STERLING BANCORP 10-K 2007
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the Fiscal Year Ended September 30, 2007
For the transition period from to
Commission File Number: 0-25233
PROVIDENT NEW YORK BANCORP
(Exact name of Registrant as Specified in its Charter)
(Registrants Telephone Number including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasonal issuer, as defined in Rule 405 of the Securities Act YES ¨ NO x
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES ¨ NO x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days YES x NO ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer See definition of accelerated and large accelerated filer in Rule 12b-2 of the Exchange Act (check one).
Large Accelerated Filer ¨ Accelerated Filer x Non-Accelerated Filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x
The aggregate market value of the voting stock held by non-affiliates of the Registrant, computed by reference to the closing price of the common stock as of March 31, 2007 was $511,864,123.
As of December 7, 2007 there were outstanding 40,461,198 shares of the Registrants common stock.
DOCUMENT INCORPORATED BY REFERENCE
Proxy Statement for the Annual Meeting of Stockholders (Part III) to be filed within 120 days after the end of the Registrants fiscal year ended September 30, 2007.
FORM 10-K TABLE OF CONTENTS
September 30, 2007
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). In addition to Provident Bank, the Company owns Hardenburgh Abstract Company of Orange County, Inc. (Hardenburgh) that was acquired in connection with the acquisition of WSB and Hudson Valley Investment Advisors, LLC (HVIA), an investment advisory firm that generates investment management fees. At September 30, 2007, Provident New York Bancorp had consolidated assets of $2.8 billion, deposits of $1.7 billion and stockholders equity of $405.1 million. As of September 30, 2007, Provident New York Bancorp had 41,230,618 shares of common stock outstanding.
Provident Bank, an independent, full-service community bank founded in 1888, is the banking subsidiary of Provident Bancorp, headquartered in Montebello, New York. With $2.8 billion in assets and 546 full-time equivalent employees, we operate 33 branches which serve the Hudson Valley region, including 32 branches located in Rockland, Orange, Sullivan, Ulster and Putnam Counties in New York, and one branch in Bergen County, New Jersey which 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 Banks 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 33 branch offices at September 30, 2007, through de novo branching, and by our acquisitions.
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 Banks customers. Through September 30, 2007, 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. may hold both residential and commercial real estate loans. WSB Funding was acquired in the Warwick acquisition and operates in the same manner as Provident REIT.
Provident Banks website (www.providentbanking.com) contains a direct link to the Companys 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 reports on Forms 3, 4 and 5 filed by the Companys directors and executive officers. Copies may also be obtained, without charge, by written request to Provident New York Bancorp Investor Relations, Attention: Miranda Grimm, 400 Rella Boulevard, Montebello, New York 10901.
Provident Municipal Bank
Provident Municipal Bank, a wholly-owned subsidiary of Provident Bank, is a New York State-chartered commercial bank which is engaged in the business of accepting deposits from municipalities in our market area. New York State law requires municipalities located in the State of New York to deposit funds with commercial banks, effectively forbidding these municipalities from depositing funds with savings banks, including federally chartered savings associations, such as Provident Bank.
From time to time the Company has made and may continue to make written or oral forward-looking statements regarding our outlook or expectations for earnings, revenues, expenses, capital levels, asset quality or other future financial or business performance, strategies or expectations, or the impact of legal, regulatory or supervisory matters on our business operations or performance. This Annual Report on Form 10-K also includes forward-looking statements. With respect to all such forward-looking statements, you should review our Risk Factors discussion in Item 1A and our Cautionary Statement Regarding Forward-Looking Information included in Item 7.
Provident Bank is an independent community bank offering a broad range of financial services to businesses and individuals as an alternative to money center and large regional banks in our market area. At September 30, 2007, our 33 full-service banking offices consisted of 12 offices in Rockland County, New York, 15 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, 2007, Provident Bank holds the #3 share of deposits in Rockland County and #2 share of deposits in Orange County, and overall has the #2 share of deposits in Rockland and Orange Counties, New York.
Rockland and Orange Counties represent a suburban area 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.
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 office 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 $10.0 million. Loans secured by commercial real estate totaled $535.0 million, or 32.8% of our total loan portfolio at September 30, 2007, and consisted of 1,075 loans outstanding with an average loan balance of approximately $499,000, 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 propertys 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 primarily emphasize the ratio of the propertys projected net cash flow to the loans 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 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 borrowers 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 a lending rate that is determined internally, or a short-term market rate index. At September 30, 2007, we had 2,320 commercial business loans outstanding with an aggregate balance of $207.2 million, or 12.6% of the total loan portfolio. As of September 30, 2007, the average commercial business loan balance was approximately $89,000 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 applicants 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 applicants 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 applicants credit history supplement the analysis of the applicants 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 $400,000, 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 borrowers 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 $500.8 million, or 30.6% of our total loan portfolio at September 30, 2007.
We 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 for loans they designate as A or A-. 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 $417,000 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, which have been underwritten to the substantially same credit standards as conforming loans, which are generally eligible for sale to various firms that specialize in the purchase of such non-conforming loans. We retained in our portfolio all loans originated in fiscal 2007, totaling $110.1 million. In our market area, due to our proximity to New York City, such larger residential loans are not uncommon.
We also originate loans other than jumbo loans that are not saleable to Fannie Mae or Freddie Mac, but are deemed to be acceptable risks. The amount of such loans originated for fiscal 2007 was $8.5 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 borrowers savings or checking account. As of September 30, 2007, bi-weekly loans totaled $188.0 million, or 37.5% of our residential loan portfolio. We retain the servicing rights on a large majority of loans sold to generate fee income and reinforce our commitment to customer service, although we may also sell non-conforming loans to mortgage banking companies, generally on a servicing-released basis. As of September 30, 2007, loans serviced for others, including loan participations, totaled $122.3 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 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, 2007, our ARM portfolio included $6.5 million in loans that re-price every six months, $33.0 million in loans that re-price once a year, $6.2 million in loans that re-price periodically after an initial fixed-rate period of one year or more and $0.3 million that reprice based upon other miscellaneous re-pricing terms. Our adjustable rate loans do not have interest-only or negative amortization features.
