|• PROVIDENT FINANCIAL HOLDINGS, INC. FORM 10-K • EXHIBIT 13 • EXHIBIT 23.1 • EXHIBIT 31.1 • EXHIBIT 31.2 • EXHIBIT 32.1 • EXHIBIT 32.2 • EXHIBIT 101 - INS • EXHIBIT 101 - SCH • EXHIBIT 101 - CAL • EXHIBIT 101 - DEF • EXHIBIT 101 - LAB • EXHIBIT 101 - PRE|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended June 30, 2012 OR
Commission File Number: 000-28304
PROVIDENT FINANCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: (951) 686-6060
Securities registered pursuant to Section 12(b) of the Act:
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 NO X .
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 NO X .
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES X NO .
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES X NO .
Indicate by check mark whether disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or other information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [X]
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer _____ Accelerated filer X .
Non-accelerated filer (Do not check if a smaller reporting company) Smaller reporting company
Indicate by check mark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2).
YES NO X .
As of September 5, 2012, there were 10,758,135 shares of the Registrant’s common stock issued and outstanding. The Registrant’s common stock is listed on the NASDAQ Global Select Market under the symbol “PROV.” 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, 2011, was $95.1 million.
DOCUMENTS INCORPORATED BY REFERENCE
PROVIDENT FINANCIAL HOLDINGS, INC.
Table of Contents
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.
Item 1. Business
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. At June 30, 2012, the Corporation had consolidated total assets of $1.3 billion, total deposits of $961.4 million and stockholders’ equity of $144.8 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 financial statements and related data, relates primarily to the Bank and its subsidiaries.
The Bank, founded in 1956, is a federally chartered stock savings bank headquartered in Riverside, California. Prior to July 21, 2011, the Bank was regulated by the Office of Thrift Supervision (“OTS”). As a result of the enactment on July 21, 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Bank is now regulated by the Office of 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.
Additionally, the Dodd-Frank Act changed the regulator of all savings and loan holding companies, including the Corporation, from the OTS to the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). For additional information regarding the Dodd-Frank Act, see “Regulation” on this Form 10-K.
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, Provident Bank Mortgage (“PBM”), a division of the Bank, and through its subsidiary, Provident Financial Corp. The business activities of the Bank consist of community banking, mortgage banking, investment services and trustee services for real estate transactions. Financial information regarding the Corporation’s two operating segments, Provident Bank and Provident Bank Mortgage, is contained in Note 17 to the Corporation’s audited consolidated financial statements included in Item 8 of this Form 10-K.
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. Mortgage banking activities primarily consist of the origination and sale of single-family mortgage loans (including second mortgages and equity lines of credit). 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. See “Subsidiary Activities” on this Form 10-K. The activities of Provident Financial Corp are included in the Provident Bank 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 and mortgage 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 has contributed $40,000 annually to the Foundation in fiscal 2012, 2011 and 2010.
On July 24, 2012, the Corporation announced that the Corporation’s Board of Directors declared a cash dividend of $0.05 per share, reflecting a 25 percent increase from the $0.04 per share paid on June 1, 2012. Shareholders of the Corporation’s common stock at the close of business on August 15, 2012 were entitled to receive the cash dividend, which was paid on September 5, 2012.
Resolution on request for accounting method change
On August 2, 2012, the Corporation received a notification from the tax authorities indicating the acceptance of the accounting method change attributable to the Corporation’s overstatement certain income items for tax reporting purposes from 2006 through 2007 resulting in an overpayment of taxes and an understatement of the deferred tax liability. As a result, the Corporation will reverse the $825,000 tax liability in the quarter ending September 30, 2012, the same quarter in which the tax authorities granted the Corporation’s request.
The Bank is headquartered in Riverside, California and operates 14 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. Through the operations of PBM, the Bank has expanded its mortgage lending market to include most of Southern California and some of Northern California. PBM operates wholesale loan production offices in Pleasanton and Rancho Cucamonga, California and retail loan production offices in City of Industry, Escondido, Fairfield, Glendora, Hermosa Beach, Pleasanton, Rancho Cucamonga (2), Riverside (4), Roseville and San Rafael, California.
The large geographic area encompassing Riverside and San Bernardino counties is referred to as the “Inland Empire.” According to 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. Western Riverside and San Bernardino counties are relatively densely populated and are within the greater Los Angeles metropolitan area. The unemployment rate in the Inland Empire in June 2012 was 12.6%, compared to 10.7% in California and 8.2% nationwide, according to the United States of America (“U.S.”) Department of Labor, Bureau of Labor Statistics. Current unemployment data improved slightly, yet remains weak, as compared to the unemployment data reported in June 2011 of 13.2% in the Inland Empire, 11.8% in California and 9.2% nationwide.
The number of California homes entering the formal foreclosure process dropped in the second calendar quarter of 2012 to its lowest level since early 2007. The decline is the result of a combination of factors, including an improving housing market, the reduction in the number of the most aggressively underwritten mortgages originated from 2005 through 2007 that may become subject to foreclosure, and the growing use of short sales (Source: DataQuick; DQNews.com – July 23, 2012 News Release).
