10-Q 1 psb10q815.txt PSB FORM 10-Q - 6/30/05 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 JUNE 30, 2005 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 August 4, 2005 was 1,712,771. PSB HOLDINGS, INC. FORM 10-Q Quarter Ended June 30, 2005 Page No. PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets June 30, 2005 (unaudited) and December 31, 2004 (derived from audited financial statements) 1 Consolidated Statements of Income Three Months and Six Months Ended June 30, 2005 and 2004 (unaudited) 2 Consolidated Statement of Changes in Stockholders' Equity Six Months Ended June 30, 2005 (unaudited) 3 Consolidated Statements of Cash Flows Six Months Ended June 30, 2005 and 2004 (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 31 Item 4. Controls and Procedures 31 PART II. OTHER INFORMATION Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32 Item 4. Submission of Matters to a Vote of Security Holders 32 Item 6. Exhibits 33 i
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PSB HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS June 30, 2005 (unaudited), December 31, 2004 (derived from audited financial statements) (dollars in thousands, except per share data) June 30, December 31, 2005 2004 ASSETS Cash and due from banks $ 13,019 $ 12,680 Interest-bearing deposits and money market funds 2,633 3,265 Federal funds sold 2,610 7,379 Cash and cash equivalents 18,262 23,324 Securities available for sale (at fair value) 72,464 68,894 Federal Home Loan Bank stock (at cost) 2,953 2,874 Loans held for sale 610 342 Loans receivable, net of allowance for loan losses of $4,309 and $4,157, respectively 370,252 343,923 Accrued interest receivable 1,971 1,744 Foreclosed assets 229 7 Premises and equipment 12,622 12,432 Mortgage servicing rights, net 853 839 Cash surrender value of bank-owned life insurance 4,627 - Other assets 1,347 595 TOTAL ASSETS $486,230 $454,974 LIABILITIES Non-interest-bearing deposits $ 53,759 $ 51,635 Interest-bearing deposits 325,781 306,590 Total deposits 379,540 358,225 Federal Home Loan Bank advances 55,000 52,000 Other borrowings 5,879 8,565 Junior subordinated debentures 7,732 - Accrued expenses and other liabilities 3,363 2,568 Total liabilities 451,514 421,358 STOCKHOLDERS' EQUITY Common stock - no par value with a stated value of $1 per share: Authorized - 3,000,000 shares Issued - 1,887,179 shares 1,887 1,887 Additional paid-in capital 9,655 9,672 Retained earnings 26,960 25,281 Accumulated other comprehensive income (loss) 72 384 Treasury stock, at cost - 174,408 and 167,586 shares, respectively (3,858) (3,608) Total stockholders' equity 34,716 33,616 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $486,230 $454,974
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PSB HOLDINGS, INC. CONSOLIDATED STATEMENTS OF INCOME Three Months Ended Six Months Ended (dollars in thousands, June 30, June 30, except per share data - unaudited) 2005 2004 2005 2004 Interest and dividend income: Loans, including fees $ 5,581 $ 4,714 $10,784 $ 9,268 Securities: Taxable 467 453 919 914 Tax-exempt 237 245 478 488 Other interest and dividends 55 46 123 92 Total interest and dividend income 6,340 5,458 12,304 10,762 Interest expense: Deposits 2,141 1,360 3,952 2,651 FHLB advances 507 504 1,057 970 Other borrowings 106 77 189 150 Junior subordinated debentures 4 - 4 - Total interest expense 2,758 1,941 5,202 3,771 Net interest income 3,582 3,517 7,102 6,991 Provision for loan losses 30 240 180 480 Net interest income after provision for loan losses 3,552 3,277 6,922 6,511 Noninterest income: Service fees 324 322 584 613 Mortgage banking 249 308 404 468 Investment and insurance sales commissions 202 90 372 181 Net gain on sale of securities - - 6 111 Increase in cash surrender value of life insurance 46 - 66 - Other noninterest income 126 135 318 222 Total noninterest income 947 855 1,750 1,595 Noninterest expense: Salaries and employee benefits 1,641 1,547 3,270 3,095 Occupancy and facilities 427 361 872 662 Loss on abandonment of premises and equipment - 329 - 329 Data processing and other office operations 168 187 340 347 Advertising and promotion 95 64 158 98 Other noninterest expenses 449 426 780 985 Total noninterest expense 2,780 2,914 5,420 5,516 Income before provision for income taxes 1,719 1,218 3,252 2,590 Provision for income taxes 548 436 1,041 854 Net income $ 1,171 $ 782 $ 2,211 $ 1,736 Basic earnings per share $ 0.68 $ 0.45 $ 1.29 $ 1.00 Diluted earnings per share $ 0.68 $ 0.45 $ 1.28 $ 0.99
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PSB HOLDINGS, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY Six months ended June 30, 2005 - unaudited Accumulated Other Additional Comprehensive Common Paid-in Retained Income Treasury (dollars in thousands) Stock Capital Earnings (Loss) Stock Totals Balance January 1, 2005 $1,887 $9,672 $25,281 $384 $(3,608) $33,616 Comprehensive income: Net income 2,211 2,211 Unrealized loss on securities available for sale, net of tax (310) (310) Reclassification adjustment for security gain included in net income, net of tax (2) (2) Total comprehensive income 1,899 Purchase of treasury stock (318) (318) Proceeds from stock options issued out of treasury (17) 65 48 Distribution of treasury stock in settlement of liability to Company directors 3 3 Cash dividends declared $.31 per share (532) (532) Balance June 30, 2005 $1,887 $9,655 $26,960 $ 72 $(3,858) $34,716
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PSB HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Six months ended June 30, 2005 and 2004 - unaudited (dollars in thousands) 2005 2004 Cash flows from operating activities: Net income $ 2,211 $ 1,736 Adjustments to reconcile net income to net cash provided by operating activities: Provision for depreciation and net amortization 822 587 Provision for loan losses 180 480 Deferred net loan origination costs (276) - Gain on sale of mortgage loans (270) (433) Provision for servicing right valuation allowance 2 48 Loss on abandonment of premises and equipment - 329 Gain on sale of premises and equipment (2) - Gain on sale of foreclosed assets (2) (37) Gain on sale of securities (6) (111) Increase in cash surrender value of life insurance (66) - FHLB stock dividends (79) (77) Changes in operating assets and liabilities: Accrued interest receivable (227) (107) Other assets (330) (119) Other liabilities 798 (588) Net cash provided by operating activities 2,755 1,708 Cash flows from investing activities: Proceeds from sale and maturities of: Securities available for sale 6,582 6,688 Payment for purchase of: Securities available for sale (10,710) (7,005) Purchase of FHLB stock - (271) Net increase in loans (26,837) (20,962) Capital expenditures (661) (3,563) Proceeds from sale of premises and equipment 2 - Proceeds from sale of foreclosed assets 60 7 Purchase of bank-owned life insurance (4,561) - Net cash used in investing activities (36,125) (25,106) Cash flows from financing activities: Net increase (decrease) in non-interest-bearing deposits 2,124 (3,662) Net increase in interest-bearing deposits 19,191 27,524 Proceeds from long-term FHLB advances 17,000 10,000 Repayments of long-term FHLB advances (14,000) (10,000) Net increase (decrease) in other borrowings (2,686) (1,081) Proceeds from issuance of junior subordinated debentures 7,481 - Dividends declared (532) (518) Proceeds from issuance of stock options 48 - Purchase of treasury stock (318) (280) Net cash provided by financing activities 28,308 21,983 Net decrease in cash and cash equivalents (5,062) (1,415) Cash and cash equivalents at beginning 23,324 18,927 Cash and cash equivalents at end $ 18,262 $17,512
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CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Six months ended June 30, 2005 and 2004 - unaudited (dollars in thousands) 2005 2004 Supplemental cash flow information: Cash paid during the period for: Interest $ 5,019 $ 3,810 Income taxes 610 883 Noncash investing and financing activities: Loans charged off $ 34 $ 117 Loans transferred to foreclosed assets 281 - Loans originated on sale of foreclosed assets - 70 Distribution of treasury stock in settlement of liability to Company directors 3 8 Common stock of PSB Holdings Statutory Trust I acquired in exchange for junior subordinated debentures 232 -
