| PROVIDENT FINANCIAL HOLDINGS INC Item 1A Risk Factors 39 Item 1A Risk Factors We assume and manage a certain degree of risk in order to conduct our business strategy |
| In addition to the risk factors described below, other risks and uncertainties not specifically mentioned, or that are currently known to, or deemed by, management to be immaterial also may materially and adversely affect our financial position, results of operation and/or cash flows |
| Before making an investment decision, you should carefully consider the risks described below together with all of the other information included in this Form 10-K If any of the circumstances described in the following risk factors actually occur to a significant degree, the value of our common stock could decline, and you could lose all or part of your investment |
| Fluctuations in interest rates could reduce our profitability and affect the value of our assets |
| Like other financial institutions, we are subject to interest rate risk |
| Our primary source of income is net interest income, which is the difference between interest earned on loans and investment securities and the interest paid on deposits and borrowings |
| We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities and the relationships of various interest rates to each other |
| Over any period of time, our interest-earning assets may be more sensitive to changes in market interest rates than our interest-bearing liabilities, or vice versa |
| In addition, the individual market interest rates underlying our loan and deposit products may not change to the same degree over a given time period |
| In any event, if market interest rates should move contrary to our position, our earnings may be negatively affected |
| In addition, loan volume and quality and deposit volume and mix can be affected by market interest rates |
| Changes in l evels of market interest rates could materially adversely affect our net interest spread, asset quality, origination volume and overall profitability |
| Interest rates have recently been at historically low levels |
| However, since June 30, 2004, the US Federal Reserve has increased its target for the federal funds rate 17 times, from 1dtta00prca to 5dtta25prca, and the most recent interest rate increase was on June 29, 2006 |
| While these short-term market interest rates have increased the pricing of our loans, it has been more than offset by the rise in our funding costs |
| In a sustained rising interest rate environment the asset yields may not match rising funding costs, which may negatively impact interest margins |
| A sustained falling interest rate environment would positively impact margins |
| We manage our assets and liabilities in order to achieve long-term profitability while limiting our exposure to the fluctuation of interest rates |
| We anticipate periodic imbalances in the interest rate sensitivity of our assets and liabilities and the relationship of various interest rates to each other |
| At any reporting period, we may have earning assets which are more sensitive to changes in interest rates than interest-bearing liabilities, or vice versa |
| The fluctuation of market interest rates can materially affect our net interest spread, interest margin, loan originations, deposit volumes and overall profitability |
| In addition, we may have valuation risk in measuring our interest rate risk position |
| The valuation risk is attributable to calculation methods (modeling risks) and assumptions used in the model, including loan prepayments and forward interest rates |
| Our mortgage banking business is subject to additional interest rate risk |
| For instance, rising interest rates may lower the loan origination volume thereby reducing the gain on sale of loans |
| Additionally, since the loan origination volume is hedged against interest rate fluctuations with forward loan sale commitments and put option contracts, rising or falling interest rates may alter the actual loan origination volume such that the hedges are insufficient to protect our profitability margins |
| Also, we cannot be assured that the value of the instruments we use 39 to hedge our loan origination volume will react to the interest rate fluctuations in the same manner as the value of the loan origination commitments which may also significantly impact profitability |
| For further information on our interest rate risks, see the discussion included in "e Item 7A Quantitative and Qualitative Disclosure About Market Risks "e on page 58 of this Form 10-K We are subject to credit risks in connection with our lending practices |
| We are subject to credit risk in connection with our loans held for investment, loans available for sale, receivable from sale of loans, investment securities and in connection with the mortgage banking activities, particularly in the sale of loans (counter-party risk) |
| We have established stringent underwriting policies to mitigate this risk for the purpose of determining the credit worthiness of each borrower |
| To assist us in this endeavor, we have established the Internal Asset Review Committee and Quality Assurance Department |
| The Internal Asset Review Committee manages the exposure to credit losses in each of these business operations, including the adequacy of allowance for loan losses; while Quality Assurance Department verifies the existence, authenticity, completeness, and accuracy of legal, compliance and credit documentation, and the quality of real property appraisals, and underwriting decisions for loan originations |
| Additionally, multi-family and commercial real estate loans bear higher credit risk as compared to single-family mortgage loans |
| These loans are typically secured by properties that are generally greater in amount, more difficult to evaluate and monitor and are susceptible to default as a result of changes in general economic conditions and, therefore, involve a greater degree of risk than single-family mortgage loans |
