Quarterly Report (10-q)

Default during the three months ended

March 31, 2013 ($000s)

investment

Commercial real estate

Residential – prime

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)
T	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
	SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

£	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
	SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____________ to _____________

Commission file number: 0-26480

PSB HOLDINGS, INC.

(Exact name of registrant as specified in charter)

WISCONSIN	39-1804877
(State of incorporation)	(I.R.S. Employer Identification Number)

1905 Stewart Avenue

Wausau, Wisconsin 54401

(Address of principal executive office)

Registrant’s telephone number, including area code: 715-842-2191

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 such report), and (2) has been subject to such filing requirements for the past 90 days.

Yes

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date 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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	£	Accelerated filer	£

Non-accelerated filer	£	Smaller reporting company	T
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2) of the Exchange Act).

Yes

The number of common shares outstanding at May 15, 2013 was 1,651,518.

PSB HOLDINGS, INC.

FORM 10-Q

Quarter Ended March 31, 2013

			Page No.
PART I.	FINANCIAL INFORMATION

	Item 1.	Financial Statements

		Consolidated Balance Sheets
		March 31, 2013 (unaudited) and December 31, 2012
		(derived from audited financial statements)	1

		Consolidated Statements of Income
		Three Months Ended March 31, 2013 and 2012 (unaudited)	2

		Consolidated Statements of Comprehensive Income
		Three Months Ended March 31, 2013 and 2012 (unaudited)	3

		Consolidated Statement of Changes in Stockholders’ Equity
		Three Months Ended March 31, 2013 (unaudited)	3

		Consolidated Statements of Cash Flows
		Three Months Ended March 31, 2013 and 2012 (unaudited)	4

		Notes to Consolidated Financial Statements	6

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	55

	Item 4.	Controls and Procedures	55

PART II.	OTHER INFORMATION

	Item 1A.	Risk Factors	55

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	55

	Item 6.	Exhibits	56

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PSB Holdings, Inc.

Consolidated Balance Sheets

March 31, 2013 unaudited, December 31, 2012 derived from audited financial statements

	March 31,			December 31,
(dollars in thousands, except per share data)	2013			2012
Assets

Cash and due from banks	$	9,856		$	20,332
Interest-bearing deposits and money market funds		2,996			1,431
Federal funds sold		—			27,084

Cash and cash equivalents		12,852			48,847

Securities available for sale (at fair value)		69,077			75,387
Securities held to maturity (fair value of $73,761 and $72,364 respectively)		71,488			69,822
Bank certificates of deposit		4,465			4,465
Loans held for sale		—			884
Loans receivable, net		492,588			477,991
Accrued interest receivable		2,389			2,157
Foreclosed assets		1,822			1,774
Premises and equipment, net		9,990			10,240
Mortgage servicing rights, net		1,443			1,233
Federal Home Loan Bank stock (at cost)		2,906			2,506
Cash surrender value of bank-owned life insurance		11,911			11,813
Other assets		4,490			4,847

TOTAL ASSETS	$	685,421		$	711,966

Liabilities

Non-interest-bearing deposits	$	74,552		$	89,819
Interest-bearing deposits		456,621			475,623

Total deposits		531,173			565,442

Federal Home Loan Bank advances		58,124			50,124
Other borrowings		23,129			20,728
Senior subordinated notes		4,000			7,000
Junior subordinated debentures		7,732			7,732
Accrued expenses and other liabilities		5,557			6,493

Total liabilities		629,715			657,519

Stockholders’ equity

Preferred stock – no par value:
Authorized – 30,000 shares; no shares issued or outstanding		—			—
Common stock – no par value with a stated value of $1 per share:
Authorized – 3,000,000 shares; Issued – 1,830,266 shares
Outstanding – 1,652,618 and 1,653,472 shares, respectively		1,830			1,830
Additional paid-in capital		6,857			7,020
Retained earnings		50,586			48,977
Accumulated other comprehensive income, net of tax		1,227			1,394
Treasury stock, at cost – 177,648 and 176,794 shares, respectively		(4,794	)		(4,774	)

Total stockholders’ equity		55,706			54,447

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	685,421		$	711,966

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PSB Holdings, Inc.

Consolidated Statements of Income

	Three Months Ended
	March 31,
(dollars in thousands, except per share data – unaudited)	2013		2012

Interest and dividend income:
Loans, including fees	$	5,687	$	5,841
Securities:
Taxable		541		572
Tax-exempt		373		263
Other interest and dividends		23		19

Total interest and dividend income		6,624		6,695

Interest expense:
Deposits		780		1,152
FHLB advances		330		352
Other borrowings		157		148
Senior subordinated notes		72		142
Junior subordinated debentures		84		85

Total interest expense		1,423		1,879

Net interest income		5,201		4,816
Provision for loan losses		323		160

Net interest income after provision for loan losses		4,878		4,656

Noninterest income:
Service fees		361		402
Mortgage banking		396		312
Investment and insurance sales commissions		287		138
Net gain on sale of securities		12		—
Increase in cash surrender value of life insurance		98		101
Other noninterest income		261		289

Total noninterest income		1,415		1,242

Noninterest expense:
Salaries and employee benefits		2,298		2,163
Occupancy and facilities		497		406
Loss on foreclosed assets		6		233
Data processing and other office operations		477		404
Advertising and promotion		78		58
FDIC insurance premiums		101		107
Other noninterest expenses		625		748

Total noninterest expense		4,082		4,119

Income before provision for income taxes		2,211		1,779
Provision for income taxes		602		599

Net income	$	1,609	$	1,180
Basic earnings per share	$	0.97	$	0.70
Diluted earnings per share	$	0.97	$	0.70

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PSB Holdings, Inc.

Consolidated Statements of Comprehensive Income

	Three Months Ended
	March 31,
(dollars in thousands – unaudited)	2013			2012

Net income	$	1,609		$	1,180

Other comprehensive income, net of tax:

Unrealized gain (loss) on securities available for sale		(126	)		2

Reclassification adjustment for security gain included in net income		(7	)		—

Amortization of unrealized gain on securities available for sale
transferred to securities held to maturity included in net income		(68	)		(71	)

Unrealized gain (loss) on interest rate swap		7			(10	)

Reclassification adjustment of interest rate swap
settlements included in earnings		27			25

Comprehensive income	$	1,442		$	1,126

PSB Holdings, Inc.

Consolidated Statement of Changes in Stockholders’ Equity

Three months ended March 31, 2013

								Accumulated
								Other
			Additional					Comprehensive
	Common		Paid-in			Retained		Income			Treasury
(dollars in thousands – unaudited)	Stock		Capital			Earnings		(Loss)			Stock			Totals

Balance January 1, 2013	$	1,830	$	7,020		$	48,977	$	1,394		$	(4,774	)	$	54,447

Comprehensive income:
Net income							1,609								1,609
Unrealized loss on securities
available for sale, net of tax									(126	)					(126	)
Reclassification adjustment for security gain
Included in net income, net of tax									(7	)					(7	)
Amortization of unrealized gain on securities
available for sale transferred to securities
held to maturity included in net income, net of tax									(68	)					(68	)
Unrealized gain on interest rate swap, net of tax									7						7
Reclassification of interest rate swap settlements
included in earnings, net of tax									27						27

Total comprehensive income															1,442

Purchase of treasury stock												(238	)		(238	)
Issuance of new restricted stock grants				(218	)							218			—
Vesting of existing restricted stock grants				55											55

Balance March 31, 2013	$	1,830	$	6,857		$	50,586	$	1,227		$	(4,794	)	$	55,706

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PSB Holdings, Inc.

Consolidated Statements of Cash Flows

Three months ended March 31, 2013 and 2012

(dollars in thousands – unaudited)	2013			2012

Cash flows from operating activities:

Net income	$	1,609		$	1,180
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for depreciation and net amortization		686			649
Provision for loan losses		323			160
Deferred net loan origination costs		(119	)		(95	)
Gain on sale of loans		(453	)		(349	)
Provision for (recapture of) servicing right valuation allowance		(123	)		66
(Gain) loss on sale of foreclosed assets		(19	)		189
Gain on sale of securities		(12	)		—
Increase in cash surrender value of life insurance		(98	)		(101	)
Changes in operating assets and liabilities:
Accrued interest receivable		(232	)		(111	)
Other assets		435			210
Other liabilities		(882	)		(1,445	)

Net cash provided by operating activities		1,115			353

Cash flows from investing activities:

Proceeds from sale and maturities of:
Securities available for sale		18,833			5,526
Securities held to maturity		1,450			1,210
Payment for purchase of:
Securities available for sale		(13,325	)		(9,518	)
Securities held to maturity		(2,890	)		(1,537	)
Redemption (purchase) of FHLB stock		(400	)		383
Net (increase) decrease in loans		(13,740	)		951
Capital expenditures		(132	)		(99	)
Proceeds from sale of foreclosed assets		141			—

Net cash provided by (used in) investing activities		(10,063	)		(3,084	)

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PSB Holdings, Inc.

Consolidated Statements of Cash Flows

Three months ended March 31, 2013 and 2012

(continued)

(dollars in thousands – unaudited)	2013			2012

Cash flows from financing activities:

Net decrease in non-interest-bearing deposits		(15,267	)		(12,846	)
Net decrease in interest-bearing deposits		(18,943	)		(2,157	)
Net increase in FHLB advances		8,000			—
Net increase (decrease) in other borrowings		2,401			(747	)
Repayment of senior subordinated notes		(3,000	)		—
Dividends declared		—			(3	)
Purchase of treasury stock		(238	)		(5	)

Net cash used in financing activities		(27,047	)		(15,758	)

Net decrease in cash and cash equivalents		(35,995	)		(18,489	)
Cash and cash equivalents at beginning		48,847			38,205

Cash and cash equivalents at end	$	12,852		$	19,716

Supplemental cash flow information:

Cash paid during the period for:
Interest	$	1,559		$	1,924
Income taxes		48			310

Noncash investing and financing activities:

Loans charged off	$	328		$	347
Loans transferred to foreclosed assets		277			358
Loans originated on sale of foreclosed assets		107			—
Issuance of unvested restricted stock grants at fair value		210			200
Vesting of restricted stock grants		36			22

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PSB Holdings, Inc.

Notes to Consolidated Financial Statements

NOTE 1 – GENERAL

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly PSB Holdings, Inc.’s (“PSB”) financial position, results of its operations, and cash flows for the periods presented, and all such adjustments are of a normal recurring nature. The consolidated financial statements include the accounts of all subsidiaries. All material intercompany transactions and balances are eliminated. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Any reference to “PSB” refers to the consolidated or individual operations of PSB Holdings, Inc. and its subsidiary Peoples State Bank and, where applicable, its subsidiary Marathon State Bank, which, as described in Note 2 below, was acquired by PSB on June 14, 2012. Dollar amounts are in thousands, except per share amounts.

These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles have been omitted or abbreviated. The information contained in the consolidated financial statements and footnotes in PSB’s Annual Report on Form 10-K for the year ended December 31, 2012 should be referred to in connection with the reading of these unaudited interim financial statements.

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are susceptible to significant change include the determination of the allowance for loan losses, mortgage servicing right assets, and the valuation of investment securities.

NOTE 2 – PSB HOLDINGS, INC. ACQUISITION OF MARATHON STATE BANK

On June 14, 2012, PSB completed its purchase of Marathon State Bank, a privately owned bank with $107 million in total assets located in the Village of Marathon City, Wisconsin (“Marathon”). Under the terms of the agreement, PSB paid $5,505 in cash, which was equal to 100% of Marathon’s tangible net book value following a special dividend by Marathon to its shareholders to reduce its book equity ratio to 6% of total assets. The following table outlines the fair value of Marathon assets and liabilities acquired including determination of the gain on bargain purchase using an accounting date of June 1, 2012. A core deposit intangible was not recorded on the purchase as the fair value calculation determined it was insignificant.

