FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 2004
[ ] 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.
WWW.PSBWI.COM
WISCONSIN 39-1804877
1905 W. Stewart Avenue
P.O. Box 1686
Wausau, Wisconsin 54402-1686
Registrant's telephone number, including area code: (715) 842-2191
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
Indicate by check 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 X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes ___ No X
The aggregate market value of the voting stock held by non-affiliates as of
June 30, 2004, was approximately $55,700,000. For purposes of this
calculation, the registrant has assumed its directors and executive officers
are affiliates. As of February 22, 2005, 1,722,771 shares of common stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement dated March 11, 2005 (to the extent specified herein): Part III
FORM 10-K
PSB HOLDINGS, INC.
TABLE OF CONTENTS
PART I
ITEM
1. Business.........................................................1
2. Properties.......................................................6
3. Legal proceedings................................................6
4. Submission of matters to a vote of security holders..............6
PART II
5. Market for registrant's common equity and related stockholder
matters..........................................................7
6. Selected financial data..........................................8
7. Management's discussion and analysis of financial condition and
results of operations...........................................10
7A. Quantitative and qualitative disclosures about market risk......46
8. Financial statements and supplementary data.....................47
9. Changes in and disagreements with accountants on accounting and
financial disclosure 82
9A. Controls and Procedures.........................................82
9B. Other Information...............................................82
PART III
10. Directors and executive officers of the registrant..............83
11. Executive compensation..........................................84
12. Security ownership of certain beneficial owners and management
and related stockholder matters.................................84
13. Certain relationships and related transactions..................85
14. Principal Auditor Fees and Services.............................85
PART IV
15. Exhibits, financial statement schedules, and reports on
Form 8-K........................................................86
i
PART I
ITEM 1. BUSINESS.
BUSINESS OPERATIONS AND PRODUCTS
PSB Holdings, Inc., a Wisconsin corporation formed in 1995, is a one-bank
holding company regulated by the Board of Governors of the Federal Reserve
System (the "Federal Reserve") under the authority of the Bank Holding Company
Act of 1956, as amended (the "BHCA"). PSB Holdings, Inc.'s sole business is
the ownership and management of Peoples State Bank, a Wisconsin state chartered
bank headquartered in Wausau, Wisconsin. Since 1962, Peoples State Bank has
operated as a community bank and currently serves customers in the central and
northern Wisconsin counties of Marathon, Oneida, and Vilas through a branch
network of 8 retail locations. This Annual Report on Form 10-K describes the
business of PSB Holdings, Inc. and Peoples State Bank as in effect on December
31, 2004, and any reference to "PSB" refers to the consolidated or individual
operations of PSB Holdings, Inc. and its subsidiary Peoples State Bank.
PSB's branch offices are located in the communities of Wausau, Rib Mountain,
Weston, Marathon, Rhinelander, Minocqua, and Eagle River, Wisconsin. PSB is
engaged in general commercial and retail banking and serves individuals,
businesses, and governmental units. PSB offers most forms of commercial
lending, including lines and letters of credit, secured and unsecured term
loans, equipment and lease financing and commercial mortgage lending. In
addition, PSB provides a full range of personal banking services, including
checking accounts, savings and time accounts, installment, credit card, and
other personal loans, as well as mortgage loans. PSB offers both commercial
and personal customers automated teller machines and online computer banking to
expand its services to customers on a 24-hour basis. Commercial customers may
use available cash management and lockbox services in addition to merchant
banking products. New services are frequently added to PSB's commercial and
retail banking departments.
PSB offers brokerage services at its Wausau locations, including the sale of
annuities, mutual funds and other investments to bank customers and the general
public. Commercial property and casualty insurance services are offered at its
Wausau home office location through Peoples Insurance Services LLC, a
subsidiary of Peoples State Bank, to bank customers and the general public.
All of PSB's products and services are directly or indirectly related to the
business of community banking and all activity is reported as one segment of
operations. Therefore, all revenue, profit and loss, and total assets are
reported in one segment and represent the entire operations of PSB.
As a community bank, the majority of PSB's operating revenues continue to come
from interest earned on loans receivable and its investment securities
portfolio. PSB does not have a dependence on any major customers and collects
revenue or obtains funding from approximately 12,700 households and businesses.
The table below shows a breakdown of principal sources of operating revenue
(including those which make up greater than 15% of total revenue).
1
(dollars in thousands)
Interest on loans Interest on securities
Years ended December 31, Amount % of revenue Amount % of revenue
2004 $19,207 75.8% $2,780 11.0%
2003 17,964 71.4% 2,859 11.4%
2002 18,022 72.0% 3,622 14.5%
As of February 21, 2005, PSB operated with 131 full-time equivalent (FTE)
employees, including 34 employed on a part time basis. None of the employees
is covered by a collective bargaining agreement. Approximately 111 of the FTE
employees serve as sales, customer contact, or customer activity support
personnel, while 20 of the employees serve primarily for administrative and
internal purposes.
During the past several years, PSB has pursued a market expansion plan that
includes de novo branching into adjacent market areas previously identified as
offering favorable long-term business prospects. Full-service bank branches
were opened in Eagle River, Rhinelander, and Minocqua, Wisconsin in 2001, 2002,
and 2004 respectively. In addition, PSB opened a new stand-alone branch in
Weston, Wisconsin during March 2005. Management believes opening in adjacent
markets capitalizes on existing management resources and customer relationships
and leverages existing shareholder capital for the benefit of long-term
shareholders. However, PSB intends to pursue opportunities to acquire
additional bank subsidiaries or banking offices out of its current market area
so that, at any time, it may be engaged in some tentative or preliminary
discussions for such purposes with officers, directors or principal
shareholders of other holding companies or banks. However, there are no plans,
understandings, or arrangements, written or oral, regarding other acquisitions
at this time.
BANK MARKET AREA AND COMPETITION
There is a mix of retail, manufacturing, agricultural and service businesses in
the areas served by PSB. PSB has substantial competition in its market areas.
Much of this competition comes from companies which are larger and have greater
resources than PSB. PSB competes for deposits and other sources of funds with
other banks, savings associations, credit unions, finance companies, mutual
funds, life insurance companies and other financial and non financial
companies. Many of these nonbank competitors offer products and services which
are functionally equivalent to the products and services offered by PSB.
Based on publicly available deposit market share information as of June 30,
2004, the following is a list of the three largest FDIC insured banking
competitors in each of PSB's primary markets and a comparison of PSB's deposit
market share to these primary competitors.
2
Deposit $'s Market
($000s) Share
MARATHON COUNTY, WISCONSIN
M&I Bank $428,970 21.0%
PEOPLES STATE BANK 298,258 14.6%
Abbotsford State Bank 153,661 7.5%
All other FDIC insured institutions 1,160,154 56.8%
ONEIDA COUNTY, WISCONSIN
M&I Bank $169,394 27.5%
Associated Bank 127,160 20.6%
F&M Bank - Wisconsin 80,565 13.1%
PEOPLES STATE BANK 30,624 5.0%
All other FDIC insured institutions 208,572 33.9%
VILAS COUNTY, WISCONSIN
First National Bank of Eagle River $120,498 33.5%
M&I Bank 94,836 26.3%
Headwaters State Bank 47,699 13.2%
PEOPLES STATE BANK 12,333 3.4%
All other FDIC insured institutions 84,654 23.5%
Recent changes in banking laws have had a significant effect on the competitive
environment in which PSB operates and are likely to continue to increase
competition for PSB. For example, current federal law permits adequately
capitalized and managed bank holding companies to engage in interstate banking
on a much broader scale than in the past. In addition, financial holding
companies are permitted to conduct a broad range of banking, insurance, and
securities activities. PSB believes that the combined effects of more
interstate banking and the development of greater "one-stop" availability for
banking, insurance, and securities services will both increase the overall
level of competition and attract competitors with which PSB may not now compete
for its customers.
In addition to competition, the business of PSB is and will continue to be
affected by general economic conditions, including the level of interest rates
and the monetary policies of the Federal Reserve (see "Regulation and
Supervision - Monetary Policy"). This competition may cause PSB to seek out
opportunities to provide additional financial services.
EXECUTIVE OFFICERS
David K. Kopperud, 59 - President of PSB and Peoples State Bank since July,
1999; previously Executive Vice-President of the Peoples State Bank (1994-
1999).
David A. Svacina, 58 - Secretary and Vice President of PSB since December 2003;
Vice President of PSB since March 2002; Executive Vice President of Peoples
State Bank since April 2003; Vice President of Peoples State Bank (1995-2003).
3
Scott M. Cattanach, 36 - Treasurer of PSB since March 2002; Senior Vice
President and Chief Financial Officer of Peoples State Bank since April 2003;
Chief Financial Officer of Peoples State Bank (2002-2003); Prior to March
2002, certified public accountant at regional public accounting firm.
REGULATION AND SUPERVISION
REGULATION
PSB is subject to regulation under both federal and state law. PSB Holdings,
Inc. is a registered bank holding company and is subject to regulation and
examination by the Federal Reserve pursuant to the BHCA. Peoples State Bank is
subject to regulation and examination by the Federal Deposit Insurance
Corporation ("FDIC") and, as a Wisconsin chartered bank, by the Wisconsin
Department of Financial Institutions.
The Federal Reserve expects a bank holding company to be a source of strength
for its subsidiary banks. As such, PSB Holdings, Inc. may be required to take
certain actions or commit certain resources to Peoples State Bank when it might
otherwise choose not to do so. Under federal and state banking laws, PSB is
subject to regulations which govern its capital adequacy, loans and loan
policies (including the extension of credit to affiliates), deposits, payment
of dividends, establishment of branch offices, mergers and other acquisitions,
investments in or the conduct of other lines of business, management personnel,
interlocking directorates and other aspects of its operations. Bank regulators
having jurisdiction over PSB generally have the authority to impose civil fines
or penalties and to impose regulatory sanctions for noncompliance with
applicable banking regulations and policies. In particular, bank regulators
have broad authority to take corrective action if Peoples State Bank fails to
maintain required minimum capital. Information concerning compliance with
applicable capital requirements is set forth in Item 8, in Note 16 of the Notes
to Consolidated Financial Statements.
Banking laws and regulations have undergone periodic revisions that have often
had a direct or indirect effect on PSB's operations and its competitive
environment. Such laws and regulations are often, if not continuously, subject
to review and possible revision. Among recent changes in the regulatory
environment in which PSB operates are the Gramm-Leach-Bliley Act of 1999, which
eliminated many of the barriers to affiliation among banks, insurance companies
and other securities or financial services companies, the Uniting and
Strengthening America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001 (the "USA PATRIOT Act") which requires banks and
other financial services companies to implement additional policies and
procedures designed to address, among other things, money laundering, terrorist
financing, identifying and reporting suspicious activities and currency
transactions, and currency crimes, and the recent "Check 21" legislation which
involves the replacement of paper check records with digital copies in order to
speed processing. Depending on the scope and timing of future regulatory
changes, it is likely they will affect the competitive environment in which PSB
operates or increase costs of regulatory compliance and, accordingly, may have
a material adverse effect on PSB's consolidated financial condition, liquidity
or results of operations.
4
MONETARY POLICY
The earnings and growth of PSB are affected by the monetary and fiscal policies
of the federal government and governmental agencies. The Federal Reserve has a
direct and indirect influence on the costs of funds used by PSB for lending and
its actions have a substantial effect on interest rates, the general
availability of credit and the economy as a whole. These policies therefore
affect the growth of bank loans and deposits and the rates charged for loans
and paid for deposits. Federal Reserve policies, in particular, have had a
significant effect on the operating results of commercial banks in the past and
are expected to do so in the future. PSB is not able to anticipate the future
impact of such policies and practices on its growth or profitability.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995 (the "Reform Act"). In
addition, certain statements in future filings by PSB with the Securities and
Exchange Commission, reports to shareholders, press releases, and in other oral
and written statements made by or with the approval of PSB which are not
statements of historical fact will constitute forward-looking statements within
the meaning of the Reform Act.
Examples of forward-looking statements include, but are not limited to: (1)
expectations concerning financial performance of PSB, (2) expectations
concerning the payment of dividends, (3) statements of plans and objectives of
PSB, (4) statements of future economic performance and (5) statements of
assumptions underlying such statements. Words such as "believes,"
"anticipates," "expects," "intends," "targeted" and similar expressions are
intended to identify forward-looking statements but are not the exclusive means
of identifying such statements. In making forward-looking statements within
the meaning of the Reform Act, PSB undertakes no obligation to publicly update
or revise any such statement.
Forward-looking statements of PSB are based on information available to PSB as
of the date of such statements and reflect PSB's expectations as of such date,
but are subject to risks and uncertainties that may cause actual results to
vary materially. In addition to specific factors which may be described in
connection with any of PSB's forward-looking statements, factors which could
cause actual results to differ materially from those discussed in the forward-
looking statements include, but are not limited to the following:
(1) the strength of the U.S. economy in general and the strength of
the local economies in the markets served by PSB;
(2) the effects of and changes in government policies, including
interest rate policies of the Federal Reserve;
(3) changes in inflation, interest rates, and market and monetary
fluctuations;
(4) the effect of changes in laws and regulations which increase
operating costs or increase competition;
(5) changes in consumer spending, borrowing and saving habits;
5
(6) increased competition in PSB's principal market areas;
(7) the timely development of and acceptance of new products and
services in the markets served by PSB;
(8) the costs associated with required changes or upgrades in our
technology;
(9) the effect of changes in accounting policies and practices;
(10) acquisitions and the inability to successfully integrate acquired
institutions or branches into current operations; and
(11) the costs and effects of litigation and of unexpected or adverse
outcomes in such litigation.
ITEM 2. PROPERTIES.
PSB's administrative offices are housed in the same building as the bank's
primary customer service location at 1905 West Stewart Avenue in Wausau,
Wisconsin. PSB's other Wisconsin branch locations, in the order they were
opened for business, include Rib Mountain, Marathon City, Wausau (Eastside),
Eagle River (in the Trig's grocery store), Rhinelander, Minocqua, and Weston.
The branch in the Trig grocery store occupies leased space within the
supermarket designed for community banking operations. The other 7 locations
are owned by PSB without encumbrance and are occupied solely by PSB and are
suitable for current operations. During 2004, PSB constructed a new banking
and administrative headquarters location in Wausau on the site occupied by the
original bank. The original building was razed after PSB occupied the new
building.
ITEM 3. LEGAL PROCEEDINGS.
PSB is subject to claims and litigation in the ordinary course of business, but
does not believe that any such claim or litigation will have a material adverse
effect on its consolidated financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
6
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET
There is no active established public trading market in PSB common stock. Bid
and ask prices are quoted primarily by one regional broker-dealer, Howe Barnes
of Chicago, Illinois, on the OTC Bulletin Board under the symbol "PSBQ.OB."
Transactions in PSB common stock are limited and sporadic.
PSB maintains an informal, annual share repurchase program of up to 1% of
outstanding shares per year. During 2004, PSB purchased 18,001 shares at an
average price of $34.91 per share. During 2003, PSB purchased 16,700 shares at
an average price of $33.10 per share.
Information required by Item 201(d) of Regulation S-K related to equity
compensation plans is set forth under Item 12, Part III, of this Annual Report
on Form 10-K.
HOLDERS
As of December 31, 2004 there were approximately 970 holders of record of PSB
common stock. Some of PSB's shares are held in "street" name and the number of
beneficial owners of such shares is not known and therefore not included in the
foregoing number.
DIVIDENDS
PSB expects that its practice of paying semi-annual dividends on its common
stock will continue, although the payment of future dividends will continue to
depend upon earnings, capital requirements, financial condition and other
factors. The principal source of funds for the payment of dividends by PSB is
dividend income from its bank subsidiary. Payment of dividends by the bank is
subject to various limitations under banking laws and regulations. At December
31, 2004, the bank could have paid a maximum of approximately $8.7 million in
additional dividends to PSB without prior regulatory approval. However, to
remain "well capitalized" under regulatory Prompt Corrective Action Provisions
(see Note 16 to the Consolidated Financial Statements), dividends could not
exceed approximately $1.7 million as of December 31, 2004. PSB has paid
regular dividends since its inception in 1995.
On December 16, 2003, PSB declared a 5% stock dividend paid January 29, 2004.
All per share information in this Annual Report on Form 10-K and the
Consolidated Financial Statements has been adjusted to reflect the impact of
this stock dividend on a proforma basis.
7
MARKET PRICES AND DIVIDENDS
Price ranges of over-the-counter quotations and dividends declared per share on
PSB common stock for the periods indicated are:
2004 Prices 2003 Prices
Quarter High Low Dividends High Low Dividends
1st $35.00 $33.30 $ - $24.86 $21.24 $ -
2nd $34.75 $34.10 $0.300 $31.52 $24.86 $0.285
3rd $34.50 $32.75 $ - $31.90 $31.43 $ -
4th $32.75 $32.10 $0.300 $35.24 $31.43 $0.285
Prices detailed for the common stock represent the bid prices reported on the
OTC Bulletin Board. The prices do not reflect retail mark-up, mark-down or
commissions, and may not necessarily represent actual transactions.
SALES AND DISTRIBUTION OF STOCK
PSB distributed 232 shares (valued at $33.62 per share) and 1,750 shares
(valued at $25.95 per share) of its common stock during 2004 and 2003,
respectively to its directors in lieu of cash payments under the director's
incentive compensation plan. Receipt of stock or deferral of value into the
director deferred compensation plan via a previously committed election was
mandatory and no investment decision was made by any member of the Board.
ITEM 6. SELECTED FINANCIAL DATA.
TABLE 1: EARNINGS SUMMARY AND SELECTED FINANCIAL DATA
Consolidated summary of earnings
Years ended December 31, 2004 2003 2002 2001 2000
(dollars in thousands, except per share data)
Total interest income $22,202 $21,050 $21,915 $23,428 $21,940
Total interest expense 8,113 7,869 9,274 12,469 12,540
Net interest income 14,089 13,181 12,641 10,959 9,400
Provision for loan losses 855 835 1,110 890 600
Net interest income after loan loss provision 13,234 12,346 11,531 10,069 8,800
Total noninterest income 3,123 4,111 3,048 2,065 1,446
Total noninterest expenses 10,975 9,351 8,226 7,315 6,474
Net income before income taxes 5,382 7,106 6,353 4,819 3,772
Provision for income taxes 1,856 2,300 1,988 1,453 1,102
Net income $ 3,526 $ 4,806 $ 4,365 $ 3,366 $ 2,670
8
Consolidated summary balance sheets
As of December 31, 2004 2003 2002 2001 2000
(dollars in thousands, except per share data)
Cash and cash equivalents $ 23,324 $ 18,927 $ 21,552 $ 25,550 $ 9,367
Securities 68,894 72,472 81,057 70,444 62,097
Total loans receivable, net of allowance 343,923 304,339 256,015 236,574 224,702
Premises and equipment, net 12,432 7,557 6,158 4,755 4,751
Other assets 6,401 5,638 6,687 6,973 5,322
Total assets $454,974 $408,933 $371,469 $344,296 $306,239
Total deposits $358,225 $316,414 $297,830 $273,635 $241,534
FHLB advances 52,000 47,000 38,000 38,000 28,000
Other borrowings 8,565 10,475 3,302 4,327 11,515
Other liabilities 2,568 2,903 3,034 2,985 2,916
Stockholders' equity 33,616 32,141 29,303 25,349 22,274
Total liabilities and stockholders' equity $454,974 $408,933 $371,469 $344,296 $306,239
Performance ratios: 2004 2003 2002 2001 2000
Basic earnings per share $ 2.04 $ 2.76 $ 2.48 $ 1.91 $ 1.48
Diluted earnings per share $ 2.03 $ 2.74 $ 2.48 $ 1.91 $ 1.48
Common dividends declared per share $ 0.60 $ 0.57 $ 0.54 $ 0.51 $ 0.49
Dividend payout ratio 29.33% 20.77% 21.65% 26.94% 32.64%
Net book value per share at year-end $19.55 $18.54 $16.75 $14.38 $12.64
Average common shares outstanding 1,725,136 1,740,106 1,758,249 1,763,381 1,802,401
Return on average stockholders' equity 10.66% 15.45% 15.97% 13.96% 12.33%
Return on average assets 0.82% 1.26% 1.25% 1.05% 0.94%
Net interest margin (tax adjusted) 3.60% 3.75% 3.95% 3.73% 3.62%
Net loan charge-offs to average loans 0.07% 0.16% 0.37% 0.14% 0.14%
Noninterest income to average assets 0.73% 1.08% 0.88% 0.65% 0.51%
Noninterest income to tax adjusted
net interest margin 21.29% 29.98% 23.12% 18.12% 14.86%
Efficiency ratio 61.70% 52.46% 50.68% 54.50% 58.05%
Salaries and benefits expense to average assets 1.44% 1.56% 1.42% 1.38% 1.35%
Other expenses to average assets 1.11% 0.89% 0.94% 0.91% 0.93%
FTE employees at year-end 133 116 116 100 86
Average equity to average assets 7.68% 8.15% 7.85% 7.53% 7.63%
Non-performing loans to gross loans at year-end 0.80% 1.08% 0.94% 1.68% 1.44%
Allowance for loan losses to loans at year-end 1.19% 1.15% 1.22% 1.24% 1.06%
year period ended December 31, 2004. This discussion should be read in
conjunction with the consolidated financial statements, notes, tables, and the
selected financial data presented elsewhere in this report. All figures are in
thousands, except per share data and per employee data.
Management's discussion and analysis contains forward-looking statements that
are provided to assist in the understanding of anticipated future financial
performance. However, such performance involves risks and uncertainties that
may cause actual results to differ materially from those in such statements.
For a discussion of certain factors that may cause such forward-looking
statements to differ materially from actual results see Item 1, Cautionary
Statement Regarding Forward-Looking Information, in this Annual Report on Form
10-K for the year ended December 31, 2004.
EXECUTIVE OVERVIEW
This overview summarizes PSB's business model and presents the primary
opportunities and challenges faced by management and the impact of economic and
industry-wide factors on PSB's operating environment. In addition, the near-
term and long-term issues on which management is most focused are outlined in
general terms as a backdrop for the detailed statistical and narrative analysis
presented in this Annual Report on Form 10-K.
Although PSB operates as a community bank, its operating environment is
significantly impacted by national economic trends and other industry factors.
Current national and banking industry wide trends impacting PSB are outlined
below.
* Following a pro-longed period of falling interest rates to historically
low levels, short-term interest rates began to rise during 2004.
However, long-term rates did not rise in a corresponding manner.
Therefore, some banks experienced a decreasing net interest margin as a
flatter yield curve brought funding costs closer to earning asset
yields.
* Although long-term market rates remained low, mortgage refinancing
activity sharply declined following a two year period of unprecedented
refinancing activity. This decrease in activity decreased fee income
from the sale of long-term fixed rate loans by banks to secondary market
investors.
