Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Safe-Harbor Statement
Certain matters in this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This Form 10-K contains statements that the Corporation believes are “forward-looking statements.” These statements relate to the Corporation’s financial condition, liquidity, results of operations, plans, objectives, future performance or business. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements the Corporation may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Corporation. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors which could cause actual results to differ materially include, but are not limited to the following: potential adverse impacts to economic conditions in our local market areas, other markets where the Company has lending relationships, or other aspects of the Company's business operations or financial markets, generally, resulting from the ongoing novel coronavirus of 2019 (“COVID-19”) and any governmental or societal responses thereto; the credit risks of lending activities, including changes in the level and trend of loan delinquencies and charge-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the residential and commercial real estate markets and may lead to increased losses and non-performing assets and may result in our allowance for loan losses not being adequate to cover actual losses and require us to materially increase our reserve; changes in general economic conditions, including the effects of inflation, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; the future of LIBOR, and the transition away from LIBOR toward new interest rate benchmarks; fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas; results of examinations of the Corporation by the FRB or of the Bank by the OCC or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to enter into a formal enforcement action or to increase our allowance for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements and restrictions on us, any of which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including changes in banking, securities and tax law, and in regulatory policies and principles, or the interpretation of regulatory capital or other rules, and including changes as a result of COVID-19; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; our ability to attract and retain deposits; our ability to control operating costs and expenses; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our common stock; adverse changes in the securities markets; the inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; war or terrorist activities; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and other risks detailed in this report and in the Corporation’s other reports filed with or furnished to the U.S. Securities and Exchange Commission (“SEC”). These developments could have an adverse impact on our financial position and our results of operations. Forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and
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assumptions, the forward-looking statements discussed in this document might not occur, and you should not put undue reliance on any forward-looking statements. These risks could cause our actual results for fiscal 2023 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us and could negatively affect the Corporation’s consolidated financial condition and consolidated results of operations as well as its stock price performance.
General
Provident Financial Holdings, Inc., a Delaware corporation, was organized in January 1996 for the purpose of becoming the holding company of Provident Savings Bank, F.S.B. upon the Bank’s conversion completed on June 27, 1996. The Corporation is regulated by the FRB. At June 30, 2022, the Corporation had total assets of $1.19 billion, total deposits of $955.5 million and total stockholders’ equity of $128.7 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 OCC, its primary federal regulator, and the 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 Corporation operates in a single business segment through the Bank. The Bank's activities include attracting deposits, offering banking services and originating and purchasing single-family, multi-family, commercial real estate, construction and, to a lesser extent, other mortgage, commercial business and consumer loans. Deposits are collected primarily from 13 banking locations located in Riverside and San Bernardino counties in California. Loans are primarily originated and purchased in Southern and Northern California to be held for investment. There are various risks inherent in the Corporation’s business including, among others, the general business environment, interest rates, the California real estate market, the demand for loans, the prepayment of loans, the repurchase of loans previously sold to investors, the secondary market conditions to sell loans, competitive conditions, legislative and regulatory changes, fraud and other risks.
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 audited Consolidated Financial Statements and accompanying selected Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Critical Accounting Policies
The discussion and analysis of the Corporation’s financial condition and results of operations is 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 consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions.
The allowance for loan losses involves significant judgment and assumptions by management, which has a material impact on the carrying value of net loans held for investment. Management considers the accounting estimate related to the allowance for loan losses a critical accounting estimate because it is highly susceptible to change from period to period, requiring management to make assumptions about probable incurred losses inherent in the loans held for investment at the date of the Consolidated Statements of Financial Condition. The impact of a sudden large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.
The allowance is based on two principles of accounting: (i) ASC 450, “Contingencies,” which requires that losses be accrued when they are probable of occurring and can be estimated; and (ii) ASC 310, “Receivables.” The allowance has two components: collectively evaluated allowances and individually evaluated allowances on loans held for investment. Each of these components is based upon estimates that can change over time. The allowance is based on historical experience and as a result can differ from actual losses incurred in the future. The Corporation also applies qualitative loss
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factors by assessing general economic indicators such as gross domestic product, retail sales, unemployment rates, employment growth, California home sales and median California home prices, as well as peer group data, reflecting the effect of events that have occurred but are not yet evidenced in the historical data. The historical data is reviewed at least quarterly and adjustments are made as needed. Various techniques are used to arrive at an individually evaluated allowance, including discounted cash flows and the fair market value of collateral. Management considers, based on currently available information, the allowance for loan losses sufficient to absorb probable losses inherent in loans held for investment. The use of these techniques is inherently subjective and the actual losses could be greater or less than the estimates, which, can materially affect amounts recognized in the Consolidated Statements of Financial Condition and Consolidated Statements of Operations.
The Corporation assesses loans individually and classifies loans when the accrual of interest has been discontinued, loans have been restructured or management has serious doubts about the future collectability of principal and interest, even though the loans may currently be performing. Factors considered in determining classification include, but are not limited to, expected future cash flows, the financial condition of the borrower and current economic conditions. The Corporation measures each non-performing loan based on the fair value of its collateral, less selling costs, or discounted cash flow and charges off those loans or portions of loans deemed uncollectible.
