10-Q 1 psb10q93003.txt PSB FORM 10-Q - 9/30/03 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 OR [ ] 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. (Exact name of registrant as specified in charter) WISCONSIN 39-1804877 (State of incorporation)(I.R.S. Employer Identification Number) 1905 West Stewart Avenue Wausau, Wisconsin 54401 (Address of principal executive office) Registrant's telephone number, including area code: 715-842-2191 Indicate by check mark 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 X No ___ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ___ No X The number of common shares outstanding at October 23, 2003 was 1,651,069. PSB HOLDINGS, INC. FORM 10-Q Quarter Ended September 30, 2003 Page No. PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets September 30, 2003 (unaudited) and December 31, 2002 (derived from audited financial statements) 1 Consolidated Statements of Income Three Months and Nine Months Ended September 30, 2003 and 2002 (unaudited) 2 Consolidated Statement of Changes in Stockholders' Equity Nine Months Ended September 30, 2003 (unaudited) 3 Consolidated Statements of Cash Flows Nine Months Ended September 30, 2003 and 2002 (unaudited) 4 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk 27 Item 4. Controls and Procedures 27 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 28 i PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS PSB HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS September 30, 2003 unaudited, December 31, 2002 derived from audited financial statements) Sept. 30, December 31, (dollars in thousands, except per share data) 2003 2002 ASSETS Cash and due from banks $ 12,377 $ 15,890 Interest-bearing deposits and money market funds 4,669 5,490 Federal funds sold - 172 Cash and cash equivalents 17,046 21,552 Securities available for sale (at fair value) 69,988 81,056 Federal Home Loan Bank stock (at cost) 2,402 2,264 Loans held for sale 179 949 Loans receivable, net of allowance for loan losses of $3,692 and $3,158, respectively 297,655 256,015 Accrued interest receivable 1,700 1,732 Foreclosed assets, net 183 573 Premises and equipment 6,481 6,158 Mortgage servicing rights, net 749 697 Other assets 635 472 TOTAL ASSETS $ 397,018 $ 371,468 LIABILITIES Non-interest-bearing deposits $ 46,700 $ 45,458 Interest-bearing deposits 263,405 252,373 Total deposits 310,105 297,831 Federal Home Loan Bank advances 43,000 38,000 Other borrowings 10,483 3,302 Accrued expenses and other liabilities 2,030 3,033 Total liabilities 365,618 342,166 STOCKHOLDERS' EQUITY Common stock - no par value with a stated value of $1 per share: Authorized - 3,000,000 shares Issued - 1,804,850 shares 1,805 1,805 Additional paid-in capital 7,150 7,150 Retained earnings 24,627 21,607 Unrealized gain on securities available for sale, net of tax 891 1,306 Treasury stock, at cost - 153,781 and 138,748 shares, respectively (3,073) (2,566) Total stockholders' equity 31,400 29,302 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 397,018 $ 371,468
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PSB HOLDINGS, INC. CONSOLIDATED STATEMENTS OF INCOME Three Months Ended Nine Months Ended (dollars in thousands, September 30, September 30, except per share data - unaudited) 2003 2002 2003 2002 Interest income: Interest and fees on loans $ 4,594 $ 4,627 $ 13,466 $ 13,466 Interest on securities: Taxable 359 665 1,475 2,033 Tax-exempt 232 223 676 674 Other interest and dividends 56 86 175 203 Total interest income 5,241 5,601 15,792 16,376 Interest expense: Deposits 1,368 1,733 4,312 5,195 FHLB advances 506 577 1,520 1,712 Other borrowings 61 35 154 115 Total interest expense 1,935 2,345 5,986 7,022 Net interest income 3,306 3,256 9,806 9,354 Provision for loan losses 240 450 705 810 Net interest income after provision for loan losses 3,066 2,806 9,101 8,544 Noninterest income: Service fees 323 334 951 890 Gain on sale of mortgage loans 718 310 1,871 642 Mortgage loan servicing, net (63) 17 (372) 36 Investment and insurance sales commissions 115 93 303 189 Net loss on sale of securities (19) - (19) - Other noninterest income 69 87 257 251 Total noninterest income 1,143 841 2,991 2,008 Noninterest expense: Salaries and employee benefits 1,508 1,320 4,343 3,735 Occupancy 286 267 859 832 Data processing and other office operations 131 153 418 413 Advertising and promotion 45 63 133 254 Other noninterest expenses 365 294 1,119 921 Total noninterest expense 2,335 2,097 6,872 6,155 Income before provision for income taxes 1,874 1,550 5,220 4,397 Provision for income taxes 639 499 1,704 1,364 Net income $ 1,235 $ 1,051 $ 3,516 $ 3,033 Basic earnings per share $ 0.75 $ 0.63 $ 2.12 $ 1.81 Diluted earnings per share $ 0.74 $ 0.63 $ 2.10 $ 1.81
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PSB HOLDINGS, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY Nine months ended September 30, 2003 - unaudited Unrealized Gain (Loss) Additional on Securities Common Paid-in Retained Available Treasury (dollars in thousands) Stock Capital Earnings For Sale Stock Totals Balance January 1, 2003 $ 1,805 $ 7,150 $ 21,607 $ 1,306 $ (2,566) $ 29,302 Comprehensive income: Net income 3,516 3,516 Unrealized loss on securities available for sale, net of tax (427) (427) Reclassification adjustment for security loss included in net income, net of tax 12 12 Total comprehensive income 3,101 Purchase of treasury stock (553) (553) Distribution of treasury stock in settlement of liability to Company directors 46 46 Cash dividends declared $.30 per share (496) (496) Balance September 30, 2003 $ 1,805 $ 7,150 $ 24,627 $ 891 $ (3,073) $ 31,400
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PSB HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Nine months ended September 30, 2003 and 2002 - unaudited 2003 2002 Cash flows from operating activities: Net income $ 3,516 $ 3,033 Adjustments to reconcile net income to net cash provided by operating activities: Provision for depreciation and net amortization 1,495 500 Provision for loan losses 705 810 Gain on sale of mortgage loans (1,871) (642) Provision for servicing right valuation allowance 28 - Loss on sale of premises and equipment - 30 (Gain) loss on sale of foreclosed assets 37 (27) Loss on sale of securities 19 - FHLB stock dividends (138) (85) Changes in operating assets and liabilities: Accrued interest receivable 32 (33) Other assets 95 (129) Other liabilities (957) (815) Net cash provided by operating activities 2,961 2,642 Cash flows from investing activities: Proceeds from sale and maturities of: Securities held to maturity - 682 Securities available for sale 40,016 8,848 Payment for purchase of: Securities held to maturity - (1,537) Securities available for sale (30,122) (12,857) Net increase in loans (40,345) (14,919) Capital expenditures (702) (1,638) Proceeds from sale of premises and equipment - 29 Proceeds from sale of foreclosed assets 280 278 Net cash used in investing activities (30,873) (21,114)
