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PFS > SEC Filings for PFS > Form 10-K on 3-Mar-2014All Recent SEC Filings




Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

On January 15, 2003, the Company became the holding company for the Bank, following the completion of the conversion of the Bank to a stock-chartered bank. The Company issued an aggregate of 59,618,300 shares of its common stock in a subscription offering to eligible depositors. Concurrent with the conversion, the Company contributed an additional 1,920,000 shares of its common stock and $4.8 million in cash to The Provident Bank Foundation, a charitable foundation established by the Bank.
The Company conducts business through its subsidiary, the Bank, a community- and customer-oriented bank currently operating 77 full-service branches throughout northern and central New Jersey.
Established in 1839, the Bank is the oldest New Jersey-chartered bank in the state. The Bank offers a full range of retail and commercial loan and deposit products, and emphasizes personal service and convenience.
The Bank's strategy is to grow profitably through a commitment to credit quality and expanding market share by acquiring, retaining and expanding customer relationships, while carefully managing interest rate risk.
In recent years, the Bank has focused on commercial real estate, multi-family and commercial loans as part of its strategy to diversify the loan portfolio and reduce interest rate risk. These types of loans generally have adjustable rates that initially are higher than residential mortgage loans and generally have a higher rate of risk. The Bank's credit policy focuses on quality underwriting standards and close monitoring of the loan portfolio. At December 31, 2013, commercial loans accounted for 66.3% of the loan portfolio and retail loans accounted for 33.7%. The Company intends to continue to diversify the loan portfolio and to focus on commercial real estate, multi-family and commercial and industrial lending relationships.
The Company's relationship banking strategy focuses on increasing core accounts and expanding relationships through its branch network, mobile banking, online banking and telephone banking touch points. The Company continues to evaluate opportunities to increase market share by expanding within existing and contiguous markets. Core deposits, consisting of all savings and demand deposit accounts, are generally a stable, relatively inexpensive source of funds. At December 31, 2013, core deposits were 84.5% of total deposits.
The Company's results of operations are primarily dependent upon net interest income, the difference between interest earned on interest-earning assets and the interest paid on interest-bearing liabilities. Changes in interest rates could have an adverse effect on net interest income to the extent the Company's interest-bearing assets and interest-bearing liabilities reprice or mature at different times or relative interest rates. An increase in interest rates generally would result in a decrease in the Company's average interest rate spread and net interest income, which could have a negative effect on profitability. The Company generates non-interest income such as income from retail and business account fees, loan servicing fees, loan origination fees, appreciation in the cash surrender value of Bank-owned life insurance, income from loan or securities sales, fees from wealth management services and investment product sales and other fees. The Company's operating expenses consist primarily of compensation and benefits expense, occupancy and equipment expense, data processing expense, the amortization of intangible assets, marketing and advertising expense and other general and administrative expenses. The Company's results of operations are also affected by general economic conditions, changes in market interest rates, changes in asset quality, changes in asset values, actions of regulatory agencies and government policies.

On December 20, 2013, the Company announced that it had entered into an agreement under which Team Capital Bank ("Team Capital") will merge with and into the Company's subsidiary, The Provident Bank. Consideration will be paid to Team Capital stockholders in a combination of stock and cash valued at approximately $122.0 million on the day of the announcement. The transaction is subject to regulatory approvals and Team Capital's stockholder approval. The merger will add twelve branches to The Provident Bank branch network, with five branches in Pennsylvania and seven in New Jersey.
On August 11, 2011, the Company's wholly owned subsidiary, The Provident Bank, completed its acquisition of Beacon Trust Company, a New Jersey limited purpose trust company, and Beacon Global Asset Management, Inc., an SEC-registered investment advisor incorporated in Delaware (collectively "Beacon"). Pursuant to the terms of the Stock Purchase Agreement announced on May 19, 2011, Beacon's former parent company, Beacon Financial Corporation, may be paid cash consideration in an amount up to $10.5 million, based upon the acquired companies' financial performance in the three years following the closing of the transaction. Subsequent to the acquisition, Beacon Global Asset Management was merged with and into Beacon Trust Company. Critical Accounting Policies
The Company considers certain accounting policies to be critically important to the fair presentation of its financial condition and results of operations. These policies require management to make complex judgments on matters which by their nature have elements of uncertainty. The sensitivity of the Company's consolidated financial statements to these critical accounting policies, and the assumptions and estimates applied, could have a significant impact on its financial condition and results of operations. These assumptions, estimates and judgments made by management can be influenced by a number of factors, including the general economic environment. The Company has identified the following as critical accounting policies:
Adequacy of the allowance for loan losses

