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 December 31, 2017:
Loans held for investment, at fair value	$	5,157	$	5,362	$	(205	)
Loans held for sale, at fair value	$	96,589	$	93,449	$	3,140

As of June 30, 2017:
Loans held for investment, at fair value	$	6,445	$	6,696	$	(251	)
Loans held for sale, at fair value	$	116,548	$	112,940	$	3,608

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 available for sale, 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 - available for sale are primarily comprised of U.S. government agency MBS and U.S. government sponsored enterprise MBS. 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) and broker price indications for similar securities in non-active markets for its fair value measurement of the CMO (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, and are then 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 (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 derived 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 derived 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 December 31, 2017 Using:
(In Thousands)	Level 1		Level 2		Level 3		Total
Assets:
Investment securities - available for sale:
U.S. government agency MBS	$	—	$	4,859	$	—	$	4,859
U.S. government sponsored enterprise MBS	—		3,127		—		3,127
Private issue CMO	—		—		419		419
Investment securities - available for sale	—		7,986		419		8,405

Loans held for investment, at fair value	—		—		5,157		5,157
Loans held for sale, at fair value	—		96,589		—		96,589
Interest-only strips	—		—		26		26

Derivative assets:
Commitments to extend credit on loans to be held for sale	—		—		737		737
TBA MBS trades	—		2		—		2
Derivative assets	—		2		737		739
Total assets	$	—	$	104,577	$	6,339	$	110,916

Liabilities:
Derivative liabilities:
Commitments to extend credit on loans to be held for sale	$	—	$	—	$	21	$	21
Mandatory loan sale commitments	—		—		24		24
TBA MBS trades	—		183		—		183
Derivative liabilities	—		183		45		228
Total liabilities	$	—	$	183	$	45	$	228



	Fair Value Measurement at June 30, 2017 Using:
(In Thousands)	Level 1		Level 2		Level 3		Total
Assets:
Investment securities - available for sale:
U.S. government agency MBS	$	—	$	5,383	$	—	$	5,383
U.S. government sponsored enterprise MBS	—		3,474		—		3,474
Private issue CMO	—		—		461		461
Investment securities - available for sale	—		8,857		461		9,318

Loans held for investment, at fair value	—		—		6,445		6,445
Loans held for sale, at fair value	—		116,548		—		116,548
Interest-only strips	—		—		31		31

Derivative assets:
Commitments to extend credit on loans to be held for sale	—		—		847		847
Mandatory loan sale commitments	—		—		47		47
TBAMBS trades	—		539		—		539
Option contracts	—		—		37		37
Derivative assets	—		539		931		1,470
Total assets	$	—	$	125,944	$	7,868	$	133,812

Liabilities:
Derivative liabilities:
Commitments to extend credit on loans to be held for sale	$	—	$	—	$	38	$	38
Derivative liabilities	—		—		38		38
Total liabilities	$	—	$	—	$	38	$	38

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 December 31, 2017
	Fair Value Measurement Using Significant Other Unobservable Inputs (Level 3)
(In Thousands)	Private Issue CMO			Loans Held For Investment, at fair value ⁽¹⁾			Interest- Only Strips			Loan Commit- ments to Originate ⁽²⁾		Manda- tory Commit- ments ⁽³⁾			Total
Beginning balance at September 30, 2017	$	448		$	6,924		$	28		$	687	$	(4	)	$	8,083
Total gains or losses (realized/unrealized):
Included in earnings	—			38			—			29		(20		)	47
Included in other comprehensive loss	—			—			(2		)	—		—			(2		)
Purchases	—			—			—			—		—			—
Issuances	—			—			—			—		—			—
Settlements	(29		)	(1,805		)	—			—		—			(1,834		)
Transfers in and/or out of Level 3	—			—			—			—		—			—
Ending balance at December 31, 2017	$	419		$	5,157		$	26		$	716	$	(24	)	$	6,294


⁽¹⁾	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.


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


⁽³⁾	Consists of mandatory loan sale commitments.



	For the Quarter Ended December 31, 2016
	Fair Value Measurement Using Significant Other Unobservable Inputs (Level 3)
(In Thousands)	Private Issue CMO			Loans Held For Investment, at fair value ⁽¹⁾			Interest- Only Strips			Loan Commit- ments to Originate ⁽²⁾			Manda- tory Commit- ments ⁽³⁾			Option Contracts			Total
Beginning balance at September 30, 2016	$	560		$	5,529		$	42		$	2,574		$	(24	)	$	22		$	8,703
Total gains or losses (realized/unrealized):
Included in earnings	—			(139		)	—			(1,098		)	(250		)	366			(1,121		)
Included in other comprehensive income (loss)	—			—			(5		)	—			—			—			(5		)
Purchases	—			—			—			—			—			94			94
Issuances	—			—			—			—			—			—			—
Settlements	(22		)	(250		)	—			—			(6		)	(482		)	(760		)
Transfers in and/or out of Level 3	—			824			—			—			—			—			824
Ending balance at December 31, 2016	$	538		$	5,964		$	37		$	1,476		$	(280	)	$	—		$	7,735


⁽¹⁾	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.


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


⁽³⁾	Consists of mandatory loan sale commitments.



	For the Six Months Ended December 31, 2017
	Fair Value Measurement Using Significant Other Unobservable Inputs (Level 3)
(In Thousands)	Private Issue CMO			Loans Held For Investment, at fair value ⁽¹⁾			Interest- Only Strips			Loan Commit- ments to Originate ⁽²⁾			Manda- tory Commit- ments ⁽³⁾			Option Contracts			Total
Beginning balance at June 30, 2017	$	461		$	6,445		$	31		$	809		$	47		$	37		$	7,830
Total gains or losses (realized/unrealized):
Included in earnings	—			46			—			(93		)	(73		)	(37		)	(157		)
Included in other comprehensive loss	1			—			(5		)	—			—			—			(4		)
Purchases	—			—			—			—			—			—			—
Issuances	—			—			—			—			—			—			—
Settlements	(43		)	(1,856		)	—			—			2			—			(1,897		)
Transfers in and/or out of Level 3	—			522			—			—			—			—			522
Ending balance at December 31, 2017	$	419		$	5,157		$	26		$	716		$	(24	)	$	—		$	6,294


⁽¹⁾	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.