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CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED Cash flows from financing activities: Net increase in non-interest-bearing deposits 1,242 1,809 Net increase in interest-bearing deposits 11,032 13,148 Proceeds from long-term FHLB advances 15,000 - Repayments of long-term FHLB advances (10,000) Net increase (decrease) in other borrowings 7,181 (813) Dividends paid (496) (320) Proceeds from issuance of stock options - 52 Purchase of treasury stock (553) (329) Net cash provided by financing activities 23,406 13,547 Net decrease in cash and cash equivalents (4,506) (4,925) Cash and cash equivalents at beginning 21,552 25,550 Cash and cash equivalents at end $ 17,046 $ 20,625 Supplemental cash flow information: Cash paid during the period for: Interest $ 6,205 $ 7,330 Income taxes 1,650 1,300 Noncash investing and financing activities: Loans charged off $ 206 $ 321 Loans transferred to foreclosed assets 178 397 Loans originated on sale of foreclosed assets 251 331 Distribution of treasury stock in settlement of liability to Company directors 46 60
5 PSB Holdings, Inc. Notes to Consolidated Financial Statements NOTE 1 - GENERAL In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly PSB Holdings, Inc.'s ("Company") financial position, results of its operations, and cash flows for the periods presented, and all such adjustments are of a normal recurring nature. The consolidated financial statements include the accounts of all subsidiaries. All material intercompany transactions and balances are eliminated. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles have been omitted or abbreviated. The information contained in the consolidated financial statements and footnotes in the Company's 2002 annual report on Form 10-K, should be referred to in connection with the reading of these unaudited interim financial statements. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are susceptible to significant change include the determination of the allowance for loan losses, mortgage servicing right asset, and the valuation of investment securities. NOTE 2 - CHANGES IN ACCOUNTING PRINCIPLE In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires the use of the purchase method of accounting for business combinations initiated after June 30, 2001. SFAS No. 142 addresses how intangible assets acquired outside of a business combination should be accounted for upon acquisition and how goodwill and other intangible assets should be accounted for after they have been initially recognized. SFAS No. 142 eliminates the amortization for goodwill and other intangible assets with indefinite lives. Other intangible assets with a finite life will be amortized over their useful life. Goodwill and other intangible assets with indefinite useful lives shall be tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset may be impaired. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. The Corporation's adoption of SFAS No. 142 on January 1, 2002 had no impact on the consolidated financial statements as of the date of adoption. 6 NOTE 3 - STOCK-BASED COMPENSATION The Company records expense relative to stock-based compensation using the "intrinsic value method". Since the exercise price is equal to the fair value of the Company's common stock on the date of the award, the intrinsic value of the Company's stock options is "zero" at the time of the award and no expense is recorded. As permitted by generally accepted accounting principles, the Company has not adopted the "fair value method" of expense recognition for stock-based compensation awards. Rather, the effects of the fair value method on the Company's earnings are presented on a pro forma basis. Because no grants of stock options were made during the three months and nine months ended September 30, 2003, there was no pro forma impact to net income or earnings per share during these periods. However, there were grants of 4,614 stock options (with an exercise price of $17.65 per share) during the quarter ended June 30, 2002. Had compensation cost for the option grants been determined in accordance with the "fair value method", net income would have decreased approximately $9,228 during the nine months ended September 30, 2002, and reduced earnings per share by less than $.01 per share. 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 at prices not less than the fair market value of the shares at the date of the grant. These options expire 10 years after the grant date. As of September 30, 2003, 26,892 options outstanding were eligible to be exercised at a weighted average exercise price of $16.80 per share. No additional shares of common stock remain reserved for future grants under the option plan approved by the shareholders. NOTE 4 - EARNINGS PER SHARE Basic earnings per share of common stock are based on the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted average number of shares adjusted for the dilutive effect of outstanding stock options. Presented below are the calculations for basic and diluted earnings per share:
Three months ended Nine months ended (dollars in thousands, except per share data) September 30, September 30, (unaudited) 2003 2002 2003 2002 Net income $ 1,235 $ 1,051 $ 3,516 $ 3,033 Weighted average shares outstanding 1,651,265 1,672,836 1,659,326 1,676,942 Effect of dilutive stock options outstanding 13,353 4,712 11,892 3,108 Diluted weighted average shares outstanding 1,664,618 1,677,548 1,671,218 1,680,050 Basic earnings per share $ 0.75 $ 0.63 $ 2.12 $ 1.81 Diluted earnings per share $ 0.74 $ 0.63 $ 2.10 $ 1.81
7 NOTE 5 - COMPREHENSIVE INCOME Generally accepted accounting principles require comprehensive income and its components, as recognized under the accounting standards, to be displayed in a financial statement with the same prominence as other financial statements. The disclosure requirements with respect to the Form 10-Q have been included in the Company's consolidated statement of changes in stockholders' equity. Comprehensive income totaled the following for the periods indicated:
Three months ended Nine months ended September 30, September 30, (dollars in thousands - unaudited) 2003 2002 2003 2002 Net income $ 1,235 $ 1,051 $ 3,516 $ 3,033 Unrealized loss on securities available for sale, net of tax (602) (187) (427) 244 Reclassification adjustment for security 12 12 loss included in net income, net of tax Comprehensive income $ 645 $ 864 $ 3,101 $ 3,277
NOTE 6 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES Loans receivable are stated at unpaid principal balances plus net deferred loan origination costs less loans in process and the allowance for loan losses. 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 amortized to income over the contractual life of the underlying loan. 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 that 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 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 8 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 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 the Company 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 homogenous loans, such as residential mortgage and consumer loans, are collectively evaluated for impairment. Specific allowances are based on discounted cash flows of expected future payments using the loans' initial effective interest rate or the fair value of collateral if the loan is collateral dependent. In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require the subsidiary Bank 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. 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 and are carried as "Loans held for sale" on the balance sheet. 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. NOTE 7 - FORECLOSED REAL ESTATE Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and 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 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 real estate. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis is presented to assist in the understanding and evaluation of the Company's financial condition and results of operations. It is intended to complement the unaudited financial statements, footnotes, and supplemental financial data appearing elsewhere in this Form 10-Q and should be read in conjunction therewith. Dollar amounts are in thousands, except per share amounts. Forward-looking statements have been made in this document that are subject to risks and uncertainties. While the Company believes these forward-looking statements are based on reasonable assumptions, all such statements involve risk and uncertainties that could cause actual results to differ materially from those contemplated in this report. The assumptions, risks, and uncertainties relating to the forward-looking statements in this report include those described under the caption "Cautionary Statements Regarding Forward- Looking Information" in Part I of the Company's Form 10-K for the year ended December 31, 2002 and, from time to time, in the Company's other filings with the Securities and Exchange Commission. BALANCE SHEET At September 30, 2003, total assets were $397,018, an increase of $36,713, or 10.2%, over September 30, 2002. Gross loans (including loans held for sale and unamortized direct loan origination costs) were $301,526 at September 30, 2003, growing $45,846 over September 30, 2002 for an increase of 17.9%. Book value of investment securities was $69,988 at September 30, 2003, a decrease of $5,685 or 7.5% from September 30, 2002. The decline in securities was due primarily to prepayments of principal on mortgage-backed securities prompted by historically low long-term mortgage rates seen during the second quarter of 2003. Asset growth since September 30, 2002 was funded by an increase in deposits of $21,513, or 7.5%, an increase in other short-term borrowings of $6,969, or 298.3%, and an additional FHLB advance of $5 million, or 13.2%.
Table 1: Period-End Loan Composition September 30, September 30, December 31, 2002 Dollars Dollars Percentage of total Percentage (dollars in thousands) 2003 2002 2003 2002 Dollars of total Commercial, industrial and agricultural $ 70,928 $ 66,463 23.5% 26.0% $ 64,529 24.8% Commercial real estate mortgage 140,266 106,902 46.5% 41.7% 114,982 44.2% Residential real estate mortgage 73,291 64,823 24.3% 25.4% 61,948 23.8% Residential real estate loans held for sale 179 - 0.1% 0.0% 949 0.4% Consumer home equity 8,637 6,601 2.9% 2.6% 7,274 2.8% Consumer and installment 8,225 10,891 2.7% 4.3% 10,440 4.0% Totals $ 301,526 $ 255,680 100.0% 100.0% $ 260,122 100.0%
10 The amount of residential real estate mortgages held increased from the year earlier period and prior quarter by a substantial amount, but continues to reflect a lower percentage of the total loan portfolio. The increase in residential mortgages during 2003 is from the Company 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 backed investment securities during this period. This program was discontinued during August 2003 and all 15 year fixed rate mortgage loans originated by the Company are currently sold to other investors on the secondary market to eliminate the associated interest rate risk. As the Company reallocated resources to handle demand for residential real estate loans prompted by historically low interest rates, it experienced substantial repayments of consumer retail installment loans that were not replaced. In its markets, the Company faces substantial competition from credit unions and other financial institutions for retail installment lending such as auto loans. The Company renewed efforts during 2003 to retain some market share in consumer lending by educating a wider range of bank staff eligible to originate consumer loans and changing the primary delivery channel from traditional loan officers to personal bankers and other retail customer contact staff. Home equity loans are actively promoted to high quality individual borrowers with low interest rates as compared to local competitors. During 2003, commercial real estate mortgages increased primarily from new commercial construction and financing owner occupied commercial retail buildings, factories, and warehouses. Non-real estate commercial and industrial loans have experienced a shift in which personal property and equipment secured loans have declined while cash flow business lines of credit have increased. The loan portfolio is the Company's primary asset subject to credit risk. The Company's process for monitoring credit risks includes weekly analysis of loan quality, delinquencies, non-performing assets, and potential problem loans. Loans are placed on a nonaccrual status when they become contractually past due 90 days or more as to interest or principal payments. All interest accrued but not collected for loans (including applicable impaired loans) that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash basis until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due have been collected and there is reasonable assurance that repayment according to the contractual terms will continue. The aggregate amount of nonperforming assets decreased $1,280 to $3,455 at September 30, 2003 from $4,735 at September 30, 2002, primarily because of fewer loans on nonaccrual status. However, nonperforming assets have increased $449 from $3,006 at December 31, 2002. Total 11 nonperforming assets as a percentage of total assets continues to be favorable with .87% and .81% at September 30, 2003 and December 31, 2002, respectively. The Company ceases to accrue interest on loans which are 90 days past due and considers them nonperforming loans until the borrower has made up any late payments and is able to continue required payments in the future. Nonperforming loans also include restructured loans until 6 consecutive monthly payments are received under the new loan terms. The Company continues to aggressively manage past due customers and lowered the level of nonperforming loans to gross loans from 1.74% at September 2002 to 1.09% at September 2003. The Company also tracks delinquencies on a contractual basis quarter to quarter. Loans contractually delinquent 30 days or more as a percentage of gross loans were 1.02% at September 2003 compared to .87% at December 2002 and 1.24% at September 2002. The allowance for loan losses was 1.23% of gross loans at September 2003 compared to 1.33% at September 2002. Management reviews the activity in individual identified problem loans weekly and adjusts for the adequacy of loan loss reserves quarterly. At September 30, 2002 nonaccrual loans included $587 of loan principal to a borrower secured by non real-estate commercial collateral. During September 2002, the Company was notified of the borrower's bankruptcy. The Bank was not the lead lender in the commercial relationship, and due to inadequate collateral protection, an additional $270 of loan loss provisions were recorded during the quarter ended September 30, 2002 to cover estimated principal losses not specifically identified and reserved previously. During October 2002, a charge-off of $376 was authorized and recorded. The remaining principal balance on this relationship was fully reserved in the allowance for loan losses from provisions made prior to September 30, 2002.
