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PSBH > SEC Filings for PSBH > Form 10-K on 25-Sep-2013All Recent SEC Filings

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Form 10-K for PSB HOLDINGS, INC.


25-Sep-2013

Annual Report


ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following analysis discusses changes in the financial condition and results of operations at and for the years ended June 30, 2013 and 2012, and should be read in conjunction with the Company's Consolidated Financial Statements and the notes thereto, appearing in Part II, Item 8 of this Annual Report on Form 10-K.

Overview

The Company's results of operations depend primarily on net interest and dividend income, which is the difference between the interest and dividend income earned on its interest-earning assets, such as loans and securities, and the interest expense on its interest-bearing liabilities, such as deposits and borrowings. The Company also generates non-interest income, primarily from fees and service charges. Gains on sales of loans and securities and cash surrender value of life insurance policies are added sources of non-interest income. The Company's non-interest expense primarily consists of employee compensation and benefits, occupancy and equipment expense, advertising, data processing, professional fees and other operating expenses.

Critical Accounting Policies

Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. Our critical accounting policies are those related to our allowance for loan losses, other-than-temporary impairment of investment securities and valuation of deferred tax assets and goodwill. Management has discussed the development, selection and application of these critical accounting policies with the Audit Committee of the Board of Directors.

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover credit losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses which is charged against income.

Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal and external loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates by management that may be susceptible to significant change. The allowance for loan losses has three components: general, specific and unallocated as further discussed below.

The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate, commercial real estate, residential construction, commercial and consumer/other. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies; loan concentrations, trends in volume and terms of loans; changes in lending practices and procedures; changes in lending management and staff; changes in the value of underlying collateral; changes in the quality of the loan review system; national and local economic trends and conditions and the effects of other external factors. There were no changes in the Company's policies or methodology pertaining to the general component of the allowance for loan losses during fiscal year ended 2013.

The specific component relates to loans that are classified as impaired. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent or foreclosure is probable. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring ("tdr/other") agreement.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring. All TDRs are initially classified as impaired.

An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general reserves in the portfolio.

Other-Than-Temporary Impairment of Securities. Management periodically reviews all investment securities with significant declines in fair value for potential other-than-temporary impairment pursuant to the guidance provided by ASC 320-10 "Investments-Debt and Equity Securities". The guidance addresses the determination as to when an investment is considered impaired, whether the impairment is other-than-temporary, and the measurement of an impairment loss. It also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments.

Goodwill. The Company's goodwill (the amount paid in excess of fair value of acquired net assets) is reviewed at least annually to ensure that there have been no events or circumstances resulting in an impairment of the recorded amount of excess purchase price. Adverse changes in the economic environment, operations of acquired business units, or other factors could result in a decline in projected fair values. If the estimated fair value is less than the carrying amount, a loss would be recognized to reduce the carrying amount to fair value.

Deferred Tax Assets and Liabilities. Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax basis of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. A valuation allowance is established against deferred tax assets when, based upon the available evidence including historical and projected taxable income, it is more likely than not that some or all of the deferred tax assets will not be realized.

Comparison of Financial Condition at June 30, 2013 and June 30, 2012

Assets. Total assets of the Company were $454.4 million at June 30, 2013, an increase of $2.1 million or 0.5%, from $452.3 million at June 30, 2012. Investments in available-for-sale securities decreased $8.7 million or 18.6%, to $38.5 million at June 30, 2013 compared to $47.2 million at June 30, 2012. Investments in held-to-maturity securities increased $29.8 million or 28.3% to $135.0 million as of June 30, 2013 compared to $105.2 million as of June 30, 2012. Cash and cash equivalents increased $1.4 million or 12.1% to $12.8 million as of June 30, 2013 compared to $11.4 million as of June 30, 2012. The increase in cash was primarily due to additional overnight monies deposited in interest-bearing accounts at the Federal Reserve Bank of Boston. Net loans outstanding decreased $16.4 million or 6.6% to $232.2 million at June 30, 2013 from $248.6 million at June 30, 2012. The decrease in loans was primarily due to decreases of $13.0 million in residential real estate loans, $1.6 million in commercial real estate loans and $1.5 million in commercial loans from June 30, 2012 to June 30, 2013.

Liabilities. Total liabilities increased $89,000, or 0.0%, to $404.3 million at June 30, 2013 from $404.2 million at June 30, 2012. Total deposits decreased $1.0 million, or 0.3%, to $341.3 million at June 30, 2013 from $342.3 million at June 30, 2012. Total securities sold under agreements to repurchase increased $1.2 million, or 32.7%, to $4.8 million at June 30, 2013 from $3.6 million at June 30, 2012.

