PROVIDENT FINANCIAL HOLDINGS INC - Annual Report: 2021 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-K

(Mark one)

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☒        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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For the fiscal year ended June 30, 2021             OR

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

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Commission File Number: 000-28304

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PROVIDENT FINANCIAL HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

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Registrant’s telephone number, including area code:    (951) 686-6060

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Securities registered pursuant to Section 12(b) of the Act:

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Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

☐ Yes ☒ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

☐ Yes ☒ No

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 ☐ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No

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

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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). ☐ Yes ☒ No

The aggregate market value of the common stock held by non affiliates of the registrant, based on the closing sales price of the registrant’s common stock as quoted on the NASDAQ Global Select Market on December 31, 2020, was $106.1 million. As of August 31, 2021, there were 7,515,795 shares of the registrant’s common stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

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PROVIDENT FINANCIAL HOLDINGS, INC.

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As used in this report, the terms “we,” “our,” “us,” and “Provident” refer to Provident Financial Holdings, Inc. and its consolidated subsidiaries, unless the context indicates otherwise. When we refer to the “Bank” or “Provident Savings Bank” in this report, we are referring to Provident Savings Bank, F.S.B., a wholly owned subsidiary of Provident Financial Holdings, Inc.

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PART I

Item 1.  Business

General

Provident Financial Holdings, Inc. (the “Corporation”), a Delaware corporation, was organized in January 1996 for the purpose of becoming the holding company of Provident Savings Bank, F.S.B. (the “Bank”) upon the Bank’s conversion from a federal mutual to a federal stock savings bank (“Conversion”). The Conversion was completed on June 27, 1996.  The Corporation is regulated by the Federal Reserve Board (“FRB”).  At June 30, 2021, the Corporation had consolidated total assets of $1.18 billion, total deposits of $938.0 million and stockholders’ equity of $127.3 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 Annual Report on Form 10-K (“Form 10-K”), including the audited consolidated financial statements and related data, relates primarily to the Bank.

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The Bank, founded in 1956, is a federally chartered stock savings bank headquartered in Riverside, California. The Bank is regulated by the Office of the Comptroller of the Currency (“OCC”), its primary federal regulator, and the Federal Deposit Insurance Corporation (“FDIC”), the insurer of its deposits.  The Bank’s deposits are federally insured up to applicable limits by the FDIC.  The Bank has been a member of the Federal Home Loan Bank (“FHLB”) – San Francisco since 1956.

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The Bank is a financial services company committed to serving consumers and small to mid-sized businesses in the Inland Empire region of Southern California. The Bank conducts its business operations as Provident Bank, and through its subsidiary, Provident Financial Corp. The business activities of the Bank consist of community banking, investment services and trustee services for real estate transactions.

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The Bank’s community banking operations primarily consist of accepting deposits from customers within the communities surrounding its full service offices and investing those funds in single-family, multi-family, commercial real estate, construction, commercial business, consumer and other mortgage loans. Through its subsidiary, Provident Financial Corp, the Bank conducts trustee services for the Bank’s real estate transactions and in the past has held real estate for investment. For additional information, see “Subsidiary Activities” in this Form 10-K. The activities of Provident Financial Corp are included in the Bank's operating segment results.  The Bank’s revenues are derived principally from interest earned on its loan and investment portfolios, and fees generated through its community banking activities.

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On June 22, 2006, the Bank established the Provident Savings Bank Charitable Foundation (“Foundation”) in order to further its commitment to the local community. The specific purpose of the Foundation is to promote and provide for the betterment of youth, education, housing and the arts in the Bank’s primary market areas of Riverside and San Bernardino counties. The Foundation was funded with a $500,000 charitable contribution made by the Bank in the fourth quarter of fiscal 2006. The Bank contributed $40,000 to the Foundation in both fiscal 2021 and 2020.

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Since the novel coronavirus of 2019 (“COVID-19”) was declared a pandemic in March 2020, COVID-19 has significantly affected our communities, customers, and operations. Efforts to limit the spread of COVID-19 led to shelter-in-place orders, the temporary closure of non-essential businesses, travel restrictions, supply chain disruptions and prohibitions on public gatherings, among other things, throughout many parts of the United States and, in particular, the markets in which we operate. Although many of these restrictions have been lifted and society has begun to re-open, the COVID-19 pandemic is ongoing and additional uncertainties exist which may continue to impact our customers, employees and vendors; the financial services and banking industry; and the economy as a whole. These uncertainties include, among other things, the extent and severity of the spread of COVID-19 including COVID-19 variants, the length of the outbreak, the extent of distribution and efficacy of vaccines, the extent of lifting of pandemic-related restrictions including social distancing and the use of facemasks, and future actions taken by governmental authorities to contain the outbreak or to mitigate its impact. In light of the uncertainties and continuing developments related the COVID-19 pandemic, the ultimate adverse impact of COVID-19 cannot be reliably estimated at this time, but it has been and is expected to continue to be material.

