Fair Value of Financial Instruments

The Corporation adopted ASC 820, “Fair Value Measurements and Disclosures,” and elected the fair value option pursuant to ASC 825, “Financial Instruments” on loans originated for sale by PBM. ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 825 permits entities to elect to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the “Fair Value Option”) at specified election dates. At each subsequent reporting date, an entity is required to report unrealized gains and losses on items in earnings for which the fair value option has been elected. The objective of the Fair Value Option is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.

The following table describes the difference at the dates indicated between the aggregate fair value and the aggregate unpaid principal balance of loans held for investment at fair value and loans held for sale at fair value:



(In Thousands)	Aggregate Fair Value		Aggregate Unpaid Principal Balance		Net Unrealized (Loss) Gain
As of September 30, 2015:
Loans held for investment, at fair value	$	4,036	$	4,167	$	(131	)
Loans held for sale, measured at fair value	$	163,644	$	156,901	$	6,743

As of June 30, 2015:
Loans held for investment, at fair value	$	4,518	$	4,495	$	23
Loans held for sale, measured at fair value	$	224,715	$	219,143	$	5,572

ASC 820-10-65-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” provides additional guidance for estimating fair value in accordance with ASC 820, “Fair Value Measurements,” when the volume and level of activity for the asset or liability have significantly decreased.

ASC 820 establishes a three-level valuation hierarchy that prioritizes inputs to valuation techniques used in fair value calculations. The three levels of inputs are defined as follows:



Level 1	-	Unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date.
Level 2	-	Observable inputs other than Level 1 such as: quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated to observable market data for substantially the full term of the asset or liability.
Level 3	-	Unobservable inputs for the asset or liability that use significant assumptions, including assumptions of risks. These unobservable assumptions reflect the Corporation’s estimate of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of pricing models, discounted cash flow models and similar techniques.

ASC 820 requires the Corporation to maximize the use of observable inputs and minimize the use of unobservable inputs. If a financial instrument uses inputs that fall in different levels of the hierarchy, the instrument will be categorized based upon the lowest level of input that is significant to the fair value calculation.

The Corporation’s financial assets and liabilities measured at fair value on a recurring basis consist of investment securities, loans held for investment at fair value, loans held for sale at fair value, interest-only strips and derivative financial instruments; while non-performing loans, mortgage servicing assets ("MSA") and real estate owned are measured at fair value on a nonrecurring basis.

Investment securities are primarily comprised of U.S. government agency MBS, U.S. government sponsored enterprise MBS, a privately issued CMO and common stock of a community development financial institution. The Corporation utilizes quoted prices in active and less than active markets for similar securities for its fair value measurement of MBS and debt securities (Level 2), broker price indications for similar securities in non-active markets for its fair value measurement of the CMO (Level 3) and a relative value analysis for the common stock in non-active markets (Level 3).

Derivative financial instruments are comprised of commitments to extend credit on loans to be held for sale, mandatory loan sale commitments, TBA MBS trades and option contracts. The fair value of TBA MBS trades is determined using quoted secondary-market prices (Level 2). The fair values of other derivative financial instruments are determined by quoted prices for a similar commitment or commitments, adjusted for the specific attributes of each commitment (Level 3).

Loans held for investment at fair value are primarily single-family loans which have been transferred from loans held for sale. The fair value is determined by the quoted secondary-market prices which account for interest rate characteristics, adjusted for management estimates of the specific credit risk attributes of each loan (Level 3).

Loans held for sale at fair value are primarily single-family loans. The fair value is determined, when possible, using quoted secondary-market prices such as mandatory loan sale commitments. If no such quoted price exists, the fair value of a loan is determined by quoted prices for a similar loan or loans, adjusted for the specific attributes of each loan (Level 2).

Non-performing loans are loans which are inadequately protected by the current net worth and paying capacity of the borrowers or of the collateral pledged. The non-performing loans are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. The fair value of a non-performing loan is determined based on an observable market price or current appraised value of the underlying collateral. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the borrower. For non-performing loans which are restructured loans, the fair value is derived from discounted cash flow analysis (Level 3), except those which are in the process of foreclosure or 90 days delinquent for which the fair value is derived from the appraised value of its collateral (Level 2). For other non-performing loans which are not restructured loans, other than non-performing commercial real estate loans, the fair value is derived from relative value analysis: historical experience and management estimates by loan type for which collectively evaluated allowances are assigned (Level 3), or the appraised value of its collateral for loans which are in the process of foreclosure or where borrowers file bankruptcy, for which the charge-off will occur when the loan becomes 60 days delinquent (Level 2). For non-performing commercial real estate loans, the fair value is derived from the appraised value of its collateral (Level 2). Non-performing loans are reviewed and evaluated on at least a quarterly basis for additional allowance and adjusted accordingly, based on the same factors identified above. This loss is not recorded directly as an adjustment to current earnings or other comprehensive income (loss), but rather as a component in determining the overall adequacy of the allowance for loan losses. These adjustments to the estimated fair value of non-performing loans may result in increases or decreases to the provision for loan losses recorded in current earnings.

