ITEM 1.
Business
Forward Looking Statements
This Annual Report on Form 10-K contains certain “forward-looking statements” which may be identified by the use of words such as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, general and local economic conditions, changes in interest rates, deposit flows, demand for mortgage and other loans, real estate values, competition, changes in accounting principles, policies, or guidelines, changes in legislation or regulation, and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing products and services.
PSB Holdings, Inc.
PSB Holdings, Inc. is the federally chartered stock holding company of Putnam Bank, and owns 100% of the common stock of Putnam Bank. PSB Holdings, Inc. also owns investment securities valued at $1.2 million as of June 30, 2012. We have not engaged in any significant business activity other than owning the common stock of Putnam Bank and investing in marketable securities. Our executive office is located at 40 Main Street, Putnam, Connecticut 06260, and our telephone number is (860) 928-6501. As of June 30, 2012, 57.1% of the outstanding stock of PSB Holdings, Inc. was owned by Putnam Bancorp, MHC.
Putnam Bancorp, MHC
Putnam Bancorp, MHC is a federally chartered mutual holding company. Putnam Bancorp, MHC has not engaged in any significant business activity other than owning the common stock of PSB Holdings, Inc. Putnam Bancorp, MHC owns 57.1% of the outstanding shares of common stock of PSB Holdings, Inc. So long as Putnam Bancorp, MHC exists, it is required to own a majority of the voting stock of PSB Holdings, Inc. As a result, stockholders other than Putnam Bancorp, MHC will not be able to exercise voting control over most matters put to a vote of stockholders and Putnam Bancorp, MHC, through its Board of Directors, will be able to exercise voting control over most matters put to a vote of stockholders.
Putnam Bancorp, MHC is headquartered at 40 Main Street in Putnam, Connecticut and its telephone number at that address is (860) 928-6501.
Putnam Bank
Putnam Bank was founded in 1862 as a state-chartered mutual savings bank. In October 2004, the Bank converted to a federally chartered stock savings bank in connection with the offering of common stock by PSB Holdings, Inc. The Bank is headquartered at 40 Main Street in Putnam, Connecticut and conducts substantially all of its business from eight full-service banking offices and one loan origination center. In addition, the Bank maintains a “Special Needs Limited Branch” and a “Limited Service (Mobile) Branch.” The telephone number at the Bank’s main office is (860) 928-6501.
Available Information
PSB Holdings, Inc. is a public company, and files interim, quarterly and annual reports with the Securities and Exchange Commission. These respective reports are on file and a matter of public record with the Securities and Exchange Commission and may be obtained on the Securities and Exchange Commission’s website (http://www.sec.gov).
Our website address is www.putnambank.com. Information on our website should not be considered a part of this annual report.
General
Our principal business consists of attracting deposits from the general public in Windham County and New London County, Connecticut and investing those deposits, together with funds generated from operations, primarily in one- to four-family residential mortgage loans and, to a lesser extent, commercial real estate loans (including multi-family real estate loans), commercial loans, construction mortgage loans and consumer loans, and in investment securities. Our revenues are derived principally from interest on loans and securities, and from loan origination and servicing fees. Our primary sources of funds are deposits and principal and interest payments on loans and securities.
Competition
We face intense competition within our market area both in making loans and attracting deposits. The Town of Putnam and the surrounding area have a high concentration of financial institutions, including large commercial banks, community banks and credit unions. Some of our competitors offer products and services that we currently do not offer, such as trust services and private banking. As of June 30, 2011, based on the FDIC’s annual Summary of Deposits Report (the most current data available), our market share of deposits represented 18.2% of deposits in Windham County and 1.6% in New London County.
Our competition for loans and deposits comes principally from commercial banks, savings institutions, mortgage banking firms and credit unions. We face additional competition for deposits from money market funds, brokerage firms, mutual funds and insurance companies. Our primary focus is to build and develop profitable customer relationships across all lines of business while maintaining our role as a community bank.
Market Area
We operate in a primarily rural market area that has a stable population and household base. We currently operate out of eight offices, which are located in Windham County and New London County, Connecticut. According to SNL Financial, LC., from 2010 to 2011, the population of Windham County increased by 0.2%, while London County reflected relatively no change (0.0%). At the same time, the population of the state of Connecticut increased by 0.1%, while the United States increased at a slightly higher rate of 0.6%. During the same period, the growth in number of households in Windham and New London Counties, as well as on a statewide basis, paralleled the relative nationwide population growth rate. In 2011, per capita income for Windham County was $26,678 and the median household income was $54,234. In the same year, per capita income for New London County was $31,615 and the median household income was $60,209. These compare to per capita income levels for the state of Connecticut and the United States of $35,026 and $26,391 and median household income levels of $65,386 and $50,227, respectively.
Windham County is located in the Northeastern corner of Connecticut and borders both Massachusetts (to the north) and Rhode Island (to the east). New London County is to the south of Windham County, located in the Southeastern corner of Connecticut. Putnam is approximately 45 miles from Hartford, Connecticut, 30 miles from Providence, Rhode Island, and 65 miles from Boston, Massachusetts.
Windham County has a diversified mix of industry groups and employment sectors, including services, wholesale/retail trade and government. These three sectors comprise approximately 68% of the employment base in Windham County. The same three sectors comprise an approximately higher 75% of the employment base in New London County; however, nearly 27% of the employment base is employed by the government sector.
Windham County’s June 2012 unemployment rate of 9.9% is higher than the New London County unemployment rate of 8.5%, which were both higher than the comparable Connecticut unemployment rate of 8.1%, and the national unemployment rate of 8.2%. Notably, the unemployment rates for the United States, Connecticut, Windham County, and New London County for June 2012 have all decreased relative to their June 2011 unemployment rates of 9.1%, 8.9%, 10.6%, and 8.9%, respectively. Our primary market area for deposits includes the communities in which we maintain our main office and our branch office locations. Our primary lending area is broader than our primary deposit market area and includes all of Windham County, and parts of the adjacent Connecticut Counties of New London and Tolland, as well as the Rhode Island and Massachusetts communities adjacent to Windham County.
Lending Activities
Historically, our principal lending activity has been the origination of first mortgage loans for the purchase or refinancing of one- to four-family residential real estate. We retain most of the loans that we originate. However, we generally sell long-term fixed rate loans in the secondary market. When we sell loans, we generally retain the servicing rights for such loans. One- to four-family residential real estate mortgage loans (including home equity loans and lines of credit) represented $200.1 million, or 79.2%, of our loan portfolio at June 30, 2012. We also offer commercial real estate loans (including multi-family real estate loans), commercial loans, construction mortgage loans (primarily secured by single-family properties) and consumer loans. At June 30, 2012, commercial real estate loans totaled $45.0 million, or 17.8% of our loan portfolio, commercial loans totaled $3.5 million, or 1.4% of our loan portfolio, residential construction mortgage loans totaled $3.0 million, or 1.2% of our loan portfolio and consumer loans, consisting primarily of automobile loans and secured personal loans, totaled $898,000, or 0.4% of our loan portfolio.
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio at June 30, of each year indicated.
(1) Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
Loan Portfolio Maturities and Yields. The following table summarizes the final maturities of the Company’s loan portfolio at June 30, 2012. This table does not reflect scheduled principal payments, unscheduled prepayments, or the ability of certain loans to reprice prior to maturity dates. Demand loans, and loans having no stated repayment schedule, are reported as being due in one year or less.
(1)
Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
The following table sets forth the scheduled repayments of fixed and adjustable rate loans at June 30, 2012 that are contractually due after June 30, 2013.
(1)
Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
At June 30, 2012, the total amount of loans that had fixed interest rates was $150.4 million, and the total amount of loans that had floating or adjustable interest rates was $100.6 million.
Residential Mortgage Loans. Our primary lending activity consists of the origination of one- to four-family residential mortgage loans that are primarily secured by properties located in Windham and New London Counties, Connecticut. At June 30, 2012, $200.1 million, or 79.2% of our loan portfolio, consisted of one- to four-family residential mortgage loans. At June 30, 2012, our residential mortgage loans included $11.3 million of home equity loans and $11.3 million of home equity lines of credit. Generally, one- to four-family residential mortgage loans are originated in amounts up to 80% of the lesser of the appraised value or purchase price of the property, with private mortgage insurance required on loans with a loan-to-value ratio in excess of 80%. We will not make loans with a loan-to-value ratio in excess of 100% for loans secured by single family homes. Fixed rate mortgage loans generally are originated for terms of 10 to 30 years. Generally, all fixed rate residential mortgage loans are underwritten according to Fannie Mae policies and procedures. Fixed rate residential mortgage loans with terms of more than 15 years are generally sold in the secondary market, although bi-weekly fixed rate mortgage loans with terms of more than 15 years are generally retained in our portfolio. Bi-weekly mortgage loans are loans that require payments to be made every two weeks. We will usually retain the servicing rights for all loans that we sell in the secondary market. We originated $39.3 million of fixed rate one- to four-family residential loans during the year ended June 30, 2012, of which $9.7 million were sold in the secondary market.
We also offer adjustable rate mortgage loans for one- to four-family properties, with an interest rate based on the one-year Constant Maturity Treasury Bill Index, which adjusts annually from the outset of the loan or which adjusts annually after a three-, five-, seven-, or ten-year initial fixed rate period. We originated $6.6 million of adjustable rate one- to four-family residential loans during the year ended June 30, 2012, of which $214,000 was sold in the secondary market. Our adjustable rate mortgage loans generally provide for maximum rate adjustments of 100 basis points per adjustment, with a lifetime maximum adjustment up to 6% above the initial rate, regardless of the initial rate. Our adjustable rate mortgage loans amortize over terms of up to 30 years.
Adjustable rate mortgage loans decrease the risk associated with changes in market interest rates by periodically repricing, but involve other risks because, as interest rates increase, the monthly or bi-weekly payments by the borrower increase, thus increasing the potential for default by the borrower. At the same time, the value of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustments permitted by our loan documents and, therefore, the effectiveness of adjustable rate mortgage loans may be limited during periods of rapidly rising interest rates. At June 30, 2012, $70.8 million, or 36.7%, of our one- to four-family residential loans had adjustable rates of interest.
In an effort to provide financing for moderate income home buyers, we offer Veterans Administration (VA), Federal Housing Administration (FHA), Connecticut Housing Finance Authority (CHFA) and Rural Development loans. These programs offer residential mortgage loans to qualified individuals. These loans are offered with fixed rates of interest and terms of up to 30 years. Such loans are secured by one- to four-family residential properties. All of these loans are originated using agency underwriting guidelines. VA, FHA and CHFA loans are closed in the name of Putnam Bank and are immediately sold on a servicing-released basis. All such loans are originated in amounts of up to 100% of the lower of the property’s appraised value or the sale price. Private mortgage insurance is required on all such loans.
All residential mortgage loans that we originate include “due-on-sale” clauses, which give us the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid. Regulations limit the amount that a savings association may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal of the property at the time the loan is originated. All borrowers are required to obtain title insurance. We also require homeowner’s insurance and fire and casualty insurance and, where circumstances warrant, flood insurance, on properties securing real estate loans. At June 30, 2012, our largest residential mortgage loan had a principal balance of $698,000 and was secured by a residence located in our primary market area. At June 30, 2012, this loan was performing in accordance with its original terms.
At June 30, 2012, home equity loans and lines of credit totaled $22.6 million, or 11.3% of our residential mortgage loans and 9.0% of total loans. Additionally, at June 30, 2012, the unadvanced amounts of home equity lines of credit totaled $10.1 million. The underwriting standards utilized for home equity loans and home equity lines of credit include a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan. Home equity loans are offered with fixed rates of interest and with terms up to 15 years. The loan-to-value ratio for a home equity loan is generally limited to 80%. However, we offer special programs to borrowers, who satisfy certain underwriting criteria, with loan-to-value ratios of up to 100%. Our home equity lines of credit have adjustable rates of interest which are indexed to the prime rate, as reported in The Wall Street Journal. Interest rates on home equity lines of credit are generally limited to a maximum rate of 14.25%.
Commercial Real Estate Loans. We originate commercial real estate loans, including multi-family real estate loans. These loans are generally secured by five unit or more apartment buildings, construction loans and loans on properties used for business purposes such as small office buildings, industrial facilities or retail facilities primarily located in our primary market area. We also offer real estate development loans to licensed contractors and builders for the construction and development of commercial real estate projects and one- to four-family residential properties. At June 30, 2012, commercial mortgage loans totaled $45.0 million, which amounted to 17.8% of total loans. Our commercial real estate underwriting policies provide that such real estate loans may be made in amounts of up to 80% of the appraised value of the property provided such loan complies with our current loans-to-one-borrower limit, which at June 30, 2012 was $5.9 million. Our commercial real estate loans may be made with terms of up to five years with 20 year amortization schedules and are offered with interest rates that are fixed or that adjust periodically and are generally indexed to the prime rate as reported in The Wall Street Journal or to Federal Home Loan Bank advance rates. In reaching a decision on whether to make a commercial real estate loan, we consider the net operating income of the property, the borrower’s expertise and credit history, and the profitability of the value of the underlying property. In addition, with respect to commercial real estate rental properties, we will also consider the term of the lease and the quality of the tenants. We generally require that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.25x. Environmental surveys are generally required for commercial real estate loans. Generally, multi-family and commercial real estate loans made to corporations, partnerships and other business entities require personal guarantees by the principals.
A commercial borrower’s financial information is monitored on an ongoing basis by requiring periodic financial statement updates, payment history reviews and periodic face-to-face meetings with the borrower. We require commercial borrowers to provide annually updated financial statements and federal tax returns. These requirements also apply to all guarantors on commercial loans. We also require borrowers with rental investment property to provide an annual report of income and expenses for the property, including a tenant list and copies of leases, as applicable. The largest commercial real estate loan in our portfolio at June 30, 2012 was a $2.7 million loan secured by property located in our primary market area. At June 30, 2012, this loan was performing in accordance with its original terms.
Loans secured by commercial real estate, including multi-family properties, generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate, including multi-family properties, are often dependent on successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy.
Residential Construction Loans. We originate construction loans to individuals for the construction and acquisition of personal residences. At June 30, 2012, construction mortgage loans totaled $3.0 million, or 1.2%, of total loans. At June 30, 2012, the unadvanced portion of these construction loans totaled $745,000.
Our construction mortgage loans generally provide for the payment of interest only during the construction phase, which is usually nine months. At the end of the construction phase, the construction loan converts to a permanent mortgage loan. Construction loans can be made with a maximum loan-to-value ratio of 95%, provided that the borrower obtains private mortgage insurance on the loan if the loan balance exceeds 80% of the appraised value or sales price, whichever is less, of the secured property. At June 30, 2012, our largest outstanding residential construction mortgage loan commitment was for $417,000, $38,000 of which was outstanding. This loan was performing according to its original terms at June 30, 2012. Construction loans to individuals are generally made on the same terms as our one- to four-family mortgage loans.
Before making a commitment to fund a residential construction loan, we require an appraisal of the property by an independent licensed appraiser. We also review and inspect each property before disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspection based on the percentage of completion method.
Construction financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost is inaccurate, we may be required to advance funds beyond the amount originally committed in order to protect the value of the property. Additionally, if the estimate of value is inaccurate, we may be confronted with a project, when completed, with a value that is insufficient to assure full payment.
Commercial Loans. At June 30, 2012, we had $3.5 million in commercial business loans which amounted to 1.4% of total loans. We make such commercial loans primarily in our market area to a variety of professionals, sole proprietorships and small businesses. Commercial lending products include term loans and revolving lines of credit. Such loans are generally used for longer-term working capital purposes such as purchasing equipment or furniture. Commercial loans are made with either adjustable or fixed rates of interest. Variable rates are based on the prime rate, as published in The Wall Street Journal, plus a margin. Fixed rate commercial loans are set at a margin above the comparable Federal Home Loan Bank advance rate.
When making commercial loans, we consider the financial statements of the borrower, our lending history with the borrower, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral. Commercial loans are generally secured by a variety of collateral, primarily accounts receivable, inventory and equipment, and are supported by personal guarantees. Depending on the collateral used to secure the loans, commercial loans are made in amounts of up to 75% of the value of the collateral securing the loan. We generally do not make unsecured commercial loans.
Commercial loans generally have greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans generally are made on the basis of the borrower’s ability to repay the loan from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. We seek to minimize these risks through our underwriting standards. At June 30, 2012, our largest commercial loan was a $299,000 loan secured by business assets located in our primary market area. This loan was performing according to its original terms at June 30, 2012.
Consumer and Other Loans. We offer a limited range of consumer loans, principally to Putnam Bank customers residing in our primary market area with acceptable credit ratings. Our consumer loans generally consist of loans on new and used automobiles, loans secured by deposit accounts and unsecured personal loans. Consumer loans totaled $898,000, or 0.4% of our total loan portfolio, at June 30, 2012.
Origination, Purchase, Sale and Servicing of Loans. Lending activities are conducted primarily by our loan personnel operating at our eight branch offices and one loan origination center. All loans originated by us are underwritten pursuant to our policies and procedures. We originate both adjustable rate and fixed rate loans. Our ability to originate fixed or adjustable rate loans is dependent upon the relative customer demand for such loans, which is affected by current and expected future levels of market interest rates.
Generally, we retain in our portfolio all bi-weekly loans and other loans that we originate, with the exception of longer-term, non-bi-weekly fixed rate one- to four-family mortgage loans. The one- to four-family loans that we currently originate for sale include mortgage loans which conform to the underwriting standards specified by Fannie Mae. We also sell all mortgage loans insured by CHFA, FHA, VA and Rural Development. Generally, all one- to four-family loans that we sell are sold pursuant to master commitments negotiated with Fannie Mae. Generally, we sell our loans without recourse. We generally retain the servicing rights on the mortgage loans sold to Fannie Mae, but sell all CHFA, VA, FHA and Rural Development loans on a servicing-released basis.
At June 30, 2012, Putnam Bank was servicing loans sold in the amount of $30.5 million. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans.
During the fiscal year ended June 30, 2012, we originated $48.7 million of fixed rate and adjustable rate one- to four-family loans, of which we retained $38.8 million. We recognize at the time of sale, the cash gain or loss on the sale of the loans based on the difference between the net cash proceeds received and the carrying value of the loans sold.
Loan Approval Procedures and Authority. The Board of Directors establishes the lending policies and loan approval limits of Putnam Bank. Loan officers generally have the authority to originate mortgage loans, consumer loans and commercial loans up to amounts established for each lending officer. Loans in amounts above the individual authorized limits require the approval of Putnam Bank’s Credit Committee. The Credit Committee is authorized to approve all one- to four family mortgage loans, commercial real estate loans, commercial loans and secured consumer loans in amounts up to $500,000. All loans of $500,000 or greater must receive the approval of Putnam Bank’s Board of Directors.
The Board annually approves independent appraisers used by Putnam Bank. For larger loans, the Bank may require an environmental site assessment to be performed by an independent professional for all non-residential mortgage loans. It is Putnam Bank’s policy to require hazard insurance on all mortgage loans.
Loan Origination Fees and Other Income. In addition to interest earned on loans, Putnam Bank receives loan origination fees. Such fees and costs vary with the volume and type of loans and commitments made and purchased, principal repayments, and competitive conditions in the mortgage markets, which in turn respond to the demand and availability of money.
Loans to One Borrower. The maximum amount that we may lend to one borrower and the borrower’s related entities is generally limited, by regulation, to 15% of our stated capital and reserves. At June 30, 2012, our regulatory limit on loans to one borrower was $5.9 million. At that date, the largest aggregate amount loaned by Putnam Bank to one borrower was $3.2 million. The loans comprising this lending relationship were performing in accordance with their original terms as of June 30, 2012.
Delinquencies and Classified Assets
Collection Procedures A computer-generated delinquency notice is mailed monthly to all delinquent borrowers, advising them of the amount of their delinquency. When a loan becomes 60 days delinquent, Putnam Bank sends a letter advising the borrower of the delinquency. The borrower is given 30 days to pay the delinquent payments or to contact Putnam Bank to make arrangements to bring the loan current over a longer period of time. If the borrower fails to bring the loan current in 30 days or to make arrangements to cure the delinquency over a longer period of time, the matter is referred to legal counsel and foreclosure proceedings are started. We may consider forbearance in cases of a temporary loss of income if a plan is presented by the borrower to cure the delinquency in a reasonable period of time after his or her income resumes.
