PROV-2014.03.31-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
[  ü ]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended
March 31, 2014
[     ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________________ to _________________
 
Commission File Number 000-28304

PROVIDENT FINANCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware  
 
33-0704889
(State or other jurisdiction of 
 
(I.R.S.  Employer 
incorporation or organization) 
 
Identification No.) 
 
3756 Central Avenue, Riverside, California 92506
(Address of principal executive offices and zip code)

(951) 686-6060
(Registrant’s telephone number, including area code)

_________________________________________________________
(Former name, former address and former fiscal year, if changed since last report)

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 12 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  ü     No      .

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ü     No      .

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer [   ] 
Accelerated filer [ ü ]
 
Non-accelerated filer [   ] 
Smaller reporting company [   ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  
Yes            No  ü  .
APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Title of class:
 
As of May 2, 2014
Common stock, $ 0.01 par value, per share
 
9,668,877 shares


PROVIDENT FINANCIAL HOLDINGS, INC.

Table of Contents
PART 1  -
FINANCIAL INFORMATION
 
 
 
 
 
ITEM 1  -
Financial Statements.  The Unaudited Interim Condensed Consolidated Financial Statements of Provident Financial Holdings, Inc. filed as a part of the report are as follows:
 
 
 
 
Page
 
Condensed Consolidated Statements of Financial Condition
 
 
 
as of March 31, 2014 and June 30, 2013
 
Condensed Consolidated Statements of Operations
 
 
 
for the Quarters and Nine Months Ended March 31, 2014 and 2013
 
Condensed Consolidated Statements of Comprehensive Income
 
 
 
for the Quarters and Nine Months Ended March 31, 2014 and 2013
 
Condensed Consolidated Statements of Stockholders’ Equity
 
 
 
for the Quarters and Nine Months Ended March 31, 2014 and 2013
 
Condensed Consolidated Statements of Cash Flows
 
 
 
for the Nine Months Ended March 31, 2014 and 2013
 
Notes to Unaudited Interim Condensed Consolidated Financial Statements
 
 
 
 
ITEM 2  -
Management’s Discussion and Analysis of Financial Condition and Results of Operations:
 
 
 
 
 
 
General
 
Safe-Harbor Statement
 
Critical Accounting Policies
 
Executive Summary and Operating Strategy
 
Off-Balance Sheet Financing Arrangements and Contractual Obligations
 
Comparison of Financial Condition at March 31, 2014 and June 30, 2013
 
Comparison of Operating Results
 
 
 
for the Quarters and Nine Months Ended March 31, 2014 and 2013
 
Asset Quality
 
Loan Volume Activities
 
Liquidity and Capital Resources
 
Commitments and Derivative Financial Instruments
 
Supplemental Information
 
 
 
 
ITEM 3  -
Quantitative and Qualitative Disclosures about Market Risk
 
 
 
 
ITEM 4  -
Controls and Procedures
 
 
 
 
PART II  -
OTHER INFORMATION
 
 
 
 
 
ITEM 1  -
Legal Proceedings
ITEM 1A -
Risk Factors
ITEM 2  -
Unregistered Sales of Equity Securities and Use of Proceeds
ITEM 3  -
Defaults Upon Senior Securities
ITEM 4  -
Mine Safety Disclosures
ITEM 5  -
Other Information
ITEM 6  -
Exhibits
 
 
 
 
SIGNATURES





PROVIDENT FINANCIAL HOLDINGS, INC.
Condensed Consolidated Statements of Financial Condition
(Unaudited)
In Thousands, Except Share Information
 
March 31,
2014
June 30,
2013
Assets
 
 
Cash and cash equivalents
$
193,469

$
193,839

Investment securities – available for sale, at fair value
17,102

19,510

Loans held for investment, net of allowance for loan losses of
$10,024 and $14,935, respectively
769,926

748,397

Loans held for sale, at fair value
104,262

188,050

Accrued interest receivable
2,502

2,992

Real estate owned, net
2,406

2,296

Federal Home Loan Bank (“FHLB”) – San Francisco stock
8,680

15,273

Premises and equipment, net
6,499

6,691

Prepaid expenses and other assets
20,275

33,993

 
 

 

Total assets
$
1,125,121

$
1,211,041

 
 

 

Liabilities and Stockholders’ Equity
 

 

 
 

 

Liabilities:
 

 

Non interest-bearing deposits
$
56,432

$
57,835

Interest-bearing deposits
851,074

865,175

Total deposits
907,506

923,010

 
 

 

Borrowings
51,447

106,491

Accounts payable, accrued interest and other liabilities
16,211

21,566

Total liabilities
975,164

1,051,067

 
 

 

Commitments and Contingencies




 
 

 

Stockholders’ equity:
 

 

Preferred stock, $.01 par value (2,000,000 shares authorized;
none issued and outstanding)
—

—

Common stock, $.01 par value (40,000,000 shares authorized;
17,711,365 and 17,661,865 shares issued; 9,665,877 and
10,386,399 shares outstanding, respectively)
177

177

Additional paid-in capital
88,290

87,742

Retained earnings
181,315

179,816

Treasury stock at cost (8,045,488 and 7,275,466 shares, respectively)
(120,293
)
(108,315
)
Accumulated other comprehensive income, net of tax
468

554

 
 

 

Total stockholders’ equity
149,957

159,974

 
 

 

Total liabilities and stockholders’ equity
$
1,125,121

$
1,211,041



The accompanying notes are an integral part of these condensed consolidated financial statements.

1


PROVIDENT FINANCIAL HOLDINGS, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
In Thousands, Except Per Share Information
 
Quarter Ended  
 March 31,
Nine Months Ended 
 March 31,
 
2014
2013
2014
2013
Interest income:
 
 
 
 
Loans receivable, net
$
8,731

$
10,290

$
27,522

$
33,209

Investment securities
82

105

260

329

FHLB – San Francisco stock
203

116

615

280

Interest-earning deposits
142

101

390

258

Total interest income
9,158

10,612

28,787

34,076

 
 
 
 
 
Interest expense:
 
 
 
 
Checking and money market deposits
94

97

292

307

Savings deposits
153

142

452

434

Time deposits
1,058

1,326

3,492

4,299

Borrowings
403

981

1,485

3,262

Total interest expense
1,708

2,546

5,721

8,302

 
 
 
 
 
Net interest income
7,450

8,066

23,066

25,774

(Recovery) provision for loan losses
(849
)
(517
)
(2,689
)
39

Net interest income, after (recovery) provision for loan losses
8,299

8,583

25,755

25,735

 
 
 
 
 
Non-interest income:
 
 
 
 
Loan servicing and other fees
252

203

778

923

Gain on sale of loans, net
5,291

13,835

17,777

52,308

Deposit account fees
628

605

1,868

1,845

Gain on sale and operations of real estate owned acquired in the settlement of loans, net
45

218

15

886

Card and processing fees
336

308

997

944

Other
239

219

683

676

Total non-interest income
6,791

15,388

22,118

57,582

 
 
 
 
 
Non-interest expense:
 
 
 
 
Salaries and employee benefits
8,811

11,519

28,175

37,375

Premises and occupancy
1,099

1,090

3,362

3,340

Equipment
435

482

1,389

1,345

Professional expenses
383

370

1,314

1,176

Sales and marketing expenses
418

513

1,224

1,349

     Deposit insurance premiums and regulatory assessments
251

241

694

883

Other
1,156

1,514

3,796

4,356

Total non-interest expense
12,553

15,729

39,954

49,824

 
 
 
 
 
Income before income taxes
2,537

8,242

7,919

33,493

Provision for income taxes
1,138

3,372

3,404

12,953

Net income
$
1,399

$
4,870

$
4,515

$
20,540

 
 
 
 
 
Basic earnings per share
$
0.14

$
0.46

$
0.45

$
1.93

Diluted earnings per share
$
0.14

$
0.45

$
0.44

$
1.88

Cash dividends per share
$
0.10

$
0.07

$
0.30

$
0.17


The accompanying notes are an integral part of these condensed consolidated financial statements.

2


PROVIDENT FINANCIAL HOLDINGS, INC.
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
In Thousands
 
For the Quarters Ended  
 March 31,
 
For the Nine Months Ended 
 March 31,
 
2014
2013
 
2014
2013
Net income
$
1,399

$
4,870

 
$
4,515

$
20,540

 
 
 
 
 
 
Change in unrealized holding gain (loss) on securities available for sale
17

50

 
(148
)
3

Other comprehensive income (loss), before income tax (expense) benefit
17

50

 
(148
)
3

 
 
 
 
 
 
Income tax (expense) benefit
(7
)
(21
)
 
62

(1
)
Other comprehensive income (loss)
10

29

 
(86
)
2

 
 
 
 
 
 
Total comprehensive income
$
1,409

$
4,899

 
$
4,429

$
20,542



The accompanying notes are an integral part of these condensed consolidated financial statements.

3


PROVIDENT FINANCIAL HOLDINGS, INC.
Condensed Consolidated Statements of Stockholders' Equity
(Unaudited)
In Thousands, Except Share Information

For the Quarters Ended March 31, 2014 and 2013:

 
Common
Stock
Additional
Paid-In Capital
Retained Earnings
Treasury Stock
Accumulated
Other
Comprehensive
Income,
Net of Tax
 
 
Shares
Amount
Total
Balance at December 31, 2013
9,851,765

$
177

$
88,358

$
180,897

$
(117,440
)
$
458

$
152,450

 
 
 
 
 
 
 
 
Net income
 
 
 
1,399

 
 
1,399

Other comprehensive income
 
 
 
 
 
10

10

Purchase of treasury stock
(194,888
)
 
 
 
(2,983
)
 
(2,983
)
Exercise of stock options
9,000

—

66

 
 
 
66

Amortization of restricted stock
 
 
50

 
 
 
50

Awards of restricted stock
 
 
(130
)
 
130

 
—

Stock options expense
 
 
76

 
 
 
76

Tax effect from stock based compensation
 
 
(130
)
 
 
 
(130
)
Cash dividends
 
 
 
(981
)
 
 
(981
)
 
 
 
 
 
 
 
 
Balance at March 31, 2014
9,665,877

$
177

$
88,290

$
181,315

$
(120,293
)
$
468

$
149,957

 
 
 
Common
Stock
Additional
Paid-In Capital
Retained Earnings
Treasury Stock
Accumulated
Other
Comprehensive
Income,
Net of Tax
 
 
Shares
Amount
Total
Balance at December 31, 2012
10,597,005

$
176

$
87,278

$
171,155

$
(103,352
)
$
599

$
155,856

 
 
 
 
 
 
 
 
Net income
 
 
 
4,870

 
 
4,870

Other comprehensive income
 
 
 
 
 
29

29

Purchase of treasury stock
(160,534
)
 
 
 
(2,815
)
 
(2,815
)
Exercise of stock options
14,000

1

98

 
 
 
99

Amortization of restricted stock
 
 
53

 
 
 
53

Stock options expense
 
 
104

 
 
 
104

Tax effect from stock based compensation
 
 
14

 
 
 
14

Cash dividends
 
 
 
(741
)
 
 
(741
)
 
 
 
 
 
 
 
 
Balance at March 31, 2013
10,450,471

$
177

$
87,547

$
175,284

$
(106,167
)
$
628

$
157,469



The accompanying notes are an integral part of these condensed consolidated financial statements.

4


For the Nine Months Ended March 31, 2014 and 2013:

 
Common
Stock
Additional
Paid-In Capital
Retained Earnings
Treasury Stock
Accumulated
Other
Comprehensive
Income (Loss),
Net of Tax
 
 
Shares
Amount
Total
Balance at June 30, 2013
10,386,399

$
177

$
87,742

$
179,816

$
(108,315
)
$
554

$
159,974

 
 
 
 
 
 
 
 
Net income
 
 
 
4,515

 
 
4,515

Other comprehensive loss
 
 
 
 
 
(86
)
(86
)
Purchase of treasury stock
(770,022
)
 
 
 
(12,057
)
 
(12,057
)
Exercise of stock options
49,500

—

362

 
 
 
362

Amortization of restricted stock
 
 
152

 
 
 
152

Awards of restricted stock
 
 
(130
)
 
130

 
—

Forfeitures of restricted stock
 
 
51

 
(51
)
 
—

Stock options expense
 
 
235

 
 

 
235

Tax effect from stock based compensation
 
 
(122
)
 
 
 
(122
)
Cash dividends
 
 
 

(3,016
)
 
 
(3,016
)
 
 
 
 
 
 
 
 
Balance at March 31, 2014
9,665,877

$
177

$
88,290

$
181,315

$
(120,293
)
$
468

$
149,957



 
Common
Stock
Additional
Paid-In Capital
Retained Earnings
Treasury Stock
Accumulated
Other
Comprehensive
Income,
Net of Tax
 
 
Shares
Amount
Total
Balance at June 30, 2012
10,856,027

$
176

$
86,758

$
156,560

$
(99,343
)
$
626

$
144,777

 
 
 
 
 
 
 
 
Net income
 
 
 
20,540

 
 
20,540

Other comprehensive income
 
 
 
 
 
2

2

Purchase of treasury stock
(448,356
)
 
 
 
(6,811
)
 
(6,811
)
Exercise of stock options
42,000

1

295

 
 
 
296

Distribution of restricted stock
800

 
 
 
 
 
—

Amortization of restricted stock
 
 
158

 
 
 
158

Forfeitures of restricted stock
 
 
13

 
(13
)
 
—

Stock options expense
 
 
238

 
 
 
238

Tax effect from stock based compensation
 
 
85

 
 
 
85

Cash dividends
 
 
 
(1,816
)
 
 
(1,816
)
 
 
 
 
 
 
 
 
Balance at March 31, 2013
10,450,471

$
177

$
87,547

$
175,284

$
(106,167
)
$
628

$
157,469



The accompanying notes are an integral part of these condensed consolidated financial statements.

5


PROVIDENT FINANCIAL HOLDINGS, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited - In Thousands)
 
Nine Months Ended 
 March 31,
 
2014
2013
Cash flows from operating activities:
 
 
Net income
$
4,515

$
20,540

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
1,217

1,261

(Recovery) provision for loan losses
(2,689
)
39

Recovery of losses on real estate owned
(20
)
(118
)
Gain on sale of loans, net
(17,777
)
(52,308
)
Gain on sale of real estate owned, net
(242
)
(1,067
)
Stock-based compensation
387

396

Increase in current and deferred income taxes
(2,690
)
(1,277
)
Tax effect from stock based compensation
122

(85
)
(Decrease) increase in accounts payable and other liabilities
(3,433
)
1,613

Decrease in prepaid expenses and other assets
350

864

Loans originated for sale
(1,490,402
)
(2,659,372
)
Proceeds from sale of loans
1,606,463

2,766,054

Net cash provided by operating activities
95,801

76,540

 
 
 
Cash flows from investing activities:
 
 
(Increase) decrease in loans held for investment, net
(22,731
)
34,871

Principal payments from investment securities available for sale
2,285

2,329

Redemption of FHLB – San Francisco stock
6,593

5,028

Proceeds from sale of real estate owned
3,655

11,910

Purchase of premises and equipment
(592
)
(894
)
Net cash (used for) provided by investing activities
(10,790
)
53,244

 
 
 
Cash flows from financing activities:
 
 
Decrease in deposits, net
(15,504
)
(26,311
)
Repayments of long-term borrowings
(55,044
)
(20,041
)
Exercise of stock options
362

296

Tax effect from stock based compensation
(122
)
85

Cash dividends
(3,016
)
(1,816
)
Treasury stock purchases
(12,057
)
(6,811
)
Net cash used for financing activities
(85,381
)
(54,598
)
 
 
 
Net (decrease) increase in cash and cash equivalents
(370
)
75,186

Cash and cash equivalents at beginning of period
193,839

145,136

Cash and cash equivalents at end of period
$
193,469

$
220,322

Supplemental information:
 
 
Cash paid for interest
$
6,056

$
8,442

Cash paid for income taxes
$
6,216

$
14,145

Transfer of loans held for sale to held for investment
$
3,980

$
3,527

Real estate acquired in the settlement of loans
$
4,178

$
9,250



The accompanying notes are an integral part of these condensed consolidated financial statements.

6


PROVIDENT FINANCIAL HOLDINGS, INC.
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

Note 1: Basis of Presentation

The unaudited interim condensed consolidated financial statements included herein reflect all adjustments which are, in the opinion of management, necessary to present a fair statement of the results of operations for the interim periods presented.  All such adjustments are of a normal, recurring nature.  The condensed consolidated statements of financial condition at June 30, 2013 are derived from the audited consolidated financial statements of Provident Financial Holdings, Inc. and its wholly-owned subsidiary, Provident Savings Bank, F.S.B. (the “Bank”) (collectively, the “Corporation”).  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”) with respect to interim financial reporting.  It is recommended that these unaudited interim condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended June 30, 2013.  The results of operations for the quarter and nine months ended March 31, 2014 are not necessarily indicative of results that may be expected for the entire fiscal year ending June 30, 2014.


Note 2: Accounting Standard Updates (“ASU”)

ASU 2011-11:
In December 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-11, “Balance Sheet (Topic 210) -Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU enhances disclosures required by GAAP by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. This information enables users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of set off associated with certain financial instruments and derivative instruments in the scope of this ASU. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of this ASU did not have a material impact on the Corporation's consolidated financial statements; however, there was a significant impact related to the footnotes to the financial statements upon adoption.

ASU 2013-01:
In January 2013, the FASB issued ASU 2013-01, "Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities." This ASU amends ASU 2011-11 to clarify that the scope applies to derivatives, repurchase and reverse repurchase agreements, and securities borrowing and lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or subject to master netting or similar arrangements. Other types of financial assets and liabilities subject to master netting or similar arrangements are not subject to the disclosure requirements in ASU 2011-11. The amendments were effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this ASU did not have a material impact on the Corporation's consolidated financial statements; however, there was a significant impact related to the footnotes to the financial statements upon adoption.

ASU 2013-02:
In February 2013, the FASB issued ASU 2013-02, "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” This ASU requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. The amendments were effective prospectively for reporting periods beginning after December 15, 2012. The Corporation's adoption of this ASU did not have a material impact on its consolidated financial statements; however, there was a significant impact related to the footnotes to the financial statements upon adoption.


7


ASU 2013-11:
In July 2013, the FASB issued ASU 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Corporation's adoption of this ASU did not have a material impact on its consolidated financial statements.

ASU 2014-04:
In January 2014, the FASB issued ASU 2014-04, "Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure." The amendments in this ASU are intended to reduce diversity in practice by clarifying when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate property recognized. Holding foreclosed real estate property presents different operational and economic risk to creditors compared with holding an impaired loan. Therefore, consistency in the timing of loan derecognition and presentation of foreclosed real estate properties is of qualitative significance to users of the creditor’s financial statements. Additionally, the disclosure of the amount of foreclosed residential real estate properties and of the recorded investment in consumer mortgage loans secured by residential real estate properties that are in the process of foreclosure is expected to provide decision-useful information to many users of the creditor’s financial statements. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. For entities other than public business entities, the amendments in this ASU are effective for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. The Corporation has not determined the impact of this ASU on its consolidated financial statements.


8



Note 3: Earnings Per Share

Basic earnings per share (“EPS”) excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of shares outstanding for the period.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would then share in the earnings of the entity.

As of March 31, 2014 and 2013, there were outstanding options to purchase 925,700 shares and 1.1 million shares of the Corporation’s common stock, respectively, of which 448,700 shares and 586,500 shares, respectively, were excluded from the diluted EPS computation as their effect was anti-dilutive. As of March 31, 2014 and 2013, there were outstanding restricted stock awards of 81,500 shares and 144,500 shares, respectively, all of which have dilutive effects.

The following table provides the basic and diluted EPS computations for the quarters and nine months ended March 31, 2014 and 2013, respectively.
 
(In Thousands, Except Earnings Per Share)
For the Quarters Ended
March 31,
For the Nine Months Ended
March 31,
 
2014
2013
2014
2013
Numerator:
 
 
 
 
     Net income – numerator for basic earnings
        per share and diluted earnings
        per share - available to common stockholders
$
1,399

$
4,870

$
4,515

$
20,540

 
 
 
 
 
Denominator:
 

 

 

 

Denominator for basic earnings per share:
 

 

 

 

 Weighted-average shares
9,792

10,549

10,061

10,668

 
 
 
 
 
   Effect of dilutive shares:
 
 
 
 
Stock options
150

191

164

157

Restricted stock
31

87

29

79

 
 
 
 
 
Denominator for diluted earnings per share:
 

 

 

 

Adjusted weighted-average shares
and assumed conversions
9,973

10,827

10,254

10,904

 
 
 
 
 
Basic earnings per share
$
0.14

$
0.46

$
0.45

$
1.93

Diluted earnings per share
$
0.14

$
0.45

$
0.44

$
1.88


9


Note 4: Operating Segment Reports

The Corporation operates in two business segments: community banking through the Bank and mortgage banking through Provident Bank Mortgage (“PBM”), a division of the Bank.

The following tables set forth condensed consolidated statements of operations and total assets for the Corporation’s operating segments for the quarters and nine months ended March 31, 2014 and 2013, respectively.

 
For the Quarter Ended March 31, 2014
(In Thousands)
Provident
Bank
Provident
Bank
Mortgage
Consolidated
Totals
Net interest income
$
6,757

$
693

$
7,450

Recovery for loan losses
(707
)
(142
)
(849
)
Net interest income, after recovery for loan losses
7,464

835

8,299

 
 
 
 
Non-interest income:
 
 
 
     Loan servicing and other fees (1)
40

212

252

     Gain on sale of loans, net (2)
52

5,239

5,291

Deposit account fees
628

—

628

     Gain on sale and operations of real estate
        owned acquired in the settlement of loans, net
45

—

45

Card and processing fees
336

—

336

Other
239

—

239

Total non-interest income
1,340

5,451

6,791

 
 
 
 
Non-interest expense:
 
 
 
Salaries and employee benefits
3,903

4,908

8,811

Premises and occupancy
639

460

1,099

Operating and administrative expenses
1,012

1,631

2,643

Total non-interest expense
5,554

6,999

12,553

Income (loss) before income taxes
3,250

(713
)
2,537

Provision (benefit) for income taxes
1,438

(300
)
1,138

Net income (loss)
$
1,812

$
(413
)
$
1,399

Total assets, end of period
$
1,022,129

$
102,992

$
1,125,121


(1) 
Includes an inter-company charge of $115 credited to PBM by the Bank during the period to compensate PBM for originating loans held for investment.
(2) 
Includes an inter-company charge of $22 credited to PBM by the Bank during the period to compensate PBM for servicing fees on loans sold on a servicing retained basis.

10


 
For the Quarter Ended March 31, 2013
(In Thousands)
Provident
Bank
Provident
Bank
Mortgage
Consolidated
Totals
Net interest income
$
6,911

$
1,155

$
8,066

(Recovery) provision for loan losses
(533
)
16

(517
)
Net interest income after (recovery) provision for loan losses
7,444

1,139

8,583

 
 
 
 
Non-interest income:
 
 
 
     Loan servicing and other fees (1)
163

40

203

     (Loss) gain on sale of loans, net (2)
(77
)
13,912

13,835

Deposit account fees
605

—

605

     Gain on sale and operations of real estate owned
        acquired in the settlement of loans, net
11

207

218

Card and processing fees
308

—

308

Other
219

—

219

Total non-interest income
1,229

14,159

15,388

 
 
 
 
Non-interest expense:
 
 
 
Salaries and employee benefits
4,178

7,341

11,519

Premises and occupancy
673

417

1,090

Operating and administrative expenses
1,149

1,971

3,120

Total non-interest expense
6,000

9,729

15,729

Income before income taxes
2,673

5,569

8,242

Provision for income taxes
1,030

2,342

3,372

Net income
$
1,643

$
3,227

$
4,870

Total assets, end of period
$
1,054,837

$
166,646

$
1,221,483


(1) 
Includes an inter-company charge of $11 credited to PBM by the Bank during the period to compensate PBM for originating loans held for investment.
(2) 
Includes an inter-company charge of $21 credited to PBM by the Bank during the period to compensate PBM for servicing fees on loans sold on a servicing retained basis.

11



 
For the Nine Months Ended March 31, 2014
 
Provident
Bank
Provident
Bank
Mortgage
Consolidated
Totals
Net interest income
$
19,995

$
3,071

$
23,066

Recovery for loan losses
(2,566
)
(123
)
(2,689
)
Net interest income, after recovery for loan losses
22,561

3,194

25,755

 
 
 
 
Non-interest income:
 
 
 
     Loan servicing and other fees (1)
384

394

778

     Gain on sale of loans, net (2)
375

17,402

17,777

Deposit account fees
1,868

—

1,868

     Gain on sale and operations of real estate owned
        acquired in the settlement of loans, net
14

1

15

Card and processing fees
997

—

997

Other
683

—

683

Total non-interest income
4,321

17,797

22,118

 
 
 
 
Non-interest expense:
 
 
 
Salaries and employee benefits
11,458

16,717

28,175

Premises and occupancy
1,952

1,410

3,362

Operating and administrative expenses
3,082

5,335

8,417

Total non-interest expense
16,492

23,462

39,954

Income (loss) before taxes
10,390

(2,471
)
7,919

Provision (benefit) for income taxes
4,443

(1,039
)
3,404

Net income (loss)
$
5,947

$
(1,432
)
$
4,515

Total assets, end of period
$
1,022,129

$
102,992

$
1,125,121


(1)
Includes an inter-company charge of $128 credited to PBM by the Bank during the period to compensate PBM for originating loans held for investment.
(2)
Includes an inter-company charge of $68 credited to PBM by the Bank during the period to compensate PBM for servicing fees on loans sold on a servicing retained basis.