The Corporation uses the amortization method for its MSA, which amortizes the MSA in proportion to and over the period of estimated net servicing income and assesses the MSA for impairment based on fair value at each reporting date. The fair value of MSA is calculated using the present value method; which includes a third party’s prepayment projections of similar instruments, weighted-average coupon rates and the estimated average life (Level 3).

The rights to future income from serviced loans that exceed contractually specified servicing fees are recorded as interest-only strips. The fair value of interest-only strips is calculated using the same assumptions that are used to value the related MSA (Level 3).

The fair value of real estate owned is derived from the lower of the appraised value or the listing price, net of estimated selling costs (Level 2).

The Corporation’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Corporation’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

The following fair value hierarchy tables present information at the dates indicated about the Corporation’s assets measured at fair value on a recurring basis:



	Fair Value Measurement at September 30, 2015 Using:
(In Thousands)	Level 1		Level 2		Level 3		Total
Assets:
Investment securities:
U.S. government agency MBS	$	—	$	7,573	$	—	$	7,573
U.S. government sponsored enterprise MBS	—		5,046		—		5,046
Private issue CMO	—		—		691		691
Common stock - community development financial institution	—		—		151		151
Investment securities	—		12,619		842		13,461

Loans held for investment, at fair value	—		—		4,036		4,036
Loans held for sale, at fair value	—		163,644		—		163,644
Interest-only strips	—		—		60		60

Derivative assets:
Commitments to extend credit on loans to be held for sale	—		—		2,510		2,510
Option contracts	—		—		57		57
Derivative assets	—		—		2,567		2,567
Total assets	$	—	$	176,263	$	7,505	$	183,768

Liabilities:
Derivative liabilities:
Commitments to extend credit on loans to be held for sale	$	—	$	—	$	6	$	6
Mandatory loan sale commitments	—		—		150		150
TBA MBS trades	—		1,542		—		1,542
Derivative liabilities	—		1,542		156		1,698
Total liabilities	$	—	$	1,542	$	156	$	1,698



	Fair Value Measurement at June 30, 2015 Using:
(In Thousands)	Level 1		Level 2		Level 3		Total
Assets:
Investment securities:
U.S. government agency MBS	$	—	$	7,906	$	—	$	7,906
U.S. government sponsored enterprise MBS	—		5,387		—		5,387
Private issue CMO	—		—		717		717
Common stock - community development financial institution	—		—		151		151
Investment securities	—		13,293		868		14,161

Loans held for investment, at fair value	—		4,518		—		4,518
Loans held for sale, at fair value	—		224,715		—		224,715
Interest-only strips	—		—		63		63

Derivative assets:
Commitments to extend credit on loans to be held for sale	—		—		1,636		1,636
TBAMBS trades	—		812		—		812
Option contracts	—		—		192		192
Derivative assets	—		812		1,828		2,640
Total assets	$	—	$	243,338	$	2,759	$	246,097

Liabilities:
Derivative liabilities:
Commitments to extend credit on loans to be held for sale	$	—	$	—	$	137	$	137
Mandatory loan sale commitments	—		—		71		71
Derivative liabilities	—		—		208		208
Total liabilities	$	—	$	—	$	208	$	208

The following tables summarize reconciliations of the beginning and ending balances during the periods shown of recurring fair value measurements recognized in the Condensed Consolidated Statements of Financial Condition using Level 3 inputs:



	For the Quarter Ended September 30, 2015
	Fair Value Measurement Using Significant Other Unobservable Inputs (Level 3)
(In Thousands)	Private Issue CMO			Common stock ⁽¹⁾		Loans Held For Investment, at fair value ⁽²⁾			Interest- Only Strips			Loan Commit- ments to Originate ₍₃₎		Manda- tory Commit- ments ⁽⁴⁾			Option Contracts			Total
Beginning balance at June 30, 2015	$	717		$	151	$	—		$	63		$	1,499	$	(71	)	$	192		$	2,551
Total gains or losses (realized/ unrealized):
Included in earnings	—			—		(155		)	—			1,005		(96		)	(88		)	666
Included in other comprehensive loss	(1		)	—		—			(3		)	—		—			—			(4		)
Purchases	—			—		—			—			—		—			89			89
Issuances	—			—		—			—			—		—			—			—
Settlements	(25		)	—		(638		)	—			—		17			(136		)	(782		)
Transfers in and/or out of Level 3	—			—		4,829			—			—		—			—			4,829
Ending balance at September 30, 2015	$	691		$	151	$	4,036		$	60		$	2,504	$	(150	)	$	57		$	7,349


⁽¹⁾	Common stock of a community development financial institution.


