The Bank receives fees from a variety of investors in return for performing the traditional services of collecting individual loan payments on loans sold by the Bank to such investors. At June 30, 2017,2020, the Bank was servicing $119.3$86.5 million of loans for others, an increasea 28% decrease from $105.5$120.2 million at June 30, 2016.2019. The increasedecrease was primarily attributable to loan prepayments, and no loans sold with servicing retained during fiscal 2017, partly offset by loan prepayments.2020. Loan servicing includes processing payments, accounting for loan funds and collecting and paying real estate taxes, hazard insurance and other loan-related items such as private mortgage insurance. After the Bank receives the gross mortgage payment from individual borrowers, it remits to the investor a predetermined net amount based on the loan sale agreement for that mortgage.
Servicing assets are amortized in proportion to and over the period of the estimated net servicing income and are carried at the lower of cost or fair value. The fair value of servicing assets is determined by calculating the present value of the estimated net future cash flows consistent with contractually specified servicing fees. The Bank periodically evaluates servicing assets for impairment, which is measured as the excess of cost over fair value. This review is performed on a disaggregated basis, based on loan type and interest rate. Generally, loan servicing becomes more valuable when interest rates rise (as prepayments typically decrease) and less valuable when interest rates decline (as prepayments typically increase). In estimating fair values at June 30, 20172020 and 2016,2019, the Bank used a weighted average Constant Prepayment Rate (“CPR”) of 17.02%26.07% and 19.68%23.86%, respectively, and a weighted-average discount rate of 9.11% and 9.07%, respectively.at both dates. The required impairment reserve against servicing assets at June 30, 20172020 and 20162019 was $158,000$291,000 and $168,000,$298,000, respectively. In aggregate, servicing assets had a carrying value of $739,000$673,000 and a fair value of $811,000$382,000 at June 30, 2017,2020, compared to a carrying value of $627,000$925,000 and a fair value of $627,000 at June 30, 2016.
The loan terms which have been modified or restructured due to a borrower’s financial difficulty, include but are not limited to:
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 Bank. The Bank 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.
The Bank upgrades restructured single-family loans to the pass category if the borrower has demonstrated satisfactory contractual payments for at least six consecutive months or 12 months for those loans that were restructured more than once and there is a reasonable assurance that the payments will continue. Once the borrower has demonstrated satisfactory contractual payments beyond 12 consecutive months, the loan is no longer categorized as a restructured loan.
corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as a loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified as loss, the institution establishes an individually evaluated allowance and may subsequently charge-off the amount of the asset classified as loss. A portion of the allowance for loan losses established to cover probable losses related to assets classified substandard or doubtful may be included in determining an institution’s regulatory capital. Assets that do not currently expose the institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated as special mention and are closely monitored by the Bank.
Not all of the Bank’s classified assets are delinquent or non-performing. In determining whether the Bank’s assets expose the Bank to sufficient risk to warrant classification, the Bank may consider various factors, including the payment history of the borrower, the loan-to-value ratio, and the debt coverage ratio of the property securing the loan. After consideration of these and other factors, the Bank may determine that the asset in question, though not currently delinquent, presents a risk of loss that requires it to be classified or designated as special mention. In addition, the Bank’s loans held for investment may include single-family, commercial and multi-family real estate loans with a balance exceeding the current market value of the collateral which are not classified because they are performing and have borrowers who have sufficient resources to support the repayment of the loan.
The Bank has established a methodology for the determination of the provision for loan losses. The methodology is set forth in a formal policy and takes into consideration the need for a collectively evaluated allowance for groups of homogeneous loans
and an individually evaluated allowance that are tied to individual problem loans. The Bank’s methodology for assessing the appropriateness of the allowance consists of several key elements.
The allowance is calculated by applying loss factors to the loans held for investment. The loss factors are applied according to loan program type and loan classification. The loss factors for each program type and loan classification are established based on an evaluation of the historical loss experience, prevailing market conditions, concentration in loan types and other relevant factors consistent with ASC 450, “Contingency”. Homogeneous loans, such as residential mortgage, home equity and consumer installment loans are considered on a pooled loan basis. A factor is assigned to each pool based upon expected charge-offs for one year. The factors for larger, less homogeneous loans, such as construction and commercial real estate loans, are based upon loss experience tracked over business cycles considered appropriate for the loan type.
Collectively evaluated or individually evaluated allowances are established to absorb losses on loans for which full collectibilitycollectability may not be reasonably assured as prescribed in ASC 310. Estimates of identifiable losses are reviewed continually and, generally, a provision (recovery) for losses is charged (credited) against operations on a quarterly basis as necessary to maintain the allowance at an appropriate level. Management presents the minutes summarizing the actions of the IAR Committee to the Bank’s Board of Directors on a quarterly basis.
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”),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.
The IAR Committee meets quarterly to review and monitor conditions in the portfolio and to determine the appropriate allowance for loan losses. To the extent that any of these conditions are apparent by identifiable problem loans or portfolio segments as of the evaluation date, the IAR Committee’s estimate of the effect of such conditions may be reflected as an individually evaluated allowance applicable to such loans or portfolio segments. Where any of these conditions is not apparent by specifically identifiable problem loans or portfolio segments as of the evaluation date, the IAR Committee’s evaluation of the probable loss related to such condition is reflected in the general allowance. The intent of the IAR Committee is to reduce the differences between estimated and actual losses. Pooled loan factors are adjusted to reflect current estimates of charge-offs for the subsequent 12 months. Loss activity is reviewed for non-pooled loans and the loss factors are adjusted, if necessary. By assessing the probable estimated losses inherent in the loans held for investment on a quarterly basis, the Bank is able to adjust specific and inherent loss estimates based upon the most recent information that has become available.
While the Bank believes that it has established its existing allowance for loan losses in accordance with GAAP, there can be no assurance that regulators, in reviewing the Bank’s loan portfolio, will not recommend that the Bank significantly increase its allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, including as a result of COVID-19 pandemic, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above.necessary. Any material increase in the allowance for loan losses may adversely affect the Bank’s financial condition and results of operations.
The following table sets forth an analysis of the Bank’s allowance for loan losses for the periods indicated. Where individually evaluated allowances have been established, any differences between the individually evaluated allowances and the amount of loss realized has been charged or credited to current operations.
The following table sets forth the breakdown of the allowance for loan losses by loan category at the periods indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance is based upon an asset classification matrix. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance in one category to absorb losses in any other categories.
Federally chartered savings institutions are permitted under federal and state laws to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and government sponsored enterprises and of state and municipal governments, deposits at the FHLB, certificates of deposit of federally insured institutions, certain bankers’ acceptances, mortgage-backed securities and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest a portion of their assets in commercial paper and corporate debt securities. Savings institutions such as the Bank are also required to maintain an investment in FHLB – San Francisco stock.
The investment policy of the Bank, established by the Board of Directors and implemented by the Bank’s Asset-Liability Committee, seeks to provide and maintain adequate liquidity, complement the Bank’s lending activities, and generate a favorable return on investment without incurring undue interest rate risk or credit risk. Investments are made based on certain considerations, such as credit quality, yield, maturity, liquidity and marketability. The Bank also considers the effect that the proposed investment would have on the Bank’s risk-based capital requirements and interest rate risk sensitivity.
The following table sets forth the composition of the Bank’s investment portfolio at the dates indicated:
(2)(3)
| Collateralized mortgage obligations (“CMO”) |
| |
(3)
| Common stock of a community development financial institution |
As of June 30, 2017, the Bank held investments with an unrealized loss position of $77,000 for less than a 12-month period. There were no other than temporary impairments at June 30, 2017.
|
| | | | | | | | | | | | | | | | | | | | |
| Unrealized Holding Losses | | Unrealized Holding Losses | | Unrealized Holding Losses |
(In Thousands) | Less Than 12 Months | | 12 Months or More | | Total |
Description of Securities | Estimated Fair Value | Unrealized Losses | | Estimated Fair Value | Unrealized Losses | | Estimated Fair Value | Unrealized Losses |
| | | | | | | | |
U.S. government sponsored enterprise MBS | $ | 28,722 |
| $ | 77 |
| | $ | — |
| $ | — |
| | $ | 28,722 |
| $ | 77 |
|
Total | $ | 28,722 |
| $ | 77 |
| | $ | — |
| $ | — |
| | $ | 28,722 |
| $ | 77 |
|
The following table sets forth the outstanding balance, maturity and weighted average yield of the investment securities at June 30, 2017:2020:
| | | | Due in One Year or Less | Due After One to Five Years | Due After Five to Ten Years | Due After Ten Years | Total | | Due in One Year or Less | Due After One to Five Years | Due After Five to Ten Years | Due After Ten Years | Total |
(Dollars in Thousands) | | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield |
Held to maturity securities: | | |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| | | | | | | | | | | |
U.S. government sponsored enterprise MBS | | $ | — |
| — | % | $ | 4,698 |
| 1.86 | % | $ | 41,404 |
| 1.74 | % | $ | 13,739 |
| 2.30 | % | $ | 59,841 |
| 1.88 | % | | $ | — | | — | % | $ | 19,389 | | 2.27 | % | $ | 50,895 | | 1.89 | % | $ | 45,479 | | 1.65 | % | $ | 115,763 | | 1.85 | % |
U.S. SBA securities | | | — | | — | | — | | — | | — | | — | | 2,064 | | 0.60 | | 2,064 | | 0.60 | |
Certificates of deposits | | 600 |
| 1.13 |
| — |
| — |
| — |
| — |
| — |
| — |
| 600 |
| 1.13 |
| | 800 | | 1.53 | | — | | — | | — | | — | | — | | — | | 800 | | 1.53 | |
Total investment securities held to maturity | | $ | 600 |
| 1.13 | % | $ | 4,698 |
| 1.86 | % | $ | 41,404 |
| 1.74 | % | $ | 13,739 |
| 2.30 | % | $ | 60,441 |
| 1.87 | % | |
Total investment securities - held to maturity | | | $ | 800 | | 1.53 | % | $ | 19,389 | | 2.27 | % | $ | 50,895 | | 1.89 | % | $ | 47,543 | | 1.60 | % | $ | 118,627 | | 1.83 | % |
| | | | | | | | | | | | | | | | | | | | | | |
Available for sale securities: | | |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| | | | | | | | | | | |
U.S. government agency MBS | | $ | — |
| — | % | $ | — |
| — | % | $ | — |
| — | % | $ | 5,383 |
| 2.21 | % | $ | 5,383 |
| 2.21 | % | | $ | — | | — | % | $ | — | | — | % | $ | — | | — | % | $ | 2,943 | | 3.32 | % | $ | 2,943 | | 3.32 | % |
U.S. government sponsored enterprise MBS | | — |
| — |
| — |
| — |
| — |
| — |
| 3,474 |
| 3.00 |
| 3,474 |
| 3.00 |
| | — | | — | | — | | — | | — | | — | | 1,577 | | 3.75 | | 1,577 | | 3.75 | |
Private issue CMO | | — |
| — |
| — |
| — |
| — |
| — |
| 461 |
| 3.00 |
| 461 |
| 3.00 |
| | — | | — | | — | | — | | — | | — | | 197 | | 3.70 | | 197 | | 3.70 | |
Total investment securities available for sale | | $ | — |
| — | % | $ | — |
| — | % | $ | — |
| — | % | $ | 9,318 |
| 2.54 | % | $ | 9,318 |
| 2.54 | % | |
Total investment securities - available for sale | | | $ | — | | — | % | $ | — | | — | % | $ | — | | — | % | $ | 4,717 | | 3.48 | % | $ | 4,717 | | 3.48 | % |
Total investment securities | | $ | 600 |
| 1.13 | % | $ | 4,698 |
| 1.86 | % | $ | 41,404 |
| 1.74 | % | $ | 23,057 |
| 2.40 | % | $ | 69,759 |
| 1.96 | % | | $ | 800 | | 1.53 | % | $ | 19,385 | | 2.27 | % | $ | 50,895 | | 1.89 | % | $ | 52,260 | | 1.77 | % | $ | 123,344 | | 1.89 | % |
The actual maturity and yield for MBS and CMO may differ from the stated maturity and stated yield due to scheduled amortization, loan prepayments and acceleration of premium amortization or discount accretion.
21
Deposit Activities and Other Sources of Funds
General. Deposits the proceeds from loan sales and loan repayments are the major sources of the Bank’s funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows are influenced significantly by general interest rates and money market conditions. Loan sales are also influenced significantly by general interest rates. Borrowings through the FHLB – San Francisco and repurchase agreements may be used to compensate for declines in the availability of funds from other sources.
Deposit Accounts. Substantially all of the Bank’s depositors are residents of the State of California. Deposits are attracted from within the Bank’s market area by offering a broad selection of deposit instruments, including checking, savings, money market and time deposits.deposit accounts. Deposit account terms vary, differentiated by the minimum balance required, the time periods that the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the Bank considers current interest rates, profitability to the Bank, interest rate risk characteristics, competition and its customers’ preferences and concerns. Generally, the Bank’s deposit rates are commensurate with the median rates of its competitors within a given market. The Bank may occasionally pay above-market interest rates to attract or retain deposits when less expensive sources of funds are not available. The Bank may also pay above-market interest rates in specific markets in order to increase the deposit base of a particular office or group of offices. The Bank reviews its deposit composition and pricing on a weekly basis.
The Bank generally offers time deposits for terms not exceeding seven years. As illustrated in the following table, time deposits represented 29%19% of the Bank’s deposit portfolio at June 30, 2017,2020, compared to 33%23% at June 30, 2016.2019. As of June 30, 2017, total2020 and 2019, there were no brokered deposits were $1.6 million with a weighted average interest rate of 3.88% and remaining maturities within two years. At June 30, 2016, total brokered deposits were $1.6 million with a weighted average interest rate of 3.88% and remaining maturities within three years.deposits. The Bank attempts to reduce the overall cost of its deposit portfolio and to increase its franchise value by emphasizing transaction accounts, which are subject to a heightened degree of competition. For additional information, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K.
22
The following table sets forth information concerning the Bank’s weighted-average interest rate of deposits at June 30, 2017:2020:
|
| | | | | | | | | | |
Weighted Average Interest Rate | Original Term | Deposit Account Type | Minimum Amount | Balance (In Thousands) | Percentage of Total Deposits |
| | | | | |
| | Transaction accounts: | | | |
—% | N/A | Checking accounts – non interest-bearing | $ | — |
| $ | 77,917 |
| 8.41 | % |
0.11% | N/A | Checking accounts – interest-bearing | $ | — |
| 259,437 |
| 28.00 |
|
0.20% | N/A | Savings accounts | $ | 10 |
| 285,967 |
| 30.86 |
|
0.27% | N/A | Money market accounts | $ | — |
| 35,323 |
| 3.81 |
|
| | | | | |
| | Time deposits: | | | |
0.05% | 30 days or less | Fixed-term, fixed rate | $ | 1,000 |
| 23 |
| — |
|
0.13% | 31 to 90 days | Fixed-term, fixed rate | $ | 1,000 |
| 6,051 |
| 0.65 |
|
0.14% | 91 to 180 days | Fixed-term, fixed rate | $ | 1,000 |
| 8,024 |
| 0.87 |
|
0.22% | 181 to 365 days | Fixed-term, fixed rate | $ | 1,000 |
| 46,341 |
| 5.00 |
|
0.54% | Over 1 to 2 years | Fixed-term, fixed rate | $ | 1,000 |
| 61,418 |
| 6.63 |
|
0.82% | Over 2 to 3 years | Fixed-term, fixed rate | $ | 1,000 |
| 21,542 |
| 2.33 |
|
1.52% | Over 3 to 5 years | Fixed-term, fixed rate | $ | 1,000 |
| 109,675 |
| 11.84 |
|
2.08% | Over 5 to 10 years | Fixed-term, fixed rate | $ | 1,000 |
| 14,803 |
| 1.60 |
|
0.39% | | | | $ | 926,521 |
| 100.00 | % |
Weighted Average Interest Rate | Original Term | Deposit Account Type | Minimum Amount | Balance (In Thousands) | Percentage of Total Deposits |
| | | | | |
| | Transaction accounts: | | | |
—% | N/A | Checking accounts – non interest-bearing | $ | — | | $ | 118,771 | | 13.30 | % |
0.10% | N/A | Checking accounts – interest-bearing | $ | — | | 290,463 | | 32.53 | |
0.13% | N/A | Savings accounts | $ | 10 | | 273,769 | | 30.66 | |
0.22% | N/A | Money market accounts | $ | — | | 39,989 | | 4.48 | |
| | | | | |
| | Time deposits: | | | |
0.05% | 30 days or less | Fixed-term, fixed rate | $ | 1,000 | | 20 | | — | |
0.13% | 31 to 90 days | Fixed-term, fixed rate | $ | 1,000 | | 4,393 | | 0.49 | |
0.29% | 91 to 180 days | Fixed-term, fixed rate | $ | 1,000 | | 9,778 | | 1.09 | |
0.59% | 181 to 365 days | Fixed-term, fixed rate | $ | 1,000 | | 40,065 | | 4.49 | |
0.47% | Over 1 to 2 years | Fixed-term, fixed rate | $ | 1,000 | | 20,531 | | 2.30 | |
1.00% | Over 2 to 3 years | Fixed-term, fixed rate | $ | 1,000 | | 19,811 | | 2.22 | |
1.30% | Over 3 to 5 years | Fixed-term, fixed rate | $ | 1,000 | | 62,102 | | 6.95 | |
1.82% | Over 5 to 10 years | Fixed-term, fixed rate | $ | 1,000 | | 13,277 | | 1.49 | |
0.26% | | | | $ | 892,969 | | 100.00 | % |
The following table indicates the aggregate dollar amount of the Bank’s time deposits with balances of $100,000 or more differentiated by time remaining until maturity as of June 30, 2017:2020:
Maturity Period | Amount |
(In Thousands) | |
Three months or less | $ | 17,194 | |
Over three to six months | 16,669 | |
Over six to twelve months | 14,895 | |
Over twelve months | 39,039 | |
Total | $ | 87,797 | |
|
| | | |
Maturity Period | Amount |
(In Thousands) | |
Three months or less | $ | 17,501 |
|
Over three to six months | 19,009 |
|
Over six to twelve months | 16,300 |
|
Over twelve months | 80,338 |
|
Total | $ | 133,148 |
|
23
Deposit Flows. The following table sets forth the balances (inclusive of interest credited) and changes in the dollar amount of deposits in the various types of accounts offered by the Bank at and between the dates indicated:
| | | At June 30, | At June 30, |
| 2017 | | 2016 | 2020 | | 2019 |
(Dollars In Thousands) | Amount | Percent of Total | Increase (Decrease) | | Amount | Percent of Total | Increase (Decrease) | Amount | Percent of Total | Increase (Decrease) | | Amount | Percent of Total | Increase (Decrease) |
| | | | |
Checking accounts – non interest-bearing | $ | 77,917 |
| 8.41 | % | $ | 6,759 |
| | $ | 71,158 |
| 7.68 | % | $ | 3,620 |
| $ | 118,771 | | 13.30 | % | $ | 28,587 | | | $ | 90,184 | | 10.72 | % | $ | 4,010 | | |
Checking accounts – interest-bearing | 259,437 |
| 28.00 |
| 21,458 |
| | 237,979 |
| 25.69 |
| 13,889 |
| 290,463 | | 32.53 | | 32,554 | | | 257,909 | | 30.66 | | (1,463 | ) | |
Savings accounts | 285,967 |
| 30.86 |
| 10,657 |
| | 275,310 |
| 29.72 |
| 20,220 |
| 273,769 | | 30.66 | | 9,382 | | | 264,387 | | 31.43 | | (25,404 | ) | |
Money market accounts | 35,323 |
| 3.81 |
| 2,241 |
| | 33,082 |
| 3.57 |
| 1,410 |
| 39,989 | | 4.48 | | 4,343 | | | 35,646 | | 4.24 | | 1,013 | | |
Time deposits: | | | | | | | | | | | | | | | |
Fixed-term, fixed rate which mature: | | | | | | | | | | | | | | | |
Within one year | 113,946 |
| 12.30 |
| (34,921 | ) | | 148,867 |
| 16.07 |
| (25,138 | ) | 90,576 | | 10.14 | | (15,504 | ) | | 106,080 | | 12.61 | | (10,253 | ) | |
Over one to two years | 64,749 |
| 6.99 |
| 7,989 |
| | 56,760 |
| 6.13 |
| (23,185 | ) | 33,995 | | 3.81 | | (3,122 | ) | | 37,117 | | 4.41 | | (28,083 | ) | |
Over two to five years | 78,815 |
| 8.51 |
| (13,533 | ) | | 92,348 |
| 9.97 |
| 602 |
| 44,471 | | 4.98 | | (4,782 | ) | | 49,253 | | 5.85 | | (5,027 | ) | |
Over five years | 10,367 |
| 1.12 |
| (513 | ) | | 10,880 |
| 1.17 |
| 10,880 |
| 935 | | 0.10 | | 240 | | | 695 | | 0.08 | | (1,120 | ) | |
Total | $ | 926,521 |
| 100.00 | % | $ | 137 |
| | $ | 926,384 |
| 100.00 | % | $ | 2,298 |
| $ | 892,969 | | 100.00 | % | $ | 51,698 | | | $ | 841,271 | | 100.00 | % | $ | (66,327 | ) | |
Time Deposits by Rates. The following table sets forth the aggregate balance of time deposits categorized by interest rates at the dates indicated:
| | | At June 30, | At June 30, |
(Dollars In Thousands) | 2017 | 2016 | 2015 | 2020 | 2019 | 2018 |
| | |
Below 1.00% | $ | 143,133 |
| $ | 146,226 |
| $ | 169,743 |
| $ | 79,521 | | $ | 80,701 | | $ | 114,975 | |
1.00 to 1.99% | 115,555 |
| 151,240 |
| 160,218 |
| 85,232 | | 95,904 | | 113,211 | |
2.00 to 2.99% | 7,622 |
| 9,822 |
| 12,667 |
| 5,224 | | 16,540 | | 7,875 | |
3.00 to 3.99% | 1,567 |
| 1,567 |
| 3,068 |
| — | | — | | 1,567 | |
Total | $ | 267,877 |
| $ | 308,855 |
| $ | 345,696 |
| $ | 169,977 | | $ | 193,145 | | $ | 237,628 | |
Time Deposits by Maturities. The following table sets forth the aggregate dollar amount of time deposits at June 30, 20172020 differentiated by interest rates and maturity:
| | (Dollars In Thousands) | One Year or Less | Over One to Two Years | Over Two to Three Years | Over Three to Four Years | After Four Years | Total | One Year or Less | Over One to Two Years | Over Two to Three Years | Over Three to Four Years | After Four Years | Total |
| | |
Below 1.00% | $ | 98,083 |
| $ | 31,255 |
| $ | 13,620 |
| $ | 169 |
| $ | 6 |
| $ | 143,133 |
| $ | 59,146 | | $ | 12,142 | | $ | 5,072 | | $ | 595 | | $ | 2,566 | | $ | 79,521 | |
1.00 to 1.99% | 15,784 |
| 30,908 |
| 35,148 |
| 17,392 |
| 16,323 |
| 115,555 |
| 31,430 | | 21,853 | | 15,641 | | 7,589 | | 8,719 | | 85,232 | |
2.00 to 2.99% | 79 |
| 1,019 |
| 850 |
| — |
| 5,674 |
| 7,622 |
| — | | — | | 5,224 | | — | | — | | 5,224 | |
3.00 to 3.99% | — |
| 1,567 |
| — |
| — |
| — |
| 1,567 |
| |
Total | $ | 113,946 |
| $ | 64,749 |
| $ | 49,618 |
| $ | 17,561 |
| $ | 22,003 |
| $ | 267,877 |
| $ | 90,576 | | $ | 33,995 | | $ | 25,937 | | $ | 8,184 | | $ | 11,285 | | $ | 169,977 | |
24
DepositActivity. The following table sets forth the deposit activity of the Bank at and for the periods indicated:
| | | At or For the Year Ended June 30, | At or For the Year Ended June 30, |
(In Thousands) | 2017 | 2016 | 2015 | 2020 | 2019 | 2018 |
| | |
Beginning balance | $ | 926,384 |
| $ | 924,086 |
| $ | 897,870 |
| $ | 841,271 | | $ | 907,598 | | $ | 926,521 | |
| | | |
Net (withdrawals) deposits before interest credited | (3,671 | ) | (2,099 | ) | 21,455 |
| |
Net deposits (withdrawals) before interest credited | | 48,755 | | (69,708 | ) | (22,418 | ) |
Interest credited | 3,808 |
| 4,397 |
| 4,761 |
| 2,943 | | 3,381 | | 3,495 | |
Net increase in deposits | 137 |
| 2,298 |
| 26,216 |
| |
Net increase (decrease) in deposits | | 51,698 | | (66,327 | ) | (18,923 | ) |
| | | |
Ending balance | $ | 926,521 |
| $ | 926,384 |
| $ | 924,086 |
| $ | 892,969 | | $ | 841,271 | | $ | 907,598 | |
Borrowings. The FHLB – San Francisco functions as a central reserve bank providing credit for member financial institutions. As a member, the Bank is required to own capital stock in the FHLB – San Francisco and is authorized to apply for advances using such stock and certain of its mortgage loans and other assets (principally investment securities) as collateral, provided certain creditworthiness standards have been met. Advances are made pursuant to several different credit programs. Each credit program has its own interest rate, maturity, terms and conditions. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. The Bank utilizes advances from the FHLB – San Francisco as an alternative to deposits to supplement its supply of lendable funds, to meet deposit withdrawal requirements and to help manage interest rate risk. The FHLB – San Francisco has, from time to time, served as the Bank’s primary borrowing source. As of June 30, 20172020 and 2016,2019, the FHLB – San Francisco borrowing capacity was limited to 35% of the Bank’s total assets at both dates.dates, amounting to $387.6 million and $391.8 million, respectively. Advances from the FHLB – San Francisco are typically secured by the Bank’s single-family residential, multi-family and commercial real estate mortgage loans. Total mortgage loans pledged to the FHLB – San Francisco were $733.4$658.7 million at June 30, 20172020 as compared to $776.5$643.0 million at June 30, 2016.2019. In addition, the Bank pledged investment securities totaling $451,000$2.2 million at June 30, 20172020 as compared to $591,000$3.2 million at June 30, 20162019 to collateralize its FHLB – San Francisco advances under the Securities-Backed Credit (“SBC”) facility. At June 30, 20172020 and 2016,2019, the Bank had $126.2$141.0 million and $91.3$101.1 million of borrowings, respectively, from the FHLB – San Francisco with a weighted-average interest rate of 2.39%2.23% and 2.78%2.62%, respectively. At June 30, 2017,2020, the outstanding borrowings mature between 20172020 and 2025 with a weighted average maturity of 5128 months. In addition to the total borrowings mentioned above, the Bank utilized its borrowing facility for letters of credit and MPF credit enhancement.enhancement for loans previously sold to the FHLB – San Francisco under the Mortgage Partnership Finance (“MPF”) program which have a recourse liability. The outstanding letters of credit at June 30, 20172020 and 20162019 was $7.0$16.0 million and $8.0$13.0 million, respectively; and the outstanding MPF credit enhancement was $2.5 million at both dates. For additional information, see Note 81 of the Notes to Consolidated Financial Statements, “Organization and Summary of Significant Accounting Policies,” under the Corporation's audited financial statementssubheading “Loans originated and held for sale” and Note 8 included in Item 8 of this Form 10-K. As of June 30, 20172020 and 2016,2019, the remaining financing availability was $284.1$228.1 million and $309.0$275.2 million, respectively, with remaining available collateral of $500.9$351.5 million and $586.9$434.7 million, respectively. In addition, as of June 30, 20172020 and 2016,2019, the Bank had secured a discount window facility of $63.5$94.4 million and $46.4$74.2 million, respectively, at the Federal Reserve Bank of San Francisco, collateralized by investment securities with a fair market value of $67.6$100.4 million and $49.4$79.0 million, respectively. The Bank also has a federal funds facility with its correspondent bank for $17.0 million which matures on June 30, 2018.2021. As of June 30, 2017,2020, there were no outstanding borrowings under the discount window facility or the federal funds facility with the correspondent bank.
