Provident Financial Holdings - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

 

 

 

(Address of principal executive offices and zip code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes      X  .            No                  .

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

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes      .               No           X .

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.

 

 

PROVIDENT FINANCIAL HOLDINGS, INC.

Table of Contents

PROVIDENT FINANCIAL HOLDINGS, INC.

Condensed Consolidated Statements of Financial Condition

(Unaudited)

Dollars in Thousands

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

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

PROVIDENT FINANCIAL HOLDINGS, INC.

Condensed Consolidated Statements of Stockholders' Equity

(Unaudited)

Dollars in Thousands

For the Quarters Ended December 31, 2008 and 2007

PROVIDENT FINANCIAL HOLDINGS, INC.

Condensed Consolidated Statements of Changes in Stockholders' Equity

(Unaudited)

Dollars in Thousands

For the Six Months Ended December 31, 2008 and 2007

PROVIDENT FINANCIAL HOLDINGS, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited - - In Thousands)

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

PROVIDENT FINANCIAL HOLDINGS, INC.

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL

STATEMENTS

December 31, 2008

Note 1: Basis of Presentation

The unaudited interim condensed consolidated financial statements included herein reflect all adjustments which are, in the opinion of management, necessary to present a fair statement of the results of operations for the interim periods presented.  All such adjustments are of a normal, recurring nature.  The condensed consolidated financial statements at June 30, 2008 are derived from the audited consolidated financial statements of Provident Financial Holdings, Inc. and its wholly owned subsidiary, Provident Savings Bank, F.S.B. (the “Bank”) (collectively, the “Corporation”).  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) with respect to interim financial reporting.  It is recommended that these unaudited interim condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended June 30, 2008.  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 quarter and six months ended December 31, 2008 are not necessarily indicative of results that may be expected for the entire fiscal year ending June 30, 2009.

Note 2: Recent Accounting Pronouncements

In September 2008, the FASB issued FSP No. 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161.”  The FSP is intended to improve disclosures about credit derivatives by requiring more information about the potential adverse effects of changes in credit risk on the financial position, financial performance, and cash flows of the sellers of credit derivatives.  It amends SFAS No. 133 to require disclosures by sellers of credit derivatives, including credit derivatives embedded in hybrid instruments.  The FSP also amends FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others,” to require an additional disclosure about the current status of the payment/performance risk of a guarantee.  Finally, the FSP clarifies the Board’s intent about the effective date of SFAS No. 161.  Accordingly, the FSP clarifies that the disclosures required by SFAS No. 161 will be incorporated upon adoption of SFAS No. 161 on July 1, 2009.  The adoption of this FSP did not have material impact on the Corporation’s consolidated financial statements.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.”  The FASB believes the Generally Accepted Accounting Principal (“GAAP”) hierarchy should be directed to entities because it is the entity (not its auditor) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP.  Accordingly, the FASB concluded that the GAAP hierarchy should reside in the accounting literature established by the FASB and is issuing this Statement to achieve that result.  The adoption of this Statement did not have a material impact on our consolidated financial statements.

Earnings (Loss) Per Share:

Basic earnings per share (“EPS”) excludes dilution and is computed by dividing income or loss available to common shareholders by the weighted-average number of shares outstanding for the period.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would then share in the earnings of the entity.  As of December 31, 2008 and 2007, there were outstanding options to purchase 907,700 shares and 734,700 shares of the Corporation common stock, respectively, of which 907,700 shares and 597,000 shares, respectively, were excluded from the diluted EPS computation as their effect was anti-dilutive.

The following table provides the basic and diluted EPS computations for the quarters and six months ended December 31, 2008 and 2007, respectively.

SFAS No. 123R, “Share-Based Payment,” requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation issued to employees and directors.  Effective July 1, 2005, the Corporation adopted SFAS No. 123R using the modified prospective method under which the provisions of SFAS No. 123R are applied to new awards and to awards modified, repurchased or cancelled after June 30, 2005 and to awards outstanding on June 30, 2005 for which requisite service has not yet been rendered.

The adoption of SFAS No. 123R resulted in incremental stock-based compensation expense and is solely related to issued and unvested stock option grants.  The incremental stock-based compensation expense for the quarters ended December 31, 2008 and 2007 was $186,000 and $136,000, respectively.  For the six months ended December 31, 2008 and 2007, the incremental stock-based compensation expense was $369,000 and $276,000, respectively.  For the first six months of fiscal 2009 and 2008, cash provided by operating activities decreased by $0 and $6,000, respectively, and cash provided by financing activities increased by an identical amount, respectively, related to excess tax benefits from stock-based payment arrangements.  These amounts are reflective of the tax benefit for stock options exercised and restricted stock distributions during the respective periods.