⁽²⁾	Beginning fiscal 2016, the valuation of loans held for investment at fair value includes the management estimates of the specific credit risk attributes of each loan (Level 3), in addition to the quoted secondary-market prices which account for interest rate characteristics.


⁽³⁾	Consists of commitments to extend credit on loans to be held for sale.


⁽⁴⁾	Consists of mandatory loan sale commitments.



	For the Quarter Ended September 30, 2014
	Fair Value Measurement Using Significant Other Unobservable Inputs (Level 3)
(In Thousands)	Private Issue CMO			Common stock ⁽¹⁾		Interest- Only Strips		Loan Commit- ments to Originate ⁽²⁾			Manda- tory Commit- ments ⁽³⁾			Option Contracts			Total
Beginning balance at June 30, 2014	$	853		$	—	$	62	$	2,566		$	(93	)	$	—		$	3,388
Total gains or losses (realized/unrealized):
Included in earnings	—			—		—		(781		)	(156		)	(105		)	(1,042		)
Included in other comprehensive (loss) income	(1		)	—		8		—			—			—			7
Purchases	—			250		—		—			—			187			437
Issuances	—			—		—		—			—			—			—
Settlements	(24		)	—		—		—			4			(49		)	(69		)
Transfers in and/or out of Level 3	—			—		—		—			—			—			—
Ending balance at September 30, 2014	$	828		$	250	$	70	$	1,785		$	(245	)	$	33		$	2,721


⁽¹⁾	Common stock of a community development financial institution.


⁽²⁾	Consists of commitments to extend credit on loans to be held for sale.


⁽³⁾	Consists of mandatory loan sale commitments.

The following fair value hierarchy tables present information about the Corporation’s assets measured at fair value at the dates indicated on a nonrecurring basis:



	Fair Value Measurement at September 30, 2015 Using:
(In Thousands)	Level 1		Level 2		Level 3		Total
Non-performing loans	$	—	$	11,146	$	3,618	$	14,764
MSA	—		—		417		417
Real estate owned, net	—		3,674		—		3,674
Total	$	—	$	14,820	$	4,035	$	18,855



	Fair Value Measurement at June 30, 2015 Using:
(In Thousands)	Level 1		Level 2		Level 3		Total
Non-performing loans	$	—	$	11,816	$	2,130	$	13,946
MSA	—		—		269		269
Real estate owned, net	—		2,398		—		2,398
Total	$	—	$	14,214	$	2,399	$	16,613

The following table presents additional information about valuation techniques and inputs used for assets and liabilities, including derivative financial instruments, which are measured at fair value and categorized within Level 3 as of September 30, 2015:



(Dollars In Thousands)	Fair Value As of September 30, 2015		Valuation Techniques	Unobservable Inputs	Range ⁽¹⁾ (Weighted Average)	Impact to Valuation from an Increase in Inputs ⁽²⁾

Assets:

Securities available-for sale: Private issue CMO	$	691	Market comparable pricing	Comparability adjustment	0.0% – 1.5% (1.2%)	Increase

Securities available-for sale: Common stock⁽³⁾	$	151	Relative value analysis	Adjusted book value	$ 38.6 million	Increase

Loans held for investment, at fair value	$	4,036	Relative value analysis	Broker quotes Credit risk factors	99.5% – 105.8% (102.2%) of par 1.2% - 100.0% (5.3%)	Increase Decrease

Non-performing loans	$	87	Discounted cash flow	Default rates	5.0%	Decrease
Non-performing loans	$	3,531	Relative value analysis	Loss severity	20.0% - 30.0% (20.8%)	Decrease

MSA	$	417	Discounted cash flow	Prepayment speed (CPR) Discount rate	7.8% - 60.0% (17.2%) 9.0% - 10.5% (9.1%)	Decrease Decrease

Interest-only strips	$	60	Discounted cash flow	Prepayment speed (CPR) Discount rate	16.4% - 23.6% (17.7%) 9.0%	Decrease Decrease

