Attached files

file filename
EX-32.2 - EXHIBIT 32.2 - BofI Holding, Inc.ex3222016123110-qexhibitq2.htm
EX-32.1 - EXHIBIT 32.1 - BofI Holding, Inc.ex3212016123110-qexhibitq2.htm
EX-31.2 - EXHIBIT 31.2 - BofI Holding, Inc.ex3122016123110-qexhibitq2.htm
EX-31.1 - EXHIBIT 31.1 - BofI Holding, Inc.ex3112016123110-qexhibitq2.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period ended December 31, 2016

¨
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 000-51201
bofiholdinghoriz400a17.jpg
BofI HOLDING, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
33-0867444
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
4350 La Jolla Village Drive, Suite 140, San Diego, CA
 
92122
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (858) 350-6200
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.    x  Yes    ¨  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filed, or a non-accelerated filer. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act of 1934.

Large accelerated filer  x
 
Accelerated filer  o
 
Non-accelerated filer  ¨
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).    ¨  Yes    x  No
The number of shares outstanding of the Registrant’s common stock on the last practicable date: 63,362,109 shares of common stock, $0.01 par value per share, as of January 24, 2017.






BOFI HOLDING, INC.
INDEX

 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I – FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
BOFI HOLDING, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands, except per share data)
December 31,
2016
 
June 30,
2016
ASSETS
 
 
 
Cash and due from banks
$
683,487

 
$
486,627

Federal funds sold
24,106

 
100

Total cash and cash equivalents
707,593

 
486,727

Securities:
 
 
 
Trading
8,151

 
7,584

Available-for-sale
379,734

 
265,447

Held-to-maturity—fair value $202,677 as of June 30, 2016

 
199,174

Stock of the Federal Home Loan Bank, at cost
54,351

 
57,123

Loans held for sale, carried at fair value
33,990

 
20,871

Loans held for sale, lower of cost or fair value
15,905

 
33,530

Loans and leases—net of allowance for loan and lease losses of $40,928 as of December 31, 2016 and $35,826 as of June 30, 2016
6,811,470

 
6,354,679

Accrued interest receivable
21,538

 
26,201

Furniture, equipment and software—net
15,126

 
13,995

Deferred income tax
32,058

 
39,171

Cash surrender value of life insurance
6,083

 
5,990

Mortgage servicing rights, carried at fair value
6,150

 
3,943

Other real estate owned and repossessed vehicles
961

 
252

Other assets
74,766

 
84,617

TOTAL ASSETS
$
8,167,876

 
$
7,599,304

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Deposits:
 
 
 
Non-interest bearing
$
634,350

 
$
588,774

Interest bearing
5,976,324

 
5,455,277

Total deposits
6,610,674

 
6,044,051

Securities sold under agreements to repurchase
35,000

 
35,000

Advances from the Federal Home Loan Bank
665,000

 
727,000

Subordinated notes and debentures and other
56,408

 
56,016

Accrued interest payable
1,700

 
1,667

Accounts payable and other liabilities
45,423

 
51,980

Total liabilities
7,414,205

 
6,915,714

COMMITMENTS AND CONTINGENCIES (Note 9)

 

STOCKHOLDERS’ EQUITY:
 
 
 
Preferred stock—$0.01 par value; 1,000,000 shares authorized;
 
 
 
Series A—$10,000 stated value and liquidation preference per share; 515 shares issued and outstanding as of December 31, 2016 and June 30, 2016
5,063

 
5,063

Common stock—$0.01 par value; 150,000,000 shares authorized; 64,761,369 shares issued and 63,359,001 shares outstanding as of December 31, 2016; 64,513,494 shares issued and 63,219,392 shares outstanding as of June 30, 2016
648

 
645

Additional paid-in capital
337,698

 
331,156

Accumulated other comprehensive income (loss)—net of tax
(2,502
)
 
(7,304
)
Retained earnings
445,857

 
384,815

Treasury stock, at cost; 1,402,368 shares as of December 31, 2016 and 1,294,102 shares as of June 30, 2016
(33,093
)
 
(30,785
)
Total stockholders’ equity
753,671

 
683,590

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
8,167,876

 
$
7,599,304


See accompanying notes to the condensed consolidated financial statements.

1


BOFI HOLDING, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) 
 
Three Months Ended
 
Six Months Ended
 
December 31,
 
December 31,
(Dollars in thousands, except per share data)
2016
 
2015
 
2016
 
2015
INTEREST AND DIVIDEND INCOME:
 
 
 
 
 
 
 
Loans and leases, including fees
$
85,839

 
$
70,117

 
$
166,458

 
$
135,195

Investments
8,462

 
5,818

 
15,323

 
11,969

Total interest and dividend income
94,301

 
75,935

 
181,781

 
147,164

INTEREST EXPENSE:
 
 
 
 
 
 
 
Deposits
14,011

 
9,709

 
27,525

 
18,732

Advances from the Federal Home Loan Bank
2,605

 
2,626

 
5,469

 
5,278

Other borrowings
1,324

 
429

 
2,646

 
855

Total interest expense
17,940

 
12,764

 
35,640

 
24,865

Net interest income
76,361

 
63,171

 
146,141

 
122,299

Provision for loan and lease losses
4,100

 
3,400

 
6,000

 
5,800

Net interest income, after provision
72,261

 
59,771

 
140,141

 
116,499

NON-INTEREST INCOME:
 
 
 
 
 
 
 
Realized gain (loss) on sale of securities
1,622

 
933

 
2,612

 
933

Other-than-temporary loss on securities:
 
 
 
 
 
 
 
Total impairment (losses) gains
(7,718
)
 
(1,037
)
 
(8,999
)
 
(1,779
)
Loss (gain) recognized in other comprehensive income
6,368

 
1,014

 
7,529

 
1,638

Net impairment loss recognized in earnings
(1,350
)
 
(23
)
 
(1,470
)
 
(141
)
Fair value gain (loss) on trading securities
456

 
(196
)
 
567

 
(126
)
Total unrealized (loss) gain on securities
(894
)
 
(219
)
 
(903
)
 
(267
)
Prepayment penalty fee income
637

 
738

 
1,935

 
1,614

Gain on sale – other
2,033

 
5,551

 
3,726

 
9,247

Mortgage banking income
4,837

 
2,909

 
9,970

 
4,787

Banking service fees and other income
8,465

 
6,308

 
14,092

 
9,695

Total non-interest income
16,700

 
16,220

 
31,432

 
26,009

NON-INTEREST EXPENSE:
 
 
 
 
 
 
 
