ITEM 1. Business - ----------------
Provident New York Bancorp
Provident New York Bancorp ("Provident Bancorp" or the "Company") is a Delaware corporation that owns all of the outstanding shares of common stock of Provident Bank (the "Bank"). On June 29, 2005 the Company changed its name from Provident Bancorp, Inc. to Provident New York Bancorp in order to differentiate itself from the numerous bank holding companies with similar names. At September 30, 2005, Provident Bancorp had consolidated assets of $2.6 billion, deposits of $1.7 billion and stockholders' equity of $395.2 million. As of September 30, 2005, Provident Bancorp had 43,505,659 shares of common stock outstanding.
Acquisition of Warwick Community Bancorp, Inc.
On October 1, 2004 the Company completed the acquisition of Warwick Community Bancorp, Inc. ("WSB" or "Warwick"). The Company paid $72.6 million in cash and issued 6,257,896 shares of its common stock in connection with the acquisition for total merger consideration of $147.2 million. 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 $703.7 million in consolidated assets, $284.5 million in loans and $475.1 million in deposits.
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 exchanged for 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 $76.5 million, consisting of 3,969,671 shares of common stock of the Company and approximately $36.8 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.
Financial statements as of September 30, 2005, reflect the effect of the exchange of shares in the second-step conversion, the stock offering, the acquisitions of ENB and WSB and the issuance of shares and contribution of cash to the charitable foundation. Goodwill recorded in the ENB and WSB acquisitions ($52.6 million and $91.6 million, respectively) 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 resulting from all acquisitions, of $13.8 million at September 30, 2005, is recognized apart from goodwill and amortized to expense over its estimated useful life and evaluated for impairment.
Provident Bank
Provident Bank, an independent, full-service community bank founded in 1888, is the banking subsidiary of Provident New York Bancorp, headquartered in Montebello, New York. With $2.6 billion in assets and almost 600 employees, we operate 35 branches that serve the Hudson Valley region, including 34 branches located in Rockland, Orange, Sullivan, Ulster and Putnam Counties in New York, and one branch in Bergen County, New Jersey that operates under the name Towncenter Bank, a division of Provident Bank, New York. We also offer deposit services to municipalities located in the State of New York through Provident Bank's wholly-owned subsidiary, Provident Municipal Bank. Provident Bank offers a complete line of commercial, community business and retail banking products and services.
We have increased our number of branch offices from 11 branch offices at September 30, 1998 to 35 branch offices at September 30, 2005. 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 the ENB and WSB acquisitions, 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, as well as ownership report on Forms 3,4 and 5 filed by the Company's directors and executive officers. Copies may also be obtained, without charge, by written request to Provident Bancorp Investor Relations, Attention: Christina Maier, 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 banks, including federally chartered savings associations, such as Provident Bank.
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 the effect on Provident Bancorp's operation from the assimilation of recent acquisitions. 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, 2005, our 35 full-service banking offices consisted of 13 offices in Rockland County, New York, 16 offices in Orange County, New York, and five offices in contiguous Ulster, Putnam, and Sullivan Counties, New York. There is one office located in Lodi, New Jersey operating as Towncenter Bank, a division of Provident Bank, 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. According to data published by the Federal Deposit Insurance Corporation ("FDIC") as of June 30, 2005, Provident Bank holds the #3 market share of deposits in Rockland and #2 share of deposits in Orange County, and overall has the #1 share of deposits in the combined markets of Rockland and Orange Counties, New York.
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 $497.9 million, or 36.6% of our total loan portfolio at September 30, 2005, and consisted of 1,101 loans outstanding with an average loan balance of approximately $452,000, 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 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 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, 2005, we had 1,791 commercial business loans outstanding with an aggregate balance of $148.8 million, or 10.9% of the total loan portfolio. As of September 30, 2005, the average commercial business loan balance was approximately $83,000, 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 $456.8 million, or 33.5% of our total loan portfolio at September 30, 2005.
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 $359,650 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 2005, totaling $19.1 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 2005 was $5.6 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, 2005, biweekly loans totaled $167.6 million, or 36.7% 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, 2005, loans serviced for others totaled $108.9 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, if the loan is not already refinanced, 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, 2005, our ARM portfolio included $5.8 million in loans that re-price every six months, $46.1 million in loans that re-price once a year and $7.8 million in loans that re-price 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. For loans with initial loan-to-value ratios in excess of 80% we generally require private mortgage insurance, although occasional exceptions may be made. Nearly all residential loans are generally required to have a mortgage escrow account from which disbursements are made for real estate taxes and for hazard and flood insurance.
Construction Loans, Land Acquisition and Development. We originate land acquisition, development and construction loans to builders in our market area. These loans totaled $66.7 million, or 4.9% of our total loan portfolio at September 30, 2005. 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, 2005, consumer loans totaled $191.8 million, or 14.1% of the total loan portfolio.
At September 30, 2005, the largest group of consumer loans consisted of $175.2 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, 2005, homeowner loans totaled $40.2 million or 3.0% of our total loan portfolio. The disbursed portion of home equity lines of credit totaled $135.0 million, or 9.9% of our total loan portfolio at September 30, 2005, with $111.8 million remaining undisbursed.
Other consumer loans include personal loans and loans secured by new or used automobiles. As of September 30, 2005, these loans totaled $16.6 million, or 1.2% 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 at our loan portfolio at September 30, 2005. 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 land acquisition loans.
The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at September 30, 2005 that are contractually due after September 30, 2006
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 generally 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 million. 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 $20 million, for the next group of borrowers is $15 million, and for the third group is $12 million. Sublimits apply based on reliance on any single property, and for commercial business loans.
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 $2.1 million at September 30, 2005.
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 $836,000 are included in other assets at September 30, 2005. See also Notes 3 and 6 of the Notes to Consolidated Financial Statements.
Loans to One Borrower. At September 30, 2005, 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 $13.8 million, $13.4 million, $10.4 million, $9.6 million and $9.5 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 the16th 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, unless well secured and in the process of collection (primarily residential mortgages). 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 related to current year income and charged to the allowance for loan losses with respect to income that was recorded in the prior fiscal year. 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, 2005, we had non-accrual loans of $212,000 and $1.4 million of loans 90 days past due and still accruing interest, which were well secured and in the process of collection. (For the years ended September 30, 2004 and prior there were no loans 90 days past due and still accruing).
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, 2005 we had two REO properties with a recorded balance of $92,000.
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, 2005, 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 $8,000. Interest income actually recognized on such loans totaled $7,000.
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 bank 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, 2005, we had $12.0 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 a problem asset 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, 2005, classified assets consisted of substandard assets of $1.9 million and $119,000 of doubtful assets.
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, and 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.
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.
Government Securities. At September 30, 2005, we held government securities available for sale with a fair value of $257.6 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, 2005, 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 10% of assets. At September 30, 2005, we held $93.6 million in bonds issued by states and political subdivisions, $43.9 million of which were classified as held to maturity at amortized cost and $49.7 million of which were classified as available for sale at fair value.
Equity Securities. At September 30, 2005, our equity securities available for sale had a fair value of $858,000 and consisted of stock issued by Freddie Mac and Fannie Mae, and certain other equity investments. We also held $21.3 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 on FHLBNY stock recorded in the year ended September 30, 2005 amounted to $688,000.
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 or private issuers for CMOs. To a lesser extent, we also invest in securities backed by agencies of the U.S. Government. At September 30, 2005, our mortgage-backed securities portfolio totaled $541.5 million, consisting of $514.8 million available for sale at fair value and $26.7 million held to maturity at amortized cost. The total mortgage-backed securities portfolio includes CMOs of $24.5 million, consisting of $22.6 million available for sale at fair value and $1.9 million held to maturity at amortized cost. The remaining mortgage-backed securities of $517.0 million were pass-through securities, consisting of $492.2 million available for sale at fair value and $24.8 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 Gmnnie 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 and duration of 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, 2005, our available for sale U. S. Treasury securities portfolio, at fair value, totaled $18.6 million, or 0.7% of total assets, and the federal agency securities portfolio, at fair value, totaled $239.0 million, or 9.2% of total assets. Of the combined U.S. Government and agency portfolio, based on amortized cost, $17.0 million had maturities of one year or less and a weighted average yield of 2.56%, and $245.6 million had maturities of between one and five years and a weighted average yield of 3.11%. 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.
State and municipal securities portfolio, based on amortized cost, had $0.7 million in securities with a final maturity of one year or less and a weighted average yield of 2.95%, and $4.2 million maturing in one to five years with a weighted average yield of 2.88%, $8.1 million maturing in five to ten years with a weighted average yield of 3.81% and $37.2 million maturing in greater than ten years with a weighted average yield of 4.06%. Equity securities available for sale at September 30, 2005 had a fair value of $858,000.
At September 30, 2005, $492.2 million of our available for sale mortgage-backed securities, at fair value, consisted of pass-through securities, which totaled 19.0% of total assets with a weighted average yield of 4.43%. Of this amount, $433.8 million with a weighted average yield of 4.49% had contractual maturities in excess of ten years. At the same date, the fair value of our available for sale CMO portfolio totaled $22.6 million, or 0.9% 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 4.0%. We own both fixed-rate and floating-rate CMOs. The underlying mortgage collateral for our portfolio of CMOs available for sale at September 30, 2005 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, 2005, our held to maturity mortgage-backed securities portfolio totaled $26.7 million at amortized cost, consisting of: $90,000 with a weighted average yield of 7.43% and contractual maturities of one year or less and $2.5 million with a weighted average yield of $5.90% and contractual maturities within five years and $6.3 million with a weighted average yield of 6.04% and contractual maturities of greater than five years, but no more than ten and $17.9 million with a weighted average yield of 4.39% with contractual maturities of greater than ten years; CMOs of $2.0 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.
State and municipal securities of $23.7 million a final maturity of one year or less with a weighted average yield of 2.61%, and 8.0 million maturing in one to five years with a weighted average yield of 3.69%, $9.4 million maturing in five to ten years with a weighted average yield of 4.05% and $2.8 million maturing in greater than ten years with a weighted average yield of 4.39%
Portfolio Maturities and Yields. The composition and maturities of the investment debt securities portfolio and the mortgage backed securities portfolio at September 30, 2005 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, 2005, our deposits totaled $1.7 billion. Interest-bearing deposits totaled $1.3 billion, and non-interest-bearing demand deposits totaled $385.1 million. NOW, savings and money market deposits totaled $869.7 million at September 30, 2005. Also at that date, we had a total of $471.6 million in certificates of deposit, of which $406.2 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, 2005.