Loans Past Due and Non-performing Assets. Loans are reviewed on a regular basis. Management determines that a loan is impaired or non-performing when it is probable at least a portion of the loan will not be collected in accordance with the original terms due to an irreversible deterioration in the financial condition of the borrower or the value of the underlying collateral. When a loan is determined to be impaired, the measurement of the loan is based on present value of expected future cash flows, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. Non-accrual loans are loans in which collectability is questionable and therefore interest on such loans will no longer be recognized on an accrual basis. All loans that become 90 days or more delinquent are placed on non-accrual status. When loans are placed on non-accrual status, unpaid accrued interest is fully reserved, and further income is recognized only to the extent received. At June 30, 2012, the Company had non-performing loans of $8.4 million and a ratio of non-performing loans to total loans of 3.34%.
Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as other real estate owned (“OREO”) until such time as it is sold. When real estate is acquired through foreclosure or by deed in lieu of foreclosure, it is recorded at its fair value, less estimated costs of disposal. If the value of the property is less than the loan, less any related specific loan loss provisions, the difference is charged against the allowance for loan losses. Any subsequent write-down of OREO is charged against earnings. At June 30, 2012, the Company had OREO of $1.7 million. Other real estate owned is included in non-performing assets.
A loan is classified as a troubled debt restructuring if the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. This usually includes a modification of loan terms, such as a reduction of the interest rate to below market terms, capitalizing past due interest or extending the maturity date and possibly a partial forgiveness of debt. Interest income on restructured loans is accrued after the borrower demonstrates the ability to pay under the restructured terms through a sustained period of repayment performance, which is generally six months.
At June 30, 2012, the Company had total non-performing assets of $10.1 million, and a ratio of total non-performing assets to total assets of 2.23%. At June 30, 2012, the Company had total non-performing assets and troubled debt restructurings of $13.5 million, and a ratio of total non-performing assets and troubled debt restructurings to total assets of 2.99%.
Non-Performing Assets. The table below sets forth the amounts and categories of our non-performing assets at the dates indicated. A loan classified in the table below as “non-accrual” does not necessarily mean that such loan is or has been delinquent. Once a loan is more than 90 days delinquent or the borrower or collateral securing the loan experiences an event that makes collectability suspect, the loan is placed on “non-accrual” status. Our policies require six months of continuous payments in order for the loan to be removed from non-accrual status.
(1)
Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
(2)
The gross interest income that would have been reported if the loans had performed in accordance with their original terms was $456,000 and $592,000 for the years ended June 30, 2012 and 2011, respectively. Actual income recognized in income was $201,000 and $202,000 for the years ended June 30, 2012 and 2011, respectively.
Total non-performing assets increased $2.6 million to $10.1 million at June 30, 2012 from $7.5 million at June 30, 2011. Non-performing assets as of June 30, 2012 consisted of $1.7 million in other real estate owned which reflects the repossession of a six-lot residential development project at a carrying value of $247,000, a single family home with a carrying value of $236,000, a commercial building at a carrying value of $166,000, five lots in a recreational park at a value of $338,000 and 202.5 acres of land carried at $696,000. Also included in non-performing assets is $8.4 million in non-performing loans. These loans consisted of 17 residential loans totaling $4.0 million, one residential construction loan totaling $424,000 and 25 commercial real estate loans totaling $4.0 million. Non-performing assets as of June 30, 2011 consisted of $1.1 million in other real estate owned which reflects the repossession of a six-lot residential development project at a carrying value of $303,000, a single family home with a carrying value of $201,000, 34 acres of land carried at $110,000, a single family home at a carrying value of $142,000, one residential/commercial office space at a carrying value of $213,000 and a single family home with a carrying value of $105,000. Also included in non-performing assets is $46,000 in Freddie Mac auction-rate trust preferred securities and $6.4 million in non-performing loans. These loans consisted of ten residential loans totaling $1.8 million and 16 commercial real estate loans totaling $4.6 million. Fourteen of these loans continue to be classified as non-performing as of June 30, 2012.
The Bank’s non-performing loans are a direct correlation to the weakened real estate climate. Management is focused on working with borrowers and guarantors to resolve these trends by restructuring or liquidating assets when prudent. Many of our commercial relationships are secured by development loans, in particular condominiums which have experienced a significant reduction in demand. The Bank reviews the strength of the guarantors; requires face to face discussions and offers restructuring suggestions that provide the borrowers with short-term relief and exit strategies. Overall, we expect to see improvement as solutions are identified and executed. The Bank obtains a current appraisal on all real estate secured loans that are 180 days or more past due if the appraisal in our file is older than one year. If the determination is made that there is the potential for collateral shortfall, an allocated reserve will be assigned to the loan for the expected deficiency. It is the policy of the Bank to charge off or write down loans or other assets when, in the opinion of the Credit Committee and loan review, the ultimate amount recoverable is less than the book value, or the collection of the amount is expected to be unduly prolonged. The level of non-performing assets is expected to fluctuate in response to changing economic and market conditions, and the relative sizes of the respective loan portfolios, along with management’s degree of success in resolving problem assets. Management takes a proactive approach with respect to the identification and resolution of problem loans. In addition, in connection with a regularly scheduled Office of the Comptroller of the Currency (“OCC”) examination, the Holding Company and Bank developed and implemented a plan to reduce classified assets. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Comparisons of Operating Results for the Fiscal Years Ended June 30, 2012 and 2011.
The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated.
(1)
Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
(2)
The difference in loans delinquent 90 days and over and non-performing loans as of June 30, 2008 is primarily related to completion of underwriting for renewals and obtaining current financial information from borrowers, with these loans otherwise performing as agreed.
Classified Assets. The Office of the Comptroller of the Currency (“OCC”) regulations and the Bank’s internal policies require that management utilize an internal asset classification system to monitor and evaluate the credit risk inherent in its loan portfolio. The bank currently classifies problem and potential problem assets as “substandard”, “doubtful”, “loss” or “special mention.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, questionable, and there is a high probability of loss. Assets classified as “loss” are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. In addition, assets that do not currently expose the Bank to sufficient risk to warrant classification in one of the aforementioned categories but possess credit deficiencies or potential weaknesses are required to be designated “special mention.”
An insured institution is required to establish general allowances for loan losses in an amount deemed prudent by management for loans classified substandard or doubtful, as well as for other potential problem loans. General allowances represent loss allowances which have been established to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss”, it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount. Our determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OCC which can order the establishment of additional general or specific loss allowances.
On the basis of management’s review of its assets, at June 30, 2012 we had classified $14.0 million of our loans as substandard and $849,000 as doubtful. Of these loans, $7.8 million were considered non-performing and included in the table of non-performing assets. At June 30, 2012, $2.7 million of our loans were designated as special mention, and none of our assets were classified as loss.
The loan portfolio is reviewed on a regular basis to determine whether any loans require classification in accordance with applicable regulations. Not all classified assets constitute non-performing assets.
Allowance for Loan Losses
Our allowance for loan losses is maintained at a level necessary to absorb loan losses that are both probable and reasonably estimable. Management, in determining the allowance for loan losses, considers the losses inherent in our loan portfolio and changes in the nature and volume of loan activities, along with the general economic and real estate market conditions. Starting with March 31, 2012, we changed the loan categories to match those used in the call report. We utilize a two-tier approach: (1) identification and establishment of specific loss allowances on impaired loans; and (2) establishment of general valuation allowances on the remainder of our loan portfolio. Once a loan becomes delinquent or otherwise identified as impaired, we may establish a specific loan loss allowance based on a review of among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loan loss experience, composition of the loan portfolio, current economic conditions and delinquency trends. The allowance is increased through provisions charged against current earnings and recoveries of previously charged-off loans. Loans that are determined to be uncollectible are charged against the allowance. While management uses available information to recognize probable and reasonably estimable loan losses, future loss provisions may be necessary based on changing economic conditions. Payments received on non-accrual commercial loans are applied first to principal. The allowance for loan losses as of June 30, 2012 was maintained at a level that represents management’s best estimate of losses inherent in the loan portfolio, and such losses were both probable and reasonably estimable.
In addition, the OCC, as an integral part of their examination process, periodically reviews our allowance for loan losses. This agency may require that we recognize additions to the allowance based on its judgment of information available to it at the time of its examination.
The following table sets forth activity in our allowance for loan losses for the years indicated.
(1) Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category, the percent of the allowance for a category to the total allowance, and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each loan category is not necessarily indicative of future losses in any particular category.
(1)
Residential mortgage loans include one- to four-family mortgage loans, residential construction loans, home equity loans, and home equity lines of credit.
(2)
Commercial loans include commercial real estate loans and commercial loans.
Each quarter, management evaluates the total balance of the allowance for loan losses based on several factors, some of which are not loan specific but are reflective of the inherent losses in the loan portfolio. This process includes, but is not limited to, a periodic review of loan collectability in light of historical experience, the nature and volume of loan activity, conditions that may affect the ability of the borrower to repay, underlying value of collateral, if applicable, and economic conditions in our immediate market area. First, we group loans by delinquency status. All loans 90 days or more delinquent are generally evaluated individually along with other impaired loans, based primarily on the present value of expected future cash flows or the value of the collateral securing the loan. Specific loss allowances are established as required by this analysis. All loans which are not individually evaluated are segregated by type, delinquency status or loan grade and a loss allowance is established by using loss experience data and management’s judgment concerning other matters it considers significant. The allowance is allocated to each category of loan based on the results of the above analysis. Small differences between the allocated balances and recorded allowances are reflected as unallocated to absorb losses resulting from the inherent imprecision involved in the loss analysis process.
This analysis process is inherently subjective, as it requires us to make estimates that are susceptible to revisions as more information becomes available. Although we believe that we have established the allowance at levels to absorb probable and estimable losses, future additions may be necessary if economic or other conditions in the future differ from the current environment.
Investment Activities
Putnam Bank’s Executive Committee is responsible for implementing Putnam Bank’s Investment Policy. The Investment Policy is reviewed annually and any changes to the policy are recommended to, and subject to, the approval of our Board of Directors. The Executive Committee is comprised of our Chairman, President, Executive Vice-President and one rotating director. Authority to make investments under the approved Investment Policy guidelines is delegated by the Executive Committee to appropriate officers. While general investment strategies are developed and authorized by the Asset/Liability Committee, the execution of specific actions rests with the Chief Executive Officer or Executive Vice-President who may act jointly or severally as Putnam Bank’s Investment Officer. The Investment Officer is responsible for ensuring that the guidelines and requirements included in the Investment Policy are followed and that all securities are considered prudent for investment. The Investment Officer is authorized to execute investment transactions (purchases and sales) up to $5 million per transaction without the prior approval of the Executive Committee and within the scope of the established investment policy. Each transaction in excess of established limits must receive prior approval of the Executive Committee.
In addition, Putnam Bank may utilize the services of an independent investment advisor to assist in managing the investment portfolio. The investment advisor is responsible for maintaining current information regarding securities dealers with whom they are conducting business on our behalf. A list of appropriate dealers is provided annually to the Board of Directors for approval and authorization prior to execution of trades. The investment advisor, through its assigned portfolio manager, must contact our President or Treasurer to review all investment recommendations and transactions and receive approval from the President or Treasurer prior to execution of any transaction that might be transacted on our behalf. Upon receipt of approval, the investment advisor, or its assigned portfolio manager, is authorized to conduct all investment business on our behalf.
Our Investment Policy requires that all securities transactions be conducted in a safe and sound manner. Investment decisions must be based upon a thorough analysis of each security instrument to determine its quality, inherent risks, fit within our overall asset/liability management objectives, effect on our risk-based capital measurement and prospects for yield and/or appreciation.
The investment policy is consistent with our overall business and asset/liability management strategy, which focuses on sustaining adequate levels of core earnings. During the fiscal year ended June 30, 2012, the Company recognized other-than-temporary write-downs of $2.0 million on non-agency mortgage-backed securities.
U.S. Government and government-sponsored securities. At June 30, 2012, the Company’s U.S. Government and government-sponsored securities portfolio classified as available-for-sale totaled $459,000, or 0.3% of total securities. At June 30, 2012, the Company’s U.S. Government and government-sponsored securities portfolio classified as held-to-maturity totaled $9.2 million, or 6.0% of total securities. While U.S. Government and government-sponsored securities generally provide lower yields than other investments in our securities investment portfolio, we maintain these investments, to the extent appropriate, for liquidity purposes, as collateral for borrowings and prepayment protection.
Corporate Bonds. At June 30, 2012, the Company’s corporate bond portfolio totaled $4.7 million, or 3.1% of total securities, all of which was classified as available-for-sale. Although corporate bonds may offer higher yields than U.S. Treasury or agency securities of comparable duration, corporate bonds also have a higher risk of default due to possible adverse changes in the credit-worthiness of the issuer. In order to mitigate this risk, our investment policy requires that corporate debt obligations be rated investment grade or better by a nationally recognized rating agency. If the bond rating goes below investment grade, then the investment is placed on an investment “watch report” and is monitored by our Investment Officer. The investment is then reviewed quarterly by our Board of Directors where a determination is made to hold or dispose of the investment.
Mortgage-Backed Securities. The Company purchases mortgage-backed securities insured or guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. We invest in mortgage-backed securities to achieve positive interest rate spreads with minimal administrative expense, and lower our credit risk as a result of the guarantees provided by Freddie Mac, Fannie Mae and Ginnie Mae. The Company also invests in collateralized mortgage obligations (CMOs or non-agency mortgage-backed securities), also insured or issued by Freddie Mac, Fannie Mae and Ginnie Mae, or private issuers such as Washington Mutual and Countrywide Home Loans. All private issuer CMOs were rated AAA at time of purchase.
Mortgage-backed securities are created by the pooling of mortgages and the issuance of a security with an interest rate that is less than the interest rate on the underlying mortgage. Mortgage-backed securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although we focus our investments on mortgage-backed securities backed by one- to four-family mortgages. The issuers of such securities (generally U.S. government agencies and government-sponsored enterprises, including Fannie Mae, Freddie Mac and Ginnie Mae) pool and resell the participation interests in the form of securities to investors such as Putnam Bank, and guarantee the payment of principal and interest to investors. Mortgage-backed securities generally yield less than the loans that underlie such securities because of the cost of payment guarantees and credit enhancements. However, mortgage-backed securities are usually more liquid than individual mortgage loans and may be used to collateralize our specific liabilities and obligations.
CMOs are a type of non-agency mortgage-backed security issued by a special purpose entity that aggregates pools of mortgage-backed securities and creates different classes of CMO securities with varying maturities and amortization schedules as well as a residual interest, with each class, or “tranche”, possessing different risk characteristics. A particular tranche of CMOs may, therefore, carry prepayment risk that differs from that of both the underlying collateral and other tranches. CMO tranches are purchased by the Company in an attempt to moderate reinvestment risk associated with mortgage-backed securities resulting from unexpected prepayment activities.
At June 30, 2012, mortgage-backed securities and CMOs classified as available for sale totaled $32.5 million, or 21.3% of total securities. At June 30, 2012, mortgage-backed securities and CMOs classified as held to maturity totaled $96.0 million, or 63.0% of total securities. At June 30, 2012, 65.9% of the mortgage-backed securities were backed by adjustable rate loans and 34.1% were backed by fixed rate mortgage loans. The mortgage-backed securities portfolio had a weighted average yield of 3.59% at June 30, 2012. Investments in mortgage-backed securities involve a risk that actual prepayments may differ from estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or if such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected by changes in interest rates.
Marketable Equity Securities. At June 30, 2012, our equity securities portfolio totaled $9.6 million, or 6.3% of total securities, all of which were classified as available for sale. At June 30, 2012, the portfolio consisted of auction-rate trust preferred securities (“ARP”). Auction-rate trust preferred securities are a floating rate preferred stock, on which the dividend rate generally resets every 90 days based on an auction process to reflect the yield demand for the instruments by potential purchasers. At June 30, 2012, our investments in auction-rate trust preferred securities consisted of investments in three corporate issuers. These securities were originally purchased by the Company because they represented highly liquid, tax-preferred investments secured, in most cases, by preferred stock issued by high quality, investment grade companies, generally other financial institutions (“collateral preferred shares”). The ARP shares, or certificates, purchased by the Company are Class A certificates, which, among other rights, entitles the holder to priority claim on dividends paid into the trust holding the preferred shares.
In most cases, the trusts which issued the ARP certificates own various callable preferred shares of stock by a single entity. In addition to the call dates for redemption established by the collateral preferred shares, each trust has a maturity date upon which the trust itself will terminate. The value of the remaining collateral preferred shares is not guaranteed, and may be more or less than the stated par value of the collateral preferred shares, and is dependent on the market value of those collateral preferred shares on the date of the trust’s maturity.
The certificates issued by the trusts previously traded in an active, open auction market, with each individual trust establishing the frequency of its auctions, typically every 90 days (the “reset date”). The results of an auction would be the exchange of certificates, at par, between participants entering or exiting the market, and resetting of the yield to be earned by holders of the Class A certificates as well as the holders of other classes of trust certificates.
Beginning in February 2008, auctions for these securities began to fail when investors declined to bid on the securities. Five of the largest investment banks that made a market in these securities (Merrill Lynch, Citigroup, USB, AG and Morgan Stanley) declined to act as bidders of last resort, as they had in the past. The auction failures did not result in the loss of any principal value to the certificate holders, but prevented many sellers from exiting, or redeeming, their certificates at the reset date. These unsuccessful sellers were required to continue to hold the certificates until the next scheduled reset date. To compensate these unsuccessful sellers, the failed auctions triggered a penalty-rate feature which provided that owners of the Class A certificates were entitled to a higher portion of the dividends, and thus a higher yield, on the Class A certificates.
During this time, the Company attempted to divest itself of the ARPs, but was prevented from doing so due to the continued failure of the auction market. The Company continued to carry its investments at par value, despite the increased liquidity risk, because the credit strength of the issuers of the collateral preferred shares remained high, and the yield remained above-market.
The turmoil in the financial markets caused the value of the underlying collateral preferred shares to decline dramatically. Market values for the ARPs from Merrill Lynch, the Company’s safekeeping agent, also declined, and the Company recorded a temporary impairment adjustment to the carrying value of the ARPs which are classified as available for sale. A temporary impairment reduces the carrying value of the investment security with an offsetting reduction in the capital accounts of the Company.
The Company had difficulty identifying market prices of comparable instruments for ARPs due to the inactive market. As a result, during the quarter ended June 30, 2009, the Company modified its methodology for determining the fair value of the ARPs classified as Level 3, and used the quoted market values of the underlying collateral preferred shares, adjusted for the higher yield earned by the Company through the Class A certificates compared with the nominal rate available to a direct owner of the collateral preferred shares. The Company continued to record a temporary impairment adjustment on the ARPs, primarily due to the depressed market values of the underlying collateral preferred shares.
During 2009, the Company concluded that the market value of the underlying collateral preferred shares did not represent orderly transactions and adopted the use of a discounted cash flow model to determine if there was any other-than-temporary impairment of its investments in the ARPs. The resulting discounted cash flow for each ARP classified as Level 3 showed no other-than-temporary impairment in the fair value of the securities.
On September 7, 2008, the U.S. Department of the Treasury placed Fannie Mae and Freddie Mac under conservatorship and assumed an equity position in these entities, which takes priority over both common and preferred stocks. Putnam Bank owned $4,000,000 in Freddie Mac auction-rate preferred securities and recorded an other-than-temporary impairment loss totaling $3.95 million during the quarters ended September 30, 2008 and December 31, 2008. The book value of this investment was $46,000 as of June 30, 2011. The Company took possession of the underlying preferred shares of this investment and sold them during the current fiscal year. A gain on sale of $235,000 was recognized.
The Company has the ability and intent to hold these securities for the time necessary to collect the expected cash flows.
