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EX-32 - EXHIBIT 32 - PSB Holdings, Inc.ex32.htm
EX-23 - EXHIBIT 23 - PSB Holdings, Inc.ex23.htm
EX-31.2 - EXHIBIT 31.2 - PSB Holdings, Inc.ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - PSB Holdings, Inc.ex31-1.htm


  
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended June 30, 2010
 
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             
 
Commission File Number: 000-50970
 
PSB Holdings, Inc.
 
(Name of Registrant as Specified in its Charter)
 
   
Federal
42-1597948
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification Number)
40 Main Street, Putnam, Connecticut
06260
(Address of Principal Executive Office)
(Zip Code)
 
(860) 928-6501
(Registrant’s Telephone Number including area code)
 
Securities Registered Under to Section 12(b) of the Act:
Common Stock, par value $0.10 per share
(Title of Class)
The NASDAQ Stock Market LLC
(Name of exchange on which registered)
 
Securities Registered Under Section 12(g) of the Exchange Act:
 
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES  ¨  NO  x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of 15(d) of the Act. YES  ¨  NO  x
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file reports), and (2) has been subject to such requirements for the past 90 days.
 
(1)  YES  x  NO  ¨
(2)  YES  x  NO  ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ¨No ¨
 
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large accelerated filer ¨
Accelerated filer  ¨
Non-accelerated filer o
Smaller reporting company   x
 
 
 

 

 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  ¨  YES    x  NO
 
The aggregate value of the voting stock held by non-affiliates of the Registrant, computed by reference to the closing price of the Common Stock as of December 31, 2009 ($3.40) was $6.1 million.
 
As of August 31, 2010, there were 6,528,863 shares outstanding of the Registrant’s Common Stock, including 3,729,846 shares owned by Putnam Bancorp, MHC.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
 
1.
Proxy Statement for the 2010 Annual Meeting of Stockholders (Part II and III)
 



 
 

 
 
 
PSB HOLDINGS, INC.
 
FORM 10-K
 
Index
 
     
   
Page
 
 
PART I
         1
     
ITEM 1.
Business
         1
     
ITEM 1A.
Risk Factors
        31
     
ITEM 1B.
Unresolved Staff Comments
        37
     
ITEM 2.
Properties
        37
     
ITEM 3.
Legal Proceedings
        38
     
ITEM 4.
[Removed and Reserved]
        38
   
PART II
        39
     
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
        39
     
ITEM 6.
Selected Financial Data
        40
     
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
        41
     
ITEM 7A.
Quantitative and Qualitative Disclosures About Market Risk
        49
     
ITEM 8.
Financial Statements and Supplementary Data
        49
     
ITEM 9.
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
        86
     
ITEM 9A.
Controls and Procedures
        86
     
ITEM 9B.
Other Information
        86
   
PART III 
        87
     
ITEM 10.
Directors, Executive Officers and Corporate Governance
        87
     
ITEM 11.
Executive Compensation
        87
     
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
        87
     
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
        87
     
ITEM 14.
Principal Accountant Fees and Services
        87
   
PART IV 
        88
   
ITEM 15.
Exhibits and Financial Statement Schedules
        88
   
Signatures
        89
 
 
 

 
PART I
 
ITEM 1.
Business
 
Forward Looking Statements
 
This Annual Report on Form 10-K contains certain “forward-looking statements” which may be identified by the use of words such as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, general and local economic conditions, changes in interest rates, deposit flows, demand for mortgage and other loans, real estate values, competition, changes in accounting principles, policies, or guidelines, changes in legislation or regulation, and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing products and services.
 
PSB Holdings, Inc.
 
PSB Holdings, Inc. is the federally chartered stock holding company of Putnam Bank, and owns 100% of the common stock of Putnam Bank. PSB Holdings, Inc. also owns investment securities valued at $1.3 million as of June 30, 2010. We have not engaged in any significant business activity other than owning the common stock of Putnam Bank and investing in marketable securities. Our executive office is located at 40 Main Street, Putnam, Connecticut 06260, and our telephone number is (860) 928-6501. 57.1% of the outstanding stock of PSB Holdings, Inc. is owned by Putnam Bancorp, MHC.
 
Putnam Bancorp, MHC
 
Putnam Bancorp, MHC is a federally chartered mutual holding company. Putnam Bancorp, MHC has not engaged in any significant business activity other than owning the common stock of PSB Holdings, Inc. Putnam Bancorp, MHC owns 57.1% of the outstanding shares of common stock of PSB Holdings, Inc. So long as Putnam Bancorp, MHC exists, it is required to own a majority of the voting stock of PSB Holdings, Inc. As a result, stockholders other than Putnam Bancorp, MHC will not be able to exercise voting control over most matters put to a vote of stockholders and Putnam Bancorp, MHC, through its Board of Directors, will be able to exercise voting control over most matters put to a vote of stockholders.
 
Putnam Bancorp, MHC is headquartered at 40 Main Street in Putnam, Connecticut and its telephone number at that address is (860) 928-6501.
 
Putnam Bank
 
Putnam Bank was originally founded in 1862 as a state-chartered mutual savings bank. In October 2004, the Bank converted to a federally chartered stock savings bank in connection with the offering of common stock by PSB Holdings, Inc. The Bank is headquartered at 40 Main Street in Putnam, Connecticut and conducts substantially all of its business from eight full-service banking offices and one loan origination center. In addition, the Bank maintains a “Special Needs Limited Branch” and a “Limited Service (Mobile) Branch.” The telephone number at the Bank’s main office is (860) 928-6501.
 

Available Information

PSB Holdings, Inc. is a public company, and files interim, quarterly and annual reports with the Securities and Exchange Commission.  These respective reports are on file and a matter of public record with the Securities and Exchange Commission and may be read and copied at the Securities and Exchange Commission’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC (http://www.sec.gov).

Our website address is www.putnambank.com.  Information on our website should not be considered a part of this annual report.
 
 
1

 
General
 
Our principal business consists of attracting deposits from the general public in Windham County and New London County, Connecticut and investing those deposits, together with funds generated from operations, primarily in one- to four-family residential mortgage loans and, to a lesser extent, commercial real estate loans (including multi-family real estate loans), commercial loans, construction mortgage loans and consumer loans, and in investment securities. Our revenues are derived principally from interest on loans and securities, and from loan origination and servicing fees. Our primary sources of funds are deposits and principal and interest payments on loans and securities.
 
Competition
 
We face intense competition within our market area both in making loans and attracting deposits. The Town of Putnam and the surrounding area have a high concentration of financial institutions, including large commercial banks, community banks and credit unions. Some of our competitors offer products and services that we currently do not offer, such as trust services and private banking. As of June 30, 2009, based on the FDIC’s annual Summary of Deposits Report (the most current data available), our market share of deposits represented 18.9% of deposits in Windham County and 1.1% in New London County.
 
Our competition for loans and deposits comes principally from commercial banks, savings institutions, mortgage banking firms and credit unions. We face additional competition for deposits from money market funds, brokerage firms, mutual funds and insurance companies. Our primary focus is to build and develop profitable customer relationships across all lines of business while maintaining our role as a community bank.
 
Market Area

 We operate in a primarily rural market area that has a stable population and household base. We currently operate out of eight offices, which are located in Windham County and New London County, Connecticut. According to a recent census report, from 2000 to 2010 the population of Windham and New London Counties increased by 0.9% and 0.3% annually while the population of the United States increased by 1.0% on an annual basis. During the same period, the number of households in Windham and New London Counties increased 0.8% and 0.4% on an annual basis, compared to the United States increase of 1.0% annually. In 2010, per capita income for Windham County was $25,171 and the median household income was $57,890. In the same year, per capita income for New London County was $30,787 and the median household income was $64,743. These compare to per capita income for the State of Connecticut and the United States of $36,065 and $26,739, respectively, and median household income of $70,340 and $54,442, respectively.
 
            Windham County is located in the Northeastern corner of Connecticut and borders both Massachusetts (to the north) and Rhode Island (to the east). New London County is to the south of Windham County, located in the Southeastern corner of Connecticut. Putnam is approximately 45 miles from Hartford, Connecticut, 30 miles from Providence, Rhode Island, and 65 miles from Boston, Massachusetts. Windham County has a diversified mix of industry groups and employment sectors, including services, wholesale/retail trade and government. These three sectors comprise approximately 66% of the employment base in Windham County. The same three sectors comprise a higher 74% of the employment base in New London County; however, approximately 28% of the employment base is employed by the government sector. Windham County's June 2010 unemployment rate of 10.5% was higher than the New London County unemployment rate of 8.5%, higher than the comparable Connecticut unemployment rate of 8.9%, and higher than the national unemployment rate of 9.5%. The Connecticut, Windham County and New London County's June 2010 unemployment rates were all higher than their June 2009 unemployment rates of 8.1%, 9.0%, and 7.6%.  Our primary market area for deposits includes the communities in which we maintain our main office and our branch office locations. Our primary lending area is broader than our primary deposit market area and includes all of Windham County, and parts of the adjacent Connecticut Counties of New London and Tolland and the Rhode Island and Massachusetts communities adjacent to Windham County.
 
Lending Activities
 
Historically, our principal lending activity has been the origination of first mortgage loans for the purchase or refinancing of one- to four-family residential real estate. We retain most of the loans that we originate. However, we generally sell long-term fixed rate loans in the secondary market. When we sell loans, we generally retain the servicing rights for such loans. One- to four-family residential real estate mortgage loans (including home equity loans and lines of credit) represented $195.0 million, or 75.4%, of our loan portfolio at June 30, 2010. We also offer commercial real estate loans (including multi-family real estate loans), commercial loans, construction mortgage loans (primarily secured by single-family properties) and consumer loans. At June 30, 2010, commercial real estate loans totaled $54.4 million, or 21.0% of our loan portfolio, commercial loans totaled $6.8 million, or 2.6% of our loan portfolio, construction mortgage loans totaled $1.3 million, or 0.5% of our loan portfolio and consumer loans, consisting primarily of automobile loans and secured personal loans, totaled $1.2 million, or 0.5% of our loan portfolio.
 
 
2

 
 
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio at June 30,
 
                                                             
   
2010
   
2009
   
2008
   
2007
   
2006
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(Dollars in thousands)
 
Mortgage Loans:
                                                           
   Residential (1)
  $ 194,960       75.37 %   $ 200,680       74.57 %   $ 181,978       72.59 %   $ 168,126       69.86 %   $ 147,706       71.50 %
   Commercial real estate
    54,398       21.03       56,500       20.99       55,406       22.10       59,274       24.63       48,210       23.34  
   Residential construction
    1,338       0.52       1,887       0.70       3,223       1.29       5,376       2.23       3,551       1.72  
Commercial
    6,786       2.62       8,958       3.33       8,687       3.46       6,449       2.68       5,693       2.76  
Consumer and other
    1,177       0.46       1,097       0.41       1,394       0.56       1,439       0.60       1,410       0.68  
                                                                                 
Total loans
  $ 258,659       100.00 %   $ 269,122       100.00 %   $ 250,688       100.00 %   $ 240,664       100.00 %   $ 206,570       100.00 %
                                                                                 
Unadvanced construction loans
    (1,521 )             (2,929 )             (6,522 )             (8,264 )             (5,486 )        
      257,138               266,193               244,166               232,400               201,084          
Net deferred loan costs
    285               324               320               282               35          
Allowance for loan losses
    (2,651 )             (2,200 )             (1,758 )             (1,780 )             (1,582 )        
                                                                                 
Loans, net
  $ 254,772             $ 264,317             $ 242,728             $ 230,902             $ 199,537          
 
(1)           Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
 
 
3

 

Loan Portfolio Maturities and Yields. The following table summarizes the scheduled repayments of our loan portfolio at June 30, 2010. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.

   
Residential (1)
   
Commercial Real Estate
   
Residential Construction
   
Commercial
   
Consumer and Other
Loans
   
Total Loans
       
   
Amount
   
Weighted Average Rate
   
Amount
   
Weighted Average Rate
   
Amount
   
Weighted Average Rate
   
Amount
   
Weighted Average Rate
   
Amount
   
Weighted Average Rate
   
Amount
   
Weighted Average Rate
 
   
(Dollars in thousands)
                                                             
Due During the Years
                                                                   
Ending June 30,
                                                                       
2011
  $ 47,259       4.38 %   $ 26,686       6.25 %   $ 1,006       5.30 %   $ 2,803       5.75 %   $ 531       6.25 %   $ 78,285       5.09 %
2012
    18,880       5.59 %     5,830       7.12 %     -       0.00 %     650       6.38 %     210       8.22 %     25,570       5.98 %
2013
    16,767       5.73 %     6,162       7.23 %     -       0.00 %     1,228       6.13 %     242       6.11 %     24,399       6.13 %
2014 to 2015
    27,679       5.54 %     7,603       6.77 %     -       0.00 %     1,785       5.15 %     177       5.96 %     37,244       5.77 %
2016 to 2020
    37,233       5.56 %     5,974       6.81 %     -       0.00 %     320       5.14 %     17       8.03 %     43,544       5.73 %
2021 and beyond
    47,142       5.60 %     954       7.56 %     -       0.00 %     -       0.00 %     -       0.00 %     48,096       5.64 %
                                                                                                 
      Total
  $ 194,960       5.30 %   $ 53,209       6.62 %   $ 1,006       5.30 %   $ 6,786       5.69 %   $ 1,177       6.55 %   $ 257,138       5.59 %
                                                                                                 
 

(1)
 
Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
 
 
4

 

The following table sets forth the scheduled repayments of fixed and adjustable rate loans at June 30, 2010 that are contractually due after June 30, 2011.
 
                   
   
Fixed
      
Adjustable
      
Total
 
   
(In thousands)
Mortgage Loans:
                 
     Residential (1)
  $ 108,259     $ 39,443     $ 147,702  
     Commercial real estate
    23,366       3,157       26,523  
Commercial
    3,202       781       3,983  
Consumer and other
    546       100       646  
                         
      Total
  $ 135,373     $ 43,481     $ 178,854  
                         
 
(1)
Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
 
At June 30, 2010, the total amount of loans that have fixed interest rates was $147.1 million, and the total amount of loans that have floating or adjustable interest rates was $110.1 million.
 
Residential Mortgage Loans. Our primary lending activity consists of the origination of one- to four-family residential mortgage loans that are primarily secured by properties located in Windham County and New London County. At June 30, 2010, $195.0 million, or 75.4% of our loan portfolio, consisted of one- to four-family residential mortgage loans. Included within these one- to four-family loans at June 30, 2010 were $16.1 million of home equity loans and $11.8 million of home equity lines of credit. Generally, one- to four-family residential mortgage loans are originated in amounts up to 80% of the lesser of the appraised value or purchase price of the property, with private mortgage insurance required on loans with a loan-to-value ratio in excess of 80%. We will not make loans with a loan-to-value ratio in excess of 100% for loans secured by single family homes. Fixed rate mortgage loans generally are originated for terms of 10 to 30 years. Generally, all fixed rate residential mortgage loans are underwritten according to Fannie Mae policies and procedures. Fixed rate residential mortgage loans with terms of more than 15 years are generally sold in the secondary market, while bi-weekly mortgages are generally retained in our portfolio. Bi-weekly mortgages are loans that require payments be made every two weeks. We will usually retain the servicing rights for all loans that we sell in the secondary market. We originated $39.3 million of fixed rate one- to four-family residential loans during the year ended June 30, 2010, of which $21.4 million were sold in the secondary market.
 
We also offer adjustable rate mortgage loans for one- to four-family properties, with an interest rate based on the one-year Constant Maturity Treasury Bill Index, which adjusts annually from the outset of the loan or which adjusts annually after a three-, five-, seven-, or ten-year initial fixed rate period. We originated $13.5 million of adjustable rate one- to four-family residential loans during the year ended June 30, 2010, of which $368,000 was sold in the secondary market. Our adjustable rate mortgage loans generally provide for maximum rate adjustments of 100 basis points per adjustment, with a lifetime maximum adjustment up to 6%, regardless of the initial rate. Our adjustable rate mortgage loans amortize over terms of up to 30 years.
 
Adjustable rate mortgage loans decrease the risk associated with changes in market interest rates by periodically repricing, but involve other risks because, as interest rates increase, the monthly or bi-weekly payments by the borrower increase, thus increasing the potential for default by the borrower. At the same time, the value of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustments permitted by our loan documents and, therefore, the effectiveness of adjustable rate mortgage loans may be limited during periods of rapidly rising interest rates. At June 30, 2010, $79.8 million, or 40.6%, of our one- to four-family residential loans had adjustable rates of interest.
 
In an effort to provide financing for moderate income home buyers, we offer Veterans Administration (VA), Federal Housing Administration (FHA), Connecticut Housing Finance Authority (CHFA) and Rural Development loans. These programs offer residential mortgage loans to qualified individuals. These loans are offered with fixed rates of interest and terms of up to 30 years. Such loans are secured by one- to four-family residential properties. All of these loans are originated using agency underwriting guidelines. VA, FHA and CHFA loans are closed in the name of Putnam Bank and are immediately sold on a servicing-released basis. All such loans are originated in amounts of up to 100% of the lower of the property’s appraised value or the sale price. Private mortgage insurance is required on all such loans.
 
 
5

 
All residential mortgage loans that we originate include “due-on-sale” clauses, which give us the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid. Regulations limit the amount that a savings association may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal of the property at the time the loan is originated. All borrowers are required to obtain title insurance. We also require homeowner’s insurance and fire and casualty insurance and, where circumstances warrant, flood insurance, on properties securing real estate loans. At June 30, 2010, our largest residential mortgage loan had a principal balance of $699,000 and was secured by a residence located in our primary market area. This loan was performing in accordance with its repayment terms.
 
We also offer home equity loans and home equity of lines of credit, both of which are secured by owner-occupied one- to four-family residences. At June 30, 2010, home equity loans and equity lines of credit totaled $27.9 million, or 14.3% of our residential mortgage loans and 10.8% of total loans. Additionally, at June 30, 2010, the unadvanced amounts of home equity lines of credit totaled $10.1 million. The underwriting standards utilized for home equity loans and home equity lines of credit include a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan. Home equity loans are offered with fixed rates of interest and with terms up to 15 years. The loan-to-value ratio for a home equity loan is generally limited to 80%. However, we offer special programs to borrowers, who satisfy certain underwriting criteria, with loan-to-value ratios of up to 100%. Our home equity lines of credit have adjustable rates of interest which are indexed to the prime rate, as reported in The Wall Street Journal. Interest rates on home equity lines of credit are generally limited to a maximum rate of 14.25%.
 
Commercial Real Estate Loans. We originate commercial real estate loans, including multi-family real estate loans that are generally secured by five unit or more apartment buildings, construction loans and loans on properties used for business purposes such as small office buildings, industrial facilities or retail facilities primarily located in our primary market area. We also offer real estate development loans to licensed contractors and builders for the construction and development of commercial real estate projects and one- to four-family residential properties. At June 30, 2010, commercial mortgage loans totaled $54.4 million, which amounted to 21.0% of total loans. Our commercial real estate underwriting policies provide that such real estate loans may be made in amounts of up to 80% of the appraised value of the property provided such loan complies with our current loans-to-one-borrower limit, which at June 30, 2010 was $5.4 million. Our commercial real estate loans may be made with terms of up to five years with 20 year amortization schedules and are offered with interest rates that are fixed or adjust periodically and are generally indexed to the prime rate as reported in The Wall Street Journal or to Federal Home Loan Bank advance rates. In reaching a decision on whether to make a commercial real estate loan, we consider the net operating income of the property, the borrower’s expertise and credit history, and the profitability of the value of the underlying property. In addition, with respect to commercial real estate rental properties, we will also consider the term of the lease and the quality of the tenants. We generally require that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.25x. Environmental surveys are generally required for commercial real estate loans. Generally, multi-family and commercial real estate loans made to corporations, partnerships and other business entities require personal guarantees by the principals.
 
A commercial borrower’s financial information is monitored on an ongoing basis by requiring periodic financial statement updates, payment history reviews and periodic face-to-face meetings with the borrower. We require commercial borrowers to provide annually updated financial statements and federal tax returns. These requirements also apply to all guarantors on commercial loans. We also require borrowers with rental investment property to provide an annual report of income and expenses for the property, including a tenant list and copies of leases, as applicable. The largest commercial real estate loan in our portfolio at June 30, 2010 was a performing $2.7 million loan secured by property located in our primary market area.
 
Loans secured by commercial real estate, including multi-family properties, generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate, including multi-family properties, are often dependent on successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy.
 
 
6

 
Residential Construction Loans. We originate construction loans to individuals for the construction and acquisition of personal residences. At June 30, 2010, construction mortgage loans totaled $1.3 million, or 0.5%, of total loans. At June 30, 2010, the unadvanced portion of these construction loans totaled $332,000.
 
Our construction mortgage loans generally provide for the payment of interest only during the construction phase, which is usually nine months. At the end of the construction phase, the construction loan converts to a permanent mortgage loan. Construction loans can be made with a maximum loan-to-value ratio of 95%, provided that the borrower obtains private mortgage insurance on the loan if the loan balance exceeds 80% of the appraised value or sales price, whichever is less, of the secured property. At June 30, 2010, our largest outstanding residential construction mortgage loan commitment was for $391,000, $167,000 of which was outstanding. This loan was performing according to its terms at June 30, 2010. Construction loans to individuals are generally made on the same terms as our one- to four-family mortgage loans.
 
Before making a commitment to fund a residential construction loan, we require an appraisal of the property by an independent licensed appraiser. We also review and inspect each property before disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspection based on the percentage of completion method.
 
Construction financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost is inaccurate, we may be required to advance funds beyond the amount originally committed in order to protect the value of the property. Additionally, if the estimate of value is inaccurate, we may be confronted with a project, when completed, with a value that is insufficient to assure full payment.
 
Commercial Loans. At June 30, 2010, we had $6.8 million in commercial loans which amounted to 2.6% of total loans. We make commercial business loans primarily in our market area to a variety of professionals, sole proprietorships and small businesses. Commercial lending products include term loans and revolving lines of credit. Such loans are generally used for longer-term working capital purposes such as purchasing equipment or furniture. Commercial loans are made with either adjustable or fixed rates of interest. Variable rates are based on the prime rate, as published in The Wall Street Journal, plus a margin. Fixed rate commercial loans are set at a margin above the comparable Federal Home Loan Bank advance rate.
 
When making commercial loans, we consider the financial statements of the borrower, our lending history with the borrower, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral.  Commercial loans are generally secured by a variety of collateral, primarily accounts receivable, inventory and equipment, and are supported by personal guarantees. Depending on the collateral used to secure the loans, commercial loans are made in amounts of up to 75% of the value of the collateral securing the loan. We generally do not make unsecured commercial loans.
 
Commercial loans generally have greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans generally are made on the basis of the borrower’s ability to repay the loan from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. We seek to minimize these risks through our underwriting standards. At June 30, 2010, our largest commercial loan was a $1.0 million loan secured by business assets located in our primary market area. This loan was performing according to its terms at June 30, 2010.
 
Consumer and Other Loans. We offer a limited range of consumer loans, principally to Putnam Bank customers residing in our primary market area with acceptable credit ratings. Our consumer loans generally consist of loans on new and used automobiles, loans secured by deposit accounts and unsecured personal loans. Consumer loans totaled $1.2 million, or 0.5% of our total loan portfolio, at June 30, 2010.
 
Origination, Purchase, Sale and Servicing of Loans. Lending activities are conducted primarily by our loan personnel operating at our eight branch offices and one loan origination center. All loans originated by us are underwritten pursuant to our policies and procedures. We originate both adjustable rate and fixed rate loans. Our ability to originate fixed or adjustable rate loans is dependent upon the relative customer demand for such loans, which is affected by current and expected future levels of market interest rates.
 
 
7

 
Generally, we retain in our portfolio all bi-weekly loans and other loans that we originate, with the exception of longer-term, fixed rate one- to four-family mortgage loans. The one- to four-family loans that we currently originate for sale include mortgage loans which conform to the underwriting standards specified by Fannie Mae. We also sell all mortgage loans insured by CHFA, FHA, VA and Rural Development. Generally, all one- to four-family loans that we sell are sold pursuant to master commitments negotiated with Fannie Mae. Generally, we sell our loans without recourse. We generally retain the servicing rights on the mortgage loans sold to Fannie Mae, but sell all CHFA, VA, FHA and Rural Development loans on a servicing-released basis.
 
At June 30, 2010, Putnam Bank was servicing loans sold in the amount of $35.2 million. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans.
 
During the fiscal year ended June 30, 2010, we originated $52.8 million of fixed rate and adjustable rate one-to four-family loans, of which $31.0 million were retained by us. We recognize at the time of sale, the cash gain or loss on the sale of the loans based on the difference between the net cash proceeds received and the carrying value of the loans sold.
 
Loan Approval Procedures and Authority. The Board of Directors establishes the lending policies and loan approval limits of Putnam Bank. Loan officers generally have the authority to originate mortgage loans, consumer loans and commercial loans up to amounts established for each lending officer. Loans in amounts above the individual authorized limits require the approval of Putnam Bank’s Credit Committee. The Credit Committee is authorized to approve the following types of loans in amounts up to $500,000: all one- to four family mortgage loans, commercial real estate loans, commercial loans and secured consumer loans. All loans of $500,000 or greater must receive the approval of Putnam Bank’s Board of Directors.
 
The Board annually approves independent appraisers used by Putnam Bank. For larger loans, the Bank may require an environmental site assessment to be performed by an independent professional for all non-residential mortgage loans. It is Putnam Bank’s policy to require hazard insurance on all mortgage loans.
 
Loan Origination Fees and Other Income. In addition to interest earned on loans, Putnam Bank receives loan origination fees. Such fees and costs vary with the volume and type of loans and commitments made and purchased, principal repayments, and competitive conditions in the mortgage markets, which in turn respond to the demand and availability of money.
 
Loans to One Borrower. The maximum amount that we may lend to one borrower and the borrower’s related entities is generally limited, by regulation, to 15% of our stated capital and reserves. At June 30, 2010, our regulatory limit on loans to one borrower was $5.4 million. At that date, the largest aggregate amount loaned by Putnam Bank to one borrower was $3.4 million. The loans comprising this lending relationship were performing in accordance with their terms as of June 30, 2010.                                                                                        
 
  Delinquencies and Classified Assets
 
                Collection Procedures A computer-generated delinquency notice is mailed monthly to all delinquent borrowers, advising them of the amount of their delinquency. When a loan becomes 60 days delinquent, Putnam Bank sends a letter advising the borrower of the delinquency. The borrower is given 30 days to pay the delinquent payments or to contact Putnam Bank to make arrangements to bring the loan current over a longer period of time. If the borrower fails to bring the loan current in 30 days or to make arrangements to cure the delinquency over a longer period of time, the matter is referred to legal counsel and foreclosure proceedings are started. We may consider forbearance in cases of a temporary loss of income if a plan is presented by the borrower to cure the delinquency in a reasonable period of time after his or her income resumes.
 
Loans Past Due and Non-performing Assets.  Loans are reviewed on a regular basis.  Management determines that a loan is impaired or non-performing when it is probable at least a portion of the loan will not be collected due to an irreversible deterioration in the financial condition of the borrower or the value of the underlying collateral.  When a loan is determined to be impaired, the measurement of the loan is based on present value of estimated future cash flows, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. Nonaccrual is defined as a loan in which collectability is questionable and therefore interest on the loan will no longer be recognized on an accrual basis. All loans that become 90 days or more delinquent are reviewed on a case-by-case basis to determine if that loan should be placed on non-accrual status.  When loans are placed on non-accrual status, unpaid accrued interest is fully reserved, and further income is recognized only to the extent received.  Other real estate owned is included in non-performing assets.  At June 30, 2010, the Company had non-performing loans of $6.3 million and a ratio of non-performing loans to total loans of 2.45%.
 
 
8

 
 
Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as other real estate owned (“OREO”) until such time as it is sold.  When real estate is acquired through foreclosure or by deed in lieu of foreclosure, it is recorded at its fair value, less estimated costs of disposal.  If the value of the property is less than the loan, less any related specific loan loss provisions, the difference is charged against the allowance for loan losses.  Any subsequent write-down of OREO is charged against earnings.  At June 30, 2010, the Company had OREO of $1.6 million and a ratio to non-performing assets of 19.76%.
 