Table 2: Allowance for Loan Losses Three months ended Nine months ended September 30, September 30, (dollars in thousands) 2003 2002 2003 2002 Allowance for loan losses at beginning $ 3,517 $ 3,254 $ 3,158 $ 2,969 Provision for loan losses 240 450 705 810 Recoveries on loans previously charged-off 13 11 35 59 (78) (321) (206) (444) Loans charged off Allowance for loan losses at end $ 3,692 $ 3,394 $ 3,692 $ 3,394
Nonperforming assets include: 1) loans that are either contractually past due 90 days or more as to interest or principal payments, on a nonaccrual status, or the terms of which have been 12 renegotiated to provide a reduction or deferral of interest or principal (restructured loans) and 2) foreclosed assets.
Table 3: Nonperforming Assets Sept. 30, Dec. 31, (dollars in thousands) 2003 2002 2002 Nonaccrual loans $ 2,775 $ 3,784 $ 1,786 Accruing loans past due 90 days or more 7 - - Restructured loans not on nonaccrual 490 655 647 Total nonperforming loans 3,272 4,439 2,433 Foreclosed assets 183 296 573 Total nonperforming assets $ 3,455 $ 4,735 $ 3,006 Nonperforming loans as a % of gross loans receivable 1.09% 1.74% 0.94% Total nonperforming assets as a % of total Assets 0.87% 1.31% 0.81%
LIQUIDITY Liquidity refers to the ability of the Company to generate adequate amounts of cash to meet the Company's need for cash at a reasonable cost. The Company manages its liquidity to provide adequate funds to support borrowing needs 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. Deposit growth is the primary source of funding. Retail core and time deposits as a percentage of total funding sources were 72.0% at September 30, 2003, and 75.2% at September 30, 2002. Wholesale funding and broker and national certificates of deposit represent the balance of the Company's total funding needs. Company use of brokered jumbo deposits has increased since September 2002 and accounted for 2.2% of the decline in retail deposits as a percentage of total funding sources. 13
Table 4: Period-end Deposit Composition September 30, 2003 2002 (dollars in thousands) $ % $ % Non-interest bearing demand $ 46,700 15.1% $ 43,316 15.0% Interest-bearing demand and savings 45,257 14.6% 32,848 11.4% Money market deposits 70,747 22.8% 74,119 25.6% Retail time deposits less than $100 59,180 19.0% 60,656 21.0% Retail time deposits $100 and over 39,968 12.9% 37,424 13.0% Broker & national time deposits less than $100 11,011 3.6% 12,946 4.5% Broker & national time deposits $100 and over 37,242 12.0% 27,283 9.5% Totals $ 310,105 100.0% $ 288,592 100.0%
The interest rate paid on money market deposits is adjustable based on the Company's discretion but generally tracks the movements of national money market funds. As short-term interest rates have decreased during 2002 and 2003, the yield on this account has declined substantially. Deposits due to investors as part of the Company's secondary market loan servicing activities included in total non-interest bearing deposits was approximately $2.4 million at September 30, 2003 compared to $4.5 million at September 30, 2002. As a source of low cost long-term deposits and in connection with a new full service retail location in Rhinelander, Wisconsin, the Company is aggressively seeking commercial non-interest bearing deposits as well as consumer core deposits.
Table 5: Summary of Changes by Significant Deposit Source September 30, Change from prior year (dollars in thousands) 2003 2002 $ % Total time deposits $100 and over $ 77,210 $ 64,707 $ 12,503 19.3% Total broker and national time deposits 48,253 40,229 8,024 19.9% Total retail time deposits 99,148 98,080 1,068 1.1% Core deposits, including money market Deposits 162,704 150,283 12,421 8.3%
The Company's retail deposit offices are in locations that demand consumer retail deposit rates generally greater than national rates for equivalent certificate of deposit terms. To fund larger commercial loan originations or acquire other large blocks of funding, the Company actively 14 purchases broker and other national time deposits. The Company actively manages such deposits to control the potential volatility of such funds while lowering overall deposit borrowing costs. Consequently, broker and national deposits increased substantially over the prior year, while local retail deposits have shown modest growth in comparison. Company policy is to limit broker and national time deposits to 20% of total assets. As of September 30, 2003 broker and national time deposits were 12.2% of total assets. Unused credit advances from the Federal Home Loan Bank of Chicago available to the Company at September 30, 2003 totaled approximately $34 million based on an open line of credit and securities available for pledging for advances. In addition, the Company had unused commitments from other correspondent banks for federal funds purchased up to $19.9 million. The primary alternative funding sources utilized are Federal Home Loan Bank advances, federal funds purchased, repurchase agreements from a base of individuals, businesses and public entities, and brokered time deposits. The Company believes its current liquidity position and sources of funds for liquidity management is adequate. Table 6 below presents maturity repricing information as of September 30, 2003. The following repricing methodologies should be noted: 1. Money market deposit accounts are considered fully repriced within 90 days. NOW and savings accounts 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. 4. Impact of rising or falling interest rates is based on a parallel yield curve change that is fully implemented within a 12 month time horizon. 15