12


 
For the Nine Months Ended March 31, 2013
 
Provident
Bank
Provident
Bank
Mortgage
Consolidated
Totals
Net interest income
$
21,388

$
4,386

$
25,774

Provision (recovery) for loan losses
287

(248
)
39

Net interest income, after provision (recovery) for loan losses
21,101

4,634

25,735

 
 
 
 
Non-interest income:
 
 
 
     Loan servicing and other fees (1)
813

110

923

     (Loss) gain on sale of loans, net (2)
(85
)
52,393

52,308

Deposit account fees
1,845

—

1,845

     Gain on sale and operations of real estate owned
        acquired in the settlement of loans, net
672

214

886

Card and processing fees
944

—

944

Other
676

—

676

Total non-interest income
4,865

52,717

57,582

 
 
 
 
Non-interest expense:
 
 
 
Salaries and employee benefits
13,174

24,201

37,375

Premises and occupancy
2,081

1,259

3,340

Operating and administrative expenses
3,429

5,680

9,109

Total non-interest expense
18,684

31,140

49,824

Income before taxes
7,282

26,211

33,493

Provision for income taxes
1,932

11,021

12,953

Net income
$
5,350

$
15,190

$
20,540

Total assets, end of period
$
1,054,837

$
166,646

$
1,221,483


(1)
Includes an inter-company charge of $38 credited to PBM by the Bank during the period to compensate PBM for originating loans held for investment.
(2)
Includes an inter-company charge of $87 credited to PBM by the Bank during the period to compensate PBM for servicing fees on loans sold on a servicing retained basis.



13


Note 5: Investment Securities

The amortized cost and estimated fair value of investment securities as of March 31, 2014 and June 30, 2013 were as follows:

March 31, 2014
 
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair
Value
 
Carrying
Value
(In Thousands)
 
 
 
 
 
Available for sale
 
 
 
 
 
U.S. government agency MBS (1)
$
9,171

$
372

$
—

$
9,543

$
9,543

U.S. government sponsored enterprise MBS
6,297

360

—

6,657

6,657

Private issue CMO (2)
899

4

(1
)
902

902

Total investment securities
$
16,367

$
736

$
(1
)
$
17,102

$
17,102


(1) 
Mortgage-Backed Securities (“MBS”).
(2) 
Collateralized Mortgage Obligations (“CMO”).

June 30, 2013
 
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair
Value
 
Carrying
Value
(In Thousands)
 
 
 
 
 
Available for sale
 
 
 
 
 
U.S. government agency MBS
$
10,361

$
455

$
—

$
10,816

$
10,816

U.S. government sponsored enterprise MBS
7,255

420

—

7,675

7,675

Private issue CMO
1,036

1

(18
)
1,019

1,019

Total investment securities
$
18,652

$
876

$
(18
)
$
19,510

$
19,510


In the third quarters of fiscal 2014 and 2013, the Corporation received MBS principal payments of $666,000 and $662,000, respectively, and did not purchase or sell investment securities. For the first nine months of fiscal 2014 and 2013, the Corporation received MBS principal payments of $2.3 million and $2.3 million, respectively, and did not purchase or sell investment securities.
  
The Corporation evaluates individual investment securities quarterly for other-than-temporary declines in market value.  As of March 31, 2014, the gross unrealized holding losses relate to one adjustable rate private issue CMO, which has been in an unrealized loss position for more than 12 months.  This compares to June 30, 2013 when the gross unrealized holding losses relate to one adjustable rate private issue CMO, which had been in an unrealized loss position for more than 12 months. The unrealized holding losses were primarily the result of perceived credit and liquidity concerns related to these CMOs.  Based on the nature of the investments, management concluded that such unrealized losses were not other than temporary as of March 31, 2014 and June 30, 2013.  The Corporation does not believe that there are any other-than-temporary impairments at March 31, 2014 and 2013; therefore, no impairment losses have been recorded for the quarters ended March 31, 2014 and 2013.  The Corporation intends and has the ability to hold these CMOs until maturity and will not likely be required to sell the CMOs before realizing a full recovery.




14


Contractual maturities of investment securities as of March 31, 2014 and June 30, 2013 were as follows:

 
March 31, 2014
 
June 30, 2013
(In Thousands)
Amortized
Cost
Estimated
Fair
Value
 
Amortized
Cost
Estimated
Fair
Value
Available for sale
 
 
 
 
 
Due in one year or less
$
—

$
—

 
$
—

$
—

Due after one through five years
—

—

 
—

—

Due after five through ten years
—

—

 
—

—

Due after ten years
16,367

17,102

 
18,652

19,510

Total investment securities
$
16,367

$
17,102

 
$
18,652

$
19,510



Note 6: Loans Held for Investment
 
Loans held for investment consisted of the following:

(In Thousands)
March 31,
2014
June 30,
2013
Mortgage loans:
 
 
Single-family
$
381,267

$
404,341

Multi-family
289,314

262,316

Commercial real estate
104,569

92,488

Construction
1,792

292

Commercial business loans
1,051

1,687

Consumer loans
324

437

Total loans held for investment, gross
778,317

761,561

 
 
 
Undisbursed loan funds
(757
)
(292
)
Deferred loan costs, net
2,390

2,063

Allowance for loan losses
(10,024
)
(14,935
)
Total loans held for investment, net
$
769,926

$
748,397


As of March 31, 2014, the Corporation had $25.5 million in mortgage loans that are subject to negative amortization, consisting of $20.8 million in multi-family loans, $3.8 million in single-family loans and $887,000 in commercial real estate loans.  This compares to $33.3 million of negative amortization mortgage loans at June 30, 2013, consisting of $24.4 million in multi-family loans, $5.1 million in single-family loans and $3.8 million in commercial real estate loans.  During the third quarter and first nine months of fiscal 2014 and 2013, no loan interest income was added to the negative amortization loan balance.  Negative amortization involves a greater risk to the Corporation because the loan principal balance may increase by a range of 110% to 115% of the original loan amount during the period of negative amortization and because the loan payment may increase beyond the means of the borrower when loan principal amortization is required.  Also, the Corporation has originated interest-only ARM loans, which typically have a fixed interest rate for the first two to five years coupled with an interest only payment, followed by a periodic adjustable rate and a fully amortizing loan payment.  As of March 31, 2014 and June 30, 2013, the interest-only ARM loans were $174.1 million and $188.5 million, or 22% and 25% of loans held for investment, respectively.


15


The following table sets forth information at March 31, 2014 regarding the dollar amount of loans held for investment that are contractually repricing during the periods indicated, segregated between adjustable rate loans and fixed rate loans.  Fixed-rate loans comprised 5% of loans held for investment at March 31, 2014, unchanged from June 30, 2013.  Adjustable rate loans having no stated repricing dates that reprice when the index they are tied to reprices (e.g. prime rate index) and checking account overdrafts are reported as repricing within one year.  The table does not include any estimate of prepayments which may cause the Corporation’s actual repricing experience to differ materially from that shown.

 
Adjustable Rate
 
 
(In Thousands)
Within One Year
After
One Year
Through 3 Years
After
3 Years
Through 5 Years
After
5 Years
Through 10 Years
Fixed Rate
Total
Mortgage loans:
 
 
 
 
 
 
Single-family
$
337,363

$
15,147

$
8,093

$
4,994

$
15,670

$
381,267

Multi-family
109,814

32,589

129,902

8,106

8,903

289,314

Commercial real estate
41,986

3,358

44,461

2,830

11,934

104,569

Construction
1,792

—

—

—

—

1,792

Commercial business loans
348

—

127

—

576

1,051

Consumer loans
310

—

—

—

14

324

Total loans held for investment, gross
$
491,613

$
51,094

$
182,583

$
15,930

$
37,097

$
778,317


The allowance for loan losses is maintained at a level sufficient to provide for estimated losses based on evaluating known and inherent risks in the loans held for investment and upon management’s continuing analysis of the factors underlying the quality of the loans held for investment.  These factors include changes in the size and composition of the loans held for investment, actual loan loss experience, current economic conditions, detailed analysis of individual loans for which full collectability may not be assured, and determination of the realizable value of the collateral securing the loans.  Provisions (recovery) for loan losses are charged (credited) against operations on a quarterly basis, as necessary, to maintain the allowance at appropriate levels.  Although management believes it uses the best information available to make such determinations, there can be no assurance that regulators, in reviewing the Corporation’s loans held for investment, will not request the Corporation to significantly increase its allowance for loan losses.  Future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly and adversely affected as a result of economic, operating, regulatory, and other conditions beyond the Corporation’s control.

In compliance with the regulatory reporting requirements of the Office of the Comptroller of the Currency (“OCC”), the Bank’s primary federal regulator, non-performing loans are charged-off to their fair market values in the period the loans, or portion thereof, are deemed uncollectible, generally after the loan becomes 150 days delinquent for real estate secured first trust deed loans and 120 days delinquent for commercial business or real estate secured second trust deed loans.  For loans that were modified from their original terms, were re-underwritten and identified in the Corporation’s asset quality reports as troubled debt restructurings (“restructured loans”), the charge-off occurs when the loan becomes 90 days delinquent; and where borrowers file bankruptcy, the charge-off occurs when the loan becomes 60 days delinquent.  The amount of the charge-off is determined by comparing the loan balance to the estimated fair value of the underlying collateral, less disposition costs, with the loan balance in excess of the estimated fair value charged-off against the allowance for loan losses.  The allowance for loan losses for non-performing loans is determined by applying Accounting Standards Codification (“ASC”) 310, “Receivables.”  For restructured loans that are less than 90 days delinquent, the allowance for loan losses are segregated into (a) individually evaluated allowances for those loans with applicable discounted cash flow calculations still in their restructuring period, classified lower than pass, and containing an embedded loss component or (b) collectively evaluated allowances based on the aggregated pooling method.  For non-performing loans less than 60 days delinquent where the borrower has filed bankruptcy, the collectively evaluated allowances are assigned based on the aggregated pooling method. For non-performing commercial real estate loans, an individually evaluated allowance is calculated based on the loan's fair value and if the fair value is higher than the loan balance, no allowance is required.


16


The following table summarizes the Corporation’s allowance for loan losses at March 31, 2014 and June 30, 2013:

(In Thousands)
March 31,
2014
June 30,
2013
Collectively evaluated for impairment:
 
 
Mortgage loans:
 
 
Single-family
$
5,467

$
8,949

Multi-family
3,405

4,689

Commercial real estate
1,034

1,053

Construction
20

—

Commercial business loans
47

78

Consumer loans
10

12

Total collectively evaluated allowance
9,983

14,781

 
 
 
Individually evaluated for impairment:
 
 
Mortgage loans:
 
 
Single-family
—

113

Commercial business loans
41

41

Total individually evaluated allowance
41

154

Total loan loss allowance
$
10,024

$
14,935



17


The following table is provided to disclose additional details on the Corporation’s allowance for loan losses:

 
For the Quarters Ended
March 31,
For the Nine Months Ended
March 31,
(Dollars in Thousands)
2014
2013
2014
2013
 
 
 
 
 
Allowance at beginning of period
$
11,041

$
18,530

$
14,935

$
21,483

 
 
 
 
 
(Recovery) provision for loan losses
(849
)
(517
)
(2,689
)
39

 
 
 
 
 
Recoveries:
 

 

 

 

Mortgage loans:
 

 

 

 

Single-family
64

374

331

537

Multi-family
56

—

75

—

Construction
—

—

20

—

Consumer loans
—

—

1

2

Total recoveries
120

374

427

539

 
 
 
 
 
Charge-offs:
 

 

 

 

Mortgage loans:
 

 

 

 

Single-family
(185
)
(1,139
)
(965
)
(4,810
)
Multi-family
(94
)
—

(1,671
)
—

Commercial real estate
—

(260
)
—

(260
)
Other
—

(159
)
—

(159
)
Commercial business loans
(9
)
—

(9
)
—

Consumer loans
—

(3
)
(4
)
(6
)
Total charge-offs
(288
)
(1,561
)
(2,649
)
(5,235
)
 
 
 
 
 
Net charge-offs
(168
)
(1,187
)
(2,222
)
(4,696
)
Balance at end of period
$
10,024

$
16,826

$
10,024

$
16,826

 
 

 

 

 

Allowance for loan losses as a percentage of gross loans held for investment
1.29
%
2.18
%
1.29
%
2.18
%
Net charge-offs as a percentage of average loans receivable, net, during the period (annualized)
0.08
%
0.49
%
0.34
%
0.62
%
Allowance for loan losses as a percentage of gross non-performing loans at the end of the period
55.55
%
73.01
%
55.55
%
73.01
%


18


The following tables identify the Corporation’s total recorded investment in non-performing loans by type, net of allowance for loan losses at March 31, 2014 and June 30, 2013:

 
 
 
(In Thousands)
March 31, 2014
 
Recorded
Investment
Allowance
for Loan
Losses (1)
 
Net
Investment
Mortgage loans:
 
 
 
Single-family:
 
 
 
With a related allowance
$
3,978

$
(831
)
$
3,147

Without a related allowance (2)
6,821

—

6,821

Total single-family loans
10,799

(831
)
9,968

 
 
 
 
Multi-family:
 
 
 
With a related allowance
965

(357
)
608

Without a related allowance (2)
2,565

—

2,565

Total multi-family loans
3,530

(357
)
3,173

 
 
 
 
Commercial real estate:
 
 
 
Without a related allowance (2)
3,562

—

3,562

Total commercial real estate loans
3,562

—

3,562

 
 
 
 
Commercial business loans:
 
 
 
With a related allowance
154

(50
)
104

Total commercial business loans
154

(50
)
104

 
 
 
 
Total non-performing loans
$
18,045

$
(1,238
)
$
16,807


(1) 
Consists of collectively and individually evaluated allowances, specifically assigned to the individual loan.
(2) 
There was no related allowance for loan losses because the loans have been charged-off to their fair value or the fair value of the collateral is higher than the individual loan balance.

19


 
 
 
(In Thousands)
June 30, 2013
 
Recorded
Investment
Allowance
for Loan
Losses (1)
 
Net
Investment
Mortgage loans:
 
 
 
Single-family:
 
 
 
With a related allowance
$
9,908

$
(2,350
)
$
7,558

Without a related allowance (2)
5,665

—

5,665

Total single-family loans
15,573

(2,350
)
13,223

 
 
 
 
Multi-family:
 
 
 
With a related allowance
4,519

(1,320
)
3,199

Without a related allowance (2)
558

—

558

Total multi-family loans
5,077

(1,320
)
3,757

 
 
 
 
Commercial real estate:
 
 
 
Without a related allowance (2)
4,572

—

4,572

Total commercial real estate loans
4,572

—

4,572

 
 
 
 
Commercial business loans:
 
 
 
With a related allowance
189

(59
)
130

Total commercial business loans
189

(59
)
130

 
 
 
 
Total non-performing loans
$
25,411

$
(3,729
)
$
21,682


(1) 
Consists of collectively and individually evaluated allowances, specifically assigned to the individual loan.
(2) 
There was no related allowance for loan losses because the loans have been charged-off to their fair value or the fair value of the collateral is higher than the individual loan balance.

At March 31, 2014 and June 30, 2013, there were no commitments to lend additional funds to those borrowers whose loans were classified as non-performing.

The following table describes the aging analysis (length of time on non-performing status) of non-performing loans, net of allowance for loan losses or charge offs, as of March 31, 2014:

 
(In Thousands)
3 Months or
Less
Over 3 to
6 Months
Over 6 to
12 Months
Over 12
Months
 
Total
Mortgage loans:
 
 
 
 
 
Single-family
$
—

$
2,928

$
438

$
6,602

$
9,968

Multi-family
156

—

1,827

1,190

3,173

Commercial real estate
878

—

1,354

1,330

3,562

Commercial business loans
—

—

5

99

104

Total
$
1,034

$
2,928

$
3,624

$
9,221

$
16,807


For the quarters ended March 31, 2014 and 2013, the Corporation’s average investment in non-performing loans was $17.1 million and $20.8 million, respectively.  The Corporation records payments on non-performing loans utilizing the cash basis or cost recovery method of accounting during the periods when the loans are on non-performing status.  For the quarters ended March 31, 2014 and 2013, interest income of $146,000 and $1.4 million, respectively, was recognized, based on cash receipts from loan payments on non-performing loans; and $175,000 and $142,000, respectively, was collected and applied to the net loan balances under the cost recovery method. Foregone interest income, which would have been recorded had the non-performing loans been

20


current in accordance with their original terms, amounted to $26,000 and $142,000 for the quarters ended March 31, 2014 and 2013, respectively, and was not included in the results of operations.

For the nine months ended March 31, 2014 and 2013, the Corporation’s average investment in non-performing loans was $17.5 million and $25.4 million, respectively.  For the nine months ended March 31, 2014 and 2013, interest income of $584,000 and $4.4 million, respectively, was recognized, based on cash receipts from loan payments on non-performing loans; and $378,000 and $258,000, respectively, was collected and applied to the net loan balances under the cost recovery method.  Foregone interest income amounted to $229,000 and $362,000 for the nine months ended March 31, 2014 and 2013, respectively, and was not included in the results of operations.

For the quarters ended March 31, 2014, there was one loan with an outstanding balance of $221,000 that was newly modified from its original terms, re-underwritten and identified in the Corporation’s asset quality reports as a restructured loan.  This compares to no loans that were newly modified from their original terms, re-underwritten or identified in the Corporation’s asset quality reports as restructured loans during the quarter ended March 31, 2013. During the quarter ended March 31, 2014, no restructured loans were in default within a 12-month period subsequent to their original restructuring.  This compares to one restructured loan with an outstanding balance of $739,000 during the quarter ended March 31, 2013 that was in default within a 12-month period subsequent to its original restructuring and required an additional provision of $260,000. Additionally, during the quarter ended March 31, 2014 and 2013, there were no loans whose modifications were extended beyond the initial maturity of the modification.

For the nine months ended March 31, 2014, there was one loan with an outstanding balance of $221,000 that was newly modified from its original terms, re-underwritten and identified in the Corporation’s asset quality reports as a restructured loan.  This compares to no loans that were newly modified from their original terms, re-underwritten or identified in the Corporation’s asset quality reports as restructured loans during the nine months ended March 31, 2013. During the nine months ended March 31, 2014, no restructured loans were in default within a 12-month period subsequent to its original restructuring.  This compares to two restructured loans with a total balance of $1.2 million during the nine months ended March 31, 2013 that were in default within a 12-month period subsequent to their original restructuring and which required an additional provision of $480,000 upon default.  Additionally, during the nine months ended March 31, 2014, there were two loans to the same borrower for $810,000 whose modifications were extended beyond the initial maturity of the modification.  For the nine months ended March 31, 2013, one loan for $131,000 had its modification extended beyond the initial maturity of the modification.

As of March 31, 2014, the net outstanding balance of the 21 restructured loans was $7.1 million:  four were classified as special mention and remain on accrual status ($1.6 million); and 17 were classified as substandard ($5.5 million, all of which were on non-accrual status).  As of June 30, 2013, the net outstanding balance of the 26 restructured loans was $9.5 million:  one was classified as special mention on accrual status ($434,000); and 25 were classified as substandard ($9.1 million, all of which were on non-accrual status). Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.  Assets that do not currently expose the Corporation to sufficient risk to warrant adverse classification but possess weaknesses are designated as special mention and are closely monitored by the Corporation.  As of March 31, 2014 and June 30, 2013, $4.3 million or 61 percent, and $6.5 million or 68 percent, respectively, of the restructured loans were current with respect to their payment status.

The Corporation upgrades restructured single-family loans to the pass category if the borrower has demonstrated satisfactory contractual payments for at least six consecutive months; 12 months for those loans that were restructured more than once; and if the borrower has demonstrated satisfactory contractual payments beyond 12 consecutive months, the loan is no longer categorized as a restructured loan for the SEC reporting purposes.  In addition to the payment history described above, multi-family, commercial real estate, construction and commercial business loans (which are sometimes referred to in this report as “preferred loans”) must also demonstrate a combination of the following characteristics to be upgraded: satisfactory cash flow, satisfactory guarantor support, and additional collateral support, among others.

To qualify for restructuring, a borrower must provide evidence of their creditworthiness such as, current financial statements, their most recent income tax returns, current paystubs, current W-2s, and most recent bank statements, among other documents, which are then verified by the Corporation.  The Corporation re-underwrites the loan with the borrower’s updated financial information, new credit report, current loan balance, new interest rate, remaining loan term, updated property value and modified payment schedule, among other considerations, to determine if the borrower qualifies.


21


The following table summarizes at the dates indicated the restructured loan balances, net of allowance for loan losses, by loan type and non-accrual versus accrual status:

(In Thousands)
March 31, 2014
June 30, 2013
Restructured loans on non-accrual status:
 
 
Mortgage loans:
 
 
Single-family
$
2,304

$
5,094

Multi-family
2,247

2,521

Commercial real estate
805

1,354

Commercial business loans
99

123

Total
5,455

9,092

 
 
 
Restructured loans on accrual status:
 

 

Mortgage loans:
 

 

Single-family
1,630

434

Total
1,630

434

 
 
 
Total restructured loans
$
7,085

$
9,526



22


The following tables show the restructured loans by type, net of allowance for loan losses, at March 31, 2014 and June 30, 2013:

 
 
 
(In Thousands)
March 31, 2014
 
Recorded
Investment
Allowance
for Loan
Losses (1)
 
Net
Investment
Mortgage loans:
 
 
 
Single-family:
 
 
 
With a related allowance
$
657

$
(164
)
$
493

Without a related allowance (2)
3,441

—

3,441

Total single-family loans
4,098

(164
)
3,934

 
 
 
 
Multi-family:
 
 
 
Without a related allowance (2)
2,247

—

2,247

Total multi-family loans
2,247

—

2,247

 
 
 
 
Commercial real estate:
 
 
 
Without a related allowance (2)
805

—

805

Total commercial real estate loans
805

—

805

 
 
 
 
Commercial business loans:
 
 
 
With a related allowance
147

(48
)
99

Total commercial business loans
147

(48
)
99

 
 
 
 
Total restructured loans
$
7,297

$
(212
)
$
7,085


(1) 
Consists of collectively and individually evaluated allowances, specifically assigned to the individual loan.
(2) 
There was no related allowance for loan losses because the loans have been charged-off to their fair value or the fair value of the collateral is higher than the individual loan balance.

23


 
 
 
(In Thousands)
June 30, 2013
 
Recorded
Investment
Allowance
for Loan
Losses (1)
 
Net
Investment
Mortgage loans:
 
 
 
Single-family:
 
 
 
With a related allowance
$
3,774

$
(795
)
$
2,979

Without a related allowance (2)
2,549

—

2,549

Total single-family loans
6,323

(795
)
5,528

 
 
 
 
Multi-family:
 
 
 
With a related allowance
3,266

(1,006
)
2,260

Without a related allowance (2)
261

—

261

Total multi-family loans
3,527

(1,006
)
2,521

 
 
 
 
Commercial real estate:
 
 
 
Without a related allowance (2)
1,354

—

1,354

Total commercial real estate loans
1,354

—

1,354

 
 
 
 
Commercial business loans:
 
 
 
With a related allowance
180

(57
)
123

Total commercial business loans
180

(57
)
123

 
 
 
 
Total restructured loans
$
11,384

$
(1,858
)
$
9,526


(1) 
Consists of collectively and individually evaluated allowances, specifically assigned to the individual loan.
(2) 
There was no related allowance for loan losses because the loans have been charged-off to their fair value or the fair value of the collateral is higher than the individual loan balance.

During the quarter ended March 31, 2014, one property was acquired in the settlement of loans, while two previously foreclosed upon properties were sold.  For the quarter ended March 31, 2013, six properties were acquired in the settlement of loans, while eight previously foreclosed upon properties were sold. During the nine months ended March 31, 2014, seven properties were acquired in the settlement of loans, while 11 previously foreclosed upon properties were sold.  For the nine months ended March 31, 2013, 22 properties were acquired in the settlement of loans, while 36 previously foreclosed upon properties were sold. As of March 31, 2014, real estate owned was comprised of six properties with a net fair value of $2.4 million, primarily located in Southern California.  This compares to 10 real estate owned properties, primarily located in Southern California, with a net fair value of $2.3 million at June 30, 2013.  A new appraisal was obtained on each of the properties at the time of foreclosure and fair value was calculated by using the lower of the appraised value or the listing price of the property, net of disposition costs.  Any initial loss was recorded as a charge to the allowance for loan losses before being transferred to real estate owned.  Subsequently, if there is further deterioration in real estate values, specific real estate owned loss reserves are established and charged to the statement of operations.  In addition, the Corporation records costs to carry real estate owned as real estate operating expenses as incurred.