 

 

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

The following tables set forth condensed statements of operations and total assets for the Corporation’s operating segments for the quarters ended December 31, 2008 and 2007, respectively (in thousands).

The following tables set forth condensed statements of operations and total assets for the Corporation’s operating segments for the six months ended December 31, 2008 and 2007, respectively (in thousands).

Note 5: Derivative and Other Financial Instruments with Off-Balance Sheet Risks

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit in the form of originating loans or providing funds under existing lines of credit, 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 Condensed Consolidated Statements of Financial Condition.  The Corporation’s exposure to credit loss, in the event of non-performance by the counterparty to these financial instruments, is represented by the contractual amount of these instruments.  The Corporation uses the same credit policies in entering into financial instruments with off-balance sheet risk as it does for on-balance sheet instruments.  As of December 31, 2008 and June 30, 2008, the Corporation had commitments to extend credit (on loans to be held for investment and loans to be held for sale) of $46.2 million and $29.4 million, respectively.  The following table provides information regarding undisbursed funds to borrowers on existing loans and lines of credit with the Bank as well as commitments to originate loans to be held for investment.

In accordance with SFAS No. 133 and interpretations of the Derivatives Implementation Group of the FASB, the fair value of the commitments to extend credit on loans to be held for sale, loan sale commitments, commitments to purchase mortgage-backed securities (“MBS”), put option contracts and call option contracts are recorded at fair value on the balance sheet, and are included in other assets or other liabilities.  The Corporation does not apply hedge accounting to its derivative financial instruments; therefore, all changes in fair value are recorded in earnings.  The net impact of derivative financial instruments on the Condensed Consolidated Statements of Operations during the quarters ended December 31, 2008 and 2007 were a gain of $748,000 and a gain of $30,000, respectively.  For the six months ended December 31, 2008 and 2007, the net impact of derivative financial instruments on the Condensed Consolidated Statements of Operations was a gain of $596,000 and a loss of $42,000, respectively.

Note 6: Income Taxes

FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes,” requires the affirmative evaluation that it is more likely than not, based on the technical merits of a tax position, that an enterprise is entitled to economic benefits resulting from positions taken in income tax returns. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements. Management has determined that there are no unrecognized tax benefits to be reported in the Corporation’s financial statements, and none are anticipated during the fiscal year ending June 30, 2009.

SFAS No. 109, “Accounting for Income Taxes,” requires that when determining the need for a valuation allowance against a deferred tax asset, management must assess both positive and negative evidence with regard to the realizability of the tax losses represented by that asset. To the extent available sources of taxable income are insufficient to absorb tax losses, a valuation allowance is necessary. Sources of taxable income for this analysis include prior years’ tax returns, the expected reversals of taxable temporary differences between book and tax income, prudent and feasible tax-planning strategies, and future taxable income.   The Corporation’s tax asset has increased during the first six months of fiscal 2009 due to an increase in its loan loss allowances. The deferred tax asset related to loan loss allowances will be realized

 

when actual charge-offs are made against the loan loss allowances. Based on the availability of loss carry-backs and projected taxable income during the periods for which loss carry-forwards are available, management believes that no valuation allowance is necessary at this time.

The Corporation files income tax returns for the United States and state of California jurisdictions.  In September 2008, the Internal Revenue Service (“IRS”) completed its examination of the Corporation’s tax returns for 2006 and 2007. Tax years subsequent to 2007 remain subject to federal examination, while the California state tax returns for years subsequent to 2004 are subject to examination by taxing authorities.  It is the Corporation’s policy to record any penalties or interest arising from federal or state taxes as a component of income tax expense.  There were no penalties or interest included in the Condensed Consolidated Statements of Operations for the quarter and six months ended December 31, 2008.

Note 7: Fair Value of Financial Instruments

The Corporation adopted SFAS No. 157, “Fair Value Measurements,” and SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” on July 1, 2008.  SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  SFAS No. 159 permits entities to elect to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the Fair Value Option) at specified election dates.  At each subsequent reporting date, an entity is required to report unrealized gains and losses on items in earnings for which the fair value option has been elected at each subsequent reporting date.  The objective of the statement is to provide entities with the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities differently without having to apply complex accounting provisions.    The Corporation did not elect to measure any financial instruments at fair value under SFAS No. 159.  Under FSP 157-2, portions of SFAS No. 157 have been deferred until years beginning after November 15, 2008 for all nonfinancial assets and nonfinancial liabilities recognized or disclosed at fair value in the financial statement on a recurring basis. Therefore, the Corporation has partially adopted the provisions of SFAS No. 157.

In October 2008, the FASB issued FSP 157-3 – “Determining the Fair Value of a Financial Asset When the Market for that Asset is not Active.”  FSP 157-3 clarifies the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.

