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Section 1: 10-K (FORM 10-K)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-K
(Mark one)
[x]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

                  For the fiscal year ended June 30, 2020            OR
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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 incorporation
 
(I.R.S. Employer
or organization)
 
Identification  Number)
     
3756 Central Avenue, Riverside, California
 
92506
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code:   (951) 686-6060
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, par value $.01 per share
Trading Symbol(s)
PROV
Name of each exchange on which registered
The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. [  ] Yes  [X] No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. [  ] Yes  [X] No

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.  [X] Yes   [   ] No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).  [ X] Yes   [  ] No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
  Large accelerated filer [  ] Accelerated filer [  ]
 
Non-accelerated filer [X]
Smallr reporting company  [X]
Emerging growth company [  ]
  
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]


Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.           [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). [  ] Yes  [X] No
The aggregate market value of the common stock held by non affiliates of the registrant, based on the closing sales price of the registrant’s common stock as quoted on the NASDAQ Global Select Market on December 31, 2019, was $148.8 million.  As of August 31, 2020, there were 7,436,315 shares of the registrant’s common stock issued and outstanding.

 DOCUMENTS INCORPORATED BY REFERENCE
1.
Portions of the Annual Report to Shareholders are incorporated by reference into Part II.

2.
Portions of the definitive Proxy Statement for the fiscal 2020 Annual Meeting of Shareholders (“Proxy Statement”) are incorporated by reference into Part III.









PROVIDENT FINANCIAL HOLDINGS, INC.
Table of Contents
 
Page
PART I
 
     Item 1.    Business:
1
                         General
1
                         Subsequent Events
1
                         Market Area
2
                         Competition
2
                         Personnel
3
                         Segment Reporting
3
                         Internet Website
3
                         Lending Activities
3
                         Loan Servicing
13
                         Delinquencies and Classified Assets
13
                         Investment Securities Activities
20
                         Deposit Activities and Other Sources of Funds
22
                         Subsidiary Activities
26
                         Regulation
27
                         Taxation
36
                         Executive Officers
38
     Item 1A.  Risk Factors
39
     Item 1B.  Unresolved Staff Comments
52
     Item 2.    Properties
52
     Item 3.    Legal Proceedings
52
     Item 4.    Mine Safety Disclosures
53
   
PART II
 
     Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
53
     Item 6.    Selected Financial Data
55
     Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations:
 56
                         General
 57
                         Critical Accounting Policies
 57
                         Executive Summary and Operating Strategy
 60
                         Off-Balance Sheet Financing Arrangements and Contractual Obligations
 63
                         Comparison of Financial Condition at June 30, 2020 and 2019
 63
                         Comparison of Operating Results for the Years Ended June 30, 2020 and 2019
 64
                         Average Balances, Interest and Average Yields/Costs
 69
                         Rate/Volume Analysis
 70
                         Liquidity and Capital Resources
 71
                         Impact of Inflation and Changing Prices
 72
                         Impact of New Accounting Pronouncements
 72
     Item 7A.  Quantitative and Qualitative Disclosures about Market Risk
 73
     Item 8.    Financial Statements and Supplementary Data
 77
     Item 9.    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 77
     Item 9A.  Controls and Procedures
 77
Item 9B.   Other Information
 79



 
Page
 PART III
 
     Item 10.   Directors, Executive Officers and Corporate Governance
79
     Item 11.   Executive Compensation
79
     Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
80
     Item 13.   Certain Relationships and Related Transactions, and Director Independence
81
     Item 14.   Principal Accountant Fees and Services
81
   
PART IV
 
     Item 15.   Exhibits, Financial Statement Schedules
81
   
Signatures
84


As used in this report, the terms “we,” “our,” “us,” and “Provident” refer to Provident Financial Holdings, Inc. and its consolidated subsidiaries, unless the context indicates otherwise. When we refer to the “Bank” or “Provident Savings Bank” in this report, we are referring to Provident Savings Bank, F.S.B., a wholly owned subsidiary of Provident Financial Holdings, Inc.






PART I

Item 1.  Business

General

Provident Financial Holdings, Inc. (the “Corporation”), a Delaware corporation, was organized in January 1996 for the purpose of becoming the holding company of Provident Savings Bank, F.S.B. (the “Bank”) upon the Bank’s conversion from a federal mutual to a federal stock savings bank (“Conversion”).  The Conversion was completed on June 27, 1996.  The Corporation is regulated by the Federal Reserve Board ("FRB").  At June 30, 2020, the Corporation had consolidated total assets of $1.18 billion, total deposits of $893.0 million and stockholders’ equity of $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 Annual Report on Form 10-K (“Form 10-K”), including the audited consolidated financial statements and related data, relates primarily to the Bank.

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

The Bank 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, and through its subsidiary, Provident Financial Corp.  The business activities of the Bank consist of community banking, investment services and trustee services for real estate transactions.

The Bank’s community banking operations primarily consist of accepting deposits from customers within the communities surrounding its full service offices and investing those funds in single-family, multi-family, commercial real estate, construction, commercial business, consumer and other mortgage loans.  Additional business activities have included originating saleable single-family loans, primarily fixed-rate first mortgages.  Through its subsidiary, Provident Financial Corp, the Bank conducts trustee services for the Bank’s real estate transactions and in the past has held real estate for investment.  For additional information, see “Subsidiary Activities” in this Form 10-K.  The activities of Provident Financial Corp are included in the Bank's operating segment results.  The Bank’s revenues are derived principally from interest earned on its loan and investment portfolios, and fees generated through its community banking activities.

On June 22, 2006, the Bank established the Provident Savings Bank Charitable Foundation (“Foundation”) in order to further its commitment to the local community.  The specific purpose of the Foundation is to promote and provide for the betterment of youth, education, housing and the arts in the Bank’s primary market areas of Riverside and San Bernardino counties.   The Foundation was funded with a $500,000 charitable contribution made by the Bank in the fourth quarter of fiscal 2006.  The
Bank contributed $40,000 to the Foundation in both fiscal 2020 and 2019.


Subsequent Event:

On July 30, 2020, the Corporation announced that the Corporation’s Board of Directors declared a cash dividend of $0.14 per share.  Shareholders of the Corporation’s common stock at the close of business on August 20, 2020 are entitled to receive the cash dividend, payable on September 10, 2020.


1

Market Area

The Bank is headquartered in Riverside, California and operates 12 full-service banking offices in Riverside County and one full-service banking office in San Bernardino County.  Management considers Riverside and Western San Bernardino counties to be the Bank’s primary market for deposits. The Bank is the largest independent community bank headquartered in Riverside County and it has the ninth largest deposit market share of all banks and the second largest of community banks in Riverside County.

The large geographic area encompassing Riverside and San Bernardino counties is referred to as the “Inland Empire.”  According to the 2010 Census Bureau population statistics, Riverside and San Bernardino Counties have the fourth and fifth largest populations in California, respectively.  The Bank’s market area consists primarily of suburban and urban communities. Riverside and Western San Bernardino counties are relatively densely populated and are within the greater Los Angeles metropolitan area.  According to the United States of America (“U.S.”) Department of Labor, Bureau of Labor Statistics, the unemployment rate in the Inland Empire in June 2020 was 14.3%, compared to 14.9% in California and 11.1% nationwide, a substantial increase due primarily to the impact of the novel coronavirus of 2019 (“COVID-19”) pandemic, compared to the unemployment data reported in June 2019, which was 4.3% in the Inland Empire, 4.2% in California and 3.7% nationwide. Recent forecasts suggest that employment will drop an annual average of 71,000 jobs during 2020 from 1.56 million in 2019 to 1.49 million in 2020 and depends heavily on how each business sector is likely to change during the remainder of 2020 (Source: Inland Empire Quarterly Economic Report - April 2020).

Inland Empire homes should continue to hold a substantial advantage for families compared to the coastal markets. This will be the case despite COVID-19’s impact as it will likely affect supply and demand in all Southern California markets. Sales volumes in all markets will slow in the second quarter as potential buyers stay home and sellers decide to stay in place. Some sales recovery will likely occur in the third quarter of the calendar year as lock-down requirements ease. Prices will likely continue rising as 2020 unfolds with the lack of supply meeting slowly increasing demand (Source: Inland Empire Quarterly Economic Report - April 2020).

Due to strong buyer demand, the percentage of homes closing below their listing prices has been decreasing. Data from Fannie Mae confirms that housing confidence is getting stronger: in a recent survey, 61 percent of respondents said now is a good time to buy. Mortgage applications are also 33 percent higher than they were at this time last year, and homebuilders saw their strongest June sales since the housing boom. This increased demand can be attributed to historically low mortgage rates, as well as buyers playing “catch-up” during the reopening after the first shutdown due to COVID-19 pandemic. But the momentum of the current rebound will likely be limited by California’s constrained housing supply, as well as the second shutdown. Housing prices have largely remained stable, even rising in the Bay Area markets. While mortgages in forbearance continue to drop, 32 percent of renters and homeowners did not make a full housing payment on July 1, 2020 according to an Apartment List survey. Renters, in particular, still face significant financial hurdles: in June 2020, 31 percent of renters reported they had little confidence in their ability to pay next month’s rent. (Source: California Association of Realtors – July 15, 2020 News Release).


Competition

The Bank faces significant competition in its market area in originating real estate loans and attracting deposits.  The population growth in the Inland Empire has attracted numerous financial institutions to the Bank’s market area.  The Bank’s primary competitors are large national and regional commercial banks as well as other community-oriented banks and savings institutions.  The Bank also faces competition from credit unions and a large number of mortgage companies that operate within its market area.  Many of these institutions are significantly larger than the Bank and therefore have greater financial and marketing resources than the Bank. This competition may limit the Bank’s growth and profitability in the future.

2

Personnel

As of June 30, 2020, the Bank had 178 full-time equivalent employees, which consisted of 123 full-time, 55 prime-time and no part-time employees.  The employees are not represented by a collective bargaining unit and management believes that its relationship with employees is good.


Reportable Segments

Management monitors the revenue and expense components of the various products and services the Bank offers, but operations are managed and financial performance is evaluated on a Corporation-wide basis in comparison to a business plan which is developed each year. Accordingly, all operations are considered by management to be one operating segment and one reportable segment as contained in the Consolidated Statements of Operations to the Corporation’s audited consolidated financial statements included in Item 8 of this Form 10-K.


Internet Website

The Corporation maintains a website at www.myprovident.com. The information contained on that website is not included as a part of, or incorporated by reference into, this Form 10-K. Other than an investor’s own internet access charges, the Corporation makes available free of charge through that website the Corporation’s annual report, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after these materials have been electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).  In addition, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding companies that file electronically with the SEC.  This information is available at www.sec.gov.


Lending Activities

General.  The lending activity of the Bank is comprised of the origination of single-family, multi-family and commercial real estate loans and, to a lesser extent, construction, commercial business, consumer and other mortgage loans to be held for investment.  Additional lending activities have included originating saleable single-family loans, primarily fixed-rate first mortgages. The Bank’s net loans held for investment were $902.8 million at June 30, 2020, representing 76.7% of consolidated total assets.  This compares to $879.9 million, or 81.1% of consolidated total assets, at June 30, 2019.

At June 30, 2020, the maximum amount that the Bank could have loaned to any one borrower and the borrower’s related entities under applicable regulations was $18.8 million, or 15% of the Bank’s unimpaired capital and surplus.  At June 30, 2020, the Bank had no loans or group of loans to related borrowers with outstanding balances in excess of this amount.  The Bank’s five largest lending relationships at June 30, 2020 consisted of: two multi-family loans totaling $4.5 million to one group of borrowers; two single-family loans totaling $4.4 million to one group of borrowers; one multi-family loan totaling $4.4 million to one group of borrowers; one multi-family and one commercial real estate loan totaling $4.4 million to one group of borrowers; and one commercial real estate loan totaling $4.2 million to one group of borrowers.  The real estate collateral for these loans is located in Southern California.  At June 30, 2020, all of these loans were performing in accordance with their repayment terms.

On February 4, 2019, the Corporation announced that it was in the best interests of the Corporation to scale back saleable single-family mortgage loan originations and improve on its efforts to increase the volume of portfolio single-family mortgage loan originations and purchases. For additional information, see “Loan Originations” and “Critical Accounting Policies” in this Form 10-K.

3

Loans Held For Investment Analysis.  The following table sets forth the composition of the Bank’s loans held for investment at the dates indicated:
   
At June 30,
   
2020
 
2019
 
2018
 
2017
 
2016
(Dollars In Thousands)
 
Amount
Percent
 
Amount
Percent
 
Amount
Percent
 
Amount
Percent
 
Amount
Percent
     
Mortgage loans:
                             
   Single-family
 
$
298,810
 
33.04
%
 
$
324,952
 
36.87
%
 
$
314,808
 
34.80
%
 
$
322,197
 
35.51
%
 
$
324,497
 
38.44
%
   Multi-family
 
491,903
 
54.38
   
439,041
 
49.81
   
476,008
 
52.63
   
479,959
 
52.89
   
415,627
 
49.23
 
   Commercial real estate
 
105,235
 
11.64
   
111,928
 
12.70
   
109,726
 
12.13
   
97,562
 
10.75
   
99,528
 
11.79
 
   Construction
 
7,801
 
0.86
   
4,638
 
0.53
   
3,174
 
0.35
   
6,994
 
0.77
   
3,395
 
0.40
 
Other
 
143
 
0.02
   
167
 
0.02
   
167
 
0.02
   
 
   
332
 
0.04
 
Total mortgage loans
 
903,892
 
99.94
   
880,726
 
99.93
   
903,883
 
99.93
   
906,712
 
99.92
   
843,379
 
99.90
 
                               
Commercial business loans
 
480
 
0.05
   
478
 
0.05
   
500
 
0.06
   
576
 
0.07
   
636
 
0.08
 
Consumer loans
 
94
 
0.01
   
134
 
0.02
   
109
 
0.01
   
129
 
0.01
   
203
 
0.02
 
Total loans held for
  investment, gross
 
904,466
 
100.00
%
 
881,338
 
100.00
%
 
904,492
 
100.00
%
 
907,417
 
100.00
%
 
844,218
 
100.00
%
                               
Advance payments of
  escrows
 
68
     
53
     
18
     
61
     
56
   
Deferred loan costs, net
 
6,527
     
5,610
     
5,560
     
5,480
     
4,418
   
Allowance for loan losses
 
(8,265
)
   
(7,076
)
   
(7,385
)
   
(8,039
)
   
(8,670
)
 
Total loans held for
  investment, net
 
$
902,796
     
$
879,925
     
$
902,685
     
$
904,919
     
$
840,022
   





4

Maturity of Loans Held for Investment.  The following table sets forth information at June 30, 2020 regarding the dollar amount of principal payments becoming contractually due during the periods indicated for loans held for investment.  Demand loans, loans having no stated schedule of principal payments, loans having no stated maturity, and overdrafts are reported as becoming due within one year.  The table does not include any estimate of prepayments, which can significantly shorten the average life of loans held for investment and may cause the Bank’s actual principal payment experience to differ materially from that shown below:
(In Thousands)
Within
One Year
After
One Year
Through
3 Years
After
3 Years
Through
5 Years
After
5 Years
Through
10 Years
Beyond
10 Years
Total
   
Mortgage loans:
           
      Single-family
$
 
$
927
 
$
1,069
 
$
3,771
 
$
293,043
 
$
298,810
 
      Multi-family
 
154
 
 
24,622
 
467,127
 
491,903
 
      Commercial real estate
215
 
5,996
 
13,696
 
73,878
 
11,450
 
105,235
 
      Construction
6,347
 
 
 
 
1,454
 
7,801
 
      Other
 
143
 
 
 
 
143
 
Commercial business loans
65
 
120
 
15
 
280
 
 
480
 
Consumer loans
94
 
 
 
 
 
94
 
Total loans held for investment, gross
$
6,721
 
$
7,340
 
$
14,780
 
$
102,551
 
$
773,074
 
$
904,466
 

The following table sets forth the dollar amount of all loans held for investment due after June 30, 2020 which have fixed and floating or adjustable interest rates:
(Dollars In Thousands)
 
Fixed-Rate
     
%
(1) 
 
Floating or
Adjustable
Rate
     
%
(1) 
                             
Mortgage loans:
                           
      Single-family
 
$
8,231
     
3
%
 
$
290,579
     
97
%
      Multi-family
   
156
     
%
   
491,747
     
100
%
      Commercial real estate
   
340
     
%
   
104,680
     
100
%
      Construction
   
     
%
   
1,454
     
100
%
      Other
   
143
     
100
%
   
     
%
Commercial business loans
   
330
     
80
%
   
85
     
20
%
Total loans held for investment, gross
 
$
9,200
     
1
%
 
$
888,545
     
99
%

(1) As a percentage of each category.

Scheduled contractual principal payments of loans do not reflect the actual life of such assets.  The average life of loans is generally substantially less than their contractual terms because of prepayments.  In addition, due-on-sale clauses generally give the Bank the right to declare loans immediately due and payable in the event, among other things, the borrower sells the real property that secures the loan.  The average life of mortgage loans tends to increase, however, when current market interest rates are substantially higher than the interest rates on existing loans held for investment and, conversely, decrease when the interest rates on existing loans held for investment are substantially higher than current market interest rates, as borrowers are generally less inclined to refinance their loans when market rates increase and more inclined to refinance their loans when market rates decrease.