Cash purchase price	$	5,505

Fair value of assets acquired:
Cash and due from banks		20,392
Securities available for sale		50,547
Loans receivable		23,760
Short-term commercial paper and bankers’ acceptances		11,713
Foreclosed assets		0
Premises and equipment		402
Core deposit intangible		0
Accrued interest receivable and other assets		550

Total fair value of assets acquired		107,364

Fair value of liabilities assumed:
Non-interest bearing deposits		23,255
Interest-bearing deposits		77,611
Accrued interest payable and other liabilities		142

Total fair value of liabilities assumed		101,008

Fair value of net assets acquired		6,356

Gain on bargain purchase	$	851

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PSB recorded a total credit mark down of $490 on Marathon’s loan portfolio on the purchase date, or 2.05% of gross purchased loan principal. Purchased impaired loan principal totaled $310 on which a $21 credit write-down was recorded. Due to the insignificant amount of total purchased impaired loans, the entire $490 credit mark down will be accreted to income as a yield adjustment based on contractual cash flows over the remaining life of the purchased loans.

Results of operations of the quarterly period ended March 31, 2013:

		Quarter ended March 31, 2013
		Net interest		Noninterest		Net		Earnings
($000s)		income		income		income		per share

	PSB Holdings, Inc.	$	5,201	$	1,415	$	1,609	$	0.97

Pro forma combined results of operations as if the combination occurred at the beginning of the quarterly period ended March 31, 2012:

	Quarter ended March 31, 2012 (pro forma combined at beginning of period)
	Net interest		Noninterest		Net		Earnings
($000s)	income		income		income		per share

PSB Holdings, Inc.	$	4,816	$	1,242	$	1,180	$	0.70
Marathon State Bank		426		12		77		0.06

Pro forma Totals	$	5,242	$	1,254	$	1,257	$	0.76

NOTE 3 – SECURITIES

The amortized cost and estimated fair value of investment securities are as follows:

			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
March 31, 2013	Cost		Gains		Losses		Value

Securities available for sale

U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	6,997	$	17	$	—	$	7,014
U.S. agency issued residential mortgage-backed securities		15,140		736		38		15,838
U.S. agency issued residential collateralized mortgage obligations		42,938		708		68		43,578
Privately issued residential collateralized mortgage obligations		145		5		—		150
Nonrated commercial paper		1,500		—		—		1,500
Nonrated SBA Loan Fund		950		—		—		950
Other equity securities		47		—		—		47

Totals	$	67,717	$	1,466	$	106	$	69,077

Securities held to maturity

Obligations of states and political subdivisions	$	69,576	$	2,495	$	105	$	71,966
Nonrated trust preferred securities		1,510		46		168		1,388
Nonrated senior subordinated notes		402		5		—		407

Totals	$	71,488	$	2,546	$	273	$	73,761

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			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
December 31, 2012	Cost		Gains		Losses		Value

Securities available for sale

U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	9,998	$	29	$	—	$	10,027
U.S. agency issued residential mortgage-backed securities		13,550		847		—		14,397
U.S. agency issued residential collateralized mortgage obligations		44,544		749		50		45,243
Privately issued residential collateralized mortgage obligations		168		5		—		173
Nonrated commercial paper		5,500		—		—		5,500
Other equity securities		47		—		—		47

Totals	$	73,807	$	1,630	$	50	$	75,387

Securities held to maturity

Obligations of states and political subdivisions	$	67,915	$	2,581	$	41	$	70,455
Nonrated trust preferred securities		1,505		60		66		1,499
Nonrated senior subordinated notes		402		8		—		410

Totals	$	69,822	$	2,649	$	107	$	72,364

Securities with a fair value of $47,581 and $44,914 at March 31, 2013 and December 31, 2012, respectively, were pledged to secure public deposits, other borrowings, and for other purposes required by law.

During the quarter ended March 31, 2013, PSB realized a net gain of $12 ($7 after tax expense) from proceeds totaling $986 on the sale of securities available for sale. There was no sale of securities during the quarter ended March 31, 2012.

NOTE 4 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Loans

Loans that management has the intent to hold for the foreseeable future or until maturity or pay-off are generally reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest on loans is credited to income as earned. Interest income is not accrued on loans where management has determined collection of such interest is doubtful or those loans which are past due 90 days or more as to principal or interest payments. When a loan is placed on nonaccrual status, previously accrued but unpaid interest deemed uncollectible is reversed and charged against current income. After being placed on nonaccrual status, additional income is recorded only to the extent that payments are received and the collection of principal becomes reasonably assured. Interest income recognition on loans considered to be impaired is consistent with the recognition on all other loans. Loan origination fees and certain direct loan origination costs are deferred and recognized as an adjustment of the related loan yield using the interest method.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes the collectability of the principal is unlikely.

Management maintains the allowance for loan losses at a level to cover probable credit losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio. In accordance with current accounting standards, the allowance is provided for losses that have been incurred based on events that have occurred as of the balance sheet date. The allowance is based on past events and current economic conditions and does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions.

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The allowance for loan losses includes specific allowances related to loans which have been judged to be impaired. A loan is impaired when, based on current information, it is probable that PSB will not collect all amounts due in accordance with the contractual terms of the loan agreement. Management has determined that impaired loans include nonaccrual loans, loans identified as restructurings of troubled debt, and loans accruing interest with elevated risk of default in the near term based on a variety of credit factors. Specific allowances on impaired loans are based on discounted cash flows of expected future payments using the loan’s initial effective interest rate or the fair value of the collateral if the loan is collateral dependent.

In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require PSB to make additions to the allowance for loan losses based on their judgments of collectability resulting from information available to them at the time of their examination.

The composition of loans categorized by the type of the loan, is as follows:

	March 31, 2013			December 31, 2012

Commercial, industrial, and municipal	$	128,875		$	132,633
Commercial real estate mortgage		190,613			183,818
Commercial construction and development		29,867			28,482
Residential real estate mortgage		116,816			105,579
Residential construction and development		13,302			15,247
Residential real estate home equity		20,734			21,756
Consumer and individual		4,494			4,715

Subtotals – Gross loans		504,701			492,230
Loans in process of disbursement		(4,937	)		(7,039	)

Subtotals – Disbursed loans		499,764			485,191
Net deferred loan costs		258			231
Allowance for loan losses		(7,434	)		(7,431	)

Net loans receivable	$	492,588		$	477,991

The following is a summary of information pertaining to impaired loans at period-end:

	March 31, 2013		December 31, 2012

Impaired loans without a valuation allowance	$	4,645	$	3,410
Impaired loans with a valuation allowance		7,357		9,029

Total impaired loans before valuation allowances		12,002		12,439
Valuation allowance related to impaired loans		2,526		2,434

Net impaired loans	$	9,476	$	10,005

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Activity in the allowance for loans losses during the three months ended March 31, 2013 follows:

Allowance for loan losses:	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Unallocated		Total

Beginning Balance	$	3,014		$	2,803		$	1,511		$	103		$	—	$	7,431
Provision		343			(293	)		264			9			—		323
Recoveries		2			—			1			5			—		8
Charge offs		(130	)		—			(172	)		(26	)		—		(328	)

Ending balance	$	3,229		$	2,510		$	1,604		$	91		$	—	$	7,434
Individually evaluated for impairment	$	1,424		$	635		$	450		$	17		$	—	$	2,526
Collectively evaluated for impairment	$	1,805		$	1,875		$	1,154		$	74		$	—	$	4,908

Loans receivable (gross):

Individually evaluated for impairment	$	4,675		$	4,539		$	2,763		$	25		$	—	$	12,002
Collectively evaluated for impairment	$	124,200		$	215,941		$	148,089		$	4,469		$	—	$	492,699

Activity in the allowance for loans losses during the three months ended March 31, 2012, follows:

Allowance for loan losses:	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Unallocated		Total

Beginning Balance	$	3,406		$	3,175		$	1,242		$	118		$	—	$	7,941
Provision		(35	)		(149	)		348			(4	)		—		160
Recoveries		1			—			—			—			—		1
Charge offs		(102	)		—			(237	)		(8	)		—		(347	)

Ending balance	$	3,270		$	3,026		$	1,353		$	106		$	—	$	7,755
Individually evaluated for impairment	$	1,445		$	947		$	689		$	18		$	—	$	3,099
Collectively evaluated for impairment	$	1,825		$	2,079		$	664		$	88		$	—	$	4,656

Loans receivable (gross):

Individually evaluated for impairment	$	6,281		$	8,693		$	2,564		$	71		$	—	$	17,609
Collectively evaluated for impairment	$	124,271		$	188,316		$	112,526		$	3,319		$	—	$	428,432

PSB maintains an independent credit administration staff that continually monitors aggregate commercial loan portfolio and individual borrower credit quality trends. All commercial purpose loans are assigned a credit grade upon origination, and credit grades for nonproblem borrowers with aggregate credit in excess of $500 are reviewed annually. In addition, all past due, restructured, or identified problem loans, both commercial and consumer purpose, are reviewed and assigned an up-to-date credit grade quarterly.

PSB uses a seven point grading scale to estimate credit risk with risk rating 1, representing the high credit quality, and risk rating 7, representing the lowest credit quality. The assigned credit grade takes into account several credit quality components which are assigned a weight and blended into the composite grade. The factors considered and their assigned weight for the final composite grade is as follows:

Cash flow (30% weight) – Considers earnings trends and debt service coverage levels.

Collateral (25% weight) – Considers loan to value and other measures of collateral coverage.

Leverage (15% weight) – Considers balance sheet debt and capital ratios compared to Robert Morris & Associates (RMA) industry medians.

Liquidity (10% weight) – Considers balance sheet current, quick, and other working capital ratios compared to RMA industry medians.

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Management (5% weight) – Considers the past performance, character, and depth of borrower management.

Guarantor (5% weight) – Considers the existence of a guarantor along with a bank’s past experience with the guarantor and his related liquidity and credit score.

Financial reporting (5% weight) – Considers the relative level of independent financial review obtained by the borrower on its financial statements, from audited financial statements down to existence of only tax returns or potentially unreliable financial information.

Industry (5% weight) – Considers the borrower’s industry and whether it is stable or subject to cyclical or seasonal factors.

Nonclassified loans are assigned a risk rating of 1 to 4 and have credit quality that ranges from well above average to some inherent industry weaknesses that may present higher than average risk due to conditions affecting the borrower, the borrower’s industry, or economic development.

Special mention and watch loans are assigned a risk rating of 5 when potential weaknesses exist that deserve management’s close attention. If left uncorrected, the potential weaknesses may result in deterioration of repayment prospects or in credit position at some future date. Substandard loans are assigned a risk rating of 6 and are inadequately protected by the current worth and borrowing capacity of the borrower. Well-defined weaknesses exist that may jeopardize the liquidation of the debt. There is a possibility of some loss if the deficiencies are not corrected. At this point, the loan may still be performing and accruing interest.

Impaired and other doubtful loans assigned a risk rating of 7 have all of the weaknesses of a substandard credit plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of current facts, conditions, and collateral values highly questionable and improbable. Impaired loans include all nonaccrual loans and all restructured loans including restructured loans performing according to the restructured terms. In special situations, an impaired loan with a risk rating of 7 could still be maintained on accrual status such as in the case of restructured loans performing according to restructured terms.

