Overview

We specialize in the delivery of service solutions to business owners, their families and consumers within our marketplace through a team based approach. We focus our efforts on core deposit generation, especially transaction accounts and quality loan growth with emphasis on growing commercial loan balances. We seek to maintain a disciplined pricing strategy on deposit generation that will allow us to compete for high quality loans while maintaining an appropriate spread over funding costs. The Company's strategic objectives include growing revenue and earnings by expanding client acquisitions, and improving credit metrics and efficiency levels. To achieve these goals we will continue to focus on high value client segments, expand delivery channels and distribution to increase client acquisitions, execute effectively by creating a highly productive performance culture, reduce operating costs, and protectively manage enterprise risk.

The Company's results reflect the effects of the implementation of our strategies as a result of our focus on strong, consistent execution. This year, we restructured the organization around markets and have hired or promoted leadership to assume the roles of market presidents. We also announced our expansion into New York City which follows through on our strategic objective of expanding our reach into the greater New York City marketplace. In addition, we have hired 6 seasoned commercial banking teams for the New York City marketplace, all with proven track records of delivering superior service to their clients, as well as restructured the legacy market teams bringing the total teams to 16. Along with the restructuring we have introduced a measurement and accountability system for the teams that align incentives with shareholder objectives.
In line with our strategies, during the month of August we acquired Gotham Bank of New York. Gotham Bank provides an attractive platform in the New York City marketplace from which to grow our franchise. The Company has also launched a new Wealth Management Services division designed to provide a full array of wealth management options to our growing and sophisticated client base. This service has already begun to fill a key need for our clients.
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. Results of operations are also significantly affected by general economic and competitive conditions, as well as changes in market interest rates, government policies and actions of regulatory authorities.
We continue to experience pressure on net interest income as low rates cause many assets to prepay or to be called. Many of our liabilities are at rates that are either fixed or already very low, so maintaining net interest margin is a function of loan growth, growth in non-interest bearing deposits and certain core deposits, and continuation of our deposit pricing discipline. Current market interest rates remain low, and may have an affect on our reinvestment opportunities.
The following is an analysis of the financial condition and results of the Company's operations. This item should be read in conjunction with the consolidated financial statements and related notes filed herewith in Part II, Item 8, "Financial Statements and Supplementary Data" and the description of the Company's business filed here within Part I, Item 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.
Allowance for Loan Losses. The methodology for determining the allowance for loan losses is considered by the Company 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. At September 30, 2012 Provident has recorded $28.3 million in its allowance for loan losses.
Goodwill and Other Intangible Assets. The Company accounts for goodwill and other intangible assets in accordance with GAAP, which, in general, requires that goodwill not be amortized, but rather that it be tested for impairment at least annually at the reporting unit level using the two step approach. Testing for impairment of goodwill and intangible assets is performed annually and 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. Changes in the local and national economy, the federal and state legislative and regulatory environments for financial institutions, the stock market, interest rates and other external factors (such

as natural disasters or significant world events) may occur from time to time, often with great unpredictability, and may materially impact the fair value of publicly traded financial institutions and could result in an impairment charge at a future date.
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. At September 30, 2012 the Bank had $2.1 million in naming rights net of amortization included in other intangibles related to Provident Bank Ball Park and $1.6 million in mortgage servicing rights included in other assets.

Income Taxes. 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. At September 30, 2012, Provident Bancorp has net deferred tax assets of $504,000.
Interest income. Interest income on loans, securities and other interest-earning assets is accrued monthly unless the Company 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 we have 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. At September 30, 2012, Provident has $35.4 million in loans in non-accrual status.
Comparison of Financial Condition at September 30, 2012 and September 30, 2011

Total assets as of September 30, 2012 were $4.0 billion, an increase of $885.6 million compared to September 30, 2011. Significant causes for the increase were the August acquisition of Gotham Bank whose assets totaled $431.4 million on the acquisition date, as well as, seasonal monies received from municipal tax collection activity. Core deposit and other intangibles increased $2.5 million as a result of the Gotham Bank acquisition offset by decreases in other intangibles relating to the pending sale of HVIA.

