PROVIDENT FINANCIAL HOLDINGS INC - Quarter Report: 2006 September (Form 10-Q)

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

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

                       For the quarterly period ended                                                             September 30, 2006

[    ]                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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.

Large accelerated filer [   ]                                 Accelerated filer [Ö ]                            Non-accelerated filer [   ]

Indicate by check mark whether the registrant is a shell company (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.

*  Includes 273,902 shares held by the Employee Stock Ownership Plan that have not been released, committed to be
    released, or allocated to participant accounts; and 3,768 shares held by the Management Recognition Plan that have been
    awarded and not yet released to the participants.

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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 Condensed Consolidated Statement of Financial Condition at June 30, 2006 is 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, 2006. The results of operations for the quarter ended September 30, 2006 are not necessarily indicative of results that may be expected for the entire fiscal year ending June 30, 2007.

Statement of Financial Accounting Standards ("SFAS" or "Statement") No. 157:
In September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 157, "Fair Value Measurements." This Statement defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value. This Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. Therefore, the definition focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption of this statement is not expected to have a material impact on the Corporation's financial condition, results of operations, or cash flows.

SFAS No. 156:
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets," an amendment of FASB Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 156 requires all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable, and permits for subsequent measurement using either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of Statement No. 140. SFAS No. 156 is effective for an entity's first fiscal year beginning after September 15, 2006. The Corporation intends to continue applying the amortization and impairment requirements of Statement No. 140.

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SFAS No. 155:
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments," amendment of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133; establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. In October 2006, the FASB exempted most pre-payable assets from provisions of SFAS No. 155 that would have required mark-to-market of those assets through results of operations if purchased at a discount to par. The adoption of this statement is not expected to have a material impact on the Corporation's financial condition, results of operations, or cash flows.

SFAS No. 154:
In May 2005, the 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 corrections. 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. The adoption of this statement did not have a material impact on the Corporation's financial condition, results of operations, or cash flows.

SEC Staff Accounting Bulletin No. 108
In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, "Quantifying Financial Misstatements," which expresses the Staff's views regarding the process of quantifying financial statement misstatements. Registrants are required to quantify the impact of correcting all misstatements, including both the carryover and reversing effects of prior year misstatements, on the current year financial statements. The techniques most commonly used in practice to accumulate and quantify misstatements are generally referred to as the "rollover" (current year statement of operations perspective) and "iron curtain" (year-end consolidated statement of financial condition perspective) approaches. The financial statements would require adjustment when either approach results in quantifying a misstatement that is material, after considering all relevant quantitative and qualitative factors. The Corporation does not expect this guidance to have a material effect on the Corporation's financial condition, results of operations, or cash flows.

FASB Interpretation No. 48 ("FIN 48"):
In July 2006 the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes," which supplements SFAS No. 109, "Accounting for Income Taxes," by defining the confidence level that a tax position must meet in order to be recognized in the financial statements. The interpretation requires that the tax effects of a position be recognized only if it is "more-likely-than-not" to be sustained based solely on its technical merits as of the reporting date. The more-likely-than-not threshold represents a positive assertion by management that a company is entitled to the economic benefits of a tax position. If a tax position is not considered more-likely-than-not to be sustained based solely on technical merits, no benefits of the position are to be recognized. Moreover, the more-likely-than-not threshold must continue to be met in each reporting period to support continued recognition of a benefit. The interpretation also requires enterprises to make explicit disclosures about uncertainties in their income tax positions, including a detailed roll forward of tax benefits taken that do not qualify for financial statement recognition. FIN 48 is

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effective for fiscal years beginning after December 15, 2006. It is not anticipated that adoption will have a material impact on the Corporation's financial condition, results of operations, or cash flows.

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, 2006 and 2005, respectively.