SFAS No. 157 establishes a three-level valuation hierarchy that prioritizes inputs to valuation techniques used in fair value calculations.  The three levels of inputs are defined as follows:

SFAS No. 157 requires the Corporation to maximize the use of observable inputs and minimize the use of unobservable inputs.  If a financial instrument uses inputs that fall in different levels of the hierarchy, the instrument will be categorized based upon the lowest level of input that is significant to the fair value calculation.

The Corporation’s financial assets and liabilities measured at fair value on a recurring basis consist of investment securities and derivative financial instruments, while loans held for sale and impaired loans are measured at fair value on a nonrecurring basis.  

 

 

Investment securities are primarily comprised of U.S. government sponsored enterprise debt securities, U.S. government agency mortgage-backed securities, U.S. government sponsored enterprise mortgage-backed securities and private issue collateralized mortgage obligations.  The Corporation utilizes unadjusted quoted prices in active markets for identical securities (Level 1) for its fair value measurement of debt securities, quoted prices in active and less than active markets for similar securities (Level 2) for its fair value measurement of mortgage-backed securities and broker price indications for similar securities in non-active markets (Level 3) for its fair value measurement of collateralized mortgage obligations (“CMO”).

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

Loans held for sale are primarily single-family loans.  The fair value is determined, when possible, using quoted secondary-market prices.  If no such quoted price exists, the fair value of a loan is determined by quoted prices for a similar loan or loans, adjusted for the specific attributes of each loan.

Impaired loans are loans which are inadequately protected by the current net worth and paying capacity of the borrowers or of the collateral pledged.  The impaired loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.  The fair value of an impaired loan is determined based on an observable market price or current appraised value of the underlying collateral.   Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the borrower.  Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.  This loss is not recorded directly as an adjustment to current earnings or comprehensive income, but rather as a component in determining the overall adequacy of the allowance for losses on loans.  These adjustments to the estimated fair value of impaired loans may result in increases or decreases to the provision for losses on loans recorded in current earnings.

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

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

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying condensed consolidated statement of financial condition using Level 3 inputs:

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

(1) The fair value of the impaired loans are derived from their respective collateral values.

Note 8: Subsequent Events

On January 20, 2009, the Corporation announced a cash dividend of $0.03 per share on the Corporation’s outstanding shares of common stock for shareholders of record as of the close of business on February 10, 2009, payable on March 6, 2009.

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

General

Provident Financial Holdings, Inc., a Delaware corporation, was organized in January 1996 for the purpose of becoming the holding company of Provident Savings Bank, F.S.B. upon the Bank’s conversion from a

 

 

federal mutual to a federal stock savings bank (“Conversion”).  The Conversion was completed on June 27, 1996.  At December 31, 2008, the Corporation had total assets of $1.55 billion, total deposits of $934.8 million and total stockholders’ equity of $117.9 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 a federally chartered stock savings bank 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.  The Bank has been a member of the Federal Home Loan Bank 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 those funds in single-family loans, multi-family loans, commercial real estate loans, construction loans, commercial business loans, consumer loans and other real estate loans.  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 currently operates 14 retail/business banking offices in Riverside County and San Bernardino County (commonly known as the Inland Empire), including the newly opened Iris Plaza office in Moreno Valley, California.  Provident Bank Mortgage operates wholesale loan production offices in Pleasanton and Rancho Cucamonga, California and retail loan production offices in Glendora and Riverside, California.  The Bank’s revenues are derived principally from interest on its loans and investment securities and fees generated through its community banking and mortgage banking activities.  There are various risks inherent in the Bank’s business including, among others, the general business environment, interest rates, the California real estate market, the demand for loans, the prepayment of loans, the repurchase of loans previously sold to investors, competitive conditions between banks and non-bank financial services providers, legislative and regulatory changes, fraud and other risks.

The Corporation, from time to time, may repurchase its common stock.  The Corporation evaluates the repurchase of its common stock when the market price of the stock is lower than its book value and/or the Corporation believes that the current market price is not commensurate with its current and future earnings potential.  Consideration is also given to the Corporation’s liquidity, regulatory capital requirements and future capital needs based on the Corporation’s current business plan.  The Corporation’s Board of Directors authorizes each stock repurchase program, the duration of which is typically 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 or in privately negotiated transactions, depending upon market conditions and the factors described above.  On June 26, 2008, the Corporation announced that its Board of Directors authorized the repurchase of up to five percent of its outstanding common stock, or approximately 310,385 shares, over a one-year period.  As a result of current economic conditions, the Corporation did not repurchase any of its shares during the quarter ended December 31, 2008.  See Part II, Item 2 – “Unregistered Sales of Equity Securities and Use of Proceeds” on page 49.

