Form 10-Q  (00137767.DOC;1)

FORM 10-Q


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


(Mark One)

S

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934


For the quarterly period ended March 31, 2007


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  S

No  £


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  £

Accelerated filer  £

Non-accelerated filer  S


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  

Yes  £

No  S


The number of common shares outstanding at May 3, 2007, was 1,573,780.






PSB HOLDINGS, INC.


FORM 10-Q


Quarter Ended March 31, 2007


 

Page No.

PART I.

FINANCIAL INFORMATION

 
   
 

Item 1.

Financial Statements

 
    
  

Consolidated Balance Sheets

 
  

March 31, 2007 (unaudited) and December 31, 2006

 
  

(derived from audited financial statements)

  1

    
  

Consolidated Statements of Income

 
  

Three Months Ended March 31, 2007 and 2006 (unaudited)

  2

    
  

Consolidated Statement of Changes in Stockholders’ Equity

 
  

Three Months Ended March 31, 2007 (unaudited)

  3

    
  

Consolidated Statements of Cash Flows

 
  

Three Months Ended March 31, 2007 and 2006 (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

28

    
 

Item 4.

Controls and Procedures

28

    
    

PART II.

OTHER INFORMATION

 
    
 

Item 1A.

Risk Factors

29

    
 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

29

    
 

Item 6.

Exhibits

30




i


PART I.  FINANCIAL INFORMATION


Item 1.  Financial Statements


PSB Holdings, Inc.

Consolidated Balance Sheets

March 31, 2007 unaudited, December 31, 2006 derived from audited financial statements

 

March 31,

December 31,

(dollars in thousands, except per share data)

2007

2006

Assets

    
     

Cash and due from banks

$  10,024 

 

$  14,738 

 

Interest-bearing deposits and money market funds

2,274 

 

1,048 

 

Federal funds sold

–    

 

9,756 

 
     

Cash and cash equivalents

12,298 

 

25,542 

 
     

Securities available for sale (at fair value)

79,032 

 

80,009 

 

Loans held for sale

688 

 

1,001 

 

Loans receivable, net

374,258 

 

369,749 

 

Accrued interest receivable

2,745 

 

2,464 

 

Foreclosed assets

356 

 

464 

 

Premises and equipment, net

11,432 

 

11,469 

 

Mortgage servicing rights, net

898 

 

908 

 

Federal Home Loan Bank stock (at cost)

3,017 

 

3,017 

 

Cash surrender value of bank-owned life insurance

6,738 

 

5,900 

 

Other assets

1,513 

 

1,317 

 
     

TOTAL ASSETS

$492,975 

 

$501,840 

 
     

Liabilities

    
     

Non-interest-bearing deposits

$  50,730 

 

$  55,083 

 

Interest-bearing deposits

333,484 

 

336,332 

 
     
 

Total deposits

384,214 

 

391,415 

 
     

Federal Home Loan Bank advances

50,000 

 

60,000 

 

Other borrowings

12,189 

 

3,995 

 

Junior subordinated debentures

7,732 

 

7,732 

 

Accrued expenses and other liabilities

3,770 

 

4,251 

 
     
 

Total liabilities

457,905 

 

467,393 

 
     

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

9,604 

 

9,645 

 

Retained earnings

31,766 

 

30,967 

 

Accumulated other comprehensive loss

(47)

 

(105)

 

Treasury stock, at cost – 303,399 and 297,223 shares, respectively

(8,140)

 

(7,947)

 
     
 

Total stockholders’ equity

35,070 

 

34,447 

 
     

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

$492,975 

 

$501,840 

 




1


PSB Holdings, Inc.

Consolidated Statements of Income

 

Three Months Ended

 

March 31,

(dollars in thousands, except per share data – unaudited)

2007

2006

     

Interest and dividend income:

    
 

Loans, including fees

$ 6,567 

 

$ 6,111 

 
 

Securities:

    
 

Taxable

616 

 

604 

 
 

Tax-exempt

305 

 

254 

 
 

Other interest and dividends

129 

 

107 

 
     
 

Total interest and dividend income

7,617 

 

7,076 

 
     

Interest expense:

    
 

Deposits

3,401 

 

2,936 

 
 

FHLB advances

614 

 

534 

 
 

Other borrowings

64 

 

28 

 
 

Junior subordinated debentures

113 

 

113 

 
     
 

Total interest expense

4,192 

 

3,611 

 
     

Net interest income

3,425 

 

3,465 

 

Provision for loan losses

120 

 

135 

 
     

Net interest income after provision for loan losses

3,305 

 

3,330 

 
     

Noninterest income:

    
 

Service fees

303 

 

295 

 
 

Mortgage banking

196 

 

207 

 
 

Investment and insurance sales commissions

124 

 

135 

 
 

Increase in cash surrender value of life insurance

60 

 

46 

 
 

Change in fair value of interest rate swap

32 

 

(205)

 
 

Other noninterest income

126 

 

144 

 
     
 

Total noninterest income

841 

 

622 

 
     

Noninterest expense:

    
 

Salaries and employee benefits

1,737 

 

1,814 

 
 

Occupancy and facilities

497 

 

472 

 
 

Data processing and other office operations

217 

 

180 

 
 

Advertising and promotion

58 

 

43 

 
 

Other noninterest expenses

575 

 

433 

 
     
 

Total noninterest expense

3,084 

 

2,942 

 
     

Income before provision for income taxes

1,062 

 

1,010 

 

Provision for income taxes

263 

 

272 

 
     

Net income

$   799 

 

$   738 

 

Basic earnings per share

$  0.50 

 

$  0.43 

 

Diluted earnings per share

$  0.50 

 

$  0.43 

 




2


PSB Holdings, Inc.

Consolidated Statement of Changes in Stockholders’ Equity

Three months ended March 31, 2007 – unaudited


    

Accumulated

  
    

Other

  
  

Additional

 

Comprehensive

  
 

Common

Paid-in

Retained

Income

Treasury

 

(dollars in thousands)

Stock

Capital

Earnings

(Loss)

Stock

Totals

       

Balance January 1, 2007

$1,887  

$9,645    

$30,967  

$(105)

$(7,947) 

$34,447 

       

Comprehensive income:

      
 

Net income

  

799  

  

799 

 

Unrealized gain on securities

      
 

available for sale, net of tax

   

   58

 

58 

       
 

Total comprehensive income

     

857 

       

Purchase of treasury stock

    

(295) 

(295)

Proceeds from stock options issued out

      
 

of treasury

 

(41)   

  

102  

61 

       

Balance March 31, 2007

$1,887  

$9,604    

$31,766  

$  (47)

$(8,140) 

$35,070 




3


PSB Holdings, Inc.

