PSB GROUP INC - FORM 10-K - EX-13

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10-K - FORM 10-K - PSB GROUP INC	k49070e10vk.htm
EX-23 - EX-23 - PSB GROUP INC	k49070exv23.htm
EX-32.1 - EX-32.1 - PSB GROUP INC	k49070exv32w1.htm
EX-31.2 - EX-31.2 - PSB GROUP INC	k49070exv31w2.htm
EX-21.1 - EX-21.1 - PSB GROUP INC	k49070exv21w1.htm
EX-31.1 - EX-31.1 - PSB GROUP INC	k49070exv31w1.htm
EX-32.2 - EX-32.2 - PSB GROUP INC	k49070exv32w2.htm

EXHIBIT 13

PORTIONS OF PSB GROUP, INC.
ANNUAL REPORT TO SHAREHOLDERS

PSB Group, Inc.

Consolidated Financial Report
December 31, 2009

PSB Group, Inc.

Contents


Report Letter			1

Consolidated Financial Statements

Balance Sheet			2

Statement of Operations			3

Statement of Stockholders’ Equity			4

Statement of Cash Flows			5

Notes to Consolidated Financial Statements			6-40

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders
PSB Group, Inc.

We have audited the accompanying consolidated balance sheet of PSB Group, Inc. as of December 31, 2009 and 2008 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each year in the three-year period ended December 31, 2009. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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 Corporation 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 Corporation’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 financial statements, 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 consolidated financial position of PSB Group, Inc. as of December 31, 2009 and 2008 and the consolidated results of their operations and cash flows for each year in the three-year period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Corporation will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Corporation has suffered recurring losses from operations and is significantly undercapitalized which raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/S/ Plante & Moran, PLLC
Auburn Hills, Michigan
March 31, 2010

PSB Group, Inc.

Consolidated Balance Sheet
(000s omitted, except per share data)


	December 31
	2009			2008
Assets
Cash and due from banks	$	8,554		$	12,268
Federal funds sold		20,706			—

Total Cash and Cash Equivalents		29,260			12,268
Securities — Available for sale (Note 3)		60,031			52,254
Loans (Note 4)		354,263			374,809
Less allowance for possible loan losses (Note 4)		(9,469	)		(7,116	)

Net loans		344,794			367,693
Loans held for sale		774			1,082
Bank premises and equipment (Note 5)		15,937			14,107
Accrued interest receivable		2,244			2,159
Other real estate owned		6,235			8,459
Other assets (Note 9)		2,754			2,494


Total assets	$	462,029		$	472,784

Liabilities and Stockholders’ Equity
Liabilities
Deposits:
Noninterest-bearing	$	54,647		$	49,661
Interest-bearing (Note 6)		388,098			362,781


Total deposits		442,745			412,442

Federal Home Loan Bank advances (Note 7)		—			15,000
ESOP loan debt (Note 7)		282			436
Accrued taxes, interest, and other liabilities (Note 9)		2,284			2,536


Total liabilities		445,311			430,414

Stockholders’ Equity (Notes 8, 10, 11, 14, and 17)
Common stock:
Authorized — 5,000,000 shares, no par value
Issued and outstanding — 3,480,110 shares in 2009 and 3,442,060 shares in 2008		23,692			23,607
Unearned ESOP benefits (Note 8)		(282	)		(436	)
Common stock held in trust (Note 8)		(410	)		(410	)
Deferred compensation obligation (Note 8)		410			410
Additional paid in capital — stock options/awards		1,096			707
Unearned compensation		(1,182	)		(976	)
Retained earnings (Accumulated deficit)		(6,740	)		6,191
Accumulated other comprehensive income (Note 1)		134			1,009


Total stockholders’ equity		16,718			30,102


Total liabilities and stockholders’ equity	$	462,029		$	460,516

See Notes to Consolidated
Financial Statements

PSB Group, Inc.

Consolidated Statement of Operations
(000s omitted, except per share data)


	Year Ended December 31
	2009			2008			2007
Interest Income
Loans, including fees	$	21,492		$	25,730		$	29,960
Securities:
Taxable		2,290			2,418			1,649
Tax-exempt		211			282			945
Federal funds sold		29			7			28

Total interest income		24,022			28,437			32,582

Interest Expense
Deposits		8,423			9,799			14,205
Short-term borrowings		9			288			614
Long-term debt		287			347			—

Total interest expense		8,719			10,434			14,819


Net Interest Income — Before provision for loan losses		15,303			18,003			17,763

Provision for Loan Losses (Note 4)		16,169			9,956			7,663


Net Interest Income — After provision for loan losses		(866	)		8,047			10,100

Other Operating Income
Service charges on deposit accounts		2,502			2,370			2,350
Gain on sale of mortgages		582			473			655
Gain (loss) on sale of available-for-sale securities		2,147			187			(41	)
Other income		1,127			1,214			1,537

Total other operating income		6,358			4,244			4,501
Other Operating Expenses
Salaries and employee benefits (Note 8)		8,105			9,563			9,930
Occupancy costs (Note 5)		3,192			3,695			3,981
Legal and professional		1,725			1,353			1,429
Other real estate expense		2,083			3,983			118
Goodwill impairment expense		—			4,458			—
FDIC insurance		1,451			331			59
Marketing expense		376			365			528
Other operating expenses		2,768			2,547			3,155

Total other operating expenses		19,700			26,295			19,200

Loss — Before federal income tax benefit		(14,208	)		(14,004	)		(4,599	)
Federal Income Tax Benefit (Note 9)		(1,277	)		(207	)		(1,857	)

Net Loss	$	(12,931	)	$	(13,797	)	$	(2,742	)

Per Share Data
Weighted average shares outstanding		3,476,188			3,265,564			3,064,829
Basic earnings(loss)	$	(3.72	)	$	(4.22	)	$	(0.89	)
Diluted earnings (loss)	$	(3.72	)	$	(4.22	)	$	(0.89	)

See Notes to Consolidated
Financial Statements.

Consolidated Statement of Stockholders’ Equity
(000s omitted, except per share data)


								Additional Paid in
								Capital - Stock								Deferred					Accumulated Other			Total
					Unearned ESOP			Options and		Unearned			Common Stock			Compensation					Comprehensive Income			Stockholders’
	Number of Shares		Common Stock		Benefits			Awards		Compensation			Held in Trust			Obligation		Retained Earnings			(Loss)			Equity
Balance — January 1, 2007		3,034,152		20,496		(744	)		33		(45	)		(230	)		230		25,062			(556	)		44,246
Comprehensive loss (Note 1):
Net loss																			(2,742	)					(2,742	)
Change in unrealized gain on securities available for sale, net of tax																						488			488


Total comprehensive loss																									(2,254	)

Stock awards		37,850		681																					681
Additional paid in capital — stock options									282		(711	)													(429	)
Cash dividends — $0.72 per share																			(2,207	)					(2,207	)
Earned ESOP benefit						154																			154


Balance — December 31, 2007		3,072,002		21,177		(590	)		315		(756	)		(230	)		230		20,113			(68	)		40,191
Comprehensive loss (Note 1):
Net loss																			(13,797	)					(13,797	)
Change in unrealized gain on securities available for sale, net of tax																						1,077			1,077


Total comprehensive loss																									(12,720	)

Sale of stock		320,893		2,034																					2,034
Stock awards		49,165		396																					396
Additional paid in capital — stock options									392		(220	)													172
Cash dividends — $0.04 per share																			(125	)					(125	)
Purchase of stock by trust														(180	)		180								—
Earned ESOP benefit						154																			154


Balance — December 31, 2008	$	3,442,060	$	23,607	$	(436	)	$	707	$	(976	)	$	(410	)	$	410	$	6,191		$	1,009		$	30,102
Comprehensive loss (Note 1):
Net loss																			(12,931	)					(12,931	)
Change in unrealized gain on securities available for sale, net of tax																						(875	)		(875	)


Total comprehensive loss																									(13,806	)

Sale of stock																									—
Stock awards		38,050		85																					85
Additional paid in capital — stock options									389		(206	)													183
Cash dividends — $0.04 per share																			—						—

Purchase of stock by trust																									—
Earned ESOP benefit						154																			154


Balance — December 31, 2009	$	3,480,110	$	23,692	$	(282	)	$	1,096	$	(1,182	)	$	(410	)	$	410	$	(6,740	)	$	134		$	16,718

Book value per share is $4.80, $8.75 and $13.38 at December 31, 2009, 2008, and 2007, respectively.

PSB Group, Inc.

Consolidated Statement of Cash Flows
(000s omitted)


	Year Ended December 31
	2009			2008			2007
Cash Flows from Operating Activities
Net loss	$	(12,931	)	$	(13,797	)	$	(2,742	)
Adjustments to reconcile net loss to net cash from operating activities:
Depreciation and amortization		1,173			1,290			1,379
Goodwill impairment (non-cash)		—			4,458			—
Provision for loan loss		16,169			9,956			7,663
Non-cash stock options/awards expense		320			568			252
Accretion and amortization of securities		496			(33	)		20
Deferred income taxes		—			888			(802	)
(Gain) loss on sale of available-for-sale securities		(2,147	)		(187	)		41
Origination and purchase of loans held for sale		(33,934	)		(28,930	)		(43,789	)
Sale of loans held for sale		34,242			28,730			46,600
(Increase) decrease in accrued interest receivable		(85	)		185			432
(Decrease) increase in accrued interest payable and other liabilities		(252	)		(444	)		1,571
Increase (decrease) in other assets		1,964			(1,651	)		(7,883	)


Net cash provided by operating activities		5,015			1,033			2,742
Cash Flows from Investing Activities
Purchase of securities available for sale		(98,436	)		(25,841	)		(18,519	)
Proceeds from maturities of securities available for sale		10,763			14,083			4,011
Proceeds from sale of securities available for sale		80,672			24,950			14,820
Net Decrease (increase) in loans		6,730			6,479			2,296
Capital expenditures		(3,055	)		(2,039	)		(2,006	)

Net cash provided by (used in) investing activities		(3,326	)		17,632			602
Cash Flows from Financing Activities
Net (decrease) increase in time deposits		(18,389	)		11,935			7,322
Net increase (decrease) in other deposits		48,692			(38,003	)		(2,772	)
Net (decrease) increase in short-term borrowings		—			(10,000	)		(6,875	)
Net (decrease) increase in long-term debt		(15,000	)		15,000			—
Sale of common stock		—			2,034			—
Cash dividends		—			(125	)		(2,207	)

Net cash provided by (used in) financing activities		15,303			(19,159	)		(4,532	)
Net Increase (Decrease) in Cash and Cash Equivalents		16,992			(494	)		(1,188	)

Cash and Cash Equivalents — Beginning of year		12,268			12,762			13,950


Cash and Cash Equivalents — End of year	$	29,260		$	12,268		$	12,762


Supplemental Information — Cash paid for
Interest	$	8,896		$	10,493		$	14,794
Income taxes	$	(1,218	)	$	(1,803	)	$	400

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 1 — Summary of Significant Accounting Policies

Basis of Presentation and Consolidation - The consolidated financial statements include the accounts of PSB Group, Inc. (the “Corporation”) and it’s wholly owned subsidiaries, Peoples State Bank, Inc. (the “Bank”) and PSB Capital, Inc. (Capital). PSB Title Insurance Agency, Inc. (PSB) is a wholly owned subsidiary of Peoples State Bank, Inc. Universal Mortgage Company (UMC), previously a wholly owned subsidiary of Peoples State Bank, was merged into the Bank in September 2008. All significant intercompany transactions are eliminated in consolidation.