Salaries and related costs
19,933

 
16,440

 
39,340

 
30,762

Professional services
1,086

 
1,270

 
2,440

 
1,633

Occupancy and equipment
1,363

 
934

 
2,638

 
1,847

Data processing and internet
2,941

 
2,299

 
6,113

 
4,179

Advertising and promotional
1,981

 
1,597

 
4,522

 
3,225

Depreciation and amortization
1,411

 
998

 
2,764

 
2,006

Real estate owned and repossessed vehicles
348

 
24

 
506

 
(50
)
FDIC and regulator fees
884

 
1,108

 
2,124

 
2,172

Other general and administrative
3,353

 
2,775

 
5,731

 
4,589

Total non-interest expense
33,300

 
27,445

 
66,178

 
50,363

INCOME BEFORE INCOME TAXES
55,661

 
48,546

 
105,395

 
92,145

INCOME TAXES
23,361

 
20,397

 
44,198

 
38,495

NET INCOME
$
32,300

 
$
28,149

 
$
61,197

 
$
53,650

NET INCOME ATTRIBUTABLE TO COMMON STOCK
$
32,222

 
$
28,071

 
$
61,042

 
$
53,495

COMPREHENSIVE INCOME
$
29,198

 
$
27,635

 
$
65,999

 
$
54,006

Basic earnings per share
$
0.50

 
$
0.44

 
$
0.94

 
$
0.84

Diluted earnings per share
$
0.50

 
$
0.44

 
$
0.94

 
$
0.84

See accompanying notes to the condensed consolidated financial statements.

2



BOFI HOLDING, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
December 31,
 
December 31,
(Dollars in thousands)
2016
 
2015
 
2016
 
2015
NET INCOME
$
32,300

 
$
28,149

 
$
61,197

 
$
53,650

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Net unrealized gain (loss) from available-for-sale securities, net of tax expense (benefit) of $(3,976) and $(376) for the three months ended December 31, 2016 and 2015, and $1,777 and $(552) for the six months ended December 31, 2016 and 2015, respectively.
(5,353
)
 
(538
)
 
2,435

 
(776
)
Other-than-temporary impairment on securities recognized in other comprehensive income, net of tax expense (benefit) of $2,363 and $401 for the three months ended December 31, 2016 and 2015, and $2,830 and $1,195 for the six months ended December 31, 2016 and 2015, respectively.
3,182

 
572

 
3,877

 
1,680

Reclassification of net (gain) loss from available-for-sale securities included in income, net of tax expense (benefit) of $691 and $385 for the three months ended December 31, 2016 and 2015, and $1,102 and $385 for the six months ended December 31, 2016 and 2015, respectively.
(931
)
 
(548
)
 
(1,510
)
 
(548
)
Other comprehensive income
(3,102
)
 
(514
)
 
4,802

 
356

Comprehensive income
$
29,198

 
$
27,635

 
$
65,999

 
$
54,006


See accompanying notes to the condensed consolidated financial statements.



3


BOFI HOLDING, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)
 
Preferred Stock
 
Common Stock
 
Additional Paid-in Capital
 
Retained
Earnings
 
Accumulated Other Comprehensive Loss, Net of Income Tax
 
Treasury
Stock
 
Total
 
 
 
 
Number of Shares
 
 
 
(Dollars in thousands)
Shares
 
Amount
 
Issued
 
Treasury
 
Outstanding
 
Amount
 
BALANCE—June 30, 2016
515

 
$
5,063

 
64,513,494

 
(1,294,102
)
 
63,219,392

 
$
645

 
$
331,156

 
$
384,815

 
$
(7,304
)
 
$
(30,785
)
 
$
683,590

Net income

 

 

 

 

 

 

 
61,197

 

 

 
61,197

Other comprehensive income

 

 

 

 

 

 

 

 
4,802

 

 
4,802

Cash dividends on preferred stock

 

 

 

 

 

 

 
(155
)
 

 

 
(155
)
Stock-based compensation expense

 

 

 

 

 

 
6,450

 

 

 

 
6,450

Restricted stock unit vesting and tax benefits

 

 
247,875

 
(108,266
)
 
139,609

 
3

 
92

 

 

 
(2,308
)
 
(2,213
)
BALANCE—December 31, 2016
515

 
$
5,063

 
64,761,369

 
(1,402,368
)
 
63,359,001

 
$
648

 
$
337,698

 
$
445,857

 
$
(2,502
)
 
$
(33,093
)
 
$
753,671



See accompanying notes to the condensed consolidated financial statements.

4


BOFI HOLDING, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) 
 
Six Months Ended
 
December 31,
(Dollars in thousands)
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
61,197

 
$
53,650

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Accretion of discounts on securities
(1,722
)
 
(2,329
)
Net accretion of discounts on loans and leases
2,724

 
1,636

Amortization of borrowing costs
104

 
2

Stock-based compensation expense
6,450

 
5,116

Tax benefit from exercise of common stock options and vesting of restricted stock grants
(95
)
 
(2,510
)
Valuation of financial instruments carried at fair value
(567
)
 
126

Net gain on sale of investment securities
(2,612
)
 
(933
)
Impairment charge on securities
1,470

 
141

Provision for loan and lease losses
6,000

 
5,800

Deferred income taxes
2,090

 
(3,963
)
Origination of loans held for sale
(844,456
)
 
(904,453
)
Unrealized (gain) loss on loans held for sale
(112
)
 
(62
)
Gain on sales of loans held for sale
(13,696
)
 
(14,034
)
Proceeds from sale of loans held for sale
859,495

 
937,049

Change in fair value of mortgage servicing rights
(364
)
 
51

(Gain) loss on sale of other real estate and foreclosed assets
4

 
(108
)
Depreciation and amortization of furniture, equipment and software
2,764

 
2,006

Net changes in assets and liabilities which provide (use) cash:
 
 
 
Accrued interest receivable
3,775

 
1,087

Other assets
7,803

 
(14,049
)
Accrued interest payable
33

 
(4
)
Accounts payable and other liabilities
(7,135
)
 
5,194

Net cash provided by (used in) operating activities
83,150

 
69,413

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of investment securities
(93,151
)
 
(96,928
)
Proceeds from sale of available-for-sale securities
121,252

 
10,069

Proceeds from repayment of securities
69,016

 
35,914

Purchase of stock of Federal Home Loan Bank
(30,939
)
 
(68,649
)
Proceeds from redemption of stock of Federal Home Loan Bank
33,711

 
67,500

Origination of loans and leases for portfolio
(1,946,482
)
 
(1,761,693
)
Origination of mortgage warehouse loans, net
(50,401
)
 
(54,327
)
Proceeds from sales of other real estate owned and repossessed assets
146

 
1,442

Purchases of loans and leases, net of discounts and premiums

 
(384
)
Principal repayments on loans
1,533,896

 
1,086,419

Net purchases of furniture, equipment and software
(3,895
)
 
(3,890
)
Net cash used in investing activities
(366,847
)
 
(784,527
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net increase in deposits
566,623

 
748,049

Proceeds from Federal Home Loan Bank advances
411,000

 
524,000

Repayment of Federal Home Loan Bank advances
(473,000
)
 
(519,000
)
Proceeds from exercise of common stock options

 
147

Proceeds from issuance of common stock

 
21,120

Tax benefit from exercise of common stock options and vesting of restricted stock grants
95

 
2,510

Cash dividends on preferred stock
(155
)
 
(155
)
Net cash provided by financing activities
504,563

 
776,671

NET CHANGE IN CASH AND CASH EQUIVALENTS
220,866

 
61,557

CASH AND CASH EQUIVALENTS—Beginning of year
486,727

 
222,874

CASH AND CASH EQUIVALENTS—End of period
$
707,593

 
$
284,431

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
Interest paid on deposits and borrowed funds
$
35,607

 
$
24,869

Income taxes paid
$
38,717

 
$
37,216

Transfers to other real estate owned and repossessed vehicles from loans
$
1,340

 
$
518

Transfers from loans held for investment to loans held for sale
$

 
$
7,985

Transfers from loans held for sale to loans held for investment
$
2,047

 
$
18,846

Securities transferred from held-to-maturity to available-for-sale portfolio
$
194,153

 
$


See accompanying notes to the condensed consolidated financial statements.