Net loans as of September 30, 2012 were $2.1 billion, an increase of $415.3 million, or 24.8%, over net loan balances of $1.7 billion at September 30, 2011. Approximately half of this increase is due to the loans acquired from Gotham Bank. Commercial real estate loans increased $369.1 million, or 52.5%, commercial business loans increased $133.4 million, or 63.5%, and ADC loans decreased $31.9 million or 18.1% to $144.1 million compared to $175.9 million as of September 30, 2011, reflecting our decision to decrease ADC lending and increase commercial lending. Consumer loans decreased by $15.2 million, or 6.8%, during the fiscal year ended September 30, 2012, residential loans decreased by $39.7 million, or 10.2%. Total loan originations, excluding loans originated for sale were $735.7 million for the fiscal year ended September 30, 2012, while repayments were $509.1 million for the fiscal year ended September 30, 2012. The allowance for loan loss increased from $27.9 million to $28.3 million as a result of provisions to loan losses of $10.6 million and net charge offs of $10.2 million.

Total securities increased by $303.4 million, to $1.2 billion at September 30, 2012 from $849.9 million at September 30, 2011. Security purchases were $774.7 million, sales of securities were $344.4 million, and maturities, calls, and repayments were $237.5 million.

Goodwill and other intangibles totaled $170.4 million at September 30, 2012 an increase of $4.9 million. The increase is a mainly related to the August 2012 acquisition of Gotham Bank off set by decreases relating to the pending sale of HVIA.

Deposits as of September 30, 2012 were $3.1 billion, an increase of $814.5 million, or 35.5%, from September 30, 2011. Included in deposits for September 30, 2012 were approximately $425.0 million in short-term seasonal municipal deposits compared to $284.0 million at September 30, 2011. As of September 30, 2012, transaction accounts were 44.9% of deposits, or $1.4 billion compared to $1.1 billion or 45.9% at September 30, 2011. As of September 30, 2012, savings deposits were $506.5 million, an increase of $76.7 million or 17.8%. Money market accounts increased $312.2 million or 61.3% to $821.7 million at September 30, 2012 and certificate of deposits increased $83.8 million or 27.6% to $387.5 million.

Borrowings decreased by $29.8 million, or 8.0%, from September 2011, to $345.2 million primarily due to the maturity of the Company's FDIC guaranteed borrowing. The company restructured of $5.0 million of FHLBNY advances during the first quarter of fiscal 2012 which had a weighted average rate of 4.04 percent and duration of 1.5 years, into new borrowings with a weighted average rate of 2.37 percent, and duration of 1.6 years. Prepayment penalties of $278,500 associated with the modifications are being amortized into interest expense over the modification period on a level yield basis.

Stockholders' equity increased $60.0 million from September 30, 2011 to $491.1 million at September 30, 2012. The increase was primarily due to an increase of $46.5 million in additional paid in capital from the issuance of 6,258,504 shares of common stock at a price of $7.35 per share . The Company received net proceeds of approximately $46.0 million. The Company's retained earnings increased $10.8 million, additionally accumulated other comprehensive income improved by $1.8 million, after realizing securities gains in fiscal year 2012 of $10.5 million. During fiscal 2012, the Company did not repurchase shares of common stock under the treasury repurchase program.

As of September 30, 2012 the Company had authorization to purchase up to additional 776, 713 shares of common stock. Bank Tier I capital to assets was 7.5% at September 30, 2012. Tangible capital as a percentage of tangible assets at the holding company level was 8.3%.
Credit Quality
Nonperforming loans ("NPLs") decreased slightly to $39.8 million at September 30, 2012 compared to $40.6 million at September 30, 2011. However, non performing loans peaked during the year at $52.0 million at March 31, 2012. The increase primarily resulted from deterioration in our ADC portfolio combined with some increase in nonperforming commercial real estate loans. Through a combination of restructuring and loan sales, along with partial charge-offs, we reduced the balance during the second half of the fiscal year.

The Allowance for Loan Losses increased from $27.9 million to $28.3 million as the provisions exceeded net charge-offs by $365,000. The allowance for loan losses at September 30, 2012 was $28.3 million, 71 percent of nonperforming loans and 1.48 percent of Provident loan portfolio. Net charge-offs for the year ended September 30, 2012 were $10.2 million, or .56% of average loans, compared to net charge-offs of $19.5 million, or 1.17% of average loans for the prior year. The decrease in net charge-offs is mostly due to decreases in net charge offs in commercial business loans and ADC loans. The prior year included $8.9 million of net charges in the ADC portfolio of which $7.5 million was from one relationship.