- ---------- (1) The weighted interest rates for these accounts, by maturity period, are 2.78% for 3 months or less; 2.70% for 3 to 6 months; 3.11% for 6 to 12 months; and 3.34% for over 12 months. The overall weighted average interest rate for accounts of $100,000 or more was 3.23%.
Borrowings. Our borrowings consist of advances and repurchase agreements. At September 30, 2005, we had access to additional Federal Home Loan Bank advances of up to $31.6 million based upon pledged mortgages and an additional $522.6 million on a collateralized basis. 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 banks, including federally chartered savings associations, such as Provident Bank. Provident Municipal Bank began operations in 2002, and at September 30, 2005 had $116.9 million in deposits from municipal entities in the communities served by Provident Bank.
Provest Services Corp.I 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, life and health insurance products to Provident Bank's customers. Through September 30, 2005, 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. WSB Funding was acquired in the Warwick acquisition and operates in the same manner as Provident REIT. Hardenburgh Abstract Company of Orange County Inc. ("Hardenburgh") is a title insurance agency that we acquired in connection with the acquisition of WSB. Hardenburgh had gross revenue from title insurance policies and abstracts of $1.6 million and net income of $377 thousand.
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 year ending September 30, 2003.
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, 2005, we had 508 full-time employees and 59 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 finds 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 New York Bancorp, 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, 2005, 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, 2005, 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 bank, 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, 2005, Provident Bank maintained approximately 82.5% 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.
o the maximum amount of dividends that could be declared by Provident Bank without regulatory approval as of October 1, 2005 was $19,864,000 plus net income of the Bank for fiscal 2006
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-bank 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 banks 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 bank. 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, 2005, 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 0.0144% of insured deposits to fund interest payments on bonds maturing in 2017 through 2019 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, 2005, Provident Bank was in compliance with this requirement. As of December 1, 2005 new capital standards will be implemented. Based on our assets and borrowings, as of September 30, 2005 we will be required to purchase an additional $1.2 million of stock in the Federal Home Loan Bank of New York.
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, 2005, 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 of 2001 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. Title III of the Act is the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001, which includes numerous provisions for fighting international money laundering and blocking terrorist access to the U.S. financial system. The provisions of the USA PATRIOT Act affecting banking organizations are generally set forth as amendments to the Bank Secrecy Act. 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 restrictions 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.) Federal law also requires all U.S. persons to comply with economic restrictions and trade sanctions administered and enforced by the Office of Foreign Assets Control ("OFAC"). OFAC rules apply to all financial institutions through which funds might travel. We have established policies, procedures and systems designed to comply with the USA PATRIOT Act and implementing regulations, as well as with OFAC.
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-bank 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 bank 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 banks, the Office of Thrift Supervision must consider the financial and managerial resources and future prospects of the bank 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 implemented a broad range of corporate governance, accounting and reporting measures for companies that have securities registered under the Exchange Act, including publicly-held bank holding companies such as Provident. Specifically, the Sarbanes-Oxley Act of 2002 and the various regulations promulgated thereunder, established, among other things: (i) new requirements for audit committees, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) the forfeiture of bonuses or other incentive-based compensation and profits from the sale of the reporting company's securities by the Chief Executive Officer in the twelve-month period following the initial publication of any financial statements that later require restatement; (iv) the creation of an independent accounting oversight board; (v) new standards for auditors and regulation of audits, including independence provisions that restrict non-audit services that accountants may provide to their audit clients; (vi) increased disclosure and reporting obligations for the reporting company and their directors and executive officers, including accelerated reporting of stock transactions and a prohibition on trading during pension blackout periods; (vii) a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions on nonpreferential terms and in compliance with other bank regulatory requirements; and (viii) a range of new and increased civil and criminal penalties for fraud and other violations of the securities law.
The Company's Chief Executive Officer and Chief Financial Officer are required to certify that its quarterly and annual reports filled with the Securities and Exchange Commission do not contain any untrue statement of a material fact. Rules promulgated under the Sarbanes-Oxley Act require that these officers certify that: they are
responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal controls; they have made certain disclosures to our auditors and the audit committee of the Board of Directors about our internal controls; and they have included information in our quarterly and annual reports about their evaluation and whether there have been significant changes in our internal controls or in other factors that could significantly affect internal controls. The Company has existing policies, procedures and systems designed to comply with the Sarbanes-Oxley Act.
ITEM 1A.
ITEM 1A. Risk Factors - ---------------------
Our Commercial Real Estate, Commercial Business and Construction Loans Expose Us to Increased Credit Risks.
At September 30, 2005, our portfolio of commercial real estate loans totaled $497.9 million, or 36.6 % of total loans, our commercial business loan portfolio totaled $148.8 million, or 10.9%, and our portfolio of construction loans totaled $66.7 million, or 4.9% of total loans. We plan to continue to emphasize the origination of these types of loans. Commercial real estate, commercial business and construction loans generally have greater credit risk than one to four family residential mortgage loans because repayment of these loans often depends on the successful business operations on the borrowers. These loans typically have larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Many of our borrowers also have more than one commercial real estate, commercial business or construction loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship may expose us to significantly greater risk of loss, compared to an adverse development with respect to a one- to four-family residential mortgage loan.
Changes in the Value of Goodwill Could Reduce Our Earnings.
We are required by accounting principles generally accepted in the United States of America to test goodwill for impairment at least annually. Testing for impairment of goodwill 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 used. As of September 30, 2005, if our goodwill were fully impaired and we were required to charge-off all of our goodwill, the pro forma reduction to our stockholders' equity would be approximately $3.62 per share.
We May Have Difficulty Managing Our Growth, Which May Divert Resources and Limit Our Ability to Successfully Expand Our Operations.
We have experienced substantial growth from acquisitions, from $757.9 million of total assets and $595.1 million of total deposits at December 31, 1998 to $2.6 billion of total assets and $1.7 billion of total deposits at September 30, 2005.
Since 1998, we have expanded our branch network by both acquiring financial institutions and establishing de novo branches. At September 30, 1998, we had 11 branch offices, compared to 35 branches at September 30, 2005.
We have incurred substantial expenses to build our management team and personnel, develop our delivery systems and establish an infrastructure to support future growth. Our future success will depend on the ability of our officers and key employees to continue to implement and improve our operational, financial and management controls, reporting systems and procedures, and to manage a growing number of client relationships. We may not be able to successfully implement improvements to our management information and control systems in an efficient or timely manner, and we may discover deficiencies in our existing systems and controls. Thus, we cannot assure you that our growth strategy will not place a strain on our administrative and operational infrastructure or require us to incur additional expenditures beyond current projects to support our future growth. Our future profitability will depend in part on our continued ability to grow. We cannot assure you that we will be able to sustain our historical growth rate or continue to grow at all, absent acquisitions.
Provident New York Bancorp's Financial Success Depends on the Successful Integration of its Recent Acquisitions.
On October 1, 2004, we completed an acquisition of Warwick Community Bancorp. (WCB). Our future
growth and profitability depends, in part, on our ability to successfully manage the combined operations of WCB as well as the operations of E.N.B. Holding Company, which was acquired on January 14, 2004. We cannot assure you that our plan to integrate and operate the combined operations will be timely or efficient, or that we will successfully retain existing customer relationships of WCB.
Our Continuing Concentration of Loans in Our Primary Market Area May Increase Our Risk.
Our success depends primarily on the general economic conditions in the counties in which we conduct business, and in the New York metropolitan area in general. Unlike large banks that are more geographically diversified, we provide banking and financial services to customers primarily in Rockland and Orange Counties, New York. We also have a branch presence in Ulster, Sullivan and Putnam Counties in New York and in Bergen County, New Jersey. The local economic conditions in our market area have a significant impact on our loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control would affect the local economic conditions and could adversely affect our financial condition and results of operations. Additionally, because we have a significant amount of commercial real estate loans, decreases in tenant occupancy also may have a negative effect on the ability of many of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings.
Changes in Market Interest Rates Could Adversely Affect Our Financial Condition and Results of Operations.
Our financial condition and result of operations are significantly affected by changes in market interest rates. Our results of operations depend substantially on our net interest income, which is the difference between the interest income that we earn on our interest-earning assets and the interest expense that we pay on our interest-bearing liabilities. Our interest-bearing liabilities generally reprice or mature more quickly than our interest-earning assets. If rates increase rapidly as a result of an improving economy, we may have to increase the rates paid on our deposits and borrowed funds more quickly than loans and investments reprice, resulting in a negative impact on interest spreads and net interest income. In addition, the impact of rising rates could be compounded if deposit customers move funds from savings accounts back to higher rate certificate of deposit accounts. Conversely, should market interest rates continue to fall below current levels, our net interest margin could also be negatively affected, as competitive pressures could keep us from further reducing rates on our deposits, and prepayments and curtailments on assets may continue. Such movements may cause a decrease in our interest rate spread and net interest margin. The bank's average cost of interest-bearing liabilities has increased, and, although the average asset yields increased this period, they did so at a slower pace due to continued market pressure. This has been offset somewhat by a greater increase of interest earning assets compared to interest bearing liabilities. Should the yield curve continue to remain "flat", a continued decline in net interest margin may occur, offsetting a portion, or all gains in net interest income generated from an increasing volume of assets.
We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates often result in increased prepayments of loans and mortgage-related securities, as borrowers refinance their loans to reduce borrowings costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments in loans or other investments that have interest rates that are comparable to the interest rates on existing loans and securities. Additionally, increases in interest rates may decrease loan demand and/or may make it more difficult for borrowers to repay adjustable rate loans.
Changes in interest rates also affect the value of our interest earning assets and in particular our securities portfolio. Generally, the value of securities fluctuates inversely with changes in interest rates. At September 30, 2005, our investment and mortgage-backed securities available for sale totaled $823.0 million. Unrealized losses on securities available for sale, net of tax, amounted to $8.2 million and are reported as a separate component of stockholders' equity. Decreases in the fair value of securities available for sale, therefore, could have an adverse effect on stockholders' equity.
We Will Be Required to Change the Way We Recognize Expense for Our Stock Options.