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 ("PSB") 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. Any reference to "PSB" refers to the consolidated or individual operations of PSB Holdings, Inc. and its subsidiary Peoples State Bank. 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 PSB's 2004 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 assets, and the valuation of investment securities. NOTE 2 - STOCK-BASED COMPENSATION PSB records expense relative to stock-based compensation using the "intrinsic value method." Since the exercise price is equal to the fair value of PSB's common stock on the date of the award, the intrinsic value of PSB's stock options is "zero" at the time of the award and no expense is recorded. As permitted by generally accepted accounting principles, PSB has not adopted the "fair value method" of expense recognition for stock-based compensation awards. Rather, the effects of the fair value method on PSB's earnings are presented on a pro forma basis. Because no grants of stock options were made during the three months and six months ended June 30, 2005 and 2004, there was no pro forma impact to net income or earnings per share during these periods. 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 with the first options scheduled to expire beginning in the year 2011. As of June 30, 2005, 21,215 options outstanding were eligible to be exercised at a weighted average 6 exercise price of $16.06 per share. No additional shares of common stock remain reserved for future grants under the option plan approved by the shareholders. NOTE 3 - 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 Six months ended (dollars in thousands, except per share data - unaudited) June 30, June 30, 2005 2004 2005 2004 Net income $ 1,171 $ 782 $ 2,211 $ 1,736 Weighted average shares outstanding 1,714,134 1,729,322 1,717,577 1,731,426 Effect of dilutive stock options outstanding 10,235 15,310 10,399 15,221 Diluted weighted average shares outstanding 1,724,369 1,744,632 1,727,976 1,746,647 Basic earnings per share $ 0.68 $ 0.45 $ 1.29 $ 1.00 Diluted earnings per share $ 0.68 $ 0.45 $ 1.28 $ 0.99
NOTE 4 - COMPREHENSIVE INCOME Comprehensive income as defined by current accounting standards for the three months and six months ended June 30, 2005 and 2004 is as follows: Three months ended Six months ended June 30, June 30, (dollars in thousands - unaudited) 2005 2004 2005 2004 Net income $ 1,171 $ 782 $ 2,211 $ 1,736 Unrealized gain (loss) on securities available for sale, net of tax 266 (1,259) (310) (781) Reclassification adjustment for security gain included in net income, net of tax - - (2) (67) Comprehensive income (loss) $ 1,437 $ (477) $ 1,899 $ 888
NOTE 5 - 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 7 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 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 as defined by current accounting standards. 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 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 loan's 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 6 - 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 8 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. NOTE 7 - INCOME TAXES The Internal Revenue Service (IRS) has audited PSB's federal income tax returns for 1999 through 2002, and has disallowed a portion of People State Bank's interest deductions for such years. The IRS asserts that PSB owes an additional $182,000 of tax and interest (computed through August 15, 2005). The IRS's contention is that municipal bonds owned by the Bank's Nevada investment subsidiary should be treated as owned by the Bank for purposes of computing the Bank's allowable interest expense. The IRS has made the same adjustment for other Wisconsin banks that have Nevada investment subsidiaries. In August 2005, PSB filed a petition with the United State Tax Court contesting such adjustment. PSB believes all tax returns are correct as filed, and, at this time, no additional tax expense for this adjustment has been recorded. NOTE 8 - CONTINGENCIES In the normal course of business, PSB is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the consolidated financial statements. NOTE 9 - JUNIOR SUBORDINATED DEBENTURES PSB Holdings Statutory Trust I, a Delaware business trust wholly owned by PSB, completed the sale of $7,500,000 of Trust Preferred Securities to a pooling vehicle of other trust preferred securities whose shares were later sold to private investors (a pooled trust preferred offering). The Trust used the proceeds from the offering and the issuance of $232,000 of common stock ownership in the Trust to purchase $7,732,000 of PSB Junior Subordinated Debentures from PSB. The Trust Preferred Securities mature in 30 years and have an initial fixed rate of 5.82% until September 2010. Following September 2010, the rate is adjusted quarterly to the three month London Interbank Offered Rate (LIBOR) plus 1.70%. The Trust Preferred Securities may be called in part or in full on September 15, 2010, and quarterly thereafter, with 30 days notice. The Trust Preferred Securities are mandatorily redeemable upon the maturity of the Debentures on September 15, 2035 or upon earlier redemption. PSB has fully and unconditionally guaranteed all of the obligations of the Trust. The guarantee covers the quarterly distributions and payments on liquidation or redemption of the Trust Preferred Securities, but only to the extent of funds held by the Trust. The Trust Preferred Securities qualify under the risk-based capital guidelines as Tier 1 capital for regulatory purposes. PSB used the proceeds from the sales of the debentures for general corporate purposes and to support continued asset growth through funding qualifying as regulatory capital. 9 NOTE 10 - DERIVATIVE INSTRUMENT PSB uses an interest rate swap to manage its risk associated with fixed rate liability funding that is subject to changes in fair value. The contract has been designated and qualifies as a fair value hedge and is reported at fair value. The contract is deemed to be fully effective and, therefore, the change in fair value of the hedge is offset against the opposite change of fair value in the liability being hedged. At the inception of the contract, PSB has documented its risk management strategy and the hedge's effectiveness. PSB interest rate risk management strategy is to change fixed brokered time deposit interest payments to a floating rate payment to better match low-cost funding with recently originated adjustable rate commercial loans. Consistent with the classification of interest payments on the related debt, the cash settlements associated with the interest rate swap are presented as operating activities in the statement of cash flows. During April 2005, PSB entered into a $10,000,000 notional amount interest rate swap contract under which it pays interest at a floating rate equal to 30 day LIBOR less 2.5 basis points and receives fixed rate payments of 4.25%. The contract is considered to be a fully effective fair value hedge and therefore changes in the fair value of the interest rate swap directly offset changes to the fair value of the liability on the balance sheet. Interest expense reported on the statement on income is equal to the floating rate paid on the swap. Both the swap (by the swap counterparty) and the liability (by PSB) are callable in April 2006, with additional semi-annual call dates until final maturity in October 2008. The fair value liability of the swap at June 30, 2005 of $19,275 is included in other liabilities on the balance sheet. 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 PSB'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. The quarterly report on Form 10-Q describes the business of PSB Holdings, Inc. and its subsidiary Peoples State Bank as in effect on June 30, 2005, and any reference to "PSB" refers to the consolidated or individual operations of PSB Holdings, Inc. and Peoples State Bank. Forward-looking statements have been made in this document that are subject to risks and uncertainties. While PSB 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 PSB's Form 10-K for the year ended December 31, 2004 and, from time to time, in PSB's other filings with the Securities and Exchange Commission. 