Non-Performing Assets. The table below sets forth the amounts and categories of our non-performing assets at the dates indicated. As of June 30, 2010, the Company had $2.9 million in troubled debt restructurings (generally loans for which a portion of interest or principal has been forgiven and loans modified at interest rates materially less than current market rates).  A loan classified in the table below as “non-accrual” does not necessarily mean that such loan is or has been delinquent. Once a loan is more than 90 days delinquent or the borrower or collateral securing the loan experiences an event that makes collectability suspect, the loan is placed on “non-accrual” status. Our policies require six months of continuous payments in order for the loan to be removed from non-accrual status.
 
 
At June 30,
 
2010
   
2009
   
2008
   
2007
   
2006
 
 
(Dollars in thousands)
                             
Non-accrual loans:
                           
    Residential mortgage loans (1)
$ 1,425     $ 1,277     $ -     $ 55     $ 63  
    Commercial real estate
  4,164       5,073       982       1,480       1,313  
    Residential construction
  -       -       -       -       -  
Commercial
  213       99       -       3       -  
Consumer and other
  -       -       -       -       -  
         Total
  5,802 (2)     6,449 (2)     982       1,538       1,376  
Accruing loans past due over 90 days:
                                     
    Residential mortgage loans (1)
  491       -       -       -       -  
    Commercial real estate
  -       -       470       -       75  
    Residential construction
  -       -       -       -       -  
Commercial
  -       -       -       -       -  
Consumer and other
  -       -       -       -       -  
         Total
  491       -       470       -       75  
         Total non-performing loans
  6,293       6,449       1,452       1,538       1,451  
Real estate owned
  1,561       1,211       -       -       -  
Other non-performing assets
  46       46       -       -       -  
         Total non-performing assets
  7,900       7,706       1,452       1,538       1,451  
Trouble debt restructurings in compliance with restructure terms
  930 (2)     259 (2)     -       -       -  
Troubled debt restructures and
                                     
 total non-performing assets
$ 8,830     $ 7,965     $ 1,452     $ 1,538     $ 1,451  
Total non-performing loans to total loans
  2.45
%
    2.42
%
    0.59 %     0.66       0.72 %
Total non-performing loans to total assets
  1.29
%
    1.35
%
    0.29 %     0.31 %     0.31 %
Total non-performing assets and
                                     
 troubled debt restructurings to total assets
  1.80
%
    1.67
%
    0.29 %     0.31 %     0.31 %
 
(1)
Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
(2)
The gross interest income that would have been reported if the loans had performed in accordance with their original terms was $445,000 and $389,000 for the years ended June 30, 2010 and 2009, respectively. Actual income recognized in income was $154,000 and $136,000 for the years ended June 30, 2010 and 2009, respectively.
 
 
9

 
 
Total non-performing assets increased $191,000 to $7.9 million at June 30, 2010 from $7.7 million at June 30, 2009. Non-performing assets as of June 30, 2010 consisted of $1.6 million in Other Real Estate Owned which reflects the repossession  of a six-lot residential development project at a carrying value of $303,000, a partially completed single family home within the same subdivision with a carrying value of $160,000 and 34 acres of land carried at $110,000, one single unit condominium at a carrying value of $112,000, a single family home at a carrying value of $142,000, one residential/commercial office space at a carrying value of $213,000, an in-substance foreclosure of a condominium project at a carrying value of $384,000 and an in-substance foreclosure of a single family home at a carrying value of $137,000.  Also included in non-performing assets is $46,000 in Freddie Mac auction-rate trust preferred securities and $6.3 million in non-performing loans.  These loans consisted of nine residential loans totaling $1.9 million, three commercial and industrial loans totaling $212,000 and 11 commercial real estate loans totaling $4.2 million.  Non-performing assets as of June 30, 2009 consisted of $1.2 million in Other Real Estate Owned which reflects the repossession of one condominium development project, $46,000 in Freddie Mac auction-rate trust preferred securities and $6.4 million in non-performing loans.  These loans consisted of four residential loans totaling $1.3 million, two commercial and industrial loans totaling $97,000 and 17 commercial real estate loans totaling $5.1 million.  Eight of these loans continue to be classified as non-performing as of June 30, 2010.

The Bank's increase in non-performing loans is a direct correlation to the deteriorating real estate climate.  Management is focused on working with borrowers and guarantors to resolve these trends by restructuring or liquidating assets when prudent. Many of our commercial relationships are secured by development loans, in particular condominiums which have experienced a significant reduction in demand. The Bank reviews the strength of the guarantors; requires face to face discussions and offers restructuring suggestions that provide the borrowers with short term relief and exit strategies. Overall, we expect to see improvement as solutions are identified and executed. The Bank obtains a current appraisal on all real estate secured loans that are 180 days or more past due if the appraisal in our file is older than one year. If the determination is made that there is the potential for collateral shortfall, an allocated reserve will be assigned to the loan for the expected deficiency. It is the policy of the Bank to charge off or write down loans or other assets when, in the opinion of the Credit Committee and Loan Review, the ultimate amount recoverable is less than the book value, or the collection of the amount is expected to be unduly prolonged.  The level of non-performing assets is expected to fluctuate in response to changing economic and market conditions, and the relative sizes of the respective loan portfolios, along with management’s degree of success in resolving problem assets. Management takes a proactive approach with respect to the identification and resolution of problem loans.  In addition, in connection with a regularly scheduled Office of Thrift Supervision (“OTS”) examination, the Holding Company and Bank developed and implemented a plan to reduce classified assets.  See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Comparisons of Operating Results for the Fiscal Years Ended June 30, 2010 and 2009.

 
10

 
 
The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated.
 
                                     
   
Loans Delinquent For
             
   
60-89 Days Past Due
   
90 Days and Over
   
Total
       
   
Number
   
Amount
   
Number
   
Amount
   
Number
   
Amount
 
   
(Dollars in thousands)
 
At June 30, 2010
                                   
    Residential (1)
    6     $ 696       4     $ 491       10     $ 1,187  
    Commercial real estate
    -       -       -       -       -       -  
    Residential construction
    -       -       -       -       -       -  
    Commercial
    -       -       -       -       -       -  
    Consumer and other loans
    -       -       -       -       -       -  
Total
    6     $ 696       4     $ 491       10     $ 1,187  
                                                 
At June 30, 2009
                                               
    Residential (1)
    3     $ 581       -     $ -       3     $ 581  
    Commercial real estate
    4       2,024       -       -       4       2,024  
    Residential construction
    -       -       -       -       -       -  
    Commercial
    -       -       -       -       -       -  
    Consumer and other loans
    -       -       -       -       -       -  
Total
    7     $ 2,605       -     $ -       7     $ 2,605  
                                                 
At June 30, 2008
                                               
    Residential (1)
    -     $ -       -     $ -       -     $ -  
    Commercial real estate
    6       1,289       11       2,859       17       4,148  
    Residential construction
    -       -       -       -       -       -  
    Commercial
    1       45       1       195       2       240  
    Consumer and other loans
    -       -       -       -       -       -  
Total
    7     $ 1,334       12     $ 3,054 (2)     19     $ 4,388  
                                                 
At June 30, 2007
                                               
    Residential (1)
    -     $ -       1     $ 16       1     $ 16  
    Commercial real estate
    1       128       -       -       1       128  
    Residential construction
    -       -       -       -       -       -  
    Commercial
    -       -       1       3       1       3  
    Consumer and other loans
    -       -       -       -       -       -  
Total
    1     $ 128       2     $ 19       3     $ 147  
                                                 
At June 30, 2006
                                               
    Residential (1)
    3     $ 133       -     $ -       3     $ 133  
    Commercial real estate
    1       633       2       755       3       1,388  
    Residential construction
    -       -       -       -       -       -  
    Commercial
    -       -       -       -       -       -  
    Consumer and other loans
    -       -       -       -       -       -  
Total
    4     $ 766       2     $ 755       6     $ 1,521  
                                                 
 

(1)  
Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
(2)  
The difference in loans delinquent 90 days and over and non-performing loans as of June 30, 2010 is primarily related to completion of underwriting for renewals and obtaining current financial information from borrowers, with these loans otherwise performing as agreed.
 
 
11

 
 
 
Classified Assets. The Office of Thrift Supervision regulations and the Bank’s internal policies require that management utilize an internal asset classification system to monitor and evaluate the credit risk inherent in its loan portfolio.  The bank currently classifies problem and potential problem assets as “substandard”, “doubtful”, “loss” or “special mention.”  An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, questionable, and there is a high probability of loss. Assets classified as “loss” are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.  In addition, assets that do not currently expose the Bank to sufficient risk to warrant classification in one of the aforementioned categories but possess credit deficiencies or potential weaknesses are required to be designated “special mention.”
 
An insured institution is required to establish general allowances for loan losses in an amount deemed prudent by management for loans classified substandard or doubtful, as well as for other problem loans. General allowances represent loss allowances which have been established to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss”, it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Office of Thrift Supervision which can order the establishment of additional general or specific loss allowances.
 
On the basis of management’s review of its assets, at June 30, 2010 we had classified $10.2 million of our loans as substandard. Of these loans, $6.3 million were considered non-performing and included in the table of Non-Performing Assets.  At June 30, 2010, none of our assets were classified as doubtful or loss.
 
The loan portfolio is reviewed on a regular basis to determine whether any loans require classification in accordance with applicable regulations. Not all classified assets constitute non-performing assets.
 
Allowance for Loan Losses
 
Our allowance for loan losses is maintained at a level necessary to absorb loan losses that are both probable and reasonably estimable. Management, in determining the allowance for loan losses, considers the losses inherent in our loan portfolio and changes in the nature and volume of loan activities, along with the general economic and real estate market conditions. We utilize a two-tier approach: (1) identification and establishment of specific loss allowances on such loans; and (2) establishment of general valuation allowances on the remainder of our loan portfolio. Once a loan becomes delinquent or is otherwise identified as a problem, we may establish a specific loan loss allowance based on a review of among other things, delinquency status, size of loans, type and market value of collateral and financial condition, of the borrowers. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loan loss experience, composition of the loan portfolio, current economic conditions, management’s judgment and losses which are probable and reasonably estimable. The allowance is increased through provisions charged against current earnings and recoveries of previously charged-off loans. Loans that are determined to be uncollectible are charged against the allowance. While management uses available information to recognize probable and reasonably estimable loan losses, future loss provisions may be necessary based on changing economic conditions. Payments received on nonaccrual commercial loans are applied first to principal. The allowance for loan losses as of June 30, 2010 was maintained at a level that represents management’s best estimate of losses inherent in the loan portfolio, and such losses were both probable and reasonably estimable.
 
In addition, the Office of Thrift Supervision, as an integral part of their examination process, periodically reviews our allowance for loan losses. This agency may require that we recognize additions to the allowance based on its judgment of information available to it at the time of its examination.
 
 
12

 
 
The following table sets forth activity in our allowance for loan losses for the years indicated.
 
   
Year Ended June 30,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
   
(Dollars in thousands)
                               
Balance at beginning of year
  $ 2,200     $ 1,758     $ 1,780     $ 1,582     $ 1,359  
Provision for loan losses
    1,049       967       51       264       200  
Charge offs:
                                       
    Residential (1)
    (50 )     (53 )     -       -       -  
    Commercial real estate
    (410 )     (400 )     -       (26 )     (10 )
    Residential construction
    -       -       -       -       -  
    Commercial
    (49 )     -       (27 )     -       -  
    Consumer and other
    (156 )     (118 )     (97 )     (86 )     (72 )
Total charge-offs
    (665 )     (571 )     (124 )     (112 )     (82 )
Recoveries:
                                       
    Residential (1)
    4       1       -       -       -  
    Commercial real estate
    -       -       10       -       -  
    Residential construction
    -       -       -       -       -  
    Commercial
    25       5       4       19       -  
    Consumer and other
    38       40       37       27       7  
Total recoveries
    67       46       51       46       7  
Net (charge-offs) recoveries
    (598 )     (525 )     (73 )     (66 )     (75 )
Transfer to allowance for off-balance sheet items
    -       -       -       -       98  
 Allowance at end of year
  $ 2,651     $ 2,200     $ 1,758     $ 1,780     $ 1,582  
                                         
Ratios:
                                       
Allowance for loan losses to non-performing loans
                                       
 at end of year
    42.13 %     34.11 %     121.07 %     115.73 %     109.03 %
Allowance for loan losses to total loans
                                       
 outstanding at the end of the year
    1.03 %     0.83 %     0.72 %     0.74 %     0.77 %
Net charge-offs to average loans outstanding
    0.22 %     0.20 %     0.03 %     0.03 %     0.04 %
                                         

 (1)           Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
 
13

 
 
Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category, the percent of the allowance for a category to the total allowance, and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category.
 
   
Amount
   
% of Allowance to Total Allowance
   
% of Loans in Category to Total Loans
 
   
(Dollars in thousands)
 
                   
At June 30, 2010
                 
Residential mortgages (1)
  $ 1,342       50.62 %     75.89 %
Commercial loans (2)
    1,198       45.19       23.65  
Consumer loans
    43       1.62       0.46  
Unallocated
    68       2.57       -  
Total allowance for loan losses
  $ 2,651       100.00 %     100.00 %
                         
At June 30, 2009
                                  
Residential mortgages (1)
  $ 1,085       49.32 %     75.27 %
Commercial loans (2)
    1,016       46.18       24.32  
Consumer loans
    11       0.50       0.41  
Unallocated
    88       4.00       -  
Total allowance for loan losses
  $ 2,200       100.00 %     100.00 %
                         
At June 30, 2008
                       
Residential mortgages (1)
  $ 842       47.89 %     73.88 %
Commercial loans (2)
    845       48.07       25.56  
Consumer loans
    15       0.85       0.56  
Unallocated
    56       3.19       -  
Total allowance for loan losses
  $ 1,758       100.00 %     100.00 %
                         
At June 30, 2007
                       
Residential mortgages (1)
  $ 919       51.63 %     72.09 %
Commercial loans (2)
    788       44.27       27.31  
Consumer loans
    25       1.40       0.60  
Unallocated
    48       2.70       -  
Total allowance for loan losses
  $ 1,780       100.00 %     100.00 %
                         
At June 30, 2006
                       
Residential mortgages (1)
  $ 570       36.03 %     73.22 %
Commercial loans (2)
    978       61.82       26.10  
Consumer loans
    29       1.83       0.68  
Unallocated
    5       0.32       -  
Total allowance for loan losses
  $ 1,582       100.00 %     100.00 %
                         
 

(1)
Residential mortgage loans include one- to four-family mortgage loans, home equity loans, and home equity lines of credit.
(2)
Commercial loans include commercial real estate loans and commercial & industrial loans.
 
 
14

 
Each quarter, management evaluates the total balance of the allowance for loan losses based on several factors, some of which are not loan specific but are reflective of the inherent losses in the loan portfolio. This process includes, but is not limited to, a periodic review of loan collectability in light of historical experience, the nature and volume of loan activity, conditions that may affect the ability of the borrower to repay, underlying value of collateral, if applicable, and economic conditions in our immediate market area. First, we group loans by delinquency status. All loans 90 days or more delinquent are evaluated individually, based primarily on the value of the collateral securing the loan. Specific loss allowances are established as required by this analysis. All loans for which a specific loss allowance has not been assigned are segregated by type, delinquency status or loan grade and a loss allowance is established by using loss experience data and management’s judgment concerning other matters it considers significant. The allowance is allocated to each category of loan based on the results of the above analysis. Small differences between the allocated balances and recorded allowances are reflected as unallocated to absorb losses resulting from the inherent imprecision involved in the loss analysis process.
 
This analysis process is inherently subjective, as it requires us to make estimates that are susceptible to revisions as more information becomes available. Although we believe that we have established the allowance at levels to absorb probable and estimable losses, future additions may be necessary if economic or other conditions in the future differ from the current environment.
 
Investment Activities
 
Putnam Bank’s Executive Committee is responsible for implementing Putnam Bank’s Investment Policy. The Investment Policy is reviewed annually and any changes to the policy are recommended to, and subject to, the approval of our Board of Directors. The Executive Committee is comprised of our Chairman, President and one rotating director. Authority to make investments under the approved Investment Policy guidelines is delegated by the Executive Committee to appropriate officers. While general investment strategies are developed and authorized by the Asset/Liability Committee, the execution of specific actions rests with the Chief Executive Officer or President who may act jointly or severally as Putnam Bank’s Investment Officer. The Investment Officer is responsible for ensuring that the guidelines and requirements included in the Investment Policy are followed and that all securities are considered prudent for investment. The Investment Officer is authorized to execute investment transactions (purchases and sales) up to $5 million per transaction without the prior approval of the Executive Committee and within the scope of the established investment policy. Each transaction in excess of established limits must receive prior approval of the Executive Committee.
 
In addition, Putnam Bank may utilize the services of an independent investment advisor to assist in managing the investment portfolio. The investment advisor is responsible for maintaining current information regarding securities dealers with whom they are conducting business on our behalf. A list of appropriate dealers is provided annually to the Board of Directors for approval and authorization prior to execution of trades. The investment advisor, through its assigned portfolio manager, must contact our President or Treasurer to review all investment recommendations and transactions and receive approval from the President or Treasurer prior to execution of any transaction that might be transacted on our behalf. Upon receipt of approval, the investment advisor, or its assigned portfolio manager, is authorized to conduct all investment business on our behalf.
 
Our Investment Policy requires that all securities transactions be conducted in a safe and sound manner. Investment decisions must be based upon a thorough analysis of each security instrument to determine its quality, inherent risks, fit within our overall asset/liability management objectives, effect on our risk-based capital measurement and prospects for yield and/or appreciation.
 

The investment policy is consistent with our overall business and asset/liability management strategy, which focuses on sustaining adequate levels of core earnings.  During the fiscal year ended June 30, 2010, the Company recognized write-downs of investments of $2.4 million in private-label CMOs.

U.S. Government and Agency Obligations. At June 30, 2010, the Company’s U.S. Government and Agency securities portfolio classified as available-for-sale totaled $6.1 million, or 3.6% of total securities. At June 30, 2010, the Company’s U.S. Government and Agency securities portfolio classified as held-to-maturity totaled $45.3 million, or 26.8% of total securities.  While U.S. Government and Agency securities generally provide lower yields than other investments in our securities investment portfolio, we maintain these investments, to the extent appropriate, for liquidity purposes, as collateral for borrowings and prepayment protection.
 
Corporate Bonds. At June 30, 2010, the Company’s corporate bond portfolio totaled $4.4 million, or 2.6% of total securities, all of which was classified as available-for-sale. Although corporate bonds may offer higher yields than U.S. Treasury or agency securities of comparable duration, corporate bonds also have a higher risk of default due to possible adverse changes in the credit-worthiness of the issuer. In order to mitigate this risk, our investment policy requires that corporate debt obligations be rated investment grade or better by a nationally recognized rating agency. If the bond rating goes below investment grade, then the investment is placed on an investment “watch report” and is monitored by our Investment Officer. The investment is then reviewed quarterly by our Board of Directors where a determination is made to hold or dispose of the investment.
 
 
15

 
Mortgage-Backed Securities. The Company purchases mortgage-backed securities insured or guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. We invest in mortgage-backed securities to achieve positive interest rate spreads with minimal administrative expense, and lower our credit risk as a result of the guarantees provided by Freddie Mac, Fannie Mae and Ginnie Mae. The Company also invests in collateralized mortgage obligations (CMOs), also insured or issued by Freddie Mac, Fannie Mae and Ginnie Mae, or private issuers such as Washington Mutual and Countrywide Home Loans. All private issuer CMOs were rated AAA at time of purchase.
 
Mortgage-backed securities are created by the pooling of mortgages and the issuance of a security with an interest rate that is less than the interest rate on the underlying mortgage. Mortgage-backed securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although we focus our investments on mortgage-backed securities backed by one- to four-family mortgages. The issuers of such securities (generally U.S. government agencies and government sponsored enterprises, including Fannie Mae, Freddie Mac and Ginnie Mae) pool and resell the participation interests in the form of securities to investors such as Putnam Bank, and guarantee the payment of principal and interest to investors. Mortgage-backed securities generally yield less than the loans that underlie such securities because of the cost of payment guarantees and credit enhancements. However, mortgage-backed securities are usually more liquid than individual mortgage loans and may be used to collateralize our specific liabilities and obligations.
 
CMOs are a type of debt security issued by a special purpose entity that aggregates pools of mortgage-backed securities and creates different classes of CMO securities with varying maturities and amortization schedules as well as a residual interest, with each class, or “tranche”, possessing different risk characteristics. A particular tranche of CMOs may, therefore, carry prepayment risk that differs from that of both the underlying collateral and other tranches. CMO tranches are purchased by the Company in an attempt to moderate reinvestment risk associated with mortgage-backed securities resulting from unexpected prepayment activities.
 
At June 30, 2010, mortgage-backed securities classified as available-for-sale totaled $67.0 million, or 39.6% of total securities.  At June 30, 2010, mortgage-backed securities classified as held-to-maturity totaled $38.0 million, or 22.4% of total securities.  At June 30, 2010, 61.9% of the mortgage-backed securities were backed by adjustable rate loans and 38.1% were backed by fixed rate mortgage loans. The mortgage-backed securities portfolio had a weighted average yield of 4.33% at June 30, 2010.  Investments in mortgage-backed securities involve a risk that actual prepayments may differ from estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or if such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected by changes in interest rates.
 

Marketable Equity Securities. At June 30, 2010, our equity securities portfolio totaled $8.5 million, or 5.0% of total securities, all of which were classified as available-for-sale.  At June 30, 2010, the portfolio consisted of auction-rate trust preferred securities (“ARP”).  Auction-rate trust preferred securities are a floating rate preferred stock, on which the dividend rate generally resets every 90 days based on an auction process to reflect the yield demand for the instruments by potential purchasers.  At June 30, 2010, our investments in auction-rate trust preferred securities consisted of investments in four corporate issuers.  These securities were originally purchased by the Company because they represented highly liquid, tax-preferred investments secured, in most cases, by preferred stock issued by high quality, investment grade companies, generally other financial institutions (“collateral preferred shares”).  The ARP shares, or certificates, purchased by the Company are Class A certificates, which, among other rights, entitles the holder to priority claim on dividends paid into the Trust holding the preferred shares.

In most cases, the trusts which issued the ARP certificates own various callable preferred shares of stock by a single entity.  In addition to the call dates for redemption established by the collateral preferred shares, each trust has a maturity date upon which the trust itself will terminate.  The value of the remaining collateral preferred shares is not guaranteed, and may be more or less than the stated par value of the collateral preferred shares, and is dependent on the market value of those collateral preferred shares on the date of the trust’s maturity.

The certificates issued by the trusts previously traded in an active, open auction market, with each individual trust establishing the frequency of its auctions, typically every 90 days (the “reset date”).  The results of an auction would be the exchange of certificates, at par, between participants entering or exiting the market, and resetting of the yield to be earned by holders of the Class A certificates as well as the holders of other classes of trust certificates.

 
16

 
Beginning in February 2008, auctions for these securities began to fail when investors declined to bid on the securities.  Five of the largest investment banks that make a market in these securities (Merrill Lynch, Citigroup, USB, AG and Morgan Stanley) declined to act as bidders of last resort, as they had in the past.  The auction failures did not result in the loss of any principal value to the certificate holders, but prevented many sellers from exiting, or redeeming, their certificates at the reset date.  These unsuccessful sellers were required to continue to hold the certificates until the next scheduled reset date.  To compensate these unsuccessful sellers, the failed auctions triggered a penalty-rate feature which provided that owners of the Class A certificates were entitled to a higher portion of the dividends, and thus a higher yield, on the Class A certificates.

During this time, the Company attempted to divest itself of the ARPs, but was prevented from doing so due to the continued failure of the auction market.  The Company continued to carry its investments at par value, despite the increased liquidity risk, because the credit strength of the issuers of the collateral preferred shares remained high, and the yield remained above-market.

On September 7, 2008, the U. S. Department of the Treasury placed Fannie Mae and Freddie Mac under conservatorship and assumed an equity position in these entities, which takes priority over both common and preferred stocks.  Putnam Bank owns $4,000,000 in Freddie Mac auction-rate preferred securities and recorded an other-than-temporary impairment loss totaling $3.95 million during the quarters ended September 30, 2008 and December 31, 2008.  The current book value of this investment as of June 30, 2010 was $46,000.

The turmoil in the financial markets caused the value of the underlying collateral preferred shares to decline dramatically.  Market values for the ARPs from Merrill Lynch, the Company’s safekeeping agent, also declined, and the Company recorded a temporary impairment adjustment to the carrying value of the ARPs which are classified as available-for-sale.  A temporary impairment reduces the carrying value of the investment security with an offsetting reduction in the capital accounts of the Company.

The Company had difficulty identifying market prices of comparable instruments for ARPs due to the inactive market.  As a result, during the quarter ended June 30, 2009, the Company modified its methodology for determining the fair value of the ARPs classified as Level 3, and used the quoted market values of the underlying collateral preferred shares, adjusted for the higher yield earned by the Company through the Class A certificates compared with the nominal rate available to a direct owner of the collateral preferred shares.  The Company continued to record a temporary impairment adjustment on the ARPs, primarily due to the depressed market values of the underlying collateral preferred shares.

The Company adopted FASB Staff Position 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” in the second quarter of 2009.  The Company concluded that the market value of the underlying collateral preferred shares did not represent orderly transactions and adopted the use of a discounted cash flow model to determine if there was any other-than-temporary impairment of its investments in the ARPs.  The resulting discounted cash flow for each of ARP classified as Level 3 showed no impairment in the fair value of the securities.

The Company has the ability and intent to hold these securities for the time necessary to collect the expected cash flows.
 
 
17

 
 
The chart below includes information on the various issuers of Auction Rate Preferred securities owned by the Company:
 
Issuer
Goldman Sachs
 
Merrill Lynch
 
Bank of America
 
Freddie Mac
 
Freddie Mac
Par amount
 $3,000,000
 
 $5,000,000
 
 $2,000,000
 
 $2,000,000
 
 $2,000,000
Book Value
 $3,000,000
 
 $5,000,000
 
 $2,000,000
 
 $23,000
 
 $23,000
Purchase Date
12-12-07
 
09-04-07
 
11-20-07
 
11-09-07
 
01-03-08
Maturity Date
08-23-26
 
05-28-27
 
08-17-47
 
06-30-20
 
06-30-20
Next Reset Date
08-20-10
 
08-27-10
 
08-16-10
 
07-09-10
 
07-02-10
Reset Frequency
Quarterly
 
Quarterly
 
Quarterly
 
Quarterly
 
Quarterly
Failed Auction
Yes
 
Yes
 
Yes
 
Yes
 
Yes
Receiving Default Rates
Yes
 
Yes
 
Yes
 
No
 
No
Current Rate
4.647%
 
4.574%
 
4.679%
 
0.000%
 
0.000%
Dividends Current:
Yes
 
Yes
 
Yes
 
No
 
No
                   
 
 The Bank’s entire auction rate preferred securities holdings as of June 30, 2010 had failed auctions for the past fiscal year.
 
Federal Home Loan Bank Stock.  At June 30, 2010, the Company owned $8.1 million of Federal Home Loan Bank of Boston stock.  This stock is classified as held-to-maturity.  The Company evaluated its investment in FHLB stock for other-than-temporary impairment as of June 30, 2010, consistent with its accounting policies. The regional banks within the Federal Home Loan Bank System have experienced higher levels of other-than-temporary impairment in their private label mortgage-backed securities and home equity loans, which has raised concerns about whether their capital levels could be reduced below regulatory requirements. In response to unprecedented market conditions and potential future losses, the FHLB has implemented an initiative to preserve capital by the adoption of a revised retained earnings target, declaration of a moratorium on excess stock repurchases and the suspension of cash dividend payments. The Company anticipates a decline in the dividend yield on its holdings in FHLB stock since the FHLB announced that dividend payments in 2010 are unlikely. There can be no assurance that the impact of recent market conditions on the financial condition of the Federal Home Loan Banks or future legislation on the Federal Home Loan Banks will not cause a decrease in the value of FHLB stock held by the Bank.  Based on the Company’s evaluation of the underlying investment, including the long-term nature of the investment, the liquidity position of the FHLB of Boston, the actions taken by the FHLB of Boston to address its regulatory capital situation and the Company’s intent and ability to hold the investment for a period of time sufficient to recover the par value, the Company did not recognize an other-than-temporary impairment loss.  Standard and Poor’s rated the Federal Home Loan Bank of Boston as AAA/Stable/A-1+ on April 14, 2010.  Even though the Company did not recognize an other-than-temporary impairment loss during the fiscal year ended June 30, 2010, continued deterioration in the FHLB of Boston’s financial position may result in future impairment losses.
 
