June 30, 2009, there has been no business transacted by PSB Capital, Inc. All significant inter-company transactions are eliminated in consolidation. Net income is derived primarily from net interest income, which is the difference between interest earned on the Bank's loan and investment portfolios and its cost of funds, primarily interest paid on deposits and borrowings. The volume of, and yields earned, on loans and investments and the volume of, and rates paid, on deposits determine net interest income.
The Company adopted SFAS 123(R), Accounting for Share Based Payments in 2006. For the first six months of 2009, the Company recorded $161 thousand in share based compensation expense. This compares to $152 thousand for the first six months of 2008.
Financial Condition
Company assets consist of customer loans, investment securities, bank premises and equipment, cash and other operating assets. Total assets increased approximately $29.2 million to $489.7 million at June 30, 2009 from $460.5 million at December 31, 2008. We increased our investment portfolio by approximately $28.2 million to $80.5 million at June 30, 2009 as compared to $52.3 million at December 31, 2008. Our loan portfolio decreased approximately $5.2 million to $369.6 million at June 30, 2009. This was the result of an $11.6 million decrease in commercial real estate loans and an $840 thousand decrease in consumer loans, partially offset by a $5.4 million increase in residential mortgages and a $1.8 million increase in other commercial loans. Loans held for sale increased $1.4 million to $2.5 million at June 30, 2009. The total of all other assets increased approximately $1.8 million at June 30, 2009, due mainly to a $2.3 million increase in Bank premises and equipment. We recently purchased the land at two existing banking facilities that we had previously leased. Other real estate owned (repossessed properties) decreased a little over $400 thousand during the first half of the year, as we began a company-wide campaign focused on the liquidation of these properties. During the first six months of 2009, we experienced net loan charge-offs of $4.8 million. This compares to net charge-offs of $2.8 million during the first six months of 2008 and $5.2 million during the second half of 2008. In addition, at June 30, 2009, we were carrying $35.1 million in non-performing loans compared to $14.0 million at December 31, 2008. This high level of net charge-offs and non-performing loans is the direct result of the continuing unfavorable economic conditions in the state of Michigan, combined with the ongoing problems related to the residential real estate market in southeast Michigan. We have no exposure in the sub-prime mortgage lending market, but through our commercial loan portfolio, we have had a number of relationships with residential real estate developers who have encountered severe problems. During the first half of 2009, we recorded a loan loss provision of $4.8 million compared to a $3.6 million provision during the first half of 2008. Our loan loss reserve as a percentage of total loans has been increased to 1.91% as of June 30, 2009, compared to 1.90% at December 31, 2008 and 1.54% at June 30, 2008. Management believes the reserve is sufficient to meet anticipated future loan losses. The discussions set forth in "Note 3 - Loans" and "Note 4 - Allowance for Possible Loan Losses" in the Financial Statements contained in this report are hereby incorporated by this reference.
Total liabilities increased $33.1 million to $463.5 million at June 30, 2009 from $430.4 million at December 31, 2008. We continue to experience favorable deposit growth without paying above market rates and without soliciting brokered deposits. Total deposits increased $32.8 million to

$445.3 million at June 30, 2009 from $412.5 at December 31, 2008. This was mainly due to a $19.7 million increase in certificates of deposit, a $9.5 million increase in savings deposits and a $5.8 million increase in non-interest bearing deposits, partially offset by a $2.2 million decrease in interest bearing demand balances. We used this increase in deposits primarily to build our investment portfolio.
Financial Results
Three Months Ended June 30, 2009
For the three months ended June 30, 2009, we realized a net loss of $1.452 million compared to a net loss of $645 thousand for the same period in 2008 and a net loss of $1.778 million in the first quarter of 2009. Total interest income decreased $915 thousand in the second quarter 2009 compared to the second quarter 2008. Interest and fees on loans decreased $882 thousand in the second quarter 2009 compared to the same period in 2008. The decrease in interest and fees on loans was due to the overall decrease in our loan portfolio and to a decrease in the yield. We realized an $18 million decrease in our average loans in the second quarter 2009 compared to the second quarter 2008. This was the result of a $16.5 million decrease in our average commercial loans and a $1.8 million decrease in average consumer loans, partially offset by a $260 thousand increase in our average residential real estate portfolio. In addition to the decrease in average loan balances, we have seen our yield on loans decrease 62 basis points in the second quarter of 2009 compared to the second quarter of 2008. This drop in yield is due to the lower overall interest rate environment experienced in 2009 and also to a $20.3 million increase in non-performing loans over the June 30, 2008 level. Interest on investment securities also declined between the two periods. Our average investment in securities increased $26.5 million over the second quarter of 2008, but the effect of the increase in the average investment was more than offset by a 171 basis points decrease in yield on those securities. The net result was a $33 thousand decrease in interest income from securities.
Partially offsetting the decrease in interest income was a $175 thousand decrease in interest expense in the second quarter of 2009 compared to the second quarter of 2008. The result was a $740 thousand decrease in net interest income comparing the two quarters. Interest on deposits decreased $113 thousand comparing the two quarters. Average interest bearing balances were $29.7 million higher in the second quarter of 2009 than the second quarter of 2008, but through disciplined pricing, we were able to lower the rates paid and reduce the interest expense on these deposits. Comparing the second quarter 2009 to the second quarter 2008 our average certificate of deposit balances increased $36.8 million, but we reduced the rate paid on these deposits by 35 basis points, resulting in an increase in the interest on certificates of deposit of $140 thousand. Our average savings balances decreased $2.8 million between the two quarters and we paid 63 basis points less in the second quarter of 2009 than the second quarter of 2008, resulting in a $202 thousand decrease in interest expense on these balances. In addition, our interest bearing demand balances decreased $4.3 million between the two quarters and we paid 40 basis points less on these balances resulting in a $51 thousand decrease in interest expense from the second quarter of 2008 to the second quarter of 2009. The decrease in interest expense on deposits was supplemented by a $62 thousand decrease in interest on borrowed funds as we decreased our average borrowings by approximately $10.3 million.
During the second quarter 2009, we recorded a $2.5 million provision for loan losses compared to a $2.2 million provision in the first quarter and a $1.6 million provision recorded in the second quarter of 2008. This level of provision is necessary due to the high net charge-offs we have realized in

