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EX-31.1 - EXHIBIT 31.1 - PROVIDENT FINANCIAL HOLDINGS INCex31193011.htm
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

[  Ö ]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the quarterly period ended                                                                                                              September 30, 2011

[     ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the transition period from ________________ to _________________
 
 
Commission File Number 000-28304

PROVIDENT FINANCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
 
Delaware                                  
 
     33-0704889
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 

3756 Central Avenue, Riverside, California 92506
(Address of principal executive offices and zip code)

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes            ü  .                      No                  .

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 
   Large accelerated filer [ ]
Accelerated filer [ü ]
 
   Non-accelerated filer [ ]
Smaller reporting company [ ]
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes      .     No  ü  .

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
 
Title of class:
 
As of November 4, 2011
     
Common stock, $ 0.01 par value, per share
 
11,409,264 shares
 

 
 


 
 

 

PROVIDENT FINANCIAL HOLDINGS, INC.

Table of Contents

PART 1  -
FINANCIAL INFORMATION
 
       
  ITEM 1  -
Financial Statements.  The Unaudited Interim Condensed Consolidated Financial Statements of Provident Financial Holdings, Inc. filed as a part of the report are as follows:
 
     
Page
 
Condensed Consolidated Statements of Financial Condition
 
   
as of September 30, 2011 and June 30, 2011
1
 
Condensed Consolidated Statements of Operations
 
   
for the Quarters Ended September 30, 2011 and 2010
2
 
Condensed Consolidated Statements of Stockholders’ Equity
 
   
for the Quarters Ended September 30, 2011 and 2010
3
 
Condensed Consolidated Statements of Cash Flows
 
   
for the Three Months Ended September 30, 2011 and 2010
4
 
Notes to Unaudited Interim Condensed Consolidated Financial Statements
5
       
  ITEM 2  -
Management’s Discussion and Analysis of Financial Condition and Results of
 
   
Operations:
 
       
 
General
  25
 
Safe-Harbor Statement
   26
 
Critical Accounting Policies
27
 
Executive Summary and Operating Strategy
29
 
Off-Balance Sheet Financing Arrangements and Contractual Obligations
30
 
Comparison of Financial Condition at September 30, 2011 and June 30, 2011
30
 
Comparison of Operating Results
 
   
for the Quarters Ended September 30, 2011 and 2010
32
 
Asset Quality
37
 
Loan Volume Activities
45
 
Liquidity and Capital Resources
45
 
Commitments and Derivative Financial Instruments
47
 
Supplemental Information
48
       
  ITEM 3  -
Quantitative and Qualitative Disclosures about Market Risk
48
       
  ITEM 4  -
Controls and Procedures
50
       
PART II  -
OTHER INFORMATION
 
       
  ITEM 1  -
Legal Proceedings
50
  ITEM 1A -
Risk Factors
50
  ITEM 2  -
Unregistered Sales of Equity Securities and Use of Proceeds
51
  ITEM 3  -
Defaults Upon Senior Securiti
51
  ITEM 4  -
(Removed and Reserved)
51
  ITEM 5  -
Other Information
51
  ITEM 6  -
Exhibits
51
       
SIGNATURES
53
   


 
 

 

PROVIDENT FINANCIAL HOLDINGS, INC.
Condensed Consolidated Statements of Financial Condition
(Unaudited)
In Thousands, Except Share Information

   
September 30,
   
June 30,
 
   
2011
   
2011
 
Assets
           
     Cash and cash equivalents
  $ 80,156     $ 142,550  
     Investment securities – available for sale, at fair value
    25,253       26,193  
     Loans held for investment, net of allowance for loan losses of
               
          $28,704 and $30,482, respectively
    859,649       881,610  
     Loans held for sale, at fair value
    278,212       191,678  
     Accrued interest receivable
    3,480       3,778  
     Real estate owned, net
    7,300       8,329  
     Federal Home Loan Bank (“FHLB”) – San Francisco stock
    25,777       26,976  
     Premises and equipment, net
    4,941       4,805  
     Prepaid expenses and other assets
    35,100       28,630  
                 
               Total assets
  $ 1,319,868     $ 1,314,549  
                 
Liabilities and Stockholders’ Equity
               
                 
Commitments and Contingencies
               
                 
Liabilities:
               
     Non interest-bearing deposits
  $ 46,044     $ 45,437  
     Interest-bearing deposits
    915,832       900,330  
               Total deposits
    961,876       945,767  
                 
     Borrowings
    186,586       206,598  
     Accounts payable, accrued interest and other liabilities
    27,810       20,441  
               Total liabilities
    1,176,272       1,172,806  
                 
Stockholders’ equity:
               
     Preferred stock, $.01 par value (2,000,000 shares authorized;
          none issued and outstanding)
               
    -       -  
     Common stock, $.01 par value (40,000,000 shares authorized;
          17,610,865 shares issued; 11,439,264 and 11,418,654 shares
           outstanding, respectively)
               
               
    176       176  
     Additional paid-in capital
    86,021       85,432  
     Retained earnings
    150,120       148,147  
     Treasury stock at cost (6,171,601 and 6,192,211 shares,
          respectively)
               
    (93,316 )     (92,650 )
     Accumulated other comprehensive income, net of tax
    595       638  
                 
               Total stockholders’ equity
    143,596       141,743  
                 
               Total liabilities and stockholders’ equity
  $ 1,319,868     $ 1,314,549  

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

 
1

 


PROVIDENT FINANCIAL HOLDINGS, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
In Thousands, Except Per Share Information
 
 
Quarter Ended
 
September 30,
September 30,
 
2011
2010
Interest income:
       
     Loans receivable, net
$ 12,749
 
$ 15,561
 
     Investment securities
147
 
241
 
     FHLB – San Francisco stock
18
 
36
 
     Interest-earning deposits
97
 
65
 
     Total interest income
13,011
 
15,903
 
         
Interest expense:
       
     Checking and money market deposits
200
 
305
 
     Savings deposits
225
 
340
 
     Time deposits
1,906
 
2,184
 
     Borrowings
1,882
 
3,262
 
     Total interest expense
4,213
 
6,091
 
         
Net interest income, before provision for loan losses
8,798
 
9,812
 
Provision for loan losses
972
 
877
 
Net interest income, after provision for loan losses
7,826
 
8,935
 
         
Non-interest income:
       
     Loan servicing and other fees
132
 
124
 
     Gain on sale of loans, net
7,276
 
9,447
 
     Deposit account fees
603
 
629
 
     Gain (loss) on sale and operations of real estate owned
         acquired in the settlement of loans, net
 
