United States SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended June 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-28304 PROVIDENT FINANCIAL HOLDINGS, INC. ---------------------------------- (Exact name of registrant as specified in its charter) Delaware 33-0704889 - --------------------------------------------- ---------------- (State or other jurisdiction of incorporation (I.R.S. Employer or organization) I.D. Number) 3756 Central Avenue, Riverside, California 92506 - --------------------------------------------- ---------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (909) 686-6060 -------------- Securities registered pursuant to Section 12(b) of the Act: None ---- Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share -------------------------------------- (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO . --- --- Indicate by check mark whether disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or other information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [ X ] As of September 15, 1998, there were issued and outstanding 4,625,414 shares of the Registrant's Common Stock. The Registrant's voting stock is listed on the NASDAQ National Market under the symbol "PROV." The aggregate market value of the voting stock held by nonaffiliates of the Registrant, based on the closing sales price of the Registrant's common stock as quoted on the NASDAQ National Market on September 15, 1998, was $66,243,996. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Annual Report to Shareholders for the fiscal year ended June 30, 1998 ("Annual Report") (Part II). 2. Portions of the definitive Proxy Statement for the 1998 Annual Meeting of Shareholders ("Proxy Statement") (Part III).
PART I ITEM 1. BUSINESS - ----------------- GENERAL Provident Financial Holdings, Inc. ("Provident Financial" or the "Corporation"), a Delaware corporation, was organized in January 1996 for the purpose of becoming the holding company for Provident Savings Bank, F.S.B. ("Savings Bank") upon the Savings Bank's conversion from a federal mutual to a federal stock savings bank ("Conversion"). The Conversion was completed on June 27, 1996. At June 30, 1998, the Corporation had total assets of $816.2 million, total deposits of $583.0 million and stockholders' equity of $86.7 million. Provident Financial has not engaged in any significant activity other than holding the stock of the Savings Bank. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Savings Bank and its subsidiaries. The Savings Bank, founded in 1956, is a federally chartered savings bank headquartered in Riverside, California. The Savings Bank is regulated by the Office of Thrift Supervision ("OTS"), its primary federal regulator, and the Federal Deposit Insurance Corporation ("FDIC"), the insurer of its deposits. The Savings Bank's deposits are federally insured up to applicable limits by the FDIC (under the Savings Association Insurance Fund ("SAIF")). The Savings Bank has been a member of the Federal Home Loan Bank ("FHLB") System since 1956. The Savings Bank's business consists of both traditional savings and loan and mortgage banking operations. The savings and loan operations primarily consist of accepting deposits from customers within the communities surrounding its full service offices and investing those funds in one- to four-family mortgage loans and, to a lesser extent, in multi-family, commercial real estate, construction, consumer and other loans. The mortgage banking activities consist of the origination and sale of mortgage loans secured by one- to four-family residences and the servicing of such loans for others. The Savings Bank has recently begun offering business loans and other business banking services. The Savings Bank's revenues are derived principally from interest on its mortgage loan portfolio and fees generated through its mortgage banking activities. RECENT DEVELOPMENTS On March 27, 1998 Provident Savings Bank consummated the purchase of the Blythe, California branch of Bank of America. The assets acquired in the transaction totaled $16.4 million, of which $15.8 million was cash, and the liabilities assumed were $16.4 million in deposits. MARKET AREA The Savings Bank is headquartered in Riverside, California and operates eight additional full-service offices in Riverside County and one in San Bernardino County. Management considers Riverside and western San Bernardino Counties to be the Savings Bank's primary market for deposits. Through the operations of its Profed Mortgage division, the Savings Bank has expanded its retail lending market to include a larger portion of southern California and southern Nevada. Profed Mortgage's loan production offices include wholesale loan departments through which the Savings Bank maintains a network of loan correspondents. Most of the Savings Bank's business is conducted in the communities surrounding the Savings Bank's full-service branches and loan production offices. The large geographic area encompassing Riverside and San Bernardino Counties is referred to as the "Inland Empire" due to a combination of the large volume of economic activity, the large population and the extremely rapid economic and demographic growth that occurred during the 1980s. According to 1995 population estimates, San Bernardino and Riverside Counties have the fourth and sixth largest county populations in California, respectively. The Savings Bank's market area consists primarily of suburban and urban communities. Western Riverside and San Bernardino Counties are relatively densely populated and are within the greater Los Angeles metropolitan area. Military spending cuts have had a negative impact on the economy and the labor force in the market area, as much of Southern California's economic growth was tied to growth in the aerospace and other defense-related industries. As the Inland Empire is widely believed to be entering a period of recovery from the recessionary trends that have prevailed in Southern California over the past several years, unemployment remains 1
above the national average but is improving. The recession in Southern California resulted in an over-supply of commercial, multi-family and residential properties but real estate values appear to be rising. The Savings Bank faces intense competition for deposits and loan originations. See "-- Competition." LENDING ACTIVITIES GENERAL. The principal lending activity of the Savings Bank is the origination of conventional, Federal Housing Administration ("FHA") and Veterans Administration ("VA") mortgage loans secured by one- to four-family residential properties. To a lesser extent, the Savings Bank also originates multi-family, commercial real estate, construction, consumer and other loans for its portfolio. The Savings Bank's net loans receivable totaled approximately $620.1 million at June 30, 1998, representing approximately 76.0% of consolidated total assets. This compares to $517.1 million, or 84.0% of consolidated total assets, at June 30, 1997. Following the Savings Bank's conversion to a stock company and the subsequent increase in capital, the Savings Bank began to retain a larger portion of its mortgage loan production. The Savings Bank believes that this strategy will enable it to leverage the new capital and provide a higher return on equity in the future. 2
<TABLE> LOAN PORTFOLIO ANALYSIS. The following table sets forth the composition of the Savings Bank's loan portfolio at the dates indicated. At June 30, ----------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (In Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Mortgage Loans: One-to four- family........ $507,194 80.08% $402,296 76.41% $327,490 70.77% $345,034 71.59% $277,986 64.94% Multi-family... 46,635 7.36 52,564 9.98 54,427 11.76 53,531 11.11 63,719 14.88 Commercial..... 42,696 6.74 47,887 9.09 54,813 11.84 61,518 12.76 63,659 14.87 Construction... 13,746 2.17 5,778 1.10 10,222 2.21 5,938 1.23 4,324 1.01 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total Mortgage loans......... 610,273 96.35 508,525 96.58 446,952 96.58 466,021 96.69 409,688 95.70 Consumer loans... 19,824 3.13 16,749 3.18 15,497 3.35 15,830 3.28 18,177 4.25 Commercial business loans........... 2,819 0.45 991 0.19 0 0.00 0 0.00 0 0.00 Other loans ..... 422 0.07 289 0.05 332 0.07 137 0.03 218 0.05 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total loans receivable... 633,336 100.00% 526,554 100.00% 462,781 100.00% 481,988 100.00% 428,083 100.00% ------- ====== ------- ====== ------- ====== ------- ====== ------- ====== Loans in process. 7,320 3,695 3,694 4,121 3,324 Deferred loan fees (298) 247 690 1,239 1,268 Allowance for loan losses.......... 6,186 5,465 5,452 5,085 3,332 -------- -------- -------- -------- -------- Total loans receivable, net..... $620,128 $517,147 $452,945 $471,543 $420,159 ======== ======== ======== ======== ======== Loans held for sale ..... $67,248 $19,984 $49,612 $34,489 $83,049 ======= ======= ======= ======= ======= 2 </TABLE>
MATURITY OF LOAN PORTFOLIO. The following table sets forth certain information at June 30, 1998, regarding the dollar amount of principal repayments becoming contractually due during the periods indicated for loans held in the Savings Bank's portfolio. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as becoming due within one year. The table does not include any estimate of prepayments, which significantly shorten the average life of loan portfolios and may cause the Savings Bank's actual repayment experience to differ from that shown below. After One After After Year 3 Years 5 years Within Through Through Through One 3 5 10 Beyond Year Years Years Years 10 Years Total ---- ----- ----- ----- -------- ----- Mortgage loans: One-to four-family. $2,835 $3,794 $3,693 $2,909 $493,963 $507,194 Multifamily........ 102 35 517 445 45,536 46,635 Commercial ........ 43 645 479 1,167 40,362 42,696 Construction....... 2,641 399 -- -- 10,706 13,746 Consumer loans...... 15 769 3,100 6,206 9,734 19,824 Commercial business loans.............. 1,551 770 498 -- -- 2,819 Other loans ........ 60 251 47 -- 64 422 ------ ------ ------ ------- -------- -------- Total loans receivable....... $7,247 $6,663 $8,334 $10,727 $600,365 $633,336 ====== ====== ====== ======= ======== ======== The following table sets forth the dollar amount of all loans held in the Savings Bank's portfolio due after June 30, 1999 which have fixed interest rates and have floating or adjustable interest rates. Floating or Adjustable Fixed-Rates Rates ----------- ----------- (In Thousands) Mortgage loans: One-to four-family............... $39,002 $465,357 Multifamily ..................... 1,042 45,491 Commercial....................... 2,684 39,969 Construction...................... 399 10,706 Consumer loans.................... 8,242 11,566 Commercial Business Lending....... 4372 896 Other loans....................... -- 362 ------- -------- Total loans receivable... $51,742 $574,347 ======= ======== 4
Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give the Savings Bank the right to declare loans immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are substantially higher than current mortgage loan market rates. ONE- TO FOUR-FAMILY RESIDENTIAL REAL ESTATE LENDING. The Savings Bank's primary focus in lending is on the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences in the communities where the Savings Bank has established full service branches and loan production offices. At June 30, 1998, $507.2 million, or 80.1% of the Savings Bank's loan portfolio consisted of permanent loans on one- to four-family residences. Since 1989, the Savings Bank has emphasized its mortgage banking activities and has sold most of the residential mortgage loans that it has originated. See "-- Mortgage Banking Activities." A portion of the ARM loans originated by the Savings Bank are retained in the Savings Bank's loan portfolio to meet the Savings Bank's asset/liability management objectives. One- to four-family loans originated for portfolio increased 73.9% during fiscal 1998 to $195.3 million. At June 30, 1998, adjustable-rate loans comprised 77.5% of the Savings Bank's loan portfolio. The Savings Bank's residential mortgage loans are generally underwritten and documented in accordance with the guidelines established by the Federal Home Loan Mortgage Corporation ("FHLMC") and the Federal National Mortgage Association ("FNMA"). All government insured loans are generally underwritten and documented in accordance with the guidelines established by the Department of Housing and Urban Development ("HUD") and the VA. The Savings Bank's loan underwriters are approved as underwriters under HUD's delegated underwriter program. The Savings Bank offers ARM loans at rates and terms competitive with market conditions. Substantially all of the ARM loans originated by the Savings Bank meet the underwriting standards of the secondary markets. The Savings Bank offers several ARM products which adjust semi-annually or annually after an initial fixed period ranging from six months to seven years subject to a limitation on the annual increase of 1.0 to 2.0 percentage points and an overall limitation of 3.0 to 6.0 percentage points. Certain ARM loans are originated with an option to convert the loan to a 30-year fixed-rate loan at the then prevailing market interest rate. The ARM loans in the Savings Bank's portfolio utilize the COFI, London interbank offered rates ("LIBOR") or the weekly average yield on one-year U.S. Treasury securities adjusted to a constant maturity of one year ("CMT"), plus a margin of 2.00% to 3.25%. Loans based on the Treasury CMT constitute a majority of the Savings Bank's loan portfolio. The COFI has become dominated by a few large savings institutions and, accordingly, movement in the index is closely tied to the deposit pricing and borrowing cost of those institutions. Currently, the Savings Bank does not originate COFI indexed loans but emphasizes products based on the one-year CMT and LIBOR, which adjust more rapidly than the COFI to changes in interest rates. The majority of the ARM loans being originated for portfolio by the Savings bank at the present time have three, five or seven year fixed periods prior to the first adjustment period. Loans of this type have an inherent interest rate risk if rates should rise during the initial fixed rate period. As of June 30, 1998, the Savings Bank had $104.3 million in mortgage loans that may be subject to negative amortization. Negative amortization involves a greater risk to the Savings Bank because during a period of high interest rates the loan principal balance may increase above the amount of the original loan up to 115% of the loan amount. However, the Savings Bank believes that the risk of default is reduced by the stability provided by payment schedules and has historically found that its origination of negative amortization loans has not resulted in higher amounts of non-performing loans. 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 in a given interest rate and competitive environment. 5
The retention of ARM loans in the Savings Bank's loan portfolio helps reduce the Savings Bank's exposure to changes in interest rates. There are, however, unquantifiable credit risks resulting from the potential of increased interest to be paid by the customer due to 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 re-pricing and the increased required payment from the borrower. Furthermore, because the ARM loans originated by the Savings Bank generally provide, as a marketing incentive, for initial rates of interest below the rates which would apply were the adjustment index plus the applicable margin initially used for pricing, these loans are subject to increased risks of default or delinquency. Another consideration is that although ARM loans allow the Savings Bank to increase the sensitivity of its asset base due to changes in the interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits. In addition, because the COFI is a lagging market index, upward adjustments on these loans may occur more slowly than increases in the Savings Bank's cost of interest-bearing liabilities, especially during periods of rapidly increasing interest rates. Because of these considerations, the Savings Bank has no assurance that yields on ARM loans will be sufficient to offset increases in the Savings Bank's cost of funds. The Savings Bank's present policy generally limits loan amounts to 97% of the appraised value or purchase price of a property, whichever is lower, for conventional loans. Higher loan-to-value ratios are available on certain government-insured programs. The Savings Bank generally requires private mortgage insurance on residential loans with a loan-to-value ratio at origination exceeding 80%. MULTI-FAMILY RESIDENTIAL AND COMMERCIAL REAL ESTATE LENDING. Historically, the Savings Bank has originated loans secured by multi-family residential and commercial real estate. At June 30, 1998, the Savings Bank's loan portfolio included $46.6 million in multi-family real estate loans and $42.7 million in commercial real estate loans, or 7.4% and 6.7%, respectively, of total loans receivable. After 1989, the Savings Bank de-emphasized this type of lending and made multi-family and commercial real estate mortgage loans only on a selective basis. With the improvement in the market and the decline in delinquencies, the Savings Bank has begun to consider loans of this type more extensively. At June 30, 1998, the Savings Bank had 94 multi-family and 117 commercial real estate loans in its portfolio, the largest of which was a multi-family real estate loan with a balance of $3.3 million. Multi-family real estate loans originated by the Savings Bank are predominately adjustable rate loans with a term to maturity of 15 years based on a 30-year amortization schedule. Commercial real estate loans originated by the Savings Bank are also predominately adjustable rate loans with a term to maturity of ten years based on a 30-year amortization schedule. Rates on multi-family and commercial ARM loans generally adjust monthly, semi-annually or annually at a specific interval over the COFI, subject to annual payment caps and life-of-loan interest rate caps. At June 30, 1998, $27.9 million, or 59.8%, of the Savings Bank's multi-family loans were secured by five to 36 unit projects, of which $17.3 million, or 37.2 %, were located in Riverside or San Bernardino Counties. The Savings Bank's commercial real estate loan portfolio generally consists of loans secured by small office buildings and small retail centers, substantially all of which are located in Southern California. The Savings Bank originates multi-family and commercial real estate loans in amounts ranging from $200,000 to $1.5 million. At June 30, 1998, the Savings Bank had 20 commercial real estate and multi-family loans with principal balances of over $1 million that totaled $32.8 million. Independent appraisers, engaged by the Savings Bank, perform appraisals on properties that secure multi-family real estate loans. Underwriting of multi-family and commercial loans includes a thorough analysis of the cash flows generated by the real estate to support the debt service and the financial resources, experience, and income level of the borrowers. Multi-family and commercial real estate lending affords the Savings Bank an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending. 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 one- to four-family residential mortgage loans. Because payments on loans secured by multi-family and commercial properties are often dependent on the successful operation and management of the properties, repayment of such loans may be impacted by adverse conditions in the real estate market or the economy. At June 30, 1998, 6
approximately $44.2 million, or 94.7 %, of the Savings Bank's multi-family loans and approximately $31.8 million, or 74.5%, of the Savings Bank's commercial real estate loans were secured by properties located in Riverside or San Bernardino County. The decline in real estate values in the early years of this decade were more pronounced with respect to multifamily and commercial real estate. Even though the Savings Bank's multi-family and commercial real estate loans are considered by Management to be seasoned, and there has been an improvement in the market, there can be no assurance that the current market value of the properties securing these loans equals or exceeds the outstanding loan balance. The Savings Bank seeks to minimize the risks posed by multi-family and commercial real estate lending by originating such loans on a selective basis. At June 30, 1998, the Savings Bank had no multi-family real estate loans and one commercial real estate loan with a balance of $422,000 that were 60 to 89 days past due. There were no multi-family real estate loans or commercial real estate loans that were delinquent 90 days or more. See also "REGULATION -- Federal Regulation of Savings Associations -- Loans to One Borrower." CONSTRUCTION LENDING. The Savings Bank also originates residential construction loans to individuals to build owner-occupied single family homes. At June 30, 1998, the Savings Bank's construction loan portfolio totaled $13.7 million, or 2.2% of total loans receivable. Occasionally, the Savings Bank makes loans to builders for the construction of small subdivisions. Typically, the Savings Bank requires a specific number of presales prior to the commencement of building in an individual phase of the planned development. With the increased demand for new housing, the Savings Bank is actively seeking construction loans for single family subdivisions. Individual residential construction loans that are not made in conjunction with the granting of permanent financing of the property are for terms of up to 12 months. Construction lending is generally considered to involve a higher level of risk as compared to one- to four-family residential lending because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated 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 value proves to be inaccurate, the Savings Bank may be confronted at, or prior to, the maturity of the loan, with a project the value of which is insufficient to assure full repayment. CONSUMER AND OTHER LENDING. The Savings Bank originates a variety of consumer loans, including secured second mortgage loans, loans secured by deposit accounts and unsecured loans. Consumer and other lending has traditionally been a small part of the Savings Bank's business. At June 30, 1998, the Savings Bank had $20.2 million, or 3.2% of its total loans receivable in outstanding consumer and other loans. COMMERCIAL BUSINESS LENDING. The Savings Bank has created a business banking department in order to diversify its credit risk and increase the average yield and re-pricing speed of its interest-earning assets. As of June 30, 1998, commercial loans totaled $2.8 million, or 0.45% of total loans. These loans represent unsecured lines of credit and term loans secured by business property. The Savings Bank is actively seeking to expand its business banking activities. MORTGAGE BANKING ACTIVITIES GENERAL. Mortgage banking involves the origination and sale of mortgage loans for the purpose of generating income on the sale of loans and fee income. The Savings Bank limits its mortgage banking lending activities to mortgage loans on one- to four-family properties. Mortgage banking generates income primarily from the sale of loans (which may be sold either servicing- retained or servicing-released) and from servicing fees from loans sold on a servicing-retained basis. Given current pricing in the mortgage markets, the Savings Bank generally sells all of its loans on a servicing-released basis to cover the cost of loan origination. Mortgage banking also generates income from origination and loan fees. Generally, the level of loan sale activity and, therefore, its contribution to the Savings Bank's profitability depends on maintaining a sufficient volume of loan originations. Changes in the level of interest rates and the local economy affect the amount of loans originated by the Savings Bank and, thus, the amount of loan sales as well as origination and loan fees earned. LOAN SOLICITATION AND PROCESSING. The Savings Bank's mortgage banking operations combine both wholesale and retail loan origination. The Savings Bank's wholesale loan production operation utilizes a network of 7
approximately 400 loan correspondents approved by the Savings Bank who originate and submit loans at a mark-up over the Savings Bank's daily published price. During the years ended June 30, 1998 and 1997, wholesale loan originations accounted for 60.7% and 58.6%, respectively, of loans originated for sale. The Savings Bank maintains a regional wholesale lending office in Rancho Cucamonga, California. The Savings Bank's retail loan production operations, which are organized in the Profed Mortgage division of the Savings Bank, utilize loan officers and processors employed by the Savings Bank. The Savings Bank's loan agents generate retail loan originations through referrals from realtors, builders and customers. As of June 30, 1998, Profed Mortgage operated three offices within Savings Bank facilities and seven free standing loan production offices located in Lake Forest, Rancho Cucamonga, Redlands, Riverside, Santa Ana and Torrence in Southern California; and in Las Vegas, Nevada. Normally, the cost of originations from retail operations exceeds the cost of wholesale operations due to the burden of additional employees and greater overhead costs. However, the revenue per mortgage for retail originations is generally higher since a portion of the origination fee mark-up is retained by the Savings Bank. Because wholesale loan production tends to decrease more dramatically than retail loan production during periods of higher interest rates, the Savings Bank is seeking to originate a greater proportion of its loans through its retail operations. Further, the Savings Bank believes that it is better able to attract repeat business and to cross-sell other banking services to borrowers generated from its retail loan production operations. The Savings Bank requires evidence of marketable title and lien position from title insurance and appraisals on all properties. The Savings Bank also requires evidence of fire and casualty insurance insuring the value of improvements. As required by federal regulations, the Savings Bank also requires flood insurance to protect the property securing its interest if such property is located in a designated flood area. LOAN COMMITMENTS AND RATE LOCKS. The Savings Bank issues commitments for residential mortgage loans conditioned upon the occurrence of certain events. Such commitments are made in writing on specified terms and conditions. Interest rate lock-ins are offered to prospective borrowers for up to a 60 day period. The borrower may lock in the rate at any time from application until the time they wish to close the loan. Occasionally, borrowers obtaining financing on new home developments are offered rate lock-ins up to 120 days from application. The Savings Bank had outstanding commitments to originate loans totaling $45.0 million at June 30, 1998. See Note 15 of Notes to Consolidated Financial Statements contained in Item 8 hereof. When the Savings Bank commits to a borrower to lock in an interest rate there is the risk to the Savings Bank that a rise in market interest rates will reduce the value of the mortgage before it can be closed and sold. To control the interest rate risk caused by mortgage banking activities, the Savings Bank uses forward sales agreements and over-the-counter put options related to mortgage-backed securities. See "-- Mortgage Banking Activities -- Hedging Activities." LOAN ORIGINATION AND OTHER FEES. The Savings Bank generally receives origination points and loan fees. Origination points are a percentage of the principal amount of the mortgage loan which are charged to the borrower for funding the loan. The amount of points charged by the Savings Bank is generally 1% to 2%. Current accounting standards require points and fees received (net of certain loan origination costs) for originating loans to be deferred and amortized into interest income over the contractual life of the loan. Net deferred fees or costs associated with loans that are prepaid or sold are recognized as income at the time of prepayment or sale. The Savings Bank had ($298,000) of net deferred mortgage loan fees at June 30, 1998. LOAN ORIGINATIONS, SALES AND PURCHASES. The Savings Bank's mortgage originations include loans insured by the FHA and VA, as well as conventional loans. Except for loans originated for the Savings Bank's portfolio, loans originated through the mortgage banking operations are originated for eventual sale into the secondary market. As such, these loans must meet the origination and underwriting criteria established by the final investors. The Savings Bank sells a large percentage of the mortgage loans that it originates as whole loans to private investors. The Savings Bank also sells conventional whole loans to FNMA and FHLMC through their purchase programs, as well as pooling loans in exchange for mortgage-backed securities guaranteed by FNMA or FHLMC. These securities are then sold through various Wall Street investment firms. In connection with such exchanges, the Savings Bank pays fees to either FNMA or FHLMC who in return guarantee the payment of scheduled principal and interest to security holders. It is the guarantee that enables the Savings Bank to efficiently 8
deliver loans into the secondary market. Conventional mortgage loans originated by the Savings Bank that do not meet FNMA or FHLMC guidelines may be sold to private institutional investors. See "-- Mortgage Banking Activities -- Hedging Activities." The following table shows the Savings Bank's loan originations, repurchases, sales and principal repayments during the periods indicated. Year Ended June 30, ---------------------------- 1998 1997 1996 ----- ----- ---- (In Thousands) Loans originated for sale: Retail originations................. $183,702 $129,740 $163,411 Wholesale originations.............. 283,744 183,642 305,756 -------- -------- -------- Total loans originated for sale.............. 467,446 313,382 469,167 -------- -------- -------- Loans sold(1): Servicing released................... 424,246 341,471 437,917 Servicing retained................... 428 1,539 16,127 -------- -------- -------- Total loans sold................... 424,674 343,010 454,044 -------- -------- -------- Loans originated for portfolio: Mortgage loans: One- to four-family ................ 195,287 112,310 39,182 Multi-family........................ 2,644 916 4,631 Commercial.......................... 370 1,562 -- Construction........................ 13,786 5,240 90 Consumer loans....................... 10,760 6,160 3,634 Commercial business loans ........... 4,179 2,008 -- Other loans.......................... 333 123 197 -------- -------- -------- Total loans originated for portfolio......................... 227,359 128,428 47,734 -------- -------- -------- Loans purchased: Mortgage loans: One- to four-family................. 20,065 2,737 1,176 Mortgage loan principal repayments.......................... 146,234 60,973 66,379 Real estate acquired in settlement of loans................. 6,932 7,094 3,967 Increase (decrease) in other items, net(2)....................... 13,215 1,105 2,838 -------- -------- -------- Net increase (decrease) in loans receivable, net..................... $150,245 $ 34,575 $ (3,475) ======== ======== ======== (1) Includes loans swapped for mortgage-backed securities. (2) Includes net changes in loans in process, discounts on loans and loss reserves. 9