Note 7: Derivative and Other Financial Instruments with Off-Balance Sheet Risks

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit in the form of originating loans or providing funds under existing lines of credit, loan sale commitments to third parties and option contracts.  These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the accompanying Condensed Consolidated Statements of Financial Condition.  The Corporation’s exposure to credit loss, in the event of non-performance by the counterparty to these financial instruments, is represented by the contractual amount of these instruments.  The Corporation uses the same credit policies in entering into financial instruments with off-balance sheet risk as it does for on-balance

24


sheet instruments.  As of March 31, 2014 and June 30, 2013, the Corporation had commitments to extend credit (on loans to be held for investment and loans to be held for sale) of $113.8 million and $262.5 million, respectively.

The following table provides information at the dates indicated regarding undisbursed funds to borrowers on existing lines of credit with the Corporation as well as commitments to originate loans to be held for investment at the dates indicated below.

Commitments
March 31,
2014
June 30,
2013
(In Thousands)
 
 
 
 
 
Undisbursed loan funds - Construction loans
$
757

$
292

Undisbursed lines of credit – Mortgage loans
809

774

Undisbursed lines of credit – Commercial business loans
1,349

952

Undisbursed lines of credit – Consumer loans
772

779

Commitments to extend credit on loans to be held for investment
5,949

6,872

Total
$
9,636

$
9,669


In accordance with ASC 815, “Derivatives and Hedging,” and interpretations of the Derivatives Implementation Group of the FASB, the fair value of the commitments to extend credit on loans to be held for sale, loan sale commitments, to be announced (“TBA”) MBS trades, put option contracts and call option contracts are recorded at fair value on the Condensed Consolidated Statements of Financial Condition.  At March 31, 2014, $1.5 million was included in other assets and $41,000 was included in other liabilities; at June 30, 2013, $7.4 million was included in other assets and $1.0 million was included in other liabilities.  The Corporation does not apply hedge accounting to its derivative financial instruments; therefore, all changes in fair value are recorded in earnings.

The following table provides information regarding the allowance for loan losses for the undisbursed funds and commitments to extend credit on loans to be held for investment for the quarters and nine months ended March 31, 2014 and 2013.

 
For the Quarters
Ended
March 31,
 
For the Nine Months
Ended
March 31,
(In Thousands)
2014
2013
 
2014
2013
Balance, beginning of the period
$
125

$
63

 
$
115

$
66

(Recovery) provision
(41
)
24

 
(31
)
21

Balance, end of the period
$
84

$
87

 
$
84

$
87


The net impact of derivative financial instruments on the gain on sale of loans contained in the Condensed Consolidated Statements of Operations during the quarters and nine months ended March 31, 2014 and 2013 was as follows:

 
For the Quarters
Ended
March 31,
 
 For the Nine Months
Ended
March 31,
Derivative Financial Instruments
2014
2013
 
2014
2013
(In Thousands)
 
 
 
 
 
Commitments to extend credit on loans to be held for sale
$
1,026

$
181

 
$
2,306

$
(562
)
Mandatory loan sale commitments and TBA MBS trades
(824
)
(463
)
 
(6,648
)
521

Option contracts
(142
)
(51
)
 
124

(492
)
Total
$
60

$
(333
)
 
$
(4,218
)
$
(533
)


25


The outstanding derivative financial instruments at the dates indicated were as follows:

 
March 31, 2014
 
June 30, 2013
Derivative Financial Instruments
Amount
Fair
Value
 
Amount
Fair
Value
(In Thousands)
 
 
 
 
 
Commitments to extend credit on loans to be held for sale (1)
$
107,866

$
1,274

 
$
255,635

$
(1,032
)
Best efforts loan sale commitments
(10,488
)
—

 
(29,847
)
—

Mandatory loan sale commitments and TBA MBS trades
(193,426
)
157

 
(410,897
)
6,805

Option contracts
(10,000
)
37

 
(10,000
)
589

Total
$
(106,048
)
$
1,468

 
$
(195,109
)
$
6,362


(1) 
Net of 27.7 percent at March 31, 2014 and 23.6 percent at June 30, 2013 of commitments which management has estimated may not fund.


Note 8: Income Taxes

ASC 740, “Income Taxes,” requires the affirmative evaluation that it is more likely than not, based on the technical merits of a tax position, that an enterprise is entitled to economic benefits resulting from positions taken in income tax returns.  If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements.  Management has determined that there are no unrecognized tax benefits to be reported in the Corporation’s financial statements.

ASC 740 requires that when determining the need for a valuation allowance against a deferred tax asset, management must assess both positive and negative evidence with regard to the realizability of the tax losses represented by that asset.  To the extent available sources of taxable income are insufficient to absorb tax losses, a valuation allowance is necessary.  Sources of taxable income for this analysis include prior years’ tax returns, the expected reversals of taxable temporary differences between book and tax income, prudent and feasible tax-planning strategies, and future taxable income.   The deferred tax asset related to the allowance will be realized when actual charge-offs are made against the allowance.  Based on the availability of loss carry-backs and projected taxable income during the periods for which loss carry-forwards are available, management believes it is more likely than not the Corporation will realize the deferred tax asset.  The Corporation continues to monitor the deferred tax asset on a quarterly basis for a valuation allowance.   The future realization of these tax benefits primarily hinges on adequate future earnings to utilize the tax benefit.  Prospective earnings or losses, tax law changes or capital changes could prompt the Corporation to reevaluate the assumptions which may be used to establish a valuation allowance.  The Corporation maintains net deferred income tax assets for deductible temporary tax differences, such as loss reserves, deferred compensation, non-accrued interest and unrealized gains. The Corporation did not have any liabilities for uncertain tax positions or any known unrecognized tax benefit at March 31, 2014 or June 30, 2013.

The Corporation files income tax returns for the United States and state of California jurisdictions.  The Internal Revenue Service has audited the Bank’s income tax returns through 1996 and the California Franchise Tax Board has audited the Bank through 1990.  Also, the Internal Revenue Service completed a review of the Corporation’s income tax returns for fiscal 2006 and 2007; and the California Franchise Tax Board completed a review of the Corporation’s income tax returns for fiscal 2007 through 2010. Based on the California Franchise Tax Board examination for the fiscal years 2009 and 2010, the Corporation recorded an additional tax expense in the quarter and nine months ended March 31, 2014 of $0 and $67,000, respectively. In addition, the Corporation recorded additional tax expense during the quarter and nine months ended March 31, 2014 for federal deferred tax asset adjustment of $136,000 and $139,000, respectively. Tax years subsequent to fiscal 2009 remain subject to federal examination, while the California state income tax returns for years subsequent to fiscal 2010 are subject to future examination by state taxing authorities.  The Corporation believes that we have adequately provided or paid income tax on all matters not yet resolved with federal and state taxing authorities.

It is the Corporation’s policy to record any penalties or interest charges arising from federal or state taxes as a component of income tax expense.  For the quarters and nine months ended March 31, 2014 and 2013, there were no tax penalties or interest charges.  



26


Note 9: Fair Value of Financial Instruments

The Corporation adopted ASC 820, “Fair Value Measurements and Disclosures,” and elected the fair value option pursuant to ASC 825, “Financial Instruments” on loans originated for sale by PBM.  ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  ASC 825 permits entities to elect to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the “Fair Value Option”) at specified election dates.  At each subsequent reporting date, an entity is required to report unrealized gains and losses on items in earnings for which the fair value option has been elected.  The objective of the Fair Value Option is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.

The following table describes the difference at the dates indicated between the aggregate fair value and the aggregate unpaid principal balance of loans held for sale at fair value.

 
 
 
(In Thousands)
 
 
Aggregate
Fair Value
Aggregate
Unpaid
Principal
Balance
 
Net
Unrealized
Gain (Loss)
As of March 31, 2014:
 
 
 
Loans held for sale, measured at fair value
$
104,262

$
101,034

$
3,228

 
 
 
 
As of June 30, 2013:
 
 
 
Loans held for sale, measured at fair value
$
188,050

$
188,545

$
(495
)

ASC 820-10-65-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” provides additional guidance for estimating fair value in accordance with ASC 820, “Fair Value Measurements,” when the volume and level of activity for the asset or liability have significantly decreased.

ASC 820 establishes a three-level valuation hierarchy that prioritizes inputs to valuation techniques used in fair value calculations.  The three levels of inputs are defined as follows:

Level 1
-
Unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date.
 
Level 2
-
Observable inputs other than Level 1 such as: quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated to observable market data for substantially the full term of the asset or liability.
 
Level 3
-
Unobservable inputs for the asset or liability that use significant assumptions, including assumptions of risks.  These unobservable assumptions reflect the Corporation’s estimate of assumptions that market participants would use in pricing the asset or liability.  Valuation techniques include the use of pricing models, discounted cash flow models and similar techniques.

ASC 820 requires the Corporation to maximize the use of observable inputs and minimize the use of unobservable inputs.  If a financial instrument uses inputs that fall in different levels of the hierarchy, the instrument will be categorized based upon the lowest level of input that is significant to the fair value calculation.

The Corporation’s financial assets and liabilities measured at fair value on a recurring basis consist of investment securities, loans held for sale at fair value, interest-only strips and derivative financial instruments; while non-performing loans, mortgage servicing assets ("MSA") and real estate owned are measured at fair value on a nonrecurring basis.

Investment securities are primarily comprised of U.S. government agency MBS, U.S. government sponsored enterprise MBS and private issue CMO.  The Corporation utilizes unadjusted quoted prices in active markets for identical securities for its fair value measurement of debt securities, quoted prices in active and less than active markets for similar securities for its fair value measurement of MBS and debt securities (Level 2), and broker price indications for similar securities in non-active markets for its fair value measurement of CMO (Level 3).

27



Derivative financial instruments are comprised of commitments to extend credit on loans to be held for sale, mandatory loan sale commitments, TBA MBS trades and option contracts.  The fair value of TBA MBS trades is determined using quoted secondary-market prices (Level 2).  The fair values of other derivative financial instruments are determined by quoted prices for a similar commitment or commitments, adjusted for the specific attributes of each commitment, including management's estimate of loan commitments which may not fund (Level 3).

Loans held for sale at fair value are primarily single-family loans.  The fair value is determined, when possible, using quoted secondary-market prices such as TBA MBS trades.  If no such quoted price exists, the fair value of a loan is determined by quoted prices for a similar loan or loans (Level 2).

Non-performing loans are loans which are inadequately protected by the current net worth and paying capacity of the borrowers or of the collateral pledged.  The non-performing loans are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.  The fair value of a non-performing loan is determined based on an observable market price or current appraised value, net of estimated disposition costs, of the underlying collateral.  Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the borrower.  For non-performing loans which are restructured loans, the fair value is derived from discounted cash flow analysis (Level 3), except for those which are in the process of foreclosure or 90 days delinquent for which the fair value is derived from the appraised value of its collateral (Level 2).  For other non-performing loans which are not restructured loans, the fair value is derived from relative value analysis: historical experience and management estimates by loan type for which collectively evaluated allowances are assigned (Level 3); or the appraised value of its collateral for loans which are in the process of foreclosure or where borrowers file bankruptcy (Level 2).  For non-performing commercial real estate loans, the fair value is derived from the appraised value of its collateral (Level 2). Non-performing loans are reviewed and evaluated on at least a quarterly basis for additional allowance and adjusted accordingly, based on the same factors identified above.  This loss is not recorded directly as an adjustment to current earnings or other comprehensive income (loss), but rather as a component in determining the overall adequacy of the allowance for loan losses.  These adjustments to the estimated fair value of non-performing loans may result in increases or decreases to the provision for loan losses recorded in current earnings.

The Corporation uses the amortization method for its MSA, which amortizes the MSA in proportion to and over the period of estimated net servicing income and assesses the MSA for impairment based on fair value at each reporting date.  The fair value of MSA is calculated using the present value method; which includes a third party’s prepayment projections of similar instruments, weighted-average coupon rates and the estimated average life (Level 3).

The rights to future income from serviced loans that exceed contractually specified servicing fees are recorded as interest-only strips.  The fair value of interest-only strips is calculated using the same assumptions that are used to value the related MSA (Level 3).

The fair value of real estate owned is derived from the lower of the appraised value at the time of foreclosure or the listing price, net of estimated disposition costs (Level 2).

The Corporation’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values.  While management believes the Corporation’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.


28


The following fair value hierarchy tables present information at the dates indicated about the Corporation’s assets measured at fair value on a recurring basis:
 
 
Fair Value Measurement at March 31, 2014 Using:
(In Thousands)
Level 1
Level 2
Level 3
Total
Assets:
 
 
 
 
Investment securities:
 
 
 
 
U.S. government agency MBS
$
—

$
9,543

$
—

$
9,543

U.S. government sponsored enterprise MBS
—

6,657

—

6,657

Private issue CMO
—

—

902

902

Investment securities
—

16,200

902

17,102

 
 
 
 
 
Loans held for sale, at fair value
—

104,262

—

104,262

Interest-only strips
—

—

72

72

 
 
 
 
 
Derivative assets:
 
 
 
 
Commitments to extend credit on loans to be held for sale
—

—

1,310

1,310

Mandatory loan sale commitments
—

—

45

45

TBA MBS trades
—

119

—

119

Option contracts
—

—

37

37

Derivative assets
—

119

1,392

1,511

Total assets
$
—

$
120,581

$
2,366

$
122,947

 
 
 
 
 
Liabilities:
 
 
 
 
Derivative liabilities:
 
 
 
 
Commitments to extend credit on loans to be held for sale
$
—

$
—

$
36

$
36

Mandatory loan sale commitments
—

—

5

5

TBA MBS trades
—

2

—

2

Derivative liabilities
—

2

41

43

Total liabilities
$
—

$
2

$
41

$
43


29


 
Fair Value Measurement at June 30, 2013 Using:
(In Thousands)
Level 1
Level 2
Level 3
Total
Assets:
 
 
 
 
Investment securities:
 
 
 
 
U.S. government agency MBS
$
—

$
10,816

$
—

$
10,816

U.S. government sponsored enterprise MBS
—

7,675

—

7,675

Private issue CMO
—

—

1,019

1,019

Investment securities
—

18,491

1,019

19,510

 
 
 
 
 
Loans held for sale, at fair value
—

188,050

—

188,050

Interest-only strips
—

—

98

98

 
 
 
 
 
Derivative assets:
 
 
 
 
Commitments to extend credit on loans to be held for sale
—

—

1,338

1,338

Mandatory loan sale commitments
—

—

405

405

TBA MBS trades
—

7,251

—

7,251

Option contracts
—

—

589

589

Derivative assets
—

7,251

2,332

9,583

Total assets
$
—

$
213,792

$
3,449

$
217,241

 
 
 
 
 
Liabilities:
 
 
 
 
Derivative liabilities:
 
 
 
 
Commitments to extend credit on loans to be held for sale
$
—

$
—

$
2,370

$
2,370

Mandatory loan sale commitments
—

—

322

322

TBA MBS trades
—

529

—

529

Derivative liabilities
—

529

2,692

3,221

Total liabilities
$
—

$
529

$
2,692

$
3,221



30


The following tables summarize reconciliations of the beginning and ending balances during the periods shown of recurring fair value measurements recognized in the Condensed Consolidated Statements of Financial Condition using Level 3 inputs:

 
For the Quarter Ended March 31, 2014
 
Fair Value Measurement
Using Significant Other Unobservable Inputs
(Level 3)
 
 
 
 
(In Thousands)
 
 
Private
Issue
CMO
 
 
Interest-
Only
Strips
Loan
Commit-
ments to
Originate (1)
Manda-
tory
Commit-
ments (2)
 
 
 
Option
Contracts
 
 
 
 
Total
Beginning balance at December 31, 2013
$
925

$
88

$
248

$
196

$
331

$
1,788

Total gains or losses (realized/unrealized):
 
 
 
 
 
 
Included in earnings
—

—

5,922

(166
)
(142
)
5,614

Included in other comprehensive loss
17

(16
)
—

—

—

1

Purchases
—

—

—

206

126

332

Issuances
—

—

1,274

—

—

1,274

Settlements
(40
)
—

(6,170
)
(196
)
(278
)
(6,684
)
Transfers in and/or out of Level 3
—

—

—

—

—

—

Ending balance at March 31, 2014
$
902

$
72

$
1,274

$
40

$
37

$
2,325


(1) 
Consists of commitments to extend credit on loans to be held for sale.
(2) 
Consists of mandatory loan sale commitments.

 
For the Quarter Ended March 31, 2013
 
Fair Value Measurement
Using Significant Other Unobservable Inputs
(Level 3)
 
 
 
 
(In Thousands)
 
 
Private
Issue
CMO
 
 
Interest-
Only
Strips
Loan
Commit-
ments to
 Originate (1)
Manda-
tory
Commit-
ments (2)
 
 
 
Option
Contracts
 
 
 
 
Total
Beginning balance at December 31, 2012
$
1,156

$
130

$
3,238

$
(71
)
$
47

$
4,500

Total gains or losses (realized/unrealized):
 
 
 
 
 
 
Included in earnings
—

—

(3,238
)
71

(47
)
(3,214
)
Included in other comprehensive loss
—

(5
)
—

—

—

(5
)
Purchases
—

—

—

—

72

72

Issuances
—

—

3,419

—

—

3,419

Settlements
(59
)
—

—

—

—

(59
)
Transfers in and/or out of Level 3
—

—

—

—

—

—

Ending balance at March 31, 2013
$
1,097

$
125

$
3,419

$
—

$
72

$
4,713


(1) 
Consists of commitments to extend credit on loans to be held for sale.
(2) 
Consists of mandatory loan sale commitments.

31


 
For the Nine Months Ended March 31, 2014
 
Fair Value Measurement
Using Significant Other Unobservable Inputs
(Level 3)
 
 
 
 
(In Thousands)
 
 
Private
Issue
CMO
 
 
Interest-
Only
Strips
Loan
Commit-
ments to
originate (1)
Manda-
tory
Commit-
ments (2)
 
 
 
Option
Contracts
 
 
 
 
Total
Beginning balance at June 30, 2013
$
1,019

$
98

$
(1,032
)
$
83

$
589

$
757

Total gains or losses (realized/unrealized):
 
 
 
 
 
 
Included in earnings
—

—

17,958

(67
)
123

18,014

Included in other comprehensive loss
20

(26
)
—

—

—

(6
)
Purchases
—

—

—

261

497

758

Issuances
—

—

4,887

—

—

4,887

Settlements
(137
)
—

(20,539
)
(237
)
(1,172
)
(22,085
)
Transfers in and/or out of Level 3
—

—

—

—

—

—

Ending balance at March 31, 2014
$
902

$
72

$
1,274

$
40

$
37

$
2,325


(1)
Consists of commitments to extend credit on loans to be held for sale.
(2)
Consists of mandatory loan sale commitments.

 
For the Nine Months Ended March 31, 2013
 
Fair Value Measurement
Using Significant Other Unobservable Inputs
(Level 3)
 
 
 
 
(In Thousands)
 
 
Private
Issue
CMO
 
 
Interest-
Only
Strips
Loan
Commit-
ments to
originate (1)
Manda-
tory
Commit-
ments (2)
 
 
 
Option
Contracts
 
 
 
 
Total
Beginning balance at June 30, 2012
$
1,242

$
130

$
3,981

$
(163
)
$
36

$
5,226

Total gains or losses (realized/unrealized):
 
 
 
 
 
 
Included in earnings
—

—

(15,589
)
1,348

(148
)
(14,389
)
Included in other comprehensive loss
(6
)
(5
)
—

—

—

(11
)
Purchases
—

—

—

(1,185
)
184

(1,001
)
Issuances
—

—

15,027

—

—

15,027

Settlements
(139
)
—

—

—

—

(139
)
Transfers in and/or out of Level 3
—

—

—

—

—

—

Ending balance at March 31, 2013
$
1,097

$
125

$
3,419

$
—

$
72

$
4,713


(1)
Consists of commitments to extend credit on loans to be held for sale.
(2)
Consists of mandatory loan sale commitments.

32


The following fair value hierarchy tables present information about the Corporation’s assets measured at fair value at the dates indicated on a nonrecurring basis:

 
Fair Value Measurement at March 31, 2014 Using:
(In Thousands)
Level 1
Level 2
Level 3
Total
Non-performing loans 
$
—

$
12,948

$
3,859

$
16,807

MSA
—

—

268

268

Real estate owned, net 
—

2,406

—

2,406

Total
$
—

$
15,354

$
4,127

$
19,481



 
Fair Value Measurement at June 30, 2013 Using:
(In Thousands)
Level 1
Level 2
Level 3
Total
Non-performing loans 
$
—

$
11,650

$
10,032

$
21,682

MSA
—

—

174

174

Real estate owned, net 
—

2,296

—

2,296

Total
$
—

$
13,946

$
10,206

$
24,152



33


The following table presents additional information about valuation techniques and inputs used for assets and liabilities, including derivative financial instruments, which are measured at fair value and categorized within Level 3 as of March 31, 2014:
(Dollars In Thousands)
Fair Value
As of
March 31,
2014
Valuation
Techniques
Unobservable Inputs
Range (1)
(Weighted Average)
Impact to
Valuation
from an
Increase in
Inputs (2)
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
Securities available-for sale: Private issue CMO
$
902

Discounted cash flow
Probability of default
Loss severity
Prepayment speed
0.5% – 2.1% (1.9%)
11.9% - 37.4% (36.2%)
6.9% – 15.9% (9.9%)
Decrease
Decrease
Decrease
 
 
 
 
 
 
Non-performing loans
$
82

Discounted cash flow
Default rates
0.0% - 30.0% (0.0%)
Decrease
Non-performing loans
$
3,777

Relative value analysis
Loss severity
20.0% - 38.0% (17.3%)
Decrease
 
 
 
 
 
 
MSA
$
268

Discounted cash flow
Prepayment speed (CPR)
Discount rate
10.4% - 60.0% (39.9%)
9.0% - 10.5% (9.2%)
Decrease
Decrease
 
 
 
 
 
 
Interest-only strips
$
72

Discounted cash flow
Prepayment speed (CPR)
Discount rate
5.2% - 56.9% (35.3%)
9.0%
Decrease
Decrease
 
 
 
 
 
 
Commitments to extend credit on loans to be held for sale
$
1,310

Relative value analysis
TBA-MBS broker quotes
 
Fall-out ratio (3)
98.3% –  104.5%
(101.9%) of par
27.3% - 27.7% (27.7%)
Decrease
 
Decrease
 
 
 
 
 
 
Mandatory loan sale commitments
$
45

Relative value analysis
TBA MBS broker quotes 

Roll-forward costs (4)
103.1% - 105.8%
(103.8%) of par
0.009%
Decrease 
 
Decrease
 
 
 
 
 
 
Option contracts
$
37

Relative value analysis
Broker quotes
 
103.6% - 104.0%
(103.6%) of par
Increase
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Commitments to extend credit on loans to be held for sale
$
36

Relative value analysis
TBA-MBS broker quotes
 
Fall-out ratio (3)
100.8% –  105.1%
(101.9%) of par
27.3% - 27.7% (27.7%)
Decrease
 
Decrease
 
 
 
 
 
 
Mandatory loan sale commitments
$
5

Relative value analysis
Investor quotes

TBA MBS broker quotes 

Roll-forward costs (4)
102.1% - 107.8%
(104.2%) of par
103.0% - 105.1%
(103.3%) of par
0.009%
Decrease 
Decrease

Decrease
 
 
 
 
 
 
(1) 
The range is based on the historical and current estimated fair values and management estimates.
(2) 
Unless otherwise noted, this column represents the directional change in the fair value of the Level 3 investments that would result from an increase to the corresponding unobservable input. A decrease to the unobservable input would have the opposite effect. Significant changes in these inputs in isolation could result in significantly higher or lower fair value measurements.
(3) 
The percentage of commitments to extend credit on loans to be held for sale which management has estimated may not fund.
(4) 
An estimated cost to roll forward the mandatory loan sale commitments which management has estimated may not be delivered to the corresponding investors in a timely manner.

The significant unobservable inputs used in the fair value measurement of the Corporation’s assets and liabilities include the following: prepayment speeds, discount rates, MBS – TBA quotes, fallout ratios, investor quotes and roll-forward costs, among

34


others.  Significant increases or decreases in any of these inputs in isolation could result in significantly lower or higher fair value measurement. The various unobservable inputs used to determine valuations may have similar or diverging impacts on valuation.

The carrying amount and fair value of the Corporation’s other financial instruments as of March 31, 2014 and June 30, 2013 were as follows:
 
March 31, 2014
(In Thousands)
Carrying
Amount
Fair
Value
 
Level 1
 
Level 2
 
Level 3
Financial assets:
 
 
 
 
 
Loans held for investment, net
$
769,926

$
756,056

—

—

$
756,056

FHLB – San Francisco stock
$
8,680

$
8,680

—

$
8,680

—

 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
Deposits
$
907,506

$
884,822

—

—

$
884,822

Borrowings
$
51,447

$
54,063

—

—

$
54,063


 
June 30, 2013
(In Thousands)
Carrying
Amount
Fair
Value
 
Level 1
 
Level 2
 
Level 3
Financial assets:
 
 
 
 
 
Loans held for investment, net
$
748,397

$
742,256

—

—

$
742,256

FHLB – San Francisco stock
$
15,273

$
15,273

—

$
15,273

—

 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
Deposits
$
923,010

$
903,654

—

—

$
903,654

Borrowings
$
106,491

$
110,404

—

—

$
110,404


Loans held for investment: For loans that reprice frequently at market rates, the carrying amount approximates the fair value.  For fixed-rate loans, the fair value is determined by either (i) discounting the estimated future cash flows of such loans over their estimated remaining contractual maturities using a current interest rate at which such loans would be made to borrowers, or (ii) quoted market prices. The allowance for loan losses is subtracted as an estimate of the underlying credit risk.