The number of homes sold in Southern California increased in June 2012 compared to June 2011 and the increase in June 2012 was the sixth consecutive monthly increase, reflecting robust investor demand and significant sales gains for mid- to high-end homes. The continuing pattern of fewer foreclosures re-selling and more activity in pricier coastal counties helped the region’s median sale price climb to a two-year high (Source: DataQuick; DQNews.com – July 17, 2012 News Release).
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 regional and super-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. The Bank’s mortgage banking operations also face competition from mortgage bankers, brokers and other financial institutions. This competition may limit the Bank’s growth and profitability in the future.
As of June 30, 2012, the Bank had 543 full-time equivalent employees, which consisted of 475 full-time, 58 part-time and 10 temporary employees. The employees are not represented by a collective bargaining unit and the Bank believes that its relationship with employees is good.
Financial information regarding the Corporation’s operating segments is contained in Note 17 to the Corporation’s audited consolidated financial statements included in Item 8 of this Form 10-K.
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 Annual Report on 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 on Form 10-K, 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.
General. The lending activity of the Bank is predominately comprised of the origination of first mortgage loans secured by single-family residential properties to be held for sale and, to a lesser extent, to be held for investment. The Bank also originates multi-family and commercial real estate loans and, to a lesser extent, commercial business, consumer and other mortgage loans to be held for investment. The Bank from time to time originates construction loans although there were no construction loans outstanding or loan originations in fiscal 2012 or 2011. Due to the decline in real estate values and deterioration of credit quality, particularly for single-family loans, and the Bank’s short-term strategy to improve liquidity and preserve capital, the Bank has reduced new loans held for investment, particularly single-family loans. The Bank’s net loans held for investment were $796.8 million at June 30, 2012, representing 63.2% of consolidated total assets. This compares to $881.6 million, or 67.1% of consolidated total assets, at June 30, 2011.
At June 30, 2012, the maximum amount that the Bank could have loaned to any one borrower and the borrower’s related entities under applicable regulations was $24.5 million, or 15% of the Bank’s unimpaired capital and surplus. At June 30, 2012, 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, 2012 consists of: seven multi-family loans totaling $4.9 million and two commercial real estate loans totaling $2.0 million to one group of borrowers; one commercial real estate loan totaling $6.2 million to one group of borrowers; four multi-family loans totaling $5.9 million to one group of borrowers; three multi-family loans, one commercial real estate loan and one commercial business loan totaling $5.6 million to one group of borrowers; and two commercial real estate loans totaling $5.6 million to one group of borrowers. The real estate collateral for these loans are located in Southern California. At June 30, 2012, all of these loans were performing in accordance with their repayment terms.
Loans Held For Investment Analysis. The following table sets forth the composition of the Bank’s loans held for investment at the dates indicated.
Maturity of Loans Held for Investment. The following table sets forth information at June 30, 2012 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.
The following table sets forth the dollar amount of all loans held for investment due after June 30, 2013 which have fixed and floating or adjustable interest rates.
(1) As 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 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.
Single-Family Mortgage Loans. The Bank’s predominant lending activity is the origination by PBM of loans secured by first mortgages on owner-occupied, single-family (one to four units) residences in the communities where the Bank has established full service branches and loan production offices. At June 30, 2012, total single-family loans held for investment decreased to $439.0 million, or 53.8% of the total loans held for investment, from $494.2 million, or 54.3% of the total loans held for investment, at June 30, 2011. The decrease in the single-family
loans in fiscal 2012 was primarily attributable to loan principal payments and real estate owned acquired in the settlement of loans, partly offset by new loans originated for investment.
The Bank’s residential mortgage loans are generally underwritten and documented in accordance with guidelines established by institutional loan buyers, Freddie Mac, Fannie Mae and the Federal Housing Administration (“FHA”) (collectively, “the secondary market”). All conforming agency loans are generally underwritten and documented in accordance with the guidelines established by these secondary market purchasers, as well as the Department of Housing and Urban Development (“HUD”), FHA and the Veterans’ Administration (“VA”). Loans are normally classified as either conforming (meeting agency criteria) or non-conforming (meeting an investor’s criteria). Non-conforming loans are typically those that exceed agency loan limits but closely mirror agency underwriting criteria. The non-conforming loans are underwritten to expanded guidelines allowing a borrower with good credit a broader range of product choices. Given the recent market environment, PBM has expanded the production of FHA, VA, Freddie Mac and Fannie Mae loans.
In fiscal 2009, the Bank implemented tighter underwriting standards commensurate with the decline in real estate market conditions. These standards remain in place today. The Bank requires verified documentation of income and assets and our underwriting conforms to agency mandated credit score requirements. Generally, mortgage insurance is required on all loans exceeding 80% loan-to-value based on the lower of purchase price or appraised value. The maximum allowable loan-to-value is 97% on a purchase transaction for conventional financing with mortgage insurance and 96.5% loan-to-value for FHA financing with mortgage insurance. Second home purchases and rate and term refinance transactions are capped at 90% loan-to-value with mortgage insurance. Non-owner purchase and rate and term refinance transactions are capped at 80% loan-to-value while non-owner refinance cash-out transactions are capped at 75% loan-to-value. We manage our underwriting standards, loan-to-value ratios and credit standards to the currently required agency and investor policies and guidelines. These standards may change at any time, given changes in real estate market conditions, secondary mortgage market requirements and changes to investor policies and guidelines.