Mortgage loans sold to FHLMC and FNMA are sold on a non-recourse basis whereby foreclosure losses are generally the responsibility of the purchasing agency and not the Savings Bank, except in the case of VA loans used to form Government National Mortgage Association ("GNMA") pools, which are subject to limitations on the VA's loan guarantees. Mortgage loans sold to private investors generally have a limited recourse arrangement varying from three to 12 months after the loan is sold. Occasionally, the Savings Bank is required to repurchase loans sold to FHLMC, FNMA or private investors if it is determined that such loans do not meet the credit requirements of the investor, or if one of the parties involved in a loan committed fraud. Such loans must be repurchased even though they may be performing. During the years ended June 30, 1998, 1997, and 1996, the Savings Bank repurchased single-family mortgage loans, totaling $3.1 million, $2.7 million, and $1.2 million, respectively. The continued increase in 1998 and 1997 repurchases was largely due to the expansion of FHA/VA mortgage loan production during those years. LOAN SERVICING. The Savings Bank receives fees from a variety of institutional mortgage owners in return for performing the traditional services of collecting individual payments. At June 30, 1998, the Savings Bank was servicing $434.7 million of loans for others. The Savings Bank's loan servicing portfolio has decreased in recent years primarily because the Savings Bank has sold a larger portion of its loans on a servicing-released basis. So long as the Savings Bank continues to sell most mortgage loans with servicing released, the size of the mortgage servicing portfolio is expected to decrease. 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. When the Savings Bank receives the gross mortgage payment from individual borrowers, it remits to the investor in the mortgage a predetermined net amount based on the yield on that mortgage. HEDGING ACTIVITIES. Mortgage banking involves the risk that a rise in market interest rates will reduce the value of a mortgage before it can be sold. This type of risk often occurs when the Savings Bank commits to a borrower to lock in an interest rate during the origination process and market interest rates increase before the mortgage can be closed and sold. Such interest rate risk also arises when mortgages are placed in the warehouse (i.e., held for sale) without locking in an interest rate for their eventual sale in the secondary market. The Savings Bank seeks to control or limit the interest rate risk caused by mortgage banking activities. The two methods used by the Savings Bank to help reduce interest rate risk from its mortgage banking activities are forward sales agreements and purchases of over-the- counter put options related to mortgage-backed securities. At various times, depending on management's assessment of interest rate movements and other economic conditions, the Savings Bank may reduce or increase its hedging positions. Under forward sales agreements, usually with FNMA, FHLMC or private investors, the Savings Bank is obligated to sell certain dollar amounts of mortgage loans that meet certain underwriting and legal criteria under specific terms before the expiration of the commitment period. These terms include the minimum maturity of loans, the yield to the purchaser, the servicing spread to the Savings Bank (if servicing is retained) and the maximum principal amount of the individual loans. Forward sales of mortgages in the pipeline protect the price of currently processed loans from interest rate fluctuations that may occur from the time the interest rate of the loan is fixed to the time of the sale. The amount of and delivery date of the forward sales commitments is based upon management's estimates as to the volume of loans that will close and the length of the origination commitment. Forward sales do not provide complete interest-rate protection, however, because of the possibility of fallout (i.e., the failure to close) during the origination process. Differences between volume and timing of actual loan originations and management's estimates can expose the Savings Bank to significant losses. If the Savings Bank is not able to deliver the mortgage loans during the appropriate delivery period, the Savings Bank may be required to pay a non-delivery fee or repurchase the delivery commitments at current market prices. Similarly, if the Savings Bank has too many loans to deliver, the Savings Bank must sell additional cash forward commitments at current market prices. Generally, the Savings Bank seeks to maintain forward sales agreements equal to the closed loans held in inventory plus a portion of the loans the Savings Bank has rate locked and/or committed to close where the interest rate is fixed and which are projected to close. The ultimate accuracy of such projections will directly bear upon the amount of interest rate risk incurred by the Savings Bank. To the extent that this strategy is not effective, the Savings Bank could have mark-to-market losses in its loans held for sale portfolio. For the year ended June 30, 1998, the Savings Bank had gains of $4.5 million attributable to sales of loans, which included hedging gains or 10
losses. At June 30, 1998, the Savings Bank had outstanding commitments to sell loans totaling $66.0 million. See Note 15 of the Notes to Consolidated Financial Statements. In order to reduce the interest rate risk associated with commitments to originate loans that are in excess of forward sales commitments, the Savings Bank purchases over-the-counter options on treasury bonds and/or mortgage- backed securities. At June 30, 1998, the Savings Bank had two option contracts outstanding with a notional value of $3,000,000. The above activities are managed continually as markets change, however, there can be no assurance that the Savings Bank will be successful in its effort to eliminate the risk of interest rate fluctuation between the time origination commitments are issued and the ultimate sale of the loan. The Savings Bank employs a risk management firm to analyze daily and report the Savings Bank's interest rate risk position with respect to its loan origination and sale activities and to advise the Savings Bank on interest rate movements and interest rate risk management strategies. The Savings Bank's hedging activities are conducted in accordance with a Board approved written policy that covers objectives, functions, instruments to be used, monitoring and internal controls. The Savings Bank does not enter into option positions for trading or speculative purposes and does not enter into options that could generate a financial obligation beyond the initial premium. DELINQUENCIES AND CLASSIFIED ASSETS DELINQUENT LOANS. When a mortgage loan borrower fails to make a required payment when due, the Savings Bank institutes collection procedures. If the Savings Bank is unsuccessful at curing a delinquency, a property inspection is performed between the 45th day and 60th day of delinquency. In most cases, delinquencies are cured promptly; however, if by the 90th day of delinquency, or sooner if the borrower is chronically delinquent, and all reasonable means of obtaining payment on time have exhausted, foreclosure, according to the terms of the security instrument and applicable law, is initiated. Interest income on loans is reduced by the full amount of accrued and uncollected interest. The Board of Directors receives monthly information as to the number and amount of all mortgage loans that are delinquent more than 30 days, the number and amount on all loans currently in foreclosure, and the status of all foreclosed and repossessed property owned by the Savings Bank. 11
<TABLE> The following table sets forth delinquencies in the Savings Bank's loan portfolio as of the dates indicated. At June 30, -------------------------------------------------------------------------------------- 1998 1997 1996 --------------------------- ----------------------------- ---------------------------- 90 90 90 60 - 89 Days Days or More 60 - 90 Days Days or More 60 - 89 Days Days or More ------------- ------------- -------------- -------------- -------------- ------------- Prin- Prin- Prin- Prin- Prin- Prin- cipal cipal cipal cipal cipal cipal Bal- Bal- Bal- Bal- Bal- Bal- Number ance Number ance Number ance Number ance Number ance Number ance of of of of of of of of of of of of Loans Loans Loans Loans Loans Loans Loans Loans Loans Loans Loans Loans ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Mortgage loans: One-to-four -family ...... 1 $176 14 $1,700 6 $918 30 $3,227 5 $763 18 $2,874 Multifamily.... -- -- -- -- -- -- 2 1,725 -- -- 2 387 Commercial..... 1 422 -- -- 1 465 2 960 -- -- -- -- Construction... -- -- -- -- -- -- -- -- -- -- -- -- Commercial Business Loans... -- -- -- -- -- -- -- -- -- -- -- -- Consumer loans... 1 2 2 35 1 14 7 201 3 66 4 30 Other loans...... -- - -- -- -- - -- -- -- -- -- -- -- ---- -- ------ -- ------ -- ------ -- ---- -- ------ Total........ 3 $600 16 $1,735 8 $1,397 41 $6,113 8 $829 24 $3,291 = ==== == ====== = ====== == ====== = ==== == ====== 12 </TABLE>
The following table sets forth information with respect to the Savings Bank's nonperforming assets and restructured loans within the meaning of SFAS No. 15 at the dates indicated (dollars in thousands). At June 30, --------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Loans accounted for on a non-accrual basis: Mortgage loans: One-to four-family.......... $1,669 $3,667 $3,511 $1,137 $1,616 Multi-family................ -- 1,176 798 142 2,039 Commercial.................. 245 979(1) -- 1,279 864 Consumer loans............... 18 150 108 -- 6 ------ ------ ------ ------ ------ Total...................... 1,932 5,972 4,417 2,558 4,525 ------ ------ ------ ------ ------ Accruing loans which are contractually past due 90 days or more: One- to four-family.......... -- 268 -- -- -- Consumer..................... -- 9 -- -- 1 ------ ------ ------ ------ ------ Total...................... -- 277 -- -- 1 ------ ------ ------ ------ ------ Total nonaccrual and 90 days or more past due loans.............. 1,932 6,249 4,417 2,558 4,526 Foreclosed real estate, net.. 4,447 2,636 2,711 6,784 4,117 ------ ------ ------ ------ ------ Total nonperforming assets... $6,379 $8,885 $7,128 $9,342 $8,643 ====== ====== ====== ====== ====== Restructured loans........... $2,074 $4,910 $4,905 $3,272 $4,015 ====== ====== ====== ====== ====== Nonaccrual and 90 days or more past due loans as a percentage of loans receivable, net...... 0.31% 1.21% 0.98% 0.54% 1.08% Nonaccrual and 90 days or more past due loans as a percentage of total assets............... 0.24 1.02 0.76 0.45 0.78 Nonperforming assets as a percentage of total assets.... 0.78 1.44 1.22 1.65 1.49 - -------------- (1) Includes two restructured loans totaling $835. The Savings Bank assesses loans individually and identifies impairment when the accrual of interest has been discontinued, loans have been restructured or management has serious doubts about the future collectibility of principal and interest, even though the loans are currently performing. Factors considered in determining impairment include, but are not limited to, expected future cash flows, the financial condition of the borrower and current economic conditions. The Savings Bank measures each impaired loan based on the fair value of its collateral and charges off those loans or portions of loans deemed uncollectible. Interest income, which would have been recorded for the year ended June 30, 1998 had nonaccruing loans been current in accordance with their original terms, amounted to approximately $899. The amount of interest 13
included in the results of operations on such loans for the year ended June 30, 1998 amounted to approximately $574. Interest income foregone on restructured loans for such periods was not material. FORECLOSED AND INVESTMENT REAL ESTATE. Real estate acquired by the Savings Bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as foreclosed real estate until it is sold. When property is acquired it is recorded at the lower of its cost, which is the unpaid principal balance of the related loan plus foreclosure costs, or market value less cost of sale. Subsequent declines in value are charged to operations. At June 30, 1998, the Savings Bank had $4.4 million, net of allowance for losses of $462,000. Due primarily to continued depressed market conditions for multi-family and commercial properties in Southern California, the Savings Bank established provisions of $326,000 for losses on foreclosed real estate during the year ended June 30, 1998. At June 30, 1998, the Savings Bank's foreclosed real estate was comprised of 21 properties. Investment real estate is carried at the lower of cost or fair market value. All costs of anticipated disposition are considered in the determination of fair value. The Savings Bank had $2.5 million of investment real estate, net of reserves at June 30, 1998, all of which was held by a wholly owned subsidiary. ASSET CLASSIFICATION. The OTS has adopted various regulations regarding problem assets of savings institutions. The regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, OTS examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset, classified as a loss, is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified as loss, the insured institution establishes specific allowances for loan losses for the full amount of the portion of the asset classified as loss. All or a portion of general loan loss allowances established to cover possible losses related to assets classified substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated as special mention and monitored by the Savings Bank. The aggregate amounts of the Savings Bank's classified assets, including assets designated as special mention, were as follows at the dates indicated (dollars in thousands): At June 30, ------------------- 1998 1997 ---- ---- Doubtful.............. $ -- $ -- Substandard assets.... 11,398 13,062 Special mention....... 1,627 489 ------- ------- Total........... $13,025 $13,551 ======= ======= Total classified assets as of percentage total assets............... 1.60% 2.20% 14
As set forth below, as of June 30, 1998, assets classified as substandard and special mention included 56 loans and properties totaling approximately $13.0 million. Number of Special Type of Loan/Property Loans Substandard Mention Total - --------------------- ----- ----------- ------- ----- (Dollars in Thousands) One- to four-family.... 39 $ 2,900 $ 265 $ 3,165 Multi-family........... 2 550 570 1,120 Commercial real estate. 3 3,501 318 3,819 Construction........... 1 -- 475 475 Real estate owned...... 11 4,447 -- 4,447 --- ------- ------ ------ Total.............. 56 $11,398 $1,627 $13,025 == ======= ====== ======= Not all of the Savings Bank's classified assets are delinquent or non-performing. In determining whether the Savings Bank's assets expose the Savings Bank to sufficient risk to warrant classification the Savings Bank may consider various factors, including the payment history of the borrower, the loan-to-value ratio, and the debt coverage ratio of the property securing the loan. Upon consideration of these factors, the Savings Bank may determine that the asset in question, though not currently delinquent, presents a risk of loss that requires it to be classified or designated as special mention. In addition, the Savings Bank's loan portfolio includes commercial and multi-family real estate loans with a balance exceeding the current market value of the collateral that are not classified because they are performing and have borrowers who have sufficient resources to support the payment of the loan. ALLOWANCE FOR LOAN LOSSES. The Savings Bank has established a methodology for the determination of provisions for loan losses. The methodology is set forth in a formal policy and takes into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual loans. In originating loans, the Savings Bank recognizes that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the collateral securing the loan. The Savings Bank increases its allowance for loan losses by charging provisions for loan losses against the Savings Bank's operations. The general valuation allowance is maintained to cover losses inherent in the portfolio of performing loans. Management reviews the adequacy of the allowance at least quarterly based on an evaluation of the portfolio, past experience, prevailing market conditions and other relevant factors. Specific valuation allowances are established to absorb losses on loans for which full collectibility may not be reasonably assured. The amount of the allowance is based on the estimated value of the collateral securing the loan and other analyses pertinent to each situation. Generally, a provision for losses is charged against operations on a monthly basis as necessary to maintain the allowances at appropriate levels. At June 30, 1998, the Savings Bank had an allowance for loan losses of $6.2 million. Management believes that the amount maintained in the allowance will be adequate to absorb losses inherent in the portfolio. Although management believes that it uses the best information available to make such determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly and adversely affected if circumstances differ substantially from the assumptions used in making the determinations. As a result of past decreases in local and regional real estate values and the significant losses experienced by many financial institutions, there has been a greater level of scrutiny by regulatory authorities of the loan portfolios of financial institutions undertaken as a part of the examinations of such institutions by banking regulators. While the Savings Bank believes it has established its existing allowance for loan losses in accordance with GAAP, there can be no assurance that regulators, in reviewing the Savings Bank's loan portfolio, will not request the Savings 15
Bank to increase significantly its allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect the Savings Bank's financial condition and results of operations. The following table sets forth an analysis of the Savings Bank's allowance for loan losses for the periods indicated. Where specific loan loss reserves have been established, any differences between the loss allowances and the amount of loss realized has been charged or credited to current operations (dollars in thousands). Year Ended June 30, -------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Balance at beginning of period.................... $5,465 $5,452 $5,085 $3,332 $3,286 Recoveries: Mortgage loans: One- to four-family....... 11 11 16 97 53 Multi-family.............. 191 60 258 145 62 Commercial................ 173 38 315 177 4 Consumer.................. 29 -- -- -- -- Other loans............... -- 27 -- 40 -- ------ ------ ------ ------ ------ Total recoveries........ 404 136 589 459 119 ------ ------ ------ ------ ------ Charge-offs: Mortgage loans: One- to four-family..... 187 457 214 772 438 Multi-family............ 2 609 934 1,589 1,112 Commercial.............. 580 309 1,335 1,101 540 Consumer loans.......... 114 -- -- 17 3 Other loans............. -- 2 -- 14 13 ------ ------ ------ ------ ------ Total charge-offs..... 883 1,377 2,483 3,493 2,106 ------ ------ ------ ------ ------ Net loan charge-offs 479 1,241 1,894 3,034 1,987 (recoveries)............. Provision for loan losses 1,200 1,254 2,261 4,787 2,033 ------ ------ ------ ------ ------ Balance at end of period. $6,186 $5,465 $5,452 $5,085 $3,332 ====== ====== ====== ====== ====== Allowance for loan losses as a percentage of gross loans receivable............... 0.98% 1.04% 1.18% 1.06% 0.78% Net loan charge-offs (recoveries) as a percentage of average loans outstanding during the period........ 0.10 0.25 0.38 0.62 0.39 Allowance for loan losses as a percentage of nonperforming loans at end of period... 320.19 87.45 123.42 198.79 73.62 16
<TABLE> The following table sets forth the breakdown of the allowance for loan losses by loan category for the periods indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any other category. At June 30, -------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 --------------- ---------------- ---------------- --------------- -------------- % of in % of in % of in % of in % of in Each Each Each Each Each Cate- Cate- Cate- Cate- Cate- gory gory gory gory gory To To To To To Total Total Total Total Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Mortgage loans: One- to four-family. $ 972 80.08% $ 863 76.40% $ 930 70.77% $ 661 71.59% $ 470 64.94 Multi-family........ 854 7.36 935 9.98 1,532 11.76 1,030 11.11 1,140 14.88 Commercial.......... 1,334 6.74 1,542 9.09 2,848 11.84 2,587 12.76 1,271 14.87 Construction........ 20 2.17 7 1.10 28 2.21 13 1.23 25 1.01 Consumer loans........ 147 3.13 114 3.18 112 3.35 108 3.28 126 4.25 Commercial business loans................ -- 0.45 -- 0.19 -- -- -- -- -- -- Other loans........... 3 0.07 2 0.06 2 0.07 1 0.03 2 0.05 Unallocated........... 2,856 N/A 2,002 N/A -- N/A 685 N/A 298 N/A ------- ------ ------- ------ ------ ------ ------ ------ ------ ------ Total allowance for loan losses........ $ 6,186 100.00% $15,465 100.00% $5,452 100.00% $5,085 100.00% $3,332 100.00% ======= ====== ======= ====== ====== ====== ====== ====== ====== ====== 17 </TABLE>
INVESTMENT ACTIVITIES Federally chartered savings institutions are permitted under federal and state laws to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, deposits at the FHLB, certificates of deposit of federally insured institutions, certain bankers' acceptances and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest a portion of their assets in commercial paper and corporate debt securities. Savings institutions like the Savings Bank are also required to maintain an investment in FHLB stock. In addition, the Savings Bank is required to maintain minimum levels of investments that qualify as liquid assets under OTS regulations. See "REGULATION" and "Liquidity and Capital Resources" in Item 7 of this Report. At June 30, 1998, the Savings Bank's regulatory liquidity was 12.83%, which is in excess of the 4.0% required by OTS regulations. The investment policy of the Savings Bank, established by the Board of Directors and implemented by the Savings Bank's asset/liability committee, seeks to provide and maintain adequate liquidity, complement the Savings Bank's lending activities, and generate a favorable return on investments without incurring undue interest and credit risk. The Savings Bank's policies, which are more restrictive than OTS regulations allow, generally limit investments to U.S. Government and agency securities, federal funds, U.S. Government sponsored agency issued mortgage-backed securities, bankers' acceptances and commercial paper. Bankers' acceptances must be issued by insured institutions, be eligible for rediscount at the Federal Reserve Bank and be rated in one of the two highest categories by a nationally recognized investment rating firm. Commercial paper issuers must be rated in one of the two highest categories by two nationally recognized investment rating firms. Investments are made based on certain considerations, which include the interest rate, yield, settlement date and maturity of the investment, the Savings Bank's liquidity position, and anticipated cash needs and sources (which in turn include outstanding commitments, upcoming maturities, estimated deposits and anticipated loan amortization and repayments). The effect that the proposed investment would have on the Savings Bank's risk-based capital is also considered during the evaluation. At June 30, 1998, the Corporation's investment securities portfolio totaled $74.0 million at amortized cost and consisted of U.S. Government and federal agency obligations. Only the Corporation's FNMA, FHLMC and REIT investments were available for sale, all other securities were classified as held to maturity. 18
<TABLE> The following table sets forth the composition of the Savings Bank's investment portfolio at the dates indicated. At June 30, -------------------------------------------------------------------------------- 1998 1997 1996 --------------------------- ------------------------- ------------------------- Esti- Esti- Esti- Amor- mated Amor- mated Amor- mated tized Market tized Market tized Market Cost Value Percent Cost Value Percent Cost Value Percent ---- ----- ------- ---- ----- ------- ---- ----- ------- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Investment securities available for sale(1) $ 521 $ 1,526 0.70% $ 21 $ 761 0.06% $ 21 $ - 0.08% Investment securities held to maturity U.S. Government and agency obligations.. 73,975 73,884 99.23 32,555 32,570 96.70 $24,973 24,977 92.02 Corporate securities (2)................. -- -- -- 998 1,000 2.97 2,000 1,992 7.37 Other(3)............. 53 64 .07 92 94 .27 145 143 0.53 ------- ------- ------ ------- ------- ------ ------- ------- ------ Total investment portfolio......... $74,549 $75,474 100.00% $33,666 $34,425 100.00% $27,139 $27,112 100.00% ======= ======= ====== ======= ======= ====== ======= ======= ====== - --------------------- (1) Consists of FHLMC, FNMA and REIT stock (2) Consists of bankers' acceptances (3) Consists of mortgage-backed securities. </TABLE> <TABLE> The following table sets forth the maturities and weighted average yields of the debt securities in the Savings Bank's securities portfolio at June 30, 1998. Due in Due Due One Year After One to After or Less Five Years Five Years Total --------------- --------------- ---------------- ---------------- Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------ ----- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> U.S. Government and federal agency obligations.......... $11,003 5.75% $20,977 6.67% $41,995 6.50% $73,975 6.43% Other........................ 00 0.00 -- -- 53 8.43% 53 8.43 ------- ---- ------- ---- ------- ---- ------- ---- Total ....................... $11,003 5.75% $20,977 6.67% $42,048 6.50% $74,028 6.44% ======= ======= ======= ======= </TABLE>
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS GENERAL. Deposits, loan repayments and the proceeds from loan sales are the major sources of the Savings Bank's funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and money market conditions. Loan sales are also influenced significantly by general interest rates. Borrowings through the FHLB-San Francisco and repurchase agreements may also be used on a short-term basis to compensate for reductions in the availability of funds from other sources. Presently, the Savings Bank has no other borrowing arrangements. 19
DEPOSIT ACCOUNTS. Substantially all of the Savings Bank's depositors are residents of the State of California. Deposits are attracted from within the Savings Bank's market area through the offering of a broad selection of deposit instruments, including checking accounts, money market deposit accounts, regular savings accounts and certificates of deposit. Deposit account terms vary, according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the Savings Bank considers current market interest rates, profitability to the Savings Bank, matching deposit and loan products and its customer preferences and concerns. Generally, the Savings Bank's deposit rates are close to the median rates of its peer group of competitors. The Savings Bank may occasionally pay above- market interest rates to attract and/or retain deposits when less expensive sources of funds are not available. The Savings Bank may also pay above-market rates in specific markets in order to increase the deposit base of a particular office or group of offices. The Savings Bank does not generally accept brokered deposits. The Savings Bank reviews its deposit mix and pricing weekly. The Savings Bank currently offers certificates of deposit for terms not exceeding 60 months. As illustrated in the following table, certificates of deposit accounted for 68.6% of the Savings Bank's deposit portfolio at June 30, 1998. The Savings Bank intends to attempt to reduce the overall cost of its deposit portfolio by increasing its consumer checking account base and by expanding into business banking. See, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" in Item 7 of this Report. The following table sets forth information concerning the Savings Bank's time deposits and other interest-bearing deposits at June 30, 1998. Weighted Per- Average centage Interest Checking and Minimum of Total Rate Term Savings Deposits Amount Balance Deposits - ---- ---- ---------------- ------ ------- -------- (In Thousands) 2.98 N/A Savings Accounts $10 62,201 10.87 1.57 N/A NOW Accounts -- 45,861 8.02 4.27 N/A Money Market Accounts -- 71,493 12.49 Certificates of Deposit ----------------------- 4.97 18-36 Months Variable CD 1,000 2,825 .49 4.74 90 Days or Less Fixed term, fixed rate 1,000 36,166 6.32 5.36 6-7 Months Fixed-term, fixed rate 1,000 40,983 7.16 5.35 9 Months Fixed-term, fixed rate 1,000 36,516 6.38 5.53 1 Year Fixed-term, fixed rate 1,000 126,237 22.06 5.69 15 Months Fixed-term, fixed rate 1,000 72,905 12.74 5.78 2 Years Fixed-term, fixed rate 1,000 33,892 5.92 5.70 3 Years Fixed-term, fixed rate 1,000 8,239 1.44 5.43 4 Years Fixed-term, fixed rate 1,000 1,917 .34 5.80 5 Years Fixed-term, Compounded Certificate 1,000 31,319 5.47 5.48 Negotiable Jumbo-negotiable rate 100,000 1,504 .26 5.33 Negotiable Mini-jumbo 50,000 199 .04 - ---- -------- ------ 4.76% $572,257 100.00% ======== ====== 20
The following table indicates the amount of the Savings Bank's certificates of deposit in amounts of $100,000 or more by time remaining until maturity as of June 30, 1998. Maturity Period Amount --------------- ------ (In Thousands) Three months or less........... $19,582 Over three through six months.. 17,672 Over six through 12 months..... 32,466 Over 12 months................. 14,497 ------- Total..................... $84,217 ======= DEPOSIT FLOW. The following table sets forth the balances (inclusive of interest credited) and changes in dollar amount of deposits in the various types of accounts offered by the Savings Bank at and between the dates indicated. At June 30, ------------------------------------------------------- 1998 1997 Percent Percent of Increase of Increase Amount Total (Decrease) Amount Total (Decrease) ------ ----- ---------- ------ ----- ---------- Non-interest-bearing. $10,768 1.85% 8,433 $2,335 .46% $721 NOW checking......... 45,862 7.87% 21,815 24,047 4.73% 3,317 Regular savings accounts............. 62,201 10.67% 16,303 45,898 9.02% (6,954) Money market deposit. 71,493 12.26% (14,503) 85,996 16.9% 2,898 Fixed-rate certificates which mature: Within 1 year....... 334,380 57.35% 48,314 286,066 56.23% 35,934 After 1 year, but within 2 years..... 35,910 6.16% (647) 36,557 7.18% (4,102) After 2 years, but within 5 years.... 19,586 3.36% (5,320) 24,906 4.9% (1,702) After 5 years...... -- -- (121) 121 0.02% 9 Other............... 2,825 .48% (8) 2,833 0.56% (736) -------- ------ ------- -------- ------ ------- Total...........$583,025 100.00% $74,266 $508,759 100.00% $29,385 -------- ------ ======= ======== ====== ======= 21
TIME DEPOSITS BY RATES. The following table sets forth the time deposits in the Savings Bank categorized by rates at the dates indicated. At June 30 --------------------------------------- 1998 1997 1996 ----- ----- ---- (In Thousands) Below 3.00% $ 184 $ 164 $ 504 3.00 - 4.49% 7,104 3,333 4,617 4.50 - 5.49% 175,701 119,452 224,224 5.50 - 6.49% 206,938 223,525 79,626 6.50 - 7.49% 2,462 3,657 11,537 Over 7.50% 312 352 573 -------- -------- -------- Total $392,701 $350,483 $321,081 ======== ======== ======== TIME DEPOSITS BY MATURITIES. The following table sets forth the amount and maturities of time deposits at June 30, 1998. Amount Due ---------------------------------------------------- Less Than 1-2 2-3 3-4 After One Year Years Years Years 4 Years Total -------- ----- ----- ----- ------- ----- (In Thousands) Below 3.00%..... 182 2 -- -- -- 184 3.00 - 4.49..... 7,104 -- -- -- -- 7,104 4.50 - 5.49%.... 164,128 7,516 1,978 45 2,034 175,701 5.50 - 6.49%.... 163,773 27,531 1,742 8,974 4,919 206,939 6.50 - 7.49%.... 1,257 1,203 -- -- 3 2,462 Over 7.50%...... 174 5 -- 132 -- 312 -------- ------- ------ ------ ------ -------- Total...... $336,618 $36,257 $3,720 $9,151 $6,956 $392,702 ======== ======= ====== ====== ====== ======== 22
DEPOSIT ACTIVITY. The following table sets forth the deposit activities of the Savings Bank for the periods indicated. Year Ended June 30, ----------------------------- 1998 1997 1996 ---- ---- ---- (In Thousands) Beginning balance........... $508,759 $479,374 $486,585 -------- -------- -------- Net deposits (withdrawals) before interest credited.. 52,020 9,128 (28,350) Interest credited........... 22,246 20,257 21,139 -------- -------- -------- Net increase (decrease) in deposits................... 74,266 29,385 (7,211) -------- -------- -------- Ending balance.............. $583,025 $508,759 $479,374 ======== ======== ======== BORROWINGS. The FHLB-San Francisco functions as a central reserve bank providing credit for savings institutions and certain other member financial institutions. As a member, the Savings Bank is required to own capital stock in the FHLB-San Francisco and is authorized to apply for advances on the security of such stock and certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the U.S. Government) provided certain creditworthiness standards have been met. Advances are made pursuant to several different credit programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. The Savings Bank utilizes advances from the FHLB-San Francisco as an alternative to retail deposits to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB-San Francisco has, from time to time, served as the Savings Bank's primary borrowing source. Advances from the FHLB-San Francisco are typically secured by the Savings Bank's first mortgage loans. At June 30, 1998, the Savings Bank had $132.0 million of borrowings from the FHLB-San Francisco at a weighted average rate of 5.7%. Such borrowings mature between 1998 and 2004. The following tables sets forth certain information regarding borrowings by the Savings Bank at the dates and for the periods indicated: At June 30, ------------------------ 1998 1997 1996 ---- ---- ---- Balance outstanding at end of period: FHLB advances......................... $132,114 $6,828 $8,578 -------- ------ ------ Weighted average rate paid on: FHLB advances.......................... 5.70% 5.82% 6.10% Year Ended June 30 ------------------------ 1998 1997 1996 ---- ---- ---- Maximum amount of borrowings outstanding at any month end: 23 PAGE