The chart below includes information on the various issuers of Auction Rate Preferred securities owned by the Company:
Issuer
Goldman Sachs
Merrill Lynch
Bank of America
Par amount
$3,000,000
$5,000,000
$2,000,000
Book Value
$3,000,000
$5,000,000
$2,000,000
Purchase Date
12-12-07
09-04-07
11-20-07
Maturity Date
08-23-26
05-28-27
08-17-47
Next Reset Date
08-21-12
08-27-12
08-16-12
Reset Frequency
Quarterly
Quarterly
Quarterly
Failed Auction
Yes
Yes
Yes
Receiving Default Rates
Yes
Yes
Yes
Current Rate
4.592%
4.714%
4.677%
Dividends Current:
Yes
Yes
Yes
The Bank’s entire auction rate preferred securities holdings as of June 30, 2012 had failed auctions for the past fiscal year.
Securities Portfolio Composition. The following table sets forth the composition of our securities portfolio, excluding Federal Home Loan Bank stock, at the dates indicated,
At June 30, 2012, we had invested in $4.9 million in Merrill Lynch auction-rate securities and $8.4 million in non-agency mortgage-backed securities, and had no other investments in a single company or entity (other than the U.S. Government or an agency of the U.S. Government) that had an aggregate book value in excess of 10% of our equity.
Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at June 30, 2012 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. State agency and municipal obligations as well as common and preferred stock yields have not been adjusted to a tax-equivalent basis. Certain mortgage-backed securities have interest rates that are adjustable and will reprice annually within the various maturity ranges. These repricing schedules are not reflected in the table below. At June 30, 2012, mortgage-backed securities with adjustable rates totaled $84.8 million.
Sources of Funds
General. Deposits have traditionally been our primary source of funds for use in lending and investment activities. In addition to deposits, funds are derived from scheduled loan payments, investment maturities, loan prepayments, retained earnings and income on earning assets. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition. Borrowings from the Federal Home Loan Bank of Boston and brokered certificates of deposit may be used to compensate for reductions in deposits and to fund loan growth.
Deposits. A majority of our depositors are persons who work or reside in Windham County and New London County, Connecticut. We offer a selection of deposit instruments, including checking, savings, money market deposit accounts, negotiable order of withdrawal (NOW) accounts and fixed-term certificates of deposit. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds must remain on deposit and the interest rate.
Interest rates paid, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market rates, liquidity requirements, rates paid by competitors and growth goals. To attract and retain deposits, we rely upon personalized customer service, long-standing relationships and competitive interest rates.
The flow of deposits is influenced significantly by general economic conditions, changes in money market and other prevailing interest rates and competition. The variety of deposit accounts that we offer allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on historical experience, management believes our deposits are relatively stable. However, the ability to attract and maintain money market accounts and certificates of deposit, and the rates paid on these deposits, have been and will continue to be significantly affected by market conditions. At June 30, 2012, $134.5 million, or 39.3%, of our deposit accounts were certificates of deposit, of which $60.7 million had maturities of one year or less.
The following table sets forth the average distribution of total deposit accounts, by account type, for the years indicated.
As of June 30, 2012, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was $62.4 million. The following table sets forth the maturity of those certificates as of June 30, 2012, in thousands.
Borrowings. Our borrowings consist of advances from, and a line of credit with, the Federal Home Loan Bank of Boston (“FHLB”), and securities sold under agreements to repurchase. At June 30, 2012, we had an available line of credit with the Federal Home Loan Bank of Boston in the amount of $2.4 million and access to additional Federal Home Loan Bank advances of up to $58.2 million. At June 30, 2012, retail securities sold under agreements to repurchase were $3.7 million. The following table sets forth information concerning balances and interest rates on our borrowings at the dates and for the years indicated.
Subsidiary Activities
PSB Holdings Inc.’s only subsidiary is Putnam Bank. Putnam Bank has three subsidiaries, Windham North Properties, LLC, PSB Realty, LLC and Putnam Bank Mortgage Servicing Company. Windham North Properties, LLC is used to acquire title to selected properties on which Putnam Bank forecloses. As of June 30, 2012, Windham North Properties, LLC, owned five such properties. PSB Realty, LLC owns a parcel of real estate located immediately adjacent to Putnam Bank’s main office. This real estate is utilized as a loan center for Putnam Bank and there are no outside tenants that occupy the premises. PSB Realty, LLC also owns the 40 High Street, Norwich branch building and real estate. Putnam Bank Mortgage Servicing Company is a qualified “passive investment company” that is intended to reduce Connecticut state taxes on interest earned on real estate loans.
Personnel
As of June 30, 2012, we had 82 full-time employees and 40 part-time employees. Our employees are not represented by any collective bargaining group. Management believes that we have good working relations with our employees.
FEDERAL AND STATE TAXATION
Federal Taxation
General. PSB Holdings, Inc. and Putnam Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below.
The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to PSB Holdings, Inc. or Putnam Bank.
Method of Accounting. For federal income tax purposes, PSB Holdings, Inc. and Putnam Bank currently report their income and expenses on the accrual method of accounting and use a tax year ending June 30 for filing their federal income tax returns.
Bad Debt Reserves. Prior to the Small Business Protection Act of 1996 (the “1996 Act”), Putnam Bank was permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at our taxable income. As a result of the 1996 Act, Putnam Bank was required to use the specific charge off method in computing its bad debt deduction beginning with its 1996 federal tax return. Savings institutions were required to recapture any excess reserves over those established as of December 31, 1987 (base year reserve). At June 30, 2012, Putnam Bank had no reserves subject to recapture in excess of its base year reserves.
Taxable Distributions and Recapture. Prior to the 1996 Act, bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income if Putnam Bank failed to meet certain thrift asset and definitional tests. Federal legislation has eliminated these thrift-related recapture rules. At June 30, 2012, our total federal pre-1988 base year reserve was approximately $2.3 million. However, under current law, pre-1988 base year reserves remain subject to recapture if Putnam Bank makes certain non-dividend distributions, repurchases any of its stock, pays dividends in excess of tax earnings and profits, or ceases to maintain a bank charter.
Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended (the “Code”) imposes an alternative minimum tax (AMT) at a rate of 20% on a base of regular taxable income plus certain tax preferences, which we refer to as “alternative minimum taxable income.” The AMT is payable to the extent such alternative minimum taxable income is in excess of an exemption amount and the AMT exceeds the regular income tax. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain AMT payments may be used as credits against regular tax liabilities in future years. At June 30, 2012, PSB Holdings, Inc. had $1.0 million of AMT payments available to carry forward to future periods.
Net Operating Loss Carryovers. A financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. At June 30, 2012, Putnam Bank had $1.4 million in net operating loss carry forwards for federal income tax purposes.
Corporate Dividends-Received Deduction. PSB Holdings, Inc. may exclude from its income 100% of dividends received from Putnam Bank as a member of the same affiliated group of corporations. The corporate dividends-received deduction is 80% in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, and corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct only 70% of dividends received or accrued on their behalf.
State Taxation
Connecticut State Taxation. PSB Holdings, Inc. and Putnam Bank and its subsidiaries, are subject to the Connecticut corporation business tax. Both entities are required to pay the regular corporation business tax (income tax).
The Connecticut corporation business tax is based on the federal taxable income before net operating loss and special deductions and makes certain modifications to federal taxable income to arrive at Connecticut taxable income. Connecticut taxable income is multiplied by the state tax rate of 7.5% to arrive at Connecticut income tax.
In 1998, the State of Connecticut enacted legislation permitting the formation of passive investment companies by financial institutions. This legislation exempts qualifying passive investment companies from the Connecticut corporation business tax and excludes dividends paid from a passive investment company from the taxable income of the parent financial institution. Putnam Bank established a passive investment company, Putnam Bank Mortgage Servicing Company, during 2007 and eliminated the state income tax expense of Putnam Bank effective July 1, 2006. If the State of Connecticut were to pass legislation in the future to eliminate the passive investment company exemption Putnam Bank would be subject to state income taxes in Connecticut.
The state tax returns have not been audited for the last five years.
SUPERVISION AND REGULATION
General
Putnam Bank is examined and supervised by the Office of the Comptroller of the Currency. This regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the Federal Deposit Insurance Corporation’s deposit insurance funds and depositors. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. Following completion of its examination, the federal agency critiques the institution’s operations and assigns its rating (known as an institution’s CAMELS rating). Under federal law, an institution may not disclose its CAMELS rating to the public. Putnam Bank also is a member of and owns stock in the Federal Home Loan Bank of Boston, which is one of the twelve regional banks in the Federal Home Loan Bank System. Putnam Bank also is regulated to a lesser extent by the Board of Governors of the Federal Reserve System, governing reserves to be maintained against deposits and other matters. The Office of the Comptroller of the Currency examines Putnam Bank and prepares reports for the consideration of its Board of Directors on any operating deficiencies. Putnam Bank’s relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters concerning the ownership of deposit accounts and the form and content of Putnam Bank’s mortgage documents.
Any change in these laws or regulations, whether by the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency or Congress, could have a material adverse impact on PSB Holdings, Inc. and Putnam Bank and their operations.
Regulatory Agreement
On June 20, 2012, Putnam Bank entered into an agreement with the Office of Comptroller of the Currency (the “Agreement”). As part of the Agreement, the Office of Comptroller of the Currency (required Putnam Bank to take a number of specific corrective actions, and required that Putnam Bank not undertake certain actions without obtaining prior approval of the Office of the Comptroller of the Currency. The Agreement replaces a memorandum of understanding that Putnam Bank entered into with the Office of Thrift Supervision.
The actions and forbearances contained in the Agreement require Putnam Bank’s Board of Directors (the “Board”) to, among other matters:
●
Appoint a Compliance Committee of the Board to monitor compliance with the Agreement.
●
The Compliance Committee must prepare and submit to the full Board within 90 days from June 20, 2012, a report detailing the actions taken to comply with the requirements of the Agreement, and thereafter to provide quarterly progress reports.
●
The full Board must forward a copy of the progress report with any comments they may have to the Assistant Deputy Comptroller.
●
Develop a detailed three year business plan for Putnam Bank which must be forwarded to the Assistant Deputy Comptroller for a prior written determination of no supervisory objection.
●
Putnam Bank may not deviate from the business plan without receiving the prior written determination of no supervisory objection from the Assistant Deputy Comptroller.
●
Prepare and forward to the Assistant Deputy Comptroller a revised capital plan for Putnam Bank that is consistent with Putnam Bank’s business plan.
●
Following receipt of the Assistant Deputy Comptroller’s written determination of no supervisory objection, the Board shall adopt and Putnam Bank shall implement the capital plan.
●
Adopt and implement a written program to review Putnam Bank’s classified investment securities and reduce the levels of classified investments.
●
Develop and implement policies and procedures to identify and monitor investment securities with other than temporary impairment.
●
Develop and implement a program to improve loan portfolio management.
●
Establish a written loan review system to review on at least a quarterly basis Putnam Bank’s loan portfolio to assure the timely identification and categorization of problem loans.
●
Prior to adoption the written loan system and any future changes must be provided to the Assistant Deputy Comptroller for a prior written determination of no supervisory objection.
●
Adopt, implement and adhere to written policies and procedures for maintaining an adequate allowance for loan and lease losses.
●
Establish a written program eliminating the basis of criticism of assets criticized by the Office of the Comptroller of the Currency or by any internal or external loan review.
The Agreement also requires that the written programs referenced above be submitted to the Office of the Comptroller of the Currency within certain timeframes following June 20, 2012, the date Putnam Bank entered into the Agreement. Management has reviewed its obligations under the Agreement and believes it will be able to fully comply with the terms of the Agreement.
Dodd-Frank Act
The Dodd-Frank Act, enacted on July 21, 2010, has changed the bank regulatory structure and the lending, investment, trading and operating activities of depository institutions and their holding companies. The Dodd-Frank Act eliminated our former primary federal regulator, the Office of Thrift Supervision, and required Putnam Bank to be regulated by the Office of the Comptroller of the Currency (the primary federal regulator for national banks). The Dodd-Frank Act also authorized the Federal Reserve Board to supervise and regulate all savings and loan holding companies, including mutual holding companies, like PSB Holdings, Inc. and Putnam Bancorp, Inc., in addition to bank holding companies that it already regulated. The Dodd-Frank Act also requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions. The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months from the enactment of Dodd-Frank that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.
The Dodd-Frank Act also created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rulemaking authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as Putnam Bank, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators. The legislation also weakened the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.
The legislation broadened the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2012. The Dodd-Frank Act increased stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and by authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.
Many of the provisions of the Dodd-Frank Act have delayed effective dates and the legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years. Although the substance and scope of these regulations cannot be completely determined at this time, it is expected that the legislation and implementing regulations will increase our operating and compliance costs.
Federal Banking Regulation
Business Activities. A federal savings association derives its lending and investment powers from the Home Owners’ Loan Act, as amended, and federal regulations issued thereunder. Under these laws and regulations, Putnam Bank may invest in mortgage loans secured by residential real estate without limitations as a percentage of assets and non-residential real estate loans certain types of debt securities and certain other assets. Putnam Bank also may establish subsidiaries that may engage in activities not otherwise permissible for Putnam Bank, including real estate investment and securities and insurance brokerage. The Dodd-Frank Act authorized depository institutions to, for the first time, pay interest on business checking accounts, effective July 21, 2011.
Capital Requirements. Federal regulations require savings associations to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for associations receiving the highest rating on the CAMELS rating system) and an 8% risk-based capital ratio. The prompt corrective action standards discussed below, in effect, establish a minimum 2% tangible capital standard.
The risk-based capital standard for savings associations requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by federal regulations based on the risks believed inherent in the type of asset. Core capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. Additionally, a savings association that retains credit risk in connection with an asset sale may be required to maintain additional regulatory capital because of the recourse back to the savings association. Putnam Bank does not typically engage in asset sales.
On June 6, 2012, the Office of the Comptroller of the Currency and the other federal bank regulatory agencies issued a series of proposed rules to revise their risk-based and leverage capital requirements and their method for calculating risk-weighted assets to make them consistent with the agreements that were reached by the Basel Committee on Banking Supervision in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (“Basel III”). The proposed rules would apply to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more, and top-tier savings and loan holding companies (“banking organizations”). Among other things, the proposed rules establish a new common equity tier 1 minimum capital requirement and a higher minimum tier 1 capital requirement, and assign higher risk weightings (150%) to exposures that are more than 90 days past due or are on nonaccrual status and certain commercial real estate facilities that finance the acquisition, development or construction of real property. The proposed rules also limit a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of a specified amount of common equity tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rules will become effective on January 1, 2013, and the changes set forth in the final rules will be phased in from January 1, 2013 through January 1, 2019.
At June 30, 2012, Putnam Bank’s capital exceeded all applicable requirements.
Loans-to-One Borrower. A federal savings association generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and unimpaired surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by certain readily marketable collateral, which does not include real estate. As of June 30, 2012, Putnam Bank was in compliance with the loans-to-one borrower limitations.
Qualified Thrift Lender Test. As a federal savings association, Putnam Bank must satisfy the qualified thrift lender, or “QTL”, test. Under the QTL test, Putnam Bank must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” in at least nine of the most recent 12-month period. “Portfolio assets” generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings association’s business.
“Qualified thrift investments” include various types of loans made for residential and housing purposes, investments related to such purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of portfolio assets. “Qualified thrift investments” also include 100% of an institution’s credit card loans, education loans and small business loans. Putnam Bank also may satisfy the QTL test by qualifying as a “domestic building and loan association” as defined in the Internal Revenue Code.
A savings association that fails the qualified thrift lender test must operate under specified restrictions. The Dodd-Frank Act made noncompliance with the QTL test potentially subject to regulatory enforcement action for a violation of law. At June 30, 2012, Putnam Bank satisfied this test.
Capital Distributions. Federal regulations govern capital distributions by a federal savings association, which include cash dividends, stock repurchases and other transactions charged to the capital account. A savings association must file an application for approval of a capital distribution if:
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the total capital distributions for the applicable calendar year exceed the sum of the association’s net income for that year to date plus the association’s retained net income for the preceding two years still available for dividend;
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the association would not be at least adequately capitalized following the distribution;
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the distribution would violate any applicable statute, regulation, agreement or Office of the Comptroller of the Currency-imposed condition; or
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the association is not eligible for expedited treatment of its filings.
Even if an application is not otherwise required, every savings association that is a subsidiary of a holding company must still file a regulatory notice at least 30 days before the Board of Directors declares a dividend or approves a capital distribution.
Such a notice or application may be disapproved if:
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the association would be undercapitalized following the distribution;
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the proposed capital distribution raises safety and soundness concerns; or
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the capital distribution would violate a prohibition contained in any statute, regulation or agreement.
In addition, the Federal Deposit Insurance Act provides that an insured depository institution shall not make any capital distribution, if after making such distribution the institution would be undercapitalized.
Liquidity. A federal savings association is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.
Community Reinvestment Act and Fair Lending Laws. All savings associations have a responsibility under the Community Reinvestment Act and related federal regulations to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In connection with its examination of a federal savings association, the Office of the Comptroller of the Currency is required to assess the association’s record of compliance with the Community Reinvestment Act. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An association’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in denial of certain corporate applications, such as branches or mergers, or in restrictions on its activities. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by federal regulators, as well as other federal regulatory agencies and the Department of Justice. Putnam Bank received a “satisfactory” Community Reinvestment Act rating in its most recent federal examination.
Privacy Standards. Federal regulations require Putnam Bank to disclose its privacy policy, including identifying with whom it shares “non-public personal information” to customers at the time of establishing the customer relationship and annually thereafter.
The regulations also require Putnam Bank to provide its customers with initial and annual notices that accurately reflect its privacy policies and practices. In addition, Putnam Bank is required to provide its customers with the ability to “opt-out” of having Putnam Bank share their non-public personal information with unaffiliated third parties before it can disclose such information, subject to certain exceptions. The implementation of these regulations did not have a material adverse effect on PSB Holdings, Inc. or Putnam Bank.
Putnam Bank must implement measures intended to insure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records, or information that could result in substantial harm or inconvenience to any customer. Putnam Bank has implemented these measures.
Transactions with Related Parties. A federal savings association’s authority to engage in transactions with its “affiliates” is limited by federal regulations and by Sections 23A and 23B of the Federal Reserve Act (the “FRA”). The term “affiliates” for these purposes generally means any company that controls, is controlled by, or is under common control with an institution. PSB Holdings, Inc. is an affiliate of Putnam Bank. In general, transactions with affiliates must be on terms that are as favorable to the association as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the association’s capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the association. In addition, federal regulations prohibit a savings association from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.
Putnam Bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Putnam Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved by Putnam Bank’s Board of Directors.
Enforcement. The Office of the Comptroller of the Currency has primary enforcement responsibility over federal savings institutions and has the authority to bring enforcement action against all “institution-affiliated parties”, including stockholders, and attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action by the Office of the Comptroller of the Currency may range from the issuance of a capital directive or cease and desist order, to removal of officers and/or directors of the institution and the appointment of a receiver or conservator. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan.
Prompt Corrective Action Regulations. Under the prompt corrective action regulations, the Office of the Comptroller of the Currency is required and authorized to take supervisory actions against undercapitalized federal savings associations. For this purpose, a savings association is placed in one of the following five categories based on the association’s capital:
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well-capitalized (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total risk-based capital);
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adequately capitalized (at least 4% leverage capital (3% for savings banks with a composite examination rating of 1), 4% Tier 1 risk-based capital and 8% total risk-based capital);
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undercapitalized (less than 8% total risk-based capital, 4% Tier 1 risk-based capital or 4% leverage capital (3% for savings banks with a composite examination rating of 1);
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significantly undercapitalized (less than 6% total risk-based capital, 3% Tier 1 risk-based capital or 3% leverage capital); and
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critically undercapitalized (less than 2% tangible capital).