Our classified loans, those rated substandard or worse, declined from $94.0 million at September 30, 2011 to $88.7 million at September 30, 2012 primarily driven by a reduction in our ADC loans commensurate with the reduction in the non performing loans from this segment. Special mention loans, however, increased from $23.0 million at September 30, 2011 to $42.4 million at September 30 2012, driven by increases in our commercial business and commercial real estate portfolios. The increase in the commercial business portfolio was primarily caused by a downgrade of a loan to a substantial borrower that was used to partially finance a residential housing development that has been paying according to terms. The increase in the Commercial real estate portfolio primarily resulted from upgrades from the substandard category.

Average Balances
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.
                                                                            Years Ended September 30,
                                          2012                                        2011                                        2010
                           Average                                     Average                                     Average
                         Outstanding                                 Outstanding                                 Outstanding
                           Balance        Interest    Yield/Rate       Balance        Interest    Yield/Rate       Balance        Interest    Yield/Rate
                                                                             (Dollars in thousands)
Interest Earning
Assets:
Loans (1)               $  1,806,136       91,010         5.04 %    $  1,665,360     $ 89,500         5.37 %    $  1,656,016     $ 92,542         5.59 %
Securities taxable           778,994       16,537         2.12           695,961       14,493         2.08           662,914       18,208         2.75
Securities-tax exempt        188,520        9,996         5.30           213,450       11,448         5.36           216,119       11,959         5.53
Federal Reserve Bank          51,351          127         0.25            14,044           32         0.23            20,009           52         0.26
Other                         18,901          865         4.58            20,933        1,148         5.48            25,007        1,198         4.79
Total Interest-earnings
assets                     2,843,902      118,535         4.17         2,609,748      116,621         4.47         2,580,065      123,959         4.80
Non-interest earning
assets                       351,397                                     339,503                                     333,495
Total assets            $  3,195,299                                $  2,949,251                                $  2,913,560
Interest Bearing
Liabilities:
NOW deposits            $    399,819          483         0.12      $    315,623          595         0.19      $    280,304          579         0.21
Savings deposits (2)         485,624          393         0.08           432,227          444         0.10           397,760          403         0.10
Money market deposits        671,325        2,194         0.33           489,347        1,595         0.33           419,152        1,456         0.35
Certificates of deposit      289,230        2,511         0.87           373,142        3,470         0.93           451,509        6,079         1.35
Senior debt                   19,136          753         3.93            51,498        2,017         3.92            51,495        2,029         3.94
Borrowings                   337,160       12,239         3.63           371,318       13,203         3.56           436,835       15,894         3.64
Total interest-bearing
liabilities                2,202,294       18,573         0.84         2,033,155       21,324         1.05         2,037,055       26,440         1.30
Non-interest bearing
deposits                     520,265                                     472,388                                     429,655
Other non-interest
bearing liabilities           25,675                                      16,418                                      21,442
Total liabilities          2,748,234                                   2,521,961                                   2,488,152
Stockholders' equity         447,065                                     427,290                                     425,408
Total liabilities and
Stockholders' equity    $  3,195,299                                $  2,949,251                                $  2,913,560
Net interest rate
spread (3)                                                3.33 %                                      3.42 %                                      3.51 %
Net Interest-earning
assets (4)              $    641,608                                $    576,593                                $    543,010
Net interest margin (5)                    99,962         3.51 %                       95,297         3.65 %                       97,519         3.78 %
Less tax equivalent
adjustment                                 (3,498 )                                    (4,007 )                                    (4,185 )
Net Interest income                      $ 96,464                                    $ 91,290                                    $ 93,334
Ratio of
interest-earning assets
to interest bearing
liabilities                                129.13 %                                    128.36 %                                    126.66 %

(1) Balances include the effect of net deferred loan origination fees and costs, the allowance for the loan losses, and non accrual loans. Includes prepayment fees and late charges.

(2) Includes club accounts and interest-bearing mortgage escrow balances.

(3) Net interest rate spread represents the difference between the tax equivalent yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(5) Net interest margin represents net interest income (tax equivalent) divided by average total interest-earning assets.

The following table presents the dollar amount of changes in interest income (on a fully tax-equivalent basis) and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and
(ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.

