FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number: 0-26480
PSB HOLDINGS, INC.
(Exact name of registrant as specified in charter)
WISCONSIN 39-1804877
(State of incorporation) (I.R.S. Employer Identification Number)
1905 WEST STEWART AVENUE
WAUSAU, WISCONSIN 54401
(Address of principal executive office)
Registrant's telephone number, including area code: 715-842-2191
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes ___ No X
The number of common shares outstanding at August 4, 2005 was 1,712,771.
PSB HOLDINGS, INC.
FORM 10-Q
Quarter Ended June 30, 2005
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
June 30, 2005 (unaudited) and December 31,
2004 (derived from audited financial statements) 1
Consolidated Statements of Income
Three Months and Six Months Ended June 30, 2005
and 2004 (unaudited) 2
Consolidated Statement of Changes in Stockholders' Equity
Six Months Ended June 30, 2005 (unaudited) 3
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2005 and 2004 (unaudited) 4
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
Item 4. Controls and Procedures 31
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 6. Exhibits 33
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PSB HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
June 30, 2005 (unaudited), December 31, 2004 (derived from audited financial
statements)
(dollars in thousands, except per share data) June 30, December 31,
2005 2004
ASSETS
Cash and due from banks $ 13,019 $ 12,680
Interest-bearing deposits and money market funds 2,633 3,265
Federal funds sold 2,610 7,379
Cash and cash equivalents 18,262 23,324
Securities available for sale (at fair value) 72,464 68,894
Federal Home Loan Bank stock (at cost) 2,953 2,874
Loans held for sale 610 342
Loans receivable, net of allowance for loan losses of $4,309
and $4,157, respectively 370,252 343,923
Accrued interest receivable 1,971 1,744
Foreclosed assets 229 7
Premises and equipment 12,622 12,432
Mortgage servicing rights, net 853 839
Cash surrender value of bank-owned life insurance 4,627 -
Other assets 1,347 595
TOTAL ASSETS $486,230 $454,974
LIABILITIES
Non-interest-bearing deposits $ 53,759 $ 51,635
Interest-bearing deposits 325,781 306,590
Total deposits 379,540 358,225
Federal Home Loan Bank advances 55,000 52,000
Other borrowings 5,879 8,565
Junior subordinated debentures 7,732 -
Accrued expenses and other liabilities 3,363 2,568
Total liabilities 451,514 421,358
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
Additional paid-in capital 9,655 9,672
Retained earnings 26,960 25,281
Accumulated other comprehensive income (loss) 72 384
Treasury stock, at cost - 174,408 and 167,586 shares,
respectively (3,858) (3,608)
Total stockholders' equity 34,716 33,616
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $486,230 $454,974
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PSB HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Six Months Ended
(dollars in thousands, June 30, June 30,
except per share data - unaudited) 2005 2004 2005 2004
Interest and dividend income:
Loans, including fees $ 5,581 $ 4,714 $10,784 $ 9,268
Securities:
Taxable 467 453 919 914
Tax-exempt 237 245 478 488
Other interest and dividends 55 46 123 92
Total interest and dividend income 6,340 5,458 12,304 10,762
Interest expense:
Deposits 2,141 1,360 3,952 2,651
FHLB advances 507 504 1,057 970
Other borrowings 106 77 189 150
Junior subordinated debentures 4 - 4 -
Total interest expense 2,758 1,941 5,202 3,771
Net interest income 3,582 3,517 7,102 6,991
Provision for loan losses 30 240 180 480
Net interest income after provision for loan losses 3,552 3,277 6,922 6,511
Noninterest income:
Service fees 324 322 584 613
Mortgage banking 249 308 404 468
Investment and insurance sales commissions 202 90 372 181
Net gain on sale of securities - - 6 111
Increase in cash surrender value of life insurance 46 - 66 -
Other noninterest income 126 135 318 222
Total noninterest income 947 855 1,750 1,595
Noninterest expense:
Salaries and employee benefits 1,641 1,547 3,270 3,095
Occupancy and facilities 427 361 872 662
Loss on abandonment of premises and equipment - 329 - 329
Data processing and other office operations 168 187 340 347
Advertising and promotion 95 64 158 98
Other noninterest expenses 449 426 780 985
Total noninterest expense 2,780 2,914 5,420 5,516
Income before provision for income taxes 1,719 1,218 3,252 2,590
Provision for income taxes 548 436 1,041 854
Net income $ 1,171 $ 782 $ 2,211 $ 1,736
Basic earnings per share $ 0.68 $ 0.45 $ 1.29 $ 1.00
Diluted earnings per share $ 0.68 $ 0.45 $ 1.28 $ 0.99
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PSB HOLDINGS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Six months ended June 30, 2005 - unaudited
Accumulated
Other
Additional Comprehensive
Common Paid-in Retained Income Treasury
(dollars in thousands) Stock Capital Earnings (Loss) Stock Totals
Balance January 1, 2005 $1,887 $9,672 $25,281 $384 $(3,608) $33,616
Comprehensive income:
Net income 2,211 2,211
Unrealized loss on securities
available for sale, net of tax (310) (310)
Reclassification adjustment for security
gain included in net income, net of tax (2) (2)
Total comprehensive income 1,899
Purchase of treasury stock (318) (318)
Proceeds from stock options issued out
of treasury (17) 65 48
Distribution of treasury stock in settlement
of liability to Company directors 3 3
Cash dividends declared $.31 per share (532) (532)
Balance June 30, 2005 $1,887 $9,655 $26,960 $ 72 $(3,858) $34,716
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PSB HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended June 30, 2005 and 2004 - unaudited (dollars in thousands)
2005 2004
Cash flows from operating activities:
Net income $ 2,211 $ 1,736
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for depreciation and net amortization 822 587
Provision for loan losses 180 480
Deferred net loan origination costs (276) -
Gain on sale of mortgage loans (270) (433)
Provision for servicing right valuation allowance 2 48
Loss on abandonment of premises and equipment - 329
Gain on sale of premises and equipment (2) -
Gain on sale of foreclosed assets (2) (37)
Gain on sale of securities (6) (111)
Increase in cash surrender value of life insurance (66) -
FHLB stock dividends (79) (77)
Changes in operating assets and liabilities:
Accrued interest receivable (227) (107)
Other assets (330) (119)
Other liabilities 798 (588)
Net cash provided by operating activities 2,755 1,708
Cash flows from investing activities:
Proceeds from sale and maturities of:
Securities available for sale 6,582 6,688
Payment for purchase of:
Securities available for sale (10,710) (7,005)
Purchase of FHLB stock - (271)
Net increase in loans (26,837) (20,962)
Capital expenditures (661) (3,563)
Proceeds from sale of premises and equipment 2 -
Proceeds from sale of foreclosed assets 60 7
Purchase of bank-owned life insurance (4,561) -
Net cash used in investing activities (36,125) (25,106)
Cash flows from financing activities:
Net increase (decrease) in non-interest-bearing deposits 2,124 (3,662)
Net increase in interest-bearing deposits 19,191 27,524
Proceeds from long-term FHLB advances 17,000 10,000
Repayments of long-term FHLB advances (14,000) (10,000)
Net increase (decrease) in other borrowings (2,686) (1,081)
Proceeds from issuance of junior subordinated debentures 7,481 -
Dividends declared (532) (518)
Proceeds from issuance of stock options 48 -
Purchase of treasury stock (318) (280)
Net cash provided by financing activities 28,308 21,983
Net decrease in cash and cash equivalents (5,062) (1,415)
Cash and cash equivalents at beginning 23,324 18,927
Cash and cash equivalents at end $ 18,262 $17,512
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CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Six months ended June 30, 2005 and 2004 - unaudited (dollars in thousands)
2005 2004
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 5,019 $ 3,810
Income taxes 610 883
Noncash investing and financing activities:
Loans charged off $ 34 $ 117
Loans transferred to foreclosed assets 281 -
Loans originated on sale of foreclosed assets - 70
Distribution of treasury stock in settlement of liability
to Company directors 3 8
Common stock of PSB Holdings Statutory Trust I acquired
in exchange for junior subordinated debentures 232 -
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PSB Holdings, Inc.