Non-performing loans are charged-off to their fair values in the period the loans, or portion thereof, are deemed uncollectible, generally after the loan becomes 150 days delinquent for real estate secured first trust deed loans and 120 days delinquent for commercial business or real estate secured second trust deed loans. For restructured loans, the charge-off occurs when the loan becomes 90 days delinquent; and where borrowers file bankruptcy, the charge-off occurs when the loan becomes 60 days delinquent. The amount of the charge-off is determined by comparing the loan balance to the estimated fair value of the underlying collateral, less disposition costs, with the loan balance in excess of the estimated fair value charged-off against the allowance for loan losses. The allowance for loan losses for non-performing loans is determined by applying ASC 310. For restructured loans that are less than 90 days delinquent, the allowance for loan losses are segregated into (a) individually evaluated allowances for those loans with applicable discounted cash flow calculations still in their restructuring period, classified lower than pass and, containing an embedded loss component or (b) collectively evaluated allowances based on the aggregated pooling method. For non-performing loans less than 60 days delinquent where the borrower has filed bankruptcy, the collectively evaluated allowances are assigned based on the aggregated pooling method. For non-performing commercial real estate loans, an individually evaluated allowance is calculated based on the loan's fair value and if the fair value is higher than the individual loan balance, no allowance is required.
A restructured loan is a loan which the Corporation, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Corporation would not otherwise consider.
The loan terms which have been modified or restructured due to a borrower’s financial difficulty, include but are not limited to:
● A reduction in the stated interest rate;
● An extension of the maturity at an interest rate below market;
● A reduction in the accrued interest; and
● Extensions, deferrals, renewals and rewrites.
The Corporation measures the allowance for loan losses of restructured loans based on the difference between the original loan’s carrying amount and the present value of expected future cash flows discounted at the original effective yield of the loan. Based on published guidance with respect to restructured loans from certain banking regulators and to conform to general practices within the banking industry, the Corporation may determine that it is appropriate to maintain certain restructured loans on accrual status because there is reasonable assurance of repayment and performance, consistent with the modified terms based upon a current, well-documented credit evaluation.
Other restructured loans are classified as “Substandard” and placed on non-performing status. The loans may be upgraded and placed on accrual status once there is a sustained period of payment performance (usually six months or, for loans that have been restructured more than once, 12 months) and there is a reasonable assurance that the payments will continue; and if the borrower has demonstrated satisfactory contractual payments beyond 12 consecutive months, the loan is no
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longer categorized as a restructured loan. In addition to the payment history described above, multi-family, commercial real estate, construction and commercial business loans must also demonstrate a combination of corroborating characteristics to be upgraded, such as: satisfactory cash flow, satisfactory guarantor support, and additional collateral support, among others.
To qualify for restructuring, a borrower must provide evidence of their creditworthiness such as, current financial statements, their most recent income tax returns, current paystubs, current W-2s, and most recent bank statements, among other documents, which are then verified by the Corporation. The Corporation re-underwrites the loan with the borrower’s updated financial information, new credit report, current loan balance, new interest rate, remaining loan term, updated property value and modified payment schedule, among other considerations, to determine if the borrower qualifies.
Interest is not accrued on any loan when its contractual payments are more than 90 days delinquent or if the loan is deemed impaired. In addition, interest is not recognized on any loan where management has determined that collection is not reasonably assured. A non-performing 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.
When a loan is categorized as non-performing, all previously accrued but uncollected interest is reversed in the current operating results. When a full recovery of the outstanding principal loan balance is in doubt, subsequent payments received are first applied as a recovery of principal charged-off and then to unpaid principal. This is referred to as the cost recovery method. A loan may be returned to accrual status at such time as the loan is brought fully current as to both principal and interest, and, in management’s judgment, such loan is considered to be fully collectible on a timely basis. However, the Corporation’s policy also allows management to continue the recognition of interest income on certain non-performing loans. This is referred to as the cash basis method under which the accrual of interest is suspended and interest income is recognized only when collected. This policy applies to non-performing loans that are considered to be fully collectible but the timely collection of payments is in doubt.
Management accounts for income taxes by estimating future tax effects of temporary differences between the tax and book basis of assets and liabilities considering the provisions of enacted tax laws. These differences result in deferred tax assets and liabilities, which are included in the Corporation’s Consolidated Statements of Financial Condition. The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, management is required to make many subjective assumptions and judgments regarding the Corporation’s income tax exposures, including judgments in determining the amount and timing of recognition of the resulting deferred tax assets and liabilities, including projections of future taxable income. Interpretations of and guidance surrounding income tax laws and regulations change over time. As such, changes in management’s subjective assumptions and judgments can materially affect amounts recognized in the Consolidated Statements of Financial Condition and Consolidated Statements of Operations. Therefore, management considers its accounting for income taxes a critical accounting policy.
Executive Summary and Operating Strategy
Provident Savings Bank, F.S.B., established in 1956, is a financial services company committed to serving consumers and small to mid-sized businesses in the Inland Empire region of Southern California. The Bank conducts its business operations as Provident Bank and through its subsidiary, Provident Financial Corp. The business activities of the Corporation, primarily through the Bank, consist of community banking and, to a lesser degree, investment services for customers and trustee services on behalf of the Bank.
Community banking operations primarily consist of accepting deposits from customers within the communities surrounding the Corporation’s full service offices and investing those funds in single-family, multi-family and commercial real estate loans. Also, to a lesser extent, the Corporation makes construction, commercial business, consumer and other mortgage loans. The primary source of income in community banking is net interest income, which is the difference between the interest income earned on loans and investment securities, and the interest expense paid on interest-bearing deposits and borrowed funds. Additionally, certain fees are collected from depositors, such as returned check fees, deposit account service charges, ATM fees, IRA/KEOGH fees, safe deposit box fees, wire transfer fees and overdraft protection fees, among others.
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During the next three years, subject to market conditions, the Corporation intends to improve its community banking business by moderately increasing total assets (by increasing single-family, multi-family, commercial real estate, construction and commercial business loans). In addition, the Corporation intends to decrease the percentage of time deposits in its deposit base and to increase the percentage of lower cost checking and savings accounts. This strategy is intended to improve core revenue through a higher net interest margin and ultimately, coupled with the growth of the Corporation, an increase in net interest income. While the Corporation’s long-term strategy is for moderate growth, management recognizes that growth may be affected by the COVID-19 pandemic and its impact to general economic conditions.
