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FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 2003
[ ] 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.
WWW.PSBWI.COM
WISCONSIN 39-1804877
1905 W. Stewart Avenue
P.O. Box 1686
Wausau, Wisconsin 54402-1686
Registrant's telephone number, including area code: (715) 842-2191
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such report), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes ___ No X
The aggregate market value of the voting stock held by non-affiliates as of
June 30, 2003, was approximately $51,522,000. For purposes of this
calculation, the registrant has assumed its directors and executive officers
are affiliates. As of March 1, 2004, 1,733,630 shares of common stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement dated March 12, 2004 (to the extent specified herein): Part III
FORM 10-K
PSB HOLDINGS, INC.
TABLE OF CONTENTS
PART I
ITEM
1. Business..........................................................1
2. Properties........................................................6
3. Legal proceedings.................................................6
4. Submission of matters to a vote of security holders...............6
PART II
5. Market for registrant's common equity and related stockholder
matters...........................................................7
6. Selected financial data...........................................9
7. Management's discussion and analysis of financial condition and
results of operations............................................10
7A. Quantitative and qualitative disclosures about market risk.......47
8. Financial statements and supplementary data......................48
9. Changes in and disagreements with accountants on accounting and
financial disclosure 85
9A. Controls and Procedures..........................................85
PART III
10. Directors and executive officers of the registrant...............86
11. Executive compensation...........................................87
12. Security ownership of certain beneficial owners and management
and related stockholder matters..................................87
13. Certain relationships and related transactions...................88
14. Principal Auditor Fees and Services..............................88
PART IV
15. Exhibits, financial statement schedules, and reports on Form 8-K.89
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PART I
ITEM 1. BUSINESS.
BUSINESS OPERATIONS AND PRODUCTS
PSB Holdings, Inc., a Wisconsin corporation formed in 1995, is a one-bank
holding company regulated by the Board of Governors of the Federal Reserve
System (the "Federal Reserve") under the authority of the Bank Holding Company
Act of 1956, as amended (the "BHCA"). PSB Holdings, Inc.'s sole business is
the ownership and management of Peoples State Bank, a Wisconsin state chartered
bank headquartered in Wausau, Wisconsin. Since 1962, Peoples State Bank has
operated as a community bank and currently serves customers in the central and
northern Wisconsin counties of Marathon, Oneida, and Vilas through a branch
network of 7 retail locations. This Annual Report on Form 10-K describes the
business of PSB Holdings, Inc. and Peoples State Bank as in effect on December
31, 2003, and any reference to "PSB" refers to the consolidated or individual
operations of PSB Holdings, Inc. and its subsidiary Peoples State Bank.
PSB's branch offices are located in the communities of Wausau, Rib Mountain,
Marathon, Rhinelander and Eagle River, Wisconsin. PSB is engaged in general
commercial and retail banking and serves individuals, businesses, and
governmental units. PSB offers most forms of commercial lending, including
lines and letters of credit, secured and unsecured term loans, equipment and
lease financing and commercial mortgage lending. In addition, PSB provides a
full range of personal banking services, including checking accounts, savings
and time accounts, installment, credit card, and other personal loans, as well
as mortgage loans. PSB offers both commercial and personal customers automated
teller machines and online computer banking to expand its services to customers
on a 24-hour basis. Commercial customers may use available cash management and
lockbox services in addition to merchant banking products. New services are
frequently added to PSB's commercial and retail banking departments.
PSB offers brokerage services at its Wausau locations, including the sale of
annuities, mutual funds and other investments to customers and the general
public. Commercial property and casualty insurance services are offered at its
Wausau home office location through Peoples Insurance Services LLC, a
subsidiary of Peoples State Bank, to bank customers and the general public.
All of PSB's products and services are directly or indirectly related to the
business of community banking and all activity is reported as one segment of
operations. Therefore, all revenue, profit and loss, and total assets are
reported in one segment and represent the entire operations of PSB.
As a community bank, the majority of PSB's operating revenues continue to be
come from interest earned on loans receivable and its investment securities
portfolio. PSB does not have a dependence on any major customers and collects
revenue from approximately 12,700 households and businesses. The table below
shows a breakdown of principal sources of operating revenue (including those
which make up greater than 15% of total revenue).
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(dollars in thousands)
Interest on loans Interest on securities
Years ended December 31, Amount % of revenue Amount % of revenue
2003 $17,964 71.4% $2,859 11.4%
2002 18,022 72.0% 3,622 14.5%
2001 19,263 76.0% 3,641 14.3%
As of February 13, 2004, PSB operated with 118 full-time equivalent (FTE)
employees, including 32 employed on a part time basis. None of the employees
is covered by a collective bargaining agreement. Approximately 99 of the FTE
employees serve as sales, customer contact, or customer activity support
personnel, while 19 of the employees serve primarily for administrative and
internal purposes.
During the past several years, PSB has pursued a market expansion plan that
includes de novo branching into adjacent market areas previously identified as
favorable long-term business prospects. Bank branches were opened in Eagle
River and Rhinelander, Wisconsin in 2001 and 2002, respectively. In addition,
PSB recently announced new branches in Weston and Minocqua, Wisconsin to be
opened during 2004. Management believes opening in adjacent markets
capitalizes on existing management resources and customer relationships and
leverages existing shareholder capital for the benefit of long-term
shareholders. PSB also seeks to expand into complementary services and during
2003 announced formation of Peoples Insurance Services LLC, a start-up
commercial property and casualty insurance services company. PSB intends to
pursue opportunities to acquire additional bank subsidiaries or banking offices
so that, at any time, it may be engaged in some tentative or preliminary
discussions for such purposes with officers, directors or principal
shareholders of other holding companies or banks. However, there are no plans,
understandings, or arrangements, written or oral, regarding other acquisitions
at this time.
BANK MARKET AREA AND COMPETITION
There is a mix of retail, manufacturing, agricultural and service businesses in
the areas served by PSB. PSB has substantial competition in its market areas.
Much of this competition comes from companies which are larger and have greater
resources than PSB. PSB competes for deposits and other sources of funds with
other banks, savings associations, credit unions, finance companies, mutual
funds, life insurance companies and other financial and non financial
companies. Many of these nonbank competitors offer products and services which
are functionally equivalent to the products and services offered by PSB.
Based on publicly available deposit market share information as of June 30,
2003, the following is a list of the three largest FDIC insured banking
competitors in each of PSB's primary markets and a comparison of PSB's deposit
market share to these primary competitors.
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Deposit $'s Market
($000s) Share
MARATHON COUNTY, WISCONSIN
M&I Bank $364,077 18.9%
PEOPLES STATE BANK 284,032 14.8%
Abbotsford State Bank 148,163 7.7%
All other FDIC insured institutions 1,129,194 58.6%
ONEIDA COUNTY, WISCONSIN
M&I Bank $169,483 27.2%
Associated Bank 138,854 22.3%
F&M Bank - Wisconsin 101,081 16.2%
PEOPLES STATE BANK 16,265 2.6%
All other FDIC insured institutions 196,718 31.7%
VILAS COUNTY, WISCONSIN
First National Bank of Eagle River $104,902 31.8%
M&I Bank 101,194 30.7%
Headwaters State Bank 46,632 14.1%
PEOPLES STATE BANK 3,946 1.2%
All other FDIC insured institutions 73,438 22.2%
Recent changes in banking laws have had a significant effect on the competitive
environment in which PSB operates and are likely to continue to increase
competition for PSB. For example, current federal law permits adequately
capitalized and managed bank holding companies to engage in interstate banking
on a much broader scale than in the past. Banks are also permitted to create
interstate branching networks in states which do not "opt out" of the new laws.
The Gramm-Leach-Bliley Act of 1999 has also increased the competitive
environment for PSB. Under this act, financial holding companies are now
permitted to conduct a broad range of banking, insurance and securities
activities. PSB believes that the combined effects of more interstate banking
and the development of greater "one-stop" availability for banking, insurance
and securities services will both increase the overall level of competition and
attract competitors with which PSB may not now compete for its customers.
In addition to competition, the business of PSB will be affected by general
economic conditions, including the level of interest rates and the monetary
policies of the Federal Reserve (see "Regulation and Supervision - Monetary
Policy"). This competition may cause PSB to seek out opportunities to provide
additional financial services.
EXECUTIVE OFFICERS
David K. Kopperud, 58 - President of PSB and Peoples State Bank since July,
1999; previously Executive Vice-President of the Peoples State Bank (1994-
1999).
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David A. Svacina, 57 - Secretary and Vice President of PSB since December 2003;
Vice President of PSB since March 2002; Executive Vice President of Peoples
State Bank since April 2003; Vice President of Peoples State Bank (1995-2003).
Scott M. Cattanach, 35, Treasurer of PSB since March 2002; Senior Vice
President and Chief Financial Officer of Peoples State Bank since April 2003;
Chief Financial Officer of Peoples State Bank (2002-2003); Prior to March
2002, certified public accountant at regional public accounting firm.
REGULATION AND SUPERVISION
REGULATION
PSB is subject to regulation under both federal and state law. PSB Holdings,
Inc. is a registered bank holding company and is subject to regulation and
examination by the Federal Reserve pursuant to the BHCA. Peoples State Bank is
subject to regulation and examination by the Federal Deposit Insurance
Corporation ("FDIC") and, as a Wisconsin chartered bank, by the Wisconsin
Department of Financial Institutions.
The Federal Reserve expects a bank holding company to be a source of strength
for its subsidiary banks. As such, PSB Holdings, Inc. may be required to take
certain actions or commit certain resources to Peoples State Bank when it might
otherwise choose not to do so. Under federal and state banking laws, PSB is
subject to regulations which govern its capital adequacy, loans and loan
policies (including the extension of credit to affiliates), deposits, payment
of dividends, establishment of branch offices, mergers and other acquisitions,
investments in or the conduct of other lines of business, management personnel,
interlocking directorates and other aspects of its operations. Bank regulators
having jurisdiction over PSB generally have the authority to impose civil fines
or penalties and to impose regulatory sanctions for noncompliance with
applicable banking regulations and policies. In particular, the FDIC has broad
authority to take corrective action if Peoples State Bank fails to maintain
required minimum capital. Information concerning compliance with applicable
capital requirements is set forth in Item 8, in Note 17 of the Notes to
Consolidated Financial Statements.
Banking laws and regulations have undergone periodic revisions that often have
a direct or indirect effect on PSB's operations and its competitive
environment. From time to time various formal or informal proposals, including
new legislation, relating to, among other things, changes with respect to
deposit insurance, permitted bank activities and restructuring of the federal
regulatory scheme have been made and may be made in the future. The Gramm-
Leach-Bliley Act of 1999, which eliminated many of the barriers to affiliation
among banks, insurance companies and other securities or financial services
companies, is an example of legislation which may, and often does, materially
affect the operation of PSB's business. Depending on the scope and timing of
future regulatory changes, it is likely they will affect the competitive
environment in which PSB operates or increase costs of regulatory compliance
and, accordingly, may have a material adverse effect on PSB's consolidated
financial condition, liquidity or results of operations.
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MONETARY POLICY
The earnings and growth of PSB are affected by the monetary and fiscal policies
of the federal government and governmental agencies. The Federal Reserve has a
direct and indirect influence on the costs of funds used by PSB for lending and
its actions have a substantial effect on interest rates, the general
availability of credit and the economy as a whole. These policies therefore
affect the growth of bank loans and deposits and the rates charged for loans
and paid for deposits. Governmental and Federal Reserve monetary policies have
had a significant effect on the operating results of commercial banks in the
past and are expected to do so in the future. PSB is not able to anticipate
the future impact of such policies and practices on its growth or
profitability.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995 (the "Reform Act"). In
addition, certain statements in future filings by PSB with the Securities and
Exchange Commission, reports to shareholders, press releases, and in other oral
and written statements made by or with the approval of PSB which are not
statements of historical fact will constitute forward-looking statements within
the meaning of the Reform Act.
Examples of forward-looking statements include, but are not limited to: (1)
expectations concerning financial performance of PSB, (2) expectations
concerning the payment of dividends, (3) statements of plans and objectives of
PSB, (4) statements of future economic performance and (5) statements of
assumptions underlying such statements. Words such as "believes,"
"anticipates," "expects," "intends," "targeted" and similar expressions are
intended to identify forward-looking statements but are not the exclusive means
of identifying such statements. In making forward-looking statements within
the meaning of the Reform Act, PSB undertakes no obligation to publicly update
or revise any such statement.
Forward-looking statements of PSB are based on information available to PSB as
of the date of such statements and reflect PSB's expectations as of such date,
but are subject to risks and uncertainties that may cause actual results to
vary materially. In addition to specific factors which may be described in
connection with any of PSB's forward-looking statements, factors which could
cause actual results to differ materially from those discussed in the forward-
looking statements include, but are not limited to the following:
(1) the strength of the U.S. economy in general and the strength of the
local economies in the markets served by PSB;
(2) the effects of and changes in government policies, including
interest rate policies of the Federal Reserve;
(3) inflation, interest rate, market and monetary fluctuations;
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(4) the effect of changes in laws and regulations which increase
operating costs or increase competition;
(5) changes in consumer spending, borrowing and saving habits;
(6) increased competition in PSB's principal market areas;
(7) the timely development of and acceptance of new products and
services in the markets served by PSB;
(8) the costs associated with required changes or upgrades in our
technology;
(9) the effect of changes in accounting policies and practices;
(10) acquisitions and the inability to successfully integrate acquired
institutions or branches into current operations; and
(11) the costs and effects of litigation and of unexpected or adverse
outcomes in such litigation.
ITEM 2. PROPERTIES.
PSB's administrative offices are housed in the same building as the bank's
primary customer service location at 1905 West Stewart Avenue in Wausau,
Wisconsin. PSB's other Wisconsin branch locations, in the order they were
opened for business, include Rib Mountain, Marathon City, Wausau (Eastside),
Rhinelander (in the Trig's grocery store), Eagle River (in the Trig's grocery
store), and Rhinelander (Anderson Street). The branches in the Trig grocery
stores occupy leased space within the supermarket designed for community
banking operations. The other five locations are owned by PSB without
encumbrance and are occupied solely by PSB and are suitable for current
operations. During July 2003, PSB announced construction of a new banking and
administrative headquarters location in Wausau on the site of the existing main
bank location to be completed during spring, 2004 which will significantly
increase available space at that location. The previous main location will be
razed after the new building is occupied.
ITEM 3. LEGAL PROCEEDINGS.
PSB is subject to claims and litigation in the ordinary course of business, but
does not believe that any such claim or litigation will have a material adverse
effect on its consolidated financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
6
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET
There is no active established public trading market in PSB common stock. Bid
and ask prices are quoted primarily by one regional broker-dealer, Howe Barnes
of Chicago, Illinois, on the OTC Bulletin Board under the symbol "PSBQ.OB."
Transactions in PSB common stock are limited and sporadic.
PSB maintains an annual, ongoing share repurchase program of up to 1% of
outstanding shares per year. Details of the most recent years repurchase
activity may be found in Item 8, in Note 14 of the Notes to Consolidated
Financial Statements.
Information required by Item 201(d) of Regulation S-K related to equity
compensation plans is set forth under Item 12, Part III, of this Annual Report
on Form 10-K.
HOLDERS
As of January 6, 2004 there were approximately 958 holders of record of PSB
common stock. Some of PSB's shares are held in "street" name and the number of
beneficial owners of such shares is not known nor included in the foregoing
number.
DIVIDENDS
PSB expects that its practice of paying semi-annual dividends on its common
stock will continue, although the payment of future dividends will continue to
depend upon earnings, capital requirements, financial condition and other
factors. During 2003, PSB equalized the semi-annual cash dividend rather than
declaring a smaller dividend during June and a larger dividend during December.
However, in total, cash dividends declared during 2003 increased over 2002.
The principal source of funds for the payment of dividends by PSB is dividend
income from the bank. Payment of dividends by the bank is subject to various
limitations under banking laws and regulations. At December 31, 2003, the bank
could have paid a maximum of approximately $9.6 million in additional dividends
to PSB without prior regulatory approval. However, to remain "well
capitalized" under regulatory Prompt Corrective Action Provisions (see Note 17
to the Consolidated Financial Statements), dividends could not exceed
approximately $2.5 million as of December 31, 2003. PSB has paid regular
dividends since its inception in 1995.
On December 16, 2003, PSB declared a 5% stock dividend payable January 29,
2004. All per share information in this Annual Report on Form 10-K and the
Consolidated Financial Statements has been adjusted to reflect the impact of
this stock dividend on a proforma basis.
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MARKET PRICES AND DIVIDENDS
Price ranges of over-the-counter quotations and dividends declared per share on
PSB common stock for the periods indicated are:
2003 Prices 2002 Prices
Quarter High Low Dividends High Low Dividends
1st $24.86 $21.24 $ - $17.14 $15.84 $ -
2nd $31.52 $24.86 $0.285 $18.70 $16.67 $0.180
3rd $31.90 $31.43 $ - $20.05 $18.27 $ -
4th $35.24 $31.43 $0.285 $23.81 $19.57 $0.360
Prices detailed for the common stock represent the bid prices reported on the
OTC Bulletin Board. The prices do not reflect retail mark-up, mark-down or
commissions, and may not necessarily represent actual transactions.
SALES AND DISTRIBUTION OF STOCK
PSB distributed 1,750 shares (valued at $25.95 per share) and 3,593 shares
(valued at $16.67 per share) of its common stock during 2003 and 2002,
respectively to its directors in lieu of cash payments under the director's
incentive compensation plan. Receipt of stock or deferral of value into the
director deferred compensation plan via a previously committed election was
mandatory and no investment decision was made by any member of the Board.
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ITEM 6. SELECTED FINANCIAL DATA.
TABLE 1: EARNINGS SUMMARY AND SELECTED FINANCIAL DATA
2003 2002 2001 2000 1999
Consolidated summary of earnings: (dollars in thousands, except per share data)
Years ended December 31,
Total interest income $21,050 $21,915 $23,428 $21,940 $17,671
Total interest expense 7,869 9,274 12,469 12,540 8,598
Net interest income 13,181 12,641 10,959 9,400 9,073
Provision for loan losses 835 1,110 890 600 460
Net interest income after loan loss provision 12,346 11,531 10,069 8,800 8,613
Total noninterest income 4,111 3,048 2,065 1,446 1,265
Total noninterest expenses 9,351 8,226 7,315 6,474 6,221
Net income before income taxes 7,106 6,353 4,819 3,772 3,657
Provision for income taxes 2,300 1,988 1,453 1,102 1,068
Net income $ 4,806 $ 4,365 $ 3,366 $ 2,670 $ 2,589
Consolidated summary balance sheets: 2003 2002 2001 2000 1999
As of December 31, (dollars in thousands, except per share data)
Cash and cash equivalents $ 18,927 $ 21,552 $ 25,550 $ 9,367 $11,988
Securities 72,472 81,057 70,444 62,097 60,332
Total loans receivable, net of allowance 304,339 256,015 236,574 224,702 180,524
Premises and equipment, net 7,557 6,158 4,755 4,751 3,897
Other assets 5,638 6,687 6,973 5,322 3,148
Total assets $408,933 $371,469 $344,296 $306,239 $259,889
Total deposits $316,414 $297,830 $273,635 $241,534 $202,354
FHLB advances 47,000 38,000 38,000 28,000 13,000
Other borrowings 10,475 3,302 4,327 11,515 21,215
Other liabilities 2,903 3,034 2,985 2,916 2,274
Stockholders' equity 32,141 29,303 25,349 22,274 21,046
Total liabilities and stockholders' equity $408,933 $371,469 $344,296 $306,239 $259,889
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Performance ratios: 2003 2002 2001 2000 1999
Basic earnings per share $ 2.76 $ 2.48 $ 1.91 $ 1.48 $ 1.40
Diluted earnings per share $ 2.74 $ 2.48 $ 1.91 $ 1.48 $ 1.40
Common dividends declared per share $ 0.57 $ 0.54 $ 0.51 $ 0.49 $ 0.48
Dividend payout ratio 20.77% 21.65% 26.94% 32.64% 34.12%
Net book value per share at year-end $18.54 $16.75 $14.38 $12.64 $11.35
Average common shares outstanding 1,740,106 1,758,249 1,763,381 1,802,401 1,854,794
Return on average stockholders' equity 15.45% 15.97% 13.96% 12.33% 12.31%
Return on average assets 1.26% 1.25% 1.05% 0.94% 1.08%
Net interest margin (tax adjusted) 3.75% 3.95% 3.73% 3.62% 4.16%
Net loan charge-offs to average loans 0.16% 0.37% 0.14% 0.14% 0.19%
Noninterest income to average assets 1.08% 0.88% 0.65% 0.51% 0.53%
Noninterest income to tax adjusted
net interest margin 29.98% 23.12% 18.12% 14.86% 13.45%
Efficiency ratio 52.46% 50.68% 54.50% 58.05% 58.29%
Salaries and benefits expense to average assets 1.56% 1.42% 1.38% 1.35% 1.51%
Other expenses to average assets 0.89% 0.94% 0.91% 0.93% 1.08%
FTE employees at year-end 116 116 100 86 91
Average equity to average assets 8.15% 7.85% 7.53% 7.63% 8.75%
Non-performing loans to gross loans at year-end 1.08% 0.94% 1.68% 1.44% 0.77%
Allowance for loan losses to loans at year-end 1.15% 1.22% 1.24% 1.06% 1.15%
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's discussion and analysis reviews significant factors with respect
to PSB's financial condition and results of operations at and for the three-
year period ended December 31, 2003. This discussion should be read in
conjunction with the consolidated financial statements, notes, tables, and the
selected financial data presented elsewhere in this report. All figures are in
thousands, except per share data and per employee data.
Management's discussion and analysis contains forward-looking statements that
are provided to assist in the understanding of anticipated future financial
performance. However, such performance involves risks and uncertainties that
may cause actual results to differ materially from those in such statements.