The commercial credit exposure based on internally assigned credit grade at March 31, 2013, follows:

			Commercial		Construction
	Commercial		Real Estate		& Development		Agricultural		Government		Total

High quality (risk rating 1)	$	40	$	—	$	—	$	—	$	—	$	40
Minimal risk (2)		17,556		19,206		269		845		91		37,967
Average risk (3)		50,163		121,049		23,943		3,149		12,315		210,619
Acceptable risk (4)		32,412		36,013		3,306		213		—		71,944
Watch risk (5)		6,837		7,734		1,735		—		—		16,306
Substandard risk (6)		579		2,291		395		—		—		3,265
Impaired loans (7)		4,521		4,320		219		154		—		9,214

Total	$	112,108	$	190,613	$	29,867	$	4,361	$	12,406	$	349,355

The commercial credit exposure based on internally assigned credit grade at December 31, 2012, follows:

			Commercial		Construction
	Commercial		Real Estate		& Development		Agricultural		Government		Total

High quality (risk rating 1)	$	38	$	—	$	—	$	—	$	—	$	38
Minimal risk (2)		16,360		20,193		305		559		1,575		38,992
Average risk (3)		51,846		103,454		22,573		3,336		12,550		193,759
Acceptable risk (4)		32,002		45,699		3,318		216		—		81,235
Watch risk (5)		8,271		8,291		1,757		—		—		18,319
Substandard risk (6)		617		2,179		327		—		—		3,123
Impaired loans (7)		5,109		4,002		202		154		—		9,467

Total	$	114,243	$	183,818	$	28,482	$	4,265	$	14,125	$	344,933

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The consumer credit exposure based on payment activity and internally assigned credit grade at March 31, 2013, follows:

	Residential-		Residential-		Construction and
	Prime		HELOC		Development		Consumer		Total

Performing	$	114,725	$	20,247	$	13,117	$	4,469	$	152,558
Impaired loans		2,091		487		185		25		2,788

Total	$	116,816	$	20,734	$	13,302	$	4,494	$	155,346

The consumer credit exposure based on payment activity and internally assigned credit grade at December 31, 2012, follows:

	Residential-		Residential-		Construction and
	Prime		HELOC		Development		Consumer		Total

Performing	$	103,292	$	21,250	$	15,094	$	4,689	$	144,325
Impaired loans		2,287		506		153		26		2,972

Total	$	105,579	$	21,756	$	15,247	$	4,715	$	147,297

The payment age analysis of loans receivable disbursed at March 31, 2013, follows:

	30-59		60-89		90+		Total				Total		90+ and
Loan Class	Days		Days		Days		Past Due		Current		Loans		Accruing

Commercial:

Commercial and industrial	$	637	$	106	$	1,132	$	1,875	$	110,233	$	112,108	$	—
Agricultural		—		24		154		178		4,183		4,361		—
Government		—		—		—		—		12,406		12,406		—

Commercial real estate:

Commercial real estate		579		266		1,320		2,165		188,448		190,613		—
Commercial construction and development		575		20		—		595		26,705		27,300		—

Residential real estate:

Residential – Prime		996		84		1,364		2,444		114,372		116,816		—
Residential – HELOC		204		29		118		351		20,383		20,734		—
Residential – construction and development		249		33		133		415		10,517		10,932		—

Consumer		8		1		16		25		4,469		4,494		—

Total	$	3,248	$	563	$	4,237	$	8,048	$	491,716	$	499,764	$	—

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The payment age analysis of loans receivable disbursed at December 31, 2012, follows:

	30-59		60-89		90+		Total				Total		90+ and
Loan Class	Days		Days		Days		Past Due		Current		Loans		Accruing

Commercial:

Commercial and industrial	$	375	$	83	$	1,795	$	2,253	$	111,990	$	114,243	$	—
Agricultural		—		154		—		154		4,111		4,265		—
Government		—		—		—		—		14,125		14,125		—

Commercial real estate:

Commercial real estate		936		76		1,028		2,040		181,778		183,818		—
Commercial construction and development		—		20		—		20		25,340		25,360		—

Residential real estate:

Residential – prime		950		274		1,344		2,568		103,011		105,579		—
Residential – HELOC		64		—		335		399		21,357		21,756		—
Residential – construction and development		—		—		133		133		11,197		11,330		—

Consumer		21		3		15		39		4,676		4,715		—

Total	$	2,346	$	610	$	4,650	$	7,606	$	477,585	$	485,191	$	—

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Impaired loans as of March 31, 2013, and during the three months then ended, by loan class, follows:

	Unpaid						Average		Interest
	Principal		Related		Recorded		Recorded		Income
	Balance		Allowance		Investment		Investment		Recognized

With no related allowance recorded:

Commercial & industrial	$	1,859	$	—	$	1,754	$	1,619	$	18
Commercial real estate		1,873		—		1,716		1,410		9
Commercial construction & development		3		—		1		1		—
Residential – prime		1,222		—		1,124		974		1
Residential – HELOC		50		—		50		25		1

With an allowance recorded:

Commercial & industrial	$	2,986	$	1,356	$	2,767	$	3,197	$	12
Commercial real estate		2,701		592		2,604		2,752		21
Commercial construction & development		218		43		218		210		4
Agricultural		155		68		154		154		—
Residential – prime		977		261		967		1,215		1
Residential – HELOC		446		133		437		472		1
Residential construction & development		185		56		185		169		—
Consumer		26		17		25		26		—

Totals:

Commercial & industrial	$	4,845	$	1,356	$	4,521	$	4,816	$	30
Commercial real estate		4,574		592		4,320		4,162		30
Commercial construction & development		221		43		219		211		4
Agricultural		155		68		154		154		—
Residential – prime		2,199		261		2,091		2,189		2
Residential – HELOC		496		133		487		497		2
Residential construction & development		185		56		185		169		—
Consumer		26		17		25		26		—

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The impaired loans at December 31, 2012, and during the year then ended, by loan class, follows:

	Unpaid						Average		Interest
	Principal		Related		Recorded		Recorded		Income
	Balance		Allowance		Investment		Investment		Recognized

With no related allowance recorded:

Commercial and industrial	$	1,521	$	—	$	1,483	$	1,545	$	88
Commercial real estate		1,176		—		1,103		2,405		194
Commercial construction and development		—		—		—		—		33
Residential – Prime		881		—		824		493		9
Residential – HELOC		—		—		—		—		3

With an allowance recorded:

Commercial and industrial	$	3,960	$	1,287	$	3,626	$	4,238	$	62
Commercial real estate		3,035		643		2,899		3,303		105
Commercial construction and development		205		31		202		427		21
Agricultural		154		40		154		91		10
Residential – Prime		1,511		277		1,463		1,746		22
Residential – HELOC		510		126		506		387		15
Residential construction and development		153		4		153		149		5
Consumer		26		26		26		48		2

Totals:

Commercial and industrial	$	5,481	$	1,287	$	5,109	$	5,783	$	150
Commercial real estate		4,211		643		4,002		5,708		299
Commercial construction and development		205		31		202		427		54
Agricultural		154		40		154		91		10
Residential – Prime		2,392		277		2,287		2,239		31
Residential – HELOC		510		126		506		387		18
Residential construction and development		153		4		153		149		5
Consumer		26		26		26		48		2

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Loans on nonaccrual status at period-end, follows:

	March 31, 2013		December 31, 2012

Commercial:

Commercial and industrial	$	2,467	$	3,023
Agricultural		154		154

Commercial real estate:

Commercial real estate		2,266		2,001
Commercial construction and development		20		1

Residential real estate:

Residential – prime		1,921		2,021
Residential – HELOC		338		365
Residential construction and development		166		133

Consumer		17		17

Total	$	7,349	$	7,715

During the quarter ended March 31, 2013, the contracts identified below were modified to capitalize unpaid property taxes, lower the interest rate, and extend payment amortization periods, and were categorized as troubled debt restructurings. During the quarter ended March 31, 2012, the commercial and industrial contracts identified below were modified to convert from amortizing principal payments to interest only payments and the commercial real estate contract was modified to capitalize unpaid property taxes. Specific loan reserves maintained in connection with loans restructured during the quarter totaled $27 at March 31, 2013 and $58 at March 31, 2012. All modified or restructured loans are classified as impaired loans. Recorded investment as presented in the tables below concerning modified loans represents principal outstanding before specific reserves.

The following table presents information concerning modifications of troubled debt made during the three months ended March 31, 2013:

		Pre-modification		Post-modification
	Number of	outstanding recorded		outstanding recorded
As of March 31, 2013 ($000s)	contracts	investment		investment at period-end

Commercial & industrial	1	$	38	$	38
Commercial real estate	2	$	221	$	221

The following table presents information concerning modifications of troubled debt made during the three months ended March 31, 2012:

		Pre-modification		Post-modification
	Number of	outstanding recorded		outstanding recorded
As of March 31, 2012 ($000s)	contracts	investment		investment at period-end

Commercial & industrial	3	$	180	$	180
Commercial real estate	1	$	379	$	379

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The following table outlines past troubled debt restructurings that subsequently defaulted within twelve months of the last restructuring date. For purposes of this table, default is defined as 90 days or more past due on restructured payments. No past troubled debt restructurings subsequently defaulted within twelve months of the last restructuring during the three months ended March 31, 2012.

NOTE 5 – FORECLOSED ASSETS

Real estate and other property acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value (after deducting estimated costs to sell) at the date of foreclosure, establishing a new cost basis. Costs related to development and improvement of property are capitalized, whereas costs related to holding property are expensed. After foreclosure, valuations are periodically performed by management, and the real estate or other property is carried at the lower of carrying amount or fair value less estimated costs to sell. Revenue and expenses from operations of foreclosed assets and changes in any valuation allowance are included in loss on foreclosed assets.

A summary of activity in foreclosed assets is as follows:

	Three months ended
	March 31,
	2013			2012

Balance at beginning of period	$	1,774		$	2,939

Transfer of loans at net realizable value to foreclosed assets		277			358
Sale proceeds		(141	)		—
Loans made on sale of foreclosed assets		(107	)		—
Net gain from sale of foreclosed assets		19			—
Provision for write-down charged to operations		—			(189	)

Balance at end of period	$	1,822		$	3,108

NOTE 6 – DEPOSITS

The distribution of deposits at period end is as follows:

	March 31, 2013		December 31, 2012

Non-interest bearing demand	$	74,552	$	89,819
Interest bearing demand (NOWs)		123,158		131,404
Savings		54,556		53,799
Money market		119,010		124,501
Retail and local time		107,176		111,462
Broker and national time		52,721		54,457

Total deposits	$	531,173	$	565,442

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NOTE 7 – OTHER BORROWINGS

Other borrowings consist of the following obligations at March 31, 2013, and December 31, 2012:

	March 31, 2013		December 31, 2012

Federal funds purchased	$	1,422	$	—
Short-term repurchase agreements		6,207		7,228
Bank stock term loan		2,000		—
Wholesale structured repurchase agreements		13,500		13,500

Total other borrowings	$	23,129	$	20,728

PSB pledges various securities available for sale as collateral for repurchase agreements. The fair value of securities pledged for repurchase agreements totaled $22,598 at March 31, 2013 and $21,931 at December 31, 2012.

During the quarter ended March 31, 2013, PSB used the proceeds from a new $2,000 fully amortizing term loan with Bankers’ Bank, Madison, Wisconsin to repay $2,000 of its 8% senior subordinated notes outstanding. PSB has pledged its common stock ownership of its subsidiary, Peoples State Bank, as collateral for the loan. The bank note carries a floating rate of interest with required principal payments of $500, $1,000, and $500, in 2013, 2014, and 2015, respectively.