* Rising interest rates have decreased the value of fixed rate debt
securities portfolios. In addition, rising interest rates have extended
the projected repayment period of amortizing debt securities, further
decreasing current market value. Many banks have seen substantial
decreases in the value of unrealized gains in the securities portfolio.
* Although bank deposits have increased since 2001, funds are beginning to
flow back into the stock market following a period of higher equity
market returns. The banking industry is likely to experience a long-
term slow erosion of deposits maintained by customers due to demographic
changes, competing investments from non-bank providers, and other
factors.
10
* Although consumer incomes and spending have been supported in recent
years by the temporary effects of lower taxes and liquidation of
homeowner equity, consumer spending going forward is expected to be more
dependent on the growth of jobs and incomes. While most consumers have
been managing their debt load, weaker borrowers or those holding
variable rate debt could be at risk as interest rates rise.
* Commercial banks and non-bank providers continue to compete aggressively
for a limited number of loan relationships. This competition has led to
declines in loan pricing margin relative to credit risk and other
factors.
* In light of competition for traditional net interest margin based
income, banks have sought to increase fee based income and become "one-
stop shopping" centers for most financial services. Service and
convenience continue to be a customer requirement impacting the ability
for smaller banks to compete for customers solely for traditional loan
and deposit products. In addition, non-bank competitors such as
insurance companies, retailers, and credit unions have sought to expand
their markets for traditional banking product customers, increasing
competition for customers and decreasing product pricing for services.
PSB operates in many ways as a local community bank, but larger in size and
scope. PSB maintains a traditional banking business model and currently does
not hold significant stand-alone derivative instruments to hedge cash flow and
fair value risks. The primary sources of income are net interest earned on
residential and commercial real estate loans made to local customers after
payment of interest to depositors. PSB also originates, sells, and services
long-term fixed rate mortgage loans to the secondary market for a substantial
amount of fee income. Depositors also pay various service fees including
overdraft charges and commercial service fees which contribute to PSB's
noninterest income. These activities make up over 90% of PSB's total revenue.
PSB serves customers through a network of eight full service locations with an
emphasis on customer service and flexibility. PSB employees are substantial
participants in community involvement for the betterment of PSB's market areas,
customers, and potential customers.
PSB recognizes many opportunities for continued growth in products, customers,
assets, and profits. PSB's relative size (compared to typical community banks,
thrifts, and credit unions) allows it to offer a wide array of financial
service products in a one-stop shopping service model. The burden of
regulatory compliance and emerging issues such as "Check 21" related to
electronic processing of paper items or compliance with anti-money laundering
regulations dictated by the USA Patriot Act are more easily borne by a larger
institution. Although greater in size, traditional community bank customer
service and flexibility is a priority. Therefore, PSB can offer better service
to customers disenfranchised by large banks and large bank mergers while
allowing them to continue their practice of one-stop shopping and commercial
support. PSB can compete against smaller local community banks and credit
unions by continuing the same level of service these customers expect, but
giving them an expanded and competitively priced product lineup due in part to
economies of scale.
PSB has invested in key management and branch personnel to capitalize on
relationships in existing and adjacent markets. PSB's growth into adjacent
markets minimized costs for name recognition and awareness while increasing the
speed in which customers are obtained via new locations and
11
improving convenience of service for existing customers. PSB intends to grow
at a level greater than may be able to be supported in existing adjacent
markets. Therefore, future market expansions are likely to be out of the area,
and be directed by an officer who is an existing local market leader.
For many years, PSB has operated with very low levels of overhead expense
relative to peer institutions, allowing for competitive pricing across its
product line. Management and employees recognize the need for an efficient and
cost effective organization which has become part of the culture of the
organization.
Against this back drop of industry-wide factors and competitive advantages and
opportunities, management monitors several areas of risk, negative tends, and
challenges. The following items represent challenges monitored by management
in both the short- and long-term. These challenges are presented in greater
detail and statistical analysis throughout this section of this Annual Report
on Form 10-K.
* Net income declined substantially during 2004 compared to 2003 and 2002.
The decline was due in part to lower mortgage banking revenue (compared
to 2003 and 2002) as refinancing activity sharply declined. In
addition, PSB incurred one-time charges related to abandonment of the
prior home office and settlement of a Wisconsin income tax audit
concerning its Nevada investment subsidiary.
* PSB continues to expand its branch network, significantly increasing
PSB's fixed overhead expense structure. In past years, low overhead
expenses allowed PSB to competitively price products while maintaining
acceptable profits for capital expansion and shareholders. As overhead
increases, additional profit gains need to come from the sale of new
services, acquisition of new customers, favorable loan and deposit
pricing, and other sources of income.
* As short-term interest rates increased during 2004, the interest rate
yield curve flattened, with short term rates (typically paid on
deposits) rising faster than longer-term rates (typically collected on
loans). PSB deposit funding costs have increased faster than earning
asset yields, thereby decreasing net interest margin. Improvements in
net interest margin are dependent in part on PSB's ability to limit core
deposit funding rate increases while at the same time attracting
deposits to fund continued loan growth.
* Although the rate of retail deposit growth during 2004 improved over
prior years, PSB continues to rely on wholesale funding such as broker
certificates of deposit and Federal Home Loan Bank of Chicago ("FHLB")
advances. In light of a long-term industry wide problem of attracting
and keeping deposits, PSB is positioning itself to meet future funding
needs in this environment. PSB has identified noninterest bearing
demand and commercial deposits as a long-term low cost source of
funding. Therefore, PSB has positioned its operations to efficiently
handle large volumes of customer activity in this area through image
processing and related initiatives. To increase deposit levels, PSB has
developed commercial treasury management products with key personnel to
attract larger commercial and governmental depositors. To attract these
deposits, above average interest rates may be required, potentially
reducing net interest margin, although net interest income dollars could
increase through leveraged growth.
12
* In connection with PSB's new treasury management product initiative,
lending activities with large commercial enterprise to be repaid solely
from cash flow are expected to increase. While PSB seeks high quality
borrowers and closely monitors credit risk on such borrowers, the
potential for large loan principal charge-offs from a single commercial
loan relationship increases.
* PSB's long-term growth plan is likely to exceed the level of assets able
to be supported by existing equity capital and future earnings retained
internally. Management monitors available sources of regulatory
qualifying capital and maintains relationships with investment banking
professionals to expedite acquisition of capital in a manner beneficial
to existing shareholders when necessary. PSB anticipates raising
additional regulatory capital through a pooled trust preferred capital
issue during 2005 as needed.
* PSB is currently involved in an Internal Revenue Service income tax
audit directed at the operations of its Nevada investment subsidiary,
PSB Investments, Inc. As described in Item 8, Note 13 of the Notes to
the Consolidated Financial Statements, an unfavorable outcome in this
audit would have an unfavorable impact on profits.
RESULTS OF OPERATIONS
PSB's net income decreased to $3,526 for 2004 compared to $4,806 in 2003 and
$4,365 during 2002 representing a decrease of 26.6% in 2004 and an increase of
10.1% in 2003. Similarly, diluted earnings per share decreased to $2.03 for
2004 compared to $2.74 in 2003 and $2.48 in 2002. Item 6 of this Annual Report
on Form 10-K presents other various financial performance ratios and measures
for the five years ending December 31, 2004. A number of separate factors
decreased PSB earnings growth relative to the past two years as outlined in the
table below. Despite these separately identifiable items, PSB operating income
before special items continues to decline from the level set in 2002 and has
grown only modestly since 2001. The following table presents PSB's net income
for the four years ending December 31, 2004 including adjustments for gain on
sale of mortgage loans and other nonrecurring income and expense items.
Years ending December 31, 2004 2003 2002 2001
Net income before special mention items, net of tax $3,301 $3,608 $3,624 $2,952
Mortgage banking 546 1,071 741 414
Net gain on sale of securities 59 48 - -
Gain on curtailment of post-retirement benefit plan - 79 - -
Loss on abandonment of premises and equipment (230) - - -
Wisconsin state income tax settlement (150) - - -
Net income $3,526 $4,806 $4,365 $3,366
As seen in the table, 2004 net income compared to 2003 net income was reduced
by one-time charges for loss on abandonment of the previous home office and a
grocery store branch location and settlement of a Wisconsin state income tax
issue related to the operations of the Nevada investment subsidiary in addition
to lower mortgage banking income. Net income before these special mention
13
items also declined by a decrease in average net interest margin on earning
assets compared to 2003 as net interest income growth was less than operating
expenses growth.
Net income in 2003 before gain on sale of mortgage loans, gain on sale of
securities, and gain on curtailment of a post-retirement benefit plan decreased
from the level seen during 2002. This decline in net income and profit growth
before these items was due primarily to a decrease in average net interest
margin on earnings assets compared to 2002 and additional wages paid to
employees based on earnings which included mortgage banking income under PSB's
incentive compensation plan.
The following discussion concerning results of operations presents a detailed
analysis of significant items impacting results from operations and trends
identified by management including:
* Average earning asset and funding sources balances and rates;
* Impact of increased asset base and changes in average net margin on net
interest income;
* Changes in the nature of profit and loss items related to net interest
income;
* Noninterest income and expense analysis, trends, and expectations;
* Anticipated impacts of current branching and administrative facilities
expansion; and
* Income tax contingencies
NET INTEREST INCOME
PSB incurs market risk primarily from interest-rate risk inherent in its
lending and deposit taking activities. Market risk is the risk of loss from
adverse changes in market prices and rates. Management actively monitors and
manages its interest-rate risk exposure. The measurement of the market risk
associated with financial instruments (such as loans and deposits) is
meaningful only when all related and offsetting on- and off-balance sheet
transactions are aggregated, and the resulting net positions are identified.
Disclosures about the fair value of financial instruments that reflect changes
in market prices and rates can be found in Item 8, Note 19 of the Notes to
Financial Statements.
PSB's primary objective in managing interest-rate risk is to minimize the
adverse impact of changes in interest rates on net interest income and capital,
while adjusting the asset-liability structure to obtain the maximum yield-cost
spread on that structure. PSB relies primarily on its asset-liability
structure to control interest-rate risk. In general, longer-term earning
assets are funded by shorter-term funding sources allowing PSB to earn net
interest income on both the credit risk taken on assets and the yield curve of
market interest rates. However, a sudden and substantial change in interest
rates may adversely impact earnings, to the extent that the interest rates
borne by assets and liabilities do not change at the same speed, to the same
extent, or on the same basis. PSB does not engage in trading activities to
enhance earnings or for hedging purposes.
Net interest income represents the difference between interest earned on loans,
securities and other interest-earning assets, and the interest expense
associated with the deposits and borrowings that fund them. Interest rate
fluctuations together with changes in volume and types of earning assets and
interest-bearing liabilities combine to affect total net interest income.
Additionally, net interest income is impacted by the sensitivity of the balance
sheet to change in interest rates, contractual maturities, and repricing
frequencies.
14
The following tables present average balance sheet data and related average
interest rates on a tax equivalent basis and the impact of changes in the
earnings assets base for the three years ending December 31, 2004.
Table 2: Average Balances and Interest Rates
2004 2003 2002
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
Assets
Interest-earning assets:
Loans(1)(2) (3) $329,133 $19,278 5.86% $282,006 $18,025 6.39% $249,247 $18,102 7.26%
Taxable securities 47,356 1,798 3.80% 51,707 1,943 3.76% 51,664 2,724 5.27%
Tax-exempt securities(2) 24,730 1,488 6.02% 22,478 1,388 6.17% 20,466 1,361 6.65%
FHLB stock 2,709 159 5.87% 2,367 153 6.46% 2,218 109 4.91%
Other 3,497 56 1.60% 6,760 74 1.09% 9,979 162 1.62%
Total(2) 407,425 22,779 5.59% 365,318 21,583 5.91% 333,574 22,458 6.73%
Non-interest-earning assets:
Cash and due from banks 13,409 10,268 8,865
Premises and equipment, net 10,508 6,410 5,453
Other assets 3,158 3,108 3,258
Allowance for loan
losses (3,885) (3,475) (3,148)
Total $430,615 $381,629 $348,002
Liabilities & stockholders' equity
Interest-bearing liabilities:
Savings and demand
deposits $ 52,982 $ 37 10.70% $40,518 $247 0.61% $32,536 $337 1.04%
Money market deposits 66,494 610 0.92% 69,238 692 1.00% 73,629 1,061 1.44%
Time deposits 166,967 4,802 2.88% 144,083 4,712 3.27% 132,848 5,437 4.09%
FHLB borrowings 47,749 2,061 4.32% 38,553 1,989 5.16% 38,000 2,289 6.02%
Other borrowings 11,824 269 2.28% 9,151 229 2.50% 3,496 149 4.26%
Total 346,016 8,113 2.34% 301,543 7,869 2.61% 280,509 9,273 3.31%
Non-interest-bearing liabilities:
Demand deposits 49,600 46,876 38,031
Other liabilities 1,915 2,098 2,127
Stockholders' equity 33,084 31,112 27,335
Total $430,615 $381,629 $348,002
Net interest income $14,666 $13,714 $13,185
Rate spread 3.25% 3.30% 3.42%
Net yield on interest-earning assets 3.60% 3.75% 3.95%
(1) Nonaccrual loans are included in the daily average loan balances outstanding.
(2) The yield on tax-exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%.
(3) Loan fees are included in total interest income as follows: 2004 - $397, 2003 - $654, 2002 - $458.
15
Table 3: Interest Income and Expense Volume and Rate Analysis
2004 compared to 2003 2003 compared to 2002
increase (decrease) due to(1) increase (decrease) due to(1)
Volume Rate Net Volume Rate Net
Interest earned on:
Loans(2) $3,011 $(1,758) $1,253 $2,378 $(2,455) $(77)
Taxable securities (164) 19 (145) 2 (783) (781)
Tax-exempt securities(2) 139 (39) 100 134 (107) 27
FHLB stock 22 (16) 6 7 37 44
Other interest income (36) 18 (18) (52) (36) (88)
Total 2,972 (1,776) 1,196 2,469 (3,344) (875)
Interest paid on:
Savings and demand deposits 76 48 124 83 (173) (90)
Money market deposits (27) (55) (82) (63) (306) (369)
Time deposits 748 (658) 90 460 (1,185) (725)
FHLB borrowings 475 (403) 72 33 (333) (300)
Other borrowings 67 (27) 40 241 (161) 80
Total 1,339 (1,095) 244 754 (2,158) (1,404)
Net interest earnings $1,633 $ (681) $ 952 $1,715 $(1,186) $ 529
(1) The change in interest due to both rate and volume has been allocated to volume
and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
(2) The yield on tax-exempt loans and investment securities has been adjusted to its fully taxable equivalent using a 34% tax rate.
During 2004, average earning assets grew 11.5% to $407,425 compared to growth
of 9.5% during 2003 and 9.2% during 2002. However, tax adjusted net interest
income increased just 6.9% to $14,666 compared to growth of 4.0% to $13,714
during 2003 and growth of 15.7% to $13,185 during 2002. The lower level of net
interest income growth during 2004 and 2003 was due to a decline in average net
interest margin on those earning assets.
Compared on an annual basis, yield on earning assets and cost of interest-
bearing liabilities declined during 2004, 2003, and 2002. During 2004, the
decline in earning assets yield was greater than the offsetting decline in the
cost of interest-bearing liabilities. As short-term interest rates increased,
earnings assets and funding sources tied to these short-term rates rose
compared to yields seen during 2003. These included taxable securities, other
overnight investments, and savings and demand deposits. However, longer-term
earning assets and long-term funding sources continued to mature at lower
rates, decreasing yields. Although the volume of additional earning assets
added $1,633 to net interest income during 2004, approximately 40% of this
benefit was lost to declines in net interest margin.
During 2003, the decline in earning asset yields was greater than the
offsetting decline in the cost of interest-bearing liabilities as savings and
other "core" customer deposits had repriced to near their floor during 2002.
Conversely, longer-term loans matured and refinanced at continually lower
rates, decreasing net interest margin during 2003. Although the volume of
additional earning assets added
16
$1,715 to net interest income during 2003, nearly 70% of this benefit was lost
to declines in net interest margin. The following table outlines the change in
yields during the three years ended December 31, 2004.
Table 4: Yield on Earning Assets
Year ended December 31, 2004 2003 2002
Yield Change Yield Change Yield Change
Yield on earning assets 5.59% -0.32% 5.91% -0.82% 6.73% -1.08%
Effective rate on all liabilities as
a percent of earning assets 1.99% -0.17% 2.16% -0.62% 2.78% -1.30%
Net yield on earning assets 3.60% -0.15% 3.75% -0.20% 3.95% 0.22%
Because PSB holds a significant amount of prime rate adjustable commercial and
home equity loans, recent increases in the prime rate are beginning to be
reflected as the yield on earning assets increased from 5.54% for the quarter
ended September 2004 to 5.59% for the quarter ended December 2004, the first
significant quarterly increase in yield during the most recent interest rate
cycle. However, the cost of interest-bearing liabilities increased 10 basis
points to 2.47% during the quarter ended December 31, 2004. PSB's ability to
increase future net interest margin is dependant on repricing core accounts in
line with earning asset yields in a rising rate environment. Increases to the
prime rate through December 31, 2004 were not yet reflected in the rate paid on
core savings and money market accounts at year-end. Absent a change to a
rising yield curve with equal short-term and long-term increases (a "parallel"
yield curve shift), management expects net interest margin to remain similar to
that seen during all of 2004. Average earning assets are projected to continue
to grow by approximately 10% during 2005.
During 2003, the decrease in the prime rate at the end of June 2003 caused a
direct reduction to net interest margin due to the inability to reprice core
deposit savings rates from their already historically low levels. Therefore,
net interest margin during 2003 decreased from that seen during 2002.
NONINTEREST INCOME
During 2004, PSB noninterest income from deposit service fees, sale of mortgage
loans and other income declined relative to net interest income as mortgage
banking income declined, reversing a trend seen in 2003 and 2002 which had
large increases in mortgage banking income. However, separate from mortgage
banking, noninterest income to net interest income did not decline as
drastically as presented in table 5 below. Noninterest income before mortgage
banking and gain on curtailment of employee benefit plan to net interest margin
was 15.8%, 16.8%, and 14.4% in 2004, 2003, and 2002, respectively. Management
believes other fee based income to be an important component of future earnings
as the net interest margin on traditional loan and deposit products declines
due to increased financial services competition. Mortgage banking income on
sale of mortgages to secondary market investors was the primary reason for net
income growth during 2003 and 2002, and was a factor in the decline in net
income during 2004 compared to these periods. The following common size income
statements present the changing mix of income and expense relative to
traditional loan and deposit product net interest income for the five years
ending December 31, 2004.
17
Table 5: Summary of Earnings as a Percent of Net Interest Income
2004 2003 2002 2001 2000
Net interest income 100.0% 100.0% 100.0% 100.0% 100.0%
Provision for loan losses 6.1% 6.3% 8.8% 8.1% 6.4%
Net interest income after loan loss provision 93.9% 93.7% 91.2% 91.9% 93.6%
Total noninterest income 22.2% 31.2% 24.1% 18.8% 15.4%
Total noninterest expenses 77.9% 70.9% 65.1% 66.8% 68.9%
Net income before income taxes 38.2% 54.0% 50.2% 43.9% 40.1%
Provision for income taxes 13.2% 17.4% 15.7% 13.3% 11.7%
Net income 25.0% 36.6% 34.5% 30.6% 28.4%
During 2004, service fees declined $48, or 3.7% from that in 2003. During
2005, PSB expects to increase service fee income due in large part to fee
income from treasury management products introduced in 2005. Mortgage banking
declined $866, or 49.0% during 2004 compared to 2003 as mortgage refinancing
activity ceased as falling long-term mortgage rates stabilized. Separate from
these items, 2004 noninterest income declined $74 due to a one-time gain on
curtailment of a post-retirement benefit plan of $131 during 2003.
During 2003, the impact of the gain on sale of mortgages and some nonrecurring
income items were significant contributors to the increase in 2003 net income
over 2002. Although the continued decline in market interest rates decreased
average net interest margin as described previously, low mortgage rates
encouraged homeowners to refinance their mortgages generating significant fee
income for PSB, offsetting lost interest margin on loans retained on PSB's
balance sheet. However, because this activity was in response to falling
interest rates, management did not expect such level of mortgage fee income to
continue in 2004. A detailed analysis of noninterest income relative to net
income before income taxes follows to highlight the impact of these items on
income.
Table 6: Noninterest Income
2004 2003 2002
% of pre-tax % of pre-tax % of pre-tax
Amount income Amount income Amount income
Service fees $1,234 22.93% $1,282 18.04% $1,217 19.16%
Mortgage banking income 901 16.74% 1,767 24.87% 1,223 19.25%
Retail investment sales commissions 427 7.93% 351 4.94% 163 2.57%
Insurance annuity sales commissions 41 0.76% 63 0.89% 69 1.09%
Net gain on sale of securities 97 1.80% 80 1.13% - 0.00%
Net gain (loss) on sale of foreclosed
property 29 0.54% (9) -0.13% 28 0.44%
Gain (loss) on disposal of premises
and equipment 3 0.06% - 0.00% (24) -0.38%
Gain on sale of non-mortgage loans - 0.00% 62 0.87% - 0.00%
Gain on curtailment of post-retirement
benefit plan - 0.00% 131 1.84% - 0.00%
Other operating income 391 7.26% 384 5.40% 372 5.86%
Total noninterest income $3,123 58.03% $4,111 57.85% $3,048 47.99%
18
PSB serviced $160,225 and $152,718 of residential real estate loans which have
been sold to the FHLB under the Mortgage Partnership Finance Program ("MPF") at
December 31, 2004 and 2003, respectively. A servicing fee equal to .25% of
outstanding principal is retained from payments collected from the customer as
compensation for servicing the loan for the FHLB. Historically low and
declining long-term fixed rate mortgage interest rates during 2001 to 2003
increased the amount of loans originated and subsequently serviced for the FHLB
from just $1 million at December 31, 2000. As long-term mortgage rates have
increased, PSB does not expect such fast growth in the serviced portfolio to
continue during 2005.
As a FHLB MPF loan servicer, PSB has provided a credit enhancement guarantee to
reimburse the FHLB for foreclosure losses in excess of 1% of the original loan
principal sold to the FHLB. In exchange for this guarantee, PSB is paid a
"credit enhancement" fee of .07% to .10% of outstanding serviced principal in
addition to the .25% collected for servicing the loan for the FHLB.
PSB recognizes a mortgage servicing right asset due to the substantial volume
of loans serviced for the FHLB. Refer to Note 1 of the consolidated financial
statements for a summary of PSB's mortgage servicing right accounting policies.