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The following table sets forth certain information regarding borrowings by the Bank at the dates and for the years indicated:
| | At or For the Year Ended June 30, | |
(Dollars In Thousands) | | 2020 | | | 2019 | | | 2018 | |
| | | |
Balance outstanding at the end of period: | | | | | | | | | |
FHLB – San Francisco advances | | $ | 141,047 | | | $ | 101,107 | | | $ | 126,163 | |
| | | | | | | | | | | | |
Weighted average rate at the end of period: | | | | | | | | | | | | |
FHLB – San Francisco advances | | | 2.23 | % | | | 2.62 | % | | | 2.47 | % |
| | | | | | | | | | | | |
Maximum amount of borrowings outstanding at any month end: | | | | | | | | | | | | |
FHLB – San Francisco advances | | $ | 141,057 | | | $ | 136,158 | | | $ | 126,163 | |
| | | | | | | | | | | | |
Average short-term borrowings during the period with respect to:(1) | | | | | | | | | | | | |
FHLB – San Francisco advances | | $ | 11,562 | | | $ | 8,425 | | | $ | 8,687 | |
| | | | | | | | | | | | |
Weighted average short-term borrowing rate during the period with respect to:(1) | | | | | | | | | | | | |
FHLB – San Francisco advances | | | 3.30 | % | | | 1.69 | % | | | 2.53 | % |
|
| | | | | | | | | |
| At or For the Year Ended June 30, |
(Dollars In Thousands) | 2017 | 2016 | 2015 |
| |
Balance outstanding at the end of period: | | | |
FHLB – San Francisco advances | $ | 126,226 |
| $ | 91,299 |
| $ | 91,367 |
|
| | | |
Weighted average rate at the end of period: | |
| |
| |
|
FHLB – San Francisco advances | 2.39 | % | 2.78 | % | 2.78 | % |
| | | |
Maximum amount of borrowings outstanding at any month end: | |
| |
| |
|
FHLB – San Francisco advances | $ | 181,287 |
| $ | 91,362 |
| $ | 131,384 |
|
| |
| |
| |
|
Average short-term borrowings during the period with respect to:(1) | |
| |
| |
|
FHLB – San Francisco advances | $ | 14,022 |
| $ | — |
| $ | 6,800 |
|
| |
| |
| |
|
Weighted average short-term borrowing rate during the period with respect to:(1) | |
| |
| |
|
FHLB – San Francisco advances | 0.45 | % | — | % | 0.22 | % |
(1) Borrowings with a remaining term of 12 months or less.
As a member of the FHLB – San Francisco, the Bank is required to maintain a minimum investment in FHLB – San Francisco stock. The Bank held the required investment of $8.1 million with no excess investment at June 30, 2017, as compared2020 of $8.0 million with an excess investment of $1.1 million. This compares to June 30, 2019 when the Bank held the required investment of $7.8$8.2 million and a $321,000with an excess investment at June 30, 2016. The Bank purchased $14,000 of FHLB - San Francisco stock in$470,000.
During fiscal 2017 to support additional borrowings and did not purchase any addition FHLB-San Francisco stock in fiscal 2016 or 2015. Also in fiscal 2017, 2016 and 2015, the Bank received cash dividends on2020, the FHLB – San Francisco redeemed $229,000 of the excess capital stock, while the Bank did not purchase any FHLB - San Francisco capital stock. During fiscal 2019, the FHLB – San Francisco did not redeem any capital stock and the Bank did not purchase any FHLB - San Francisco capital stock. In fiscal 2020 and 2019, the FHLB – San Francisco distributed $534,000 and $707,000 of $967,000, $721,000 and $796,000, respectively.cash dividends, respectively, to the Bank. The cash dividends received onby the FHLB - San Francisco stockBank in fiscal 2017 and 20152019 included a special cash dividend.dividend of $133,000, not replicated in fiscal 2020.
Subsidiary Activities
Federal savings institutions generally may invest up to 3% of their assets in service corporations, provided that at least one-half of any amount in excess of 1% is used primarily for community, inner-city and community development projects. The Bank’s investment in its service corporations did not exceed these limits at June 30, 20172020 and 2016 .2019.
The Bank has three wholly owned subsidiaries: Provident Financial Corp (“PFC”), Profed Mortgage, Inc., and First Service Corporation. PFC’s current activities include: (i) acting as trustee for the Bank’s real estate transactions and (ii) holding real estate for investment, if any. Profed Mortgage, Inc., which formerly conducted the Bank’s mortgage banking activities, and First Service Corporation are currently inactive. At June 30, 20172020 and 2016,2019, the Bank’s investment in its subsidiaries was $44,000$9,000 and $57,000,$15,000, respectively.
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REGULATION
The following is a brief description of certain laws and regulations which are applicable to the Corporation and the Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.
Legislation is introduced from time to time in the United States Congress (“Congress”) that may affect the Corporation’s and the Bank’s operations. In addition, the regulations governing the Corporation and the Bank may be amended from time to time by the OCC, FDIC, Federal Reserve Board, theFRB and SEC, and the Consumer Financial Protection Bureau ("CFPB"), as appropriate. Any such legislation or regulatory changes in the future could adversely affect the operations and financial condition of the Corporation and the Bank. The Bank and no prediction can be made as tocannot predict whether any such changes may occur.
The Dodd-Frank Act has significantly changed the bank regulatory structure and is affecting the lending, investment, trading and operating activities of depository institutions and their holding companies. The Dodd-Frank Act eliminated the Office of Thrift Supervision, the Bank’s former federal banking regulator, and responsibility for the supervision and regulation of federal savings associations such as the Bank was transferred to the OCC July 21, 2011. The OCC is the agency that is primarily responsible for the regulation and supervision of national banks. Among other changes, the Dodd-Frank Act established the CFPB as an independent bureau of the Federal Reserve Board. The CFPB assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations and has authority to impose new requirements. The Bank is subject to consumer protection regulations issued by the CFPB with respect to our compliance with consumer financial protection laws and CFPB regulations.
Many aspects of the Dodd-Frank Act are subject to delayed effective dates and/or rulemaking by the federal banking agencies. Their impact on operations cannot yet be fully assessed. However, it is likely that the Dodd-Frank Act will increase the regulatory burden, compliance costs and interest expense for the Corporation, the Bank and the financial services industry more generally.
General
The Bank, as a federally chartered savings institution, is subject to extensive regulation, examination and supervision by the OCC, as its primary federal regulator, and the FDIC, as its insurer of deposits. The Bank's relationship with its depositors and borrowers is regulated by federal consumer protection laws, and the CFPB issues regulations under those laws, which must be complied with by the Bank. The Bank is a member of the FHLB System and its deposits are insured up to applicable limits by the FDIC. The Bank must file reports with the OCC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OCC to evaluate the Bank’s safety and soundness and compliance with various regulatory requirements. Under certain circumstances, the FDIC may also examine the Bank. This regulatory structure establishes a comprehensive framework of activities in which the Bank may engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss allowancesreserves for regulatory purposes. Any change in such policies, whether by the OCC, the FRB, the FDIC or Congress, could have a material adverse impact on the Corporation and the Bank and their operations. The Corporation, as a savings and loan holding company, is required to file certain reports with, is subject to examination by, and otherwise must comply with the rules and regulations of the Federal Reserve Board,FRB, its primary regulator. The Corporation is also subject to the rules and regulations of the SEC under the federal securities laws. For additional information, see “Savings and Loan Holding Company Regulations” below in this Form 10-K.
In connection with the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), the laws and regulations affecting depository institutions and their holding companies have changed particularly affecting the bank regulatory structure and the lending, investment, trading and operating activities of depository institutions and their holding companies. Among other changes, the Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”) as an independent bureau of the Federal Reserve Board. The CFPB assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations and has authority to impose new requirements. The Bank is subject to regulations issued by the CFPB, but as a smaller financial institution, the Bank is generally subject to supervision and enforcement by the OCC with respect to its compliance with consumer financial protection laws and CFPB regulations.
On May 23, 2018, the President signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act passed by Congress (the “Act”). The Act contains a number of provisions extending regulatory relief to banks and savings institutions and their holding companies. Some of these provisions may benefit the Corporation and the Bank, such as (1) a simplified capital ratio, called the Community Bank Leverage Ratio or CBLR, computed as the ratio of tangible equity capital to average consolidated total assets to be set by the federal banking regulators at not less than 8% and not more than 10%, which for most institutions with less than $10 billion in consolidated assets may replace the leverage and risk-based capital ratios under current regulations; (2) an option for federal savings institutions to operate as national banks with respect to limits on lending, investments, and subsidiaries, without changing their charters to national bank charters; and (3) a lower risk weight on certain
27
loans classified as high volatility commercial real estate exposures. Effective January 1, 2020, the CBRL was 9.0%. These CBLR rules were modified in response to the COVID-19 pandemic. See "- The Coronavirus Aid, Relief, and Economic Security Act of 2020" below.
Federal Regulation of Savings Institutions
Office of the Comptroller of the Currency. The OCC has extensive authority over the operations of federally charteredfederal savings institutions. As part of this authority, the Bank is required to file periodic reports with the OCC and is subject to periodic examinations by the OCC. The OCC also has extensive enforcement authority over all federally charteredfederal savings institutions, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and-desist or removal orders and initiate injunctive actions.prompt corrective action orders. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OCC. Except under certain circumstances, public disclosure of final enforcement actions by the OCC is required by law.
All federal savings institutions must pay assessments to the OCC, to fund the agency’s operations. The general assessments, paid on a semi-annual basis, are determined based on the savings institution’s total assets, including consolidated subsidiaries. The Bank’s OCC annual assessmentassessments for the fiscal years ended June 30, 2017, 20162020 and 2015 was $279,000, $275,0002019 were $227,000 and $263,000,$262,000, respectively.
Federal law provides that federally chartered savings institutions are generally subject to the national bankThe Bank's general permissible lending limit onfor loans to one borrower. A federally chartered savings institution may not make a loan or extend credit to a single or related group of borrowers
in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent,borrower is equal to 10%the greater of $500,000 or 15% of unimpaired capital and surplus if(except for loans fully secured by specifiedcertain readily marketable collateral.collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). The Bank’s limitlimits on loans to one borrower or group of related borrowers was $18.9 million and $19.4 million, at June 30, 20172020 and 2016,2019 were $18.8 million and $18.3 million, respectively. At June 30, 2017,2020, the Bank’s largest lending relationship to a single borrower or group of borrowers were threeconsists of two multi-family loans totaling $8.1$4.5 million, which were performing according to theirits original payment terms.
The OCC, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan.
The OCC’s oversight of the Bank includes reviewing its compliance with the customer privacy requirements imposed by the Gramm-Leach-Bliley Act of 1999 (“GLBA”) and the anti-money laundering provisions of the USA Patriot Act of 2001 (“USA Patriot Act”) and regulations thereunder. The GLBA privacy requirements place limitations on the sharing of consumer financial information with unaffiliated third parties. They also require each financial institution offering financial products or services to retail customers to provide such customers with its privacy policy and with the opportunity to “opt out” of the sharing of their personal information with unaffiliated third parties. The USA Patriot Act significantly expands theimposes significant responsibilities ofon financial institutions in preventingto prevent the use of the United States financial system to fund terrorist activities. Its anti-money laundering provisions require financial institutions operating in the United States to develop anti-money laundering compliance programs and due diligence policies and controls to ensure the detection and reporting of money laundering. These compliance programs are intended to supplement existing compliance requirements under the Bank Secrecy Act and the regulations of the Office of Foreign Assets Control Regulations.Control.
Federal Home Loan Bank System. The Bank is a member of the FHLB – San Francisco, which is one of 11 regional FHLBs, that administer the home financing credit functioneach of member financial institutions. Each FHLBwhich serves as a reserve or central bank for its members within its assigned region. ItThe FHLB - San Francisco is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Agency. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB.FHLB - San Francisco. In addition, all long-term advances are required to provide funds for residential home financing. At June 30, 20172020 and 2016,2019, the Bank had $126.2$141.0 million and $91.3$101.1 million of outstanding advances, respectively, from the FHLB – San Francisco with a remaining available credit facility of $284.1$228.1 million and $309.0$275.2 million, respectively, based on 35% of total assets for both dates, which is limited to available
28
collateral. For additional information, see “Business – Deposit Activities and Other Sources of Funds – Borrowings” above in this Form 10-K.
As a member of the FHLB - San Francisco, the Bank is required to purchase and maintain stock in the FHLB – San Francisco. At June 30, 20172020 and 2016,2019, the Bank held $8.1$8.0 million and $8.2 million of FHLB-San Francisco stock, at both datesrespectively, which was in compliance with this membership requirement. During fiscal 2017 and 2016,2020, there was noa $229,000 excess capital redemption.redemption as compared to no redemption in fiscal 2019. In fiscal 2017, 20162020 and 2015,2019, the FHLB – San Francisco distributed $967,000, $721,000$534,000 and $796,000$707,000 of cash dividends, respectively, to the Bank. The cash dividends received in fiscal 2019 included a special cash dividend of $133,000, not replicated in fiscal 2020. There is no guarantee in the future that the FHLB – San Francisco will pay cash dividends or redeem excess capital stock held by its members.
Under federal law, the FHLB - San Francisco is required to contribute to low and moderately priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low and moderate income housing projects. These contributions have in the past adversely affected the level of FHLB dividends paid by the FHLB - San Francisco and could continue to do so in the future. These contributions also could have an adverse effect on the value of FHLB - San Francisco stock in the future. A reduction in value of the Bank's FHLB - San Francisco stock may result in a corresponding reduction in the Bank’s capital.
Insurance of Accounts and Regulation by the FDIC. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC. Deposits are insuredFDIC insures deposits up to $250,000 per account owner as defined by the FDIC, backed by the full faith and credit of the United States Government.States. As insurer, the FDIC imposes deposit insurance premiums in the form of assessments and is authorized to conduct examinations of and to require reporting by FDIC insured institutions. It may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OCC an opportunity to take such action, and may terminate the savings institution's deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition. Management of the Bank is not aware of any practice, condition or violation that might lead to termination of the Bank's deposit insurance.
TheUnder its regulations, the FDIC imposes ansets assessment rates for deposit insurance on all depository institutions. Under the FDIC’s risk-based assessment system, insuredestablished small institutions are assigned to risk categories(generally, those with total assets of less than $10 billion) based on supervisory evaluations, regulatory capital levelsan institution’s weighted average CAMELS component ratings and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned and certain adjustments specified by FDIC regulations, with institutions deemed less risky paying lower assessments. Currently,financial ratios. Total base assessment rates (inclusive of certain possible adjustments)currently range from 1.53 to 4030 basis points of each institution’s total assets less tangible capital (subjectsubject to upward adjustment for certain debt).adjustments. Assessment rates are expected to decrease in the future as the reserve ratio increases in specified increments. The FDIC may increase or decrease the scale uniformly, except that no adjustment can deviate more thanits rates up to two basis points fromwithout further rule-making. In an emergency, the base scale without notice and comment rulemaking. The FDIC’s current system representsFDIC may also impose a change, required by the Dodd-Frank Act, from its prior practice of basing the assessment on an institution’s volume of deposits.special assessment.
The Dodd-Frank Act increased the minimum target Deposit Insurance FundFDIC deposit insurance reserve ratio from 1.15% of estimated insured deposits1.15 percent to 1.35% of estimated insured deposits.1.35 percent. The FDIC must achievesurpassed the 1.35% ratio byas of September 30, 2020 with insured institutions with assets of $10 billion or more funding the increase.2018. The Dodd-Frank Act eliminateddirected the 1.5% maximum fund ratio, instead leaving itFDIC to offset the effects of higher assessments due to the discretion ofincrease in the reserve ratio on established small institutions by charging higher assessments to large institutions. To implement this mandate, large and highly complex institutions paid a surcharge on their base since established small institutions automatically receive credits from the FDIC andfor the portion of their assessments that contribute to the increase. In September 2019, the FDIC has exercised that discretion by establishingawarded a long term fund ratio of 2%.
The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of the Bank. No predictions can be made as to whatsmall bank assessment rates will be in the future.
In additioncredit to the assessmentBank totaling $297,000, which reduced insurance assessments for deposit insurance, institutions are required to make payments on bonds issued inapproximately the late 1980s byfirst nine months of fiscal 2020. For the Financing Corporation to recapitalize a predecessor deposit insurance fund. These assessments, which may be revised based uponfiscal year 2020, the level of DIF deposits, will continue until the bonds mature in the years 2017 through 2019. This payment is established quarterly and during the Financing Corporation's year ending March 31, 2017 averaged 3.58 basis points (annualized) of assessable assets. The Financing Corporation was chartered in 1987 solelyaverage annualized rate for the purpose of functioning as a vehicle for the recapitalization of the depositoverall FDIC insurance system.assessments was 3.00 basis points.
Qualified Thrift Lender Test. All Like all savings institutions including(subject to a narrow exception not applicable to the Bank), the Bank areis required to meet a qualified thrift lender (“QTL”) test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its total assets as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 month periodmonths on a rolling basis. As an alternative, a savings institution may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code of 1986 (“Code”)., as amended. Under either test, such assets primarily consist of residential housing related loans and investments.
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Any savings institution that fails to meet the QTL test is subject to certain operating restrictions and the Dodd-Frank Act also specifies that failing the QTL test ismay be required to convert to a violationnational bank charter, and a savings and loan holding company of law that could result insuch an enforcement action and dividend limitations.institution may become regulated as a bank holding company. As of June 30, 2017,2020, the Bank maintained 96.1%88.7% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test. During fiscal 20172020 and 2016,2019, the Bank was in compliance with the QTL teststest as of each month end during the stated fiscal years.end.
Capital Requirements. Federally insured savings institutions, such as the Bank, are required by the OCC to maintain minimum levels of regulatory capital. As required by the Dodd-Frank Act, in July 2013, the OCC and the other federal bank regulatory agencies issuedcapital, including a final rule that revises the comprehensive regulatory capital framework for all U.S. financial institutions and their holding companies including the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision. The final rule applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $1 billion or more and top-tier savings and loan holding companies.
The Bank is subject to the capital requirements adopted by the OCC, and the Corporation is subject to the same capital requirements adopted by the Federal Reserve Board. These requirements include a required ratio for common equity Tier 1 (“CET1”) capital to risk-based assets ratio, a leverageTier 1 capital to risk-based assets ratio, a total capital to risk-based assets ratio and a Tier 1 capital ratio, risk-weightings ofto total assets for purposesleverage ratio. The capital standards require the maintenance of the risk-based capital ratios, an additional capital conservation buffer over the required capital ratios and definitions of what qualifies as capital for purposes of meeting these various capital requirements. Under the capital regulations, to meet thefollowing minimum capital ratios plus the capital conservation buffer applicable to the Bank for calendar 2017, the Bank must exceed the following ratios are:ratios: (i) a CETICET1 capital ratio of 5.75%4.5%; (ii) a Tier 1 capital ratio of 7.25%6%; (iii) a total capital ratio of 9.25%8%; and (iv) a Tier 1 leverage ratio of 4%.
Certain changes in what constitutes regulatory capital are subject to transition periods. These changes include the phasing-out of certain instruments as qualifying capital. The Bank does not have any of these instruments. Mortgage servicing rights and deferred tax assets over designated percentages of CET1 are also deducted from capital subject to a transition period ending December 31, 2017.capital. In addition, Tier 1 capital includes accumulated other comprehensive income, which includes all unrealized gains and losses on available for sale debt, equity securities and interest-only strips, subject to a transition period ending December 31, 2017.
strips. Because of ourthe Bank’s asset size, we werethe Bank was given a one-time option to permanently opt-out of the inclusion of unrealized gains and losses on available for sale debt, equity securities and interest-only strips in ourits capital calculations. WeThe Bank elected to exercise this option to opt-out in order to reduce the impact of market volatility on ourits regulatory capital levels.
As noted above, in addition to the minimum CET1, Tier 1 and total capital ratios, theThe Bank also must maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum risk-based capital levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. The phase-in of the capital conservation buffer requirement began in January 2016 at 0.625% of risk-weighted assets and the requirement increases each year until it is fully implemented in January 2019. Failure to maintain the required capital conservation buffer will limit the ability of the Bank to pay dividends, repurchase shares or pay discretionary bonuses. If the Bank does not have the ability to pay dividends to the Corporation, the Corporation may be limited in its ability to pay dividends to its stockholders.
Under the current standards, inIn order to be considered well-capitalized under the prompt corrective action regulations, the Bank must havemaintain a CET1 capitalrisk-based ratio of 6.5%, a Tier 1 capitalrisk-based ratio of 8%, a total risk-based capital ratio of 10% and a Tier1 leverage ratio of 5%, and the Bank must not be subject to any of certain mandates by the OCC requiring it as an individual institution to meet any specified capital level. Effective January 1, 2020, a bank or savings institution that elects to use the Community Bank Leverage Ratio will generally be considered well-capitalized and to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0%. In order to qualify for the Community Bank Leverage Ratio framework, in addition to maintaining a leverage ratio greater than 9%, the bank or institution also must have total consolidated assets of less than $10 billion, off-balance sheet exposures of 25% or less of its total consolidated assets, and trading assets and trading liabilities of 5.0% or less of its total consolidated assets, all as of the end of the most recent quarter. A bank electing the framework that ceases to meet any qualifying criteria in a future period and that has a leverage ratio greater than 8% will be allowed a grace period of two reporting periods to satisfy the CBLR qualifying criteria or comply with the generally applicable capital requirements. A bank may opt out of the framework at any time, without restriction, by reverting to the generally applicable risk-based capital rule. These CBLR rules were modified in response to the COVID-19 pandemic. See "- The Coronavirus Aid, Relief, and Economic Security Act of 2020" below.
As of June 30, 2017,2020, the most recent notification from the OCC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. See Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Prompt Corrective Action. An institution is considered adequately capitalized if it meets the minimum capital ratios described above. The OCC is required to take certain supervisory actions against undercapitalized savings institutions, the severity of which depends upon the institution's degree of undercapitalization. Subject to a narrow exception, the OCC is required to appoint a receiver or conservator for a savings institution that is "critically undercapitalized." OCC regulations also require that a capital restoration plan be filed with the OCC within 45 days of the date a savings institution receives notice that
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it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. “Significantly undercapitalized” and “critically undercapitalized” institutions are subject to more extensive mandatory regulatory actions. The OCC also may take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Limitations on Capital Distributions. OCC regulations impose various restrictions on savings institutions and on their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Generally, savings institutions, such as the Bank, that before and after the proposed distribution are well-capitalized, may make capital distributions during any calendar year up to 100% of net income for the year-to-date plus retained net income for the two preceding years. However, an institution deemed to be in need of more than normal supervision or in troubled condition by the OCC may have its dividend authority restricted by the OCC. If the Bank, however, proposes to make a capital distribution when it does not meet its capital requirements (or will not following the proposed capital distribution) or that will exceed these net income-based limitations, it must obtain the OCC's approval prior to making such distribution. In addition, the Bank must file a prior written notice of a dividend with the Federal Reserve Board.FRB. The Federal Reserve BoardFRB or the OCC may object to a capital distribution based on safety and soundness concerns. Further restrictions on Bank dividends may apply if the Bank fails the QTL test. In addition, as noted above, if the Bank does not have the required capital conservation buffer, its ability to pay dividends to the Corporation will be limited, which may limit the ability of the Corporation to pay dividends to its stockholders.