5


BOFI HOLDING, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTH PERIODS ENDED DECEMBER 31, 2016 AND 2015
(Dollars in thousands, except per share data)
(Unaudited)

1.
BASIS OF PRESENTATION

The condensed consolidated financial statements include the accounts of BofI Holding, Inc. and its wholly owned subsidiary, BofI Federal Bank (the “Bank” and collectively with BofI Holding, Inc., the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation.

The accompanying interim condensed consolidated financial statements, presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”), are unaudited and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of financial condition and results of operations for the interim periods. All adjustments are of a normal and recurring nature. Results for the six months ended December 31, 2016 are not necessarily indicative of results that may be expected for any other interim period or for the year as a whole. Certain information and note disclosures normally included in the audited annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) with respect to interim financial reporting. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes for the year ended June 30, 2016 included in our Annual Report on Form 10-K.

2.
SIGNIFICANT ACCOUNTING POLICIES
Securities. Debt securities are classified as held-to-maturity and carried at amortized cost when management has both the positive intent and ability to hold them to maturity. Debt securities are classified as available-for-sale when they might be sold before maturity. Trading securities refer to certain types of assets that banks hold for resale at a profit or when the Company elects to account for certain securities at fair value. Increases or decreases in the fair value of trading securities are recognized in earnings as they occur. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. During the quarter ended September 30, 2016, the Company elected to reclassify all of its held-to-maturity securities to available-for-sale. See Note 4 – “Securities” for further information.
Gains and losses on securities sales are based on a comparison of sales proceeds and the amortized cost of the security sold using the specific identification method. Purchases and sales are recognized on the trade date. Interest income includes amortization of purchase premiums or discounts. Premiums and discounts on securities are amortized or accreted using the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. The Company’s portfolios of held-to-maturity and available-for-sale securities are reviewed quarterly for other-than-temporary impairment. In performing this review, management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) how to record an impairment by assessing whether the Company intends to sell or it is more likely than not that it will be required to sell a security in an unrealized loss position before the Company recovers the security’s amortized cost. If either of these criteria for (4) is met, the entire difference between amortized cost and fair value is recognized in earnings. Alternatively, if the criteria for (4) is not met, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
Loans and Leases. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred purchase premiums and discounts, deferred loan origination fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Premiums and discounts on loans purchased as well as loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method.
The Company provides equipment financing to its customers through a variety of lease arrangements. The most common arrangement is a direct financing (capital) lease. For direct financing leases, lease receivables are recorded on the balance sheet but the leased property is not, although the Company generally retains legal title to the leased property until the end of each lease. Direct financing leases are stated at the net amount of minimum lease payments receivable, plus any unguaranteed residual value, less the amount of unearned income and net acquisition discount at the reporting date. Direct lease origination costs are amortized over the weighted average life of the lease portfolio. Leases acquired in an acquisition are initially measured and recorded at their fair value on the acquisition date. Purchase discounts or premiums on acquired leases are recognized as an adjustment to interest

6


income over the contractual life of the leases using the effective interest method or taken into income when the related leases are paid off. Direct financing leases are subject to our allowance for loans and leases.
Recognition of interest income on all portfolio segments is generally discontinued at the time the loan or lease is 90 days delinquent unless the loan or lease is well secured and in process of collection. Past due status is based on the contractual terms of the loan or lease. In all cases, loans or leases are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not received for loans or leases placed on nonaccrual, is reversed against interest income. Interest received on such loans or leases is accounted for on the cash-basis or cost recovery method, until qualifying for return to accrual. Loans and leases are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Loans Held for Sale. U.S government agency (“agency”) loans originated and intended for sale in the secondary market are carried at fair value. Net unrealized gains and losses are recognized through the income statement. The Bank sells its mortgage loans with either servicing released or servicing retained depending upon market pricing. Gains and losses on loan sales are recorded as mortgage banking income, based on the difference between sales proceeds and carrying value. Non-agency loans held for sale are carried at the lower of cost or fair value.
Loans that were originated with the intent and ability to hold for the foreseeable future (loans held in portfolio) but which have been subsequently designated as being held for sale for risk management or liquidity needs are carried at the lower of cost or fair value calculated on an individual loan by loan basis.
There may be times when loans have been classified as held for sale and for some reason cannot be sold. Loans transferred to a long-term-investment classification from held-for-sale are transferred at the lower of cost or market value on the transfer date. Any difference between the carrying amount of the loan and its outstanding principal balance is recognized as an adjustment to yield by the interest method. A loan cannot be classified as a long-term investment unless the Bank has both the ability and the intent to hold the loan for the foreseeable future or until maturity.
Allowance for Loan and Lease Losses. The allowance for loan and lease losses is maintained at a level estimated to provide for probable incurred losses in the loan and lease portfolio. Management determines the adequacy of the allowance based on reviews of individual loans and leases and pools of loans, recent loss experience, current economic conditions, the risk characteristics of the various categories of loans and other pertinent factors. This evaluation is inherently subjective and requires estimates that are susceptible to significant revision as more information becomes available. The allowance is increased by the provision for loan and lease losses, which is charged against current period operating results and recoveries of loans previously charged-off. The allowance is decreased by the amount of charge-offs of loans deemed uncollectible. Allocations of the allowance may be made for specific loans but the entire allowance is available for any loan that, in management’s judgment, should be charged off. See Note 5 of these financial statement footnotes and the financial statement footnotes for the year ended June 30, 2016 included in our Annual Report on Form 10-K for further information.