The following information relates to securities sold under repurchase agreements and other borrowings:

	Three months ended
	March 31,
	2013		2012

As of end of period – weighted average rate		2.84%		3.09%
For the period:
Highest month-end balance	$	23,129	$	19,156
Daily average balance	$	21,154	$	19,072
Weighted average rate		3.01%		3.12%

NOTE 8 – SENIOR SUBORDINATED NOTES

During the quarter ended March 31, 2013, PSB elected to prepay $7,000 of its 8% senior subordinated notes with $1,000 of cash and $6,000 in proceeds from an issue of new subordinated debt. The new debt included $4,000 of privately placed notes carrying a 3.75% fixed interest rate with semi-annual interest only payments, due in 2018, and $2,000 in a fully amortizing bank stock term loan with Bankers’ Bank, Madison, Wisconsin, carrying a floating rate of interest based on changes in the 90-day LIBOR plus 3.00% and maturing in 2015. The $4,000 of new fixed rate debt is held by related parties, including directors and a significant shareholder.

NOTE 9 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

PSB is exposed to certain risks relating to its ongoing business operations. The primary risk managed by using derivative instruments is interest rate risk. Interest rate swaps are entered into to manage interest rate risk associated with PSB’s variable rate junior subordinated debentures. Accounting standards require PSB to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. PSB designates its interest rate swap associated with the junior subordinated debentures as a cash flow hedge of variable-rate debt. For derivative financial instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative instrument representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

From time to time, PSB will also enter into fixed interest rate swaps with customers in connection with their floating rate loans to PSB. When fixed rate swaps are originated with customers, an identical offsetting swap is also entered into by PSB with a correspondent bank. These swap arrangements are intended to offset each other as “back to back” swaps and allow PSB’s loan customer to obtain fixed rate loan financing via the swap while PSB exchanges these fixed payments with a correspondent bank. In these arrangements, PSB’s net cash flows and interest income are equal to the floating rate loan originated in connection with the swap. These customer swaps are not designated as hedging instruments and are accounted for at fair value with changes in fair value recognized in the income statement during the current period.

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PSB is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. PSB controls the credit risk of its financial contracts through credit approvals, limits, and monitoring procedures, and does not expect any counterparties to fail their obligations. PSB swaps originated with correspondent banks are over-the-counter (OTC) contracts. Negotiated OTC derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amounts, exercise prices, and maturity.

At period end, the following interest rate swaps to hedge variable-rate debt were outstanding:

	March 31, 2013	December 31, 2012

Notional amount	$7,500	$7,500
Pay fixed rate	2.72%	2.72%
Receive variable rate	0.28%	0.31%
Maturity	September 2017	September 2017
Unrealized gain (loss) fair value	$ (645)	$ (699)

This agreement provides for PSB to receive payments at a variable rate determined by the three-month LIBOR in exchange for making payments at a fixed rate. Actual maturities may differ from scheduled maturities due to call options and/or early termination provisions. No interest rate swap agreements were terminated prior to maturity during the quarter ended March 31, 2013 or 2012. Risk management results for the quarter ended March 31, 2013 related to the balance sheet hedging of variable rate debt indicates that the hedge was 100% effective, and no component of the derivative instrument’s gain or loss was excluded from the assessment of hedge effectiveness.

As of March 31, 2013, approximately $183 of losses ($111 after tax impacts) reported in other comprehensive income related to the interest rate swap are expected to be reclassified into interest expense as a yield adjustment of the hedged borrowings during the 12-month period ending March 31, 2014. The interest rate swap agreement was secured by cash and cash equivalents of $850 at March 31, 2013, and December 31, 2012.

PSB maintains outstanding interest rate swaps with customers and correspondent banks associated with its lending activities that are not designated as hedges. At period end, the following floating interest rate swaps were outstanding with customers:

	March 31, 2013	December 31, 2012

Notional amount	$14,816	$14,979
Receive fixed rate (average)	1.99%	1.99%
Pay variable rate (average)	0.20%	0.21%
Maturity	March 2015 – Oct. 2021	March 2015 – Oct. 2021
Weighted average remaining term	3.7 years	3.9 years
Unrealized gain (loss) fair value	$ 589	$ 673

At period end, the following offsetting fixed interest rate swaps were outstanding with correspondent banks:

	March 31, 2013	December 31, 2012

Notional amount	$14,816	$14,979
Pay fixed rate (average)	1.99%	1.99%
Receive variable rate (average)	0.20%	0.21%
Maturity	March 2015 – Oct. 2021	March 2015 – Oct. 2021
Weighted average remaining term	3.7 years	3.9 years
Unrealized gain (loss) fair value	$ (589)	$ (673)

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NOTE 10 – INCOME TAX EFFECTS ON ITEMS OF COMPREHENSIVE INCOME (LOSS)

	Three Months Ended
	March 31, 2013
Period ended March 31, 2013		Pre-tax			Income Tax
(dollars in thousands)		Inc. (Exp.)			Exp. (Credit)

Unrealized loss on securities available for sale		$	(219	)	$	(93	)
Reclassification adjustment for gain included in net income			(12	)		(5	)
Amortization of unrealized gain on securities available for sale transferred
to securities held to maturity included in net income			(112	)		(44	)
Unrealized gain on interest rate swap			8			1
Reclassification adjustment of interest rate swap settlements included in earnings			45			18

Totals		$	(290	)	$	(123	)

	Three Months Ended
	March 31, 2012
Period ended March 31, 2012		Pre-tax			Income Tax
(dollars in thousands)		Inc. (Exp.)			Exp. (Credit)

Unrealized gain on securities available for sale			4			2
Amortization of unrealized gain on securities available for sale transferred
to securities held to maturity included in net income			(117	)		(46	)
Unrealized loss on interest rate swap			(17	)		(7	)
Reclassification adjustment of interest rate swap settlements included in earnings			41			16

Totals		$	(89	)	$	(35	)

NOTE 11 – RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME

During the quarter ended March 31, 2013, PSB reclassified $12 ($7 after tax impacts) to reduce comprehensive net income following a gain on sale of securities available for sale. The reduction to comprehensive net income was recognized as a $12 ($7 after tax impacts) gain on sale of securities on the statement of income during the quarter.

During the quarter ended March 31, 2013, PSB reclassified $45 ($27 after tax impacts) of interest rate swap settlements which increased comprehensive income. The increase to comprehensive net income was recognized as a $45 ($27 after tax impacts) increase to interest expense on junior subordinated debentures on the statement of income during the quarter.

NOTE 12 – STOCK-BASED COMPENSATION

PSB granted restricted stock to certain employees having an initial market value of $210 during the three months ended March 31, 2013 compared to $200 granted during the three months ended March 31, 2012. Restricted shares vest to employees based on continued PSB service over a six-year period and are recognized as compensation expense over the vesting period. Cash dividends are paid on unvested shares at the same time and amount as paid to PSB common shareholders. Cash dividends paid on unvested restricted stock shares are charged to retained earnings as significantly all restricted shares are expected to vest to employees. Unvested shares are subject to forfeiture upon employee termination. During the three months ended March 31, compensation expense recorded from amortization of restricted shares expected to vest to employees was $36 and $22 during 2013 and 2012, respectively.

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The following tables summarize information regarding restricted stock outstanding at March 31, 2013 and 2012 including activity during the three months then ended.

				Weighted
				Average
	Shares			Grant Price

January 1, 2012		25,572		$	17.79
Restricted stock granted		8,895			22.48
Restricted stock legally vested		(4,058	)		(16.08	)

March 31, 2012		30,409		$	19.39

January 1, 2013		30,409		$	19.39
Restricted stock granted		8,076			26.00
Restricted stock legally vested		(5,883	)		(17.85	)

March 31, 2013		32,602		$	21.30

Scheduled compensation expense per calendar year assuming all restricted shares eventually vest to employees would be as follows:

2013	$	146
2014		146
2015		137
2016		122
2017		82
Thereafter		42

Totals	$	675

NOTE 13 – EARNINGS PER SHARE

Basic earnings per share of common stock are based on the weighted average number of common shares outstanding during the period. Unvested but issued restricted shares are considered to be outstanding shares and used to calculate the weighted average number of shares outstanding and determine net book value per share. Diluted earnings per share is calculated by dividing net income by the weighted average number of shares adjusted for the dilutive effect of outstanding stock options. On June 19, 2012, the Company declared a 5% stock dividend to shareholders of record July 16, 2012, which was paid in the form of additional common stock on July 30, 2012. All references in the accompanying consolidated financial statements and footnotes to the number of common shares and per share amounts during 2012 have been restated to reflect the 5% stock dividend.

Presented below are the calculations for basic and diluted earnings per share:

	Three months ended
	March 31,
(dollars in thousands, except per share data – unaudited)	2013		2012

Net income	$	1,609	$	1,180

Weighted average shares outstanding		1,656,162		1,663,138
Effect of dilutive stock options outstanding		—		186

Diluted weighted average shares outstanding		1,656,162		1,663,324

Basic earnings per share	$	0.97	$	0.70
Diluted earnings per share	$	0.97	$	0.70

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NOTE 14 – CONTINGENCIES

In the normal course of business, PSB is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the consolidated financial statements.

NOTE 15 – FAIR VALUE MEASUREMENTS

Certain assets and liabilities are recorded or disclosed at fair value to provide financial statement users additional insight into PSB’s quality of earnings. Under current accounting guidance, PSB groups assets and liabilities which are recorded 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. 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 (with Level 1 considered highest and Level 3 considered lowest). All transfers between levels are recognized as occurring at the end of the reporting period.

Following is a brief description of each level of the fair value hierarchy:

Level 1 – Fair value measurement is based on quoted prices for identical assets or liabilities in active markets.

Level 2 – Fair value measurement is based on (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar assets or liabilities in markets that are not active; or (3) valuation models and methodologies for which all significant assumptions are or can be corroborated by observable market data.

Level 3 – Fair value measurement is based on valuation models and methodologies that incorporate at least one significant assumption that cannot be corroborated by observable market data. Level 3 measurements reflect PSB’s estimates about assumptions market participants would use in measuring fair value of the asset or liability.

Some assets and liabilities, such as securities available for sale, loans held for sale, mortgage rate lock commitments, and interest rate swaps, are measured at fair value on a recurring basis under GAAP. Other assets and liabilities, such as impaired loans, foreclosed assets, and mortgage servicing rights are measured at fair value on a nonrecurring basis.

Following is a description of the valuation methodology used for each asset and liability measured at fair value on a recurring or nonrecurring basis, as well as the classification of the asset or liability within the fair value hierarchy.

Securities available for sale – Securities available for sale may be classified as Level 1, Level 2, or Level 3 measurements within the fair value hierarchy and are measured on a recurring basis. Level 1 securities include equity securities traded on a national exchange. The fair value measurement of a Level 1 security is based on the quoted price of the security. Level 2 securities include U.S. government and agency securities, obligations of states and political subdivisions, corporate debt securities, and mortgage-related securities. The fair value measurement of a Level 2 security is obtained from an independent pricing service and is based on recent sales of similar securities and other observable market data and represents a market approach to fair value.

At March 31, 2013 and December 31, 2012, Level 3 securities include a common stock investment in Bankers’ Bank, Madison, Wisconsin that is not traded on an active market. Historical cost of the common stock is assumed to approximate fair value of this investment.

Loans held for sale – Loans held for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value and are measured on a recurring basis. The fair value measurement of a loan held for sale is based on current secondary market prices for similar loans, which is considered a Level 2 measurement and represents a market approach to fair value.