The Corporation began to distribute quarterly cash dividends in the quarter ended September 30, 2002.  On October 30, 2008, the Corporation declared a quarterly cash dividend of $0.05 per share for the Corporation’s shareholders of record at the close of business on November 21, 2008, which was paid on December 16, 2008.  On January 20, 2009, the Corporation declared a cash dividend of $0.03 per share on the Corporation’s outstanding shares of common stock for shareholders of record as of the close of business on February 10, 2009, payable on March 6, 2009.  Future declarations or payments of dividends will be subject to the consideration of the Corporation’s Board of Directors, which will take into account the Corporation’s financial condition, results of operations, tax considerations, capital requirements, industry standards, legal restrictions, economic conditions and other factors, including the regulatory restrictions which affect the payment of dividends by the Bank to the Corporation.  Under Delaware law, dividends may be paid either out of surplus or, if there is no surplus, out of net profits for the current fiscal year and/or the preceding fiscal year in which the dividend is declared.

Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding the financial condition and results of operations of the Corporation.  The

 

 

information contained in this section should be read in conjunction with the Unaudited Interim Condensed Consolidated Financial Statements and accompanying selected Notes to Unaudited Interim Condensed Consolidated Financial Statements.

Safe-Harbor Statement

This Form 10-Q contains statements that the Corporation believes are “forward-looking statements.”  These statements relate to the Corporation’s financial condition, results of operations, plans, objectives, future performance or business.  You should not place undue reliance on these statements, as they are subject to risks and uncertainties.  When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements the Corporation may make.  Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Corporation.  There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements.  Factors which could cause actual results to differ materially include, but are not limited to, the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the Office of Thrift Supervision, Federal Deposit Insurance Corporation or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses or to write-down assets;  our ability to control operating costs and expenses;  our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; legislative or regulatory changes that adversely affect our business; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board; war or terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and other risks detailed in the Corporation’s reports filed with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the fiscal year ended June 30, 2008.

Critical Accounting Policies

The discussion and analysis of the Corporation’s financial condition and results of operations are based upon the Corporation’s condensed 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.

Allowance for loan losses involves significant judgment 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) SFAS No. 5, “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and can be estimated; 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 require 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 two components: a formula allowance for groups of homogeneous loans and a specific valuation allowance for identified problem loans.  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.  The history is reviewed at least quarterly and adjustments are made as needed.  Various techniques are used to arrive at specific loss estimates, including historical loss information, discounted cash flows and the fair market value of collateral.  The use of these techniques is inherently subjective and the actual losses could be greater or less than the estimates.

Interest is not accrued on any loan when its contractual payments are more than 90 days delinquent or if the loan is deemed impaired.  In addition, interest is not recognized on any loan where management has determined that collection is not reasonably assured.  A non-accrual 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.

SFAS No. 133, “Accounting for Derivative Financial Instruments and Hedging Activities,” requires that derivatives of the Corporation be recorded in the consolidated financial statements at fair value.  Management considers this accounting policy to be a critical accounting policy.  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, commitments to purchase MBS and option contracts to mitigate the risk of the commitments to extend credit.  Estimates of the percentage of commitments to extend credit on loans to be held for sale that may not fund are based upon historical data and current market trends.  The fair value adjustments of the derivatives are recorded in the consolidated statements of operations with offsets to other assets or other liabilities in the consolidated statements of financial condition.

Management accounts for income taxes by estimating future tax effects of temporary differences between the tax and book basis of assets and liabilities considering the provisions of enacted tax laws.  These differences result in deferred tax assets and liabilities, which are included in the Corporation’s Condensed Consolidated Statements of Financial Condition.  Management’s judgment is required in determining the amount and timing of recognition of the resulting deferred tax assets and liabilities, including projections of future taxable income.  Therefore, management considers its accounting for income taxes a critical accounting policy.

Executive Summary and Operating Strategy

Provident Savings Bank, F.S.B., established in 1956, is a financial services company committed to serving consumers and small to mid-sized businesses in the Inland Empire region of Southern California.  The Bank conducts its business operations as Provident Bank, Provident Bank Mortgage, a division of the Bank, and through its subsidiary, Provident Financial Corp.  The business activities of the Corporation, primarily through the Bank and its subsidiary, consist of community banking, mortgage banking, and to a lesser degree, investment services for customers and trustee services on behalf of the Bank.