Consolidated Statements of Cash Flows

Three months ended March 31, 2007 and 2006 – unaudited


(dollars in thousands)

2007  

2006  

   

Cash flows from operating activities:

  
   
 

Net income

$     799 

$     738 

 

Adjustments to reconcile net income to net cash provided by (used in ) operating activities:

  
 

Provision for depreciation and net amortization

395 

421 

 

Provision for loan losses

120 

135 

 

Deferred net loan origination costs

(126)

(131)

 

Gain on sale of loans

(89)

(89)

 

Provision for servicing right valuation allowance

(6)

(13)

 

Gain on sale of premises and equipment

–    

(1)

 

Gain on sale of foreclosed assets

(4)

–    

 

Increase in cash surrender value of life insurance

(60)

(46)

 

Changes in operating assets and liabilities:

  
 

Accrued interest receivable

(281)

(123)

 

Other assets

(230)

136 

 

Other liabilities

(481)

(1,064)

   
 

Net cash provided by (used in) operating activities

37 

(37)

   

Cash flows from investing activities:

  
   
 

Proceeds from sale and maturities of securities available for sale

3,388 

1,793 

 

Payment for purchase of securities available for sale

(2,302)

(4,407)

 

Net increase in loans

(4,288)

(6,825)

 

Capital expenditures

(184)

(52)

 

Proceeds from sale of premises and equipment

–    

1 

 

Proceeds from sale of foreclosed assets

124 

–    

 

Purchase of bank-owned life insurance

(778)

–    

   
 

Net cash used in investing activities

(4,040)

(9,490)



4


Consolidated Statements of Cash Flows, continued


Cash flows from financing activities:

  
   
 

Net decrease in non-interest-bearing deposits

(4,353)

(5,599)

 

Net increase (decrease) in interest-bearing deposits

(2,848)

897 

 

Proceeds from long-term FHLB advances

–    

4,000 

 

Repayments of long-term FHLB advances

(10,000)

(6,000)

 

Net increase in other borrowings

8,194 

1,444 

 

Proceeds from exercise of stock options

61 

18 

 

Purchase of treasury stock

(295)

(123)

   
 

Net cash used in financing activities

(9,241)

(5,363)

   

Net decrease in cash and cash equivalents

(13,244)

(14,890)

Cash and cash equivalents at beginning

25,542 

26,604 

   

Cash and cash equivalents at end

$ 12,298 

$ 11,714 

   

Supplemental cash flow information:

  
   

Cash paid during the period for:

  
 

Interest

$   4,049 

$   3,560 

 

Income taxes

275 

435 

   

Noncash investing and financing activities:

  
   
 

Loans charged off

$          8 

$          1 

 

Loans transferred to foreclosed assets

13 

509 




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.  Dollar amounts are in thousands, except per share amounts.  


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 Annual Report on Form 10-K for the year ended December 31, 2006, 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


Under the terms of an incentive stock option plan adopted during 2001, shares of unissued common stock were 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.  No additional shares of common stock remain reserved for future grants under the option plan approved by the shareholders.  As of March 31, 2007, 15,762 options were outstanding and eligible to be exercised at a weighted average exercise price of $16.10 per share.  During the three months ended March 31, 2007, and 2006, options were exercised with respect to 3,824 shares at an average price of $15.98 per share (in 2007), and with respect to 1,177 shares at an average price of $15.82 per share (in 2006).  The total estimated intrinsic value of options exercised was $53 and $17 during the three months ended March 31, 2007 and 2006, respectively.  


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.  



6


Presented below are the calculations for basic and diluted earnings per share:


 

Three months ended

(dollars in thousands, except per share data – unaudited)

March 31,

 

2007

2006

     

Net income

$         799

 

$         738

 
     

Weighted average shares outstanding

1,589,980

 

1,705,290

 

Effect of dilutive stock options outstanding

7,425

 

9,831

 
     

Diluted weighted average shares outstanding

1,597,405

 

1,715,121

 
     

Basic earnings per share

$        0.50

 

$        0.43

 

Diluted earnings per share

$        0.50

 

$        0.43

 


NOTE 4 – COMPREHENSIVE INCOME


Comprehensive income as defined by current accounting standards for the three months ended March 31, 2007 and 2006 is as follows:


 

Three months ended

 

March 31,

(dollars in thousands – unaudited)

 2007

 2006

     

Net income

$ 799

 

$ 738 

 

Unrealized gain (loss) on securities available for sale, net of tax

58

 

(138)

 
     

Comprehensive income

$ 857

 

$ 600 

 


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 only to the extent that payments are received and the collection of principal becomes reasonably assured.  Interest income recognition on loans considered to be impaired under current accounting standards is consistent with the recognition on all other loans.



7


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 PSB 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 ASSETS


Real estate and other property 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 or other property 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 assets.


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 the Bank’s interest deductions for such years.  The IRS asserts that PSB owes an additional $184 of tax and interest.  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 deduction.  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 States Tax Court contesting such adjustment.  In November 2006, the facts in the Tax Court case were fully stipulated, and in December 2006, both PSB and the IRS filed opening and reply briefs in the case.  A decision from the Tax Court judge handling the case is expected in 2007.  PSB believes in accordance with FIN 48 (discussed in Note



8


11 below) that it is not more likely than not that the IRS will prevail, therefore no additional tax expense has been recorded.


NOTE 8 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES


All derivative instruments are recorded at their fair values.  If derivative instruments are designated as hedges of fair values, both the change in the fair value of the hedge and the hedged item are included in current earnings.  Fair value adjustments related to cash flow hedges are recorded in other comprehensive income and reclassified to earnings when the hedged transaction is reflected in earnings.  Ineffective portions of hedges are reflected in income.


NOTE 9 – 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 10 – HOLDING COMPANY LINE OF CREDIT


PSB entered into a line of credit at the parent holding company level for advances up to $1 million which expires in March 2008.  The line carries a variable rate of interest based on changes in the 30-day London Interbank Offered Rate (LIBOR) plus 1.50%.  As of March 31, 2007, no advances were outstanding on the line.


NOTE 11 – CURRENT YEAR ACCOUNTING CHANGES


In March 2006, FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets, as an amendment to SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.  SFAS No. 156 allows PSB a choice in accounting for servicing rights, either under the amortization method (lower of cost or market as is currently used by PSB) or by the fair value method.  PSB adopted SFAS No. 156 on January 1, 2007, and made the election to continue to account for its mortgage servicing rights under the amortization method.  Adoption of SFAS No. 156 did not have a material effect on PSB’s financial condition or results of operations.


In June 2006, FASB issued Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48).  FIN 48 clarifies how uncertain tax positions and the potential liabilities associated with such positions should be reflected in earnings and disclosed in the notes to the financial statements.  PSB adopted FIN 48 on January 1, 2007.  PSB did not maintain excess tax reserves and no adjustment to the January 1, 2007, balance of retained earnings as a cumulative change in accounting principal was made.  The adoption of FIN 48 did not have a material effect on PSB’s financial condition or results of operations.


NOTE 12 – STRUCTURED REPURCAHSE AGREEMENT LIABILITY


In March 2007, PSB entered into a new 4.65% fixed-rate structured repurchase agreement of $7 million classified as Other Borrowings on the March 31, 2007 Consolidated Balance Sheets.  The repurchase agreement provides the issuer with a one-time put option to PSB in March 2008, with a final agreement maturity in March 2010.  Securities available for sale of approximately $7.7 million were pledged in connection with the repurchase agreement.