The table below summarizes the components of PSB's mortgage banking income for
the three years ending December 31, 2004.
Table 7: Mortgage Banking Income
Years ending December 31,
2004 2003 2002
Cash gain on sale of mortgage loans $ 363 $1,229 $ 652
Originated mortgage servicing rights 334 792 840
Gain on sale of mortgage loans 697 2,021 1,492
Mortgage servicing fee income 396 325 131
FHLB credit enhancement fee income 117 96 27
Amortization of mortgage servicing rights (293) (700) (312)
Change in servicing right valuation allowance (16) 25 (115)
Loan servicing fee income, net 204 (254) (269)
Mortgage banking income $ 901 $1,767 $1,223
NONINTEREST EXPENSE
Noninterest expenses year over year continue to increase growing 12.4% during
2002, 13.7% during 2003 and 17.4% during 2004. However, 2004 included a
special charge for loss on abandonment of premises and equipment related to the
razing of the former home office building and closure of a grocery store branch
in Rhinelander following establishment of a separate stand alone branch near
the same location. Excluding this loss on abandonment, noninterest expense
increased 13.3% over 2003.
During 2004, noninterest expense grew faster than income, thereby unfavorably
increasing the efficiency ratio to 61.70%. The 2004 efficiency ratio before
the loss on abandonment of premises and equipment was 59.56% compared to 52.46%
during 2003. Other factors resulting in the less favorable efficiency ratio
during 2004 were the large decline in mortgage banking income and slower net
19
interest income growth relative to growth in operating expenses. As PSB
invests in new branch facilities and personnel (as occurred during 2004),
future years will have a significantly higher fixed cost structure than in
prior years. Management expects the efficiency ratio during 2005 to remain
similar to 2004 in a range from 58% to 59%.
During 2003 and 2002, increases in noninterest expenses were offset by
increases in net interest income and other income of similar amounts so that
PSB's efficiency ratio was 50.68% in 2002 and 52.46% in 2003. Salaries and
employee benefits showed the greatest increase relative to net interest income
and other income during 2003.
The table below outlines in detail noninterest expenses for the three years
ending December 31, 2004.
Table 8: Noninterest Expense
Years ended December 31,
2004 2003 2002
% of net % of net % of net
margin margin margin
& other & other & other
Amount income Amount income Amount income
Wages, except incentive compensation $5,059 28.44% $4,476 25.11% $3,765 23.19%
Incentive compensation 157 0.88% 466 2.61% 414 2.55%
Net deferred loan origination costs (306) -1.72% (259) -1.45% (256) -1.58%
Profit sharing and retirement plan expense 313 1.76% 327 1.83% 280 1.72%
Post-retirement health care benefits plan 26 0.15% 62 0.35% 74 0.46%
Health insurance 389 2.19% 377 2.12% 275 1.69%
Payroll taxes and other employee benefits 551 3.10% 503 2.82% 375 2.31%
Total salaries and employee benefits 6,189 34.80% 5,952 33.39% 4,927 30.34%
Occupancy expense 1,609 9.04% 1,127 6.32% 1,093 6.73%
Loss on abandonment of premises and
equipment 379 2.13% - 0.00% - 0.00%
Data processing other office operations 655 3.68% 547 3.07% 583 3.59%
Advertising and promotion 263 1.48% 172 0.96% 319 1.97%
Directors fees and benefits 254 1.43% 270 1.51% 173 1.07%
Legal and professional expenses 316 1.78% 290 1.63% 219 1.35%
Other expenses 1,310 7.36% 993 5.58% 912 5.63%
Total noninterest expense $10,975 61.70% $9,351 52.46% $8,226 50.68%
Note - Net interest income (net margin) is calculated on a tax equivalent basis
using a tax rate of 34%.
The average number of full time equivalent employees ("FTE") was 106, 119, and
126 in 2002, 2003, and 2004, respectively. Average base wages per FTE were
approximately $35,500, $37,600, and $40,100 in 2002, 2003, and 2004,
respectively, increasing 6.6% during 2004 and 5.9% during 2003. Although
effective January 1, 2004, employees were granted inflationary and merit
increase averaging 2.9%, new employees hired later in 2004 were for senior
sales positions and other bank officers requiring greater than average base pay
levels. The increase in base pay during 2003 was due to one-time merit and
inflationary increases granted to employees effective January 1, 2003 averaging
6.1%.
20
For 2005, employees were granted inflationary and merit increases
averaging 3.4% effective January 1, 2005.
During 2004, separate from the increase in base pay, salaries and employee
expense declined $346 compared to 2003 due primarily to lower incentive
compensation and profit sharing expenses of $323. PSB offers employees an
incentive compensation program based on achievement of the bank's net income
requirements and achievement of department and individual goals. In addition,
PSB's profit sharing contribution to the qualified employee retirement plan is
a percentage of net income before income taxes. During 2002 and 2003, the
highest levels of incentive compensation were paid. However, because the
program is based on net income growth, incentive compensation is variable, and
declined during 2004. Should net income increase according to plan during 2005
and future years, incentive compensation expense is expected to increase.
During 2004, occupancy expenses increased $482, or 42.8% due to $254 in
additional premises and equipment depreciation expense, one-time charges for
moving into the new home office of $23, and settlement of a sales tax audit
related largely to premises and equipment investment and maintenance of $52.
All other increases to occupancy expense totaled $153, an increase of 13.6%.
PSB occupied a new home office and principal customer financial center on June
28, 2004, placing into service the 32,000 square foot $4.8 million dollar
facility (including furniture and equipment). Annual depreciation expense is
estimated to increase $186 from the new investment in the home office.
Abandonment of the old main office (the building was razed) located on the same
property generated a cumulative one-time charge to operations of $329 ($199
after tax benefits). During December 2004, PSB closed its grocery store branch
located in Rhinelander, Wisconsin. In accordance with the lease agreement, PSB
accrued $50 for costs to remove leasehold improvements in accordance with the
lease agreement as a loss on abandonment of premises and equipment. Following
the decision to close the Rhinelander grocery store branch, depreciation of
remaining leasehold improvements was accelerated to the date of closing, adding
approximately $115 of additional depreciation expense during 2004 that had
originally been allocated to future years.
Advertising and promotion expenses declined during 2003 as PSB took much of its
advertising and design work in-house. In addition, PSB updated the bank logo
and other media for a change in brand during 2002, which increased nonrecurring
expenses during that year. With the opening of two new branch locations and a
new administrative home office during 2004, advertising and promotion increased
to capitalize on these new initiatives and market exposure.
Directors' fees and benefits increased during 2003 due to an increase in fees
effective January 1, 2003. Increases to the director fees schedule are
infrequent and the 2003 increase was the first in several years. Directors'
fees are expected to remain similar to 2004 levels in 2005.
Other noninterest expenses during 2004 includes $127 of collection fees written
off in response to regulatory requirements to account for collection fees as
expense until collected, despite PSB's expectation that these fees will be
collected from the borrower in the future as part of the loan agreement or from
SBA loan guarantee reimbursements. PSB now accounts for collection expenses
when paid, and credits future reimbursements of such expenses when received.
PSB formed Peoples Insurance Services LLC during September 2003 as a start up
commercial property and casualty insurance agency that operates as a division
of Peoples State Bank. As a
21
start-up, the agency is incurring costs in excess of revenue at this time. The
agency's net loss (after tax benefits) from operations (excluding inter-company
cost allocations for rent, management fees, and interest expense) was $129 and
$39 during 2004 and 2003, respectively. The primary expense from agency
operations is salaries and benefits, which were $171 in 2004 and $41 in 2003.
Commission income on sale of insurance products by the LLC has been
significantly less than originally planned, increasing losses above the
original pro-forma budget, despite operating with lower expenses than
projected. Commission income collected during 2004 totaled $9.
PROVISION FOR LOAN LOSSES
The adequacy of the allowance for loan losses is assessed based upon credit
quality, existing economic conditions and loss exposure by loan category.
Management determines the allowance for loan losses based on past loan
experience, current economic conditions, composition of the loan portfolio, and
the potential for future loss. Accordingly, the amount charged to expense is
based on management's evaluation of the loan portfolio. It is PSB's policy
that when available information confirms that specific loans, or portions
thereof, including impaired loans, are uncollectible, these amounts are
promptly charged off against the allowance. The provision for loan losses was
$855, in 2004; compared to $835 in 2003 and $1,110 in 2002. See additional
discussion under the section titled "Allowance for Loan Losses."
INCOME TAXES
The effective tax rate was 34.5% in 2004, 32.4% in 2003, and 31.3% in 2002.
The increase in the 2004 effective rate was due to a Wisconsin state income tax
settlement regarding operations of the Nevada investment subsidiary totaling
$150 (after federal tax benefits). Excluding this one-time charge, the
effective rate would have been 31.7%. During 2004, PSB earned a greater
portion of tax-exempt income on municipal securities relative to total income
compared to prior years, reducing the effective tax rate. See Item 8, Note 13
of the Notes to Consolidated Financial Statements for additional tax
information.
The increase in the effective rate during 2003 and 2002 was due in part to
overall pre-tax income increasing faster than the relative size of the tax-
exempt municipal securities portfolio and state tax favored earnings at PSB's
Nevada investment subsidiary, PSB Investments, Inc.
As described in Note 13 of the Notes to Consolidated Financial Statements,
PSB's open tax returns are currently under audit by the Internal Revenue
Service in connection with PSB Investments, Inc. activities. PSB believes it
has calculated and paid appropriate income taxes in all cases in accordance
with written tax code and regulations. PSB has been assessed approximately
$170 in taxes, interest, and penalties for the tax years ending 1999 through
2002 as a result of the IRS audit; however, this assessment is in the process
of being appealed.
BALANCE SHEET CHANGES AND ANALYSIS
Summary balance sheets for the five years ended December 31, 2004 are presented
in Item 6 to this Annual Report on Form 10-K. Total asset growth was 11.3%,
10.1%, and 7.9% during the years ended December 31, 2004, 2003, and 2002,
respectively. Presented in the table below is the balance sheet for five years
as of December 31, 2004 as a percentage of total assets.
22
Table 9: Summary Balance Sheet as a Percent of Total Assets
As of December 31, 2004 2003 2002 2001 2000
Cash and cash equivalents 5.1% 4.6% 5.8% 7.4% 3.1%
Securities 15.1% 17.7% 21.8% 20.5% 20.3%
Total loans receivable, net of allowance 75.6% 74.4% 68.9% 68.7% 73.4%
Premises and equipment, net 2.7% 1.8% 1.7% 1.4% 1.6%
Other assets 1.5% 1.5% 1.8% 2.0% 1.6%
Total assets 100.0% 100.0% 100.0% 100.0% 100.0%
Total deposits 78.7% 77.4% 80.2% 79.5% 78.9%
FHLB advances 11.4% 11.5% 10.2% 11.0% 9.1%
Other borrowings 1.9% 2.6% 0.9% 1.3% 3.8%
Other liabilities 0.6% 0.6% 0.8% 0.8% 0.9%
Stockholders' equity 7.4% 7.9% 7.9% 7.4% 7.3%
Total liabilities and stockholders' equity 100.0% 100.0% 100.0% 100.0% 100.0%
During 2004, 2003, and 2002, the asset mix has increased in loans receivable
but decreased in securities held. Investment in premises and equipment also
continues to increase with a new full service branch facilities and a new home
office added during this same period.
Equity capital as a percentage of total assets declined during 2004 to levels
in place before 2002, after increasing in 2003 and 2002. At December 31, 2004,
deposits increased slightly as a funding source of assets after declining
during 2003 when PSB increased reliance on FHLB advances and other borrowings
(primarily repurchase agreements) to fund asset growth. However, deposits
include a greater amount of wholesale market broker certificates of deposit at
December 31, 2004, and 2003 than in prior years. Local retail deposits have
shown little growth during 2004 and 2003 relative to other funding sources.
The table below presents changes in the mix of average earning assets and
interest bearing liabilities for the three years ending December 31, 2004.
Table 10: Mix of Average Interest Earning Assets and Average Interest Bearing
Liabilities
Year ended December 31, 2004 2003 2002
Loans 80.8% 77.2% 74.7%
Taxable securities 11.6% 14.2% 15.5%
Tax-exempt securities 6.1% 6.2% 6.1%
FHLB stock 0.7% 0.6% 0.7%
Other 0.8% 1.8% 3.0%
Total interest earning assets 100.0% 100.0% 100.0%
Savings and demand deposits 15.3% 13.4% 11.6%
Money market deposits 19.2% 23.0% 26.3%
Time deposits 48.3% 47.8% 47.4%
FHLB advances 13.8% 12.8% 13.6%
Other borrowings 3.4% 3.0% 1.3%
Total interest bearing liabilities 100.0% 100.0% 100.0%
23
During 2004 and 2003, the growth in loans as a percentage of the earning assets
mix was funded in part by a change in the mix of securities and reduction in
overnight federal funds sold (other earning assets). During the past several
years, a greater portion of interest bearing liabilities have been from savings
and demand deposits while money market balances have declined as market rates
for the product have fallen.
PSB is party to limited off balance sheet activity and has not purchased any
significant stand alone derivative instruments for the purpose of enhancing
earnings or hedging cash flow or the fair value of monetary instruments. PSB's
primary off balance sheet arrangement is with the FHLB as a MPF mortgage loan
servicer. In addition to servicing residential first mortgage loans owned by
the FHLB, PSB retains some recourse risk if the FHLB incurs principal losses in
excess of an initial loss pool.
The following sections concerning changes in the balance sheet present a
detailed analysis of significant items impacting balance sheet trends
identified by management including:
* Decline in securities held relative to other assets;
* Increase in commercial real estate lending but declines in retail
consumer lending;
* Level of nonperforming loans and other assets;
* Increased activity in mortgage loan servicing activities; and
* Change in deposit mix and slowing retail local deposit growth
INVESTMENT SECURITIES PORTFOLIO
The investment securities portfolio is intended to provide PSB with adequate
liquidity, flexible asset/liability management and a source of stable income.
At December 31, 2004, all securities are classified as available for sale and
reported at fair value. Unrealized gains and losses are excluded from earnings
but are reported as other comprehensive income in a separate component of
stockholders' equity, net of income tax. The investment portfolio represented
17.7% and 20.4% of average earning assets in 2004 and 2003, respectively. The
following table presents the fair value and amortized cost securities held by
PSB at December 31, 2004, 2003, and 2002.
Table 11: Investment Securities Portfolio Maturities
Years Ended December 31
2004 2003 2002
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
U.S. Treasury securities and obligations
of U.S. government agencies $7,785 $7,771 $11,912 $12,148 $11,788 $12,201
Obligations of states and political
subdivisions 24,089 24,883 23,513 24,664 20,905 21,926
Mortgage backed securities 6,119 6,141 7,933 7,979 4,519 4,547
Collateralized mortgage obligations 28,024 27,801 25,526 25,383 41,260 41,835
Trust preferred securities 2,250 2,250 2,250 2,250 500 500
Other equity securities 48 48 48 48 48 48
Total $68,315 $68,894 $71,182 $72,472 $79,020 $81,057
24
During 2004, a number of U.S. government agency securities were called (without
re-investment) or sold to fund loan growth, as part of a pro-active asset-
liability management strategy. Against a market expectation of higher security
yields in 2005, some lower yielding securities were sold and re-invested in
higher coupon loans receivable. See Item 8, Note 4 of the Notes to
Consolidated Financial Statements for additional information on security sales.
As short-term market rates increased in 2004, yield on taxable securities
stabilized at 3.80%. Management expects the yield on taxable securities to
increase slightly over that seen during 2004 as market rates for terms greater
than two years in maturity are expected to increase.
As market interest rates continued to fall during 2003, a large percentage of
PSB's collateralized mortgage obligations ("CMOs") prepaid and it received
large cash flows to be reinvested. These significant prepayments also required
purchase premiums to be amortized against income much more quickly that
anticipated when the CMO was purchased which contributed to declining yields.
The yield on taxable securities, including CMOs, was 3.76% during 2003 compared
to 5.27% during 2002.
During 2003, at the time CMOs prepayments were accelerating, reinvestment rates
for similar securities were at historic lows. As part of proactive asset-
liability management, PSB chose to reinvest these CMO cash flows in 15 year
fixed rate residential mortgages held on PSB' balance sheet. The program
absorbed approximately $6 million of securities cash flow during 2003. Refer
to the discussion of changes in loans for additional information on this
temporary program.
During 2004, PSB continued investment in tax-exempt securities due to steepness
in the yield curve and greater tax effected returns available. Also due to the
steepness of the market interest rate yield curve during 2003, PSB reinvested
some of the CMO security prepayment proceeds in additional long-term municipal
securities to gain higher tax advantaged yields. However, because PSB
maintains an investment "ladder" of maturities in its municipal portfolio,
current maturities continue to be reinvested at lower rates, gradually reducing
the tax adjusted yield on municipal securities. The municipal security yield
is expected to continue to decline slightly during 2005 even as current market
interest rates increase.
During 2003, PSB expanded securities ownership into additional categories not
previously held. In light of PSB's asset/liability position and expectation of
interest rate movements, pass through mortgage backed securities of 15 year
single family mortgage pools were purchased as noted in the table above. In
addition, PSB purchased nonrated trust preferred securities issued by bank
holding companies in Wisconsin. As with nonrated municipal securities, PSB
considers ownership of such local issues to have no more risk than out of state
rated issues due to PSB's understanding of local markets, municipalities, and
issuers. Each security purchased by PSB is subject to a full and formal risk
analysis considering (among other factors) the liquidity needs of the bank and
the credit risk of the issuer. Although the original maturity on each trust
preferred security was 30 years, the interest rates on each security currently
adjust, or will adjust after an initial fixed rate period based on the 90 day
LIBOR rate, reducing PSB's interest rate risk on these longer maturity assets.
PSB does not expect to purchase additional trust preferred securities during
2005.
The following table categorizes securities by scheduled maturity date and does
not take into account the existence of optional calls held by the security
issuer. Therefore, actual funds flow from maturing securities may be different
than presented below. Maturity of mortgage backed securities and
collateralized mortgage obligations, some of which call for scheduled monthly
payments of principal
25
and interest, are categorized by average principal life of the security.
Yields by security type and maturity are based on amortized security cost.
Table 12: Investment Securities Distribution at December 31, 2004
After one but After five but
Within one year within five years within ten years After ten years
Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury securities and obligations
of U.S. government agencies $7,771 3.65%
Obligations of states and
political subdivisions(1) $1,338 6.73% $10,519 6.35% $13,026 5.75%
Mortgage backed securities 5,381 4.37% 760 4.84%
Collateralized mortgage obligations 4,758 3.64% 23,04 33.73%
Non-rated trust preferred securities 2,250 5.84%
Other equity securities 48 29.47%
Totals $6,144 4.61% $46,714 4.36% $13,786 5.70% $2,250 5.84%
(1) Weighted average yields on tax-exempt securities have been calculated on a tax-equivalent basis using a
rate of 34%.
At December 31, 2004 and 2003, PSB's securities portfolio did not contain
securities of any single issuer where the aggregate carrying value of such
securities exceeded 10% of stockholders' equity.
Securities with an approximate carrying value (fair value) of $27,982 and
$17,994 at December 31, 2004 and 2003, respectively, were pledged primarily to
secure public deposits, other borrowings, and for other purposes required by
law. The substantial increase in securities pledged was due to the increase in
local governmental and municipal funds in excess of insured limits obtained by
PSB during 2004.
The market value of the investment portfolio as a percentage of book value has
been impacted by perceived and actual increases in short to mid term interest
rates during the past two years. Increases in current market rates decrease
the market value of a portfolio of fixed rate securities held. At December 31,
2004 market value was 100.8% of book value compared to 101.8% of book value at
December 31, 2003 and 102.6% of book value at December 31, 2002. The net
unrealized gain on securities available for sale, recorded as a separate
component of stockholders' equity, was $384, net of deferred taxes of $195 at
December 31, 2004 compared to a gain of $844 net of deferred income taxes of
$446 at December 31, 2003. Unrealized securities gains, net of income tax
effects are not considered regulatory capital under current banking
regulations. Management believes investment security yields have a stabilizing
effect on net interest margin during periods of interest rate swings and
expects to hold existing securities until maturity or repayment unless such
funds are needed for liquidity due to unexpected loan growth or depositor
withdrawals or if the sale is beneficial to PSB's interest rate risk and return
profile.
26
As a member of the FHLB system, PSB is required to hold stock in the FHLB based
on total assets and anticipated level of long-term borrowings to be advanced to
its bank subsidiary. This stock has a purchase cost and par value of $100 per
share. The stock is recorded at cost which approximates market value.
Transfer of the stock is substantially restricted. The FHLB pays dividends in
both cash and additional shares of stock. During the three years ended
December 31, 2004, FHLB dividends have been in the form of additional shares of
stock. In accordance with industry accounting conventions, PSB records FHLB
dividends in the form of stock as income in the year received. The average
dividend rate paid to PSB on FHLB stock was 5.87%, 6.46%, and 4.91% in 2004,
2003, and 2002, respectively. Due to limitations on future stock dividends
recently announced by the FHLB, management expects the yield on FHLB stock to
decline during 2005 to a level between 5.00% and 5.50%.
LOANS RECEIVABLE
Total loans as presented in the following table include loans held for sale to
the secondary market and expected final fully disbursed principal on
construction loans not yet fully disbursed at year-end. Total loans receivable
increased 13.2%, 18.6%, and 9.0% at December 31, 2004, 2003, and 2002,
respectively. During 2004, the majority of this growth was split between
commercial real estate and residential real estate mortgages. During 2003, the
majority of this growth also came from additional real estate loans, both
commercial real estate and residential 15 year fixed rate first mortgages that
fit into PSB's asset-liability management plans. During 2004, loan growth
occurred at all branch locations, while in 2003, approximately $23 million of
PSB's $50 million in total 2003 growth was originated by PSB's new Rhinelander,
Wisconsin branch location which opened during August 2002.
Table 13: Loan Composition
2004 2003 2002 2001 2000
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
Commercial,
industrial, municipal
and agricultural $72,456 20.25% $66,934 21.17% $64,527 24.21% $64,503 26.38% $71,414 31.00%
Commercial real
estate mortgage 145,856 40.77% 128,290 40.58% 102,238 38.35% 84,150 34.41% 45,157 19.60%
Real estate construction
(commercial and
residential) 38,308 10.71% 37,639 11.91% 26,052 9.77% 15,609 6.38% 11,231 4.87%
Residential real
estate mortgage 82,696 23.11% 66,065 20.90% 55,078 20.66% 61,787 25.27% 82,309 35.72%
Residential real estate
mortgage held for sale 342 0.10% 207 0.07% 949 0.36% 1,403 0.57% 114 0.05%
Residential real
estate home equity 11,620 3.25% 9,252 2.93% 7,274 2.73% 4,576 1.87% 4,400 1.91%
Consumer and
individual 6,482 1.81% 7,728 2.44% 10,439 3.92% 12,522 5.12% 15,784 6.85%
Totals $357,760 100.00% $316,115 100.00% $266,557 100.00% $244,550 100.00% $230,409 100.00%
27
Commercial real estate growth continues to drive PSB loan growth, as it has for
several years. Separate from commercial real estate loans and real estate
construction at December 31, other loan categories have changed little from
$174,021 at December 31, 2000 to $173,596 at December 31, 2004. Commercial
real estate loans are originated for a broad range of business purposes
including non-owner occupied office rental space, multi family rental units,
owner occupied manufacturing facilities, and owner occupied retail sales space.