Community banking operations primarily consist of accepting deposits from customers within the communities surrounding the Bank’s full service offices and investing those funds in single-family, multi-family, commercial real estate, construction, commercial business, consumer and other loans.  Additionally, certain fees are collected from depositors, such as returned check fees, deposit account service charges, ATM fees, IRA/KEOGH fees, safe deposit box fees, travelers check fees, and wire transfer fees, among others.  The primary source of income in community banking is net interest income, which is the difference between the interest income earned on loans and investment securities, and the interest expense paid on interest-bearing deposits and borrowed funds.  During the next three years, although not immediately given the uncertain environment, the Corporation intends to improve the community banking business by moderately growing total assets; by decreasing the concentration of single-family mortgage loans within loans held for investment; and by increasing the concentration of higher yielding multi-family, commercial real estate, construction and commercial business loans (which are sometimes referred to in this report as “preferred loans”).  In addition, over time, the Corporation intends to decrease the percentage of time deposits in its deposit base and to increase the percentage of lower cost checking and savings accounts.  This strategy is intended to improve core revenue through a higher net interest margin and ultimately, coupled with the growth of the Corporation, an increase in net interest income.  While the Corporation’s long-term strategy described moderate growth, management may determine from time to time that shrinking the balance sheet is the most prudent short-term strategy in response to deteriorating general economic conditions.

 

 

Mortgage banking operations primarily consist of the origination and sale of mortgage loans secured by single-family residences.  The primary sources of income in mortgage banking are gain on sale of loans and certain fees collected from borrowers in connection with the loan origination process.  The Corporation will continue to restructure its operations in response to the rapidly changing mortgage banking environment.  Changes may include a different product mix, further tightening of underwriting standards, a further reduction in its operating expenses or a combination of these and other changes.

Investment services operations primarily consist of selling alternative investment products such as annuities and mutual funds to the Bank’s depositors.  Provident Financial Corp performs trustee services for the Bank’s real estate secured loan transactions and has in the past held, and may in the future hold, real estate for investment.  Investment services and trustee services contribute a very small percentage of gross revenue.

There are a number of risks associated with the business activities of the Corporation, many of which are beyond the Corporation’s control, including: changes in accounting principles, changes in regulation and changes in the economy, among others.  The Corporation attempts to mitigate many of these risks through prudent banking practices such as interest rate risk management, credit risk management, operational risk management, and liquidity management.  The current economic environment presents heightened risk for the Corporation primarily with respect to falling real estate values and higher loan delinquencies.  Declining real estate values may lead to higher loan losses since the majority of the Corporation’s loans are secured by real estate located within California.  Significant declines in the value of California real estate may inhibit the Corporation’s ability to recover on defaulted loans by selling the underlying real estate.  For further details on risk factors, see the Safe-Harbor Statement on page 17 and Item 1A – Risk Factors on page 45.

Off-Balance Sheet Financing Arrangements and Contractual Obligations

The following table summarizes the Corporation’s contractual obligations at December 31, 2008 and the effect these obligations are expected to have on the Corporation’s liquidity and cash flows in future periods (in thousands):

The expected obligation for time deposits and FHLB – San Francisco advances include anticipated interest accruals based on the respective contractual terms.

In addition to the off-balance sheet financing arrangements and contractual obligations mentioned above, the Corporation has derivatives and other financial instruments with off-balance sheet risks as described in Note 5 of the Notes to Unaudited Interim Consolidated Financial Statements on page 11.

Comparison of Financial Condition at December 31, 2008 and June 30, 2008

Total assets decreased $81.3 million, or five percent, to $1.55 billion at December 31, 2008 from $1.63 billion at June 30, 2008.  The decrease was primarily attributable to a decrease in loans held for investment.

Loans held for investment decreased $102.7 million, or eight percent, to $1.27 billion at December 31, 2008 from $1.37 billion at June 30, 2008.  During the first six months of fiscal 2009, the Bank originated $17.2 million of loans held for investment, of which $7.4 million, or 43 percent, were “preferred loans”

 

 

 

(multi-family, commercial real estate, construction and commercial business loans).  The Bank did not purchase any loans for investment in the first six months of fiscal 2009, resulting from the Corporation’s decision to compete less aggressively for origination volume given the economic uncertainty of the current banking environment.  Total loan principal payments during the first six months of fiscal 2009 were $89.7 million, compared to $134.7 million during the comparable period in fiscal 2008.  The balance of preferred loans decreased to $528.5 million, or 41 percent of loans held for investment at December 31, 2008, as compared to $569.6 million, or 41 percent of loans held for investment at June 30, 2008.  Purchased loans serviced by others at December 31, 2008 were $132.7 million, or 10 percent of loans held for investment, compared to $146.5 million, or 11 percent of loans held for investment at June 30, 2008.

The table below describes the geographic dispersion of real estate secured loans held for investment at December 31, 2008, as a percentage of the total dollar amount outstanding:

(1) Other than the Inland Empire.