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 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 Loans. We originate land acquisition, development and construction loans to builders in our market area. These loans totaled $153.1 million, or 9.3% of our total loan portfolio at September 30, 2007. 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 50% of the appraised value of the property, although for certain borrowers we deem to be our lowest risk, higher loan-to-value ratios may be allowed. 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, 2007, consumer loans totaled $242.0 million, or 14.7% of the total loan portfolio.
At September 30, 2007, the largest group of consumer loans consisted of $222.4 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, 2007, homeowner loans totaled $59.7 million or 3.6% of our total loan portfolio. The disbursed portion of home equity lines of credit totaled $162.7 million, or 9.9% of our total loan portfolio at September 30, 2007, with $161.6 million remaining undisbursed.
Other consumer loans include personal loans and loans secured by new or used automobiles. As of September 30, 2007, these loans totaled $19.6 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, which includes most personal 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.
Our procedures for underwriting consumer loans include an assessment of an applicants credit history and the ability to meet existing obligations and payments on the proposed loan. Although an applicants 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. We generally lend at a 80% loan to value ratio for these types of loans, but will go to 90% loan to value with a strong loan profile and higher pricing.
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.
Student Loans. During 2007, we originated student loans in connection with a third party who had contracted to repurchase the loans upon completion of the annual advances. Such loans were classified as held for sale. During 2007 the Company originated $9.0 million in student loans. As of June 30, 2007 the Company no longer originates these student loans and has no loans held for sale at September 30, 2007.
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio, excluding loans held for sale, by type of loan at the dates indicated.
Loan Portfolio Maturities and Yields. The following table summarizes the scheduled repayments of our loan portfolio at September 30, 2007. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.
The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at September 30, 2007 that are contractually due after September 30, 2008.
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 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. Consistent with its long-standing credit policies, Provident Bank does not originate or hold subprime mortgage loans, which we consider to be loans to borrowers with subprime credit scores combined with either high loan-to-value or high debt-to-income ratios. We also hold no subprime loans through our investment portfolio.
We are a qualified loan servicer for both Fannie Mae and Freddie Mac. Our policy generally 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, $15 million for the next group of borrowers and $12 million for the third group. Sublimits apply based on reliance on any single property, and for commercial business loans. On occasion, the Board of Directors may approve higher exposure limits for loans to one borrower in an amount not to exceed the legal lending limit of the Bank. The Board may also authorize the Director Loan Committee to approve loans for specific borrowers up to a designated Board approved limit in excess of the policy limit, for that borrower.
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 and in connection with certain residential mortgage refinances.
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 $3.5 million at September 30, 2007.
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 $768,000 are included in other intangible assets at September 30, 2007. See also Notes 2 and 5 of the Notes to Consolidated Financial Statements.
Loans to One Borrower. At September 30, 2007, 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 $24.7 million, $22.1 million, $17.6 million, $16.2 million and $15.1 million. See RegulationRegulation of Provident BankLoans 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.
A computer-generated late notice is sent by the 16th day after the payment due date on a loan requesting the payment due plus any late charge that was assessed. Accounts are distributed to a collector or account officer to contact borrowers, determine the reason for delinquency and arrange for payment, and accounts are monitored electronically for receipt of payments. If payments are not received within 30 days of the original due date, a letter demanding payment of all arrearages is sent and contact efforts are continued. If payment is not received within 60 days of the due date, loans are generally accelerated and payment in full is demanded. Failure to pay within 90 days of the original due date generally results in legal action, notwithstanding ongoing collection efforts. Unsecured consumer loans are generally charged-off after 120 days. For 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. In addition, loans are placed on non-accrual status when, in the opinion of management, there is sufficient reason to question the borrowers 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 borrowers financial condition and payment record. At September 30, 2007, we had non-accrual loans of $3.5 million and $3.7 million of loans 90 days past due and still accruing interest, which were well secured and in the process of collection. At September 30, 2006 we had non-accrual loans of $3.4 and $1.6 million of loans 90 days past due and still accruing interest.
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, 2007 we had two REO properties with a recorded balance of $139,000.
Loan Portfolio Delinquencies. 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, 2007, 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 $362,000. Interest income actually recognized on such loans totaled $105,000.
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 as 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, 2007, we had $8.3 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 managements review of our assets at September 30, 2007, classified assets consisted of substandard assets of $5.9 million and $92,000 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 managements judgment, deserve current recognition in estimating probable incurred 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 incurred 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 incurred 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 incurred 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:
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 and/or 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 borrowers 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.
Allowance for Loan Losses By Year. The following table sets forth activity in our allowance for loan losses for the years indicated.
On January 14, 2004, Ellenville National Bank was acquired by and merged into Provident Bank (the ENB acquisition in the tables below); on October 1, 2004 Warwick Savings Bank and Towne Center Bank (theWSB acquisition in the tables below) were acquired by and merged into Provident Bank.
The E.N.B. Acquisition increased the proportion of commercial loan assets due to the greater concentration in commercial mortgage and commercial & industrial loans compared to the Provident Bank portfolio. In addition, the proportion of criticized loans in both the retail and commercial portfolios in the acquired portfolio was higher than in the Provident portfolio. As a result of the greater proportion of commercial loans and a higher proportion of criticized loans, asset quality was modestly reduced.
