The following table sets forth the outstanding balance, maturity and weighted average yield of the investment securities at June 30, 2018:2020:
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.
The Bank generally offers time deposits for terms not exceeding seven years. As illustrated in the following table, time deposits represented 26%19% of the Bank’s deposit portfolio at June 30, 2018,2020, compared to 29%23% at June 30, 2017.2019. As of June 30, 2018, 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 one year. At June 30, 2017, total brokered deposits were $1.6 million with a weighted average interest rate of 3.88% and remaining maturities within two 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.
The following table sets forth information concerning the Bank’s weighted-average interest rate of deposits at June 30, 2018:2020:
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, 2018:2020:
The following table sets forth certain information regarding borrowings by the Bank at the dates and for the years indicated:
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 at June 30, 2018 and 20172020 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 $8.2 million and $8.1 million, respectively, with noan excess investment at either date. Inof $470,000.
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, 20182020 and 2017 .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, 20182020 and 2017,2019, the Bank’s investment in its subsidiaries was $28,000$9,000 and $44,000,$15,000, respectively.
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.
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
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.
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, 20182020 and 2017,2019, the Bank held $8.2$8.0 million and $8.1$8.2 million of FHLB-San Francisco stock, respectively, which was in compliance with this membership requirement. During fiscal 2018 and 2017,2020, there was noa $229,000 excess capital redemption.redemption as compared to no redemption in fiscal 2019. In fiscal 2018, 20172020 and 2016,2019, the FHLB – San Francisco distributed $568,000, $967,000$534,000 and $721,000$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 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.
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.
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
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.
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
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.
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, 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.
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
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.
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.
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.
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.
rate of 28.06%, which was based on the applicable tax rates before and after the Tax Act and corresponding number of days in the fiscal year before and after enactment, and then will be a flat 21% corporate income tax rate for fiscal 2019 and thereafter.
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, 2018,2020, 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. 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 2018,2020, the Bank declared and paid $5.0$7.5 million of cash dividends to the Corporation while the Corporation declared and paid $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 2018,2020, there were 3,000no shares of restricted common stock distributed to employee or non-employee members of the Corporation’s Board of Directors and 7,500 shares of restricted common stock distributed to employees, while 2,000 shares of restricted common stock were forfeited.Directors. Also, there were 54,000no shares of non-qualified stock options exercised and 29,750while 12,528 shares of incentive stock options were exercised as disqualifying dispositions, while 24,900 shares of non-qualified stock options expired during fiscal 2018.dispositions. As a result, there was a $144,000$5,000 federal tax benefit effect from stock-based compensation in fiscal 2018.2020.
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 2015 and forwardthereafter remain subject to federal examination, while the California state tax returns for fiscal 2015 and fiscal years 2014 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, 20182020 and 2017,
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2019, the Corporation’s net state tax rate was 7.8%8.5% and 7.1%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 $62,000$3,000 state tax benefit effect from stock-based compensation in fiscal 2018,2020, 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. TheDuring fiscal 2020 and 2019, the Corporation paid annual franchise taxes of $208,000 in fiscal 2018; while in fiscal 2017$200,000 and 2016, the Corporation paid annual franchise taxes of $180,000 for each year.$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 | 7072 | Chairman and | Chairman and |
| | Chief Executive Officer | Chief Executive Officer |
| | | |
Robert "Scott" Ritter | 4951 | — | Senior Vice President |
| | | Provident Bank MortgageSingle-Family Division |
| | | |
Donavon P. Ternes | 5860 | President | President |
| | Chief Operating Officer | Chief Operating Officer |
| | Chief Financial Officer | Chief Financial Officer |
| | Corporate Secretary | Corporate Secretary |
| | | |
David S. Weiant | 5961 | — | Senior Vice President |
| | | Chief Lending Officer |
| | | |
Gwendolyn L. Wertz | 5254 | — | Senior Vice President |
| | | Retail Banking Division |
| |
(1) | As of June 30, 2018.2020. |
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 Provident Savings Bank since 1974, currently serving as Chairman and Chief Executive Officer of the Bank 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 until June 2011. Mr. Blunden also serves on the Board of Directors of the Western Bankers Association and the Federal Home Loan Bank of San Francisco.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, 2018,2020, 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.trade and it is not known how changes in tariffs being imposed on international trade 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;
| |
▪ | an increase in loan delinquencies, problem assets and foreclosures; |
| |
▪ | 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. |
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.
Our business may be adversely affected by credit risk associated with residential property.
At June 30, 2018, $314.82020, $298.8 million, or 34.6%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. 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. Recessionary 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. Further, the Tax Act enacted in the fourth quarter of 2017 could negatively impact our customers because it lowers the existing caps on mortgage interest deductions and limits the state and local tax deductions. These changes could make it more difficult for borrowers to make their loan payments, and could also negatively impact the housing market, which could adversely affect our business and loan growth.
Further, manySome 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, 2018 and 2017, we originated $1.28 billion and $1.99 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 focus on managing our asset quality, single-family loans originated and purchased for investment were $90.4 million and $99.8 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, 2018,2020, our single-family residential borrowers had a weighted average FICO score of 735750 at the time of loan origination.
As of June 30, 2018,2020, these non-traditional loans totaled $79.0$40.9 million, comprising 25.0%13.7% of total single-family residential loans held for investment and 8.7%4.5% of total loans held for investment. At that date, interest-only loans totaled $1.5 million, stated income loans totaled $72.0 million, negative amortization loans totaled $2.3$38.5 million, more than 30-year amortization loans totaled $8.9$5.8 million, and low FICO score loans totaled $7.6$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. At June 30, 2018, all of our interest-only loans 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, 2018, none of the 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, 2018, $3.7 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, 2018, $630,000 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, 2018, the Bank had $2.3 million of single-family loans which permitted negative amortization as compared to $2.7 million of single-family loans at June 30, 2017.
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, 2018,2020, we had $585.7$597.1 million or 64.4%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 some 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 one-to-four familysingle-family residential loan. Repayment on these loans isare 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, 2018,2020, the Bank had $5.5$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 $6.3$5.0 million in multi-family and commercial real estate loans at June 30, 2017.2019. 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.
A secondary market for mostmany types of multi-family loans 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. 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 $13.5$142.1 million of loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2018,2020, compared to $61.7$51.1 million of purchased loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2017.2019. 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 $2.1 million, $5.2 million and $7.5 million for the fiscal years ended June 30, 2018, 2017 and 2016, 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, 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 34.6%33.0% of our total loan portfolio at June 30, 2018,2020, were $79.0$40.9 million or 8.7%4.5% of total loans held for investment that 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 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 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.charge-offs. If charge-offs in future periods exceed the allowance for loan losses, we may 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, 2018, 20172020 and 2016,2019, our non-performing assets (which consist of non-accrual loans and REO were $7.0 million, $9.6$4.9 million and $13.0$6.2 million, respectively, or 0.6%, 0.8%0.42% and 1.1%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. UncertaintyThe 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, significant impairment of 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, result in a lower volume of corresponding loan originations or other administrative costs which may materially adversely affect our results of operations.
We have experienced historically low interest rates in recent years but interest rates have been increasing. Mortgage production, especially refinancing, generally declines in rising interest rate environments resulting in fewer loans that are available to be sold to investors. When interest rates rise, or even if they do not, there can be no assurance that our mortgage production will continue at current levels. Because we sell a substantial portion of the mortgage loans we originate, the profitability of our mortgage banking operations depends in large part upon our ability to aggregate a high volume of loans and sell them in the secondary market at a gain. Thus, in addition to the interest rate environment, our mortgage business is dependent upon (i) the existence of an active secondary market and (ii) our ability to profitably sell loans into that market. The loans in our held for sale portfolio are carried at fair market value with changes recognized in our statement of operations. Carrying the loans at fair value may also increase the volatility in our earnings.
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.
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 2018, 20172020 and 2016,2019, the Bank repurchased $602,000, $1.7$1.1 million and $1.7 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 $0, $11,000 and $470,000 were made for loan repurchase settlements in fiscal 2018, 2017 and 2016, 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.
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;
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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▪ | 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; |
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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. In an attempt to helpFRB. After steadily increasing the overall economy, the Federal Reserve has kept interest rates low through its targeted Fed Funds rate. The Federal Reserve Board has steadily increased thetarget federal funds rate overin 2018 and 2017, the last three fiscal yearsFRB 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 1.75%0.0% to 2.00%0.25% as of March 31, 2020. The FRB could make additional changes in June 2018 and indicated further increases in the federal funds rate in the futureinterest rates during 2020 subject to economic conditions. AsIf the Federal Reserve increasesFRB 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 investment 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 a resultis the case with many financial institutions, our emphasis on increasing the development of the relatively low interest rate environment, an significant percentage of ourcore deposits, are comprised of certificates of deposit and otherthose deposits yieldingbearing 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, 2018,2020, we had $116.3$90.6 million in time deposits that mature within one year, $118.8 million in non-interest bearing checking accounts and $583.8$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. 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 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.
Conditions in theIneffective liquidity management could adversely affect our financial markets may limit our access to additional funding to meet our liquidity needs.results and 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
47
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. In particular, our liquidity position could be significantly constrained if we are unable to access funds from the FHLB-San Francisco or other wholesale funding sources, or 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 revenues 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 fulfill obligations such as repaying our borrowings or meeting deposit withdrawal 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 our 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. The Bank's involvement in litigation has recently increased significantly, primarily as a result of employment matters.may increase significantly. The expenses of pendingsome legal proceedings will adversely affect the Bank'sBank’s results of operations until they are resolved. Further, 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 a 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-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 clientscustomers for such fraudulent transactions on clients’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 clients’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.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,
49
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 clientscustomers 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 clientscustomers and underlying transactions. Any compromise of our security 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. Although 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 losses 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, financial condition and results of operations.
Our security measures may not protect us from system failures or 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. 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 not 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 we 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.
Our operationsWe rely on numerous external vendors.
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 clients,customers, or cyber-attacks or security breaches of the networks, systems or devices that our clientscustomers use to access our products and services could result in clientcustomer 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 many years as a result of earthquake damage or other natural disaster. 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. 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 risk that many of our borrowers may experience uninsured property losses, or sustained job interruption and/or 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, 20182020 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, 2018,2020, the net deferred tax asset was approximately $4.2$3.0 million, a decrease from $4.3$3.5 million at the prior fiscal year end. The net deferred tax asset results primarily from (1) ourdeferred 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 (2)and (3) deferred compensation, (3) litigation reserves and (4) deferred loan costs.
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 Code (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 of 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.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, 20182020 is fully realizable based on our expected future earnings; however, we willexpected future earnings may not know thebe realized, which could impact of the ownership change until we complete our fiscal 2018 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, 2018,2020, the net book value of the Bank’s property (including land and buildings) and its furniture, fixtures and equipment was $8.7$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 nine 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 2018 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 incidental 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
52
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, Gina McKeen-Chaplin, individually and on behalf of others similarly situated vs. the Bank was filed in the United States District Court for the Eastern District of California (the "Court") against the Bank claiming damages, restitution and injunctive relief for alleged misclassification of certain employees as exempt rather than non-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 “McKeen-Chaplin lawsuit”).
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. As a result of the Ninth Circuit’s unfavorable ruling, the Bank filed on September 7, 2017, a petition for writ of certiorari to the United States Supreme Court, which was denied on November 27, 2017.flows.
On May 22, 2013, counsel in the McKeen-Chaplin lawsuit filed another class action called Neal vs. Provident Savings Bank, F.S.B. (the “Neal lawsuit”) in California Superior Court in Alameda County (the "State Court"). The Neal lawsuit is virtually identical to the McKeen-Chaplin lawsuit alleging that mortgage underwriters were misclassified as exempt employees.
On December 18, 2017, the Bank entered into a Memorandum of Understanding with the plaintiffs' representatives to memorialize an agreement in principle to settle the pending McKeen-Chaplin and Neal Lawsuits. The Memorandum of Understanding assumes class certification for purposes of the settlement only and provides for an aggregate settlement payment by the Bank of $1.8 million, which includes all settlement funds, the named plaintiff service payments, and class counsel's attorneys' fees and costs. Any additional costs and expenses related to employer-side payroll taxes will be paid by the Bank. The parties since have successfully negotiated a mutually acceptable long-form agreement which has been fully executed.
On February 21, 2018, plaintiffs filed a motion in McKeen-Chaplin asking the District Court to approve the FLSA portion of the settlement. The parties also worked together to jointly request that the Court of Appeal in Neal pass jurisdiction back to the trial court to oversee the settlement process. The Neal court granted the motion for preliminary approval on May 15, 2018. Subsequently, on July 18, 2018 the District Court approved the FLSA portion of the settlement which will allow the parties to begin the process of providing notice of the settlement to the Neal class.
The Bank's decision to settle these lawsuits was the result of the unfavorable ruling by the United States Supreme Court in the McKeen-Chaplin lawsuit and the significant legal costs, distraction from day-to-day operating activities and substantial resources that would be required to defend the Bank in protracted litigation if the Neal lawsuit would proceed. In addition, the Bank determined that the settlement would reduce the Bank's potential exposure to damages, penalties, fines and plaintiffs' legal fees in the event of an unfavorable outcome in the Neal lawsuit. The settlement will include the dismissal of all claims against the Bank and related parties in the McKeen-Chaplin and Neal Lawsuits without any admission of liability or wrongdoing attributed to the Bank. The settlement described in the long-form agreement remains subject to court approval and other customary conditions, including a limitation on the number of plaintiffs in each lawsuit that may opt out of the proposed settlement. If the opt out number for either lawsuit is exceeded, the Bank may at its sole and absolute discretion void the settlement within 30 days of receiving notice of the number of plaintiff’s electing to opt out of the settlement.
Based on the proposed settlement, the Corporation recorded a litigation settlement expense accrual of $650,000 in the second quarter of fiscal 2018 to fully reserve for the agreed upon settlement amount.
On August 6, 2015, a former employee, Christina Cannon, filed a lawsuit called Cannon vs. the Bank 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. On September 8, 2017, the attorneys for the plaintiffs in the Cannon Lawsuit sent notification to the Bank and to the California Labor & Workforce Development Agency informing them of their intent to bring a claim under the Private Attorneys’ General Act of 2004 (“PAGA”) on behalf of all non-exempt employees and covering a variety of alleged wage and hour violations. On September 12, 2017, the Bank entered into a Memorandum of Understanding with the plaintiffs’ representatives to memorialize an agreement in principle to settle the pending Cannon Lawsuit. The Memorandum of Understanding assumes class certification for purposes of the settlement only and provides for an aggregate settlement payment by the Bank of $2.8 million, which includes all settlement funds, the class representative enhancement award, settlement administrator’s expenses, any employer-side payroll taxes, and class counsel’s attorneys’ fees and costs. The Bank’s decision to settle this matter was the result of the significant legal costs, distraction from day-to-day operating activities and substantial resources that would be required to defend the Bank in protracted litigation. In addition, the Bank determined that the settlement would reduce the Bank’s potential exposure to damages, penalties, fines and plaintiffs’ legal fees in the event of an unfavorable outcome in a court trial. The settlement includes the dismissal of all claims against the Bank and related parties in the Cannon Lawsuit and claim under the PAGA, without any admission of liability or wrongdoing attributed to the Bank. The settlement described in the Memorandum of Understanding remains subject to court approval and other customary conditions. Because of the uncertainty surrounding this litigation, no litigation reserve had been previously established by the Bank resulting in the full $2.8 million settlement expense being recognized in the first quarter of fiscal 2018.
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, 2018,record, and there were approximately 311 stockholders of record.
|
| | | | |
| First (Ended September 30) | Second (Ended December 31) | Third (Ended March 31) | Fourth (Ended June 30) |
| | | | |
2018 Quarters: | | | | |
High | $20.00 | $19.99 | $19.23 | $19.78 |
Low | $17.62 | $18.13 | $17.87 | $17.86 |
| | | | |
2017 Quarters: | | | | |
High | $20.00 | $20.66 | $20.25 | $20.35 |
Low | $17.72 | $17.68 | $18.20 | $18.32 |
| | | | |
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 policy on July 24, 2002. Quarterly dividends paid for the quarters ended September 30, 2017, December 31, 2017, March 31, 2018 and June 30, 2018 wereof $0.14 per share for each quarter. By comparison, quarterly dividends paid forshare. The Corporation’s shareholders of record at the quarters endedclose of business on August 20, 2020 will receive the cash 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.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 2018 and 2017, the Bank declared and paid cash dividends of $5.0 million and $10.0 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 2018,the quarter ended June 30, 2020, the Corporation repurchased 383,585did 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 $19.00$19.43 per share under the June 2017 stock repurchase plan and the authorization to repurchase the 1,615 remaining shares expired. In addition, the Corporation purchased 3,291 shares of distributed restricted common stock in settlement of employees' withholding tax obligations. On April 26, 2018, the Corporation's Board of Directors authorized the repurchase of up to 5% of outstanding shares, or 373,000 shares.share. As of June 30, 2018,2020, 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 2018.
|
| | | | | | | | | |
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, 2018 – April 30, 2018 | 108 |
| $ | 18.21 |
| 108 |
| 40,885 |
|
May 1, 2018 – May 31, 2018 | 30,792 |
| $ | 18.31 |
| 30,792 |
| 10,093 |
|
June 1, 2018 – June 30, 2018 | 8,478 |
| $ | 18.28 |
| 8,478 |
| 373,000 |
|
Total | 39,378 |
| $ | 18.30 |
| 39,378 |
| 373,000 |
|
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, 2018, the authorization to repurchaseRepresents the remaining 1,615 shares available for future purchases under the June 2017April 2020 stock repurchase plan expired and the April 2018 stock repurchase plan authorizing the repurchase of 373,000 shares became effective.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.
|
| | | | | | | | | | | | | | | | | | |
| 6/30/2013 | 6/30/2014 | 6/30/2015 | 6/30/2016 | 6/30/2017 | 6/30/2018 |
PROV | $ | 100.00 |
| $ | 140.93 |
| $ | 151.57 |
| $ | 170.38 |
| $ | 184.21 |
| $ | 188.17 |
|
NASDAQ Stock Index | $ | 100.00 |
| $ | 125.15 |
| $ | 134.07 |
| $ | 137.20 |
| $ | 162.73 |
| $ | 186.88 |
|
NASDAQ Bank Index | $ | 100.00 |
| $ | 118.35 |
| $ | 133.41 |
| $ | 117.79 |
| $ | 172.66 |
| $ | 191.45 |
|
| 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, 20132015 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; disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions; our ability to implement our branch expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our common stock; adverse changes in the securities markets; the inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the
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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, 2018,2020, the Corporation had total assets of $1.18 billion, total deposits of $907.6$893.0 million and total stockholders’ equity of $120.5$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, 2018, the Corporation declared a quarterly cash dividend of $0.14 per share. The Corporation’s shareholders of record at the close of business on August 21, 2018 will receive the cash dividend, which is payable on September 11, 2018. 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, 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 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. 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, 2018 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 | $ | 3,098 |
| $ | 4,355 |
| $ | 1,986 |
| $ | 623 |
| $ | 10,062 |
|
Pension benefits | 248 |
| 496 |
| 497 |
| 6,450 |
| 7,691 |
|
Time deposits | 117,512 |
| 94,075 |
| 28,580 |
| 1,830 |
| 241,997 |
|
FHLB – San Francisco advances | 27,793 |
| 24,921 |
| 34,175 |
| 51,309 |
| 138,198 |
|
FHLB – San Francisco letter of credit | 8,000 |
| — |
| — |
| — |
| 8,000 |
|
FHLB – San Francisco MPF credit enhancement(1) | — |
| — |
| — |
| 2,458 |
| 2,458 |
|
Total | $ | 156,651 |
| $ | 123,847 |
| $ | 65,238 |
| $ | 62,670 |
| $ | 408,406 |
|
| |
(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, 2018, the Bank serviced $11.8 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, 20182020 and 2017,2019, these commitments were $66.3$13.6 million and $111.8$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, 20182020 and 20172019
Total assets decreased $25.1increased $92.0 million, or 2%9%, to $1.18 billion at June 30, 20182020 from $1.20$1.08 billion at June 30, 2017.2019. The decreaseincrease was primarily attributable to decreasesincreases in loans held for sale and cash and cash equivalents, partly offset by an increase in investment securities and loans held to maturity.for investment.
Total cash and cash equivalents, primarily excess cash deposited with the Federal Reserve Bank of San Francisco, decreased $29.5increased $45.4 million, or 41%64%, to $43.3$116.0 million at June 30, 20182020 from $72.8$70.6 million at June 30, 2017.2019. The decreaseincrease was primarily attributable to the untilization of cash to fund the increase in investment securities held to maturity and a decreaseincreases in customer deposits and borrowings, partly offset by a decreasethe increases in loans held for sale.investment and investment securities. The balance of cash and cash equivalents at June 30, 20182020 was consistent towith 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 $25.5$23.2 million, or 37%23%, to $95.3$123.3 million at June 30, 20182020 from $69.8$100.1 million at June 30, 2017.2019. 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 decreased $2.2increased $22.9 million, or 3% to $902.7$902.8 million at June 30, 20182020 from $904.9$879.9 million at June 30, 2017.2019. In fiscal 2018,2020, the Corporation originated $186.4$106.0 million of loans held for investment, consisting primarily of single-family, multi-family and commercial real estate loans, compared to $191.9down 12% from $120.2 million, consisting primarily of single-family, multi-family and multi-familycommercial real estate loans, for the same period last year. In addition, the Corporation purchased $13.5$142.1 million of loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2018, compared to $61.72020, up 178% from $51.1 million of purchased loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2017.2019. Total loan principal payments in fiscal 20182020 were $208.5$228.3 million, a 6% increaseup 17% from $197.0$195.4 million in
fiscal 2017. In addition,2019. There was no REO acquired in the settlement of loans in both fiscal 2018 was $2.2 million, an 18% increase from $1.8 million in2020 and fiscal 2017.2019. The balance of multi-family, commercial real estate, construction and commercial business loans, net of undisbursed loan funds, increased 1%9% to $589.4$605.4 million at June 30, 20182020 from $585.1$556.1 million at June 30, 2017,2019, and represented 65%67% and 64%63% of loans held for investment, respectively. The balance of single-family loans held for investment decreased $7.4$26.2 million, or 2%8%, to $314.8$298.8 million at June 30, 2018,2020, from $322.2$325.0 million at June 30, 2017.