Stockholders' Equity. Total stockholders' equity increased $2.0 million, or 4.0% to $50.1 million at June 30, 2013 from $48.1 million at June 30, 2012. The increase was primarily due to net income of $1.3 million and a decrease of $490,000 in accumulated other comprehensive loss for the fiscal year ended June 30, 2013.

Comparison of Operating Results for the Fiscal Years Ended June 30, 2013 and 2012

Net Income. Net income amounted to $1.3 million, or $0.21 per basic and diluted share for the fiscal year ended June 30, 2013 compared to net income of $1.0 million or $0.16 per basic and diluted share for the fiscal year ended June 30, 2012.

Interest and Dividend Income. Interest and dividend income decreased by $2.4 million, or 14.0%, to $15.3 million for the fiscal year ended June 30, 2013 from $17.7 million for the fiscal year ended June 30, 2012. The decrease in interest and dividend income resulted primarily from a 51 basis point decrease in the yield on average interest-earning assets to 3.61% for the fiscal year ended June 30, 2013 from 4.12% for the fiscal year ended June 30, 2012. This decrease in yield is primarily due to the current low rate environment and a shift from loans into investments. Interest income on loans decreased by $1.4 million, or 11.1%, to $11.5 million for the fiscal year ended June 30, 2013 from $13.0 million for the fiscal year ended June 30, 2012. Interest and dividend income on investment securities decreased $1.1 million, or 22.2%, to $3.7 million for the fiscal year ended June 30, 2013 from $4.8 million for the fiscal year ended June 30, 2012. The yield on average investment securities decreased 65 basis points to 2.18% for the fiscal year ended June 30, 2013 from 2.83% for the fiscal year ended June 30, 2012. Average interest-earning assets decreased $8.1 million to $422.6 million for the fiscal year ended June 30, 2013 from $430.7 million for the fiscal year ended June 30, 2012. Average investment securities increased $1.4 million, average loans decreased $9.8 million and average other earning assets increased $282,000 from year to year.

Interest Expense. Interest expense decreased by $1.9 million, or 28.0%, to $4.8 million for the fiscal year ended June 30, 2013 from $6.7 million for the fiscal year ended June 30, 2012. The decrease in interest expense resulted primarily from a decrease in the cost of average interest-bearing liabilities which decreased by 44 basis points to 1.34% for the fiscal year ended June 30, 2013 as compared to 1.78% for the fiscal year ended June 30, 2012. The cost of average interest-bearing deposits decreased 28 basis points to 1.04% for the fiscal year ended June 30, 2013 from 1.32% for the fiscal year ended June 30, 2012 and the cost of other borrowed money decreased 69 basis points to 2.81% for the fiscal year ended June 30, 2013 from 3.50% for the fiscal year ended June 30, 2012. This decrease in cost is primarily due to the current low rate environment. Average interest-bearing deposits increased $384,000 to $295.6 million for the fiscal year ended June 30, 2013 from $295.2 million for the fiscal year ended June 30, 2012. Average NOW accounts increased $1.1 million, average savings deposits increased $5.3 million and average time deposits decreased $5.1 million year over year. Average borrowings decreased $18.1 million to $60.9 million for the fiscal year ended June 30, 2013 from $79.0 million for the fiscal year ended June 30, 2012.

Net Interest Income. Net interest income decreased $624,000, or 5.6%, to $10.5 million for the fiscal year ended June 30, 2013 from $11.1 million for the fiscal year ended June 30, 2012. The primary reason for the decrease in our net interest income was the change in rates for the fiscal year ended June 30, 2013 compared to the fiscal year ended June 30, 2012.

Provision for Loan Losses. The Company's provision for loan losses decreased $382,000, or 33.2% to $770,000 for the fiscal year ended June 30, 2013 from $1.2 million for the fiscal year ended June 30, 2012. The lower provision for loan losses reflects the Bank's lower non-performing loans and reduced charge-offs. Non-performing loans decreased to $6.3 million at June 30, 2013 from $8.4 million at June 30, 2012. The allowance for loan losses was $2.7 million at June 30, 2013 compared to $2.9 million at June 30, 2012. The ratio of the allowance to total loans outstanding was 1.15% as of June 30, 2013 compared to 1.16% as of June 30, 2012, and the ratio of the allowance to non-performing loans was 42.46% as of June 30, 2013 compared to 34.74% as of June 30, 2012.