The Bank previously offered closed-end, fixed-rate home equity loans that were secured by the borrower’s primary residence. These loans did not exceed 100% 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, 2012, home equity loans amounted to $1.5 million or 0.4% of single-family loans held for investment, as compared to $1.7 million or 0.3% of single-family loans held for investment at June 30, 2011. The Bank also offered secured lines of credit, which are generally secured by a second mortgage on the borrower’s primary residence up to 100% of the appraised value of the residence. Secured lines of credit have an interest rate that is typically one to two percentage points above the prime lending rate. As of June 30, 2012 and 2011, the outstanding balance of secured lines of credit was $1.2 million and $1.0 million, respectively. The Bank ceased the origination of home equity loans and secured lines of credit in the second quarter of fiscal 2008 as a result of the deterioration in single-family real estate values.
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 the underwriting standards of the secondary market. The Bank offers several ARM products, which adjust monthly, semi-annually, or annually after an initial fixed period ranging from one month to five 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 three or five-year fixed periods prior to the first adjustment (“3/1 or 5/1 hybrids”), and do not require principal amortization for up to 120 months. Loans of this type have embedded interest rate risk if interest rates should rise during the initial fixed rate period.
The reset of interest rates on ARM loans, primarily interest-only single-family loans, to fully-amortizing status has not created a payment shock for most borrowers primarily because the majority of loans are repricing at 2.75% over six-month LIBOR, which has resulted in a lower interest rate than the borrower’s pre-adjustment interest rate. Management expects that the economic recovery will be slow to develop, which may translate to an extended period of lower interest rates and a reduced risk of mortgage payment shock for the foreseeable future, though the
continuation of currently weak economic conditions may increase the risk of delinquencies and defaults. The higher delinquency levels experienced by the Bank in fiscal 2008 through 2012 was primarily due to higher unemployment, the recent U.S. recession, continuing weak economic conditions and the decline in real estate values, particularly in California. It should be noted, however, that the delinquency level experienced in fiscal 2012 has improved as compared to the levels experienced in fiscal 2008 through 2011.
In fiscal 2006, during the Bank’s 50th Anniversary, the Bank offered 50-year single-family ARM loans. At June 30, 2012, the Bank had 32 loans outstanding for $11.9 million with a 50-year term, compared to 35 loans for $13.8 million at June 30, 2011.
As of June 30, 2012, the Bank had $40.2 million in negative amortization mortgage loans (a loan in which accrued interest exceeding the required monthly loan payment may be added to the loan principal), which consisted of $26.7 million of multi-family loans, $7.0 million of commercial real estate loans and $6.5 million of single-family loans. This compares to $50.4 million at June 30, 2011, which consisted of $31.3 million of multi-family loans, $11.5 million of commercial real estate loans and $7.6 million of single-family loans. 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 a collateral for the loan does not increase proportionally. Negative amortization is only permitted up to a specific level, typically up to 115% of the original loan amount, and the payment on such loans is subject to increased payments when the level is reached, adjusting periodically as provided in the loan documents and potentially resulting in a higher payment by the borrower. The adjustment of these loans to higher payment requirements can be a substantial factor in higher delinquency levels because the borrower may not be able to make the higher payments. Also, real estate values may decline and credit standards may tighten in concert with the higher payment requirement, making it difficult for borrowers to sell their homes or refinance their mortgages to pay off their mortgage obligation.
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 market environment, the production of ARM loans has been substantially reduced because borrowers favor 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 or the expiration of interest-only periods. 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. Such loans are subject to increased risks of default or delinquency. Additionally, while ARM loans allow the Bank to decrease the sensitivity of its assets as a result of changes in interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits.
In addition to fully amortizing ARM loans, the Bank has interest-only ARM loans, which typically have a fixed interest rate for the first three to five years, followed by a periodic adjustable interest rate, coupled with an interest only payment of three to ten years, followed by a fully amortizing loan payment for the remaining term. As of June 30, 2012 and 2011, interest-only, first trust deed, ARM loans were $209.1 million and $241.6 million, or 25.6% and 26.5%, respectively, of the loans held for investment. 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 rates. Because of these characteristics, the Bank has no assurance that yields on ARM loans will be sufficient to offset increases in the Bank’s cost of funds.
The following table describes certain credit risk characteristics of the Bank’s single-family, first trust deed, mortgage loans held for investment as of June 30, 2012:
The following table summarizes the amortization schedule of the Bank’s interest only single-family, first trust deed, mortgage loans held for investment, including the percentage of those which are identified as non-performing or 30 – 89 days delinquent as of June 30, 2012:
The following table summarizes the interest rate reset (repricing) schedule of the Bank’s stated income single-family, first trust deed, mortgage loans held for investment, including the percentage of those which are identified as non-performing or 30 – 89 days delinquent as of June 30, 2012:
A decline in real estate values subsequent to the time of origination of our 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, changes in tax laws and other governmental statutes, regulations and policies and acts of nature, such as earthquakes and other natural disasters particular to California where substantially all of our real estate collateral is located. If real estate values continue to decline from the levels at the time of loan origination, the
value of our 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. Additionally, the Bank does not periodically update the LTV on its loans held for investment by obtaining new appraisals or broker price opinions unless a specific loan has demonstrated deterioration or the Bank receives a loan modification request from a borrower. Therefore, it is reasonable to assume that the LTV ratios disclosed in the following table may be understated in comparison to the current LTV ratios as a result of the year of origination, the subsequent general decline in real estate values that may have occurred and the specific location of the individual properties. The Bank cannot quantify the current LTVs of its loans held for investment or quantify the impact of the decline in real estate values to the original LTVs of its loans held for investment by loan type, geography, or other subsets.