Goodwill valuation and analysis for impairment

Valuation of securities available for sale and impairment analysis

Valuation of deferred tax assets

The calculation of the allowance for loan losses is a critical accounting policy of the Company. The allowance for loan losses is a valuation account that reflects management's evaluation of the probable losses in the loan portfolio. The Company maintains the allowance for loan losses through provisions for loan losses that are charged to income. Charge-offs against the allowance for loan losses are taken on loans where management determines that the collection of loan principal is unlikely. Recoveries made on loans that have been charged-off are credited to the allowance for loan losses.
The Company's evaluation of the adequacy of the allowance for loan losses includes a review of all loans on which the collectibility of principal may not be reasonably assured. For residential mortgage and consumer loans, this is determined primarily by delinquency and collateral values. For commercial real estate and commercial loans, an extensive review of financial performance, payment history and collateral values is conducted on a quarterly basis. As part of the evaluation of the adequacy of the allowance for loan losses, each quarter management prepares an analysis that categorizes the entire loan portfolio by certain risk characteristics such as loan type (residential mortgage, commercial mortgage, construction, commercial, etc.) and loan risk rating.
When assigning a risk rating to a loan, management utilizes a nine point internal risk rating system. Loans deemed to be "acceptable quality" are rated 1 through 4, with a rating of 1 established for loans with minimal risk. Loans deemed to be of "questionable quality" are rated 5 (watch) or 6 (special mention). Loans with adverse classifications (substandard, doubtful or loss) are rated 7, 8 or 9, respectively. Commercial mortgage, commercial and construction loans are rated individually and each lending officer is responsible for risk rating loans in their portfolio. These risk ratings are then reviewed by the department manager and/or the Chief Lending Officer and the Credit Administration Department. The risk ratings are also confirmed through periodic loan review examinations, which are currently performed by an independent third party and periodically, by the Credit Committee in the credit renewal or approval. In addition, the Bank requires an annual review be performed for commercial and commercial real estate loans above certain dollar thresholds, depending on loan type, to help determine the appropriate risk ratings. Management assigns general valuation allowance ("GVA") percentages to each risk rating category for use in allocating the allowance for loan losses, giving consideration to historical loss experience by loan type and other qualitative or environmental factors such as trends and levels of delinquencies, impaired loans, charge-offs, recoveries, loan volume, as well as the national and local economic trends and conditions. The appropriateness of these percentages is evaluated by management at least annually and monitored on a quarterly basis, with changes made when they are required. In the second quarter of 2013, management completed its most recent evaluation of the GVA percentages. As a result of that evaluation, GVA percentages applied to residential