PSB Group, Inc. was formed on February 28, 2003 as a bank holding company for the purpose of owning Peoples State Bank, Inc. pursuant to a plan of reorganization adopted by the Bank and its stockholders. Pursuant to the reorganization, each share of Peoples State Bank, Inc. stock held by existing stockholders of the Bank was exchanged for three shares of common stock of PSB Group, Inc.

Use of Estimates - The accounting and reporting policies of PSB Group, Inc. conform to accounting principles generally accepted in the United States of America. Management is required to make significant estimates (such as the allowance for possible loan losses, deferred taxes, foreclosed assets and intangible assets) and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates and assumptions.

Nature of Operations - The Corporation provides full-service banking through 11 branch offices and two loan origination offices to the Michigan communities of Wayne, Oakland, Macomb, and Genesee counties.

Significant Group Concentrations of Credit Risk - Most of the Corporation’s activities are with customers located within Southeastern Michigan. Note 3 discuss the types of securities in which the Corporation invests. Note 4 discusses the types of lending in which the Corporation engages. The Corporation does not have any significant concentrations to any one customer, but does have a significant concentration of lending to non-residential commercial real estate entities.

Cash and Cash Equivalents - For purposes of the consolidated statement of cash flows, cash and cash equivalents include cash and balances due from banks, federal funds sold, and securities purchased under agreements to resell, all of which had original maturities of 90 days or less.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 1 — Summary of Significant Accounting Policies (Continued)

The Bank is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2009 and 2008, these reserve balances amounted to $3,116,000 and $2,779,000, respectively.

Securities - Debt securities that management has the positive intent and the ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as “available for sale” and are recorded at fair value, with unrealized gains and losses, net of related deferred income taxes, excluded from earnings and reported in other comprehensive income.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair values of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Loans - The Corporation grants mortgage, commercial, and consumer loans to customers. Loans 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 recognized as an adjustment of the related loan yield using the interest method.

The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in the process of collection. In all cases, loans are placed on nonaccrual or charged off at an earlier date if principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 1 — Summary of Significant Accounting Policies (Continued)

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.

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 recognized in a valuation allowance by charges to income.

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 uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based on management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific and general components. The specific components relate to loans that are classified as doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal and 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

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 1 — Summary of Significant Accounting Policies (Continued)

circumstances surrounding the loan and the borrower, including 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.

Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of homogenous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment disclosures.

Off-balance-sheet Instruments - In the ordinary course of business, the Corporation has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit, and standby letters of credit.

Foreclosed Assets - Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of the foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.

Bank Premises and Equipment - Land is carried at cost. Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation, computed on the straight-line method, is charged to operations over the estimated useful lives of the properties. Leasehold improvements are amortized over the terms of their respective leases or the estimated useful lives of the improvements, whichever is shorter.

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 effect of the various temporary differences between the book value and tax basis of the various balance sheet assets and liabilities, and gives the current recognition of changes in tax rates and laws. Valuation allowances are established when necessary, to reduce deferred tax assets to the amount expected to be realized.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 1 — Summary of Significant Accounting Policies (Continued)

Earnings Per Common Share - Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. 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 Corporation relate solely to outstanding stock options and stock awards, and are determined using the treasury stock method. For the years ended December 31, 2009, 2008 and 2007, the outstanding stock options and awards would have an anti-dilutive effect and therefore have not been included in the calculation of diluted earnings per share.

Employee Stock Ownership Plan (ESOP) - Compensation expense is recognized as ESOP shares are committed to be released. Allocated and committed to be released ESOP shares are considered outstanding for earnings per share calculation based on debt service payments. Other ESOP shares are excluded from earnings per share calculation. Dividends declared on allocated ESOP shares are charged to retained earnings. Dividends declared on unallocated ESOP shares are used to satisfy debt service. The value of unearned shares to be allocated to ESOP participants for future services not yet performed is reflected as a reduction of stockholders’ equity.

Comprehensive Income (Loss) - Accounting principles generally require that revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, however, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 1 — Summary of Significant Accounting Policies (Continued)

The components of accumulated other comprehensive income (loss) and related tax effects are as follows (000s omitted):


	2009		2008		2007
Total gains on available-for-sale securities	$	2,281	$	1,196	$	(144	)
Less: Realized gains(losses) on available-for-sale securities		2,147		187		(41	)

Unrealized holding gains(losses) on available-for-sale securities		134		1,009		(103	)

Tax effect		—		—		(35	)


Accumulated other comprehensive income	$	134	$	1,009	$	(68	)

Reclassification - Certain amounts appearing in the prior year’s financial statements have been reclassified to conform to the current year’s financial statements.

Goodwill - Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is not amortized but it is assessed at least annually for impairment, and any such impairment will be recognized in the period identified. During 2008, it was determined that Goodwill was indeed impaired. Accordingly, 100% of our Goodwill, or $4,458,000 was written-off in the 4^th quarter of 2008.

Stock Compensation Plans – The Corporation applies the recognition and measurement of stock based compensation accounting rules for stock based compensation which is referred to as the fair value method. Compensation cost is based on the fair value of the equity issued to employees. The Company recognizes compensation expense related to restricted stock awards over the period the services are performed. In 2009, 44,600 restricted shares were granted compared to 20,950 restricted shares that were granted in 2008. No new stock options were granted in 2009, compared to 61,400 options that were granted in 2008.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 2 — Management’s Plan

The consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business. On September 28, 2009, the Bank entered into a Stipulation and Consent to the Issuance of an Order to Cease and Desist (the “Order”) with the FDIC and the Office of Financial and Insurance Regulation for the State of Michigan (“OFIR”) that, among other things, requires us to increase and maintain our leverage capital ratio to at least 8% (see Note 16 for additional details). Failure to increase our capital ratio or further declines in our capital ratios exposes us to additional restrictions and regulatory actions, including regulatory take-over. This uncertainty as to our ability to meet existing and future regulatory requirements raises serious doubt about our ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent on many factors, including regulatory action and the ability of management to achieve its recovery plan which is discussed below. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The Company has aggressively pursued various available alternatives to improve its capital ratios, including raising capital, reducing assets, cutting operating costs and reorganizing management. While we received interest from potential private equity investors, our Board has determined that consummation of a transaction is not likely in the near term. Accordingly, our Board determined that the immediate implementation of our recovery plan, while continuing to seek new capital, is in the best interest of our stakeholders. The recovery plan is designed to improve the Company’s financial health and capital ratios by downsizing the bank and focusing on reducing our operating costs.

Key elements of the recovery plan include, but are not limited to:

•		Aggressively manage the bank’s existing loan portfolios to minimize further credit losses and to maximize recoveries,

•		Shrink the bank’s balance sheet,

•		Reduce the bank’s loan portfolio through pay-downs, restructuring and significantly reducing lending activity, and

•		Significantly lower operating costs to align with the restructured business model.

Our Board has a Strategic Planning Committee, chaired by Mr. Sydney Ross, a director of both PSB Group and the bank, to ensure implementation and successful execution of the recovery plan, monitor the progress of capital raising efforts, and to actively engage the Company’s strategic initiatives.

While implementing the above key elements will not achieve the leverage capital mandate of 8%, as required by the Cease and Desist Order, these actions are designed to reduce the capital needs of the bank by reducing its balance sheet and establishing a more streamlined and focused organization with a reduced infrastructure. However, there is no assurance that the recovery plan will be acceptable to our regulators, that we will be able to successfully implement this recovery plan or that the elements

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

contemplated by the recovery plan are sufficient to ensure that we will continue operating as a going concern.

Note 3 — Securities

The amortized cost and estimated market value of securities are as follows

(000s omitted):


	2009
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Market
	Cost		Gains		Losses			Value
Available-for-sale securities:
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	39,946	$	302	$	(93	)	$	40,155
Obligations of state and political subdivisions		17,919		116		(141	)		17,894
Other		2,032		—		(50	)		1,982


Total available-for-sale securities	$	59,897	$	418	$	(284	)	$	60,031


	2008
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Market
	Cost		Gains		Losses			Value
Available-for-sale securities:
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	43,833	$	1,318	$	(5	)	$	45,146
Obligations of state and political subdivisions		5,380		6		(260	)		5,126
Other		2,032		—		(50	)		1,982


Total available-for-sale securities	$	51,245	$	1,324	$	(315	)	$	52,254

The amortized cost and estimated market value of securities at December 31, 2009, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties (000s omitted):

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 3 — Securities (Continued)


	Available for Sale
	Amortized		Market
	Cost		Value
Due in one year or less	$	22,055	$	22,064
Due in one through five years		9,021		9,110
Due after five years through ten years		4,666		4,680
Due after ten years		7,282		7,162


Total		43,024		43,016

Federal agency pools		14,841		15,033
Other		2,032		1,982


Total	$	59,897	$	60,031

Proceeds from the sale of available-for-sale securities during 2009, 2008, and 2007 were $80,672,000, $24,950,000 and $14,820,000, respectively. Gross realized gains amounted to $2,181,400, $225,000 and $22,200, respectively. Gross realized losses amounted to $34,100, $38,300 and $63,100, respectively. The tax provision (benefit) applicable to these net realized gains and losses amounted to $0, $63,500 and ($13,900), respectively.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 3 — Securities (Continued)

Information pertaining to securities with gross unrealized losses at December 31, 2009 and 2008, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows (000s omitted):


	2009
	Less Than Twelve Months				Over Twelve Months
	Gross				Gross
	Unrealized				Unrealized
	Losses		Fair Value		Losses		Fair Value
Available-for-sale securities:
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	93	$	9,329	$	—	$	—

Obligations of state and political subdivisions		141		5,441		—		—

Other		—		—		50		450


Total available-for-sale securities	$	234	$	14,770	$	50	$	450


	2008
	Less Than Twelve Months				Over Twelve Months
	Gross				Gross
	Unrealized				Unrealized
	Losses		Fair Value		Losses		Fair Value
Available-for-sale securities:
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	5	$	375	$	—	$	—

Obligations of state and political subdivisions		242		3,653		18		396

Other		50		450		—		—


Total available-for-sale securities	$	297	$	4,478	$	18	$	396

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 3 — Securities (Continued)

At December 31, 2009 and 2008, securities having a carrying value of $34,456,471 and $43,642,734 (market value of $34,649,218 and $44,958,376), respectively, were pledged to secure public deposits, repurchase agreements, and for other purposes required by law.