The Warwick Acquisition increased the proportion of commercial loan assets due to a higher concentration of commercial mortgage loans in the WSB portfolio compared to the Provident portfolio. The acquired portfolio had a lower proportion of criticized loans in the retail and commercial portfolios than the Provident portfolio, which provided an improvement in that measure of asset quality. This resulted in an overall neutral effect on asset quality, as the increase in commercial loan assets was offset by a reduction in the proportion of criticized loans.
The tables below reflect the nature of the portfolios acquired and their impact on the combined portfolio composition and asset quality:
Following is the chart of the allocation of the allowance for loan losses for the acquired portfolios:
Impact of ENB Acquisition on Allowance Account
Impact of WSB Acquisition on Allowance Account
As a result of the ENB Acquisition, $5.8 million in loan loss reserve was recorded and $4.9 million was recorded with respect to the WSB Acquisition. These represent the amounts, which in the opinion of management, were necessary to absorb the losses inherent in the acquired portfolios in accordance with the same standards as then applied to the Provident loan portfolio.
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.
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 Boards 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 Boards 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 CMOs, 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.
Statement of Financial Accounting Standard (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 to hold and our intent. Securities available for sale are reported at fair value, while securities held to maturity are reported at amortized cost. We do not have a trading portfolio.
Government and Agency Securities. At September 30, 2007, we held government and agency securities available for sale with a fair value of $83.9 million, consisting primarily of 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, 2007, 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, 2007, we held $162.4 million in bonds issued by states and political subdivisions, $23.1 million of which were classified as held to maturity at amortized cost and $139.3 million of which were classified as available for sale at fair value.
Equity Securities. At September 30, 2007, our equity securities available for sale had a fair value of $111,000 and consisted of stock issued by Fannie Mae, and certain other equity investments. We also held $32.8 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, 2007 amounted to $2.2 million.
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; (iii) increase liquidity, and (iv) maintain our status as a thrift for charter purposes and income tax purposes. We invest primarily in mortgage-backed securities issued or sponsored by Freddie Mac, Fannie Mae 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, 2007, our mortgage-backed securities portfolio totaled $586.0 million, consisting of $571.7 million available for sale at fair value and $14.3 million held to maturity at amortized cost. The total mortgage-backed securities portfolio includes CMOs of $39.4 million, consisting of $38.2 million available for sale at fair value and $1.2 million held to maturity at amortized cost. The remaining mortgage-backed securities of $546.6 million were pass-through securities, consisting of $533.5 million available for sale at fair value and $13.1 million held to maturity at amortized cost.
Mortgage-backed securities are created by pooling mortgages and issuing a security collateralized by the pool of mortgages with an interest rate that is less than the interest rate on the underlying mortgages. Mortgage-backed securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although most of our mortgage-backed securities are collateralized by single-family mortgages. The issuers of such securities (generally U.S. Government agencies and government sponsored enterprises, including Fannie Mae, Freddie Mac and Ginnie Mae) pool and resell the participation interests in the form of securities to investors, such as us, and guarantee the payment of principal and interest to these investors. Investments in mortgage-backed securities involve a risk that actual prepayments will be greater or less than the prepayment rate estimated at the time of purchase, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby affecting the net yield 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, 2007, our available for sale federal agency securities portfolio, at fair value, totaled $83.9 million, or 3.0% of total assets. Of the federal agency portfolio, based on amortized cost, $54.0 million had maturities of one year or less and a weighted average yield of 3.26%, and $29.9 million had maturities of between one and five years and a weighted average yield of 5.28%. 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 securitys individual terms following an initial holding period of from 12 to 24 months.
State and municipal securities portfolio, available for sale, based on amortized cost, had $1.9 million in securities with a final maturity of one year or less and a weighted average yield of 3.17%; $8.7 million maturing in one to five years with a weighted average yield of 3.49%; $24.2 million maturing in five to ten years with a weighted average yield of 3.88% and $105.2 million maturing in greater than ten years with a weighted average yield of 4.08%. Equity securities available for sale at September 30, 2007 had a fair value of $111,000.
At September 30, 2007, $571.7 million of our available for sale mortgage-backed securities, at fair value, consisted of pass-through securities, which totaled 20.5% of total assets. The total amortized cost of these pass- through securities was $539.2 million and consisted of $383.3 million, $153.3. million and $2.9 million of Fannie Mae, Freddie Mac and Ginnie Mae MBS, respectively, with respective weighted averages yields of 4.83%, 5.19% and 5.20%. At the same date, the fair value of our available for sale CMO portfolio totaled $38.2 million, or 1.4% of total assets, and consisted of CMOs issued by government sponsored agencies such as Fannie Mae, Freddie Mac and private party issuers. The amortized cost of these CMOs result in a weighted average yield of 4.81%. We own both fixed-rate and floating-rate CMOs. The underlying mortgage collateral for our portfolio of CMOs available for sale at September 30, 2007 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, 2007, our held to maturity mortgage-backed securities portfolio totaled $14.3 million at amortized cost, consisting of: $3,000 with a weighted average yield of 4.47% and contractual maturities of one year or less and $533,000 with a weighted average yield of 6.40% and contractual maturities within five years and $4.5 million with a weighted average yield of 5.91% and contractual maturities of five to ten years and $9.3 million with a weighted average yield of 4.68% with contractual maturities of greater than ten years; CMOs of $1.2 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 totaled $23.1 million at amortized cost and consisted of $5.9 million, with a final maturity of one year or less and a weighted average yield of 3.87%; $9.6 million, maturing in one to five years, with a weighted average yield of 3.98%; $3.4 million maturing in five to ten years, with a weighted average yield of 4.11% and $4.2 million, maturing in greater than ten years, with a weighted average yield of 4.20%.
Portfolio Maturities and Yields. The following table summarizes the composition and maturities of the investment debt securities portfolio and the mortgage backed securities portfolio at September 30, 2007. 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. In fiscal 2006 we introduced our power money market account. With this account, interest is earned at a higher rate, but requires substantial balances and a checking account relationship. We provide a variety of commercial checking accounts and other products for businesses. In addition, we provide low-cost checking account services for low-income customers.
