PROVIDENT FINANCIAL HOLDINGS INC - Quarter Report: 2005 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

                       For the quarterly period ended .............................................................. September 30, 2005

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

                      For the transition period from ________________ to _________________

Commission File Number 000-28304

PROVIDENT FINANCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

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 Ö .     No     .

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes Ö .     No     .

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

Yes      .    No  Ö .

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

    Title of class:                                                                                                                                            As of November 2, 2005

Common stock, $ 0.01 par value, per share                                                                                                6,927,163 shares*

* Includes 334,769 shares held by the Employee Stock Ownership Plan ("ESOP") that have not been released, committed to be
   released, or allocated to participant accounts; and 9,588 shares held by the Management Recognition Plan ("MRP") that have
   been committed to be released and allocated to participant accounts.

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

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

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

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

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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 balance sheet data at June 30, 2005 is derived from the audited consolidated financial statements of Provident Financial Holdings, Inc. and its wholly owned subsidiary, Provident Savings Bank, F.S.B. (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, 2005, as amended (SEC File No. 000-28304). 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 ended September 30, 2005 are not necessarily indicative of results that may be expected for the entire fiscal year ending June 30, 2006.

Statement of Financial Accounting Standards ("SFAS") No. 154:
In May 2005, the Financial Accounting Standards Board ("FASB") issued SFAS No. 154, "Accounting Changes and Error Corrections," that addresses accounting for changes in accounting principle, changes in accounting estimates, changes required by an accounting pronouncement in the instance that the pronouncement does not include specific transition provisions, and error correction. SFAS No. 154 requires retrospective application to prior periods' financial statements of changes in accounting principle and error correction unless impracticable to do so. SFAS No. 154 states an exception to retrospective application when a change in accounting principle, or the method of applying it, may be inseparable from the effect of a change in accounting estimate. When a change in principle is inseparable from a change in estimate, such as depreciation, amortization or depletion, the change to the financial statements is to be presented in a prospective manner. SFAS No. 154 and the required disclosures are effective for accounting changes and error corrections in fiscal years beginning after December 15, 2005.

SFAS No. 123R:
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment." This Statement supersedes Accounting Principles Board ("APB") Opinion No. 25 and its related implementation guidance and is a revision of SFAS No. 123. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement requires a public entity to measure the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available). If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.

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The Corporation adopted the revised accounting for stock-based compensation requirements on July 1, 2005. SFAS No. 123R allows for two alternative transition methods. The Corporation intends to follow the modified prospective method, which requires application of the new statement to new awards and to awards modified, repurchased, or cancelled after the required effective date. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite services are rendered on or after the effective date. The compensation cost of that portion of awards shall be based on the grant-date fair value of those awards as calculated for pro-forma disclosures under the original SFAS No. 123.

EITF No. 03-1:
In June 2005, the FASB decided not to provide additional guidance on the meaning of other-than-temporary impairment, and directed the staff to issue proposed FASB Staff Position ("FSP") Emerging Issues Task Force ("EITF") 03-1-a, "Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1," as final. The final FSP will supersede EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," and EITF Topic No. D-44, "Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value." The final FSP (retitled FSP FAS 115-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments") will replace the guidance set forth in paragraphs 10-18 of EITF Issue 03-1 with references to existing other-than-temporary impairment guidance, such as SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the SEC Staff Accounting Bulletin No. 59, "Accounting for Non-Current Marketable Equity Securities," and APB Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock." FSP FAS 115-1 will codify the guidance set forth in EITF Topic D-44 and clarify that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made. FAS 115-1 will be effective for reporting periods beginning after December 15, 2005.

Earnings Per Share:
Basic earnings per share ("EPS") excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would then share in the earnings of the entity. The following table provides the basic and diluted EPS computations for the quarters ended September 30, 2005 and 2004, respectively.

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Prior to the quarter ended September 30, 2005, stock options were accounted for under APB Opinion No. 25 using the intrinsic value method. Accordingly, no stock option expense was recorded in periods prior to the three months ended September 30, 2005, since the exercise price of the options issued has always been equal to the market value at the date of grant. SFAS No. 123R 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.