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 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.  This Quarterly Report on Form 10-Q describes the business of PSB Holdings, Inc. and its subsidiary Peoples State Bank as in effect on March 31, 2007, 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 “Forward-Looking Statements” in Item I of PSB’s Form 10-K for the year ended December 31, 2006 (“2006 Form 10-K”) and, from time to time, in PSB’s other filings with the Securities and Exchange Commission.  PSB does not intend to update forward-looking statements.  Additional risk factors relating to an investment in PSB common stock are described under Item 1A of the 2006 Form 10-K.


Management Discussion and Analysis – 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 analysis presented in this Quarterly Report on Form 10-Q.


2007 first quarter March net income was $.50 per diluted share, down from the December 2006 quarter of $.54 per share, but up from $.43 per share in the March 2006 quarter.  Earnings for last year’s March 2006 quarter included a special item from recording an interest rate swap at fair value without the ability to offset the liability against the hedged certificate of deposit.  Initially marking the swap to fair value during the March 2006 quarter lowered net income by $.07 per share.  Excluding this item, diluted earnings per share would have been $.50 for the quarter ended March 31, 2006.  This swap liability was prepaid in March 2007.


Return on average assets based on reported net income for the quarter ended March 31, 2007 and 2006 was .65% and .60%, respectively.  Return on equity based on reported net income for the quarter ended March 31, 2007 and 2006 was 9.34% and 8.34%, respectively.  


Declining or flat net income compared to prior quarters is due to rising non-interest expenses while net interest income has remained flat.  Although net interest margin has increased slightly, average earning assets remain at levels less than in the March 2006 quarter, resulting in flat tax adjusted net interest income.  Non-interest expenses in the quarter ended March 31, 2007, included three special expense items, including consulting costs related to Sarbanes-Oxley Act Section 404, a long-term donation commitment for a qualifying community reinvestment project, and legal costs relative to PSB’s ongoing Tax Court issue.  These three expenses totaled $163 in the March 2007 quarter, or $.06 per share.  Earnings are expected to increase modestly during the remainder of 2007 from earning asset growth while expenses remain similar to current levels.  




10


Assets at March 31, 2007, were $493.0 million, compared to $500.3 million at March 31, 2006, a decrease of $7.3 million or 1.5%.  Total loans receivable were $374.3 million at March 31, 2007 compared to $378.6 million at March 31, 2006, a decrease of $4.3 million or 1.1%.  On a linked quarter basis, average loans receivable increased from $370.3 million in the December 2006 quarter to $372.4 million in the March 2007 quarter, an increase of .6% (2.3% on an annualized basis).  Commercial purpose loans (including commercial real estate loans) provided the increase in average loans receivable over the December 2006 quarter.


Noninterest bearing demand deposits declined approximately $4.4 million as of March 31, 2007, compared to prior quarter ended December 31, 2006.  Business demand balances led the decline which was offset slightly by an increase in individual retail demand deposits.  Wholesale funding, including brokered deposits, FHLB advances, and structured repurchase agreements, declined approximately $7.5 million.  Federal funds sold totaling $9.8 million held at December 31, 2006, supported repayment of the wholesale funds and decline in demand deposits during the March 2007 quarter.  However, during the remainder of 2007, PSB expects to require increased use of wholesale funding for loan growth not able to be fully supported by local deposit growth.


Quarterly net interest margin of 3.13% increased over prior year March 2006 margin of 3.10% and increased on a linked quarter basis to the December 2006 net margin of 3.06%.  The March 2007 margin increase compared to the December 2006 quarter was due to increase in loan yields from 6.90% in the December 2006 quarter to 7.09%, the first quarterly average above 7.00% since the quarter ended December 2002.  Offsetting a portion of the increase in yield on earning assets was an increase in interest bearing demand deposit costs due to seasonal municipal and government balances from annual tax collections.  Such balances generally earn higher, negotiated interest rates.  Therefore, savings and demand deposits costs increased from 2.80% in the December 2006 quarter to 3.08% in the March 2007 quarter.  During the remainder of 2007, increases in yields on both loans and interest-bearing deposits are expected to moderate with net interest margin continuing at levels seen during the current March 2007 quarter.


Noninterest income in March 2007 excluding the change in fair value of interest rate swap declined $18 (2.2%) to $809, from $827 in the March 2006 quarter.  Mortgage banking and commissions on sale of investment and insurance products led the decline.  Despite a reduction in salaries and employee benefits expense of $77 (4.2%) during the March 2007 quarter compared to the March 2006 quarter, total noninterest expenses increased $142, or 4.8%.  Noninterest expenses as a percent of average assets were 2.51% and 2.38% during the quarters ended March 31, 2007, and 2006, respectively.  Operating expenses increased during March 2007 from three separate factors accounting for a total of $163 increase in expense over the March 2006 quarter ($.06 per share after tax benefits) as mentioned previously.  


Overall loan portfolio credit quality improved during the March 2007 compared to recent quarters, although total nonperforming assets at March 31, 2007, of $3,989 exceeded those at March 31, 2006, of $3,655.  PSB’s provision for loan losses was $120 in the first quarter 2007, compared to a provision of $135 in the first quarter 2006.  Annualized net charge-offs (recoveries) were (.01%) and .00% during the March 2007 and 2006 quarters, respectively.  At March 31, 2007, the allowance for loan losses was 1.22% of total loans, compared to 1.13% a year earlier.  PSB continues to work out some larger problem credits and foreclosed properties and expects to receive payout without loss on the largest of these credits in the June 2007 quarter.  




11


Management Discussion and Analysis – Statistical Tables and Analysis


BALANCE SHEET


At March 31, 2007 total assets were $492,975, a decrease of $8,865, or 1.8%, from December 31, 2006.  Changes in assets since December 31, 2006 consisted of:


 

Three months ended

Increase (decrease) in assets ($000s)

March 31, 2007

 

$

%

   

Commercial real estate mortgage loans

$   3,988 

 

2.5%

 

Commercial, industrial and agricultural loans

1,030 

 

1.0%

 

Bank-owned life insurance

838 

 

14.2%

 

Other assets (various categories)

292 

 

1.5%

 

Residential real estate mortgage and home equity loans

(792)

 

-0.7%

 

Investment securities

(977)

 

-1.2%

 

Cash and cash equivalents

(13,244)

 

-51.9%

 
     

Total decrease in assets

$  (8,865)

 

-1.8%

 


The change in net assets was supported by changes in funding sources during the three months ended March 31, 2007 as follows:


 

Three months ended

Increase (decrease) in liabilities and equity ($000s)

March 31, 2007

 

$

%

   

Other borrowings

$    8,194 

 

205.1%

 

Stockholders’ equity

623 

 

1.8%

 

Retail certificates of deposit > $100

421 

 

0.8%

 

Other liabilities and debt (various categories)

(481)

 

-4.0%

 

Core deposits (including MMDA)

(3,113)

 

-1.1%

 

Wholesale certificates of deposit

(4,509)

 

-6.6%

 

FHLB advances

(10,000)

 

-16.7%

 
     

Total decrease in liabilities and stockholders’ equity

$   (8,865)

 

-1.8%

 


During the March 2007 quarter, PSB used excess cash and cash equivalents to paydown wholesale funding on a net basis while funding commercial purpose loan growth.  Local deposits declined during the quarter and are not expected to fully fund loan growth during the remainder of 2007.  Therefore, the wholesale funding repaid during recent periods of loan paydowns is expected to again be utilized to the extent local deposit growth does not support commercial loan growth.  