Activities of Savings Associations and Their Subsidiaries. When a savings institution establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the associationsavings institution controls, the savings institution must notifyfile a notice or application with the OCC and in certain circumstances with the FDIC and the OCC 30 days in advance and provide the required information in connection with such notification.receive regulatory approval or non-objection. Savings institutions also must conduct the activities of subsidiaries in accordance with existing regulations and orders.
The With respect to subsidiaries generally, the OCC may determine that the continuationinvestment by a savings institution in, or the activities of, its ownership, control of,a subsidiary must be restricted or its relationship to, the subsidiary constitutes a serious risk to theeliminated based on safety and soundness or stability of the savings institution or is inconsistent with sound banking practices or with the purposes of the Federal Deposit Insurance Act. Based upon that determination, the FDIC or the OCC has the authority to order the savings institution to divest itself of control of the subsidiary. The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the DIF. If so, it may require that no DIF member engage in that activity directly.legal reasons.
Transactions with Affiliates and Insiders.Affiliates. The Bank’s authority to engage in transactions with “affiliates” is limited by Sections 23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve Board’sFRB’s Regulation W. The term “affiliates” for
these purposes generally meansmean any company that controls or is under common control with an institution except subsidiaries of the institution. The Corporation and its non-savings institution subsidiaries are affiliates of the Bank. In general, transactions with affiliates must be on terms that are as favorable to the institution as comparable transactions with non-affiliates. In addition, certain types of transactions are restricted to an aggregate percentage of the institution’s capital. Collateral in specified amounts must be provided by affiliates in order to receive loans from an institution. Savings institutionsInstitutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary. Federally insured depositoryFDIC-insured institutions are subject, with certain exceptions, to certain restrictions on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. Collateral in specified amounts must be provided by affiliates in order to receive loans from an institution. In addition, these institutions are prohibited from engaging in certain tying arrangements in connection with any extension of credit or the providing of any property or service.
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) generally prohibits the Corporation from making loans to its executive officers and directors. However, that act contains a specific exception for loans by a depository institution to its executive officers and directors, if the lending is in compliance with federal banking laws. Under such laws, the Bank’s authority to extend credit to executive officers, directors and 10% stockholders (“insiders”), as well as entities which such persons control, is limited. The law restricts both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank’s capital position and requires certain Board approval procedures to be followed. Such loans must be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of
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repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. There are additional restrictions applicable to loans to executive officers.
Community Reinvestment Act and Consumer Protection Laws. Under the Community Reinvestment Act of 1977 (“CRA”), every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment ActCRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Community Reinvestment Act.CRA. The Community Reinvestment ActCRA requires the OCC, in connection with the examination of the Bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the Bank. The OCC may use an unsatisfactory rating as the basis for the denial of an application. Similarly, the FRB is required to take into account the performance of an insured institution under the CRA when considering whether to approve an acquisition by the institution’s holding company. Due to heightened attention to the Community Reinvestment ActCRA in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community. The Bank received a rating of satisfactory when it was last examined for Community Reinvestment ActCRA compliance.
In connection with its deposit-taking, lending and other activities, the Bank is subject to a number of federal laws designed to protect consumers and promote lending to various sectors of the economy and population. Some state laws can apply to these activities as well. The CFPB issues regulations and standards under these federal consumer protection laws, which include, among others, the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act and the Real Estate Settlement Procedures Act. Through its rulemaking authority, the CFPB has promulgated many finala number of regulations under these laws that affect ourthe bank’s consumer businesses. Among these regulatory initiatives, are final regulations setting “ability to repay” and “qualified mortgage” standards for residential mortgage loans and establishing new mortgage loan servicing and loan originator compensation standards. The Bank devotes substantial compliance, legal and operational business resources to ensure compliance with theseapplicable consumer protection standards. In addition, the OCC has enacted customer privacy regulations that limit the ability of the Bank to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with non-affiliated parties.
Bank Secrecy Act/Anti-Money Laundering Laws. TheBank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA Patriot Act of 2001. These laws and regulations require the Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing and to verify the identity of their customers. Violations of these requirements can result in substantial civil and criminal sanctions. In addition, provisions of the USA Patriot Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing mergers and acquisitions.
Regulatory and Criminal Enforcement Provisions. The OCC has primary enforcement responsibility over federally chartered savings institutions and has the authority to bring action against all “institution-affiliated parties,” including stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease-and-desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide
range of violations and can amount to $25,000be nearly $2.0 million per day or $1.1 million per dayviolation in especially egregious cases. The FDIC has the authority to recommend to the OCC that an enforcement action be taken with respect to a particular savings institution. If the OCC does not take action, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness. As required by statute, the federal banking agencies have adopted interagency guidelines prescribing standards for safety and soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes
32
impaired. If the OCC determines that a savings institution fails to meet any standard prescribed by the guidelines, the OCC may require the institution to submit an acceptable plan to achieve compliance with the standard.
Federal Reserve System. The FRB requires that all depository institutions maintain reserves on transaction accounts or non-personal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank. Interest-bearing checking accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any non-personal time deposits at a bank. Effective March 26, 2020, the FRB reduced reserve requirement ratios to 0%, which eliminated reserve requirements for all depository institutions.
Environmental Issues Associated with Real Estate Lending. The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), is a federal statute, generally imposes strict liability on all prior and present "owners and operators" of sites containing hazardous waste. However, Congress acted to protect secured creditors by providing that the term "owner and operator" excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan.
To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which costs often substantially exceed the value of the collateral property.
Other Consumer Protection Laws and Regulations. The Dodd-Frank Act established the CFPB and empowered it to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. The Bank is subject to consumer protection regulations issued by the CFPB, but as a financial institution with assets of less than $10 billion, the Bank is generally subject to supervision and enforcement by the OCC with respect to compliance with consumer financial protection laws and CFPB regulations
The Bank is subject to a broad array of federal and state consumer protection laws and regulations that govern almost every aspect of its business relationships with consumers. While the following list set forth below is not exhaustive, these include the GLBA, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (more commonly known as the USA Patriot Act), the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfers Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Fair Credit Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices, and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans, and providing other services. Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages, and the loss of certain contractual rights.
Savings and Loan Holding Company RegulationsRegulation
General. As The Corporation is a unitary savings and loan holding company, the Corporation is subject to the regulatory oversight of the Federal Reserve Board.FRB. Accordingly, the Corporation is required to register and file reports with the Federal Reserve BoardFRB and is subject to regulation and examination by the Federal Reserve Board.FRB. In addition, the Federal Reserve BoardFRB has enforcement authority over the Corporation and its non-savings institution subsidiaries, which also permits the Federal Reserve BoardFRB to restrict or prohibit activities that are determined to present a serious risk to the subsidiary savings institution. In accordance with the Dodd-Frank Act, the federal banking regulatorsFRB must require any company that controls an
33
FDIC-insured depository institution to serve as a source of financial strength for the institution, with the ability to provide financial assistance if the institution suffers financial distress.institution. These and other Federal Reserve BoardFRB policies, and regulationsas well as the capital conservation buffer may restrict the Corporation’s ability to pay dividends.
Capital Requirements. The Corporation is subject to regulatory capital requirements adopted by For a savings and loan holding company that qualifies as a small bank holding company under the Federal Reserve Board, which generally are the sameFRB’s Small Bank Holding Company Policy Statement, such as the Corporation, the capital requirements for the Bank. These capital requirements include provisions that might impact the ability of the Corporation to pay dividendsregulations apply to its stockholders or repurchase its shares.savings institution subsidiaries, but not the Corporation. The FRB expects the holding company’s savings institution subsidiaries to be well capitalized under the prompt corrective action regulations. For a description of the capital regulations, see “Federal Regulation of Savings Institutions - Capital Requirements” above.
Activities Restrictions. The GLBA provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below.companies. The GLBA also specifies, subject to a grandfather provision, that existing savings and loan holding companies may only engage in such activities. The Corporation qualifies for the grandfathering and is therefore not restricted in terms of its activities. Upon any non-supervisory acquisition by the Corporation of another savings association as a separate subsidiary, the Corporation would become a multiple savings and loan holding company and would be limited to those activities permitted multiple savings and loan holding companies by Federal Reserve BoardFRB regulation. Multiple savings and loan holding companies may engage in activities permitted for financial holding companies, and certain other activities including acting as a trustee under a deed of trust and real estate investments.
If the Bank fails the QTL test, the Corporation must, within one year of that failure, register as, and become subject to the restrictions applicable to bank holding companies. For additional information, see “Federal Regulation of Savings Institutions – Qualified Thrift Lender Test” in this Form 10-K.
Mergers and Acquisitions. The Corporation must obtain approval from the Federal Reserve BoardFRB before acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company or acquiring such an institution or holding company by merger, consolidation or purchase of its assets. In evaluating an application for the Corporation to acquire control of a savings institution, the Federal Reserve BoardFRB would consider the financial and managerial resources and future prospects of the Corporation and the target institution, the effect of the acquisition on the risk to the DIF, the convenience and the needs of the community, including performance under the CRA and competitive factors.
The Federal Reserve BoardFRB may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions; (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the statesstate of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Acquisition of the Company. Any company, except a bank holding company, that acquires control of a savings association or savings and loan holding company becomes a “savings and loan holding company” subject to registration, examination and regulation by the Federal ReserveFRB and must obtain the prior approval of the Federal ReserveFRB under the Savings and Loan Holding Company Act before obtaining control of a savings association or savings and loan holding company. A bank holding company must obtain the prior approval of the Federal ReserveFRB under the Bank Holding Company Act before obtaining control or more than 5% of a class of voting stock of a savings association or savings and loan holding company and remains subject to regulation under the Bank Holding Company Act. The term “company” includes corporations, partnerships, associations, and certain trusts and other entities. “Control” of a savings association or savings and loan holding company is deemed to exist if a company has voting control, directly or indirectly of more than 25% of any class of the savings association’s voting stock or controls in any manner the election of a majority of the directors of the savings association or savings and loan holding company, and may be presumed under other circumstances, including, but not limited to, holding in certain cases 10% or more of a class of voting securities if the institution has a class of registered securities, as the Corporation has.securities. Control may be direct or indirect and may occur through acting in concert with one or more other persons. In addition, a savings and loan holding company must obtain Federal ReserveFRB approval prior to acquiring voting control of more than 5% of any class of voting stock of another savings association or another savings association holding company. A similar provision limiting the
34
acquisition by a bank holding company of 5% or more of a class of voting stock of any company is included in the Bank Holding Company Act.
Accordingly, the prior approval of the Federal Reserve BoardFRB would be required:
before any savings and loan holding company or bank holding company could acquire 5% or more of the common stock of the Corporation; and
before any other company could acquire 25% or more of the common stock of the Corporation, and may be required for an acquisition of as little as 10% of such stock.
In addition, persons that are not companies are subject to the same or similar definitions of control with respect to savings and loan holding companies and savings associations and requirements for prior regulatory approval by the Federal ReserveFRB in the case of control of a savings and loan holding company or by the OCC in the case of control of a savings association not obtained through control of a holding company of such savings association.
Sarbanes-Oxley Act. The Sarbanes-Oxley Act was enacted in 2002 in response to public concerns regarding corporate accountability in connection with certain accounting scandals. The stated goals of the Sarbanes-Oxley Act were to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the SEC, under the Securities Exchange Act of 1934, including the Corporation.
The Sarbanes-Oxley Act includes very specific additional disclosure requirements and corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosures, corporate governance and related rules and mandates.rules. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and
management and between a board of directors and its committees. As noted above, the Dodd-Frank Act imposes additional disclosure and corporate government requirements and represents further federal involvement in matters historically addressed by state corporate law.
Dividends and Stock Repurchases. The Federal ReserveFRB’s policy statement on the payment of cash dividends applicable to savings and loan holding companies providesexpresses its view that a savings and loan holding company must maintain an adequate capital position and generally should not pay cash dividends unless the company’s net income for the past year is sufficient to fully fund the cash dividends and that the prospective rate of earnings appears consistent with the company’s capital needs, asset quality, and overall financial condition. The Federal ReserveFRB policy statement also indicates that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. As discussed above, the capital conservation buffer requirements can limit the ability of a savings and loan holding company to pay dividends. In addition, a savings and loan holding company is required to give the Federal ReserveFRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding twelve months, is equal to 10% or more of its consolidated net worth. The Federal ReserveFRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal ReserveFRB order or any condition imposed by, or written agreement with, the Federal Reserve.FRB.
As discussed above, the capital conservation buffer requirements may also limit or preclude dividends payable by the Corporation.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank-Act imposesimposed various restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions and implements capital regulations discussed above under “Federal"Federal Regulation of Savings Institutions - Capital Requirements." In addition, among other changes,requirements, the Dodd-Frank Act requires public companies, such as the Corporation, to (i) provide their shareholders with a non-binding vote (a) at least once every three years on the compensation paid to executive officers and (b) at least once every six years on whether they should have a “say on pay” vote every one, two or three years; (ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments; (iii) provide
35
disclosure in annual proxy materials concerning the relationship between the executive compensation paid and the financial performance of the issuer; and (iv) amend Item 402 of Regulation S-K to requirefor certain public companies to disclose the ratio of the Chief Executive Officer's annual total compensation to the median annual total compensation of all other employees. For certainemployees..
The Coronavirus Aid, Relief, and Economic Security Act of provisions2020: In response to the COVID-19 pandemic, the CARES Act was signed into law on March 27, 2020. Among other things, the CARES Act directs federal banking agencies to adopt interim final rules to lower the threshold under the CBLR from 9% to 8% and to provide a reasonable grace period for a community bank that falls below the threshold to regain compliance, in each case until the earlier of the Act, the implementing regulations have not been promulgated, so the full impacttermination date of the Dodd-Franknational emergency or December 31, 2020. In April 2020, the federal banking agencies issued two interim final rules implementing this directive. One interim final rule provides that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement.
The CARES Act also allows banks to elect to suspend requirements under accounting principles generally accepted in the United States of America (“GAAP”) for loan modifications related to the COVID-19 pandemic (for loans that were not more than 30 days past due as of December 31, 2019) that would otherwise be categorized as a restructured loan, including impairment for accounting purposes, until the earlier of 60 days after the termination date of the national emergency or December 31, 2020. According to the CARES Act and related banking agency guidance, banks are not be required to designate as a troubled debt restructuring loans that were modified as a result of the COVID-19 pandemic and made on public companies cannot be determined at this time.a good faith basis to borrowers who were current. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act and related banking agency guidance if they were not more than 30 days past due on their contractual payments as of December 31, 2019, or prior to any relief, respectively, and have experienced financial difficulty as a result of COVID-19. For additional information related to loan modifications as a result of the COVID-19 pandemic, see “Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – COVID-19 Impact to the Corporation.”
The CARES Act also authorized the Small Business Administration (“SBA”) to temporarily guarantee loans under a new loan program called the Paycheck Protection Program, or PPP. The goal of the PPP was to avoid as many layoffs as possible, and to encourage small businesses to maintain payrolls. The Bank did not participate in the PPP loan program..
TAXATION
Federal Taxation
General. The Corporation and the Bank report their income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank’s reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Corporation. On December 22, 2017, the U.S. Government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and businesses. For businesses, the Tax Act reduces the corporate federal income tax rate from a maximum of 35% to a flat 21%. The corporate federal income tax rate reduction was effective January 1, 2018.
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Other major changes include expensing of equipment investment; elimination of personal and dependent exemptions, the tax on people who do not obtain adequate health insurance coverage, and the corporate alternative minimum tax; and increases in the standard deduction, the estate tax exemption, and the individual alternative minimum tax exemption.
Tax Bad Debt Reserves. As a result of legislation enacted in 1996, the reserve method of accounting for bad debt reserves was repealed for tax years beginning after December 31, 1995. Due to such repeal, the Bank is no longer able to calculate its deduction for bad debts using the percentage-of-taxable-income or the experience method. Instead, the Bank is permitted to deduct as bad debt expense its specific charge-offs during the taxable year. In addition, the legislation required savings institutions to recapture into taxable income, over a six-year period, their post 1987 additions to their bad debt tax reserves. As of the effective date of the legislation, the Bank had no post 1987 additions to its bad debt tax reserves. As of June 30, 2017,2020, the Bank’s total pre-1988 bad debt reserve for tax purposes was approximately $9.0 million. Under current law, a savings institution will not be required to recapture its pre-1988 bad debt reserve unless the Bank makes a “non-dividend distribution” as defined below. Currently, the Corporation uses the specific charge-off method to account for bad debt deductions for income tax purposes.
Distributions. In the event that the Bank makes “non-dividend distributions” to the Corporation that are considered as made from the reserve for losses on qualifying real estate property loans, to the extent the reserve for such losses exceeds the amount that would have been allowed under the experience method or from the supplemental reserve for losses on loans (“Excess Distributions”), then an amount based on the amount distributed will be included in the Bank’s taxable income. Non-dividend distributions include distributions in excess of the Bank’s current and accumulated earnings and profits, distributions in redemption of stock, and
distributions in partial or complete liquidation. However, dividends paid out of the Bank’s current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank’s bad debt reserve. Thus, any dividends to the Corporation that would reduce amounts appropriated to the Bank’s bad debt reserve and deducted for federal income tax purposes would create a tax liability for the Bank. The amount of additional taxable income attributable to an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if the Bank makes a “non-dividend distribution,” then approximately one and one-half times the amount distributed will be included in taxable income for federal income tax purposes, assuming a 35% corporate income tax rate (exclusive of state and local taxes).purposes. For additional information, see "Regulation - Federal Regulation of Savings Institutions - Limitations on Capital Distributions” in this Form 10-K for limits on the payment of dividends by the Bank. The Bank does not intend to pay dividends that would result in a recapture of any portion of its tax bad debt reserve. During fiscal 2017,2020, the Bank declared and paid $10.0$7.5 million of cash dividends to the Corporation while the Corporation declared and paid $4.1$4.2 million of cash dividends to shareholders.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative minimum taxable income (“AMTI”) at a rate of 20%. In addition, only 90% of AMTI can be offset by net operating loss carryovers. AMTI is increased by an amount equal to 75% of the amount by which the Corporation’s adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses).
Tax Effect from Stock-Based Compensation. During fiscal 2017,2020, there were no shares of restricted common stock distributed to employee or non-employee members of the Corporation’s Board of Directors. ThereAlso, there were 87,750 shares of restricted common stock distributed to employees, 15,250 shares of restricted common stock that were forfeited, 92,850 shares of non-qualified stock options that expired, 16,010no shares of non-qualified stock options exercised and 33,854while 12,528 shares of incentive stock options that were exercised as disqualifying dispositions of the Corporation’s common stock during fiscal 2017.dispositions. As a result, there was a $42,000$5,000 federal tax benefit effect from stock-based compensation in fiscal 2017.2020.
Other Matters. 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 2009 and 2010. Fiscal 2016 and fiscal years 2013 and forwardthereafter remain subject to federal examination, while the California state tax returns for fiscal 2015 and fiscal years 2012 and forwardthereafter are subject to examination by state taxing authorities.
State Taxation
California. The California franchise tax rate applicable to the Bank, equals the franchise tax rate applicable to corporations generally, plus an “in lieu” rate of 2%, which is approximately equal to personal property taxes and business license taxes paid by such corporations (but not generally paid by banks or financial corporations such as the Corporation). At June 30, 20172020 and 2016,
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2019, the Corporation’s net state tax rate was 7.1%8.5% and 7.0%7.7%, respectively. Bad debt deductions are available in computing California franchise taxes using the specific charge-off method. The Bank and its California subsidiaries file California franchise tax returns on a combined basis. The Corporation will be treated as a general corporation subject to the general corporate tax rate. There was a $15,000$3,000 state tax benefit effect from stock-based compensation in fiscal 2017,2020, as described above in the section entitled "Federal Taxation."
Delaware. As a Delaware holding company not earning income in Delaware, the Corporation is exempted from Delaware corporate income tax, but is required to file an annual report with and pay an annual franchise tax to the State of Delaware. InDuring fiscal 2017, 20162020 and 2015,2019, the Corporation paid annual franchise taxes of $180,000 for each year.$200,000 and $200,000, respectively.
EXECUTIVE OFFICERS
The following table sets forth information with respect to the executive officers of the Corporation and the Bank:
|
| | | |
| | Position |
Name | Age(1) | Corporation | Bank |
| | | |
Craig G. Blunden | 6972 | Chairman and | Chairman and |
| | Chief Executive Officer | Chief Executive Officer |
| | | |
Robert "Scott" Ritter | 4851 | — | Senior Vice President |
| | | Provident Bank MortgageSingle-Family Division |
| | | |
Donavon P. Ternes | 5760 | President | President |
| | Chief Operating Officer | Chief Operating Officer |
| | Chief Financial Officer | Chief Financial Officer |
| | Corporate Secretary | Corporate Secretary |
| | | |
David S. Weiant | 5861 | — | Senior Vice President |
| | | Chief Lending Officer |
| | | |
Gwendolyn L. Wertz | 5154 | — | Senior Vice President |
| | | Retail Banking Division |
| |
(1) | As of June 30, 2017.2020. |
Biographical Information
Set forth below is certain information regarding the executive officers of the Corporation and the Bank. There are no family relationships among or between the executive officers.
Craig G. Blunden has been associated with theProvident Savings Bank since 1974, has held his positions at the Bank since 1991 andcurrently serving as Chairman and Chief Executive Officer of the CorporationBank and Provident, positions he has held since 1991 and 1996, respectively. He served as President of the Bank from 1991 until June 2011 and as President of Provident from its formation in 1996.1996 until June 2011. Mr. Blunden also serves on the Board of Directors of the FHLB – San Francisco, the CaliforniaWestern Bankers Association and is past Chairman of the Board of the Greater Riverside Chamber of Commerce.Association.
Robert "Scott" Ritter joined the Bank as Senior Vice President of the Provident Bank Mortgage division on September 26, 2016.2016 and currently oversees the single-family mortgage division. Prior to joining the Bank, Mr. Ritter was the Chief Operating Officer at California Mortgage Advisors since November 2011 where he was responsible for overseeing all of California Mortgage Advisors' operations, including product
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development, underwriting, loan processing and information technology. Prior to that, he held positions with increasing responsibilities at mortgage banking firms such as Green Point Financial and its predecessor Headlands Mortgage Company, among others.
Donavon P. Ternes joined the Bank and the Corporation as Senior Vice President and Chief Financial Officer on November 1, 2000 and was appointed Secretary of the Corporation and the Bank in April 2003. Effective January 1, 2008, Mr. Ternes was appointed Executive Vice President and Chief Operating Officer, while continuing to serve as the Chief Financial Officer and Corporate Secretary of the Bank and the Corporation. Effective June 27, 2011, the Board of Directors of the Bank and the Corporation promoted Mr. Ternes to serve as President of the Bank and the Corporation, while continuing to serve as Chief Operating Officer, Chief Financial Officer and Corporate Secretary. Prior to joining the Bank, Mr. Ternes was the President, Chief Executive Officer, Chief Financial Officer and Director of Mission Savings and Loan Association, located in Riverside, California, holding those positions for over 11 years.
David S. Weiant joined the Bank as Senior Vice President and Chief Lending Officer on June 29, 2007. Prior to joining the Bank, Mr. Weiant was a Senior Vice President of Professional Business Bank (June 2006 to June 2007) where he was responsible for commercial lending in the Los Angeles and Inland Empire regions of Southern California.
Gwendolyn L. Wertz joined the Bank as Senior Vice President of Retail Banking on February 3, 2014. Prior to joining the Bank, Ms. Wertz was with CommerceWest Bank where she was responsible for the management of commercial banking activities, treasury management and specialty banking. Prior to that she was with Opportunity Bank, N.A. where she was responsible for the commercial treasury sales and service team. Ms. Wertz has more than 2530 years of experience with financial institutions including the last 1015 years in senior management roles. Her experience includes depository growth initiatives, operations, compliance, and deposit acquisition management.
Item 1A. Risk Factors
We assume and manage a certain degree of risk in order to conduct our business. In addition to the risk factors described below, other risks and uncertainties not specifically mentioned, or that are currently known to, or deemed by, management to be immaterial also may materially and adversely affect our financial position, results of operation and/or cash flows. Before making an investment decision, you should carefully consider the risks described below together with all of the other information included in this Form 10-K. If any of the circumstances described in the following risk factors actually occur to a significant degree, the value of our common stock could decline, and you could lose all or part of your investment.
The COVID-19 pandemic has adversely impacted our ability to conduct business and is expected to adversely impact our financial results and those of our customers. The ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.
The COVID-19 pandemic has significantly adversely affected our operations and the way we provide banking services to businesses and individuals, many of whom were under government issued stay-at-home orders for much of the three months ended June 30, 2020. As an essential business, we continue to provide banking and financial services to our customers with in-person and drive-thru access available at the majority of our branch locations. In addition, we continue to provide access to banking and financial services through online banking, ATMs and by telephone. If the COVID-19 pandemic worsens it could limit or disrupt our ability to provide banking and financial services to our customers.
Although the stay-at-home orders have been partially lifted in California, some of our employees continue to work remotely to enable us to continue to provide banking services to our customers. Heightened cybersecurity, information security and operational risks may result from these remote work-from-home arrangements. We also could be adversely affected if key
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personnel or a significant number of employees were to become unavailable due to the effects and restrictions of the COVID-19 pandemic. We also rely upon our third-party vendors to conduct business and to process, record and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.
