FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________
(checked box) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 2005
(box) 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 mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes (box) No (checked box)
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes (box) No (checked box)
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 (checked box) No (box)
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. (box)
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer (box) Accelerated filer (box)
Non-accelerated filer (checked box)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes (box) No (checked box)
The aggregate market value of the voting stock held by non-affiliates as of
June 30, 2005, was approximately $49,300,000. For purposes of this
calculation, the registrant has assumed its directors and executive officers
are affiliates. As of February 15, 2006, 1,705,771 shares of common stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement dated March 10, 2006 (to the extent specified herein): Part III
FORM 10-K
PSB HOLDINGS, INC.
TABLE OF CONTENTS
PART I
ITEM
1. Business.........................................................1
1A. Risk Factors.....................................................5
1B. Unresolved Staff Comments........................................9
2. Properties.......................................................9
3. Legal proceedings................................................9
4. Submission of matters to a vote of security holders..............9
PART II
5. Market for registrant's common equity and related stockholder
matters.........................................................10
6. Selected financial data.........................................11
7. Management's discussion and analysis of financial condition and
results of operations...........................................13
7A. Quantitative and qualitative disclosures about market risk......51
8. Financial statements and supplementary data.....................52
9. Changes in and disagreements with accountants on accounting and
financial disclosure............................................85
9A. Controls and Procedures.........................................85
9B. Other Information...............................................85
PART III
10. Directors and executive officers of the registrant..............86
11. Executive compensation..........................................87
12. Security ownership of certain beneficial owners and management
and related stockholder matters.................................87
13. Certain relationships and related transactions..................88
14. Principal Accountant Fees and Services..........................88
PART IV
15. Exhibits, financial statement schedules, and reports on Form
8-K.............................................................89
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PART I
ITEM 1. BUSINESS.
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K, including "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in Item 7, contains
forward-looking statements that involve risks, uncertainties, and assumptions.
Forward-looking statements are not guarantees of performance. If the risks or
uncertainties ever materialize or the assumptions prove incorrect, the results
of PSB Holdings, Inc. and its consolidated subsidiaries ("PSB") may differ
materially from those expressed or implied by such forward-looking statements
and assumptions. All statements other than statements of historical fact are
statements that could be deemed forward-looking statements. Forward-looking
statements may be identified by, among other things, expressions of beliefs or
expectations that certain events may occur or are anticipated, and projections
or statements of expectations. Risks, uncertainties, and assumptions relating
to forward-looking statements include general business and economic conditions,
changes in fiscal and monetary policies, increased competition, changes in
customers' preferences for types and sources of financial services, the timely
development and acceptance of new products and services, increased costs of
operation (including increased funding costs), changes in laws and regulation
that govern PSB's operations, increases in credit risks and losses, loss of key
personnel, unforeseen liabilities arising from current or prospective claims or
litigation, the inability to execute expansion plans, errors in the application
of critical accounting policies, unanticipated adverse decisions by tax
authorities, the inability to pay dividends, lack of marketability of PSB
stock, and the effect of certain organizational anti-takeover provisions.
These and other risks, uncertainties, and assumptions are described under the
caption "Risk Factors" in Item 1A of this Annual Report on Form 10-K and from
time to time in our other filings with the Securities and Exchange Commission
after the date of this report. PSB assumes no obligation, and does not intend,
to update these forward-looking statements.
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 full-service 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, 2005, 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
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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.
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 local 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 13,000 households and businesses.
The table below shows a breakdown of principal sources of operating revenue.
(dollars in thousands) Interest on loans Interest on securities
Years ended December 31, Amount % of revenue Amount % of revenue
2005 $22,347 76.4% $2,944 10.1%
2004 $19,207 75.8% $2,780 11.0%
2003 $17,964 71.4% $2,859 11.4%
As of February 3, 2006, PSB operated with 147 full-time equivalent ("FTE")
employees, including 33 employed on a part time basis. None of the employees
is covered by a collective bargaining agreement. Approximately 126 of the FTE
employees serve as sales, customer contact, or customer activity support
personnel, while 21 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 full-service branch in
Weston, Wisconsin during March 2005. Management believes opening in adjacent
markets capitalizes on existing management resources and customer relationships
and leverages existing stockholder capital for the long-term benefit of
stockholders. 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
stockholders 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. New
bank and nonbank competitors continue to enter our markets on a regular basis.
Based on publicly available deposit market share information as of June 30,
2005, 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.
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Deposit $'s Market
($000s) Share
MARATHON COUNTY, WISCONSIN
M&I Bank $ 447,040 21.1%
PEOPLES STATE BANK 323,377 15.2%
Associated Bank 191,745 9.0%
All other FDIC insured institutions 1,158,502 54.7%
ONEIDA COUNTY, WISCONSIN
M&I Bank $ 177,289 28.0%
Associated Bank 126,095 19.9%
Citizens Bank 77,990 12.3%
PEOPLES STATE BANK 41,773 6.6%
All other FDIC insured institutions 210,642 33.2%
VILAS COUNTY, WISCONSIN
First National Bank of Eagle River $ 120,463 31.4%
M&I Bank 100,266 26.1%
Headwaters State Bank 47,906 12.5%
PEOPLES STATE BANK 15,265 4.0%
All other FDIC insured institutions 99,987 26.0%
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 to replace or supplement
traditional net interest income.
EXECUTIVE OFFICERS
David K. Kopperud, 60 - President of PSB and Peoples State Bank since July
1999; previously Executive Vice-President of the Peoples State Bank (1994-
1999).
David A. Svacina, 59 - 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).
Scott M. Cattanach, 37 - 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.
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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 17 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.
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.
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ITEM 1A. RISK FACTORS
An investment in PSB Holdings, Inc. common stock involves a significant degree
of risk. The following paragraphs describe what we believe are the most
significant risks of investing in PSB common stock. You should also read
carefully the cautionary statement in Item 1 regarding the use of forward-
looking statements in this discussion.
PSB'S BUSINESS AND EARNINGS COULD BE ADVERSELY AFFECTED BY CHANGES IN GENERAL
BUSINESS AND ECONOMIC CONDITIONS, INCLUDING INCREASED CREDIT RISK AND INTEREST
RATE RISK.
PSB's business and earnings are sensitive to general business and economic
conditions in the United States and, in particular, central and northern
Wisconsin where it has significant operations. These conditions include short-
term and long-term interest rates, inflation, monetary supply, fluctuations in
both debt and equity capital markets, the strength of the U.S. and local
economies, acts or threats of war or terrorism that negatively affect general
business and economic conditions in the U.S., and consumer spending, borrowing,
and saving habits. For example, an economic downturn, increase in
unemployment, or higher interest rates could decrease the demand for loans and
other products and services and/or result in a deterioration in credit quality
and/or loan performance and collectability. Reduced loan demand or nonpayment
of loans would have an adverse effect on PSB's financial condition and results
of operations.
PSB EARNINGS COULD BE ADVERSELY AFFECTED BY THE FISCAL AND MONETARY POLICIES OF
THE FEDERAL GOVERNMENT AND ITS AGENCIES.
The policies of the Federal Reserve impact PSB significantly. The Federal
Reserve regulates the supply of money and credit in the United States. Its
policies directly and indirectly influence the rate of interest earned on loans
and paid on borrowings and interest-bearing deposits and can also affect the
value of financial instruments PSB holds. Those policies determine to a
significant extent PSB's cost of funds for lending and investing. Changes in
those policies are beyond PSB's control and are difficult to predict. Changes
in Federal Reserve policies may increase the risk that PSB's customers may fail
to repay their loans, and reduce the demand for PSB's products and services.
THE BANKING AND FINANCIAL SERVICES INDUSTRY IS HIGHLY COMPETITIVE AND INCREASES
IN COMPETITIVE LEVELS COULD ADVERSELY AFFECT PSB'S FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
PSB operates in a highly competitive environment in the products and services
PSB offers and the markets in which PSB serves. The competition among
financial services providers to attract and retain customers is intense.
Customer loyalty can be easily influenced by a competitor's new products,
especially offerings that provide cost savings to the customer or greater
interest rates on deposit products. Some of PSB's competitors may be better
able to provide a wider range of products and services over a greater
geographic area. The banking and financial services industry is likely to
become even more competitive as a result of legislative, regulatory, and
technological changes and the continued consolidation of the industry.
Technology has lowered barriers to entry and made it possible for non-banks to
offer products and services traditionally provided by banks, such as automatic
funds transfer and automatic payment systems. Also, investment banks and
insurance companies are competing in more banking businesses such as syndicated
lending and consumer banking. Many of PSB's non-bank competitors are subject
to fewer regulatory constraints and have lower cost structures. PSB expects
the consolidation of the banking and financial services industry to result in
larger, better-capitalized companies offering a wide array of financial
services and products. Increased competition could result in loss of customers
or reductions in PSB's net interest margin and fee income.
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TRADITIONAL GEOGRAPHIC BOUNDARIES TO COMMERCIAL DEPOSIT COLLECTION AND
COMMERCIAL LOAN ORIGINATION ARE ERODING, INCREASING COMPETITION AGAINST PSB'S
PRODUCTS.
Just as technology and the presence of a robust secondary market lowered net
interest margins and increased competition for residential mortgage loans,
changes in technology and providers are increasing competition and lowering net
interest margins on commercial products. Recent Check 21 legislation has
allowed out of area competitors to place on-site deposit item readers (often
referred to as "remote capture" devices) at their customer's place of business
eliminating the need for a local depository institution. Similarly, an
emerging secondary market for commercial lending has increased out of area
competition for and decreased spreads on some commercial loans traditionally
made by local banks. This increased competition may continue to adversely
affect PSB's results of operations.
IF PSB CANNOT ATTAIN COMPARABLE GROWTH RATES IN LOANS AND LOCAL DEPOSITS, IT
MAY HAVE A MATERIAL ADVERSE EFFECT ON PSB'S CAPITAL POSITION AND RESULTS OF
OPERATIONS.
Local deposit growth has not been sufficient to fund continued asset growth in
recent years. Out of area wholesale funding in the form of brokered
certificates of deposit and Federal Home Loan Bank advances have been obtained
to fund incremental asset growth. These wholesale funding sources are
generally more sensitive to overall market interest rate changes and could be
more costly than local deposit funding. Ongoing use of wholesale funds also
reduces the amount of outside funding available for emergency liquidity on both
a short-term and long-term basis, substantially increasing the cost to obtain
emergency liquidity. If certain capital levels are not maintained by PSB,
access to the brokered certificate of deposit market could be substantially
reduced, increasing wholesale funding costs.
PSB MAY LOSE FEE INCOME AND DEPOSITS IF A SIGNIFICANT PORTION OF CONSUMERS
DECIDE NOT TO USE BANKS TO COMPLETE THEIR FINANCIAL TRANSACTIONS.
Technology and other changes are allowing parties to complete financial
transactions that historically have involved banks at one or both ends of the
transaction. For example, consumers can now pay bills and transfer funds
directly without banks. The process of eliminating banks as intermediaries,
known as disintermediation, could result in the loss of fee income, as well as
the loss of customer deposits and income generated from those deposits.
PSB'S FUNDING COSTS MAY INCREASE IF CONSUMERS DECIDE NOT TO USE BANKS AS THEIR
PRIMARY SOURCE TO INVEST LIQUID OR OTHER PERSONAL ASSETS.
While the banking industry has historically held a majority of available
deposits, generational factors and trends in using other non-banking providers
for investment of funds may reduce the level of deposits available to fund
banking assets and increase the cost of funding. Demographic trends in the
United States point to a growing transfer of wealth to the next generation in
the following decades that could accelerate this transfer of wealth out of the
banking system and into other non-banking providers. If this change occurs,
PSB's funding costs could increase and adversely affect PSB's results of
operations.
PSB'S MARKET SHARE MAY DECLINE IF IT DOES NOT PROVIDE NEW PRODUCTS AND SERVICES
THAT GAIN MARKET ACCEPTANCE AND REGULATORY APPROVAL.
PSB's success depends, in part, on its ability to adapt its products and
services to evolving industry standards and to control expenses. There is
increasing pressure on financial services companies to provide products and
services at lower prices. This can reduce PSB's net interest margin and
revenues from its fee-based products and services. In addition, PSB's success
depends in part on its ability to generate
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significant levels of new business in its existing markets and in identifying
and penetrating markets. The widespread adoption of new technologies,
including Internet-based services, could require PSB to make substantial
expenditures to modify or adapt its existing products and services or render
PSB's existing products obsolete. If PSB cannot successfully introduce new
products and services, achieve market acceptance of its products and services,
develop and maintain loyal customers, and/or break into targeted markets, its
financial conditions, liquidity, and results of operations will be adversely
affected.
INVESTMENT TO PROMOTE FUTURE GROWTH OF CUSTOMERS AND NEW PRODUCT TYPES MAY NOT
YIELD RETURNS PLANNED BY MANAGEMENT.
PSB has substantially increased investment in premises and equipment to a level
approximately 36% of stockholders' equity in 2005 compared to approximately 19%
of equity during 2001. In addition, certain economies of scale are not yet
realized, as the ratio of total assets per employee has remained similar
despite substantial increases in total assets as certain departments have
increased to manage more sophisticated PSB products and risk management
systems. In addition, PSB relies on technology to process virtually all of its
customer's transactions and continually evaluates and implements technology
upgrades and improvements. Results from operations will be negatively effected
if these investments in premises, technology, and staffing do not generate
additional revenue to offset increasing operating expenses.
CHANGES IN LAWS AND REGULATIONS COULD INCREASE COMPETITION AND PSB'S OPERATING
COSTS.
PSB and its subsidiary bank are heavily regulated at the federal and state
levels. This regulation is designed primarily to protect consumers,
depositors, and the banking system as a whole, not stockholders of PSB.
Congress and state legislatures and federal and state regulatory agencies
continually review banking laws, regulations, and policies for possible
changes. Changes to statutes, regulations, or regulatory policies, including
changes in interpretation or implementation of statutes, regulations, or
policies, could adversely affect PSB in substantial and unpredictable ways
including limiting the types of financial services and products PSB may offer,
increasing the ability of non-banks to offer competing financial services and
products, and/or increasing PSB's cost structures. Also, PSB's failure to
comply with laws, regulations, or policies could result in sanctions by
regulatory agencies and damage to its reputation.
PSB HAS INCREASED THE SIZE OF HISTORICAL COMMERCIAL AND INDUSTRIAL LOAN
RELATIONSHIPS, EXPOSING PSB TO POTENTIALLY LARGER CREDIT LOSSES ON ONE
RELATIONSHIP IN THE EVENT OF DEFAULT.
PSB has acquired a number of commercial relationships for which credit has been
issued based primarily on the customer's cash flow and business collateral to a
level greater than in past years. In the event of a failure of one of these
large commercial customers, PSB could incur substantial losses from default of
loan principal. A significant loan loss from such a large commercial customer
would result in a larger provision for loan losses and reduce income.
THE LOSS OF KEY LOAN PERSONNEL MAY DAMAGE CUSTOMER RELATIONSHIPS AND REDUCE
PSB'S LOAN VOLUME AND NET EARNINGS.
Many of the PSB's largest customers have close relationships with their
servicing account officer and may have a loyalty to that officer beyond PSB's
product offerings. Loss of certain relationship officers may cause current
customers to stop using PSB's products and pursue new products offered by their
current account officer through a different employer. PSB's continued success
depends to a significant extent upon the continued employment of its
relationship officers. The loss of services of any of PSB's relationship
officers could cause PSB's business to suffer.
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UNEXPECTED LIABILITIES RESULTING FROM CURRENT OR FUTURE CLAIMS OR CONTINGENCIES
MAY HAVE A MATERIAL ADVERSE EFFECT ON PSB'S BUSINESS, OPERATING RESULTS, AND
FINANCIAL CONDITION.