We account for our stock option plan in accordance with Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, we recognize compensation expense only if the exercise price of an option is less than the fair value of the underlying stock on the date of the grant. As of October 1, 2005 we will change our method of accounting for stock options granted. Statement of Financial Accounting Standards No.123R, "Accounting for Stock Based Compensation," Under Statement of Financial Accounting Standards No. 123R, the grant-date fair value of options is recognized as compensation expense over the vesting period. Our net income will decrease by approximately $939,000 per year based on options currently granted, using the fair-value-based method of accounting for stock options. Our diluted earnings per share will decrease by approximately $0.02 per share.
A Breach of Information Security Could Negatively Affect our Earnings.
Increasingly, we depend upon date processing, communication and information exchange on a variety of computing platforms and networks, and over the internet. We cannot be certain all our systems are entirely free from vulnerability to attack, despite safeguards we have instituted. In addition, we rely on the services of a variety of vendors to meet our data processing and communication needs. If information security is breached, information can be lost or misappropriated, resulting in financial loss or costs to us or damages to others. These costs or losses could materially exceed the amount of insurance coverage, if any, which would adversely affect our earnings.
We are Subject to Heightened Regulatory Scrutiny with respect to Bank Secrecy and Anti-money Laundering Statutes and Regulations.
Recently, regulators have intensified their focus on the USA PATRIOT Act's anti-money laundering and Bank Secrecy Act compliance requirements. There is also increased scrutiny of our compliance with the rules enforced by the Office of Foreign Assets Control. In order to comply with regulations, guidelines and examination procedures in this area, we have been required to adopt new policies and procedures and to install new systems. We cannot be certain that the policies, procedures and systems we have in place are flawless. Therefore, there is no assurance that in every instance we are in full compliance with these requirements.
Various Factors May Make Takeover Attempts More Difficult to Achieve.
Our Board of Directors has no current intention to sell control of Provident Bancorp. Provisions of our certificate of incorporation and bylaws, federal regulations, Delaware law and various other factors may make it more difficult for companies or persons to acquire control of Provident Bancorp without the consent of our Board of Directors. You may want a take over attempt to succeed because, for example, a potential acquirer could offer a premium over the then prevailing market price of our common stock. The factors that may discourage takeover attempts or make them more difficult include:
Office of Thrift Supervision regulations. Office of Thrift Supervision regulations prohibit, for three years following the completion of a mutual-to-stock conversion, the direct or indirect acquisition of more than 10% of any class of equity security of a converted bank without the prior approval of the Office of Thrift Supervision. We completed our mutual-to-stock conversion on January 14, 2004.
Certificate of incorporation and statutory provisions. Provisions of the certificate of incorporation and bylaws of Provident Bancorp and Delaware law may make it more difficult and expensive to pursue a takeover attempt that management opposes. These provisions also would make it more difficult to remove our current Board of Directors or management, or to elect new directors. There provisions include limitations on voting rights of beneficial owners of more than 10% of our common stock, supermajority voting requirements for certain business combinations and the election of directors to staggered terms of three years. Our bylaws also contain provisions regarding the timing and content of stockholder proposals and nominations and qualification for service on the Board of Directors.
Required change in control payments and issuance of stock options and recognition and retention plan shares. We have entered into employment agreements with certain executive officers, which will require payments to be made to them in the event their employment is terminated following a change in control of Provident Bancorp or Provident Bank. We have also adopted the 2004 Provident Bancorp, Inc. Stock Option Plan to permit additional issuance of stock options and recognition and retention plan shares to key employees and directors that will require payments to them in connection with a change in control of Provident Bancorp. We have granted additional
restricted shares and options under this plan. These payments will have the effect of increasing the cost of acquiring Provident Bancorp, thereby discouraging future takeover attempts.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments - ----------------------------------
Not Applicable.
ITEM 2.
ITEM 2. Properties - ------------------
As of September 30, 2005, Provident Bank leased 19 properties, including its headquarters location, from third parties. In addition, Provident Bank owns 17 properties. At September 30, 2005, the net book value of our properties was $26.1 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
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, 2005.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and - ------------------------------------------------------------------------------ Issuer Purchases of Equity Securities - -------------------------------------
(A)
The shares of common stock of Provident New York Bancorp are quoted on the Nasdaq National Market ("NASDAQ") under the symbol "PBNY." Prior to June 29, 2005 the Company traded on the NASDAQ under the symbol "PBCP". As of September 30, 2005, Provident Bancorp had 11 registered market makers, 6,488 stockholders of record (excluding the number of persons or entities holding stock in street name through various brokerage firms), and 43,505,659 shares outstanding.
The following table sets forth market price and dividend information for the common stock for the past two fiscal years. 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.
Cash Dividends Quarter Ended High Low Declared - --------------------- ---------- ------------ -----------------
September 30, 2005 $12.60 $11.33 $0.05 June 30, 2005 12.17 10.13 0.045 March 31, 2005 13.21 12.04 0.045 December 31, 2004 13.76 11.50 0.04
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
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. Repurchases of the Company's shares of common stock during the fourth quarter of the fiscal year ended September 30, 2005 are detailed in (C) below. There were no sales of unregistered securities during the quarter ended September 30, 2005.
(B)
Not Applicable
(C)
(1) The total number of shares purchased during the periods indicated includes shares deemed to have been received from employees who exercised stock options by submitting previously acquired shares of common stock in satisfaction of the exercise price, as is permitted under the Company's stock benefit plans and shares repurchased as part of a previously authorized repurchase program.
(2) The Company announced in May, 2005 that it authorized the repurchase of 2,200,000 shares, or approximately 5% of common shares currently outstanding, having completed its first repurchase program of 2,295,000 shares in May, (2005.)
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 and title insurance fees. Our non-interest expense consists primarily of salaries and employee benefits, occupancy and office expenses, advertising and promotion expense, professional fees, core deposit amortization 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 New York Bancorp are discussed herein on a consolidated basis with the Bank. Reference to Provident New York Bancorp or the Company may signify the Bank, depending on the context.
The following is an analysis of the financial condition and results of the Company's operations. 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 within Part I, Item I, "Business."
Overview
The Company provides financial services to individuals and businesses in New York and New Jersey. 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 $2.6 billion at September 30, 2005 from $1.8 billion at September 30, 2004. This 42.2% increase resulted principally from the acquisition of WSB in October 2005, which added $703.7 million of assets as of the merger date. Also during 2005, the Company furthered its commercial lending and banking initiatives. Excluding the loans acquired with WSB, commercial loans increased 7.3%.
Net income for the year ended September 30, 2005 increased 92.8% to $21.2 million, or $0.49 per diluted share from $11.0 million, or $0.29 per diluted share for the year ended September 30, 2004. Net income for fiscal 2004 included a $3.0 million after-tax charge ($0.08 per diluted share) for the formation of the Charitable Foundation. The increase is primarily due to the increase in interest earning assets acquired from WSB and to a lesser extent, internal growth. During 2005, the Company additionally benefited for a full year from the investment of funds raised in the 2004 offering, the acquisitions of ENB in January 2004, WSB in October 2005, 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, and high costs of deposits and borrowings, which reduced the Company's net interest margin.
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 non-accrual 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, unless the assets are well secured and in the process of collection. At such time, unpaid interest is reversed by charging interest income for interest in the current fiscal year or the allowance for loan losses with respect to prior year income. Interest payments received on non accrual loans (including impaired loans) are not recognized as income unless future collections are reasonably assured. 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 focusing on core deposit generation and quarterly loan growth. 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 (in 1995) and extended service hours (since 1987). 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 while continuing to grow our residential mortgage and consumer lending businesses. As a result, we believe that we have developed a high quality diversified loan portfolio with a favorable mix of loan types, maturities and yields.
Expanding our Retail Banking Franchise. Management intends to continue the expansion of our 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.
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(1) Balances include the effect of net deferred loan origination fees and costs, and the allowance for the 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, 2005 and September 30, 2004
Total assets as of September 30, 2005 were $2.6 billion, an increase of $771.2 million, or 42.2%, over assets of $1.8 billion at September 30, 2004. The increase was primarily due to the October 2004 acquisition of Warwick, whose assets totaled $703.7 million on the merger date, and the purchase of an HSBC Bank USA, National Association ("HSBC") branch office in South Fallsburg, New York, which added $23.3 million of assets in the third quarter of 2005, as well as internal growth of the Company. Goodwill increased by $92.4 million from September 30, 2004 as a result of the completion of the Warwick acquisition, and core deposit intangibles increased by $8.1 million, net of $3.9 million in amortization, from September 30, 2004 as a result of the Warwick and the South Fallsburg HSBC branch acquisitions.
Net loans as of September 30, 2005 were $1.3 billion, an increase of $359.8 million, or 36.7%, over net loan balances of $980.3 million at September 30, 2004. Loans acquired from WSB totaled $288.2 million, while allowances for loan losses acquired in connection with WSB were $4.9 million, or 1.7% of WSB's outstanding loan balances. Inclusive of Warwick loans acquired, commercial loans increased by $226.6 million, or 46.5%, over balances at September 30, 2004. Consumer loans increased by $61.8 million, or 47.6%, during the year ended September 30, 2005, while residential loans increased by $76.0 million, or 20.0%. Total loan originations increased from $357.1 million for the year ended September 30, 2004 to $515.4 million for the year ended September 30,
2005. However, repayments and sales of loans have also increased from $294.2 million for 2004 to $442.1 million for the year ended September 30, 2005. Loan quality continues to be strong. At $1.6 million, non-performing loans as a percentage of total loans was 0.12%, as opposed to 0.27% at September 30, 2004.
Securities increased by $290.5 million, or 48.2%, to $893.9 million at September 30, 2005 from $603.4 million at September 30, 2004. Securities acquired from Warwick totaled $298.2 million. Investments were made primarily in mortgage-backed securities, which increased by $182.3 million, or 50.7%, and in U.S. Government and federal agency securities, which increased by $108.2 million, or 44.3% and tax exempt securities which increased by $41.6 million or 85%.
Deposits as of September 30, 2005 were $1.7 billion, up $486.9 million, or 39.3%, from the balance at September 30, 2004. Deposits acquired from Warwick and HSBC totaled $475.1 million and $23.3 million, respectively. As of September 30, 2005, retail and commercial transaction accounts were 31.9% of deposits compared to 30.0% at September 30, 2004.