Impaired loans – Loans are not measured at fair value on a recurring basis. Carrying value of impaired loans that are not collateral dependent are based on the present value of expected future cash flows discounted at the applicable effective interest rate and, thus, are not fair value measurements. However, impaired loans considered to be collateral dependent are measured at fair value on a nonrecurring basis. The fair value measurement of an impaired loan that is collateral dependent is based on the fair value of the underlying collateral. Fair value measurements of underlying collateral that utilize observable market data, such as independent appraisals reflecting recent comparable sales, are considered Level 2 measurements. Other fair value measurements that incorporate internal collateral appraisals or broker price opinions, net of selling costs, or estimated assumptions market participants would use to measure fair value, such as discounted cash flow measurements, are considered Level 3 measurements and represent a market approach to fair value.

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In the absence of a recent independent appraisal, collateral dependent impaired loans are valued based on a recent broker price opinion generally discounted by 10% plus estimated selling costs. In the absence of a broker price opinion, collateral dependent impaired loans are valued at the lower of last appraisal value or the current real estate tax value discounted by 30% plus estimated selling costs. Property values are impacted by many macroeconomic factors. In general, a declining economy or rising interest rates would be expected to lower fair value of collateral dependent impaired loans while an improving economy or falling interest rates would be expected to increase fair value of collateral dependent impaired loans.

Foreclosed assets – Real estate and other property acquired through, or in lieu of, loan foreclosure are not measured at fair value on a recurring basis. Initially, foreclosed assets are recorded at fair value less estimated costs to sell at the date of foreclosure. Estimated selling costs typically range from 5% to 15% of the property value. Valuations are periodically performed by management, and the real estate or other property is carried at the lower of carrying amount or fair value less estimated costs to sell. Fair value measurements are based on current formal or informal appraisals of property value compared to recent comparable sales of similar property. Independent appraisals reflecting comparable sales less than two years old are considered Level 2 measurements, while internal assessments of appraised value based on current market activity, including broker price opinions, are considered Level 3 measurements and represent a market approach to fair value. Property values are impacted by many macroeconomic factors. In general, a declining economy or rising interest rates would be expected to lower fair value of foreclosed assets while an improving economy or falling interest rates would be expected to increase fair value of foreclosed assets.

Mortgage servicing rights – Mortgage servicing rights are not measured at fair value on a recurring basis. However, mortgage servicing rights that are impaired are measured at fair value on a nonrecurring basis. Serviced loan pools are stratified by year of origination and term of the loan, and a valuation model is used to calculate the present value of expected future cash flows for each stratum. When the carrying value of a stratum exceeds its fair value, the stratum is measured at fair value. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as costs to service, a discount rate, custodial earnings rate, ancillary income, default rates and losses, and prepayment speeds. Although some of these assumptions are based on observable market data, other assumptions are based on unobservable estimates of what market participants would use to measure fair value. As a result, the fair value measurement of mortgage servicing rights is considered a Level 3 measurement and represents an income approach to fair value. When market mortgage rates decline, borrowers may have the opportunity to refinance their existing mortgage loans at lower rates, increasing the risk of prepayment of loans on which we maintain mortgage servicing rights. Therefore, declining long term interest rates would decrease the fair value of mortgage servicing rights. Significant unobservable inputs at March 31, 2013 used to measure fair value included:

Direct annual servicing cost per loan	$	50
Direct annual servicing cost per loan in process of foreclosure	$	500
Weighted average prepayment speed: CPR		54.51%
Weighted average prepayment speed: PSA		1,053.81%
Weighted average discount rate		8.09%
Asset reinvestment rate		4.00%
Short-term cost of funds		0.25%
Escrow inflation adjustment		1.00%
Servicing cost inflation adjustment		1.00%

Mortgage rate lock commitments – The fair value of mortgage rate lock commitments is measured on a recurring basis. Fair value is based on current secondary market pricing for delivery of similar loans and the value of originated mortgage servicing rights on loans expected to be delivered, which is considered a Level 2 fair value measurement.

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Interest rate swap agreements – Fair values for interest rate swap agreements are based on the amounts required to settle the contracts based on valuations provided by third-party dealers in the contracts, which is considered a Level 2 fair value measurement, and are measured on a recurring basis.

			Recurring Fair Value Measurements Using
			Quoted Prices in
			Active Markets		Significant Other		Significant
			for Identical		Observable		Unobservable
			Assets		Inputs		Inputs
(dollars in thousands)			(Level 1)		(Level 2)		(Level 3)

Assets measured at fair value on a recurring basis at March 31, 2013:

Securities available for sale:

U.S. Treasury and agency debentures	$	7,014	$	—	$	7,014	$	—
U.S. agency issued residential MBS and CMO		59,416		—		59,416		—
Privately issued residential MBS and CMO		150		—		150		—
Nonrated commercial paper		1,500		—		1,500		—
Nonrated SBA loan fund (CDFI Fund)		950		—		950		—
Other equity securities		47		—		—		47

Total securities available for sale		69,077		—		69,030		47
Mortgage rate lock commitments		59		—		59		—
Interest rate swap agreements		589		—		589		—

Total assets	$	69,725	$	—	$	69,678	$	47

Liabilities – Interest rate swap agreements	$	1,234	$	—	$	1,234	$	—

Assets measured at fair value on a recurring basis at December 31, 2012:

Securities available for sale:

U.S. Treasury and agency debentures	$	10,027	$	—	$	10,027	$	—
U.S. agency issued residential MBS and CMO		59,640		—		59,640		—
Privately issued residential MBS and CMO		173		—		173		—
Nonrated commercial paper		5,500		—		5,500		—
Other equity securities		47		—		—		47

Total securities available for sale		75,387		—		75,340		47
Loans held for sale		884		—		884		—
Mortgage rate lock commitments		91		—		91		—
Interest rate swap agreements		673		—		673		—

Total assets	$	77,035	$	—	$	76,988	$	47

Liabilities – Interest rate swap agreements	$	1,372	$	—	$	1,372	$	—

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Reconciliation of fair value measurements using significant unobservable inputs:

	Securities
	Available
(dollars in thousands)	For Sale

Balance at January 1, 2012:	$	47
Total realized/unrealized gains and (losses):
Included in earnings		—
Included in other comprehensive income		—
Purchases, maturities, and sales		—
Transferred from Level 2 to Level 3		—
Transferred to held to maturity classification		—

Balance at March 31, 2012	$	47

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 March 31, 2012	$	—

Balance at January 1, 2013	$	47
Total realized/unrealized gains and (losses):
Included in earnings		—
Included in other comprehensive income		—
Purchases, maturities, and sales		—
Transferred from Level 2 to Level 3		—
Transferred to held to maturity classification		—

Balance at March 31, 2013	$	47

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 March 31, 2013	$	—

			Nonrecurring Fair Value Measurements Using
			Quoted Prices in
			Active Markets		Significant Other		Significant
			for Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	($000s)		(Level 1)		(Level 2)		(Level 3)

Assets measured at fair value on a nonrecurring basis at March 31, 2013:

Impaired loans	$	3,075	$	—	$	869	$	2,206
Foreclosed assets		1,822		—		797		1,025
Mortgage servicing rights		1,443		—		—		1,443

Total assets	$	6,340	$	—	$	1,666	$	4,674


Assets measured at fair value on a nonrecurring basis at December 31, 2012:

Impaired loans	$	2,973	$	—	$	328	$	2,645
Foreclosed assets		1,774		—		752		1,022
Mortgage servicing rights		1,233		—		—		1,233

Total assets	$	5,980	$	—	$	1,080	$	4,900

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At March 31, 2013, loans with a carrying amount of $4,009 were considered impaired and were written down to their estimated fair value of $3,075 net of a valuation allowance of $934. At December 31, 2012, loans with a carrying amount of $3,955 were considered impaired and were written down to their estimated fair value of $2,973, net of a valuation allowance of $982. Changes in the valuation allowances are reflected through earnings as a component of the provision for loan losses or as a charge-off against the allowance for loan losses.

At March 31, 2013, foreclosed assets with a carrying amount of $2,400 had been written down to a fair value of $1,822, less costs to sell. During the quarter ended March 31, 2013, foreclosed assets with a fair value of $277 were acquired through or in lieu of foreclosure, which is the fair value net of estimated costs to sell. No write-downs to fair value were included in earnings during the quarter ended March 31, 2013.

At December 31, 2012, foreclosed assets with a carrying amount of $2,352 had been written down to a fair value of $1,774, less costs to sell. During the quarter ended March 31, 2012, foreclosed assets with a fair value of $358 were acquired through or in lieu of foreclosure, which is the fair value net of estimated costs to sell. An impairment charge of $189 was recorded as a reduction to earnings during the quarter ended March 31, 2012.

At March 31, 2013, mortgage servicing rights with a carrying amount of $1,600 were considered impaired and were written down to their estimated fair value of $1,443, resulting in an impairment allowance of $157. At December 31, 2012, mortgage servicing rights with a carrying amount of $1,513 were considered impaired and were written down to their estimated fair value of $1,233, resulting in an impairment allowance of $280. Changes in the impairment allowances are reflected through earnings as a component of mortgage banking income.

PSB estimates fair value of all financial instruments regardless of whether such instruments are measured at fair value. The following methods and assumptions were used by PSB to estimate fair value of financial instruments not previously discussed.

Cash and cash equivalents – Fair value reflects the carrying value of cash, which is a Level 1 measurement.

Securities held to maturity – Fair value of securities held to maturity is based on dealer quotations on similar securities near period-end, which is considered a Level 2 measurement. Certain debt issued by banks or bank holding companies purchased by PSB as securities held to maturity is valued on a cash flow basis discounted using market rates reflecting credit risk of the borrower, which is considered a Level 3 measurement.

Bank certificates of deposit – Fair value of fixed rate certificates of deposit included in other investments is estimated by discounting future cash flows using current rates at which similar certificates could be purchased, which is a Level 3 measurement.

Loans – Fair value of variable rate loans that reprice frequently are based on carrying values. Loans with an active sale market, such as one- to four-family residential mortgage loans, estimate fair value based on sales of loans with similar structure and credit quality. Fair value of other loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings. Fair value of impaired and other nonperforming loans are estimated using discounted expected future cash flows or the fair value of underlying collateral, if applicable. Except for collateral dependent impaired loans valued using an independent appraisal of collateral value, reflecting a Level 2 fair value measurement, fair value of loans is considered to be a Level 3 measurement due to internally developed discounted cash flow measurements.

Federal Home Loan Bank stock – Fair value is the redeemable (carrying) value based on the redemption provisions of the Federal Home Loan Bank, which is considered a Level 3 fair value measurement.

Accrued interest receivable and payable – Fair value approximates the carrying value, which is considered a Level 3 fair value measurement.

Cash value of life insurance – Fair value is based on reported values of the assets by the issuer which are redeemable to the insured, which is considered a Level 1 fair value measurement.

Deposits – Fair value of deposits with no stated maturity, such as demand deposits, savings, and money market accounts, by definition, is the amount payable on demand on the reporting date. Fair value of fixed rate time deposits is estimated using discounted cash flows applying interest rates currently offered on issue of similar time deposits. Use of internal discounted cash flows provides a Level 3 fair value measurement.

FHLB advances and other borrowings – Fair value of fixed rate, fixed term borrowings is estimated by discounting future cash flows using the current rates at which similar borrowings would be made as calculated by the lender or correspondent. Fair value of borrowings with variable rates or maturing within 90 days approximates the carrying value of these borrowings. Fair values based on lender provided settlement provisions are considered a Level 2 fair value measurement. Other borrowings with local customers in the form of repurchase agreements are estimated using internal assessments of discounted future cash flows, which is a Level 3 measurement.