Notes to Consolidated Financial Statements
NOTE 1 - GENERAL
In the opinion of management, the accompanying unaudited consolidated financial
statements contain all adjustments necessary to present fairly PSB Holdings,
Inc.'s ("PSB") financial position, results of its operations, and cash flows
for the periods presented, and all such adjustments are of a normal recurring
nature. The consolidated financial statements include the accounts of all
subsidiaries. All material intercompany transactions and balances are
eliminated. The results of operations for the interim periods are not
necessarily indicative of the results to be expected for the full year. Any
reference to "PSB" refers to the consolidated or individual operations of PSB
Holdings, Inc. and its subsidiary Peoples State Bank.
These interim consolidated financial statements have been prepared according to
the rules and regulations of the Securities and Exchange Commission and,
therefore, certain information and footnote disclosures normally presented in
accordance with generally accepted accounting principles have been omitted or
abbreviated. The information contained in the consolidated financial
statements and footnotes in PSB's 2004 annual report on Form 10-K, should be
referred to in connection with the reading of these unaudited interim financial
statements.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ significantly from those estimates.
Estimates that are susceptible to significant change include the determination
of the allowance for loan losses, mortgage servicing right assets, and the
valuation of investment securities.
NOTE 2 - STOCK-BASED COMPENSATION
PSB records expense relative to stock-based compensation using the "intrinsic
value method." Since the exercise price is equal to the fair value of PSB's
common stock on the date of the award, the intrinsic value of PSB's stock
options is "zero" at the time of the award and no expense is recorded.
As permitted by generally accepted accounting principles, PSB has not adopted
the "fair value method" of expense recognition for stock-based compensation
awards. Rather, the effects of the fair value method on PSB's earnings are
presented on a pro forma basis. Because no grants of stock options were made
during the three months and six months ended June 30, 2005 and 2004, there was
no pro forma impact to net income or earnings per share during these periods.
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
at prices not less than the fair market value of the shares at the date of the
grant. These options expire 10 years after the grant date with the first
options scheduled to expire beginning in the year 2011. As of June 30, 2005,
21,215 options outstanding were eligible to be exercised at a weighted average
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exercise price of $16.06 per share. No additional shares of common stock
remain reserved for future grants under the option plan approved by the
shareholders.
NOTE 3 - EARNINGS PER SHARE
Basic earnings per share of common stock are based on the weighted average
number of common shares outstanding during the period. Diluted earnings per
share is calculated by dividing net income by the weighted average number of
shares adjusted for the dilutive effect of outstanding stock options.
Presented below are the calculations for basic and diluted earnings per share:
Three months ended Six months ended
(dollars in thousands, except per share data - unaudited) June 30, June 30,
2005 2004 2005 2004
Net income $ 1,171 $ 782 $ 2,211 $ 1,736
Weighted average shares outstanding 1,714,134 1,729,322 1,717,577 1,731,426
Effect of dilutive stock options outstanding 10,235 15,310 10,399 15,221
Diluted weighted average shares outstanding 1,724,369 1,744,632 1,727,976 1,746,647
Basic earnings per share $ 0.68 $ 0.45 $ 1.29 $ 1.00
Diluted earnings per share $ 0.68 $ 0.45 $ 1.28 $ 0.99
NOTE 4 - COMPREHENSIVE INCOME
Comprehensive income as defined by current accounting standards for the three
months and six months ended June 30, 2005 and 2004 is as follows:
Three months ended Six months ended
June 30, June 30,
(dollars in thousands - unaudited) 2005 2004 2005 2004
Net income $ 1,171 $ 782 $ 2,211 $ 1,736
Unrealized gain (loss) on securities
available for sale, net of tax 266 (1,259) (310) (781)
Reclassification adjustment for security
gain included in net income, net of tax - - (2) (67)
Comprehensive income (loss) $ 1,437 $ (477) $ 1,899 $ 888
NOTE 5 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans receivable are stated at unpaid principal balances plus net deferred loan
origination costs less loans in process and the allowance for loan losses.
Interest on loans is credited to income as earned. Interest income is not
accrued on loans where management has determined collection of such interest is
doubtful or those loans which are past due 90 days or more as to principal or
interest payments. When a loan is placed on nonaccrual status, previously
accrued but unpaid interest deemed uncollectible is reversed and charged
against current income. After being placed on nonaccrual status, additional
income is recorded
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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 contractual life of the underlying loan.
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 that 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 as of the balance sheet date. The allowance is
based on past events and current economic conditions, and does not include the
effects of expected losses on specific loans or groups of loans that are
related to future events or expected changes in economic conditions. While
management uses the best information available to make its evaluation, future
adjustments to the allowance may be necessary if there are significant changes
in economic conditions.
The allowance for loan losses includes specific allowances related to loans
which have been judged to be impaired 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 homogenous loans, such as residential mortgage and consumer
loans, are collectively evaluated for impairment. Specific allowances are
based on discounted cash flows of expected future payments using the loan's
initial effective interest rate or the fair value of collateral if the loan is
collateral dependent.
In addition, various regulatory agencies periodically review the allowance for
loan losses. These agencies may require the subsidiary Bank 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.
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 and are
carried as "Loans held for sale" on the balance sheet. 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.
NOTE 6 - FORECLOSED REAL ESTATE
Real estate properties acquired through, or in lieu of, loan foreclosure are to
be sold and are initially recorded at fair value (after deducting estimated
costs to sell) at the date of foreclosure, establishing a new cost basis.
Costs related to development and improvement of property are
8
capitalized, whereas costs related to holding property are expensed. After
foreclosure, valuations are periodically performed by management and the real
estate 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.
NOTE 7 - INCOME TAXES
The Internal Revenue Service (IRS) has audited PSB's federal income tax returns
for 1999 through 2002, and has disallowed a portion of People State Bank's
interest deductions for such years. The IRS asserts that PSB owes an
additional $182,000 of tax and interest (computed through August 15, 2005).
The IRS's contention is that municipal bonds owned by the Bank's Nevada
investment subsidiary should be treated as owned by the Bank for purposes of
computing the Bank's allowable interest expense. The IRS has made the same
adjustment for other Wisconsin banks that have Nevada investment subsidiaries.
In August 2005, PSB filed a petition with the United State Tax Court contesting
such adjustment. PSB believes all tax returns are correct as filed, and, at
this time, no additional tax expense for this adjustment has been recorded.
NOTE 8 - 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 9 - JUNIOR SUBORDINATED DEBENTURES
PSB Holdings Statutory Trust I, a Delaware business trust wholly owned by PSB,
completed the sale of $7,500,000 of Trust Preferred Securities to a pooling
vehicle of other trust preferred securities whose shares were later sold to
private investors (a pooled trust preferred offering). The Trust used the
proceeds from the offering and the issuance of $232,000 of common stock
ownership in the Trust to purchase $7,732,000 of PSB Junior Subordinated
Debentures from PSB.
The Trust Preferred Securities mature in 30 years and have an initial fixed
rate of 5.82% until September 2010. Following September 2010, the rate is
adjusted quarterly to the three month London Interbank Offered Rate (LIBOR)
plus 1.70%. The Trust Preferred Securities may be called in part or in full on
September 15, 2010, and quarterly thereafter, with 30 days notice. The Trust
Preferred Securities are mandatorily redeemable upon the maturity of the
Debentures on September 15, 2035 or upon earlier redemption.
PSB has fully and unconditionally guaranteed all of the obligations of the
Trust. The guarantee covers the quarterly distributions and payments on
liquidation or redemption of the Trust Preferred Securities, but only to the
extent of funds held by the Trust. The Trust Preferred Securities qualify
under the risk-based capital guidelines as Tier 1 capital for regulatory
purposes. PSB used the proceeds from the sales of the debentures for general
corporate purposes and to support continued asset growth through funding
qualifying as regulatory capital.
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NOTE 10 - DERIVATIVE INSTRUMENT
PSB uses an interest rate swap to manage its risk associated with fixed rate
liability funding that is subject to changes in fair value. The contract has
been designated and qualifies as a fair value hedge and is reported at fair
value. The contract is deemed to be fully effective and, therefore, the change
in fair value of the hedge is offset against the opposite change of fair value
in the liability being hedged. At the inception of the contract, PSB has
documented its risk management strategy and the hedge's effectiveness. PSB
interest rate risk management strategy is to change fixed brokered time deposit
interest payments to a floating rate payment to better match low-cost funding
with recently originated adjustable rate commercial loans. Consistent with the
classification of interest payments on the related debt, the cash settlements
associated with the interest rate swap are presented as operating activities in
the statement of cash flows.