At September 30, 2007, our deposits totaled $1.7 billion. Interest-bearing deposits totaled $1.3 billion, and non-interest-bearing demand deposits totaled $377.4 million. NOW, savings and money market deposits totaled $773.1 million at September 30, 2007. Also at that date, we had a total of $563.2 million in certificates of deposit, of which $509.7 million had maturities of one year or less. Although we have a significant portion of our deposits in shorter-term certificates of deposit, our 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, although we may have to match competitive rates to retain many of these accounts.
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. Our limited purpose commercial bank subsidiary, Provident Municipal Bank, accepts 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. At September 30, 2007 we had $14.2 million in brokered certificates of deposit.
Distribution of Deposit Accounts by Type. The following table sets forth the distribution of total deposit accounts, by account type, at the dates indicated.
The following table sets forth the distribution of average deposit accounts by account category with the average rates paid at the dates indicated.
Certificates of Deposit by Interest Rate Range. The following table sets forth information concerning certificates of deposit by interest rate ranges at the dates indicated.
Certificates of Deposit by Time to Maturity. The following table sets forth certificates of deposit by time remaining until maturity as of September 30, 2007.
Short-term Borrowings. Our short-term borrowings (less than one year) consist of advances, repurchase agreements and overnight borrowings. At September 30, 2007, we had access to additional Federal Home Loan Bank advances of up to an additional $327.3 million on a collateralized basis. The following table sets forth information concerning balances and interest rates on our short-term borrowings at the dates and for the years indicated.
Activities of Subsidiaries and Affiliated Entities
Provident Municipal Bank is a wholly-owned subsidiary of Provident Bank. Provident Municipal Bank is a New York State-chartered commercial bank whose purpose is limited to accepting municipal deposits and investing funds obtained into investment securities. New York State law requires municipalities located in the state of New York to deposit funds with commercial banks, effectively forbidding these municipalities from depositing funds with savings banks, including federally chartered savings associations, such as Provident Bank. At September 30, 2007 Provident Municipal Bank had $176.5 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 Banks customers. Through September 30, 2007, 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. may hold 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 $1.2 million and net income of $255,000 in 2007.
The Company acquired Hudson Valley Investment Advisors, LLC (HVIA) on June 1, 2006. HVIA is an investment advisory firm that generates investment management fees. HVIA generated $2.1 million in fee income in 2007 for the Company and net income of $410,000 in 2007.
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.
As of September 30, 2007, we had 492 full-time employees and 92 part-time employees. The employees are not represented by a collective bargaining unit and we consider our relationship with our employees to be good.
As a savings and loan holding company, Provident Bancorp and its federal savings bank subsidiary, Provident Bank, are supervised and regulated by the Office of Thrift Supervision (OTS). As a state-chartered, insured bank, Provident Municipal Bank is regulated by the New York State Department of Banking and the Federal Deposit Insurance Corporation (FDIC). Because it is an FDIC-insured institution, Provident Bank also is subject to regulation by the FDIC. Provident Banks 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 Banks loan documents. As a regulated financial services firm, our relationships and good standing with regulators are of fundamental importance to the continuation and growth of our businesses. The OTS, SEC, and other regulators have broad enforcement powers, and powers to approve, deny, or refuse to act upon our applications or notices to conduct new activities, acquire or divest businesses or assets, or reconfigure existing operations.
Provident Bancorp and its subsidiaries are subject to numerous governmental regulations, some of which are summarized below. These summaries are not complete and you should refer to these laws and regulations for more information. There are numerous rules governing the regulation of financial services institutions and their holding companies. Accordingly, the following discussion is general in nature and does not purport to be complete or to describe all of the laws and regulations that apply to us. Failure to comply with applicable laws and regulations could result in a range of sanctions and enforcement actions, including the imposition of civil money penalties, formal agreements and cease and desist orders. Applicable laws and regulations may change in the future and any such change could have a material adverse impact on Provident Bancorp, Provident Bank or Provident Municipal Bank.
In addition, Provident Bancorp and its subsidiaries are subject to examination by regulators, which results in examination reports and ratings (which are not publicly available) that can impact the conduct and growth of our businesses. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. An examination downgrade by any of our federal bank regulators potentially can result in the imposition of significant limitations on our activities and growth. These regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies. This supervisory framework could materially impact the conduct, growth and profitability of our operations.
Holding Company Regulation
Provident Bancorp is a unitary savings and loan holding company because it owns only one savings association. The OTS has supervisory and enforcement authority over Provident Bancorp and its non-bank subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a risk to Provident Bank.
Provident Bancorp must generally limit its activities to those permissible for (i) financial holding companies under the Bank Holding Company Act, or (ii) multiple savings and loan holding companies under the Savings and Loan Holding Company Act. Activities in which a financial holding company may engage are those considered financial in nature or those incidental or complementary to financial activities. These activities include lending, trust and investment advisory activities, insurance agency activities, and securities and insurance underwriting activities. Activities permitted to a multiple savings and loan holding companies include certain real estate investment activities, and other activities permitted to bank holding companies under the Bank Holding Company Act.
Federal law prohibits Provident Bancorp, directly or indirectly, or through one or more subsidiaries, from acquiring control of another savings association or a savings and loan holding company, without prior written approval of the OTS. It also prohibits the acquisition or retention of, with specified exceptions, more than 5% of the voting shares of a savings association or savings and loan holding company that is not already a subsidiary, without prior written approval of the OTS. In evaluating applications for acquisition, the OTS must consider the financial and managerial resources and future prospects of the company and association involved, the effect of the acquisition on the association, the risk to the Deposit Insurance Fund, the convenience and needs of the community to be served, and competitive factors.