 
18

 
 
 
Securities Portfolio Composition. The following table sets forth the composition of our securities portfolio, excluding Federal Home Loan Bank stock, at the dates indicated,
 
   
At June 30,
   
2010
   
2009
   
2008
 
   
Carrying
   
Percent
   
Carrying
   
Percent
   
Carrying
   
Percent
 
   
Value
   
of total
   
Value
   
of total
   
Value
   
of total
 
(Dollars in thousands)
                                   
Securities, available for sale:
                                   
U.S. Government and agency securities
  $ 6,101       3.6 %   $ 19,667       11.8 %   $ 19,472       9.2 %
State agency and municipal obligations
    -       - %     -       - %     4,547       2.1 %
Corporate bonds and other securities
    4,368       2.6 %     9,263       5.6 %     17,214       8.1 %
Mortgage-backed securities
    66,967       39.6 %     123,596       74.0 %     151,850       71.6 %
Equity securities
    8,457       5.0 %     12,362       7.4 %     19,000       9.0 %
  Total securities, available for sale
    85,893       50.8 %     164,888       98.8 %     212,083       100.0 %
Securities, held-to-maturity:
                                               
U.S. Government and agency securities
    45,275       26.8 %     2,000       1.2 %     -       - %
Mortgage-backed securities
    37,974       22.4 %     -       - %     -       - %
  Total securities, held-to-maturity
    83,249       49.2 %     2,000       1.2 %     0       0.0 %
                                                 
   Total securities
  $ 169,142       100.0 %   $ 166,888       100.0 %   $ 212,083       100.0 %
                                                 
 
Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at June 30, 2010 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. State agency and municipal obligations as well as common and preferred stock yields have not been adjusted to a tax-equivalent basis. Certain mortgage-backed securities have interest rates that are adjustable and will reprice annually within the various maturity ranges. These repricing schedules are not reflected in the table below. At June 30, 2010, mortgage-backed securities with adjustable rates totaled $65.0 million.

   
In One Year or Less
   
After One Year Through Five Years
   
After Five Years Through Ten Years
   
After Ten Years
   
Total
 
(Dollars in thousands)
                             
Securities available-for-sale:
                             
U.S. Government and agency securities
  $ 1,122     $ 957     $ 2,003     $ 2,019     $ 6,101  
Corporate debt securities
    -       -       -       4,368     $ 4,368  
Mortgage-backed securities
    293       3,978       5,052       57,644     $ 66,967  
Total debt securities
    1,415       4,935       7,055       64,031       77,436  
Equity securities
    -       -       -       8,457     $ 8,457  
                                         
Total securities available-for-sale
  $ 1,415     $ 4,935     $ 7,055     $ 72,488     $ 85,893  
Securities held-to-maturity:
                                       
U.S. Government and agency securities
    -       24,250       19,025       2,000     $ 45,275  
Mortgage-backed securities
    -       -       -       37,974     $ 37,974  
Total securities held-to-maturity
    -       24,250       19,025       39,974     $ 83,249  
                                         
Total securities
  $ 1,415     $ 29,185     $ 26,080     $ 112,462     $ 169,142  
Weighted average yield
    4.60 %     2.38 %     3.07 %     4.17 %     3.71 %
                                         
 
 
19

 
Sources of Funds
 
General. Deposits have traditionally been our primary source of funds for use in lending and investment activities. In addition to deposits, funds are derived from scheduled loan payments, investment maturities, loan prepayments, retained earnings and income on earning assets. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition. Borrowings from the Federal Home Loan Bank of Boston and brokered certificates of deposit may be used to compensate for reductions in deposits and to fund loan growth.
 
Deposits. A majority of our depositors are persons who work or reside in Windham County and New London County, Connecticut. We offer a selection of deposit instruments, including checking, savings, money market deposit accounts, negotiable order of withdrawal (NOW) accounts and fixed-term certificates of deposit. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds must remain on deposit and the interest rate.
 
Interest rates paid, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market rates, liquidity requirements, rates paid by competitors and growth goals. To attract and retain deposits, we rely upon personalized customer service, long-standing relationships and competitive interest rates.
 
The flow of deposits is influenced significantly by general economic conditions, changes in money market and other prevailing interest rates and competition. The variety of deposit accounts that we offer allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on historical experience, management believes our deposits are relatively stable. However, the ability to attract and maintain money market accounts and certificates of deposit, and the rates paid on these deposits, have been and will continue to be significantly affected by market conditions. At June 30, 2010, $144.3 million, or 43.1%, of our deposit accounts were certificates of deposit, of which $74.8 million had maturities of one year or less.

 
20

 
 
The following table sets forth the distribution of total deposit accounts, by account type, for the years indicated.

   
For the Year Ended June 30,
 
   
2010
   
2009
   
2008
 
               
Weighted
               
Weighted
               
Weighted
 
   
Average
         
Average
   
Average
         
Average
   
Average
         
Average
 
   
Balance
   
Percent
   
Rate
   
Balance
   
Percent
   
Rate
   
Balance
   
Percent
   
Rate
 
   
(Dollars in thousands)
                                           
                                                       
Demand deposits
  $ 35,279       10.99 %     - %   $ 36,219       12.39 %     - %   $ 38,846       13.64 %     - %
NOW accounts
    80,526       25.08       1.11       42,360       14.49       1.90       29,813       10.47       2.37  
Regular savings
    46,447       14.46       0.35       45,684       15.63       0.46       47,397       16.64       0.60  
Money market accounts     
    11,036       3.43       0.88       12,006       4.10       1.08       15,496       5.44       1.70  
Club accounts
    237       0.07       0.30       261       0.09       3.79       250       0.09       4.17  
      173,525       54.04       0.67       136,530       46.70       0.85       131,802       46.28       0.96  
Certificates of deposit
    147,599       45.96       2.58       155,813       53.30       3.27       153,012       53.72       3.87  
       Total
  $ 321,124       100.00 %     1.55 %   $ 292,343       100.00 %     2.14 %   $ 284,814       100.00 %     2.52 %
                                                                         

As of June 30, 2010, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was approximately $64.4 million. The following table sets forth the maturity of those certificates as of June 30, 2010.
 
Maturity Period
 
At June 30, 2010
 
       
   
(In thousands)
 
            
Three months or less
  $ 19,542  
Over three through six months
    4,509  
Over six months through one year
    11,148  
Over one year through three years
    16,657  
Over three years
    12,569  
     Total
  $ 64,425  
         
 
 
21

 
 Borrowings. Our borrowings consist of advances from, and a line of credit with, the Federal Home Loan Bank of Boston, and repurchase agreements. At June 30, 2010, we had an available line of credit with the Federal Home Loan Bank of Boston in the amount of $2.4 million and access to additional Federal Home Loan Bank advances of up to $22.8 million. At June 30, 2010, retail repurchase agreements were $5.9 million.  The following table sets forth information concerning balances and interest rates on our borrowings at the dates and for the years indicated.

 
   
At and For The Year Ended
   
June 30,
   
2010
   
2009
   
2008
 
   
(Dollars in thousands)
 
                   
Maximum amount of advances outstanding
                 
at any month end during the year:
                 
      FHLB advances
  $ 120,500     $ 150,204     $ 152,236  
      Repurchase Agreements with other companies
    -       -       -  
      Repurchase Agreements with customers
    15,179       8,637       6,406  
Average advances outstanding during the year:
                       
      FHLB advances
    106,473       140,685       145,691  
      Repurchase Agreements with other companies
    -       -       -  
      Repurchase Agreements with customers
    9,154       5,535       4,603  
Balance outstanding at end of year:
                       
      FHLB advances
    100,500       120,500       150,215  
      Repurchase Agreements with other companies
    -       -       -  
      Repurchase Agreements with customers
    5,896       4,471       6,406  
Weighted average interest rate during the year:
                       
      FHLB advances
    3.95 %     4.05 %     4.62 %
      Repurchase Agreements with other companies
    -       -       -  
      Repurchase Agreements with customers
    1.03       2.28       2.84  
Weighted average interest rate at end of year:
                       
      FHLB advances
    3.89 %     4.06 %     3.95 %
      Repurchase Agreements with other companies
    -       -       -  
      Repurchase Agreements with customers
    0.33       2.30       2.17  
                         
 
Subsidiary Activities
 
PSB Holdings Inc.’s only subsidiary is Putnam Bank. Putnam Bank has three subsidiaries, Windham North Properties, LLC, PSB Realty, LLC and Putnam Bank Mortgage Servicing Company. Windham North Properties, LLC is used to acquire title to selected properties on which Putnam Bank forecloses. As of June 30, 2010, Windham North Properties, LLC, owned five such properties.  PSB Realty, LLC owns a single parcel of real estate located immediately adjacent to Putnam Bank’s main office. This real estate is utilized as a loan center for Putnam Bank and there are no outside tenants that occupy the premises. PSB Realty, LLC also owns the 40 High Street, Norwich branch building and real estate.  Putnam Bank Mortgage Servicing Company is a qualified “passive investment company” that is intended to reduce Connecticut state taxes on interest earned on real estate loans.
 
Personnel
 
As of June 30, 2010, we had 83 full-time employees and 38 part-time employees. Our employees are not represented by any collective bargaining group. Management believes that we have good working relations with our employees.
 
FEDERAL AND STATE TAXATION
 
Federal Taxation
 
General. PSB Holdings, Inc. and Putnam Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. PSB Holdings, Inc.’s and Putnam Bank’s tax returns have not been audited during the past five years. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to PSB Holdings, Inc. or Putnam Bank.
 
 
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Method of Accounting. For federal income tax purposes, PSB Holdings, Inc. and Putnam Bank currently report their income and expenses on the accrual method of accounting and use a tax year ending June 30 for filing their federal income tax returns.
 
Bad Debt Reserves. Prior to the Small Business Protection Act of 1996 (the “1996 Act”), Putnam Bank was permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at our taxable income. As a result of the 1996 Act, Putnam Bank was required to use the specific charge off method in computing its bad debt deduction beginning with its 1996 federal tax return. Savings institutions were required to recapture any excess reserves over those established as of December 31, 1987 (base year reserve). At June 30, 2010 Putnam Bank had no reserves subject to recapture in excess of its base year reserves.
 
Taxable Distributions and Recapture. Prior to the 1996 Act, bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income if Putnam Bank failed to meet certain thrift asset and definitional tests. Federal legislation has eliminated these thrift-related recapture rules. At June 30, 2010, our total federal pre-1988 base year reserve was approximately $2.3 million. However, under current law, pre-1988 base year reserves remain subject to recapture if Putnam Bank makes certain non-dividend distributions, repurchases any of its stock, pays dividends in excess of tax earnings and profits, or ceases to maintain a bank charter.
 
Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended (the “Code”) imposes an alternative minimum tax (AMT) at a rate of 20% on a base of regular taxable income plus certain tax preferences, which we refer to as “alternative minimum taxable income.” The AMT is payable to the extent such alternative minimum taxable income is in excess of an exemption amount and the AMT exceeds the regular income tax. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain AMT payments may be used as credits against regular tax liabilities in future years. At June 30, 2010, PSB Holdings, Inc. had $705,000 of AMT payments available to carry forward to future periods.
 
Net Operating Loss Carryovers. A financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. At June 30, 2010, Putnam Bank had no net operating loss carry forwards for federal income tax purposes.
 
Corporate Dividends-Received Deduction. PSB Holdings, Inc. may exclude from its income 100% of dividends received from Putnam Bank as a member of the same affiliated group of corporations. The corporate dividends-received deduction is 80% in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, and corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct only 70% of dividends received or accrued on their behalf.
 
State Taxation
 
Connecticut State Taxation. PSB Holdings, Inc. and Putnam Bank and its subsidiaries, are subject to the Connecticut corporation business tax. Both entities are required to pay the regular corporation business tax (income tax).
 
The Connecticut corporation business tax is based on the federal taxable income before net operating loss and special deductions and makes certain modifications to federal taxable income to arrive at Connecticut taxable income. Connecticut taxable income is multiplied by the state tax rate of 7.5% to arrive at Connecticut income tax.
 

In 1998, the State of Connecticut enacted legislation permitting the formation of passive investment companies by financial institutions. This legislation exempts qualifying passive investment companies from the Connecticut corporation business tax and excludes dividends paid from a passive investment company from the taxable income of the parent financial institution. Putnam Bank established a passive investment company, Putnam Bank Mortgage Servicing Company, during 2007 and eliminated the state income tax expense of Putnam Bank effective July 1, 2006. If the State of Connecticut were to pass legislation in the future to eliminate the passive investment company exemption Putnam Bank would be subject to state income taxes in Connecticut.
 
The Company has received notification from the Internal Revenue Service of an upcoming audit of the federal tax return filed for the fiscal year ended June 30, 2009.  The state tax returns have not been audited for the last five years.
 
 
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SUPERVISION AND REGULATION
 
General
 
Putnam Bank is examined and supervised by the Office of Thrift Supervision. This regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the Federal Deposit Insurance Corporation’s deposit insurance funds and depositors. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. Following completion of its examination, the federal agency critiques the institution’s operations and assigns its rating (known as an institution’s CAMELS rating). Under federal law, an institution may not disclose its CAMELS rating to the public. Putnam Bank also is a member of and owns stock in the Federal Home Loan Bank of Boston, which is one of the twelve regional banks in the Federal Home Loan Bank System. Putnam Bank also is regulated to a lesser extent by the Board of Governors of the Federal Reserve System, governing reserves to be maintained against deposits and other matters. The Office of Thrift Supervision examines Putnam Bank and prepares reports for the consideration of its Board of Directors on any operating deficiencies. Putnam Bank’s relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters concerning the ownership of deposit accounts and the form and content of Putnam Bank’s mortgage documents.
 
Any change in these laws or regulations, whether by the Federal Deposit Insurance Corporation, the Office of Thrift Supervision or Congress, could have a material adverse impact on PSB Holdings, Inc. and Putnam Bank and their operations.
 

Under the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Office of Thrift Supervision’s functions relating to federal savings associations, including rulemaking authority, are transferred to the Comptroller of the Currency within one year of the July 21, 2010 date of enactment of the new legislation, unless extended by up to six months by the Secretary of the Treasury. The thrift charter has been preserved and a new Deputy Comptroller of the Currency will supervise and examine federal savings associations and savings banks.
 
New Federal Legislation

The recently enacted Dodd-Frank Act will significantly change the current bank regulatory structure and affect the lending, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act will eliminate our current primary federal regulator, the Office of Thrift Supervision, and require Putnam Bank to be regulated by the Office of the Comptroller of the Currency (the primary federal regulator for national banks). The Dodd-Frank Act also authorizes the Federal Reserve Board to supervise and regulate all savings and loan holding companies, including mutual holding companies, like PSB Holdings, Inc. and Putnam Bancorp, Inc., in addition to bank holding companies that it currently regulates.  As a result, the Federal Reserve Board’s current regulations applicable to bank holding companies, including holding company capital requirements, will apply to savings and loan holding companies like PSB Holdings, Inc. and Putnam Bancorp, Inc.  These capital requirements are substantially similar to the capital requirements currently applicable to Putnam Bank, as described in “Supervision and Regulation—Federal Banking Regulation—Capital Requirements.”  Moreover, Putnam Bancorp, Inc. will require the approval of the Federal Reserve Board before it may waive the receipt of any dividends from PSB Holdings, Inc., and there is no assurance that the Federal Reserve Board will approve future dividend waivers or what conditions it may impose on such waivers.  See “Recently enacted financial reform legislation may have an adverse effect on our ability to pay dividends, which would adversely affect the value of our common stock,” in the Risk Factors section of this annual report.  The Dodd-Frank Act also requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions.  Bank holding companies with assets of less than $500 million are exempt from these capital requirements.  Under the Dodd-Frank Act, the proceeds of trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with less than $15 billion of assets.  The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.
 
The Dodd-Frank Act also creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rulemaking authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as Putnam Bank, including the authority to prohibit “unfair, deceptive or abusive” acts and practices.  The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.  Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators.  The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.
 
 
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The legislation also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution.  The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2013.  Lastly, the Dodd-Frank Act will increase stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and by authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials.  The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.
 
It is difficult to predict at this time what impact the new legislation and implementing regulations will have on community banks, such as Putnam Bank, including the lending and credit practices of such banks.  Moreover, many of the provisions of the Dodd-Frank Act will not take effect for at least a year, and the legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years.  Although the substance and scope of these regulations cannot be determined at this time, it is expected that the legislation and implementing regulations, particularly those provisions relating to the new Consumer Financial Protection Bureau, will increase our operating and compliance costs.
 
Federal Banking Regulation
 
Business Activities. A federal savings association derives its lending and investment powers from the Home Owners’ Loan Act, as amended, and the regulations of the Office of Thrift Supervision. Under these laws and regulations, Putnam Bank may invest in mortgage loans secured by residential real estate without limitations as a percentage of assets and non-residential real estate loans which may not in the aggregate exceed 400% of capital, commercial business loans up to 20% of assets in the aggregate and consumer loans up to 35% of assets in the aggregate, certain types of debt securities and certain other assets. Putnam Bank also may establish subsidiaries that may engage in activities not otherwise permissible for Putnam Bank, including real estate investment and securities and insurance brokerage.
 
Capital Requirements. Office of Thrift Supervision regulations require savings associations to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for associations receiving the highest rating on the CAMELS rating system) and an 8% risk-based capital ratio. The prompt corrective action standards discussed below, in effect, establish a minimum 2% tangible capital standard.
 
The risk-based capital standard for savings associations requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision based on the risks believed inherent in the type of asset. Core capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. Additionally, a savings association that retains credit risk in connection with an asset sale may be required to maintain additional regulatory capital because of the recourse back to the savings association. Putnam Bank does not typically engage in asset sales.
 
At June 30, 2010, Putnam Bank’s capital exceeded all applicable requirements.

Loans-to-One Borrower. A federal savings association generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and unimpaired surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of June 30, 2010, Putnam Bank was in compliance with the loans-to-one borrower limitations.
 
 
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Qualified Thrift Lender Test. As a federal savings association, Putnam Bank must satisfy the qualified thrift lender, or “QTL”, test. Under the QTL test, Putnam Bank must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” in at least nine of the most recent 12-month period. “Portfolio assets” generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings association’s business.
 
“Qualified thrift investments” include various types of loans made for residential and housing purposes, investments related to such purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of portfolio assets. “Qualified thrift investments” also include 100% of an institution’s credit card loans, education loans and small business loans. Putnam Bank also may satisfy the QTL test by qualifying as a “domestic building and loan association” as defined in the Internal Revenue Code.
 
A savings association that fails the qualified thrift lender test must either convert to a commercial bank charter or operate under specified restrictions. At June 30, 2010, Putnam Bank satisfied this test.
 
Capital Distributions. Office of Thrift Supervision regulations govern capital distributions by a federal savings association, which include cash dividends, stock repurchases and other transactions charged to the capital account. A savings association must file an application for approval of a capital distribution if:
 
 
the total capital distributions for the applicable calendar year exceed the sum of the association’s net income for that year to date plus the association’s retained net income for the preceding two years still available for dividend;
 
 
the association would not be at least adequately capitalized following the distribution;
 
 
the distribution would violate any applicable statute, regulation, agreement or Office of Thrift Supervision-imposed condition; or
 
 
the association is not eligible for expedited treatment of its filings.
 
Even if an application is not otherwise required, every savings association that is a subsidiary of a holding company must still file a notice with the Office of Thrift Supervision at least 30 days before the Board of Directors declares a dividend or approves a capital distribution.
 
The Office of Thrift Supervision may disapprove a notice or application if:
 
 
the association would be undercapitalized following the distribution;
 
 
the proposed capital distribution raises safety and soundness concerns; or
 
 
the capital distribution would violate a prohibition contained in any statute, regulation or agreement.
 
In addition, the Federal Deposit Insurance Act provides that an insured depository institution shall not make any capital distribution, if after making such distribution the institution would be undercapitalized.
 
Liquidity. A federal savings association is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.
 
Community Reinvestment Act and Fair Lending Laws. All savings associations have a responsibility under the Community Reinvestment Act and related regulations of the Office of Thrift Supervision to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In connection with its examination of a federal savings association, the Office of Thrift Supervision is required to assess the association’s record of compliance with the Community Reinvestment Act. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An association’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in denial of certain corporate applications, such as branches or mergers, or in restrictions on its activities. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the Office of Thrift Supervision, as well as other federal regulatory agencies and the Department of Justice. Putnam Bank received a “satisfactory” Community Reinvestment Act rating in its most recent federal examination.
 
Privacy Standards. Federal regulations require Putnam Bank to disclose its privacy policy, including identifying with whom it shares “non-public personal information” to customers at the time of establishing the customer relationship and annually thereafter.
 
The regulations also require Putnam Bank to provide its customers with initial and annual notices that accurately reflect its privacy policies and practices. In addition, Putnam Bank is required to provide its customers with the ability to “opt-out” of having Putnam Bank share their non-public personal information with unaffiliated third parties before it can disclose such information, subject to certain exceptions. The implementation of these regulations did not have a material adverse effect on PSB Holdings, Inc. or Putnam Bank. The Gramm-Leach-Bliley Act also allows each state to enact legislation that is more protective of consumers’ personal information. We cannot predict whether Connecticut may enact such legislation or what impact, if any, it would have if enacted.
 
 
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Putnam Bank must implement measures intended to insure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records, or information that could result in substantial harm or inconvenience to any customer. Putnam Bank has implemented these measures.
 
Transactions with Related Parties. A federal savings association’s authority to engage in transactions with its “affiliates” is limited by Office of Thrift Supervision regulations and by Sections 23A and 23B of the Federal Reserve Act (the “FRA”). The term “affiliates” for these purposes generally means any company that controls, is controlled by, or is under common control with an institution. PSB Holdings, Inc. is an affiliate of Putnam Bank. In general, transactions with affiliates must be on terms that are as favorable to the association as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the association’s capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the association. In addition, Office of Thrift Supervision regulations prohibit a savings association from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.
 
Putnam Bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Putnam Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved by Putnam Bank’s Board of Directors.
 
Enforcement. The Office of Thrift Supervision has primary enforcement responsibility over federal savings institutions and has the authority to bring enforcement action against all “institution-affiliated parties”, including stockholders, and attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action by the Office of Thrift Supervision may range from the issuance of a capital directive or cease and desist order, to removal of officers and/or directors of the institution and the appointment of a receiver or conservator. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The Federal Deposit Insurance Corporation also has the authority to terminate deposit insurance or to recommend to the Director of the Office of Thrift Supervision that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director of the Office of Thrift Supervision, the Federal Deposit Insurance Corporation has authority to take action under specified circumstances.
 
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan.
 
Prompt Corrective Action Regulations. Under the prompt corrective action regulations, the Office of Thrift Supervision is required and authorized to take supervisory actions against undercapitalized savings associations. For this purpose, a savings association is placed in one of the following five categories based on the association’s capital:
 
 
well-capitalized (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total risk-based capital);
 
 
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adequately capitalized (at least 4% leverage capital (3%for savings banks with a composite examination rating of 1), 4% Tier 1 risk-based capital and 8% total risk-based capital);
 
 
undercapitalized (less than 8% total risk-based capital, 4% Tier 1 risk-based capital or 4% leverage capital (3%for savings banks with a composite examination rating of 1);
 
 
significantly undercapitalized (less than 6% total risk-based capital, 3% Tier 1 risk-based capital or 3% leverage capital); and
 
 
critically undercapitalized (less than 2% tangible capital).
 
Generally, the banking regulator is required to appoint a receiver or conservator for an association that is “critically undercapitalized” within specific time frames. The regulations also provide that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date an association receives notice that it is “undercapitalized”, “significantly undercapitalized” or “critically undercapitalized”. The criteria for an acceptable capital restoration plan include, among other things, the establishment of the methodology and assumptions for attaining adequately capitalized status on an annual basis, procedures for ensuring compliance with restrictions imposed by applicable federal regulations, the identification of the types and levels of activities the savings association will engage in while the capital restoration plan is in effect, and assurances that the capital restoration plan will not appreciably increase the current risk profile of the savings association. Any holding company for the savings association required to submit a capital restoration plan must guarantee the lesser of: an amount equal to 5% of the savings association’s assets at the time it was notified or deemed to be undercapitalized by the Office of Thrift Supervision, or the amount necessary to restore the savings association to adequately capitalized status. This guarantee remains in place until the Office of Thrift Supervision notifies the savings association that it has maintained adequately capitalized status for each of four consecutive calendar quarters, and the Office of Thrift Supervision has the authority to require payment and collect payment under the guarantee. Failure by a holding company to provide the required guarantee will result in certain operating restrictions on the savings association, such as restrictions on the ability to declare and pay dividends, pay executive compensation and management fees, and increase assets or expand operations. The Office of Thrift Supervision may also take any one of a number of discretionary supervisory actions against undercapitalized associations, including the issuance of a capital directive and the replacement of senior executive officers and directors.
 
At June 30, 2010, Putnam Bank met the criteria for being considered “well-capitalized”.
 

Insurance of Deposit Accounts. The Dodd-Frank Act permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009.  Non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2013.

Pursuant to the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”), the Federal Deposit Insurance Corporation is authorized to set the reserve ratio for the Deposit Insurance Fund annually at between 1.15% and 1.5% of estimated insured deposits.  The Dodd-Frank Act mandates that the statutory minimum reserve ratio of the Deposit Insurance Fund increase from 1.15% to 1.35% of insured deposits by September 30, 2020.  Banks with assets of less than $10 billion are exempt from any additional assessments necessary to increase the reserve fund above 1.15%.

As part of a plan to restore the reserve ratio to 1.15%, the Federal Deposit Insurance Corporation imposed a special assessment on all insured institutions equal to five basis points of assets less Tier 1 capital as of June 30, 2009, which was payable on September 30, 2009.  In addition, the Federal Deposit Insurance Corporation has increased its quarterly deposit insurance assessment rates and amended the method by which rates are calculated.  Beginning in the second quarter of 2009, institutions are assigned an initial base assessment rate ranging from 12 to 45 basis points of deposits depending on risk category. The initial base assessment is then adjusted based upon the level of unsecured debt, secured liabilities and brokered deposits, to establish a total base assessment rate ranging from seven to 77.5 basis points.

On November 12, 2009, the Federal Deposit Insurance Corporation approved a final rule requiring insured depository institutions to prepay on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012.   Estimated assessments for the fourth quarter of 2009 and for all of 2010 are based upon the assessment rate in effect on September 30, 2009, with three basis points added for the 2011 and 2012 assessment rates.  In addition, a 5% annual growth in the assessment base is assumed.  Prepaid assessments are to be applied against the actual quarterly assessments until exhausted, and may not be applied to any special assessments that may occur in the future.  Any unused prepayments will be returned to the institution on June 30, 2013.  On December 30, 2009, we prepaid $2.9 million in estimated assessment fees for the fourth quarter of 2009 through 2012.  Because the prepaid assessments represent the prepayment of future expense, they do not affect our regulatory capital (the prepaid asset will have a risk-weighting of 0%) or tax obligations.

 
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Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the Federal Deposit Insurance Corporation. We do not believe we are taking or are subject to any action, condition or violation that could lead to termination of our deposit insurance.
 
In addition to the Federal Deposit Insurance Corporation assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended June 30, 2010, the annualized FICO assessment was equal to 1.04 basis points for each $100 in domestic deposits maintained at an institution.
 
 
Prohibitions Against Tying Arrangements. Federal savings associations are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
 
Federal Home Loan Bank System. Putnam Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of the Federal Home Loan Bank of Boston, Putnam Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its borrowings from the Federal Home Loan Bank, whichever is greater. As of June 30, 2010, Putnam Bank was in compliance with this requirement.
 
Federal Reserve System. The Federal Reserve Board regulations require savings associations to maintain noninterest-earning reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts. At June 30, 2010, Putnam Bank was in compliance with these reserve requirements.
 
The USA PATRIOT Act
 
The USA PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. Certain provisions of the act impose affirmative obligations on a broad range of financial institutions, including savings banks, like Putnam Bank. These obligations include enhanced anti-money laundering programs, customer identification programs and regulations relating to private banking accounts or correspondence accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States).
 
Sarbanes-Oxley Act                                           
 
The Sarbanes-Oxley Act of 2002 was enacted in response to public concerns regarding corporate accountability in connection with certain accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.
 

 We have existing policies, procedures and systems designed to comply with these regulations, and we are further enhancing and documenting such policies, procedures and systems to ensure continued compliance with these regulations.
 