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Subsequent Event:

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On July 22, 2021, the Corporation announced that the Corporation’s Board of Directors declared a cash dividend of $0.14 per share.  Shareholders of the Corporation’s common stock at the close of business on August 12, 2021 were entitled to receive the cash dividend, which was paid on September 2, 2021.

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Market Area

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The Bank is headquartered in Riverside, California and operates 12 full-service banking offices in Riverside County and one full-service banking office in San Bernardino County. Management considers Riverside and Western San Bernardino counties to be the Bank’s primary market for deposits. The Bank is the largest independent community bank headquartered in Riverside County and it has the tenth largest deposit market share of all banks and the second largest of community banks in Riverside County.

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The large geographic area encompassing Riverside and San Bernardino counties is referred to as the “Inland Empire.” According to the 2020 Census Bureau population statistics, Riverside and San Bernardino Counties have the fourth and fifth largest populations in California, respectively. The Bank’s market area consists primarily of suburban and urban communities. Riverside and Western San Bernardino counties are relatively densely populated and are within the greater Los Angeles metropolitan area. According to the United States of America (“U.S.”) Department of Labor, Bureau of Labor Statistics, the unemployment rate for both the Inland Empire and the State of California in June 2021 was 7.9%, compared to 5.9% nationwide. This elevated level of unemployment rate was due primarily to the impact of the COVID-19 pandemic, although it was much lower as compared to the unemployment data reported in June 2020, which was 13.3% in the Inland Empire, 14.1% in California and 11.1% nationwide. Recent forecasts suggest that the Inland Empire economy is regaining 62,400 jobs in calendar 2021, up 4.15% from 2020. The job gain is expected to be due to the reopening of businesses in the food and beverages, retail, hotel and entertainment sectors as well as growth in logistics, construction and health care. Assuming this job growth, the Inland Empire job level would be at 1,564,300 jobs or just 3,200 jobs or 0.2 percent below its level at the end of 2019 (Source: Inland Empire Quarterly Economic Report - May 2021).

California home sales in June 2021 were up 28.3% percent from a year ago, when 339,910 homes were sold on an annualized basis. The June 2021 statewide and Inland Empire median home price was $819,630 and $525,000, up 30.9% and 28% from June 2020, respectively. (Source: California Association of Realtors – July 16, 2021 News Release).

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Competition

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The Bank faces significant competition in its market area in originating real estate loans and attracting deposits. The population growth in the Inland Empire has attracted numerous financial institutions to the Bank’s market area. The Bank’s primary competitors are large national and regional commercial banks as well as other community-oriented banks and savings institutions. The Bank also faces competition from credit unions and a large number of mortgage companies that operate within its market area, as well as unregulated or less regulated non-banking entities, operating locally and elsewhere. Many of these institutions are significantly larger than the Bank and therefore have greater financial and marketing resources than the Bank. This competition may limit the Bank’s growth and profitability in the future.

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Reportable Segments

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Management monitors the revenue and expense components of the various products and services the Bank offers, but operations are managed and financial performance is evaluated on a Corporation-wide basis in comparison to a business plan which is developed each year. Accordingly, all operations are considered by management to be one operating segment and one reportable segment as contained in the Consolidated Statements of Operations to the Corporation’s audited consolidated financial statements included in Item 8 of this Form 10-K.

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Internet Website

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The Corporation maintains a website at www.myprovident.com. The information contained on that website is not included as a part of, or incorporated by reference into, this Form 10-K. Other than an investor’s own internet access charges, the Corporation makes available free of charge through that website the Corporation’s annual report, quarterly reports on Form

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10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after these materials have been electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).  In addition, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding companies that file electronically with the SEC. This information is available at www.sec.gov.

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Lending Activities

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General.  The lending activity of the Bank is comprised of the origination of single-family, multi-family and commercial real estate loans and, to a lesser extent, construction, commercial business, consumer and other mortgage loans to be held for investment. Additional lending activities have included originating saleable single-family loans, primarily fixed-rate first trust deed mortgages. The Bank’s net loans held for investment were $851.0 million at June 30, 2021, representing 71.9% of consolidated total assets. This compares to $902.8 million, or 76.7% of consolidated total assets, at June 30, 2020.

