FAIR VALUE MEASUREMENTS

12 Months Ended

Dec. 31, 2011

Fair Value Measurements

FAIR VALUE MEASUREMENTS

NOTE 22 FAIR VALUE MEASUREMENTS

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

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

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

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

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

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

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

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

At December 31, 2011 and 2010, Level 3 securities include common stock investments in securities that are not traded on an active market. Amortized historical cost of the security is assumed to approximate fair value of these investments.

Loans – Loans are not measured at fair value on a recurring basis. However, loans considered to be impaired (see Note 4) may be measured at fair value on a nonrecurring basis. The fair value measurement of an impaired loan that is collateral dependent is based on the fair value of the underlying collateral. All other impaired loan fair value measurements are based on the present value of expected future cash flows discounted at the applicable effective interest rate and, thus, are not fair value measurements. Fair value measurements of underlying collateral that utilize observable market data, such as independent appraisals reflecting recent comparable sales, are considered Level 2 measurements. Other fair value measurements that incorporate internal collateral appraisals or estimated assumptions market participants would use to measure fair value, such as discounted cash flow measurements at market rates, are considered Level 3 measurements and represent an income approach to fair value.

Foreclosed assets – Real estate and other property acquired through, or in lieu of, loan foreclosure are not measured at fair value on a recurring basis. Initially, foreclosed assets are recorded at fair value less estimated costs to sell at the date of foreclosure. Valuations are periodically performed by management, and the real estate or other property is carried at the lower of carrying amount or fair value less estimated costs to sell. Fair value measurements are based on current formal or informal appraisals of property value compared to recent comparable sales of similar property. Independent appraisals reflecting comparable sales are considered Level 2 measurements, while internal assessments of appraised value based on current market activity are considered Level 3 measurements and represent an income approach to fair value.

Mortgage servicing rights – Mortgage servicing rights are not measured at fair value on a recurring basis. However, mortgage servicing rights that are impaired are measured at fair value on a nonrecurring basis. Serviced loan pools are stratified by year of origination and term of the loan, and a valuation model is used to calculate the present value of expected future cash flows for each stratum. When the carrying value of a stratum exceeds its fair value, the stratum is measured at fair value. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as costs to service, a discount rate, custodial earnings rate, ancillary income, default rates and losses, and prepayment speeds. Although some of these assumptions are based on observable market data, other assumptions are based on unobservable estimates of what market participants would use to measure fair value. As a result, the fair value measurement of mortgage servicing rights is considered a Level 3 measurement and represents an income approach to fair value. Significant unobservable inputs at December 31, 2011, used to measure fair value included:

Direct annual servicing cost per loan	$50
Direct annual servicing cost per loan in process of foreclosure	$500
Weighted average prepayment speed: CPR	0.68%
Weighted average prepayment speed: PSA	253%
Weighted average cash flow discount rate	9.34%
Asset reinvestment rate	4.00%
Short-term cost of funds	0.25%
Escrow inflation adjustment	1.00%
Servicing cost inflation adjustment	1%

Mortgage rate lock commitments – The fair value of mortgage rate lock commitments is not measured on a recurring basis. Fair value is based on current secondary market pricing for delivery of similar loans and the value of originated mortgage servicing rights on loans expected to be delivered. Although some of these assumptions are based on observable market data, other assumptions are based on unobservable estimates of what market participants would use to measure fair value. As a result, the fair value measurement of mortgage rate lock commitments is considered a Level 3 measurement and represents an income approach to fair value. Significant unobservable inputs at December 31, 2011, used to measure fair value included:

• Estimated failure to close on 10% of period-end rate lock commitments 
• Estimated combined cash gain on sale of principal and originated mortgage servicing rate equal to 1% of mortgage rate lock loan principal

Interest rate swap agreements – Fair values for interest rate swap agreements are based on the amounts required to settle the contracts based on valuations provided by third-party dealers in the contracts.

Information regarding the fair value of assets measured at fair value on a recurring basis as of December 31:

			Recurring Fair Value Measurements Using
			Quoted Prices
			in Active		Significant
	Assets and		Markets for		Other		Significant
	Liabilities		Identical		Observable		Unobservable
	Measured at		Assets		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
2011
Assets:
Securities available for sale:
U.S. Treasury and agency debentures	$	518	$	0	$	518	$	0
U.S. agency issued residential MBS and CMO		58,389		0		58,389		0
Privately issued residential MBS and CMO		429		0		429		0
Other equity securities		47		0		0		47
Total securities available for sale		59,383		0		59,336		47
Interest rate swaps		555		0		555		0
Total assets	$	59,938	$	0	$	59,891	$	47
Liabilities – Interest rate swaps	$	1,131	$	0	$	1,131	$	0
2010
Assets:
Securities available for sale:
U.S. Treasury and agency debentures	$	1,041	$	0	$	1,041	$	0
Obligations of states and political subdivisions
U.S. agency issued residential MBS and CMO		53,201		0		53,201		0
Privately issued residential MBS and CMO		980		0		980		0
Other equity securities		51		0		0		51
Total assets	$	55,273	$	0	$	55,222	$	51
Liabilities – Interest rate swaps	$	25	$	0	$	25	$	0