5

The table below describes the geographic dispersion of real estate secured loans held for investment (gross) at June 30, 2020 and 2019, as a percentage of the total dollar amount outstanding (dollars in thousands):

As of June 30, 2020:
 
Inland
Empire
Southern
California(1)
Other
California
Other
States
Total
Loan Category
Balance
%
Balance
%
Balance
%
Balance
%
Balance
%
Single-family
$
82,019
 
28
%
$
140,888
 
47
%
$
75,372
 
25
%
$
531
 
%
$
298,810
 
100
%
Multi-family
66,427
 
14
%
321,556
 
65
%
103,609
 
21
%
311
 
%
491,903
 
100
%
Commercial real
   estate
23,501
 
22
%
47,484
 
45
%
34,250
 
33
%
 
%
105,235
 
100
%
Construction
1,115
 
14
%
5,190
 
67
%
1,496
 
19
%
 
%
7,801
 
100
%
Other
 
%
143
 
100
%
 
%
 
%
143
 
100
%
Total
$
173,062
 
19
%
$
515,261
 
57
%
$
214,727
 
24
%
$
842
 
%
$
903,892
 
100
%

(1)
Other than the Inland Empire.

As of June 30, 2019:
 
Inland
Empire
Southern
California(1)
Other
California
Other
States
Total
Loan Category
Balance
%
Balance
%
Balance
%
Balance
%
Balance
%
Single-family
$
104,967
 
33
%
$
146,963
 
45
%
$
71,997
 
22
%
$
1,025
 
%
$
324,952
 
100
%
Multi-family
70,241
 
16
%
272,282
 
62
%
96,192
 
22
%
326
 
%
439,041
 
100
%
Commercial real
   estate
30,551
 
27
%
54,010
 
48
%
27,367
 
25
%
 
%
111,928
 
100
%
Construction
525
 
11
%
3,579
 
77
%
534
 
12
%
 
%
4,638
 
100
%
Other
 
%
 
%
167
 
100
%
 
%
167
 
100
%
Total
$
206,284
 
24
%
$
476,834
 
54
%
$
196,257
 
22
%
$
1,351
 
%
$
880,726
 
100
%

(1)
Other than the Inland Empire.

Single-Family Mortgage Loans.  One of the Bank’s primary lending activity is the origination and purchase of adjustable rate mortgage loans to be held for investment secured by first mortgages on owner-occupied, single-family (one to four units) residences in the communities where the Bank’s branches are located and surrounding areas in Southern and Northern California.  During fiscal 2020 the Bank originated $36.4 million and purchased $70.7 million of single-family loans to be held for investment, all of which were underwritten in accordance with the Bank’s origination guidelines. This compares to single-family loan originations of $55.4 million and purchases of $33.3 million during fiscal 2019. At June 30, 2020, total single-family loans held for investment decreased 8% to $298.8 million, or 33.0% of the total loans held for investment, from $325.0 million, or 36.9% of the total loans held for investment, at June 30, 2019.  The decrease in the single-family loans in fiscal 2020 was primarily attributable to loan principal payments that exceeded new loans originated and purchased for investment. During fiscal 2020, the Bank had net recoveries of $69,000 in non-performing single-family loans, as compared to net recoveries of $167,000 during fiscal 2019. At June 30, 2020 and 2019, total non-performing single-family loans were $4.9 million and $5.2 million, net of allowances and charge-offs, respectively, and $219,000 and $660,000 were past due 30 to 89 days, respectively.

The Bank has underwriting standards that generally conform with the standards of governmental sponsored entities (“GSE”) including Fannie Mae and Freddie Mac. Mortgage insurance is usually required for all loans exceeding 80% loan-to-value (“LTV”) based on the lower of the purchase price or appraised value at the time of loan origination.  The Bank is not currently offering loans with LTV ratios greater than 80% and is requiring lender-paid mortgage insurance for LTV ratios between 70.01% and 80.00%. The ratio is derived by dividing the original loan balance by the lower of the original appraised value or purchase price of the real estate collateral. Currently, the maximum LTV ratio is 80% for purchase and rate and term refinances and 65% for cash-out refinances.  The maximum loan amount offered is $1.5 million for a purchase or rate and term refinance

6

and $1.0 million for a cash-out refinance.  The lowest FICO score currently offered is 690 for a purchase transaction and 720 for a cash-out transaction. The FICO score represents the creditworthiness of a borrower based on the borrower’s credit history, as reported by an independent third party.  A higher FICO score indicates a greater degree of creditworthiness.  Bank regulators have issued guidance stating that a FICO score of 660 and below is indicative of a “subprime” borrower. The Bank currently lends on single-family residential 1-2 unit properties, planned unit developments and condominiums.  The Bank typically conforms its underwriting standards to GSE policies in place at the time of underwriting which are applicable to the particular loan.  These standards may change at any time, given changes in real estate market conditions or changes to GSE policies and guidelines. For additional protection, the Bank purchases lender-paid mortgage insurance for certain single-family mortgage loans. As of June 30, 2020, a total of $40.0 million of single-family mortgage loans with an 83% weighted average LTV at the time of origination have lender-paid mortgage insurance providing a weighted average coverage ratio of 12% of the original loan amount.

The Bank offers closed-end, fixed-rate home equity loans that are secured by the borrower’s primary residence.  These loans do not exceed 80% of the appraised value of the residence and have terms of up to 15 years requiring monthly payments of principal and interest.  At June 30, 2020, home equity loans amounted to $5.3 million or 1.8% of single-family loans held for investment, as compared to $11.0 million or 3.4% of single-family loans held for investment at June 30, 2019.

The Bank offers adjustable rate mortgage (“ARM”) loans at rates and terms competitive with market conditions. Substantially all of the ARM loans originated by the Bank meet GSE underwriting standards.  The Bank offers several ARM products, which adjust monthly, semi-annually, or annually after an initial fixed period ranging from one month to ten years subject to a limitation on the annual increase of one to two percentage points and an overall limitation of three to six percentage points.  The following indexes, plus a margin of 2.00% to 3.25%, are used to calculate the periodic interest rate changes: the London Interbank Offered Rate (“LIBOR”), the FHLB Eleventh District cost of funds (“COFI”), the 12-month average U.S. Treasury (“12 MAT”) or the weekly average yield on one year U.S. Treasury securities adjusted to a constant maturity of one year (“CMT”).  Loans based on the LIBOR index constitute a majority of the Bank’s loans held for investment.  The majority of the ARM loans held for investment have five, seven, or  ten-year fixed periods prior to the first adjustment (“5/1, 7/1, or 10/1 hybrids”) and provide for fully amortizing loan payments throughout the term of the loan.  Loans of this type have embedded interest rate risk if interest rates should rise during the initial fixed rate period.

Prior to fiscal 2009, the Bank offered stated income single-family mortgage loans.  As of June 30, 2020 and 2019, the outstanding balance of the stated income single-family mortgage loans was $38.5 million and $52.6 million, respectively, of which $1.8 million and $2.1 million, respectively were non-performing, while no loans were 30-89 days delinquent at June 30, 2020 and $660,000 were 30-89 days delinquent at June 30, 2019.

Borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates and fees charged for each type of loan.  The relative amount of fixed-rate mortgage loans and ARM loans that can be originated at any time is largely determined by the demand for each product in a given interest rate and competitive environment. Given the recent low-rate market environment, the production of ARM loans was significantly lower than fixed rate mortgages.

The retention of ARM loans, rather than fixed-rate loans, helps to reduce the Bank’s exposure to changes in interest rates.  There is, however, unquantifiable credit risk resulting from the potential of increased interest charges to be paid by the borrower as a result of increases in interest rates.  It is possible that, during periods of rising interest rates, the risk of default on ARM loans may increase as a result of the increase in the required payment from the borrower.  Furthermore, the risk of default may increase because ARM loans originated by the Bank occasionally provide, as a marketing incentive, for initial rates of interest below those rates that would apply if the adjustment index plus the applicable margin were initially used for pricing.  Because of these characteristics, ARM loans are subject to increased risks of default or delinquency.  Additionally, while ARM loans allow the Bank to increase the sensitivity of its assets as a result of changes in interest rates, the extent of this interest rate sensitivity is limited by the periodic and lifetime interest rate adjustment limits.  Furthermore, because loan indexes may not respond perfectly to changes in market interest rates, upward adjustments on loans may occur more slowly than increases in the Bank’s cost of interest-bearing liabilities, especially during periods of rapidly increasing interest

7

rates. Conversely, market downward adjustments on the Bank’s cost of funds typically lag adjustments on ARM loans which may occur more rapidly during periods of declining interest rates. For additional information concerning the effect of interest rates on its loan portfolio, see Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” of this Form 10-K.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) requires lenders to make a reasonable, good faith determination of a borrower’s ability to repay any consumer closed-end credit transaction secured by a dwelling and to limit prepayment penalties.  Increased risks of legal challenge, private right of action and regulatory enforcement actions result from these rules. The Bank may originate loans that do not meet the definition of a “qualified mortgage” (“QM”). To mitigate the risks involved with non-QM loans, the Bank has implemented systems, processes, procedural and product changes, and maintains its underwriting standards, to ensure that the “ability-to-repay” requirements of the new rules are adequately addressed.

A decline in real estate values subsequent to the time of origination of real estate secured loans could result in higher loan delinquency levels, foreclosures, provisions for loan losses and net charge-offs.  Real estate values and real estate markets are beyond the Bank’s control and are generally affected by changes in national, regional or local economic conditions and other factors.  These factors include fluctuations in interest rates and the availability of loans to potential purchasers, housing supply and demand, changes in tax laws and other governmental statutes, regulations and policies and acts of nature, such as earthquakes, fires and other natural disasters particular to California where substantially all of its real estate collateral is located.  If real estate values decline from the levels at the time of loan origination, the value of its real estate collateral securing the loans could be significantly reduced.  The Bank’s ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and it would be more likely to suffer losses on defaulted loans.
  
Multi-Family and Commercial Real Estate Mortgage Loans.  At June 30, 2020, multi-family mortgage loans were $491.9 million and commercial real estate loans were $105.2 million, or 54.4% and 11.6%, respectively, of loans held for investment.  This compares to multi-family mortgage loans of $439.0 million and commercial real estate loans of $111.9 million, or 49.8% and 12.7%, respectively, of loans held for investment at June 30, 2019.  Consistent with its strategy to diversify the composition of loans held for investment, the Bank has made the origination and purchase of multi-family and commercial real estate loans a priority.  During fiscal 2020 the Bank originated $65.5 million and purchased $71.3 million of multi-family and commercial real estate loans, all of which were underwritten in accordance with the Bank’s origination guidelines.  This compares to loan originations of $57.6 million and loan purchases of $17.8 million during fiscal 2019. At June 30, 2020, the Bank had 660 multi-family and 143 commercial real estate loans in loans held for investment. This compares to 644 multi-family and 146 commercial real estate loans in loans held for investment at June 30, 2019.

Multi-family mortgage loans originated by the Bank are predominately adjustable rate loans, including 1/1, 3/1, 5/1 and 7/1 hybrids, with a term to maturity of 10 to 30 years and a 25 to 30 year amortization schedule.  Commercial real estate loans originated by the Bank are also predominately adjustable rate loans, including 1/1, 3/1 and 5/1 hybrids, with a term to maturity of 10 to 30 years and a 25 to 30 year amortization schedule.  Rates on multi-family and commercial real estate ARM loans generally adjust monthly, quarterly, semi-annually or annually at a specific margin over the respective interest rate index, subject to period interest rate caps and life-of-loan interest rate caps.  At June 30, 2020, $464.5 million, or 94.4%, of the Bank’s multi-family loans were secured by five to 36 unit projects.  The Bank’s commercial real estate loan portfolio generally consists of loans secured by small office buildings, light industrial buildings, warehouses and small retail centers.  Properties securing multi-family and commercial real estate loans are primarily located in Alameda, Los Angeles, Orange, Riverside, San Bernardino, San Diego, San Francisco and Santa Clara counties.  The Bank originates multi-family and commercial real estate loans in amounts typically ranging from $350,000 to $6.0 million.  At June 30, 2020, the Bank had 66 commercial real estate and multi-family loans with principal balances greater than $1.5 million totaling $155.0 million.  The Bank obtains appraisals on all properties that secure multi-family and commercial real estate loans.  Underwriting of multi-family and commercial real estate loans includes, among other considerations, a thorough analysis of the cash flows generated by the property to support the debt service and the financial resources, experience and the income level of the borrowers and guarantors.

Multi-family and commercial real estate loans afford the Bank an opportunity to price the loans with higher interest rates than those generally available from single-family mortgage loans.  However, loans secured by such properties are generally greater

8

in amount, more difficult to evaluate and monitor and are more susceptible to default as a result of general economic conditions and, therefore, involve a greater degree of risk than single-family residential mortgage loans.  Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation and management of the properties, repayment of such loans may be impacted by adverse conditions in the real estate market or the economy.  During both fiscal 2020 and 2019, the Bank had no charge-offs or recoveries on non-performing multi-family and commercial real estate loans.  At June 30, 2020 or 2019, there were no non-performing multi-family and commercial real estate loans and none were past due 30 to 89 days.  Non-performing loans and/or delinquent loans may increase if there is a general decline in California real estate markets and in the event poor general economic conditions prevail.

Construction Loans.  The Bank originates from time to time two types of construction loans: short-term construction loans and construction/permanent loans.  During fiscal 2020 and 2019, the Bank originated a total of $4.0 million and $7.2 million of construction loans (including undisbursed loan funds), respectively.  As of June 30, 2020 and 2019, the Bank had short-term construction loans totaling $6.3 million and $4.2 million, respectively, and construction/permanent loans totaling $1.5 million and $410,000, respectively, net of undisbursed loan funds of $4.0 million and $6.6 million, respectively.
Short-term construction loans include three types of loans: custom construction, tract construction, and speculative construction. The Bank provides construction financing for single-family, multi-family and commercial real estate properties.  Custom construction loans are made to individuals who, at the time of application, have a contract executed with a builder to construct their residence.  Custom construction loans are generally originated for a term of 12 to 18 months, with fixed interest rates at the prime lending rate plus a margin and with loan-to-value ratios of up to 75% of the appraised value of the completed property.  The owner secures long-term permanent financing at the completion of construction. At June 30, 2020, there were three custom single-family construction loans totaling $2.1 million with $376,000 of undisbursed funds. This compares to June 30, 2019 when the Bank had two custom single-family construction loans totaling $1.6 million with $916,000 of undisbursed funds.

The Bank makes tract construction loans to subdivision builders.  These subdivisions are usually financed and built in phases.  A thorough analysis of market trends and demand within the area are reviewed for feasibility.  Tract construction may include the building and financing of model homes under a separate loan.  The terms for tract construction loans are generally 12 months with interest rates fixed at a margin above the prime lending rate.  At June 30, 2020, there were no tract construction loans.

Speculative construction loans are made to home builders and are termed “speculative” because the home builder does not have, at the time of loan origination, a signed sale contract with a home buyer who has a commitment for permanent financing with either the Bank or another lender for the finished home.  The home buyer may be identified during or after the construction period.  The builder may be required to debt service the speculative construction loan for a significant period of time after the completion of construction until the homebuyer is identified.  At June 30, 2020, there were three single-family speculative construction loans of $2.6 million with $828,000 of undisbursed funds. This compares to June 30, 2019 when the Bank had one single-family speculative construction loan totaling $716,000 with $529,000 of undisbursed funds.

Construction/permanent loans automatically roll from the construction to the permanent phase.  The construction phase of a construction/permanent loan generally lasts nine to 12 months and the interest rate charged is generally fixed at a margin above prime rate and with a loan-to-value ratio of up to 75% of the appraised value of the completed property.  At June 30, 2020, there were $1.5 million of construction/permanent loans as compared to $410,000 of construction/permanent loans at June 30, 2019.

Construction loans under $1.0 million are approved by Bank personnel specifically designated to approve construction loans.  The Bank’s Loan Committee, comprised of the Chief Executive Officer, Chief Lending Officer, Chief Financial Officer, Senior Vice President – Single-Family Division and Vice President - Loan Administration, approves all construction loans over $1.0 million.  Prior to approval of any construction loan, an independent fee appraiser inspects the site and the Bank reviews the existing or proposed improvements, identifies the market for the proposed project, and analyzes the pro-forma data and assumptions on the project.  In the case of a tract or speculative construction loan, the Bank reviews the experience and expertise of the builder.  The Bank obtains credit reports, financial statements and tax returns on the borrowers and guarantors,

9

an independent appraisal of the project, and any other expert report necessary to evaluate the proposed project.  In the event of cost overruns, the Bank requires the borrower to deposit their own funds into a loan-in-process account, which the Bank disburses consistent with the completion of the subject property pursuant to a revised disbursement schedule.

The construction loan documents require that construction loan proceeds be disbursed in increments as construction progresses.  Disbursements are based on periodic on-site inspections by independent inspectors and Bank personnel.  At inception, the Bank also requires borrowers to deposit funds into the loan-in-process account covering the difference between the actual cost of construction and the loan amount.  The Bank regularly monitors the construction loan portfolio, economic conditions and housing inventory.  The Bank’s property inspectors perform periodic inspections.  The Bank believes that the internal monitoring system helps reduce many of the risks inherent in its construction loans.

Construction loans afford the Bank the opportunity to achieve higher interest rates and fees with shorter terms to maturity than its single-family mortgage loans.  Construction loans, however, are generally considered to involve a higher degree of risk than single-family mortgage loans because of the inherent difficulty in estimating both a property’s value at completion of the project and the cost of the project.  The nature of these loans is such that they are generally more difficult to evaluate and monitor.  If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the project.  If the estimate of value upon completion proves to be inaccurate, the Bank may be confronted with a project whose value is insufficient to assure full repayment.  Projects may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors.  Loans to builders to construct homes for which no purchaser has been identified carry additional risk because the payoff for the loan depends on the builder’s ability to sell the property prior to the time that the construction loan matures.  The Bank has sought to address these risks by adhering to strict underwriting policies, disbursement procedures and monitoring practices.  In addition, because the Bank’s construction lending is in its primary market area, changes in the local or regional economy and real estate market could adversely affect the Bank’s construction loans held for investment. During fiscal 2020, the Bank had no charge-offs or recoveries and no loans were non-performing or 30-89 days delinquent at June 30, 2020. During fiscal 2019, the Bank had no charge-offs or recoveries, but had one loan totaling $971,000 that was non-performing and no loans were 30-89 days delinquent at June 30, 2019.