Investment services operations primarily consist of selling alternative investment products such as annuities and mutual funds to the Bank’s depositors. Investment services and trustee services contribute a very small percentage of gross revenue.
Provident Financial Corp performs trustee services for the Bank’s real estate secured loan transactions and has in the past held, and may in the future hold, real estate for investment.
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, laws, regulation, interest rates and the economy, among others. The Corporation attempts to mitigate many of these risks through prudent banking practices, such as interest rate risk management, credit risk management, operational risk management, and liquidity risk management. The California economic environment presents heightened risk for the Corporation primarily with respect to real estate values and loan delinquencies. Since the majority of the Corporation’s loans are secured by real estate located within California, significant declines in the value of California real estate may also inhibit the Corporation’s ability to recover on defaulted loans by selling the underlying real estate. For further details on risk factors and uncertainties, see “Safe-Harbor Statement” included above in this Item 7, and Item 1A, "Risk Factors.”
Comparison of Financial Condition at June 30, 2022 and 2021
Total assets increased slightly to $1.19 billion at June 30, 2022 from $1.18 billion at June 30, 2021. The increase was primarily attributable to an increase in loans held for investment, partly offset by decreases in cash and cash equivalents and investment securities.
Total cash and cash equivalents, primarily excess cash deposited with the Federal Reserve Bank of San Francisco, decreased $46.9 million, or 67%, to $23.4 million at June 30, 2022 from $70.3 million at June 30, 2021. The decrease was primarily attributable to the utilization of cash to fund loans held for investment. The balance of cash and cash equivalents at June 30, 2022 was consistent with the Corporation’s strategy of adequately managing credit and liquidity risk.
Total investment securities (held to maturity and available for sale) decreased $38.5 million, or 17%, to $188.4 million at June 30, 2022 from $226.9 million at June 30, 2021. The decrease was primarily the result of scheduled and accelerated principal payments on investment securities, partly offset by purchases of investment securities held to maturity. For additional information on investment securities, see Note 2 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Loans held for investment increased $89.0 million, or 10% to $940.0 million at June 30, 2022 from $851.0 million at June 30, 2021. In fiscal 2022, the Corporation originated $299.8 million of loans held for investment, consisting primarily of single-family, multi-family and commercial real estate loans, up 39% from $215.0 million, consisting primarily of single-family and multi-family loans, for fiscal 2021. In addition, the Corporation purchased $6.4 million of loans to be held for investment (solely comprised of single-family loans) in fiscal 2022, down 62% from $16.9 million of purchased loans to be held for investment (consisting of single-family and multi-family loans) in fiscal 2021. Total loan principal payments in fiscal 2022 were $221.3 million, down 21% from $281.5 million in fiscal 2021. There was no REO acquired in the settlement of loans in both fiscal 2022 and fiscal 2021. The balance of multi-family, commercial real estate, construction and commercial business loans, net of undisbursed loan funds, decreased 4% to $559.5 million at June 30, 2022 from $583.6 million at June 30, 2021, and represented 60% and 68% of loans held for investment, respectively. The balance of single-family loans held for investment increased $109.9 million, or 41%, to $378.2 million at June 30, 2022, from $268.3
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million at June 30, 2021. For additional information on loans held for investment, see Note 3 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Total deposits increased $17.5 million, or 2%, to $955.5 million at June 30, 2022 from $938.0 million at June 30, 2021. Transaction accounts increased $36.9 million, or 5%, to $834.4 million at June 30, 2022 from $797.5 million at June 30, 2021; while time deposits decreased $19.3 million, or 14%, to $121.1 million at June 30, 2022 from $140.4 million at June 30, 2021. As of June 30, 2022 and 2021, the percentage of transaction accounts to total deposits was 87% and 85%, respectively. Non interest-bearing deposits as a percentage of total deposits remained unchanged at 13% on June 30, 2022 as compared to June 30, 2021. The change in deposit mix was consistent with the Corporation’s marketing strategy to promote transaction accounts and the strategic decision to increase the percentage of lower cost checking and savings accounts in its deposit base and decrease the percentage of time deposits by competing less aggressively for time deposits. For additional information on deposits, see Note 6 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Borrowings, consisting of FHLB – San Francisco advances decreased $16.0 million, or 16%, to $85.0 million at June 30, 2022 from $101.0 million at June 30, 2021. The decrease was due to scheduled maturities and prepayments of advances during fiscal 2022, partly offset by a new $5.0 million overnight advance on June 30, 2022. The weighted-average maturity of the Corporation’s FHLB – San Francisco advances was approximately 16 months at June 30, 2022, down from 24 months at June 30, 2021. For additional information on borrowings, see Note 7 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Total stockholders’ equity increased $1.4 million or 1% to $128.7 million at June 30, 2022 from $127.3 million at June 30, 2021, primarily as a result of net income and the amortization of stock-based compensation benefits in fiscal 2022, partly offset by stock repurchases (see Part II, Item 5, “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of this Form 10-K) and quarterly cash dividends paid to shareholders.