Table 6: Interest Rate Sensitivity Gap Analysis September 30, 2003 (dollars in thousands) 0-90 Days 91-180 days 181-365 days 1-2 yrs. Bynd 2-5 yrs. Beyond 5 yrs. Total Earning assets: Loans $ 110,354 $ 21,297 $ 42,432 $ 51,038 $ 61,331 $ 15,074 $ 301,526 Securities 3,780 4,658 9,004 18,126 18,067 16,353 69,988 FHLB stock 2,402 - - - - - 2,402 Other earning assets 4,669 - - - - - 4,669 Total $ 121,205 $ 25,955 $ 51,436 $ 69,164 $ 79,398 $ 31,427 $ 378,585 Cumulative rate sensitive assets $ 121,205 $ 147,160 $ 198,596 $ 267,760 $ 347,158 $ 378,585 Interest-bearing liabilities Interest-bearing $ 91,698 $ 17,351 $ 48,178 $ 22,974 $ 33,691 $ 49,513 $ 263,405 deposits FHLB advances 16,000 - - 19,000 8,000 - 43,000 Other borrowings 2,907 1,644 3,728 - 2,204 - 10,483 Total $ 110,605 $ 18,995 $ 51,906 $ 41,974 $ 43,895 $ 49,513 $ 316,888 Cumulative interest sensitive liabilities $ 110,605 $ 129,600 $ 181,506 $ 223,480 $ 267,375 $ 316,888 Interest sensitivity gap for the individual period $ 10,600 $ 6,960 $ (470) $ 27,190 $ 35,503 $ (18,086) Ratio of rate sensitive assets to rate sensitive liabilities for the individual period 109.6% 136.6% 99.1% 164.8% 180.9% 63.5% Cumulative interest sensitivity gap $ 10,600 $ 17,560 $ 17,090 $ 44,280 $ 79,783 $ 61,697 Cumulative ratio of rate sensitive assets to rate sensitive 109.6 113.5% 109.4% 119.8% 129.8% 119.5% liabilities
If interest rates rose 200 basis points or fell 100 basis points, the 365 day cumulative ratio of rate sensitive assets to rate sensitive liabilities would change from 109.4% to 103.7% (if up 200 basis points) and 113.3% (if down 100 basis points), respectively. The Asset/Liability Committee uses financial modeling techniques that measure the interest rate risk. Policies established by the Bank's Asset/Liability Committee 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. The Company also uses various policy measures to assess adequacy of the Company's liquidity and interest rate risk as described below. 16 Basic Surplus The Company 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 and therefore are not guaranteed contractual funds. The Company's basic surplus, including available open line of credit FHLB advances not yet utilized at September 30, 2003 and 2002 was 7.4% and 14.0%, respectively and above the 5% minimum required by policy. Interest Rate Risk Limits The Company 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, the Company models interest rate simulations on a quarterly basis. Company 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. At September 30, 2003, net interest income for the next 12 months was projected to increase 1.64% if rates increased 200 basis points, and was projected to decrease 1.55% if rates decreased 100 basis points, which is less than the 15% required by policy and was considered acceptable by management. At September 30, 2002, net interest income for the next 12 months was projected to decrease 1.88% if rates increased 200 basis points, and was projected to decrease 1.75% if rates decreased 100 basis points. 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 money market accounts) are also considered core long-term funding sources. The core funding utilization ratio is defined as assets with a maturity in excess of 60 months divided by core funding. The Company'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. At September 30, 2003, the Company's core funding utilization ratio was projected to be 44.6% if rates increased 200 basis points and was therefore within policy requirements. At September 30, 2002, the Company's core funding utilization ratio was projected to be 42.0% if rates increased 200 basis points. CAPITAL RESOURCES Stockholders' equity at September 30, 2003 increased $3,310 to $31,400, or 11.8% from $28,090 at September 30, 2002. Stockholders' equity included unrealized gains on securities available for sale, net of their tax effect, of $891 at September 30, 2003 compared to unrealized gains of $735 at September 30, 2002. 17 The adequacy of the Company's capital is regularly reviewed to ensure sufficient capital is available for current and future needs and is in compliance with regulatory guidelines. As of September 30, 2003, and 2002, the Subsidiary Bank's Tier 1 risk-based capital ratio, total risk-based capital, and Tier 1 leverage ratio were well in excess of regulatory minimums and were classified as "well-capitalized". Management expects the Company to remain well-capitalized during the remainder of 2003 based on planned asset growth. The Company maintains an annual, ongoing share repurchase program of up to 1% of outstanding shares per year. During the quarter ended September 30, 2003, the Company completed the annual repurchase program and repurchased 400 shares at an average price of $34.00 per share. For all of 2003, 16,700 shares were repurchased at an average price of $33.10 per share. For the remainder of 2003, management anticipates retaining capital to support asset growth while continuing a cash dividend to shareholders. Effective with the $.30 dividend declared June 17, 2003, the Company intends to equalize the amounts of the semi-annual cash dividends. Accordingly, under the dividend policy, the Company expects that the dividend to be paid in January, 2004 may be less than the January 2003 dividend, but that the total dividends to be paid in July 2003 and January 2004 will exceed the $.565 per share total dividends paid in July 2002 and January 2003. The Company also reaffirmed its goal of increasing its shareholder dividend on an annual basis subject to operating results and financial condition of the Company.