| Since payments on loans secured by multi-family and commercial real estate 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 |
| Our multi-family and commercial real estate loans are primarily located in Los Angeles, Orange, Riverside, San Bernardino and San Diego Counties |
| Our non-traditional or "e Alt-A "e loans include interest-only loans, stated-income loans and more than 30-year amortization loans and bear higher credit risk |
| In the case of interest-only loans a borrowerapstas payment is subject to change in the future when the loan converts to a fully-amortizing status |
| In the case of stated income loans a borrower may misrepresent his income or source of income (which we have not verified) in order to obtain the loan |
| The borrower may not have sufficient income to qualify for the loan amount and may not be able to make the monthly loan payment |
| In the case of more than 30-year amortization loans the term of the loan requires many more monthly payments from the borrower (ultimately increasing the cost of the home) and subjects the loan to more interest rate cycles, economic cycles and employment cycles which i ncreases the possibility that the borrower is negatively impacted by one of these cycles and is no longer willing or able to meet his monthly payment obligations |
| Our funding sources may prove insufficient to replace deposits and support our future growth |
| We rely on customer deposits and advances from the FHLB - San Francisco and other borrowings to fund our operations |
| Although we have historically been able to replace maturing deposits and advances if desired, no assurance can be given that we would be able to replace such funds in the future if our financial condition or the financial condition of the FHLB - San Francisco or market conditions were to change |
| Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates |
| Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs |
| In this case, our profitability would be adversely affected |
| Although we consider such sources of funds adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives |
| There can be no assurance additional borrowings, if sought, would be available to us or, if available, would be on favorable terms |
| If additional financing sources are unavailable or are not available on reasonable terms, our growth and future prospects could be adversely affected |
| Our success depends primarily on the general economic conditions of the State of California and the specific local markets in which we operate |
| Adverse economic conditions unique to the California markets could have a material adverse effect on our financial condition and results of operations |
| Further, a significant decline in general economic conditions, caused by inflation, recession, unemployment, changes in securities markets or other factors could impact our state and local markets and, in turn, also have a material adverse effect on our financial condition and results of operations |
| Of particular concern are the rising real estate values, which may prove unsustainable in our current rising interest rate environment and may lead to higher loan losses since the majority of our loans are secured by real estate located within California |
| Similarly, if California were to experience significant declines in real estate values, this decline may inhibit our ability to recover on defaulted loans by selling the underlying real estate |
| Competition with other financial institutions could adversely affect our profitability |
| The banking and financial services industry is very competitive |
| Legal and regulatory developments have made it easier for new and sometimes unregulated competitors to compete with us |
| Consolidation among financial service providers has resulted in fewer very large national and regional banking and financial institutions holding a large accumulation of assets |
| These institutions generally have significantly greater resources, a wider geographic presence or greater accessibility |
| Our competitors sometimes are also able to offer more services, more favorable pricing or greater customer convenience than we do |
| In addition, our competition has grown from new banks and other financial services providers that target our existing or potential customers |
| As consolidation continues among large banks, we expect additional institutions to try to exploit our market |
| Technological developments have allowed competitors including some non-depository institutions, to compete more effectively in local markets and have expanded the range of financial products, services and capital available to our target customers |
| If we are unable to implement, maintain and use such technologies effectively, we may not be able to offer products or achieve cost-efficiencies necessary to compete in our industry |
| In addition, some of these competitors have fewer regulatory constraints and lower cost structures |
| The loss of key members of our senior management team could adversely affect our business |
| We believe that our success depends largely on the efforts and abilities of our senior management |
| Their experience and industry contacts significantly benefit us |
| The competition for qualified personnel in the financial services industry is intense, and the loss of any of our key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect our business |
| We are subject to extensive government regulation and supervision |
| We are subject to extensive federal and state regulation and supervision, primarily through the Bank and certain non-bank subsidiaries |
| Banking regulations are primarily intended to protect depositors &apos funds, federal deposit insurance funds and the banking system as a whole, not shareholders |
| These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things |
| Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes |
| Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways |
| Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things |
| Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations |
| While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur |
| Business - REGULATION "e on page 29 of this Form 10-K 41 We rely heavily on the proper functioning of our technology |
| We rely heavily on communications and information systems to conduct our business |
| Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems |
| While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed |
| The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations |
| We rely on third-party service providers for much of our communications, information, operating and financial control systems technology |
| If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to locate alternative sources of such services, and we cannot assure that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality, as found in our existing systems, without the need to expend substantial resources, if at all |
| Any of these circumstances could have an adverse effect on our business |
| Terrorist activities could cause reductions in investor confidence and substantial volatility in real estate and securities markets |
| It is impossible to predict the extent to which terrorist activities may occur in the United States or other regions, or their effect on a particular security issue |
| It is also uncertain what effects any past or future terrorist activities and/or any consequent actions on the part of the United States government and others will have on the United States and world financial markets, local, regional and national economics, and real estate markets across the United States |
| Among other things, reduced investor confidence could result in substantial volatility in securities markets, a decline in general economic conditions and real estate related investments and an increase in loan defaults |
| Such unexpected losses and events could materially affect our results of operations |
| We rely on dividends from subsidiaries for most of our revenue |
| Provident Financial Holdings, Inc is a separate and distinct legal entity from its subsidiaries |
| We receive substantially all of our revenue from dividends from our subsidiaries |
| These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on our debt |
| Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay us |
| Also, our right to participate in a distribution of assets upon a subsidiaryapstas liquidation or reorganization is subject to the prior claims of the subsidiaryapstas creditors |
| In the event the Bank is unable to pay dividends to us, we may not be able to service our debt, pay obligations or pay dividends on our common stock |
| The inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition and results of operations If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud, and, as a result, investors and depositors could lose confidence in our financial reporting, which could adversely affect our business, the trading price of our stock and our ability to attract additional deposits |
| In connection with the enactment of the Sarbanes-Oxley Act of 2002 and the implementation of the rules and regulations promulgated by the SEC, we document and evaluate our internal control over financial reporting in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act |
| This requires us to prepare an annual management report on our internal control over financial reporting, including among other matters, managementapstas assessment of the effectiveness of internal control over financial reporting and an attestation report by our independent auditors addressing these assessments |
| If we fail to identify and correct any significant deficiencies in the design or operating effectiveness of our internal control over financial reporting or fail to prevent fraud, current and potential shareholders and depositors could lose confidence in our internal controls and financial reporting, 42 which could adversely affect our business, financial condition and results of operations, the trading price of our stock and our ability to attract additional deposits |
| Changes in accounting standards may affect our performance |
| Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations |
| From time to time there are changes in the financial accounting and reporting standards that govern the preparation of our financial statements |
| These changes can be difficult to predict and can materially impact how we report and record our financial condition and results of operations |
| In some cases, we could be required to apply a new or revised standard retroactively, resulting in restating prior period financial statements |
| Earthquakes and other natural disasters in our primary market area may result in material losses because of damage to collateral properties and borrowers &apos inability to repay loans |
| Since our geographic concentration is in Southern California, we are subject to earthquakes and other natural disasters |
| A major earthquake or other natural disaster may disrupt our business operations for an indefinite period of time and could result in material losses to our operations, although we have not experienced any losses in the past five years as a result of earthquake damage or other natural disaster to collateral securing loans |
| In addition to possibly sustaining damage to our own property, a substantial number of our borrowers would likely incur property damage to the collateral securing their loans |
| Although we are in an earthquake prone area, we and other lenders in the market area may not require earthquake insurance as a condition of making a loan |
| Additionally, if the collateralized properties are only damaged and not destroyed to the point of total insurable loss, borrowers may suffer sustained job interruption or job loss, which may materially impair their abilit y to meet the terms of their loan obligations |