For a discussion of certain factors that may cause such forward-looking
statements to differ materially from actual results see Item 1, Cautionary
Statement Regarding Forward-Looking Information, in this Annual Report on Form
10-K for the year ended December 31, 2003.
EXECUTIVE OVERVIEW
This overview summarizes PSB's business model and presents the primary
opportunities and challenges faced by management and the impact of economic and
industry-wide factors on PSB's operating environment. In addition, the near-
term and long-term issues on which
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management is most focused are outlined in general terms as a backdrop for the
detailed statistical and narrative analysis presented in this Annual Report on
Form 10-K.
Although PSB operates as a community bank, its operating environment is
significantly impacted by national economic trends and other industry factors.
Current national and banking industry wide trends impacting PSB are outlined
below.
* As rates fell during 2001 and 2002, deposits and other short-term
funding sources were repriced at historically low rates. Longer-term
loans continued to earn higher rates but gradually repriced into the
lower rate market. Therefore, many banks enjoyed increased net interest
margins during 2002 during this transition period. However, as rates
remained low during 2003, earning asset yields continued to fall while
deposits remained at interest rate floors. Bank margins generally
declined during 2003 and may continue to decline somewhat during 2004 if
market rates continue at current levels.
* Long-term market rates declined substantially during 2002 and 2003 which
prompted unprecedented mortgage refinancing activity. This activity
increased fee income from the sale of long-term fixed rate loans by
banks to secondary market investors. As mortgage rates stabilize or
increase, this fee income is not expected to recur during 2004.
* In light of stock market value declines during 2001 and 2002, many
investors moved funds out of the equity markets and back into depository
institutions, providing many banks with large amounts of unexpected
liquidity. In addition, wholesale certificate of deposit market
activity increased as large national depositors accepted lower relative
rates from banks in exchange for certainty of income compared to the
equity markets. Prior to this period, banks had experienced a long-term
slow erosion of deposits maintained by customers. As equity market
returns recover, it is likely this erosion will begin again.
* Banks with excess deposit funding during the past few years have
competed aggressively for a limited number of loan relationships
considering the ongoing recession beginning in 2002. The competition
has led to declines in loan pricing margin relative to credit risk and
other factors.
* In light of competition for traditional net interest margin based
income, banks have sought to increase fee based income and become "one-
stop shopping" centers for most financial services. Service and
convenience continue to be a customer requirement impacting the ability
for smaller banks to compete for customers solely for traditional loan
and deposit products. In addition, non-bank competitors such as
insurance companies, retailers, and credit unions have sought to expand
their markets for traditional banking product customers, increasing
competition for customers and decreasing product pricing for services.
* Although the recent recession has increased bank loan losses, the
increase has been small relative to past economic cycles. The banking
industry as a whole has maintained strong capital and profits during the
recessionary period.
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PSB operates in many ways as a local community bank, but larger in size and
scope. PSB maintains a traditional banking business model and does not employ
stand-alone derivative instruments to hedge cash flow and fair value risks.
The primary sources of income are net interest earned on residential and
commercial real estate loans made to local customers after payment of interest
to depositors. PSB also originates, sells, and services long-term fixed rate
mortgage loans to the secondary market for a substantial amount of fee income.
Depositors also pay various service fees including overdraft charges and
commercial service fees which contribute to PSB's noninterest income. These
activities make up over 90% of PSB's total revenue.
PSB serves customers through a network of seven full service locations with an
emphasis on customer service and flexibility. PSB employees are substantial
participants in community involvement for the betterment of PSB's market areas,
customers, and potential customers.
PSB recognizes many opportunities for continued growth in products, customers,
assets, and profits. PSB's relative size (compared to typical community banks)
allows it to offer a wide array of financial service products in a one-stop
shopping service model. The burden of regulatory compliance and emerging
issues such as "Check 21" related to electronic processing of paper items are
more easily borne by a larger institution. Although greater in size,
traditional community bank customer service and flexibility is a priority.
Therefore, PSB can offer better service to customers disenfranchised by large
banks and large bank mergers while allowing them to continue their practice of
one-stop shopping and commercial support. PSB can compete against smaller
local community banks and credit unions by continuing the same level of service
these customers expect, but giving them an expanded and competitively priced
product lineup due in part to economies of scale.
PSB has invested in key management and branch personnel to capitalize on
relationships in existing and adjacent markets. PSB's planned growth into
adjacent markets minimizes costs for name recognition and awareness while
increasing the speed in which customers are obtained via new locations and
improving convenience of service for existing customers.
For many years, PSB has operated with very low levels of overhead expense
relative to peer institutions, allowing for competitive pricing across its
product line. Management and employees recognize the need for an efficient and
cost effective organization which has become part of the culture of the
organization.
Against the back drop of industry-wide factors and competitive advantages and
opportunities, management monitors several areas of risk, negative tends, and
challenges. The following items represent challenges monitored by management
in both the short- and long-term. These challenges are presented in greater
detail and statistical analysis throughout this section of this Annual Report
on Form 10-K.
* Net income growth during 2002 and 2003 was driven substantially by
mortgage banking as a result of declining market mortgage interest rates.
This mortgage refinancing activity is not expected to continue during
2004, impacting PSB's ability to continue profit growth.
12
* PSB was presented with favorable opportunities to expand its branch
network into management's previously identified expansion areas in
Minocqua and Weston, Wisconsin, that were unexpected and sooner than
originally anticipated. In addition, due to growth in size and
operations, construction of a new main bank and administrative office
began during 2003. Each of the facility expansions will be placed in
service during 2004, significantly increasing PSB's fixed overhead
expense structure. In past years, low overhead expenses allowed PSB to
competitively price products while maintaining acceptable profits for
capital expansion and shareholders. As overhead increases, additional
profit gains need to come from the sale of new services, acquisition of
new customers, favorable loan and deposit pricing, and other sources of
income.
* In the near-term, PSB anticipates that 2004 earnings will be below 2003
and more in line with 2002 due in large part to lower mortgage banking
income and increased overhead expenses associated with market expansions
to Minocqua and Weston, Wisconsin and use of the new main bank and home
office facility. Despite the anticipated decline in annual 2004
earnings, management considers each office a long-term investment for the
benefit of shareholders and the future vibrancy of PSB.
* Competition for local loan customers continues to increase as new
competitors enter PSB's home market in Marathon County, Wisconsin, and as
PSB expands into Minocqua and Weston, Wisconsin. In addition, local
deposit pricing remains higher than some Wisconsin and Midwest
communities increasing PSB's incremental cost of financing. These
factors, including the expected long-term erosion of national bank system
deposits lead management to believe that net interest margin levels
relative to credit risk and other factors will be difficult to maintain
in 2004 and in the long-term.
* During the past several years, increases in loans receivable have not
been offset by similar levels of increased local retail deposits.
Consequently, PSB has substantially increased the level of wholesale
funding such as broker certificates of deposit and Federal Home Loan Bank
of Chicago ("FHLB") advances. In light of a long-term industry wide
problem on attracting and keeping deposits, PSB is positioning itself to
meet future funding needs in this environment. PSB has identified
personal and commercial noninterest bearing demand deposits as a long-
term low cost source of funding. Therefore, PSB is positioning its
operations to efficiently handle large volumes of customer activity in
this area through image processing and related initiatives. PSB
continually improves its method to track liquidity and consistently price
funding sources based on a complete picture of profitability. Incentive
compensation plans also highlight deposit gathering at standard rates and
products as a key component of incentive compensation.
* PSB's long-term growth plan is likely to exceed the level of assets able
to be supported by existing equity capital and future earnings retained
internally. Management monitors available sources of regulatory
qualifying capital and maintains relationships with
13
investment banking professionals to expedite acquisition of capital in a
manner beneficial to existing shareholders when necessary. PSB has no
current plans for a trust preferred capital issue, subordinated debt, or
additional issue of common stock.
* The number of growth initiatives currently undertaken by PSB is
significantly greater than traditionally undertaken. In past years, PSB
would open a branch location or take on new initiatives every few years.
However, since late 2001, PSB has or is planning to open four branch
locations and has started a de novo commercial property and casualty
insurance services agency. After careful consideration by management,
these expansion opportunities are expected to enhance PSB's long-term
shareholder value. These increased number of initiatives have the
potential to spread management resources thinly and have financial
results different than originally planned.
* PSB is currently involved in Internal Revenue Service and Wisconsin
Department of Revenue income tax audits for separate issues directed at
the operations of its Nevada investment subsidiary, PSB Investments, Inc.
As described in Item 8, Note 14 of the Notes to the Consolidated
Financial Statements, an unfavorable outcome in these audits would have
an unfavorable impact on profits and could change the manner in which PSB
holds and manages investment securities and other earning assets.
RESULTS OF OPERATIONS
PSB's net income increased to $4,806 for 2003 compared to $4,365 in 2002 and
$3,366 during 2001 representing increases of 10.1% in 2003 and 29.7% in 2002.
Similarly, diluted earnings per share grew to $2.74 for 2003 compared to $2.48
in 2002 and $1.91 in 2001. Item 6 of this Annual Report on Form 10-K presents
other various financial performance ratios and measures for the five years
ending December 31, 2003. PSB has experienced substantial earnings growth
during the past several years due primarily to mortgage banking income from the
sale and servicing of long-term fixed rate secondary market loans, and an
increase in net interest income on increased earning assets held primarily in
the form of loans receivable. In addition, during 2003, PSB experienced two
items of noninterest income that could be considered nonrecurring and did not
occur during 2002 or 2001. The following table presents PSB's net income for
the three years ending December 31, 2003 including adjustments for gain on sale
of mortgage loans and the nonrecurring income items during 2003.
Years ending December 31, 2003 2002 2001
Gain on sale of mortgage loans, net of tax $1,225 $904 $414
Net gain on sale of securities, net of tax 48 - -
Gain on curtailment of post-
retirement benefit plan, net of tax 79 - -
Other income, net of tax 3,454 3,461 2,952
Net income $4,806 $4,365 $3,366
14
As seen in the table, 2003 net income before gain on sale of mortgage loans,
gain on sale of securities, and gain on curtailment of a post-retirement
benefit plan decreased from the level seen during 2002. This decline in net
income and profit growth before these items was due primarily to a decrease in
average net interest margin on earnings assets compared to 2002 and additional
wages paid to employees based on earnings which included mortgage banking
income under PSB's incentive compensation plan. Conversely, 2002 net income
increased substantially over 2001 due to an increase in average net margin on
earning assets, a larger earning assets base, and an increase in deposit
service fees collected in connection with a new customer checking convenience
program in which customers pay a per item fee in exchange for coverage of
short-term overdrafts.
The following discussion concerning results of operations present a detailed
analysis of significant items impacting results from operations and trends
identified by management including:
* Average earning asset and funding sources balances and rates;
* Impact of increased asset base and changes in average net margin on net
interest income;
* Changes in the nature of profit and loss items related to net interest
income;
* Noninterest income and expense analysis, trends, and expectations;
* Anticipated impacts of current branching and administrative facilities
expansion; and
* Income tax contingencies
NET INTEREST INCOME
PSB incurs market risk primarily from interest-rate risk inherent in its
lending and deposit taking activities. Market risk is the risk of loss from
adverse changes in market prices and rates. Management actively monitors and
manages its interest-rate risk exposure. The measurement of the market risk
associated with financial instruments (such as loans and deposits) is
meaningful only when all related and offsetting on- and off-balance sheet
transactions are aggregated, and the resulting net positions are identified.
Disclosures about the fair value of financial instruments that reflect changes
in market prices and rates can be found in Item 8, Note 20 of the Notes to
Financial Statements.
PSB's primary objective in managing interest-rate risk is to minimize the
adverse impact of changes in interest rates on net interest income and capital,
while adjusting the asset-liability structure to obtain the maximum yield-cost
spread on that structure. PSB relies primarily on its asset-liability
structure to control interest-rate risk. In general, longer-term earning
assets are funded by shorter-term funding sources allowing PSB to earn net
interest income on both the credit risk taken on assets and the yield curve of
market interest rates. However, a sudden and substantial change in interest
rates may adversely impact earnings, to the extent that the interest rates
borne by assets and liabilities do not change at the same speed, to the same
extent, or on the same basis. PSB does not engage in trading activities to
enhance earnings or for hedging purposes.
Net interest income represents the difference between interest earned on loans,
securities and other interest-earning assets, and the interest expense
associated with the deposits and
15
borrowings that fund them. Interest rate fluctuations together with changes
in volume and types of earning assets and interest-bearing liabilities combine
to affect total net interest income. Additionally, net interest income is
impacted by the sensitivity of the balance sheet to change in interest rates,
contractual maturities, and repricing frequencies.
The following tables present average balance sheet data and related average
interest rates on a tax equivalent basis and the impact of changes in the
earnings assets base for the three years ending December 31, 2003.
Table 2: Average Balances and Interest Rates
2003 2002 2001
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
Assets
Interest-earning assets:
Loans(1)(2) (3) $282,006 $18,025 6.39% $249,247 $18,102 7.26% $226,819 $19,301 8.51%
Taxable securities 51,707 1,943 3.76% 51,664 2,724 5.27% 48,272 2,866 5.94%
Tax-exempt securities(2) 22,478 1,388 6.17% 20,466 1,361 6.65% 17,191 1,174 6.83%
FHLB stock 2,367 153 6.46% 2,218 109 4.91% 2,097 135 6.44%
Other 6,760 74 1.09% 9,979 162 1.62% 11,120 389 3.50%
Total(2) 365,318 21,583 5.91% 333,574 22,458 6.73% 305,499 23,865 7.81%
Non-interest-earning assets:
Cash and due from banks 10,268 8,865 9,223
Premises and equipment, net 6,410 5,453 4,557
Other assets 3,108 3,258 3,447
Allowance for loan
losses (3,475) (3,148) (2,642)
Total $381,629 $348,002 $320,084
Liabilities & stockholders' equity
Interest-bearing liabilities:
Savings and demand
deposits $40,518 $247 0.61% $32,536 $337 1.04% $25,685 $436 1.70%
Money market deposits 69,238 692 1.00% 73,629 1,061 1.44% 75,553 2,825 3.74%
Time deposits 144,083 4,712 3.27% 132,848 5,437 4.09% 115,093 6,509 5.66%
FHLB borrowings 38,553 1,989 5.16% 38,000 2,289 6.02% 37,764 2,266 6.00%
Other borrowings 9,151 229 2.50% 3,496 149 4.26% 6,414 432 6.74%
Total 301,543 7,869 2.61% 280,509 9,273 3.31% 260,509 12,468 4.79%
Non-interest-bearing liabilities:
Demand deposits 46,876 38,031 32,710
Other liabilities 2,098 2,127 2,757
Stockholders' equity 31,112 27,335 24,108
Total $381,629 $348,002 $320,084
Net interest income 13,714 13,185 11,397
Rate spread 3.30% 3.42% 3.02%
Net yield on interest-earning assets 3.75% 3.95% 3.73%
(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%.
(3) Loan fees are included in total interest income as follows: 2003 - $654,
2002 - $458, 2001 - $344.
16
Table 3: Interest Income and Expense Volume and Rate Analysis
2003 compared to 2002 2002 compared to 2001
increase (decrease) due to(1) increase (decrease) due to(1)
Volume Rate Net Volume Rate Net
Interest earned on:
Loans(2) $2,378 $(2,455) $(77) $1,917 $(3,116) $(1,199)
Taxable securities 2 (783) (781) 204 (346) (142)
Tax-exempt securities(2) 134 (107) 27 224 (37) 187
FHLB stock 7 37 44 8 (34) (26)
Other interest income (52) (36) (88) (39) (188) (227)
Total 2,469 (3,344) (875) 2,314 (3,721) (1,407)
Interest paid on:
Savings and demand deposits 83 (173) (90) 116 (215) (99)
Money market deposits (63) (306) (369) (71) (1,693) (1,764)
Time deposits 460 (1,185) (725) 1,014 (2,086) (1,072)
Short-term borrowings 33 (333) (300) (196) (87) (283)
Long-term borrowings 241 (161) 80 15 8 23
Total 754 (2,158) (1,404) 878 (4,073) (3,195)
Net interest earnings $1,715 $(1,186) $ 529 $1,436 $ 352 $1,788
(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.
During 2003, average earning assets grew 9.5% to $365,318 compared to growth of
9.2% during 2002 and 13.5% during 2001. However, tax adjusted net interest
income increased just 4.0% to $13,714 compared to growth of 15.7% to $13,185
during 2002 and growth of 17.1% to $11,397 during 2001. The lower level of net
interest income growth during 2003 was due to a decline in average net interest
margin on those earning assets.
Yield on earning assets and cost of interest-bearing liabilities declined
during 2003, 2002, and 2001. However, during 2003, the decline in earning
assets yield was greater than the offsetting decline in the cost of interest-
bearing liabilities as savings and other "core" customer deposits had repriced
to near their floor during 2002. Conversely, longer-term loans matured and
refinanced at continually lower rates, decreasing net interest margin during
2003. Although the volume of additional earning assets added $1,715 to net
interest income during 2003, nearly 2/3 of this benefit was lost to declines in
net interest margin. During 2002 and 2001, net interest income benefited from
both an increase in the earning assets base and an increase in average net
17
interest margin. The following table outlines the change in yields during the
three years ended December 31, 2003.
Table 4: Yield on Earning Assets
Year ended December 31, 2003 2002 2001
Yield Change Yield Change Yield Change
Yield on earning assets 5.91% -0.82% 6.73% -1.08% 7.81% -0.47%
Effective rate on all liabilities as
a percent of earning assets 2.16% -0.62% 2.78% -1.30% 4.08% -0.58%
Net yield on earning assets 3.75% -0.20% 3.95% 0.22% 3.73% 0.11%
Because PSB holds a significant amount of prime rate adjustable commercial and
home equity loans, the decrease in the prime rate at the end of June 2003
caused a direct reduction to net interest margin due to the inability to
reprice core deposit savings rates from their already historically low levels.
By the end of 2003, both assets and liabilities had appeared to be fully
repriced at today's lower interest rates. Tax adjusted net interest margin for
the 3rd and 4th quarter of 2003 were 3.67% and 3.65%, respectively. Absent a
sharp change in market interest rates, management expects net interest margin
to remain similar to that seen during the 4th quarter of 2003 during all of
2004. Average earnings assets are projected to continue to grow by
approximately 10% during 2004.
NONINTEREST INCOME
PSB noninterest income from deposit service fees, sale of mortgage loans and
other income continues to grow relative to net interest income, reducing PSB's
dependence on traditional sources of revenue from interest bearing products.
Noninterest income to tax-adjusted net interest margin grew from 18.1% in 2001
to 23.1% in 2002 and 30.0% during 2003. Management believes other fee based
income to be an important component of future earnings as the net interest
margin on traditional loan and deposit products becomes smaller due to
increased financial services competition. Gain on sale of mortgages to
secondary market investors was the primary reason for net income growth during
2003 , 2002, and 2001. The following common size income statement presents the
changing mix of income and expense relative to traditional loan and deposit
product net interest income for the five years ending December 31, 2003.
Table 5: Summary of Earnings as a Percent of Net Interest Income
2003 2002 2001 2000 1999
Net interest income 100.0% 100.0% 100.0% 100.0% 100.0%
Provision for loan losses 6.3% 8.8% 8.1% 6.4% 5.1%
Net interest income after loan loss provision 93.7% 91.2% 91.9% 93.6% 94.9%
Total noninterest income 31.2% 24.1% 18.8% 15.4% 13.9%
Total noninterest expenses 70.9% 65.1% 66.8% 68.9% 68.6%
Net income before income taxes 54.0% 50.2% 43.9% 40.1% 40.2%
Provision for income taxes 17.4% 15.7% 13.3% 11.7% 11.8%
Net income 36.6% 34.5% 30.6% 28.4% 28.4%
18
During the past several years, noninterest income as a percentage of net
interest income has increased and was 31% of net interest income during 2003
compared to 14% during 1999. Even if the impact of gain on sale of mortgage
loans is removed, noninterest income increased relative to total net interest
income. In addition to increased income from the gain on sale of mortgage
loans, PSB increased deposit service fee income and commissions on sale of
uninsured investment and insurance products. During 2003, the impact of the
gain on sale of mortgages and some nonrecurring income items were significant
contributors to the increase in 2003 net income over 2002. Although the
continued decline in market interest rates decreased average net interest
margin as described previously, low mortgage rates encouraged homeowners to
refinance their mortgages generating significant fee income for PSB, offsetting
lost interest margin on loans retained on PSB's balance sheet. However,
because this activity was in response to falling interest rates, management
does not expect such level of mortgage fee income to continue in 2004. A
detailed analysis of noninterest income relative to net income before income
taxes follows to highlight the impact of these items on income.
Table 6: Noninterest Income
2003 2002 2001
% of pre-tax % of pre-tax % of pre-tax
Amount income Amount income Amount income
Service fees $1,282 18.04% $1,217 19.16% $1,011 20.98%
Mortgage banking income 1,767 24.87% 1,223 19.25% 683 14.17%
Retail investment sales commissions 351 4.94% 163 2.57% 193 4.00%
Insurance annuity sales commissions 63 0.89% 69 1.09% - 0.00%
Net gain on sale of securities 80 1.13% - 0.00% - 0.00%
Net gain (loss) on sale of foreclosed property (9) -0.13% 28 0.44% (10) -0.21%
Gain (loss) on disposal of premises and equipment - 0.00% (24) -0.38% 48 1.00%
Gain on sale of non-mortgage loans 62 0.87% - 0.00% - 0.00%
Gain on curtailment of post-retirement benefit plan 131 1.84% - 0.00% - 0.00%
Other operating income 384 5.40% 372 5.86% 140 2.91%
Total noninterest income $4,111 57.85% $3,048 47.99% $2,065 42.85%
Mortgage banking income includes the gain on sale of mortgages and fees for
servicing those mortgages for other investors. Mortgage banking income as a
percent of pre-tax income increased 75% over that seen during 2001 and 29% over
than seen during 2002. In addition, gain on sale of securities and other loans
and the gain on curtailment of post-retirement benefit plan increased pre-tax
income by $273. These income items and this level of mortgage banking income
are not expected to recur during 2004. This decline in noninterest income is
expected to be offset somewhat by increased retail investment sales commissions
and increased mortgage loan servicing fees during 2004 so that the decline in
total noninterest income is anticipated to be approximately $850.