During April 2005, PSB entered into a $10,000,000 notional amount interest rate
swap contract under which it pays interest at a floating rate equal to 30 day
LIBOR less 2.5 basis points and receives fixed rate payments of 4.25%. The
contract is considered to be a fully effective fair value hedge and therefore
changes in the fair value of the interest rate swap directly offset changes to
the fair value of the liability on the balance sheet. Interest expense
reported on the statement on income is equal to the floating rate paid on the
swap. Both the swap (by the swap counterparty) and the liability (by PSB) are
callable in April 2006, with additional semi-annual call dates until final
maturity in October 2008. The fair value liability of the swap at June 30,
2005 of $19,275 is included in other liabilities on the balance sheet.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis is presented to assist in the
understanding and evaluation of PSB's financial condition and results of
operations. It is intended to complement the unaudited financial statements,
footnotes, and supplemental financial data appearing elsewhere in this Form 10-
Q and should be read in conjunction therewith. Dollar amounts are in
thousands, except per share amounts. The quarterly report on Form 10-Q
describes the business of PSB Holdings, Inc. and its subsidiary Peoples State
Bank as in effect on June 30, 2005, and any reference to "PSB" refers to the
consolidated or individual operations of PSB Holdings, Inc. and Peoples State
Bank.
Forward-looking statements have been made in this document that are subject to
risks and uncertainties. While PSB believes these forward-looking statements
are based on reasonable assumptions, all such statements involve risk and
uncertainties that could cause actual results to differ materially from those
contemplated in this report. The assumptions, risks, and uncertainties
relating to the forward-looking statements in this report include those
described under the caption "Cautionary Statements Regarding Forward-Looking
Information" in Part I of PSB's Form 10-K for the year ended December 31, 2004
and, from time to time, in PSB's other filings with the Securities and Exchange
Commission.
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EXECUTIVE OVERVIEW
This overview summarizes PSB's financial trends and the primary opportunities
and challenges faced by management. It is intended to assist the reader in
better understanding these trends and management's plan to address them. In
addition, the near-term issues on which management is most focused are outlined
in general terms as a backdrop for more detailed statistical and narrative
analysis presented in this Quarterly Report on Form 10-Q.
PSB earnings increased substantially during the three and six months ended June
30, 2005 compared to the prior year periods. The prior year quarter ended June
30, 2004 included a special charge of $199 after tax benefits as the prior home
office building (located on the same property now used as a home office by PSB)
was demolished. Even if this special charge is disregarded, earnings per share
are up 21% for the quarter ended June 30, 2005 and up 16% for the six months
ended June 30, 2005 compared to last year.
Credit quality continues to improve as existing problem loans are reduced while
PSB originates new high credit quality commercial loans to large local
businesses. Recognizing this improvement in credit quality, provisions for
loan losses have declined compared to the prior year, contributing to increased
2005 net income.
PSB is strategically expanding into additional commercial banking products and
has recently invested in people, equipment, and products to serve larger
commercial borrowers. Loans originated to this customer base are typically at
much lower credit spreads than lending to PSB's traditional small business
customer. Because this loan growth has substantially outpaced deposit growth,
these loans have been funded with high-cost funding, primarily brokered
certificates of deposit and high-yield money market and government funds. This
combination of lower asset yields and higher cost funding has contributed to
the decrease in net margin compared to prior periods. In addition, during the
June 2005 quarter, some wholesale funding was extended to take advantage of
temporary declines in mid-term wholesale funding costs (3 to 6 years to final
maturity). This extension combined with new adjustable rate commercial loan
originations has increased the asset sensitivity of the balance sheet.
PSB is seeking to increase net margin by aggressively acquiring new non-
interest bearing deposits from both commercial treasury management services and
retail deposits. After extensive research on features and pricing of
competitive products, PSB products have been updated and new commercial
treasury management software for our customers was recently introduced.
Growth in residential mortgage loans held for investment has been small as loan
originations have been sold to the secondary market to increase profit compared
to holding such loans in the portfolio. Despite a national trend toward
origination of non-traditional mortgage products such as "option ARMs" and
interest rate only mortgages, PSB has not changed mortgage lending standards or
introduced such products.
In June 2005, PSB raised $7.5 million of regulatory capital for general
corporate purposes from the issuance of trust preferred securities. This
capital will support continued asset growth at a
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minimal cost of capital without diluting the holdings of existing shareholders.
This capital issue is reflected as junior subordinated debentures on PSB's
balance sheet in accordance with current accounting standards.
DETAILED MANAGEMENT DISCUSSION AND ANALYSIS
BALANCE SHEET
At June 30, 2005, total assets were $486,230, an increase of $17,538, or 3.7%,
over March 31, 2005, and an increase of $31,256, or 6.9%, over December 31,
2004. Asset growth for the three months and six months ended June 30, 2005,
consisted of:
Three months ended Six months ended
Increase (decrease) in assets ($000s) June 30, 2005 June 30, 2005
$ % $ %
Increase in commercial, industrial and agricultural loans $ 7,097 8.5% $18,124 25.0%
Increase (decrease) in cash and cash equivalents 7,084 63.4% (5,062) -21.7%
Increase in residential real estate mortgage loans 2,407 2.5% 4,402 4.7%
Increase in investment securities 1,381 1.9% 3,570 5.2%
Net change in other assets (various categories) 1,313 3.8% 2,807 8.6%
Investment in bank-owned life insurance 45 1.0% 4,627 100.0%
Increase (decrease) in commercial real estate mortgage loans (1,789) -1.1% 2,788 1.7%
Total increase in assets $17,538 3.7% $31,256 6.9%
PSB continues to emphasize non real estate commercial loan origination during
2005, and growth in this type of loan represented 40.5% of the total net
increase in assets during the quarter ended June 30, 2005 and 58.0% of the net
increase in assets since December 31, 2004. Commercial lending growth is
anticipated to be the greatest portion of asset growth during the remainder of
2005.
Cash and cash equivalents increased $7,084 during the quarter ended June 30,
2005 from additional operating cash held in correspondent banks and an increase
in federal funds sold after the June 28, 2005 trust preferred capital issue
proceeds were received. However, cash and cash equivalents continue to be down
$5,062 from December 31, 2004 primarily from a decrease in federal funds sold
of $4,769.
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Net asset growth for the three months and six months ended June 30, 2005, was
funded by the following:
Three months ended Six months ended
Increase (decrease) in liabilities and equity ($000s) June 30, 2005 June 30, 2005
$ % $ %
Increase in wholesale certificates of deposit $16,875 30.6% $18,192 33.8%
Increase in junior subordinated debentures 7,732 100.0% 7,732 100.0%
Increase in FHLB advances 3,000 5.8% 3,000 5.8%
Increase in retail certificates of deposit > $100 2,220 4.0% 2,645 4.8%
Net increase in other liabilities (various categories) 1,036 44.5% 795 31.0%
Increase in stockholders' equity 779 2.3% 1,100 3.3%
Increase (decrease) in core deposits (including MMDA) (4,939) -1.9% 478 0.2%
Decrease in other borrowings (9,165) -60.9% (2,686) -31.4%
Total increase in liabilities and stockholders' equity $17,538 3.7% $31,256 6.9%
The majority of asset growth during the quarter ended June 30, 2005 was funded
by an increase in wholesale certificates of deposit. Core deposits declined
during the second quarter of 2005 as cyclical municipal deposits acquired
during the beginning of 2005 declined as expected. Origination of core
deposits, including non-interest bearing deposits, is a key strategic
initiative for management to lessen reliance on wholesale funding and to
increase net margin generated by commercial loan growth. During July 2005, PSB
introduced new commercial treasury management products to existing customers
and is actively pursuing new customers to increase local deposit growth.
Although commercial loan covenants require deposits to be held at PSB,
increases in commercial deposits may occur slowly as the commercial loan
customers take steps to move deposits to PSB and change their treasury
management procedures to use the PSB product.