PSB has little lending activity for agricultural purposes. Management of PSB
is involved in the communities serviced by PSB and has a strong understanding
of the local economy, its business leaders, and trends in successful business
development. Based on this knowledge, PSB offers flexible terms and efficient
approvals which have allowed it to make inroads in this type of lending.
PSB hired an additional experienced commercial lender late in 2004 to lead the
treasury management initiative for PSB and expects commercial loan principal to
experience continued growth. However, many of the these relationships are
expected to carry large aggregate loan balances secured by the customer's
operating cash flow in connection with a line of credit tied to treasury
management services. This type of lending requires a more sophisticated
initial and ongoing credit analysis and could increase the relative size of
individual loan charge-offs in the event of a problem loan.
Retained, in-house residential real estate mortgage loans increased to $82,696
at the end of 2004, compared to $66,065 at the end of 2003 and $55,078 at the
end of 2002. During 2004, a residential loan program aimed at high value
vacation homes in the Wisconsin Northwoods increased the amount of loans held
in-house.
During 2003, despite the trend of customer mortgage refinancing into the
secondary market offering low long-term rates, the amount of residential real
estate mortgages held increased from the year earlier period by a substantial
amount. The increase in residential mortgages during 2003 is from retaining
some 15 year fixed rate mortgages rather than selling the principal to the
secondary market. These mortgages were retained as part of an asset-liability
management strategy to maximize net interest margin without a significant
increase in interest rate risk due to the current cash and projected liquidity
position in light of interest sensitivity of the entire balance sheet and
opportunities for re-investment of investment security cash flows into loans or
other new securities. The amount of 15 year fixed rate mortgages originated by
the program during 2003 was approximately $12.0 million with an average yield
of 4.95%. Approximately one-half of this production was funded by maturing and
prepaid mortgage related investment securities during this period. This
program was discontinued during August 2003.
In addition to residential real estate loans retained by PSB and recognized on
the balance sheet, PSB also serviced $160,225 at December 31, 2004, and
$152,718 at December 31, 2003 of residential real estate loans which have been
sold to the FHLB under the MPF. As part of the asset/liability and interest
rate sensitivity management strategy, PSB generally does not retain long-term
15 to 30 year fixed rate mortgages in its own portfolio. These serviced loans
are not recognized on PSB's balance sheet. As previously discussed in the
analysis of noninterest income, management does not expect to see serviced
loans grow at the pace seen during 2001 through 2003.
28
As a FHLB MPF loan servicer, PSB has provided a credit enhancement guarantee to
reimburse the FHLB for foreclosure losses in excess of 1% of the original loan
principal sold to the FHLB. At December 31, 2004, the maximum obligation for
such guarantees would be approximately $743 if total foreclosure losses on the
entire pool of approximately $160 million loans exceeded $2,951. At December
31, 2003, the maximum obligation for such guarantees was approximately $554 if
total foreclosure losses on the entire pool of approximately $153 million loans
exceeded $2,562. In exchange for this guarantee, PSB is paid a "credit
enhancement" fee. These first mortgage loans are underwritten using
standardized and conservative criteria on residential properties in PSB's local
communities. Management believes loans serviced for the FHLB will realize
minimal foreclosure losses in the future and that PSB will experience no loan
losses related to charge-offs in excess of the FHLB 1% loss pool. The central
and northern Wisconsin residential real estate market has not experienced the
run-up in home values seen by other parts of the country. The average
residential first mortgage originated by PSB under the FHLB program was
approximately $121 in 2004 and $100 during 2003. Management does not expect to
be significantly impacted by loss exposure if housing values drop from a
substantial increase in future mortgage lending rates.
Real estate construction loans grew $669, or 1.8% during 2004 compared to
growth of $11,587, or 44.4% during 2003. Loans in this classification are
primarily short-term loans that provide financing for the acquisition or
development of commercial real estate, such as multi-family or other commercial
development projects. PSB retains permanent financing on these projects
following completion of construction in a majority of cases.
Installment loans to consumers and individuals totaled $6,482 at December 31,
2004, down $1,246 from $7,728 at 2003. December 31, 2003 consumer loans were
down $2,711 from $10,439 at year-end 2002. Installment loans include short-
term installment loans, automobile loans, recreational vehicle loans, credit
card loans, and other personal loans. PSB experiences extensive competition
from local credit unions offering low rates on installment loans and has
directed resources toward more profitable lending categories such as
residential fixed rate mortgages and commercial real estate lending during the
past several years. However, as short-term rates were low, many customers
appeared to borrow on a tax deductible home equity line of credit for many
purposes funded by a consumer installment loan in the past. Total home equity
and installment loans were $18,102, $16,980, and $17,713 at December 31, 2004,
2003, and 2002, respectively.
The following table categorizes loan principal by scheduled maturity and does
not take into account any prepayment options held by the borrower. The loan
portfolio is widely diversified by types of borrowers, industry groups, and
market areas. Significant loan concentrations are considered to exist for a
financial institution when there are amounts loaned to numerous borrowers
engaged in similar activities that would cause them to be similarly impacted by
economic conditions. At December 31, 2004, no concentrations existed in PSB's
portfolio in excess of 10% of total loans.
29
Table 14: Loan Maturity Distribution and Interest Rate Sensitivity
Loan Maturity
As of December 31, 2004: One year Over one year Over
or less to five years five years
Commercial, industrial, municipal, and agricultural $ 49,277 $ 22,617 $ 562
Commercial real estate mortgage 61,923 78,871 5,062
Real estate construction 38,308 - -
Residential real estate mortgage 17,205 32,474 33,017
Residential real estate mortgage held for sale 342 - -
Residential real estate home equity 11,620 - -
Consumer and individual 2,912 3,098 472
Totals $181,587 $137,060 $39,113
Fixed rate - $129,522 $39,113
Variable rate - 7,538 -
Totals - $137,060 $39,113
ALLOWANCE FOR LOAN LOSSES
The loan portfolio is the primary asset subject to credit risk. Credit risk is
controlled through the use of credit standards, review of potential borrowers,
and loan payment performance. During 2004, the allowance for loan losses
increased as net loan charge-offs declined significantly compared to the prior
year, while provisions increased slightly. During 2003 the allowance for loan
losses as a percentage of gross loans declined due to an improvement in
portfolio quality and charge-off of a significant problem loan identified
during 2002. As of December 31, 2004, the allowance for loan losses as a
percentage of total loans outstanding was 1.19% and was 148.3% of nonperforming
loans, compared to 1.15% and 106.0%, respectively, at December 31, 2003. In
addition to coverage from the allowance for loan losses, nonperforming loans
are secured by various collateral including real estate and consumer
collateral.
Table 15: Loan Loss Experience
Years ended December 31
2004 2003 2002 2001 2000
Average balance of loans for period $329,133 $282,006 $249,247 $226,819 $207,527
Allowance for loan losses at
beginning of year $3,536 $3,158 $2,969 $2,407 $2,099
Loans charged off:
Commercial, industrial, municipal,
and agricultural 116 243 628 148 250
Commercial real estate mortgage - - - - -
Residential real estate mortgage 85 170 201 75 14
Consumer and individual 65 109 156 107 51
Total charge-offs 266 522 985 330 315
30
Table 15: Loan Loss Experience (Continued)
Years ended December 31
2004 2003 2002 2001 2000
Recoveries on loans previously charged-off:
Commercial, industrial, municipal,
and agricultural 1 44 33 1 16
Commercial real estate mortgage - - - - -
Residential real estate mortgage 10 5 6 - 3
Consumer and individual 21 16 25 1 4
Total recoveries 32 65 64 2 23
Net loans charged-off 234 457 921 328 292
Provision for loan losses 855 835 1,110 890 600
Allowance for loan losses at
end of year $4,157 $3,536 $3,158 $2,969 $2,407
Ratio of net charge-offs
during the year to average loans 0.07% 0.16% 0.37% 0.14% 0.14%
Ratio of allowance for loan losses
to loans receivable at end of year 1.19% 1.15% 1.22% 1.24% 1.06%
The allowance for loan losses represents management's estimate of an amount
adequate to provide for potential losses in the loan portfolio. Adequacy of
the allowance for loan losses is based on management's ongoing review and
grading of the loan portfolio, past loan loss experience, trends in past due
and nonperforming loans, and current economic conditions. PSB has an internal
risk analysis and review staff that continuously reviews loan quality.
The allocation of the year-end allowance for loan losses for each of the past
five years based on management's estimates of loss exposure by category of
loans is shown in the following table. The allocation methodology applied by
PSB focuses on changes in the size and character of the loan portfolio, current
and expected economic conditions, the geographic and industry mix of the loan
portfolio and historical losses by category. The total allowance is available
to absorb losses from any segment of the portfolio. Management allocates the
allowance for loan losses by pools of risk and by loan type. PSB combines
estimates of the allowance needed for loans analyzed individually and loans
analyzed on a pool basis. The determination of allocated reserves for larger
commercial loans involves a review of individual higher-risk transactions,
focusing on loan grading, and assessment of specific loss content and possible
resolutions of problem credits. While management uses available information to
recognize losses on loans, future adjustments may be necessary based on changes
in economic conditions.
31
Table 16: Allocation of Allowance for Loan Losses as of December 31,
2004 2003 2002 2001 2000
% of % of % of % of % of
Dollar principal Dollar principal Dollar principal Dollar principal Dollar principal
Commercial, industrial,
municipal and agricultural $1,989 2.75% $2,002 2.99% $1,919 2.97% $1,738 2.69% $1,467 2.05%
Commercial real estate
mortgage 1,635 0.89% 1,022 0.62% 569 0.45% 417 0.43% 87 0.16%
Residential real estate
mortgage 221 0.23% 205 0.27% 167 0.27% 174 0.26% 162 0.19%
Consumer and individual 62 0.96% 52 0.67% 72 0.69% 89 0.71% 369 2.34%
Impaired loans 250 17.73% 255 15.67% 431 30.33% 551 26.09% 322 16.94%
Unallocated - - - - -
Totals $4,157 $3,536 $3,158 $2,969 $2,407
Net loans charged off declined to .07% of average loans during 2004 compared to
.16% in 2003 and .37% for 2002. Loans charged off are subject to continuous
review and specific efforts are taken to achieve maximum recovery of principal,
accrued interest, and related expenses. During 2002, PSB was notified of the
bankruptcy of a large commercial loan customer in which it was not the lead
lender. Due to inadequate collateral protection, an additional $270 of loan
loss provisions were recorded during 2002 to cover estimated principal losses
not specifically identified and reserved previously. A charge-off of $376 was
also recorded during 2002 on this relationship. During 2003, the remaining
principal balance of $211 on this relationship (fully reserved in the allowance
for loan losses at December 31, 2002) was charged off during 2003. Separate
from these charge-offs, net charge-offs to average loans would have been .09%
during 2003 and .22% during 2002.
Nonperforming loans are defined as loans 90 days or more past due but still
accruing, nonaccrual loans including those defined as impaired under current
accounting standards, and restructured loans. Loans are generally placed on
nonaccrual status when contractually past due 90 days or more as to interest or
principal payments. Previously accrued and uncollected interest on such loans
is reversed, and income is recorded only to the extent that interest payments
are subsequently received and principal is collectible.
Loans past due 90 days or more but still accruing interest are also included in
nonperforming loans. Also included in nonperforming loans are restructured
loans. Restructured loans involve the granting of concessions to the borrower
involving the modification of terms of the loan, such as changes in payment
schedule or interest rate, or capitalization of unpaid real estate taxes or
unpaid interest. The majority of restructured loans represent capitalized loan
principal and/or interest and real estate taxes that borrowers were unable to
repay according to the original repayment terms. Such loans are subject to
senior management review and ongoing monitoring and are made in cases where the
borrower's delinquency is considered short-term from circumstances the borrower
is believed able to overcome.
32
Table 17: Nonperforming Loans and Foreclosed Assets
December 31,
2004 2003 2002 2001 2000
Nonaccrual loans not considered impaired $1,555 $1,898 $750 $1,801 $1,123
Nonaccrual impaired loans 619 1,221 1,036 1,235 803
Accruing loans past due 90 days or more - - - - -
Restructured loans 628 216 647 999 1,348
Total non-performing loans $2,802 $3,335 $2,433 $4,035 $3,274
Foreclosed assets $ 7 $ 84 $ 573 $ 421 $ 17
Impaired loans accruing income $ 791 $ 406 $ 385 $ 877 $1,098
Total non-performing loans as a percent
of gross loans receivable 0.80% 1.08% 0.94% 1.68% 1.44%
Nonperforming loans at December 31, 2004, decreased by $533 to $2,802 from
$3,335 at December 31, 2003. Nonperforming loans to gross loans was .80% at
December 31, 2004, compared to 1.08% at December 2003. PSB also tracks
delinquencies on a contractual basis quarter to quarter since some problem
loans currently making payments remain on non-accrual status until ongoing
ability to repay according to the contract is shown. Loans contractually
delinquent 30 days or more as a percentage of gross loans were .56% at December
2004 compared to .63% at December 2003 and .87% at December 2002. Management
continues to work aggressively with problem credits and expects the level of
non performing loans to total loans and net charge-offs to average loans during
2005 to be similar to that seen during 2004.
Interest payments on nonaccrual and impaired loans are typically applied to
principal unless collectibility of the principal amount is fully assured, in
which case interest is recognized on the cash basis. The interest that would
have been reported in 2004 if all such loans had been current throughout the
year in accordance with their original terms was $181 in comparison to $96
actually collected. The total reduction in interest income during 2003 and
2002 as a result of discontinuing the accrual of interest on loans that are
delinquent for 90 days or more was $142 and $54, respectively.
OFF BALANCE SHEET ARRANGEMENTS
As described previously, PSB serviced residential mortgage loans of $160,225 at
December 31, 2004, and $152,718 at December 31, 2003 which have been sold to
the FHLB under the MPF Program and are not included on PSB's balance sheet. As
a FHLB MPF loan servicer, PSB has provided a credit enhancement guarantee to
reimburse the FHLB for foreclosure losses in excess of 1% of the original loan
principal sold to the FHLB. At December 31, 2003, the maximum obligation for
such guarantees would be approximately $743 if total foreclosure losses on the
entire pool of approximately $160 million loans exceeded $2,951. Management
believes loans serviced for the FHLB will realize minimal foreclosure losses in
the future and that PSB will experience no loan losses related to
33
charge-offs in excess of the FHLB 1% loss pool. Therefore, PSB does not
maintain any recourse liability for possible losses.
Under bank regulatory capital rules, this recourse obligation to the FHLB is
risk-weighted for the purposes of the total capital to risk-weighted assets
capital calculation. The majority of the recourse loans held at December 31,
2004 require risk capital at least equal to 8% of PSB recourse obligation.
However, the loan program used by PSB since October 2003 requires risk capital
equal to the recourse obligation (the original MPF program used by PSB has
expired and all new loans are originated under this new capital arrangement).
As of December 31, 2004, the amount of risk based capital needed to be
considered well-capitalized under prompt correction action provisions increased
$288 due to the MPF recourse obligation. During 2005, as new loans continue to
be originated under the new program, risk based capital needs will increase
equal to additional recourse obligation. However, in light of the existing
capital structure of PSB, plans to increase regulatory capital, and anticipated
activity in loan originations during 2005, management does not expect these
capital requirements to impact operations in the near-term.
Other significant off-balance sheet financial instruments include the various
loan commitments outlined in Item 8, Note 14 of the Notes to Consolidated
Financial Statements. These lending commitments are a traditional and
customary part of lending operations and many of the commitments are expected
to expire without being drawn upon.
LIQUIDITY AND CAPITAL RESOURCES
PSB has experienced substantial internal asset growth during the past several
years while maintaining similar equity capital related to asset size. During
2004, this growth was funded primarily by retail and large local depositors,
while in 2003 and 2002, this growth was funded primarily by wholesale
depositors and FHLB advances. These sources of wholesale funding are limited
both by the wholesale lender's ability to raise individual depositor funds and
by internal policy limitations on aggregate exposure to use of such funds.
Increased loans to customers have been the significant use of these funds. The
table below outlines in summary form the sources and uses of cash for the three
years ending December 31, 2004. These sources and uses of funds and their
impact on past and future growth is discussed in depth later in this analysis
of liquidity.
34
Table 18: Summary Sources and Uses of Cash
2004 2003 2002
Cash flows from operating activities $ 4,939 $7,392 $6,247
Payment of dividends to shareholders and purchase of treasury stock (1,662) (1,551 $(1,338)
Operating cash flow retained by PSB 3,277 5,841 4,909
Additional financing received from retail and local depositors, net 36,633 9,995 9,665
Additional financing received from wholesale depositors, net 5,178 8,589 14,530
Proceeds from additional FHLB advances 5,000 9,000 -
Proceeds from additional other borrowings, net - 7,173 -
Proceeds from additional capital received from shareholders 63 - 52
Cash flow retained from operations and financing before
debt repayment 50,151 40,598 29,156
Repayment of other borrowings, net (1,910) - (1,025)
Cash flow retained from operations and financing after debt repayment 48,241 40,598 28,131
Funds received from sale and maturities of investment securities, net 2,726 7,368 -
Proceeds from sale of nonmonetary assets 47 280 279
Cash flows available for investing activities 51,014 48,246 28,410
Funds loaned to customers, net (40,377) (48,959) (20,923)
Funds invested in securities, net - - (9,528)
Funds used to purchase Federal Home Loan Bank stock (271) - -
Capital expenditures (5,969) (1,912) (1,957)
Cash flows used in investing activities (46,617) (50,871) (32,408)
Net increase (decrease) in cash held at beginning of year 4,397 (2,625) (3,998)
Cash and cash equivalents at beginning of year 18,927 21,552 25,550
Cash and cash equivalents at end of year $23,324 $18,927 $21,552
DEPOSITS
Core retail deposits are PSB's largest source of funds. PSB considers core
retail deposits to include noninterest-bearing demand deposits, interest
bearing demand and savings deposits, money market demand deposits, and retail
time deposits less than $100. Core retail deposits represented 54.7%, 55.7%,
and 59.1% of total assets as of December 31, 2004, 2003, and 2002,
respectively. Growth in local retail core deposits has been modest during the
past several years. PSB's retail deposit growth is continuously influenced by
competitive pressure from other financial institutions, as well as other
investment opportunities available to customers. To continue asset growth,
deposit growth was supplemented by additional wholesale certificate of deposits
(in additional to additional FHLB advances). The following table outlines the
average distribution of deposits during the three years ending December 31,
2004.
35
Table 19: Average Deposits Distribution
2004 2003 2002
Interest Interest Interest
Amount Rate paid Amount Rate paid Amount Rate paid
Noninterest bearing
demand deposits $49,600 n/a $46,876 n/a $38,031 n/a
Interest bearing demand
and savings deposits 52,982 0.70% 40,518 0.61% 32,536 1.04%
Money market demand deposits 66,494 0.92% 69,238 1.00% 73,629 1.44%
Retail and local time deposits 110,925 2.77% 99,851 3.19% 99,982 4.12%
Wholesale time deposits 56,042 3.09% 44,232 3.46% 32,866 4.02%
Totals $336,043 1.72% $300,715 1.88% $277,044 2.47%
Average retail deposit growth 9.17% 5.04% n/a*
Average total deposit growth 11.75% 8.54% 11.24%
*Prior to 2002, PSB did not maintain separate information on average balance of
wholesale time deposits and related interest expense.
Due to the increasingly competitive nature of time deposit funding, both
locally and nationally, PSB believes transactional based deposits to be the
best source of low-cost funding in the long-term. Such personal and commercial
deposits are attracted and retained through factors other than interest rate
alone, including high level of customer service, network of deposit taking
branches, and convenience of use, and provide a high level of fee based income
and available short-term liquidity via clearing float. Therefore, PSB actively
promotes transactional based deposit products. This emphasis is reflected in
an increase in average noninterest bearing demand deposits during the past
several years.
During 2004 and 2003, average interest bearing demand deposits increased due to
new municipal and government agency deposits, many of which require pledging of
security collateral. During 2004, PSB committed greater resources to expand
deposits from municipalities and governments. As of December 31, 2004,
deposits from governmental entities totaled approximately $21,117. However,
due to limitations on securities available for pledging, the level of municipal
deposit growth seen during 2004 and 2003 may not be repeated during 2005.
Retail time deposits increased substantially during 2004 in large part due to
large local deposits collected under the "Certificate of Deposit Account
Registry System" (CDARS), a nation-wide program in which network banks work
together to obtain greater FDIC insurance on deposits through sharing of
banking charters. Average balances of CDARS deposits were $5,022 during 2004
and $67 during 2003. PSB became a member of this program during 2003. For
regulatory purposes, these deposits are considered brokered deposits and
disclosed as such on quarterly regulatory filings. However, for internal and
external reporting other than for Call Report purposes, these deposits are
36
considered to be retail deposits since the terms of the account are set
directly between PSB and its local customer. Accordingly, these deposits are
included as "Retail time deposits $100 and over" in Table 20.
During much of 2003 and 2002, rates (including broker fees) on broker deposits
were less than local retail deposits for equivalent terms. During 2003, the
average rate paid on wholesale deposits was greater than the rate paid on
retail time deposits because, in general, wholesale deposit original terms were
greater than those typically seen on retail time deposits. During 2003 and
2002, various larger commercial loans were offered at longer-term fixed rate
financing terms (typically 5 years) that were simultaneously funded by similar
term wholesale deposits. Because the average term on wholesale certificates
was longer than local certificates, the wholesale yield increased relative to
local time deposits during 2003.
