NOTE 4 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Loans

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

Allowance for Loan Losses

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

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

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

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 resulting from information available to them at the time of their examination.

The composition of loans at period-end, categorized by the type of the loan, is as follows:

	June 30, 2011			December 31, 2010

Commercial, industrial, and municipal	$	130,747		$	129,063
Commercial real estate mortgage		185,200			180,937
Construction and development		28,033			35,310
Residential real estate mortgage		75,203			71,675
Residential real estate home equity		24,976			23,774
Consumer and individual		3,745			3,929

Subtotals – Gross loans		447,904			444,688
Loans in process of disbursement		(2,565	)		(5,177	)

Subtotals – Disbursed loans		445,339			439,511
Net deferred loan costs		223			250
Allowance for loan losses		(7,817	)		(7,960	)

Net loans receivable	$	437,745		$	431,801

The following is a summary of information pertaining to impaired loans:

	June 30, 2011		December 31, 2010

Impaired loans without a valuation allowance	$	3,639	$	8,773
Impaired loans with a valuation allowance		13,628		2,643

Total impaired loans before valuation allowances		17,267		11,416
Valuation allowance related to impaired loans		3,387		1,496

Net impaired loans	$	13,880	$	9,920

Activity in the allowance for loan losses during the six months ended June 30, 2011, follows:

Allowance for loan losses:	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Unallocated		Total

Beginning balance	$	3,862		$	3,674		$	211		$	213		$	–	$	7,960
Provision		579			(653	)		932			(68	)		–		790
Recoveries		139			6			–			5			–		150
Charge offs		(766	)		(132	)		(102	)		(83	)		–		(1,083	)

Ending balance	$	3,814		$	2,895		$	1,041		$	67		$	–	$	7,817
Individually evaluated for impairment	$	1,943		$	882		$	542		$	20		$	–	$	3,387
Collectively evaluated for impairment	$	1,871		$	2,013		$	499		$	47		$	–	$	4,430

Loans receivable (gross):

Individually evaluated for impairment	$	7,338		$	7,688		$	2,163		$	78		$	–	$	17,267
Collectively evaluated for impairment	$	123,409		$	192,238		$	111,323		$	3,667		$	–	$	430,637

The commercial credit exposure based on internally assigned credit grade at June 30, 2011 and at December 31, 2010, follows:

At June 30, 2011	Commercial		Commercial Real Estate		Construction & Development		Agricultural		Government		Total

High quality (credit risk rating 1)	$	58	$	–	$	–	$	–	$	–	$	58
Minimal risk (2)		6,811		21,609		451		653		1,780		31,304
Average risk (3)		56,299		115,987		7,609		1,572		5,262		186,729
Acceptable risk (4)		41,355		31,052		2,357		393		–		75,157
Watch risk (5)		8,523		8,998		3,892		–		–		21,413
Substandard risk (6)		703		247		36		–		–		986
Impaired loans (7)		7,023		7,307		381		315		–		15,026

Total	$	120,772	$	185,200	$	14,726	$	2,933	$	7,042	$	330,673

At December 31, 2010	Commercial		Commercial Real Estate		Construction & Development		Agricultural		Government		Total

High quality (credit risk rating 1)	$	83	$	–	$	–	$	–	$	–	$	83
Minimal risk (2)		3,854		27,792		1,055		664		1,922		35,287
Average risk (3)		57,667		107,639		7,865		1,507		6,024		180,702
Acceptable risk (4)		37,373		33,482		12,594		293		–		83,742
Watch risk (5)		10,303		6,560		145		–		–		17,008
Substandard risk (6)		4,797		3,010		237		–		–		8,044
Impaired loans (7)		4,218		2,454		345		358		–		7,375

Total	$	118,295	$	180,937	$	22,241	$	2,822	$	7,946	$	332,241

The consumer credit exposure based on payment activity at June 30, 2011 and at December 31, 2010, follows:

At June 30, 2011	Residential – Prime		Residential – HELOC		Construction & Development		Consumer		Total

Performing	$	73,602	$	24,877	$	13,209	$	3,684	$	115,372
Nonperforming		1,601		99		98		61		1,859

Total	$	75,203	$	24,976	$	13,307	$	3,745	$	117,231

At December 31, 2010	Residential – Prime		Residential – HELOC		Construction & Development		Consumer		Total