10 EXECUTIVE OVERVIEW This overview summarizes PSB's financial trends and the primary opportunities and challenges faced by management. It is intended to assist the reader in better understanding these trends and management's plan to address them. In addition, the near-term issues on which management is most focused are outlined in general terms as a backdrop for more detailed statistical and narrative analysis presented in this Quarterly Report on Form 10-Q. PSB earnings increased substantially during the three and six months ended June 30, 2005 compared to the prior year periods. The prior year quarter ended June 30, 2004 included a special charge of $199 after tax benefits as the prior home office building (located on the same property now used as a home office by PSB) was demolished. Even if this special charge is disregarded, earnings per share are up 21% for the quarter ended June 30, 2005 and up 16% for the six months ended June 30, 2005 compared to last year. Credit quality continues to improve as existing problem loans are reduced while PSB originates new high credit quality commercial loans to large local businesses. Recognizing this improvement in credit quality, provisions for loan losses have declined compared to the prior year, contributing to increased 2005 net income. PSB is strategically expanding into additional commercial banking products and has recently invested in people, equipment, and products to serve larger commercial borrowers. Loans originated to this customer base are typically at much lower credit spreads than lending to PSB's traditional small business customer. Because this loan growth has substantially outpaced deposit growth, these loans have been funded with high-cost funding, primarily brokered certificates of deposit and high-yield money market and government funds. This combination of lower asset yields and higher cost funding has contributed to the decrease in net margin compared to prior periods. In addition, during the June 2005 quarter, some wholesale funding was extended to take advantage of temporary declines in mid-term wholesale funding costs (3 to 6 years to final maturity). This extension combined with new adjustable rate commercial loan originations has increased the asset sensitivity of the balance sheet. PSB is seeking to increase net margin by aggressively acquiring new non- interest bearing deposits from both commercial treasury management services and retail deposits. After extensive research on features and pricing of competitive products, PSB products have been updated and new commercial treasury management software for our customers was recently introduced. Growth in residential mortgage loans held for investment has been small as loan originations have been sold to the secondary market to increase profit compared to holding such loans in the portfolio. Despite a national trend toward origination of non-traditional mortgage products such as "option ARMs" and interest rate only mortgages, PSB has not changed mortgage lending standards or introduced such products. In June 2005, PSB raised $7.5 million of regulatory capital for general corporate purposes from the issuance of trust preferred securities. This capital will support continued asset growth at a 11 minimal cost of capital without diluting the holdings of existing shareholders. This capital issue is reflected as junior subordinated debentures on PSB's balance sheet in accordance with current accounting standards. DETAILED MANAGEMENT DISCUSSION AND ANALYSIS BALANCE SHEET
At June 30, 2005, total assets were $486,230, an increase of $17,538, or 3.7%, over March 31, 2005, and an increase of $31,256, or 6.9%, over December 31, 2004. Asset growth for the three months and six months ended June 30, 2005, consisted of: Three months ended Six months ended Increase (decrease) in assets ($000s) June 30, 2005 June 30, 2005 $ % $ % Increase in commercial, industrial and agricultural loans $ 7,097 8.5% $18,124 25.0% Increase (decrease) in cash and cash equivalents 7,084 63.4% (5,062) -21.7% Increase in residential real estate mortgage loans 2,407 2.5% 4,402 4.7% Increase in investment securities 1,381 1.9% 3,570 5.2% Net change in other assets (various categories) 1,313 3.8% 2,807 8.6% Investment in bank-owned life insurance 45 1.0% 4,627 100.0% Increase (decrease) in commercial real estate mortgage loans (1,789) -1.1% 2,788 1.7% Total increase in assets $17,538 3.7% $31,256 6.9%
PSB continues to emphasize non real estate commercial loan origination during 2005, and growth in this type of loan represented 40.5% of the total net increase in assets during the quarter ended June 30, 2005 and 58.0% of the net increase in assets since December 31, 2004. Commercial lending growth is anticipated to be the greatest portion of asset growth during the remainder of 2005. Cash and cash equivalents increased $7,084 during the quarter ended June 30, 2005 from additional operating cash held in correspondent banks and an increase in federal funds sold after the June 28, 2005 trust preferred capital issue proceeds were received. However, cash and cash equivalents continue to be down $5,062 from December 31, 2004 primarily from a decrease in federal funds sold of $4,769. 12
Net asset growth for the three months and six months ended June 30, 2005, was funded by the following: Three months ended Six months ended Increase (decrease) in liabilities and equity ($000s) June 30, 2005 June 30, 2005 $ % $ % Increase in wholesale certificates of deposit $16,875 30.6% $18,192 33.8% Increase in junior subordinated debentures 7,732 100.0% 7,732 100.0% Increase in FHLB advances 3,000 5.8% 3,000 5.8% Increase in retail certificates of deposit > $100 2,220 4.0% 2,645 4.8% Net increase in other liabilities (various categories) 1,036 44.5% 795 31.0% Increase in stockholders' equity 779 2.3% 1,100 3.3% Increase (decrease) in core deposits (including MMDA) (4,939) -1.9% 478 0.2% Decrease in other borrowings (9,165) -60.9% (2,686) -31.4% Total increase in liabilities and stockholders' equity $17,538 3.7% $31,256 6.9%
The majority of asset growth during the quarter ended June 30, 2005 was funded by an increase in wholesale certificates of deposit. Core deposits declined during the second quarter of 2005 as cyclical municipal deposits acquired during the beginning of 2005 declined as expected. Origination of core deposits, including non-interest bearing deposits, is a key strategic initiative for management to lessen reliance on wholesale funding and to increase net margin generated by commercial loan growth. During July 2005, PSB introduced new commercial treasury management products to existing customers and is actively pursuing new customers to increase local deposit growth. Although commercial loan covenants require deposits to be held at PSB, increases in commercial deposits may occur slowly as the commercial loan customers take steps to move deposits to PSB and change their treasury management procedures to use the PSB product.
Table 1: Period-End Loan Composition June 30, June 30, December 31, 2004 Dollars Dollars Percentage of total Percentage (dollars in thousands) 2005 2004 2005 2004 Dollars of total Commercial, industrial, and agricultural $ 90,580 $ 70,871 24.1% 21.5%$ 72,456 20.8% Commercial real estate mortgage 167,319 156,964 44.6% 47.7% 164,531 47.2% Residential real estate mortgage 97,413 84,235 26.0% 25.6% 93,011 26.7% Residential real estate loans held for sale 610 - 0.2% 0.0% 342 0.1% Consumer home equity 12,779 9,791 3.4% 3.0% 11,620 3.3% Consumer and installment 6,470 7,365 1.7% 2.2% 6,462 1.9% Totals $375,171 $329,226 100.0% 100.0% $348,422 100.0%
The loan portfolio is PSB's primary asset subject to credit risk. PSB's process for monitoring credit risks includes monthly analysis of loan quality, delinquencies, nonperforming assets, and potential problem loans. Loans are placed on a nonaccrual status when they become 13 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. 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 renegotiated to provide a reduction or deferral of interest or principal (restructured loans), 2) restructured loans until six consecutive monthly payments are received under the new loan terms, and 3) foreclosed assets. The aggregate amount of nonperforming assets decreased $316 (11.2%) to $2,493 at June 30, 2005 from $2,809 at December 31, 2004. Total nonperforming assets as a percentage of total assets decreased to .51% at June 30, 2005 from .62% at December 31, 2004, and .76% at June 30, 2004. PSB also tracks delinquencies on a contractual basis quarter to quarter. Loans contractually delinquent 30 days or more as a percentage of gross loans were .57% at June 30, 2005 compared to .56% at December 31, 2004, and .84% at June 30, 2004. The allowance for loan losses was 1.15% of gross loans at June 30, 2005 compared to 1.19% at December 31, 2004, and 1.19% at June 30, 2004.