Had the Corporation determined compensation cost based on the fair value at the grant date for stock options exercisable under SFAS No. 123R prior to July 1, 2005, the Corporation's results of operations would have been adjusted to the pro forma amounts for the period indicated below:

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The Corporation operates in two business segments: community banking (Provident Savings Bank, F.S.B. ("Bank")) and mortgage banking (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 September 30, 2005 and 2004, respectively (in thousands).

(1)    Includes an inter-company charge of $997 credited to PBM by the Bank during the period to compensate PBM for originating loans held for investment.
(2)    Includes an inter-company charge of $60 credited to PBM by the Bank during the period to compensate PBM for servicing fees on loans sold on a
        servicing retained basis.

(1)    Includes an inter-company charge of $1.6 million credited to PBM by the Bank during the period to compensate PBM for originating loans held for investment.
(2)    Includes an inter-company charge of $142 credited to PBM by the Bank during the period to compensate PBM for servicing fees on loans sold on a
        servicing retained basis.

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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 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.

In accordance with SFAS No. 133 and interpretations of the Derivative Implementation Group of the FASB, 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 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 consolidated statements of operations during the quarters ended September 30, 2005 and 2004 was a gain of $319,000 and a gain of $41,000, respectively.

(1)    Net of estimated commitments of 24.9 percent at September 30, 2005, 25.0 percent at June 30, 2005 and 25.1 percent at
         September 30, 2004, which may not fund.

In the third quarter of fiscal 2004, the Corporation adopted the SEC guidance regarding loan commitments that are recognized as derivatives pursuant to SFAS No. 133. As a result of implementing the SEC Staff Accounting Bulletin No. 105, "Application of Accounting Principles to Loan Commitments," the Corporation excludes the recognition of servicing released premiums in the valuation of commitments to extend credit on loans to be held for sale. The Corporation's previous practice had been to recognize, at the inception of the rate lock, the anticipated servicing released premiums on the underlying loans. The Corporation elected to prospectively apply this guidance to new loan commitments initiated after January 1, 2004. This action delays the recognition of servicing released premiums until the underlying loans are funded and sold.

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On September 13, 2005, the Corporation announced the signing of a Purchase and Sale Agreement to sell a commercial office building located in Riverside, California. The transaction is subject to certain conditions and contingencies such as the buyer's ability to secure financing and the buyer's due diligence review, among others. The Corporation anticipates that the transaction will close during the quarter ending December 31, 2005. The successful completion of the transaction is expected to result in a gain (net of taxes) of approximately $3.4 million.

On October 27, 2005, the Board of Directors of the Bank declared a cash dividend of $2.0 million to the Corporation, which was paid on October 31, 2005.

On October 28, 2005, the Corporation announced a cash dividend of $0.14 per share on the Corporation's outstanding shares of common stock for shareholders of record at the close of business on November 22, 2005, payable on December 16, 2005.

On October 31, 2005, the Corporation announced the signing of a Lease Agreement with the intention of opening a new retail/business banking office in the La Sierra area in Riverside, California. The La Sierra Branch will become the Bank's 13^th full-service branch and is scheduled to open in the summer of 2006 subject to the approval of the Office of Thrift Supervision and the completion of the shopping center.

Provident Financial Holdings, Inc., a Delaware corporation, was organized in January 1996 for the purpose of becoming the holding company for 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 September 30, 2005, the Corporation had total assets of $1.6 billion, total deposits of $963.1 million and total stockholders' equity of $126.3 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 under the Savings Association Insurance Fund ("SAIF"). 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 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

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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 including, among others, interest 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 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 privately negotiated transactions, depending upon market conditions and the factors described above. On June 24, 2005, the Corporation announced that its Board of Directors authorized the repurchase of up to five percent of its common stock, or approximately 347,840 shares, over a one-year period. Please refer to the Issuer Purchases of Equity Securities table under Part II, Item 2 - "Unregistered Sales of Equity Securities and Use of Proceeds" on page 28.