The table below describes the geographic dispersion of real estate secured2019. For additional information on loans held for investment, (gross)see Note 3 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Total deposits increased $51.7 million, or 6%, to $893.0 million at June 30, 20182020 from $841.3 million at June 30, 2019. Transaction accounts increased $74.9 million, or 12%, to $723.0 million at June 30, 2020 from $648.1 million at June 30, 2019; while time deposits decreased $23.1 million, or 12%, to $170.0 million at June 30, 2020 from $193.1 million at June 30, 2019. As of June 30, 2020 and 2017,2019, the percentage of transaction accounts to total deposits was 81% and 77%, respectively. Non-interest bearing deposits as a percentage of the total dollar amount outstanding (dollars in thousands):
As of June 30, 2018:
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Inland Empire | Southern California(1) | Other California | Other States | Total |
Loan Category | Balance | % | Balance | % | Balance | % | Balance | % | Balance | % |
Single-family | $ | 110,510 |
| 35 | % | $ | 149,261 |
| 48 | % | $ | 53,960 |
| 17 | % | $ | 1,077 |
| — | % | $ | 314,808 |
| 100 | % |
Multi-family | 76,473 |
| 16 | % | 287,174 |
| 60 | % | 109,684 |
| 23 | % | 2,677 |
| 1 | % | 476,008 |
| 100 | % |
Commercial real estate | 32,224 |
| 29 | % | 47,903 |
| 44 | % | 29,599 |
| 27 | % | — |
| — | % | 109,726 |
| 100 | % |
Construction | 208 |
| 3 | % | 6,763 |
| 90 | % | 505 |
| 7 | % | — |
| — | % | 7,476 |
| 100 | % |
Other | — |
| — | % | — |
| — | % | 167 |
| 100 | % | — |
| — | % | 167 |
| 100 | % |
Total | $ | 219,415 |
| 24 | % | $ | 491,101 |
| 54 | % | $ | 193,915 |
| 21 | % | $ | 3,754 |
| 1 | % | $ | 908,185 |
| 100 | % |
| |
(1)
| Other than the Inland Empire. |
As 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. |
Loans held for sale decreased $20.2 million, or 17%,deposits increased to $96.3 million13.3% at June 30, 20182020 from $116.5 million10.7% at June 30, 2017. 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 $727.0 million, or 38%, to $1.19 billion in fiscal 2018 from $1.91 billion in fiscal 2017. The lower volume of loans originated and purchased for sale was due primarily to higher mortgage interest rates during fiscal 2018, which has reduced refinance activity and activity in the home purchase market.
Total deposits decreased $18.9 million, or 2%, to $907.6 million at June 30, 2018 from $926.5 million at June 30, 2017. Time deposits decreased $30.3 million, or 11%, to $237.6 million at June 30, 2018 from $267.9 million at June 30, 2017; while transaction accounts increased $11.4 million, or 2%, to $670.0 million at June 30, 2018 from $658.6 million at June 30, 2017.2019. 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 were unchanged at $126.2increased $39.9 million, or 39%, to $141.0 million at June 30, 2018 as compared to the balance2020 from $101.1 million at June 30, 2017.2019. The increase was due to new advances, partly offset by the maturity of advances during fiscal 2020. The weighted-average maturity of the Corporation’s FHLB – San Francisco advances was approximately 4628 months at June 30, 2018,2020, down from 5144 months at June 30, 2017.
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 $7.7 million, or 6%,increased 3% to $120.5$124.0 million at June 30, 2018,2020 from $128.2$120.6 million at June 30, 2017,2019, 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 to shareholders, partly offset by net income and the amortization of stock-based compensation benefits in fiscal 2018.shareholders.
Comparison of Operating Results for the Years Ended June 30, 20182020 and 20172019
General. The Corporation recorded net income of $2.1$7.7 million, or $0.28$1.01 per diluted share, for the fiscal year ended June 30, 2018, as compared to net income of $5.22020, up $3.3 million, or $0.6475%, from $4.4 million, or $0.58 per diluted share, for the fiscal year ended June 30, 2017.2019. The $3.1 million decreaseincrease in net income in fiscal 20182020 was primarily attributable to a $9.9$16.3 million decrease in non-interest expense, partly offset by a $8.0 million decrease in non-interest income (mainly a $7.3 million decrease in the gain on sale of loans), a $1.8 million decrease in net interest income and a $1.6 million increase in other non-interest expenses and a $1.8 million net tax charge resulting from the revaluation of net deferred tax assets consistent with the Tax Act, partly offset by a $6.9 million decrease in salaries and employee benefit expense.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 91%71% in fiscal 20182020 from 88%89% in fiscal 2017.2019. Return on average assets in fiscal 2018 decreased2020 increased to 0.18%0.69% from 0.43%0.39% in fiscal 20172019 and return on average stockholders' equity in fiscal 2018 decreased2020 increased to 1.73%6.26% from 3.94%3.63% in fiscal 2017.2019.
Net Interest Income. Net interest income increased $562,000,decreased $1.8 million, or 2%5%, to $36.3$36.4 million in fiscal 20182020 from $35.7$38.2 million in fiscal 2017.2019. This increasedecrease resulted from an increasea decrease in the net interest margin partly offset byand, to a lesser extent, a decrease in the average balance of interest-earning assets. The net interest margin increased 13decreased 11 basis points to 3.19%3.36% in fiscal 20182020 from 3.06%3.47% in fiscal 2017,2019, due to an 11 basis point increasedecrease in the average yield on interest-earning assets, andpartially offset by a twoone basis point decrease in the average cost of interest-bearing liabilities. The average balance of interest-earning assets decreased $27.5$17.9 million, or 2%, to $1.14$1.08 billion in fiscal 20182020 from $1.17$1.10 billion in fiscal 2017.2019.
Interest Income. Total interest income increased $295,000,decreased $1.9 million, or 1%4%, to $42.7$42.5 million for fiscal 20182020 from $42.4$44.4 million for fiscal 2017.2019. The increasedecrease was primarily due to higher interest income on investment securities and interest-earning deposits partly offset by lower interest income on loans receivable and interest-earning deposits and lower cash dividends from FHLB -– San Francisco stock. The average yield on interest-earning assets increased 11 basis points to 3.75% in fiscal 2018 from 3.64% in fiscal 2017. The increase in the average yield on interest-earning assets was primarily the result of increases in the average yield on and in the percentage of investment securities comprising total interest-earning assets and an increase in the average yield earned on loans receivable and interest-earning deposits. The decrease in the average balance of interest-earning assets was primarily attributable to decreases in the average balance of loans receivable and interest-earning deposits, partly offset by an increase in the average balance of investment securities.
Interest income on loans receivable decreased $233,000,$947,000, or 1%2%, to $40.0$39.1 million in fiscal 20182020 from $40.2$40.1 million in fiscal 2017.2019. This decrease was attributable to both a lower average loan balance, partly offset by a higheryield and average loan yield.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 including(including loans held for sale in fiscal 2019) decreased $39.1$10.6 million, or 4%1%, to $986.8$915.4 million during fiscal 20182020 from $1.03 billion$926.0 million during fiscal 2017. The average loan yield, including2019. There were no loans held for sale during fiscal 2018 increased 14 basis points to 4.06% from 3.92% in fiscal 2017.2020. The average balance of loans held for sale decreased $71.9 million, or 45%, to $88.9 million for fiscal 2018 from $160.8 million in fiscal 2017 while2019 was $46.3 million with the weighted average yield on loans held for sale increased 42 basis points to 4.10% in fiscal 2018 from 3.68% in fiscal 2017. The average balance of loans held for investment increased $32.8 million, or 4%, to $897.9 million for fiscal 2018 from $865.1 million in fiscal 2017 and the average yield on loans held for investment increased eight basis points to 4.05% in fiscal 2018 from 3.97% in fiscal 2017.4.69%.
Interest income from investment securities increased $769,000,$78,000, or 134%4%, to $1.3$2.1 million in fiscal 20182020 from $575,000$2.0 million in fiscal 2017.2019. This increase was primarily a result of an increase in the average balance and, toyield, partly offset by a lesser extent, an increasedecrease in the average yield. The average balance of investment securities increased $39.1 million, or 76%, to $90.7 million in fiscal 2018 from $51.6 million in fiscal 2017 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 increased 3735 basis points to 1.48%2.44% during fiscal 20182020 from 1.11%2.09% during fiscal 2017.2019. The increase in the average yield of investment securities was primarily attributable to the purchase of new investment securities with a higher average yield than the existing portfolio and theupward 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 an accelerated amortizationthe purchase of purchase premiums resultingnew investment securities during the second half of fiscal 2020 with a lower average yield than the existing portfolio. 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 principal payments.payments on mortgage-backed securities, partly offset by the new purchases of investment securities. During fiscal 2018,2020, the Bank purchased $53.9$55.9 million of mortgage-backed securities with ana weighted average yield of 2.04% and renewed a $200,000 certificate of deposit at another financial institution with a term more than 90 days1.16% and did not sell any investment securities.
During fiscal 2018,2020, the Bank received $568,000$534,000 of cash dividends from its FHLB - San Francisco stock, a decrease of $399,000$173,000 or 41%24% from the $967,000$707,000 of cash dividends received in fiscal 2017.2019. The decrease in cash dividends was due primarily to a special cash dividend of $133,000 received in the second quarter of fiscal 20172019 that was not replicated in fiscal 2018,2020, and as a result, the average yield decreased 495207 basis points to 6.99%6.55% in fiscal 20182020 from 11.94%8.62% in fiscal 2017.2019.
Interest income from interest-earning deposits, primarily cash deposited at the Federal Reserve Bank of San Francisco, increased $158,000,decreased $880,000, or 25%57%, to $784,000$657,000 in fiscal 20182020 from $626,000$1.5 million in fiscal 2017,2019, due to a higherlower average yield, partly offset by a lowerhigher average balance. The average yield increased 69decreased 134 basis points to 1.45%0.90% in fiscal 20182020 from 0.76%2.24% in fiscal 2017,2019, resulting from recent increasesdecreases in the targettargeted federal funds interest rate. The average balance of interest-earning deposits decreased $27.6increased $4.0 million, or 34%6%, to $53.4$71.8 million in fiscal 20182020 from $81.0$67.8 million in fiscal 2017, due to the utilization of excess liquidity to fund an increase in investment securities and a decrease in customer deposits.2019.
Interest Expense. Total interest expense for fiscal 20182020 was $6.4$6.1 million as compared to $6.7$6.2 million for fiscal 2017,2019, a decrease of $267,000,$153,000, or 4%2%. This decrease was primarily attributable to a lower interest expense on deposits, particularly in time deposits.deposits, partly offset by a higher interest expense on borrowings. The average balance of interest-bearing liabilities principally deposits and borrowings, decreased $20.1$17.7 million or 2% to $1.03 billion$972.0 million during fiscal 20182020 as compared to $1.05 billion$989.7 million during fiscal 2017.2019. This
65
decrease was attributable to declinesa decline in the average balance of both time deposits, andpartly offset by an increase in the average balance of borrowings. The average cost of interest-bearing liabilities was 0.62% during fiscal 2018,2020, down twoone basis pointspoint from 0.64%0.63% during fiscal 2017. The decrease in the average cost of liabilities was primarily due to a lower average cost of deposits, partly offset by a higher average cost of borrowings.2019.
Interest expense on deposits for fiscal 20182020 was $3.5$2.9 million as compared to $3.8$3.4 million for the same period of fiscal 2017,2019, a decrease of $313,000,$438,000, or 8%13%. The decrease in interest expense on deposits was primarily attributable to a lower average balance, and, to a lesser extent, a lower average cost ofparticularly time deposits. The average balance of deposits decreased $16.8$36.0 million, or 2%4%, to $915.3$844.1 million during fiscal 20182020 from $932.1$880.1 million during fiscal 2017.2019. The average balance of time deposits decreased by $38.5$34.1 million, or 13%15%, to $251.6$186.3 million in fiscal 20182020 from $290.1$220.4 million in fiscal 2017.2019. 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 $21.6decreased $1.9 million or 3%, to $663.7$657.8 million in fiscal 20182020 from $642.1$659.7 million in fiscal 2017.2019. The average balance of transaction accounts to total deposits in the fiscal 20182020 was 73%78%, compared to 69%75% in fiscal 2017.2019. The average cost of deposits decreased three basis points to 0.35% in fiscal 2020 from 0.38% in fiscal 2018 from 0.41% during fiscal 2017.2019. The average cost of transaction accounts was 0.14% in fiscal 2018 remained unchanged at2020, down one basis point from 0.15% as compared to the average cost in fiscal 2017;2019; while the average cost of time deposits in fiscal 20182020 was 0.99%1.09%, up one basis point, from 0.98%1.08% in fiscal 2017.2019.
Interest expense on borrowings, consisting of FHLB - San Francisco advances, for fiscal 20182020 increased $46,000,$285,000, or 2%10%, to $2.9$3.1 million as compared to $2.8 million in fiscal 2017.2019. The increase in interest expense on borrowings was due primarily to a higher average cost,balance, partly offset by a lower average balance.cost. The average balance of borrowings increased $18.3 million, or 17%, to $127.9 million during fiscal 2020 from $109.6 million during fiscal 2019. The average cost of borrowings increaseddecreased to 2.56%2.43% in fiscal 20182020 from 2.45%2.58% in fiscal 2017, an increase2019, a decrease of 1115 basis points. The increasedecrease in the average cost of borrowings was primarily due to the increased utilization of short-term advancesnew borrowings with a lower average cost in fiscal 2018 with a higher cost as compared to fiscal 2017. The average balance of borrowings decreased $3.3 million, or 3%, to $114.0 million during fiscal 2018 from $117.3 million during fiscal 2017.2020.
Provision (Recovery) for Loan Losses. During fiscal 2018,2020, the Corporation recorded a recovery from the allowanceprovision for loan losses of $536,000,$1.1 million, as compared to a $1.0 million$475,000 recovery from the allowance for loan losses during fiscal 2017,2019. The provision for loan losses in fiscal 2020 was primarily due to a $506,000 or 49% decrease. The recovery fromqualitative component established in the allowance for loan losses methodology in fiscal 2018 was primarily attributableresponse to the reduction in non-performing loansCOVID-19 pandemic and higher risk construction loansits continued and our maintaining a relatively stable credit risk profile, as reflected in our asset quality ratios described below. The decrease in the amount of the recovery year over year was primarily due net loan charge-offs in fiscal 2018 compared to net loan recoveries in fiscal 2017.forecasted adverse economic impact. The allowance for loan losses decreased $654,000,increased $1.2 million, or 8%17%, to $7.4$8.3 million at June 30, 20182020 from $8.0$7.1 million at June 30, 2017.2019.
Non-performing assets (net of the collectively evaluated allowances and individually evaluated allowances), with underlying collateral primarily located in Southern California, decreased $2.6$1.3 million or 27%21% to $7.0$4.9 million, or 0.59%0.42% of total assets, at June 30, 2018,2020, compared to $9.6$6.2 million, or 0.80%0.57% of total assets, at June 30, 2017.2019. Non-performing loans at June 30, 2018 decreased $1.92020 were $4.9 million, or 24% since June 30, 2017 to $6.1 million and were comprised of 2118 single-family loans ($6.04.9 million) and one commercial business loan ($64,000)31,000). There was no REO at June 30, 2018 decreased $709,000 or 44% to $906,000 consisting of two single-family properties acquired in the settlement of loans.2020 and 2019. As of June 30, 2018, 48%2020, 33%, or $2.9$1.6 million of non-performing loans have a current payment status. Net loan charge-offsrecoveries in fiscal 20182020 were $118,000$70,000 or 0.01% of average loans receivable, compared to net loan recoveries of $411,000$166,000 or 0.04%0.02% of average loans receivable in fiscal 2017.
2019.
Classified assets at June 30, 20182020 were $15.8$14.1 million, comprised of $7.5$8.6 million in the special mention category, $7.4$5.5 million in the substandard category and $906,000 inno outstanding REO. Classified assets at June 30, 20172019 were $13.3$16.2 million, comprised of $3.7$8.6 million in the special mention category, $8.0$7.6 million in the substandard category and $1.6 million inno outstanding REO. Classified assets increased at June 30, 2018 from the June 30, 2017 level primarily as a result of an increase in special mention loans due to the non-compliance by a single borrower with loan covenants related to three multi-family loans totaling $3.9 million. 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, inre-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 2018, whileyear ended June 30, 2019, there were no loans that were newly modified from their original terms, in fiscal 2017. As of June 30, 2018,re-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 no loans were converted to real estate owned. The outstanding balance of restructured loans at June 30, 2020 was $5.2 million: one loan was classified as special mention and remained on accrual status ($389,000); one loan was classified as substandard and remains on accrual status ($1.4 million); and nine$2.6
66
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 on non-accrual status ($3.4 million).status. As of June 30, 2018, 56%2020, 44%, or $2.9$1.2 million of the restructured loans have a current payment status, consistent with their modified payment terms. During fiscal 2018,2020, no restructured loans were in default within a 12-month period subsequent to their original restructuring and no restructured loan was extended beyond the initial maturity of the modification.restructuring.
The allowance for loan losses was $7.4$8.3 million at June 30, 2018,2020, or 0.81%0.91% of gross loans held for investment, compared to $8.0$7.1 million, or 0.88%0.80% of gross loans held for investment at June 30, 2017.2019. The allowance for loan losses at June 30, 20182020 includes $157,000$100,000 of individually evaluated allowances, compared to $101,000$130,000 of individually evaluated allowances at June 30, 2017.2019. 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, 2018.2020. 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 $8.9$8.0 million, or 29%64%, to $21.9$4.5 million in fiscal 20182020 from $30.8$12.5 million in fiscal 2017.2019. The decrease was primarily attributable to a reductionthe decrease in the gain on sale of loans, partly offset by higher loan servicing and other fees and a decrease in loss on the sale and operations of real estate owned acquired in the settlement of loans.
The net gain on sale of loans decreased $9.9$7.3 million, or 39%102%, to $15.8 milliona net loss of $132,000 for fiscal 20182020 from $25.7a net gain of $7.1 million in fiscal 2017.2019. 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, to a lesser extent, 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 $1.15 billion in fiscal 2018 as compared to $1.83 billion in fiscal 2017, down $676.1 million or 37%. The decrease in theno loan sale volume in fiscal 2018 was attributable2020, as compared to increases in mortgage interest rates$410.7 million during fiscal 2018 resulting in a decrease in refinance activity and loans originated for home purchases. The2019 with an average loan sale margin for PBM during fiscal 2018 was 1.37% as compared to 1.40% in fiscal 2017, a decrease of three basis points. The decline in the average loan sale margin was the result of competitive pricing pressure due to market conditions consistent with falling demand for mortgages, partly mitigated by a higher percentage of retail loan originations, which typically have a higher loan sale margin, as compared to wholesale loan originations. The total retail loan originations as a percentage of total loans originated by PBM during fiscal 2018 was 58%, up from 53% in fiscal 2017. The 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 $2.1 million and $3.4 million in fiscal 2018 and 2017, respectively. The gain on sale of loans in fiscal 2018 also includes a $22,000 recourse reserve recovery on loans sold that are subject to repurchase, compared to a $137,000 recourse reserve recovery on loans sold in fiscal 2017.1.73 percent.
The loan servicing and otherDeposit account fees increased $324,000,decreased $318,000, or 26%16%, to $1.6 million for fiscal 20182020 from $1.3$1.9 million in fiscal 2017.2019, 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 increasedecrease was attributable primarily to higher loan prepayment fees.
The net lossa lower fair value gain on sale and operations of real estate owned acquired in the settlement of loans improved $471,000, or 85%, to a net loss of $86,000held for investment at fair value in fiscal 2018 from a net loss of $557,0002020 in comparison to fiscal 2017. The net loss in fiscal 2018 was comprised of $89,000 of net operating expenses and a $558,000 net loss on the sale of four REO properties, partly offset by a $561,000 recovery from the loss reserve on real estate owned. The net loss in fiscal 2017 was comprised of $255,000 of net operating expenses and a $440,000 provision for losses on real estate owned, partly offset by a $138,000 net gain on the sale of seven REO properties.2019.
Non-Interest Expense. Total non-interest expense in fiscal 20182020 was $53.2$28.9 million, a decrease of $5.6$16.3 million, or 10%36%, as compared to $58.8$45.2 million in fiscal 2017.2019. The decrease in non-interest expense was primarily attributable to a decreasedecreases in salaries and employee benefits expense, partly offset by an increase inpremises and occupancy expenses, equipment expense and other operating expenses.
Salaries and employee benefits expense decreased $6.9$11.2 million, or 17%37%, to $34.8$18.9 million in fiscal 20182020 from $41.7$30.1 million in fiscal 2017.2019. The decrease in salaries and employee benefits was primarily due to lowerfewer employees and incentive compensation costspayments consistent with the scaling back of saleable single-family mortgage loan originations. The salaries and PBM staff reductionsemployee benefits expense in fiscal 2019 includes approximately $11.4 million of salaries and employee benefits expenses related to lower mortgage bankingthe staffing associated with saleable single-family loan originations. Total PBMoriginations, which includes $1.7 million of one-time costs associated with staff
67
reductions. There were no loans originated for sale in fiscal 2020, as compared to $467.1 million in fiscal 2019; while total loans originated and purchased for investment in fiscal 20182020 was $1.27 billion, down $718.5$248.1 million, up 45% from $171.2 million in fiscal 2019.