The following reconciles the beginning and ending balances of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the years ended December 31:

	Securities
	Available
	for Sale
Balance at January 1, 2010:	$	1,609
Total realized/unrealized gains (losses):
Included in earnings		0
Included in other comprehensive income		(95	)
Purchases, maturities, and sales		400
Transferred from Level 2 to Level 3 - FNMA preferred stock		5
Transferred to held to maturity classification		(1,868	)
Balance at December 31, 2010	$	51
Total gains (losses) for the period included in earnings attributable to the change
in unrealized gains or losses relating to assets still held at December 31, 2010	$	0
Balance at January 1, 2011:	$	51
Total realized/unrealized gains (losses):
Included in earnings		0
Included in other comprehensive income		0
Purchases, maturities, and sales		(4	)
Balance at December 31, 2011	$	47
Total gains (losses) for the period included in earnings attributable to the change
in unrealized gains or losses relating to assets still held at December 31, 2011	$	0

Information regarding the fair value of assets and liabilities measured at fair value on a nonrecurring basis as of December 31 follows:

			Nonrecurring Fair Value Measurements Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
	Assets		Identical		Observable		Unobservable
	Measured at		Assets		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
2011
Assets:
Impaired loans	$	4,086	$	0	$	0	$	4,086
Foreclosed assets		2,939		0		0		2,939
Mortgage servicing rights		1,205		0		0		1,205
Mortgage rate lock commitments		60		0		0		60
Total assets	$	8,290	$	0	$	0	$	8,290
2010
Assets:
Impaired loans	$	1,147	$	0	$	0	$	1,147
Foreclosed assets		4,967		0		0		4,967
Mortgage servicing rights		1,100		0		0		1,100
Mortgage rate lock commitments		57		0		0		57
Total assets	$	7,271	$	0	$	0	$	7,271

At December 31, 2011, loans with a carrying amount of $5,306 were considered impaired and were written down to their estimated fair value of $4,086, net of a valuation allowance of $1,220. At December 31, 2010, loans with a carrying amount of $2,643 were considered impaired and were written down to their estimated fair value of $1,147, net of a valuation allowance of $1,496. Changes in the valuation allowances are reflected through earnings as a component of the provision for loan losses.

At December 31, 2011, mortgage servicing rights with a carrying amount of $1,286 were considered impaired and were written down to their estimated fair value of $1,205, resulting in an impairment allowance of $81. At December 31, 2010, mortgage servicing rights with a carrying amount of $1,303 were considered impaired and were written down to their estimated fair value of $1,100, resulting in an impairment allowance of $203. Changes in the impairment allowances are reflected through earnings as a component of mortgage banking income.

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

Cash and cash equivalents – Fair value approximates the carrying value.

Securities held to maturity – Fair value of securities held to maturity is based on dealer quotations on similar securities at period-end, which is considered a Level 2 measurement.

Bank certificates of deposit – Fair value of fixed rate certificates of deposit is estimated by discounting future cash flows using current rates at which similar certificates could be purchased.

Loans – Fair value of variable rate loans that reprice frequently are based on carrying values. Loans with an active sale market, such as one- to four-family residential mortgage loans, estimate fair value based on sales of loans with similar structure and credit quality. Fair value of other loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings. Fair value of impaired and other nonperforming loans is estimated using discounted expected future cash flows or the fair value of underlying collateral, if applicable.

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

Federal Home Loan Bank stock – Fair value is the redeemable (carrying) value based on the redemption provisions of the Federal Home Loan Bank.

Accrued interest receivable and payable – Fair value approximates the carrying value.

Cash value of life insurance – Fair value is based on reported values of the assets by the issuer which are redeemable to the insured.

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

FHLB advances and other borrowings – Fair value of fixed rate, fixed term borrowings is estimated by discounting future cash flows using the current rates at which similar borrowings would be made. Fair value of borrowings with variable rates or maturing within 90 days approximates the carrying value of these borrowings.

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

The carrying amounts and fair values of PSB’s financial instruments consisted of the following at December 31:

	2011				2010
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	38,205	$	38,205	$	40,331	$	40,331
Securities		108,677		110,134		108,379		106,935
Bank certificates of deposit		2,484		2,577		2,484		2,510
Net loans receivable and loans held for sale		437,596		444,799		432,237		441,157
Accrued interest receivable		2,068		2,068		2,238		2,238
Mortgage servicing rights		1,205		1,205		1,100		1,100
Mortgage rate lock commitments		60		60		57		57
FHLB stock		3,250		3,250		3,250		3,250
Cash surrender value of life insurance		11,406		11,406		10,899		10,899
Interest rate swaps		555		555		0		0
Financial liabilities:
Deposits	$	481,509	$	484,640	$	465,257	$	468,331
FHLB advances		50,124		52,547		57,434		59,909
Other borrowings		19,691		21,454		31,511		33,105
Senior subordinated notes		7,000		7,120		7,000		6,695
Junior subordinated debentures		7,732		4,849		7,732		3,986
Interest rate swaps		1,131		1,131		25		25
Accrued interest payable		623		623		848		848