Generally, the banking regulator is required to appoint a receiver or conservator for an association that is “critically undercapitalized” within specific time frames. The regulations also provide that a capital restoration plan must be filed with the Office of the Comptroller of the Currency within 45 days of the date an association receives notice that it is “undercapitalized”, “significantly undercapitalized” or “critically undercapitalized.” The criteria for an acceptable capital restoration plan include, among other things, the establishment of the methodology and assumptions for attaining adequately capitalized status on an annual basis, procedures for ensuring compliance with restrictions imposed by applicable federal regulations, the identification of the types and levels of activities the savings association will engage in while the capital restoration plan is in effect, and assurances that the capital restoration plan will not appreciably increase the current risk profile of the savings association. Any holding company for the savings association required to submit a capital restoration plan must guarantee the lesser of: an amount equal to 5% of the savings association’s assets at the time it was notified or deemed to be undercapitalized by the Office of the Comptroller of the Currency, or the amount necessary to restore the savings association to adequately capitalized status. This guarantee remains in place until the Office of the Comptroller of the Currency notifies the savings association that it has maintained adequately capitalized status for each of four consecutive calendar quarters, and the Office of the Comptroller of the Currency has the authority to require payment and collect payment under the guarantee. Failure by a holding company to provide the required guarantee will result in certain operating restrictions on the savings association, such as restrictions on the ability to declare and pay dividends, pay executive compensation and management fees, and increase assets or expand operations. The Office of the Comptroller of the Currency may also take any one of a number of discretionary supervisory actions against undercapitalized associations, including the issuance of a capital directive and the replacement of senior executive officers and directors.
At June 30, 2012, Putnam Bank met the criteria for being considered “well-capitalized”.
Insurance of Deposit Accounts. The Dodd-Frank Act permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009. Non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2012.
Effective April 1, 2011, the Federal Deposit Insurance Corporation implemented a requirement of the Dodd-Frank Act to revise its assessment system to base it on each institution’s total assets less tangible capital of each institution instead of deposits. The Federal Deposit Insurance Corporation also revised its assessment schedule so that it ranges from 2.5 basis points for the least risky institutions to 45 basis points for the riskiest.
Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the Federal Deposit Insurance Corporation. We do not believe we are taking or are subject to any action, condition or violation that could lead to termination of our deposit insurance.
The Dodd-Frank Act increased the minimum target ratio for the Deposit Insurance Fund from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC and the FDIC has exercised that discretion by establishing a long-term fund ratio of 2%.
In addition to the Federal Deposit Insurance Corporation assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended June 30, 2012, the annualized FICO assessment was equal to 0.66 basis points of an institution’s total assets less tangible capital.
Prohibitions Against Tying Arrangements. Federal savings associations are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
Federal Home Loan Bank System. Putnam Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of the Federal Home Loan Bank of Boston, Putnam Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank in specified amounts. As of June 30, 2012, Putnam Bank was in compliance with this requirement.
The USA PATRIOT Act
The USA PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. Certain provisions of the act impose affirmative obligations on a broad range of financial institutions, including savings banks, like Putnam Bank. These obligations include enhanced anti-money laundering programs, customer identification programs and regulations relating to private banking accounts or correspondence accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States).
Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002 was enacted in response to public concerns regarding corporate accountability in connection with certain accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.
We have existing policies, procedures and systems designed to comply with these regulations, and we are further enhancing and documenting such policies, procedures and systems to ensure continued compliance with these regulations.
Holding Company Regulation
General. Putnam Bancorp, MHC and PSB Holdings, Inc. are savings and loan holding companies within the meaning of the Home Owners’ Loan Act. As such, Putnam Bancorp, MHC and PSB Holdings, Inc. are registered with the Federal Reserve Board and are subject to Federal Reserve Board regulations, examinations, supervision and reporting requirements. In addition, the Federal Reserve Board has enforcement authority over PSB Holdings, Inc. and Putnam Bancorp, MHC, and their subsidiaries. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. Pursuant to the Dodd-Frank Act, the Federal Reserve Board assumed regulatory authority over savings and loan holding companies from the Office of Thrift Supervision on July 21, 2011. As federal corporations, PSB Holdings, Inc. and Putnam Bancorp, MHC are generally not subject to state business organization laws.
Permitted Activities. Pursuant to Section 10(o) of the Home Owners’ Loan Act and federal regulations and policy, a mutual holding company and a federally chartered mid-tier holding company such as PSB Holdings, Inc. may engage in the following activities: (i) investing in the stock of a savings association; (ii) acquiring a mutual association through the merger of such association into a savings association subsidiary of such holding company or an interim savings association subsidiary of such holding company; (iii) merging with or acquiring another holding company, one of whose subsidiaries is a savings association; (iv) investing in a corporation, the capital stock of which is available for purchase by a savings association under federal law or under the law of any state where the subsidiary savings association or associations share their home offices; (v) furnishing or performing management services for a savings association subsidiary of such company; (vi) holding, managing or liquidating assets owned or acquired from a savings subsidiary of such company; (vii) holding or managing properties used or occupied by a savings association subsidiary of such company; (viii) acting as trustee under deeds of trust; (ix) any other activity (A) that the Federal Reserve Board, by regulation, has determined to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956, unless the Federal Reserve Board, by regulation, prohibits or limits any such activity for savings and loan holding companies; or (B) in which multiple savings and loan holding companies were authorized (by regulation) to directly engage on March 5, 1987; (x), subject to meeting certain criteria, any activity permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act, including securities and insurance underwriting; and (xi) purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such savings and loan holding company is approved by the Federal Reserve Board. If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company resulting from such merger or acquisition may only invest in assets and engage in activities listed in (i) through (xi) above, and has a period of two years to cease any nonconforming activities and divest any nonconforming investments.
The Home Owners’ Loan Act prohibits a savings and loan holding company, including PSB Holdings, Inc. and Putnam Bancorp, MHC, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior written approval of the Federal Reserve Board. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a nonsubsidiary company engaged in activities other than those permitted by the Home Owners’ Loan Act, or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Board must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.
The Federal Reserve Board is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Capital. Savings and loan holding companies are not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. Instruments such as cumulative preferred stock and trust preferred securities will no longer be includable as Tier 1 capital, which is currently permitted for bank holding companies. Instruments issued by May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less. There is a five-year transition period (from the July 21, 2010 effective date of the Dodd-Frank Act) before the capital requirements will apply to savings and loan holding companies.
Dividends and repurchases. The Federal Reserve Board has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies that it has made applicable to savings and loan holding companies as well. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory review of capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. The policy statement also provides for regulatory review prior to a holding company redeeming or repurchasing regulatory capital instruments when the holding company is experiencing financial weaknesses or redeeming or repurchasing common stock or perpetual preferred stock that would result in a net reduction as of the end of a quarter in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies could affect the ability of PSB Holdings, Inc. to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions.
Source of Strength. The Dodd-Frank Act extended the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.
Waivers of Dividends by Putnam Bancorp, MHC. Federal regulations require Putnam Bancorp, MHC to notify the Federal Reserve Board of any proposed waiver of its receipt of dividends from PSB Holdings, Inc. The Office of Thrift Supervision, the previous regulator for Putnam Bancorp, MHC, allowed dividend waivers where the mutual holding company’s board of directors determined that the waiver was consistent with its fiduciary duties and the waiver would not be detrimental to the safety and soundness of the institution. The Federal Reserve Board has recently issued an interim final rule providing that, pursuant to a Dodd-Frank Act grandfathering provision, it may not object to dividend waivers under similar circumstances, but adding the requirement that a majority of the mutual holding company’s members eligible to vote have approved a waiver of dividends by the company within 12 months prior to the declaration of the dividend being waived. The Federal Reserve Board has typically not allowed dividend waivers by mutual bank holding companies and, therefore, the ability of Putnam Bancorp, MHC to waive dividends for in the future is uncertain.
Conversion of Putnam Bancorp, MHC to Stock Form. Federal regulations permit Putnam Bancorp, MHC to convert from the mutual form of organization to the capital stock form of organization (a “Conversion Transaction”). There can be no assurance when, if ever, a Conversion Transaction will occur, and the Board of Directors has no current intention or plan to undertake a Conversion Transaction. In a Conversion Transaction a new stock holding company would be formed as the successor to PSB Holdings, Inc. (the “New Holding Company”), Putnam Bancorp, MHC’s corporate existence would end, and certain depositors of Putnam Bank would receive the right to subscribe for additional shares of the New Holding Company. In a Conversion Transaction, each share of common stock held by stockholders other than Putnam Bancorp, MHC (“Minority Stockholders”) would be automatically converted into a number of shares of common stock of the New Holding Company determined pursuant to an exchange ratio that ensures that Minority Stockholders own the same percentage of common stock in the New Holding Company as they owned in PSB Holdings, Inc. immediately prior to the Conversion Transaction. Under a provision of the Dodd-Frank Act applicable to Putnam Bancorp, MHC, Minority Stockholders would not be diluted because of any dividends waived by Putnam Bancorp, MHC (and waived dividends would not be considered in determining an appropriate exchange ratio), in the event Putnam Bancorp, MHC converts to stock form.
Federal Securities Laws
PSB Holdings, Inc. common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934. PSB Holdings, Inc. is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.
PSB Holdings, Inc. common stock held by persons who are affiliates (generally officers, directors and principal shareholders) of PSB Holdings, Inc. may not be resold without registration or unless sold in accordance with certain resale restrictions. If PSB Holdings, Inc. meets specified current public information requirements, each affiliate of PSB Holdings, Inc. is able to sell in the public market, without registration, a limited number of shares in any three-month period.
Reports to Security Holders
PSB Holdings, Inc. files annual and quarterly reports with the SEC on Forms 10-K and 10-Q, respectively. PSB Holdings, Inc. also files current reports on the Form 8-K with the SEC. In addition, PSB Holdings, Inc. files preliminary and definitive proxy materials with the SEC.
PSB Holdings, Inc. is an electronic filer. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of the site is http://www.sec.gov.
ITEM 1A.
ITEM 1A.
Risk Factors
We could record future losses on our investment securities portfolio.
A number of factors or combinations of factors could cause us to conclude in one or more future reporting periods that an unrealized loss that exists with respect to these securities constitutes an additional impairment that is other-than-temporary, which could result in material losses to us. These factors include, but are not limited to, continued failure to make scheduled interest payments, an increase in the severity of the unrealized loss on a particular security, an increase in the continuous duration of the unrealized loss without an improvement in value or changes in market conditions and/or industry or issuer specific factors that would render us unable to forecast a full recovery in value. In addition, the fair values of the trust preferred securities could decline if the overall economy and the financial condition of some of the issuers continue to deteriorate and there remains limited liquidity for these securities.
We have been negatively affected by current local and national market and economic conditions. A continuation or worsening of these conditions could adversely affect our operations, financial condition and earnings.
The severe economic recession of 2008 and 2009 and the weak economic recovery since then have resulted in continued uncertainty in the financial markets and the expectation of weak general economic conditions, including high levels of unemployment. The resulting economic pressure on consumers and businesses has adversely affected our business, financial condition and results of operations. The credit quality of loan and investment securities portfolios has deteriorated at many financial institutions and the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline. Our commercial and multifamily real estate loan customers have experienced increases in vacancy rates and declines in rental rates for both multifamily and commercial properties. Financial companies’ stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets. A continuation or worsening of these conditions could result in reduced loan demand and further increases in loan delinquencies, loan losses, loan loss provisions, costs associated with monitoring delinquent loans and disposing of foreclosed property, and otherwise negatively affect our operations, financial condition and earnings.
Concentration of loans in our primary market area, which has recently experienced an economic downturn, may increase risk.
Our success depends primarily on the general economic conditions in the State of Connecticut, as nearly all of our loans are to customers in the state. Accordingly, the local economic conditions in the State of Connecticut have a significant impact on the ability of borrowers to repay loans as well as our ability to originate new loans. As such, a decline in real estate valuations in this market would lower the value of the collateral securing those loans. In addition, continued weakening in general economic conditions such as inflation, recession, unemployment or other factors beyond our control could negatively affect our financial results.
Strong competition within our market area may limit our growth and profitability.
Competition in the banking and financial services industry is intense. In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors have substantially greater resources and lending limits than we have and offer certain services that we do not or cannot provide. In addition, recently some of our larger financial institution competitors, offer loans with lower interest rates on more attractive terms than those offered by Putnam Bank, which we expect to continue in the foreseeable future. Our profitability depends upon our continued ability to successfully compete in our market area. The greater resources and deposit and loan products offered by our competition may limit our ability to increase our interest earning assets. For additional information see “Business of Putnam Bank-Competition.”
Because we intend to increase our commercial real estate and commercial loan originations, our lending risk will increase and downturns in the real estate market or local economy could adversely affect our earnings.
Commercial real estate and commercial loans generally have more risk than residential mortgage loans. Because the repayment of commercial real estate and commercial loans depends on the successful management and operation of the borrower’s properties or related businesses, repayment of such loans can be affected by adverse conditions in the real estate market or the local economy. Commercial real estate and commercial loans may also involve relatively large loan balances to individual borrowers or groups of related borrowers. A downturn in the real estate market or the local economy could adversely impact the value of properties securing the loan or the revenues from the borrower’s business thereby increasing the risk of non-performing loans. As our commercial real estate and commercial loan portfolio increases, the corresponding risks and potential for losses from these loans may also increase.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance. Our allowance for loan losses was 1.16% of total loans and 34.74% of non-performing loans at June 30, 2012. Material additions to our allowance would materially decrease our net income.
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our results of operations and financial condition.
Because we originate a significant number of mortgage loans secured by residential real estate, decreases in real estate values could adversely affect the value of property used as collateral for such loans. At June 30, 2012, loans secured by real estate represented 98.3% of our total loans, substantially all of which are secured by properties located in Windham County. Adverse changes in the economy also may have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings. As of June 30, 2012, the unemployment rate in Windham County, Connecticut was 9.9%, and the New London County unemployment rate was 8.5% compared to the national unemployment rate of 8.2% and the unemployment rate for Connecticut as a whole of 8.1%.
Future changes in interest rates may reduce our profits.
Our ability to make a profit largely depends on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between:
●
the interest income we earn on our interest-earning assets, such as loans and securities; and
●
the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings.
The rates we earn on our assets and the rates we pay on our liabilities are generally fixed for a contractual period of time. Like many savings institutions, our liabilities generally have shorter contractual maturities than our assets. This imbalance can create significant earnings volatility, because market interest rates change over time. In a period of rising interest rates, the interest income earned on our assets may not increase as rapidly as the interest paid on our liabilities. In a period of declining interest rates, the interest income earned on our assets may decrease more rapidly than the interest paid on our liabilities, as borrowers speed up prepayments of mortgage loans, and mortgage-backed securities and callable investment securities are called, requiring us to reinvest those cash flows at lower interest rates. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Market Risk, Liquidity and Capital resources.”
In addition, changes in interest rates can affect the average life of loans and mortgage-backed and related securities. A reduction in interest rates results in increased prepayments of loans and mortgage-backed and related securities, as borrowers refinance their debt in order to reduce their borrowing costs. This creates reinvestment risk, which is the risk that we may not be able to reinvest prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities.
At June 30, 2012, our “rate shock” analysis prepared by our third party consultant indicates that our net portfolio value would decrease by $5.4 million if there was an instantaneous 200 basis point increase in market interest rates. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Market Risk, Liquidity and Capital resources.”
Historically low interest rates may adversely affect our net interest income and profitability.
During the past three years it has been the policy of the Board of Governors of the Federal Reserve System to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, market rates on the loans we have originated and the yields on securities we have purchased have been at lower levels than as available prior to 2008. Consequently, the average yield on our interest earning assets has decreased to 4.12% for the year ended June 30, 2012 from 4.99% for the year ended June 30, 2010. As a general matter, our interest-bearing liabilities reprice or mature more quickly than our interest-earning assets. This has resulted in increases in net interest income in the short term. However, our ability to lower our interest expense is limited at these interest rate levels while the average yield on our interest-earning assets may continue to decrease. The Board of Governors of the Federal Reserve System has indicated its intention to continue to maintain low interest rates in the near future. Accordingly, our net interest income (the difference between interest income earned on assets and interest expense paid on liabilities) may decrease, which may have an adverse affect on our profitability.
The expiration of unlimited Federal Deposit Insurance Corporation insurance on certain non-interest-bearing transaction accounts may increase our costs and reduce our liquidity levels.
On December 31, 2012, unlimited Federal Deposit Insurance Corporation insurance on certain non-interest-bearing transaction accounts is scheduled to expire. Unlimited insurance coverage does not apply to money market deposit accounts or negotiable order of withdrawal accounts. The reduction in Federal Deposit Insurance Corporation insurance on other types of accounts to the standard $250,000 maximum amount may cause depositors to place such funds in fully insured interest-bearing accounts, which would increase our costs of funds and negatively affect our results of operations, or may cause depositors to withdraw their deposits and invest uninsured funds in investments perceived as being more secure, such as securities issued by the United States Treasury. This may reduce our liquidity, or require us to pay higher interest rates to maintain our liquidity by retaining deposits.
If our investment in the common stock of the Federal Home Loan Bank of Boston is classified as other-than-temporarily impaired or as permanently impaired, earnings and stockholders’ equity could decrease.
We own stock of the Federal Home Loan Bank of Boston, which is part of the Federal Home Loan Bank system. The Federal Home Loan Bank of Boston common stock is held to qualify for membership in the Federal Home Loan Bank of Boston and to be eligible to borrow funds under the Federal Home Loan Bank of Boston’s advance programs. The aggregate cost of our Federal Home Loan Bank of Boston common stock as of June 30, 2012, was $7.5 million based on its par value. There is no market for Federal Home Loan Bank of Boston common stock.
Although the Federal Home Loan Bank of Boston is not reporting current operating difficulties, it is possible that the capital of the Federal Home Loan Bank system, including the Federal Home Loan Bank of Boston, could be substantially diminished. This could occur with respect to an individual Federal Home Loan Bank due to the requirement that each Federal Home Loan Bank is jointly and severally liable along with the other Federal Home Loan Banks for the consolidated obligations issued through the Office of Finance, a joint office of the Federal Home Loan Banks, or due to the merger of a Federal Home Loan Bank experiencing operating difficulties into a stronger Federal Home Loan Bank. Consequently, there continues to be a risk that our investment in Federal Home Loan Bank of Boston common stock could be deemed other-than-temporarily impaired at some time in the future, and if this occurs, it would cause our earnings and stockholders’ equity to decrease by the impairment charge.
Stockholders other than our mutual holding company own a minority of PSB Holdings, Inc.’s common stock and are not able to exercise voting control over most matters put to a vote of stockholders.
Public stockholders own a minority of the outstanding shares of PSB Holdings, Inc. common stock. As a result, stockholders other than Putnam Bancorp, MHC are not able to exercise voting control over most matters put to a vote of stockholders. Putnam Bancorp, MHC owns a majority of PSB Holdings, Inc.’s common stock and, through its Board of Directors, is able to exercise voting control over most matters put to a vote of stockholders. The same directors and officers who manage PSB Holdings, Inc. and Putnam Bank also manage Putnam Bancorp, MHC. Putnam Bancorp, MHC may exercise its voting control to prevent a sale or merger transaction in which stockholders could receive a premium for their shares.
Our stock value may be negatively affected by federal regulations restricting takeovers and our mutual holding company structure.
Federal regulations restricting takeovers. Regulatory policy prohibits the acquisition of a mutual holding company subsidiary by any person or entity other than a mutual holding company or a mutual institution. While Putnam Bancorp, MHC’s regulator recently changed, there can be no assurance that there will be a change in this policy.
The mutual holding company structure may impede takeovers. Putnam Bancorp, MHC, as the majority stockholder of PSB Holdings, Inc., is able to control the outcome of virtually all matters presented to stockholders for their approval, including a proposal to acquire PSB Holdings, Inc. Accordingly, Putnam Bancorp, MHC may prevent the sale of control or merger of PSB Holdings, Inc. or its subsidiaries even if such a transaction were favored by a majority of the public stockholders of PSB Holdings, Inc.
The corporate governance provisions in our charter and bylaws may prevent or impede the holders of a minority of our common stock from obtaining representation on our Board of Directors.