Table 1: Period-End Loan Composition
June 30, June 30, December 31, 2004
Dollars Dollars Percentage of total Percentage
(dollars in thousands) 2005 2004 2005 2004 Dollars of total
Commercial, industrial, and agricultural $ 90,580 $ 70,871 24.1% 21.5%$ 72,456 20.8%
Commercial real estate mortgage 167,319 156,964 44.6% 47.7% 164,531 47.2%
Residential real estate mortgage 97,413 84,235 26.0% 25.6% 93,011 26.7%
Residential real estate loans held for sale 610 - 0.2% 0.0% 342 0.1%
Consumer home equity 12,779 9,791 3.4% 3.0% 11,620 3.3%
Consumer and installment 6,470 7,365 1.7% 2.2% 6,462 1.9%
Totals $375,171 $329,226 100.0% 100.0% $348,422 100.0%
The loan portfolio is PSB's primary asset subject to credit risk. PSB's
process for monitoring credit risks includes monthly analysis of loan quality,
delinquencies, nonperforming assets, and potential problem loans. Loans are
placed on a nonaccrual status when they become
13
contractually past due 90 days or more as to interest or principal payments.
All interest accrued but not collected for loans (including applicable impaired
loans) that are placed on nonaccrual or charged off is reversed against
interest income. The interest on these loans is accounted for on the cash
basis until qualifying for return to accrual status. Loans are returned to
accrual status when all the principal and interest amounts contractually due
have been collected and there is reasonable assurance that repayment according
to the contractual terms will continue.
Nonperforming assets include: 1) loans that are either contractually past due
90 days or more as to interest or principal payments, on a nonaccrual status,
or the terms of which have been renegotiated to provide a reduction or deferral
of interest or principal (restructured loans), 2) restructured loans until six
consecutive monthly payments are received under the new loan terms, and
3) foreclosed assets. The aggregate amount of nonperforming assets decreased
$316 (11.2%) to $2,493 at June 30, 2005 from $2,809 at December 31, 2004.
Total nonperforming assets as a percentage of total assets decreased to .51% at
June 30, 2005 from .62% at December 31, 2004, and .76% at June 30, 2004. PSB
also tracks delinquencies on a contractual basis quarter to quarter. Loans
contractually delinquent 30 days or more as a percentage of gross loans were
.57% at June 30, 2005 compared to .56% at December 31, 2004, and .84% at June
30, 2004. The allowance for loan losses was 1.15% of gross loans at June 30,
2005 compared to 1.19% at December 31, 2004, and 1.19% at June 30, 2004.
Table 2: Allowance for Loan Losses
Three months ended Six months ended
June 30, June 30,
(dollars in thousands) 2005 2004 2005 2004
Allowance for loan losses at beginning $4,303 $3,700 $4,157 $3,536
Provision for loan losses 30 240 180 480
Recoveries on loans previously charged off 4 - 6 7
Loans charged off (28) (34) (34) (117)
Allowance for loan losses at end $4,309 $3,906 $4,309 $3,906
Table 3: Nonperforming Assets
June 30, December 31,
(dollars in thousands) 2005 2004 2004
Nonaccrual loans $1,740 $2,660 $2,174
Accruing loans past due 90 days or more - - -
Restructured loans not on nonaccrual 524 573 628
Total nonperforming loans 2,264 3,233 2,802
Foreclosed assets 229 46 7
Total nonperforming assets $2,493 $3,279 $2,809
Nonperforming loans as a % of gross loans receivable 0.60% 0.98% 0.80%
Total nonperforming assets as a % of total assets 0.51% 0.76% 0.62%
14
LIQUIDITY
Liquidity refers to the ability of PSB to generate adequate amounts of cash to
meet PSB's need for cash at a reasonable cost. PSB manages its liquidity to
provide adequate funds to support borrowing needs 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.
Deposit growth is the primary source of funding. Retail and local deposits
continue to comprise the bulk of asset funding and were 63.2% of total assets
at June 30, 2005 compared to 68.8% of total assets at December 31, 2004 and
63.7% at June 30, 2004. Federal Home Loan Bank advances and broker and
national certificates of deposit continue to represent a significant portion of
PSB's total funding ability, and is expected to grow as a percentage of assets
during the remainder of 2005.
Table 4: Period-end Deposit Composition
June 30, December 31,
2005 2004 2004
(dollars in thousands) $ % $ % $ %
Non-interest bearing demand $ 53,759 14.2% $ 46,901 13.8% $ 51,635 14.4%
Interest bearing demand and savings 61,8771 6.3% 51,112 15.0% 64,574 18.0%
Money market deposits 66,402 17.5% 65,576 19.3% 68,666 19.2%
Retail time deposits less than $100 67,308 17.7% 61,335 18.0% 63,993 17.8%
Total core deposits 249,346 65.7% 224,924 66.1% 248,868 69.4%
Retail time deposits $100 and over 58,104 15.3% 49,929 14.7% 55,459 15.5%
Broker & national time deposits less than $100 2,319 0.6% 6,174 1.8% 4,594 1.3%
Broker & national time deposits $100 and over 69,771 18.4% 59,249 17.4% 49,304 13.8%
Totals $379,540 100.0% $340,276 100.0% $358,225 100.0%
Although core deposits are 10.9% greater than at June 30, 2004, most of that
growth occurred prior to December 31, 2004. Since that date, deposit growth
has come from brokered and national time deposits including $18,192, or 85.3%
of total deposit growth of $21,315 since December 31, 2004. A significant
portion of the increase in core deposits over June 30, 2004 came from interest
bearing demand (NOW) deposits from local governmental entities. These deposits
are required to be collateralized and carry an interest rate that moves with
the overall market. Because the local governmental entities within these
categories generally carry their highest annual balances during the first
quarter of the year, this level of growth was not expected to continue and
interest-bearing demand and savings balances did decline $10,399 during the
quarter ended June 30, 2005.
PSB originates retail certificates of deposit with local depositors under a
program known as the Certificate of Deposit Account Registry System (CDARS) in
which PSB customer deposits (with participation of other banks in the CDARS
network) are able to obtain levels of FDIC deposit insurance coverage in
amounts greater than traditional limits. For purposes of Table 4 above, these
certificates are included in retail time deposits $100 and over and totaled
$11,020 at June 30, 2005, $7,666 at December 31, 2004, and $6,993 at June 30,
2004. Although classified as retail time deposits in the table above, these
balances are required to be classified as broker deposits on PSB's quarterly
regulatory call reports.
15
PSB's policy is to limit broker and national time (not including CDARS)
deposits to 20% of total assets. Broker and national deposits as a percentage
of total assets was 14.8%, 11.8%, and 15.2% at June 30, 2005, December 31,
2004, and June 30, 2004, respectively. Early in the second quarter of 2005,
short-term funding of federal funds purchased of $5.6 million as of March 31,
2005 was refinanced with additional broker deposits. Additional broker
deposits were obtained during that period to fund anticipated loan growth.
Broker deposits as a percentage of total assets is expected to increase during
2005 as loan growth continues to outpace core deposit growth.
Table 5: Summary of Balance by Significant Deposit Source
June 30, December 31,
(dollars in thousands) 2005 2004 2004
Total time deposits $100 and over $127,875 $109,178 $104,763
Total broker and national time deposits 72,090 65,423 53,898
Total retail time deposits 125,412 111,264 119,452
Core deposits, including money market deposits 249,346 224,924 248,868
Table 6: Change in June 30, 2005 Deposit Balance since Prior Period Ended:
June 30, 2004 December 31, 2004
(dollars in thousands) $ % $ %
Total time deposits $100 and over $18,697 17.1% $23,112 22.1%
Total broker and national time deposits 6,667 10.2% 18,192 33.8%
Total retail time deposits 14,148 12.7% 5,960 5.0%
Core deposits, including money market deposits 24,422 10.9% 478 0.2%
Table 7: Available but Unused Funding Sources other than Retail Deposits:
June 30, 2005 December 31, 2004
Unused, but Amount Unused, but Amount
(dollars in thousands) Available Used Available Used
Overnight federal funds purchased $32,500 $ - $22,500 $ -
FHLB advances under blanket mortgage lien 11,636 55,000 14,855 52,000
Repurchase agreements 18,224 5,879 12,871 8,565
Wholesale market time deposits 25,156 72,090 37,097 53,898
Total available but unused funds $87,516 $132,969 $87,323 $114,463
Funding as a percent of total assets 18.0% 27.3% 19.2% 25.2%
16
Despite the increased usage of broker deposits, PSB continues to have adequate
sources of available funding for growth as outlined in Table 7 above. Unused
FHLB advances available under the blanket mortgage lien have declined $3,219,
or 21.7% since December 31, 2004. However, securities freed from pledging as
governmental NOW deposits were withdrawn increased repurchase agreements
capacity by $5,353, or 41.6% since December 31, 2004. Brokered time deposit
capacity has declined substantially since December 31, 2004, falling $11,941,
or 32.2%.