Brand Partnership Products. The Bank has agreements with H&R Block, Inc. (“H&R Block”) and its wholly-owned subsidiaries that allow the Bank to provide H&R Block-branded financial products and services. The products and services that represent the primary focus and the majority of transactional volume that the Bank processes are described in detail below.
The first product is Emerald Prepaid MasterCard® services. The Bank entered into agreements to offer this product in August 2015. Under the agreements, the Bank is responsible for the primary oversight and control of the prepaid card programs of a wholly-owned subsidiary of H&R Block. The Bank holds the prepaid card customer deposits for those cards issued under the prepaid programs in non-interest bearing accounts and earns a fixed fee paid by H&R Block’s subsidiary for each automated clearing house (“ACH”) transaction processed through the prepaid card customer accounts. A portion of H&R Block’s customers use the Emerald Card as an option to receive federal and state income tax refunds. The prepaid customer deposits are included in non-interest bearing deposit liabilities on the balance sheet of the Company and the ACH fee income is included in the income statement under the line banking service fees and other income.
The second product is Refund Transfer. The Bank entered into agreements to offer this product in August 2015. The Bank is responsible for the primary oversight and control of the refund transfer program of a wholly-owned subsidiary of H&R Block. The Bank opens a temporary bank account for each H&R Block customer who is receiving an income tax refund and elects to defer payment of his or her tax preparation fees. After the Internal Revenue Service and any state income tax authorities transfer the refund into the customer’s account, the net funds are transferred to the customer and the temporary deposit account is closed. The Bank earns a fixed fee paid by H&R Block for each of the H&R Block customers electing a Refund Transfer. The fees are earned primarily in the quarters ending March 31st and are included in the income statement under the line banking service fees and other income.

7


The third product is Emerald Advance. The Bank entered into agreements to offer this product in August 2015. Under the agreements the Bank is responsible for the underwriting guidelines and credit policies for unsecured consumer lines of credit offered to H&R Block customers. The Bank offers and funds unsecured lines of credit to consumers primarily through the H&R Block tax preparation offices and earns interest income and fee income. The Bank retains 10% of the Emerald Advance and sells the remainder to H&R Block. The lines of credit are included in loans and leases on the balance sheet of the Company and the interest income and fee income are included in the income statement under the line loans and leases interest and dividend income.
The fourth product is an Individual Retirement Account (“IRA”). The Bank entered into agreements to offer this product in August 2015, but the initial offering of this product through H&R Block offices occurs in conjunction with the tax season ending April 18, 2017. The Bank is responsible for the primary oversight and control of the IRA product. During a tax preparation session with an H&R Block tax preparer, the customer is given an option to open a traditional IRA or Roth IRA savings account with the Bank. If the customer elects the option to open an account and meets the Bank’s requirements, an account is opened on the Bank’s core operating system under the Bank’s oversight and control. The customer has the option to deposit funds for the IRA through check or ACH. The Bank provides IRA custodial services, earns a nominal fee paid by the customers for any account closures or transfers out, and pays customers interest based on their IRA balance. The fees are included in the income statement under the line banking service fees and other income and interest paid is included under the line deposit interest expense.
The fifth product is an interest-free Refund Advance loan. The Bank entered into agreements to offer this product in October 2016. Under the agreements the Bank will perform disbursement and repayment services and provide funding for interest-free Refund Advance loans to H&R Block customers. The Bank, in conjunction with its agreement partners, offers and funds interest-free loans to consumers, secured by the consumer’s tax refund receivable, primarily through the H&R Block tax preparation offices and earns fee income. The average life of the Refund Advance loan is expected to be ten days. The Bank retains the Refund Advance loans that it funds and will be included in loans and leases on the balance sheet of the Company and fee income will be included in the income statement under the line banking service fees and other income.
New Accounting Pronouncements. In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (ASU) 2015-03 Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. Under the amended guidance, debt issuance costs related to a recognized debt liability are required to be presented as deductions from the carrying amounts of the corresponding debt liabilities, consistent with the presentation of debt discounts and premiums. The amended guidance was adopted for the quarter ended September 30, 2016 and applied retrospectively in accordance with the amended guidance, wherein the balance sheet of each individual period presented has been adjusted to reflect the period-specific effects of applying the amended guidance. The adoption of this guidance did not materially impact our consolidated financial position or consolidated results of operations.
In June 2016, the FASB issued ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which (i) significantly changes the impairment model for most financial assets that are measured at amortized cost and certain other instruments from an incurred loss model to an expected loss model; and (ii) provides for recording credit losses on available-for-sale debt securities through an allowance account. ASU 2016-13 also requires certain incremental disclosures. ASU 2016-13 should be applied on a modified-retrospective transition approach that would require a cumulative-effect adjustment to the opening retained earnings in the statement of financial condition as of the date of adoption. A prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. The guidance will be effective for the Company’s financial statements that include periods beginning July 1, 2020. Early adoption is permitted beginning July 1, 2019. The Company is currently evaluating the impact of this ASU and the Company expects ASU 2016-13 to have a material impact on the Company’s consolidated financial statements.
3.
FAIR VALUE

Fair value is defined as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accounting Standards Codification Topic 820, Fair Value Measurement, also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1:
Quoted prices in active markets for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 1 assets and liabilities include debt and equity securities that are actively traded in an exchange or over-the-counter market and are highly liquid, such as, among other assets and securities, certain U.S. treasury and other U.S. government debt.
Level 2:
Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market

8


data for substantially the full term of the assets or liabilities. Level 2 assets include securities with quoted prices that are traded less frequently than exchange-traded instruments and whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.
Level 3:
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models such as discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
When available, the Company generally uses quoted market prices to determine fair value, in which case the items are classified in Level 1. In some cases where a market price is available, the Company will make use of acceptable practical expedients (such as matrix pricing) to calculate fair value, in which case the items are classified in Level 2.
The Company considers relevant and observable market prices in its valuations where possible. The frequency of transactions, the size of the bid-ask spread and the nature of the participants are some of the factors the Company uses to help determine whether a market is active and orderly or inactive and not orderly. Price quotes based upon transactions that are not orderly are not considered to be determinative of fair value and should be given little, if any, weight in measuring fair value.
If quoted market prices are not available, fair value is based upon internally developed valuation techniques that use, where possible, current market-based or independently sourced market parameters, such as interest rates, credit spreads, housing value forecasts, etc. Items valued using such internally generated valuation techniques are classified according to the lowest level input or value driver that is significant to the valuation. Thus, an item may be classified in Level 3 even though there may be some significant inputs that are readily observable.
The following section describes the valuation methodologies used by the Company to measure various financial instruments at fair value, including an indication of the level in the fair value hierarchy in which each instrument is generally classified:
Securities—trading. Trading securities are recorded at fair value. The trading portfolio consists of two different issues of floating-rate debt securities collateralized by pools of bank trust preferred securities. Recent liquidity and economic uncertainty have made the market for collateralized debt obligations less active or inactive. As quoted market prices are not available, the Level 3 fair values for these securities are determined by the Company utilizing industry-standard tools to calculate the net present value of the expected cash flows available to the securities from the underlying assets. The Company’s expected cash flows are calculated for each security and include the impact of actual and forecasted bank defaults within each collateral pool as well as structural features of the security’s tranche such as lock outs, subordination and overcollateralization. The forecast of underlying bank defaults in each pool is based upon a quarterly financial update including the trend in non-performing assets, the allowance for loan and lease losses and the underlying bank’s capital ratios. Also a factor is the Company’s loan and lease loss experience in the local economy in which the bank operates. At December 31, 2016, the Company’s forecast of cash flows for both securities includes actual and forecasted defaults totaling 17.9% of all banks in the collateral pools, compared to 16.1% of the banks actually in default. The expected cash flows reflect the Company’s best estimate of all pool losses which are then applied to the overcollateralization reserve and the subordinated tranches to determine the cash flows. The Company selects a discount rate margin based upon the spread between U.S. Treasury rates and the market rates for active credit grades for financial companies. The discount margin when added to the U.S. Treasury rate determines the discount rate, reflecting primarily market liquidity and interest rate risk since expected credit loss is included in the cash flows. At December 31, 2016, the Company used a weighted average discount margin of 475 basis points above U.S. Treasury rates to calculate the net present value of the expected cash flows and the fair value of its trading securities.
The Level 3 fair values determined by the Company for its trading securities rely heavily on management’s assumptions as to the future credit performance of the collateral banks, the impact of the global and regional economic activity, the timing of forecasted defaults and the discount rate applied to cash flows. The fair value of the trading securities at December 31, 2016 is sensitive to an increase or decrease in the discount rate. An increase in the discount margin of 100 basis points would have reduced the total fair value of the trading securities and decreased net income before income tax by $803. A decrease in the discount margin of 100 basis points would have increased the total fair value of the trading securities and increased net income before income tax by $921.
Securities—available-for-sale and held-to-maturity. Available-for-sale (“AFS”) securities are recorded at fair value and consist of residential mortgage-backed securities (“RMBS”) issued by U.S. agencies, non-agencies, collateralized loan obligations, and municipals. Held-to-maturity (“HTM”) securities are recorded at amortized cost and consist of RMBS issued by U.S. agencies, RMBS issued by non-agencies, and municipals. Fair value for U.S. agency securities is generally based on quoted market prices of similar securities used to form a dealer quote or a pricing matrix. There continues to be significant illiquidity in the market for RMBS issued by non-agencies, impacting the availability and reliability of transparent pricing. As orderly quoted market prices