Provisions in our charter and bylaws may prevent or impede holders of a minority of our common stock from obtaining representation on our board of directors. For example, our board of directors is divided into three staggered classes. A classified board makes it more difficult for stockholders to change a majority of the directors because it generally takes at least two annual elections of directors for this to occur. Second, our charter provides that there will not be cumulative voting by stockholders for the election of our directors which means that Putnam Bancorp, MHC, as the holder of a majority of the shares eligible to be voted at a meeting of stockholders, may elect all of our directors to be elected at that meeting. Third, our bylaws contain procedures and timetables for a stockholder wanting to make a nomination for the election of directors or a proposal for new business at a meeting of stockholders, the effect of which may be to give our management time to solicit its own proxies in an attempt to defeat any dissident slate of nominations if management thinks it is in the best interest of stockholders generally.
Federal policy on remutualization transactions could prohibit acquisition of PSB Holdings, Inc., which may lower our stock price.
Current federal regulations permit a mutual holding company to be acquired by a mutual institution in a remutualization transaction. However, the Office of Thrift Supervision, Putnam Bancorp, MHC’s previous regulator, issued a policy statement indicating that it viewed remutualization transactions as raising significant issues concerning disparate treatment of minority stockholders and the mutual interests of the mutual holding company, and also raising issues concerning the effect on the mutual interests of the acquiring entity. The policy statement indicated that, under certain circumstances, these transactions would receive special scrutiny and would be rejected unless the applicant can clearly demonstrate that the regulatory concerns are not warranted in the particular case. Should these transactions be prohibited or otherwise restricted in the future, our per-share stock price may be adversely affected.
Government responses to economic conditions may adversely affect our operations, financial condition and earnings.
The Dodd-Frank Wall Street Reform and Consumer Protection Act has changed the bank regulatory framework, created an independent consumer protection bureau that has assumed the consumer protection responsibilities of the various federal banking agencies, and established more stringent capital standards for banks and bank holding companies. Bank regulatory agencies also have been responding aggressively to concerns and adverse trends identified in examinations. Ongoing uncertainty and adverse developments in the financial services industry and the domestic and international credit markets, and the effect of the Dodd-Frank Act and regulatory actions, may adversely affect our operations by restricting our business activities, including our ability to originate or sell loans, modify loan terms, or foreclose on property securing loans. These risks could affect the performance and value of our loan and investment securities portfolios, which also would negatively affect our financial performance.
The Dodd-Frank Act and related regulations may have an adverse effect on our ability to pay dividends, which would adversely affect the value of our common stock.
The value of PSB Holdings, Inc.’s common stock is significantly affected by its ability to pay dividends to its public stockholders. PSB Holdings, Inc.’s ability to pay dividends to our stockholders is subject to the ability of Putnam Bank to make capital distributions to PSB Holdings, Inc., or the availability of cash at the holding company level in the event Putnam Bank’s earnings are not sufficient to pay dividends.
Moreover, the amount of the dividends that we are able to pay our public stockholders is affected by the ability of Putnam Bancorp, MHC, our mutual holding company, to waive the receipt of dividends declared by PSB Holdings, Inc. Regulations of the Office of Thrift Supervision, our previous federal regulator, allowed federally chartered mutual holding companies to waive dividends without taking into account the amount of waived dividends in determining an appropriate exchange ratio in the event of a conversion of a mutual holding company to stock form. However, under the Dodd-Frank Act, the powers and duties of the Office of Thrift Supervision relating to mutual holding companies have been transferred to the Federal Reserve Board, and the Office of Thrift Supervision was eliminated. The Dodd-Frank Act also provides that a mutual holding company must give the Federal Reserve Board notice before waiving the receipt of dividends, and sets forth certain standards for allowing a waiver of dividends by a mutual holding company. Under these standards, waived dividends must be considered in determining an appropriate exchange ratio in the event of a conversion of the mutual holding company to stock form, unless a mutual holding company has waived dividends prior to December 1, 2009, which Putnam Bancorp, MHC has done. However, the Federal Reserve Board has recently issued an interim final rule requiring that, even where a mutual holding company has waived dividends prior to December 1, 2009, a majority of the mutual holding company’s members eligible to vote must approve a waiver of dividends by the mutual holding company within 12 months prior to the declaration of the dividend being waived. Accordingly, the ability of Putnam Bancorp, MHC to waive dividends in the future is uncertain.
We are subject to extensive regulatory oversight.
We and our subsidiaries are subject to extensive regulation and supervision. Regulators have intensified their focus on bank lending criteria and controls, and on the USA PATRIOT Act’s anti-money laundering and Bank Secrecy Act compliance requirements. There also is increased scrutiny of our compliance practices generally and particularly with the rules enforced by the Office of Foreign Assets Control. Our failure to comply with these and other regulatory requirements could lead to, among other remedies, administrative enforcement actions and legal proceedings. In addition, the Dodd-Frank Act and implementing regulations are likely to have a significant effect on the financial services industry, which are likely to increase operating costs and reduce profitability. Regulatory or legislative changes could make regulatory compliance more difficult or expensive for us, and could cause us to change or limit some of our products and services, or the way we operate our business.
Legislative or regulatory responses to perceived financial and market problems could impair our rights against borrowers.
Current and future legislative regulatory proposals would reduce the amount distressed borrowers are otherwise contractually obligated to pay under their mortgage loans, and may limit the ability of lenders to foreclose on mortgage collateral. If proposals such as these, or other proposals limiting Putnam Bank’s rights as a creditor, were to be implemented, we could experience increased credit losses on our loans and mortgage-backed securities, or increased expense in pursuing our remedies as a creditor.
Recent health care legislation could increase our expenses or require us to pass further costs on to our employees, which could adversely affect our operations, financial condition and earnings.
Legislation enacted in 2010 requires companies to provide expanded health care coverage to their employees, such as affordable coverage to part-time employees and coverage to dependent adult children of employees. Companies will also be required to enroll new employees automatically into one of their health plans. Compliance with these and other new requirements of the health care legislation will increase our employee benefits expense, and may require us to pass these costs on to our employees, which could give us a competitive disadvantage in hiring and retaining qualified employees.
The requirement to account for certain assets at estimated fair value may adversely affect our results of operations.
We report certain assets, including securities available for sale, at fair value. Generally, for securities that are reported at fair value, we use quoted market prices or valuation models that utilize observable market inputs to estimate fair value. Because we carry these assets on our books at their estimated fair value, we may record losses even if the asset in question presents minimal credit risk. Under current accounting requirements, elevated delinquencies, defaults, and estimated losses from the disposition of collateral in our non-agency mortgage-backed securities portfolio may require us to recognize additional other-than-temporary impairments in future periods with respect to our securities portfolio. The amount and timing of any impairment recognized will depend on the severity and duration of the decline in the estimated fair value of the asset and our estimate of the anticipated recovery period.
Further downgrades in the U.S. government’s sovereign credit rating, and in the credit ratings of instruments issued, insured or guaranteed by certain related institutions, agencies and instrumentalities, could result in risks to us and the general economy that we are not able to predict.
On August 5, 2011, Standard & Poor’s downgraded the United States long-term debt rating from its AAA rating to AA+. On August 8, 2011, Standard & Poor’s downgraded the credit ratings of certain long-term debt instruments issued by Fannie Mae and Freddie Mac and other U.S. government agencies linked to long-term U.S. debt. Instruments of this nature are key assets on the balance sheets of financial institutions, including Putnam Bank. These downgrades could adversely affect the market value of such instruments, and could adversely impact our ability to obtain funding that is collateralized by affected instruments, as well as affecting the pricing of that funding when it is available. We cannot predict if, when or how these changes to the credit ratings will affect economic conditions. These ratings downgrades could result in a significant adverse impact to us, and could exacerbate the other risks to which we are subject.
Because the nature of the financial services business involves a high volume of transactions, we face significant operational risks.
We operate in diverse markets and rely on the ability of our employees and systems to process a high number of transactions. Operational risk is the risk of loss resulting from our operations, including but not limited to, the risk of fraud by employees or persons outside our company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements, and business continuation and disaster recovery. Insurance coverage may not be available for such losses, or where available, such losses may exceed insurance limits. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action, and suffer damage to our reputation.
Risks associated with system failures, interruptions, or breaches of security could negatively affect our earnings.
Information technology systems are critical to our business. We use various technology systems to manage our customer relationships, general ledger, securities, deposits, and loans. We have established policies and procedures to prevent or limit the impact of system failures, interruptions, and security breaches, but such events may still occur and may not be adequately addressed if they do occur. In addition any compromise of our systems could deter customers from using our products and services. Although we rely on security systems to provide security and authentication necessary to effect the secure transmission of data, these precautions may not protect our systems from compromises or breaches of security.
In addition, we outsource some of our data processing to certain third-party providers. If these third-party providers encounter difficulties, or if we have difficulty communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
The occurrence of any system failures, interruption, or breach of security could damage our reputation and result in a loss of customers and business thereby subjecting us to additional regulatory scrutiny, or could expose us to litigation and possible financial liability. Any of these events could have a material adverse effect on our financial condition and results of operations.
ITEM 1B.
ITEM 1B.
Unresolved Staff Comments
Not applicable.
ITEM 2.
ITEM 2.
Properties
We conduct substantially all of our business through our main office, seven full service branch offices and one loan origination center. We also conduct limited business operations through a “Special Needs Limited Branch” and a “Limited Services Branch”. In 2002, we began Limited Service (Mobile) Branch activities. The Limited Services (Mobile) Branch serves approximately eight locations in our primary market area consisting of schools and retirement facilities. Bank personnel visit these facilities approximately once per week and, in the case of school locations, conduct deposit taking activities and, in the case of the retirement facilities, conduct deposit taking, check cashing, notary and certificate of deposit renewal activities. Set forth below is information on our office locations as of June 30, 2012. The net book value of our premises, land and equipment was approximately $4.5 million at June 30, 2012.
(1)
Our personnel are at this location for approximately three hours once a week. The facility provides a furnished room for us at no cost. Our personnel conduct limited banking activities, such as deposit-taking, check cashing, notary and certificate of deposit renewals. We began operating at this location in 2002.
ITEM 3.
ITEM 3.
Legal Proceedings
From time to time, we are involved as plaintiff or defendant in various legal proceedings arising in the ordinary course of business. At June 30, 2012, we were not involved in any legal proceedings the outcome of which would be material to our financial condition or results of operations.
ITEM 4.
ITEM 4.
Mine Safety Disclosures
Not applicable.
PART II
ITEM 5.
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a) Our common stock is traded on the NASDAQ Global Market under the symbol “PSBH.” Putnam Bancorp, MHC owned 3,729,846 shares, or 57.1% of our outstanding common stock. The approximate number of holders of record of PSB Holdings, Inc.’s common stock as of August 31, 2012 was 453. Certain shares of PSB Holdings, Inc. are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. The following table presents quarterly market information for PSB Holdings, Inc.’s common stock for the periods ended June 30, 2012 and June 30, 2011. The following information with respect to trading prices was provided by the NASDAQ Global Market.
For a discussion of regulatory factors restricting our ability to pay dividends to our stockholders, see Item 1, “Business-Regulation and Supervision-Holding Company Regulation Limitation-Dividends”, and “-Waivers of Dividends by Putnam Bancorp, MHC”, and Item 1A. “Risk Factors-The Dodd-Frank Act and related regulations may have an adverse effect on our ability to pay dividends, which would adversely affect the value of our common stock.”
PSB Holdings, Inc. has no source of income other than dividends from Putnam Bank, earnings from the investment of proceeds from the sale of shares of common stock retained by PSB Holdings, Inc. and interest payments with respect to PSB Holdings, Inc.’s loan to the Employee Stock Ownership Plan. Accordingly, dividend payments by PSB Holdings, Inc. are dependent primarily on dividends it receives from Putnam Bank. For a discussion of restrictions on the ability of Putnam Bank to pay dividends to PSB Holdings, Inc., see Item 1, “Business-Regulation and Supervision-Federal Banking Regulation-Capital Distributions.”
Information with respect to securities authorized for issuance under the Company’s Equity Compensation Plan is contained in Item 12 of this Annual Report on Form 10-K.
ITEM 6.
ITEM 6.
Selected Financial Data
The Company has derived the following selected consolidated financial and other data in part from its consolidated financial statements. The following is only a summary and you should read it in conjunction with the Company’s consolidated financial statements and notes thereto. The information at June 30, 2012 and 2011 and for the fiscal years ended June 30, 2012 and 2011 is derived in part from the audited consolidated financial statements that appear in Item 8 of this Annual Report on Form 10-K. The information at June 30, 2010, 2009 and 2008, for the fiscal years ended June 30, 2010, 2009 and 2008, is derived in part from audited consolidated financial statements that do not appear in this document.
(1)
Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities.
(2)
Represents net interest income as a percent of average interest-earning assets.
(3)
Represents non-interest expense divided by the sum of net interest income and non-interest income.
ITEM 7.
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following analysis discusses changes in the financial condition and results of operations at and for the years ended June 30, 2012 and 2011, and should be read in conjunction with the Company’s Consolidated Financial Statements and the notes thereto, appearing in Part II, Item 8 of this Annual Report on Form 10-K.
Overview
The Company’s results of operations depend primarily on net interest and dividend income, which is the difference between the interest and dividend income earned on its interest-earning assets, such as loans and securities, and the interest expense on its interest-bearing liabilities, such as deposits and borrowings. The Company also generates non-interest income, primarily from fees and service charges. Gains on sales of loans and securities and cash surrender value of life insurance policies are added sources of non-interest income. The Company’s non-interest expense primarily consists of employee compensation and benefits, occupancy and equipment expense, advertising, data processing, professional fees and other operating expenses.
Critical Accounting Policies
Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. Our critical accounting policies are those related to our allowance for loan losses, other-than-temporary impairment of investment securities, valuation of deferred tax assets and goodwill. Management has discussed the development, selection and application of these critical accounting policies with the Audit Committee of the Board of Directors.
Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover credit losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses which is charged against income.
Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal and external loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates by management that may be susceptible to significant change. The allowance for loan losses has three components: general, specific and unallocated as further discussed below.
The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate, commercial real estate, residential construction, commercial and consumer/other. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies; loan concentrations, trends in volume and terms of loans; changes in lending practices and procedures; changes in lending management and staff; changes in the value of underlying collateral; changes in the quality of the loan review system; national and local economic trends and conditions and the effects of other external factors. During the year ended June 30, 2012, the Company changed the allowance for loan loss calculation to add certain qualitative factors and amend loan segment characterization, resulting in a change in accounting estimate. Qualitative factors were added for changes in lending practices and procedures; changes in the value of underlying collateral; changes in lending management and staff; changes in the quality of the loan review system and the effects of other external factors. In addition, loan segments within the allowance were amended to correspond to call report requirements. These changes did not quantitatively impact the dollar amount of the allowance for loan losses at June 30, 2012, as changes relate only to qualitative assessments and methodology in how the allowance is calculated.
The specific component relates to loans that are classified as impaired. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent or foreclosure is probable. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring (“TDR”) agreement.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring. All TDRs are initially classified as impaired.
An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general reserves in the portfolio.
Other-Than-Temporary Impairment of Securities. Management periodically reviews all investment securities with significant declines in fair value for potential other-than-temporary impairment pursuant to the guidance provided by ASC 320-10 “Investments-Debt and Equity Securities”. The guidance addresses the determination as to when an investment is considered impaired, whether the impairment is other-than-temporary, and the measurement of an impairment loss. It also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments.
Goodwill. The Company’s goodwill (the amount paid in excess of fair value of acquired net assets) is reviewed at least annually to ensure that there have been no events or circumstances resulting in an impairment of the recorded amount of excess purchase price. Adverse changes in the economic environment, operations of acquired business units, or other factors could result in a decline in projected fair values. If the estimated fair value is less than the carrying amount, a loss would be recognized to reduce the carrying amount to fair value.
Comparison of Financial Condition at June 30, 2012 and June 30, 2011
Assets. Total assets of the Company were $452.3 million at June 30, 2012, a decrease of $20.2 million or 4.3%, from $472.5 million at June 30, 2011. Investments in available-for-sale securities decreased $10.8 million or 18.6%, to $47.2 million at June 30, 2012 compared to $58.0 million at June 30, 2011. Investments in held-to-maturity securities decreased $9.5 million or 8.3% to $105.2 million as of June 30, 2012 compared to $114.7 million as of June 30, 2011. The reduction in investments was used to fund the repayment of Federal Home Loan Bank borrowings. Cash and cash equivalents increased $3.1 million or 38.0% to $11.4 million as of June 30, 2012 compared to $8.3 million as of June 30, 2011. The increase in cash was primarily due to additional overnight monies deposited in interest-bearing accounts at the Federal Reserve Bank of Boston. Net loans outstanding decreased $4.6 million or 1.8% to $248.6 million at June 30, 2012 from $253.2 million at June 30, 2011. The decrease in loans was primarily due to a decrease of $8.5 million in commercial real estate loans and $3.9 million in commercial loans. This was partially offset by an increase of $7.1 million in residential mortgage loans from June 30, 2011 to June 30, 2012.
Liabilities. Total liabilities decreased $21.5 million, or 5.1%, to $404.2 million at June 30, 2012 from $425.7 million at June 30, 2011, primarily due to a decrease in Federal Home Loan Bank advances of $30.0 million, or 35.9% to $53.5 million at June 30, 2012 from $83.5 million at June 30, 2011. Total deposits increased $8.5 million, or 2.6%, to $342.3 million at June 30, 2012 from $333.8 million at June 30, 2011.
Stockholders’ Equity. Total stockholders’ equity increased $1.4 million, or 3.0% to $48.1 million at June 30, 2012 from $46.7 million at June 30, 2011. The increase was primarily due to net income of $1.05 million and a decrease of $254,000 in accumulated other comprehensive loss for the fiscal year ended June 30, 2012.
Comparison of Operating Results for the Fiscal Years Ended June 30, 2012 and 2011
Net Income. Net income amounted to $1.05 million, or $0.16 per basic and diluted share for the fiscal year ended June 30, 2012 compared to net income of $1.10 million or $0.17 per basic and diluted share for the fiscal year ended June 30, 2011.
Interest and Dividend Income. Interest and dividend income decreased by $2.0 million, or 10.1%, to $17.7 million for the fiscal year ended June 30, 2012 from $19.7 million for the fiscal year ended June 30, 2011. The decrease in interest and dividend income resulted primarily from a 28 basis point decrease in the yield on average interest-earning assets to 4.12% for the fiscal year ended June 30, 2012 from 4.40% for the fiscal year ended June 30, 2011. This decrease in yield is primarily due to the current low rate environment. Interest income on loans decreased by $730,000, or 5.3%, to $13.0 million for the fiscal year ended June 30, 2012 from $13.7 million for the fiscal year ended June 30, 2011. Interest and dividend income on investment securities decreased $1.3 million, or 23.2%, to $4.3 million for the fiscal year ended June 30, 2012 from $5.6 million for the fiscal year ended June 30, 2011. The yield on average investment securities decreased 41 basis points to 2.83% for the fiscal year ended June 30, 2012 from 3.24% for the fiscal year ended June 30, 2011. Average interest-earning assets decreased $17.8 million to $430.7 million for the fiscal year ended June 30, 2012 from $448.5 million for the fiscal year ended June 30, 2011. Average investment securities decreased $18.0 million, average loans decreased $1.1 million and average other earning assets increased $1.3 million from year to year.
Interest Expense. Interest expense decreased by $1.7 million, or 20.5%, to $6.7 million for the fiscal year ended June 30, 2012 from $8.4 million for the fiscal year ended June 30, 2011. The decrease in interest expense resulted primarily from a decrease in the cost of average interest-bearing liabilities which decreased by 33 basis points to 1.78% for the fiscal year ended June 30, 2012 as compared to 2.11% for the fiscal year ended June 30, 2011. The cost of average interest-bearing deposits decreased 29 basis points to 1.32% for the fiscal year ended June 30, 2012 from 1.61% for the fiscal year ended June 30, 2011 and the cost of other borrowed money decreased seven basis points to 3.50% for the fiscal year ended June 30, 2012 from 3.57% for the fiscal year ended June 30, 2011. This decrease in cost is primarily due to the current low rate environment. Average interest-bearing deposits increased $133,000 to $295.2 million for the fiscal year ended June 30, 2012 from $295.1 million for the fiscal year ended June 30, 2011. Average NOW accounts increased $1.6 million, average savings deposits increased $3.1 million and average time deposits decreased $6.1 million year over year. Average borrowings decreased $22.5 million to $79.0 million for the fiscal year ended June 30, 2012 from $101.5 million for the fiscal year ended June 30, 2011.
