Provident Financial Holdings - 10-Q quarterly report FY

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

* Includes 344,913 shares held by the employee stock ownership plan ("ESOP") that have not been released, committed to be released, or allocated to participant accounts; and 33,329 shares held by the management recognition plan ("MRP") which have been committed to be released and allocated to participant accounts.

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

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

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

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

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The unaudited interim consolidated financial statements included herein reflect all adjustments which are, in the opinion of management, necessary to present a fair statement of the results of operations for the interim periods presented. All such adjustments are of a normal, recurring nature. The balance sheet data at June 30, 2002 is derived from the audited consolidated financial statements of Provident Financial Holdings, Inc. (the "Corporation"). Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission. It is suggested that these unaudited interim consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended June 30, 2002 (SEC File No. 000-28304) of the Corporation. Certain amounts in the prior periods' financial statements have been reclassified to conform to the current period's presentation. The results of operations for the interim periods are not indicative of results for the full year.

Note 2: Earnings Per Share

Basic earnings per share ("EPS") excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would then share in the earnings of the entity. The following tables provide the basic and diluted EPS computations for the quarter ended September 30, 2002 and 2001, respectively.

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Note 3: Operating Segment Reports

The Corporation operates in two business segments: community banking (Provident Bank) and mortgage banking (Provident Bank Mortgage, a division of Provident Bank). The following tables set forth condensed income statements and total assets for the Corporation's operating segments for the quarter ended September 30, 2002 and 2001, respectively.

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Note 4: Recent Accounting Pronouncements

SFAS No. 141:
SFAS No. 141, "Business Combinations," requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001; the use of the pooling-of-interest method is no longer allowed. The adoption of this statement had no material impact on the Corporation's financial position, results of operations or cash flows.

SFAS No. 142:
SFAS No. 142, "Goodwill and Other Intangible Assets," requires that amortization of goodwill ceases and as an alternative, the carrying value of goodwill be evaluated for impairment on at least an annual basis. Intangible assets will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. The adoption of this statement did not have a material impact on the Corporation's financial position, results of operations or cash flows.

SFAS No. 144:
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," replaces SFAS No. 121. SFAS No. 144 requires that long-lived assets be measured at the lower of the carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. It also expands the reporting of discontinued operations to include all components of an entity with operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001. The adoption of this statement did not have a material impact on the Corporation's financial position, results of operations or cash flows.

SFAS No. 146:
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," addresses financial accounting and reporting for costs associated with exit or disposal activities and supersedes Emerging Issues Task Force ("EITF") Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entities' commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value.  The provisions of this statement shall be effective for exit or disposal activities initiated after December 31, 2002.  The adoption of this statement is not expected to have a material impact on the Corporation's financial position, results of operations or cash flows.

SFAS No. 147:
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions," which provides guidance on the accounting for the acquisition of a financial institution.  This statement requires that the excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a business combination represents goodwill that should be accounted for under SFAS No. 142, "Goodwill and Other Intangible Assets."  Thus, the specialized accounting guidance in paragraph 5 of SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions," will not apply after September 30, 2002.  If certain criteria in SFAS No. 147 are met, the amount of the unidentifiable intangible asset will be reclassified to goodwill upon adoption of the statement.  Financial institutions meeting conditions outlined in SFAS No. 147 will be required to restate previously issued financial statements.  Additio nally, the scope of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," is amended to include long-term customer-relationship intangible assets such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets.  This statement is effective for the Bank beginning October 1, 2002.  The Corporation has adopted the new standard as of October 1, 2002 and the adoption of this standard did not have a material impact on the Company's financial position or results of operation.

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Note 5: Subsequent Event
Provident Financial Holdings, Inc. announced on October 28, 2002 that the Corporation's Board of Directors declared a quarterly cash dividend of $0.05 per share on the Corporation's outstanding shares of common stock. Shareholders of record at the close of business on November 15, 2002 will be entitled to receive the cash dividend. The cash dividend will be payable on December 6, 2002.

ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operations

General
Provident Financial Holdings, Inc. (the "Corporation"), a Delaware corporation, was organized in January 1996 for the purpose of becoming the holding company for 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 September 30, 2002, the Corporation had total assets of $1.1 billion, total deposits of $708.4 million and total stockholders' equity of $101.1 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.