12


Table 1:  Period-End Loan Composition


 

March 31,

 

March 31,

 

December 31, 2006

 

Dollars

Dollars

 

Percentage of total

  

Percentage

(dollars in thousands)

2007

2006

 

2007

2006

 

Dollars

of total

         

Commercial, industrial and agricultural

$102,010  

$ 92,799  

 

26.9% 

24.2% 

 

$100,980 

26.9%  

Commercial real estate mortgage

163,939  

174,091  

 

43.1% 

45.5% 

 

159,951 

42.6%  

Residential real estate mortgage

94,787  

96,587  

 

25.0% 

25.2% 

 

96,017 

25.6%  

Residential real estate loans held for sale

688  

–     

 

0.2% 

0.0% 

 

1,001 

0.3%  

Consumer home equity

13,354  

12,724  

 

3.5% 

3.3% 

 

12,603 

3.4%  

Consumer and installment

4,774  

6,758  

 

1.3% 

1.8% 

 

4,676 

1.2%  

         

Totals

$379,552  

$382,959  

 

100.0% 

100.0% 

 

$375,228 

100.0%  


The loan portfolio is PSB’s primary asset subject to credit risk.  PSB’s process for monitoring credit risks includes quarterly analysis of loan quality, delinquencies, nonperforming 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.  All payments received on nonaccrual loans are applied directly to principal 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 $756 to $3,989 at March 31, 2007, compared to December 31, 2006, but increased $334 from March 31, 2006.  PSB worked out of several nonaccrual loans during the March 2007 quarter and expects to be repaid during the June 2007 quarter on the largest nonaccrual loan currently in the March 31, 2007, portfolio.  During the March 2007, quarter, approximately 81% of the net decrease in nonaccrual loans as of March 31, 2007, compared to December 31, 2006, came from repayment of three larger problem credits.  Following repayment of the largest nonaccrual loan during the upcoming June quarter, nonperforming assets as a percentage of total assets is expected to decline to less than .75% as of June 30, 2007.  


Due to PSB’s accounting policy to apply all payments received on nonaccrual loans to principal, repayment or refinance of large nonaccrual loans can substantially increase loan interest income in the quarter repaid due to recapture of interest income.  During the March 2007 quarter, net interest income increased approximately $36 from repayment of the three larger problem credits.  Anticipated repayment of the largest nonaccrual credit held as of March 31, 2007, during the June quarter is expected to increase net interest income approximately $64 during the June 2007 quarter.




13


Table 2:  Allowance for Loan Losses


 

Three months ended

 

March 31,

(dollars in thousands)

2007

2006

     

Allowance for loan losses at beginning

$4,478 

 

$4,180  

 
     

Provision for loan losses

120 

 

135  

 

Recoveries on loans previously charged-off

16 

 

10  

 

Loans charged off

(8)

 

(1) 

 
     

Allowance for loan losses at end

$4,606 

 

$4,324  

 


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), and 2) foreclosed assets.


Table 3:  Nonperforming Assets


 

March 31,

 

December 31,

(dollars in thousands)

2007

2006

 

2006

        

Nonaccrual loans

$3,633 

 

$2,457 

  

$4,281 

 

Accruing loans past due 90 days or more

–    

 

–    

  

–    

 

Restructured loans not on nonaccrual

–    

 

316 

  

–    

 
        

Total nonperforming loans

3,633 

 

2,773 

  

4,281 

 

Foreclosed assets

356 

 

882 

  

464 

 
        

Total nonperforming assets

$3,989 

 

$3,655 

  

$4,745 

 
        

Nonperforming loans as a % of gross loans receivable

0.96% 

 

0.72% 

  

1.14% 

 
        

Total nonperforming assets as a % of total assets

0.81% 

 

0.73% 

  

0.95% 

 


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.  Retail and local deposits are the primary source of funding.  Retail and local deposits were 65.1% of total assets at March 31, 2007 compared to 64.5% of total assets at December 31, 2006, and 65.9% at March 31, 2006.  Federal Home Loan Bank advances, broker and national certificates of deposit, and structured repurchase agreements represent a significant portion of PSB’s total funding ability.  Despite paydown of net wholesale funding during the March 2007 quarter, loan growth is expected to outpace local deposit growth during the remainder of 2007, thereby increasing use of wholesale funding.




14


Table 4:  Period-end Deposit Composition


 

March 31,

 

December 31,

(dollars in thousands)

2007

 

2006

 

2006

 

$

%

 

$

%

 

$

%

         

Non-interest bearing demand

$  50,730 

13.2%

 

$  55,746 

14.1%

 

$  55,083 

14.1%

Interest-bearing demand and savings

80,642 

21.0%

 

84,114 

21.2%

 

78,876 

20.2%

Money market deposits

66,967 

17.4%

 

64,704 

16.3%

 

67,050 

17.1%

Retail time deposits less than $100

70,718 

18.4%

 

69,835 

17.6%

 

71,161 

18.2%

         

Total core deposits

269,057 

70.0%

 

274,399 

69.2%

 

272,170 

69.6%

Retail time deposits $100 and over

51,735 

13.5%

 

55,137 

13.9%

 

51,314 

13.1%

Broker & national time deposits less than $100

1,335 

0.3%

 

1,529 

0.4%

 

1,532 

0.4%

Broker & national time deposits $100 and over

62,087 

16.2%

 

64,769 

16.5%

 

66,399 

16.9%

         

Totals

$384,214 

100.0%

 

$395,834 

100.0%

 

$391,415 

100.0%


Wholesale funding generally carries higher interest rates than local funding, so loan growth supported by wholesale funds often generates lower net interest spreads than loan growth supported by local funds.  However, wholesale funds provide PSB the ability to quickly raise large funding blocks and to match loan terms to minimize interest rate risk and avoid the higher incremental cost to existing deposits from simply increasing retail rates to raise local deposits.  Rates paid on local deposits are significantly impacted by competitor interest rates and the local economy’s ability to grow in a way that supports deposit needs for all local banks.  


To increase local deposits while minimizing existing deposit incremental costs, PSB has sought to raise local deposits by payment of premium interest rates on interest bearing demand (NOW) and money market deposits from local governments, companies, and private individuals able to maintain high compensating balances.  Some of these deposits are required to be collateralized and all carry an interest rate that adjusts with overall market rates.  Because the local governmental entities are dependent on local tax revenue and state funding for operations, balances within these accounts may be cyclical during the year.  High-yield NOW and money market deposits increased $5,287, to $59,913 at March 31, 2007, from $54,626 at December 31, 2006, but declined $775 from $60,688 at March 31, 2006.  These high yield accounts have tiered interest rates which pay the highest rate only on account balances generally in excess of $100.  These accounts do not include PSB’s standard retail money market accounts which pay higher rates, but on significantly lower tiered balances.  The high-yield balances account for a significant percentage of PSB’s interest bearing demand and savings and money market accounts dollars.  High yield balances were 41%, 37%, and 41% of total interest bearing demand and savings and money market accounts as of March 31, 2007, December 31, 2006, and March 31, 2006, respectively.