Performing	$	70,242	$	23,632	$	12,928	$	3,851	$	110,653
Nonperforming		1,433		142		141		78		1,794

Total	$	71,675	$	23,774	$	13,069	$	3,929	$	112,447

The payment age analysis of loans receivable disbursed at June 30, 2011 and at December 31, 2010 follows:

Loan Class at June 30, 2011	30-59 Days		60-89 Days		90+ Days		Total Past Due		Current		Total Loans		90+ and Accruing

Commercial:

Commercial and industrial	$	567	$	269	$	2,743	$	3,579	$	117,193	$	120,772	$	–
Agricultural		–		179		–		179		2,754		2,933		–
Government		–		–		–		–		7,042		7,042		–

Commercial real estate:

Commercial real estate		868		411		864		2,143		183,057		185,200		–
Commercial construction and development		–		–		444		444		13,618		14,061		–

Residential real estate:

Residential – prime		285		298		1,323		1,906		73,297		75,203		–
Residential – HELOC		114		–		69		183		24,793		24,976		–
Residential – construction and development		–		–		78		78		11,328		11,407		–

Consumer		21		1		60		82		3,663		3,745		–

Total	$	1,855	$	1,158	$	5,581	$	8,594	$	436,745	$	445,339	$	–

Loan Class at December 31, 2010	30-59 Days		60-89 Days		90+ Days		Total Past Due		Current		Total Loans		90+ and Accruing

Commercial:

Commercial and industrial	$	2,235	$	694	$	2,305	$	5,234	$	113,061	$	118,295	$	–
Agricultural		–		–		72		72		2,750		2,822		–
Government		–		–		–		–		7,946		7,946		–

Commercial real estate:

Commercial real estate		178		355		1,545		2,078		178,859		180,937		–
Commercial construction and development		–		145		448		593		17,930		18,523		–

Residential real estate:

Residential – prime		649		267		758		1,674		70,001		71,675		–
Residential – HELOC		26		35		78		139		23,635		23,774		–
Residential – construction and development		17		–		99		116		11,494		11,610		–

Consumer		8		3		78		89		3,840		3,929		–

Total	$	3,113	$	1,499	$	5,383	$	9,995	$	429,516	$	439,511	$	–

Impaired loans at June 30, 2011, and during the six months then ended, by loan class, follows:

At June 30, 2011	Unpaid Principal Balance		Related Allowance		Recorded Investment		Average Recorded Investment		Interest Income Recognized

With no related allowance recorded:

Commercial & industrial	$	1,372	$	–	$	1,372	$	2,292	$	20
Commercial real estate		1,920		–		1,920		3,622		51
Commercial construction & development		–		–		–		120		–
Agricultural		300		–		300		300		8
Government		–		–		–		–		–
Residential – prime		47		–		47		338		1
Residential – HELOC		–		–		–		23		–
Residential construction & development		–		–		–		12		–
Consumer		–		–		–		11		–

With an allowance recorded:

Commercial & industrial	$	5,651	$	1,940	$	3,711	$	2,298	$	65
Commercial real estate		5,247		733		4,514		2,388		94
Commercial construction & development		521		149		372		342		2
Agricultural		15		3		12		11		–
Government		–		–		–		–		–
Residential – prime		1,729		387		1,342		922		9
Residential – HELOC		289		126		163		112		4
Residential construction & development		98		29		69		54		–
Consumer		78		20		58		39		1

Totals:

Commercial & industrial	$	7,023	$	1,940	$	5,083	$	4,590	$	85
Commercial real estate		7,167		733		6,434		6,010		145
Commercial construction & development		521		149		372		462		2
Agricultural		315		3		312		311		8
Government		–		–		–		–		–
Residential – prime		1,776		387		1,389		1,260		10
Residential – HELOC		289		126		163		135		4
Residential construction & development		98		29		69		66		–
Consumer		78		20		58		50		1

Loans on nonaccrual status by loan class at June 30, 2011 and December 31, 2010, follows:

	June 30, 2011		December 31, 2010

Commercial:

Commercial and industrial	$	3,904	$	4,546
Agricultural		15		72
Government		–		–

Commercial real estate:

Commercial real estate		1,606		2,119
Commercial construction and development		449		508

Residential real estate:

Residential – prime		1,601		1,433
Residential – HELOC		99		142
Residential construction and development		98		141

Consumer		61		78

Total	$	7,833	$	9,039