Participation Loan Purchases and Sales.  In an effort to expand production and diversify risk, the Bank purchases loans and loan participations, with collateral primarily in California, which allows for greater geographic distribution outside of the Bank’s primary lending areas.  The Bank generally purchases between 50% and 100% of the total loan amount. When the Bank purchases a participation loan, the lead lender will usually retain a servicing fee, thereby decreasing the loan yield.  This servicing fee approximates the expense the Bank would incur if the Bank were to service the loan.  All properties serving as collateral for loan participations are inspected by an employee of the Bank or a third party inspection service prior to being approved by the Loan Committee and the Bank relies upon the same underwriting criteria required for those loans originated by the Bank.  The Bank purchased $142.1 million of loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2020, compared to $51.1 million of purchased loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2019.  As of June 30, 2020, total loans serviced by other financial institutions were $23.9 million, as compared to $33.9 million at June 30, 2019.  As of June 30, 2020, all loans serviced by others were performing according to their original contractual payment terms, except for two loans that were in forbearance pursuant to a loan modification consistent with the Coronavirus Aid, Relief, and Economic Security Act of 2020, (“CARES Act”) signed into law on March 27, 2020 and/or the April 7, 2020 Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (“Interagency Statement”). The CARES Act and 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 and/or Interagency Statement prior to any relief, are not troubled debt restructurings. For additional information related to loan modifications as a result of the COVID-19 pandemic, see “Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – COVID-19 Impact to the Corporation.”

The Bank also sells participating interests in loans when it has been determined that it is beneficial to diversify the Bank’s risk.  Participation sales enable the Bank to maintain acceptable loan concentrations and comply with the Bank’s loans to one

10

borrower policy.  Generally, selling a participating interest in a loan increases the yield to the Bank on the portion of the loan that is retained.  The Bank did not sell any participation loans in fiscal 2020 or fiscal 2019.

Commercial Business Loans.  The Bank has a Business Banking Department that primarily serves businesses located within the Inland Empire.  Commercial business loans allow the Bank to diversify its lending and increase the average loan yield.  As of June 30, 2020, commercial business loans were $480,000, or 0.1% of loans held for investment, a slight increase from $478,000, or 0.1% of loans held for investment at June 30, 2019.  These loans represent secured and unsecured lines of credit and term loans secured by business assets.

Commercial business loans are generally made to customers who are well known to the Bank and are generally secured by accounts receivable, inventory, business equipment and/or other assets.  The Bank’s commercial business loans may be structured as term loans or as lines of credit.  Lines of credit are made at variable rates of interest equal to a negotiated margin above the prime rate and term loans are at a fixed or variable rate.  The Bank may also require personal guarantees from financially capable parties associated with the business based on a review of personal financial statements.  Commercial business term loans are generally made to finance the purchase of assets and have maturities of five years or less.  Commercial lines of credit are typically made for the purpose of providing working capital and are usually approved with a term of one year or less.

Commercial business loans involve greater risk than residential mortgage loans and involve risks that are different from those associated with residential and commercial real estate loans.  Real estate loans are generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral value and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default.  Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets including real estate, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment because accounts receivable may not be collectible and inventories and equipment may be obsolete or of limited use.  Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is secondary and oftentimes an insufficient source of repayment.  At June 30, 2020 and 2019, the Bank had $31,000 and $41,000 of non-performing commercial business loans, respectively, net of allowances and charge-offs.  During fiscal 2020 or 2019, the Bank had no charge-offs or recoveries on commercial business loans.

Consumer Loans.  At June 30, 2020 and 2019, the Bank’s consumer loans were $94,000 and $134,000, respectively, or less than 0.1% of the Bank’s loans held for investment at these dates.  The Bank offers open-ended lines of credit on either a secured or unsecured basis.  The Bank offers secured savings lines of credit which have an interest rate that is four percentage points above the COFI, which adjusts monthly.  There were no secured savings lines of credit at June 30, 2020 and 2019.

Consumer loans potentially have a greater risk than residential mortgage loans, particularly in the case of loans that are unsecured.  Consumer loan collections are dependent on the borrower’s ongoing financial stability, and thus are more likely to be adversely affected by job loss (especially now as a result of the COVID-19 pandemic), illness or personal bankruptcy.  Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.  The Bank had no non-performing consumer loans at June 30, 2020 and 2019.  During fiscal 2020, the Bank had $1,000 of net recoveries on consumer loans, as compared to net charge-offs of $1,000 during fiscal 2019.

Loans Originations, Purchases, Sales and Repayments

Mortgage loans are originated for both investment and prior to scaling back originations of saleable single-family fixed-rate mortgage loans during fiscal 2019, a large amount of single-family fixed-rate mortgage loans were originated for sale to institutional investors. Mortgage loans sold to investors generally were sold without recourse other than standard representations and warranties.  Generally, mortgage loans sold to Fannie Mae and Freddie Mac were sold on a non-recourse basis and foreclosure losses are generally the responsibility of the purchaser and not the Bank, except in the case of Federal Housing Administration (“FHA”) and Veterans’ Administration (“VA”) used to form Government National Mortgage

11

Association pools, which are subject to limitations on the FHA’s and VA’s loan guarantees. For additional information, see Note 1 of the Notes to Consolidated Financial Statements, “Organization and Summary of Significant Accounting Policies,” under the subheading “Loans originated and held for sale” included in Item 8 of this Form 10-K.

The following table shows the Bank’s loan originations, purchases, sales and principal repayments during the periods indicated:
 
Year Ended June 30,
(In Thousands)
2020
2019
2018
   
Loans originated for sale:
     
     Retail originations
$
 
$
296,992
 
$
679,504
 
     Wholesale originations
 
170,102
 
506,492
 
          Total loans originated for sale
 
467,094
 
1,185,996
 
       
Loans sold:
     
     Servicing released
 
(551,754
)
(1,174,618
)
     Servicing retained
 
(7,196
)
(27,566
)
          Total loans sold
 
(558,950
)
(1,202,184
)
       
Loans originated for investment:
     
     Mortgage loans:
     
          Single-family
36,427
 
55,410
 
90,434
 
          Multi-family
51,022
 
42,191
 
66,355
 
          Commercial real estate
14,468
 
15,402
 
24,749
 
          Construction
3,983
 
7,159
 
4,667
 
          Other
143
 
 
167
 
     Consumer loans
1
 
 
4
 
          Total loans originated for investment
106,044
 
120,162
 
186,376
 
       
Loans purchased for investment:
     
     Mortgage loans:
     
          Single-family
70,733
 
33,256
 
 
          Multi-family
71,344
 
16,645
 
12,654
 
          Commercial real estate
 
1,157
 
868
 
          Total loans purchased for investment
142,077
 
51,058
 
13,522
 
       
Loan principal repayments
(228,250
)
(195,386
)
(208,503
)
Real estate acquired in the settlement of loans
 
 
(2,171
)
Increase (decrease) in other items, net(1)
3,000
 
(3,036
)
4,480
 
Net increase (decrease) in loans held for investment and loans held for sale
  at fair value
$
22,871
 
$
(119,058
)
$
(22,484
)

(1)
Includes net changes in undisbursed loan funds, deferred loan fees or costs, allowance for loan losses, fair value of loans held for investment, fair value of loans held for sale, advance payments of escrows and repurchases.

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Loan Servicing

The Bank receives fees from a variety of investors in return for performing the traditional services of collecting individual loan payments on loans sold by the Bank to such investors.  At June 30, 2020, the Bank was servicing $86.5 million of loans for others, a 28% decrease from $120.2 million at June 30, 2019.  The decrease was attributable to loan prepayments, and no loans sold with servicing retained during fiscal 2020.  Loan servicing includes processing payments, accounting for loan funds and collecting and paying real estate taxes, hazard insurance and other loan-related items such as private mortgage insurance. After the Bank receives the gross mortgage payment from individual borrowers, it remits to the investor a predetermined net amount based on the loan sale agreement for that mortgage.

Servicing assets are amortized in proportion to and over the period of the estimated net servicing income and are carried at the lower of cost or fair value.  The fair value of servicing assets is determined by calculating the present value of the estimated net future cash flows consistent with contractually specified servicing fees.  The Bank periodically evaluates servicing assets for impairment, which is measured as the excess of cost over fair value.  This review is performed on a disaggregated basis, based on loan type and interest rate.  Generally, loan servicing becomes more valuable when interest rates rise (as prepayments typically decrease) and less valuable when interest rates decline (as prepayments typically increase).  In estimating fair values at June 30, 2020 and 2019, the Bank used a weighted average Constant Prepayment Rate (“CPR”) of 26.07% and 23.86%, respectively, and a weighted-average discount rate of 9.11% at both dates.  The required impairment reserve against servicing assets at June 30, 2020 and 2019 was $291,000 and $298,000, respectively.  In aggregate, servicing assets had a carrying value of $673,000 and a fair value of $382,000 at June 30, 2020, compared to a carrying value of $925,000 and a fair value of $627,000 at June 30, 2019.


Delinquencies and Classified Assets

Delinquent Loans.  When a mortgage loan borrower fails to make a required payment when due, the Bank initiates collection procedures.  In most cases, delinquencies are cured promptly; however, if the loan remains delinquent on the 120th day for single-family loans or the 90th day for other loans, or sooner if the borrower is chronically delinquent, and after all reasonable means of obtaining the payment have been exhausted, foreclosure proceedings, according to the terms of the security instrument and applicable law, are initiated.  Interest income is reduced by the full amount of accrued and uncollected interest on such loans.

The following table sets forth delinquencies in the Bank’s loans held for investment as of the dates indicated, gross of collectively and individually evaluated allowances, if any:
 
At June 30,
 
2020
 
2019
 
2018
 
30 – 89 Days
 
Non-performing
 
30 - 89 Days
 
Non-performing
 
30 - 89 Days
 
Non-performing
(Dollars In Thousands)
Number
of
Loans
Principal
Balance
of Loans
 
Number
of
 Loans
Principal
Balance
of Loans
 
Number
of
Loans
Principal
Balance
of Loans
 
Number
of
Loans
Principal
Balance
of Loans
 
Number
of
 Loans
Principal
Balance
of Loans
 
Number
of
 Loans
Principal
Balance
of Loans
   
Mortgage loans:
                                 
    Single-family
1
 
$
219
   
18
 
$
5,318
   
2
 
$
660
   
20
 
$
5,640
   
1
 
$
804
   
21
 
$
6,141
 
    Construction
 
   
 
   
 
   
1
 
971
   
 
   
 
 
Commercial business
   loans
 
   
1
 
35
   
 
   
1
 
49
   
 
   
1
 
70
 
Consumer loans(1)
15
 
   
 
   
61
 
5
   
 
   
2
 
1
   
 
 
       Total
16
 
$
219
   
19
 
$
5,353
   
63
 
$
665
   
22
 
$
6,660
   
3
 
$
805
   
22
 
$
6,211
 

(1)
At June 30, 2020 and 2019, the balance includes 15 and 61 overdrawn consumer deposit accounts, respectively, which were not reported on June 30, 2018 due to immateriality.

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As of June 30, 2020, total non-performing assets, net of allowance for loan losses and fair value adjustments, were $4.9 million, or 0.42% of total assets, which was primarily comprised of: 18 single-family loans ($4.9 million); one commercial business loan ($31,000); and no real estate owned (“REO”).  As of June 30, 2020, 33%, or $1.6 million of non-performing loans had a current payment status. This compares to total non-performing assets, net of allowance for loan losses and fair value adjustments, of $6.2 million, or 0.57% of total assets, with $4.4 million, or 70%, of non-performing loans with a current payment status at June 30, 2019 and no REO.
The following table sets forth information with respect to the Bank’s non-performing assets and troubled debt restructurings (“restructured loans”), net of allowance for loan losses and fair value adjustments, at the dates indicated:
 
At June 30,
(Dollars In Thousands)
2020
2019
2018
2017
2016
           
Loans on non-performing status
  (excluding restructured loans):
         
Mortgage loans:
         
     Single-family
$
2,281
 
$
3,315
 
$
2,665
 
$
4,668
 
$
6,292
 
     Multi-family
 
 
 
 
709
 
     Commercial real estate
 
 
 
201
 
 
     Construction
 
971
 
 
 
 
     Total
2,281
 
4,286
 
2,665
 
4,869
 
7,001
 
           
Accruing loans past due 90 days or more
 
 
 
 
 
           
Restructured loans on non-performing status:
         
Mortgage loans:
         
     Single-family
2,612
 
1,891
 
3,328
 
3,061
 
3,232
 
Commercial business loans
31
 
41
 
64
 
65
 
76
 
     Total
2,643
 
1,932
 
3,392
 
3,126
 
3,308
 
           
Total non-performing loans
4,924
 
6,218
 
6,057
 
7,995
 
10,309
 
           
Real estate owned, net
 
 
906
 
1,615
 
2,706
 
Total non-performing assets
$
4,924
 
$
6,218
 
$
6,963
 
$
9,610
 
$
13,015
 
           
Non-performing loans as a percentage of
  loans held for investment, net
0.55
%
0.71
%
0.67
%
0.88
%
1.23
%
           
Non-performing loans as a percentage
of total assets
0.42
%
0.57
%
0.52
%
0.67
%
0.88
%
           
Non-performing assets as a percentage
of total assets
0.42
%
0.57
%
0.59
%
0.80
%
1.11
%

The Bank assesses loans individually and classifies the loans as non-performing and substandard in accordance with regulatory requirements when the accrual of interest has been discontinued, loans have been restructured or management has serious doubts about the future collectability of principal and interest, even though the loans are currently performing.  Factors considered in determining classification include, but are not limited to, expected future cash flows, collateral value, the financial condition of the borrower and current economic conditions. The Bank measures each non-performing loan based on ASC 310, “Receivables,” establishes a collectively evaluated or individually evaluated allowance and charges off those loans or portions of loans deemed uncollectible.

14

Restructured Loans.  A troubled debt restructuring is a loan which the Bank, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Bank would not otherwise consider.

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

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.

For the fiscal year ended June 30, 2020, there were two loans that were newly modified from their original terms, re-underwritten or identified as a restructured loan; one loan (previously modified) was downgraded to the substandard category; while one loan was upgraded from the special mention to pass category; two substandard loans were paid off; and no loans were converted to REO.  For the fiscal year ended June 30, 2019, there were no loans that were newly modified from their original terms, re-underwritten or identified as a restructured loan; one loan (previously modified) was downgraded; while three loans were upgraded to the pass category; one loan was paid off; and no loans were converted to REO.  During the fiscal years ended June 30, 2020 and 2019, no restructured loans were in default within a 12-month period subsequent to their original restructuring.  Additionally, during the fiscal year ended June 30, 2020, there were no restructured loans that were extended beyond the initial maturity of the modification; while in fiscal 2019, there was one restructured loan of $56,000 that was extended beyond the initial maturity of the modification.

As of June 30, 2020, the net outstanding balance of the Corporation’s eight restructured loans was $2.6 million: all eight loans were classified as substandard on non-accrual status.  As of June 30, 2020, $1.7 million, or 65 percent, of the restructured loans were current with respect to their payment status, consistent with their modified terms. As of June 30, 2019, the net outstanding balance of the Corporation’s eight restructured loans was $3.8 million:  one was classified as special mention on accrual status ($437,000); one was classified as substandard on accrual status ($1.4 million); and six were classified as substandard on non-accrual status ($1.9 million).  As of June 30, 2020, $1.2 million, or 44 percent, of the restructured loans were current with respect to their payment status, consistent with their modified terms. 

The Bank upgrades restructured single-family loans to the pass category if the borrower has demonstrated satisfactory contractual payments for at least six consecutive months or 12 months for those loans that were restructured more than once and there is a reasonable assurance that the payments will continue.  Once the borrower has demonstrated satisfactory contractual payments beyond 12 consecutive months, the loan is no longer categorized as a restructured loan. In March 2020, the Bank began offering short-term loan modifications to assist borrowers during the COVID-19 pandemic. The CARES Act and Interagency Statement provided that a short-term modification made in response to COVID-19 and which meets certain criteria does not need to be accounted for as a restructured loan. Accordingly, the Corporation does not account for such loan modifications as restructured loans. For additional information related to loan modifications as a result of the COVID-19 pandemic, see “Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – COVID-19 Impact to the Corporation.”

Other Loans of Concern.  As of June 30, 2020, $8.6 million of loans which were not disclosed as non-performing loans were classified as special mention because known information about possible credit problems of the borrowers causes management to have some doubt as to the ability of such borrowers to comply with present loan repayment terms.  Of these loans, $3.1 million were single-family mortgage loans, $3.8 million were multi-family mortgage loans and $1.7 million was a construction loan.  As of June 30, 2019, $8.6 million of loans which were not disclosed as non-performing loans were classified as special

15

mention because known information about possible credit problems of the borrowers causes management to have some doubt as to the ability of such borrowers to comply with present loan repayment terms.  Of these loans, $3.8 million were single-family mortgage loans, $3.9 million were multi-family mortgage loans and $927,000 was a commercial real estate loan.

Foreclosed Real Estate.  Real estate acquired by the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as REO until it is sold.  When a property is acquired, it is recorded at its fair market value less the estimated cost of sale.  Subsequent declines in value are charged to operations.  As of June 30, 2020 and 2019, there was no REO property at both dates. In managing the real estate owned properties for quick disposition, the Bank completes the necessary repairs and maintenance to the individual properties before listing for sale, obtains new appraisals and broker price opinions (“BPO”) to determine current market listing prices, and engages local realtors who are most familiar with real estate sub-markets, among other techniques, which generally results in the quick disposition of real estate owned.