Table 7: Capital Ratios - Consolidated Holding Company September 30, Dec 31. 2003 2002 2002 Tier 1 capital to period end tangible assets (leverage ratio) 7.68% 7.59% 7.55% Tier 1 capital to adjusted risk-weighted assets 9.79% 10.33% 10.25% Total capital to adjusted risk-weighted assets 10.97% 11.58% 11.41%
On November 19, 2002, the Company's shareholders approved an increase in authorized shares from 1,000,000 to 3,000,000, allowing the Board of Directors to effect a 2 for 1 stock split paid on December 2, 2002. All references in the accompanying financial statements and statistical analysis to the number of common shares and per share amounts for 2002 have been restated to reflect the split. PREMISES AND EQUIPMENT The Company announced during July 2003 the construction of a new bank and financial services office and administrative headquarters located on property adjacent to the existing Wausau, Wisconsin, main office location. Construction of the 32,000 square foot office and drive-through canopy began during August with completion anticipated by the end of the second quarter 2004. The existing Wausau main office which has been used since the Bank opened in 1962 and as most recently expanded during 1992 will be razed. Building project costs including necessary 18 furniture, fixtures, and equipment are estimated to be $4.4 million. Annual depreciation expense after this investment in fixed assets and equipment is estimated to increase $165 ($100 after income tax benefits). As of November 6, 2003, approximately $749 had been spent on the project ($451 was spent by September 30, 2003). The amount of interest capitalized as project costs by September 30, 2003 was insignificant. RESULTS OF OPERATIONS Net income for the quarter ended September 30, 2003 totaled $1,235, or $.75 for basic earnings per share, and $.74 for diluted earnings per share. Comparatively, net income for the quarter ended September 30, 2002 was $1,051, or $.63 per share for basic and diluted earnings per share. Operating results for the third quarter 2003 generated an annualized return on average assets of 1.26% and an annualized return on average equity of 15.76%, compared to 1.17% and 15.00% for the comparable period in 2002. The following Table 8 presents consolidated quarterly summary financial data of PSB Holdings, Inc. and Subsidiary. 19
Table 8: Financial Summary (dollars in thousands, except per share data) Quarter ended Sept. 30, June 30, March 31, Dec. 31, Sept. 30, EARNINGS AND DIVIDENDS: 2003 2003 2003 2002 2002 Net interest income $ 3,306 $ 3,268 $ 3,232 $ 3,288 $ 3,256 Provision for loan losses $ 240 $ 240 $ 225 $ 300 $ 450 Other noninterest income $ 1,143 $ 726 $ 1,122 $ 1,040 $ 841 Other noninterest expense $ 2,335 $ 2,220 $ 2,317 $ 2,072 $ 2,097 Net income $ 1,235 $ 1,057 $ 1,224 $ 1,332 $ 1,051 Basic earnings per share $ 0.75 $ 0.64 $ 0.73 $ 0.80 $ 0.63 Diluted earnings per share $ 0.74 $ 0.63 $ 0.73 $ 0.80 $ 0.63 Dividends declared per share $ - $ 0.300 $ - $ 0.375 $ - Net book value per share $ 19.02 $ 18.63 $ 18.24 $ 17.59 $ 16.83 Dividend payout ratio 0.00% 46.88% 0.00% 46.88% 0.00% Average common shares outstanding 1,651,265 1,661,142 1,665,729 1,667,341 1,672,836 BALANCE SHEET - AVERAGE BALANCES: Loans receivable, net of allowances for loss $ 288,448 $ 265,863 $ 256,715 $ 255,591 $ 249,691 Assets $ 389,267 $ 371,537 $ 365,906 $ 363,507 $ 355,224 Deposits $ 307,752 $ 292,698 $ 289,635 $ 291,049 $ 283,889 Stockholders' equity $ 31,085 $ 30,670 $ 29,848 $ 28,677 $ 27,792 PERFORMANCE RATIOS: Return on average assets (1) 1.26% 1.14% 1.36% 1.45% 1.17% Return on average stockholders' equity (1) 15.76% 13.82% 16.63% 18.43% 15.00% Average tangible stockholders' equity to average assets 7.70% 7.92% 7.84% 7.71% 7.61% Net loan charge-offs to average loans 0.02% 0.01% 0.03% 0.21% 0.12% Nonperorming loans to gross loans 1.09% 1.06% 1.13% 0.94% 1.74% Allowance for loan losses to gross loans 1.23% 1.26% 1.28% 1.22% 1.33% Net interest rate margin (1)(2) 3.67% 3.83% 3.89% 3.89% 3.95% Net interest rate spread (1)(2) 3.21% 3.34% 3.42% 3.36% 3.43% Service fee revenue as a percent of average demand deposits (1) 2.48% 2.83% 2.99% 2.98% 3.41% Noninterest income as a percent of gross revenue 17.90% 12.13% 17.49% 15.81% 13.05% Efficiency ratio (2) 50.94% 53.86% 51.67% 46.42% 49.52% Noninterest expenses to average assets (1) 2.38% 2.40% 2.57% 2.26% 2.34% STOCK PRICE INFORMATION: High $ 34.24 $ 34.00 $ 27.25 $ 25.00 $ 21.05 Low $ 33.00 $ 30.00 $ 23.75 $ 20.55 $ 19.18 Market value at quarter-end $ 33.50 $ 33.25 $ 27.25 $ 25.00 $ 20.58 (1) Annualized (2) The yield on tax-exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%.