Comparison of Operating Results for the Years Ended June 30, 2022 and 2021
General. The Corporation recorded net income of $9.1 million, or $1.22 per diluted share, for the fiscal year ended June 30, 2022, up $1.5 million, or 20%, from $7.6 million, or $1.00 per per diluted share, for the fiscal year ended June 30, 2021. The increase in net income in fiscal 2022 compared to fiscal 2021 was primarily attributable to a $956,000 increase in net interest income and a $1.8 million increase in the recovery from the allowance for loan losses. The Corporation's efficiency ratio, defined as non-interest expense divided by the sum of net interest income and non-interest income, improved to 71% in fiscal 2022 from 73% in fiscal 2021. Return on average assets in fiscal 2022 increased to 0.76% from 0.64% in fiscal 2021 and return on average stockholders' equity in fiscal 2022 increased to 7.14% from 6.05% in fiscal 2021.
Net Interest Income. Net interest income increased $956,000, or 3%, to $31.6 million in fiscal 2022 from $30.6 million in fiscal 2021. This increase resulted from an increase in the net interest margin and, to a lesser extent, an increase in the average balance of interest-earning assets. The net interest margin increased six basis points to 2.72% in fiscal 2022 from 2.66% in fiscal 2021, due primarily to a 14 basis points decrease in the average cost of interest-bearing liabilities, partly offset by a six basis points decrease in the average yield on interest-earning assets. The average balance of interest-earning assets increased $8.2 million, or 1%, to $1.16 billion in fiscal 2022 from $1.15 billion in fiscal 2021. The average balance of interest-bearing liabilities increased $8.4 million or 1% to $1.05 billion during fiscal 2022 as compared to $1.04 billion during fiscal 2021.
Interest Income. Total interest income decreased $471,000, or 1%, to $34.7 million for fiscal 2022 from $35.2 million for fiscal 2021. The decrease was primarily attributable to a decrease in interest income on loans receivable, partly offset by an increase in interest income on investment securities, FHLB – San Francisco stock and interest-earning deposits.
Interest income on loans receivable decreased $695,000, or 2%, to $32.2 million in fiscal 2022 from $32.9 million in fiscal 2021. This decrease was attributable to a lower average loan yield, partly offset by a higher average loan balance. The weighted average loan yield during fiscal 2022 decreased 10 basis points to 3.70% from 3.80% in fiscal 2021, due primarily to the decrease in market interest rates resulting from the decline in the general economic conditions impacted by the
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COVID-19 pandemic in the first half of fiscal 2022 with the reverse impact from the improved economic conditions in the second half of fiscal 2022. The average balance of loans receivable increased $6.8 million, or 1%, to $870.3 million during fiscal 2022 from $863.5 million during fiscal 2021.
Interest income from investment securities increased $57,000, or 3%, to $1.9 million in fiscal 2022 from $1.8 million in fiscal 2021. This increase was primarily a result of increases in both the average yield and the average balance. The average yield on investment securities increased two basis points to 0.92% for fiscal 2022 from 0.90% for fiscal 2021. The increase in the average yield of investment securities was primarily attributable to purchases of new investment securities during fiscal 2022 with a higher average yield than the existing portfolio, repricings of adjustable rate mortgage-backed securities to a higher yield and a lower premium amortization ($1.6 million compared to $2.0 million) resulting from lower principal payments. The average balance of investment securities increased $1.3 million, or 1%, to $206.9 million in fiscal 2022 from $205.6 million in fiscal 2021 as a result of the new purchases of investment securities, partly offset by scheduled and accelerated principal payments on mortgage-backed securities. During fiscal 2022, the Bank purchased $19.0 million of mortgage-backed securities and collateralized mortgage obligations with a weighted average yield of 1.34% and did not sell any investment securities.
During fiscal 2022, the Bank received $489,000 of cash dividends from its FHLB - San Francisco stock, an increase of $71,000 or 17% from the $418,000 of cash dividends received in fiscal 2021. The increase in cash dividends was due primarily to a higher average yield (5.98% vs. 5.22%) and, to a lesser extent, a higher average balance of FHLB-San Francisco stock owned ($8.2 million vs. $8.0 million).
Interest income from interest-earning deposits, primarily cash deposited at the Federal Reserve Bank of San Francisco, increased $96,000, or 123%, to $174,000 in fiscal 2022 from $78,000 in fiscal 2021, due to a higher average yield. The average yield increased 13 basis points to 0.23% in fiscal 2022 from 0.10% in fiscal 2021, resulting from increases in the targeted federal funds interest rate in the second half of fiscal 2022.
Interest Expense. Total interest expense for fiscal 2022 was $3.1 million as compared to $4.6 million for fiscal 2021, a decrease of $1.5 million, or 33%. This decrease was primarily attributable to a lower interest expense on borrowings and, to a lesser extent, a lower interest expense on deposits, particularly on time deposits. The average cost of interest-bearing liabilities was 0.30% during fiscal 2022, down 14 basis point from 0.44% during fiscal 2021, while the average balance of interest-bearing liabilities was $1.05 billion during fiscal 2022, up $8.4 million or 1% from $1.04 billion during fiscal 2021.
Interest expense on deposits for fiscal 2022 was $1.1 million as compared to $1.7 million for fiscal 2021, a decrease of $601,000, or 34%. The decrease in interest expense on deposits was attributable to a lower average cost, particularly for time deposits, partly offset by an increase in average balance. The average cost of deposits decreased seven basis points to 0.12% in fiscal 2022 from 0.19% in fiscal 2021. The average cost of transaction accounts was 0.05% in fiscal 2022, down one basis point from 0.06% in fiscal 2021; while the average cost of time deposits in fiscal 2022 was 0.57%, down 25 basis points, from 0.82% in fiscal 2021. The average balance of deposits increased $47.1 million, or 5%, to $961.5 million during fiscal 2022 from $914.4 million during fiscal 2021. The average balance of transaction accounts increased $70.0 million, or 9%, to $830.0 million in fiscal 2022 from $760.0 million in fiscal 2021. The average balance of time deposits decreased by $22.9 million, or 15%, to $131.5 million in fiscal 2022 from $154.4 million in fiscal 2021. The average balance of transaction accounts to total deposits in the fiscal 2022 was 86%, compared to 83% in fiscal 2021. The increase in the average balance of transaction accounts and the decrease in the average balance of time deposits are consistent with the Bank's marketing strategy to promote transaction accounts and the strategic decision to compete less aggressively on time deposit interest rates.