Asset Classification.  The OCC has adopted various regulations regarding the problem assets of savings institutions.  The regulations require that each institution review and classify its assets on a regular basis.  In addition, in connection with examinations of institutions, OCC examiners have the authority to identify problem assets and, if appropriate, require them to be classified.  There are three classifications for problem assets: substandard, doubtful and loss.  Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss.  An asset classified as a loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted.  If an asset or portion thereof is classified as loss, the institution establishes an individually evaluated allowance and may subsequently charge-off the amount of the asset classified as loss.  A portion of the allowance for loan losses established to cover probable losses related to assets classified substandard or doubtful may be included in determining an institution’s regulatory capital.  Assets that do not currently expose the institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated as special mention and are closely monitored by the Bank.

Classified assets improved 13% to $14.1 million at June 30, 2020 from $16.2 million at June 30, 2019. The aggregate amounts of the Bank’s classified assets are primarily located in California.




16


The following table summarizes classified assets, which is comprised of classified loans, including loans classified by the Bank as special mention, net of allowance for loan losses, and REO at the dates indicated:
 
At June 30, 2020
 
At June 30, 2019
(Dollars In Thousands)
Balance
Count
 
Balance
Count
           
Special mention loans:
         
Mortgage loans:
         
     Single-family
$
3,120
 
7
   
$
3,795
 
13
 
     Multi-family
3,777
 
3
   
3,864
 
3
 
     Commercial real estate
1,703
 
1
   
927
 
1
 
     Total special mention loans
8,600
 
11
   
8,586
 
17
 
           
Substandard loans:
         
Mortgage loans:
         
     Single-family
5,438
 
22
   
6,631
 
23
 
     Construction
 
   
971
 
1
 
Commercial business loans
31
 
1
   
41
 
1
 
     Total substandard loans
5,469
 
23
   
7,643
 
25
 
           
Total classified loans
14,069
 
34
   
16,229
 
42
 
           
Real estate owned:
         
     Single-family
 
   
 
 
     Total real estate owned
 
   
 
 
           
Total classified assets
$
14,069
 
34
   
$
16,229
 
42
 
                       
Total classified assets as a percentage of total assets
 
1.20
%
       
1.50
%
   

Not all of the Bank’s classified assets are delinquent or non-performing.  In determining whether the Bank’s assets expose the Bank to sufficient risk to warrant classification, the Bank may consider various factors, including the payment history of the borrower, the loan-to-value ratio, and the debt coverage ratio of the property securing the loan.  After consideration of these and other factors, the Bank may determine that the asset in question, though not currently delinquent, presents a risk of loss that requires it to be classified or designated as special mention.  In addition, the Bank’s loans held for investment may include single-family, commercial and multi-family real estate loans with a balance exceeding the current market value of the collateral which are not classified because they are performing and have borrowers who have sufficient resources to support the repayment of the loan.

Allowance for Loan Losses.  The allowance for loan losses is maintained to cover losses inherent in the loans held for investment.  In originating loans, the Bank recognizes that losses will be experienced and that the risk of loss will vary with, among other factors, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the collateral securing the loan. The responsibility for the review of the Bank’s assets and the determination of the adequacy of the allowance lies with the Internal Asset Review Committee (“IAR Committee”).  The Bank adjusts its allowance for loan losses by charging (crediting) its provision (recovery) for loan losses against the Bank’s operations.

The Bank has established a methodology for the determination of the provision for loan losses.  The methodology is set forth in a formal policy and takes into consideration the need for a collectively evaluated allowance for groups of homogeneous loans

17

and an individually evaluated allowance that are tied to individual problem loans.  The Bank’s methodology for assessing the appropriateness of the allowance consists of several key elements.

The allowance is calculated by applying loss factors to the loans held for investment. The loss factors are applied according to loan program type and loan classification.  The loss factors for each program type and loan classification are established based on an evaluation of the historical loss experience, prevailing market conditions, concentration in loan types and other relevant factors consistent with ASC 450, “Contingency”.  Homogeneous loans, such as residential mortgage, home equity and consumer installment loans are considered on a pooled loan basis.  A factor is assigned to each pool based upon expected charge-offs for one year.   The factors for larger, less homogeneous loans, such as construction and commercial real estate loans, are based upon loss experience tracked over business cycles considered appropriate for the loan type.

Collectively evaluated or individually evaluated allowances are established to absorb losses on loans for which full collectability may not be reasonably assured as prescribed in ASC 310.  Estimates of identifiable losses are reviewed continually and, generally, a provision (recovery) for losses is charged (credited) against operations on a quarterly basis as necessary to maintain the allowance at an appropriate level.  Management presents the minutes summarizing the actions of the IAR Committee to the Bank’s Board of Directors on a quarterly basis.

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

The IAR Committee meets quarterly to review and monitor conditions in the portfolio and to determine the appropriate allowance for loan losses.  To the extent that any of these conditions are apparent by identifiable problem loans or portfolio segments as of the evaluation date, the IAR Committee’s estimate of the effect of such conditions may be reflected as an individually evaluated allowance applicable to such loans or portfolio segments.  Where any of these conditions is not apparent by specifically identifiable problem loans or portfolio segments as of the evaluation date, the IAR Committee’s evaluation of the probable loss related to such condition is reflected in the general allowance.  The intent of the IAR Committee is to reduce the differences between estimated and actual losses.  Pooled loan factors are adjusted to reflect current estimates of charge-offs for the subsequent 12 months.  Loss activity is reviewed for non-pooled loans and the loss factors are adjusted, if necessary.   By assessing the probable estimated losses inherent in the loans held for investment on a quarterly basis, the Bank is able to adjust specific and inherent loss estimates based upon the most recent information that has become available.

At June 30, 2020, the Bank had an allowance for loan losses of $8.3 million, or 0.91% of gross loans held for investment, compared to an allowance for loan losses at June 30, 2019 of $7.1 million, or 0.80% of gross loans held for investment. A $1.1 million provision for loan losses was recorded in fiscal 2020, compared to a $475,000 recovery from the allowance for loan losses in fiscal 2019.  The increase in the allowance for loan losses was due primarily to a qualitative reserve resulting from the COVID-19 pandemic and its continued and forecasted adverse economic impact. Although management believes the best information available is used to make such provision (recovery), future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly and adversely affected if circumstances differ substantially from the assumptions used in making the determinations.

18

While the Bank believes that it has established its existing allowance for loan losses in accordance with GAAP, there can be no assurance that regulators, in reviewing the Bank’s loan portfolio, will not recommend that the Bank significantly increase its allowance for loan losses.  In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, including as a result of COVID-19 pandemic, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary. Any material increase in the allowance for loan losses may adversely affect the Bank’s financial condition and results of operations.

The following table sets forth an analysis of the Bank’s allowance for loan losses for the periods indicated.  Where individually evaluated allowances have been established, any differences between the individually evaluated allowances and the amount of loss realized has been charged or credited to current operations.

 
Year Ended June 30,
(Dollars In Thousands)
2020
2019
2018
2017
2016
   
Allowance at beginning of period
$
7,076
 
$
7,385
 
$
8,039
 
$
8,670
 
$
8,724
 
Provision (recovery) for loan losses
1,119
 
(475
)
(536
)
(1,042
)
(1,715
)
Recoveries:
         
Mortgage Loans:
         
     Single-family
70
 
198
 
278
 
507
 
539
 
     Multi-family
 
 
 
18
 
1,228
 
     Commercial real estate
 
 
 
 
216
 
Commercial business loans
 
 
 
75
 
85
 
Consumer loans
2
 
2
 
 
13
 
1
 
          Total recoveries
72
 
200
 
278
 
613
 
2,069
 
           
Charge-offs:
         
Mortgage loans:
         
     Single-family
(1
)
(31
)
(392
)
(199
)
(406
)
Consumer loans
(1
)
(3
)
(4
)
(3
)
(2
)
          Total charge-offs
(2
)
(34
)
(396
)
(202
)
(408
)
           
Net recoveries (charge-offs)
70
 
166
 
(118
)
411
 
1,661
 
Allowance at end of period
$
8,265
 
$
7,076
 
$
7,385
 
$
8,039
 
$
8,670
 
           
Allowance for loan losses as a percentage of
  gross loans held for investment
0.91
%
0.80
%
0.81
%
0.88
%
1.02
%
Net (recoveries) charge-offs as a percentage
  of average loans receivable, net, during the
  period
(0.01
)%
(0.02
)%
0.01
%
(0.04
)%
(0.17
)%


19

The following table sets forth the breakdown of the allowance for loan losses by loan category at the periods indicated.  Management believes that the allowance can be allocated by category only on an approximate basis.  The allocation of the allowance is based upon an asset classification matrix. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance in one category to absorb losses in any other categories.
 
At June 30,
 
2020
 
2019
 
2018
 
2017
 
2016
(Dollars In Thousands)
Amount
% of
Loans in
Each
Category
to Total
Loans
 
Amount
% of
Loans in
Each
Category
to Total
 Loans
 
Amount
% of
Loans in
Each
Category
to Total
Loans
 
Amount
% of
Loans in
Each
Category
to Total
Loans
 
Amount
% of
Loans in
Each
Category
to Total
Loans
                             
  Mortgage loans:
                           
       Single-family
$
2,622
 
33.04
%
 
$
2,709
 
36.87
%
 
$
2,783
 
34.80
%
 
$
3,601
 
35.51
%
 
$
4,933
 
38.44
%
       Multi-family
4,329
 
54.38
   
3,219
 
49.81
   
3,492
 
52.63
   
3,420
 
52.89
   
2,800
 
49.23
 
       Commercial real estate
1,110
 
11.64
   
1,050
 
12.70
   
1,030
 
12.13
   
879
 
10.75
   
848
 
11.79
 
       Construction
171
 
0.86
   
61
 
0.53
   
47
 
0.35
   
96
 
0.77
   
31
 
0.40
 
       Other
3
 
0.02
   
3
 
0.02
   
3
 
0.02
   
 
   
7
 
0.04
 
  Commercial business loans
24
 
0.05
   
26
 
0.05
   
24
 
0.06
   
36
 
0.07
   
43
 
0.08
 
  Consumer loans
6
 
0.01
   
8
 
0.02
   
6
 
0.01
   
7
 
0.01
   
8
 
0.02
 
 Total allowance for
     loan losses
$
8,265
 
100.00
%
 
$
7,076
 
100.00
%
 
$
7,385
 
100.00
%
 
$
8,039
 
100.00
%
 
$
8,670
 
100.00
%


Investment Securities Activities

Federally chartered savings institutions are permitted under federal and state laws to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and government sponsored enterprises and of state and municipal governments, deposits at the FHLB, certificates of deposit of federally insured institutions, certain bankers’ acceptances, mortgage-backed securities and federal funds.  Subject to various restrictions, federally chartered savings institutions may also invest a portion of their assets in commercial paper and corporate debt securities.  Savings institutions such as the Bank are also required to maintain an investment in FHLB – San Francisco stock.

The investment policy of the Bank, established by the Board of Directors and implemented by the Bank’s Asset-Liability Committee, seeks to provide and maintain adequate liquidity, complement the Bank’s lending activities, and generate a favorable return on investment without incurring undue interest rate risk or credit risk.  Investments are made based on certain considerations, such as credit quality, yield, maturity, liquidity and marketability. The Bank also considers the effect that the proposed investment would have on the Bank’s risk-based capital requirements and interest rate risk sensitivity.

At June 30, 2020 and 2019, the Bank’s investment securities portfolio was $123.3 million and $100.1 million, respectively, which primarily consisted of federal agency and GSE obligations.  The Bank’s investment securities portfolio was classified as held to maturity and available for sale. The Corporation purchased held to maturity mortgage-backed securities totaling $55.9 million and $39.7 million during fiscal 2020 and 2019, respectively.


20

The following table sets forth the composition of the Bank’s investment portfolio at the dates indicated:
 
At June 30,
 
2020
 
2019
 
2018
(Dollars In Thousands)
Amortized
Cost
Estimated
Fair
Value
Percent
 
Amortized
Cost
Estimated
Fair
Value
Percent
 
Amortized
Cost
Estimated
Fair
Value
Percent
                       
Held to maturity securities:
                     
   U.S. government sponsored
  enterprise MBS (1)
$
115,763
 
$
118,354
 
93.99
%
 
$
90,394
 
$
91,669
 
90.47
%
 
$
84,227
 
$
83,668
 
88.32
%
   U.S. SBA securities(2)
2,064
 
2,047
 
1.63
   
2,896
 
2,890
 
2.85
   
2,986
 
2,971
 
3.14
 
   Certificates of deposits
800
 
800
 
0.63
   
800
 
800
 
0.79
   
600
 
600
 
0.63
 
      Total investment securities -
     held to maturity
$
118,627
 
$
121,201
 
96.25
%
 
$
94,090
 
$
95,359
 
94.11
%
 
$
87,813
 
$
87,239
 
92.09
%
                       
Available for sale securities:
                     
    U.S. government agency MBS(1)
$
2,823
 
$
2,943
 
2.34
%
 
$
3,498
 
$
3,613
 
3.57
%
 
$
4,234
 
$
4,384
 
4.63
%
   U.S. government sponsored
  enterprise MBS(1)
1,556
 
1,577
 
1.25
   
1,998
 
2,087
 
2.06
   
2,640
 
2,762
 
2.91
 
   Private issue CMO(3)
204
 
197
 
0.16
   
261
 
269
 
0.26
   
346
 
350
 
0.37
 
      Total investment securities -
     available for sale
$
4,583
 
$
4,717
 
3.75
%
 
$
5,757
 
$
5,969
 
5.89
%
 
$
7,220
 
$
7,496
 
7.91
%
      Total investment securities
$
123,210
 
$
125,918
 
100.00
%
 
$
99,847
 
$
101,328
 
100.00
%
 
$
95,033
 
$
94,735
 
100.00
%

(1)
Mortgage-backed securities (“MBS”)
(2)
Small Business Administration ("SBA")
(3)
Collateralized mortgage obligations (“CMO”)

The following table sets forth the outstanding balance, maturity and weighted average yield of the investment securities at June 30, 2020:
   
Due in
One Year
or Less
Due
After One to
Five Years
Due
After Five to
Ten Years
Due
After
Ten Years
Total
(Dollars in Thousands)
 
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Held to maturity securities:
                     
   U.S. government sponsored
   enterprise MBS
 
$
 
%
$
19,389
 
2.27
%
$
50,895
 
1.89
%
$
45,479
 
1.65
%
$
115,763
 
1.85
%
   U.S. SBA securities
 
 
 
 
 
 
 
2,064
 
0.60
 
2,064
 
0.60
 
   Certificates of deposits
 
800
 
1.53
 
 
 
 
 
 
 
800
 
1.53
 
Total investment securities -
held to maturity
 
$
800
 
1.53
%
$
19,389
 
2.27
%
$
50,895
 
1.89
%
$
47,543
 
1.60
%
$
118,627
 
1.83
%
                       
Available for sale securities:
                     
   U.S. government agency MBS
 
$
 
%
$
 
%
$
 
%
$
2,943
 
3.32
%
$
2,943
 
3.32
%
   U.S. government sponsored
   enterprise MBS
 
 
 
 
 
 
 
1,577
 
3.75
 
1,577
 
3.75
 
   Private issue CMO
 
 
 
 
 
 
 
197
 
3.70
 
197
 
3.70
 
Total investment securities -
available for sale
 
$
 
%
$
 
%
$
 
%
$
4,717
 
3.48
%
$
4,717
 
3.48
%
Total investment securities
 
$
800
 
1.53
%
$
19,385
 
2.27
%
$
50,895
 
1.89
%
$
52,260
 
1.77
%
$
123,344
 
1.89
%

The actual maturity and yield for MBS and CMO may differ from the stated maturity and stated yield due to scheduled amortization, loan prepayments and acceleration of premium amortization or discount accretion.

21

Deposit Activities and Other Sources of Funds

General.  Deposits and loan repayments are the major sources of the Bank’s funds for lending and other investment purposes.  Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows are influenced significantly by general interest rates and money market conditions. Borrowings through the FHLB – San Francisco and repurchase agreements may be used to compensate for declines in the availability of funds from other sources.

Deposit Accounts.  Substantially all of the Bank’s depositors are residents of the State of California.  Deposits are attracted from within the Bank’s market area by offering a broad selection of deposit instruments, including checking, savings, money market and time deposit accounts. Deposit account terms vary, differentiated by the minimum balance required, the time periods that the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the Bank considers current interest rates, profitability to the Bank, interest rate risk characteristics, competition and its customers’ preferences and concerns.  Generally, the Bank’s deposit rates are commensurate with the median rates of its competitors within a given market.  The Bank may occasionally pay above-market interest rates to attract or retain deposits when less expensive sources of funds are not available.  The Bank may also pay above-market interest rates in specific markets in order to increase the deposit base of a particular office or group of offices.  The Bank reviews its deposit composition and pricing on a weekly basis.

The Bank generally offers time deposits for terms not exceeding seven years.  As illustrated in the following table, time deposits represented 19% of the Bank’s deposit portfolio at June 30, 2020, compared to 23% at June 30, 2019.  As of June 30, 2020 and 2019, there were no brokered deposits. The Bank attempts to reduce the overall cost of its deposit portfolio and to increase its franchise value by emphasizing transaction accounts, which are subject to a heightened degree of competition.  For additional information, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K.