Borrowings increased by $227.3 million from $214.9 million at September 30, 2004 to $442.2 million at September 30, 2005. $160 million of the increase is related to the borrowings assumed from Warwick.
Stockholders' equity increased by $45.6 million to $395.2 million at September 30, 2005 compared to $349.5 million at September 30, 2004. Shares of common stock with a value of $74.6 million were issued for the purchase of Warwick. Net income of $21.2 million and ESOP allocations of $809,000 for the fiscal year also increased equity. Partially offsetting the increases were the payments of cash dividends totaling $7.5 million and a decrease of $8.0 million in other comprehensive income due to unrealized losses on available for sale securities. Since September 30, 2004, we have purchased a total of 3.2 million treasury shares, which further decreased stockholders' equity by $38.0 million.
As of September 30, 2005, 1,307,400 shares remain under our previously announced repurchase authorization. Also during 2005, 762,400 shares of restricted stock were granted from treasury shares. Tier I capital to assets stands at 9.6% at September 30, 2005.
Comparison of Operating Results for the Years Ended September 30, 2005 and - -------------------------------------------------------------------------- September 30, 2004 - ------------------
Net income for the year ended September 30, 2005, was $21.2 million. This compares to $11.1 million for the year ended September 30, 2004. Diluted earnings per share were $0.49 for the year ended September 30, 2005 compared to $0.29 for the prior fiscal year. Earnings per share results for the prior year have been restated to reflect the 4.4323-to-one exchange ratio as a result of the Company's second-step conversion in 2004.
Interest Income. Interest income for the year ended September 30, 2005 increased to $115.3 million, an increase of $40.8 million, or 54.7%, compared to the prior year. The increase was primarily due to higher average balances of loans and securities, along with higher yields in both asset classes. Average interest-earning assets for the year ended September 30, 2005 were $2.2 billion, an increase of $767.6 million, or 53.1%, over average interest-earning assets for the year ended September 30, 2003 of $1.4 billion. Average loan balances grew by $402.1 million and average balances of securities and other earning assets increased by $365.5 million. On a tax-equivalent basis, average yields on interest earning assets increased by six basis points to 5.26% for the year ended September 30, 2005, from 5.20% for the year ended September 30, 2004. Higher market interest rates were the primary reason for the increase in asset yields.
Interest income on loans for the year ended September 30, 2005 grew 49.3% to $80.7 million from $54.1 million for the prior fiscal year. Interest income on commercial loans for the year ended September 30, 2005 increased to $46.5 million, up 77.6% from commercial loan interest income of $26.2 million for the prior fiscal year. Average balances of commercial loans grew $299.1 million to $684.8 million, with no change in the average yield. Interest income on consumer loans increased by $3.6 million, or 70.2%. 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 $25.6 million for the year ended September 30, 2005, up $2.8 million, or 12.1%, from the prior year.
Interest income on securities and other earning assets increased to $34.5 million for the year ended September 30, 2005, compared to $20.4 million for the prior year. This was due to a tax-equivalent increase of eight basis points in yields along with the $365.5 million increase in the average balances of securities and other earning assets.
Interest Expense. Interest expense for the year ended September 30, 2005 increased by $16.4 to $29.4 million, an increase of 126.5% compared to interest expense of $13.0 million for the prior fiscal year. The increase was primarily due to an increase in the average balance of interest-bearing liabilities of $686.8 million, or 64.3%, which resulted primarily from the Warwick and HSBC South Fallsburg branch acquisitions. In addition, average rates paid on interest-bearing liabilities for the year ended September 30, 2005 increased by 46 basis points to 1.67% from 1.21% in fiscal 2004. The average interest rate paid on certificates of deposit increased by 57 basis points to 2.27% for the year ended September 30, 2005, from 1.70% for the prior year. For the year ended September 30, 2005, average balances of lower cost savings and money market accounts increased by $188.8 million and $77.3 million, respectively, while average balances of certificates of deposit increased by $123.4 million compared to the year ended September 30, 2004. The average interest rate paid on savings and money market accounts increased by 12 and 59 basis points to 0.56% and 1.16%, respectively, for the year ended September 30, 2005, from 0.44% and 0.57% for the prior year.
Net Interest Income for the fiscal year ended September 30, 2005 was $85.9 million, compared to $61.5 million for the year ended September 30, 2004, an increase of $24.3 million or 39.6%. Interest income increased $40.8 million to $115.3 million for the fiscal year ending September 30, 2005, compared to $74.5 million for the prior year. The increase in interest income was largely due to a $767.6 million increase in average interest-earning assets to $2.2 billion during the year ended September 30, 2005, as compared to $1.4 billion for the prior fiscal year. The increase is primarily due to the Warwick acquisition and continued internal growth. An increase in average yield on earning assets of six basis points, from 5.20% to 5.26%, on a fully taxable equivalent basis, also contributed to the increase in net interest income. Average yields increased in both the loan and securities and other earning assets portfolios, of 17 basis points and eight basis points, respectively, with the overall yield on total interest-earning assets increasing in every category. Interest expense increased by $16.4 million for the fiscal year ended September 30, 2005 from $13.0 million for the year ended September 30, 2004, to $29.4 million, as average interest-bearing liabilities increased by $686.8 million and the average cost of interest-bearing liabilities increased 46 basis points. The net interest margin declined by 37 basis points to 3.94%, while the net interest spread declined by 40 basis points to 3.59%, due to the assets acquired in the Warwick acquisition being recorded at then-current market interest rates and the increase in short-term interest rates. This change in short-term rates, which affected funding costs to a larger degree than existing earning assets (which are primarily fixed-rate until maturity) was disproportionately large as compared to the change in longer term market interest rates, and thus has decreased net interest margin. The Federal Reserve has increased short-term rates eleven times since May 2004, increasing the target federal funds rate from 1% to 3.75%. Conversely, the 10-year treasury rate has decreased from an average of 4.29% for the fiscal year ended September 30, 2004 to 4.20% for the year ended September 30, 2005. The Bank's average cost of interest-bearing liabilities has increased and, although the average asset yields increased during this period, they did so at a slower pace due to continued market pressure. This has been offset somewhat by a greater increase of interest earning assets compared to interest bearing liabilities Should the yield curve continue to "flatten," a continued decline in net interest margin may occur, offsetting a portion of gains in net interest income generated from an increasing volume of assets.
Provision for Loan Losses. We recorded $750,000 and $800,000 in loan loss provisions for the year ended September 30, 2005 and September 30, 2004, respectively. At September 30, 2005 the allowance for loan losses totaled $22.0 million, or 1.62% of the loan portfolio, compared to $17.4 million, or 1.74% of the loan portfolio at September 30, 2004. Net charge-offs for the years ended September 30, 2005 and 2004 were $975,000 and $266,000, respectively (an annual rate of 0.07% and 0.03%, respectively, of the average loan portfolio). The $709,000 increase occurred primarily due to the increase in volume and loans acquired through our acquisitions.
The provision for loan losses was primarily attributable to growth in the loan portfolio of $364.4 million, representing an increase of 36.5%, which included $288.2 million of loans acquired, along with $4.9 million in acquired allowance for loan losses, as part of our acquisition of WSB. In addition, higher risk loan categories, primarily commercial real estate loans and commercial business loans, provided most of this increase. However, non-performing loans decreased $1.1 million from September 30, 2004, to $1.6 million at September 30, 2005.
We increased the percentage allowance requirements in the retail loan portfolio to reflect the increase in home equity lines of credit, as they are considered somewhat more risky than first mortgage loans, because they are secured by second mortgages, and are tied to a recently increasing prime rate. 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 was $17.9 million for the fiscal year ended September 30, 2005 compared to $11.6 million for the prior fiscal year. Deposit fees and service charges increased by $3.8 million, or 57.5% to $10.4 million, of which $1.8 million was generated from the acquired Warwick branches, while $2.0 million was primarily due to volume-driven increases in overdraft, non-sufficient funds, and ATM and debit card fees. Loan fees and late charges increased by $679,000 or 81.6% to $1.5 million largely due to pre-payment penalties. Income derived from the Company's BOLI investments increased by $1.2 million, or 224.3%, due to the additional BOLI investment of $24.1 million ($13.3 million of which were added from the WSB acquisition), and the receipt of death benefit proceeds. Title insurance fee income derived from the new Hardenburgh Abstract Company, Inc. was $1.6 million. Gains on the sale of securities were $369,000 for the 2005 fiscal year compared to $2.5 million for the prior fiscal year. During the year ended September 30, 2005, the Company also recorded gains on sales of loans totaling $206,000 compared to $320,000 for the prior year. For the year ending September 30, 2005, there was of $681,000 in income pertaining to our investment as a limited partner in a low-income housing partnership. The investment had been amortized quarterly since 1996 in excess of our interest in the partnership. There was no material impact on any quarter in the affected periods.
Non-interest expense for the fiscal year ended September 30, 2005 increased by $14.4 million, or 25.7%. Excluding the 2004 charge of $5.0 million, pre-tax, for the Charitable Foundation, non-interest expenses for the year ended September 30, 2005 increased by $19.4 million, or 38.0%, to $70.6 million, compared to $51.1 million for the same period in 2004. The acquisitions of ENB in January 2004 and Warwick in October 2004 played a major role in the increases in most categories. Compensation and employee benefits increased by $8.6 million, or 37.3%, to $31.6 million for the year ended September 30, 2005. The increase was primarily attributable to the acquisitions. Occupancy and office operations increased by $2.8 million, or 42.2%, for the year ended September 30, 2005, almost all of which was attributable to the acquisitions. Advertising and promotion increased $1.1 million or 51.3%, primarily as a result of the Company's new brand identity and the additional promotions in the Orange County market. Amortization of core deposit intangible increased by $1.9 million as a result of acquired deposits. Data and check processing expense increased $1.1 million, or 31.2%, primarily due to the higher level of services related to the accounts acquired in the mergers and in the acquisition of the new HSBC South Fallsburg branch. Other expenses increased by $2.5 million, or 44.4%, primarily due to increases in correspondent bank expense, postage, telephone expense, loan servicing and credit report expenses, and insurance premium expense, all of which directly related to the increased size of Provident Bank following the mergers. ATM and debit card expense increased $550,000, or 68.2%, primarily as a result of the increase in the number of accounts.