FHLB – San Francisco stock: The carrying amount reported for FHLB – San Francisco stock approximates fair value. When redeemed, the Corporation will receive an amount equal to the par value of the stock.

Deposits: The fair value of time deposits is estimated using a discounted cash flow calculation. The discount rate is based upon rates currently offered for deposits of similar remaining maturities.  The fair value of transaction accounts (checking, money market and savings accounts) is based on management estimates, consistent with current market conditions.

Borrowings: The fair value of borrowings has been estimated using a discounted cash flow calculation.  The discount rate on such borrowings is based upon rates currently offered for borrowings of similar remaining maturities.

The Corporation has various processes and controls in place to ensure that fair value is reasonably estimated.  The Corporation generally determines fair value of their Level 3 assets and liabilities by using internally developed models which primarily utilize discounted cash flow techniques and prices obtained from independent management services or brokers.  The Corporation performs due diligence procedures over third-party pricing service providers in order to support their use in the valuation process.  The fair values of investment securities, commitments to extend credit on loans held for sale, mandatory commitments and option contracts are determined from the independent management services or brokers; while the fair value of MSA and interest-only strips are determined using the internally developed models which are based on discounted cash flow analysis.  The fair value of non-performing loans is calculated by using discounted cash flows, relative value analysis or collateral value, less selling costs.

While the Corporation believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.  During the quarter ended March 31, 2014, there were no significant changes to the

35


Corporation’s valuation techniques that had, or are expected to have, a material impact on its consolidated financial position or results of operations.


Note 10: Incentive Plans

As of March 31, 2014, the Corporation had five share-based compensation plans, which are described below.  These plans are the 2013 Equity Incentive Plan (“2013 Plan”), the 2010 Equity Incentive Plan (“2010 Plan”), the 2006 Equity Incentive Plan (“2006 Plan”), the 2003 Stock Option Plan and the 1996 Stock Option Plan.

For the quarters ended March 31, 2014 and 2013, the compensation cost for these plans was $126,000 and $157,000, respectively.  The income tax effect recognized in the Condensed Consolidated Statements of Financial Condition for share-based compensation plans was a $(130,000) debit and a $14,000 credit in the quarters ended March 31, 2014 and 2013, respectively.

For the nine months ended March 31, 2014 and 2013, the compensation cost for these plans was $387,000 and $396,000, respectively.  The income tax effect recognized in the Condensed Consolidated Statements of Financial Condition for share-based compensation plans was a $(122,000) debit and an $85,000 credit for the nine months ended March 31, 2014 and 2013, respectively.

Equity Incentive Plan.  The Corporation established and the shareholders approved the 2013 Plan, the 2010 Plan and the 2006 Plan for directors, advisory directors, directors emeriti, officers and employees of the Corporation and its subsidiary.  The 2013 Plan authorizes 300,000 stock options and 300,000 shares of restricted stock.  The 2013 Plan also provides that no person may be granted more than 60,000 stock options or 45,000 shares of restricted stock in any one year. The 2010 Plan authorizes 586,250 stock options and 288,750 shares of restricted stock.  The 2010 Plan also provides that no person may be granted more than 117,250 stock options or 43,312 shares of restricted stock in any one year.  The 2006 Plan authorizes 365,000 stock options and 185,000 shares of restricted stock.  The 2006 Plan also provides that no person may be granted more than 73,000 stock options or 27,750 shares of restricted stock in any one year.

Equity Incentive Plan - Stock Options.  Under the 2013 Plan, 2010 Plan and 2006 Plan (collectively, “the Plans”), options may not be granted at a price less than the fair market value at the date of the grant.  Options typically vest over a five-year or shorter period as long as the director, advisory director, director emeritus, officer or employee remains in service to the Corporation.  The options are exercisable after vesting for up to the remaining term of the original grant.  The maximum term of the options granted is 10 years.

The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option valuation model with the following assumptions.  The expected volatility is based on implied volatility from historical common stock closing prices for the prior 84 months.  The expected dividend yield is based on the most recent quarterly dividend on an annualized basis.  The expected term is based on the historical experience of all fully vested stock option grants and is reviewed annually.  The risk-free interest rate is based on the U.S. Treasury note rate with a term similar to the underlying stock option on the particular grant date.

 
For the Quarter
Ended
March 31, 2014
For the Nine Months
Ended
March 31, 2014
Expected volatility range
55.1
%
55.1
%
Weighted-average volatility
55.1
%
55.1
%
Expected dividend yield
2.6
%
2.6
%
Expected term (in years)
7.7

7.7

Risk-free interest rate
2.3
%
2.3
%

During the third quarter of fiscal 2014, 20,000 options were granted while 9,000 options were exercised and 9,500 options were forfeited.  This compares to the third quarter of fiscal 2013 when 14,000 options were exercised. For the first nine months of fiscal 2014, 20,000 options were granted, while 49,500 options were exercised and 31,300 options were forfeited.  This compares to the first nine months of fiscal 2013 when 20,000 options were granted, 42,000 options were exercised and 24,000 options were forfeited. As of March 31, 2014 and 2013, there were 499,750 and 188,450 stock options available for future grants under the Plans, respectively.


36


The following tables summarize the stock option activity in the Plans for the quarter and nine months ended March 31, 2014.

 
For the Quarter Ended March 31, 2014
Options
Shares
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term (Years)
Aggregate
Intrinsic
Value
($000)
Outstanding at December 31, 2013
649,500

$12.89
 
 
Granted
20,000

$15.14
 
 
Exercised
(9,000
)
$7.39
 
 
Forfeited
(9,500
)
$28.31
 
 
Outstanding at March 31, 2014
651,000

$12.81
5.81
$3,704
Vested and expected to vest at March 31, 2014
608,400

$13.11
5.68
$3,410
Exercisable at March 31, 2014
438,000

$14.87
4.96
$2,236

 
For the Nine Months Ended March 31, 2014
Options
Shares
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term (Years)
Aggregate
Intrinsic
Value
($000)
Outstanding at June 30, 2013
711,800

$12.71
 
 
Granted
20,000

$15.14
 
 
Exercised
(49,500
)
$7.33
 
 
Forfeited
(31,300
)
$20.64
 
 
Outstanding at March 31, 2014
651,000

$12.81
5.81
$3,704
Vested and expected to vest at March 31, 2014
608,400

$13.11
5.68
$3,410
Exercisable at March 31, 2014
438,000

$14.87
4.96
$2,236

As of March 31, 2014 and 2013, there was $717,000 and $1.1 million of unrecognized compensation expense, respectively, related to unvested share-based compensation arrangements under the Plans.  The expense is expected to be recognized over a weighted-average period of 2.0 years and 2.4 years, respectively.  The forfeiture rate during the first nine months of fiscal 2014 and 2013 was 20 percent for both periods, and was calculated by using the historical forfeiture experience of all fully vested stock option grants and is reviewed annually.

Equity Incentive Plan – Restricted Stock.  The Corporation used 300,000 shares, 288,750 shares and 185,000 shares of its treasury stock to fund the 2013 Plan, the 2010 Plan and the 2006 Plan, respectively.  Awarded shares typically vest over a five-year or shorter period as long as the director, advisory director, director emeriti, officer or employee remains in service to the Corporation.  Once vested, a recipient of restricted stock will have all rights of a shareholder, including the power to vote and the right to receive dividends.  The Corporation recognizes compensation expense for the restricted stock awards based on the fair value of the shares at the award date.

There was no restricted stock activity in the third quarter of fiscal 2014 and 2013, other than the award of 15,000 shares in the third quarter of fiscal 2014. For the first nine months of fiscal 2014, there was no restricted stock activity, other than the award of 15,000 shares and the forfeiture of 5,750 shares. This compares to the vesting and distribution of 800 shares and the forfeiture of 1,500 shares of restricted stock in the first nine months of fiscal 2013. As of March 31, 2014 and 2013, there were 460,350 shares and 169,600 shares of restricted stock available for future awards under the Plans.


37


The following tables summarize the unvested restricted stock activity in the quarter and nine months ended March 31, 2014.

 
For the Quarter Ended March 31, 2014
Unvested Shares
Shares
Weighted-Average
Award Date
Fair Value
Unvested at December 31, 2013
66,500

$7.07
Granted
15,000

$13.96
Vested
—

$—
Forfeited
—

$—
Unvested at March 31, 2014
81,500

$8.34
Expected to vest at March 31, 2014
65,200

$8.34

 
For the Nine Months Ended March 31, 2014
Unvested Shares
Shares
Weighted-Average
Award Date
Fair Value
Unvested at June 30, 2013
72,250

$7.07
Granted
15,000

$13.96
Vested
—

$—
Forfeited
(5,750
)
$7.07
Unvested at March 31, 2014
81,500

$8.34
Expected to vest at March 31, 2014
65,200

$8.34

As of March 31, 2014 and 2013, the unrecognized compensation expense was $529,000 and $568,000, respectively, related to unvested share-based compensation arrangements under the Plans, and reported as a reduction to stockholders’ equity.  This expense is expected to be recognized over a weighted-average period of 2.3 years and 2.2 years, respectively.  Similar to stock options, a forfeiture rate of 20 percent has been applied for the restricted stock compensation expense calculations in the first nine months of fiscal 2014 and 2013, for both periods.  For the nine months ended March 31, 2014 and 2013, the fair value of shares vested and distributed was $0 and $9,000, respectively.

Stock Option Plans.  The Corporation established the 2003 Stock Option Plan and the 1996 Stock Option Plan (collectively, the “Stock Option Plans”) for key employees and eligible directors under which options to acquire up to 352,500 shares and 1.15 million shares of common stock, respectively, may be granted.  Under the Stock Option Plans, stock options may not be granted at a price less than the fair market value at the date of the grant.  Stock options typically vest over a five-year period on a pro-rata basis as long as the employee or director remains in service to the Corporation.  The stock options are exercisable after vesting for up to the remaining term of the original grant.  The maximum term of the stock options granted is 10 years.  As of March 31, 2014, no stock options remain available for future grant under the 2003 and 1996 Stock Option Plans, which expired in November 2013 and January 2007, respectively.

The fair value of each stock option grant is estimated on the date of the grant using the Black-Scholes option valuation model with the following assumptions.  The expected volatility is based on implied volatility from historical common stock closing prices for the prior 84 months.  The expected dividend yield is based on the most recent quarterly dividend on an annualized basis.  The expected term is based on the historical experience of all fully vested stock option grants and is reviewed annually.  The risk-free interest rate is based on the U.S. Treasury note rate with a term similar to the underlying stock option on the particular grant date.

For the third quarter of fiscal 2014 and 2013, there was no activity in the Stock Option Plans, except forfeitures of 50,000 shares in the third quarter of fiscal 2014. For the first nine months of fiscal 2014 and 2013, there was no activity in the Stock Option Plans, except forfeitures of 138,000 shares and 7,500 shares, respectively. As of March 31, 2014 and 2013, there were no stock options and 14,900 stock options available for future grants under the Stock Option Plans, respectively.


38


The following tables summarize the activity in the Stock Option Plans for the quarter and nine months ended March 31, 2014.

 
For the Quarter Ended March 31, 2014
 
 
 
 
Options
 
 
 
 
Shares
 
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic
Value
($000)
Outstanding at December 31, 2013
324,700

$25.17
 
 
Granted
—

$—
 
 
Exercised
—

$—
 
 
Forfeited
(50,000
)
$30.00
 
 
Outstanding at March 31, 2014
274,700

$24.29
0.84
$—
Vested and expected to vest at March 31, 2014
274,700

$24.29
0.84
$—
Exercisable at March 31, 2014
274,700

$24.29
0.84
$—

 
For the Nine Months Ended March 31, 2014
 
 
 
 
Options
 
 
 
 
Shares
 
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic
Value
($000)
Outstanding at June 30, 2013
412,700

$24.30
 
 
Granted
—

$—
 
 
Exercised
—

$—
 
 
Forfeited
(138,000
)
$24.30
 
 
Outstanding at March 31, 2014
274,700

$24.29
0.84
$—
Vested and expected to vest at March 31, 2014
274,700

$24.29
0.84
$—
Exercisable at March 31, 2014
274,700

$24.29
0.84
$—

As of March 31, 2014 and 2013, there was no unrecognized compensation expense at both dates, related to unvested share-based compensation arrangements under the Stock Option Plans.


39



Note 11: Reclassification adjustment of Accumulated Other Comprehensive Income ("AOCI")

ASU 2013-02, "Comprehensive Income (Topic 220)," requires disclosure of reclassification adjustments of AOCI, including changes in AOCI balances by component and significant items reclassified out of AOCI.

The following tables provide the changes in AOCI by component for the quarters and nine months ended March 31, 2014 and 2013.

 
For the Quarter Ended March 31, 2014
 
Unrealized gain and losses on
 
(In Thousands)
Investment securities available for sale
Interest-only strips
Total
 
 
 
 
Beginning balance at December 31, 2013
$
408

$
50

$
458

 
 
 
 
Other comprehensive income (loss) before reclassifications
19

(9
)
10

Amount reclassified from accumulated other comprehensive income
—

—

—

Net other comprehensive income (loss)
19

(9
)
10

 
 
 
 
Ending balance at March 31, 2014
$
427

$
41

$
468


 
For the Quarter Ended March 31, 2013
 
Unrealized gain and losses on
 
(In Thousands)
Investment securities available for sale
Interest-only strips
Total
 
 
 
 
Beginning balance at December 31, 2012
$
525

$
74

$
599

 
 
 
 
Other comprehensive income (loss) before reclassifications
32

(3
)
29

Amount reclassified from accumulated other comprehensive income
—

—

—

Net other comprehensive income (loss)
32

(3
)
29

 
 
 
 
Ending balance at March 31, 2013
$
557

$
71

$
628


 
For the Nine Months Ended March 31, 2014
 
Unrealized gain and losses on
 
(In Thousands)
Investment securities available for sale
Interest-only strips
Total
 
 
 
 
Beginning balance at June 30, 2013
$
498

$
56

$
554

 
 
 
 
Other comprehensive loss before reclassifications
(71
)
(15
)
(86
)
Amount reclassified from accumulated other comprehensive income
—

—

—

Net other comprehensive loss
(71
)
(15
)
(86
)
 
 
 
 
Ending balance at March 31, 2014
$
427

$
41

$
468



40


 
For the Nine Months Ended March 31, 2013
 
Unrealized gain and losses on
 
(In Thousands)
Investment securities available for sale
Interest-only strips
Total
 
 
 
 
Beginning balance at June 30, 2012
$
552

$
74

$
626

 
 
 
 
Other comprehensive income (loss) before reclassifications
5

(3
)
2

Amount reclassified from accumulated other comprehensive income
—

—

—

Net other comprehensive income (loss)
5

(3
)
2

 
 
 
 
Ending balance at March 31, 2013
$
557

$
71

$
628


There were no significant items reclassified out of AOCI for the quarters and nine months ended March 31, 2014 and 2013.

Note 12: Offsetting Derivative and Other Financial Instruments

The Corporation’s derivative transactions are generally governed by International Swaps and Derivatives Association Master Agreements and similar arrangements, which include provisions governing the setoff of assets and liabilities between the parties. When the Corporation has more than one outstanding derivative transaction with a single counterparty, the setoff provisions contained within these agreements generally allow the non-defaulting party the right to reduce its liability to the defaulting party by amounts eligible for setoff, including the collateral received as well as eligible offsetting transactions with that counterparty, irrespective of the currency, place of payment, or booking office. The Corporation’s policy is to present its derivative assets and derivative liabilities on the Condensed Consolidated Statements of Financial Condition on a net basis for each type of derivatives. The derivative assets and liabilities are comprised of mandatory loan sale commitments, TBA MBS trades and option contracts.

The following tables present the gross and net amounts of derivative assets and liabilities and other financial instruments as reported in the Corporation’s Condensed Consolidated Statement of Financial Condition, and the gross amount not offset in the Corporation’s Condensed Consolidated Statement of Financial Condition as of the dates indicated.

As of March 31, 2014:

 
 
 
Net
 
 
 
 
 
Gross
Amount
 
 
 
 
 
Amount
of Assets
Gross Amount Not
 
 
 
Offset in the
Presented in
Offset in the Condensed
 
 
Gross
Condensed
the Condensed
Statement of Financial Condition
 
 
Amount of
Statement
Statement
 
Cash
 
 
Recognized
of Financial
of Financial
Financial
Collateral
Net
(In Thousands)
Assets
Condition
Condition
Instruments
Received
Amount
Assets
 
 
 
 
 
 
   Derivatives
$
200

$
2

$
198

$
—

$
—

$
198

Total
$
200

$
2

$
198

$
—

$
—

$
198



41


 
 
 
Net
 
 
 
 
 
Gross
Amount
 
 
 
 
 
Amount
of Liabilities
Gross Amount Not
 
 
 
Offset in the
Presented in
Offset in the Condensed
 
 
Gross
Condensed
the Condensed
Statement of Financial Condition
 
 
Amount of
Statement
Statement
 
Cash
 
 
Recognized
of Financial
of Financial
Financial
Collateral
Net
(In Thousands)
Liabilities
Condition
Condition
Instruments
Pledged
Amount
Liabilities
 
 
 
 
 
 
   Derivatives
$
4

$
—

$
4

$
—

$
—

$
4

Total
$
4

$
—

$
4

$
—

$
—

$
4


As of June 30, 2013:
 
 
 
Net
 
 
 
 
 
Gross
Amount
 
 
 
 
 
Amount
of Assets
Gross Amount Not
 
 
 
Offset in the
Presented in
Offset in the Condensed
 
 
Gross
Condensed
the Condensed
Statement of Financial Condition
 
 
Amount of
Statement
Statement
 
Cash
 
 
Recognized
of Financial
of Financial
Financial
Collateral
Net
(In Thousands)
Assets
Condition
Condition
Instruments
Received
Amount
Assets
 
 
 
 
 
 
   Derivatives
$
8,245

$
579

$
7,666

$
—

$
—

$
7,666

Total
$
8,245

$
579

$
7,666

$
—

$
—

$
7,666


 
 
 
Net
 
 
 
 
 
Gross
Amount
 
 
 
 
 
Amount
of Liabilities
Gross Amount Not
 
 
 
Offset in the
Presented in
Offset in the Condensed
 
 
Gross
Condensed
the Condensed
Statement of Financial Condition
 
 
Amount of
Statement
Statement
 
Cash
 
 
Recognized
of Financial
of Financial
Financial
Collateral
Net
(In Thousands)
Liabilities
Condition
Condition
Instruments
Pledged
Amount
Liabilities
 
 
 
 
 
 
   Derivatives
$
851

$
579

$
272

$
—

$
—

$
272

Total
$
851

$
579

$
272

$
—

$
—

$
272



Note 13: Subsequent Events

On April 29, 2014, the Corporation announced that the Corporation’s Board of Directors declared a quarterly cash dividend of $0.10 per share.  Shareholders of the Corporation’s common stock at the close of business on May 20, 2014 will be entitled to receive the cash dividend.  The cash dividend will be payable on June 11, 2014.

On May 9, 2014, the Corporation announced that the Corporation’s Board of Directors authorized the repurchase of up to five percent of the Corporation’s common stock, or approximately 476,960 shares. The Corporation will purchase the shares from time to time in the open market or through privately negotiated transactions over a one-year period depending on market conditions, the capital requirements of the Corporation, and available cash that can be allocated to the stock repurchase plan, among other

42


considerations. The May 2014 stock repurchase program is effective immediately, since the Corporation has completed the November 2013 stock repurchase program by purchasing the remaining 129,675 shares during the quarter ending June 30, 2014.



ITEM 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

Provident Financial Holdings, Inc., a Delaware corporation, was organized in January 1996 for the purpose of becoming the holding company of Provident Savings Bank, F.S.B. upon the Bank’s conversion from a federal mutual to a federal stock savings bank (“Conversion”).  The Conversion was completed on June 27, 1996.  The Corporation is regulated by the Federal Reserve Board (“FRB”).  At March 31, 2014, the Corporation had total assets of $1.13 billion, total deposits of $907.5 million and total stockholders’ equity of $150.0 million.  The Corporation has not engaged in any significant activity other than holding the stock of the Bank.  Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Bank and its subsidiaries.  As used in this report, the terms “we,” “our,” “us,” and “Corporation” refer to Provident Financial Holdings, Inc. and its consolidated subsidiaries, unless the context indicates otherwise.

The Bank, founded in 1956, is a federally chartered stock savings bank headquartered in Riverside, California.  The Bank is regulated by the Office of the Comptroller of the Currency (“OCC”), its primary federal regulator, and the Federal Deposit Insurance Corporation (“FDIC”), the insurer of its deposits.  The Bank’s deposits are federally insured up to applicable limits by the FDIC.  The Bank has been a member of the Federal Home Loan Bank System since 1956.

The Corporation’s business consists of community banking activities and mortgage banking activities, conducted by Provident Bank and Provident Bank Mortgage, a division of the Bank.  Community banking activities primarily consist of accepting deposits from customers within the communities surrounding the Bank’s full service offices and investing those funds in single-family loans, multi-family loans, commercial real estate loans, construction loans, commercial business loans, consumer loans and other real estate loans.  The Bank also offers business checking accounts, other business banking services, and services loans for others.  Mortgage banking activities consist of the origination, purchase and sale of mortgage loans secured primarily by single-family residences.  The Bank currently operates 15 retail/business banking offices in Riverside County and San Bernardino County (commonly known as the Inland Empire).  Provident Bank Mortgage operates two wholesale loan production offices: one in Pleasanton and one in Rancho Cucamonga, California; and 14 retail loan production offices in City of Industry, Elk Grove, Escondido, Glendora, Hermosa Beach, Livermore, Rancho Cucamonga, Riverside (3), Roseville, San Rafael, Santa Barbara and Westlake Village, California.  The Corporation’s revenues are derived principally from interest on its loans and investment securities and fees generated through its community banking and mortgage banking activities.  There are various risks inherent in the Corporation’s business including, among others, the general business environment, interest rates, the California real estate market, the demand for loans, the prepayment of loans, the repurchase of loans previously sold to investors, the secondary market conditions to sell loans, competitive conditions, legislative and regulatory changes, fraud and other risks.

The Corporation began to distribute quarterly cash dividends in the quarter ended September 30, 2002.  On January 28, 2014, the Corporation declared a quarterly cash dividend of $0.10 per share for the Corporation’s shareholders of record at the close of business on February 19, 2014, which was paid on March 10, 2014.  Future declarations or payments of dividends will be subject to the consideration of the Corporation’s Board of Directors, which will take into account the Corporation’s financial condition, results of operations, tax considerations, capital requirements, industry standards, legal restrictions, economic conditions and other factors, including the regulatory restrictions which affect the payment of dividends by the Bank to the Corporation.  Under Delaware law, dividends may be paid either out of surplus or, if there is no surplus, out of net profits for the current fiscal year and/or the preceding fiscal year in which the dividend is declared.

Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding the financial condition and results of operations of the Corporation.  The information contained in this section should be read in conjunction with the Unaudited Interim Condensed Consolidated Financial Statements and accompanying selected Notes to Unaudited Interim Condensed Consolidated Financial Statements.


Safe-Harbor Statement

Certain matters in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  This Form 10-Q contains statements that the Corporation believes are “forward-looking statements.”  These statements relate to the Corporation’s financial condition, results of operations, plans, objectives, future performance or business.  You should not place undue reliance on these statements, as they are subject to risks and uncertainties.  When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements the Corporation may make.  Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Corporation.  There are a number of important factors that could cause future results

43


to differ materially from historical performance and these forward-looking statements.  Factors which could cause actual results to differ materially include, but are not limited to, the credit risks of lending activities, including changes in the level and trend of loan delinquencies and charge-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the residential and commercial real estate markets and may lead to increased losses and non-performing assets and may result in our allowance for loan losses not being adequate to cover actual losses and require us to materially increase our reserve; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas; secondary market conditions for loans and our ability to sell loans in the secondary market; results of examinations of the Corporation by the FRB or of the Bank by the OCC or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to enter into a formal enforcement action or to increase our allowance for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements and restrictions on us, any of which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules, including as a result of Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd Frank Act") and the implementing regulations; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating costs and expenses; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; computer systems on which we depend could fail or experience a security breach; our ability to implement our branch expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our common stock;  adverse changes in the securities markets; the inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; war or terrorist activities; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and other risks detailed in the Corporation’s reports filed with or furnished to the SEC, including its Annual Report on Form 10-K for the fiscal year ended June 30, 2013.


Critical Accounting Policies

The discussion and analysis of the Corporation’s financial condition and results of operations is based upon the Corporation’s condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements.  Actual results may differ from these estimates under different assumptions or conditions.