32
 
 
(368
 
)
     Card and processing fees
331
 
316
 
     Other
174
 
187
 
     Total non-interest income
8,548
 
10,335
 
         
Non-interest expense:
       
     Salaries and employee benefits
8,854
 
7,377
 
     Premises and occupancy
872
 
820
 
     Equipment
314
 
325
 
     Professional expenses
433
 
383
 
     Sales and marketing expenses
199
 
134
 
     Deposit insurance premiums and regulatory assessments
171
 
681
 
     Other
1,460
 
1,490
 
     Total non-interest expense
12,303
 
11,210
 
         
Income before income taxes
4,071
 
8,060
 
Provision for income taxes
1,753
 
3,531
 
     Net income
$   2,318
 
$   4,529
 
         
Basic earnings per share
$ 0.20
 
$ 0.40
 
Diluted earnings per share
$ 0.20
 
$ 0.40
 
Cash dividends per share
$ 0.03
 
$ 0.01
 

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

 
2

 

PROVIDENT FINANCIAL HOLDINGS, INC.
Condensed Consolidated Statements of Stockholders' Equity
(Unaudited)
In Thousands, Except Share Information
For the Quarters Ended September 30, 2011 and 2010


 
 
 
Common
Stock
 
 
Additional
Paid-In
 
 
 
Retained
 
 
 
Treasury
 
 
Unearned
Stock
Accumulated
Other
Comprehensive
Income,
 
 
Shares
 
Amount
Capital
Earnings
Stock
Compensation
Net of Tax
Total
Balance at July 1, 2011
11,418,654
 
$ 176
$ 85,432
 
$ 148,147
 
$ (92,650
)
$ -
 
$ 638
 
$ 141,743
 
                               
Comprehensive income:
                             
   Net income
         
2,318
             
2,318
 
   Change in unrealized holding loss on
      securities available for sale, net of
      reclassification of $0 of  net gain
      included in net income and net of
      tax benefit of $(31)
                     
 
 
 
 
(43
 
 
 
 
)
 
 
 
 
(43
 
 
 
 
)
Total comprehensive income
                         
2,275
 
                           
-
 
Purchase of treasury stock (1)
(79,690
)
         
(666
)
       
(666
)
Distribution of restricted stock
100,300
                       
-
 
Amortization of restricted stock
     
302
                 
302
 
Stock options expense
     
287
                 
287
 
Cash dividends
         
(345
)
           
(345
)
                               
Balance at September 30, 2011
11,439,264
 
$ 176
$ 86,021
 
$ 150,120
 
$ (93,316
)
$ -
 
$ 595
 
$ 143,596
 

     (1) Includes the repurchase of 11,523 shares of distributed restricted stock.


 
 
 
Common
Stock
 
 
Additional
Paid-In
 
 
 
Retained
 
 
 
Treasury
 
 
Unearned
Stock
Accumulated
Other
Comprehensive
Income,
 
 
Shares
 
Amount
Capital
Earnings
Stock
Compensation
Net of Tax
Total
Balance at July 1, 2010
11,406,654
 
$ 176
$ 85,663
 
$ 135,383
 
$ (93,942
)
$ (203
)
$ 667
 
$ 127,744
 
                               
Comprehensive income:
                             
   Net income
         
4,529
             
4,529
 
   Change in unrealized holding loss on
      investment securities available for
      sale, net of reclassification of
      $0 of net gain included in net
      income and net of tax benefit
      of $(9)
                     
 
 
 
 
 
(13
 
 
 
 
 
)
 
 
 
 
 
(13
 
 
 
 
 
)
Total comprehensive income
                         
4,516
 
                               
Distribution of restricted stock
800
                           
Amortization of restricted stock
     
103
                 
103
 
Stock options expense
     
135
                 
135
 
Allocations of contribution to ESOP (1)
     
17
         
68
     
85
 
Cash dividends
         
(114
)
           
(114
)
                               
Balance at September 30, 2010
11,407,454
 
$ 176
$ 85,918
 
$ 139,798
 
$ (93,942
)
$ (135
)
$ 654
 
$ 132,469
 

(1)  
Employee Stock Ownership Plan (“ESOP”).

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

 
3

 

PROVIDENT FINANCIAL HOLDINGS, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited - In Thousands)
 
Three Months Ended
September 30,
 
 
 
2011
   
2010
 
Cash flows from operating activities:
         
   Net income
$      2,318
   
$      4,529
 
   Adjustments to reconcile net income to net cash used for
         
    operating activities:
         
       Depreciation and amortization
452
   
360
 
       Provision for loan losses
972
   
877
 
       Provision for losses on real estate owned
105
   
230
 
       Gain on sale of loans, net
(7,276
)
 
(9,447
)
       Gain on sale of real estate owned, net
(361
)
 
(391
)
       Stock-based compensation
589
   
238
 
       ESOP expense
-
   
84
 
       Decrease in current and deferred income taxes
1,721
   
3,422
 
       Increase in cash surrender value of the bank owned life insurance
(48
)
 
(51
)
   Increase in accounts payable and other liabilities
1,751
   
1,454
 
   (Increase) decrease in prepaid expenses and other assets
(2,095
)
 
780
 
   Loans originated for sale
(568,060
)
 
(649,471
)
   Proceeds from sale of loans
488,657
   
596,493
 
Net cash used for operating activities
(81,275
)
 
(50,893
)
           
Cash flows from investing activities:
         
   Decrease in loans held for investment, net
17,234
   
26,185
 
   Principal payments from investment securities available for sale
898
   
2,022
 
   Redemption of FHLB – San Francisco stock
1,199
   
1,224
 
   Proceeds from sale of real estate owned
4,793
   
8,626
 
   Purchase of premises and equipment
(329
)
 
(125
)
Net cash provided by investing activities
23,795
   
37,932
 
           
Cash flows from financing activities:
         
   Increase (decrease) in deposits, net
16,109
   
(685
)
   Repayments of long-term borrowings
(20,012
)
 
(15,012
)
   ESOP loan payment
-
   
1
 
   Cash dividends
(345
)
 
(114
)
   Treasury stock purchases
(666
)
 
-
 
Net cash used for financing activities
(4,914
)
 
(15,810
)
           
Net decrease in cash and cash equivalents
(62,394
)
 
(28,771
)
Cash and cash equivalents at beginning of period
142,550
   
96,201
 
Cash and cash equivalents at end of period
$    80,156
   
$    67,430
 
Supplemental information:
         