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At June 30, 2021, the maximum amount that the Bank could have loaned to any one borrower and the borrower’s related entities under applicable regulations was $19.4 million, or 15% of the Bank’s unimpaired capital and surplus. At June 30, 2021, the Bank had no loans or group of loans to related borrowers with outstanding balances in excess of this amount.  The Bank’s five largest lending relationships at June 30, 2021 consisted of: four multi-family loans totaling $5.3 million to one group of borrowers; eight single-family loans and one multi-family loan totaling $5.3 million to one group of borrowers; two multi-family loans totaling $4.5 million to one group of borrowers; one multi-family loan totaling $4.3 million to one group of borrowers; and one multi-family loan and one commercial real estate loan totaling $4.3 million to one group of borrowers.  The real estate collateral for these loans is located in Southern and Northern California.  At June 30, 2021, all of these loans were performing in accordance with their repayment terms.

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Loans Held For Investment Analysis.  The following table sets forth the composition of the Bank’s loans held for investment at the dates indicated:

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Maturity of Loans Held for Investment. The following table sets forth information at June 30, 2021 regarding the dollar amount of principal payments becoming contractually due during the periods indicated for loans held for investment. Demand loans, loans having no stated schedule of principal payments, loans having no stated maturity, and overdrafts are reported as becoming due within one year. The table does not include any estimate of prepayments, which can significantly

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shorten the average life of loans held for investment and may cause the Bank’s actual principal payment experience to differ materially from that shown below:

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The following table sets forth the dollar amount of all loans held for investment due after one year from June 30, 2021 which have fixed and floating or adjustable interest rates:

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Scheduled contractual principal payments of loans do not reflect the actual life of such assets. The average life of loans is generally substantially less than their contractual terms because of prepayments. In addition, due-on-sale clauses generally give the Bank the right to declare loans immediately due and payable in the event, among other things, the borrower sells the real property that secures the loan. The average life of mortgage loans tends to increase, however, when current market interest rates are substantially higher than the interest rates on existing loans held for investment and, conversely, decrease when the interest rates on existing loans held for investment are substantially lower than current market interest rates, as borrowers are generally less inclined to refinance their loans when market rates increase and more inclined to refinance their loans when market rates decrease.

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The table below describes the geographic dispersion of real estate secured loans held for investment (gross) at June 30, 2021 and 2020, as a percentage of the total dollar amount outstanding (dollars in thousands):

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As of June 30, 2021:

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As of June 30, 2020:

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Single-Family Mortgage Loans.  One of the Bank’s primary lending activity is the origination and purchase of adjustable and fixed rate mortgage loans to be held for investment secured by first trust deed mortgages on owner-occupied, single-family (one to four units) residences in the communities where the Bank’s branches are located and surrounding areas in Southern and Northern California.  During fiscal 2021 the Bank originated $120.7 million and purchased $5.4 million of single-family loans to be held for investment, all of which were underwritten in accordance with the Bank’s origination guidelines. This compares to single-family loan originations of $36.4 million and purchases of $70.7 million during fiscal 2020. At June 30, 2021, total single-family loans held for investment decreased 10% to $268.3 million, or 31.5% of the total loans held for investment, from $298.8 million, or 33.0% of the total loans held for investment, at June 30, 2020. The decrease in the single-family loans in fiscal 2021 was primarily attributable to loan principal payments that exceeded new loans originated and purchased for investment. During fiscal 2021, the Bank had net recoveries of $31,000 in non-performing single-family loans, as compared to net recoveries of $69,000 during fiscal 2020. At June 30, 2021 and 2020, total non-performing single-family loans were $7.9 million and $4.9 million, net of allowances and charge-offs, and $0 and $219,000 were past due 30 to 89 days, respectively.

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The Bank has underwriting standards that generally conform with the standards of the governmental sponsored entities (“GSE”) which include Fannie Mae and Freddie Mac. Mortgage insurance is usually required for all loans exceeding 80% loan-to-value (“LTV”) based on the lower of the purchase price or appraised value at the time of loan origination.  The Bank is not currently offering loans with LTV ratios greater than 90%. The ratio is derived by dividing the original loan balance by the lower of the original appraised value or purchase price of the real estate collateral. Currently, the maximum LTV ratio is 90% for purchase and rate and term refinances and 75% for cash-out refinances. The maximum loan amount offered is $1.5 million.  The lowest FICO score currently offered is 690 for a purchase transaction and 720 for a cash-out transaction. The FICO score represents the creditworthiness of a borrower based on the borrower’s credit history, as

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reported by an independent third party. A higher FICO score indicates a greater degree of creditworthiness. Bank regulators have issued guidance stating that a FICO score of 660 and below is indicative of a “subprime” borrower. The Bank currently lends on residential properties classified as single-family unit, planned unit developments and condominiums. Underwriting standards and guidelines may change at any time given changes in real estate market conditions or changes to GSE policies and guidelines. For additional protection, the Bank purchases lender-paid mortgage insurance for certain single-family mortgage loans. As of June 30, 2021, a total of $55.7 million of single-family mortgage loans with an 78% weighted average LTV at the time of origination have lender-paid mortgage insurance providing a weighted average coverage ratio of 11% of the original loan amount.