Interest expense on borrowings, consisting of FHLB - San Francisco advances, for fiscal 2022 decreased $826,000, or 29%, to $2.0 million as compared to $2.8 million in fiscal 2021. The decrease in interest expense on borrowings was due primarily to a lower average balance, partly offset by a slightly higher average cost. The average balance of borrowings decreased $38.7 million, or 31%, to $86.9 million during fiscal 2022 from $125.6 million during fiscal 2021. The decrease in the average balance was due primarily to the maturities and prepayment of advances in fiscal 2022. The average cost of borrowings was 2.29% in fiscal 2022, up five basis points from 2.24% in fiscal 2021. The Bank prepaid a total of $10.0 million in advances with total prepayment fees of $39,000 in fiscal 2022, as compared to the prepayment of $25.0 million in advances with total prepayment fees of $33,000 in fiscal 2021.
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Provision (Recovery) for Loan Losses. During fiscal 2022, the Corporation recorded a recovery from the allowance for loan losses of $2.5 million, as compared to a recovery from the allowance for loan losses of $708,000 during fiscal 2021. The recovery from the allowance for loan losses in fiscal 2022 was primarily due to an improvement in the forecasted economic metrics utilized in the qualitative component adjustment to the allowance for loan losses reflecting improved general economic conditions and recoveries from the allowance for loan losses from non-performing loans and classified loans that were upgraded or paid off, partly offset by an increase in loans held for investment. The recovery from the allowance for loan losses in fiscal 2021 was primarily due to an improvement in the forecasted economic metrics utilized in the qualitative component adjustment to the allowance for loan losses attributable to an improved economic outlook during the second half of fiscal 2021, reducing the expected impact of the COVID-19 pandemic to the credit quality of the loan portfolio, and a decrease in loans held for investment.
Non-performing assets, comprised soley of non-performing loans (net of the collectively evaluated allowances and individually evaluated allowances), with underlying collateral primarily located in Southern California, was $1.4 million at June 30, 2022, down $7.2 million or 84% from $8.6 million at June 30, 2021. Non-performing loans at June 30, 2022 were $1.4 million, comprised of seven single-family loans. As of June 30, 2022, all of the non-performing loans have a current payment status. Net loan recoveries in fiscal 2022 were $439,000 or 0.05% of average loans receivable, compared to net loan recoveries of $30,000 or 0.00% of average loans receivable in fiscal 2021. At both June 30, 2022 and June 30, 2021, there was no REO.
Management believes that, based on currently available information, the allowance for loan losses is sufficient to absorb potential losses inherent in loans held for investment at June 30, 2022 under the incurred loss methodology.
Classified assets, comprised soley of loans, were $1.6 million at June 30, 2022, comprised of $224,000 in the special mention category and $1.4 million in the substandard category. Classified assets at June 30, 2021 were $10.4 million, comprised of $1.8 million in the special mention category and $8.6 million in the substandard category. For additional information, see Item 1, “Business - “Delinquencies and Classified Assets” in this Form 10-K.
For the fiscal year ended June 30, 2022, there were no loans that were newly modified from their original terms, re-underwritten or identified as a restructured loan; three loans were upgraded to the pass category; seven loans were paid off; and no loans were converted to real estate owned. For the fiscal year ended June 30, 2021, there were 20 loans that were newly modified from their original terms (including 19 COVID-19 related forbearance loans downgraded when their monthly payment deferrals were extended beyond six months), re-underwritten or identified as restructured loans; two loans were upgraded to the pass category; three loans were paid off; and no loans were converted to real estate owned. The outstanding balance of restructured loans at June 30, 2022 was $4.5 million (13 loans), down 43% from $7.9 million (23 loans) at June 30, 2021. As of June 30, 2022, one restructured loan of $722,000 was in non-accrual status. As of June 30, 2022, all of the restructured loans have a current payment status, consistent with their modified payment terms. During fiscal 2022, no restructured loans were in default within a 12-month period subsequent to their original restructuring.
The allowance for loan losses was $5.6 million at June 30, 2022, or 0.59% of gross loans held for investment, compared to $7.6 million, or 0.88% of gross loans held for investment at June 30, 2021. The allowance for loan losses at June 30, 2022 includes $38,000 of individually evaluated allowances, compared to $384,000 of individually evaluated allowances at June 30, 2021. Management believes that, based on currently available information, the allowance for loan losses is sufficient to absorb potential losses inherent in loans held for investment at June 30, 2022. For additional information, see Item 1, “Business - Delinquencies and Classified Assets - Allowance for Loan Losses” in this Form 10-K.
The allowance for loan losses is maintained at a level sufficient to provide for estimated losses based on evaluating known and inherent risks in the loans held for investment portfolio and upon management's continuing analysis of the factors underlying the quality of the loans held for investment. These factors include changes in the size and composition of the loans held for investment, actual loan loss experience, current economic conditions, detailed analysis of individual loans for which full collectability may not be assured, and determination of the realizable value of the collateral securing the loans. Provisions (recoveries) for loan losses are charged (credited) against operations on a quarterly basis, as necessary, to maintain the allowance at appropriate levels. Management believes that the amount maintained in the allowance will be adequate to absorb probable losses inherent in the loans held for investment. Although management believes it uses the best information available to make such determinations, there can be no assurance that regulators, in reviewing the Bank's
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loans held for investment, will not request the Bank to significantly increase its allowance for loan losses. Future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly and adversely affected as a result of economic, operating, regulatory and other conditions beyond the control of the Bank, including as a result of the COVID-19 pandemic.