PSB may be involved from time to time in a variety of litigation arising out of
its business. PSB's insurance may not cover all claims that may be asserted
against it, and any claims asserted against PSB, regardless of merit or
eventual outcome, may harm PSB's reputation. In addition, PSB may not be able
to obtain appropriate types or levels of insurance in the future, nor may PSB
be able to obtain adequate replacement policies with acceptable terms, if at
all. Should the ultimate judgments or settlements in any actual or threatened
claims or litigation exceed PSB's insurance coverage, they could have a
material adverse effect on PSB's business, operating results, and financial
condition.
POTENTIAL ACQUISITION OR OTHER EXPANSION OF OUR MARKET MAY HAVE A DIFFERENT
RESULT THAN PLANNED AND MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS,
OPERATING RESULTS, AND FINANCIAL CONDITION.
Difficulty in operating in a new market, or in integrating an acquired business
may cause PSB not to realize expected revenue increases, cost savings,
increases in market presence, or other projected benefits. PSB may not attract
sufficient loan or deposit volume in a new market to offset the increased
costs. The integration process of an acquired business or location could
result in higher than expected deposit attrition (run-off), loss of customers
and key employees, the disruption of PSB's business or the business of the
acquired company, or otherwise adversely affect PSB's ability to maintain
existing relationships with customers and employees or to enter into new
business relationships. These factors could contribute to PSB not achieving
the anticipated benefits of the market expansion or acquisition within the
desired time frames, if at all.
PSB'S ACCOUNTING POLICIES AND METHODS ARE THE BASIS OF HOW PSB REPORTS ITS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, AND THEY MAY REQUIRE MANAGEMENT
TO MAKE ESTIMATES ABOUT MATTERS THAT ARE INHERENTLY UNCERTAIN.
PSB's accounting policies and methods are fundamental to how PSB records and
reports its financial condition and results of operations. PSB's management
must exercise judgment in selecting and applying many of these accounting
policies and methods in order to ensure that they comply with generally
accepted accounting principles and reflect management's judgment as to the most
appropriate manner in which to record and report PSB's financial condition and
results of operations. In some cases, management must select the accounting
policy or method to apply from two or more alternatives, any of which might be
reasonable under the circumstances yet might result in PSB's reporting
materially different amounts than would have been reported under a different
alternative. Information on PSB's critical accounting policies is contained in
this Annual Report on Form 10-K in Item 7, Management's Discussion and Analysis
of Financial Condition and Results of Operations.
UNEXPECTED TAX LIABILITY AS A RESULT OF EXAMINATIONS AND CHALLENGES BY TAX
AUTHORITIES MAY HARM PSB'S FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
In the normal course of business, PSB and its subsidiary are subject to
examinations and challenges from federal and state tax authorities regarding
the amount of taxes due in connection with investments it has made and the
businesses in which it is engaged. Recently, federal and state taxing
authorities have become increasingly aggressive in challenging tax positions
taken by financial institutions. These tax positions may relate to tax
compliance, sales and use, franchise, gross receipts, payroll, property, and
income tax issues, including tax base, apportionment, and tax planning. The
challenges made by tax authorities may result in adjustments to the timing or
amount of taxable income or deductions or the allocation of income among tax
jurisdictions. See, Item 8, Note 13 of Notes to Consolidated Financial
Statements. If such challenges are
8
made and are not resolved in PSB's favor, they could have an adverse effect on
PSB's financial condition and results of operations.
INVESTORS MAY NOT BE ABLE TO LIQUIDATE THEIR PSB HOLDINGS WHEN DESIRED BECAUSE
THERE IS NO ACTIVE PUBLIC TRADING MARKET FOR PSB STOCK.
There is no active public established trading market for PSB stock. As a
result, investors may not be able to resell shares at the price or time they
desire.
PSB CANNOT GUARANTEE CONTINUED CASH DIVIDEND PAYMENTS OR THAT IT WILL BE ABLE
TO MEET ITS OBLIGATIONS TO HOLDERS OF ITS TRUST PREFERRED SECURITIES.
PSB is a separate and distinct legal entity from Peoples State Bank. It
receives substantially all of its revenue from bank dividends. These dividends
are the principal source of funds to pay dividends on PSB's common stock and
interest on its junior subordinated debt. The payment of dividends by the bank
is subject to federal law restrictions as well as to the laws of Wisconsin.
Although semi-annual cash dividends have been paid on PSB common stock for many
years, a decline in operating income or need to retain earnings for regulatory
capital or growth may cause PSB to lower or stop the existing cash dividend.
PSB'S ARTICLES OF INCORPORATION COULD MAKE MORE DIFFICULT OR DISCOURAGE AN
ACQUISITION OF PSB.
PSB's articles of incorporation require the approval of two-thirds of all
shares outstanding in order to effect a merger, share exchange, or other
reorganization. This provision may discourage potential takeover attempts,
discourage bids for our common stock at a premium over market price, or
otherwise adversely affect the market price of our common stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
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.
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.
9
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 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 2005, PSB purchased 17,200 shares at an
average price of $31.18 per share. During 2004, PSB purchased 18,001 shares at
an average price of $34.91 per share.
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 planspurchased under the
purchased (or unit) or programs plans or programs
Period (a) (b) (c) (d)
October 2005 - $ - - -
November 2005 3,800 30.15 3,800 3,400
December 2005 3,400 30.50 3,400 -
Quarterly Totals 7,200 $30.32 7,200 -
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, 2005, there were approximately 958 holders of record of PSB
common stock. Some of PSB's shares are held in "street" name brokerage
accounts 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, 2005, the bank could have paid a maximum of approximately $15.5 million in
additional dividends to PSB without prior regulatory approval. However, to
remain "well capitalized" under regulatory Prompt Corrective Action Provisions
(see Note 17 to the Consolidated Financial Statements), dividends could not
exceed approximately $7.6 million as of December 31, 2005. PSB has paid
regular dividends since its inception in 1995.
10
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 included in Item 8 has been adjusted to
reflect the impact of this stock dividend on a proforma basis.
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:
2005 Prices 2004 Prices
Quarter High Low Dividends High Low Dividends
1st $32.15 $31.85 $ - $35.00 $33.30 $ -
2nd $31.85 $30.75 $ 0.310 $34.75 $34.10 $ 0.300
3rd $31.00 $30.65 $ - $34.50 $32.75 $ -
4th $30.90 $29.25 $ 0.310 $32.75 $32.10 $ 0.300
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 120 shares (valued at $32.10 per share) and 232 shares (valued
at $33.62 per share) of its common stock during 2005 and 2004, 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, 2005 2004 2003 2002 2001
(dollars in thousands, except per share data)
Total interest income $25,764 $22,202 $21,050 $21,915 $23,428
Total interest expense 11,655 8,113 7,869 9,274 12,469
Net interest income 14,109 14,089 13,181 12,641 10,959
Provision for loan losses 160 855 835 1,110 890
Net interest income after loan loss provision 13,949 13,234 12,346 11,531 10,069
Total noninterest income 3,468 3,123 4,111 3,048 2,065
Total noninterest expenses 11,040 10,975 9,351 8,226 7,315
Net income before income taxes 6,377 5,382 7,106 6,353 4,819
Provision for income taxes 2,037 1,856 2,300 1,988 1,453
Net income $ 4,340 $ 3,526 $ 4,806 $ 4,365 $ 3,366
11
Consolidated summary balance sheets:
As of December 31, 2005 2004 2003 2002 2001
(dollars in thousands, except per share data)
Cash and cash equivalents $ 26,604 $ 23,324 $ 18,927 $ 21,552 $ 25,550
Securities 81,501 68,894 72,472 81,057 70,444
Total loans receivable, net of allowance 372,411 343,923 304,339 256,015 236,574
Premises and equipment, net 12,632 12,432 7,557 6,158 4,755
Bank owned life insurance 4,805 - - - -
Other assets 8,205 6,401 5,638 6,687 6,973
Total assets $506,158 $454,974 $408,933 $371,469 $344,296
Total deposits $400,536 $358,225 $316,414 $297,830 $273,635
FHLB advances 54,000 52,000 47,000 38,000 38,000
Other borrowings 4,497 8,565 10,475 3,302 4,327
Junior subordinated debentures 7,732 - - - -
Other liabilities 3,908 2,568 2,903 3,034 2,985
Stockholders' equity 35,485 33,616 32,141 29,303 25,349
Total liabilities and stockholders' equity $506,158 $454,974 $408,933 $371,469 $344,296
Performance ratios: 2005 2004 2003 2002 2001
Basic earnings per share $ 2.53 $ 2.04 $ 2.76 $ 2.48 $ 1.91
Diluted earnings per share $ 2.52 $ 2.03 $ 2.74 $ 2.48 $ 1.91
Common dividends declared per share $ 0.62 $ 0.60 $ 0.57 $ 0.54 $ 0.51
Dividend payout ratio 24.42% 29.33% 20.77% 21.65% 26.94%
Net book value per share at year-end $ 20.81 $ 19.55 $ 18.54 $ 16.75 $ 14.38
Average common shares outstanding 1,714,648 1,725,136 1,740,106 1,758,249 1,763,381
Return on average stockholders' equity 12.39% 10.66% 15.45% 15.97% 13.96%
Return on average assets 0.90% 0.82% 1.26% 1.25% 1.05%
Net interest margin (tax adjusted) 3.23% 3.60% 3.75% 3.95% 3.73%
Net loan charge-offs to average loans 0.04% 0.07% 0.16% 0.37% 0.14%
Noninterest income to average assets 0.72% 0.73% 1.08% 0.88% 0.65%
Noninterest income to tax adjusted
net interest margin 23.61% 21.29% 29.98% 23.12% 18.12%
Efficiency ratio (tax adjusted) 60.80% 61.70% 52.46% 50.68% 54.50%
Salaries and benefits expense to average asset 1.36% 1.44% 1.56% 1.42% 1.38%
Other expenses to average assets 0.91% 1.11% 0.89% 0.94% 0.91%
FTE employees at year-end 145 133 116 116 100
Average equity to average assets 7.23% 7.68% 8.15% 7.85% 7.53%
Non-performing loans to gross loans at year-end 0.74% 0.80% 1.08% 0.94% 1.68%
Allowance for loan losses to loans at year-end 1.11% 1.19% 1.15% 1.22% 1.24%
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Management's discussion and analysis reviews significant factors with respect
to PSB's financial condition and results of operations at and for the three-
year period ended December 31, 2005. 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, like other portions of this Annual Report
on Form 10-K, includes 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 described in such forward-looking statements.
A cautionary statement regarding forward-looking statements is set forth under
the caption "Forward-Looking Statements" in Item 1 of this Annual Report on
Form 10-K. This discussion and analysis should be considered in light of such
cautionary statement and the risk factors disclosed in Item 1A of this report.
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. These risk factors were outlined
in Item 1A previously.
PSB operates in many ways as a local community bank, but larger in size and
scope. PSB maintains a traditional retail and commercial 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 loans made to
local customers after payment of interest to depositors. PSB originates,
sells, and services long-term fixed rate mortgage loans to the secondary market
for a substantial amount of fee income. Depositors pay various service fees
including overdraft charges and commercial service fees which contribute to
PSB's noninterest income. PSB sells retail investment products on a commission
basis primarily to individuals. Interest income on loans, mortgage banking
income, service charges on deposit accounts, and investment sales commissions
make up approximately 85% of PSB's gross revenue, consistent with recent years.
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. Although greater in
size than typical community banks, traditional community bank customer service
and flexibility differentiate PSB from larger financial service providers.
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
13
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 minimizes costs for name recognition and awareness while increasing the
speed in which customers are obtained via new locations and 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 a local market leader in that area.
Against this back drop of industry-wide factors and competitive advantages and
opportunities, management monitors several areas of risk, negative trends, 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 increased substantially during 2005 compared to 2004, due to
2004 incurring several one-time charges and significantly reduced 2005
provisions for loan losses. However, 2005 net income continued to be
less than 2003 net income (the highest level for PSB to date) which was
driven significantly by mortgage banking income.
* The reduction in provision for loan losses in 2005 compared to prior
years was due to an overall reduction in problem loans, and favorable
resolution of long-time problems for which specific loss reserves had
been applied. Such reduced provisions for loan losses relative to net
growth in loans receivable is not expected to continue during 2006
thereby reducing net income.
* Net interest margin continued a decline that began in 2003. Rising
short-term interest rates (that began with Federal Reserve discount rate
increases during June 2004) have increased deposit costs faster than
corresponding longer-term lending rate income. Static gap analysis
shows earning assets repriced with similar timing to interest-bearing
liabilities, but the extent of deposit repricing has been greater than
loans as the market's interest yield curve flattened significantly
during 2005. 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 providing continued loan growth supported by these funds.
* PSB continues to expand its branch network, opening a branch in Weston,
Wisconsin during 2005, continuing significant increases to 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 stockholders. 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.
* Although the rate of retail deposit growth during 2005 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 restructured 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 and other large-
balance high yield deposit accounts with key personnel to attract larger
commercial and governmental
14
depositors. To attract these deposits, above market interest rates were
required, but have resulted in local deposits with significantly larger
average balances.
* In connection with PSB's new treasury management product initiative,
lending activities with large commercial enterprises to be repaid solely
from cash flow have increased. 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. Additional staff and other investments were
added in 2005 in the credit analysis area to better monitor commercial
credit relationships.
* PSB has petitioned the United States Tax Court regarding an Internal
Revenue Service assessment for tax related to disallowance of interest
expense on holding tax-exempt obligations at 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 Tax Court petition would have an unfavorable impact on
profits.
* Income from service fees on deposit accounts continued a decline
beginning in 2003. The change has been led by a decline of $113 (or
27%) in business service charges since 2003. The business service
charges were reduced due to local competitive pressures and from an
account fee restructuring aimed at increasing the level of commercial
local noninterest bearing demand accounts.
RESULTS OF OPERATIONS
PSB's net income increased to $4,340 for 2005 compared to $3,526 in 2004 after
net income of $4,806 during 2003 representing an increase of 23.1% in 2005 and
a decrease of 26.6% in 2004. Similarly, diluted earnings per share increased
to $2.52 for 2005 compared to $2.03 in 2004 and $2.74 in 2003. 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, 2005. A number of separate
factors impacted PSB earnings during the past several years as outlined in the
table below. Despite these separately identifiable items, PSB operating income
before the provision for loan losses and 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 five years ending December
31, 2005 presented before the provision for loan losses (after-tax) and
identifying adjustments for gain on sale of mortgage loans and other
nonrecurring income and expense items.
15
TABLE 2: SUMMARY OPERATING INCOME
Years ending December 31, 2005 2004 2003 2002 2001
Net income before provision for loan losses,
and special items, net of tax $3,792 $3,965 $4,114 $4,297 $3,491
Less: Provision for loan losses, net of tax 97 518 506 673 539
Net income before special items, net of tax $3,695 $3,447 $3,608 $3,624 $2,952
Mortgage banking income 533 546 1,071 741 414
Net gain on sale of securities 4 59 48 - -
Gain on sale of Pulse ATM stock 47
Recovery (write-off) of collection expenses 61 (77)
Loss on abandonment of home office (199)
Branch closure charges (100)
Wisconsin state income tax settlement (150)
Gain on curtailment of post-retirement benefit plan 79
Net income $4,340 $3,526 $4,806 $4,365 $3,366
While 2005 net income before special non-recurring items and mortgage banking
income increased to the highest level in the past five years, net income was
substantially improved by a reduction in the provision for loan losses. The
low provision levels seen in 2005 are not expected to continue during 2006,
reducing future income. Net income before provision for loan losses and
special items continues to decline primarily from a decrease in average net
interest margin in 2005 and 2004 compared to prior years as net interest income
growth was significantly less than operating expense growth.
2004 net income compared to 2003 net income was also 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 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 earning assets compared to 2002 and additional wages paid to
employees based on earnings which included mortgage banking income under PSB's
incentive compensation plan.