The Bank, founded in 1956, is federally chartered and headquartered in Riverside, California. The Bank is regulated by the Office of Thrift Supervision ("OTS"), 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 (under the Savings Association Insurance Fund ("SAIF")). The Bank has been a member of the Federal Home Loan Bank ("FHLB") System since 1956.

The Bank's business consists of community banking activities and mortgage banking activities. Community banking activities primarily consist of accepting deposits from customers within the communities surrounding the Bank's full service offices and investing these funds in single-family loans, multi-family loans, commercial real estate loans, construction loans, commercial business loans, consumer loans and other real estate loans. In addition, the Bank also offers business checking accounts, other business banking services and services loans for others. Mortgage banking activities consist of the origination and sale of mortgage and consumer loans secured primarily by single-family residences. The Bank's revenues are derived principally from interest on its loan and investment portfolios and fees generated through its community banking and mortgage banking activities. There are various risks inherent in the Bank's business. The Bank's business is subject to, among other risks, intere st rate changes and the prepayment of loans and investments.

The Corporation, from time to time, may repurchase its common stock as a way to enhance the Corporation's earnings per share. The Corporation considers the repurchase of its common stock if the market value of the stock is lower than its book value and/or the Corporation believes that the current stock price is under valued as compared to its current and future income projections. Consideration is also given to the Corporation's liquidity and capital requirements and its future capital needs based on the Corporation's current business plans. The Corporation's Board of Directors authorizes each stock repurchase program, the duration of which is normally one year. Once the stock repurchase program is authorized, Management may repurchase the Corporation's common stock from time to time in the open market, depending upon market conditions and the factors described above.

In July 2002, the Board of Directors of the Corporation approved a quarterly cash dividend policy, with the first quarterly cash dividend of $0.05 per share distributed on August 30, 2002 to shareholders of record on August 7, 2002. Future declarations or payments of dividends will be subject to determination by 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, 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 fiscal year in which the dividend is declared and/or the preceding fiscal year.

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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 Unaudited Interim Consolidated Financial Statements and accompanying Selected Notes to Unaudited Interim Consolidated Financial Statements.

Critical Accounting Policies

The discussion and analysis of the Corporation's financial condition and results of operations are based upon our 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 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 financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Accounting for the allowance for loan losses involves significant judgments and assumptions by management, which have a material impact on the carrying value of net loans. Management considers this accounting policy to be a critical accounting policy. The allowance is based on two principles of accounting:  (i) Statement of Financial Accounting Standards, or SFAS, No. 5, "Accounting for Contingencies," which requires that losses be accrued when they are probable of occurring and estimable; and (ii) SFAS No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures," which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The allowance has three components: (i) a formula allowance for groups of homogenous loans (ii) a specific allowance for identified problem loans and (iii) an unallocated allowance. Each of these components is based upon estimates that can change over time. The formula allowance is based primarily on historical experience and as a result can differ from actual losses incurred in the future. This history is reviewed at least quarterly and adjustments are made as needed. Various techniques are used to arrive at specific loss estimates. Historical loss information, discounted cash flows and fair market value of collateral. The use of these values is inherently subjective and the actual losses could be greater or less than the estimates. Also see "Provision for Loan Losses."

SFAS No.133 requires that off-balance sheet derivatives of the Corporation are recorded in the Consolidated Financial Statements at fair value. The Bank's derivatives are primarily the result of its mortgage banking activities in the form of commitments to extend credit, commitments to sell loans and option contracts to hedge the risk of the commitments. Estimates of the percentage of commitments to extend credit on loans to be held for sale that will not fund are based upon historical data and current market trends. The fair value adjustments of the derivatives are recorded in the Consolidated Statements of Operations with offsets to other assets or other liabilities in the Consolidated Statements of Financial Condition.

Comparison of Financial Condition at September 30, 2002 and June 30, 2002

Total assets as of September 30, 2002 increased $93.0 million to $1.10 billion from $1.01 billion at June 30, 2002. This increase was primarily a result of increases in loans held for investment, loans held for sale, receivable from sale of loans and investment securities.