PSB serviced $152,718 and $95,408 of residential real estate loans which have
been sold to the FHLB under the Mortgage Partnership Finance Program ("MPF") at
December 31, 2003 and 2002, respectively. A servicing fee equal to .25% of
outstanding principal is retained from payments collected from the customer as
compensation for servicing the loan for the FHLB. Historically low and
declining long-term fixed rate mortgage interest rates during 2001 to 2003
increased the amount of loans originated and subsequently serviced for the FHLB
from just $1 million at December 31, 2000.
As a FHLB 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. In exchange for this guarantee, PSB is paid a
"credit enhancement" fee of .07% to .10% of outstanding serviced principal in
addition to the .25% collected for servicing the loan for the FHLB.
19
PSB recognizes a mortgage servicing right asset due to the substantial volume
of loans serviced for the FHLB. Refer to Note 1 of the consolidated financial
statements for a summary of PSB's mortgage servicing right accounting policies.
The table below summarizes the components of PSB's mortgage banking income for
the three years ending December 31, 2003.
Table 7: Mortgage Banking Income
Years ending December 31,
2003 2002 2001
Cash gain on sale of mortgage loans $1,229 $652 $362
Originated mortgage servicing rights 792 840 321
Gain on sale of mortgage loans 2,021 1,492 683
Mortgage servicing fee income 325 131 37
FHLB credit enhancement fee income 96 27 -
Amortization of mortgage servicing rights (700) (312) (37)
Change in servicing right valuation allowance 25 (115) -
Loan servicing fee income, net (254) (269) -
Mortgage banking income $1,767 $1,223 $683
During early 2002, PSB offered a new checking convenience product called
"Overdraft Defender" to retail demand deposit customers in good standing. In
exchange for a fee per item, PSB would cover a customer overdraft for a short
period for a limited dollar amount as a convenience to demand deposit
customers. The program increased the number of customers who used their
checking account for infrequent small purchases in excess of collected funds.
Following introduction of the program, net collected overdraft fees increased
from $446 during 2001 to $773 during 2002. Overdraft fees collected during
2003 remained similar to 2002 at $748.
Also during 2003, PSB increased the number of staff that sold uninsured
investment and insurance products on a commission basis. Doing so increased
retail investment sale commissions from $193 and $163 in 2001 and 2002,
respectively, to $351 during 2003. The current number of sales staff is
expected to remain the same during 2004.
20
NONINTEREST EXPENSE
Noninterest expenses year over year continue to increase growing 13.0% during
2001, 12.4% during 2002 and 13.7% during 2003. However, net interest income
and other income have increased by similar amounts so that PSB's efficiency
ratio has remained in a range from 54.50% during 2001 to 50.68% in 2002 to
52.46% in 2003. Salaries and employee benefits showed the greatest increase
relative to net interest income and other income during 2003. The table below
outlines in detail noninterest expenses for the three years ending December 31,
2003.
Table 8: Noninterest Expense
Years ended December 31,
2003 2002 2001
% of net % of net % of net
margin & margin & margin &
Amount other income Amount other income Amount other income
Wages, except incentive compensation $4,476 25.11% $3,765 23.19% $3,320 24.66%
Incentive compensation 466 2.61% 414 2.55% 290 2.15%
Net deferred loan origination costs (259) -1.45% (256) -1.58% (156) -1.16%
Profit sharing and retirement plan expense 327 1.83% 280 1.72% 263 1.95%
Post-retirement health care benefits plan 62 0.35% 74 0.46% 46 0.34%
Payroll taxes and other employee benefits 880 4.94% 650 4.00% 656 4.87%
Total salaries and employee benefits 5,952 33.39% 4,927 30.34% 4,419 32.81%
Occupancy expense 1,127 6.32% 1,093 6.73% 917 6.81%
Data processing other office operations 547 3.07% 583 3.59% 523 3.89%
Advertising and promotion 172 0.96% 319 1.97% 307 2.28%
Directors fees and benefits 266 1.49% 171 1.05% 244 1.81%
Legal and professional expenses 230 1.29% 181 1.12% 170 1.26%
Other expenses 1,057 5.94% 952 5.88% 735 5.64%
Total noninterest expense $9,351 52.46% $8,226 50.68% $7,315 54.50%
Note - Net interest income (net margin) is calculated on a tax equivalent basis
using a tax rate of 34%.
The average number of full time equivalent employees ("FTE") was 119, 106, and
93 in 2003, 2002, and 2001, respectively. Average base wages per FTE were
$35,699, $35,518, and $37,613 in 2001, 2002, and 2003, respectively, increasing
5.8% during 2003. The increase in base pay was due to one-time merit and
inflationary increases granted to employees effective January 1, 2003 averaging
6.1%. For 2004, employees were granted inflationary and merit increases
averaging 2.9%. Separate from an increase in payroll taxes based on paid
wages, other employee benefits increased $92 due to additional health insurance
benefit costs. PSB offers employees health insurance through a self-insured
plan with stop-loss limits as described in Item 8, Note 12 of the Notes to
Consolidated Financial Statements.
PSB offers employees an incentive compensation program based on achievement of
the bank's net income requirements and achievement of department and individual
goals. In addition, PSB's profit sharing contribution to the qualified
employee retirement plan is a percentage of net income before income taxes
based on achievement of pre-set levels of net income. During 2002 and 2003,
the highest levels of incentive compensation were paid. However, because the
program is based on net income growth, incentive compensation is variable, and
could decline during 2004, reducing operating expenses if profit growth slows
due to branch expansion costs, declining mortgage loan sales, or other factors.
21
Advertising and promotion expenses declined during 2003 as PSB took much of its
advertising and design work in-house. In addition, PSB updated the bank logo
and other media for a change in brand during 2002, which increased nonrecurring
expenses during that year. With the opening of two new branch locations and a
new administrative home office during 2004, PSB expects to increase advertising
and promotion to capitalize on these new initiatives and market exposure.
Directors' fees and benefits increased during 2003 due to an increase in fees
effective January 1, 2003. Increases to the director fees schedule are
infrequent and the 2003 increase was the first in several years. Directors'
fees are expected to remain the same during 2004. Directors' fees during 2001
included $104 for termination of a director deferred compensation plan.
Separate from this nonrecurring item, directors' fees in 2001 would have been
$140.
PSB formed Peoples Insurance Services LLC during September 2003 as a start up
commercial property and casualty insurance agency. As a start-up, the agency
is incurring costs in excess of revenue at this time. The agency's net loss
from operations during 2003 was $47. The agency is expected to incur
additional losses during 2004 not to exceed $100.
In addition to the anticipated decline in mortgage banking income described
previously, PSB will incur additional operating expense during 2004 for new
branch expansions in Minocqua and Weston, Wisconsin and a new main bank and
administrative office in Wausau, Wisconsin. The new branches are expected to
grow quickly due to existing relationships PSB has in those areas. Both
locations are expected to achieve month over month profits within the first 24
months of operation. However, during 2004, operating expenses at these
locations will exceed net interest income and fee income. In addition, the new
main bank and administrative office in Wausau, Wisconsin is expected to be
placed in service during the second quarter 2004. While the new facility will
significantly increase office and service space at PSB's main location,
operating expenses will increase due to additional building and equipment
depreciation, cleaning and utilities. The new home office is being constructed
on the site of the existing office, which will be razed after moving into the
new building. Current accounting standards require that the undepreciated cost
basis of the old office be recorded as a loss on disposal of a long-lived
asset. Lastly, PSB is implementing a new imaging system for item and check
processing and replacing significant pieces of check processing equipment which
will better serve existing customers and give PSB access to new commercial
customers demanding high level cash management services. The new equipment is
also expected to reduce personnel required for back office operations while at
the same time increasing check capabilities. The table below presents the
estimated after tax reduction to 2004 net income from each of these
initiatives:
Minocqua and Weston, Wisconsin branches initial net losses $ 94
Loss on disposal of long-live asset (Home office) and additional
depreciation expense related to home office 261
Additional depreciation expense related to check imaging and sorting system 32
Total estimated reduction to net income from 2004 new initiatives $387
22
PROVISION FOR LOAN LOSSES
The adequacy of the allowance for loan losses is assessed based upon credit
quality, existing economic conditions and loss exposure by loan category.
Management determines the allowance for loan losses based on past loan
experience, current economic conditions, composition of the loan portfolio, and
the potential for future loss. 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, or portions
thereof, including impaired loans, are uncollectible, these amounts are
promptly charged off against the allowance. The provision for loan losses was
$835, in 2003; compared to $1,110 in 2002 and $890 in 2001. See additional
discussion under the section titled "Allowance for Loan Losses."
INCOME TAXES
The effective tax rate was 32.4% in 2003, 31.3% in 2002, and 30.2% in 2001.
The increase in the effective rate during 2003 and 2002 was due in part to
overall pre-tax income increasing faster than the relative size of the tax-
exempt municipal securities portfolio and state tax favored earnings at PSB's
Nevada investment subsidiary, PSB Investments, Inc. See Item 8, Note 13 of the
Notes to Consolidated Financial Statements for additional tax information.
As described in Note 14 of the Notes to Consolidated Financial Statements,
PSB's open tax returns are currently under audit by the Internal Revenue
Service and the Wisconsin Department of Revenue for separate issues in
connection with PSB Investments, Inc. activities. PSB believes it has
calculated and paid appropriate income taxes in all cases in accordance with
written tax code and regulations. If either the IRS or Wisconsin Department of
Revenue is successful in its efforts, it would result in a negative impact on
earnings, which would be recorded as tax expense when assessed.
BALANCE SHEET CHANGES AND ANALYSIS
Summary balance sheets for the five years ended December 31, 2003 are presented
in Item 6 to this Annual Report on Form 10-K. Total asset growth was 10.1%,
7.9%, and 12.4% during the years ended December 31, 2003, 2002, and 2001,
respectively. Presented in the table below is the balance sheet for five years
as of December 31, 2003 as a percentage of total assets.
23
Table 9: Summary Balance Sheet as a Percent of Total Assets
As of December 31, 2003 2002 2001 2000 1999
Cash and cash equivalents 4.6% 5.8% 7.4% 3.1% 4.6%
Securities 17.7% 21.8% 20.5% 20.3% 23.2%
Total loans receivable, net of allowance 74.4% 68.9% 68.7% 73.4% 69.5%
Premises and equipment, net 1.8% 1.7% 1.4% 1.6% 1.5%
Other assets 1.5% 1.8% 2.0% 1.6% 1.2%
Total assets 100.0% 100.0% 100.0% 100.0% 100.0%
Total deposits 77.4% 80.2% 79.5% 78.9% 77.9%
FHLB advances 11.5% 10.2% 11.0% 9.1% 5.0%
Other borrowings 2.6% 0.9% 1.3% 3.8% 8.2%
Other liabilities 0.6% 0.8% 0.8% 0.9% 0.8%
Stockholders' equity 7.9% 7.9% 7.4% 7.3% 8.1%
Total liabilities and stockholders' equity 100.0% 100.0 % 100.0% 100.0% 100.0%
During 2003 and 2002, the asset mix has increased in loans receivable but
decreased in securities held. Investment in premises and equipment has also
increased with a new full service branch facility in Rhinelander, Wisconsin and
ongoing construction of a new main office and administrative headquarters in
Wausau, Wisconsin.
Equity capital as a percentage of total assets remained similar during the past
several years. However, the mix of funding sources changed as deposits has
declined as a percentage of assets. Instead, PSB has increased reliance on
FHLB advances and other borrowings (primarily repurchase agreements) to fund
asset growth during 2003. In addition, retained deposits include a greater
amount of wholesale market broker certificates of deposit at December 31, 2003
than in prior years. Local retail deposits have shown little growth during
2003 and 2002 relative to other funding sources. The table below presents
changes in the mix of average earning assets and interest bearing liabilities
for the three years ending December 31, 2003.
Table 10: Mix of Average Interest Earning Assets and Average Interest Bearing
Liabilities
Year ended December 31, 2003 2002 2001
Loans 77.2% 74.7% 74.3%
Taxable securities 14.2% 15.5% 15.8%
Tax-exempt securities 6.2% 6.1% 5.6%
FHLB stock 0.6% 0.7% 0.7%
Other 1.8% 3.0% 3.6%
Total interest earning assets 100.0% 100.0% 100.0%
Savings and demand deposits 13.4% 11.6% 9.9%
Money market deposits 23.0% 26.3% 29.0%
Time deposits 47.8% 47.4% 44.2%
FHLB advances 12.8% 13.6% 14.5%
Other borrowings 3.0% 1.3% 2.5%
Total interest bearing liabilities 100.0% 100.0% 100.0%
24
The growth in loans as a percentage of the earning assets mix was funded in
part by a change in the mix of securities and reduction in overnight federal
funds sold (other earning assets). During the past several years, a greater
portion of interest bearing liabilities have been from savings and demand
deposits while money market balances have declined as market rates for the
product have fallen.
PSB is party to limited off balance sheet activity and has not purchased any
stand alone derivative instruments for the purpose of enhancing earnings or
hedging cash flow or the fair value of monetary instruments. PSB's primary off
balance sheet arrangement is with the FHLB as a MPF mortgage loan servicer. In
addition to servicing residential first mortgage loans owned by the FHLB, PSB
retains some recourse risk if the FHLB incurs principal losses in excess of an
initial loss pool. See "Off-Balance Sheet Arrangements."
The following sections concerning changes in the balance sheet present a
detailed analysis of significant items impacting balance sheet trends
identified by management including:
* Decline in securities held relative to other assets;
* Increase in commercial real estate lending but declines in retail
consumer lending;
* Level of nonperforming loans and other assets;
* Increased activity in mortgage loan servicing activities; and
* Change in deposit mix and slowing retail local deposit growth
INVESTMENT SECURITIES PORTFOLIO
The investment securities portfolio is intended to provide PSB with adequate
liquidity, flexible asset/liability management and a source of stable income.
At December 31, 2003, all securities are classified as available for sale and
reported at fair value. Unrealized gains and losses are excluded from earnings
but are reported as other comprehensive income in a separate component of
stockholders' equity, net of income tax. At December 31, 2001, tax-exempt
municipal securities were considered held to maturity and were recorded at net
amortized cost. The investment portfolio represented 20.4% and 21.6% of
average earning assets in 2003 and 2002, respectively. The following table
presents the fair value and amortized cost securities held by PSB at December
31, 2003, 2002, and 2001.
25
Table 11: Investment Securities Portfolio Maturities
Years Ended December 31
2003 2002 2001
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
U.S. Treasury securities and obligations
of U.S. government agencies $11,912 $12,148 $11,788 $12,201 $9,516 $9,673
Obligations of states and political
subdivisions 23,513 24,664 20,905 21,926 20,287 20,355
Mortgage backed securities 7,933 7,979 4,519 4,547
Collateralized mortgage obligations 25,526 25,383 41,260 41,835 39,717 40,312
Trust preferred securities 2,250 2,250 500 500
Other equity securities 48 48 48 48 173 173
Total $71,182 $72,472 $79,020 $81,057 $69,693 $70,513
As market interest rates continued to fall during 2003, a large percentage of
PSB's collateralized mortgage obligations ("CMOs") prepaid and it received
large cash flows to be reinvested. These significant unexpected prepayments
also required purchase premiums to be amortized against income much more
quickly that anticipated when the CMO was purchased which contributed to
declining yields. The yield on taxable securities, including CMOs, was 3.76%
during 2003 compared to 5.27% during 2002. As market interest rates associated
with mortgage lending increased during the fourth quarter of 2003, security
yields on CMOs and mortgage backed securities stabilized at 4.10% for the
quarter ending December 31, 2003. Management expects the yield on taxable
securities to remain similar during the beginning of 2004.
At the time CMOs prepayments were accelerating, reinvestment rates for similar
securities were at historic lows. As part of proactive asset-liability
management, PSB chose to reinvest these CMO cash flows in 15 year fixed rate
residential mortgages held on PSB' balance sheet. The program absorbed
approximately $6 million of securities cash flow during 2003. Refer to the
discussion of changes in loans for additional information on this temporary
program.
Due to the steepness of the market interest rate yield curve during 2003, PSB
reinvested some of the CMO security prepayment proceeds in additional long-term
municipal securities to gain higher tax advantaged yields. Tax effected yield
on municipal securities declined just .48% to 6.17% during 2003 compared to
6.65% during 2002. Because PSB maintains an investment "ladder" of maturities
in its municipal portfolio, current maturities continue to be reinvested at
lower rates, gradually reducing the tax adjusted yield on municipal securities.
The municipal security yield is expected to continue to decline during 2004
even as current market interest rates stabilize or increase.
During 2003 and 2002, PSB expanded securities ownership into additional
categories not used prior to 2002. In light of PSB's asset/liability position
and expectation of interest rate movements, pass through mortgage backed
securities of 15 year single family mortgage pools were purchased as noted in
the table above. In addition, PSB purchased nonrated trust preferred
securities issued by bank holding companies in Wisconsin. As with nonrated
municipal securities, PSB considers ownership of such local issues to have no
more risk that out of state rated issues due to PSB's understanding of local
markets, municipalities, and issuers. Each
26
security purchased by PSB is subject to a full and formal risk analysis
considering (among other factors) the liquidity needs of the bank and the
credit risk of the issuer. Although the original maturity on each trust
preferred security was 30 years, the interest rates on each security currently
adjust, or will adjust after an initial fixed rate period based on the 90 day
LIBOR rate, reducing PSB's interest rate risk on these longer maturity assets.
PSB does not expect to purchase additional trust preferred securities during
2004.
During December 2002, PSB transferred the entire securities held to maturity
portfolio to available for sale status. At the date of transfer, municipal
securities had a net book value of $21,027 and fair value of $22,056 for an
unrealized gain of $1,029. In accordance with current accounting standards,
the transferred municipal securities were recorded at fair value and
stockholders' equity increased $673 net of income tax effects at the date of
transfer to recognize additional unrealized gain on securities available for
sale. PSB reclassified municipal securities to increase available liquidity.
The following table categorizes securities by scheduled maturity date and does
not take into account the existence of optional calls held by the security
issuer. Therefore, actual funds flow from maturing securities may be different
than presented below. Maturity of mortgage backed securities and
collateralized mortgage obligations, some of which call for scheduled monthly
payments of principal and interest, are categorized by average principal life
of the security. Yields by security type and maturity are based on amortized
security cost.
Table 12: Investment Securities Distribution
After one but After five but
Within one year within five years within ten years After ten years
Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury securities and obligations
of U.S. government agencies $1,516 2.84% $8,477 3.53% $2,155 4.97%
Obligations of states and
political subdivisions(1) $959 6.68% $8,704 6.54% $14,609 5.71% $392 5.99%
Mortgage backed securities 5,305 4.25% 2,674 4.58%
Collateralized mortgage obligations 3,673 4.40% 20,703 3.72% 1,007 4.40%
Non-rated trust preferred securities 2,250 5.63%
Other equity securities 48 13.22%
Totals $6,196 4.44% $43,189 4.32% $20,445 5.42% $2,642 5.68%
(1) Weighted average yields on tax-exempt securities have been calculated on a
tax-equivalent basis using a rate of 34%.
At December 31, 2003 and 2002, PSB's securities portfolio did not contain
securities of any single issuer where the aggregate carrying value of such
securities exceeded 10% of stockholders' equity.
27
Securities with an approximate carrying value (fair value) of $17,994 and
$7,907 at December 31, 2003 and 2002, respectively, were pledged primarily to
secure public deposits, other borrowings, and for other purposes required by
law. The substantial increase in securities pledged was due to the increase in
local governmental and municipal funds in excess of insured limits obtained by
PSB during 2003.
The market value of the investment portfolio as a percentage of book value has
been impacted by changes in overall market interest rates during the past
several years. At December 31, 2003 market value was 101.8% of book value
compared to 102.6% of book value at December 31, 2002 and 101.2% of book value
at December 31, 2001. The net unrealized gain on securities available for
sale, recorded as a separate component of stockholders' equity, was $844, net
of deferred taxes of $446 at December 31, 2003 compared to a gain of $1,306 net
of deferred income taxes of $731 at December 31, 2002. Unrealized securities
gains, net of income tax effects are not considered regulatory capital under
current banking regulations. Management believes investment security yields
have a stabilizing effect on net interest margin during periods of interest
rate swings and expects to hold existing securities until maturity or repayment
unless such funds are needed for liquidity due to unexpected loan growth or
depositor withdrawals or if the sale is beneficial to PSB's interest rate risk
and return profile.
As a member of the FHLB system, PSB is required to hold stock in the FHLB based
on total assets and anticipated level of long-term borrowings to be advanced to
its bank subsidiary. This stock has a purchase cost and par value of $100 per
share. The stock is recorded at cost which approximates market value.
Transfer of the stock is substantially restricted. The FHLB pays dividends in
both cash and additional shares of stock. During the three years ended
December 31, 2003, FHLB dividends have been in the form of additional shares of
stock. In accordance with industry accounting conventions, PSB records FHLB
dividends in the form of stock as income in the year received. The average
dividend rate paid to PSB on FHLB stock was 6.46%, 4.91%, and 6.44% in 2003,
2002, and 2001, respectively.
LOANS RECEIVABLE
Total loans as presented in the following table include loans held for sale to
the secondary market and expected final fully disbursed principal on
construction loans not yet fully disbursed at year-end. Total loans receivable
increased 18.6%, 9.0%, and 6.1% at December 31, 2003, 2002, and 2001,
respectively. The majority of this growth came from additional real estate
loans, both commercial real estate and residential 15 year fixed rate first
mortgages that fit into PSB's asset-liability management plans. Approximately
$23 million of PSB's $50 million in total 2003 growth was originated by PSB's
new Rhinelander, Wisconsin branch location which opened during August 2002.