The following table provides a detailed breakdown of the Bank’s single-family, first trust deed, mortgage loans held for investment by the calendar year of origination and geographic location as of June 30, 2012:
Multi-Family and Commercial Real Estate Mortgage Loans. At June 30, 2012, multi-family mortgage loans were $278.1 million and commercial real estate loans were $95.3 million, or 34.1% and 11.7%, respectively, of loans held for investment. This compares to multi-family mortgage loans of $304.8 million and commercial real estate loans of $103.6 million, or 33.5% and 11.4%, respectively, of loans held for investment at June 30, 2011. 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 2012 the Bank originated $46.6 million and purchased $8.2 million of multi-family and commercial real estate loans, all of which were reunderwritten in accordance with the Bank’s origination guidelines. This compares to loan originations of $3.8 million and purchases of $7.1 million during fiscal 2011. At June 30, 2012, the Bank had 376 multi-family and 123 commercial real estate loans in loans held for investment.
Multi-family mortgage loans originated by the Bank are predominately adjustable rate loans, including 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 3/1 and 5/1 hybrids, with a term to maturity of 10 years and a 25 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 annual interest rate caps and life-of-loan interest rate caps. At June 30, 2012, $242.8 million, or 87.0%, 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 centers, warehouses and small retail centers. Properties securing multi-family and commercial real estate loans are primarily located in Los Angeles, Orange, Riverside, San Bernardino and San Diego counties. The Bank originates multi-family and commercial real estate loans in amounts typically ranging from $350,000 to $4.0 million. At June 30, 2012, the Bank had 50 commercial real estate and multi-family loans with principal balances greater than $1.5 million totaling $119.9 million, all of which were performing in accordance with their terms. The Bank obtains appraisals on 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 receive higher interest rates than those generally available from single-family mortgage loans. However, loans secured by such properties are generally greater 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 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. At June 30, 2012, the Bank had $1.5 million, net of individually and collectively evaluated allowances, of non-performing multi-family loans and $3.2 million, net of individually and collectively evaluated allowances, of non-performing commercial real estate loans. At June 30, 2012, the Bank had no multi-family or commercial real estate loans which were past due 30 to 89 days. Non-performing loans and delinquent loans may increase as a result of the general decline in Southern California real estate markets and poor general economic conditions.
The following table summarizes the interest rate reset or maturity schedule of the Bank’s multi-family loans held for investment, including the percentage of those which are identified as non-performing, 30 – 89 days delinquent or not fully amortizing as of June 30, 2012:
The following table summarizes the interest rate reset or maturity schedule of the Bank’s commercial real estate loans held for investment, including the percentage of those which are identified as non-performing, 30 – 89 days delinquent or not fully amortizing as of June 30, 2012:
The following table provides a detailed breakdown of the Bank’s multi-family mortgage loans held for investment by the calendar year of origination and geographic location as of June 30, 2012:
The following table provides a detailed breakdown of the Bank’s commercial real estate mortgage loans held for investment by the calendar year of origination and geographic location as of June 30, 2012:
Construction Mortgage Loans. The Bank originates from time to time two types of construction loans: short-term construction loans and construction/permanent loans. The Bank had no construction loans at June 30, 2012 and 2011, as a result of management’s decision in fiscal 2006 to reduce tract construction loan originations (given anticipated unfavorable real estate market conditions). There were no loan originations of construction mortgage loans in fiscal 2012 and 2011.
Other mortgage loans. At June 30, 2012, other mortgage loans, which consisted of land loans, were $755,000, or 0.1% of loans held for investment, down from $1.5 million, or 0.2% of loans held for investment, at June 30, 2011. The Bank makes land loans, primarily lot loans, to accommodate borrowers who intend to build on the land within a specified period of time. The majority of these land loans are for the construction of single-family residences; however, the Bank may make short-term loans on a limited basis for the construction of commercial properties. The terms generally require a fixed rate with maturity between 18 to 36 months.
Participation Loan Purchases and Sales. In an effort to expand production and diversify risk, the Bank purchases loan participations, with collateral primarily in California, which allows for greater geographic distribution of the Bank’s loans and increases loan production volume. The Bank solicits other lenders to purchase participating interests in multi-family and commercial real estate loans. 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 $8.2 million of loans in fiscal 2012, slightly higher than $7.1 million purchased in fiscal 2011. As of June 30, 2012, total loans serviced by other financial institutions were $18.7 million, down 8% from $20.4 million at June 30, 2011. As of June 30, 2012, all loans serviced by others were performing according to their contractual agreements.
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 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 loan participation interests in fiscal 2012 and 2011.
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, 2012, commercial business loans were $2.6 million, or 0.3% of loans held for investment, a decrease of $1.9 million, or 42%, during fiscal 2012. 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 values 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. The Bank had $172,000 of non-performing commercial business loans at June 30, 2012, up 20% from $143,000 at June 30, 2011. During fiscal 2012, the Bank had net charge-offs of $261,000 on commercial business loans, as compared to a net recovery of $25,000 during fiscal 2011.