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 20 of the Notes to
Consolidated 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
16
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.
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, 2005.
17
TABLE 3: AVERAGE BALANCES AND INTEREST RATES
2005 2004 2003
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
Assets
Interest-earning assets:
Loans(1)(2)(3) $368,626 $22,423 6.08% $329,133 $19,278 5.86% $282,006 $18,025 6.39%
Taxable securities 49,514 1,966 3.97% 47,356 1,798 3.80% 51,707 1,943 3.76%
Tax-exempt securities(2) 24,574 1,482 6.03% 24,730 1,488 6.02% 22,478 1,388 6.17%
FHLB stock 2,958 162 5.48% 2,709 159 5.87% 2,367 153 6.46%
Other 8,666 311 3.59% 3,497 56 1.60% 6,760 74 1.09%
Total(2) 454,338 26,344 5.80% 407,425 22,779 5.59% 365,318 21,583 5.91%
Non-interest-earning assets:
Cash and due from banks 13,102 13,409 10,268
Premises and equipment,
net 12,643 10,508 6,410
Cash surrender value life ins. 4,186
Other assets 4,338 3,158 3,108
Allowance for loan losses (4,240) (3,885) (3,475)
Total $484,367 $430,615 $381,629
Liabilities & stockholders' equity
Interest-bearing liabilities:
Savings and demand deposits $ 69,894 $ 1,201 1.72% $ 52,982 $ 371 0.70% $ 40,518 $ 247 0.61%
Money market deposits 70,042 1,222 1.74% 66,494 610 0.92% 69,238 692 1.00%
Time deposits 188,335 6,596 3.50% 166,967 4,802 2.88% 144,083 4,712 3.27%
FHLB borrowings 52,208 2,133 4.09% 47,749 2,061 4.32% 38,553 1,989 5.16%
Other borrowings 8,739 272 3.11% 11,824 269 2.28% 9,151 229 2.50%
Junior sub. Debentures 3,961 231 5.83%
Total 393,179 11,655 2.96% 346,016 8,113 2.34% 301,543 7,869 2.61%
Non-interest-bearing liabilities:
Demand deposits 53,285 49,600 46,876
Other liabilities 2,864 1,915 2,098
Stockholders' equity 35,039 33,084 31,112
Total $484,367 $430,615 $381,629
Net interest income $14,689 $14,666 $13,714
Rate spread 2.84% 3.25% 3.30%
Net yield on interest-earning assets 3.23% 3.60% 3.75%
(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: 2005 - $238, 2004 - $397, 2003 - $654.
18
TABLE 4: INTEREST INCOME AND EXPENSE VOLUME AND RATE ANALYSIS
2005 compared to 2004 2004 compared to 2003
increase (decrease) due to (1)increase (decrease) due to (1)
Volume Rate Net Volume Rate Net
Interest earned on:
Loans(2) $2,401 $ 744 $3,145 $2,762 $(1,509) $1,253
Taxable securities 86 82 168 (165) 20 (145)
Tax-exempt securities(2) (9) 3 (6) 136 (36) 100
FHLB stock 14 (11) 3 20 (14) 6
Other interest income 186 69 255 (52) 34 (18)
Total 2,678 887 3,565 2,701 (1,505) 1,196
Interest paid on:
Savings and demand deposits 291 539 830 87 37 124
Money market deposits 62 550 612 (25) (57) (82)
Time deposits 748 1,046 1,794 659 (569) 90
FHLB borrowings 182 (110) 72 397 (325) 72
Other borrowings (96) 99 3 61 (21) 40
Junior subordinated debentures 231 - 231
Total 1,418 2,124 3,542 1,179 (935) 244
Net interest earnings $1,260 $(1,237) $ 23 $1,522 $ (570) $ 952
(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 2005, average earning assets grew 11.5% to $454,338 compared to growth
of 11.5% during 2004 and 9.5% during 2003. However, tax adjusted net interest
income increased just .2% to $14,689 compared to growth of 6.9% to $14,666
during 2004 and growth of 4.0% to $13,714 during 2003. As market rates
increased during 2005, yield on earning assets increased .21% but cost of
interest-bearing liabilities increased .62%, lowering the interest rate spread
..41% to 2.84% from 3.25% in 2004. Although the volume of additional earning
assets added $1,260 to net interest income during 2005, approximately 98% of
this benefit was lost to declines in net interest margin.
Changes in 2005 net margin were impacted primarily by 1) the flattening shape
of the yield curve, and 2) local competitive pressures on loan and deposit
pricing. During 2005 continued discount rate increases by the Federal Reserve
of 200 basis points (short-term rate increases) were not matched by
corresponding yield increases of approximately 100 basis points in longer term
yields such as three-year fixed rate maturities. This reduced the spread
between short-term overnight funding expense and mid-term rate income commonly
in place for PSB loan originations. A flattening yield curve in 2005 would
have been expected to reduce net interest margin even if the mid-term assets
funded with short-term liabilities would have repriced in a manner consistent
with overall market interest rates.
Exacerbating the flattening of net interest margin was the extent to which
market rate increase were able to be repriced by PSB during 2005. Of the 200
basis point increase in short-term market rates, PSB short-term average deposit
funding rates increased 91 basis points. Compared to the approximately 100
basis
19
point increase in market loan rates in the three year average term, PSB
loan yields increased 22 basis points. These disproportionate rate increases
resulted from competitive pressures to limit loan increases and maximize
deposit rate increases during 2005.
A substantial driver in 2005 PSB short-term deposit rate increases were sales
of high yield money market and interest-bearing demand NOW deposits during 2005
to municipalities and individual high dollar balance accounts. These high
yield accounts are priced relative to the 30 day LIBOR and change with
movements of wholesale market rates. Due to this rate structure, short-term
market rate increases on 36% of the December 31, 2005 savings, interest-bearing
demand, and money market deposits were fully realized by the end of 2005.
These products have resulted in attracting local funding of approximately
$52,270 with average account balances of approximately $261 as of December 31,
2005.
Yield on both earning assets and cost of interest-bearing liabilities declined
during 2004 and 2003. However, during 2004 and 2003, 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 beginning in June
2004, earnings assets and funding sources tied to these short-term rates rose
compared to yields seen during 2003. For example, in 2004 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 during 2004, decreasing yields. Although
the volume of additional earning assets added $1,522 to net interest income
during 2004, approximately 37% 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 already 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 $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, 2005.
TABLE 5: YIELD ON EARNING ASSETS
Year ended December 31, 2005 2004 2003
Yield Change Yield Change Yield Change
Yield on earning assets 5.80% 0.21% 5.59% -0.32% 5.91% -0.82%
Effective rate on all liabilities as
a percent of earning assets 2.57% 0.58% 1.99% -0.17% 2.16% -0.62%
Net yield on earning assets 3.23% -0.37% 3.60% -0.15% 3.75% -0.20%
NONINTEREST INCOME
As shown in Table 7, during 2005, PSB noninterest income increased $345
primarily from a $160 increase in cash surrender value of life insurance
contracts purchased during early 2005, a gain on sale of Pulse ATM stock of
$78, and an increase in retail investment sales commissions of $183. Absent
these items, noninterest income declined $76 primarily from $46 lower service
fee income. Other operating income increased $99 led by an increase of $34 in
merchant banking income. 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.
20
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. 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 2005 and 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 (before tax
adjustment) for the five years ending December 31, 2005.
TABLE 6: SUMMARY OF EARNINGS AS A PERCENT OF NET INTEREST INCOME
2005 2004 2003 2002 2001
Net interest income 100.0% 100.0% 100.0% 100.0% 100.0%
Provision for loan losses 1.1% 6.1% 6.3% 8.8% 8.1%
Net interest income after loan loss provision 98.9% 93.9% 93.7% 91.2% 91.9%
Total noninterest income 24.6% 22.2% 31.2% 24.1% 18.8%
Total noninterest expenses 78.2% 77.9% 70.9% 65.1% 66.7%
Net income before income taxes 45.3% 38.2% 54.0% 50.2% 44.0%
Provision for income taxes 14.4% 13.2% 17.4% 15.7% 13.3%
Net income 30.9% 25.0% 36.6% 34.5% 30.7%
2005 service fee income declined $46 due primarily to a decline in commercial
deposit service fee income of $65, or 17.7%. During 2005, commercial service
fees were reduced on certain accounts to provide more competitive products as
part of a strategic plan to increase the level of commercial demand deposits.
During 2005 average commercial demand deposits did increase $2,131, or 6.4%
after experiencing just 1.6% growth during 2004. PSB had expected to increase
service fee income during 2005 from fees on new treasury management products.
However, customer treasury management fees have not yet substantially increased
income.
During 2004, service fees declined $48 from that in 2003 due again to a decline
in commercial account service charges of $48, or 11.6%. 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 after 2003. A detailed analysis of noninterest income relative to net
income before income taxes follows to highlight the impact of these items on
income.
21
TABLE 7: NONINTEREST INCOME
Years Ended December 31, 2005 2004 2003
% of pre-tax % of pre-tax % of pre-tax
Amount income Amount income Amount income
Service fees $1,188 18.63% $1,234 22.93% $1,282 18.04%
Mortgage banking income 880 13.80% 901 16.74% 1,767 24.87%
Retail investment sales commissions 610 9.57% 427 7.93% 351 4.94%
Increase in cash surrender value of
life insurance 160 2.51% - 0.00% - 0.00%
Insurance annuity sales commissions 38 0.60% 41 0.76% 63 0.89%
Net gain on sale of securities 6 0.09% 97 1.80% 80 1.13%
Net gain (loss) on sale of foreclosed
property (1) -0.02% 29 0.54% (9) -0.13%
Gain on disposal of premises and
equipment 2 0.03% 3 0.06% - 0.00%
Gain on sale of non-mortgage loans 17 0.27% - 0.00% 62 0.87%
Gain on sale of Pulse ATM stock 78 1.22% - 0.00% - 0.00%
Gain on curtailment of post-retirement
benefit plan - 0.00% - 0.00% 131 1.84%
Other operating income 490 7.68% 391 7.26% 384 5.40%
Total noninterest income $3,468 54.38% $3,123 58.03% $4,111 57.85%
PSB serviced $169,708 and $160,225 of residential real estate loans which have
been sold to the FHLB under the Mortgage Partnership Finance Program ("MPF") at
December 31, 2005 and 2004, 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. As a FHLB MPF loan servicer,
PSB is also 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. See "Off Balance Sheet Arrangements."
PSB recognizes a mortgage servicing right asset due to the substantial volume
of loans serviced for the FHLB. Refer to Note 1 of the Notes to 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, 2005.
22
TABLE 8: MORTGAGE BANKING INCOME
Years ending December 31, 2005 2004 2003
Cash gain on sale of mortgage loans $ 312 $ 363 $1,229
Originated mortgage servicing rights 269 334 792
Gain on sale of mortgage loans 581 697 2,021
Mortgage servicing fee income 415 396 325
FHLB credit enhancement fee income 112 117 96
Amortization of mortgage servicing rights (235) (293) (700)
Change in servicing right valuation allowance 7 (16) 25
Loan servicing fee income, net 299 204 (254)
Mortgage banking income $ 880 $ 901 $1,767
TABLE 9: FHLB MORTGAGE PARTNERSHIP FINANCING (MPF) PROGRAM SERVICING
PSB Credit FHLB Mortgage
Principal Enhancement Funded First Servicing
As of December 31, 2005 Serviced Guarantee Loss Account Right, net
MPF 100 Program (agent program) $100,186 $ 499 $2,494 $455
MPF125 Program (closed loan program) 69,522 633 805 425
Total FHLB MPF serviced loans $169,708 $1,132 $3,299 $880
FHLB MPF Program elements as a percentage of principal serviced:
As of December 31, 2005: MPF 100 MPF 125
PSB credit enhancement guarantee 0.50% 0.91%
FHLB funded first loss account 2.49% 1.16%
Mortgage servicing right, net 0.45% 0.61%
NONINTEREST EXPENSE
Noninterest expenses year over year continue to increase growing .6% during
2005, 17.4% during 2004, and 13.7% during 2003. 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, 2005 noninterest
expense increased 4.2% over 2004, and 2004 noninterest expense increased 13.3%
over 2003.
The 2005 efficiency ratio improved to 60.80% compared to 2004 ratio of 61.70%.
In 2004, noninterest expense grew faster than income, thereby unfavorably
increasing the efficiency ratio compared to the 2003 efficiency ratio of
52.46%. However, the 2004 efficiency ratio before the non-recurring loss on
abandonment of premises and equipment was 59.56% compared to 60.80% in 2005,
and 52.46% during
23
2003. Other factors resulting in the less favorable efficiency ratio during
2005 and 2004 compared to 2003 were the large decline in mortgage banking
income and slower net interest income growth relative to growth in operating
expenses. As PSB invests in new branch facilities and personnel (as occurred
during 2005 and 2004), future years will have a significantly higher fixed cost
structure than in prior years.
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, 2005.
TABLE 10: NONINTEREST EXPENSE
Years Ended December 31, 2005 2004 2003
% of net % of net % of net
margin margin margin
& other & other & other
Amount income(1) Amount income(1) Amount income(1)
Wages, except incentive compensation $ 5,577 30.72% $ 5,059 28.44% $ 4,476 25.11%
Incentive compensation 135 0.74% 157 0.88% 466 2.61%
Deferred loan origination costs (659) -3.63% (306) -1.72% (259) -1.45%
Health insurance 516 2.84% 389 2.19% 377 2.12%
Profit sharing and retirement plan expense 315 1.73% 313 1.76% 327 1.83%
Deferred compensation plan expense 127 0.70% 18 0.10% 8 0.04%
Post-retirement health care benefits plan 8 0.04% 26 0.15% 62 0.35%
Payroll taxes and other employee benefits 591 3.25% 533 3.00% 495 2.78%
Total salaries and employee benefits 6,610 36.39% 6,189 34.80% 5,952 33.39%
Occupancy expense 1,767 9.73% 1,609 9.04% 1,127 6.32%
Loss on abandonment of premises and
equipment - 0.00% 379 2.13% - 0.00%
Data processing and other office operations 741 4.08% 655 3.68% 547 3.07%
Advertising and promotion 287 1.58% 263 1.48% 172 0.96%
Directors fees and benefits 225 1.24% 254 1.43% 270 1.51%
Legal and professional expenses 230 1.27% 316 1.78% 290 1.63%
Write-off (recovery) of collection expenses (101) -0.56% 127 0.71% - 0.00%
Other expenses 1,281 7.07% 1,183 6.65% 993 5.58%
Total noninterest expense $11,040 60.80% $10,975 61.70% $ 9,351 52.46%
(1) 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 138, 126, and
119 in 2005, 2004, and 2003, respectively. Average base wages per FTE were
approximately $40,400, $40,100, and $37,600 in 2005, 2004, and 2003,
respectively, increasing .7% during 2005 and 6.6% during 2004.
During 2005, health insurance expense increased $127 or 32.6% from both higher
individual stop loss limits under the self-insured plan and greater plan
claims. Deferred loan origination costs increased
24
substantially as PSB adopted a new automated method to account for net loan
origination fees and costs in accordance with Statement of Financial Accounting
Standard No. 91. Although greater net costs were deferred, amortization of
these costs also accelerated, resulting in an increase in net deferred loan
costs of $66 during 2005 compared to $52 during 2004.
As a method to retain key employees with PSB, a deferred compensation program
was initiated during 2005. PSB deferred compensation plan contributions
increased $109 to $127 during 2005 under the new plan provisions. See Item 8,
Note 11 of Notes to Consolidated Financial Statements.