The allowance for loan losses involves significant judgment and assumptions by management, which has a material impact on the carrying value of net loans.  Management considers the accounting estimate related to the allowance for loan losses a critical accounting estimate because it is highly susceptible to change from period to period, requiring management to make assumptions about probable incurred losses inherent in the loans held for investment at the date of the Condensed Consolidated Statements of Financial Condition. The impact of a sudden large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.

The allowance is based on two principles of accounting:  (i) ASC 450, “Contingencies,” which requires that losses be accrued when they are probable of occurring and can be estimated; and (ii) ASC 310, “Receivables.”  The allowance has two components: collectively evaluated allowances and individually evaluated allowances on loans held for investment.  Each of these components is based upon estimates that can change over time.  The allowance is based on historical experience and as a result can differ from actual losses incurred in the future.  Additionally, differences may result from changes to qualitative factors such as unemployment data, gross domestic product, interest rates, retail sales, the value of real estate and real estate market conditions.  The historical

44


data is reviewed at least quarterly and adjustments are made as needed.  Various techniques are used to arrive at an individually evaluated allowance, including discounted cash flows and the fair market value of collateral.  Management considers, based on currently available information, the allowance for loan losses sufficient to absorb probable losses inherent in loans held for investment.  The use of these techniques is inherently subjective and the actual losses could be greater or less than the estimates, which, can materially affect amounts recognized in the Condensed Consolidated Statements of Financial Condition and Condensed Consolidated Statements of Operations.

The Corporation assesses loans individually and classifies loans when the accrual of interest has been discontinued, loans have been restructured or management has serious doubts about the future collectibility of principal and interest, even though the loans may currently be performing.  Factors considered in determining classification include, but are not limited to, expected future cash flows, the financial condition of the borrower and current economic conditions.  The Corporation measures each non-performing loan based on the fair value of its collateral, less selling costs, or discounted cash flow and charges off those loans or portions of loans deemed uncollectible.

In compliance with the OCC’s regulatory reporting requirements, non-performing loans are charged-off to their fair values in the period the loans, or portion thereof, are deemed uncollectible, generally after the loan becomes 150 days delinquent for real estate secured first trust deed loans and 120 days delinquent for commercial business or real estate secured second trust deed loans.  For restructured loans, the charge-off occurs when the loans becomes 90 days delinquent; and where borrowers file bankruptcy, the charge-off occurs when the loan becomes 60 days delinquent.  The amount of the charge-off is determined by comparing the loan balance to the estimated fair value of the underlying collateral, less disposition costs, with the loan balance in excess of the estimated fair value charged-off against the allowance for loan losses.  The allowance for loan losses for non-performing loans is determined by applying ASC 310.  For restructured loans that are less than 90 days delinquent, the allowance for loan losses are segregated into (a) individually evaluated allowances for those loans with applicable discounted cash flow calculations or (b) collectively evaluated allowances based on the aggregated pooling method.  For non-performing loans less than 60 days delinquent where the borrower has filed bankruptcy, the collectively evaluated allowances are assigned based on the aggregated pooling method. For non-performing commercial real estate loans, an individually evaluated allowance is calculated based on the loan's fair value and if the fair value is higher than the individual loan balance, no allowance is required.

A troubled debt restructuring (“restructured loan”) is a loan which the Corporation, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Corporation would not otherwise consider.

The loan terms which have been modified or restructured due to a borrower’s financial difficulty, include but are not limited to:
a)
A reduction in the stated interest rate.
b)
An extension of the maturity at an interest rate below market.
c)
A reduction in the accrued interest.
d)
Extensions, deferrals, renewals and rewrites.

The Corporation measures the allowance for loan losses of restructured loans based on the difference between the original loan’s carrying amount and the present value of expected future cash flows discounted at the original effective yield of the loan.  Based on published guidance with respect to restructured loans from certain banking regulators and to conform to general practices within the banking industry, the Corporation determined it was appropriate to maintain certain restructured loans on accrual status because there is reasonable assurance of repayment and performance, consistent with the modified terms based upon a current, well-documented credit evaluation.

Other restructured loans are classified as “Substandard” and placed on non-performing status.  The loans may be upgraded and placed on accrual status once there is a sustained period of payment performance (usually six months or, for loans that have been restructured more than once, 12 months) and there is a reasonable assurance that the payments will continue; and if the borrower has demonstrated satisfactory contractual payments beyond 12 consecutive months, the loan is no longer categorized as a restructured loan for SEC reporting purposes.  In addition to the payment history described above, multi-family, commercial real estate, construction and commercial business loans must also demonstrate a combination of corroborating characteristics to be upgraded, such as: satisfactory cash flow, satisfactory guarantor support, and additional collateral support, among others.

To qualify for restructuring, a borrower must provide evidence of their creditworthiness such as, current financial statements, their most recent income tax returns, current paystubs, current W-2s, and most recent bank statements, among other documents, which are then verified by the Corporation.  The Corporation re-underwrites the loan with the borrower’s updated financial information, new credit report, current loan balance, new interest rate, remaining loan term, updated property value and modified payment schedule, among other considerations, to determine if the borrower qualifies.


45


Interest is not accrued on any loan when its contractual payments are more than 90 days delinquent or if the loan is deemed impaired.  In addition, interest is not recognized on any loan where management has determined that collection is not reasonably assured.  A non-performing loan may be restored to accrual status when delinquent principal and interest payments are brought current and future monthly principal and interest payments are expected to be collected.

When a loan is categorized as non-performing, all previously accrued but uncollected interest is reversed in the current operating results.  When a full recovery of the outstanding principal loan balance is in doubt, subsequent payments received are first applied as a recovery of principal charge-offs and then to unpaid principal.  This is referred to as the cost recovery method.  A loan may be returned to accrual status at such time as the loan is brought fully current as to both principal and interest, and, in management’s judgment, such loan is considered to be fully collectible on a timely basis.  However, the Corporation’s policy also allows management to continue the recognition of interest income on certain non-performing loans.  This is referred to as the cash basis method under which the accrual of interest is suspended and interest income is recognized only when collected.  This policy applies to non-performing loans that are considered to be fully collectible but the timely collection of payments is in doubt.
 
ASC 815 , “Derivatives and Hedging,” requires that derivatives of the Corporation be recorded in the condensed consolidated financial statements at fair value.  Management considers its accounting policy for derivatives to be a critical accounting policy because these instruments have certain interest rate risk characteristics that change in value based upon changes in the capital markets.  The Corporation’s derivatives are primarily the result of its mortgage banking activities in the form of commitments to extend credit, commitments to sell loans, TBA MBS trades and option contracts to mitigate the risk of the commitments to extend credit.  Estimates of the percentage of commitments to extend credit on loans to be held for sale that may not fund are based upon historical data and current market trends.  The fair value adjustments of the derivatives are recorded in the Condensed Consolidated Statements of Operations with offsets to other assets or other liabilities in the Condensed Consolidated Statements of Financial Condition.

Management accounts for income taxes by estimating future tax effects of temporary differences between the tax and book basis of assets and liabilities considering the provisions of enacted tax laws.  These differences result in deferred tax assets and liabilities, which are included in the Corporation’s Condensed Consolidated Statements of Financial Condition.  The application of income tax law is inherently complex.  Laws and regulations in this area are voluminous and are often ambiguous.  As such, management is required to make many subjective assumptions and judgments regarding the Corporation’s income tax exposures, including judgments in determining the amount and timing of recognition of the resulting deferred tax assets and liabilities, including projections of future taxable income.  Interpretations of and guidance surrounding income tax laws and regulations change over time.  As such, changes in management’s subjective assumptions and judgments can materially affect amounts recognized in the Condensed Consolidated Statements of Financial Condition and Condensed Consolidated Statements of Operations.  Therefore, management considers its accounting for income taxes a critical accounting policy.


Executive Summary and Operating Strategy

Provident Savings Bank, F.S.B., established in 1956, is a financial services company committed to serving consumers and small to mid-sized businesses in the Inland Empire region of Southern California.  The Bank conducts its business operations as Provident Bank, Provident Bank Mortgage, a division of the Bank, and through its subsidiary, Provident Financial Corp.  The business activities of the Corporation, primarily through the Bank and its subsidiary, consist of community banking, mortgage banking and, to a lesser degree, investment services for customers and trustee services on behalf of the Bank.

Community banking operations primarily consist of accepting deposits from customers within the communities surrounding the Corporation’s full service offices and investing those funds in single-family, multi-family and commercial real estate loans.  Also, to a lesser extent, the Corporation makes construction, commercial business, consumer and other loans.  The primary source of income in community banking is net interest income, which is the difference between the interest income earned on loans and investment securities, and the interest expense paid on interest-bearing deposits and borrowed funds.  Additionally, certain fees are collected from depositors, such as returned check fees, deposit account service charges, ATM fees, IRA/KEOGH fees, safe deposit box fees, travelers check fees, wire transfer fees and overdraft protection fees, among others.

During the next three years, subject to market conditions, the Corporation intends to improve its community banking business by moderately growing total assets; by decreasing the concentration of single-family mortgage loans within loans held for investment; and by increasing the concentration of higher yielding preferred loans (i.e., multi-family, commercial real estate, construction and commercial business loans).  In addition, the Corporation intends to decrease the percentage of time deposits in its deposit base and to increase the percentage of lower cost checking and savings accounts.  This strategy is intended to improve core revenue through a higher net interest margin and ultimately, coupled with the growth of the Corporation, an increase in net interest income.  While the Corporation’s long-term strategy is for moderate growth, management recognizes that the total balance sheet

46


may decline or stabilize at current levels in response to weaknesses in general economic conditions, which may improve capital ratios and mitigate credit and liquidity risk.

Mortgage banking operations primarily consist of the origination, purchase and sale of mortgage loans secured by single-family residences.  The primary sources of income in mortgage banking are gain on sale of loans and certain fees collected from borrowers in connection with the loan origination process.  The Corporation will continue to modify its operations, including the number of mortgage banking personnel, in response to the rapidly changing mortgage banking environment.  Changes may include a different product mix, further tightening of underwriting standards, variations in its operating expenses or a combination of these and other changes.

Provident Financial Corp performs trustee services for the Bank’s real estate secured loan transactions and has in the past held, and may in the future hold real estate for investment.  Investment services operations primarily consist of selling alternative investment products such as annuities and mutual funds to the Bank’s depositors.  Investment services and trustee services contribute a very small percentage of gross revenue.

There are a number of risks associated with the business activities of the Corporation, many of which are beyond the Corporation’s control, including: changes in accounting principles, laws, regulation, interest rates and the economy, among others.  The Corporation attempts to mitigate many of these risks through prudent banking practices, such as interest rate risk management, credit risk management, operational risk management, and liquidity risk management.  The current relatively weak California economic environment presents heightened risk for the Corporation primarily with respect to real estate values and loan delinquencies.  Although real estate values and unemployment rates have been improving since 2009, any future decline in real estate values or increase in unemployment rates may lead to higher loan losses since the majority of the Corporation’s loans are secured by real estate located within California.  Significant declines in the value of California real estate may also inhibit the Corporation’s ability to recover on defaulted loans by selling the underlying real estate.  The Corporation’s operating costs may increase significantly as a result of the Dodd-Frank Act.   Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Corporation.


Off-Balance Sheet Financing Arrangements and Contractual Obligations

The following table summarizes the Corporation’s contractual obligations at March 31, 2014 and the effect these obligations are expected to have on the Corporation’s liquidity and cash flows in future periods:

 
Payments Due by Period
(In Thousands)
Less than
1 year
1 to less
than  3 years
3 to
5 years
Over
5 years
Total
Operating obligations
$
1,892

$
2,950

$
1,358

$
250

$
6,450

Pension benefits
220

441

441

6,929

8,031

Time deposits
194,612

157,730

29,963

1,579

383,884

FHLB – San Francisco advances
11,341

2,634

12,353

32,951

59,279

FHLB – San Francisco letter of credit
5,000

—

—

—

5,000

FHLB – San Francisco MPF credit enhancement (1)
176

352

352

1,633

2,513

Total
$
213,241

$
164,107

$
44,467

$
43,342

$
465,157


(1) 
Represents the recourse provision for loans previously sold by the Bank to the FHLB – San Francisco under its Mortgage Partnership Finance (“MPF”) program.  The FHLB – San Francisco discontinued the MPF program on October 6, 2006.  As of March 31, 2014, the Bank serviced $41.5 million of loans under this program.

The expected obligation for time deposits and FHLB – San Francisco advances include anticipated interest accruals based on the respective contractual terms.

In addition to the off-balance sheet financing arrangements and contractual obligations mentioned above, the Corporation has derivatives and other financial instruments with off-balance sheet risks as described in Note 7 of the Notes to Unaudited Interim Condensed Consolidated Financial Statements.


47


 
Comparison of Financial Condition at March 31, 2014 and June 30, 2013

Total assets decreased $85.9 million, or seven percent, to $1.13 billion at March 31, 2014 from $1.21 billion at June 30, 2013.  The decrease was primarily attributable to a decrease in loans held for sale, with most of the proceeds deployed to payoff maturing FHLB borrowings.

Total cash and cash equivalents, primarily excess cash deposited with the Federal Reserve Bank of San Francisco, decreased slightly to $193.5 million at March 31, 2014 from $193.8 million at June 30, 2013.  The relatively high balance in cash and cash equivalents is primarily attributable to the slow economic recovery and rise in mortgage interest rates over the last year which has reduced loan demand preventing the Corporation from fully utilizing the excess cash for loans held for investment and for sale; and it is consistent with the Corporation’s strategy of managing credit, interest rate and liquidity risk.

Total investment securities decreased $2.4 million, or 12 percent, to $17.1 million at March 31, 2014 from $19.5 million at June 30, 2013.  The decrease was primarily the result of scheduled and accelerated principal payments on mortgage-backed securities.  For further analysis on investment securities, see Note 5 of the Notes to Unaudited Interim Condensed Consolidated Financial Statements.

Loans held for investment increased $21.5 million, or three percent, to $769.9 million at March 31, 2014 from $748.4 million at June 30, 2013.  Total loan principal payments during the first nine months of fiscal 2014 were $101.7 million, a five percent decrease from $107.1 million in the comparable period in fiscal 2013.  In addition, real estate owned acquired in the settlement of loans in the first nine months of fiscal 2014 was $4.2 million, a 55 percent decline from $9.3 million in the same period last year due primarily to the improvement in the Corporation's credit quality and general improvement in real estate markets.  During the first nine months of fiscal 2014 and 2013, the Corporation originated $120.1 million and $63.9 million, respectively, of loans held for investment, consisting primarily of multi-family and commercial real estate loans.  During the first nine months of fiscal 2014 and 2013, the Corporation did not purchase any loans to be held for investment. The balance of preferred loans increased 11 percent to $396.0 million at March 31, 2014, compared to $356.5 million at June 30, 2013, and represented 51 percent and 47 percent of loans held for investment, respectively.  The balance of single-family loans held for investment decreased six percent to $381.3 million at March 31, 2014, compared to $404.3 million at June 30, 2013, and represented approximately 49 percent and 53 percent of loans held for investment, respectively.

The tables below describe the geographic dispersion of gross real estate secured loans held for investment at March 31, 2014 and June 30, 2013, as a percentage of the total dollar amount outstanding:

As of March 31, 2014
(Dollars In Thousands)
Inland
Empire
Southern
California (1)
Other
California
Other
States
 
Total
Loan Category
Balance
%
Balance
%
Balance
%
Balance
%
Balance
%
Single-family
$
111,907

29
%
$
204,793

54
%
$
61,563

16
%
$
3,004

1
%
$
381,267

100
%
Multi-family
60,679

21
%
156,057

54
%
69,180

24
%
3,398

1
%
289,314

100
%
Commercial real estate
47,103

45
%
48,255

46
%
9,211

9
%
—

—
%
104,569

100
%
Construction
1,792

100
%
—

—
%
—

—
%
—

—
%
1,792

100
%
Total
$
221,481

28
%
$
409,105

53
%
$
139,954

18
%
$
6,402

1
%
$
776,942

100
%

(1) 
Other than the Inland Empire.


48


As of June 30, 2013
(Dollars In Thousands)
Inland
Empire
Southern
California (1)
Other
California
Other
States
 
Total
Loan Category
Balance

%
Balance

%
Balance

%
Balance

%
Balance

%
Single-family
$
119,858

29
%
$
221,306

55
%
$
59,624

15
%
$
3,553

1
%
$
404,341

100
%
Multi-family
46,245

18
%
158,058

60
%
54,564

21
%
3,449

1
%
262,316

100
%
Commercial real estate
49,660

54
%
40,104

43
%
2,724

3
%
—

—
%
92,488

100
%
Construction
292

100
%
—

—
%
—

—
%
—

—
%
292

100
%
Total
$
216,055

29
%
$
419,468

55
%
$
116,912

15
%
$
7,002

1
%
$
759,437

100
%

(1) 
Other than the Inland Empire.

Loans held for sale decreased $83.8 million, or 45 percent, to $104.3 million at March 31, 2014 from $188.1 million at June 30, 2013.  The decrease was primarily due to the lower volume of loans originated for sale reflecting a reduction in refinancing transactions due to the recent rise in mortgage interest rates.

The outstanding balance of FHLB - San Francisco stock decreased $6.6 million, or 43 percent, to $8.7 million at March 31, 2014 from $15.3 million at June 30, 2013. The decrease was due to the excess stock redemption received from the FHLB - San Francisco. At March 31, 2014, the minimum FHLB - San Francisco stock requirement was $8.7 million and there was no excess FHLB - San Francisco stock. This compares to the minimum FHLB - San Francisco stock requirement of $8.7 million with excess FHLB stock of $6.6 million at June 30, 2013.

Total deposits decreased $15.5 million, or two percent, to $907.5 million at March 31, 2014 from $923.0 million at June 30, 2013.  Transaction accounts increased $9.1 million, or two percent, to $529.9 million at March 31, 2014 from $520.8 million at June 30, 2013; while time deposits decreased $24.6 million, or six percent, to $377.6 million at March 31, 2014 from $402.2 million at June 30, 2013.  The change in deposit mix was consistent with the Corporation’s marketing strategy to promote transaction accounts and the strategic decision to increase the percentage of transaction accounts in its deposit base and decrease the percentage of time deposits by competing less aggressively on time deposit interest rates.

Borrowings, consisting of FHLB – San Francisco advances, decreased $55.1 million, or 52 percent, to $51.4 million from $106.5 million at June 30, 2013, primarily due to scheduled maturities during the nine months ended March 31, 2014.  The weighted-average maturity of the Corporation’s FHLB – San Francisco advances was approximately 56 months at March 31, 2014, compared to 32 months at June 30, 2013.

Total stockholders’ equity decreased $10.0 million, or six percent, to $150.0 million at March 31, 2014, from $160.0 million at June 30, 2013, primarily as a result of stock repurchases (See Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds”) and quarterly cash dividends paid, partly offset by net income during the first nine months of fiscal 2014.


Comparison of Operating Results for the Quarters and Nine Months Ended March 31, 2014 and 2013

The Corporation’s net income for the third quarter of fiscal 2014 was $1.4 million, a decrease of $3.5 million, or 71 percent, from $4.9 million in the same period of fiscal 2013. For the first nine months of fiscal 2014, the Corporation’s net income was $4.5 million, a decrease of $16.0 million, or 78 percent, from $20.5 million in the same period of fiscal 2013. The decrease in net income for each period was attributable to the decreases in non-interest income and net interest income, partially offset by the recoveries from the allowance for loan losses and decreases in non-interest expenses and provision for income taxes.

The Corporation’s efficiency ratio, defined as non-interest expense divided by the sum of net interest income and non-interest income, increased to 88 percent for the third quarter of fiscal 2014 from 67 percent for the same period of fiscal 2013.  For the first nine months of fiscal 2014, the Corporation’s efficiency ratio also increased to 88 percent from 60 percent for the same period of fiscal 2013. The increase in the efficiency ratio for each period was primarily the result of a significant decrease in non-interest income and net interest income outpacing the decrease in non-interest expense.


49


Return on average assets for the third quarter of fiscal 2014 was 0.50 percent, down 109 basis points from 1.59 percent in the same period last year.  For the first nine months of fiscal 2014, return on average assets was 0.52 percent, down 168 basis points from 2.20 percent in the same period last year.

Return on average equity for the third quarter of fiscal 2014 was 3.70 percent compared to 12.48 percent for the same period last year.  For the first nine months of fiscal 2014, return on average equity was 3.89 percent compared to 18.02 percent for the same period last year.

Diluted earnings per share for the third quarter of fiscal 2014 were $0.14, a 69 percent decrease from $0.45 in the same period last year. For the first nine months of fiscal 2014, diluted earnings per share were $0.44, a 77 percent decrease from $1.88 in the same period last year.

Net Interest Income:

For the Quarters Ended March 31, 2014 and 2013.  Net interest income decreased $616,000, or eight percent, to $7.5 million for the third quarter of fiscal 2014 from $8.1 million for the comparable period in fiscal 2013, due to a lower average earning asset balance and, to a lesser extent, a lower net interest margin.  The average balance of earning assets decreased $78.4 million, or seven percent, to $1.09 billion in the third quarter of fiscal 2014 from $1.17 billion in the comparable period of fiscal 2013, due primarily to a weak demand for new loans and it was consistent with the Corporation’s strategy of managing liquidity, interest rate and credit risk. The weighted-average yield of interest-earning assets decreased by 27 basis points to 3.36 percent and the weighted-average cost of interest-bearing liabilities decreased by 27 basis points to 0.72 percent for the third quarter of fiscal 2014 as compared to the same period last year. The net interest margin was 2.74 percent in the third quarter of fiscal 2014, down two basis points from 2.76 percent in the same period of fiscal 2013 due to the impact of the decline in the average yield of interest-earning assets outpacing the impact of the decline in the average cost of interest-bearing liabilities.

For the Nine Months Ended March 31, 2014 and 2013.  Net interest income decreased $2.7 million, or 11 percent, to $23.1 million for the first nine months of fiscal 2014 from $25.8 million for the comparable period in fiscal 2013, due to a lower average earning asset balance and, to a lesser extent, a lower net interest margin.  The average balance of earning assets decreased $83.4 million, or seven percent, to $1.11 billion in the first nine months of fiscal 2014 from $1.20 billion in the comparable period of fiscal 2013, consistent with the Corporation’s strategy of managing liquidity, interest rate and credit risk. The net interest margin was 2.76 percent in the first nine months of fiscal 2014, down 11 basis points from 2.87 percent in the same period of fiscal 2013 due to the decline in the average yield on interest-earning assets outpacing the declining cost of liabilities.  The weighted-average yield on interest-earning assets decreased by 35 basis points to 3.45 percent, while the weighted-average cost of interest-bearing liabilities decreased by 26 basis points to 0.78 percent for the first nine months of fiscal 2014 as compared to the same period last year.
  
Interest Income:

For the Quarters Ended March 31, 2014 and 2013.  Total interest income decreased by $1.4 million, or 13 percent, to $9.2 million for the third quarter of fiscal 2014 from $10.6 million in the same quarter of fiscal 2013.  This decrease was the result of the lower average balance of earning assets, particularly loans receivable, and, to a lesser extent, the lower average earning asset yield, particularly on loans receivable.

Loans receivable interest income decreased $1.6 million, or 15 percent, to $8.7 million in the third quarter of fiscal 2014 from $10.3 million for the same quarter of fiscal 2013.  This decrease was attributable to a lower average loan balance and, to a much lesser extent, a lower average loan yield.  The average balance of loans receivable, including loans held for sale, decreased $121.5 million, or 13 percent, to $842.7 million for the third quarter of fiscal 2014 as compared to $964.2 million in the same quarter of fiscal 2013.  The decrease in the average balance of loan receivable was due primarily to a lower balance of loans held for sale, the slow economic recovery creating weak demand for loans held for investment and the Corporation’s strategy of managing liquidity, interest rate and credit risk. The average loan yield during the third quarter of fiscal 2014 decreased 13 basis points to 4.14 percent from 4.27 percent during the same quarter last year.  The decrease in the average loan yield was primarily attributable to the repricing of adjustable rate loans to lower interest rates and payoffs of loans which carried a higher average yield than the average yield of loans receivable, partly offset by an increase in the average yield of loans held for sale. The average balance of loans held for sale decreased $118.1 million, or 59 percent, to $81.8 million during the third quarter of fiscal 2014 from $199.9 million in the same quarter of fiscal 2013. The average yield on the loans held for sale increased 78 basis points to 4.09 percent in the third quarter of fiscal 2014 from 3.31 percent in the same quarter of fiscal 2013, primarily due to the increase in mortgage interest rates.
 

50


Interest income from investment securities decreased $23,000, or 22 percent, to $82,000 for the third quarter of fiscal 2014 from $105,000 in the same quarter of fiscal 2013.  This decrease was attributable to a lower average balance of investment securities and, to a lesser extent, a lower average yield.  The average balance of investment securities decreased $3.3 million, or 16 percent, to $17.5 million during the third quarter of fiscal 2014 from $20.8 million during the same quarter of fiscal 2013.  The decrease in the average balance was primarily due to scheduled and accelerated principal payments on mortgage-backed securities.  The average yield on investment securities decreased 14 basis points to 1.88 percent during the quarter ended March 31, 2014 from 2.02 percent during the quarter ended March 31, 2013.  The decrease in the average yield of investment securities was primarily attributable to the repricing of adjustable rate mortgage-backed securities to lower interest rates.  During the third quarter of fiscal 2014, the Corporation did not purchase any investment securities, while $666,000 of principal payments were received on mortgage-backed securities.