Note 4 — Loans

A summary of the balances of loans at December 31, 2009 and 2008 is as follows (000s omitted):


	2009			2008
Mortgage loans on real estate:
Residential 1-4 family	$	63,586		$	58,399
Commercial		216,860			234,121
Construction		13,109			14,964
Second mortgages		7,551			9,918
Equity lines of credit		11,108			13,260


Total mortgage loans		312,214			330,662

Commercial loans		36,314			37,305

Consumer installment loans		6,055			7,296


Subtotal		354,583			375,263

Less allowances for loan losses		(9,469	)		(7,116	)
Net deferred loan fees		(320	)		(454	)


Loans — Net	$	344,794		$	367,693

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 4 — Loans (Continued)

An analysis of the allowance for loan losses is as follows (000s omitted):


	2009			2008			2007
Balance — Beginning of year	$	7,116		$	5,184		$	4,257
Loan loss provision		16,169			9,956			7,663
Loan losses		(14,270	)		(8,387	)		(7,185	)
Loan loss recoveries		454			363			449

Balance — End of year	$	9,469		$	7,116		$	5,184


As a percentage of total loans		2.67			1.90			1.33

The following is a summary of information pertaining to impaired loans (000s omitted):


	2009		2008
Impaired loans without a valuation allowance	$	22,054	$	8,245

Impaired loans with a valuation allowance		34,968		8,260


Total impaired loans	$	57,022	$	16,505


Valuation allowance related to impaired loans	$	2,712	$	2,334


Total non-accrual loans	$	38,026	$	11,955


Total loans past due 90 days or more and still accruing	$	8	$	575


	2009		2008		2007
Average investment in impaired loans	$	25,296	$	13,174	$	12,809


Interest income recognized on impaired loans	$	594	$	815	$	637


Interest income recognized on a cash basis on impaired loans
	$	594	$	815	$	637

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 4 — Loans (Continued)

No additional funds are committed to be advanced in connection with impaired loans. Of the $57,022,000 in total impaired loans at December 31, 2009, $20,230,000, or 35%, is troubled restructured debt that is in compliance with the modified terms of the loans.

Note 5 — Bank Premises and Equipment

Bank premises and equipment at December 31, 2009 and 2008 consisted of the following (000s omitted):


	2009		2008
Land	$	6,266	$	3,480
Buildings and improvements		12,428		12,382
Furniture, fixtures, and equipment		12,306		12,153


Total bank premises and equipment		31,000		28,015

Less accumulated depreciation and amortization		15,063		13,908


Net carrying amount	$	15,937	$	14,107

Depreciation expense totaled $1,173,000, $1,290,000 and $1,379,000 during 2009, 2008, and 2007, respectively.

Pursuant to the terms of non-cancelable lease agreements in effect at December 31, 2009 pertaining to banking premises and equipment, future minimum rent commitments under various operating leases are as follows (000s omitted):


2010	$	350
2011		285
2012		145
2013		138
2014		138
Thereafter		115


Total	$	1,171

Total rent expense for the years ended December 31, 2009, 2008, and 2007 amounted to $498,000, $928,000 and $778,000 respectively. During 2009, the Company purchased land at two branch facilities that was previously leased. The purchases will save approximately $230 thousand per year in lease expenses.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 6 — Deposits

Interest-bearing deposits at December 31, 2009 and 2008 consisted of the following (000s omitted):


	2009		2008
NOW accounts	$	34,105	$	29,128
Savings		33,108		110,707
Money market demand		132,226		15,898
Time:
$100,000 and over		93,356		102,835
Under $100,000		95,303		104,213


Total interest-bearing deposits	$	388,098	$	362,781

The remaining maturities of certificates of time deposit outstanding at December 31, 2009 are as follows (000s omitted):


	Under		$100,000
	$100,000		and Over
2010	$	72,720	$	73,288
2011		17,573		13,959
2012		2,010		2,260
2013		947		105
2014		1,111		2,756
Thereafter		942		988


Total	$	95,303	$	93,356

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 7 — Borrowing Arrangements

The Corporation has an agreement with the Federal Home Loan Bank of Indianapolis under which the Corporation may obtain advances up to an aggregate amount of $26,300,000. As of December 31, 2009, the Corporation had no advances outstanding. The Corporation has provided a blanket pledge of all of the Corporation’s residential mortgage loans as collateral on advances under this agreement.

The Corporation has guaranteed a loan from an outside financial institution to the Employee Stock Ownership Plan (ESOP) with the ESOP stock pledged as collateral. Since ESOP debt is guaranteed by the Corporation, it is reflected on the consolidated balance sheet as a liability with a related amount shown as a reduction in stockholders’ equity.

As of December 31, 2009, scheduled maturities of the ESOP note payable are as follows (000s omitted):


2010	$	154

2011		128


Total	$	282

The Corporation also borrows Federal Funds on an overnight basis to meet short-term liquidity needs.

Note 8 — Benefit Plans

The Corporation has a defined contribution 401(k), employee profit-sharing, and Employee Stock Ownership (ESOP) plan covering substantially all employees. Employer matching contributions are discretionary. The Corporation typically matches 100 percent of the first 3 percent of employee contributions and 50 percent of the next 3 percent of employee contributions to the 401(k) plan. Employer 401(k) matching contributions and profit-sharing contributions are at the discretion of the Corporation’s Board of Directors. The Bank ceased the matching program during 2009 and does not anticipate reinstating the program during 2010. Employer 401(k) matching contributions to the plan were approximately $67,000, $197,000 and $196,000 during 2009, 2008, and 2007, respectively. Employer profit-sharing contributions made to the ESOP were approximately $209,000, $176,000 and $200,000 during 2009, 2008, and 2007, respectively.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 8 — Benefit Plans (Continued)

The ESOP has entered into a 6 year note payable with an outside financial institution. The terms of the note include a variable rate payable, due in annual installments to 2011, floating at LIBOR plus 1.75 which was 2.03% at December 31, 2009. The Corporation has guaranteed the loan, with the ESOP stock pledged as collateral.

The shares held by the ESOP are held in a suspense account for allocation to the participants as the loan is repaid. Shares held by the ESOP include the following at December 31, 2009 and had a fair value of approximately $93,000:


Allocated			63,502
Committed to be allocated			—
Unallocated			14,117


Total			77,619

The Corporation also has entered into deferred compensation arrangements with certain of its directors. Amounts deferred under the arrangements are invested in Corporation common stock and are maintained in a rabbi trust. The Corporation has 37,111 shares of common stock reserved for the various plans with a related obligation of $410,000 established within stockholders’ equity as of December 31, 2009. Assets of the rabbi trust are consolidated with the Corporation, and the value of the Corporation’s stock held in the rabbi trust is classified in stockholders’ equity and generally accounted for in a manner similar to treasury stock.

The Corporation recognizes the original amount of deferred compensation as the basis for recognition in the rabbi trust. Changes in fair value owed to directors are not recognized as the arrangements do not permit diversification and must be settled by the delivery of a fixed number of shares of the Corporation’s common stock. The Rabbi Trust held 37,111 shares as of December 31, 2009. Of these shares, 11,499 were purchased in December 2005 at a price of $20 per share and 25,612 shares were purchased in March 2008 at a price of $7 per share. There were no transactions involving the rabbi trust prior to the year ended December 31, 2005. During 2009, no dividends were paid to the Rabbi Trust on the 37,111 shares held.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 9

- Federal Income Taxes

The provision for federal income taxes reflected in the consolidated statement of operations for the years ended December 31, 2009, 2008, and 2007 consisted of the following (000s omitted):


	2009			2008			2007
Current (benefit) expense	$	(1,277	)	$	(1,055	)	$	947
Deferred (benefit) expense		—			(802	)		(53	)


Total income tax expense	$	(1,277	)	$	(1,857	)	$	894

A reconciliation of the difference between total federal income tax expense and the amount computed by applying the statutory tax rates to income before income taxes follows:


	Percent of Pretax Income
	2009			2008			2007
Amount computed at statutory rates		(34	)		(34	)		34
Increase (decrease) resulting from:
Tax-exempt municipal interest		(1	)		(6	)		(11	)
Goodwill impairment		—			32			—
Change in deferred tax asset valuation allowance		25			22			—
Other		1			(15	)		1


Effective tax rate		(9	)		(1	)		24

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 9

- Federal Income Taxes (Continued)

The details of the net deferred tax asset (liability) at December 31, 2009 and 2008 are as follows (000s omitted):


	2009			2008
Deferred tax assets:
Provision for loan losses	$	3,060		$	2,008
Net deferred loan fees		106			152
Accrued employee benefits		57			63
Deferred compensation		284			279
Unrealized losses on investment securities available for sale					—
Net operating loss		2,783			500
Other real estate owned		1,229			1,230
Other		230			230


Total deferred tax assets		7,749			4,462

Less: Valuation allowance		(6,619	)		(3,113	)

Deferred tax liabilities:
Property and equipment		349			361
Original issue discount		382			552
Other		399			436


Total deferred tax liabilities		1,130			1,349


Net deferred tax asset	$	—		$	—

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 10

- Stock-based Compensation

			During 2004, the Corporation adopted the PSB Group, Inc. 2004 Stock Compensation Plan and has reserved 450,000 shares of common stock for issuance under the plan. For stock options granted, vesting is to be specified at the time of grant and options will expire 10 years after the grant date. The exercise price of each option granted will not be below the fair market value of the Corporation’s common stock on the date of the grant.

			The fair value of options granted during the years 2009 and 2008 was $0 and $90,000, respectively. That cost is expected to be recognized over a weighted-average period of 1.1 years.

			A summary of the Corporation’s option activity for the year ended December 31, 2009 is as follows:


	2008
					Weighted
					Average
			Weighted		Remaining
	Number		Average		Contractual		Aggregate
	of		Exercise		Term (in		Instrinsic
	Shares		Price		years)		Value
Options outstanding — Beginning of year		94,893	$	19.70		8.5		—
Options granted		61,400		10.50		9.5		—
Options exercised		—		—		—		—
Options forfeited		11,000		14.49		9.5		—

Options outstanding — End of year		145,293	$	16.21		8.5		—

Exercisable at end of year		54,365	$	20.85		7.5		—

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 10

- Stock-based Compensation (Continued)


	Shares		Price		(years)		Value
Options outstanding — Beginning of year		145,293	$	16.21		8.5		—
Options granted		—		—		—		—
Options exercised		—		—		—		—
Options forfeited		14,000		16.70		7.5		—

Options outstanding — End of year		131,293	$	16.26		7.5		—

Exercisable at end of year		85,762	$	18.21		7.0		—

Information pertaining to options outstanding at December 31, 2009 is as follows:


					Options
	Options Outstanding				Exercisable
			Weighted
			Average
Exercise	Number		Remaining		Number
Price	Outstanding		Contractual Life		Outstanding
$24.42		22,100		5.5		22,100
$18.00		59,793		7.0		47,195
$10.50		49,400		8.5		16,467

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 10

- Stock-based Compensation (Continued)

In addition to the stock options granted, there were stock awards of 44,600 shares granted in 2009 and 20,950 shares awarded in 2008. The following table summarizes the activity of restricted stock awards:


	Year Ended December 31,
	2009			2008
Beginning of period		53,764			39,650
Granted		44,600			20,950
Vested		(844	)		(3,686	)
Forfeited		(6,550	)		(3,150	)

Non-vested, end of period		90,970			53,764

The stock awards were issued under the same stock based compensation plan as the options. The stock awards were valued no less than market value and the vesting period varies by issuance. Total share-based compensation cost for both the stock options and awards that has been charged against income was $319,000 and $349,000 for 2009 and 2008, respectively. As of December 31, 2009, there was approximately $297,600 of total unrecognized share based compensation cost related to options and awards granted under the plan.