Total premises and occupancy expense decreased $1.5 million, or 36% from $1.99 billion30%, to $3.5 million in fiscal 2017. There were 173 full-time equivalent employees at PBM on June 30, 2018 compared2020 from $5.0 million in fiscal 2019. The decrease in both premises and occupancy expenses and equipment expense was due primarily to 253 full-time equivalent employees at PBM on June 30, 2017.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 increased $1.6decreased $1.1 million, or 25%27%, to $8.0$3.0 million in fiscal 20182020 from $6.4$4.1 million in fiscal 2017.2019. The increasedecrease was primarily attributable to a $2.2 million increase in litigation expenses (see Part I, Item 3. Legal Proceeding), partly offset by lower expenses related to reduced loan originations.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 Tax Act reduced the federal corporate income tax rate from a maximum 35% to a flat 21% as of January 1, 2018. Since the Corporation has a fiscal year end of June 30th, the reduced corporate federal income tax rate for fiscal year 2018 was the result of the application of a blended federal statutory tax rate of 28.06%, which was based on the applicable federal corporate income tax rates before and after the Tax Act and corresponding number of days in the fiscal year before and after enactment. The Corporation will realize the full impact of the reduced statutory federal corporate income tax rate of 21% in fiscal 2019, which began on July 1, 2018.
The provision for income taxes was $3.4$3.2 million for fiscal 2018,2020, representing an effective tax rate of 61.4%29.5%, as compared to $3.6$1.5 million in fiscal 2017,2019, representing an effective tax rate of 40.9%25.4%. The decline in the provision for income taxes was due primarily to the decline in net income before income taxes, partly offset by a net tax charge of $1.8 million resulting from the revaluation of net deferred tax assets consistent with the Tax Act, leading to the higher effective tax rate in fiscal 2018 as compared to fiscal 2017.
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, 2017 and 2016
General. The Corporation recorded net income of $5.2 million, or $0.64 per diluted share, for the fiscal year ended June 30, 2017, as compared to net income of $7.5 million, or $0.88 per diluted share, for the fiscal year ended June 30, 2016. The $2.3 million decrease in net income in fiscal 2017 was primarily attributable to a $6.3 million decrease in non-interest income, partly offset by a $3.4 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. The Corporation's efficiency ratio, defined as non-interest expense divided by the sum of net interest
income and non-interest income, increased to 88% in fiscal 2017 from 84% in fiscal 2016. Return on average assets in fiscal 2017 decreased to 0.43% from 0.64% in fiscal 2016 and return on average stockholders' equity in fiscal 2017 decreased to 3.94% from 5.43% in fiscal 2016.
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Net Interest Income. Net interest income increased $3.4 million, or 11%, to $35.7 million in fiscal 2017 from $32.3 million in fiscal 2016. This increase resulted from an increase in the average balance of earning assets 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 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. 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 17 basis points to 3.64% in fiscal 2017 from 3.47% in fiscal 2016. The increase in the average yield on interest-earning assets was primarily the result of the decrease in excess liquidity yielding a nominal interest rate, resulting from the increases in loans receivable and investment securities.
Interest income on loans receivable increased $2.5 million, or 7%, to $40.2 million in fiscal 2017 from $37.7 million in fiscal 2016. This increase was attributable to a higher average loan balance, partly offset by a lower average yield. The average balance of loans receivable, consisting of loans held for investment and loans held for sale, increased $76.5 million, or 8%, to $1.03 billion during fiscal 2017 from $949.4 million during fiscal 2016. The average loan yield, including 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. 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 while the average yield on loans held for sale decreased eight basis points to 3.68% in fiscal 2017 from 3.76% in fiscal 2016.
Interest income from investment securities increased $217,000, or 61%, to $575,000 in fiscal 2017 from $358,000 in fiscal 2016. 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 $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. The average yield on investment securities decreased 33 basis points to 1.11% during fiscal 2017 from 1.44% during fiscal 2016. 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 and accelerated amortization of purchase premiums resulting from accelerated principal payments. During fiscal 2017, the Bank purchased $34.5 million with an average yield of 1.75% and did not sell any investment securities.
During fiscal 2017, the Bank received $967,000 of cash dividends from its FHLB - San Francisco stock, an increase of $246,000 from the $721,000 of cash dividends received in fiscal 2016. The increase in cash dividends was due primarily to a special cash dividend received in the second quarter of fiscal 2017, and as a result, the average yield increased 303 basis points to 11.94% in fiscal 2017 from 8.91% in fiscal 2016.
Interest income from interest-earning deposits, primarily cash deposited at the Federal Reserve Bank of San Francisco, increased $59,000, or 10%, to $626,000 in fiscal 2017 from $567,000 in fiscal 2016, due to a higher average yield, partly offset by a lower average cash balance. The average yield increased 39 basis points to 0.76% in fiscal 2017 from 0.37% in fiscal 2016, resulting from increases in the target federal funds interest rate. The average balance of interest-earning deposits decreased $70.9 million, or 47%, to $81.0 million in fiscal 2017 from $151.9 million in fiscal 2016, due to the utilization of excess liquidity to fund increases in loans held for investment and investment securities.
Interest Expense. Total interest expense for fiscal 2017 was $6.7 million as compared to $7.0 million for fiscal 2016, a decrease of $296,000, or 4%. This decrease was primarily attributable to a decrease in the average cost of interest-bearing liabilities, partly offset by an increase in the average balance of interest-bearing liabilities. The average cost of interest-bearing liabilities was 0.64% during fiscal 2017, down five basis points from 0.69% 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.
Interest expense on deposits for fiscal 2017 was $3.8 million as compared to $4.4 million for the same period of fiscal 2016, a decrease of $589,000, 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 of 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. The average balance of deposits increased $8.5 million, or 1%, to $932.1 million during fiscal 2017 from $923.6 million during fiscal 2016. The average balance of time deposits decreased by $35.0 million, or 11%, to $290.1 million in fiscal 2017 from $325.1 million in fiscal 2016. 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 $43.6 million, or 7%, to $642.1 million in fiscal 2017 from $598.5 million in fiscal 2016. The average balance of transaction accounts to total deposits in the fiscal 2017 was 69%, compared to 65% in fiscal 2016.
Interest expense on borrowings, consisting of FHLB - San Francisco advances, for fiscal 2017 increased $293,000, or 11%, to $2.9 million from $2.6 million for fiscal 2016. 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 million, or 28%, to $117.3 million during fiscal 2017 from $91.3 million during fiscal 2016. The average cost of borrowings decreased to 2.45% in fiscal 2017 from 2.82% in fiscal 2016, a decrease of 37 basis points. The decrease in the average cost of borrowings was primarily due to the increased utilization of overnight borrowings and short-term advances with a much lower average cost than long-term FHLB advances.
Provision (Recovery) for Loan Losses. During fiscal 2017, the Corporation recorded a recovery from the allowance for loan losses of $1.0 million, as compared to a $1.7 million recovery from the allowance for loan losses during fiscal 2016, a $673,000 or 39% decrease. The decrease in the recovery was primarily attributable 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. The allowance for loan losses decreased $631,000, or 7%, to $8.0 million at June 30, 2017 from $8.7 million at June 30, 2016.
Non-performing assets (net of the collectively evaluated allowances and individually evaluated allowances), with underlying collateral primarily located in Southern California, decreased $3.4 million or 26% to $9.6 million, or 0.80% of total assets, at June 30, 2017, compared to $13.0 million, or 1.11% of total assets, at June 30, 2016. Non-performing loans at June 30, 2017 decreased $2.3 million or 22% since June 30, 2016 to $8.0 million and were comprised of 27 single-family loans ($7.7 million); one commercial real estate loan ($201,000) and one commercial business loan ($65,000). Real estate owned 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. As of June 30, 2017, 47%, or $3.7 million of non-performing loans have a current payment status. Net recoveries in fiscal 2017 were $411,000 or 0.04% of average loans receivable, compared to net recoveries of $1.7 million or 0.17% of average loans receivable in fiscal 2016.
Classified assets at June 30, 2017 were $13.3 million, comprised of $3.7 million in the special mention category, $8.0 million in the substandard category and $1.6 million in real estate owned. 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 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. 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 2017 and 2016. As of June 30, 2017, the outstanding balance of restructured loans was $3.6 million: one loan was classified as special mention and remained on accrual status ($506,000); and nine loans were classified as substandard ($3.1 million, all on non-accrual status). As of June 30, 2017, 46%, or $1.7 million of the restructured loans have a current payment status, consistent with their modified payment terms. During fiscal 2017, 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 million at June 30, 2017, or 0.88% of gross loans held for investment, compared to $8.7 million, or 1.02% of gross loans held for investment at June 30, 2016. The allowance for loan losses at June 30, 2017 includes $101,000 of individually evaluated allowances, compared to $20,000 of individually evaluated allowances at June 30, 2016. 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. 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 $6.3 million, or 17%, to $30.8 million in fiscal 2017 from $37.1 million in fiscal 2016. The decrease was primarily attributable to a decrease in the gain on sale of loans.
The net gain on sale of loans decreased $5.8 million, or 18%, to $25.7 million for fiscal 2017 from $31.5 million in fiscal 2016. The decrease was a result of a lower volume 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, 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 the loan sale volume in fiscal 2017 was attributable to increases in mortgage interest rates during fiscal 2017 resulting primarily to a decrease in refinance activity. The average loan sale margin for PBM during fiscal 2017 was 1.40% as compared to 1.57% in fiscal 2016, a decrease of 17 basis points. The decrease in the average loan sale margin for fiscal 2017 was 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%, up from 46% in fiscal 2016. The 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 million in fiscal 2017, as compared 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 $255,000 in net operating expenses 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 $207,000 in net operating expenses, partly offset by a $60,000 recovery from the loss reserve on real estate owned and a $52,000 net gain on the sale of 10 real estate owned properties.
Non-Interest Expense. Total non-interest expense in fiscal 2017 was $58.8 million, an increase of $526,000, or 1%, as compared to $58.3 million in fiscal 2016. The increase in non-interest expense was primarily the result of an increase in other operating expenses related to the litigation expenses of $1.0 million 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 and deposit insurance premiums and regulatory assessments.
Salaries and employee benefits expense decreased $867,000, or 2%, to $41.7 million in fiscal 2017 from $42.6 million in fiscal 2016. The decrease in salaries and employee benefits was primarily due to lower PBM salaries and employee benefits expenses resulting from fewer loans originated for sale.
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 million for fiscal 2017, representing an effective tax rate of 40.9%, as compared to $5.4 million in fiscal 2016, representing an effective tax rate of 41.8%. 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, | Year Ended June 30, |
| 2018 | | 2017 | | 2016 | 2020 | | 2019 | | 2018 |
(Dollars In Thousands) | Average Balance | Interest | Yield/ Cost | | Average Balance | Interest | Yield/ Cost | | Average Balance | Interest | Yield/ Cost | Average Balance | Interest | Yield/ Cost | | Average Balance | Interest | Yield/ Cost | | Average Balance | Interest | Yield/ Cost |
Interest-earning assets: | | | | | | | | | | | | | | | | |
Loans receivable, net(1) | $ | 986,815 |
| $ | 40,016 |
| 4.06 | % | | $ | 1,025,885 |
| $ | 40,249 |
| 3.92 | % | | $ | 949,412 |
| $ | 37,658 |
| 3.97 | % | $ | 915,353 | | $ | 39,145 | | 4.28 | % | | $ | 926,003 | | $ | 40,092 | | 4.33 | % | | $ | 986,815 | | $ | 40,016 | | 4.06 | % |
Investment securities | 90,719 |
| 1,344 |
| 1.48 | % | | 51,575 |
| 575 |
| 1.11 | % | | 24,895 |
| 358 |
| 1.44 | % | 86,761 | | 2,120 | | 2.44 | % | | 97,870 | | 2,042 | | 2.09 | % | | 90,719 | | 1,344 | | 1.48 | % |
FHLB – San Francisco stock | 8,126 |
| 568 |
| 6.99 | % | | 8,097 |
| 967 |
| 11.94 | % | | 8,094 |
| 721 |
| 8.91 | % | 8,155 | | 534 | | 6.55 | % | | 8,199 | | 707 | | 8.62 | % | | 8,126 | | 568 | | 6.99 | % |
Interest-earning deposits | 53,438 |
| 784 |
| 1.45 | % | | 81,027 |
| 626 |
| 0.76 | % | | 151,867 |
| 567 |
| 0.37 | % | 71,766 | | 657 | | 0.90 | % | | 67,816 | | 1,537 | | 2.24 | % | | 53,438 | | 784 | | 1.45 | % |
| | | | | | | | | | | | | | | | |
Total interest-earning assets | 1,139,098 |
| 42,712 |
| 3.75 | % | | 1,166,584 |
| 42,417 |
| 3.64 | % | | 1,134,268 |
| 39,304 |
| 3.47 | % | 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 | 32,905 |
| | | | 32,003 |
| | | | 35,009 |
| | | 31,720 | | | | | 30,778 | | | | | 32,905 | | | |
| | | | | | | | | | | | | | | | |
Total assets | $ | 1,172,003 |
| | | | $ | 1,198,587 |
| | | | $ | 1,169,277 |
| | | $ | 1,113,755 | | | | | $ | 1,130,666 | | | | | $ | 1,172,003 | | | |
| | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | |
Checking and money market accounts(2) | $ | 372,781 |
| 407 |
| 0.11 | % | | $ | 358,532 |
| 387 |
| 0.11 | % | | $ | 334,814 |
| 450 |
| 0.13 | % | $ | 396,399 | | 424 | | 0.11 | % | | $ | 381,790 | | 428 | | 0.11 | % | | $ | 372,781 | | 407 | | 0.11 | % |
Savings accounts | 290,959 |
| 595 |
| 0.20 | % | | 283,520 |
| 579 |
| 0.20 | % | | 263,678 |
| 657 |
| 0.25 | % | 261,432 | | 496 | | 0.19 | % | | 277,896 | | 572 | | 0.21 | % | | 290,959 | | 595 | | 0.20 | % |
Time deposits | 251,604 |
| 2,493 |
| 0.99 | % | | 290,080 |
| 2,842 |
| 0.98 | % | | 325,149 |
| 3,290 |
| 1.01 | % | 186,317 | | 2,023 | | 1.09 | % | | 220,432 | | 2,381 | | 1.08 | % | | 251,604 | | 2,493 | | 0.99 | % |
| | �� | | | | | | | | | | | | | | | |
Total deposits | 915,344 |
| 3,495 |
| 0.38 | % | | 932,132 |
| 3,808 |
| 0.41 | % | | 923,641 |
| 4,397 |
| 0.48 | % | 844,148 | | 2,943 | | 0.35 | % | | 880,118 | | 3,381 | | 0.38 | % | | 915,344 | | 3,495 | | 0.38 | % |
| | | | | | | | | | | | | | | | |
Borrowings | 113,984 |
| 2,917 |
| 2.56 | % | | 117,329 |
| 2,871 |
| 2.45 | % | | 91,331 |
| 2,578 |
| 2.82 | % | 127,882 | | 3,112 | | 2.43 | % | | 109,558 | | 2,827 | | 2.58 | % | | 113,984 | | 2,917 | | 2.56 | % |
| | | | | | | | | | | | | | | | |
Total interest-bearing liabilities | 1,029,328 |
| 6,412 |
| 0.62 | % | | 1,049,461 |
| 6,679 |
| 0.64 | % | | 1,014,972 |
| 6,975 |
| 0.69 | % | 972,030 | | 6,055 | | 0.62 | % | | 989,676 | | 6,208 | | 0.63 | % | | 1,029,328 | | 6,412 | | 0.62 | % |
| | | | | | | | | | | | | | | | |
Non interest-bearing liabilities | 19,392 |
| | | | 16,828 |
| | | | 16,604 |
| | | 18,968 | | | | | 19,288 | | | | | 19,392 | | | |
| | | | | | | | | | | | | | | | |
Total liabilities | 1,048,720 |
| | | | 1,066,289 |
| | | | 1,031,576 |
| | | 990,998 | | | | | 1,008,964 | | | | | 1,048,720 | | | |
| | | | | | | | | | | | | | | | |
Stockholders’ equity | 123,283 |
| | | | 132,298 |
| | | | 137,701 |
| | | 122,757 | | | | | 121,702 | | | | | 123,283 | | | |
Total liabilities and stockholders’ equity | $ | 1,172,003 |
| | | | $ | 1,198,587 |
| | | | $ | 1,169,277 |
| | | $ | 1,113,755 | | | | | $ | 1,130,666 | | | | | $ | 1,172,003 | | | |
| | | | | | | | | | | | | | | | |
Net interest income | | $ | 36,300 |
| | | | $ | 35,738 |
| | | | $ | 32,329 |
| | | $ | 36,401 | | | | | $ | 38,170 | | | | | $ | 36,300 | | |
| | | | | | | | | | | | | | | | |
Interest rate spread(3) | | 3.13 | % | | | 3.00 | % | | | 2.78 | % | | 3.30 | % | | | 3.40 | % | | | 3.13 | % |
Net interest margin(4) | | 3.19 | % | | | 3.06 | % | | | 2.85 | % | | 3.36 | % | | | 3.47 | % | | | 3.19 | % |
Ratio of average interest-earning assets to average interest-bearing liabilities | | 110.66 | % | | | 111.16 | % | | | 111.75 | % | |
Ratio of average interest- earning assets to average interest-bearing liabilities | | | 111.32 | % | | | 111.14 | % | | | 110.66 | % |
| |
(1) | Includes loans held for sale and non-performing loans, as well as net deferred loan costs of $1.1 million, $874$1.2 million and $598$1.1 million for the years ended June 30, 2018, 20172020, 2019 and 2016,2018, respectively. |
| |
(2) | Includes the average balance of non interest-bearing checking accounts of $79.9$90.0 million, $72.9$84.1 million and $66.4$79.9 million in fiscal 2018, 20172020, 2019 and 2016,2018, respectively. |
| |
(3) | Represents the difference between the weighted-average yield on all interest-earning assets and the weighted-average rate on all interest-bearing liabilities. |
| |
(4) | Represents net interest income as a percentage of average interest-earning assets. |
69
Rate/Volume Variance
The following tables set forth the effects of changing rates and volumes on interest income and expense of the Corporation for the period presented. Information is provided with respect to the effects attributable to changes in volume (changes in volume multiplied by prior rate), the effects attributable to changes in rate (changes in rate multiplied by prior volume) and the effects attributable to changes that cannot be allocated between rate and volume. Please refer to Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations, Comparison of Operating Results for the Years Ended June 30, 2018 and 2017 and Comparison of Operating Results for the Years Ended June 30, 2017 and 2016" of this Form 10-K.
| Year Ended June 30, 2020 Compared To Year Ended June 30, 2019 Increase (Decrease) Due to |
(In Thousands) | Rate | Volume | Rate/ Volume | Net |
Interest-earning assets: | | | | |
Loans receivable(1) | $ | (491 | ) | $ | (461 | ) | $ | 5 | | $ | (947 | ) |
Investment securities | 349 | | (232 | ) | (39 | ) | 78 | |
FHLB – San Francisco stock | (170 | ) | (4 | ) | 1 | | (173 | ) |
Interest-earning deposits | (915 | ) | 88 | | (53 | ) | (880 | ) |
Total net change in income on interest-earning assets | (1,227 | ) | (609 | ) | (86 | ) | (1,922 | ) |
| | | | |
Interest-bearing liabilities: | | | | |
Checking and money market accounts | — | | 8 | | (12 | ) | (4 | ) |
Savings accounts | (44 | ) | (35 | ) | 3 | | (76 | ) |
Time deposits | 14 | | (369 | ) | (3 | ) | (358 | ) |
Borrowings | (161 | ) | 474 | | (28 | ) | 285 | |
Total net change in expense on interest-bearing liabilities | (191 | ) | 78 | | (40 | ) | (153 | ) |
Net (decrease) increase in net interest income | $ | (1,036 | ) | $ | (687 | ) | $ | (46 | ) | $ | 1,769 | |
|
| | | | | | | | | | | | |
| Year Ended June 30, 2018 Compared To Year Ended June 30, 2017 Increase (Decrease) Due to |
(In Thousands) | Rate | Volume | Rate/ Volume | Net |
Interest-earning assets: | | | | |
Loans receivable(1) | $ | 1,354 |
| $ | (1,532 | ) | $ | (55 | ) | $ | (233 | ) |
Investment securities | 190 |
| 434 |
| 145 |
| 769 |
|
FHLB – San Francisco stock | (401 | ) | 3 |
| (1 | ) | (399 | ) |
Interest-earning deposits | 558 |
| (210 | ) | (190 | ) | 158 |
|
Total net change in income on interest-earning assets | 1,701 |
| (1,305 | ) | (101 | ) | 295 |
|
| | | | |
Interest-bearing liabilities: | | | | |
Checking and money market accounts | — |
| 20 |
| — |
| 20 |
|
Savings accounts | — |
| 16 |
| — |
| 16 |
|
Time deposits | 32 |
| (377 | ) | (4 | ) | (349 | ) |
Borrowings | 132 |
| (82 | ) | (4 | ) | 46 |
|
Total net change in expense on interest-bearing liabilities | 164 |
| (423 | ) | (8 | ) | (267 | ) |
Net increase (decrease) in net interest income | $ | 1,537 |
| $ | (882 | ) | $ | (93 | ) | $ | 562 |
|
| |
(1) | Includes loans held for sale and non-performing loans. For purposes of calculating volume, rate and rate/volume variances, non-performing loans were included in the weighted-average balance outstanding. |
|
| | | | | | | | | | | | |
| Year Ended June 30, 2017 Compared To Year Ended June 30, 2016 Increase (Decrease) Due to |
(In Thousands) | Rate | Volume | Rate/ Volume | Net |
Interest-earning assets: | | | | |
Loans receivable(1) | $ | (407 | ) | $ | 3,036 |
| $ | (38 | ) | $ | 2,591 |
|
Investment securities | (79 | ) | 384 |
| (88 | ) | 217 |
|
FHLB – San Francisco stock | 246 |
| — |
| — |
| 246 |
|
Interest-earning deposits | 597 |
| (262 | ) | (276 | ) | 59 |
|
Total net change in income on interest-earning assets | 357 |
| 3,158 |
| (402 | ) | 3,113 |
|
| | | | |
Interest-bearing liabilities: | | | | |
Checking and money market accounts | (89 | ) | 31 |
| (5 | ) | (63 | ) |
Savings accounts | (118 | ) | 50 |
| (10 | ) | (78 | ) |
Time deposits | (105 | ) | (354 | ) | 11 |
| (448 | ) |
Borrowings | (344 | ) | 733 |
| (96 | ) | 293 |
|
Total net change in expense on interest-bearing liabilities | (656 | ) | 460 |
| (100 | ) | (296 | ) |
Net increase (decrease) in net interest income | $ | 1,013 |
| $ | 2,698 |
| $ | (302 | ) | $ | 3,409 |
|
70
| Year Ended June 30, 2019 Compared To Year Ended June 30, 2018 Increase (Decrease) Due to |
(In Thousands) | Rate | Volume | Rate/ Volume | Net |
Interest-earning assets: | | | | |
Loans receivable(1) | $
| 2,709 | | $ | (2,469 | ) | $ | (164 | ) | $ | 76 | |
Investment securities | 548 | | 106 | | 44 | | 698 | |
FHLB – San Francisco stock | 133 | | 5 | | 1 | | 139 | |
Interest-earning deposits | 431 | | 208 | | 114 | | 753 | |
Total net change in income on interest-earning assets | 3,821 | | (2,150 | ) | (5 | ) | 1,666 | |
| | | | |
Interest-bearing liabilities: | | | | |
Checking and money market accounts | — | | 21 | | — | | 21 | |
Savings accounts | 29 | | (51 | ) | (1 | ) | (23 | ) |
Time deposits | 225 | | (309 | ) | (28 | ) | (112 | ) |
Borrowings | 24 | | (113 | ) | (1 | ) | (90 | ) |
Total net change in expense on interest-bearing liabilities | 278 | | (452 | ) | (30 | ) | (204 | ) |
Net increase (decrease) in net interest income | $ | 3,543 | | $ | (1,698 | ) | $ | 25 | | $ | 1,870 | |
| |
(1) | Includes loans held for sale and non-performing loans. For purposes of calculating volume, rate and rate/volume variances, non-performing loans were included in the weighted-average balance outstanding. |
Liquidity and Capital Resources
The Corporation's primary sources of funds are deposits, proceeds from the sale of loans originated and purchased for sale, proceeds from principal and interest payments on loans, proceeds from the maturity and sale of investment securities, proceeds from FHLB - San Francisco advances, and access to the discount window facility at the Federal Reserve Bank of San Francisco. While maturities and scheduled amortization of loans and investment securities are a relatively predictable source of funds, deposit flows and mortgage prepayments and loan sales are greatly influenced by general interest rates, economic conditions and competition.