Total loans held for investment increased $33.4 million, or 6 percent, to $627.0 million at September 30, 2002 from $593.6 million at June 30, 2002. Despite a large number of loan repayments during the first quarter of fiscal 2003 ($94.6 million, or 15 percent of the average loans held for investment), the Bank was able to add $129.3 million of loans held for investment, of which $46.8 million were "preferred" loans (multi-family, commercial real estate, construction and commercial business loans). The increase in the preferred loans reflects the Corporation's strategies stated in the Form 10-K for the year ended June 30, 2002. Of the total new loans held for investment, $12.1 million were purchased loans, all of which were

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preferred loans. Total purchased loans serviced by others at September 30, 2002 were $36.5 million or 6 percent of the loans held for investment, compared to $33.7 million or 6 percent of the loans held for investment at June 30, 2002.

Total loans held for sale increased $8.5 million to $10.2 million at September 30, 2002 from $1.7 million at June 30, 2002. This increase was primarily a result of the timing between the loan funding dates versus the loan sale dates.

Total receivable from the sale of loans increased $10.9 million to $78.1 million at September 30, 2002 from $67.2 million at June 30, 2002. The increase in the receivable was primarily a result of the timing between the loan sale dates versus settlement dates.

Total investment securities increased $31.9 million, or 12 percent, to $303.8 million at September 30, 2002 from $271.9 million at June 30, 2002. For the first three months of fiscal 2003, $87.4 million of investment securities were called by the issuers and $10.0 million of investment securities were sold for a gain, while $134.9 million of investment securities were purchased. The high volume of called securities was the result of the significant decline in interest rates during the period and the result of intended purchases of callable short-term investments which have coupon rates higher than market rates ("cushion bonds"). The types of securities called were government agency callable bonds and were primarily issued by the FHLB, the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC").

Total deposits increased $31.0 million, or 5 percent, to $708.4 million at September 30, 2002 from $677.4 million at June 30, 2002. This increase was primarily attributable to an increase of $12.8 million in transaction deposits and an increase of $18.1 million in certificates of deposit. The Corporation continued its focus on building client relationships through checking accounts and fee generating products and services.

Borrowings, which consist entirely of FHLB advances, increased $60.0 million, or 30 percent, to $262.5 million at September 30, 2002 from $202.5 million at June 30, 2002. The average maturity of the Corporation's existing FHLB advances was approximately 44 months (26 months, based on put dates) at September 30, 2002 as compared to the average maturity of 46 months (27 months, based on put dates) at June 30, 2002.

Total stockholders' equity decreased $1.9 million, or 2 percent, to $101.1 million at September 30, 2002, from $103.0 million at June 30, 2002 due primarily to the stock repurchases and the impact of stock based compensation accruals, partly offset by the net income during the first three months of fiscal 2003. A total of 254,700 shares, with an average price of $23.74 per share, were repurchased during the first three months of fiscal 2003. As a result of these stock repurchases, the March 2002 Stock Repurchase Plan was completed earlier than anticipated and a total of 277,200 shares were purchased at an average cost of $22.81 per share. Subsequent to the Stock Repurchase Plan announced on September 17, 2002, a total of 75,000 shares have been repurchased at an average cost of $25.00 per share. During the first three months of fiscal 2003, the Corporation awarded 12,558 shares of common stock to outside directors and certain officers pursuant to the Management Recognition Plan ("MRP") .

Comparison of Operating Results for the Quarter Ended September 30, 2002 and 2001

The Corporation's net income for the quarter ended September 30, 2002 was $3.7 million, an increase of $1.5 million, or 68 percent, from $2.2 million during the same quarter of fiscal 2002. This increase was primarily attributable to an increase in the gain on sale of loans.

The Corporation's net interest income before loan loss provision increased by $243,000, or 4 percent to $7.1 million for the quarter ended September 30, 2002 from $6.8 million during the comparable period of fiscal 2002. This increase was the result of a higher net interest margin, which was partly offset by a decrease in the average earning assets. The net interest margin improved to 2.94 percent in the first quarter of fiscal 2003 from 2.60 percent during the same period of fiscal 2002. The increase in the net interest

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margin during the first three months of fiscal 2003 was primarily a result of the decline in the average cost of funds, which outpaced the decline in the average yield of the earning assets.

The Corporation's efficiency ratio improved to 51 percent in the first quarter of fiscal 2003 from 63 percent in the same period of fiscal 2002. Return on average assets for the quarter ended September 30, 2002 increased to 1.46 percent from 0.79 percent in the same period last year. Return on average equity for the quarter ended September 30, 2002 increased to 14.25 percent from 8.93 percent in the same period last year.