Income Taxes. Income tax expense was $11.2 million for the fiscal year ended September 30, 2005 compared to $5.1 million for fiscal 2004, representing effective tax rates of 34.5% and 31.8%, respectively. The higher effective rate in fiscal 2005 is primarily attributable to the lower proportion of non-taxable securities to taxable, an increase in state taxes, and the release of tax contingency reserves in 2004 that did not occur in 2005. These increases were partially offset by a relative decrease in nondeductible stock-based compensation expense.
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 as well as a one time recognition of income from a limited partnership. 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 following table describes the effect of the Non-GAAP results.
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
Comparison of Operating Results for the Years Ended September 30, 2004 and - -------------------------------------------------------------------------- September 30, 2003 Comparison of - --------------------------------
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.
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 provision 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. $5.7 million of allowance for loan losses was acquired and 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.
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 as well as a one time recognition of income from a limited partnership. 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 following table describes the effect of the Non-GAAP results.
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):
For the year ended September 30, -------------------------------- 2004 2003 ----------- ----------- Diluted earnings per share $ 0.29 $ 0.32 Charge for establishment of charitable foundation (1) (0.08) -- Merger integration expenses (1) (0.01) -- Rounding 0.01 -- ----------- -----------
Diluted net operating earnings per share $ 0.39 $ 0.32 =========== ===========
Net Income $ 11,017 $ 11,251 Charge for establishment of charitable foundation (1) (3,000) -- Merger integration expenses (1) (464) -- ----------- -----------
Net operating income $ 14,481 $ 11,251 =========== ===========
(1) After related tax effect at 40% marginal rate.
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, 2005 and 2004, 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, 2005, commercial and retail loan commitments totaled $53.3 million. Standby letters of credit totaled $17.1 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 and personal lines, which totaled $230.0 million at September 30, 2005, 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, 2005. 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 ("U.S. GAAP"). U.S. 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, 2005, 2004 and 2003, our loan originations totaled $515.4 million, $357.1 million and $451.1 million, respectively. Purchases of securities available for sale totaled $385.3 million, $468.4 million and $219.5 million for the years ended September 30, 2005, 2004 and 2003, respectively. Purchases of securities held to maturity totaled $23.7 million, $12.2 million and $27.6 million for the years ended September 30, 2005, 2004 and 2003, respectively. These activities were funded primarily by deposit growth (a financing activity), and by principal repayments on loans and securities. Loan origination commitments totaled $53.3 million at September 30, 2005, and consisted of $44.8 million at adjustable or variable rates and $8.5 million at fixed rates. Unused lines of credit granted to customers were $230.0 million at September 30, 2005. We anticipate that we will have sufficient funds available to meet current loan commitments and lines of credit.
In December 2002 we invested $12.0 million in BOLI contracts and an additional $10.0 million in April 2005. 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 $37.7 million at September 30, 2005.
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 (decrease)/increase in total deposits (excluding deposits acquired during 2005, 2004 and 2002 as part of the acquisitions of WSB, ENB and NBF, respectively) was $(11.7) million, $43.1 million and $69.9 million for the years ended September 30, 2005, 2004 and 2003, respectively. Certificates of deposit that are scheduled to mature in one year or less from September 30, 2005 totaled $406.2 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 $269.5 million was outstanding at September 30, 2005. At September 30, 2005 we had the ability to borrow an additional $31.6 million under our credit facilities with the Federal Home Loan Bank. The Bank may borrow an additional $522,569 by pledging securities not required to be pledged for other purposes as of September 30, 2005.
Recent Accounting Standards
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 did not have a material impact on the consolidated financial statements.
In December 2004, the FASB Issued Statement of Financial Accounting Standards No. 123R (Statement 123R), "Share-Based Payments", the provisions of which become effective for the corporation in fiscal 2006. This Statement eliminates the alternative to use APB No. 25's intrinsic value method of accounting that was provided in Statement 123 as originally issued. Statement 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. While the fair-value-based method prescribed by Statement 123R is similar to the fair-value-based method disclosed under the provisions of Statement 123 in most respects, there some differences. The Company estimates that annual expense using the Black Scholes method beginning in fiscal 2006 will be approximately $1,151 or $939 after tax and the diluted earnings per share impact will be approximately $0.02. This impact does not include the effect of reload options or forfeitures or options accelerations due to termination or retirement of personnel, the effect of which cannot be measured with any degree of certainty.
Effective March 31, 2004, Emerging Issues Task Force Issue No. 03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments ("EITF 03-1") was issued. EITF 03-1 provides guidance for determining the meaning of "other-than-temporarily impaired" and its application to certain debt and equity securities within the scope of Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115") and investments accounted for under the cost method. The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates ("other than temporary impairment") must be recorded for as are loans under the AICPA's Statement of Position 03-3 ("SOP 03-3") on purchased loans, which provides guidance on the treatment of potential credit losses (unrecoverable principle) and decreased, or lower then expected yields.
In May 2005, the FASB Issued Statement of Financial Accounting Standards No. 154 ("SFAS 154"), "Accounting Changes and Error Corrections,' replacing APB Opinion No. 20 and FASB Statement No.3, which changes the treatment and reporting requirements for both accounting errors and changes of accounting principles, and provides guidance on determining the treatment of the retrospective application of a change. This Statement applies to all voluntary changes in accounting principles. At this time management believes this statement will have no impact on the reporting of our operations or financial condition.
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. The adoption of the provisions of this standard did not 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, 2005, 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, 2005, in the event of an immediate 200 basis point decrease in interest rates, we would be expected to experience a 4.1% increase in NPV and a 5.4% 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 16.6% decrease in NPV and a 1.4% 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.
During the past fiscal year, the federal funds rate has increased from 1.75% to 3.75% while U.S. Treasury rates in the five year maturities have increased from 3.37% to 4.19% and in 10 year maturities from 4.12% to 4.32%. This "flattening" of the yield curve has had the effect of increasing the rate paid on interest bearing deposits at a faster pace than the rate earned on term investments and fixed rate loans in the Bank's portfolio. Continued flattening of the yield curve could cause further desintermediation of deposits into higher yielding liabilities and further increase the rate paid for short term borrowings while receiving little benefit on the yield earned on assets that are invested in periods beyond the period of short term interest rates and could cause a further decline in the market value of available sale securities without a commensurate change in the national market value of liabilities used in the calculation of "NPV".
ITEM 8.
ITEM 8. Financial statements and Supplementary Data - ---------------------------------------------------
The following are included in this item:
(A) Report of Management on Internal Control Over Financial Reporting
(B) Report of Independent Registered Public Accounting Firm - Financial Statements
(C) Report of Independent Registered Public Accounting Firm - Internal Control Over Financial Reporting
(D) Consolidated Statements of Financial Condition as of September 30, 2005 and 2004
(E) Consolidated Statements of Income for the years ended September 30, 2005, 2004 and 2003
(F) Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income for the years ended September 30, 2005, 2004 and 2003
(G) Consolidated Statements of Cash Flows for the years ended September 30, 2005, 2004 and 2003
(H) 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 Management on Internal Control Over Financial Reporting -----------------------------------------------------------------
The Board of Directors and Stockholders Provident New York Bancorp:
The management of Provident New York Bancorp, ("the Company") is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control system was designed to provide reasonable assurance to the company's management and Board of Directors regarding the preparation and fair presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
The Company's management assessed the effectiveness of the company's internal control over financial reporting as of September 30, 2005. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control -Integrated Framework. Based on our assessment we believe that, as of September 30, 2005, the company's internal control over financial reporting is effective based on those criteria.
KPMG LLP, an independent registered public accounting firm that audited the financial statements in this Annual Report, has issued an attestation report on management's assessment of the Company's internal control over financial reporting as of September 30, 2005, which is included herein on page 59.
/s/ George Strayton ------------------------------------------------- By: George Strayton President, and Chief Executive Officer (Principal Executive Officer) December 8, 2005
/s/ Paul Maisch ------------------------------------------------- By: Paul Maisch Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) December 8, 2005
Report of Independent Registered Public Accounting Firm -------------------------------------------------------
The Board of Directors and Stockholders Provident New York Bancorp:
We have audited the accompanying consolidated statements of financial condition of Provident New York Bancorp and subsidiaries as of September 30, 2005 and 2004 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended September 30, 2005. 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 the Company and subsidiaries as of September 30, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of September 30, 2005, based on the criteria established in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated December 8, 2005 expressed an unqualified opinion on management's assessment of, and the effective operation of, internal control over financial reporting.
/s/ KPMG LLP - ------------------- New York, New York December 8, 2005
Report of Independent Registered Public Accounting Firm -------------------------------------------------------
The Board of Directors and Stockholders Provident New York Bancorp:
We have audited management's assessment, included in the accompanying Report of Management on Internal Control Over Financial Reporting, that Provident New York Bancorp and subsidiaries (the Company) maintained effective internal control over financial reporting as of September 30, 2005, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of September 30, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2005, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company and subsidiaries as of September 30, 2005 and 2004, and the related consolidated statements of income, stockholders' equity, comprehensive income, and cash flows for each of the years in the three-year period ended September 30, 2005, and our report dated December 8, 2005 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
New York, New York December 8, 2005
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Consolidated Statements of Financial Condition September 30, 2005 and 2004 (Dollars in thousands, except per share data)
See accompanying notes to consolidated financial statements.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Consolidated Statements of Income Years Ended September 30, 2005, 2004 and 2003 (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 Loss Years Ended September 30, 2005, 2004 and 2003 (Dollars in thousands, except per share data)
See accompanying notes to consolidated financial statements.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Consolidated Statements of Cash Flows Years Ended September 30, 2005, 2004 and 2003 (Dollars in thousands)
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Consolidated Statements of Cash Flows Continued Years Ended September 30, 2005, 2004 and 2003 (Dollars in thousands)
See accompanying notes to consolidated financial statements.
PROVIDENT NEW YORK BANCORP 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, Inc. completed its stock offering in connection with the second-step conversion from a mutual holding company, a federal corporation, to a publicly held stock holding company, incorporated in the State of Delaware. In anticipation of the second-step conversion the Board of Directors of the MHC formed a Delaware corporation known as "Provident Bancorp, Inc." Concurrent with the public stock offering of shares, representing the former ownership interest of the MHC, the MHC ceased to exist and Provident Federal was replaced by the new Provident Bancorp. Inc.