9


are not available, the Level 3 fair values for these securities are determined by the Company utilizing industry-standard tools to calculate the net present value of the expected cash flows available to the securities from the underlying mortgage assets. The Company computes Level 3 fair values for each non-agency RMBS in the same manner (as described below) whether available-for-sale or held-to-maturity.
To determine the performance of the underlying mortgage loan pools, the Company estimates prepayments, defaults, and loss severities based on a number of macroeconomic factors, including housing price changes, unemployment rates, interest rates and borrower attributes such as credit score and loan documentation at the time of origination. For each security, the Company inputs a projection of monthly default rates, loss severity rates and voluntary prepayment rates for the underlying mortgages for the remaining life of each security to determine the expected cash flows. The projections of default rates are derived by the Company from the historic default rate observed in the pool of loans collateralizing the security, increased by and decreased by the forecasted increase or decrease in the national unemployment rate. The projections of loss severity rates are derived by the Company from the historic loss severity rate observed in the pool of loans, increased by (and decreased by) the forecasted decrease or increase in the national home price appreciation (“HPA”) index. The largest factors influencing the Company’s modeling of the monthly default rate are unemployment and HPA, as a strong correlation exists. The national unemployment rate announced prior to the end of the period covered by this report (reported for November 2016) was 4.6%, down from the high of 10.0% in October 2009. Consensus estimates for unemployment are that the rate will continue to decline. Going forward, the Company is projecting lower monthly default rates. The range of loss severity rates applied to each default used in the Company’s projections at December 31, 2016 are from 40.0% up to 68.8% based upon individual bond historical performance. The default rates and the severities are projected for every non-agency RMBS security held by the Company and will vary monthly based upon the actual performance of the security and the macroeconomic factors discussed above.
To determine the discount rates used to compute the present value of the expected cash flows for these non-agency RMBS securities, the Company separates the securities by the borrower characteristics in the underlying pool. Specifically, “prime” securities generally have borrowers with higher FICO scores and better documentation of income. “Alt-A” securities generally have borrowers with a lower FICO and less documentation of income. “Pay-option ARMs” are Alt-A securities with borrowers that tend to pay the least amount of principal (or increase their loan balance through negative amortization). The Company calculates separate discount rates for prime, Alt-A and Pay-option ARM non-agency RMBS securities using market-participant assumptions for risk, capital and return on equity. The range of annual default rates used in the Company’s projections at December 31, 2016 are from 1.5% up to 13.7% with prime securities tending toward the lower end of the range and Alt-A and Pay-option ARMs tending toward the higher end of the range. The Company applies its discount rates to the projected monthly cash flows which already reflect the full impact of all forecasted losses using the assumptions described above. When calculating present value of the expected cash flows at December 31, 2016, the Company computed its discount rates as a spread between 239 and 668 basis points over the interpolated swap curve with prime securities tending toward the lower end of the range and Alt-A and Pay-option ARMs tending toward the higher end of the range.
The Bank’s estimate of fair value for non-agency securities using Level 3 pricing is highly subjective and is based on the Bank’s estimate of voluntary prepayments, default rates, severities and discount margins, which are forecasted monthly over the remaining life of the security. Changes in one or more of these assumptions can cause a significant change in the estimated fair value. For further details see the table later in this note that summarizes quantitative information about Level 3 fair value measurements.
Loans Held for Sale. Loans held for sale at fair value are primarily single-family and multifamily residential loans. The fair value of residential loans held for sale is determined by pricing for comparable assets or by existing forward sales commitment prices with investors.
Impaired Loans. Impaired loans are loans which are inadequately protected by the current net worth and paying capacity of the borrowers or the collateral pledged. The accrual of interest income has been discontinued for impaired loans. The impaired loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. The Company assesses loans individually and identifies impairment when the loan is classified as impaired, has been restructured, or management has serious doubts about the future collectibility of principal and interest, even though the loans may currently be performing. The fair value of an impaired loan is determined based on an observable market price or current appraised value of the underlying collateral. The fair value of impaired loans with specific write-offs or allocations of the allowance for loan losses are generally based on recent real estate appraisals or internal valuation analyses consistent with the methodology used in real estate appraisals and include other third-party valuations and analysis of cash flows. These appraisals and analyses are updated at least on an annual basis. The Company primarily obtains real estate appraisals and in the rare cases where an appraisal cannot be obtained, the Company performs an internal valuation analysis. These appraisals and analyses may utilize a single valuation approach or a combination of approaches including comparable sales and income approaches. The sales comparison approach uses at least three recent similar property sales to help determine the fair value of the property being appraised. The income approach is calculated by taking the net operating income generated by the collateral property of the rent collected and dividing it by an