28
Table 13: Loan Composition
2003 2002 2001 2000 1999
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
Commercial,
industrial, municipal
and agricultural $66,934 21.17% $64,527 24.21% $64,503 26.38% $71,414 31.00% $60,300 32.42%
Commercial real
estate mortgage 128,290 40.58% 102,238 38.35% 84,150 34.41% 45,157 19.60% 28,046 15.08%
Real estate construction
(commercial and
residential) 37,639 11.91% 26,052 9.77% 15,609 6.38% 11,231 4.87% 9,654 5.19%
Residential real
estate mortgage 66,065 20.90% 55,078 20.66% 61,787 25.27% 82,309 35.72% 70,556 37.93%
Residential real estate
mortgage held for sale 207 0.07% 949 0.36% 1,403 0.57% 114 0.05% - 0.00%
Residential real
estate home equity 9,252 2.93% 7,274 2.73% 4,576 1.87% 4,400 1.91% 4,075 2.19%
Consumer and
individual 7,728 2.44% 10,439 3.92% 12,522 5.12% 15,784 6.85% 13,375 7.19%
Totals $316,115 100.00% $266,557 100.00% $244,550 100.00% $230,409 100.00% $186,006 100.00%
Commercial real estate growth continues to drive PSB loan growth, as it has for
several years. Separate from commercial real estate loans and real estate
construction at December 31, other loan categories have changed little from
$148,306 at December 31, 1999 to $150,186 at December 31, 2003. Commercial
real estate loans are originated for a broad range of business purposes
including non-owner occupied office rental space, multi family rental units,
owner occupied manufacturing facilities, and owner occupied retail sales space.
PSB has little lending activity for agricultural purposes. Management of PSB
is involved in the communities serviced by PSB and has a strong understanding
of the local economy, its business leaders, and trends in successful business
development. Based on this knowledge, PSB offers flexible terms and efficient
approvals which have allowed it to made inroads in this type of lending. PSB
hired an additional experienced commercial lender during early 2004 and expects
commercial loan principal to experience continued growth.
Retained, in-house residential real estate mortgage loans increased to $66,065
at the end of 2003, compared to $55,078 at the end of 2002 and $61,787 at the
end of 2001. During 2002 and much of 2003, in-house mortgages typically
included 1 to 3 year balloon mortgages which have been offered rates no less
than longer term 15 to 20 year fixed rates available in the secondary market.
Many of these borrowers have refinanced into a long-term fixed rate mortgage,
thereby decreasing residential real estate mortgages held by PSB.
Traditionally, in-house balloon mortgages have increased when long-term fixed
rates were high, most recently during 2000 (when in-house mortgages were
$82,309).
29
Despite this trend, the amount of residential real estate mortgages held
increased from the year earlier period by a substantial amount. The increase
in residential mortgages during 2003 is from retaining some 15 year fixed rate
mortgages rather than selling the principal to the secondary market. These
mortgages were retained as part of an asset-liability management strategy to
maximize net interest margin without a significant increase in interest rate
risk due to the current cash and projected liquidity position in light of
interest sensitivity of the entire balance sheet and opportunities for re-
investment of investment security cash flows into loans or other new
securities. The amount of 15 year fixed rate mortgages originated by the
program during 2003 was approximately $12.0 million with an average yield of
4.95%. Approximately one-half of this production was funded by maturing and
prepaid mortgage related investment securities during this period. This
program was discontinued during August 2003 and all 15 year fixed rate mortgage
loans currently originated by PSB are sold to other investors on the secondary
market to eliminate the associated interest rate risk. During 2004, PSB does
not expect to retain any 15 year fixed rate mortgage production but does expect
to place some 5 to 7 year fixed rate balloon and adjustable rate mortgages on
the balance sheet as is beneficial to profits, risk mitigation and asset-
liability management.
In addition to residential real estate loans retained by PSB and recognized on
the balance sheet, PSB also serviced $152,718 at December 31, 2003, and $95,408
at December 31, 2002 of residential real estate loans which have been sold to
the FHLB under the MPF. As part of the asset/liability and interest rate
sensitivity management strategy, PSB generally does not retain long-term 15 to
30 year fixed rate mortgages in its own portfolio. These serviced loans are
not recognized on PSB's balance sheet. As previously discussed in the analysis
of noninterest income, management does not expect to see serviced loans grow at
the pace of the past two years.
As a FHLB 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. At December 31, 2003, the maximum obligation for
such guarantees would be approximately $554 if total foreclosure losses on the
entire pool of approximately $153 million loans exceeded $2,562. At December
31, 2002, the maximum obligation for such guarantees was approximately $262 if
total foreclosure losses on the entire pool of approximately $95 million loans
exceeded $1,280. In exchange for this guarantee, PSB is paid a "credit
enhancement" fee. These first mortgage loans are underwritten using
standardized and conservative criteria on residential properties in PSB's local
communities. Management believes loans serviced for the FHLB will realize
minimal foreclosure losses in the future and that PSB will experience no loan
losses related to charge-offs in excess of the FHLB 1% loss pool. The central
and northern Wisconsin residential real estate market has not experienced the
run-up in home values seen by other parts of the country. The average
residential first mortgage originated by PSB under the FHLB program was
approximately $100 during 2003. Management does not expect to be significantly
impacted by loss exposure if housing values drop from a substantial increase in
future mortgage lending rates.
Real estate construction loans grew $11,587, or 44.4% during 2003 compared to
growth of $10,443, or 66.9% during 2002. Loans in this classification are
primarily short-term loans that provide financing for the acquisition or
development of commercial real estate, such as multi-
30
family or other commercial development projects. PSB retains permanent
financing on these projects following completion of construction in a
majority of cases.
Installment loans to consumers and individuals totaled $7,728 at December 31,
2003, down $2,711 from $10,439 at 2002. December 31, 2002 consumer loans were
down $2,083 from $12,522 at year-end 2001. Installment loans include short-
term installment loans, automobile loans, recreational vehicle loans, credit
card loans, and other personal loans. PSB experiences extensive competition
from local credit unions offering low rates on installment loans and has
directed resources toward more profitable lending categories such as
residential fixed rate mortgages and commercial real estate lending during the
past several years. However, during early 2004, PSB created a new position of
Retail Sales Manager staffed by an experienced and qualified consumer banking
professional to lead an improvement in consumer lending and retail deposit
product activity. Despite substantial competition in these products from
strong local credit unions, PSB believes a competitive product line in this
area is important for serving existing customers and obtaining new customers
with competitively priced products delivered with above average service and
flexibility.
The following table categorizes loan principal by scheduled maturity and does
not take into account any prepayment options held by the borrower. The loan
portfolio is widely diversified by types of borrowers, industry groups, and
market areas. Significant loan concentrations are considered to exist for a
financial institution when there are amounts loaned to numerous borrowers
engaged in similar activities that would cause them to be similarly impacted by
economic conditions. At December 31, 2003, no concentrations existed in PSB's
portfolio in excess of 10% of total loans.
Table 14: Loan Maturity Distribution and Interest Rate Sensitivity
Loan Maturity
One year Over one year Over
As of December 31, 2003: or less to five years five years
Commercial, industrial, municipal,
and agricultural $43,279 $21,440 $2,215
Commercial real estate mortgage 50,946 71,943 5,401
Real estate construction 37,639
Residential real estate mortgage 16,617 25,735 23,713
Residential real estate mortgage held for sale 207 - -
Residential real estate home equity 9,177 - 75
Consumer and individual 2,910 4,247 571
Totals $160,775 $123,365 $31,975
Fixed rate $120,639 $31,975
Variable rate 2,726 -
Totals $123,365 $31,975
31
ALLOWANCE FOR LOAN LOSSES
The loan portfolio is the primary asset subject to credit risk. Credit risk is
controlled through the use of credit standards, review of potential borrowers,
and loan payment performance. During 2003 the allowance for loan losses as a
percentage of gross loans declined due to an improvement in portfolio quality
and charge-off of a significant problem loan identified during 2002. As of
December 31, 2003, the allowance for loan losses as a percentage of total loans
outstanding was 1.15% and was 106.0% of nonperforming loans, compared to 1.22%
and 129.8%, respectively, at December 31, 2002. In addition to coverage from
the allowance for loan losses, nonperforming loans are secured by various
collateral including real estate and consumer collateral.
Table 15: Loan Loss Experience
Years ended December 31
2003 2002 2001 2000 1999
Average balance of loans for period $282,006 $249,247 $226,819 $207,527 $163,929
Allowance for loan losses at
beginning of year $3,158 $2,969 $2,407 $2,099 $1,947
Loans charged off:
Commercial, industrial, municipal,
and agricultural 243 628 148 250 374
Commercial real estate mortgage - - - - -
Residential real estate mortgage 170 201 75 14 20
Consumer and individual 109 156 107 51 38
Total charge-offs 522 985 330 315 432
Recoveries on loans previously charged-off:
Commercial, industrial, municipal,
and agricultural 44 33 1 16 74
Commercial real estate mortgage - - - - -
Residential real estate mortgage 5 6 - 3 -
Consumer and individual 16 25 1 4 50
Total recoveries 65 64 2 23 124
Net loans charged-off 457 921 328 292 308
Provision for loan losses 835 1,110 890 600 460
Allowance for loan losses at
end of year $3,536 $3,158 $2,969 $2,407 $2,099
Ratio of net charge-offs
during the year to average loans 0.16% 0.37% 0.14% 0.14% 0.19%
Ratio of allowance for loan losses
to loans receivable at end of year 1.15% 1.22% 1.24% 1.06% 1.15%
32
The allowance for loan losses represents management's estimate of an amount
adequate to provide for potential losses in the loan portfolio. Adequacy of
the allowance for loan losses is based on management's ongoing review and
grading of the loan portfolio, past loan loss experience, trends in past due
and nonperforming loans, and current economic conditions. PSB has an internal
risk analysis and review staff that continuously reviews loan quality.
The allocation of the year-end allowance for loan losses for each of the past
five years based on management's estimates of loss exposure by category of
loans is shown in the following table. The allocation methodology applied by
PSB focuses on changes in the size and character of the loan portfolio, current
and expected economic conditions, the geographic and industry mix of the loan
portfolio and historical losses by category. The total allowance is available
to absorb losses from any segment of the portfolio. Management allocates the
allowance for credit losses by pools of risk and by loan type. PSB combines
estimates of the allowance needed for loans analyzed individually and loans
analyzed on a pool basis. The determination of allocated reserves for larger
commercial loans involves a review of individual higher-risk transactions,
focusing on loan grading, and assessment of specific loss content and possible
resolutions of problem credits. While management uses available information to
recognize losses on loans, future adjustments may be necessary based on changes
in economic conditions.
Table 16: Allocation of Allowance for Loan Losses
As of December 31,
2003 2002 2001 2000 1999
% of % of % of % of % of
Dollar principal Dollar principal Dollar principal Dollar principal Dollar principal
Commercial, industrial,
municipal, and agricultural 2,002 2.99% $1,919 2.97% $1,738 2.69% $1,467 2.05% 1,263 .09%
Commercial real estate
mortgage 1,022 0.62% 569 0.45% 417 0.43% 87 0.16% 61 .16%
Eesidential real estate
mortgage 205 0.27% 167 0.27% 174 0.26% 162 0.19% 156 0.21%
Consumer and individual 52 0.67% 72 0.69% 89 0.71% 369 2.34% 322 2.41%
Impaired loans 255 15.67% 431 30.33% 551 26.09% 322 16.94% 297 3.46%
Unallocated - - - - -
Totals $3,536 $3,158 $2,969 $2,407 $2,099
Net loans charged off declined to .16% of average loans during 2003 compared to
..37% in 2002 and .14% for 2001. Loans charged off are subject to continuous
review and specific efforts are taken to achieve maximum recovery of principal,
accrued interest, and related expenses. During 2002, PSB was notified of the
bankruptcy of a large commercial loan customer in which it was not the lead
lender. Due to inadequate collateral protection, an additional $270 of loan
loss provisions were recorded during 2002 to cover estimated principal losses
not specifically identified and reserved previously. A charge-off of $376 was
also recorded during 2002 on this relationship. During 2003, the remaining
principal balance of $211 on this relationship (fully reserved in the allowance
for loan losses at December 31, 2002) was charged off during 2003. Separate
from these charge-offs, net charge-offs to average loans would have been .09%
during 2003 and .22% during 2002.
33
Nonperforming loans are defined as nonaccrual loans, loans 90 days or more past
due but still accruing, nonaccrual loans defined as impaired under current
accounting standards, and restructured loans. Loans are generally placed on
nonaccrual status when contractually past due 90 days or more as to interest or
principal payments. Previously accrued and uncollected interest on such loans
is reversed, and income is recorded only to the extent that interest payments
are subsequently received and principal is collectible.
Loans past due 90 days or more but still accruing interest are also included in
nonperforming loans. Also included in nonperforming loans are restructured
loans. Restructured loans involve the granting of concessions to the borrower
involving the modification of terms of the loan, such as changes in payment
schedule or interest rate, or capitalization of unpaid real estate taxes or
unpaid interest. The majority of restructured loans represent capitalized loan
principal and/or interest and real estate taxes that borrowers were unable to
repay according to the original repayment terms. Such loans are subject to
senior management review and ongoing monitoring and are made in cases where the
borrower's delinquency is considered short-term from circumstances the borrower
is believed able to overcome.
Table 17: Nonperforming Loans and Foreclosed Assets
December 31,
2003 2002 2001 2000 1999
Nonaccrual loans not considered impaired $1,898 $750 $1,801 $1,123 $620
Nonaccrual impaired loans 1,221 1,036 1,235 803 510
Accruing loans past due 90 days or more - - - - -
Restructured loans 216 647 999 1,348 278
Total non-performing loans $3,335 $2,433 $4,035 $3,274 $1,408
Foreclosed assets $ 84 $ 573 $ 421 $ 17 $ 24
Impaired loans accruing income $ 406 $ 385 $ 877 $1,098 $1,696
Total non-performing loans as a percent
of gross loans receivable 1.08% 0.94% 1.68% 1.44% 0.77%
Nonperforming loans at December 31, 2003, increased by $902 to $3,335 from
$2,433 at December 31, 2002. Nonperforming loans to gross loans was 1.08% at
December 31, 2003, compared to .94% at December 2002. PSB also tracks
delinquencies on a contractual basis quarter to quarter since some problem
loans currently making payments remain on non-accrual status until ongoing
ability to repay according to the contract is shown. Loans contractually
delinquent 30 days or more as a percentage of gross loans were .63% at December
2003 compared to .87% at December 2002 and 1.68% at December 2001. Management
continues to work aggressively with problem credits and expects the level of
non performing loans to total loans and net charge-offs to average loans during
2004 to be similar to that seen during 2003.
Interest payments on nonaccrual and impaired loans are typically applied to
principal unless collectibility of the principal amount is fully assured, in
which case interest is recognized on the
34
cash basis. The interest that would have been reported in 2003 if all such
loans had been current throughout the year in accordance with their original
terms was $248 in comparison to $106 actually collected. The total reduction
in interest income during 2002 and 2001 as a result of discontinuing the
accrual of interest on loans that are delinquent for 90 days or more was $54
and $68, respectively.
OFF BALANCE SHEET ARRANGEMENTS
As described previously, PSB serviced residential mortgage loans of $152,718 at
December 31, 2003, and $95,408 at December 31, 2002 which have been sold to the
FHLB under the MPF Program and are not included on PSB's balance sheet. As a
FHLB 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. At December 31, 2003, the maximum obligation for
such guarantees would be approximately $554 if total foreclosure losses on the
entire pool of approximately $153 million loans exceeded $2,562. Management
believes loans serviced for the FHLB will realize minimal foreclosure losses in
the future and that PSB will experience no loan losses related to charge-offs
in excess of the FHLB 1% loss pool. Therefore, PSB does not maintain any
recourse liability for possible losses.
Under bank regulatory capital rules, this recourse obligation to the FHLB is
risk-weighted for the purposes of the total capital to risk-weighted assets
capital calculation. The majority of the recourse loans held at December 31,
2003 require risk capital equal to 8% of PSB recourse obligation. However, the
loan program used by PSB since October 2003 requires risk capital equal to the
recourse obligation (the original MPF program used by PSB has expired and all
new loans are originated under this new capital arrangement). As of December
31, 2003, the amount of risk based capital needed to be considered well-
capitalized under prompt correction action provisions increased $116. During
2004, as new loans are originated under the new program, risk based capital
needs will increase equal to additional recourse obligation. However, in light
of the capital structure of PSB and anticipated activity in loan originations
during 2004, management does not expect these capital requirements to impact
operations in the near-term.
Other significant off-balance sheet financial instruments include the various
loan commitments outlined in Item 8, Note 14 of the Notes to Consolidated
Financial Statements. These lending commitments are a traditional and
customary part of lending operations and many of the commitments are expected
to expire without being drawn upon.
LIQUIDITY AND CAPITAL RESOURCES
PSB has experienced substantial internal asset growth during the past several
years while maintaining similar equity capital related to asset size. This
growth has been funded primarily by wholesale depositors and FHLB advances,
rather than local retail deposit growth. These sources of wholesale funding
are limited both by the wholesale lender's ability to raise individual
depositor funds and by internal limitations on use of such funds. Increased
loans to customers have been the significant use of these funds. The table
below outlines in summary form the sources and uses of cash for the three years
ending December 31, 2003. These sources and uses
35
of funds and their impact on past and future growth is discussed in depth later
in this analysis of liquidity.
Table 18: Summary Sources and Uses of Cash
2003 2002 2001
Cash flows from operating activities $7,392 $6,247 $3,284
Payment of dividends to shareholders and purchase of treasury stock (1,551) $(1,338) $(907)
Operating cash flow retained by PSB 5,841 4,909 2,377
Additional financing received from retail depositors, net 9,995 9,665 30,598
Additional financing received from wholesale depositors, net 8,589 14,530 1,503
Proceeds from additional FHLB advances 9,000 - 10,000
Proceeds from additional other borrowings, net 7,173 - -
Proceeds from additional capital received from shareholders - 52 -
Cash flow retained from operations and financing before debt repayment 40,598 29,156 44,478
Repayment of other borrowings, net (1,025) (7,188)
Cash flow retained from operations and financing after debt repayment 40,598 28,131 37,290
Funds received from sale and maturities of investment securities, net 7,368 - -
Proceeds from sale of nonmonetary assets 280 279 636
Cash flows available for investing activities 48,246 28,410 37,926
Increase in funds loaned to customers, net (48,959) (20,923) (13,524)
Funds invested in securities, net - (9,528) (7,462)
Capital expenditures (1,912) (1,957) (758)
Cash flows used in investing activities (50,871) (32,408) (21,744)
Net increase (decrease) in cash held at beginning of year $(2,625) $(3,998) $16,182
Cash and cash equivalents at beginning of year 21,552 25,550 9,368
Cash and cash equivalents at end of year $18,927 $21,552 $25,550
DEPOSITS
Retail deposits are PSB's largest source of funds. Retail deposits represented
65.5%, 69.4%, and 72.0% of total assets as of December 31, 2003, 2002, and
2001, respectively. However, growth in local retail deposits has slowed during
the past several years. PSB's retail deposit growth is continuously influenced
by competitive pressure from other financial institutions, as well as other
investment opportunities available to customers. To continue asset growth,
deposit growth was supplemented by additional wholesale certificate of deposits
(in additional to additional FHLB advances). The following table outlines the
average distribution of deposits during the three years ending December 31,
2003.
36
Table 19: Average Deposits Distribution
2003 2002 2001
Interest Interest Interest
Amount Rate paid Amount Rate paid Amount Rate paid
Noninterest bearing
demand deposits $46,876 n/a $38,031 n/a $32,710 n/a
Interest bearing demand
and savings deposits 40,518 0.61% 32,536 1.04% 25,685 1.70%
Money market demand deposits 69,238 1.00% 73,629 1.44% 75,553 3.74%
Retail time deposits 99,851 3.19% 99,982 4.12% 115,093 5.66%
Wholesale time deposits 44,232 3.46% 32,866 4.02% n/a* n/a*
Totals $300,715 1.88% $277,044 2.47% $249,041 3.92%
Average retail deposit growth 5.0% n/a* n/a*
*Prior to 2002, PSB did not maintain separate information on average balance of
wholesale time deposits and related interest expense.
Due to the increasing competitive nature of time deposit funding, both locally
and nationally, PSB believes transactional based deposits to be the best source
of low-cost funding in the long-term. Such personal and commercial deposits
are attracted and retained through factors other than interest rate alone,
including high level of customer service, network of deposit taking branches,
and convenience of use, and provide a high level of fee base income and
available short-term liquidity via clearing float. Therefore, PSB actively
promotes transactional based deposit products. This emphasis is reflected in
an increase in average noninterest bearing demand deposits during the past
several years. Interest bearing demand deposits have also increased primarily
due to new municipal and government agency deposits, many of which require
pledging of security collateral. During 2004, PSB intends to commit greater
resources to expand deposits from municipalities and governments. However, due
to securities available for pledging, the level of municipal deposit growth
seen during 2003 and 2002 may not be repeated.
Increased demand deposit balances have been offset by a decline in money market
deposits. Prior to 2002, PSB promoted a money market balance tied to a
national money market index. When money market rates were relatively high
prior to 2001, PSB generated substantial deposit growth in this product.
During 2002, PSB changed its rate on money market deposits from being based on
a national index to changing at the discretion of management. This change
benefited customers during 2003 and 2002 as the index rate would have been less
than the rate paid by PSB. However, many local depository institutions have
maintained high money market rates despite the decline in national rates on
short-term funds. Because of this, some money market funds have been removed
by customers, and presumable reinvested at higher money rates at other
institutions. In the near term, the incremental money market deposit funds
that could be raised by significantly raising the money market interest rate
would not be sufficient to offset the incremental financing cost relative to
other alternatives. PSB does not anticipate making
37
significant changes to the money market products during 2004 and does not
expect significant growth in these accounts.