FHLB advances......................... $132,114 $8,578 $25,578 Approximate average short-term borrowings outstanding with respect to: FHLB advances......................... 121,500 7,098 $20,354 Approximate average short-term borrowings outstanding with respect to: FHLB advances......................... 5.69% 5.87% 6.16% SUBSIDIARY ACTIVITIES Federal savings associations generally may invest up to 3% of their assets in service corporations, provided that at least one-half of any amount in excess of 1% is used primarily for community, inner-city and community development projects. The Savings Bank's investment in its service corporations did not exceed these limits at June 30, 1998. The Savings Bank has three wholly owned subsidiaries: Profed Mortgage, Inc., Provident Financial Corp. ("Provident Financial") and First Service Corporation ("First Service"). Provident Financial participated in a number of real estate joint ventures in the 1980s, with the last joint ventures entered into in 1989. The final joint venture was concluded with the sale of the remaining land in July 1995. Provident Financial's current activities include: (i) acting as trustee for the Savings Bank's real estate transactions, (ii) engaging in annuity sales and providing brokerage services at branch offices of the Savings Bank, (iii) selling property and life insurance, primarily to Savings Bank customers, and (iv) holding real estate for investment. The real estate held for investment by Provident Financial at June 30, 1998 totaled $2.5 million. Profed Mortgage, Inc., which formerly contained the Savings Bank's mortgage banking activities that are currently conducted by the Savings Bank's Profed Mortgage division, and First Service are currently inactive. At June 30, 1998, the Savings Bank's investment in its subsidiaries was $3.8 million. REGULATION GENERAL The Savings Bank is subject to extensive regulation, examination and supervision by the OTS as its chartering agency, and the FDIC, as the insurer of its deposits. The activities of federal savings institutions are governed by the Home Owners' Loan Act, as amended (the "HOLA") and, in certain respects, the Federal Deposit Insurance Act ("FDIA") and the regulations issued by the OTS and the FDIC to implement these statutes. These laws and regulations delineate the nature and extent of the activities in which federal savings associations may engage. Lending activities and other investments must comply with various statutory and regulatory capital requirements. In addition, the Savings Bank's relationship with its depositors and borrowers is also regulated to a great extent, especially in such matters as the ownership of deposit accounts and the form and content of the Savings Bank's mortgage documents. The Savings Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OTS and the FDIC to review the Savings Bank's compliance with various regulatory requirements. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, 24
whether by the OTS, the FDIC or Congress, could have a material adverse impact on the Corporation, the Savings Bank and their operations. The Corporation, as a savings and loan holding company, is also required to file certain reports with, and otherwise comply with the rules and regulations of, the OTS. FEDERAL REGULATION OF SAVINGS ASSOCIATIONS OFFICE OF THRIFT SUPERVISION. The OTS is an office in the Department of the Treasury subject to the general oversight of the Secretary of the Treasury. The OTS generally possesses the supervisory and regulatory duties and responsibilities formerly vested in the Federal Home Loan Bank Board. Among other functions, the OTS issues and enforces regulations affecting federally insured savings associations and regularly examines these institutions. FEDERAL HOME LOAN BANK SYSTEM. The FHLB System, consisting of 12 FHLBs, is under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The designated duties of the FHFB are to: supervise the FHLBs; ensure that the FHLBs carry out their housing finance mission; ensure that the FHLBs remain adequately capitalized and able to raise funds in the capital markets; and ensure that the FHLBs operate in a safe and sound manner. The Savings Bank, as a member of the FHLB-San Francisco, is required to acquire and hold shares of capital stock in the FHLB-San Francisco in an amount equal to the greater of (i) 1.0% of the aggregate outstanding principal amount of residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or (ii) 1/20 of its advances (borrowings) from the FHLB-San Francisco. The Savings Bank is in compliance with this requirement with an investment in FHLB-San Francisco stock of $6.6 million at June 30, 1998. FEDERAL DEPOSIT INSURANCE CORPORATION. The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of depository institutions. The FDIC currently maintains two separate insurance funds: the BIF and the SAIF. As insurer of deposits, the FDIC has examination, supervisory and enforcement authority over all savings associations. The Savings Bank's accounts are insured by the SAIF to the maximum extent permitted by law. The Savings Bank currently pays deposit insurance premiums to the FDIC based on a risk-based assessment system established by the FDIC. Under applicable regulations, institutions are assigned to one of three capital groups which are based solely on the level of an institution's capital --"well capitalized," "adequately capitalized," and "undercapitalized" - -- which are defined in the same manner as the regulations establishing the prompt corrective action system, as discussed below. These three groups are then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered to be healthy to those which are considered to be of substantial supervisory concern. The matrix so created results in nine assessment risk classifications, with rates that until September 30, 1996 ranged from 0.23% of insured deposits for well capitalized, financially sound institutions with only a few minor weaknesses to 0.31% of insured deposits for undercapitalized institutions that pose a substantial risk of loss to the SAIF unless effective corrective action is taken. Pursuant to the Deposit Insurance Fund ("DIF") Act, which was enacted on September 30, 1996, the FDIC imposed a special assessment on each depository institution with SAIF-assessable deposits which resulted in the SAIF achieving its designated reserve ratio. In connection therewith, the FDIC reduced the assessment schedule for SAIF members, effective January 1, 1997, to a range of 0% to 0.27%, with most institutions, including the Savings Bank, paying 0%. This assessment schedule is the same as that for the BIF, which reached its designated reserve ratio in 1995. In addition, since January 1, 1997, SAIF members are charged an assessment of 0.065% of SAIF-assessable deposits for the purpose of paying interest on the obligations issued by the Financing Corporation ("FICO") in the 1980s to help fund the thrift industry cleanup. BIF-assessable deposits will be charged an assessment to help pay interest on the FICO bonds at a rate of approximately 0.013% until the 25
earlier of December 31, 1999 or the date upon which the last savings association ceases to exist, after which time the assessment will be the same for all insured deposits. The DIF Act provides for the merger of the BIF and the SAIF into the Deposit Insurance Fund on January 1, 1999, but only if no insured depository institution is a savings association on that date. The DIF Act contemplates the development of a common charter for all federally chartered depository institutions and the abolition of separate charters for national banks and federal savings associations. It is not known what form the common charter may take and what effect, if any, the adoption of a new charter would have on the operation of the Savings Bank. The FDIC may terminate the deposit insurance of any insured depository institution if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which could result in termination of the deposit insurance of the Savings Bank. LIQUIDITY REQUIREMENTS. Under OTS regulations, each savings institution is required to maintain an average daily balance of liquid assets (cash, certain time deposits and savings accounts, bankers' acceptances, and specified U.S. Government, state or federal agency obligations and certain other investments) equal to a monthly average of not less than a specified percentage (currently 4.0%) of its net withdrawable accounts plus short-term borrowings. Monetary penalties may be imposed for failure to meet liquidity requirements. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Liquidity and Capital Resources" in Item 7 of this Report. PROMPT CORRECTIVE ACTION. Under the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action. Under the regulations, an institution shall be deemed to be (i) "well capitalized" if it has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-based capital ratio of 6.0% or more, has a leverage ratio of 5.0% or more and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure; (ii) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0% or more and a leverage ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized;" (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a leverage ratio that is less than 4.0% (3.0% under certain circumstances); (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a leverage ratio that is less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. A federal banking agency may, after notice and an opportunity for a hearing, reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category if the institution is in an unsafe or unsound condition or has received in its most recent examination, and has not corrected, a less than satisfactory rating for asset quality, management, earnings or liquidity. (The OTS may not, however, reclassify a significantly undercapitalized institution as critically undercapitalized.) An institution generally must file a written capital restoration plan which meets specified requirements, as well as a performance guaranty by each company that controls the institution, with the appropriate federal banking agency within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly under- capitalized or critically undercapitalized. Immediately upon becoming 26
under-capitalized, an institution shall become subject to various mandatory and discretionary restrictions on its operations. At June 30, 1998, the Savings Bank was categorized as "well capitalized" under the prompt corrective action regulations of the OTS. STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking regulatory agencies have prescribed, by regulation, standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings; and (viii) compensation, fees and benefits ("Guidelines"). The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OTS determines that the Savings Bank fails to meet any standard prescribed by the Guidelines, the agency may require the Savings Bank to submit to the agency an acceptable plan to achieve compliance with the standard. OTS regulations establish deadlines for the submission and review of such safety and soundness compliance plans. QUALIFIED THRIFT LENDER TEST. All savings associations are required to meet a qualified thrift lender ("QTL") test set forth in Section 10(m) of the HOLA and regulations of the OTS thereunder to avoid certain restrictions on their operations. A savings institution that fails to become or remain a QTL shall either become a national bank or be subject to the following restrictions on its operations: (i) the association may not make any new investment or engage in activities that would not be permissible for national banks; (ii) the association may not establish any new branch office where a national bank located in the savings institution's home state would not be able to establish a branch office; (iii) the association shall be ineligible to obtain new advances from any FHLB; and (iv) the payment of dividends by the association shall be subject to the rules regarding the statutory and regulatory dividend restrictions applicable to national banks. Also, beginning three years after the date on which the savings institution ceases to be a QTL, the savings institution would be prohibited from retaining any investment or engaging in any activity not permissible for a national bank and would be required to repay any outstanding advances to any FHLB. In addition, within one year of the date on which a savings association controlled by a company ceases to be a QTL, the company must register as a bank holding company and become subject to the rules applicable to such companies. A savings institution may requalify as a QTL if it thereafter complies with the QTL test. Currently, the QTL test requires that either an institution qualify as a domestic building and loan association under the Internal Revenue Code or that 65% of an institution's "portfolio assets" (as defined) consist of certain housing and consumer-related assets on a monthly average basis in nine out of every 12 months. Assets that qualify without limit for inclusion as part of the 65% requirement are loans made to purchase, refinance, construct, improve or repair domestic residential housing and manufactured housing; home equity loans; mortgage-backed securities (where the mortgages are secured by domestic residential housing or manufactured housing); FHLB stock; direct or indirect obligations of the FDIC; and loans for educational purposes, loans to small business and loans made through credit cards. In addition, the following assets, among others, may be included in meeting the test subject to an overall limit of 20% of the savings institution's portfolio assets: 50% of residential mortgage loans originated and sold within 90 days of origination; 100% of consumer and educational loans (limited to 10% of total portfolio assets); and stock issued by the FHLMC or the FNMA. Portfolio assets consist of total assets minus the sum of (i) goodwill and other intangible assets, (ii) property used by the savings institution to conduct its business, and (iii) liquid assets up to 20% of the institution's total assets. At June 30, 1998, the qualified thrift investments of the Savings Bank were approximately 95.0% of its portfolio assets. CAPITAL REQUIREMENTS. Under OTS regulations a savings association must satisfy three minimum capital requirements: core capital, tangible capital and risk-based capital. Savings associations must meet all of the 27
standards in order to comply with the capital requirements. The Corporation is not subject to any minimum capital requirements. OTS capital regulations establish a 3% core capital or leverage ratio (defined as the ratio of core capital to adjusted total assets). Core capital is defined to include common stockholders' equity, noncumulative perpetual preferred stock and any related surplus, and minority interests in equity accounts of consolidated subsidiaries, less (i) any intangible assets, except for certain qualifying intangible assets; (ii) certain mortgage servicing rights; and (iii) equity and debt investments in subsidiaries that are not "includable subsidiaries," which is defined as subsidiaries engaged solely in activities not impermissible for a national bank, engaged in activities impermissible for a national bank but only as an agent for its customers, or engaged solely in mortgage-banking activities. In calculating adjusted total assets, adjustments are made to total assets to give effect to the exclusion of certain assets from capital and to account appropriately for the investments in and assets of both includable and nonincludable subsidiaries. Institutions that fail to meet the core capital requirement would be required to file with the OTS a capital plan that details the steps they will take to reach compliance. In addition, the OTS's prompt corrective action regulation provides that a savings institution that has a leverage ratio of less than 4% (3% for institutions receiving the highest CAMEL examination rating) will be deemed to be "undercapitalized" and may be subject to certain restrictions. See "-- Federal Regulation of Savings Associations -- Prompt Corrective Action." Savings associations also must maintain "tangible capital" not less than 1.5% of the Savings Bank's adjusted total assets. "Tangible capital" is defined, generally, as core capital minus any "intangible assets" other than purchased mortgage servicing rights. Each savings institution must maintain total risk-based capital equal to at least 8% of risk-weighted assets. Total risk-based capital consists of the sum of core and supplementary capital, provided that supplementary capital cannot exceed core capital, as previously defined. Supplementary capital includes (i) permanent capital instruments such as cumulative perpetual preferred stock, perpetual subordinated debt, and mandatory convertible subordinated debt, (ii) maturing capital instruments such as subordinated debt, intermediate-term preferred stock and mandatory convertible subordinated debt, and (iii) general valuation loan and lease loss allowances up to 1.25% of risk-weighted assets. The risk-based capital regulation assigns each balance sheet asset held by a savings institution to one of four risk categories based on the amount of credit risk associated with that particular class of assets. Assets not included for purposes of calculating capital are not included in calculating risk-weighted assets. The categories range from 0% for cash and securities that are backed by the full faith and credit of the U.S. Government to 100% for repossessed assets or assets more than 90 days past due. Qualifying residential mortgage loans (including multi-family mortgage loans) are assigned a 50% risk weight. Consumer, commercial, home equity and residential construction loans are assigned a 100% risk weight, as are non-qualifying residential mortgage loan sand that portion of land loans and nonresidential construction loans which do not exceed an 80% loan-to-value ratio. The book value of assets in each category is multiplied by the weighing factor (from 0% to 100%) assigned to that category. These products are then totaled to arrive at total risk-weighted assets. Off-balance sheet items are included in risk-weighted assets by converting them to an approximate balance sheet "credit equivalent amount" based on a conversion schedule. These credit equivalent amounts are then assigned to risk categories in the same manner as balance sheet assets and included risk-weighted assets. The OTS has incorporated an interest rate risk component into its regulatory capital rule. Under the rule, savings associations with "above normal" interest rate risk exposure would be subject to a deduction from total capital for purposes of calculating their risk-based capital requirements. A savings association's interest rate risk is measured by the decline in the net portfolio value of its assets (i.e., the difference between incoming and outgoing discounted cash flows from assets, liabilities and off-balance sheet contracts) that would result from a hypothetical 200 basis point increase or decrease in market interest rates divided by the estimated economic value of the association's assets, as calculated in accordance with guidelines set forth by the OTS. A savings association whose measured interest rate risk exposure exceeds 2% must deduct an interest rate risk component in calculating 28
its total capital under the risk-based capital rule. The interest rate risk component is an amount equal to one-half of the difference between the institution's measured interest rate risk and 2%, multiplied by the estimated economic value of the association's assets. That dollar amount is deducted from an association's total capital in calculating compliance with its risk-based capital requirement. Under the rule, there is a two quarter lag between the reporting date of an institution's financial data and the effective date for the new capital requirement based on that data. The rule also provides that the Director of the OTS may waive or defer an association's interest rate risk component on a case-by-case basis. Under certain circumstances, a savings association may request an adjustment to its interest rate risk component if it believes that the OTS-calculated interest rate risk component overstates its interest rate risk exposure. In addition, certain "well-capitalized" institutions may obtain authorization to use their own interest rate risk model to calculate their interest rate risk component in lieu of the OTS-calculated amount. The OTS has postponed the date that the component will first be deducted from an institution's total capital. At June 30, 1998, the Savings Bank's tier I leverage capital of approximately $64.8 million, or 9.3% of average assets, was $30.0 million in excess of the OTS requirement of $34.8 million, or 5.0% of adjusted total assets. As of such date, the Savings Bank's tier I capital of approximately $64.8 million, or 12.9% of risk weighted assets, was $34.7 million in excess of the OTS requirement of $30.1 million, or 6.0% of risk weighted assets. Finally, at June 30, 1998, the Savings Bank had risk-based capital of approximately $70.9 million or 14.1% of total risk-weighted assets, which was $20.7 million in excess of the OTS risk-based capital requirement of $50.2 million or 10% of risk-weighted assets. LIMITATIONS ON CAPITAL DISTRIBUTIONS. OTS regulations impose uniform limitations on the ability of all savings associations to engage in various distributions of capital such as dividends, stock repurchases and cash-out mergers. In addition, OTS regulations require the Savings Bank to give the OTS 30 days' advance notice of any proposed declaration of dividends, and the OTS has the authority under its supervisory powers to prohibit the payment of dividends. The regulation utilizes a three-tiered approach which permits various levels of distributions based primarily upon a savings association's capital level. A Tier 1 savings association has capital in excess of its fully phased-in capital requirement (both before and after the proposed capital distribution). A Tier 1 savings association may make (without application but upon prior notice to, and no objection made by, the OTS) capital distributions during a calendar year up to 100% of its net income to date during the calendar year plus one-half its surplus capital ratio (i.e., the amount of capital in excess of its fully phased-in requirement) at the beginning of the calendar year or the amount authorized for a Tier 2 association. Capital distributions in excess of such amount require advance notice to the OTS. A Tier 2 savings association has capital equal to or in excess of its minimum capital requirement but below its fully phased-in capital requirement (both before and after the proposed capital distribution). Such an association may make (without application) capital distributions up to an amount equal to 75% of its net income during the previous four quarters depending on how close the association is to meeting its fully phased-in capital requirement. Capital distributions exceeding this amount require prior OTS approval. Tier 3 associations are savings associations with capital below the minimum capital requirement (either before or after the proposed capital distribution). Tier 3 associations may not make any capital distributions without prior approval from the OTS. The Savings Bank is currently meeting the criteria to be designated a Tier 1 association and, consequently, could at its option (after prior notice to, and no objection made by, the OTS) distribute up to 100% of its net income during the calendar year plus 50% of its surplus capital ratio at the beginning of the calendar year less any distributions previously paid during the year. LOANS TO ONE BORROWER. Under the HOLA, savings institutions are generally subject to the national bank limit on loans to one borrower. Generally, this limit is 15% of the Savings Bank's unimpaired capital and surplus, plus an additional 10% of unimpaired capital and surplus, if such loan is secured by readily-marketable collateral, which is defined to include certain financial instruments and bullion. The OTS by regulation has amended the loans to one borrower rule to permit savings associations meeting certain requirements, including capital requirements, to extend loans to one borrower in additional amounts under circumstances limited 29
essentially to loans to develop or complete residential housing units. At June 30, 1998, the Savings Bank's limit on loans to one borrower was $11.5 million. At June 30, 1998, the Savings Bank's largest aggregate amount of loans to one borrower was $3.9 million. ACTIVITIES OF THRIFT INSTITUTIONS AND THEIR SUBSIDIARIES. When a savings association establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the association controls, the savings association must notify the FDIC and the OTS 30 days in advance and provide the information each agency may, by regulation, require. Savings associations also must conduct the activities of subsidiaries in accordance with existing regulations and orders. The OTS may determine that the continuation by a savings association of its ownership control of, or its relationship to, the subsidiary constitutes a serious risk to the safety, soundness or stability of the association or is inconsistent with sound banking practices or with the purposes of the FDIA. Based upon that determination, the FDIC or the OTS has the authority to order the savings association to divest itself of control of the subsidiary. The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the SAIF. If so, it may require that no SAIF member engage in that activity directly. TRANSACTIONS WITH AFFILIATES. Savings associations must comply with Sections 23A and 23B of the Federal Reserve Act ("Sections 23A and 23B") relative to transactions with affiliates in the same manner and to the same extent as if the savings association were a Federal Reserve member bank. A savings and loan holding company, its subsidiaries and any other company under common control are considered affiliates of the subsidiary savings association under the HOLA. Generally, Sections 23A and 23B: (i) limit the extent to which the insured association or its subsidiaries may engage in certain covered transactions with an affiliate to an amount equal to 10% of such institution's capital and surplus and place an aggregate limit on all such transactions with affiliates to an amount equal to 20% of such capital and surplus, and (ii) require that all such transactions be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, the purchase of assets, the issuance of a guaranty and similar types of transactions. Three additional rules apply to savings associations: (i) a savings association may not make any loan or other extension of credit to an affiliate unless that affiliate is engaged only in activities permissible for bank holding companies; (ii) a savings association may not purchase or invest in securities issued by an affiliate (other than securities of a subsidiary); and (iii) the OTS may, for reasons of safety and soundness, impose more stringent restrictions on savings associations but may not exempt transactions from or otherwise abridge Section 23A or 23B. Exemptions from Section 23A or 23B may be granted only by the Federal Reserve Board, as is currently the case with respect to all FDIC-insured banks. The Savings Bank has not been significantly affected by the rules regarding transactions with affiliates. The Savings Bank's authority to extend credit to executive officers, directors and 10% shareholders, as well as entities controlled by such persons, is currently governed by Sections 22(g) and 22(h) of the Federal Reserve Act, and Regulation O thereunder. Among other things, these regulations require that such loans be made on terms and conditions substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. Regulation O also places individual and aggregate limits on the amount of loans the Savings Bank may make to such persons based, in part, on the Savings Bank's capital position, and requires certain board approval procedures to be followed. The OTS regulations, with certain minor variances, apply Regulation O to savings institutions. 30
SAVINGS AND LOAN HOLDING COMPANY REGULATION HOLDING COMPANY ACQUISITIONS. The HOLA and OTS regulations issued thereunder generally prohibit a savings and loan holding company, without prior OTS approval, from acquiring more than 5% of the voting stock of any other savings association or savings and loan holding company or controlling the assets thereof. They also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of such holding company, from acquiring control of any savings association not a subsidiary of such savings and loan holding company, unless the acquisition is approved by the OTS. HOLDING COMPANY ACTIVITIES. As a unitary savings and loan holding company, the Corporation generally is not subject to activity restrictions. If the Corporation acquires control of another savings association as a separate subsidiary other than in a supervisory acquisition, it would become a multiple savings and loan holding company. There generally are more restrictions on the activities of a multiple savings and loan holding company than on those of a unitary savings and loan holding company. The HOLA provides that, among other things, no multiple savings and loan holding company or subsidiary thereof which is not an insured association shall commence or continue for more than two years after becoming a multiple savings and loan association holding company or subsidiary thereof, any business activity other than: (i) furnishing or performing management services for a subsidiary insured institution, (ii) conducting an insurance agency or escrow business, (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary insured institution, (iv) holding or managing properties used or occupied by a subsidiary insured institution, (v) acting as trustee under deeds of trust, (vi) those activities previously directly authorized by regulation as of March 5, 1987 to be engaged in by multiple holding companies or (vii) those activities authorized by the Federal Reserve Board as permissible for bank holding companies, unless the OTS by regulation, prohibits or limits such activities for savings and loan holding companies. Those activities described in (vii) above also must be approved by the OTS prior to being engaged in by a multiple holding company. QUALIFIED THRIFT LENDER TEST. The HOLA requires any savings and loan holding company that controls a savings association that fails the QTL test, as explained under "-- Federal Regulation of Savings Associations -- Qualified Thrift Lender Test," must, within one year after the date on which the association ceases to be a QTL, register as and be deemed a bank holding company subject to all applicable laws and regulations. TAXATION FEDERAL TAXATION GENERAL. The Corporation and the Savings Bank report their income on a fiscal year basis using the accrual method of accounting and will be subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Savings Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Savings Bank or the Corporation. TAX BAD DEBT RESERVES. For taxable years beginning prior to January 1, 1996, savings institutions such as the Savings Bank which met certain definitional tests primarily relating to their assets and the nature of their business ("qualifying thrifts") were permitted to establish a reserve for bad debts and to make annual additions thereto, which additions may, within specified formula limits, have been deducted in arriving at their taxable income. The Savings Bank's deduction with respect to "qualifying loans," which are generally loans secured by certain interests in real property, may have been computed using an amount based on the Savings Bank's actual loss experience, or a percentage equal to 8% of the Savings Bank's taxable income, computed with certain modifications and reduced by the amount of any permitted additions to the nonqualifying reserve. The Savings Bank's deduction with respect to nonqualifying loans was computed under the experience method, which essentially allows a deduction based on the Savings Bank's actual loss experience over a period of several years. Each year the Savings Bank selected the most favorable way to calculate the deduction attributable to an addition 31