Statement of Financial Accounting Standards ("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 was $33,000 for the first quarter ended September 30, 2006, down 65% from $93,000 in the same period last year, due primarily to a prior period adjustment of $63,000. For the first quarter of fiscal 2007 and 2006, cash provided by operating activities decreased by $23,000 and $29,000, respectively, and cash provided by financing activities increased by an identical amount related to excess tax benefits from stock-based payment arrangements. This amount is reflective of the tax benefit for stock options exercised and restricted stock distributions during the respective period.

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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 September 30, 2006 and 2005, respectively (in thousands).

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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, 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 quarter ended September 30, 2006 was a gain of $319,000, unchanged from the quarter ended September 30, 2005.

On October 3, 2006, the Bank signed a Lease Agreement with the intention of opening a new retail/business banking office at the southeast corner of Iris Avenue and Perris Boulevard in Moreno Valley, California. The branch will become the Bank's 14th full-service branch and is scheduled to open in the fall of 2007, subject to the approval of the Office of Thrift Supervision and the completion of the shopping center.

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On October 24, 2006, the Board of Directors of the Bank declared a cash dividend of $3.25 million to the Corporation, which was paid on October 25, 2006.

On October 24, 2006, the Corporation announced a cash dividend of $0.18 per share on the Corporation's outstanding shares of common stock for shareholders of record as of the close of business on November 17, 2006, payable on December 11, 2006.

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 September 30, 2006, the Corporation had total assets of $1.7 billion, total deposits of $915.0 million and total stockholders' equity of $138.4 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's revenues are derived principally from interest on its loan 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, investments, competitive conditions between banks and non-bank financial services providers, regulatory changes, and other risks.

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 in privately negotiated transactions, depending upon market conditions and the factors described above. On May 23, 2006, the Corporation announced that its Board of Directors authorized the repurchase of up to five percent of its common stock, or approximately 350,558 shares, over a one-year period. For additional information regarding the Corporation's repurchases during the quarter ended September 30, 2006, see Part II, Item 2 - "Unregistered Sales of Equity Securities and Use of Proceeds" on Page 29.

The Corporation began to distribute quarterly cash dividends in the quarter ended September 30, 2002. On July 25, 2006, the Corporation announced a quarterly cash dividend of $0.15 per share for the Corporation's shareholders of record at the close of business on August 17, 2006, which was paid on September 8, 2006. 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,

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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. On July 25, 2006, the Board of Directors of the Bank declared a $10.25 million cash dividend to the Holding Company, which was paid on August 15, 2006. 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, 2006 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 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 disclosed herein or 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, 2006. Forward-looking statements are effective only as of the date that they are made and the Corporation assumes no obligation to update forward-looking 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. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Accounting for the allowance for loan losses involves significant 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 three components: (i) a formula allowance for groups of homogeneous loans, (ii) a specific valuation 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 techniques is inherently subjective and the actual losses could be greater or less than the estimates. For further details, see "Comparison of Operating

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Results for the Quarters Ended September 30, 2006 and 2005 - Provision for Loan Losses" on page 18 of this Form 10-Q.

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 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 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. During 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.

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 the Bank's 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 lessor degree, investment services.

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 investment securities, and the interest expense produced by 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; decrease the concentration of single-family mortgage loans within its loans held for investment; and increase the concentration of multi-family, commercial real estate, construction and commercial business loans. In addition, over time, the Corporation also intends to decrease the percentage of time deposits in its deposit base and to increase the percentage 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 concentrate on high margin mortgage banking products such as Alt-

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A fixed rate, Alt-A adjustable rate and second trust deed loans. The Alt-A loans are underwritten to expanded guidelines allowing a borrower with good credit a broader range of product choices. The "Alt-A" choices include interest-only loans, stated-income loans and greater than 30-year amortization loans. The Corporation believes that it can maintain its gain on sale margin at approximately the same levels experienced during the prior year.

Investment services primarily consist of selling alternative investment products such as annuities and mutual funds to our depositors.

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 and changes in regulation, 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 on defaulted loans by selling the underlying real estate.