Consumer Loans. At June 30, 2012, the Bank’s consumer loans were $506,000, or 0.1% of the Bank’s loans held for investment, a decrease of 33% during fiscal 2012. 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. Secured savings lines of credit at June 30, 2012 and 2011 were $314,000 and $520,000, respectively, and are included in consumer loans.
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, 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 consumer loans accounted for on a non-performing basis at June 30, 2012 or 2011.
Mortgage Banking Activities
General. Mortgage banking involves the origination and sale of single-family mortgages (first and second trust deeds), including equity lines of credit, by PBM for the purpose of generating gains on sale of loans and fee income on the origination of loans. PBM also originates single-family loans to be held for investment. Due to the recent economic and real estate conditions and consistent with the Bank’s short-term strategy, PBM has been primarily originating loans and, to a lesser extend, purchasing loans for sale to investors. Given current pricing in the mortgage markets, the Bank sells the majority of its loans on a servicing-released basis. Generally, the level of loan sale activity and, therefore, its contribution to the Bank’s profitability depends on maintaining a sufficient volume of loan originations. Changes in the level of interest rates and the California economy affect the number of loans originated by PBM and, thus, the amount of loan sales, gain on sale of loans, net interest income and loan fees earned. The origination and purchases of loans, primarily fixed rate loans, during fiscal 2012, 2011 and 2010 were $2.52 billion, $2.15 billion and $1.80 billion, respectively. The total loan origination volume in fiscal 2012 was higher than fiscal 2011 and 2010, primarily as a result of relatively low mortgage interest rates, a less competitive mortgage banking environment and more stable, though still weakened, real estate market. The low mortgage rates were primarily a result of the actions taken by the U.S. Department of Treasury and Federal Reserve to reduce interest rates in response to the global credit crisis. Of the total PBM loan originations, loans originated for investment were $2.5 million, $1.8 million and $818,000 in fiscal 2012, 2011 and 2010, respectively.
Loan Solicitation and Processing. The Bank’s mortgage banking operations consist of both wholesale and retail loan originations. The Bank’s wholesale loan production utilizes a network of approximately 654 loan brokers approved by the Bank who originate and submit loans at a markup over the Bank’s daily published price. Accepted loans are funded and sold by the Bank. Wholesale loans originated and purchased for sale in fiscal 2012, 2011 and 2010 were $1.51 billion, $1.39 billion and $1.34 billion, respectively. PBM has two regional wholesale lending offices: one in Pleasanton and one in Rancho Cucamonga, California, housing wholesale originators, underwriters and processors.
PBM’s retail loan production operations utilize loan officers, underwriters and processors. PBM’s loan officers generate retail loan originations primarily through referrals from realtors, builders, employees and customers. As of June 30, 2012, PBM operated stand-alone retail loan production offices in City of Industry, Escondido, Fairfield, Glendora, Hermosa Beach, Pleasanton, Rancho Cucamonga (2), Riverside (4), Roseville and San Rafael, California. Generally, the cost of retail operations exceeds the cost of wholesale operations as a result of the additional employees needed for retail operations. The revenue per mortgage for retail originations is, however, generally higher since the origination fees are retained by the Bank instead of the wholesale loan broker. Retail loans originated for sale in fiscal 2012, 2011 and 2010 were $1.01 billion, $750.7 million and $464.1 million, respectively.
The Bank requires evidence of marketable title, lien position, loan-to-value, title insurance and appraisals on all properties. The Bank also requires evidence of fire and casualty insurance on the value of improvements. As stipulated by federal regulations, the Bank requires flood insurance to protect the property securing its interest if such property is located in a designated flood area.
Loan Commitments and Rate Locks. The Bank issues commitments for residential mortgage loans conditioned upon the occurrence of certain events. Such commitments are made with specified terms and conditions. Interest rate locks are generally offered to prospective borrowers for up to a 60-day period. The borrower may lock in the rate at any time from application until the time they wish to close the loan. Occasionally, borrowers obtaining financing in new home developments are offered rate locks for up to 120 days from application. The Bank’s outstanding commitments to originate loans to be held for sale at June 30, 2012 and 2011 were $220.4 million and $107.5 million, respectively (see Note 15 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K). When the Bank issues a loan commitment to a borrower, there is a risk to the Bank that a rise in interest rates will reduce the value of the mortgage before it can be closed and sold. To control the interest rate risk caused by mortgage banking activities, the Bank uses loan sale commitments and over-the-counter put and call option contracts related to mortgage-backed securities. If the Bank is unable to reasonably predict the amount of loan commitments which may not fund (fallout), the Bank may enter into “best-efforts” loan sale commitments (see “Derivative Activities” on this Form 10-K).
Loan Origination and Other Fees. The Bank may receive origination points and loan fees. Origination points are a percentage of the principal amount of the mortgage loan, which is charged to a borrower for funding a loan. The amount of points charged by the Bank ranges from 0% to 2.5%. Current accounting standards require points and fees received for originating loans held for investment (net of certain loan origination costs) to be deferred and amortized into interest income over the contractual life of the loan. Origination fees and costs for loans originated for sale are deferred until the related loans are sold. Net deferred fees or costs associated with loans that are prepaid or sold are recognized as income or expense at the time of prepayment or sale. At June 30, 2012 and 2011, the Bank had $2.1 million and $2.6 million, respectively, of unamortized deferred loan origination costs (net) in loans held for investment.