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The Bank currently offers closed-end, fixed-rate home equity loans that are secured by the borrower’s primary residence. These loans do not exceed 75% of the appraised value of the residence and have terms of 30 years requiring monthly payments of principal and interest. At June 30, 2021, home equity loans amounted to $2.8 million or 1.0% of single-family loans held for investment, as compared to $5.3 million or 1.8% of single-family loans held for investment at June 30, 2020.

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The Bank currently offers fixed rate loan products in Riverside and San Bernardino counties and adjustable rate mortgage (“ARM”) loans throughout California. Substantially all of the loans originated by the Bank meet GSE underwriting standards based on credit and collateral. The Bank offers several ARM products which adjust semi-annually after an initial fixed period ranging from five to ten years subject to a limitation on semi-annual and lifetime changes.  Currently, the ARM programs have a rate consisting of an Index tied to the Secured Overnight Financing Rate (“SOFR”), plus a margin. The programs are limited to a maximum, semi-annual increase or decrease of one percentage point with a maximum lifetime increase of five percentage points.  The rate may not fall below the margin. The portfolio currently consists of the following indexes, plus a margin of between 2.00% and 3.25%, which are used to calculate the periodic interest rate changes: the London Interbank Offered Rate (“LIBOR”), SOFR, the FHLB Eleventh District cost of funds (“COFI”), the 12-month average U.S. Treasury (“12 MAT”) or the weekly average yield on one year U.S. Treasury securities adjusted to a constant maturity of one year (“CMT”).  Loans based on the LIBOR index constitute a majority of the Bank’s loans held for investment.  The majority of the ARM loans held for investment have five, seven, or  ten-year fixed periods prior to the first adjustment (“5/1, 7/1, or 10/1 hybrids”) and provide for fully amortizing loan payments throughout the term of the loan.  Loans of this type have embedded interest rate risk if interest rates should rise during the initial fixed rate period.

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Prior to fiscal 2009, the Bank offered stated income single-family mortgage loans.  As of June 30, 2021 and 2020, the outstanding balance of the stated income single-family mortgage loans was $26.0 million and $38.5 million, respectively, of which $997,000 and $1.8 million, respectively were non-performing, while no loans were 30-89 days delinquent at June 30, 2021 and 2020.

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Borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates and fees charged for each type of loan.  The relative amount of fixed-rate mortgage loans and ARM loans that can be originated at any time is largely determined by the demand for each product in a given interest rate and competitive environment. Given the recent low-rate market environment, the production of ARM loans was significantly lower than fixed rate mortgages.

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The retention of ARM loans, rather than fixed-rate loans, helps to reduce the Bank’s exposure to changes in interest rates.  There is, however, unquantifiable credit risk resulting from the potential of increased interest charges to be paid by the borrower as a result of increases in interest rates.  It is possible that, during periods of rising interest rates, the risk of default on ARM loans may increase as a result of the increase in the required payment from the borrower.  Further, the risk of default may increase because ARM loans originated by the Bank occasionally provide, as a marketing incentive, for initial rates of interest below those rates that would apply if the adjustment index plus the applicable margin were initially used for pricing.  Because of these characteristics, ARM loans are subject to increased risks of default or delinquency.  Additionally, while ARM loans allow the Bank to increase the sensitivity of its assets as a result of changes in interest rates, the extent of this interest rate sensitivity is limited by the periodic and lifetime interest rate adjustment limits. Furthermore, because loan indexes may not respond perfectly to changes in market interest rates, upward adjustments on loans may occur more slowly than increases in the Bank’s cost of interest-bearing liabilities, especially during periods of rapidly increasing interest rates. Conversely, downward adjustments on the Bank’s cost of funds typically lag adjustments on ARM loans which may occur more rapidly during periods of declining interest rates. For additional information concerning the effect of interest rates on our loan portfolio, see Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” of this Form 10-K.

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The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) requires lenders to make a reasonable, good faith determination of a borrower’s ability to repay any consumer closed-end credit transaction secured by a dwelling and to limit prepayment penalties.  Increased risks of legal challenge, private right of action and regulatory enforcement actions result from these rules. The Bank may originate loans that do not meet the definition of a “qualified mortgage” (“QM”). To mitigate the risks involved with non-QM loans, the Bank has implemented systems, processes, procedural and product changes, and maintains its underwriting standards, to ensure that the “ability-to-repay” requirements are adequately addressed.