The FHLB – San Francisco cash dividend received in the third quarter of fiscal 2014 was $203,000, compared to $116,000 in the same quarter of fiscal 2013.  In the third quarter of fiscal 2014, the Bank received a $2.2 million partial redemption of the FHLB – San Francisco excess capital stock at par, as compared to the $1.9 million capital stock redemption in the same period of fiscal 2013.

Interest income from interest-earning deposits, primarily cash deposited at the Federal Reserve Bank of San Francisco, was $142,000 in the third quarter of fiscal 2014, up 41 percent from $101,000 in the same quarter of fiscal 2013.  The increase was due to a higher average balance for the third quarter of fiscal 2014 as compared to the same period last year as the average yield was unchanged at 25 basis points during both periods.  The average balance of the interest-earning deposits in the third quarter of fiscal 2014 was $218.7 million, an increase of $54.8 million or 33 percent, from $163.9 million in the same quarter of fiscal 2013. The increase in the average balance of the interest-earning deposits was due primarily to the decrease in the average balance of loans held for sale, with most of the proceeds deployed to payoff maturing FHLB borrowings.

For the Nine Months Ended March 31, 2014 and 2013.  Total interest income decreased by $5.3 million, or 16 percent, to $28.8 million for the first nine months of fiscal 2014 from $34.1 million in the same period of fiscal 2013.  This decrease was the result of the lower average balance of earning assets, particularly on loans receivable, and, to a lesser extent, the lower average earning asset yield, particularly on loans receivable.

Loans receivable interest income decreased $5.7 million, or 17 percent, to $27.5 million in the first nine months of fiscal 2014 from $33.2 million for the same period of fiscal 2013.  This decrease was attributable to a lower average loan balance and, to a much lesser extent, a lower average loan yield.  The average balance of loans receivable, including loans held for sale, decreased $139.8 million, or 14 percent, to $876.7 million for the first nine months of fiscal 2014 as compared to $1.02 billion in the same period of fiscal 2013. The average loan yield during the first nine months of fiscal 2014 decreased 17 basis points to 4.19 percent from 4.36 percent during the same period last year.  The decrease in the average loan yield was primarily attributable to the repricing of adjustable rate loans to lower interest rates and payoffs of loans which carried a higher average yield than the average yield of loans receivable, partly offset by an increase in the average yield of loans held for sale. The average balance of loans held for sale decreased $120.4 million, or 49 percent, to $124.0 million during the first nine months of fiscal 2014 from $244.4 million in the the same period of fiscal 2013. The average yield on the loans held for sale increased 70 basis points to 4.12 percent in the first nine months of fiscal 2014 from 3.42 percent in the same period of fiscal 2013, primarily due to the increase in mortgage interest rates.

Interest income from investment securities decreased $69,000, or 21 percent, to $260,000 for the first nine months of fiscal 2014 from $329,000 in the same period of fiscal 2013.  This decrease was attributable to a lower average balance of investment securities and, to a lesser extent, a lower average yield.  The average balance of investment securities decreased $3.5 million, or 16 percent, to $18.2 million during the first nine months of fiscal 2014 from $21.7 million during the same period of fiscal 2013.  The decrease in the average balance was primarily due to scheduled and accelerated principal payments on mortgage-backed securities.  The average yield on investment securities decreased 12 basis points to 1.90 percent during the nine months ended March 31, 2014 from 2.02 percent during the same period ended March 31, 2013.  The decrease in the average yield of investment securities was primarily attributable to the repricing of adjustable rate mortgage-backed securities to lower interest rates.  During the first nine months of fiscal 2014, the Corporation did not purchase any investment securities, while $2.3 million of principal payments were received on mortgage-backed securities.

The FHLB – San Francisco cash dividend received in the first nine months of fiscal 2014 was $615,000, compared to $280,000 in the same period of fiscal 2013.  In the first nine months of fiscal 2014, the Bank received a $6.6 million partial redemption of the FHLB – San Francisco excess capital stock at par, as compared to the $5.0 million capital stock redemption in the same period of fiscal 2013.


51


Interest income from interest-earning deposits, primarily cash deposited at the Federal Reserve Bank of San Francisco, was $390,000 in the first nine months of fiscal 2014, up 51 percent from $258,000 in the same period of fiscal 2013.  The increase was due to a higher average balance for the first nine months of fiscal 2014 as compared to the same period last year as the average yield was unchanged at 25 basis points during both nine month periods.  The average balance of the interest-earning deposits in the first nine months of fiscal 2014 was $205.4 million, an increase of $67.8 million or 49 percent, from $137.6 million in the same period of fiscal 2013.

Interest Expense:

For the Quarters Ended March 31, 2014 and 2013.  Total interest expense for the third quarter of fiscal 2014 was $1.7 million as compared to $2.5 million for the same period last year, a decrease of $838,000, or 33 percent.  This decrease was primarily attributable to a lower average balance of interest-bearing liabilities, particularly borrowings, and, to a lesser extent, a lower average cost of interest-bearing liabilities.

Interest expense on deposits for the third quarter of fiscal 2014 was $1.3 million as compared to $1.6 million for the same period last year, a decrease of $260,000, or 17 percent.  The decrease in interest expense on deposits was primarily attributable to a lower average cost and, to a lesser extent, a lower average balance.  The average cost of deposits decreased to 0.58 percent during the third quarter of fiscal 2014 from 0.68 percent during the same quarter last year, a decrease of 10 basis points.  The decrease in the average cost of deposits was attributable primarily to higher cost time deposits repricing to lower current market interest rates and a lower percentage of time deposits to the total deposit balance. The average balance of deposits decreased $22.0 million to $909.7 million during the quarter ended March 31, 2014 from $931.7 million during the same period last year.  The decrease in the average balance was primarily attributable to a decrease in time deposits.  Strategically, the Corporation has been promoting transaction accounts and competing less aggressively for time deposits.  The Corporation believes the increase in transaction accounts was also attributable to the impact of depositors seeking an alternative to lower yielding time deposits in light of the current low interest rate environment.  The average balance of transaction accounts to total deposits in the third quarter of fiscal 2014 was 58 percent, compared to 55 percent in the same period of fiscal 2013.

Interest expense on borrowings, consisting of FHLB – San Francisco advances, for the third quarter of fiscal 2014 decreased $578,000, or 59 percent, to $403,000 from $981,000 for the same period last year.  The decrease in interest expense on borrowings was the result of a lower average balance and, to a much lesser extent, lower average cost.  The average balance of borrowings decreased $59.3 million, or 54 percent, to $51.4 million during the quarter ended March 31, 2014 from $110.7 million during the same period last year.  The decrease in the average balance was due to scheduled maturities.  The average cost of borrowings decreased to 3.18 percent for the quarter ended March 31, 2014 from 3.59 percent in the same quarter last year, a decrease of 41 basis points.  The decrease in average cost was due to maturities of higher costing advances.

For the Nine Months Ended March 31, 2014 and 2013.  Total interest expense for the first nine months of fiscal 2014 was $5.7 million as compared to $8.3 million for the same period last year, a decrease of $2.6 million, or 31 percent.  This decrease was primarily attributable to a lower average balance of interest-bearing liabilities, particularly borrowings, and, to a lesser extent, a lower average cost of interest-bearing liabilities.

Interest expense on deposits for the first nine months of fiscal 2014 was $4.2 million as compared to $5.0 million for the same period last year, a decrease of $804,000, or 16 percent.  The decrease in interest expense on deposits was primarily attributable to a lower average cost and, to a lesser extent, a lower average balance.  The average cost of deposits decreased to 0.61 percent during the first nine months of fiscal 2014 from 0.71 percent during the same period last year, a decrease of 10 basis points.  The decrease in the average cost of deposits was attributable to interest rate reductions in core deposits and new time deposits with a lower average cost replacing maturing time deposits with a higher average cost, consistent with current relatively low market interest rates.  The average balance of deposits decreased $28.0 million, or three percent, to $918.0 million during the nine months ended March 31, 2014 from $946.0 million during the same period last year.  The decrease in the average balance was primarily attributable to a decrease in time deposits, partly offset by an increase in transaction accounts.  The average balance of transaction accounts to total deposits in the first nine months of fiscal 2014 was 57 percent, compared to 54 percent in the same period of fiscal 2013.

Interest expense on borrowings, consisting of FHLB – San Francisco advances, for the first nine months of fiscal 2014 decreased $1.8 million, or 54 percent, to $1.5 million from $3.3 million for the same period last year.  The decrease in interest expense on borrowings was the result of a lower average balance and, to a much lesser extent, lower average cost.  The average balance of borrowings decreased $60.0 million, or 49 percent, to $61.3 million during the nine months ended March 31, 2014 from $121.3 million during the same period last year.  The decrease in the average balance was due to scheduled maturities.  The average cost of borrowings decreased to 3.23 percent for the nine months ended March 31, 2014 from 3.58 percent in the same period last year, a decrease of 35 basis points.  The decrease in average cost was due to maturities of higher costing advances.


52


The following tables present the average balance sheets for the quarters and nine months ended March 31, 2014 and 2013, respectively:

Average Balance Sheets
 
Quarter Ended
March 31, 2014
 
Quarter Ended
March 31, 2013
(Dollars In Thousands)
Average
Balance
Interest
Yield/
Cost
 
Average
Balance
Interest
Yield/
Cost
Interest-earning assets:
 
 
 
 
 
 
 
Loans receivable, net (1)
$
842,714

$
8,731

4.14
%
 
$
964,154

$
10,290

4.27
%
Investment securities
17,461

82

1.88
%
 
20,838

105

2.02
%
FHLB – San Francisco stock
10,633

203

7.64
%
 
19,020

116

2.44
%
Interest-earning deposits
218,711

142

0.25
%
 
163,911

101

0.25
%
 
 
 
 
 
 
 
 
Total interest-earning assets
1,089,519

9,158

3.36
%
 
1,167,923

10,612

3.63
%
 
 
 
 
 
 
 
 
Non interest-earning assets
39,613

 
 
 
56,209

 
 
 
 
 
 
 
 
 
 
Total assets
$
1,129,132

 
 
 
$
1,224,132

 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
Checking and money market accounts (2)
$
289,590

94

0.13
%
 
$
288,151

97

0.14
%
Savings accounts
238,334

153

0.26
%
 
226,606

142

0.25
%
Time deposits
381,789

1,058

1.12
%
 
416,958

1,326

1.29
%
 
 
 
 
 
 
 
 
Total deposits
909,713

1,305

0.58
%
 
931,715

1,565

0.68
%
 
 
 
 
 
 
 
 
Borrowings
51,452

403

3.18
%
 
110,733

981

3.59
%
 
 
 
 
 
 
 
 
Total interest-bearing liabilities
961,165

1,708

0.72
%
 
1,042,448

2,546

0.99
%
 
 
 
 
 
 
 
 
Non interest-bearing liabilities
16,791

 
 
 
25,632

 
 
 
 
 
 
 
 
 
 
Total liabilities
977,956

 
 
 
1,068,080

 
 
 
 
 
 
 
 
 
 
Stockholders’ equity
151,176

 
 
 
156,052

 
 
Total liabilities and stockholders’ equity
$
1,129,132

 
 
 
$
1,224,132

 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
7,450

 
 
 
$
8,066

 
 
 
 
 
 
 
 
 
Interest rate spread (3)
 
 
2.64
%
 
 
 
2.64
%
Net interest margin (4)
 
 
2.74
%
 
 
 
2.76
%
Ratio of average interest-earning assets to
   average interest-bearing liabilities
 
 
113.35
%
 
 
 
112.04
%
Return on average assets
 
 
0.50
%
 
 
 
1.59
%
Return on average equity
 
 
3.70
%
 
 
 
12.48
%
 
(1) 
Includes loans held for sale and non-performing loans, as well as net deferred loan cost amortization of $89 and $122 for the quarters ended March 31, 2014 and 2013, respectively.
(2) 
Includes the average balance of non interest-bearing checking accounts of $55.0 million and $53.2 million during the quarters ended March 31, 2014 and 2013, respectively.
(3) 
Represents the difference between the weighted-average yield on all interest-earning assets and the weighted-average rate on all interest-bearing liabilities.
(4) 
Represents net interest income before provision for loan losses as a percentage of average interest-earning assets.


53


 
Nine Months Ended
March 31, 2014
 
Nine Months Ended
March 31, 2013
 
Average
Balance
Interest
Yield/
Cost
 
Average
Balance
Interest
Yield/
Cost
Interest-earning assets:
 
 
 
 
 
 
 
Loans receivable, net (1)
$
876,708

$
27,522

4.19
%
 
$
1,016,543

$
33,209

4.36
%
Investment securities
18,243

260

1.90
%
 
21,749

329

2.02
%
FHLB – San Francisco stock
12,347

615

6.64
%
 
20,270

280

1.83
%
Interest-earning deposits
205,386

390

0.25
%
 
137,585

258

0.25
%
 
 
 
 
 
 
 
 
Total interest-earning assets
1,112,684

28,787

3.45
%
 
1,196,147

34,076

3.80
%
 
 
 
 
 
 
 
 
Non interest-earning assets
37,839

 
 
 
49,209

 
 
 
 
 
 
 
 
 
 
Total assets
$
1,150,523

 
 
 
$
1,245,356

 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
Checking and money market accounts (2)
$
291,109

292

0.13
%
 
$
286,510

307

0.14
%
Savings accounts
235,794

452

0.26
%
 
228,212

434

0.25
%
Time deposits
391,088

3,492

1.19
%
 
431,249

4,299

1.33
%
 
 
 
 
 
 
 
 
Total deposits
917,991

4,236

0.61
%
 
945,971

5,040

0.71
%
 
 
 
 
 
 
 
 
Borrowings
61,284

1,485

3.23
%
 
121,342

3,262

3.58
%
 
 
 
 
 
 
 
 
Total interest-bearing liabilities
979,275

5,721

0.78
%
 
1,067,313

8,302

1.04
%
 
 
 
 
 
 
 
 
Non interest-bearing liabilities
16,301

 
 
 
26,057

 
 
 
 
 
 
 
 
 
 
Total liabilities
995,576

 
 
 
1,093,370

 
 
 
 
 
 
 
 
 
 
Stockholders’ equity
154,947

 
 
 
151,986

 
 
Total liabilities and stockholders’ equity
$
1,150,523

 
 
 
$
1,245,356

 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
23,066

 
 
 
$
25,774

 
 
 
 
 
 
 
 
 
Interest rate spread (3)
 
 
2.67
%
 
 
 
2.76
%
Net interest margin (4)
 
 
2.76
%
 
 
 
2.87
%
Ratio of average interest-earning assets to
   average interest-bearing liabilities
 
 
113.62
%
 
 
 
112.07
%
Return on average assets
 
 
0.52
%
 
 
 
2.20
%
Return on average equity
 
 
3.89
%
 
 
 
18.02
%

(1)
Includes loans held for sale and non-performing loans, as well as net deferred loan cost amortization of $388 and $469 for the nine months ended March 31, 2014 and 2013, respectively.
(2)
Includes the average balance of non interest-bearing checking accounts of $57.1 million and $52.8 million during the nine months ended March 31, 2014 and 2013, respectively.
(3)
Represents the difference between the weighted-average yield on all interest-earning assets and the weighted-average rate on all interest-bearing liabilities.
(4)
Represents net interest income before provision for loan losses as a percentage of average interest-earning assets.


54


The following tables provide the rate/volume variances for the quarters and nine months ended March 31, 2014 and 2013, respectively:

Rate/Volume Variance

 
Quarter Ended March 31, 2014 Compared
To Quarter Ended March 31, 2013
Increase (Decrease) Due to
(In Thousands)
Rate
Volume
Rate/
Volume
Net
Interest-earning assets:
 
 
 
 
     Loans receivable (1)
$
(302
)
$
(1,296
)
$
39

$
(1,559
)
Investment securities
(7
)
(17
)
1

(23
)
FHLB – San Francisco stock
247

(51
)
(109
)
87

Interest-bearing deposits
—

41

—

41

Total net change in income on interest-earning assets
(62
)
(1,323
)
(69
)
(1,454
)
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
Checking and money market accounts
(3
)
—

—

(3
)
Savings accounts
1

10

—

11

Time deposits
(171
)
(112
)
15

(268
)
Borrowings
(113
)
(525
)
60

(578
)
Total net change in expense on interest-bearing liabilities
(286
)
(627
)
75

(838
)
Net increase (decrease) in net interest income
$
224

$
(696
)
$
(144
)
$
(616
)
 
(1) 
Includes loans held for sale and non-performing loans.  For purposes of calculating volume, rate and rate/volume variances, non-performing loans were included in the weighted-average balance outstanding.

 
Nine Months Ended March 31, 2014 Compared
To Nine Months Ended March 31, 2013
Increase (Decrease) Due to
 
Rate
Volume
Rate/
Volume
Net
Interest-earning assets:
 
 
 
 
     Loans receivable (1)
$
(1,292
)
$
(4,573
)
$
178

$
(5,687
)
Investment securities
(19
)
(53
)
3

(69
)
FHLB – San Francisco stock
730

(109
)
(286
)
335

Interest-bearing deposits
—

132

—

132

Total net change in income on interest-earning assets
(581
)
(4,603
)
(105
)
(5,289
)
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
Checking and money market accounts
(20
)
5

—

(15
)
Savings accounts
3

14

1

18

Time deposits
(448
)
(401
)
42

(807
)
Borrowings
(321
)
(1,614
)
158

(1,777
)
Total net change in expense on interest-bearing liabilities
(786
)
(1,996
)
201

(2,581
)
Net increase (decrease) in net interest income
$
205

$
(2,607
)
$
(306
)
$
(2,708
)

(1)
Includes loans held for sale and non-performing loans.  For purposes of calculating volume, rate and rate/volume variances, non-performing loans were included in the weighted-average balance outstanding.


55


Provision (Recovery) for Loan Losses:

For the Quarters Ended March 31, 2014 and 2013.  During the third quarter of fiscal 2014, the Corporation recorded a recovery from the allowance for loan losses of $(849,000), up 64 percent from the recovery from the allowance for loan losses of $(517,000) in the same period of fiscal 2013.  The higher recovery in the third quarter of fiscal 2014 was primarily attributable to further improvement in credit quality during the past year.  Non-performing loans declined $4.9 million, or 23 percent, to $16.8 million at March 31, 2014 as compared to $21.7 million at June 30, 2013 and were $20.2 million at March 31, 2013.  Net charge-offs in the third quarter of fiscal 2014 were $168,000 or 0.08 percent (annualized) of average loans receivable, down $1.0 million, or 86 percent, from $1.2 million or 0.49 percent (annualized) of average loans receivable in the same quarter of fiscal 2013.  Total classified loans, consisting of special mention and substandard loans, were $41.3 million at March 31, 2014 as compared $44.7 million at June 30, 2013 and to $41.9 million at March 31, 2013.

For the Nine Months Ended March 31, 2014 and 2013.  During the first nine months of fiscal 2014, the Corporation recorded a recovery from the allowance for loan losses of $(2.7 million), an improvement from a provision for loan losses of $39,000 in the same period of fiscal 2013.  The improvement in the recovery from the allowance for loan losses in the first nine months of fiscal 2014 was primarily attributable to an improvement in credit quality. Net charge-offs declined to $2.2 million or 0.34 percent (annualized) of average loans receivable in the first nine months of fiscal 2014 as compared to $4.7 million or 0.62 percent (annualized) of loans receivable in the same period of fiscal 2013, a decrease of $2.5 million or 53 percent.
 
The allowance for loan losses was determined through quantitative and qualitative adjustments including the Bank's charge-off experience and reflects the impact on loans held for investment from the current general economic conditions of the U.S. and California economies such as the improving unemployment rate and higher home prices in California.  See related discussion of “Asset Quality” below.

At March 31, 2014, the allowance for loan losses was $10.0 million, comprised of collectively evaluated allowances of $10.0 million and individually evaluated allowances of $41,000; in comparison to the allowance for loan losses of $14.9 million at June 30, 2013, comprised of collectively evaluated allowances of $14.8 million and individually evaluated allowances of $154,000.  The allowance for loan losses as a percentage of gross loans held for investment was 1.29 percent at March 31, 2014 compared to 1.96 percent at June 30, 2013.  Management considers, based on currently available information, the allowance for loan losses sufficient to absorb potential losses inherent in loans held for investment.  For further analysis on the allowance for loan losses, see Note 6 of the Notes to Unaudited Interim Condensed Consolidated Financial Statements.

Non-Interest Income:

For the Quarters Ended March 31, 2014 and 2013.  Total non-interest income decreased $8.6 million, or 56 percent, to $6.8 million for the quarter ended March 31, 2014 from $15.4 million for the same period last year.  The decrease was primarily attributable to a decrease in the gain on sale of loans.

The net gain on sale of loans decreased $8.5 million, or 62 percent, to $5.3 million for the third quarter of fiscal 2014 from $13.8 million in the same quarter of fiscal 2013 reflecting the impact of a significantly lower loan sale volume and a lower average loan sale margin.  Total loans sold for the quarter ended March 31, 2014 were $380.2 million, a decrease of $527.9 million or 58 percent, from $908.1 million for the same quarter last year.  The average loan sale margin for PBM during the third quarter of fiscal 2014 was 1.44 percent, down 34 basis points from 1.78 percent for the same period of fiscal 2013.  The decreases in the average loan sale margin and loan sale volume were attributable to the increase in mortgage interest rates during the past year and an increase in competition. The gain on sale of loans for the third quarter of fiscal 2014 includes a $127,000 recourse reserve recovery on loans sold that are subject to repurchase, compared to a $(27,000) recourse provision in the comparable quarter last year.  As of March 31, 2014, the total recourse reserve for loans sold that are subject to repurchase was $1.1 million, compared to $2.1 million at June 30, 2013 and $2.3 million at March 31, 2013.  See “Asset Quality” for additional information related to the recourse reserve liability.  The gain on sale of loans also includes a favorable fair-value adjustment on derivative financial instruments pursuant to ASC 815 and ASC 825 that amounted to a net gain of $718,000 in the third quarter of fiscal 2014 as compared to an unfavorable fair-value adjustment net loss of $(6.0 million) in the same period last year.  The fair-value adjustment on derivative financial instruments was consistent with our mortgage banking activity and the volatility of the mortgage interest rates. As of March 31, 2014, the fair value of derivative financial instruments pursuant to ASC 815 and ASC 825 was $4.7 million, compared to $5.9 million at June 30, 2013 and $8.3 million at March 31, 2013.

Total loans originated and purchased for sale decreased $436.4 million, or 55 percent, to $353.7 million in the third quarter of fiscal 2014 from $790.1 million for the same period last year.  The loan origination volume has declined because the recent rise in mortgage interest rates has severely curtailed refinance activity.


56


For the Nine Months Ended March 31, 2014 and 2013.  Total non-interest income decreased $35.5 million, or 62 percent, to $22.1 million for the nine months ended March 31, 2014 from $57.6 million for the same period last year.  The decrease was primarily attributable to a decrease in the gain on sale of loans.

The net gain on sale of loans decreased $34.5 million, or 66 percent, to $17.8 million for the first nine months of fiscal 2014 from $52.3 million in the same period of fiscal 2013 reflecting the impact of a significantly lower loan sale volume and lower average loan sale margin.  Total loans sold for the nine months ended March 31, 2014 were $1.57 billion, a decrease of $1.14 billion or 42 percent, from $2.71 billion for the same period last year.  The average loan sale margin for PBM during the first nine months of fiscal 2014 was 1.30 percent, down 68 basis points from 1.98 percent for the same period of fiscal 2013.  The gain on sale of loans for the first nine months of fiscal 2014 includes a $383,000 recourse reserve recovery on loans sold that are subject to repurchase, compared to a $(1.9 million) recourse reserve provision in the comparable period last year.  The gain on sale of loans also includes an unfavorable fair-value adjustment on derivative financial instruments pursuant to ASC 815 and ASC 825, a net loss of $(495,000) in the first nine months of fiscal 2014 as compared to an unfavorable fair-value adjustment, a net loss of $(5.8 million), in the same period last year.

Total loans originated and purchased for sale decreased $1.17 billion, or 44 percent, to $1.49 billion in the first nine months of fiscal 2014 from $2.66 billion for the same period last year. The loan origination volume has declined because the recent rise in mortgage interest rates has severely curtailed refinance activity.

Non-Interest Expense:

For the Quarters Ended March 31, 2014 and 2013.  Total non-interest expense in the quarter ended March 31, 2014 was $12.6 million, a decrease of $3.1 million or 20 percent, as compared to $15.7 million in the quarter ended March 31, 2013.  The decrease in non-interest expense was primarily due to decreases in salaries and employee benefits and other operating expenses related to mortgage banking operations.

Total salaries and employee benefits decreased $2.7 million, or 24 percent, to $8.8 million in the third quarter of fiscal 2014 from $11.5 million in the same period of fiscal 2013.  The decrease was primarily attributable to lower incentive compensation and a lower average number of staff employed by PBM, resulting from the decrease in loan originations. PBM loan originations decreased $430.5 million, or 54 percent, to $362.2 million in the third quarter of fiscal 2014 from $792.7 million in the comparable period in fiscal 2013. The PBM division has reduced its workforce by an average of 75.4 full-time equivalents ("FTE"), or 20 percent, to an average of 296.9 FTE during the quarter ended March 31, 2014 from an average of 372.3 FTE during the quarter ended March 31, 2013.

For the Nine Months Ended March 31, 2014 and 2013.  Total non-interest expense in the nine months ended March 31, 2014 was $40.0 million, a decrease of $9.8 million or 20 percent, as compared to $49.8 million in the same period ended March 31, 2013.  The decrease in non-interest expense was primarily due to decreases in salaries and employee benefits and other operating expenses related to mortgage banking operations.

Total salaries and employee benefits decreased $9.2 million, or 25 percent, to $28.2 million in the first nine months of fiscal 2014 from $37.4 million in the same period of fiscal 2013.  The decrease was primarily attributable to lower incentive compensation and a lower average number of staff employed by PBM, resulting from the decrease in loan originations. PBM loan originations decreased $1.17 billion, or 44 percent, to $1.50 billion in the first nine months of fiscal 2014 from $2.67 billion in the comparable period in fiscal 2013. The PBM division has reduced its workforce by an average of 31.2 FTE, or nine percent, to an average of 329.8 FTE during the nine months ended March 31, 2014 from an average of 361.0 FTE during the same period ended March 31, 2013.

Provision for Income Taxes:

The income tax provision reflects accruals for taxes at the applicable rates for federal income tax and California franchise tax based upon reported pre-tax income, adjusted for the effect of all permanent differences between income for tax and financial reporting purposes, such as non-deductible stock-based compensation, bank-owned life insurance policies and certain California tax-exempt loans.  Therefore, there are fluctuations in the effective income tax rate from period to period based on the relationship of net permanent differences to income before tax.

For the Quarters Ended March 31, 2014 and 2013.  The income tax provision was $1.1 million for the quarter ended March 31, 2014 as compared to $3.4 million for the same quarter last year.  The effective income tax rate for the quarter ended March 31, 2014 was 44.9 percent as compared to 40.9 percent in the same quarter last year.  The income tax provision in the quarter ended March 31, 2014 included a net tax provision for prior period of $136,000, as compared to a net tax recovery of $108,000.

57


The Corporation believes that the effective income tax rate applied in the third quarter of fiscal 2014 reflects its current income tax obligations.

For the Nine Months Ended March 31, 2014 and 2013.  The income tax provision was $3.4 million for the nine months ended March 31, 2014 as compared to $13.0 million for the same period last year.  The effective income tax rate for the nine months ended March 31, 2014 was 43.0 percent as compared to 38.7 percent in the same period last year.  The income tax provision for the nine months ended March 31, 2014 included a net tax provision for prior periods of $206,000. The income tax provision for the nine months ended March 31, 2013 included a net tax recovery for prior periods of $1.2 million, which includes a tax liability reversal of $825,000 as a result of the August 2, 2012 notification from the tax authorities indicating the acceptance of an accounting method change.  The Corporation believes that the effective income tax rate applied in the first nine months of fiscal 2014 reflects its current income tax obligations.


Asset Quality

Non-performing loans, net of the allowance for loan losses, consisting of loans with collateral primarily located in Southern California, decreased $4.9 million, or 23 percent, to $16.8 million at March 31, 2014 from $21.7 million at June 30, 2013.  Non-performing loans as a percentage of loans held for investment improved to 2.18 percent at March 31, 2014 from 2.90 percent at June 30, 2013.  The non-performing loans at March 31, 2014 were primarily comprised of 34 single-family loans ($9.9 million); eight commercial real estate loans ($3.6 million); eight multi-family loans ($3.2 million) and four commercial business loans ($104,000).  This compares to the non-performing loans at June 30, 2013 which were primarily comprised of 50 single-family loans ($13.2 million); eight commercial real estate loans ($4.6 million); seven multi-family loans ($3.8 million) and five commercial business loans ($130,000). No interest accruals were made for loans that were past due 90 days or more or if the loans were deemed non-performing.

When a loan is considered non-performing, as defined by ASC 310 “Receivables,” the Corporation measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate.  However, if the loan is “collateral-dependent” or foreclosure is probable, impairment is measured based on the fair value of the collateral.  At least quarterly, management reviews non-performing loans.  When the measured value of an individually identified non-performing loan is less than the recorded investment in the loan, the Corporation charges-off or records an individually evaluated allowance equal to the excess of the recorded investment in the loan over its measured value.  For non-performing commercial real estate loans, an individually evaluated allowance is calculated based on the loan's fair value and if the fair value is higher than the loan balance, no allowance is required. A collectively evaluated allowance is provided on loans which do not have a charge-off or individually evaluated allowance and is determined based on a quantitative and a qualitative analysis using a loss migration methodology.  The loans are classified by type and loan grade, and the historical loss migration is tracked for the various stratifications.  Loss experience is quantified for the most recent four quarters, and that loss experience is applied to the stratified portfolio at each quarter end.  The qualitative analysis data includes current unemployment rates, retail sales, gross domestic product, employment growth, real estate value trends, home sales, and commercial real estate vacancy rates, among other current economic data.

As of March 31, 2014, total restructured loans, net of allowance for loan losses, declined to $7.1 million from $9.5 million at June 30, 2013, a decrease of $2.4 million, or 25 percent.  At March 31, 2014 and June 30, 2013, $5.5 million and $9.1 million, respectively, of these restructured loans were classified as non-performing.  As of March 31, 2014, $4.3 million, or 61 percent, of the restructured loans have a current payment status; this compares to $6.5 million, or 68 percent, of restructured loans that had a current payment status as of June 30, 2013.

Real estate owned was $2.4 million at March 31, 2014, an increase of $110,000 or five percent from $2.3 million at June 30, 2013.  Real estate owned at March 31, 2014 was comprised of two single-family properties ($423,000), two commercial real estate properties ($2.0 million) and two undeveloped lots ($9,000).  The Corporation has not suspended foreclosure activity at anytime through the most recent credit cycle because, to date, the Corporation has not been in a situation where its foreclosure documentation, process or legal standing has been challenged by a court.  The Corporation maintains the original promissory note and deed of trust for loans held for investment.  As a result, the Corporation does not rely on lost-note affidavits to fulfill foreclosure filing requirements.

Non-performing assets, which includes non-performing loans and real estate owned, decreased $4.8 million, or 20 percent, to $19.2 million or 1.71 percent of total assets at March 31, 2014 from $24.0 million or 1.98 percent of total assets at June 30, 2013.  Restructured loans which are performing in accordance with their modified terms and are not otherwise classified non-accrual are not included in non-performing assets.  For further analysis on non-performing loans and restructured loans, see Note 6 of the Notes to Unaudited Interim Condensed Consolidated Financial Statements.


58


Occasionally, the Corporation is required to repurchase loans sold to Freddie Mac, Fannie Mae or other institutional investors if it is determined that such loans do not meet the credit requirements of the investor, or if one of the parties involved in the loan misrepresented pertinent facts, committed fraud, or if such loans were 90-days past due within 120 days of the loan funding date. During the third quarter and first nine months of fiscal 2014, the Corporation repurchased two loans, totaling $315,000 and three loans, totaling $437,000, respectively, from investors pursuant to the recourse/repurchase covenants contained in the Corporation’s loan sale agreements, while additional repurchase requests were settled that did not result in the repurchase of the loan itself.  In the third quarter and nine months of fiscal 2013, the Corporation repurchased two loans, totaling $483,000, and three loans, totaling $790,000, respectively, from an investor pursuant to the recourse/repurchase covenants contained in the loan sale agreements, while additional repurchase requests were settled that did not result in the repurchase of the loan itself.  The primary reasons for honoring the repurchase requests are borrower fraud, undisclosed liabilities on borrower applications, and documentation, verification and appraisal disputes.  For the third quarter and first nine months of fiscal 2014, the Corporation had a recovery of $(127,000) and $(383,000), respectively, and settled claims for $7,000 and $660,000, respectively.  This compares to the third quarter and first nine months of fiscal 2013 when the Corporation had a provision of $27,000 and $1.9 million, respectively; and settled claims for $5.5 million and $5.8 million, respectively. The settlement claims in the third quarter and nine months ended March 31, 2013 was due primarily to the $5.5 million payment of the global settlement with the Corporation's largest legacy loan investor. As of March 31, 2014, the total recourse reserve for loans sold that are subject to repurchase was $1.1 million, compared to $2.1 million at June 30, 2013 and $2.3 million at March 31, 2013.
  
Beginning in 2008, in connection with the down turn in the real estate market, the Corporation implemented tighter underwriting standards to reduce potential loan repurchase requests, including requiring higher credit scores, generally lower debt-to-income ratios, and verification of income and assets, among other criteria.  Despite management’s diligent estimate of the recourse reserve, the Corporation is still subject to risks and uncertainties associated with potentially higher loan repurchase claims from investors, primarily those related to loans originated and sold in the calendar years 2004 through 2007.

The following table shows the summary of the recourse liability for the quarters and nine months ended March 31, 2014 and 2013:

 
For the Quarters Ended
March 31,
 For the Nine Months Ended
March 31,
Recourse Liability
2014
2013
2014
2013
(In Thousands)
 
 
 
 
 
 
 
 
 
Balance, beginning of the period
$
1,202

$
7,776

$
2,111

$
6,183

(Recovery) provision
(127
)
27

(383
)
1,930

Net settlements in lieu of loan repurchases
(7
)
(5,501
)
(660
)
(5,811
)
Balance, end of the period
$
1,068

$
2,302

$
1,068

$
2,302


A decline in real estate values subsequent to the time of origination of the Corporation’s real estate secured loans could result in higher loan delinquency levels, foreclosures, provisions for loan losses and net charge-offs.  Real estate values and real estate markets are beyond the Corporation’s control and are generally affected by changes in national, regional or local economic conditions and other factors.  These factors include fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies and acts of nature, such as earthquakes and national disasters particular to California where substantially all of the Corporation’s real estate collateral is located.  If real estate values decline from the levels described in the following tables (which were calculated at the time of loan origination), the value of the real estate collateral securing the Corporation’s loans as set forth in the table above could be significantly overstated.  The Corporation’s ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and it would be more likely to suffer losses on defaulted loans.  The Corporation generally does not update the loan-to-value ratio (“LTV”) on its loans held for investment by obtaining new appraisals or broker price opinions (nor does the Corporation intend to do so in the future as a result of the costs and inefficiencies associated with completing the task) unless a specific loan has demonstrated deterioration or the Corporation receives a loan modification request from a borrower (in which case individually evaluated allowances are established, if required).  Therefore, it is reasonable to assume that the LTV ratios disclosed in the following tables may be understated in comparison to their current LTV ratios as a result of their year of origination, the subsequent general decline in real estate values that occurred and the specific location of the individual properties.  The Corporation has not quantified the current LTVs of its loans held for investment nor the impact the decline in real estate values has had on the original LTVs of its loans held for investment.


59


The following table describes certain credit risk characteristics of the Corporation’s single-family, first trust deed, mortgage loans held for investment as of March 31, 2014:

(Dollars In Thousands)
Outstanding
Balance (1)
Weighted-
Average
FICO (2)
Weighted-
Average
LTV (3)
Weighted-
Average
Seasoning (4)
Interest only
$
172,990

734
72%
7.56 years
Stated income (5)
$
182,609

731
68%
8.27 years
FICO less than or equal to 660
$
13,254

643
66%
8.11 years
Over 30-year amortization
$
15,768

733
65%
8.60 years

(1) 
The outstanding balance presented on this table may overlap more than one category.  Of the outstanding balance, $4.7 million of “interest only,” $7.6 million of “stated income,” $1.3 million of “FICO less than or equal to 660,” and $237 of “over 30-year amortization” balances were non-performing.
(2) 
Based on borrowers’ FICO scores at the time of loan origination.  The FICO score represents the creditworthiness of a borrower based on the borrower’s credit history, as reported by an independent third party.  A higher FICO score indicates a greater degree of creditworthiness.  Bank regulators have issued guidance stating that a FICO score of 660 and below is indicative of a “subprime” borrower.
(3) 
LTV is the ratio calculated by dividing the current loan balance by the lower of the original appraised value or purchase price of the real estate collateral.
(4) 
Seasoning describes the number of years since the funding date of the loan.
(5) 
Stated income is defined as borrower stated income on his/her loan application which was not subject to verification during the loan origination process.

The following table summarizes the amortization schedule of the Corporation’s interest only single-family, first trust deed, mortgage loans held for investment, including the percentage of those which are identified as non-performing or 30 – 89 days delinquent as of March 31, 2014:

(Dollars In Thousands)
 
Balance
 
Non-Performing (1)
30 - 89 Days
Delinquent
Fully amortize in the next 12 months
$
2,095

8%
—%
Fully amortize between 1 year and 5 years
170,895

3%
—%
Fully amortize after 5 years
—

—%
—%
Total
$
172,990

3%
—%

(1) 
As a percentage of each category.

The following table summarizes the interest rate reset (repricing) schedule of the Corporation’s stated income single-family, first trust deed, mortgage loans held for investment, including the percentage of those which are identified as non-performing or 30 – 89 days delinquent as of March 31, 2014:

(Dollars In Thousands)
 
Balance (1)

 
Non-Performing (1)
30 - 89 Days
Delinquent (1)
Interest rate reset in the next 12 months
$
176,918

4%
1%
Interest rate reset between 1 year and 5 years
5,691

23%
—%
Interest rate reset after 5 years
—

—%
—%
Total
$
182,609

4%
—%

(1) 
As a percentage of each category.  Also, the loan balances and percentages on this table may overlap with the interest only single-family, first trust deed, mortgage loans held for investment table.

The reset of interest rates on adjustable rate mortgage loans (primarily interest only single-family loans) to a fully-amortizing status has not created a payment shock for a large percentage of the Corporation’s borrowers primarily because the majority of the loans are repricing at a 2.75 percent margin over six-month LIBOR which has resulted in a lower interest rate than the borrowers

60


pre-adjustment interest rate.  Management expects that the economic recovery from the recent recession will be slow to develop, which may translate to an extended period of lower interest rates and a reduced risk of mortgage payment shock for the foreseeable future, though the continuation of weak economic conditions may increase the risk of delinquencies and defaults. The higher delinquency levels experienced by the Bank in fiscal 2008 through 2011 was primarily due to high unemployment, the recent U.S. recession, weak economic conditions and the decline in real estate values, particularly in California. It should be noted, however, that delinquency levels experienced since fiscal 2011 have improved, primarily due to an improvement in real estate markets and general economic conditions, as compared to the levels experienced in fiscal 2008 through 2011.
 
The following table describes certain credit risk characteristics, geographic locations and the calendar year of loan origination of the Corporation’s single-family, first trust deed, mortgage loans held for investment, at March 31, 2014:

 
Calendar Year of Origination
 
(Dollars In Thousands)
2006 &
Prior
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
YTD
2014
 
Total
Loan balance (in thousands)
$276,128
$51,917
$25,456
$916
$345
$1,611
$6,104
$9,277
$4,234
$375,988
Weighted-average LTV (1)
67%
72%
75%
53%
87%
71%
56%
58%
61%
68%
Weighted-average age (in years)
8.85
6.76
6.01
4.65
3.56
2.60
1.62
0.74
0.17
7.91
Weighted-average FICO (2)
731
732
741
750
751
726
749
741
754
733
Number of loans
860
111
48
3
2
6
27
39
11
1,107
 
 
 
 
 
 
 
 
 
 
 
Geographic breakdown (%)
 
 
 
 
 
 
 
 
 
 
Inland Empire
29%
29%
27%
100%
37%
41%
20%
22%
33%
29%
Southern California (3)
61%
39%
39%
—%
63%
41%
36%
30%
9%
54%
Other California (4)
9%
30%
34%
—%
—%
18%
44%
48%
58%
16%
Other States
1%
2%
—%
—%
—%
—%
—%
—%
—%
1%
Total
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%

(1) 
LTV is the ratio calculated by dividing the current loan balance by the lower of the original appraised value or purchase price of the real estate collateral.
(2) 
At time of loan origination.
(3) 
Other than the Inland Empire.
(4) 
Other than the Inland Empire and Southern California.


61


The following table describes certain credit risk characteristics, geographic locations and the calendar year of loan origination of the Corporation’s multi-family loans held for investment, at March 31, 2014:

 
Calendar Year of Origination
 
(Dollars In Thousands)
2006 &
Prior
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
YTD
2014
 
Total
Loan balance (in thousands)
$88,027
$23,518
$6,711
$—
$—
$20,788
$36,604
$93,688
$19,978
$289,314
Weighted-average LTV (1)
47%
56%
45%
—%
—%
58%
55%
59%
52%
54%
Weighted-average DCR (2)
1.39x
1.23x
1.43x
-x
-x
1.50x
1.69x
1.68x
1.45x
1.52x
Weighted-average age (in years)
8.91
6.67
5.94
—
—
2.54
1.67
0.65
0.11
4.00
Weighted-average FICO (3)
706
700
772
—
—
744
733
760
777
742
Number of loans
143
36
8
—
—
22
44
122
25
400
 
 
 
 
 
 
 
 
 
 
 
Geographic breakdown (%)
 
 
 
 
 
 
 
 
 
 
Inland Empire
16%
6%
21%
—%
—%
29%
12%
32%
19%
21%
Southern California (4)
52%
86%
79%
—%
—%
58%
58%
44%
49%
54%
Other California (5)
28%
8%
—%
—%
—%
13%
30%
24%
32%
24%
Other States
4%
—%
—%
—%
—%
—%
—%
—%
—%
1%
Total
100%
100%
100%
—%
—%
100%
100%
100%
100%
100%

(1) 
LTV is the ratio calculated by dividing the current loan balance by the lower of the original appraised value or purchase price of the real estate collateral.
(2) 
Debt Coverage Ratio (“DCR”) at time of origination.
(3) 
At time of loan origination.
(4) 
Other than the Inland Empire.
(5) 
Other than the Inland Empire and Southern California.

The following table summarizes the interest rate reset or maturity schedule of the Corporation’s multi-family loans held for investment, including the percentage of those which are identified as non-performing, 30 – 89 days delinquent or not fully amortizing as of March 31, 2014:

(Dollars In Thousands)
 
 
Balance
 
Non-
Performing (1)
 
30 - 89 Days
Delinquent
Percentage
Not Fully
Amortizing (1)
Interest rate reset or mature in the next 12 months
$
110,579

3%
—%
38%
Interest rate reset or mature between 1 year and 5 years
168,559

—%
—%
9%
Interest rate reset or mature after 5 years
10,176

—%
—%
62%
Total
$
289,314

1%
—%
22%

(1) 
As a percentage of each category.


62


The following table describes certain credit risk characteristics, geographic locations and the calendar year of loan origination of the Corporation’s commercial real estate loans held for investment, at March 31, 2014:

 
Calendar Year of Origination
 
(Dollars In Thousands)
2006 &
Prior
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
YTD
2014
Total (5)(6)
Loan balance (in thousands)
$31,393
$12,198
$3,650
$7,237
$373
$782
$19,012
$22,439
$7,485
$104,569
Weighted-average LTV (1)
47%
53%
33%
60%
58%
63%
54%
48%
47%
50%
Weighted-average DCR (2)
2.05x
1.77x
1.65x
1.29x
1.26x
1.47x
1.85x
1.81x
1.95x
1.85x
Weighted-average age (in years)
9.06
6.78
5.98
4.76
3.85
2.27
1.51
0.67
0.13
4.51
Weighted-average FICO (2)
705
727
764
722
705
770
751
754
760
736
Number of loans
41
11
7
2
2
1
18
28
9
119
 
 
 
 
 
 
 
 
 
 
 
Geographic breakdown (%):
 
 
 
 
 
 
 
 
 
 
Inland Empire
39%
45%
6%
100%
52%
—%
69%
35%
7%
45%
Southern California (3)
61%
41%
94%
—%
48%
100%
31%
39%
70%
46%
Other California (4)
—%
14%
—%
—%
—%
—%
—%
26%
23%
9%
Other States
—%
—%
—%
—%
—%
—%
—%
—%
—%
—%
Total
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%

(1) 
LTV is the ratio calculated by dividing the current loan balance by the lower of the original appraised value or purchase price of the real estate collateral.
(2) 
At time of loan origination.
(3) 
Other than the Inland Empire.
(4) 
Other than the Inland Empire and Southern California.
(5) 
Comprised of the following: $24.9 million in Retail; $19.9 million in Office; $17.3 million in Mixed Use; $12.2 million in Mobile Home Park; $6.1 million in Warehouse; $5.7 million in Light Industrial/Manufacturing; $5.2 million in Medical/Dental Office; $3.5 million in Mini-Storage; $3.3 million in Restaurant/Fast Food; $2.7 million in Research and Development; $1.8 million in Hotel and Motel; $1.6 million in Automotive – Non Gasoline; and $389,000 in Other.
(6) 
Consisting of $83.4 million or 79.7 percent in investment properties and $21.2 million or 20.3 percent in owner occupied properties.

The following table summarizes the interest rate reset or maturity schedule of the Corporation’s commercial real estate loans held for investment, including the percentage of those which are identified as non-performing, 30 – 89 days delinquent or not fully amortizing as of March 31, 2014:

(Dollars In Thousands)
 
 
Balance
 
Non-
Performing (1)
 
30 - 89 Days
Delinquent
Percentage
Not Fully
Amortizing (1)
Interest rate reset or mature in the next 12 months
$
42,228

5%
—%
87%
Interest rate reset or mature between 1 year and 5 years
62,341

3%
—%
74%
Interest rate reset or mature after 5 years
—

—%
—%
—%
Total
$
104,569

3%
—%
79%

(1) 
As a percentage of each category.


63


The following table sets forth information with respect to the Corporation’s non-performing assets and restructured loans, net of allowance for loan losses, at the dates indicated:

(In Thousands)
At March 31,
2014
At June 30,
2013
Loans on non-accrual status (excluding restructured loans):
 
 
Mortgage loans:
 
 
Single-family
$
7,664

$
8,129

Multi-family
926

1,236

Commercial real estate
2,757

3,218

Commercial business loans
5

7

Total
11,352

12,590

 
 
 
Accruing loans past due 90 days or more
—

—

 
 
 
Restructured loans on non-accrual status:
 
 
Mortgage loans:
 
 
Single-family
2,304

5,094

Multi-family
2,247

2,521

Commercial real estate
805

1,354

Commercial business loans
99

123

Total
5,455

9,092

 
 
 
Total non-performing loans
16,807

21,682

 
 
 
Real estate owned, net
2,406

2,296

Total non-performing assets
$
19,213

$
23,978

 
 
 
Restructured loans on accrual status:
 
 
Mortgage loans:
 
 
Single-family
$
1,630

$
434

Total
$
1,630

$
434

 
 
 
Non-performing loans as a percentage of loans held for investment, net
   of allowance for loan losses
2.18
%
2.90
%
 
 
 
Non-performing loans as a percentage of total assets
1.49
%
1.79
%
 
 
 
Non-performing assets as a percentage of total assets
1.71
%
1.98
%


64


The following table describes the non-performing loans, net of allowance for loan losses, by the calendar year of origination as of March 31, 2014:

 
Calendar Year of Origination
 
(In Thousands)
2006 &
Prior
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
YTD
2014
 
Total
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
Single-family
$
5,662

$
2,186

$
1,682

$
—

$
—

$
—

$
—

$
438

$
—

$
9,968

 
Multi-family
2,995

178

—

—

—

—

—

—

—

3,173

 
Commercial real estate
2,802

—

—

—

—

—

760

—

—

3,562

Commercial business loans
—

—

—

96

—

—

8

—

—

104

Total
$
11,459

$
2,364

$
1,682

$
96

$
—

$
—

$
768

$
438

$
—

$
16,807


The following table describes the non-performing loans, net of allowance for loan losses, by the geographic location as of March 31, 2014:

(In Thousands)
 
Inland Empire
Southern
California (1)
Other
California (2)
 
Other States
 
Total
Mortgage loans:
 
 
 
 
 
 
Single-family
$
4,331

$
4,521

$
1,116

$
—

$
9,968

 
Multi-family
432

328

2,413

—

3,173

 
Commercial real estate
2,208

1,354

—

—

3,562

Commercial business loans
21

83

—

—

104

Total
$
6,992

$
6,286

$
3,529

$
—

$
16,807


(1) 
Other than the Inland Empire.
(2) 
Other than the Inland Empire and Southern California.