Table 20: Period-End Deposit Composition
December 31,
2004 2003
$ % $ %
Non-interest bearing demand $ 51,635 14.4% $ 50,563 16.0%
Interest-bearing demand and savings 64,574 18.0% 46,797 14.8%
Money market deposits 68,666 19.2% 70,879 22.4%
Retail time deposits less than $100 63,993 17.8% 59,422 18.7%
Total core deposits 248,868 69.4% 227,661 71.9%
Retail time deposits $100 and over 55,459 15.5% 40,033 12.7%
Broker & national time deposits
less than $100 4,594 1.3% 10,221 3.2%
Broker & national time deposits $100
and over 49,304 13.8% 38,499 12.2%
Totals $358,225 100.0% $316,414 100.0%
Table 21: Change in Deposit Composition
December 31, % Change from prior year
2004 2003 2004 2003
Total time deposits $100 and over $104,763 $78,532 33.4% 19.7%
Total broker and national time deposits 53,898 48,720 10.6% 21.4%
Total retail time deposits 119,452 99,455 20.1% 0.2%
Core deposits, including money market deposits 248,868 227,661 9.3% 3.8%
Large time deposits and wholesale broker deposits continue to grow as a
percentage of total deposits and were 24.0% and 21.7% of total assets at
December 31, 2004, and 2003, respectively. Growth in retail time deposits and
local "core" deposits has been low relative to overall asset growth. During
late 2004, PSB created a new Treasury Management product team in part to
organize collection of non-maturity deposits from municipalities and corporate
cash management accounts and lessen reliance on large CD deposits as a primary
funding source. PSB believes it has competitively priced
37
deposit products in its local markets and will seek to actively promote them
during 2005. However, based on expected asset growth in existing and new
markets during 2004, management believes broker wholesale funding will continue
to be used during 2005.
PSB policy allows broker funds to be used up to 20% of total assets. Available
and unused broker deposits were approximately $37,097 and $33,067 at December
31, 2004 and 2003, respectively, under this policy. The table below outlines
maturities of time deposits of $100 or more, including broker and retail time
deposits. Management is aware of the potential volatility of broker deposits
due to funds flowing out of the banking system and into other investment
vehicles, and other factors, that could increase the incremental cost of
obtaining these types of deposits. Broker deposits represent just one
potential financing source in addition to FHLB advances and repurchase
agreements.
Table 22: Maturity Distribution of Certificates of Deposit of $100 or More at
December 31, 2004
Balance Rate
3 months or less $ 16,037 2.13%
Over 3 months through 6 months 19,517 2.75%
Over 6 months through 12 months 22,885 2.71%
Over 1 year through 5 years 40,832 3.93%
Over 5 years 5,492 4.54%
Totals $104,763 3.20%
CONTRACTUAL OBLIGATIONS
PSB is party to various contractual obligations requiring use of funds as part
of its normal operations. The table below outlines the principal amounts and
timing of these obligations, excluding amounts due for interest, if applicable.
Most of these obligations, including time deposits, are routinely refinanced
into a similar replacement obligation without requiring any substantial outflow
of cash. However, renewal of these obligations is dependent on PSB's ability
to offer competitive market equivalent interest rates or availability of
collateral for pledging such as retained mortgage loans or securities as in the
case of advances from the FHLB. PSB's funds management policy includes a
formal liquidity contingency plan to identify low cost and liquid funds
available in the event of a liquidity crisis.
Table 23: Contractual Obligations at December 31, 2004
Payments due by period
Total < 1 year 1-3 years 3-5 years > 5 years
Time deposits $173,350 $101,171 $53,309 $13,313 $5,557
Long-term Federal Home Loan Bank advances 52,000 26,000 5,000 21,000 -
Other long-term borrowings 6,100 2,417 2,256 1,427 -
Deferred compensation and retirement agreements 347 10 3 - 334
Post-retirement health insurance benefits plan 272 - - - 272
Branch bank operating lease commitments 61 46 15 - -
Premises and equipment purchase commitments 300 300 - - -
Total contractual obligations $232,430 $129,944 $60,583 $35,740 $6,163
38
LIQUIDITY, FUNDING SOURCES, AND INTEREST RATE SENSITIVITY
Primary short-term and long-term funding sources other than retail deposits
include federal funds purchased from other correspondent banks, repurchase
agreements from security pledging, advances from the FHLB, and use of wholesale
time deposits. The following table outlines the available and unused portion
of these funding sources (based on collateral and/or company policy
limitations) as of December 31, 2004 and 2003. During 2005, PSB expects total
net asset growth from existing and new market locations to be approximately $45
million, a significant portion of which will be funded by use of funding
sources other than deposits.
Table 24: Available but Unused Funding Sources other than Retail Deposits:
2004 2003
As of December 31, Unused, but Amount Unused, but Amount
Available Used Available Used
Overnight federal funds purchased $22,500 $ - $22,500 $ -
FHLB advances under blanket mortgage lien 14,855 52,000 8,165 47,000
Repurchase agreements 12,871 8,565 25,458 10,475
Wholesale market time deposits 37,097 53,898 33,067 48,720
Total available but unused funds $87,323 $114,463 $89,190 $106,195
Overnight federal funds purchased totaling $22,500 are available through three
primary correspondent banks. These lines are not supported by a formal written
arrangement, but represent best efforts ability on the part of correspondent
banks to raise these funds. During 2004, average daily federal funds purchased
were $2,140 compared to $2,579 during 2003. The cost of these funds is subject
to change based on changes in the discount rate as determine by the Federal
Reserve. PSB may maintain a continuous position in overnight federal funds
purchased up to 60 days before amounts must be liquidated for at least one
business day. Consideration of the need for federal funds purchased is part of
PSB's daily cash management and funding procedures and represents the first
source of liquidity as needed.
Under the existing credit line with the FHLB described in Item 8, Note 9 of the
Notes to Consolidated Financial Statements, PSB may borrow up to 61% of
qualifying existing mortgage loan collateral. In addition, PSB may pledge
certain investment securities to obtain additional funding under repurchase
agreement. FHLB advances carry substantial penalties for early prepayment that
are generally not recovered from the lower interest rates in refinancing. The
amount of early prepayment penalty is a function of the difference between the
current borrowing rate, and the rate currently available for refinancing.
Therefore, existing high cost FHLB advances borrowed prior to 2001 were not
refinanced in the substantially lower long term rate market experienced during
2004 and 2003. FHLB advance funding may be obtained for various terms on a
daily basis at PSB's request, and represents PSB's second source of liquidity
as needed after federal funds purchased.
Repurchase agreements represent overnight and long-term funding in exchange for
securities owned by PSB for a designated time period for an agreed upon
interest rate. Item 8, Note 10 of the Notes to Consolidated Financial
Statements outlines the activity in these other borrowings and federal funds
39
purchased during the three years ending December 31, 2004. Although PSB does
not currently have any repurchase agreements with the FHLB, it does have a
written agreement providing for their use in exchange for securities held. An
additional $12,871 and $25,458 of FHLB funding could be obtained upon pledge of
these available securities as of December 31, 2004, and 2003, respectively.
As described in the changes in deposits and deposit activity above, wholesale
broker deposits have represented a growing source of asset growth funding
during the past several years. PSB's policy allows up to 20% of assets to be
funded with wholesale time deposits. Wholesale time deposits as a percentage
of assets were 11.8%, 11.9%, and 10.8% of total assets at December 31, 2004,
2003, and 2002, respectively.
PSB's Asset-Liability Management process provides a unified approach to
management of liquidity, capital, and interest rate risk, and to provide
adequate funds to support the borrowing requirements and deposit flow of its
customers. Management views liquidity as the ability to raise cash at a
reasonable cost or with a minimum of loss and as a measure of balance sheet
flexibility to react to marketplace, regulatory, and competitive changes.
Management's overall strategy is to coordinate the volume of rate sensitive
assets and liabilities to minimize the impact of interest rate movement on the
net interest margin. Table 25 represents PSB's earning sensitivity to changes
in interest rates at December 31, 2004. It is a static indicator which does
not reflect various repricing characteristics and may not indicate the
sensitivity of net interest income in a changing interest rate environment.
The following repricing methodologies should be noted in Table 25:
1. Money market deposit accounts are considered fully repriced within 90
days. Interest bearing demand (NOW) and savings deposits are considered
"core" deposits as they are generally insensitive to interest rate
changes. These deposits are considered to reprice beyond 5 years.
2. Nonaccrual loans are considered to reprice beyond 5 years.
3. Assets and liabilities with contractual calls or prepayment options are
repriced according to the likelihood of the call or prepayment being
exercised in the current interest rate environment.
Table 25 reflects a nearly neutral gap position in essentially all individual
categories until those beyond 1 year. The cumulative one-year gap ratio as of
December 31, 2004 is positive at 101.0% compared to 110.4% at December 31,
2003. A significant factor in PSB's ability to match the repricing of assets
and liabilities in line with the expectations in the table is the ability to
delay increases in interest rates paid on "core" deposits such as NOW,
statement savings, and MMDA accounts when market rates begin to increase. PSB
conducts incremental cost analysis of various sources of funding on an ongoing
basis and will rely on such analysis to slow core deposit interest rate growth
until adjustable rate loan rates benefits from future increases in the prime
lending rate.
40
Table 25: Interest Rate Sensitivity Gap Analysis
December 31, 2004
0-90 Days 91-180 days 181-365 days 1-2 yrs. Bynd 2-5 yrs. Bynd 5 yrs. Total
Earning assets:
Loans $118,470 $ 35,070 $ 42,683 $ 56,821 $ 78,491 $ 16,887 $348,422
Securities 6,225 3,844 7,087 14,339 24,282 13,117 68,894
FHLB stock 2,874 2,874
Other earning assets 10,644 10,644
Total $138,213 $ 38,914 $ 49,770 $ 71,160 $102,773 $ 30,004 $430,834
Cumulative rate
sensitive assets $138,213 $177,127 $226,897 $298,057 $400,830 $430,834
Interest-bearing liabilities
Interest-bearing deposits $119,104 $ 32,659 $ 41,922 $ 31,600 $ 34,891 $ 46,414 $306,590
FHLB advances 18,000 6,000 2,000 - 26,000 - 52,000
Other borrowings 3,482 346 1,053 1,050 2,634 - 8,565
Total $140,586 $ 39,005 $ 44,975 $ 32,650 $ 63,525 $ 46,414 $367,155
Cumulative interest
sensitive liabilities $140,586 $179,591 $224,566 $257,216 $320,741 $367,155
Interest sensitivity gap for
the individual period $ (2,373) $ (91) $ 4,795 $ 38,510 $ 39,248 $(16,410)
Ratio of rate sensitive assets to
rate sensitive liabilities for
the individual period 98.3% 99.8% 110.7% 217.9% 161.8% 64.6%
Cumulative interest
sensitivity gap $ (2,373) $ (2,464) $ 2,331 $ 40,841 $ 80,089 $ 63,679
Cumulative ratio of rate sensitive
assets to rate sensitive
liabilities 98.3% 98.6% 101.0% 115.9% 125.0% 117.3%
PSB uses financial modeling techniques to measure interest rate risk. These
policies are intended to limit exposure of earnings at risk. A formal
liquidity contingency plan exists that directs management to the least
expensive liquidity sources to fund sudden and unanticipated liquidity needs.
PSB also uses various policy measures to assess adequacy of liquidity and
interest rate risk as described below.
BASIC SURPLUS
PSB measures basic surplus as the amount of existing net liquid assets (after
deducting short-term liabilities and coverage for anticipated deposit funding
outflows during the next 30 days) divided by total assets. The basic surplus
calculation does not consider unused but available correspondent bank federal
funds purchased, as those funds are subject to availability based on the
correspondent bank's own liquidity needs and therefore are not guaranteed
contractual funds. However, basic surplus does include unused but available
FHLB advances under the open line of credit supported by a blanket lien on
mortgage collateral. PSB's policy is to maintain a basic surplus of at least
5%. Basic surplus was 7.1% and 8.0% at December 31, 2004, and 2003,
respectively. The decline in basic surplus during 2004 was due primarily to
lower levels of securities available for deposit pledging.
41
INTEREST RATE RISK LIMITS
PSB balances the need for liquidity with the opportunity for increased net
interest income available from longer term loans held for investment and
securities. To measure the impact on net interest income from interest rate
changes, PSB models interest rate simulations on a quarterly basis. Changes in
interest rates are assumed to be a parallel yield curve shift fully implemented
over a 12 month time frame. PSB's policy is that projected net interest income
over the next 12 months will not be reduced by more than 15% given a change in
interest rates of up to 200 basis points. The projected increase (decrease) in
net interest income on the existing balance sheet for the next 12 months if
rates increased 200 basis points was (.04%) and 3.17% at December 31, 2004, and
2003, respectively. The projected decrease in net interest income for the next
12 months if rates decreased 100 basis points was 2.15% and 2.50% at December
31, 2004, and 2003, respectively.
CORE FUNDING UTILIZATION
To assess whether interest rate sensitivity beyond one year helps mitigate or
exacerbate the short-term rate sensitive position, a quarterly measure of core
funding utilization is made. Core funding is defined as liabilities with a
maturity in excess of 60 months and capital. Core deposits including DDA, NOW
and non-maturity savings accounts (except money market accounts) are also
considered core long-term funding sources. The core funding utilization ratio
is defined as assets that reprice in excess of 60 months divided by core
funding. PSB's target for the core funding utilization ratio is to remain at
80% or below given the same 200 basis point changes in rates that apply to the
guidelines for interest rate risk limits exposure described previously. PSB's
core fund utilization ratio after a projected 200 basis point increase in rates
was 46.49% and 46.53% at December 31, 2004, and 2003, respectively.
CAPITAL ADEQUACY
PSB is required to maintain minimum levels of capital to be considered well-
capitalized under current banking regulation. Refer to Item 8, Note 16 of the
Notes to Consolidated Financial Statements for these requirements and PSB's
current capital position relative to these requirements. The primary increase
in stockholders' equity during the three years ending December 31, 2004 has
been retained net income not distributed to shareholders. Failure to remain
well-capitalized would prevent PSB from obtaining future wholesale broker time
deposits which have been an important source of funding during the past several
years. Refer to Item 8, Statement of Changes in Stockholder's Equity in the
Consolidated Financial Statements for detailed activity in the capital
accounts. Average tangible regulatory Tier 1 leverage capital was 7.55%,
7.86%, and 7.66% during 2004, 2003, and 2002, respectively. The following
table presents a reconciliation of stockholders' equity as presented in the
December 31, 2004, 2003, and 2002 consolidated balance sheets to regulatory
capital.
42
Table 26: Capital Ratios
December 31,
2004 2003 2002
Stockholders' equity $33,616 $32,141 $29,302
Disallowed mortgage servicing right assets (84) (81) (70)
Unrealized (gain) loss on securities available for sale (384) (844) (1,306)
Tier 1 regulatory capital 33,148 31,216 27,926
Add: allowance for loan losses 4,157 3,536 3,158
Total regulatory capital $37,305 $34,752 $31,084
Total assets $454,974 $408,933 $371,468
Disallowed mortgage servicing right assets (84) (81) (70)
Unrealized (gain) loss on securities available for sale (384) (844) (1,306)
Tangible assets $454,506 $408,008 $370,092
Risk-weighted assets (as defined by current regulations) $350,224 $318,005 $272,377
Tier 1 capital to average tangible assets (leverage ratio) 7.40% 7.83% 7.71%
Tier 1 capital to adjusted risk-weighted assets 9.46% 9.82% 10.25%
Total capital to adjusted risk-weighted assets 10.65% 10.93% 11.41%
On December 16, 2003, PSB declared a 5% stock dividend in additional to the
regular semi-annual cash dividend. The stock dividend was paid to shareholders
of record as of January 6, 2004 on January 29, 2004. All references in this
Annual Report on Form 10-K to the number of common shares and per share amounts
for 2004, 2003, and 2002 have been restated to reflect the 5% stock dividend.
PSB maintains an incentive stock option plan approved by shareholders during
2001 as described in Item 8, Note 15 of the Notes to Consolidated Financial
Statements. As of December 31, 2004, all shares available under the plan have
been granted and no shares of common stock remained reserved for future grants.
PSB pays a regular semi-annual cash dividend as described in Item 5 of this
Annual Report of Form 10-K. In addition, PSB maintains an informal, annual,
ongoing share repurchase program of up to 1% of outstanding shares per year as
described in Item 5 of this Annual Report of Form 10-K. Although PSB is
currently purchasing treasury shares under the buyback program, management is
pursuing a growth strategy which may require significant capital to be
maintained to support asset growth. Therefore, large scale stock buybacks or
dividend payments substantially in excess of past periods are not anticipated.
Based on expected asset growth during 2005, PSB expects to approach the "Well-
Capitalized" minimum of 10% of risk-adjusted assets as defined by current
regulation. Therefore, PSB is
43
performing due diligence regarding various capital options to accommodate
current and future growth. In particular, management believes participation
in a pooled trust preferred capital offering to be the most cost effective way
for PSB to support asset growth without diluting current shareholder ownership
percentages. Participation in pooled trust preferred offerings occurs
generally on a quarterly basis. Trust preferred capital securities may provide
up to 25% of PSB's total Tier 1 regulatory capital. As of December, 31, 2004,
PSB could utilize up to $10,900 of trust preferred securities as additional
Tier 1 regulatory capital. Management monitors regulatory capital on a regular
basis and is prepared to participate in a pooled trust preferred offering to
remain well-capitalized during 2005 as needed.
CRITICAL ACCOUNTING ESTIMATES
ALLOWANCE FOR LOAN LOSSES
Current accounting standards call for the allowance for loan losses to include
both specific losses on identified problem loans (Statement of Financial
Accounting Standard ("SFAS") No. 114, "Accounting by Creditors for Impairment
of a Loan") and "inherent" losses on existing loan pools not yet considered
problem loans (SFAS No. 5, "Accounting for Contingencies"). Determination of
the allowance for loan losses at period-end is based primarily on subjective
factors and management assessment of risk in the existing portfolio. Actual
results, if significantly different from that using estimates at period-end,
could have a material impact on the results of operations.
Loans receivable, for the purpose of estimating the allowance for loan losses,
are separated into four primary categories - Residential real estate loan pool,
consumer installment loan pool, specifically identified problem commercial
loans, and pools of non-problem commercial purposes loans subcategorized by
credit risk assessment. PSB makes the following estimates and performs the
following procedures when setting the allowance for loan losses at period-end:
1. Categorize existing loan principal into either commercial purpose loans,
a pool of residential real estate loans, or a pool of consumer
installment loans.
2. Commercial purpose loans are subcategorized into credit risk "grades"
based on an internal determination of risk established during credit
analysis and updated no less than annually. Determination of risk
grades takes into account several factors including collateral, cash
flow, borrower's industry environment, financial statement strength, and
other factors. PSB uses four risk grades for non-problem commercial
purpose loans.
44
3. Identified problem loans are classified into two additional risk grades
and individually reviewed to determine specific reserves required for
each relationship depending on the specific collateral and timing of
cash flows to be received. The allowance for loan losses provided for
these problem loans is based substantially on management's estimates
related the value of collateral, timing of cash flows to be received
from the borrower or sale of the collateral, and likelihood of the
specific borrower's ability to repay all amounts due without foreclosure
of collateral. Management updates the cash flow analysis of problem
loan relationships quarterly.
4. Other commercial loans not considered to be problem loans are assigned
an estimated loan loss allowance based on historical "inherent" losses
for loans of similar credit risk. These allowances range from .25% of
principal to 2.5% of principal depending on the assigned credit risk
grade. An inaccurate assignment of credit risk grade to a loan
relationship could significantly increase the actual levels of
allowances required for that loan, and therefore management's assigned
of credit risk is a significant estimate. Management reviews actual
long-term losses to the inherent losses assigned by credit risk grade
and updates allowance percentages as needed.
5. Similar to nonproblem commercial purpose loans, inherent losses are
assigned to the residential real estate loan pool. However, since
residential real estate loan risk characteristics are very similar from
borrower to borrower, a flat percentage loss of principal is applied to
real estate loans rather than breaking the pool into subcategories of
credit risk. The percentage applied is based primarily on historical
losses on similar residential loan pools. An inaccurate estimate of
inherent losses related to the real estate loan pool could significantly
increase the actual levels of allowances required.
6. Similar to the residential real estate loan pool, consumer installment
loans are assigned an estimated loss based on a flat percentage of
principal outstanding. The percentage applied is based primarily on
historical losses on similar consumer installment loan pools. An
inaccurate estimate of inherent losses related to the consumer
installment loan pool could significantly increase the actual levels of
allowances required.
After calculating the estimate of required allowances for loan losses using the
steps above, an analysis of the level of problem and past due loans is made
relative to the aggregate allowance for loan losses recorded. If past due and
problem loans are significantly rising, additional unallocated reserves may be
recorded to account for this additional risk of loss before it is recognized in
the allowance for loan losses calculation by the change in commercial credit
risk grades, or increase in the historical inherent loss percentage assigned to
the real estate and consumer installment loan pools. As of December 31, 2004,
there were no unallocated loan loss allowances recorded.
MORTGAGE SERVICING RIGHTS
As required by current accounting standards (SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities"), PSB records a mortgage servicing right asset ("MSR") when PSB
continues to service borrower payments and maintenance activities on loans in
which the principal has been sold to the FHLB or other secondary market
investors. PSB's MSR calculation is calculated on a individual loan level
basis and uses public financial market information for many of the significant
estimates. PSB makes the following estimates and performs the following
procedures when accounting for MSRs:
1. Serviced loans are stratified by risk of prepayment criteria.
Currently, strata are first based on the year in which the loan was
originated, then on term, and then on the range of interest rates within
that term.
2. PSB uses the discount approach to generate the initial value for the
OMSR. It takes the average of the current dealer consensus on
prepayment speeds as reported to Reuters or the
45
prepayment speed implied in the mortgage backed security prices for
newly created loans along with other assumptions to general an estimate
of future cash flows. The present value of estimated cash flows equals
the fair value of the OMSR. PSB capitalizes the lower of fair value or
cost of the OMSR. Other than the estimate of public dealer consensus of
prepayment speeds, significant fair value and cost estimates include:
* Servicing cost of $60 per loan annually
* Cash flow discount rate of 8% to 10%, depending on year of
origination
* Short-term reinvestment rate on the float of payments to
investors of 2%
Changes in these estimates and assumptions would change the initial
value recorded for OMSRs and change the gain on sale of mortgage loans
recorded in the income statement.
3. Amortization of the OMSR is calculated based on actual payment activity
on a per loan basis. Because all loans are handled individually,
curtailments decrease MSRs as well as regularly scheduled payments. The
loan servicing value is amortized on a level yield basis.
4. Significant declines in current market mortgage interest rates decrease
the fair value of existing MSRs due the increase in anticipated
prepayments above the original assumed speed. SFAS No. 140 requires
that impairment testing be performed and that MSRs be recorded at the
lower of fair value or amortized cost. PSB performs quarterly
impairment testing on its MSRs. Actual prepayment speeds (based on
actual PSB customer activity on a loan level basis) are compared to the
assumed prepayment speed on the date of the last quarterly impairment
testing (or the origination prepayment speed if a new loan). The fair
value assumptions other than prepayment speed are combined with the new
estimated prepayment speed to create a new fair value. An impairment
allowance is recorded for any shortfall between the new fair value and
the original cost after adjusting for past amortization and
curtailments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required by this Item 7A is set forth in Item 6, Selected
Financial Data, and under subcaptions "Results of Operations," "Market Risk,"
"Net Interest Income," "Provision for Loan Losses," "Investment Portfolio,"
"Deposits," and "Liquidity and Interest Sensitivity" under Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations.