Holding Company Regulation
 
General. Putnam Bancorp, MHC and PSB Holdings, Inc. are nondiversified savings and loan holding companies within the meaning of the Home Owners’ Loan Act. As such, Putnam Bancorp, MHC and PSB Holdings, Inc. are registered with the Office of Thrift Supervision and are subject to Office of Thrift Supervision regulations, examinations, supervision and reporting requirements. In addition, the Office of Thrift Supervision has enforcement authority over PSB Holdings, Inc. and Putnam Bancorp, MHC, and their subsidiaries. Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. As federal corporations, PSB Holdings, Inc. and Putnam Bancorp, MHC are generally not subject to state business organization laws.
 
 
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Permitted Activities. Pursuant to Section 10(o) of the Home Owners’ Loan Act and Office of Thrift Supervision regulations and policy, a mutual holding company and a federally chartered mid-tier holding company such as PSB Holdings, Inc. may engage in the following activities: (i) investing in the stock of a savings association; (ii) acquiring a mutual association through the merger of such association into a savings association subsidiary of such holding company or an interim savings association subsidiary of such holding company; (iii) merging with or acquiring another holding company, one of whose subsidiaries is a savings association; (iv) investing in a corporation, the capital stock of which is available for purchase by a savings association under federal law or under the law of any state where the subsidiary savings association or associations share their home offices; (v) furnishing or performing management services for a savings association subsidiary of such company; (vi) holding, managing or liquidating assets owned or acquired from a savings subsidiary of such company; (vii) holding or managing properties used or occupied by a savings association subsidiary of such company; (viii) acting as trustee under deeds of trust; (ix) any other activity (A) that the Federal Reserve Board, by regulation, has determined to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956, unless the Director of the Office of Thrift Supervision, by regulation, prohibits or limits any such activity for savings and loan holding companies; or (B) in which multiple savings and loan holding companies were authorized (by regulation) to directly engage on March 5, 1987; (x) any activity permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act, including securities and insurance underwriting; and (xi) purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such savings and loan holding company is approved by the Director. If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company resulting from such merger or acquisition may only invest in assets and engage in activities listed in (i) through (xi) above, and has a period of two years to cease any nonconforming activities and divest any nonconforming investments.
 
The Home Owners’ Loan Act prohibits a savings and loan holding company, including PSB Holdings, Inc. and Putnam Bancorp, MHC, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior written approval of the Office of Thrift Supervision. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a nonsubsidiary company engaged in activities other than those permitted by the Home Owners’ Loan Act, or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.
 
The Office of Thrift Supervision is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
 

Under the Dodd-Frank Act, the powers and duties of the Office of Thrift Supervision relating to savings and loan holding companies and their subsidiaries, including rulemaking and supervision authority, will be transferred to the Federal Reserve Board no later than one year from the July 21, 2010 effective date of the legislation, subject to extension of up to six months if requested by the Secretary of the Treasury.
 

Waivers of Dividends by Putnam Bancorp, MHC. Office of Thrift Supervision regulations require Putnam Bancorp, MHC to notify the Office of Thrift Supervision of any proposed waiver of its receipt of dividends from PSB Holdings, Inc. The Office of Thrift Supervision reviews dividend waiver notices on a case- by-case basis, and, in general, does not object to any such waiver if: (i) the mutual holding company’s board of directors determines that such waiver is consistent with such directors’ fiduciary duties to the mutual holding company’s members; and (ii) The waiver would not be detrimental to the safe and sound operation of the subsidiary savings bank.  Putnam Bancorp, MHC waived all dividends paid by PSB Holdings, Inc. during the fiscal year ended June 30, 2010 and is expected to do so in the future.  See “—New Federal Legislation” for a discussion of the Dodd-Frank Act’s provisions related to Putnam Bancorp, MHC’s ability to waive dividends in the future.
 
 
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Conversion of Putnam Bancorp, MHC to Stock Form. Office of Thrift Supervision regulations permit Putnam Bancorp, MHC to convert from the mutual form of organization to the capital stock form of organization (a “Conversion Transaction”). There can be no assurance when, if ever, a Conversion Transaction will occur, and the Board of Directors has no current intention or plan to undertake a Conversion Transaction. In a Conversion Transaction a new stock holding company would be formed as the successor to PSB Holdings, Inc. (the “New Holding Company”), Putnam Bancorp, MHC’s corporate existence would end, and certain depositors of Putnam Bank would receive the right to subscribe for additional shares of the New Holding Company. In a Conversion Transaction, each share of common stock held by stockholders other than Putnam Bancorp, MHC (“Minority Stockholders”) would be automatically converted into a number of shares of common stock of the New Holding Company determined pursuant to an exchange ratio that ensures that Minority Stockholders own the same percentage of common stock in the New Holding Company as they owned in PSB Holdings, Inc. immediately prior to the Conversion Transaction. Under Office of Thrift Supervision regulations, Minority Stockholders would not be diluted because of any dividends waived by Putnam Bancorp, MHC (and waived dividends would not be considered in determining an appropriate exchange ratio), in the event Putnam Bancorp, MHC converts to stock form. The total number of shares held by Minority Stockholders after a Conversion Transaction also would be increased by any purchases by Minority Stockholders in the stock offering conducted as part of the Conversion Transaction.
 

Under the Dodd-Frank Act, in a Conversion Transaction of a mutual holding company that has waived
dividends it had a right to receive from a subsidiary savings association before December 1, 2009, waived dividends from the savings association would not be considered in determining an appropriate exchange ratio.
 
Federal Securities Laws
 
PSB Holdings, Inc. common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934. PSB Holdings, Inc. is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.
 
PSB Holdings, Inc. common stock held by persons who are affiliates (generally officers, directors and principal shareholders) of PSB Holdings, Inc. may not be resold without registration or unless sold in accordance with certain resale restrictions. If PSB Holdings, Inc. meets specified current public information requirements, each affiliate of PSB Holdings, Inc. is able to sell in the public market, without registration, a limited number of shares in any three-month period.
 
Reports to Security Holders
 
PSB Holdings, Inc. files annual and quarterly reports with the SEC on Forms 10-K and 10-Q, respectively. PSB Holdings, Inc. also files current reports on the Form 8-K with the SEC. Finally, PSB Holdings, Inc. files preliminary and definitive proxy materials with the SEC.
 
The public may read and copy any materials filed by PSB Holdings, Inc. with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. PSB Holdings, Inc. is an electronic filer. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of the site is http://www.sec.gov.
 

ITEM 1A.
Risk Factors

We could record future losses on our investment securities portfolio.
 
A number of factors or combinations of factors could cause us to conclude in one or more future reporting periods that an unrealized loss that exists with respect to these securities constitutes an additional impairment that is other than temporary, which could result in material losses to us.  These factors include, but are not limited to, continued failure to make scheduled interest payments, an increase in the severity of the unrealized loss on a particular security, an increase in the continuous duration of the unrealized loss without an improvement in value or changes in market conditions and/or industry or issuer specific factors that would render us unable to forecast a full recovery in value.  In addition, the fair values of the trust preferred securities could decline if the overall economy and the financial condition of some of the issuers continue to deteriorate and there remains limited liquidity for these securities.

 
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We have been negatively affected by current market and economic conditions.  A continuation or worsening of these conditions could adversely affect our operations, financial condition and earnings.
 
The severe economic recession of 2008 and 2009 and the weak economic recovery since then have resulted in continued uncertainty in the financial markets and the expectation of weak general economic conditions, including high levels of unemployment, continuing through 2010.  The resulting economic pressure on consumers and businesses has adversely affected our business, financial condition and results of operations.  The credit quality of loan and investment securities portfolios has deteriorated at many financial institutions and the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline.  Our commercial and multifamily real estate loan customers have experienced increases in vacancy rates and declines in rental rates for both multifamily and commercial properties.  Financial companies’ stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets.  A continuation or worsening of these conditions could result in reduced loan demand and further increases in loan delinquencies, loan losses, loan loss provisions, costs associated with monitoring delinquent loans and disposing of foreclosed property, and otherwise negatively affect our operations, financial condition and earnings.
 
Concentration of loans in our primary market area, which has recently experienced an economic downturn, may increase risk.

Our success depends primarily on the general economic conditions in the State of Connecticut, as nearly all of our loans are to customers in the state.  Accordingly, the local economic conditions in the State of Connecticut have a significant impact on the ability of borrowers to repay loans as well as our ability to originate new loans.  As such, a decline in real estate valuations in this market would lower the value of the collateral securing those loans.  In addition, a significant weakening in general economic conditions such as inflation, recession, unemployment or other factors beyond our control could negatively affect our financial results.
 
Strong competition within our market area may limit our growth and profitability.
 
Competition in the banking and financial services industry is intense.  In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere.  Many of these competitors have substantially greater resources and lending limits than we have and offer certain services that we do not or cannot provide.  In addition, recently some of our larger financial institution competitors, offer loans with lower interest rates on more attractive terms than those offered by Putnam Bank, which we expect to continue in the foreseeable future.  Our profitability depends upon our continued ability to successfully compete in our market area.  The greater resources and deposit and loan products offered by our competition may limit our ability to increase our interest earning assets.  For additional information see “Business of Putnam Bank—Competition.”
 
Because We Intend to Increase Our Commercial Real Estate and Commercial Loan Originations, Our Lending Risk Will Increase and Downturns in the Real Estate Market or Local Economy Could Adversely Affect Our Earnings.
 
Commercial real estate and commercial loans generally have more risk than residential mortgage loans.  Because the repayment of commercial real estate and commercial loans depends on the successful management and operation of the borrower’s properties or related businesses, repayment of such loans can be affected by adverse conditions in the real estate market or the local economy.  Commercial real estate and commercial loans may also involve relatively large loan balances to individual borrowers or groups of related borrowers.  A downturn in the real estate market or the local economy could adversely impact the value of properties securing the loan or the revenues from the borrower’s business thereby increasing the risk of nonperforming loans.  As our commercial real estate and commercial loan portfolio increases, the corresponding risks and potential for losses from these loans may also increase.
 
If Economic Conditions Deteriorate, Our Results of Operations and Financial Condition Could Be Adversely Affected as Borrowers’ Ability to Repay Loans Declines and the Value of the Collateral Securing Our Loans Decreases.
 
Our financial results may be adversely affected by changes in prevailing economic conditions, including decreases in real estate values, changes in interest rates which may cause a decrease in interest rate spreads, adverse employment conditions, the monetary and fiscal policies of the federal government and other significant external events.  Because we originate a significant number of mortgage loans secured by residential real estate, decreases in real estate values could adversely affect the value of property used as collateral for such loans.  At June 30, 2010, loans secured by real estate represented 96.9% of our total loans, substantially all of which are secured by properties located in Windham County.  Adverse changes in the economy also may have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings.  As of June 30, 2010, the unemployment rate in Windham County, Connecticut was 10.5%, and the New London County unemployment rate was 8.5% compared to the national unemployment rate of 9.5% and the unemployment rate for Connecticut as a whole of 8.9%.
 
 
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If Our Allowance for Loan Losses is Not Sufficient to Cover Actual Loan Losses, Our Earnings Could Decrease.
 
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans.  In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions.  If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance.  Our allowance for loan losses was 1.03% of total loans and 42.13% of nonperforming loans at June 30, 2010. Material additions to our allowance would materially decrease our net income.
 
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs.  Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our results of operations and financial condition.
 
Future Changes in Interest Rates May Reduce our Profits.
 
Our ability to make a profit largely depends on our net interest income, which could be negatively affected by changes in interest rates.  Net interest income is the difference between:
 
      
the interest income we earn on our interest-earning assets, such as loans and securities; and
 
      
the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings.
 
The rates we earn on our assets and the rates we pay on our liabilities are generally fixed for a contractual period of time.  Like many savings institutions, our liabilities generally have shorter contractual maturities than our assets.  This imbalance can create significant earnings volatility, because market interest rates change over time.  In a period of rising interest rates, the interest income earned on our assets may not increase as rapidly as the interest paid on our liabilities.  In a period of declining interest rates, the interest income earned on our assets may decrease more rapidly than the interest paid on our liabilities, as borrowers speed up prepayments of mortgage loans, and mortgage-backed securities and callable investment securities are called, requiring us to reinvest those cash flows at lower interest rates.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Management of Market Risk.”
 
In addition, changes in interest rates can affect the average life of loans and mortgage-backed and related securities.  A reduction in interest rates results in increased prepayments of loans and mortgage-backed and related securities, as borrowers refinance their debt in order to reduce their borrowing costs. This creates reinvestment risk, which is the risk that we may not be able to reinvest prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities.
 
At June 30, 2010, our “rate shock” analysis prepared by a third-party consultant indicates that our net portfolio value would decrease by $6.7 million if there was an instantaneous 200 basis point increase in market interest rates.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Management of Market Risk.”
 
Stockholders Other than Our Mutual Holding Company Own a Minority of PSB Holdings, Inc.’s Common Stock and Are Not Be Able to Exercise Voting Control Over Most Matters Put to a Vote of Stockholders.
 
Public stockholders own a minority of the outstanding shares of PSB Holdings, Inc. common stock.  As a result, stockholders other than Putnam Bancorp, MHC are not able to exercise voting control over most matters put to a vote of stockholders. Putnam Bancorp, MHC owns a majority of PSB Holdings, Inc.’s common stock and, through its Board of Directors, is able to exercise voting control over most matters put to a vote of stockholders.  The same directors and officers who manage PSB Holdings, Inc. and Putnam Bank also manage Putnam Bancorp, MHC.  Putnam Bancorp, MHC may exercise its voting control to prevent a sale or merger transaction in which stockholders could receive a premium for their shares.
 
 
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Our Stock Value May be Negatively Affected by Federal Regulations Restricting Takeovers and our Mutual Holding Company Structure.
 
Federal Regulations Restricting Takeovers.  Current OTS policy prohibits the acquisition of a mutual holding company subsidiary by any person or entity other than a mutual holding company or a mutual institution.
 
The Mutual Holding Company Structure May Impede Takeovers.  Putnam Bancorp, MHC, as the majority stockholder of PSB Holdings, Inc., is able to control the outcome of virtually all matters presented to stockholders for their approval, including a proposal to acquire PSB Holdings, Inc.  Accordingly, Putnam Bancorp, MHC may prevent the sale of control or merger of PSB Holdings, Inc. or its subsidiaries even if such a transaction were favored by a majority of the public stockholders of PSB Holdings, Inc.
 
The Corporate Governance Provisions in our Charter and Bylaws May Prevent or Impede the Holders of a Minority of our Common Stock from Obtaining Representation on our Board of Directors.
 
Provisions in our charter and bylaws may prevent or impede holders of a minority of our common stock from obtaining representation on our board of directors. For example, our board of directors is divided into three staggered classes. A classified board makes it more difficult for stockholders to change a majority of the directors because it generally takes at least two annual elections of directors for this to occur. Second, our charter provides that there will not be cumulative voting by stockholders for the election of our directors which means that Putnam Bancorp, MHC, as the holder of a majority of the shares eligible to be voted at a meeting of stockholders, may elect all of our directors to be elected at that meeting. Third, our bylaws contain procedures and timetables for a stockholder wanting to make a nomination for the election of directors or a proposal for new business at a meeting of stockholders, the effect of which may be to give our management time to solicit its own proxies in an attempt to defeat any dissident slate of nominations if management thinks it is in the best interest of stockholders generally.
 
Office of Thrift Supervision Policy on Remutualization Transactions Could Prohibit Acquisition of PSB Holdings, Inc., which May Lower our Stock Price.
 
Current Office of Thrift Supervision regulations permit a mutual holding company to be acquired by a mutual institution in a remutualization transaction. However, the Office of Thrift Supervision has issued a policy statement indicating that it views remutualization transactions as raising significant issues concerning disparate treatment of minority stockholders and the mutual interests of the mutual holding company and as raising issues concerning the effect on the mutual interests of the acquiring entity. Under certain circumstances the Office of Thrift Supervision intends to give these issues special scrutiny and reject applications providing for the remutualization of a mutual holding company unless the applicant can clearly demonstrate that the Office of Thrift Supervision’s concerns are not warranted in the particular case. Should the Office of Thrift Supervision prohibit or otherwise restrict these transactions in the future, our per-share stock price may be adversely affected.
 
Government responses to economic conditions may adversely affect our operations, financial condition and earnings.
 
Newly enacted financial reform legislation will change the bank regulatory framework, create an independent consumer protection bureau that will assume the consumer protection responsibilities of the various federal banking agencies, and establish more stringent capital standards for banks and bank holding companies.  The legislation will also result in new regulations affecting the lending, funding, trading and investment activities of banks and bank holding companies.  Bank regulatory agencies also have been responding aggressively to concerns and adverse trends identified in examinations.  Ongoing uncertainty and adverse developments in the financial services industry and the domestic and international credit markets, and the effect of new legislation and regulatory actions in response to these conditions, may adversely affect our operations by restricting our business activities, including our ability to originate or sell loans, modify loan terms, or foreclose on property securing loans.  These measures are likely to increase our costs of doing business and may have a significant adverse effect on our lending activities, financial performance and operating flexibility.  In addition, these risks could affect the performance and value of our loan and investment securities portfolios, which also would negatively affect our financial performance.
 
Furthermore, the Board of Governors of the Federal Reserve System, in an attempt to help the overall economy, has, among other things, kept interest rates low through its targeted federal funds rate and the purchase of mortgage-backed securities.  If the Federal Reserve Board increases the federal funds rate, overall interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic recovery.  In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of underlying collateral securing loans, which could negatively affect our financial performance.
 
 
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Recently enacted financial reform legislation may have an adverse effect on our ability to pay dividends, which would adversely affect the value of our common stock.

The value of PSB Holdings, Inc.’s common stock is significantly affected by our ability to pay dividends to our public stockholders.  PSB Holdings, Inc.’s ability to pay dividends to our stockholders is subject to the ability of Putnam Bank to make capital distributions to PSB Holdings, Inc., and also to the availability of cash at the holding company level in the event earnings are not sufficient to pay dividends.  Moreover, our ability to pay dividends and the amount of such dividends is affected by the ability of Putnam Bancorp, MHC, our mutual holding company, to waive the receipt of dividends declared by PSB Holdings, Inc.

Office of Thrift Supervision regulations allow federally chartered mutual holding companies to waive dividends without taking into account the amount of waived dividends in determining an appropriate exchange ratio in the event of a conversion of a mutual holding company to stock form.  However, under the recently enacted Dodd-Frank Act, the powers and duties of the Office of Thrift Supervision relating to mutual holding companies will be transferred to the Federal Reserve Board within one year of the enactment of the legislation (subject to an extension of up to six months), and the Office of Thrift Supervision will be eliminated.  Accordingly, the Federal Reserve Board will become the new regulator of PSB Holdings, Inc. and Putnam Bancorp, MHC.  The Dodd-Frank Act also provides that a mutual holding company will be required to give the Federal Reserve Board notice before waiving the receipt of dividends, and sets forth the standards for granting a waiver, including a requirement that waived dividends be considered in determining an appropriate exchange ratio in the event of a conversion of the mutual holding company to stock form.  The Dodd-Frank Act, however, further provides that the Federal Reserve Board may not consider waived dividends in determining an appropriate exchange ratio in a conversion to stock form by any federal mutual holding company, such as Putnam Bancorp, MHC, that has waived dividends prior to December 1, 2009.  The Federal Reserve Board historically has generally not allowed mutual holding companies to waive the receipt of dividends, and there can be no assurance as to the conditions, if any, the Federal Reserve Board will place on future dividend waiver requests by grandfathered mutual holding companies such as Putnam Bancorp, MHC.

Financial reform legislation recently enacted by Congress will, among other things, eliminate the Office of Thrift Supervision, tighten capital standards, create a new Consumer Financial Protection Bureau and result in new laws and regulations that are expected to increase our costs of operations.
 
The recently enacted Dodd-Frank Act will significantly change the current bank regulatory structure and affect the lending, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act will eliminate our current primary federal regulator, the Office of Thrift Supervision, and require Putnam Bank to be regulated by the Office of the Comptroller of the Currency (the primary federal regulator for national banks). The Dodd-Frank Act also authorizes the Board of Governors of the Federal Reserve System to supervise and regulate all savings and loan holding companies, including mutual holding companies, like PSB Holdings, Inc. and Putnam Bancorp, MHC, in addition to bank holding companies that it currently regulates.  As a result, the Federal Reserve Board’s current regulations applicable to bank holding companies, including holding company capital requirements, will apply to savings and loan holding companies like PSB Holdings, Inc. and Putnam Bancorp, MHC.  These capital requirements are substantially similar to the capital requirements currently applicable to Putnam Bank, as described in “Supervision and Regulation—Federal Banking Regulation—Capital Requirements.”  Moreover, Putnam Bancorp, MHC will require the approval of the Federal Reserve Board before it may waive the receipt of any dividends from PSB Holdings, Inc., and there is no assurance that the Federal Reserve Board will approve future dividend waivers or what conditions it may impose on such waivers.  See “—Recently enacted financial reform legislation may have an adverse effect on our ability to pay dividends, which would adversely affect the value of our common stock.”  The Dodd-Frank Act also requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions.  Bank holding companies with assets of less than $500 million are exempt from these capital requirements.  The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.
 
The Dodd-Frank Act also creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as Putnam Bank, including the authority to prohibit “unfair, deceptive or abusive” acts and practices.  The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.  Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators.  The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.
 
 
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The legislation also broadens the base for Federal Deposit Insurance Corporation insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution.  The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2013.  Lastly, the Dodd-Frank Act will increase stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and by authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials.  The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.
 
It is difficult to predict at this time what impact the new legislation and implementing regulations will have on community banks, including the lending and credit practices of such banks.  Moreover, many of the provisions of the Dodd-Frank Act will not take effect for at least a year, and the legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years.  Although the substance and scope of these regulations cannot be determined at this time, it is expected that the legislation and implementing regulations, particularly those provisions relating to the new Consumer Financial Protection Bureau and mutual holding company dividend waivers, will increase our operating and compliance costs and restrict our ability to pay dividends, respectively.

We are subject to extensive regulatory oversight.
 
We and our subsidiaries are subject to extensive regulation and supervision.  Regulators have intensified their focus on bank lending criteria and controls, and on the USA PATRIOT Act’s anti-money laundering and Bank Secrecy Act compliance requirements.  There also is increased scrutiny of our compliance practices generally and particularly with the rules enforced by the Office of Foreign Assets Control.  Our failure to comply with these and other regulatory requirements could lead to, among other remedies, administrative enforcement actions and legal proceedings.  In addition, the Dodd-Frank Act and implementing regulations are likely to have a significant effect on the financial services industry, which are likely to increase operating costs and reduce profitability.  Regulatory or legislative changes could make regulatory compliance more difficult or expensive for us, and could cause us to change or limit some of our products and services, or the way we operate our business.
 
Legislative or regulatory responses to perceived financial and market problems could impair our rights against borrowers.
 
Current and future proposals made by members of Congress would reduce the amount distressed borrowers are otherwise contractually obligated to pay under their mortgage loans, and may limit the ability of lenders to foreclose on mortgage collateral.  If proposals such as these, or other proposals limiting Putnam Bank’s rights as a creditor, were to be implemented, we could experience increased credit losses on our loans and mortgage-backed securities, or increased expense in pursuing our remedies as a creditor.
 
Recent health care legislation could increase our expenses or require us to pass further costs on to our employees, which could adversely affect our operations, financial condition and earnings.
 
Legislation enacted in 2010 requires companies to provide expanded health care coverage to their employees, such as affordable coverage to part-time employees and coverage to dependent adult children of employees.  Companies will also be required to enroll new employees automatically into one of their health plans.  Compliance with these and other new requirements of the health care legislation will increase our employee benefits expense, and may require us to pass these costs on to our employees, which could give us a competitive disadvantage in hiring and retaining qualified employees.
 
 
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The requirement to account for certain assets at estimated fair value, and a proposal to account for additional financial assets and liabilities at estimated fair value, may adversely affect our results of operations.
 
We report certain assets, including securities, at fair value, and a recent proposal would require us to report most of our financial assets and liabilities at fair value.  Generally, for securities that are reported at fair value, we use quoted market prices or valuation models that utilize observable market inputs to estimate fair value.  Because we carry these assets on our books at their estimated fair value, we may record losses even if the asset in question presents minimal credit risk.  Under current accounting requirements, elevated delinquencies, defaults, and estimated losses from the disposition of collateral in our private-label mortgage-backed securities portfolio may require us to recognize additional other-than-temporary impairments in future periods with respect to our securities portfolio.  The amount and timing of any impairment recognized will depend on the severity and duration of the decline in the estimated fair value of the asset and our estimate of the anticipated recovery period.  Under proposed accounting requirements, we may be required to record reductions in the fair value of nearly all of our financial assets and liabilities (including loans) either through a charge to net income or through a reduction to accumulated other comprehensive income.  Accordingly, we could be required to record losses on assets such as loans where we have no intention to sell the loan and expect the loan to be repaid in full.  This could result in a decrease in net income, a decrease in our stockholders’ equity, or both.
 
Any future Federal Deposit Insurance Corporation insurance premiums or special assessments will adversely affect our earnings.
 
As part of its plan to restore the Federal Deposit Insurance Corporation’s insurance reserve ratio to 1.15% of estimated insured deposits, the Federal Deposit Insurance Corporation imposed a special assessment equal to five basis points of assets less Tier 1 capital as of June 30, 2009, which was payable on September 30, 2009.  In addition, the Federal Deposit Insurance Corporation increased its quarterly deposit insurance assessment rates and amended the method by which rates are calculated.  The Dodd-Frank Act also requires the reserve ratio of the Deposit Insurance Fund to increase from 1.15% to 1.35% of insured deposits by September 30, 2020, although banks with assets of less than $10 billion are exempt from any additional assessments to achieve the higher reserve ratio.
 
On November 12, 2009, the Federal Deposit Insurance Corporation also approved a final rule requiring insured depository institutions to prepay on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012.  Estimated assessments for the fourth quarter of 2009 and for all 2010 are based upon the assessment rate in effect on September 30, 2009, with three basis points added for the 2011 and 2012 assessment rates.  In addition, a 5% annual growth rate in the assessment base is assumed.  Prepaid assessments are to be applied against the actual quarterly assessments until exhausted, and may not be applied to any special assessments that may occur in the future.  Any unused prepayments will be returned to the institution on June 30, 2013.  On December 30, 2009, we prepaid $2.9 million in estimated assessment fees for the fourth quarter of 2009 through 2012.  Actions the Federal Deposit Insurance Corporation takes in the future could result in significantly higher deposit insurance premiums, special assessments, or prepaid assessments, which could have a significant affect on our earnings.
 
ITEM 1B.           Unresolved Staff Comments
 
Not applicable.

ITEM 2.               Properties

We conduct substantially all of our business through our main office, seven full service branch offices and one loan origination center.  We also conduct limited business operations through a “Special Needs Limited Branch” and a “Limited Services Branch”.  In 2002, we began Limited Service (Mobile) Branch activities.  The Limited Services (Mobile) Branch serves approximately eight locations in our primary market area consisting of schools and retirement facilities.  Bank personnel visit these facilities approximately once per week and, in the case of school locations, conduct deposit taking activities and, in the case of the retirement facilities, conduct deposit taking, check cashing, notary and certificate of deposit renewal activities.  Set forth below is information on our office locations as of June 30, 2010.  The net book value of our premises, land and equipment was approximately $5.3 million at June 30, 2010.
 
37

 
 
 
Leased or
 
Year Acquired
 
Square
   
Net Book Value
 
Location
Owned
 
or Leased
 
Footage
   
of Real Property
 
               
(In thousands)
 
Main Office:
                 
40 Main Street
Owned
 
1974
    14,938     $ 1,201  
Putnam, Connecticut 06260
                     
                       
Full Service Branches:
                     
251 Kennedy Drive
Leased
 
2006
    473       89  
Putnam, Connecticut 06260
                     
                       
100 Averill Road
Owned
 
1981
    2,487       519  
Pomfret Center, Connecticut 06259
                     
                       
125 Wauregan Road
Owned
 
1993
    2,452       350  
Danielson, Connecticut 06239
                     
                       
11 Pratt Road
Owned
 
2000
    2,162       343  
Plainfield, Connecticut 06374
                     
                       
461 Voluntown Road, Rte. 138
Leased
 
2005
    2,600       46  
Griswold, Connecticut 06351
                     
                       
2 Chapman Lane
Owned
 
2009
    2,400       711  
Gales Ferry, Connecticut 06335
                     
                       
40 High Street
Owned
 
2009
    2,800       1,199  
Norwich, Connecticut (2)
                     
                       
Loan Center:
                     
50 Canal Street
Owned
 
2000
    2,940       163  
Putnam, Connecticut 06260
                     
                       
ATM Remote Location:
                     
168 Route 169
Leased
 
2003
    30    
__
 
Woodstock, Connecticut 06281
                     
                       
Special Needs Limited Branch (1):
                     
Creamery Brook Retirement Village
__
     
__
   
__
 
36 Vina Lane
                     
Brooklyn, Connecticut 06234
                     
         Total
                $ 4,621  
 

(1)
Our personnel are at this location for approximately three hours once a week. The facility provides a furnished room for us at no cost. Our personnel conduct limited banking activities, such as deposit-taking, check cashing, notary and certificate of deposit renewals. We began operating at this location in 2002.
(2)
The Norwich branch opened for business on September 2, 2009.
 