to the tax bad debt reserve. The Savings Bank used the experience method bad debt deduction for the taxable year ended June 30, 1996. Recently enacted legislation repealed the reserve method of accounting for bad debt reserves for tax years beginning after December 31, 1995. As result, the Savings Bank is no longer able to calculate its deduction for bad debts using the percentage-of-taxable-income method or the experience method. Instead, the Savings Bank will be required to compute its deduction based on specific charge-offs during the taxable year. This legislation also requires savings associations to recapture into taxable income over a six-year period their post-1987 additions to their bad debt tax reserves, thereby generating additional tax liability. As of the effective date of the legislation, the Savings Bank had no post-1987 additions to its bad debt tax reserves. Under prior law, if the Savings Bank failed to satisfy the qualifying thrift definitional tests in any taxable year, it would have been unable to make additions to its bad debt reserve. Instead, the Savings Bank would have been required to deduct bad debts as they occurred and would have additionally been required to recapture its bad debt reserve deductions ratably over a multi-year period. At June 30, 1998, the Savings Bank's total bad debt reserve for tax purposes was approximately $7.7 million. Among other things, the qualifying thrift definitional tests required the Savings Bank to hold at least 60% of its assets as "qualifying assets." Qualifying assets generally include cash, obligations of the United States or any agency or instrumentality thereof, certain obligations of a state or political subdivision thereof, loans secured by interests in improved residential real property or by savings accounts, student loans and property used by the Savings Bank in the conduct of its banking business. Under current law, a savings association will not be required to recapture its pre-1988 bad debt reserves if it ceases to meet the qualifying thrift definitional tests. DISTRIBUTIONS. To the extent that the Savings Bank makes "nondividend distributions" to the Corporation that are considered as made: (i) from the reserve for losses on qualifying real property loans, to the extent the reserve for such losses exceeds the amount that would have been allowed under the experience method; or (ii) from the supplemental reserve for losses on loans ("Excess Distributions"), then an amount based on the amount distributed will be included in the Savings Bank's taxable income. Nondividend distributions include distributions in excess of the Savings Bank's current and accumulated earnings and profits, distributions in redemption of stock, and distributions in partial or complete liquidation. However, dividends paid out of the Savings Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Savings Bank's bad debt reserve. Thus, any dividends to the Corporation that would reduce amounts appropriated to the Savings Bank's bad debt reserve and deducted for federal income tax purposes would create a tax liability for the Savings Bank. The amount of additional taxable income attributable to an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if, after the Conversion, the Savings Bank makes a "nondividend distribution," then approximately one and one-half times the amount so used would be includable in gross income for federal income tax purposes, assuming a 35% corporate income tax rate (exclusive of state and local taxes). See "REGULATION" for limits on the payment of dividends by the Savings Bank. The Savings Bank does not intend to pay dividends that would result in a recapture of any portion of its tax bad debt reserve. CORPORATE ALTERNATIVE MINIMUM TAX. The Code imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. The excess of the tax bad debt reserve deduction using the percentage of taxable income method over the deduction that would have been allowable under the experience method is treated as a preference item for purposes of computing the AMTI. In addition, only 90% of AMTI can be offset by net operating loss carryovers. AMTI is increased by an amount equal to 75% of the amount by which the Savings Bank's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). For taxable years beginning after December 31, 1986, and before January 1, 1996, an environmental tax of .12% of the excess of AMTI (with certain modification) over $2.0 million is imposed on corporations, including the Savings Bank, whether or not an Alternative Minimum Tax ("AMT") is paid. 32
OTHER MATTERS. The IRS is in the process of reviewing activity for the Savings Bank's tax returns for fiscal years 1994, 1995 and 1996. The California Franchise Tax Board through tax year 1990 has audited the Savings Bank. STATE TAXATION CALIFORNIA. The California franchise tax rate applicable to the Savings Bank equals the franchise tax rate applicable to corporations generally, plus an "in lieu" rate of 2%, which is approximately equal to personal property taxes and business license taxes paid by such corporations (but not generally paid by banks or financial corporations such as the Savings Bank). At June 30, 1998, the total tax rate was 10.84%. Bad debt deductions are available in computing California franchise taxes using the specific charge-off method. The Savings Bank and its California subsidiaries file California state franchise tax returns on a combined basis. The Corporation will be treated as a general corporation subject to the general corporate tax rate. DELAWARE. As a Delaware holding company not earning income in Delaware, the Corporation is exempted from Delaware corporate income tax, but is required to file an annual report with and pay an annual franchise tax to the State of Delaware. COMPETITION The Savings Bank faces significant competition in its market area in both originating real estate loans and attracting deposits. The rapid population growth in Riverside County has attracted numerous financial institutions to the Savings Bank's market areas, which resulted in competition that has been exacerbated by the recessionary trends that have prevailed in the Savings Bank's market area in the past several years. The Savings Bank's primary competitors are large regional and super-regional commercial banks as well as other community-oriented banks and savings institutions. The Savings Bank also faces competition from credit unions and a large number of mortgage companies that operate within its market area. Many of these institutions are significantly larger than the Savings Bank and therefore have greater financial and marketing resources than the Savings Bank. The Savings Bank's mortgage banking operations also face strong competition from other mortgage bankers and brokers as well as other financial institutions. Such competition may limit the Savings Bank's growth and profitability in the future. PERSONNEL As of June 30, 1998, the Savings Bank had 263 full-time and 83 part-time employees. The employees are not represented by a collective bargaining unit and the Savings Bank believes its relationship with its employees to be good. YEAR 2000 The company has undertaken a major project to ensure that its internal operating systems, as well as those of its major customers and suppliers, will be fully capable of processing transactions in the Year 2000 and beyond. The initial phase of the project was to assess and identify all internal business processes requiring modification and to develop comprehensive renovation plans as needed. This phase was largely completed in late 1997. The second phase, expected to be accomplished by the end of 1998, was largely completed in late 1997. The second phase, expected to be accomplished by the end of 1998, will be to execute those renovation plans and begin testing systems by simulating Year 2000 data conditions. Testing and implementation is planned to be completed during the first half of 1999. The cost of the project primarily consists of replacement systems and the reallocation of internal resources. The estimated cost of the project is $3.5 million, which includes approximately $2.5 million in replacement equipment and software, $400,000 in equipment write-downs, and $200,000 in outside project management expenses. In addition, the estimated value of internal resources allocated to the Year 2000 project is approximately $400,000. The replacement equipment and software will be capitalized and depreciated in accordance with the Company's normal accounting policies. Beyond the cost described, it is not expected that the Year 2000 project will have any material effect on the Company's results of operations, liquidity or capital resources. The risk of Year 2000 processing problems is not completely known. As a participant in the domestic payment system, the Company's Year 2000 preparedness is largely dependent upon the preparedness of other participants in the system including the United States government. The Company does rely on third-party software vendors. The Company is 33
developing contingency plans for its most critical vendors, as well as its internal systems, in the event of failure in the Year 2000. ITEM 2. PROPERTIES - ------------------ At June 30, 1998, the net book value of the Savings Bank's property (including land and buildings) and its fixtures, furniture and equipment was $7.4 million. The Savings Bank's home office, which is owned by the Savings Bank, is located in Riverside, California. In addition, the Savings Bank has ten branch offices, of which nine are in Riverside County in the cities of Riverside (2), Moreno Valley (3), Hemet, Sun City, Rancho Mirage and Blythe, California and one is in Redlands, California in San Bernardino County. Seven of the Savings Bank's branch offices are owned by the Savings Bank and three are leased. The leases expire in 2000 and 2008. The Savings Bank also has seven separate loan production offices, which are located in Riverside, Rancho Cucamonga, Redlands, Santa Ana, Lake Forest and Torrance, California and Las Vegas, Nevada. All of these offices are leased. The leases expire from 1998 to 2003. ITEM 3. LEGAL PROCEEDINGS - -------------------------- Periodically, there have been various claims and lawsuits involving the Savings Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Savings Bank holds security interests, claims involving the making and servicing of real property loans and other issues in the ordinary course of and incident to the Savings Banks' business. The Savings Bank is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Savings Bank. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------ No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended June 30, 1998. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER - -------------------------------------------------------------------------- MATTERS ------- The information required herein is incorporated by reference from page 39 of the Corporation's Annual Report, which is included herein as Exhibit 13. As of September 15, 1998, there were approximately 1,970 stockholders of record. The Board of Directors of the Corporation has not formulated a dividend policy and does not intend to pay cash dividends in the near future. Future declarations or payments of dividends will be subject to determination by the Corporation's Board of Directors, which will take into account the Corporation's financial condition, results of operations, tax considerations, capital requirements, industry standards, economic conditions and other factors, including the regulatory restrictions which affect the payment of dividends by the Savings Bank to the Corporation. Under Delaware law, dividends may be paid either out of surplus or, if there is no surplus, out of net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. 34
ITEM 6. SELECTED FINANCIAL DATA - -------------------------------- The information required herein is incorporated by reference from pages 4 and 5 of the Corporation's Annual Report. The following table sets forth quarterly financial data. QUARTERLY FINANCIAL DATA (UNAUDITED) 1998 -------------------------------------------- Fourth Third Second First Total Quarter Quarter Quarter Quarter ----- ------- ------- ------- ------- (Dollars in Thousands, Except per share) Interest income............ $50,096 $13,461 $13,004 $12,210 $11,421 Interest expense........... 29,417 8,153 7,628 7,169 6,467 ------- ------- ------- ------- ------- Net interest income........ 20,679 5,308 5,376 5,041 4,954 Noninterest income......... 9,145 2,757 2,010 2,192 2,186 Provision for loan losses.. 1,200 150 300 450 300 Noninterest expense........ 19,899 5,812 4,999 4,773 4,315 ------- ------- ------- ------- ------- Earnings before taxes...... 8,725 2,103 2,087 2,010 2,525 Taxes on income............ 3,705 904 886 857 1,058 ------- ------- ------- ------- ------- Net earnings .............. $ 5,020 $ 1,199 $ 1,201 $ 1,153 1,467 ======= ======= ======= ======= ======= Per common share: Per share earnings, diluted $1.11 $.27 $.27 $.25 $.32 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------------------------------------------------------------------------ RESULTS OF OPERATIONS --------------------- Certain information required herein is incorporated by reference from pages 6 through 11 of the Corporation's Annual Report. AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS/COST 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. Such 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. 35
<TABLE> Year Ended June 30, ------------------------------------------------------------------------------ 1998 1997 1996 ------------------------ -------------------------- -------------------------- Average Average Average Average Yield/ Average Yield/ Average Yield/ Balance Interest Cost Balance Interest Cost Balance Interest Cost ------- -------- ---- ------- -------- ---- ------- -------- ---- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Interest-earning assets: Loans receivable, net (1)(2)................. $613,672 46,305 7.55% $498,853 $38,445 7.71% $504,336 $39,701 7.87% Investment securities... 52,361 3,257 6.22 55,207 3,133 5.68 20,135 1,386 6.88 FHLB stock.............. 5,214 303 5.81 4,749 290 6.10 4,489 230 5.13 Interest-earning deposits 4,358 231 5.31 14,712 731 4.97 13,873 500 3.61 -------- ------ ---- -------- ------- ---- -------- ------- ---- Total interest-earning assets................ 675,605 50,096 7.41 573,521 42,599 7.43 542,833 41,817 7.70 -------- ------ -------- ------- -------- ------- Non-interest-earning assets 27,502 25,051 21,313 -------- -------- -------- Total assets....... $703,107 $598,572 $564,146 ======== ======== ======== Interest-bearing liabilities: Passbook accounts....... $50,010 1,216 2.43 $49,567 1,363 2.75 $ 52,345 1,743 3.33 Demand and NOW accounts. 119,571 3,470 2.90 111,059 3,733 3.36 111,145 4,237 3.81 Certificate accounts.... 368,501 21,025 5.71 329,099 18,016 5.47 326,056 18,027 5.53 -------- ------ ---- -------- ------- ---- -------- ------- ---- Total deposits .... 538,082 25,711 4.78 489,725 23,112 4.72 489,546 24,007 4.90 FHLB advances........... 64,228 3,695 5.75 7,098 416 5.87 20,155 1,260 6.25 Other borrowings........ 206 11 5.35 -- -- -- 840 2 0.24 -------- ------ ---- -------- ------- ---- -------- ------- ---- Total interest- bearing liabilities 602,516 29,417 4.88 496,823 23,528 4.74 510,541 25,269 4.95 -------- ------ -------- ------- -------- ------- Non-interest-bearing liabilities............. 16,602 15,912 13,432 -------- -------- -------- Total liabilities....... 619,118 512,735 523,973 -------- -------- -------- Shareholders equity..... 83,989 80,837 40,173 -------- -------- -------- Total liabilities and Shareholders equity............ 703,107 $598,572 $564,146 ======== ======== ======== Net interest income..... $20,679 $19,071 $16,548 ======= ======= ======= Interest rate spread(3). 2.53% 2.69% 2.75% Net interest margin(4).. 3.06% 3.33% 3.05% Ratio of average interest-earning assets to average interest- bearing liabilities.... 112.13% 115.44% 106.33% (1) Includes loans available for sale. (2) Includes deferred loan fee amortization of ($752,000), ($254,000) and $112,000 for the years ended June 30, 1998, 1997 and 1996, respectively. (3) Represents difference between weighted average yield on all interest-earning assets and weighted average rate on all interest-bearing liabilities. (4) Represents net interest income before provision for loan losses as a percentage of average interest-earning assets. 37 </TABLE>
YIELDS EARNED AND RATES PAID The following table sets forth (on a consolidated basis) for the periods and at the dates indicated the weighted average yields earned on the Savings Bank's assets and the weighted average interest rates paid on the Savings Bank's liabilities, together with the net yield on interest-earning assets. At June Year Ended June 30, 30, ----------------------- 1998 1998 1997 1996 ---- ---- ---- ---- Weighted average yield on: Loans receivable (1)................. 7.63% 7.55% 7.71% 7.87% Investment securities................ 6.44 6.22 5.68 6.88 FHLB stock........................... 5.88 5.81 6.10 5.13 Interest-earning deposits............ 5.41 5.31 4.97 3.61 All interest-earning assets.......... 7.49 7.41 7.43 7.70 Weighted average rate paid on: Passbook accounts.................... 2.98 2.43 2.75 3.33 Demand and NOW accounts.............. 2.95 2.90 3.36 3.81 Certificate accounts................. 5.50 5.71 5.47 5.53 FHLB advances........................ 5.70 5.75 5.87 6.25 Other borrowings..................... 5.14 5.34 -- 0.30 All interest-beraing liabilities..... 4.86 4.88 4.74 4.95 Interest rate spread (spread between weighted average rates on all interest-earnings assets and all interest-bearing liabilities......... 2.63 2.53 2.69 2.75 Net interest margin (net interest income as a percentage of average interest-earning assets)............. 3.16 3.06 3.33 3.05 (1) Includes loans available for sale. RATE/VOLUME TABLE The following table sets forth the effects of changing rates and volumes on interest income and expense of the Savings Bank. Information is provided with respect to (i) effects attributable to changes in volume (changes in volume multiplied by prior rate); (ii) effects attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) changes that cannot be allocated between rate and volume. 38
<TABLE> 1998 Compared to Year 1997 Compared to Year Ended June 30, 1997 Ended June 30, 1996 Increase (Decrease) Due to Increase (Decrease) Due to Rate/ Rate/ Rate Volume Volume Net Rate Volume Volume Net ---- ------ ------ --- ---- ------ ------ --- (In Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> Interest income: Loans Receivable (1).............. ($804) $8,849 ($185) $7,860 ($834) ($432) $9 ($1,257) Investment securities....... 300 (161) (15) 123 (243) 2,415 (424) 1,748 FHLB stock........ (13) 28 (1) 14 44 13 3 60 Interest-bearing deposits......... 50 (515) (35) (500) 189 30 11 230 ----- ------ ----- ------ ------ ------ ----- ------ Total net change in income on interest earning assets.......... (467) 8,201 (236) 7,497 (844) 2,026 (401) 781 ----- ------ ----- ------ ------ ------ ----- ------ Interest-bearing liabilities: Passbook accounts.. (157) 12 (1) (146) (304) (92) 17 (379) Demand and NOW (510) 286 (39) (263) (501) (3) -- (504) accounts.......... Certificate accounts. 761 2,157 91 3,009 (178) 168 (2) (12) FHLB advances...... (8) 3,351 (64) 3,279 (77) (816) 50 (843) Other borrowings... -- -- 11 11 (3) (3) 3 (3) ----- ------ ----- ------ ------ ------ ----- ------ Total net change in expense on interest-bearing liabilities ....... 86 5,806 (3) 5,890 (1,063) (746) 68 1,741 ----- ------ ----- ------ ------ ------ ----- ------ Net change in net interest income...... ($553) $2,395 ($234) $1,607 $219 $2,772 ($469) $2,522 ===== ====== ====== ====== ==== ====== ===== ====== (1) Includes loans available for sale. For purposes of calculating volume, rate and rate/volume variances, nonaccrual loans were included in the weighted average balance outstanding. 39 </TABLE>
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS SFAS No.130. "Reporting Comprehensive Income." Comprehensive income is comprised of net income and all changes to stockholder's equity, except those due to investments by owners (changes in paid-in capital) and distributions to owners (dividends). This statement requires that all components of comprehensive income and total comprehensive income be reported in the financial statements. The Company will adopt this statement in the year ended June 30, 1999. Management does not believe that the adoption of this statement will have a material impact on the financial position or results of operations of the Company. SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information." This statement requires public companies to report certain information about operating segments as well as certain information about products, services and major customer in their financial statements. The Company will adopt this statement in the year ended June 30, 1999. Management does not believe that the adoption of this statement will have a material impact on the financial position or results of operations of the Company. SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes new accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. The Company must adopt this statement in the year ended June 30, 2000. Management will evaluate the impact of SFAS 133, if any, on its consolidated financial reporting during fiscal 1999. The consolidated financial statements and related financial data presented herein have been prepared in accordance with GAAP which generally requires the measurement of financial position and operating results in terms of historical dollars, without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation is reflected in the increased cost of the Savings Bank's operations. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. In the current interest rate environment, liquidity and maturity structure of the Savings Bank's assets and liabilities are critical to the maintenance of performance levels. SUBSEQUENT EVENTS On August 17, 1998, the Corporation announced the completion of a 5% stock repurchase program in which 228,711 shares were repurchased at an average price of $20.32. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ---------------------------------------------------- The information required herein is incorporated by reference from pages 13 through 38 of the Corporation's Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------------------------------------------------------------------------ FINANCIAL DISCLOSURE -------------------- None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------ The information concerning the Corporation's directors required by this Item is incorporated by reference from the information set forth under "Proposal I - Election of Directors" and "Compliance with Section 16(a) of the Exchange Act" in the Proxy Statement. 40
EXECUTIVE OFFICERS OF THE CORPORATION AND SAVINGS BANK Age at Position June 30, --------------------------------------------- Name 1998 Corporation Savings Bank ---- ---- ----------- ------------ Craig G. Blunden 50 President, Chief President, Chief Executive Officer Executive Officer and and Director Director Brian M. Riley 33 Chief Financial Senior Vice President Office and Chief Financial Officer Robert G. Schrader 58 Secretary Executive Vice President, Chief Operating Officer Secretary and Director Donald L. Blanchard 47 N/A Senior Vice President, Retail Banking Lil Brunner 44 N/A Senior Vice President Chief Information Officer Richard L. Gale 46 N/A Senior Vice President, Mortgage Banking BIOGRAPHICAL INFORMATION Set forth below is certain information regarding the Executive Officers of the Corporation and the Savings Bank. There are no family relationships among or between the directors or executive officers. Craig G. Blunden has been associated with the Savings Bank since 1974 and has held his current positions at the Savings Bank since 1991 and as President and Chief Executive Officer of the Corporation since its formation in 1996. Mr. Blunden also serves on the Foundation Board of Trustees for the University of California, Riverside, the Western League of Savings Institutions Board of Directors and America's Community Bankers Mortgage Finance Committee. Robert G. Schrader has been associated with the Savings Bank since 1963 and has served as Executive Vice President of the Savings Bank since January 1995. From 1990 through 1994, Mr. Schrader served as Senior Vice President of the Savings Bank. Mr. Schrader has held his current position with the Corporation since its formation in 1996. Donald L. Blanchard, who joined the Savings Bank in 1989, has held his current position with the Savings Bank since 1989. Richard L. Gale, who joined the Savings Bank in 1988, has served as President of the Profed Mortgage division since 1989. Mr. Gale has held his current position with the Savings Bank since 1993. Brian M. Riley, who joined the Savings Bank in 1997, was previously Executive Vice President/Chief Financial Officer for Metro Commerce Bank from 1992 to 1997. Lil Brunner, who joined the Savings Bank in 1993, was general auditor prior to being promoted to Chief Information Officer in 1997. 51
ITEM 11. EXECUTIVE COMPENSATION - -------------------------------- The information required by this Item is incorporated by reference to the information under "Excutive Compensation" and "Directors' Compensation" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------ The information required by this Item is incorporated by reference to the information under "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. (c) Changes in Control The Corporation is not aware of any arrangements, icnluding any pledge by any person of securities of the Corporation, the operation of which may at a subsequent date result in a change in control of the Corporation. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------- The information required by this Item is incorporated by reference to the information under "Transactions with Management" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------- (a) (1) (2) Report of Independent Accountants Consolidated Financial Statements (a)Consolidated Balance Sheets, June 30, 1998 and 1997 (b)Consolidated Statement of Operations For the Years Ended June 30, 1998, 1997 and 1996 (c)Consolidated Statement of Stockholders' Equity For the Years Ended June 30, 1998, 1997 and 1996 (d)Consolidated Statement of Cash Flows For the Years Ended June 30, 1998, 1997 and 1996 (e)Notes to Consolidated Financial Statements Schedules to the consolidated financial statements have been omitted as the required information is inapplicable. 52
(3) Exhibits 3.1 Certificate of Incorporation of Provident Financial Holdings, Inc. (Incorporated by reference to Exhibit 3.1 to the Corporation's Registration Statement on Form S-1 (File No. 333-2230)) 3.2 Bylaws of Provident Financial Holdings, Inc. (Incorporated by reference to Exhibit 3.2 to the Corporation's Registration Statement on Form S-1 (File No. 333-2230)) 10.1 Employment Agreement with Craig G. Blunden (Incorporated by reference to Exhibit 10.1 to the Corporation's Annual Report on Form 10-K for the Year Ended June 30, 1997) 10.2 Post-Retirement Compensation Agreement with Craig G. Blunden (Incorporated by reference to Exhibit 10.2 to the Corporation's Annual Report on Form 10-K for the Year Ended June 30, 1997) 10.3 Severance Agreement with Robert G. Schrader (Incorporated by reference to Exhibit 10.3 to the Corporation's Annual Report on Form 10-K for the Year Ended June 30, 1996) 10.4 1996 Stock Option Plan (incorporated by reference to Exhibit A to the Corporation's proxy statement dated December 12, 1996) 10.5 1996 Management Recognition Plan (incorporated by reference to Exhibit B to the Corporation's proxy statement dated December 12, 1996) 10.6 Severance Agreement Richard Gale 10.7 Severance Agreement with Brian Riley 10.8 Severance Agreement with Donald Blanchard 13. Annual Report to Stockholders 21. Subsidiaries of Registrant 23. Consent of Independent Auditors 27. Financial data schedule (b) The Corporation did not file any Reports on Form 8-K during the quarter ended June 30, 1998. 53
SIGNATURES Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PROVIDENT FINANCIAL HOLDINGS, INC. Date: September 25, 1998 By: /s/Craig G. Blunden --------------------------------- Craig G. Blunden President and Chief Executive Officer Pursuant to the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURES TITLE DATE ---------- ----- ---- /s/Craig G. Blunden President, Chief September 25, 1998 - ----------------------------- Executive Officer and Craig G. Blunden Director (Principal Executive Officer) /s/Brian M. Riley Chief Financial Officer September 25, 1998 - ----------------------------- (Principal Financial Brian M. Riley and Accounting Officer) /s/Robert G. Schrader Director September 25, 1998 - ----------------------------- Robert G. Schrader /s/Bruce W. Bennett Director September 25, 1998 - ----------------------------- Bruce W. Bennett /s/Debbi H. Guthrie Director September 25, 1998 - ----------------------------- Debbi H. Guthrie /s/Roy H. Taylor Director September 25, 1998 - ----------------------------- Roy H. Taylor /s/William E. Thomas Director September 25, 1998 - ----------------------------- William E. Thomas
EXHIBIT 10.6 Severance Agreement with Richard Gale
FORM OF SEVERANCE AGREEMENT FOR CERTAIN OFFICERS Agreement THIS AGREEMENT is made effective as of June 28, 1998 by and between PROVIDENT SAVINGS BANK, F.S.B. (the "Bank"); PROVIDENT FINANCIAL HOLDINGS, INC. ("Company"); and Richard Gale (the "Executive"). WHEREAS, the Bank recognizes the substantial contribution Executive has made to the Bank and wishes to protect his position therewith for the period provided in this Agreement; and WHEREAS, Executive serves in the position of Senior Vice President, a position of substantial responsibility; NOW, THEREFORE, in consideration of the foregoing and upon the other terms and conditions hereinafter provided, the parties hereto agree as follows: 1. Term of Agreement The term of this Agreement shall be deemed to have commenced as of the date first above written and shall continue for a period of twelve (12) full calendar months thereafter. Commencing on the first anniversary date of this Agreement and continuing at each anniversary date thereafter, the Board of Directors of the Bank ("Board") may extend the Agreement for an additional year. The Board will conduct a performance evaluation of the Executive for purposes of determining whether to extend the Agreement, and the results thereof shall be included in the minutes of the Board's meeting. 2. Payments to Executive Upon Change in Control (a) Upon the occurrence of a Change in Control (as herein defined) followed within twelve (12) months of the effective date of a Change in Control by the voluntary or involuntary termination of Executive's employment, other than for Cause, as defined in Section 2(c) hereof, the provisions of Section 3 shall apply. For purposes of this Agreement, "voluntary termination" shall be limited to the circumstances in which the Executive elects to voluntarily terminate his employment within twelve (12) months of the effective date of a Change in Control following any demotion, loss of title, office or significant authority, reduction in his annual compensation or benefits (other than a reduction affecting the Bank's personnel generally), or relocation of his principal place of employment by more than thirty-five (35) miles from its location immediately prior to the Change in Control. (b) A "Change in Control" of the Company or the Bank shall be deemed to occur if and when (a) an offeror other than the Company purchases shares of the common stock of the Company or the Bank pursuant to a tender or exchange offer for such shares, (b) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) is or becomes the beneficial owner, directly or indirectly, of securities of the Company or the Bank representing 25% or more of the combined voting power of the Company's then outstanding securities, (c) the membership of the board of directors of the Company or the Bank changes as the result of a contested election, such that individuals who were directors at the beginning of any twenty-four (24) month period (whether commencing before or after the date of adoption of this Plan) do not constitute a majority of the Board at the end of such period, or (d) shareholders of the Company or the Bank approve a merger, consolidation, sale or disposition of all or substantially all of the Company's or the Bank's assets, or a plan of partial or complete liquidation.