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Senior subordinated notes and junior subordinated debentures – Fair value of fixed rate, fixed term notes and debentures are estimated internally by discounting future cash flows using the current rates at which similar borrowings would be made, which is a Level 3 fair value measurement.

The carrying amounts and fair values of PSB’s financial instruments consisted of the following at March 31, 2013:

	March 31, 2013
	Carrying		Estimated		Fair Value Hierarchy Level
	Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets ($000s):

Cash and cash equivalents	$	12,852	$	12,852	$	12,852	$	—	$	—
Securities		140,565		142,838		—		140,996		1,842
Bank certificates of deposit		4,465		4,539		—		—		4,539
Net loans receivable and loans held for sale		492,588		497,603		—		869		496,734
Accrued interest receivable		2,389		2,389		—		—		2,389
Mortgage servicing rights		1,443		1,443		—		—		1,443
Mortgage rate lock commitments		59		59		—		59		—
FHLB stock		2,906		2,906		—		—		2,906
Cash surrender value of life insurance		11,911		11,911		11,911		—		—
Interest rate swap agreements		589		589		—		589		—

Financial liabilities ($000s):

Deposits	$	531,173	$	533,436	$	—	$	—	$	533,436
FHLB advances		58,124		59,348		—		59,348		—
Other borrowings		23,129		24,289		—		14,771		9,518
Senior subordinated notes		4,000		3,481		—		—		3,481
Junior subordinated debentures		7,732		4,801		—		—		4,801
Interest rate swap agreements		1,234		1,234		—		1,234		—
Accrued interest payable		475		475		—		—		475

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The carrying amounts and fair values of PSB’s financial instruments consisted of the following at December 31, 2012:

	December 31, 2012
	Carrying		Estimated		Fair Value Hierarchy Level
	Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets ($000s):

Cash and cash equivalents	$	48,847	$	48,847	$	48,847	$	—	$	—
Securities		145,209		147,751		—		145,795		1,956
Bank certificates of deposit		4,465		4,538		—		—		4,538
Net loans receivable and loans held for sale		478,875		484,925		—		1,212		483,713
Accrued interest receivable		2,157		2,157		—		—		2,157
Mortgage servicing rights		1,233		1,233		—		—		1,233
Mortgage rate lock commitments		91		91		—		91		—
FHLB stock		2,506		2,506		—		—		2,506
Cash surrender value of life insurance		11,813		11,813		11,813		—		—
Interest rate swap agreements		673		673		—		673		—

Financial liabilities ($000s):

Deposits	$	565,442	$	568,014	$	—	$	—	$	568,014
FHLB advances		50,124		51,590		—		51,590		—
Other borrowings		20,728		22,118		—		14,890		7,228
Senior subordinated notes		7,000		7,000		—		—		7,000
Junior subordinated debentures		7,732		4,911		—		—		4,911
Interest rate swap agreements		1,372		1,372		—		1,372		—
Accrued interest payable		697		697		—		—		697

NOTE 16 – CURRENT YEAR AND COMPARABLE PRIOR YEAR PERIOD ACCOUNTING CHANGES

FASB ASC Topic 210, “Balance Sheet.” In January 2013, clarifications were issued of new authoritative accounting guidance first issued in December 2011 concerning disclosure of information about offsetting and related arrangements associated with derivative instruments. The clarifications and originally issued guidance require additional disclosures associated with offsetting and collateral arrangements with derivative instruments to enable users of PSB’s financial statements to understand the effect of those arrangements on its financial position beginning March 31, 2013. These new disclosures were added as necessary during the quarter ended March 31, 2013 and did not have a significant impact to the reporting of PSB’s financial results upon adoption.

FASB ASC Topic 805, Business Combinations. In October 2012, new authoritative accounting guidance was issued that addressed accounting for an indemnification asset acquired as a result of a government-assisted acquisition of a financial institution when a subsequent change in cash flows expected to be collected is identified. After identification of the new cash flows, the reporting entity should subsequently account for the change in the measurement of the indemnification asset on the same basis as accounting for the change in the assets subject to the indemnification. Amortization of these changes in value is limited to the remaining contractual term of the indemnification agreement. These new rules became effective for changes in cash flows identified beginning January 1, 2013. Adoption of this new guidance did not have an impact on PSB’s financial statements.

FASB ASC Topic 220, Comprehensive Income. In February 2013, new authoritative accounting guidance was issued which required PSB to report the effect of significant reclassifications out of accumulated other comprehensive income in a footnote to the financial statements. The disclosure was effective beginning March 31, 2013 on a prospective basis. The change did not have a significant impact on PSB’s financial reporting or results of operations upon adoption.

FASB ASC Topic 220, “Comprehensive Income.” In June 2011, new authoritative accounting guidance was approved that required changes to the presentation of comprehensive net income. Effective during the quarter ended March 31, 2012, PSB began to present comprehensive income as a separate financial statement directly after the basic income statement. Adoption of the new presentation standards for comprehensive income did not have any financial impact to PSB’s financial results or operations.

FASB ASC Topic 820, “Fair Value Measurements.” In May 2011, new authoritative accounting guidance concerning fair value measurements was issued. Significant provisions of the new guidance now require both domestic and international companies to follow existing United States guidance in measuring fair value. In addition, certain Level 3 unobservable inputs and impacts to fair value from sensitivity of these inputs to changes must be disclosed. Lastly, the level of fair value hierarchy used to estimate fair value of financial instruments not accounted for at fair value on the balance sheet (such as loans receivable and deposits) must be disclosed. These new disclosures were adopted during the quarter ended March 31, 2012 and did not have a significant impact to PSB financial reporting or operations.

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NOTE 17 – SUBSEQUENT EVENTS

Management has reviewed PSB’s operations for potential disclosure of information or financial statement impacts related to events occurring after March 31, 2013 but prior to the release of these financial statements. Based on the results of this review, no subsequent event disclosures or financial statement impacts to the recently completed quarter are required as of the release date.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis (“MD&A”) reviews significant factors with respect to our financial condition as of March 31, 2013 compared to December 31, 2012 and results of our operations for the three months ended March 31, 2013 compared to the results of operations for the three months ended March 31, 2012. The following MD&A concerning our operations is intended to satisfy three principal objectives:

Provide a narrative explanation of our financial statements that enables investors to see the company through the eyes of management.

Enhance the overall financial disclosure and provide the context within which our financial information should be analyzed.

Provide information about the quality of, and potential variability of, our earnings and cash flow, so that investors can ascertain the likelihood that past performance is, or is not, indicative of future performance.

Management’s discussion and analysis, like other portions of this Quarterly Report on Form 10-Q, includes forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, our anticipated future financial performance involves risks and uncertainties that may cause actual results to differ materially from those described in our forward-looking statements. A cautionary statement regarding forward-looking statements is set forth under the caption “Forward-Looking Statements” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012, and, from time to time, in our other filings with the Securities Exchange Commission. We do not intend to update forward-looking statements. This discussion and analysis should be considered in light of that cautionary statement. Additional risk factors relating to an investment in our common stock are also described under Item 1A of the 2012 Annual Report on Form 10-K.

This discussion should be read in conjunction with the consolidated financial statements, notes, tables, and the selected financial data presented elsewhere in this report. All figures are in thousands, except per share data and per employee data.

EXECUTIVE OVERVIEW

Results of Operations

March 2013 quarterly earnings were $.97 per share on net income of $1,609 compared to earnings of $.70 per share on net income of $1,180 during the March 2012 quarter, up 36%. March 2013 earnings benefited from higher net interest income compared to March 2012, up $385, or 8%, as total average interest earning assets increased 14% over the prior year quarter including $33 million in organic loan growth (up 8%) and the June 2012 acquisition of Marathon State Bank (“Marathon”) which added $24 million in loans. Noninterest income also increased $173 during the March 2013 quarter compared to March 2012, led by record investment sales commissions and higher mortgage refinance income. This additional revenue offset increased operating expenses, up $307, or 8%, excluding loss on foreclosed assets for both years and $117 in Marathon merger professional expenses incurred in March 2012. Total quarterly credit costs, including provision for loan losses and loss on foreclosed assets, declined $64, or 16%, during the March 2013 quarter compared to the March 2012 quarter as nonperforming assets declined $6.9 million, or 37%, during the past 12 months. Lastly, the March 2013 quarterly provision for income tax expense was reduced $73 for benefits realized on amendment of Marathon’s previously filed tax returns. Excluding the March 2013 benefit from amended tax returns and March 2012 professional fee expense, both of which were associated with the purchase of Marathon, March 2013 earnings were $.93 per share compared to $.77 per share during March 2012, up 21%.

Looking ahead to the June 2013 quarter, net income growth will be challenged by continued downward pressure on net interest margin, an expected decline in mortgage banking refinance activity and retail investment sales commission income, and stable provisions for loan losses. Declining credit costs, including provision for loan losses and loss on foreclosed assets, is not expected to be a significant driver to net income growth during 2013 as it was during 2012.

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Credit Quality

March 31, 2013 nonperforming assets were 1.74% of total assets compared to 1.75% at December 31, 2012 and 3.11% at March 31, 2012.Total nonperforming assets decreased $528, or 4%, since December 31, 2012, and decreased $6,924, or 37%, since March 31, 2012. During the past year, the improvement in nonperforming assets was due to a $4,168 reduction in accruing restructured loans repaid on certain borrowers’ sale of collateral, and a $1,286 reduction in foreclosed assets from sale of our largest foreclosed property held since 2009. At March 31, 2013, the allowance for loan losses was $7,434, or 1.49% of total loans (74% of nonperforming loans), compared to $7,431, or 1.53% of total loans (70% of nonperforming loans) at December 31, 2012, and $7,755, or 1.75% of total loans (52% of nonperforming loans) at March 31, 2012. Net charge-offs of loan principal were $320 during the quarter ended March 31, 2013 compared to $346 during the March 2012 quarter. Annualized net loan charge-offs declined slightly and were 0.26% and 0.31% of total loans during the quarters ended March 31, 2013, and 2012, respectively.

Asset Growth and Liquidity

Total assets were $685.4 million at March 31, 2013, down $26.5 million (3.7%) since December 31, 2012, but up $78.6 million (13.0%) since March 31, 2012. Assets since March 2012 increased on the purchase of Marathon during June 2012. Marathon held $107.4 million of assets on the purchase date including cash equivalents, securities, and other short-term investments totaling $82.7 million. Since the purchase, a portion of Marathon’s cash and securities have been used to reduce wholesale funding (including brokered certificates of deposit, Federal Home Loan Bank advances, and wholesale repurchase agreements) which declined to $124.3 million at March 31, 2013 compared to $132.5 million at March 31, 2012, down 6.2%.

Total assets declined since December 31, 2012 as $36.0 million in short-term cash and cash equivalents were used to support $32.5 million in local deposit withdrawals including seasonal deposits totaling $24.4 million from commercial and municipal depositors. An $8.0 million increase in FHLB borrowings and $4.6 million of maturing investment security cash flow was used to fund $8.9 million in residential real estate mortgage net loan growth and $5.0 million in commercial related net loan growth. During the quarter ended March 31, 2013, Marathon branch deposits (excluding short-term seasonal deposits) declined $2.3 million, or 2.5%, led by a $2.4 million decline in certificates of deposit.