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


⁽³⁾	Consists of mandatory loan sale commitments.



	For the Six Months Ended December 31, 2016
	Fair Value Measurement Using Significant Other Unobservable Inputs (Level 3)
(In Thousands)	Private Issue CMO			Loans Held For Investment, at fair value ⁽¹⁾			Interest- Only Strips			Loan Commit- ments to originate ⁽²⁾			Manda- tory Commit- ments ⁽³⁾			Option Contracts			Total
Beginning balance at June 30, 2016	$	601		$	5,159		$	47		$	3,785		$	(31	)	$	—		$	9,561
Total gains or losses (realized/ unrealized):
Included in earnings	—			(101		)	—			(2,309		)	(255		)	344			(2,321		)
Included in other comprehensive (loss) income	1			—			(10		)	—			—			—			(9		)
Purchases	—			—			—			—			—			138			138
Issuances	—			—			—			—			—			—			—
Settlements	(64		)	(678		)	—			—			6			(482		)	(1,218		)
Transfers in and/or out of Level 3	—			1,584			—			—			—			—			1,584
Ending balance at December 31, 2016	$	538		$	5,964		$	37		$	1,476		$	(280	)	$	—		$	7,735


⁽¹⁾	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.


⁽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 December 31, 2017 Using:
(In Thousands)	Level 1		Level 2		Level 3		Total
Non-performing loans	$	—	$	7,038	$	947	$	7,985
MSA	—		—		450		450
Real estate owned, net	—		621		—		621
Total	$	—	$	7,659	$	1,397	$	9,056



	Fair Value Measurement at June 30, 2017 Using:
(In Thousands)	Level 1		Level 2		Level 3		Total
Non-performing loans	$	—	$	7,049	$	946	$	7,995
MSA	—		—		407		407
Real estate owned, net	—		1,615		—		1,615
Total	$	—	$	8,664	$	1,353	$	10,017

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 December 31, 2017:



(Dollars In Thousands)	Fair Value As of December 31, 2017		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	$	419	Market comparable pricing	Comparability adjustment	0.6% – 1.7% (1.5%)	Increase

Loans held for investment, at fair value	$	5,157	Relative value analysis	Broker quotes Credit risk factors	97.9% – 104.8% (100.8%) of par 1.2% - 100.0% (4.6%)	Increase Decrease

Non-performing loans	$	61	Discounted cash flow	Default rates	5.0%	Decrease
Non-performing loans	$	886	Relative value analysis	Loss severity	20.0% - 30.0% (21.4%)	Decrease

MSA	$	450	Discounted cash flow	Prepayment speed (CPR) Discount rate	10.2% - 60.0% (21.3%) 9.0% - 10.5% (9.2%)	Decrease Decrease

Interest-only strips	$	26	Discounted cash flow	Prepayment speed (CPR) Discount rate	15.6% - 29.7% (27.4%) 9.0%	Decrease Decrease

Commitments to extend credit on loans to be held for sale	$	737	Relative value analysis	TBA-MBS broker quotes Fall-out ratio ⁽³⁾	99.3% – 105.1% (102.0%) of par 12.9% - 32.0% (30.6%)	Increase Decrease

Liabilities:

Commitments to extend credit on loans to be held for sale	$	21	Relative value analysis	TBA-MBS broker quotes Fall-out ratio ⁽³⁾	98.5% – 101.5% (100.8%) of par 12.9% - 32.0% (30.6%)	Increase Decrease

Mandatory loan sale commitments	$	24	Relative value analysis	TBA MBS broker quotes Roll-forward costs ⁽⁴⁾	100.9% - 103.4% (103.4%) of par 0.012%	Decrease Decrease


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


⁽⁴⁾	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 other inputs. 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 December 31, 2017 and June 30, 2017 was as follows:



	December 31, 2017
(In Thousands)	Carrying Amount		Fair Value		Level 1	Level 2		Level 3
Financial assets:
Investment securities - held to maturity	$	87,626	$	87,336	—	$	87,336	$	—
Loans held for investment, not recorded at fair value	$	880,819	$	864,096	—	—		$	864,096
FHLB – San Francisco stock	$	8,108	$	8,108	—	$	8,108	—

Financial liabilities:
Deposits	$	907,788	$	874,441	—	—		$	874,441
Borrowings	$	111,189	$	111,141	—	—		$	111,141



	June 30, 2017
(In Thousands)	Carrying Amount		Fair Value		Level 1	Level 2		Level 3
Financial assets:
Investment securities - held to maturity	$	60,441	$	60,629	—	$	60,629	—
Loans held for investment, not recorded at fair value	$	898,474	$	885,650	—	—		$	885,650
FHLB – San Francisco stock	$	8,108	$	8,108	—	$	8,108	—

Financial liabilities:
Deposits	$	926,521	$	896,140	—	—		$	896,140
Borrowings	$	126,226	$	126,083	—	—		$	126,083

Investment securities - held to maturity: The investment securities - held to maturity consist of time deposits at CRA qualified minority financial institutions and U.S. government sponsored enterprise MBS. Due to the short-term nature of the time deposits, the principal balances approximated fair value (Level 2). For the MBS, 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).

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 estimated using a discounted cash flow calculation and management estimates of 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 December 31, 2017, 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.