As a public company with securities registered under the Securities Exchange Act of 1934, Provident Bancorp also is subject to that statute and to the Sarbanes-Oxley Act.
Provident Bancorp is a legal entity separate and distinct from its savings association and other subsidiaries, and its principal sources of funds are cash dividends paid by these subsidiaries. OTS regulations limit the amount of capital distributions, including cash dividends, stock repurchases, and other transactions charged to the institutions capital account, that can be made by Provident Bank. Furthermore, because Provident Bank is a subsidiary of a holding company, it must file a notice with the OTS at least 30 days before Provident Banks Board of Directors declares a dividend or approves a capital distribution. This notice may be denied if the OTS finds that:
Provident Bank must file an application (rather than a notice) with the OTS if, among other things, the total amount of all capital distributions, including the proposed distribution, for the calendar year exceeds the institutions net income for that year, plus retained net income for the preceding two years.
As of October 1, 2007, the maximum amount of dividends that could be declared by Provident Bank for fiscal 2008, without regulatory approval, was net income for fiscal 2008, plus $14.4 million.
As a savings and loan holding company, Provident Bancorp is not currently subject to any regulatory capital requirements. However, as a federal savings association, Provident Bank is subject to OTS capital requirements. The OTS regulations require savings associations to meet three minimum capital standards: at least an 8% risk-based capital ratio, a 4% leverage ratio (3% for institutions receiving the highest supervisory rating), and at least a 1.5% tangible capital ratio.
The OTS risk-based capital standards require a savings association to maintain at least a Tier 1 (core) capital ratio to risk-weighted assets of at least 4%, and a total (core plus supplementary) capital ratio to risk-weighted assets of at least 8%. To determine these ratios, the regulations define core capital as common stockholders equity (including retained earnings), certain non-cumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of fully consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. Supplementary capital is defined as including cumulative perpetual preferred stock, mandatory convertible securities, subordinated debt, 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. The amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor ranging from 0% to 100%, assigned by the OTS capital regulation based on the risks inherent in the type of asset.
The OTS leverage ratio is defined as the ratio of core capital to adjusted total assets. The tangible capital ratio is defined as the ratio of tangible capital (the components of which are very similar to those of core capital) to adjusted total assets.
As an FDIC-insured bank, Provident Municipal Bank is subject to the risk-based capital and leverage capital requirements of the FDIC. These requirements are similar to the OTS risk-based capital and leverage capital requirements described above.
In addition to the foregoing, the OTS, the FDIC and other federal banking agencies possess broad powers under current federal law to take prompt corrective action in connection with depository institutions that do not meet minimum capital requirements. For this purpose, the law establishes five capital categories for insured depository institution: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. To be considered well capitalized, an institution must maintain a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, a leverage capital ratio of 5% or greater, and not be subject to any order or written directive to meet and maintain a specific capital level for any capital measure. An adequately capitalized institution must have a Tier 1 capital ratio of at least 4%, a total capital ratio of at least 8%, and a leverage capital ratio of at least 4%.
If an institution fails to meet these capital requirements, progressively more severe restrictions are placed on the institutions operations, management and capital distributions, depending on the capital category in which an institution is placed. Any institution that is determined to be undercapitalized, significantly undercapitalized, or critically undercapitalized is required to raise additional capital. In addition, numerous mandatory supervisory actions become immediately applicable to the insured depository institution, including, but not limited to, restrictions on growth, investment activities, capital distributions, and affiliate transactions. The federal banking agencies also may take any one of a number of discretionary supervisory actions against undercapitalized institutions, including the replacement of senior executive officers and directors. The agencies also may appoint a receiver or conservator for a savings association that is critically undercapitalized.
At September 30, 2007, the capital of Provident Bank and Provident Municipal Bank exceeded all applicable capital requirements, and each met the requirements to be treated as a well-capitalized institution.
The FDIC insures deposit accounts in Provident Bank and Provident Municipal Bank generally up to a maximum of $100,000 per separately-insured depositor, and up to a maximum of $250,000 per separately-insured depositor for certain retirement accounts As FDIC-insured depository institutions, Provident Bank and Provident Municipal Bank are required to pay deposit insurance premiums based on the risk each institution poses to the Deposit Insurance Fund. Currently, the annual FDIC assessment rate ranges from $0.05 to $0.43 per $100 of insured deposits, based on the institutions relative risk to the Deposit Insurance Fund, as measured by the institutions regulatory capital position and other supervisory factors. The FDIC also has the authority to raise or lower assessment rates on insured deposits, subject to limits, and to impose special additional assessments.
In addition, the FDIC collects funds from insured institutions sufficient to pay interest on debt obligations of the Financing Corporation (FICO). FICO is a government-sponsored entity that was formed to borrow the money necessary to carry out the closing and ultimate disposition of failed thrift institutions by the Resolution Trust Corporation. The current annual rate established by the FDIC for the FICO assessment is 1.14 basis points.
For the quarter ended September 30, 2007, the annualized FICO assessment was equal to 1.25 basis points for each $100 in domestic deposits maintained at an institution. We were allocated $1.4 million in DIF assessment credits as of January 1, 2007. Remaining DIF assessment credits at September 30, 2007 were approximately $759,000.