During the remainder of 2013, PSB expects to fund future loan and asset growth from a combination of additional wholesale funding, primarily brokered or national certificates of deposits and FHLB advances, and local deposit growth. PSB regularly maintains access to wholesale markets to fund loan originations and manage local depositor needs. At March 31, 2013, unused and available wholesale funding was approximately $261 million, or 38% of total assets, compared to $273 million, or 38% of total assets at December 31, 2012. Unused wholesale funding sources include federal funds purchased lines of credit, Federal Reserve Discount Window advances, FHLB advances, brokered and national certificates of deposit, and a holding company correspondent bank line of credit.

Capital Resources

During the quarter ended March 31, 2013, stockholders’ equity increased $1,259 primarily from $1,609 of net income less $238 used to repurchase 8,930 shares of stock on the open market at an average price of $26.62 per share. During the March 2012 quarter, 200 shares of common stock were repurchased at an average price of $23.25 per share.

On February 1, 2013, PSB refinanced $7 million of 8% senior subordinated notes with $1 million of cash and $6 million in proceeds from issuance of new debt. The new debt includes $4 million of privately placed senior subordinated notes carrying a 3.75% fixed interest rate with interest only payments, due in 2018, and $2 million in a fully amortizing term note with a correspondent bank carrying a floating rate of interest and maturing in 2015. Although the previous 8% notes qualified as Tier 2 regulatory capital, the new $6 million in notes do not qualify as Tier 2 regulatory capital, which reduced the total regulatory capital ratio from 14.87% at December 31, 2012 to 13.66% at March 31, 2013. The refinancing is expected to reduce interest expense by $322 during 2013 compared to 2012. Interest expense on senior subordinated notes was $72 and $142 during the quarters ended March 31, 2013 and 2012, respectively and contributed to increased quarterly net income in 2013 compared to the prior year.

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Net book value increased to $33.71 per share at March 31, 2013, compared to $30.96 per share at March 31, 2012, an increase of 8.9%. PSB’s common equity to assets ratio increased to 8.13% at March 31, 2013 compared to 7.65% at December 31, 2012 due to increased retained earnings and a 3.7% reduction in assets during the quarter. However, the equity to assets ratio continues to be less than 8.48% at March 31, 2012 due to the purchase of Marathon in the June 2012 quarter using existing cash on hand without the issuance of new common stock. For regulatory purposes, the $7.7 million junior subordinated debentures maturing September 2035 reflected as debt on the Consolidated Balance Sheet are reclassified as Tier 1 regulatory equity capital. We were considered “well capitalized” under banking regulations at March 31, 2013.

During 2012, the banking regulatory agencies, including the Board of Governors of the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC), issued two new regulatory capital proposals that are likely to have a significant impact on our regulatory capital needs if finalized. Among other significant changes, the proposal would phase out our current $7.7 million of junior subordinated debentures from Tier 1 capital and move them to Tier 2 capital classification over a 10 year period beginning in 2013. This change would reduce our leverage capital ratio and our Tier 1 risk adjusted capital ratio. Separately, proposed changes to the calculation of risk weighted assets during 2015 would increase the denominator of risk adjusted capital ratios, including the Tier 1 capital and Tier 2 (“Total”) capital ratio, which would reduce our risk adjusted capital ratios. The regulatory agencies have estimated that industry wide total risk adjusted assets are likely to increase an average of 20% due to the proposed changes. Lastly, under the proposal, minimum capital ratios to be considered well capitalized, including the impact of the proposed “capital buffer,” would be 6.50% for the leverage ratio, 8.50% for the Tier 1 to risk adjusted capital ratio, and 10.50% for the total risk adjusted capital ratio, up from 5.00%, 6.00%, and 10.00%, respectively.

We continue to internally review the timing and extent of the proposed changes on our regulatory capital position. As a reference for this discussion, assuming the immediate loss of junior subordinated debentures as Tier 1 capital and a 20% increase in total risk adjusted assets, our pro forma March 31, 2013 leverage ratio would have been 7.91% instead of 9.00%, our Tier 1 risk adjusted capital ratio would have been 9.09% instead of 12.41%, and our total risk adjusted capital ratio would have been 11.59% instead of 13.66%. Increased regulatory capital requirements could impact our ability to pay shareholder cash dividends of profits, repurchase shares of treasury stock, or the pace of which we could grow in assets, both organically and via merger and acquisition activities.

Therefore, although no current plans exist, future capital needs during the next several years would likely be met by issuance of our authorized common or preferred stock as needed. Due to relatively high cost of capital options, required debt service payments on our new February 1, 2013 $2 million correspondent bank loan, expected higher regulatory capital demands, and potential future merger and acquisition activities requiring capital, we do not expect to buy back significant common stock shares during the next several quarters. We do expect to continue to pay our traditional semi-annual cash dividend assuming continued profitable operations and projections of adequate future capital levels for growth.

Off Balance –Sheet Arrangements and Contractual Obligations

Our largest volume off-balance sheet activity involves our servicing of payments and related collection activities on approximately $270 million of residential 1 to 4 family mortgages sold to FHLB and FNMA at March 31, 2013. At March 31, 2013, we provided a credit enhancement against FHLB loss under five separate “master commitments” associated with 12% of the total serviced principal (down from 13% at December 31, 2012), up to a maximum guarantee of $1.9 million in the aggregate. However, we would incur such loss only if the FHLB first lost $1.8 million on this remaining loan pool of approximately $33 million as part of their “First Loss Account” (discussed here in the aggregate, although the guarantee is applied on an individual master commitment basis). Since inception of our guarantees to the FHLB beginning in 2000, only $0.4 million of $425 million of loans originated with guarantees have represented a principal loss, all of which has been borne by the FHLB within their First Loss Account. No loans have been sold by us to the FHLB with our Credit Enhancement Guarantee of principal since October 2008 and we do not intend to originate future loans with the guarantee.

During the March 2013 quarter, a provision for serviced mortgage loan recourse liability of $203 was recorded as a reduction to mortgage banking income. A recourse loss of $125 was charged against the liability during March 2013 due to foreclosure losses on a mortgage sold to the FHLB that was determined to have been improperly underwritten. This loan and other loans originated by a former employee were reviewed and the situation is believed to be isolated, although a $78 recourse liability continued to be maintained at March 31, 2013. Total representation and warranty losses on loans improperly underwritten totaled $28 and $38 during the years ended 2012 and 2011, respectively. No recourse liability was maintained at December 31, 2012.

We also utilize interest rate swaps to hedge costs associated with certain variable rate debt (notional amount of $7,500 at March 31, 2013) and as a tool for our customers to obtain long-term fixed rate commercial loan financing (offsetting notional amounts of $14,816). These arrangements and related off balance sheet commitments are outlined in Note 9 in the Notes to Consolidated Financial Statements. Aggregate net unrealized losses on fair value of all interest rate swaps determined by offsetting all swap positions were $645 and $699 at March 31, 2013 and December 31, 2012, respectively before tax impacts.

We provide various commitments to extend credit for both commercial and consumer purposes totaling approximately $106 million at March 31, 2013 compared to $105 million at December 31, 2012. These lending commitments are a traditional and customary part of lending operations and many of the commitments are expected to expire without being drawn upon.

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RESULTS OF OPERATIONS

Earnings

Quarter ended March 31, 2013 compared to March 31, 2012

March 2013 quarterly earnings were $1,609, or $.97 per diluted share compared to $1,180, or $.70 per diluted share during March 2012, an increase of $429, or $.27 per share, up 36%. March 2013 earnings benefited from higher net interest income compared to March 2012, up $385, or 8%, as total average interest earning assets increased 14% over the prior year quarter from organic loan growth and the June 2012 acquisition of Marathon. Noninterest income also increased $173 during the March 2013 quarter compared to March 2012, led by record investment sales commissions and higher mortgage refinance income. This additional revenue offset increased operating expenses, up $307, or 8%, excluding loss on foreclosed assets for both years and $117 in Marathon merger professional expenses incurred in March 2012. Total quarterly credit costs, including provision for loan losses and loss on foreclosed assets, declined $64, or 16%, during the March 2013 quarter compared to the March 2012 quarter as nonperforming assets declined $6.9 million, or 37%, during the past 12 months. Lastly, the March 2013 quarterly provision for income tax expense was reduced $73 for benefits realized on amendment of Marathon’s previously filed tax returns. Excluding the March 2013 benefit from amended tax returns and March 2012 professional fee expense, both of which were associated with the purchase of Marathon, March 2013 earnings were $.93 per share compared to $.77 per share during March 2012, up 21%. Refer to Table 1 below for a presentation of net income and earnings per share both before and after non-recurring items. Table 2 below outlines key financial performance metrics for five linked quarters ending March 31, 2013.

We do not expect to experience quarter over quarter increased earnings as great as that seen during the March 2013 quarter compared to the March 2012 quarter during the remainder of 2013 due to downward pressure on net interest margin and a decline in mortgage banking income as interest rates stabilize and after several periods of long-term mortgage rate declines. Offsetting these negative trends are increased earning assets, which we expect will cause a continued increase in net interest income despite a decline in net margin, as well as a decline in noninterest expenses compared to 2012, which included the Marathon acquisition and conversion costs. All things considered, we expect earnings per share during the year ended December 31, 2013 to be similar to those seen during 2012, assuming continued improvement in credit quality trends.

Table 1: Impact of Special Income and Expense Items on Continuing Operations (a non-GAAP measure)

	Quarter ended March 31,
($000s, net of income tax effects)	2013			2012

Net income from continuing operations before credit costs	$	1,735		$	1,535
Less: Credit costs		(199	)		(238	)

Net income from continuing operations after credit costs		1,536			1,297
Add: Benefit from amendment of Marathon income tax returns		73			—
Less: Marathon merger related expenses		—			(117	)

Net income	$	1,609		$	1,180

	Quarter ended March 31,
(per diluted share, net of income tax effects)	2013			2012

Net income from continuing operations before credit costs	$	1.05		$	0.91
Less: Credit costs		(0.12	)		(0.14	)

Net income from continuing operations after credit costs		0.93			0.77
Add: Benefit from amendment of Marathon income tax returns		0.04			—
Less: Marathon merger related expenses		—			(0.07	)
					—
Net income	$	0.97		$	0.70

Return on average assets was .95% (.90% before the Marathon tax benefit) and .78% (.86% before the Marathon merger related expenses) during the quarters ended March 31, 2013, and 2012, respectively. Return on average stockholders’ equity was 11.83% (11.30% before the Marathon tax benefit) and 9.30% (10.23% before the Marathon merger related expenses) during the quarters ended March 31, 2013 and 2012, respectively.

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The following Table 2 presents PSB’s consolidated quarterly summary financial data.