10


assumed capitalization rate. Adjustments are routinely made in the process by the appraisers to account for differences between the comparable sales and income data available. When measuring the fair value of the impaired loan based upon the projected sale of the underlying collateral, the Company subtracts the costs expected to be incurred for the transfer of the underlying collateral, which includes items such as sales commissions, delinquent taxes and insurance premiums. 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. Such adjustments are typically significant and result in a Level 3 classification for the inputs for determining fair value.
Other Real Estate Owned and Repossessed Vehicles. Non-recurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (“OREO”) are measured at the lower of carrying amount or fair value, less estimated costs to sell. Fair values are generally based on third-party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.
Mortgage Servicing Rights. The Company initially records all mortgage servicing rights (“MSRs”) at fair value and accounts for MSRs at fair value during the life of the MSR, with changes in fair value recorded through current period earnings. Fair value adjustments encompass market-driven valuation changes as well as modeled amortization involving the run-off of value that occurs due to the passage of time as individual loans are paid by borrowers. Market expectations about loan duration, and correspondingly the expected term of future servicing cash flows, may vary from time to time due to changes in expected prepayment activity, especially when interest rates rise or fall. Market expectations of increased loan prepayment speeds may negatively impact the fair value of the single family MSRs. Fair value is also dependent on the discount rate used in calculating present value, which is imputed from observable market activity and market participants and results in Level 3 classification. Management reviews and adjusts the discount rate on an ongoing basis. An increase in the discount rate would reduce the estimated fair value of the MSRs asset.
Mortgage Banking Derivatives. Fair value for mortgage banking derivatives are either based upon prices in active secondary markets for identical securities or based on quoted market prices of similar assets used to form a dealer quote or a pricing matrix. If no such quoted price exists, the fair value of a commitment is determined by quoted prices for a similar commitment or commitments, adjusted for the specific attributes of each commitment. These fair values are then adjusted for items such as fallout and estimated costs to originate the loan.

The Company’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 Company’s valuation methodologies are appropriate and consistent with or, in some cases, more conservative than 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 relevant reporting date.


11


The following table sets forth the Company’s financial assets and liabilities measured at fair value on a recurring basis at December 31, 2016 and June 30, 2016. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:
 
December 31, 2016
(Dollars in thousands)
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
ASSETS:
 
 
 
 
 
 
 
Securities—Trading: Collateralized Debt Obligations
$

 
$

 
$
8,151

 
$
8,151

Securities—Available-for-Sale:
 
 
 
 
 
 
 
Agency RMBS
$

 
$
33,264

 
$

 
$
33,264

Non-Agency RMBS

 

 
82,226

 
82,226

Municipal

 
29,373

 

 
29,373

Other Debt Securities

 
234,871

 

 
234,871

Total—Securities—Available-for-Sale
$

 
$
297,508

 
$
82,226

 
$
379,734

Loans Held for Sale
$

 
$
33,990

 
$

 
$
33,990

Mortgage Servicing Rights
$

 
$

 
$
6,150

 
$
6,150

Other assets – Derivative Instruments
$

 
$

 
$
2,340

 
$
2,340

LIABILITIES:
 
 
 
 
 
 
 
   Other liabilities – Derivative Instruments
$

 
$

 
$
89

 
$
89

 
 
 
 
 
 
 
 
 
June 30, 2016
(Dollars in thousands)
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
 
 
 
 
 
 
 
 
ASSETS:
 
 
 
 
 
 
 
Securities—Trading: Collateralized Debt Obligations
$

 
$

 
$
7,584

 
$
7,584

Securities—Available-for-Sale:
 
 
 
 
 
 
 
Agency RMBS
$

 
$
33,722

 
$

 
$
33,722

Non-Agency RMBS

 

 
9,364

 
9,364

Municipal

 
34,719

 

 
34,719

Other Debt Securities

 
187,642

 

 
187,642

Total—Securities—Available-for-Sale
$

 
$
256,083

 
$
9,364

 
$
265,447

Loans Held for Sale
$

 
$
20,871

 
$

 
$
20,871

Mortgage Servicing Rights
$

 
$

 
$
3,943

 
$
3,943

Other assets – Derivative Instruments
$

 
$

 
$
2,202

 
$
2,202

LIABILITIES:
 
 
 
 
 
 
 
Other liabilities – Derivative Instruments
$

 
$

 
$
884

 
$
884



12


The following tables present additional information about assets measured at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value:
 
For the Three Months Ended
 
December 31, 2016
(Dollars in thousands)
Securities – Trading: Collateralized Debt Obligations
 
Securities – Available-for-Sale: Non-Agency RMBS
 
Mortgage Servicing Rights
 
Derivative Instruments, net
 
Total
 
 
 
 
 
 
 
 
 
 
Opening balance
$
7,695

 
$
133,169

 
$
4,855

 
$
2,186

 
$
147,905

Transfers into Level 3

 

 

 

 

Transfers out of Level 3

 

 

 

 

Total gains or losses for the period:
 
 
 
 
 
 
 
 
 
Included in earnings—Sale of mortgage-backed securities

 
(2,569
)
 

 

 
(2,569
)
Included in earnings—Fair value gain (loss) on trading securities
456

 

 

 

 
456

Included in earnings—Mortgage banking income

 

 
585

 
65

 
650

Included in other comprehensive income

 
1,780

 

 

 
1,780

Purchases, originations, issues, sales and settlements:
 
 
 
 
 
 
 
 
 
Purchases/originations

 

 
710

 

 
710

Issues

 

 

 

 

Sales

 
(44,210
)
 

 

 
(44,210
)
Settlements

 
(4,594
)
 

 

 
(4,594
)
Other-than-temporary impairment

 
(1,350
)
 

 

 
(1,350
)
Closing balance
$
8,151

 
$
82,226

 
$
6,150

 
$
2,251

 
$
98,778

 
 
 
 
 
 
 
 
 
 
Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period
$
456

 
$
(2,569
)
 
$
585

 
$
65

 
$
(1,463
)
 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended
 
December 31, 2016
(Dollars in thousands)
Securities – Trading: Collateralized Debt Obligations
 
Securities – Available-for-Sale: Non-Agency RMBS
 
Mortgage Servicing Rights
 
Derivative Instruments, net
 
Total
 
 
 
 
 
 
 
 
 
 
Opening Balance
$
7,584

 
$
9,364

 
$
3,943

 
$
1,318

 
$
22,209

Transfers into Level 3

 
124,547

 

 

 
124,547

Transfers out of Level 3

 

 

 

 

Total gains or losses for the period:
 
 
 
 
 
 
 
 


Included in earnings—Sale of mortgage-backed securities

 
(1,868
)
 

 

 
(1,868
)
Included in earnings—Fair value gain (loss) on trading securities
567

 

 

 

 
567

Included in earnings—Mortgage banking income


 

 
364

 
933

 
1,297

Included in other comprehensive income

 
9,314

 

 

 
9,314

Purchases, originations, issues, sales and settlements:
 
 
 
 
 
 
 
 


Purchases/originations

 

 
1,843

 

 
1,843

Issues

 

 

 

 

Sales

 
(50,609
)
 

 

 
(50,609
)
Settlements

 
(7,052
)
 

 

 
(7,052
)
Other-than-temporary impairment

 
(1,470
)
 

 

 
(1,470
)
Closing balance
$
8,151

 
$
82,226

 
$
6,150

 
$
2,251

 
$
98,778

 
 
 
 
 
 
 
 
 
 
Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period
$
567

 
$
(1,868
)
 
$
364

 
$
933

 
$
(4
)