Note 11 — Off-balance-sheet Activities

			Credit-related Financial Instruments - The Corporation is a party to credit-related 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 extend credit, standby letters of credit, and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet.

			The Corporation’s exposure to credit loss is represented by the contractual amount of these commitments. The Corporation follows the same credit policies in making commitments as it does for on-balance-sheet instruments.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 11 — Off-balance-sheet Activities (Continued)

At December 31, 2009 and 2008, the following financial instruments were outstanding whose contract amounts represent credit risk (000s omitted):


	2009		2008
Commitments to grant loans	$	2,660	$	3,139
Unfunded commitments under lines of credit		27,219		32,541
Commercial and standby letters of credit		2,488		2,606

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Corporation, is based on management’s credit evaluation of the customer.

Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are generally collateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Corporation is committed.

Commercial and standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. These letters of credit are primarily used to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year.

Almost all of the standby letters of credit are secured and, in the event of nonperformance by the customers, the Corporation has rights to the underlying collateral provided including commercial real estate, physical plant and property, inventory, receivables, cash, and marketable securities.

Collateral Requirements - To reduce credit risk related to the use of credit-related financial instruments, the Corporation might deem it necessary to obtain collateral. The amount and nature of the collateral obtained are based on the Bank’s credit evaluation of the customer. Collateral held varies, but may include cash, securities, accounts receivable, inventory, property, plant, and equipment, and real estate.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 12 — 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 Corporation’s consolidated financial statements.

Note 13 — Restrictions on Dividends, Loans, and Advances

Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank. The total amount of dividends that may be paid at any date is generally limited to the retained earnings of the Bank, and loans or advances are limited to 10 percent of the Bank’s capital stock and surplus on a secured basis.

At December 31, 2009, the Bank had no retained earnings available for the payment of dividends. Accordingly, all $17,388,000 of the Corporation’s equity in the net assets of the Bank was restricted at December 31, 2009. Funds available for loans or advances by the Bank to the Corporation amounted to $2,672,000.

On September 28, 2009, the Bank entered into a Stipulation and Consent to the Issuance of an Order to Cease and Desist (the “Order”) with the FDIC and the Office of Financial and Insurance Regulation for the State of Michigan (“OFIR”).

Among other restrictions, the Order states that the Bank may not declare or pay any cash dividend without prior written consent of the FDIC and OFIR. The Corporation may be restricted in its ability to pay dividends to shareholders since its sole source of income is dividends from the Bank. See Note 16 for additional restrictions.

Note 14 — Related Party Transactions

In the ordinary course of business, the Corporation has granted loans to principal officers and directors and their affiliates amounting to $1,255,000 at December 31, 2009 and $1,374,000 at December 31, 2008. During the year ended December 31, 2009, total principal additions were $28,000 and total principal payments were $147,000.

Deposits from related parties held by the Corporation at December 31, 2009 and 2008 amounted to $1,239,000 and $769,000, respectively.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 15 — Fair Value of Financial Instruments

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based on quoted market prices. However, in many instances, there are no quoted market prices for the Corporation’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. This disclosure excludes all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation.

The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments:

Cash and Cash Equivalents - The carrying amounts of cash and short-term instruments approximate fair values.

Securities - Fair values for securities are based on quoted market prices. (See Note 17 for further information.)

Loans Held for Sale - Fair values for loans held for sale are based on commitments on hand from investors or prevailing market prices.

Loans Receivable - For variable-rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one- to four-family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial, and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 15 — Fair Value of Financial Instruments (Continued)

Deposit Liabilities - The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Long-term Borrowings - The fair values of the Corporation’s long-term borrowings are estimated using discounted cash flow analyses based on the Bank’s current incremental borrowing rates for similar types of borrowing arrangements.

Short-term Borrowings - The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements.

Accrued Interest - The carrying amounts of accrued interest approximate fair value.

Other Instruments - The fair values of other financial instruments, including loan commitments and unfunded letters of credit, based on a discounted cash flow analyses, are not material.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 15 — Fair Value of Financial Instruments (Continued)

The estimated fair values and related carrying or notional amounts of the Corporation’s financial instruments are as follows (000s omitted):


	2009				2008
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Assets:
Cash and short-term investments	$	29,260	$	29,260	$	12,268	$	12,268
Securities		60,031		60,031		52,254		52,254
Loans		344,794		357,800		367,693		380,415
Loans held for sale		774		794		1,082		1,100
Accrued interest receivable		2,244		2,244		2,159		2,159

Liabilities:
Noninterest-bearing deposits		54,647		54,647		49,661		49,661
Interest-bearing deposits		388,098		390,331		362,781		366,465
Long-term debt		282		282		15,436		15,924
Accrued interest payable		221		221		398		398

Note 16 — Regulatory Matters

A bank that has a risk-based capital ratio less than 8%, or a Tier 1 risk-based capital ratio less than 4%, or a leverage ratio less than 4% is considered to be “undercapitalized.” The FDIC is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization.

The Order required the Bank to take action in the following areas:

•

The Bank must have and retain qualified management.

•

The board of directors was required to assume full responsibility for the approval of sound policies and objectives and for the supervision of all of the Bank’s activities.

•

Increase the Bank’s level of Tier 1 capital as a percentage of total assets to at least 8 percent.

•

Charge off any loans classified as “loss.”

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 16 — Regulatory Matters (Continued)

•

Prohibit the extension of credit to borrowers that have had loans with the Bank that were classified “substandard”, “doubtful” or “special mention” without prior Board approval.

•

Prohibit the extension of credit to borrowers that have had loans charged off or classified as “loss” in exam reports.

•

The Bank may not declare or pay any cash dividend without prior written consent of the FDIC and OFIR.

•

Prior to submission or publication of all Reports of Condition, the board shall review the adequacy of the Bank’s Allowance for Loan and Lease Losses, (“ALLL”).

•

Within 30 days of the effective date of the Order, the Bank was required to eliminate and/or correct all violations of law, rule, and regulations.

•

Within 60 days from the effective date of the Order, the Bank was required to correct all deficiencies in the loans listed for “Special Mention.”

•

Prepare and submit progress reports the FDIC and OFIR.

The Order is required to remain in effect until it is modified or terminated by the FDIC and OFIR. As of December 31, 2009, the Bank was out of compliance with the Order’s requirement that the Bank increase its level of Tier 1 capital as a percentage of total assets to at least 8 percent. Non-compliance with the Order requirements may cause the Bank to become subject to further enforcement actions by the FDIC and the OFIR.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 16 — Regulatory Matters (Continued)

The Corporation’s and the Bank’s actual capital amounts and ratios as of December 31, 2009 and 2008 are presented in the table.


						For Capital						To Be Well-
	Actual					Adequacy Purposes						capitalized
	Amount		Ratio			Amount			Ratio			Amount			Ratio
As of December 31, 2009:
Total capital (to risk-weighted assets)
PSB Group, Inc.	$	21,085		5.94	%	$	28,400	>		8.0	%		N/A	>		N/A
Peoples State Bank, Inc.	$	21,755		6.13	%	$	28,400	>		8.0	%	$	35,500	>		10.0	%
Tier I capital (to risk-weighted assets)
PSB Group, Inc.	$	16,584		4.67	%	$	14,200	>		4.0	%		N/A	>		N/A
Peoples State Bank, Inc.	$	17,254		4.86	%	$	14,200	>		4.0	%	$	21,300	>		6.0	%
Tier I capital (to average assets)
PSB Group, Inc.	$	16,584		3.48	%	$	19,000	>		4.0	%		N/A	>		N/A
Peoples State Bank, Inc.	$	17,254		3.63	%	$	19,000	>		4.0	%	$	23,800	>		5.0	%
As of December 31, 2008:
Total capital (to risk-weighted assets)
PSB Group, Inc.	$	33,812		9.01	%	$	30,300	>		8.0	%		N/A	>		N/A
Peoples State Bank, Inc.	$	34,236		9.13	%	$	30,300	>		8.0	%	$	37,900	>		10.0	%
Tier I capital (to risk-weighted assets)
PSB Group, Inc.	$	29,093		7.76	%	$	15,100	>		4.0	%		N/A	>		N/A
Peoples State Bank, Inc.	$	29,518		7.87	%	$	15,100	>		4.0	%	$	22,700	>		6.0	%
Tier I capital (to average assets)
PSB Group, Inc.	$	29,093		6.19	%	$	18,700	>		4.0	%		N/A	>		N/A
Peoples State Bank, Inc.	$	29,518		6.29	%	$	18,700	>		4.0	%	$	23,300	>		5.0	%

Note 17 — Fair Value Measurement

The following tables contain information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at December 31, 2009, and the valuation techniques used by the Corporation to determine those fair values.

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 17 — Fair Value Measurement (Continued)

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Corporation’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.

Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2009
(dollars in thousands)

Significant

Quoted Prices in

Other

Significant

Active Markets

Observable

Unobservable

for Identical Assets

Inputs

Balance at

(Level 1)

(Level 2)

(Level 3)

December 31, 2009

Assets

Investment securities — AFS

1,005

58,576

450

60,031

Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2008
(dollars in thousands)

Significant

Quoted Prices in

Other

Significant

Active Markets

Observable

Unobservable

for Identical Assets

Inputs

Balance at

(Level 1)

(Level 2)

(Level 3)

December 31, 2009

Assets

Investment securities — AFS

—

51,524

730

52,254

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 17 — Fair Value Measurement (Continued)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis
(dollars in thousands)


	Investment Securities -AFS
Balance at January 1, 2008		795
Total realized and unrealized gains (losses) included in income
Total unrealized gains (losses) included in other comprehensive income		(40	)
Net purchases, sales, calls and maturities		(25	)
Net transfers in/out of Level 3

Balance at December 31, 2008		730

Total realized and unrealized gains (losses) included in income
Total unrealized gains (losses) included in other comprehensive income
Net purchases, sales, calls and maturities
Net transfers in/out of Level 3	$	(280	)

Balance at December 31, 2009	$	450

Investment Securities Available for Sale. Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices for similar assets, if available. If quoted prices are not available, fair values are measured using matrix pricing models, or other model-based valuation techniques requiring observable inputs other than quoted prices such as yield curves, prepayment speeds, and default rates. Recurring Level 1 securities would include U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets. Recurring Level 2 securities include U.S. government agency securities, U.S. government sponsored agency securities, mortgage-backed securities, collateralized mortgage obligations and municipal bonds. Where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. Changes in fair market value are recorded in other comprehensive income as the securities are available for sale.

Of the Level 3 assets that were still held by the Corporation at December 31, 2009, there was $50 thousand in unrealized losses included in other comprehensive income in the consolidated balance sheet. There were no gains or losses realized through the income statement for these assets during 2009.

Both observable and unobservable inputs may be used to determine the fair value of positions classified as Level 3 assets and liabilities. As a result, the unrealized gains and losses for these assets and liabilities presented in the tables above may include changes in the fair value that were attributable to both observable and unobservable inputs.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 17 — Fair Value Measurement (Continued)

Available-for-sale investment securities categorized as Level 3 assets consist of a trust preferred investment issued by a local area bank holding company. The Corporation estimates fair value of these investments on the present value of expected future cash flows using management’s best estimate of key assumptions.