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, 2018, 20172020 and 2016,2019, the Bank originated loans in the amounts of $1.37 billion, $2.10 billion$106.0 million and $2.13 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 2018, 20172020 and 20162019 in the amounts of $13.5 million, $61.7$142.1 million and $45.9$51.1 million, respectively. TotalThere were no loans sold in fiscal 2018, 2017 and 2016 were $1.20 billion, $1.97 billion and $1.99 billion, respectively.2020, as compared to $559.0 million in fiscal 2019. At June 30, 2018, 20172020 and 2016,2019, the Bank had loan origination commitments totaling $66.3 million, $111.8$13.6 million and $191.7$4.3 million, respectively, with undisbursed loan funds of $4.3 million, $9.0$4.0 million and $11.3$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, 2018, 20172020 and 2016,2019, the net increase (decrease) increase in deposits was $(18.9 million), $137,000$51.7 million and $2.3$(66.3) million, respectively. On June 30, 2018,2020, time deposits that are scheduled to mature in one year or less were $116.3$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, 2018,2020, total cash and cash equivalents were $43.3$116.0 million, or 3.7%9.9% of total assets. Depending on market conditions and the pricing of deposit products
71
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, 2018,2020, the remaining financing availability at FHLB - San Francisco was $275.1$228.1 million and the remaining unusedavailable collateral was $500.3$351.5 million. In addition, the Bank has secured a $73.2$94.4 million discount window facility at the Federal Reserve Bank of San Francisco, collateralized by investment securities with a fair market value of $77.9$100.4 million. The Bank also has a federal funds
facility with its correspondent bank for $17.0 million which matures on June 30, 2019.2021. As of June 30, 2018,2020, there were no outstanding borrowings under the discount window facility or the federal funds facility with its correspondent bank.
Regulations require the Bank to maintain adequate liquidity to assure safe and sound operations. The Bank's average liquidity ratio (defined as the ratio of average qualifying liquid assets to average deposits and borrowings) for the quarter ended June 30, 2018 decreased2020 increased to 14.9%23.1% from 22.1%20.7% during the same quarter ended June 30, 2017.2019. The decreaseincrease in the liquidity ratio was due primarily to the declineincrease in average qualifying liquid assets, which exceededpartly offset by the declinesmaller increase in average deposits and borrowingsliquidity base during the quarter ended June 30, 20182020 in comparison to the quarter ended June 30, 2017.2019. The Bank augments its liquidity by maintaining sufficient borrowing capacity at the FHLB - San Francisco.Francisco, Federal Reserve Bank of San Francisco and 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.
At June 30, 2018, Provident Financial Holdings, Inc. and2020, the Bank each exceeded all regulatory capital requirements. Under the prompt corrective action provisions, minimum ratios of 5.0% for Tier 1 Leverage Capital, 6.5% for Common Equity Tier 1 ("CET1") Capital, 8.0% for Tier 1 Capital and 10.0% for Total Capital are required to be deemed “well capitalized.” As of June 30, 2018,2020, the Bank exceeded the capital ratios needed to be considered well capitalized with Tier 1 Leverage Capital, CET1 Capital, Tier 1 Capital and Total Capital ratios of 10.0%10.1%, 16.8%17.5%, 16.8%17.5% and 17.9%, respectively; as did the Corporation with Tier 1 Leverage Capital, CET1 Capital, Tier 1 Capital and Total Capital ratios of 10.3%, 17.4%, 17.4% and 18.5%18.8%, respectively.
Impact of Inflation and Changing Prices
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.
Impact of New Accounting Pronouncements
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
72
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.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Quantitative Aspects of Market Risk. The Corporation does not maintain a trading account for any class of financial instrument nor does it purchase high-risk derivative financial instruments. Furthermore, the Corporation is not subject to foreign currency exchange rate risk or commodity price risk. The primary market risk that the Corporation faces is interest rate risk. For information regarding the sensitivity to interest rate risk of the Corporation's interest-earning assets and interest-bearing liabilities, see “Interest Rate Risk” below and Item 1, “Business - Lending Activities - Maturity of Loans Held for Investment,” “- Investment Securities Activities,” and “- Deposit Activities and Other Sources of Funds - Time Deposits by Maturities” in this Form 10-K.
Qualitative Aspects of MarketInterest Rate Risk. One of the Corporation's principal financial objectives is to achieve long-term profitability while reducing its exposure to fluctuating interest rates. The Corporation, through the Corporation's Asset-Liability Committee, has sought to reduce the exposure of its earnings to changes in interest rates by attempting to manage the repricing mismatch between interest-earning assets and interest-bearing liabilities. The principal element in achieving this objective is to increase the interest-rate sensitivity of the Corporation's interest-earning assets by retaining for its portfolio new loan originations with interest rates subject to periodic adjustment to market conditions and by selling fixed-rate, single-family mortgage loans.conditions. In addition, the Corporation maintains an investment portfolio, which is largely comprised of U.S. government agency MBS and U.S. government sponsored enterprise MBS with contractual maturities of up to 30 years that reprice frequently or have a relatively short-average life. The Corporation relies on retail deposits as its primary source of funds while utilizing FHLB - San Francisco advances as a secondary source of funding. Management believes retail deposits, unlike brokered deposits, reduce the effects of interest rate fluctuations because they generally represent a more stable source of funds. As part of its interest rate risk management strategy, the Corporation promotes transaction accounts and time deposits with terms up to seven years. For additional information, see Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K.
Interest Rate Risk. The principal financial objective of the Corporation's interest rate risk management function is to achieve long-term profitability while limiting its exposure to the fluctuation of interest rates. The Corporation, through the Corporation's Asset-Liability Committee, has sought to reduce the exposure of its earnings to changes in interest rates by managing the repricing mismatch between interest-earning assets and interest-bearing liabilities. The principal element in achieving this objective is to manage the interest-rate sensitivity of the Corporation's assets by retaining loans with interest rates subject to periodic market adjustments. In addition, the Corporation maintains a liquid investment portfolio primarily comprised of U.S. government agency MBS and government sponsored enterprise MBS. The Corporation relies on retail deposits as its primary source of funding while utilizing FHLB - San Francisco advances as a secondary source of funding which can be structured with favorable interest rate risk characteristics. As part of its interest rate risk management strategy, the Corporation promotes transaction accounts.
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 current targetAs of June 30, 2020, the targeted federal funds rate is 2.00%range was 0.00% to 0.25%, making an immediate change of -200 and -300minus 200 basis points or more improbable.
73
The following table sets forth as of June 30, 20182020 the estimated changes in NPV based on the indicated interest rate environment (dollars in thousands):
| | Basis Points ("bp") Change in Rates | Net Portfolio Value | NPV Change(1) | Portfolio Value of Assets | NPV as Percentage of Portfolio Value Assets(2) | Sensitivity Measure(3) | Net Portfolio Value | NPV Change(1) | Portfolio Value of Assets | NPV as Percentage of Portfolio Value Assets(2) | Sensitivity Measure(3) |
+400 bp | $ | 248,291 |
| $ | 127,558 |
| $ | 1,278,916 |
| 19.41% | +917 bp | |
+300 bp | $ | 222,946 |
| $ | 102,213 |
| $ | 1,260,028 |
| 17.69% | +745 bp | $ | 257,269 | | $ | 112,645 | | $ | 1,308,513 | | 19.66% | +773 bp |
+200 bp | $ | 193,006 |
| $ | 72,273 |
| $ | 1,236,787 |
| 15.61% | +537 bp | $ | 226,594 | | $ | 81,970 | | $ | 1,283,155 | | 17.66% | +573 bp |
+100 bp | $ | 158,446 |
| $ | 37,713 |
| $ | 1,209,329 |
| 13.10% | +286 bp | $ | 191,278 | | $ | 46,654 | | $ | 1,253,317 | | 15.26% | +333 bp |
- | $ | 120,733 |
| $ | — |
| $ | 1,179,012 |
| 10.24% | - | $ | 144,624 | | $ | — | | $ | 1,212,307 | | 11.93% | - |
-100 bp | $ | 112,690 |
| $ | (8,043 | ) | $ | 1,170,936 |
| 9.62% | -62 bp | $ | 125,871 | | $ | (18,753 | ) | $ | 1,191,392 | | 10.57% | -136 bp |
| |
(1) | Represents the increase (decrease) of the NPV at the indicated interest rate change in comparison to the NPV at June 30, 20182020 (“base case”). |
| |
(2) | Calculated as the NPV divided by the portfolio value of total assets. |
| |
(3) | Calculated as the change in the NPV ratio (NPV as a Percentage of Portfolio Value Assets) from the base case amount assuming the indicated change in interest rates (expressed in basis points). |
The following table is derived from the internal interest rate risk model and represents the change in the NPV at a -100 basis point rate shock at June 30, 20182020 and 2017 :2019:
| At June 30, 2020 | At June 30, 2019 |
| (-100 bp rate shock) | (-100 bp rate shock) |
Pre-Shock NPV Ratio: NPV as a % of PV Assets | 11.93% | 11.80% |
Post-Shock NPV Ratio: NPV as a % of PV Assets | 10.57% | 10.67% |
Sensitivity Measure: Change in NPV Ratio | -136 bp | -113 bp |
|
| | |
| At June 30, 2018 | At June 30, 2017 |
| (-100 bp rate shock) | (-100 bp rate shock) |
Pre-Shock NPV Ratio: NPV as a % of PV Assets | 10.24% | 11.49% |
Post-Shock NPV Ratio: NPV as a % of PV Assets | 9.62% | 10.16% |
Sensitivity Measure: Change in NPV Ratio | -62 bp | -133 bp |
The pre-shock NPV ratio increased 13 basis points to 11.93 percent at June 30, 2020 from 11.80 percent at June 30, 2019 while the post-shock NPV ratio decreased 10 basis points to 10.57 percent at June 30, 2020 from 10.67 percent at June 30, 2019. The increase of the NPV ratios was primarily attributable to net income in fiscal 2020 and a higher net valuation of total assets in comparison to total liabilities, partly offset by a $7.5 million cash dividend distribution from the Bank to the Corporation in September 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
74
maturity. For transaction accounts (checking, money market and savings deposits) that have no contractual maturity, the table presents estimated principal cash flows and, as applicable, the Corporation's historical experience, management's judgment and statistical analysis as applicable, concerning their most likely withdrawal behaviors.
The following table represents the interest rate gap analysis of the Corporation's assets and liabilities as of June 30, 2018:2020:
| | | | Term to Contractual Repricing, Estimated Repricing, or Contractual Maturity (1) |
| | | | | | | | | | | | | | | | As of June 30, 2020 |
| | Term to Contractual Repricing, Estimated Repricing, or Contractual Maturity(1) | |
| | As of June 30, 2018 | |
| | 12 months or less | Greater than 1 year to 3 years | Greater than 3 years to 5 years | Greater than 5 years or non sensitive | Total | |
(Dollars In Thousands) | | (Dollars In Thousands) | 12 months or less | Greater than 1 year to 3 years | Greater than 3 years to 5 years | Greater than 5 years or non-sensitive | Total |
| | (In thousands) | | | |
Repricing Assets: | Repricing Assets: | | Repricing Assets: | | | |
| Cash and cash equivalents | $ | 36,296 |
| $ | — |
| $ | — |
| $ | 7,005 |
| $ | 43,301 |
| |
| Investment securities | 47,501 |
| — |
| — |
| 47,808 |
| 95,309 |
| Cash and cash equivalents | $ | 110,712 | | $ | — | | $ | — | | $ | 5,322 | | $ | 116,034 | |
| Loans held for investment | 298,716 |
| 236,191 |
| 284,166 |
| 83,612 |
| 902,685 |
| Investment securities | 22,294 | | — | | — | | 101,050 | | 123,344 | |
| Loans held for sale | 96,298 |
| — |
| — |
| — |
| 96,298 |
| Loans held for investment | 295,447 | | 237,795 | | 276,372 | | 93,182 | | 902,796 | |
| FHLB - San Francisco stock | 8,199 |
| — |
| — |
| — |
| 8,199 |
| FHLB - San Francisco stock | 7,970 | | — | | — | | — | | 7,970 | |
| Other assets | — |
| — |
| — |
| 29,757 |
| 29,757 |
| Other assets | 3,271 | | — | | — | | 23,422 | | 26,693 | |
| | Total assets | 487,010 |
| 236,191 |
| 284,166 |
| 168,182 |
| 1,175,549 |
| | Total assets | 439,694 | | 237,795 | | 276,372 | | 222,976 | | 1,176,837 | |
| | | | | | | |
Repricing Liabilities and Equity: | Repricing Liabilities and Equity: |
| Repricing Liabilities and Equity: | | | |
| Checking deposits - non-interest bearing | — |
| — |
| — |
| 86,174 |
| 86,174 |
| Checking deposits - non-interest bearing | — | | — | | — | | 118,771 | | 118,771 | |
| Checking deposits - interest bearing | 38,906 |
| 77,812 |
| 77,812 |
| 64,842 |
| 259,372 |
| Checking deposits - interest bearing | 43,569 | | 87,139 | | 87,139 | | 72,616 | | 290,463 | |
| Savings deposits | 57,959 |
| 115,916 |
| 115,916 |
| — |
| 289,791 |
| Savings deposits | 54,754 | | 109,508 | | 109,507 | | — | | 273,769 | |
| Money market deposits | 17,317 |
| 17,316 |
| — |
| — |
| 34,633 |
| Money market deposits | 19,995 | | 19,994 | | — | | — | | 39,989 | |
| Time deposits | 116,333 |
| 91,363 |
| 28,117 |
| 1,815 |
| 237,628 |
| Time deposits | 90,576 | | 59,932 | | 18,534 | | 935 | | 169,977 | |
| FHLB - San Francisco borrowings | 25,000 |
| 20,000 |
| 31,163 |
| 50,000 |
| 126,163 |
| Borrowings | 30,000 | | 61,047 | | 50,000 | | — | | 141,047 | |
| Other liabilities | — |
| — |
| — |
| 21,331 |
| 21,331 |
| Other liabilities | 345 | | — | | — | | 18,500 | | 18,845 | |
| Stockholders' equity | — |
| — |
| — |
| 120,457 |
| 120,457 |
| Stockholders' equity | — | | — | | — | | 123,976 | | 123,976 | |
| | Total Liabilities and stockholders' equity | 255,515 |
| 322,407 |
| 253,008 |
| 344,619 |
| 1,175,549 |
| | Total liabilities and stockholders' equity | 239,239 | | 337,620 | | 265,180 | | 334,798 | | 1,176,837 | |
| | | | | | | |
Repricing gap positive (negative) | Repricing gap positive (negative) | $ | 231,495 |
| $ | (86,216 | ) | $ | 31,158 |
| $ | (176,437 | ) | $ | — |
| Repricing gap positive (negative) | $ | 200,455 | | $ | (99,825 | ) | $ | 11,192 | | $ | (111,822 | ) | $ | — | |
Cumulative repricing gap: | Cumulative repricing gap: | | Cumulative repricing gap: | | | |
| Dollar amount | $ | 231,495 |
| $ | 145,279 |
| $ | 176,437 |
| $ | — |
| $ | — |
| Dollar amount | $ | 200,455 | | $ | 100,630 | | $ | 111,822 | | $ | — | | $ | — | |
| Percent of total assets | 20 | % | 12 | % | 15 | % | — | % | — | % | Percent of total assets | 17 | % | 9 | % | 10 | % | — | % | — | % |
(1) Cash and cash equivalents are presented as estimated repricing; investment securities and loans held for investment are presented as contractual maturities or contractual repricing (without consideration for prepayments); loans held for sale and transaction accounts are presented as estimated repricing; FHLB - San Francisco stock is presented as contractual repricing; transaction accounts (checking, savings and money market deposits) are presented as estimated repricing; while time deposits (without consideration for early withdrawals) and FHLB - San Francisco borrowings are presented as contractual maturities.
The static gap analysis shows a positive position in the "Cumulative repricing gap - dollar amount" category, indicating more assets are sensitive to repricing than liabilities. Non-maturity checking deposits are available for immediate withdrawal and are therefore assumed to be inherently sensitive to changes in interest rates. Management views non-interest bearing deposits to be the least sensitive to changes in market interest rates and these accounts are therefore characterized as long-term funding. Interest-bearing checking deposits are considered more sensitive, followed by increased sensitivity for savings and money market deposits. For the purpose of calculating gap, a portion of these interest-bearing deposit balances are assumed to be subject to estimated repricing
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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:
The Corporation’s current balance sheet and repricing characteristics;
Forecasted balance sheet growth consistent with the business plan;
Current interest rates and yield curves and management estimates of projected interest rates;
Embedded options, interest rate floors, periodic caps and lifetime caps;
Repricing characteristics for market rate sensitive instruments;
Loan, investment, deposit and borrowing cash flows;
Loan prepayment estimates for each type of loan; and
Immediate, permanent and parallel movements in interest rates of plus 400, 300, 200 and 100 and minus 100 basis points.
The following table describes the results of the analysis at June 30, 20182020 and 2017:2019:
| | At June 30, 2018 | | At June 30, 2017 | |
At June 30, 2020 | | At June 30, 2020 | | At June 30, 2019 |
Basis Point (bp) Change in Rates | Change in Net Interest Income | | Basis Point (bp) Change in Rates | Change in Net Interest Income | Change in Net Interest Income | | Basis Point (bp) Change in Rates | Change in Net Interest Income |
+400 bp | 7.84% | | +400 bp | 16.70% | |
+300 bp | 6.83% | | +300 bp | 14.23% | 15.11%
| | +300 bp | 6.85% |
+200 bp | 5.73% | | +200 bp | 11.62% | 9.95% | | +200 bp | 4.39% |
+100 bp | 4.53% | | +100 bp | 8.29% | 5.25% | | +100 bp | 2.36% |
-100 bp | (3.98)% | | -100 bp | (3.68)% | (0.05)% | | -100 bp | (3.63)% |
At June 30, 20182020 and 2017,2019, the Corporation was asset sensitive as its interest-earning assets at those dates are expected to reprice more quickly than its interest-bearing liabilities during the subsequent 12-month period. Therefore, in a rising interest rate environment, the model projects an increase in net interest income over the subsequent 12-month period. In a falling interest rate environment, the results project a decrease in net interest income over the subsequent 12-month period.
Management believes that the assumptions used to complete the analysis described in the table above are reasonable. However, past experience has shown that immediate, permanent and parallel movements in interest rates will not necessarily occur. Additionally, while the analysis provides a tool to evaluate the projected net interest income to changes in interest rates, actual results may be substantially different if actual experience differs from the assumptions used to complete the analysis, particularly with respect to the 12-month business plan when asset growth is forecast. Therefore, the model results that the Corporation discloses should be thought of as a risk management tool to compare the trends of the Corporation’s current disclosure to previous disclosures, over time, within the context of the actual performance of the treasury yield curve.
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Item 8. Financial Statements and Supplementary Data
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.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
a) An evaluation of the Corporation’s disclosure controls and procedures (as defined in Section 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934 (the “Act”)) was carried out under the supervision and with the participation of the Corporation’s Chief Executive Officer, Chief Financial Officer and the Corporation’s Disclosure Committee as of the end of the period covered by this 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, 20182020 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, 2018,2020, 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.
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Management Report on Internal Control Over Financial Reporting
In thisThis management report includes the following subsidiary institution of Provident Financial Holdings, Inc. and subsidiary (the "Corporation") that, Provident Savings Bank, F.S.B. which is subject to Part 363 is included in the statement of management's responsibilities; the report on management's assessment of compliance with the Federal laws and regulations pertaining to insider loans and the Federal and, if applicable, State laws and regulations pertaining to dividend restrictions; and the report on management's assessment of internal control over financial reporting: Provident Savings Bank, F.S.B.reporting.