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A decline in real estate values subsequent to the time of origination of real estate secured loans could result in higher loan delinquency levels, foreclosures, provisions for loan losses and net charge-offs.  Real estate values and real estate markets are beyond the Bank’s control and are generally affected by changes in national, regional or local economic conditions and other factors.  These factors include fluctuations in interest rates and the availability of loans to potential purchasers, housing supply and demand, changes in tax laws and other governmental statutes, regulations and policies and acts of nature, such as earthquakes, fires and other natural disasters particular to California where substantially all of our real estate collateral is located.  If real estate values decline from the levels at the time of loan origination, the value of our real estate collateral securing the loans could be significantly reduced.  Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and it would be more likely to suffer losses on defaulted loans.

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Multi-Family and Commercial Real Estate Mortgage Loans.  At June 30, 2021, multi-family mortgage loans were $484.4 million and commercial real estate loans were $95.3 million, or 56.8% and 11.2%, respectively, of loans held for investment.  This compares to multi-family mortgage loans of $491.9 million and commercial real estate loans of $105.2 million, or 54.4% and 11.6%, respectively, of loans held for investment at June 30, 2020.  Consistent with its strategy to diversify the composition of loans held for investment, the Bank has made the origination and purchase of multi-family and commercial real estate loans a priority.  During fiscal 2021 the Bank originated $88.8 million and purchased $11.5 million of multi-family and commercial real estate loans, all of which were underwritten in accordance with the Bank’s origination guidelines.  This compares to loan originations of $65.5 million and loan purchases of $71.3 million during fiscal 2020. At June 30, 2021, the Bank had 654 multi-family and 134 commercial real estate loans in loans held for investment. This compares to 660 multi-family and 143 commercial real estate loans in loans held for investment at June 30, 2020.

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Multi-family mortgage loans originated by the Bank are predominately adjustable rate loans, including 1/1, 3/1, 5/1, 7/1 and 10/1 hybrids, with a term to maturity of 10 to 30 years and a 25 to 30 year amortization schedule.  Commercial real estate loans originated by the Bank are also predominately adjustable rate loans, including 1/1, 3/1 and 5/1 hybrids, with a term to maturity of 10 to 30 years and a 25 to 30 year amortization schedule.  Rates on multi-family and commercial real estate ARM loans generally adjust monthly, quarterly, semi-annually or annually at a specific margin over the respective interest rate index, subject to period interest rate caps and life-of-loan interest rate caps.  At June 30, 2021, $466.1 million, or 96.2%, of the Bank’s multi-family loans were secured by five to 36 unit projects.  The Bank’s commercial real estate loan portfolio generally consists of loans secured by small office buildings, light industrial buildings, warehouses and small retail centers.  Properties securing multi-family and commercial real estate loans are primarily located in Alameda, Los Angeles, Orange, Riverside, San Bernardino, San Diego, San Francisco and Santa Clara counties.  The Bank originates multi-family and commercial real estate loans in amounts typically ranging from $350,000 to $6.0 million.  At June 30, 2021, the Bank had 60 commercial real estate and multi-family loans with principal balances greater than $1.5 million totaling $139.6 million.  The Bank obtains appraisals on all properties that secure multi-family and commercial real estate loans.  Underwriting of multi-family and commercial real estate loans includes, among other considerations, a thorough analysis of the cash flows generated by the property to support the debt service and the financial resources, experience and the income level of the borrowers and guarantors.

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Multi-family and commercial real estate loans afford the Bank an opportunity to price the loans with higher interest rates than those generally available from single-family mortgage loans.  However, loans secured by such properties are generally greater in amount, more difficult to evaluate and monitor and are more susceptible to default as a result of general economic conditions and, therefore, involve a greater degree of risk than single-family residential mortgage loans.  Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation and management of the properties, repayment of such loans may be impacted by adverse

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conditions in the real estate market or the economy.  During both fiscal 2021 and 2020, the Bank had no charge-offs or recoveries on non-performing multi-family and commercial real estate loans. At June 30, 2021, there was one non-performing multi-family loan of $781,000 and no non-performing commercial real estate loans, as compared to no non-performing multi-family and commercial real estate loans at June 30, 2020. At June 30, 2021 and 2020, there were no multi-family or commercial real esate loans that were past due 30 to 89 days. Non-performing loans and/or delinquent loans may increase if there is a general decline in California real estate markets and in the event poor general economic conditions prevail.

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Construction Loans.  The Bank originates from time to time two types of construction loans: short-term construction loans and construction/permanent loans.  During fiscal 2021 and 2020, the Bank originated a total of $5.4 million and $4.0 million of construction loans (including undisbursed loan funds), respectively.  As of June 30, 2021 and 2020, the Bank had short-term construction loans totaling $2.8 million and $6.3 million, respectively, and construction/permanent loans totaling $279,000 and $1.5 million respectively, net of undisbursed loan funds of $3.0 million and $4.0 million, respectively.