As a result of the stock offering and conversion, the Bank was a wholly owned subsidiary of Provident Bancorp, Inc. (Parent), which changed its name as described below, 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 (see Note 3 "Acquisitions")
Provident Bancorp, Inc. 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 was exchanged for 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 and liabilities. Outstanding shares for purposes of calculating prior year per share amounts have been adjusted to reflect to the exchange ratio applied in the Conversion.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
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.
On June 29, 2005 Provident Bancorp, Inc. changed its name to Provident New York Bancorp in order to differentiate itself from the numerous bank holding companies with similar names. It began trading on the NASDAQ under the stock symbol "PBNY" on that date. Prior to that date its common stock traded under the stock symbol "PBCP".
(2) Nature of Business and 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 Sullivan, Ulster and Putnam Counties, New York and Bergen County, New Jersey. 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 association 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 National Bank of Florida ("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 New York Bancorp. 83% of the Bank's loans are collateralized or dependent on real estate.
(a) Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of Provident New York Bancorp, Hardenburgh Abstract Title Company, which provides title searches and insurance for residential and commercial real estate, 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. and WSB Funding, Inc. which are real estate investment trusts that hold 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.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
(b) Securities
Securities include US Treasury, US Government Agency, municipal and corporate bonds, mortgage backed securities, collateralized mortgage obligations, marketable and equity securities.
The Company can classify 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.
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 or call date. 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.
Securities deemed to be other-than-temporarily impaired are permanently written down from their original cost basis to reflect the adjusted fair value subsequent to a measurement for impairment. The impairment is deemed permanent if there are serious credit concerns regarding a particular debt issuer, or severe fluctuation in interest rates. The permanent adjustment is charged to current earnings in the period of measurement. The method employed to determine the loss in value is covered in Statement of Position ("SOP") 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer", which covers the requisite treatment for purchased loans with potential credit loss and/or those which return a lower than expected yield.
(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. Interest income on loans is accrued on a level yield method.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
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, unless well secured and in the process of collection (primarily residential mortgages). Accrual of interest ceases and, in general, uncollected past due interest is reversed and charged against current interest income, related to the current year. Prior years' non-accrual interest is charged to the allowance for loan losses. 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 estimated life 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 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
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
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 three to 40 years. Leasehold improvements are amortized on a straight-line basis over the terms of the respective leases, including renewal options, or the estimated useful lives of the 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 acquisitions is not amortized to expense, but instead is evaluated for impairment at least annually. The core deposit intangibles recorded in 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.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
(k) Income Taxes
Net 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. A deferred tax asset 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 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 Statement of Financial Accounting Standard ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities. 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. As of September 30, 2005 and 2004 the Company had no derivative trading or hedging activities.
(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. Beginning in October 2005, we will no longer account for stock options in
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
accordance with APB Opinion No. 25, as all publicly owned companies will be required to account for stock-based compensation in accordance with SFAS No. 123R, beginning in fiscal years ending after December 30, 2005. SFAS No. 123R will require the recording of compensation expense based on the fair value of the option grants in the period they vest.
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 exchange 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 2005, 2004 and 2003 was $3.07, $2.71, and $1.13, respectively, using the Black-Scholes option-pricing model with assumptions as follows for the respective years: dividend yields of 1.4%, 1.4%, and 1.8%; expected volatility rates of 18.73%, 20.10%, and 14.67%; risk-free interest rates of 4.46%, 2.7%, and 3.3%; and expected option lives of approximately 7.9 years, 4 years, and 5 years.
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R (Statement 123R), "Share-Based Payments", the provisions of which become effective for the corporation in fiscal 2006. This Statement eliminates the alternative to use APB No. 25's intrinsic value method of accounting that was provided in Statement 123 as originally issued. Statement 123R requires companies to recognize the cost of employee services received in exchange for awards of
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
equity instruments based on the grant-date fair value of those awards. While the fair-value-based method prescribed by Statement 123R is similar to the fair-value-based method disclosed under the provisions of Statement 123 in most respects, there are some differences. The Company estimates that annual expense using the Black Sholes method beginning in fiscal 2006 will be approximately $1,151, or $939 after tax and the diluted earnings per share impact will be $0.02. This impact does not include the effect of reload options or forfeitures or option accelerations due to termination or retirement of personnel, the effect of which cannot be measured with any degree of certainty.
(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 were exercised and unvested RRP shares became vested during the periods. For purposes of computing both basic and diluted EPS, outstanding shares include all shares issued to the Mutual Holding Company (for the years ending September 30, 2004 and 2003), 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 the community banking operation, which constitutes the Company's only operating segment for financial reporting purposes.
(3) Acquisitions
The Company has been active in acquisitions over the past several years. All acquisitions were accounted for using purchase method of accounting. Accordingly, the assets acquired and liabilities assumed were recorded by the Company at their fair values at the acquisition date.
On October 1, 2004 the Company completed its acquisition of Warwick Community Bancorp, Inc. ("WSB" or "Warwick"), located in Warwick, New York. WSB was 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 of Orange County, Inc. in Goshen, New York.
On January 14, 2004, the Company completed its acquisition of ENB, located in Ellenville, New York. ENB was the holding company for Ellenville National Bank.
On April 23, 2002, the Company completed its acquisition of the National Bank of Florida ("NBF"), located in Florida, New York.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
Below is the summary of the financial transactions, including the most recent branch purchase on May 19, 2005 of an HSBC Bank USA, National Association ("HSBC") branch office in South Fallsburg, New York, which was consolidated with the Bank's existing branch in South Fallsburg.
Goodwill is not amortized to expense, but is reviewed for impairment at least annually, with impairment losses charged to expense, if and when they occur. The core deposit intangible asset is recognized apart from goodwill and amortized to expense over its estimated useful life and evaluated, at least annually, for impairment.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
The following table presents unaudited pro forma information as if WSB and ENB had been consummated on October 1, 2002. 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 WSB and ENB on October 1, 2002.
The following table summarizes the purchase price allocation relating to the acquisitions of WSB and ENB. This allocation is based on the estimated fair values of assets acquired and liabilities assumed at the acquisition date.
The Company incurred $1,124 and $773 in costs associated with the integration of acquisitions into the Company. These costs are included in non- interest expense for the year ended September 30, 2005 and 2004, respectively.
PROVIDENT NEW YORK BANCORP 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 NEW YORK BANCORP 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.
Proceeds from sales of securities available for sale during the years ended September 30, 2005, 2004 and 2003 totaled $61,522, $163,263 and $39,416, respectively. These sales resulted in gross realized gains of $916, $2,556, and $2,166 for the years ended September 30, 2005, 2004 and 2003, respectively, and gross realized losses of $547, $101, and $160 in fiscal 2005, 2004 and 2003, respectively.
Securities with carrying amounts of $162,580 and $54,819 were pledged as collateral for borrowings under securities repurchase agreements at September 30, 2005 and September 30, 2004, respectively. U.S. Government and municipal securities with carrying amounts of $134,779 and $113,491 were pledged as collateral for municipal deposits and other purposes at September 30, 2005 and September 30, 2004, 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 NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
Substantially all of the unrealized losses at September 30, 2005 relate to investment grade securities and are attributable to changes in market interest rates subsequent to purchase. There were no securities with unrealized losses that were individually significant dollar amounts at September 30, 2005. A total of 269 available for sale securities were in a continuous unrealized loss position for less than 12 months, and 97 securities for 12 months or longer. For securities with fixed maturities, there are no securities past due or securities for which the Company currently believes it is not probable that it will collect all amounts due according to the contractual terms of the investment. Because the Company has the ability and intent to hold securities with unrealized losses until a market price recovery (which, for fixed maturities, may be until maturity) the Company did not consider these investments to be other-than-temporarily impaired at September 30, 2005 except for an investment in Freddie Mac perpetual preferred stock, for which it has been determined that an impairment loss of $93 existed on a recorded basis of $905. (See Recent Accounting Standards for discussion of a new accounting pronouncement that will provide additional guidance with respect to impairment evaluations).
PROVIDENT NEW YORK BANCORP 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 NEW YORK BANCORP 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, 2005 --------------------------- Amortized cost Fair value ----------- ----------- Remaining period to contractual maturity: Less than one year $ 23,849 $ 23,816 One to five years 8,142 8,240 Five to ten years 9,413 9,508 Greater than ten years 2,834 2,838 ----------- ----------- Total $ 44,238 $ 44,402 =========== ===========
There were no sales of securities held to maturity during the years ended September 30, 2005, 2004 and 2003.
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 NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
Substantially all of the unrealized losses on held to maturity securities at September 30, 2005 relate to investment grade securities or local municipal general obligation bonds and are attributable to changes in market interest rates subsequent to purchase. There were no securities with unrealized losses that were individually significant dollar amounts at September 30, 2005. A total of 68 held to maturity securities were in a continuous unrealized loss position for less than 12 months, and 20 securities for 12 months or longer. For securities with fixed maturities, there are no securities past due or securities for which the Company currently believes it is not probable that it will collect all amounts due according to the contractual terms of the investment. Because the Company has the ability and intent to hold securities with unrealized losses until maturity, the Company did not consider these investments to be other-than-temporarily impaired at September 30, 2005. (See Recent Accounting Standards for discussion of a new accounting pronouncement that will provide additional guidance with respect to impairment evaluations).
(6) Loans
The components of the loan portfolio, excluding loans held for sale, were as follows:
September 30, ---------------------------- 2005 2004 ----------- ----------- One- to four-family residential mortgage loans: Fixed rate $ 395,463 $ 328,337 Adjustable rate 61,331 52,412 ----------- ----------- 456,794 380,749 ----------- ----------- 497,936 327,414 Commercial business loans 148,825 105,196 Construction loans 66,710 54,294 ----------- ----------- 713,471 486,904 ----------- ----------- Consumer loans: Home equity lines of credit 134,997 80,013 Homeowner loans 40,221 26,921 Other consumer loans 16,590 23,047 ----------- ----------- 191,808 129,981 ----------- ----------- Total loans 1,362,073 997,634 Allowance for loan losses (22,008) (17,353) ----------- ----------- Total loans, net $ 1,340,065 $ 980,281 =========== ===========
Total loans include net deferred loan origination costs of $2,110 and $1,263 at September 30, 2005 and September 30, 2004, 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, Sullivan, Putnam Counties of New York and Bergen County, New Jersey. The ability of the Company's borrowers to make principal and interest payments is dependent upon, among other things, the level of overall
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
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.