ITEM 3.
Legal Proceedings
 
From time to time, we are involved as plaintiff or defendant in various legal proceedings arising in the ordinary course of business. At June 30, 2010, we were not involved in any legal proceedings, the outcome of which would be material to our financial condition or results of operations.
 
ITEM 4.
[Removed and Reserved]
 
 
38

 
PART II
 
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
(a) Our common stock is traded on the NASDAQ Global Market under the symbol “PSBH.” Putnam Bancorp, MHC owns 3,729,846 shares, or 57.1% of our outstanding common stock. The approximate number of holders of record of PSB Holdings, Inc.’s common stock as of August 31, 2010 was 491. Certain shares of PSB Holdings, Inc. are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. The following table presents quarterly market information for PSB Holdings, Inc.’s common stock for the periods ended June 30, 2010 and June 30, 2009. The following information with respect to trading prices was provided by the NASDAQ Global Market.
 
   
High
   
Low
   
Dividends
 
Fiscal 2009
                 
Quarter ended September 30, 2008
  $ 9.50     $ 7.80     $ 0.10  
Quarter ended December 31, 2008
    8.26       3.23       0.09  
Quarter ended March 31, 2009
    4.72           3.60          0.05  
Quarter ended June 30, 2009
    5.20       3.60       0.05  
Fiscal 2010
                       
Quarter ended September 30, 2009
  $ 5.00     $ 2.78     $ 0.04  
Quarter ended December 31, 2009
    4.00       2.61       -  
Quarter ended March 31, 2010
    5.33       3.01       -  
Quarter ended June 30, 2010
    5.18       4.00       -  
                         
 
Dividend payments by PSB Holdings, Inc. are dependent primarily on dividends it receives from Putnam Bank, because PSB Holdings, Inc. has no source of income other than dividends from Putnam Bank, earnings from the investment of proceeds from the sale of shares of common stock retained by PSB Holdings, Inc. and interest payments with respect to PSB Holdings, Inc.’s loan to the Employee Stock Ownership Plan.
 
In addition, reference is made to the “Market for Common Stock” section of PSB Holdings, Inc. 2010 Annual Report to Stockholders, which is incorporated herein by reference.
 
Information with respect to securities authorized for issuance under the Company’s Equity Compensation Plan is incorporated by reference herein from the Company’s Proxy Statement.
 
(b) Not applicable.
 
(c) Not applicable
 
 
39

 
ITEM 6.
Selected Financial Data
 
The Company has derived the following selected consolidated financial and other data in part from its consolidated financial statements and notes appearing elsewhere in this report.
 
   
At or For the Year Ended June 30,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
   
(Dollars in thousands)
Selected Financial Condition Data:
                             
                               
Total Assets
  $ 489,359     $ 477,349     $ 494,499     $ 491,198     $ 474,417  
Cash and cash equivalents
    23,291       6,059       8,146       13,198       8,195  
Securities available-for-sale
    85,893       164,888       212,083       215,322       238,730  
Securities held-to-maturity
    83,249       2,000       -       -       -  
Loans receivable, net
    254,772       264,317       242,728       230,902       199,537  
Loans held-for-sale
    1,470       1,200       675       1,478       934  
Deposits
    335,146       308,099       283,724       293,473       296,965  
Borrowings
    106,396       124,971       156,621       141,857       124,593  
Total capital
    43,855       39,896       49,437       51,251       48,912  
                                         
   
At or For the Year Ended June 30,
      2010       2008       2007       2006       2005  
   
(Dollars in thousands)
 
Selected Operating Data:
                                       
                                         
Interest and dividend income
  $ 22,462     $ 25,318     $ 27,205     $ 25,364     $ 19,437  
Interest expense
    10,125       12,726       15,229       14,795       8,801  
     Net interest income
    12,337       12,592       11,976       10,569       10,636  
Provision for loan losses
    1,049       967       51       263       200  
     Net interest income after provision for
                                       
     loan losses
    11,288       11,625       11,925       10,306       10,436  
Noninterest income (charge)
    1,983       (12,559 )     3,193       2,741       2,436  
Noninterest expense
    11,700       10,807       10,945       10,769       10,139  
Income (loss) before income taxes
    1,571       (11,741 )     4,173       2,278       2,733  
Income tax expense (benefit)
    309       (4,610 )     1,105       354       617  
     Net income (loss)
  $ 1,262     $ (7,131 )   $ 3,068     $ 1,924     $ 2,116  
                                         
 
 
40

 
   
June 30,
 
Selected Financial Ratios and Other Data:
 
2010
   
2009
   
2008
   
2007
   
2006
 
                               
Performance Ratios:
                             
Return on average assets
    0.26 %     -1.47 %     0.63 %     0.40 %     0.54 %
Return on average equity
    2.93       -17.76       5.95       3.74       4.09  
Interest rate spread (1)
    2.47       2.46       2.04       1.76       2.33  
Net interest margin (2)
    2.74       2.79       2.59       2.35       2.84  
Noninterest expense to average assets
    2.42       2.23       2.23       2.17       2.57  
Efficiency Ratio (3)
    81.70    
NA
      72.15       80.91       77.56  
Basic earnings (loss) per share
  $ 0.20     $ (1.14 )   $ 0.49     $ 0.29     $ 0.31  
Diluted earnings (loss) per share
  $ 0.20     $ (1.14 )   $ 0.48     $ 0.28     $ 0.30  
Average interest-earning assets to average interest-bearing liabilities
    112.03 %     112.01 %     116.77 %     117.87 %     121.72 %
                                         
Capital Ratios:
                                       
Equity to total assets at end of period
    8.96 %     8.36 %     10.00 %     10.43 %     10.31 %
Average equity to average assets
    8.92       8.30       10.51       10.80       13.10  
Total capital to risk-weighted assets
    13.42       10.92       16.24       16.60       13.25  
Tier 1 capital to risk-weighted assets
    12.38       10.20       15.58       15.89       12.66  
Tier 1 capital to adjusted tangible assets
    6.91       6.62       8.34       8.22       7.26  
Dividend payout ratio
    0.20       (0.25 )     0.63       0.83       0.74  
                                         
Asset Quality Ratios:
                                       
Allowance for loan losses as a percent of total loans
    1.03 %     0.83 %     0.72 %     0.74 %     0.77 %
Allowance for loan losses as a percent of nonperforming loans
    42.13       34.11       121.07       115.73       109.03  
Net charge-offs to average outstanding loans during the period
    0.22       0.20       0.03       0.03       0.04  
Nonperforming loans as a percent of total loans
    2.45       2.42       0.59       0.66       0.72  
Nonperforming assets as a percent of total assets
    1.80       1.67       0.29       0.31       0.31  
                                         
Other Data:
                                       
Number of full-service offices
    8       7       7       7       6  
 
 

   (1)   Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities.
   (2)
Represents net interest income as a percent of average interest-earning assets.
   (3) Represents noninterest expense divided by the sum of net interest income and noninterest income.
 
 
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following analysis discusses changes in the financial condition and results of operations at and for the years ended June 30, 2010 and 2009, and should be read in conjunction with the Company’s Consolidated Financial Statements and the notes thereto, appearing in Part II, Item 7 of this Annual Report on Form 10-K.
 
Overview
 
The Company’s results of operations depend primarily on net interest and dividend income, which is the difference between the interest and dividend income earned on its interest-earning assets, such as loans and securities, and the interest expense on its interest-bearing liabilities, such as deposits and borrowings. The Company also generates noninterest income, primarily from fees and service charges. Gains on sales of loans and securities and cash surrender value of life insurance policies are added sources of noninterest income. The Company’s noninterest expense primarily consists of employee compensation and benefits, occupancy and equipment expense, advertising, data processing, professional fees and other operating expenses.
 

              Net Income. Net income increased $8.4 million to $1.3 million or $.20 per basic share and per diluted share for the fiscal year ended June 30, 2010 from a net loss of $7.1 million or ($1.14) per basic share and diluted share for the fiscal year ended June 30, 2009.  The net loss for the fiscal year ended June 30, 2009 was primarily due to other-than-temporarily impaired pre-tax investment write-downs of $15.97 million compared to investment write-downs of $2.4 million for the fiscal year ended June 30, 2010.
 
 
41

 
Critical Accounting Policies
 
Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. Our critical accounting policies are those related to our allowance for loan losses and goodwill.  Management has discussed the development, selection and application of these critical accounting policies with the Audit Committee of the Board of Directors.
 
Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover credit losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses which is charged against income.
 
Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal and external loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates by management that may be susceptible to significant change.
 
The analysis has two components: specific and general allocations. Specific allocations are made for loans for which collection is questionable and the loan is downgraded. Additionally, the size of the allocation is measured by determining an expected collection or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We also analyze historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allowance for loan losses. Actual loan losses may be significantly more than the allowances we have established which could have a material negative effect on our financial results.
 
Goodwill. The Company’s goodwill (the amount paid in excess of fair value of acquired net assets) is reviewed at least annually to ensure that there have been no events or circumstances resulting in an impairment of the recorded amount of excess purchase price. Adverse changes in the economic environment, operations of acquired business units, or other factors could result in a decline in projected fair values. If the estimated fair value is less than the carrying amount, a loss would be recognized to reduce the carrying amount to fair value.
 
Comparison of Financial Condition at June 30, 2010 and June 30, 2009
 
Assets. Total assets of the Company were $489.4 million at June 30, 2010, an increase of $12.1 million or 2.5%, from $477.3 million at June 30, 2009.  Investments in available-for-sale securities decreased $79.0 million or 47.9%, to $85.9 million at June 30, 2010 compared to $164.9 million at June 30, 2009.  Investments in held-to-maturity securities increased   $81.2 million to $83.2 million as of June 30, 2010 compared to $2.0 million as of June 30, 2009.  Cash and cash equivalents increased $17.2 million to $23.3 million as of June 30, 2010 compared to $6.1 million as of June 30, 2009.  Net loans outstanding decreased $9.5 million or 3.6% to $254.8 million at June 30, 2010 from $264.3 million at June 30, 2009. This decrease was primarily due to a decrease of $5.7 million, or 2.9% in residential mortgage loans. Total commercial loans decreased $4.3 million, or 6.5%, from June 30, 2009 to June 30, 2010.
 
Liabilities. Total liabilities increased $8.0 million, or 1.8%, to $445.5 million at June 30, 2010 from $437.5 million at June 30, 2009, primarily due to an increase in total deposits of $27.0 million, or 8.8%, to $335.1 million at June 30, 2010 from $308.1 million at June 30, 2009.   This was partially offset by a decrease in Federal Home Loan Bank advances of $20.0 million, or 16.6% to $100.5 million at June 30, 2010 from $120.5 million at June 30, 2009.
 
Stockholders’ Equity. Total stockholders’ equity increased $4.0 million, or 9.9% to $43.9 million at June 30, 2010 from $39.9 million at June 30, 2009. The increase was primarily due to a decrease of $2.5 million in other comprehensive loss and net income of $1.3 million for the fiscal year ended June 30, 2010.
 
 
42

 
 
Comparison of Operating Results for the Fiscal Years Ended June 30, 2010 and 2009
 

Net Income. Net income amounted to $1.3 million, or $0.20 per basic share and per diluted share for the fiscal year ended June 30, 2010 compared to a net loss of $7.1 million or ($1.14) per basic and diluted share for the fiscal year ended June 30, 2009.
 
Interest and Dividend Income. Interest and dividend income decreased by $2.86 million, or 11.3%, to $22.46 million for the fiscal year ended June 30, 2010 from $25.32 million for the fiscal year ended June 30, 2009. The decrease in interest and dividend income resulted primarily from a 62 basis point decrease in the yield on average interest-earning assets to 4.99% for the fiscal year ended June 30, 2010 from 5.61% for the fiscal year ended June 30, 2009.  Interest income on loans decreased by $77,000, or 0.5%, to $14.64 million for the fiscal year ended June 30, 2010 from $14.72 million for the fiscal year ended June 30, 2009. Interest and dividend income on investment securities decreased $2.8 million, or 26.2%, to $7.8 million for the fiscal year ended June 30, 2010 from $10.6 million for the fiscal year ended June 30, 2009.  The yield on average investment securities decreased 89 basis points to 4.62% for the fiscal year ended June 30, 2010 from 5.51% for the fiscal year ended June 30, 2009.  Average interest-earning assets decreased $1.2 million to $449.8 million for the fiscal year ended June 30, 2010 from $451.0 million for the fiscal year ended June 30, 2009.  Average investment securities decreased $22.9 million, average loans increased $10.4 million and average other earning assets increased $11.3 million from year to year.
 
Interest Expense. Interest expense decreased by $2.6 million, or 20.4%, to $10.1 million for fiscal year ended June 30, 2010 from $12.7 million for the fiscal year ended June 30, 2009. The decrease in interest expense resulted primarily from a decrease in the cost of average interest-bearing liabilities which decreased by 64 basis points to 2.52% for the fiscal year ended June 30, 2010 as compared to 3.16% for the fiscal year ended June 30, 2009.  The cost of average interest-bearing deposits decreased 66 basis points to 2.04% for the fiscal year ended June 30, 2010 from 2.70% for the fiscal year ended June 30, 2009 and the cost of other borrowed money decreased 26 basis points to 3.72% for the fiscal year ended June 30, 2010 from 3.98% for the fiscal year ended June 30, 2009.  Average interest-bearing deposits increased $29.7 million to $285.8 million for the fiscal year ended June 30, 2010 from $256.1 million for the fiscal year ended June 30, 2009.  Average NOW accounts increased $38.2 million and average time deposits decreased $8.2 million.  Average Borrowed money decreased $30.6 million to $115.6 million for the fiscal year ended June 30, 2010 from $146.2 million for the fiscal year ended June 30, 2009.
 
Net Interest Income. Net interest income decreased $255,000, or 2.0%, to $12.3 million for the fiscal year ended June 30, 2010 from $12.6 million for the fiscal year ended June 30, 2009. The primary reason for the decrease in our net interest income was the decrease in the net interest margin to 2.74% for the fiscal year ended June 30, 2010 compared to 2.79% for the fiscal year ended June 30, 2009.  Net interest income decreased $450,000 due to the change in rates during the fiscal year ended June 30, 2010 and this was partially offset by an increase in net interest income of $195,000 due to the change in volume and mix during the fiscal year ended June 30, 2010.
 
    Provision for Loan Losses. The Company’s provision for loan losses increased $82,000 to $1.0 million for the fiscal year ended June 30, 2010 from $967,000 for the fiscal year ended June 30, 2009.  Net loans decreased $9.5 million or 3.6% from June 30, 2009 to June 30, 2010.  Generally, commercial loans are considered to present greater risk than one- to four-family residential real estate loans, and, therefore, require greater allowances for loan losses compared to the same amount of one- to four-family residential real estate loans.  The higher provision also reflects the Bank’s nonperforming loans, charge-offs and the loan loss factors for commercial mortgage, construction and commercial business loan portfolios due to adverse market conditions.  Nonperforming loans decreased to $6.3 million at June 30, 2010 from $6.4 million at June 30, 2009. The ratio of the allowance to gross loans outstanding was 1.03% as of June 30, 2010 compared to 0.82% as of June 30, 2009.  The ratio of the allowance to nonperforming loans was 42.13% as of June 30, 2010 compared to 34.11% as of June 30, 2009.  To the best of our knowledge, we have provided for all losses that are both probable and reasonable to estimate at June 30, 2010 and 2009.
 

Noninterest Income.   Noninterest income was $2.0 million for the fiscal year ended June 30, 2010 compared to noninterest charges of $12.6 million for the fiscal year ended June 30, 2009.  This was primarily due to write-downs of investments of $15.97 million for the fiscal year ended June 30, 2009 compared to $2.4 million in investment write-downs for the fiscal year ended June 30, 2010.  The write-downs for the fiscal year ended June 30, 2009 consisted of $9.79 million in private label CMOs, $3.95 million in Freddie Mac pass-through auction-rate securities issued by trusts consisting solely of Freddie Mac preferred stock, $320,000 in CIT Group corporate debt and $1.91 million in Lehman Brothers corporate debt.  The write-downs for the fiscal year ended June 30, 2010 consisted of private label CMOs.  Net gains on sales and calls of securities increased $1.3 million to $1.4 million for the fiscal year ended June 30, 2010 compared to $128,000 for the fiscal year ended June 30, 2009.
 
 
43

 
Noninterest Expense. Noninterest expense increased by $893,000, or 8.3%, to $11.7 million for the fiscal year ended June 30, 2010 from $10.8 million for the fiscal year ended June 30, 2009. Compensation and benefits expense increased by $103,000, or 1.8%, to $5.9 million for the fiscal year ended June 30, 2010 from $5.8 million for the fiscal year ended June 30, 2009.  Occupancy and equipment expense increased by $66,000, or 5.6%, to $1.24 million for the fiscal year ended June 30, 2010 from $1.17 million for the fiscal year ended June 30, 2009.  Included in this increase was the opening of a new full-service branch in Norwich, Connecticut in October 2009.  All other noninterest expense, consisting primarily of data processing expense, FDIC deposit insurance, professional fees and marketing expense increased by $724,000, or 18.8%, to $4.6 million for the fiscal year ended June 30, 2010 from $3.9 million for the fiscal year ended June 30, 2009. This was primarily due to increases in prepayment penalties on FHLB borrowings of $187,000, write-downs on other real estate owned of $321,000 on a property sold in October 2009 and FDIC deposit insurance of $69,000 during the fiscal year ended June 30, 2010.
 

            Provision for Income Taxes.  Income tax expense increased by $4.9 million, or 106.7%, to $309,000 for the year ended June 30, 2010 from a tax benefit of $4.6 million for the year ended June 30, 2009. Our effective tax rate was 19.7% for the year ended June 30, 2010, compared to (39.3%) for the year ended June 30, 2009. This benefit was primarily due to the investment write-downs mentioned above.  The effective tax rate differed from the statutory tax rate of 34% primarily due to the dividends-received deduction applicable to certain securities in our investment portfolio, tax-exempt municipal income and non-taxable bank-owned life insurance income.
 
 
44

 

Average Balance Sheet
 
The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
 
   
2010
   
2009
   
2008
 
Years ended June 30,
 
Average
 
Income/
 
Yield/
   
Average
 
Income/
   
Yield/
   
Average
   
Income/
 
Yield/
 
 (in thousands)
 
Balance
 
Expense
 
Cost
   
Balance
 
Expense
   
Cost
   
Balance
   
Expense
 
Cost
 
 Earning Assets:
                                             
 Investment securities
  $ 169,043   $ 7,811     4.62 %   $ 192,014   $ 10,584       5.51 %   $ 219,397     $ 11,821     5.39 %
 Loans
    265,142     14,641     5.52 %     254,742     14,718       5.78 %     240,403       15,274     6.35 %
 Other earning assets
    15,606     10     0.06 %     4,281     16       0.37 %     2,921       110     3.77 %
 Total interest-earnings assets
    449,791     22,462     4.99 %     451,037     25,318       5.61 %     462,721       27,205     5.88 %
 Non-interest-earning assets
    32,813                   32,808                     27,909                
 Total assets
  $ 482,604                 $ 483,845                   $ 490,630                
                                                                 
 Interest-bearing liabilities:
                                                               
 NOW accounts
  $ 80,526     1,317     1.64 %   $ 42,360     944       2.23 %   $ 29,813       777     2.61 %
 Savings accounts
    46,447     195     0.42 %     45,684     250       0.55 %     47,397       329     0.69 %
 Money market accounts
    11,036     111     1.01 %     12,006     188       1.57 %     15,496       300     1.94 %
 Time deposits
    147,836     4,200     2.84 %     156,074     5,525       3.54 %     153,262       6,967     4.55 %
 Borrowed money
    115,630     4,302     3.72 %     146,220     5,819       3.98 %     150,294       6,856     4.56 %
 Total interest-bearing liabilities
    401,475     10,125     2.52 %     402,344     12,726       3.16 %     396,262       15,229     3.84 %
 Non-interest-bearing demand deposits
    35,280                   36,219                     38,846                
 Other non-interest-bearing liabilities
    2,782                   5,121                     3,954                
 Capital accounts
    43,067                   40,161                     51,568                
 Total liabilities and capital accounts
  $ 482,604                 $ 483,845                   $ 490,630                
                                                                 
 Net interest income
        $ 12,337                 $ 12,592                     $ 11,976        
 Interest rate spread
                2.47 %                   2.45 %                   2.04 %
 Net interest-earning assets
  $ 48,316                 $ 48,693                   $ 66,459                
 Net interest margin
                2.74 %                   2.79 %                   2.59 %
 Average earning assets to
                                                               
    average interest-bearing liabilities
                112.03 %                   112.10 %                   116.77 %
 
 
45

 
 
Rate/Volume Analysis
 
The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.
 
   
2010 Compared to 2009
   
2009 Compared to 2008
   
2008 Compared to 2007
 
 (Dollars in thousands)
 
Increase (Decrease) Due to
   
Increase (Decrease) Due to
   
Increase (Decrease) Due to
 
 INTEREST-EARNING ASSETS:
 
Rate
   
Volume
   
Net
   
Rate
   
Volume
   
Net
   
Rate
   
Volume
   
Net
 
 Interest and Dividend Income:
                                                     
 Investment securities
  $ (1,594 )   $ (1,179 )   $ (2,773 )   $ 267     $ (1,504 )   $ (1,237 )   $ 994     $ (416 )     $ 578  
 Loans
    (665 )     588       (77 )     (1,434 )     878       (556 )     (34 )     1,362       1,328  
 Other interest-earning assets
    (22 )     16       (6 )     (122 )     28       (94 )     (42 )     (23 )     (65 )
 TOTAL INTEREST-EARNING ASSETS
    (2,281 )     (575 )     (2,856 )     (1,289 )     (598 )     (1,887 )     918       923              1,841  
                                                                         
INTEREST-BEARING LIABILITIES:
                                                                 
 Interest Expense:
                                                                       
 NOW accounts
    (303 )     676       373       (125 )     292       167       296       91       387  
 Savings accounts
    (59 )     4       (55 )     (67 )     (12 )     (79 )     (24 )     (30 )     (54 )
 Money Market accounts
    (63 )     (14 )     (77 )     (51 )     (61 )     (112 )     37       (88 )     (51 )
 Time deposits
    (1,046 )     (279 )     (1,325 )     (1,568 )     126       (1,442 )     93       (56 )     37  
 Other borrowed money
    (360 )     (1,157 )     (1,517 )     (855 )     (182 )     (1,037 )     (834 )     949       115  
 TOTAL INTEREST-BEARING LIABILITIES
    (1,831 )     (770 )     (2,601 )     (2,666 )     163       (2,503 )     (432 )     866       434  
                                                                         
 CHANGE IN NET INTEREST INCOME
  $ (450 )   $ 195     $ (255 )   $ 1,377     $ (761 )   $ 616     $ 1,350     $ 57     $ 1,407  
 
 
46

 

Market Risk, Liquidity and Capital Resources

Market Risk

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

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

Net interest income at-risk measures the risk of a decline in earnings due to potential short-term and long term changes in interest rates.  The table below represents an analysis of our IRR as measured by the estimated changes in NII, resulting from an instantaneous and sustained parallel shift in the yield curve (+100 and +200 basis points) at June 30, 2010 and June 30, 2009.

         
Net Interest Income At-Risk
         
   
Estimated Increase (Decrease)
 
Estimated Increase (Decrease)
Change in Interest Rates
 
in NII
 
in NII
(Basis Points)
 
June 30, 2010
 
June 30, 2009
         
Stable
       
+ 100
 
-1.25%
 
-1.50%
+ 200
 
-4.59%
 
-4.14%

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

Net Portfolio Value Simulation Analysis.  The Office of Thrift Supervision requires the computation of amounts by which the net present value of an institution’s cash flow from assets, liabilities and off-balance sheet items (the institution’s net portfolio value or “NPV”) would change in the event of a range of assumed changes in market interest rates.  The Office of Thrift Supervision provides all institutions that file a Consolidated Maturity/Rate Schedule as a part of their quarterly Thrift Financial Report an interest rate sensitivity report of net portfolio value.  The Office of Thrift Supervision simulation model uses a discounted cash flow analysis and an option-based pricing approach to measuring the interest rate sensitivity of net portfolio value.  Historically, the Office of Thrift Supervision model estimated the economic value of each type of asset, liability and off-balance sheet contract under the assumption that the United States Treasury yield curve increases or decreases instantaneously by 100 to 300 basis point increments.  However, given the current low level of market interest rates, we did not prepare a net portfolio value calculation for an interest rate decrease of greater than 100 basis points.  A basis point equals one-hundredth of one percent, and 200 basis points equals two percent, an increase in interest rates from 3% to 5% would mean, for example, a 200 basis point increase in the “Change in Interest Rates” column below.  The Office of Thrift Supervision provides us the results of the interest rate sensitivity model, which is based on information we provide to the Office of Thrift Supervision to estimate the sensitivity of our net portfolio value.

 
47

 
The tables below set forth, at March 31, 2010, indicated the estimated changes in our net portfolio value that would result from the designated instantaneous changes in the United States Treasury yield curve.  Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.  This data is for Putnam Bank only and does not include any yield curve changes in the assets of PSB Holdings, Inc.  We do not believe that there has been a material change in our NPV position between March 31, 2010 and June 30, 2010.
 
                     
               
NPV as a Percentage of Present
               
Value of Assets (3)
       
Estimated Increase (Decrease) in
       
Change in
     
NPV
     
Increase
Interest Rates
 
Estimated
             
(Decrease)
(basis points) (1)
 
NPV (2)
 
Amount
 
Percent
 
NPV Ratio (4)
 
(basis points)
                     
+300
 
 $             34,033
 
 $           (11,736)
 
-26%
 
7.09%
 
-199
+200
 
 $             40,086
 
 $             (5,683)
 
-12%
 
8.19%
 
-90
+100
 
 $             44,158
 
 $             (1,611)
 
-4%
 
8.87%
 
-21
0
 
 $             45,769
 
 $                       -
 
0%
 
9.08%
 
0
-100
 
 $             45,872
 
 $                  104
 
0%
 
9.02%
 
-7

(1)  
Assumes an instantaneous uniform change in interest rates at all maturities.
(2)  
NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.
(3)  
Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.
(4)  
NPV ratio represents NPV divided by the present value of assets.
 
Liquidity and Capital Resources
 
The term “liquidity” refers to the ability of the Company and the Bank to meet current and future short-term financial obligations. The Company and the Bank further define liquidity as the ability to generate adequate amounts of cash to fund loan originations, deposit withdrawals and operating expenses. Liquidity management is both a daily and long-term function of business management. The Bank’s primary sources of liquidity are deposits, scheduled amortization and prepayments of loan principal and mortgage-related securities, and Federal Home Loan Bank borrowings. The Bank can borrow funds from the Federal Home Loan Bank based on eligible collateral of loans and securities. The Bank had Federal Home Loan Bank borrowings as of June 30, 2010 of $100.5 million with unused borrowing capacity of $25.2 million.
 
The Bank’s primary investing activities are the origination of loans and the purchase of investment securities. During the years ended June 30, 2010 and 2009, the Bank’s net loan principal (collections) originations were $7.0 million for the fiscal year ended June 30, 2010 and ($23.9) million for the fiscal year ended June 30, 2009.  Purchases of securities totaled $105.3 million and $14.8 million, for the years ended June 30, 2010 and 2009, respectively.
 
Loan repayments and maturing investment securities are a relatively predictable source of funds. However, deposit flows, calls of investment securities and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and economic conditions and competition in the marketplace. These factors reduce the predictability of the timing of these sources of funds. Deposit flows are affected by the level of interest rates, by the interest rates and products offered by competitors and by other factors. The Bank monitors its liquidity position frequently and anticipates that it will have sufficient funds to meet its current funding commitments.
 
Certificates of deposit totaled $144.3 million at June 30, 2010. The Bank relies on competitive rates, customer service and long-standing relationships with customers to retain deposits. Based on the Bank’s experience with deposit retention and current retention strategies, management believes that, although it is not possible to predict future terms and conditions upon renewal, a significant portion of such deposits will remain with the Bank.
 
