt corrective action standards discussed below, in effect, establish a minimum 2% tangible capital standard.
The risk-based capital standard for savings associations requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks inherent in the type of asset. Core capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, allowance for loan and lease losses up to a maximum of 1.25% of risk-weighted assets, and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
At September 30, 2004, Provident Bank's capital exceeded all applicable requirements.
Loans to One Borrower. A federal savings association generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus on an unsecured basis. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of September 30, 2004, Provident Bank was in compliance with the loans-to-one-borrower limitations.
Qualified Thrift Lender Test. As a federal savings association, Provident Bank is subject to a qualified thrift lender, or "QTL," test. Under the QTL test, Provident Bank must maintain at least 65% of its "portfolio assets" in "qualified thrift investments" in at least nine months of the most recent 12-month period. "Portfolio assets" generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings association's business.
"Qualified thrift investments" include various types of loans made for residential and housing purposes, investments related to such purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of portfolio assets. "Qualified thrift investments" also include 100% of an institution's credit card loans, education loans and small business loans. Provident Bank also may satisfy the QTL test by qualifying as a "domestic building and loan association" as defined in the Internal Revenue Code of 1986.
A savings association that fails the QTL test must either convert to a bank charter or operate under specified restrictions. At September 30, 2004, Provident Bank maintained approximately 85% of its portfolio assets in qualified thrift investments, and therefore satisfied the QTL test.
Capital Distributions. Office of Thrift Supervision regulations govern capital distributions by a federal savings association, which include cash dividends, stock repurchases and other transactions charged to the institution's capital account. A savings association must file an application for approval of a capital distribution if:
o the total capital distributions for the applicable calendar year exceed the sum of the savings association's net income for that year to date plus the savings association's retained net income for the preceding two years;
o the savings association would not be at least adequately capitalized following the distribution;
o the distribution would violate any applicable statute, regulation, agreement or Office of Thrift Supervision-imposed condition; or
o the savings association is not eligible for expedited treatment of its filings.
Even if an application is not otherwise required, every savings association that is a subsidiary of a holding company must still file a notice with the Office of Thrift Supervision at least 30 days before the board of directors declares a dividend or approves a capital distribution.
The Office of Thrift Supervision may disapprove a notice or application if:
o the savings association would be undercapitalized following the distribution;
o the proposed capital distribution raises safety and soundness concerns; or
o the capital distribution would violate a prohibition contained in any statute, regulation or agreement.
Liquidity. A federal savings association is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.
Community Reinvestment Act and Fair Lending Laws. All savings associations have a responsibility under the Community Reinvestment Act and related regulations of the Office of Thrift Supervision to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In connection with its examination of a federal savings association, the Office of Thrift Supervision is required to assess the savings association's record of compliance with the Community Reinvestment Act. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. A savings association's failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the Office of Thrift Supervision, as well as other federal regulatory agencies and the Department of Justice. Provident Bank received an "outstanding" Community Reinvestment Act rating in its most recent federal examination.
Privacy Standards. Effective July 2001, financial institutions, including Provident Bank, became subject to regulations implementing the privacy protection provisions of the Gramm-Leach-Bliley Act. These regulations require Provident Bank to disclose its privacy policy, including identifying with whom it shares "nonpublic personnel information," to customers at the time of establishing the customer relationship and annually thereafter. In addition, Provident Bank is required to provide its customers with the ability to "opt-out" of having Provident Bank share their nonpublic personal information with unaffiliated third parties before it can disclose such information, subject to certain exceptions. The implementation of these regulations did not have a material adverse effect on Provident Bank. The Gramm-Leach-Bliley Act also allows each state to enact legislation that is more protective of consumers' personal information.
Also effective July 1, 2001, the Office of Thrift Supervision and other federal banking agencies adopted guidelines establishing standards for safeguarding customer information to implement certain provisions of the Gramm-Leach-Bliley Act. The guidelines describe the agencies' expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of a financial institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to insure the security and confidentiality of customer records and information, to protect against any anticipated threats or hazards to the security or integrity of such records and to protect against unauthorized access to or use of such records, or information that could result in substantial harm or inconvenience to any customer. Provident Bank has implemented these guidelines, and such implementation did not have a material adverse effect on our operations.
Transactions with Related Parties. A federal savings association's authority to engage in transactions with its "affiliates" is limited by Office of Thrift Supervision regulations and by Sections 23A and 23B of the Federal Reserve Act. The term "affiliates" for these purposes generally means any company that controls or is under common control with an institution. Provident Bancorp, Inc. and its non-savings institution subsidiaries will be affiliates of Provident Bank. In general, transactions with affiliates must be on terms that are as favorable to the savings association as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the savings association's capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the savings association. In addition, Office of Thrift Supervision regulations prohibit a savings association from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.
Provident Bank's authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Provident Bank's capital. In addition, extensions of credit in excess of certain limits must be approved by Provident Bank's board of directors.
Enforcement. The Office of Thrift Supervision has primary enforcement responsibility over federal savings institutions and has the authority to bring enforcement action against all "institution-affiliated parties," including stockholders, and attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution, receivership, conservatorship or the termination of deposit insurance. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The Federal Deposit Insurance Corporation also has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take action under specified circumstances.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan.
Prompt Corrective Action Regulations. Under the prompt corrective action regulations, the Office of Thrift Supervision is required and authorized to take supervisory actions against undercapitalized savings associations. For this purpose, a savings association is placed in one of the following five categories based on the savings association's capital:
o well-capitalized (at least 5% leverage capital, 6% tier 1 risk-based capital and 10% total risk-based capital);
o adequately capitalized (at least 4% leverage capital, 4% tier 1 risk-based capital and 8% total risk-based capital);
o undercapitalized (less than 3% leverage capital, 4% tier 1 risk-based capital or 8% total risk-based capital);
o significantly undercapitalized (less than 3% leverage capital, 3% tier 1 risk-based capital or 6% total risk-based capital); and
o critically undercapitalized (less than 2% tangible capital).
Generally, the banking regulator is required to appoint a receiver or conservator for a savings association that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date a bank receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to the savings association, including, but not limited to, restrictions on growth, investment activities, capital distributions and affiliate transactions. The Office of Thrift Supervision may also take any one of a number of discretionary supervisory actions against undercapitalized savings associations, including the issuance of a capital directive and the replacement of senior executive officers and directors.
At September 30, 2004, Provident Bank met the criteria for being considered "well-capitalized."
Insurance of Deposit Accounts. Deposit accounts in Provident Bank are insured by the Savings Association Insurance Fund and, to a limited extent, the Bank Insurance Fund of the Federal Deposit Insurance Corporation, generally up to a maximum of $100,000 per separately insured depositor. Provident Bank's deposits, therefore, are subject to Federal Deposit Insurance Corporation deposit insurance assessments. The Federal Deposit Insurance Corporation has adopted a risk-based system for determining deposit insurance assessments. The Federal Deposit Insurance Corporation is authorized to raise the assessment rates as necessary to maintain the required ratio of reserves to insured deposits of 1.25%. In addition, all Federal Deposit Insurance Corporation-insured institutions must pay assessments to the Federal Deposit Insurance Corporation at an annual rate of .0212% of insured deposits to fund interest payments on bonds maturing in 2017 that were issued by a federal agency to recapitalize the predecessor to the Savings Association Insurance Fund.
Prohibitions Against Tying Arrangements. Federal savings associations are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
Federal Home Loan Bank System. Provident Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of The Federal Home Loan Bank of New York, Provident Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its borrowings from the Federal Home Loan Bank, whichever is greater. As of September 30, 2004, Provident Bank was in compliance with this requirement.
Federal Reserve System
Federal Reserve Board regulations require savings associations to maintain non-interest-earning reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts. At September 30, 2004, Provident Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the Office of Thrift Supervision.
The USA PATRIOT Act
The USA PATRIOT Act gives the federal government powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. Certain provisions of the act impose affirmative obligations on a broad range of financial institutions, such as Provident Bank. These obligations include enhanced anti-money laundering programs, customer identification programs and regulations relating to private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States).
The federal banking agencies have begun to propose and implement regulations pursuant to the USA PATRIOT Act. These regulations would require financial institutions to adopt the policies and procedures contemplated by the USA PATRIOT Act. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control Regulations.
Holding Company Regulation
Provident Bancorp is a unitary savings and loan holding company, subject to regulation and supervision by the Office of Thrift Supervision. The Office of Thrift Supervision has enforcement authority over Provident Bancorp and its non-savings institution subsidiaries. Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a risk to Provident Bank.
Under prior law, a unitary savings and loan holding company generally had no regulatory restrictions on the types of business activities in which it could engage, provided that its subsidiary savings bank was a qualified thrift lender. The Gramm-Leach-Bliley Act of 1999, however, restricts unitary savings and loan holding companies not existing on, or applied for before, May 4, 1999 to those activities permissible for financial holding companies or for multiple savings and loan holding companies. Provident Bancorp is not a grandfathered unitary savings and loan holding company and, therefore, is limited to the activities permissible for financial holding companies or for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance, incidental to financial activities or complementary to a financial activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain additional activities authorized by Office of Thrift Supervision regulations.
Federal law prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring control of another savings institution or holding company thereof, without prior written approval of the Office of Thrift Supervision. It also prohibits the acquisition or retention of, with specified exceptions, more than 5% of the equity securities of a company engaged in activities that are not closely related to banking or financial in nature or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision must consider the financial and managerial resources and future prospects of the savings institution involved the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.
Federal Securities Law
The common stock of Provident Bancorp is registered with the Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934 (the "Exchange Act"). Provident Bancorp is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act. Common stock of Provident Bancorp held by persons who are affiliates (generally officers, directors and principal stockholders) of Provident Bancorp may not be resold without registration or unless sold in accordance with certain resale restrictions. If Provident Bancorp meets specified current public information requirements, each affiliate of Provident Bancorp is able to sell in the public market, without registration, a limited number of shares in any three-month period.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (the "Act"), provides for corporate governance, disclosure and accounting reforms intended to address corporate and accounting fraud. The Act establishes a new accounting oversight board that enforces auditing, quality control and independence standards, and will be funded by fees from all publicly traded companies. The Act also places certain restrictions on the scope of services that may be provided by accounting firms to their public company audit clients. Any non-audit services being provided to a public company audit client will require preapproval by the company's audit committee. In addition, the Act makes certain changes to the requirements for audit partner rotation after a period of time. The Act also requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the Securities and Exchange Commission, subject to civil and criminal penalties if they knowingly or willingly violate this certification requirement. In addition, under the Act, counsel is required to report to the chief executive officer or chief legal officer of the company, evidence of a material violation of the securities laws or a breach of fiduciary duty by a company and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the board of directors or the board itself.
Under the Act, longer prison terms will apply to corporate executives who violate federal securities laws; the period during which certain types of suits can be brought against a company or its officers is extended; and bonuses issued to top executives prior to restating a company's financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan "blackout" periods, and loans to company executives (other than loans by financial institutions permitted by federal rules and regulations) are restricted. In addition, a provision directs that civil penalties levied by the Securities and Exchange Commission as a result of any judicial or administrative action under the Act be deposited to a fund for the benefit of harmed investors. The Federal Accounts for Investor Restitution provision also requires the Securities and Exchange Commission to develop methods of improving collection rates. The legislation accelerates the time frame for disclosures
by public companies, as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in beneficial ownership in a company's securities within two business days of the change.
The Act also increases the oversight of, and codifies certain requirements relating to, audit committees of public companies and how they interact with the company's "registered public accounting firm." Audit Committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the public company. In addition, companies must disclose whether at least one member of the committee is an "audit committee financial expert" (as defined by Securities and Exchange Commission regulations) and if not, why not. Under the Act, a company's registered public accounting firm will be prohibited from performing statutorily mandated audit services for a company if such company's chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions had been employed by such firm and participated in the audit of such company during the one-year period preceding the audit initiation date. The Act prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent accountant engaged in the audit of the company's financial statements for the purpose of rendering the financial statements materially misleading. The Act also requires the Securities and Exchange Commission to prescribe rules requiring inclusion of any internal control report and assessment by management in the annual report to shareholders. The Act requires the company's registered public accounting firm that issues the audit report to attest to and report on management's assessment of the company's internal controls.
Although we will incur additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, management does not expect that such compliance will have a material impact on our results of operations or financial condition.
ITEM 2.
ITEM 2. Properties - ------------------
As of September 30, 2004, Provident Bank leased 14 properties, including its headquarters location, from third parties. In addition, Provident Bank owns fourteen properties. At September 30, 2004, the net book value of our properties was $11.6 million. The following is a list of our locations:
Corporate Office, Commercial Lending Division, and Investment Management and Trust Department:
# 400 Rella Boulevard Montebello, NY 10901 (845) 369-8040
* owned # leased - ----------------------
ITEM 3.
ITEM 3. Legal Proceedings - -------------------------
Provident Bancorp is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business which, in the aggregate, involve amounts which are believed by management to be immaterial to Provident Bancorp's financial condition and results of operations.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders - -----------------------------------------------------------
No matters were submitted to a vote of stockholders during the quarter ended September 30, 2004.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and - ------------------------------------------------------------------------------ Issuer Purchases of Equity Securities - -------------------------------------
The common stock of Provident Bancorp is quoted on the Nasdaq National Market under the symbol "PBCP." As of September 30, 2004, Provident Bancorp had 11 registered market makers, 6,243 stockholders of record (excluding the number of persons or entities holding stock in street name through various brokerage firms), and 39,618,373 shares outstanding.
The following table sets forth market price and dividend information for the common stock for the past two fiscal years.
Cash Dividends Quarter Ended High Low Declared ------------------ ------ ------ --------------
September 30, 2004 $11.75 $10.58 $0.04 June 30, 2004 11.90 10.25 0.04 March 31, 2004 12.15 10.64 0.035 December 31, 2003 10.87 9.33 0.035
September 30, 2003 9.70 7.47 0.034 June 30, 2003 7.46 7.04 0.034 March 31, 2003 7.11 6.77 0.032 December 31, 2002 7.11 6.26 0.029
Information prior to January 14, 2004 has been restated to reflect the 4.4323-to-1 stock split in conjunction with the Company's second-step stock offering.
Payment of dividends on Provident Bancorp's common stock is subject to determination and declaration by the Board of Directors and depends on a number of factors, including capital requirements, regulatory limitations on the payment of dividends, the results of operations and financial condition, tax considerations and general economic conditions. No assurance can be given that dividends will be declared or, if declared, what the amount of dividends will be, or whether such dividends will continue. There were no repurchases of the Company's shares of common stock during the fourth quarter of the fiscal year ended September 30, 2004.
ITEM 6.
ITEM 6. Selected Financial Data - -------------------------------
The following financial condition data and operating data are derived from the audited consolidated financial statements of Provident Bancorp. Additional information is provided in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and related notes included as Item 7
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results - ------------------------------------------------------------------------------- of Operations - -------------
General
Our results of operations depend primarily on our net interest income, which is the difference between the interest income on our earning assets, such as loans and securities, and the interest expense paid on our deposits and borrowings. Results of operations are also affected by non-interest income and expense, the provision for loan losses and income tax expense. Non-interest income consists primarily of banking fees and service charges, gains (losses) on sales of loans and securities available for sale and net increases in the cash surrender value of bank-owned life insurance ("BOLI") contracts. Our non-interest expense consists primarily of salaries and employee benefits, occupancy and office expenses, advertising and promotion expense and data processing expenses. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities. The financial condition and results of operations of Provident Bancorp are discussed herein on a consolidated basis with the Bank. Reference to Provident Bancorp may signify the Bank, depending on the context and time period.