(c) Executive shall not have the right to receive termination benefits pursuant to Section 3 hereof upon Termination for Cause. The term "Termination for Cause" shall mean termination because of the Executive's intentional failure to perform stated duties, personal dishonesty, incompetence, willful misconduct, any breach of fiduciary duty involving personal profit, willful violation of any law, rule, regulation (other than traffic violations or similar offenses) or final cease and desist order, or any material breach of any material provision of this Agreement. In determining incompetence, the acts or omissions shall be measured against standards generally prevailing in the savings institution industry. Notwithstanding the foregoing, Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to him a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths of the members of the Board at a meeting of the Board called and held for that purpose (after reasonable notice to Executive and an opportunity for him, together with counsel, to be heard before the Board), finding that in the good faith opinion of the Board, Executive was guilty of conduct justifying Termination for Cause and specifying the particulars thereof in detail. The Executive shall not have the right to receive compensation or other benefits for any period after Termination for Cause. 3. Termination (a) Upon the occurrence of a Change in Control during the term of this Agreement, followed within twelve (12) months of the effective date of a Change in Control by the voluntary or involuntary termination of the Executive's employment, other than for Termination for Cause, the Bank shall be obligated to pay the Executive, or in the event of his subsequent death, his beneficiary or beneficiaries, or his estate, as the case may be, as severance pay, a sum equal to two (2) times Executive's then current base annual salary in a lump sum no later than thirty (30) days after the date of his termination. (b) Upon the occurrence of a Change in Control during the term of this Agreement, followed within twelve (12) months of the effective date of a Change in Control by the Executive's voluntary or involuntary termination of employment, other than for Termination for Cause, the Bank shall cause to be continued life, medical, dental and disability coverage substantially identical to the coverage maintained by the Bank for the Executive prior to his severance. Such coverage shall cease upon expiration of twelve (12) months from the date of the Executive's termination. (c) Notwithstanding the preceding paragraphs of this Section 3, in the event that the aggregate payments or benefits to be made or afforded to the Executive under this Section would be deemed to include an "excess parachute payment" under Section 280G of the Internal Revenue Code of 1986, as amended, such payments or benefits shall be payable or provided to Executive over the minimum period necessary to reduce the present value of such payments or benefits to an amount which is one dollar ($1.00) less than three (3) times the Executive's "base amount" under Section 280G(b)(3) of the Code. (d) Any payments made to the Executive pursuant to this Agreement, or otherwise, are subject to and conditioned upon compliance with 12 U.S.C. Section 1828(k) and any regulations promulgated thereunder. (e) As a condition of the receipt of any payments or benefits under this Section 3, Executive shall in writing release the Bank, the Company or any successors thereto from any or all claims or causes of action relating to Executive's termination of employment. 4. Effect on Prior Agreements and Existing Benefit Plans This Agreement contains the entire understanding between the parties hereto and supersedes any prior agreement between the Bank and Executive, except that this Agreement shall not affect or operate to reduce any benefit or compensation inuring to Executive of a kind elsewhere provided. No provision of this Agreement shall be interpreted to mean that Executive is subject to receiving fewer benefits than those available to him without reference to this Agreement. -2-
5. No Attachment (a) Except as required by law, no right to receive payments under this Agreement shall be subject to anticipation, commutation, alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation, or to execution, attachment, levy, or similar process or assignment by operation of law, and any attempt, voluntary or involuntary, to affect any such action shall be null, void, and of no effect. (b) This Agreement shall be binding upon, and inure to the benefit of, Executive, the Company, the Bank and their respective successors and assigns. 6. Modification and Waiver (a) This Agreement may not be modified or amended except by an instrument in writing signed by the parties hereto. (b) No term or condition of this Agreement shall be deemed to have been waived, nor shall there by an estoppel against the enforcement of any provision of this Agreement, except by written instrument of the party charged with such waiver or estoppel. No such written waiver shall be deemed a continuing waiver unless specifically stated therein, and each such waiver shall operate only as to the specific term or condition waived and shall not constitute a waiver of such term or condition for the future or as to any act other than that specifically waived. 7. Required Provisions (a) The Bank may terminate the Executive's employment at any time, but any termination by the Bank, other than Termination for Cause, shall not prejudice Executive's right to compensation or other benefits under this Agreement. Executive shall not have the right to receive compensation or other benefits for any period after Termination for Cause as defined in Section 2(c) herein. (b) If the Executive is suspended and/or temporarily prohibited from participating in the conduct of the Bank's affairs by a notice served under Section 8(e)(3) or (g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. 1818(e)(3) and (g)(1)), the Bank's obligations under the Agreement shall be suspended as of the date of service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Bank may, in its discretion, (i) pay the Executive all or part of the compensation withheld while its contract obligations were suspended and (ii) reinstate (in whole or in part) any of its obligations that were suspended. (c) If the Executive is removed and/or permanently prohibited from participating in the conduct of the Bank's affairs by an order issued under Section 8(e)(4) or (g)(1) of the FDIA (12 U.S.C. 1818(e)(4) or (g)(1)), all obligations of the Bank under the Agreement shall terminate as of the effective date of the order, but vested rights of the contracting parties shall not be affected. (d) If the Bank is in default (as defined in Section 3(x)(1) of the FDIA), all obligations under this Agreement shall terminate as of the date of default, but this paragraph shall not affect any vested rights of the parties. (e) All obligations under this Agreement may be terminated: (i) by the Director of the Office of Thrift Supervision (the "Director") or his or her designee at the time the Federal Deposit Insurance Corporation or the Resolution Trust Corporation enters into an agreement to provide assistance to or on behalf of the Bank under the authority contained in Section 13(c) of the FDIA and (ii) by the Director, or his or her designee at the time the Director or such designee approves a supervisory merger to resolve problems related to operation of the Bank or when the Bank is determined by the Director to be in an unsafe -3-
or unsound condition. Any rights of the parties that have already vested, however, shall not be affected by such action. 8. Severability If, for any reason, any provision of this Agreement, or any part of any provision, is held invalid, such invalidity shall not affect any other provision of this Agreement or any part of such provision not held so invalid, and each such other provision and part thereof shall to the full extent consistent with law continue in full force and effect. 9. Headings for Reference Only The headings of sections and paragraphs herein are included solely for convenience of reference and shall not control the meaning or interpretation of any of the provisions of this Agreement. 10. Governing Law The validity, interpretation, performance, and enforcement of this Agreement shall be governed by the laws of the State of California, unless preempted by Federal law as now or hereafter in effect. Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration, conducted before a panel of three arbitrators sitting in a location selected by the employee within fifty (50) miles from the location of the Bank, in accordance with the rules of the American Arbitration Bank then in effect. 11. Source of Payments All payments provided in this Agreement shall be timely paid in cash or check from the general funds of the Bank. The Company, however, guarantees all payments and the provision of all amounts and benefits due hereunder to Executive and, if such payments are not timely paid or provided by the Bank, such amounts and benefits shall be paid or provided by the Company. 12. Payment of Legal Fees All reasonable legal fees paid or incurred by Executive pursuant to any dispute or question of interpretation relating to this Agreement shall be paid or reimbursed by the Bank if Executive is successful on the merits pursuant to a legal judgment, arbitration or settlement. 13. Successor to the Bank or the Company The Bank and the Company shall require any successor or assignee, whether direct or indirect, by purchase, merger, consolidation or otherwise, to all or substantially all the business or assets of the Bank or the Company, expressly and unconditionally to assume and agree to perform the Bank's or the Company's obligations under this Agreement, in the same manner and to the same extent that the Bank or the Company would be required to perform if no such succession or assignment had taken place. -4-
14. Signatures IN WITNESS WHEREOF, the Bank and the Company have caused this Agreement to be executed by a duly authorized officer, and Executive has signed this Agreement, on the day and date first written above. ATTEST: PROVIDENT SAVINGS BANK, F.S.B. By: /s/ Craig G. Blunden - ---------------------------- ---------------------------------- ATTEST: PROVIDENT FINANCIAL HOLDINGS, INC. By: /s/ Craig G. Blunden - ---------------------------- ---------------------------------- WITNESS: By: /s/ Richard L. Gale - ---------------------------- ---------------------------------- Executive
EXHIBIT 10.7 Severance Agreement with Brian Riley
FORM OF SEVERANCE AGREEMENT FOR CERTAIN OFFICERS Agreement THIS AGREEMENT is made effective as of June 2, 1998 by and between PROVIDENT SAVINGS BANK, F.S.B. (the "Bank"); PROVIDENT FINANCIAL HOLDINGS, INC. ("Company"); and Brian Riley (the "Executive"). WHEREAS, the Bank recognizes the substantial contribution Executive has made to the Bank and wishes to protect his position therewith for the period provided in this Agreement; and WHEREAS, Executive serves in the position of Senior Vice President, a position of substantial responsibility; NOW, THEREFORE, in consideration of the foregoing and upon the other terms and conditions hereinafter provided, the parties hereto agree as follows: 1. Term of Agreement The term of this Agreement shall be deemed to have commenced as of the date first above written and shall continue for a period of twelve (12) full calendar months thereafter. Commencing on the first anniversary date of this Agreement and continuing at each anniversary date thereafter, the Board of Directors of the Bank ("Board") may extend the Agreement for an additional year. The Board will conduct a performance evaluation of the Executive for purposes of determining whether to extend the Agreement, and the results thereof shall be included in the minutes of the Board's meeting. 2. Payments to Executive Upon Change in Control (a) Upon the occurrence of a Change in Control (as herein defined) followed within twelve (12) months of the effective date of a Change in Control by the voluntary or involuntary termination of Executive's employment, other than for Cause, as defined in Section 2(c) hereof, the provisions of Section 3 shall apply. For purposes of this Agreement, "voluntary termination" shall be limited to the circumstances in which the Executive elects to voluntarily terminate his employment within twelve (12) months of the effective date of a Change in Control following any demotion, loss of title, office or significant authority, reduction in his annual compensation or benefits (other than a reduction affecting the Bank's personnel generally), or relocation of his principal place of employment by more than thirty-five (35) miles from its location immediately prior to the Change in Control. (b) A "Change in Control" of the Company or the Bank shall be deemed to occur if and when (a) an offeror other than the Company purchases shares of the common stock of the Company or the Bank pursuant to a tender or exchange offer for such shares, (b) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) is or becomes the beneficial owner, directly or indirectly, of securities of the Company or the Bank representing 25% or more of the combined voting power of the Company's then outstanding securities, (c) the membership of the board of directors of the Company or the Bank changes as the result of a contested election, such that individuals who were directors at the beginning of any twenty-four (24) month period (whether commencing before or after the date of adoption of this Plan) do not constitute a majority of the Board at the end of such period, or (d) shareholders of the Company or the Bank approve a merger, consolidation, sale or disposition of all or substantially all of the Company's or the Bank's assets, or a plan of partial or complete liquidation.
14. Signatures IN WITNESS WHEREOF, the Bank and the Company have caused this Agreement to be executed by a duly authorized officer, and Executive has signed this Agreement, on the day and date first written above. ATTEST: PROVIDENT SAVINGS BANK, F.S.B. By: /s/ Craig G. Blunden - ---------------------------- ---------------------------------- ATTEST: PROVIDENT FINANCIAL HOLDINGS, INC. By: /s/ Craig G. Blunden - ---------------------------- ---------------------------------- WITNESS: By: /s/ Brian M. Riley - ---------------------------- ---------------------------------- Executive
EXHIBIT 10.8 Severance Agreement with Donald Blanchard
FORM OF SEVERANCE AGREEMENT FOR CERTAIN OFFICERS Agreement THIS AGREEMENT is made effective as of June 28, 1998 by and between PROVIDENT SAVINGS BANK, F.S.B. (the "Bank"); PROVIDENT FINANCIAL HOLDINGS, INC. ("Company"); and Donald Blanchard (the "Executive"). WHEREAS, the Bank recognizes the substantial contribution Executive has made to the Bank and wishes to protect his position therewith for the period provided in this Agreement; and WHEREAS, Executive serves in the position of Senior Vice President, a position of substantial responsibility; NOW, THEREFORE, in consideration of the foregoing and upon the other terms and conditions hereinafter provided, the parties hereto agree as follows: 1. Term of Agreement The term of this Agreement shall be deemed to have commenced as of the date first above written and shall continue for a period of twelve (12) full calendar months thereafter. Commencing on the first anniversary date of this Agreement and continuing at each anniversary date thereafter, the Board of Directors of the Bank ("Board") may extend the Agreement for an additional year. The Board will conduct a performance evaluation of the Executive for purposes of determining whether to extend the Agreement, and the results thereof shall be included in the minutes of the Board's meeting. 2. Payments to Executive Upon Change in Control (a) Upon the occurrence of a Change in Control (as herein defined) followed within twelve (12) months of the effective date of a Change in Control by the voluntary or involuntary termination of Executive's employment, other than for Cause, as defined in Section 2(c) hereof, the provisions of Section 3 shall apply. For purposes of this Agreement, "voluntary termination" shall be limited to the circumstances in which the Executive elects to voluntarily terminate his employment within twelve (12) months of the effective date of a Change in Control following any demotion, loss of title, office or significant authority, reduction in his annual compensation or benefits (other than a reduction affecting the Bank's personnel generally), or relocation of his principal place of employment by more than thirty-five (35) miles from its location immediately prior to the Change in Control. (b) A "Change in Control" of the Company or the Bank shall be deemed to occur if and when (a) an offeror other than the Company purchases shares of the common stock of the Company or the Bank pursuant to a tender or exchange offer for such shares, (b) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) is or becomes the beneficial owner, directly or indirectly, of securities of the Company or the Bank representing 25% or more of the combined voting power of the Company's then outstanding securities, (c) the membership of the board of directors of the Company or the Bank changes as the result of a contested election, such that individuals who were directors at the beginning of any twenty-four (24) month period (whether commencing before or after the date of adoption of this Plan) do not constitute a majority of the Board at the end of such period, or (d) shareholders of the Company or the Bank approve a merger, consolidation, sale or disposition of all or substantially all of the Company's or the Bank's assets, or a plan of partial or complete liquidation.