15


During 2006, PSB began to offer a retail high yield MMDA deposit account in response to local competitive pressure and rising market interest rates for such funds.  High yield MMDA dollars increased from $18,791 at March 31, 2006, to $34,210 at March 31, 2007.  However, it appears a significant portion of the account growth came from existing MMDA dollars previously held by customers in PSB’s original “core” MMDA account.  At March 31, 2006, the original “core rate” MMDA held $33,438 of balances which has declined to $19,696 of balances as of March 31, 2007.  PSB expects this type of disintermediation to continue during 2007.


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 $10,374 at March 31, 2007, $10,367 at December 31, 2006, and $11,077 at March 31, 2006.  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.  


PSB’s internal 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 12.9%, 13.5%, and 13.3% at March 31, 2007, December 31, 2006, and March 31, 2006, respectively.  Although use of brokered deposits declined in the March 2007 quarter, such balances are expected to increase during the remainder of 2007 as planned loan growth is expected to exceed local deposit growth.


Table 5:  Summary of Balance by Significant Deposit Source


 

March 31,

 

December 31,

(dollars in thousands)

2007

2006

 

2006

      

Total time deposits $100 and over

$113,822 

$119,906

 

$117,713 

 

Total broker and national time deposits

63,422 

66,298

 

67,931 

 

Total retail time deposits

122,453 

124,972

 

122,475 

 

Core deposits, including money market deposits

269,057 

274,399

 

272,170 

 


Table 6:  Change in Deposit Balance since Prior Period Ended


 

March 31, 2006

 

December 31, 2006

(dollars in thousands)

$

%

 

$

%

      

Total time deposits $100 and over

$(6,084)  

-5.1%

 

$(3,891)  

-3.3%

Total broker and national time deposits

(2,876)  

-4.3%

 

(4,509)  

-6.6%

Total retail time deposits

(2,519)  

-2.0%

 

(22)  

0.0%

Core deposits, including money market deposits

(5,342)  

-1.9%

 

(3,113)  

-1.1%




16


Table 7:  Available but Unused Funding Sources other than Retail Deposits


 

March 31, 2007

 

December 31, 2006

 

Unused, but

Amount

 

Unused, but

Amount

(dollars in thousands)

Available

Used

 

Available

Used

        

Overnight federal funds purchased

$  30,986

 

$    1,514 

 

$  32,500 

 

$        –    

FHLB advances under blanket mortgage lien

34,099

 

50,000 

 

23,783 

 

60,000 

Repurchase agreements

5,047

 

10,675 

 

25,092 

 

3,995 

Wholesale market time deposits

35,173

 

63,422 

 

32,437 

 

67,931 

        

Total available but unused funds

$105,305

 

$125,611 

 

$113,812 

 

$131,926 

        

Funding as a percent of total assets

21.4%

 

25.5% 

 

22.7% 

 

26.3% 


Total FHLB advances in excess of approximately $60,000 require the purchase of additional FHLB stock equal to 5% of the advance amount.  Under the FHLB’s current capital plan, FHLB stock dividends have declined to a return under 3% of outstanding stock par value.  Therefore, significant additional FHLB advances may carry additional cost relative to other wholesale borrowing alternatives due to the lower than market stock dividend rate currently paid.


The table below presents maturity repricing information as of March 31, 2007.  The following repricing methodologies should be noted:


1.

Money market deposit accounts are considered fully repriced within 90 days.  Certain 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


 

March 31, 2007

(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

$142,839 

$  33,621   

$  51,587    

$  66,058

$  73,304

 

$  12,143  

 

$379,552

 

Securities

5,501 

2,644   

8,298    

15,166

25,630

 

21,793  

 

79,032

 

FHLB stock

3,017 

       

3,017

 

CSV bank-owned life

         
 

insurance

      

6,738  

 

6,738

 

Other earning assets

2,274 

       

2,274

          

Total

$153,631 

$  36,265   

$  59,885    

$  81,224

$  98,934

 

$  40,674  

 

$470,613

          

Cumulative rate

         
 

sensitive assets

$153,631 

$189,896   

$249,781    

$331,005

$429,939

 

$470,613  

  
          

Interest-bearing liabilities

         
 

Interest-bearing deposits

$149,686 

$  47,078   

$  35,824    

$  31,326

$  35,184

 

$  34,386  

 

$333,484

 

FHLB advances

2,000 

–      

12,000    

16,000

20,000

 

–     

 

50,000

 

Other borrowings

2,832 

300   

458    

760

7,839

 

–     

 

12,189

 

Junior subordinated

         
 

debentures

      

7,732  

 

7,732

          

Total

$154,518 

$  47,378   

$  48,282    

$  48,086

$  63,023

 

$  42,118  

 

$403,405

          

Cumulative interest

         
 

sensitive liabilities

$154,518 

$201,896   

$250,178    

$298,264

$361,287

 

$403,405  

  
          

Interest sensitivity gap for

         
 

the individual period

$     (887)

$(11,113)  

$  11,603    

$  33,138

$  35,911

 

$   (1,444) 

  
         

Ratio of rate sensitive assets

        
 

to rate sensitive liabilities

         
 

for the individual period

99.4% 

76.5%   

124.0%    

168.9%

157.0%

 

96.6%  

  
           

Cumulative interest

         
 

sensitivity gap

$     (887)

$(12,000)  

$      (397)   

$  32,741

$  68,652

 

$  67,208  

  
          

Cumulative ratio of rate

         
 

sensitive assets to

         
 

rate sensitive liabilities

99.4% 

94.1%   

99.8%    

111.0%

119.0%

 

116.7%  

  


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.




18


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 March 31, 2007, December 31, 2006, and March 31, 2006, was 7.4%, 10.1%, and 5.4%, respectively.


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.  The following table presents the projected impact to net interest income by certain rate change scenarios and the change to the one year cumulative ratio of rate sensitive assets to rate sensitive liabilities.  


Table 9:  Net Interest Margin Rate Simulation Impacts


Period Ended:

March 2007

December 2006

March 2006

    

Cumulative 1 year gap ratio

   
 

Base

 100%

   95%

   99%

 

Up 200

   94%

   92%

   97%

 

Down 200

 106%

 103%

 107%

     

Change in Net Interest Income – Year 1

  
 

Up 200 during the year

-0.80%

-2.90%

-1.20%

 

Down 200 during the year

-0.80%

 0.80%

-1.00%

     

Change in Net Interest Income – Year 2

  
 

No rate change (base case)

 2.80%

 4.60%

5.40%

 

Following up 200 in year 1

 0.80%

-0.70%

3.60%

 

Following down 200 in year 1

-2.20%

 3.10%

1.20%


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 certain 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.  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 March 31, 2007, December 31, 2006, and March 31, 2006, PSB’s core funding utilization ratio was projected to be 54%, 57%, and 51%, respectively, after a rate increase of 200 basis points and was therefore within policy requirements.




19


CAPITAL RESOURCES


Stockholders’ equity increased $623 to $35,070 during the three months ended March 31, 2007.  Net book value per share increased from $21.67 per share at December 31, 2006, to $22.14 per share at March 31, 2007.  During the quarter, $295 was used to repurchase 10,000 shares of PSB stock at an average price of $29.53 per share.  On April 16, 2007, PSB announced an expansion of its annual share repurchase plan during the remainder of 2007.  Under the customary repurchase plan, PSB has repurchased 1% of outstanding shares annually.  However, for the remainder of 2007, PSB is authorized to buyback an additional 40,000 shares (approximately 2.5% of outstanding shares) from time to time at current market prices.