Loan Originations, Sales and Purchases. The Bank’s mortgage originations include loans insured by the FHA and VA as well as conventional loans. Except for loans originated as held for investment, loans originated through mortgage banking activities are intended for eventual sale into the secondary market. As such, these loans must meet the origination and underwriting criteria established by secondary market investors. The Bank sells a large percentage of the mortgage loans that it originates as whole loans to investors. The Bank also sells conforming whole loans to Fannie Mae and Freddie Mac (see “Derivative Activities” on this Form 10-K).
The following table shows the Bank’s loan originations, purchases, sales and principal repayments during the periods indicated.
Mortgage loans sold to investors generally are sold without recourse other than standard representations and warranties. Generally, mortgage loans sold to Fannie Mae and Freddie Mac are 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 FHA and VA loans used to form Government National Mortgage Association (“GNMA”) pools, which are subject to limitations on the FHA’s and VA’s loan guarantees.
Loans previously sold by the Bank to the FHLB – San Francisco under its Mortgage Partnership Finance (“MPF”) program have a recourse provision. The FHLB – San Francisco absorbs the first four basis points of loss, and a credit
scoring process is used to calculate the credit enhancement or recourse amount to the Bank once the first four basis points is exhausted. All losses above this calculated recourse amount are the responsibility of the FHLB – San Francisco in addition to the first four basis points of loss. The FHLB – San Francisco pays the Bank a credit enhancement fee on a monthly basis to compensate the Bank for accepting the recourse obligation. FHLB – San Francisco discontinued the MPF program on October 6, 2006. As of June 30, 2012 and 2011, the Bank serviced $68.0 million and $87.0 million, respectively, of loans under this program and has established a recourse liability of $734,000 and $96,000, respectively. In fiscal 2012, 2011 and 2010, a net recourse loss of $439,000, $9,000 and $19,000, respectively, was recognized under this program.
Occasionally, the Bank is required to repurchase loans sold to Fannie Mae, Freddie Mac or investors if it is determined that such loans do not meet the credit requirements of the investor, or if one of the parties involved in the loan misrepresented pertinent facts, committed fraud, or if such loans were 30 days past due within 120 days of the loan funding date. During fiscal 2012, 2011 and 2010, the Bank repurchased $1.6 million, $0 and $368,000 of single-family mortgage loans, respectively. However, additional repurchase requests were settled for an aggregate of $439,000, $2.0 million and $3.4 million in fiscal 2012, 2011 and 2010, respectively, that did not result in the repurchase of the loan itself.
Derivative Activities. Mortgage banking involves the risk that a rise in interest rates will reduce the value of a mortgage before it can be sold. This type of risk occurs when the Bank commits to an interest rate lock on a borrower’s application during the origination process and interest rates increase before the loan can be sold. Such interest rate risk also arises when mortgages are placed in the warehouse (i.e., held for sale) without locking in an interest rate for their eventual sale in the secondary market. The Bank seeks to control or limit the interest rate risk caused by mortgage banking activities. The two methods used by the Bank to help reduce interest rate risk from its mortgage banking activities are loan sale commitments and the purchase of over-the-counter put and call option contracts related to mortgage-backed securities. At various times, depending on loan origination volume and management’s assessment of projected loans which may not fund, the Bank may reduce or increase its derivative positions. If the Bank is unable to reasonably predict the amount of loan commitments which may not fund, the Bank may enter into “best-efforts” loan sale commitments rather than “mandatory” loan sale commitments. Mandatory loan sale commitments may include whole loan and/or To-Be-Announced MBS (“TBA-MBS”) loan sale commitments.
Under mandatory loan sale commitments, usually with Fannie Mae, Freddie Mac or investors, the Bank is obligated to sell certain dollar amounts of mortgage loans that meet specific underwriting and legal criteria before the expiration of the commitment period. These terms include the maturity of the individual loans, the yield to the purchaser, the servicing spread to the Bank (if servicing is retained) and the maximum principal amount of the individual loans. The mandatory loan sale commitments protect loan sale prices from interest rate fluctuations that may occur from the time the interest rate of the loan is established to the time of its sale. The amount of and delivery date of the loan sale commitments are based upon management’s estimates as to the volume of loans that will close and the length of the origination commitments. The mandatory loan sale commitments do not provide complete interest-rate protection, however, because of the possibility of loans which may not fund during the origination process. Differences between the estimated volume and timing of loan originations and the actual volume and timing of loan originations can expose the Bank to significant losses. If the Bank is not able to deliver the mortgage loans during the appropriate delivery period, the Bank may be required to pay a non-delivery fee or repurchase the commitments at current market prices. Similarly, if the Bank has too many loans to deliver, the Bank must execute additional loan sale commitments at current market prices, which may be unfavorable to the Bank. Generally, the Bank seeks to maintain loan sale commitments equal to the funded loans held for sale at fair value, plus those applications that the Bank has rate locked and/or committed to close, adjusted by the projected fallout. The ultimate accuracy of such projections will directly bear upon the amount of interest rate risk incurred by the Bank.