The following table summarizes the Corporation's contractual obligations at September 30, 2006 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.

Total assets increased $73.3 million, or five percent, to $1.70 billion at September 30, 2006 from $1.62 billion at June 30, 2006. The increase was primarily attributable to increases in investment securities and loans held for investment.

Total investment securities increased $16.6 million, or nine percent, to $193.8 million at September 30, 2006 from $177.2 million at June 30, 2006. The increase was primarily the result of the purchase of $28.9 million of investment securities settled in August 2006, partly offset by scheduled and accelerated principal payments on mortgage-backed securities. The Bank evaluates individual investment securities quarterly for other-than-temporary declines in the market value. The Bank believes there are no other-than-temporary impairments at September 30, 2006, therefore, no impairment losses have been recorded as of September 30, 2006.

Loans held for investment increased $43.1 million, or three percent, to $1.31 billion at September 30, 2006 from $1.26 billion at June 30, 2006. During the first three months of fiscal 2007, the Bank originated

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$110.1 million of loans held for investment, of which $60.6 million, or 55 percent, were "preferred loans" (multi-family, commercial real estate, construction and commercial business loans), which includes the purchase of $35.5 million of loans. The loans purchased in the first three months of fiscal 2007 are secured by real estate located primarily in California (property inspections were performed on those loans above $400,000) and all loans were underwritten by the Corporation prior to purchase (using the same underwriting criteria as an originated loan). Total loan repayments during the first three months of fiscal 2007 were $78.4 million, compared to $143.8 million during the first three months of fiscal 2006. The balance of preferred loans increased to $479.3 million, or 36 percent of loans held for investment at September 30, 2006, as compared to $433.8 million, or 34 percent of loans held for investment at June 30, 2006. Purchased loans serviced by others at September 30, 2006 were $124.8 million, or nine percent of loans held for investment, compared to $102.7 million, or eight percent of loans held for investment at June 30, 2006.

Receivable from the sale of loans increased $6.6 million, or seven percent, to $106.5 million at September 30, 2006 from $99.9 million at June 30, 2006. The increase was attributable to the timing differences between loan sale and loan sale settlement dates, partly offset by a decline in loan sales volume during the first quarter of fiscal 2007 in comparison to the fourth quarter of fiscal 2006.

Total deposits decreased $2.6 million, or less than one percent, to $915.0 million at September 30, 2006 from $917.6 million at June 30, 2006. This decrease was primarily attributable to a decrease of $17.1 million in transaction accounts, partly offset by an increase of $14.5 million in time deposits. The decrease in transaction accounts and the increase in time deposits was primarily attributable to the increase in short-term interest rates and depositors switching from savings deposits to time deposits.

Borrowings, which consisted primarily of FHLB - San Francisco advances, increased $71.4 million, or 13 percent, to $617.6 million at September 30, 2006 from $546.2 million at June 30, 2006. The increase in borrowings was primarily the result of the increases in investment securities and loans held for investment and the decrease in deposits. The weighted-average maturity of the Bank's existing FHLB - San Francisco advances was approximately 25 months (20 months, based on put dates) at September 30, 2006 as compared to the weighted-average maturity of 30 months (24 months, based on put dates) at June 30, 2006.

Total stockholders' equity increased $2.2 million, or two percent, to $138.4 million at September 30, 2006, from $136.2 million at June 30, 2006, primarily as a result of the net income and stock option exercises during the first three months of fiscal 2007, which was partly offset by common stock repurchases and a quarterly cash dividend paid during the first three months of fiscal 2007. During the first three months of fiscal 2007, a total of 6,500 stock options with an average strike price of $23.62 per share were exercised. Also, a total of 111,185 shares were repurchased under the existing stock repurchase program at an average price of $30.35 per share. As of September 30, 2006, 37 percent of the authorized shares of the May 2006 stock repurchase program were purchased, leaving 220,044 shares available for future repurchase. During the first three months of fiscal 2007, the Corporation also repurchased 812 shares of restricted stock at an average price of $29.90 per share. The total cash dividend paid in the first three months of fiscal 2007 was $1.0 million.