During 2005 and 2004, PSB invested in new branch facilities in Minocqua, Wausau
(home office), and Weston, Wisconsin in addition to technology investments in
image capture and transport, and a new on-line retail and commercial on-line
banking product. These investments continue to increase ongoing occupancy and
data processing costs. Occupancy costs increased 9.8% and 42.8% in 2005 and
2004, respectively. Data processing and other office operations costs
increased 13.1% and 19.7% in 2005 and 2004, respectively. During 2005, PSB
introduced a new internet based home banking and commercial treasury management
system which contributed to increased data processing costs. Past and future
technology investments are expected to continue to increase data processing
costs during 2006.
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 2003 and 2002, the
highest levels of incentive compensation were paid. However, incentive
compensation is variable, and declined during 2004 and was stable in 2005 due
to a lower level of profitability compared to expectations. Should final net
income meet budgeted expectations for 2006, incentive compensation expense is
expected to increase compared to 2005 and 2004.
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, in the amount of $52,
of a sales tax audit related largely to premises and equipment investment and
maintenance. 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). 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.
Other noninterest expenses during 2004 include $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.
During 2005, a past collection fee expense of $101 was recovered, which reduced
noninterest expenses.
25
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.
PSB formed Peoples Insurance Services LLC (the "Agency") during September 2003
as a start up commercial property and casualty insurance agency that operated
as a division of Peoples State Bank. Following two years of operation, the
book of insurance business was sold to an unrelated insurance agency in
exchange for future servicing of existing customers following ongoing losses in
excess of expectations. The Agency incurred net losses (after tax benefits)
from operations (excluding inter-company cost allocations for rent, management
fees, and interest expense) was $66, $129, and $39 during 2005, 2004, and 2003,
respectively.
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
$160 in 2005 compared to $855 in 2004 and $835 in 2003.
A reduction in the provision for loan losses during 2005 compared to prior
years was a significant contributor to increased 2005 net income. The
reduction in provision was due to an improvement in credit quality, a decline
in the pace of net loan growth, and favorable resolution of a significant long-
term problem loan for which specific reserves had been provided in previous
years.
Non-performing loans relative to total loans and total assets continued to
decline during 2005 compared to 2004 and 2003. See additional discussion under
this Item 7 in the section titled "Allowance for Loan Losses." In addition,
nearly 65% of the $28,511 net increase in gross loans receivable during 2005
was categorized internally as having above average commercial credit quality,
or as retail non-problem residential mortgages. A majority of these high
credit loans originated as part of PSB's commercial and treasury management
strategic growth initiative and were made to large local companies with strong
operating cash flow and/or having strong guarantors.
Gross loans increased $40,205 during 2004 and $48,702 during 2003 compared to
$28,511 in 2005, requiring greater reserve provisions to accommodate larger new
loan growth during 2004 and 2003.
During 2005, PSB also received repayment of a long-time problem loan for which
$160 in specific loss reserves had previously been allocated. This specific
reserve was taken back into income upon loan payoff without loss of principal.
PSB does not expect all these favorable conditions to recur next year and
anticipates increased provision for loan losses during 2006.
26
INCOME TAXES
The effective tax rate was 31.9% in 2005, 34.5% in 2004, and 32.4% in 2003.
The increase in the 2004 effective rate was due to a Wisconsin state income tax
settlement totaling $150 (after federal tax benefits) regarding operations of
the Nevada investment subsidiary. Excluding this one-time charge, the
effective rate would have been 31.7%. During 2005, tax-exempt income from bank
owned life insurance and tax exempt municipal income kept the 2005 effective
rate near 2004 levels. 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.
As described in Note 13 of the Notes to Consolidated Financial Statements,
PSB's open tax returns are under audit by the Internal Revenue Service in
connection with PSB Investments, Inc. activities. PSB has petitioned the
United States Tax Court to review the case. Initial court proceedings are
expected to occur during 2006. PSB believes it has calculated and paid
appropriate income taxes in all cases in accordance with written tax code and
regulations. Through November 15, 2005, PSB has been assessed approximately
$184 in taxes, interest, and penalties for the tax years ending 1999 through
2002 as a result of the IRS audit.
BALANCE SHEET CHANGES AND ANALYSIS
Summary balance sheets for the five years ended December 31, 2005 are presented
in Item 6 to this Annual Report on Form 10-K. Total asset growth was 11.2%,
11.3%, and 10.1% during the years ended December 31, 2005, 2004, and 2003,
respectively. Presented in the table below is a summary balance sheet for the
five years ended as of December 31, 2005 as a percentage of total assets.
TABLE 11: SUMMARY BALANCE SHEET AS A PERCENT OF TOTAL ASSETS
As of December 31, 2005 2004 2003 2002 2001
Cash and cash equivalents 5.3% 5.1% 4.6% 5.8% 7.4%
Securities 16.1% 15.1% 17.7% 21.8% 20.5%
Total loans receivable, net of allowance 73.6% 75.6% 74.4% 68.9% 68.7%
Premises and equipment, net 2.5% 2.7% 1.9% 1.7% 1.4%
Bank owned life insurance 0.9% 0.0% 0.0% 0.0% 0.0%
Other assets 1.6% 1.5% 1.4% 1.8% 2.0%
Total assets 100.0% 100.0% 100.0% 100.0% 100.0%
Total deposits 79.1% 78.7% 77.4% 80.2% 79.5%
FHLB advances 10.7% 11.4% 11.5% 10.2% 11.0%
Other borrowings 0.9% 1.9% 2.6% 0.9% 1.3%
Junior subordinated debentures 1.5% 0.0% 0.0% 0.0% 0.0%
Other liabilities 0.8% 0.6% 0.6% 0.8% 0.8%
Stockholders' equity 7.0% 7.4% 7.9% 7.9% 7.4%
Total liabilities and stockholders' equity 100.0% 100.0% 100.0% 100.0% 100.0%
Commercial, industrial, and commercial real estate loan principal increased
during 2005, although the majority of the increase occurred during the first
six months of 2005. Total commercial purpose loans (including closed-end and
disbursed construction commercial real estate loans) increased $24,676 during
27
2005, or 48% of total asset growth. Growth in securities and the investment in
bank owned life insurance was $17,412 or 34% of total asset growth. Demand
deposits, savings, and jumbo brokered certificates increased $42,872 and funded
84% of total asset growth during 2005.
Equity capital as a percentage of total assets declined during 2005 to the
lowest level of the past five years as asset growth outpaced retained income
growth. However, regulatory capital levels increased substantially during 2005
via issuance of trust preferred securities categorized as junior subordinated
debentures on the balance sheet.
During 2004 and 2003, the asset mix increased in loans receivable but decreased
in securities held. Investment in premises and equipment also increased with a
new home office and a full service branch facility added during 2004.
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, 2005, 2004, and 2003 than in prior
years. The table below presents changes in the mix of average earning assets
and interest bearing liabilities for the three years ending December 31, 2005.
TABLE 12: MIX OF AVERAGE INTEREST EARNING ASSETS AND AVERAGE INTEREST BEARING
LIABILITIES
Year ended December 31, 2005 2004 2003
Loans 81.1% 80.8% 77.2%
Taxable securities 10.9% 11.6% 14.2%
Tax-exempt securities 5.4% 6.1% 6.2%
FHLB stock 0.7% 0.7% 0.6%
Other 1.9% 0.8% 1.8%
Total interest earning assets 100.0% 100.0% 100.0%
Savings and demand deposits 17.8% 15.3% 13.4%
Money market deposits 17.8% 19.2% 23.0%
Time deposits 47.9% 48.3% 47.8%
FHLB advances 13.3% 13.8% 12.8%
Other borrowings 2.2% 3.4% 3.0%
Junior subordinated debentures 1.0% 0.0% 0.0%
Total interest bearing liabilities 100.0% 100.0% 100.0%
The structure of PSB's average earning assets changed little during 2005 with a
slightly greater emphasis on loans and reduction in securities. However, PSB's
average funding structure became more weighted toward savings and demand
deposits, specifically local government and municipality high yield NOW
accounts with a reduction in money market deposits and other borrowings.
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
28
demand deposits while money market balances have declined as market rates
for the product fell prior to 2005.
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, 2005, 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 16.3%, 17.7%, and 20.4% of average earning assets in 2005, 2004,
and 2003, respectively. The following table presents the fair value and
amortized cost of securities held by PSB at December 31, 2005, 2004, and 2003.
TABLE 13: INVESTMENT SECURITIES DISTRIBUTION
As of December 31, 2005 2004 2003
Fair % of Fair % of Fair % of
Value Portfolio Value Portfolio Value Portfolio
U.S. Treasury securities and obligations
of U.S. government agencies $23,235 28.51% $ 7,771 11.28% $12,148 16.76%
Obligations of states and political
subdivisions 26,170 32.11% 24,883 36.12% 24,664 34.03%
Mortgage backed securities 6,784 8.32% 6,141 8.91% 7,979 11.01%
Collateralized mortgage obligations 23,014 28.24% 27,801 40.35% 25,383 35.03%
Trust preferred securities 2,250 2.76% 2,250 3.27% 2,250 3.10%
Other equity securities 48 0.06% 48 0.07% 48 0.07%
Total $81,501 100.00% $68,894 100.00% $72,472 100.00%
During 2005, short-term market interest rates rose greater than longer-term
rates, with market expectations of continued short-term rate increases during
2006. In light of this rising rate environment, PSB generally purchased
securities with final maturities less than five years, and allocated fewer new
purchases to securities with extension risk such as mortgage backed securities
and collateralized mortgage obligations ("CMOs"). The U. S. government agency
allocation grew substantially through purchase of securities with final
maturities generally less than 5 years containing either one-time or recurring
issuer call options. Due to a flattening yield curve, mid-term agency
securities with issuer call options offered rising yields in excess of those
available with longer-term bullet maturity structures. At December 31, 2005,
approximately 43% of the U. S. agency portfolio consisted of securities without
issuer call options or securities with a final call option within one year
where the likelihood of the issuer call is considered remote.
During 2005, taxable security yields increased .17% to 3.97% as short term and
intermediate term interest rates increased. However, longer term market rates
continue to be stable and the long-term tax-exempt securities portfolio yield
was stable at 6.03% tax adjusted. 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 2006 even as current market interest rates increase.
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
29
during 2003, PSB reinvested some of the CMO security prepayment proceeds in
additional long-term municipal securities to gain higher tax advantaged yields.
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 3 of the Notes to
Consolidated Financial Statements, for additional information on security
sales.
As market interest rates continued to fall during 2003, a large percentage of
PSB's CMOs prepaid and PSB received large cash flows to be reinvested. These
significant prepayments also required purchase premiums to be amortized against
income much more quickly than 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 CMO 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's 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 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.
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 and interest, are categorized by average principal life
of the security. Yields by security type and maturity are based on amortized
security cost.
30
TABLE 14: INVESTMENT SECURITIES MATURITIES AND RATES
After one but After five but
Within one year within five years within ten years After ten years
As of December 31, 2005 Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury securities and obligations
of U.S. government agencies $4,220 3.90% $19,015 4.17%
Obligations of states and
political subdivisions(1) $1,804 6.77% $10,839 6.47% $13,527 5.39%
Mortgage backed securities 6,126 4.46% 658 4.82%
Collateralized mortgage obligations 2,054 3.48% 20,960 3.88%
Non-rated trust preferred securities 2,250 7.22%
Other equity securities 48 29.47%
Totals $8,126 4.55% $56,940 4.53% $14,185 5.36% 2,250 7.22%
(1) Weighted average yields on tax-exempt securities have been calculated on a
tax-equivalent basis using a rate of 34%.
At December 31, 2005 and 2004, 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 $22,950, $27,982,
and $17,994 at December 31, 2005, 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 from 2003 to
2004 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,
2005, market value was 99.0% of book value compared to 100.8% of book value at
December 31, 2004 and 101.8% of book value at December 31, 2003. The net
unrealized loss on securities available for sale, recorded as a separate
component of stockholders' equity, was $542, net of deferred taxes of $312 at
December 31, 2005 compared to an unrealized gain of $384 net of deferred income
taxes of $195 at December 31, 2004. Unrealized securities gains and losses,
net of income tax effects, do not impact the level of 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.
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, 2005, FHLB dividends have been in the form of additional shares of
stock. In accordance with industry accounting conventions, PSB records FHLB
31
dividends in the form of stock as income in the year received. The average
dividend rate paid to PSB on FHLB stock was 5.48%, 5.87%, and 6.46% in 2005,
2004, and 2003, respectively. Due to limitations on future dividends recently
announced by the FHLB, management expects the yield on FHLB stock to decline
during 2006 to a level between 3.00% and 3.50%. The FHLB system banks have
been criticized recently by federal regulators and required to submit capital
plans and register their capital stock with the Securities and Exchange
Commission. Due to this heightened level of regulatory oversight and in
recognition of stock transfer restrictions, PSB's investment in FHLB stock has
been evaluated for impairment and will be evaluated annually in the future.
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
as presented in the table below increased 8.5%, 13.2%, and 18.6% at December
31, 2005, 2004, and 2003, respectively. During 2005, loan growth was
predominantly in the commercial and industrial category as PSB sought larger
local commercial customers as part of the strategic initiative in the
commercial lending and treasury management area. During 2005, loan growth
occurred predominantly in the PSB home market in Marathon County, Wisconsin.
During 2004, the majority of 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 was widespread over 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.
32
TABLE 15: LOAN COMPOSITION
As of December 31, 2005 2004 2003 2002 2001
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
Commercial,
industrial, municipal
and agricultural $ 86,070 22.18% $ 72,456 20.25% $ 66,934 21.17% $ 64,527 24.21% $64,503 26.38%
Commercial real
estate mortgage 149,538 38.53% 145,856 40.77% 128,290 40.58% 102,238 38.35% 84,150 34.41%
Real estate construction
(commercial and
residential) 46,259 11.92% 38,308 10.71% 37,639 11.91% 26,052 9.77% 15,609 6.38%
Residential real
estate mortgage 87,205 22.47% 82,696 23.11% 66,065 20.90% 55,078 20.66% 61,787 25.27%
Residential real estate
mortgage held for sale - 0.00% 342 0.10% 207 0.07% 949 0.36% 1,403 0.57%
Residential real
estate home equity 13,058 3.37% 11,620 3.25% 9,252 2.93% 7,274 2.73% 4,576 1.87%
Consumer and
individual 5,919 1.53% 6,482 1.81% 7,728 2.44% 10,439 3.92% 12,522 5.12%
Totals $388,049 100.00% $357,760 100.00% $316,115 100.00% $266,557 100.00% $244,550 100.00%
Commercial real estate growth drove PSB loan growth for several years prior to
2005. However, growth in the commercial real estate category has stabilized,
while commercial and industrial loans continue to increase from a focus on this
customer segment. 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.
Average commercial and industrial and commercial real estate loan principal
balances, excluding unused lines of credit, were $230 as of December 31, 2005.
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 served by PSB and believes it 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.
Residential mortgage lending retained in-house increased during 2005 primarily
from rising long-term secondary market rates relative to PSB's 1, 2, and 3 year
balloon products making such in-house balloon
33
products more competitive versus secondary market rates. In addition, PSB
retains second mortgage loans on certain high value homes requiring total
financing above the conforming secondary market limit after selling the first
mortgage into the secondary market. These second mortgages generally carry
balloon payment terms of five years or less. During 2004, a residential loan
program aimed at high value vacation homes in the Wisconsin Northwoods in
connection with a new branch location 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 $169,708 at December 31, 2005, and
$160,225 at December 31, 2004 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.
Real estate construction loans grew $7,951, or 20.8% during 2005 compared to
growth of $669, or 1.8% during 2004. 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 include short-term personal loans, automobile loans,
recreational vehicle loans, and credit card 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, due to income tax advantages, many customers
appeared to borrow on a tax deductible home equity line of credit for many
purposes formerly funded by a consumer installment loan. Total home equity and
installment loans were $18,977, $18,102, and $16,980 at December 31, 2005,
2004, and 2003, 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, 2005, no concentrations existed in PSB's
portfolio in excess of 10% of total loans.