Overnight federal funds purchased totaling $32,500 are available through four
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 the six months ended June 30, 2005, average
daily federal funds purchased were $6,408 compared to $4,861 during the same
period in 2004. 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 generally up to 14
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.
Table 8 below presents maturity repricing information as of June 30, 2005. The
following repricing methodologies should be noted:
1. Money market deposit accounts are considered fully repriced within 90
days. NOW and savings accounts are considered "core" deposits as they are
generally insensitive to interest rate changes. These deposits are generally
considered to reprice beyond five years.
2. Nonaccrual loans are considered to reprice beyond five 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.
4. Impact of rising or falling interest rates is based on a parallel yield
curve change that is fully implemented within a 12-month time horizon.
17
Table 8: Interest Rate Sensitivity Gap Analysis
June 30, 2005
(dollars in thousands) 0-90 days 91-180 days 181-365 days 1-2 yrs Beyond 2-5 yrs Beyond 5 yrs Total
Earning assets:
Loans $146,420 $ 28,749 $ 38,898 $ 60,861 $ 80,789 $ 19,454 $375,171
Securities 4,515 5,180 10,677 12,026 26,975 13,091 72,464
FHLB stock 2,953 2,953
CSV bank-owned life ins. 4,627 4,627
Other earning assets 5,243 5,243
Total $159,131 $ 33,929 $ 49,575 $ 72,887 $107,764 $ 37,172 $460,458
Cumulative rate
sensitive assets $159,131 $ 193,060 $242,635 $ 315,522 $423,286 $460,458
Interest-bearing liabilities
Interest-bearing deposits $135,574 $ 22,216 $ 36,308 $ 41,979 $ 42,970 $ 46,734 $325,781
FHLB advances 5,000 2,000 6,000 7,000 35,000 55,000
Other borrowings 1,045 774 1,389 415 2,256 5,879
Junior subordinated
debentures
7,732 7,732
Total $141,619 $ 24,990 $ 43,697 $ 49,394 $ 80,226 $ 54,466 $394,392
Cumulative interest
sensitive liabilities $141,619 $ 166,609 $ 210,306 $ 259,700 $ 339,926 $394,392
Interest sensitivity gap for
the individual period $ 17,512 $ 8,939 $ 5,878 $ 23,493 $ 27,538 $(17,294)
Ratio of rate sensitive assets to
rate sensitive liabilities for
the individual period 112.4% 135.8% 113.5% 147.6% 134.3% 68.2%
Cumulative interest
sensitivity gap $ 17,512 $ 26,451 $ 32,329 $ 55,822 $ 83,360 $ 66,066
Cumulative ratio of rate sensitive
assets to rate sensitive
liabilities 112.4% 115.9% 115.4% 121.5% 124.5% 116.8%
At June 30, 2005, if interest rates had changed 200 basis points, the 365-day
cumulative ratio of rate sensitive assets to rate sensitive liabilities would
have changed from approximately 115% to 109% (if up 200 basis points) and 125%
(if down 200 basis points), respectively. At December 31, 2004, the 365-day
cumulative ratio of rate sensitive assets to rate sensitive liabilities would
have changed from approximately 101% to 95% (if up 200 basis points) and 105%
(if down 100 basis points), respectively. At June 30, 2004, if interest rates
had risen 200 basis points or had fallen 100 basis points, the 365-day
cumulative ratio of rate sensitive assets to rate sensitive liabilities would
have changed from approximately 92% to 89% (if up 200 basis points) and 96% (if
down 100 basis points), respectively. Beginning in June 2005, PSB began to
model downward rate change projections up to 200 basis points, rather than 100
basis points, reflecting
18
the short-term rate increases from historically low interest rate floors during
the past twelve months. The Asset/Liability Committee uses financial modeling
techniques that measure the interest rate risk. Policies established by PSB's
Asset/Liability Committee 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 the adequacy of PSB's 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. PSB's basic surplus, including available open line of
credit FHLB advances not yet utilized at June 30, 2005, December 31, 2004, and
June 30, 2004, was 5.6%, 7.1%, and 7.0%, respectively and above the 5% minimum
required by policy. The decline in the basic surplus is primarily a result of
lower FHLB borrowing capacity and pledging of securities for deposits from
governmental entities, which reduced available unencumbered net liquid assets.
During the second quarter 2005, PSB brought the basic surplus percentage back
into policy from a 3.5% ratio at March 31, 2005 by reallocating deposits to
free up available security collateral.
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. Company
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. At June 30, 2005, December 31, 2004, and June 30, 2004, net interest
income for the next 12 months was projected to increase 1.34%, decrease .04%,
and decrease .46%, respectively, if rates increase 200 basis points. At June
30, 2005, net interest income for the next 12 months was projected to decrease
5.0% if rates decrease 200 basis points. At December 31, 2004, and June 30,
2004, net interest income for the next 12 months was projected to decrease
2.15%, and .70%, respectively, if rates decrease 100 basis points. These
changes are within policy requirements and considered acceptable by management.
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
19
accounts) are also considered core long-term funding sources. The core funding
utilization ratio is defined as assets with a maturity 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. At June 30, 2005, December 31, 2004, and June 30, 2004, PSB's core
funding utilization ratio was projected to be 47%, 46% and 54%, respectively,
after a rate increase of 200 basis points and was therefore within policy
requirements.
CAPITAL RESOURCES
Stockholders' equity at June 30, 2005 increased $1,100 to $34,716, or 3.3% from
$33,616 at December 31, 2004. After shareholder stock buybacks of $318 and
cash dividends declared of $532, net income retained during the six months
ended June 30, 2005 was $1,361. However, capital decreased $312 since December
31, 2004 from a decline in the unrealized gain on securities available for sale
(net of tax effects) as increases in short-term rates reduced the value of
fixed rate debt securities. All other net increases in capital totaled $51.
Stockholders' equity included unrealized gains on securities available for
sale, net of their tax effect, of $72 at June 30, 2005, compared to unrealized
gains of $384 at December 31, 2004.
The adequacy of PSB's capital is regularly reviewed to ensure sufficient
capital is available for current and future needs and is in compliance with
regulatory guidelines. As of June 30, 2005 and December 31, 2004, PSB's
subsidiary bank's Tier 1 risk-based capital ratio, total risk-based capital,
and Tier 1 leverage ratio were in excess of regulatory minimums and were
classified as "well-capitalized." 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. Average
tangible stockholders' equity (book basis) to average assets was 7.22% during
the June 2005 quarter, 7.49% during the December 2004 quarter, and 7.61% during
the June 2004 quarter.
However, regulatory capital increased $7,500 as PSB issued pooled trust
preferred securities, which qualify as Tier 1 regulatory capital although
presented as junior subordinated debentures under current accounting standards.
The junior subordinated debentures carry a fixed interest rate of 5.82% through
September 2010, after which interest is adjusted quarterly to 90 day LIBOR plus
1.70%. This additional regulatory capital will be used for general corporate
purposes including supporting additional asset growth.
PSB maintains an annual, ongoing share repurchase program of up to 1% of
outstanding shares per year and 4,000 shares at $31.50 per share were purchased
under this program during the quarter ended June 30, 2005. During the six
months ended June 30, 2005, 10,000 shares at an average price of $31.80 per
share were purchased under this program. In order to fund an exercise of
employee stock options, exercised at a price of $15.83 per share, 3,058 shares
of the buyback were re-issued. PSB anticipates that it will purchase another
7,200 shares during 2005 on the open market at prices then in effect.