The following is an analysis of the financial condition and results of operations of the Company. This item should be read in conjunction with the consolidated financial statements and related notes filed herewith in Part II, Item 8, "Financial Statements and Supplementary Data" and the description of the Company's business filed here with in Part I, Item I, "Business."
Overview
The Company provides financial services to individuals and businesses in Upstate New York. The Company's business is primarily accepting deposits from customers through its banking centers and investing those deposits, together with funds generated from operations and borrowings, in residential mortgages, commercial real estate loans, commercial business loans and leases, consumer loans, and investment securities. Additionally, the Company offers wealth management services.
Total assets increased to $1.8 billion at September 30, 2004 from $1.2 billion at September 30, 2003. This 56% increase resulted principally from the investment of the $192.5 million of capital raised from the Offering and the concurrent $349.7 million of assets acquired from ENB in January 2004. Given the historically low interest rate environment, the Company invested a portion of the proceeds from the Offering in short-term investments. Although this strategy forgoes some short-term profits, management believes this initiative will better position the Company for long-term growth and profitability when interest rates begin to rise. During 2004, the Company furthered its commercial lending and banking initiatives. Excluding the loans acquired with ENB, commercial loans increased 78%.
Net income for the year ended September 30, 2004 decreased 2% to $11.0 million, or $0.29 per diluted share from $11.3 million, or $0.32 per diluted share for the year September 30, 2003. The decline is primarily due to an after-tax charge of $3.0 million due to the establishment of the charitable foundation in connection with the Offering. During 2004, the Company benefited from the investment of funds raised in the Offering, the acquisition of ENB in January and increased commercial real estate and business lending activity. These benefits were partially offset by the impact of the low interest rate environment on its investment and loan portfolio yields, which reduced the Company's net interest rate spread.
Critical Accounting Policies
Our accounting and reporting policies are prepared in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Accounting policies considered critical to our financial results include the allowance for loan losses, accounting for goodwill and other intangible assets, accounting for deferred income taxes and the recognition of interest income.
The methodology for determining the allowance for loan losses is considered by management to be a critical accounting policy due to the high degree of judgment involved, the subjectivity of the assumptions utilized and the potential for changes in the economic environment that could result in changes to the amount of the allowance for loan losses considered necessary. We evaluate our assets at least quarterly, and review their risk components as a part of that evaluation. See Note 3, Summary of Significant Accounting Policies--Allowance for Loan Losses in our Notes to Consolidated Financial Statements for a discussion of the risk components. We consistently review the risk components to identify any changes in trends. Accounting for goodwill is considered to be a critical policy because goodwill must be tested for impairment at least annually using a "two-step" approach that involves the identification of reporting units and the estimation of fair values. The estimation of fair values involves a high degree of judgment and subjectivity in the assumptions utilized. If goodwill is determined to be impaired, it would be expensed in the period in which it became impaired.
We also use judgment in the valuation of other intangible assets (core deposit base intangibles). A core deposit base intangible asset has been recorded for core deposits (defined as checking, money market and savings deposits) that were acquired in an acquisition that was accounted as a purchase business combination. The core deposit base intangible asset has been recorded using the assumption that the acquired deposits provide a more favorable source of funding than more expensive wholesale borrowings. An intangible asset has been recorded for the present value of the difference between the expected interest to be incurred on these deposits and interest expense that would be expected if these deposits were replaced by wholesale borrowings, over the expected lives of the core deposits. If we find these deposits have a shorter life than was estimated, we will write down the asset by expensing the amount that is impaired.
We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.
Interest income on loans, securities and other interest-earning assets is accrued monthly unless management considers the collection of interest to be doubtful. Loans are placed on nonaccrual status when payments are contractually past due 90 days or more, or when management has determined that the borrower is unlikely to meet contractual principal or interest obligations. At such time, unpaid interest is reversed by charging interest income. Interest payments received on nonaccrual loans (including impaired loans) are recognized as income unless future collections are doubtful. Loans are returned to accrual status when collectibility is no longer considered doubtful.
Management Strategy
We operate as an independent community bank that offers a broad range of customer-focused financial services as an alternative to money center banks in our market area. Management has invested in the infrastructure and staffing to support our strategy of serving the financial needs of individuals, businesses and municipalities in our market area. This has resulted in a change in our business mix, providing a favorable platform for long-term sustainable growth. Highlights of management's business strategy are as follows:
Operating as a Community Bank. As an independent community bank, we emphasize the local nature of our decision-making to respond more effectively to the needs of our customers while providing a full range of financial services to the individuals, corporations and municipalities in our market area. We offer a broad range of financial products to meet the changing needs of the marketplace, including internet banking, cash management services and sweep accounts. In addition, we offer asset management and trust services to meet the investing needs of individuals, corporations and not-for-profit entities. As a result, we are able to provide locally the financial services required to meet the needs of the majority of existing and potential customers in our market.
Enhancing Customer Service. We are committed to providing superior customer service as a way to differentiate us from our competition. As part of our commitment to service, we have established Sunday banking and extended service hours. In addition, we offer multiple access channels to our customers, including our branch and ATM network, internet banking, our Customer Care Telephone Center and our Automated Voice Response system. We reinforce in our employees a commitment to customer service through extensive training, recognition programs and measurement of service standards.
Growing and Diversifying our Loan Portfolio. We offer a broad range of loan products to commercial businesses, real estate owners, developers and individuals. To support this activity, we have developed commercial, consumer and residential loan departments staffed with experienced professionals to promote the continued growth and prudent management of loan assets. We have experienced consistent and significant growth in our commercial loan portfolio over the years while continuing to grow our residential mortgage and consumer lending businesses. As a result, we believe that we have developed a diversified loan portfolio with a favorable mix of loan types, maturities and yields.
Expanding our Retail Banking Franchise. Management intends to continue expansion of its retail banking franchise and to increase the number of households and businesses served in our market area. Our strategy is to deliver exceptional customer service, which depends on up-to-date technology and convenient access, as well as courteous personal contact from a trained and motivated workforce. This approach has resulted in continued growth in core deposits, which has improved our overall cost of funds. Management intends to maintain this strategy, which will require ongoing investment in retail banking locations and technology to support exceptional service levels for Provident Bank's customers.
Analysis of Net Interest Income
Net interest income is the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. Net interest income depends on the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them, respectively.
The following table sets forth average balance sheets, average yields and costs, and certain other information for the years indicated. Tax-exempt securities are reported on a tax-equivalent basis, using a 35% federal tax rate. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
- --------------------------------------------------------------------------------
(1) Balances include the effect of net deferred loan origination fees and costs, and the allowance for loan losses.
(2) Includes club accounts and interest-bearing mortgage escrow balances.
(3) Net interest rate spread represents the difference between the tax equivalent yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(4) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(5) Net interest margin represents net interest income (tax equivalent) divided by average total interest-earning assets.
The following table presents the dollar amount of changes in interest income (on a fully tax-equivalent basis) and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
Comparison of Financial Condition at September 30, 2004 and September 30, 2003
Total assets. Total assets as of September 30, 2004 were $1.8 billion, an increase of $651.8 million, or 55.5%, over total assets of $1.2 billion at September 30, 2003. The increase is due primarily to: (i) the January acquisition of ENB, whose assets totaled $349.7 million on the merger date; (ii) proceeds from the offering in the second-step conversion of $192.5 million, net of related costs; and (iii) internal growth of the Company.
Total securities. Total securities increased by $229.1 million, or 61.2%, to $603.4 million at September 30, 2004 from $374.3 million at September 30, 2003 as the Company invested the majority of the stock offering in securities. We primarily invested in mortgage-backed securities, which increased by $147.3 million, or 69.5%, and in U.S. Government and Federal Agency Securities, which increased by $60.3 million or 45.2%.
Net loans. Net loans as of September 30, 2004 were $980.3 million, an increase of $277.1 million, or 39.4%, over net loan balances of $703.2 million at September 30, 2003. Loans acquired from ENB totaled $219.2 million, while the allowance for loan losses acquired in connection with ENB were $5.7 million, or 2.6% of ENB's outstanding loan balances. Inclusive of ENB loans acquired, (1) commercial loans increased by $234.0 million, or 92.6%, over balances at September 30, 2003; (2) consumer loans increased by $49.4 million, or 61.2%, during the twelve-month period; and (3) residential loans remained unchanged. Asset quality continues to be strong. At $2.7 million, or 0.15% of total assets, non-performing assets were down from $4.7 million at September 30, 2003 as two loans totaling $2.1 million were resolved in the fiscal fourth quarter of 2004. At September 30, 2004, non-performing loans totaled $2.7 million, or 0.27% of total loans, compared to $4.7 million, or 0.66% of total loans, at September 30, 2003.
Deposits. Deposits as of September 30, 2004 were $1.2 billion, up $370.0 million, or 42.6%, from $869.6 million at September 30, 2003. Deposits acquired from ENB totaled $326.8 million. Our deposit mix has continued to change along with our deposit growth. Transaction accounts (demand and NOW deposits) represented 30% of deposits at September 30, 2004, compared to 26% at September 30, 2003. Savings and money market account balances, which totaled $533.4 million at September 30, 2004, represented 43% of deposits at that date, compared to 47% at September 30, 2003. Certificates of deposit remained at 27% of deposits at September 30, 2004 the same as at September 30, 2003. This shift in mix to lower cost transaction accounts had a positive impact on earnings in fiscal 2004.
Stockholders' Equity. Stockholders' equity increased by $231.7 million to $349.5 million at September 30, 2004, compared to $117.9 million at September 30, 2003. The Company completed its second-step conversion in January 2004 raising $192.5 million in new capital, net of related costs from the issuance of 19,573,000 shares of its common stock. In addition, $39.7 million and $4.0 million, respectively, in new capital were issued for the purchase of ENB and for the formation of the charitable foundation. Net income of $11.0 million for the fiscal year also increased capital. Partially offsetting the increases were the payments of cash dividends totaling $5.0 million, the purchase of Employee Stock Option Plan ("ESOP") shares totaling $10.0 million and net declines in accumulated comprehensive income of $3.8 million.
During fiscal 2004, the Company did not repurchase shares of its common stock. The total shares (not adjusted to reflect the 4.4323-to-1 conversion ratio) repurchased under its previously announced repurchase programs, which authorized the repurchase of up to 553,990 shares, including the March 2003 authorization of 177,250 shares, was 399,555 shares through September 30, 2004. At September 30, 2004, there were no shares of common stock held by the Company in connection with a repurchase program as the treasury shares were cancelled in connection with the second step stock conversion. Pursuant to applicable Office of Thrift Supervision regulations that restrict stock repurchases for one year following the completion of a mutual stock conversion, the authorization to repurchase shares of the Company's common stock expired in connection with its second-step conversion on January 14, 2004. However, at September 30, 2004 the Company held 36,794 shares in treasury relating to the purchase of shares from participants in the Recognition and Retention Plan ("RRP"), at market value, to fund the individual participants' applicable tax liability on vested shares.
Comparison of Operating Results for the Years Ended September 30, 2004 and - -------------------------------------------------------------------------- September 30, 2003 - ------------------
Net income for the year ended September 30, 2004, was $11.0 million, including after-tax charges of: (i) $3.0 million due to the establishment of the charitable foundation in connection with the second-step conversion in January 2004, and (ii) $463,000 in merger integration costs for Ellenville National Bank ("ENB"). This compares to $11.3 million for the year ended September 30, 2003. Diluted earnings per share were $0.29 for the year ended September 30, 2004 compared to $0.32 for the prior fiscal year. Excluding the above items, adjusted diluted earnings per share would have been $0.39 for the fiscal year ended September 30, 2004 compared to $0.32 for fiscal 2003. Earnings per share results for the prior periods have been restated to reflect the 4.4323-to-one conversion ratio as a result of the Company's second-step conversion.
Supplemental Reporting of Non-GAAP Results of Operations. The Company is providing supplemental reporting of its results on a "net operating" basis, from which the Company excludes the after-tax charge for establishing the charitable foundation, and the after-tax effect of expenses associated with merging acquired operations into the Company. Although "net operating income" as defined by the Company is not a GAAP measure, management believes that this information helps investors understand the effect of acquisition activity and the establishment of the charitable foundation in reported results. The after-tax effect of the establishment of the charitable foundation was $3.0 million ($0.08 per share). Merger integration expenses were $464,000 ($0.01 per share) after tax for the year ended September 30, 2004. Net operating income for the year was $14.5 million, an increase of 28.7% from $11.3 million in the year-earlier. Expressed as an annualized rate of return on average assets and average stockholders' equity, net operating income was 0.90% and 5.17% respectively, in the year ended September 30, 2004, compared with 1.04% and 9.92% in the year ended September 30, 2003.
Reconciliation of GAAP and Non-GAAP results of operations: A reconciliation of diluted earnings per share and net income with diluted net operating earnings per share and net operating income follows (in thousands, except per share amounts):
(1) After related tax effect at 40% marginal rate.
Interest Income. Interest income on a tax-equivalent basis for the year ended September 30, 2004 increased to $75.2 million, an increase of $17.1 million, or 29.4%, compared to the prior year. The increase was primarily due to higher average balances of loans and securities, offset in large part by lower average yields in both asset classes. Average interest-earning assets for the year ended September 30, 2004 were $1.4 billion, an increase of $441.5 million, or 44.0%, over average interest-earning assets for the year ended September 30, 2003 of $1.0 billion. Average loan balances grew by $203.6 million and average balances of securities and other earning assets increased by $237.9 million. On a tax-equivalent basis, average yields on interest earning assets fell by 59 basis points to 5.20% for the year ended September 30, 2004, from 5.79% for the year ended September 30, 2003. Lower market interest rates were the primary reason for the decline in asset yields.
Interest income on loans for the year ended September 30, 2004 grew 23.5% to $54.1 million from $43.8 million for the prior fiscal year. Interest income on commercial loans for the year ended September 30, 2004 increased to $26.2 million, up 72.7% from commercial loan interest income of $15.2 million for the prior fiscal year. Average balances of commercial loans grew $165.4 million to $385.7 million, and the impact of that increase offset a nine basis point decline in average yield. The lower average yield was due, in part, to the effect on commercial business loans of the lower average prime rate of 4.11% in fiscal 2004 compared to 4.24% in fiscal 2003. Interest income on consumer loans increased by $1.0 million, or 25.6%. Our fixed-rate consumer loans have short average maturities, and our adjustable-rate consumer loans float with the prime rate. Income earned on residential mortgage loans was $22.8 million for the year ended September 30, 2004, down $1.8 million, or 7.3%, from the prior year. Despite an increase of $8.7 million in average residential mortgage loan balances, interest income was negatively impacted as yields declined by 60 basis points to 5.84% from 6.44%, reflecting the impact of lower market rates and refinancing activity.
Interest income on securities and other earning assets increased to $21.2 million for the year ended September 30, 2004, compared to $14.4 million for the prior year. A 69 basis-point decline in yields was offset by a $237.9 million increase in the average balances of securities and other earning assets.