Non-interest Income. Non-interest income increased $257,000, or 11.3%, to $2.5 million for the fiscal year ended June 30, 2013 compared to $2.3 million for the fiscal year ended June 30, 2012. This was primarily due to decreased other-than-temporary write-downs of investment securities of $1.5 million to $462,000 for the fiscal year ended June 30, 2013 compared to $2.0 million for the fiscal year ended June 30, 2012. The write-downs for the fiscal years ended June 30, 2013 and 2012 consisted of credit losses on non-agency mortgage-backed securities. Included in the fiscal year ended June 30, 2012 was a legal settlement on previously written-down securities of $1.5 million. Mortgage banking activities increased $149,000 to $298,000 for the fiscal year ended June 30, 2013 compared to $149,000 for the fiscal year ended June 30, 2012. Bank-owned life insurance income increased $158,000 to $486,000 for the fiscal year ended June 30, 2013 compared to $328,000 for the fiscal year ended June 30, 2012. This increase included a $176,000 non-taxable death benefit realized during the fiscal year ended June 30, 2013.

Non-interest Expense. Non-interest expense decreased by $362,000, or 3.3%, to $10.6 million for the fiscal year ended June 30, 2013 from $10.9 million for the fiscal year ended June 30, 2012. Salaries and employee benefits expense decreased by $89,000, or 1.5%, to $5.7 million for the fiscal year ended June 30, 2013 from $5.8 million for the fiscal year ended June 30, 2012. Occupancy and equipment expense decreased by $48,000, or 3.7%, to $1.2 million for the fiscal year ended June 30, 2013 from $1.3 million for the fiscal year ended June 30, 2012. All other non-interest expense, consisting primarily of data processing expense, FDIC deposit insurance, professional fees and marketing expense decreased by $225,000, or 5.8%, to $3.7 million for the fiscal year ended June 30, 2013 from $3.9 million for the fiscal year ended June 30, 2012. This was primarily due to decreases in marketing expense of $115,000, write-downs of other real estate owned of $23,000 and amortization of intangible assets of $29,000.

Provision for Income Taxes. Income tax expense increased by $90,000, or 41.9%, to $305,000 for the year ended June 30, 2013 from $215,000 for the year ended June 30, 2012. The change can be attributed to a 29.8% increase in pre-tax income offset by the increase in bank-owned life insurance income. Our effective tax rate was 18.6% for the year ended June 30, 2013, compared to 17.0% for the year ended June 30, 2012. The effective tax rates differed from the statutory tax rate of 34% primarily due to the dividends-received deduction applicable to certain securities in our investment portfolio, tax-exempt municipal income and non-taxable bank-owned life insurance income.

Average Balance Sheet

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

                                                                                     June 30,
                                               2013                                    2012                                    2011
                                 Average      Income/       Yield/       Average      Income/       Yield/       Average      Income/       Yield/
                                 Balance      Expense        Cost        Balance      Expense        Cost        Balance      Expense        Cost
                                                                              (Dollars in thousands)
 Interest earning assets:
 Investment securities          $ 169,826     $  3,708         2.18 %   $ 168,419     $  4,765         2.83 %   $ 186,412     $  6,032         3.24 %
 Loans                            245,881       11,531         4.69 %     255,645       12,964         5.07 %     256,737       13,694         5.33 %
 Other interest earning
assets                              6,929           14         0.20 %       6,647            9         0.14 %       5,353            4         0.07 %
 Total interest-earnings
assets                            422,636       15,253         3.61 %     430,711       17,738         4.12 %     448,502       19,730         4.40 %
 Non-interest-earning assets       29,182                                  31,520                                  32,209
 Total assets                   $ 451,818                               $ 462,231                               $ 480,711

 Interest-bearing
liabilities:
 NOW accounts                   $  92,818          513         0.55 %   $  91,767          700         0.76 %   $  90,186          934         1.04 %
 Savings accounts                  56,325          102         0.18 %      51,063          169         0.33 %      48,004          168         0.35 %
 Money market accounts             14,313           56         0.39 %      15,117           93         0.62 %      13,517          111         0.82 %
 Time deposits                    132,124        2,411         1.82 %     137,250        2,927         2.13 %     143,357        3,536         2.47 %
 Borrowings                        60,909        1,712         2.81 %      78,996        2,766         3.50 %     101,469        3,621         3.57 %
 Total interest-bearing
liabilities                       356,489        4,794         1.34 %     374,193        6,655         1.78 %     396,533        8,370         2.11 %
 Non-interest-bearing demand
deposits                           42,518                                  38,948                                  35,914
 Other non-interest-bearing
liabilities                         2,627                                   2,364                                   2,162
 Capital accounts                  50,184                                  46,726                                  46,102
 Total liabilities and
capital accounts                $ 451,818                               $ 462,231                               $ 480,711

 Net interest income                          $ 10,459                                $ 11,083                                $ 11,360
 Interest rate spread                                          2.27 %                                  2.34 %                                  2.29 %
 Net interest-earning assets    $  66,147                               $  56,518                               $  51,969
 Net interest margin                                           2.47 %                                  2.57 %                                  2.53 %
 Average earning assets to
  average interest-bearing
liabilities                                                  118.56 %                                115.10 %                                113.11 %

Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

                                  Years ended June 30,                         Years ended June 30,
                                 2013 Compared to 2012                        2012 Compared to 2011
                               Increase (Decrease) Due to                   Increase (Decrease) Due to
 Interest-earning
assets:                    Rate           Volume          Net           Rate           Volume          Net
 Interest and
Dividend Income:                                           (in thousands)
 Investment
securities              $   (1,096 )    $       39     $  (1,057 )   $     (717 )    $     (550 )   $  (1,267 )
 Loans                        (950 )          (483 )      (1,433 )         (672 )           (58 )        (730 )
 Other
interest-earning
assets                           5               -             5              4               1             5
 Total
interest-earning
assets                      (2,041 )          (444 )      (2,485 )       (1,385 )          (607 )      (1,992 )

 Interest-bearing
liabilities
 Interest Expense:
 NOW accounts                 (195 )             8          (187 )         (250 )            16          (234 )
 Savings accounts              (83 )            16           (67 )           (9 )            10             1
 Money Market
accounts                       (32 )            (5 )         (37 )          (30 )            12           (18 )
 Time deposits                (410 )          (106 )        (516 )         (463 )          (146 )        (609 )
 Borrowings                   (488 )          (566 )      (1,054 )          (67 )          (788 )        (855 )
 Total
interest-bearing
liabilities                 (1,208 )          (653 )      (1,861 )         (819 )          (896 )      (1,715 )

 Change in net
interest income         $     (833 )    $      209     $    (624 )   $     (566 )    $      289     $    (277 )

Market Risk, Liquidity and Capital Resources

Market Risk

The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk ("IRR"). Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits and other borrowings. As a result, a principal part of our business strategy is to manage IRR and reduce the exposure of our net interest income ("NII") to changes in market interest rates. Accordingly, our Board of Directors has established an Asset/Liability Management Committee which is responsible for evaluating the IRR inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors. With the assistance of an IRR management consultant, the committee monitors the level of IRR on a regular basis and generally meets at least on a quarterly basis to review our asset/liability policies and IRR position.

We have sought to manage our IRR in order to minimize the exposure of our earnings and capital to changes in interest rates. As part of our ongoing asset/liability management, we currently use the following strategies to manage our IRR: (i) using alternative funding sources, such as advances from the Federal Home Loan Bank of Boston, to "match fund" certain investments and/or loans; (ii) continued emphasis on increasing core deposits; (iii) offering adjustable rate and shorter-term home equity loans, commercial real estate loans, construction loans and commercial and industrial loans; (iv) offering a variety of consumer loans, which typically have shorter-terms; (v) investing in mortgage-backed securities with variable rates or fixed rates with shorter durations. Shortening the average maturity of our interest-earning assets by increasing our investments in shorter-term loans and securities, as well as loans and securities with variable rates of interest, helps to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our NII to changes in market interest rates.

Net interest income at-risk measures the risk of a decline in earnings due to potential short-term and long term changes in interest rates. The table below represents an analysis of our IRR as measured by the estimated changes in NII, resulting from an instantaneous and sustained parallel shift in the yield curve (+100 and +200 basis points) at June 30, 2013 and June 30, 2012.

                  Net Interest Income At-Risk

                      Estimated Increase     Estimated Increase
                          (Decrease)             (Decrease)
Change in Interest          in NII                 in NII
      Rates
  (Basis Points)        June 30, 2013          June 30, 2012

      Stable
      + 100                 0.29%                  -0.56%
      + 200                 -2.99%                 -4.81%

The preceding income simulation analysis does not represent a forecast of NII and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, which are subject to change, including: the nature and timing of interest rate levels including the yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. Also, as market conditions vary prepayment/refinancing levels will likely deviate from those assumed, the varying impact of interest rate changes on caps and floors embedded in adjustable rate loans, early withdrawal of deposits, changes in product preferences, and other internal/external variables.

Net Portfolio Value Simulation Analysis. We compute the amounts by which the net present value of our cash flow from assets, liabilities and off-balance sheet items (the institution's net portfolio value or "NPV") would change in the event of a range of assumed changes in market interest rates. Given the current low level of market interest rates, we do not prepare a net portfolio value calculation for an interest rate decrease of greater than 100 basis points. A basis point equals one-hundredth of one percent, and 200 basis points equals two percent, an increase in interest rates from 3% to 5% would mean, for example, a 200 basis point increase in the "Change in Interest Rates" column below.

The tables below set forth, at June 30, 2013, the estimated changes in our net portfolio value that would result from the designated instantaneous changes in . . .

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