The Corporation's net income for the first quarter ended September 30, 2006 was $5.3 million, an increase of $325,000, or seven percent, from $4.9 million during the same quarter of fiscal 2006. This increase was primarily attributable to an increase in non-interest income, partly offset by a decrease in net interest income and an increase in provision for loan losses.

The Corporation's net interest income before the provision for loan losses decreased by $214,000, or two percent, to $10.8 million for the quarter ended September 30, 2006 from $11.0 million during the comparable period of fiscal 2006. This decrease was the result of a lower net interest margin, partly offset by higher average earning assets. The net interest margin decreased to 2.68 percent in the first quarter of fiscal 2007, down 12 basis points from 2.80 percent for the same period of fiscal 2006. The decrease in the net interest margin during the first quarter of fiscal 2007 was primarily attributable to the increase in the average cost of funds, which was more than the increase in the average yield of earning assets. The interest spread narrowed to 2.42 percent in the quarter ended September 30, 2006 from 2.64 percent in the same 

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period last year, a decline of 22 basis points. The average balance of earning assets increased $40.3 million, or three percent, to $1.61 billion in the first quarter of fiscal 2007 from $1.57 billion in the comparable period of fiscal 2006.

The Corporation's efficiency ratio improved to 45 percent in the first quarter of fiscal 2007 from 48 percent in the same period of fiscal 2006. The improvement was primarily attributable to the gain on sale of real estate recognized in the first quarter of fiscal 2007.

Return on average assets for the quarter ended September 30, 2006 increased six basis points to 1.28 percent from 1.22 percent in the same period last year. Return on average equity for the quarter ended September 30, 2006 decreased to 15.25 percent from 15.80 percent for the same period last year.

Diluted earnings per share for the quarter ended September 30, 2006 were $0.77, an increase of eight percent from $0.71 for the quarter ended September 30, 2005.

Interest Income. Total interest income increased by $2.9 million, or 14 percent, to $24.2 million for the first quarter of fiscal 2007 from $21.3 million in the same quarter of fiscal 2006. 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 2007 was 6.02 percent, 58 basis points higher than the average yield of 5.44 percent during the same period of fiscal 2006.

Loan interest income increased $3.0 million, or 16 percent, to $22.0 million in the quarter ended September 30, 2006 from $19.0 million for the same quarter of fiscal 2006. 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 $84.4 million, or six percent, to $1.4 billion during the first quarter of fiscal 2007 from $1.3 billion during the same quarter of fiscal 2006. The average loan yield during the first quarter of fiscal 2007 increased 48 basis points to 6.34 percent from 5.86 percent during the same quarter last year. The increase in the average loan yield was primarily attributable to mortgage loans originated with higher interest rates, the repricing of adjustable rate loans during the period and a higher percentage of preferred loans, which generally have a higher yield.

Interest income from investment securities decreased $117,000, or six percent, to $1.7 million during the quarter ended September 30, 2006 from $1.8 million during the same quarter of fiscal 2006. This decrease was primarily a result of a decrease in the average balance, partly offset by an increase in average yield. The average balance of investment securities decreased $41.3 million, or 18 percent, to $183.1 million in the first quarter of fiscal 2007 from $224.4 million in the same quarter of fiscal 2006. During the first quarter of fiscal 2007, $28.9 million of investment securities were purchased and $3.0 million matured, while $9.7 million of principal was received on mortgage-backed securities ("MBS"). The average yield on the investment securities increased 48 basis points to 3.71 percent during the quarter ended September 30, 2006 from 3.23 percent during the quarter ended September 30, 2005. The increase in the average yield of investment securities was primarily a result of the new purchases with a higher average yield (5.42% vs. the average yield of 3.71%) and a decline in the accelerated principal payments on MBS with a corresponding reduction to the MBS premium amortization. The accelerated premium amortization in the first quarter of fiscal 2007 declined by $102,000 to $16,000 as compared to $118,000 in the same quarter of fiscal 2006.