  Cash paid for interest
$ 4,301
   
$   6,134
 
  Cash paid for income taxes
$         -
   
$      100
 
  Transfer of loans held for sale to held for investment
$    856
   
$           -
 
  Real estate acquired in the settlement of loans
$ 5,682
   
$ 14,975
 

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

 
4

 


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

September 30, 2011


Note 1: Basis of Presentation

The unaudited interim condensed consolidated financial statements included herein reflect all adjustments which are, in the opinion of management, necessary to present a fair statement of the results of operations for the interim periods presented.  All such adjustments are of a normal, recurring nature.  The condensed consolidated statements of financial condition at June 30, 2011 are derived from the audited consolidated financial statements of Provident Financial Holdings, Inc. and its wholly-owned subsidiary, Provident Savings Bank, F.S.B. (the “Bank”) (collectively, the “Corporation”).  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) with respect to interim financial reporting.  It is recommended that these unaudited interim condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended June 30, 2011.  The results of operations for the quarter ended September 30, 2011 are not necessarily indicative of results that may be expected for the entire fiscal year ending June 30, 2012.


Note 2: Accounting Standard Updates (“ASU”)

ASU 2010-06:
In January 2010, the Financial Accounting Standards Board (“FASB”) issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements.” ASU 2010-06 requires additional disclosures about fair value measurements including transfers in and out of Levels 1 and 2 and a higher level of disaggregation for the different types of financial instruments.  For the reconciliation of Level 3 fair value measurements, information about purchases, sales, issuances and settlements should be presented separately.  This ASU was effective for annual and interim reporting periods beginning after December 15, 2009 for most of the disclosures and for periods beginning after December 15, 2010 for the new Level 3 disclosures. Comparative disclosures are not required in the first year the disclosures are required.  The Corporation’s adoption of this ASU did not have a material effect on its consolidated financial statements.

ASU 2011-02:
In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.”  This ASU provides additional guidance for creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring.  The provisions of this standard are effective for the first interim or annual period beginning on or after June 15, 2011.  The Corporation’s adoption of this ASU did not have a material effect on its consolidated financial statements.

ASU 2011-03:
In April 2011, the FASB issued ASU No. 2011-03, “Reconsideration of Effective Control for Repurchase Agreements.”  The update amends existing guidance to remove from the assessment of effective control, the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and, as well, the collateral maintenance implementation guidance related to that criterion.  ASU No. 2011-03 is effective for the Corporation’s reporting period beginning on or after December 15, 2011. The guidance applies prospectively to transactions or modification of existing transactions that occur on or after the effective date and early adoption is not permitted.  The Corporation has not determined the impact of this ASU on the Corporation’s consolidated financial statements.

ASU 2011-04:
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 developed common requirements between U.S. GAAP and IFRSs for measuring fair value and for disclosing
 
 
 
5

 
 
 
information about fair value measurements.  The effective date of ASU 2011-04 will be during interim or annual period beginning after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date.  Early adoption is not permitted.  The Corporation has not determined the impact of this ASU on the Corporation’s consolidated financial statements.

ASU 2011-05:
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.”  ASU 2011-05 attempts to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income.  The effective date of ASU 2011-05 will be the first interim or fiscal period beginning after December 15, 2011 and should be applied retrospectively to transactions or modifications of existing transactions that occur on or after the effective date.  Early adoption is permitted.  The Corporation has not determined the impact of this ASU on the Corporation’s consolidated financial statements.


Note 3: Earnings Per Share

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

As of September 30, 2011 and 2010, there were outstanding options to purchase 1,249,700 shares and 905,200 shares of the Corporation’s common stock, respectively, of which 656,700 shares and 905,200 shares, respectively, were excluded from the diluted EPS computation as their effect was anti-dilutive.

The following table provides the basic and diluted EPS computations for the quarters ended September 30, 2011 and 2010, respectively.

       
 
(In Thousands, Except Share Information)
 
For the Quarter
Ended
September 30,
 
   
2011
   
2010
 
Numerator:
           
Net income – numerator for basic earnings
         per share and diluted earnings per share -
         available to common stockholders
  $ 2,318     $ 4,529  
                 
Denominator:
               
     Denominator for basic earnings per share:
         Weighted-average shares
               
    11,468       11,362  
                 
     Effect of dilutive securities:
               
         Restricted stock dilution
    47       -  
                 
     Denominator for diluted earnings per share:
               
         Adjusted weighted-average shares and assumed
             conversions
    11,515       11,362  
                 
Basic earnings per share
  $ 0.20     $ 0.40  
Diluted earnings per share
  $ 0.20     $ 0.40  


 
6

 

Note 4: Operating Segment Reports

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

The following tables set forth condensed consolidated statements of operations and total assets for the Corporation’s operating segments for the quarters ended September 30, 2011 and 2010, respectively (in thousands).


 
For the Quarter Ended September 30, 2011
   
Provident
 
 
Provident
Bank
Consolidated
 
Bank
Mortgage
Totals
Net interest income, before provision for loan losses
$        7,558
 
$     1,240
 
$        8,798
 
Provision for loan losses
709
 
263
 
972
 
Net interest income, after provision for loan losses
6,849
 
977
 
7,826
 
             
Non-interest income:
           
     Loan servicing and other fees
119
 
13
 
132
 
     Gain on sale of loans, net
7
 
7,269
 
7,276
 
     Deposit account fees
603
 
-
 
603
 
     (Loss) gain on sale and operations of real estate
        owned acquired in the settlement of loans, net
 
(32
 
)
 
64
 
 
32
 
     Card and processing fees
331
 
-
 
331
 
     Other
174
 
-
 
174
 
          Total non-interest income
1,202
 
7,346
 
8,548
 
             
Non-interest expense:
           
     Salaries and employee benefits
4,189
 
4,665
 
8,854
 
     Premises and occupancy
597
 
275
 
872
 
     Operating and administrative expenses
940
 
1,637
 
2,577
 
          Total non-interest expense
5,726
 
6,577
 
12,303
 
Income before income taxes
2,325
 
1,746
 
4,071
 
Provision for income taxes
1,019
 
734
 
1,753
 
Net income
$        1,306
 
$     1,012
 
$        2,318
 
Total assets, end of period
$ 1,049,345
 
$ 270,523
 
$ 1,319,868
 

 
7

 



 
For the Quarter Ended September 30, 2010
   
Provident
 
 
Provident
Bank
Consolidated
 
Bank
Mortgage
Totals
Net interest income, before provision for loan losses
$ 8,705
 
$ 1,107
 
$  9,812
 
Provision for loan losses
516
 
361
 
877
 
Net interest income, after provision for loan losses
8,189
 
746
 
8,935
 
             
Non-interest income:
           