There is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the start of the pandemic. As a result, management is confronted with a significant and unfamiliar degree of uncertainty in estimating the impact of the pandemic on credit quality, revenues and asset values. To date, the COVID-19 pandemic has resulted in declines in loan demand and originations, deposit availability, market interest rates and negatively impacted many of our business and consumer borrower’s ability to make their loan payments. Because the length of the pandemic and the efficacy of the extraordinary measures being put in place by the government to address its economic consequences are unknown, including a continued low recent reductions in the targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest margin will be adversely affected. Many of our borrowers have become unemployed or may face unemployment, and certain businesses are at risk of insolvency as their revenues decline precipitously, especially in businesses related to travel, hospitality, leisure and physical personal services. Businesses may ultimately not reopen as there is a significant level of uncertainty regarding the level of economic activity that will return to our markets over time, the impact of governmental assistance, the speed of economic recovery, the resurgence of COVID-19 in subsequent seasons and changes to demographic and social norms that will take place.
The impact of the pandemic is expected to continue to adversely affect us during calendar 2020 and possibly longer as the ability of many of our customers to make loan payments has been significantly affected. Although the Corporation makes estimates of loan losses related to the pandemic as part of its evaluation of the allowance for loan losses, such estimates involve significant judgment and are made in the context of significant uncertainty as to the impact the pandemic will have on the credit quality of our loan portfolio. It is possible that increased loan delinquencies, adversely classified loans and loan charge-offs will increase in the future as a result of the pandemic. Consistent with guidance provided by banking regulators, we have modified loans by providing various loan payment deferral options to our borrowers affected by the COVID-19 pandemic. Notwithstanding these modifications, these borrowers may not be able to resume making full payments on their loans once the deferral period is over or the COVID-19 pandemic is resolved. Any increase in the allowance for credit losses will result in a decrease in net income and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.
Even after the COVID-19 pandemic subsides, the U.S. economy will likely require some time to recover from its effects, the length of which is unknown, and during which we may experience a recession. As a result, we anticipate our business may be materially and adversely affected during this recovery. To the extent the effects of the COVID-19 pandemic adversely impact our business, financial condition, liquidity or results of operations, it may also have the effect of heightening many of the other risks described below.
Our business may be adversely affected by downturns in the national economy and the regional economies on which we depend.
As of June 30, 2017,2020, approximately 78%76% of our real estate loans were secured by collateral and made to borrowers located in Southern California with the balance located predominantly throughout the rest of California. Adverse economic conditions in California may reduce our rate of growth, affect our customers' ability to repay loans and adversely impact our financial condition and earnings. General economic conditions, including inflation, unemployment and money supply fluctuations, also may adversely affect our profitability adversely. Weakness in the global economy has adversely affected many businesses operating in our markets that are dependent upon international trade and it is not known how the recent withdrawal by the United States from the Trans-Pacific Partnershipchanges in tariffs being imposed on international trade agreement may also affect these businesses. Changes in agreements or relationships between the United States and other countries may also affect these businesses. The COVID-19 pandemic has adversely impacted most of the Company's
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customers directly or indirectly. Their businesses have been adversely affected by quarantines and unemployment rates have recently improved,travel restrictions due to the COVID-19 pandemic. See “-The COVID-19 pandemic has adversely impacted our ability to conduct business and is expected to adversely impact our financial results and those of our customers. The ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.”
A deterioration in economic conditions in the market areas we serve as a result of COVID-19 or other factors could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:
an increase in loan delinquencies, problem assets and foreclosures;
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▪ | an increase in loan delinquencies, problem assets and foreclosures; |
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▪ | the slowing of sales of foreclosed assets; |
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▪ | a decline in demand for our products and services; |
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▪ | a decline in the value of collateral for loans may in turn reduce customers' borrowing power, and the value of assets and collateral associated with existing loans; |
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▪ | the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; and |
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▪ | a decrease in the amount of our low cost or non interest-bearing deposits. |
we may increase our allowance for loan losses;
the slowing of sales of foreclosed assets;
a decline in demand for our products and services;
a decline in the value of collateral for loans may in turn reduce customers' borrowing power, and the value of assets and collateral associated with existing loans;
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; and
a decrease in the amount of our low cost or non interest-bearing deposits.
A decline in Southern California economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse. Many of the loans in our portfolio are secured by real estate. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower’s ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors, including changes in general or regional economic conditions, governmental rules or policies and natural disasters such as fires and earthquakes. If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected.
A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.
A return of recessionary conditions and/or negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate values and sales volumes and high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.
Furthermore, the Board of Governors of the Federal Reserve System, in an attempt to help the overall economy, has, among other things, adjust interest rates through its targeted federal funds rate. The Federal Reserve Board has increased the federal funds rate by 25 basis points to a range of 1.00% to 1.25% in June 2017 and indicated further increases in the federal funds rate in the future.
As the federal funds rate increases, market interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic recovery. In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of underlying collateral securing loans, which could negatively affect our financial performance.
Our business may be adversely affected by credit risk associated with residential property.
At June 30, 2017, $322.22020, $298.8 million, or 35.2%33.0% of our loans held for investment, were secured by single-family residential real property. This type of lending is generally sensitive to regional and local economic conditions that may significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. Declines in residential real estate values securing these types of loans may increase the level of borrower defaults and losses above our recent charge-off experience on these loans. Jumbo single-family loans which do not conform to secondary market mortgage requirements for our market areas are not immediately saleable in the secondary market and may expose us to increased risk because of their larger balances. Further, manyRecessionary conditions or declines in the volume of single-family real estate sales and/or the sales prices as well as elevated unemployment rates may result in higher than expected loan delinquencies or problem assets, and a decline in demand for our products and services. These potential negative events may cause us to incur losses, adversely affect our capital and liquidity and damage our financial condition and business operations.
Some of our residential mortgage loans are secured by liens on mortgage properties in which the borrowers have little or no equity because either we originated a first mortgage with an 80% loan-to-value ratio and a concurrent second mortgage for a combined loan-to-value ratio of up to 100% or because of the decline in home values in our market areas. Residential loans with high loan-to-value ratios will be more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses.
Our prior emphasis on non-traditional single-family residential loans exposes us to increased lending risk.
During the fiscal years ended June 30, 2017 and 2016, we originated $1.99 billion and $2.00 billion, respectively, in single-family residential loans. We historically sell the vast majority of the single-family residential loans we originate and purchase and retain the remaining single-family residential loans as held for investment. As a result of our current focus on managing our asset quality, single-family loans originated and purchased for investment were $99.8 million and $41.4 million during these same time periods, virtually all of which conform to or satisfy the requirements for sale in the secondary market.
Prior to fiscal 2009, many of the loans we originated for investment consisted of non-traditional single-family residential loans that do not conform to Fannie Mae or Freddie Mac underwriting guidelines as a result of the characteristics of the borrower or property, the loan terms, loan size or exceptions from agency underwriting guidelines. In exchange for the additional risk to us associated with these loans, these borrowers generally are required to pay a higher interest rate, and depending on the credit history, a lower loan-to-value ratio was generally required than for a conforming loan. Our non-traditional single-family
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residential loans include interest-only loans, loans to borrowers who provided limited or no documentation of their income or stated income loans, negative amortization loans (a loan in which accrued interest exceeding the required monthly loan payment is added to loan principal up to 115% of the original loan amount), more than 30-year amortization loans, and loans to borrowers with a FICO score below 660 (these loans are considered subprime by the OCC). Including these low FICO score loans, as of June 30, 2017,2020, our single-family residential borrowers had a weighted average FICO score of 736750 at the time of loan origination.
As of June 30, 2017,2020, these non-traditional loans totaled $113.4$40.9 million, comprising 35.2%13.7% of total single-family residential loans held for investment and 12.5%4.5% of total loans held for investment. At that date, interest-only loans totaled $17.6 million, stated income loans totaled $100.3 million, negative amortization loans totaled $2.7$38.5 million, more than 30-year amortization loans totaled $10.2$5.8 million, and low FICO score loans totaled $9.5$3.4 million, negative amortization loans totaled $622,000 (the outstanding balances described may overlap more than one category). In the case of interest-only loans, a borrower's monthly payment is subject to change when the loan converts to fully-amortizing status. Of the $17.6 million of interest-only loans, $17.0 million begin to fully amortize within one year and $578,000 begin to fully amortize after one to five years. Since the borrower's monthly payment may increase by a substantial amount even without an increase in prevailing market interest rates, there is no assurance that the borrower will be able to afford the increased monthly payment at the time of conversion. Additionally, lower prevailing prices for residential real estate may make it difficult for borrowers to sell their homes to pay off their mortgages and tightened underwriting standards may make it difficult for borrowers to refinance their loan prior to the time of conversion to fully-amortizing status. At June 30, 2017, $451,000 of our interest-only single-family residential loans were non-performing and none were 30-89 days delinquent.
In the case of stated income loans, a borrower may misrepresent his income or source of income (which we have not verified) to obtain the loan. The borrower may not have sufficient income to qualify for the loan amount and may not be able to make the monthly loan payment. At June 30, 2017, $5.2 million of our stated income single-family residential loans were non-performing and none were 30-89 days delinquent.
In the case of more than 30-year amortization loans, the term of the loan requires many more monthly payments from the borrower (ultimately increasing the cost of the home) and subjects the loan to more interest rate cycles, economic cycles and employment cycles, which increases the possibility that the borrower is negatively impacted by one of these cycles and is no longer willing or able to meet his or her monthly payment obligations. At June 30, 2017, $220,000 of our more than 30-year amortization single-family residential loans were non-performing and none were 30-89 days delinquent.
Negative amortization involves a greater risk to us because credit risk exposure increases when the loan incurs negative amortization and the value of the home serving as collateral for the loan does not increase proportionally. Negative amortization is only permitted up to a specified level and the payment on such loans is subject to increased payments when the level is reached, adjusting periodically as provided in the loan documents and potentially resulting in higher payments from the borrower. The adjustment of these loans to higher payment requirements can be a substantial factor in higher loan delinquency levels because the borrowers may not be able to make the higher payments. Also, real estate values may decline and credit standards may tighten in concert with the higher payment requirement, making it difficult for borrowers to sell their homes or refinance their mortgages to pay off their mortgage obligation. As of June 30, 2017, the Bank had $2.7 million of single-family loans which permitted negative amortization as compared to $3.1 million of single-family loans at June 30, 2016.
Our multi-family and commercial real estate loans involve higher principal amounts than other loans and repayment of these loans may be dependent on factors outside our control or the control of our borrowers.
We originate multi-family residential and commercial real estate loans for individuals and businesses for various purposes, which are secured by residential and non-residential properties. At June 30, 2017,2020, we had $577.5$597.1 million or 63.0%66.0% of total loans held for investment in multi-family and commercial real estate mortgage loans. These loans typically involve higher principal amounts than other types of loans and repayment issome of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a single-family residential loan. Repayment on these loans are dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower's project is reduced as a result of leases not being obtained or renewed, the borrower's ability to repay the loan may be impaired. Multi-family and commercial real estate loans also expose a lender to greater credit risk than loans secured by single-family residential real estate because the collateral securing these loans typically cannot be sold as easily as single-family residential real estate. In addition, many of our multi-family and commercial real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property to make the payment, which may increase the risk of default or non-payment. In addition, as of June 30, 2017,2020, the Bank had $6.3$4.7 million in negative amortization multi-family and commercial real estate mortgage loans (a loan in which accrued interest exceeding the required monthly loan payment may be added to the loan principal) as compared to $7.1$5.0 million in multi-family and commercial real estate loans at June 30, 2016.2019. Negative amortization involves a greater risk to the Bank because the credit risk exposure increases when the loan incurs negative amortization and the value of the property serving as collateral for the loan does not increase proportionally.
IfA secondary market for many types of multi-family and commercial real estate loans is not readily liquid, so we have less opportunity to mitigate credit risk by selling part or all of our interest in these loans. As a result of these characteristics, if we foreclose on a multi-family or commercial real estate loan, our holding period for the collateral typically is longer than for a single-family residential mortgage loan because there are fewer potential purchasers of the collateral. Additionally, multi-family and commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, charge-offs on multi-family and commercial real estate loans may be larger on a per loan basis than those incurred with our single-family residential or consumer loan portfolios.
We occasionally purchase loans in bulk or “pools.” We may experience lower yields or losses on loan “pools” because the assumptions we use when purchasing loans in bulk may not prove correct.
In order to achieve our loan growth objectives and/or improve earnings, we may purchase loans, either individually, through participations, or in bulk. The Corporation purchased $61.7$142.1 million of loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2017,2020, compared to $45.9$51.1 million of purchased loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2016.2019. When we determine the purchase price we are willing to pay to purchase loans in bulk, management makes certain assumptions about, among other things, how fast borrowers will prepay their loans,
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the real estate market, our ability to collect loans successfully and, if necessary, our ability to dispose of any real estate that may be acquired through foreclosure. When we purchase loans in bulk, we perform certain due diligence procedures and typically require customary limited indemnities. To the extent that our underlying assumptions prove to be inaccurate or the basis for those assumptions change, the purchase price paid for “pools” of loans may prove to have been excessive, resulting in a lower yield or a loss of some or all of the loan principal. For example, if we purchase pools of loans at a premium and some of the loans are prepaid before we expected we will earn less interest income on the purchase than expected. Our success in growing through purchases of loan “pools” depends on our ability to price loan “pools” properly and on the general economic conditions within the geographic areas where the underlying properties of our loans are located.
Acquiring loans through bulk purchases may involve acquiring loans of a type or in geographic areas where management may not have substantial prior experience. We may experience continuing variation in our operating results.be exposed to a greater risk of loss to the extent that bulk purchases contain such loans.
We reported net income of $5.2 million, $7.5 million and $9.8 million for the fiscal years ended June 30, 2017, 2016 and 2015, respectively. Several factors affecting our business can cause significant variations in our quarterly and annual results of operations. In particular, variations in the volume of our loan originations and sales, the differences between our costs of funds and the average interest rates of originated or purchased loans, our inability to complete significant loan sale transactions in a particular quarter and problems generally affecting the mortgage loan industry can result in significant increases or decreases in our revenues from quarter to quarter. A delay in closing a particular loan sale transaction during a quarter or year could postpone recognition of the gain on sale of loans. If we were unable to sell a sufficient number of loans at a premium in a particular reporting period, our revenues for such period could decline, resulting in lower net income and possibly a net loss for such period, which could have a material adverse effect on our results of operations and financial condition.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
cash flow of the borrower and/or the project being financed;
the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
the duration of the loan;
the character and creditworthiness of a particular borrower; and
changes in economic and industry conditions.
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▪ | cash flow of the borrower and/or the project being financed; |
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▪ | the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan; |
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▪ | the duration of the loan; |
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▪ | the character and creditworthiness of a particular borrower; and |
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▪ | changes in economic and industry conditions. |
We maintain an allowance for loan losses, which is a reserve established through a provision (recovery) for loan losses charged (credited) to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by management through periodic reviews and consideration of several factors, including, but not limited to:
our collectively evaluated allowance, based on our historical default and loss experience and certain macroeconomic factors based on management's expectations of future events; and
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▪ | our collectively evaluated allowance, based on our historical default and loss experience and certain macroeconomic factors based on management's expectations of future events; and |
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▪ | our individually evaluated allowance, based on our evaluation of non-performing loans and the underlying collateral. |
our individually evaluated allowance, based on our evaluation of non-performing loans and the underlying fair value of collateral or based on discounted cash flow for restructured loans.
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans, losses, and delinquency experience, and evaluate economic conditions and make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for additions to our allowance through an increase in the provision for loan losses.losses, which is charged against income. Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the provision for loan losses and our allowance for loan losses. Further, included in our single-family residential loan portfolio, which comprised 35.2%33.0% of our total loan portfolio at June 30, 2017,2020, were $113.4$40.9 million or 12.5%4.5% of total loans held for investment of inthat were non-traditional single-family loans, which include interest-only loans, negative amortization and more than 30-year amortization loans, stated income loans and low FICO score loans, all of which have a higher risk of default and loss than conforming residential mortgage loans. For additional information, see “Our prior emphasis on non-traditional single-familybusiness may be adversely affected by credit risk associated with residential loans exposes us to increased lending risk”property” above. Management also recognizes that significant new growth in loan portfolios, new loan products and the refinancing of existing loans can result in portfolios comprised of unseasoned loans that
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may not perform in a historical or projected manner and will increase the risk that our allowance may be insufficient to absorb losses without significant additional provisions. Furthermore, the Financial Accounting Standards Board (“FASB”) has adopted a new accounting standard, ASC 326 Current Expected Credit Losses (“CECL”), that will be effective for our first fiscal yearyears, including interim periods within those fiscal years, beginning after December 15, 2019.2019, however, the FASB board in July 2019 extended the adoption date for certain SEC registrants, including the Corporation, to fiscal years, including interim periods within those fiscal years, beginning after December 15, 2022. This standard referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for credit losses.losses at inception of the loan. This will change the current method of providing allowances for credit losses that are probable, which may require us to increase our allowance for loan losses, and may greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for credit losses. The federal banking regulators (the FRB, the OCC and the FDIC) have adopted a rule that applies to smaller reporting companies, such as the Corporation, beginning in 2023. In addition, a further decline in national and local economic conditions, including as a result of the COVID-19 pandemic, results of the bank regulatory agencies periodicallyperiodic review our allowance for loan losses or other factors and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. Lastly, ifcharge-offs. If charge-offs in future periods exceed the allowance for loan losses, we willmay need additional provisions to increase the allowance for loan losses. Any increases in the provision for
loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations and capital.
If our non-performing assets increase, our earnings will be adversely affected.
At June 30, 2017, 20162020 and 2015,2019, our non-performing assets (which consist of non-accrual loans and real estate owned (“REO”)) were $9.6 million, $13.0$4.9 million and $16.3$6.2 million, respectively, or 0.8%, 1.1%0.42% and 1.4%0.57% of total assets, respectively. Our non-performing assets adversely affect our net income in various ways:
we record interest income only on a cash basis for non-accrual loans except for non-performing loans under the cost recovery method where interest is applied to the principal of the loan as a recovery of the charge-offs, if any, and we do not record interest income for REO;
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▪ | we record interest income only on a cash basis for non-accrual loans except for non-performing loans under the cost recovery method where interest is applied to the principal of the loan as a recovery of the charge-offs, if any, and we do not record interest income for REO; |
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▪ | we must provide for probable loan losses through a current period charge to the provision for loan losses; |
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▪ | non-interest expense increases when we write down the value of properties in our REO portfolio to reflect changing market values or recognize other-than-temporary impairment (“OTTI”) on non-performing investment securities; |
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▪ | there are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance fees related to our REO; and |
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▪ | the resolution of non-performing assets requires the active involvement of management, which can distract them from more profitable activity. |
we must provide for probable loan losses through a current period charge to the provision for loan losses;
non-interest expense increases when we write down the value of properties in our REO portfolio to reflect changing market values or recognize other-than-temporary impairment (“OTTI”) on non-performing investment securities;
there are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance fees related to our REO; and
the resolution of non-performing assets requires the active involvement of management, which can distract them from more profitable activity.
If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our non-performing assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our financial condition and results of operations.
Our securities portfolio may be negatively impacted by fluctuations in market value and interest rates.
Our securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other comprehensive income and/or earnings. Fluctuations in market value may be caused by changes in market interest rates, lower market prices for securities and limited investor demand. Our securities portfolio is evaluated for other-than-temporary impairment. If this evaluation shows impairment to the actual or projected cash flows associated with one or more securities, a potential loss to earnings may occur. Changes in interest rates can also have an adverse effect on our financial condition, as our available-for-sale securities are reported at their estimated fair value, and therefore are impacted by fluctuations in interest rates. We increase or decrease our shareholders' equity by the amount of change in the estimated fair value of the available-for-sale securities, net of taxes. There can be no assurance that the declines in market value, including as a result of the COVID-19 pandemic, will not result in other-than-temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net incomeresults of operations and capital levels.
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Uncertainty relating to the LIBOR calculation process and potential phasing out of LIBOR may adversely affect our results of operations.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, subordinated debentures, or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally. The FRB, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S. dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities ("SOFR"). SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question, although transactions using SOFR have been completed including by Fannie Mae. Both Fannie Mae and Freddie Mac have recently announced that they will cease accepting adjustable rate mortgages tied to LIBOR by the end of 2020 and will soon begin accepting mortgages based on SOFR. Continued uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans and securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may incur significant expenses in effecting the transition, and may be subject to disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our results of operations.
If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.
We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed upon and the property is taken in as REO and at certain other times during the REO holding period. Our net book value (“NBV”) in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (“fair value”). A charge-off is recorded for any excess in the asset's NBV over its fair value. If our valuation process is incorrect, the fair value of the investments in real estate may not be sufficient to recover our NBV in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in real estate could have a material adverse effect on our financial condition and results of operations.
In addition, bank regulators periodically review our REO and may require us to recognize further charge-offs. Any increase in our charge-offs, as required by the bank regulators, may have a material adverse effect on our financial condition and results of operations.
An increase in interest rates, change in the programs offered by governmental sponsored entities (“GSE”) or our ability to qualify for such programs may reduce our mortgage revenues, which would negatively impact our non-interest income.
Our mortgage banking operations provide a significant portion of our non-interest income. We generate mortgage revenues primarily from gains on the sale of single-family residential loans pursuant to programs currently offered by Fannie Mae, Freddie Mac and other investors on a servicing released basis. These entities account for a substantial portion of the secondary market in
residential mortgage loans. Any future changes in these programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially adversely affect our results of operations. Further, in a rising or higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This would result in a decrease in mortgage revenues and a corresponding decrease in non-interest income. In addition, our results of operations are affected by the amount of non-interest expense associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations.
Secondary mortgage market conditions could have a material adverse impact on our financial condition and earnings.
In addition to being affected by interest rates, the secondary mortgage markets are also subject to investor demand for single-family residential loans and mortgage-backed securities and increased investor yield requirements for those loans and securities. These conditions may fluctuate or even worsen in the future. In light of current conditions, there is a higher risk to retaining a larger portion of mortgage loans than we would in other environments until they are sold to investors. We believe our ability to retain mortgage loans is limited. As a result, a prolonged period of secondary market illiquidity may reduce our loan production volumes and could have a material adverse impact on our future earnings and financial condition.
Any breach of representations and warranties made by us to our loan purchasers or credit default on our loan sales may require us to repurchase or substitute such loans we have sold.
We engagehave previously engaged in bulk loan sales pursuant to agreements that generally require us to repurchase or substitute loans in the event of a breach of a representation or warranty made by us to the loan purchaser. Any misrepresentation during
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the mortgage loan origination process or, in some cases, upon any fraud or early payment default on such mortgage loans, may require us to repurchase or substitute loans. Any claims asserted against us in the future by one of our loan purchasers may result in liabilities or legal expenses that could have a material adverse effect on our results of operations and financial condition. During fiscal 2017, 20162020 and 2015,2019, the Bank repurchased $1.7 million, $1.7$1.1 million and $1.6 million$948,000 of single-familysingle family loans, respectively. However, many additional repurchase requests were settled during the periods that did not result in the repurchase of the loan itself. Aggregate payments of $11,000, $470,000 and $50,000 were made for loan repurchase settlements in fiscal 2017, 2016 and 2015, respectively. The loan repurchase settlement in fiscal 2016 was due primarily to a global settlement with one of the Bank’s legacy loan investors, which eliminated all past, current and future repurchase claims from this particular investor, in exchange for a one-time $400,000 payment.
The CFPB, which was created under the Dodd-Frank Act, has issued a number of final regulations and changes to certain consumer protections under existing laws and continues to issue new rules. These final rules, most of the provisions of which (including the qualified mortgage rule) generally prohibit creditors from extending mortgage loans without regard for the consumer’s ability-to-repay and add restrictions and requirements to mortgage origination and servicing practices. In addition, these rules limit prepayment penalties and require the creditor to retain evidence of compliance with the ability-to-repay requirement for three years. Compliance with these rules has increased our overall regulatory compliance costs and may require changes to our underwriting practices with respect to residential mortgage loans. This includes compliance with, The Truth in Lending Act and the Real Estate Settlement Procedures Act Integrated Disclosure (TRID) rule, which combines certain disclosures that consumers receive in connection with applying for and closing a mortgage loan. Moreover, these rules may adversely affect the volume of mortgage loans that we originate for sale and may subject us to increased potential liabilities and/or repurchases if we fail to comply with these rules.
Hedging against interest rate exposure may adversely affect our earnings.
We employ techniques that limit, or “hedge,” the adverse effects of rising interest rates on our loans held for sale, originated interest rate locks and our mortgage servicing asset. Our hedging activity varies based on the level and volatility of interest rates and other changing market conditions. These techniques may include purchasing or selling futures contracts, purchasing put and call options on securities or securities underlying futures contracts, or entering into other mortgage-backed derivatives. There are, however, no perfect hedging strategies, and interest rate hedging may fail to protect us from loss. Moreover, hedging activities could result in losses if the event against which we hedge does not materialize. Additionally, interest rate hedging could fail to protect us or adversely affect us because, among other things:
available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;
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▪ | available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought; |
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▪ | the duration of the hedge may not match the duration of the related liability; |
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▪ | the party owing money in the hedging transaction may default on its obligation to pay; |
the duration of the hedge may not match the duration of the related liability;
the party owing money in the hedging transaction may default on its obligation to pay;
the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction;
the value of derivatives used for hedging may be adjusted from time to time in accordance with accounting rules to reflect changes in fair value; and
downward adjustments, or “mark-to-market losses,” would reduce our stockholders' equity.