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, 2018,2020, 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).
The effectiveness of internal control over financial reporting as of June 30, 2018, has been audited by Deloitte & Touche LLP, the independent registered public accounting firm who also audited the Corporation's consolidated financial statements. Deloitte & Touche LLP's attestation report on the Corporation's internal control over financial reporting follows.
The managementManagement of the Corporation has assessed the Corporation's compliance with the Federal laws and regulations pertaining to insider loans and the Federal and, if applicable, State laws and regulations pertaining to dividend restrictions during the fiscal year that ended on June 30, 2018.2020. Management has concluded that the Corporation complied with the Federal laws and regulations pertaining to insider loans and the Federal and, if applicable, State laws and regulations pertaining to dividend restrictions during the fiscal year that ended on June 30, 2018.2020.
Date: August 31, 2018
/s/ Craig G. Blunden
Craig G. Blunden
Chairman and Chief Executive OfficerSeptember 4, 2020
/s/ Donavon P. Ternes | /s/ Craig G. Blunden
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| Chairman and Chief Executive Officer
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| /s/ Donavon P. Ternes
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| Donavon P. Ternes |
| President, Chief Operating Officer and
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| Chief Financial Officer |
Donavon P. Ternes
President, Chief Operating Officer and
Chief Financial Officer
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Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
Provident Financial Holdings, Inc.
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of Provident Financial Holdings, Inc. and subsidiary (the “Corporation”) as of June 30, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Because management’s assessment and our audit were conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), management’s assessment and our audit of the Corporation’s internal control over financial reporting included controls over the preparation of the schedules equivalent to the basic financial statements in accordance with the instructions for the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C). In our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of June 30, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
We have not examined and, accordingly, we do not express an opinion or any other form of assurance on management's statement referring to compliance with laws and regulations.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended June 30, 2018, of the Corporation and our report dated August 31, 2018, expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Corporation’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Bank in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process 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. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting 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.
/s/ Deloitte & Touche LLP
Costa Mesa, California
August 31, 2018
Item 9B. Other Information
Not applicable.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this item regarding the Corporation’s Board of Directors is incorporated herein by reference from the section captioned “Proposal I – Election of Directors” in the Corporation’s Proxy Statement, a copy of which will be filed with the Securities and Exchange Commission no later than 120 days after the Corporation’s fiscal year end.
The executive officers of the Corporation and the Bank are elected annually and hold office until their respective successors have been elected and qualified or until death, resignation or removal by the Board of Directors. For information regarding the Corporation’s executive officers, see Item 1, “Business - Executive Officers” in this Form 10-K.
Compliance with Section 16(a) of the Exchange Act
The information required by this item is incorporated herein by reference from the section captioned “Compliance with Section 16(a) of the Exchange Act” in the Corporation’s Proxy Statement, a copy of which will be filed with the Securities and Exchange Commission no later than 120 days after the Corporation’s fiscal year end.
Code of Ethics for Senior Financial Officers
The Corporation has adopted a Code of Ethics, which applies to all directors, officers, and employees of the Corporation. The Code of Ethics is publicly available as Exhibit 14 to the Corporation’s Annual Report on Form 10-K for the fiscal year June 30, 2007, and is available on the Corporation’s website, www.myprovident.com. If the Corporation makes any substantial amendments to the Code of Ethics or grants any waiver, including any implicit waiver, from a provision of the Code to the Corporation’s Chief Executive Officer, Chief Financial Officer or Controller, the Corporation will disclose the nature of such amendment or waiver on the Corporation’s website and in a report on Form 8-K.
Audit Committee and Audit Committee Financial Expert
The Corporation has a separately-designated standing audit committee established in accordance with section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The audit committee consists of three independent directors of the Corporation: Joseph P. Barr, Judy A. Carpenter and Debbi H. Guthrie. The Corporation has designated Joseph P. Barr, Audit Committee Chairman, as its audit committee financial expert. Mr. Barr is independent, as independence for audit committee members is defined under the listing standards of the NASDAQ Stock Market, a Certified Public Accountant in California and Ohio and has been practicing public accounting for over 40 years.
Nominating Procedures
There have been no material changes to the procedures by which shareholders may recommend nominees to ourits Board of Directors since last disclosed to shareholders.
Item 11. Executive Compensation
The information required by this item is incorporated herein by reference from the sections captioned “Executive Compensation” and “Directors’ Compensation” in the Proxy Statement, a copy of which will be filed with the Securities and Exchange Commission no later than 120 days after the Corporation’s fiscal year end.
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Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Security Ownership of Certain Beneficial Owners.
The information required by this item is incorporated herein by reference from the section captioned “Security Ownership of Certain Beneficial Owners and Management” in the Corporation’s Proxy Statement, a copy of which will be filed with the Securities and Exchange Commission no later than 120 days after the Corporation’s fiscal year end.
(b) Security Ownership of Management.
The information required by this item is incorporated herein by reference from the sections captioned “Security Ownership of Certain Beneficial Owners and Management” and “Proposal 1 - Election of Directors” in the Corporation’s Proxy Statement, a copy of which will be filed with the Securities and Exchange Commission no later than 120 days after the Corporation’s fiscal year end.
(c) Changes Inin Control.
The Corporation is not aware of any arrangements, including any pledge by any person of securities of the Corporation, the operation of which may at a subsequent date result in a change in control of the Corporation.
(d) Equity Compensation Plan Information.
The following table summarizes share and exercise price information regarding the Corporation's equity compensation plans as of June 30, 2018:2020:
| | Plan Category | Plan Category | Number of Securities to Be Issued Upon Exercise of Outstanding Options, Warrants and Rights | | Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights | | Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a)) | Plan Category | Number of Securities to Be Issued Upon Exercise of Outstanding Options, Warrants and Rights | | Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights | | Number of Securities Remaining Available for
Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a)) |
| | (a) | | (b) | | (c) | | (a) | | (b) | | (c) |
Equity compensation plans approved by security holders: | Equity compensation plans approved by security holders: | | | | Equity compensation plans approved by security holders: | | | | | |
| 2006 Equity Incentive Plan: | | | | 2006 Equity Incentive Plan: | | | | | |
| | Stock Options | 36,500 |
| | $14.98 | | — |
| | Stock Options | 33,500 | | | $15.69 | | — | |
| | Restricted Stock | 5,500 |
| | N/A | | — |
| | Restricted Stock | 1,500 | | | N/A | | — | |
| 2010 Equity Incentive Plan: | | | | 2010 Equity Incentive Plan: | | | | | |
| | Stock Options | 320,000 |
| | $11.21 | | 30,000 |
| | Stock Options | 312,000 | | | $12.14 | | — | |
| | Restricted Stock | 66,000 |
| | N/A | | 6,750 |
| | Restricted Stock | 6,750 | | | N/A | | — | |
| 2013 Equity Incentive Plan: | | | | 2013 Equity Incentive Plan: | | | | | |
| | Stock Options | 172,500 |
| | $15.19 | | 117,500 |
| | Stock Options | 209,000 | | | $16.70 | | 57,500 | |
| | Restricted Stock | 27,000 |
| | N/A | | 261,000 |
| | Restricted Stock | 217,250 | | | N/A | | 51,250 | |
| | | | | | | | | | | |
Equity compensation plans not approved by security holders | Equity compensation plans not approved by security holders | N/A |
| | N/A | | N/A |
| Equity compensation plans not approved by security holders | N/A | | N/A | | N/A |
| Total | 627,500 |
| | $12.77 | (1) | 415,250 |
| Total | 780,000 | | | $14.07 | (1) | 108,750 | |
(1) Excludes restricted stock from the calculation since restricted stock awards do not contain an exercise price requirement.
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Item 13. Certain Relationships and Related Transactions, and Director Independence
Certain Relationships and Related Transactions. The information required by this item is incorporated herein by reference from the section captioned “Board of Directors’ Meetings, Board Committees and Corporate Governance Matters - Corporate Governance - Certain Relationships and Related Transactions” in the Corporation’s Proxy Statement, a copy of which will be filed with the Securities and Exchange Commission no later than 120 days after the Corporation’s fiscal year end.
Director Independence. The information contained in the section captioned “Board of Directors’ Meetings, Board Committees and Corporate Governance Matters - Corporate Governance - Director Independence” in the Proxy Statement is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
The information required by this item is incorporated herein by reference from the section captioned “Proposal 3 - Ratification of Appointment of Independent Auditor” in the Corporation’s Proxy Statement, a copy of which will be filed with the Securities and Exchange Commission no later than 120 days after the Corporation’s fiscal year end.
PART IV
Item 15. Exhibits, Financial Statement Schedules.
(a) 1. Financial Statements
See Exhibit 13 to Consolidated Financial Statements beginning on this Form 10-K.
2. Financial Statement Schedules
Schedules to the Consolidated Financial Statements have been omitted as the required information is inapplicable.
(b) Exhibits
Exhibits are available from the Corporation by written request
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4.1 | Form of Certificate of Provident's Common Stock (incorporated by reference to the Corporation’s Registration Statement on Form S-1 (333-2230) filed on March 11, 1996)) |
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14.0 | section titled About: Investor Relations. |
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101 | The following materials from the Corporation’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018,2020, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Statements of Financial Condition; (2) Consolidated Statements of Operations; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Stockholders’ Equity; (5) Consolidated Statements of Cash Flows; and (6) Selected Notes to Consolidated Financial Statements. |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Date: | August 31, 2018September 4, 2020 | Provident Financial Holdings, Inc. |
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| | /s/ Craig G. Blunden |
| | Craig G. Blunden |
| | Chairman and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
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SIGNATURES | | TITLE | DATE |
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/s/ Craig G. Blunden | | Chairman and | August 31, 2018September 4, 2020 |
Craig G. Blunden | | Chief Executive Officer (Principal Executive Officer) | |
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/s/ Donavon P. Ternes | | President, Chief Operating Officer | August 31, 2018September 4, 2020 |
Donavon P. Ternes | | and Chief Financial Officer (Principal Financial and Accounting Officer) | |
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/s/ Joseph P. Barr | | Director | August 31, 2018September 4, 2020 |
Joseph P. Barr | | | |
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/s/ Bruce W. Bennett | | Director | August 31, 2018September 4, 2020 |
Bruce W. Bennett | | | |
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/s/ Judy A. Carpenter | | Director | August 31, 2018September 4, 2020 |
Judy A. Carpenter | | | |
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/s/ Debbi H. Guthrie | | Director | August 31, 2018September 4, 2020 |
Debbi H. Guthrie | | | |
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/s/ Roy H. Taylor | | Director | August 31, 2018September 4, 2020 |
Roy H. Taylor | | | |
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/s/ William E. Thomas | | Director | August 31, 2018September 4, 2020 |
William E. Thomas | | | |
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Provident Financial Holdings, Inc.
Consolidated Financial Statements
Index
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Report of Independent Registered Public Accounting Firm | 86
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Consolidated Statements of Financial Condition as of June 30, 20182020 and 20172019 | 87
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Consolidated Statements of Operations for the years ended June 30, 2018, 20172020 and 20162019 | 88
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Consolidated Statements of Comprehensive Income for the years ended June 30, 2018, 20172020 and 20162019 | 89
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Consolidated Statements of Stockholders’ Equity for the years ended June 30, 2018, 20172020 and 20162019 | 90
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Consolidated Statements of Cash Flows for the years ended June 30, 2018, 20172020 and 20162019 | 91
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Notes to Consolidated Financial Statements | 93
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Report of Independent Registered Public Accounting Firm
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of
Provident Financial Holdings, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of financial condition of Provident Financial Holdings, Inc. and subsidiary (the “Corporation”) as of June 30, 20182020 and 2017,2019, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows, for each of the threetwo years in the period ended June 30, 2018,2020, and the related notes (collectively referred to as the “financial statements”"financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Corporation as of June 30, 20182020 and 2017,2019, and the results of its operations and its cash flows for each of the threetwo years in the period ended June 30, 2018,2020, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Corporation’s internal control over financial reporting as of June 30, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 31, 2018, expressed an unqualified opinion on the Corporation’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on the Corporation’s financial statements based on our audits. We are a public accounting firm registered with the PCAOBPublic Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Corporation in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/Deloitte & Touche LLP
Costa Mesa, California
August 31, 2018
September 4, 2020
We have served as the Corporation’sCorporation's auditor since 2001.
86
PROVIDENT FINANCIAL HOLDINGS, INC.
Consolidated Statements of Financial Condition
(In Thousands, Except Share Information) | June 30, 2020 | June 30, 2019 |
Assets | | |
Cash and cash equivalents | $ | 116,034 | | $ | 70,632 | |
Investment securities - held to maturity, at cost | 118,627 | | 94,090 | |
Investment securities – available for sale, at fair value | 4,717 | | 5,969 | |
Loans held for investment, net of allowance for loan losses of $8,265 and $7,076, respectively; includes $2,258 and $5,094 of loans held at fair value, respectively) | 902,796 | | 879,925 | |
Accrued interest receivable | 3,271 | | 3,424 | |
Federal Home Loan Bank (“FHLB”) – San Francisco stock | 7,970 | | 8,199 | |
Premises and equipment, net | 10,254 | | 8,226 | |
Prepaid expenses and other assets | 13,168 | | 14,385 | |
| | |
Total assets | $ | 1,176,837 | | $ | 1,084,850 | |
| | |
Liabilities and Stockholders’ Equity | | |
| | |
Liabilities: | | |
Non interest-bearing deposits | $ | 118,771 | | $ | 90,184 | |
Interest-bearing deposits | 774,198 | | 751,087 | |
Total deposits | 892,969 | | 841,271 | |
| | |
Borrowings | 141,047 | | 101,107 | |
Accounts payable, accrued interest and other liabilities | 18,845 | | 21,831 | |
Total liabilities | 1,052,861 | | 964,209 | |
| | |
Commitments and Contingencies (Note 14) | | |
| | |
Stockholders’ equity: | | |
Preferred stock, $0.01 par value (2,000,000 shares authorized; none issued and outstanding) | — | | — | |
Common stock, $0.01 par value (40,000,000 shares authorized; 18,097,615 and 18,081,365 shares issued; 7,436,315 and 7,486,106 shares outstanding, respectively) | 181 | | 181 | |
Additional paid-in capital | 95,593 | | 94,351 | |
Retained earnings | 194,345 | | 190,839 | |
Treasury stock at cost (10,661,300 and 10,595,259 shares, respectively) | (166,247 | ) | (164,891 | ) |
Accumulated other comprehensive income, net of tax | 104 | | 161 | |
| | |
Total stockholders’ equity | 123,976 | | 120,641 | |
| | |
Total liabilities and stockholders’ equity | $ | 1,176,837 | | $ | 1,084,850 | |
The accompanying notes are an integral part of these consolidated financial statements.
87
|
| | | | | | |
(In Thousands, Except Share Information) | June 30, 2018 | June 30, 2017 |
Assets | | |
Cash and cash equivalents | $ | 43,301 |
| $ | 72,826 |
|
Investment securities - held to maturity, at cost | 87,813 |
| 60,441 |
|
Investment securities – available for sale, at fair value | 7,496 |
| 9,318 |
|
Loans held for investment, net of allowance for loan losses of $7,385 and $8,039, respectively; includes $5,234 and $6,445 of loans held at fair value, respectively) | 902,685 |
| 904,919 |
|
Loans held for sale, at fair value | 96,298 |
| 116,548 |
|
Accrued interest receivable | 3,212 |
| 2,915 |
|
Real estate owned, net | 906 |
| 1,615 |
|
Federal Home Loan Bank (“FHLB”) – San Francisco stock | 8,199 |
| 8,108 |
|
Premises and equipment, net | 8,696 |
| 6,641 |
|
Prepaid expenses and other assets | 16,943 |
| 17,302 |
|
| |
| |
|
Total assets | $ | 1,175,549 |
| $ | 1,200,633 |
|
| |
| |
|
Liabilities and Stockholders’ Equity | |
| |
|
| |
| |
|
Liabilities: | |
| |
|
Non interest-bearing deposits | $ | 86,174 |
| $ | 77,917 |
|
Interest-bearing deposits | 821,424 |
| 848,604 |
|
Total deposits | 907,598 |
| 926,521 |
|
| |
| |
|
Borrowings | 126,163 |
| 126,226 |
|
Accounts payable, accrued interest and other liabilities | 21,331 |
| 19,656 |
|
Total liabilities | 1,055,092 |
| 1,072,403 |
|
| |
| |
|
Commitments and Contingencies (Note 14) |
|
|
|
|
| |
| |
|
Stockholders’ equity: | |
| |
|
Preferred stock, $0.01 par value (2,000,000 shares authorized; none issued and outstanding) | — |
| — |
|
Common stock, $0.01 par value (40,000,000 shares authorized; 18,033,115 and 17,949,365 shares issued; 7,421,426 and 7,714,052 shares outstanding, respectively) | 181 |
| 180 |
|
Additional paid-in capital | 94,957 |
| 93,209 |
|
Retained earnings | 190,616 |
| 192,754 |
|
Treasury stock at cost (10,611,689 and 10,235,313 shares, respectively) | (165,507 | ) | (158,142 | ) |
Accumulated other comprehensive income, net of tax | 210 |
| 229 |
|
| |
| |
|
Total stockholders’ equity | 120,457 |
| 128,230 |
|
| |
| |
|
Total liabilities and stockholders’ equity | $ | 1,175,549 |
| $ | 1,200,633 |
|
PROVIDENT FINANCIAL HOLDINGS, INC.Consolidated Statements of Operations
| | Year Ended June 30, | |
(In Thousands, Except Per Share Information) | | 2020 | | | | 2019 | |
Interest income: | | |
Loans receivable, net | $ | 39,145 | | | $ | 40,092 | |
Investment securities | 2,120 | | | 2,042 | |
FHLB – San Francisco stock | 534 | | | 707 | |
Interest-earning deposits | 657 | | | 1,537 | |
Total interest income | 42,456 | | | 44,378 | |
| | |
Interest expense: | | |
Deposits | 2,943 | | | 3,381 | |
Borrowings | 3,112 | | | 2,827 | |
Total interest expense | 6,055 | | | 6,208 | |
| | | |
Net interest income | 36,401 | | | 38,170 | |
Provision (recovery) for loan losses | 1,119 | | | (475 | ) |
Net interest income, after provision (recovery) for loan losses | 35,282 | | | 38,645 | |
| | |
Non-interest income: | | |
Loan servicing and other fees | 819 | | | 1,051 | |
(Loss) gain on sale of loans, net | (132 | ) | | 7,135 | |
Deposit account fees | 1,610 | | | 1,928 | |
Card and processing fees | 1,454 | | | 1,568 | |
Other | 769 | | | 829 | |
Total non-interest income | 4,520 | | | 12,511 | |
| | |
Non-interest expense: | | |
Salaries and employee benefits(1) | 18,913 | | | 30,149 | |
Premises and occupancy(2) | 3,465 | | | 5,038 | |
Equipment expense(3) | 1,129 | | | 2,474 | |
Professional expense | 1,439 | | | 1,864 | |
Sales and marketing expense | 773 | | | 980 | |
Deposit insurance premium and regulatory assessments | 227 | | | 590 | |
Other | 2,954 | | | 4,141 | |
Total non-interest expense | 28,900 | | | 45,236 | |
| | |
Income before income taxes | 10,902 | | | 5,920 | |
Provision for income taxes | 3,213 | | | 1,503 | |
Net income | $ | 7,689 | | | $ | 4,417 | |
Basic earnings per share | $ | 1.03 | | | $ | 0.59 | |
Diluted earnings per share | $ | 1.01 | | | $ | 0.58 | |
Cash dividends per share | $ | 0.56 | | | $ | 0.56 | |
(1) | Includes $1.7 million of non-recurring expenses related to scaling back origination of saleable single-family mortgage loans for the fiscal year ended June 30, 2019. |
(2) | Includes $0.3 million of non-recurring expenses related to scaling back the origination of saleable single-family mortgage loans for the fiscal year ended June 30, 2019. |
(3) | Includes $0.8 million of non-recurring expenses related to scaling back the origination of saleable single-family mortgage loans for the fiscal year ended June 30, 2019. |
The accompanying notes are an integral part of these consolidated financial statements.
88
PROVIDENT FINANCIAL HOLDINGS, INC.
Consolidated Statements of Comprehensive Income
| Year Ended June 30, |
(In Thousands) | 2020 | 2019 |
Net income | $ | 7,689 | | | $ | 4,417 | |
| | | | |
Change in unrealized holding losses on securities available for sale and interest-only strips | (81 | ) | (70 | ) |
Reclassification of losses to net income | — | | — | |
Other comprehensive loss, before income tax benefit | (81 | ) | (70 | ) |
Income tax benefit | (24 | ) | (21 | ) |
Other comprehensive loss | (57 | ) | (49 | ) |
Total comprehensive income | $ | 7,632 | | | $ | 4,368 | |
The accompanying notes are an integral part of these consolidated financial statements.
93
PROVIDENT FINANCIAL HOLDINGS, INC.