     Loan servicing and other fees
111
 
13
 
124
 
     (Loss) gain on sale of loans, net
(131
)
9,578
 
9,447
 
     Deposit account fees
629
 
-
 
629
 
     (Loss) gain on sale and operations of real estate
        Owned acquired in the settlement of loans, net
 
(377
 
)
 
9
 
 
(368
 
)
     Card and processing fess
316
 
-
 
316
 
     Other
186
 
1
 
187
 
          Total non-interest income
734
 
9,601
 
10,335
 
             
Non-interest expense:
           
     Salaries and employee benefits
3,199
 
4,178
 
7,377
 
     Premises and occupancy
610
 
210
 
820
 
     Operating and administrative expenses
1,626
 
1,387
 
3,013
 
          Total non-interest expense
5,435
 
5,775
 
11,210
 
Income before income taxes
3,488
 
4,572
 
8,060
 
Provision for income taxes
1,609
 
1,922
 
3,531
 
Net income
$ 1,879
 
$ 2,650
 
$  4,529
 
Total assets, end of period
$ 1,163,125
 
$ 226,042
 
$ 1,389,167
 


Note 5: Investment Securities

The amortized cost and estimated fair value of investment securities as of September 30, 2011 and June 30, 2011 were as follows:

 
 
September 30, 2011
 
Amortized
Cost
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Estimated
Fair
Value
 
Carrying
Value
(In Thousands)
                 
Available for sale
                 
 
U.S. government agency MBS (1)
$ 13,405
 
$ 480
 
$     -
 
$ 13,885
 
$ 13,885
 
U.S. government sponsored
  enterprise MBS
 
9,626
 
 
454
 
 
-
 
 
10,080
 
 
10,080
 
Private issue CMO (2)
1,359
 
-
 
(71
)
1,288
 
1,288
Total investment securities
$ 24,390
 
$ 934
 
$ (71
)
$ 25,253
 
$ 25,253

(1)  
Mortgage-backed securities (“MBS”).
(2)  
Collateralized Mortgage Obligations (“CMO”).


 
8

 


 
 
June 30, 2011
 
Amortized
Cost
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Estimated
Fair
Value
 
Carrying
Value
(In Thousands)
                 
Available for sale
                 
 
U.S. government agency MBS
$ 13,935
 
$ 474
 
$     -
 
$ 14,409
 
$ 14,409
 
U.S. government sponsored
  enterprise MBS
 
9,960
 
 
457
 
 
-
 
 
10,417
 
 
10,417
 
Private issue CMO
1,396
 
-
 
(29
)
1,367
 
1,367
Total investment securities
$ 25,291
 
$ 931
 
$ (29
)
$ 26,193
 
$ 26,193

In the first quarter of fiscal 2012 and 2011, the Bank received MBS principal payments of $898,000 and $2.0 million, respectively, and did not purchase or sell investment securities.  The Bank evaluates individual investment securities quarterly for other-than-temporary declines in market value.  The Bank does not believe that there are any other-than-temporary impairments at September 30, 2011 or June 30, 2011; therefore, no impairment losses have been recorded for the quarter ended September 30, 2011.
 
Contractual maturities of investment securities as of September 30, 2011 and June 30, 2011 were as follows:
 
   
September 30, 2011
   
June 30, 2011
 
         
Estimated
         
Estimated
 
   
Amortized
   
Fair
   
Amortized
   
Fair
 
(In Thousands)   
Cost
   
Value
   
Cost
   
Value
 
Available for sale
                       
Due in one year or less
  $ -     $ -     $ -     $ -  
Due after one through five years
    -       -       -       -  
Due after five through ten years
    -       -       -       -  
Due after ten years
    24,390       25,253       25,291       26,193  
Total investment securities
  $ 24,390     $ 25,253     $ 25,291     $ 26,193  


Note 6: Loans Held for Investment
 
Loans held for investment consisted of the following:
 
(In Thousands)    
September 30,
2011
   
June 30,
2011
 
             
Mortgage loans:
           
Single-family
  $ 480,530     $ 494,192  
Multi-family
    298,072       304,808  
Commercial real estate
    100,863       103,637  
Other
    1,528       1,530  
Commercial business loans
    4,267       4,526  
Consumer loans
    748       750  
Total loans held for investment, gross
    886,008       909,443  
                 
Deferred loan costs, net
    2,345       2,649  
Allowance for loan losses
    (28,704 )     (30,482 )
Total loans held for investment, net
  $ 859,649     $ 881,610  

As of September 30, 2011, the Bank had $48.4 million in mortgage loans that are subject to negative amortization, consisting of $29.6 million in multi-family loans, $11.3 million in commercial real estate loans and $7.5 million in single-family loans.  This compares to $50.4 million of negative amortization mortgage loans at June 30, 2011, consisting of $31.3 million in multi-family loans, $11.5 million in commercial real estate loans and $7.6 million in single-family loans.  The amount of negative amortization included in loan balances decreased to $339,000 at September 30, 2011 from $353,000 at June 30, 2011.  During the first quarter of fiscal 2012, approximately $13,000,
 
 
 
 
9

 
or 0.10%, of loan interest income was added to the negative amortization loan balance, down from $17,000, or 0.11% in the comparable quarter of fiscal 2010.  Negative amortization involves a greater risk to the Bank because the loan principal balance may increase by a range of 110% to 115% of the original loan amount during the period of negative amortization and because the loan payment may increase beyond the means of the borrower when loan principal amortization is required.  Also, the Bank has originated interest-only ARM loans, which typically have a fixed interest rate for the first two to five years coupled with an interest only payment, followed by a periodic adjustable rate and a fully amortizing loan payment.  As of September 30, 2011 and June 30, 2011, the interest-only ARM loans were $238.2 million and $247.8 million, or 26.8% and 27.2% of loans held for investment, respectively.

The following table sets forth information at September 30, 2011 regarding the dollar amount of loans held for investment that are contractually repricing during the periods indicated, segregated between adjustable rate loans and fixed rate loans.  Fixed-rate loans comprised 5% of loans held for investment at September 30, 2011, unchanged from June 30, 2011.  Adjustable rate loans having no stated repricing dates but reprice when the index they are tied to reprices (e.g. prime rate index) and checking account overdrafts are reported as repricing within one year.  The table does not include any estimate of prepayments which may cause the Bank’s actual repricing experience to differ materially from that shown below.