Regulation of Provident Bank
Business Activities. As a federal savings association, Provident Bank derives its deposit, lending and investment powers from the Home Owners Loan Act and the regulations of the OTS. Under these laws and regulations, Provident Bank may offer any type of deposit accounts, make or invest in mortgage loans secured by residential and commercial real estate, make and invest in commercial and consumer loans, certain types of debt securities and certain other loans and assets, subject in certain cases to certain limits. Provident Bank also may establish and operate subsidiaries that engage in activities permissible for Provident Bank, as well as service corporation subsidiaries that engage in activities not permissible for Provident Bank to engage in directly (such as real estate investment, and securities and insurance brokerage). Pursuant to this authority, Provident Bank operates certain subsidiaries, including Provest Services Corp., which holds an investment in a limited partnership that operates an assisted living facility; Provest Services Corp. II, through which Provident Bank offers annuities and insurance products to its customers. Provident Bank also controls Provident REIT, Inc. and WSB Funding to hold residential and commercial real estate loans. Certain of Provident Banks subsidiaries are subject to separate regulatory requirements, such as those applicable to insurance agencies and investment advisors. Hardenburgh Abstract Company of Orange County Inc., a title insurance company; and Hudson Valley Investment Advisors, LLC, an investment advisory firm are subsidiaries of Provident New York Bancorp.
Qualified Thrift Lender Test. As a federal savings association, Provident Bank must meet the qualified thrift lender (QTL) test. Under the QTL test, Provident Bank must maintain at least 65% of its portfolio assets in qualified thrift investments in at least nine months of the most recent 12-month period. Portfolio assets generally means total assets of a savings association, less the sum of certain specified liquid assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings
associations business. Qualified thrift investments are primarily mortgage loans and securities, and other investments related to housing, home equity loans, credit card loans, education loans and other consumer loans to a certain percentage of assets. 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. If Provident Bank were to fail the QTL test, it would be required to either convert to a bank charter or operate under specified restrictions.
At September 30, 2007, Provident Bank maintained approximately 87% of its portfolio assets in qualified thrift investments, and satisfied the QTL test.
Loans to One Borrower. Provident Bank generally may not make loans 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, up 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, 2007, Provident Bank was in compliance with the loans-to-one-borrower limitations.
Transactions with Affiliates. Provident Bank is subject to restrictions on transactions with affiliates that are the same as those applicable to commercial banks under Sections 23A and 23B of the Federal Reserve Act, as well as certain additional restrictions imposed on federal savings associations by the Home Owners Loan Act. The term affiliate under these laws means any company that controls or is under common control with a savings association and includes Provident Bancorp and its non-bank subsidiaries. Transactions between Provident Bank and certain affiliates are restricted to an aggregate percentage of Provident Banks capital, and in general must be collateralized with certain specified assets. The Home Owners Loan Act further prohibit a savings association from lending to any affiliate that is engaged in activities not permissible for a bank holding company and from purchasing or investing in securities issued by any affiliate other than with respect to shares of a subsidiary. Permissible transactions with affiliates must be on terms that are as favorable to the savings association as comparable transactions with non-affiliates.
Provident Bank also is restricted in its ability to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, to the same extent as such restrictions apply to commercial banks. Extensions of credit to insiders must (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; (ii) not involve more than the normal risk of repayment or present other unfavorable features; and (iii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate. In addition, extensions of credit in excess of certain limits must be approved by Provident Banks Board of Directors.
Safety and Soundness Regulations. Federal law requires each federal banking agency to prescribe certain safety and soundness 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 Establishing Standards for Safety and Soundness to implement the safety and soundness requirements of 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. 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 a deficiency persists, the agency must issue an order that requires the institution to correct the deficiency, in addition to taking other statutorily-mandated or discretionary actions.
Enforcement. The OTS has primary enforcement responsibility over federal savings associations such as Provident Bank, and has the authority to bring enforcement action against all institution-affiliated parties, including controlling stockholders and attorneys, appraisers, and accountants who knowingly or recklessly participate in wrongful action likely to have a significant 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 or directors of the institution, receivership, conservatorship, or the termination of deposit insurance. Civil money penalties may be imposed for a wide range of violations and actions. The FDIC also has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular savings association. If action is not taken by the OTS, the FDIC has authority to take action under specified circumstances.
Community Reinvestment Act and Fair Lending Laws. All savings associations have a responsibility under the Community Reinvestment Act (CRA) and related regulations of the OTS to help meet the credit needs of their communities, including low- and
moderate-income neighborhoods, consistent with safe and sound operations. The OTS is required to assess the savings associations record of compliance with the CRA, and to assign one of four possible ratings to an institutions CRA performance, including outstanding, satisfactory, needs to improve, and substantial noncompliance. The Equal Credit Opportunity Act and the Fair Housing Act also prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. A savings associations failure to comply with the provisions of the CRA 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 OTS, 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.
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 of New York 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, 2007, Provident Bank was in compliance with this requirement.
Other Regulations. Provident Bank is subject to federal consumer protection statues and regulations promulgated under these laws, including, but not limited to, the:
Provident Bank also is subject to federal laws protecting the confidentiality of consumer financial records, and limiting the ability of the institution to share non-public personal information with third parties.
Finally, Provident Bank is subject to extensive anti-money laundering provisions and requirements, which require the institution to have in place a comprehensive customer identification program and an anti-money laundering program and procedures. These laws and regulations also prohibit financial institutions from engaging in business with foreign shell banks; require financial institutions to have due diligence procedures and, in some cases, enhanced due diligence procedures for foreign correspondent and private banking accounts; and improve information sharing between financial institutions and the U.S. government. Provident Bank has established polices and procedures intended to comply with these provisions.
ITEM 1A. Risk Factors
Our Commercial Real Estate, Commercial Business and Construction Loans Expose Us to Increased Credit Risks.
At September 30, 2007, our portfolio of commercial real estate loans totaled $535.0 million, or 32.8% of total loans, our commercial business loan portfolio totaled $207.2 million, or 12.6% of total loans, and our portfolio of construction loans totaled $153.1 million, or 9.3% 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 of 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 and Intangible Assets Could Reduce Our Earnings.
We are required by U.S. Generally accepted accounting principles to test goodwill and other intangible assets for impairment at least annually. Testing for impairment of goodwill and intangible assets 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, 2007, if our goodwill and intangible assets 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 $4.06 per share.