Total loans held for sale increased $17.9 million, or 63 percent, to $46.4 million at December 31, 2008 from $28.5 million at June 30, 2008.  The increase was due primarily to the timing difference between loan originations and loan sale settlements.  See “Loan Volume Activities” on page 36.

Total investment securities decreased $8.2 million, or five percent, to $144.9 million at December 31, 2008 from $153.1 million at June 30, 2008.  The decrease was primarily the result of scheduled and accelerated principal payments on mortgage-backed securities.  The Bank evaluates individual investment securities quarterly for other-than-temporary declines in market value.  The Bank does not believe that there are any other-than-temporary impairments at December 31, 2008; therefore, no impairment losses have been recorded as of December 31, 2008.

Total deposits decreased $77.6 million, or eight percent, to $934.8 million at December 31, 2008 from $1.01 billion at June 30, 2008.  This decrease was primarily attributable to the strategic decision to compete less aggressively on time deposit interest rates, partly offset by the Bank’s marketing strategy to promote transaction accounts.

Borrowings, consisting of FHLB – San Francisco advances increased slightly to $480.7 million at December 31, 2008 from $479.3 million at June 30, 2008.  The increase in borrowings was primarily the result of the decrease in deposits and the increase in loans held for sale, partly offset by the decrease in loans held for investment.  The weighted-average maturity of the Bank’s FHLB – San Francisco advances was approximately 29 months (27 months, if put options are exercised by the FHLB – San Francisco) at December 31, 2008, as compared to the weighted-average maturity of 23 months (20 months, if put options were exercised by the FHLB – San Francisco) at June 30, 2008.

Total stockholders’ equity decreased $6.1 million, or five percent, to $117.9 million at December 31, 2008, from $124.0 million at June 30, 2008, primarily as a result of the net loss and the quarterly cash dividends paid during the first six months of fiscal 2009.  No stock options were exercised and no common stock was repurchased during the first six months of fiscal 2009.  The total cash dividend paid to the Corporation’s shareholders in the first six months of fiscal 2009 was $620,000.

The Corporation’s net loss for the quarter ended December 31, 2008 was $6.5 million, compared to net income of $1.0 million during the same quarter of fiscal 2008.  For the six months ended December 31, 2008, the Corporation’s net loss was $6.2 million, compared to net income of $1.7 million during the same period of fiscal 2008.  The decrease for both periods was primarily a result of the increase in the provision for loan losses, partly offset by the increase in net interest income (before provision for loan losses), the increase in non-interest income and the decrease in operating expenses.

The Corporation’s efficiency ratio improved to 58 percent in the second quarter of fiscal 2009 from 64 percent in the same period of fiscal 2008.  For the six months ended December 31, 2008, the efficiency ratio improved to 55 percent from 68 percent in the six months ended December 31, 2007.  The improvement in the efficiency ratio for both these periods was a result of the increase in net interest income (before provision for loan losses), the increase in non-interest income and the decrease in non-interest expenses.

Return on average assets for the quarter ended December 31, 2008 decreased 193 basis points to (1.67) percent from 0.26 percent in the same period last year.  For the six months ended December 31, 2008 and 2007, the return on average assets was (0.78) percent and 0.21 percent, respectively, a decrease of 99 basis points.

Return on average equity for the quarter ended December 31, 2008 decreased to (21.44) percent from 3.30 percent for the same period last year.  For the six months ended December 31, 2008, the return on average equity decreased to (10.07) percent from 2.60 percent for the same period last year.

Diluted earnings per share for the quarter ended December 31, 2008 were $(1.05), compared to $0.17 for the quarter ended December 31, 2007.  For the six months ended December 31, 2008 and 2007, diluted earnings per share were $(1.00) and $0.27, respectively.

Net Interest Income:

For the Quarters Ended December 31, 2008 and 2007.  The Corporation’s net interest income (before the provision for loan losses) increased by $673,000, or seven percent, to $10.2 million for the quarter ended December 31, 2008 from $9.6 million in the comparable period in fiscal 2008.  This increase was the result of a higher net interest margin, partly offset by lower average earning assets.  The net interest margin increased to 2.70 percent in the second quarter of fiscal 2009, up 28 basis points from 2.42 percent for the same period of fiscal 2008.  The increase in the net interest margin during the second quarter of fiscal 2009 was primarily attributable to a decrease in the average cost of funds which declined more than the average yield on earning assets.  The average balance of earning assets decreased $66.3 million to $1.52 billion in the second quarter of fiscal 2009 from $1.58 billion in the comparable period of fiscal 2008.