Diluted earnings per share for the quarter ended September 30, 2002 were $0.69, an increase of 77 percent from $0.39 for the quarter ended September 30, 2001. The increase in the diluted earnings per share was the result of the higher net income recorded during the three months ended September 30, 2002 and the shares purchased while executing the Corporation's stock repurchase program during the last 12 months.

Interest Income. Total interest income decreased by $4.0 million, or 22 percent, to $14.6 million for the quarter of fiscal 2003 from $18.6 million during the same quarter of fiscal 2002. This decrease was primarily the result of a lower average loan balance and a lower average loan yield. The average earning assets during the first quarter of fiscal 2003 were $962.1 million, a decrease of $89.8 million or 9 percent, from $1.05 billion during the same period of fiscal 2002. The average yield on earning assets during the first quarter of fiscal 2003 was 6.07 percent, 100 basis points lower than the average yield of 7.07 percent during the same period of fiscal 2002.

Loan interest income decreased $2.9 million, or 20 percent, to $11.7 million in the quarter ended September 30, 2002 as compared to $14.6 million for the same quarter of fiscal 2002. This decrease was attributable to a lower average loan balance and a lower average loan yield. The average balance of loans outstanding, including the receivable from sale of loans and the loans held for sale decreased $93.6 million, or 12 percent, to $672.7 million during the first quarter of fiscal 2003 from $766.3 million during the same quarter of fiscal 2002. The average loan yield during the first quarter of fiscal 2003 was 6.98 percent as compared to 7.60 percent during the same quarter last year. The decline of the average loan balance and the average loan yield were primarily attributable to loan prepayments and loans repriced to lower interest rates resulting from the significant decline in mortgage interest rates, in addition to new mortgage loans with lower interest rates.

Interest income from investment securities decreased $692,000, or 21 percent, to $2.7 million during the quarter ended September 30, 2002 from $3.4 million during the same quarter of fiscal 2002. This decrease was primarily due to a decrease in the average yield, which was partly offset by an increase in the average balance. The yield on the investment securities portfolio decreased 235 basis points from 6.24 percent during the quarter ended September 30, 2001 to 3.89 percent during the quarter ended September 30, 2002. The average balance of investment securities increased $59.2 million, or 27 percent, to $275.4 million in the first quarter of fiscal 2003 from $216.2 million in the same quarter of fiscal 2002.

FHLB stock dividends decreased by $9,000, or 4 percent, to $192,000 in the first quarter of fiscal 2003 from $201,000 in the same period of fiscal 2002. This decrease was attributable to a lower average balance, which was partly offset by a higher average yield. The average balance of FHLB stock declined $3.6 million to $12.4 million during the first quarter of fiscal 2003 from $16.0 million during the same period of fiscal 2002. The average yield on FHLB stock increased 117 basis points to 6.18 percent during the first quarter of fiscal 2003 from 5.01 percent during the same period last year. The increase in the average yield in the first quarter of fiscal 2003 was primarily the result of an additional $58,000 in dividend income received in August 2002. Excluding the dividend income adjustment, the yield in the first quarter of fiscal 2003 would have been 4.31 percent, a decrease of 70 basis points from the same period last year.

Interest income from interest-earning deposits decreased $452,000 to $6,000 in the first quarter of fiscal 2003 from $458,000 in the same period of fiscal 2002. This decrease was attributable to a lower average balance and a lower average yield. The average balance of interest-earning deposits decreased to $1.5 million during the first quarter of fiscal 2003 from $53.3 million during the same period of fiscal 2002. The decrease in the average balance was primarily attributable to a decrease of federal funds investments, resulting from the investment of excess funds in short-term investment securities. The average yield on the

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interest-bearing deposits decreased 187 basis points to 1.57 percent during the first quarter of fiscal 2003 from 3.44 percent during the same period last year. The decline in the average yield was mainly due to the decline in the federal funds rate during the first quarter of fiscal 2003 as compared to the same period of fiscal 2002.

Interest Expense. Total interest expense for the quarter ended September 30, 2002 was $7.5 million as compared to $11.8 million for the same period of fiscal 2002, a decrease of $4.3 million, or 36 percent. This decrease was primarily attributable to a decrease in the average balance and the average cost. The average cost of liabilities was 3.38 percent during the quarter ended September 30, 2002, down 138 basis points compared to 4.76 percent during the same period of fiscal 2002. The average balance of interest-bearing liabilities declined $94.5 million, or 10 percent, to $884.7 million during the first quarter of fiscal 2003 from $979.2 million during the same period last year.