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 substantially depend 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. Since 2005, after the completion of the second step conversion and the ENB and WSB acquisitions shifts in short term market rates led to an inverted yield curve and consequently fierce competition for deposits. The overall increase in interest bearing deposits due to this competition and eventual migration of deposits to higher rate products increased interest bearing deposit funding costs from 1.2% in 2005 to 2.6% in 2007. Additionally, average wholesale funding costs, as measured by the cost of borrowings, increased from 3.4% in 2005 to 4.9% in 2007. These increases outpaced the tax equivalent average yield on earning assets, which increased from 5.3% in 2005 to 6.3% in 2007. This increase in funding costs in excess of earning asset yields was offset by the overall increase in average earning assets over the same period from $2.2 billion to $2.5 billion in 2007. The overall result was that tax equivalent net interest income remained relatively unchanged at $86.8 million in 2005, $84.8 million in 2006 and $84.7 million in 2007. 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, if competitive market pressures limit our ability to reduce liability costs as the level of short-term interest rates decrease, or liability costs increase in response to increasing short-term rates. In this regard, we have $289.5 million in structured advances with FHLB. The advances have interest rates that are below the level of comparable fixed term borrowings. If interest rates rise the borrowings may be called whereby the funds would need to be replaced at higher levels.
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, 2007, our investment and mortgage-backed securities available for sale totaled $795.0 million. Unrealized losses on securities available for sale, net of tax, amounted to $3.9 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.
A Breach of Information Security Could Negatively Affect our Earnings.
Increasingly, we depend upon data 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. Disruptions to our vendors systems may arise from events that are wholly or partially beyond our vendors control (including, for example, computer viruses or electrical or telecommunications outages). If information security is breached, despite the controls we have instituted, 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 Extensive Regulatory Oversight
We and our subsidiaries are subject to extensive regulation and supervision. Regulators have intensified their focus on bank lending criteria and controls, and on the USA PATRIOT Acts 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 the anti-money laundering 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. Our failure to comply with these and other regulatory requirements can lead to, among other remedies, administrative enforcement actions, and legal proceedings. In addition, recently enacted, proposed and future legislation and regulations have had, will continue to have or may have significant impact on the financial services industry. Regulatory or legislative changes could make regulatory compliance more difficult or expensive for us, and could cause us to change or limit some of our products and services, or the way we operate our business.
We are subject to competition from both banks and non-banking companies.
The financial services industry, including commercial banking, is highly competitive, and we encounter strong competition for deposits, loans and other financial services in our market area. Our principal competitors include commercial banks, other savings banks and savings and loan associations, mutual funds, money market funds, finance companies, trust companies, insurers, leasing companies, credit unions, mortgage companies, real estate investment trusts (REITs), private issuers of debt obligations, venture capital firms, and suppliers of other investment alternatives, such as securities firms. Many of our non-bank competitors are not subject to the same degree of regulation as we are and have advantages over us in providing certain services. Many of our competitors are significantly larger than we are and have greater access to capital and other resources. Also, our ability to compete effectively is dependent on our ability to adapt successfully to technological changes within the banking and financial services industry.
Various Factors May Make Takeover Attempts More Difficult to Achieve.
Our Board of Directors has no current intention to sell control of Provident New York 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 New York Bancorp without the consent of our Board of Directors. One 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:
Certificate of incorporation and statutory provisions. Provisions of the certificate of incorporation and bylaws of Provident New York 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. These provisions also 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 executive officers, that require payments to be made to them in the event their employment is terminated following a change in control of Provident New York Bancorp or Provident Bank. We have issued stock grants and stock options in accordance with the 2004 Provident Bancorp Inc. Stock Incentive Plan. The majority of grants under the plan were made in 2005 and generally vest over five years. In the event of a change in control, the vesting of stock and option grants accelerate. In 2006 we adopted the Provident Bank & Affiliates Transition Benefit Plan. The plan calls for severance payments ranging from 12 weeks to one year for employees not covered by separate agreements if they are terminated in connection with a change in control of the Company. These payments and the acceleration of grants would increase the cost of acquiring Provident New York Bancorp, thereby discouraging future takeover attempts.
ITEM 2. Properties
We maintain our executive offices, commercial lending division and Investment management and trust department at a leased facility located at 400 Rella Boulevard, Montebello, NY consisting of 40,923 square feet. At September 30, 2007, we conducted our business through 33 full-service branches. Of our 33 branches 15 are located in Orange County, NY, 12 in Rockland County, NY, 2 Ulster County, NY, 2 Sullivan County, NY, 1 Putnam County, NY and 1 in Bergen County, NJ. Additionally, 19 of our branches are owned and 14 are leased. The square footage of our branches range from 300 to 19,675 square feet.
In addition to our branch network and corporate headquarters we lease 6 and own 4 additional properties which are held for general corporate purposes. The total square footage of these properties is 30,844 square feet and they are located in Orange, Rockland, Sullivan and Ulster counties. At September, 30, 2007, the net book value of our properties was $24.0 million. See note 7 of the Notes to Consolidated Financial Statements filed herewith in Item 8, Financial Statements and Supplementary Data for further detail on our premises and equipment
ITEM 3. Legal Proceedings
Provident New York 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 that are believed by management to be immaterial to Provident New York Bancorps financial condition and results of operations.
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, 2007.
ITEM 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The shares of common stock of Provident New York Bancorp are quoted on the NASDAQ Global Select (NASDAQ) under the symbol PBNY.. As of September 30, 2007, Provident New York Bancorp had 28 registered market makers, 6,166 stockholders of record (excluding the number of persons or entities holding stock in street name through various brokerage firms), and 41,230,618 shares outstanding.
Market Price and Dividends. The following table sets forth market price and dividend information for the common stock for the past two fiscal years.