The activities described above are managed continually as markets change; however, there can be no assurance that the Bank will be successful in its effort to eliminate the risk of interest rate fluctuations between the time origination commitments are issued and the ultimate sale of the loan. The Bank completes a daily analysis, which reports the Bank’s interest rate risk position with respect to its loan origination and sale activities. The Bank’s interest rate risk management activities are conducted in accordance with a written policy that has been approved by the Bank’s Board of Directors which covers objectives, functions, instruments to be used, monitoring and internal controls. The
Bank does not enter into option positions for trading or speculative purposes and does not enter into option contracts that could generate a financial obligation beyond the initial premium paid. The Bank does not apply hedge accounting to its derivative financial instruments; therefore, all changes in fair value are recorded in earnings.
At June 30, 2012 and 2011, the Bank had put option contracts outstanding with a nominal value of $15.0 million and $13.0 million, respectively. At June 30, 2012 and 2011, the Bank had outstanding mandatory loan sale commitments of $101.6 million and $96.4 million, respectively; outstanding TBA-MBS trades of $307.0 million and $183.5 million, respectively; outstanding best-efforts loan sale commitments of $30.5 million and $8.2 million, respectively; and commitments to originate loans to be held for sale of $220.4 million and $107.5 million, respectively (see Note 15 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K). Additionally, as of June 30, 2012 and 2011, the Bank’s loans held for sale at fair value were $231.6 million and $191.7 million, respectively, which were also covered by the loan sale commitments described above. For fiscal 2012 and 2011, the Bank had a net gain of $5.7 million and $590,000, respectively, attributable to the underlying derivative financial instruments used to mitigate the interest rate risk of its mortgage banking activities and the fair-value adjustment on loans held for sale.
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, 2012, the Bank was servicing $98.9 million of loans for others, a decline from $109.4 million at June 30, 2011. The decrease was primarily attributable to loan prepayments. 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, 2012 and 2011, the Bank used a weighted average Constant Prepayment Rate (“CPR”) of 26.61% and 19.10%, respectively, and a weighted-average discount rate of 9.10% and 9.02%, respectively. The required impairment reserve against servicing assets at June 30, 2012 and 2011 was $164,000 and $76,000, respectively. The increase in impairment reserve was due primarily to expected higher prepayments. In aggregate, servicing assets had a carrying value of $327,000 and a fair value of $398,000 at June 30, 2012, compared to a carrying value of $354,000 and a fair value of $589,000 at June 30, 2011.
Rights to future income from serviced loans that exceed contractually specified servicing fees are recorded as interest-only strips. Interest-only strips are carried at fair value, utilizing the same assumptions used to calculate the value of the underlying servicing assets, with any unrealized gain or loss, net of tax, recorded as a component of accumulated other comprehensive income (loss). Interest-only strips had a fair value of $130,000, gross unrealized gains of $127,000 and an amortized cost of $3,000 at June 30, 2012, compared to a fair value of $200,000, gross unrealized gains of $197,000 and an amortized cost of $3,000 at June 30, 2011.
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 by the 90th day of delinquency, or sooner if the borrower is chronically delinquent, and 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.
A loan is placed on non-performing status when its contractual payments are more than 90 days delinquent or if the loan is deemed impaired. In addition, interest income 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.
Restructured Loans. A troubled debt restructuring (“restructured loan”) 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) A reduction in the stated interest rate.
b) An extension of the maturity at an interest rate below market.
c) A reduction in the accrued interest.
d) Extensions, deferrals, renewals and rewrites.
To qualify for restructuring, a borrower must provide evidence of their creditworthiness such as, current financial statements, their most recent income tax returns, current paystubs, current W-2s, and most recent bank statements, among other documents, which are then verified by the Bank. The Bank re-underwrites the loan with the borrower’s updated financial information, new credit report, current loan balance, new interest rate, remaining loan term, updated property value and modified payment schedule, among other considerations, to determine if the borrower qualifies.
The following table 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.
The following table sets forth information with respect to the Bank’s non-performing assets and restructured loans, net of allowance for loan losses, at the dates indicated.
The following table describes the non-performing loans, net of allowance for loan losses, by the calendar year of origination as of June 30, 2012:
The following table describes the non-performing loans, net of allowance for loan losses, by the geographic location as of June 30, 2012:
The following table summarizes classified assets, which is comprised of classified loans, net of allowance for loan losses, and real estate owned at the dates indicated:
The Bank assesses loans individually and classifies as substandard non-performing loans when the accrual of interest has been discontinued, loans have been restructured or management has serious doubts about the future collectibility of principal and interest, even though the loans 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
Accounting Standards Codification (“ASC”) 310, “Receivables,” establishes a collectively evaluated or individually evaluated allowance and charges off those loans or portions of loans deemed uncollectible.
During the fiscal year ended June 30, 2012, 24 loans for $10.1 million were modified from their original terms, were re-underwritten at current market interest rates and were identified in the Bank’s asset quality reports as restructured loans. This compares to 43 loans for $20.7 million that were modified in the fiscal year ended June 30, 2011. As of June 30, 2012, the outstanding balance of modified (restructured) loans was $25.1 million, comprised of 56 loans. These restructured loans are classified as follows: 12 loans are classified as pass, are not included in the classified asset totals and remain on accrual status ($5.5 million); three loans are classified as special mention and remain on accrual status ($4.0 million); and 41 loans are classified as substandard on non-performing status ($15.6 million, all are on non-accrual status). As of June 30, 2012, 74%, or $18.5 million of the restructured loans have a current payment status. Restructured loans which are initially classified as “Substandard” and placed on non-performing status may be upgraded and placed on accrual status once there is a sustained period of payment performance (usually six months or longer) and there is a reasonable assurance that the payment will continue.