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Short-term construction loans include three types of loans: custom construction, tract construction, and speculative construction. The Bank provides construction financing for single-family, multi-family and commercial real estate properties.  Custom construction loans are made to individuals who, at the time of application, have a contract executed with a builder to construct their residence.  Custom construction loans are generally originated for a term of 12 to 18 months, with adjustable or fixed interest rates at the prime lending rate plus a margin and with loan-to-value ratios of up to 75% of the appraised value of the completed property.  The owner secures long-term permanent financing at the completion of construction. At June 30, 2021, there were two custom single-family construction loans totaling $1.7 million with $611,000 of undisbursed funds. This compares to June 30, 2020 when the Bank had two custom single-family construction loans totaling $2.1 million with $376,000 of undisbursed funds.

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From time to time the Bank makes lot loans to individuals to finance land acquisition prior to the start of construction or tract construction loans to subdivision builders.  These subdivisions are usually financed and built in phases.  A thorough analysis of market trends and demand within the area are reviewed for feasibility.  Tract construction may include the building and financing of model homes under a separate loan. At June 30, 2021, there was one land loan of $139,000 and no tract construction loans, as compared to one land loan of $143,000 and no tract construction loans at June 30, 2020.

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Speculative construction loans are made to home builders and are termed “speculative” because the home builder does not have, at the time of loan origination, a signed sale contract with a home buyer who has a commitment for permanent financing with either the Bank or another lender for the finished home.  The home buyer may be identified during or after the construction period.  The builder may be required to debt service the speculative construction loan for a significant period of time after the completion of construction until the homebuyer is identified.  At June 30, 2021, there were no single-family speculative construction loans. This compares to June 30, 2020 when the Bank had three single-family speculative construction loans totaling $2.6 million with $828,000 of undisbursed funds.

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Construction/permanent loans automatically roll from the construction to the permanent phase.  The construction phase of a construction/permanent loan generally lasts nine to 12 months and the interest rate charged is generally fixed at a margin above prime rate and with a loan-to-value ratio of up to 75% of the appraised value of the completed property.  At June 30, 2021, there were $279,000 of construction/permanent loans as compared to $1.5 million of construction/permanent loans at June 30, 2020.

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Construction loans under $1.0 million are approved by Bank personnel specifically designated to approve construction loans.  The Bank’s Loan Committee, comprised of the Chief Executive Officer, Chief Lending Officer, Chief Financial Officer, Senior Vice President – Single-Family Division and Vice President - Loan Administration, approves all construction loans over $1.0 million.  Prior to approval of any construction loan, an independent fee appraiser inspects the site and the Bank reviews the existing or proposed improvements, identifies the market for the proposed project, and analyzes the pro-forma data and assumptions on the project.  In the case of a tract or speculative construction loan, the Bank reviews the experience and expertise of the builder.  The Bank obtains credit reports, financial statements and tax returns on the borrowers and guarantors, an independent appraisal of the project, and any other expert report necessary to evaluate the proposed project.  In the event of cost overruns, the Bank requires the borrower to deposit their own funds

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into a loan-in-process account, which the Bank disburses consistent with the completion of the subject property pursuant to a revised disbursement schedule.

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The construction loan documents require that construction loan proceeds be disbursed in increments as construction progresses.  Disbursements are based on periodic on-site inspections by independent inspectors and Bank personnel.  At inception, the Bank also requires borrowers to deposit funds into the loan-in-process account covering the difference between the actual cost of construction and the loan amount.  The Bank regularly monitors the construction loan portfolio, economic conditions and housing inventory.  The Bank’s property inspectors perform periodic inspections.  The Bank believes that the internal monitoring system helps reduce many of the risks inherent in its construction loans.

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Construction loans afford the Bank the opportunity to achieve higher interest rates and fees with shorter terms to maturity than its single-family mortgage loans.  Construction loans, however, are generally considered to involve a higher degree of risk than single-family mortgage loans because of the inherent difficulty in estimating both a property’s value at completion of the project and the cost of the project.  The nature of these loans is such that they are generally more difficult to evaluate and monitor.  If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the project.  If the estimate of value upon completion proves to be inaccurate, the Bank may be confronted with a project whose value is insufficient to assure full repayment.  Projects may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors.  Loans to builders to construct homes for which no purchaser has been identified carry additional risk because the payoff for the loan depends on the builder’s ability to sell the property prior to the time that the construction loan matures.  The Bank has sought to address these risks by adhering to strict underwriting policies, disbursement procedures and monitoring practices.  In addition, because the Bank’s construction lending is in its primary market area, changes in the local or regional economy and real estate market could adversely affect the Bank’s construction loans held for investment. During fiscal 2021 and 2020, the Bank had no charge-offs or recoveries and no loans were non-performing or 30-89 days delinquent at June 30, 2021.