Table 2: Allowance for Loan Losses Three months ended Six months ended June 30, June 30, (dollars in thousands) 2005 2004 2005 2004 Allowance for loan losses at beginning $4,303 $3,700 $4,157 $3,536 Provision for loan losses 30 240 180 480 Recoveries on loans previously charged off 4 - 6 7 Loans charged off (28) (34) (34) (117) Allowance for loan losses at end $4,309 $3,906 $4,309 $3,906
Table 3: Nonperforming Assets June 30, December 31, (dollars in thousands) 2005 2004 2004 Nonaccrual loans $1,740 $2,660 $2,174 Accruing loans past due 90 days or more - - - Restructured loans not on nonaccrual 524 573 628 Total nonperforming loans 2,264 3,233 2,802 Foreclosed assets 229 46 7 Total nonperforming assets $2,493 $3,279 $2,809 Nonperforming loans as a % of gross loans receivable 0.60% 0.98% 0.80% Total nonperforming assets as a % of total assets 0.51% 0.76% 0.62%
14 LIQUIDITY Liquidity refers to the ability of PSB to generate adequate amounts of cash to meet PSB's need for cash at a reasonable cost. PSB 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 and local deposits continue to comprise the bulk of asset funding and were 63.2% of total assets at June 30, 2005 compared to 68.8% of total assets at December 31, 2004 and 63.7% at June 30, 2004. Federal Home Loan Bank advances and broker and national certificates of deposit continue to represent a significant portion of PSB's total funding ability, and is expected to grow as a percentage of assets during the remainder of 2005.
Table 4: Period-end Deposit Composition June 30, December 31, 2005 2004 2004 (dollars in thousands) $ % $ % $ % Non-interest bearing demand $ 53,759 14.2% $ 46,901 13.8% $ 51,635 14.4% Interest bearing demand and savings 61,8771 6.3% 51,112 15.0% 64,574 18.0% Money market deposits 66,402 17.5% 65,576 19.3% 68,666 19.2% Retail time deposits less than $100 67,308 17.7% 61,335 18.0% 63,993 17.8% Total core deposits 249,346 65.7% 224,924 66.1% 248,868 69.4% Retail time deposits $100 and over 58,104 15.3% 49,929 14.7% 55,459 15.5% Broker & national time deposits less than $100 2,319 0.6% 6,174 1.8% 4,594 1.3% Broker & national time deposits $100 and over 69,771 18.4% 59,249 17.4% 49,304 13.8% Totals $379,540 100.0% $340,276 100.0% $358,225 100.0%
Although core deposits are 10.9% greater than at June 30, 2004, most of that growth occurred prior to December 31, 2004. Since that date, deposit growth has come from brokered and national time deposits including $18,192, or 85.3% of total deposit growth of $21,315 since December 31, 2004. A significant portion of the increase in core deposits over June 30, 2004 came from interest bearing demand (NOW) deposits from local governmental entities. These deposits are required to be collateralized and carry an interest rate that moves with the overall market. Because the local governmental entities within these categories generally carry their highest annual balances during the first quarter of the year, this level of growth was not expected to continue and interest-bearing demand and savings balances did decline $10,399 during the quarter ended June 30, 2005. PSB originates retail certificates of deposit with local depositors under a program known as the Certificate of Deposit Account Registry System (CDARS) in which PSB customer deposits (with participation of other banks in the CDARS network) are able to obtain levels of FDIC deposit insurance coverage in amounts greater than traditional limits. For purposes of Table 4 above, these certificates are included in retail time deposits $100 and over and totaled $11,020 at June 30, 2005, $7,666 at December 31, 2004, and $6,993 at June 30, 2004. Although classified as retail time deposits in the table above, these balances are required to be classified as broker deposits on PSB's quarterly regulatory call reports. 15 PSB's policy is to limit broker and national time (not including CDARS) deposits to 20% of total assets. Broker and national deposits as a percentage of total assets was 14.8%, 11.8%, and 15.2% at June 30, 2005, December 31, 2004, and June 30, 2004, respectively. Early in the second quarter of 2005, short-term funding of federal funds purchased of $5.6 million as of March 31, 2005 was refinanced with additional broker deposits. Additional broker deposits were obtained during that period to fund anticipated loan growth. Broker deposits as a percentage of total assets is expected to increase during 2005 as loan growth continues to outpace core deposit growth.
Table 5: Summary of Balance by Significant Deposit Source June 30, December 31, (dollars in thousands) 2005 2004 2004 Total time deposits $100 and over $127,875 $109,178 $104,763 Total broker and national time deposits 72,090 65,423 53,898 Total retail time deposits 125,412 111,264 119,452 Core deposits, including money market deposits 249,346 224,924 248,868
Table 6: Change in June 30, 2005 Deposit Balance since Prior Period Ended: June 30, 2004 December 31, 2004 (dollars in thousands) $ % $ % Total time deposits $100 and over $18,697 17.1% $23,112 22.1% Total broker and national time deposits 6,667 10.2% 18,192 33.8% Total retail time deposits 14,148 12.7% 5,960 5.0% Core deposits, including money market deposits 24,422 10.9% 478 0.2%
Table 7: Available but Unused Funding Sources other than Retail Deposits: June 30, 2005 December 31, 2004 Unused, but Amount Unused, but Amount (dollars in thousands) Available Used Available Used Overnight federal funds purchased $32,500 $ - $22,500 $ - FHLB advances under blanket mortgage lien 11,636 55,000 14,855 52,000 Repurchase agreements 18,224 5,879 12,871 8,565 Wholesale market time deposits 25,156 72,090 37,097 53,898 Total available but unused funds $87,516 $132,969 $87,323 $114,463 Funding as a percent of total assets 18.0% 27.3% 19.2% 25.2%
16 Despite the increased usage of broker deposits, PSB continues to have adequate sources of available funding for growth as outlined in Table 7 above. Unused FHLB advances available under the blanket mortgage lien have declined $3,219, or 21.7% since December 31, 2004. However, securities freed from pledging as governmental NOW deposits were withdrawn increased repurchase agreements capacity by $5,353, or 41.6% since December 31, 2004. Brokered time deposit capacity has declined substantially since December 31, 2004, falling $11,941, or 32.2%. Overnight federal funds purchased totaling $32,500 are available through four primary correspondent banks. These lines are not supported by a formal written arrangement, but represent best efforts ability on the part of correspondent banks to raise these funds. During the six months ended June 30, 2005, average daily federal funds purchased were $6,408 compared to $4,861 during the same period in 2004. The cost of these funds is subject to change based on changes in the discount rate as determine by the Federal Reserve. PSB may maintain a continuous position in overnight federal funds purchased generally up to 14 days before amounts must be liquidated for at least one business day. Consideration of the need for federal funds purchased is part of PSB's daily cash management and funding procedures and represents the first source of liquidity as needed. Table 8 below presents maturity repricing information as of June 30, 2005. 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 generally considered to reprice beyond five years. 2. Nonaccrual loans are considered to reprice beyond five 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. 17
Table 8: Interest Rate Sensitivity Gap Analysis June 30, 2005 (dollars in thousands) 0-90 days 91-180 days 181-365 days 1-2 yrs Beyond 2-5 yrs Beyond 5 yrs Total Earning assets: Loans $146,420 $ 28,749 $ 38,898 $ 60,861 $ 80,789 $ 19,454 $375,171 Securities 4,515 5,180 10,677 12,026 26,975 13,091 72,464 FHLB stock 2,953 2,953 CSV bank-owned life ins. 4,627 4,627 Other earning assets 5,243 5,243 Total $159,131 $ 33,929 $ 49,575 $ 72,887 $107,764 $ 37,172 $460,458 Cumulative rate sensitive assets $159,131 $ 193,060 $242,635 $ 315,522 $423,286 $460,458 Interest-bearing liabilities Interest-bearing deposits $135,574 $ 22,216 $ 36,308 $ 41,979 $ 42,970 $ 46,734 $325,781 FHLB advances 5,000 2,000 6,000 7,000 35,000 55,000 Other borrowings 1,045 774 1,389 415 2,256 5,879 Junior subordinated debentures 7,732 7,732 Total $141,619 $ 24,990 $ 43,697 $ 49,394 $ 80,226 $ 54,466 $394,392 Cumulative interest sensitive liabilities $141,619 $ 166,609 $ 210,306 $ 259,700 $ 339,926 $394,392 Interest sensitivity gap for the individual period $ 17,512 $ 8,939 $ 5,878 $ 23,493 $ 27,538 $(17,294) Ratio of rate sensitive assets to rate sensitive liabilities for the individual period 112.4% 135.8% 113.5% 147.6% 134.3% 68.2% Cumulative interest sensitivity gap $ 17,512 $ 26,451 $ 32,329 $ 55,822 $ 83,360 $ 66,066 Cumulative ratio of rate sensitive assets to rate sensitive liabilities 112.4% 115.9% 115.4% 121.5% 124.5% 116.8%