mortgage loans, first-lien home equity loans and commercial mortgage loans were reduced to reflect the decrease in the historical loss experience. In addition, multi-family loans were segregated from other commercial mortgage loans as a result of differing risk characteristics and were assigned GVA percentages accordingly. Multi-family GVAs were established at levels lower than when previously included with other commercial mortgage loans as a result of lower historical loss experience resulting from the diverse cash flow sources supporting these loans.
Management believes the primary risks inherent in the portfolio are a decline in the economy, generally, a decline in real estate market values, rising unemployment or a protracted period of unemployment at current elevated levels, increasing vacancy rates in commercial investment properties and possible increases in interest rates in the absence of economic improvement. Any one or a combination of these events may adversely affect borrowers' ability to repay their loans, resulting in increased delinquencies, loan losses and future levels of provisions. Accordingly, the Company has provided for loan losses at the current level to address the current risk in its loan portfolio. Management considers it important to maintain the ratio of the allowance for loan losses to total loans at an acceptable level given current economic conditions, interest rates and the composition of the portfolio.
Although management believes that the Company has established and maintained the allowance for loan losses at appropriate levels, additions may be necessary if future economic and other conditions differ substantially from the current operating environment. Management evaluates its estimates and assumptions on an ongoing basis giving consideration to historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. Such estimates and assumptions are adjusted when facts and circumstances dictate. Illiquid credit markets, volatile securities markets, and declines in the housing and commercial real estate markets and the economy generally have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods. In addition, various regulatory agencies periodically review the adequacy of the Company's allowance for loan losses as an integral part of their examination process. Such agencies may require the Company to recognize additions to the allowance or additional write-downs based on their judgments about information available to them at the time of their examination. Although management uses the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short-term change.
Additional critical accounting policies relate to judgments about other asset impairments, including goodwill, investment securities and deferred tax assets. Goodwill is evaluated for impairment on an annual basis, or more frequently if events or changes in circumstances indicate potential impairment between annual measurement dates.
The Company qualitatively determines whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount before performing Step 1 of the goodwill impairment test. If an entity concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the entity would be required to perform Step 1 of the assessment and then, if needed, Step 2 to determine whether goodwill is impaired. However, if it is more likely than not that the fair value of the reporting unit is more than its carrying amount, the entity does not need to apply the two-step impairment test. For this analysis, the Reporting Unit is defined as the Bank, which includes all core and retail banking operations of the Company but excludes the assets, liabilities, equity, earnings and operations held exclusively at the Company level. The guidance provides certain factors an entity should consider in its qualitative assessment in determining whether it is more likely than not that a reporting unit's fair value is less than its carrying amount. The factors include:

            Macroeconomic conditions, such as deterioration in economic
             condition and limited access to capital.

            Industry and market considerations, such as increased competition,
             regulatory developments and decline in market-dependent multiples.

            Cost factors, such as increased labor costs, cost of materials and
             other operating costs.

            Overall financial performance, such as declining cash flows and
             decline in revenue or earnings.

            Other relevant entity-specific events, such as changes in
             management, strategy or customers, litigation and contemplation of

            Reporting unit events, such as selling or disposing a portion of a
             reporting unit and a change in composition of assets.

The Company completed its annual goodwill impairment test as of September 30, 2013. Based upon its qualitative assessment of goodwill, the Company concluded it is more likely than not that the fair value of the reporting unit exceeds its carrying amount, goodwill was not impaired and no further quantitative analysis (Step 1) was warranted.