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Participation Loan Purchases and Sales.  In an effort to expand production and diversify risk, the Bank purchases loans and loan participations, with collateral primarily in California, which allows for greater geographic distribution outside of the Bank’s primary lending areas.  The Bank generally purchases between 50% and 100% of the total loan amount. When the Bank purchases a participation loan, the lead lender will usually retain a servicing fee, thereby decreasing the loan yield.  This servicing fee approximates the expense the Bank would incur if the Bank were to service the loan.  All properties serving as collateral for loan participations are inspected by an employee of the Bank or a third party inspection service prior to being approved by the Loan Committee and the Bank relies upon the same underwriting criteria required for those loans originated by the Bank.  The Bank purchased $16.9 million of loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2021, compared to $142.1 million of purchased loans to be held for investment (primarily single-family and multi-family loans) in fiscal 2020. The decline in loan purchases was due primarily to the uncertainly of the asset quality during the COVID-19 pandemic. As of June 30, 2021, total loans serviced by other financial institutions were $13.6 million, as compared to $23.9 million at June 30, 2020. As of June 30, 2021, all loans serviced by others were performing according to their original contractual payment terms, except for one loan of $365,000 that was in the non-performing category. As of June 30, 2020, all loans serviced by others were performing according to their original contractual payment terms, except for two loans that were in forbearance pursuant to a loan modification consistent with the Coronavirus Aid, Relief, and Economic Security Act of 2020, (“CARES Act”) signed into law on March 27, 2020 and/or the April 7, 2020 Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (“Interagency Statement”). The CARES Act as amended on December 27, 2020, by the Consolidated Appropriations Act (“CAA”), and the Interagency Statement provides guidance regarding the modification of loans as a result of the COVID-19 pandemic, and outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under the CARES Act and/or Interagency Statement prior to any relief, are not troubled debt restructurings, through January 1, 2022 or 60 days after the end of the national emergency declared by the President, whichever is earlier. For additional information related to loan modifications as a result of the COVID-19 pandemic, see “Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – COVID-19 Impact to the Corporation.”

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The Bank also sells participating interests in loans when it has been determined that it is beneficial to diversify the Bank’s risk.  Participation sales enable the Bank to maintain acceptable loan concentrations and comply with the Bank’s loans to

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one borrower policy.  Generally, selling a participating interest in a loan increases the yield to the Bank on the portion of the loan that is retained.  The Bank did not sell any participation loans in fiscal 2021 or fiscal 2020.

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Commercial Business Loans.  The Bank has a Business Banking Department that primarily serves businesses located within the Inland Empire.  Commercial business loans allow the Bank to diversify its lending and increase the average loan yield.  As of June 30, 2021, commercial business loans were $849,000, or 0.1% of loans held for investment, up 77% from $480,000, or 0.1% of loans held for investment at June 30, 2020.  These loans represent secured and unsecured lines of credit and term loans secured by business assets.

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Commercial business loans are generally made to customers who are well known to the Bank and are generally secured by accounts receivable, inventory, business equipment and/or other assets.  The Bank’s commercial business loans may be structured as term loans or as lines of credit.  Lines of credit are made at variable rates of interest equal to a negotiated margin above the prime rate and term loans are at a fixed or variable rate.  The Bank may also require personal guarantees from financially capable parties associated with the business based on a review of personal financial statements.  Commercial business term loans are generally made to finance the purchase of assets and have maturities of five years or less.  Commercial lines of credit are typically made for the purpose of providing working capital and are usually approved with a term of one year or less.

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Commercial business loans involve greater risk than residential mortgage loans and involve risks that are different from those associated with residential and commercial real estate loans.  Real estate loans are generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral value and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default.  Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets including real estate, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment because accounts receivable may not be collectible and inventories and equipment may be obsolete or of limited use.  Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is secondary and oftentimes an insufficient source of repayment.  At June 30, 2021, there were no non-performing commercial business loans, as compared to $31,000 of non-performing commercial business loans, net of allowances and charge-offs at June 20, 2020. During fiscal 2021 or 2020, the Bank had no charge-offs or recoveries on commercial business loans.

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Consumer Loans.  At June 30, 2021 and 2020, the Bank’s consumer loans were $95,000 and $94,000, respectively, or less than 0.1% of the Bank’s loans held for investment at these dates.  The Bank offers open-ended lines of credit on either a secured or unsecured basis.  The Bank offers secured savings lines of credit which have an interest rate that is four percentage points above the COFI, which adjusts monthly.  There were no secured savings lines of credit at June 30, 2021 and 2020.