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▪ | the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; |
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▪ | the value of derivatives used for hedging may be adjusted from time to time in accordance with accounting rules to reflect changes in fair value; and |
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▪ | downward adjustments, or “mark-to-market losses,” would reduce our stockholders' equity. |
Fluctuating interest rates can adversely affect our profitability.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board.FRB. After steadily increasing the target federal funds rate in 2018 and 2017, the FRB in 2019 decreased the target federal funds rate by 75 basis points, and in response to the COVID-19 pandemic in March 2020, an additional 150 basis point decrease to a range of 0.0% to 0.25% as of March 31, 2020. The FRB could make additional changes in interest rates during 2020 subject to economic conditions. If the FRB changes the targeted Fed Funds rate, overall interest rates will likely rise or fall, which may negatively impact the housing markets and the U.S. economic recovery. In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of collateral securing loans, which could negatively affect our financial performance.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, which could negatively impact shareholders' equity, and our ability to realize gains from the sale of such assets; (iii) our ability to obtain and retain deposits in competition with other available investment alternatives; (iv) the ability of our borrowers to repay adjustable or variable rate loans; and (v) the average duration of our mortgage-backedinvestment securities portfolio and other interest-earning assets. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments decline more rapidly than the interest rates paid on deposits and other borrowings. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially affected.
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A sustained increase in market interest rates could adversely affect our earnings. As is the case with many financial institutions, our emphasis on increasing the development of core deposits, those deposits bearing no or a relatively low rate of interest with no stated maturity date, has resulted in our having a significant amount of these deposits bearing a relatively low rate of interest and having a shorter duration than our assets. At June 30, 2017,2020, we had $113.9$90.6 million in time deposits that mature within one year, $118.8 million in non-interest bearing checking accounts and $580.7$604.2 million in interest-bearing checking, savings and money market accounts. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. In addition, a substantial majoritymost of our single family residential mortgage loans have adjustable interest rates. As a result, these loans may experience a higher rate of default in a rising interest rate environment.
Changes in interest rates also affect the value of our interest-earning assets and, in particular, our securities portfolio. Generally, the fair value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized gains and losses on securities available for sale are reported as a separate component of equity, net of tax. Decreases in the fair value of securities available for sale resulting from increases in interest rates could have an adverse effect on stockholders’ equity.
Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. Further, a prolonged period of exceptionally low market interest rates, such as we are currently experiencing, limits our ability to lower our interest expense, while the average yield on our interest-earning assets may decrease as our loans reprice or are originated at these low market rates. Accordingly, our net interest income may decrease, which may have an adverse effect on our profitability. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our consolidated balance sheet.sheet or projected operating results. In this regard, because the length of the COVID-19 pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the recent 150 basis point reductions in the targeted federal funds rate, until the pandemic subsides, the Company expects its net interest income and net interest margin will be adversely affected in 2020 and possibly longer. For additional information concerning the effect of interest rates on our loan portfolio, see Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” of this Form 10-K.
The financial services market is undergoing rapid technological changes, and if we are unable to stay current with those
changes, we will not be able to effectively compete.
The financial services market including mortgage banking services, is undergoing rapid changes with frequent introductions of new technology-driven products and services. Our future success will depend, in part, on our ability to keep pace with the technological changes and to use technology to satisfy and grow customer demand for our products and services and to create additional efficiencies in our operations. We expect that we will need to make substantial investments in our technology and information systems to compete effectively and to stay current with technological changes. Some of our competitors have substantially greater resources to invest in technological improvements and will be able to invest more heavily in developing and adopting new technologies, which may put us at a competitive disadvantage. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. As a result, our ability to effectively compete to retain or acquire new business may be impaired, and our business, financial condition or results of operations may be adversely affected.
Liquidity riskIneffective liquidity management could impairadversely affect our ability to fund operationsfinancial results and jeopardize our financial condition.
LiquidityEffective liquidity management is essential to our business. We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress. An inability to raise funds through deposits, borrowings the sale of loans or other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities or the terms of which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our
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business activity as a result of a downturn in the California markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry. Deposit flows, calls of investment securities and wholesale borrowings, and the prepayment of loans and mortgage-related securities are also strongly influenced by such external factors as the direction of interest rates, whether actual or perceived, and competition for deposits and loans in the markets we serve. Furthermore, changesIn particular, our liquidity position could be significantly constrained if we are unable to access funds from the FHLB's underwriting guidelines for wholesale borrowings or lending policies may limit or restrict our ability to borrow, and could therefore have a significant adverse impact on our liquidity. In addition, the need to replace funds in the event of large-scale withdrawals of brokered deposits could require us to pay significantly higher interest rates on retail depositsFHLB-San Francisco or other wholesale funding sources, which would have an adverse impactor if adequate financing is not available at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources, our net interest income and net income. Arevenues may not increase proportionately to cover our costs. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or to fulfill obligations such obligations as repaying our borrowings or meeting deposit withdrawal demands.demands, any of which could, in turn, have a material adverse effect on our business, financial condition and results of operations.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions.
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions. Recently severalSeveral banking institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. Currently, we believe our capital resources satisfy our capital requirements for the foreseeable future. However, we may at some point need to raise additional capital to support continued growth.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside of our control, and on our financial condition and performance. Accordingly, we cannot make assurances that we will be able to raise additional capital if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially impaired and our financial condition and liquidity could be materially and adversely affected. In addition, any additional capital we obtain may result in the dilution of the interests of existing holders of our common stock. Further, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse regulatory action.
Our litigation related costs might continue to increase.
The Bank is subject to a variety of legal proceedings that have arisen in the ordinary course of the Bank's business. In the current economic environment, theThe Bank's involvement in litigation has increased significantly, primarily as a result of employment matters and defaulted borrowers asserting claims to defeat or delay foreclosure proceedings.may increase significantly. The Bank believes that it has meritorious defenses in legal actions where it has been named as a defendant and is vigorously defending these suits. Although management, based on discussion with litigation counsel, believes that such proceedings will not have a material adverse effect on the financial condition or operations of the Bank, there can be no assurance that a resolution of any such legal matters will not result in significant liability to the Bank nor have a material adverse impact on its financial condition and results of operations or the Bank's ability to meet applicable regulatory requirements. Moreover, the expenses of pendingsome legal proceedings will adversely affect the Bank'sBank’s results of operations until they are resolved. ThereFurther, there can be no assurance that the Bank'sBank’s loan workout and other activities will not expose the Bank to additional legal actions, including lender liability or environmental claims. For furthera discussion of our pending litigation, see Item 3. “Legal Proceedings” of this Form 10-K.
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Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
Our loansAs a bank, we are susceptible to businesses and individuals andfraudulent activity that may be committed against us or our deposit relationships and related transactions are subjectclients, which may result in financial losses or increased costs to exposureus or our customers, disclosure or misuse of our information or our customer’s information, misappropriation of assets, privacy breaches against our customers, litigation or damage to the risk of loss due toour reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other financial crimes.dishonest acts. Nationally, reported incidents of fraud and other financial crimes have increased. We have also experienced an increase in losses due to apparent fraud and other financial crimes. While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur.
We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber attack. Communications and information systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to breaches, fraudulent or unauthorized access, denial or degradation of service attacks, misuse, computer viruses, malware or other malicious code and cyber attackscyber-attacks that could have a security impact. If one or more of these events occur, this could jeopardize our or our customers' confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us. We could also suffer significant reputational damage.
Further, our cardholders use their debit and credit cards to make purchases from third parties or through third party processing services. As such, we are subject to risk from data breaches of such third party’s information systems or their payment processors. Such a data security breach could compromise our account information. The payment methods that we offer also subject us to potential fraud and theft by criminals, who are becoming increasingly more sophisticated, seeking to obtain unauthorized access to or exploit weaknesses that may exist in the payment systems. If we fail to comply with applicable rules or requirements for the payment methods we accept, or if payment-related data is compromised due to a breach or misuse of data, we may be liable for losses associated with reimbursing our customers for such fraudulent transactions on customers’ card accounts, as well as costs incurred by payment card issuing banks and other third parties or may be subject to fines and higher transaction fees, or our ability to accept or facilitate certain types of payments may be impaired. We may also incur other costs related to data security breaches, such as replacing cards associated with compromised card accounts. In addition, our customers could lose confidence in certain payment types, which may result in a shift to other payment types or potential changes to our payment systems that may result in higher costs.
Breaches of information security also may occur through intentional or unintentional acts by those having access to our systems or our customers’ or counterparties’ confidential information, including employees. The Corporation is continuously working to install new and upgrade its existing information technology systems and provide employee awareness training around ransomware, phishing, malware, and other cyber risks to further protect the Corporation against cyber risks and security breaches.
There continues to be a rise in electronic fraudulent activity, security breaches and cyber-attacks within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts. We are regularly the target of attempted cyber and other security threats and must continuously monitor and develop our information technology networks and infrastructure to prevent, detect, address and mitigate the risk of unauthorized access, misuse,
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computer viruses and other events that could have a security impact. Insider or employee cyber and security threats are increasingly a concern for companies, including ours. We are not aware that we have experienced any material misappropriation, loss or other unauthorized disclosure of confidential or personally identifiable information as a result of a cyber-security breach or other act, however, some of our customers may have been affected by these breaches, which could increase their risks of identity theft, debit and card fraud and other fraudulent activity that could involve their accounts with us.
Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation. Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions. Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. TheseAlthough we have developed and continue to invest in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, these precautions may not protect our systems from compromises or breaches of our security measures, and could result in significant legal liability and significantlosses to us or our customers, our loss of business and/or customers, damage to our reputation, the incurrence of additional expenses, disruption to our business, our inability to grow our online services or other businesses, additional regulatory scrutiny or penalties, or our exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on our business.business, financial condition and results of operations.
Our security measures may not protect us from system failures or interruptions.interruptions. While we have established policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and other operational functions to certain third-party providers. While the Corporation selects third-party vendors carefully, it does not control their actions. If our third-party providers encounter difficulties including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches or if we otherwise have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our ability to deliver products and services to our customers and otherwise conduct business operations could be adversely impacted. Replacing these third-party vendors could also entail significant delay and expense. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
The occurrence of any We cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. We may require usnot be insured against all types of losses as a result of third party failures and insurance coverage may be inadequate to cover all losses resulting from breaches, system failures or other disruptions. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify alternative sources of such services, and there is no assurancewe cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all. Further, the occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our financial condition and results of operations.
The board of directors oversees the risk management process, including the risk of cybersecurity, and engages with management on cybersecurity issues.
We rely on other companies to provide key components of our business infrastructure.
We rely on numerous external vendors to provide us with products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements because of changes in the vendor’s organizational structure, financial
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condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results of operations. We also could be adversely affected to the extent such an agreement is not renewed by a third party vendor or is renewed on terms less favorable to us. Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our vendors’ performance, including aspects which they delegate to third parties. Disruptions or failures in the physical infrastructure or operating systems that support our business and customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in customer attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.
If our enterprise risk management framework is not effective at mitigating risk and loss to us, we could suffer unexpected losses and our results of operations could be materially adversely affected.
Our enterprise risk management framework seeks to achieve an appropriate balance between risk and return, which is critical to optimizing stockholder value. We have established processes and procedures intended to identify, measure, monitor, report, analyze, and control the types of risk to which we are subject to. These risks include, among others, liquidity, credit, market, interest rate, operational, legal and compliance, and reputational risk. Our framework also includes financial or other modeling methodologies that involve management assumptions and judgment. We also maintain a compliance program to identify measure, assess, and report on our adherence to applicable laws, policies, and procedures. While we assess and improve these programs on an ongoing basis, there can be no assurance that our risk management or compliance programs, along with other related controls, will effectively mitigate risk under all circumstances, or that it will adequately mitigate any risk or loss to us. However, as with any risk management framework, there are inherent limitations to our risk management strategies as they may exist, or develop in the future, including risks that we have not appropriately anticipated or identified. If our risk management framework proves ineffective, we could suffer unexpected losses and our business, financial condition, results of operations or growth prospects could be materially adversely affected. We may also be subject to potentially adverse regulatory consequences.
Managing reputational risk is important to attracting and maintaining customers, investors and employees.
Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable or fraudulent activities of our customers. We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation.
Earthquakes, fires, mudslides and other natural disasters in our primary market area may result in material losses because of damage to collateral properties and borrowers' inability to repay loans.
Since our geographic concentration is in Southern California, we are subject to earthquakes, fires, mudslides and other natural disasters. A major earthquake or other natural disaster may disrupt our business operations for an indefinite period of time and could result in material losses, although we have not experienced any losses in the past sixmany years as a result of earthquake damage or other natural disaster. In addition to possibly sustaining damage to our own property, a substantial number of our borrowers would likely incur property damage to the collateral securing their loans. Although we are in an earthquake prone area, we and other lenders in the market area may not require earthquake insurance as a condition of making a loan. Additionally,In addition to possibly sustaining damage to our own properties, if there is a major earthquake, fire, mudslide, or other natural disaster, we face the collateralized properties are only damaged and not destroyed to the pointrisk that many of total insurable loss,our borrowers may sufferexperience uninsured property losses, or sustained job interruption and/or job loss which may materially impair their ability to meet the terms of their loan obligations.
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Our assets as of June 30, 20172020 include a deferred tax asset, the full value of which we may not be able to realize.
We recognize deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. At June 30, 2017,2020, the net deferred tax asset was approximately $4.3$3.0 million, a decrease from $5.4$3.5 million at the prior fiscal year end. The net deferred tax asset results primarily from our(1) deferred loan costs, (2) provisions for loan losses recorded for financial reporting purposes, which were in the past significantly larger than net loan charge-offs deducted for tax reporting proposes.
As a result of our follow-on stock offering in December 2009, we may experience an “ownership change” as defined under Section 382 of the Internal Revenue Code of 1986, as amended (which is generally a greater than 50 percentage point increase by certain “5% shareholders” over a rolling three-year period). Section 382 imposes an annual limitation on the utilization ofproposes and (3) deferred tax assets, such as net operating loss carryforwards and other tax attributes, once an ownership change has occurred. Depending on the size of the annual limitation (which is in part a function of our market capitalization at the time of the ownership change) and the remaining carryforward period of the tax assets (U.S. federal net operating losses generally may be carried forward for a period of 20 years), we could realize a permanent loss of a portion of our U.S. federal and state deferred tax assets and certain built-in losses that have not been recognized for tax purposes.compensation, among others.
We regularly review our deferred tax assets for recoverability based on our history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income. We believe the recorded net deferred tax asset at June 30, 20172020 is fully realizable based on our expected future earnings; however, we willexpected future earnings may not know thebe realized, which could impact of the recent ownership change until we complete our fiscal 2017 tax return. Based on our preliminary analysis of the actual impact of the “ownership change” on our deferred tax assets,assets.
We rely on dividends from the Bank for substantially all of our revenue at the holding company level.
We are an entity separate and distinct from our principal subsidiary, the Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary. Accordingly, we believe thatare, and will be, dependent upon dividends from the impactBank to pay the principal of and interest on our deferred tax asset is unlikelyindebtedness, to be material. This is a preliminarysatisfy our other cash needs and complex analysis and requires us to make certain judgments in determining the annual limitation. As a result, it is possible that we could ultimately lose a significant portion of our deferred tax assets, which could have a material adverse effectpay dividends on our resultscommon stock. The Bank's ability to pay dividends is subject to its ability to earn net income and to meet certain regulatory requirements. In the event the Bank is unable to pay dividends to us, we may not be able to pay dividends on our common stock. Also, our right to participate in a distribution of operations and financial condition.assets upon a subsidiary's liquidation or reorganization is subject to the prior claims of the subsidiary's creditors.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
At June 30, 2017,2020, the net book value of the Bank’s property (including land and buildings) and its furniture, fixtures and equipment was $6.6$7.7 million. The Bank’s home office is located in Riverside, California. Including the home office, the Bank has 1413 retail banking offices, 1312 of which are located in Riverside County in the cities of Riverside (5), Moreno Valley, Hemet, Sun City, Rancho Mirage, Corona, Temecula La Quinta and Blythe. One office is located in Redlands, San Bernardino County, California. The Bank owns six of the retail banking offices and has eightseven leased retail banking offices. The leases expire from 20182020 to 2026. The Bank also leases 10 stand-alone loan production offices, whichIn the opinion of management, all properties are locatedadequately covered by insurance, are in Atascadero, Brea, Escondido, Glendora, Pleasanton, Rancho Cucamonga (2), Riverside (2)a good state of repair and Roseville, California. The leases expire from 2017 to 2020.are appropriately designed for their present and future use.
Item 3. Legal Proceedings
Periodically, there have been various claims and lawsuits involving the Corporation, such as claims to enforce liens, condemnation proceedings on properties in which the Corporation holds security interests, claims involving the making and servicing of real property loans, employment matters and other issues in the ordinary course of and incidentincidental to the Corporation’s business. These proceedings and the associated legal claims are often contested and the outcome of individual matters is not always predictable. Additionally, in some actions, it is difficult to assess potential exposure because the
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Corporation is still in the early stages of the litigation. The Corporation is not a party to any pending legal proceedings that it believes would have a material adverse effect on theits financial condition, operations or cash flows of the Corporation, except as set forth below. Additionally, in some actions, it is difficult to assess potential exposure because the Corporation is still in the early stages of the litigation.
On December 17, 2012, a class and collective action lawsuit, by Gina McKeen-Chaplin, individually and on behalf of eight others similarly situated against the Bank was filed in the United States District Court for the Eastern District of California (the “Court”) claiming damages, restitution and injunctive relief for alleged misclassification of certain employees as exempt rather than non-flows.
exempt, resulting in a failure to pay appropriate overtime compensation, to provide meal and rest periods, to pay waiting time penalties and to provide accurate wage statements. The plaintiffs seek unspecified monetary relief.
On August 12, 2015, the Court issued an order denying the plaintiffs' motion for summary judgment and granting the Bank's motion for summary judgment affirming that the plaintiffs were properly classified as exempt employees and denying the federal claims. On August 18, 2015, the plaintiffs filed an appeal to the order. On July 5, 2017, the United States Court of Appeals for the Ninth Circuit (the “Ninth Circuit”) reversed the Court’s ruling granting the Bank's motion for summary judgment, instead ruling the plaintiffs were improperly classified as exempt employees and were entitled to overtime compensation. The Ninth Circuit remanded the case back to the Court with instructions to enter summary judgement in favor of the plaintiffs. The Bank is evaluating its legal options with respect to the Ninth Circuit’s decision, including the possible filing of a petition for writ of certiorari to the United States Supreme Court. As a result of the Ninth Circuit’s unfavorable ruling, the Corporation recorded an additional litigation accrual of $1.0 million in the Corporation’s Consolidated Statements of Operations for the fiscal year ended June 30, 2017. It is reasonably possible the Management estimate of this litigation accrual could change as more information becomes available during litigation of this matter.
On May 22, 2013, counsel in the McKeen-Chaplin matter filed another class action called Neal versus Provident Savings Bank, F.S.B. in California Superior Court in Alameda County (the "State Court"). The Neal class action is virtually identical to the McKeen-Chaplin class action alleging that mortgage underwriters were misclassified as exempt employees. The plaintiffs in the Neal case filed a motion for class certification on March 12, 2015. The Bank filed an opposition to the motion and the hearing on the motion was held on July 17, 2015. The State Court denied the motion for class certification. The plaintiffs appealed that ruling. The appeal is fully briefed and the Bank is waiting for the California First District Court of Appeal to schedule oral argument. Presently, the Bank cannot assess the potential exposure in the Neal class action because the Bank is still in the early stages of the litigation and the class certification decision is on appeal. The Bank intends to defend this case vigorously.
On August 6, 2015, a former employee, Christina Cannon, filed a lawsuit called Cannon versus Provident Savings Bank, F.S.B. in the California Superior Court for the County of San Bernardino. Cannon seeks to represent a class of all non-exempt employees in a class action lawsuit brought under California’s Unfair Competition Law, Business & Professions Code section 17200. The underlying claims include unpaid overtime (including off-the-clock work), meal and rest period violations, minimum wage violations, and failure to reimburse business expenses. Based on the Bank's initial investigation and discovery to date, the Bank does not believe that the plaintiff’s claims are generally meritorious. Presently, the Bank cannot assess the potential exposure for this matter because the Bank is still in the early stages of the litigation and the issue of whether the case is appropriate for class treatment has not been litigated. The Bank is unable to predict whether the plaintiff will be able to certify a class, and if so, what the breadth of the class would be. Additionally, it is difficult to quantify at this stage of the case which claims, if any, would be amenable to class treatment and what the potential exposure might be on such claims. The Bank intends to defend this case vigorously.
The Corporation is not a party to any other pending legal proceedings that it believes would have a material adverse effect on the financial condition, operations and cash flows of the Corporation.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The common stock of Provident Financial Holdings, Inc. is listed on the NASDAQ Global Select Market under the symbol PROV. The following table provides the high and low sales prices for Provident Financial Holdings, Inc.At June 30, 2020, there were 7,436,315 shares of common stock during the last two fiscal yearsissued and outstanding held by quarter. As422 shareholders of June 30, 2017,record, and there were approximately 300 stockholders of record.
|
| | | | |
| First (Ended September 30) | Second (Ended December 31) | Third (Ended March 31) | Fourth (Ended June 30) |
| | | | |
2017 Quarters: | | | | |
High | $20.00 | $20.66 | $20.25 | $20.35 |
Low | $17.72 | $17.68 | $18.20 | $18.32 |
| | | | |
2016 Quarters: | | | | |
High | $17.20 | $19.19 | $19.01 | $18.50 |
Low | $15.51 | $16.05 | $16.73 | $16.81 |
| | | | |
1,707 persons or entities that hold stock in nominee or “street name” accounts with brokers.
The Corporation’s cash dividend payout policy is reviewed regularly by management and the Board of Directors. The Board of directors has declared quarterly cash dividends on the Corporation’s common stock for consecutive quarters since September 30, 2002. On July 30, 2020, the Corporation adopteddeclared a quarterly cash dividend policyof $0.14 per share. The Corporation’s shareholders of record at the close of business on July 24, 2002. Quarterly dividends paid forAugust 20, 2020 will receive the quarters endedcash dividend, which is payable on September 30, 2016, December 31, 2016, March 31, 2017 and June 30, 2017 were $0.13 per share for each quarter. By comparison, quarterly dividends paid for the quarters ended September 30, 2015, December 31, 2015, March 31, 2016 and June 30, 2016 were $0.12 per share for each quarter.10, 2020. Future declarations or payments of dividends will be subject to the approvalconsideration 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. In addition, the Corporation’s wholly-owned operating subsidiary, the Bank, is required to file a notice and receive the non-objection of the Federal Reserve Board prior to paying any dividends or making any capital distributions to the Corporation. In fiscal 2017 and 2016, the Bank declared and paid cash dividends of $10.0 million and $15.0 million, respectively, to the Corporation. For additional information, see Item 1, "Business – Regulation - Federal Regulation of Savings Institutions - Limitations on Capital Distributions” and Item 1A., “Risk Factors - The short-term and long-term impact of the changing regulatory capital requirements and new capital rules is uncertain" in this Form 10-K. 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.
The Corporation repurchases its common stock consistent with Board-approved stock repurchase plans. During fiscal 2017,the quarter ended June 30, 2020, the Corporation repurchased 425,350did not purchase any shares withof the Corporation’s common stock. For the fiscal year ended June 30, 2020, the Corporation purchased 66,041 shares of the Corporation’s common stock at an average cost of $19.31$19.43 per share, of which 28,350 and 397,000 shares were purchased under the October 2015 and May 2016 stock repurchase plans, respectively. In addition, the Corporation purchased 25,598 shares of distributed restricted common stock in settlement of employees' withholding tax obligations. The October 2015 and May 2016 stock repurchase plans were completed in fiscal 2017. On June 19, 2017, the Corporation's Board of Directors authorized the repurchase of up to 5% of outstanding shares, or 385,200 shares.share. As of June 30, 2017,2020, no shares have been repurchased under this plan.the April 2020 stock repurchase plan, leaving all 371,815 shares available for future purchases.
During the quarter ended June 30, 2020, the Corporation did not issue any shares of common stock from the exercise of certain stock options and no shares of restricted common stock vested. For the fiscal year ended June 30, 2020, the Corporation issued 16,250 shares of common stock consistent with the exercise of certain stock options and no shares of restricted common stock vested. During the quarter and fiscal year ended June 30, 2020, the Corporation did not sell any securities that were not registered under the Securities Act of 1933.
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The table below sets forth information regarding the Corporation’s purchases of its common stock during the fourth quarter of fiscal 2017.
|
| | | | | | | | | |
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) |
April 1, 2017 – April 30, 2017 | — |
| $ | — |
| — |
| 189,495 |
|
May 1, 2017 – May 31, 2017 | 46,740 |
| $ | 19.01 |
| 46,740 |
| 142,755 |
|
June 1, 2017 – June 30, 2017 | 142,755 |
| $ | 19.80 |
| 142,755 |
| 385,200 |
|
Total | 189,495 |
| $ | 19.61 |
| 189,495 |
| 385,200 |
|
2020.