The principal balances of non-performing loans were as follows:
Gross interest income that would have been recorded if the foregoing non-accrual loans had remained current in accordance with their contractual terms totaled $8, $163, and $354, for the years ended September 30, 2005, 2004 and 2003, respectively, compared to interest income actually recognized (including income recognized on a cash basis) of $7, $119, and $167, respectively.
The Company's total recorded investment in impaired loans, as defined by SFAS No. 114, was $0 and $231 at September 30, 2005 and September 30, 2004, 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, 2005 and 2004 due to the adequacy of collateral values. The Company's average recorded investment in impaired loans was $116 and $523 during the years ended September 30, 2005 and 2004, respectively.
Activity in the allowance for loan losses is summarized as follows:
PROVIDENT NEW YORK BANCORP 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, 2005, 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 $206 in fiscal 2005, $320 in fiscal 2004, and $1,096 in fiscal 2003. At September 30, 2005 and 2004 there was $0 and $855 in loans held for sale, respectively. Other assets at September 30, 2005 and 2004 include capitalized mortgage servicing rights with an amortized cost of $836 and $746, 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 $108,856 and $84,924 at September 30, 2005 and 2004, respectively. Mortgage escrow funds include balances of $554 and $493 at September 30, 2005 and 2004, respectively, related to loans serviced for others.
(7) Accrued Interest Receivable
The components of accrued interest receivable were as follows:
(8) Premises and Equipment, Net
Premises and equipment are summarized as follows:
PROVIDENT NEW YORK BANCORP 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 $116.9 million and $106.7 million at September 30, 2005 and September 30, 2004, 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:
Certificate of deposit accounts with a denomination of $100 or more totaled $131,687 and $93,912 at September 30, 2005 and 2004, respectively. The FDIC generally insures depositor accounts up to $100 as defined in the applicable regulations.
PROVIDENT NEW YORK BANCORP 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 borrowings up to the amount of eligible mortgages that have been pledged as collateral under a blanket security agreement. As of September 30, 2005 and September 30, 2004, the Bank had pledged mortgages totaling $301,154 and $267,457, respectively. Based on outstanding borrowings under the line totaling $269,529 and $164,969 as of September 30, 2005 and September 30, 2004, the bank had unused borrowing capacity under the FHLB of New York Line of Credit of $31,625 and $102,489, respectively. The Bank may borrow an additional $522,569 by pledging securities not required to be pledged for other purposes as of September 30, 2005.
PROVIDENT NEW YORK BANCORP 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 3.4 years and 2.7 years at September 30, 2005 and 2004, respectively. Average borrowings under securities repurchase agreements were $164,541 and $43,183 during the years ended September 30, 2005 and 2004, respectively, and the maximum outstanding month-end balance was $167,062 and $50,246, respectively.
FHLB borrowings of $122.1 million and $20,000 at September 30, 2005 and 2004 respectively are callable quarterly, at the discretion of the FHLB. These borrowings have a weighted average remaining term to the contractual maturity dates of approximately 3.3 years and two years and weighted average interest rates of 4.71% and 4.9% at September 30, 2005 and 2004, respectively.
Interest expense on borrowings consists principally of overnight and short-term advances from FHLB, and were $15.7 million, $5.1 million, and $4.3 million for years ending September 30, 2005, 2004, and 2003, respectively.
(11) Income Taxes
Income tax expense consists of the following:
PROVIDENT NEW YORK BANCORP 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:
PROVIDENT NEW YORK BANCORP 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 NEW YORK BANCORP 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, 2005 and 2004.
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 for Federal tax purposes were $9,313 and $4,600 at September 2005 and 2004 respectively. The Bank's tax bad debt reserves for NY State purposes were $46,478 and $34,900 at September 30, 2005 and 2004, respectively. Associated deferred tax liabilities of $5,988 and $3,660 have not been recognized at those dates since the Company does not expect that the Federal base-year reserves and New York State bad debt 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 New York Bancorp 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 acquisitions of ENB and WSB the Company assumed the ENB and WSB Pension Plans, both of which were defined benefit plans. The ENB plan was frozen in connection with the merger of ENB into the Company. The WSB Pension Plan, which was already frozen at the time of acquisition, has also been assumed by the Company.
PROVIDENT NEW YORK BANCORP 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:
A discount rate of 5.75% and a rate of increase in future compensation levels of 4.0% were used in determining the actuarial present value of the projected benefit obligation at September 30, 2005 (6.00% and 5.00%, respectively, at September 30, 2004). The weighted average long-term rate of return on plan assets was 7.21% for fiscal 2005 and 7.75% for fiscal 2004. The discount rate, long-term rate of return on plan assets and
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
future compensation increase assumptions for the WSB and ENB Plan at the dates of acquisition were 6.0%, 7.0% and 0.0%, respectively, for the year ended September 30, 2005.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
2006 $ 1,183 2007 1,250 2008 1,373 2009 1,536 2010 1,754 2011-2015 10,832
PROVIDENT NEW YORK BANCORP 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:
Weighted-average pension plan asset allocations based on the fair value of such assets at September 30, 2005, and target allocations for 2006, by asset category, are as follows:
The expected long-term rate of return assumption as of each measurement date was determined by taking into consideration asset allocations as of each such date, historical returns on the types of assets held and current economic factors. The Company's investment policy for determining the asset allocation targets was developed based on the desire to maximize total return while placing a strong emphasis on preservation of capital. In general, it is hoped that, in the aggregate, changes in the fair value of plan assets will be less volatile than similar changes in appropriate market indices. Returns on invested assets are periodically compared with target market indices for each asset type to aid management in evaluating such returns.
There were no pension plan assets consisting of Provident New York Bancorp equity securities (common stock) at September 30, 2005 and at September 30, 2004.
The Company makes contributions to its funded qualified pension plans as required by government regulation or as deemed appropriate by management after considering the fair value of plan assets, expected returns on such assets, and the present value of benefit obligations of the plans. At this time, the Company can not reasonably estimate the contributions it will make in 2006.
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, due to amounts limited by the Internal Revenue Code of 1986, as amended ("IRS Code"). The periodic pension expense for the supplemental plan amounted to $172, $113, and $97 for the years ended September 30, 2005, 2004 and 2003, respectively. The actuarial present value of the projected benefit obligation was $1,373 and $877 at September 30, 2005 and 2004,
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
respectively, and the vested benefit obligation was $1,338 and $800 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.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
Data relating to the postretirement benefit plan follows:
The components of the net postretirement benefit expense were as follows:
Estimated Future Benefit Payments
The following benefit payments are expected to be paid in future years:
2006 $ 85 2007 90 2008 88 2009 92 2010 94 2011-2015 557
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
Assumptions used for plan 2005 2004 ------------------------------------------------ ---- ----
Medical trend rate next year 4.50% 5.00% Ultimate trend rate 4.50% 4.50% Discount rate 6.00% 6.00% Discount rate used to value periodic cost 6.00% 6.75%
There is no impact of a 1% increase or decrease in health care trend rate due to the Company's cap on cost.
(c) Employee Savings Plan
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 $493, $294, and $248 for the years ended September 30, 2005, 2004 and 2003, respectively.
(d) Employee Stock Ownership Plan
In connection with the Reorganization and Offering in 1999, Provident Federal established an ESOP for eligible employees who meet certain age and service requirements. The ESOP borrowed $3,760 from Provident Federal 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 New York Bancorp 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 $1,993, $1,896, and $1,012 for the years ended September 30, 2005, 2004 and 2003, respectively. Through September 30, 2005 and 2004, a cumulative total of 1,120,336 shares and 923,717 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
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
committed to be released for allocation is deducted from stockholders' equity (1,248,427 shares with a cost of $10,045 and a fair value of approximately $14,569 at September 30, 2005 and 1,445,045 shares with a cost of $10,854 and a fair value of approximately $16,965 at September 30, 2005, respectively).
A supplemental savings plan has also been established for certain senior officers to compensate executives for benefits provided under the Bank's tax qualified plans that are limited by the IRS Code. Expense recognized for this plan was $157, $198, and $67 for the years ended September 30, 2005, 2004 and 2003, respectively. Amounts accrued and recorded in other liabilities at September 30, 2005 and 2004 were $2.1 million and $1.4 million respectively.
(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 of $(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. In January 2005, the Company's stockholders approved the Provident Bancorp, Inc. 2004 Stock Incentive Plan, under the terms of which the Company is authorized to issue up to 798,920 shares of common stock as restricted stock awards. On March 10, 2005 a total of 762,400 shares were awarded under the RRP, and the grant-date fair value $12.84 per share of the shares of $(9,789) was charged to stockholders' equity. The awards vested 10% on September 30, 2005. The remainder will vest 20% on each of four annual vesting dates beginning on September 30, 2006 and 10% on March 10, 2010. RRP expense was $979, $506, and $526 for the years ended September 30, 2005, 2004 and 2003, respectively. In 2003, 27,413 shares were forfeited and returned to the plan as available for future grant. Employees who retire under circumstances, approved by the Executive Compensation Committee of the Board of Directors of the Company, may be entitled to accelerate the vesting of individual awards. Such acceleration would require a charge to earnings for the award shares that would then vest.
(f) Stock Option Plan
The Company's stockholders 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 was reserved for issuance under the Stock Option Plan, although the Company may also fund option exercises using treasury shares. The Company's stockholders also approved the Provident Bancorp, Inc. 2004 Stock Incentive Plan. In February 2005 under terms of the plan, a total of 1,997,300 shares of authorized but unissued common stock was reserved for issuance under the Stock Option Plan. In March, 2005 1,718,300 options were granted. Under both plans, options have a ten-year term and may be either non-qualified stock options or incentive stock options. Reload options may be granted under the terms of the 2000 Stock Option Plan 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. The 2004 Plan options do not contain reload options. 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.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
The following is a summary of activity in the Stock Option Plan:
At September 30, 2005 and 2004, respectively, there were 312,843 and 3,843 shares available for future grant.
A summary of stock options at September 30, 2005 follows:
The Company used an option pricing model to estimate the grant date present value of stock options granted. The weighted-average estimated value per option granted was $3.07 in 2005, $2.71 in 2004 and $1.13 in 2003. The values were calculated using the following weighted-average assumptions: an option term of 7.9 years (representing the estimated period between grant date and exercise date based on historical data); a risk-free interest rate of 4.46% in 2005, 2.71% in 2004 and 3.30% in 2003 (representing the yield on a U.S.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
Treasury security with a remaining term equal to the expected option term); expected volatility of 19% in 2005, 20% in 2004 and 15% in 2003 and estimated dividend yields of 1.4% in 2005, 1.4% in 2004 and 1.8% in 2003 (representing the approximate annualized cash dividend rate paid with respect to a share of common stock at or near the grant date).