46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEPENDENT AUDITOR'S REPORT
Board of Directors
PSB Holdings, Inc.
Wausau, Wisconsin
We have audited the accompanying consolidated balance sheets of PSB Holdings,
Inc. and Subsidiary as of December 31, 2004 and 2003, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 2004.
These financial statements are the responsibility of PSB's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of PSB Holdings, Inc.
and Subsidiary at December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2004, in conformity with accounting principles generally
accepted in the United States.
WIPFLI LLP
Wipfli LLP
January 21, 2005
Wausau, Wisconsin
47
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
(dollars in thousands except per share data)
ASSETS 2004 2003
Cash and due from banks $ 12,680 $ 13,754
Interest-bearing deposits and money market funds 3,265 1,214
Federal funds sold 7,379 3,959
Cash and cash equivalents 23,324 18,927
Securities available for sale (at fair value) 68,894 72,472
Federal Home Loan Bank stock (at cost) 2,874 2,444
Loans held for sale 342 207
Loans receivable, net of allowance for loan losses of $4,157
and $3,536 in 2004 and 2003, respectively 343,923 304,339
Accrued interest receivable 1,744 1,617
Foreclosed assets 7 84
Premises and equipment 12,432 7,557
Mortgage servicing rights, net 839 814
Other assets 595 472
TOTAL ASSETS $ 454,974 $ 408,933
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest-bearing $ 51,635 $ 50,563
Interest-bearing 306,590 265,851
Total deposits 358,225 316,414
Federal Home Loan Bank advances 52,000 47,000
Other borrowings 8,565 10,475
Accrued expenses and other liabilities 2,568 2,903
Total liabilities 421,358 376,792
Stockholders' equity:
Common stock - No par value with a stated value of $1 per share:
Authorized - 3,000,000 shares
Issued - 1,887,179 shares 1,887 1,887
Outstanding - 1,719,593 and 1,733,398, respectively
Additional paid-in capital 9,672 9,694
Retained earnings 25,281 22,789
Accumulated other comprehensive income 384 844
Treasury stock, at cost - 167,586 and 153,781 shares, respectively (3,608) (3,073)
Total stockholders' equity 33,616 32,141
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 454,974 $ 408,933
See accompanying notes to consolidated financial statements.
48
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
(dollars in thousands except per share data)
2004 2003 2002
Interest and dividend income:
Loans, including fees $ 19,207 $ 17,964 $ 18,022
Securities:
Taxable 1,798 1,943 2,724
Tax-exempt 982 916 898
Other interest and dividends 215 227 271
Total interest income 22,202 21,050 21,915
Interest expense:
Deposits 5,783 5,651 6,836
Federal Home Loan Bank advances 2,061 1,989 2,289
Other borrowings 269 229 149
Total interest expense 8,113 7,869 9,274
Net interest income 14,089 13,181 12,641
Provision for loan losses 855 835 1,110
Net interest income after provision for loan losses 13,234 12,346 11,531
Noninterest income:
Service fees 1,234 1,282 1,217
Mortgage banking 901 1,767 1,223
Investment and insurance sales commissions 484 434 250
Net gain on sale of securities 97 80 0
Gain on curtailment of post-retirement benefit plan 0 131 0
Other operating income 407 417 358
Total noninterest income 3,123 4,111 3,048
Noninterest expense:
Salaries and employee benefits 6,189 5,952 4,927
Occupancy and facilities 1,609 1,127 1,093
Loss on abandonment of premises and equipment 379 0 0
Data processing and other office operations 655 547 583
Advertising and promotion 263 172 319
Other operating expense 1,880 1,553 1,304
Total noninterest expense 10,975 9,351 8,226
Income before income taxes 5,382 7,106 6,353
Provision for income taxes 1,856 2,300 1,988
Net income $ 3,526 $ 4,806 $ 4,365
Basic earnings per share $ 2.04 $ 2.76 $ 2.48
Diluted earnings per share $ 2.03 $ 2.74 $ 2.48
See accompanying notes to consolidated financial statements.
49
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
(dollars in thousands except per share data)
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY
STOCK CAPITAL EARNINGS INCOME (LOSS) STOCK TOTALS
Balance, January 1, 2002 $ 1,805 $ 7,159 $ 18,186 $ 491 $ (2,291) $ 25,350
Comprehensive income:
Net income 4,365 4,365
Unrealized gain on securities
available for sale, net of tax of $470 815 815
Total comprehensive income 5,180
Purchase of treasury stock (394) (394)
Proceeds from stock options issued
out of treasury (9) 60 51
Distribution of treasury stock in
payment of director fees 60 60
Cash dividends declared $.54 per share (944) (944)
Balance, December 31, 2002 1,805 7,150 21,607 1,306 (2,565) 29,303
Comprehensive income:
Net income 4,806 4,806
Unrealized loss on securities
available for sale, net of tax of
$253 (414) (414)
Reclassification adjustment for
net security gains, included in
net income, net of tax of $32 (48) (48)
Total comprehensive income 4,344
Purchase of treasury stock (553) (553)
Distribution of treasury stock in
payment of director fees 45 45
Stock dividend declared-5% of shares 82 2,544 (2,626)
Cash dividends declared $.57 per share (998) (998)
Balance, December 31, 2003 1,887 9,694 22,789 844 (3,073) 32,141
Comprehensive income:
Net income 3,526 3,526
Unrealized loss on securities
available for sale, net of tax of (401) (401)
$212
Reclassification adjustment for
net security gains, included in
net income, net of tax of $38 (59) (59)
Total comprehensive income 3,066
Purchase of treasury stock (628) (628)
Proceeds from stock options
issued out of treasury (22) 85 63
Distribution of treasury stock in
payment of director fees 8 8
Cash dividends declared $.60 per share (1,034) (1,034)
Balance, December 31, 2004 $ 1,887 $ 9,672 $ 25,281 $ 384 $ (3,608) $ 33,616
See accompanying notes to consolidated financial statements.
50
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
(dollars in thousands except per share data)
2004 2003 2002
Cash flows from operating activities:
Net income $ 3,526 $ 4,806 $ 4,365
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for depreciation and net amortization 1,298 1,763 859
Provision for deferred income taxes 23 0 360
Provision for loan losses 855 835 1,110
Proceeds from sales of loans held for sale 41,321 132,845 94,252
Originations of loans held for sale (41,093) (130,874) (93,146)
Gain on sale of loans (697) (2,021) (1,492)
Provision for (recapture of) mortgage servicing right
valuation allowance 16 (25) 115
Net (gain) loss on sale of premises
and equipment (3) 0 24
Loss on abandonment of premises and equipment 379 0 0
Realized gain on sale of securities available for sale (97) (80) 0
Net (gain) loss on sale of foreclosed assets (29) 9 (28)
Federal Home Loan Bank stock dividends (159) (180) (114)
Changes in operating assets and liabilities:
Accrued interest receivable (127) 115 141
Other assets 103 285 (308)
Accrued expenses and other liabilities (377) (86) 109
Net cash provided by operating activities 4,939 7,392 6,247
Cash flows from investing activities:
Proceeds from sale and maturities of:
Held-to-maturity securities 0 0 1,000
Available-for-sale securities 19,444 46,515 20,737
Payment for purchase of:
Held-to-maturity securities 0 0 (1,758)
Available-for-sale securities (16,718) (39,147) (29,507)
Purchase of Federal Home Loan Bank stock (271) 0 0
Net increase in loans (40,377) (48,959) (20,923)
Capital expenditures (5,969) (1,912) (1,957)
Proceeds from sale of premises and equipment 3 0 1
Proceeds from sale of foreclosed assets 44 280 278
Net cash used in investing activities (43,844) (43,223) (32,129)
See accompanying notes to consolidated financial statements.
51
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
(dollars in thousands except per share data)
2004 2003 2002
Cash flows from financing activities:
Net increase in non-interest-bearing deposits $ 1,072 $ 5,106 $ 3,950
Net increase in interest-bearing deposits 40,739 13,478 20,245
Net increase (decrease) in other borrowings (1,910) 7,173 (1,025)
Proceeds from issuance of long-term FHLB advances 15,000 25,000 0
Repayments of long-term FHLB advances (10,000) (16,000) 0
Dividends declared (1,034) (998) (944)
Proceeds from issuance of stock options 63 0 52
Purchase of treasury stock (628) (553) (394)
Net cash provided by financing activities 43,302 33,206 21,884
Net increase (decrease) in cash and cash equivalents 4,397 (2,625) (3,998)
Cash and cash equivalents at beginning 18,927 21,552 25,550
Cash and cash equivalents at end $ 23,324 $ 18,927 $ 21,552
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 7,935 $ 8,088 $ 9,508
Income taxes 1,935 2,265 1,700
NONCASH INVESTING AND FINANCING ACTIVITIES:
Loans charged off $ 266 $ 522 $ 985
Loans transferred to foreclosed assets 0 178 839
Loans originated on sale of foreclosed assets 110 379 531
Distribution of treasury stock in payment of
director fees 8 45 60
Transfer of held-to-maturity securities to the
available-for-sale category 0 0 21,057
Transfer of equity from retained earnings for
5% stock dividend 0 2,626 0
See accompanying notes to consolidated financial statements.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands except per
share data)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPAL BUSINESS ACTIVITY
PSB Holdings, Inc., operates Peoples State Bank, a full-service financial
institution with a primary service area including, but not limited to,
Marathon, Oneida, and Vilas Counties, Wisconsin. It provides a variety of
banking products, including uninsured investment and insurance products, long-
term fixed rate residential mortgages, and commercial property and casualty
insurance.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of PSB Holdings,
Inc. and its subsidiary Peoples State Bank. Peoples State Bank owns and
operates a Nevada subsidiary, PSB Investments, Inc., to manage the Bank's
investment securities. The Bank also owns and operates a limited liability
company, Peoples Insurance Services, LLC, an insurance agency offering
commercial property and casualty insurance. All significant intercompany
balances and transactions have been eliminated. The accounting and reporting
policies of PSB conform to generally accepted accounting principles (GAAP) and
to the general practices within the banking industry. Any reference to "PSB"
refers to the consolidated or individual operations of PSB Holdings, Inc. and
its subsidiary Peoples State Bank.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make certain
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from those estimates.
CASH EQUIVALENTS
For purposes of reporting cash flows in the consolidated financial statements,
cash and cash equivalents include cash and due from banks, interest-bearing
deposits and money market funds, and federal funds sold, all of which have
original maturities of three months or less.
SECURITIES
Securities are assigned an appropriate classification at the time of purchase
in accordance with management's intent. Securities held to maturity represent
those debt securities for which PSB has the positive intent and ability to hold
to maturity. PSB has no held to maturity securities.
Trading securities include those securities bought and held principally for the
purpose of selling them in the near future. PSB has no trading securities.
Securities not classified as either securities held to maturity or trading
securities are considered available for sale and reported at fair value
determined from estimates of brokers or other sources.
53
Unrealized gains and losses are excluded from earnings but are reported as
other comprehensive income, net of income tax effects, in a separate component
of stockholders' equity.
Any gains and losses on sales of securities are recognized at the time of sale
using the specific identification method.
FEDERAL HOME LOAN BANK STOCK
As a member of the Federal Home Loan Bank (FHLB) system, PSB is required to
hold stock in the FHLB based on asset size and the anticipated level of
borrowings to be advanced to PSB. This stock is recorded at cost, which
approximates fair value. Transfer of the stock is substantially restricted.
LOANS HELD FOR SALE
PSB sells substantially all long-term fixed-rate single-family mortgage loans
it originates to the FHLB. The gain or loss associated with sales of single-
family mortgage loans is recorded as a component of mortgage banking revenue.
Originations and sales of single-family mortgage loans will vary significantly
from period to period depending on customer preferences for fixed-rate mortgage
loans and customer refinance activity. Accordingly, the gain or loss
associated with sales of single-family mortgage loans may vary substantially
from period to period. In general, however, fluctuations in gains or losses on
sales of single-family mortgage loans are offset to some degree by opposite
changes in the amortization of mortgage servicing rights, which is also
recorded as a component of mortgage banking revenue (refer to "Mortgage
Servicing Rights").
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated market value in the aggregate. Net
unrealized losses are recognized through a valuation allowance by charges to
income. Gains and losses on the sale of loans held for sale are determined
using the specific identification method using quoted market prices.
In sales of mortgage loans to the FHLB, PSB retains a secondary portion of the
credit risk on the underlying loans in exchange for a credit enhancement fee.
When applicable, PSB records a recourse liability to provide for potential
credit losses. Because the loans involved in these transactions are similar to
those in PSB's loans held for investment, the review of the adequacy of the
recourse liability is similar to the review of the adequacy of the allowance
for loan losses (refer to "Allowance for Loan Losses").
LOANS
Loans that management has the intent to hold for the foreseeable future or
until maturity or pay-off generally are 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 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
54
placed on nonaccrual status, additional income is recorded only to the extent
that payments are received or the collection of principal becomes reasonably
assured. Interest income recognition on loans considered to be impaired under
current accounting standards is consistent with the recognition on all other
loans.
Loan origination fees and certain direct loan origination costs are deferred
and amortized to income over the estimated life of the underlying loan.
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 collectibility of the principal is
unlikely.
Management believes the allowance for loan losses is adequate 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
commercial purpose loans which have been judged to be impaired as defined by
current accounting standards. 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 commercial, financial, agricultural, and commercial real estate
loans that have a nonaccrual status or have had their terms restructured meet
this definition. Large groups of homogeneous loans, such as mortgage and
consumer loans, are collectively evaluated for impairment. 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. Interest income is
recognized on the cash basis.
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 collectibility based on information
available to them at the time of their examination.
In management's judgment, the allowance for loan losses is adequate to cover
probable losses relating to specifically identified loans, as well as probable
losses inherent in the balance of the loan portfolio.
MORTGAGE SERVICING RIGHTS
PSB continues to service most single-family mortgage loans it sells to the
FHLB. Servicing mortgage loans includes such functions as collecting monthly
payments of principal and interest from borrowers, passing such payments
through to third-party investors, maintaining escrow accounts for
55
taxes and insurance, and making such payments when they are due. When
necessary, servicing mortgage loans also includes functions related to the
collection of delinquent principal and interest payments, loan foreclosure
proceedings, and disposition of foreclosed real estate. PSB generally earns a
servicing fee of 25 basis points on the outstanding loan balance for performing
these services as well as fees and interest income from ancillary sources such
as delinquency charges and float. Servicing fee income is recorded as a
component of mortgage banking revenue, net of the amortization and charges
described in the following paragraphs.
PSB records originated mortgage servicing rights (OMSR) as a component of gain
on sale of mortgage loans when the obligation to service such loans has been
retained. The initial value recorded for OMSR is based on the relative values
of the servicing fee adjusted for expected future costs to service the loans,
as well as income and fees expected to be received from ancillary sources, as
previously described. The carrying value of OMSR is amortized against service
fee income in proportion to estimated gross servicing revenues, net of
estimated costs of servicing, adjusted for expected prepayments. In addition
to this periodic amortization, the carrying value of OMSR associated with loans
that actually prepay is also charged against servicing fee income as
amortization. As a result of the latter charges, there may be considerable
variation in amortization of OMSR from period to period depending on actual
customer prepayment activity. In general, however, variations in the
amortization of OMSR will offset to some degree opposite changes in gains or
losses on sales of single-family mortgage loans, as previously described (refer
to "Loans Held for Sale").
The carrying value of OMSR recorded in PSB's Consolidated Balance Sheets
("mortgage servicing rights" or "MSRs") is subject to impairment because of
changes in loan prepayment expectations and in market discount rates used to
value the future cash flows associated with such assets. In valuing MSRs, PSB
stratifies the loans by year of origination, term of the loan, and range of
interest rates within each term. If, based on a periodic evaluation, the
estimated fair value of the MSRs related to a particular stratum is determined
to be less than its carrying value, a valuation allowance is recorded against
such stratum and against PSB's loan servicing fee income, which is included as
a component of mortgage banking revenue. A valuation allowance is not recorded
if the estimated fair value of a stratum exceeds its carrying value. Because
of this inconsistent treatment, PSB may be required to maintain a valuation
allowance against MSRs even though the estimated fair value of PSB's total MSR
portfolio exceeds its carrying value in total. The valuation allowance is
calculated using the current outstanding principal balance of the related
loans, long-term prepayment assumptions as provided by independent sources, a
market-based discount rate, and other management assumptions related to future
costs to service the loans, as well as ancillary sources of income.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, net of accumulated depreciation.
Depreciation is computed principally on the straight-line method and is based
on the estimated useful lives of the assets varying primarily from 30 to 40
years on buildings, 5 to 10 years on furniture and equipment, and 3 years on
computer hardware and software. Maintenance and repair costs are charged to
expense as incurred. Gains or losses on disposition of property and equipment
are reflected in income.
56
FORECLOSED ASSETS
Real estate and other property acquired through, or in lieu of, loan
foreclosure 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 real estate.
RETIREMENT PLANS
PSB maintains a defined contribution 401(k) profit sharing plan which covers
substantially all full-time employees.
INCOME TAXES
Deferred income taxes have been provided under the liability method. Deferred
tax assets and liabilities are determined based on the difference between the
financial statement and tax bases of assets and liabilities as measured by the
enacted tax rates which will be in effect when these differences are expected
to reverse. Deferred tax expense is the result of changes in the deferred tax
asset and liability and is a component of the provision for income taxes.
ADVERTISING AND PROMOTIONAL COSTS
Costs relating to PSB's advertising and promotion are generally expensed when
paid.
RATE LOCK COMMITMENTS
PSB enters into commitments to originate loans whereby the interest rate on the
loan is determined prior to funding (rate lock commitments). Rate lock
commitments on mortgage loans that are intended to be sold are considered to be
derivatives. Rate lock commitments are recorded only to the extent of fees
received since recording the estimated fair value of these commitments would
not have a significant impact on the consolidated financial statements.
SEGMENT INFORMATION
PSB, through a branch network of its banking subsidiary, provides a full range
of consumer and commercial banking services to individuals, businesses, and
farms in north central Wisconsin. These services include demand, time, and
savings deposits; safe deposit services; credit cards; notary services; night
depository; money orders, traveler's checks, and cashier checks; savings bonds;
secured and unsecured consumer, commercial, and real estate loans; ATM
processing; cash management; and financial planning. While PSB's chief
decision makers monitor the revenue streams of various PSB products and
services, operations are managed and financial performance is evaluated on a
companywide basis. Accordingly, all of PSB's banking operations are considered
by management to be aggregated in one reportable operating segment.
57
STOCK-BASED COMPENSATION
Generally accepted accounting principles encourage all entities to adopt a fair
value based method of accounting for employee stock compensation plans, whereby
compensation cost is measured at the grant date based on the value of the award
and is recognized over the service period, which is usually the vesting period.
At December 31, 2004, the rules also allow an entity to continue to measure
compensation cost for those plans using the intrinsic value based method of
accounting, whereby compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date over the amount an employee must
pay to acquire the stock. However, effective during the quarter ending
September 30, 2005, GAAP will change to require all stock-based compensation to
be reflected as income (refer to "Future Accounting Changes").
PSB follows the provisions of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and uses the "intrinsic value method"
of recording stock-based compensation cost. Because stock options are granted
with an exercise price equal to fair value at the date of grant, no
compensation expense is recorded.
The following table illustrates the effect on net income and earnings per share
if the fair value based method had been applied to all outstanding and unvested
awards in each period:
2004 2003 2002
Net income, as reported $ 3,526 $ 4,806 $ 4,365
Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects 0 0 0
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method for all awards,
net of related tax effects 0 0 (9)
Pro forma net income $ 3,526 $ 4,806 $ 4,356
Earning per share - Basic and diluted
As reported:
Basic $ 2.04 $ 2.76 $ 2.48
Diluted $ 2.03 $ 2.74 $ 2.48
Pro forma:
Basic $ 2.04 $ 2.76 $ 2.48
Diluted $ 2.03 $ 2.74 $ 2.47
58
The fair value of stock options granted in 2002 was estimated at the date of
grant using the Black-Scholes methodology. No options were granted in 2004 and
2003. The following assumptions were made in estimating the fair value for
options granted for the year ended December 31, 2002:
2002
Dividend yield 2.75%
Risk-free interest rate 3.83%
Weighted average expected life (years) 10
Expected volatility 7.59%
The weighted average fair value of options at their grant date, using the
assumptions shown above, was computed at $1.90 per share for options granted in
2002.
COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses,
gains, and losses be included in net income. Certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
consolidated balance sheets.
FUTURE ACCOUNTING CHANGES
In December 2004, the Financial Accounting Standards Board (FASB) amended
Statement of Financial Accounting Standards (SFAS) No. 123 Share-Based Payment
in part to require all share-based awards and compensation to be reflected in
earnings. The amendment is effective for PSB during the quarter ending
September 30, 2005. The change is not expected to have a material effect on
PSB's financial condition or results of operations.
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the current
year presentation.
NOTE 2 CHANGES IN ACCOUNTING PRINCIPLES
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. This interpretation sets forth expanded disclosure
requirements in the financial statements about a guarantor's obligations under
certain guarantees that it has issued, including standby letters of credit
issued by PSB to customers in the normal course of lending operations. In
certain circumstances, a guarantor is required to recognize a liability for the
fair value of the obligation at the inception of the guarantee. FASB
Interpretation No. 45 was effective for PSB during 2003, but its adoption did
not have a material effect on PSB's financial condition or results of
operations.
59
NOTE 3 CASH AND DUE FROM BANKS
PSB is required to maintain a certain reserve balance, in cash or on deposit
with the Federal Reserve Bank, based upon a percentage of deposits. The total
required reserve balance as of December 31, 2004 was approximately $3,330.
In the normal course of business, PSB maintains cash and due from bank balances
with correspondent banks. Accounts at each institution are insured by the
Federal Deposit Insurance Corporation up to $100,000. PSB also maintains cash
balances in money market funds. Such balances are not insured. Uninsured cash
and cash equivalent balances totaled $13,145 and $11,580 at December 31, 2004
and 2003, respectively.