The Corporation began to distribute quarterly cash dividends in the quarter ended September 30, 2002. On July 26, 2005, the Corporation announced a quarterly cash dividend of $0.14 per share for the Corporation's shareholders of record at the close of the business day on August 17, 2005, which was paid on September 8, 2005. 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, 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.

Certain matters in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 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 as a result of a wide range of factors including, but not limited to, the general business environment, interest rates, the California real estate market, the demand for loans, competitive conditions between banks and non-bank financial services providers, regulatory changes, and other risks detailed in the Corporation's reports filed with the SEC, including the Annual Report on Form 10-K for the fiscal year ended June 30, 2005, as amended. Forward-looking statements are effective only as of the date that they are made and the Corporation assumes no obligation to update this information.

The discussion and analysis of the Corporation's financial condition and results of operations are based upon the Corporation's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America and conform to prevailing

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practices within the banking industry. 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. Management considers the accounting for the allowance for loan losses and accounting for derivatives to be critical accounting policies.

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. 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 three components: (i) a formula allowance for groups of homogeneous 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. 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 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. For further details, see the "Provision for Loan Losses" narrative on page 18.

Interest is generally not accrued on any loan when its contractual payments are more than 90 days delinquent. In addition, interest is not recognized on any loan for which 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, the loan is paying in accordance with its payment terms for a minimum six-month period, and future monthly principal and interest payments are expected to be collected.

Properties acquired through foreclosure or deed in lieu of foreclosure are transferred to the real estate owned portfolio and carried at the lower of cost or estimated fair value less the estimated costs to sell the property. The fair values of the properties are based upon current appraisals. The difference between the fair value of the real estate collateral and the loan balance at the time of the transfer is recorded as a loan charge-off if fair value is lower. Subsequent to foreclosure, management periodically performs additional valuations and the properties are adjusted, if necessary, to the lower of carrying value or fair value, less estimated selling costs. The determination of a property's estimated fair value includes revenues projected to be realized from disposal of the property, construction and renovation costs.

SFAS No. 133, "Accounting for Derivative Financial Instruments and Hedging Activities," as amended, requires that derivatives of the Corporation be 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 mitigate the risk of the commitments. 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.

Community banking operations primarily consist of accepting deposits from customers within the communities surrounding its full service offices and investing those funds in single-family, multi-family, commercial real estate, construction, commercial business, consumer and other loans. Additionally, certain fees are collected from depositors for services provided to them such as, non-sufficient fund 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 produced by loans and securities, and the interest

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expense paid on interest-bearing deposits and borrowed funds. During the next three years the Corporation intends to increase the community banking business by growing total assets; restructure the balance sheet by decreasing the percentage of investment securities to total assets and increasing the percentage of loans held for investment to total assets; and increase the concentration of multi-family, commercial real estate, construction and commercial business loans. In addition, over time, the Corporation also intends to emphasize the growth of 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.

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. During the next three years the Corporation intends to originate and sell high margin mortgage banking products such as alt-A fixed rate, alt-A adjustable rate and second trust deed loans. Additionally, mortgage banking operations will continue to originate loans held for investment secured by single-family residences.

Investment services primarily consists of selling alternative investment products such as annuities and mutual funds to our depositors and real estate operations primarily consists of deriving net rental income from tenants that occupy the Corporation's real estate held for investment. Each of these businesses generates a relatively small portion of the Corporation's net income.

There are a number of risks associated with the business activities of the Corporation, many of which are beyond the Corporation's control, including: general economic conditions, either nationally or locally; changes in interest rates; changes in real estate values; changes in accounting principles; changes in regulation; changes in deposit and funding flows; and changes in competition among financial institutions or non-financial institutions, 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 rising short-term interest rates and an increased concern that rising real estate values are unsustainable. Rising short-term interest rates have led to a flatter yield curve placing pressure on the Corporation's net interest margin since the Corporation's assets are generally priced at the intermediate or long end of the yield curve and interest-bearing liabilities are generally priced at the short end of the yield curve. Rising real estate values may prove unsustainable which 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 California real estate may inhibit the Corporation's ability to recover losses on defaulted loans from selling the underlying real estate.