At June 30, 2005, if interest rates had changed 200 basis points, the 365-day cumulative ratio of rate sensitive assets to rate sensitive liabilities would have changed from approximately 115% to 109% (if up 200 basis points) and 125% (if down 200 basis points), respectively. At December 31, 2004, the 365-day cumulative ratio of rate sensitive assets to rate sensitive liabilities would have changed from approximately 101% to 95% (if up 200 basis points) and 105% (if down 100 basis points), respectively. At June 30, 2004, if interest rates had risen 200 basis points or had fallen 100 basis points, the 365-day cumulative ratio of rate sensitive assets to rate sensitive liabilities would have changed from approximately 92% to 89% (if up 200 basis points) and 96% (if down 100 basis points), respectively. Beginning in June 2005, PSB began to model downward rate change projections up to 200 basis points, rather than 100 basis points, reflecting 18 the short-term rate increases from historically low interest rate floors during the past twelve months. The Asset/Liability Committee uses financial modeling techniques that measure the interest rate risk. Policies established by PSB'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. PSB also uses various policy measures to assess the adequacy of PSB's liquidity and interest rate risk as described below. Basic Surplus PSB 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. PSB's basic surplus, including available open line of credit FHLB advances not yet utilized at June 30, 2005, December 31, 2004, and June 30, 2004, was 5.6%, 7.1%, and 7.0%, respectively and above the 5% minimum required by policy. The decline in the basic surplus is primarily a result of lower FHLB borrowing capacity and pledging of securities for deposits from governmental entities, which reduced available unencumbered net liquid assets. During the second quarter 2005, PSB brought the basic surplus percentage back into policy from a 3.5% ratio at March 31, 2005 by reallocating deposits to free up available security collateral. Interest Rate Risk Limits PSB 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, PSB 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 June 30, 2005, December 31, 2004, and June 30, 2004, net interest income for the next 12 months was projected to increase 1.34%, decrease .04%, and decrease .46%, respectively, if rates increase 200 basis points. At June 30, 2005, net interest income for the next 12 months was projected to decrease 5.0% if rates decrease 200 basis points. At December 31, 2004, and June 30, 2004, net interest income for the next 12 months was projected to decrease 2.15%, and .70%, respectively, if rates decrease 100 basis points. These changes are within policy requirements and considered acceptable by management. 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 19 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. PSB'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 June 30, 2005, December 31, 2004, and June 30, 2004, PSB's core funding utilization ratio was projected to be 47%, 46% and 54%, respectively, after a rate increase of 200 basis points and was therefore within policy requirements. CAPITAL RESOURCES Stockholders' equity at June 30, 2005 increased $1,100 to $34,716, or 3.3% from $33,616 at December 31, 2004. After shareholder stock buybacks of $318 and cash dividends declared of $532, net income retained during the six months ended June 30, 2005 was $1,361. However, capital decreased $312 since December 31, 2004 from a decline in the unrealized gain on securities available for sale (net of tax effects) as increases in short-term rates reduced the value of fixed rate debt securities. All other net increases in capital totaled $51. Stockholders' equity included unrealized gains on securities available for sale, net of their tax effect, of $72 at June 30, 2005, compared to unrealized gains of $384 at December 31, 2004. The adequacy of PSB'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 June 30, 2005 and December 31, 2004, PSB's subsidiary bank's Tier 1 risk-based capital ratio, total risk-based capital, and Tier 1 leverage ratio were in excess of regulatory minimums and were classified as "well-capitalized." Failure to remain well-capitalized would prevent PSB from obtaining future wholesale broker time deposits which have been an important source of funding during the past several years. Average tangible stockholders' equity (book basis) to average assets was 7.22% during the June 2005 quarter, 7.49% during the December 2004 quarter, and 7.61% during the June 2004 quarter. However, regulatory capital increased $7,500 as PSB issued pooled trust preferred securities, which qualify as Tier 1 regulatory capital although presented as junior subordinated debentures under current accounting standards. The junior subordinated debentures carry a fixed interest rate of 5.82% through September 2010, after which interest is adjusted quarterly to 90 day LIBOR plus 1.70%. This additional regulatory capital will be used for general corporate purposes including supporting additional asset growth. PSB maintains an annual, ongoing share repurchase program of up to 1% of outstanding shares per year and 4,000 shares at $31.50 per share were purchased under this program during the quarter ended June 30, 2005. During the six months ended June 30, 2005, 10,000 shares at an average price of $31.80 per share were purchased under this program. In order to fund an exercise of employee stock options, exercised at a price of $15.83 per share, 3,058 shares of the buyback were re-issued. PSB anticipates that it will purchase another 7,200 shares during 2005 on the open market at prices then in effect. 20
Table 9: Capital Ratios - Consolidated Holding Company (dollars in thousands) June 30, Dec. 31, 2005 2004 2004 Stockholders' equity $ 34,716 $ 32,239 $ 33,616 Junior subordinated debentures, net 7,500 - - Disallowed mortgage servicing right assets (85) (80) (84) Unrealized (gain) loss on securities available for sale (72) 4 (384) Tier 1 regulatory capital 42,059 32,163 33,148 Add: allowance for loan losses 4,309 3,906 4,157 Total regulatory capital $ 46,368 $ 36,069 $ 37,305 Total assets $486,230 $431,216 $454,974 Disallowed mortgage servicing right assets (85) (80) (84) Unrealized (gain) loss on securities available for sale (72) 4 (384) Tangible assets $486,073 $431,140 $454,506 Risk-weighted assets (as defined by current regulations) $381,443 $337,462 $350,224 Tier 1 capital to average tangible assets (leverage ratio) 8.76% 7.55% 7.40% Tier 1 capital to adjusted risk-weighted assets 11.03% 9.53% 9.46% Total capital to adjusted risk-weighted assets 12.16% 10.69% 10.65%
RESULTS OF OPERATIONS Net income for the quarter ended June 30, 2005 was $1,171, or $.68 for basic and diluted earnings per share. Comparatively, net income for the quarter ended June 30, 2004 was $782, or $.45 per share for basic and diluted earnings per share. The prior year June 2004 quarter included a special charge of $.11 per share ($199 after tax benefits) for write-off of investment in the old home office demolished after a newly constructed home office was placed in service on the same property. June 2004 earnings before the special charge were $.56 per share. Net income for the six months ended June 30, 2005 was $2,211, or $1.29 for basic and $1.28 for diluted earnings per share. Comparatively, net income for the six months ended June 30, 2004 was $1,736, or $1.00 for basic and $.99 for diluted earnings per share. As noted previously, the prior year period included a special charge of $.11 per share ($199 after tax benefits) for write-off of investment in the old home office. Diluted earnings per share for the six months ended June 2004 before the special charge were $1.10 per share. 21 Both the June quarterly and year-to-date periods saw increased earnings over last year and 2005 net income is expected to be in a range of $4.3 million to $4.6 million. Table 10 below indicates the return on average assets, return on average equity, and key operating expense ratios for the quarterly and year-to- date periods as reported and adjusted for the special charge on abandonment of the home office in 2004.