The following table shows the restructured loans by type, net of allowance for loan losses, at June 30, 2012 and 2011:
(1) Consists of collectively and individually evaluated allowances.
(1) Consists of specific valuation allowances.
As of June 30, 2012, total non-performing assets were $40.0 million, or 3.17% of total assets, which was primarily comprised of: 87 single-family loans ($29.1 million); six commercial real estate loans ($3.2 million); four multi-family loans ($1.5 million); one other mortgage loan ($522,000); six commercial business loans ($172,000); and real estate owned comprised of 18 single-family properties ($4.7 million), one multi-family property ($366,000), four undeveloped lots acquired in the settlement of loans ($385,000) and one commercial real estate property (fully reserved). As of June 30, 2012, 49%, or $17.1 million of non-performing loans have a current payment status, primarily restructured loans. Compared to June 30, 2011, total non-performing assets decreased $5.5 million, or 12%.
Foregone interest income, which would have been recorded for the fiscal years ended June 30, 2012 and 2011 had the non-performing loans been current in accordance with their original terms, amounted to $876,000 and $1.3 million, respectively, and was not included in the results of operations for the fiscal years ended June 30, 2012 and 2011.
As of June 30, 2012, $4.9 million of loans which were not disclosed as non-performing loans or restructured loans but where known information about possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with present loan repayment terms were classified as special mention, of which $2.1 million were single-family mortgage loans, $2.8 million were multi-family mortgage loans and $33,000 were commercial business loans. As of June 30, 2011, $12.8 million of loans were classified by the Bank as special mention.
Foreclosed Real Estate. Real estate acquired by the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When a property is acquired, it is recorded at the lower of its cost, which is the unpaid principal balance, net of deferred fees/costs, escrow balances and foreclosure costs, or its market value less the estimated cost of sale. Subsequent declines in value are charged to operations. As of June 30, 2012, the real estate owned balance was $5.5 million (24 properties), primarily single-family residences located in Southern California, compared to $8.3 million (54 properties) at June 30, 2011. 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 for the full amount or for the portion of the asset classified as loss. A portion of allowances 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.
The aggregate amounts of the Bank’s classified assets, including loans classified by the Bank as special mention, were as follows at the dates indicated:
Classified assets decreased at June 30, 2012 from the June 30, 2011 level primarily due to loan classification upgrades, particularly those restructured loans with satisfactory contractual payments for at least six consecutive months; disposition of real estate owned properties and a general improvement in the real estate market, resulting in fewer delinquent loans. The classified assets are primarily located in Southern California.
As set forth below, loans classified as substandard and special mention as of June 30, 2012 were comprised of 125 loans totaling $53.0 million.
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 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 or crediting its provision 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 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, multi-family 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 collectibility may not be reasonably assured as prescribed in ASC 310. Estimates of identifiable losses are reviewed continually and, generally, a provision for losses is charged against operations on a monthly 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.
In compliance with the OCC’s regulatory reporting requirements which do not recognize specific valuation allowances, the Bank modified its charge-off policy on non-performing loans during the quarter ended March 31, 2012 and, subsequent to the OCC’s review, the Bank further modified its charge-off policy in the quarter ended June 30, 2012. Historically, the Bank established a specific valuation allowance for non-performing loans at under ASC
310 based upon the estimated fair value of the underlying collateral, less disposition costs, in comparison to the loan balance or used a discounted cash flow method for non-performing restructured loans. The specific valuation allowance was not charged-off until the foreclosure process was complete. Under the modified policy, 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 loans becomes 90 days delinquent; and where borrowers file bankruptcy, the charge-off occurs when the loan becomes 60 days delinquent. The amount of the charge-off is determined by comparing the loan balance to the estimated fair value of the underlying collateral, less disposition costs, with the loan balance in excess of the estimated fair value charged-off against the allowance for loan losses. Both methods are acceptable under accounting principles generally accepted in the United States of America (“GAAP”). The modification to the charge-off policy resulted in $3.01 million of additional charge-offs in the fourth quarter of fiscal 2012 and a total of $4.00 million of additional charge-offs for fiscal 2012, but had no impact to the allowance for loans losses or the provision for loan losses because these charge-offs were timely identified in previous periods as specific valuation allowances and were included in the Bank’s loss experience as part of the evaluation of the allowance for loan losses in those prior periods. The allowance for loan losses for non-performing loans is determined by applying ASC 310. The change in method did not have a material impact to the allowance for loan losses. For restructured loans that are less than 90 days delinquent, the allowance for loan losses are segregated into (a) individually evaluated allowances for those loans with applicable discounted cash flow calculations or (b) collectively evaluated allowances based on the aggregated pooling method. For non-performing loans less than 60 days delinquent where the borrower has filed bankruptcy, the collectively evaluated allowances are assigned based on the aggregated pooling method.
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 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, 2012, the Bank had an allowance for loan losses of $21.5 million, or 2.63% of gross loans held for investment, compared to an allowance for loan losses at June 30, 2011 of $30.5 million, or 3.34% of gross loa