NOTE 4 SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated fair value of investment securities are as
follows:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
December 31, 2004
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 7,785 $ 37 $ 51 $ 7,771
Obligations of states and political
subdivisions 24,089 893 99 24,883
Mortgage-backed securities 6,119 38 16 6,141
Collateralized mortgage obligations 28,024 11 234 27,801
Nonrated trust preferred securities 2,250 0 0 2,250
Other equity securities 48 0 0 48
Totals $ 68,315 $ 979 $ 400 $ 68,894
December 31, 2003
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 11,912 $ 262 $ 26 $ 12,148
Obligations of states and political
subdivisions 23,513 1,211 60 24,664
Mortgage-backed securities 7,933 65 19 7,979
Collateralized mortgage obligations 25,526 71 214 25,383
Nonrated trust preferred securities 2,250 0 0 2,250
Other equity securities 48 0 0 48
Totals $ 71,182 $ 1,609 $ 319 $ 72,472
60
Fair values of securities are estimated based on financial models or prices
paid for similar securities. It is possible interest rates could change
considerably resulting in a material change in the estimated fair value.
The following table indicates the amount of months securities that are
considered to be temporarily impaired have been in an unrealized loss position
at December 31.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
DESCRIPTION OF SECURITIES VALUE LOSS VALUE LOSS VALUE LOSS
DECEMBER 31, 2004
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 3,449 $ 5 $ 1 $ 0 $ 3,449 $ 51
Obligations of states and political
subdivisions 4,535 87 416 12 4,951 99
Mortgage-backed securities 2,093 14 190 2 2,283 16
Collateralized mortgage obligations 17,693 180 6,595 54 24,288 234
Total temporarily impaired securities $ 27,770 $ 332 $ 7,201 $ 68 $ 34,971 $ 400
DECEMBER 31, 2003
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 1,974 $ 26 $ 0 $ 0 $ 1 ,974 $ 26
Obligations of states and political
subdivisions 3,119 60 0 0 3,119 60
Mortgage-backed securities 1,865 19 0 0 1,865 19
Collateralized mortgage obligations 14,063 214 0 0 14,063 214
Total temporarily impaired securities $ 21,021 $ 319 $ 0 $ 0 $ 21,021 $ 319
At December 31, 2004, 62 debt securities have unrealized losses with aggregate
depreciation of 1.1% from the Company's amortized cost basis. These unrealized
losses relate principally to the increase in interest rates and are not due to
changes in the financial condition of the issuer. In analyzing an issuer's
financial condition, management considers whether the securities are issued by
a government body or agency, whether a rating agency has downgraded the
securities, and industry analysts' reports. Since management has the ability
to hold debt securities until maturity (or the foreseeable future for
securities available for sale), no declines are deemed to be other than
temporary.
The amortized cost and estimated fair value of debt securities available for
sale at December 31, 2004, by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
61
ESTIMATED
AMORTIZED FAIR
COST VALUE
Due in one year or less $ 1,326 $ 1,338
Due after one year through five years 17,879 18,290
Due after five years through ten years 12,669 13,026
Due after ten years 2,250 2,250
Subtotals 34,124 34,904
Mortgage-backed securities and
collateralized mortgage obligations 34,143 33,942
Totals $ 68,267 $ 68,846
Securities with a fair value of $27,982 and $17,994 at December 31, 2004 and
2003, respectively, were pledged to secure public deposits and other borrowings
and for other purposes required by law.
During 2004 and 2003, respectively, proceeds from the sale of securities
totaled $4,926 and $8,839 with gross gains of $111 and $107 and gross losses of
$14 and $27. No securities were sold during 2002.
During December 2002, PSB transferred the entire securities held to maturity
portfolio to available-for-sale status. Securities held to maturity consisted
of municipal securities. At the date of transfer, municipal securities had a
net book value of $21,027 and a fair value of $22,056 for an unrealized gain of
$1,030. In accordance with current accounting standards, the transferred
municipal securities were recorded at fair value and stockholders' equity
increased $673 net of income tax effects at the date of transfer to recognize
additional unrealized gain on securities available for sale. PSB reclassified
municipal securities to increase available liquidity.
NOTE 5 LOANS
The composition of loans categorized by the initial purpose of the loan is as
follows:
2004 2003
Commercial, industrial, and municipal $ 72,456 $ 66,934
Commercial real estate mortgage 145,856 128,290
Residential real estate mortgage 82,696 66,065
Real estate construction 38,308 37,639
Residential real estate home equity 11,620 9,252
Consumer and individual 6,482 7,728
Subtotals 357,418 315,908
Net deferred loan costs 368 316
Loans in process of disbursement (9,706) (8,349)
Allowance for loan losses (4,157) (3,536)
Net loans receivable $ 343,923 $ 304,339
62
PSB originates and holds adjustable rate residential mortgage loans with
variable rates of interest. The rate of interest on these loans is capped over
the life of the loan. At December 31, 2004 and 2003, none of the approximately
$12,114 and $8,324 of variable rate loans, respectively had reached the
interest rate cap.
PSB, in the ordinary course of business, grants loans to its executive officers
and directors, including their families and firms in which they are principal
owners. All loans to executive officers and directors are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with others and, in the
opinion of management, did not involve more than the normal risk of
collectibility or present other unfavorable features. Activity in such loans
is summarized below:
2004 2003
Loans outstanding at beginning $ 1,421 $ 3,822
New loans 5,145 1,460
Repayments (1,816) (3,861)
Loans outstanding at end $ 4,750 $ 1,421
The following is a summary of information pertaining to impaired loans and
nonperforming loans:
DECEMBER 31,
2004 2003 2002
Impaired loans without a valuation allowance $ 133 $ 0 $ 5
Impaired loans with a valuation allowance 1,277 1,627 1,416
Total impaired loans $ 1,410 $ 1,627 $ 1,421
Valuation allowance related to impaired loans $ 250 $ 255 $ 431
YEARS ENDED DECEMBER 31,
2004 2003 2002
Average recorded investment, net of allowance for
loan losses $ 1,342 $ 1,419 $ 2,217
Interest income recognized $ 65 $ 105 $ 180
Interest income recognized on a cash basis
on impaired loans $ 28 $ 65 $ 145
Total loans receivable (including nonaccrual impaired loans) maintained on
nonaccrual status as of December 31, 2004 and 2003 were $2,174 and $3,119
respectively. There were no loans past due 90 days or more but still accruing
income at December 31, 2004 and 2003.
63
An analysis of the allowance for loan losses for the three years ended
December 31 follows:
2004 2003 2002
Balance, January 1 $ 3,536 $ 3,158 $ 2,969
Provision charged to operating expense 855 835 1,110
Recoveries on loans 32 65 64
Loans charged off (266) (522) (985)
Balance, December 31 $ 4,157 $ 3,536 $ 3,158
Under a secondary market loan servicing program with the FHLB, PSB provides a
credit enhancement guarantee to reimburse the FHLB for foreclosure losses in
excess of 1% of original loan principal sold to the FHLB in exchange for a
monthly fee. At December 31, 2004, PSB serviced payments on $160,225 of first
lien residential loan principal for the FHLB. At December 31, 2004, the
maximum Company obligation for such guarantees would be approximately $743 if
total foreclosure losses on the entire pool of loans exceed approximately
$2,951. Management believes the likelihood of a reimbursement for loss payable
to the FHLB to be remote and does not maintain any recourse liability for
possible losses.
NOTE 6 MORTGAGE SERVICING RIGHTS
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage loans
serviced for others were $160,225 and $152,718 at December 31, 2004 and 2003,
respectively. The following is a summary of changes in the balance of MSR:
ORIGINATED VALUATION
MSR ALLOWANCE TOTAL
Balance at January 1, 2002 $ 284 $ 0 $ 284
Additions from originated servicing 840 0 840
Amortization charged to earnings (312) 0 (312)
Change in valuation allowance charged to earnings 0 (115) (115)
Balance at December 31, 2002 812 (115) 697
Additions from originated servicing 792 0 792
Amortization charged to earnings (700) 0 (700)
Change in valuation allowance charged to earnings 0 25 25
Balance at December 31, 2003 904 (90) 814
Additions from originated servicing 334 0 334
Amortization charged to earnings (293) 0 (293)
Change in valuation allowance charged to earnings 0 (16) (16)
Balance at December 31, 2004 $ 945 $ (106) $ 839
64
NOTE 7 PREMISES AND EQUIPMENT
The composition of premises and equipment follows:
2004 2003
Land $ 2,620 $ 1,567
Buildings and improvements 8,376 5,487
Furniture and equipment 4,321 3,286
Construction in progress 639 1,617
Total cost 15,956 11,957
Less - Accumulated depreciation and amortization 3,524 4,400
Totals $ 12,432 $ 7,557
Depreciation and amortization charged to operating expenses amounted to $767 in
2004, $513 in 2003, and $500 in 2002.
During 2004, PSB placed in service a new $4.8 million main office and incurred
a one-time charge for abandonment of premises and equipment of $329 as the
prior home office located on the same property was razed. Also during 2004,
PSB closed a Rhinelander, Wisconsin branch in leased space and accrued $50 for
abandonment of premises and equipment to remove leasehold improvements and meet
other termination requirements.
PSB has committed approximately $300 for future premises and equipment
acquisitions at December 31, 2004, related to a branch location in Weston,
Wisconsin.
LEASE COMMITMENTS
PSB leases various pieces of equipment under cancelable leases and office space
for one supermarket branch location under a noncancelable lease. PSB has the
option to renew the noncancelable branch location lease for an additional term
upon expiration. The lease is classified as operating. Future minimum
payments under the noncancelable lease are as follows:
2005 $ 46
2006 15
Total $ 61
Rental expense for all operating leases was $89, $84, and $81, for the years
ended December 31, 2004, 2003, and 2002, respectively.
65
NOTE 8 DEPOSITS
The distribution of deposits at December 31 is as follows:
2004 2003
Non-interest-bearing demand deposits $ 51,635 $ 50,563
Interest-bearing demand deposits (NOWs) 38,329 22,864
Savings deposits 26,245 23,933
Money market deposits 68,666 70,879
Retail time deposits 119,452 99,455
Wholesale market and national time deposits 53,898 48,720
Total deposits $ 358,225 $ 316,414
The scheduled maturities of time deposits at December 31, 2004 are summarized
as follows:
2005 $ 101,171
2006 31,483
2007 21,826
2008 5,822
2009 7,491
Thereafter 5,557
Total $ 173,350
Time deposits with individual balances greater than $100,000 totaled $100,549
and $73,935 at December 31, 2004 and 2003, respectively.
Deposits from PSB directors, officers, and related parties at December 31, 2004
and 2003 totaled $4,397 and $4,938, respectively.
NOTE 9 FEDERAL HOME LOAN BANK ADVANCES
FHLB advances at December 31, consist of the following:
WEIGHTED
SCHEDULED RANGE OF AVERAGE
MATURITY RATES RATE AMOUNT
December 31, 2004
Fixed rate advances, interest only payments 2005 2.42-6.21% 5.17% $ 26,000
Fixed rate advances, interest only payments 2007 2.63% 2.63% 5,000
Fixed rate advances, interest only payments 2008 3.90-5.07% 4.34% 8,000
Fixed rate advances, interest only payments 2009 3.48-4.19% 3.76% 13,000
Totals 4.45% $ 52,000
66
At December 31, 2004, fixed rate advances maturing during 2008 include a $3,000 advance
at a rate of 5.07% that is callable by the FHLB.
December 31, 2003
Fixed rate advance, interest only payments 2004 1.22% 1.22% $ 15,000
Fixed rate advance, interest only payments 2005 6.10-6.21% 6.16% 19,000
Fixed rate advance, interest only payments 2008 3.90-5.07% 4.34% 8,000
Fixed rate advance, interest only payments 2009 3.48% 3.48% 5,000
Totals 3.99% $ 47,000
At December 31, 2003, all fixed rate advances with scheduled maturity in 2005
were callable by the FHLB.
FHLB advances are subject to a prepayment penalty if they are repaid prior to
maturity. PSB may draw upon a FHLB open line of credit up to approximately 61%
of unencumbered 1-4 family residential first mortgage loans pledged as
collateral out of its portfolio. The FHLB advances are also secured by $2,874
and $2,444 of FHLB stock owned by the Bank at December 31, 2004 and 2003,
respectively. PSB may draw both short-term and long-term advances on a maximum
line of credit totaling approximately $67,598 as of December 31, 2004, based on
residential real estate loan collateral. At December 31, 2004, PSB's available
and unused portion of this line of credit totaled approximately $14,855. PSB
also has, under a current agreement with the FHLB, an ability to borrow up to
$12,871 by pledging securities available for sale.
NOTE 10 OTHER BORROWINGS
Other borrowings consist of securities sold under both short-term and long-term
repurchase agreements totaling $8,565 and $10,475 at December 31, 2004 and
2003, respectively.
PSB pledges various securities available for sale as collateral for repurchase
agreements. The fair value of securities pledged for repurchase agreements
totaled $9,328 and $12,083 at December 31, 2004 and 2003, respectively.
Amortized cost of the securities pledged was $9,305 and $11,868, at December
31, 2004 and 2003, respectively.
The following information relates to federal funds purchased and securities
sold under repurchase agreements for the years ended December 31:
2004 2003 2002
As of end of year:
Weighted average rate 2.68% 2.39% 3.98%
For the year:
Highest month-end balance $ 20,826 $ 13,463 $ 4,540
Daily average balance $ 11,824 9,151 $ 3,496
Weighted average rate 2.28% 2.50% 4.26%
Repurchase agreements with related parties totaled $39 and $160 at December 31,
2004 and 2003, respectively.
67
NOTE 11 RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS
PSB has established a 401(k) profit-sharing plan for its employees. PSB
matches 50% of employees' salary deferrals up to the first 6% of pay deferred.
PSB also may declare a discretionary profit-sharing contribution. The expense
recognized for contributions to the plan for the years ended December 31, 2004,
2003, and 2002 was $313, $327, and $280, respectively.
PSB maintains an unfunded, postretirement health care benefit plan which covers
the officers of PSB. After retirement, PSB will pay between 25% and 50% of the
health insurance premiums for former PSB officers until the officer reaches age
65 or the qualifying age for Medicare coverage. To qualify, an officer must
have at least 15 years of service, be employed by PSB at retirement, and must
be at least 62 years of age at retirement. The actual amount paid is based
upon years of service to PSB. During 2003, the plan's benefits were changed to
cover the period noted above. Prior to 2003, plan benefits continued until the
officer's death.
The following table provides a reconciliation of changes in the postretirement
health care benefit plan for the years ended December 31, 2004 and 2003:
2004 2003
Reconciliation of benefit obligations:
Obligation at beginning $ 254 $ 336
Service cost 5 20
Interest cost 17 32
Benefit payments (8) (13)
Net amortization of prior service costs 4 10
Gain on curtailment of post-retirement benefit plan 0 (131)
Obligation at end $ 272 $ 254
The following table provides the components of net periodic benefit cost of the
plans for the years ended December 31, 2004, 2003, and 2002:
POSTRETIREMENT
HEALTH CARE
BENEFIT PLAN
2004 2003 2002
Service cost $ 5 $ 20 $ 29
Interest cost 17 32 32
Net amortization of prior service costs 4 10 13
Gain on curtailment of post-retirement benefit plan 0 (131) 0
Net periodic pension cost (gain) $ 26 $ (69) $ 74
68
The following table provides a reconciliation of the impact of the curtailment
of plan benefits during 2003.
BEFORE EFFECT OF AFTER PLAN
PLAN CHANGE PLAN CHANGE CHANGE
Accumulated postretirement benefit obligation:
Retirees $ 214 $ 0 $ 214
Other Actives 384 (322) 62
Total 598 (322) 276
Unrecognized net loss (169) 169 0
Unrecognized prior service cost (44) 22 (22)
Accrued post-retirement benefit obligation $ 385 $ (131) $ 254
The assumptions used in the measurement of PSB's benefit obligation are shown
in the following table:
POSTRETIREMENT
HEALTH CARE
BENEFIT PLAN
2004 2003 2002
Discount rate 5.50% 6.25% 6.75%
Health care cost trend rate 9.00% 6.50% 6.75%
The health care cost trend rate is anticipated to be 9.0% in 2005 through 2006
and then decline to 6.5% in 2007 and thereafter.
Assumed health care cost trend rates could have a significant effect on the
amounts reported for the health care benefit plan. A 1% increase in assumed
health care cost trend rates would have the following effects:
2004 2003 2002
Effect on service and interest cost $ 0 $ 13 $ 15
Effect on accumulated benefit obligation at December 31 4 4 103
NOTE 12 SELF-FUNDED HEALTH INSURANCE PLAN
PSB has established an employee medical benefit plan to self-insure claims up
to $25 per year for each individual with a $521 stop-loss per year for
participants in the aggregate. Coverages in 2005 will be $30 per individual
and $604 in the aggregate. PSB and its covered employees contribute to the
fund to pay the claims and stop-loss premiums. Medical benefit plan costs are
expensed as incurred. The liability recognized for claims incurred but not yet
paid was $58 and $63 as of December 31, 2004 and 2003, respectively. Health
insurance expense recorded in 2004, 2003, and 2002 was $389, $377, and $275,
respectively.
69
NOTE 13 INCOME TAXES
The components of the provision for income taxes are as follows:
2004 2003 2002
Current income tax provision:
Federal $ 1,258 $ 2,003 $ 1,460
State 575 297 168
Total current 1,833 2,300 1,628
Deferred income tax expense (benefit):
Federal 73 1 300
State (50) (1) 60
Total deferred 23 0 360
Total provision for income taxes $ 1,856 $ 2,300 $ 1,988
A summary of the source of differences between income taxes at the federal
statutory rate and the provision for income taxes for the years ended December
31, follows:
2004 2003 2002
PERCENT PERCENT PERCENT
OF OF OF
PRETAX PRETAX PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
Tax expense at
statutory rate $ 1,830 34.0 $ 2,416 34.0 $ 2,160 34.0
Increase (decrease)
in taxes resulting from:
Tax-exempt
interest (371) (6.9) (342) (4.8) (338) (5.3)
State income tax 347 6.4 195 2.7 150 2.4
Other 50 1.0 31 0.5 16 0.2
Provision for income
taxes $ 1,856 34.5 $ 2,300 32.4 $ 1,988 31.3
70
Deferred income taxes are provided for the temporary differences between the
financial reporting basis and the tax basis of PSB's assets and liabilities.
The major components of the net deferred tax assets are as follows:
2004 2003
Deferred tax assets:
Allowance for loan losses $ 1,422 $ 1,173
Deferred compensation and director's fees 146 89
State net operating loss 39 33
Post-retirement health care benefits 107 100
Employee pension plan 13 17
Other 22 2
Valuation allowances (39) (33)
Gross deferred tax assets 1,710 1,381
Deferred tax liabilities:
Premises and equipment 402 206
Mortgage servicing rights 330 320
FHLB stock 269 207
Deferred net loan origination costs 151 125
Unrealized gain on securities available for sale 195 446
Prepaid assets 58 0
Gross deferred tax liabilities 1,405 1,304
Net deferred tax asset $ 305 $ 77
PSB pays state income taxes on individual, unconsolidated net earnings. At
December 31, 2004, net operating loss carryforwards of the parent company of
approximately $722 existed to offset future state taxable income. These net
operating losses will begin to expire in 2012. A valuation allowance has been
recognized to adjust deferred tax assets to the amount of net operating losses
expected to be utilized to offset future income. If realized, the tax benefit
for this item will reduce current tax expense for that period. The valuation
allowance increased $6 and $4 in 2004 and 2003, respectively.
During 2004, PSB resolved a Wisconsin state income tax audit initiated during
2003. Like many Wisconsin financial institutions, PSB has a Nevada based
subsidiary that holds and manages investment assets which have not been subject
to Wisconsin tax. The Wisconsin Department of Revenue (the "Department")
instituted an audit program specifically aimed at out-of-state bank
subsidiaries, including PSB. The Department took the position that a portion
of the income of the out-of-state subsidiaries is taxable in Wisconsin. After
consideration of the cost to litigate and the potential risk of a substantial
loss in litigation, PSB decided to accept a standardized settlement offered by
the Department to Wisconsin banks with out-of-state subsidiaries with no
admission of wrongdoing. The settlement increased the provision for income
taxes after federal benefits by $150. PSB continues to operate the subsidiary
to manage a portion of the Bank's investment security portfolio.
The Internal Revenue Service (IRS) is currently conducting an audit of PSB's
open tax returns. PSB has been assessed approximately $170 in taxes, interest,
and penalties for the tax years ending 1999 through 2002 as a result of the IRS
audit; however, this assessment is in the process of being appealed.
71
PSB believes all tax returns were filed appropriately and, at this time, no
additional tax expense has been recorded.
NOTE 14 COMMITMENTS, CONTINGENCIES, AND CREDIT RISK
CREDIT RISK
PSB is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. Those instruments involve, to varying degrees, elements of credit
risk in excess of the amount recognized in the balance sheets.
PSB's exposure to credit loss in the event of nonperformance by the other party
to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amount of those
instruments. PSB uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments. These
commitments at December 31 are as follows:
2004 2003
Commitments to extend credit $ 48,566 $ 40,935
Commercial letters of credit - variable rate 1,499 707
Unused home equity lines of credit - variable rate 11,437 8,936
Unused credit card commitments - fixed rate 3,367 3,260
Credit enhancement under the FHLB of Chicago
Mortgage Partnership Finance program 743 554
Totals $ 65,612 $ 54,392
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. PSB evaluates each customer's creditworthiness on a case-by-case
basis. The amount of collateral obtained, if deemed necessary upon extension
of credit, is based on management's credit evaluation of the party. Collateral
held varies but may include accounts receivable, inventory, property, plant,
and equipment, and income-producing commercial properties.
Letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. Those guarantees are primarily
issued to support public and private borrowing arrangements. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. Collateral held varies as specified
above and is required in instances which PSB deems necessary. The commitments
are generally structured to allow for 100% collateralization on all letters of
credit.
Credit card commitments are commitments on credit cards issued by PSB and
serviced by Elan Financial Services (a subsidiary of U.S. Bancorp.). These
commitments are unsecured.
72
CONCENTRATION OF CREDIT RISK
PSB grants residential mortgage, commercial, and consumer loans predominantly
in Marathon, Oneida, and Vilas Counties, Wisconsin. There are no significant
concentrations of credit to any one debtor or industry group. Management
believes the diversity of the local economy will prevent significant losses in
the event of an economic downturn.
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 15 STOCK OPTION PLAN
Under the terms of an incentive stock option plan adopted during 2001, shares
of unissued common stock are reserved for options to officers and key employees
of PSB at prices not less than the fair market value of the shares at the date
of the grant. Options may be exercised anytime after the option grant's six
month anniversary. These options expire ten years after the grant date. As of
December 31, 2004, all 24,273 options outstanding were eligible to be
exercised. The following tables summarize information regarding stock options
outstanding at December 31, 2004 and activity during the three years ended
December 31, 2004.