14. Signatures IN WITNESS WHEREOF, the Bank and the Company have caused this Agreement to be executed by a duly authorized officer, and Executive has signed this Agreement, on the day and date first written above. ATTEST: PROVIDENT SAVINGS BANK, F.S.B. By: /s/ Craig G. Blunden - ---------------------------- ---------------------------------- ATTEST: PROVIDENT FINANCIAL HOLDINGS, INC. By: /s/ Craig G. Blunden - ---------------------------- ---------------------------------- WITNESS: By: /s/ Donald Blanchard - ---------------------------- ---------------------------------- Executive
EXHIBIT 13 Annual Report to Stockholders
CORPORATE VALUE In today's marketplace, "community bank" is an often-overused cliche that is long on ideals and short on action. We at Provident wish to dispel the myth that ideas and actions are incompatible. We remain committed to the belief that our communities are better served when decisions about financial products and services are made locally by people who know the markets. Our corporate values reinforce this philosophy and challenge us to empower our ideas with action. At Provident, we aspire to... 1. Be the preeminent financial services provider within our market region 2. Develop effective distribution channels for our products and services 3. Be a customer focused business that seeks to provide financial solutions 4. Leverage the use of technology to achieve the best ROI that supports our operating culture 5. Understand that people drive the bottom line, therefore we will o Seek only the best people o Provide resources that guarantee excellence in products, service and operations o Empower the talent to get it done! TABLE OF CONTENTS - ----------------- Message From the Chairman 2 Financial Highlights 4 Management's Discussion and Analysis 6 Report of Independent Accountants 12 Consolidated Financial Statements 13 Notes to Consolidated Financial Statements 18 Shareholder Information 39 Market Information 39 Corporate Profile 39 Board of Directors and Senior Officers 40 Provident Bank and ProFed Mortgage Locations INSIDE BACK COVER 1
MESSAGE FROM THE CHAIRMAN DEAR FELLOW SHAREHOLDERS, By many measures, fiscal 1998 was a true success. Net income for the year was $5.0 million, up from a SAIF assessment adjusted net income of $3.8 million in fiscal 1997 ($1.9 million including the SAIF assessment). This represents an increase of over 31%. These results were achieved in a year in which we added significant growth. Total assets reached $816 million by year-end, an increase of $200 million, or 33%, from the prior year-end. As a result of our accelerated growth and consistent performance, our return on equity more than doubled to 5.98% while our return on assets improved to 0.71%. We remain committed to profitable growth and continued improvement in our ROE. Mortgage originations accelerated during fiscal 1998 as low interest rates and a positive economic environment combined to produce the best lending conditions in years. Over $467 million in mortgage loans were originated for sale during fiscal 1998. Gains from the sale of these loans increased to $4.5 million, up from $3.6 million in fiscal 1997. Our loan portfolio increased by $103 million, or 20% during fiscal 1998. Despite this significant growth, net loan losses hit a four-year low of $479,000 and non-performing assets of $6.4 million represented just 0.78% of total assets at June 30, 1998. The quality of our loan portfolio reflects the continued improvement within the Inland Empire's economic condition. Recognizing the value of repurchasing our own shares, we completed a five percent stock repurchase in January 1998 and announced regulatory approval for a second share repurchase program in July 1998. The second repurchase program was completed one month later as 228,711 shares were repurchased at an average price of $20.32 per share. We believe that our price to book multiple remains one of the lowest in the industry and worthy of attention. Our stock price responded favorable to the share repurchases as it reached a new high of $24.25 in March before settling to $20.75 at year-end. Our stock provided a 24.8% return in fiscal 1998 to those investors who held shares for the entire year. 2
Perhaps the most significant trend of fiscal 1998 was the frenzied pace of bank acquisitions. More than five of our strongest competitors were either merged out of existence or announced merger plans during the year. This phenomenon provides us with an incredible opportunity to emerge as the dominant, independent financial services provider within the Inland Empire. We recognize that this position requires us to assume a leading role in the delivery of products and services. To prepare, we are in the process of installing new state of the art data systems that will enable us to offer technology based solutions to our clients for many years to come. We anticipate that these core systems will be fully functional by March 1999. In addition to the challenge of converting our data systems, this fiscal 1999 will be devoted to making sure we stay on track with Year 2000 preparations. A significant component in our Year 2000 preparedness is the replacement of our core data systems. Separately, we are in constant communication with "mission critical" vendors to ensure that they too will be prepared for this monumental date. We certainly expect to be fully Year 2000 compliant within our established time line. But we must ultimately rely on the preparations of others within financial payment system including the United States government. With the number of conflicting priorities this next year, we expect that asset growth will take a lesser role in fiscal 1999 than it did in fiscal 1998. We are carefully considering the impact of any potential expansion opportunities on our overall objectives and strategic priorities during the coming year. Nevertheless, we look forward to another quality year as we continue to become the preeminent financial services provider within the Inland Empire. Sincerely, Craig G. Blunden Chairman, President and Chief Executive Officer 3
FINANCIAL HIGHLIGHTS The following tables set forth information concerning the consolidated financial position and results of operations of the Corporation and its subsidiary at the dates and for the periods indicated. At or for the year ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 1995 1994 - ----------------------------------------------------------------------------- (In Thousands) FINANCIAL CONDITION DATA: Total assets $816,205 $615,500 $584,847 $567,186 $580,336 Loans held for investment, net 620,128 517,147 452,945 471,543 420,159 Loans available for sale, net 67,248 19,984 49,612 34,489 83,049 Cash and overnight deposits 23,433 20,111 30,831 11,433 19,909 Investment securities 75,554 34,406 27,118 20,067 26,301 Deposits 583,025 508,759 479,374 486,585 471,787 Borrowings 132,114 6,828 8,578 35,063 56,153 Stockholders' equity (1) 86,650 85,447 85,970 37,323 41,315 ------------------------------------------------- OPERATING DATA: Interest income $ 50,096 $ 42,599 $ 41,817 $ 36,020 $ 36,197 Interest expense 29,417 23,528 25,269 22,491 19,532 Net interest income 20,679 19,071 16,548 13,529 16,665 Provision for loan losses 1,200 1,254 2,261 4,787 2,033 Net interest income after provision 19,479 17,817 14,287 8,742 14,632 Loan servicing and other fees 3,035 2,738 2,442 2,476 3,072 Gains from sale of loans 4,491 3,597 4,753 701 1,246 Gain on bulk sale of servicing rights -- -- -- -- 2,052 Other non-interest income 1,619 1,273 2,256 1,308 1,141 Real estate operations, net 196 (11) (101) (1,600) (366) Operating expenses 20,095 22,313 19,499 17,354 23,758 Income (loss) before income taxes 8,725 3,101 4,138 (5,727) (1,981) Provision (benefit) for income taxes 3,705 1,160 1,332 (1,735) (648) Net income (loss) $ 5,020 $ 1,941 $ 2,806 $ (3,992) $ (1,333) - ----------------------------------------------------------------------------- Basic earnings per share $ 1.14 $ 0.41 N/A N/A N/A ============================================================================= Diluted earnings per share $ 1.11 $ 0.41 N/A N/A N/A ============================================================================= - ----------------- (1) For years prior to 1996, amount represents retained earnings, substantially restricted. 4
FINANCIAL HIGHLIGHTS At or For the Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 1995 1994 - ----------------------------------------------------------------------------- KEY OPERATING RATIOS: PERFORMANCE RATIOS Return (loss) on assets(1) 0.71% 0.32% 0.50% (0.72)% (0.23)% Return (loss) on shareholders' equity(2) 5.98 2.26 6.98 (9.81) (3.08) Interest rate spread(3) 2.53 2.69 2.75 2.31 2.71 Net interest margin(4) 3.06 3.33 3.05 2.55 2.99 Average interest-earning assets to average interest- bearing liabilities 112.13 115.44 106.32 105.60 108.05 Operating and administrative expenses as a percent of average total assets 2.86 3.73 3.46 3.13 4.09 REGULATORY CAPITAL RATIOS Tangible capital 8.09 9.89 10.41 6.19 6.65 Core capital 8.09 9.89 10.41 6.19 6.69 Risk-based capital 14.12 16.12 16.49 11.25 12.68 ASSET QUALITY RATIOS Nonaccrual and 90 days or more past due loans as a percent of loans held for investment, net 0.31 1.21 0.98 0.54 1.08 Nonperforming assets as a percent of total assets 0.78 1.44 1.22 1.65 1.49 Allowance for loan losses as a percent of gross loans held for investment 0.98 1.04 1.18 1.06 0.78 Allowance for loan losses as a percent of nonperforming loans 320.19 87.45 123.43 198.79 73.62 Net charge-offs (recoveries) to average outstanding loans 0.10 0.25 0.38 0.62 0.39 - ----------------- (1) Net income (loss) divided by average total assets. (2) Net income (loss) divided by average stockholders' equity. (3) Difference between weighted average yield on interest-earning assets and weighted average rate on interest- bearing liabilities. (4) Net interest income as a percentage of average interest-earning assets. 5
Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL 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 Consolidated Financial Statements and accompanying notes thereto. OPERATING STRATEGY The Corporation's primary goal has been to improve its profitability while maintaining a sound capital position. To accomplish this goal, the Corporation has employed an operating strategy that includes: (1) originating for its portfolio one- to four-family residential mortgage loans, primarily with adjustable rates; (2) enhancing net income and controlling interest rate risk by originating loans for sale in the secondary market; (3) diversifying its revenue sources through commercial banking and; (4) improving asset quality by limiting new originations of commercial real estate and multi- family loans, increasing real estate owned marketing efforts and establishing and utilizing more effective problem loan monitoring procedures; (5) increasing assets in order to leverage the Corporation's capital position; and (6) controlling operating expenses. The Corporation and the Savings Bank intend to continue this operating strategy in an effort to enhance long-term profitability while maintaining a reasonable level of loan loss reserves. The Savings Bank intends to enhance such strategy by expanding the products and services it offers within its primary market area in order to improve market share. The profitability of the Savings Bank's operations depends primarily on its net interest income, its non-interest income (principally from mortgage banking activities) and its non-interest expense. Net interest income is the difference between the income the Savings Bank receives on its loan and investment portfolio and its cost of funds, which consists of interest paid on deposits and borrowings. Non-interest income is comprised of income from mortgage banking activities, gains on the occasional sale of assets and miscellaneous fees and income. Mortgage banking generates income from the sale of mortgage loans (which may be sold with servicing retained or with servicing released) and from servicing fees on loans sold on a servicing-retained basis. The Savings Bank receives a higher price for loans sold on a servicing-released basis because it is relinquishing the right to service the loan. The contribution of mortgage banking activities to the Savings Bank's results of operations is highly dependent on the demand for loans by borrowers and investors, and therefore the amount of gain on sale of loans may vary significantly from period to period as a result of changes in market interest rates and the local and national economy and whether the Savings Bank sells loans servicing-released or servicing-retained. The Savings Bank's profitability is also affected by the level of non-interest expense. Non-interest expenses include compensation and benefits, occupancy and equipment expenses, deposit insurance premiums, data servicing expenses and other operating costs. Non-interest expenses related to mortgage banking activities include compensation and benefits, occupancy and equipment expenses, telephone and other operating costs, all of which are related to the volume of loans originated. The Corporation's results of operations may be adversely affected during periods of reduced loan demand to the extent that non-interest expenses associated with mortgage banking activities are not reduced commensurate with the decrease in loan originations. COMPARISON OF FINANCIAL CONDITION Total assets increased from $615.5 million at June 30, 1997 to $816.2 million at June 30, 1998 primarily as a result of growth in the loan and investment securities portfolios. Loans held for investment increased $103.0 million from $517.1million at June 30, 1997 to $620.1 million at June 30, 1998. The Savings Bank, during the later half of fiscal 1997, decided to accept a larger percentage of ARM loans generated by its mortgage division into its own portfolio. The Savings Bank believes that this strategy will help leverage its capital base through high quality loans which will produce a higher return on assets and equity. Loans held for sale increased from $20.0 million at June 30, 1997 to $67.2 million at June 30, 1998. The amount of loans held for sale is largely dependent on timing of loan fundings, loan commitment expirations, and loan sale settlements. 6
Management's Discussion and Analysis of Financial Condition and Results of Operations As part of the leveraging strategy, the Corporation purchased investment securities when they could be profitably matched against borrowings. This activity increased the investment securities held to maturity by $40.4 million to $74.0 million at June 30, 1998. Total liabilities increased from $530.1 million at June 30, 1997 to $729.6 million at June 30, 1998 as a result of retail deposit growth and an increase in Federal Home Loan Bank advances. Deposits increased from $508.8 million at June 30, 1997 to $583.0 million at June 30, 1998. During 1998, the Savings Bank continued its emphasis on building new client relationships, particularly in the low cost checking account area. FHLB advances increased from $6.8 million at June 30, 1997 to $132.1 million at June 30, 1998 as the Savings Bank utilized FHLB advances to finance a portion of its loan and investment security growth. Total stockholders' equity was $86.7 million at June 30, 1998 compared to $85.4 million at June 30, 1997. The Corporation repurchased 251,000 shares for a total cost of $5.0 million, which offset the $5.0 million increase in retained earnings. The Corporation's book value per share increased from $17.37 at June 30, 1997 to $17.85 at June 30, 1998. COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED JUNE 30, 1997 AND 1998 GENERAL. The Corporation reported net earnings of $5.0 million, or $1.11 per diluted share, for the year ended June 30, 1998 as compared to $1.9 million, or $0.41 per diluted share, for the year ended June 30, 1997. The increase in operating results between fiscal 1997 and fiscal 1998 was due primarily to a one-time $3.2 million SAIF assessment charged in fiscal 1997. NET INTEREST INCOME. Net interest income increased by $1.6 million, or 8.4%, from $19.1 million in fiscal 1997 to $20.7 million in fiscal 1998. This increase resulted principally from the growth of interest earning assets and interest earning liabilities. INTEREST INCOME. The average yield on interest-earning assets for 1998, at 7.41%, remained on a par with the average yield for 1997. Total interest income increased by $7.5 million in 1998 due to the increase in loans receivable. The yield on loans receivable decreased 16 basis points to 7.55%, reflecting the general decrease in interest rates during the year. Interest income on investment securities increased slightly in fiscal 1998 to $3.3 million from $3.1 million in 1997. The average balance in investment securities declined from $55.2 million in 1997 to $52.4 million in 1998 due to purchases of treasury stock while the yield increased from 5.7% to 6.2% as the maturities on renewing securities were lengthened. INTEREST EXPENSE. Interest expense increased on both deposits and FHLB advances reflecting the growth in the balance sheet of the Corporation. Average total deposits increased by $48.4 million to $538.1 million during fiscal 1998, primarily in certificate accounts, which grew by $39.4 million to $368.5 million. The average cost of passbook accounts declined 32 basis points to 2.43% in 1998, along with demand and NOW accounts which decreased 46 basis points to 2.90%. The average cost of certificate accounts increased by 24 basis points to 5.71% during the year, reflecting competitive forces within the marketplace and special offerings to promote growth in the portfolio. Average FHLB advances increased from $7.1 million in 1997 to $64.2 million in 1998 in support of the growth in asset, while the average cost declined from 5.87% to 5.75%. PROVISIONS FOR LOAN LOSSES. Provisions for credit losses declined slightly in fiscal 1998 to $1.2 million as compared to $1.3 million in fiscal 1997. Charge-offs declined in one-to-four family and multifamily properties while commercial real estate and consumer loans showed increases. The allowance for loan losses ended fiscal 1998 at $6.2 million, compared to $5.5 million in 1997. Because of growth in the loan portfolio during fiscal 1998 the ratio of the allowance for loan losses as a percent of total loans outstanding declined from 1.04% in 1997 to 0.98% in 1998. The allowance for loan losses as a percent of nonperforming loans at the end of the period was 320.2% compared to 87.5% at the end of 1997. NON-INTEREST INCOME. Total non-interest income increased by 20.2%, from $7.6 million in 1997 to $9.1 million in 1998 primarily as a result of higher gains on sale of loans. The ratio of gains to total loan sales remained constant during the two periods at 105 basis points, however, the volume of sales increased from $343 million in 1997 to $425 million in 1998. 7
Management's Discussion and Analysis of Financial Condition and Results of Operations NON-INTEREST EXPENSE. Total non-interest expense decreased by $2.4 million, or 10.9% in 1998 because of the one-time SAIF assessment of $3.2 million in 1997. Salaries and employee benefits increased by $1.2 million, or 10.5%, to $12.5 million on higher mortgage production compensation and the adoption of additional benefit programs. INCOME TAXES. The provision for income taxes was $3.7 million for fiscal 1998 (for an effective tax rate of 42.5%) compared to $1.2 million in 1997 (for an effective tax rate of 37.4%). The Corporation eliminated the valuation allowance previously established against the deferred state tax asset because Management determined that it was more likely than not to utilize this future benefit. COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED JUNE 30, 1996 AND 1997 GENERAL. The Company reported net earnings of $1.9 million for the year ended June 30, 1997 compared to $2.8 million for the year ended June 30, 1996. The decline in operating results between fiscal 1996 and fiscal 1997 was due primarily to a one-time $3.2 million SAIF assessment charged in fiscal 1997. Without this special assessment, net income for fiscal 1997 would have been $3.8 million. NET INTEREST INCOME. Net interest income increased by $2.6 million, or 15.2%, from $16.5 million in fiscal 1996 to $19.1 million in fiscal 1997. This increase resulted principally from the investment of the conversion proceeds into interest earning assets and the widening of the Corporation's net interest margin from 3.1% to 3.3%. INTEREST INCOME. The average yield on interest-earning assets declined slightly in fiscal 1997 because a large portion of the stock conversion proceeds were invested in short-term securities. Total interest income increased by $782,000 in 1997 due to the increase in earning assets provided by the stock conversion. The average balance in investment securities rose from $20.1 million in 1996 to $55.2 million in 1997 while the yield decreased from 6.9% to 5.7%. The loans receivable yield also decreased 16 basis points reflecting the slightly downward trend of interest rates during the year. INTEREST EXPENSE. Interest expense declined on both deposits and FHLB advances. The conversion proceeds allowed the Corporation to repay higher cost FHLB advances. The average balance of these advances declined from $20.2 million in fiscal 1996 to $7.1 million in fiscal 1997. With the decline in interest rates during fiscal 1997, the average cost of deposits decreased by 18 basis points from 4.9% in 1996 to 4.7% in 1997. PROVISIONS FOR LOAN LOSSES. Provisions for credit losses declined in fiscal 1997 to $1.3 million as compared to $2.3 million in fiscal 1996. A smaller provision was required because of a significant decline in credit losses. Credit losses fell from $2.5 million in 1996 to $1.4 million in 1997. Commercial real estate losses, which fell from $1.3 million in 1996 to $309,000 in 1997, experienced the greatest drop. The allowance for loan losses ended fiscal 1997 at $5.5 million, unchanged from 1996. Because of growth in the loan portfolio during fiscal 1997 the ratio of the allowance for loan losses as a percent of total loans outstanding declined from 1.18% in 1996 to 1.04% in 1997. Allowance for loan losses as a percent of nonperforming loans at the end of the period was 87.5% compared to 123.4% at the end of 1996. Recent loss reserve experience has indicated that a reduction in the ratio is warranted. NON-INTEREST INCOME. Total non-interest income decreased by 19.5%, from $9.5 million in 1996 to $7.6 million in 1997 primarily as a result of lower gains on sale of loans. The ratio of gains to total loan sales remained constant during the two periods at 105 basis points, however, the volume of sales declined from $454 million in 1996 to $343 million in 1997. In addition, non-interest income was increased in 1996 by the receipt of $1 million in life insurance proceeds on a former Chief Executive Officer. NON-INTEREST EXPENSE. Total non-interest expense increased by $2.7 million, or 13.9% in 1997 because of the one-time SAIF assessment of $3.2 million. The payment of this special assessment brought the SAIF fund to its legally required minimum reserve level which should result in lower premiums in future years. 8
Management's Discussion and Analysis of Financial Condition and Results of Operations INCOME TAXES. Provision for income taxes was $1.2 million for fiscal 1997 (for an effective tax rate of 37.4%) compared to $1.3 million in 1996 (for an effective tax rate of 32.2%). The Corporation eliminated the valuation allowance previously established against the deferred state tax asset because management determined that it was more likely than not to utilize its future benefit. The effective rate for 1996 was lower because it was reduced by $1.0 million in non-taxable life insurance proceeds. ASSET AND LIABILITY MANAGEMENT The principal financial objective of the Corporation's interest rate risk management function is to achieve long-term profitability while limiting its exposure to fluctuating interest rates. The Corporation has sought to reduce exposure of its earnings to changes in market interest rates by managing the mismatch between asset and liability maturities and interest rates. The principal element in achieving this objective is to increase the interest-rate sensitivity of the Corporation's assets by holding loans with interest rates subject to periodic market adjustments. In addition, the Savings Bank maintains a liquid investment portfolio comprised of short-term government securities. The Savings Bank relies on retail deposits as its primary source of funds. Management believes retail deposits, compared to brokered deposits, limits the effects of interest rate fluctuations because they generally represent a more stable source of funds. As part of its interest rate risk management strategy, the Savings Bank promotes transaction accounts and certificates of deposit with terms up to five years. Using data from the Savings Bank's quarterly reports to the OTS, the Savings Bank receives a report from the OTS that measures interest rate risk by modeling the change in Net Portfolio Value ("NPV") over a variety of interest rate scenarios. This procedure for measuring interest rate risk was developed by the OTS to replace the "gap" analysis (the difference between interest-earning assets and interest-bearing liabilities that mature or reprice within a specific time period). NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The calculation is intended to illustrate the change in NPV that would occur in the event of an immediate change in interest rates of at least 200 basis points with no effect given to any steps which management might take to counter the effect of that interest rate movement. The following table is provided by the OTS and sets forth as of June 30, 1998 the estimated changes in NPV based on the indicated interest rate environments. In general, if interest rates increase, the NPV of the Savings Bank and its expected future net interest income would both decrease. Conversely, if interest rates decrease, the NPV of the Savings Bank and its expected future net interest income would both increase. No effect has been given to any steps that management of the Savings Bank may take to counter the effects of interest rate movements presented in the table. Net Portfolio as % of Net Portfolio Value Portfolio Value of Assets - ------------------------------------------------------------------------------ Basis Point ("bp") Change in Rates $ Amount $ Change(1) % Change NPV Ratio(2) Change(3) - ------------------------------------------------------------------------------ (Dollars in Thousands) +400 bp $ 61,225 $(32,972) (35)% 8.01% (335) bp +300 bp 73,289 (20,908) (22) 9.35 (201) bp +200 bp 83,656 (10,541) (11) 10.43 (93) bp +100 bp 90,963 (3,233) (3) 11.13 (23) bp 0 bp 94,196 - - 11.36 - -100 bp 95,006 809 1 11.34 (2) bp -200 bp 96,042 1,845 2 11.36 0 bp -300 bp 99,837 5,641 6 11.67 31 bp -400 bp 106,063 11,866 13 12.22 86 bp (1) Represents the increase (decrease) of the estimated NPV at the indicated change in interest rates compared to the NPV based on prevailing interest rates at June 30, 1998 ("base case"). (2) Calculated as the estimated NPV divided by the portfolio value of total assets ("PV"). (3) Calculated as the change in the NPV ratio from the base case amount assuming the indicated change in interest rates. 9 PAGE
Management's Discussion and Analysis of Financial Condition and Results of Operations The following table is provided by the OTS and is based on the calculations in the above table. It sets forth the change in the NPV Ratio at a 200 bp rate shock at the end of the last three quarters of fiscal 1998. At At At June 30, March 31, December 31, 1998 1998 1997 - ----------------------------------------------------------------------------- RISK MEASURES: 200 BP RATE SHOCK: Pre-Shock NPV Ratio: NPV as % of PV of Assets 11.36% 11.99% 12.43% Exposure Measure: Post-Shock NPV Ratio 10.43 10.33 11.42 Sensitivity Measure: Change in NPV Ratio 93 bp 166 bp 101 bp As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as ARM loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could likely deviate significantly from those assumed in calculating the table. It is also possible that, as a result of an interest rate increase, the increased mortgage payments required of ARM borrowers could result in an increase in delinquencies and defaults. Changes in market interest rates would also affect the volume and profitability of the Corporation's mortgage banking activities. Accordingly, the data presented in the tables above should not be relied upon as indicative of actual results in the event of changes in interest rates. Furthermore, the NPV presented in the foregoing tables is not intended to represent the fair market value of the Savings Bank, nor does it represent amounts that would be available for distribution to stockholders in the event of the liquidation of the Corporation. LIQUIDITY AND CAPITAL RESOURCES The Corporation's primary sources of funds are deposits, proceeds from sales of loans originated for sale, proceeds from principal and interest payments on loans, the maturity of and interest income on investment securities, and FHLB advances. While maturities and scheduled amortization of loans and investment securities are a predictable source of funds, deposit flows, mortgage prepayments and loan sales are greatly influenced by general interest rates, economic conditions and competition. The Savings 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 Savings Bank generally maintains sufficient cash and overnight deposits to meet short-term liquidity needs. At June 30, 1998, cash (including overnight deposits) totaled $23.4 million, or 2.9% of total assets. In addition, the Savings Bank maintains a credit facility with the FHLB-San Francisco, which provides for immediately available advances. Advances under this credit facility totaled $132.1 million at June 30, 1998. Depending on market conditions and the pricing of deposit products and FHLB borrowings, the Savings Bank may continue to rely on FHLB borrowings for its liquidity needs. The OTS requires a savings institution to maintain an average daily balance of liquid assets (cash and eligible investments) equal to at least 4.0% of the average daily balance of its net withdrawable deposits and short-term borrowings. The Savings Bank's actual liquidity ratio at June 30, 1998 was 9.3%. The Savings Bank has in the past consistently maintained liquidity levels relatively close to and in excess of regulatory requirements and believes this is an appropriate strategy for proper asset and liability management. 10
Management's Discussion and Analysis of Financial Condition and Results of Operations The primary investing activity of the Savings Bank is the origination of mortgage loans. During years ended June 30, 1998, 1997 and 1996, the Savings Bank originated loans in the amounts of $707.3 million, $441.8 million and $516.9 million, respectively. At June 30, 1998, the Savings Bank had loan commitments totaling $44.9 million and undisbursed loans in process totaling $7.3 million. The Savings Bank anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificates of deposit that are scheduled to mature in less than one year from June 30, 1998 totaled $336.6 million. Historically, the Savings Bank has been able to retain a significant amount of its deposits as they mature. Management of the Savings Bank believes it has adequate resources to fund all loan commitments by deposits and FHLB advances and that it can adjust the offering rates of savings certificates to retain deposits in changing interest rate environments. The Savings Bank is required to maintain specific amounts of capital pursuant to OTS requirements. As of June 30, 1998, the Savings Bank was in compliance with all regulatory capital requirements which were effective as of such date with tier I leverage, tier I capital and risk-based capital ratios of 9.3%, 12.9% and 14.1%, respectively. YEAR 2000 The Company has undertaken a major project to ensure that its internal operating systems, as well as those of its major customers and suppliers, will be fully capable of processing transactions in the Year 2000 and beyond. The initial phase of the project was to assess and identify all internal business processes requiring modification and to develop comprehensive renovation plans as needed. This phase was largely completed in late 1997. The second phase, expected to be accomplished by the end of 1998, will be to execute those renovation plans and begin testing systems by simulating Year 2000 data conditions. Testing and implementation is planned to be completed during the first half of 1999. The cost of the project primarily consists of replacement systems and the reallocation of internal resources. The estimated cost of the project is $3.5 million, which includes approximately $2.5 million in replacement equipment and software, $400,000 in equipment write-downs, and $200,000 in outside project management expenses. In addition, the estimated value of internal resources allocated to the Year 2000 project is approximately $400,000. The replacement equipment and software will be capitalized and depreciated in accordance with the Company's normal accounting policies. Beyond the costs described, it is not expected that the Year 2000 project will have any material effect on the Company's results of operations, liquidity or capital resources. The risk of Year 2000 processing problems is not completely known. As a participant in the domestic payment system, the Company's Year 2000 preparedness is largely dependent upon the preparedness of other participants in the system including the United States government. The Company does rely on third-party software vendors and service providers for many critical functions in the conduct of its business. The focus of the Company has been to monitor and test the Year 2000 compliance progress of its critical vendors. The Company is developing contingency plans for its most critical vendors, as well as its internal systems, in the event of failure in the Year 2000. 11
REPORT OF INDEPENDENT ACCOUNTANTS TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF PROVIDENT FINANCIAL HOLDINGS, INC. In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Provident Financial Holdings, Inc. and its subsidiary at June 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP Los Angeles, CA August 14, 1998 12