20 NET INTEREST INCOME Net interest income is the most significant component of earnings. Tax adjusted net interest income increased $47 from $3,394 for the quarter ended September 30, 2002 to $3,441 for the current quarter ended September 30, 2003. For the comparable 9-month periods ending September 30, 2003 and 2002, tax adjusted net interest income increased $437, comprised of an increased $1,213 from additional asset volume, but decreased $776 due to declining net interest margin. Quarterly tax-adjusted net interest margin as a percent of average interest earning assets decreased from 3.95 % in September 2002 to 3.67 % in September 2003. Net interest margin was 3.95 % for the year ended December 31, 2002. During 2002, the Company benefited from a falling interest rate environment as deposits and short-term borrowings repriced faster at lower rates than loans with longer terms and maturities. However, the prolonged low interest rate environment through September 30, 2003 has put more pressure on loan and asset yields than on already low cost of funds. In addition, the Company has positioned itself for an eventual increase in interest rates by extending maturities of certain liabilities at a higher cost. The Company continues to be asset sensitive as seen in Table 6 with a 365 day cumulative ratio of rate sensitive assets to rate sensitive liabilities of 109.4%. In the near term, the Company expects net interest margin to stabilize as loan and security assets have received the majority of anticipated prepayments due to declining interest rates. In addition, the Company expects the prime to remain the same in the near term. Quarterly yield on earning assets decreased 95 basis points to 5.73% compared to 6.68% at September 30, 2002. Similarly, the costs for interest-bearing liabilities decreased 73 basis points to 2.52% from 3.25% at September 30, 2002. Management believes short-term term interest rates to be at the bottom of the current interest rate cycle. In addition, long-term interest rates are expected to increase modestly as the national economy improves growth prospects. Management believes it is well positioned for future rate increases, as well as continued stable rate environments relative to competitors. Refer to the previous discussion on management of net interest margin and the liquidity for the Company's strategies and positions in this area. 21
Table 9A: Net Interest Income Analysis (Quarter) (dollars in thousands) Quarter ended Sept. 30, 2003 Quarter ended Sept. 30, 2002 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Assets Interest-earning assets: Loans (1)(2) $ 292,023 $ 4,609 6.26% $ 252,879 $ 4,650 7.30% Taxable securities 48,500 359 2.94% 50,678 665 5.21% Tax-exempt securities (2) 22,744 352 6.14% 20,431 338 6.56% FHLB stock 2,391 38 6.31% 2,234 27 4.79% Other 6,457 18 1.11% 14,698 59 1.59% Total (2) 372,115 5,376 5.73% 340,920 5,739 6.68% Non-interest-earning assets: Cash and due from banks 11,439 8,529 Premises and equipment, net 6,302 5,692 Other assets 2,986 3,271 Allowance for loan losses (3,575) (3,188) Total $ 389,267 $ 355,224 Liabilities & stockholders' equity Interest-bearing liabilities: Savings and demand deposits $ 42,589 $ 63 0.59% $ 34,110 $ 88 1.02% Money market deposits 69,230 161 0.92% 72,555 267 1.46% Time deposits 144,298 1,144 3.15% 138,413 1,378 3.95% FHLB borrowings 38,707 506 5.19% 38,000 577 6.02% Other borrowings 9,684 61 2.50% 3,363 35 4.13% Total 304,508 1,935 2.52% 286,441 2,345 3.25% Non-interest-bearing liabilities: Demand deposits 51,635 38,811 Other liabilities 2,039 2,180 Stockholders' equity 31,085 27,792 Total $ 389,267 $ 355,224 Net interest income 3,441 3,394 Rate spread 3.21% 3.43% Net yield on interest-earning assets 3.67% 3.95% (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%.
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Table 9B: Net Interest Income Analysis (YTD) (dollars in thousands) Nine months ended Sept 30, 2003 Nine months ended Sept. 30, 2002 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Assets Interest-earning assets: Loans (1)(2) $ 273,854 $ 13,509 6.60% $ 246,040 $ 13,525 7.35% Taxable securities 53,871 1,475 3.66% 49,901 2,033 5.45% Tax-exempt securities (2) 22,003 1,024 6.22% 20,400 1,021 6.69% FHLB stock 2,345 111 6.33% 2,204 81 4.91% Other 7,424 64 1.15% 9,893 122 1.65% Total (2) 359,497 16,183 6.02% 328,438 16,782 6.83% Non-interest-earning assets: Cash and due from banks 10,200 9,023 Premises and equipment, Net 6,229 5,226 Other assets 3,125 3,231 Allowance for loan Losses (3,396) (3,140) Total $ 375,655 $ 342,778 Liabilities & stockholders' equity Interest-bearing liabilities: Savings and demand Deposits $ 39,255 $ 182 0.62% $ 32,018 $ 267 1.11% Money market deposits 68,449 520 1.02% 73,312 818 1.49% Time deposits 142,783 3,610 3.38% 130,834 4,110 4.20% FHLB borrowings 38,238 1,520 5.31% 38,000 1,712 6.02% Other borrowings 7,823 154 2.63% 3,521 115 4.37% Total 296,548 5,986 2.70% 277,685 7,022 3.38% Non-interest-bearing liabilities: Demand deposits 46,307 36,178 Other liabilities 2,265 2,009 Stockholders' equity 30,535 26,906 Total $ 375,655 $ 342,778 Net interest income 10,197 9,760 Rate spread 3.32% 3.45% Net yield on interest-earning assets 3.79% 3.97% (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%.
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Table 10: Interest Expense and Expense Volume and Rate Analysis Nine months ended September 30, 2003 2003 compared to 2002 increase (decrease) due to (1) (dollars in thousands) Volume Rate Net Interest earned on: Loans (2) $ 1,529 $ (1,545) $ (16) Taxable securities 162 (720) (558) Tax-exempt securities (2) 80 (77) 3 FHLB stock 5 25 30 Other interest income (30) (28) (58) Total 1,746 (2,345) (599) Interest paid on: Savings and demand deposits 60 (145) (85) Money market deposits (54) (244) (298) Time deposits 375 (875) (500) FHLB borrowings 11 (203) (192) Other borrowings 141 (102) 39 Total 533 (1,569) (1,036) Net interest earnings $ 1,213 $ (776) $ 437 (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.