The Corporation also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets are impaired loans accounted for under FASB ASC Topic 310: Accounting by Creditors for Impairment of a Loan. The Corporation has estimated the fair value of these assets using Level 2 inputs, including discounted cash flow projections and estimated realizable value of the underlying collateral (typically based on outside appraisals).

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2009
(dollars in thousands)


			Quoted Prices		Significant Other		Significant		Total Losses
			in Active Markets		Observable		Unobservable		for the period
	Balance at		for Identical Assets		Inpute		Inputs		ended
	December 31, 2009		(Level 1)		(Level 2)		(Level 3)		December 31, 2009
Assets
Impaired Loans accounted for under FAS 114	$	42,072	$	—	$	—	$	42,072	$	5,001


Other Real Estate Owned	$	6,235	$	—	$	6,235	$	—	$	1,311

Impaired Loans — The Corporation does not record loans at fair value on a recurring basis. However, on occasion, a loan is considered impaired and an allowance for loan loss is established. A loan is considered impaired when it is probable that all of the principal and interest due under the original terms of the loan may not be collected. Once a loan is identified as individually impaired, management measures impairment in accordance with FASB ASC Topic 310: Accounting by Creditors for Impairment of a Loan. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. In accordance with FASB ASC Topic 825: The Fair Value Option for Financial Assets and Liabilities, impaired loans where an allowance is established based on the fair value of collateral requires classification in the fair value hierarchy. When the fair value of the collateral is based on an observable

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 17 — Fair Value Measurement (Continued)

market price or a current appraised value, the Corporation records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Corporation records the impaired loan as nonrecurring Level 3.

Other Real Estate - Other real estate is carried at the lower of (1) the fair value of the asset, determined by current appraisal, less the estimated costs to sell the asset or (2) the remaining balance of the related loan.

Other assets, including goodwill and other intangible assets, are also subject to periodic impairment assessments under other accounting principles generally accepted in the United States of America. These assets are not considered financial instruments. Accordingly, these assets have been omitted from the above disclosures.

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 18 — Condensed Financial Statements of Parent Company

The following represents the condensed financial statements of PSB Group, Inc. (the “Parent”) only. The Parent-only financial information should be read in conjunction with the Corporation’s consolidated financial statements.

The condensed balance sheet at December 31 is as follows (000s omitted):


	2009		2008
Assets
Cash at subsidiary bank	$	18	$	308
Investment in subsidiaries		17,389		30,528
Other		18		111


Total assets	$	17,425	$	30,947

Liabilities
Borrowings — ESOP	$	282	$	436
Deferred Compensation		425		409


Total liabilities		707		845

Stockholders’ Equity		16,718		30,102


Liabilities and Stockholders’ Equity	$	17,425	$	30,947

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 18 — Condensed Financial Statements of Parent Company (Continued)

The condensed statement of operations for the years ended December 31, 2009, 2008 and 2007 is as follows (000s omitted):


	2009			2008			2007
Operating income — dividends from subsidiaries	$	—		$	—		$	1,560
Operating expense		(327	)		(300	)		(352	)


Income (loss) — Before income taxes and equity in undistributed income (loss) of subsidiaries		(327	)		(300	)		1,208

Income tax expense(benefit)		21			(102	)		(120	)


Income (loss) — Before equity in undistibuted income (loss) of subsidiaries		(348	)		(198	)		1,328

Equity in undistributed income(loss) of subsidiaries		(12,583	)		(13,599	)		(4,070	)


Net loss	$	(12,931	)	$	(13,797	)	$	(2,742	)

PSB Group, Inc.

Notes to Consolidated Financial Statements
December 31, 2009, 2008, and 2007

Note 18 — Condensed Financial Statements of Parent Company (Continued)

The condensed statement of cash flows for the years ended December 31, 2009, 2008 and 2007 is as follows (000s omitted):


	2009			2008			2007
Cash Flows from Operating Activities
Net loss	$	(12,931	)	$	(13,797	)	$	(2,742	)
Adjustments to reconcile net loss to net cash from operating activities:
Equity in loss of subsidiaries		12,584			13,599			2,510
Net change in other assets		41			(47	)		232
Net change in other liabilities		16			(159	)		111

Net cash (used in) provided by operating activities		(290	)		(404	)		111
Cash Flows from Investing Activities —
Dividend from subsidiaries		—			—			1,560
Investment in subsidiaries		—			(1,334	)		—


Net cash (used in) provided by investing activities		—			(1,334	)		1,560
Cash Flows from Financing Activities
Sale of common stock		—			2,034			—
Cash dividends		—			(125	)		(2,207	)


Net cash (used in) provided by financing activities		—			1,909			(2,207	)

Net Increase (Decrease) in Cash and Cash Equivalents		(290	)		171			(536	)

Cash and Cash Equivalents — Beginning of year		308			137			673


Cash and Cash Equivalents — End of year	$	18		$	308		$	137

PSB Group, Inc.

Management Financial Report

December 31, 2009

Table of Contents


Management’s Discussion and Analysis			42-55
Market Information			56

Information Concerning Forward-Looking Statements

Statements contained in this report which are not historical facts are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements involve important known and unknown risks, uncertainties and other factors and can be identified by phrases using “estimate,” “anticipate,” “believe,” “project,” “expect,” “intend,” “predict,” “potential,” “future,” “may,” “should” and similar expressions or words. Such forward-looking statements are subject to risk and uncertainties which could cause actual results to differ materially from those projected. Such risks and uncertainties include potential changes in interest rates, competitive factors in the financial services industry, general economic conditions, the effect of new legislation and other risks detailed in documents filed by the Company with the Securities and Exchange Commission from time to time.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Basis of Presentation. Management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements under “Part II, Item 8. Financial Statements and Supplementary Data.” The consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business. We are under a Cease and Desist Order that, among other things, requires us to increase and maintain our leverage and total risk-based capital ratios to at least minimums of 8% and 12%, respectively, by November 27, 2009. Failure to increase our capital ratios or further declines in our capital ratios exposes us to additional restrictions and regulatory actions, including regulatory take-over. This uncertainty as to our ability to meet existing or future regulatory requirements raises substantial doubt about our ability to continue as a going concern. Management’s plans concerning these matters are discussed under “Liquidity and Capital Resources” below and in Note 2 to the Consolidated Financial Statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Overview. PSB Group, Inc. (the “Corporation”) was formed on February 28, 2003 as a bank holding company for the purpose of owning Peoples State Bank (the “Bank”) pursuant to a plan of reorganization adopted by the Bank and its stockholders. Pursuant to the reorganization, each share of Peoples State Bank stock held by existing stockholders of the Bank was exchanged for three shares of common stock of PSB Group, Inc.

The consolidated financial statements include the accounts of PSB Group, Inc. and its wholly owned subsidiaries, Peoples State Bank and PSB Capital, Inc. PSB Insurance Agency, Inc. is a wholly owned subsidiary of Peoples State Bank. Universal Mortgage Company, previously a wholly owned subsidiary of the Bank was merged directly into the Bank on September 1, 2008. PSB Capital, Inc. was formed in October, 2004. Through December 31, 2009, there had been no business transacted by PSB Capital, Inc. All significant inter-company transactions are eliminated in consolidation.

Net income is derived primarily from net interest income, which is the difference between interest earned on the Bank’s loan and investment portfolios and its cost of funds, primarily interest paid on deposits and borrowings. The volume of, and yields earned, on loans and investments and the volume of, and rates paid, on deposits and borrowings, determine net interest income.

Financial Condition. Assets consist of loans, investment securities, bank premises and equipment, cash and other operating assets. At December 31, 2009, the Corporation had assets totaling $462.0 million compared to $460.5 million at December 31, 2008. Total assets increased $1.5 million during 2009. Net loans decreased $22.9 million in 2009. The economy in southeastern Michigan continued to struggle in 2009, suffering through record unemployment, a lack of consumer confidence and continued troubles in the automobile industry. As a result, quality loan opportunities were limited and asset growth was conservatively centered around our investment portfolio. We have a long-term target of holding 15% – 20% of our assets in investment securities to lower the overall risk profile of the Bank. During 2009, we continued to move toward that goal by increasing our investment portfolio by $7.8 million. We also increased our cash and cash equivalents by approximately $17.0 million, providing the necessary liquidity to increase our investment portfolio further as additional quality investment opportunities become available.

During 2009, we also increased our bank premises and equipment by approximately $1.8 million. This was mainly the result of purchasing the land at two of our branch facilities that was previously leased. We estimate that the land purchases will save over $230 thousand in lease expenses each year. During the year we were also able to reduce our investment in other real estate owned (repossessed real property) by approximately $2.2 million, a 26% reduction.

Total deposits increased in 2009 by approximately $30.3 million. Non-interest bearing deposits increased approximately $5.0 million. Our combined interest bearing demand deposits and savings balances increased $43.7 million. In December 2009, we made some changes to our Prime Savings product that resulted in the reclassification of the product from a savings product to a money market product (See Note

6). The increases were partially offset by an $18.4 million decrease in our higher cost certificates of deposits. This decrease in total deposits was used in part to pre-pay $15 million in FHLB advances.

Loans – Loans consist primarily of commercial, residential mortgage, and consumer products offered in the communities served by the Bank. Total loans, net of the allowance for loan losses, at December 31, 2009, decreased to $344.8 million, from $367.7 million at December 31, 2008, a decrease of $22.9 million during 2009.

Commercial and construction loans decreased from $286.4 million to $266.3 million, a decrease of $20.1 million or 7.0% during 2009. During 2008, commercial and construction loans decreased $16.5 million or 5.4% from $302.9 million at December 31, 2007. The decreases in 2009 and 2008 are primarily the result of the continuing unfavorable economic conditions in the southeast Michigan market.

1-4 family residential mortgage loan balances totaled $63.6 and $58.4 million as of December 31, 2009 and 2008, respectively. Residential mortgage loan balances increased $5.2 million or 8.9% during 2009. This increase was primarily the result of the purchase of approximately $8.0 million of residential mortgage loans in 2009. During 2009, we realized a 21% increase in the number of residential mortgage loans closed and a 34% increase in the number of residential loans sold. 1-4 family residential loans increased $2.2 million or 4.0% during 2008.

Consumer loans decreased approximately $1.2 million or 17.0% in 2009 from $7.3 million to $6.1 million. This decrease was partly the result of management’s decision to let our indirect loan portfolio continue to run off during 2009, and also due to lower demand.

The following table shows the details of the Bank’s loan portfolio as of the dates indicated. Mortgages on real estate include 1-4 family residential, commercial real estate, construction loans, second mortgages and equity lines of credit (see Note 4 to the financial statements). Loan balances are shown net of unearned income.


	December 31,
	2009		2008		2007		2006		2005
					(in thousands)
Mortgages on real estate	$	311,940	$	330,271	$	320,641	$	335,809	$	306,586
Commercial		36,268		37,244		59,945		51,827		46,294
Consumer		6,055		7,294		8,726		10,708		12,213

Total Loans	$	354,263	$	374,809	$	389,312	$	398,344	$	365,093

The following table shows the loans by category as of December 31, 2009 and the period in which they mature. Loan balances are shown net of unearned income.