2009 and the increase in non-performing loans. Management believes this provision is necessary to maintain the loan loss reserve at an appropriate level.
Total other operating income increased $849 thousand in the second quarter 2009 compared to the second quarter 2008. This increase was mainly the result of an $847 thousand increase in the gains on the sale of investment securities. Total other operating expenses were reduced by $431 thousand when comparing the second quarters of 2009 and 2008. Salary and benefits expense decreased $396 thousand. This is mainly due to staff cuts and a freeze on merit increases for all employees in 2009. Salaries and wages have been reduced by $183 thousand and fringe benefits have been reduced by $213 thousand when comparing the second quarter of 2009 to the second quarter of 2008. Occupancy costs have been reduced by $125 thousand including a $43 thousand reduction in equipment maintenance costs and a $30 thousand reduction in rent expense as we closed two mortgage origination offices between the two periods. Legal and professional expenses remained relatively flat comparing the two quarters. Other real estate owned expenses decreased $264 thousand comparing the second quarter of 2009 to the second quarter of 2008, due mainly to lower write-downs in the value of the repossessed properties. We also realized a $48 thousand decrease in marketing expense and an $86 thousand decrease in other operating expenses as we continued concerted efforts to control costs. The decreases in non-interest expenses were partially offset by a $497 thousand increase in FDIC insurance expense. This included a 15 basis points increase in our basic assessment rate as well as a one-time special assessment levied by the FDIC against the banking industry, our portion of which was $232 thousand.
Six Months Ended June 30, 2009
For the six months ended June 30, 2009, we realized a net loss of $3.2 million compared to a net loss of $2.1 million for the same period in 2008 and a net loss of $11.6 million in the second half of 2008. Total interest income decreased $1.9 million in the first half 2009 compared to the first half 2008. Interest and fees on loans decreased $1.8 million in the first half 2009 over the same period in 2008. The decrease in interest and fees on loans was due to the overall decrease in our loan portfolio and to a decrease in the yield. Average total loans decreased $14.7 million comparing the first half of 2009 to the first half of 2008. We realized a $13.6 million decrease in the average balance of our commercial loan portfolio. Lending volumes remain low as quality loan opportunities are scarce. This decrease in commercial loan balances, combined with a 64 basis points drop in yield resulted in a $1.5 million decrease in interest income on our commercial loans. The drop in yield is due to the lower overall interest rate environment in 2009, as well as a $20.3 million increase in non-performing loans. The average balance of our consumer loan portfolio also contracted, decreasing by $2.3 million. The drop in consumer loan balances combined with a 147 basis points drop in yield resulted in a $238 thousand decrease in interest income on consumer loans. We were able to increase the average balance in our residential real estate portfolio by $1.2 million over the June 2008 level, but the positive effect of the increase in loan balances was more than offset by a 41 basis points drop in yield. The result was a $67 thousand decrease in interest income on our residential real estate loans. During the first half of 2009, we were able to increase our average investment in securities by $11.6 million. However, the yield on the investment portfolio decreased 112 basis points, resulting in a $129 thousand decease in interest income on the securities portfolio.
Total interest expense decreased $911 thousand in the first half of 2009 compared to the first half of 2008. Interest on deposits decreased $792 thousand. Our average balance of interest bearing