13


 
For the Three Months Ended
 
December 31, 2015
(Dollars in thousands)
Securities – Trading: Collateralized Debt Obligations
 
Securities – Available-for-Sale: Non-Agency RMBS
 
Mortgage Servicing Rights
 
Derivative Instruments, net
 
Total
 
 
 
 
 
 
 
 
 
 
Opening balance
$
7,902

 
$
24,993

 
$
2,687

 
$
1,018

 
$
36,600

Transfers into Level 3

 

 

 

 

Transfers out of Level 3

 

 

 

 

Total gains or losses for the period:
 
 
 
 
 
 
 
 
 
Included in earnings—Sale of mortgage-backed securities

 
(680
)
 

 

 
(680
)
Included in earnings—Fair value gain on trading securities
(196
)
 

 

 

 
(196
)
Included in earnings—Mortgage banking income

 

 
95

 
13

 
108

Included in other comprehensive income

 
(715
)
 

 

 
(715
)
Purchases, originations, issues, sales and settlements:
 
 
 
 
 
 
 
 
 
Purchases/originations

 

 
693

 

 
693

Issues

 

 

 

 

Sales

 
(2,089
)
 

 

 
(2,089
)
Settlements

 
(369
)
 

 

 
(369
)
Other-than-temporary impairment

 
(4
)
 

 

 
(4
)
Closing balance
$
7,706

 
$
21,136

 
$
3,475

 
$
1,031

 
$
33,348

 
 
 
 
 
 
 
 
 
 
Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period
$
(196
)
 
$
(680
)
 
$
95

 
$
13

 
$
(768
)
 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended
 
December 31, 2015
(Dollars in thousands)
Securities – Trading: Collateralized Debt Obligations
 
Securities – Available-for-Sale: Non-Agency RMBS
 
Mortgage Servicing Rights
 
Derivative Instruments, net
 
Total
 
 
 
 
 
 
 
 
 
 
Opening Balance
$
7,832

 
$
26,633

 
$
2,098

 
$
2,261

 
$
38,824

Transfers into Level 3

 

 

 

 

Transfers out of Level 3

 

 

 

 

Total gains or losses for the period:
 
 
 
 
 
 
 
 
 
Included in earnings—Sale of mortgage-backed securities

 
(680
)
 

 

 
(680
)
Included in earnings—Fair value gain (loss) on trading securities
(126
)
 

 

 

 
(126
)
Included in earnings—Mortgage banking income

 

 
(51
)
 
(1,230
)
 
(1,281
)
Included in other comprehensive income

 
(961
)
 

 

 
(961
)
Purchases, originations, issues, sales and settlements:
 
 
 
 
 
 
 
 
 
Purchases/originations

 

 
1,428

 

 
1,428

Issues

 

 

 

 

Sales

 
(2,089
)
 

 

 
(2,089
)
Settlements

 
(1,728
)
 

 

 
(1,728
)
Other-than-temporary impairment

 
(39
)
 

 

 
(39
)
Closing balance
$
7,706

 
$
21,136

 
$
3,475

 
$
1,031

 
$
33,348

 
 
 
 
 
 
 
 
 
 
Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period
$
(126
)
 
$
(680
)
 
$
(51
)
 
$
(1,230
)
 
$
(2,087
)

14



The table below summarizes the quantitative information about level 3 fair value measurements at the periods indicated:
 
December 31, 2016
(Dollars in thousands)
Fair Value
Valuation Technique
Unobservable Input
Range (Weighted Average)
Securities – Trading:
Collateralized Debt Obligations
$
8,151

Discounted Cash Flow
Total Projected Defaults,
Discount Rate over Treasury
13.7 to 22.0% (17.8%)
4.75 to 4.75% (4.75%)
Securities – Available-for-Sale:
Non-agency RMBS
$
82,226

Discounted Cash Flow
Projected Constant Prepayment Rate,
Projected Constant Default Rate,
Projected Loss Severity,
Discount Rate over LIBOR
2.5 to 25.3% (10.0%)
1.5 to 13.7% (4.3%)
40.0 to 68.8% (57.4%)
2.39 to 6.68% (3.61%)
Mortgage Servicing Rights
$
6,150

Discounted Cash Flow
Projected Constant Prepayment Rate,
Life (in years),
Discount Rate
6.6 to 21.7% (9.0%)
2.9 to 8.5 (6.9)
9.5 to 13.0% (9.7%)
Derivative Instruments, net
$
2,251

Sales Comparison Approach
Projected Sales Profit of Underlying Loans
0.2 to 0.7% (0.5%)
 
June 30, 2016
(Dollars in thousands)
Fair Value
Valuation Technique
Unobservable Input
Range (Weighted Average)
Securities – Trading:
Collateralized Debt Obligations
$
7,584

Discounted Cash Flow
Total Projected Defaults,
Discount Rate over Treasury
11.7 to 21.0% (16.5%)
5.0 to 5.0% (5.0%)
Securities – Available-for-Sale:
Non-agency RMBS
$
9,364

Discounted Cash Flow
Projected Constant Prepayment Rate,
Projected Constant Default Rate,
Projected Loss Severity,
Discount Rate over LIBOR
9.1 to 20.6% (14.2%)
1.5 to 13.6% (6.1%)
40.0 to 68.8% (51.5%)
2.5 to 2.9% (2.8%)
Mortgage Servicing Rights
$
3,943

Discounted Cash Flow
Projected Constant Prepayment Rate,
Life (in years),
Discount Rate
7.8 to 21.8% (10.6%)
3.5 to 7.1 (6.2)
9.5 to 10.5% (9.5%)
Derivative Instruments, net
$
1,318

Sales Comparison Approach
Projected Sales Profit of Underlying Loans
0.3 to 0.6% (0.4%)


The significant unobservable inputs used in the fair value measurement of the Company’s residential mortgage-backed securities are prepayment rates, probability of default, and loss severity in the event of default. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

The table below summarizes changes in unrealized gains and losses and interest income recorded in earnings for level 3 trading assets and liabilities that are still held at the periods indicated:
 
For the Three Months Ended
 
For the Six Months Ended
 
December 31,
 
December 31,
(Dollars in thousands)
2016
 
2015
 
2016
 
2015
Interest income on investments
$
70

 
$
60

 
$
143

 
$
117

Fair value adjustment
456

 
(195
)
 
567

 
(126
)
Total
$
526

 
$
(135
)
 
$
710

 
$
(9
)


15


The table below summarizes assets measured for impairment on a non-recurring basis:
 
December 31, 2016
(Dollars in thousands)
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Balance
Impaired Loans:
 
 
 
 
 
 
 
Single family real estate secured:
 
 
 
 
 
 
 
Mortgage
$

 
$

 
$
28,351

 
$
28,351

Home equity

 

 
47

 
47

Multifamily real estate secured

 

 
5,478

 
5,478

Commercial real estate secured

 

 
232

 
232

Auto and RV secured

 

 
216

 
216

Other

 

 
445

 
445

Total
$

 
$

 
$
34,769

 
$
34,769

Other real estate owned and foreclosed assets:
 