Interest expense on deposits for the quarter ended September 30, 2002 was $4.5 million as compared to $7.6 million for the same period of fiscal 2002, a decrease of $3.1 million, or 41 percent. Average deposits decreased $35.5 million, or 5 percent, to $685.1 million during the quarter ended September 30, 2002 from $720.6 million during the same period of fiscal 2002. The average cost of deposits decreased to 2.62 percent during the quarter ended September 30, 2002 from 4.18 percent during the same quarter of fiscal 2002, a decline of 156 basis points. The decline in the average cost was attributable to the general decline in interest rates and also to the change in the composition of the deposits. The average balance of transaction deposits increased to 51 percent of total deposits in the first quarter of fiscal 2003, compared to 40 percent of the total deposits in the same period last year.

Interest expense on borrowings for the quarter ended September 30, 2002 was $3.0 million as compared to $4.2 million for the same period of fiscal 2002, a decrease of $1.2 million, or 29 percent. The average balance of borrowings was $199.6 million during the quarter ended September 30, 2002 as compared to $258.7 million for the same quarter of fiscal 2002, a decrease of $59.1 million, or 23 percent. The average cost of borrowings decreased to 6.00 percent for the quarter ended September 30, 2002 from 6.38 percent in the same quarter of fiscal 2002, a decline of 38 basis points. The Bank prepaid $20.0 million of FHLB advances requiring a $298,000 interest penalty during the first quarter of fiscal 2003 and $10.0 million of FHLB advances requiring a $55,000 interest penalty during the same period last year. Excluding the prepayments, the average cost of borrowings would have been 5.46 percent in the first quarter of fiscal 2003 and 6.30 percent in the same period last year.

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The following table depicts the average balance sheets for the quarter ended September 30, 2002 and 2001, respectively:

Average Balance Sheets
(Dollars in thousands)

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The following table provides the rate/volume variances for the quarters ended September 30, 2002 and 2001, respectively:

Rate/Volume Variance
(Dollars in thousands)

Provision for Loan Losses. A $200,000 loan loss provision was recorded during the first quarter of fiscal 2003, as compared to $120,000 during the same period of fiscal 2002. The allowance for loan losses was $6.8 million at September 30, 2002 as compared to $6.6 million at June 30, 2002. The allowance for loan losses as a percentage of gross loans held for investment was 1.07 percent at September 30, 2002 as compared to 1.10 percent at June 30, 2002.

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 loan portfolio and upon management's continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the realizable value of the collateral securing the loans. Provisions for losses are charged against operations on a monthly basis as necessary to maintain the allowance at appropriate levels. Management believes that the amount maintained in the allowance will be adequate to absorb losses inherent in the portfolio. Although management believes it uses the best information available to make such determinations, there can be no assurance that regulators, in reviewing the Corporati on's loan portfolio, will not request the Corporation to increase significantly 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 due to economic, operating, regulatory, and other conditions beyond the control of the Corporation.

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The following table is provided to disclose additional details on the Corporation's allowance for loan losses and asset quality:

Allowance for Loan Losses

Non-Interest Income. Total non-interest income increased $2.4 million, or 65 percent, to $6.1 million during the quarter ended September 30, 2002 from $3.7 million during the same period of fiscal 2002. The increase in non-interest income was primarily attributable to an increase in the gain on sale of loans.

The gain on sale of loans increased $1.8 million, or 78 percent, to $4.1 million for the quarter ended September 30, 2002 from $2.3 million during the same quarter of fiscal 2002. This increase was primarily the result of a higher average loan sale margin in the first quarter of fiscal 2003 compared to the same quarter of fiscal 2002. The average loan sale margin during the first quarter of fiscal 2003 was 1.44 percent as compared to 0.82 percent during the same period of fiscal 2002. Total loans originated for sale during the first quarter of fiscal 2003 decreased $13.1 million, or 5 percent, to $256.0 million as compared

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to $269.1 million in the same period of fiscal 2002. The decrease in the loans originated for sale was a result of a larger portion of loan origination volume retained as loans held for investment. Total loan originations, which included $12.1 million of purchased loans, were $385.2 million in the first quarter of fiscal 2003, compared to $308.8 million, which included $9.8 million of purchased loans, in the same period last year. Loan originations held for investment, including purchased loans, were $129.3 million in the first quarter of fiscal 2003, compared to $39.8 million in the same period last year.