34
TABLE 16: LOAN MATURITY DISTRIBUTION AND INTEREST RATE SENSITIVITY
Loan Maturity
As of December 31, 2005: One year Over one year Over
or less to five years five years
Commercial, industrial, municipal
and agricultural $ 49,575 $ 35,829 $ 666
Commercial real estate mortgage 62,382 77,388 9,768
Real estate construction 46,259
Residential real estate mortgage 26,143 36,997 24,065
Residential real estate mortgage held for sale - - -
Residential real estate home equity 13,058 - -
Consumer and individual 2,910 2,769 240
Totals $200,327 $152,983 $34,739
Fixed rate $145,595 $34,739
Variable rate 7,388 -
Totals $152,983 $34,739
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 2005, provisions to the allowance for
loan losses were greatly reduced, for reasons outlined earlier under the
section "Provision for Loan Losses." The reduced provision lowered the
allowance for loan losses to 1.11% of loans from 1.19% of loans as of December
31, 2004 despite lower net charge-offs during 2005. As of December 31, 2005,
the allowance for loan losses as a percentage of nonperforming loans was 150.6%
compared to 148.3%, at December 31, 2004. In addition to coverage from the
allowance for loan losses, nonperforming loans are secured by various
collateral including real estate and consumer collateral.
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.
35
TABLE 17: LOAN LOSS EXPERIENCE
Years ended December 31 2005 2004 2003 2002 2001
Average balance of loans for period $368,626 $329,133 $282,006 $249,247 $226,819
Allowance for loan losses at
beginning of year $4,157 $3,536 $3,158 $2,969 $2,407
Loans charged off:
Commercial, industrial, municipal,
and agricultural 55 116 243 628 148
Commercial real estate mortgage - - - - -
Residential real estate mortgage 61 85 170 201 75
Consumer and individual 54 65 109 156 107
Total charge-offs 170 266 522 985 330
Recoveries on loans previously charged-off:
Commercial, industrial, municipal,
and agricultural 24 1 44 33 1
Commercial real estate mortgage - - - - -
Residential real estate mortgage - 10 5 6 -
Consumer and individual 9 21 16 25 1
Total recoveries 33 32 65 64 2
Net loans charged-off 137 234 457 921 328
Provision for loan losses 160 855 835 1,110 890
Allowance for loan losses at
end of year $4,180 $4,157 $3,536 $3,158 $2,969
Ratio of net charge-offs
during the year to average loans 0.04% 0.07% 0.16% 0.37% 0.14%
Ratio of allowance for loan losses
to loans receivable at end of year 1.11% 1.19% 1.15% 1.22% 1.24%
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.
Net loans charged off declined to .04% of average loans during 2005 compared to
..07% in 2004 and .16% for 2003. 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
36
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.
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.
TABLE 18: ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
As of December 31, 2005 2004 2003 2002 2001
% of % of % of % of % of
Dollar principal Dollar principal Dollar principal Dollar principal Dollar principal
Commercial, industrial,
municipal, and agricultural $2,082 2.42% $1,989 2.75% $2,002 2.99% $1,919 2.97% $1,738 2.69%
Commercial real estate
mortgage 1,680 0.86% 1,635 0.89% 1,022 0.62% 569 0.45% 417 0.43%
Residential real estate
mortgage 170 0.17% 221 0.23% 205 0.27% 167 0.27% 174 0.26%
Consumer and individual 53 0.90% 62 0.96% 52 0.67% 72 0.69% 89 0.71%
Impaired loans 195 8.72% 250 17.73% 255 15.67% 431 30.33% 551 26.09%
Unallocated - - - - -
Totals $4,180 $4,157 $3,536 $3,158 $2,969
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.
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.
37
TABLE 19: NONPERFORMING LOANS AND FORECLOSED ASSETS
As of December 31, 2005 2004 2003 2002 2001
Nonaccrual loans not considered impaired $1,058 $1,555 $1,898 $ 750 $1,801
Nonaccrual impaired loans 1,335 619 1,221 1,036 1,235
Accruing loans past due 90 days or more - - - - -
Restructured loans 382 628 216 647 999
Total non-performing loans $2,775 $2,802 $3,335 $2,433 $4,035
Foreclosed assets $ 373 $ 7 $ 84 $ 573 $ 421
Impaired loans accruing income $ 902 $ 791 $ 406 $ 385 $ 877
Total non-performing loans as a percent
of gross loans receivable 0.74% 0.80% 1.08% 0.94% 1.68%
Nonperforming loans at December 31, 2005, decreased by $27 to $2,775 from
$2,802 at December 31, 2004. Nonperforming loans to gross loans was .74% at
December 31, 2005, compared to .80% at December 2004. 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 .98% at December
2005 compared to .56% at December 2004 and .63% at December 2003. The increase
in delinquencies at December 2005 involved two borrowers in separate industries
in situations expected to be worked out during 2006 with minimal loss
potential. Without these two borrowers, loans contractually delinquent 30 days
or more as a percentage of gross loans would be .73% at December 2005.
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 2005 if all such loans had been current throughout the
year in accordance with their original terms was $192 in comparison to $144
actually collected. The net reduction in interest income during 2004 and 2003
as a result of discontinuing the accrual of interest on loans that were
delinquent for 90 days or more was $85 and $142, respectively.
OFF BALANCE SHEET ARRANGEMENTS
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, 2005, the maximum obligation for
such guarantees would be approximately $1,132 if total foreclosure losses on
the entire pool of approximately $170 million loans exceeded $3,300. At
December 31, 2004, the maximum obligation for such guarantees was approximately
$743 if total foreclosure losses on the entire pool of approximately $160
million loans exceeded $2,951. In exchange for this guarantee, PSB is paid a
"credit enhancement" fee. These first mortgage loans are underwritten using
standardized criteria considered by management to be conservative 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
38
FHLB program was approximately $133 in 2005 and $121 during 2004. Management
does not expect to be significantly impacted by loss exposure if housing values
drop from a substantial increase in future mortgage lending rates.
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. Total risk-based capital required to be held for the
recourse obligations under the FHLB MPF programs was $673 at December 31, 2005.
During 2006, as new loans continue to be originated under the new program, risk
based capital needs will increase equal to additional recourse obligations.
However, in light of the existing capital structure of PSB and anticipated
activity in loan originations during 2006, management does not expect these
capital requirements to impact operations in the near-term.
PSB is party to limited off balance sheet activity but did enter into a stand
alone interest rate swap to convert fixed rate funding to variable during 2005.
The $10 million interest rate swap had a 3.5 year term with an initial
counterparty call after 1 year. Following the initial call option, the issuer
has optional call options every 6 months until maturity. Under the
arrangement, PSB pays floating rate funding equal to 30 day LIBOR less 2.5
basis points, and receives 4.25% fixed payments due on the hedged wholesale
funding. Both the swap and wholesale funding are marked to fair value and were
not fully effective during 2005. The impact to net income of ineffectiveness
was insignificant during 2005. See Item 8, Note 14 of the Notes to
Consolidated Financial Statements for additional derivative information.
Other significant off-balance sheet financial instruments include the various
loan commitments outlined in Item 8, Note 15 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 relative to asset size. During
2005 and 2004, this growth was funded primarily by retail and large local
depositors, while in 2003 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 most 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, 2005. These sources and uses of funds and
their impact on past and future growth is discussed in depth later in this
analysis of liquidity.
39
TABLE 20: SUMMARY SOURCES AND USES OF CASH
Year Ended December 31, 2005 2004 2003
Cash flows from operating activities $ 5,912 $ 4,864 $ 7,348
Payment of dividends to stockholders and purchase of treasury stock (1,596) (1,662) (1,551)
Operating cash flow retained by PSB 4,316 3,202 5,797
Additional financing received from retail and local depositors, net 27,086 36,633 9,995
Additional financing received from wholesale depositors, net 15,225 5,178 8,589
Proceeds from additional FHLB advances, net 2,000 5,000 9,000
Proceeds from additional other borrowings, net - - 7,173
Proceeds from issuance of junior subordinated debentures 7,481 - -
Proceeds from additional capital received from stockholders 48 63 -
Cash flow retained from operations and financing before debt repayment 56,156 50,076 40,554
Repayment of other borrowings, net (4,068) (1,910)
Cash flow retained from operations and financing after debt repayment 52,088 48,166 40,554
Funds received from sale and maturities of investment securities, net - 2,726 7,368
Proceeds from sale of nonmonetary assets 71 47 280
Cash flows available for investing activities 52,159 50,939 48,202
Funds loaned to customers, net (29,002) (40,302) (48,915)
Funds invested in securities, net (14,166) - -
Funds used to purchase Federal Home Loan Bank stock - (271)
Funds used to purchase bank-owned life insurance (4,645) - -
Capital expenditures (1,066) (5,969) (1,912)
Cash flows used in investing activities (48,879) (46,542) (50,827)
Net increase (decrease) in cash held at beginning of year $ 3,280 $ 4,397 $ (2,625)
Cash and cash equivalents at beginning of year 23,324 18,927 21,552
Cash and cash equivalents at end of year $ 26,604 $ 23,324 $ 18,927
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%, 54.7%,
and 55.7% of total assets as of December 31, 2005, 2004, and 2003,
respectively. The rate of growth in average local deposits has increased
steadily during the past three years and was 12.9% for 2005. This growth was
driven in 2005 by large balance high yield municipal and individual accounts.
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 (and additional
FHLB advances). The following table outlines the average distribution of
deposits during the three years ending December 31, 2005.
40
TABLE 21: AVERAGE DEPOSITS DISTRIBUTION
Year Ended December 31, 2005 2004 2003
Interest Interest Interest
Amount Rate paid Amount Rate paid Amount Rate paid
Noninterest bearing
demand deposits $ 53,285 n/a $ 49,600 n/a $ 46,876 n/a
Interest bearing demand
and savings deposits 69,894 1.72% 52,982 0.70% 40,518 0.61%
Money market demand deposits 70,042 1.74% 66,494 0.92% 69,238 1.00%
Retail and local time deposits 122,769 3.29% 110,925 2.77% 99,851 3.19%
Wholesale time deposits 65,566 3.90% 56,042 3.09% 44,232 3.46%
Totals $381,556 2.36% $336,043 1.72% $300,715 1.88%
Average retail deposit growth 12.85% 9.17% 5.04%
Average total deposit growth 13.54% 11.75% 8.54%
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 the past three years, average interest bearing demand and money market
deposits increased due to new municipal and government agency deposits and high
balance, high yield NOW accounts. During 2005, PSB committed greater resources
to expand deposits from these types of customers. As of December 31, 2005,
high yield deposits totaled approximately $52,270 compared to deposits of
$28,066 at December 31, 2004. Sale of high yield deposits is led by the need
to fund loan growth. If the pace of future loan growth declines, the level of
high yield deposit growth seen during 2005 and 2004 may not be repeated during
2006. The emphasis on originating high balance, high yield NOW and MMDA
accounts to municipalities and individuals contributed to the increase in yield
paid on core deposit accounts, in addition to the market based increases in
short-term rates during 2005. Total high yield NOW and MMDA accounts
represented 87% of total core deposit growth during 2005.
Retail time deposits increased during 2005 and 2004 in 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 $8,864 during 2005, $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
considered to be retail
41
deposits since the terms of the account are set directly between PSB and its
local customer on a retail basis. Accordingly, these deposits are included
as "Retail time deposits $100 and over" in Table 20. Total CDARS deposits
totaled $10,697 and $7,666 at December 31, 2005 and 2004, respectively. Other
increases in retail and local time deposit average balances are from normal
deposit collection activities and promotions.
During 2005, the average yield paid on wholesale time deposits compared to
retail deposits increased substantially, while comparison of yield on those two
products remained similar in 2003 and 2004. The 2005 increase is due to
wholesale funding costs rising much faster than local retail costs. Typically
wholesale costs move much more quickly than local deposit costs due to national
market interest rate changes. Therefore, continued short-term rate pricing
increases were reflected sooner in wholesale deposits increasing the spread
over local deposit yields.
TABLE 22: PERIOD-END DEPOSIT COMPOSITION
As of December 31, 2005 2004
$ % $ %
Non-interest bearing demand $ 61,345 15.3% $ 51,635 14.4%
Interest-bearing demand and savings 79,644 19.9% 64,574 18.0%
Money market deposits 66,625 16.6% 68,666 19.2%
Retail time deposits less than $100 69,198 17.3% 63,993 17.8%
Total core deposits 276,812 69.1% 248,868 69.4%
Retail time deposits $100 and over 54,601 13.6% 55,459 15.5%
Broker & national time deposits
less than $100 1,727 0.4% 4,594 1.3%
Broker & national time deposits $100
and over 67,396 16.9% 49,304 13.8%
Totals $400,536 100.0% $358,225 100.0%
TABLE 23: CHANGE IN DEPOSIT COMPOSITION
% Change from prior yr
At December 31, 2005 2004 2005 2004
Total time deposits $100 and over $121,997 $104,763 16.5% 33.4%
Total broker and national time deposits 69,123 53,898 28.2% 10.6%
Total retail time deposits 123,799 119,452 3.6% 20.1%
Core deposits, including money market deposits 276,812 248,868 11.2% 9.3%
Large time deposits and wholesale broker deposits continue to grow and were
24.4% and 24.0% of total assets at December 31, 2005 and 2004, respectively.
However, growth in retail time deposits and local "core" deposits accelerated
compared to prior years and grew 11.2% during 2005. 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 deposit products in its local markets
and actively promoted them during 2005.
42
PSB policy allows broker funds to be used up to 20% of total assets. Available
and unused broker deposits were approximately $32,109 and $37,097 at December
31, 2005 and 2004, 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 wholesale financing source in addition to FHLB advances and
repurchase agreements.
TABLE 24: MATURITY DISTRIBUTION OF CERTIFICATES OF DEPOSIT OF $100 OR MORE
At December 31, 2005 Balance Rate
3 months or less $ 9,930 3.51%
Over 3 months through 6 months 13,909 3.64%
Over 6 months through 12 months 38,321 3.98%
Over 1 year through 5 years 55,869 4.25%
Over 5 years 3,968 4.04%
Totals $121,997 4.03%
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 25: LONG-TERM CONTRACTUAL OBLIGATIONS AT DECEMBER 31, 2005
Principal payments due by period
Total < 1 year 1-3 years 3-5 years > 5 years
Time deposits $192,922 $106,353 $59,049 $23,532 $ 3,988
Long-term Federal Home Loan Bank advances 54,000 6,000 19,000 29,000 -
Other long-term borrowings 2,759 989 1,353 417 -
Junior subordinated debentures 7,732 - - - 7,732
Deferred compensation agreements 655 - - - 655
Post-retirement health insurance benefits plan 248 21 46 44 137
Branch bank operating lease commitments 114 46 68 - -
Premises and equipment purchase commitments - - - - -
Total contractual obligations $258,430 $113,409 $79,516 $52,993 $12,512
43
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, 2005 and 2004. During 2006, PSB expects total
net asset growth from existing markets to be approximately $45 million, a
significant portion of which is expected to be funded by use of funding sources
other than deposits.
TABLE 26: AVAILABLE BUT UNUSED FUNDING SOURCES OTHER THAN RETAIL DEPOSITS:
December 31, 2005 December 31, 2004
Unused, but Amount Unused, but Amount
Available Used Available Used
Overnight federal funds purchased $ 32,500 $ - $22,500 $ -
FHLB advances under blanket mortgage lien 27,616 54,000 14,855 52,000
Repurchase agreements 27,081 4,497 12,871 8,565
Wholesale market time deposits 32,109 69,123 37,097 53,898
Total available but unused funds $119,306 $127,620 $87,323 $114,463
Funding as a percent of total assets 23.6% 25.2% 19.2% 25.2%
Overnight federal funds purchased totaling $32,500 are available through four
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 2005, average daily federal funds purchased
were $2,338 compared to $2,140 during 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 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.