			One year						Loans maturing
	One year		to five		After five				More than one year
	or less		years		years		Total		Fixed		Variable
	(in thousands)
Mortgages on real estate	$	85,460	$	152,255	$	74,225	$	311,940	$	171,970	$	54,510
Commercial		18,709		15,576		1,983		36,268		11,480		6,079
Consumer		1,911		1,712		2,432		6,055		4,144		—

Total Loans	$	106,080	$	169,543	$	78,640	$	354,263	$	187,594	$	60,589

In 2009, as the result of the continued close scrutiny of our loan portfolio and net charge-offs of $13.8 million, management recorded a $16.2 million loan loss provision in order to build the allowance to an appropriate level. This compares to $8.0 million in net charge-offs and a $10.0 million provision in 2008. These increases, as well as the high level of impaired loans discussed below, are the direct result of the continued overall weakness in the Michigan economy. The real estate market in southeast Michigan has been particularly hard hit. While we have no exposure to the sub-prime mortgage lending market and very little exposure in residential construction and land development, we have suffered losses in our commercial loan portfolio on loans secured by real estate. Real estate values have dropped precipitously over the last few years which has directly led to charge-offs. The Bank’s portfolio of non-accrual loans was $38.0 million at December 31, 2009, up $26.1 million from December 31, 2008. Renegotiated loans have increased $17.2 million during the same period. Overall, our non-performing loans have increased by approximately $43.0 million since December 31, 2008. Troubled renegotiated debt accounts for 40% of the non-performing loans. These loans are performing as modified, and in many cases the borrowers should be able to return to the original payments in six to twelve months.

The Bank’s allowance for possible loan losses to non-performing loans is approximately 15% at December 31, 2009 compared to 35% at December 31, 2008. At December 31, 2009, the allowance for possible loan losses totaled $9.5 million, or 2.67% of total outstanding loans. This compares to a $7.1 million allowance at December 31, 2008 that was 1.90% of total outstanding loans. This increase better positions us to handle the challenges that we will face in the future.

The following table shows the detail of non-performing loans as of the dates indicated.


	December 31,
	2009			2008			2007			2006			2005
							(in thousands)
Nonaccrual loans	$	38,026		$	11,955		$	18,245		$	3,069		$	1,651
Loans past due 90 or more days		8			575			1,280			4,148			2,044
Renegotiated loans		25,118			7,903			1,347			486			515

Total non-performing loans		63,152			20,433			20,872			7,703			4,210
Other real estate owned		6,235			8,459			5,996			325			306

Total non-performing assets	$	69,387		$	28,892		$	26,868		$	8,028		$	4,516


Total non-performing loans to total loans		17.83	%		5.45	%		5.36	%		1.93	%		1.15	%
Total non-performing assets to total assets		15.02	%		6.27	%		5.46	%		1.61	%		0.91	%

The Bank places loans in non-accrual status when, in the opinion of management, uncertainty exists as to the ultimate collection of principal and interest. The Bank has no foreign loans. Management knows of no loans which have not been disclosed above which cause it to have doubts as to the ability of such borrowers to comply with the contractual loan terms, or which may have a material effect on the Bank’s balance sheet or results from operations. Other real estate decreased $2.2 million (26%) in 2009. As of December 31, 2009, other real estate consists of 39 properties compared to 52 properties at December 31, 2008, as we were able to dispose of many properties during the year. Other real estate is carried on the books at the lower of, fair value less the estimated cost to sell, or, the carrying amount of the loan at the date of foreclosure.

Of the $63.2 million in non-performing loans, $54.6 million is real estate related and $3.3 million is other commercial. We attribute this level of non-performing loans to the continuing poor economic conditions in the state of Michigan, especially the effects on the real estate market, including higher vacancy rates, higher unemployment and lower consumer spending. Net charge-offs increased to $13.8 million in 2009 compared to $8.0 million in 2008. $12.0 million of the 2009 net charge-offs were related to real estate loans. After analysis of the allowance for loan losses, management determined that a $16.2 million provision

was necessary to build the allowance for loan losses to an adequate level. This compares to a $10.0 million provision in 2008 and a $7.7 million provision in 2007.

The following table presents the changes in the allowance for loan losses during the periods indicated.


	December 31,
	2009			2008			2007			2006			2005
						(in thousands)
Balance — Beginning of year	$	7,116		$	5,184		$	4,257		$	3,670		$	3,394
Loans charged off:
Mortgages on real estate		(12,213	)		(6,813	)		(5,470	)		(205	)		(536	)
Commercial		(1,712	)		(1,261	)		(1,054	)		(1,229	)		(702	)
Consumer		(345	)		(313	)		(661	)		(282	)		(642	)

Total Charge offs		(14,270	)		(8,387	)		(7,185	)		(1,716	)		(1,880	)

Recoveries on loans previously charged off:
Mortgages on real estate		240			109			36			—			80
Commercial		81			55			209			241			225
Consumer		133			199			204			223			297

Total Recoveries		454			363			449			464			602

Provision for loan losses		16,169			9,956			7,663			1,839			1,554


Balance — End of year	$	9,469		$	7,116		$	5,184		$	4,257		$	3,670

The following table shows the allocation of the allowance for loan losses by specific category as of the dates indicated.


	December 31,
	2009					2008					2007					2006					2005
											(in thousands)
			Percent of					Percent of					Percent of					Percent of					Percent of
			Loans in					Loans in					Loans in					Loans in					Loans in
			Each					Each					Each					Each					Each
			Category					Category					Category					Category					Category
	Allocated		to Total			Allocated		to Total			Allocated		to Total			Allocated		to Total			Allocated		to Total
	Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans
Mortgages	$	8,247		88.05	%	$	6,418		88.11	%	$	4,239		82.36	%	$	716		84.30	%	$	609		84.09	%
Commercial		1,025		10.24	%		539		9.94	%		675		15.40	%		2,895		13.01	%		2,221		12.56	%
Consumer		196		1.71	%		158		1.95	%		266		2.24	%		528		2.69	%		690		3.35	%
Unallocated		1		n/a			1		n/a			4		n/a			118		n/a			150		n/a

Total	$	9,469		100.00	%	$	7,116		100.00	%	$	5,184		100.00	%	$	4,257		100.00	%	$	3,670		100.00	%

Investment securities — Investment securities totaled $60.0 million as of December 31, 2009 versus $52.2 million as of December 31, 2008, an increase of $7.8 million. Each of these figures includes adjustments for fluctuations in market values on available for sale securities (see Note 3 to the financial statements). During 2009, the Bank sold certain securities that generated $2.1 million in securities gains. This compares to gains of $187 thousand on the sale of securities in 2008.

The following table shows the amortized cost and the fair market value of the Bank’s securities portfolio as of the dates indicated.


	December 31,
	2009				2008
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
			(in thousands)
Available-for-sale securities:
U. S. treasury securities and obligations of other U.S. government agencies	$	39,946	$	40,155	$	43,834	$	45,146
Obligations of states and political subdivisions		17,919		17,894		5,380		5,126
Mortgage-backed securities		—		—		—		—
Corporate debt securities		500		450		500		450
Equities		1,532		1,532		1,532		1,532

Total available-for-sale securities	$	59,897	$	60,031	$	51,246	$	52,254

Maturity of the investment securities (at par value) and the weighted average yield for each range of maturities as of December 31, 2009 are shown in the table below. The yields on municipal securities are on a tax equivalent basis.


						From one to					From five to					After ten
	One year or less					five years					ten years					years					Equity					Total
	Dollar		Yield			Dollar		Yield			Dollar		Yield			Dollar		Yield			Dollar		Yield			Dollar		Yield
													(in thousands)
Obligations of U.S. government agencies	$	17,351		2.70	%	$	15,402		3.55	%	$	6,350		3.68	%	$	—		—		$	—		—		$	39,103		3.19	%
Obligations of states and political subdivisions		4,405		5.30	%		3,775		5.11	%		2,415		5.57	%		7,020		6.17	%		—		—			17,615		5.64	%
Mortgage-backed securities		—		—			—		—			—		—			—		—			—		—			—		—
Corporate debt securities		—		—			—		—			—		—			500		3.77	%		—		—			500		3.77	%
Equity securities & others		—		—			—		—			—		—			—		—			1,532		2.04	%		1,532		2.04	%

Total	$	21,756		3.23	%	$	19,177		3.86	%	$	8,765		4.20	%	$	7,520		6.01	%	$	1,532		2.04	%	$	58,750		3.90	%

Deposits — The Bank depends primarily upon customer deposits and short-term borrowing for funds with which to conduct its business. Bank deposits consist primarily of retail deposit products including checking and savings accounts from individuals and businesses, NOW accounts, money market demand accounts and time deposit accounts (CDs). Deposits totaled $442.7 million and $412.4 million at December 31, 2009 and 2008, respectively, an increase of $30.3 million, or over 7%. We increased our money market demand balances the most in 2009 ($116.3 million). This increase was largely due to a reclassification of our very successful Prime Savings product. Certain changes were made to the structure of this product in December 2009 and it is now classified as a money market demand account where it had previously been classified as a savings account. As of December 31, 2009, we held $118.7 million in Prime Savings balances compared to $74.9 million at December 31, 2008. In addition, we realized a $5 million increase in our non-interest bearing demand balances and a $5 million increase in our NOW balances. The increases were partially offset by an $18.4 million decrease in CDs and a $5.1 million decrease in other savings and other money market demand balances. Overall, in 2009, we experienced very strong deposit growth. As of December 31, 2009, we held no brokered deposits.

Management relies on lower-interest bearing demand and savings deposit accounts to fund a significant portion of the Bank’s operations. These accounts greatly improve net interest margins because of the lower interest rates paid to the customers. Non-interest bearing demand deposits plus the lower rate savings balances totaled $87.8 million at December 31, 2009.

The following table shows the details of the Bank’s deposit balances as of the dates indicated.


	December 31,
	2009		2008		2007
	(in thousands)
Noninterest bearing demand deposits	$	54,647	$	49,661	$	59,028
NOW accounts		34,105		29,128		33,750
Savings		33,108		110,707		132,588
Money market demand		132,226		15,898		18,030
Time under $100,000		95,303		104,213		81,446
Time over $100,000		93,356		102,835		113,668

Total deposits	$	442,745	$	412,442	$	438,510

The following table shows the maturity breakdown of the Bank’s time deposits over $100,000 as of December 31, 2009.


	December 31, 2009
	(in thousands)
Time Deposits Over $100,000 Maturing in:
Less than three months	$	31,333
Three through six months		9,635
Six months through one year		32,119
Over one year		20,269

Total deposits	$	93,356

Borrowings — The Bank had no FHLB advances and $282,000 in ESOP notes payable as of December 31, 2009. This compares to short-term FHLB advances of $15,000,000 and $436,000 in ESOP notes payable outstanding as of December 31, 2008.