The Company may, based upon its qualitative assessment, or at its option, perform the two-step process to evaluate the potential impairment of goodwill. If, based upon Step 1, the fair value of the Reporting Unit exceeds its carrying amount, goodwill of the Reporting Unit is considered not impaired. However, if the carrying amount of the Reporting Unit exceeds its fair value, an additional test must be performed. The second step test compares the implied fair value of the Reporting Unit's goodwill with the carrying amount of that goodwill. An impairment loss would be recorded to the extent that the carrying amount of goodwill exceeds its implied fair value.
The Company's available for sale securities portfolio is carried at estimated fair value, with any unrealized gains or losses, net of taxes, reported as accumulated other comprehensive income or loss in Stockholders' Equity. Estimated fair values are based on market quotations or matrix pricing as discussed in Note 5 to the audited consolidated financial statements. Securities which the Company has the positive intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost. The Company conducts a periodic review and evaluation of the securities portfolio to determine if any declines in the fair values of securities are other-than-temporary. In this evaluation, if such a decline were deemed other-than-temporary, the Company would measure the total credit-related component of the unrealized loss, and recognize that portion of the loss as a charge to current period earnings. The remaining portion of the unrealized loss would be recognized as an adjustment to accumulated other comprehensive income. The fair value of the securities portfolio is significantly affected by changes in interest rates. In general, as interest rates rise, the fair value of fixed-rate securities decreases and as interest rates fall, the fair value of fixed-rate securities increases. Turmoil in the credit markets resulted in a lack of liquidity in certain sectors of the mortgage-backed securities market. Increases in delinquencies and foreclosures have resulted in limited trading activity and significant price declines, regardless of favorable movements in interest rates. The Company determines if it has the intent to sell these securities or if it is more likely than not that the Company would be required to sell the securities before the anticipated recovery. If either exists, the decline in value is considered other-than-temporary. In this evaluation, the Company recognized an other-than-temporary securities impairment loss in 2013 and 2011, totaling $434,000 and $302,000, respectively. No other-than-temporary securities impairment loss was incurred in 2012.
The determination of whether deferred tax assets will be realizable is predicated on the reversal of existing deferred tax liabilities, utilization against carryback years and estimates of future taxable income. Such estimates are subject to management's judgment. A valuation allowance is established when management is unable to conclude that it is more likely than not that it will realize deferred tax assets based on the nature and timing of these items. A valuation reserve of $1.1 million was established in 2009 pertaining primarily to state tax benefits on net operating losses at the Bank and unused capital loss carryforwards. In 2011, management released the valuation allowance associated with the state net operating losses, approximately $840,000, due to expectation of current and future taxable income. At December 31, 2013, the Company maintained a valuation allowance of $242,000, related to unused capital loss carryforwards.
Analysis of Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends on the relative amounts of interest-earning assets and interest-bearing liabilities and the rates of interest earned on such assets and paid on such liabilities.
Average Balance Sheet. The following table sets forth certain information for the years ended December 31, 2013, 2012 and 2011. For the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities is expressed both in dollars and rates. No tax equivalent adjustments were made. Average balances are daily averages.

                                                                 For the Year Ended December 31,
                                    2013                                       2012                                       2011
                     Average        Interest      Average       Average        Interest      Average       Average        Interest      Average
                   Outstanding       Earned/      Yield/      Outstanding       Earned/      Yield/      Outstanding       Earned/      Yield/
                     Balance          Paid         Rate         Balance          Paid         Rate         Balance          Paid         Rate
                                                                      (Dollars in thousands)
Deposits          $     15,240     $      38        0.25 %   $     32,200     $      81        0.25 %   $     47,727     $     119        0.25 %
Federal funds
sold and
investments              1,560             1        0.04            1,439             1        0.09            1,457             -        0.01
securities(1)          353,639        10,987        3.11          351,981        11,808        3.35          345,528        12,160        3.52
available for
sale                 1,188,253        23,567        1.98        1,348,376        27,327        2.03        1,302,233        34,393        2.64
Federal Home Loan
Bank Stock              44,127         1,683        3.81           39,137         1,814        4.63           38,259         1,764        4.61
Net loans(2)         4,922,245       216,501        4.40        4,658,422       221,228        4.75        4,423,125       227,283        5.11
assets               6,525,064       252,777        3.87        6,431,555       262,259        4.08        6,158,329       275,719        4.46
earning assets         739,168                                    739,386                                    734,778
Total assets      $  7,264,232                               $  7,170,941                               $  6,893,107
Savings deposits  $    928,245           960        0.10 %   $    901,398         1,449        0.16 %   $    899,020         2,971        0.33 %
Demand deposits      2,652,419         7,456        0.28        2,581,802        10,292        0.40        2,272,780        15,168        0.67
Time deposits          878,413         9,615        1.09        1,041,533        13,607        1.31        1,213,292        18,413        1.52
Borrowed funds         908,778        18,736        2.06          864,728        19,574        2.26          909,531        23,177        2.55
liabilities          5,367,855        36,767        0.68        5,389,461        44,922        0.83        5,294,623        59,729        1.13
liabilities            900,364                                    803,722                                    657,056
Total liabilities    6,268,219                                  6,193,183                                  5,951,679
equity                 996,013                                    977,758                                    941,428
Total liabilities
and equity        $  7,264,232                               $  7,170,941                               $  6,893,107
Net interest
income                             $ 216,010                                  $ 217,337                                  $ 215,990
Net interest rate
spread                                              3.19 %                                     3.25 %                                     3.33 %
Net interest
earning assets    $  1,157,209                               $  1,042,094                               $    863,706
Net interest
margin(3)                                           3.31 %                                     3.38 %                                     3.49 %
Ratio of
assets to total
liabilities              1.22x                                      1.19x                                      1.16x