Non-Interest Income. Total non-interest income was $4.7 million in fiscal 2022, an increase of $143,000 or 3% from $4.6 million in fiscal 2021. The increase was primarily attributable to an increase in other non-interest income as well as in deposit account fees, partly offset by the decrease in loan servicing and other fees.
Loan servicing and other fees decreased $114,000, or 10%, to $1.1 million for fiscal 2022 from $1.2 million in fiscal 2021. The decrease was due primarily to a fair value adjustment of loans held at fair value, partly offset by a higher mortgage servicing asset valuation.
Other non-interest income increased $168,000, or 30%, to $719,000 in fiscal 2022 from $551,000 in fiscal 2021. The increase was due primarily to a $40,000 recovery from the recourse reserve for sold loans in fiscal 2022 as compared to a $105,000 provision for losses on sold loans in fiscal 2021.
Non-Interest Expense. Total non-interest expense in fiscal 2022 was $25.9 million, an increase of $182,000 or 1% from $25.7 million in fiscal 2021. The increase in non-interest expense was primarily attributable to increases in salaries and employee benefits and equipment expense, partly offset by decreases in premises and occupancy expense, professional expense and other non-interest expenses.
Salaries and employee benefits expense increased $676,000, or 4%, to $15.8 million in fiscal 2022 from $15.2 million in fiscal 2021. The increase in salaries and employee benefits expense was primarily due to a lower credit from the Employee Retention Tax Credit (“ERTC”), partly offset by decreases in equity incentive compensation expense and retirement benefit expense. The ERTC credit was recorded for qualified wages consistent with the criteria outlined within the CAA and American Rescue Plan Act of 2021 where eligible employers can claim a maximum credit equal to 70 percent of $10,000 of qualified wages paid to an employee per calendar quarter for the year 2021. The Bank recorded a $1.2 million ERTC credit in fiscal 2022, down $1.2 million or 50% from $2.4 million in fiscal 2021. The Bank recorded $798,000 of stock-based compensation expense in fiscal 2022, down $505,000 or 39% from $1.3 million in fiscal 2021, primarily due to adjustments upon vesting of prior restricted stock grants. The Bank also recorded a $217,000 accrual for the retirement benefit expense in fiscal 2022, down $346,000 or 61% from $563,000 in fiscal 2021.
Equipment expense increased $129,000 or 11% to $1.3 million in fiscal 2022 from $1.2 million in fiscal 2021. The increase was primarily due to a higher maintenance of software license costs resulting from additional software implementations and increases in software renewal costs in fiscal 2022.
Premises and occupancy expense decreased $311,000, or 9%, to $3.2 million in fiscal 2022 from $3.5 million in fiscal 2021. The decrease was due primarily to a lower network services expense, including a refund of $136,000 from a vendor on previously paid network services invoices that were overstated when billed.
Professional expenses decreased $142,000, or 9%, to $1.4 million in fiscal 2022 from $1.6 million in fiscal 2021. The decrease was due primarily to lower legal expenses as litigation was settled in fiscal 2021.
Other non-interest expenses decreased $123,000, or 4%, to $3.0 million in fiscal 2022 from $3.1 million in fiscal 2021. The decrease was due primarily to a litigation settlement of $145,000 in fiscal 2021, not replicated in fiscal 2022.
Provision for Income Taxes. The income tax provision reflects accruals for taxes at the applicable rates for federal income tax and California franchise tax based upon reported pre-tax income, adjusted for the effect of all permanent differences between income for tax and financial reporting purposes, such as non-deductible stock-based compensation, bank-owned life insurance policies and certain California tax-exempt loans, among others. Therefore, there are fluctuations in the effective income tax rate from period to period based on the relationship of net permanent differences to income before tax.
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The provision for income taxes was $3.8 million for fiscal 2022, representing an effective tax rate of 29.3%, as compared to $2.6 million in fiscal 2021, representing an effective tax rate of 25.8%. The higher provision for income taxes in fiscal 2022 in comparison to fiscal 2021 was due primarily to a higher net income before provision for income taxes, while the higher effective tax rate in fiscal 2022 was attributable to no tax benefits from the exercise of stock options and the non-taxable treatment of the lower ERTC for state tax purposes in fiscal 2022 as compared to fiscal 2021.
The Corporation’s effective tax rate may differ from the estimated tax rates described above due to discrete items such as further adjustments to net deferred tax assets, excess tax benefits derived from stock option exercises and non-taxable earnings from bank owned life insurance, among other items. The Corporation determined that the above tax rates meet its estimated income tax obligations. For additional information, see Note 8, "Income Taxes," of the Notes to Consolidated Financial Statements, contained in Item 8 of this Form 10-K.
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Average Balances, Interest and Average Yields/Costs
The following table sets forth certain information for the periods regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and average yields and costs thereof. Yields and costs for the periods indicated are derived by dividing income or expense by the average monthly balance of assets or liabilities, respectively, for the periods presented.