20
Table 9: Capital Ratios - Consolidated Holding Company
(dollars in thousands) June 30, Dec. 31,
2005 2004 2004
Stockholders' equity $ 34,716 $ 32,239 $ 33,616
Junior subordinated debentures, net 7,500 - -
Disallowed mortgage servicing right assets (85) (80) (84)
Unrealized (gain) loss on securities available for sale (72) 4 (384)
Tier 1 regulatory capital 42,059 32,163 33,148
Add: allowance for loan losses 4,309 3,906 4,157
Total regulatory capital $ 46,368 $ 36,069 $ 37,305
Total assets $486,230 $431,216 $454,974
Disallowed mortgage servicing right assets (85) (80) (84)
Unrealized (gain) loss on securities available for sale (72) 4 (384)
Tangible assets $486,073 $431,140 $454,506
Risk-weighted assets (as defined by current regulations) $381,443 $337,462 $350,224
Tier 1 capital to average tangible assets (leverage ratio) 8.76% 7.55% 7.40%
Tier 1 capital to adjusted risk-weighted assets 11.03% 9.53% 9.46%
Total capital to adjusted risk-weighted assets 12.16% 10.69% 10.65%
RESULTS OF OPERATIONS
Net income for the quarter ended June 30, 2005 was $1,171, or $.68 for basic
and diluted earnings per share. Comparatively, net income for the quarter
ended June 30, 2004 was $782, or $.45 per share for basic and diluted earnings
per share. The prior year June 2004 quarter included a special charge of $.11
per share ($199 after tax benefits) for write-off of investment in the old home
office demolished after a newly constructed home office was placed in service
on the same property. June 2004 earnings before the special charge were $.56
per share.
Net income for the six months ended June 30, 2005 was $2,211, or $1.29 for
basic and $1.28 for diluted earnings per share. Comparatively, net income for
the six months ended June 30, 2004 was $1,736, or $1.00 for basic and $.99 for
diluted earnings per share. As noted previously, the prior year period
included a special charge of $.11 per share ($199 after tax benefits) for
write-off of investment in the old home office. Diluted earnings per share for
the six months ended June 2004 before the special charge were $1.10 per share.
21
Both the June quarterly and year-to-date periods saw increased earnings over
last year and 2005 net income is expected to be in a range of $4.3 million to
$4.6 million. Table 10 below indicates the return on average assets, return on
average equity, and key operating expense ratios for the quarterly and year-to-
date periods as reported and adjusted for the special charge on abandonment of
the home office in 2004.
Table 10: Comparative Key Operating Ratios
Quarter ended June 30, Six months ended June 30,
Reported Proforma Reported Proforma
2005 2004 2004* 2005 2004 2004*
Return on average assets 0.98% 0.73% 0.92% 0.94% 0.83% 0.93%
Return on average equity 13.55% 9.52% 11.94% 12.90% 10.63% 11.88%
Efficiency ratio 59.53% 64.54% 57.25% 59.33% 62.18% 58.47%
Noninterest expense to
average assets 2.32% 2.74% 2.43% 2.31% 2.66% 2.49%
* Proforma 2004 is before the special charge for abandonment of home office in
June 2004 of $199 after tax benefits.
The following Table 11 presents PSB's consolidated quarterly summary financial
data.
22
Table 11: Financial Summary
(dollars in thousands, except per share data) Quarter ended
June 30 March 31, Dec. 31, Sept. 30, June 30,
2005 2005 2004 2004 2004
EARNINGS AND DIVIDENDS:
Net interest income $3,582 $3,520 $3,577 $3,521 $3,517
Provision for loan losses $ 30 $ 150 $ 180 $ 195 $ 240
Other noninterest income $ 947 $ 803 $ 764 $ 764 $ 855
Other noninterest expense $2,780 $2,640 $2,626 $2,833 $2,914
Net income $1,171 $1,040 $1,043 $ 747 $ 782
Basic earnings per share (3) $ 0.68 $ 0.60 $ 0.61 $ 0.43 $ 0.45
Diluted earnings per share (3) $ 0.68 $ 0.60 $ 0.60 $ 0.43 $ 0.45
Dividends declared per share (3) $ 0.31 $ - $ 0.30 $ - $ 0.30
Net book value per share $20.27 $19.77 $19.55 $19.41 $18.68
Semi-annual dividend payout ratio 24.06% n/a 28.82% n/a 29.84%
Average common shares outstanding 1,714,134 1,721,058 1,717,394 1,720,436 1,729,322
BALANCE SHEET - AVERAGE BALANCES:
Loans receivable, net of allowances for loss $367,948 $354,136 $341,997 $331,167 $320,471
Assets $480,325 $465,083 $448,591 $439,177 $426,826
Deposits $376,252 $367,394 $353,310 $347,015 $330,337
Stockholders' equity $ 34,665 $ 33,989 $ 34,076 $ 33,010 $ 32,942
PERFORMANCE RATIOS:
Return on average assets (1) 0.98% 0.91% 0.92% 0.67% 0.73%
Return on average stockholders' equity (1) 13.55% 12.41% 12.18% 8.98% 9.52%
Average tangible stockholders' equity to
average assets 7.22% 7.25% 7.49% 7.46% 7.61%
Net loan charge-offs to average loans 0.01% 0.00% 0.04% 0.00% 0.01%
Nonperforming loans to gross loans 0.60% 0.74% 0.80% 0.94% 0.98%
Allowance for loan losses to gross loans 1.15% 1.18% 1.19% 1.22% 1.19%
Net interest rate margin (1)(2) 3.32% 3.40% 3.50% 3.51% 3.64%
Net interest rate spread (1)(2) 2.96% 3.05% 3.12% 3.17% 3.30%
Service fee revenue as a percent of
average demand deposits (1) 2.56% 2.19% 2.22% 2.52% 2.63%
Noninterest income as a percent
of gross revenue 13.00% 11.87% 11.64% 11.93% 13.54%
Efficiency ratio (2) 59.53% 59.11% 58.52% 63.95% 64.54%
Noninterest expenses to average assets (1) 2.32% 2.30% 2.33% 2.56% 2.74%
STOCK PRICE INFORMATION:
High $31.85 $32.20 $33.25 $35.25 $35.60
Low $30.63 $31.85 $32.00 $33.00 $34.50
Market value at quarter-end $30.75 $31.85 $32.10 $33.00 $34.50
(1)Annualized
(2)The yield on tax-exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%.
(3)Due to rounding, cumulative quarterly per share performance may not equal annual per share totals.
23
NET INTEREST INCOME
Net interest income is the most significant component of earnings. Tax
adjusted net interest income increased $63 (1.7%) from $3,660 for the quarter
ended June 30, 2004 to $3,723 for the current quarter ended June 30, 2005, and
increased $110 (1.5%) from $7,276 for the six months ended June 30, 2004 to
$7,386 for the six months ended June 30, 2005. Net interest income has been
negatively impacted by a flattening yield curve and competitive pressures on
deposit rates while loan growth continued to be funded with higher cost
wholesale funds. Margin on earning assets declined from 3.64% in the June 2004
quarter, and from 3.40% in the March 2005 quarter to 3.32% during the June 2005
quarter. Earning asset yields increased slightly and were 5.78% at June 2005,
5.66% at March 2005, and 5.57% at June 2004. However, the cost of interest-
bearing liabilities increased from 2.27% during the quarter ended June 2004 to
2.61% for the March 2005 quarter and 2.82% for the June 2005 quarter.
PSB updated accounting procedures during March 2005 to improve recognition and
amortization of deferred loan origination fees and costs in accordance with
Statement of Financial Accounting Standard No. 91, Accounting for Nonrefundable
Fees and Costs Associated with Originating or Acquiring Loans ("FAS 91"). This
change is more fully described in this Quarterly Report on Form 10-Q under
"Noninterest Expense." Tax-adjusted net interest margin before accounting
adjustments for FAS 91 would have been 3.46% during the June 2005 quarter
(compared to a reported 3.32%), and 3.68% in the June 2004 quarter (compared to
a reported 3.64%). Tax-adjusted net interest margin before accounting
adjustments for FAS 91 would have been 3.48% during the six months ended June
2005 (compared to a reported 3.36%), and 3.73% in the six months ended June
2004 (compared to a reported 3.68%).
The increase in funding costs has been led by interest-bearing core deposits
(excluding retail certificates of deposit), whose average cost increased from
.80% for the six months ended June 30, 2004 to 1.46% for the six months ended
June 30, 2005. This increase is in response to Federal Reserve discount rate
increases that began in June 2004 and have continued through the current date.