Net Interest Income. Net interest income decreased $277,000, or 2.4%, to $11.1 million for the fiscal year ended June 30, 2012 from $11.4 million for the fiscal year ended June 30, 2011. The primary reason for the decrease in our net interest income was the change in rates for the fiscal year ended June 30, 2012 compared to the fiscal year ended June 30, 2011.
Provision for Loan Losses. The Company’s provision for loan losses increased $237,000, or 25.9% to $1.15 million for the fiscal year ended June 30, 2012 from $915,000 for the fiscal year ended June 30, 2011. The higher provision for loan losses reflects the Bank’s non-performing loans, charge-offs and increases to our historical loan loss factors for commercial mortgage, residential construction and commercial loan portfolios due to adverse market conditions. In addition, non-performing loans increased to $8.4 million at June 30, 2012 from $6.4 million at June 30, 2011. The provisions established the allowance for loan losses at $2.9 million at June 30, 2012 compared to $3.1 million at June 30, 2011. The ratio of the allowance to gross loans outstanding was 1.16% as of June 30, 2012 compared to 1.20% as of June 30, 2011, and the ratio of the allowance to non-performing loans was 34.74% as of June 30, 2012 compared to 47.86% as of June 30, 2011. Decreases in and charge-offs of specific reserves on impaired loans is the primary reason for the decrease in the allowance for loan losses at June 30, 2012 compared to June 30, 2011.
Non-interest Income. Non-interest income decreased $224,000, or 8.9%, to $2.3 million for the fiscal year ended June 30, 2012 compared to $2.5 million for the fiscal year ended June 30, 2011. This was primarily due to increased other-than-temporary write-downs of investment securities of $899,000 to $2.0 million for the fiscal year ended June 30, 2012 compared to $1.1 million for the fiscal year ended June 30, 2011. The write-downs for the fiscal years ended June 30, 2012 and 2011 consisted of credit losses on non-agency mortgage-backed securities. This was partially offset by an increase in legal settlement on previously written-down securities of $1.0 million to $1.5 million for the fiscal year ended June 30, 2012 compared to $420,000 for the fiscal year ended June 30, 2011. Fees for services decreased $216,000 to $1.8 million for the fiscal year ended June 30, 2012 compared to $2.0 million for the fiscal year ended June 30, 2011.
Non-interest Expense. Non-interest expense decreased by $368,000, or 3.3%, to $10.9 million for the fiscal year ended June 30, 2012 from $11.3 million for the fiscal year ended June 30, 2011. Salaries and employee benefits expense decreased by $83,000, or 1.4%, to $5.8 million for the fiscal year ended June 30, 2012 from $5.9 million for the fiscal year ended June 30, 2011. Occupancy and equipment expense decreased by $42,000, or 3.2%, to $1.3 million for the fiscal year ended June 30, 2012 from $1.3 million for the fiscal year ended June 30, 2011. All other non-interest expense, consisting primarily of data processing expense, FDIC deposit insurance, professional fees and marketing expense decreased by $243,000, or 5.9%, to $3.9 million for the fiscal year ended June 30, 2012 from $4.1 million for the fiscal year ended June 30, 2011. This was primarily due to decreases in data processing expense of $223,000 and FDIC deposit insurance of $168,000. This was partially offset by increases in advertising and marketing of $57,000 and professional fees of $69,000 during the fiscal year ended June 30, 2012.
Provision for Income Taxes. Income tax expense decreased by $322,000, or 60.0%, to $215,000 for the year ended June 30, 2012 from $537,000 for the year ended June 30, 2011. The change can be attributed to non-taxable income from bank owned life insurance and dividends from investment securities, a 22.6% decrease in pre-tax income and changes in other temporary differences. Our effective tax rate was 17.0% for the year ended June 30, 2012, compared to 32.8% for the year ended June 30, 2011. The effective tax rates differed from the statutory tax rate of 34% primarily due to the dividends-received deduction applicable to certain securities in our investment portfolio, tax-exempt municipal income and non-taxable bank-owned life insurance income.
Average Balance Sheet
The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.
Market Risk, Liquidity and Capital Resources
Market Risk
The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk (“IRR”). Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits and other borrowings. As a result, a principal part of our business strategy is to manage IRR and reduce the exposure of our net interest income (“NII”) to changes in market interest rates. Accordingly, our Board of Directors has established an Asset/Liability Management Committee which is responsible for evaluating the IRR inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors. With the assistance of an IRR management consultant, the committee monitors the level of IRR on a regular basis and generally meets at least on a quarterly basis to review our asset/liability policies and IRR position.
We have sought to manage our IRR in order to minimize the exposure of our earnings and capital to changes in interest rates. As part of our ongoing asset/liability management, we currently use the following strategies to manage our IRR: (i) using alternative funding sources, such as advances from the Federal Home Loan Bank of Boston, to “match fund” certain investments and/or loans; (ii) continued emphasis on increasing core deposits; (iii) offering adjustable rate and shorter-term home equity loans, commercial real estate loans, construction loans and commercial and industrial loans; (iv) offering a variety of consumer loans, which typically have shorter-terms; (v) investing in mortgage-backed securities with variable rates or fixed rates with shorter durations. Shortening the average maturity of our interest-earning assets by increasing our investments in shorter-term loans and securities, as well as loans and securities with variable rates of interest, helps to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our NII to changes in market interest rates.
Net interest income at-risk measures the risk of a decline in earnings due to potential short-term and long term changes in interest rates. The table below represents an analysis of our IRR as measured by the estimated changes in NII, resulting from an instantaneous and sustained parallel shift in the yield curve (+100 and +200 basis points) at June 30, 2012 and June 30, 2011.
The preceding income simulation analysis does not represent a forecast of NII and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, which are subject to change, including: the nature and timing of interest rate levels including the yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. Also, as market conditions vary prepayment/refinancing levels will likely deviate from those assumed, the varying impact of interest rate changes on caps and floors embedded in adjustable rate loans, early withdrawal of deposits, changes in product preferences, and other internal/external variables.
Net Portfolio Value Simulation Analysis. We compute the amounts by which the net present value of our cash flow from assets, liabilities and off-balance sheet items (the institution’s net portfolio value or “NPV”) would change in the event of a range of assumed changes in market interest rates. Given the current low level of market interest rates, we do not prepare a net portfolio value calculation for an interest rate decrease of greater than 100 basis points. A basis point equals one-hundredth of one percent, and 200 basis points equals two percent, an increase in interest rates from 3% to 5% would mean, for example, a 200 basis point increase in the “Change in Interest Rates” column below.
The tables below set forth, at June 30, 2012, the estimated changes in our net portfolio value that would result from the designated instantaneous changes in the United States Treasury yield curve based on information produced by an external consultant. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. This data is for Putnam Bank only and does not include any yield curve changes in the assets of PSB Holdings, Inc
(1)
Assumes an instantaneous uniform change in interest rates at all maturities.
(2)
NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.
(3)
Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.
(4)
NPV ratio represents NPV divided by the present value of assets.
Liquidity and Capital Resources
The term “liquidity” refers to the ability of the Company and the Bank to meet current and future short-term financial obligations. The Company and the Bank further define liquidity as the ability to generate adequate amounts of cash to fund loan originations, deposit withdrawals and operating expenses. Liquidity management is both a daily and long-term function of business management. The Bank’s primary sources of liquidity are deposits, scheduled amortization and prepayments of loan principal and mortgage-related securities, and Federal Home Loan Bank borrowings. The Bank can borrow funds from the Federal Home Loan Bank based on eligible collateral of loans and securities. The Bank had Federal Home Loan Bank borrowings as of June 30, 2012 of $53.5 million with unused borrowing capacity of $60.6 million.
The Bank’s primary investing activities are the origination of loans and the purchase of investment securities. The Bank’s net loan principal repayments net of originations were $1.8 million for the fiscal year ended June 30, 2012 and $282,000 for the fiscal year ended June 30, 2011. Purchases of securities totaled $38.0 million and $93.7 million, for the years ended June 30, 2012 and 2011, respectively.
Loan repayments and maturing investment securities are a relatively predictable source of funds. However, deposit flows, calls of investment securities and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and economic conditions and competition in the marketplace. These factors reduce the predictability of the timing of these sources of funds. Deposit flows are affected by the level of interest rates, by the interest rates and products offered by competitors and by other factors. The Bank monitors its liquidity position frequently and anticipates that it will have sufficient funds to meet its current funding commitments.
Certificates of deposit totaled $134.5 million at June 30, 2012. The Bank relies on competitive rates, customer service and long-standing relationships with customers to retain deposits. Based on the Bank’s experience with deposit retention and current retention strategies, management believes that, although it is not possible to predict future terms and conditions upon renewal, a significant portion of such deposits will remain with the Bank.
Management is not aware of any known trends, events or uncertainties that will have, or are reasonably likely to have, a material effect on the Company’s or the Bank’s liquidity, capital or operations, nor is management aware of any current recommendations by regulatory authorities which, if implemented, would have a material effect on the Company’s or the Bank’s liquidity, capital or operations.
Off-Balance Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, lines of credit, and letters of credit.
For the year ended June 30, 2012, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
Impact of Recent Accounting Pronouncements
For a discussion of the impact of recent accounting pronouncements, see note 2 of the notes to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.
Effect of Inflation and Changing Prices
The financial statements and related financial data presented in this Annual Report on Form 10-K have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
ITEM 7A.
ITEM 7A.
Quantitative and Qualitative Disclosures About Market Risk
Information required by this item is included in “ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation,” above.
ITEM 8.
ITEM 8.
Consolidated Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
PSB Holdings, Inc.
We have audited the consolidated balance sheet of PSB Holdings, Inc. and Subsidiary (the “Company”) as of June 30, 2012, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit 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 provides 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 as of June 30, 2012, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
Boston, Massachusetts
September 26, 2012
The Board of Directors and Stockholders
PSB Holdings, Inc.
Putnam, Connecticut
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have audited the accompanying consolidated balance sheet of PSB Holdings, Inc. and Subsidiary as of June 30, 2011 and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit 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 consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of PSB Holdings, Inc. and Subsidiary as of June 30, 2011, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
SHATSWELL, MacLEOD & COMPANY, P.C.
West Peabody, Massachusetts
September 20, 2011
PSB Holdings, Inc. and Subsidiary
Consolidated Balance Sheets
June 30, 2012 and 2011
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
PSB Holdings, Inc. and Subsidiary
Consolidated Statements of Income
Years Ended June 30, 2012 and 2011
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
PSB Holdings, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders’ Equity
Years Ended June 30, 2012 and 2011
(1) The June 30, 2012 and 2011 ending balances include $1,250,000 and $2,887,000, respectively, of pre-tax unrealized losses in which other-than-temporary impairment has been recognized.
(continued)
The accompanying notes are an integral part of these consolidated financial statements.
PSB Holdings, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders’ Equity (Concluded)
Years Ended June 30, 2012 and 2011
At June 30, 2012, accumulated other comprehensive loss consist of $1,534,000 in net unrealized losses on securities available-for-sale, net of tax effects of $521,000.
The accompanying notes are an integral part of these consolidated financial statements.
PSB Holdings, Inc. and Subsidiary
Consolidated Statements of Cash Flows
Years Ended June 30, 2012 and 2011
(continued)
The accompanying notes are an integral part of these consolidated financial statements.
PSB Holdings, Inc. and Subsidiary
Consolidated Statement of Cash Flows (Concluded)
Years Ended June 30, 2012 and 2011
The accompanying notes are an integral part of these consolidated financial statements.
PSB Holdings, Inc. and Subsidiary
Notes to Financial Statements
Years Ended June 30, 2012 and 2011
1. NATURE OF OPERATIONS
PSB Holdings, Inc. (the “Company”) is a federally chartered holding company formed on May 27, 2003 for the purpose of acquiring all of the common stock of Putnam Bank (the “Bank”) concurrent with the Bank’s reorganization from a mutual savings institution to the mutual holding company form of organization. No shares were offered to the public as part of this reorganization.
On October 4, 2004, the Company completed a plan of stock issuance pursuant to which 44.5% of its common stock was sold to eligible depositors and the Putnam Savings Bank Employee Stock Ownership Plan (“ESOP”). The Company issued a total of 6,943,125 shares.
3,729,846 shares, representing 53.72% of total shares issued, were issued to Putnam Bancorp MHC in exchange for its ownership of the bank. The sole purpose of Putnam Bancorp MHC is to own a majority of the common stock of PSB Holdings, Inc.
As part of the stock issuance, the Bank established the ESOP, which purchased 257,062 shares of common stock. The ESOP borrowed the necessary funds from the Company. The Bank intends to make annual contributions adequate to meet the debt service requirements of the ESOP.
In connection with the stock offering the Company established The Putnam Savings Foundation and contributed 123,588 shares of common stock, representing 4% of shares sold to the public. The Foundation supports charities in the geographic area the Bank serves.
The Bank is a federally chartered savings bank and provides a full range of banking services to individual and small business customers located primarily in Connecticut. The Bank is subject to competition from other financial institutions throughout the region. There are no concentrations of credit to borrowers that have similar economic characteristics. The majority of the Company’s loan portfolio is comprised of loans collateralized by real estate located in the state of Connecticut.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of the Company and its subsidiary conform to accounting principles generally accepted in the United States of America and predominant practices within the banking industry. The consolidated financial statements of the Company were prepared using the accrual basis of accounting. The significant accounting policies of the Company are summarized below to assist the reader in better understanding the consolidated financial statements and other data contained herein.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change are the allowance for loan losses, other-than-temporary impairment of securities, the valuation of goodwill and the valuation of deferred tax assets.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank, and the Bank’s wholly owned subsidiaries, Windham North, LLC, PSB Realty, LLC and Putnam Bank Mortgage Servicing Company. All significant intercompany accounts and transactions have been eliminated in the consolidation.
Cash and Cash Equivalents
For the purposes of reporting cash flows, cash and cash equivalents include cash, amounts due from depository institutions and interest-bearing deposits with other banks.
Cash and due from banks as of June 30, 2012 and 2011 includes $5,650,000, which is subject to withdrawals and usage restrictions to satisfy the reserve requirements of the Federal Reserve Bank, target balances at Bankers Bank Northeast and for other purposes.
Cash is maintained in bank accounts which, at times may exceed insured limits. The Company has not experienced any issues in such accounts and does not believe it is exposed to any significant credit risk on cash.
Securities
Investments in debt securities are adjusted for amortization of premiums and accretion of discounts computed so as to approximate the interest method. Gains or losses on sales of investment securities are computed on a specific identification basis. All security transactions are recorded on the trade date.
The Company classifies debt and equity securities into one of three categories: held-to-maturity, available-for-sale, or trading. These security classifications may be modified after acquisition only under certain specified conditions. In general, securities may be classified as held-to-maturity only if the Company has the positive intent and ability to hold them to maturity. Trading securities are defined as those bought and held principally for the purpose of selling them in the near term. All other securities must be classified as available-for-sale.
Held-to-maturity securities are measured at amortized cost in the consolidated balance sheets. Unrealized holding gains and losses are not included in earnings or in other comprehensive income/loss. They are disclosed in the notes to the consolidated financial statements.
Available-for-sale securities are carried at fair value on the consolidated balance sheets. Unrealized holding gains and losses are not included in earnings but are included in other comprehensive income/loss, net of applicable taxes.
Trading securities are carried at fair value on the consolidated balance sheets. Unrealized holding gains and losses for trading securities are included in earnings. The Company held no securities classified as trading at June 30, 2012 and 2011.
Each reporting period, the Company evaluates all securities classified as available-for-sale or held-to-maturity, with a decline in fair value below the amortized cost of the investment to determine whether or not the impairment is deemed to be other-than-temporary (“OTTI”).
OTTI is required to be recognized if (1) the Company intends to sell the security; (2) it is “more likely than not” that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. Marketable equity securities are evaluated for OTTI based on the severity and duration of the impairment and, if deemed to be other than temporary, the declines in fair value are reflected in earnings as realized losses. For impaired debt securities that the Company intends to sell, or more likely than not will be required to sell, the full amount of the depreciation is recognized as OTTI through earnings. For all other impaired debt securities, credit-related OTTI is recognized through earnings and non-credit related OTTI is recognized in other comprehensive income/loss, net of applicable taxes.
Federal Home Loan Bank of Boston Stock, at Cost
The Bank, as a member of the Federal Home Loan Bank (“FHLB”) system, is required to maintain an investment in capital stock of the FHLB of Boston. Based on redemption provisions, the stock has no quoted market value and is carried at cost. At its discretion, the FHLB of Boston may declare dividends on the stock. The Bank reviews for impairment based on the ultimate recoverability of the cost basis in the stock. As of June 30, 2012, no impairment has been recognized.
Loans Held-For-Sale
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are provided for in a valuation allowance by charges to income.
Interest income on loans held-for-sale is accrued currently and classified as interest on loans.
Loans
The Company’s loan portfolio includes residential real estate, commercial real estate, residential construction, commercial and consumer/other segments. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.
The accrual of interest on all loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.
The allowance for loan losses is evaluated on a quarterly basis by management. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of general, specific and unallocated components, as further described below.
General component
The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate, commercial real estate, residential construction, commercial and consumer/other. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies; loan concentrations, trends in volume and terms of loans; changes in lending practices and procedures; changes in lending management and staff; changes in the value of underlying collateral; changes in the quality of the loan review system; national and local economic trends and conditions and the effects of other external factors. During the year ended June 30, 2012, the Company changed the allowance for loan loss calculation to add certain qualitative factors and amend loan segment characterization, resulting in a change in accounting estimate. Qualitative factors were added for changes in lending practices and procedures; changes in the value of underlying collateral; changes in lending management and staff; changes in the quality of the loan review system and the effects of other external factors. In addition, loan segments within the allowance were amended to correspond to call report requirements. These changes did not quantitatively impact the dollar amount of the allowance for loan losses at June 30, 2012, as changes relate only to qualitative assessments and methodology in how the allowance is calculated.
The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:
Residential real estate - The Company generally does not originate loans with a loan-to-value ratio greater than 80% and does not originate subprime loans. All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.
Commercial real estate - Loans in this segment are primarily income-producing properties throughout New England. The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on the credit quality in this segment. Management obtains rent rolls annually and continually monitors the cash flows of these loans.
Residential construction - Loans in this segment primarily include speculative real estate development loans for which payment is derived from sale of the property. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.
Commercial - Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.
Consumer/other - Loans in this segment are generally secured and repayment is dependent on the credit quality of the individual borrower.
Specific component
The specific component relates to loans that are classified as impaired. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent or foreclosure is probable. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring (“TDR”) agreement.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring. All TDRs are initially classified as impaired.
Unallocated component
An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general reserves in the portfolio.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Cost and related allowances for depreciation and amortization of premises and equipment retired or otherwise disposed of are removed from the respective accounts with any gain or loss included in income or expense. Depreciation and amortization are calculated principally on the straight-line method over the estimated useful lives of the assets or term of lease if shorter. Estimated lives are 5 to 40 years for buildings and premises, 3 to 20 years for furniture, fixtures and equipment and lease terms range from 1 to 25 years. Expenditures for replacements or major improvements are capitalized; expenditures for normal maintenance and repairs are charged to expense as incurred.
Other Real Estate Owned
Other real estate owned includes properties acquired through foreclosure and properties classified as in-substance foreclosures. These properties are carried at the lower of cost or estimated fair value less estimated costs to sell. Any write-down from cost to estimated fair value required at the time of foreclosure or classification as in-substance foreclosure is charged to the allowance for loan losses. Expenses incurred in connection with maintaining these assets, subsequent write-downs and gains or losses recognized upon sale are charged to expense.