                                     2012 vs. 2011                                 2011 vs. 2010
                          Increase (Decrease)           Total           Increase (Decrease)           Total
                                 Due to               Increase                Due to                Increase
                          Volume         Rate        (Decrease)        Volume          Rate        (Decrease)
                                                        (Dollars in thousands)
Interest-earning
assets:
Loans                  $    7,367     $  (5,857 )   $     1,510     $      670      $  (3,712 )   $    (3,042 )
Securities taxable          1,761           283           2,044            878         (4,593 )        (3,715 )
Securities tax exempt      (1,325 )        (127 )        (1,452 )         (147 )         (364 )          (511 )
Federal Reserve Bank           92             3              95            (15 )           (5 )           (20 )
Other earning assets          (90 )        (193 )          (283 )         (191 )          141             (50 )
Total interest-earning
assets                      7,805        (5,891 )         1,914          1,195         (8,533 )        (7,338 )
Interest-bearing
Liabilities:
NOW deposits                  139          (251 )          (112 )           73            (57 )            16
Savings deposits               46           (97 )           (51 )           41              -              41
Money market deposits         599             -             599            229            (90 )           139
Certificates of
deposit                      (745 )        (214 )          (959 )         (934 )       (1,675 )        (2,609 )
Senior Debt                (1,269 )           5          (1,264 )            -            (12 )           (12 )
Borrowings                 (1,223 )         259            (964 )       (2,347 )         (344 )        (2,691 )
Total interest-bearing
liabilities                (2,453 )        (298 )        (2,751 )       (2,938 )       (2,178 )        (5,116 )
Less tax equivalent
adjustment                   (466 )         (43 )          (509 )          (51 )         (127 )          (178 )
Change in net interest
income                 $   10,724     $  (5,550 )   $     5,174     $    4,184      $  (6,228 )   $    (2,044 )

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.
Comparison of Operating Results for the Years Ended September 30, 2012 and September 30, 2011
Net income for the year ended September 30, 2012 was $19.9 million or $0.52 per diluted share. This compares to net income of $11.7 million, or $0.31 per diluted share for the year ended September 30, 2011.

Interest Income. Interest income on a tax equivalent basis for the year ended September 30, 2012 increased to $100.0 million, a increase of $4.7 million, or 4.9 %, compared to the prior year. Average interest-earning assets for the year ended September 30, 2012 were $2.8 billion, an increase of $234.2 million, or 9.0%, over average interest-earning assets for the year ended September 30, 2011. Average loan balances increased by $140.8 million, average balances at the Federal Reserve Bank increased $37.3 million and average balances of other earning assets decreased by $2.0 million, primarily FHLB stock. On a tax-equivalent basis, average yields on interest earning assets decreased by 30 basis points to 4.17% for the year ended September 30, 2012, from 4.47% for the year ended September 30, 2011. The primary reasons for the decrease in asset yields are declines in general market interest rates on new lending activity, and the sale of securities with subsequent reinvestment at lower yields. Interest income on loans for the year ended September 30, 2012 increased $1.5 million to $91.0 million from $89.5 million for the prior fiscal year. Interest income on commercial loans for the year ended September 30, 2012 increased to $61.2 million, as compared to commercial loan interest income of $57.4 million for the prior fiscal year. Average balances of commercial loans

grew $173.4 million to $1.2 billion, with a 47 basis point decrease in the average yield. Prime rate remained at 3.25% during fiscal year 2012. Commercial loans adjustable with the prime rate totaled $354.7 million at September 30, 2012. Interest income on consumer loans decreased to $10.1 million, as compared to consumer loan interest income of $10.5 million for the prior fiscal year. Average balances of consumer loans decreased $11.9 million to $221.4 million, with a increase of 5 basis points in the average yield. Consumer loans adjustable with the prime rate totaled $162.2 million at September 30, 2012. Income earned on residential mortgage loans was $19.7 million for the year ended September 30, 2012, down $1.9 million, from the prior year as a result of refinancing activity at lower rates and lower outstanding average balances.

Tax-equivalent interest income on securities, balances at Federal Reserve Bank and other earning assets increased to $27.5 million for the year ended September 30, 2012, compared to $27.1 million for the prior year. This was due to a tax-equivalent decrease of 22 basis points in yields. The Company sold $344.4 million in securities and recorded $10.5 million in gains on the sales. Further during fiscal 2012, proceeds totaling $237.5 million in security . . .