Table 10: Comparative Key Operating Ratios Quarter ended June 30, Six months ended June 30, Reported Proforma Reported Proforma 2005 2004 2004* 2005 2004 2004* Return on average assets 0.98% 0.73% 0.92% 0.94% 0.83% 0.93% Return on average equity 13.55% 9.52% 11.94% 12.90% 10.63% 11.88% Efficiency ratio 59.53% 64.54% 57.25% 59.33% 62.18% 58.47% Noninterest expense to average assets 2.32% 2.74% 2.43% 2.31% 2.66% 2.49% * Proforma 2004 is before the special charge for abandonment of home office in June 2004 of $199 after tax benefits.
The following Table 11 presents PSB's consolidated quarterly summary financial data. 22
Table 11: Financial Summary (dollars in thousands, except per share data) Quarter ended June 30 March 31, Dec. 31, Sept. 30, June 30, 2005 2005 2004 2004 2004 EARNINGS AND DIVIDENDS: Net interest income $3,582 $3,520 $3,577 $3,521 $3,517 Provision for loan losses $ 30 $ 150 $ 180 $ 195 $ 240 Other noninterest income $ 947 $ 803 $ 764 $ 764 $ 855 Other noninterest expense $2,780 $2,640 $2,626 $2,833 $2,914 Net income $1,171 $1,040 $1,043 $ 747 $ 782 Basic earnings per share (3) $ 0.68 $ 0.60 $ 0.61 $ 0.43 $ 0.45 Diluted earnings per share (3) $ 0.68 $ 0.60 $ 0.60 $ 0.43 $ 0.45 Dividends declared per share (3) $ 0.31 $ - $ 0.30 $ - $ 0.30 Net book value per share $20.27 $19.77 $19.55 $19.41 $18.68 Semi-annual dividend payout ratio 24.06% n/a 28.82% n/a 29.84% Average common shares outstanding 1,714,134 1,721,058 1,717,394 1,720,436 1,729,322 BALANCE SHEET - AVERAGE BALANCES: Loans receivable, net of allowances for loss $367,948 $354,136 $341,997 $331,167 $320,471 Assets $480,325 $465,083 $448,591 $439,177 $426,826 Deposits $376,252 $367,394 $353,310 $347,015 $330,337 Stockholders' equity $ 34,665 $ 33,989 $ 34,076 $ 33,010 $ 32,942 PERFORMANCE RATIOS: Return on average assets (1) 0.98% 0.91% 0.92% 0.67% 0.73% Return on average stockholders' equity (1) 13.55% 12.41% 12.18% 8.98% 9.52% Average tangible stockholders' equity to average assets 7.22% 7.25% 7.49% 7.46% 7.61% Net loan charge-offs to average loans 0.01% 0.00% 0.04% 0.00% 0.01% Nonperforming loans to gross loans 0.60% 0.74% 0.80% 0.94% 0.98% Allowance for loan losses to gross loans 1.15% 1.18% 1.19% 1.22% 1.19% Net interest rate margin (1)(2) 3.32% 3.40% 3.50% 3.51% 3.64% Net interest rate spread (1)(2) 2.96% 3.05% 3.12% 3.17% 3.30% Service fee revenue as a percent of average demand deposits (1) 2.56% 2.19% 2.22% 2.52% 2.63% Noninterest income as a percent of gross revenue 13.00% 11.87% 11.64% 11.93% 13.54% Efficiency ratio (2) 59.53% 59.11% 58.52% 63.95% 64.54% Noninterest expenses to average assets (1) 2.32% 2.30% 2.33% 2.56% 2.74% STOCK PRICE INFORMATION: High $31.85 $32.20 $33.25 $35.25 $35.60 Low $30.63 $31.85 $32.00 $33.00 $34.50 Market value at quarter-end $30.75 $31.85 $32.10 $33.00 $34.50 (1)Annualized (2)The yield on tax-exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%. (3)Due to rounding, cumulative quarterly per share performance may not equal annual per share totals.
23 NET INTEREST INCOME Net interest income is the most significant component of earnings. Tax adjusted net interest income increased $63 (1.7%) from $3,660 for the quarter ended June 30, 2004 to $3,723 for the current quarter ended June 30, 2005, and increased $110 (1.5%) from $7,276 for the six months ended June 30, 2004 to $7,386 for the six months ended June 30, 2005. Net interest income has been negatively impacted by a flattening yield curve and competitive pressures on deposit rates while loan growth continued to be funded with higher cost wholesale funds. Margin on earning assets declined from 3.64% in the June 2004 quarter, and from 3.40% in the March 2005 quarter to 3.32% during the June 2005 quarter. Earning asset yields increased slightly and were 5.78% at June 2005, 5.66% at March 2005, and 5.57% at June 2004. However, the cost of interest- bearing liabilities increased from 2.27% during the quarter ended June 2004 to 2.61% for the March 2005 quarter and 2.82% for the June 2005 quarter. PSB updated accounting procedures during March 2005 to improve recognition and amortization of deferred loan origination fees and costs in accordance with Statement of Financial Accounting Standard No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans ("FAS 91"). This change is more fully described in this Quarterly Report on Form 10-Q under "Noninterest Expense." Tax-adjusted net interest margin before accounting adjustments for FAS 91 would have been 3.46% during the June 2005 quarter (compared to a reported 3.32%), and 3.68% in the June 2004 quarter (compared to a reported 3.64%). Tax-adjusted net interest margin before accounting adjustments for FAS 91 would have been 3.48% during the six months ended June 2005 (compared to a reported 3.36%), and 3.73% in the six months ended June 2004 (compared to a reported 3.68%). The increase in funding costs has been led by interest-bearing core deposits (excluding retail certificates of deposit), whose average cost increased from .80% for the six months ended June 30, 2004 to 1.46% for the six months ended June 30, 2005. This increase is in response to Federal Reserve discount rate increases that began in June 2004 and have continued through the current date. Discount rate increases since June 2004 through June 30, 2005 totaled 2.25%. These increases were not yet reflected in the average cost of core deposits at June 30, 2004. Future discount rate increases are expected to continue to be reflected in the core deposit rates. In addition, a majority of the commercial loan growth in the six months ended June 2005 was funded by high-yield money market and NOW accounts sold to new large depositors and local governmental entities earning rates tied to the 30- day LIBOR rate or other adjustable wholesale rates. Lastly, wholesale deposits continue to make up a growing portion of the deposit base and renewal rates on these time deposits have increased at a rate similar to the Federal Reserve discount rate increase, which has increased funding costs. While short-term funding costs have increased as described above, mid-term rates out to 5 years have remained similar over the 12 months ended June 30, 2005. Because PSB originates some loans with fixed rates to mid-term maturities funded by short-term deposits, this flattening yield curve has decreased the interest rate spread seen during 2003 and 2004. 24 While PSB's balance sheet remains largely neutral to interest rate changes, to facilitate retention and growth in core deposits and support continued loan growth with wholesale funding, net margin is expected to decline slightly in the coming quarter.