Year Ended June 30,
2022
2021
2020
Average
Yield/
Average
Yield/
Average
Yield/
(Dollars In Thousands)
Balance
Interest
Cost
Balance
Interest
Cost
Balance
Interest
Cost
Interest-earning assets:
Loans receivable, net (1)
$
870,328
$
32,161
3.70
%
$
863,507
$
32,856
3.80
%
$
915,353
$
39,145
4.28
%
Investment securities
206,876
1,906
0.92
%
205,628
1,849
0.90
%
86,761
2,120
2.44
%
FHLB – San Francisco stock
8,172
489
5.98
%
8,008
418
5.22
%
8,155
534
6.55
%
Interest-earning deposits
74,897
174
0.23
%
74,952
78
0.10
%
71,766
657
0.90
%
Total interest-earning assets
1,160,273
34,730
2.99
%
1,152,095
35,201
3.06
%
1,082,035
42,456
3.92
%
Non interest-earning assets
32,787
30,916
31,720
Total assets
$
1,193,060
$
1,183,011
$
1,113,755
Interest-bearing liabilities:
Checking and money market accounts (2)
$
505,726
220
0.04
%
$
470,129
268
0.06
%
$
396,399
424
0.11
%
Savings accounts
324,292
172
0.05
%
289,848
208
0.07
%
261,432
496
0.19
%
Time deposits
131,479
752
0.57
%
154,374
1,269
0.82
%
186,317
2,023
1.09
%
Total deposits (3)
961,497
1,144
0.12
%
914,351
1,745
0.19
%
844,148
2,943
0.35
%
Borrowings
86,883
1,991
2.29
%
125,589
2,817
2.24
%
127,882
3,112
2.43
%
Total interest-bearing liabilities
1,048,380
3,135
0.30
%
1,039,940
4,562
0.44
%
972,030
6,055
0.62
%
Non interest-bearing liabilities
17,272
18,158
18,968
Total liabilities
1,065,652
1,058,098
990,998
Stockholders’ equity
127,408
124,913
122,757
Total liabilities and stockholders’ equity
$
1,193,060
$
1,183,011
$
1,113,755
Net interest income
$
31,595
$
30,639
$
36,401
Interest rate spread (4)
2.69
%
2.62
%
3.30
%
Net interest margin (5)
2.72
%
2.66
%
3.36
%
Ratio of average interest- earning assets to average interest-bearing liabilities
110.67
%
110.78
%
111.32
%
(1) Includes non-performing loans, as well as net deferred loan costs of $1.8 million, $2.5 million and $1.1 million for the years ended June 30, 2022, 2021 and 2020, respectively.
(2) Includes the average balance of non interest-bearing checking accounts of $119.5 million, $116.1 million and $90.0 million in the years ended June 30, 2022, 2021 and 2020, respectively.
(3) Includes the average balance of uninsured deposits of $169.2 million, $152.9 million and $122.3 million in the years ended June 30, 2022, 2021 and 2020, respectively.
(4) Represents the difference between the weighted-average yield on all interest-earning assets and the weighted-average rate on all interest-bearing liabilities.
(5) Represents net interest income as a percentage of average interest-earning assets.
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Rate/Volume Variance
The following tables set forth the effects of changing rates and volumes on interest income and expense of the Corporation for the period presented. Information is provided with respect to the effects attributable to changes in volume (changes in volume multiplied by prior rate), the effects attributable to changes in rate (changes in rate multiplied by prior volume) and the effects attributable to changes that cannot be allocated between rate and volume.
Year Ended June 30, 2022 Compared
To Year Ended June 30, 2021
Increase (Decrease) Due to
(In Thousands)
Rate
Volume
Rate/Volume
Net
Interest-earning assets:
Loans receivable (1)
$
(947)
$
259
$
(7)
$
(695)
Investment securities
46
11
—
57
FHLB – San Francisco stock
61
9
1
71
Interest-bearing deposits
96
—
—
96
Total net change in income on interest-earning assets
(744)
279
(6)
(471)
Interest-bearing liabilities:
Checking and money market accounts
(62)
21
(7)
(48)
Savings accounts
(53)
24
(7)
(36)
Time deposits
(386)
(188)
57
(517)
Borrowings
60
(867)
(19)
(826)
Total net change in expense on interest-bearing liabilities
(441)
(1,010)
24
(1,427)
Net (decrease) increase in net interest income
$
(303)
$
1,289
$
(30)
$
956
(1) Includes non-performing loans. For purposes of calculating volume, rate and rate/volume variances, non-performing loans were included in the weighted-average balance outstanding.
Year Ended June 30, 2021 Compared
To Year Ended June 30, 2020
Increase (Decrease) Due to
(In Thousands)
Rate
Volume
Rate/ Volume
Net
Interest-earning assets:
Loans receivable (1)
$
(4,319)
$
(2,219)
$
249
$
(6,289)
Investment securities
(1,340)
2,900
(1,831)
(271)
FHLB – San Francisco stock
(108)
(10)
2
(116)
Interest-earning deposits
(583)
29
(25)
(579)
Total net change in income on interest-earning assets
(6,350)
700
(1,605)
(7,255)
Interest-bearing liabilities:
Checking and money market accounts
(200)
81
(37)
(156)
Savings accounts
(308)
54
(34)
(288)
Time deposits
(492)
(348)
86
(754)
Borrowings
(243)
(56)
4
(295)
Total net change in expense on interest-bearing liabilities
(1,243)
(269)
19
(1,493)
Net (decrease) increase in net interest income
$
(5,107)
$
969
$
(1,624)
$
(5,762)
(1) Includes non-performing loans. For purposes of calculating volume, rate and rate/volume variances, non-performing loans were included in the weighted-average balance outstanding.
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Liquidity and Capital Resources
The Corporation's primary sources of funds are deposits, proceeds from principal and interest payments on loans, proceeds from the maturity and sale of investment securities, proceeds from FHLB - San Francisco advances, and access to the discount window facility at the Federal Reserve Bank of San Francisco. While maturities and scheduled amortization of loans and investment securities are a relatively predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.