(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, 2005 and 2004 consists of the after-tax net unrealized loss of $(8,184) and $(186) respectively and minimum liability for retirement plans of $(183) and $(111) at September 30, 2005, and 2004, respectively.
PROVIDENT NEW YORK BANCORP 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):
(1) Includes all shares issued to the Mutual Holding Company (2004, up until January 14, 2004, and for the year ending September 30, 2003), but excludes unallocated ESOP shares.
(2) Prior period share information has been adjusted to reflect the 4.4323-to-one exchange ratio in connection with the Company's second-step conversion in January 2004.
(3) Represents incremental shares computed using the treasury stock method.
(15) Stockholders' Equity
(a) Regulatory Capital Requirements
OTS regulations require banks 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%.
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 banks into five categories - well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
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 New York Bancorp.
Management believes that, as of September 30, 2005 and 2004 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 NEW YORK BANCORP 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, 2005 and 2004, 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, 2005 and 2004.
Tangible and Tier 1 capital amounts represent the stockholder's equity of the Bank, less intangible assets and after-tax net unrealized gains (losses) on securities available for sale and any other disallowed assets, such as deferred income taxes. 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 NEW YORK BANCORP 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:
(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. After September 30, 2005 the amount that can be paid to Provident New York Bancorp by Provident Bank is $19,864 plus net income in fiscal 2006 for Provident Bank. The Bank paid no cash dividends to Provident New York Bancorp during the year ended September 30, 2005 ($15 million during the year ended September 30, 2004 and $3,500 during the year ended September 30, 2003).
Unlike the Bank, Provident New York Bancorp is not subject to OTS regulatory limitations on the payment of dividends to its stockholders.
(c) Stock Repurchase Programs
During the year the Company announced two stock repurchase programs. The first, which was announced in the first quarter of 2005, authorized the repurchase of 2,295,000 shares and was completed in June 2005. The second, which was announced in the second quarter of 2005, authorized the repurchase of 2,200,000 shares, of which 1,307,400 remain to be purchased. The total number of shares repurchased under repurchase programs during the fiscal year ending September 30, 2005, was 3,187,600 at a total cost of $38.0 million.
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
(d) Liquidation Rights
Upon completion of the second-step conversion in January 2004, the Bank established a special "liquidation account" in accordance with OTS regulations. The account was established for the benefit of Eligible Account Holders and Supplemental Eligible Account Holders (as defined in the plan of conversion) in an amount equal to the greater of (i) the Mutual Holding Company's ownership interest in the retained earnings of Provident Federal as of the date of its latest balance sheet contained in the prospectus, or (ii) the retained earnings of the Bank at the time that the Bank reorganized into the Mutual Holding Company in 1999. Each Eligible Account Holder and Supplemental Eligible Account Holder that continues to maintain his or her deposit account at the Bank would be entitled, in the event of a complete liquidation of the Bank, to a pro rata interest in the liquidation account prior to any payment to the stockholders of the Holding Company. The liquidation account is reduced annually on December 31 to the extent that Eligible Account Holders and Supplemental Eligible Account Holders have reduced their qualifying deposits as of each anniversary date. Subsequent increases in deposits do not restore such account holder's interest in the liquidation account. The Bank may not pay cash dividends or make other capital distributions if the effect thereof would be to reduce its stockholder's equity below the amount of the liquidation account.
(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, ------------------------- 2005 2004 --------- --------- Lending-related instruments: Loan origination commitments 53,258 90,365 Unused lines of credit 229,957 120,695 Standby letters of credit 17,141 12,711
(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.
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
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
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 loan origination commitments at September 30, 2005 provide for interest rates ranging principally from 5.42% to 8.75%.
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, 2005, the Company had $17,141 in outstanding letters of credit, of which $7,225 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 were obligated to make payments to the Company, based on the notional amounts, to the extent that the three-month LIBOR rate exceeded 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, 2005, 2004, and 2003 includes charges of $0, $0, and $16, respectively, for the effect of the interest rate cap agreements. The remaining amount reported in accumulated other 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
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
more than one year at September 30, 2005 are $1,856 for fiscal 2006, $1,829 for fiscal 2007, $1,800 for fiscal 2008, $1,546 for fiscal 2009, $1,314 for fiscal 2010 and a total of $12,513 for later years. Occupancy and office operations expense includes net rent expense of $1,666, $1,435, and $1,202, for the years ended September 30, 2005, 2004 and 2003, 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 NEW YORK BANCORP 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 NEW YORK BANCORP 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, 2005 and 2004, the estimated fair values of these instruments approximated the related carrying amounts, which were insignificant.
(19) Recent Accounting Standards and Interpretations
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 did not have a material impact on the consolidated financial statements.
In December 2004, the FASB Issued Statement of Financial Accounting Standards No. 123R (Statement 123R), "Share-Based Payments", the provisions of which become effective for the corporation in fiscal 2006. This Statement eliminates the alternative to use APB No. 25's intrinsic value method of accounting that was provided in Statement 123 as originally issued. Statement 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. While the fair-value-based method prescribed by Statement 123R is similar to the fair-value-
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
based method disclosed under the provisions of Statement 123 in most respects, there some differences. The Company estimates that annual expense using the Black Sholes method beginning in fiscal 2006 will be approximately $1,151 or $939 after tax and the diluted earnings per share impact will be approximately $0.02. This impact does not include the effect of reload options or forfeitures or options accelerations due to termination or retirement of personnel, the effect of which cannot be measured with any degree of certainty.
Effective March 31, 2004 Emerging Issues Task Force Issue No. 03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments ("EITF 03-1") was issued. EITF 03-1 provides guidance for determining the meaning of "other-than-temporarily impaired" and its application to certain debt and equity securities within the scope of Statement of Financial Accounting Standards No. 115 Accounting for Certain Investments in Debt and Equity rates (` Securities ("SFAS 115") and investmentsaccounted for under the cost method. The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates ("other than temporary impairment") must be recorded for as are loans under the AICPA's Statement of Position 03-3 ("SOP 03-3") on purchased loans, which provides guidance on the treatment of potential credit losses (unrecoverable principle) and decreased, or lower then expected yields.
In May 2005, the FASB Issued Statement of Financial Accounting Standards No. 154 ("SFAS 154"), "Accounting Changes and Error Corrections,' replacing APB Opinion No. 20 and FASB Statement No.3, which changes the treatment and reporting requirements for both accounting errors and changes of accounting principles, and provides guidance on determining the treatment of the retrospective application of a change. This Statement applies to all voluntary changes in accounting principles. At this time management believes this statement will have no impact on the reporting of our operations or financial condition.
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. The adoption of the provisions of this standard did not have a material impact on the results of future operations.
PROVIDENT NEW YORK BANCORP 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 New York Bancorp and the related condensed statements of income and cash flows:
PROVIDENT NEW YORK BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except per share data)
PROVIDENT NEW YORK BANCORP 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, 2005 and 2004:
* The second quarter of 2004 includes $5,000 in expense recognized for the formation of the charitable foundation
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 l3a-15(e) and l5d-l5(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 changes in our internal control over financial reporting during the period covered by this report or, to our knowledge, in other factors, that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
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 2006 (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.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and - --------------------------------------------------------------------------- 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, 2005, 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 Service - ----------------------------------------------
The "Proposal II -- 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 and Financial Statement Schedules - ---------------------------------------------------
(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, 2005 and 2004
(C) Consolidated Statements of Income for the years ended September 30, 2005, 2004 and 2003
(D) Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income for the years ended September 30, 2005, 2004, and
(E) Consolidated Statements of Cash Flows for the years ended September 30, 2005, 2004 and 2003
(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 New York Bancorp(1) -------------------------------------------------------------------------- 3.2 Bylaws of Provident New York Bancorp(1) -------------------------------------------------------------------------- 4 Form of Common Stock Certificate of Provident New York Bancorp(1) -------------------------------------------------------------------------- 10.1 Employee Stock Ownership Plan(2) -------------------------------------------------------------------------- 10.2 Employment Agreement with George Strayton, as amended(2) -------------------------------------------------------------------------- 10.3 Form of Employment Agreement(2) -------------------------------------------------------------------------- 10.4 Deferred Compensation Agreement, as amended and restated(1) -------------------------------------------------------------------------- 10.5 Supplemental Executive Retirement Plan, as amended(2) -------------------------------------------------------------------------- 10.6 Management Incentive Program(2) -------------------------------------------------------------------------- 10.7 1996 Long-Term Incentive Plan for Officers and Directors, as amended(2) -------------------------------------------------------------------------- 10.8 Provident Bank 2000 Stock Option Plan(3) -------------------------------------------------------------------------- 10.9 Provident Bank 2000 Recognition and Retention Plan(3) -------------------------------------------------------------------------- 10.10 Employment Agreement with Paul A. Maisch(5) -------------------------------------------------------------------------- 10.11 Provident Bancorp, Inc. 2004 Stock Incentive Plan(6) -------------------------------------------------------------------------- 10.12 Provident Bank Executive Officer Incentive Plan(7) -------------------------------------------------------------------------- 14 Code of Ethics(4) -------------------------------------------------------------------------- 21 Subsidiaries of Registrant -------------------------------------------------------------------------- 23 Consent of KPMG LLP -------------------------------------------------------------------------- 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 --------------------------------------------------------------------------
(1) 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.
(2) 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.
(3) 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.
(4) 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.
(5) Incorporated by reference from the Quarterly Report on Form l0-Q of Provident Bancorp, Inc., a Delaware corporation (File No. 0-25233), filed with the Commission on August 12, 2004.
(6) Incorporated by reference to Appendix A to the proxy statement for the Company's 2005 Annual Meeting of Stockholders (File No. 0-25233), filed with the Commission on January 19, 2005.
(7) Incorporated by reference to Exhibit 10 to the Current Report on Form 8-K (Commission File No. 0- 25233), filed with the Commission on December 5, 2004.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, Provident New York Bancorp has duly caused this report to be signed on its behalf by the undersigned, there unto duly authorized.
Provident New York Bancorp
Date: December 8, 2005 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.