Non-Interest Expense. Total non-interest expense increased $76,000, or 1 percent, to $6.7 million during the quarter ended September 30, 2002 from $6.6 million in the same period of fiscal 2002. This increase was primarily attributable to an increase in loan production related expenses, such as commissions paid to loan agents, employee incentives and marketing expenses. These increases were partially offset by a decrease in equipment, professional and other operating expenses. The efficiency ratio in the first quarter of fiscal 2003 improved to 51 percent as compared to 63 percent during the same period last year.

Income taxes. Income tax expense was $2.5 million for the quarter ended September 30, 2002 as compared to $1.6 million during the same period of fiscal 2002. The effective tax rate for the quarters ended September 30, 2002 and 2001 was approximately 41 percent and 42 percent, respectively.

Asset Quality. Non-accrual loans, which primarily consisted of single-family loans, declined $1.8 million to $886,000 at September 30, 2002 from $2.7 million at September 30, 2001. No interest accruals were made for loans that were past due 90 days or more.

The non-accrual and 90 days or more past due loans as a percentage of net loans held for investment decreased to 0.14 percent at September 30, 2002 from 0.42 percent at September 30, 2001. Non-performing assets, including real estate owned, as a percentage of total assets decreased to 0.14 percent at September 30, 2002 from 0.26 percent last year. The improvement in the non-performing assets was due primarily to fewer mortgage loans classified as non-accrual, and the payoff of three loans classified at September 30, 2001.

Restructured loans declined from $1.4 million at September 30, 2001 to zero at September 30, 2002, which is attributable to the payoff of the single remaining loan restructured in prior periods.

The Corporation reviews significant loans individually and identifies when impairment has occurred. Loans are identified as impaired when it is deemed probable that the borrower will be unable to meet the scheduled principal and interest payments under the terms of the loan agreement. Impairment is based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price or the fair value of the collateral if the loan is collateral dependent.

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The following table is provided to disclose details on asset quality (dollars in thousands):

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The following table is provided to disclose details related to the volume of loans originated, purchased and sold:

Loan Volume Activities
(In thousands)

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The Bank has been experiencing a large volume of loan prepayments in its loan portfolio and it has become increasingly difficult to reinvest these cash flows in assets that carry similar or better interest rate risk characteristics. The recent refinance market has been dominated by fixed rate loans and the Bank does not add long-term fixed rate loans to its portfolio particularly when interest rates are at or near historical lows. Therefore, while the Bank has taken steps to address the issue of rising liquidity levels, the Bank finds that a larger percentage of its earning assets are invested at significantly lower rates than the Bank would like. The Bank has mitigated the impact of this in several ways. The Bank has increased the balance of the investment securities portfolio, generated more loans for portfolio from its mortgage banking, business banking and major loan divisions, and purchased commercial real estate and construction loans from other financial inst itutions. Also, the Bank has reduced the average balance of certificates of deposit and the average balance of FHLB advances. This has been accomplished with prudent interest-rate-risk management practices.

The Bank is committed to changing the loan portfolio composition with more emphasis on multi-family, commercial real estate, construction and commercial business loans ("preferred loans"). These loans generally have higher yields as compared to single-family loans. During the first three months of fiscal 2003, the volume of loans generated for portfolio increased $89.5 million, or 225 percent, to $129.3 million as compared to $39.8 million in the comparable period last year. Of the total loans generated for portfolio, $46.8 million, or 36 percent were preferred loans.

The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum requirements can initiate certain mandatory actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet certain specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors.

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The Bank's actual and required capital amounts and ratios as of September 30, 2002 are as follows (dollars in thousands):

Commitments and Derivatives. 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, and forward loan sale agreements to third parties. 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 counter party to these financial instruments, is represented by the contractual amount of these instruments. The Corporation uses the same credit policies in making commitments to extend credit as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend money to a customer at some future date as long as all conditions have been met in the agreement. These commitments generally have expiration dates within 60 days of the commitment date and may require the payment of a fee. Since some of these commitments are expected to expire, the total commitment amount outstanding does not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis prior to issuing a commitment. Interest rates on commitments to extend credit ranged from 5.00% to 11.50% at September 30, 2002 as compared to 6.00% to 14.50% at June 30, 2002. Commitments to extend credit on loans to be held for investment were $28.3 million at September 30, 2002 as compared to $18.2 million at June 30, 2002.