Consolidated Statements of Operations
|
| | | | | | | | | |
| Year Ended June 30, |
(In Thousands, Except Per Share Information) | 2018 | 2017 | 2016 |
Interest income: | | | |
Loans receivable, net | $ | 40,016 |
| $ | 40,249 |
| $ | 37,658 |
|
Investment securities | 1,344 |
| 575 |
| 358 |
|
FHLB – San Francisco stock | 568 |
| 967 |
| 721 |
|
Interest-earning deposits | 784 |
| 626 |
| 567 |
|
Total interest income | 42,712 |
| 42,417 |
| 39,304 |
|
| | | |
Interest expense: | | | |
Deposits | 3,495 |
| 3,808 |
| 4,397 |
|
Borrowings | 2,917 |
| 2,871 |
| 2,578 |
|
Total interest expense | 6,412 |
| 6,679 |
| 6,975 |
|
| | | |
Net interest income | 36,300 |
| 35,738 |
| 32,329 |
|
Recovery from the allowance for loan losses | (536 | ) | (1,042 | ) | (1,715 | ) |
Net interest income, after recovery from the allowance for loan losses | 36,836 |
| 36,780 |
| 34,044 |
|
| | | |
Non-interest income: | | | |
Loan servicing and other fees | 1,575 |
| 1,251 |
| 1,068 |
|
Gain on sale of loans, net | 15,802 |
| 25,680 |
| 31,521 |
|
Deposit account fees | 2,119 |
| 2,194 |
| 2,319 |
|
Loss on sale and operations of real estate owned acquired in the settlement of loans, net | (86 | ) | (557 | ) | (95 | ) |
Card and processing fees | 1,541 |
| 1,451 |
| 1,448 |
|
Other | 944 |
| 802 |
| 800 |
|
Total non-interest income | 21,895 |
| 30,821 |
| 37,061 |
|
| | | |
Non-interest expense: | | | |
Salaries and employee benefits | 34,821 |
| 41,742 |
| 42,609 |
|
Premises and occupancy | 5,134 |
| 5,061 |
| 4,646 |
|
Equipment expense | 1,576 |
| 1,447 |
| 1,503 |
|
Professional expense | 1,912 |
| 2,075 |
| 2,089 |
|
Sales and marketing expense | 1,039 |
| 1,323 |
| 1,331 |
|
Deposit insurance premium and regulatory assessments | 749 |
| 773 |
| 1,018 |
|
Other(1) | 7,973 |
| 6,364 |
| 5,063 |
|
Total non-interest expense | 53,204 |
| 58,785 |
| 58,259 |
|
| | | |
Income before income taxes | 5,527 |
| 8,816 |
| 12,846 |
|
Provision for income taxes(2) | 3,396 |
| 3,609 |
| 5,372 |
|
Net income | $ | 2,131 |
| $ | 5,207 |
| $ | 7,474 |
|
| | | |
Basic earnings per share | $ | 0.28 |
| $ | 0.66 |
| $ | 0.90 |
|
Diluted earnings per share | $ | 0.28 |
| $ | 0.64 |
| $ | 0.88 |
|
Cash dividends per share | $ | 0.56 |
| $ | 0.52 |
| $ | 0.48 |
|
(1) Includes $3.4 million and $1.2 million of litigation settlement expenses for the fiscal years ended June 30, 2018 and 2017, respectively.
(2) Includes a net tax charge of $1.8 million resulting from the revaluation of net deferred tax assets consistent with the Tax Cuts and Jobs Act of 2017 ("Tax Act") for the fiscal year ended June 30, 2018.
The accompanying notes are an integral part of these consolidated financial statements.
94
PROVIDENT FINANCIAL HOLDINGS, INC.
Consolidated Statements of Comprehensive Income
|
| | | | | | | | | |
| Year Ended June 30, |
(In Thousands) | 2018 | 2017 | 2016 |
Net income | $ | 2,131 |
| $ | 5,207 |
| $ | 7,474 |
|
| | | |
Change in unrealized holding losses on securities available for sale and interest-only strips | (137 | ) | (145 | ) | (134 | ) |
Reclassification of losses to net income | 41 |
| — |
| 103 |
|
Other comprehensive loss, before income tax benefit | (96 | ) | (145 | ) | (31 | ) |
Income tax benefit(1) | 36 |
| 61 |
| 13 |
|
Other comprehensive loss | (60 | ) | (84 | ) | (18 | ) |
Total comprehensive income | $ | 2,071 |
| $ | 5,123 |
| $ | 7,456 |
|
(1) Includes income tax benefit from the reclassification of losses to net income.
The accompanying notes are an integral part of these consolidated financial statements.
95
PROVIDENT FINANCIAL HOLDINGS, INC.
Consolidated Statements of Stockholders' Equity
|
| | | | | | | | | | | | | | | | | | | | |
| Common Stock | Additional Paid-In Capital | Retained Earnings | Treasury Stock | Accumulated Other Compre-hensive Income (Loss), Net of Tax | |
(In Thousands, Except Share Information) | Shares | Amount | Total |
Balance at June 30, 2015 | 8,634,607 |
| $ | 177 |
| $ | 88,893 |
| $ | 188,206 |
| $ | (136,470 | ) | $ | 331 |
| $ | 141,137 |
|
| | | | | | | |
Net income | | | | 7,474 |
| | | 7,474 |
|
Other comprehensive loss | | | | | | (18 | ) | (18 | ) |
Purchase of treasury stock (1) | (749,857 | ) | | | | (13,038 | ) | | (13,038 | ) |
Distribution of restricted stock | 10,000 |
| | | | | | — |
|
Amortization of restricted stock | | | 578 |
| | | | 578 |
|
Exercise of stock options | 80,500 |
| 1 |
| 589 |
| | | | 590 |
|
Stock options expense | | | 520 |
| | | | 520 |
|
Tax effect from stock-based compensation | | | 222 |
| | | | 222 |
|
Cash dividends(2) | | | | (4,014 | ) | | | (4,014 | ) |
Balance at June 30, 2016 | 7,975,250 |
| 178 |
| 90,802 |
| 191,666 |
| (149,508 | ) | 313 |
| 133,451 |
|
| | | | | | | |
Net income | | | | 5,207 |
| | | 5,207 |
|
Other comprehensive loss | | | | | | (84 | ) | (84 | ) |
Purchase of treasury stock (1) | (450,948 | ) | | | | (8,714 | ) | | (8,714 | ) |
Forfeiture of restricted stock | | | 134 |
| | (134 | ) | | — |
|
Distribution of restricted stock | 87,750 |
| | | | | | — |
|
Amortization of restricted stock | | | 776 |
| | | | 776 |
|
Award of restricted stock | | | (214 | ) | | 214 |
| | — |
|
Exercise of stock options | 102,000 |
| 2 |
| 940 |
| | | | 942 |
|
Stock options expense | | | 714 |
| | | | 714 |
|
Tax effect from stock-based compensation | | | 57 |
| | | | 57 |
|
Cash dividends(2) | | | | (4,119 | ) | | | (4,119 | ) |
Balance at June 30, 2017 | 7,714,052 |
| 180 |
| 93,209 |
| 192,754 |
| (158,142 | ) | 229 |
| 128,230 |
|
| | | | | | | |
Net income | | | | 2,131 |
| | | 2,131 |
|
Other comprehensive loss | | | | (41 | ) | | (19 | ) | (60 | ) |
Purchase of treasury stock (1) | (386,876 | ) | | | | (7,347 | ) | | (7,347 | ) |
Forfeiture of restricted stock | | | 18 |
| | (18 | ) | | — |
|
Distribution of restricted stock | 10,500 |
| | | | | | — |
|
Amortization of restricted stock | | | 589 |
| | | | 589 |
|
Exercise of stock options | 83,750 |
| 1 |
| 676 |
| | | | 677 |
|
Stock options expense | | | 465 |
| | | | 465 |
|
Cash dividends(2) | | | | (4,228 | ) | | | (4,228 | ) |
Balance at June 30, 2018 | 7,421,426 |
| $ | 181 |
| $ | 94,957 |
| $ | 190,616 |
| $ | (165,507 | ) | $ | 210 |
| $ | 120,457 |
|
| Common Stock | Additional
Paid-In | Retained | Treasury | Accumulated Other Compre- hensive Income (Loss), | |
(In Thousands, Except Share Information) | Shares | Amount | Capital | Earnings | Stock | Net of Tax | Total |
Balance at June 30, 2018 | 7,421,426 | | $ | 181 | | $ | 94,957 | | $ | 190,616 | | $ | (165,507 | ) | $ | 210 | | $ | 120,457 | |
| | | | | | | |
Net income | | | | 4,417 | | | | 4,417 | |
Other comprehensive loss | | | | | | (49 | ) | (49 | ) |
Purchase of treasury stock (1) | (73,070 | ) | | | | (1,412 | ) | | (1,412 | ) |
Distribution of restricted stock | 89,500 | | | | | | | — | |
Amortization of restricted stock | | | 515 | | | | | 515 | |
Award of restricted stock | | | (2,028 | ) | | 2,028 | | | — | |
Exercise of stock options | 48,250 | | | | 553 | | | | | 553 | |
Stock options expense | | | 354 | | | | | 354 | |
Cash dividends(2) | | | | (4,194 | ) | | | (4,194 | ) |
Balance at June 30, 2019 | 7,486,106 | | $ | 181 | | $ | 94,351 | | $ | 190,839 | | $ | (164,891 | ) | $ | 161 | | $ | 120,641 | |
| | | | | | | |
Net income | | | | 7,689 | | | | 7,689 | |
Other comprehensive loss | | | | | | (57 | ) | (57 | ) |
Purchase of treasury stock | (66,041 | ) | | | | (1,283 | ) | | (1,283 | ) |
Forfeiture of restricted stock | | | 73 | | | (73 | ) | | — | |
Amortization of restricted stock | | | 873 | | | | | 873 | |
Exercise of stock options | 16,250 | | | | 215 | | | | | 215 | |
Stock options expense | | | 81 | | | | | 81 | |
Cash dividends(2) | | | | (4,183 | ) | | | (4,183 | ) |
Balance at June 30, 2020 | 7,436,315 | | $ | 181 | | $ | 95,593 | | $ | 194,345 | | $ | (166,247 | ) | $ | 104 | | $ | 123,976 | |
| |
(1) | Includes the repurchasepurchase of 3,291 shares, 25,598 shares and 3,09021,071 shares of distributed restricted stock in fiscal 2018, 2017 and 2016, respectively2019 in settlement of employees' withholding tax obligations and the repurchase of 4,500 shares from employees' stock option exercises in fiscal 2016.obligations. |
| |
(2) | Cash dividends of $0.56 per share $0.52 per share and $0.48 per share were paid in both fiscal 2018, 20172020 and 2016, respectively.2019. |
The accompanying notes are an integral part of these consolidated financial statements.
96
PROVIDENT FINANCIAL HOLDINGS, INC.
Consolidated Statements of Cash Flows
|
| | | | | | | | | |
| Year Ended June 30, |
(In Thousands) | 2018 | 2017 | 2016 |
Cash flows from operating activities: | | | |
Net income | $ | 2,131 |
| $ | 5,207 |
| $ | 7,474 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 3,130 |
| 2,640 |
| 1,909 |
|
Recovery from the allowance for loan losses | (536 | ) | (1,042 | ) | (1,715 | ) |
(Recovery) provision of losses on real estate owned | (561 | ) | 440 |
| (60 | ) |
Gain on sale of loans, net | (15,802 | ) | (25,680 | ) | (31,521 | ) |
Loss (gain) on sale of real estate owned, net | 558 |
| (138 | ) | (52 | ) |
Stock-based compensation | 1,054 |
| 1,490 |
| 1,098 |
|
Provision for deferred income taxes | 165 |
| 1,194 |
| 217 |
|
Tax effect from stock-based compensation | — |
| (57 | ) | (222 | ) |
Increase (decrease) in accounts payable, accrued interest and other liabilities | 2,174 |
| 3,408 |
| (422 | ) |
(Increase) decrease in prepaid expenses and other assets | (824 | ) | (1,521 | ) | 137 |
|
Loans originated for sale | (1,185,996 | ) | (1,913,038 | ) | (1,962,869 | ) |
Proceeds from sale of loans | 1,222,493 |
| 2,010,539 |
| 2,033,815 |
|
Net cash provided by operating activities | 27,986 |
| 83,442 |
| 47,789 |
|
| | | |
Cash flows from investing activities: | | | |
Increase in loans held for investment, net | (223 | ) | (66,349 | ) | (32,123 | ) |
Purchase of investment securities held to maturity | (54,148 | ) | (35,302 | ) | (41,683 | ) |
Maturity of investment securities held to maturity | 200 |
| 1,000 |
| — |
|
Principal payments from investment securities held to maturity | 25,497 |
| 13,134 |
| 2,328 |
|
Principal payments from investment securities available for sale | 1,734 |
| 1,950 |
| 2,500 |
|
Proceeds from redemptions of investment securities held for sale | — |
| 147 |
| — |
|
Purchase of FHLB – San Francisco stock | (91 | ) | (14 | ) | — |
|
Proceeds from sale of real estate owned | 2,635 |
| 2,409 |
| 6,573 |
|
Purchase of premises and equipment | (2,909 | ) | (1,491 | ) | (1,517 | ) |
Net cash used for investing activities | (27,305 | ) | (84,516 | ) | (63,922 | ) |
(Continued)
The accompanying notes are an integral part of these consolidated financial statements.
97
PROVIDENT FINANCIAL HOLDINGS, INC.
Consolidated Statements of Cash Flows
|
| | | | | | | | | |
| Year Ended June 30, |
(In Thousands) | 2018 | 2017 | 2016 |
Cash flows from financing activities: | | | |
(Decrease) increase in deposits, net | (18,923 | ) | 137 |
| 2,298 |
|
Proceeds from long-term borrowings | 10,000 |
| 20,000 |
| — |
|
Repayments of long-term borrowings | (10,063 | ) | (73 | ) | (68 | ) |
Proceeds from short-term borrowings, net | — |
| 15,000 |
| — |
|
Treasury stock purchases | (7,347 | ) | (8,714 | ) | (13,038 | ) |
Proceeds from exercise of stock options | 677 |
| 942 |
| 590 |
|
Withholding taxes on stock-based compensation | (322 | ) | (536 | ) | (54 | ) |
Tax effect from stock-based compensation | — |
| 57 |
| 222 |
|
Cash dividends | (4,228 | ) | (4,119 | ) | (4,014 | ) |
Net cash (used for) provided by financing activities | (30,206 | ) | 22,694 |
| (14,064 | ) |
| | | |
Net (decrease) increase in cash and cash equivalents | (29,525 | ) | 21,620 |
| (30,197 | ) |
Cash and cash equivalents at beginning of year | 72,826 |
| 51,206 |
| 81,403 |
|
Cash and cash equivalents at end of year | $ | 43,301 |
| $ | 72,826 |
| $ | 51,206 |
|
Supplemental information: | | | |
Cash paid for interest | $ | 6,410 |
| $ | 6,645 |
| $ | 6,985 |
|
Cash paid for income taxes | $ | 2,765 |
| $ | 3,039 |
| $ | 3,845 |
|
Transfer of loans held for sale to held for investment | $ | 1,692 |
| $ | 3,776 |
| $ | 4,889 |
|
Real estate acquired in the settlement of loans | $ | 2,171 |
| $ | 1,845 |
| $ | 6,347 |
|
The accompanying notes are an integral part of these consolidated financial statements.
9890
PROVIDENT FINANCIAL HOLDINGS, INC.
Consolidated Statements of Cash Flows
| Year Ended June 30, |
(In Thousands) | 2020 | 2019 |
Cash flows from operating activities: | | |
Net income | $ | 7,689 | | | $ | 4,417 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | |
Depreciation and amortization | 3,391 | | 3,075 | |
Provision (recovery) for loan losses | 1,119 | | (475 | ) |
Loss (gain) on sale of loans, net | 132 | | (7,135 | ) |
Stock-based compensation | 954 | | 869 | |
Provision for deferred income taxes | 552 | | 650 | |
(Decrease) increase in accounts payable, accrued interest and other liabilities | (3,086 | ) | 1,865 | |
(Increase) decrease in prepaid expenses and other assets | (2,797 | ) | 765 | |
Loans originated for sale | — | | (467,094 | ) |
Proceeds from sale of loans | — | | 570,154 | |
Net cash provided by operating activities | 7,954 | | 107,091 | |
| | |
Cash flows from investing activities: | | |
(Increase) decrease in loans held for investment, net | (25,108 | ) | 22,479 | |
Purchase of investment securities - held to maturity | (56,262 | ) | (40,682 | ) |
Maturity of investment securities - held to maturity | 400 | | 800 | |
Principal payments from investment securities - held to maturity | 30,890 | | 32,765 | |
Principal payments from investment securities - available for sale | 1,173 | | 1,463 | |
Proceeds from redemption of FHLB – San Francisco stock | 229 | | — | |
Proceeds from sale of real estate owned | — | | 915 | |
Purchase of premises and equipment | (229 | ) | (449 | ) |
Net cash (used for) provided by investing activities | (48,907 | ) | 17,291 | |
(Continued)
The accompanying notes are an integral part of these consolidated financial statements.
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PROVIDENT FINANCIAL HOLDINGS, INC.
Consolidated Statements of Cash Flows
| Year Ended June 30, |
(In Thousands) | 2020 | 2019 | |
Cash flows from financing activities: | | | |
Increase (decrease) in deposits, net | 51,698 | | (66,327 | ) | |
Proceeds from long-term borrowings | 30,007 | | — | | |
Repayments of long-term borrowings | (67 | ) | (10,056 | ) | |
Proceeds (repayments) of short-term borrowings, net | 10,000 | | (15,000 | ) | |
Treasury stock purchases | (1,283 | ) | (1,412 | ) | |
Proceeds from exercise of stock options | 215 | | 553 | | |
Withholding taxes on stock-based compensation | (32 | ) | (615 | ) | |
Cash dividends | (4,183 | ) | (4,194 | ) | |
Net cash provided by (used for) financing activities | 86,355 | | (97,051 | ) | |
| | | |
Net increase in cash and cash equivalents | 45,402 | | 27,331 | | |
Cash and cash equivalents at beginning of year | 70,632 | | 43,301 | | |
Cash and cash equivalents at end of year | $ | 116,034 | | $ | 70,632 | | |
Supplemental information: | | | |
Cash paid for interest | $ | 6,056 | | $ | 6,221 | | |
Cash paid for income taxes | $ | 775 | | $ | 1,555 | | |
Transfer of loans held for sale to held for investment | $ | 1,085 | | $ | 1,909 | | |
The accompanying notes are an integral part of these consolidated financial statements.
92
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2018
2020
Note 1: Organization and Summary of Significant Accounting Policies
Basis of presentation
The consolidated financial statements include the accounts of Provident Financial Holdings, Inc., and its wholly owned subsidiary, Provident Savings Bank, F.S.B. (collectively, the “Corporation”). All inter-company balances and transactions have been eliminated.
Provident Savings Bank, F.S.B. (the “Bank”) converted from a federally chartered mutual savings bank to a federally chartered stock savings bank effective June 27, 1996. Provident Financial Holdings, Inc., a Delaware corporation organized by the Bank, acquired all of the capital stock of the Bank issued in the conversion; the transaction was recorded on a book value basis.
The Corporation has determined that it operates in twoone business segments: community bankingsegment through the Bank and mortgage banking through Provident Bank Mortgage (“PBM”), a division of the Bank. The Bank's activities include attracting deposits, offering banking services and originating and purchasing single-family, multi-family, commercial real estate, construction and, to a lesser extent, other mortgage, commercial business and consumer loans.loans for investment/its loan portfolio. Deposits are collected primarily from 1413 banking locations located in Riverside and San Bernardino counties in California. PBM'sAdditional activities include originating saleable single-family loans, primarily fixed-rate first mortgages for sale to investors and to a lesser extent, for investment by the Bank.mortgages. Loans are primarily originated and purchased in Southern California and Northern California by loan agents employed by the Bank, from its banking locations and freestanding lending offices. PBM operates wholesale loan production offices in Pleasanton and Rancho Cucamonga, California and retail loan production offices in Atascadero, Brea, Escondido, Glendora, Rancho Cucamonga, Riverside (3) and Roseville, California.
Use of estimates
The accounting and reporting policies of the Corporation conform to generally accepted accounting principles in the United States of America (“GAAP”). The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and of the loan repurchase reserve, and the valuation of investment securities, available for sale, loans held for sale,the valuation of loans held for investment at fair value, deferred tax assets, loan servicing assets, real estate owned derivative financial instruments and deferred compensation costs.
The following accounting policies, together with those disclosed elsewhere in the consolidated financial statements, represent the significant accounting policies of Provident Financial Holdings, Inc. and the Bank.
Cash and cash equivalents
Cash and cash equivalents include cash on hand and due from banks, as well as overnight deposits placed at the Federal Reserve Bank – San Francisco and correspondent banks.
Investment securities
The Corporation classifies its qualifying investments as available for sale or held to maturity. The Corporation classifies investments as held to maturity when it has the ability and it is management’s positive intent to hold such securities to maturity. Securities held to maturity are carried at amortized historical cost. All other securities are classified as available for sale and are carried at fair value. Fair value generally is determined based upon quoted market prices. Changes in net unrealized gains (losses) on securities available for sale are included in accumulated other comprehensive income, net of tax. Gains and losses on sale or dispositions of investment securities are included in non-interest income and are determined using the specific identification method. Purchase premiums and discounts are amortized over the expected average life of the securities using the effective interest method.
93
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2020
Investment securities are reviewed annually for possible other-than-temporary impairment (“OTTI”). For debt securities, an OTTI is evident if the Corporation intends to sell the debt security or will more likely than not be required to sell the debt security before full recovery of the entire amortized cost basis is realized. However, even if the Corporation does not intend to sell the debt security and will not likely be required to sell the debt security before recovery of its entire amortized cost basis, the Corporation must
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2018
evaluate expected cash flows to be received and determine if a credit loss has occurred. In the event of a credit loss, the credit component of the impairment is recognized within non-interest income and the non-credit component is recognized through accumulated other comprehensive income, net of tax.
PBM activities
Mortgage loans are originated for both investment and sale to the secondary market. Since the Corporation is primarily a single-family adjustable-rate mortgage (“ARM”) lender for its own portfolio, a high percentage of fixed-rate loans are originated for sale to institutional investors.
Accounting Standards Codification (“ASC”) No. 825, “Financial Instruments,” allows for the option to report certain financial assets and liabilities at fair value initially and at subsequent measurement dates with changes in fair value included in earnings. The option may be applied instrument by instrument, but it is irrevocable. The Corporation has elected the fair value option on PBM loans held for sale and believes the fair value option most closely aligns the timing of the recognition of non-interest income and non-interest expense. Fair value is generally determined by measuring the value of outstanding loan sale commitments in comparison to investors’ current yield requirements as calculated on the aggregate loan basis. Loans are generally sold without recourse, other than standard representations and warranties. A high percentage of loans are sold on a servicing released basis. In some transactions, the Corporation may retain the servicing rights in order to generate servicing income. Where the Corporation continues to service loans after sale, investors are paid their share of the principal collections together with interest at an agreed-upon rate, which generally differs from the loan’s contractual interest rate.
