LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

3 Months Ended

Mar. 31, 2014

Loans Receivable And Allowance For Loan Losses

LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

NOTE 3 – 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:

	March 31, 2014			December 31, 2013
Commercial, industrial, and municipal	$	121,449		$	130,220
Commercial real estate mortgage		200,058			212,850
Commercial construction and development		17,405			13,672
Residential real estate mortgage		122,323			123,980
Residential construction and development		16,971			18,277
Residential real estate home equity		20,474			20,677
Consumer and individual		3,207			3,567
Subtotals – Gross loans		501,887			523,243
Loans in process of disbursement		(7,215	)		(6,895	)
Subtotals – Disbursed loans		494,672			516,348
Net deferred loan costs		312			315
Allowance for loan losses		(6,882	)		(6,783	)
Net loans receivable	$	488,102		$	509,880

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

	March 31, 2014		December 31, 2013
Impaired loans without a valuation allowance	$	9,034	$	9,303
Impaired loans with a valuation allowance		7,643		6,472
Total impaired loans before valuation allowances		16,677		15,775
Valuation allowance related to impaired loans		2,564		2,108
Net impaired loans	$	14,113	$	13,667

Activity in the allowance for loans losses during the three months ended March 31, 2014 follows:

Allowance for loan losses:	Commercial			Commercial Real Estate		Residential Real Estate			Consumer			Unallocated		Total
Beginning Balance	$	2,828		$	2,653	$	1,223		$	79		$	—	$	6,783
Provision		(426	)		12		566			(12	)		—		140
Recoveries		4			—		3			1			—		8
Charge offs		(27	)		—		(21	)		(1	)		—		(49	)
Ending balance	$	2,379		$	2,665	$	1,771		$	67		$	—	$	6,882

Activity in the allowance for loans losses during the three months ended March 31, 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		343			(293	)		264			9			—		323
Recoveries		2			—			1			5			—		8
Charge offs		(130	)		—			(172	)		(26	)		—		(328	)
Ending balance	$	3,229		$	2,510		$	1,604		$	91		$	—	$	7,434

The following tables provide other information regarding the allowance for loan losses and balances by type of allowance methodology.

	At March 31, 2014
			Commercial		Residential
Allowance for loan losses:	Commercial		Real Estate		Real Estate		Consumer		Unallocated		Total
Individually evaluated for impairment	$	1,038	$	803	$	704	$	19	$	—	$	2,564
Collectively evaluated for impairment		1,341		1,862		1,067		48		—		4,318
Total allowance for loan losses	$	2,379	$	2,665	$	1,771	$	67	$	—	$	6,882
Loans receivable (gross):
Individually evaluated for impairment	$	7,888	$	5,471	$	3,299	$	19	$	—	$	16,677
Collectively evaluated for impairment		113,561		211,992		156,469		3,188		—		485,210
Total loans receivable (gross)	$	121,449	$	217,463	$	159,768	$	3,207	$	—	$	501,887

	At December 31, 2013
			Commercial		Residential
Allowance for loan losses:	Commercial		Real Estate		Real Estate		Consumer		Unallocated		Total
Individually evaluated for impairment	$	1,167	$	695	$	228	$	18	$	—	$	2,108
Collectively evaluated for impairment		1,661		1,958		995		61	$	—		4,675
Total allowance for loan losses	$	2,828	$	2,653	$	1,223	$	79	$	—	$	6,783
Loans receivable (gross):
Individually evaluated for impairment	$	8,102	$	5,527	$	2,129	$	17	$	—	$	15,775
Collectively evaluated for impairment		122,118		220,995		160,805		3,550	$	—		507,468
Total loans receivable (gross)	$	130,220	$	226,522	$	162,934	$	3,567	$	—	$	523,243

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 PSB’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 March 31, 2014, follows: 