   
Adjustable Rate
   
     
After
After
After
   
     
One Year
3 Years
5 Years
   
   
Within
Through
Through
Through
Fixed
 
(In Thousands)
One Year
3 Years
5 Years
10 Years
Rate
Total
             
Mortgage loans:
           
 
Single-family
 $ 421,929
 $ 46,365
 $   5,678
 $      746
$   5,812
 $ 480,530
 
Multi-family
207,440
38,072
 14,090
 23,838
14,632
298,072
 
Commercial real estate
64,976
10,655
2,695
 4,721
17,816
100,863
 
Other
1,292
 -
 -
 -
236
1,528
Commercial business loans
2,118
 -
 -
 -
2,149
4,267
Consumer loans
703
 -
 -
 -
45
748
 
Total loans held for investment, gross
 $ 698,458
 $ 95,092
 $ 22,463
 $ 29,305
$ 40,690
$ 886,008

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


 
10

 
The following tables summarize the Corporation’s allowance for loan losses at September 30, 2011 and June 30, 2011:

(In Thousands)
September 30, 2011
 
June 30,  2011
       
General loan loss allowance:
     
 
Mortgage loans:
     
   
Single-family
$ 11,157
 
$ 11,561
   
Multi-family
2,823
 
2,810
   
Commercial real estate
1,754
 
1,796
   
Other
5
 
5
 
Commercial business loans
177
 
178
 
Consumer loans
15
 
16
   
Total general loan loss allowance
15,931
 
16,366
         
Specific loan loss allowance:
     
 
Mortgage loans:
     
   
Single-family
11,267
 
12,654
   
Multi-family
607
 
581
   
Commercial real estate
236
 
231
   
Other
320
 
321
 
Commercial business loans
325
 
329
 
Consumer loans
18
 
-
   
Total specific loan loss allowance
12,773
 
14,116
Total loan loss allowance
$ 28,704
 
$ 30,482


 
11

 

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

   
Three Months Ended
 
   
September 30,
 
(Dollars in Thousands)
 
2011
   
2010
 
             
Allowance at beginning of period
  $ 30,482     $ 43,501  
                 
Provision for loan losses
    972       877  
                 
Recoveries:
               
Mortgage loans:
               
Single-family
    113       1  
       Total recoveries
    113       1  
                 
Charge-offs:
               
Mortgage loans:
               
Single-family
    (2,861 )     (5,291 )
Consumer loans
    (2 )     (2 )
     Total charge-offs
    (2,863 )     (5,293 )
                 
     Net charge-offs
    (2,750 )     (5,292 )
          Allowance at end of period
  $ 28,704     $ 39,086  
                 
Allowance for loan losses as a percentage of gross loans held for
     investment
               
    3.23 %     3.88 %
                 
Net charge-offs as a percentage of average loans receivable, net,
     during the period
               
    1.04 %     1.82 %
                 
Allowance for loan losses as a percentage of gross non-performing
     loans at the end of the period
               
    57.61 %     55.28 %


 
12

 



The following tables identify the Corporation’s total recorded investment in non-performing loans by type, net of specific allowances for loan losses, at September 30, 2011 and June 30, 2011:

 
 
 
 
(In Thousands)
September 30, 2011
 
 
Recorded
Investment
Specific
Allowance
For Loan
Losses
 
 
Net
Investment
           
Mortgage loans:
         
 
Single-family:
         
   
With a related allowance
 $ 41,508
 
 $ (11,267
)
 $ 30,241
   
Without a related allowance
1,313
 
-
 
 1,313
 
Total single-family loans
42,821
 
 (11,267
)
31,554
 
 
Multi-family:
         
   
With a related allowance
2,534
 
 (607
)
 1,927
 
Total multi-family loans
2,534
 
(607
)
1,927
           
 
Commercial real estate:
         
   
With a related allowance
2,447
 
 (236
)
 2,211
   
    Without a related allowance
388
 
-
 
388
 
Total commercial real estate loans
2,835
 
(236
)
2,599
           
 
Other:
         
   
    With a related allowance
1,292
 
(320
)
972
 
Total other loans
1,292
 
(320
)
972
           
Commercial business loans:
         
   
   With a related allowance
328
 
(325
)
3
 
Total commercial business loans
328
 
 (325
)
3
           
Consumer loans:
         
   
   With a related allowance
18
 
(18
)
-
 
Total consumer loans
18
 
 (18
)
-
Total non-performing loans
 $ 49,828
 
 $ (12,773
)
 $ 37,055


 
13

 


 
 
 
 
(In Thousands)
June 30, 2011
 
 
Recorded
Investment
Specific
Allowance
For Loan
Losses
 
 
Net
Investment
           
Mortgage loans:
         
 
Single-family:
         
   
With a related allowance
$ 42,958
 
 $ (12,655
)
$ 30,303
   
Without a related allowance
1,535
 
-
 
1,535
 
Total single-family loans
44,493
 
 (12,655
)
31,838
 
 
Multi-family:
         
   
With a related allowance
2,534
 
 (581
)
1,953
 
Total multi-family loans
2,534
 
(581
)
1,953
           
 
Commercial real estate:
         
   
With a related allowance
2,451
 
 (231
)
2,220
 
Total commercial real estate loans
2,451
 
(231
)
2,220
           
 
Other:
         
   
    With a related allowance
1,292
 
(320
)
972
 
Total other loans
1,292
 
(320
)
972
           
Commercial business loans:
         
   
    With a related allowance
331
 
(329
)
2
   
    Without a related allowance
141
 
-
 
141
 
Total commercial business loans
472
 
 (329
)
143
Total non-performing loans
 $ 51,242
 
 $ (14,116
)
 $ 37,126

At September 30, 2011 and June 30, 2011, there were no commitments to lend additional funds to those borrowers whose loans were classified as impaired.

The following table describes the aging analysis (length of time on non-performing status) of non-performing loans, net of specific allowance for loan losses, as of September 30, 2011:

 
(In Thousands)
3 Months
or Less
Over 3 to
6 Months
Over 6 to
12 Months
Over 12
Months
 
Total
Mortgage loans:
         
 
Single-family
$   9,969
$ 7,605
$ 3,996
$   9,984
$ 31,554
 
Multi-family
-
-
-
1,927
1,927
 
Commercial real estate
388
918
1,293
-
2,599
 
Other
-
-
972
-
972
Commercial business loans
-
-
3
-
3
 
Total
$ 10,357
$ 8,523
$ 6,264
$ 11,911
$ 37,055

During the quarters ended September 30, 2011 and 2010, the Corporation’s average investment in non-performing loans was $36.6 million and $58.4 million, respectively.  Interest income of $1.5 million and $1.7 million was recognized, based on cash receipts, on non-performing loans during the quarters ended September 30, 2011 and 2010, respectively.  The Corporation records interest on non-performing loans utilizing the cash basis method of accounting during the periods when the loans are on non-performing status.  Foregone interest income, which would have been recorded had the non-performing loans been current in accordance with their original terms, amounted to $313,000 and $363,000 for the quarters ended September 30, 2011 and 2010, respectively, and was not included in the results of operations.