The following table shows the balance, term and interest rate of the Bank’s borrowings:


			Outstanding as of
			12/31/2009				12/31/2008
					(dollars in thousands)
Type	Matures		Dollar		Rate		Dollar		Rate
FHLB Advance		—	$	—		—	$	5,000	2.97% Fixed
FHLB Advance		—	$	—		—	$	10,000	2.66% Fixed
ESOP Note Payable		2011	$	282	2.03% Variable		$	436	5.81% Variable

Total			$	282			$	15,436

Contractual Obligations — The Corporation is party to certain contractual financial obligations, including the repayment of debt and operating lease payments. These future financial obligations are presented below:


	Payments due - as of December 31, 2009
					(in thousands)
	0-12 Months		2-3 Years		4-5 Years		After 5 Years		Total
Operating Leases	$	350	$	430	$	276	$	115	$	1,171
Federal Funds	$	—	$	—	$	—	$	—	$	—
ESOP Note Payable	$	154	$	128	$	—	$	—	$	282
FHLB Advances	$	—	$	—	$	—	$	—	$	—

Total	$	504	$	558	$	276	$	115	$	1,453

Off Balance Sheet Obligations — At December 31, 2009, the Corporation had commitments to extend credit of $29.9 million and a $2.5 million obligation under a stand-by letter of credit.

Results of Operations. For the year ended December 31, 2009, we realized a net loss of $12.9 million compared to a net loss of $13.8 million in 2008. The 2008 loss was greatly impacted by two one-time charges that management elected to take in the fourth quarter. The first was a non-cash charge of $4.5 million to fully write-off our goodwill. The second was the full write-down of a deferred tax asset of $3.1 million. Net interest income declined $2.7 million comparing 2009 to 2008. Our net interest margin decreased to 3.38% in 2009 from 4.06% in 2008. The provision for loan losses was increased in 2009 to $16.2 million compared to $10.0 million in 2008. This increased our reserve for possible loan losses to $9.5 million, or 2.67% of total loans at December 31, 2009. This compares to a reserve of $7.1 million, or 1.90% of total loans at December 31, 2008. We feel this level of reserve is necessary given the challenges our customers continue to face and the elevated level of non-performing loans. Non-interest income increased

$2.1 million in 2009 over 2008. Non-interest expense decreased $6.6 million in 2009 compared to 2008. Due to tax law changes that allow us to carry 2008 and 2009 net operating losses back five years rather than the three years that was previously allowed, we were able to accrue a federal income tax credit of $1.3 million in 2009 compared to a credit of $207 thousand in 2008.

Interest and fee income on loans decreased approximately $4.2 million in 2009. This decrease was mainly the result of an 85 basis points decrease in our loan yield during the year. A $43 million increase in our non-performing loans, including Troubled Debt Restructured (TDR) was a major factor in our declining interest income. Also contributing to the decrease in interest income was a $16.3 million decrease in our average loan balances in 2009.

Interest income on investment securities decreased approximately $177 thousand in 2009 even though our average investment in securities increased $26.8 million during the year. This was the result of a 169 basis points decrease in our investment yield during the year. For liquidity purposes, we kept a higher than normal portion of our portfolio in shorter term, lower yielding investments.

Interest expense decreased $1.7 million in 2009. Most of this decrease is due to lower rates paid on our deposit balances. Interest expense on our deposit balances was $1.4 million less in 2009 than in 2008. On average, we paid 70 basis points less on our savings balances in 2009 than in 2008. This reduced the interest expense on our savings balances by $890 thousand. Through disciplined pricing, we were able to reduce the average rate paid on our certificates of deposit by 60 basis points in 2009, saving $422 thousand during the year. This was accomplished while increasing our average CD balances by approximately $22.8 million. By lowering the rate paid on our interest bearing demand balances (NOW and money market accounts) by 20 basis points, we cut the interest expense on these balances by approximately $64 thousand. We increased our average interest bearing demand balances by approximately $6.5 million while lowering the rates in 2009. Because we were able to increase our deposit balances in 2009, we were able to pay-down our debt. Our average debt in 2009 was approximately $10.7 million less than in 2008. As a result, the interest expense on our borrowings was $338 thousand lower in 2009 than in 2008. Overall, we were able to lower our average cost of funds by 45 basis points, or $1.7 million in 2009.

The following table presents the Bank’s consolidated balance of earning assets, interest bearing liabilities, the amount of interest income or interest expense attributable to each category, the average yield or rate for each category and the net interest margin for the periods indicated. Interest income is stated on a non-tax equivalent basis. Non-accrual loan balances are included in the loan totals.


	Year ended December 31,
	2009							2008							2007
	Average							Average							Average
	Balance		Interest		Rate			Balance		Interest		Rate			Balance		Interest		Rate
								(dollars in thousands)
Federal funds sold	$	19,247	$	53		0.28	%	$	306	$	7		2.29	%	$	598	$	28		4.68	%
Investment securities — taxable	$	59,589	$	2,265		3.80	%	$	49,062	$	2,418		4.93	%	$	36,091	$	1,649		4.57	%
Investment securities — tax-exempt	$	5,752	$	212		3.69	%	$	6,818	$	282		4.14	%	$	24,073	$	945		3.93	%
Loans, net of unearned income	$	368,826	$	21,492		5.83	%	$	385,174	$	25,730		6.68	%	$	412,274	$	29,960		7.27	%

Total earning assets	$	453,414	$	24,022		5.30	%	$	441,360	$	28,437		6.44	%	$	473,036	$	32,582		6.89	%

Interest bearing deposits	$	384,233	$	8,423		2.19	%	$	358,920	$	9,799		2.73	%	$	385,758	$	14,205		3.68	%
Funds borrowed	$	11,986	$	296		2.47	%	$	22,695	$	635		2.80	%	$	12,334	$	614		4.98	%

Total interest bearing liabilities	$	396,219	$	8,719		2.20	%	$	381,615	$	10,434		2.73	%	$	398,092	$	14,819		3.72	%

Net interest income			$	15,303						$	18,003						$	17,763

Net interest spread						3.10	%						3.71	%						3.17	%
Net interest margin						3.38	%						4.08	%						3.76	%

The following table shows the dollar amount of changes in interest income for each major category of interest earning asset, interest expense for each major category of interest bearing liability and the amount

of the change attributable to changes in average balances (volume) or average interest rates for the periods shown.


	2009 compared to 2008												2008 compared to 2007
	Change			Change			Change						Change			Change			Change
	due to			due to			due to			Total			due to			due to			due to			Total
	Rate			Volume			Mix			Change			Rate			Volume			Mix			Change
										(in thousands)
Federal funds sold	$	(6	)	$	433		$	(381	)	$	46		$	(14	)	$	(14	)	$	7		$	(21	)
Investment securities – taxable	$	(553	)	$	519		$	(119	)	$	(153	)	$	129		$	593		$	47		$	769
Investment securities – tax-exempt	$	(31	)	$	(44	)	$	5		$	(70	)	$	49		$	(678	)	$	(34	)	$	(663	)
Loans, net of unearned income	$	(3,285	)	$	(1,092	)	$	139		$	(4,238	)	$	(2,432	)	$	(1,970	)	$	172		$	(4,230	)

Total interest income	$	(3,875	)	$	(184	)	$	(356	)	$	(4,415	)	$	(2,268	)	$	(2,069	)	$	192		$	(4,145	)

Interest bearing deposits	$	(1,931	)	$	691		$	(136	)	$	(1,376	)	$	(3,664	)	$	(988	)	$	246		$	(4,406	)

Funds borrowed	$	(74	)	$	(299	)	$	35		$	(339	)	$	(270	)	$	516		$	(226	)	$	20

Total interest expense	$	(2,005	)	$	392		$	(101	)	$	(1,715	)	$	(3,934	)	$	(472	)	$	20		$	(4,386	)

Net interest income	$	(1,870	)	$	(576	)	$	(254	)	$	(2,700	)	$	1,666		$	(1,597	)	$	172		$	241

Management expects market interest rates to remain relatively flat in 2010. A change in interest rates, either rising or falling, is not expected to have a significant impact on the Bank’s net interest income. The Bank’s Asset/Liability Committee meets regularly to, among other things, monitor interest rate fluctuations and to change product mix and pricing in an effort to provide steady growth in net interest income.

Non-interest income, which consists of service charges and other fees of $6,358,000, $4,244,000 and $4,501,000 was recorded for the years ended December 31, 2009, 2008 and 2007, respectively. This represents a 50% increase in non-interest income in 2009 compared to a 6% decrease in 2008. We realized an almost $2 million increase in gains on the sale of securities in 2009 as we re-structured our portfolio during the year. We also realized a $132 thousand increase in deposit service charges in 2009 as we continued to re-design and re-price many of our deposit products. We recorded a $109 thousand (23%) increase in the gains on the sale of mortgage loans in 2009 as we saw a 23% increase in the dollar value of mortgage loans sold during the year. The increases in non-interest income were partially offset by an $87 thousand decrease in other income in 2009. This includes a $210 thousand decrease in the gains on the sale of other real estate, partially offset by a $113 thousand increase in income from the rent of other real estate.

Non-interest expense, which includes salaries and benefits, occupancy and other operating expenses, decreased to $19.7 million in 2009 from $26.3 million in 2008. Management’s decision to write-off $4.5 million in Goodwill in the 4^th quarter of 2008 was the biggest contributing factor to this decrease in non-interest expense. Goodwill is not amortized, but it is assessed for impairment, and any such impairment would be recognized in the period in which it is identified. During 2008, it was determined that Goodwill was indeed impaired. Accordingly, 100% of our goodwill was written-off in the 4^th quarter of 2008.

Salary and benefits expense was reduced for the second year in a row. Total compensation decreased approximately $1.5 million, or 15% in 2009. We reduced FTE (number of full-time equivalent employees) from 146 at December 31, 2008 to 129 at December 31, 2009. Salaries were frozen in 2009 and no bonuses were paid. We also temporarily discontinued matching employee 401K Plan contributions in May of 2009.

Occupancy costs were reduced by $503 thousand in 2009. This decrease includes a $428 thousand decrease in rent expense. This was the result of purchasing the land at two of our branches that was previously leased, and the fact that in 2008 we had a one-time rent charge to recognize the future lease liability on a mortgage office that we closed.

Legal and professional fees were increased $372 thousand in 2009. Legal expenses increased $487 thousand in 2009. Much of this increase was related to collection efforts associated with problem loans. This

was partially offset by a $54 thousand reduction in professional consulting fees, a $31 thousand decrease in accounting and auditing fees and a $29 thousand decrease in fees paid to the board of directors.

Like most banks across the country, we sustained a significant increase in FDIC premiums in 2009. Our total FDIC expense increased $1.1 million in 2009. Our basic insurance rate was increased and like all banks we were charged with a one-time special assessment in the third quarter of 2009. Our portion of this special assessment was $232 thousand.

Other operating expenses increased $221 thousand in 2009. This was mainly the result of one-time pre-payment charge from the FHLB for pre-paying $15 million in fixed rate advances.

Due to tax law changes enacted in 2009, that allow us to carry 2008 and 2009 net operating losses back five years versus the three years that was previously allowed, we were able to accrue a $1.3 million federal income tax credit in 2009.