Under the existing credit line with the FHLB described in Item 8, Note 8 of the
Notes to Consolidated Financial Statements, PSB may borrow up to 75% of
qualifying existing mortgage loan collateral. Prior to 2005, PSB could borrow
up to 61% of qualifying existing mortgage collateral. In addition, PSB may
pledge certain investment securities to obtain additional funding under
repurchase agreements. 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. 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 9 of the Notes to Consolidated Financial
Statements outlines the activity in these other borrowings and federal funds
purchased during the three years ending December 31, 2005. Although PSB does
not currently have any repurchase agreements with the FHLB, it does have a
written agreement providing for their use in exchange
44
for securities held. An additional $27,081 and $12,871 of FHLB funding could
have been obtained upon pledge of these available securities as of December 31,
2005 and 2004, 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 13.7%, 11.8%, and 11.9% of total assets at December 31, 2005,
2004, and 2003, respectively.
PSB's asset-liability management process provides a unified approach to
management of liquidity, capital, and interest rate risk, as well as providing
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 27 represents PSB's earning sensitivity to changes
in interest rates at December 31, 2005. 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 27:
1. Money market deposit accounts and high yield interest bearing demand
(NOW) accounts are considered fully repriced within 90 days. Retail
priced 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 27 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, 2005 was positive at 107.4% compared to 101.0% at December 31,
2004. 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, 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. Although holding a positive gap ratio, net interest margin was reduced
during 2005 as assets repriced to a lesser extent than liabilities repricing
during that same period.
45
TABLE 27: INTEREST RATE SENSITIVITY ANALYSIS
At December 31, 2005 0-90 Days 91-180 days 181-365 days 1-2 yrs. Bynd 2-5 yrs. Beyond 5 yrs. Total
Earning assets:
Loans $143,324 $ 27,299 $ 49,277 $ 54,842 $ 82,782 $ 19,067 $376,591
Securities 3,545 3,499 9,141 12,762 38,926 13,628 81,501
FHLB stock 3,017 3,017
CSV bank-owned life ins. 4,805 4,805
Other earning assets 10,896 10,896
Total $160,782 $ 30,798 $ 58,418 $ 67,604 $121,708 $ 37,500 $476,810
Cumulative rate
sensitive assets $160,782 $191,580 $249,998 $317,602 $439,310 $476,810
Interest-bearing liabilities
Interest-bearing deposits $138,190 $ 26,636 $ 59,303 $ 35,791 $ 36,828 $ 42,443 $339,191
FHLB advances 6,000 - - 9,000 39,000 54,000
Other borrowings 1,987 740 - 614 1,156 4,497
Junior subordinated
debentures 7,732 7,732
Total $146,177 $ 27,376 $ 59,303 $ 45,405 $ 84,716 $ 42,443 $405,420
Cumulative interest
sensitive liabilities $146,177 $173,553 $232,856 $278,261 $362,977 $405,420
Interest sensitivity gap for
the individual period $ 14,605 $ 3,422 $ (885) $ 22,199 $ 36,992 $ (4,943)
Ratio of rate sensitive assets
to rate sensitive liabilities
for the individual period 110.0% 112.5% 98.5% 148.9% 143.7% 88.4%
Cumulative interest
sensitivity gap $ 14,605 $ 18,027 $ 17,142 $ 39,341 $ 76,333 $ 71,390
Cumulative ratio of rate
sensitive assets to rate
sensitive liabilities 110.0% 110.4% 107.4% 114.1% 121.0% 117.6%
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
46
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 10.6% and 7.1% at
December 31, 2005 and 2004, respectively.
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 .69% and (.04)% at December 31, 2005 and
2004, respectively. The projected decrease in net interest income for the next
12 months if rates decreased 200 basis points was 3.34% and 2.15% at December
31, 2005 and 2004, 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 high yield NOW and 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 51.1% and 46.5% at December 31, 2005 and 2004,
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 17 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, 2005 has
been retained net income not distributed to stockholders via cash dividends or
share buybacks on the open market. 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 capital to total assets was 7.24%, 7.55%, and 7.86% during 2005, 2004,
and 2003, respectively. The following table presents a reconciliation of
stockholders' equity as presented in the December 31, 2005, 2004, and 2003
consolidated balance sheets to regulatory capital.
47
TABLE 28: CAPITAL RATIOS
December 31, 2005 2004 2003
Stockholders' equity $35,485 $33,616 $32,141
Junior subordinated debentures, net 7,500 - -
Disallowed mortgage servicing right assets (88) (84) (81)
Unrealized (gain) loss on securities available for sale 542 (384) (844)
Tier 1 regulatory capital 43,439 33,148 31,216
Add: allowance for loan losses 4,180 4,157 3,536
Total regulatory capital $47,619 $37,305 $34,752
Total assets $506,158 $454,974 $408,933
Disallowed mortgage servicing right assets (88) (84) (81)
Unrealized (gain) loss on securities available for sale 542 (384) (844)
Tangible assets $506,612 $454,506 $408,008
Risk-weighted assets (as defined by current regulations) $392,790 $350,224 $318,005
Tier 1 capital to average tangible assets (leverage ratio) 8.71% 7.40% 7.83%
Tier 1 capital to risk-weighted assets 11.06% 9.46% 9.82%
Total capital to risk-weighted assets 12.12% 10.65% 10.93%
Regulatory capital increased significantly during 2005 from issuance of trust
preferred securities represented by junior subordinated debentures on the
consolidated balance sheet at December 31, 2005. Refer to Item 8, Note 10 in
the Consolidated Financial Statements for detailed information on the trust
preferred security issue. Trust preferred capital securities may provide up to
25% of PSB's total Tier 1 regulatory capital. As of December, 31, 2005, PSB
could utilize up to $4,480 of additional trust preferred securities proceeds as
additional Tier 1 regulatory capital.
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 stockholders
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
have been restated to reflect the 5% stock dividend.
PSB maintains an incentive stock option plan approved by stockholders during
2001 as described in Item 8, Note 16 of the Notes to Consolidated Financial
Statements. As of December 31, 2005, 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, possibly eliminating the informal buyback
program.
48
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.
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 change 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 in comparison 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.
49
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 rise significantly, additional unallocated reserves may be
recorded to account for this additional risk of loss before it is recognized 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 in the allowance for loan losses calculation. As of December 31,
2005, 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 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 8.25% to 10%, depending on year of
origination
* Short-term reinvestment rate on the float of payments to
investors of 3% (rising to 5% in 2006)
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.
50
4. Significant declines in current market mortgage interest rates decrease
the fair value of existing MSRs due to 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.
51
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, 2005 and 2004, 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, 2005.
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, 2005 and 2004, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2005, in conformity with accounting principles generally
accepted in the United States.
WIPFLI LLP
Wipfli LLP
January 20, 2006
Wausau, Wisconsin
52
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
(dollars in thousands except per share data)
ASSETS 2005 2004
Cash and due from banks $ 15,708 $ 12,680
Interest-bearing deposits and money market funds 988 3,265
Federal funds sold 9,908 7,379
Cash and cash equivalents 26,604 23,324
Securities available for sale (at fair value) 81,501 68,894
Loans held for sale 0 342
Loans receivable, net of allowance for loan losses of $4,180 and $4,157
in 2005 and 2004, respectively 372,411 343,923
Accrued interest receivable 2,245 1,744
Foreclosed assets 373 7
Premises and equipment 12,632 12,432
Mortgage servicing rights, net 880 839
Federal Home Loan Bank stock (at cost) 3,017 2,874
Cash surrender value of bank owned life insurance 4,805 0
Other assets 1,690 595
TOTAL ASSETS $506,158 $454,974
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest-bearing $ 61,345 $ 51,635
Interest-bearing 339,191 306,590
Total deposits 400,536 358,225
Federal Home Loan Bank advances 54,000 52,000
Other borrowings 4,497 8,565
Junior subordinated debentures 7,732 0
Accrued expenses and other liabilities 3,908 2,568
Total liabilities 470,673 421,358
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
Outstanding - 1,705,571 and 1,719,593, respectively
Additional paid-in capital 9,655 9,672
Retained earnings 28,561 25,281
Accumulated other comprehensive income (loss) (542) 384
Treasury stock, at cost - 181,608 and 167,586, respectively (4,076) (3,608)
Total stockholders' equity 35,485 33,616
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $506,158 $454,974
See accompanying notes to consolidated financial statements.
53
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
(dollars in thousands except per share data)
2005 2004 2003
Interest and dividend income:
Loans, including fees $22,347 $19,207 $17,964
Securities:
Taxable 1,966 1,798 1,943
Tax-exempt 978 982 916
Other interest and dividends 473 215 227
Total interest and dividend income 25,764 22,202 21,050
Interest expense:
Deposits 9,019 5,783 5,651
Federal Home Loan Bank advances 2,133 2,061 1,989
Other borrowings 272 269 229
Junior subordinated debentures 231 0 0
Total interest expense 11,655 8,113 7,869
Net interest income 14,109 14,089 13,181
Provision for loan losses 160 855 835
Net interest income after provision for loan losses 13,949 13,234 12,346
Noninterest income:
Service fees 1,188 1,234 1,282
Mortgage banking 880 901 1,767
Investment and insurance sales commissions 689 484 434
Net gain on sale of securities 6 97 80
Increase in cash surrender value of life insurance 160 0 0
Gain on curtailment of postretirement benefit plan 0 0 131
Other operating income 545 407 417
Total noninterest income 3,468 3,123 4,111
Noninterest expense:
Salaries and employee benefits 6,610 6,189 5,952
Occupancy and facilities 1,767 1,609 1,127
Loss on abandonment of premises and equipment 0 379 0
Data processing and other office operations 741 655 547
Advertising and promotion 287 263 172
Other operating expense 1,635 1,880 1,553
Total noninterest expense 11,040 10,975 9,351
Income before income taxes 6,377 5,382 7,106
Provision for income taxes 2,037 1,856 2,300
Net income $ 4,340 $ 3,526 $ 4,806
Basic earnings per share $ 2.53 $ 2.04 $ 2.76
Diluted earnings per share $ 2.52 $ 2.03 $ 2.74
See accompanying notes to consolidated financial statements.
54
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003 (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, 2003 $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 $212 (401) (401)
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
Comprehensive income:
Net income 4,340 4,340
Unrealized loss on securities
available for sale, net of tax of $505 (922) (922)
Reclassification adjustment for
net security gains, included in
net income, net of tax of $2 (4) (4)
Total comprehensive income 3,414
Purchase of treasury stock (536) (536)
Proceeds from stock options
issued out of treasury (17) 65 48
Distribution of treasury stock in
payment of director fees 3 3
Cash dividends declared $.62 per share (1,060) (1,060)
Balance, December 31, 2005 $1,887 $9,655 $28,561 $(542) $(4,076) $35,485
See accompanying notes to consolidated financial statements.
55
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
(dollars in thousands except per share data)
2005 2004 2003
Increase (decrease) in cash and cash equivalents:
Cash flows from operating activities:
Net income $ 4,340 $ 3,526 $ 4,806
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for depreciation and net amortization 1,679 1,529 1,978
Provision for deferred income taxes 200 23 0
Provision for loan losses 160 855 835
Deferred net loan origination costs (512) (306) (259)
Proceeds from sales of loans held for sale 45,933 41,321 132,845
Originations of loans held for sale (45,278) (41,093) (130,874)
Gain on sale of loans (598) (697) (2,021)
Provision for (recapture of) mortgage servicing right
valuation allowance (7) 16 (25)
Net gain on sale of premises and equipment (2) (3) 0
Loss on abandonment of premises and equipment 0 379 0
Realized gain on sale of available for sale securities (6) (97) (80)
Net (gain) loss on sale of foreclosed assets 1 (29) 9
Increase in cash surrender value of life insurance (160) 0 0
Federal Home Loan Bank stock dividends (143) (159) (180)
Changes in operating assets and liabilities:
Accrued interest receivable (501) (127) 115
Other assets (537) 103 285
Accrued expenses and other liabilities 1,343 (377) (86)
Net cash provided by operating activities 5,912 4,864 7,348
Cash flows from investing activities:
Proceeds from sale and maturities of available-for-sale securities 13,339 19,444 46,515
Payment for purchase of available-for-sale securities (27,505) (16,718) (39,147)
Purchase of Federal Home Loan Bank stock 0 (271) 0
Net increase in loans (29,002) (40,302) (48,915)
Capital expenditures (1,066) (5,969) (1,912)
Proceeds from sale of premises and equipment 2 3 0
Proceeds from sale of foreclosed assets 69 44 280
Purchase of bank-owned life insurance (4,645) 0 0
Net cash used in investing activities (48,808) (43,769) (43,179)
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CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
(dollars in thousands except per share data)
2005 2004 2003
Cash flows from financing activities:
Net increase in non-interest-bearing deposits $ 9,710 $ 1,072 $ 5,106
Net increase in interest-bearing deposits 32,601 40,739 13,478
Proceeds from issuance of long-term FHLB advances 23,000 15,000 25,000
Repayments of long-term FHLB advances (21,000) (10,000) (16,000)
Net increase (decrease) in other borrowings (4,068) (1,910) 7,173
Proceeds from issuance of junior subordinated debentures 7,481 0 0
Dividends declared (1,060) (1,034) (998)
Proceeds from issuance of stock options 48 63 0
Purchase of treasury stock (536) (628) (553)
Net cash provided by financing activities 46,176 43,302 33,206
Net increase (decrease) in cash and cash equivalents 3,280 4,397 (2,625)
Cash and cash equivalents at beginning 23,324 18,927 21,552
Cash and cash equivalents at end $26,604 $23,324 $18,927
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $11,269 $ 7,935 $ 8,088
Income taxes 1,692 1,935 2,265
NONCASH INVESTING AND FINANCING ACTIVITIES:
Loans charged off $ 170 $ 266 $ 522
Loans transferred to foreclosed assets 436 0 178
Loans originated on sale of foreclosed assets 0 110 379
Distribution of treasury stock in payment of
director fees 3 8 45
Common stock of PSB Holdings Statutory Trust I acquired in
exchange for junior subordinated debentures 232 0 0
Transfer of equity from retained earnings for
5% stock dividend 0 0 2,626
See accompanying notes to consolidated financial statements.
57
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 treasury management
services.
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. 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. 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. Amortization of premiums and accretion of discounts are recognized in
interest income using the interest method over the estimated lives of the
securities.
58
Declines in fair value of securities that are deemed to be other than
temporary, if applicable, are reflected in earnings as realized losses. In
estimating other-than-temporary impairment losses, management considers the
length of time and the extent to which fair value has been less than cost, the
financial condition and near-term prospects of the issuer, and the intent and
ability of PSB to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value. Gains and
losses on the sale of securities are recorded on the trade date and determined
using the specific-identification method.
LOANS HELD FOR SALE
PSB sells substantially all long-term fixed-rate single-family mortgage loans
it originates to the secondary market. 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 Federal Home Loan Bank ("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 is doubtful or those loans which are
past due 90 days or more as to principal or interest payments. When a loan is
placed on nonaccrual status, previously accrued but unpaid interest deemed
uncollectible is reversed and charged against current income. After being
placed on nonaccrual status, additional income is recorded only to the extent
that payments are received 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 recognized as an adjustment of the related loan yield using the interest
method.
59
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.
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.
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 assets.
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.
60
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 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.
FEDERAL HOME LOAN BANK STOCK
As a member of the 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. The stock is
evaluated for impairment on an annual basis. Transfer of the stock is
substantially restricted.
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BANK-OWNED LIFE INSURANCE
PSB has purchased life insurance policies on certain officers. Bank-owned life
insurance is recorded at its cash surrender value. Changes in cash surrender
value are recorded in other income.