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Consumer loans potentially have a greater risk than residential mortgage loans, particularly in the case of loans that are unsecured.  Consumer loan collections are dependent on the borrower’s ongoing financial stability, and thus are more likely to be adversely affected by job loss (especially now as a result of the COVID-19 pandemic), illness or personal bankruptcy.  Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.  The Bank had no non-performing consumer loans at June 30, 2021 and 2020.  During fiscal 2021, the Bank had $1,000 of net chargeoffs on consumer loans, as compared to net recoveries of $1,000 during fiscal 2020.

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Loans Originations, Purchases, Sales and Repayments

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Mortgage loans are primarily originated for investment. Prior to scaling back originations of saleable single-family fixed-rate mortgage loans during fiscal 2019, a large amount of single-family fixed-rate mortgage loans were originated for sale to institutional investors. Mortgage loans sold to investors generally were sold without recourse other than standard representations and warranties. Generally, mortgage loans sold to Fannie Mae and Freddie Mac were sold on a non-recourse basis and foreclosure losses are generally the responsibility of the purchaser and not the Bank, except in the case of Federal Housing Administration (“FHA”) and Veterans’ Administration (“VA”) loans used to form Government National Mortgage Association pools, which are subject to limitations on the FHA’s and VA’s loan guarantees.

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The following table shows the Bank’s loan originations, purchases, sales and principal repayments during the periods indicated:

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Loan Servicing

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The Bank receives fees from a variety of investors in return for performing the traditional services of collecting individual loan payments on loans sold by the Bank to such investors.  At June 30, 2021, the Bank was servicing $50.4 million of loans for others, a 42% decrease from $86.5 million at June 30, 2020.  The decrease was primarily attributable to loan prepayments.  Loan servicing includes processing payments, accounting for loan funds and collecting and paying real estate taxes, hazard insurance and other loan-related items such as private mortgage insurance. After the Bank receives the gross mortgage payment from individual borrowers, it remits to the investor a predetermined net amount based on the loan sale agreement for that mortgage.

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Servicing assets are amortized in proportion to and over the period of the estimated net servicing income and are carried at the lower of cost or fair value.  The fair value of servicing assets is determined by calculating the present value of the estimated net future cash flows consistent with contractually specified servicing fees.  The Bank periodically evaluates

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servicing assets for impairment, which is measured as the excess of cost over fair value.  This review is performed on a disaggregated basis, based on loan type and interest rate.  Generally, loan servicing becomes more valuable when interest rates rise (as prepayments typically decrease) and less valuable when interest rates decline (as prepayments typically increase).  In estimating fair values at June 30, 2021 and 2020, the Bank used a weighted average Constant Prepayment Rate (“CPR”) of 21.82% and 26.07%, respectively, and a weighted-average discount rate of 9.10% and 9.11%, respectively. The required impairment reserve against servicing assets at June 30, 2021 and 2020 was $176,000 and $291,000, respectively. In aggregate, servicing assets had a carrying value of $384,000 and a fair value of $208,000 at June 30, 2021, compared to a carrying value of $673,000 and a fair value of $382,000 at June 30, 2020.

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Delinquencies and Classified Assets

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Delinquent Loans.  When a mortgage loan borrower fails to make a required payment when due, the Bank initiates collection procedures.  In most cases, delinquencies are cured promptly; however, if the loan remains delinquent on the 120th day for single-family loans or the 90th day for other loans, or sooner if the borrower is chronically delinquent, and after all reasonable means of obtaining the payment have been exhausted, foreclosure proceedings, according to the terms of the security instrument and applicable law, are initiated.  Interest income is reduced by the full amount of accrued and uncollected interest on such loans.

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The following table sets forth delinquencies in the Bank’s loans held for investment as of the dates indicated, gross of collectively and individually evaluated allowances, if any:

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As of June 30, 2021, total non-performing assets, net of allowance for loan losses and fair value adjustments, were $8.6 million, or 0.73% of total assets, which was primarily comprised of: 27 single-family loans ($7.9 million); one multi-family loan ($781,000); and no real estate owned (“REO”). As of June 30, 2021, $7.7 million, or 89%, of non-performing loans had a current payment status. This compares to total non-performing assets, net of allowance for loan losses and fair value adjustments, of $4.9 million, or 0.42% of total assets, with $1.6 million, or 33%, of non-performing loans with a current payment status at June 30, 2020 and no REO.

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The following table sets forth information with respect to the Bank’s non-performing assets and troubled debt restructurings (“restructured loans”), net of allowance for loan losses and fair value adjustments, at the dates indicated:

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