			Commercial		Construction
	Commercial		Real Estate		& Development		Agricultural		Government		Total
High quality (risk rating 1)	$	15	$	—	$	—	$	—	$	—	$	15
Minimal risk (2)		18,299		17,668		118		1,065		74		37,224
Average risk (3)		54,669		137,474		12,483		2,521		6,367		213,514
Acceptable risk (4)		21,582		31,333		3,037		513		347		56,812
Watch risk (5)		7,425		7,439		1,630		—		—		16,494
Substandard risk (6)		684		810		—		—		—		1,494
Impaired loans (7)		4,670		5,334		137		128		3,090		13,359
Total	$	107,344	$	200,058	$	17,405	$	4,227	$	9,878	$	338,912

The commercial credit exposure based on internally assigned credit grade at December 31, 2013, follows:

			Commercial		Construction
	Commercial		Real Estate		& Development		Agricultural		Government		Total
High quality (risk rating 1)	$	44	$	—	$	—	$	—	$	—	$	44
Minimal risk (2)		24,085		19,249		120		1,115		78		44,647
Average risk (3)		51,745		145,673		8,863		2,563		6,512		215,356
Acceptable risk (4)		26,395		34,154		2,917		424		357		64,247
Watch risk (5)		8,146		7,572		1,632		—		—		17,350
Substandard risk (6)		654		815		—		—		—		1,469
Impaired loans (7)		4,860		5,387		140		152		3,090		13,629
Total	$	115,929	$	212,850	$	13,672	$	4,254	$	10,037	$	356,742

The consumer credit exposure based on payment activity and internally assigned credit grade at March 31, 2014, follows:

	Residential-		Construction and		Residential-
	Prime		Development		HELOC		Consumer		Total
Performing	$	119,484	$	16,926	$	20,059	$	3,188	$	159,657
Impaired loans		2,839		45		415		19		3,318
Total	$	122,323	$	16,971	$	20,474	$	3,207	$	162,975

The consumer credit exposure based on payment activity and internally assigned credit grade at December 31, 2013, follows:

	Residential-		Construction and		Residential-
	Prime		Development		HELOC		Consumer		Total
Performing	$	122,408	$	18,230	$	20,167	$	3,550	$	164,355
Impaired loans		1,572		47		510		17		2,146
Total	$	123,980	$	18,277	$	20,677	$	3,567	$	166,501

The payment age analysis of loans receivable disbursed at March 31, 2014, follows:

	30-59		60-89		90+		Total				Total		90+ and
Loan Class	Days		Days		Days		Past Due		Current		Loans		Accruing
Commercial:
Commercial and industrial	$	3,568	$	624	$	376	$	4,568	$	102,776	$	107,344	$	—
Agricultural		—		—		128		128		4,099		4,227		—
Government		—		—		—		—		9,878		9,878		—
Commercial real estate:
Commercial real estate		301		169		855		1,325		198,733		200,058		—
Commercial construction and development		17		—		—		17		13,417		13,434		—
Residential real estate:
Residential – Prime		1,370		301		388		2,059		120,264		122,323		—
Residential – HELOC		48		18		214		280		20,194		20,474		—
Residential – construction and development		139		—		—		139		13,588		13,727		—
Consumer		14		30		6		50		3,157		3,207		—
Total	$	5,457	$	1,142	$	1,967	$	8,566	$	486,106	$	494,672	$	—

The payment age analysis of loans receivable disbursed at December 31, 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	$	297	$	57	$	610	$	964	$	114,965	$	115,929	$	—
Agricultural		—		—		152		152		4,102		4,254		—
Government		—		—		—		—		10,037		10,037		—
Commercial real estate:
Commercial real estate		376		547		1,276		2,199		210,651		212,850		—
Commercial construction and development		—		—		—		—		11,434		11,434		—
Residential real estate:
Residential – prime		369		87		335		791		123,189		123,980		—
Residential – HELOC		45		14		314		373		20,304		20,677		—
Residential – construction and development		37		—		—		37		13,583		13,620		—
Consumer		2		10		9		21		3,546		3,567		—
Total	$	1,126	$	715	$	2,696	$	4,537	$	511,811	$	516,348	$	—