The primary investing activity of the Bank has been the origination and purchase of loans held for investment. During the fiscal years ended June 30, 2022 and 2021, the Bank originated loans held for investment of $299.8 million and $215.0 million, respectively. In addition, the Bank purchased loans held for investment from other financial institutions in fiscal 2022 and 2021 of $6.4 million and $16.9 million, respectively. At June 30, 2022 and 2021, the Bank had loan origination commitments totaling $43.4 million and $21.9 million, respectively, with undisbursed loan funds of $3.4 million and $4.5 million, respectively. The Bank anticipates that it will have sufficient funds available to meet its current loan origination commitments.
The Bank's primary financing activity is gathering deposits. During the fiscal years ended June 30, 2022 and 2021, the net increase in deposits was $17.5 million and $45.0 million, respectively. On June 30, 2022, time deposits that are scheduled to mature in one year or less were $78.6 million. Historically, the Bank has been able to retain a significant percentage of its time deposits as they mature by adjusting deposit rates based upon the current interest rate environment.
The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to support loan growth and deposit withdrawals, to satisfy financial commitments and to take advantage of investment opportunities. The Bank generally maintains sufficient cash and cash equivalents to meet short-term liquidity needs. At June 30, 2022, total cash and cash equivalents were $23.4 million, or 2.0% of total assets. Depending on market conditions and the pricing of deposit products and FHLB - San Francisco advances, the Bank may continue to rely on FHLB - San Francisco advances for part of its liquidity needs. As of June 30, 2022, the remaining financing availability at FHLB - San Francisco was $310.3 million and the remaining available collateral was $310.5 million. In addition, the Bank has secured a $153.9 million discount window facility at the Federal Reserve Bank of San Francisco, collateralized by investment securities with a fair market value of $163.7 million. The Bank also has a federal funds facility with its correspondent bank for $50.0 million which matures on June 30, 2023. As of June 30, 2022, there were no outstanding borrowings under the discount window facility or the federal funds facility with its correspondent bank.
Regulations require the Bank to maintain adequate liquidity to assure safe and sound operations. The Bank's average liquidity ratio (defined as the ratio of average qualifying liquid assets to average deposits and borrowings) for the quarter ended June 30, 2022 decreased to 24.3% from 32.0% during the same quarter ended June 30, 2021. The decrease in the liquidity ratio was due primarily to the decrease in average qualifying liquid assets and the increase in average deposits and borrowings during the quarter ended June 30, 2022 in comparison to the quarter ended June 30, 2021. The Bank augments its liquidity by maintaining sufficient borrowing capacity at the FHLB - San Francisco, Federal Reserve Bank of San Francisco and its correspondent bank.
We incur capital expenditures on an ongoing basis to expand and improve our product offerings, enhance and modernize our technology infrastructure, and to introduce new technology-based products to compete effectively in our markets. We evaluate capital expenditure projects based on a variety of factors, including expected strategic impacts (such as forecasted impact on revenue growth, productivity, expenses, service levels and customer retention) and our expected return on investment. The amount of capital investment is influenced by, among other things, current and projected demand for our services and products, cash flow generated by operating activities, cash required for other purposes and regulatory considerations.
Based on our current capital allocation objectives, during fiscal 2023 we project expending approximately $989,000 to $1.9 million of cash for capital investment in property, plant and equipment. In addition, we currently expect to continue our current practice of paying quarterly cash dividends on our common stock subject to our Board of Directors' discretion to modify or terminate this practice at any time and for any reason without prior notice. Our current quarterly common stock dividend rate is $0.14 per share, as approved by our Board of Directors, which we believe is a dividend rate per share
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which enables us to balance our multiple objectives of managing and investing in the Bank, and returning a substantial portion of our cash to our shareholders.
The Bank, as a federally-chartered, federally insured savings bank, is subject to the capital requirements established by the OCC. Under the OCC's capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors. In addition, Provident Financial Holdings, Inc., as a savings and loan holding company registered with the FRB, is required by the FRB to maintain capital adequacy that generally parallels the OCC requirements. Since the holding company has less than $3.0 billion in assets, the capital guidelines apply on a bank only basis, and the Federal Reserve expects the holding company’s subsidiary bank to be well capitalized under the prompt corrective action regulations.
At June 30, 2022, the Bank exceeded all regulatory capital requirements. Under the prompt corrective action provisions, minimum ratios of 5.0% for Tier 1 Leverage Capital, 6.5% for CET1 Capital, 8.0% for Tier 1 Risk-based Capital and 10.0% for Total Risk-based Capital are required to be deemed “well capitalized.” As of June 30, 2022, the Bank exceeded the capital ratios needed to be considered well capitalized with Tier 1 Leverage Capital, CET1 Capital, Tier 1 Risk-based Capital and Total Risk-based Capital ratios of 10.5%, 19.6%, 19.6% and 20.5%, respectively.
Impact of New Accounting Pronouncements
Various elements of the Corporation's accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified several accounting policies that, as a result of the judgments, estimates and assumptions inherent in those policies, are important to gain an understanding of the financial statements of the Corporation. These policies relate to the methodology for the recognition of interest income, determination of the provision and allowance for loan losses, the estimated fair value of derivative financial instruments and the valuation of mortgage servicing rights and real estate owned. These policies and judgments, estimates and assumptions are described in greater detail in this Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and in the section entitled “Organization and Summary of Significant Accounting Policies” contained in Note 1 of the Notes to the Consolidated Financial Statements included in Item 8 of this Form 10-K. Management believes that the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However, because of the sensitivity of the financial statements to these accounting policies, changes to the judgments, estimates and assumptions used could result in material differences in the results of operations or financial condition.