During much of 2002 and 2003, rates (including broker fees) on broker deposits
have been less than local retail deposits for equivalent terms. During 2003,
the average rate paid on wholesale deposits was greater than the rate paid on
retail time deposits because, in general, wholesale deposit original terms were
greater than those typically seen on retail time deposits. During 2002 and
2003, various larger commercial loans have been offered at longer-term fixed
rate financing terms (typically 5 years) that were simultaneously funded by
similar term wholesale deposits. Because the average term on wholesale
certificates was longer than local certificates, the wholesale yield increased
relative to local time deposits during 2003.
Table 20: Period-End Deposit Composition
December 31,
2003 2002
$ % $ %
Non-interest bearing demand $50,563 16.0% $45,457 15.3%
Interest-bearing demand and savings 46,797 14.8% 38,545 12.9%
Money market deposits 70,879 22.4% 74,418 24.9%
Retail time deposits less than $100 59,422 18.7% 60,982 20.5%
Retail time deposits $100 and over 40,033 12.7% 38,297 12.9%
Broker & national time deposits
less than $100 10,221 3.2% 12,847 4.3%
Broker & national time deposits $100
and over 38,499 12.2% 27,284 9.2%
Totals $316,414 100.0% $297,830 100.0%
Table 21: Change in Deposit Composition
December 31, % Change from prior year
2003 2002 2003 2002
Total time deposits $100 and over $78,532 $65,581 19.7% 30.2%
Total broker and national time deposits 48,720 40,131 21.4% 56.8%
Total retail time deposits 99,455 99,279 0.2% 3.5%
Core deposits, including money market
deposits 168,239 158,421 6.2% 4.1%
Large time deposits and wholesale broker deposits continue to grow as a
percentage of total deposits. Growth in retail time deposits and local "core"
deposits has been low relative to overall asset growth. During early 2004, PSB
created a new Retail Sales Manager position to coordinate efforts on consumer
lending and deposit products to improve sale of such deposits. PSB believes it
has competitively priced deposit products in its local markets and seeks to
actively promote them during 2004. However, based on expected asset growth in
existing and new markets during 2004, management believes broker wholesale
funding will continue to be
38
used during 2004. PSB policy allows broker funds to be used up to 20% of total
assets. Available and unused broker deposits were approximately $33,067 and
$34,163 at December 31, 2003 and 2002, respectively. The table below outlines
maturities of time deposits of $100 or more, including broker and retail time
deposits. Management is aware of the potential volatility of broker deposits
due to funds flowing out of the banking system and into other investment
vehicles, and other factors, that could increase the incremental cost of
obtaining these types of deposits. Broker deposits represent just one
potential financing source in addition to FHLB advances and repurchase
agreements.
Table 22: Maturity Distribution of Certificates of Deposit of $100 or More
December 31, 2003
Balance Rate
3 months or less $6,248 1.96%
Over 3 months through 6 months 11,250 2.47%
Over 6 months through 12 months 27,601 2.06%
Over 1 year through 5 years 29,599 4.15%
Over 5 years 3,834 4.48%
Totals $78,532
CONTRACTUAL OBLIGATIONS
PSB is party to various contractual obligations requiring use of funds as part
of its normal operations. The table below outlines the principal amounts and
timing of these obligations, excluding amounts due for interest, if applicable.
Most of these obligations, including time deposits, are routinely refinanced
into a similar replacement obligation without requiring any substantial outflow
of cash. However, renewal of these obligations is dependent on PSB's ability
to offer competitive market equivalent interest rates or availability of
collateral for pledging such as retained mortgage loans or securities as in the
case of advances from the FHLB. PSB's funds management policy includes a
formal liquidity contingency plan to identify low cost and liquid funds
available in the event of a liquidity crisis.
Table 23: Contractual Obligations at December 31, 2003
Payments due by period
Total < 1 year 1-3 years 3-5 years > 5 years
Time deposits $148,175 $90,423 $34,252 $18,908 $4,592
Long-term Federal Home Loan Bank advances 32,000 - 19,000 8,000 5,000
Other long-term borrowings 7,816 5,539 1,376 901 -
Deferred compensation and retirement agreements 214 13 16 - 185
Post-retirement health insurance benefits plan 254 - - - - 254
Branch bank operating lease commitments 133 72 61 - -
Premises and equipment purchase commitments 3,174 3,174 - - -
Total contractual obligations $191,766 $99,221 $54,705 $27,809 $10,031
39
LIQUIDITY, FUNDING SOURCES, AND INTEREST RATE SENSITIVITY
Primary short-term and long-term funding sources other than retail deposits
include federal funds purchased from other correspondent banks, repurchase
agreements from security pledging, advances from the FHLB and use of wholesale
time deposits. The following table outlines the available and unused portion
of these funding sources (based on collateral and/or company policy
limitations) as of December 31, 2003. During 2004, PSB expects total net asset
growth from existing and new market locations to be approximately $50 million,
a significant portion of which will be funded by use of funding sources other
than deposits.
Table 24: Available but Unused Funding Sources other than Retail Deposits:
December 31, 2003
Unused, but Amount
Available Used
Overnight federal funds purchased $22,500 $ -
FHLB advances under blanket mortgage lien 8,165 47,000
Repurchase agreements 25,458 10,475
Wholesale market time deposits 33,067 48,720
Total available but unused funds $89,190 $106,195
Overnight federal funds purchased totaling $22,500 are available through three
primary correspondent banks. These lines are not supported by a formal written
arrangement, but represent best efforts ability on the part of correspondent
banks to raise these funds. During 2003, average daily federal funds purchased
were $2,579 compared to $84 during 2002. The cost of these funds is subject to
change based on changes in the discount rate as determine by the Federal
Reserve. PSB may maintain a continuous position in overnight federal funds
purchased up to 60 days before amounts must be liquidated for at least one
business day. Consideration of the need for federal funds purchased is part of
PSB's daily cash management and funding procedures and represents the first
source of liquidity as needed.
Under the existing credit line with the FHLB described in Item 8, Note 9 of the
Notes to Consolidated Financial Statements, PSB may borrow up to 60% of
qualifying existing mortgage loan collateral. In addition, PSB may pledge
certain investment securities to obtain additional funding under repurchase
agreement. FHLB advance rates for terms equal to or less than 5 years are
generally more favorable that local retail deposits rates or brokered or other
wholesale funding. FHLB advances carry substantial penalties for early
prepayment that are generally not recovered from the lower interest rates in
refinancing. The amount of early prepayment penalty is a function of the
difference between the current borrowing rate, and the rate currently available
for refinancing. Therefore, existing high cost FHLB advances borrowed prior to
2001 were not refinanced in the substantially lower long term rate market
experienced during 2003 and 2002. FHLB advance funding may be obtained for
various terms on a daily basis at PSB's request, and represents PSB's second
source of liquidity as needed after federal funds purchased.
40
Repurchase agreements represent overnight and long-term funding in exchange for
securities owned by PSB for a designated time period for an agreed upon
interest rate. Item 8, Note 10 of the Notes to Consolidated Financial
Statements outlines the activity in these other borrowings and federal funds
purchased during the three years ending December 31, 2003. Although PSB does
not currently have any repurchase agreements with the FHLB, it does have a
written agreement providing for their use in exchange for securities held. An
additional $25,458 of FHLB funding could be obtained upon pledge of these
available securities as of December 31, 2003.
As described in the changes in deposits and deposit activity above, wholesale
broker deposits have represented a growing source of asset growth funding
during the past several years. PSB's policy allows up to 20% of assets to be
funded with wholesale time deposits. Wholesale time deposits as a percentage
of assets were 11.9%, 10.8%, and 7.4% of total assets at December 31, 2003,
2002, and 2001, respectively.
PSB's Asset-Liability Management process provides a unified approach to
management of liquidity, capital and interest rate risk, and to provide
adequate funds to support the borrowing requirements 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.
Management's overall strategy is to coordinate the volume of rate sensitive
assets and liabilities to minimize the impact of interest rate movement on the
net interest margin. Table 25 represents PSB's earning sensitivity to changes
in interest rates at December 31, 2003. It is a static indicator which does
not reflect various repricing characteristics and may not indicate the
sensitivity of net interest income in a changing interest rate environment.
The following repricing methodologies should be noted in Table 25:
1. Money market deposit accounts are considered fully repriced within 90
days. Interest bearing demand (NOW) and savings deposits are considered
"core" deposits as they are generally insensitive to interest rate
changes. These deposits are considered to reprice beyond 5 years.
2. Nonaccrual loans are considered to reprice beyond 5 years.
3. Assets and liabilities with contractual calls or prepayment options are
repriced according to the likelihood of the call or prepayment being
exercised in the current interest rate environment.
Table 25 reflects a positive gap position in essentially all individual and
cumulative categories until those beyond 5 years. The cumulative one-year gap
ratio is positive at 110.4% compared to 109.4% at December 31, 2002. A
significant factor in PSB's ability to match the repricing of assets and
liabilities in line with the expectations in the table is the ability to delay
increases in interest rates paid on "core" deposits such as NOW, statement
savings, and MMDA accounts when market rates begin to increase. PSB conducts
incremental cost analysis of various sources
41
of funding on an ongoing basis and will rely on such analysis to slow core
deposit interest rate growth until adjustable rate loan rates benefits from
future increases in the prime lending rate.
Table 25: Interest Rate Sensitivity Gap Analysis
December 31, 2003
0-90 Days 91-180 days 181-365 days 1-2 yrs. Bynd 2-5 yrs. Bynd 5 yrs. Total
Earning assets:
Loans $111,946 $23,515 $46,075 $53,447 $58,045 $15,054 $308,082
Securities 5,012 3,072 7,653 16,295 24,879 15,561 72,472
FHLB stock 2,444 2,444
Other earning assets 5,173 5,173
Total $124,575 $26,587 $53,728 $69,742 $82,924 $30,615 388,171
Cumulative rate
sensitive assets $124,575 $151,162 $204,890 $274,632 $357,556 $388,171
Interest-bearing liabilities
Interest-bearing deposits $91,581 $25,788 $44,813 $19,819 $36,996 $46,854 $265,851
FHLB advances 15,000 19,000 8,000 5,000 47,000
Other borrowings 2,171 1,023 5,254 2,027 10,475
Total $108,752 $26,811 $50,067 $40,846 $44,996 $51,854 323,326
Cumulative interest
sensitive liabilities $108,752 $135,563 $185,630 $226,476 $271,472 $323,326
Interest sensitivity gap for
the individual period $ 15,823 $(224) $3,661 $28,896 $37,928 $(21,239)
Ratio of rate sensitive assets to
rate sensitive liabilities for
the individual period 114.5% 99.2% 107.3% 170.7% 184.3% 59.0%
Cumulative interest
sensitivity gap $ 15,823 $15,599 $19,260 $48,156 $86,084 $64,845
Cumulative ratio of rate
sensitive assets to rate
sensitive liabilities 114.5% 111.5% 110.4% 121.3% 131.7% 120.1%
During 2002, PSB created new financial modeling techniques to measure interest
rate risk. These policies 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 adequacy of liquidity and
interest rate risk as described below.
BASIC SURPLUS
PSB measures basic surplus as the amount of existing net liquid assets (after
deducting short-term liabilities and coverage for anticipated deposit funding
outflows during the next 30 days) divided by total assets. The basic surplus
calculation does not consider unused but available correspondent bank federal
funds purchased, as those funds are subject to availability based on the
correspondent bank's own liquidity needs and therefore are not guaranteed
contractual funds. However, basic surplus does include unused but available
FHLB advances under the open line of credit supported by a blanket lien on
mortgage collateral. PSB's policy is to maintain a basic
42
surplus of at least 5%. Basic surplus was 8.0% and 15.0% at December 31, 2003,
and 2002, 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. Changes in
interest rates are assumed to be a parallel yield curve shift fully implemented
over a 12 month time frame. PSB's 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 projected increase in net
interest income on the existing balance sheet for the next 12 months if rates
increased 200 basis points was 3.17% and 1.28% at December 31, 2003 and 2002,
respectively. The projected decrease in net interest income for the next 12
months if rates decreased 100 basis points was -2.50% and -1.00% at December
31, 2003, and 2002, respectively.
CORE FUNDING UTILIZATION
To assess whether interest rate sensitivity beyond one year helps mitigate or
exacerbate the short-term rate sensitive position, a quarterly measure of core
funding utilization is made. Core funding is defined as liabilities with a
maturity in excess of 60 months and capital. Core deposits including DDA, NOW
and non-maturity savings accounts (except money market accounts) are also
considered core long-term funding sources. The core funding utilization ratio
is defined as assets that reprice 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. PSB's
core fund utilization ratio after a projected 200 basis point increase in rates
was 46.53% and 41.00% at December 31, 2003, and 2002, respectively.
CAPITAL ADEQUACY
PSB is required to maintain minimum levels of capital to be considered well-
capitalized under current banking regulation. Refer to Item 8, Note 17 of the
Notes to Consolidated Financial Statements for these requirements and PSB's
current capital position relative to these requirements. The primary increase
in stockholders' equity during the three years ending December 31, 2003 has
been retained net income not distributed to shareholders. 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. Refer to Item 8, Statement of Changes in Stockholder's Equity in the
Consolidated Financial Statements for detailed activity in the capital
accounts. Average tangible regulatory Tier 1 leverage capital was 7.86%,
7.66%, and 7.53% during 2003, 2002, and 2001, respectively. The following
table presents a reconciliation of stockholders' equity as presented in the
December 31, 2003, 2002, and 2001 consolidated balance sheets to regulatory
capital.
43
Table 26: Capital Ratios
December 31,
2003 2002 2001
Stockholders' equity $32,141 $29,302 $25,349
Disallowed mortgage servicing right assets (81) (70) (28)
Unrealized (gain) loss on securities available for sale (844) (1,306) (491)
Tier 1 regulatory capital 31,216 27,926 24,830
Add: allowance for loan losses 3,536 3,158 2,969
Total regulatory capital $34,752 $31,084 $27,799
Total assets $408,933 $371,468 $344,296
Disallowed mortgage servicing right assets (81) (70) (28)
Unrealized (gain) loss on securities available for sale (844) (1,306) (491)
Tangible assets $408,008 $370,092 $343,777
Risk-weighted assets (as defined by current regulations) $318,005 $272,377 $248,751
Tier 1 capital to period end tangible assets (leverage ratio) 7.65% 7.55% 7.22%
Tier 1 capital to adjusted risk-weighted assets 9.82% 10.25% 9.98%
Total capital to adjusted risk-weighted assets 10.93% 11.41% 11.18%
On December 16, 2003, PSB declared a 5% stock dividend in additional to the
regular semi-annual cash dividend. The stock dividend was paid to shareholders
of record as of January 6, 2004 on January 29, 2004. PSB also affected a 2-
for-1 stock split paid December 2, 2002. All references in its Management
Discussion and Analysis to the number of common shares and per share amounts
for 2003, 2002, and 2001 have been restated to reflect the 2-for-1 split and
the 5% stock dividend.
PSB pays a regular semi-annual cash dividend as described in Item 5 of this
Annual Report of Form 10-K. In addition, PSB maintains an annual, ongoing
share repurchase program of up to 1% of outstanding shares per year as
described in Item 8, Note 14 of the Notes to Consolidated Financial Statements.
PSB maintains an incentive stock option plan approved by shareholders during
2001 as described in Item 8, Note 15 of the Notes to Consolidated Financial
Statements. As of December 31, 2003, all shares available under the plan have
been granted and no shares of common stock remained reserved for future grants.
Although PSB is currently purchasing treasury shares under the buyback program
described above, management is pursuing a growth strategy which may require
significant capital to be maintained to support asset growth. Therefore, large
scale stock buybacks or dividend payments
44
substantially in excess of past periods are not anticipated. Based on expected
asset growth during 2004, PSB expects to remain well-capitalized during 2004
with a Tier 1 leverage capital ratio in excess of 7.0%.
CRITICAL ACCOUNTING ESTIMATES
ALLOWANCE FOR LOAN LOSSES
Current accounting standards call for the allowance for loan losses to include
both specific losses on identified problem loans (Statement of Financial
Accounting Standard ("SFAS") No. 114, "Accounting by Creditors for Impairment
of a Loan") and "inherent" losses on existing loan pools not yet considered
problem loans (SFAS No. 5, "Accounting for Contingencies"). Determination of
the allowance for loan losses at period-end is based primarily on subjective
factors and management assessment of risk in the existing portfolio. Actual
results, if significantly different from that using estimates at period-end,
could have a material impact on the results of operations.
Loans receivable, for the purpose of estimating the allowance for loan losses,
are separated into four primary categories - Residential real estate loan pool,
consumer installment loan pool, specifically identified problem commercial
loans, and pools of non-problem commercial purposes loans subcategorized by
credit risk assessment. PSB makes the following estimates and performs the
following procedures when setting the allowance for loan losses at period-end:
1. Categorize existing loan principal into either commercial purpose loans,
a pool of residential real estate loans, or a pool of consumer
installment loans.
2. Commercial purpose loans are subcategorized into credit risk "grades"
based on an internal determination of risk established during credit
analysis and updated no less than annually. Determination of risk grades
takes into account several factors including collateral, cash flow,
borrower's industry environment, financial statement strength, and other
factors. PSB uses four risk grades for non-problem commercial purpose
loans.
3. Identified problem loans are classified into two additional risk grades
and individually reviewed to determine specific reserves required for
each relationship depending on the specific collateral and timing of cash
flows to be received. The allowance for loan losses provided to these
problem loans is based substantially on management's estimates related
the value of collateral, timing of cash flows to be received from the
borrower or sale of the collateral, and likelihood of the specific
borrower's ability to repay all amounts due without foreclosure of
collateral. Management updates the cash flow analysis of problem loan
relationships quarterly.
4. Other commercial loans not considered to be problem loans are assigned an
estimated loan loss allowance based on historical "inherent" losses for
loans of similar credit risk. These allowances range from .25% of
principal to 2.5% of principal depending on the assigned credit risk
grade. An inaccurate assignment of credit risk grade to a loan
relationship could significantly increase the actual levels of allowances
required for that
45
loan, and therefore management's assigned of credit risk is a significant
estimate. Management reviews actual long-term losses to the inherent
losses assigned by credit risk grade and updates allowance percentages as
needed.
5. Similar to nonproblem commercial purpose loans, inherent losses are
assigned to the residential real estate loan pool. However, since
residential real estate loan risk characteristics are very similar from
borrower to borrower, a flat percentage loss of principal is applied to
real estate loans rather than breaking the pool into subcategories of
credit risk. The percentage applied is based primarily on historical
losses on similar residential loan pools. An inaccurate estimate of
inherent losses related to the real estate loan pool could significantly
increase the actual levels of allowances required.
6. Similar to the residential real estate loan pool, consumer installment
loans are assigned an estimated of loss based on a flat percentage of
principal outstanding. The percentage applied is based primarily on
historical losses on similar consumer installment loan pools. An
inaccurate estimate of inherent losses related to the consumer
installment loan pool could significantly increase the actual levels of
allowances required.
After calculating the estimate of required allowances for loan losses using the
steps above, an analysis of the level of problem and past due loans is made
relative to the aggregate allowance for loan losses recorded. If past due and
problem loans are significantly rising, additional unallocated reserves may be
recorded to account for this additional risk of loss before it is recognized in
the allowance for loan losses calculation by the change in commercial credit
risk grades, or increase in the historical inherent loss percentage assigned to
the real estate and consumer installment loan pools. As of December 31, 2003,
there were no unallocated loan loss allowances recorded.
MORTGAGE SERVICING RIGHTS
As required by current accounting standards (SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities"), PSB records a mortgage servicing right asset ("MSR") when PSB
continues to service borrower payments and maintenance activities on loans in
which the principal has been sold to the FHLB or other secondary market
investors. PSB's MSR calculation is calculated on a individual loan level
basis and uses public financial market information for many of the significant
estimates. PSB makes the following estimates and performs the following
procedures when accounting for MSRs:
1. Serviced loans are stratified by risk of prepayment criteria. Currently,
strata are first based on the year in which the loan was originated, then
on term, and then on the range of interest rates within that term. At
December 31, 2003, PSB used 16 strata on which to calculate the value
originated mortgage servicing rights ("OMSRs") and to amortize and
calculate impairment of existing MSRs.
2. PSB uses the discount approach to generate the initial value for the
OMSR. It takes the average of the current dealer consensus on prepayment
speeds as reported to Reuters or
46
the prepayment speed implied in the mortgage backed security prices for
newly created loans along with other assumptions to general an estimate
of future cash flows. The present value of estimated cash flows equals
the fair value of the OMSR. PSB capitalizes the lower of fair value or
cost of the OMSR. Other than the estimate of public dealer consensus of
prepayment speeds, significant fair value and cost estimates include:
* Servicing cost of $60 per loan annually
* Cash flow discount rate of 8% to 10%, depending on year of
origination
* Short-term reinvestment rate on the float of payments to
investors of 2%
Changes in these estimates and assumptions would change the initial value
recorded for OMSRs and change the gain on sale of mortgage loans recorded
in the income statement.
3. Amortization of the OMSR is calculated based on actual payment activity
on a per loan basis. Because all loans are handled individually,
curtailments decrease MSRs as well as regularly scheduled payments. The
loan servicing value is amortized on a level yield basis.
4. Significant declines in current market mortgage interest rates decrease
the fair value of existing MSRs due the increase in anticipated
prepayments above the original assumed speed. SFAS No. 140 requires that
impairment testing be performed and that MSRs be recorded at the lower of
fair value or amortized cost. PSB performs quarterly impairment testing
on its MSRs. Actual prepayment speeds (based on actual PSB customer
activity on a loan level basis) are compared to the assumed prepayment
speed on the date of the last quarterly impairment testing (or the
origination prepayment speed if a new loan). The fair value assumptions
other than prepayment speed are combined with the new estimated
prepayment speed to create a new fair value. An impairment allowance is
recorded for any shortfall between the new fair value and the original
cost after adjusting for past amortization and curtailments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item 7A is set forth in Item 6, "Selected
Financial Data" and under sub captions "Results of Operations", "Market Risk",
"Net Interest Income", "Provision for Loan Losses", "Investment Portfolio",
"Deposits", and "Liquidity and Interest Sensitivity" under Item 7, Management's
Discussion and Analysis of Financial Conditions.