Recovery Plan. The Company has aggressively pursued various available alternatives to improve its capital ratios, including raising capital, reducing assets, cutting operating costs and reorganizing management. While we received interest from potential private equity investors, our Board has determined that consummation of a transaction is not likely in the near term. Accordingly, our Board determined that the immediate implementation of our recovery plan, while continuing to seek new capital, is in the best interest of our stakeholders. The recovery plan is designed to improve the Company’s financial health and capital ratios by downsizing the bank and focusing on reducing our operating costs.

Key elements of the recovery plan include, but are not limited to:

	•		Aggressively manage the bank’s existing loan portfolios to minimize further credit losses and to maximize recoveries,

	•		Shrink the bank’s balance sheet,

	•		Reduce the bank’s loan portfolio through pay-downs, restructuring and significantly reducing lending activity, and

	•		Significantly lower operating costs to align with the restructured business model.

Liquidity and Capital Resources. Liquidity is the measurement of the Bank’s ability to have adequate cash or access to cash to meet financial obligations when due, as well as to fund corporate expansion or other activities. The Bank expects to meet its liquidity requirements through a combination of working capital provided by operating activities, attracting customer deposits, advances under Federal Home Loan Bank credit facilities and through the Federal Reserve Discount Window, and possible future periodic sales of investment securities and mortgages into secondary markets. Management believes that the Bank’s cash flow will be sufficient to support its existing operations for the foreseeable future.

The Corporation generated $5 million in cash through operating activities during 2009. This compares to $1 million provided by operating activities in 2008 and $2.7 million provided in 2007. Other

sources of cash in 2009 include $30.3 million raised through increased deposits and $6.7 million generated through a net pay-down of the loan portfolio. This increase in cash was used to fund the $15 million early pay-off of our FHLB advances, fund the $7 million net increase in our investment portfolio and pay for $3 million in capital expenditures. The remainder of the increase in cash is held in cash and cash equivalents at the end of the year providing additional liquidity until it can be re-deployed to more favorable investment options.

The Corporation had total equity of $16.7 million at December 31, 2009 and $30.1 million at December 31, 2008. The decrease in equity was primarily due to our $12.9 million net loss. At December 31, 2009, the ratio of stockholders’ equity to total assets was 3.62% compared to 6.54% at December 31, 2008. The capital levels of the Bank and the Corporation now fall below the minimum guidelines for being considered adequately capitalized (see note 16 to the financial statements).

We are under a Cease and Desist Order that, among other things, requires us to increase and maintain our leverage and total risk-based capital ratios to at least 8% and 12%, respectively, by November 27, 2009. Failure to increase our capital ratios or further declines in our capital ratios exposes us to additional restrictions and regulatory actions, including regulatory take-over. This uncertainty as to our ability to meet existing or future regulatory requirements raises substantial doubt about our ability to continue as a going concern.

At December 31, 2009, the Bank held cash and cash equivalents of approximately $29.3 million and the entire investment portfolio of $60 million was classified as available-for-sale. The estimated market value of the available-for-sale securities exceeded the amortized cost by approximately $134 thousand at December 31, 2009.

The primary impact of inflation on the Corporation’s operations is increased asset yields, deposit costs and operating overhead. Unlike most industrial companies, virtually all of 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 they would on non-financial companies. Although interest rates do not necessarily move in the same direction, or to the same extent, as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. The effects of inflation can magnify the growth of assets and if significant, require that equity capital increase at a faster rate than would otherwise be necessary.

Regulatory Orders

The Order required the Bank to take action in the following areas:

	•		The Bank must have and retain qualified management.

	•		The board of directors was required to assume full responsibility for the approval of sound policies and objectives and for the supervision of all of the Bank’s activities.

	•		Increase the Bank’s level of Tier 1 capital as a percentage of total assets to at least 8 percent.

	•		Charge off any loans classified as “loss.”

	•		Prohibit the extension of credit to borrowers that have had loans with the Bank that were classified “substandard”, “doubtful” or “special mention” without prior Board approval.

	•		Prohibit the extension of credit to borrowers that have had loans charged off or classified as “loss” in exam reports.

	•		The Bank may not declare or pay any cash dividend without prior written consent of the FDIC and OFIR.

	•		Prior to submission or publication of all Reports of Condition, the board shall review the adequacy of the Bank’s Allowance for Loan and Lease Losses, (“ALLL”).

	•		Within 30 days of the effective date of the Order, the Bank was required to eliminate and/or correct all violations of law, rule, and regulations.

	•		Within 60 days from the effective date of the Order, the Bank was required to correct all deficiencies in the loans listed for “Special Mention.”

	•		Prepare and submit progress reports the FDIC and OFIR.

Quantitative and Qualitative Disclosures About Market Risk

To a great extent, the Corporation’s operating strategies focus on asset/liability management. The purpose of its Asset/Liability Management Policy is to provide stable net interest income growth while both maintaining adequate liquidity and protecting the Bank’s earnings from undue interest rate risk. The Bank follows its Asset/Liability Management Policy for controlling exposure to interest rate risk. The Asset/Liability Management Policy is established by Management and is approved by the Board of Directors. Because of loan repayments, the investment securities due to mature in 2010 and available lines of credit, management believes the Bank is sufficiently liquid.

The Asset/Liability Management Policy also is designed to maintain an appropriate balance between rate-sensitive assets and liabilities in order to maximize interest rate spreads. The Bank monitors the sensitivity of its assets and liabilities with respect to changes in interest rates and maturities and directs the allocation of its funds accordingly. The strategy of the Bank has been to maintain, to the extent possible, a balanced position between assets and liabilities and to place appropriate emphasis on the sensitivity of its assets.

The following table sets forth the estimated maturity or re-pricing and the resulting interest sensitivity gap, of the Bank’s interest-earning assets and interest-bearing liabilities at December 31, 2009 and the cumulative interest sensitivity gap at December 31, 2009. The amounts in the table are derived from internal data of the Bank and could be significantly affected by external factors such as changes in prepayment assumptions, early withdrawals of deposits and competition.


	Estimated Maturity or Re-pricing at December 31, 2009
	Less than three			Three months to			One to five			Due after five
	months			less than one year			years			years			Total
Interest earning assets:
Securities (1) (2)	$	2,100		$	8,541		$	16,933		$	32,457		$	60,031
Loans		112,284			29,269			167,755			44,955			354,263

Total interest earning assets	$	114,384		$	37,810		$	184,688		$	77,412		$	414,294


Interest bearing liabilities:
Savings and interest bearing demand deposits	$	199,439		$	—		$	—		$	—		$	199,439
Time deposits		57,215			89,097			42,347			—			188,659
Short term borrowings		—			—			—			—			—
Long term borrowings		154			—			128			—			282

Total interest bearing liabilites	$	256,808		$	89,097		$	42,475		$	—		$	388,380


Interest rate sensitivity gap – current	$	(142,424	)	$	(51,287	)	$	142,213		$	77,412		$	25,914

Interest rate sensitivity gap – cumulative	$	(142,424	)	$	(193,711	)	$	(51,498	)	$	25,914

Cumulative interest rate sensitivity gap as a percent of total assets		-30.83	%		-41.93	%		-11.15	%		5.61	%


(1)		Equity investments have been placed in the 0-3 month category.

(2)		Re-pricing is based on anticipated call dates, and may vary from contractual maturities.

Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities and periods to re-pricing, they may react differently to changes in market interest rates. Also, interest rates on assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other assets and liabilities may follow changes in market interest rates. Additionally, certain assets have features that restrict changes in the interest rates of such assets, both on a short-term basis and over the lives of such assets. The gap table presented above is based on stated maturities and next re-pricing dates and does not take into account prepayment or withdrawal assumptions. In the event of a change in market interest rates, prepayments and early withdrawals could cause significant deviation from the stated maturities and re-pricings.

According to the traditional banking industry static gap table set forth above, the Bank was liability sensitive with a negative cumulative one-year gap of $193.7 million or 42% of interest-earning assets at December 31, 2009. In general, based upon this analysis, and the Bank’s mix of deposits, loans and investments, increases in interest rates would be expected to result in a decrease in the Bank’s net interest margin. However, a different tool, an interest sensitivity model, is the primary tool used in assessing interest rate risk, by estimating the effect that specific upward and downward changes in interest rates would have on pre-tax net interest income. Key assumptions used in the model include prepayment speeds on mortgage related assets; changes in market conditions, loan volumes and pricing; and management’s determination of core deposit sensitivity. These assumptions are inherently uncertain and, as a result, the model can not precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in other market conditions.

Based on the December 31, 2009 simulation, the Company is in a neutral position relative to interest rate changes. Based on the position of the balance sheet and management’s assumptions concerning core deposit sensitivity and other assumptions, net interest income will not be significantly impacted whether rates rise or fall.

Application of Critical Accounting Policies

Allowance for Loan Losses – The allowance for loan losses is calculated with the objective of maintaining a reserve sufficient to absorb estimated probable loan losses. Loan losses are charged against the allowance when management believes loan balances are uncollectible. Subsequent recoveries, if any, are credited to the allowance. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. This evaluation is inherently subjective as it requires an estimate of the loss content for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows and an estimate of the value of collateral after holding and selling costs.

A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and 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 principal and interest payments when due. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures. Residential mortgages are grouped by delinquency and assigned different loan loss reserves depending on whether they are classified as low, moderate or high risk.

Accounting for Goodwill - Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is not amortized but it is assessed at least annually for impairment, and any such impairment will be recognized in the period identified. During 2008, it was determined the Goodwill was indeed impaired. Accordingly, 100% of our Goodwill, or $4,458,000 was written-off during the 4^th quarter of 2008.

Market Information

The table below shows, for the periods indicated, the high and low prices for common stock in the over-the-counter market of which PSB Group, Inc. is aware. This information was obtained from a third-party reporting service and while we believe the information is correct, we do not warrant its accuracy. These quotations may represent inter-dealer prices without retail mark-ups, mark-downs or commissions and do not necessarily represent actual stock transactions. There is not an active market for the common stock of PSB Group, Inc.

2009

High

Low

Dividend Declared

First Quarter

2.60

0.56

0.00

Second Quarter

2.90

0.75

0.00

Third Quarter

1.95

1.08

0.00

Fourth Quarter

1.95

0.25

0.00

2008

High

Low

Dividend Declared

First Quarter

9.75

6.05

0.04

Second Quarter

8.90

3.85

0.00

Third Quarter

7.50

3.00

0.00

Fourth Quarter

5.15

1.15

0.00

On December 31, 2009, PSB Group, Inc. had 466 holders of record of its common stock. The stock is quoted on the OTC Bulletin Board under the symbol “PSBG.OB”. Howe, Barnes, Hoefer & Arnett, Inc. and Monroe Securities, Inc. are market makers in the stock.

Contact Information:


Todd Raclaw		Steven Schroeder
Howe, Barnes, Hoefer & Arnett, Inc.		Monroe Securities, Inc.
222 Riverside Plaza — 7^th Floor		100 North Riverside Plaza, Suite 1620
Chicago, IL 60606		Chicago, IL 60606
(800) 800-4693		(800) 766-5560
www.howebarnes.com		www.monroesecurities.com

PSB GROUP INC - FORM 10-K - EX-13 - March 31, 2010

Attached files

PSB GROUP INC Reports