The following table summarizes the Corporation's contractual obligations at September 30, 2005 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 respective contractual terms.

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Total assets remained unchanged at $1.6 billion at September 30, 2005 as compared to June 30, 2005. The decreases in investment securities and receivable from sale of loans were primarily offset by the increase in federal funds sold.

Federal funds sold increased to $59.0 million at September 30, 2005 from $5.6 million at June 30, 2005. The increase was attributable to incoming funds received late in the day on September 30, 2005 that could not be used in a timely manner to pay down short-term FHLB - San Francisco advances.

Total investment securities decreased $18.3 million, or eight percent, to $214.1 million at September 30, 2005 from $232.4 million at June 30, 2005. The decrease was primarily the result of scheduled and accelerated principal payments on mortgage-backed securities. The Bank evaluates all of its investment securities quarterly for other-than-temporary declines in the market value of individual investment securities. The Bank has not recorded impairment losses as of September 30, 2005.

Loans held for investment remained unchanged at $1.13 billion at September 30, 2005 as compared to June 30, 2005. In the first three months of fiscal 2006, the Bank originated $166.1 million of loans held for investment, of which $60.2 million, or 36 percent, were "preferred loans" (multi-family, commercial real estate, construction and commercial business loans), including the purchase of $3.2 million of loans during the period. The collateral that secures the purchased loans is located primarily in Southern California. During the first quarter of fiscal 2006, the Bank sold $18.5 million of loans held for investment which contained certain higher risk characteristics (stated income, interest only, loan to value ratio greater than 74 percent, combined loan to value ratio greater than 95 percent and credit scores less than 700). During the quarter, the Bank tightened its underwriting criteria for Alt "A" loans eligible for loans held for investment and developed an "A" loan program designed to provide sufficient volume to replace the volume lost in the Alt "A" program. These actions were taken to reduce the credit risk exposure of loans held for investment. Total loan repayments during the first three months of fiscal 2006 were $143.8 million. The balance of preferred loans increased to $318.9 million, or 28 percent of loans held for investment at September 30, 2005, as compared to $318.2 million or 28 percent of loans held for investment, at June 30, 2005. Purchased loans serviced by others at September 30, 2005 were $57.6 million, or five percent of loans held for investment, compared to $63.9 million, or six percent of loans held for investment at June 30, 2005.

Loans held for sale increased $8.2 million, or 144 percent, to $13.9 million at September 30, 2005 from $5.7 million at June 30, 2005. The increase was the result of timing differences between loan funding and loan sale dates.

Receivable from the sale of loans decreased $43.2 million, or 26 percent, to $124.6 million at September 30, 2005 from $167.8 million at June 30, 2005. The decrease was the result of timing differences between loan sale and loan sale settlement dates.

Total deposits increased $44.5 million, or five percent, to $963.1 million at September 30, 2005 from $918.6 million at June 30, 2005. This increase was primarily attributable to an increase of $54.2 million in time deposits, partly offset by a decrease of $9.7 million in transaction accounts. The increase in time deposits and the decrease in transaction accounts were attributable primarily to the increase in short-term interest rates and the Bank's advertising campaign for time deposits during the first quarter of fiscal 2006.

Borrowings, which consisted entirely of FHLB - San Francisco advances, decreased $53.5 million, or 10 percent, to $507.3 million at September 30, 2005 from $560.8 million at June 30, 2005. The decrease in borrowings was primarily the result of the increase in deposits and the decreases in loans held for investment and receivable from sale of loans. The weighted-average maturity of the Bank's existing FHLB - San Francisco advances was approximately 38 months (32 months, based on put dates) at September 30, 2005 as compared to the weighted-average maturity of 36 months (31 months, based on put dates) at June 30, 2005.