For the quarter ended September 30, 2011, twelve loans for $4.8 million were modified from their original terms, were re-underwritten and were identified in the Corporation’s asset quality reports as restructured loans. This
 
 
 
14

 
 
compares to 21 loans for $9.4 million that were re-underwritten and were identified in the Corporation’s asset quality reports as restructured loans during the quarter ended September 30, 2010.  During the quarter ended September 30, 2011, two restructured loans with a total loan balance of $771,000 were in default within a 12-month period subsequent to their original restructuring and required a $200,000 additional provision for loan losses.  This compares to one restructured loan with a total loan balance of $285,000 that was in default within a 12-month period subsequent to its original restructuring and required an additional provision for loan losses of $133,000 in the quarter ended September 30, 2010.  As of September 30, 2011, the net outstanding balance of the 87 restructured loans was $36.1 million:  26 were classified as pass and remain on accrual status ($11.6 million); eight were classified as special mention and remain on accrual status ($5.7 million); 52 were classified as substandard ($18.8 million total, with 47 of the 52 loans or $17.1 million on non-accrual status); and one loan was classified as a complete loss and is on non-accrual 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; 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 (which are sometimes referred to in this report as “preferred loans”) must also demonstrate a combination of the following 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 Bank.  The Bank re-underwrites the loan with the borrower’s updated financial information, new credit report, current loan balance, new interest rate, remaining loan term, updated property value and modified payment schedule, among other considerations, to determine if the borrower qualifies.

The following table summarizes at the dates indicated the restructured loans by loan types and non-accrual versus accrual status:

(In Thousands)
September 30, 2011
 
June 30, 2011
 
Restructured loans on non-accrual status:
       
 
Mortgage loans:
       
   
Single-family
$ 13,940
 
$ 15,133
 
   
Multi-family
490
 
490
 
   
Commercial real estate
1,660
 
1,660
 
   
Other
972
 
972
 
 
Commercial business loans
3
 
143
 
   
Total
17,065
 
18,398
 
           
Restructured loans on accrual status:
       
 
Mortgage loans:
       
   
Single-family
12,940
 
15,589
 
   
Multi-family
4,172
 
3,665
 
   
Commercial real estate
1,473
 
1,142
 
 
     Other
236
 
237
 
 
Commercial business loans
189
 
125
 
   
Total
19,010
 
20,758
 
   
Total restructured loans
$ 36,075
 
$ 39,156
 

 
15

 

The following table shows the restructured loans by type, net of specific valuation allowances for loan losses, at September 30, 2011 and June 30, 2011:

 
 
 
 
(In Thousands)
September 30, 2011
 
 
 
Recorded
Investment
Specific
Allowance
For Loan
Losses
 
 
Net
Investment
 
             
Mortgage loans:
           
 
Single-family:
           
   
With a related allowance
 $ 16,943
 
 $ (3,003
)
$ 13,940
 
   
Without a related allowance
12,940
 
-
 
 12,940
 
 
Total single-family loans
29,883
 
 (3,003
)
26,880
 
             
 
Multi-family:
           
   
With a related allowance
517
 
(27
)
490
 
   
Without a related allowance
4,172
 
-
 
 4,172
 
 
Total multi-family loans
4,689
 
(27
)
4,662
 
             
 
Commercial real estate:
           
   
With a related allowance
1,837
 
(177
)
1,660
 
   
Without a related allowance
1,473
 
-
 
1,473
 
 
Total commercial real estate loans
3,310
 
(177
)
3,133
 
             
 
Other:
           
   
With a related allowance
1,292
 
(320
)
972
 
   
Without a related allowance
236
 
-
 
236
 
 
Total other loans
1,528
 
(320
)
1,208
 
             
Commercial business loans:
           
   
With a related allowance
328
 
(325
)
3
 
   
Without a related allowance
189
 
-
 
189
 
 
Total commercial business loans
517
 
(325
)
192
 
Total restructured loans
 $ 39,927
 
 $ (3,852
)
$ 36,075 
 


 
16

 


 
 
 
 
(In Thousands)
June 30, 2011
 
 
Recorded
Investment
Specific
Allowance
For Loan
Losses
 
 
Net
Investment
           
Mortgage loans:
         
 
Single-family:
         
   
With a related allowance
$ 19,092
 
 $ (3,959
)
 $ 15,133
   
Without a related allowance
15,589
 
-
 
15,589
 
Total single-family loans
34,681
 
 (3,959
)
30,722
           
 
Multi-family:
         
   
With a related allowance
517
 
(27
)
490
   
Without a related allowance
3,665
 
-
 
3,665
 
Total multi-family loans
4,182
 
(27
)
4,155
           
 
Commercial real estate:
         
   
With a related allowance
1,837
 
(177
)
1,660
   
Without a related allowance
1,142
 
-
 
1,142
 
Total commercial real estate loans
2,979
 
(177
)
2,802
           
 
Other:
         
   
With a related allowance
1,293
 
(321
)
972
   
Without a related allowance
237
 
-
 
237
 
Total other loans
1,530
 
(321
)
1,209
           
Commercial business loans:
         
   
With a related allowance
53
 
(51
)
2
   
Without a related allowance
266
 
-
 
266
 
Total commercial business loans
319
 
(51
)
268
Total restructured loans
 $ 43,691
 
 $ (4,535
)
 $ 39,156 
   
During the quarter ended September 30, 2011, sixteen properties were acquired in the settlement of loans, while 18 previously foreclosed upon properties were sold.  As of September 30, 2011, real estate owned was comprised of 52 properties with a net fair value of $7.3 million, primarily located in Southern California.  This compares to 54 real estate owned properties, primarily located in Southern California, with a net fair value of $8.3 million at June 30, 2011.  A new appraisal was obtained on each of the properties at the time of foreclosure and fair value was calculated by using the lower of the appraised value or the listing price of the property, net of disposition costs.  Any initial loss was recorded as a charge to the allowance for loan losses before being transferred to real estate owned.  Subsequently, if there is further deterioration in real estate values, specific real estate owned loss reserves are established and charged to the statement of operations.  In addition, the Corporation reflects costs to carry real estate owned as real estate operating expenses as incurred.