 
48

 
Management is not aware of any known trends, events or uncertainties that will have, or are reasonably likely to have, a material effect on the Company’s or the Bank’s liquidity, capital or operations, nor is management aware of any current recommendations by regulatory authorities which, if implemented, would have a material effect on the Company’s or the Bank’s liquidity, capital or operations.
 
Off-Balance Sheet Arrangements
 
In addition to the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, lines of credit, and letters of credit.
 
For the year ended June 30, 2010, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
 
ITEM 7A.
Quantitative and Qualitative Disclosures About Market Risk
 
Information required by this item is included in “ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation,” above.
 
ITEM 8.
Financial Statements and Supplementary Data
 
 
 
49

 
 
 
 
 
 
The Board of Directors and Stockholders
PSB Holdings, Inc.
Putnam, Connecticut
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
We have audited the accompanying consolidated balance sheets of PSB Holdings, Inc. and Subsidiary as of June 30, 2010 and 2009 and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of PSB Holdings, Inc. and Subsidiary as of June 30, 2010 and 2009, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
   
  
/s/Shatswell, Macleod & Company, P.C.
 
SHATSWELL, MacLEOD & COMPANY, P.C.
 
West Peabody, Massachusetts
September 9, 2010

 
50

 
 
PSB HOLDINGS, INC. AND SUBSIDIARY
 
CONSOLIDATED BALANCE SHEETS
 
June 30, 2010 and 2009
(In Thousands)

   
2010
   
2009
 
ASSETS
           
Cash and due from depository institutions
  $ 21,711     $ 5,509  
Interest-bearing demand deposits with other banks
    1,580       -  
Federal funds sold
    -       550  
Cash and cash equivalents
    23,291       6,059  
Investments in available-for-sale securities (at fair value)
    85,893       164,888  
Investments in held-to-maturity securities (fair value of $83,698 as of June 30, 2010 and $1,945 as of June 30, 2009)
    83,249       2,000  
Federal Home Loan Bank stock, at cost
    8,056       8,056  
Loans held-for-sale
    1,470       1,200  
                 
Loans
    257,423       266,517  
Allowance for loan losses
    (2,651 )     (2,200 )
Net loans
    254,772       264,317  
                 
Premises and equipment
    5,292       5,159  
Accrued interest receivable
    1,698       1,891  
Other real estate owned
    1,561       1,211  
Goodwill
    6,912       6,912  
Intangible assets
    473       651  
Bank owned life insurance
    6,191       5,912  
Other assets
    10,501       9,093  
Total assets
  $ 489,359     $ 477,349  
                 
LIABILITIES AND STOCKHOLDERS’EQUITY
               
Deposits:
               
Noninterest-bearing
  $ 36,206     $ 35,246  
Interest-bearing
    298,940       272,853  
Total deposits
    335,146       308,099  
Mortgagors’ escrow accounts
    1,627       1,564  
Federal Home Loan Bank advances
    100,500       120,500  
Securities sold under agreements to repurchase
    5,896       4,471  
Other liabilities
    2,335       2,819  
Total liabilities
    445,504       437,453  
Stockholders’ equity:
               
Preferred stock, $.10 par value, 1,000,000 shares authorized, no shares issued and outstanding
    -       -  
Common stock, $.10 par value, 12,000,000 shares authorized, 6,943,125 shares issued, 6,528,863 and 6,529,209 shares outstanding at June 30, 2010 and 2009, respectively
    694       694  
Additional paid-in capital
    30,633       30,656  
Retained earnings
    21,550       20,383  
Accumulated other comprehensive loss
    (2,776 )     (5,277 )
Unearned ESOP shares
    (1,821 )     (1,940 )
Unearned stock awards
    (212 )     (409 )
Treasury stock, at cost (414,262 and 413,916 shares at June 30, 2010 and 2009, respectively)
    (4,213 )     (4,211 )
Total stockholders’ equity
    43,855       39,896  
Total liabilities and stockholders’ equity
  $ 489,359     $ 477,349  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
51

 
 
PSB HOLDINGS, INC. AND SUBSIDIARY
 
CONSOLIDATED STATEMENTS OF INCOME
 
Years Ended June 30, 2010 and 2009
(In Thousands)

   
2010
   
2009
 
Interest and dividend income:
           
Interest and fees on loans
  $ 14,641     $ 14,718  
Interest on debt securities:
               
Taxable
    7,270       9,607  
Tax-exempt
    -       138  
Dividends on marketable equity securities
    541       729  
Dividends on Federal Home Loan Bank stock
    -       110  
Interest on federal funds sold and other
    10       16  
Total interest and dividend income
    22,462       25,318  
Interest expense:
               
Interest on deposits
    5,823       6,907  
Interest on Federal Home Loan Bank advances
    4,208       5,693  
Interest on securities sold under agreements to repurchase
    94       126  
Total interest expense
    10,125       12,726  
Net interest and dividend income
    12,337       12,592  
Provision for loan losses
    1,049       967  
Net interest and dividend income after provision for loan losses
    11,288       11,625  
Noninterest income (charges):
               
Fees for services
    2,285       2,337  
Write-down of securities (includes total losses of $5,421 and $20,792, net of $2,972 and $4,821 recognized in other comprehensive loss, pretax)
    (2,449 )     (15,971 )
Gain on sales and calls of securities, net
    1,424       128  
Mortgage banking activities
    217       173  
Net commissions from brokerage service
    82       152  
Bank owned life insurance income
    279       457  
Other income
    145       165  
Total noninterest income (charges)
    1,983       (12,559 )
Noninterest expense:
               
Salaries and employee benefits
    5,888       5,785  
Occupancy and equipment expense
    1,238       1,172  
Data processing
    770       699  
Advertising and marketing
    283       348  
Professional fees
    332       301  
Amortization of intangible asset
    178       206  
Deposit insurance assessment
    764       695  
Prepayment penalty on Federal Home Loan Bank advances
    187       -  
Write down of other real estate owned
    321       -  
Other expense
    1,739       1,601  
Total noninterest expense
    11,700       10,807  
Income (loss) before income tax expense (benefit)
    1,571       (11,741 )
Income tax expense (benefit)
    309       (4,610 )
Net income (loss)
  $ 1,262     $ (7,131 )
                 
Earnings (loss) per common share
               
Basic
  $ 0.20     $ (1.14 )
Diluted
  $ 0.20     $ (1.14 )
                 
Weighted average common shares outstanding
               
Basic
    6,312,287       6,279,399  
Diluted
    6,312,287       6,279,399  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
52

 
 
PSB HOLDINGS, INC. AND SUBSIDIARY
 
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
 
Years Ended June 30, 2010 and 2009
(Dollars in thousands, except per share data)
                                                 
   
Common
Stock
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
 Loss (1)
   
Unearned
ESOP
Shares
   
Unearned
Stock
Awards
   
Treasury
Stock
   
Total
 
Balance, June 30, 2008
  $ 694     $ 30,795     $ 28,663     $ (3,816 )   $ (2,089 )   $ (605 )   $ (4,205 )   $ 49,437  
Comprehensive loss:
                                                               
Net loss
    -       -       (7,131 )     -       -       -       -       -  
Net change in unrealized holding losses on available-for-sale securities, net of tax effect
    -       -       -       (1,461 )     -       -       -       -  
Comprehensive loss
    -       -       -       -       -       -       -       (8,592 )
Dividends declared
    -       -       (1,084 )     -       -       -       -       (1,084 )
ESOP shares released
    -       (64 )     -       -       149       -       -       85  
Purchase of treasury stock
    -       -       -       -       -       -       (6 )     (6 )
Stock-based compensation expense
    -       (75 )     -       -       -       196       -       121  
Cumulative effect of a change in accounting principle - initial adoption of ASC 715-60
    -       -       (65 )     -       -       -       -       (65 )
Balance, June 30, 2009
    694       30,656       20,383       (5,277 )     (1,940 )     (409 )     (4,211 )     39,896  
Comprehensive income:
                                                               
Net income
    -       -       1,262       -       -       -       -       -  
Net change in unrealized holding losses on available-for-sale securities, net of tax effect
    -       -       -       2,501       -       -       -       -  
Comprehensive income
    -       -       -       -       -       -       -       3,763  
Dividends declared
    -       -       (95 )     -       -       -       -       (95 )
ESOP shares released
    -       (69 )     -       -       119       -       -       50  
Purchase of treasury stock
    -       -       -       -       -       -       (2 )     (2 )
Stock-based compensation expense
    -       46       -       -       -       197       -       243  
Balance, June 30, 2010
  $ 694     $ 30,633     $ 21,550     $ (2,776 )   $ (1,821 )   $ (212 )   $ (4,213 )   $ 43,855  
 
(1) The June 30, 2010 and 2009 ending balances includes $3,525,000 and $4,821,000, respectively, of pre-tax unrealized losses in which other-than-temporary impairment has been recognized.

 
53

 
 
PSB HOLDINGS, INC. AND SUBSIDIARY
 
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
 
Years Ended June 30, 2010 and 2009
(Dollars in thousands, except per share data)
(Continued)
 
Reclassification disclosure for the years ended June 30:
             
   
2010
   
2009
 
   
(In Thousands)
 
Unrealized holding losses on available-for-sale securities:
           
Net unrealized holding gains (losses) on available-for-sale securities
  $ 2,751     $ (18,052 )
Reclassification adjustment for losses realized in net income
    1,037       15,843  
      3,788       (2,209 )
Income tax (expense) benefit
    (1,287 )     748  
Other comprehensive income (loss), net of tax
  $ 2,501     $ (1,461 )
 
The accompanying notes are an integral part of these consolidated financial statements.

 
54

 
 
PSB HOLDINGS, INC. AND SUBSIDIARY
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Years Ended June 30, 2010 and 2009
(In Thousands)
             
   
2010
   
2009
 
Cash flows from operating activities:
           
Net income (loss)
  $ 1,262     $ (7,131 )
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
               
Amortization of securities, net
    450       101  
Gain on sales and calls of securities, net
    (1,424 )     (128 )
Write down of securities
    2,449       15,971  
Net increase in loans held-for-sale
    (270 )     (525 )
Amortization of premium on purchased loans
    -       1  
Change in deferred loan costs, net
    39       (5 )
Provision for loan losses
    1,049       967  
Loss on sale of other real estate owned
    31       7  
Writedown of other real estate owned
    321       -  
Loss on disposal of equipment
    -       2  
Depreciation and amortization
    527       496  
Amortization of core deposit intangible
    178       206  
Increase in accrued interest receivable and other assets
    (4,557 )     (233 )
Increase in cash surrender value of bank owned life insurance
    (279 )     (295 )
Bank owned life insurance death benefit income
    -       (162 )
Decrease in other liabilities
    (383 )     (446 )
Deferred tax expense (benefit)
    1,970       (4,427 )
ESOP shares released
    50       85  
Stock-based compensation expense
    285       165  
                 
Net cash provided by operating activities
    1,698       4,649  
                 
Cash flows from investing activities:
               
Purchases of available-for-sale securities
    (1,000 )     (12,847 )
Proceeds from sales of available-for-sale securities
    31,706       4,629  
Proceeds from maturities of available-for-sale securities
    50,838       37,260  
Purchase of held-to-maturity securities
    (104,335 )     (2,000 )
Proceeds from maturities of held-to-maturity securities
    22,850       -  
Purchase of Federal Home Loan Bank stock
    -       (113 )
Loan originations and principal collections, net
    7,029       (23,884 )
Recoveries of loans previously charged off
    67       46  
Proceeds from sale of other real estate owned
    715       71  
Proceeds from surrender of bank owned life insurance policy
    -       343  
Net cash provided by branch acquisition
    -       708  
Capital expenditures - premises and equipment
    (617 )     (919 )
Capital expenditures - other real estate owned
    (16 )     -  
                 
Net cash provided by investing activities
    7,237       3,294  

 
55

 
 
PSB HOLDINGS, INC. AND SUBSIDIARY
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Years Ended June 30, 2010 and 2009
(In Thousands)
(continued)
             
   
2010
   
2009
 
Cash flows from financing activities:
           
Net increase in demand deposits, NOW and savings accounts
    38,876       17,620  
Net (decrease) increase in time deposits
    (11,829 )     5,087  
Net increase in mortgagors’ escrow accounts
    63       141  
Net change in short-term Federal Home Loan Bank advances
    -       (13,000 )
Proceeds from Federal Home Loan Bank advances
    9,500       24,000  
Repayment of Federal Home Loan Bank advances
    (29,500 )     (40,715 )
Net increase (decrease) in securities sold under agreements to repurchase
    1,425       (1,935 )
Acquisition of treasury stock
    (2 )     (6 )
Dividends paid
    (236 )     (1,222 )
                 
Net cash provided by (used in) financing activities
    8,297       (10,030 )
                 
Net increase (decrease) in cash and cash equivalents
    17,232       (2,087 )
Cash and cash equivalents at beginning of year
    6,059       8,146  
Cash and cash equivalents at end of year
  $ 23,291     $ 6,059  
                 
Supplemental disclosures:
               
Interest paid
  $ 10,206     $ 12,793  
Income taxes paid
    646       407  
Loans transferred to other real estate owned
    2,040       1,289  
Deferred gain on sale of other real estate owned in other liabilities
    40       -  
Loans originated to finance sale of other real estate owned
    679       -  
                 
Savings Institute Bank & Trust Company Branch Acquisition
               
Net loans acquired
          $ 3  
Fixed assets acquired
            950  
Other assets
            7  
              960  
                 
Deposits assumed
            1,668  
Net cash provided by acquisition
          $ 708  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
56

 
 
PSB HOLDINGS, INC. AND SUBSIDIARY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Years Ended June 30, 2010 and 2009
(In Thousands)
 
NOTE 1 - NATURE OF OPERATIONS
 
PSB Holdings, Inc. (the Company) is a federally chartered holding company formed on May 27, 2003 for the purpose of acquiring all of the common stock of Putnam Bank (the Bank) concurrent with the Bank’s reorganization from a mutual savings institution to the mutual holding company form of organization. No shares were offered to the public as part of this reorganization.
 
On October 4, 2004, the Company completed a plan of stock issuance pursuant to which 44.5% of its common stock was sold to eligible depositors and the Putnam Savings Bank Employee Stock Ownership Plan (ESOP). The Company issued a total of 6,943,125 shares.
 
3,729,846 shares, representing 53.72% of total shares issued, was issued to Putnam Bancorp MHC in exchange for its ownership of the bank. The sole purpose of Putnam Bancorp MHC is to own a majority of the common stock of PSB Holdings, Inc.
 
As part of the stock issuance, the Bank established the ESOP, which purchased 257,062 shares of common stock. The ESOP borrowed the necessary funds from the Company. The Bank intends to make annual contributions adequate to meet the debt service requirements of the ESOP.
 
In connection with the stock offering the Company established The Putnam Savings Foundation and contributed 123,588 shares of common stock, representing 4% of shares sold to the public. The Foundation supports charities in the geographic area the Bank serves.
 
The Bank is a federally chartered savings bank and provides a full range of banking services to individual and small business customers located primarily in Eastern Connecticut. The Bank is subject to competition from other financial institutions throughout the region.
 
NOTE 2 - ACCOUNTING POLICIES
 
The accounting and reporting policies of the Company and its subsidiary conform to accounting principles generally accepted in the United States of America and predominant practices within the banking industry. The consolidated financial statements of the Company were prepared using the accrual basis of accounting. The significant accounting policies of the Company are summarized below to assist the reader in better understanding the consolidated financial statements and other data contained herein.
     
 
USE OF ESTIMATES:
   
 
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
   
 
BASIS OF PRESENTATION:
   
 
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank, and the Bank’s wholly owned subsidiaries, Windham North, LLC, PSB Realty, LLC and Putnam Bank Mortgage Servicing Company. All significant intercompany accounts and transactions have been eliminated in the consolidation.

 
57

 

 
CASH AND CASH EQUIVALENTS:
   
 
For the purposes of reporting cash flows, cash and cash equivalents include cash, amounts due from depository institutions, interest-bearing demand deposits with other banks and federal funds sold.
   
 
Cash and due from banks as of June 30, 2010 includes $5,650,000, which is subject to withdrawals and usage restrictions to satisfy the reserve requirements of the Federal Reserve Bank, target balances at Bankers Bank and for other purposes.
   
 
SECURITIES:
   
 
Investments in debt securities are adjusted for amortization of premiums and accretion of discounts computed so as to approximate the interest method. Gains or losses on sales of investment securities are computed on a specific identification basis.
   
 
The Company classifies debt and equity securities into one of three categories: held-to-maturity, available-for-sale, or trading. These security classifications may be modified after acquisition only under certain specified conditions. In general, securities may be classified as held-to-maturity only if the Company has the positive intent and ability to hold them to maturity. Trading securities are defined as those bought and held principally for the purpose of selling them in the near term. All other securities must be classified as available-for-sale.
   
 
--
Held-to-maturity securities are measured at amortized cost in the consolidated balance sheets. Unrealized holding gains and losses are not included in earnings, or in a separate component of capital. They are merely disclosed in the notes to the consolidated financial statements.
     
 
--
Available-for-sale securities are carried at fair value on the consolidated balance sheets. Unrealized holding gains and losses are not included in earnings but are reported as a net amount (less expected tax) in a separate component of capital until realized.
     
 
--
Trading securities are carried at fair value on the consolidated balance sheets. Unrealized holding gains and losses for trading securities are included in earnings.
     
 
For any debt security with a fair value less than its amortized cost basis, the Company will determine whether it has the intent to sell the debt security or whether it is more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis. If either condition is met, the Company will recognize a full impairment charge to earnings. For all other debt securities that are considered other-than-temporarily impaired and do not meet either condition, the credit loss portion of impairment will be recognized in earnings as realized losses. The temporary impairment related to all other factors will be recorded in other comprehensive income.
   
 
Declines in marketable equity securities below their cost that are deemed other than temporary are reflected in earnings as realized losses.

 
58

 

 
FEDERAL HOME LOAN BANK OF BOSTON STOCK, AT COST:
   
 
As a member of the Federal Home Loan Bank (FHLB), the Bank is required to invest in $100 par value stock of the FHLB. The FHLB capital structure mandates that members must own stock as determined by their Total Stock Investment Requirement which is the sum of a member’s Membership Stock Investment Requirement and Activity-Based Stock Investment Requirement. The Membership Stock Investment Requirement is calculated as 0.35% of member’s Stock Investment Base, subject to a minimum investment of $10,000 and a maximum investment of $25,000,000. The Stock Investment Base is an amount calculated based on certain assets held by a member that are reflected on call reports submitted to applicable regulatory authorities. The Activity-Based Stock Investment Requirement is calculated as 4.5% of a member’s outstanding principal balances of FHLB advances plus a percentage of advance commitments, 4.5% of standby letters of credit issued by the FHLB and 4.5% of the value of intermediated derivative contracts. Management evaluates the Bank’s investment in FHLB of Boston stock for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market conditions warrant such evaluation. Based on its most recent analysis of the FHLB of Boston as of June 30, 2010, management deems its investment in FHLB of Boston stock to be not other-than-temporarily impaired.
   
 
On December 8, 2008, the Federal Home Loan Bank of Boston announced a moratorium on the repurchase of excess stock held by its members. The moratorium will remain in effect indefinitely.
   
 
LOANS HELD-FOR-SALE:
   
 
Loans held-for-sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses are provided for in a valuation allowance by charges to operations. Interest income on mortgages held-for-sale is accrued currently and classified as interest on loans.
   
 
LOANS:
   
 
Loans receivable that management has the intent and ability to hold until maturity or payoff, are reported at their outstanding principal balances adjusted for amounts due to borrowers on unadvanced loans, any charge-offs, the allowance for loan losses and any deferred fees or costs on originated loans, or unamortized premiums or discounts on purchased loans.
   
 
Interest on loans is recognized on a simple interest basis.
   
 
Loan origination and commitment fees and certain direct origination costs are deferred, and the net amount amortized as an adjustment of the related loan’s yield. The Company is amortizing these amounts over the contractual life of the related loans.
   
 
Residential mortgage loans, home equity loans and lines are generally placed on nonaccrual when reaching 90 days past due or in process of foreclosure. Secured consumer loans are written down to realizable value and unsecured consumer loans are charged-off when they are greater than 90 days past due. Commercial real estate loans and commercial business loans which are 90 days or more past due are generally placed on nonaccrual status, unless secured by sufficient cash or other assets immediately convertible to cash. When a loan has been placed on nonaccrual status, previously accrued and uncollected interest is reversed against interest on loans. A loan can be returned to accrual status when collectability of principal is reasonably assured and the loan has performed for a period of time, generally six months.
   
 
Cash receipts of interest income on impaired loans are credited to principal to the extent necessary to eliminate doubt as to the collectibility of the net carrying amount of the loan. Some or all of the cash receipts of interest income on impaired loans is recognized as interest income if the remaining net carrying amount of the loan is deemed to be fully collectible. When recognition of interest income on an impaired loan on a cash basis is appropriate, the amount of income that is recognized is limited to that which would have been accrued on the net carrying amount of the loan at the contractual interest rate. Any cash interest payments received in excess of the limit and not applied to reduce the net carrying amount of the loan are recorded as recoveries of charge-offs until the charge-offs are fully recovered.

 
59

 

 
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 upon 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.
   
 
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. 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 smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.
   
 
PREMISES AND EQUIPMENT:
   
 
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Cost and related allowances for depreciation and amortization of premises and equipment retired or otherwise disposed of are removed from the respective accounts with any gain or loss included in income or expense. Depreciation and amortization are calculated principally on the straight-line method over the estimated useful lives of the assets. Estimated lives are 5 to 40 years for buildings and premises and 3 to 20 years for furniture, fixtures and equipment. Expenditures for replacements or major improvements are capitalized; expenditures for normal maintenance and repairs are charged to expense as incurred.
   
 
OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURES:
   
 
Other real estate owned includes properties acquired through foreclosure and properties classified as in-substance foreclosures in accordance with ASC 310-40, “Receivables – Troubled Debt Restructuring by Creditors.” These properties are carried at the lower of cost or estimated fair value less estimated costs to sell. Any writedown from cost to estimated fair value required at the time of foreclosure or classification as in-substance foreclosure is charged to the allowance for loan losses. Expenses incurred in connection with maintaining these assets, subsequent writedowns and gains or losses recognized upon sale are included in other expense.
   
 
In accordance with ASC 310-10-35, “Receivables – Overall – Subsequent Measurements,” the Company classifies loans as in-substance repossessed or foreclosed if the Company receives physical possession of the debtor’s assets regardless of whether formal foreclosure proceedings take place.

 
60

 

 
FAIR VALUES OF FINANCIAL INSTRUMENTS:
   
 
ASC 825, “Financial Instruments,” requires that the Company disclose estimated fair values for its financial instruments. Fair value methods and assumptions used by the Company in estimating its fair value disclosures are as follows:
   
 
Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets’ fair values.
   
 
Securities: Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
   
 
Loans held-for-sale: Fair values for loans held-for-sale are estimated based on outstanding investor commitments, or in the absence of such commitments, are based on current investor yield requirements.
   
 
Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are estimated by discounting the future cash flows, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.
   
 
Accrued interest receivable: The carrying amount of accrued interest receivable approximates its fair value.
   
 
Deposit liabilities: The fair values disclosed for demand deposits, regular savings, NOW accounts, and money market accounts are equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for 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.
   
 
Mortgagors’ escrow accounts: The carrying value of escrow accounts approximates fair value.
   
 
Federal Home Loan Bank Advances: Fair values for Federal Home Loan Bank advances are estimated using a discounted cash flow technique that applies interest rates currently being offered on advances to a schedule of aggregated expected monthly maturities on Federal Home Loan Bank advances.
   
 
Securities sold under agreements to repurchase: The carrying amounts reported on the consolidated balance sheets for securities sold under agreements to repurchase approximate their fair values.
   
 
Off-balance sheet instruments: The fair value of commitments to originate loans is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments and the unadvanced portion of loans, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligation with the counterparties at the reporting date.
   
 
EARNINGS PER SHARE (EPS):
   
 
EPS is computed by dividing net income allocated to common stockholders by the weighted average common shares outstanding. Net income allocated to common stockholders represents net income less income allocated to participating securities (see discussion below). Diluted earnings per common share is computed by dividing income allocated to common stockholders by the weighted average common shares outstanding plus amounts representing the dilutive effect of stock options outstanding and restricted stock, if applicable.

 
61

 

 
On July 1, 2009, the Company adopted new accounting guidance on earnings per share that defines unvested share-based payment awards that contain nonforfeitable rights to dividends as participating securities that are included in computing EPS using the two-class method. The two-class method is an earnings allocation formula under which EPS is calculated for common stock and participating securities according to dividends declared and participating rights in undistributed earnings. Under this method, all earnings (distributed and undistributed) are allocated to participating securities and common shares based on their respective rights to receive dividends.
 
     
Income
(Numerator)
    Shares (Denominator)    
Per-Share
Amount
 
 
Year ended June 30, 2010:
                       
 
Basic EPS
                       
 
Net income
 
$
1,262,000
                 
 
Dividends and undistributed earnings allocated to unvested shares
   
(6,000
)
               
 
Net income and income allocated to common stockholders
   
1,256,000
     
6,312,287
   
$
0.20
 
 
Effect of dilutive securities options and warrants
   
 
     
N/A
         
 
Diluted EPS
                       
 
Income allocated to common stockholders and assumed conversions
 
$
1,256,000
     
6,312,287
   
$
0.20
 
                           
 
Year ended June 30, 2009:
                       
 
Basic EPS
                       
 
Net loss
 
$
(7,131,000
)
               
 
Dividends and loss allocated to unvested shares
   
(9,000
)
               
 
Net loss and loss allocated to common stockholders
   
(7,140,000
)
   
6,279,399
   
$
(1.14
)
 
Effect of dilutive securities options and warrants
   
 
     
N/A
         
 
Diluted EPS
                       
 
Loss allocated to common stockholders and assumed conversions
 
$
(7,140,000
)
   
6,279,399
   
$
(1.14
)

 
ADVERTISING:
   
 
The Company directly expenses costs associated with advertising as they are incurred.
   
 
INCOME TAXES:
   
 
The Company recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are established for the temporary differences between the accounting basis and the tax basis of the Company’s assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled. The Company’s policy is to recognize interest and penalties assessed on tax positions in income tax expense.
   
 
EMPLOYEE STOCK OWNERSHIP PLAN:
   
 
The Company established an Employee Stock Ownership Plan (the ESOP) as part of its minority stock issuance on October 4, 2004. The ESOP is accounted for in accordance with ASC 718-40, “Compensation - Stock Compensation - Employee Stock Ownership Plan.” Under ASC 718-40, unearned ESOP shares are not considered outstanding and are therefore not taken into account when computing earnings per share. Unearned ESOP shares are presented as a reduction to stockholders’ equity and represent shares to be allocated to ESOP participants in future periods for services provided to the Company. As shares are committed to be released, compensation expense is recognized for the fair market value of the stock and stockholders’ equity is increased by a corresponding amount. The loan to the ESOP will be repaid principally from the Bank’s contributions to the ESOP and dividends payable on common stock held by ESOP over a period of 20 years.

 
62

 

 
STOCK BASED COMPENSATION:
   
 
As more fully described in Note 15, the Company has a stock based incentive plan authorizing various types of incentive awards that may be granted to directors, officers and employees. The Company accounts for the plan under ASC 718-10, “Compensation - Stock Compensation - Overall.” In accordance with ASC 718-10, the Company records share-based compensation expense related to outstanding stock option and restricted stock awards based upon the fair value at the date of grant over the vesting period of such awards on a straight-line basis. During the years ended June 30, 2010 and 2009, $285,000 and $165,000, respectively, in stock-based employee compensation was recognized.
   
 
RECENT ACCOUNTING PRONOUNCEMENTS:
   
 
In June 2009, the Financial Accounting Standards Board (“FASB”) issued an update to Accounting Standard Codification 105-10, “Generally Accepted Accounting Principles.” This standard establishes the FASB Accounting Standard Codification (“Codification” or “ASC”) as the source of authoritative U.S. GAAP recognized by the FASB for nongovernmental entities. The Codification is effective for interim and annual periods ending after September 15, 2009. The Codification is a reorganization of existing U.S. GAAP and does not change existing U.S. GAAP. The Company adopted this standard during the third quarter of 2009. The adoption had no impact on the Company’s financial position or results of operations.
   