CONSOLIDATED BALANCE SHEETS Provident Financial Holdings, Inc. and Subsidiary - ----------------------------------------------------------------------------- (Dollars in Thousands) June 30, - ----------------------------------------------------------------------------- 1998 1997 ASSETS Cash $ 20,933 $ 10,411 Overnight deposits 2,500 9,700 - ----------------------------------------------------------------------------- Total cash and cash equivalents 23,433 20,111 Investment securities - held to maturity 74,028 33,645 available for sale 1,526 761 Loans held for investment, net 620,128 517,147 Loans available for sale, net 67,248 19,984 Accrued interest receivable 4,940 3,378 Real estate available for sale, net 6,922 5,676 Federal Home Loan Bank stock 6,606 4,879 Premises and equipment, net 7,429 6,825 Prepaid expenses and other assets 3,945 3,094 - ----------------------------------------------------------------------------- Total assets $816,205 $615,500 ============================================================================= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Non-interest bearing deposits $ 10,768 $ 2,335 Interest bearing deposits 572,257 506,424 - ----------------------------------------------------------------------------- Total deposits 583,025 508,759 Borrowings 132,114 6,828 Accounts payable, accrued interest and other liabilities 14,416 14,466 - ----------------------------------------------------------------------------- Total liabilities 729,555 530,053 - ----------------------------------------------------------------------------- Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value; authorized 2,000,000 shares; none issued and outstanding Common stock, $.01 par value; authorized 15,000,000 shares; issued 5,125,215 shares; outstanding 4,854,125 and 4,920,215, respectively 51 51 Additional paid-in capital 50,875 49,842 Retained earnings - substantially restricted 47,090 42,070 Treasury stock at cost (251,000 and 205,000 shares, respectively) (5,305) (3,291) Unearned stock compensation (6,654) (3,720) Unrealized gain on securities available for sale, net of tax 593 495 - ----------------------------------------------------------------------------- Total stockholders' equity 86,650 85,447 - ----------------------------------------------------------------------------- Total liabilities and stockholders' equity $816,205 $615,500 ============================================================================= The accompanying notes are an integral part of these financial statements. 13
CONSOLIDATED STATEMENTS OF OPERATIONS Provident Financial Holdings, Inc. and Subsidiary - ------------------------------------------------------------------------------ (Dollars in Thousands) Year Ended June 30, - ------------------------------------------------------------------------------ 1998 1997 1996 Interest income: Loans (Note 3) $ 46,305 $ 38,445 $ 39,701 Investment securities (Note 2) 3,791 4,154 2,116 - ----------------------------------------------------------------------------- Total interest income 50,096 42,599 41,817 Interest expense: Deposits (Note 7) 25,711 23,112 24,007 Borrowings 3,706 416 1,262 - ----------------------------------------------------------------------------- Total interest expense 29,417 23,528 25,269 - ----------------------------------------------------------------------------- Net interest income 20,679 19,071 16,548 Provision for loan losses (Note 3) 1,200 1,254 2,261 - ----------------------------------------------------------------------------- Net interest income, after provision for loan losses 19,479 17,817 14,287 - ----------------------------------------------------------------------------- Non-interest income Loan servicing and other fees 3,035 2,738 2,442 Gain on sale of loans, net 4,491 3,597 4,753 Life insurance proceeds 1,000 Other 1,619 1,273 1,256 - ----------------------------------------------------------------------------- Total non-interest income 9,145 7,608 9,451 - ----------------------------------------------------------------------------- Non-interest expenses Salaries and employee benefits 12,450 11,269 11,444 Premises and occupancy 2,065 2,064 1,939 SAIF insurance premiums 329 3,954 1,293 Telephone 410 427 426 Other 4,645 4,610 4,498 - ----------------------------------------------------------------------------- Total non-interest expenses 19,899 22,324 19,600 Income (loss) before income taxes 8,725 3,101 4,138 Provision (benefit) for income taxes 3,705 1,160 1,332 - ----------------------------------------------------------------------------- Net income $ 5,020 $ 1,941 $ 2,806 ============================================================================= Basic earnings per share $ 1.14 $ 0.41 N/A ============================================================================= Diluted earnings per share $ 1.11 $ 0.41 N/A ============================================================================= The accompanying notes are an integral part of these financial statements. 14
<TABLE> CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Provident Financial Holdings, Inc. and Subsidiary Unrealized Gain on Common Stock Additional Unearned Securities --------------- Paid-in Retained Treasury Stock Available Shares Amount Capital Earnings Stock Compensation For Sale Total - --------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Balance at June 30, 1995 $37,323 $37,323 Issuance of stock in a public offering 5,125,215 $51 $49,728 49,779 Purchase of shares by ESOP $(4,100) (4,100) Release of ESOP shares 14 148 162 Net Income 2,806 2,806 - --------------------------------------------------------------------------------------------------------- Balance at June 30, 1996 5,125,215 51 49,742 40,129 (3,952) 85,970 Net income 1,941 1,941 Purchase of treasury stock (205,000) $(3,291) (3,291) Release of shares under stock-based compensation plans 100 232 332 Unrealized gain on securities available for sale, net of tax $495 495 - --------------------------------------------------------------------------------------------------------- Balance at June 30, 1997 4,920,215 51 49,842 42,070 (3,291) (3,720) 495 85,447 Net income 5,020 5,020 Purchase of treasury stock (251,000) (4,983) (4,983) Issuance of shares under MRP 184,910 729 2,969 (3,698) Release of shares under stock-based compensation plans 304 764 1,068 Change in unrealized gain on securities available for sale, net of tax 98 98 - --------------------------------------------------------------------------------------------------------- Balance at June 30, 1998 4,854,125 $51 $50,785 $47,090 $(5,305) $(6,654) $593 $86,650 ========================================================================================================= The accompanying notes are an integral part of these financial statements. 15 </TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS Provident Financial Holdings, Inc. and Subsidiary - ------------------------------------------------------------------------------ (Dollars in Thousands) Year Ended June 30, - ------------------------------------------------------------------------------ 1998 1997 1996 Cash flows from operating activities: Net income $ 5,020 $ 1,941 $ 2,806 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 659 1,082 1,058 Amortization of loan fees (754) (254) (112) Provision for loan losses 1,200 1,254 2,261 Provision for losses on real estate 126 306 239 Gain on sale of loans (4,491) (3,597) (4,753) (Decrease) increase in accounts payable and other liabilities (49) 3,541 2,710 (Increase) decrease in prepaid expenses and other assets (2,237) 153 (592) Loans originated for sale (467,446) (313,382) (469,167) Proceeds from sale of loans 424,673 346,607 458,797 Stock compensation 1,068 332 Other (1,000) - ----------------------------------------------------------------------------- Net cash (used for) provided by operating activities (42,231) 37,983 (7,753) Cash flows from investing activities: Net (increase) decrease in loans (110,187) (70,891) 13,047 Maturity of investment securities 57,502 285,034 207,104 Purchases of investment securities (98,430) (292,322) (214,155) Purchase of Federal Home Loan Bank stock (1,727) Proceeds from disposal of real estate 5,561 5,518 8,619 Purchases of premises and equipment, net of proceeds from sales (1,199) (881) (609) Other (536) 495 1,000 - ----------------------------------------------------------------------------- Net cash (used for) provided by investing activities (149,016) (73,047) 15,006 - ----------------------------------------------------------------------------- The accompanying notes are an integral part of these financial statements. 16
CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont'd) Provident Financial Holdings, Inc. and Subsidiary - ------------------------------------------------------------------------------ (Dollars in Thousands) Year Ended June 30, - ------------------------------------------------------------------------------ 1998 1997 1996 Cash flows from financing activities: Net increase (decrease) in deposits $ 74,266 $ 29,385 $ (7,211) Repayment of Federal Home Loan Bank Advances (2,638,693) (1,750) (37,000) Proceeds from Federal Home Loan Bank Advances 2,763,979 12,500 Proceeds from issuance of capital stock 45,841 Treasury stock purchases (4,983) (3,291) Net decrease in securities sold under agreements to repurchase (1,985) - ----------------------------------------------------------------------------- Net cash provided by financing activities 194,569 24,344 12,145 - ----------------------------------------------------------------------------- Net increase (decrease) increase in cash and cash equivalents 3,322 (10,720) 19,398 Cash and cash equivalents at beginning of period 20,111 30,831 11,433 - ----------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 23,433 $ 20,111 $ 30,831 ============================================================================= Supplemental information: Cash paid for interest $ 29,984 $ 23,505 $ 25,302 ============================================================================= Cash paid for income taxes $ 4,623 $ 732 $ 704 ============================================================================= Real estate acquired in settlement of loans $ 6,932 $ 5,721 $ 3,433 ============================================================================= The accompanying notes are an integral part of these financial statements. 17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (DOLLARS IN THOUSANDS) Provident Savings Bank, FSB (the Bank) converted from a federally chartered mutual savings bank to a Federally chartered stock savings bank effective Junea27, 1996. Provident Financial Holdings, Inc. (the Holding Company), a Delaware corporation organized by the Bank, acquired all of the capital stock of the Bank issued in the conversion; the transaction was recorded on a book value basis. Any references to financial information for periods prior to June 30, 1996 refer to the Bank prior to conversion. The following accounting policies, together with those disclosed elsewhere in the consolidated financial statements, represent the significant accounting policies of Provident Financial Holdings, Inc. and subsidiary. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Provident Financial Holdings Inc., and its wholly-owned subsidiary, Provident Savings Bank, FSB (collectively, the Company). All significant intercompany balances and transactions have been eliminated. The Company operates primarily in one business segment -attracting customer deposits to originate loans secured primarily by mortgages on residential real estate. The segment includes ancillary activities related to real estate lending such as mortgage banking and real estate development. Customer deposits are collected substantially from Riverside and San Bernardino Counties out of ten branch locations with lending operations in California and Nevada using nine lending offices. The accounting and reporting policies of the Company conform to generally accepted accounting principles and to prevailing practices within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, due from banks and overnight deposits. INVESTMENT SECURITIES The Company classifies its qualifying investments as available for sale or held to maturity. Management has reviewed the securities portfolio and classified securities as either held to maturity or available for sale. The Company's policy of classifying investments as held to maturity is based upon its ability and management's intent to hold such securities to maturity. Securities expected to be held to maturity are carried at amortized historical cost. All other securities are classified as available for sale and are carried at fair value. Fair value is determined based upon quoted market prices. Unrealized gains and losses on securities available for sale are included in stockholders' equity net of taxes. Gains and losses on dispositions of investment securities are included in noninterest income and are determined using the specific identification method. 18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS LOANS Loans held for investment consist primarily of long-term loans secured by first trust deeds on single-family residences, other residential property, commercial property and land. The adjustable-rate mortgage (ARM) is the Company's primary loan investment. Loan origination fees and certain direct origination expenses are deferred and amortized to interest income on loans over the contractual life of the loan using the interest method. Amortization is discontinued for nonperforming loans. Interest receivable represents, for the most part, the current month's interest which will be included as a part of the borrower's next monthly loan payment. Interest receivable is accrued only if deemed collectible. Loans generally are deemed to be in non-accrual status when they become 90 days past due. When a loan is placed on non-accrual status, interest accrued but not received is reversed against income. MORTGAGE BANKING ACTIVITIES Loans are originated for both investment and sale in the secondary market. Since the Company is primarily an adjustable-rate mortgage lender for its own portfolio, most fixed rate products are originated for sale to others. Loans available-for-sale are carried at lower of cost or fair value. Fair value is generally determined by outstanding commitments from investors or current investor yield requirements as calculated on the aggregate loan basis. The Company sells loans in order to minimize interest rate risk and to provide additional funds for investment by the Company. Loans are sold without recourse other than short term covenants which are standard in the industry. For some loans sold, the Company may retain the servicing rights in order to generate servicing income. Where the Company continues to service loans after sale, investors are paid their share of the principal collections together with interest at an agreed-upon rate, which generally differs from the loan's contractual interest rate. Gains or losses on sales of loans, including fees received or paid, are recognized at the time of sale and are determined by the difference between the net sales proceeds and the book value of the loans sold. When loans are sold with servicing retained, the carrying value is allocated between the assets transferred and the fair value of the retained servicing in determining the amount of gain. Servicing assets and liabilities are amortized over the estimated life of the net servicing income or loss and are assessed for subsequent impairment. Bulk sales of servicing rights are recognized when title and all risks and rewards of ownership of the underlying loans have been irrevocably transferred to the buyer and all significant contingencies have been resolved. ALLOWANCE FOR LOAN LOSSES It is the policy of the Company to provide for estimated losses on real estate loans when any significant and permanent decline in the value of the underlying collateral occurs. Periodic reviews are made in an attempt to identify potential problems at an early date. Individual loans are periodically reviewed and are classified according to their inherent risk. The internal asset classification system used by the Company is the primary basis by which the Company evaluates the possible loss exposure. Management's determination of the adequacy of the allowance for losses is based on an evaluation of the portfolio, past experience, prevailing market conditions, and other relevant factors. The determination of the allowance for loan losses is based on estimates that are particularly susceptible to changes in the economic environment and market conditions. The allowance is increased by the provision for losses charged against income and reduced by charge-offs, net of recoveries. IMPAIRED LOANS The Company assesses loans individually and identifies impairment when the accrual of interest has been discontinued, loans have been restructured or management has serious doubts about the future collectibility of principal and interest, even though the loans are currently performing. Factors considered in determining impairment include, but are not limited to, expected future cash flows, the financial condition of the borrower and current economic conditions. The Company measures each impaired loan based on the fair value of its collateral and charges off those loans or portions of loans deemed uncollectible. 19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS REAL ESTATE AVAILABLE FOR SALE All foreclosed real estate and investment real estate is available for sale. Real estate acquired through foreclosure is initially recorded at the lesser of the loan balance at the time of foreclosure or the fair value of the real estate acquired less estimated selling costs. All real estate is carried at the lower of cost or fair value less estimated selling costs. Real estate loss provisions are recorded when the carrying value of the property exceeds the fair value. Costs relating to improvement of property are capitalized. Other costs are expensed as incurred. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed primarily on a straight-line basis over the estimated useful lives as follows: Buildings 10-40 years Furniture and fixtures 3-10 years Computer equipment 3-5 years Automobiles 3 years Leasehold improvements are amortized over the shorter of the respective lease terms or the lives of the improvements. Maintenance and repair costs are charged to operations as incurred. INCOME TAXES Taxes are provided on substantially all income and expense items included in earnings, regardless of the period in which such items are recognized for tax purposes. Taxes on income are determined by using the liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, all expected future events other than enactments of changes in the tax law or rates are considered. A valuation allowance is provided against deferred tax assets when realization is not considered more likely than not. RISKS AND UNCERTAINTIES In the normal course of its business, the Company encounters two significant types of risk: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on a different basis, than its interest-earning assets. Credit risk is the risk of default on the Company's loan portfolio that results from the borrower's inability or unwillingness to make contractually required payments. Market risk results from changes in the value of assets and liabilities which may impact, favorably or unfavorably, the realiability of those assets and liabilities held by the Company. The Company is subject to the regulations of various government agencies. These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions resulting from the regulators' judgments based on information available to them at the time of their examination. NET INCOME PER COMMON SHARE Effective June 30, 1998, the Company adopted a new accounting standard, SFAS No. 128,"Earnings Per Share" which replaces retroactively the presentation of primary earnings per share (EPS) and fully diluted EPS. Basic EPS represents net income divided by the weighted average common shares outstanding during the period excluding any potential dilutive effects. Diluted EPS gives effect to all potential issuances of common stock that would have caused basic EPS to be lower as if the issuance had already occurred. Accordingly, diluted EPS reflects as increase in the weighted average shares outstanding due to the assumed exercise of stock options and the vesting of restricted stock. 20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) The Company recognizes compensation expense when shares are committed to be released to directly compensate employees in an amount equal to the fair value of the shares so committed. The difference between the amount of compensation expense and the cost of the shares released is recorded as additional paid-in capital. Therefore, total shareholders' equity is not affected. MANAGEMENT RECOGNITION PLAN (MRP) The Company recognizes compensation expense over the vesting period of the shares awarded equal to the fair value of the shares at the date of allocation. POSTRETIREMENT BENEFITS The estimated obligation for postretirement health care and life insurance benefits is determined based on an actuarial computation of the cost of current and future benefits for employees and retirees. Such costs are charged to expense during the years that the employees provide service. RECLASSIFICATIONS Certain reclassifications of prior year financial data have been made to conform to the current reporting practices of the Company. RECENT ACCOUNTING PRONOUNCEMENTS SFAS No. 130, "Reporting Comprehensive Income." Comprehensive income is comprised of net income and all changes to stockholders' equity, except those due to investments by owners (changes in paid-in capital) and distributions to owners (dividends). This statement requires that all components of comprehensive income and total comprehensive income be reported in the financial statements. The Company will adopt this statement in the year ended June 30, 1999. Management does not believe that the adoption of this statement will have a material impact on the financial position or results of operations of the Company. SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information." This statement requires public companies to report certain information about operating segments as well as certain information about products, services and major customers in their financial statements. The Company will adopt this statement in the year ended June 30, 1999. Management does not believe that the adoption of this statement will have a material impact on the financial position or results of operations of the Company. SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes new accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. The Company must adopt this statement in the year ended June 30, 2000. Management will evaluate the impact of SFAS 133, if any, on its consolidated financial reporting during fiscal 1999. 2. INVESTMENT SECURITIES (DOLLARS IN THOUSANDS) The amortized and estimated fair value of investment securities as of June 30, 1998 were as follows: June 30, 1998 - ----------------------------------------------------------------------------- Gross Gross Estimated Book Unrealized Unrealized Fair Carrying Value Gains (Losses) Value Value - ----------------------------------------------------------------------------- Held to maturity securities U.S. Treasury securities and obligations of other U.S. government agencies and corporations $73,975 $ 56 $(147) $73,884 $73,975 Other 53 11 - 64 53 - ----------------------------------------------------------------------------- Total held to maturity 74,028 67 (147) 73,948 74,028 - ----------------------------------------------------------------------------- Available for sale securities FHLMC stock 20 921 - 941 941 FNMA stock 1 84 - 85 85 Real Estate Investment Trust 500 - - 500 500 - ----------------------------------------------------------------------------- Total available for sale 521 1,005 - 1,526 1,526 - ----------------------------------------------------------------------------- Total investment securities $74,549 $1,072 $(147) $75,474 $75,554 ============================================================================= 21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The book value and estimated market value of investment securities as of June 30, 1997 were as follows: June 30, 1997 - ----------------------------------------------------------------------------- Gross Gross Estimated Book Unrealized Unrealized Fair Carrying Value Gains (Losses) Value Value - ----------------------------------------------------------------------------- Held to maturity securities U.S. Treasury securities and obligations of other U.S. government agencies and corporations $33,553 $ 53 $(36) $33,570 $33,553 Other 92 2 - 94 92 - ----------------------------------------------------------------------------- Total held to maturity 33,645 55 (36) 33,664 33,645 - ----------------------------------------------------------------------------- Available for sale securities FHLMC stock 20 680 - 700 700 FNMA stock 1 60 - 61 61 - ----------------------------------------------------------------------------- Total available for sale 21 740 - 761 761 - ----------------------------------------------------------------------------- Total investment securities $33,666 $795 $(36) $34,425 $34,406 ============================================================================= The maturities of investment securities were as follows: June 30, 1998 June 30, 1997 - ----------------------------------------------------------------------------- Amortized Market Amortized Market Cost Value Cost Value - ----------------------------------------------------------------------------- Due in one year $11,003 $11,009 $23,096 $23,183 Due after one through five years 20,977 21,017 10,549 10,481 Due beyond five years 42,048 41,922 - - - ----------------------------------------------------------------------------- $74,028 $73,948 $33,645 $33,664 ============================================================================= 22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. LOANS HELD FOR INVESTMENT (DOLLARS IN THOUSANDS) Loans held for investment consisted of the following: June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Residential real estate - single family $507,194 $402,296 Residential real estate - multi-family 46,635 52,564 Commercial real estate 42,696 47,887 Real estate construction 13,746 5,778 Commercial business lending 2,819 991 Consumer 19,824 16,749 Other 422 289 - ----------------------------------------------------------------------------- 633,336 526,554 Less: Undisbursed loan funds 7,320 3,695 Deferred loan fees (268) 102 Unearned discounts on loans purchased (30) 145 Allowance for loan losses 6,186 5,465 - ----------------------------------------------------------------------------- $620,128 $517,147 ============================================================================= Fixed rate loans comprised 22% and 14%, respectively, of the loan portfolio at June 30, 1998 and 1997. The following summarizes the components of the net change in the allowance for loan losses: Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------- Balance, beginning of period $ 5,465 $ 5,452 $ 5,085 Provision for losses 1,200 1,254 2,261 Recoveries 404 136 589 (Charge-offs) (883) (1,377) (2,483) - ----------------------------------------------------------------------------- Balance, end of period $ 6,186 $ 5,465 $ 5,452 ============================================================================= 23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The effect of nonaccrual and restructured loans on interest income for the years ended June 30, 1998, 1997 and 1996 is presented below: Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------- Contractual interest due $ 899 $ 871 $ 814 Interest recognized 547 539 589 - ----------------------------------------------------------------------------- Net interest foregone $ 352 $ 332 $ 225 ============================================================================= At June 30, 1998 and 1997, there were no commitments to lend additional funds to those borrowers whose loans were classified as impaired. The following table identifies the Company's total recorded investment in impaired loans, net of specific allowances, by type at June 30: June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Non-accrual loans: Single family $ 1,669 $ 3,667 Multi-family - 1,176 Commercial 245 144 Non-mortgage 18 150 Restructured loans: Single family - 268 Multi-family - - Commercial 2,074 4,642 Non-mortgage - - Other impaired loans: Single family 114 116 Multi-family 146 150 Commercial - - Non-mortgage - - - ----------------------------------------------------------------------------- Total impaired loans $ 4,266 $ 10,313 ============================================================================= 24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS During the years ended June 30, 1998 and 1997, the Company's average investment in impaired loans was $7,212 and $10,054, respectively, and interest income recorded during this period was $574 and $581, respectively. The Company records interest on non-accrual loans utilizing the cash basis method of accounting during periods when the loans are in non-accrual status. In the ordinary course of business, the Bank makes loans to its directors, officers and employees at substantially the same terms prevailing at the time of origination for comparable transactions with borrowers. The following is a summary of related party loan activity: Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------- Balance, beginning of period $ 1,825 $ 2,462 $ 2,315 Originations 1,364 43 471 Payments (105) (340) (90) Termination (343) (340) (234) - ----------------------------------------------------------------------------- Balance, end of period $ 2,741 $ 1,825 $ 2,462 ============================================================================= 4. MORTGAGE BANKING (DOLLARS IN THOUSANDS) The following summarizes the unpaid principal balance of loans serviced by the Company: Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------- Loans serviced for Federal Home Loan Mortgage Corporation $149,730 $189,586 $221,019 Loans serviced for Federal National Mortgage Association 233,066 274,348 305,446 Loans serviced for other investors 51,905 66,384 74,632 - ----------------------------------------------------------------------------- $434,701 $530,318 $601,097 ============================================================================= Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and foreclosure processing. Loan servicing income includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees. The Company held borrowers' escrow balances related to loans serviced for others of $754 and $882 as of June 30, 1998 and 1997, respectively. These escrow balances are included in deposits in the accompanying consolidated balance sheet. 25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The composition of loans sold was as follows: Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------- Loans sold Servicing - released $424,246 $341,471 $437,917 Servicing - retained 428 1,539 16,127 - ----------------------------------------------------------------------------- $424,674 $343,010 $454,044 ============================================================================= Loans receivable available for sale consisted of the following: June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Adjustable rate $ 153 $ 4,128 Fixed rate 67,095 15,856 - ----------------------------------------------------------------------------- $ 67,248 $ 19,984 ============================================================================= 5. REAL ESTATE AVAILABLE FOR SALE (DOLLARS IN THOUSANDS) Real estate consisted of the following: June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Foreclosed real estate $ 4,909 $ 2,761 Investment real estate 2,624 3,504 - ----------------------------------------------------------------------------- 7,533 6,265 - ----------------------------------------------------------------------------- Allowance for estimated losses: Foreclosed real estate (462) (126) Investment real estate (149) (463) - ----------------------------------------------------------------------------- (611) (589) - ----------------------------------------------------------------------------- $ 6,922 $ 5,676 ============================================================================= The following summarizes the components of the net change in the allowance for losses on real estate: Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------- Balance, beginning of period $ 589 $ 755 $ 1,342 Provisions for losses 326 306 239 Charge-offs (304) (472) (826) - ----------------------------------------------------------------------------- Balance, end of period $ 611 $ 589 $ 755 ============================================================================= 26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. PREMISES AND EQUIPMENT (DOLLARS IN THOUSANDS) Premises and equipment consisted of the following: June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Land $ 2,648 $ 2,564 Buildings 6,812 6,678 Leasehold improvements 578 491 Furniture and equipment 8,736 7,594 Automobiles 146 180 - ----------------------------------------------------------------------------- 18,920 17,507 Less accumulated depreciation and amortization (11,491) (10,682) - ----------------------------------------------------------------------------- $ 7,429 $ 6,825 ============================================================================= 7.DEPOSITS (DOLLARS IN THOUSANDS) June 30, 1998 June 30, 1997 - ----------------------------------------------------------------------------- Interest Rate Amount Interest Rate Amount - ----------------------------------------------------------------------------- Checking deposits 0%-3.20% $ 56,630 0%-1.00% $ 26,382 Passbook deposits 1.98%-4.78% 62,201 2.08%-2.96% 45,898 Money market deposits 2.37%-4.51% 71,493 1.00%-4.55% 85,995 Term deposits Under $100,000 2.00%-8.00% 308,484 2.62%-8.00% 281,946 $100,000 and over 4.40%-8.00% 84,217 4.40%-8.00% 68,538 - ----------------------------------------------------------------------------- $583,025 $508,759 ============================================================================= Weighted average interest rate on deposits 4.67% 4.79% ============================================================================= On March 26, 1998, the Bank assumed $16 million in deposits in connection with its purchase of the Blythe branch of Bank of America and subsequently merged its operations in Blythe. The aggregate annual maturities of term accounts are as follows: June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Within one year $336,618 $288,178 One to two years 36,257 37,173 Two to three years 3,720 13,278 Three to four years 9,151 3,255 Thereafter 6,955 8,599 - ----------------------------------------------------------------------------- $392,701 $350,483 ============================================================================= Interest expense is summarized as follows: Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------- Checking $ 223 $ 229 $ 203 Term deposits 21,025 18,036 18,027 Money market deposits 3,247 3,490 4,034 Passbook deposits 1,216 1,357 1,743 - ----------------------------------------------------------------------------- $ 25,711 $ 23,112 $ 24,007 ============================================================================= 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company is required to maintain cash and reserve balances with the Federal Reserve Bank. Such reserve is calculated based on deposit levels and amounted to $1,585 and $903 at Junea30, 1998 and 1997, respectively. 