Payment of dividends on Provident New York Bancorps 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 Companys shares of common stock during the fourth quarter of the fiscal year ended September 30, 2007 are detailed in (C) below. There were no sales of unregistered securities during the quarter ended September 30, 2007.
Set forth below is a stock performance graph comparing the yearly total return on our shares of common stock, commencing with the closing price on September 30, 2002, with (a) the cumulative total return on stocks included in the NASDAQ Composite Index, and (b) the cumulative total return on stocks included in the SNL Mid-Atlantic Thrift Index.
There can be no assurance that our stock performance in the future will continue with the same or similar trend depicted in the graph below. We will not make or endorse any predictions as to future stock performance.
PROVIDENT NEW YORK BANCORP
This stock performance graph shall not be deemed incorporated by reference by any general statement incorporating by reference this form 10-K under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that Provident New York Bancorp specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts.
ITEM 6. Selected Financial Data
The following financial condition data and operating data are derived from the audited consolidated financial statements of Provident New York Bancorp. Additional information is provided in Managements Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes included as Item 7 and Item 8 of this report, respectively.
footnotes on following page
ITEM 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
The Company provides financial services to individuals and businesses in New York and New Jersey. The Companys business is primarily accepting deposits from customers through its banking centers and investing those deposits, together with funds generated from operations and borrowings, in, commercial real estate loans, commercial business loans, residential mortgages, consumer loans, and investment securities. Additionally, the Company offers wealth management services.
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, and net increases in the cash surrender value of bank-owned life insurance (BOLI) contracts, title insurance fees and investment management fees. Our non-interest expense consists primarily of salaries and employee benefits, stock-based compensation, occupancy and office expenses, advertising and promotion expense, professional fees, intangible assets 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 fiscal year 2007 has been particularly challenging as a flattening and slightly inverted yield curve existed for most of the year. Our cost of funds has risen faster than our yield on assets, negatively impacting net interest income. In September 2007, the Federal Reserve lowered the federal funds target rate 50 basis points to 4.75% due to credit and liquidity issues in the credit markets The treasury yield curve remains inverted from overnight to two years, however a normal sloping curve has emerged from two to ten years. 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.
Net income for the year ended September 30, 2007, decreased 2.8% to $19.6 million, or $0.48 per diluted share from $20.2 million, or $0.49 per diluted share for the year ended September 30, 2006. Net income for the year ended September 30, 2005 was $21.2 million, or $0.49 per diluted share. Net interest income on a tax equivalent basis has been relatively unchanged over the past three years. Net interest margin declined over the three years ended September 30, 2007 from 3.98% in 2005 to 3.57% in 2007. Declines in margins have been offset by increases in average earning assets from $2.2 billion in 2005 to $2.5 billion 2007. During this period average deposits have remained relatively unchanged averaging $1.7 million in each of the three years ended September 30, 2007. Average total interest bearing liabilities rose in line with the increase in earning assets, however the cost of interest bearing liabilities rose at a faster pace than the yield on earning assets, reflecting deposit migration and wholesale funding cost increases. Additionally, as average loans have grown from $1.3 billion in 2005 to $1.5 billion in 2007 the provision for loan losses increased from $750,000 in 2005 to $1.8 million in 2007.
Non interest income was $17.0 million in 2005 increasing $2.8 million (resulting from banking fees as well as investment management fees) to $19.8 million in 2007. Non interest expense was $70.6 million in 2005 increasing $4.0 million to $74.6 million in 2007. Stock based compensation increased due to a new accounting requirement to expense stock options and new stock grants, advertising and promotion increased to improve market share and enhance franchise value. Compensation expense increased for support staff and in-house data processing, partially offset by certain benefit cost reductions. Data processing cost decreases by bringing systems in-house during 2006 were partially offset by the equipment costs in office operations expense.
Total assets remained at the same level at $2.8 billion at September 30, 2007 and September 30, 2006. As the Company furthered its commercial lending and banking initiatives, loans increased by 11.2% and investment securities decreased by 17.8% compared to the year ended September 30, 2006.
The following is an analysis of the financial condition and results of the Companys 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 Companys business filed here within Part I, Item 1, Business.
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 loans at least quarterly, and review their risk components as a part of that evaluation. See Note 1, Basis of Financial Statement Presentation and Summary of Significant Accounting Policies 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. A core deposit base intangible asset has been recorded for core deposits (defined as checking, money market and savings deposits) that were acquired in acquisitions that were accounted for as purchase business combinations. 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. Other intangible assets have been recorded in connection with the acquisition of HVIA for non-competition and customer intangibles. As of September 30, 2007 the Company had $10.3 million recorded in core deposit intangibles.
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 collectability is no longer considered doubtful.
We operate as an independent community bank that offers a broad range of customer-focused financial services as an alternative to large regional, multi-state and international banks in our market area. Management has invested in the infrastructure and staffing to support our strategy of serving the financial needs of businesses, individuals and municipalities in our market area focusing on core deposit generation and quality loan growth. This has resulted in a change in our business mix, providing a favorable platform for long-term sustainable growth. Highlights of managements 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 businesses, individuals, 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, on a selective basis, sweep accounts. In addition, we offer asset management services to meet the investing needs of individuals, corporations and not-for-profit entities. As a result, we are able to provide, at the local level, 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 (since 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. In 2006 we launched our Service Excellence Program designed to maintain the highest level of service to our customer base.
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 maintain 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 Banking Franchise. Management intends to continue the expansion of the retail banking franchise and to increase the number of households served and products used by businesses and consumers in our market area. Our strategy is to deliver exceptional customer service, which depends on up-to-date technology and multiple access channels, as well as courteous personal contact from a trained and motivated workforce. This approach has resulted in a relatively high level of core deposits, which improves 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 Banks 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.