 
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets,” and SFAS No. 167, “Amendments to FASB Interpretation No. 46(R).” These standards are effective for the first interim reporting period of fiscal year 2011. SFAS No. 166 amends the guidance in ASC 860 to eliminate the concept of a qualifying special-purpose entity (“QSPE”) and changes some of the requirements for derecognizing financial assets. SFAS No. 167 amends the consolidation guidance in ASC 810-10. Specifically, the amendments will (a) eliminate the exemption for QSPEs from the new guidance, (b) shift the determination of which enterprise should consolidate a variable interest entity (“VIE”) to a current control approach, such that an entity that has both the power to make decisions and right to receive benefits or absorb losses that could potentially be significant, will consolidate a VIE, and (c) change when it is necessary to reassess who should consolidate a VIE. These standards are not expected to have a significant impact on the Company’s financial statements.
   
 
In August 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05, “Measuring Liabilities at Fair Value,” which updates ASC 820-10, “Fair Value Measurements and Disclosures.” The updated guidance clarifies that the fair value of a liability can be measured in relation to the quoted price of the liability when it trades as an asset in an active market, without adjusting the price for restrictions that prevent the sale of the liability. This guidance was effective beginning October 1, 2009. The guidance did not change the Company’s valuation techniques for measuring liabilities at fair value.
   
 
In June 2008, the FASB updated ASC 260-10, “Earnings Per Share”. The guidance concludes that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities that should be included in the earnings allocation in computing earnings per share under the two-class method. The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior period earnings per share data presented must be adjusted retrospectively. The adoption of this update, effective July 1, 2009, did not have a material impact on the Company’s earnings per share.
   
 
In February 2008, the FASB updated ASC 860, “Transfers and Servicing.” This guidance clarifies how the transferor and transferee should separately account for a transfer of a financial asset and a related repurchase financing if certain criteria are met. This guidance became effective July 1, 2009. The adoption of this guidance did not have a material effect on the Company’s results of operations or financial position.

 
63

 

 
In December 2007, the FASB updated ASC 805, “Business Combinations.” The updated guidance will significantly change the accounting for business combinations. Under ASC 805, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. It also amends the accounting treatment for certain specific items including acquisition costs and non controlling minority interests and includes a substantial number of new disclosure requirements. ASC 805 applies prospectively to business combinations for which the acquisition date is on or after July 1, 2009. The adoption of this statement did not have a material impact on its financial condition and results of operations.
   
 
In March 2010, the FASB issued ASU 2010-11, “Scope Exception Related to Embedded Credit Derivatives.” The ASU clarifies that certain embedded derivatives, such as those contained in certain securitizations, CDOs and structured notes, should be considered embedded credit derivatives subject to potential bifurcation and separate fair value accounting. The ASU allows any beneficial interest issued by a securitization vehicle to be accounted for under the fair value option at transition. At transition, the Company may elect to reclassify various debt securities (on an instrument-by-instrument basis) from held-to-maturity (HTM) or available-for-sale (AFS) to trading. The new rules are effective July 1, 2010. The Company is currently analyzing the impact of the changes to determine the population of instruments that may be reclassified to trading upon adoption.
   
 
In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements.” The ASU requires disclosing the amounts of significant transfers in and out of Level 1 and 2 of the fair value hierarchy and describing the reasons for the transfers. The disclosures are effective for reporting periods beginning after December 15, 2009. The Company adopted ASU 2010-06 as of July 1, 2010. Additionally, disclosures of the gross purchases, sales, issuances and settlements activity in the Level 3 of the fair value measurement hierarchy will be required for fiscal years beginning after December 15, 2010.
   
 
In April 2010, the FASB issued ASU 2010-18, “Effect of a Loan Modification When the Loan is Part of a Pool That is Accounted for as a Single Asset.” As a result of this ASU, modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. The amendments in this ASU are effective for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. The amendments are to be applied prospectively. Early application is permitted.
   
 
In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” This ASU is created to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. This ASU is intended to provide additional information to assist financial statement users in assessing the entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The amendments in this ASU are effective for public entities as of the end of a reporting period for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. For nonpublic entities, the disclosures are effective for annual reporting periods ending on or after December 15, 2011.

 
64

 
 
NOTE 3 - INVESTMENT SECURITIES
 
Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent. The amortized cost of securities and their approximate fair values are as follows as of June 30:
                         
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
   
(In Thousands)
 
Available-for-sale:
                       
June 30, 2010:
                       
Debt securities:
                       
U.S. government and agency obligations:
                       
Due within one year
  $ 1,089     $ 33     $ -     $ 1,122  
From one through five years
    894       63       -       957  
From five through ten years
    2,000       3       -       2,003  
After ten years
    2,005       14       -       2,019  
      5,988       113       -       6,101  
                                 
Corporate bonds and other obligations:
                               
After ten years
    5,998       -       (1,630 )     4,368  
                                 
Mortgage-backed securities
    68,065       2,616       (3,714 )     66,967  
                                 
Equity securities:
                               
Auction rate preferred
    10,047       6       (1,596 )     8,457  
Total available-for-sale securities
  $ 90,098     $ 2,735     $ (6,940 )   $ 85,893  
                                 
June 30, 2009:
                               
Debt securities:
                               
U.S. government and agency obligations:
                               
From one through five years
  $ 3,787     $ 159     $ -     $ 3,946  
From five through ten years
    1,005       21       -       1,026  
After ten years
    14,501       210       (16 )     14,695  
      19,293       390       (16 )     19,667  
                                 
Corporate bonds and other obligations:
                               
Due within one year
    1,994       6       (49 )     1,951  
From one through five years
    2,741       39       (4 )     2,776  
After ten years
    6,995       16       (2,475 )     4,536  
      11,730       61       (2,528 )     9,263  
                                 
Mortgage-backed securities
    126,811       3,568       (6,783 )     123,596  
                                 
Equity securities:
                               
Auction rate preferred
    15,047       88       (2,773 )     12,362  
Total available-for-sale securities
  $ 172,881     $ 4,107     $ (12,100 )   $ 164,888  

 
65

 
 
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
 Losses
   
Fair
Value
 
   
(In Thousands)
 
Held-to-maturity:
                       
June 30, 2010:
                       
Debt securities:
                       
U.S. government and agency obligations:
                       
From one through five years
  $ 24,250     $ 74     $ -     $ 24,324  
From five through ten years
    19,025       151       -       19,176  
After ten years
    2,000       5       -       2,005  
      45,275       230       -       45,505  
                                 
Mortgage-backed securities
    37,974       320       (101 )     38,193  
Total held-to-maturity securities
  $ 83,249     $ 550     $ (101 )   $ 83,698  
                                 
June 30, 2009:
                               
Debt securities:
                               
U.S. government and agency obligations:
                               
After ten years
  $ 2,000     $ -     $ (55 )   $ 1,945  
Total held-to-maturity securities
  $ 2,000     $ -     $ (55 )   $ 1,945  
 
Proceeds from sales of available-for-sale securities during the year ended June 30, 2010 amounted to $31,706,000. Gross realized gains and gross realized losses on those sales amounted to $1,447,000 and $35,000, respectively. Proceeds from sales of available-for-sale securities during the year ended June 30, 2009 amounted to $4,629,000. Gross realized gains and gross realized losses on those sales amounted to $141,000 and $59,000, respectively. The tax provision applicable to these net realized gains amounted to $482,000 and $28,000, respectively.
 
The aggregate amortized cost basis and fair value of securities of issuers which exceeded 10% of stockholders’ equity were as follows as of June 30, 2010:
 
 
Issuer
   
Amortized
Cost
   
Fair
Value
 
       
(In Thousands)
 
 
Merrill Lynch Auction Rate Pass Thru
    $ 5,000     $ 3,980  
 
As of June 30, 2010 and 2009, the total carrying value of securities pledged as collateral to secure public deposits, the Federal Reserve Bank discount window, and repurchase agreements was $27,425,000 and $17,021,000, respectively.

 
66

 
 
The aggregate fair value and unrealized losses of securities that have been in a continuous unrealized loss position for less than twelve months and for twelve months or more are as follows as of June 30:
                                     
   
Less than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
   
(In Thousands)
 
June 30, 2010:
                                   
Corporate bonds and other obligations
  $ -     $ -     $ 4,368     $ 1,630     $ 4,368     $ 1,630  
Mortgage-backed securities
    12,307       101       1,032       188       13,339       289  
Equity securities
    2,744       256       5,660       1,340       8,404       1,596  
Total temporarily impaired securities
    15,051       357       11,060       3,158       26,111       3,515  
                                                 
Other-than-temporarily impaired debt securities: (1)
                                               
Mortgage-backed securities
    852       419       14,349       3,107       15,201       3,526  
Total temporarily impaired and other-than-temporarily impaired securities
  $ 15,903     $ 776     $ 25,409     $ 6,265     $ 41,312     $ 7,041  
                                                 
June 30, 2009:
                                               
U.S. government agencies
  $ 2,929     $ 71     $ -     $ -     $ 2,929     $ 71  
Corporate bonds and other obligations
    -       -       5,493       2,528       5,493       2,528  
Mortgage-backed securities
    5,268       1,053       1,892       724       7,160       1,777  
Equity securities
    12,227       2,773       -       -       12,227       2,773  
Total temporarily impaired securities
    20,424       3,897       7,385       3,252       27,809       7,149  
                                                 
Other-than-temporarily impaired debt securities: (1)
                                               
Mortgage-backed securities
    -       -       14,231       5,006       14,231       5,006  
Total temporarily impaired and other-than-temporarily impaired securities
  $ 20,424     $ 3,897     $ 21,616     $ 8,258     $ 42,040     $ 12,155  
 
(1) Includes other-than-temporary impaired available-for-sale debt securities in which a portion of the other-than-temporary impairment loss remains in accumulated other comprehensive income.
 
As of June 30, 2010 the Bank had 25 individual investment securities which the fair value of the security is less than the amortized cost of the security. Management believes the unrealized losses in the above table related to debt securities are attributable primarily to changes in market interest rates and current market inefficiencies in the pricing of these types of securities. The trust preferred securities, included in corporate bonds and other obligations, and the auction rate preferred securities, included in equity securities, are issued by various financial institutions and corporations. The cash flows generated from the trusts issuing these securities are projected to be adequate to repay all principal and interest on these securities. Management has the intent and ability to hold these securities until cost recovery occurs. Management’s assessment of the Company’s ability to hold securities until cost recovery incorporates a comprehensive analysis of several factors within the Company’s overall asset/liability management process. These factors include, among others, liquidity needs, future funding requirements and available borrowing capacity.
 
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market conditions warrant such evaluation. The investment securities portfolio is generally evaluated for other-than-temporary impairment under ASC 320-10, “Investments - Debt and Equity Securities.” However, certain purchased beneficial interests, including non-agency mortgage-backed securities and pooled trust preferred securities are evaluated using ASC 325-40, “Investments - Other - Beneficial Interests in Securitized Financial Assets.”

 
67

 
 
For those debt securities for which the fair value of the security is less than its amortized cost and the Company does not intend to sell such security and it is more likely than not that it will not be required to sell such security prior to the recovery of its amortized cost basis less any credit losses, ASC 320-10 requires that the credit component of the other-than-temporary impairment losses be recognized in earnings while the noncredit component is recognized in other comprehensive loss, net of related taxes.
 
The following table summarizes other-than-temporary impairment losses on securities for the years ended June 30:
                         
   
Equity
Securities
   
Corporate
Securities
   
Non-Agency
Mortgage-Backed
Securities
   
Total
 
   
(In Thousands)
 
June 30, 2010:
                       
Total other-than-temporary impairment losses
  $ -     $ -     $ 5,421     $ 5,421  
Less: unrealized other-than-temporary losses recognized in other comprehensive loss (1)
    -       -       2,972       2,972  
                                 
Net impairment losses recognized in earnings (2)
  $ -     $ -     $ 2,449     $ 2,449  
                                 
June 30, 2009:
                               
Total other-than-temporary impairment losses
  $ 3,953     $ 2,225     $ 14,614     $ 20,792  
Less: unrealized other-than-temporary losses recognized in other comprehensive loss (1)
    -       -       4,821       4,821  
                                 
Net impairment losses recognized in earnings (2)
  $ 3,953     $ 2,225     $ 9,793     $ 15,971  
 
(1) Represents the noncredit component of the other-than-temporary impairment on the securities.
(2) Represents the credit component of the other-than-temporary impairment on securities.
 
Activity related to the credit component recognized in earnings on debt securities held by the Company for which a portion of other-than-temporary impairment was recognized in other comprehensive loss for the years ended June 30, 2010 and 2009 is as follows:
             
 
2010
 
2009
 
 
Total
 
Total
 
 
(In Thousands)
 
(In Thousands)
 
Balance, July 1
  $ 9,793     $ -  
Additions for the credit component on debt securities in which other-than-temporary impairment was not previously recognized
    48       9,793  
Additions for the credit component on debt securities in which other-than-temporary impairment was previously recognized
    2,401       -  
Balance, June 30
  $ 12,242     $ 9,793  

 
68

 
 
For the year ended June 30, 2010, securities with other-than-temporary impairment losses related to credit that were recognized in earnings consisted of non-agency mortgage-backed securities. In accordance with ASC 325-10 and ASC 325-40, for debt securities, the Company estimated the portion of loss attributable to credit using a discounted cash flow model. Significant inputs for the non-agency mortgage-backed securities included the estimated cash flows of the underlying collateral based on key assumptions, such as default rate, loss severity and prepayment rate. Assumptions used can vary widely from loan to loan, and are influenced by such factors as loan interest rate, geographical location of the borrower, borrower characteristics and collateral type. The present value of the expected cash flows were compared to the Company’s holdings to determine the credit-related impairment loss. Based on the expected cash flows derived from the model, the Company expects to recover the remaining unrealized losses on non-agency mortgage-backed securities. Significant assumptions used in the valuation of non-agency mortgage-backed securities were as follows as of June 30, 2010:
                     
   
Weighted
Average
 
Range
 
     
Minimum
 
Maximum
 
Prepayment rates
   
13.8
%
 
7.2
%
 
24.5
%
Default rates
   
15.5
%
 
5.3
%
 
29.7
%
Loss severity
   
39.7
%
 
23.3
%
 
48.5
%
 
NOTE 4 - LOANS
 
Loans consisted of the following as of June 30:
             
   
2010
   
2009
 
   
(Dollars In Thousands)
 
Residential mortgages
  $ 194,960     $ 200,680  
Commercial mortgages
    54,398       56,500  
Construction mortgages
    1,338       1,887  
Commercial
    6,786       8,958  
Installment
    729       812  
Collateral
    309       130  
Other
    139       155  
      258,659       269,122  
Unadvanced construction loans
    (1,521 )     (2,929 )
      257,138       266,193  
Allowance for loan losses
    (2,651 )     (2,200 )
Deferred costs, net
    285       324  
Net loans
  $ 254,772     $ 264,317  
Weighted average yield
    5.58 %     5.72 %

 
69

 
 
The Company’s lending is conducted principally in Eastern Connecticut.  The Company’s investment in loans includes both adjustable and fixed rate loans.  The composition of the Company’s investment in loans at June 30, was as follows:
 
   
2010
   
2009
 
   
(In Thousands)
 
Fixed rate:
           
Term to maturity
           
One month through one year
  $ 2,809     $ 5,194  
One year through three years
    11,967       10,545  
Three years through five years
    11,008       15,350  
Five years through ten years
    27,584       28,145  
Over ten years
    93,715       96,336  
      147,083       155,570  
Adjustable rate:
               
Rate adjustment
               
One month through one year
    52,107       57,444  
One year through three years
    23,599       24,315  
Three years through five years
    27,048       20,172  
Over five years
    7,301       8,692  
      110,055       110,623  
Total loans
  $ 257,138     $ 266,193  
 
The adjustable rate loans generally have interest rate adjustment limitations and are generally indexed to the Company’s cost of funds, prime rate, or to the U.S. Treasury Bill rate.
 
Changes in the allowance for loan losses were as follows for the years ended June 30:
 
   
2010
   
2009
 
   
(In Thousands)
 
Beginning balance
  $ 2,200     $ 1,758  
Recoveries of loans previously charged off
    67       46  
Charge offs
    (665 )     (571 )
Provision for loan losses
    1,049       967  
Balance at end of period
  $ 2,651     $ 2,200  
 
Certain directors and executive officers of the Company and companies in which they have significant ownership interest were customers of the Bank during the year ended June 30, 2010.  Total loans to such persons and their companies amounted to $71,000 as of June 30, 2010.  During the year ended June 30, 2010, principal payments totaled $9,000 and principal advances totaled $27,000.
 
The following table sets forth information regarding nonaccrual loans and accruing loans 90 days or more overdue as of June 30:
 
   
2010
   
2009
 
   
(In Thousands)
 
             
Total nonaccrual loans
  $ 5,802     $ 6,449  
                 
Accruing loans which are 90 days or more overdue
    491       -  
                 
Nonperforming loans
  $ 6,293     $ 6,449  
 
 
70

 
 
Information about loans that meet the definition of an impaired loan in ASC 310-10-35, “Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality - Subsequent Measurement,” is as follows as of June 30:
 
   
2010
   
2009
 
   
Recorded
   
Related
   
Recorded
   
Related
 
   
Investment
   
Allowance
   
Investment
   
Allowance
 
   
In Impaired
   
For Credit
   
In Impaired
   
For Credit
 
   
Loans
   
Losses
   
Loans
   
Losses
 
   
(In Thousands)
 
Loans for which there is a related allowance for credit losses
  $ 2,230     $ 446     $ 3,556     $ 289  
                                 
Loans for which there is no related allowance for credit losses
    3,934       -       1,874       -  
                                 
Totals
  $ 6,164     $ 446     $ 5,430     $ 289  
                                 
Average recorded investment in impaired loans during the year ended June 30
  $ 6,173             $ 2,410          
                                 
Related amount of interest income recognized during the time, in the year ended June 30, that the loans were impaired
                               
                                 
Total recognized
  $ 107             $ 5          
                                 
Amount recognized using a cash-basis method of accounting
  $ 57             $ 0          
 
Included in certain loan categories in the impaired loans are troubled debt restructurings that were classified as impaired.  At June 30, 2010 and 2009, the Company had $2,121,000 and $723,000 loans, respectively, that were modified in trouble debt restructurings and impaired.
 
Loans serviced for others are not included in the accompanying consolidated balance sheets.  The unpaid principal balances of mortgage and other loans serviced for others were $35,172,000 and $29,669,000 at June 30, 2010 and 2009, respectively.  The Company has not recorded mortgage servicing rights related to loans sold with servicing retained due to their immaterial amount.
 
NOTE 5 - PREMISES AND EQUIPMENT
 
The following is a summary of premises and equipment as of June 30:
 
   
2010
   
2009
 
   
(In Thousands)
 
Land
  $ 470     $ 470  
Buildings
    6,293       5,953  
Furniture and equipment
    2,772       2,530  
      9,535       8,953  
Accumulated depreciation and amortization
    (4,243 )     (3,794 )
    $ 5,292     $ 5,159  
 
Depreciation expense amounted to $461,000 and $410,000 for the years ended June 30, 2010 and 2009, respectively.
 
 
71

 
 
NOTE 6 - GOODWILL AND INTANGIBLE ASSETS
 
Intangible assets consist of goodwill and core deposit intangibles which resulted from the Bank’s purchase of three branches from another financial institution in October 2005.  Goodwill is evaluated for impairment on an annual basis.  For the year ended June 30, 2010 and 2009 no impairment was found.  The core deposit intangible is being amortized on an accelerated basis over a ten year period.
 
   
June 30,
 
   
2010
   
2009
 
   
(In Thousands)
 
Balances not subject to amortization:
           
Goodwill
  $ 6,912     $ 6,912  
Balances subject to amortization:
               
Core Deposit Intangible
    473       651  
Total intangible assets
  $ 7,385     $ 7,563  
 
The amortization expense was $178,000 and $206,000 for the years ended June 30, 2010 and 2009, respectively.  Expected future amortization expense is as follows:
 
    (In Thousands)  
Years Ended June 30,
     
2011
  $ 149  
2012
    121  
2013
    93  
2014
    65  
2015
    37  
Thereafter
    8  
Total
  $ 473  
 
The following table reflects the gross carrying amount of core deposit intangibles as of June 30:
 
   
2010
 
   
(In Thousands)
 
   
Gross
         
Net
 
   
Carrying
   
Accumulated
   
Carrying
 
   
Amount
   
Amortization
   
Amount
 
Core deposit intangible
  $ 1,553     $ 1,080     $ 473  
                         
    2009  
   
(In Thousands)
 
   
Gross
           
Net
 
   
Carrying
   
Accumulated
   
Carrying
 
   
Amount
   
Amortization
   
Amount
 
Core deposit intangible
  $ 1,553     $ 902     $ 651  
 
 
72

 

NOTE 7 - DEPOSITS
 
The balances and the rates at which the Company paid interest on deposit accounts at June 30, were as follows:
 
   
2010
    2009  
         
Weighted
         
Weighted
 
         
Average
         
Average
 
   
Amount
   
Rate
   
Amount
   
Rate
 
   
(Dollars In Thousands)
Demand deposits
  $ 36,206       - %   $ 35,246       - %
NOW accounts
    95,321       1.11       57,612       1.90  
Regular savings
    48,105       0.35       47,285       0.46  
Money market accounts
    10,948       0.88       11,504       1.08  
Clubs
    265       0.30       322       3.79  
      190,845       0.70       151,969       0.96  
Certificate accounts maturing in:
                               
Less than one year
    74,779       1.74       104,428       2.91  
One year to two years
    26,256       3.59       16,884       3.25  
Two years to three years
    15,641       3.18       16,662       4.70  
Three years to five years
    27,625       3.54       18,156       4.06  
      144,301       2.58       156,130       3.27  
Total deposits
  $ 335,146       1.51 %   $ 308,099       2.13 %
 
The aggregate amount of time deposit accounts in denominations of $100,000 or more as of June 30, 2010 and 2009 was $64,425,000 and $62,300,000, respectively.  Deposits are insured by the FDIC up to $250,000.
 
NOTE 8 - BORROWED FUNDS
 
At June 30, borrowed funds consisted of the following:
 
   
2010
   
2009
 
         
Weighted
         
Weighted
 
         
Average
         
Average
 
   
Amount Due
   
Rate
   
Amount Due
   
Rate
 
   
(Dollars In Thousands)
 
Short-term borrowing
                       
FHLB advances
  $ -       - %   $ -       - %
Repurchase agreements
    5,896       0.30       4,471       2.30  
Total short-term borrowings
    5,896       0.30       4,471       2.30  
                                 
Long-term Federal Home Loan Bank of Boston (FHLB) advances
                               
Year of maturity:
                               
2010
    -       -       19,000       4.72  
2011
    19,000       3.40       29,500       3.51  
2012
    40,000       4.46       40,000       4.46  
2013
    5,000       3.23       5,000       3.23  
2014
    17,500       3.19       9,000       3.15  
2015
    1,000       3.35       -       -  
2017
    10,000       4.15       10,000       4.15  
2018
    8,000       3.91       8,000       3.91  
Total long-term borrowings
    100,500       3.89       120,500       4.06  
Total borrowed funds
  $ 106,396       3.69 %   $ 124,971       3.99 %
 
 
73

 
 
As of June 30, 2010, loans with a principal balance of $152,883,000 were specifically pledged to secure available borrowings from the FHLB.  The maturity schedule above reflects final maturity; however, some are callable at earlier dates.
 
Additionally, the Bank has a line of credit with Federal Home Loan Bank of Boston in the amount of $2,354,000.
 
At June 30, 2010, the interest rates on FHLB advances ranged from 2.82% to 4.75%.  At June 30, 2010, the weighted average interest rate on FHLB advances was 3.89%.
 
Securities sold under agreements to repurchase as of June 30, 2010 consist of securities sold on a short term basis by the Bank that have been accounted for not as sales but as borrowings.  The securities consist of U.S. government agency bonds that are held in the Bank’s safekeeping account at State Street Bank and Trust under the control of the Bank and pledged to the purchasers of the securities.
 
NOTE 9 - INCOME TAXES
 
The components of income tax expense (benefit) for the fiscal years ended June 30 are as follows:
             
   
2010
   
2009
 
   
(In Thousands)
 
Current:
           
Federal
  $ (1,662 )   $ (184 )
State
    1       1  
      (1,661 )     (183 )
Deferred:
               
Federal
    1,970       (4,415 )
Change in valuation allowance
    -       (12 )
      1,970       (4,427 )
Total income tax expense (benefit)
  $ 309     $ (4,610 )
 
Deferred income taxes reflect the impact of “temporary differences” between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations.
 
The Bank established Putnam Bank Mortgage Servicing Company during the year ended June 30, 2007.  The subsidiary qualifies and operates as a Connecticut passive investment company pursuant to legislation.  Because the subsidiary earns sufficient income from passive investments and its dividends to the parent are exempt from Connecticut Corporation Business Tax, the subsidiary Bank no longer expects to incur Connecticut income tax expense or to recognize its Connecticut deferred tax asset.  The Parent company is still subject to the Connecticut Corporation Business Tax.
 
The reasons for the differences between the statutory federal income tax rate of 34% and the effective tax rates are summarized as follows for the years ended June 30:
             
   
2010
   
2009
 
   
(In Thousands)
 
Federal income tax at statutory rate
  $ 534     $ (3,992 )
Increase (decrease) in tax resulting from:
               
State taxes, net of federal tax benefit
    1       1  
Qualifying option expense (benefit)
    18       (7 )
Dividends received deduction
    (129 )     (174 )
Bank-owned life insurance
    (95 )     (155 )
Tax-exempt municipal income, net
    (9 )     (52 )
Change in valuation allowance
    -       (12 )
Other, net
    (11 )     (219 )
Income tax (benefit) expense
  $ 309     $ (4,610 )
Effective tax rates
    19.6 %     (39.3 )%
 
 
74

 
 
The Company had gross deferred tax assets and gross deferred tax liabilities as follows as of June 30:
             
   
2010
   
2009
 
   
(In Thousands)
 
Deferred tax assets:
           
Net unrealized holding loss on available-for-sale securities
  $ 1,429     $ 2,716  
Allowance for loan losses
    872       748  
Write down of securities
    1,878       4,565  
Contribution carryforward
    102       102  
Deferred compensation
    183       177  
Stock based compensation
    93       81  
Post retirement benefits - ASC 715-60
    35       33  
Federal AMT carryover
    705       81  
Interest receivable on nonaccrual loans
    101       42  
Other
    13       -  
Gross deferred tax asset
    5,411       8,545  
                 
Deferred tax liabilities:
               
Depreciation and amortization
    (508 )     (372 )
Deferred loan fees
    (97 )     (110 )
Gross deferred tax liability
    (605 )     (482 )
Net deferred tax asset
  $ 4,806     $ 8,063  
 
Retained earnings at June 30, 2009 includes a contingency reserve for loan losses of $2,284,000 which represents the tax reserve balance existing at December 31, 1987 and is maintained in accordance with provisions of the Internal Revenue Code applicable to thrift institutions.  It is not anticipated that the Company will incur a federal income tax liability related to the reduction of this reserve and accordingly, deferred income taxes of approximately $777,000 have not been recognized as of June 30, 2010.
 
It is the Company’s policy to provide for uncertain tax positions and the related interest and penalties based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities.  As of June 30, 2010 and 2009, there were no material uncertain tax positions related to federal and state income tax matters.  The Company is currently open to audit under statute of limitations by the Internal Revenue Service and state taxing authorities for the years ended June 30, 2007 through June 30, 2010.
 
NOTE 10 - COMMITMENTS AND CONTINGENT LIABILITIES
 
As of June 30, 2010 the Company leases space for its Gales Ferry, Griswold and Putnam Price Chopper branch offices.  The leases for the branch offices expire March 31, 2015, October 31, 2014 and August 31, 2011, respectively.  All leases contain renewal options at the Company’s discretion.  The Company also has miscellaneous equipment leases with various terms.  The total minimum rental due in future periods under these existing agreements is as follows as of June 30, 2010:
 
   
(In Thousands)
 
2011
  $ 162  
2012
    118  
2013
    105  
2014
    101  
2015
    46  
Total
  $ 532  
 
Total rental expense amounted to $168,000 and $170,000 for the years ended June 30, 2010 and 2009, respectively.
 
 
75

 
 
NOTE 11 - FAIR VALUE MEASUREMENTS
 
The Company adopted ASC 820-10, “Fair Value Measurements and Disclosures,” which provides a framework for measuring fair value under generally accepted accounting principles.  This guidance also allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis.  The Company did not elect fair value treatment for any financial assets or liabilities upon adoption.
 