Total stockholders' equity increased $3.3 million, or three percent, to $126.3 million at September 30, 2005, from $123.0 million at June 30, 2005, primarily as a result of the net income during the first three months of fiscal 2006, which was partly offset by common stock repurchases and a quarterly cash dividend

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paid during the first quarter of fiscal 2006. During the first three months of fiscal 2006, a total of 28,000 shares were repurchased under the existing stock repurchase program at an average price of $28.30 per share. As of September 30, 2005, eight percent of the authorized shares of the June 2005 stock repurchase plan were purchased, leaving approximately 319,840 shares available for future repurchase. The total cash dividend paid in the first quarter of fiscal 2006 was $974,000.

The Corporation's net income for the first quarter ended September 30, 2005 was $4.9 million, an increase of $678,000, or 16 percent, from $4.3 million during the same quarter of fiscal 2005. This increase was primarily attributable to an increase in net interest income and a decrease in provision for loan loss, partly offset by an increase in non-interest expense.

The Corporation's net interest income before provision for loan losses increased by $1.0 million, or 10 percent, to $11.0 million for the quarter ended September 30, 2005 from $10.0 million during the comparable period of fiscal 2005. This increase was the result of higher average earning assets, partly offset by a lower net interest margin. The average balance of earning assets increased $252.0 million, or 19 percent, to $1.6 billion in the first quarter of fiscal 2006 from $1.3 billion in the comparable period of fiscal 2005. The net interest margin decreased to 2.80 percent in the first quarter of fiscal 2006, down 23 basis points from 3.03 percent during the same period of fiscal 2005. The decrease in the net interest margin during the first quarter of fiscal 2006 was primarily attributable to an increase in the average cost of funds, partly offset by an increase in the average yield of earning assets.

The Corporation's efficiency ratio increased slightly to 48 percent in the first quarter of fiscal 2006 from 47 percent in the same period of fiscal 2005. Return on average assets for the quarter ended September 30, 2005 decreased 2 basis points to 1.22 percent from 1.24 percent in the same period last year; while return on average equity for the quarter ended September 30, 2005 increased to 15.80 percent from 15.35 percent in the same period last year. Diluted earnings per share for the quarter ended September 30, 2005 were $0.71, an increase of 18 percent from $0.60 for the quarter ended September 30, 2004.

Interest Income. Total interest income increased by $4.2 million, or 25 percent, to $21.3 million for the first quarter of fiscal 2006 from $17.1 million in the same quarter of fiscal 2005. This increase was primarily the result of a higher average balance of earning assets and a higher average earning asset yield. The average yield on earning assets during the first quarter of fiscal 2006 was 5.44 percent, 24 basis points higher than the average yield of 5.20 percent during the same period of fiscal 2005. Increases in the average yield on loans, investment securities and interest-earning deposits were partly offset by a decrease in the average yield on FHLB - San Francisco stock.

Loan interest income increased $4.3 million, or 29 percent, to $19.0 million in the quarter ended September 30, 2005 from $14.7 million for the same quarter of fiscal 2005. This increase was attributable to a higher average loan balance and a higher average loan yield. The average balance of loans outstanding, including receivable from sale of loans and loans held for sale, increased $274.8 million, or 27 percent, to $1.3 billion during the first quarter of fiscal 2006 from $1.0 billion during the same quarter of fiscal 2005. The average loan yield during the first quarter of fiscal 2006 increased to 5.86 percent from 5.73 percent during the same quarter last year. The increase in the average loan yield was primarily attributable to new mortgage loans originated with higher interest rates and the repricing of adjustable rate loans during the period.

Interest income from investment securities decreased $220,000, or 11 percent, to $1.8 million during the quarter ended September 30, 2005 from $2.0 million during the same quarter of fiscal 2005. This decrease was primarily a result of a decrease in average balance, partly offset by an increase in average yield. The average balance of investment securities decreased $35.1 million, or 14 percent, to $224.4 million in the first quarter of fiscal 2006 from $259.5 million in the same quarter of fiscal 2005. The average yield on the investment securities portfolio increased 10 basis points to 3.23 percent during the quarter ended September 30, 2005 from 3.13 percent during the quarter ended September 30, 2004. The increase in the average yield of investment securities was primarily a result of a decline in the accelerated principal payments on mortgage-backed securities ("MBS") with a corresponding reduction to the MBS premium amortization. The accelerated amortization in the first quarter of fiscal 2006 declined by $75,000 to $118,000 as

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compared to $193,000 in the same quarter of fiscal 2005. This decline in the accelerated amortization resulted in an increase of 13 basis points in the investment yield.