65


The following table summarizes classified assets, which is comprised of classified loans, net of allowance for loan losses, and real estate owned at the dates indicated:

 
At March 31,
2014
 
At June 30,
2013
(Dollars In Thousands)
Balance
Count
 
Balance
Count
Special mention loans:
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
Single-family
$
5,682

16

 
$
3,111

11

Multi-family
7,467

4

 
2,485

3

Commercial real estate
—

—

 
1,296

3

Commercial business loans
38

1

 
25

1

Total special mention loans
13,187

21

 
6,917

18

 
 
 
 
 
 
Substandard loans:
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
Single-family
10,669

37

 
13,299

51

Multi-family
9,800

16

 
15,222

15

Commercial real estate
7,579

11

 
9,116

12

Commercial business loans
104

4

 
130

5

Total substandard loans
28,152

68

 
37,767

83

 
 
 
 
 
 
Total classified loans
41,339

89

 
44,684

101

 
 
 
 
 
 
Real estate owned:
 
 
 
 
 
Single-family
423

2

 
2,287

7

Commercial real estate
1,974

2

 
—

1

Other
9

2

 
9

2

Total real estate owned
2,406

6

 
2,296

10

 
 
 
 
 
 
Total classified assets
$
43,745

95

 
$
46,980

111




66


Loan Volume Activities

The following table is provided to disclose details related to the volume of loans originated, purchased and sold for the quarters and nine months indicated:

 
For the Quarters Ended
March 31,
For the Nine Months Ended
March 31,
(In Thousands)
2014
2013
2014
2013
Loans originated and purchased for sale:
 
 
 
 
Retail originations
$
179,913

$
369,884

$
736,842

$
1,262,590

Wholesale originations and purchases
173,805

420,198

753,560

1,396,782

        Total loans originated and purchased for sale (1)
353,718

790,082

1,490,402

2,659,372

 
 
 
 
 
Loans sold:
 
 
 
 
Servicing released
(377,860
)
(904,900
)
(1,566,205
)
(2,696,370
)
Servicing retained
(2,371
)
(3,159
)
(7,866
)
(13,836
)
        Total loans sold (2)
(380,231
)
(908,059
)
(1,574,071
)
(2,710,206
)
 
 
 
 
 
Loans originated for investment:
 
 
 
 
Mortgage loans:
 
 
 
 
Single-family
8,452

2,589

13,630

7,766

Multi-family
20,015

9,608

82,873

33,948

Commercial real estate
7,498

6,539

21,940

22,044

Construction
—

—

1,500

—

Commercial business loans
167

40

180

100

        Total loans originated for investment  (3)
36,132

18,776

120,123

63,858

 
 
 
 
 
Loans purchased for investment:
 
 
 
 
Mortgage loans:
 
 
 
 
Multi-family
—

—

—

—

Total loans purchased for investment
—

—

—

—

 
 
 
 
 
Mortgage loan principal payments
(25,258
)
(36,759
)
(101,679
)
(107,120
)
Real estate acquired in settlement of loans
(206
)
(2,474
)
(4,178
)
(9,250
)
Increase (decrease) in other items, net (4)
2,406

(4,045
)
7,144

(1,117
)
 
 
 
 
 
Net decrease in loans held for investment and loans held for sale at fair value
$
(13,439
)
$
(142,479
)
$
(62,259
)
$
(104,463
)

(1) 
Includes PBM loans originated and purchased for sale during the quarters and nine months ended March 31, 2014 and 2013 totaling $353.7 million, $790.1 million, $1.49 billion and $2.66 billion, respectively.
(2) 
Includes PBM loans sold during the quarters and nine months ended March 31, 2014 and 2013 totaling $380.2 million, $908.1 million, $1.57 billion and $2.71 billion, respectively.
(3) 
Includes PBM loans originated for investment during the quarters and nine months ended March 31, 2014 and 2013 totaling $8.4 million, $2.6 million, $13.6 million and $7.8 million, respectively.
(4) 
Includes net changes in undisbursed loan funds, deferred loan fees or costs, allowance for loan losses and fair value of loans held for sale.

Loans that the Corporation has originated for sale are primarily sold on a servicing released basis.  Clear ownership is conveyed to the investor by endorsing the original note in favor of the investor; transferring the servicing to a new servicer consistent with

67


investor instructions; communicating the servicing transfer to the borrower as required by law; and sending the loan file and collateral instruments electronically to the investor contemporaneous with receiving the cash proceeds from the sale of the loan.  Additionally, the Corporation registers the change of ownership in the mortgage electronic registration system known as MERS as required by the contractual terms of the loan sale agreement.  The Corporation does not believe that completing this additional registration clouds ownership of the note since the steps previously described have also been taken.  Also, the Corporation retains an imaged copy of the entire loan file and collateral instruments as an abundance of caution in the event questions arise that can only be answered by reviewing the loan file.  Additionally, the Corporation does not originate or sponsor mortgage-backed securities.


Liquidity and Capital Resources

The Corporation’s primary sources of funds are deposits, proceeds from the sale of loans originated and purchased for sale, proceeds from principal and interest payments on loans, proceeds from the maturity and sale of investment securities, FHLB – San Francisco advances, and access to the discount window facility at the Federal Reserve Bank of San Francisco.  While maturities and scheduled amortization of loans and investment securities are a relatively predictable source of funds, deposit flows, mortgage prepayments and loan sales are greatly influenced by general interest rates, economic conditions and competition.

The primary investing activity of the Corporation is the origination and purchase of loans held for investment and loans held for sale.  During the first nine months of fiscal 2014 and 2013, the Corporation originated and purchased $1.61 billion and $2.72 billion of loans, respectively.  The total loans sold in the first nine months of fiscal 2014 and 2013 were $1.57 billion and $2.71 billion, respectively.  At March 31, 2014, the Corporation had loan origination commitments totaling $113.8 million, undisbursed lines of credit totaling $2.9 million and undisbursed loan funds totaling $757,000.  The Corporation anticipates that it will have sufficient funds available to meet its current loan commitments.

The Corporation’s primary financing activity is gathering deposits.  During the first nine months of fiscal 2014, the net decrease in deposits was $15.5 million, or two percent, primarily due to the scheduled maturities in time deposits. The decrease in time deposits was consistent with the Corporation's operating strategy. On March 31, 2014, time deposits scheduled to mature in one year or less were $192.6 million and total time deposits with a principal amount of $100,000 or higher were $185.5 million.   Historically, the Corporation has been able to retain a significant percentage of its time deposits as they mature by adjusting deposit rates to the current interest rate environment.

The Corporation must maintain an adequate level of liquidity to ensure the availability of sufficient funds to support loan growth and deposit withdrawals, to satisfy financial commitments and to take advantage of investment opportunities.  The Corporation generally maintains sufficient cash and cash equivalents to meet short-term liquidity needs.  At March 31, 2014, total cash and cash equivalents were $193.5 million, or 17 percent of total assets.    Depending on market conditions and the pricing of deposit products and FHLB – San Francisco advances, the Bank may rely on FHLB – San Francisco advances for part of its liquidity needs.  As of March 31, 2014, the financing availability at FHLB – San Francisco was limited to 35 percent of total assets; the remaining borrowing facility was $338.0 million and the remaining available collateral was $454.8 million.  In addition, the Bank has secured a $15.1 million discount window facility at the Federal Reserve Bank of San Francisco, collateralized by investment securities with a fair market value of $15.9 million.  As of March 31, 2014, there was no outstanding borrowing under this facility.

Regulations require thrifts to maintain adequate liquidity to assure safe and sound operations. The Bank’s average liquidity ratio (defined as the ratio of average qualifying liquid assets to average deposits and borrowings) for the quarter ended March 31, 2014 decreased to 35.0 percent from 41.1 percent for the quarter ended June 30, 2013.  The relatively high level of liquidity was primarily attributable to a slow economic recovery creating weak demand for loans held for investment and the recent decline in loans originated for sale; and was consistent with the Corporation’s strategy to mitigate liquidity risk.


68


The Bank is required to maintain specific amounts of capital pursuant to OCC requirements.  Under the OCC prompt corrective action provisions, a minimum of 5.0 percent for Tier 1 Leverage Capital, 6.0 percent for Tier 1 Risk-Based Capital and 10.0 percent for Total Risk-Based Capital is required to be deemed “well capitalized.”  As of March 31, 2014, the Bank exceeded all regulatory capital requirements to be deemed “well capitalized.”  The Bank’s actual and required capital amounts and ratios as of March 31, 2014 were as follows:

(Dollars In Thousands)
Amount
Percent
 
 
 
Tier 1 leverage capital
$
143,868

12.80
%
Requirement to be “Well Capitalized”
56,218

5.00

 
 
 
Excess over requirement
$
87,650

7.80
%
 
 
 
Tier 1 risk-based capital
$
143,868

19.96
%
Requirement to be “Well Capitalized”
43,258

6.00

 
 
 
Excess over requirement
$
100,610

13.96
%
 
 
 
Total risk-based capital
$
152,974

21.22
%
Requirement to be “Well Capitalized”
72,096

10.00

 
 
 
Excess over requirement
$
80,878

11.22
%

The ability of the Corporation to pay dividends to stockholders depends primarily on the ability of the Bank to pay dividends to the Corporation.  The Bank may not declare or pay a cash dividend if the effect thereof would cause its net worth to be reduced below the regulatory capital requirements imposed by federal regulation.  In the third quarter of fiscal 2014, the Bank declared a cash dividend of $7.5 million to the Corporation, which was paid on April 1, 2014; while the Corporation paid $981,000 of cash dividends to its shareholders.  For the first nine months of fiscal 2014, the Bank declared cash dividends and paid $27.5 million to the Corporation, while the Corporation paid $3.0 million of cash dividends to its shareholders.


Commitments and Derivative Financial Instruments

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit, in the form of originating loans or providing funds under existing lines of credit, loan sale agreements to third parties and option contracts.  These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the accompanying Condensed Consolidated Statements of Financial Condition.  The Corporation’s exposure to credit loss, in the event of non-performance by the counterparty to these financial instruments, is represented by the contractual amount of these instruments.  The Corporation uses the same credit policies in entering into financial instruments with off-balance sheet risk as it does for on-balance sheet instruments.  For a discussion on commitments and derivative financial instruments, see Note 7 of the Notes to Unaudited Interim Condensed Consolidated Financial Statements.


Supplemental Information

 
At
March 31,
2014
At
June 30,
2013
At
March 31,
2013
 
 
 
 
Loans serviced for others (in thousands)
$85,543
$92,156
$95,935
 
 
 
 
Book value per share
$15.51
$15.40
$15.07

69




ITEM 3 – Quantitative and Qualitative Disclosures about Market Risk.

One of the Corporation’s principal financial objectives is to achieve long-term profitability while reducing its exposure to fluctuating interest rates.  The Corporation has sought to reduce the exposure of its earnings to changes in interest rates by attempting to manage the repricing mismatch between interest-earning assets and interest-bearing liabilities.  The principal element in achieving this objective is to increase the interest-rate sensitivity of the Corporation’s interest-earning assets by retaining for its portfolio new loan originations with interest rates subject to periodic adjustment to market conditions and by selling fixed-rate, single-family mortgage loans.  In addition, the Corporation maintains an investment portfolio, which is largely in U.S. government agency MBS and U.S. government sponsored enterprise MBS with contractual maturities of up to 30 years that reprice frequently.  The Corporation relies on retail deposits as its primary source of funds while utilizing FHLB – San Francisco advances as a secondary source of funding.  Management believes retail deposits, unlike brokered deposits, reduces the effects of interest rate fluctuations because they generally represent a more stable source of funds.  As part of its interest rate risk management strategy, the Corporation promotes transaction accounts and time deposits with terms up to five years.

Through the use of an internal interest rate risk model, the Corporation is able to analyze its interest rate risk exposure by measuring the change in net portfolio value (“NPV”) over a variety of interest rate scenarios.  NPV is defined as the net present value of expected future cash flows from assets, liabilities and off-balance sheet contracts.  The calculation is intended to illustrate the change in NPV that would occur in the event of an immediate change in interest rates of -100, +100, +200, +300 and +400 basis points (“bp”) with no effect given to steps that management might take to counter the effect of the interest rate movement. The current federal funds rate is 0.25 percent making an immediate change of -200 and -300 basis points improbable.

The following table is derived from the internal interest rate risk model and represents the NPV based on the indicated changes in interest rates as of March 31, 2014 (dollars in thousands).

Basis Points ("bp")
Change in Rates
Net
Portfolio
Value
NPV
Change(1)
Portfolio
Value of
Assets
NPV as Percentage
of Portfolio Value
Assets(2)
Sensitivity
Measure(3)
+400 bp
$
248,335

$
91,877

$
1,208,396

20.55%
+686 bp
+300 bp
$
225,748

$
69,290

$
1,191,475

18.95%
+526 bp
+200 bp
$
209,468

$
53,010

$
1,181,807

17.72%
+403 bp
+100 bp
$
187,314

$
30,856

$
1,166,115

16.06%
+237 bp
0 bp
$
156,458

$
—

$
1,142,451

13.69%
- bp
-100 bp
$
138,053

$
(18,405
)
$
1,130,581

12.21%
-148 bp

(1) 
Represents the increase (decrease) of the NPV at the indicated interest rate change in comparison to the NPV at March 31, 2014 (“base case”).
(2) 
Calculated as the NPV divided by the portfolio value of total assets.
(3) 
Calculated as the change in the NPV ratio from the base case amount assuming the indicated change in interest rates (expressed in basis points).

The following table is derived from the internal interest rate risk model and represents the change in the NPV at a -100 basis point rate shock at March 31, 2014 and June 30, 2013.

 
At March 31, 2014
At June 30, 2013
 
(-100 bp rate shock)
(-100 bp rate shock)
Pre-Shock NPV Ratio: NPV as a % of PV Assets
13.69%
14.44%
Post-Shock NPV Ratio: NPV as a % of PV Assets
12.21%
13.28%
Sensitivity Measure: Change in NPV Ratio
148 bp
116 bp
TB 13a Level of Risk
Minimal      
Minimal      

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing tables.  For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may

70


react in different degrees to changes in market interest rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates.  Additionally, certain assets, such as adjustable rate mortgage (“ARM”) loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset.  Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from time deposits could likely deviate significantly from those assumed when calculating the results described in the tables above.  It is also possible that, as a result of an interest rate increase, the higher mortgage payments required from ARM borrowers could result in an increase in delinquencies and defaults.  Changes in market interest rates may also affect the volume and profitability of the Corporation’s mortgage banking operations.  Accordingly, the data presented in the tables in this section should not be relied upon as indicative of actual results in the event of changes in interest rates.  Furthermore, the NPV presented in the foregoing tables is not intended to present the fair market value of the Corporation, nor does it represent amounts that would be available for distribution to shareholders in the event of the liquidation of the Corporation.

The Corporation also models the sensitivity of net interest income for the 12-month period subsequent to any given month-end assuming a dynamic balance sheet (accounting for the Corporation’s current balance sheet, 12-month business plan, embedded options, rate floors, periodic caps, lifetime caps, and loan, investment, deposit and borrowing cash flows, among others), and immediate, permanent and parallel movements in interest rates of plus 400, 300, 200 and 100 and minus 100 basis points.  The following table describes the results of the analysis at March 31, 2014 and June 30, 2013.

At March 31, 2014
 
At June 30, 2013
Basis Point (bp)
Change in Rates
Change in
Net Interest Income
 
Basis Point (bp)
Change in Rates
Change in
Net Interest Income
+400 bp
22.39%
 
+400 bp
16.40%
+300 bp
28.63%
 
+300 bp
19.68%
+200 bp
19.63%
 
+200 bp
14.30%
+100 bp
11.46%
 
+100 bp
10.14%
-100 bp
(13.75)%
 
-100 bp
(16.81)%

At both March 31, 2014 and June 30, 2013, the Corporation was asset sensitive as its interest-earning assets are expected to reprice more quickly than its interest-bearing liabilities during the subsequent 12-month period.  Therefore, in a rising interest rate environment, the model projects an increase in net interest income over the subsequent 12-month period.  In a falling interest rate environment, the results project a decrease in net interest income over the subsequent 12-month period.

Management believes that the assumptions used to complete the analysis described in the table above are reasonable.  However, past experience has shown that immediate, permanent and parallel movements in interest rates will not necessarily occur.  Additionally, while the analysis provides a tool to evaluate the projected net interest income to changes in interest rates, actual results may be substantially different if actual experience differs from the assumptions used to complete the analysis, particularly with respect to the 12-month business plan when asset growth is forecast.  Therefore, the model results that the Corporation discloses should be thought of as a risk management tool to compare the trends of the Corporation’s current disclosure to previous disclosures, over time, within the context of the actual performance of the treasury yield curve.


ITEM 4 – Controls and Procedures.

a) An evaluation of the Corporation’s disclosure controls and procedures (as defined in Section 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934 (the “Act”)) was carried out under the supervision and with the participation of the Corporation’s Chief Executive Officer, Chief Financial Officer and the Corporation’s Disclosure Committee as of the end of the period covered by this quarterly report.  In designing and evaluating the Corporation’s disclosure controls and procedures, management recognizes that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met.  Also, because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Corporation have been detected.  Additionally, in designing disclosure controls and procedures, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.  Based on their evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that the

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Corporation’s disclosure controls and procedures as of March 31, 2014 are effective, at the reasonable assurance level, in ensuring that the information required to be disclosed by the Corporation in the reports it files or submits under the Act is (i) accumulated and communicated to the Corporation’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

b) There have been no changes in the Corporation’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the quarter ended March 31, 2014, that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.  The Corporation does not expect that its internal control over financial reporting will prevent all error and all fraud.  A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met.  Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Corporation have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.  The design of any control procedure is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.


PART II – OTHER INFORMATION

Item 1.  Legal Proceedings.

From time to time, the Corporation or its subsidiaries are engaged in legal proceedings in the ordinary course of business, none of which are currently considered to have a material impact on the Corporation’s financial position or results of operations.


Item 1A.  Risk Factors.

There have been no material changes in the risk factors previously disclosed in Part I, Item IA of our Annual Report of Form 10-K for the year ended June 30, 2013.


Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

The table below represents the Corporation’s purchases of its equity securities for the third quarter of fiscal 2014.

 
 
 
 
Period
 
 
(a) Total
Number of
Shares Purchased
 
 
(b) Average
Price Paid
per Share
 
(c) Total Number of
Shares Purchased as
Part of Publicly
Announced Plan
(d) Maximum
Number of Shares
that May Yet Be
Purchased Under the
Plan (1)
January 1 – 31, 2014
—

$
—

—

324,563

February 1 – 28, 2014
118,122

15.02

118,122

206,441

March 1 – 31, 2014
76,766

15.76

76,766

129,675

Total
194,888

$
15.31

194,888

129,675


(1) 
On November 26, 2013, the Corporation announced a new stock repurchase plan of up to five percent of the Corporation's outstanding common stock, or approximately 499,905 shares, which expires on November 26, 2014.

During the quarter ended March 31, 2014, the Corporation purchased 194,888 shares of the Corporation’s common stock at an average cost of $15.31 per share.  For the nine months ended March 31, 2014, the Corporation purchased 770,022 shares of the Corporation's common stock at an average cost of $15.66 per share. The March 2013 stock repurchase program which authorized 522,523 shares was completed during the period May 2013 through November 2013 with an average cost of $16.09 per share. As

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of March 31, 2014, a total of 370,230 shares or 74 percent of the shares authorized in the November 2013 stock repurchase program have been purchased at an average cost of $15.09 per share, leaving 129,675 shares available for future purchases. The Corporation did not sell any securities that were not registered under the Securities Act of 1933.


Item 3.  Defaults Upon Senior Securities.

Not applicable.


Item 4.  Mine Safety Disclosures.

Not applicable.


Item 5.  Other Information.

Not applicable.


Item 6.  Exhibits.

Exhibits:     
3.1 (a)
Certificate of Incorporation of Provident Financial Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Corporation’s Registration Statement on Form S-1 (File No. 333-2230))
 
 
3.1 (b)
Certificate of Amendment to Certificate of Incorporation of Provident Financial Holdings, Inc. as filed with the Delaware Secretary of State on November 24, 2009
 
 
3.1 (c)
Bylaws of Provident Financial Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Corporation’s Current Report on Form 8-K filed on March 28, 2014)
 
 
10.1
Employment Agreement with Craig G. Blunden (incorporated by reference to Exhibit 10.1 to the Corporation’s Form 8-K dated December 19, 2005)
 
 
10.2
Post-Retirement Compensation Agreement with Craig G. Blunden (incorporated by reference to Exhibit 10.2 to the Corporation’s Form 8-K dated December 19, 2005)
 
 
10.3
1996 Stock Option Plan (incorporated by reference to Exhibit A to the Corporation’s proxy statement dated December 12, 1996)
 
 
10.4
1996 Management Recognition Plan (incorporated by reference to Exhibit B to the Corporation’s proxy statement dated December 12, 1996)
 
 
10.5
Form of Severance Agreement with Richard L. Gale, Kathryn R. Gonzales, Lilian Salter, Donavon P. Ternes and David S. Weiant (incorporated by reference to Exhibit 10.1 and 10.2 in the Corporation’s Form 8-K dated February 24, 2012)
 
 
10.6
2003 Stock Option Plan (incorporated by reference to Exhibit A to the Corporation’s proxy statement dated October 21, 2003)
 
 
10.7
Form of Incentive Stock Option Agreement for options granted under the 2003 Stock Option Plan (incorporated by reference to Exhibit 10.13 to the Corporation’s Annual Report on Form 10-K for the fiscal year June 30, 2005).
 
 

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10.8
Form of Non-Qualified Stock Option Agreement for options granted under the 2003 Stock Option Plan (incorporated by reference to Exhibit 10.14 to the Corporation’s Annual Report on Form 10-K for the fiscal year June 30, 2005).
 
 
10.9
2006 Equity Incentive Plan (incorporated by reference to Exhibit A to the Corporation’s proxy statement dated October 12, 2006)
 
 
10.10
Form of Incentive Stock Option Agreement for options granted under the 2006 Equity Incentive Plan (incorporated by reference to Exhibit 10.10 in the Corporation’s Form 10-Q for the quarter ended December 31, 2006)
 
 
10.11
Form of Non-Qualified Stock Option Agreement for options granted under the 2006 Equity Incentive Plan (incorporated by reference to Exhibit 10.11 in the Corporation’s Form 10-Q for the quarter ended December 31, 2006)
 
 
10.12
Form of Restricted Stock Agreement for restricted shares awarded under the 2006 Equity Incentive Plan (incorporated by reference to Exhibit 10.12 in the Corporation’s Form 10-Q for the quarter ended December 31, 2006)
 
 
10.13
2010 Equity Incentive Plan (incorporated by reference to Exhibit A to the Corporation’s proxy statement dated October 28, 2010)
 
 
10.14
Form of Incentive Stock Option Agreement for options granted under the 2010 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 in the Corporation’s Form 8-K dated November 30, 2010)
 
 
10.15
Form of Non-Qualified Stock Option Agreement for options granted under the 2010 Equity Incentive Plan (incorporated by reference to Exhibit 10.2 in the Corporation’s Form 8-K dated November 30, 2010)
 
 
10.16
Form of Restricted Stock Agreement for restricted shares awarded under the 2010 Equity Incentive Plan (incorporated by reference to Exhibit 10.3 in the Corporation’s Form 8-K dated November 30, 2010)
 
 
10.17
Post-Retirement Compensation Agreement with Donavon P. Ternes (incorporated by reference to Exhibit 10.13 to the Corporation’s Form 8-K dated July 7, 2009)
 
 
10.18
2013 Equity Incentive Plan (incorporated by reference to Exhibit A to the Corporation’s proxy statement dated October 24, 2013)
 
 
10.19
Form of Incentive Stock Option Agreement for options granted under the 2013 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 in the Corporation’s Form 8-K dated November 30, 2013)
 
 
10.20
Form of Non-Qualified Stock Option Agreement for options granted under the 2013 Equity Incentive Plan (incorporated by reference to Exhibit 10.2 in the Corporation’s Form 8-K dated November 30, 2013)
 
 
10.21
Form of Restricted Stock Agreement for restricted shares awarded under the 2013 Equity Incentive Plan (incorporated by reference to Exhibit 10.3 in the Corporation’s Form 8-K dated November 30, 2013)
 
 
14
Code of Ethics for the Corporation’s directors, officers and employees (incorporated by reference to Exhibit 14 in the Corporation’s Annual Report on Form 10-K dated September 12, 2007)
 
 
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
32.1
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 

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32.2
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
101
The following materials from the Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, formatted in Extensible Business Reporting Language (XBRL): (1) Condensed Consolidated Statements of Financial Condition; (2) Condensed Consolidated Statements of Operations; (3) Condensed Consolidated Statements of Comprehensive Income; (4) Condensed Consolidated Statements of Stockholders’ Equity; (5) Condensed Consolidated Statements of Cash Flows; and (6) Selected Notes to Condensed Consolidated Financial Statements.*
(*) 
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.



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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
 
Provident Financial Holdings, Inc. 
 
 
 
 
 
 
Date: May 12, 2014
/s/ Craig G. Blunden                                        
 
Craig G. Blunden
 
Chairman and Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
 
 
Date: May 12, 2014
/s/ Donavon P. Ternes                                       
 
Donavon P. Ternes 
 
President, Chief Operating Officer and
Chief Financial Officer
(Principal Financial and Accounting Officer)


































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Exhibit Index

31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
32.1
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
32.2
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
101
The following materials from the Corporation’s Quarterly Report on Form 10-Q for the quarter   ended March 31, 2014, formatted in Extensible Business Reporting Language (XBRL): (1) Condensed Consolidated Statements of Financial Condition; (2) Condensed Consolidated Statements of Operations; (3) Condensed Consolidated Statements of Comprehensive Income; (4) Condensed Consolidated Statements of Stockholders’ Equity; (5) Condensed Consolidated Statements of Cash Flows; and (6) Selected Notes to Condensed Consolidated Financial Statements.*
 
 
(*)    
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.


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