Loans previously sold to the FHLB – San Francisco under the Mortgage Partnership Finance (“MPF”) program have a recourse liability. The FHLB – San Francisco absorbs the first four basis points of loss by establishing a first loss account and a credit scoring process is used to calculate the maximum recourse amount for the Bank. All losses above the Bank’s maximum recourse are the responsibility of the FHLB – San Francisco. The FHLB – San Francisco pays the Bank a credit enhancement fee on a monthly basis to compensate the Bank for accepting the recourse obligation. As of June 30, 2018, the Bank serviced $11.8 million of loans under this program and has established a recourse liability of $83,000 as compared to $15.1 million of loans serviced and a recourse liability of $105,000 at June 30, 2017.
Occasionally, the Bank is required to repurchase loans sold to Freddie Mac, Fannie Mae or other investors if it is determined that such loans do not meet the credit requirements of the investor, or if one of the parties involved in the loan misrepresented pertinent facts, committed fraud, or if such loans were 90-days past due within 120 days of the loan funding date. During the years ended June 30, 2018, 2017 and 2016, the Bank repurchased $602,000, $1.7 million and $1.7 million of single-family loans, respectively. Other repurchase requests were settled for $0, $11,000 and $470,000 in fiscal 2018, 2017 and 2016, respectively, which did not result in the repurchase of the loan itself. In addition to the specific recourse liability for the MPF program, the Bank has established a recourse liability of $200,000 and $200,000 for loans sold to other investors as of June 30, 2018 and 2017, respectively.
In fiscal 2016, the Bank entered into 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. The settlement agreement was executed in March 2016 and paid in April 2016. The settlement required the accrual of an additional recourse provision of $144,000 during the third quarter of fiscal 2016 which fully funded the settlement amount in addition to the recourse reserve that had already been provided in the prior periods for this investor.
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2018
Activity in the recourse liability for the years ended June 30, 2018 and 2017 was as follows:
|
| | | | | | |
(In Thousands) | June 30, 2018 | June 30, 2017 |
Balance, beginning of year | $ | 305 |
| $ | 453 |
|
Recourse recovery | (22 | ) | (137 | ) |
Net settlements in lieu of loan repurchases | — |
| (11 | ) |
Balance, end of the year | $ | 283 |
| $ | 305 |
|
The Bank is obligated to refund loan sale premiums to investors when a loan pays off within a specific time period following the loan sale; the time period ranges from three to six months, depending upon the loan sale agreement. Total loan sale premium refunds in fiscal 2018, 2017 and 2016 were $648,000, $578,000 and $384,000, respectively. As of June 30, 2018 and 2017, the Bank’s estimated liability was $113,000 and $102,000, respectively, for future loan sale premium refunds.
Gains or losses on the sale of loans, including fees received or paid, are recognized at the time of sale and are determined by the difference between the net sales proceeds and the allocated book value of the loans sold. When loans are sold with servicing retained, the carrying value of the loans is allocated between the portion sold and the portion retained (i.e., mortgage servicing assets and interest-only strips), based on estimates of their respective fair values.
Mortgage servicing assets (“MSA”) 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 MSA is based on the present value of estimated net future cash flows related to contractually specified servicing fees. The Bank periodically evaluates MSA for impairment, which is measured as the excess of cost over fair value. For additional information, see Note 4 of the Notes to Consolidated Financial Statements, “Mortgage Loan Servicing and Loans Originated for Sale.”
Rights to future income from serviced loans that exceed contractually specified servicing fees are recorded as interest-only strips. Interest-only strips are carried at fair value, utilizing the same assumptions that are used to value the related servicing assets, with any unrealized gain or loss, net of tax, recorded as a component of accumulated other comprehensive income. Interest-only strips are included in prepaid expenses and other assets in the accompanying Consolidated Statements of Financial Condition. As of June 30, 2018 and 2017, the fair value of the interest-only strips was $23,000 and $31,000, respectively, and the net unrealized gain after statutory taxes were applied to the interest-only strips was $16,000 and $18,000, respectively.
Loans held for sale
Loans held for sale consist primarily of long-term fixed-rate loans secured by first trust deeds on single-family residences, the majority of which are Federal Housing Administration (“FHA”), United States Department of Veterans Affairs (“VA”), Fannie Mae and Freddie Mac loan products. The loans are generally offered to customers located in (a) Southern California, primarily in Riverside and San Bernardino counties, commonly known as the Inland Empire, and Orange, Los Angeles, San Diego and other surrounding counties and (b) Northern California, primarily Alameda, Placer, San Luis Obispo and other surrounding counties. The loans have been hedged with loan sale commitments, To-Be-Announced ("TBA") Mortgage-Backed-Securities ("MBS") trades and option contracts. The loan sale settlement period is generally between 20 to 30 days from the date of the loan funding. The Corporation adopted ASC 820, “Fair Value Measurements and Disclosures,” and elected the fair value option (ASC 825, “Financial Instruments”) on loans held for sale.
Loans held for investment
Loans held for investment consist of long-term adjustable rate loans secured by first trust deeds on single-family residences, other residential property, commercial property and land.residences. Additionally, multi-family and commercial real estate loans secured by commercial property, land and other residential properties have become a substantial part of loans held for investment and comprised 64%66% and 63% of total loans held for investment at June 30, 20182020 and 2017,2019, respectively. These loans are generally offered to customers and businesses located in the same areas of Southern and Northern California described above.California.
Net loan origination fees and certain direct origination expenses are deferred and amortized to interest income over the contractual life of the loan using the effective interest method. Amortization is discontinued for non-performing loans. Interest receivable represents, for the most part, the current month’s interest, which will be included as a part of the borrower’s next monthly loan
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2018
payment. Interest receivable is accrued only if deemed collectible. Loans are placed on non-performing status when they become 90 days past due or if the loan is deemed impaired. When a loan is placed on non-performing status, interest accrued but not received is reversed against interest income. Interest income on non-performing loans is subsequently recognized only to the extent that cash is received and the principal balance is deemed collectible. If the principal balance is not deemed collectible, the entire payment received (principal and interest) is applied to the outstanding loan balance. Non-performing loans that become current as to both principal and interest are returned to accrual status after demonstrating satisfactory payment history (usually six consecutive months) and when future payments are expected to be collected.
Allowance for loan losses
The allowance for loan losses involves significant judgment and assumptions by management, which has a material impact on the carrying value of net loans. Management considers the accounting estimate related to the allowance for loan losses a critical accounting estimate because it is highly susceptible to changes from period to period, requiring management to make assumptions about probable incurred losses inherent in the loan portfolio at the balance sheet date. 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,” which requires that losses be accrued for non-performing loans that may be determined on an individually evaluated basis or based on an aggregated pooling method where the allowance is developed primarily by using historical charge-off statistics.method. The allowance has two components: collectively evaluated allowances and individually evaluated allowances. 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 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. Management considers, based on currently available information, the allowance for loan losses sufficient to absorb probable losses inherent in loans held for investment. Various techniques are used to arrive at an individually evaluated allowance, including discounted cash
94
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2020
flows and the fair market value of collateral. The use of these techniques is inherently subjective and the actual losses could be greater or less than the estimates. Management considers, based
Loans originated and held for sale
Mortgage loans are originated for both investment and sale to the secondary market. Since the Corporation is primarily a single-family adjustable-rate mortgage (“ARM”) lender for its own loan portfolio, fixed-rate loans are originated for sale to institutional investors. Loans held for sale consist primarily of long-term fixed-rate loans secured by first trust deeds on currently available information,single-family residences, the allowance formajority of which are Federal Housing Administration (“FHA”), United States Department of Veterans Affairs (“VA”), Fannie Mae and Freddie Mac loan losses sufficientproducts. The loans are generally offered to absorb probable losses inherentcustomers located in (a) Southern California, primarily in Riverside and San Bernardino counties, commonly known as the Inland Empire, and Orange, Los Angeles, San Diego and other surrounding counties and (b) Northern California, primarily Alameda, Placer, San Luis Obispo and other surrounding counties. The loans have been hedged with loan sale commitments, TBA MBS trades and option contracts. The loan sale settlement period is generally between 20 to 30 days from the date of the loan funding. On February 4, 2019, the Corporation announced that it was its best interests to scale back the saleable single-family mortgage loan originations and focus on increasing the portfolio single-family mortgage loans.
The Corporation adopted Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” and elected the fair value option (ASC 825, “Financial Instruments”) on loans held for investment.sale. ASC 825 allows for the option to report certain financial assets and liabilities at fair value initially and at subsequent measurement dates with changes in fair value included in earnings. The option may be applied instrument by instrument, but it is irrevocable. The Corporation has elected the fair value option on loans held for sale and believes the fair value option most closely aligns the timing of the recognition of non-interest income and non-interest expense. Fair value is generally determined by measuring the value of outstanding loan sale commitments in comparison to investors’ current yield requirements as calculated on the aggregate loan basis. Loans are generally sold without recourse, other than standard representations and warranties. A high percentage of loans are sold on a servicing released basis. In some transactions, the Corporation may retain the servicing rights in order to generate servicing income. Where the Corporation continues to service loans after sale, investors are paid their share of the principal collections together with interest at an agreed-upon rate, which generally differs from the loan’s contractual interest rate.
Loans previously sold to the FHLB – San Francisco under the Mortgage Partnership Finance (“MPF”) program have a recourse liability. The FHLB – San Francisco absorbs the first four basis points of loss by establishing a first loss account and a credit scoring process is used to calculate the maximum recourse amount for the Bank. All losses above the Bank’s maximum recourse are the responsibility of the FHLB – San Francisco. The FHLB – San Francisco pays the Bank a credit enhancement fee on a monthly basis to compensate the Bank for accepting the recourse obligation. As of June 30, 2020, the Bank serviced $7.4 million of loans under this program and has established a recourse liability of $70,000 as compared to $9.7 million of loans serviced and a recourse liability of $50,000 at June 30, 2019.
Occasionally, the Bank is required to repurchase loans sold to Freddie Mac, Fannie Mae or other investors if it is determined that such loans do not meet the credit requirements of the investor, or if one of the parties involved in the loan misrepresented pertinent facts, committed fraud, or if such loans were 90-days past due within 120 days of the loan funding date. During the years ended June 30, 2020 and 2019, the Bank repurchased $1.1 million and $948,000 of single-family loans, respectively. No other repurchase requests, which did not result in the repurchase of the loan itself, were settled in fiscal 2020 and 2019. In addition to the specific recourse liability for the MPF program, the Bank established a recourse liability of $200,000 for loans sold to other investors as of both, June 30, 2020 and 2019.
95
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2020
Activity in the recourse liabilities for the years ended June 30, 2020 and 2019 was as follows:
| For Year Ended June 30, |
(In Thousands) | 2020 | 2019 |
Balance, beginning of year | $ | 250 | | $ | 283 | |
Recourse reserve (recovery) | 20 | | (33 | ) |
Balance, end of the year | $ | 270 | | $ | 250 | |
The Bank is obligated to refund loan sale premiums to investors when a loan pays off within a specific time period following the loan sale; the time period ranges from three to six months, depending upon the loan sale agreement. Total loan sale premium refunds in fiscal 2020 and 2019 were $78,000 and $96,000, respectively. The Bank has no estimated liability for future loan sale premium refunds at June 30, 2020, as compared to $25,000 at June 30, 2019.
Gains or losses on the sale of loans, including fees received or paid, are recognized at the time of sale and are determined by the difference between the net sales proceeds and the allocated book value of the loans sold.
Mortgage servicing assets (“MSA”) 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 MSA is based on the present value of estimated net future cash flows related to contractually specified servicing fees. The Bank periodically evaluates MSA for impairment, which is measured as the excess of cost over fair value. For additional information, see Note 4 of the Notes to Consolidated Financial Statements, “Mortgage Loan Servicing and Loans Originated for Sale.”
Allowance for unfunded loan commitments
The Corporation maintains the allowance for unfunded loan commitments at a level that is adequate to absorb estimated probable losses related to these unfunded credit facilities. The Corporation determines the adequacy of the allowance based on periodic evaluations of the unfunded credit facilities, including an assessment of the probability of commitment usage, credit risk factors for loans outstanding to these same customers, and the terms and expiration dates of the unfunded credit facilities. The allowance for unfunded loan commitments is recorded in other liabilities on the Consolidated Statements of Financial Condition. Net adjustments to the allowance for unfunded loan commitments are included in other non-interest expense on the Consolidated Statements of Operations.
Loans in forbearance
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. For commercial and consumer customers, the Corporation has provided relief options, including payment deferrals and fee waivers.
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.
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
96
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2020
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.
Troubled debt restructuring (“restructured loans”)
A 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. These financial difficulties include, but are not limited to, the borrowers default status on any of their debts, bankruptcy and recent changes in their financial circumstances (loss of job, etc.).
The loan terms which have been modified or restructured due to a borrower’s financial difficulty, may include but are not limited to:
| |
a) | A reduction in the stated interest rate. |
| |
b) | An extension of the maturity at an interest rate below market. |
| |
c) | A reduction in the accrued interest. |
| |
d) | Extensions, deferrals, renewals and rewrites. |
| |
e) | Loans that have been discharged in a Chapter 7 Bankruptcy that have not been reaffirmed by the borrower. |
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2018
To qualify for restructuring, a borrower must provide evidence of creditworthiness such as, current financial statements, 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.
The Corporation measures the allowance for loan losses of restructured loans based on the difference between the loan's original carrying amount and the present value of expected future cash flows discounted at the original effective yield of the loan. Based on the Office of the Comptroller of the Currency's ("OCC") guidance with respect to restructured loans and to conform to general practices within the banking industry, the Corporation maintains certain restructured loans on accrual status, provided 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 Corporation 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 consecutive months for those loans that were restructured more than once. Once 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.
Non-performing loans
The Corporation assesses loans individually and classifies as non-performing 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
97
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2020
Corporation measures each non-performing loan based on ASC 310, establishes a collectively evaluated or individually evaluated allowance and charges off those loans or portions of loans deemed uncollectible.
Real estate owned
Real estate acquired through foreclosure is initially recorded at the fair value of the real estate acquired, less estimated selling costs. Subsequent to foreclosure, the Corporation charges current earnings for estimated losses if the carrying value of the property exceeds its fair value. Gains or losses on the sale of real estate are recognized upon disposition of the property. Costs relating to improvement, maintenance and repairs of the property are expensed as incurred under gain (loss) on sale and operations of real estate owned acquired in the settlement of loans within the Consolidated Statements of Operations.
Impairment of long-lived assets
The Corporation reviews its long-lived assets for impairment annually or when events or circumstances indicate that the carrying amount of these assets may not be recoverable. Long-lived assets include buildings, land, fixtures, furniture and equipment. An asset is considered impaired when the expected discounted cash flows over the remaining useful life are less than the net book value. When impairment is indicated for an asset, the amount of impairment loss is the excess of the net book value over its fair value.
Premises and equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed primarily on a straight-line basis over the estimated useful lives as follows:
|
| | |
| Buildings | 10 to 40 years |
| Furniture and fixtures | 3 to 10 years |
| Automobiles | 3 to 5 years |
| Computer equipment | 3 to 5 years |
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2018
Leasehold improvements are amortized over the lesser of their respective lease terms or the useful life of the improvement, which ranges from one to 10 years. Maintenance and repair costs are charged to operations as incurred.
Income taxes
The Corporation accounts for income taxes in accordance with ASC 740, “Income Taxes.” ASC 740 requires the affirmative evaluation that it is more likely than not, based on the technical merits of a tax position, that an enterprise is entitled to economic benefits resulting from positions taken in income tax returns. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements.
ASC 740 requires that when determining the need for a valuation allowance against a deferred tax asset, management must assess both positive and negative evidence with regard to the realizability of the tax losses represented by that asset. To the extent available, if sources of taxable income are insufficient to absorb tax losses, a valuation allowance is necessary. Sources of taxable income for this analysis include prior years’ tax returns, the expected reversals of taxable temporary differences between book and tax income, prudent and feasible tax-planning strategies, and future taxable income. The deferred income tax asset related to the allowance for loan losses will be realized when actual charge-offs are made against the allowance. Based on the availability of loss carry-backs and projected taxable income during the periods for which loss carry-forwards are available, management believes it is more likely than not the Corporation will realize the deferred tax asset. The Corporation continues to monitor the deferred tax asset on a quarterly basis for a valuation allowance. The future realization of these tax benefits primarily hinges on adequate future earnings to utilize the tax benefit. Prospective earnings or losses, tax law
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Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2020
changes or capital changes could prompt the Corporation to reevaluate the assumptions which may be used to establish a valuation allowance. As of June 30, 20182020 and 2017,2019, the estimated deferred tax asset was $4.2$3.0 million and $4.3$3.5 million,, respectively. respectively, and presented in prepaid expenses and other assets. The Corporation maintains net deferred tax assets for deductible temporary tax differences, such as loss reserves, deferred compensation, non-accrued interest and unrealized gains.gains, among other items. The decrease in the net deferred tax asset resulted primarily from items related to lossa decline in litigation reserves state taxes, fair value adjustments and depreciation,an increase in deferred loan costs, partly offset by deferred compensationincreases in loan loss reserves and deferred loan costs.compensation. The Corporation did not have any liabilities for uncertain tax positions or any known unrecognized tax benefit at June 30, 20182020 or 2017.2019.
Bank owned life insurance ("BOLI"(“BOLI”)
ASC 715-60-35, "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements," requires an employer to recognize obligations associated with endorsement split-dollar life insurance arrangements that extend into the participant's post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. The Corporation adopted ASC 715-60-35 using the latter option, i.e., based on the future death benefit. The Bank purchases BOLI policies on the lives of certain executive officers while they are employed by the Bank and is the owner and beneficiary of the policies. The Bank invests in BOLI to provide an efficient form of funding for long-term retirement and other employee benefits costs. The Bank records these BOLI policies within prepaid expenses and other assets in the Consolidated Statements of Financial Condition at each policy’s respective cash surrender value, with net changes recorded in other non-interest income and salaries and employee benefits expense in the Consolidated Statements of Operations.
Cash dividend
A declaration or payment of dividends is at the discretion of the Corporation’s Board of Directors, who take into account the Corporation’s financial condition, results of operations, tax considerations, capital requirements, industry standards, 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. For additional information, see Note 22 of the Notes to Consolidated Financial Statements regarding the subsequent event related to the cash dividend.
Stock repurchases
The Corporation repurchases its common stock consistent with Board-approved stock repurchase plans. During fiscal 2018, the Corporation repurchased 383,5852020, a total of 66,041 shares withof common stock were purchased at an average cost of $19.00$19.43 per share, allshare. As of which were purchased underJune 30, 2020, a total of 371,815 shares remain available for future repurchase pursuant to the June 2017Corporation’s April 2020 stock repurchase plan. In addition, the Corporation purchased 3,291 shares of distributed restricted stock in settlement of employees' withholding tax obligations. As of June 19, 2018, the June 2017 stock repurchase plan expired. On April 26, 2018, the
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2018
Corporation approved a new plan authorizing the repurchase of up to 5% of outstanding shares, or 373,000 shares, all of which were available for purchase at June 30, 2018.
Earnings per common share (“EPS”)
Basic EPS represents net income divided by the weighted average common shares outstanding during the period excluding any potential dilutive effects. Diluted EPS gives effect to any potential issuance of common stock that would have caused basic EPS to be lower as if the issuance had already occurred. Accordingly, diluted EPS reflects an increase in the weighted average shares outstanding as a result of the assumed exercise of stock options and the vesting of restricted stock. The computation of diluted EPS does not assume exercise of stock options and vesting of restricted stock that would have an anti-dilutive effect on EPS.
Stock-based compensation
ASC 718, “Compensation – Stock Compensation,” requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation issued to employees and directors. Stock-based
99
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2020
compensation expense, inclusive of restricted stock expense, recognized in the consolidated statements of operations for the years ended June 30, 2018, 20172020 and 20162019 was $1.1 million, $1.5 million$954,000 and $1.1 million,$869,000, respectively.
Employee Stock Ownership Plan ("ESOP")
The Corporation recognizes compensation expense when the Bank contributes funds to the ESOP for the purchase of the Corporation’s common stock to be allocated to the ESOP participants. Since the contributions are discretionary, the benefits payable under the ESOP cannot be estimated.
Restricted stock
The Corporation recognizes compensation expense over the vesting period of the shares awarded, equal to the fair value of the shares at the award date. A total of $873,000 and $515,000 of restricted stock expense was amortized during fiscal 2020 and 2019, respectively.
Post retirementPost-retirement benefits
The estimated obligation for post retirementpost-retirement health care and life insurance benefits is determined based on an actuarial computation of the cost of current and future benefits for the eligible (grandfathered) retirees and employees. The post retirement benefit liability is included in accounts payable, accrued interest and other liabilities in the Consolidated Statements of Financial Condition. Effective July 1, 2003, the Corporation discontinued the post retirement-retirement health care and life insurance benefits to any employee not previously qualified (grandfathered) for these benefits. At June 30, 20182020 and 2017,2019, the accrued liability for post retirementpost-retirement benefits was $204,000$184,000 and $187,000,$196,000, respectively, which was fully funded consistent with actuarially determined estimates of the future obligation.
Comprehensive income
ASC 220, “Comprehensive Income,” requires that realized revenue, expenses, gains and losses be included in net income (loss). Unrealized gains (losses) on available for sale securities and interest-only strips are reported as a separate component of the stockholders’ equity section of the Consolidated Statements of Financial Condition and the change in the unrealized gains (losses) are reported on the Consolidated Statements of Comprehensive Income and Consolidated Statements of Stockholders' Equity.