Interest Expense. Interest expense for the year ended September 30, 2004 increased by $922,000 to $13.0 million, an increase of 7.6% compared to interest expense of $12.1 million for the prior fiscal year. The increase was primarily due to an increase of $241.1 million, or 29.1%, in average interest-bearing liabilities resulting from the ENB acquisition. Average rates paid on interest-bearing liabilities for the year ended September 30, 2004 declined by 25 basis points to 1.21% from 1.46% in fiscal 2003. The average interest rate paid on certificates of deposit fell by 43 basis points to 1.70% for the year ended September 30, 2004, from 2.13% for the prior year. For the year ended
September 30, 2004, average balances of lower cost savings and money market accounts increased by $80.5 million and $29.0 million, respectively, while average balances of certificates of deposit increased by $71.1 million compared to the year ended September 30, 2003. The average interest rate paid on savings and money market accounts fell by 10 and 21 basis points to 0.44% and 0.57%, respectively, for the year ended September 30, 2004, from 0.54% and 0.78% for the prior year.
Net Interest Income. On a tax-equivalent basis, net interest income for the year ended September 30, 2004 increased to $62.3 million, compared to $46.1 million for the year ended September 30, 2003, an increase of $16.2 million or 35.0%, which was largely due to a $200.4 million increase in average net earning assets. The increase in interest income of $17.1 million, or 29.4%, reflects a decline in yield of 59 basis points to 5.20% on average earning assets, offset by an increase in average earning asset balances of $441.5 million, or 44.0%, to $1.4 billion as of September 30, 2004. The cost of interest bearing liabilities increased by $922,000 as the average rate paid on interest bearing liabilities decreased 25 basis points to 1.21%, but was offset by an increase in average balances of $241.1 million to $1.1 billion. Net interest margin decreased from 4.59% to 4.31% and net interest spread decreased from 4.33% to 3.99%.
This increase in our net interest income was due, in large part, to the relative changes in the yield and cost of our assets and liabilities as a result of decreasing market interest rates since 2001. This decrease in market interest rates has reduced the cost of interest-bearing liabilities faster and to a greater extent than the rates on interest-earning assets such as loans and securities. We have seen a reversal in recent months as the Board of Governors of the Federal Reserve System has begun to increase the federal funds rate. By historical standards, however, interest rates remain relatively low. However, if recently low interest rate levels persist for an extended period of time, the prepayment of assets could continue at a rate exceeding scheduled repayment. Such funds received would most likely be reinvested at lower yields than that of our previously held assets. Also, as the reduction in liability costs have already exceeded the pace at which assets repriced downward, net interest margin may be further compressed. Conversely, if market interest rates continue to rise as a result of an economic recovery, (primarily if shorter term interest rates rise without a corresponding increase in intermediate term interest rates) competitive pressures could cause us to increase our funding costs and lead to pressure on the net interest margin.
Provision for Loan Losses. We recorded $800,000 and $900,000, respectively, in loan loss provisions for the years ended September 30, 2004 and September 30, 2003, respectively. At September 30, 2004 the allowance for loan losses totaled $17.4 million, or 1.74% of the loan portfolio, compared to $11.1 million, or 1.55% of the loan portfolio at September 30, 2003. Net charge-offs for the year ended September 30, 2004 were $266,000 and $214,000, respectively (an annual rate of 0.03% of the average loan portfolio).
The increase in the allowance for loan losses was primarily attributable to growth in the loan portfolio of $55.9 million, representing an increase of 9.09%. In addition, higher risk loan categories, primarily commercial real estate loans and commercial business loans provided most of this increase. In January 2004, we acquired $219.2 million in loans as part of our acquisition of ENB. An additional $5.7 million in the allowance for loan losses was recorded for the addition of the loan portfolio of ENB. The allowance for loan losses was also increased as loans that were delinquent, criticized or classified grew to $9.0 million at September 30, 2002 from $7.5 million at September 30, 2001, an increase of $1.5 million. An increase in commercial mortgage loans of $2.9 million was partially offset by a decrease in the retail categories (residential mortgages, equity lines of credit and consumer loans) of $1.2 million and a decrease in commercial and industrial loans of $294,000.
We increased the percentage allowance requirements in the retail loan portfolio to reflect the higher delinquencies in the consumer loan portfolio. We also increased the percentage allowance in the commercial loan portfolio to reflect the potential impact of loan growth in new adjacent markets, and continued growth in larger, more complex loans. There has also been a slight increase in the risk ratings of the performing loan portfolio.
Non-Interest Income. Non-interest income for the fiscal year ended September 30, 2004 was $11.6 million compared to $9.6 million for the fiscal year ended September 30, 2003, an increase of $2.0 million, or 21.1%. Gains on sales of securities and loans were $2.5 million and $320,000, respectively, for the current year, representing a combined decrease of $327,000 from the securities and loan sales gains of $2.0 million and $1.1 million, respectively, for the prior
year. Deposit fees and service charges increased to $6.6 million for the current fiscal year, an increase of $2.1 million, or 48.2%, over the same period last year. The increase is primarily attributable to increases in service fees of $1.2 million resulting from the acquired branches, coupled with volume-related increases in service fees on new and existing accounts at the "legacy" Provident branches. Other income including loan fees and charges increased by $207,000, or 10.2%, to $2.2 million for the year ended September 30, 2004, from $2.0 million for the same period last year. The increase is primarily due to $552,000 in income from the Bank Owned Life Insurance ("BOLI") for the current fiscal year compared to $483,000 for the same period last year, as the BOLI program was only established for nine months of fiscal 2003, and $107,000 in increased income on mutual funds and annuity sales.
Non-Interest Expense. Non-interest expense for the fiscal year ended September 30, 2004 was $56.1 million, a $19.4 million, or 52.6%, increase over expenses of $36.8 million for the fiscal year ended September 30, 2003. The increase was primarily attributable to a contribution of $5.0 million for the establishment of the Charitable Foundation in connection with the second-step stock conversion in January, 2004 and other expenses associated with the completed and pending acquisitions of ENB and Warwick, respectively. Major increases in compensation and benefits ($2.5 million) and occupancy and office operations ($1.1 million) were directly attributable to the increased operations resulting from the acquisition of ENB. Compensation and benefits increased by an additional $3.1 million due to annual salary increases and staff additions. Stock-based compensation expense increased by $584,000, or 26.5%, as the Company's per share value increased from an average of $7.43 per share for the year ended September 30, 2003 to an average of $10.95 per share for the year ended September 30, 2004. Also, the Company allocated additional shares related to the $10.0 million ESOP plan purchase. Professional fees increased to $2.7 million for the year ended September 30, 2004, an increase of $1.1 million, or 68.0%, over the comparable period in the prior year. The increase is primarily due to the additional fees associated with Sarbanes-Oxley compliance, and the fees for contracted consultants engaged during the integration periods of ENB and Warwick. Additional increases in non-interest expense categories for the current fiscal year were advertising costs of $393,000, or 23.7%, and a volume-related increase of $711,000, or 24.3%, in data and check processing costs. The Company incurred $773,000 in integration costs for the current fiscal year, due primarily to the expenses associated with the systems conversion of ENB. Amortization of intangible assets increased by $1.6 million due to the addition of the ENB core deposit intangible. Other non-interest expense increased by $2.1 million, or 39.0%, primarily due to increases in SEC and shareholder relations expenses ($231,000), supplies expenses ($520,000), postage ($269,000), ATM transaction expenses ($172,000), insurance expense ($199,000), courier related expense ($148,000), and miscellaneous operational write-offs ($215,000).
Income Taxes. Income tax expense was $5.1 million for the fiscal year ended September 30, 2004 compared to $6.3 million for fiscal 2003, representing effective tax rates of 31.8% and 36.1%, respectively. The lower effective tax rate in fiscal 2004 is attributable to an increase in tax-exempt securities, a decrease in state taxes and the release of tax contingency reserves due, in part, to closed examination years.
Comparison of Operating Results for the Years Ended September 30, 2003 and - -------------------------------------------------------------------------- September 30, 2002 - ------------------
Net income for the year ended September 30, 2003, was $11.3 million, an increase of $1.8 million, or 18.1%, compared to net income of $9.5 million for the year ended September 30, 2002. Basic and diluted earnings per share increased to $0.33 and $0.32, respectively, for the year ended September 30, 2003, compared to $0.28 and $0.27, respectively, for the year ended September 30, 2002. The increase in net income reflected a $5.1 million, or 29.9%, decrease in interest expense and a $4.2 million, or 76.9%, increase in non-interest income, which were partially offset by a $4.6 million, or 14.4%, increase in non-interest expense and a $2.2 million, or 3.6%, decrease in interest income.
Interest Income. Interest income for the year ended September 30, 2003 declined to $57.8 million, a decrease of $2.2 million, or 3.6%, compared to the prior year. The decrease was primarily due to lower average yields on loans and securities, offset in large part by higher average balances in both asset classes. Average interest-earning assets for the year ended September 30, 2003 were $1.0 billion, an increase of $96.8 million, or 10.7%, over average interest-earning assets for the year ended September 30, 2002 of $907.7 million. Average loan balances grew by $52.4 million and average balances of securities and other earning assets increased by $44.4 million. Average tax equivalent yields on interest earning assets fell by 85 basis points to 5.79% for the year ended September 30, 2003, from 6.64% for the year ended September 30, 2002. Lower market interest rates were the primary reason for the decline in asset yields.
Total interest income on loans for the year ended September 30, 2003 declined 2.6% to $43.8 million from $45.0 million for the prior fiscal year. Interest income on commercial loans for the year ended September 30, 2003 increased to $15.2 million, up 6.8% from commercial loan interest income of $14.2 million for the prior fiscal year. Average balances of commercial loans grew $32.0 million to $220.3 million, and the impact of that increase offset a 66 basis point decline in average yield. The lower average yield was due, in part, to the effect on commercial business loans of the lower average prime rate of 4.24% in fiscal 2003 compared to 4.86% in fiscal 2002. Interest income on consumer loans declined by $715,000, or 15.0% for the year. Our fixed-rate consumer loans have short average maturities, and our adjustable-rate consumer loans float with the prime rate. Income earned on residential mortgage loans was $24.6 million for the year ended September 30, 2003, down $1.4 million, or 5.4%, from the prior year. Despite an increase of $16.7 million in average residential mortgage loan balances, interest income was negatively impacted as yields declined by 68 basis points to 6.44% from 7.12%, reflecting the impact of lower market rates and refinancing activity.
Interest income on securities and other earning assets decreased to $14.0 million for the year ended September 30, 2003, compared to $15.0 million for the prior year. A 106 basis-point decline in yields offset a $44.4 million increase in the average balances of securities and other earning assets.
Interest Expense. Interest expense for the year ended September 30, 2003 fell by $5.1 million to $12.1 million, a decrease of 29.9% compared to interest expense of $17.2 million for the prior fiscal year. The decrease was primarily due to lower rates paid on interest-bearing deposits and borrowings, as well as to a higher concentration of non-interest-bearing and low interest-bearing deposits in fiscal 2003. Average rates paid on interest-bearing liabilities for the year ended September 30, 2003 declined by 81 basis points to 1.46% from 2.27% last year. The average interest rate paid on certificates of deposit fell by 111 basis points to 2.13% for the year ended September 30, 2003, from 3.24% for the prior year. For the year ended September 30, 2003, average balances of lower cost savings and money market accounts increased by $49.4 million and $15.7 million, respectively, while average balances of certificates of deposit increased by only $4.0 million compared to the year ended September 30, 2002. The average interest rate paid on savings and money market accounts fell by 47 and 57 basis points to 0.54% and 0.78%, respectively, for the year ended September 30, 2003, from 1.01% and 1.35% for the prior year.
Net Interest Income. Net interest income on a tax equivalent basis, for the year ended September 30, 2003 increased to $46.1 million, compared to $43.1 million for the year ended September 30, 2002, an increase of $3.0 million or 7.0%, which was largely due to a $25.1 million increase in average net earning assets. The decrease in interest income of $2.2 million, or 3.6%, reflects a decline in yield of 85 basis points to 5.79% on average earning assets, mostly offset by an increase in average earning asset balances of $96.8 million, or 10.7%, to $1.0 billion as of September 30, 2003. The cost of interest bearing liabilities declined by $5.1 million as the average rate paid on interest bearing liabilities decreased 81 basis points to 1.46%, offsetting an increase in average balances of $71.7 million to $827.9 million. Net interest margin decreased from 4.75% to 4.59% and net interest spread decreased from 4.37% to 4.33%.
Provision for Loan Losses. We recorded $900,000 in loan loss provisions for each of the years ended September 30, 2003 and September 30, 2002. At September 30, 2003 the allowance for loan losses totaled $11.1 million, or 1.55% of the loan portfolio, compared to $10.4 million, or 1.55% of the loan portfolio at September 30, 2003. See "Comparison of Operating Results for the year Ended September 30, 2004 and September 30, 2003--Provision for Loan Losses," above.
Non-Interest Income. Non-interest income for the fiscal year ended September 30, 2003 was $9.6 million compared to $5.4 million for the fiscal year ended September 30, 2002, an increase of $4.2 million, or 76.9%. This increase was primarily attributable to realized gains on securities available for sale and sales of loans of $2.0 million and $1.1 million, respectively, in the current fiscal year, a combined increase of $2.5 million over the securities and loan sales gains of $607,000 for the prior fiscal year. Other factors include an increase of $786,000, or 18.7%, in banking fees and service charges, $483,000 in income from the new BOLI program, which began in December 2002, and an increase in prepayment fees of $264,000.
Non-Interest Expense. Non-interest expense for the fiscal year ended September 30, 2003 was $36.8 million, a $4.6 million, or 14.4%, increase over expenses of $32.2 million for the fiscal year ended September 30, 2002. The increase was primarily attributable to an increase in compensation and employee benefits of $3.5 million, or 20.0%, primarily related to annual merit raises, staff for new branches, the payout of an employment agreement and the increased cost of stock-based compensation plans due to the increase in the market price of our common stock.
Occupancy and office operations expense increased by $370,000, or 7.7%, due primarily to the expenses associated with the branches acquired as part of the acquisition of The National Bank of Florida; we owned these branches for only five months in fiscal 2002. Advertising and promotion costs increased by $187,000, or 12.7%, due to additional advertising related to new branches and products. Increases in loan and deposit accounts generated a volume-related increase of $472,000, or 19.3%, in data and check processing costs. A focus on technological development and internal controls resulted in an increase in professional fees over the same period in 2002 of $427,000, or 42.0%, to $1.4 million. Amortization of intangible assets increased by $152,000, or 53.1%, as the core deposit amortization for The National Bank of Florida was in place for all of fiscal 2003, compared to five months in fiscal 2002. Other expenses increased by $91,000, or 2.1%, due primarily to an increase of $226,000, or 54.6%, in ATM charges related to the increase in transaction accounts and greater debit card usage.
Income Taxes. Income tax expense was $6.3 million for the fiscal year ended September 30, 2003 compared to $5.6 million for fiscal 2002, representing effective tax rates of 36.1% and 36.9%, respectively. The lower effective tax rate in fiscal 2003 is primarily attributable to the transfer of $12.5 million in assets from taxable securities to tax-exempt bank owned life insurance.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used by the Company for general corporate purposes or for customer needs. Corporate purpose transactions are used to help manage credit, interest rate, and liquidity risk or to optimize capital. Customer transactions are used to manage customers' requests for funding.
The Company's off-balance sheet arrangements, which principally include lending commitments, are described below. At September 30, 2004 and 2003, the Company had no interests in non-consolidated special purpose entities.
Lending Commitments. Lending commitments include loan commitments, standby letters of credit and unused business credit lines. These instruments are not recorded in the consolidated balance sheet until funds are advanced under the commitments. The Company provides these lending commitments to customers in the normal course of business.
For commercial customers, loan commitments generally take the form of revolving credit arrangements to finance customers' working capital requirements. For retail customers, loan commitments are generally lines of credit secured by residential property. At September 30, 2004, commercial and retail loan commitments totaled $211.0 million. Standby letters of credit totaled $12.7 million. Standby letters of credit are conditional commitments to guarantee performance, typically of a contract or the financial integrity, of a customer to a third party. Unused business, personal and credit card lines, which totaled $120.7 million at September 30, 2004, are generally for short-term borrowings.
Provident Bank applies essentially the same credit policies and standards as it does in the lending process when making these commitments. See Note 16 to Consolidated Financial Statements in Item 8 hereof for additional information regarding lending commitments.
Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include operating leases for premises and equipment.
The following table summarizes our significant fixed and determinable contractual obligations and other funding needs by payment date at September 30, 2004. The payment amounts represent those amounts due to the recipient and do not include any unamortized premiums or discounts or other similar carrying amount adjustments.
Impact of Inflation and Changing Prices
The financial statements and related notes of Provident Bancorp have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
Liquidity and Capital Resources
The overall objective of our liquidity management is to ensure the availability of sufficient cash funds to meet all financial commitments and to take advantage of investment opportunities. We manage liquidity in order to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise.
Our primary sources of funds are deposits, principal and interest payments on loans and securities, wholesale borrowings, the proceeds from maturing securities and short-term investments, and the proceeds from the sales of loans and securities. The scheduled amortization of loans and securities, as well as proceeds from borrowings, are predictable sources of funds. Other funding sources, however, such as deposit inflows, mortgage prepayments and mortgage loan sales are greatly influenced by market interest rates, economic conditions and competition.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in the Consolidated Statements of Cash Flows in our consolidated financial statements. Our primary investing activities are the origination of residential one- to four-family and commercial real estate loans, and the purchase of investment securities and mortgage-backed securities. During the years ended September 30, 2004, 2003 and 2002, our loan originations totaled $342.5 million, $403.5 million and $202.5 million, respectively. Purchases of securities available for sale totaled $468.4 million, $219.5 million and $73.5 million for the years ended September 30, 2004, 2003 and 2002, respectively. Purchases of securities held to maturity totaled $12.2 million, $27.6 million and $34.4 million for the years ended September 30, 2004, 2003 and 2002, respectively. These activities were funded primarily by deposit growth (a financing activity), and by principal repayments on loans and securities. Loan origination commitments totaled $90.4 million at September 30, 2004, and consisted of $78.7 million at adjustable or variable rates and $11.7 million at fixed rates. Unused lines of credit granted to customers were $120.7 million at September 30, 2004. We anticipate that we will have sufficient funds available to meet current loan commitments and lines of credit.
In December 2003 we invested $12.0 million in BOLI contracts. These investments are illiquid and are therefore classified as other assets. Earnings from BOLI are derived from the net increase in cash surrender value of the BOLI contracts and the proceeds from the payment on the insurance policies, if any. BOLI contracts totaled $13.2 million at September 30, 2004.
Deposit flows are generally affected by the level of market interest rates, the interest rates and other conditions on deposit products offered by our banking competitors, and other factors. The net increase in total deposits (excluding deposits acquired during 2004 and 2002 as part of the acquisitions of ENB and NBF, respectively) was $43.1 million, $69.9 million and $58.4 million for the years ended September 30, 2004, 2003 and 2002, respectively. Certificates of deposit that are scheduled to mature in one year or less from September 30, 2004 totaled $277.8 million. Based upon prior experience and our current pricing strategy, management believes that a significant portion of such deposits will remain with us.
We generally remain fully invested and utilize additional sources of funds through Federal Home Loan Bank of New York advances, of which $164.9 million was outstanding at September 30, 2004. At September 30, 2004 we had the ability to borrow an additional $383.0 million under our credit facilities with the Federal Home Loan Bank.
Recent Accounting Standards
FASB Interpretation (FIN) No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, was issued in November 2002. 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. The disclosure requirements in this interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The interpretation also requires a guarantor to recognize, at fair value, a liability for the obligation at inception of the guarantee (effective for guarantees issued or modified after December 31, 2002). The adoption of FIN No. 45 did not have a material impact on the consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123. This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effects of the method used on reported results. The provisions of this statement are not expected to have a material impact on the consolidated financial statements.
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, to provide guidance on the identification of entities controlled through means other than voting rights. FIN No. 46 specifies how a business enterprise should evaluate its interests in a variable interest entity to determine whether to consolidate that entity. A variable interest entity must be consolidated by its primary beneficiary if the entity does not effectively disperse risks among the parties involved. A public company with a variable interest in an entity created before February 1, 2003 must apply FIN No. 46 in the first interim or annual period ending after December 15, 2003. The adoption of FIN No. 46 is not expected to have a significant effect on the consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, for certain decisions made by the Board as part of the Derivative Implementation Group process. This statement is effective for contracts entered into or modified after June 30, 2003 and hedging relationships designated after June 30, 2003. Management does not expect that the provisions of SFAS No. 149 will have a material impact on the results of operations or financial condition.
SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity was issued in May 2003. Under this statement, certain freestanding financial instruments that embody obligations for the issuer and that are now classified in equity, must be classified as liabilities (or as assets in some circumstances). Generally, SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. However, the effective date of the statement's provisions related to the classification and measurement of certain mandatorily redeemable non-controlling interests has been deferred indefinitely by the FASB, pending further Board action. Adoption of this standard did not have an impact on the consolidated financial statements.
In November 2003, the Emerging Issues Task Force ("EITF") issued issue summary 03-1 ("EITF 03-1"), The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. EITF 03-01 addressed an entity's treatment of the impairment of securities when such impairment is considered other than temporary. The preliminary summary required disclosures only related to other than temporary impairment. In March 2004, the EITF continued its discussion and reached a consensus on the procedures for recognizing an impairment of securities considered other than temporarily impaired. The guidance in EITF 03-1 was intended to be effective for reporting periods beginning after June 15, 2004. However, in September 2004, the FASB issued FSP EITF 03-1-1, which deferred the effective date for the measurement and recognition provisions of EITF 03-1 until further implementation guidance could be established. Management does not believe the provisions of this standard, as currently written, will have a material impact on the results of future operations.
In December 2003, the Accounting Standards Executive Committee ("AcSEC") issued Statement of Position ("SOP") 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer." The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. The SOP addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. The SOP applies to loans acquired in business combinations but does not apply to loans originated by the Company. Management does not believe the provision of this standard will have a material impact on the results of future operations.
On March 9, 2004, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 105, Application of Accounting Principles to Loan Commitments. SAB No. 105 requires that when a company is recognizing and valuing a loan commitment at fair value, only differences between the guaranteed interest rate in the loan commitment and a market interest rate should be included. Any expected future cash flows related to the customer relationships or loan servicing should be excluded from the fair value measurement. The expected future cash flows that are excluded from the fair-value determination include anticipated fees for servicing the funded loan, late-payment charges, other ancillary fees, or other cash flows from servicing rights. The guidance in SAB No. 105 is effective for mortgage-loan commitments that are accounted for as derivatives and are entered into after March 31, 2004. Management does not believe the provisions of this standard will have a material impact on the results of future operations.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk - -------------------------------------------------------------------
Management of Interest Rate Risk
Management believes that our most significant form of market risk is interest rate risk. The general objective of our interest rate risk management is to determine the appropriate level of risk given our business strategy, and then manage that risk in a manner that is consistent with our policy to limit the exposure of our net interest income to changes in market interest rates. Provident Bank's asset/liability management committee ("ALCO"), which consists of certain members of senior management, evaluates the interest rate risk inherent in certain assets and liabilities, our operating environment, and capital and liquidity requirements, and modifies our lending, investing and deposit gathering strategies accordingly. A committee of the Board of Directors reviews the ALCO's activities and strategies, the effect of those strategies on our net interest margin, and the effect that changes in market interest rates would have on the economic value of our loan and securities portfolios as well as the intrinsic value of our deposits and borrowings.
We actively evaluate interest rate risk in connection with our lending, investing, and deposit activities. We emphasize the origination of residential fixed-rate mortgage loans that are repaid monthly and bi-weekly, fixed-rate commercial mortgage loans, adjustable-rate residential and commercial mortgage loans, commercial business loans and consumer loans. Depending on market interest rates and our capital and liquidity position, we may retain all of the fixed-rate, fixed-term residential mortgage loans that we originate or we may sell all or a portion of such longer-term loans, generally on a servicing-retained basis. We also invest in short-term securities, which generally have lower yields compared to longer-term investments. Shortening the average maturity of our interest-earning assets by increasing our investments in shorter-term loans and securities helps to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our net interest income to changes in market interest rates. These strategies may adversely affect net interest income due to lower initial yields on these investments in comparison to longer-term, fixed-rate loans and investments.
Management monitors interest rate sensitivity primarily through the use of a model that simulates net interest income under varying interest rate assumptions. Management also evaluates this sensitivity using a model that estimates the change in Provident Bank's net portfolio value ("NPV") over a range of interest rate scenarios. NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. Both models assume estimated loan prepayment rates, reinvestment rates and deposit decay rates that seem most likely based on historical experience during prior interest rate changes.
The table below sets forth, as of September 30, 2004, the estimated changes in our NPV and our net interest income that would result from the designated instantaneous changes in the U.S. Treasury yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
The table set forth above indicates that at September 30, 2004, in the event of an immediate 100 basis point decrease in interest rates, we would be expected to experience a 0.8% increase in NPV and a 3.4% decrease in net
interest income. In the event of an immediate 200 basis point increase in interest rates, we would be expected to experience a 12.0% decrease in NPV and a 0.1% decrease in net interest income.
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV and net interest income requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The NPV and net interest income table presented above assumes that the composition of our interest-rate sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and, accordingly, the data does not reflect any actions management may undertake in response to changes in interest rates. The table also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or the repricing characteristics of specific assets and liabilities. Accordingly, although the NPV and net interest income table provides an indication of our sensitivity to interest rate changes at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data - ---------------------------------------------------
The following are included in this item:
(A) Report of Independent Registered Public Accounting Firm
(B) Consolidated Statements of Financial Condition as of September 30, 2004 and 2003
(C) Consolidated Statements of Income for the years ended September 30, 2004, 2003 and 2002
(D) Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income for the years ended September 30, 2004, 2003 and 2002
(E) Consolidated Statements of Cash Flows for the years ended September 30, 2004, 2003 and 2002
(F) Notes to Consolidated Financial Statements
The supplementary data required by this item (selected quarterly financial data) is provided in Note 21 of the Notes to Consolidated Financial Statements.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders Provident Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition of Provident Bancorp, Inc. and subsidiaries (the Company) as of September 30, 2004 and 2003, and the related consolidated statements of income, changes in stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended September 30, 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 financial position of Provident Bancorp, Inc. and subsidiaries as of September 30, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2004, in conformity with U.S. generally accepted accounting principles.
\s\ KPMG LLP
New York, New York December 10, 2004
PROVIDENT BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Financial Condition September 30, 2004 and 2003 (Dollars in thousands, except per share data)
PROVIDENT BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Income Years Ended September 30, 2004, 2003 and 2002 (Dollars in thousands, except per share data)
See accompanying notes to consolidated financial statements.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income (Loss) Years Ended September 30, 2004, 2003 and 2002 (Dollars in thousands, except per share data)
See accompanying notes to consolidated financial statements.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years Ended September 30, 2004, 2003 and 2002 (Dollars in thousands)
PROVIDENT BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued Years Ended September 30, 2004, 2003 and 2002 (Dollars in thousands)
See accompanying notes to consolidated financial statements.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(1) Reorganization and Stock Offerings
Initial Public Offering
On January 7, 1999, Provident Bank (the Bank) completed its reorganization into a mutual holding company structure (the Reorganization). As part of the Reorganization, the Bank converted from a federally-chartered mutual savings bank to a federally-chartered stock savings bank (the Conversion). The Bank became the wholly owned subsidiary of Provident Bancorp, Inc., a federal corporation ("Provident Federal"), which became the majority-owned subsidiary of Provident Bancorp, MHC ("the Mutual Holding Company").
Provident Bancorp, Inc. issued a total of 8,280,000 common shares on January 7, 1999, consisting of 3,864,000 shares (or 46.67%) sold to the public (the Offering) and 4,416,000 shares (or 53.33%) issued to the Mutual Holding Company. The net proceeds from the sale of shares to the public amounted to $37,113. Provident Bancorp, Inc. utilized net proceeds of $24,000 to make a capital contribution to the Bank. The Company's employee stock ownership plan (ESOP) purchased 309,120 shares (or 8% of the number of shares sold in the Offering) in open market transactions, during January and February 1999, at a total cost of $3,760.
Second Step Conversion
On January 14, 2004 Provident Bancorp, MHC completed its stock offering in connection with the second-step conversion from a mutual holding company, a federal corporation, to a publicly held bank holding company, incorporated in the State of Delaware. In anticipation of the second-step conversion the board of Directors of Provident Bancorp, MHC formed a Delaware Corporation known as the "Provident Bancorp, Inc." Concurrent with the public stock offering of Provident Bancorp, MHC shares, Provident Bancorp, MHC ceased to exist and Provident Federal was replaced by the "New Provident Bancorp. Inc."
As a result of the stock offering and conversion, Provident Bank (Bank) is a wholly owned subsidiary of Provident Bancorp, Inc. (Parent), a publicly held bank holding company, Collectively, the Bank and Parent company are referred to herein as the "Company". In addition, the Company simultaneously completed its acquisition of E.N.B. Holding Company, Inc., ("ENB") located in Ellenville, New York.
Provident Bancorp, MHC sold 19,573,000 shares of common stock at $10.00 per share to depositors of the Bank as of June 30, 2002 and September 30, 2003. The new holding company also issued 400,000 shares of common stock and contributed $1.0 million in cash to the Provident Bank Charitable Foundation. In addition, each outstanding share of common stock of Provident Federal as of January 14, 2004 has been converted into 4.4323 new shares of the Company's common stock.
Cash was paid in lieu of the issuance of fractional shares. In connection with the Conversion, the number of shares of authorized but unissued preferred stock was unchanged and the amount of common stock authorized was increased to 75,000,000 shares par value $0.01. The Conversion was accounted for as reorganization in corporate form with no change in the historical basis of the Company's assets
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
and liabilities. Outstanding shares for purposes of calculating prior year per share amounts have been adjusted to give recognition to the exchange ratio applied in the Conversion. Prior year share data within the consolidated statements of condition not been restated for the exchange ratio.
Costs related to the Offering, primarily marketing fees paid to the Company's investment banking firm, professional fees, registration fees, and printing and mailing costs were $3.5 million and accordingly, net offering proceeds were $192.2 million.
(2) Summary of Significant Accounting Policies
The Bank is a community bank offering financial services to individuals and businesses primarily in Rockland and Orange Counties, New York and the contiguous area. The Bank's principal business is accepting deposits and, together with funds generated from operations and borrowings, investing in various types of loans and securities. The Bank is a federally-chartered savings bank and its deposits are insured up to applicable limits by the Savings Association Insurance Fund of the Federal Deposit Insurance Corporation (FDIC) and deposits related to the NBF and ENB acquisitions and Provident Municipal Bank are insured by the Bank Insurance Fund of the FDIC. The Office of Thrift Supervision (OTS) is the primary regulator for the Bank and for Provident Bancorp, Inc.
(a) Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of Provident Bancorp, Inc., the Bank, and the Bank's wholly owned subsidiaries. These subsidiaries are (i) Provident Municipal Bank (PMB) which is a limited-purpose, New York State-chartered commercial bank formed to accept deposits from municipalities in the Company's market area, (ii) Provident REIT, Inc. which is a real estate investment trust that holds a portion of the Company's real estate loans, (iii) Provest Services Corp. I which has invested in a low-income housing partnership, and (iv) Provest Services Corp. II which has engaged a third-party provider to sell mutual funds and annuities to the Bank's customers. Intercompany transactions and balances are eliminated in consolidation.
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, income and expense. Actual results could differ significantly from these estimates. An estimate that is particularly susceptible to significant near-term change is the allowance for loan losses, which is discussed below.
Certain prior-year amounts have been reclassified to conform to the current-year presentation. For purposes of reporting cash flows, cash equivalents (if any) include highly-liquid, short-term investments such as overnight federal funds.
(b) Securities
The Company classifies its securities among three categories - held to maturity, trading, and available for sale. Management determines the appropriate classification of the Company's securities at the time of purchase.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Held-to-maturity securities are limited to debt securities for which management has the intent and the Company has the ability to hold to maturity. These securities are reported at amortized cost.
Trading securities are debt and equity securities held principally for the purpose of selling them in the near term. These securities are reported at fair value, with unrealized gains and losses included in earnings. The Company does not engage in security trading activities.
All other debt and marketable equity securities are classified as available for sale. These securities are reported at fair value, with unrealized gains and losses (net of the related deferred income tax effect) excluded from earnings and reported in a separate component of stockholders' equity (accumulated other comprehensive income or loss). Available-for-sale securities include securities that management intends to hold for an indefinite period of time, such as securities to be used as part of the Company's asset/liability management strategy or securities that may be sold in response to changes in interest rates, changes in prepayment risks, the need to increase capital, or similar factors.
Premiums and discounts on debt securities are recognized in interest income on a level-yield basis over the period to maturity. The cost of securities sold is determined using the specific identification method. Unrealized losses are charged to earnings when management determines that the decline in fair value of a security is other than temporary.
(c) Loans
Loans (other than loans held for sale) are reported at amortized cost less the allowance for loan losses. Mortgage loans originated and held for sale in the secondary market (if any) are reported at the lower of aggregate cost or estimated fair value. Fair value is estimated based on outstanding investor commitments or, in the absence of such commitments, based on current investor yield requirements. Net unrealized losses, if any, are recognized in a valuation allowance by a charge to earnings.
A loan is placed on nonaccrual status when management has determined that the borrower may be unable to meet contractual principal or interest obligations, or when payments are 90 days or more past due. Accrual of interest ceases and, in general, uncollected past due interest (including interest applicable to prior years, if any) is reversed and charged against current interest income. Interest payments received on nonaccrual loans, including impaired loans, are not recognized as income unless warranted based on the borrower's financial condition and payment record.
The Company defers nonrefundable loan origination and commitment fees, and certain direct loan origination costs, and amortizes the net amount as an adjustment of the yield over the contractual term of the loan. If a loan is prepaid or sold, the net deferred amount is recognized in the statement of income at that time.
(d) Allowance for Loan Losses
The allowance for loan losses is established through provisions for losses charged to earnings. Losses on loans (including impaired loans) are charged to the allowance for loan losses when
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
management believes that the collection of principal is unlikely. Recoveries of loans previously charged-off are credited to the allowance when realized.
The allowance for loan losses is an amount that management believes is necessary to absorb probable losses on existing loans that may become uncollectible, based on evaluations of the collectability of the loans. Management's evaluations, which are subject to periodic review by the OTS, take into consideration factors such as the Company's past loan loss experience, changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and collateral values, and current economic conditions that may affect the borrowers' ability to pay. Future adjustments to the allowance for loan losses may be necessary based on changes in economic and real estate market conditions, further information obtained regarding known problem loans, results of regulatory examinations, the identification of additional problem loans, and other factors.
The Company considers a loan to be impaired when, based on current information and events, it is probable that it will be unable to collect all principal and interest contractually due. Certain loans are individually evaluated for collectability in accordance with the Company's ongoing loan review procedures (principally commercial real estate, commercial business and construction loans). Smaller-balance homogeneous loans are collectively evaluated for impairment, such as residential mortgage loans and consumer loans. Impaired loans are based on one of three measures - the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. If the measure of an impaired loan is less than its recorded investment, an impairment loss is recognized as a charge to the allowance for loan losses.
(e) Mortgage Servicing Assets
The cost of an originated mortgage loan that is sold with servicing retained is allocated between the loan and the servicing right. The cost allocated to the retained servicing right is capitalized as a separate asset and amortized thereafter in proportion to, and over the period of, estimated net servicing income. Capitalized mortgage servicing rights are included in other assets and are assessed for impairment based on the fair value of those rights, and impairment losses are recognized in a valuation allowance by charges to income.
(f) Federal Home Loan Bank Stock
As a member of the Federal Home Loan Bank (FHLB) of New York, the Bank is required to hold a certain amount of FHLB stock. This stock is a nonmarketable equity security and, accordingly, is reported at cost.
(g) Premises and Equipment
Premises and equipment are reported at cost, less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets which range from 3 to 40 years. Leasehold improvements are amortized on a straight-line basis over the terms of the respective leases or the estimated useful lives of the
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
improvements, whichever is shorter. Routine holding costs are charged to expense as incurred, while significant improvements are capitalized.
(h) Goodwill and Other Intangible Assets
Goodwill recorded in the NBF and ENB acquisitions is not amortized to expense, but instead is evaluated for impairment at least annually. The core deposit intangibles recorded in both the NBF and ENB acquisitions are amortized to expense using an accelerated method over their estimated lives of approximately eight years, and are evaluated for impairment at least annually. Impairment losses on intangible assets are charged to expense if and when they occur.
(i) Real Estate Owned
Real estate properties acquired through loan foreclosures are recorded initially at estimated fair value less expected sales costs, with any resulting write-down charged to the allowance for loan losses. Subsequent valuations are performed by management, and the carrying amount of a property is adjusted by a charge to expense to reflect any subsequent declines in estimated fair value. Fair value estimates are based on recent appraisals and other available information. Routine holding costs are charged to expense as incurred, while significant improvements are capitalized. Gains and losses on sales of real estate owned are recognized upon disposition. Real estate owned is included in other assets.
(j) Securities Repurchase Agreements
In securities repurchase agreements, the Company transfers securities to counterparty under an agreement to repurchase the identical securities at a fixed price on a future date. These agreements are accounted for as secured financing transactions since the Company maintains effective control over the transferred securities and the transfer meets other specified criteria. Accordingly, the transaction proceeds are recorded as borrowings and the underlying securities continue to be carried in the Company's securities portfolio. Disclosure of the pledged securities is made in the consolidated statements of financial condition if the counterparty has the right by contract to sell or repledge such collateral.
(k) Income Taxes
Deferred taxes are recognized for the estimated future tax effects attributable to "temporary differences" between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax laws or rates is recognized in income tax expense in the period that includes the enactment date of the change.
A deferred tax liability is recognized for all temporary differences that will result in future taxable income and is carried on the balance sheet in other liabilities. A deferred tax asset, which is carried on the balance sheet in other assets, is recognized for all temporary differences that will result in future tax deductions, subject to reduction of the asset by a valuation allowance in certain
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
circumstances. This valuation allowance is recognized if, based on an analysis of available evidence, management determines that it is more likely than not that some portion or all of the deferred tax asset will not be realized. The valuation allowance is subject to ongoing adjustment based on changes in circumstances that affect management's judgment about the realizability of the deferred tax asset. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense.
(l) Interest Rate Cap Agreements
Interest rate cap agreements are accounted for in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which the Company adopted as of October 1, 2000. These agreements are cash flow hedges as they are used to reduce the variability of cash flows from potentially higher interest payments associated with upward interest rate repricings on a portion of the Company's certificate of deposit accounts and borrowings. In accordance with SFAS No. 133, the interest rate cap agreements are reported at fair value. Changes in fair value attributable to time value are reported in interest expense, while changes attributable to intrinsic value are reported in accumulated other comprehensive income until earnings are affected by the variability in cash flows of the hedged liabilities.
(m) Stock-Based Compensation Plans
Compensation expense is recognized for the ESOP equal to the fair value of shares that have been allocated or committed to be released for allocation to participants. Any difference between the fair value at that time and the ESOP's original acquisition cost is charged or credited to stockholders' equity (additional paid-in capital). The cost of ESOP shares that have not yet been allocated or committed to be released for allocation is deducted from stockholders' equity.
The Company accounts for the Stock Option Plan in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, compensation expense is recognized only if the exercise price of an option is less than fair value of the underlying stock on the date of the grant. The fair value of shares awarded under the recognition and retention plan (RRP), measured at the grant date, is recognized as unearned compensation (a deduction from stockholders' equity) and amortized to compensation expense as the shares become vested. Tax benefits attributable to any tax deductions that are greater than the amount of compensation expense recognized for financial statement purposes are credited to additional paid-in capital.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
SFAS No. 123, Accounting for Stock-Based Compensation, encourages the use of a fair-value-based method of accounting for employee stock compensation plans, but permits the continued use of the intrinsic-value-based method of accounting prescribed by APB Opinion No. 25. Under SFAS No. 123, the grant-date fair value of options is recognized as compensation expense over the vesting period. The Company has elected to continue to apply APB Opinion No. 25 and disclose the pro forma information required by SFAS No. 123. Had stock-based compensation expense been recognized in accordance with SFAS No. 123, the Company's net income and earnings per common share would have been adjusted to the following pro forma amounts:
(1) Prior period share information has been adjusted to reflect the 4.4323-to-one conversion ratio in connection with the Company's second step conversion in January 2004.
The estimated per-share fair value of stock options granted in fiscal 2004, 2003 and 2002 was $2.71, $1.13 and $1.59, respectively, using the Black-Scholes option-pricing model with assumptions as follows for the respective years: dividend yields of 1.4%, 1.8% and 1.4%; expected volatility rates of 20.10%, 14.67% and 22.40%; risk-free interest rates of 2.7%, 3.3% and 4.2%; and expected option lives of approximately 4 years, 5 years and 6 years.
(n) Earnings Per Share
Basic earnings per share (EPS) is computed by dividing net income applicable to common stock by the weighted average number of common shares outstanding during the period. Diluted EPS is computed in a similar manner, except that the weighted average number of common shares is increased to include incremental shares (computed using the treasury stock method) that would have been outstanding if all potentially dilutive stock options and unvested RRP shares were exercised or became vested during the period. For purposes of computing both basic and diluted
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
EPS, outstanding shares include all shares issued to the Mutual Holding Company, (for the years ending September 30, 2003 and 2002), but exclude unallocated ESOP shares.
(o) Segment Information
Public companies are required to report certain financial information about significant revenue-producing segments of the business for which such information is available and utilized by the chief operating decision maker. As a community-oriented financial institution, substantially all of the Company's operations involve the delivery of loan and deposit products to customers. Management makes operating decisions and assesses performance based on an ongoing review of these community banking operations, which constitute the Company's only operating segment for financial reporting purposes.
(3) Acquisitions
Acquisition of the E.N.B. Holding Company, Inc. (ENB)
On January 14, 2004, simultaneously with the Conversion and Offering, the Company acquired 100% of the outstanding common shares of ENB the holding company of Ellenville National Bank headquartered in Ellenville, New York with five locations in Orange County, New York. Subsequent to the acquisition, ENB branch locations were merged into Provident's banking center network. The Company paid $4,830 per share, in a combination of cash and stock from the Offering. The aggregate purchase price of $76.5 million included the issuance of 3,969,676 shares of Provident stock, cash payments totaling $36.8 million and capitalized costs related to the acquisition, primarily investment banking and professional fees, of $4.8 million. The value of the shares issued to ENB was based on the Offering price of $10.00 per share. This acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of ENB have been included in the consolidated statement of income from the date of acquisition.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The following table presents unaudited pro forma information as if ENB had been consummated on September 30, 2001. This pro forma information gives effect to certain adjustments, including accounting adjustments related to fair value adjustments, amortization of core deposit intangibles and related income tax effects. The pro forma information does not necessarily reflect the results of operations that would have occurred had the Company acquired ENB on September 30, 2001. Pro forma (unaudited)
2002 2003 2004 ------- ------- ------- Net interest income $55,905 $59,895 $64,102 ------- ------- ------- Noninterest income 7,989 11,989 12,162 Noninterest expense 45,271 51,567 60,838 Net income 11,978 12,804 10,567 ======= ======= =======
Basic earnings per share $ 0.31 $ 0.34 $ 0.29 ======= ======= =======
Diluted earnings per share $ 0.31 $ 0.33 0.28 ======= ======= =======
The following table summarizes the purchase price allocation relating to the acquisition of ENB. This allocation is based on the estimated fair values of assets acquired and liabilities assumed at the acquisition date:
January 14, ----------- Cash and Cash equivalents $ 29,218 Securities available for sale 96,960 Loans, net 213,730 Goodwill 51,794 Core deposit intangible 6,624 Other assets 8,005 -------- Total assets acquired 406,331
Deposits 327,284 Other liabilities 2,577 -------- Total liabilities assumed 329,861 -------- Net assets acquired $ 76,470 ======== Consideration paid for ENB $ 76,470 ========
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The core deposit intangible acquired of $6,624 (none of which is tax deductible)is being amortized over 7.6 years. Amortization expense for the core deposit intangible was $1,762 for the year ending September 30, 2004. Scheduled core deposit amortization expense is $1,583 for fiscal 2005, $1,074 for fiscal 2006, $763 for fiscal 2007, $553 for fiscal 2008, $404 for fiscal 2009 and $485 for later years. Goodwill of $51,794 was assigned to the Company's banking segment of which none is deductible for income tax purposes.
The Company incurred $773 in costs associated with the integration of ENB into the Company. These costs are included in non- interest expense for the year ended September 30, 2004.
Acquisition of The National Bank of Florida
On April 23, 2002, the Company consummated its acquisition of The National Bank of Florida (NBF), which was merged with and into the Bank, in an all-cash transaction. The Company acquired 100% of the outstanding common stock of NBF for $28,100, pursuant to an Agreement and Plan of Merger entered into during November 2001. The acquisition was made to further the Company's strategic objective of expanding its retail and commercial banking market share in Orange County, New York, where NBF conducted its operations.
The NBF acquisition was accounted for using the purchase method of accounting. Accordingly, the assets acquired and liabilities assumed were recorded by the Company at their fair values at the acquisition date. The total acquisition cost (including direct transaction costs) exceeded the fair value of the net assets acquired by $15,253. This amount was recognized as intangible assets, consisting of goodwill of $13,466 (none of which is tax deductible) and a core deposit intangible of $1,787.
The core deposit intangible represents the estimated value of acquired depositor relationships, principally attributable to the relatively low-cost funding provided by such deposits. Amortization expense for the core deposit intangible was $301, $438 and $286 for each of the years ending September 30, 2004, 2003 and 2002, respectively. The accumulated amortization was $1,025 as of September 30, 2004. Scheduled core deposit amortization expense is $220 for fiscal 2005, $164 for fiscal 2006, $123 for fiscal 2007, $94 for fiscal 2008, $72 for fiscal 2009 and $89 for later years.
Costs incurred by the Company to integrate the operations of NBF into the Bank amounted to $531 and are included in non-interest expense for the year ended September 30, 2002.
The following is a summary of the fair values of the assets acquired and liabilities assumed at the acquisition date (in thousands):
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Assets acquired: Cash and cash equivalents $ 24,286 Securities 55,809 Loans, net 23,112 Goodwill 13,466 Core deposit intangible 1,787 Other 2,726 -------- Total assets acquired 121,186
Liabilities assumed: Deposits 88,182 Other 4,904 -------- Total liabilities assumed 93,086 -------- Cash paid for NBF common stock $ 28,100 ========
Amounts attributable to NBF are included in the Company's consolidated financial statements from the date of acquisition. Pro forma combined operating results for the fiscal year ended September 30, 2002 , as if NBF had been acquired at the beginning of those periods, have not been presented since the NBF acquisition would not materially affect such results.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Subsequent Event Acquisition of Warwick Community Bancorp, Inc.
On October 1, 2004 the Company announced the completion of its acquisition of Warwick Community Bancorp, Inc. ("WCBI"), located in Warwick, New York. Warwick Community Bancorp, Inc. is the holding company for The Warwick Savings Bank, headquartered in Warwick, New York, The Towne Center Bank, headquartered in Lodi, New Jersey and Hardenburgh Abstract Company headquartered in Goshen, New York. In addition, Warwick Commercial Bank is a subsidiary of The Warwick Savings Bank.
Shareholders of WCBI as of the close of business on October 1, 2004 received total merger consideration of approximately $147.2 million, consisting of approximately 6,257,892 shares of common stock of the Company and approximately $72.6 million in cash (including cash paid in lieu of fractional shares). Shareholders who elected to receive all cash or indicated "No Preference" received $32.26 in cash for each of their WCBI shares. Shareholders who elected to receive all stock received 2.7810 shares of common stock of the Company for 99.89% of their shares of common stock of WCBI and $32.26 in cash for each of the remaining 0.11% of their shares. Shareholders who elected to receive cash and shares of common stock of the Company received $32.26 in cash for the cash portion of their election, 2.7810 shares of common stock of the Company for 99.89% of their stock election shares and $32.26 in cash for each of the remaining 0.11% of their stock election shares. Cash was issued in lieu of fractional shares at a rate of $11.612 per whole share.
On the merger date, WCBI had total loans of $284.5 million, total deposits of $475.1 million and total assets of $703.7 million.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(4) Securities Available for Sale
The following is a summary of securities available for sale:
Equity securities principally consist of Freddie Mac and Fannie Mae common and preferred stock.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The following is a summary of the amortized cost and fair value of investment securities available for sale (other than equity securities), by remaining period to contractual maturity. Actual maturities may differ because certain issuers have the right to call or prepay their obligations.
September 30, 2004 --------------------------- Investment Securities Amortized cost Fair Value -------------- ---------- Remaining period to contractual maturity $ $ Less than one year 11,401 11,432 One to five years 185,321 184,800 Five to ten years 5,763 5,793 Greater than ten years 10,785 10,836 -------- -------- Total $213,270 $212,861 ======== ========
Proceeds from sales of securities available for sale during the years ended September 30, 2004, 2003 and 2002 totaled $163,263, $39,416 and $56,049, respectively. These sales resulted in gross realized gains of $2,556, $2,166 and $745 for the years ended September 30, 2004, 2003 and 2002, respectively, and gross realized losses of $101, $160 and $284 in fiscal 2004, 2003 and 2002, respectively.
Securities with carrying amounts of $54,819 and $32,749 were pledged as collateral for borrowings under securities repurchase agreements at September 30, 2004 and September 30, 2003, respectively. U.S. Government and municipal securities with carrying amounts of $113,491 and $36,703 were pledged as collateral for municipal deposits and other purposes at September 30, 2004 and September 30, 2003, respectively.
The following table summarizes those securities available for sale with unrealized losses, segregated by the length of time in a continuous unrealized loss position:
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(5) Securities Held to Maturity
The following is a summary of securities held to maturity:
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The following is a summary of the amortized cost and fair value of investment securities held to maturity, by remaining period to contractual maturity. Actual maturities may differ because certain issuers have the right to call or repay their obligations.
September 30, 2004 ----------------------- Amortized cost Fair value --------- ---------- Remaining period to contractual maturity: Less than one year $10,196 $10,197 One to five years 9,248 9,550 Five to ten years 9,926 10,188 Greater than ten years 833 853 ------- ------- Total $30,203 $30,788 ======= =======
There were no sales of securities held to maturity during the years ended September 30, 2004, 2003 and 2002.
The following table summarizes those securities held to maturity with unrealized losses, segregated by the length of time in a continuous unrealized loss position:
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(6) Loans
The components of the loan portfolio, excluding loans held for sale, were as follows:
September 30, ------------------------- 2004 2003 --------- --------- One- to four-family residential mortgage loans: Fixed rate $ 328,337 $ 327,916 Adjustable rate 52,412 52,860 --------- --------- 380,749 380,776 --------- --------- Commercial real estate loans 327,414 188,360 Commercial business loans 105,196 54,174 Construction loans 54,294 10,323 --------- --------- 486,904 252,857 --------- --------- Consumer loans: Home equity lines of credit 80,013 50,197 Homeowner loans 26,921 25,225 Other consumer loans 23,047 5,198 --------- --------- 129,981 80,620 --------- --------- Total loans 997,634 714,253
Allowance for loan losses (17,353) (11,069) --------- --------- Total loans, net $ 980,281 $ 703,184 ========= =========
Total loans include net deferred loan origination costs of $1,263 and $903 at September 30, 2004 and September 30, 2003, respectively.
A substantial portion of the Company's loan portfolio is secured by residential and commercial real estate located in Rockland and Orange Counties of New York and contiguous areas such as Ulster and Sullivan Counties of New York. The ability of the Company's borrowers to make principal and interest payments is dependent upon, among other things, the level of overall economic activity and the real estate market conditions prevailing within the Company's concentrated lending area. Commercial real estate and construction loans are considered by management to be of somewhat greater credit risk than loans to fund the purchase of a primary residence due to the generally larger loan amounts and dependency on income production or sale of the real estate. Substantially all of these loans are collateralized by real estate located in the Company's primary market area.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The principal balances of non-accrual loans were as follows:
September 30, ------------------ 2004 2003 ------ ------ One- to four-family residential mortgage loans $1,597 $ 951 Commercial real estate loans 488 3,632 Commercial business 474 -- Consumer loans 178 114 ------ ------ Total non-accrual loans $2,737 $4,697 ====== ======
Gross interest income that would have been recorded if the foregoing non-accrual loans had remained current in accordance with their contractual terms totaled $163, $354, and $371 for the years ended September 30, 2004, 2003 and 2002, respectively, compared to interest income actually recognized (including income recognized on a cash basis) of $119, $167 and $83, respectively.
The Company's total recorded investment in impaired loans, as defined by SFAS No. 114, was $231 and $815 at September 30, 2004 and September 30, 2003, respectively. Substantially all of these loans were collateral-dependent loans measured based on the fair value of the collateral. The Company determines the need for an allowance for loan impairment under SFAS No. 114 on a loan-by-loan basis. An impairment allowance was not required at September 30, 2004 and 2003 due to the adequacy of collateral values. The Company's average recorded investment in impaired loans was $523 and $701 during the years ended September 30, 2004 and 2003, respectively.
Activity in the allowance for loan losses is summarized as follows:
Year ended September 30, ------------------------ 2004 2003 -------- -------- Balance at beginning of year $ 11,069 $ 10,383 Provision for loan losses 800 900 Charge-offs (484) (352) Recoveries 218 138 Allowance recorded in ENB acquisition 5,750 -- -------- -------- Balance at end of year $ 17,353 $ 11,069 ======== ========
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Provisions for losses and other activity in the allowance for losses on real estate owned were insignificant during the years ended September 30, 2004 and 2003. Certain residential mortgage loans originated by the Company are sold in the secondary market. Other non-interest income includes net gains on such sales of $320 in fiscal 2004, $1,096 in fiscal 2003 and $146 in fiscal 2002. At September 30, 2004 and 2003 there was $855 and $2,364 in loans held for sale, respectively. Other assets at September 30, 2004 and 2003 include capitalized mortgage servicing rights with an amortized cost of $746 and $702, respectively, which approximated fair value.
The Company generally retains the servicing rights on mortgage loans sold. Servicing loans for others involves collecting payments, maintaining escrow accounts, making remittances to investors and, if necessary, processing foreclosures. Mortgage loans serviced for others totaled approximately $84,924 and $83,346 at September 30, 2004 and 2003, respectively. Mortgage escrow funds include balances of $493 and $816 at September 30, 2004 and 2003, respectively, related to loans serviced for others.
(7) Accrued Interest Receivable
The components of accrued interest receivable were as follows:
September 30, ------------------ 2004 2003 ------ ------ Loans $3,095 $2,064 Securities 3,720 2,787 ------ ------ Total accrued interest receivable $6,815 $4,851 ====== ======
(8) Premises and Equipment, Net
Premises and equipment are summarized as follows:
September 30, ----------------------- 2004 2003 -------- -------- Land and land improvements $ 1,772 $ 1,407 Buildings 10,247 6,843 Leasehold improvements 6,312 6,084 Furniture, fixtures, and equipment 15,340 11,791 -------- -------- 33,671 26,125 Accumulated depreciation and amortization (16,825) (14,478) -------- -------- Total premises and equipment, net $ 16,846 $ 11,647 ======== ========
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(9) Deposits
Deposit balances and weighted average interest rates are summarized as follows:
Municipal deposits held by PMB totaled $106.7 million and $31.0 million at September 30, 2004 and September 30, 2003, respectively. PMB commenced its public deposit operations on April 19, 2002. See note 4, Securities Available for Sale, for the amount of securities that are pledged as collateral for municipal deposits and other purposes.
Certificates of deposit had remaining periods to contractual maturity as follows:
September 30, --------------------- 2004 2003 -------- -------- Remaining period to contractual maturity: Less than one year $277,812 $190,140 One to two years 25,874 29,638 Two to three years 17,065 5,910 Greater than three years 12,572 10,550 -------- -------- Total certificates of deposit $333,323 $236,238 ======== ========
Certificate of deposit accounts with a denomination of $100 or more totaled $93,912 and $48,615 at September 30, 2004 and 2003, respectively. The FDIC generally insures depositor accounts up to $100 as defined in the applicable regulations.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Interest expense on deposits is summarized as follows:
(10) FHLB and Other Borrowings
The Company's FHLB and other borrowings and weighted average interest rates are summarized as follows:
As a member of the FHLB of New York, the Bank may borrow in the form of term and overnight FHLB advances up to 30% of its total assets, or approximately $548,000 and $352,000 at September 30, 2004 and 2003, respectively. The Bank's unused FHLB borrowing capacity was approximately $383,000 and $228,000, respectively, at those dates. FHLB advances are secured by the Bank's investment in FHLB stock and by a blanket security agreement. This agreement requires the Bank to maintain as collateral certain qualifying assets (such as securities and residential mortgage loans) not otherwise pledged. The Bank satisfied this collateral requirement at September 30, 2004 and 2003. At September 30, 2004 repurchase agreements included $9,962 to other than the FHLB.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Securities repurchase agreements had weighted average remaining terms to maturity of approximately 2.7 years and 3.2 years at September 30, 2004 and 2003, respectively. Average borrowings under securities repurchase agreements were $43,183 and $35,953 during the years ended September 30, 2004 and 2003, respectively, and the maximum outstanding month-end balance was $50,246 and $40,359, respectively.
FHLB borrowings of $20,000 at September 30, 2004 and 2003 are callable quarterly, at the discretion of the FHLB. These borrowings have a weighted average remaining term to the contractual maturity dates of approximately 2 years and 3 years and weighted average interest rates of 4.9% and 5.11% at September 30, 2004 and 2003, respectively.
(11) Income Taxes
Income tax expense consists of the following:
Years ended September 30, ------------------------------- 2004 2003 2002 ------- ------- ------- Current tax expense: Federal $ 5,556 $ 5,137 $ 5,872 State 656 594 863 ------- ------- ------- 6,212 5,731 6,735 ------- ------- ------- Deferred tax expense (benefit): Federal (789) 610 (918) State (287) 3 (254) ------- ------- ------- (1,076) 613 (1,172) ------- ------- ------- Total income tax expense $ 5,136 $ 6,344 $ 5,563 ======= ======= =======
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Actual income tax expense differs from the tax computed based on pre-tax income and the applicable statutory Federal tax rate, for the following reasons:
Years ended September 30, --------------------------------- 2004 2003 2002 ------- ------- ------- Tax at Federal statutory rate $ 5,654 $ 6,158 $ 5,282 State income taxes, net of Federal tax benefit 240 388 396 Tax-exempt interest (460) (234) (193) Nondeductible portion of ESOP expense 408 222 161 BOLI Income (193) (169) -- Low-income housing tax credits (72) (72) (72) Other, net (441) 51 (11) ------- ------- ------- Actual income tax expense $ 5,136 $ 6,344 $ 5,563 ======= ======= ======= Effective income tax rate 31.8% 36.1% 36.9% ======= ======= =======
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The tax effects of temporary differences that give rise to deferred tax assets and liabilities are summarized below. The net amount is reported in other assets or other liabilities in the consolidated statements of financial condition.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Based on management's consideration of historical and anticipated future pre-tax income, as well as the reversal period for the items giving rise to the deferred tax assets and liabilities, a valuation allowance for deferred tax assets was not considered necessary at September 30, 2004 and 2003.
The Bank is subject to special provisions in the Federal and New York State tax laws regarding its allowable tax bad debt deductions and related tax bad debt reserves. Tax bad debt reserves consist of a defined "base-year" amount, plus additional amounts accumulated after the base year. Deferred tax liabilities are recognized with respect to reserves accumulated after the base year, as well as any portion of the base-year amount that is expected to become taxable (or recaptured) in the foreseeable future. The Bank's base-year tax bad debt reserves were $4,600 for Federal tax purposes and $39,000 and $34,900 for New York State tax purposes at September 30, 2004 and 2003, respectively. Associated deferred tax liabilities of $3,900 and $3,660 have not been recognized at those dates since the Company does not expect that the base-year reserves will become taxable in the foreseeable future. Under the tax laws, events that would result in taxation of certain of these reserves include (i) redemptions of the Bank's stock or certain excess distributions by the Bank to Provident Bancorp, Inc. and (ii) failure of the Bank to maintain a specified qualifying-assets ratio or meet other thrift definition tests for New York State tax purposes.
(12) Employee Benefit Plans and Stock-Based Compensation Plans
(a) Pension Plan
The Company has a noncontributory defined benefit pension plan covering substantially all of its employees. Employees who are twenty-one years of age or older and have worked for the Company for one year are eligible to participate in the plan. The Company's funding policy is to contribute annually an amount sufficient to meet statutory minimum funding requirements, but not in excess of the maximum amount deductible for Federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date, but also for benefits expected to be earned in the future. As part of the acquisition of ENB the Company assumed the ENB Pension Plan, a defined benefit plan. The ENB plan was frozen in connection with the merger of ENB into the Company.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The following is a summary of changes in the projected benefit obligation and fair value of plan assets, together with a reconciliation of the funded status to the amount of prepaid pension costs reported in other assets in the consolidated statements of financial condition:
September 30, --------------------- 2004 2003 -------- -------- Changes in projected benefit obligation: Beginning of year $ 11,520 $ 9,132 Service cost 787 669 Interest cost 990 673 Actuarial loss 903 1,255 Acquisition of ENB plan 7,132 -- Benefits paid (428) (209) -------- -------- End of year 20,904 11,520 -------- -------- Changes in fair value of plan assets: Beginning of year 9,896 7,887 Actual gain on plan assets 802 1,056 Employer contributions 3,309 1,162 Employee contributions 20 -- Acquisition of ENB plan 6,236 -- Benefits and distributions paid (619) (209) -------- -------- End of year 19,644 9,896 -------- -------- Funded status at end of year (1,260) (1,624) Unrecognized net actuarial loss 4,154 3,132 Unrecognized prior service cost (43) (56) Unrecognized net transition obligation 10 36 -------- -------- Prepaid pension costs $ 2,861 $ 1,488 ======== ========
A discount rate of 6.00% and a rate of increase in future compensation levels of 5.00% were used in determining the actuarial present value of the projected benefit obligation at September 30, 2004 (6.25% and 5.00%, respectively, at September 30, 2003). The long-term rate of return on plan assets was 7.75% for both fiscal 2004 and 2003. The discount rate, long-term rate of return on plan assets and future compensation increase assumptions for the ENB Plan were 6.00%, 6.00% and 0.00%, respectively, for the year ended September 30, 2004.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
2005 $ 692 2006 835 2007 893 2008 993 2009 1,126 2010-2014 6,423
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The components of the net periodic pension expense were as follows:
The Company has also established a non-qualified Supplemental Executive Retirement Plan to provide certain executives with supplemental retirement benefits in addition to the benefits provided by the pension plan. The periodic pension expense for the supplemental plan amounted to $113, $97 and $90 for the years ended September 30, 2004, 2003 and 2002, respectively. The actuarial present value of the projected benefit obligation was $877 and $759 at September 30, 2004 and 2003, respectively, and the vested benefit obligation was $800 and $653 for the same periods, respectively, all of which is unfunded.
(b) Other Postretirement Benefits Plan
The Company's postretirement health care plan, which is unfunded, provides optional medical, dental and life insurance benefits to retirees. In accordance with SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, the cost of postretirement benefits is accrued over the years in which employees provide services to the date of their full eligibility for such benefits. As permitted by SFAS No. 106, the Company has elected to amortize the transition obligation for accumulated benefits as an expense over a 20-year period. The periodic expense recognized for this plan was $43, $40 and $32 for the years ended September 30, 2004, 2003 and 2002, respectively.
(c) Employee Savings Plans
The Company also sponsors a defined contribution plan established under Section 401(k) of the Internal Revenue Code. Eligible employees may elect to contribute up to 50% of their compensation to the plan. The Company currently makes matching contributions equal to 50% of a participant's contributions up to a maximum matching contribution of 3% of compensation. Voluntary and matching contributions are invested, in accordance with the participant's direction, in one or a number of investment options. Savings plan expense was $294, $248 and $206 for the years ended September 30, 2004, 2003 and 2002, respectively.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(d) Employee Stock Ownership Plan
In connection with the Reorganization and Offering in 1999, the Company established an ESOP for eligible employees who meet certain age and service requirements. The ESOP borrowed $3,760 from Provident Bancorp, Inc. and used the funds to purchase 1,370,112 shares of common stock in the open market subsequent to the Offering. The Bank makes periodic contributions to the ESOP sufficient to satisfy the debt service requirements of the loan which has a ten-year term and bears interest at the prime rate. The ESOP uses these contributions, and any dividends received by the ESOP on unallocated shares, to make principal and interest payments on the loan.
In connection with the Second-Step Stock Conversion and Offering in January, 2004, the Company established an additional ESOP for eligible employees. The ESOP borrowed $9,987 from Provident Bancorp, Inc. and used the funds to purchase 998,650 shares of common stock in the offering. The term of the second ESOP loan is twenty years.
ESOP shares are held by the plan trustee in a suspense account until allocated to participant accounts. Shares released from the suspense account are allocated to participants on the basis of their relative compensation in the year of allocation. Participants become vested in the allocated shares over a period not to exceed five years. Any forfeited shares are allocated to other participants in the same proportion as contributions.
ESOP expense was $1,896, $1,012 and $835 for the years ended September 30, 2004, 2003 and 2002, respectively. Through September 30, 2004 and 2003, a cumulative total of 923,717 shares and 786,706 shares, respectively, have been allocated to participants or committed to be released for allocation, respectively. The cost of ESOP shares that have not yet been allocated to participants or committed to be released for allocation is deducted from stockholders' equity (1,445,045 shares with a cost of $10,854 and a fair value of approximately $16,965 at September 30, 2004 and 583,405 shares with a cost of $1,597 and a fair value of approximately $5,500 at September 30, 2003, respectively).
A supplemental savings plan has also been established for certain senior officers. Expense recognized for this plan was $198, $67 and $68 for the years ended September 30, 2004, 2003 and 2002, respectively.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(e) Recognition and Retention Plan
In February 2000, the Company's stockholders approved the Provident Bank 2000 Recognition and Retention Plan (the RRP). The principal purpose of the RRP is to provide executive officers and directors a proprietary interest in the Company in a manner designed to encourage their continued performance and service. A total of 856,320 shares were awarded under the RRP in February 2000, and the grant-date fair value of these shares $(2,995) was charged to stockholders' equity. The awards vest at a rate of 20% on each of five annual vesting dates, the first of which was September 30, 2000. RRP expense was $506, $526 and $621 for the years ended September 30, 2004, 2003 and 2002, respectively. In 2003, 27,413 shares were forfeited and returned to the plan as available for future grant.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(f) Stock Option Plan
The stockholders also approved the Provident Bank 2000 Stock Option Plan (the Stock Option Plan) in February 2000. A total of 1,712,640 shares of authorized but unissued common stock has been reserved for issuance under the Stock Option Plan, although the Company may also fund option exercises using treasury shares. Options have a ten-year term and may be either non-qualified stock options or incentive stock options. Reload options may be granted and provide for the automatic grant of a new option at the then-current market price in exchange for each previously owned share tendered by an employee in a stock-for-stock exercise. Each option entitles the holder to purchase one share of common stock at an exercise price equal to the fair market value of the stock on the grant date.
The following is a summary of activity in the Stock Option Plan:
Weighted Shares subject average to option exercise price -------------- -------------- Outstanding at September 30, 2001 1,545,987 3.52
Granted 196,488 5.86 Exercised (385,584) 3.71 Forfeited (13,740) 3.50 ---------- ---------- Outstanding at September 30, 2002 1,343,151 3.81
Granted 47,065 7.08 Exercised (154,327) 3.96 Forfeited (22,385) 3.50 ---------- ---------- Outstanding at September 30, 2003 1,213,504 $ 3.92 ---------- ---------- Granted 191,418 11.77 Exercised (82,059) 3.70 ---------- ---------- Outstanding at September 30, 2004 1,322,863 $ 5.05 ========== ==========
Options exercisable at September 30, 2004, 2003 and 2002 totaled 1,182,863, 918,204 and 697,923 respectively, with a weighted average exercise price of approximately $4.25, $4.00 and $3.77 per share, respectively. These options had weighted average remaining terms of 6.0, 6.4 years and 7.4 years at the respective dates. There were 3,843 shares and 178,843 shares available for future option grants at September 30, 2004 and 2003, respectively.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(13) Comprehensive Income
Comprehensive income represents the sum of net income and items of other comprehensive income or loss that are reported directly in stockholders' equity, such as the change during the period in the after-tax net unrealized gain or loss on securities available for sale. The Company has reported its comprehensive income in the consolidated statements of changes in stockholders' equity.
The components of other comprehensive income (loss) are summarized as follows:
The Company's accumulated other comprehensive income included in stockholders' equity at September 30, 2004 and 2003 consists of the after-tax net unrealized (loss) gain of $(186) and $3,482, respectively and minimum liability for supplemental retirement plan of ( $111) at September 30, 2004.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(14) Earnings Per Common Share
The following is a summary of the calculation of earnings per share (EPS):
Years ended September 30, ------------------------------------- 2004 2003 2002 ------- ------- ------- (In thousands, except per share data) Net income $11,017 $11,251 $ 9,527 ======= ======= ======= Weighted average common shares outstanding for computation of basic EPS(1) (3) 36,809 34,186 34,137
Common-equivalent shares due to the dilutive effect of stock options and RRP awards(2) (3) 635 477 523 ------- ------- -------
Weighted average common shares for computation of diluted EPS $37,444 $34,663 $34,660 ======= ======= =======
Earnings per common share:(3) Basic $ 0.30 $ 0.33 $ 0.28 Diluted 0.29 0.32 0.27 ======= ======= =======
(1) Includes all shares issued to the Mutual Holding Company (2004 up until January 14, 2004 and for 2003 and 2002), but excludes unallocated ESOP shares.
(2) Represents incremental shares computed using the treasury stock method.
(3) Prior period share information has been adjusted to reflect the 4.4323-to-one conversion ratio in connection with the Company's second-step conversion in January 2004.
(15) Stockholders' Equity
(a) Regulatory Capital Requirements
OTS regulations require savings institutions to maintain a minimum ratio of tangible capital to total adjusted assets of 1.5%, a minimum ratio of Tier 1 (core) capital to total adjusted assets of 4.0%, and a minimum ratio of total (core and supplementary) capital to risk-weighted assets of 8.0%.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Under its prompt corrective action regulations, the OTS is required to take certain supervisory actions (and may take additional discretionary actions) with respect to an undercapitalized institution. Such actions could have a direct material effect on the institution's financial statements. The regulations establish a framework for the classification of savings institutions into five categories - well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Generally, an institution is considered well-capitalized if it has a Tier 1 (core) capital ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least 6.0%, and a total risk-based capital ratio of at least 10.0%.
The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the OTS about capital components, risk weightings and other factors. These capital requirements apply only to the Bank, and do not consider additional capital retained by Provident Bancorp, Inc.
Management believes that, as of September 30, 2004 and 2003 the Bank met all capital adequacy requirements to which it was subject. Further, the most recent OTS notification categorized the Bank as a well-capitalized institution under the prompt corrective action regulations. There have been no conditions or events since that notification that management believes have changed the Bank's capital classification.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The following is a summary of the Bank's actual regulatory capital amounts and ratios at September 30, 2004 and 2003, compared to the OTS requirements for minimum capital adequacy and for classification as a well-capitalized institution. PMB is also subject to certain regulatory capital requirements which it satisfied as of September 30, 2004 and 2003.
Tangible and Tier 1 capital amounts represent the stockholder's equity of the Bank, less intangible assets and after-tax net unrealized gains on securities available for sale. Total capital represents Tier 1 capital plus the allowance for loan losses up to a maximum amount equal to 1.25% of risk-weighted assets.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The following is a reconciliation of the Bank's total stockholder's equity under accounting principles generally accepted in the United States of America ("GAAP") and its regulatory capital:
September 30, ------------------------ 2004 2003 --------- --------- Total GAAP stockholder's equity $ 259,790 $ 112,039 Goodwill and intangible assets (70,490) (15,163) Unrealized gain on securities available for sale 186 (3,379) --------- --------- Tangible, tier 1 core and Tier 1 risk-based capital 189,486 93,497 Allowance for loan losses 14,290 8,544 --------- --------- Total risk-based capital $ 203,776 $ 102,041 ========= =========
(b) Dividend Payments
Under OTS regulations, savings associations such as the Bank generally may declare annual cash dividends up to an amount equal to the sum of net income for the current year and net income retained for the two preceding years. Dividend payments in excess of this amount require OTS approval. The Bank paid cash dividends of $15 million to Provident Bancorp, Inc. during the year ended September 30, 2004 ( $3,500 during the year ended September 30, 2003 and none during the year ended September 30, 2002).
Unlike the Bank, Provident Bancorp, Inc. is not subject to OTS regulatory limitations on the payment of dividends to its shareholders.
(c) Stock Repurchase Programs
The Company completed a stock repurchase program during the year ended September 30, 2000, purchasing 193,200 (unadjusted for the 4.4323-to-one conversion) common shares for the treasury at a total cost of $3,061. In July 2000, the Company announced a second repurchase program to acquire up to 5%, or 183,540, of its publicly-traded shares as market conditions warrant. This
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
program was completed in May 2003. A third repurchase program was announced in March 2003 to acquire up to 5% or approximately 177,250 shares. The authorization to repurchase shares of the Company's common stock expired in connection with its second step conversion on January 14, 2004, pursuant to applicable Office.of Thrift Supervision regulations that restricted stock repurchases for one year following the completion of a mutual stock conversion. The restriction does not apply to treasury stock purchases in connection with ESOP and option plans.
(d) Liquidation Rights
All depositors who had liquidation rights with respect to the Bank as of the effective date of the Reorganization continue to have such rights solely with respect to the Mutual Holding Company, as long as they continue to hold deposit accounts with the Bank. In addition, all persons who were depositors of the Bank as of the date of the second step stock offering have liquidation rights with respect to the Mutual Holding Company.
(16) Off-Balance-Sheet Financial Instruments
In the normal course of business, the Company is a party to off-balance-sheet financial instruments that involve, to varying degrees, elements of credit risk and interest rate risk in addition to the amounts recognized in the consolidated financial statements. The contractual or notional amounts of these instruments, which reflect the extent of the Company's involvement in particular classes of off-balance-sheet financial instruments, are summarized as follows:
September 30, ---------------------- 2004 2003 -------- -------- Lending-related instruments: Loan origination commitments: Fixed-rate loans $ 11,671 $ 15,742 Adjustable-rate loans 78,694 55,602 Unused lines of credit 120,695 79,593 Standby letters of credit 12,711 8,976
(a) Lending-Related Instruments
The contractual amounts of loan origination commitments, unused lines of credit and standby letters of credit represent the Company's maximum potential exposure to credit loss, assuming (i) the instruments are fully funded at a later date, (ii) the borrowers do not meet the contractual payment obligations, and (iii) any collateral or other security proves to be worthless. The contractual amounts of these instruments do not necessarily represent future cash requirements since certain of these instruments may expire without being funded and others may not be fully drawn upon. Substantially all of these lending-related instruments have been entered into with customers located in the Company's primary market area described in Note 6.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Loan origination commitments are legally-binding agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments have fixed expiration dates (generally ranging up to 60 days) or other termination clauses, and may require payment of a fee by the customer. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral, if any, obtained by the Company upon extension of credit, is based on management's credit evaluation of the borrower. Collateral varies but may include mortgages on residential and commercial real estate, deposit accounts with the Company, and other property. The Company's fixed-rate loan origination commitments at September 30, 2004 provide for interest rates ranging principally from 4.25% to 8.25%.
Unused lines of credit are legally-binding agreements to lend to a customer as long as there is no violation of any condition established in the contract. Lines of credit generally have fixed expiration dates or other termination clauses. The amount of collateral obtained, if deemed necessary by the Company, is based on management's credit evaluation of the borrower.
Standby letters of credit are commitments issued by the Company on behalf of its customer in favor of a beneficiary that specify an amount the Company can be called upon to pay upon the beneficiary's compliance with the terms of the letter of credit. These commitments are primarily issued in favor of local municipalities to support the obligor's completion of real estate development projects. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
As of September 30, 2004, the Company had $12,711in outstanding letters of credit, of which $3,871 were secured by cash collateral.
(b) Interest Rate Cap Agreements
At September 30, 2002, the Company was a party to two interest rate cap agreements with a total notional amount of $50,000. These interest rate caps matured in March and April 2003. These agreements were entered into to reduce the variability of cash flows from potentially higher interest payments associated with upward interest rate repricings on a portion of the Company's certificate of deposit accounts and borrowings. The counterparties to the agreements are obligated to make payments to the Company, based on the notional amounts, to the extent that the three-month LIBOR rate exceeds specified levels during the term of the agreements. These specified rate levels were 8.25% and 6.50% for interest rate cap agreements with notional amounts of $30,000 and $20,000, respectively.
The Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as of October 1, 2000, and recorded an after-tax transition adjustment of $41 to recognize the interest rate cap agreements at fair value. The Company's interest rate cap agreements were accounted for as cash flow hedges under SFAS No. 133 and were reported at fair value, which was insignificant at September 30, 2002. Interest expense for the years ended September 30, 2004, 2003, and 2002 includes charges of $0, $16, and $64, respectively, for the effect of the interest rate cap agreements. The remaining amount reported in accumulated other
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
comprehensive income with respect to these agreements at September 30, 2002 was reclassified into earnings during fiscal 2003.
(17) Commitments and Contingencies
Certain premises and equipment are leased under operating leases with terms expiring through 2025. The Company has the option to renew certain of these leases for terms of up to five years. Future minimum rental payments due under noncancelable operating leases with initial or remaining terms of more than one year at September 30, 2004 are $2,603 for fiscal 2005, $1,467 for fiscal 2006, $1,361 for fiscal 2007, $1,419 for fiscal 2008, $851 for fiscal 2009 and a total of $11,249 for later years. Occupancy and office operations expense includes net rent expense of $1,435, $1,202, and $1,137 for the years ended September 30, 2004, 2003 and 2002, respectively.
The Company is a defendant in certain claims and legal actions arising in the ordinary course of business. Management, after consultation with legal counsel, does not anticipate losses on any of these claims or actions that would have a material adverse effect on the consolidated financial statements.
(18) Fair Values of Financial Instruments
SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of fair value information for those financial instruments for which it is practicable to estimate fair value, whether or not such financial instruments are recognized in the consolidated statements of financial condition. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation.
Quoted market prices are used to estimate fair values when those prices are available, although active markets do not exist for many types of financial instruments. Fair values for these instruments must be estimated by management using techniques such as discounted cash flow analysis and comparison to similar instruments. These estimates are highly subjective and require judgments regarding significant matters, such as the amount and timing of future cash flows and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates. Since these estimates are made as of a specific point in time, they are susceptible to material near-term changes. Fair values disclosed in accordance with SFAS No. 107 do not reflect any premium or discount that could result from the sale of a large volume of a particular financial instrument, nor do they reflect possible tax ramifications or estimated transaction costs.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
The following is a summary of the carrying amounts and estimated fair values of financial assets and liabilities (none of which were held for trading purposes):
The following paragraphs summarize the principal methods and assumptions used by management to estimate the fair value of the Company's financial instruments.
(a) Securities
The estimated fair values of securities were based on quoted market prices.
(b) Loans
Fair values were estimated for portfolios of loans with similar financial characteristics. For valuation purposes, the total loan portfolio was segregated into adjustable-rate and fixed-rate categories. Fixed-rate loans were further segmented by type, such as residential mortgage, commercial mortgage, commercial business and consumer loans. Loans were also segmented by maturity dates.
Fair values were estimated by discounting scheduled future cash flows through estimated maturity using a discount rate equivalent to the current market rate on loans that are similar with regard to collateral, maturity and the type of borrower. The discounted value of the cash flows was reduced by a credit risk adjustment based on loan categories. Based on the current composition of the Company's loan portfolio, as well as past experience and current economic conditions and trends, the future cash flows were adjusted by prepayment assumptions that shortened the estimated remaining time to maturity and therefore affected the fair value estimates.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(c) Deposits
In accordance with SFAS No. 107, deposits with no stated maturity (such as savings, demand and money market deposits) were assigned fair values equal to the carrying amounts payable on demand. Certificates of deposit were segregated by account type and original term, and fair values were estimated by discounting the contractual cash flows. The discount rate for each account grouping was equivalent to the current market rates for deposits of similar type and maturity.
These fair values do not include the value of core deposit relationships that comprise a significant portion of the Company's deposit base. Management believes that the Company's core deposit relationships provide a relatively stable, low-cost funding source that has a substantial value separate from the deposit balances.
(d) FHLB Borrowings
Fair values of FHLB borrowings were estimated by discounting the contractual cash flows. A discount rate was utilized for each outstanding borrowing equivalent to the then-current rate offered by the FHLB on borrowings of similar type and maturity.
(e) Other Financial Instruments
The other financial assets and liabilities listed in the preceding table have estimated fair values that approximate the respective carrying amounts because the instruments are payable on demand or have short-term maturities and present relatively low credit risk and interest rate risk.
The fair values of the Company's off-balance-sheet financial instruments described in Note 16 were estimated based on current market terms (including interest rates and fees), considering the remaining terms of the agreements and the credit worthiness of the counterparties. At September 30, 2004 and 2003, the estimated fair values of these instruments approximated the related carrying amounts, which were insignificant.
(19) Recent Accounting Standards and Interpretations
FASB Interpretation (FIN) No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, was issued in November 2002. 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. The disclosure requirements in this interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The interpretation also requires a guarantor to recognize, at fair value, a liability for the obligation at inception of the guarantee (effective for guarantees issued or modified after December 31, 2002). The adoption of FIN No. 45 did not have a material impact on the consolidated financial statements.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123. This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effects of the method used on reported results. The provisions of this statement are not expected to have a material impact on the consolidated financial statements.
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, to provide guidance on the identification of entities controlled through means other than voting rights. FIN No. 46 specifies how a business enterprise should evaluate its interests in a variable interest entity to determine whether to consolidate that entity. A variable interest entity must be consolidated by its primary beneficiary if the entity does not effectively disperse risks among the parties involved. A public company with a variable interest in an entity created before February 1, 2003 must apply FIN No. 46 in the first interim or annual period ending after December 15, 2003. The adoption of FIN No. 46 is not expected to have a significant effect on the consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, for certain decisions made by the Board as part of the Derivative Implementation Group process. This statement is effective for contracts entered into or modified after June 30, 2003 and hedging relationships designated after June 30, 2003. Management does not expect that the provisions of SFAS No. 149 will have a material impact on the results of operations or financial condition.
SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity was issued in May 2003. Under this statement, certain freestanding financial instruments that embody obligations for the issuer and that are now classified in equity, must be classified as liabilities (or as assets in some circumstances). Generally, SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. However, the effective date of the statement's provisions related to the classification and measurement of certain mandatorily redeemable non-controlling interests has been deferred indefinitely by the FASB, pending further Board action. Adoption of this standard did not have an impact on the consolidated financial statements.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
In November 2003, the Emerging Issues Task Force ("EITF") issued issue summary 03-1 ("EITF 03-1"), The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. EITF 03-01 addressed an entity's treatment of the impairment of securities when such impairment is considered other than temporary. The preliminary summary required disclosures only related to other than temporary impairment. In March 2004, the EITF continued its discussion and reached a consensus on the procedures for recognizing an impairment of securities considered other than temporarily impaired. The guidance in EITF 03-1 was intended to be effective for reporting periods beginning after June 15, 2004. However, in September 2004, the FASB issued FSP EITF 03-1-1, which deferred the effective date for the measurement and recognition provisions of EITF 03-1 until further implementation guidance could be established. Management does not believe the provisions of this standard, as currently written, will have a material impact on the results of future operations.
In December 2003, the Accounting Standards Executive Committee ("AcSEC") issued Statement of Position ("SOP") 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer." The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. The SOP addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. The SOP applies to loans acquired in business combinations but does not apply to loans originated by the Company. Management does not believe the provision of this standard will have a material impact on the results of future operations.
On March 9, 2004, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 105, Application of Accounting Principles to Loan Commitments. SAB No. 105 requires that when a company is recognizing and valuing a loan commitment at fair value, only differences between the guaranteed interest rate in the loan commitment and a market interest rate should be included. Any expected future cash flows related to the customer relationships or loan servicing should be excluded from the fair value measurement. The expected future cash flows that are excluded from the fair-value determination include anticipated fees for servicing the funded loan, late-payment charges, other ancillary fees, or other cash flows from servicing rights. The guidance in SAB No. 105 is effective for mortgage-loan commitments that are accounted for as derivatives and are entered into after March 31, 2004. Management does not believe the provisions of this standard will have a material impact on the results of future operations.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(20) Condensed Parent Company Financial Statements
Set forth below are the condensed statements of financial condition of Provident Bancorp, Inc. and the related condensed statements of income and cash flows:
September 30, Condensed Statements of --------------------- Financial Condition 2004 2003 -------- -------- Assets: Cash $ 74,726 $ 3,640 Securities available for sale -- 2,297 Loan receivable from ESOP 11,491 1,880 Investment in Provident Bank 258,922 110,441 Other assets 5,182 107 -------- -------- Total assets $350,321 $118,365 ======== ======== Liabilities $ 809 $ 508 Stockholders' equity 349,512 117,857 -------- -------- Total liabilities and stockholders' equity $350,321 $118,365 ======== ========
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(21) Quarterly Results of Operations (Unaudited)
The following is a condensed summary of quarterly results of operations for the years ended September 30, 2004 and 2003:
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and - -------------------------------------------------------------------------------- Financial Disclosure --------------------
None
ITEM 9A.
ITEM 9A. Controls and Procedures. - ---------------------------------
(a) Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this annual report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.
(b) Changes in internal controls.
There were no significant changes made in our internal control over financial reporting during the period covered by this report or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation.
PART III
ITEM 9B.
ITEM 9B. Other Information. - ---------------------------
Not applicable.
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant - -----------------------------------------------------------
The "Proposal I - Election of Directors" section of Provident Bancorp's Proxy Statement for the Annual Meeting of Stockholders to be held in February 2005 (the "Proxy Statement") is incorporated herein by reference.
ITEM 11.
ITEM 11. Executive Compensation - -------------------------------
The "Proposal I - Election of Directors" section of the Proxy Statement is incorporated herein by reference.
PROVIDENT BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management & - -------------------------------------------------------------------------------- Related Stockholder Matters ---------------------------
Provident Bancorp does not have any equity compensation programs that were not approved by stockholders, other than its employee stock ownership plan.
Set forth below is certain information as of September 30, 2004, regarding equity compensation that has been approved by stockholders.
(1) Represents shares that have been granted but have not yet vested.
(2) Weighted average exercise price represents Stock Option Plan only, since RRP shares have no exercise price.
The "Proposal I - Election of Directors" section of the Proxy Statement is incorporated herein by reference.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions - -------------------------------------------------------
The "Transactions with Certain Related Persons" section of the Proxy Statement is incorporated herein by reference.
ITEM 14.
ITEM 14. Principal Accountant Fees and Services - -----------------------------------------------
The "Proposal IV - Ratification of Appointment of Independent Registered Public Accounting Firm" section of the proxy statement is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - -------------------------------------------------------------------------
(1) Financial Statements --------------------
The financial statements filed in Item 8 of this Form 10-K are as follows:
(A) Independent Auditors' Report
(B) Consolidated Statements of Financial Condition as of September 30, 2004 and 2003
(C) Consolidated Statements of Income for the years ended September 30, 2004, 2003 and 2002
(D) Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income for the years ended September 30, 2004, 2003, and 2002
(E) Consolidated Statements of Cash Flows for the years ended September 30, 2004, 2003 and 2002
(F) Notes to Consolidated Financial Statements
(2) Financial Statement Schedules -----------------------------
All financial statement schedules have been omitted as the required information is inapplicable or has been included in the Notes to Consolidated Financial Statements.
(3) Exhibits --------
3.1 Certificate of Incorporation of Provident Bancorp, Inc.*
3.2 Bylaws of Provident Bancorp, Inc.*
4 Form of Common Stock Certificate of Provident Bancorp, Inc.*
10.1 Employee Stock Ownership Plan**
10.2 Employment Agreement with George Strayton, as amended**
10.3 Form of Employment Agreement**
10.4 Deferred Compensation Agreement, as amended and restated*
10.5 Supplemental Executive Retirement Plan, as amended**
10.6 Management Incentive Program**
10.7 1996 Long-Term Incentive Plan for Officers and Directors, as amended**
10.8 Provident Bank 2000 Stock Option Plan***
10.9 Provident Bank 2000 Recognition and Retention Plan***
10.10 Employment Agreement with Paul A. Maisch*****
14 Code of Ethics****
21 Subsidiaries of Registrant
23 Consent of KPMG LLP
24 Power of Attorney (set forth on signature page)
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification Pursuant to 18 U.S.C. Section 1350, as amended by Section 906 of the Sarbanes-Oxley Act of 2002
- ----------
* Incorporated by reference to the Registration Statement on Form S-1 (File No. 333-108795), originally filed with the Commission on September 15, 2003 and amended on October 31, 2003 and November 10, 2003.
** Incorporated by reference to the Registration Statement on Form S-1 of Provident Bancorp, Inc., a federal corporation (File No. 333-63593), originally filed with the Commission on September 17, 1998 and amended on November 6, 1998 and November 12, 1998.
*** Incorporated by reference from the Proxy Statement for the 2000 Annual Meeting of Stockholders of Provident Bancorp, Inc., a federal corporation (File No. 0-25233), filed with the Commission on January 18, 2000.
**** Incorporated by reference from the Annual Report on Form 10-K of Provident Bancorp, Inc., a federal corporation (File No. 0-25233), filed with the Commission on December 29, 2003.
***** Incorporated by reference from the Quarterly Report on Form 10-Q of Provident Bancorp, Inc., a federal corporation (File No. 0-25233), filed with the Commission on August 12, 2004.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, Provident Bancorp has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Provident Bancorp, Inc.
Date: December 13, 2004 By: /s/ George Strayton ---------------------------------- George Strayton President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
By: /s/ George Strayton By: /s/ Paul A. Maisch ------------------------------- ---------------------------------- George Strayton Paul A. Maisch President, Chief Executive Chief Financial Officer and Officer and Director Senior Vice President
Date: December 13, 2004 Date: December 13, 2004
By: /s/ William F. Helmer By: /s/ Dennis L. Coyle ------------------------------- ---------------------------------- William F. Helmer Dennis L. Coyle, Vice Chairman Chairman of the Board
Date: December 13, 2004 Date: December 13, 2004
By: /s/ Judith Hershaft By: /s/ Thomas F. Jauntig, Jr. ------------------------------- ---------------------------------- Judith Hershaft, Director Thomas F. Jauntig, Jr., Director
Date: December 13, 2004 Date: December 13, 2004
By: /s/ Donald T. McNelis By: /s/ Richard A. Nozell ------------------------------- ---------------------------------- Donald T. McNelis, Director Richard A. Nozell, Director
Date: December 13, 2004 Date: December 13, 2004
By: /s/ William R. Sichol, Jr. By: /s/ Burt Steinberg ------------------------------- ---------------------------------- William R. Sichol, Jr., Burt Steinberg, Director Director
Date: December 13, 2004 Date: December 13, 2004
By: /s/ F. Gary Zeh By: /s/ Victoria Kossover ------------------------------- ---------------------------------- F. Gary Zeh, Director Victoria Kossover, Director
Date: December 13, 2004 Dated: December 13, 2004