(1) Average outstanding balance amounts are at amortized cost.

(2) Average outstanding balances are net of the allowance for loan losses, deferred loan fees and expenses, and loan premiums and discounts and include non-accrual loans.

(3) Net interest income divided by average interest-earning assets.

Rate/Volume Analysis. The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

                                                       Year Ended December 31,
                                     2013 vs. 2012                                2012 vs. 2011

                          Increase/(Decrease)           Total          Increase/(Decrease)           Total
                                 Due to               Increase/               Due to               Increase/
                          Volume         Rate        (Decrease)        Volume         Rate        (Decrease)
                                                           (In thousands)
Deposits, Federal
funds sold and
short-term investments $      (43 )   $       -     $       (43 )   $      (37 )   $       -     $       (37 )
Investment securities          55          (876 )          (821 )          224          (576 )          (352 )
Securities available
for sale                   (3,186 )        (574 )        (3,760 )        1,181        (8,247 )        (7,066 )
Federal Home Loan Bank
Stock                         214          (345 )          (131 )           41             9              50
Loans                      12,127       (16,854 )        (4,727 )       11,070       (17,125 )        (6,055 )
Total interest-earning
assets                      9,167       (18,649 )        (9,482 )       12,479       (25,939 )       (13,460 )
Savings deposits               42          (531 )          (489 )            8        (1,530 )        (1,522 )
Demand deposits               274        (3,110 )        (2,836 )        1,853        (6,729 )        (4,876 )
Time deposits              (1,962 )      (2,030 )        (3,992 )       (2,423 )      (2,383 )        (4,806 )
Borrowed funds                965        (1,803 )          (838 )       (1,103 )      (2,500 )        (3,603 )
Total interest-bearing
liabilities                  (681 )      (7,474 )        (8,155 )       (1,665 )     (13,142 )       (14,807 )
Net interest income    $    9,848     $ (11,175 )   $    (1,327 )   $   14,144     $ (12,797 )   $     1,347

Comparison of Financial Condition at December 31, 2013 and December 31, 2012 Total assets increased $203.6 million, or 2.8%, to $7.49 billion at December 31, 2013, from $7.28 billion at December 31, 2012. The increase was primarily due to increases in total loans, partially offset by a decline in total securities. Total loans increased $290.1 million, or 5.9%, to $5.19 billion at December 31, 2013, from $4.90 billion at December 31, 2012. For the year ended December 31, 2013, loan originations totaling $1.77 billion and loan purchases of $34.8 million were partially offset by repayments of $1.47 billion and loan sales of $31.0 million. Multi-family loans increased $204.9 million to $928.9 million at December 31, 2013, compared to $724.0 million at December 31, 2012. Commercial loans increased $65.8 million to $932.2 million at December 31, 2013, compared to $866.4 million at December 31, 2012, commercial real estate loans increased $50.7 million to $1.40 billion at December 31, 2013, compared to $1.35 billion at December 31, 2012, and construction loans increased $63.2 million to $183.3 . . .

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