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.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
All derivative instruments are recorded at their fair values. If derivative
instruments are designated as hedges of fair values, both the change in the
fair value of the hedge and the hedged item are included in current earnings.
Fair value adjustments related to cash flow hedges are recorded in other
comprehensive income and reclassified to earnings when the hedged transaction
is reflected in earnings. Ineffective portions of hedges are reflected in
income.
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.
FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of financial instruments are estimated using relevant market
information and other assumptions, as more fully disclosed separately. Fair
value estimates involve uncertainties and matters of significant judgment
regarding interest rates, credit risk, prepayments, and other factors,
especially in the absence of broad markets for particular items. Changes in
assumptions or in market conditions could significantly affect the estimates.
The fair value estimates of existing on- and off-balance-sheet financial
instruments do not include the value of anticipated future business or the
values of assets and liabilities not considered financial instruments.
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
62
services include demand, time, and savings deposits; safe deposit services;
credit cards; notary services; night depository; money orders, traveler's
checks, and cashier's 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.
STOCK-BASED COMPENSATION
GAAP encourages 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, 2005,
GAAP also allows an entity to continue to measure compensation cost for these
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 March 31, 2006, GAAP will
change to require all stock-based compensation to be reflected in income (refer
to "Future Accounting Changes").
During the three years ended December 31, 2005, PSB followed the provisions of
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and used 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 was recorded.
There were no stock options granted during the three years ended December 31,
2005.
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 amended Statement of
Financial Accounting Standards 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 March 31, 2006. 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 CASH AND CASH EQUIVALENTS
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 was approximately $207 and $3,330 at December 31, 2005
and 2004, respectively.
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.
63
Uninsured cash and cash equivalent balances totaled $14,306 and $13,145 at
December 31, 2005 and 2004, respectively.
NOTE 3 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, 2005
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $23,529 $ 4 $ 298 $23,235
Obligations of states and political
subdivisions 26,040 370 240 26,170
Mortgage-backed securities 6,954 0 170 6,784
Collateralized mortgage obligations 23,534 0 520 23,014
Nonrated trust preferred securities 2,250 0 0 2,250
Other equity securities 48 0 0 48
Totals $82,355 $374 $1,228 $81,501
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
64
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
2005
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $17,785 $172 $ 3,374 $126 $21,159 $ 298
Obligations of states and
political subdivisions 4,534 81 4,765 159 9,299 240
Mortgage-backed securities 5,094 115 1,690 55 6,784 170
Collateralized mortgage obligations 4,332 67 18,682 453 23,014 520
Total temporarily impaired securities $31,745 $435 $28,511 $793 $60,256 $1,228
2004
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 3,449 $ 51 $ 0 $ 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
At December 31, 2005, 111 debt securities have unrealized losses with aggregate
depreciation of 2.0% from the amortized cost basis. At December 31, 2004, 62
debt securities had unrealized losses with aggregate depreciation of 1.1% from
the 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 issuers. 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.
65
The amortized cost and estimated fair value of debt securities available for
sale at December 31, 2005, 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.
ESTIMATED
AMORTIZED FAIR
COST VALUE
Due in one year or less $6,042 $6,024
Due after one year through five years 29,908 29,854
Due after five years through ten years 13,619 13,527
Due after ten years 2,250 2,250
Subtotals 51,819 51,655
Mortgage-backed securities and
collateralized mortgage obligations 30,488 29,798
Totals $82,307 $81,453
Securities with a fair value of $22,950 and $27,982 at December 31, 2005 and
2004, respectively, were pledged to secure public deposits and other borrowings
and for other purposes required by law.
During 2005, 2004, and 2003, respectively, proceeds from the sale of securities
totaled $206, $4,926, and $8,839 with gross gains of $6, $111, and $107, with
no gross losses for 2005, and gross losses of $14 and $27 during 2004 and 2003,
respectively.
NOTE 4 LOANS
The composition of loans at December 31 categorized by the initial purpose of
the loan is as follows:
2005 2004
Commercial, industrial, and municipal $ 86,070 $ 72,456
Commercial real estate mortgage 149,538 145,856
Residential real estate mortgage 87,205 82,696
Real estate construction 46,259 38,308
Residential real estate home equity 13,058 11,620
Consumer and individual 5,919 6,482
Subtotals 388,049 357,418
Net deferred loan costs 434 368
Loans in process of disbursement (11,892) (9,706)
Allowance for loan losses (4,180) (4,157)
Net loans receivable $372,411 $343,923
PSB originates and holds adjustable rate residential mortgage loans and
commercial purpose loans with variable rates of interest. The rate of interest
on some of these loans is capped over the life of the loan. At December 31,
2005 and 2004, PSB held $32,397 and $19,844, respectively, of variable rate
loans with
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interest rate caps. Of these loans, $9,703 had reached the interest rate cap
at December 31, 2005. None of these loans had reached the interest rate cap at
December 31, 2004.
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:
2005 2004
Loans outstanding at beginning $ 4,750 $ 1,421
New loans 4,638 5,145
Repayments (3,628) (1,816)
Loans outstanding at end $ 5,760 $ 4,750
The following is a summary of information pertaining to impaired loans and
nonperforming loans:
DECEMBER 31, 2005 2004 2003
Impaired loans without a valuation allowance $ 422 $ 133 $ 0
Impaired loans with a valuation allowance 1,815 1,277 1,627
Total impaired loans $2,237 $1,410 $1,627
Valuation allowance related to impaired loans $ 195 $ 250 $ 255
YEARS ENDED DECEMBER 31, 2005 2004 2003
Average recorded investment, net of allowance
for loan losses $2,428 $1,342 $1,419
Interest income recognized $ 183 $ 65 $ 105
Interest income recognized on a cash basis
on impaired loans $ 78 $ 28 $ 65
No additional funds are committed to be advanced in connection with impaired
loans.
Total loans receivable (including nonaccrual impaired loans) maintained on
nonaccrual status as of December 31, 2005 and 2004 were $2,393 and $2,174,
respectively. There were no loans past due 90 days or more but still accruing
income at December 31, 2005 and 2004.
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An analysis of the allowance for loan losses for the three years ended
December 31 follows:
2005 2004 2003
Balance, January 1 $4,157 $3,536 $3,158
Provision charged to operating expense 160 855 835
Recoveries on loans 33 32 65
Loans charged off (170) (266) (522)
Balance, December 31 $4,180 $4,157 $3,536
Under a secondary market loan servicing program with the FHLB, PSB in exchange
for a monthly fee provides a credit enhancement guarantee to reimburse the FHLB
for foreclosure losses in excess of 1% of original loan principal sold to the
FHLB. At December 31, 2005, PSB serviced payments on $169,708 of first lien
residential loan principal for the FHLB. At December 31, 2005, the maximum PSB
obligation for such guarantees would be approximately $1,132 if total
foreclosure losses on the entire pool of loans exceed approximately $3,300.
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 5 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 FHLB and others were $170,091 and $160,225 at December 31, 2005
and 2004, respectively. The following is a summary of changes in the balance
of MSR:
ORIGINATED VALUATION
MSR ALLOWANCE TOTAL
Balance at January 1, 2003 $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
Additions from originated servicing 269 0 269
Amortization charged to earnings (235) 0 (235)
Change in valuation allowance
charged to earnings 0 7 7
Balance at December 31, 2005 $979 $ (99) $880
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NOTE 6 PREMISES AND EQUIPMENT
The composition of premises and equipment follows:
2005 2004
Land $ 2,692 $ 2,620
Buildings and improvements 9,241 8,376
Furniture and equipment 5,089 4,321
Construction in progress 0 639
Total cost 17,022 15,956
Less - Accumulated depreciation and amortization 4,390 3,524
Totals $12,632 $12,432
Depreciation and amortization charged to operating expenses amounted to $866 in
2005, $767 in 2004, and $513 in 2003.
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.
LEASE COMMITMENTS
PSB leases various pieces of equipment under cancelable leases and office space
for one branch location under a noncancelable lease. PSB has the option to
renew the noncancelable branch location lease for two additional two-year terms
upon expiration in May 2008. The lease is classified as operating. Future
minimum payments under the noncancelable lease are as follows:
2006 $ 46
2007 47
2008 21
Total $114
Rental expense for all operating leases was $63, $89, and $84, for the years
ended December 31, 2005, 2004, and 2003, respectively.
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NOTE 7 DEPOSITS
The distribution of deposits at December 31 is as follows:
2005 2004
Non-interest-bearing demand $ 61,345 $ 51,635
Interest-bearing demand (NOWs) 53,108 38,329
Savings 26,536 26,245
Money market 66,625 68,666
Retail time 123,799 119,452
Wholesale market and national time 69,123 53,898
Total deposits $400,536 $358,225
The scheduled maturities of time deposits at December 31, 2005, are summarized
as follows:
2006 $106,353
2007 35,827
2008 23,222
2009 8,463
2010 15,069
Thereafter 3,988
Total $192,922
Time deposits with individual balances of $100 and over totaled $121,997 and
$104,763 at December 31, 2005 and 2004, respectively.
Deposits from PSB directors, officers, and related parties at December 31, 2005
and 2004 totaled $4,399 and $4,397, respectively.
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NOTE 8 FEDERAL HOME LOAN BANK ADVANCES
FHLB advances at December 31, consist of the following:
WEIGHTED
SCHEDULED RANGE OF AVERAGE
MATURITY RATES RATE AMOUNT
2005
Fixed rate, interest only 2006 3.57-3.74% 3.68% $ 6,000
Fixed rate, interest only 2007 2.63-4.72% 3.39% 9,000
Fixed rate, interest only 2008 3.90-5.07% 4.35% 10,000
Fixed rate, interest only 2009 3.48-4.50% 3.94% 17,000
Fixed rate, interest only 2010 4.34-4.88% 4.54% 12,000
Totals 4.03% $54,000
2004
Fixed rate, interest only 2005 2.42-6.21% 5.17% $26,000
Fixed rate, interest only 2007 2.63% 2.63% 5,000
Fixed rate, interest only 2008 3.90-5.07% 4.34% 8,000
Fixed rate, interest only 2009 3.48-4.19% 3.76% 13,000
Totals 4.45% $52,000
At December 31, 2005 and 2004, fixed rate advances maturing during 2008 include
a $3,000 advance at a rate of 5.07% that is 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 75%
of unencumbered 1-4 family residential first mortgage loans pledged as
collateral out of its portfolio. The FHLB advances are also secured by $3,017
and $2,874 of FHLB stock owned by the Bank at December 31, 2005 and 2004,
respectively. PSB may draw both short-term and long-term advances on a maximum
line of credit totaling approximately $81,616 based on residential real estate
mortgage collateral totaling $110,343 as of December 31, 2005. At December 31,
2005, PSB's available and unused portion of this line of credit totaled
approximately $27,616. PSB also has, under a current agreement with the FHLB,
an ability to borrow up to $27,081 by pledging securities available for sale.
NOTE 9 OTHER BORROWINGS
Other borrowings consist of securities sold under both short-term and long-term
repurchase agreements totaling $4,497 and $8,565 at December 31, 2005 and 2004,
respectively.
PSB pledges various securities available for sale as collateral for repurchase
agreements. The fair value of securities pledged for repurchase agreements
totaled $4,141 and $9,328 at December 31, 2005 and 2004, respectively. Due to
unusually large short-term increases by some municipal repurchase customers
from year-end tax collections, securities pledged as collateral at December 31,
2005 were less than the repurchase account balance by a net of $356 (8% of
repurchase agreements). Necessary additional collateral was pledged in January
2006 as part of the PSB's normal collateralization review procedures.
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The following information relates to federal funds purchased and securities
sold under repurchase agreements for the years ended December 31:
2005 2004 2003
As of end of year:
Weighted average rate 2.76% 2.68% 2.39%
For the year:
Highest month-end balance $16,038 $20,826 $13,463
Daily average balance $ 8,739 $11,824 $ 9,151
Weighted average rate 3.11% 2.28% 2.50%
There were no related-party repurchase agreements at December 31, 2005.
Repurchase agreements with related parties totaled $39 at December 31, 2004.
NOTE 10 JUNIOR SUBORDINATED DEBENTURES
PSB Holdings Statutory Trust I (the "Trust"), a Delaware business trust wholly
owned by PSB, completed the sale of $7,500 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 of common stock
ownership in the Trust to purchase $7,732 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%. Total interest expense on the junior subordinated debenture was
$231 in 2005. Dividends received on common stock of the Trust were $6 in 2005.
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 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.
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, 2005,
2004, and 2003 was $315, $313, and $327, respectively.
PSB maintains deferred compensation agreements with certain vice presidents and
other senior executives at December 31, 2005. PSB matches 20% of the amount of
employees' salary deferrals up to the first 15% of pay deferred. Two key
executives also receive additional matching and incentive contributions under
the plan based on average asset growth. PSB directors may elect to defer
earned directors fees into a separate deferred directors' fees plan. No PSB
match is made on directors fees deferred. Cumulative
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deferred balances earn a crediting rate generally equal to 50% of PSB's return
on average equity. The agreements provide for annual benefits paid in a lump
sum at retirement or in monthly installments for a 15-year period commencing
the month following each participant's normal retirement date. PSB is accruing
this liability for the participants over the remaining periods of service. The
liability outstanding under the agreements was $655 and $334 at December 31,
2005 and 2004, respectively. The amount charged to operations was $127, $18,
and $8 for 2005, 2004, and 2003, respectively.
PSB maintained an unfunded, postretirement health care benefit plan which
covered the officers of PSB. After retirement, PSB would pay between 25% and
50% of the health insurance premiums for former PSB officers until the officer
reached age 65 or the qualifying age for Medicare coverage. To qualify, an
officer must have had at least 15 years of service, been employed by PSB at
retirement, and must have been at least 62 years of age at retirement. The
actual amount paid was based upon years of service to PSB. During 2003, the
plan's benefits were changed to cover the benefit period noted above. Prior to
2003, plan benefits continued until the officer's death. Retirees currently
receiving benefits were unaffected by this change and, therefore, would receive
benefits until their death.
During 2005, the plan was again changed to remove all benefits for officers
currently employed and not yet in retirement. Retirees currently receiving
benefit payments under the plan were unaffected by the change. Concurrently,
an agreement was made with three current officers so that PSB will pay 50% of
the health insurance premiums until the officer reaches age 65 or the
qualifying age for Medicare coverage if the officer retires from PSB after
reaching age 62. At December 31, 2005, there were four retirees receiving
benefits under the plan who will continue to receive benefits until their
death. The current liability for future benefits to officers who were removed
from the plan in 2005 was insignificant, and no gain on curtailment of the
postretirement benefit plan was recorded during 2005.
The liability for future postretirement plan health care benefits was $248 and
$272 at December 31, 2005 and 2004, respectively. Postretirement health care
benefit plan expense was $8, $26, and $62 in 2005, 2004, and 2003,
respectively.
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 postretirement benefit obligation $ 385 $(131) $ 254
NOTE 12 SELF-FUNDED HEALTH INSURANCE PLAN
PSB has established an employee medical benefit plan to self-insure claims up
to $30 per year for each individual with a $604 stop-loss per year for
participants in the aggregate. Coverages in 2006 will be $30 per individual
and $783 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 $54 and $58 as of December 31, 2005 and 2004,
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respectively. Health insurance expense recorded in 2005, 2004, and 2003 was
$516, $389, and $377, respectively.