47
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITOR'S REPORT
Board of Directors
PSB Holdings, Inc.
Wausau, Wisconsin
We have audited the accompanying consolidated balance sheets of PSB Holdings,
Inc. and Subsidiary as of December 31, 2003 and 2002, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 2003.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of PSB Holdings, Inc.
and Subsidiary at December 31, 2003, and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003 in conformity with accounting principles generally
accepted in the United States.
WIPFLI LLP
Wipfli LLP
January 22, 2004
Wausau, Wisconsin
48
CONSOLIDATED BALANCE SHEETS
(dollars in thousands except per share data)
DECEMBER 31,
ASSETS 2003 2002
Cash and due from banks $ 13,754 $ 15,890
Interest-bearing deposits and money market funds 1,214 5,490
Federal funds sold 3,959 172
Cash and cash equivalents 18,927 21,552
Securities available for sale (at fair value) 72,472 81,057
Federal Home Loan Bank stock 2,444 2,264
Loans held for sale 207 949
Loans receivable, net of allowance for loan losses of $3,536
and $3,158 in 2003 and 2002, respectively 304,339 256,015
Accrued interest receivable 1,617 1,732
Foreclosed assets 84 573
Premises and equipment 7,557 6,158
Mortgage servicing rights, net 814 697
Other assets 472 472
TOTAL ASSETS $ 408,933 $ 371,469
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest-bearing $ 50,563 $ 45,457
Interest-bearing 265,851 252,373
Total deposits 316,414 297,830
Federal Home Loan Bank advances 47,000 38,000
Other borrowings 10,475 3,302
Accrued expenses and other liabilities 2,903 3,034
Total liabilities 376,792 342,166
Stockholders' equity:
Common stock - No par value with a stated value of $1 per share:
Authorized - 3,000,000 shares
Issued - 1,804,850 shares 1,805 1,805
Outstanding, 1,651,069 and 1,666,102, respectively
Common stock dividend distributable - 82,329 shares 82 0
Additional paid-in capital 9,694 7,150
Retained earnings 22,789 21,607
Accumulated other comprehensive income 844 1,306
Treasury stock, at cost - 153,781 and 138,748 shares, respectively (3,073) (2,565)
Total stockholders' equity 32,141 29,303
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 408,933 $ 371,469
See accompanying notes to consolidated financial statements.
49
CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands except per share data)
YEARS ENDED DECEMBER 31,
2003 2002 2001
Interest income:
Interest and fees on loans $ 17,964 $ 18,022 $ 19,263
Interest on securities:
Taxable 1,943 2,724 2,866
Tax-exempt 916 898 775
Other interest and dividends 227 271 524
Total interest income 21,050 21,915 23,428
Interest expense:
Deposits 5,651 6,836 9,771
Federal Home Loan Bank advances 1,989 2,289 2,266
Other borrowings 229 149 432
Total interest expense 7,869 9,274 12,469
Net interest income 13,181 12,641 10,959
Provision for loan losses 835 1,110 890
Net interest income after provision for loan losses 12,346 11,531 10,069
Noninterest income:
Service fees 1,282 1,217 1,011
Mortgage banking 1,767 1,223 683
Investment and insurance sales commissions 434 250 183
Net gain on sale of securities 80 0 0
Gain on curtailment of post-retirement benefit plan 131 0 0
Other operating income 417 358 188
Total noninterest income 4,111 3,048 2,065
Noninterest expense:
Salaries and employee benefits 5,952 4,927 4,419
Occupancy and facilities 1,127 1,093 917
Data processing and other office operations 547 583 523
Advertising and promotion 172 319 307
Other operating expense 1,553 1,304 1,149
Total noninterest expense 9,351 8,226 7,315
Income before income taxes 7,106 6,353 4,819
Provision for income taxes 2,300 1,988 1,453
Net income $ 4,806 $ 4,365 $ 3,366
Basic earnings per share $ 2.76 $ 2.48 $ 1.91
Diluted earnings per share $ 2.74 $ 2.48 $ 1.91
See accompanying notes to consolidated financial statements.
50
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(dollars in thousands except per share data)
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY
STOCK CAPITAL EARNINGS INCOME (LOSS) STOCK TOTALS
Balance, January 1, 2001 $ 1,805 $ 7,159 $ 15,727 $ (125) $ (2,291) $ 22,275
Comprehensive income:
Net income 0 0 3,366 0 0 3,366
Unrealized gain on securities
available for sale, net of tax
of $260 0 0 0 616 0 616
Total comprehensive income 3,982
Cash dividends declared $.51
Per share 0 0 (907) 0 0 (907)
Balance, December 31, 2001 1,805 7,159 18,186 491 (2,291) 25,350
Comprehensive income:
Net income 0 0 4,365 0 0 4,365
Unrealized gain on securities
available for sale, net of tax
of $470 0 0 0 815 0 815
Total comprehensive income 5,180
Purchase of treasury stock 0 0 0 0 (394) (394)
Proceeds from stock options
issued out of treasury 0 (9) 0 0 60 51
Distribution of treasury stock in
payment of director fees 0 0 0 0 60 60
Cash dividends declared
$.54 per share 0 0 (944) 0 0 (944)
Balance, December 31, 2002 1,805 7,150 21,607 1,306 (2,565) 29,303
Comprehensive income:
Net income 0 0 4,806 0 0 4,806
Unrealized loss on securities
available for sale, net of tax
of $253 0 0 0 (414) 0 (414)
Reclassification adjustment for
net security gains, included in
net income, net of tax of $32 0 0 0 (48) 0 (48)
Total comprehensive income 4,344
Purchase of treasury stock 0 0 0 0 (553) (553)
Distribution of treasury stock in
payment of director fees 0 0 0 0 45 45
Stock dividend declared - 5% of 82 2,544 (2,626) 0 0 0
shares
Cash dividends declared
$.57 per share 0 0 (998) 0 0 (998)
Balance, December 31, 2003 $ 1,887 $ 9,694 $ 22,789 $ 844 $ (3,073) $ 32,141
See accompanying notes to consolidated financial statements.
51
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands except per share data) YEARS ENDED DECEMBER 31,
2003 2002 2001
Cash flows from operating activities:
Net income $ 4,806 $ 4,365 $ 3,366
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for depreciation and net amortization 1,763 859 583
Provision (benefit) from deferred income taxes 0 360 (54)
Provision for loan losses 835 1,110 890
Proceeds from sales of loans held for sale 132,845 94,252 60,435
Originations of loans held for sale (130,874) (93,146) (61,042)
Gain on sale of loans (2,021) (1,492) (683)
Provision for (recapture of) mortgage servicing right
valuation allowance (25) 115 0
Net (gain) loss on sale of premises
and equipment 24 (48)
Realized gain on sale of available for sale security (80)
Net (gain) loss on sale of foreclosed assets 9 (28) 10
Federal Home Loan Bank stock dividends (180) (114) (142)
Changes in operating assets and liabilities:
Accrued interest receivable 115 141 229
Other assets 285 (308) (329)
Accrued expenses and other liabilities (86) 109 69
Net cash provided by operating activities 7,392 6,247 3,284
Cash flows from investing activities:
Proceeds from sale and maturities of:
Held-to-maturity securities 0 1,000 1,185
Available-for-sale securities 46,515 20,737 26,571
Payment for purchase of:
Held-to-maturity securities 0 (1,758) (7,523)
Available-for-sale securities (39,147) (29,507) (27,695)
Net increase in loans (48,959) (20,923) (13,524)
Capital expenditures (1,912) (1,957) (758)
Proceeds from sale of premises and equipment 0 1 289
Proceeds from sale of foreclosed assets 280 278 347
Net cash used in investing activities (43,223) (32,129) (21,108)
52
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31,
2003 2002 2001
Cash flows from financing activities:
Net increase in non-interest-bearing deposits $ 5,106 $ 3,950 $ 6,315
Net increase in interest-bearing deposits 13,478 20,245 25,786
Net increase (decrease) in other borrowings 7,173 (1,025) (7,188)
Proceeds from issuance of long-term FHLB advances 25,000 0 10,000
Repayments of long-term FHLB advances (16,000) 0 0
Dividends declared (998) (944) (907)
Proceeds from issuance of stock options 0 52 0
Purchase of treasury stock (553) (394) 0
Net cash provided by financing activities 33,206 21,884 34,006
Net increase (decrease) in cash and cash equivalents (2,625) (3,998) 16,182
Cash and cash equivalents at beginning 21,552 25,550 9,368
Cash and cash equivalents at end $ 18,927 $ 21,552 $ 25,550
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 8,088 $ 9,508 $ 12,817
Income taxes 2,265 1,700 1,542
NONCASH INVESTING AND FINANCING ACTIVITIES:
Loans charged off $ 522 $ 985 $ 331
Loans transferred to foreclosed assets 178 839 894
Loans originated on sale of foreclosed assets 379 531 133
Distribution of treasury stock in payment
of director fees 45 60 0
Transfer of held-to-maturity securities to the
available-for-sale category 0 21,057 0
Transfer of equity from retained earnings for
5% stock dividend 2,626 0 0
See accompanying notes to consolidated financial statements.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPAL BUSINESS ACTIVITY
PSB Holdings, Inc. (the "Company"), operates Peoples State Bank (the "Bank"), a
full-service financial institution with a primary service area including, but
not limited to, Marathon, Oneida, and Vilas Counties, Wisconsin. It provides a
variety of banking products, including uninsured investment and insurance
products, long-term fixed rate residential mortgages, and commercial property
and casualty insurance.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of PSB Holdings,
Inc. and its subsidiary Peoples State Bank. Peoples State Bank owns and
operates a Nevada subsidiary, PSB Investments, Inc., to manage the Bank's debt
and investment securities. The Bank also owns and operates a limited liability
company, Peoples Insurance Services, LLC, an insurance agency offering
commercial property and casualty insurance. All significant intercompany
balances and transactions have been eliminated. The accounting and reporting
policies of the Company conform to generally accepted accounting principles
(GAAP) and to the general practices within the banking industry.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make certain
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from those estimates.
CASH EQUIVALENTS
For purposes of reporting cash flows in the consolidated financial statements,
cash and cash equivalents include cash and due from banks, interest-bearing
deposits and money market funds, and federal funds sold, all of which have
original maturities of three months or less.
SECURITIES
Securities are assigned an appropriate classification at the time of purchase
in accordance with management's intent. Securities held to maturity represent
those debt securities for which the Company has the positive intent and ability
to hold to maturity. Accordingly, these securities are carried at cost
adjusted for amortization of premium and accretion of discount calculated using
the effective yield method. Unrealized gains and losses on securities held to
maturity are not recognized in the financial statements.
Trading securities include those securities bought and held principally for the
purpose of selling them in the near future. The Company has no trading
securities.
Securities not classified as either securities held to maturity or trading
securities are considered available for sale and reported at fair value
determined from estimates of brokers or other sources. Unrealized
54
gains and losses are excluded from earnings but are reported as other
comprehensive income, net of income tax effects, in a separate component of
stockholders' equity.
Any gains and losses on sales of securities are recognized at the time of sale
using the specific identification method.
FEDERAL HOME LOAN BANK STOCK
As a member of the Federal Home Loan Bank (FHLB) system, the Bank is required
to hold stock in the FHLB based on asset size and the anticipated level of
borrowings to be advanced to the Company. This stock is recorded at cost,
which approximates fair value. Transfer of the stock is substantially
restricted.
INTEREST AND FEES ON LOANS
Interest on loans is credited to income as earned. Interest income is not
accrued on loans where management has determined collection of such interest
doubtful or those loans which are past due 90 days or more as to principal or
interest payments. When a loan is placed on nonaccrual status, previously
accrued but unpaid interest deemed uncollectible is reversed and charged
against current income. After being placed on nonaccrual status, additional
income is recorded only to the extent that payments are received or the
collection of principal becomes reasonably assured. Interest income
recognition on loans considered to be impaired under current accounting
standards is consistent with the recognition on all other loans.
Loan origination fees and certain direct loan origination costs are deferred
and amortized to income over the estimated life of the underlying loan.
ALLOWANCE FOR LOAN LOSSES
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 based on events that have occurred 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
commercial purpose loans which have been judged to be impaired as defined by
current accounting standards. A loan is impaired when, based on current
information, it is probable that the Company will not collect all amounts due
in accordance with the contractual terms of the loan agreement. Management has
determined that commercial, financial, agricultural, and commercial real estate
loans that have a nonaccrual status or have had their terms restructured meet
this definition. Large groups of homogeneous loans, such as mortgage and
consumer loans, are collectively evaluated for impairment. Specific allowances
on impaired loans are based on discounted cash flows of expected future
payments using the loan's initial effective interest rate
55
or the fair value of the collateral if the loan is collateral dependent.
Interest income is recognized on the cash basis.
In addition, various regulatory agencies periodically review the allowance for
loan losses. These agencies may require the Company 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.
In management's judgment, the allowance for loan losses is adequate to cover
probable losses relating to specifically identified loans, as well as probable
losses inherent in the balance of the loan portfolio.
LOANS HELD FOR SALE
The Company sells substantially all of the fixed-rate single-family mortgage
loans it originates to the FHLB. The gain or loss associated with sales of
single-family mortgage loans is recorded as a component of mortgage banking
revenue.
Originations and sales of single-family mortgage loans will vary significantly
from period to period depending on customer preferences for fixed-rate mortgage
loans and customer refinance activity. Accordingly, the gain or loss
associated with sales of single-family mortgage loans may vary substantially
from period to period. In general, however, fluctuations in gains or losses on
sales of single-family mortgage loans are offset to some degree by opposite
changes in the amortization of mortgage servicing rights, which is also
recorded as a component of mortgage banking revenue (refer to "Mortgage
Servicing Rights").
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. 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.
In sales of mortgage loans to the FHLB, the Company retains a secondary portion
of the credit risk on the underlying loans in exchange for a credit enhancement
fee. When applicable, the Company records a recourse liability to provide for
potential credit losses. Because the loans involved in these transactions are
similar to those in the Company's loans held for investment, the review of the
adequacy of the recourse liability is similar to the review of the adequacy of
the allowance for loan losses (refer to "Allowance for Loan Losses").
MORTGAGE SERVICING RIGHTS
The Company continues to service most single-family mortgage loans it sells to
third parties. Servicing mortgage loans includes such functions as collecting
monthly payments of principal and interest from borrowers, passing such
payments through to third-party investors, maintaining escrow accounts for
taxes and insurance, and making such payments when they are due. When
necessary, servicing mortgage loans also includes functions related to the
collection of delinquent principal and interest payments, loan foreclosure
proceedings, and disposition of foreclosed real estate. The Company generally
earns a servicing fee of 25 basis points on the outstanding loan balance for
performing these services as well as fees and interest income from ancillary
sources such as delinquency charges and float. Servicing fee income is
recorded as a component of mortgage banking revenue, net of the amortization
and charges described in the following paragraphs.
56
The Company records originated mortgage servicing rights (OMSR) as a component
of gain on sale of mortgage loans when the obligation to service such loans has
been retained. The initial value recorded for OMSR is based on the relative
values of the servicing fee adjusted for expected future costs to service the
loans, as well as income and fees expected to be received from ancillary
sources, as previously described. The carrying value of OMSR is amortized
against service fee income in proportion to estimated gross servicing revenues,
net of estimated costs of servicing, adjusted for expected prepayments. In
addition to this periodic amortization, the carrying value of OMSR associated
with loans that actually prepay is also charged against servicing fee income as
amortization. As a result of the latter charges, there may be considerable
variation in amortization of OMSR from period to period depending on actual
customer prepayment activity. In general, however, variations in the
amortization of OMSRs will offset to some degree opposite changes in gains or
losses on sales of single-family mortgage loans, as previously described (refer
to "Loans Held for Sale").
The carrying value of OMSR is recorded in the Company's Consolidated Balance
Sheets ("mortgage servicing rights" or "MSRs") is subject to impairment because
of changes in loan prepayment expectations and in market discount rates used to
value the future cash flows associated with such assets. In valuing MSRs, the
Company stratifies the loans by year of origination, term of the loan, and
range of interest rates within each term. If, based on a periodic evaluation,
the estimated fair value of the MSRs related to a particular stratum is
determined to be less than its carrying value, a valuation allowance is
recorded against such stratum and against the Company's loan servicing fee
income, which is included as a component of mortgage banking revenue. A
valuation allowance is not recorded if the estimated fair value of a stratum
exceeds its carrying value. Because of this inconsistent treatment, the
Company may be required to maintain a valuation allowance against MSRs even
though the estimated fair value of the Company's total MSR portfolio exceeds
its carrying value in total. The valuation allowance is calculated using the
current outstanding principal balance of the related loans, long-term
prepayment assumptions as provided by independent sources, a market-based
discount rate, and other management assumptions related to future costs to
service the loans, as well as ancillary sources of income.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, net of accumulated depreciation.
Depreciation is computed principally on the straight-line method and is based
on the estimated useful lives of the assets varying primarily from 30 to 40
years on buildings, 5 to 10 years on equipment, and 3 years on computer
hardware and software. Maintenance and repair costs are charged to expense as
incurred. Gains or losses on disposition of property and equipment are
reflected in income.
FORECLOSED ASSETS
Real estate and other property acquired through, or in lieu of, loan
foreclosure 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 real estate.
RETIREMENT PLANS
The Company maintains a defined contribution 401(k) profit-sharing plan which
covers substantially all full-time employees.
57
INCOME TAXES
Deferred income taxes have been provided under the liability method. Deferred
tax assets and liabilities are determined based on the difference between the
financial statement and tax bases of assets and liabilities as measured by the
enacted tax rates which will be in effect when these differences are expected
to reverse. Deferred tax expense is the result of changes in the deferred tax
asset and liability and is a component of the provision for income taxes.
ADVERTISING AND PROMOTIONAL COSTS
Costs relating to Company advertising and promotion are generally expensed when
paid.
STOCK-BASED COMPENSATION
Generally accepted accounting principles encourage all entities to adopt a fair
value based method of accounting for employee stock compensation plans, whereby
compensation cost is measured at the grant date based on the value of the award
and is recognized over the service period, which is usually the vesting period.
However, the rules also allow an entity to continue to measure compensation
cost for those plans using the intrinsic value based method of accounting,
whereby compensation cost is the excess, if any, of the quoted market price of
the stock at the grant date over the amount an employee must pay to acquire the
stock.
The Company has elected to continue with the intrinsic value based method.
Stock options issued under the Company's stock option plan have no intrinsic
value at the grant date, and no compensation cost is recognized for them.
COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses,
gains, and losses be included in net income. Certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
statement of financial condition.
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the current
year presentation.
NOTE 2 CHANGES IN ACCOUNTING PRINCIPLES
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. This
interpretation sets forth expanded disclosure requirements in the financial
statements about a guarantor's obligations under certain guarantees that it has
issued, including standby letters of credit issued by the Company to customers
in the normal course of lending operations. In certain circumstances, a
guarantor is required to recognize a liability for the fair value of the
obligation at the inception of the guarantee. FASB Interpretation No.45 was
effective for the Company during 2003, but its adoption did not have a material
effect on the Company's financial condition or results of operations.
58
NOTE 3 CASH AND DUE FROM BANKS
The Bank is required to maintain a certain reserve balance, in cash or on
deposit with the Federal Reserve Bank, based upon a percentage of deposits.
The total required reserve balance as of December 31, 2003 was approximately
$2,561.
In the normal course of business, the Company and its subsidiary maintain cash
and due from bank balances with correspondent banks. Accounts at each
institution are insured by the Federal Deposit Insurance Corporation up to
$100,000. The Company and its subsidiary also maintain cash balances in money
market funds. Such balances are not insured. Uninsured cash and cash
equivalent balances totaled $11,580 and $19,560 at December 31, 2003 and 2002,
respectively.
NOTE 4 SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated fair value of investment securities are as
follows:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
December 31, 2003
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 11,912 $ 262 $ 26 $ 12,148
Obligations of states and political
subdivisions 23,513 1,211 60 24,664
Mortgage-backed securities 7,933 65 19 7,979
Collateralized mortgage obligations 25,526 71 214 25,383
Nonrated trust preferred securities 2,250 0 0 2,250
Other equity securities 48 0 0 48
Totals $ 71,182 $ 1,609 $ 319 $ 72,472
December 31, 2002
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 11,788 $ 413 $ 0 $ 12,201
Obligations of states and political
subdivisions 20,905 1,021 0 21,926
Mortgage-backed securities 4,519 28 0 4,547
Collateralized mortgage obligations 41,260 622 47 41,835
Nonrated trust preferred securities 500 0 0 500
Other equity securities 48 0 0 48
Totals $ 79,020 $ 2,084 $ 47 $ 81,057
59
Fair values of securities are estimated based on financial models or prices
paid for similar securities. It is possible interest rates could change
considerably resulting in a material change in the estimated fair value.
The following table indicates the amount of time securities have been in an
unrealized loss position that are considered to be temporarily impaired at
December 31, 2003.
LESS THAN 12 MONTHS
FAIR UNREALIZED
VALUE LOSS
U.S. Treasury securities and obligations of U.S. government
corporations and agencies $ 1,974 $ 26
Obligations of states and political subdivisions 3,119 60
Mortgage-backed securities 1,865 19
Collateralized mortgage obligations 14,063 214
Total temporarily impaired securities $ 21,021 $ 319
There were no securities in an unrealized loss position for greater than 12
months at December 31, 2003. Securities with unrealized losses at December 31,
2003 are considered temporarily impaired because an increase in overall market
interest rates has reduced the year-end fair value based on the security's
coupon rate as of December 31, 2003. If held to maturity, the unrealized loss
will be zero, and all principal due will be collected in addition to scheduled
interest payment at the coupon rate.