PROVISION FOR LOAN LOSSES Management determines the adequacy of the provision for loan losses based on past loan experience, current economic conditions, and composition of the loan portfolio. Accordingly, the amount charged to expense is based on management's evaluation of the loan portfolio. It is the Company's policy that when available information confirms that specific loans and leases, or portions thereof, including impaired loans, are uncollectible, these amounts are promptly charged off against the allowance. The provision for loan losses was $240 for the three months ended September 30, 2003, and $450 for the three months ended September 30, 2002. Net charge-offs as a percentage of average loans outstanding were .02% and .12% during the three months ended September 30, 2003 and 2002, respectively. Refer to the discussion of a large problem loan relationship at September 2002 under the Balance Sheet discussion following Table 1: Period-End Loan Composition. 24 Nonperforming loans are reviewed to determine exposure for potential loss within each loan category. The adequacy of the allowance for loan losses is assessed based on credit quality and other pertinent loan portfolio information. The adequacy of the allowance and the provision for loan losses is consistent with the composition of the loan portfolio and recent credit quality history. NONINTEREST INCOME Noninterest income grew $302 in the third quarter 2003 to $1,143 compared to $841 in 2002. Virtually all of this growth ($328) was from an increase of income from the sale of long-term fixed rate mortgage loans, net of servicing right amortization and provision for impairment. The majority of loans sold to outside investors continue to be serviced by the Bank directly with the customer. Gain on sale and servicing of such loans during the quarter was $655 in September 2003 compared to $327 during September 2002. For the nine months ended September 30, gain on sale and servicing fixed rate mortgages was $1,499 and $678 in 2003 and 2002, respectively. During June 2003, additional expense from a change in accounting estimate related to accounting for mortgage servicing rights of $236 was recorded which reduced second quarter diluted earnings by approximately $.09 per share. Through September 30, 2003, the gain on sale and servicing of loans is more than double the prior year's activity through September 30, 2002, and has substantially enhanced income as interest margins declined during 2003. Management does not expect the current level of mortgage refinancing income to continue during the fourth quarter 2003. The Company intends to replace this fee income with ongoing servicing fees of the existing mortgage portfolio and additional investment and insurance sales income. During 2003, the Bank increased the number of commissioned investment sales professionals on staff. Investment and insurance sales commissions were $303 during the nine months ended September 2003 compared to $189 in the same period ended September 2002. On September 3, 2003, the Company announced formation of Peoples Insurance Services LLC, a commercial property and casualty insurance agency and brokerage. The Company believes the commercial insurance products are a good fit with the existing commercial loan customer base in addition to opportunities available with non-customers in the local market area. Mr. Jeff Cole has been named President of Peoples Insurance Services and brings experience in pricing insurance products in addition to experience in managing and selling such insurance products. At September 30, 2003, the Company serviced $148,738 of loans for outside investors compared to $64,780 serviced at September 30, 2002. The following table summarizes the activity in mortgage servicing rights for the nine-month period ended September 30, 2003. The valuation allowance was recorded to recognize impairment of the mortgage servicing right asset due to declines in interest rates that may cause borrowers to prepay mortgage principal much faster than estimated at the time the mortgage was originated. 25
Table 11: Mortgage Servicing Rights Activity Nine months ended September 30, 2003 Originated Valuation (dollars in thousands) MSR Allowance Total January 1, 2003 $ 812 $ (115) $ 697 Originated servicing 714 714 Amortization charged to earnings (634) (634) Valuation adjustment charged to earnings (28) (28) September 30, 2003 $ 892 $ (143) $ 749
As a FHLB Mortgage Partnership Finance loan servicer, the Company 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 on an aggregate pool basis. At September 30, 2003, the maximum Company obligation on the entire servicing portfolio for such guarantees would be approximately $493 (.33% of the serviced principal). Due to historical strength of mortgage borrowers in our markets, the original 1% of principal loss pool provided by the FHLB, and current economic conditions, management believes the possibility of losses under guarantees to the FHLB to be remote. Accordingly, no provision for a recourse liability has been made for this recourse obligation on loans currently serviced by the Company. NONINTEREST EXPENSE Noninterest operating expenses increased $238 to $2,335 in September 2003 compared to $2,097 during September 2002, an increase of 11.3%. Increases in employee salaries and benefits totaled $188 during the quarter ended September 30, 2003 compared to the prior year quarter, as bank employees were granted inflationary and merit increases effective January 1, 2003 averaging 6.1%. In addition, the Company hired additional lenders in our Rhinelander market and investment and insurance sales representatives during 2003 that have had a significant impact. Operating expenses as a percent of average assets increased slightly to 2.38% during the third quarter September 2003 compared to 2.34% during September 2002. Year to date, additional operating costs have been offset by increased revenue, as the expense efficiency ratio improved to 52.11% for the nine months ended September 2003 compared to 52.30% in the prior year. 26 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There has been no material change in the information provided in response to Item 7A of the Company's Form 10-K for the year ended December 31, 2002. ITEM 4. INTERNAL CONTROLS AND PROCEDURES As of the end of the period covered by this report, management, under the supervision, and with the participation, of the Company's President and Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Rule 13a-15(c) 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 the Company's disclosure controls and procedures were effective in all material respects. There have been no significant changes in the Company's internal controls or in other factors which could significantly affect internal controls subsequent to the date the Company carried out its evaluation, nor were there any significant deficiencies or material weaknesses identified which required any corrective action to be taken. 27 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K: (a) Exhibits. Exhibits required by Item 601 of Regulation S-K. Exhibit Number Description 31.1 Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002 31.2 Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002 32.1 Certifications under Section 906 of Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K: Form 8-K dated September 3, 2003. The Company filed a current report on Form 8-K on September 3, 2003, to announce the commencement of commercial insurance sales through a wholly-owned subsidiary, Peoples Insurance Services LLC under Item 9. Form 8-K dated July 23, 2003. The Company filed a current report on Form 8-K on July 23, 2003, reporting earnings for the second quarter ended June 30, 2003, under Item 5 and additional related disclosure under Items 9 and 12. Form 8-K dated July 14, 2003. The Company filed a current report on Form 8-K on July 14, 2003, to announce the construction of a new regional financial services office and administrative headquarters under Item 9. 28 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PSB HOLDINGS, INC. November 12, 2003 SCOTT M. CATTANACH Scott M. Cattanach Treasurer (On behalf of the Registrant and as Principal Financial Officer) 29 EXHIBIT INDEX TO FORM 10-Q OF PSB HOLDINGS, INC. FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 PURSUANT TO SECTION 102(D) OF REGULATION S-T (17 C.F.R. Section 232.102(D)) The following exhibits are filed as part this report: 31.1 Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002 31.2 Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002 32.1 Certifications under Section 906 of Sarbanes-Oxley Act of 2002