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) |
April 1, 2020 – April 30, 2020 | — | | $ | — | | — | | 371,815 | |
May 1, 2020 – May 31, 2020 | — | | $ | — | | — | | 371,815 | |
June 1, 2020 – June 30, 2020 | — | | $ | — | | — | | 371,815 | |
Total | — | | $ | — | | — | | 371,815 | |
(1) | On June 19, 2017,Represents the Corporation announced a newremaining shares available for future purchases under the April 2020 stock repurchase plan to repurchase up to 5% of outstanding shares or 385,200 shares.plan. |
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Performance Graph
The following graph compares the cumulative total shareholder return on the Corporation’s common stock with the cumulative total return of the Nasdaq Stock Index (U.S. Stock) and Nasdaq Bank Index. Total return assumes the reinvestment of all dividends.
|
| | | | | | | | | | | | | | | | | | |
| 6/30/2012 | 6/30/2013 | 6/30/2014 | 6/30/2015 | 6/30/2016 | 6/30/2017 |
PROV | $ | 100.00 |
| $ | 139.96 |
| $ | 131.50 |
| $ | 155.91 |
| $ | 175.20 |
| $ | 189.47 |
|
NASDAQ Stock Index | $ | 100.00 |
| $ | 121.39 |
| $ | 151.91 |
| $ | 162.75 |
| $ | 166.54 |
| $ | 197.53 |
|
NASDAQ Bank Index | $ | 100.00 |
| $ | 138.29 |
| $ | 163.66 |
| $ | 184.49 |
| $ | 162.89 |
| $ | 238.77 |
|
| 6/30/2015 | 6/30/2016 | 6/30/2017 | 6/30/2018 | 6/30/2019 | 6/30/2020 |
PROV | $ | 100.00 | | $ | 112.41 | | $ | 121.53 | | $ | 124.14 | | $ | 140.68 | | $ | 92.67 | |
NASDAQ Stock Index | $ | 100.00 | | $ | 102.33 | | $ | 121.37 | | $ | 139.39 | | $ | 151.92 | | $ | 162.49 | |
NASDAQ Bank Index | $ | 100.00 | | $ | 88.29 | | $ | 129.42 | | $ | 143.50 | | $ | 142.81 | | $ | 110.36 | |
|
| |
| (1) Assumes that the value of the investment in the Corporation’s common stock and each index was $100 on June 30, 20122015 and that all dividends were reinvested. |
For additional information, see Part III, Item 12 of this Form 10-K for information regarding the Corporation’s Equity Compensation Plans, which is incorporated into this Item 5 by reference.
Item 6. Selected Financial Data
The information contained under the heading “Financial Highlights” in the Corporation’s Annual Report to Shareholders is included as Exhibit 13 to this Form 10-K and is incorporated herein by reference. This information is qualified in its entirety by the detailed information included elsewhere herein and should be read along with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8. “Financial Statements and Supplementary Data” included in this Form 10-K.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Safe-Harbor Statement
Certain matters in this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This Form 10-K contains statements that the Corporation believes are “forward-looking statements.” These statements relate to the Corporation’s financial condition, liquidity, results of operations, plans, objectives, future performance or business. 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 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 following: the effect of the novel coronavirus of 2019 (“COVID-19”) pandemic, including on the Corporation’s credit quality and business operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and global economies, and consumer and corporate customers, including economic activity, employment levels and market liquidity; 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; uncertainty regarding the future of the London Interbank Offered Rate ("LIBOR"), and the potential transition away from LIBOR toward new interest rate benchmarks; 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, California Consumer Privacy 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; computerdisruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on which we depend could fail or experience a security breach;the third-party vendors who perform several of our ability to implement our branch expansion strategy;critical processing functions; 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
56
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, including the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act"), Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (“Interagency Statement”), and other risks detailed in this report and in the Corporation’s other reports filed with or furnished to the SEC. These developments could have an adverse impact on our financial position and our results of operations. Forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur, and you should not put undue reliance on any forward-looking statements.
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”).FRB. At June 30, 2017,2020, the Corporation had total assets of $1.20$1.18 billion, total deposits of $926.5$893.0 million and total stockholders’ equity of $128.2$124.0 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 OCC, its primary federal regulator, and the Federal Deposit Insurance Corporation (“FDIC”),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’sCorporation operates in a single business consists of community banking activities and mortgage banking activities, conducted by Provident Bank and Provident Bank Mortgage, a division ofsegment through the Bank. CommunityThe Bank's activities include attracting deposits, offering banking activities primarily consist of accepting deposits from customers within the communities surrounding the Bank’s full service officesservices and investing those funds inoriginating and purchasing single-family, loans, multi-family, loans, commercial real estate, loans, construction loans,and, to a lesser extent, other mortgage, commercial business loans,and consumer loans and other real estate loans. The Bank also offers business checking accounts, other businessDeposits are collected primarily from 13 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 14 retail/business banking officeslocations located in Riverside County and San Bernardino County (commonly known as the Inland Empire). Provident Bank Mortgage operates two wholesale loan production offices: onecounties in PleasantonCalifornia. Additional activities have included originating saleable single-family loans, primarily fixed-rate first mortgages. Loans are primarily originated and onepurchased in Rancho Cucamonga, California;Southern and nine retail loan production offices in Atascadero, Brea, Escondido, Glendora, Rancho Cucamonga, Riverside (3) and Roseville,Northern 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 July 31, 2017, the Corporation declared a quarterly cash dividend of $0.14 per share, reflecting an eight percent increase from the $0.13 per share paid on June 9, 2017. The Corporation’s shareholders of record at the close of business on August 21, 2017 will receive the cash dividend, which is payable on September 11, 2017. 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 audited Consolidated Financial Statements and accompanying selected Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Critical Accounting Policies
The discussion and analysis of the Corporation’s financial condition and results of operations is based upon the Corporation’s 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
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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 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.loans held for investment. 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 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 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 Consolidated Statements of Financial Condition and 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 collectibilitycollectability 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.
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 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 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 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 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.
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The loan terms which have been modified or restructured due to a borrower’s financial difficulty, include but are not limited to:
A reduction in the stated interest rate.rate;
An extension of the maturity at an interest rate below market.market;
A reduction in the accrued interest.interest; and
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. 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.
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-offscharged-off 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 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 Consolidated Statements of Operations with offsets to other assets or other liabilities in the 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 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
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regulations change over time. As such, changes in management’s subjective assumptions and judgments can materially affect amounts recognized in the Consolidated Statements of Financial Condition and 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 mortgage 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 increasing total assets; byasset (by increasing single-family, mortgage loans and 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 growth may not occurbe difficult as a result of weaknesses in general economic conditions. Because the length of the COVID-19 pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the recent 150 basis point reductions in the targeted federal funds rate, until the pandemic subsides, the Corporation expects its net interest income and net interest margin will be adversely affected in 2020 and possibly longer.
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.
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.
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 California economic environment presents heightened risk for the Corporation primarily with respect to real estate values and loan delinquencies. 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. In addition, 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. For further details on risk factors and uncertainties, see “Safe-Harbor Statement” included above in this item 7, and Item 1A, "Risk Factors.”
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COVID-19 Impact to the Corporation
The Corporation is actively monitoring and responding to the effects of the rapidly-changing COVID-19 pandemic. The health, safety and well-being of its customers, employees and communities are the Corporation’s top priorities. Centers of Disease Control (“CDC”) guidelines, as well as directives from federal, state, county and local officials, are being closely followed to make informed operational decisions.
During this unprecedented time, the Corporation is working diligently with its employees to implement CDC-advised health, hygiene and social distancing practices. To avoid service disruptions, most of its employees currently work from the Corporation’s premises and promote social distancing standards. To date, there have been limited service disruptions. The Corporation’s Employee Assistance Program is provided at no cost for employees and family members seeking counseling services for mental health and emotional support needs. The Corporation also adheres to the Families First Coronavirus Response Act (FFCRA), which includes the Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Expansion.
During the COVID-19 pandemic, taking care of customers and providing uninterrupted access to services are top priorities for the Corporation. All of the Corporation’s banking centers are open for business with regular business hours while implementing CDC guidelines for social distancing and enhanced cleaning. Customers can also conduct their banking business using drive throughs, online and mobile banking services, ATMs, and telephone banking.
On March 27, 2020, the CARES Act was signed into law and on April 7, 2020, the Board of Governors of the Federal Reserve System, FDIC, National Credit Union Administration, OCC and consumer Financial Protection Bureau issued Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (“Interagency Statement”). Among other things, the CARES Act and Interagency Statement provided relief to borrowers, including the opportunity to defer loan payments while not negatively affecting their credit standing. The CARES Act and/or Interagency Statement provided guidance around the modification of loans as a result of the COVID-19 pandemic, and outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under the CARES Act or Interagency Statement prior to any relief, are not troubled debt restructurings. For commercial and consumer customers, the Corporation has provided relief options, including payment deferrals from 90 days to 180 days and fee waivers. As of June 30, 2020, the Corporation has 48 single-family forbearance loans, with outstanding balances of $19.9 million or 2.20 percent of total loans, and five multi-family, commercial real estate and business loans, with outstanding balances of $2.7 million or 0.29 percent of total loans that were modified in accordance with the CARES Act or Interagency Statement.
Interest income continues to be recognized during the payment deferrals, unless the loans are non-performing. After the payment deferral period, scheduled loan payments will once again become due and payable. The forbearance amount will be due and payable in full as a balloon payment at the end of the loan term or sooner if the loan becomes due and payable in full at an earlier date.
All loans modified due to COVID-19 will be separately monitored and any request for continuation of relief beyond the initial modification will be reassessed at that time to determine if a further modification should be granted and if a downgrade in risk rating is appropriate.
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As of June 30, 2020, loan forbearance related to COVID-19 hardship requests are described below:
| Forbearance Granted | Forbearance Completed | Forbearance Remaining |
(Dollars In Thousands) | Number of Loans | Amount | Number of Loans | Amount | Number of Loans | Amount |
Single-family loans | | 52 | | $ | 21,470 | | | 4 | | $ | 1,579 | | | 48 | | $ | 19,891 | |
Multi-family loans | | 3 | | | 1,592 | | | — | | | — | | | 3 | | | 1,592 | |
Commercial real estate loans | | 2 | | | 1,071 | | | — | | | — | | | 2 | | | 1,071 | |
Total loan forbearance | | 57 | | $ | 24,133 | | | 4 | | $ | 1,579 | | | 53 | | $ | 22,554 | |
As of June 30, 2020, loan forbearance outstanding balances are described below:
(Dollars In Thousands) | Number of Loans | Amount | % of Total Loans | Weighted Avg. LTV(1) | Weighted Avg. FICO(2) | Weighted Avg. Debt Coverage Ratio(3) | Weighted Avg. Forbearance Period Granted(4) |
Single-family loans | | 48 | | $ | 19,891 | | 2.20 | % | | 64 | % | | 727 | | | N/A | | | 6.0 | |
Multi-family loans | | 3 | | | 1,592 | | 0.17 | % | | 41 | % | | 719 | | | 1.65 | x | | 3.3 | |
Commercial real estate loans(5) | | 2 | | | 1,071 | | 0.12 | % | | 31 | % | | 755 | | | 1.36 | x | | 3.5 | |
Total loans in forbearance | | 53 | | $ | 22,554 | | 2.49 | % | | 61 | % | | 727 | | | 1.53 | x | | 5.7 | |
(1) | Current loan balance in comparison to the original appraised value. |
(2) | At time of loan origination, borrowers and/or guarantors. |
(3) | At time of loan origination. |
(5) | Comprised of $579 thousand in Office and $493 thousand in Mixed Used – Office/Single-Family Residential. |
In addition, as of June 30, 2020, the Bank had pending requests for payment relief for an additional seven single-family loans totaling approximately $2.6 million.
After the payment deferral period, normal loan payments will once again become due and payable. The forbearance amount will be due and payable in full as a balloon payment at the end of the loan term or sooner if the loan becomes due and payable in full at an earlier date. The Corporation believes the steps we are taking are necessary to effectively manage its portfolio and assist the borrowers through the ongoing uncertainty surrounding the duration, impact and government response to the COVID-19 pandemic.
For customers that may need access to funds in their certificates of deposit to assist with living expenses during the COVID-19 pandemic, the Corporation is waiving early withdrawal penalties on a case by case basis. Overdraft and other fees are also waived on a case-by-case basis. The Corporation is cautious when paying overdrafts beyond the client's total deposit relationship, overdraft protection options or their overdraft coverage limits.
The Corporation anticipates that the COVID-19 pandemic may continue to impact the business in future periods in one or more of the following ways, among others:
Higher provisions for certain commercial real estate loans may be incurred, especially to borrowers with tenants in industries, such as hospitality, travel, food service and restaurants and bars, and businesses providing physical services;
Significantly lower market interest rates which may have a negative impact on variable rate loans indexed to LIBOR, U.S. treasury and prime indices and on deposit pricing, as interest rate adjustments typically lag the effect on the yield earned on interest-earning assets because rates on many deposit accounts are decision-based, not tied to a specific market-based index, and are based on competition for deposits;
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Certain additional fees for deposit and loan products may be waived or reduced;
Non-interest income may decline due to a decrease in fees earned as spending habits change by debit card customers complying with “Stay at Home” requirements and who otherwise may be adversely affected by reductions in their personal income or job losses;
Non-interest expenses related to the effects of the COVID-19 pandemic may increase, including cleaning costs, supplies, equipment and other items; and
Additional loan forbearance or modifications may occur and borrowers may default on their loans, which may necessitate further increases to the allowance for loan losses.
While the full impact of COVID-19 on the Corporation's future financial results is uncertain and not currently estimable, the Corporation believes that the impact could be materially adverse to its financial condition and results of operations depending on the length and severity of the economic downturn brought on by the COVID-19 pandemic.
Off-Balance Sheet Financing Arrangements and Contractual Obligations
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.credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the accompanying 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 15 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Contractual Obligations.Off-balance sheet arrangements. The following table summarizes the Corporation’s contractual obligations at June 30, 2017 and the effect these obligations are expected to have on the Corporation’s liquidity and cash flows in future periods:
|
| | | | | | | | | | | | | | | |
| Payments Due by Period |
(Dollars In Thousands) | Less than 1 year | 1 year to less than 3 years | 3 year to 5 years | Over 5 years | Total |
Operating obligations | $ | 2,593 |
| $ | 3,592 |
| $ | 1,915 |
| $ | 1,077 |
| $ | 9,177 |
|
Pension benefits | 241 |
| 482 |
| 483 |
| 6,655 |
| 7,861 |
|
Time deposits | 116,059 |
| 117,321 |
| 29,940 |
| 10,456 |
| 273,776 |
|
FHLB – San Francisco advances | 27,728 |
| 14,930 |
| 44,594 |
| 52,307 |
| 139,559 |
|
FHLB – San Francisco letter of credit | 7,000 |
| — |
| — |
| — |
| 7,000 |
|
FHLB – San Francisco MPF credit enhancement(1) | — |
| — |
| — |
| 2,458 |
| 2,458 |
|
Total | $ | 153,621 |
| $ | 136,325 |
| $ | 76,932 |
| $ | 72,953 |
| $ | 439,831 |
|
| |
(1)
| Represents the recourse provision for loans previously sold by the Bank to the FHLB – San Francisco under its Mortgage Partnership Finance program. As of June 30, 2017, the Bank serviced $15.1 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.
The Bank 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 investors, TBA MBS trades and option contracts.credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the accompanying Consolidated Statements of Financial Condition included in Item 8 of this Form 10-K.Condition. The Bank's exposure to credit loss, in the event of non-performance by the counter party to these financial instruments, is represented by the contractual amount of these instruments. The Bank uses the same credit policies in making commitments to extend credit as it does for on-balance sheet instruments. As of June 30, 20172020 and 2016,2019, these commitments were $111.8$13.6 million and $191.7$4.3 million, respectively. For a discussion on financial instruments with off-balance sheet risks, see Note 15 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Comparison of Financial Condition at June 30, 20172020 and 20162019
Total assets increased $29.3$92.0 million, or 3%9%, to $1.20$1.18 billion at June 30, 20172020 from $1.17$1.08 billion at June 30, 2016.2019. The increases wereincrease was primarily attributable to increases in loans held for investment, cash and cash equivalents, and investment securities held to maturity, partly offset by decreases inand loans held for sale.investment.
Total cash and cash equivalents, primarily excess cash deposited with the Federal Reserve Bank of San Francisco, increased $21.6$45.4 million, or 42%64%, to $72.8$116.0 million at June 30, 20172020 from $51.2$70.6 million at June 30, 2016.2019. The increase was primarily attributable to a decreaseincreases in customer deposits and borrowings, partly offset by the increases in loans held for saleinvestment and increases in borrowings and customer deposits, partly offset by an increase in loans held for investment.investment securities. The relatively high balance of cash and cash equivalents at June 30, 20172020 was due toconsistent with the Corporation’s strategy of adequately managing credit and liquidity risk.
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Total investment securities (held to maturity and available for sale) increased $18.3$23.2 million, or 36%23%, to $69.8$123.3 million at June 30, 20172020 from $51.5$100.1 million at June 30, 2016.2019. The increase was primarily the result of purchases of mortgage-backed securities held to maturity, partly offset by scheduled and accelerated principal payments on mortgage-backed securities. For further analysisadditional information on investment securities, see Note 2 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Loans held for investment increased $64.9$22.9 million, or 8%,3% to $904.9$902.8 million at June 30, 20172020 from $840.0$879.9 million at June 30, 2016.2019. In fiscal 2017,2020, the Corporation originated $191.9$106.0 million of loans held for investment, consisting primarily of single-family, multi-family and multi-familycommercial real estate loans, compared to $170.2down 12% from $120.2 million, consisting primarily of single-family, multi-family and commercial real estate loans, for the same period last year. In addition, the Corporation purchased $61.7$142.1 million of loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2017, compared to $45.92020, up 178% from $51.1 million of purchased loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2016.2019. Total loan principal payments in fiscal 20172020 were $197.0$228.3 million, a 5% increaseup 17% from $187.0$195.4 million in fiscal 2016. In addition, real estate owned2019. There was no REO acquired in the settlement of loans in both fiscal 2017 was $1.8 million, a 71% decrease from $6.3 million in2020 and fiscal 2016.2019. The balance of preferred loans (i.e., multi-family, commercial real estate, construction and commercial business loans, net of undisbursed loan funds)funds, increased 13%9% to $585.1$605.4 million at June 30, 20172020 from $519.2
$556.1 million at June 30, 2016,2019, and represented 64%67% and 61%63% of loans held for investment, respectively. The balance of single-family loans held for investment decreased $2.3$26.2 million, or 1%8%, to $322.2$298.8 million at June 30, 2017,2020, from $324.5$325.0 million at June 30, 2016.
The table below describes the geographic dispersion of real estate secured2019. For additional information on loans held for investment, (gross) at June 30, 2017 and 2016, as a percentagesee Note 3 of the total dollar amount outstanding (dollarsNotes to Consolidated Financial Statements included in thousands):
AsItem 8 of June 30, 2017
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Inland Empire | Southern California(1) | Other California | Other States | Total |
Loan Category | Balance | % | Balance | % | Balance | % | Balance | % | Balance | % |
Single-family | $ | 102,686 |
| 32 | % | $ | 156,045 |
| 49 | % | $ | 62,249 |
| 19 | % | $ | 1,217 |
| — | % | $ | 322,197 |
| 100 | % |
Multi-family | 80,861 |
| 17 | % | 282,871 |
| 59 | % | 113,459 |
| 24 | % | 2,768 |
| — | % | 479,959 |
| 100 | % |
Commercial real estate | 31,497 |
| 32 | % | 42,192 |
| 43 | % | 23,873 |
| 25 | % | — |
| — | % | 97,562 |
| 100 | % |
Construction | 3,760 |
| 24 | % | 10,614 |
| 66 | % | 1,635 |
| 10 | % | — |
| — | % | 16,009 |
| 100 | % |
Total | $ | 218,804 |
| 24 | % | $ | 491,722 |
| 54 | % | $ | 201,216 |
| 22 | % | $ | 3,985 |
| — | % | $ | 915,727 |
| 100 | % |
| |
(1)
| Other than the Inland Empire. |
As of June 30, 2016
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Inland Empire | Southern California(1) | Other California | Other States | Total |
Loan Category | Balance |
| % | Balance |
| % | Balance |
| % | Balance |
| % | Balance |
| % |
Single-family | $ | 100,148 |
| 31 | % | $ | 167,574 |
| 51 | % | $ | 55,277 |
| 17 | % | $ | 1,498 |
| 1 | % | $ | 324,497 |
| 100 | % |
Multi-family | 77,075 |
| 18 | % | 245,301 |
| 59 | % | 90,409 |
| 22 | % | 2,842 |
| 1 | % | 415,627 |
| 100 | % |
Commercial real estate | 34,162 |
| 34 | % | 40,066 |
| 40 | % | 25,300 |
| 26 | % | — |
| — | % | 99,528 |
| 100 | % |
Construction | 1,457 |
| 10 | % | 10,514 |
| 72 | % | 2,682 |
| 18 | % | — |
| — | % | 14,653 |
| 100 | % |
Other | 260 |
| 78 | % | 72 |
| 22 | % | — |
| — | % | — |
| — | % | 332 |
| 100 | % |
Total | $ | 213,102 |
| 25 | % | $ | 463,527 |
| 54 | % | $ | 173,668 |
| 20 | % | $ | 4,340 |
| 1 | % | $ | 854,637 |
| 100 | % |
| |
(1)
| Other than the Inland Empire. |
Loans held for sale decreased $73.0 million, or 39%, to $116.5 million at June 30, 2017 from $189.5 million at June 30, 2016. The decrease was primarily due to a lower volume of loans originated for sale and the timing difference between loan fundings and loan sale settlements. Total loans originated and purchased for sale decreased $49.8 million, or 3%, to $1.91 billion in fiscal 2017 from $1.96 billion in fiscal 2016. The lower volume of loans originated and purchased for sale was due primarily to higher mortgage interest rates during fiscal 2017, which has reduced refinance activity.this Form 10-K.
Total deposits increased slightly$51.7 million, or 6%, to $926.5$893.0 million at June 30, 20172020 from $926.4$841.3 million at June 30, 2016.2019. Transaction accounts increased $41.1$74.9 million, or 7%12%, to $658.6$723.0 million at June 30, 20172020 from $617.5$648.1 million at June 30, 2016;2019; while time deposits decreased $41.0$23.1 million, or 13%12%, to $267.9$170.0 million at June 30, 20172020 from $308.9$193.1 million at June 30, 2016.2019. As of June 30, 2020 and 2019, the percentage of transaction accounts to total deposits was 81% and 77%, respectively. Non-interest bearing deposits as a percentage of total deposits increased to 13.3% at June 30, 2020 from 10.7% at June 30, 2019. 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 lower cost checking and savings accounts in its deposit base and decrease the percentage of time deposits by competing less aggressively for time deposits. For additional information on deposits, see Note 7 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Borrowings, consisting of FHLB – San Francisco advances increased $34.9$39.9 million, or 38%39%, to $126.2$141.0 million at June 30, 20172020 from $91.3$101.1 million at June 30, 2016,2019. The increase was due to $20.0 million of new long-term advances and $15.0 million of new short-term advances, partly offset by $73,000 in principal payments on two amortizing advances.the maturity of advances during fiscal 2020. The weighted-average maturity of the Corporation’s FHLB – San Francisco advances was approximately 5128 months at June 30, 2017,2020, down from 6944 months at June 30, 2016.
2019. For additional information on borrowings, see Note 8 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Total stockholders’ equity decreased $5.3 million, or 4%,increased 3% to $128.2$124.0 million at June 30, 2017,2020 from $133.5$120.6 million at June 30, 2016,2019, primarily as a result of net income and the amortization of stock-based compensation benefits in fiscal 2020, partly offset by stock repurchases (see Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds” of this Form 10-K) and quarterly cash dividends paid partly offset by net income in fiscal 2017.to shareholders.
Comparison of Operating Results for the Years Ended June 30, 20172020 and 20162019
General. The Corporation recorded net income of $5.2$7.7 million, or $0.64$1.01 per diluted share, for the fiscal year ended June 30, 2017, as compared to net income of $7.52020, up $3.3 million, or $0.8875%, from $4.4 million, or $0.58 per diluted share, for the fiscal year ended June 30, 2016.2019. The lower percentage decrease in the diluted earnings per share in comparison to the percentage decrease in the net income was primarily attributable to stock repurchases during fiscal 2017. The $2.3 million decreaseincrease in net income in fiscal 20172020 was primarily attributable to a $6.3$16.3 million decrease in non-interest expense, partly offset by a $8.0 million decrease in non-interest income partly offset by(mainly a $3.4$7.3 million increase in net interest income, a $673,000 decrease in the recovery from the allowance for loan losses and a $1.8 million decrease in the provision for income taxes. The decrease in non-interest income was primarily attributable to a decrease in the gain on sale of loans.loans), a $1.8 million decrease in net interest income and a $1.6 million increase in the provision for loan losses. The Corporation's efficiency ratio,
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defined as non-interest expense divided by the sum of net interest income and non-interest income, increasedimproved to 88%71% in fiscal 20172020 from 84%89% in fiscal 2016.2019. Return on average assets in fiscal 2017 decreased2020 increased to 0.43%0.69% from 0.64%0.39% in fiscal 20162019 and return on average stockholders' equity in fiscal 2017 decreased2020 increased to 3.94%6.26% from 5.43%3.63% in fiscal 2016.2019.
Net Interest Income. Net interest income increased $3.4decreased $1.8 million, or 11%5%, to $35.7$36.4 million in fiscal 20172020 from $32.3$38.2 million in fiscal 2016.2019. This increasedecrease resulted from an increasea decrease in the average balance of earning assetsnet interest margin and, to a lesser extent, an increase in the net interest margin. The average balance of earning assets increased $32.3 million, or 3%, to $1.17 billion in fiscal 2017 from $1.13 billion in fiscal 2016. The net interest margin increased 21 basis points to 3.06% in fiscal 2017 from 2.85% in fiscal 2016, due to a significant increase in the average yield on interest-earning assets and a smaller decrease in the average cost of interest-bearing liabilities.