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In an effort to minimize its exposure to interest rate fluctuations on commitments to extend credit where the underlying loan will be sold, the Corporation enters into forward loan sale agreements to sell certain dollar amounts of fixed rate and adjustable rate loans to third parties. These agreements specify the minimum maturity of the loans, the yield to the purchaser, the servicing spread to the Corporation (if servicing is retained), the maximum principal amount of all loans to be delivered and the maximum principal amount of individual loans to be delivered. The Corporation typically satisfies these forward loan sale agreements with its current loan production; at September 30, 2002 and June 30, 2002 the aggregate amount of loans held for sale and of commitments to extend credit on loans to be held for sale exceeded the Corporation's forward loan sale agreements. Interest rates on forward loan sale agreements ranged from 5.00% to 6.50% at September 30, 2002 as compared to 5.50% to 7.00% at June 30, 2002.

In addition to the instruments described above, the Corporation also purchases over-the-counter put option contracts (with expiration dates that generally coincide with the terms of the commitments to extend credit) which mitigate the interest rate risk inherent in commitments to extend credit. The contract amount of these instruments reflects the extent of involvement the Corporation has in this particular class of financial instruments. The Corporation's exposure to loss on these financial instruments is limited to the premiums paid for the put option contracts. Put options are adjusted to market in accordance with SFAS No. 133.

In accordance with SFAS No. 133 and interpretations of the Derivative Implementation Group, the fair value of the commitments to extend credit on loans to be held for sale, forward loan sale agreements and put option contracts are recorded at fair value on the balance sheet, and are included in other assets or (other liabilities). The Corporation is not applying hedge accounting to its derivative financial instruments; therefore, all changes in fair value are recorded in earnings. The net impact of derivative financial instruments on the consolidated statements of operations during the quarters ended September 30, 2002 and 2001 was a gain of $286,000 and a loss of $298,000, respectively.

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Forward-Looking Statements

Certain matters in this quarterly report on Form 10-Q for the quarterly period ended September 30, 2002 constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements relate to, among others, expectations of the business environment in which the Corporation operates, projections of future performance, perceived opportunities in the market, potential future credit experience, and statements regarding the Corporation's mission and vision. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties. The Corporation's actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements due to a wide range of factors including, but not limited to, the general business environment, interest rates, the California real estate market, competitive conditions between banks and non-bank financial services providers, regulatory changes, and other risks detailed in the Corporation's reports filed with the Securities and Exchange Commission, including the Annual Report on Form 10-K for the fiscal year ended June 30, 2002. Forward-looking statements are effective only as of the date that they are made and the Corporation assumes no obligation to update this information.

ITEM 3 Quantitative and Qualitative Disclosures about Market Risk

The principal financial objective of the Corporation's interest rate risk management function is to achieve long-term profitability while limiting its exposure to the fluctuation of interest rates. The Bank, through its Asset and Liability Committee ("ALCO"), has sought to reduce the exposure of its earnings to changes in market interest rates by managing the mismatch between asset and liability maturities. The principal element in achieving this objective is to manage the interest-rate sensitivity of the Bank's assets by holding loans with interest rates subject to periodic market adjustments. In addition, the Bank maintains a liquid investment portfolio comprised of government agency securities, including mortgage backed securities, and investment grade securities. The Bank relies on retail deposits as its primary source of funding while utilizing FHLB advances as a secondary source of funding. As part of its interest rate risk management strategy , the Bank promotes transaction accounts and certificates of deposit with terms up to five years.

Through the use of an internal interest rate risk model, the Bank is able to analyze its interest rate risk exposure by measuring the change in Net Portfolio Value ("NPV") over a variety of interest rate scenarios. NPV is the net present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The calculation is intended to illustrate the change in NPV that would occur in the event

of an immediate change in interest rates of at least 100 basis points with no effect given to any steps which management might take to counter the effect of that interest rate movement.

The following table represents the NPV based on the indicated changes in interest rates as of September 30, 2002 (dollars in thousands).