Commitments to extend credit on loans to be held for sale	$	2,510	Relative value analysis	TBA-MBS broker quotes Fall-out ratio ⁽⁴⁾	98.0% – 105.0% (102.2%) of par 19.8% - 31.7% (30.1%)	Decrease Decrease

Option contracts	$	57	Relative value analysis	Broker quotes	128.9% of par	Increase

Liabilities:

Commitments to extend credit on loans to be held for sale	$	6	Relative value analysis	TBA-MBS broker quotes Fall-out ratio ⁽⁴⁾	100.5% – 102.8% (101.0%) of par 19.8% - 31.7% (30.1%)	Increase Increase

Mandatory loan sale commitments	$	150	Relative value analysis	Investor quotes TBA MBS broker quotes Roll-forward costs ⁽⁵⁾	104.5% - 106.6% (104.8%) of par 0.005%	Increase Increase


⁽¹⁾	The range is based on the estimated fair values and management estimates.


⁽²⁾	Unless otherwise noted, this column represents the directional change in the fair value of the Level 3 investments that would result from an increase to the corresponding unobservable input. A decrease to the unobservable input would have the opposite effect. Significant changes in these inputs in isolation could result in significantly higher or lower fair value measurements.


⁽³⁾	Common stock of a community development financial institution.


⁽⁴⁾	The percentage of commitments to extend credit on loans to be held for sale which management has estimated may not fund.


⁽⁵⁾	An estimated cost to roll forward the mandatory loan sale commitments which management has estimated may not be delivered to the corresponding investors in a timely manner.

The significant unobservable inputs used in the fair value measurement of the Corporation’s assets and liabilities include the following: prepayment speeds, discount rates, MBS – TBA quotes, fallout ratios, broker quotes and roll-forward costs, among others. Significant increases or decreases in any of these inputs in isolation could result in significantly lower or higher fair value measurement. The various unobservable inputs used to determine valuations may have similar or diverging impacts on valuation.

The carrying amount and fair value of the Corporation’s other financial instruments as of September 30, 2015 and June 30, 2015 were as follows:



	September 30, 2015
(In Thousands)	Carrying Amount		Fair Value		Level 1	Level 2		Level 3
Financial assets:
Loans held for investment, not recorded at fair value	$	801,651	$	807,570	—	—		$	807,570
FHLB – San Francisco stock	$	8,094	$	8,094	—	$	8,094	—

Financial liabilities:
Deposits	$	924,866	$	896,555	—	—		$	896,555
Borrowings	$	91,351	$	94,330	—	—		$	94,330



	June 30, 2015
(In Thousands)	Carrying Amount		Fair Value		Level 1	Level 2		Level 3
Financial assets:
Loans held for investment, not recorded at fair value	$	809,716	$	815,385	—	—		$	815,385
FHLB – San Francisco stock	$	8,094	$	8,094	—	$	8,094	—

Financial liabilities:
Deposits	$	924,086	$	895,664	—	—		$	895,664
Borrowings	$	91,367	$	93,219	—	—		$	93,219

Loans held for investment, not recorded at fair value: 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 over their estimated remaining contractual maturities using a current interest rate at which such loans would be made to borrowers, or (ii) quoted market prices. The allowance for loan losses is subtracted as an estimate of the underlying credit risk.

FHLB – San Francisco stock: The carrying amount reported for FHLB – San Francisco stock approximates fair value. When redeemed, the Corporation will receive an amount equal to the par value of the stock.

Deposits: The fair value of time deposits is estimated using a discounted cash flow calculation. The discount rate is based upon rates currently offered for deposits of similar remaining maturities. The fair value of transaction accounts (checking, money market and savings accounts) is based on management estimates, consistent with current market conditions.

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 Corporation has various processes and controls in place to ensure that fair value is reasonably estimated. The Corporation generally determines fair value of their Level 3 assets and liabilities by using internally developed models which primarily utilize discounted cash flow techniques and prices obtained from independent management services or brokers. The Corporation performs due diligence procedures over third-party pricing service providers in order to support their use in the valuation process. The fair values of investment securities, commitments to extend credit on loans held for sale, mandatory commitments and option contracts are determined from the independent management services or brokers; while the fair value of MSA and interest-only strips are determined using the internally developed models which are based on discounted cash flow analysis. The fair value of non-performing loans is determined by calculating discounted cash flows, relative value analysis or collateral value, less selling costs.

While the Corporation believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. During the quarter ended September 30, 2015, there were no significant changes to the Corporation’s valuation techniques that had, or are expected to have, a material impact on its consolidated financial position or results of operations.