Impaired loans as of March 31, 2014, and during the three 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	$	2,673	$	—	$	2,625	$	2,743	$	28
Commercial real estate		2,523		—		2,365		2,371		16
Commercial construction & development		1		—		—		—		—
Government		3,090		—		3,090		3,090		—
Residential – prime		946		—		834		850		1
Residential – HELOC		120		—		120		115		1
With an allowance recorded:
Commercial & industrial	$	2,286	$	996	$	2,045	$	2,022	$	8
Commercial real estate		3,201		770		2,969		2,990		2
Commercial construction & development		139		33		137		139		2
Agricultural		128		42		128		140		—
Residential – prime		2,051		557		2,005		1,356		9
Residential – HELOC		308		135		295		348		—
Residential construction & development		48		12		45		46		—
Consumer		21		19		19		18		—
Totals:
Commercial & industrial	$	4,959	$	996	$	4,670	$	4,765	$	36
Commercial real estate		5,724		770		5,334		5,361		18
Commercial construction & development		140		33		137		139		2
Agricultural		128		42		128		140		—
Government		3,090		—		3,090		3,090		—
Residential – prime		2,997		557		2,839		2,206		10
Residential – HELOC		428		135		415		463		1
Residential construction & development		48		12		45		46		—
Consumer		21		19		19		18		—

The impaired loans at December 31, 2013, 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	$	2,906	$	—	$	2,861	$	2,172	$	135
Commercial real estate		2,555		—		2,376		1,740		85
Commercial construction and development		1		—		—		—		—
Government		3,090		—		3,090		1,545		150
Residential – Prime		979		—		866		845		14
Residential – HELOC		110		—		110		55		3
With an allowance recorded:
Commercial and industrial	$	2,231	$	1,112	$	1,999	$	2,813	$	43
Commercial real estate		3,143		621		3,011		2,955		81
Commercial construction and development		142		74		140		171		8
Agricultural		152		55		152		153		—
Residential – Prime		749		101		706		1,085		9
Residential – HELOC		412		119		400		453		5
Residential construction and development		49		8		47		100		1
Consumer		19		18		17		22		—
Totals:
Commercial and industrial	$	5,137	$	1,112	$	4,860	$	4,985	$	178
Commercial real estate		5,698		621		5,387		4,695		166
Commercial construction and development		143		74		140		171		8
Agricultural		152		55		152		153		—
Government		3,090		—		3,090		1,545		150
Residential – Prime		1,728		101		1,572		1,930		23
Residential – HELOC		522		119		510		508		8
Residential construction and development		49		8		47		100		1
Consumer		19		18		17		22		—

Loans on nonaccrual status at period-end, follows:

	March 31, 2014		December 31, 2013
Commercial:
Commercial and industrial	$	1,567	$	1,575
Agricultural		128		152
Commercial real estate:
Commercial real estate		4,168		4,103
Commercial construction and development		17		17
Residential real estate:
Residential – prime		1,052		1,059
Residential – HELOC		282		387
Residential construction and development		28		30
Consumer		19		17
Total	$	7,261	$	7,340

During the quarter ended March 31, 2014, the contracts identified below were modified to capitalize unpaid property taxes or to extend payment amortization periods, and were categorized as troubled debt restructurings. During the quarter ended March 31, 2013, the contracts identified below were modified to capitalize unpaid property taxes, lower the interest rate, or extend payment amortization periods. Specific loan reserves maintained in connection with loans restructured during the quarter totaled $54 at March 31, 2014 and $27 at March 31, 2013. 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 three months ended March 31, 2014:

		Pre-modification		Post-modification
	Number of	outstanding recorded		outstanding recorded
As of March 31, 2014	contracts	investment		investment at period-end
Commercial & industrial	1	$	60	$	60
Commercial real estate – prime	2	$	309	$	309

The following table presents information concerning modifications of troubled debt made during the three months ended March 31, 2013:

		Pre-modification		Post-modification
	Number of	outstanding recorded		outstanding recorded
As of March 31, 2013	contracts	investment		investment at period-end
Commercial & industrial	1	$	38	$	38
Commercial real estate	2	$	221	$	221

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 three months ended	Number of	Recorded
March 31, 2014	contracts	investment
Commercial and industrial	1	$	59
Commercial real estate	2	$	227
Residential real estate – prime	1	$	86

Default during the three months ended	Number of	Recorded
March 31, 2013	contracts	investment
Commercial real estate	1	$	74
Residential real estate – prime	1	$	90