Discount rate increases since June 2004 through June 30, 2005 totaled 2.25%.
These increases were not yet reflected in the average cost of core deposits at
June 30, 2004. Future discount rate increases are expected to continue to be
reflected in the core deposit rates.
In addition, a majority of the commercial loan growth in the six months ended
June 2005 was funded by high-yield money market and NOW accounts sold to new
large depositors and local governmental entities earning rates tied to the 30-
day LIBOR rate or other adjustable wholesale rates. Lastly, wholesale deposits
continue to make up a growing portion of the deposit base and renewal rates on
these time deposits have increased at a rate similar to the Federal Reserve
discount rate increase, which has increased funding costs.
While short-term funding costs have increased as described above, mid-term
rates out to 5 years have remained similar over the 12 months ended June 30,
2005. Because PSB originates some loans with fixed rates to mid-term
maturities funded by short-term deposits, this flattening yield curve has
decreased the interest rate spread seen during 2003 and 2004.
24
While PSB's balance sheet remains largely neutral to interest rate changes, to
facilitate retention and growth in core deposits and support continued loan
growth with wholesale funding, net margin is expected to decline slightly in
the coming quarter.
Table 12A: Net Interest Income Analysis (Quarter)
(dollars in thousands) Quarter ended June 30, 2005 Quarter ended June 30, 2004
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
Assets
Interest-earning assets:
Loans (1)(2) $372,286 $ 5,600 6.03% $324,251 $4,731 5.85%
Taxable securities 48,311 467 3.88% 47,596 453 3.82%
Tax-exempt securities (2) 23,693 359 6.08% 24,595 371 6.05%
FHLB stock 2,941 40 5.46% 2,679 36 5.39%
Other 2,201 15 2.73% 4,190 10 0.96%
Total (2) 449,432 6,481 5.78% 403,311 5,601 5.57%
Non-interest earning assets:
Cash and due from banks 14,145 13,840
Premises and equipment, net 12,607 10,246
Cash surrender value of
life insurance 4,602 -
Other assets 3,877 3,209
Allowance for loan losses (4,338) (3,780)
Total $480,325 $426,826
Liabilities & stockholders' equity
Interest bearing liabilities:
Savings and demand deposits $64,624 $249 1.55% $ 53,180 $ 88 0.66%
Money market deposits 69,945 301 1.73% 64,450 144 0.90%
Time deposits 190,932 1,591 3.34% 163,555 1,128 2.77%
FHLB borrowings 53,066 507 3.83% 47,000 504 4.30%
Other borrowings 13,433 106 3.17% 14,718 77 2.10%
Junior sub. debentures 255 4 6.29% - - 0.00%
Total 392,255 2,758 2.82% 342,903 1,941 2.27%
Non-interest bearing liabilities:
Demand deposits 50,751 49,152
Other liabilities 2,654 1,829
Stockholders' equity 34,665 32,942
Total $480,325 $426,826
Net interest income 3,723 3,660
Rate spread 2.96% 3.30%
Net yield on interest-earning assets 3.32% 3.64%
(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%.
25
Table 12B: Net Interest Income Analysis (Six Months)
(dollars in thousands)Six months ended June 30, 2005Six months ended June 30, 2004
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
Assets
Interest-earning assets:
Loans (1)(2) $365,348 $10,822 5.97% $317,485 $9,302 5.88%
Taxable securities 47,530 919 3.90% 47,738 914 3.84%
Tax-exempt securities (2) 24,100 724 6.06% 24,617 739 6.02%
FHLB stock 2,921 80 5.52% 2,575 76 5.92%
Other 3,460 43 2.51% 3,572 16 0.90%
Total (2) 443,359 12,588 5.73% 395,987 11,047 5.59%
Non-interest earning assets:
Cash and due from banks 13,811 12,657
Premises and equipment, net 12,563 9,267
Cash surrender value of
life insurance 3,670 -
Other assets 3,613 2,986
Allowance for loan losses (4,277) (3,695)
Total $472,739 $417,202
Liabilities & stockholders' equity
Interest bearing liabilities:
Savings and demand deposits $68,595 $488 1.43% $52,500 $ 173 0.66%
Money market deposits 70,807 523 1.49% 65,760 298 0.91%
Time deposits 182,980 2,941 3.24% 156,395 2,180 2.80%
FHLB borrowings 50,989 1,057 4.18% 46,808 970 4.16%
Other borrowings 12,861 189 2.96% 14,137 150 2.13%
Junior sub. debentures 128 4 6.30% - - 0.00%
Total 386,360 5,202 2.72% 335,600 3,771 2.25%
Non-interest bearing liabilities:
Demand deposits 49,464 46,992
Other liabilities 2,351 1,868
Stockholders' equity 34,564 32,742
Total $472,739 $417,202
Net interest income 7,386 7,276
Rate spread 3.01% 3.34%
Net yield on interest-earning assets 3.36% 3.68%
(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%.
26
Table 13: Interest Expense and Expense Volume and Rate Analysis
Six months ended June 30, 2005
2005 compared to 2004
(dollars in thousands) increase (decrease) due to (1)
Volume Rate Net
Interest earned on:
Loans (2) $1,396 $ 124 $1,520
Taxable securities (4) 9 5
Tax-exempt securities (2) (15) - (15)
FHLB stock 10 (6) 4
Other interest income - 27 27
Total 1,387 154 1,541
Interest paid on:
Savings and demand deposits 53 262 315
Money market deposits 23 202 225
Time deposits 369 392 761
FHLB borrowings 86 1 87
Other borrowings (13) 52 39
Junior subordinated debentures - 4 4
Total 518 913 1,431
Net interest earnings $ 869 $ (759) $ 110
(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.
PROVISION FOR LOAN LOSSES
Management determines the adequacy of the provision for loan losses based on
past loan experience, current economic conditions, and composition of the loan
portfolio. 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 and leases, or portions thereof,
including impaired loans, are uncollectible, these amounts are promptly charged
off against the allowance. The provision for loan losses was $30 and $240 for
the three months ended June 30, 2005, and 2004, respectively. The provision
for loan losses was $180 and $480 for the six months ended June 30, 2005, and
2004, respectively. The continued improvement in credit quality and
delinquency ratios and growing history of minimal net loan charge-offs of
similar loans allowed PSB to reduce the provision for loan losses during the
June 2005 quarter. Provisions for loan losses are expected to remain low
compared to prior year quarters for the remainder of 2005.
27
Nonperforming loans are reviewed to determine exposure for potential loss
within each loan category. The adequacy of the allowance for loan losses is
assessed based on credit quality and other pertinent loan portfolio
information. The adequacy of the allowance and the provision for loan losses
is consistent with the composition of the loan portfolio and recent credit
quality history.
NONINTEREST INCOME
Quarterly noninterest income increased $92 in the June 2005 quarter to $947
compared to $855 in June 2004. The change was led by an increase of $110 in
commissions from the sale of retail investment products. A decline in mortgage
banking income of $59 to $249 in June 2005 compared to $308 in June 2004 was
offset by a $46 increase in the cash surrender value of life insurance.
Service fee income of $324 during the June 2005 quarter was similar to income
of $322 during the June 2004 quarter, but recovered substantially from $260 of
fees in the March 2005 quarter. Fees for retail service products increased
effective April 1, 2005, contributing to the increase over March 2005.
For the six months ended June 30, noninterest income increased $155 to $1,750
in 2005 compared to $1,595 in 2004. The change was led by an increase in sales
of retail investment product commissions of $151. Increases in cash surrender
value of life insurance of $66 have offset a decline in mortgage banking of
$64. During February 2005, PSB purchased $4.5 million of bank-owned life
insurance on bank officers in connection with new employee deferred
compensation and incentive plans. A decline of $105 in gain on sale of
securities was largely offset by a one-time payout of $78 received from
Discover Financial Services on the purchase of the Pulse ATM system (in which
PSB was a cooperative member).
Peoples Insurance Services LLC, PSB's commercial property and casualty
insurance agency and brokerage (a September 2003 start-up), incurred a net loss
of $53 and $75 for the six months ended June 30, 2005, and 2004, respectively.
Total commission revenue is significantly less than planned. PSB is
investigating various options to provide insurance products to our customers
and community in a profitable manner with a resolution expected during the
upcoming quarter ending September 30, 2005.