Table 12A: Net Interest Income Analysis (Quarter) (dollars in thousands) Quarter ended June 30, 2005 Quarter ended June 30, 2004 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Assets Interest-earning assets: Loans (1)(2) $372,286 $ 5,600 6.03% $324,251 $4,731 5.85% Taxable securities 48,311 467 3.88% 47,596 453 3.82% Tax-exempt securities (2) 23,693 359 6.08% 24,595 371 6.05% FHLB stock 2,941 40 5.46% 2,679 36 5.39% Other 2,201 15 2.73% 4,190 10 0.96% Total (2) 449,432 6,481 5.78% 403,311 5,601 5.57% Non-interest earning assets: Cash and due from banks 14,145 13,840 Premises and equipment, net 12,607 10,246 Cash surrender value of life insurance 4,602 - Other assets 3,877 3,209 Allowance for loan losses (4,338) (3,780) Total $480,325 $426,826 Liabilities & stockholders' equity Interest bearing liabilities: Savings and demand deposits $64,624 $249 1.55% $ 53,180 $ 88 0.66% Money market deposits 69,945 301 1.73% 64,450 144 0.90% Time deposits 190,932 1,591 3.34% 163,555 1,128 2.77% FHLB borrowings 53,066 507 3.83% 47,000 504 4.30% Other borrowings 13,433 106 3.17% 14,718 77 2.10% Junior sub. debentures 255 4 6.29% - - 0.00% Total 392,255 2,758 2.82% 342,903 1,941 2.27% Non-interest bearing liabilities: Demand deposits 50,751 49,152 Other liabilities 2,654 1,829 Stockholders' equity 34,665 32,942 Total $480,325 $426,826 Net interest income 3,723 3,660 Rate spread 2.96% 3.30% Net yield on interest-earning assets 3.32% 3.64% (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%.
25
Table 12B: Net Interest Income Analysis (Six Months) (dollars in thousands)Six months ended June 30, 2005Six months ended June 30, 2004 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Assets Interest-earning assets: Loans (1)(2) $365,348 $10,822 5.97% $317,485 $9,302 5.88% Taxable securities 47,530 919 3.90% 47,738 914 3.84% Tax-exempt securities (2) 24,100 724 6.06% 24,617 739 6.02% FHLB stock 2,921 80 5.52% 2,575 76 5.92% Other 3,460 43 2.51% 3,572 16 0.90% Total (2) 443,359 12,588 5.73% 395,987 11,047 5.59% Non-interest earning assets: Cash and due from banks 13,811 12,657 Premises and equipment, net 12,563 9,267 Cash surrender value of life insurance 3,670 - Other assets 3,613 2,986 Allowance for loan losses (4,277) (3,695) Total $472,739 $417,202 Liabilities & stockholders' equity Interest bearing liabilities: Savings and demand deposits $68,595 $488 1.43% $52,500 $ 173 0.66% Money market deposits 70,807 523 1.49% 65,760 298 0.91% Time deposits 182,980 2,941 3.24% 156,395 2,180 2.80% FHLB borrowings 50,989 1,057 4.18% 46,808 970 4.16% Other borrowings 12,861 189 2.96% 14,137 150 2.13% Junior sub. debentures 128 4 6.30% - - 0.00% Total 386,360 5,202 2.72% 335,600 3,771 2.25% Non-interest bearing liabilities: Demand deposits 49,464 46,992 Other liabilities 2,351 1,868 Stockholders' equity 34,564 32,742 Total $472,739 $417,202 Net interest income 7,386 7,276 Rate spread 3.01% 3.34% Net yield on interest-earning assets 3.36% 3.68% (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%.
26
Table 13: Interest Expense and Expense Volume and Rate Analysis Six months ended June 30, 2005 2005 compared to 2004 (dollars in thousands) increase (decrease) due to (1) Volume Rate Net Interest earned on: Loans (2) $1,396 $ 124 $1,520 Taxable securities (4) 9 5 Tax-exempt securities (2) (15) - (15) FHLB stock 10 (6) 4 Other interest income - 27 27 Total 1,387 154 1,541 Interest paid on: Savings and demand deposits 53 262 315 Money market deposits 23 202 225 Time deposits 369 392 761 FHLB borrowings 86 1 87 Other borrowings (13) 52 39 Junior subordinated debentures - 4 4 Total 518 913 1,431 Net interest earnings $ 869 $ (759) $ 110 (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 PSB'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 $30 and $240 for the three months ended June 30, 2005, and 2004, respectively. The provision for loan losses was $180 and $480 for the six months ended June 30, 2005, and 2004, respectively. The continued improvement in credit quality and delinquency ratios and growing history of minimal net loan charge-offs of similar loans allowed PSB to reduce the provision for loan losses during the June 2005 quarter. Provisions for loan losses are expected to remain low compared to prior year quarters for the remainder of 2005. 27 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 Quarterly noninterest income increased $92 in the June 2005 quarter to $947 compared to $855 in June 2004. The change was led by an increase of $110 in commissions from the sale of retail investment products. A decline in mortgage banking income of $59 to $249 in June 2005 compared to $308 in June 2004 was offset by a $46 increase in the cash surrender value of life insurance. Service fee income of $324 during the June 2005 quarter was similar to income of $322 during the June 2004 quarter, but recovered substantially from $260 of fees in the March 2005 quarter. Fees for retail service products increased effective April 1, 2005, contributing to the increase over March 2005. For the six months ended June 30, noninterest income increased $155 to $1,750 in 2005 compared to $1,595 in 2004. The change was led by an increase in sales of retail investment product commissions of $151. Increases in cash surrender value of life insurance of $66 have offset a decline in mortgage banking of $64. During February 2005, PSB purchased $4.5 million of bank-owned life insurance on bank officers in connection with new employee deferred compensation and incentive plans. A decline of $105 in gain on sale of securities was largely offset by a one-time payout of $78 received from Discover Financial Services on the purchase of the Pulse ATM system (in which PSB was a cooperative member). Peoples Insurance Services LLC, PSB's commercial property and casualty insurance agency and brokerage (a September 2003 start-up), incurred a net loss of $53 and $75 for the six months ended June 30, 2005, and 2004, respectively. Total commission revenue is significantly less than planned. PSB is investigating various options to provide insurance products to our customers and community in a profitable manner with a resolution expected during the upcoming quarter ending September 30, 2005. As a FHLB Mortgage Partnership Finance (MPF) loan servicer, PSB 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. The following table 14 summarizes loan principal serviced for the FHLB by the MPF program as of June 30, 2005. 28
Table 14: FHLB Mortgage Partnership Financing (MPF) Program Servicing PSB Credit FHLB Mortgage Principal Enhancement Funded First Servicing As of June 30, 2005 ($000s) Serviced Guarantee Loss Account Right, net MPF 100 Program (agent program) $110,010 $499 $2,494 $497 MPF 125 Program (closed loan program) 55,393 448 630 356 Total FHLB MPF serviced loans $165,403 $947 $3,124 $853
FHLB MPF Program elements as a percentage of principal serviced: As of June 30, 2005 MPF 100 MPF 125 PSB credit enhancement guarantee 0.45% 0.81% FHLB funded first loss account 2.27% 1.14% Mortgage servicing right, net 0.45% 0.64%