The amortized cost and estimated fair value of debt securities available for
sale at December 31, 2003, by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
ESTIMATED
AMORTIZED FAIR
COST VALUE
Due in one year or less $ 2,449 $ 2,474
Due after one year through five years 16,621 17,182
Due after five years through ten years 15,955 16,764
Due after ten years 2,650 2,642
Mortgage-backed securities and
collateralized mortgage obligations 33,459 33,362
Totals $ 71,134 $ 72,424
60
Securities with a fair value of $17,994 and $7,907 at December 31, 2003 and
2002, respectively, were pledged to secure public deposits and other borrowings
and for other purposes required by law.
During 2003, proceeds from the sale of securities totaled $8,839 with gross
gains of $107 and gross losses of $27. No securities were sold during 2002 or
2001.
During December 2002, the Company transferred the entire securities held to
maturity portfolio to available-for-sale status. Securities held to maturity
consisted of municipal securities. At the date of transfer, municipal
securities had a net book value of $21,027 and a fair value of $22,056 for an
unrealized gain of $1,030. In accordance with current accounting standards,
the transferred municipal securities were recorded at fair value and
stockholders' equity increased $673 net of income tax effects at the date of
transfer to recognize additional unrealized gain on securities available for
sale. The Company reclassified municipal securities to increase available
liquidity.
NOTE 5 LOANS
The composition of loans categorized by the initial purpose of the loan is as
follows:
2003 2002
Commercial and industrial $ 66,934 $ 64,527
Commercial real estate mortgage 128,290 102,238
Residential real estate mortgage 66,065 55,078
Real estate construction 37,639 26,052
Residential real estate home equity 9,252 7,274
Consumer and individual 7,728 10,439
Subtotals 315,908 265,608
Net deferred loan costs 316 273
Loans in process of disbursement (8,349) (6,708)
Allowance for loan losses (3,536) (3,158)
Net loans receivable $ 304,339 $ 256,015
The Company, in the ordinary course of business, grants loans to its executive
officers and directors, including their families and firms in which they are
principal owners. All loans to executive officers and directors are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with others and, in the
opinion of management, did not involve more than the normal risk of
collectibility or present other unfavorable features. Activity in such loans
is summarized below:
2003 2002
Loans outstanding at beginning $ 3,822 $ 5,035
New loans 1,460 1,159
Repayments (3,861) (2,372)
Loans outstanding at end $ 1,421 $ 3,822
61
The following is a summary of information pertaining to impaired loans:
DECEMBER 31
2003 2002
Impaired loans without a valuation allowance $ 0 $ 5
Impaired loans with a valuation allowance 1,627 1,416
Total impaired loans $ 1,627 $ 1,421
Valuation allowance related to impaired loans $ 255 $ 431
YEARS ENDED DECEMBER 31, 2003 2002 2001
Average recorded investment, net of allowance
for loan losses $ 1,419 $ 2,217 $ 2,177
Interest income recognized $ 105 $ 180 $ 191
Interest income recognized on a cash basis
on impaired loans $ 65 $ 145 $ 88
Total loans receivable (including nonaccrual impaired loans) maintained on
nonaccrual status as of December 31, 2003 and 2002 were $3,119 and $1,786
respectively. There were no loans past due 90 days or more but still accruing
income at December 31, 2003 and 2002.
An analysis of the allowance for loan losses for the three years ended December
31, follows:
2003 2002 2001
Balance, January 1 $ 3,158 $ 2,969 $ 2,408
Provision charged to operating expense 835 1,110 890
Recoveries on loans 65 64 2
Loans charged off (522) (985) (331)
Balance, December 31 $ 3,536 $ 3,158 $ 2,969
Under a secondary market loan servicing program with the Federal Home Loan Bank
(FHLB), the Company provides a credit enhancement guarantee to reimburse the
FHLB for foreclosure losses in excess of 1% of original loan principal sold to
the FHLB in exchange for a monthly fee. At December 31, 2003, the Company
serviced payments on $152,718 of first lien residential loan principal for the
FHLB.
62
At December 31, 2003, the maximum Company obligation for such guarantees
would be approximately $554 if total foreclosure losses on the entire pool of
loans exceed approximately $2,562. Management believes the likelihood of a
reimbursement for loss payable to the FHLB to be remote and does not maintain
any recourse liability for possible losses.
NOTE 6 MORTGAGE SERVICING RIGHTS
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage loans
serviced for others were $152,718 and $95,408 at December 31, 2003 and 2002,
respectively. The following is a summary of changes in the balance of mortgage
servicing rights (MSR):
ORIGINATED VALUATION
MSR ALLOWANCE TOTAL
Balance at January 1, 2001 $ 0 $ 0 $ 0
Additions from originated servicing 321 0 321
Amortization charged to earnings (37) 0 (37)
Balance at December 31, 2001 284 0 284
Additions from originated servicing 840 0 840
Amortization charged to earnings (312) 0 (312)
Change in valuation allowance
charged to earnings 0 (115) (115)
Balance at December 31, 2002 812 (115) 697
Additions from originated servicing 792 0 792
Amortization charged to earnings (700) 0 (700)
Change in valuation allowance
charged to earnings 0 25 25
Balance at December 31, 2003 $ 904 $ (90) $ 814
63
NOTE 7 PREMISES AND EQUIPMENT
The composition of premises and equipment follows:
2003 2002
Land $ 1,567 $ 1,397
Buildings and improvements 5,487 5,452
Furniture and equipment 3,286 3,121
Construction in progress 1,617 79
Total cost 11,957 10,049
Less - Accumulated depreciation and amortization 4,400 3,891
Totals $ 7,557 $ 6,158
Depreciation and amortization charged to operating expenses amounted to $513 in
2003, $500 in 2002, and $513 in 2001.
The Company has committed approximately $3,174 for future premises and
equipment acquisitions at December 31, 2003.
LEASE COMMITMENTS
The Company leases various pieces of equipment under cancelable leases and
office space for two supermarket branch locations under noncancelable leases.
The Company has the option to renew the noncancelable branch location leases
for an additional term upon expiration. All leases are classified as
operating. Future minimum payments under the noncancelable leases are as
follows:
2004 $ 72
2005 46
2006 15
Total $ 133
Rental expense for all operating leases was $84, $81, and $57 for the years
ended December 31, 2003, 2002, and 2001, respectively.
64
NOTE 8 DEPOSITS
The distribution of deposits at December 31 is as follows:
2003 2002
Non-interest-bearing demand deposits $ 50,563 $ 45,457
Interest-bearing demand deposits (NOWs) 22,864 18,119
Savings deposits 23,933 20,426
Money market deposits 70,879 74,418
Retail time deposits 99,455 99,279
Wholesale market time deposits 48,720 40,131
Total deposits $ 316,414 $ 297,830
The scheduled maturities of time deposits at December 31, 2003 are summarized
as follows:
2004 $ 90,423
2005 19,945
2006 14,307
2007 15,081
2008 3,827
Thereafter 4,592
Total $ 148,175
Time deposits with individual balances greater than $100,000 totaled $73,935
and $60,502 at December 31, 2003 and 2002, respectively.
Deposits from Company directors, officers, and related parties at December 31,
2003 and 2002 totaled $4,938 and $6,751, respectively.
65
NOTE 9 FEDERAL HOME LOAN BANK ADVANCES
FHLB advances at December 31, consist of the following:
2003 2002
Note payable, monthly interest payments only at 1.25%
to 1.27%, due January 2004 (During January 2004, the
Company renewed $15,000 of this borrowing for a
one-month term at 1.22% and $5,000 of this borrowing for a
five-year term at 3.48%) $ 20,000 $ 0
Note payable, monthly interest payments only at 5.45%,
due January 2003 0 10,000
Note payable, monthly interest payments only at 6.50%,
due November 2003 0 6,000
Note payable to the FHLB, monthly interest payments
only at 6.21%, due February 2005, callable by the FHLB 5,000 5,000
beginning February 2001
Note payable, monthly interest payments only at 6.17%,
due March 2005, callable by the FHLB beginning March 2001 8,000 8,000
Note payable, monthly interest payments only at 6.10%,
due April 2005, callable by the FHLB beginning January 6,000 6,000
2001
Note payable, monthly interest payments only at 3.90%,
due January 2008 5,000 0
Note payable, monthly interest payments only at 5.07%,
due February 2008, callable by the FHLB beginning 3,000 3,000
February 2001
Totals $ 47,000 $ 38,000
66
The scheduled principal maturities are:
2004 $ 15,000
2005 19,000
2006 0
2007 0
2008 8,000
2009 5,000
Total $ 47,000
FHLB advances are subject to a prepayment penalty if they are repaid prior to
maturity. The Company has $22,000 of FHLB advances that are callable either
six months or one year after origination and quarterly thereafter. The Company
is required to maintain as collateral unencumbered 1-4 family residential first
mortgage loans in its portfolio aggregating at least 167% of the amount of
outstanding advances from the FHLB. The FHLB advances are also secured by
$2,444 and $2,264 of FHLB stock owned by the Bank at December 31, 2003 and
2002, respectively.
As a member of the FHLB system, the Company may draw both short-term and long-
term advances on a maximum line of credit totaling approximately $55,165 as of
December 31, 2003, based on real estate loan collateral. At December 31, 2003,
the Company's available and unused portion of this line of credit totaled
approximately $8,165. The Company also has, under a current agreement with the
FHLB, an ability to borrow up to $25,458 by pledging securities available for
sale.
NOTE 10 OTHER BORROWINGS
Other borrowings consist of securities sold under both short-term and long-term
repurchase agreements totaling $10,475 and $3,302 at December 31, 2003 and
2002, respectively.
The Company pledges U.S. Treasury and agency securities available for sale as
collateral for repurchase agreements. The fair value of securities pledged for
repurchase agreements totaled $12,083 and $5,445 at December 31, 2003 and 2002,
respectively. Amortized cost of the securities pledged was $11,868 and $5,179,
at December 31, 2003 and 2002, respectively.
The following information relates to federal funds purchased and securities
sold under repurchase agreements for the years ended December 31:
2003 2002 2001
As of end of year:
Weighted average rate 2.39% 3.98% 5.01%
For the year:
Highest month-end balance $ 13,463 $ 4,540 $ 9,047
Daily average balance $ 9,151 $ 3,496 $ 6,414
Weighted average rate 2.50% 4.26% 6.74%
Repurchase agreements with related parties totaled $160 and $227 at December
31, 2003 and 2002, respectively.
67
NOTE 11 RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS
The Company has established a 401(k) profit-sharing contribution pension plan
for its employees. The Company matches 50% of employees' salary deferrals up
to the first 6% of pay deferred. The Company also may declare a discretionary
profit-sharing contribution. The expense recognized for contributions to the
plan for the years ended December 31, 2003, 2002, and 2001 was $327, $280, and
$263 respectively.
The Company also maintained an unfunded retirement plan for its directors.
Under the terms of the plan, directors who had at least 15 years of service
were eligible for benefits of between 25% and 50% of the fees earned in the
last five years of service. Effective December 31, 2000, the plan was
terminated and benefits frozen. In 2001, termination vesting was provided to
all directors on a pro-rata basis. The liability recognized in the financial
statements for this plan was $29 and $42 at December 31, 2003 and 2002,
respectively. There was no expense recognized in 2003 and 2002 on the plan.
The expense recognized in 2001 associated with the plan termination was
approximately $104,000.
The Company maintains an unfunded, postretirement health care benefit plan
which covers the officers of the Company. After retirement, the Company will
pay between 25% and 50% of the health insurance premiums for former Company
officers until the officer reaches age 65 or the qualifying age for Medicare
coverage. To qualify, an officer must have at least 15 years of service, be
employed by the Company at retirement, and must be at least 62 years of age at
retirement. The actual amount paid is based upon years of service to the
Company.
During 2003, the plan's benefits were changed to cover the period noted above.
Prior to 2003, plan benefits continued until the officer's death.
The following table provides a reconciliation of changes in the postretirement
health care benefit plan for the years ended December 31, 2003 and 2002:
2003 2002
Reconciliation of benefit obligations:
Obligation at beginning $ 336 $ 276
Service cost 20 29
Interest cost 32 32
Benefit payments (13) (14)
Net amortization of prior service costs 10 13
Gain on curtailment of post-retirement benefit plan (131) 0
Obligation at end $ 254 $ 336
68
The following table provides the components of net periodic benefit cost of the
plans for the years ended December 31, 2003, 2002, and 2001:
POSTRETIREMENT
HEALTH CARE
BENEFIT PLAN
2003 2002 2001
Service cost $ 20 $ 29 $ 17
Interest cost 32 32 22
Net amortization of prior service costs 10 13 7
Gain on curtailment of post-retirement benefit plan (131) 0 0
Net periodic pension cost (gain) $ (69) $ 74 $ 46
The following table provides a reconciliation of the impact of the curtailment
of plan benefits during 2003.
BEFORE EFFECT OF AFTER PLAN
PLAN CHANGE PLAN CHANGE CHANGE
Accumulated postretirement benefit obligation:
Retirees $ 214 $ 0 $ 214
Other Actives 384 (322) 62
Total 598 (322) 276
Unrecognized net loss (169) 169 0
Unrecognized prior service cost (44) 22 (22)
Accrued post-retirement benefit obligation $ 385 $ (131) $ 254
The assumptions used in the measurement of the Company's benefit obligation are
shown in the following table:
POSTRETIREMENT
HEALTH CARE
BENEFIT PLAN
2003 2002 2001
Discount rate 6.25% 6.75% 7.50%
Health care cost trend rate 6.50% 6.75% 7.00%
69
The health care cost trend rate is anticipated to be 9.0% in 2004 through 2006,
then decline to 6.5% in 2007 and thereafter.
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care benefit plan. A 1% increase in assumed health
care cost trend rates would have the following effects:
2003 2002 2001
Effect on service and interest cost $ 13 $ 15 $ 9
Effect on accumulated benefit obligation at December 31 89 103 67
NOTE 12 SELF-FUNDED HEALTH INSURANCE PLAN
The Company has established an employee medical benefit plan to self-insure
claims up to $20 per year for each individual with a $475 stop-loss per year
for participants in the aggregate. Coverages in 2004 will be $25 per
individual and $521 in the aggregate. The Company and its covered employees
contribute to the fund to pay the claims and stop-loss premiums. Medical
benefit plan costs are expensed as incurred. The liability recognized for
claims incurred but not yet paid was $63 and $71 as of December 31, 2003 and
2002, respectively. Health insurance expense recorded in 2003, 2002, and 2001
was $367, $275, and $273, respectively.
NOTE 13 INCOME TAXES
The components of the provision for income taxes are as follows:
2003 2002 2001
Current income tax provision:
Federal $ 2,003 $ 1,460 $ 1,414
State 297 168 93
Total current 2,300 1,628 1,507
Deferred income tax expense (benefit):
Federal 1 300 (43)
State (1) 60 (11)
Total deferred 0 360 (54)
Total provision for income taxes $ 2,300 $ 1,988 $ 1,453
70
A summary of the source of differences between income taxes at the federal
statutory rate and the provision for income taxes for the years ended December
31, follows:
2003 2002 2001
PERCENT PERCENT PERCENT
OF OF OF
PRETAX PRETAX PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
Tax expense at
statutory rate $ 2,416 34.0 $ 2,160 34.0 $ 1,638 34.0
Increase (decrease)
in taxes resulting
from:
Tax-exempt
interest (342) (4.8) (338) (5.3) (284) (5.9)
State income tax 195 2.7 150 2.4 54 1.1
Other 31 0.5 16 0.2 45 1.0
Provision for income
taxes $ 2,300 32.4 $ 1,988 31.3 $ 1,453 30.2
71
Deferred income taxes are provided for the temporary differences between the
financial reporting basis and the tax basis of the Company's assets and
liabilities. The major components of the net deferred tax assets are as
follows:
2003 2002
Deferred tax assets:
Allowance for loan losses $ 1,173 $ 1,054
Deferred compensation and director's fees 89 17
State net operating loss 33 29
Post-retirement health care benefits 100 129
Employee pension plan 17 21
Other 2 2
Valuation allowances (33) (29)
Gross deferred tax assets 1,381 1,223
Deferred tax liabilities:
Premises and equipment 203 172
Mortgage servicing rights 320 275
FHLB stock 207 136
Deferred net loan origination costs 125 108
Unrealized gain on securities available for sale 446 731
Other 3 9
Gross deferred tax liabilities 1,304 1,431
Net deferred tax asset (liability) $ 77 $ (208)
The Company and its subsidiary Bank pay state income taxes on individual,
unconsolidated net earnings. At December 31, 2003, net operating loss
carryforwards of the parent company of approximately $619 existed to offset
future state taxable income. These net operating losses will begin to expire
in 2012. A valuation allowance has been recognized to adjust deferred tax
assets to the amount of net operating losses expected to be utilized to offset
future income. If realized, the tax benefit for this item will reduce current
tax expense for that period. The valuation allowance increased $4 and $5 in
2003 and 2002, respectively.
NOTE 14 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
CREDIT RISK
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments
72
to extend credit and standby letters of credit. Those instruments involve, to
varying degrees, elements of credit risk in excess of the amount recognized in
the balance sheets.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments
and conditional obligations as it does for on-balance-sheet instruments. These
commitments at December 31, are as follows:
2003 2002
Commitments to extend credit $ 40,935 $ 36,695
Commercial stand by letters of credit - variable rate 707 889
Home equity lines of credit - variable rate 8,936 5,892
Credit card commitments - fixed rate 3,260 3,217
Totals $ 53,838 $ 46,693
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary
upon extension of credit, is based on management's credit evaluation of the
party. Collateral held varies but may include accounts receivable, inventory,
property, plant, and equipment, and income-producing commercial properties.
Letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. Those guarantees are primarily
issued to support public and private borrowing arrangements. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. Collateral held varies as specified
above and is required in instances which the Company deems necessary. The
commitments are generally structured to allow for 100% collateralization on all
letters of credit.
Credit card commitments are commitments on credit cards issued by the Company
and serviced by Elan Financial Services (a subsidiary of U.S. Bancorp.). These
commitments are unsecured.
CONCENTRATION OF CREDIT RISK
The Company grants residential mortgage, commercial, and consumer loans
predominantly in Marathon, Oneida, and Vilas Counties, Wisconsin. There are no
significant concentrations of credit to any one debtor or industry group.
Management believes the diversity of the local economy will prevent significant
losses in the event of an economic downturn.
73
CONTINGENCIES
In the normal course of business, the Company 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.
Like many Wisconsin financial institutions, the Company has a non-Wisconsin
subsidiary that holds and manages investment assets which have not been subject
to Wisconsin tax. The Wisconsin Department of Revenue (the "Department") has
instituted an audit program specifically aimed at out-of-state bank
subsidiaries and has indicated that it may withdraw favorable rulings
previously issued in connection with such subsidiaries. As a result of these
developments, the Department may take the position that the income of the out-
of-state subsidiaries is taxable in Wisconsin, which will likely be challenged
by financial institutions in the state. If the Department is successful in its
efforts, it would result in a negative impact on the earnings of the Company.
In addition, the Internal Revenue Service is currently conducting an audit of
the Company's open tax returns. At this time, the Company does not accept any
additional tax liability as a result of this audit.
INTEREST RATE RISK
The Company originates and holds adjustable rate residential mortgage loans
with variable rates of interest. The rate of interest on these loans is capped
over the life of the loan. At December 31, 2003 and 2002, none of the
approximately $8,324 and $14,154 of variable rate loans, respectively had
reached the interest rate cap.
OTHER COMMITMENTS
The Company has an annual, ongoing share repurchase program of up to 1% of
outstanding shares per year. The Company repurchased 16,700 shares during 2003
at an average price per share of $33.10. The Company repurchased 20,830 shares
during 2002 at an average price per share of $18.93. The Company anticipates
repurchasing approximately 17,300 shares during 2004 at market prices in effect
at the time of purchase.
74
NOTE 15 STOCK OPTION PLAN
Under the terms of an incentive stock option plan adopted during 2001, shares
of unissued common stock are reserved for options to officers and key employees
of the Company at prices not less than the fair market value of the shares at
the date of the grant. Options may be exercised anytime after the option
grant's six month anniversary. These options expire ten years after the grant
date. As of December 31, 2003, all 28,237 options outstanding were eligible to
be exercised. The following tables summarize information regarding stock
options outstanding at December 31, 2003 and activity during the 3 years ended
December 31, 2003.
OPTIONS EXERCISABLE
EXERCISE PRICES SHARES
$15.83 23,392
$16.81 4,845
WEIGHTED
AVERAGE
SHARES PRICE
January 1, 2001 $ 0 $
Options granted 26,655 15.79
Options exercised 0
January 1, 2002 26,655 15.83
Options granted 4,845 16.81
Options exercised (3,263) 15.83
December 31, 2002 28,237 16.00
Options granted 0
Options exercised 0
December 31, 2003 $ 28,237 $ 16.00
75
As of December 31, 2003, no additional shares of common stock remain reserved
for future grants to officers and key employees under the option plan approved
by the shareholders.
The Company follows the provisions of Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees, and uses the "intrinsic value
method" of recording stock-based compensation cost. Because stock options are
granted with an exercise price equal to fair value at the date of grant, no
compensation expense is recorded.
The following table illustrates the effect of net income and earnings per share
if the fair value based method had been applied to all outstanding and unvested
awards in each period:
2003 2002 2001
Net income, as reported $ 4,806 $ 4,365 $ 3,366
Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects 0 0 0
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method for all awards,
net of related tax effects 0 (9) (61)
Pro forma net income $ 4,806 $ 4,356 $ 3,305
Earning per share - Basic and diluted
As reported -
Basic $ 2.76 $ 2.48 $ 1.91
Diluted $ 2.74 $ 2.48 $ 1.91
Pro forma -
Basic $ 2.76 $ 2.48 $ 1.87
Diluted $ 2.74 $ 2.47 $ 1.87
The fair value of stock options granted in 2002 and 2001 was estimated at the
date of grant using the Black-Scholes methodology. No options were granted in
2003. The following assumptions were made in estimating the fair value for
options granted for the years ended December 31:
2002 2001
Dividend yield 2.75% 3.09%
Risk-free interest rate 3.83% 5.54%
Weighted average expected life (years) 10 10
Expected volatility 7.59% 2.42%
The weighted average fair value of options at their grant date, using the
assumptions shown above, was computed at $1.90 per share for options granted in
2002 and $2.30 per share for options granted in 2001.