22

The following table sets forth information concerning the Bank’s weighted-average interest rate of deposits at June 30, 2020:
Weighted
Average
Interest Rate
 Original Term
Deposit  Account Type
Minimum
Amount
Balance
(In Thousands)
Percentage
of Total
Deposits
           
   
Transaction accounts:
     
   —%
N/A
Checking accounts – non interest-bearing
$
 
$
118,771
 
13.30
%
0.10%
N/A
Checking accounts – interest-bearing
$
 
290,463
 
32.53
 
0.13%
N/A
Savings accounts
$
10
 
273,769
 
30.66
 
0.22%
N/A
Money market accounts
$
 
39,989
 
4.48
 
           
   
Time deposits:
     
0.05%
30 days or less
Fixed-term, fixed rate
$
1,000
 
20
 
 
0.13%
31 to 90 days
Fixed-term, fixed rate
$
1,000
 
4,393
 
0.49
 
0.29%
91 to 180 days
Fixed-term, fixed rate
$
1,000
 
9,778
 
1.09
 
0.59%
181 to 365 days
Fixed-term, fixed rate
$
1,000
 
40,065
 
4.49
 
0.47%
Over 1 to 2 years
Fixed-term, fixed rate
$
1,000
 
20,531
 
2.30
 
1.00%
Over 2 to 3 years
Fixed-term, fixed rate
$
1,000
 
19,811
 
2.22
 
1.30%
Over 3 to 5 years
Fixed-term, fixed rate
$
1,000
 
62,102
 
6.95
 
1.82%
Over 5 to 10 years
Fixed-term, fixed rate
$
1,000
 
13,277
 
1.49
 
0.26%
     
$
892,969
 
100.00
%

The following table indicates the aggregate dollar amount of the Bank’s time deposits with balances of $100,000 or more differentiated by time remaining until maturity as of June 30, 2020:
Maturity Period
Amount
(In Thousands)
 
Three months or less
$
17,194
 
Over three to six months
16,669
 
Over six to twelve months
14,895
 
Over twelve months
39,039
 
Total
$
87,797
 






23

Deposit Flows. The following table sets forth the balances (inclusive of interest credited) and changes in the dollar amount of deposits in the various types of accounts offered by the Bank at and between the dates indicated:
 
At June 30,
 
2020
 
2019
(Dollars In Thousands)
Amount
Percent
of
Total
Increase
(Decrease)
 
Amount
Percent
of
Total
Increase
(Decrease)
       
Checking accounts – non interest-bearing
$
118,771
 
13.30
%
$
28,587
   
$
90,184
 
10.72
%
$
4,010
   
Checking accounts – interest-bearing
290,463
 
32.53
 
32,554
   
257,909
 
30.66
 
(1,463
)
 
Savings accounts
273,769
 
30.66
 
9,382
   
264,387
 
31.43
 
(25,404
)
 
Money market accounts
39,989
 
4.48
 
4,343
   
35,646
 
4.24
 
1,013
   
Time deposits:
               
     Fixed-term, fixed rate which mature:
               
          Within one year
90,576
 
10.14
 
(15,504
)
 
106,080
 
12.61
 
(10,253
)
 
          Over one to two years
33,995
 
3.81
 
(3,122
)
 
37,117
 
4.41
 
(28,083
)
 
          Over two to five years
44,471
 
4.98
 
(4,782
)
 
49,253
 
5.85
 
(5,027
)
 
          Over five years
935
 
0.10
 
240
   
695
 
0.08
 
(1,120
)
 
       Total
$
892,969
 
100.00
%
$
51,698
   
$
841,271
 
100.00
%
$
(66,327
)
 

Time Deposits by Rates.  The following table sets forth the aggregate balance of time deposits categorized by interest rates at the dates indicated:
 
At June 30,
(Dollars In Thousands)
2020
2019
2018
   
Below 1.00%
$
79,521
 
$
80,701
 
$
114,975
 
1.00 to 1.99%
85,232
 
95,904
 
113,211
 
2.00 to 2.99%
5,224
 
16,540
 
7,875
 
3.00 to 3.99%
 
 
1,567
 
            Total
$
169,977
 
$
193,145
 
$
237,628
 

Time Deposits by Maturities.  The following table sets forth the aggregate dollar amount of time deposits at June 30, 2020 differentiated by interest rates and maturity:
(Dollars In Thousands)
One Year
or Less
Over One
to
Two Years
Over Two
to
Three Years
Over Three
to
Four Years
After
Four
Years
Total
   
Below 1.00%
$
59,146
 
$
12,142
 
$
5,072
 
$
595
 
$
2,566
 
$
79,521
 
1.00 to 1.99%
31,430
 
21,853
 
15,641
 
7,589
 
8,719
 
85,232
 
2.00 to 2.99%
 
 
5,224
 
 
 
5,224
 
           Total
$
90,576
 
$
33,995
 
$
25,937
 
$
8,184
 
$
11,285
 
$
169,977
 


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Deposit Activity.  The following table sets forth the deposit activity of the Bank at and for the periods indicated:
 
At or For the Year Ended June 30,
(In Thousands)
2020
2019
2018
   
Beginning balance
$
841,271
 
$
907,598
 
$
926,521
 
       
Net deposits (withdrawals) before interest credited
48,755
 
(69,708
)
(22,418
)
Interest credited
2,943
 
3,381
 
3,495
 
Net increase (decrease) in deposits
51,698
 
(66,327
)
(18,923
)
       
        Ending balance
$
892,969
 
$
841,271
 
$
907,598
 


Borrowings.  The FHLB – San Francisco functions as a central reserve bank providing credit for member financial institutions.  As a member, the Bank is required to own capital stock in the FHLB – San Francisco and is authorized to apply for advances using such stock and certain of its mortgage loans and other assets (principally investment securities) as collateral, provided certain creditworthiness standards have been met.  Advances are made pursuant to several different credit programs.  Each credit program has its own interest rate, maturity, terms and conditions.  Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit.  The Bank utilizes advances from the FHLB – San Francisco as an alternative to deposits to supplement its supply of lendable funds, to meet deposit withdrawal requirements and to help manage interest rate risk.  The FHLB – San Francisco has, from time to time, served as the Bank’s primary borrowing source.  As of June 30, 2020 and 2019, the FHLB – San Francisco borrowing capacity was limited to 35% of the Bank’s total assets at both dates, amounting to $387.6 million and $391.8 million, respectively.  Advances from the FHLB – San Francisco are typically secured by the Bank’s single-family residential, multi-family and commercial real estate mortgage loans.  Total mortgage loans pledged to the FHLB – San Francisco were $658.7 million at June 30, 2020 as compared to $643.0 million at June 30, 2019.  In addition, the Bank pledged investment securities totaling $2.2 million at June 30, 2020 as compared to $3.2 million at June 30, 2019 to collateralize its FHLB – San Francisco advances under the Securities-Backed Credit (“SBC”) facility.  At June 30, 2020 and 2019, the Bank had $141.0 million and $101.1 million of borrowings, respectively, from the FHLB – San Francisco with a weighted-average interest rate of 2.23% and 2.62%, respectively.  At June 30, 2020, the outstanding borrowings mature between 2020 and 2025 with a weighted average maturity of 28 months.  In addition to the total borrowings mentioned above, the Bank utilized its borrowing facility for letters of credit and credit enhancement for loans previously sold to the FHLB – San Francisco under the Mortgage Partnership Finance (“MPF”) program which have a recourse liability.  The outstanding letters of credit at June 30, 2020 and 2019 was $16.0 million and $13.0 million, respectively; and the outstanding MPF credit enhancement was $2.5 million at both dates.  For additional information, see Note 1 of the Notes to Consolidated Financial Statements, “Organization and Summary of Significant Accounting Policies,” under the subheading “Loans originated and held for sale” and Note 8 included in Item 8 of this Form 10-K.  As of June 30, 2020 and 2019, the remaining financing availability was $228.1 million and $275.2 million, respectively, with remaining available collateral of $351.5 million and $434.7 million, respectively.  In addition, as of June 30, 2020 and 2019, the Bank had secured a discount window facility of $94.4 million and $74.2 million, respectively, at the Federal Reserve Bank of San Francisco, collateralized by investment securities with a fair market value of $100.4 million and $79.0 million, respectively.  The Bank also has a federal funds facility with its correspondent bank for $17.0 million which matures on June 30, 2021.  As of June 30, 2020, there were no outstanding borrowings under the discount window facility or the federal funds facility with the correspondent bank.


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The following table sets forth certain information regarding borrowings by the Bank at the dates and for the years indicated:

   
At or For the Year Ended June 30,
 
(Dollars In Thousands)
 
2020
   
2019
   
2018
 
       
Balance outstanding at the end of period:
                 
            FHLB – San Francisco advances
 
$
141,047
   
$
101,107
   
$
126,163
 
                         
Weighted average rate at the end of period:
                       
            FHLB – San Francisco advances
   
2.23
%
   
2.62
%
   
2.47
%
                         
Maximum amount of borrowings outstanding at any month end:
                       
            FHLB – San Francisco advances
 
$
141,057
   
$
136,158
   
$
126,163
 
                         
Average short-term borrowings during the period
with respect to:(1)
                       
            FHLB – San Francisco advances
 
$
11,562
   
$
8,425
   
$
8,687
 
                         
Weighted average short-term borrowing rate during the period
with respect to:(1)
                       
            FHLB – San Francisco advances
   
3.30
%
   
1.69
%
   
2.53
%
(1)  Borrowings with a remaining term of 12 months or less.

As a member of the FHLB – San Francisco, the Bank is required to maintain a minimum investment in FHLB – San Francisco stock.  The Bank held the required investment at June 30, 2020 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 with an excess investment of $470,000.

During fiscal 2020, the FHLB – San Francisco redeemed $229,000 of the excess capital stock, while the Bank did not purchase any FHLB - San Francisco capital stock. During fiscal 2019, the FHLB – San Francisco did not redeem any capital stock and the Bank did not purchase any FHLB - San Francisco capital stock. In fiscal 2020 and 2019, the FHLB – San Francisco distributed $534,000 and $707,000 of cash dividends, respectively, to the Bank.  The cash dividends received by the Bank in fiscal 2019 included a special cash dividend of $133,000, not replicated in fiscal 2020.


Subsidiary Activities

Federal savings institutions generally may invest up to 3% of their assets in service corporations, provided that at least one-half of any amount in excess of 1% is used primarily for community, inner-city and community development projects.  The Bank’s investment in its service corporations did not exceed these limits at June 30, 2020 and 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, 2020 and 2019, the Bank’s investment in its subsidiaries was $9,000 and $15,000, respectively.

26


REGULATION

The following is a brief description of certain laws and regulations which are applicable to the Corporation and the Bank.  The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.

Legislation is introduced from time to time in the United States Congress (“Congress”) that may affect the Corporation’s and the Bank’s operations.  In addition, the regulations governing the Corporation and the Bank may be amended from time to time by the OCC, FDIC, FRB and SEC, as appropriate.  Any such legislation or regulatory changes in the future could adversely affect the operations and financial condition of the Corporation and the Bank. The Bank cannot predict whether any such changes may occur.

General

The Bank, as a federally chartered savings institution, is subject to extensive regulation, examination and supervision by the OCC, as its primary federal regulator, and the FDIC, as its insurer of deposits.  The Bank's relationship with its depositors and borrowers is regulated by federal consumer protection laws, 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. This regulatory structure establishes a comprehensive framework of activities in which the Bank may engage and is intended primarily for the protection of the insurance fund and depositors.  The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes.  Any change in such policies, whether by the OCC, the FRB, the FDIC or Congress, could have a material adverse impact on the Corporation and the Bank and their operations.  The Corporation, as a savings and loan holding company, is required to file certain reports with, is subject to examination by, and otherwise must comply with the rules and regulations of the FRB, its primary regulator.  The Corporation is also subject to the rules and regulations of the SEC under the federal securities laws.  For additional information, see “Savings and Loan Holding Company Regulations” below in this Form 10-K.

In connection with the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), the laws and regulations affecting depository institutions and their holding companies have changed particularly affecting the bank regulatory structure and the lending, investment, trading and operating activities of depository institutions and their holding companies. Among other changes, the Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”) as an independent bureau of the Federal Reserve Board. The CFPB assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations and has authority to impose new requirements. The Bank is subject to regulations issued by the CFPB, but as a smaller financial institution, the Bank is generally subject to supervision and enforcement by the OCC with respect to its compliance with consumer financial protection laws and CFPB regulations.

On May 23, 2018, the President signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act passed by Congress (the “Act”). The Act contains a number of provisions extending regulatory relief to banks and savings institutions and their holding companies. Some of these provisions may benefit the Corporation and the Bank, such as (1) a simplified capital ratio, called the Community Bank Leverage Ratio or CBLR, computed as the ratio of tangible equity capital to average consolidated total assets to be set by the federal banking regulators at not less than 8% and not more than 10%, which for most institutions with less than $10 billion in consolidated assets may  replace the leverage and risk-based capital ratios under current regulations; (2) an option for federal savings institutions to operate as national banks with respect to limits on lending, investments, and subsidiaries, without changing their charters to national bank charters; and (3) a lower risk weight on certain

27

loans classified as high volatility commercial real estate exposures. Effective January 1, 2020, the CBRL was 9.0%. These CBLR rules were modified in response to the COVID-19 pandemic. See "- The Coronavirus Aid, Relief, and Economic Security Act of 2020" below.

Federal Regulation of Savings Institutions

Office of the Comptroller of the Currency.  The OCC has extensive authority over the operations of federal savings institutions.  As part of this authority, the Bank is required to file periodic reports with the OCC and is subject to periodic examinations by the OCC. The OCC also has extensive enforcement authority over all federal savings institutions, including the Bank.  This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and-desist or removal orders and initiate prompt corrective action orders.  In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices.  Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OCC.  Except under certain circumstances, public disclosure of final enforcement actions by the OCC is required by law.

All federal savings institutions must pay assessments to the OCC, to fund the agency’s operations.  The general assessments, paid on a semi-annual basis, are determined based on the savings institution’s total assets, including consolidated subsidiaries.  The Bank’s OCC annual assessments for the fiscal years ended June 30, 2020 and 2019 were $227,000 and $262,000, respectively.

The Bank's general permissible lending limit for loans to one borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). The Bank’s limits on loans to one borrower or group of related borrowers at June 30, 2020 and 2019 were $18.8 million and $18.3 million, respectively.  At June 30, 2020, the Bank’s largest lending relationship to a single borrower or group of borrowers consists of two multi-family loans totaling $4.5 million, which were performing according to its original payment terms.

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 imposes significant responsibilities on financial institutions to 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 requirements under the Bank Secrecy Act and the regulations of the Office of Foreign Assets Control.

Federal Home Loan Bank System.  The Bank is a member of the FHLB – San Francisco, which is one of 11 regional FHLBs, each of which serves as a reserve or central bank for its members within its assigned region.  The FHLB - San Francisco is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System.  It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Agency.  All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB - San Francisco.  In addition, all long-term advances are required to provide funds for residential home financing.  At June 30, 2020 and 2019, the Bank had $141.0 million and $101.1 million of outstanding advances, respectively, from the FHLB – San Francisco with a remaining available credit facility of $228.1 million and $275.2 million, respectively, based on 35% of total assets for both dates, which is limited to available

28

collateral.  For additional information, see “Business – Deposit Activities and Other Sources of Funds – Borrowings” above in this Form 10-K.

As a member of the FHLB - San Francisco, the Bank is required to purchase and maintain stock in the FHLB – San Francisco.  At June 30, 2020 and 2019, the Bank held $8.0 million and $8.2 million of FHLB-San Francisco stock, respectively, which was in compliance with this membership requirement.  During fiscal 2020, there was a $229,000 excess capital redemption as compared to no redemption in fiscal 2019.  In fiscal 2020 and 2019, the FHLB – San Francisco distributed $534,000 and $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.

Insurance of Accounts and Regulation by the FDIC.  The Deposit Insurance Fund (“DIF”) of the FDIC insures deposits up to $250,000 per account owner as defined by the FDIC, backed by the full faith and credit of the United States.  As insurer, the FDIC imposes deposit insurance premiums in the form of assessments and is authorized to conduct examinations of and to require reporting by FDIC insured institutions.  It may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund.  The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OCC an opportunity to take such action, and may terminate the savings institution's deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.  Management of the Bank is not aware of any practice, condition or violation that might lead to termination of the Bank's deposit insurance.

Under its regulations, the FDIC sets assessment rates for established small institutions (generally, those with total assets of less than $10 billion) based on an institution’s weighted average CAMELS component ratings and certain financial ratios. Total base assessment rates currently range from 3 to 30 basis points subject to certain adjustments. Assessment rates are expected to decrease in the future as the reserve ratio increases in specified increments. The FDIC may increase or decrease its rates up to two basis points without further rule-making. In an emergency, the FDIC may also impose a special assessment.

The Dodd-Frank Act increased the minimum FDIC deposit insurance reserve ratio from 1.15 percent to 1.35 percent. The FDIC surpassed the 1.35% as of September 30, 2018. The Dodd-Frank Act directed the FDIC to offset the effects of higher assessments due to the increase in the reserve ratio on established small institutions by charging higher assessments to large institutions. To implement this mandate, large and highly complex institutions paid a surcharge on their base since established small institutions automatically receive credits from the FDIC for the portion of their assessments that contribute to the increase. In September 2019, the FDIC awarded a small bank assessment credit to the Bank totaling $297,000, which reduced insurance assessments for approximately the first nine months of fiscal 2020. For the fiscal year 2020, the average annualized rate for the overall FDIC insurance assessments was 3.00 basis points.

Qualified Thrift Lender Test.  Like all savings institutions (subject to a narrow exception not applicable to the Bank), the Bank is required to meet a qualified thrift lender (“QTL”) test to avoid certain restrictions on their operations.  This test requires a savings institution to have at least 65% of its total assets as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis.  As an alternative, a savings institution may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code of 1986 (“Code”), as amended.  Under either test, such assets primarily consist of residential housing related loans and investments.