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 March 31, 2007, and December 31, 2006, the 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 to average assets was 7.02% during the March 2007 quarter, 6.96% during the December 2006 quarter, and 7.24% during the March 2006 quarter.


During the three months ended March 31, 2007, 3,824 treasury shares were re-issued to fund an exercise of employee stock options, exercised at an average price of $15.98 per share.  These option exercises had a total intrinsic value of $53 upon exercise.  Refer to Note 2 to the Consolidated Financial Statements for additional details on the PSB stock compensation plan.


Table 10:  Capital Ratios – Consolidated Holding Company


 

March 31,

 

December 31,

(dollars in thousands)

2007

2006

 

2006

     

Stockholders’ equity

$  35,070 

 

$  35,980 

  

$  34,447  

 

Junior subordinated debentures, net

7,500 

 

7,500 

  

7,500  

 

Disallowed mortgage servicing right assets

(90)

 

(89)

  

(91) 

 

Unrealized loss on securities available for sale

47 

 

680 

  

105  

 
        

Tier 1 regulatory capital

42,527 

 

44,071 

  

41,961  

 

Add:  allowance for loan losses

4,606 

 

4,324 

  

4,478  

 
        

Total regulatory capital

$  47,133 

 

$  48,395 

  

$  46,439  

 
        

Total assets

$492,975 

 

$500,331 

  

$501,840  

 

Disallowed mortgage servicing right assets

(90)

 

(89)

  

(91) 

 

Unrealized loss on securities available for sale

47 

 

680 

  

105  

 
        

Tangible assets

$492,932 

 

$500,922 

  

$501,854  

 
        

Risk-weighted assets (as defined by current regulations)

$393,876 

 

$393,001 

  

$390,040  

 
        

Tier 1 capital to average tangible assets (leverage ratio)

8.55% 

 

8.77% 

  

8.43%  

 

Tier 1 capital to risk-weighted assets

10.80% 

 

11.21% 

  

10.76%  

 

Total capital to risk-weighted assets

11.97% 

 

12.31% 

  

11.91%  

 



20





RESULTS OF OPERATIONS


Net income for the quarter ended March 31, 2007, was $.50 per diluted share, or $799, as compared to $.43 per diluted share, or $738, in the first quarter of 2006.  The March 2006 earnings were significantly impacted by a $205 charge to record an interest rate swap at fair value.  It was determined during the quarter that the hedge accounting previously applied on the swap and hedged broker certificate did not meet the requirements under current accounting rules.  Therefore, the swap was marked to fair value in the March 2006 quarter while the hedged certificate was retained at net book value.  After tax benefits, this charge decreased earnings $124.  Quarterly net income before this special item was $862 in March 2006, or $.50 per diluted share.  Operating results for the first quarter of 2006 generated an annualized return on average assets of .60% (.70% before the swap adjustment) and an annualized return on average equity of 8.34% (9.75% before the swap adjustment).


Return on average assets based on reported net income for the quarters ended March 31, 2007 and 2006 was .65% and .60%, respectively.  Return on equity based on reported net income for the quarters ended March 31, 2007 and 2006 was 9.34% and 8.34%, respectively.


The following Table 11 presents PSB’s consolidated quarterly summary financial data.




21


Table 11:  Financial Summary

 

Quarter ended – unaudited

 

March 31,

December 31,

September 30,

June 30,

March 31,

(dollars in thousands, except per share data)

2007

2006

2006

2006

2006

Earnings and dividends:

     
      
 

Net interest income

$      3,425

 

$      3,428

 

$      3,396

 

$      3,483

 

$      3,465

 
 

Provision for loan losses

$         120

 

$         120

 

$         120

 

$         120

 

$         135

 
 

Other noninterest income

$         841

 

$         865

 

$         912

 

$         877

 

$         622

 
 

Other noninterest expense

$      3,084

 

$      2,932

 

$      2,784

 

$      3,044

 

$      2,942

 
 

Net income

$         799

 

$         873

 

$         965

 

$         851

 

$         738

 
           
 

Basic earnings per share(3)

$        0.50

 

$        0.55

 

$        0.60

 

$        0.50

 

$        0.43

 
 

Diluted earnings per share(3)

$        0.50

 

$        0.54

 

$        0.60

 

$        0.50

 

$        0.43

 
 

Dividends declared per share(3)

$          –   

 

$        0.32

 

$          –   

 

$        0.32

 

$          –   

 
 

Net book value per share

$      22.14

 

$      21.67

 

$      21.42

 

$      20.29

 

$      21.13

 
           
 

Semi-annual dividend payout ratio

n/a     

 

27.68%

 

n/a     

 

32.22%

 

n/a     

 
 

Average common shares outstanding

1,589,980

 

1,593,320

 

1,600,364

 

1,685,166

 

1,705,290

 
            

Balance sheet – average balances:

          
           
 

Loans receivable, net of allowances for loss

$  372,448

 

$  370,256

 

$  377,528

 

$  382,138

 

$  375,179

 
 

Assets

$  497,349

 

$  497,502

 

$  503,209

 

$  505,586

 

$  502,194

 
 

Deposits

$  387,803

 

$  388,299

 

$  393,093

 

$  394,075

 

$  398,707

 
 

Stockholders' equity

$    34,692

 

$    34,463

 

$    33,363

 

$    35,626

 

$    35,867

 
           

Performance ratios:

          
           
 

Return on average assets(1)

0.65%

 

0.70%

 

0.76%

 

0.68%

 

0.60%

 
 

Return on average stockholders’ equity(1)

9.34%

 

10.05%

 

11.48%

 

9.58%

 

8.34%

 
 

Average tangible stockholders’ equity to

          
 

average assets(4)

7.02%

 

6.96%

 

6.79%

 

7.20%

 

7.24%

 
 

Net loan charge-offs to average loans(1)

-0.01%

 

0.01%

 

-0.04%

 

0.24%

 

0.00%

 
 

Nonperforming loans to gross loans

0.96%

 

1.14%

 

1.15%

 

0.57%

 

0.72%

 
 

Allowance for loan losses to gross loans

1.22%

 

1.20%

 

1.17%

 

1.09%

 

1.13%

 
 

Net interest rate margin(1)(2)

3.13%

 

3.06%

 

2.99%

 

3.06%

 

3.10%

 
 

Net interest rate spread(1)(2)

2.62%

 

2.52%

 

2.47%

 

2.56%

 

2.63%

 
 

Service fee revenue as a percent of

          
 

average demand deposits(1)

2.57%

 

2.39%

 

2.71%

 

2.66%

 

2.29%

 
 

Noninterest income as a percent

          
 

of gross revenue

9.94%

 

10.25%

 

10.85%

 

10.64%

 

8.08%

 
 

Efficiency ratio(2)

69.32%

 

65.68%

 

62.28%

 

67.51%

 

69.42%

 
 

Noninterest expenses to average assets(1)

2.51%

 

2.34%

 

2.19%

 

2.41%

 

2.38%

 
           

Stock price information:

          
           
 

High

$      30.35

 

$      30.75

 

$      32.65

 

$      34.00

 

$      31.05

 
 

Low

$      28.00

 

$      30.15

 

$      30.00

 

$      30.60

 

$      30.50

 
 

Market value at quarter-end

$      28.50

 

$      30.25

 

$      30.35

 

$      32.50

 

$      30.80

 


(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.