 
 
 
 
 
 
Single family real estate
$

 
$

 
$
908

 
$
908

Autos and RVs

 

 
53

 
53

Total
$

 
$

 
$
961

 
$
961

 
 
 
 
 
 
 
 
 
June 30, 2016
(Dollars in thousands)
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Balance
Impaired Loans:
 
 
 
 
 
 
 
Single family real estate secured:
 
 
 
 
 
 
 
Mortgage
$

 
$

 
$
28,610

 
$
28,610

Home equity

 

 
33

 
33

Multifamily real estate secured

 

 
2,218

 
2,218

Commercial real estate secured

 

 
254

 
254

Auto and RV secured

 

 
278

 
278

Other

 

 
676

 
676

Total
$

 
$

 
$
32,069

 
$
32,069

Other real estate owned and foreclosed assets:
 
 
 
 
 
 
 
Multifamily real estate

 

 
207

 
207

Autos and RVs

 

 
45

 
45

Total
$

 
$

 
$
252

 
$
252

HTM Securities – Non-Agency RMBS
$

 
$

 
$
79,164

 
$
79,164


Impaired loans measured for impairment on a non-recurring basis using the fair value of the collateral for collateral-dependent loans have a carrying amount of $34,769, after charge-offs of $903 for the six months ended December 31, 2016, and life to date charge-offs of $5,665. Impaired loans had a related allowance of $705 at December 31, 2016.

Other real estate owned and foreclosed assets, which are measured at the lower of carrying value or fair value less costs to sell, had a net carrying amount of $961 after charge-offs of $323 for the three months ended December 31, 2016.
Held-to-maturity securities measured for impairment on a non-recurring basis had no fair value and no carrying amount at December 31, 2016, with no net impairment charges to income and no changes to other comprehensive income during the six months ended December 31, 2016. The Company recognized net impairment charges to income of $102 and an increase in other

16


comprehensive income of $3,496 for the six months ended December 31, 2015. These held-to-maturity securities are valued using Level 3 inputs.
The Company has elected the fair value option for Agency loans held for sale. These loans are intended for sale and the Company believes that the fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loan. None of these loans are 90 days or more past due nor on nonaccrual as of December 31, 2016 and June 30, 2016.
As of December 31, 2016 and June 30, 2016, the aggregate fair value, contractual balance (including accrued interest), and unrealized gain was as follows:
(Dollars in thousands)
December 31, 2016
 
June 30, 2016
Aggregate fair value
$
33,990

 
$
20,871

Contractual balance
33,232

 
20,226

Unrealized gain
$
758

 
$
645

The total amount of unrealized gains and losses from changes in fair value included in earnings for the period indicated below for loans held for sale were:
 
For the Three Months Ended
 
For the Six Months Ended
 
December 31,
 
December 31,
(Dollars in thousands)
2016
 
2015
 
2016
 
2015
Interest income
$
192

 
$
161

 
$
329

 
$
433

Change in fair value
99

 
(286
)
 
1,046

 
(1,292
)
Total
$
291

 
$
(125
)
 
$
1,375

 
$
(859
)

17


The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at the periods indicated:
 
December 31, 2016
(Dollars in thousands)
Fair Value
Valuation Technique(s)
Unobservable Input
Range (Weighted Average) 1
Impaired loans:
 
 
 
 
Single family real estate secured:
 
 
 
 
Mortgage
$
28,351

Sales comparison approach
Adjustment for differences between the comparable sales
-33.3 to 56.4% (-3.0%)
Home equity
$
47

Sales comparison approach
Adjustment for differences between the comparable sales
-7.8 to 22.0% (1.5%)
Multifamily real estate secured
$
5,478

Sales comparison approach, income approach,
Discounted cash flows
Adjustment for differences between the comparable sales and adjustments for differences in net operating income expectations
-26.7 to 25.0% (-9.5%)
Commercial real estate secured
$
232

Sales comparison approach and income approach
Adjustment for differences between the comparable sales and adjustments for differences in net operating income expectations
0.0 to 23.6% (11.8%)
Auto and RV secured
$
216

Sales comparison approach
Adjustment for differences between the comparable sales
-31.0 to 25.9% (-6.7%)
Other
$
445

Discounted cash flow
Projected Constant Prepayment Rate,
Projected Constant Default Rate,
Projected Loss Severity,
Discount Rate
0.0 to 0.0% (0.0%)
0.0 to 10.0% (5.0%)
100.0 to 100.0% (100.0%)
4.9 to 6.0% (5.4%)
Other real estate owned and foreclosed assets:
 
 
 
 
Single family real estate
$
908

Sales comparison approach
Adjustment for differences between the comparable sales
-23.0 to 12.5% (-5.3%)
Autos and RVs
$
53

Sales comparison approach
Adjustment for differences between the comparable sales
-5.9 to 16.1% (4.3%)
_______________________ 
1 For impaired loans, other real estate owned and foreclosed assets the ranges shown may vary positively or negatively based on the comparable sales reported in the current appraisal. In certain instances, the range can be significant due to small sample sizes and in some cases the property being valued having limited comparable sales with similar characteristics at the time the current appraisal is conducted.


18


 
June 30, 2016
(Dollars in thousands)
Fair Value
Valuation Technique(s)
Unobservable Input
Range (Weighted Average) 1
Impaired loans:
 
 
 
 
Single family real estate secured:
 
 
 
 
Mortgage
$
28,610

Sales comparison approach
Adjustment for differences between the comparable sales
-40.6 to 69.5% (6.2%)
Home equity
$
33

Sales comparison approach
Adjustment for differences between the comparable sales
-27.2 to 0.0% (-11.1%)
Multifamily real estate secured
$
2,218

Sales comparison approach and income approach
Adjustment for differences between the comparable sales and adjustments for differences in net operating income expectations, capitalization rate
-29.7 to 58.0% (3.0%)
Commercial real estate secured
$
254

Sales comparison approach and income approach
Adjustment for differences between the comparable sales and adjustments for differences in net operating income expectations, capitalization rate
0.0 to 66.7% (33.3%)
Auto and RV secured
$
278

Sales comparison approach
Adjustment for differences between the comparable sales
0.0 to 22.8% (10.6%)
Other
$
676

Discounted cash flow
Projected Constant Prepayment Rate,
Projected Constant Default Rate,
Projected Loss Severity,
Discount Rate
0.0 to 0.0% (0.0%)
0.0 to 10.0% (5.0%)
100.0 to 100.0% (100.0%)
6.6 to 8.0% (7.3%)
Other real estate owned and foreclosed assets:
 
 
 
 
Multifamily real estate
$
207

Sales comparison approach and income approach
Adjustment for differences between the comparable sales and adjustments for differences in net operating income expectations, capitalization rate
0.0 to 25.0% (12.5%)
Autos and RVs
$
45

Sales comparison approach
Adjustment for differences between the comparable sales
0.0 to 20.6% (10.2%)
HTM Securities – Non-Agency RMBS
$
79,164

Discounted cash flow