Accounting standard updates (“ASU”)
ASU 2015-14:2016-02:
In August 2015,February 2016, the Financial Accounting Standards Board (“FASB”("FASB") issued ASU 2015-14, "Revenue from Contracts with Customers (Topic 606)," which defers the effective date of ASU No. 2014-09 one year. ASU No. 2014-09 created Topic 606 and supersedes Topic 605, Revenue Recognition. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the new guidance requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2018
applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. Management adopted the new guidance on July 1, 2018. Management has completed its identification of all revenue streams included in the financial statements and identified which revenue streams are within the scope of the pronouncement. Management does not expect the adoption of this ASU to have a material impact on the Corporation’s Consolidated Financial Statements.
ASU 2016-02:
In February 2016, the FASB issued ASU 2016-02, "Leases“Leases (Topic 842)."” This ASU introduces a lessee model that brings most leases on the balance sheet and aligns many of the underlying principles of the new lessor model with those in the new revenue recognition standard, ASC 606, Revenue From Contracts With Customers. The new leases standard represents a wholesale change to lease accounting requiring the recognition of lease assets and will most likely resultlease liabilities in significant implementation challenges during the transition periodbalance sheet and beyond.
disclosure of key information about leasing arrangements. The principal change required by ASU 2016-02 relates to lessee accounting, for operating leases, a lessee is required to (1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position, (2) recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term generally on a straight-line basis, and (3) classify all cash payments within operating activities in the statement of cash flows. For leases with an initial term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. ASU 2016-02 also changes disclosure requirements related to leasing activities and requires certain qualitative disclosures along with specific quantitative disclosures. This ASU will bewas effective for annual periods
100
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 2020
beginning after December 15, 2018 (i.e., calendar periods beginning on January 1, 2019), and interim periods therein, early adoption iswas permitted. In July 2018, the FASB issued ASU 2018-11, Leases, Targeted Improvements, which allowed entities the option of initially applying the new leases standard at the adoption date (such as January 1, 2019, for calendar year-end public business entities) and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In January 2019, the FASB issued ASU 2019-01, Codification Improvements. The Corporation is currently evaluating the provisions ofamendments in this ASU included the following items: (i) determining the fair value of the underlying asset by lessors that are not manufacturers or dealers; (ii) requiring cash received from lessors from sales-type and direct financing leases to determinebe presented in the potential impactcash flow statement within investing activities; and (iii) clarifying interim disclosure requirements. The effective date and transition requirements for the new standard will have on its consolidated financial statements.first and second items of ASU 2019-01 were effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019. The Corporation leases buildingseffective date and offices under non-cancelable operating leases,transition requirements for the majoritythird item of which will be subject to this ASU. WhileASU 2019-01 were the Corporation has not quantified the impact to its balance sheet, upon thesame as ASU 2016-02. The adoption of this ASU did not have a material impact on the Corporation expectsCorporation’s Consolidated Financial Statements. See Note 5 of the Notes to report increased assets and increased liabilities on its consolidated statements of financial condition as a result of recognizing right-of-use assets and lease liabilities related to these leases and certain equipment under non-cancelable operating lease agreements, which currently are not reflected in its consolidated statements of financial condition.Consolidated Financial Statements for additional discussion.
ASU 2016-13:
In June 2016, the FASBFinancial Accounting Standards Board (“FASB”) issued ASU 2016-13, "Financial“Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ThisInstruments,” and subsequent amendments to the initial guidance in November 2018, ASU requires organizations to measureNo. 2018-19, April 2019, ASU 2019-04, May 2019, ASU 2019-05, November 2019, ASU 2019-11, February 2020, ASU 2020-02 and March 2020, ASU 2020-03, all expected credit lossesof which clarifies codification and corrects unintended application of the guidance. In November 2019, the FASB also issued ASU 2019-10, “Financial Instruments — Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates” extending the adoption date for financial instruments held atcertain registrants, including the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. This ASUCorporation. These ASUs will be effective for fiscal years beginning after December 15, 2019,2022, including interim periods within those fiscal years. The Corporation is evaluating its current expected loss methodology of its loan and investment portfolios to identify the necessary modifications in accordance with this standardthese standards and expects a change in the processes and procedures to calculate the allowance for loan losses, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. A valuation adjustment to its allowance for loan losses or investment portfolio that is identified in this process will be reflected as a one-time adjustment in equity rather than earnings upon this ASU adoption. The Corporation is in the process of compiling historical data that will be used to calculate expected credit losses on its loan portfolio to ensure the Corporation is fully compliant with the ASUthese ASUs at the adoption date and is evaluating the potential impact adoption of this ASUthat these ASUs will have on its consolidated financial statements.the Corporation’s Consolidated Financial Statements. Once adopted, the Corporation anticipates the allowance for loan losses to increase through a one‑time adjustment to retained earnings, however, until the evaluation is complete the magnitude of the potential increase will be unknown.
ASU 2017-07:2018-13:
In March 2017, the FASB issued ASU 2017-07, "Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-Retirement Benefit Cost." This ASU requires an employer to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost as defined in paragraphs 715-30-35-4 and 715-60-35-9 are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item or items are used to present the other components of net benefit cost, that line item or items must be appropriately described. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. Management adopted the new guidance on July 1, 2018. The Corporation's adoption of this ASU is not expected to have a material impact on its consolidated financial statements.
ASU 2018-02:
In FebruaryAugust 2018, the FASB issued ASU 2018-02, "Income Statement—Reporting Comprehensive Income2018-13, “Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement, which modifies disclosure requirements on fair value measurements to improve their effectiveness.” The guidance permits entities to consider materiality when evaluating fair value measurement disclosures and, among other modifications, requires certain new disclosures related to Level 3 fair value measurements. This guidance will be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted. The guidance only affects disclosures in the notes to the consolidated financial statements and will not otherwise affect the Corporation’s Consolidated Financial Statements.
ASU 2020-04:
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 220)848): ReclassificationFacilitation of Certain Taxthe Effects from Accumulated Other Comprehensive Income."of reference Rate Reform on Financial Reporting. This ASU allows a reclassification from accumulatedapplies to contracts, hedging relationships and other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act. Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Act and will improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects
transactions that reference
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 20182020
LIBOR or other rate references expected to be discontinued because of the Tax Act, the underlying guidance that requires that the effectreference rate reform. The ASU permits an entity to make necessary modifications to eligible contracts or transactions without requiring contract re-measurement or reassessment of a change in tax laws or rates be included in income from continuing operationsprevious accounting determination. This ASU is not affected. The amendments in this ASU also require certain disclosures about stranded tax effects. The amendments in this ASU should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act is recognized. The amendments in this ASU are effective for all entities for fiscal years beginning afteras of March 12, 2020 through December 15, 2018, and interim periods within those fiscal years.31, 2022. The Corporation elected to early adoptis in the process of compiling data on the impact of reference rate reform and has not determined the impact of the adoption of this ASU and to reclassify $41,000 of stranded tax effects from accumulated other comprehensive income to retained earnings in the fourth quarter of fiscal 2018.
ASU 2018-05:
In March 2018, FASB issued ASU No. 2018-05, "Income Taxes (Topic 740)." This ASU was issued to provide guidance on the income tax accounting implications of the Tax Act and allows for entities to report provisional amounts for specific income tax effects of the Tax Act for which the accounting under ASC Topic 740 was not yet complete but a reasonable estimate could be determined. A measurement period of one year is allowed to complete the accounting effects under ASC Topic 740 and revise any previous estimates reported. Any provisional amounts or subsequent adjustments included in an entity’sits consolidated financial statements during the measurement period should be included in income from continuing operations as an adjustment to tax expense in the reporting period the amounts are determined. The Corporation recorded a $1.84 million provisional next tax charge as reported in the Consolidated Statements of Operations in the Form 10-Q for the quarter ended December 31, 2017. As of June 30, 2018, the Corporation recorded a $76,000 adjustment to the net deferred tax asset revaluation resulting in a $1.77 million net tax charge for the fiscal year ended June 30, 2018.statements.
Note 2: Investment Securities
The amortized cost and estimated fair value of investment securities as of June 30, 20182020 and 20172019 were as follows:
| | June 30, 2018 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized (Losses) | Estimated Fair Value | Carrying Value | |
June 30, 2020 | | Amortized Cost | Gross Unrealized Gains | Gross Unrealized (Losses) | Estimated Fair Value | Carrying Value |
(In Thousands) | | |
Held to maturity | | |
U.S. government sponsored enterprise MBS | $ | 84,227 |
| $ | 203 |
| $ | (762 | ) | $ | 83,668 |
| $ | 84,227 |
| $ | 115,763 | | $ | 2,636 | | $ | (45 | ) | $ | 118,354 | | $ | 115,763 | |
U.S. SBA securities(1) | 2,986 |
| — |
| (15 | ) | 2,971 |
| 2,986 |
| 2,064 | | — | | (17 | ) | 2,047 | | 2,064 | |
Certificate of deposits | 600 |
| — |
| — |
| 600 |
| 600 |
| 800 | | — | | — | | 800 | | 800 | |
Total investment securities - held to maturity | $ | 87,813 |
| $ | 203 |
| $ | (777 | ) | $ | 87,239 |
| $ | 87,813 |
| $ | 118,627 | | $ | 2,636 | | $ | (62 | ) | $ | 121,201 | | $ | 118,627 | |
| | |
Available for sale | | |
U.S. government agency MBS | $ | 4,234 |
| $ | 150 |
| $ | — |
| $ | 4,384 |
| $ | 4,384 |
| $ | 2,823 | | $ | 120 | | $ | — | | $ | 2,943 | | $ | 2,943 | |
U.S. government sponsored enterprise MBS | 2,640 |
| 122 |
| — |
| 2,762 |
| 2,762 |
| 1,556 | | 21 | | — | | 1,577 | | 1,577 | |
Private issue CMO(2) | 346 |
| 4 |
| — |
| 350 |
| 350 |
| 204 | | — | | (7 | ) | 197 | | 197 | |
Total investment securities - available for sale | $ | 7,220 |
| $ | 276 |
| $ | — |
| $ | 7,496 |
| $ | 7,496 |
| $ | 4,583 | | $ | 141 | | $ | (7 | ) | $ | 4,717 | | $ | 4,717 | |
Total investment securities | $ | 95,033 |
| $ | 479 |
| $ | (777 | ) | $ | 94,735 |
| $ | 95,309 |
| $ | 123,210 | | $ | 2,777 | | $ | (69 | ) | $ | 125,918 | | $ | 123,344 | |
| |
(1) | Small BusinesBusiness Administration ("SBA"). |
| |
(2) | Collateralized Mortgage Obligations (“CMO”). |
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 20182020
| | June 30, 2017 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized (Losses) | Estimated Fair Value | Carrying Value | |
June 30, 2019 | | Amortized Cost | Gross Unrealized Gains | Gross Unrealized (Losses) | Estimated Fair Value | Carrying Value |
(In Thousands) | | |
Held to maturity | | |
U.S. government sponsored enterprise MBS | $ | 59,841 |
| $ | 265 |
| $ | (77 | ) | $ | 60,029 |
| $ | 59,841 |
| $ | 90,394 | | $ | 1,289 | | $ | (14 | ) | $ | 91,669 | | $ | 90,394 | |
U.S. SBA securities | | 2,896 | | — | | (6 | ) | 2,890 | | 2,896 | |
Certificate of deposits | 600 |
| — |
| — |
| 600 |
| 600 |
| 800 | | — | | — | | 800 | | 800 | |
Total investment securities - held to maturity | $ | 60,441 |
| $ | 265 |
| $ | (77 | ) | $ | 60,629 |
| $ | 60,441 |
| $ | 94,090 | | $ | 1,289 | | $ | (20 | ) | $ | 95,359 | | $ | 94,090 | |
| | |
Available for sale | | |
U.S. government agency MBS | $ | 5,197 |
| $ | 186 |
| $ | — |
| $ | 5,383 |
| $ | 5,383 |
| $ | 3,498 | | $ | 116 | | $ | (1 | ) | $ | 3,613 | | $ | 3,613 | |
U.S. government sponsored enterprise MBS | 3,301 |
| 173 |
| — |
| 3,474 |
| 3,474 |
| 1,998 | | 89 | | — | | 2,087 | | 2,087 | |
Private issue CMO(1) | 456 |
| 5 |
| — |
| 461 |
| 461 |
| |
Private issue CMO | | 261 | | 8 | | — | | 269 | | 269 | |
Total investment securities - available for sale | $ | 8,954 |
| $ | 364 |
| $ | — |
| $ | 9,318 |
| $ | 9,318 |
| $ | 5,757 | | $ | 213 | | $ | (1 | ) | $ | 5,969 | | $ | 5,969 | |
Total investment securities | $ | 69,395 |
| $ | 629 |
| $ | (77 | ) | $ | 69,947 |
| $ | 69,759 |
| $ | 99,847 | | $ | 1,502 | | $ | (21 | ) | $ | 101,328 | | $ | 100,059 | |
| |
(1)
| Collateralized Mortgage Obligations (“CMO”). |
In fiscal 2018, 20172020 and 2016,2019, the Corporation received MBS principal payments of $27.2$32.1 million $15.1and $34.2 million, respectively and $4.8 million, respectively; did not sell any investment securities; and $147,000 of common stock was redeemed in fiscal 2017.securities. The Corporation purchased mortgage-backed securities totaling $53.9 million, $34.5$55.9 million and $41.7$39.9 million during fiscal 2018, 20172020 and 2016,2019, respectively.
As of June 30, 20182020 and 2017,2019, the Corporation held investments with an unrealized loss position of $777,000$69,000 and $77,000,$21,000, respectively.
|
| | | | | | | | | | | | | | | | | | | | |
As of June 30, 2018 | Unrealized Holding Losses | | Unrealized Holding Losses | | Unrealized Holding Losses |
(In Thousands) | Less Than 12 Months | | 12 Months or More | | Total |
| Fair | Unrealized | | Fair | Unrealized | | Fair | Unrealized |
Description of Securities | Value | Losses | | Value | Losses | | Value | Losses |
| | | | | | | | |
U.S. government sponsored enterprise MBS | $ | 47,045 |
| $ | 762 |
| | $ | — |
| $ | — |
| | $ | 47,045 |
| $ | 762 |
|
U.S. SBA securities | $ | 2,964 |
| $ | 15 |
| | $ | — |
| $ | — |
| | $ | 2,964 |
| $ | 15 |
|
Total | $ | 50,009 |
| $ | 777 |
| | $ | — |
| $ | — |
|
| $ | 50,009 |
| $ | 777 |
|
|
| | | | | | | | | | | | | | | | | | | | |
As of June 30, 2017 | Unrealized Holding Losses | | Unrealized Holding Losses | | Unrealized Holding Losses |
(In Thousands) | Less Than 12 Months | | 12 Months or More | | Total |
| Fair | Unrealized | | Fair | Unrealized | | Fair | Unrealized |
Description of Securities | Value | Losses | | Value | Losses | | Value | Losses |
| | | | | | | | |
U.S. government sponsored enterprise MBS | $ | 28,722 |
| $ | 77 |
| | $ | — |
| $ | — |
| | $ | 28,722 |
| $ | 77 |
|
Total | $ | 28,722 |
| $ | 77 |
| | $ | — |
| $ | — |
| | $ | 28,722 |
| $ | 77 |
|
As of June 30, 2020 | Unrealized Holding Losses | | Unrealized Holding Losses | | Unrealized Holding Losses |
(In Thousands) | Less Than 12 Months | | 12 Months or More | | Total |
| Fair | Unrealized | | Fair | Unrealized | | Fair | Unrealized |
Description of Securities | Value | Losses | | Value | Losses | | Value | Losses |
Held to maturity | | | | | | | | |
U.S. government sponsored enterprise MBS | $ | 12,731 | | $ | 45 | | | $ | — | | $ | — | | | $ | 12,731 | | $ | 45 | |
U.S. SBA securities | | — | | $ | — | | | | 2,040 | | | 17 | | | | 2,040 | | | 17 | |
Total investment securities – held to maturity | $ | 12,731 | | $ | 45 | | | $ | 2,040 | | $ | 17 | | | $ | 14,771 | | $ | 62 | |
| | | | | | | | | | | | | | | | | | | | |
Available for sale | | | | | | | | | | | | | | | | | | | | |
Private issue CMO | $ | 197 | | $ | 7 | | | $ | — | | $ | — | | | $ | 197 | | $ | 7 | |
Total investment securities – available for sale | $ | 197 | | $ | 7 | | | $ | — | | $ | — | | | $ | 197 | | $ | 7 | |
Total investment securities | $ | 12,928 | | $ | 52 | | | $ | 2,040 | | $ | 17 | | | $ | 14,968 | | $ | 69 | |
103
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 20182020
As of June 30, 2019 | Unrealized Holding Losses | | Unrealized Holding Losses | | Unrealized Holding Losses |
(In Thousands) | Less Than 12 Months | | 12 Months or More | | Total |
| Fair | Unrealized | | Fair | Unrealized | | Fair | Unrealized |
Description of Securities | Value | Losses | | Value | Losses | | Value | Losses |
Held to maturity | | | | | | | | |
U.S. government sponsored enterprise MBS | $ | 6,507 | | $ | 8 | | | $ | 1,657 | | $ | 6 | | | $ | 8,164 | | $ | 14 | |
U.S. SBA securities | | — | | $ | — | | | | 2,883 | | | 6 | | | | 2,883 | | | 6 | |
Total investment securities – held to maturity | $ | 6,507 | | $ | 8 | | | $ | 4,540 | | $ | 12 | | | $ | 11,047 | | $ | 20 | |
| | | | | | | | | | | | | | | | | | | | |
Available for sale | | | | | | | | | | | | | | | | | | | | |
U.S. government agency MBS | $ | 289 | | $ | 1 | | | $ | — | | $ | — | | | $ | 289 | | $ | 1 | |
Total investment securities – available for sale | $ | 289 | | $ | 1 | | | $ | — | | $ | — | | | $ | 289 | | $ | 1 | |
Total investment securities | $ | 6,796 | | $ | 9 | | | $ | 4,540 | | $ | 12 | | | $ | 11,336 | | $ | 21 | |
As of June 30, 2018 and 2017,2020, the Corporation had investment securities with unrealized holding losses of $52,000 that were less than 12 months and $17,000 that were in an unrealized loss position for more than 12 months, as compared to investment securities at June 30, 2019 with unrealized holding losses of $9,000 that were less than 12 months and $12,000 that were in an unrealized loss position for more than 12 months. The unrealized loss at June 30, 20182020 was attributable to 13two U.S. government sponsored enterprise MBS, one U.S. SBA security and three private issue CMOs and, based on the nature of the investments, management concluded that such unrealized losses were not other than temporary. The unrealized loss at June 30, 2019 was attributable to one U.S. government agency MBS, three U.S. government sponsored enterprise MBS and one U.S. SBA security, and based on the nature of the investment,investments, management concluded that such unrealized loss was not other than temporary; while the unrealized loss at June 30, 2017 was attributable to five U.S. government sponsored enterprise MBS and, based on the nature of the investment, management concluded that such unrealized loss waslosses were not other than temporary. The Corporation does not believe that there was any OTTI at June 30, 20182020 and 2017.2019. At each of these dates, the Corporation intended and had the ability to hold the investment securities and was not likely to be required to sell the securities before realizing a full recovery.
Contractual maturities of investment securities as of June 30, 20182020 and 20172019 were as follows:
104
|
| | | | | | | | | | | | | |
| June 30, 2018 | | June 30, 2017 |
(In Thousands) | Amortized Cost | Estimated Fair Value | | Amortized Cost | Estimated Fair Value |
Held to maturity | | | | | |
Due in one year or less | $ | 600 |
| $ | 600 |
| | $ | 600 |
| $ | 600 |
|
Due after one through five years | 24,961 |
| 24,569 |
| | 4,698 |
| 4,708 |
|
Due after five through ten years | 22,847 |
| 22,477 |
| | 41,404 |
| 41,374 |
|
Due after ten years | 39,405 |
| 39,593 |
| | 13,739 |
| 13,947 |
|
Total investment securities - held to maturity | $ | 87,813 |
| $ | 87,239 |
| | $ | 60,441 |
| $ | 60,629 |
|
| | | | | |
Available for sale | | | | | |
Due in one year or less | $ | — |
| $ | — |
| | $ | — |
| $ | — |
|
Due after one through five years | — |
| — |
| | — |
| — |
|
Due after five through ten years | — |
| — |
| | — |
| — |
|
Due after ten years | 7,220 |
| 7,496 |
| | 8,954 |
| 9,318 |
|
No stated maturity (common stock) | — |
| — |
|
| — |
| — |
|
Total investment securities - available for sale | $ | 7,220 |
| $ | 7,496 |
| | $ | 8,954 |
| $ | 9,318 |
|
Total investment securities | $ | 95,033 |
| $ | 94,735 |
| | $ | 69,395 |
| $ | 69,947 |
|
Provident Financial Holdings, Inc.
Notes to Consolidated Financial Statements
June 30, 20182020
The Corporation has developed an internal loan grading system to evaluate and quantify the Bank’s loans held for investment portfolio with respect to quality and risk. Management continually evaluates the credit quality of the Corporation’s loan portfolio
and conducts a quarterly review of the adequacy of the allowance for loan losses using quantitative and qualitative methods. The Corporation has adopted an internal risk rating policy in which each loan is rated for credit quality with a rating of pass, special mention, substandard, doubtful or loss. The two primary components that are used during the loan review process to determine the proper allowance levels are individually evaluated allowances and collectively evaluated allowances. Quantitative loan loss factors are developed by determining the historical loss experience, expected future cash flows, discount rates and collateral fair values, among others. Qualitative loan loss factors are developed by assessing general economic indicators such as Gross Domestic Product, Retail Sales, Unemployment Rates, Employment Growth, California Home Sales and Median California Home Prices, among others. The Corporation assigns individual factors for the quantitative and qualitative methods for each loan category and each internal risk rating.
The Corporation categorizes all of the loans held for investment into risk categories based on relevant information about the ability of the borrower to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. A description of the general characteristics of the risk grades is as follows: