XOTC:PSBQ Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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FORM 10-Q

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

(Mark One)    
S QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
     
  For the quarterly period ended March 31, 2012  
     
  OR  
     
£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
  For the transition period from _____________ to _____________  

 

Commission file number: 0-26480

 

PSB HOLDINGS, INC.
(Exact name of registrant as specified in charter)
     
WISCONSIN   39-1804877
(State of incorporation)   (I.R.S. Employer Identification Number)
     
1905 West Stewart Avenue
Wausau, Wisconsin 54401
(Address of principal executive office)

 

Registrant’s telephone number, including area code: 715-842-2191

 

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 report), and (2) has been subject to such filing requirements for the past 90 days.

Yes         S            No         £

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes         S            No         £

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer £ Accelerated filer £  
           
  Non-accelerated filer £ Smaller reporting company S  
  (Do not check if a smaller reporting company)      

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2) of the Exchange Act).

Yes         o            No        x

 

The number of common shares outstanding at May 15, 2012 was 1,584,637.


 
 

PSB HOLDINGS, INC.

 

FORM 10-Q

 

Quarter Ended March 31, 2012

 

    Page No.
PART I. FINANCIAL INFORMATION  
     
  Item 1. Financial Statements  
       
    Consolidated Balance Sheets
March 31, 2012 (unaudited) and December 31, 2011
(derived from audited financial statements)
  1
       
    Consolidated Statements of Income
Three Months Ended March 31, 2012 and 2011 (unaudited)
  2
       
   

Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 2012 and 2011 (unaudited)

  3
       
    Consolidated Statement of Changes in Stockholders’ Equity
Three Months Ended March 31, 2012 (unaudited)
  3
       
    Consolidated Statements of Cash Flows
Three Months Ended March 31, 2012 and 2011 (unaudited)
  4
       
    Notes to Consolidated Financial Statements   6
       
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
       
  Item 3. Quantitative and Qualitative Disclosures About Market Risk 52
       
  Item 4. Controls and Procedures 52
       
PART II. OTHER INFORMATION  
       
  Item 1A. Risk Factors 53
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 53
       
  Item 6. Exhibits 54
-i-

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

PSB Holdings, Inc.

Consolidated Balance Sheets

March 31, 2012 unaudited, December 31, 2011 derived from audited financial statements

   March 31,   December 31, 
(dollars in thousands, except per share data)  2012   2011 
Assets          
           
Cash and due from banks  $6,662   $14,805 
Interest-bearing deposits and money market funds   1,250    1,829 
Federal funds sold   11,804    21,571 
           
Cash and cash equivalents   19,716    38,205 
           
Securities available for sale (at fair value)   63,145    59,383 
Securities held to maturity (fair value of $50,917 and $50,751, respectively)   49,492    49,294 
Bank certificates of deposit   2,484    2,484 
Loans held for sale   852    39 
Loans receivable, net   435,481    437,557 
Accrued interest receivable   2,179    2,068 
Foreclosed assets   3,108    2,939 
Premises and equipment, net   9,866    9,928 
Mortgage servicing rights, net   1,151    1,205 
Federal Home Loan Bank stock (at cost)   2,867    3,250 
Cash surrender value of bank-owned life insurance   11,507    11,406 
Other assets   4,940    5,109 
           
TOTAL ASSETS  $606,788   $622,867 
           
Liabilities          
           
Non-interest-bearing deposits  $62,452   $75,298 
Interest-bearing deposits   404,054    406,211 
           
Total deposits   466,506    481,509 
           
Federal Home Loan Bank advances   50,124    50,124 
Other borrowings   18,944    19,691 
Senior subordinated notes   7,000    7,000 
Junior subordinated debentures   7,732    7,732 
Accrued expenses and other liabilities   4,980    6,449 
           
Total liabilities   555,286    572,505 
           
Stockholders’ equity          
           
Preferred stock - no par value:          
   Authorized – 30,000 shares; no shares issued or outstanding        
Common stock – no par value with a stated value of $1 per share:          
   Authorized – 3,000,000 shares; Issued – 1,751,431 shares          
   Outstanding – 1,584,077 and 1,575,804 shares, respectively   1,751    1,751 
Additional paid-in capital   5,115    5,323 
Retained earnings   47,288    46,111 
Accumulated other comprehensive income, net of tax   1,880    1,934 
Treasury stock, at cost – 167,354 and 175,627 shares, respectively   (4,532)   (4,757)
           
Total stockholders’ equity   51,502    50,362 
           
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $606,788   $622,867 
-1-

 

PSB Holdings, Inc.

Consolidated Statements of Income

   Three Months Ended 
   March 31, 
(dollars in thousands, except per share data – unaudited)  2012   2011 
         
Interest and dividend income:          
   Loans, including fees  $5,841   $6,044 
   Securities:          
     Taxable   572    678 
     Tax-exempt   263    297 
   Other interest and dividends   19    24 
           
       Total interest and dividend income   6,695    7,043 
           
Interest expense:          
   Deposits   1,152    1,429 
   FHLB advances   352    457 
   Other borrowings   148    167 
   Senior subordinated notes   142    142 
   Junior subordinated debentures   85    84 
           
       Total interest expense   1,879    2,279 
           
Net interest income   4,816    4,764 
Provision for loan losses   160    360 
           
Net interest income after provision for loan losses   4,656    4,404 
           
Noninterest income:          
   Service fees   402    379 
   Mortgage banking   312    425 
   Investment and insurance sales commissions   138    130 
   Increase in cash surrender value of life insurance   101    106 
   Other noninterest income   289    357 
           
       Total noninterest income   1,242    1,397 
           
Noninterest expense:          
   Salaries and employee benefits   2,163    2,110 
   Occupancy and facilities   406    453 
   Loss on foreclosed assets   233    295 
   Data processing and other office operations   404    313 
   Advertising and promotion   58    61 
   FDIC insurance premiums   107    189 
   Other noninterest expenses   748    532 
           
       Total noninterest expense   4,119    3,953 
           
Income before provision for income taxes   1,779    1,848 
Provision for income taxes   599    563 
           
Net income  $1,180   $1,285 
Basic earnings per share  $0.74   $0.82 
Diluted earnings per share  $0.74   $0.82 
-2-

PSB Holdings, Inc.

Consolidated Statements of Comprehensive Income

   Three Months Ended 
   March 31, 
(dollars in thousands – unaudited)  2012   2011 
         
Net income  $1,180   $1,285 
           
Other comprehensive income, net of tax:          
           
   Unrealized gain (loss) on securities available for sale   2    (53)
           
   Amortization of unrealized gain on securities available for sale transferred to securities          
       held to maturity included in net income   (71)   (86)
           
   Unrealized gain (loss) on interest rate swap   (10)   26 
           
   Reclassification adjustment of interest rate swap settlements included in earnings   25    27 
           
Comprehensive income  $1,126   $1,199 

 

 

PSB Holdings, Inc.

Consolidated Statement of Changes in Stockholders’ Equity

Three months ended March 31, 2012

               Accumulated         
               Other         
       Additional       Comprehensive         
   Common   Paid-in   Retained   Income   Treasury     
(dollars in thousands – unaudited)  Stock   Capital   Earnings   (Loss)   Stock   Totals 
                         
Balance January 1, 2012  $1,751   $5,323   $46,111   $1,934   $(4,757)  $50,362 
                               
Comprehensive income:                              
   Net income             1,180              1,180 
   Unrealized gain on securities                              
     available for sale, net of tax                  2         2 
   Amortization of unrealized gain on securities                              
     available for sale transferred to securities                              
     held to maturity included in net income, net of tax                  (71)        (71)
   Unrealized loss on interest rate swap, net of tax                  (10)        (10)
   Reclassification of interest rate swap settlements                              
     included in earnings, net of tax                  25         25 
                               
       Total comprehensive income                            1,126 
                               
Purchase of treasury stock                       (5)   (5)
Issuance of new restricted stock grants        (230)             230     
Vesting of existing restricted stock grants        22                   22 
Cash dividends declared on unvested restricted stock grants             (3)             (3)
                               
Balance March 31, 2012  $1,751   $5,115   $47,288   $1,880   $(4,532)  $51,502 
-3-

PSB Holdings, Inc.

Consolidated Statements of Cash Flows

Three months ended March 31, 2012 and 2011

 

(dollars in thousands – unaudited)  2012   2011 
         
Cash flows from operating activities:          
           
   Net income  $1,180   $1,285 
   Adjustments to reconcile net income to net cash provided by operating activities:          
     Provision for depreciation and net amortization   649    535 
     Provision for loan losses   160    360 
     Deferred net loan origination costs   (95)   (75)
     Gain on sale of loans   (349)   (205)
     Provision for (recapture of) servicing right valuation allowance   66    (141)
     Loss on sale and write-down of foreclosed assets   189    200 
     Increase in cash surrender value of life insurance   (101)   (106)
     Changes in operating assets and liabilities:          
       Accrued interest receivable   (111)   (106)
       Other assets   210    115 
       Other liabilities   (1,445)   (1,427)
           
   Net cash provided by operating activities   353    435 
           
Cash flows from investing activities:          
           
   Proceeds from sale and maturities of:          
     Securities available for sale   5,526    4,631 
     Securities held to maturity   1,210    945 
   Payment for purchase of:          
     Securities available for sale   (9,518)   (12,428)
     Securities held to maturity   (1,537)   (442)
   Redemption of FHLB stock   383     
   Net (increase) decrease in loans   951    (4,142)
   Capital expenditures   (99)   (19)
   Proceeds from sale of foreclosed assets       74 
   Purchase of bank-owned life insurance       (93)
           
   Net cash used in investing activities   (3,084)   (11,474)
           

 

-4-

PSB Holdings, Inc.

Consolidated Statements of Cash Flows

Three months ended March 31, 2012

(continued)

 

(dollars in thousands – unaudited)  2011   2012 
         
Cash flows from financing activities:          
           
   Net decrease in non-interest-bearing deposits   (12,846)   (6,870)
   Net decrease in interest-bearing deposits   (2,157)   (14,104)
   Net increase in FHLB advances       3,667 
   Net decrease in other borrowings   (747)   (4,057)
   Dividends declared   (3)   (3)
   Proceeds from exercise of stock options       4 
   Purchase of treasury stock   (5)    
           
   Net cash used in financing activities   (15,758)   (21,363)
           
Net decrease in cash and cash equivalents   (18,489)   (32,402)
Cash and cash equivalents at beginning   38,205    40,331 
           
Cash and cash equivalents at end  $19,716   $7,929 
           
Supplemental cash flow information:          
           
Cash paid during the period for:          
     Interest  $1,924   $2,353 
     Income taxes   310    475 
           
Noncash investing and financing activities:          
           
     Loans charged off  $347   $946 
     Loans transferred to foreclosed assets   358    135 
     Issuance of unvested restricted stock grants at fair value   200    200 
     Vesting of restricted stock grants   22    26 
-5-

PSB Holdings, Inc.

Notes to Consolidated Financial Statements

 

 

NOTE 1 – GENERAL

 

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly PSB Holdings, Inc.’s (“PSB”) financial position, results of its operations, and cash flows for the periods presented, and all such adjustments are of a normal recurring nature. The consolidated financial statements include the accounts of all subsidiaries. All material intercompany transactions and balances are eliminated. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Any reference to “PSB” refers to the consolidated or individual operations of PSB Holdings, Inc. and its subsidiary Peoples State Bank. Dollar amounts are in thousands, except per share amounts.

 

These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles have been omitted or abbreviated. The information contained in the consolidated financial statements and footnotes in PSB’s Annual Report on Form 10-K for the year ended December 31, 2011 should be referred to in connection with the reading of these unaudited interim financial statements.

 

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are susceptible to significant change include the determination of the allowance for loan losses, mortgage servicing right assets, and the valuation of investment securities.

 

NOTE 2 – SECURITIES

 

The amortized cost and estimated fair value of investment securities are as follows:

 

       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
March 31, 2012  Cost   Gains   Losses   Value 
                 
Securities available for sale                    
                     
U.S. Treasury securities and obligations of U.S. government corporations and agencies  $501   $11   $   $512 
U.S. agency issued residential mortgage-backed securities   18,993    1,034    14    20,013 
U.S. agency issued residential collateralized mortgage obligations   41,358    872    19    42,211 
Privately issued residential collateralized mortgage obligations   352    10        362 
Other equity securities   47            47 
                     
Totals  $61,251   $1,927   $33   $63,145 
                     
Securities held to maturity                    
                     
Obligations of states and political subdivisions  $47,598   $1,571   $67   $49,102 
Nonrated trust preferred securities   1,491    38    122    1,407 
Nonrated senior subordinated notes   403    5        408 
                     
Totals  $49,492   $1,614   $189   $50,917 
                     

 

-6-

 

       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
December 31, 2011  Cost   Gains   Losses   Value 
                 
Securities available for sale                    
                     
U.S. Treasury securities and obligations of U.S. government corporations and agencies  $501   $17   $   $518 
U.S. agency issued residential mortgage-backed securities   18,754    1,068    6    19,816 
U.S. agency issued residential collateralized mortgage obligations   37,774    806    7    38,573 
Privately issued residential collateralized mortgage obligations   418    11        429 
Other equity securities   47            47 
                     
Totals  $57,494   $1,902   $13   $59,383 
                     
Securities held to maturity                    
                     
Obligations of states and political subdivisions  $47,404   $1,636   $30   $49,010 
Nonrated trust preferred securities   1,487    40    195    1,332 
Nonrated senior subordinated notes   403    6        409 
                     
Totals  $49,294   $1,682   $225   $50,751 

 

Securities with a fair value of $47,863 and $56,659 at March 31, 2012 and December 31, 2011, respectively, were pledged to secure public deposits, other borrowings, and for other purposes required by law.

 

NOTE 3 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

 

Loans

 

Loans that management has the intent to hold for the foreseeable future or until maturity or pay-off are generally reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest on loans is credited to income as earned. Interest income is not accrued on loans where management has determined collection of such interest is doubtful or those loans which are past due 90 days or more as to principal or interest payments. When a loan is placed on nonaccrual status, previously accrued but unpaid interest deemed uncollectible is reversed and charged against current income. After being placed on nonaccrual status, additional income is recorded only to the extent that payments are received and the collection of principal becomes reasonably assured. Interest income recognition on loans considered to be impaired is consistent with the recognition on all other loans. Loan origination fees and certain direct loan origination costs are deferred and recognized as an adjustment of the related loan yield using the interest method.

 

Allowance for Loan Losses

 

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes the collectability of the principal is unlikely.

 

Management maintains the allowance for loan losses at a level to cover probable credit losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio. In accordance with current accounting standards, the allowance is provided for losses that have been incurred based on events that have occurred as of the balance sheet date. The allowance is based on past events and current economic conditions and does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions.

 

The allowance for loan losses includes specific allowances related to loans which have been judged to be impaired. A loan is impaired when, based on current information, it is probable that PSB will not collect all amounts due in accordance with the contractual terms of the loan agreement. Management has determined that impaired loans include nonaccrual loans, loans identified as restructurings of troubled debt, and loans accruing interest with elevated risk of default in the near term based on a variety of credit factors. Specific allowances on impaired loans are based on discounted cash flows of expected future payments using the loan’s initial effective interest rate or the fair value of the collateral if the loan is collateral dependent.

-7-

 

In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require PSB to make additions to the allowance for loan losses based on their judgments of collectability resulting from information available to them at the time of their examination.

 

The composition of loans, categorized by the type of the loan, is as follows:

 

   March 31, 2012   December 31, 2011 
         
Commercial, industrial, and municipal  $130,552   $127,192 
Commercial real estate mortgage   178,844    184,360 
Commercial construction and development   18,165    20,078 
Residential real estate mortgage   78,588    78,114 
Residential construction and development   13,122    13,419 
Residential real estate home equity   23,380    23,193 
Consumer and individual   3,390    3,732 
           
Subtotals - Gross loans   446,041    450,088 
Loans in process of disbursement   (3,004)   (4,787)
           
Subtotals - Disbursed loans   443,037    445,301 
Net deferred loan costs   199    197 
Allowance for loan losses   (7,755)   (7,941)
           
Net loans receivable  $435,481   $437,557 

 

The following is a summary of information pertaining to impaired loans at period-end:

 

   March 31, 2012   December 31, 2011 
         
Impaired loans without a valuation allowance  $6,560   $5,474 
Impaired loans with a valuation allowance   11,049    11,745 
           
Total impaired loans before valuation allowances   17,609    17,219 
Valuation allowance related to impaired loans   3,099    3,178 
           
Net impaired loans  $14,510   $14,041 

 

Activity in the allowance for loans losses during the three months ended March 31, 2012 and 2011, follows:

 

   March 31, 2012 
Allowance for loan losses:  Commercial   Commercial
Real Estate
   Residential
Real Estate
   Consumer   Unallocated   Total 
                         
Beginning Balance  $3,406   $3,175   $1,242   $118   $   $7,941 
Provision   (35)   (149)   348    (4)       160 
Recoveries   1                    1 
Charge offs   (102)       (237)   (8)       (347)
                               
Ending balance  $3,270   $3,026   $1,353   $106   $   $7,755 
Individually evaluated for impairment  $1,445   $947   $689   $18   $   $3,099 
Collectively evaluated for impairment  $1,825   $2,079   $664   $88   $   $4,656 
                               
Loans receivable (gross):                              
                               
Individually evaluated for impairment  $6,281   $8,693   $2,564   $71   $   $17,609 
Collectively evaluated for impairment  $124,271   $188,316   $112,526   $3,319   $   $428,432 

 

-8-

   March 31, 2011 
Allowance for loan losses:  Commercial   Commercial
Real Estate
   Residential
Real Estate
   Consumer   Unallocated   Total 
                         
Beginning balance  $3,862   $3,674   $211   $213   $   $7,960 
Provision   650    (868)   672    (94)       360 
Recoveries   1            2        3 
Charge offs   (725)   (132)   (82)   (7)       (946)
                               
Ending balance  $3,788   $2,674   $801   $114   $   $7,377 
Individually evaluated for impairment  $1,844   $820   $349   $44   $   $3,057 
Collectively evaluated for impairment  $1,944   $1,854   $452   $70   $   $4,320 
                               
Loans receivable (gross):                              
                               
Individually evaluated for impairment  $6,813   $4,985   $1,150   $472   $   $13,420 
Collectively evaluated for impairment  $120,177   $207,101   $105,008   $3,601   $   $435,887 

 

PSB maintains an independent credit administration staff that continually monitors aggregate commercial loan portfolio and individual borrower credit quality trends. All commercial purpose loans are assigned a credit grade upon origination, and credit grades for nonproblem borrowers with aggregate credit in excess of $500 are reviewed annually. In addition, all past due, restructured, or identified problem loans, both commercial and consumer purpose, are reviewed and assigned an up-to-date credit grade quarterly.

 

PSB uses a seven point grading scale to estimate credit risk with risk rating 1, representing the high credit quality, and risk rating 7, representing the lowest credit quality. The assigned credit grade takes into account several credit quality components which are assigned a weight and blended into the composite grade. The factors considered and their assigned weight for the final composite grade is as follows:

 

Cash flow (30% weight) – Considers earnings trends and debt service coverage levels.

 

Collateral (25% weight) – Considers loan to value and other measures of collateral coverage.

 

Leverage (15% weight) – Considers balance sheet debt and capital ratios compared to Robert Morris & Associates (RMA) industry medians.

 

Liquidity (10% weight) – Considers balance sheet current, quick, and other working capital ratios compared to RMA industry medians.

 

Management (5% weight) – Considers the past performance, character, and depth of borrower management.

 

Guarantor (5% weight) – Considers the existence of a guarantor along with a bank’s past experience with the guarantor and his related liquidity and credit score.

 

Financial reporting (5% weight) – Considers the relative level of independent financial review obtained by the borrower on its financial statements, from audited financial statements down to existence of only tax returns or potentially unreliable financial information.

 

Industry (5% weight) – Considers the borrower’s industry and whether it is stable or subject to cyclical or seasonal factors.

 

Nonclassified loans are assigned a risk rating of 1 to 4 and have credit quality that ranges from well above average to some inherent industry weaknesses that may present higher than average risk due to conditions affecting the borrower, the borrower’s industry, or economic development.

 

Special mention and watch loans are assigned a risk rating of 5 when potential weaknesses exist that deserve management’s close attention. If left uncorrected, the potential weaknesses may result in deterioration of repayment prospects or in credit position at some future date. Substandard loans are assigned a risk rating of 6 and are inadequately protected by the current worth and borrowing capacity of the borrower. Well-defined weaknesses exist that may jeopardize the liquidation of the debt. There is a possibility of some loss if the deficiencies are not corrected. At this point, the loan may still be performing and accruing.

-9-

 

Impaired and other doubtful loans assigned a risk rating of 7 have all of the weaknesses of a substandard credit plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of current facts, conditions, and collateral values highly questionable and improbable. Impaired loans include all nonaccrual loans and all restructured loans including restructured loans performing according to the restructured terms. In special situations, an impaired loan with a risk rating of 7 could still be maintained on accrual status such as in the case of restructured loans performing according to restructured terms.

 

The commercial credit exposure based on internally assigned credit grade at March 31, 2012, follows:

 

       Commercial   Construction             
   Commercial   Real Estate   & Development   Agricultural   Government   Total 
                         
High quality (risk rating 1)  $37   $   $   $   $   $37 
Minimal risk (2)   10,488    21,862    180    529    1,648    34,707 
Average risk (3)   58,862    99,037    11,514    1,216    11,128    181,757 
Acceptable risk (4)   31,762    40,283    2,392    305        74,742 
Watch risk (5)   7,470    8,602    1,856            17,928 
Substandard risk (6)   826    998    1,592            3,416 
Impaired loans (7)   6,253    8,062    631    28        14,974 
                               
Total  $115,698   $178,844   $18,165   $2,078   $12,776   $327,561 

 

The commercial credit exposure based on internally assigned credit grade at December 31, 2011, follows:

 

       Commercial   Construction             
   Commercial   Real Estate   & Development   Agricultural   Government   Total 
                         
High quality (risk rating 1)  $65   $0   $0   $0   $0   $65 
Minimal risk (2)   10,404    21,922    205    534    1,660    34,725 
Average risk (3)   54,387    103,614    12,981    1,088    6,153    178,223 
Acceptable risk (4)   38,381    42,435    2,401    307    0    83,524 
Watch risk (5)   7,054    7,972    2,903    0    0    17,929 
Substandard risk (6)   675    1,005    937    0    0    2,617 
Impaired loans (7)   6,456    7,412    651    28    0    14,547 
                               
Total  $117,422   $184,360   $20,078   $1,957   $7,813   $331,630 

 

The consumer credit exposure based on payment activity at March 31, 2012, follows:

 

    Residential-   Residential-   Construction and         
    Prime   HELOC   Development   Consumer   Total 
                      
Performing   $76,673   $23,196   $13,044   $3,332   $116,245 
Nonperforming    1,915    184    78    58    2,235 
                            
Total   $78,588   $23,380   $13,122   $3,390   $118,480 

 

The consumer credit exposure based on payment activity at December 31, 2011, follows:

 

    Residential-   Residential-   Construction and         
    Prime   HELOC   Development   Consumer   Total 
                      
Performing   $76,474   $23,034   $13,341   $3,677   $116,526 
Nonperforming    1,640    159    78    55    1,932 
                            
Total   $78,114   $23,193   $13,419   $3,732   $118,458 

 

-10-

The payment age analysis of loans receivable disbursed at March 31, 2012, follows:

 

   30-59   60-89   90+   Total       Total   90+ and 
Loan Class  Days   Days   Days   Past Due   Current   Loans   Accruing 
                             
Commercial:                                   
                                    
Commercial and industrial  $942   $313   $1,269   $2,524   $113,174   $115,698   $ 
Agricultural                   2,078    2,078     
Government                   12,776    12,776     
                                    
Commercial real estate:                                   
                                    
Commercial real estate   312    242    1,358    1,912    176,932    178,844     
Commercial construction and development   42        127    169    16,948    17,117     
                                    
Residential real estate:                                   
                                    
Residential – Prime   1,762    102    1,167    3,031    75,557    78,588     
Residential – HELOC   118    12    99    229    23,151    23,380     
Residential – construction and development   35        78    113    11,053    11,166     
                                    
Consumer   102    2    57    161    3,229    3,390     
                                    
Total  $3,313   $671   $4,155   $8,139   $434,898   $443,037   $ 

 

The payment age analysis of loans receivable disbursed at December 31, 2011, follows:

 

   30-59   60-89   90+   Total       Total   90+ and 
Loan Class  Days   Days   Days   Past Due   Current   Loans   Accruing 
                             
Commercial:                                   
                                    
Commercial and industrial  $670   $25   $2,041   $2,736   $114,686   $117,422   $ 
Agricultural                   1,957    1,957     
Government                   7,813    7,813     
                                    
Commercial real estate:                                   
                                    
Commercial real estate   542        1,229    1,771    182,589    184,360     
Commercial construction and development           145    145    17,195    17,340     
                                    
Residential real estate:                                   
                                    
Residential – prime   1,127    173    1,144    2,444    75,670    78,114     
Residential – HELOC   255    5    129    389    22,804    23,193     
Residential – construction and development       35    77    112    11,258    11,370     
                                    
Consumer   11        54    65    3,667    3,732     
                                    
Total  $2,605   $238   $4,819   $7,662   $437,639   $445,301   $ 

 

-11-

Impaired loans as of March 31, 2012, and during the three months then ended, by loan class, follows:

 

   Unpaid           Average   Interest 
   Principal   Related   Recorded   Recorded   Income 
   Balance   Allowance   Investment   Investment   Recognized 
                     
With no related allowance recorded:                         
                          
Commercial & industrial  $1,930   $   $1,930   $1,768   $15 
Commercial real estate   4,167        4,167    3,937    72 
Residential – prime   363        363    263    2 
Residential – HELOC   100        100    50    1 
                          
With an allowance recorded:                         
                          
Commercial & industrial  $4,323   $1,417   $2,906   $3,061   $19 
Commercial real estate   3,895    778    3,117    3,065    37 
Commercial construction & development   631    169    462    461    7 
Agricultural   28    28             
Residential – prime   1,818    502    1,316    1,449    2 
Residential – HELOC   184    145    39    88     
Residential construction & development   99    42    57    83    1 
Consumer   71    18    53    54     
                          
Totals:                         
                          
Commercial & industrial  $6,253   $1,417   $4,836   $4,829   $34 
Commercial real estate   8,062    778    7,284    7,002    109 
Commercial construction & development   631    169    462    461    7 
Agricultural   28    28             
Residential – prime   2,181    502    1,679    1,712    4 
Residential – HELOC   284    145    139    138    1 
Residential construction & development   99    42    57    83    1 
Consumer   71    18    53    54     

 

-12-

The impaired loans at December 31, 2011, and during the year then ended, by loan class, follows:

 

   Unpaid           Average   Interest 
   Principal   Related   Recorded   Recorded   Income 
   Balance   Allowance   Investment   Investment   Recognized 
                     
With no related allowance recorded:                         
                          
Commercial and industrial  $1,606   $   $1,606   $2,409   $51 
Commercial real estate   3,706        3,706    4,515    204 
Commercial construction and development               120     
Agricultural               150     
Residential – Prime   162        162    396    1 
Residential – HELOC               23     
Residential construction and development               12     
Consumer               11     
                          
With an allowance recorded:                         
                          
Commercial and industrial  $4,850   $1,635   $3,215   $2,050   $93 
Commercial real estate   3,706    694    3,012    1,637    154 
Commercial construction and development   651    191    460    386    23 
Agricultural   28    28        5    2 
Residential – Prime   2,029    448    1,581    1,041    53 
Residential – HELOC   268    131    137    99    9 
Residential construction and development   144    36    108    74    5 
Consumer   69    15    54    37    2 
                          
Totals:                         
                          
Commercial and industrial  $6,456   $1,635   $4,821   $4,459   $144 
Commercial real estate   7,412    694    6,718    6,152    358 
Commercial construction and development   651    191    460    506    23 
Agricultural   28    28        155    2 
Residential – Prime   2,191    448    1,743    1,437    54 
Residential – HELOC   268    131    137    122    9 
Residential construction and development   144    36    108    86    5 
Consumer   69    15    54    48    2 

 

-13-

Loans on nonaccrual status at period-end, follows:

 

   March 31, 2012   December 31, 2011 
         
Commercial:          
           
       Commercial and industrial  $3,995   $4,309 
       Agricultural        
       Government        
           
Commercial real estate:          
           
       Commercial real estate   1,709    1,585 
       Commercial construction and development   130    148 
           
Residential real estate:          
           
       Residential – prime   1,915    1,640 
       Residential – HELOC   184    159 
       Residential construction and development   78    78 
           
Consumer   58    55 
           
Total  $8,069   $7,974 

 

The following tables present information concerning modifications of troubled debt made during the three months ended March 31, 2012 and 2011. During the quarter ended March 31, 2012, the commercial and industrial contracts identified below were modified to convert from amortizing principal payments to interest only payments and the commercial real estate contract was modified to capitalize unpaid property taxes. During the quarter ended March 31, 2011, the commercial and industrial contract identified below was modified to defer principal payments due. No loan principal was charged off or forgiven in connection with the modifications during the quarters ended March 31, 2012 or 2011. All modified or restructured loans are classified as impaired loans. Recorded investment as presented in the tables concerning modified loans below represents principal outstanding before specific reserves. Specific loan reserves maintained in connection with these impaired loans totaled $58 at March 31, 2012 and $4 at March 31, 2011.

 

The following table presents information concerning modifications of troubled debt made during the quarter ended March 31, 2012:

 

    Pre-modification Post-modification
  Number of outstanding recorded outstanding recorded
As of March 31, 2012 ($000s) contracts investment investment at period-end
       
Commercial and industrial 3 $ 180 $ 180
Commercial real estate 1 $ 379 $ 379

 

The following table presents information concerning modifications of troubled debt made during the quarter ended March 31, 2011:

 

    Pre-modification Post-modification
  Number of outstanding recorded outstanding recorded
As of March 31, 2011 ($000s) contracts investment investment at period-end
       
Commercial and industrial 1 $  25 $  25

 

During the quarters ended March 31, 2012 or 2011, there were no defaults of troubled debt restructurings that were previously restructured within the past 12 months. Default is defined as 90 days or more past due on restructured payments.

-14-

NOTE 4 – FORECLOSED ASSETS

 

Real estate and other property acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value (after deducting estimated costs to sell) at the date of foreclosure, establishing a new cost basis. Costs related to development and improvement of property are capitalized, whereas costs related to holding property are expensed. After foreclosure, valuations are periodically performed by management, and the real estate or other property is carried at the lower of carrying amount or fair value less estimated costs to sell. Revenue and expenses from operations and changes in any valuation allowance are included in loss on foreclosed assets.

 

A summary of activity in foreclosed assets is as follows:

 

   Three months ended 
   March 31, 
   2012   2011 
         
Balance at beginning of period  $2,939   $4,967 
           
Transfer of loans at net realizable value to foreclosed assets   358    135 
Sale proceeds       (74)
Net gain from sale of foreclosed assets       24 
Provision for write-down charged to operations   (189)   (224)
           
Balance at end of period  $3,108   $4,828 

 

NOTE 5 – DEPOSITS

 

The distribution of deposits at period end is as follows:

 

   March 31, 2012   December 31, 2011 
         
Non-interest bearing demand  $62,452   $75,298 
Interest bearing demand (NOWs)   106,221    108,894 
Savings   27,871    28,056 
Money market   110,788    102,993 
Retail and local time   90,296    91,702 
Broker and national time   68,878    74,566 
           
Total deposits  $466,506   $481,509 

 

-15-

NOTE 6 – OTHER BORROWINGS

 

Other borrowings consist of the following obligations at March 31, 2012, and December 31, 2011:

 

   March 31, 2012   December 31, 2011 
         
Federal funds purchased  $   $ 
Short-term repurchase agreements   5,444    6,191 
Wholesale structured repurchase agreements   13,500    13,500 
           
Total other borrowings  $18,944   $19,691 

 

PSB pledges various securities available for sale as collateral for repurchase agreements. The fair value of securities pledged for repurchase agreements totaled $22,100 at March 31, 2012 and $22,977 at December 31, 2011.

 

The following information relates to securities sold under repurchase agreements and other borrowings for the periods ended March 31:

 

   Three months ended 
   March 31, 
   2012   2011 
         
As of end of period - weighted average rate   3.09%   2.42%
For the period:          
    Highest month-end balance  $19,156   $32,644 
    Daily average balance  $19,072   $30,714 
    Weighted average rate   3.12%   2.21%

 

NOTE 7 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

PSB is exposed to certain risks relating to its ongoing business operations. The primary risk managed by using derivative instruments is interest rate risk. Interest rate swaps are entered into to manage interest rate risk associated with PSB’s variable rate junior subordinated debentures. Accounting standards require PSB to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. PSB designates its interest rate swap associated with the junior subordinated debentures as a cash flow hedge of variable-rate debt. For derivative financial instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative instrument representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

 

From time to time, PSB will also enter into fixed interest rate swaps with customers in connection with their floating rate loans to PSB. When fixed rate swaps are originated with customers, an identical offsetting swap is also entered into by PSB with a correspondent bank. These swap arrangements are intended to offset each other as “back to back” swaps and allow PSB’s loan customer to obtain fixed rate loan financing via the swap while PSB exchanges these fixed payments with a correspondent bank. In these arrangements, PSB’s net cash flows and interest income are equal to the floating rate loan originated in connection with the swap. These customer swaps are not designated as hedging instruments and are accounted for at fair value with changes in fair value recognized in the income statement during the current period.

 

PSB is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. PSB controls the credit risk of its financial contracts through credit approvals, limits, and monitoring procedures, and does not expect any counterparties to fail their obligations. PSB swaps originated with correspondent banks are over-the-counter (OTC) contracts. Negotiated OTC derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amounts, exercise prices, and maturity.

 

-16-

At period end, the following interest rate swaps to hedge variable-rate debt were outstanding:

 

  March 31, 2012 December 31, 2011
     
Notional amount: $ 7,500  $ 7,500 
Pay fixed rate: 2.72% 2.72%
Receive variable rate: 0.47% 0.55%
Maturity: September 2017 September 2017
Unrealized gain (loss) fair value: $ (552) $ (576)

 

This agreement provides for PSB to receive payments at a variable rate determined by the three-month LIBOR in exchange for making payments at a fixed rate. Actual maturities may differ from scheduled maturities due to call options and/or early termination provisions. No interest rate swap agreements were terminated prior to maturity during the three months ended March 31, 2012 or 2011. Risk management results for the three months ended March 31, 2012 related to the balance sheet hedging of variable rate debt indicates that the hedge was 100% effective, and no component of the derivative instrument’s gain or loss was excluded from the assessment of hedge effectiveness.

 

As of March 31, 2012, approximately $169 of losses ($103 after tax impacts) reported in other comprehensive income related to the interest rate swap are expected to be reclassified into interest expense as a yield adjustment of the hedged borrowings during the 12-month period ending March 31, 2013. The interest rate swap agreement was secured by cash and cash equivalents of $780 at March 31, 2012, and by $680 at December 31, 2011.

 

PSB maintains outstanding interest rate swaps with customers and correspondent banks associated with its lending activities that are not designated as hedges. At period end, the following floating interest rate swaps were outstanding with customers:

 

  March 31, 2012 December 31, 2011
     
Notional amount: $ 15,458 $ 14,324
Receive fixed rate (average): 1.99% 2.05%
Pay variable rate (average): 0.24% 0.29%
Maturity: March 2015 – Oct. 2021 March 2015 – Oct. 2021
Weighted average remaining term 4.6 years 4.9 years
Unrealized gain (loss) fair value: $ 516 $ 555

 

At period end, the following offsetting fixed interest rate swaps were outstanding with correspondent banks:

 

  March 31, 2012 December 31, 2011
     
Notional amount: $ 15,458 $ 14,324
Pay fixed rate (average): 1.99% 2.05%
Receive variable rate (average): 0.24% 0.29%
Maturity: March 2015 – Oct. 2021 March 2015 – Oct. 2021
Weighted average remaining term 4.6 years 4.9 years
Unrealized gain (loss) fair value: $ (516) $ (555)

 

-17-

NOTE 8 – INCOME TAX EFFECTS ON ITEMS OF COMPREHENSIVE INCOME (LOSS)

 

   Three Months Ended 
   March 31, 2012 
Period ended March 31, 2012  Pre-tax Inc.   Income Tax Exp. 
(dollars in thousands)  (Exp.)   (Credit) 
         
Unrealized gain on securities available for sale   4    2 
Amortization of unrealized gain on securities available for sale transferred to securities          
   held to maturity included in net income   (117)   (46)
Unrealized loss on interest rate swap   (17)   (7)
Reclassification adjustment of interest rate swap settlements included in earnings   41    16 
           
Totals  $(89)  $(35)

 

   Three Months Ended 
   March 31, 2011 
Period ended March 31, 2011  Pre-tax Inc.   Income Tax Exp. 
(dollars in thousands)  (Exp.)   (Credit) 
         
Unrealized loss on securities available for sale   (87)   (34)
Amortization of unrealized gain on securities available for sale transferred to securities          
   held to maturity included in net income   (142)   (56)
Unrealized gain on interest rate swap   43    17 
Reclassification adjustment of interest rate swap settlements included in earnings   45    18 
           
Totals  $(141)  $(55)

 

NOTE 9 – STOCK-BASED COMPENSATION

 

Under the terms of an incentive stock option plan adopted during 2001, shares of unissued common stock were reserved for options to officers and key employees at prices not less than the fair market value of the shares at the date of the grant. No additional shares of common stock remain reserved for future grants under the option plan approved by the shareholders. As of March 31, 2012 and December 31, 2011, 560 options were outstanding and eligible to be exercised at an exercise price of $16.83 per share. These options were subsequently exercised during April 2012. During the three months ended March 31, 2011, 263 options were exercised at $15.80 per share.

 

PSB granted restricted stock to certain employees having an initial market value of $200 during the three months ended March 31, 2012 and 2011. Restricted shares vest to employees based on continued PSB service over a six-year period and are recognized as compensation expense over the vesting period. Cash dividends are paid on unvested shares at the same time and amount as paid to PSB common shareholders. Cash dividends paid on unvested restricted stock shares are charged to retained earnings as significantly all restricted shares are expected to vest to employees. Unvested shares are subject to forfeiture upon employee termination. During the three months ended March 31, compensation expense recorded from amortization of restricted shares expected to vest to employees was $22 and $26 during 2012 and 2011, respectively.

-18-

 

The following tables summarize information regarding restricted stock outstanding at March 31, 2012 and 2011 including activity during the three months then ended.

 

       Weighted 
       Average 
   Shares   Grant Price 
         
January 1, 2011   18,530   $16.46 
Restricted stock granted   8,695    23.00 
Restricted stock legally vested   (2,867)   (17.45)
           
March 31, 2011   24,358   $18.68 
           
January 1, 2012   24,358   $18.68 
Restricted stock granted   8,473    23.60 
Restricted stock legally vested   (3,865)   (16.88)
           
March 31, 2012   28,966   $20.36 

 

Scheduled compensation expense per calendar year assuming all restricted shares eventually vest to employees would be as follows:

  

 2012   $105 
 2013    125 
 2014    125 
 2015    95 
 2016    80 
 Thereafter    40 
        
 Totals   $570 

 

NOTE 10 – EARNINGS PER SHARE

 

Basic earnings per share of common stock are based on the weighted average number of common shares outstanding during the period. Unvested but issued restricted shares are considered to be outstanding shares and used to calculate the weighted average number of shares outstanding and determine net book value per share. Diluted earnings per share is calculated by dividing net income by the weighted average number of shares adjusted for the dilutive effect of outstanding stock options.

 

Presented below are the calculations for basic and diluted earnings per share:

 

   Three months ended 
   March 31, 
(dollars in thousands, except per share data - Unaudited)  2012   2011 
         
Net income  $1,180   $1,285 
           
Weighted average shares outstanding   1,583,941    1,572,825 
Effect of dilutive stock options outstanding   177    1,227 
           
Diluted weighted average shares outstanding   1,584,118    1,574,052 
           
Basic earnings per share  $0.74   $0.82 
Diluted earnings per share  $0.74   $0.82 

 

-19-

NOTE 11 – PSB HOLDINGS, INC. ACQUISITION OF MARATHON STATE BANK

 

On March 16, 2012, PSB announced that it had entered into a definitive agreement under which PSB will pay cash to acquire all outstanding shares of common stock of Marathon State Bank, a privately owned bank with $107 million in total assets as of March 31, 2012 located in the Village of Marathon City, Wisconsin (“Marathon”). Under the terms of the agreement, PSB will pay an estimated cash purchase price of $5.6 million, which is equal to 100% of Marathon’s tangible net book value following a special dividend by Marathon to its shareholders to reduce its book equity ratio to 6% of total assets. The transaction is expected to be accretive to PSB’s 2012 earnings excluding estimated one-time merger costs of approximately $220 (including $117 of such costs expensed in the quarter ended March 31, 2012) and pre-tax integration costs of approximately $450 related primarily to data processing system conversion and sale of PSB’s existing branch location in the same community after consolidating operations into the Marathon State Bank facility. The transaction is expected to close during the June 2012 quarter pending regulatory approval. The following table presents key information for PSB Holdings, Inc. estimated on a consolidated pro-forma basis as of the upcoming merger date:

 

  PSB Holdings, Inc.
  Pro-forma with Marathon State Bank
   
Total loans receivable, net $   465,000  
Total deposits 554,000  
Total assets 695,000  
Core deposit intangible asset 440  
Regulatory Tier 1 leverage ratio 8.20%  
Regulatory Tier 2 total capital ratio 14.20%  

 

PSB does not expect to record a purchased goodwill asset in connection with the Marathon acquisition.

 

NOTE 12 – CONTINGENCIES

 

In the normal course of business, PSB is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the consolidated financial statements.

 

NOTE 13 – FAIR VALUE MEASUREMENTS

 

Certain assets and liabilities are recorded or disclosed at fair value to provide financial statement users additional insight into PSB’s quality of earnings. Under current accounting guidance, PSB groups assets and liabilities which are recorded at fair value in three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement (with Level 1 considered highest and Level 3 considered lowest). All transfers between levels are recognized as occurring at the end of the reporting period.

 

Following is a brief description of each level of the fair value hierarchy:

 

Level 1 – Fair value measurement is based on quoted prices for identical assets or liabilities in active markets.

 

Level 2 – Fair value measurement is based on (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar assets or liabilities in markets that are not active; or (3) valuation models and methodologies for which all significant assumptions are or can be corroborated by observable market data.

 

Level 3 – Fair value measurement is based on valuation models and methodologies that incorporate at least one significant assumption that cannot be corroborated by observable market data. Level 3 measurements reflect PSB’s estimates about assumptions market participants would use in measuring fair value of the asset or liability.

 

Some assets and liabilities, such as securities available for sale, loans held for sale, mortgage rate lock commitments, and interest rate swaps, are measured at fair value on a recurring basis under GAAP. Other assets and liabilities, such as impaired loans, foreclosed assets, and mortgage servicing rights are measured at fair value on a nonrecurring basis.

 

Following is a description of the valuation methodology used for each asset and liability measured at fair value on a recurring or nonrecurring basis, as well as the classification of the asset or liability within the fair value hierarchy.

 

Securities available for sale – Securities available for sale may be classified as Level 1, Level 2, or Level 3 measurements within the fair value hierarchy and are measured on a recurring basis. Level 1 securities include equity securities traded on a national exchange. The fair value measurement of a Level 1 security is based on the quoted price of the security. Level 2 securities include U.S. government and agency securities, obligations of states and political subdivisions, corporate debt securities, and mortgage-related securities. The fair value measurement of a Level 2 security is obtained from an independent pricing service and is based on recent sales of similar securities and other observable market data and represents a market approach to fair value.

-20-

 

At March 31, 2012 and December 31, 2011, Level 3 securities include a common stock investment in Bankers’ Bank, Madison, Wisconsin that is not traded on an active market. Historical cost of the common stock is assumed to approximate fair value of this investment.

 

Loans held for sale – Loans held for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value and are measured on a recurring basis. The fair value measurement of a loan held for sale is based on current secondary market prices for similar loans, which is considered a Level 2 measurement and represents a market approach to fair value.

 

Impaired loans – Loans are not measured at fair value on a recurring basis. Carrying value of impaired loans that are not collateral dependent are based on the present value of expected future cash flows discounted at the applicable effective interest rate and, thus, are not fair value measurements. However, impaired loans considered to be collateral dependent are measured at fair value on a nonrecurring basis. The fair value measurement of an impaired loan that is collateral dependent is based on the fair value of the underlying collateral. Fair value measurements of underlying collateral that utilize observable market data, such as independent appraisals reflecting recent comparable sales, are considered Level 2 measurements. Other fair value measurements that incorporate internal collateral appraisals or broker price opinions, net of selling costs, or estimated assumptions market participants would use to measure fair value, such as discounted cash flow measurements, are considered Level 3 measurements and represent a market approach to fair value.

 

In the absence of a recent independent appraisal, collateral dependent impaired loans are valued based on a recent broker’s price opinion generally discounted by 10% plus estimated selling costs. In the absence of a broker’s price opinion, collateral dependent impaired loans are valued at the lower of last appraisal value or the current real estate tax value discounted by 20% to 50%, depending on internal judgments on the condition of the property, plus estimated selling costs. Property values are impacted by many macroeconomic factors. In general, a declining economy or rising interest rates would be expected to lower fair value of collateral dependent impaired loans while an improving economy or falling interest rates would be expected to increase fair value of collateral dependent impaired loans.

 

Foreclosed assets – Real estate and other property acquired through, or in lieu of, loan foreclosure are not measured at fair value on a recurring basis. Initially, foreclosed assets are recorded at fair value less estimated costs to sell at the date of foreclosure. Valuations are periodically performed by management, and the real estate or other property is carried at the lower of carrying amount or fair value less estimated costs to sell. Fair value measurements are based on current formal or informal appraisals of property value compared to recent comparable sales of similar property. Independent appraisals reflecting comparable sales are considered Level 2 measurements, while internal assessments of appraised value based on current market activity, including broker price opinions, are considered Level 3 measurements and represent a market approach to fair value. Property values are impacted by many macroeconomic factors. In general, a declining economy or rising interest rates would be expected to lower fair value of foreclosed assets while an improving economy or falling interest rates would be expected to increase fair value of foreclosed assets.

 

Mortgage servicing rights – Mortgage servicing rights are not measured at fair value on a recurring basis. However, mortgage servicing rights that are impaired are measured at fair value on a nonrecurring basis. Serviced loan pools are stratified by year of origination and term of the loan, and a valuation model is used to calculate the present value of expected future cash flows for each stratum. When the carrying value of a stratum exceeds its fair value, the stratum is measured at fair value. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as costs to service, a discount rate, custodial earnings rate, ancillary income, default rates and losses, and prepayment speeds. Although some of these assumptions are based on observable market data, other assumptions are based on unobservable estimates of what market participants would use to measure fair value. As a result, the fair value measurement of mortgage servicing rights is considered a Level 3 measurement and represents an income approach to fair value. When market mortgage rates decline, borrowers may have the opportunity to refinance their existing mortgage loans at lower rates, increasing the risk of prepayment of loans on which we maintain mortgage servicing rights. Therefore, declining long term interest rates would decrease the fair value of mortgage servicing rights. Significant unobservable inputs at March 31, 2012 used to measure fair value included:

 

Direct annual servicing cost per loan  $50 
Direct annual servicing cost per loan in process of foreclosure  $500 
Weighted average prepayment speed: CPR   1.32%
Weighted average prepayment speed: PSA   276%
Weighted average discount rate   9.30%
Asset reinvestment rate   4.00%
Short-term cost of funds   0.25%
Escrow inflation adjustment   1.00%
Servicing cost inflation adjustment   1.00%

 

Mortgage rate lock commitments – The fair value of mortgage rate lock commitments is measured on a recurring basis. Fair value is based on current secondary market pricing for delivery of similar loans and the value of originated mortgage servicing rights on loans expected to be delivered, which is considered a Level 2 fair value measurement.

 

-21-

Interest rate swap agreements – Fair values for interest rate swap agreements are based on the amounts required to settle the contracts based on valuations provided by third-party dealers in the contracts, which is considered a Level 2 fair value measurement, and are measured on a recurring basis.

 

       Recurring Fair Value Measurements Using 
       Quoted Prices in         
       Active Markets   Significant Other   Significant 
       for Identical   Observable   Unobservable 
       Assets   Inputs   Inputs 
(dollars in thousands)      (Level 1)   (Level 2)   (Level 3) 
                 
Assets measured at fair value on a recurring basis at March 31, 2012:
                     
Securities available for sale:                    
                     
   U.S. Treasury and agency debentures  $512   $   $512   $ 
   U.S. agency issued residential MBS and CMO   62,224        62,224     
   Privately issued residential MBS and CMO   362        362     
   Other equity securities   47            47 
                     
Total securities available for sale   63,145        63,098    47 
Loans held for sale   852        852     
Mortgage rate lock commitments   67        67     
Interest rate swap agreements   516        516     
                     
Total assets  $64,580   $   $64,533   $47 
                     
Liabilities – Interest rate swap agreements  $1,068   $   $1,068   $ 
                     
Assets measured at fair value on a recurring basis at December 31, 2011:
                     
Securities available for sale:                    
                     
  U.S. Treasury and agency debentures  $518   $   $518   $ 
  U.S. agency issued residential MBS and CMO   58,389        58,389     
  Privately issued residential MBS and CMO   429        429     
  Other equity securities   47            47 
                     
Total securities available for sale   59,383        59,336    47 
Loans held for sale   39        39     
Mortgage rate lock commitments   60        60     
Interest rate swap agreements   555        555     
                     
Total assets  $60,037   $   $59,990   $47 
                     
Liabilities – Interest rate swap agreements  $1,131   $   $1,131   $ 
                     

 

-22-

Reconciliation of fair value measurements using significant unobservable inputs:

 

   Securities 
   Available 
(dollars in thousands)  For Sale 
     
Balance at January 1, 2011:  $51 
  Total realized/unrealized gains and (losses):     
      Included in earnings    
      Included in other comprehensive income    
  Purchases, maturities, and sales    
  Transferred from Level 2 to Level 3    
  Transferred to held to maturity classification    
      
Balance at March 31, 2011  $51 
      
Total gains or (losses) for the period included in earnings attributable to the     
change in unrealized gains or losses relating to assets still held at March 31, 2011  $ 
      
Balance at January 1, 2012  $47 
   Total realized/unrealized gains and (losses):     
      Included in earnings    
      Included in other comprehensive income    
   Purchases, maturities, and sales    
   Transferred from Level 2 to Level 3    
   Transferred to held to maturity classification    
      
Balance at March 31, 2012  $47 
      
Total gains or (losses) for the period included in earnings attributable to the     
change in unrealized gains or losses relating to assets still held at March 31, 2012  $ 

 

 

       Nonrecurring Fair Value Measurements Using 
       Quoted Prices in         
       Active Markets   Significant Other   Significant 
       for Identical   Observable   Unobservable 
       Assets   Inputs   Inputs 
   ($000s)   (Level 1)   (Level 2)   (Level 3) 
                 
Assets measured at fair value on a nonrecurring basis at March 31, 2012:
                     
Impaired loans  $1,938   $   $   $1,938 
Foreclosed assets   3,108        450    2,658 
Mortgage servicing rights   1,151            1,151 
                     
Total assets  $6,197   $   $450   $5,747 
                     
                     
Assets measured at fair value on a nonrecurring basis at December 31, 2011:
                     
Impaired loans  $4,086   $   $   $4,086 
Foreclosed assets   2,939        587    2,352 
Mortgage servicing rights   1,205            1,205 
                     
Total assets  $8,230   $   $587   $7,643 

 

-23-

At March 31, 2012, loans with a carrying amount of $2,965 were considered impaired and were written down to their estimated fair value of $1,938 net of a valuation allowance of $1,027. At December 31, 2011, loans with a carrying amount of $5,306 were considered impaired and were written down to their estimated fair value of $4,086, net of a valuation allowance of $1,220. Changes in the valuation allowances are reflected through earnings as a component of the provision for loan losses.

 

At March 31, 2012, mortgage servicing rights with a carrying amount of $1,298 were considered impaired and were written down to their estimated fair value of $1,151, resulting in an impairment allowance of $147. At December 31, 2011, mortgage servicing rights with a carrying amount of $1,286 were considered impaired and were written down to their estimated fair value of $1,205, resulting in an impairment allowance of $81. Changes in the impairment allowances are reflected through earnings as a component of mortgage banking income.

 

PSB estimates fair value of all financial instruments regardless of whether such instruments are measured at fair value. The following methods and assumptions were used by PSB to estimate fair value of financial instruments not previously discussed.

 

Cash and cash equivalents – Fair value reflects the carrying value of cash, which is a Level 1 measurement.

 

Securities held to maturity – Fair value of securities held to maturity is based on dealer quotations on similar securities near period-end, which is considered a Level 2 measurement. Certain debt issued by banks or bank holding companies purchased by PSB as securities held to maturity is valued on a cash flow basis discounted using market rates reflecting credit risk of the borrower, which is considered a Level 3 measurement.

 

Bank certificates of deposit – Fair value of fixed rate certificates of deposit included in other investments is estimated by discounting future cash flows using current rates at which similar certificates could be purchased, which is a Level 3 measurement.

 

Loans – Fair value of variable rate loans that reprice frequently are based on carrying values. Loans with an active sale market, such as one- to four-family residential mortgage loans, estimate fair value based on sales of loans with similar structure and credit quality. Fair value of other loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings. Fair value of impaired and other nonperforming loans are estimated using discounted expected future cash flows or the fair value of underlying collateral, if applicable. Except for collateral dependent impaired loans valued using an independent appraisal of collateral value, reflecting a Level 2 fair value measurement, fair value of loans is considered to be a Level 3 measurement due to internally developed discounted cash flow measurements.

 

Federal Home Loan Bank stock – Fair value is the redeemable (carrying) value based on the redemption provisions of the Federal Home Loan Bank, which is considered a Level 3 fair value measurement.

 

Accrued interest receivable and payable – Fair value approximates the carrying value, which is considered a Level 3 fair value measurement.

 

Cash value of life insurance – Fair value is based on reported values of the assets by the issuer which are redeemable to the insured, which is considered a Level 1 fair value measurement.

 

Deposits – Fair value of deposits with no stated maturity, such as demand deposits, savings, and money market accounts, by definition, is the amount payable on demand on the reporting date. Fair value of fixed rate time deposits is estimated using discounted cash flows applying interest rates currently offered on issue of similar time deposits. Use of internal discounted cash flows provides a Level 3 fair value measurement.

 

FHLB advances and other borrowings – Fair value of fixed rate, fixed term borrowings is estimated by discounting future cash flows using the current rates at which similar borrowings would be made as calculated by the lender or correspondent. Fair value of borrowings with variable rates or maturing within 90 days approximates the carrying value of these borrowings. Fair values based on lender provided settlement provisions are considered a Level 2 fair value measurement. Other borrowings with local customers in the form of repurchase agreements are estimated using internal assessments of discounted future cash flows, which is a Level 3 measurement.

 

Senior subordinated notes and junior subordinated debentures – Fair value of fixed rate, fixed term notes and debentures are estimated internally by discounting future cash flows using the current rates at which similar borrowings would be made, which is a Level 3 fair value measurement.

 

-24-

The carrying amounts and fair values of PSB’s financial instruments consisted of the following:

 

   March 31, 2012 
   Carrying   Estimated   Fair Value Hierarchy Level 
   Amount   Fair Value   Level 1   Level 2   Level 3 
Financial assets ($000s):                    
                     
Cash and cash equivalents  $19,716   $19,716   $19,716