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

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit in the form of originating loans or providing funds under existing lines of credit, loan sale commitments to third parties and option contracts.  These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the accompanying Condensed Consolidated Statements of Financial Condition.  The Corporation’s exposure to credit loss, in the event of non-performance by the counterparty to these financial instruments, is represented by the contractual amount of these instruments.  The Corporation uses the same credit policies in entering into financial instruments with off-balance sheet risk as it does for on-balance sheet instruments.  As of September 30, 2011 and June 30, 2011, the Corporation had commitments to extend credit (on loans to be held for investment and loans to be held for sale) of $188.6 million and $107.7 million, respectively.
 
 
 
17

 

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

 
September 30,
 
June 30,
Commitments
2011
 
2011
(In Thousands)
     
       
Undisbursed lines of credit – Mortgage loans
$ 1,002
 
$ 1,028
Undisbursed lines of credit – Commercial business loans
2,466
 
2,867
Undisbursed lines of credit – Consumer loans
913
 
956
Commitments to extend credit on loans to be held for investment
1,604
 
200
Total
$ 5,985
 
$ 5,051

In accordance with ASC 815, “Derivatives and Hedging,” and interpretations of the Derivatives Implementation Group of the FASB, the fair value of the commitments to extend credit on loans to be held for sale, loan sale commitments, commitments to sell MBS, put option contracts and call option contracts are recorded at fair value on the Condensed Consolidated Statements of Financial Condition.  At September 30, 2011, $3.6 million was included in other assets and $1.9 million was included in other liabilities; at June 30, 2011, $1.3 million is included in other assets and $0 was included in other liabilities.  The Corporation does not apply hedge accounting to its derivative financial instruments; therefore, all changes in fair value are recorded in earnings.

The net impact of derivative financial instruments on the Condensed Consolidated Statements of Operations during the quarters ended September 30, 2011 and 2010 was as follows:

 
 For the Quarters
Ended
September 30,
 
Derivative Financial Instruments
2011
 
2010
 
(In Thousands)
       
         
Commitments to extend credit on loans to be held for sale
$  2,824
 
$   (528
)
Mandatory loan sale commitments
(533
)
554
 
TBA(1) MBS trades
(1,939
)
2,641
 
Option contracts
(154
)
(25
)
Total
$     198
 
$ 2,642
 

(1) To be announced (“TBA”).

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

 
 September 30, 2011
 
 June 30, 2011
 
     
Fair
     
Fair
 
Derivative Financial Instruments
Amount
 
Value
 
Amount
 
Value
 
(In Thousands)
               
                 
Commitments to extend credit on loans
               
  to be held for sale (1)
$  186,953
 
$  3,462
 
$  107,458
 
$    638
 
Best efforts loan sale commitments
(14,558
)
-
 
(8,159
)
-
 
Mandatory loan sale commitments
(168,952
)
(130
)
(96,356
)
403
 
TBA MBS trades
(279,500
)
(1,763
)
(183,500
)
176
 
Put option contracts
(10,000
)
48
 
(13,000
)
99
 
Call option contracts
10,000
 
94
 
-
 
-
 
Total
$ (276,057
)
$  1,711
 
$ (193,557
)
$ 1,316
 

(1)  
Net of 38.6 percent at September 30, 2011 and 31.0 percent at June 30, 2011 of commitments, which management has estimated may not fund.


 
18

 
Note 8: Income Taxes

FASB ASC 740, “Income Taxes,” requires the affirmative evaluation that it is more likely than not, based on the technical merits of a tax position, that an enterprise is entitled to economic benefits resulting from positions taken in income tax returns.  If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements.  Management has determined that there are no unrecognized tax benefits to be reported in the Corporation’s financial statements, and none are anticipated during the fiscal year ending June 30, 2012.

ASC 740 requires that when determining the need for a valuation allowance against a deferred tax asset, management must assess both positive and negative evidence with regard to the realizability of the tax losses represented by that asset.  To the extent available sources of taxable income are insufficient to absorb tax losses, a valuation allowance is necessary.  Sources of taxable income for this analysis include prior years’ tax returns, the expected reversals of taxable temporary differences between book and tax income, prudent and feasible tax-planning strategies, and future taxable income.   The deferred tax asset related to the allowance will be realized when actual charge-offs are made against the allowance.  Based on the availability of loss carry-backs and projected taxable income during the periods for which loss carry-forwards are available, management believes it is more likely than not the Corporation will realize the deferred tax asset.  The Corporation continues to monitor the deferred tax asset on a quarterly basis for a valuation allowance.   The future realization of these tax benefits primarily hinges on adequate future earnings to utilize the tax benefit.  Prospective earnings or losses, tax law changes or capital changes could prompt the Corporation to reevaluate the assumptions which may be used to establish a valuation allowance.  As of September 30, 2011, the estimated deferred tax asset was $9.5 million, a $459,000 or five percent decrease, from $9.9 million at June 30, 2011.  The Corporation did not have any liabilities for uncertain tax positions or any known unrecognized tax benefit at September 30, 2011 or June 30, 2011.

The Corporation files income tax returns for the United States and state of California jurisdictions.  The Internal Revenue Service has audited the Bank’s income tax returns through 1996 and the California Franchise Tax Board has audited the Bank through 1990.  The Internal Revenue Service also completed a review of the Corporation’s income tax returns for fiscal 2006 and 2007.  Tax years subsequent to 2007 remain subject to federal examination, while the California state tax returns for years subsequent to 2004 are subject to examination by state taxing authorities.  The California Franchise Tax Board completed a review of the Corporation’s income tax returns for fiscal 2007 and 2008.  It is the Corporation’s policy to record any penalties or interest charges arising from federal or state taxes as a component of income tax expense.  For the quarter ended September 30, 2011, there was a $14,000 interest charge (related to the State of California tax return for fiscal 2007) and no tax penalties; and for the quarter ended September 30, 2010, there was a $13,000 interest charge (related to the State of California tax returns for fiscal 2007 and 2008) and no tax penalties.


Note 9: Fair Value of Financial Instruments

The Corporation adopted ASC 820, “Fair Value Measurements and Disclosures,” on July 1, 2008 and elected the fair value option (ASC 825, “Financial Instruments”) on May 28, 2009 on loans originated for sale by PBM.  ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  ASC 825 permits entities to elect to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the Fair Value Option) at specified election dates.  At each subsequent reporting date, an entity is required to report unrealized gains and losses on items in earnings for which the fair value option has been elected.  The objective of the Fair Value Option is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.