deposits actually increased $16.5 million, but again, through disciplined pricing, we were able to reduce total interest expense. Comparing the first half of 2009 to the first half of 2008 our average certificate of deposit balances increased $27.6 million, but we reduced the rate paid on these deposits by 67 basis points, resulting in an increase in the interest on certificates of deposit of $168 thousand. Our average savings balances decreased $6.9 million between the two periods and we paid 77 basis points less in the first half of 2009 than the first half of 2008, resulting in a $525 thousand decrease in interest expense on these balances. In addition, our interest bearing demand balances decreased $4.2 million between the two periods and we paid 38 basis points less on these balances resulting in a $99 thousand decrease in interest expense from the first half of 2008 to the first half of 2009. The year-to-date decrease in interest expense on deposits was supplemented by a $911 thousand decrease in interest on borrowed funds as we decreased our average borrowings by approximately $10.6 million.
During the first half of 2009, we recorded a $4.8 million provision for loan losses compared to a $3.6 million provision recorded in the first half of 2008. This increase in the provision is due to the increase in net charge-offs we have realized in 2009 and the increase in non-performing loans. Management believes this provision is necessary to maintain the reserve at an appropriate level. Total other operating income increased $731 thousand in the first half 2009 compared to the first half 2008. Deposit service charges increased $34 thousand. We also realized a $921 thousand increase in the gain on the sale of securities comparing the first half of 2009 to the first half of 2008. The increases were partially offset by a $224 thousand decrease in other income. While we did realize a $60 thousand increase in the gain on the sale of mortgages (included in other income), we also experienced a $179 thousand increase in losses on the sale of other real estate owned (included in other income) and a $52 thousand decrease in investment referral fee income as activity slowed in 2009. Total other operating expenses were reduced by $1.5 million in the first six months of 2009 compared to the same period in 2008, even though our FDIC insurance expense increased $679 thousand. The FDIC increase included a 15 basis points increase in our basic assessment rate as well as the one-time special assessment of $232 thousand that was mentioned earlier. Salary and benefits expense was reduced by $878 thousand. This was mainly due to staff cuts, a freeze in merit increases in 2009 and the suspension of 401K Plan matching contributions for the period May - December 2009. In addition, there was a $200 thousand one-time expense for retiree medical benefits that was recorded in 2008. Occupancy costs have been reduced by $271 thousand, including a $163 thousand reduction in equipment maintenance and depreciation expenses and a $61 thousand reduction in rent expense as we closed two mortgage origination offices. Legal and professional expenses increased $27 thousand. Other real estate owned expenses decreased $1 million due mainly to lower write-downs in the value of the repossessed properties in 2009. Marketing expenses remained relatively flat. Other operating expenses were reduced by $56 thousand as we continue our efforts to control costs.
Liquidity
The Company manages its liquidity position with the objective of maintaining sufficient funds to respond to the needs of depositors and borrowers and to take advantage of earnings enhancement opportunities. In addition to the normal inflow of funds from core-deposit growth, together with repayments and maturities of loans and investments, the Company utilizes other short-term funding sources such as Federal Home Loan Bank advances and the Federal Reserve Discount Window.

During the six months ended June 30, 2009, the Company increased deposits by $32.8 million. Proceeds from the maturity and sale of securities provided $39.4 million in cash during the first six months of 2009. These sources of cash, along with the $2.2 million in cash provided by operating activities, were primarily used to fund the $67.6 in securities that were purchased and $2.9 million in capital expenditures. In addition, they funded a $1.0 million increase in our loan portfolio and a $2.8 million increase in our cash position. As a result, as of June 30, 2009 we had $15.1 million in cash and cash equivalents. A figure that management considers sufficient to meet our future liquidity needs.
Off Balance Sheet Arrangements and Contractual Obligations The only significant off-balance sheet obligations incurred routinely by the Company are its commitments to extend credit and its stand-by letters of credit. At June 30, 2009, the Company had commitments to extend credit of $35.0 million and stand-by letters of credit of $2.4 million compared to $35.7 million and $2.6 million, respectively, at December 31, 2008. Capital Resources
Banks are expected to meet a minimum risk-based capital to risk-weighted assets ratio of 8%, of which at least one-half (4%) must be in the form of Tier 1
(core) capital. The remaining one-half may be in the form of Tier 1 or Tier 2 (supplemental) capital. The amount of loan loss allowance that may be included in capital is limited to 1.25% of risk-weighted assets. The Bank is currently, and expects to continue to be, in compliance with these guidelines. The following table shows the capital totals and ratios for the Bank as of June 30, 2009:

                Tier 1 capital                           $ 26,705
                Total capital                            $ 31,386
                Tier 1 capital to risk-weighted assets       7.18 %
                Total capital to risk-weighted assets        8.43 %
                Tier 1 capital to average assets             5.51 %

As described in the Company's Form 8K filed on February 5, 2008, under a memorandum of understanding entered into with the FDIC and Michigan's Office of Financial and Insurance Regulation, the Bank is required to maintain its Tier 1 capital to assets ratio at not less than 8%.