OPTIONS EXERCISABLE
EXERCISE PRICES SHARES
$15.83 19,428
$16.81 4,845
WEIGHTED
AVERAGE
SHARES PRICE
January 1, 2002 $ 26,655 $ 16.00
Options granted 4,845 16.81
Options exercised (3,263) 15.83
January 1, 2003 28,237 16.00
Options granted 0
Options exercised 0
December 31, 2003 28,237 16.00
Options granted 0
Options exercised (3,964) 15.83
December 31, 2004 $ 24,273 $ 16.03
73
As of December 31, 2004, no additional shares of common stock remain reserved
for future grants to officers and key employees under the option plan approved
by the shareholders.
NOTE 16 CAPITAL REQUIREMENTS
PSB and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory-and possibly additional
discretionary-actions by regulators that, if undertaken, could have a direct
material effect on PSB's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, PSB and
the Bank must meet specific capital guidelines that involve quantitative
measures of assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require PSB and the Bank to maintain minimum amounts and ratios (set forth in
the following table) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December
31, 2004, that PSB and the Bank meet all capital adequacy requirements.
As of December 31, 2004, the most recent notification from the FDIC categorized
the Bank as well-capitalized under the regulatory framework for prompt
corrective action. To be categorized as well-capitalized, the Bank must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage
ratios as set forth in the table. There are no conditions or events since that
notification that management believes have changed the Bank's category.
PSB's and the Bank's actual and regulatory capital amounts and ratios are as
follows:
TO BE WELL-
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
As of December 31, 2004:
Total capital (to risk
weighted assets):
Consolidated $37,305 10.7% $28,017 8.0% N/A N/A
Subsidiary bank $36,745 10.5% $28,017 8.0% $35,021 10.0%
Tier I capital (to risk
weighted assets):
Consolidated $33,148 9.5% $14,008 4.0% N/A N/A
Subsidiary bank $32,588 9.3% $14,008 4.0% $21,013 6.0%
74
TO BE WELL-
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
Tier I capital (to
average assets):
Consolidated $33,148 7.4% $17,918 4.0% N/A N/A
Subsidiary bank $32,588 7.3% $17,856 4.0% $22,320 5.0%
As of December 31, 2003:
Total capital (to risk
weighted assets):
Consolidated $34,752 10.9% $25,440 8.0% N/A N/A
Subsidiary bank $34,345 10.8% $25,440 8.0% $31,800 10.0%
Tier I capital (to risk
weighted assets):
Consolidated $31,216 9.8% $12,720 4.0% N/A N/A
Subsidiary bank $30,809 9.7% $12,720 4.0% $19,080 6.0%
Tier I capital (to
average assets):
Consolidated $31,216 7.8% $15,975 4.0% N/A N/A
Subsidiary bank $30,809 7.7% $15,971 4.0% $19,963 5.0%
NOTE 17 EARNINGS PER SHARE
Basic and diluted earnings per share data are based on the weighted-average
number of common shares outstanding during each period. Diluted earnings per
share are further adjusted for potential common shares that were dilutive and
outstanding during the period. Potential common shares consist of stock
options outstanding under the incentive plan. The dilutive effect of potential
common shares is computed using the treasury stock method. All stock options
are assumed to be 100% vested for purposes of the earnings per share
computations. The computation of earnings per share for the years ended
December 31 are as follows:
2004 2003 2002
Weighted average shares outstanding 1,725,136 1,740,106 1,758,249
Effect of dilutive stock options outstanding 14,757 12,854 4,474
Diluted weighted average shares outstanding 1,739,893 1,752,960 1,762,723
Basic earnings per share $ 2.04 $ 2.76 $ 2.48
Diluted earnings per share $ 2.03 $ 2.74 $ 2.48
75
On November 19, 2002, PSB's stockholders approved an increase in authorized
shares from 1,000,000 to 3,000,000, allowing the Board of Directors to effect a
2 for 1 stock split paid on December 2, 2002. On December 16, 2003, PSB
declared a 5% stock dividend to stockholders of record on January 6, 2004,
which was paid on January 29, 2004. All references in the accompanying
consolidated financial statements to the number of common shares and per share
amounts for 2004, 2003, and 2002 have been restated to reflect the split and
the 5% stock dividend.
NOTE 18 RESTRICTIONS ON RETAINED EARNINGS
The subsidiary Bank is restricted by banking regulations from making dividend
distributions above prescribed amounts and is limited in making loans and
advances to PSB. At December 31, 2004, the retained earnings of the subsidiary
available for distribution as dividends without regulatory approval was
approximately $8,728.
NOTE 19 FAIR VALUE OF FINANCIAL INSTRUMENTS
Current accounting standards require that PSB disclose estimated fair values
for its financial instruments. Fair value estimates, methods, and assumptions
are set forth below for PSB's financial instruments.
The following methods and assumptions were used by PSB in estimating its fair
value disclosures for financial statements:
Cash and cash equivalents: The carrying amounts reported in the balance sheets
approximate fair value.
Securities: Fair values are based on quoted market prices, where available.
If a quoted market price is not available, fair value is estimated using quoted
market prices for similar securities.
Loans held for sale: Fair value is based on commitments on hand from investors
or prevailing market prices.
Loans: Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as commercial,
residential mortgage, and other consumer. The fair value of loans is
calculated by discounting scheduled cash flows through the estimated maturity
using estimated market discount rates that reflect the credit and interest rate
risk inherent in the loan. The estimate of maturity is based on PSB's
repayment schedules for each loan classification. In addition, for impaired
loans, marketability and appraisal values for collateral were considered in the
fair value determination. The carrying amount of accrued interest approximates
its fair value.
Mortgage Servicing Rights: Fair values are based on estimated discounted cash
flows based on current market rates and the anticipated repayment term of the
serviced loans or estimates of similar prices for similar rights.
Deposit Liabilities: The fair value of deposits with no stated maturity, such
as non-interest-bearing demand deposits, savings, NOW accounts, and money
market accounts, is equal to the amount
76
payable on demand at the reporting date. The fair value of certificates of
deposit is based on the discounted value of contractual cash flows. The
discount rate reflects the credit quality and operating expense factors of PSB.
FHLB Advances: The fair value of PSB's long-term advances (other than
deposits) is estimated using discounted cash flow analyses based on PSB's
current incremental borrowing rates for similar types of borrowing
arrangements.
Other Borrowings: The fair value of other borrowings with no stated maturity,
such as federal funds purchased, is equal to the amount payable on demand at
the reporting date. Fair value for fixed rate repurchase agreements is
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on repurchase agreements to a schedule of aggregated
expected maturities on the existing agreements.
Off-Balance-Sheet Instruments: The fair value of commitments would be
estimated using the fees currently charged to enter into similar agreements,
taking into account the remaining terms of the agreements, the current interest
rates, and the present creditworthiness of the counter parties. Since this
amount is immaterial, no amounts for fair value are presented.
The carrying amounts and fair values of PSB's financial instruments consisted
of the following at December 31:
2004 2003
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
Financial assets:
Cash and cash equivalents $ 23,324 $ 23,324 $ 18,927 $ 18,927
Securities 68,894 68,894 72,472 72,472
FHLB stock 2,874 2,874 2,444 2,444
Net loans receivable 344,265 343,463 304,546 306,743
Accrued interest receivable 1,744 1,744 1,617 1,617
Mortgage servicing rights 839 839 814 814
Financial liabilities:
Deposits 358,225 357,566 316,414 318,194
FHLB advances 52,000 51,964 47,000 48,315
Other borrowings 8,565 8,548 10,475 10,524
Accrued interest payable 891 891 713 713
LIMITATIONS
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from
offering for sale at one time PSB's entire holdings of a particular financial
77
instrument. Because no market exists for a significant portion of PSB's
financial instruments, fair value estimates are based on judgments regarding
future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and, therefore, cannot be determined with precision.
Changes in assumptions could significantly affect the estimates. Fair value
estimates are based on existing on- and off-balance-sheet financial instruments
without attempting to estimate the value of anticipated future business and the
value of assets and liabilities that are not considered financial instruments.
Significant assets and liabilities that are not considered financial assets or
liabilities include premises and equipment, other assets, and other
liabilities. In addition, the tax ramifications related to the realization of
the unrealized gains or losses can have a significant effect on fair value
estimates and have not been considered in the estimates.
NOTE 20 CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following condensed balance sheets as of December 31, 2004 and 2003, and
condensed statements of income and cash flows for the years ended December 31,
2004, 2003, and 2002, for PSB Holdings, Inc. should be read in conjunction with
the consolidated financial statements and footnotes.
BALANCE SHEETS
December 31, 2004 and 2003
ASSETS 2004 2003
Cash and due from banks $ 1,044 $ 877
Investment in Peoples State Bank 33,056 31,734
Other assets 32 32
TOTAL ASSETS $ 34,132 $ 32,643
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued dividends payable $ 516 $ 502
Total stockholders' equity 33,616 32,141
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 34,132 $ 32,643
78
NOTE 20 (CONTINUED)
STATEMENTS OF INCOME
Years Ended December 31, 2004, 2003, and 2002
2004 2003 2002
Income:
Dividends from Peoples State Bank $ 1,822 $ 1,361 $ 1,750
Dividends from other investments 10 20 0
Interest 3 4 3
Total income 1,835 1,385 1,753
Expenses:
Transfer agent and shareholder communication 42 40 34
Other 78 74 66
Total expenses 120 114 100
Income before income taxes and equity in
undistributed net income of Peoples State Bank 1,715 1,271 1,653
Provision for income tax benefit (29) (30) (32)
Net income before equity in undistributed
net income of Peoples State Bank 1,744 1,301 1,685
Equity in undistributed net income of
Peoples State Bank 1,782 3,505 2,680
Net income $ 3,526 $ 4,806 $ 4,365
79
NOTE 20 (CONTINUED)
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2004, 2003, and 2002
2004 2003 2002
Increase (decrease) in cash and due from
banks:
Cash flows from operating activities:
Net income $ 3,526 $ 4,806 $ 4,365
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed net income of
Peoples State Bank (1,782) (3,505) (2,680)
Decrease in other assets 0 2 39
Increase (decrease) in dividends payable 14 (123) 37
Net cash provided by operating activities 1,758 1,180 1,761
Cash flows from financing activities:
Dividends declared (1,034) (998) (944)
Proceeds from stock options issued
out of treasury 63 0 51
Proceeds from stock shares issued
to Peoples State Bank out of treasury
used to pay Directors fees 8 45 60
Purchase of treasury stock (628) (553) (394)
Net cash used in financing activities (1,591) (1,506) (1,227)
Net increase (decrease) in cash and due
from banks 167 (326) 534
Cash and due from banks at beginning 877 1,203 669
Cash and due from banks at end $ 1,044 $ 877 $ 1,203
80
NOTE 21 SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
THREE MONTHS ENDED
March 31 June 30 Sept 30 Dec 31
2004
Interest income $ 5,304 $ 5,458 $ 5,638 $ 5,802
Interest expense 1,830 1,941 2,117 2,225
Net interest income 3,474 3,517 3,521 3,577
Provision for loan losses 240 240 195 180
Net income applicable to
common stock 954 782 747 1,043
Basic earnings per share 0.55 0.45 0.43 0.61
Diluted earnings per share 0.55 0.45 0.43 0.60
2003
Interest income $ 5,293 $ 5,258 $ 5,241 $ 5,258
Interest expense 2,061 1,990 1,935 1,883
Net interest income 3,232 3,268 3,306 3,375
Provision for loan losses 225 240 240 130
Net income applicable to
common stock 1,224 1,057 1,235 1,290
Basic earnings per share* 0.70 0.61 0.71 0.74
Diluted earnings per share* 0.70 0.60 0.71 0.74
2002
Interest income $ 5,370 $ 5,405 $ 5,601 $ 5,539
Interest expense 2,376 2,301 2,345 2,251
Net interest income 2,994 3,104 3,256 3,288
Provision for loan losses 180 180 450 300
Net income applicable to
common stock 958 1,024 1,051 1,332
Basic and diluted earnings
per share 0.54 0.58 0.60 0.76
*Basic and diluted earnings per share for the year ended December 31, 2003
were $2.76 and $2.74, respectively. Due to rounding, however, quarterly
diluted earnings per share do not total $2.74 on this summary.
81
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES.
As of the end of the period covered by this Annual Report on Form 10-K,
management, under the supervision, and with the participation, of PSB's
President and Chief Executive Officer and the Chief Financial Officer (the
Treasurer), evaluated the effectiveness of the design and operation of PSB's
disclosure controls and procedures as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934. Based upon, and as of the date of such
evaluation, the President and Chief Executive Officer and the Chief Financial
Officer concluded that PSB's disclosure controls and procedures were effective
in all material respects. There have been no significant changes in PSB's
internal controls or in other factors which could significantly affect internal
controls subsequent to the date PSB carried out its evaluation, nor were there
any significant deficiencies or material weaknesses identified which required
any corrective action to be taken.
ITEM 9B. OTHER INFORMATION.
Not applicable.
82
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information relating to directors of PSB is incorporated into this Annual
Report on Form 10-K by this reference to the disclosure in PSB's proxy
statement dated March 11, 2005 relating to the 2005 annual meeting of
shareholders (the "2005 Proxy Statement") under the subcaption "Election of
Directors - Election of Directors."
Information relating to the identification of executive officers of PSB is
found in Part I of this Annual Report on Form 10-K.
Information required under Rule 405 of Regulation S-K is incorporated into this
Annual Report on Form 10-K by this reference to the disclosure in the 2005
Proxy Statement under the subcaption "Beneficial Ownership of Common Stock -
Section 16(a) Beneficial Ownership Reporting Compliance."
CODE OF ETHICS
PSB has adopted a Code of Ethics Policy for all directors, officers, and
employees and a Code of Compliance and Reporting Requirements for Senior
Management and Senior Financial Officers which covers PSB's Chief Executive
Officer, Treasurer (the chief financial and accounting officer), each Vice
President, and the Secretary. The Code of Compliance and Reporting
Requirements for Senior Management and Senior Financial Officers has been
posted on PSB's website under "Investor Relations" at www.psbwi.com. In the
event PSB amends or waives any provision of the Code of Compliance and
Reporting Requirements for Senior Management and Senior Financial Officers, PSB
intends to disclose such amendment or waiver at the website address where the
code may also be found.
AUDIT COMMITTEE
The Board of Directors has appointed an Audit Committee in accordance with
Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Mr. Polzer (Chairman), Mr. Crooks, Mr. Fish, Mr. Gullickson,
and Mr. Sonnentag serve on the Audit Committee (PSB is not a "listed issuer" as
defined in SEC Rule 10A-3).
FINANCIAL EXPERT
The SEC has adopted rules which require PSB to disclose whether one of the
members of the Audit Committee qualifies under SEC rules as an "audit committee
financial expert." Based on its review of the SEC rules, the Board does not
believe that any member of the Audit Committee can be classified as an "audit
committee financial expert."
In order to qualify as an "audit committee financial expert," a member of the
Audit Committee must, for all practical purposes, have the attributes and
career experience of a person who has been actively involved in the
preparation, auditing, or evaluation of public company financial statements.
PSB's size and geographic location make it difficult to recruit directors who
have these specific
83
qualifications. While it may be possible to recruit a director having these
specific qualifications, the Board believes that each of its members should
have a familiarity with PSB's market area and an understanding of PSB's
customer base, in addition to meeting the other general criteria described
in the 2005 Proxy Statement under "Election of Directors - Nominations -
Qualifications," and that it is not in the best interest of PSB to nominate
a director who does not possess these characteristics. Moreover, the
Committee has the authority under its charter to retain or dismiss the
independent auditor and to hire such other experts or legal counsel as it deems
appropriate in order to fulfill its duties, and it therefore believes that it
has access to required financial expertise. The Board will consider any
potential candidates who meet its current general qualification criteria and
those of an "audit committee financial expert," but, for the time being, the
Board believes that the current members of the Committee, working with the
independent auditor, are qualified to perform the duties required in the
Committee's charter.
ITEM 11. EXECUTIVE COMPENSATION.
Information relating to director compensation is incorporated into this Annual
Report on Form 10-K by this reference to the disclosure in the 2005 Proxy
Statement under the subcaption "The Board of Directors - Compensation of
Directors."
Information relating to the compensation of executive officers is incorporated
into this Annual Report on Form 10-K by this reference to (1) the disclosure in
the 2005 Proxy Statement beginning under the caption "Executive Officer
Compensation," through the disclosure under the subcaption,
"- Employment and Change of Control Agreements," and (2) the disclosure in the
2005 Proxy Statement under the subcaption "- Committee's Report on Compensation
Policies - Compensation Committee and Board Interlocks and Insider
Participation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
Information relating to security ownership of certain beneficial owners and
management is incorporated into this Annual Report on Form 10-K by this
reference to the disclosure in the 2005 Proxy Statement beginning under the
caption "Beneficial Ownership of Common Stock" and ending at the subcaption "-
Section 16(a) Beneficial Ownership Reporting Compliance."
The following table sets forth, as of December 31, 2004, information with
respect to compensation plans under which PSB's common stock is authorized for
issuance:
84
Plan category Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining availablefor
of outstanding options, outstanding options, future issuance under
warrants and rights warrants and rights equity compensation plans
(excluding securities
reflected in column (a))
(a) (b) (c)
Equity compensation 24,273 $16.03 0
plans approved by
security holders
Equity compensation 0 n/a n/a
plans not approved by
security holders
Total 24,273 $16.03 0
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information relating to certain relationships and related transactions with
directors and officers is incorporated into this Annual Report on Form 10-K by
this reference to the disclosure in the 2005 Proxy Statement under the
subcaption "The Board of Directors - The Board - Certain Relationships and
Related Transactions."
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Information relating to the fees and services of PSB's principal accountant is
incorporated into this Annual Report on Form 10-K by this reference to the
disclosure in the 2005 Proxy Statement under the subcaptions "Audit Committee
Report and Related Matters - Independent Auditor and Fees," and "- Audit
Committee Pre-Approval Policies."
85
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report.
(1) The following consolidated financial statements of PSB and the
Independent Auditors' Report thereon are filed as part of this report:
(i) Consolidated Balance Sheets as of December 31, 2004 and 2003
(ii) Consolidated Statements of Income for the years ended December 31,
2004, 2003, and 2002
(iii) Consolidated Statements of Stockholders' Equity for the years
ended December 31, 2004, 2003, and 2002
(iv) Consolidated Statements of Cash Flows for the years ended December
31, 2004, 2003, and 2002
(v) Notes to Consolidated Financial Statements
(2) No financial statement schedules are required by Item 15(d).
(3) The following exhibits required by Item 601 of Regulation S-K are filed
as part of this report.
Exhibit
Number Description
3.1 Restated Articles of Incorporation (incorporated by reference to
Exhibit 3.1 to PSB's Annual Report on Form 10-K for the fiscal
year ended December 31, 2002)
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to PSB's Annual
Report on Form 10-K for the fiscal year ended December 31, 2000)
4.1 Articles of Incorporation and Bylaws (see Exhibits 3.1 and 3.2)
10.1 Bonus Plan of Directors of the Bank (incorporated by reference to
Exhibit 10.1 to PSB's Annual Report on Form 10-K for the fiscal
year ended December 31, 2002)*
10.2 Non-Qualified Retirement Plan for Directors of the Bank
(incorporated by reference to Exhibit 10.2 to PSB's Annual Report
on Form 10-K for the fiscal year ended December 31, 2001)*
10.3 Senior Management Incentive Compensation Plan
10.4 2001 Stock Option Plan (incorporated by reference to Exhibit 10.5
to PSB's Quarterly Report on Form 10-Q for the period ended June
30, 2001)*
86
10.5 Employment and Change of Control Agreement with David K. Kopperud
(incorporated by reference to Exhibit 10.5 to PSB's Annual Report
on Form 10-K for the fiscal year ended December 31, 2002)*
10.6 Employment and Change of Control Agreement with David A. Svacina
(incorporated by reference to Exhibit 10.6 to PSB's Annual Report
on Form 10-K for the fiscal year ended December 31, 2002)*
10.7 Employment and Change of Control Agreement with Scott M. Cattanach
(incorporated by reference to Exhibit 10.2 to PSB's Quarterly
Report on Form 10-Q for the period ended March 31, 2003)*
10.8 Directors Deferred Compensation Plan (incorporated by reference to
Exhibit 10.1 to PSB's Quarterly Report on Form 10-Q for the period
ended March 31, 2003)*
10.9 Executive Deferred Compensation Plan
10.10 Incentive Deferred Bonus Plan
10.11 Survivor Income Plan
21.1 Subsidiaries of PSB (incorporated by reference to Exhibit 21.1 to
PSB's Annual Report on Form 10-K for the fiscal year ended
December 31, 2000)
23.1 Consent of Wipfli LLP
31.1 Certification of CEO pursuant to Section 302 of Sarbanes-Oxley Act
of 2002
31.2 Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Act
of 2002
32.1 Certifications under Section 906 of Sarbanes-Oxley Act of 2002
*Denotes Executive Compensation Plans and Arrangements.
(b) Exhibits.
See Item 15(a)(3).
(c) Financial Schedules.
Not applicable.
87
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PSB Holdings, Inc.
March 11, 2005 By: DAVID K. KOPPERUD
David K. Kopperud, President
and Chief Executive Officer
Pursuant to the requirement of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on this 11th day of March, 2005.
Signature and Title Signature and Title
DAVID K. KOPPERUD SCOTT M. CATTANACH
David K. Kopperud, President Scott M. Cattanach, Treasurer and CFO
Chief Executive Officer and a Director (Principal Financial Officer and
Accounting Officer)
DIRECTORS:
GORDON P. CONNOR PATRICK L. CROOKS
Gordon P. Connor Patrick L. Crooks
WILLIAM J. FISH CHARLES A. GHIDORZI
William J. Fish Charles A. Ghidorzi
GORDON P. GULLICKSON JOHN H. SONNENTAG
Gordon P. Gullickson John H. Sonnentag
THOMAS R. POLZER THOMAS A. RIISER
Thomas R. Polzer Thomas A. Riiser
WILLIAM M. REIF
William M. Reif
88
EXHIBIT INDEX
TO
FORM 10-K
OF
PSB HOLDINGS, INC.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
PURSUANT TO SECTION 102(D) OF REGULATION S-T
(17 C.F.R. Section 232.102(D))
The following exhibits are filed as part of this report:
10.3 Senior Management Incentive Compensation Plan
10.9 Executive Deferred Compensation Plan
10.10 Incentive Deferred Bonus Plan
10.11 Survivor Income Plan
23.1 Consent of Wipfli LLP
31.1 Certification of CEO pursuant to Section 302 of Sarbanes-Oxley Act
of 2002
31.2 Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Act
of 2002
32.1 Certifications under Section 906 of Sarbanes-Oxley Act of 2002
89