FHLB - San Francisco stock dividends increased by $35,000, or nine percent, to $405,000 in the first quarter of fiscal 2006 from $370,000 in the same period of fiscal 2005. This increase was attributable to a higher average balance, partly offset by a lower average yield. The average balance of FHLB - San Francisco stock increased $9.1 million to $37.9 million during the first quarter of fiscal 2006 from $28.8 million during the same period of fiscal 2005. The increase in FHLB - San Francisco stock was in accordance with the borrowing requirements of the FHLB - San Francisco. The average yield on FHLB - San Francisco stock decreased 87 basis points to 4.27 percent during the first quarter of fiscal 2006 from 5.14 percent during the same period last year. The decrease in the average yield was primarily a result of lower dividend accruals, which are based upon the actual dividends received in the prior periods.

Interest Expense. Total interest expense for the quarter ended September 30, 2005 was $10.3 million as compared to $7.1 million for the same period of fiscal 2005, an increase of $3.2 million, or 45 percent. This increase was primarily attributable to a higher average balance of interest-bearing liabilities and an increase in the average cost. The average balance of interest-bearing liabilities increased $235.8 million, or 19 percent, to $1.5 billion during the first quarter of fiscal 2006 from $1.2 billion during the same period of fiscal 2005. The average cost of interest-bearing liabilities was 2.80 percent during the quarter ended September 30, 2005, up 49 basis points from 2.31 percent during the same period of fiscal 2005.

Interest expense on deposits for the quarter ended September 30, 2005 was $5.0 million as compared to $3.5 million for the same period of fiscal 2005, an increase of $1.5 million, or 43 percent. The increase in interest expense on deposits was primarily attributable to a higher average balance and a higher average cost. The average balance of deposits increased $65.7 million, or eight percent, to $936.9 million during the quarter ended September 30, 2005 from $871.2 million during the same period of fiscal 2005. The average balance of transaction accounts decreased by $81.4 million, or 15 percent, to $473.9 million in the quarter ended September 30, 2005 from $555.3 million in the same quarter ended September 30, 2004. The decrease was attributable to a decline in money market and savings accounts, partly offset by an increase in checking accounts. The average balance of time deposits increased by $147.1 million, or 47 percent, to $463.0 million in the quarter ended September 30, 2005 as compared to $315.9 million in the same quarter ended September 30, 2004. The increase in time deposits is primarily attributable to the successful time deposit marketing campaign and depositors switching from money market accounts to time deposits. The average balance of transaction account deposits to total deposits in the first quarter of fiscal 2006 was 51 percent, as compared to 64 percent in the same period of fiscal 2005. The average cost of deposits increased to 2.11 percent during the quarter ended September 30, 2005 from 1.61 percent during the same quarter of fiscal 2005, an increase of 50 basis points. The increase in the average cost of deposits was attributable to the general rise in interest rates.

Interest expense on borrowings for the quarter ended September 30, 2005 increased $1.8 million, or 50 percent, to $5.4 million from $3.6 million for the same period of fiscal 2005. The increase in interest expense on borrowings was primarily a result of a higher average balance and a slightly higher average cost. The average balance of borrowings increased $170.1 million, or 48 percent, to $526.3 million during the quarter ended September 30, 2005 from $356.2 million during the same period of fiscal 2005. The average cost of borrowings increased to 4.04 percent for the quarter ended September 30, 2005 from 4.02 percent in the same quarter of fiscal 2005, an increase of two basis points. The increase in the average cost of borrowings was the result of new long-term advances at a higher average cost, partly offset by a higher percentage of overnight borrowings to total borrowings, which generally have a lower average cost.

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The following table depicts the average balance sheets for the quarters ended September 30, 2005 and 2004, 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, 2005 and 2004, respectively:

Rate/Volume Variance
(In Thousands)