LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

9 Months Ended

Sep. 30, 2013

Loans Receivable And Allowance For Loan Losses

LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

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

The composition of loans categorized by the type of the loan, is as follows:

	September 30, 2013			December 31, 2012
Commercial, industrial, and municipal	$	143,396		$	132,633
Commercial real estate mortgage		208,544			183,818
Commercial construction and development		13,592			28,482
Residential real estate mortgage		124,469			105,579
Residential construction and development		15,033			15,247
Residential real estate home equity		20,346			21,756
Consumer and individual		4,312			4,715
Subtotals – Gross loans		529,692			492,230
Loans in process of disbursement		(5,993	)		(7,039	)
Subtotals – Disbursed loans		523,699			485,191
Net deferred loan costs		300			231
Allowance for loan losses		(7,126	)		(7,431	)
Net loans receivable	$	516,873		$	477,991

The following is a summary of information pertaining to impaired loans at period-end:

	September 30, 2013		December 31, 2012
Impaired loans without a valuation allowance	$	9,463	$	3,410
Impaired loans with a valuation allowance		6,173		9,029
Total impaired loans before valuation allowances		15,636		12,439
Valuation allowance related to impaired loans		2,274		2,434
Net impaired loans	$	13,362	$	10,005

Activity in the allowance for loans losses during the nine months ended September 30, 2013 follows:

Allowance for loan losses:	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Unallocated		Total
Beginning Balance	$	3,014		$	2,803		$	1,511		$	103		$	—	$	7,431
Provision		3,553			226			198			38			—		4,015
Recoveries		2			30			3			11			—		46
Charge offs		(3,568	)		(174	)		(574	)		(50	)		—		(4,366	)
Ending balance	$	3,001		$	2,885		$	1,138		$	102		$	—	$	7,126
Individually evaluated for impairment	$	1,232		$	821		$	196		$	25		$	—	$	2,274
Collectively evaluated for impairment	$	1,769		$	2,064		$	942		$	77		$	—	$	4,852
Loans receivable (gross):
Individually evaluated for impairment	$	8,228		$	5,222		$	2,161		$	25		$	—	$	15,636
Collectively evaluated for impairment	$	135,168		$	216,914		$	157,687		$	4,287		$	—	$	514,056

Activity in the allowance for loans losses during the nine months ended September 30, 2012, follows:

Allowance for loan losses:	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Unallocated		Total
Beginning Balance	$	3,406		$	3,175		$	1,242		$	118		$	—	$	7,941
Provision		233			(458	)		530			20			—		325
Recoveries		6			4			3			4			—		17
Charge offs		(105	)		(234	)		(462	)		(51	)		—		(852	)
Ending balance	$	3,540		$	2,487		$	1,313		$	91		$	—	$	7,431
Individually evaluated for impairment	$	1,625		$	570		$	336		$	6		$	—	$	2,537
Collectively evaluated for impairment	$	1,915		$	1,917		$	977		$	85		$	—	$	4,894
Loans receivable (gross):
Individually evaluated for impairment	$	5,741		$	8,955		$	2,543		$	15		$	—	$	17,254
Collectively evaluated for impairment	$	132,280		$	200,772		$	131,541		$	5,287		$	—	$	469,880

PSB maintains an independent credit administration staff that continually monitors aggregate commercial loan portfolio and individual borrower credit quality trends. All commercial purpose loans are assigned a credit grade upon origination, and credit grades for nonproblem borrowers with aggregate credit in excess of $500 are reviewed annually. In addition, all past due, restructured, or identified problem loans, both commercial and consumer purpose, are reviewed and assigned an up-to-date credit grade quarterly.

PSB uses a seven point grading scale to estimate credit risk with risk rating 1, representing the high credit quality, and risk rating 7, representing the lowest credit quality. The assigned credit grade takes into account several credit quality components which are assigned a weight and blended into the composite grade. The factors considered and their assigned weight for the final composite grade is as follows:

Cash flow (30% weight) – Considers earnings trends and debt service coverage levels.

Collateral (25% weight) – Considers loan to value and other measures of collateral coverage.

Leverage (15% weight) – Considers balance sheet debt and capital ratios compared to Robert Morris & Associates (RMA) industry medians.