29

Any savings institution that fails to meet the QTL test is subject to certain operating restrictions and may be required to convert to a national bank charter, and a savings and loan holding company of such an institution may become regulated as a bank holding company.  As of June 30, 2020, the Bank maintained 88.7% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test.  During fiscal 2020 and 2019, the Bank was in compliance with the QTL test as of each month end.

Capital Requirements. Federally insured savings institutions, such as the Bank, are required by the OCC to maintain minimum levels of regulatory capital, including a common equity Tier 1 (“CET1”) capital to risk-based assets ratio, a Tier 1 capital to risk-based assets ratio, a total capital to risk-based assets ratio and a Tier 1 capital to total assets leverage ratio. The capital standards require the maintenance of the following minimum capital ratios: (i) a CET1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%.

Mortgage servicing rights and deferred tax assets over designated percentages of CET1 are also deducted from capital.  In addition, Tier 1 capital includes accumulated other comprehensive income, which includes all unrealized gains and losses on available for sale debt, equity securities and interest-only strips.  Because of the Bank’s asset size, the Bank was given a one-time option to permanently opt-out of the inclusion of unrealized gains and losses on available for sale debt, equity securities and interest-only strips in its capital calculations. The Bank elected to exercise this option to opt-out in order to reduce the impact of market volatility on its regulatory capital levels.

The Bank also must maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum risk-based capital levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses. If the Bank does not have the ability to pay dividends to the Corporation, the Corporation may be limited in its ability to pay dividends to its stockholders.

In order to be considered well-capitalized under the prompt corrective action regulations, the Bank must maintain a CET1 risk-based ratio of 6.5%, a Tier 1 risk-based ratio of 8%, a total risk-based capital ratio of 10% and a leverage ratio of 5%, and the Bank must not be subject to any of certain mandates by the OCC requiring it as an individual institution to meet any specified capital level. Effective January 1, 2020, a bank or savings institution that elects to use the Community Bank Leverage Ratio will generally be considered well-capitalized and to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0%. In order to qualify for the Community Bank Leverage Ratio framework, in addition to maintaining a leverage ratio greater than 9%, the bank or institution also must have total consolidated assets of less than $10 billion, off-balance sheet exposures of 25% or less of its total consolidated assets, and trading assets and trading liabilities of 5.0% or less of its total consolidated assets, all as of the end of the most recent quarter. A bank electing the framework that ceases to meet any qualifying criteria in a future period and that has a leverage ratio greater than 8% will be allowed a grace period of two reporting periods to satisfy the CBLR qualifying criteria or comply with the generally applicable capital requirements.  A bank may opt out of the framework at any time, without restriction, by reverting to the generally applicable risk-based capital rule. These CBLR rules were modified in response to the COVID-19 pandemic. See "- The Coronavirus Aid, Relief, and Economic Security Act of 2020" below.

As of June 30, 2020, the most recent notification from the OCC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action.  See Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.

Prompt Corrective Action.  An institution is considered adequately capitalized if it meets the minimum capital ratios described above. The OCC is required to take certain supervisory actions against undercapitalized savings institutions, the severity of which depends upon the institution's degree of undercapitalization.  Subject to a narrow exception, the OCC is required to appoint a receiver or conservator for a savings institution that is "critically undercapitalized." OCC regulations also require that a capital restoration plan be filed with the OCC within 45 days of the date a savings institution receives notice that

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it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. “Significantly undercapitalized” and “critically undercapitalized” institutions are subject to more extensive mandatory regulatory actions.  The OCC also may take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.

Limitations on Capital Distributions.  OCC regulations impose various restrictions on savings institutions and on their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account.  Generally, savings institutions, such as the Bank, that before and after the proposed distribution are well-capitalized, may make capital distributions during any calendar year up to 100% of net income for the year-to-date plus retained net income for the two preceding years.  However, an institution deemed to be in need of more than normal supervision or in troubled condition by the OCC may have its dividend authority restricted by the OCC.  If the Bank, however, proposes to make a capital distribution when it does not meet its capital requirements (or will not following the proposed capital distribution) or that will exceed these net income-based limitations, it must obtain the OCC's approval prior to making such distribution.  In addition, the Bank must file a prior written notice of a dividend with the FRB. The FRB or the OCC may object to a capital distribution based on safety and soundness concerns.  Further restrictions on Bank dividends may apply if the Bank fails the QTL test.  In addition, as noted above, if the Bank does not have the required capital conservation buffer, its ability to pay dividends to the Corporation will be limited, which may limit the ability of the Corporation to pay dividends to its stockholders.

Activities of Savings Associations and Their Subsidiaries.  When a savings institution establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the savings institution controls, the savings institution must file a notice or application with the OCC and in certain circumstances with the FDIC and receive regulatory approval or non-objection. Savings institutions also must conduct the activities of subsidiaries in accordance with existing regulations and orders. With respect to subsidiaries generally, the OCC may determine that investment by a savings institution in, or the activities of, a subsidiary must be restricted or eliminated based on safety and soundness or legal reasons.

Transactions with Affiliates. The Bank’s authority to engage in transactions with “affiliates” is limited by Sections 23A and 23B of the Federal Reserve Act as implemented by the FRB’s Regulation W.  The term “affiliates” for these purposes generally mean any company that controls or is under common control with an institution except subsidiaries of the institution. The Corporation and its non-savings institution subsidiaries are affiliates of the Bank. In general, transactions with affiliates must be on terms that are as favorable to the institution as comparable transactions with non-affiliates.  In addition, certain types of transactions are restricted to an aggregate percentage of the institution’s capital.  Institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary. FDIC-insured institutions are subject, with certain exceptions, to certain restrictions on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. Collateral in specified amounts must be provided by affiliates in order to receive loans from an institution. In addition, these institutions are prohibited from engaging in certain tying arrangements in connection with any extension of credit or the providing of any property or service.

The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) generally prohibits the Corporation from making loans to its executive officers and directors.  However, that act contains a specific exception for loans by a depository institution to its executive officers and directors, if the lending is in compliance with federal banking laws.  Under such laws, the Bank’s authority to extend credit to executive officers, directors and 10% stockholders (“insiders”), as well as entities which such persons control, is limited.  The law restricts both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank’s capital position and requires certain Board approval procedures to be followed. Such loans must be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of

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repayment.  There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees.  There are additional restrictions applicable to loans to executive officers.

Community Reinvestment Act and Consumer Protection Laws.  Under the Community Reinvestment Act of 1977 (“CRA”), every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods.  The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA.  The CRA requires the OCC, in connection with the examination of the Bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the Bank.  The OCC may use an unsatisfactory rating as the basis for the denial of an application.  Similarly, the FRB is required to take into account the performance of an insured institution under the CRA when considering whether to approve an acquisition by the institution’s holding company. Due to heightened attention to the CRA in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community.  The Bank received a rating of satisfactory when it was last examined for CRA compliance.

In connection with its deposit-taking, lending and other activities, the Bank is subject to a number of federal laws designed to protect consumers and promote lending to various sectors of the economy and population. Some state laws can apply to these activities as well. The CFPB issues regulations and standards under these federal laws, which include, among others, the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act and the Real Estate Settlement Procedures Act.  Through its rulemaking authority, the CFPB has promulgated a number of regulations under these laws that affect the bank’s consumer businesses.  Among these are regulations setting “ability to repay” and “qualified mortgage” standards for residential mortgage loans and establishing new mortgage loan servicing and loan originator compensation standards. The Bank devotes substantial compliance, legal and operational business resources to ensure compliance with applicable consumer protection standards. In addition, the OCC has enacted customer privacy regulations that limit the ability of the Bank to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with non-affiliated parties.

Bank Secrecy Act/Anti-Money Laundering LawsThe Bank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA Patriot Act of 2001.  These laws and regulations require the Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing and to verify the identity of their customers.  Violations of these requirements can result in substantial civil and criminal sanctions.  In addition, provisions of the USA Patriot Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing mergers and acquisitions.

Regulatory and Criminal Enforcement Provisions.  The OCC has primary enforcement responsibility over federally chartered savings institutions and has the authority to bring action against all “institution-affiliated parties,” including stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution.  Formal enforcement action may range from the issuance of a capital directive or cease-and-desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance.  Civil penalties cover a wide range of violations and can be nearly $2.0 million per day per violation in especially egregious cases.  The FDIC has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings institution.  If the OCC does not take action, the FDIC has authority to take such action under certain circumstances.  Federal law also establishes criminal penalties for certain violations.

Standards for Safety and Soundness. As required by statute, the federal banking agencies have adopted interagency guidelines prescribing standards for safety and soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes

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impaired. If the OCC determines that a savings institution fails to meet any standard prescribed by the guidelines, the OCC may require the institution to submit an acceptable plan to achieve compliance with the standard.

Federal Reserve System. The FRB requires that all depository institutions maintain reserves on transaction accounts or non-personal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank. Interest-bearing checking accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any non-personal time deposits at a bank. Effective March 26, 2020, the FRB reduced reserve requirement ratios to 0%, which eliminated reserve requirements for all depository institutions.

Environmental Issues Associated with Real Estate Lending.  The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), is a federal statute, generally imposes strict liability on all prior and present "owners and operators" of sites containing hazardous waste.  However, Congress acted to protect secured creditors by providing that the term "owner and operator" excludes a person whose ownership is limited to protecting its security interest in the site.  Since the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan.

To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which costs often substantially exceed the value of the collateral property.

Other Consumer Protection Laws and Regulations.  The Dodd-Frank Act established the CFPB and empowered it to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. The Bank is subject to consumer protection regulations issued by the CFPB, but as a financial institution with assets of less than $10 billion, the Bank is generally subject to supervision and enforcement by the OCC with respect to compliance with consumer financial protection laws and CFPB regulations

The Bank is subject to a broad array of federal and state consumer protection laws and regulations that govern almost every aspect of its business relationships with consumers.  While the following  list is not exhaustive, these include the the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfers Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Fair Credit Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices, and various regulations that implement some or all of the foregoing.  These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans, and providing other services.  Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages, and the loss of certain contractual rights.


Savings and Loan Holding Company Regulation

General.  The Corporation is a unitary savings and loan holding company, subject to the regulatory oversight of the FRB.  Accordingly, the Corporation is required to register and file reports with the FRB and is subject to regulation and examination by the FRB.  In addition, the FRB has enforcement authority over the Corporation and its non-savings institution subsidiaries, which also permits the FRB to restrict or prohibit activities that are determined to present a serious risk to the subsidiary savings institution.  In accordance with the Dodd-Frank Act, the FRB must require any company that controls an

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FDIC-insured depository institution to serve as a source of financial strength for the institution. These and other FRB policies, as well as the capital conservation buffer may restrict the Corporation’s ability to pay dividends.

Capital Requirements.  For a savings and loan holding company that qualifies as a small bank holding company under the FRB’s Small Bank Holding Company Policy Statement, such as the Corporation, the capital regulations apply to its savings institution subsidiaries, but not the Corporation. The FRB expects the holding company’s savings institution subsidiaries to be well capitalized under the prompt corrective action regulations. For a description of the capital regulations, see “Federal Regulation of Savings Institutions - Capital Requirements” above.

Activities Restrictions.  The GLBA provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies.  The GLBA also specifies, subject to a grandfather provision, that existing savings and loan holding companies may only engage in such activities.  The Corporation qualifies for the grandfathering and is therefore not restricted in terms of its activities.  Upon any non-supervisory acquisition by the Corporation of another savings association as a separate subsidiary, the Corporation would become a multiple savings and loan holding company and would be limited to those activities permitted by FRB regulation.  Multiple savings and loan holding companies may engage in activities permitted for financial holding companies, and certain other activities including acting as a trustee under a deed of trust and real estate investments.

If the Bank fails the QTL test, the Corporation must, within one year of that failure, register as, and become subject to the restrictions applicable to bank holding companies.  For additional information, see “Federal Regulation of Savings Institutions – Qualified Thrift Lender Test” in this Form 10-K.

Mergers and Acquisitions.  The Corporation must obtain approval from the FRB before acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company or acquiring such an institution or holding company by merger, consolidation or purchase of its assets.  In evaluating an application for the Corporation to acquire control of a savings institution, the FRB would consider the financial and managerial resources and future prospects of the Corporation and the target institution, the effect of the acquisition on the risk to the DIF, the convenience and the needs of the community, including performance under the CRA and competitive factors.

The FRB may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions; (i) supervisory acquisitions and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions.  The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

Acquisition of the Company.  Any company, except a bank holding company, that acquires control of a savings association or savings and loan holding company becomes a “savings and loan holding company” subject to registration, examination and regulation by the FRB and must obtain the prior approval of the FRB under the Savings and Loan Holding Company Act before obtaining control of a savings association or savings and loan holding company.  A bank holding company must obtain the prior approval of the FRB under the Bank Holding Company Act before obtaining control or more than 5% of a class of voting stock of a savings association or savings and loan holding company and remains subject to regulation under the Bank Holding Company Act.  The term “company” includes corporations, partnerships, associations, and certain trusts and other entities.  “Control” of a savings association or savings and loan holding company is deemed to exist if a company has voting control, directly or indirectly of more than 25% of any class of the savings association’s voting stock or controls in any manner the election of a majority of the directors of the savings association or savings and loan holding company, and may be presumed under other circumstances, including, but not limited to, holding in certain cases 10% or more of a class of voting securities.  Control may be direct or indirect and may occur through acting in concert with one or more other persons.  In addition, a savings and loan holding company must obtain FRB approval prior to acquiring voting control of more than 5% of any class of voting stock of another savings association or another savings association holding company.  A similar provision limiting the
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acquisition by a bank holding company of 5% or more of a class of voting stock of any company is included in the Bank Holding Company Act.
Accordingly, the prior approval of the FRB would be required:
before any savings and loan holding company or bank holding company could acquire 5% or more of the common stock of the Corporation; and
before any other company could acquire 25% or more of the common stock of the Corporation, and may be required for an acquisition of as little as 10% of such stock.

In addition, persons that are not companies are subject to the same or similar definitions of control with respect to savings and loan holding companies and savings associations and requirements for prior regulatory approval by the FRB in the case of control of a savings and loan holding company or by the OCC in the case of control of a savings association not obtained through control of a holding company of such savings association.

Sarbanes-Oxley Act.  The Sarbanes-Oxley Act was enacted in 2002 in response to public concerns regarding corporate accountability in connection with certain accounting scandals.  The stated goals of the Sarbanes-Oxley Act were to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.  The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the SEC, under the Securities Exchange Act of 1934, including the Corporation.

The Sarbanes-Oxley Act includes very specific additional disclosure requirements and corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosures, corporate governance and related rules.  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.

Dividends and Stock Repurchases.  The FRB’s policy statement on the payment of cash dividends applicable to savings and loan holding companies expresses its view that a savings and loan holding company must maintain an adequate capital position and generally should not pay cash dividends unless the company’s net income for the past year is sufficient to fully fund the cash dividends and that the prospective rate of earnings appears consistent with the company’s capital needs, asset quality, and overall financial condition. The FRB policy statement also indicates that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. In addition, a savings and loan holding company is required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding twelve months, is equal to 10% or more of its consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, FRB order or any condition imposed by, or written agreement with, the FRB.

As discussed above, the capital conservation buffer requirements may also limit or preclude dividends payable by the Corporation.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010:  The Dodd-Frank-Act imposed various restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions and implements capital regulations discussed above under "Federal Regulation of Savings Institutions - Capital Requirements." In addition, among other requirements, the Dodd-Frank Act requires public companies, such as the Corporation, to (i) provide their shareholders with a non-binding vote (a) at least once every three years on the compensation paid to executive officers and (b) at least once every six years on whether they should have a “say on pay” vote every one, two or three years; (ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments; (iii) provide

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disclosure in annual proxy materials concerning the relationship between the executive compensation paid and the financial performance of the issuer; and (iv) for certain public companies disclose the ratio of the Chief Executive Officer's annual total compensation to the median annual total compensation of all other employees..

The Coronavirus Aid, Relief, and Economic Security Act of 2020: In response to the COVID-19 pandemic, the CARES Act was signed into law on March 27, 2020.  Among other things, the CARES Act directs federal banking agencies to adopt interim final rules to lower the threshold under the CBLR from 9% to 8% and to provide a reasonable grace period for a community bank that falls below the threshold to regain compliance, in each case until the earlier of the termination date of the national emergency or December 31, 2020.  In April 2020, the federal banking agencies issued two interim final rules implementing this directive.  One interim final rule provides that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework.  It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater.  The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement.  It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement.

The CARES Act also allows banks to elect to suspend requirements under accounting principles generally accepted in the United States of America (“GAAP”) for loan modifications related to the COVID-19 pandemic (for loans that were not more than 30 days past due as of December 31, 2019) that would otherwise be categorized as a restructured loan, including impairment for accounting purposes, until the earlier of 60 days after the termination date of the national emergency or December 31, 2020. According to the CARES Act and related banking agency guidance, banks are not be required to designate as a troubled debt restructuring loans that were modified as a result of the COVID-19 pandemic and made on a good faith basis to borrowers who were current. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.  Borrowers are considered current under the CARES Act and related banking agency guidance if they were  not more than 30 days past due on their contractual payments as of December 31, 2019, or prior to any relief, respectively, and have experienced financial difficulty as a result of COVID-19. For additional information related to loan modifications as a result of the COVID-19 pandemic, see “Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – COVID-19 Impact to the Corporation.”

The CARES Act also authorized the Small Business Administration (“SBA”) to temporarily guarantee loans under a new loan program called the Paycheck Protection Program, or PPP.  The goal of the PPP was to avoid as many layoffs as possible, and to encourage small businesses to maintain payrolls. The Bank did not participate in the PPP loan program..