(4) Tangible stockholders' equity excludes the impact of cumulative other comprehensive income (loss).



22



NET INTEREST INCOME


Net interest income is the most significant component of earnings.  Tax adjusted net interest income increased $9 from $3,599 for the quarter ended December 31, 2006, to $3,608 for the current quarter ended March 31, 2007, and declined $40 from $3,648 for the quarter ended March 31, 2006.  Net interest income has declined from a year earlier due to a smaller level of average earning assets which declined from $468,533 in the March 2006 quarter to $467,896 in the March 2007 quarter.  Refer to Table 4 and the related discussion in the “Liquidity” section of this Quarterly Report on Form 10-Q for additional rate and run-off information.  Quarterly product balances, yields, and costs are presented in Table 12.


Tax adjusted net interest margin was 3.13% during the first quarter 2007 compared to 3.06% in the December 2006 quarter and 3.10% during the first quarter 2006.  The March 2007 margin increase compared to the December 2006 quarter was due in part to an increase in the average loan rate that exceed ongoing increases in deposit rates.  March 2007 was aided by collection of several loans previously classified as nonaccrual loans as discussed previously following Table 1 in the discussion of Balance Sheet Changes.  Collection of these loans increased loan income by $36 from cumulative recognition of past interest collected while the loan was in nonaccrual.  March 2007 net margin would have been 3.10% before repayment of these problem loans.


After a period of regularly increasing short term rates in response to Federal Reserve discount rate increase, the pace of regular quarterly yield and cost increases has begun to slow.  However, local deposit pricing continues to bring deposits, and particularly certificate of deposit rates, to levels near to equivalent wholesale funding “all in” cost.  Loan yield in the quarter ended March 31, 2007, was 7.09% compared to 6.55% a year ago, an increase of 54 basis points.  Rate paid on interest-bearing deposits was 4.06% during the first quarter 2007 compared to 3.57% a year ago, an increase of 49 basis points.





23


Table 12:  Net Interest Income Analysis (Quarter)


 

Quarter ended March 31, 2007

 

Quarter ended March 31, 2006

 

Average

 

Yield/

 

Average

 

Yield/

(dollars in thousands)

Balance

Interest

Rate

 

Balance

Interest

Rate

Assets

           

Interest-earning assets:

           
 

Loans(1)(2)

$376,981 

 

$6,593

 

7.09%

 

$379,428 

 

$6,131

 

6.55%

 

Taxable securities

49,242 

 

616

 

5.07%

 

56,458 

 

604

 

4.34%

 

Tax-exempt securities(2)

30,875 

 

462

 

6.07%

 

25,791 

 

385

 

6.05%

 

FHLB stock

3,017 

 

23

 

3.09%

 

3,017 

 

19

 

2.55%

 

Other

7,781 

 

106

 

5.52%

 

7,909 

 

88

 

4.51%

            
 

Total(2)

467,896 

 

7,800

 

6.76%

 

472,603 

 

7,227

 

6.20%

            

Non-interest-earning assets:

           
 

Cash and due from banks

10,993 

     

11,317 

    
 

Premises and equipment, net

11,468 

     

12,554 

    
 

Cash surrender value ins

6,370 

     

4,822 

    
 

Other assets

5,155 

     

5,147 

    
 

Allowance for loan losses

(4,533)

     

(4,249)

    
            
 

Total

$497,349 

     

$502,194 

    
            

Liabilities & stockholders’ equity

           

Interest-bearing liabilities:

           
 

Savings and demand deposits

$  83,688 

 

$  636

 

3.08%

 

$ 87,754 

 

$   595

 

2.75%

 

Money market deposits

67,900 

 

564

 

3.37%

 

66,580 

 

433

 

2.64%

 

Time deposits

188,435 

 

2,201

 

4.74%

 

192,059 

 

1,908

 

4.03%

 

FHLB borrowings

56,656 

 

614

 

4.40%

 

52,533 

 

534

 

4.12%

 

Other borrowings

6,449 

 

64

 

4.02%

 

3,928 

 

28

 

2.89%

 

Junior subordinated debentures

7,732 

 

113

 

5.93%

 

7,732 

 

113

 

5.93%

            
 

Total

410,860 

 

4,192

 

4.14%

 

410,586 

 

3,611

 

3.57%

            

Non-interest-bearing liabilities:

           
 

Demand deposits

47,780 

     

52,314 

    
 

Other liabilities

4,017 

     

3,427 

    
 

Stockholders’ equity

34,692 

     

35,867 

    
             
 

Total

$497,349 

     

$502,194 

    
          

Net interest income

 

$3,608

    

$3,616

  

Rate spread

  

2.62%

   

2.63%

Net yield on interest-earning assets

  

3.13%

   

3.10%


(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%.




24


Table 13:  Interest Expense and Expense Volume and Rate Analysis (Year to Date)


 

2007 compared to 2006

 

increase (decrease) due to(1)

(dollars in thousands)

Volume

Rate

Net

       

Interest earned on:

      
 

Loans(2)

$(43)

 

$505 

 

$462  

 
 

Taxable securities

(90)

 

102 

 

12  

 
 

Tax-exempt securities(2)

76 

 

1 

 

77  

 
 

FHLB stock

–   

 

4 

 

4  

 
 

Other interest income

(2)

 

20 

 

18  

 
       

Total

(59)

 

632 

 

573  

 
       

Interest paid on:

      
 

Savings and demand deposits

(31)

 

72 

 

41  

 
 

Money market deposits

11 

 

120 

 

131  

 
 

Time deposits

(42)

 

335 

 

293  

 
 

FHLB borrowings

45 

 

35 

 

80  

 
 

Other borrowings

25 

 

11 

 

36  

 
 

Junior subordinated debentures

–   

 

–   

 

–    

 
       

Total

8 

 

573 

 

581  

 
       

Net interest earnings

$(67)

 

$ 59 

 

$  (8) 

 


(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 $120 for the three months ended March 31, 2007, and $135 for the three months ended March 31, 2006.  Annualized net charge-offs (recoveries) as a percentage of average loans outstanding were (.01%) during the three months ended March 31, 2007, compared to .00% for the March 2006 quarter.


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.  The current quarterly level of loan loss provision is expected to continue during the remainder of 2007.



25


NONINTEREST INCOME


Quarterly noninterest income increased $219 in the March 2007 quarter to $841 from $622 in the March 2006 quarter.  However, the March 2006 quarter contained a noncash charge of $205 related to the change in fair value of an interest rate swap while the March 2007 quarter contained an increase to income of $32 from the change in swap fair value during the quarter (refer to additional discussion concerning the swap below).  Noninterest income in March 2007 excluding the change in fair value of interest rate swap declined $18 (2.2%) to $809, from $827 in the March 2006 quarter.  Lower mortgage banking and commissions on sale of investment and insurance products led the decline.   