Liquidity (10% weight) – Considers balance sheet current, quick, and other working capital ratios compared to RMA industry medians.

Management (5% weight) – Considers the past performance, character, and depth of borrower management.

Guarantor (5% weight) – Considers the existence of a guarantor along with a bank’s past experience with the guarantor and his related liquidity and credit score.

Financial reporting (5% weight) – Considers the relative level of independent financial review obtained by the borrower on its financial statements, from audited financial statements down to existence of only tax returns or potentially unreliable financial information.

Industry (5% weight) – Considers the borrower’s industry and whether it is stable or subject to cyclical or seasonal factors.

Nonclassified loans are assigned a risk rating of 1 to 4 and have credit quality that ranges from well above average to some inherent industry weaknesses that may present higher than average risk due to conditions affecting the borrower, the borrower’s industry, or economic development.

Special mention and watch loans are assigned a risk rating of 5 when potential weaknesses exist that deserve management’s close attention. If left uncorrected, the potential weaknesses may result in deterioration of repayment prospects or in credit position at some future date. Substandard loans are assigned a risk rating of 6 and are inadequately protected by the current worth and borrowing capacity of the borrower. Well-defined weaknesses exist that may jeopardize the liquidation of the debt. There is a possibility of some loss if the deficiencies are not corrected. At this point, the loan may still be performing and accruing interest.

Impaired and other doubtful loans assigned a risk rating of 7 have all of the weaknesses of a substandard credit plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of current facts, conditions, and collateral values highly questionable and improbable. Impaired loans include all nonaccrual loans and all restructured loans including restructured loans performing according to the restructured terms. In special situations, an impaired loan with a risk rating of 7 could still be maintained on accrual status such as in the case of restructured loans performing according to restructured terms.

The commercial credit exposure based on internally assigned credit grade at September 30, 2013, follows:

			Commercial		Construction
	Commercial		Real Estate		& Development		Agricultural		Government		Total
High quality (risk rating 1)	$	51	$	—	$	—	$	—	$	—	$	51
Minimal risk (2)		33,663		19,674		75		1,206		83		54,701
Average risk (3)		54,473		139,442		8,399		2,657		8,401		213,372
Acceptable risk (4)		23,801		35,566		2,985		396		367		63,115
Watch risk (5)		9,180		7,906		1,633		—		—		18,719
Substandard risk (6)		890		876		358		—		—		2,124
Impaired loans (7)		4,960		5,080		142		178		3,090		13,450
Total	$	127,018	$	208,544	$	13,592	$	4,437	$	11,941	$	365,532

The commercial credit exposure based on internally assigned credit grade at December 31, 2012, follows:

			Commercial		Construction
	Commercial		Real Estate		& Development		Agricultural		Government		Total
High quality (risk rating 1)	$	38	$	—	$	—	$	—	$	—	$	38
Minimal risk (2)		16,360		20,193		305		559		1,575		38,992
Average risk (3)		51,846		103,454		22,573		3,336		12,550		193,759
Acceptable risk (4)		32,002		45,699		3,318		216		—		81,235
Watch risk (5)		8,271		8,291		1,757		—		—		18,319
Substandard risk (6)		617		2,179		327		—		—		3,123
Impaired loans (7)		5,109		4,002		202		154		—		9,467
Total	$	114,243	$	183,818	$	28,482	$	4,265	$	14,125	$	344,933

The consumer credit exposure based on payment activity and internally assigned credit grade at September 30, 2013, follows:

	Residential-		Residential-		Construction and
	Prime		HELOC		Development		Consumer		Total
Performing	$	122,794	$	19,908	$	14,985	$	4,287	$	161,974
Impaired loans		1,675		438		48		25		2,186
Total	$	124,469	$	20,346	$	15,033	$	4,312	$	164,160

The consumer credit exposure based on payment activity and internally assigned credit grade at December 31, 2012, follows:

	Residential-		Residential-		Construction and
	Prime		HELOC		Development		Consumer		Total
Performing	$	103,292	$	21,250	$	15,094	$	4,689	$	144,325
Impaired loans		2,287		506		153		26		2,972
Total	$	105,579	$	21,756	$	15,247	$	4,715	$	147,297

The payment age analysis of loans receivable disbursed at September 30, 2013, follows:

	30-59		60-89		90+		Total				Total		90+ and
Loan Class	Days		Days		Days		Past Due		Current		Loans		Accruing
Commercial:
Commercial and industrial	$	567	$	423	$	838	$	1,828	$	125,190	$	127,018	$	—
Agricultural		—		—		178		178		4,259		4,437		—
Government		—		—		—		—		11,941		11,941		—
Commercial real estate:
Commercial real estate		272		395		1,244		1,911		206,633		208,544		—
Commercial construction and development		—		—		—		—		11,747		11,747		—
Residential real estate:
Residential – Prime		245		—		325		570		123,899		124,469		—
Residential – HELOC		90		18		266		374		19,972		20,346		—
Residential – construction and development		—		—		—		—		10,885		10,885		—
Consumer		7		2		9		18		4,294		4,312		—
Total	$	1,181	$	838	$	2,860	$	4,879	$	518,820	$	523,699	$	—

The payment age analysis of loans receivable disbursed at December 31, 2012, follows:

	30-59		60-89		90+		Total				Total		90+ and
Loan Class	Days		Days		Days		Past Due		Current		Loans		Accruing
Commercial:
Commercial and industrial	$	375	$	83	$	1,795	$	2,253	$	111,990	$	114,243	$	—
Agricultural		—		154		—		154		4,111		4,265		—
Government		—		—		—		—		14,125		14,125		—
Commercial real estate:
Commercial real estate		936		76		1,028		2,040		181,778		183,818		—
Commercial construction and development		—		20		—		20		25,340		25,360		—
Residential real estate:
Residential – prime		950		274		1,344		2,568		103,011		105,579		—
Residential – HELOC		64		—		335		399		21,357		21,756		—
Residential – construction and development		—		—		133		133		11,197		11,330		—
Consumer		21		3		15		39		4,676		4,715		—
Total	$	2,346	$	610	$	4,650	$	7,606	$	477,585	$	485,191	$	—

Impaired loans as of September 30, 2013, and during the nine months then ended, by loan class, follows:

	Unpaid						Average		Interest
	Principal		Related		Recorded		Recorded		Income
	Balance		Allowance		Investment		Investment		Recognized
With no related allowance recorded:
Commercial & industrial	$	2,748	$	—	$	2,620	$	2,052	$	80
Commercial real estate		2,708		—		2,513		1,808		74
Commercial construction & development		2		—		—		—		—
Government		3,090				3,090		1,545		77
Residential – prime		1,314		—		1,160		992		7
Residential – HELOC		80		—		80		40		2
With an allowance recorded:
Commercial & industrial	$	2,576	$	1,153	$	2,340	$	2,983	$	42
Commercial real estate		2,638		780		2,567		2,733		71
Commercial construction & development		144		41		142		172		6
Agricultural		179		79		178		166		—
Residential – prime		529		112		515		989		3
Residential – HELOC		370		76		358		432		3
Residential construction & development		50		8		48		101		1
Consumer		23		25		25		26		—
Totals:
Commercial & industrial	$	5,324	$	1,153	$	4,960	$	5,035	$	122
Commercial real estate		5,346		780		5,080		4,541		145
Commercial construction & development		146		41		142		172		6
Agricultural		179		79		178		166		—
Government		3,090		—		3,090		1,545		77
Residential – prime		1,843		112		1,675		1,981		10
Residential – HELOC		450		76		438		472		5
Residential construction & development		50		8		48		101		1
Consumer		23		25		25		26		—

The impaired loans at December 31, 2012, and during the year then ended, by loan class, follows:

	Unpaid						Average		Interest
	Principal		Related		Recorded		Recorded		Income
	Balance		Allowance		Investment		Investment		Recognized
With no related allowance recorded:
Commercial and industrial	$	1,521	$	—	$	1,483	$	1,545	$	88
Commercial real estate		1,176		—		1,103		2,405		194
Commercial construction and development		—		—		—		—		33
Residential – Prime		881		—		824		493		9
Residential – HELOC		—		—		—		—		3
With an allowance recorded:
Commercial and industrial	$	3,960	$	1,287	$	3,626	$	4,238	$	62
Commercial real estate		3,035		643		2,899		3,303		105
Commercial construction and development		205		31		202		427		21
Agricultural		154		40		154		91		10
Residential – Prime		1,511		277		1,463		1,746		22
Residential – HELOC		510		126		506		387		15
Residential construction and development		153		4		153		149		5
Consumer		26		26		26		48		2
Totals:
Commercial and industrial	$	5,481	$	1,287	$	5,109	$	5,783	$	150
Commercial real estate		4,211		643		4,002		5,708		299
Commercial construction and development		205		31		202		427		54
Agricultural		154		40		154		91		10
Residential – Prime		2,392		277		2,287		2,239		31
Residential – HELOC		510		126		506		387		18
Residential construction and development		153		4		153		149		5
Consumer		26		26		26		48		2

Loans on nonaccrual status at period-end, follows:

	September 30, 2013		December 31, 2012
Commercial:
Commercial and industrial	$	2,191	$	3,023
Agricultural		178		154
Commercial real estate:
Commercial real estate		3,003		2,001
Commercial construction and development		18		1
Residential real estate:
Residential – prime		1,265		2,021
Residential – HELOC		332		365
Residential construction and development		30		133
Consumer		19		17
Total	$	7,036	$	7,715

During the quarter and nine months ended September 30, 2013, the contracts identified below were modified to capitalize unpaid property taxes, convert amortizing payments to interest only payments, extend the amortization period, or lower the interest rate, and were categorized as troubled debt restructurings. During the quarter and nine months ended September 30, 2012, the contracts identified below were modified to convert from amortizing principal payments to interest only payments, extend payment amortization periods, or to capitalize unpaid property taxes. Specific loan reserves maintained in connection with loans restructured during the year to date period totaled $165 at September 30, 2013, and $262 at September 30, 2012. All modified or restructured loans are classified as impaired loans. Recorded investment as presented in the tables below concerning modified loans represents principal outstanding before specific reserves.

The following table presents information concerning modifications of troubled debt made during the quarter ended September 30, 2013:

		Pre-modification		Post-modification
	Number of	outstanding recorded		outstanding recorded
As of September 30, 2013 ($000s)	contracts	investment		investment at period-end
Commercial & industrial	1	$	75	$	75
Commercial real estate	1	$	82	$	81
Residential real estate – prime	4	$	777	$	774

The following table presents information concerning modifications of troubled debt made during the quarter ended September 30, 2012:

		Pre-modification		Post-modification
	Number of	outstanding recorded		outstanding recorded
As of September 30, 2012 ($000s)	contracts	investment		investment at period-end
Commercial & industrial	3	$	481	$	475
Residential real estate – prime	1	$	121	$	89

The following table presents information concerning modifications of troubled debt made during the nine months ended September 30, 2013:

		Pre-modification		Post-modification
	Number of	outstanding recorded		outstanding recorded
As of September 30, 2013 ($000s)	contracts	investment		investment at period-end
Commercial & industrial	4	$	471	$	369
Commercial real estate	3	$	303	$	288
Residential real estate – prime	5	$	867	$	862

The following table presents information concerning modifications of troubled debt made during the nine months ended September 30, 2012:

		Pre-modification		Post-modification
	Number of	outstanding recorded		outstanding recorded
As of September 30, 2012 ($000s)	contracts	investment		investment at period-end
Commercial & industrial	6	$	661	$	637
Commercial real estate	2	$	527	$	508
Residential real estate – prime	1	$	121	$	89

The following table outlines past troubled debt restructurings that subsequently defaulted within twelve months of the last restructuring date. For purposes of this table, default is defined as 90 days or more past due on restructured payments.

Default during the quarter ended	Number of	Recorded
September 30, 2013 ($000s)	contracts	Investment
Commercial & industrial	1	$	172

Default during the nine months ended	Number of	Recorded
September 30, 2013 ($000s)	contracts	Investment
Commercial and industrial	1	$	172
Commercial real estate	1	$	81
Residential – prime	1	$	88

Default during the quarter ended	Number of	Recorded
September 30, 2012 ($000s)	contracts	Investment
Commercial real estate	1	$	45

Default during the nine months ended	Number of	Recorded
September 30, 2012 ($000s)	contracts	Investment
Commercial & industrial	1	$	—
Commercial real estate	1	$	45