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

 
 
 
(In Thousands)
 
 
Aggregate
Fair Value
 
Aggregate
Unpaid
Principal
Balance
 
 
Net
Unrealized
Gain
 
As of September 30, 2011:
           
Single-family loans measured at fair value
$ 278,212
 
$ 265,804
 
$ 12,408
 

 
 
19

 
 
On April 9, 2009, the FASB issued ASC 820-10-65-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.”  This ASC provides additional guidance for estimating fair value in accordance with ASC 820, “Fair Value Measurements,” when the volume and level of activity for the asset or liability have significantly decreased.

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

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

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

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

Investment securities are primarily comprised of U.S. government agency mortgage-backed securities, U.S. government sponsored enterprise mortgage-backed securities and private issue collateralized mortgage obligations.  The Corporation utilizes unadjusted quoted prices in active markets for identical securities for its fair value measurement of debt securities, quoted prices in active and less than active markets for similar securities for its fair value measurement of mortgage-backed securities and debt securities, and broker price indications for similar securities in non-active markets for its fair value measurement of collateralized mortgage obligations.

Derivative financial instruments are comprised of commitments to extend credit on loans to be held for sale, loan sale commitments and option contracts.  The fair value is determined, when possible, using quoted secondary-market prices.  If no such quoted price exists, the fair value of a commitment is determined by quoted prices for a similar commitment or commitments, adjusted for the specific attributes of each commitment.

Loans held for sale at fair value are primarily single-family loans.  The fair value is determined, when possible, using quoted secondary-market prices such as mandatory loan sale commitments.  If no such quoted price exists, the fair value of a loan is determined by quoted prices for a similar loan or loans, adjusted for the specific attributes of each loan.
 
Non-performing loans are loans which are inadequately protected by the current net worth and paying capacity of the borrowers or of the collateral pledged and the accrual of interest income has been discontinued.  The non-performing loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.  The Corporation assesses loans individually and identifies impairment when the loan is classified as non-performing, been restructured or management has serious doubts about the future collectibility of principal and interest, even though the loans may currently be performing.  The fair value of a non-performing loan is determined based on an observable market price or current appraised value of the underlying collateral.  Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the borrower.  For non-performing loans which are also restructured loans, the fair value is derived from discounted cash flow analysis, except those
 
 
20

 
 
 
which are in the process of foreclosure, for which the fair value is derived from the appraised value of its collateral.  Non-performing loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.  This loss is not recorded directly as an adjustment to current earnings or other comprehensive income (loss), but rather as a component in determining the overall adequacy of the allowance for loan losses.  These adjustments to the estimated fair value of non-performing loans may result in increases or decreases to the provision for loan losses recorded in current earnings.

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

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

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

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

The following fair value hierarchy table presents information about the Corporation’s assets measured at fair value on a recurring basis:

 
Fair Value Measurement at September 30, 2011 Using:
(In Thousands)
Level 1
Level 2
 
Level 3
 
Total
 
Assets:
             
 
Investment securities:
             
   
U.S. government agency MBS
$ -
$   13,885
 
$        -
 
$   13,885
 
   
U.S. government sponsored
 enterprise MBS
 
-
 
10,080
 
 
-
 
 
10,080
 
   
Private issue CMO
-
-
 
1,288
 
1,288
 
     
Investment securities
-
23,965
 
1,288
 
25,253
 
                 
 
Loans held for sale, at fair value
-
278,212
 
-
 
278,212
 
 
Interest-only strips
-
-
 
167
 
167
 
                 
 
Derivative assets:
             
   
Commitments to extend credit on loans to be
  held for sale
 
-
 
-
 
 
3,469
 
 
3,469
 
   
Mandatory loan sale commitments
-
-
 
105
 
105
 
   
Option contracts
-
-
 
142
 
142
 
     
Derivative assets
-
-
 
3,716
 
3,716
 
Total assets
$ -
$ 302,177
 
$ 5,171
 
$ 307,348
 
               
Liabilities:
             
 
Derivative liabilities:
             
   
Commitments to extend credit on loans to be
  held for sale
 
$ -
 
$             -
 
 
$        7
 
 
$             7
 
   
Mandatory loan sale
-
-
 
235
 
235
 
   
TBA MBS trades
-
1,763
 
-
 
1,763
 
     
Derivative liabilities
 
1,763
 
242
 
2,005
 
Total liabilities
$ -
$    1,763
 
$   242
 
$     2,005
 

 
 
 
21

 
 

 
 
Fair Value Measurement at June 30, 2011 Using:
(In Thousands)
Level 1
Level 2
 
Level 3
 
Total
 
Assets:
             
 
Investment securities:
             
   
U.S. government agency MBS
$ -
$   14,409
 
$        -
 
$   14,409
 
   
U.S. government sponsored
 enterprise MBS
 
-
 
10,417
 
 
-
 
 
10,417
 
   
Private issue CMO
-
-
 
1,367
 
1,367
 
     
Investment securities
-
24,826
 
1,367
 
26,193
 
                 
 
Loans held for sale, at fair value
-
191,678
 
-
 
191,678
 
 
Interest-only strips
-
-
 
200
 
200
 
                 
 
Derivative assets:
             
   
Commitments to extend credit on loans to be
  held for sale
 
-
 
-
 
 
797
 
 
797
 
   
Mandatory loan sale commitments
-
-
 
403
 
403
 
   
TBA MBS trades
-
252
 
-
 
252
 
   
Option contracts
-
-
 
99
 
99
 
     
Derivative assets
-
252
 
1,299
 
1,551
 
Total assets
$ -
$ 216,756
 
$ 2,866
 
$ 219,622
 
               
Liabilities:
             
 
Derivative liabilities:
             
   
Commitments to extend credit on loans to be
  held for sale
 
$ -
 
$   -
 
 
$ 159
 
 
$ 159
 
   
TBA MBS trades
-
76
 
-
 
76
 
     
Derivative liabilities
-
76
 
159
 
235
 
Total liabilities
$ -
$ 76
 
$ 159
 
$ 235
 

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the Condensed Consolidated Statements of Financial Condition using Level 3 inputs:

 
Fair Value Measurement
Using Significant Other Unobservable Inputs
(Level 3)
 
 
(In Thousands)
 
 
Private
Issue
CMO
 
 
Interest-
Only
Strips
Loan
Commit-ments to originate
(1)
Manda-
tory
Commit-
ments
(2)
 
 
 
Option
Contracts
 
 
 
 
Total
 
Beginning balance at July 1, 2011
$ 1,367
 
$ 200
 
$    638