PSB ceased originating loans under the MPF 100 program during November 2003. Since that time all originations have been through the FHLB MPF 125 closed loan program. 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 PSB. NONINTEREST EXPENSE Noninterest operating expenses declined $134 to $2,780 in the quarter ended June 2005 compared to $2,914 during the quarter ended June 2004. However, the June 2004 quarter included a special charge to write-off the remaining investment in the prior home office totaling $329. In addition, salaries and wages in the June 2005 quarter were reduced by $183 as PSB implemented a daily automated system to improve accounting for deferred loan fees and costs (including lender and support personnel salaries) in accordance with current accounting standards (FAS 91) earlier in 2005. FAS 91 requires loan origination fees and direct loan origination costs to be deferred and amortized as a yield adjustment earned on the loan. Previously, these accounting adjustments for deferral of costs were made only at year-end and in prior years had an immaterial impact on the individual quarterly financial statements. The change in accounting procedure was made to simplify operations and improve the accuracy of earnings reporting. Before the June 2005 deferral of wages under FAS 91 and the June 2004 special home office write-off, noninterest expenses were $2,963 for June 2005, and $2,585 in June 2004, an increase of $378, or 14.6%. The increase over the prior year quarter consisted primarily of $277 in additional wages and benefits from a growing number of employees and $66 in additional occupancy expenses in the June 2005 quarter. Total quarterly operating expenses to average 29 total assets before the FAS 91 deferral of wages and the June 2004 special home office write-off were 2.47% for June 2005 and 2.43% for June 2004 (annualized). Offsetting the increase to June 2005 quarter income from deferred employee wage expense related to new loan originations under FAS 91 were reductions to income from deferral of loan origination fees collected, and amortization of previously capitalized net loan origination costs against net interest income. Taken together, all FAS 91 accounting adjustments increased June 2005 quarterly net income by $18 and decreased June 2004 quarterly net income by $22. For the six months ended June 30, noninterest operating expenses declined $96 to $5,420 in 2005 compared to $5,516 during 2004. During the March 2005 quarter, a reimbursement of collection fees on a problem loan were recovered, which decreased other noninterest expenses by $101. Conversely, the prior year March 2004 quarter included $127 of collection fees written off to other noninterest expense in response to regulatory requirements to account for collection fees as expense until collected. As noted above, the June 2004 quarter included a special charge to write-off the remaining investment in the prior home office totaling $329. In addition, salaries and wages during the six months ended June 2005 quarter were reduced by $347 as PSB implemented a daily automated system to improve accounting for deferred loan fees and costs (including lender and support personnel salaries) in accordance with current accounting standards (FAS 91) earlier in 2005. For the six months ended June 30, before the deferral of wages under FAS 91, the June 2004 special home office write-off, and the impact of the special collection expense adjustments, noninterest expenses were $5,868 for June 2005, and $5,060 in June 2004, an increase of $808, or 16.0%. The increase over the prior year consisted primarily of $522 in additional wages and benefits, $210 in additional occupancy expenses, and $60 increase in marketing and advertising costs in the six months ended June 30, 2005. Total year-to-date operating expenses to average total assets before the FAS 91 deferral of wages, the June 2004 special home office write-off, and the special collection expenses were 2.50% for June 2005 and 2.44% for June 2004 (annualized). Offsetting the increase to income during the six months ended June 30, 2005 from deferred employee wage expense related to new loan originations under FAS 91 were reductions to income from deferral of loan origination fees collected, and amortization of previously capitalized net loan origination costs against net interest income. Taken together, all FAS 91 accounting adjustments increased year-to-date June 2005 net income by $47 and decreased year-to-date June 2004 income by $44. 30 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 PSB's Form 10-K for the year ended December 31, 2004. ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, management, under the supervision, and with the participation, of PSB's President and Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of PSB's disclosure controls and procedures pursuant to Rule 13a-15(c) under the Securities Exchange Act of 1934. Based upon such evaluation, the President and Chief Executive Officer and the Chief Financial Officer concluded that PSB's disclosure controls and procedures were effective in all material respects as of the end of the period covered by this report. There were no changes in PSB's internal control over financial reporting during the fiscal quarter covered by this report that materially affected, or are reasonably likely to materially affect, PSB's internal control over financial reporting. 31 PART II - OTHER INFORMATION ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Purchases of Equity Securities - Quarter ending June 30, 2005 Maximum number Total number (or approximate of shares (or dollar value) of Total number units) purchased shares (or units) of shares Average price as part of publicly that may yet be (or units) paid per share announced plans purchased under the purchased (or unit) or programs plans or programs Period (a) (b) (c)(1) (d)(2) April 2005 - - - - May 2005 4,000 31.50 4,000 7,200 June 2005 - - - - Quarterly Totals 4,000 31.50 4,000 7,200 (1) Includes 4,000 shares purchased pursuant to program announced on December 17, 2002, pursuant to which the Board of Directors authorized the repurchase of up to 1% of PSB's outstanding common stock per year in open market or privately negotiated transactions (the "Plan"). No price or expiration date was specified for the Plan's purchases. (2) Shares which may yet be purchased in 2005 under the Plan.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITIES HOLDERS The annual meeting of shareholders of the Company was held on April 19, 2005. The only matter voted upon was the election of directors. The number of votes cast for, or withheld, were as follows:
ELECTION OF DIRECTORS For Withheld Gordon P. Connor 947,972 73,644 Patrick L. Crooks 1,008,668 12,948 William J. Fish 1,010,523 11,093 Charles A. Ghidorzi 995,778 25,838 Gordon P. Gullickson 994,651 26,965 David K. Kopperud 1,009,445 12,171 Thomas R. Polzer 1,010,334 11,282 William M. Reif 998,800 22,816 Thomas A. Riiser 1,011,048 10,568 John H. Sonnentag 935,829 85,787
32 ITEM 6. EXHIBITS Exhibits required by Item 601 of Regulation S-K. Exhibit Number Description 4.1 Bylaws, as last amended April 9, 1996 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 33 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. August 15, 2005 SCOTT M. CATTANACH Scott M. Cattanach Treasurer (On behalf of the Registrant and as Principal Financial Officer) 34 EXHIBIT INDEX TO FORM 10-Q OF PSB HOLDINGS, INC. FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005 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: 4.1 Bylaws, as last amended April 9, 1996 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