TAXATION

Federal Taxation

General.  The Corporation and the Bank report their income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank’s reserve for bad debts discussed below.  The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Corporation. On December 22, 2017, the U.S. Government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and businesses. For businesses, the Tax Act reduces the corporate federal income tax rate from a maximum of 35% to a flat 21%. The corporate federal income tax rate reduction was effective January 1, 2018.

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Other major changes include expensing of equipment investment; elimination of personal and dependent exemptions, the tax on people who do not obtain adequate health insurance coverage, and the corporate alternative minimum tax; and increases in the standard deduction, the estate tax exemption, and the individual alternative minimum tax exemption.

Tax Bad Debt Reserves.  As a result of legislation enacted in 1996, the reserve method of accounting for bad debt reserves was repealed for tax years beginning after December 31, 1995.  Due to such repeal, the Bank is no longer able to calculate its deduction for bad debts using the percentage-of-taxable-income or the experience method.  Instead, the Bank is permitted to deduct as bad debt expense its specific charge-offs during the taxable year.  In addition, the legislation required savings institutions to recapture into taxable income, over a six-year period, their post 1987 additions to their bad debt tax reserves.  As of the effective date of the legislation, the Bank had no post 1987 additions to its bad debt tax reserves.  As of June 30, 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 2020, the Bank declared and paid $7.5 million of cash dividends to the Corporation while the Corporation declared and paid $4.2 million of cash dividends to shareholders.

Tax Effect from Stock-Based Compensation.  During fiscal 2020, there were no shares of restricted common stock distributed to employee or non-employee members of the Corporation’s Board of Directors. Also, there were no shares of non-qualified stock options exercised while 12,528 shares of incentive stock options were exercised as disqualifying dispositions.  As a result, there was a $5,000 federal tax benefit effect from stock-based compensation in fiscal 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 thereafter remain subject to federal examination, while the California state tax returns for fiscal 2015 and fiscal years thereafter 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, 2020 and

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2019, the Corporation’s net state tax rate was 8.5% and 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 $3,000 state tax benefit effect from stock-based compensation in fiscal 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. During fiscal 2020 and 2019, the Corporation paid franchise taxes of $200,000 and $200,000, respectively.


EXECUTIVE OFFICERS

The following table sets forth information with respect to the executive officers of the Corporation and the Bank:

   
Position
Name
Age(1)
Corporation
Bank
       
Craig G. Blunden
72
Chairman and
Chairman and
   
Chief Executive Officer
Chief Executive Officer
       
Robert "Scott" Ritter
51
Senior Vice President
     
Single-Family Division
       
Donavon P. Ternes
60
President
President
   
Chief Operating Officer
Chief Operating Officer
   
Chief Financial Officer
Chief Financial Officer
   
Corporate Secretary
Corporate Secretary
       
David S. Weiant
61
Senior Vice President
     
Chief Lending Officer
       
Gwendolyn L. Wertz
54
Senior Vice President
     
Retail Banking Division

(1)
As of June 30, 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.

Robert "Scott" Ritter joined the Bank as Senior Vice President on September 26, 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 30 years of experience with financial institutions including the last 15 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, 2020, approximately 76% of our real estate loans were secured by collateral and made to borrowers located in Southern California with the balance located predominantly throughout the rest of California.  Adverse economic conditions in California may reduce our rate of growth, affect our customers' ability to repay loans and adversely impact our financial condition and earnings.  General economic conditions, including inflation, unemployment and money supply fluctuations, also may adversely affect our profitability adversely.  Weakness in the global economy has adversely affected many businesses operating in our markets that are dependent upon international trade and it is not known how 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 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;
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 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, 2020, $298.8 million, or 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.

Some of our residential mortgage loans are secured by liens on mortgage properties in which the borrowers have little or no equity because either we originated a first mortgage with an 80% loan-to-value ratio and a concurrent second mortgage for a combined loan-to-value ratio of up to 100% or because of the decline in home values in our market areas. Residential loans with high loan-to-value ratios will be more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses.

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 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, 2020, our single-family residential borrowers had a weighted average FICO score of 750 at the time of loan origination.

As of June 30, 2020, these non-traditional loans totaled $40.9 million, comprising 13.7% of total single-family residential loans held for investment and 4.5% of total loans held for investment.  At that date, stated income loans totaled $38.5 million, more than 30-year amortization loans totaled $5.8 million, and low FICO score loans totaled $3.4 million, negative amortization loans totaled $622,000 (the outstanding balances described may overlap more than one category).

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, 2020, we had $597.1 million or 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 single-family residential loan. Repayment on these loans are dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower's project is reduced as a result of leases not being obtained or renewed, the borrower's ability to repay the loan may be impaired.  Multi-family and commercial real estate loans also expose a lender to greater credit risk than loans secured by single-family residential real estate because the collateral securing these loans typically cannot be sold as easily as single-family residential real estate.  In addition, many of our multi-family and commercial real estate loans are not fully amortizing and contain large balloon payments upon maturity.  Such balloon payments may require the borrower to either sell or refinance the underlying property to make the payment, which may increase the risk of default or non-payment.  In addition, as of June 30, 2020, the Bank had $4.7 million in negative amortization multi-family mortgage loans (a loan in which accrued interest exceeding the required monthly loan payment may be added to the loan principal) as compared to $5.0 million in multi-family and commercial real estate loans at June 30, 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 many types of multi-family and commercial real estate loans is not readily liquid, so we have less opportunity to mitigate credit risk by selling part or all of our interest in these loans. As a result of these characteristics, if we foreclose on a multi-family or commercial real estate loan, our holding period for the collateral typically is longer than for a single-family residential mortgage loan because there are fewer potential purchasers of the collateral. 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 $142.1 million of loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2020, compared to $51.1 million of purchased loans to be held for investment (primarily single-family and multi-family loans) in fiscal 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 be exposed to a greater risk of loss to the extent that bulk purchases contain such loans.

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.

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
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 33.0% of our total loan portfolio at June 30, 2020, were $40.9 million or 4.5% of total loans held for investment that were non-traditional single-family loans, which include 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 business may be adversely affected by credit risk associated with residential 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 fiscal years, including interim periods within those fiscal years, beginning after December 15, 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 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 periodic 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.  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, 2020 and 2019, our non-performing assets were $4.9 million and $6.2 million, respectively, or 0.42% and 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;
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 results of operations and capital levels.

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Uncertainty relating to the LIBOR calculation process and potential phasing out of LIBOR may adversely affect our results of operations.

On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, subordinated debentures, or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally. The FRB, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S. dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities ("SOFR"). SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question, although transactions using SOFR have been completed including by Fannie Mae. Both Fannie Mae and Freddie Mac have recently announced that they will cease accepting adjustable rate mortgages tied to LIBOR by the end of 2020 and will soon begin accepting mortgages based on SOFR. Continued uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans and securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may incur significant expenses in effecting the transition, and may be subject to disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our results of operations.

If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.

We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed upon and the property is taken in as REO and at certain other times during the REO holding period.  Our net book value (“NBV”) in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (“fair value”). A charge-off is recorded for any excess in the asset's NBV over its fair value.  If our valuation process is incorrect, the fair value of the investments in real estate may not be sufficient to recover our NBV in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in real estate could have a material adverse effect on our financial condition and results of operations.

In addition, bank regulators periodically review our REO and may require us to recognize further charge-offs.  Any increase in our charge-offs, as required by the bank regulators, may have a material adverse effect on our financial condition and results of operations.

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 have 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 2020 and 2019, the Bank repurchased $1.1 million and $948,000 of single family loans, respectively.

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.

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 FRB. After steadily increasing  the target federal funds rate in 2018 and 2017,  the FRB in 2019  decreased the target federal funds rate by 75 basis points, and in response to the COVID-19 pandemic in March 2020, an additional 150 basis point decrease to a range of 0.0% to 0.25% as of March 31, 2020. The FRB could make additional changes in interest rates during 2020 subject to economic conditions. If the FRB changes the targeted Fed Funds rate, overall interest rates will likely rise or fall, which may negatively impact the housing markets and the U.S. economic recovery. In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of collateral securing loans, which could negatively affect our financial performance.

We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, which could negatively impact shareholders' equity, and our ability to realize gains from the sale of such assets; (iii) our ability to obtain and retain deposits in competition with other available investment alternatives; (iv) the ability of our borrowers to repay adjustable or variable rate loans; and (v) the average duration of our 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 is the case with many financial institutions, our emphasis on increasing the development of core deposits, those deposits bearing no or a relatively low rate of interest with no stated maturity date, has resulted in our having a significant amount of these deposits bearing a relatively low rate of interest and having a shorter duration than our assets. At June 30, 2020, we had $90.6 million in time deposits that mature within one year, $118.8 million in non-interest bearing checking accounts and $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, most of our 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 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.

Ineffective liquidity management could adversely affect our financial results and condition.

Effective 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 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.  Several 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. 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 may increase significantly. The expenses of some legal proceedings will adversely affect the Bank’s results of operations until they are resolved. Further, there can be no assurance that the Bank’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.

As a bank, we are susceptible to fraudulent activity that may be committed against us or our clients, which may result in financial losses or increased costs to us 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 our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. Nationally, reported incidents of fraud and other financial crimes have increased. We have also experienced 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 customers for such fraudulent transactions on customers’ card accounts, as well as costs incurred by payment card issuing banks and other third parties or may be subject to fines and higher transaction fees, or our ability to accept or facilitate certain types of payments may be impaired. We may also incur other costs related to data security breaches, such as replacing cards associated with compromised card accounts. In addition, our customers could lose confidence in certain payment types, which may result in a shift to other payment types or potential changes to our payment systems that may result in higher costs.

Breaches of information security also may occur through intentional or unintentional acts by those having access to our systems or our customers’ or counterparties’ confidential information, including employees. The Corporation is continuously working to install new and upgrade its existing information technology systems and provide employee awareness training around ransomware, phishing, malware, and other cyber risks to further protect the Corporation against cyber risks and security breaches.

There continues to be a rise in electronic fraudulent activity, security breaches and cyber-attacks within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts. We are regularly the target of attempted cyber and other security threats and must continuously monitor and develop our information technology networks and infrastructure to prevent, detect, address and mitigate the risk of unauthorized access, misuse,

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 customers may have been affected by these breaches, which could increase their risks of identity theft, debit and card fraud and other fraudulent activity that could involve their accounts with us.

Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation. Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions. Any compromise of our security 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.

We rely on other companies to provide key components of our business infrastructure.
We rely on numerous external vendors to provide us with products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements because of changes in the vendor’s organizational structure, financial

50


condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results of operations. We also could be adversely affected to the extent such an agreement is not renewed by a third party vendor or is renewed on terms less favorable to us. Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our vendors’ performance, including aspects which they delegate to third parties. Disruptions or failures in the physical infrastructure or operating systems that support our business and customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in customer attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.

If our enterprise risk management framework is not effective at mitigating risk and loss to us, we could suffer unexpected losses and our results of operations could be materially adversely affected.

Our enterprise risk management framework seeks to achieve an appropriate balance between risk and return, which is critical to optimizing stockholder value. We have established processes and procedures intended to identify, measure, monitor, report, analyze, and control the types of risk to which we are subject to.  These risks include, among others, liquidity, credit, market, interest rate, operational, legal and compliance, and reputational risk.  Our framework also includes financial or other modeling methodologies that involve management assumptions and judgment. We also maintain a compliance program to identify measure, assess, and report on our adherence to applicable laws, policies, and procedures.  While we assess and improve these programs on an ongoing basis, there can be no assurance that our risk management or compliance programs, along with other related controls, will effectively mitigate risk under all circumstances,  or that it will adequately mitigate any risk or loss to us.  However, as with any risk management framework, there are inherent limitations to our risk management strategies as they may exist, or develop in the future, including risks that we have not appropriately anticipated or identified. If our risk management framework proves ineffective, we could suffer unexpected losses and our business, financial condition, results of operations or growth prospects could be materially adversely affected. We may also be subject to potentially adverse regulatory consequences.

Managing reputational risk is important to attracting and maintaining customers, investors and employees.

Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable or fraudulent activities of our customers.  We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective.  Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation.

Earthquakes, fires, mudslides and other natural disasters in our primary market area may result in material losses because of damage to collateral properties and borrowers' inability to repay loans.

Since our geographic concentration is in 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, 2020 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, 2020, the net deferred tax asset was approximately $3.0 million, a decrease from $3.5 million at the prior fiscal year end.  The net deferred tax asset results primarily from (1) deferred loan costs, (2) provisions for loan losses recorded for financial reporting purposes, which were in the past significantly larger than net loan charge-offs deducted for tax reporting proposes and (3) deferred compensation, among others.

We regularly review our deferred tax assets for recoverability based on our history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income. We believe the recorded net deferred tax asset at June 30, 2020 is fully realizable based on our expected future earnings; however, expected future earnings may not be realized, which could impact our deferred tax 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 are, and will be, dependent upon dividends from the Bank to pay the principal of and interest on our indebtedness, to satisfy our other cash needs and to pay dividends on our common 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 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, 2020, the net book value of the Bank’s property (including land and buildings) and its furniture, fixtures and equipment was $7.7 million. The Bank’s home office is located in Riverside, California.  Including the home office, the Bank has 13 retail banking offices, 12 of which are located in Riverside County in the cities of Riverside (5), Moreno Valley, Hemet, Sun City, Rancho Mirage, Corona, Temecula and Blythe. One office is located in Redlands, San Bernardino County, California. The Bank owns six of the retail banking offices and has seven leased retail banking offices.  The leases expire from 2020 to 2026. In the opinion of management, all properties are adequately covered by insurance, are in a good state of repair and 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 its financial condition, operations or cash flows.


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.  At June 30, 2020, there were 7,436,315 shares of common stock issued and outstanding held by 422 shareholders of record, and there were approximately 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 declared a quarterly cash dividend of $0.14 per share.  The Corporation’s shareholders of record at the close of business on August 20, 2020 will receive the cash dividend, which is payable on September 10, 2020.  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.

The Corporation repurchases its common stock consistent with Board-approved stock repurchase plans. During the quarter ended June 30, 2020, the Corporation did not purchase any shares of 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 $19.43 per share. As of June 30, 2020, no shares have been repurchased under 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 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)
Represents the remaining shares available for future purchases under the April 2020 stock repurchase 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.


 
6/30/2015
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, 2015 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; 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; 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 successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our common stock; adverse changes in the securities markets; the inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the

56

implementation of new accounting methods; war or terrorist activities; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, including the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act"), Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (“Interagency Statement”), and other risks detailed in this report and in the Corporation’s other reports filed with or furnished to the SEC.  These developments could have an adverse impact on our financial position and our results of operations. Forward-looking statements are based upon management’s beliefs and assumptions at the time they are made.  We undertake no obligation to publicly update or revise any forward-looking statements included in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur, and you should not put undue reliance on any forward-looking statements.


General

Provident Financial Holdings, Inc., a Delaware corporation, was organized in January 1996 for the purpose of becoming the holding company of Provident Savings Bank, F.S.B. upon the Bank’s conversion from a federal mutual to a federal stock savings bank (“Conversion”).  The Conversion was completed on June 27, 1996.  The Corporation is regulated by the FRB.  At June 30, 2020, the Corporation had total assets of $1.18 billion, total deposits of $893.0 million and total stockholders’ equity of $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 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 operates in a single business segment through 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.  Deposits are collected primarily from 13 banking locations located in Riverside and San Bernardino counties in California.  Additional activities have included originating saleable single-family loans, primarily fixed-rate first mortgages.  Loans are primarily originated and purchased in Southern and Northern California. 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.

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 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 collectability 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;
An extension of the maturity at an interest rate below market;
A reduction in the accrued 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 charged-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.

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 and through its subsidiary, Provident Financial Corp.  The business activities of the Corporation, primarily through the Bank, consist of community 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 asset (by increasing single-family, 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 be 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.

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.
(4)
In months.
(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

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.  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.

Off-balance sheet arrangements.  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. 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 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, 2020 and 2019, these commitments were $13.6 million and $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, 2020 and 2019

Total assets increased $92.0 million, or 9%, to $1.18 billion at June 30, 2020 from $1.08 billion at June 30, 2019.  The increase was primarily attributable to increases in cash and cash equivalents, investment securities and loans held for investment.

Total cash and cash equivalents, primarily excess cash deposited with the Federal Reserve Bank of San Francisco, increased $45.4 million, or 64%, to $116.0 million at June 30, 2020 from $70.6 million at June 30, 2019.  The increase was primarily attributable to increases in customer deposits and borrowings, partly offset by the increases in loans held for investment and investment securities. The balance of cash and cash equivalents at June 30, 2020 was consistent with the Corporation’s strategy of adequately managing credit and liquidity risk.

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Total investment securities (held to maturity and available for sale) increased $23.2 million, or 23%, to $123.3 million at June 30, 2020 from $100.1 million at June 30, 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 additional information on investment securities, see Note 2 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.

Loans held for investment increased $22.9 million, or 3% to $902.8 million at June 30, 2020 from $879.9 million at June 30, 2019.  In fiscal 2020, the Corporation originated $106.0 million of loans held for investment, consisting primarily of single-family, multi-family and commercial real estate loans, down 12% from $120.2 million, consisting primarily of single-family, multi-family and commercial real estate loans, for the same period last year.  In addition, the Corporation purchased $142.1 million of loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2020, up 178% from $51.1 million of purchased loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2019. Total loan principal payments in fiscal 2020 were $228.3 million, up 17% from $195.4 million in fiscal 2019.  There was no REO acquired in the settlement of loans in both fiscal 2020 and fiscal 2019.  The balance of multi-family, commercial real estate, construction and commercial business loans, net of undisbursed loan funds, increased 9% to $605.4 million at June 30, 2020 from $556.1 million at June 30, 2019, and represented 67% and 63% of loans held for investment, respectively.  The balance of single-family loans held for investment decreased $26.2 million, or 8%, to $298.8 million at June 30, 2020, from $325.0 million at June 30, 2019. For additional information on loans held for investment, 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, 2020 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 2019, the percentage of transaction accounts to total deposits was 81% and 77%, respectively. Non-interest bearing deposits as a percentage of total deposits increased to 13.3% at June 30, 2020 from 10.7% at June 30, 2019. The change in deposit mix was consistent with the Corporation’s marketing strategy to promote transaction accounts and the strategic decision to increase the percentage of lower cost checking and savings accounts in its deposit base and decrease the percentage of time deposits by competing less aggressively for time deposits. For additional information on deposits, see Note 7 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.