For the Six Months Ended December 31, 2008 and 2007.  Net interest income (before the provision for loan losses) for the first six months of fiscal 2009 was $21.5 million, up $2.6 million or 14 percent from $18.9 million during the same period of fiscal 2008.  This increase was the result of a higher net interest margin, partly offset by lower average earning assets.  The net interest margin increased to 2.79 percent in the first six months of fiscal 2009, up 38 basis points from 2.41 percent during the same period of fiscal 2008.  The increase in the net interest margin during the first six months of fiscal 2009 was primarily attributable to a decrease in the average cost of funds which decreased more than the average yield on earning assets, which remained relatively stable, coupled with the lower average balance of interest earning assets.  The average balance of earning assets decreased $28.7 million, or two percent, to $1.54 billion in the first six months of fiscal 2009 from $1.57 billion in the comparable period of fiscal 2008.

Interest Income:

For the Quarters Ended December 31, 2008 and 2007.  Total interest income decreased by $2.7 million, or 11 percent, to $21.3 million for the second quarter of fiscal 2009 from $24.0 million in the same quarter of fiscal 2008.  This decrease was primarily the result of a lower average earning asset yield and a lower

 

 

average balance of earning assets.  The average yield on earning assets during the second quarter of fiscal 2009 was 5.62 percent, 45 basis points lower than the average yield of 6.07 percent during the same period of fiscal 2008.

Loans receivable interest income decreased $2.1 million, or 10 percent, to $19.6 million in the quarter ended December 31, 2008 from $21.7 million for the same quarter of fiscal 2008.  This decrease was attributable to a lower average loan yield and a lower average loan balance.  The average loan yield during the second quarter of fiscal 2009 decreased 28 basis points to 5.93 percent from 6.21 percent during the same quarter last year.  The decrease in the average loan yield was primarily attributable to accrued interest reversals from newly classified non-accrual loans and loan payoffs which carried a higher average yield than the average yield of loans receivable.  The average balance of loans outstanding, including loans held for sale, decreased $72.6 million, or five percent, to $1.33 billion during the second quarter of fiscal 2009 from $1.40 billion in the same quarter of fiscal 2008.

Interest income from investment securities decreased $98,000, or five percent, to $1.8 million during the quarter ended December 31, 2008 from $1.9 million in the same quarter of fiscal 2008.  The decrease was primarily a result of a decrease in average yield and a decrease in the average balance.  The average yield on investment securities decreased 12 basis points to 4.83 percent during the quarter ended December 31, 2008 from 4.95 percent during the quarter ended December 31, 2007.  The decrease in the average yield of investment securities was primarily attributable to the net premium amortization of $24,000 in the second quarter of fiscal 2009 as compared to the net discount amortization of $4,000 in the comparable quarter of fiscal 2008.  During the second quarter of fiscal 2009, the Bank did not purchase any investment securities, while $7.5 million of principal payments were received on mortgage-backed securities.  The average balance of investment securities decreased $4.5 million, or three percent, to $149.3 million in the second quarter of fiscal 2009 from $153.8 million in the same quarter of fiscal 2008.

FHLB – San Francisco stock dividends were $(125,000) in the second quarter of fiscal 2009, down from $432,000 in the same period of fiscal 2008.  The decline was primarily attributable to the FHLB announcement that they will not pay a dividend for the quarter ended December 31, 2008 and an accrual adjustment resulting from a lower actual dividend received in November 2008 than accrued for the relevant period.

For the Six Months Ended December 31, 2008 and 2007.  Total interest income decreased by $3.5 million, or seven percent, to $44.3 million for the first six months of fiscal 2009 from $47.8 million in the same period of fiscal 2008.  This decrease was primarily the result of a lower average balance of earning assets and a lower average earning asset yield.  The average yield on earning assets during the first six months of fiscal 2009 was 5.75 percent, 33 basis points lower than the average yield of 6.08 percent during the same period of fiscal 2008.

Loans receivable interest income decreased $2.9 million, or seven percent, to $40.3 million in the six months ended December 31, 2008 from $43.2 million for the same period of fiscal 2008.  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 loans held for sale, decreased $36.0 million, or three percent, to $1.35 billion during the first six months of fiscal 2009 from $1.39 billion during the same period of fiscal 2008.  The average loan yield during the first six months of fiscal 2009 decreased 26 basis points to 5.97 percent from 6.23 percent during the same period last year.  The decrease in the average loan yield was primarily attributable to accrued interest reversals from newly classified non-accrual loans and loan payoffs which carried a higher average yield than the average yield of loans receivable.

Interest income from investment securities increased $63,000 to $3.7 million during the six months ended December 31, 2008 from $3.6 million in the same period of fiscal 2008.  This increase was primarily a result of an increase in average yield and an increase in the average balance.  The average yield on the investment securities increased seven basis points to 4.88 percent during the six months ended December 31, 2008 from 4.81 percent during the six months ended December 31, 2007.  The average balance of investment securities increased $418,000, or less than one percent, to $152.0 million in the first six months of fiscal 2009 from $151.6 million in the same period of fiscal 2008.  During the first six months of fiscal 2009, $8.1 million of investment securities were purchased, while $15.9 million of principal payments were received on mortgage-backed securities.