Interest Income. Interest income increased $3.1 million, or 8%, to $42.4 million for fiscal 2017 from $39.3 million for fiscal 2016. The increase was a result of an increase in the average balance and, to a lesser extent, an increase in the average yield of earning assets. The increase in average balance of earning assets was primarily attributable to increases in the average balance of loans receivable and investment securities, partly offset by a decrease in the average balance of interest-earning deposits.assets. The decrease in average interest-earning deposits was primarily due to the deployment of excess cash to fund originations of loans held for sale and loans held for investment and purchases of investment securities. The average yield on interest-earning assets increased 17net interest margin decreased 11 basis points to 3.64%3.36% in fiscal 20172020 from 3.47% in fiscal 2016. The increase2019, due to an 11 basis point decrease in the average yield on interest-earning assets, partially offset by a one basis point decrease in the average cost of interest-bearing liabilities. The average balance of interest-earning assets decreased $17.9 million, or 2%, to $1.08 billion in fiscal 2020 from $1.10 billion in fiscal 2019.
Interest Income. Total interest income decreased $1.9 million, or 4%, to $42.5 million for fiscal 2020 from $44.4 million for fiscal 2019. The decrease was primarily the result of the decrease in excess liquidity yielding a nominaldue to lower interest rate, resulting from the increases inincome on loans receivable and investment securities.interest-earning deposits and lower cash dividends from FHLB – San Francisco stock.
Interest income on loans receivable increased $2.5 million,decreased $947,000, or 7%2%, to $40.2$39.1 million in fiscal 20172020 from $37.7$40.1 million in fiscal 2016.2019. This increasedecrease was attributable to a higher average loan balance, partly offset byboth a lower average yield.loan yield and average loan balance. The weighted average loan yield during fiscal 2020 decreased five basis points to 4.28% from 4.33% in fiscal 2019, due primarily to the decrease in market interest rates resulting from the decline in the general economic conditions impacted by the COVID-19 pandemic. The average balance of loans receivable consisting of loans held for investment and(including loans held for sale increased $76.5in fiscal 2019) decreased $10.6 million, or 8%1%, to $1.03 billion during fiscal 2017 from $949.4$915.4 million during fiscal 2016. The average loan yield, including2020 from $926.0 million during fiscal 2019. There were no loans held for sale during fiscal 2017 decreased five basis points to 3.92% from 3.97% in fiscal 2016. The average balance of loans held for investment increased $58.6 million, or 7%, to $865.1 million for fiscal 2017 from $806.5 million in fiscal 2016 while the average yield on loans held for investment decreased three basis points to 3.97% in fiscal 2017 from 4.00% in fiscal 2016.2020. The average balance of loans held for sale increased $17.9 million, or 13%, to $160.8 million for fiscal 2017 from $142.9 million in fiscal 2016 while2019 was $46.3 million with the weighted average yield on loans held for sale decreased eight basis points to 3.68% in fiscal 2017 from 3.76% in fiscal 2016.of 4.69%.
Interest income from investment securities increased $217,000,$78,000, or 61%4%, to $575,000$2.1 million in fiscal 20172020 from $358,000$2.0 million in fiscal 2016.2019. This increase was primarily a result of an increase in the average balance,yield, partly offset by a decrease in the average yield. The average balance of investment securities increased $26.7 million, or 107%, to $51.6 million in fiscal 2017 from $24.9 million in fiscal 2016 as a result of new purchases of investment securities, partly offset by scheduled and accelerated principal payments on mortgage-backed securities.balance. The average yield on investment securities decreased 33increased 35 basis points to 1.11%2.44% during fiscal 20172020 from 1.44%2.09% during fiscal 2016.2019. The decreaseincrease in the average yield of investment securities was primarily attributable to the upward repricing of adjustable rate mortgage-backed securities during the first half of fiscal 2020 and a lower premium amortization resulting from lower principal payments, partly offset by the purchase of new investment securities during the second half of fiscal 2020 with a lower average yield than the existing portfolioportfolio. The average balance of investment securities decreased $11.1 million, or 11%, to $86.8 million in fiscal 2020 from $97.9 million in fiscal 2019 as a result of scheduled and accelerated amortizationprincipal payments on mortgage-backed securities, partly offset by the new purchases of purchase premiums resulting from accelerated principal payments.investment securities. During fiscal 2017,2020, the Bank purchased $34.5$55.9 million of mortgage-backed securities with ana weighted average yield of 1.75%1.16% and did not sell any investment securities.
During fiscal 2017,2020, the Bank received $967,000$534,000 of cash dividends from its FHLB - San Francisco stock, an increasea decrease of $246,000$173,000 or 24% from the $721,000$707,000 of cash dividends received in fiscal 2016.2019. The increasedecrease in cash dividends was due primarily to a special cash
dividend of $133,000 received in the second quarter of fiscal 2017,2019 that was not replicated in fiscal 2020, and as a result, the average yield increased 303decreased 207 basis points to 11.94%6.55% in fiscal 20172020 from 8.91%8.62% in fiscal 2016.2019.
Interest income from interest-earning deposits, primarily cash deposited at the Federal Reserve Bank of San Francisco, increased $59,000,decreased $880,000, or 10%57%, to $626,000$657,000 in fiscal 20172020 from $567,000$1.5 million in fiscal 2016,2019, due to a higherlower average nominal yield, partly offset by a lowerhigher average cash balance. The average nominal yield increased 39decreased 134 basis points to 0.76%0.90% in fiscal 20172020 from 0.37%2.24% in fiscal 2016,2019, resulting from recent increasesdecreases in the targeted federal funds interest rates.rate. The average balance of interest-earning deposits decreased $70.9increased $4.0 million, or 47%6%, to $81.0$71.8 million in fiscal 20172020 from $151.9$67.8 million in fiscal 2016, due to the utilization of excess liquidity to fund increases in loans held for investment and investment securities.2019.
Interest Expense. Total interest expense for fiscal 20172020 was $6.7$6.1 million as compared to $7.0$6.2 million for fiscal 2016,2019, a decrease of $296,000,$153,000, or 4%2%. This decrease was primarily attributable to a lower interest expense on deposits, particularly in time deposits, partly offset by a higher interest expense on borrowings. The average balance of interest-bearing liabilities decreased $17.7 million or 2% to $972.0 million during fiscal 2020 as compared to $989.7 million during fiscal 2019. This
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decrease was attributable to a decline in the average costbalance of interest-bearing liabilities,deposits, partly offset by an increase in the average balance of interest-bearing liabilities.borrowings. The average cost of interest-bearing liabilities was 0.64%0.62% during fiscal 2017,2020, down fiveone basis pointspoint from 0.69%0.63% during fiscal 2016. The decrease in the average cost of liabilities was primarily due to a lower average cost of borrowings and deposits. The average balance of interest-bearing liabilities, principally deposits and borrowings, increased 3% to $1.05 billion during fiscal 2017 as compared to $1.01 billion during fiscal 2016. The increase of the average balance was attributable to both, deposits, primarily transaction accounts, and borrowings.2019.
Interest expense on deposits for fiscal 20172020 was $3.8$2.9 million as compared to $4.4$3.4 million for the same period of fiscal 2016,2019, a decrease of $589,000,$438,000, or 13%. The decrease in interest expense on deposits was primarily attributable to a lower average cost in each deposit category and a lower percentage balance, ofparticularly time deposit to total deposits, partly offset by a higher average balance.
The average cost of deposits decreased seven basis points to 0.41% in fiscal 2017 from 0.48% during fiscal 2016. The average cost of time deposits in fiscal 2017 was 0.98%, down three basis points, from 1.01% in fiscal 2016. The average cost of transaction accounts in fiscal 2017 declined by three basis point to 0.15% from 0.18% in fiscal 2016.deposits. The average balance of deposits increased $8.5decreased $36.0 million, or 1%4%, to $932.1$844.1 million during fiscal 20172020 from $923.6$880.1 million during fiscal 2016.2019. The average balance of time deposits decreased by $35.0$34.1 million, or 11%15%, to $290.1$186.3 million in fiscal 20172020 from $325.1$220.4 million in fiscal 2016.2019. The decrease in the average balance of time deposits was offset by an increasemuch larger than the decrease in the average balance of transaction accounts, consistent with the Bank's marketing strategy to promote transaction accounts and the strategic decision to compete less aggressively on time deposit interest rates. The average balance of transaction accounts increased $43.6decreased $1.9 million or 7%, to $642.1$657.8 million in fiscal 20172020 from $598.5$659.7 million in fiscal 2016.2019. The average balance of transaction accounts to total deposits in the fiscal 20172020 was 69 percent,78%, compared to 65 percent75% in fiscal 2016.2019. The average cost of deposits decreased three basis points to 0.35% in fiscal 2020 from 0.38% in fiscal 2019. The average cost of transaction accounts was 0.14% in fiscal 2020, down one basis point from 0.15% in fiscal 2019; while the average cost of time deposits in fiscal 2020 was 1.09%, up one basis point, from 1.08% in fiscal 2019.
Interest expense on borrowings, consisting of FHLB - San Francisco advances, for fiscal 20172020 increased $293,000,$285,000, or 11%10%, to $2.9$3.1 million from $2.6as compared to $2.8 million forin fiscal 2016.2019. The increase in interest expense on borrowings was due primarily to a higher average balance, partly offset by a lower average cost. The average balance of borrowings increased $26.0$18.3 million, or 28%17%, to $117.3$127.9 million during fiscal 20172020 from $91.3$109.6 million during fiscal 2016.2019. The average cost of borrowings decreased to 2.45%2.43% in fiscal 20172020 from 2.82%2.58% in fiscal 2016,2019, a decrease of 3715 basis points. The decrease in the average cost of borrowings was primarily due to the increased utilization of overnightnew borrowings and short-term advances with a much lower average cost than long-term FHLB advances.in fiscal 2020.
Provision (Recovery) for Loan Losses. During fiscal 2017,2020, the Corporation recorded a recovery from the allowanceprovision for loan losses of $1.0$1.1 million, as compared to a $1.7 million$475,000 recovery from the allowance for loan losses during fiscal 2016,2019. The provision for loan losses in fiscal 2020 was primarily due to a $673,000 or 39% decrease. The decreasequalitative component established in the recovery was primarily attributableallowance for loan losses methodology in response to an 8% increase in the outstanding balance of loans held for investment to $904.9 million at June 30, 2017 from $840.0 million at June 30, 2016, partly offset by further improvement in credit quality, as described below.COVID-19 pandemic and its continued and forecasted adverse economic impact. The allowance for loan losses decreased $631,000,increased $1.2 million, or 7%17%, to $8.0$8.3 million at June 30, 20172020 from $8.7$7.1 million at June 30, 2016.2019.
Non-performing assets (net of the collectively evaluated allowanceallowances and individually evaluated allowance)allowances), with underlying collateral primarily located in Southern California, decreased $3.4$1.3 million or 26%21% to $9.6$4.9 million, or 0.80%0.42% of total assets, at June 30, 2017,2020, compared to $13.0$6.2 million, or 1.11%0.57% of total assets, at June 30, 2016.2019. Non-performing loans at June 30, 2017 decreased $2.32020 were $4.9 million, or 22% since June 30, 2016 to $8.0 million and were comprised of 2718 single-family loans ($7.74.9 million); one commercial real estate loan ($201,000) and one commercial business loan ($65,000)31,000). Real estate ownedThere was no REO at June 30, 2017 decreased $1.1 million or 41% to $1.6 million consisting of two single-family properties acquired in the settlement of loans.2020 and 2019. As of June 30, 2017, 47%2020, 33%, or $3.7$1.6 million of non-performing loans have a current payment status. Net loan recoveries in fiscal 20172020 were $411,000$70,000 or 0.04%0.01% of average loans receivable, compared to net loan recoveries of $1.7 million$166,000 or 0.17%0.02% of average loans receivable in fiscal 2016.
2019.
Classified assets at June 30, 20172020 were $13.3$14.1 million, comprised of $3.7$8.6 million in the special mention category, $8.0$5.5 million in the substandard category and $1.6 million in real estate owned.no outstanding REO. Classified assets at June 30, 20162019 were $21.9$16.2 million, comprised of $8.9$8.6 million in the special mention category, $10.3$7.6 million in the substandard category and $2.7 million in real estate owned. Classified assets decreased at June 30, 2017 from the June 30, 2016 level primarily as a result of improvements in credit quality and stabilization of real estate markets.no outstanding REO. For additional information, see Item 1, “Business - “Delinquencies and Classified Assets” in this Form 10-K.
ThereFor the fiscal year ended June 30, 2020, there were two loans that were newly modified from their original terms, re-underwritten or identified as a restructured loan; one loan (previously modified) was downgraded; one loan was upgraded to the pass category; two loans were paid off; and no loans were converted to real estate owned. For the fiscal year ended June 30, 2019, there were no loans that were newly modified from their original terms, in fiscal 2017re-underwritten or identified as a restructured loan; one loan (previously modified) was downgraded; three loans were upgraded to the pass category; one loan was paid off; and 2016. As of June 30, 2017, theno loans were converted to real estate owned. The outstanding balance of restructured loans at June 30, 2020 was $3.6 million: one loan was classified as special mention and remained on accrual status ($506,000); and nine$2.6
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million (eight loans), down 32 percent from $3.8 million (eight loans) at June 30, 2019. As of June 30, 2020, all restructured loans were classified as substandard ($3.1 million, all on non-accrual status).status. As of June 30, 2017, 46%2020, 44%, or $1.7$1.2 million of the restructured loans have a current payment status, consistent with their modified payment terms. During fiscal 2017,2020, no restructured loans were in default within a 12-month period subsequent to their original restructuring. Additionally, during fiscal 2017, one restructured loan with a total balance of $85,000 had its modification extended beyond the initial maturity of the modification.
The allowance for loan losses was $8.0$8.3 million at June 30, 2017,2020, or 0.88%0.91% of gross loans held for investment, compared to $8.7$7.1 million, or 1.02%0.80% of gross loans held for investment at June 30, 2016.2019. The allowance for loan losses at June 30, 20172020 includes $101,000$100,000 of individually evaluated allowances, compared to $20,000$130,000 of individually evaluated allowances at June 30, 2016.2019. Management believes that, based on currently available information, the allowance for loan losses is sufficient to absorb potential losses inherent in loans held for investment at June 30, 2017.2020. For additional information, see Item 1, “Business - Delinquencies and Classified Assets - Allowance for Loan Losses” in this Form 10-K.
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 portfolio 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 collectibilitycollectability may not be assured, and determination of the realizable value of the collateral securing the loans. Provisions (recoveries) for loan losses are charged (credited) against operations on a quarterly basis, as necessary, to maintain the allowance at appropriate levels. Management believes that the amount maintained in the allowance will be adequate to absorb probable losses inherent in the loans held for investment. Although management believes it uses the best information available to make such determinations, there can be no assurance that regulators, in reviewing the Bank's loans held for investment, will not request the Bank 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 control of the Bank.Bank, including as a result of the COVID-19 pandemic.
Non-Interest Income. Total non-interest income decreased $6.3$8.0 million, or 17%64%, to $30.8$4.5 million in fiscal 20172020 from $37.1$12.5 million in fiscal 2016.2019. The decrease was primarily attributable to athe decrease in the gain on sale of loans.
The net gain on sale of loans decreased $5.8$7.3 million, or 18%102%, to $25.7 milliona net loss of $132,000 for fiscal 20172020 from $31.5a net gain of $7.1 million in fiscal 2016.2019. The decreasenet loss in fiscal 2020 was a result of a lower volumeprimarily attributable to loan sale premium refunds from the early payoff of loans originated for sale and a lower average loan sale margin. Total loan sale volume, which includes the net change in commitments to extend credit on loans to be held for sale,previously sold. There was $1.83 billion in fiscal 2017 as compared to $2.01 billion in fiscal 2016, down $180.4 million or 9%. The decrease in theno loan sale volume in fiscal 2017 was attributable2020, as compared to increases in mortgage interest rates$410.7 million during fiscal 2017 resulting in a decrease in refinance activity, partly offset by2019 with an increase in loans originated for home purchases. The average loan sale margin of 1.73 percent.
Deposit account fees decreased $318,000, or 16%, to $1.6 million for PBM during fiscal 2017 was 1.40% as compared to 1.57%2020 from $1.9 million in fiscal 2016, a decrease of 17 basis points.2019, due primarily to certain fees that were waived related to accounts impacted by the COVID-19 pandemic.
Loan servicing and other fees decreased $232,000, or 22%, to $819,000 for fiscal 2020 from $1.1 million in fiscal 2019. The decrease in the average loan sale margin for fiscal 2017 was attributable primarily attributable to volatility in loan servicing premiums in the cash markets. Additionally, product composition was less favorable with a higher percentage of loan sales comprised of lower margin products. The total refinance loans as percentage of total loans originated by PBM during fiscal 2017 was 49 percent, up from 46 percent in fiscal 2016. Thefair value gain on sale of loans includes an unfavorable fair-value adjustment on loans held for sale and derivative financial instruments (commitments to extend credit, commitments to sell loans, TBA MBS trades and option contracts) that amounted to a net loss of $3.4 millioninvestment at fair value in fiscal 2017, as compared2020 in comparison to a favorable fair-value adjustment that amounted to a net gain of $742,000 in fiscal 2016. The gain on sale of loans in fiscal 2017 also includes a $137,000 recourse reserve recovery on loans sold that are subject to repurchase, compared to a $155,000 provision for recourse reserves on loans sold in fiscal 2016.
The net loss on sale and operations of real estate owned acquired in the settlement of loans increased $462,000 to a net loss of $557,000 in fiscal 2017 from a net loss of $95,000 in fiscal 2016. The net loss in fiscal 2017 was comprised of the net operating expenses of $255,000 and a $440,000 provision for losses on real estate owned, partly offset by a $138,000 net gain on the sale
of seven real estate owned properties. The net loss in fiscal 2016 was comprised of the net operating expenses of $207,000, partly offset by a $60,000 recovery from the losses on real estate owned and a $52,000 net gain on the sale of 10 real estate owned properties.2019.
Non-Interest Expense. Total non-interest expense in fiscal 20172020 was $58.8$28.9 million, an increasea decrease of $526,000,$16.3 million, or 1%36%, as compared to $58.3$45.2 million in fiscal 2016.2019. The increasedecrease in non-interest expense was primarily the result of an increase in other operating expenses relatedattributable to the litigation accrual of $1.0 million (see Part I, Item 3. Legal Proceeding) and an increase in premises and occupancy expenses related to the relocation of the retail banking home office, partly offset by decreases in salaries and employee benefits expense, premises and deposit insurance premiumsoccupancy expenses, equipment expense and regulatory assessments.other operating expenses.
Salaries and employee benefits expense decreased $867,000,$11.2 million, or 2%37%, to $41.7$18.9 million in fiscal 20172020 from $42.6$30.1 million in fiscal 2016.2019. The decrease in salaries and employee benefits was primarily due to lower PBMfewer employees and incentive payments consistent with the scaling back of saleable single-family mortgage loan originations. The salaries and employee benefits expense in fiscal 2019 includes approximately $11.4 million of salaries and employee benefits expenses resulting from lowerrelated to the staffing associated with saleable single-family loan originations, which includes $1.7 million of one-time costs associated with staff
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reductions. There were no loans originated for sale.sale in fiscal 2020, as compared to $467.1 million in fiscal 2019; while total loans originated and purchased for investment in fiscal 2020 was $248.1 million, up 45% from $171.2 million in fiscal 2019.
Total premises and occupancy expense decreased $1.5 million, or 30%, to $3.5 million in fiscal 2020 from $5.0 million in fiscal 2019. The decrease in both premises and occupancy expenses and equipment expense was due primarily to the closure of 10 loan production offices and one retail banking center resulting in lower office rents and depreciation of furniture and fixtures, consistent with the Corporation’s business decision to scale back the saleable single-family mortgage loan originations. In addition fiscal 2019 included $337,000 of non-recurring charges related to accelerated lease expenses and depreciation of furniture and fixtures.
Total equipment expense decreased $1.4 million, or 56%, to $1.1 million in fiscal 2020 from $2.5 million in fiscal 2019. The decrease was primarily attributable to lower equipment depreciation and $758,000 of non-recurring charges in fiscal 2019 related to termination, charge-off, or modification of data processing and other contractual arrangements, consistent with the Corporation’s business decision to scale back the saleable single-family mortgage loan originations.
Other non-interest expense decreased $1.1 million, or 27%, to $3.0 million in fiscal 2020 from $4.1 million in fiscal 2019. The decrease was primarily attributable to lower expenses related to reduced loan originations and a $296,000 reversion of a previously recognized legal settlement expense.
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, among others. 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.
The provision for income taxes was $3.6$3.2 million for fiscal 2017,2020, representing an effective tax rate of 40.9%29.5%, as compared to $5.4$1.5 million in fiscal 2016,2019, representing an effective tax rate of 41.8%25.4%.
The Corporation’s effective tax rate may differ from the estimated tax rates described above due to discrete items such as further adjustments to net deferred tax assets, excess tax benefits derived from stock option exercises and non-taxable earnings from bank owned life insurance, among other items. The Corporation determined that the above tax rates meet its estimated income tax obligations. For additional information, see Note 9, "Income Taxes," of the Notes to Consolidated Financial Statements, contained in Item 8 of this Form 10-K.
Comparison of Operating Results for the Years Ended June 30, 2016 and 2015
General. The Corporation recorded net income of $7.5 million, or $0.88 per diluted share, for the fiscal year ended June 30, 2016, as compared to net income of $9.8 million, or $1.07 per diluted share, for the fiscal year ended June 30, 2015. The $2.3 million decrease in net income in fiscal 2016 was primarily attributable to a $3.3 million decrease in non-interest income, partly offset by a $1.9 million decrease in the provision for income taxes. The decrease in non-interest income was primarily attributable to a decrease in mortgage banking loan production. The Corporation's efficiency ratio, defined as non-interest expense divided by the sum of net interest income and non-interest income, increased to 84% in fiscal 2016 from 79% in fiscal 2015. Return on average assets in fiscal 2016 decreased to 0.64% from 0.87% in fiscal 2015 and return on average stockholders' equity in fiscal 2016 decreased to 5.43% from 6.81% in fiscal 2015.
Net Interest Income. Net interest income decreased $946,000, or 3%, to $32.3 million in fiscal 2016 from $33.3 million in fiscal 2015. This decrease resulted principally from a decrease in the net interest margin, partly offset by an increase in the average balance of earning assets. The net interest margin decreased 18 basis points to 2.85% in fiscal 2016 from 3.03% in fiscal 2015. The average balance of earning assets increased $36.7 million, or 3%, to $1.13 billion in fiscal 2016 from $1.10 billion in fiscal 2015.
Interest Income. Interest income decreased $392,000, or 1%, to $39.3 million for fiscal 2016 from $39.7 million for fiscal 2015. The decrease in interest income was primarily a result of a decrease in the average yield of earning assets, partly offset by an increase in the average balance. The average yield on earning assets decreased 15 basis points to 3.47% in fiscal 2016 from 3.62% in fiscal 2015. The decrease in the average yield on earning assets was primarily the result of the increase in excess liquidity yielding a nominal interest rate, resulting from the decline in loans receivable, partly offset by the increase in investment securities.
Interest income on loans receivable decreased $679,000, or 2%, to $37.7 million in fiscal 2016 from $38.3 million in fiscal 2015. This decrease was attributable to a lower average loan balance. The average balance of loans receivable, consisting of loans held for investment and loans held for sale, decreased $15.6 million, or 2%, to $949.4 million during fiscal 2016 from $965.0 million during fiscal 2015. The average loan yield, including loans held for sale, during fiscal 2016 remained unchanged at 3.97% as compared to fiscal 2015. The average balance of loans held for sale decreased $25.3 million, or 15%, to $142.9 million for fiscal 2016 from $168.2 million in fiscal 2015 and the average yield on loans held for sale decreased one basis point to 3.76% in fiscal 2016 from 3.77% in fiscal 2015.
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Interest income from investment securities increased $71,000, or 25%, to $358,000 in fiscal 2016 from $287,000 in fiscal 2015. This increase was primarily a result of an increase in the average balance, partly offset by a decrease in the average yield. The average balance of investment securities increased $8.7 million, or 54%, to $24.9 million in fiscal 2016 from $16.2 million in fiscal 2015 as a result of new purchases of investment securities, partly offset by scheduled and accelerated principal payments on mortgage-backed securities. The average yield on investment securities decreased 33 basis points to 1.44% during fiscal 2016 from 1.77% during fiscal 2015. The decrease in the average yield of investment securities was primarily attributable to the purchase of new investment securities with a lower average yield than the existing portfolio. During fiscal 2016, the Bank purchased $41.7 million of investment securities with an average yield of 1.43% and did not sell any investment securities.
During fiscal 2016, the Bank received $721,000 of cash dividends from its FHLB - San Francisco stock, down $75,000 from the $796,000 of cash dividends received in fiscal 2015. The decrease in cash dividends was due primarily to a $261,000 special cash dividend in fiscal 2015 which was not replicated in fiscal 2016, partly offset by a higher average stock balance. The average balance of FHLB stock increased by $800,000, or 11%, to $8.1 million in fiscal 2016 from $7.3 million in fiscal 2015. The average yield decreased by 200 basis points to 8.91% in fiscal 2016 from 10.91% in fiscal 2015.
Interest income from interest-earning deposits increased $291,000, or 105%, to $567,000 in fiscal 2016 from $276,000 in fiscal 2015, due to a higher average cash balance deposited at the Federal Reserve Bank of San Francisco earning a nominal yield of 37 basis points and 25 basis points, respectively. The average balance of interest-earning deposits increased by $42.9 million, or 39%, to $151.9 million in fiscal 2016 from $109.0 million in fiscal 2015, due to temporarily investing excess cash from ongoing business activities in short-term, highly liquid instruments as part of the Corporation’s interest rate risk management strategy. The increase in the nominal yield was the result of the 25 basis point increase in the federal funds target rate from 25 basis points to 50 basis points beginning on December 17, 2015.