Borrowings, consisting of FHLB – San Francisco advances increased $39.9 million, or 39%, to $141.0 million at June 30, 2020 from $101.1 million at June 30, 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 28 months at June 30, 2020, down from 44 months at June 30, 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 increased 3% to $124.0 million at June 30, 2020 from $120.6 million at June 30, 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.


Comparison of Operating Results for the Years Ended June 30, 2020 and 2019

General.  The Corporation recorded net income of $7.7 million, or $1.01 per diluted share, for the fiscal year ended June 30, 2020, up $3.3 million, or 75%, from $4.4 million, or $0.58 per diluted share, for the fiscal year ended June 30, 2019. The increase in net income in fiscal 2020 was primarily attributable to a $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 the provision for loan losses. The Corporation's efficiency ratio,

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defined as non-interest expense divided by the sum of net interest income and non-interest income, improved to 71% in fiscal 2020 from 89% in fiscal 2019. Return on average assets in fiscal 2020 increased to 0.69% from 0.39% in fiscal 2019 and return on average stockholders' equity in fiscal 2020 increased to 6.26% from 3.63% in fiscal 2019.

Net Interest Income.  Net interest income decreased $1.8 million, or 5%, to $36.4 million in fiscal 2020 from $38.2 million in fiscal 2019. This decrease resulted from a decrease in the net interest margin and, to a lesser extent, a decrease in the average balance of interest-earning assets. The net interest margin decreased 11 basis points to 3.36% in fiscal 2020 from 3.47% in fiscal 2019, due to an 11 basis point decrease in the average yield on interest-earning assets, partially offset by a one basis point decrease in the average cost of interest-bearing liabilities. The average balance of interest-earning assets decreased $17.9 million, or 2%, to $1.08 billion in fiscal 2020 from $1.10 billion in fiscal 2019.

Interest Income.  Total interest income decreased $1.9 million, or 4%, to $42.5 million for fiscal 2020 from $44.4 million for fiscal 2019. The decrease was primarily due to lower interest income on loans receivable and interest-earning deposits and lower cash dividends from FHLB – San Francisco stock.

Interest income on loans receivable decreased $947,000, or 2%, to $39.1 million in fiscal 2020 from $40.1 million in fiscal 2019. This decrease was attributable to both a lower average loan yield and average loan balance. The weighted average loan yield during fiscal 2020 decreased five basis points to 4.28% from 4.33% in fiscal 2019, due primarily to the decrease in market interest rates resulting from the decline in the general economic conditions impacted by the COVID-19 pandemic. The average balance of loans receivable (including loans held for sale in fiscal 2019) decreased $10.6 million, or 1%, to $915.4 million during fiscal 2020 from $926.0 million during fiscal 2019. There were no loans held for sale in fiscal 2020. The average balance of loans held for sale in fiscal 2019 was $46.3 million with the weighted average yield of 4.69%.

Interest income from investment securities increased $78,000, or 4%, to $2.1 million in fiscal 2020 from $2.0 million in fiscal 2019. This increase was primarily a result of an increase in the average yield, partly offset by a decrease in the average balance.  The average yield on investment securities increased 35 basis points to 2.44% during fiscal 2020 from 2.09% during fiscal 2019. The increase in the average yield of investment securities was primarily attributable to the upward repricing of adjustable rate mortgage-backed securities during the first half of fiscal 2020 and a lower premium amortization resulting from lower principal payments, partly offset by the purchase of new investment securities during the second half of fiscal 2020 with a lower average yield than the existing 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 on mortgage-backed securities, partly offset by the new purchases of investment securities. During fiscal 2020, the Bank purchased $55.9 million of mortgage-backed securities with a weighted average yield of 1.16% and did not sell any investment securities.

During fiscal 2020, the Bank received $534,000 of cash dividends from its FHLB - San Francisco stock, a decrease of $173,000 or 24% from the $707,000 of cash dividends received in fiscal 2019.  The decrease in cash dividends was due primarily to a special cash dividend of $133,000 received in the second quarter of fiscal 2019 that was not replicated in fiscal 2020, and as a result, the average yield decreased 207 basis points to 6.55% in fiscal 2020 from 8.62% in fiscal 2019.

Interest income from interest-earning deposits, primarily cash deposited at the Federal Reserve Bank of San Francisco, decreased $880,000, or 57%, to $657,000 in fiscal 2020 from $1.5 million in fiscal 2019, due to a lower average yield, partly offset by a higher average balance. The average yield decreased 134 basis points to 0.90% in fiscal 2020 from 2.24% in fiscal 2019, resulting from decreases in the targeted federal funds interest rate.  The average balance of interest-earning deposits increased $4.0 million, or 6%, to $71.8 million in fiscal 2020 from $67.8 million in fiscal 2019.

Interest Expense.  Total interest expense for fiscal 2020 was $6.1 million as compared to $6.2 million for fiscal 2019, a decrease of $153,000, or 2%.  This decrease was primarily attributable to a lower interest expense on deposits, particularly in time deposits, partly offset by a higher interest expense on borrowings. The average balance of interest-bearing liabilities decreased $17.7 million or 2% to $972.0 million during fiscal 2020 as compared to $989.7 million during fiscal 2019. This

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decrease was attributable to a decline in the average balance of deposits, partly offset by an increase in the average balance of borrowings. The average cost of interest-bearing liabilities was 0.62% during fiscal 2020, down one basis point from 0.63% during fiscal 2019.

Interest expense on deposits for fiscal 2020 was $2.9 million as compared to $3.4 million for fiscal 2019, a decrease of $438,000, or 13%.  The decrease in interest expense on deposits was primarily attributable to a lower average balance, particularly time deposits. The average balance of deposits decreased $36.0 million, or 4%, to $844.1 million during fiscal 2020 from $880.1 million during fiscal 2019. The average balance of time deposits decreased by $34.1 million, or 15%, to $186.3 million in fiscal 2020 from $220.4 million in fiscal 2019. The decrease in the average balance of time deposits was much 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 decreased $1.9 million to $657.8 million in fiscal 2020 from $659.7 million in fiscal 2019. The average balance of transaction accounts to total deposits in the fiscal 2020 was 78%, compared to 75% in fiscal 2019. The average cost of deposits decreased three basis points to 0.35% in fiscal 2020 from 0.38% in fiscal 2019. The average cost of transaction accounts was 0.14% in fiscal 2020, down one basis point from 0.15% in fiscal 2019; while the average cost of time deposits in fiscal 2020 was 1.09%, up one basis point, from 1.08% in fiscal 2019.

Interest expense on borrowings, consisting of FHLB - San Francisco advances, for fiscal 2020 increased $285,000, or 10%, to $3.1 million as compared to $2.8 million in fiscal 2019.  The increase in interest expense on borrowings was due primarily to a higher average balance, partly offset by a lower average cost. The average balance of borrowings increased $18.3 million, or 17%, to $127.9 million during fiscal 2020 from $109.6 million during fiscal 2019. The average cost of borrowings decreased to 2.43% in fiscal 2020 from 2.58% in fiscal 2019, a decrease of 15 basis points. The decrease in the average cost of borrowings was primarily due to new borrowings with a lower average cost in fiscal 2020.

Provision (Recovery) for Loan Losses.  During fiscal 2020, the Corporation recorded a provision for loan losses of $1.1 million, as compared to a $475,000 recovery from the allowance for loan losses during fiscal 2019. The provision for loan losses in fiscal 2020 was primarily due to a qualitative component established in the allowance for loan losses methodology in response to the COVID-19 pandemic and its continued and forecasted adverse economic impact. The allowance for loan losses increased $1.2 million, or 17%, to $8.3 million at June 30, 2020 from $7.1 million at June 30, 2019.

Non-performing assets (net of the collectively evaluated allowances and individually evaluated allowances), with underlying collateral primarily located in Southern California, decreased $1.3 million or 21% to $4.9 million, or 0.42% of total assets, at June 30, 2020, compared to $6.2 million, or 0.57% of total assets, at June 30, 2019.  Non-performing loans at June 30, 2020 were $4.9 million, comprised of 18 single-family loans ($4.9 million) and one commercial business loan ($31,000).  There was no REO at June 30, 2020 and 2019.  As of June 30, 2020, 33%, or $1.6 million of non-performing loans have a current payment status. Net loan recoveries in fiscal 2020 were $70,000 or 0.01% of average loans receivable, compared to net loan recoveries of $166,000 or 0.02% of average loans receivable in fiscal 2019.

Classified assets at June 30, 2020 were $14.1 million, comprised of $8.6 million in the special mention category, $5.5 million in the substandard category and no outstanding REO.  Classified assets at June 30, 2019 were $16.2 million, comprised of $8.6 million in the special mention category, $7.6 million in the substandard category and no outstanding REO. For additional information, see Item 1, “Business - “Delinquencies and Classified Assets” in this Form 10-K.

For the fiscal year ended June 30, 2020, there were two loans that were newly modified from their original terms, re-underwritten or identified as a restructured loan; one loan (previously modified) was downgraded; one loan was upgraded to the pass category; two loans were paid off; and no loans were converted to real estate owned.  For the fiscal year ended June 30, 2019, there were no loans that were newly modified from their original terms, 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 $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.  As of June 30, 2020, 44%, or $1.2 million of the restructured loans have a current payment status, consistent with their modified payment terms.  During fiscal 2020, no restructured loans were in default within a 12-month period subsequent to their original restructuring.

The allowance for loan losses was $8.3 million at June 30, 2020, or 0.91% of gross loans held for investment, compared to $7.1 million, or 0.80% of gross loans held for investment at June 30, 2019.  The allowance for loan losses at June 30, 2020 includes $100,000 of individually evaluated allowances, compared to $130,000 of individually evaluated allowances at June 30, 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, 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 collectability 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, including as a result of the COVID-19 pandemic.

Non-Interest Income.  Total non-interest income decreased $8.0 million, or 64%, to $4.5 million in fiscal 2020 from $12.5 million in fiscal 2019. The decrease was primarily attributable to the decrease in the gain on sale of loans.

The net gain on sale of loans decreased $7.3 million, or 102%, to a net loss of $132,000 for fiscal 2020 from a net gain of $7.1 million in fiscal 2019. The net loss in fiscal 2020 was primarily attributable to loan sale premium refunds from the early payoff of loans previously sold. There was no loan sale volume in fiscal 2020, as compared to $410.7 million during fiscal 2019 with an average loan sale margin of 1.73 percent.

Deposit account fees decreased $318,000, or 16%, to $1.6 million for fiscal 2020 from $1.9 million in fiscal 2019, due primarily to certain fees that were waived related to accounts impacted by the COVID-19 pandemic.

Loan servicing and other fees decreased $232,000, or 22%, to $819,000 for fiscal 2020 from $1.1 million in fiscal 2019. The decrease was attributable primarily to a lower fair value gain on loans held for investment at fair value in fiscal 2020 in comparison to fiscal 2019.

Non-Interest Expense.  Total non-interest expense in fiscal 2020 was $28.9 million, a decrease of $16.3 million, or 36%, as compared to $45.2 million in fiscal 2019. The decrease in non-interest expense was primarily attributable to decreases in salaries and employee benefits expense, premises and occupancy expenses, equipment expense and other operating expenses.

Salaries and employee benefits expense decreased $11.2 million, or 37%, to $18.9 million in fiscal 2020 from $30.1 million in fiscal 2019. The decrease in salaries and employee benefits was primarily due to fewer employees and incentive payments consistent with the scaling back of saleable single-family mortgage loan originations. The salaries and employee benefits expense in fiscal 2019 includes approximately $11.4 million of salaries and employee benefits expenses related to the staffing associated with saleable single-family loan originations, 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 2020 was $248.1 million, up 45% from $171.2 million in fiscal 2019.

Total premises and occupancy expense decreased $1.5 million, or 30%, to $3.5 million in fiscal 2020 from $5.0 million in fiscal 2019. The decrease in both premises and occupancy expenses and equipment expense was due primarily to the closure of 10 loan production offices and one retail banking center resulting in lower office rents and depreciation of furniture and fixtures, consistent with the Corporation’s business decision to scale back the saleable single-family mortgage loan originations. In addition fiscal 2019 included $337,000 of non-recurring charges related to accelerated lease expenses and depreciation of furniture and fixtures.

Total equipment expense decreased $1.4 million, or 56%, to $1.1 million in fiscal 2020 from $2.5 million in fiscal 2019.  The decrease was primarily attributable to lower equipment depreciation and $758,000 of non-recurring charges in fiscal 2019 related to termination, charge-off, or modification of data processing and other contractual arrangements, consistent with the Corporation’s business decision to scale back the saleable single-family mortgage loan originations.

Other non-interest expense decreased $1.1 million, or 27%, to $3.0 million in fiscal 2020 from $4.1 million in fiscal 2019. The decrease was primarily attributable to lower expenses related to reduced loan originations and a $296,000 reversion of a previously recognized legal settlement expense.

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

The provision for income taxes was $3.2 million for fiscal 2020, representing an effective tax rate of 29.5%, as compared to $1.5 million in fiscal 2019, representing an effective tax rate of 25.4%.

The Corporation’s effective tax rate may differ from the estimated tax rates described above due to discrete items such as further adjustments to net deferred tax assets, excess tax benefits derived from stock option exercises and non-taxable earnings from bank owned life insurance, among other items. The Corporation determined that the above tax rates meet its estimated income tax obligations.  For additional information, see Note 9, "Income Taxes," of the Notes to Consolidated Financial Statements, contained in Item 8 of this Form 10-K.





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Average Balances, Interest and Average Yields/Costs

The following table sets forth certain information for the periods regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and average yields and costs thereof.   Yields and costs for the periods indicated are derived by dividing income or expense by the average monthly balance of assets or liabilities, respectively, for the periods presented.
 
Year Ended June 30,
 
2020
 
2019
 
2018
(Dollars In Thousands)
Average
Balance
Interest
Yield/
Cost
 
Average
Balance
Interest
Yield/
Cost
 
Average
Balance
Interest
Yield/
Cost
Interest-earning assets:
                     
Loans receivable, net(1)
$
915,353
 
$
39,145
 
4.28
%
 
$
926,003
 
$
40,092
 
4.33
%
 
$
986,815
 
$
40,016
 
4.06
%
Investment securities
86,761
 
2,120
 
2.44
%
 
97,870
 
2,042
 
2.09
%
 
90,719
 
1,344
 
1.48
%
FHLB – San Francisco stock
8,155
 
534
 
6.55
%
 
8,199
 
707
 
8.62
%
 
8,126
 
568
 
6.99
%
Interest-earning deposits
71,766
 
657
 
0.90
%
 
67,816
 
1,537
 
2.24
%
 
53,438
 
784
 
1.45
%
                       
Total interest-earning assets
1,082,035
 
42,456
 
3.92
%
 
1,099,888
 
44,378
 
4.03
%
 
1,139,098
 
42,712
 
3.75
%
                       
Non interest-earning assets
31,720
       
30,778
       
32,905
     
                       
Total assets
$
1,113,755
       
$
1,130,666
       
$
1,172,003
     
                       
Interest-bearing liabilities:
                     
Checking and money market
  accounts(2)
$
396,399
 
424
 
0.11
%
 
$
381,790
 
428
 
0.11
%
 
$
372,781
 
407
 
0.11
%
Savings accounts
261,432
 
496
 
0.19
%
 
277,896
 
572
 
0.21
%
 
290,959
 
595
 
0.20
%
Time deposits
186,317
 
2,023
 
1.09
%
 
220,432
 
2,381
 
1.08
%
 
251,604
 
2,493
 
0.99
%
                       
Total deposits
844,148
 
2,943
 
0.35
%
 
880,118
 
3,381
 
0.38
%
 
915,344
 
3,495
 
0.38
%
                       
Borrowings
127,882
 
3,112
 
2.43
%
 
109,558
 
2,827
 
2.58
%
 
113,984
 
2,917
 
2.56
%
                       
Total interest-bearing
   liabilities
972,030
 
6,055
 
0.62
%
 
989,676
 
6,208
 
0.63
%
 
1,029,328
 
6,412
 
0.62
%
                       
Non interest-bearing
   liabilities
18,968
       
19,288
       
19,392
     
                       
Total liabilities
990,998
       
1,008,964
       
1,048,720
     
                       
Stockholders’ equity
122,757
       
121,702
       
123,283
     
Total liabilities and
  stockholders’ equity
$
1,113,755
       
$
1,130,666
       
$
1,172,003
     
                       
Net interest income
 
$
36,401
       
$
38,170
       
$
36,300
   
                       
Interest rate spread(3)
   
3.30
%
     
3.40
%
     
3.13
%
Net interest margin(4)
   
3.36
%
     
3.47
%
     
3.19
%
Ratio of average interest-
  earning assets to average
  interest-bearing liabilities
   
111.32
%
     
111.14
%
     
110.66
%

(1)
Includes loans held for sale and non-performing loans, as well as net deferred loan costs of $1.1 million, $1.2 million and $1.1 million for the years ended June 30, 2020, 2019 and 2018, respectively.
(2)
Includes the average balance of non interest-bearing checking accounts of $90.0 million, $84.1 million and $79.9 million in fiscal 2020, 2019 and 2018, respectively.