In accordance with ASC 820-10, the Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
 
Level 1 - Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.  Level 1 also includes U.S. Treasury, other U.S. Government and agency mortgage-backed securities that are traded by dealers or brokers in active markets.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
 
Level 2 - Valuations for assets and liabilities traded in less active dealer or broker markets.  Valuations are obtained from third party pricing services for identical or comparable assets or liabilities.
 
Level 3 - Valuations for assets and liabilities that are derived from other methodologies, including option pricing models, discounted cash flow models and similar techniques, are not based on market exchange, dealer, or broker traded transactions.  Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets and liabilities.
 
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
 
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.  These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities carried at fair value for June 30, 2010 and 2009.
 
The Company’s cash instruments are generally classified within level 1 or level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.
 
The Company’s investment in mortgage-backed securities and other debt securities available-for-sale is generally classified within level 2 of the fair value hierarchy.  For these securities, we obtain fair value measurements from independent pricing services.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. treasury yield curve, trading levels, market consensus prepayment speeds, credit information and the instrument’s terms and conditions.
 
Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence.  In the absence of such evidence, management’s best estimate is used.  Subsequent to inception, management only changes level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalization and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.
 
The Company’s impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral.  Collateral values are estimated using level 2 inputs based upon appraisals of similar properties obtained from a third party.  For level 3 inputs fair values are based on management estimates.
 
 
76

 

Other real estate owned values are estimated using level 2 inputs based upon appraisals of similar properties obtained from a third party.  For level 3 inputs fair values are based on management estimates.
 
The following summarizes assets measured at fair value for the period ending June 30.
 
ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS
                         
   
Fair Value Measurements at Reporting Date Using:
 
(In Thousands)
 
Total
   
Quoted Prices in
Active Markets for
Identical Assets
Level 1
   
Significant
Other Observable
Inputs
Level 2
   
Significant
Unobservable
Inputs
Level 3
 
June 30, 2010:
                       
Securities available-for-sale:
                       
U.S. Government agency securities
  $ 6,101     $ -     $ 6,101     $ -  
Corporate securities
    4,368       -       4,368       -  
Mortgage-backed securities insured or guaranteed by U.S. Government enterprises
    50,734       -       50,734       -  
Non-agency mortgage-backed securities
    16,233       -       16,233       -  
Equity securities
    8,457       -       -       8,457  
Totals
  $ 85,893     $ -     $ 77,436     $ 8,457  
                                 
June 30, 2009:
                               
Securities available-for-sale:
                               
U.S. Government agency securities
  $ 19,667     $ -     $ 19,667     $ -  
Corporate securities
    9,263       -       9,263       -  
Mortgage-backed securities insured or guaranteed by U.S. Government enterprises
    103,330       -       103,330       -  
Non-agency mortgage-backed securities
    20,266       -       20,266       -  
Equity securities
    12,362       -       4,896       7,466  
Totals
  $ 164,888     $ -     $ 157,422     $ 7,466  
 
   
Fair Value Measurements
Using Significant Unobservable Inputs
Level 3
 
(In Thousands)
 
Available-for-Sale
Securities
   
Total
 
Beginning balance July 1, 2008
  $ 19,000     $ 19,000  
Total gains or losses (realized/unrealized)
               
Included in earnings
    (13,472 )     (13,472 )
Included in other comprehensive loss
    14,080       14,080  
Principal payments on securities
    (1,114 )     (1,114 )
Accretion of securities, net
    1       1  
Transfers out of Level 3
    (11,029 )     (11,029 )
Ending balance, June 30, 2009
    7,466       7,466  
Total gains or losses (realized/unrealized)
               
Included in earnings
               
Included in other comprehensive income
    991       991  
Principal payments on securities
               
Accretion of securities, net
               
Transfers out of Level 3
    -       -  
Ending balance, June 30, 2010
  $ 8,457     $ 8,457  
 
 
77

 
 
 
   
Fair Value Measurements
Using Significant Unobservable Inputs
Level 3
 
(In Thousands)
 
Available-for-Sale
Securities
   
Total
 
June 30, 2010:
           
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date
  $ -     $ -  
                 
June 30, 2009:
               
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date
  $ -     $ -  

ASSETS MEASURED AT FAIR VALUE ON A NONRECURRING BASIS

Under certain circumstances we make adjustments to fair value for our assets and liabilities although they are not measured at fair value on an ongoing basis.  The following table presents the financial instruments carried on the consolidated balance sheet by caption and by level in the fair value hierarchy at June 30, 2010 and 2009, for which a nonrecurring change in fair value has been recorded:
                         
   
Fair Value Measurements at Reporting Date Using:
 
(In Thousands)
 
Total
   
Quoted Prices in
Active Markets for
Identical Assets
Level 1
   
Significant
Other Observable
Inputs
Level 2
   
Significant
Unobservable
Inputs
Level 3
 
June 30, 2010:
                       
Impaired loans
  $ 1,784     $ -     $ -     $ 1,784  
Other real estate owned
    1,561       -       391       1,170  
Totals
  $ 3,345     $ -     $ 391     $ 2,954  
                                 
June 30, 2009:
                               
Impaired loans
  $ 3,267     $ -     $ 3,267     -  
Totals
  $ 3,267     $ -     $ 3,267     $ -  
 
      Fair Value Measurements  
      Using Significant Unobservable Inputs  
      Level 3  
         
Other Real
       
   
Impaired Loans
   
Estate Owned
   
Total
 
(In Thousands)
                 
Beginning balance, June 30, 2009
  $ -     $ -     $ -  
       Total gains or losses
                       
       Transfers in and/or out of Level 3
    1,784       1,170       2,954  
Ending balance, June 30, 2010
  $ 1,784     $ 1,170     $ 2,954  
 
 
78

 

The estimated fair values of the Company’s financial instruments, all of which are held or issued for purposes other than trading, are as follows as of June 30:
                         
   
2010
   
2009
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
 
 
(In Thousands)
 
Financial assets:
                       
Cash and cash equivalents
  $ 23,291     $ 23,291     $ 6,059     $ 6,059  
Available-for-sale securities
    85,893       85,893       164,888       164,888  
Held-to-maturity securities
    83,249       83,698       2,000       1,945  
Federal Home Loan Bank stock
    8,056       8,056       8,056       8,056  
Loans held-for-sale
    1,470       1,504       1,200       1,214  
Loans, net
    254,772       257,194       264,317       266,369  
Accrued interest receivable
    1,698       1,698       1,891       1,891  
                                 
Financial liabilities:
                               
Deposits
    335,146       338,166       308,099       311,070  
Mortgagors’ escrow accounts
    1,627       1,627       1,564       1,564  
Federal Home Loan Bank advances
    100,500       105,438       120,500       126,057  
Securities sold under agreements to repurchase
    5,896       5,896       4,471       4,471  

The carrying amounts of financial instruments shown in the above table are included in the consolidated balance sheets under the indicated captions.  Accounting policies related to financial instruments are described in Note 2.

NOTE 12 - FINANCIAL INSTRUMENTS

The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to originate loans, standby letters of credit and unadvanced funds on loans.  The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.  The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Companys exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments is represented by the contractual amounts of those instruments.  The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to originate loans are agreements to lend to a customer provided there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Company evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower.  Collateral held varies, but may include secured interests in mortgages, accounts receivable, inventory, property, plant and equipment and income-producing properties.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a customer to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  As of June 30, 2010 and 2009, the maximum potential amount of the Company’s obligation was $857,000 and $898,000, respectively, for financial and standby letters of credit.  The Company’s outstanding letters of credit generally have a term of less than one year.  If a letter of credit is drawn upon, the Company may seek recourse through the customer’s underlying line of credit.  If the customer’s line of credit is also in default, the Company may take possession of the collateral, if any, securing the line of credit.
 
 
79

 
 
Notional amounts of financial instrument liabilities with off-balance-sheet credit risk are as follows as of June 30:
             
   
2010
   
2009
 
 
 
(In Thousands)
 
Commitments to originate loans
  $ 1,305     $ 4,687  
Unadvanced portions of loans:
               
Construction loans
    1,521       2,929  
Lines of credit
    15,213       16,859  
Letters of credit
    857       898  
    $ 18,896     $ 25,373  

There is no material difference between the notional amounts and the estimated fair values of the above off-balance sheet liabilities.

NOTE 13 - SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK

Most of the Company’s business activity is with customers located within the state.  There are no concentrations of credit to borrowers that have similar economic characteristics.  The majority of the Company’s loan portfolio is comprised of loans collateralized by real estate located in the state of Connecticut.

NOTE 14 - REGULATORY MATTERS

The Company, as a federally chartered holding company, is not subject to capital requirements.  The Bank is subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s consolidated financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), of Core capital (as defined) to adjusted tangible assets (as defined) and Tangible capital (as defined) to Tangible assets (as defined).  Management believes, as of June 30, 2010 and 2009, that the Bank meets all capital adequacy requirements to which it is subject.

As of June 30, 2010, the most recent notification from the Office of Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based, tangible equity and Core capital ratios as set forth in the table.  There are no conditions or events since that notification that management believes have changed the institution’s category.

The Bank’s actual capital amounts and ratios are also presented in the table:
                                     
                            To Be Well  
                            Capitalized Under  
   
 
   
 
    For Capital     Prompt Corrective  
   
Actual
    Adequacy Purposes     Action Provisions  
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
 
 
(Dollar amounts in thousands)
 
As of June 30, 2010:
                                   
Tangible Equity Capital (to Tangible Assets)
  $ 33,359       6.91 %   $ 7,237       1.50 %     N/A       N/A  
Core Capital (to Adjusted Tangible Assets)
    33,359       6.91       19,298       4.00     $ 24,122       5.00 %
Tier 1 Capital (to Risk-Weighted Assets)
    33,359       12.38       9,916       4.00       14,874       6.00  
Total Capital (to Risk-Weighted Assets)
    33,268       13.42       19,832       8.00       24,790       10.00  
 
 
80

 
 
                           
To Be Well
 
                           
Capitalized Under
 
         
 
   
For Capital
   
Prompt Corrective
 
   
Actual
    Adequacy Purposes    
Action Provisions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
   
(Dollar amounts in thousands)
 
As of June 30, 2009:
                                   
Tangible Equity Capital (to Tangible Assets)
    31,376       6.62       7,105       1.50       N/A       N/A  
Core Capital (to Adjusted Tangible Assets)
    31,376       6.62       18,947       4.00       23,683       5.00  
Tier 1 Capital (to Risk-Weighted Assets)
    31,376       10.20       12,302       4.00       18,453       6.00  
Total Capital (to Risk-Weighted Assets)
    33,569       10.92       24,604       8.00       30,755       10.00  

The Bank’s capital under generally accepted accounting principles is reconciled as follows as of June 30:

   
2010
   
2009
 
   
(In Thousands)
 
Capital under generally accepted accounting principles
  $ 39,997     $ 36,209  
Intangible assets
    (6,865 )     (7,150 )
Disallowed deferred tax assets
    (2,555 )     (2,978 )
Unrealized losses on available-for-sale securities
    2,782       5,295  
Tier 1 capital
    33,359       31,376  
Allowance for loan losses
    2,585       2,193  
Deduction for low-level recourse and residual interests
    (2,676 )     -  
Total Risk-Based capital
  $ 33,268     $ 33,569  

The ability of the Company to pay dividends depends, in part, on the ability of the Bank to pay dividends to the Company.  The Bank will not be able to declare or pay a cash dividend on, or repurchase any of its common stock, if the effect thereof would be to reduce the regulatory capital of the Bank to an amount below amounts required under Office of Thrift Supervision (OTS) rules and regulations.  In addition, in connection with a regularly scheduled OTS examination, the Company and Bank developed and implemented a plan to reduce classified assets.

NOTE 15 - BENEFIT PLANS

Defined Contribution Plan

The Bank has a defined contribution plan that covers substantially all of the Bank’s employees.  Contributions to the plan are discretionary and are voted on annually by the Board of Directors of the Bank.  The Bank recognized expense of $232,000 and $196,000 for the years ended June 30, 2010 and 2009, respectively.

401(k) Plan

The Bank has a 401(k) plan covering each eligible employee.  Employees must be 21 years of age, work at least 1,000 hours per year, and have at least one year of service with the Bank to be eligible to participate.  Employees may defer gross compensation up to certain limits defined in the Internal Revenue Code.  The Bank’s matching contribution is discretionary.  For the years ended June 30, 2010 and 2009 the Bank chose to contribute 25% of an employee’s deferral on a maximum of 4% of the employee’s salary.  The Bank contributed $35,000 and $33,000 to the plan during the years ended June 30, 2010 and 2009, respectively.

In 2009, the Bank adopted ASC 715-60, “Compensation - Retirement Benefits - Defined Benefit Plan - Other Postretirement,” and recognized a liability for the Bank’s future postretirement benefit obligations under certain death benefit agreements.  The Bank recognized this change in accounting principles as a cumulative effect adjustment to retained earnings of $65,000 net of deferred tax asset of $33,000.  The total liability for the arrangements included in other liabilities was $102,000 at June 30, 2010 and $96,000 at June 30, 2009.  Expense under this arrangement was $6,000 for 2010 and $23,000 for 2009.  Death benefits paid under this arrangement were $0 for 2010 and $25,000 for 2009.
 
 
81

 
 
Employee Stock Ownership Plan
 
The Bank established the ESOP on October 4, 2004 in connection with its common stock offering.  The ESOP purchased 257,062 shares of the common stock of the Company.  To fund the purchase, the ESOP borrowed $2.6 million from the Company.  The borrowing is at an initial interest rate of 4.75% and is to be repaid on a pro-rata basis in 20 substantially equal annual installments.  The collateral for the loan is the common stock of the Company purchased by the ESOP.
 
The shares of stock purchased by the ESOP are held in a suspense account until they are released for allocation among participants.  The shares will be released annually from the suspense account and the released shares will be allocated amount the participants on the basis of each participant’s compensation for the year of allocation.  As shares are released from collateral, the Bank recognizes compensation expense equal to the average market price of the shares during the period and the shares will be outstanding for earnings-per-share purposes.  The shares not released are reported as unearned ESOP shares in the capital accounts of the consolidated balance sheets.  ESOP expense for the years ended June 30, 2010 and 2009 was $50,000 and $85,000, respectively.  At June 30, 2010 and 2009 there were 74,955 and 62,176 shares allocated, respectively, and 182,107 and 194,886 unreleased ESOP shares, respectively.  The fair value of unreleased ESOP shares at June 30, 2010 and 2009 was $880,000 and $945,000, respectively.
 
Stock-based Incentive Plan
 
At the annual meeting of stockholders on October 31, 2005, stockholders of the Company approved the PSB Holdings, Inc. 2005 Stock-Based Incentive Plan (the Incentive Plan).  Under the Incentive Plan, the Company may grant up to 340,213 stock options and 136,085 shares of restricted stock to its employees, officers and directors for an aggregate amount of up to 476,298 shares of the Company’s common stock for issuance upon the grant or exercise of awards.  Both incentive stock options and non-statutory stock options may be granted under the Incentive Plan.
 
On November 7, 2005, the Company awarded 319,800 options to purchase the Company’s common stock and 129,281 shares of restricted stock.  Stock option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of grant ($10.60) with a maximum term of ten years.  Both stock option and restricted stock awards vest at 20% per year beginning on the first anniversary of the date of the grant.
 
On June 7, 2006, the Company awarded 18,000 options to purchase the Company’s common stock and 6,000 shares of restricted stock.  Stock option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of grant ($10.78) with a maximum term of ten years.  Both stock option and restricted stock awards vest at 20% per year beginning on the first anniversary of the date of the grant.
 
On May 25, 2007, the Company awarded 29,000 options to purchase the Company’s common stock and 9,500 shares of restricted stock.  Stock option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of grant ($10.70) with a maximum term of ten years.  Both stock option and restricted stock awards vest at 20% per year beginning on the first anniversary of the date of the grant.
 
Stock options and restricted stock awards are considered common stock equivalents for the purpose of computing earnings per share on a diluted basis.
 
In accordance with ASC 718-10, the Company has recorded share-based compensation expense related to outstanding stock option and restricted stock awards based upon the fair value at the date of grant over the vesting period of such awards on a straight-line basis.  The fair value of each restricted stock allocation, based on the market price at the date of grant, is recorded to unearned stock awards.  Compensation expenses related to unearned restricted shares are amortized to compensation and benefits expense over the vesting period of the restricted stock awards.  The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing method which includes several assumptions such as volatility, expected dividends, expected term and risk-free rate for each stock option award.
 
 
82

 
 
In determining the expected term of the option awards, the Company elected to follow the simplified method as permitted by the SEC Staff Accounting Bulletin 107, which was issued to provide guidance on the implementation of ASC 718-10.  Under this method, the Company has estimated the expected term of the options as being equal to the average of the vesting term plus the original contractual term.  The Company estimated its volatility using the historical volatility of other, similar companies during a period of time equal to the expected life of the options.  The risk-free rate for the periods within the contractual life of the options is based upon the U.S. Treasury yield curve in effect at the time of grant.  The weighted-average fair value of stock options granted using the Black-Scholes option pricing method and the assumptions used to determine the weighted-average fair value of stock options granted were as follows:
 
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for stock option grants in the year ended June 30, 2006 and 2007.
                         
    November 7, 2005 Grant     June 7, 2006 Grant     May 25, 2007 Grant  
Dividend yield
    1.89 %     2.23 %     2.24 %
Expected volatility
    12.65 %     12.17 %     11.04 %
Risk-free interest rate
    4.56 %     4.95 %     4.86 %
Expected life
    6.5       6.5       6.5  
Fair value
  $ 2.00     $ 1.97     $ 1.84  
 
A summary of the status of the Plans as of June 30, 2010 and 2009 and changes during the years then ended is presented below:
 
    2010     2009  
         
Weighted-Average
         
Weighted-Average
 
   
Shares
   
Exercise Price
   
Shares
   
Exercise Price
 
Outstanding at beginning of year
    222,921     $ 10.62       269,747     $ 10.62  
Granted
    -       -       -       -  
Exercised
    -       -       -       -  
Forfeited
    -       -       (46,826 )     10.62  
Outstanding at end of year
    222,921     $ 10.62       222,921     $ 10.62  
                                 
Options exercisable at year-end
    173,737     $ 10.61       129,153     $ 10.61  
 
The following table summarizes information about stock options outstanding as of June 30, 2010:
 
Options Outstanding    
Options Exercisable
 
     
Number
 
Weighted-Average
       
Number
       
     
Outstanding
 
Remaining
 
Weighted-Average
   
Exercisable
   
Weighted-Average
 
Exercise Price
   
as of 6/30/10
 
Contractual Life
 
Exercise Price
   
as of 6/30/10
   
Exercise Price
 
$ 10.60       193,921  
5.36 years
  $ 10.60       155,137     $ 10.60  
  10.70       23,000  
6.90 years
    10.70       13,800       10.70  
  10.78       6,000  
5.94 years
    10.78       4,800       10.78  
 
At June 30, 2010, there was $143,000 of total unrecognized compensation costs related to nonvested share based compensation.  That cost is expected to be recognized over a weighted average period of 0.5 years.  The Company recorded share-based compensation expense of $285,000 and $165,000 for the years ended June 30, 2010 and 2009, respectively in connection with the stock option and restricted stock awards.
 
NOTE 16 - SUBSEQUENT EVENTS
 
Management has evaluated subsequent events through September 9, 2010, which is the date the financial statements were available to be issued.  There were no subsequent events that require adjustment to or disclosure in the consolidated financial statements.
 
 
83

 
 
NOTE 17 - RECLASSIFICATION
 
Certain amounts in the prior year have been reclassified to be consistent with the current years statement presentation.
 
NOTE 18 - PARENT COMPANY ONLY FINANCIAL STATEMENTS
 
The following financial statements are for the Company (Parent Company Only) and should be read in conjunction with the consolidated financial statements of the Company.
 
PSB HOLDINGS, INC.
(Parent Company Only)
 
Balance Sheets
(In Thousands)
   
June 30,
 
ASSETS
 
2010
   
2009
 
Cash and due from depository institutions
  $ 38     $ 191  
Investment in Putnam Bank
    39,996       36,209  
Investment in available-for-sale securities
    1,256       1,457  
Loan to ESOP
    2,103       2,218  
Other assets
    611       419  
Total assets
  $ 44,004     $ 40,494  
                 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Other liabilities
  $ 149     $ 598  
Stockholders’ equity
    43,855       39,896  
Total liabilities and stockholders’ equity
  $ 44,004     $ 40,494  
 
Statements of Income
(In Thousands)
   
For the Years Ended
 
   
June 30,
 
   
2010
   
2009
 
Interest and dividends on investments
  $ 44     $ 78  
Interest on loan
    71       123  
Total interest and dividend income
    115       201  
Interest expense
    2       6  
Net interest and dividend income
    113       195  
Investment security gains
    44       -  
Other expense
    176       193  
 
               
(Loss) income before income tax (benefit) expense and equity in undistributed net income (loss) of subsidiary
    (19 )     2  
Income tax (benefit) expense
    (6 )     1  
(Loss) income before equity in undistributed net income (loss) of subsidiary
    (13 )     1  
Equity in undistributed net income (loss) of subsidiary     1,275       (7,132 )
         Net income (loss)   $ 1,262     $ (7,131 )
 
 
84

 
PSB HOLDINGS, INC.
(Parent Company Only)
(continued)
 
Statements of Cash Flows
(In Thousands)
   
For the Years Ended
 
   
June 30,
 
   
2010
   
2009
 
Cash flows from operating activities:
           
Net income (loss)
  $ 1,262     $ (7,131
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
               
Amortization of securities, net
    1       2  
Gain on sales of available-for-sale securities
    (44 )     -  
Deferred income tax expense
    4       5  
ESOP shares released
    50       85  
(Increase) decrease in other assets
    (10 )     1  
Increase in due from subsidiary
    (219 )     -  
(Decrease) increase in due to subsidiary
    (308 )     72  
(Decrease) increase in other liabilities
    -       13  
Stock-based compensation expense
    285       165  
Undistributed net (income) loss of subsidiary
    (1,275 )     7,132  
                 
Net cash (used in) provided by operating activities
    (254 )     344  
                 
Cash flows from investing activities:
               
Purchases of available-for-sale securities
    (1,000 )     -  
Proceeds from sales of available-for-sale securities
    946       -  
Proceeds from maturities of available-for-sale securities
    278       397  
Principal payments received on loans to ESOP
    115       93  
                 
Net cash (used in) provided by investing activities
    339       490  
                 
Cash flows from financing activities:
               
Purchase of treasury stock
    (2 )     (6 )
Payment of cash dividends on common stock
    (236 )     (1,222 )
                 
Net cash used in financing activities
    (238 )     (1,228 )
                 
Net decrease in cash and cash equivalents
    (153 )     (394 )
Cash and cash equivalents at beginning of year
    191       585  
Cash and cash equivalents at end of year
  $ 38     $ 191  
 
 
 
 
85

 
 
ITEM 9.
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
 
None.
 
ITEM 9A.
Controls and Procedures
 
    (a)  Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. There has been no change in the Company’s internal control over financial reporting during the Company’s fourth quarter of fiscal year 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
 

(b)  Management’s annual report on internal control over financial reporting.
 
 Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.

The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
Management, including the principal executive officer and principal financial officer, assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2010, based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in “Internal Control-Integrated Framework.”  Based on such assessment, management believes that, as of June 30, 2010, the Company’s internal control over financial reporting is effective, based on those criteria.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.  As the Company is a smaller reporting company, management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only the management’s report in this annual report.
 
ITEM 9B.
Other Information
 
None.
 
 
86

 
 
PART III
 
ITEM 10.
Directors, Executive Officers and Corporate Governance
 
PSB Holdings, Inc. has adopted a Code of Ethics that applies to PSB Holdings, Inc.’s principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions. The Code of Ethics can be accessed on PSB Holdings, Inc.’s website at www.putnambank.com. The Code of Ethics is also filed as Exhibit 14 to this Form 10-K.
 
Information concerning directors and executive officers of PSB Holdings is incorporated herein by reference from our definitive Proxy Statement dated October 1, 2010 related to the 2010 Annual Meeting of Stockholders (the “Proxy Statement”), specifically the section captioned “Proposal I—Election of Directors.”
 
ITEM 11.
Executive Compensation
 
Information concerning executive compensation is incorporated herein by reference from the Proxy Statement, specifically the section captioned “Proposal I—Election of Directors.”
 
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
Information concerning security ownership of certain owners and management is incorporated herein by reference from the Proxy Statement, specifically the sections captioned “Voting Securities and Principal Holders Thereof” and “Proposal I—Election of Directors.”
 
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
 
Information concerning relationships and transactions is incorporated herein by reference from the Proxy Statement, specifically the section captioned “Transactions with Certain Related Persons.”
 
ITEM 14.
Principal Accountant Fees and Services
 
Information concerning principal accountant fees and services is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Proposal 2-Ratification of Appointment of Independent Registered Public Accounting Firm.”
 
 
87

 

PART IV
 
ITEM 15.
Exhibits and Financial Statement Schedules
 
(a) Financial Statements
 
(A) Management Responsibility Statement
 
(B) Report of Independent Registered Public Accounting Firm
 
(C) Consolidated Balance Sheets
 
(D) Consolidated Statements of Income
 
(E) Consolidated Statements of Changes In Stockholders’ Equity
 
(F) Consolidated Statements of Cash Flows
 
(G) Notes to Consolidated Financial Statements
 
(b) Exhibits.
           3.1  Charter of PSB Holdings, Inc.*

           3.2  Bylaws of PSB Holdings, Inc.*

           4.    Form of Common Stock Certificate of PSB Holdings, Inc.*

         10.1  Employee Stock Ownership Plan*

         10.2  Deferred Compensation Plan*

         10.3  Purchase and assumption agreement concerning the Griswold, Ledyard, and Plainfield branches between  People’s Savings Bank and Putnam Bank dated June 13, 2005**

        10.4  PSB Holdings, Inc. 2005 Stock-Based Incentive Plan***
 
        14.    Code of Ethics
 
        21.    Subsidiaries of Registrant*

        23    Consent of Shatswell, MacLeod & Company, P.C.

        31.1   Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

        31.2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

        32.     Certification of Chief Financial Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
(c) Financial Statement Schedules
 
 
*
Incorporated by reference to the Registration Statement on Form SB-2 of PSB Holdings, Inc. (file no. 333-116364), originally filed with the Securities and Exchange Commission on June 10, 2004, as amended.
**
Incorporated by reference to Exhibit 10.1 of the current report on form 8-K of PSB Holdings, Inc. originally filed with the Securities and Exchange Commission on June 16, 2005.
***
Incorporated by reference to Appendix B of the Company’s Definitive Proxy Statement dated September 20, 2005 as filed with the Securities and Exchange Commission on September 19, 2005.
****
Incorporated by reference to Exhibit 14 of the Company’s Annual Report on Form 10K for year ended June 30, 2008, filed with the Securities and Exchange Commission on September 23, 2008.
 
 
88

 
SIGNATURES  
 
In accordance with Section 13 of the Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
         
   
PSB HOLDINGS, INC.
       
Date: September 24, 2010
 
By:
/S/    THOMAS A. BORNER        
       
Thomas A. Borner
       
Chief Executive Officer and Director
(Duly Authorized Representative)
 
In accordance with the Exchange Act, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
 
         
Signatures
 
Title
 
Date
         
 
/S/    THOMAS A. BORNER
 
 
Chief Executive Officer and Chairman of the Board (Principal
 
 
September 24, 2010
Thomas A. Borner     Executive Officer)    
         
 
/S/    ROBERT J. HALLORAN, JR.
 
 
President and Treasurer (Principal Financial
 
 
September 24, 2010
Robert J. Halloran, Jr.     and Accounting Officer)    
         
 
/S/    CHARLES W. BENTLEY, JR.
 
 
Director
 
 
September 24, 2010
Charles W. Bentley, Jr.        
 
/S/   JITENDRA K. SINHA
 
 
Director
 
 
September 24, 2010
Jitendra K. Sinha        
 
/S/    PAUL M. KELLY
 
 
Director
 
 
September 24, 2010
Paul M. Kelly        
 
/S/    RICHARD A. LOOMIS
 
 
Director
 
 
September 24, 2010
Richard A. Loomis        
 
/S     JOHN P. MILLER
 
 
Director
 
 
September 24, 2010
John P. Miller        
 
/S/    MARY E. PATENAUDE
 
 
Director
 
 
September 24, 2010
Mary E. Patenaude
       
 
/S/    CHARLES H. PUFFER
 
 
Director
 
 
September 24, 2010
Charles H. Puffer
       
 
 
89