NOTE 13 INCOME TAXES
The components of the provision for income taxes are as follows:
2005 2004 2003
Current income tax provision:
Federal $1,533 $1,258 $2,003
State 304 575 297
Total current 1,837 1,833 2,300
Deferred income tax expense (benefit):
Federal 155 73 1
State 45 (50) (1)
Total deferred 200 23 0
Total provision for income taxes $2,037 $1,856 $2,300
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:
2005 2004 2003
PERCENT PERCENT PERCENT
OF OF OF
PRETAX PRETAX PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
Tax expense at
statutory rate $2,168 34.0 $1,830 34.0 $2,416 34.0
Increase (decrease)
in taxes resulting from:
Tax-exempt
interest (370) (5.8) (371) (6.9) (342) (4.8)
Bank owned
life insurance (54) (0.9) 0 0.0 0 0.0
State income tax 230 3.6 347 6.4 195 2.7
Other 63 1.0 50 1.0 31 0.5
Provision for income
taxes $2,037 31.9 $1,856 34.5 $2,300 32.4
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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:
2005 2004
Deferred tax assets:
Allowance for loan losses $1,426 $1,422
Deferred compensation and director's fees 263 146
State net operating loss 55 39
Postretirement health care benefits 98 107
Employee pension plan 8 13
Unrealized loss on securities available for sale 312 0
Other 0 22
Valuation allowances (55) (39)
Gross deferred tax assets 2,107 1,710
Deferred tax liabilities:
Premises and equipment 576 402
Mortgage servicing rights 347 330
FHLB stock 326 269
Deferred net loan origination costs 176 151
Unrealized gain on securities available for sale 0 195
Prepaid expenses 70 58
Gross deferred tax liabilities 1,495 1,405
Net deferred tax asset $ 612 $ 305
PSB and its subsidiary bank pay state income taxes on individual,
unconsolidated net earnings. At December 31, 2005, net operating loss
carryforwards of the parent company of approximately $1,029 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 $16 and $6 in
2005 and 2004, 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. 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) has audited PSB's federal income tax returns
for 1999 through 2002, and has disallowed a portion of Peoples State Bank's
(the "Bank") interest deductions for such years. The IRS asserts that PSB owes
an additional $184 of tax and interest (computed through November 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
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August 2005, PSB filed a petition with the United States 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 14 HEDGING ACTIVITIES
PSB has asset/liability policies that include guidelines for measuring and
monitoring interest rate risk. Within these guidelines, parameters have been
established for maximum fluctuations in net interest income. Possible
fluctuations are measured and monitored using simulation modeling. The
policies provide for the use of derivative instruments and hedging activities
to aid in managing interest rate risk to within the policy parameters.
PSB's assets include a significant portion of variable rate loans which are
funded by wholesale fixed rate brokered certificates of deposit. As such, PSB
may periodically enter in derivative financial instruments to mitigate
exposures to fluctuations in the cash flow of loans and/or the fair value of
deposits from changes in interest rates. Interest rate swap arrangements may
be utilized to hedge against these fluctuations.
During 2005, PSB entered into an interest rate swap contract classified as a
fair value hedge that converts the fixed rate payments on certain wholesale
broker certificates of deposit to variable rates of interest. The interest
rate risk management strategy is to change fixed brokered time deposit interest
payments to a floating rate payment to better match adjustable rate commercial
loans. The swap was not fully effective in 2005. Both the swap (by the swap
counterparty) and the liability (by PSB) are callable in April 2006, with
additional semiannual call dates until final maturity in October 2008.
Summary information about interest rate swaps at December 31, 2005 follows:
Notional amount $10,000
Weighted average pay rate 4.35%
Weighted average receive rate 4.25%
Weighted average final maturity - Years 2.75
Fair value liability of swap $ 168
NOTE 15 COMMITMENTS, CONTINGENCIES, AND CREDIT RISK
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET 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.
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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:
2005 2004
Commitments to extend credit $53,041 $48,566
Commercial standby letters of credit - Variable rate 197 1,499
Unused home equity lines of credit - Variable rate 12,970 11,437
Unused credit card commitments - Variable rate 3,606 3,367
Credit enhancement under the FHLB of Chicago
Mortgage Partnership Finance program 1,132 743
Totals $70,946 $65,612
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.
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.
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NOTE 16 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, 2005, all 20,971 options outstanding were eligible to be
exercised with 16,126 options exercisable at $15.83 per share and 4,845 options
exercisable at $16.81 per share. The following table summarizes information
regarding stock options outstanding at December 31, 2005 and activity during
the three years ended December 31, 2005, 2004, and 2003.
WEIGHTED
AVERAGE
SHARES PRICE
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 16.00
Options granted 0
Options exercised (3,058) 15.83
Option forfeited (244) 15.83
December 31, 2005 20,971 $16.06
As of December 31, 2005, 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 17 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, 2005, that PSB and the Bank meet all capital adequacy requirements.
78
As of December 31, 2005, 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, 2005:
Total capital (to risk
weighted assets):
Consolidated $47,619 12.12% $31,432 8.00% n/a n/a
Peoples State Bank $46,932 11.95% $31,419 8.00% $39,274 10.00%
Tier I capital (to risk
weighted assets):
Consolidated $43,439 11.06% $15,725 4.00% n/a n/a
Peoples State Bank $42,752 10.88% $15,718 4.00% $23,577 6.00%
Tier I capital (to
average assets):
Consolidated $43,439 8.71% $19,949 4.00% n/a n/a
Peoples State Bank $42,752 8.58% $19,931 4.00% $24,914 5.00%
As of December 31, 2004:
Total capital (to risk
weighted assets):
Consolidated $37,305 10.65% $28,017 8.00% n/a n/a
Peoples State Bank $36,745 10.49% $28,017 8.00% $35,021 10.00%
Tier I capital (to risk
weighted assets):
Consolidated $33,148 9.46% $14,008 4.00% n/a n/a
Peoples State Bank $32,588 9.30% $14,008 4.00% $21,013 6.00%
Tier I capital (to
average assets):
Consolidated $33,148 7.40% $17,918 4.00% n/a n/a
Peoples State Bank $32,588 7.27% $17,856 4.00% $22,320 5.00%
NOTE 18 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
79
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:
2005 2004 2003
Weighted average shares outstanding 1,714,648 1,725,136 1,740,106
Effect of dilutive stock options outstanding 10,096 14,757 12,854
Diluted weighted average shares outstanding 1,724,744 1,739,893 1,752,960
Basic earnings per share $2.53 $2.04 $2.76
Diluted earnings per share $2.52 $2.03 $2.74
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 2005, 2004, and 2003 have been restated to
reflect the 5% stock dividend.
NOTE 19 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, 2005, the retained earnings of the subsidiary
bank available for distribution as dividends without regulatory approval was
approximately $15,513.
NOTE 20 FAIR VALUE OF FINANCIAL INSTRUMENTS
The methods and assumptions used to estimate fair value are described as
follows:
Carrying amount is the estimated fair value for cash and cash equivalents,
other short-term borrowings, FHLB stock, accrued interest receivable and
payable, bank-owned life insurance, demand deposits, and variable rate loans or
deposits that reprice frequently and fully. Security fair values are based on
market prices or dealer quotes, and if no such information is available, on the
rate and term of the security and information about the issuer. For fixed rate
loans or deposits and for variable rate loans, or deposits with infrequent
repricing or repricing limits, fair value is based on discounted cash flows
using current market rates applied to the estimated life and credit risk. Fair
values for impaired loans are estimated using discounted cash flow analysis or
underlying collateral values. Fair value of loans held for sale is based on
market quotes. Fair value of FHLB advances and junior subordinated debentures
is based on current rates for similar financing. The fair value of interest
rate swaps is based on market prices or dealer quotes. Fair value of mortgage
servicing rights is based on discounted cash flows over the anticipated
repayment term of serviced loans. The fair value of off-balance-sheet credit-
related items is not significant.
80
The carrying amounts and fair values of PSB's financial instruments consisted
of the following at December 31:
2005 2004
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
FINANCIAL ASSETS:
Cash and cash equivalents $26,604 $26,604 $23,324 $23,324
Securities 81,501 81,501 68,894 68,894
Net loans receivable 372,411 367,790 344,265 343,463
Accrued interest receivable 2,245 2,245 1,744 1,744
Mortgage servicing rights 880 880 839 839
FHLB stock 3,017 3,017 2,874 2,874
Cash surrender value of life insurance 4,805 4,805 0 0
FINANCIAL LIABILITIES:
Deposits 400,536 398,455 358,225 357,566
FHLB advances 54,000 52,963 52,000 51,964
Other borrowings 4,497 4,460 8,565 8,548
Junior subordinated debentures 7,732 7,484 0 0
Accrued interest payable 1,277 1,277 891 891
NOTE 21 CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following condensed balance sheets as of December 31, 2005 and 2004, and
condensed statements of income and cash flows for the years ended December 31,
2005, 2004, and 2003, for PSB Holdings, Inc. should be read in conjunction with
the consolidated financial statements and footnotes.
BALANCE SHEETS
December 31, 2005 and 2004
ASSETS 2005 2004
Cash and due from banks $ 1,109 $ 1,044
Investment in Peoples State Bank 42,298 33,056
Other assets 359 32
TOTAL ASSETS $43,766 $34,132
LIABILITIES AND STOCKHOLDERS' EQUITY
Junior subordinated debentures $ 7,732 $ 0
Accrued dividends payable 529 516
Other liabilities 20 0
Total stockholders' equity 35,485 33,616
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $43,766 $34,132
81
STATEMENTS OF INCOME
Years Ended December 31, 2005, 2004, and 2003
2005 2004 2003
Income:
Dividends from Peoples State Bank $1,875 $1,822 $1,361
Dividends from other investments 16 10 20
Interest 6 3 4
Total income 1,897 1,835 1,385
Expenses:
Interest expense on junior subordinated debentures 231 0 0
Transfer agent and shareholder communication 38 42 40
Other 65 78 74
Total expenses 334 120 114
Income before income taxes and equity in
undistributed net income of Peoples State Bank 1,563 1,715 1,271
Provision for income tax benefit (109) (29) (30)
Net income before equity in undistributed
net income of Peoples State Bank 1,672 1,744 1,301
Equity in undistributed net income of
Peoples State Bank 2,668 1,782 3,505
Net income $4,340 $3,526 $4,806
82
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2005, 2004, and 2003
2005 2004 2003
Increase (decrease) in cash and due from
banks:
Cash flows from operating activities:
Net income $4,340 $3,526 $4,806
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed net income of
Peoples State Bank (2,668) (1,782) (3,505)
(Increase) decrease in other assets (76) 0 2
Increase in other liabilities 20 0 0
Increase (decrease) in dividends payable 13 14 (123)
Net cash provided by operating activities 1,629 1,758 1,180
Cash flows from investing activities -
Investment in Peoples State Bank (7,500) 0 0
Cash flows from financing activities:
Proceeds from issuance of junior subordinated
debentures 7,481 0 0
Dividends declared (1,060) (1,034) (998)
Proceeds from stock options issued
out of treasury 48 63 0
Proceeds from stock shares issued
to Peoples State Bank out of treasury
used to pay Directors' fees 3 8 45
Purchase of treasury stock (536) (628) (553)
Net cash provided by (used in) financing activities 5,936 (1,591) (1,506)
Net increase (decrease) in cash and due
from banks 65 167 (326)
Cash and due from banks at beginning 1,044 877 1,203
Cash and due from banks at end $1,109 $1,044 $877
83
SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
THREE MONTHS ENDED
March 31 June 30 Sept 30 Dec 31
2005
Interest income $5,964 $6,340 $6,606 $6,854
Interest expense 2,444 2,758 3,098 3,355
Net interest income 3,520 3,582 3,508 3,499
Provision (credit) for loan losses 150 30 (50) 30
Noninterest income 803 947 906 812
Net income 1,040 1,171 1,066 1,063
Basic earnings per share * 0.60 0.68 0.62 0.62
Diluted earnings per share * 0.60 0.68 0.62 0.62
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
Noninterest income 740 855 764 764
Net income 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
Noninterest income 1,122 726 1,143 1,120
Net income 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
* Basic and diluted earnings per share may not foot to the total for the year
ended December 31 due to rounding
84
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.
ITEM 9B. OTHER INFORMATION.
Not applicable.
85
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 10, 2006 relating to the 2006 annual meeting of
stockholders (the "2006 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 2006
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 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 2006 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
86
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 2006 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 2006 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
2006 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 2006 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, 2005, information with
respect to compensation plans under which PSB's common stock is authorized for
issuance:
Plan category Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
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
plans approved by
security holders 20,971 $16.06 0
Equity compensation
plans not approved by
security holders 0 n/a n/a
Total 20,971 $16.06 0
87
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 2006 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 2006 Proxy Statement under the subcaptions "Audit Committee
Report and Related Matters - Independent Auditor and Fees," and "- Audit
Committee Pre-Approval Policies."
88
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, 2005 and 2004
(ii) Consolidated Statements of Income for the years ended December 31,
2005, 2004, and 2003
(iii) Consolidated Statements of Stockholders' Equity for the years
ended December 31, 2005, 2004, and 2003
(iv) Consolidated Statements of Cash Flows for the years ended December
31, 2005, 2004, and 2003
(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 3.1 to PSB's Current
Report on Form 8-K dated February 21, 2006)
4.1 Indenture dated June 28, 2005 between PSB Holdings, Inc. as
issuer, and Wilmington Trust Company, as trustee, including the
form of Junior Subordinated Debenture as Exhibit A thereto
(incorporated by reference to Exhibit 1.1 to PSB's Current Report
on Form 8-K dated June 28, 2005)
4.2 Guarantee Agreement dated June 28, 2005 between PSB Holdings,
Inc., as guarantor, and Wilmington Trust Company, as guarantee
trustee (incorporated by reference to Exhibit 1.2 to PSB's Current
Report on Form 8-K dated June 28, 2005)
4.3 Amended and Restated Declaration of Trust dated June 28, 2005
among PSB Holdings, Inc., as sponsor, Wilmington Trust Company, as
Institutional and Delaware Trustees, and the Administrators named
therein, including the form of trust preferred securities
(incorporated by reference to Exhibit 1.3 to PSB's Current Report
on Form 8-K dated June 28, 2005)
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)*
89
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 (incorporated by
reference to Exhibit 10.3 to PSB's Annual Report on Form 10-K for
the year ended December 31, 2004)*
10.4 2001 Stock Option Plan as amended March 15, 2005 (incorporated by
reference to Exhibit 10.3 to PSB's Quarterly Report on Form 10-Q
for the period ended March 31, 2005)*
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 Amendment No. 1 to Employment Agreement of David K. Kopperud
(incorporated by reference to Exhibit 10.1 to PSB's Current Report
on Form 8-K dated April 12, 2005)
10.7 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)*
10.8 Amendment No. 1 to Employment Agreement of David A. Svacina
(incorporated by reference to Exhibit 10.2 to PSB's Current Report
on Form 8-K dated April 12, 2005)
10.9 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)*
10.10 Amendment No. 1 to Employment Agreement of Scott M. Cattanach
(incorporated by reference to Exhibit 10.3 to PSB's Current Report
on Form 8-K dated April 12, 2005)
10.11 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)*
10.12 Executive Deferred Compensation Plan (incorporated by reference to
Exhibit 10.9 to PSB's Annual Report on Form 10-K for the year
ended December 31, 2004)*
10.13 Amendment to Executive Deferred Compensation Plan - David K.
Kopperud (incorporated by reference to Exhibit 10.1 to PSB's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2005)*
10.14 Amendment to Executive Deferred Compensation Plan - David A.
Svacina (incorporated by reference to Exhibit 10.2 to PSB's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2005)*
10.15 Incentive Deferred Bonus Plan (incorporated by reference to
Exhibit 10.10 to PSB's Annual Report on Form 10-K for the year
ended December 31, 2004)*
90
10.16 Survivor Income Plan (incorporated by reference to Exhibit 10.11
to PSB's Annual Report on Form 10-K for the year ended December
31, 2004)*
10.17 Executive Officer Post Retirement Benefit Plan (incorporated by
reference to Exhibit 10.4 to PSB's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2005)*
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.
91
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 10, 2006 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 10th day of March, 2006.
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
92
EXHIBIT INDEX
TO
FORM 10-K
OF
PSB HOLDINGS, INC.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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 of this report:
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
93