Interest Expense. Total interest expense for fiscal 2016 was $7.0 million as compared to $6.4 million for fiscal 2015, an increase of $554,000, or 9%. This increase was primarily attributable to an increase in the average balance of borrowings, partly offset by a lower average balance of time deposits. The average balance of interest-bearing liabilities, principally deposits and borrowings, increased 5% to $1.01 billion during fiscal 2016 as compared to $971.1 million during fiscal 2015. The increase of the average balance was attributable to both, deposits, primarily transaction accounts, and borrowings. The average cost of interest-bearing liabilities was 0.69% during fiscal 2016, up three basis points from 0.66% during fiscal 2015. The increase in the average cost of liabilities was primarily due to a higher average cost of borrowings, partly offset by a lower average cost of deposits.
Interest expense on deposits for fiscal 2016 was $4.4 million as compared to $4.8 million for the same period of fiscal 2015, a decrease of $364,000, or 8%. The decrease in interest expense on deposits was primarily attributable to a lower average balance and a lower average cost of time deposits. The average cost of deposits decreased four basis points to 0.48% in fiscal 2016 from 0.52% during fiscal 2015. The average cost of time deposits in fiscal 2016 was 1.01%, down two basis points, from 1.03% in fiscal 2015. The average cost of transaction accounts in fiscal 2016 declined by one basis point to 0.18% from 0.19% in fiscal 2015. The average balance of deposits increased $13.5 million to $923.6 million during fiscal 2016 from $910.1 million during fiscal 2015. The decrease in the average cost of deposits was primarily attributable to 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 time deposits decreased by $33.9 million, or 9%, to $325.1 million in fiscal 2016 from $359.0 million in fiscal 2015. The decrease in the average balance of time deposits was offset by an increase in the average balance of transaction accounts, consistent with the Bank's marketing strategy to promote transaction accounts and the strategic decision to compete less aggressively on time deposit interest rates. The average balance of transaction accounts increased $47.4 million, or 9%, to $598.5 million in fiscal 2016 from $551.1 million in fiscal 2015. The average balance of transaction accounts to total deposits in the fiscal 2016 was 65 percent, compared to 61 percent in fiscal 2015
Interest expense on borrowings, solely FHLB - San Francisco advances, for fiscal 2016 increased $918,000, or 55%, to $2.6 million from $1.7 million for fiscal 2015. The increase in interest expense on borrowings was due primarily to a higher average balance and, to a lesser extent, a higher average cost. The average balance of borrowings increased $30.2 million, or 49%, to $91.3 million during fiscal 2016 from $61.1 million during fiscal 2015, resulting from $50.0 million of advances taken during the first half of calendar 2015. The average cost of borrowings increased to 2.82% in fiscal 2016 from 2.72% in fiscal 2015, an increase of 10 basis points, resulting primarily from the maturities of overnight borrowings during fiscal 2015 with much lower interest rates.
Provision (Recovery) for Loan Losses. During fiscal 2016, the Corporation recorded a recovery from the allowance for loan losses of $1.7 million, as compared to a $1.4 million recovery from the allowance for loan losses during fiscal 2015. Although the total loans held for investment increased 3% to $840.0 million at June 30, 2016 from $814.2 million at June 30, 2015, the
allowance for loan losses was virtually unchanged at $8.7 million at June 30, 2016 as compared to June 30, 2015, reflecting the improved loan credit quality, as described below.
Non-performing assets (net of the collectively evaluated allowance and individually evaluated allowance), with underlying collateral primarily located in Southern California, decreased to $13.0 million, or 1.11% of total assets, at June 30, 2016, compared to $16.3 million, or 1.39% of total assets, at June 30, 2015. The non-performing assets at June 30, 2016 were primarily comprised of 35 single-family loans ($9.5 million); two multi-family loans ($709,000); one commercial business loan ($76,000); one consumer loan (fully reserved); and real estate owned comprised of four single-family properties ($2.7 million) acquired in the settlement of loans. As of June 30, 2016, 59%, or $6.1 million of non-performing loans have a current payment status. Net recoveries in fiscal 2016 were $1.7 million or 0.17% of average loans receivable, compared to net recoveries of $367,000 or 0.04% of average loans receivable in fiscal 2015.
Classified assets at June 30, 2016 were $21.9 million, comprised of $8.9 million in the special mention category, $10.3 million in the substandard category and $2.7 million in real estate owned. Classified assets at June 30, 2015 were $31.1 million, comprised of $8.2 million in the special mention category, $20.5 million in the substandard category and $2.4 million in real estate owned. Classified assets decreased at June 30, 2016 from the June 30, 2015 level primarily as a result of improvements in credit quality and stabilization of real estate markets. For additional information, see Item 1, “Business - “Delinquencies and Classified Assets” in this Form 10-K.
There were no loans that were modified from their original terms in fiscal 2016 and 2015. As of June 30, 2016, the outstanding balance of restructured loans was $4.6 million: three loans were classified as special mention and remained on accrual status ($1.3 million); and 10 loans were classified as substandard ($3.3 million, all on non-accrual status). As of June 30, 2016, 41%, or $1.9 million of the restructured loans have a current payment status, consistent with their modified payment terms.
The allowance for loan losses was $8.7 million at June 30, 2016, or 1.02% of gross loans held for investment, compared to $8.7 million, or 1.06% of gross loans held for investment at June 30, 2015. The allowance for loan losses at June 30, 2016 includes $20,000 of individually evaluated allowances, compared to $98,000 of individually evaluated allowances at June 30, 2015. Management believes that, based on currently available information, the allowance for loan losses is sufficient to absorb potential losses inherent in loans held for investment at June 30, 2016. For additional information, see Item 1, “Business - Delinquencies and Classified Assets - Allowance for Loan Losses” in this Form 10-K.
Non-Interest Income. Total non-interest income decreased $3.3 million, or 8%, to $37.1 million in fiscal 2016 from $40.4 million in fiscal 2015. The decrease was primarily attributable to a decrease in the gain on sale of loans.
The gain on sale of loans decreased $2.7 million, or 8%, to $31.5 million for fiscal 2016 from $34.2 million in fiscal 2015. The decrease was a result of a lower volume of loans originated for sale, partly offset by a higher average loan sale margin. Total loan sale volume, which includes the net change in commitments to extend credit on loans to be held for sale, was $2.01 billion in fiscal 2016 as compared to $2.49 billion in fiscal 2015, down $478.7 million or 19%. The decrease in the loan sale volume in fiscal 2016 was attributable to a decrease in refinance activity as compared to fiscal 2015. The average loan sale margin for PBM during fiscal 2016 was 1.57% as compared to 1.37% in fiscal 2015, an increase of 20 basis points. The gain on sale of loans includes a favorable fair-value adjustment on loans held for sale and derivative financial instruments (commitments to extend credit, commitments to sell loans, TBA MBS trades and option contracts) that amounted to a net gain of $742,000 in fiscal 2016, as compared to an unfavorable fair-value adjustment that amounted to a net loss of $186,000 in fiscal 2015. The gain on sale of loans in fiscal 2016 also includes a $155,000 provision for recourse reserves on loans sold that are subject to repurchase, compared to an $86,000 recourse reserve recovery on loans sold in fiscal 2015.
The sale and operations of real estate owned acquired in the settlement of loans reflected a net loss of $95,000 in fiscal 2016, as compared to a net gain of $282,000 in fiscal 2015. The net loss in fiscal 2016 was comprised of the net operating expenses of $207,000, partly offset by a $60,000 recovery from the losses on real estate owned and a $52,000 net gain on the sale of 10 real estate owned properties. The net gain in fiscal 2015 was comprised of a $468,000 net gain on the sale of 10 real estate owned properties and a $10,000 recovery from the losses on real estate owned, partly offset by the net operating expenses of $196,000.
Non-Interest Expense. Total non-interest expense in fiscal 2016 was $58.3 million, an increase of $290,000 as compared to $58.0 million in fiscal 2015. The increase in non-interest expense was primarily the result of an increase in salaries and employee benefits expense, partly offset by decreases in equipment expense, sales and marketing expenses and other operating expenses related to the decline in mortgage banking operations, resulting in lower variable expenses.
Salaries and employee benefits increased $991,000, or 2%, to $42.6 million in fiscal 2016 from $41.6 million in fiscal 2015. The increase in salaries and employee benefits was primarily due to higher PBM salaries and employee benefits expense, partly offset by lower incentive compensation costs. Total PBM loan originations and purchases decreased $518.1 million, or 21%, to $2.00 billion in fiscal 2016 from $2.52 billion in fiscal 2015. For additional information, see Note 17 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K, for further details on PBM salaries and employee benefits.
Equipment expenses, sales and marketing expenses and other operating expenses decreased $635,000, or 7%, to $7.9 million in fiscal 2016 from $8.5 million in fiscal 2015, attributable primarily to the decline in loan volume at PBM.
Provision for Income Taxes. The provision for income taxes was $5.4 million for fiscal 2016, representing an effective tax rate of 41.8%, as compared to $7.3 million in fiscal 2015, representing an effective tax rate of 42.6%. The Corporation determined that the above tax rates meet its estimated income tax obligations. For additional information, see Note 9, "Income Taxes," of the Notes to Consolidated Financial Statements, contained in Item 8 of this Form 10-K.
Average Balances, Interest and Average Yields/Costs
The following table sets forth certain information for the periods regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and average yields and costs thereof. Yields and costs for the periods indicated are derived by dividing income or expense by the average monthly balance of assets or liabilities, respectively, for the periods presented.
| Year Ended June 30, |
| 2020 | | 2019 | | 2018 |
(Dollars In Thousands) | Average Balance | Interest | Yield/ Cost | | Average Balance | Interest | Yield/ Cost | | Average Balance | Interest | Yield/ Cost |
Interest-earning assets: | | | | | | | | | | | |
Loans receivable, net(1) | $ | 915,353 | | $ | 39,145 | | 4.28 | % | | $ | 926,003 | | $ | 40,092 | | 4.33 | % | | $ | 986,815 | | $ | 40,016 | | 4.06 | % |
Investment securities | 86,761 | | 2,120 | | 2.44 | % | | 97,870 | | 2,042 | | 2.09 | % | | 90,719 | | 1,344 | | 1.48 | % |
FHLB – San Francisco stock | 8,155 | | 534 | | 6.55 | % | | 8,199 | | 707 | | 8.62 | % | | 8,126 | | 568 | | 6.99 | % |
Interest-earning deposits | 71,766 | | 657 | | 0.90 | % | | 67,816 | | 1,537 | | 2.24 | % | | 53,438 | | 784 | | 1.45 | % |
| | | | | | | | | | | |
Total interest-earning assets | 1,082,035 | | 42,456 | | 3.92 | % | | 1,099,888 | | 44,378 | | 4.03 | % | | 1,139,098 | | 42,712 | | 3.75 | % |
| | | | | | | | | | | |
Non interest-earning assets | 31,720 | | | | | 30,778 | | | | | 32,905 | | | |
| | | | | | | | | | | |
Total assets | $ | 1,113,755 | | | | | $ | 1,130,666 | | | | | $ | 1,172,003 | | | |
| | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | |
Checking and money market accounts(2) | $ | 396,399 | | 424 | | 0.11 | % | | $ | 381,790 | | 428 | | 0.11 | % | | $ | 372,781 | | 407 | | 0.11 | % |
Savings accounts | 261,432 | | 496 | | 0.19 | % | | 277,896 | | 572 | | 0.21 | % | | 290,959 | | 595 | | 0.20 | % |
Time deposits | 186,317 | | 2,023 | | 1.09 | % | | 220,432 | | 2,381 | | 1.08 | % | | 251,604 | | 2,493 | | 0.99 | % |
| | | | | | | | | | | |
Total deposits | 844,148 | | 2,943 | | 0.35 | % | | 880,118 | | 3,381 | | 0.38 | % | | 915,344 | | 3,495 | | 0.38 | % |
| | | | | | | | | | | |
Borrowings | 127,882 | | 3,112 | | 2.43 | % | | 109,558 | | 2,827 | | 2.58 | % | | 113,984 | | 2,917 | | 2.56 | % |
| | | | | | | | | | | |
Total interest-bearing liabilities | 972,030 | | 6,055 | | 0.62 | % | | 989,676 | | 6,208 | | 0.63 | % | | 1,029,328 | | 6,412 | | 0.62 | % |
| | | | | | | | | | | |
Non interest-bearing liabilities | 18,968 | | | | | 19,288 | | | | | 19,392 | | | |
| | | | | | | | | | | |
Total liabilities | 990,998 | | | | | 1,008,964 | | | | | 1,048,720 | | | |
| | | | | | | | | | | |
Stockholders’ equity | 122,757 | | | | | 121,702 | | | | | 123,283 | | | |
Total liabilities and stockholders’ equity | $ | 1,113,755 | | | | | $ | 1,130,666 | | | | | $ | 1,172,003 | | | |
| | | | | | | | | | | |
Net interest income | | $ | 36,401 | | | | | $ | 38,170 | | | | | $ | 36,300 | | |
| | | | | | | | | | | |
Interest rate spread(3) | | | 3.30 | % | | | | 3.40 | % | | | | 3.13 | % |
Net interest margin(4) | | | 3.36 | % | | | | 3.47 | % | | | | 3.19 | % |
Ratio of average interest- earning assets to average interest-bearing liabilities | | | 111.32 | % | | | | 111.14 | % | | | | 110.66 | % |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended June 30, |
| 2017 | | 2016 | | 2015 |
(Dollars In Thousands) | Average Balance | Interest | Yield/ Cost | | Average Balance | Interest | Yield/ Cost | | Average Balance | Interest | Yield/ Cost |
Interest-earning assets: | | | | | | | | | | | |
Loans receivable, net(1) | $ | 1,025,885 |
| $ | 40,249 |
| 3.92 | % | | $ | 949,412 |
| $ | 37,658 |
| 3.97 | % | | $ | 965,035 |
| $ | 38,337 |
| 3.97 | % |
Investment securities | 51,575 |
| 575 |
| 1.11 | % | | 24,895 |
| 358 |
| 1.44 | % | | 16,227 |
| 287 |
| 1.77 | % |
FHLB – San Francisco stock | 8,097 |
| 967 |
| 11.94 | % | | 8,094 |
| 721 |
| 8.91 | % | | 7,294 |
| 796 |
| 10.91 | % |
Interest-earning deposits | 81,027 |
| 626 |
| 0.76 | % | | 151,867 |
| 567 |
| 0.37 | % | | 108,971 |
| 276 |
| 0.25 | % |
| | | | | | | | | | | |
Total interest-earning assets | 1,166,584 |
| 42,417 |
| 3.64 | % | | 1,134,268 |
| 39,304 |
| 3.47 | % | | 1,097,527 |
| 39,696 |
| 3.62 | % |
| | | | | | | | | | | |
Non interest-earning assets | 32,003 |
| | | | 35,009 |
| | | | 35,570 |
| | |
| | | | | | | | | | | |
Total assets | $ | 1,198,587 |
| | | | $ | 1,169,277 |
| | | | $ | 1,133,097 |
| | |
| | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | |
Checking and money market accounts(2) | $ | 358,532 |
| 387 |
| 0.11 | % | | $ | 334,814 |
| 450 |
| 0.13 | % | | $ | 304,668 |
| 419 |
| 0.14 | % |
Savings accounts | 283,520 |
| 579 |
| 0.20 | % | | 263,678 |
| 657 |
| 0.25 | % | | 246,401 |
| 641 |
| 0.26 | % |
Time deposits | 290,080 |
| 2,842 |
| 0.98 | % | | 325,149 |
| 3,290 |
| 1.01 | % | | 358,990 |
| 3,701 |
| 1.03 | % |
| | | | | | | | | | | |
Total deposits | 932,132 |
| 3,808 |
| 0.41 | % | | 923,641 |
| 4,397 |
| 0.48 | % | | 910,059 |
| 4,761 |
| 0.52 | % |
| | | | | | | | | | | |
Borrowings | 117,329 |
| 2,871 |
| 2.45 | % | | 91,331 |
| 2,578 |
| 2.82 | % | | 61,074 |
| 1,660 |
| 2.72 | % |
| | | | | | | | | | | |
Total interest-bearing liabilities | 1,049,461 |
| 6,679 |
| 0.64 | % | | 1,014,972 |
| 6,975 |
| 0.69 | % | | 971,133 |
| 6,421 |
| 0.66 | % |
| | | | | | | | | | | |
Non interest-bearing liabilities | 16,828 |
| | | | 16,604 |
| | | | 17,986 |
| | |
| | | | | | | | | | | |
Total liabilities | 1,066,289 |
| | | | 1,031,576 |
| | | | 989,119 |
| | |
| | | | | | | | | | | |
Stockholders’ equity | 132,298 |
| | | | 137,701 |
| | | | 143,978 |
| | |
Total liabilities and stockholders’ equity | $ | 1,198,587 |
| | | | $ | 1,169,277 |
| | | | $ | 1,133,097 |
| | |
| | | | | | | | | | | |
Net interest income | | $ | 35,738 |
| | | | $ | 32,329 |
| | | | $ | 33,275 |
| |
| | | | | | | | | | | |
Interest rate spread(3) | | | 3.00 | % | | | | 2.78 | % | | | | 2.96 | % |
Net interest margin(4) | | | 3.06 | % | | | | 2.85 | % | | | | 3.03 | % |
Ratio of average interest-earning assets to average interest-bearing liabilities | | | 111.16 | % | | | | 111.75 | % | | | | 113.02 | % |
| |
(1) | Includes loans held for sale and non-performing loans, as well as net deferred loan costs of $874, $598$1.1 million, $1.2 million and $468$1.1 million for the years ended June 30, 2017, 20162020, 2019 and 2015,2018, respectively. |
The primary investing activity of the Bank has been the origination and purchase of loans held for investment and, prior to fiscal 2020, loans held for sale. During the fiscal years ended June 30, 2017, 20162020 and 2015,2019, the Bank originated loans in the amounts of $2.10 billion, $2.13 billion$106.0 million and $2.64 billion,$587.3 million, respectively, the vast majority of which $467.1 million were sold, as noted below.originated for sale in fiscal 2019. In addition, the Bank purchased loans held for investment from other financial institutions in fiscal 2017, 20162020 and 20152019 in the amounts of $61.7 million, $45.9$142.1 million and $16.6$51.1 million, respectively. TotalThere were no loans sold in fiscal 2017, 2016 and 2015 were $1.97 billion, $1.99 billion and $2.41 billion, respectively.2020, as compared to $559.0 million in fiscal 2019. At June 30, 2017, 20162020 and 2015,2019, the Bank had loan origination commitments totaling $111.8 million, $191.7$13.6 million and $144.3$4.3 million, respectively, with undisbursed loan funds of $9.0 million, $11.3$4.0 million and $3.4$6.6 million, respectively. The Bank anticipates that it will have sufficient funds available to meet its current loan origination commitments.
The Bank's primary financing activity is gathering deposits. During the fiscal years ended June 30, 2017, 20162020 and 2015,2019, the net increase (decrease) in deposits was $137,000, $2.3$51.7 million and $26.2$(66.3) million, respectively. On June 30, 2017,2020, time deposits that are scheduled to mature in one year or less were $113.9$90.6 million. Historically, the Bank 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 Bank 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 Bank generally maintains sufficient cash and cash equivalents to meet short-term liquidity needs. At June 30, 2017,2020, total cash and cash equivalents were $72.8$116.0 million, or 6.1%9.9% of total assets. Depending on market conditions and the pricing of deposit products
and FHLB - San Francisco advances, the Bank may continue to rely on FHLB - San Francisco advances for part of its liquidity needs. As of June 30, 2017,2020, the remaining financing availability at FHLB - San Francisco was $284.1$228.1 million and the remaining unusedavailable collateral was $500.9$351.5 million. In addition, the Bank has secured a $63.5$94.4 million discount window facility at the Federal Reserve Bank of San Francisco, collateralized by investment securities with a fair market value of $67.6$100.4 million. The Bank also has a federal funds
facility with its correspondent bank for $17.0 million which matures on June 30, 2018.2021. As of June 30, 2017,2020, there were no outstanding borrowings under the discount window facility or the federal funds facility with its correspondent bank.
The Bank, as a federally-chartered, federally insured savings bank, is subject to the capital requirements established by the OCC. Under the OCC's capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank'sBank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank'sBank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors. In addition, Provident Financial Holdings, Inc., as a savings and loan holding company registered with the FRB, is required by the FRB to maintain capital adequacy that generally parallels the OCC requirements. Since the holding company has less than $3.0 billion in assets, the capital guidelines apply on a bank only basis, and the Federal Reserve expects the holding company’s subsidiary bank to be well capitalized under the prompt corrective action regulations.
The Corporation's consolidated financial statements are prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time as a result of inflation. The impact of inflation is reflected in the increasing cost of the Corporation's operations. Unlike most industrial companies, nearly all assets and liabilities of the Corporation are monetary. As a result, interest rates have a greater impact on the Corporation's performance than do the effects of general levels of inflation. In addition, interest rates do not necessarily move in the direction, or to the same extent, as the prices of goods and services.
Various elements of the Corporation's accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified several accounting policies that, as a result of the judgments, estimates and assumptions inherent in those policies, are important to gain an understanding
of the financial statements of the Corporation. These policies relate to the methodology for the recognition of interest income, determination of the provision and allowance for loan losses, the estimated fair value of derivative financial instruments and the valuation of mortgage servicing rights and real estate owned. These policies and judgments, estimates and assumptions are described in greater detail in this Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and in the section entitled “Organization and Summary of Significant Accounting Policies” contained in Note 1 of the Notes to the Consolidated Financial Statements included in Item 8 of this Form 10-K. Management believes that the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However, because of the sensitivity of the financial statements to these critical accounting policies, changes to the judgments, estimates and assumptions used could result in material differences in the results of operations or financial condition.
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+300 basis points (“bp”) with no effect given to steps that management might take to counter the effect of the interest rate movement. The currentAs of June 30, 2020, the targeted federal funds rate is 1.25 percentrange was 0.00% to 0.25%, making an immediate change of -200 and -300minus 200 basis points or more improbable.
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 June 30, 20172020 and 2016 :2019:
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 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”)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 measures and evaluates the potential effects of interest rate movements through an interest rate sensitivity "gap" analysis. Interest rate sensitivity reflects the potential effect on net interest income when there is movement in interest rates. For loans, securities and liabilities with contractual maturities, the table presents principal cash flows.contractual repricing or scheduled
The following table represents the interest rate gap analysis of the Corporation's assets and liabilities as of June 30, 2017:2020:
as follows: interest-bearing checking deposits at 15% per year, savings deposits at 20% per year and money market deposits at 50% in the first and second years.
The gap results presented above could vary substantially if different assumptions are used or if actual experience differs from the assumptions used in the preparation of the gap analysis. Furthermore, the gap analysis provides a static view of interest rate risk
exposure at a specific point in time without taking into account redirection of cash flows activity and deposit fluctuations, and repricing.fluctuations.
The extent to which the net interest margin will be impacted by changes in prevailing interest rates will depend on a number of factors, including how quickly interest-earning assets and interest-bearing liabilities react to interest rate changes. It is not uncommon for rates on certain assets or liabilities to lag behind changes in the market rates of interest. Additionally, prepayments of loans and early withdrawals of certificates of deposit could cause interest sensitivities to vary. As a result, the relationship between interest-earning assets and interest-bearing liabilities, as shown in the aboveprevious table, is only a general indicator of interest rate sensitivity and the effect of changing interest rates of interest on the net interest income is likely to be different from that predicted solely on the basis of the interest rate sensitivity analysis set forth in the aboveprevious table.
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, among others:other items:
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.
Please refer to the Consolidated Financial Statements and Notes to Consolidated Financial Statements in this Form 10-K and incorporated into this Item 8 by reference.
None.
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 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 Corporation’s disclosure controls and procedures as of June 30, 20172020 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 fiscal year ended June 30, 2017,2020, 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.
Management of the Corporation is responsible for preparing the Corporation’s annual consolidated financial statements in accordance with generally accepted accounting principles; for establishing and maintaining an adequate internal control structure and procedures for financial reporting, including controls over the preparation of regulatory financial statements in accordance with the instructions for the ConsolidatedParent Company Only Financial Statements for BankSmall Holding Companies (Form FR Y-9C)Y-9SP); and for complying with the Federal laws and regulations pertaining to insider loans and the Federal and, if applicable, State laws and regulations pertaining to dividend restrictions. The Corporation's internal control over financial reporting was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
To comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, the Corporation designed and implemented a structured and comprehensive assessment process to evaluate its internal control over financial reporting across
the enterprise. The assessment of the effectiveness of the Corporation's internal control over financial reporting was based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management's assessment of the Corporation's internal control over financial reporting was also conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), which include controls over the preparation of the schedules equivalent to the basic financial statements in accordance with the instructions for the ConsolidatedParent Company Only Financial Statements for BankSmall Holding Companies (Form FR Y-9C)Y-9SP).
Because of its inherent limitations, including the possibility of human error and the circumvention of overriding controls, a system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Based on its assessment, management has concluded that, as of June 30, 2017,2020, the Corporation's internal control over financial reporting, including controls over the preparation of regulatory financial statements in accordance with the instructions for the ConsolidatedParent Company Only Financial Statements for BankSmall Holding Companies (Form FR Y-9C)Y-9SP), is effective based on the criteria established in Internal Control-Integrated Framework (2013).