Goodwill
Goodwill is measured as the excess of the cost of a business acquisition over the sum of the amounts assigned to identifiable tangible and intangible assets acquired less liabilities assumed. Goodwill is not amortized but is reviewed for impairment annually or more frequently if circumstances warrant. The goodwill impairment analysis is a two-step test.
The first step (“Step 1”) is used to identify potential impairment, and involves comparing the reporting unit’s (the consolidated Company, in our case) estimated fair value to its carrying amount, including goodwill. If the estimated fair value of the reporting unit exceeds its carrying amount, goodwill is not deemed to be impaired. Should the carrying amount of the reporting unit exceed its estimated fair value, an indicator of impairment is deemed to exist and a second step is performed to measure the amount of such impairment, if any. The second step (“Step 2”) involves calculating the implied fair value of goodwill. The implied fair value of goodwill is determined in a manner similar to how the amount of goodwill is determined in a business combination (i.e. by measuring the excess of the
estimated fair value, as determined in Step 1, over the aggregate estimated fair values of the individual assets, liabilities, and identifiable intangibles as of the impairment testing date). If the implied fair value of goodwill exceeds the carrying amount of goodwill assigned to the reporting unit, no impairment exists. If the carrying amount of goodwill exceeds the implied fair value of the goodwill, an impairment loss is recorded in an amount equal to such excess. An impairment loss cannot exceed the carrying amount of goodwill, and the loss (write-down) establishes a new carrying amount for the goodwill. Subsequent reversal of goodwill impairment losses is not permitted. Application of the goodwill impairment test requires significant judgments including estimation of future cash flows, which are dependent on internal forecasts, estimation of the long-term rate of growth, the period over which cash flows will occur, and determination of our cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and/or conclusions related to goodwill impairment. For the year ended June 30, 2012, the Company had no goodwill impairment.
Bank-owned Life Insurance
Bank-owned life insurance policies are reflected on the consolidated balance sheet at cash surrender value. Changes in the net cash surrender value of the policies, as well as insurance proceeds received, are reflected in non-interest income on the consolidated statement of income and are not subject to income taxes.
Fair Value of Financial Instruments
The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Fair value methods and assumptions used by the Company in estimating its fair value disclosures are as follows:
Cash and Cash Equivalents: The carrying amounts of cash and cash equivalents approximate fair values based on the short-term nature of the assets.
Investment Securities and FHLB Stock: As of June 30, 2012, all fair value measurements on investment securities are obtained from a third party pricing source and are not adjusted by management. The fair value of securities to be held-to-maturity and available-for-sale is estimated based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Ownership of FHLB of Boston stock is restricted to member banks; therefore, the stock is not traded. The estimated fair value of FHLB of Boston stock is equal to its carrying value, which represents the price at which the FHLB of Boston is obligated to redeem its stock.
Loans, net: For valuation purposes, the loan portfolio was segregated into its significant categories, which are residential real estate, commercial real estate, residential construction, commercial and consumer/other loans. These categories were further segregated, where appropriate, into components based on significant financial characteristics such as type of interest rate (fixed or adjustable). Fair values were estimated for each component using assumptions developed by management and a valuation model provided by a third party specialist.
The fair values of residential real estate, commercial real estate, residential construction, commercial and consumer and other loans were estimated by discounting the anticipated cash flows from the respective portfolios. Estimates of the timing and amount of these cash flows considered factors such as future loan prepayments. The discount rates reflected current market rates for loans with similar terms to borrowers of similar credit quality. The fair value of home equity lines of credit was based on the outstanding loan balances. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Loans held for sale: Loans held for sale are accounted for at the lower of cost or market and the fair value of loans held for sale are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted as required for changes in loan characteristics.
Accrued interest: The carrying amounts of accrued interest approximate fair value.
Deposits and Mortgagors’ Escrow: The fair value of deposits with no stated maturity such as demand deposits, NOW, regular savings, and money market deposit accounts, and mortgagors’ escrow accounts, is equal to the amount payable on demand. The fair value estimates do not include the benefit that results from the generally lower cost of funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. The fair value estimate of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using market rates currently offered for deposits having similar remaining maturities.
Federal Home Loan Bank Advances: The fair values of the Company’s Federal Home Loan Bank advances are estimated using discounted cash flow analyses based on the current incremental borrowing rates in the market for similar types of borrowing arrangements.
Securities Sold Under Agreements to Repurchase: The Company enters into overnight repurchase agreements with its customers. Since these agreements are short-term instruments, the fair value of these agreements approximates their recorded balance. The fair value of these agreements are determined by discounting the anticipated future cash payments using rates currently available to the Bank for debt with similar terms and remaining maturities.
Off-Balance Sheet Instruments: The fair value of off-balance-sheet mortgage lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. In the case of the commitments discussed in Note 12, the fair value equals the carrying amounts which are not significant.
Earnings per Share (EPS)
Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. If rights to dividends on unvested options/awards are non-forfeitable, these unvested awards/options are considered outstanding in the computation of basic earnings per share. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options and restricted stock awards and are determined using the treasury stock method.
Treasury shares and unallocated ESOP shares are not deemed outstanding for earnings per share calculations.
Earnings per share have been computed based on the following:
At June 30, 2012, options for 222,921 shares were not included in the computation of earnings per share as the effects were anti-dilutive.
Transfers of Financial Assets
Transfers of an entire financial asset, a group of entire financial assets, or a participating interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets.
Advertising
The Company directly expenses costs associated with advertising as they are incurred.
Income Taxes
Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax basis of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. A valuation allowance is established against deferred tax assets when, based upon the available evidence including historical and projected taxable income, it is more likely than not that some or all of the deferred tax assets will not be realized.
Income tax benefits related to stock compensation in excess of grant date fair value less any proceeds on exercise are recognized as an increase to additional paid-in capital upon vesting or exercising and delivery of the stock. Any income tax effects related to stock compensation that are less than grant date fair value less any proceeds on exercise would be recognized as a reduction of additional paid in capital to the extent of previously recognized income tax benefits and then through income tax expense for the remaining amount.
Employee Benefit Plans
The Company established an Employee Stock Ownership Plan (the ESOP) as part of its minority stock issuance on October 4, 2004. The ESOP is accounted for in accordance with Accounting Standards Codification (“ASC”) 718-40, “Compensation - Stock Compensation - Employee Stock Ownership Plan.” Under ASC 718-40, unearned ESOP shares are not considered outstanding and are therefore not taken into account when computing earnings per share. Unearned ESOP shares are presented as a reduction to stockholders’ equity and represent shares to be allocated to ESOP participants in future periods for services provided to the Company. As shares are committed to be released, compensation expense is recognized for the fair market value of the stock and stockholders’ equity is increased by a corresponding amount. The loan to the ESOP will be repaid principally from the Bank’s contributions to the ESOP and dividends payable on common stock held by ESOP over a period of 20 years.
As more fully described in Note 14, the Company has a stock-based incentive plan authorizing various types of incentive awards that may be granted to directors, officers and employees. The Company accounts for the plan under ASC 718-10, “Compensation - Stock Compensation - Overall.” In accordance with ASC 718-10, the Company records share-based compensation expense related to outstanding stock option and restricted stock awards based upon the fair value at the date of grant over the vesting period of such awards on a straight-line basis. During the years ended June 30, 2012 and 2011, $24,000 and $121,000, respectively, in stock-based employee compensation was recognized.
Recent Accounting Pronouncements
In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-02, Receivables (Topic 310), A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update provides additional guidance and clarification to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring (“TDR”). This update is effective for the first interim or annual period beginning on or after June 15, 2011, with retrospective application to the beginning of the annual period of adoption. The measurement of impairment should be done prospectively in the period of adoption for loans that are newly identified as TDRs upon adoption of this update. In addition, the TDR disclosures required by ASU 2010-20, Receivables (Topic 310), Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses should be provided beginning in the period of adoption of this update. This guidance was adopted by the Company as of July 1, 2011 and did not have a material impact on the Company’s consolidated financial statements.
In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing (Topic 860), Reconsideration of Effective Control for Repurchase Agreements. This update removes from the assessment of effective control for repurchase agreements (1) the criterion used to assess effective control relating to the transferor’s ability to repurchase or redeem financial assets even in the event of a default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. This update is effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. This guidance was adopted by the Company as of January 1, 2012, and did not have a material impact on the Company’s consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This update clarifies and expands the disclosures pertaining to unobservable inputs in Level 3 fair value measurements. The guidance also requires, for public companies, disclosure of the level within the fair value hierarchy for assets and liabilities not measured at fair value in the statement of financial position but for which the fair value is disclosed. The amendments in this update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. This guidance was adopted by the Company as of January 1, 2012, and did not have a material impact on the Company’s consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income. This update amends the disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (OCI) as part of the statement of changes in stockholder’s equity. Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The changes, as modified by ASU 2011-12, are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, although early application is permitted. In December 2011, the FASB issued ASU 2011-12 to defer changes that relate to the presentation of reclassification adjustments but the other requirements of ASU 2011-05 remain in effect. This amendment will be effective for the Company for annual and interim periods beginning July 1, 2012 and is not expected to have a material impact on the Company’s consolidated financial statements.
In September 2011, the FASB issued ASU 2011-08, Intangibles - Goodwill and Other (Topic 350), Testing Goodwill for Impairment. This update is intended to reduce the complexity and cost of performing an evaluation of impairment of goodwill. Under the new guidance, an entity will have the option of first assessing qualitative factors (events and circumstances) to determine whether it is more likely than not (meaning a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. If, after considering all relevant events and circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test will be unnecessary. The amendments will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. This amendment will be effective for the Company for annual and interim periods beginning July 1, 2012 and is not expected to have a material impact on the Company’s consolidated financial statements.
3. INVESTMENT SECURITIES
Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent. The amortized cost of securities and their fair values, by maturity, are as follows as of the dates indicated:
Proceeds from sales of available-for-sale securities during the year ended June 30, 2012 amounted to $328,000. Gross realized gains and gross realized losses on those sales amounted to $235,000 and $0, respectively. Proceeds from sales of available-for-sale securities during the year ended June 30, 2011 amounted to $6,636,000. Gross realized gains and gross realized losses on those sales amounted to $254,000 and $0, respectively.
During the years ended June 30, 2012 and 2011, the Company received a legal settlement on securities previously written-down due to OTTI in the amounts of $1,452,000 and $420,000, respectively.
The aggregate amortized cost basis and fair value of securities of non-government issuers which exceeded 10% of stockholders’ equity were as follows as of June 30, 2012:
As of June 30, 2012, the total carrying value of securities pledged as collateral to secure public deposits, the Federal Reserve Bank discount window, borrowings and repurchase agreements was $69,965,000. As of June 30, 2011, the total carrying value of securities pledged as collateral to secure public deposits, the Federal Reserve Bank discount window, and repurchase agreements was $35,841,000.
The aggregate fair value and unrealized losses of securities that have been in a continuous unrealized loss position for less than twelve months and for twelve months or more are as follows as of the dates indicated:
(1) Includes other-than-temporary impaired available-for-sale debt securities in which a portion of the other-than-temporary impairment loss remains in accumulated other comprehensive loss.
At June 30, 2012, the Company had seven U.S. government-sponsored and guaranteed securities with an unrealized loss. The unrealized losses were primarily caused by interest rate fluctuations. These investments are guaranteed or sponsored by the U.S. government or an agency thereof. Accordingly, it is expected that the securities would not be settled at a price less than the par value of the investment. Because the decline in market value is attributable to changes in interest rates and not to credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2012.
At June 30, 2012, the Company had five corporate bonds and other securities with an unrealized loss. These unrealized losses relate to investments in companies within the financial services sector. The unrealized losses are primarily caused by (a) interest rate fluctuations, (b) recent decreases in profitability and near-term profit forecasts by industry analysts and (c) recent downgrades by industry analysts. The contractual terms of these investments do not permit the companies to settle the security at a price less than the par value of investment. While the companies’ credit ratings have decreased, the Company currently does not believe it is probable that it will be unable to collect all amounts due according to the contractual terms of the investments. Therefore, it is expected that the bonds would not be settled at a price less than the par value of the investment. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2012.
For the years ended June 30, 2012, securities with other-than-temporary impairment losses related to credit loss that were recognized in earnings consisted of non-agency mortgage-backed securities. For these debt securities, the Company estimated the portion of loss attributable to credit loss using a discounted cash flow model. Significant inputs included the estimated cash flows of the underlying loans based on key assumptions, such as default rate, loss severity and prepayment rate. Assumptions can vary widely from security to security, and are influenced by such factors as loan interest rate, geographical location of the borrower, borrower characteristics and collateral type. The present value of the expected cash flows was compared to the Company’s amortized cost basis to determine the credit-related impairment loss. Based on the expected cash flows derived from the model, the Company expects to recover the remaining unrealized losses on these securities.
For those debt securities for which the fair value of the security is less than its amortized cost and the Company does not intend to sell such security and it is more likely than not that it will not be required to sell such security prior to the recovery of its amortized cost basis less any credit losses, the credit component of the other-than-temporary impairment losses is recognized in earnings while the non-credit component is recognized in other comprehensive income/loss, net of related taxes.
The following table summarizes other-than-temporary impairment losses on securities for the years ended:
(1) Represents the non-credit component of the other-than-temporary impairment.
(2) Represents the credit component of the other-than-temporary impairment.
Activity related to the credit component recognized in earnings on debt securities held by the Company for which a portion of other-than-temporary impairment was recognized in accumulated other comprehensive loss for the year end June 30, 2012 and 2011 is as follows:
Significant assumptions used in the valuation of non-agency mortgage-backed securities were as follows as of June 30, 2012:
At June 30, 2012 and 2011, the auction-rate trust preferred securities (ARP) portfolio totaled $9,636,000 and $10,400,000 respectively, all of which were classified as available-for-sale. At June 30, 2012, two ARP’s were in an unrealized loss position. Auction-rate trust preferred securities are a floating rate preferred stock, on which the dividend rate generally resets every 90 days based on an auction process to reflect the yield demand for the instruments by potential purchasers. Our investments in auction-rate trust preferred securities consist of investments in three corporate issuers. These securities were originally purchased by the Company because they represented highly liquid, tax-preferred investments secured, in most cases, by preferred stock issued by high quality, investment grade companies (generally other financial institutions) (“collateral preferred shares”). The ARP shares, or certificates, purchased by the Company are Class A certificates, which, among other rights, entitle the holder to priority claim on dividends paid into the Trust holding the preferred shares.
In most cases, the trusts which issued the ARP certificates own various callable preferred shares of stock by a single entity. In addition to the call dates for redemption established by the collateral preferred shares, each trust has a maturity date upon which the trust itself will terminate. The value of the remaining collateral preferred shares is not guaranteed, and may be more or less than the stated par value of the collateral preferred shares, and is dependent on the market value of those collateral preferred shares on the date of the trust’s maturity.
The certificates issued by the trusts traded in an active, open auction market, with each individual trust establishing the frequency of its auctions, typically every 90 days (the “reset date”). The results of an auction would be the exchange of certificates, at par, between participants entering or exiting the market, and resetting of the yield to be earned by holders of the Class A certificates as well as the holders of other classes of trust certificates.
Beginning in February 2008, auctions for these securities began to fail when investors declined to bid on the securities. Five of the largest investment banks that made a market in these securities (Merrill Lynch, Citigroup, UBS, AIG and Morgan Stanley) declined to act as bidders of last resort, as they had in the past. The auction failures did not result in the loss of any principal value to the certificate holders, but prevented many sellers from exiting, or redeeming, their certificates at the reset date. These unsuccessful sellers were required to continue to hold the certificates until the next scheduled reset date. To compensate these unsuccessful sellers, the failed auctions triggered a penalty-rate feature which provided that owners of the Class A certificates were entitled to a higher portion of the dividends, and thus a higher yield, on the Class A certificates.
During this time, the Company attempted to divest itself of the ARPs, but was prevented from doing so due to the continued failure of the auction market. The Company continued to carry its investments at par value, despite the increased liquidity risk, because the credit strength of the issuers of the collateral preferred shares remained high, and the yield remained above-market.
The turmoil in the financial markets caused the value of the underlying collateral preferred shares to decline. These declines in value are not considered other-than-temporary at June 30, 2012 and 2011.
4. LOANS
Loans consisted of the following as of June 30:
The Company’s lending is conducted principally in Eastern Connecticut. The Company’s loan portfolio includes both adjustable and fixed rate loans. The composition of the Company’s loan portfolio, by maturity, at June 30, 2012 and 2011 was as follows:
The adjustable rate loans generally have interest rate adjustment limitations and are generally indexed to the Company’s cost of funds, prime rate, or to the U.S. Treasury Bill rate.
The following tables set forth information regarding the allowance for loan losses by portfolio segment at and for the years ended June 30, 2012 and 2011:
Credit Quality Information
The Company utilizes a nine grade internal loan rating risk system as follows:
Loans rated 1 - 5: Loans in these categories are considered “pass” rated loans with low to average risk.
Loans rated 6: Loans in this category are considered “special mention.” These loans are starting to show signs of potential weakness and are being closely monitored by management.
Loans rated 7: Loans in this category are considered “substandard.” Generally, a loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged. There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.
Loans rated 8: Loans in this category are considered “doubtful.” Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.
Loans rated 9: Loans in this category are considered uncollectible (“loss”) and of such little value that their continuance as loans is not warranted.
On an annual basis, or more often if needed, the Company formally reviews the ratings on all residential real estate, commercial real estate, residential construction, commercial and consumer/other loans. Annually, the Company engages an independent third-party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its annual review process. Credit quality for residential real estate and consumer/other loans is determined by monitoring loan payment history and ongoing communications with customers.
The following tables present the Company’s loans by risk rating as of June 30, 2012 and 2011.
The following is a summary of past due and non-accrual loans at June 30, 2012 and 2011:
At June 30, 2012, there were no loans greater than 90 days past due still accruing interest. At June 30, 2011, one residential real estate loan in the amount of $32,000 was greater than 90 days past due and still accruing interest.
The following is information pertaining to impaired loans:
Included in certain impaired loan categories are troubled debt restructurings that were classified as impaired. At June 30, 2012 and 2011, the Company had $8,237,000 and $5,682,000 in loans, respectively, that were modified in troubled debt restructurings and considered impaired.
The following table represents modifications that were deemed to be troubled debt restructures during the year ended June 30, 2012:
The majority of residential loans were modified to reduce stated interest rates and others were modified to extend maturity dates and change amortization schedules. The majority of commercial loans were modified to reduce stated interest rates and others were modified to grant interest-only payments on amortizing loans. Management performs a discounted cash flow calculation to determine the amount of impaired reserve required on each of the troubled debt restructures. Any reserve is recorded through the provision for loan losses.
The following is a summary of troubled debt restructurings that have subsequently defaulted within one year of modification during the year ended June 30, 2012.
The defaults on the residential and commercial loans were the result of the borrower’s delinquent loan payments. As of June 30, 2012, the commercial loan was current, one residential loan was current and the other was past due greater than 90 days and placed on non-accrual.
At June 30, 2012, $567,000 in additional funds are committed to be advanced in connection with TDR’s.
Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage and other loans serviced for others were $30,542,000 and $32,277,000 at June 30, 2012 and 2011, respectively. A portion of these loans were sold with certain recourse provisions, and at June 30, 2012 the related maximum contingent liability amounted to $445,000 which is not recorded in the consolidated financial statements. The Company has evaluated mortgage servicing rights related to loans sold with servicing retained and due to their immaterial amount, has not recorded a servicing asset.
Certain directors and executive officers of the Company and companies in which they have significant ownership interest were customers of the Bank during the year ended June 30, 2012 and 2011. Total loans to such persons and their companies amounted to $61,000 and $80,000 as of June 30, 2012 and 2011, respectively. During the year ended June 30, 2012 and 2011, principal payments totaled $19,000 and $17,000, and principal advances totaled $0 and $25,000, respectively.
5. PREMISES AND EQUIPMENT
The following is a summary of premises and equipment as of June 30:
Depreciation expense amounted to $393,000 and $496,000 for the years ended June 30, 2012 and 2011, respectively.