FHLB - San Francisco stock dividends increased by $109,000, or 27 percent, to $514,000 in the first quarter of fiscal 2007 from $405,000 in the same period of fiscal 2006. This increase was attributable to a higher average yield and a higher average balance. The average yield on FHLB - San Francisco stock increased 109 basis points to 5.36 percent during the first quarter of fiscal 2007 from 4.27 percent during the same period last year. The increase in the average yield was due to the stock dividends declared by the FHLB - San Francisco. The average balance of FHLB - San Francisco stock increased $449,000 to $38.4 million during the first quarter of fiscal 2007 from $37.9 million during the same period of fiscal 2006. The increase in FHLB - San Francisco stock was in accordance with the borrowing requirements of the FHLB - San Francisco.

Interest Expense. Total interest expense for the quarter ended September 30, 2006 was $13.4 million as compared to $10.3 million for the same period of fiscal 2006, an increase of $3.1 million, or 30 percent. This increase was primarily attributable to an increase in the average cost and a higher average balance of 

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interest-bearing liabilities. The average cost of interest-bearing liabilities was 3.60 percent during the quarter ended September 30, 2006, up 80 basis points from 2.80 percent during the same period of fiscal 2006. The average balance of interest-bearing liabilities, principally deposits and borrowings, increased $18.7 million, or one percent, to $1.48 billion during the first quarter of fiscal 2007 from $1.46 billion during the same period of fiscal 2006.

Interest expense on deposits for the quarter ended September 30, 2006 was $6.8 million as compared to $5.0 million for the same period of fiscal 2006, an increase of $1.8 million, or 36 percent. The increase in interest expense on deposits was primarily attributable to a higher average cost, partly offset by a lower average balance. The average cost of deposits increased to 2.96 percent during the quarter ended September 30, 2006 from 2.11 percent during the same quarter of fiscal 2006, an increase of 85 basis points. The increase in the average cost of deposits, primarily in time deposits, was attributable to the general rise in short-term interest rates. The average balance of deposits decreased $25.0 million, or three percent, to $911.9 million during the quarter ended September 30, 2006 from $936.9 million during the same period of fiscal 2006. The average balance of transaction accounts decreased by $90.8 million, or 19 percent, to $383.1 million in the quarter ended September 30, 2006 from $473.9 million in the quarter ended September 30, 2005. The decrease was primarily attributable to a decline in savings accounts. The average balance of time deposits increased by $65.8 million, or 14 percent, to $528.8 million in the quarter ended September 30, 2006 as compared to $463.0 million in the quarter ended September 30, 2005. The increase in time deposits is primarily attributable to depositors switching from savings deposits to time deposits. The average balance of transaction account deposits to total deposits in the first quarter of fiscal 2007 was 42 percent, compared to 51 percent in the same period of fiscal 2006.

Interest expense on borrowings, which consisted primarily of FHLB - San Francisco advances, for the quarter ended September 30, 2006 increased $1.2 million, or 22 percent, to $6.6 million from $5.4 million for the same period of fiscal 2006. The increase in interest expense on borrowings was primarily a result of a higher average cost and a higher average balance. The average cost of borrowings increased to 4.61 percent for the quarter ended September 30, 2006 from 4.04 percent in the same quarter of fiscal 2006, an increase of 57 basis points. The increase in the average cost of borrowings was the result of higher short-term interest rates. The average balance of borrowings increased $43.7 million, or eight percent, to $570.0 million during the quarter ended September 30, 2006 from $526.3 million during the same period of fiscal 2006.

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The following table depicts the average balance sheets for the quarters ended September 30, 2006 and 2005, 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, 2006 and 2005, respectively:

Rate/Volume Variance
(In Thousands)