8. BORROWINGS (DOLLARS IN THOUSANDS) Borrowings consisted of the following: June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Advances from Federal Home Loan Bank $132,114 $ 6,828 Advances from the Federal Home Loan Bank were collateralized by pledges of certain real estate loans with an aggregate principal balance at June 30, 1998 and 1997 of $331,855 and $207,129, respectively. The Bank's overall borrowing capacity which is limited to 30% of total assets, as reported on the Bank's quarterly thrift financial reports, is approximately $241,357 and $178,530 at June 30, 1998 and 1997, respectively. As a member of the FHLB system, the Bank is required to maintain a minimum investment in FHLB stock. The investment exceeds the required level by $9 and $188 at June 30, 1998 and 1997, respectively. Any excess may be redeemed by the Bank or called by FHLB at par. The aggregate annual maturities of advances are as follows: June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Within one year $121,500 $ 6,500 One to two years 10,260 Two to three years 260 Over three years 354 68 - ----------------------------------------------------------------------------- $132,114 $ 6,828 ============================================================================= Weighted average interest rate 5.70% 5.82% ============================================================================= 9. INCOME TAXES (DOLLARS IN THOUSANDS) The provision for income taxes consisted of the following: Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------- Current: Federal $ 3,376 $ 1,339 $ 1,244 State 1,001 270 111 - ----------------------------------------------------------------------------- 4,377 1,609 1,355 - ----------------------------------------------------------------------------- Deferred: Federal (649) (62) (95) State (23) (387) 72 - ----------------------------------------------------------------------------- (672) (449) (23) - ----------------------------------------------------------------------------- Provision (benefit) for income taxes $ 3,705 $ 1,160 $ 1,332 ============================================================================= 28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The provision for income taxes differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to pre-tax income from continuing operations as a result of the following differences: Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------- Federal statutory income tax rate 34.0% 34.0% 34.0% State taxes net of Federal tax effect 7.2% 7.3% 2.9% Release of state valuation allowance (9.8%) Life insurance proceeds (10.7%) Other 1.3% 5.9% 6.0% - ----------------------------------------------------------------------------- Effective income tax rate 42.5% 37.4% 32.2% ============================================================================= Deferred tax liabilities (assets) by jurisdiction were as follows: June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Deferred taxes - federal $ (1,264) $ (934) Deferred taxes - state (632) (774) - ----------------------------------------------------------------------------- $ (1,896) $ (1,708) ============================================================================= Deferred tax liabilities (assets) were comprised of the following: June 30, - ----------------------------------------------------------------------------- 1997 1996 - ----------------------------------------------------------------------------- State taxes $ - $ 216 Depreciation 299 474 Federal Home Loan Bank dividends 1,498 1,374 Unrealized Gain on Securities 412 - - ----------------------------------------------------------------------------- Total deferred tax liabilities 2,209 2,064 - ----------------------------------------------------------------------------- State Tax (79) - Market value adjustments (94) (230) Loss reserves (2,705) (2,675) Deferred compensation (694) (667) Investment in real estate (141) (142) Other (392) (58) - ----------------------------------------------------------------------------- Total deferred tax assets (4,105) (3,772) - ----------------------------------------------------------------------------- Net deferred tax assets $ (1,896) $ (1,708) ============================================================================= 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. CAPITAL (DOLLARS IN THOUSANDS) Retained earnings at June 30, 1998 and 1997 included approximately $9,019 for which federal income tax of approximately $3,066 had not been provided. If the amounts that qualify as deductions for federal income tax purposes are later used for purposes other than for bad debt losses, including distribution in liquidation, they will be subject to federal income tax at the then current corporate tax rate. If those amounts are not so used, they will not be subject to tax even in the event the Company were to convert its charter. Federal regulations require that investments in subsidiaries conducting real estate investments and joint venture activities be phased out by 1996 or, that institutions conducting such activities maintain sufficient capital over the minimum regulatory requirements. The Company maintains capital in excess of the minimum requirements. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under 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 weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of June 30, 1998, that the Bank meets all capital adequacy requirements to which it is subject. Various adjustments are required to be made to retained earnings and total assets for computing these capital ratios, depending on an institution's capital and asset structure. The adjustment presently applicable to the Bank is for equity investments in real estate. In addition, in calculating risk-based capital, general loss allowances are includable as capital on a limited basis. As of June 30, 1998, the most recent notification from the Office of the Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, core, and tangible leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. The Bank's actual capital amounts and ratios as of June 30, 1998 and 1997 are as follows: To Be Well Capitalized Under Prompt Corrective Actual Action Provisions - ----------------------------------------------------------------------------- Amount Ratio Amount Ratio - ----------------------------------------------------------------------------- As of June 30, 1998 Risk based Capital (to risk weighted assets) $ 70,940 14.12% $ 50,240 Greater than 10.0% or equal to Core Capital (Tier I) (to total assets) 64,754 8.09% 40,032 Great than 5.0% or equal to Tier I leverage (to average assets) 64,754 9.32% 34,756 Greater than 5.0% or equal to Tier I capital (to risk weighted assets) 64,754 12.89% 30,144 Greater than 6.0% or equal to Tangible Capital (to total assets) 64,754 8.09% 32,035 Greater than 4.0% or equal to As of June 30, 1997 Risk based Capital (to risk weighted assets) $ 63,293 16.12% $ 39,268 Greater than 10.0% or equal to Core Capital (Tier I) (to total assets) 58,377 9.89% 29,513 Greater than 5.0% or equal to Tier I leverage (to average assets) 58,377 10.21% 28,586 Greater than 5.0% or equal to Tier I capital (to risk weighted assets) 58,377 14.87% 23,561 Greater than 6.0% or equal to Tangible Capital (to total assets) 58,377 9.89% 23,610 Greater than 4.0% or equal to 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. BENEFIT PLANS (DOLLARS IN THOUSANDS) The Company has a 401(k) defined-contribution plan covering all employees meeting specific age and service requirements. Under the plan, employees may contribute up to 10% of their pre-tax compensation. The Company makes matching contributions up to 3% of participants' pre-tax compensation. Participants vest immediately in their own contributions with 100% vesting in the Company's contributions occurring after 6 years of credited service. The Company's expense for these plans was approximately $142, $13, and $550 for the years ended Junea30, 1998, 1997 and 1996, respectively. The Company has severance agreements with certain of its officers which are renewable on an annual basis at the Company's option and a multi-year employment contract with one executive officer. The Company has an unfunded obligation of approximately $2,228 and $1,745 at Junea30, 1998 and 1997, respectively, to pay certain benefits upon retirement. Actuarially determined retirement costs are being accrued and expensed annually. EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) As part of the conversion, an ESOP was established for all employees who are age 21 or older and have completed one year of service with the Company during which they have served a minimum of 1,000 hours. The ESOP borrowed $4,100 from the Company to purchase 410,017 shares of the common stock issued in the conversion. The loan will be repaid principally from the Company's contributions to the ESOP over a period of 15 years. At June 30, 1998, the outstanding balance on the loan was $3,619. Shares purchased with the loan proceeds are held in an unearned ESOP shares account and released on a pro rata basis as the loan is repaid. Contributions to the ESOP and shares released from the unearned ESOP shares account are allocated among participants on the basis of compensation, as described in the plan, in the year of allocation. Benefits generally become 100% vested after six years of credited service. Vesting will accelerate upon retirement, death or disability of the participant or in the event of a change in control of the Company. Forfeitures will be reallocated among remaining participating employees in the same proportion as contributions. Benefits may be payable upon death, retirement, early retirement, disability or separation from service. Since the annual contributions are discretionary, the benefits payable under the ESOP cannot be estimated. The expense related to the ESOP totaled $579 and $338 for the years ending Junea30, 1998 and 1997. At June 30, 1998, the unearned ESOP shares account of $3,449 is reported as a reduction of stockholders' equity. The table below reflects ESOP activity for the period indicated: Year Ended June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Unallocated shares at beginning of period 371,964 395,234 Allocated 27,052 23,270 - ----------------------------------------------------------------------------- Unallocated shares at end of period 344,912 371,964 ============================================================================= The fair value of unallocated ESOP shares totaled $7,157 and $6,184 at June 30, 1998 and 1997, respectively. 12. INCENTIVE PLANS MANAGEMENT RECOGNITION PLAN AND TRUST (MRP) The Company has established the 1996 Management Recognition Plan ("MRP") to provide key employees and eligible directors with a propriety interest in the growth, development and financial success of the Company through the award of restricted stock. The Company acquired 205,000 shares of its common stock in the open market to fund the MRP. At June 30, 1998, 184,910 shares had been awarded with a weighted average fair value at the date of grant of $20.00 per share. Awarded shares vest over a five-year period as long as the employee or director remain an employee or director of the Company. The Company recognizes compensation expense for the MRP based on the fair value of the shares at grant date. MRP compensation expense for the year ended June 30, 1998 was $493. 31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS STOCK OPTION PLAN The Company has established the 1996 Stock Option Plan ("Plan") for certain of its directors and key employees under which up to 512,522 shares of common stock have been authorized to be granted. Under the Plan, options may not be granted at a price less than the fair market value at the date of grant. Options are exercisable in equal installments over a five-year period as long as the employee or director remain an employee or director of the Company. The maximum term of the options granted during 1997 is 10 years. The following is a summary of changes in options outstanding: Weighted Number of Average Shares Price - ----------------------------------------------------------------------------- Outstanding at July 1, 1996 -- $ -- Granted (weighted average fair value of $8.38) 356,500 15.25 - ----------------------------------------------------------------------------- Outstanding at June 30, 1997 356,500 15.25 Granted (weighted average fair value of $10.93) 75,000 20.59 Cancelled 46,000 15.25 - ----------------------------------------------------------------------------- Outstanding at June 30, 1998 385,500 $16.29 - ----------------------------------------------------------------------------- For outstanding options the weighted average remaining contractual life was 8.77 years. There were 62,100 shares under options that were exercisable at June 30, 1998. At June 30, 1998 127,022 shares were available for future grants under the Plan. ADDITIONAL STOCK OPTION PLAN INFORMATION The Company adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123 "Accounting for Stock Based Compensation" (SFAS No. 123) in 1997. As permitted by SFAS No. 123, the Company continues to measure compensation cost in accordance with Accounting Principles Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25), but provides pro forma disclosures of net income and earnings per share as if the fair method (as defined in SFAS No. 123) had been applied beginning in 1997. The Company has calculated the fair value of stock-based awards to employees using the Black-Scholes option pricing model with the following weighted average assumptions: 5 year expected life; stock volatility, 28% and 27% in 1998 and 1997, respectively; risk free interest rates, 5.5% and 6.6% in 1998 and 1997, respectively; and no dividends during the expected term. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. If the computed fair values of the awards had been amortized to expense over the vesting period of the awards, pro forma net income and basic earnings per share would have been $4,505 and $1.03 per share in 1998 and $1,789 and $0.38 per share in 1997. 13. EARNINGS PER SHARE As of December 15, 1997, the Company adopted SFAS No. 128, "Earnings per Share." SFAS No. 128 simplifies the standards for computing earnings per share previously found in APB Opinion No. 15, "Earnings per Share." It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator for the basic and diluted EPS computations. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would then share in the earnings of the entity. 32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Year Ended June 30, 1998 Income Shares Per Share (numerator) (denominator) Amount - ----------------------------------------------------------------------------- NET INCOME $5,020 - ----------------------------------------------------------------------------- BASIC EPS Net income available to common shareholders $5,020 4,388,090 $1.14 ============================================================================= EFFECT OF DILUTIVE SHARES Stock options 94,222 Restricted stock awards 19,701 - ----------------------------------------------------------------------------- DILUTED EPS Net income to common shareholders plus assumed conversion $5,020 4,502,013 $1.11 ============================================================================= For the Year Ended June 30, 1998 - ----------------------------------------------------------------------------- Income Shares Per Share (numerator) (denominator) Amount - ----------------------------------------------------------------------------- NET INCOME $1,941 - ----------------------------------------------------------------------------- BASIC EPS Net income available to common shareholders $1,941 4,705,043 $0.41 ============================================================================= EFFECT OF DILUTIVE SHARES Stock options 40,309 - ----------------------------------------------------------------------------- DILUTED EPS Net income to common shareholders plus assumed conversions $1,941 4,745,352 $0.41 ============================================================================= 14. COMMITMENTS AND CONTINGENCIES (DOLLARS IN THOUSANDS) The Company is involved in various legal matters associated with its normal operations. In the opinion of management, these matters will be resolved without material effect on the Company's financial position. 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company conducts a portion of its operations in leased facilities under noncancellable agreements classified as operating leases. In addition, the Company leases data processing equipment under operating leases expiring during the next five years. The following is a schedule of minimum rental payments under such operating leases which expire at various dates: June 30, 1998 - ----------------------------------------------------------------------------- Fiscal Year 1999 $ 507 2000 343 2001 174 2002 137 2003 100 Thereafter 182 - ----------------------------------------------------------------------------- Total minimum payments required $1,443 ============================================================================= Lease expense under operating leases approximated $679, $656, and $390 for the years ended Junea30, 1998, 1997 and 1996, respectively. 15. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (DOLLARS IN THOUSANDS) The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, in the form of originating loans or providing funds under existing lines of credit, and forward commitments to sell loans to third parties. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the accompanying consolidated balance sheet. The Company's exposure to credit loss, in the event of nonperformance by the other party to these financial 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS instruments is represented by the contractual notional amount of these instruments. The Company uses the same credit policies in making commitments to extend credit as it does for on-balance sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as all conditions have been met in the contract. These commitments generally have expiration dates within 60 days of the commitment date and may require the payment of a fee. Since some of these commitments are expected to expire, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. At June 30, 1998 and 1997, interest rates on commitments to lend ranged from 6.00% to 10.85% and 5.50% to 12.99%, respectively. In an effort to minimize its exposure to interest rate fluctuations on fixed rate loans originated for sale, the Company enters into forward agreements to sell certain dollar amounts of fixed rate loans to third parties. These agreements specify the minimum maturity of the loans, yield to purchaser and servicing spread to the Company (if servicing is retained), and the maximum principal amount of individual loans. The Company typically satisfies these forward sale agreements with its current production; at June 30, 1998 and 1997 the aggregate amount of loans available for sale and of commitments to originate exceeded the Company's forward sales commitments to sell loans. At June 30, 1998 and 1997, interest rates on commitments to sell loans ranged from 6.00% to 11.00% and 5.75% to 12.25%, respectively. The Company is exposed to interest rate risk on fixed rate commitments to originate loans for sale to the extent forward sale agreements have not been entered into. To minimize this risk, the Company purchases over the counter put options with option periods that generally coincide with the terms of the commitments to originate loans. The contract or notional amount of these instruments reflect the extent of involvement the Company has in this particular class of financial instruments. The Bank's exposure to loss on these financial instruments is limited to the premiums paid. Premiums paid and deferred gains on put options are recorded as an adjustment to the carrying value of loans available for sale and recognized in earnings when the loan is sold. At June 30, 1998, the notional principal amount of options outstanding was $3,000. There were no options outstanding at June 30, 1997. In addition to construction loans in process, the Company had the following outstanding commitments: June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Commitments to originate mortgage loans: Fixed rate $ 38,385 $ 31,070 Adjustable rate 6,537 19,902 44,922 50,972 - ----------------------------------------------------------------------------- Unused lines of credit 9,529 7,569 Commitments to sell loans 65,965 22,298 16. FAIR VALUES OF FINANCIAL INSTRUMENTS (DOLLARS IN THOUSANDS) The reported fair values of financial instruments are based on various factors. In some cases, fair values represent quoted market prices for identical or comparable instruments. In other cases, fair values have been estimated based on assumptions concerning the amount and timing of estimated future cash flows, assumed discount rates and other factors reflecting varying degrees of risk. The estimates are subjective in nature and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Accordingly, the reported fair values may not represent actual values of the financial instruments that could have been realized as of year end or that will be realized in the future. The following methods and assumptions were used to estimate the fair value of each class of significant financial instruments: 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Cash and due from banks, federal funds sold, interest bearing deposits with banks: The carrying amount of these financial assets approximates the fair value. Investment securities: The fair value of investment securities is based on quoted market prices or dealer quotes. Loans available for sale: Fair values for loans are based on quoted market prices. Forward commitments to sell loans have been considered in the determination of the estimated fair value of loans available for sale. Loans held for investment: For loans that reprice frequently at market rates, the carrying amount approximates the fair value. For fixed-rate loans, the fair value is determined by either (i) discounting the estimated future cash flows of such loans, using a current interest rate at which such loans would be made to borrowers over estimated remaining contractual maturities, or (ii) quoted market prices. The allowance for loan losses is subtracted as an estimate of the underlying credit risk. Accrued interest receivable: The carrying value for accrued interest receivable approximates fair value because of the short-term nature of the financial instruments. Federal Home Loan Bank stock: The carrying amount reported for FHLB stock approximates fair value. If redeemed, the Company will receive an amount equal to the par value of the stock. Deposits: The fair value of demand and savings deposits is the amount payable on demand at the reporting date. The carrying amount for variable-rate, fixed-term time deposit accounts approximates fair value. The fair value of fixed-rate time deposits is estimated using a discounted cash flow calculation. The discount rate on such deposits is based upon rates currently offered for deposits of similar remaining maturities. Borrowings: The fair value of borrowings has been estimated using a discounted cash flow calculation. The discount rate on such borrowings is based upon rates currently offered for borrowings of similar remaining maturities. The fair value of securities sold under agreements to repurchase is the carrying amount at the reporting date since these agreements were repaid within one month of the reporting date. Commitments: Commitments to extend credit at June 30, 1998 are offered at substantially the same rates and terms of commitments offered on June 30, 1998 to parties of similar credit worthiness. Therefore, it is presumed that no significant difference exists between the carrying and fair value. See Note 14. The carrying amount and fair values of the Company's financial instruments were as follows: June 30, 1998 June 30, 1997 - ----------------------------------------------------------------------------- Carrying Market Carrying Market Amount Value Amount Value - ----------------------------------------------------------------------------- FINANCIAL ASSETS: Cash $ 23,433 $ 23,433 $ 20,111 $ 20,111 Investment securities 74,028 73,948 33,645 33,664 Loans receivable available for sale 67,248 68,035 19,984 20,188 Loans held for investment 620,128 621,340 517,147 518,981 Accrued interest receivable 4,940 4,940 3,378 3,378 FHLB stock 6,606 6,606 4,879 4,879 FINANCIAL LIABILITIES: Deposits 583,025 585,237 508,759 509,462 Borrowings 132,114 132,118 6,828 6,841 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. CONVERSION (DOLLARS IN THOUSANDS) In connection with the conversion (see Note 1), the Company issued and sold to the public 5,125,215 shares of its common stock (par value $.01 per share) at a price of $10.00 per share. The proceeds, net of $1,474 in conversion costs, received by the Company from the issuance amounted to $49,779. Prior to the completion of the conversion, Provident Financial Holdings, Inc. had no assets or liabilities and did not conduct any business other than of an organizational nature. At the time of the conversion, the Bank established a liquidation account in the amount of $40,000 which was equal to its total retained earnings as of May 31, 1996. The liquidation account will be maintained for the benefit of eligible account holders who continue to maintain their accounts at the Bank after the conversion. The liquidation account will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder's interest in the liquidation account. In the event of a complete liquidation, each eligible account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. The Company may not declare or pay cash dividends on or repurchase any of its shares of common stock, if the effect would cause stockholder's equity to be reduced below applicable regulatory capital maintenance requirements or if such declaration and payment would otherwise violate regulatory requirements. 18. HOLDING COMPANY CONDENSED FINANCIAL INFORMATION (DOLLARS IN THOUSANDS) This information should be read in conjunction with the other notes to the consolidated financial statements. The following is the condensed balance sheet for Provident Financial Holdings, Inc. (Holding Company only) as of June 30, 1998 and 1997 and condensed statements of operations and cash flows for the year ended June 30, 1998. CONDENSED BALANCE SHEETS June 30, - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- ASSETS Cash $ 2,176 $ 792 Investment securities held to maturity 12,003 18,171 Investment securities available for sale 500 -- Investment in subsidiary 68,337 63,165 Other assets 3,788 3,931 - ----------------------------------------------------------------------------- $ 86,804 $ 86,059 ============================================================================= LIABILITIES AND STOCKHOLDERSAE EQUITY Other liabilities $ 748 $ 612 - ----------------------------------------------------------------------------- Stockholders' equity 86,056 85,447 - ----------------------------------------------------------------------------- $ 86,804 $ 86,059 ============================================================================= 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED STATEMENT OF OPERATIONS Year ended Year ended June 30, June 30, 1998 1997 - ----------------------------------------------------------------------------- Interest and other income $ 1,143 $ 1,470 General and administrative expense 297 185 - ----------------------------------------------------------------------------- Income before equity in earnings of the subsidiary 846 1,285 Equity in earnings of the subsidiary 4,599 1,267 - ----------------------------------------------------------------------------- Income before income taxes 5,445 2,552 Income taxes 425 611 - ----------------------------------------------------------------------------- Net income $ 5,020 $ 1,941 ============================================================================= CONDENSED STATEMENT OF CASH FLOWS Year Ended Year Ended June 30, June 30, 1998 1997 - ----------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 5,020 $ 1,941 Adjustments to reconcile net earnings to cash used by operating activities: Equity in earnings of the subsidiary (4,599) (1,267) Decrease in other assets 143 1,561 Increase in other liabilities 136 562 - ----------------------------------------------------------------------------- Net cash provided by operating activities 700 2,797 - ----------------------------------------------------------------------------- Cash flow from investing activities: Purchase of investing securities held to maturity (15,390) (64,445) Maturity of investing securities held to maturity 21,557 64,247 Purchase of investment securities available for sale (500) - - ----------------------------------------------------------------------------- Net cash used by investing activities 5,667 (198) - ----------------------------------------------------------------------------- Cash flow from financing activities: Treasury stock purchases (4,983) (3,291) - ----------------------------------------------------------------------------- Net decrease in cash during the year 1,384 (692) Cash and cash equivalents, beginning of year 792 1,484 - ----------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 2,176 $ 792 ============================================================================= 38
SHAREHOLDER INFORMATION MARKET FOR COMMON STOCK The common stock of Provident Financial Holdings, Inc. is listed on the NASDAQ Stock Market under the symbol of PROV. The following table provides the high and low stock prices for PROV during the last two fiscal years. First Second Third Fourth (September 30,) (December 31,) (March 31,) (June 30,) - ----------------------------------------------------------------------------- 1998 QUARTERS High $20.13 $22.25 $24.25 $24.13 Low 16.75 19.56 20.00 20.13 1997 QUARTERS High 12.63 14.63 17.25 17.38 Low 10.13 12.38 13.75 14.13 - ----------------------------------------------------------------------------- ANNUAL MEETING The annual meeting of shareholders will be held at the Riverside Art Museum at 3425 Mission Inn Avenue, Riverside, California on Tuesday, October 27, 1998, at 11:00 a.m. A formal notice of the meeting, together with a proxy statement and proxy form, will be mailed to shareholders. CORPORATE OFFICES Provident Financial Holdings, Inc. 3756 Central Avenue Riverside, CA 92506 (909) 686-6060 CORPORATE COUNSEL Breyer & Aguggia 1300 I Street, N.W. Washington, D.C. 20005 INDEPENDENT ACCOUNTANTS PricewaterhouseCoopers LLP 400 South Hope Street Los Angeles, CA 90071 TRANSFER AGENT Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016 (908) 497-2300 MARKET INFORMATION Provident Financial Holdings, Inc. is traded on the NASDAQ Stock Market under the symbol of PROV. FINANCIAL INFORMATION Requests for copies of forms 10-K and 10-Q filed with the Securities and Exchange Commission should be directed in writing to: Brian M. Riley Chief Financial Officer Provident Financial Holdings, Inc. 3756 Central Avenue Riverside, CA 92506 CORPORATE PROFILE Provident Financial Holdings, Inc. ("Corporation"), a Delaware corporation, was organized in January 1996 for the purpose of becoming the holding company for Provident Savings Bank, F.S.B. ("Savings Bank") upon the Savings Bank's conversion from a federal mutual to a federal stock savings bank ("Conversion"). The Conversion was completed on June 27, 1996. The Corporation does not engage in any significant activity other than holding the stock of the Savings Bank. The Savings Bank serves the banking needs of select communities in Riverside and San Bernardino Counties and has mortgage lending operations in Southern California and Nevada. 39
BOARD OF DIRECTORS AND SENIOR OFFICERS BOARD OF DIRECTORS Bruce W. Bennett President Community Care & Rehabilitation Center Craig G. Blunden Chairman, President & CEO Provident Savings Bank, FSB Debbi H. Guthrie President Roy O. Huffman Roofing Company Robert G. Schrader Executive Vice President & Chief Operating Officer Provident Savings Bank, FSB Roy H. Taylor President Talbot-Goldware & Taylor Insurance William E. Thomas Partner Burke, Williams & Sorenson, LLP SENIOR OFFICERS PROVIDENT FINANCIAL HOLDINGS, INC.: Craig G. Blunden Chairman, President & CEO Brian M. Riley Chief Financial Officer Robert G. Schrader Corporate Secretary PROVIDENT SAVINGS BANK, FSB: Craig G. Blunden Chairman, President & CEO Robert G. Schrader Executive Vice President & Chief Operating Officer Donald L. Blanchard Senior Vice President Retail Banking Lil Brunner Senior Vice President Chief Information Officer Richard L. Gale Senior Vice President Mortgage Banking Brian M. Riley Senior Vice President Chief Financial Officer 40
PROVIDENT BANK BRANCH LOCATIONS CORPORATE OFFICE 3756 Central Avenue Riverside, CA 92506 DOWNTOWN BUSINESS CENTER 4001 Main Street Riverside, CA 92501 CANYON CREST 5225 Canyon Crest Drive #86 Riverside, CA 92507 MORENO VALLEY 12460 Heacock Street Moreno Valley, CA 92553 MORENO VALLEY NORTH 23575 Sunnymead Ranch Pkwy. Moreno Valley, CA 92557 REDLANDS 125 E. Citrus Avenue Redlands, CA 92373 SUN CITY 27010 Sun City Boulevard Sun City, CA 92586 HEMET 1690 E. Florida Avenue Hemet, CA 92544 RANCHO MIRAGE 71-991 Highway 111 Rancho Mirage, CA 92270 BLYTHE 350 E. Hobson Way Blythe, CA 92225 CUSTOMER INFORMATION LINE 1-800-442-5201 PROFED MORTGAGE BRANCH LOCATIONS DIVISION OFFICE 3756 Central Avenue Riverside, CA 92506 WHOLESALE OFFICES ----------------- RANCHO CUCAMONGA 10390 Commerce Center Drive Suite 190 Rancho Cucamonga, CA 91730 RETAIL OFFICES -------------- LAKE FOREST - PACIFIC SUNBELT 23201 Lake Center Drive Suite 100 Lake Forest, CA 92630 LAS VEGAS - PACIFIC SUNBELT 7720 West Sahara Avenue Suite 106 Las Vegas, NV 89117 RANCHO CUCAMONGA 10390 Commerce Center Drive Suite 280 Rancho Cucamonga, CA 91730 RANCHO MIRAGE 71-991 Highway 111 Rancho Mirage, CA 92270 REDLANDS 501 W. Redlands Blvd., Suite G Redlands, CA 92373 SANTA ANA 1450 N. Tustin Avenue, Suite 212 Santa Ana, CA 92705 TORRANCE 22805 Hawthorne Blvd. Torrance, CA 90505 RIVERSIDE 2915 Van Buren Blvd., Suite J-2 Riverside, CA 92503 41
EXHIBIT 21 Subsidiaries of the Registrant
Parent - ------ Provident Financial Holdings, Inc. Percentage Jurisdiction or Subsidiaries (a) of Ownership State of Incorporation - ---------------- ------------ ---------------------- Provident Savings Bank, F.S.B. 100% United States Profed Mortgage, Inc.(1) 100% California Provident Financial Corporation(1) 100% California First Service Corporation(1) 100% California (1) This corporation is a wholly owned subsidiary of Provident Savings Bank, F.S.B.
EXHIBIT 23 Consent of Independent Auditors
CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-30935) of Provident Financial Holdings, Inc. of our report dated August 14, 1998 appearing on page 12 of the 1998 Annual Report which is incorporated in this Annual Report which is incorporated in this Annual Report on Form 10-K. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Los Angeles, California September 24, 1998