During 2005, PSB entered into an interest rate swap (receive fixed, pay variable payments) to hedge the interest rate risk inherent in a brokered certificate of deposit.  Fair value hedge accounting allows a company to record the change in fair value of the hedged item, in this case, the brokered certificate, as an adjustment to income as an offset to the mark-to-market adjustment on the related interest rate swap.  However, during March 2006, PSB determined this swap did not qualify for hedge accounting.  Eliminating the application of fair value hedge accounting in 2006 reversed the fair value adjustment that was made to the brokered certificate.  Marking the swap liability to fair value generated a charge of $205 ($124 after tax benefits) during the three months ended March 31, 2006.  


As regular monthly swap settlement payments made during the year ended December 31, 2006, reduced the swap liability and as market interest rate expectations reduced the projected swap liability, PSB elected to repay the October 2008 maturity swap in full during the March 2007 quarter with a payment of $115.  At the current 30-day LIBOR rate of 5.32%, PSB would save $86 in settlement payments during the remainder of calendar 2007 by prepaying the swap if this LIBOR rate were to remain unchanged.  Table 14 below summarizes the impact to pre-tax income from interest rate swap activity.


Table 14:  Interest Rate Swap Net Expenss


 

Quarter ended March

(dollars in thousands)

2007

2006

     

Net monthly settlement expense

$ 15 

 

$   8

 

Net change in unrealized fair value liability (income) expense

(32)

 

205

 
     

Total swap (income) expense during the period

$(17)

 

$213

 




26


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 summarizes loan principal serviced for the FHLB by the MPF program as of March 31, 2007.


Table 15:  FHLB Mortgage Partnership Financing (MPF) Program Servicing


  

PSB Credit

FHLB

Mortgage

 

Principal

Enhancement

Funded First

Servicing

As of March 31, 2007 ($000s)

Serviced

Guarantee

Loss Account

Right, net

     

MPF 100 Program (agent program)

  $84,780

  $499

$2,494

$381

MPF125 Program (closed loan program)

    84,728

    922

 1,031

  517

     

Total FHLB MPF serviced loans

$169,508

$1,421

$3,525

$898


FHLB MPF Program elements as a percentage of principal serviced:


 

March 31, 2007

December 31, 2007

As of period ended:

MPF 100

MPF 125

MPF 100

MPF 125

     

PSB credit enhancement guarantee

0.59%

1.09%

0.57%

1.08%

FHLB funded first loss account

2.94%

1.22%

2.85%

1.21%

Multiple of FHLB funded loss account to

    
 

PSB credit enhancement guarantee

4.98

1.12

5.00

1.12

Mortgage servicing right, net

0.45%

0.61%

0.46%

0.61%


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


Despite a reduction in salaries and employee benefits expense of $77 (4.2%) during the March 2007 quarter compared to the March 2006 quarter, total noninterest expenses increased $142, or 4.8%.  Noninterest expenses as a percent of average assets were 2.51% and 2.38% during the quarters ended March 31, 2007, and 2006, respectively.  PSB expects salaries and employee benefits costs to be less than that seen during 2006 as it continues to pursue staffing efficiencies.  Primarily through attrition, PSB expects to lower staffing FTE levels by approximately 5% to 10% by the end of 2007.  Significant savings in health insurance benefits were realized during the March 2007 quarter.  Total health plan benefit expense was $180 in the March 2007 quarter compared to $228 in the March 2006 quarter.  The decrease in expense was due to changes in plan benefits effective January 1, 2007, internal programs to encourage employee wellness, and decreased claims under the self-funded plan.  PSB expects health insurance expense to approximate levels seen during 2006 during the remainder of the current year.




27


Operating expenses increased during March 2007 from three separate factors accounting for a total of $163 increase in expense over the March 2006 quarter ($.06 per share after tax benefits).  Consulting costs relative to compliance with Section 404 of the Sarbanes-Oxley Act (“SOX 404”) were $69 in March 2007 after consulting costs of $26 during the December 2006 quarter.  PSB’s initial SOX 404 implementation date is December 31, 2007.  There were no significant SOX 404 consulting costs in the March 2006 quarter.  PSB expects SOX consulting costs to be at similar levels during the June 2007 quarter.   


In addition, PSB recorded a long-term donation commitment for a qualifying community reinvestment project during March 2007 totaling $44.  Lastly, PSB incurred legal costs relative to its ongoing income tax issue regarding TEFRA interest deductibility currently under Tax Court review totaling $50.  Prior to these legal costs, the Wisconsin Bankers’ Association (WBA) and the Community Bankers’ of Wisconsin (CBW) trade associations had raised member funds and organized reimbursement of legal defense costs during 2006.  PSB and the WBA/CBW intend to work together to continue to raise member funds to support PSB’s legal costs which will be recorded as a reduction to legal expense when received in future quarters.


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, 2006.


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 (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) pursuant to Exchange Act Rule 13a-15.  Based upon, and as of the date of such evaluation, the President and Chief Executive Officer and the Chief Financial Officer concluded that PSB’s disclosure controls and procedures were effective.  There were no changes in PSB’s internal control over financial reporting (as such term is defined in Exchange Act Rule 13a-15(f)) during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, PSB’s internal control over financial reporting.




28


PART II – OTHER INFORMATION


Item 1A.  Risk Factors


In addition to the other information set forth in this report, this report should be considered in light of the risk factors discussed in Part I, “Item 1A.  Risk Factors” in PSB’s Annual Report on Form 10-K for the year ended December 31, 2006, which could materially affect PSB’s business, financial condition, or future results of operations.  The risks described in PSB’s Annual Report on Form 10-K are not the only risks facing PSB.  Additional risks and uncertainties not currently known to PSB or that it currently deems to be immaterial also may materially adversely affect PSB’s business, financial condition, and/or operating results.


Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds


Purchases of Equity Securities


    

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)

(d)(2)

     

January 2007

  –

$   –   

–

16,000

February 2007

  6,000(1)

 30.15

–

16,000

March 2007

  4,000(1)

 28.60

–

16,000

     

Quarterly totals

10,000

$29.53

–

16,000


(1) Purchase made in privately negotiated transaction.

(2) Pursuant to PSB’s annual plan to repurchase up to 1% of shares outstanding at beginning of fiscal year.


Sales of Unregistered Securities


Shares of PSB common stock have been issued pursuant to the exercise by employees or former employees of PSB of options granted under the 2001 Stock Option Plan on the dates and for the exercise prices listed in the following table.  The options and the underlying common stock issued were exempt from registration under the Securities Act of 1933, as amended, pursuant to the exemption afforded by Section 3(a)(11) as all optionees were residents of the state of Wisconsin.


Date

Number of Shares

Price per Share

Aggregate Price

    

1/3/2007

3,263

$15.84

$51,686

3/20/2007

  561

$16.80

$9,425




29


Item 6.  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




30


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.




May 14, 2007

SCOTT M. CATTANACH

Scott M. Cattanach

Treasurer


(On behalf of the Registrant and as

Principal Financial Officer)





31




EXHIBIT INDEX

to

FORM 10-Q

of

PSB HOLDINGS, INC.

for the quarterly period ended March 31, 2007

Pursuant to Section 102(d) of Regulation S-T

(17 C.F.R. §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