As a FHLB Mortgage Partnership Finance (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 on an aggregate
pool basis. The following table 14 summarizes loan principal serviced for the
FHLB by the MPF program as of June 30, 2005.
28
Table 14: FHLB Mortgage Partnership Financing (MPF) Program Servicing
PSB Credit FHLB Mortgage
Principal Enhancement Funded First Servicing
As of June 30, 2005 ($000s) Serviced Guarantee Loss Account Right, net
MPF 100 Program (agent program) $110,010 $499 $2,494 $497
MPF 125 Program (closed loan program) 55,393 448 630 356
Total FHLB MPF serviced loans $165,403 $947 $3,124 $853
FHLB MPF Program elements as a percentage of principal serviced:
As of June 30, 2005 MPF 100 MPF 125
PSB credit enhancement guarantee 0.45% 0.81%
FHLB funded first loss account 2.27% 1.14%
Mortgage servicing right, net 0.45% 0.64%
PSB ceased originating loans under the MPF 100 program during November 2003.
Since that time all originations have been through the FHLB MPF 125 closed loan
program. Due to historical strength of mortgage borrowers in our markets, the
original 1% of principal loss pool provided by the FHLB, and current economic
conditions, management believes the possibility of losses under guarantees to
the FHLB to be remote. Accordingly, no provision for a recourse liability has
been made for this recourse obligation on loans currently serviced by PSB.
NONINTEREST EXPENSE
Noninterest operating expenses declined $134 to $2,780 in the quarter ended
June 2005 compared to $2,914 during the quarter ended June 2004. However, the
June 2004 quarter included a special charge to write-off the remaining
investment in the prior home office totaling $329. In addition, salaries and
wages in the June 2005 quarter were reduced by $183 as PSB implemented a daily
automated system to improve accounting for deferred loan fees and costs
(including lender and support personnel salaries) in accordance with current
accounting standards (FAS 91) earlier in 2005. FAS 91 requires loan
origination fees and direct loan origination costs to be deferred and amortized
as a yield adjustment earned on the loan. Previously, these accounting
adjustments for deferral of costs were made only at year-end and in prior years
had an immaterial impact on the individual quarterly financial statements. The
change in accounting procedure was made to simplify operations and improve the
accuracy of earnings reporting.
Before the June 2005 deferral of wages under FAS 91 and the June 2004 special
home office write-off, noninterest expenses were $2,963 for June 2005, and
$2,585 in June 2004, an increase of $378, or 14.6%. The increase over the
prior year quarter consisted primarily of $277 in additional wages and benefits
from a growing number of employees and $66 in additional occupancy expenses in
the June 2005 quarter. Total quarterly operating expenses to average
29
total assets before the FAS 91 deferral of wages and the June 2004 special home
office write-off were 2.47% for June 2005 and 2.43% for June 2004 (annualized).
Offsetting the increase to June 2005 quarter income from deferred employee wage
expense related to new loan originations under FAS 91 were reductions to income
from deferral of loan origination fees collected, and amortization of
previously capitalized net loan origination costs against net interest income.
Taken together, all FAS 91 accounting adjustments increased June 2005 quarterly
net income by $18 and decreased June 2004 quarterly net income by $22.
For the six months ended June 30, noninterest operating expenses declined $96
to $5,420 in 2005 compared to $5,516 during 2004. During the March 2005
quarter, a reimbursement of collection fees on a problem loan were recovered,
which decreased other noninterest expenses by $101. Conversely, the prior year
March 2004 quarter included $127 of collection fees written off to other
noninterest expense in response to regulatory requirements to account for
collection fees as expense until collected. As noted above, the June 2004
quarter included a special charge to write-off the remaining investment in the
prior home office totaling $329. In addition, salaries and wages during the
six months ended June 2005 quarter were reduced by $347 as PSB implemented a
daily automated system to improve accounting for deferred loan fees and costs
(including lender and support personnel salaries) in accordance with current
accounting standards (FAS 91) earlier in 2005.
For the six months ended June 30, before the deferral of wages under FAS 91,
the June 2004 special home office write-off, and the impact of the special
collection expense adjustments, noninterest expenses were $5,868 for June 2005,
and $5,060 in June 2004, an increase of $808, or 16.0%. The increase over the
prior year consisted primarily of $522 in additional wages and benefits, $210
in additional occupancy expenses, and $60 increase in marketing and advertising
costs in the six months ended June 30, 2005. Total year-to-date operating
expenses to average total assets before the FAS 91 deferral of wages, the June
2004 special home office write-off, and the special collection expenses were
2.50% for June 2005 and 2.44% for June 2004 (annualized).
Offsetting the increase to income during the six months ended June 30, 2005
from deferred employee wage expense related to new loan originations under FAS
91 were reductions to income from deferral of loan origination fees collected,
and amortization of previously capitalized net loan origination costs against
net interest income. Taken together, all FAS 91 accounting adjustments
increased year-to-date June 2005 net income by $47 and decreased year-to-date
June 2004 income by $44.
30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There has been no material change in the information provided in response to
Item 7A of PSB's Form 10-K for the year ended December 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management, under the
supervision, and with the participation, of PSB's President and Chief Executive
Officer and the Chief Financial Officer, evaluated the effectiveness of the
design and operation of PSB's disclosure controls and procedures pursuant to
Rule 13a-15(c) under the Securities Exchange Act of 1934. Based upon 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 as of the end of the period covered by this report.
There were no changes in PSB's internal control over financial reporting during
the fiscal quarter covered by this report that materially affected, or are
reasonably likely to materially affect, PSB's internal control over financial
reporting.
31
PART II - OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Purchases of Equity Securities - Quarter ending June 30, 2005
Maximum number
Total number (or approximate
of shares (or dollar value) of
Total number units) purchased shares (or units)
of shares Average price as part of publicly that may yet be
(or units) paid per share announced plans purchased under the
purchased (or unit) or programs plans or programs
Period (a) (b) (c)(1) (d)(2)
April 2005 - - - -
May 2005 4,000 31.50 4,000 7,200
June 2005 - - - -
Quarterly Totals 4,000 31.50 4,000 7,200
(1) Includes 4,000 shares purchased pursuant to program announced on December
17, 2002, pursuant to which the Board of Directors authorized the repurchase of
up to 1% of PSB's outstanding common stock per year in open market or privately
negotiated transactions (the "Plan"). No price or expiration date was
specified for the Plan's purchases.
(2) Shares which may yet be purchased in 2005 under the Plan.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITIES HOLDERS
The annual meeting of shareholders of the Company was held on April 19, 2005.
The only matter voted upon was the election of directors. The number of votes
cast for, or withheld, were as follows:
ELECTION OF DIRECTORS
For Withheld
Gordon P. Connor 947,972 73,644
Patrick L. Crooks 1,008,668 12,948
William J. Fish 1,010,523 11,093
Charles A. Ghidorzi 995,778 25,838
Gordon P. Gullickson 994,651 26,965
David K. Kopperud 1,009,445 12,171
Thomas R. Polzer 1,010,334 11,282
William M. Reif 998,800 22,816
Thomas A. Riiser 1,011,048 10,568
John H. Sonnentag 935,829 85,787
32
ITEM 6. EXHIBITS
Exhibits required by Item 601 of Regulation S-K.
Exhibit
Number Description
4.1 Bylaws, as last amended April 9, 1996
31.1 Certification of CEO under Section 302 of Sarbanes-Oxley Act
of 2002
31.2 Certification of CFO under Section 302 of Sarbanes-Oxley Act
of 2002
32.1 Certifications under Section 906 of Sarbanes-Oxley Act of
2002
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PSB HOLDINGS, INC.
August 15, 2005 SCOTT M. CATTANACH
Scott M. Cattanach
Treasurer
(On behalf of the Registrant and as
Principal Financial Officer)
34
EXHIBIT INDEX
TO
FORM 10-Q
OF
PSB HOLDINGS, INC.
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
PURSUANT TO SECTION 102(D) OF REGULATION S-T
(17 C.F.R. Section 232.102(D))
The following exhibits are filed as part this report:
4.1 Bylaws, as last amended April 9, 1996
31.1 Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002
31.2 Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002
32.1 Certifications under Section 906 of Sarbanes-Oxley Act of 2002