6. GOODWILL AND INTANGIBLE ASSETS
Intangible assets consist of goodwill and core deposit intangibles which resulted from the Bank’s purchase of three branches from another financial institution in October 2005. Goodwill is evaluated for impairment on an annual basis, and for the year ended June 30, 2012 and 2011 was not deemed to be impaired. The core deposit intangible is being amortized on an accelerated basis over a ten year period.
The amortization expense for the core deposit intangible was $122,000 and $149,000 for the years ended June 30, 2012 and June 30, 2011, respectively.
Expected future amortization expense is as follows:
The following table reflects the gross carrying amount of core deposits intangibles as of June 30:
7. DEPOSITS
The balances and the rates at which the Company paid interest on deposit accounts at June 30, were as follows:
The aggregate amount of time deposit accounts in denominations of $100,000 or more as of June 30, 2012 and 2011 was $62,390,000 and $64,650,000, respectively.
8. BORROWED FUNDS
Borrowed funds consisted of the following at June 30:
As of June 30, 2012 and 2011, loans with a principal balance of $84,992,000 and $122,215,000, respectively, were specifically pledged to secure available borrowings from the FHLB. The maturity schedule above reflects final maturity; however, some are callable by the FHLB of Boston at earlier dates.
Additionally, the Bank has a line of credit with Federal Home Loan Bank of Boston in the amount of $2,354,000. No amounts were outstanding at June 30 2012, and 2011.
Securities sold under agreements to repurchase as of June 30, 2012 and 2011 consist of securities sold on a short-term basis by the Bank that have been accounted for as borrowings. The securities consist of U.S. Government agency bonds that are held in the Bank’s safekeeping account at State Street Bank and Trust under the control of the Bank and pledged to the purchasers of the securities.
9. INCOME TAXES
The following are components of income tax expense (benefit) for the fiscal years ended June 30:
Deferred income taxes reflect the impact of “temporary differences” between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations.
The Bank established Putnam Bank Mortgage Servicing Company during the year ended June 30, 2007. The subsidiary qualifies and operates as a Connecticut passive investment company pursuant to legislation. Because the subsidiary earns sufficient income from passive investments and its dividends to the parent are exempt from Connecticut Corporation Business Tax, the subsidiary Bank no longer expects to incur Connecticut income tax expense or to recognize its Connecticut deferred tax asset. The Parent company is still subject to the Connecticut Corporation Business Tax.
The reasons for the differences between the statutory federal income tax rate of 34% and the effective tax rates are summarized as follows for the years ended June 30:
The Company had gross deferred tax assets and gross deferred tax liabilities as follows as of June 30:
Retained earnings at June 30, 2012 includes a contingency reserve for loan losses of $2,284,000 which represents the tax reserve balance existing at December 31, 1987 and is maintained in accordance with provisions of the Internal Revenue Code applicable to thrift institutions. It is not anticipated that the Company will incur a federal income tax liability related to the reduction of this reserve and accordingly, deferred income taxes of approximately $777,000 have not been recognized as of June 30, 2012 and 2011.
It is the Company’s policy to provide for uncertain tax positions and the related interest and penalties based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. As of June 30, 2012 and 2011, there were no material uncertain tax positions related to federal and state income tax matters. The Company is currently open to audit under statute of limitations by the Internal Revenue Service and state taxing authorities for the years ended June 30, 2009 through June 30, 2012. The Company records interest and penalties as part of income tax expense. No interest or penalties were recorded for the years ended June 30, 2012 and 2011.
10. COMMITMENTS AND CONTINGENT LIABILITIES
Lease Commitments
As of June 30, 2012 the Company leases space for its Gales Ferry, Griswold and Putnam Price Chopper branch offices. The leases for the branch offices expire March 31, 2015, October 31, 2014 and August 31, 2016, respectively. All leases contain renewal options at the Company’s discretion. The Company also has miscellaneous equipment leases with various terms. The total minimum rental due in future periods under these existing agreements is as follows as of June 30, 2012:
Total rental expense amounted to $153,000 and $162,000 for the years ended June 30, 2012 and 2011, respectively.
Legal Contingencies
Various legal claims also arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the Company’s consolidated financial statements.
11. FAIR VALUE MEASURMENTS
The Company groups its assets measured at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value.
Level 1 - Valuation is based on quoted prices in active markets for identical assets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets.
Level 2 - Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets.
Level 3 - Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets. Level 3 assets include financial instruments whose value is determined using unobservable inputs to pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. During the years ended June 30, 2012 and 2011, there were no significant transfers between level 1 and level 2 of the fair value hierarchy.
Assets Measured at Fair Value on a Recurring Basis
The following summarizes assets measured at fair value for the period ending June 30.
The table below represent the changes in Level 3 assets measured at fair value on a recurring basis for the years ended June 30, 2012 and 2011:
During the years ended June 30, 2012 and 2011, there were no gains or losses included in earnings attributable to the change in unrealized gains or losses relating to recurring Level 3 assets still held at June 30, 2012 or 2011.
There were no liabilities measured at fair value on a recurring basis at June 30, 2012 and 2011.
Assets Measured at Fair Value on a Non-Recurring Basis
Under certain circumstances the Company makes adjustments to fair value for assets not measured at fair value on an ongoing basis. The following table presents the assets carried on the consolidated balance sheet by caption and by level in the fair value hierarchy at June 30, 2012 and 2011, for which a nonrecurring fair value adjustment has been recorded:
The amount of loans represents the carrying value of impaired loans net of related write-downs and valuation allowances for which adjustments are based on the estimated fair value of the underlying collateral. The other real estate owned amount represents the carrying value for which adjustments are also based on the estimated fair value of the property.
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 a market may not readily exist 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.
There were no liabilities measured at fair value on a non-recurring basis at June 30, 2012 and 2011.
The estimated fair values and carrying values of the Company’s financial instruments, all of which are held or issued for purposes other than trading, are as follows as of June 30:
The carrying amounts of financial instruments shown in the above table are included in the consolidated balance sheets under the indicated captions. Accounting policies related to financial instruments are described in Note 2.
12. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The Company is 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 to originate loans, standby letters of credit and unadvanced funds on loans. The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for loan commitments is represented by the contractual amounts of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to originate loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. 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 by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include secured interests in mortgages, accounts receivable, inventory, property, plant and equipment and income-producing properties.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. As of June 30, 2012 and 2011, the maximum potential amount of the Company’s obligation was $842,000 and $782,000, respectively, for financial and standby letters of credit. The Company’s outstanding letters of credit generally have a term of less than one year. If a letter of credit is drawn upon, the Company may seek recourse through the customer’s underlying line of credit. If the customer’s line of credit is also in default, the Company may take possession of the collateral, if any, securing the line of credit.
Notional amounts of commitments with off-balance-sheet credit risk are as follows as of June 30:
13. REGULATORY MATTERS
The Company, as a federally chartered holding company, is not subject to capital requirements. The Bank is 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 Bank’s consolidated 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 1 capital (as defined in the regulations) to risk-weighted assets (as defined), of Core capital (as defined) to adjusted tangible assets (as defined) and Tangible capital (as defined) to Tangible assets (as defined). Management believes, as of June 30, 2012 and 2011, that the Bank meets all capital adequacy requirements to which it is subject.
As of June 30, 2012, the most recent notification from the Office of the Comptroller of the Currency (“OCC”) 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 1 risk-based, tangible equity and Core capital ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution’s category.
The Bank’s actual capital amounts and ratios as of June 30, 2012 and 2011 are also presented in the table:
The following table provides a reconciliation of the Company’s total consolidated equity to the capital amounts for the Bank reflected in the preceding table:
The Bank’s capital under generally accepted accounting principles is reconciled as follows as of June 30:
The ability of the Company to pay dividends depends, in part, on the ability of the Bank to pay dividends to the Company. The Bank will not be able to declare or pay a cash dividend on, or repurchase any of its common stock, if the effect thereof would be to reduce the regulatory capital of the Bank to an amount below amounts required under OCC rules and regulations.
On June 20, 2012, the Bank entered into an agreement with the OCC (the “Agreement”). As part of the Agreement, the OCC required the Bank to take a number of specific corrective actions, and required that the Bank not undertake certain actions without obtaining prior approval of the OCC. The Agreement replaces a memorandum of understanding that Putnam Bank entered into with the Office of Thrift Supervision. Management has reviewed its obligations under the Agreement and believes it will be able to fully comply with the terms of the Agreement.
14. BENEFIT PLANS
Defined Contribution Plan
The Bank has a defined contribution plan that covers substantially all of the Bank’s employees. Contributions to the plan are discretionary and are voted on annually by the Board of Directors of the Bank. The Bank recognized expense of $158,000 and $231,000 for the years ended June 30, 2012 and 2011, respectively.
401(k) Plan
The Bank has a 401(k) plan covering each eligible employee. Employees must be 21 years of age, work at least 1,000 hours per year, and have at least one year of service with the Bank to be eligible to participate. Employees may defer gross compensation up to certain limits defined in the Internal Revenue Code. The Bank’s matching contribution is discretionary. For the years ended June 30, 2012 and 2011 the Bank chose to contribute 25% of an employee’s deferral on a maximum of 4% of the employee’s salary. The Bank contributed $33,000 to the plan during the years ended June 30, 2012 and 2011.
Other Postretirement Benefit Plan
The Bank has recorded a liability for its future postretirement benefit obligations under certain death benefit agreements. The total liability for the arrangements included in other liabilities was $162,000 at June 30, 2012 and $109,000 at June 30, 2011. Expense under this arrangement was $53,000 for 2012 and $6,000 for 2011. No death benefits were paid under this arrangement for 2012 and 2011.
Employee Stock Ownership Plan
The Bank established the ESOP on October 4, 2004 in connection with its common stock offering. The ESOP purchased 257,062 shares of the common stock of the Company. To fund the purchase, the ESOP borrowed $2.6 million from the Company. The borrowing is at an initial interest rate of 4.75% and is to be repaid on a pro-rata basis in 20 substantially equal annual installments. The collateral for the loan is the common stock of the Company purchased by the ESOP.
The shares of stock purchased by the ESOP are held in a suspense account until they are released for allocation among participants. The shares will be released annually from the suspense account and the released shares will be allocated amount the participants on the basis of each participant’s compensation for the year of allocation. As shares are released from collateral, the Bank recognizes compensation expense equal to the average market price of the shares during the period and the shares will be outstanding for earnings-per-share purposes. The shares not released are reported as unearned ESOP shares in the capital accounts of the consolidated balance sheets. ESOP expense for the years ended June 30, 2012 and 2011 was $60,000 and $57,000, respectively. At June 30, 2012 and 2011 there were 100,513 and 87,734 shares allocated, respectively, and 156,549 and 169,328 unreleased ESOP shares, respectively. The fair value of unreleased ESOP shares at June 30, 2012 and 2011 was $654,000 and $879,000, respectively.
Stock-based Incentive Plan
At the annual meeting of stockholders on October 31, 2005, stockholders of the Company approved the PSB Holdings, Inc. 2005 Stock-Based Incentive Plan (the Incentive Plan). Under the Incentive Plan, the Company may grant up to 340,213 stock options and 136,085 shares of restricted stock to its employees, officers and directors for an aggregate amount of up to 476,298 shares of the Company’s common stock for issuance upon the grant or exercise of awards. Both incentive stock options and non-statutory stock options may be granted under the Incentive Plan.
On November 7, 2005, the Company awarded 319,800 options to purchase the Company’s common stock and 129,281 shares of restricted stock. Stock option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of grant ($10.60) with a maximum term of ten years. Both stock option and restricted stock awards vest at 20% per year beginning on the first anniversary of the date of the grant.
On June 7, 2006, the Company awarded 18,000 options to purchase the Company’s common stock and 6,000 shares of restricted stock. Stock option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of grant ($10.78) with a maximum term of ten years. Both stock option and restricted stock awards vest at 20% per year beginning on the first anniversary of the date of the grant.
On May 25, 2007, the Company awarded 29,000 options to purchase the Company’s common stock and 9,500 shares of restricted stock. Stock option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of grant ($10.70) with a maximum term of ten years. Both stock option and restricted stock awards vest at 20% per year beginning on the first anniversary of the date of the grant. Stock options are considered common stock equivalents for the purpose of computing earnings per share on a diluted basis.
The Company has recorded share-based compensation expense related to outstanding stock option and restricted stock awards based upon the fair value at the date of grant over the vesting period of such awards on a straight-line basis. The fair value of each restricted stock allocation, based on the market price at the date of grant, is recorded to unearned stock awards. Compensation expenses related to unearned restricted shares are amortized to compensation and benefits expense over the vesting period of the restricted stock awards. The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model which includes several assumptions such as volatility, expected dividends, expected term and risk-free rate for each stock option award.
In determining the expected term of the option awards, the Company elected to follow the simplified method as permitted by ASC 718-10-599-1, which was issued to provide guidance on the implementation of ASC 718-10. Under this method, the Company has estimated the expected term of the options as being equal to the average of the vesting term plus the original contractual term. The Company estimated its volatility using the historical volatility of other, similar companies during a period of time equal to the expected life of the options. The risk-free rate for the periods within the contractual life of the options is based upon the U.S. Treasury yield curve in effect at the time of grant. The weighted-average fair value of stock options granted using the Black-Scholes option pricing model and the assumptions used to determine the weighted-average fair value of stock options granted were as follows:
A summary of the status of the Incentive Plan as of June 30, 2012 and 2011 and changes during the years then ended is presented below:
The following table summarizes information about stock options outstanding as of June 30, 2012:
At June 30, 2012, there were no unrecognized compensation costs related to nonvested share based compensation. The Company recorded share-based compensation expense of $24,000 and $121,000 for the years ended June 30, 2012 and 2011, respectively, in connection with the stock option and restricted stock awards.
15. RECLASSIFICATION
Certain amounts in the prior year have been reclassified to be consistent with the current year’s statement presentation.
16. PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following financial statements are for the Company (Parent Company) and should be read in conjunction with the consolidated financial statements of the Company.
PSB Holdings, Inc. and Subsidiary
(Parent Company Only)
Balance Sheets
June 30, 2012 and 2011
(In thousands)
PSB Holdings, Inc. and Subsidiary
(Parent Company Only)
Statements of Income
For the Years Ended June 30, 2012 and 2011
(In thousands)
PSB Holdings, Inc. and Subsidiary
(Parent Company Only)
Statements of Cash Flows
June 30, 2012 and 2011
(In thousands)
ITEM 9.
ITEM 9.
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
Information concerning principal accountant fees and services is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Proposal 2-Ratification of Appointment of Independent Registered Public Accounting Firm.”
ITEM 9A.
ITEM 9A.
Controls and Procedures
(a) Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, (1) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (2) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer as appropriate to allow timely discussions regarding required disclosures.
There has been no change in the Company’s internal control over financial reporting during the Company’s fourth quarter of fiscal year 2012 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
(b) Management’s annual report on internal control over financial reporting.
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.
The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management, including the principal executive officer and principal financial officer, assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2012, based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in “Internal Control-Integrated Framework.” Based on such assessment, management believes that, as of June 30, 2012, the Company’s internal control over financial reporting is effective, based on those criteria.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. As the Company is a smaller reporting company, management’s report is not subject to attestation by the Company’s registered public accounting firm pursuant to provisions of the Dodd-Frank Act that permit the Company to provide only the management’s report in this annual report.
ITEM 9B.
ITEM 9B.
Other Information
None.
PART III
ITEM 10.
ITEM 10.
Directors, Executive Officers and Corporate Governance
PSB Holdings, Inc. has adopted a Code of Ethics that applies to PSB Holdings, Inc.’s principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions. The Code of Ethics can be accessed on PSB Holdings, Inc.’s website at www.putnambank.com. The Code of Ethics is Exhibit 14 to this Form 10-K.
Information concerning directors and executive officers of PSB Holdings is incorporated herein by reference from our definitive Proxy Statement to be dated October 1, 2012 related to the 2012 Annual Meeting of Stockholders (the “Proxy Statement”), specifically the section captioned “Proposal I-Election of Directors.”
ITEM 11.
ITEM 11.
Executive Compensation
Information concerning executive compensation is incorporated herein by reference from the Proxy Statement, specifically the section captioned “Proposal I-Election of Directors.”
ITEM 12.
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Proxy Statement, specifically the sections captioned “Voting Securities and Principal Holders Thereof” and “Proposal I-Election of Directors.”
Management of PSB Holdings, Inc. knows of no arrangements, including any pledge by any person or securities of PSB Holdings, Inc., the operation of which may at a subsequent date result in a change in control of the registrant.
Set forth below is information as of June 30, 2012 regarding equity compensation plans. Other than the ESOP, the Company does not have any equity compensation plans that were not approved by its stockholders.
(1)
Reflects options to purchase shares of common stock awarded under the Incentive Plan.
(2)
Relates to 222,921 outstanding stock options.
(3)
Includes 15,717 shares of restricted stock and 117,292 options available for issuance under the Incentive Plan.
ITEM 13.
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
Information concerning relationships and transactions is incorporated herein by reference from the Proxy Statement, specifically the sections captioned “Proposal I - Election of Directors” and “Transactions with Certain Related Persons.”
ITEM 14.
ITEM 14.
Principal Accountant Fees and Services
Information concerning principal accountant fees and services is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Proposal 2-Ratification of Appointment of Independent Registered Public Accounting Firm.”
PART IV
ITEM 15.
ITEM 15.
Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
(A) Management Responsibility Statement
(B) Report of Independent Registered Public Accounting Firm
(C) Consolidated Balance Sheets
(D) Consolidated Statements of Income
(E) Consolidated Statements of Changes In Stockholders’ Equity
(F) Consolidated Statements of Cash Flows
(G) Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules. All financial statement schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto.
(a)(3) Exhibits.
3.1 Charter of PSB Holdings, Inc.*
3.2 Bylaws of PSB Holdings, Inc.*
4. Form of Common Stock Certificate of PSB Holdings, Inc.*
10.1 Employee Stock Ownership Plan*
10.2 Deferred Compensation Plan*
10.3 PSB Holdings, Inc. 2005 Stock-Based Incentive Plan**
10.4 Agreement By and Between Putnam Bank, Putnam, Connecticut and The Comptroller of the Currency
14. Code of Ethics***
21. Subsidiaries of Registrant*
23. Consent of Shatswell, MacLeod & Company, P.C.
23.1 Consent of Wolf & Company, P.C.
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32. Certification of Chief Financial Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
The following materials from the Company’s Annual Report on Form 10-K for the twelve months ended June 30, 2012, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Changes in Stockholders’ Equity, (iv) the Condensed Consolidated Statements of Cash Flows and (v) the Notes to Condensed Consolidated Financial Statements. ****
*
Incorporated by reference to the Registration Statement on Form SB-2 of PSB Holdings, Inc. (file no. 333-116364), originally filed with the Securities and Exchange Commission on June 10, 2004, as amended.
**
Incorporated by reference to Appendix B of the Company’s Definitive Proxy Statement dated September 20, 2005 as filed with the Securities and Exchange Commission on September 19, 2005.
***
Incorporated by reference to Exhibit 14 of the Company’s Annual Report on Form 10-K for year ended June 30, 2007, filed with the Securities and Exchange Commission on September 21, 2007.
****
To be filed by amendment.
SIGNATURES
In accordance with Section 13 of the Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
In accordance with the Exchange Act, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signatures
Title
Date
/s/ Thomas A. Borner
President, Chief Executive Officer and Vice-Chairman of the Board (Principal Executive Officer)
September 26, 2012
Thomas A. Borner
/s/ Robert J. Halloran, Jr.
Executive Vice-President and Treasurer (Principal Financial and Accounting Officer)
September 26, 2012
Robert J. Halloran, Jr.
/s/ Charles W. Bentley, Jr.
Director
September 26, 2012
Charles W. Bentley, Jr.
/s/ jitendra k. sinha
Director
September 26, 2012
Jitendra K. Sinha
/s/ Paul M. Kelly
Director
September 26, 2012
Paul M. Kelly
/s/ Richard A. Loomis
Director
September 26, 2012
Richard A. Loomis
/s/ John P. Miller
Director
September 26, 2012
John P. Miller
/s/ Charles H. Puffer
Chairman of the Board
September 26, 2012
Charles H. Puffer