 

 

Interest Expense:

For the Quarters Ended December 31, 2008 and 2007.  Total interest expense for the quarter ended December 31, 2008 was $11.1 million as compared to $14.5 million for the same period of fiscal 2008, a decrease of $3.4 million, or 23 percent.  This decrease was primarily attributable to a lower average cost of interest-bearing liabilities and a lower average balance.  The average cost of interest-bearing liabilities was 3.12 percent during the quarter ended December 31, 2008, down 78 basis points from 3.90 percent during the same period of fiscal 2008.  The average balance of interest-bearing liabilities, principally deposits and borrowings, decreased $59.9 million, or four percent, to $1.41 billion during the second quarter of fiscal 2009 from $1.47 billion during the same period of fiscal 2008.

Interest expense on deposits for the quarter ended December 31, 2008 was $6.3 million as compared to $9.2 million for the same period of fiscal 2008, a decrease of $2.9 million, or 32 percent.  The decrease in interest expense on deposits was primarily attributable to a lower average cost and a lower average balance.  The average cost of deposits decreased to 2.66 percent during the quarter ended December 31, 2008 from 3.62 percent during the same quarter of fiscal 2008, a decrease of 96 basis points.  The decrease in the average cost of deposits was attributable primarily to new time deposits with a lower average cost, replacing maturing time deposits with a higher average cost, consistent with declining short-term interest rates.  The average balance of deposits decreased $70.8 million, or seven percent, to $937.5 million during the quarter ended December 31, 2008 from $1.01 billion during the same period of fiscal 2008.  The decline in the average balance was primarily in time deposits, the result of the Bank’s strategic decision to compete less aggressively for this product.  The average balance of transaction account deposits to total deposits in the second quarter of fiscal 2009 was unchanged at 34 percent, compared to the same period of fiscal 2008.

Interest expense on borrowings, consisting primarily of FHLB – San Francisco advances, for the quarter ended December 31, 2008 decreased $463,000, or nine percent, to $4.8 million from $5.3 million for the same period of fiscal 2008.  The decrease in interest expense on borrowings was primarily a result of a lower average cost, partly offset by a higher average balance.  The average cost of borrowings decreased to 4.02 percent for the quarter ended December 31, 2008 from 4.50 percent in the same quarter of fiscal 2008, a decrease of 48 basis points.  The decrease in the average cost of borrowings was primarily the result of maturing long-term advances which had a higher average cost than the average cost of new advances. Additionally, short-term advance interest rates have fallen as a result of U.S. Treasury and Federal Reserve Board actions. The average balance of borrowings increased $10.9 million, or two percent, to $476.4 million during the quarter ended December 31, 2008 from $465.5 million during the same period of fiscal 2008.

For the Six Months Ended December 31, 2008 and 2007.  Total interest expense was $22.8 million for the first six months of fiscal 2009 as compared to $28.8 million for the same period of fiscal 2008, a decrease of $6.0 million, or 21 percent.  This decrease was primarily attributable to a lower average balance of interest-bearing liabilities and a decrease in the average cost.  The average balance of interest-bearing liabilities, principally deposits and borrowings, decreased $25.3 million, or two percent, to $1.44 billion during the first six months of fiscal 2009 from $1.46 billion during the same period of fiscal 2008.  The average cost of interest-bearing liabilities was 3.16 percent during the six months ended December 31, 2008, down 75 basis points from 3.91 percent during the same period of fiscal 2008.

 

 

Interest expense on borrowings, consisting primarily of FHLB – San Francisco advances, for the six months ended December 31, 2008 decreased $862,000, or eight percent, to $9.5 million from $10.4 million for the same period of fiscal 2008.  The decrease in interest expense on borrowings was primarily a result of a lower average cost, partly offset by a higher average balance.  The average cost of borrowings decreased to 3.96 percent for the six months ended December 31, 2008 from 4.52 percent in the same period ended December 31, 2007, a decrease of 56 basis points.  The decrease in the average cost of borrowings was primarily the result of maturing long-term advances which had a higher average cost than the average cost of new advances.  Additionally, short-term advance interest rates have fallen as a result of U.S. Treasury and Federal Reserve Board actions.  The average balance of borrowings increased $22.5 million, or five percent, to $477.6 million during the six months ended December 31, 2008 from $455.1 million during the same period of fiscal 2008.

The following table depicts the average balance sheets for the quarters and six months ended December 31, 2008 and 2007, respectively:

Average Balance Sheets

(Dollars in thousands)