76
NOTE 16 STOCK SPLIT
On November 19, 2002, the Company's shareholders approved an increase in
authorized shares from 1,000,000 to 3,000,000, allowing the Board of Directors
to effect a 2 for 1 stock split paid on December 2, 2002. On December 16,
2003, the Company declared a 5% stock dividend to shareholders of record on
January 6, 2004, which was paid on January 29, 2004. All references in the
accompanying consolidated financial statements to the number of common shares
and per share amounts for 2003, 2002, and 2001 have been restated to reflect
the split and the 5% stock dividend.
NOTE 17 CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory-and possibly additional
discretionary-actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to risk-
weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2003, that the
Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 2003, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as well-capitalized under the
regulatory framework for prompt corrective action. To be categorized as well-
capitalized, the Bank must maintain minimum total risk-based, Tier I risk-
based, and Tier I leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the Bank's category.
77
The Company's and the Bank's actual and regulatory capital amounts and ratios
are as follows:
TO BE WELL-
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
As of December 31, 2003:
Total capital (to risk
weighted assets):
Consolidated $34,752 10.9% $25,440 8.0% N/A N/A
Subsidiary bank $34,345 10.8% $25,440 8.0% $31,800 10.0%
Tier I capital (to risk
weighted assets):
Consolidated $31,216 9.8% $12,720 4.0% N/A N/A
Subsidiary bank $30,809 9.7% $12,720 4.0% $19,080 6.0%
Tier I capital (to
average assets):
Consolidated $31,216 7.8% $15,975 4.0% N/A N/A
Subsidiary bank $30,809 7.7% $15,971 4.0% $19,963 5.0%
As of December 31, 2002:
Total capital (to risk
weighted assets):
Consolidated $31,085 11.4% $21,790 8.0% N/A N/A
Subsidiary bank $30,473 11.2% $21,790 8.0% $27,238 10.0%
Tier I capital (to risk
weighted assets):
Consolidated $27,926 10.2% $10,895 4.0% N/A N/A
Subsidiary bank $27,315 10.0% $10,895 4.0% $16,343 6.0%
Tier I capital (to
average assets):
Consolidated $27,926 7.7% $14,538 4.0% N/A N/A
Subsidiary bank $27,315 7.5% $14,537 4.0% $18,171 5.0%
78
NOTE 18 EARNINGS PER SHARE
Basic and diluted earnings per share data are based on the weighted-average
number of common shares outstanding during each period. Diluted earnings per
share are further adjusted for potential common shares that were dilutive and
outstanding during the period. Potential common shares consist of stock
options outstanding under the incentive plan. The dilutive effect of potential
common shares is computed using the treasury stock method. All stock options
are assumed to be 100% vested for purposes of the earnings per share
computations. The computation of earnings per share for the years ended
December 31, are as follows:
2003 2002 2001
Weighted average shares outstanding 1,740,106 1,758,249 1,763,381
Effect of dilutive stock options outstanding 12,854 4,474 0
Diluted weighted average shares outstanding 1,752,960 1,762,723 1,763,381
Basic earnings per share $ 2.76 $ 2.48 $ 1.91
Diluted earnings per share $ 2.74 $ 2.48 $ 1.91
NOTE 19 RESTRICTIONS ON RETAINED EARNINGS
The subsidiary Bank is restricted by banking regulations from making dividend
distributions above prescribed amounts and is limited in making loans and
advances to the Company. At December 31, 2003, the retained earnings of the
subsidiary available for distribution as dividends without regulatory approval
was approximately $9,680.
NOTE 20 FAIR VALUE OF FINANCIAL INSTRUMENTS
Current accounting standards require that the Company disclose estimated fair
values for its financial instruments. Fair value estimates, methods, and
assumptions are set forth below for the Company's financial instruments.
The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial statements:
Cash and cash equivalents: The carrying amounts reported in the balance sheets
approximate fair value.
Securities: Fair values are based on quoted market prices, where available.
If a quoted market price is not available, fair value is estimated using quoted
market prices for similar securities.
Loans held for sale: Fair value is based on commitments on hand from investors
or prevailing market prices.
Loans: Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as commercial,
residential mortgage, and other consumer. The fair value of loans is
calculated by discounting scheduled cash flows through the estimated maturity
using estimated market
79
discount rates that reflect the credit and interest rate risk inherent in the
loan. The estimate of maturity is based on the Company's repayment schedules
for each loan classification. In addition, for impaired loans, marketability
and appraisal values for collateral were considered in the fair value
determination. The carrying amount of accrued interest approximates its fair
value.
Mortgage Servicing Rights: Fair values are based on estimated discounted cash
flows based on current market rates and anticipated repayment term of the
serviced loans or estimates of similar prices for similar rights.
Deposit Liabilities: The fair value of deposits with no stated maturity, such
as non-interest-bearing demand deposits, savings, NOW accounts, and money
market accounts, is equal to the amount payable on demand at the reporting
date. The fair value of certificates of deposit is based on the discounted
value of contractual cash flows. The discount rate reflects the credit quality
and operating expense factors of the Company.
FHLB Advances: The fair value of the Company's long-term advances (other than
deposits) is estimated using discounted cash flow analyses based on the
Company's current incremental borrowing rates for similar types of borrowing
arrangements.
Other Borrowings: The fair value of other borrowings with no stated maturity,
such as federal funds purchased, is equal to the amount payable on demand at
the reporting date. Fair value for fixed rate repurchase agreements is
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on repurchase agreements to a schedule of aggregated
expected maturities on the existing agreements.
Off-Balance-Sheet Instruments: The fair value of commitments would be
estimated using the fees currently charged to enter into similar agreements,
taking into account the remaining terms of the agreements, the current interest
rates, and the present creditworthiness of the counter parties. Since this
amount is immaterial, no amounts for fair value are presented.
The carrying amounts and fair values of the Company's financial instruments
consisted of the following at December 31:
2003 2002
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
Financial assets:
Cash and cash equivalents $ 18,927 $ 18,927 $ 21,552 $ 21,552
Securities 72,472 72,472 81,057 81,057
FHLB stock 2,444 2,444 2,264 2,264
Net loans receivable 304,546 306,743 256,964 259,243
Accrued interest receivable 1,617 1,617 1,732 1,732
Mortgage servicing rights 814 814 697 697
Financial liabilities:
Deposits 316,414 318,194 297,830 300,103
FHLB advances 47,000 48,315 38,000 40,272
Other borrowings 10,475 10,524 3,302 3,346
Accrued interest payable 713 713 932 932
80
LIMITATIONS
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from
offering for sale at one time the Company's entire holdings of a particular
financial instrument. Because no market exists for a significant portion of
the Company's financial instruments, fair value estimates are based on
judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments, and other
factors. These estimates are subjective in nature and involve uncertainties
and matters of significant judgment and, therefore, cannot be determined with
precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance-sheet financial
instruments without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments. Significant assets and liabilities that are not
considered financial assets or liabilities include premises and equipment,
other assets, and other liabilities. In addition, the tax ramifications
related to the realization of the unrealized gains or losses can have a
significant effect on fair value estimates and have not been considered in the
estimates.
NOTE 21 CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following condensed balance sheets as of December 31, 2003 and 2002, and
condensed statements of income and cash flows for the years ended December 31,
2003, 2002, and 2001, for PSB Holdings, Inc. should be read in conjunction with
the consolidated financial statements and footnotes.
BALANCE SHEETS
December 31, 2003 and 2002
ASSETS 2003 2002
Cash and due from banks $ 877 $ 1,203
Investment in Peoples State Bank 31,734 28,691
Other assets 32 34
TOTAL ASSETS $ 32,643 $ 29,928
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued dividends payable $ 502 $ 625
Total stockholders' equity 32,141 29,303
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $ 32,643 $ 29,928
81
STATEMENTS OF INCOME
Years Ended December 31, 2003, 2002, and 2001
2003 2002 2001
Income:
Dividends from Peoples State Bank $ 1,361 $ 1,750 $ 1,064
Dividends from other investments 20 0 0
Interest 4 3 4
Total income 1,385 1,753 1,068
Expenses:
Transfer agent and shareholder communication 40 34 12
Other 74 66 123
Total expenses 114 100 135
Income before income taxes and equity in
undistributed net income of Peoples State Bank 1,271 1,653 933
Provision for income tax benefit (30) (32) (44)
Net income before equity in undistributed
net income of Peoples State Bank 1,301 1,685 977
Equity in undistributed net income of
Peoples State Bank 3,505 2,680 2,389
Net income $ 4,806 $ 4,365 $ 3,366
82
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003, 2002, and 2001
2003 2002 2001
Increase (decrease) in cash and due from
banks:
Cash flows from operating activities:
Net income $ 4,806 $ 4,365 $ 3,366
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed net income of
Peoples State Bank (3,505) (2,680) (2,389)
(Increase) decrease in other assets 2 39 (46)
Increase (decrease) in dividends payable (123) 37 18
Net cash provided by operating activities 1,180 1,761 949
Cash flows from financing activities:
Dividends declared (998) (944) (908)
Proceeds from stock options issued
out of treasury 0 51 0
Proceeds from stock shares issued
to Peoples State Bank out of treasury
used to pay Directors fees 45 60 0
Purchase of treasury stock (553) (394) 0
Net cash used in financing activities (1,506) (1,227) (908)
Net increase (decrease) in cash and due from bank (326) 534 41
Cash and due from banks at beginning 1,203 669 628
Cash and due from banks at end $ 877 $ 1,203 $ 669
83
NOTE 22 SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
THREE MONTHS ENDED
March 31 June 30 Sept 30 Dec 31
2003
Interest income $ 5,293 $ 5,258 $ 5,241 $ 5,258
Interest expense 2,061 1,990 1,935 1,883
Net interest income 3,232 3,268 3,306 3,375
Provision for loan losses 225 240 240 130
Net income applicable to
common stock 1,224 1,057 1,235 1,290
Basic earnings per share * 0.70 0.61 0.71 0.74
Diluted earnings per share* 0.70 0.60 0.71 0.74
2002
Interest income $ 5,370 $ 5,405 $ 5,601 $ 5,539
Interest expense 2,376 2,301 2,345 2,251
Net interest income 2,994 3,104 3,256 3,288
Provision for loan losses 180 180 450 300
Net income applicable to
common stock 958 1,024 1,051 1,332
Basic and diluted earnings
per share 0.54 0.58 0.60 0.76
2001
Interest income $ 6,046 $ 5,979 $ 5,833 $ 5,570
Interest expense 3,559 3,349 2,924 2,636
Net interest income 2,487 2,630 2,909 2,934
Provision for loan losses 150 150 150 440
Net income applicable to
common stock 769 839 885 873
Basic and diluted earnings
per share 0.44 0.47 0.50 0.50
* Basic and diluted earnings per share for the year ended December 31, 2003
were $2.76 and $2.74, respectively. Due to rounding, however, quarterly
diluted earnings per share do not total $2.74 on this summary.
84
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this Annual Report on Form 10-K,
management, under the supervision, and with the participation, of PSB's
President and Chief Executive Officer and the Chief Financial Officer (the
Treasurer), evaluated the effectiveness of the design and operation of PSB's
disclosure controls and procedures pursuant to Rule 13a-15(e) under the
Securities Exchange Act of 1934. Based upon, and as of the date of such
evaluation, the President and Chief Executive Officer and the Chief Financial
Officer concluded that PSB's disclosure controls and procedures were effective
in all material respects. There have been no significant changes in PSB's
internal controls or in other factors which could significantly affect internal
controls subsequent to the date PSB carried out its evaluation, nor were there
any significant deficiencies or material weaknesses identified which required
any corrective action to be taken.
85
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to directors of PSB is incorporated into this Annual
Report on Form 10-K by this reference to the disclosure in PSB's proxy
statement dated March 12, 2004 relating to the 2004 annual meeting of
shareholders (the "2004 Proxy Statement") under the subcaption "Election of
Directors - Election of Directors."
Information relating to the identification of executive officers of PSB is
found in Part I of this Annual Report on Form 10-K.
Information required under Rule 405 of Regulation S-K is incorporated into this
Annual Report on Form 10-K by this reference to the disclosure in the 2004
Proxy Statement under the subcaption "Beneficial Ownership of Common Stock -
Section 16(a) Beneficial Ownership Reporting Compliance."
CODE OF ETHICS
PSB has adopted a Code of Ethics Policy for all directors, officers, and
employees and a Code of Compliance and Reporting Requirements for Senior
Management and Senior Financial Officers which covers PSB's Chief Executive
Officer, Treasurer (the chief financial and accounting officer), each Vice
President, and the Secretary.
AUDIT COMMITTEE
The Board of Directors has appointed an Audit Committee in accordance with
Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Mr. Polzer (Chairman), Mr. Crooks, Mr. Fish, Mr. Gullickson,
and Mr. Sonnentag serve on the Audit Committee (PSB is not a "listed issuer" as
defined in SEC Rule 10A-3).
FINANCIAL EXPERT
The SEC has adopted rules which require PSB to disclose whether one of the
members of the Audit Committee qualifies under SEC rules as an "audit committee
financial expert." Based on its review of the SEC rules, the Board does not
believe that any member of the Audit Committee can be classified as an "audit
committee financial expert."
In order to qualify as an "audit committee financial expert," a member of the
Audit Committee must, for all practical purposes, have the attributes and
career experience of a person who has been actively involved in the
preparation, auditing, or evaluation of public company financial statements.
PSB's size and geographic location make it difficult to recruit directors who
have these specific qualifications. While it may be possible to recruit a
director having these specific qualifications, the Board believes that each of
its members should have a familiarity with PSB's market area and an
understanding of PSB's customer base, in addition to meeting the other general
criteria described in the 2004 Proxy Statement under "Election of Directors -
86
Nominations - Qualifications," and that it is not in the best interest of PSB
to nominate a director who does not possess these characteristics. Moreover,
the Committee has the authority under its charter to retain or dismiss the
independent auditor and to hire such other experts or legal counsel as it deems
appropriate in order to fulfill its duties, and it therefore believes that it
has access to required financial expertise. The Board will consider any
potential candidates who meet its current general qualification criteria and
those of an "audit committee financial expert," but, for the time being, the
Board believes that the current members of the Committee, working with the
independent auditor, are qualified to perform the duties required in the
Committee's charter.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to director compensation is incorporated into this Annual
Report on Form 10-K by this reference to the disclosure in the 2004 Proxy
Statement under the subcaption "The Board of Directors - Compensation of
Directors."
Information relating to the compensation of executive officers is incorporated
into this Annual Report on Form 10-K by this reference to (1) the disclosure in
the 2004 Proxy Statement beginning under the caption "Executive Officer
Compensation," through the disclosure under the subcaption, "- Employment and
Change of Control Agreements," and (2) the disclosure in the 2004 Proxy
Statement under the subcaption "- Committee's and Board's Report on
Compensation Policies - Compensation Committee and Board Interlocks and Insider
Participation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information relating to security ownership of certain beneficial owners and
management is incorporated into this Annual Report on Form 10-K by this
reference to the disclosure in the 2004 Proxy Statement beginning under the
caption "Beneficial Ownership of Common Stock" and ending at the subcaption "-
Section 16(a) Beneficial Ownership Reporting Compliance."
87
The following table sets forth, as of December 31, 2003, information with
respect to compensation plans under which PSB's common stock is authorized for
issuance:
Plan category Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under
warrants and rights warrants and rights equity compensation plans
(excluding securities
reflected in column (a))
(a) (b) (c)
Equity compensation 28,237 $16.00 0
plans approved by
security holders
Equity compensation 0 N/A N/A
plans not approved by
security holders
Total 28,237 $16.00 0
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to certain relationships and related transactions with
directors and officers is incorporated into this Annual Report on Form 10-K by
this reference to the disclosure in the 2004 Proxy Statement under the
subcaption "The Board of Directors - The Board - Certain Relationships and
Related Transactions."
ITEM 14. PRINCIPAL AUDITOR FEES AND SERVICES
Information relating to the fees and services of PSB's principal accountant is
incorporated into this Annual Report on Form 10-K by this reference to the
disclosure in the 2004 Proxy Statement under the subcaptions "Audit Committee
Report and Related Matters - Independent Auditor and Fees," and "- Audit
Committee Pre-Approval Policies."
88
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report.
(1) The following consolidated financial statements of PSB and the
Independent Auditors' Report thereon are filed as part of this report:
(i) Consolidated Balance Sheets as of December 31, 2003 and 2002
(ii) Consolidated Statements of Income for the years ended December 31,
2003, 2002, and 2001
(iii) Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2003, 2002, and 2001
(iv) Consolidated Statements of Cash Flows for the years ended December
31, 2003, 2002, and 2001
(v) Notes to Consolidated Financial Statements
(2) No financial statement schedules are required by Item 15(d).
(3) The following exhibits required by Item 601 of Regulation S-K are filed
as part of this report.
Exhibit
Number Description
3.1 Restated Articles of Incorporation (incorporated by reference to
Exhibit 3.1 to PSB's Annual Report on Form 10-K for the fiscal year
ended December 31, 2002)
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to PSB's Annual
Report on Form 10-K for the fiscal year ended December 31, 2000)
4.1 Articles of Incorporation and Bylaws (see Exhibits 3.1 and 3.2)
10.1 Bonus Plan of Directors of the Bank (incorporated by reference to
Exhibit 10.1 to PSB's Annual Report on Form 10-K for the fiscal
year ended December 31, 2002)*
10.2 Non-Qualified Retirement Plan for Directors of the Bank
(incorporated by reference to Exhibit 10.2 to PSB's Annual Report
on Form 10-K for the fiscal year ended December 31, 2001)*
10.3 Senior Management Incentive Compensation Plan (incorporated by
reference to Exhibit 10.4 to PSB's Quarterly Report on Form 10-Q
for the period ended June 30, 2000)*
89
10.4 2001 Stock Option Plan (incorporated by reference to Exhibit 10.5
to PSB's Quarterly Report on Form 10-Q for the period ended June
30, 2001)*
10.5 Employment and Change of Control Agreement with David K. Kopperud
(incorporated by reference to Exhibit 10.5 to PSB's Annual Report
on Form 10-K for the fiscal year ended December 31, 2002)*
10.6 Employment and Change of Control Agreement with David A. Svacina
(incorporated by reference to Exhibit 10.6 to PSB's Annual Report
on Form 10-K for the fiscal year ended December 31, 2002)*
10.7 Employment and Change of Control Agreement with Scott M. Cattanach
(incorporated by reference to Exhibit 10.2 to PSB's Quarterly
Report on Form 10-Q for the period ended March 31, 2003)*
10.8 Directors Deferred Compensation Plan (incorporated by reference to
Exhibit 10.1 to PSB's Quarterly Report on Form 10-Q for the period
ended March 31, 2003)*
10.9 Employment and Change of Control Agreement with Todd R. Toppen*
21.1 Subsidiaries of PSB (incorporated by reference to Exhibit 21.1 to
PSB's Annual Report on Form 10-K for the fiscal year ended December
31, 2000)
31.1 Certification of CEO pursuant to Section 302 of Sarbanes-Oxley Act
of 2002
31.2 Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Act
of 2002
32.1 Certifications under Section 906 of Sarbanes-Oxley Act of 2002
*Denotes Executive Compensation Plans and Arrangements.
(b) Reports on Form 8-K.
Form 8-K dated September 3, 2003. PSB filed a current report on Form 8-K
on September 3, 2003, reporting the commencement of its commercial
insurance business under Item 5.
Form 8-K dated October 24, 2003. PSB filed a current report on Form 8-K
on October 24, 2003, reporting earnings for the quarter ended September
30, 2003, under Item 5 and additional related disclosure under Item 9,
Regulation FD Disclosure, and Item 12, Results of Operations and
Financial Condition.
Form 8-K dated December 17, 2003. PSB filed a current report on Form 8-K
on December 17, 2003, reporting the declaration of a 5% stock dividend
payable January 29, 2004, under Item 5.
90
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PSB Holdings, Inc.
By DAVID K. KOPPERUD March 12, 2004
David K. Kopperud, President
and Chief Executive Officer
Pursuant to the requirement of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on this 12th day of March, 2004.
Signature and Title Signature and Title
DAVID K. KOPPERUD SCOTT M. CATTANACH
David K. Kopperud, President Scott M. Cattanach, Treasurer and CFO
Chief Executive Officer and a Director (Principal Financial Officer and
Accounting Officer)
DIRECTORS:
GORDON P. CONNOR PATRICK L. CROOKS
Gordon P. Connor Patrick L. Crooks
WILLIAM J. FISH CHARLES A. GHIDORZI
William J. Fish Charles A. Ghidorzi
GORDON P. GULLICKSON JOHN H. SONNENTAG
Gordon P. Gullickson John H. Sonnentag
THOMAS R. POLZER THOMAS A. RIISER
Thomas R. Polzer Thomas A. Riiser
WILLIAM M. REIF
William M. Reif
91
EXHIBIT INDEX
TO
FORM 10-K
OF
PSB HOLDINGS, INC.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
PURSUANT TO SECTION 102(D) OF REGULATION S-T
(17 C.F.R. SECTION 232.102(D))
The following exhibits are filed as part of this report:
10.9 Employment and Change of Control Agreement with Todd R. Toppen
31.1 Certification of CEO pursuant to Section 302 of Sarbanes-Oxley Act
of 2002
31.2 Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Act
of 2002
32.1 Certifications under Section 906 of Sarbanes-Oxley Act of 2002
92