Table 2: Financial Summary

(dollars in thousands, except per share data)			Quarter ended
	March 31,		December 31,		September 30,		June 30,		March 31,
Earnings and dividends:	2013		2012		2012		2012		2012

Net interest income	$	5,201	$	5,294	$	5,163	$	4,880	$	4,816
Provision for loan losses	$	323	$	460	$	—	$	165	$	160
Other noninterest income	$	1,415	$	1,559	$	1,444	$	2,323	$	1,242
Other noninterest expense	$	4,082	$	4,349	$	4,860	$	4,064	$	4,119
Net income	$	1,609	$	1,685	$	1,226	$	1,918	$	1,180

Basic earnings per share ⁽³⁾	$	0.97	$	1.01	$	0.74	$	1.15	$	0.70
Diluted earnings per share ⁽³⁾	$	0.97	$	1.01	$	0.74	$	1.15	$	0.70
Dividends declared per share ⁽³⁾	$	—	$	0.38	$	—	$	0.36	$	—
Net book value per share	$	33.71	$	32.93	$	32.34	$	31.64	$	30.96

Semi-annual dividend payout ratio		n/a		23.42%		n/a		19.44%		n/a
Average common shares outstanding		1,656,162		1,662,929		1,663,472		1,663,410		1,663,138

Balance sheet – average balances:

Loans receivable, net of allowances for loss	$	485,495	$	472,096	$	460,697	$	447,886	$	436,907
Assets	$	689,687	$	691,688	$	698,103	$	639,404	$	607,917
Deposits	$	541,672	$	546,371	$	550,564	$	493,349	$	466,121
Stockholders’ equity	$	55,137	$	54,661	$	53,440	$	52,835	$	51,016

Performance ratios:

Return on average assets ⁽¹⁾		0.95%		0.97%		0.70%		1.21%		0.78%
Return on average stockholders’ equity ⁽¹⁾		11.83%		12.26%		9.13%		14.60%		9.30%
Average stockholders’ equity less
accumulated other comprehensive income
(loss) to average assets		7.82%		7.71%		7.44%		8.01%		8.10%
Net loan charge-offs to average loans ⁽¹⁾		0.26%		0.38%		0.19%		0.24%		0.31%
Nonperforming loans to gross loans		2.02%		2.20%		2.93%		2.95%		3.38%
Allowance for loan losses to gross loans		1.49%		1.53%		1.55%		1.61%		1.75%
Nonperforming assets to tangible equity
plus the allowance for loan losses ⁽⁴⁾		19.33%		20.54%		28.59%		29.34%		32.44%
Net interest rate margin ⁽¹⁾⁽²⁾		3.37%		3.38%		3.37%		3.42%		3.50%
Net interest rate spread ⁽¹⁾⁽²⁾		3.20%		3.19%		3.21%		3.20%		3.27%
Service fee revenue as a percent of
average demand deposits ⁽¹⁾		1.89%		1.94%		2.17%		2.41%		2.66%
Noninterest income as a percent of gross revenue		17.60%		18.35%		17.24%		25.81%		15.65%
Efficiency ratio ⁽²⁾		59.50%		61.31%		70.89%		54.85%		66.04%
Noninterest expenses to average assets ⁽¹⁾		2.40%		2.50%		2.77%		2.56%		2.73%

Stock price information:

High	$	28.50	$	28.75	$	29.20	$	26.67	$	24.76
Low	$	25.30	$	25.50	$	24.50	$	21.81	$	21.86
Last trade value at quarter-end	$	28.00	$	26.00	$	28.75	$	25.24	$	24.76

⁽¹⁾	Annualized

⁽²⁾	The yield on tax-exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%.

⁽³⁾	Due to rounding, cumulative quarterly per share performance may not equal annual per share totals.

⁽⁴⁾	Tangible stockholders’ equity excludes intangible assets and any preferred stock capital elements.

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Net Interest Income

Quarter ended March 31, 2013 compared to March 31, 2012

Net interest income is the most significant component of earnings. Tax adjusted net interest income totaled $5,446 during the March 2013 quarter compared to $4,995 during the March 2012 quarter, an increase of $451, or 9.0%. Increased net interest income was due to an increase in average earning assets during the March 2013 quarter compared to March 2012, which increased $80,423, or 14.0%, due to the acquisition of Marathon during the June 2012 quarter. Refer to Note 2 of the Notes to Consolidated Financial Statements for information on assets acquired with the Marathon purchase.

Tax adjusted net interest margin was 3.37% during the March 2013 quarter compared to 3.38% during the linked December 2012 quarter’s net margin and 3.50% during the March 2012 quarter. During the December 2012 quarter, net interest income benefited from resolution of past due interest due PSB on its investment in trust preferred debentures issued by Johnson Financial Group, Inc. December 2012 quarterly net interest income before consideration of the $105 interest payment from Johnson would have been $5,430 and net margin would have been 3.31%. Net margin declined during the March 2013 quarter compared to the March 2012 as earning asset yields fell faster than the cost of interest bearing liabilities as deposits and other liabilities remain near functional minimums in an extended exceptionally low rate environment.

Although net interest income increased over prior quarterly periods from increased average earning assets, net margin remains under significant pressure from falling loan yields. During the quarter ended March 31, 2013, loan yields declined .19% (to 4.72%) while the average deposit cost declined only .08% (to .58%) compared to the linked December 2012 quarter. Most of the increased March 2013 net margin compared to the December 2012 quarter (excluding past due interest collected on the Johnson investment) was due to reduced senior subordinated debt interest expense following the February 1, 2013 refinance to lower the interest rate. Refer to Note 8 of the Notes to Consolidated Financial Statements for details on the subordinated note refinance.

In light of very low market rates and intense competition for high credit quality loan growth, PSB expects loan yields during the upcoming quarter to decline as maturities and originations are repriced at rates lower than the current portfolio. The decline in loan yield may be greater than deposit costs can be reduced with deposit rates already near functional minimums. In addition, PSB expects investment securities yields to continue to decline during the June 2013 quarter as maturing funds are reinvested into significantly lower market yields. However, approximately $27 million of existing wholesale funding with a 2.52% average cost is scheduled to mature or be repriced during the remainder of 2013. Lower wholesale funding costs, including on the refinanced senior subordinated notes, and increased average earning assets during 2013 compared to 2012 are expected to support net interest income growth during the June 2013 quarter.

During the March 2013 and March 2012 quarters, net interest margin benefited from interest rate floors on certain commercial-related loans and retail residential home equity lines of credit. The coupon rate on approximately $74 million, or 15.8%, of gross loans at March 31, 2013 was supported by an average interest rate floor approximately 123 basis points greater than the normal adjustable rate. If current interest rate levels were assumed to remain the same, the annualized increase to net interest income and net interest margin was approximately $910 and .14%, respectively, based on those existing loan floors and average total earning assets during the quarter ended March 31, 2013. During a period of rising short-term interest rates, we expect average funding costs (which are not currently subject to contractual caps on the interest rate) to rise while the yield on loans with interest rate floors would remain the same until those loans’ adjustable rate index caused coupon rates to exceed the loan rate floor. The speed in which short-term interest rates increase is expected to have a significant impact on net interest income from loans with interest rate floors. Quickly rising short-term rates would allow adjustable rate loans with floors to reprice to rates higher than the existing floor faster, impacting net interest income less adversely than if short-term rates rose slowly or deliberately.

At March 31, 2012, the coupon rate on approximately $102 million, or 22.9%, of gross loans at March 31, 2012 was supported by an average interest rate floor approximately 142 basis points greater than the normal adjustable rate. The annualized increase to net interest income and net interest margin was approximately $1,444 and .25%, respectively, based on those existing loan floors and average total earning assets during the quarter ended March 31, 2012.

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The following Tables present a schedule of yields and costs for the three months ended March 31, 2013, compared to the prior year period ended March 31, 2012, and the interest income and expense volume and rate analysis for the three months ended March 31, 2013, compared to the three months ended March 31, 2012.

Table 3: Net Interest Income Analysis (Quarter)

(dollars in thousands)	Quarter ended March 31, 2013							Quarter ended March 31, 2012
	Average					Yield/		Average					Yield/
	Balance			Interest		Rate		Balance			Interest		Rate
Assets
Interest-earning assets:
Loans ⁽¹⁾⁽²⁾	$	492,977		$	5,740		4.72%	$	444,962		$	5,885		5.32%
Taxable securities		91,316			541		2.40%		78,848			572		2.92%
Tax-exempt securities ⁽²⁾		51,984			565		4.41%		30,439			398		5.26%
FHLB stock		2,675			1		0.15%		3,056			1		0.13%
Other		16,240			22		0.55%		17,464			18		0.41%

Total ⁽²⁾		655,192			6,869		4.25%		574,769			6,874		4.81%

Non-interest-earning assets:
Cash and due from banks		9,934							8,413
Premises and equipment, net		10,207							9,918
Cash surrender value insurance		11,851							11,445
Other assets		9,985							11,427
Allowance for loan losses		(7,482	)						(8,055	)

Total	$	689,687						$	607,917

Liabilities and stockholders’ equity
Interest-bearing liabilities:
Savings and demand deposits	$	181,768		$	114		0.25%	$	135,723		$	222		0.66%
Money market deposits		122,311			104		0.34%		107,403			173		0.65%
Time deposits		160,139			562		1.42%		162,175			757		1.88%
FHLB borrowings		52,680			330		2.54%		51,267			352		2.76%
Other borrowings		21,154			157		3.01%		19,072			148		3.12%
Senior subordinated notes		5,500			72		5.31%		7,000			142		8.16%
Junior subordinated debentures		7,732			84		4.41%		7,732			85		4.42%

Total		551,284			1,423		1.05%		490,372			1,879		1.54%

Non-interest-bearing liabilities:
Demand deposits		77,454							60,820
Other liabilities		5,812							5,709
Stockholders’ equity		55,137							51,016

Total	$	689,687						$	607,917
Net interest income				$	5,446						$	4,995
Rate spread							3.20%							3.27%
Net yield on interest-earning assets							3.37%							3.50%

⁽¹⁾	Nonaccrual loans are included in the daily average loan balances outstanding.

⁽²⁾	The yield on tax-exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%.

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Table 4: Interest Income and Expense Volume and Rate Analysis (Year to Date)

Three months ended March 31, 2013

	2013 compared to 2012
	increase (decrease) due to (1)
(dollars in thousands)		Volume			Rate			Net

Interest earned on:
Loans ⁽²⁾		$	559		$	(704	)	$	(145	)
Taxable securities			74			(105	)		(31	)
Tax-exempt securities ⁽²⁾			234			(67	)		167
Other interest income			(2	)		6			4

Total			865			(870	)		(5	)

Interest paid on:
Savings and demand deposits			28			(136	)		(108	)
Money market deposits			12			(81	)		(69	)
Time deposits			(7	)		(188	)		(195	)
FHLB borrowings			9			(31	)		(22	)
Other borrowings			15			(6	)		9
Senior subordinated notes			(20	)		(50	)		(70	)
Junior subordinated debentures			—			(1	)		(1	)

Total			37			(493	)		(456	)

Net interest earnings		$	828		$	(377	)	$	451

⁽¹⁾	The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

⁽²⁾	The yield on tax-exempt loans and investment securities has been adjusted to its fully taxable equivalent using a 34% tax rate.

Interest Rate Sensitivity

We incur market risk primarily from interest-rate risk inherent in our lending and deposit taking activities. Market risk is the risk of loss from adverse changes in market prices and rates. We actively monitor and manage our interest-rate risk exposure. The measurement of the market risk associated with financial instruments (such as loans and deposits) is meaningful only when all related and offsetting on- and off-balance sheet transactions are aggregated, and the resulting net positions are identified. Disclosures about the fair value of financial instruments that reflect changes in market prices and rates can be found in Note 15 of the Notes to Consolidated Financial Statements.

Our primary objective in managing interest-rate risk is to minimize the adverse impact of changes in interest rates on net interest income and capital, while adjusting the asset-liability structure to obtain the maximum yield-cost spread on that structure. We rely primarily on our asset-liability structure reflected on the Consolidated Balance Sheets to control interest-rate risk. In general, longer-term earning assets are funded by shorter-term funding sources allowing us to earn net interest income on both the credit risk taken on assets and the yield curve of market interest rates. However, a sudden and substantial change in interest rates may adversely impact earnings, to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. We do not engage in significant trading activities to enhance earnings or for hedging purposes.

Our overall strategy is to coordinate the volume of rate sensitive assets and liabilities to minimize the impact of interest rate movement on the net interest margin. The following Table represents our earnings sensitivity to changes in interest rates at March 31, 2013. It is a static indicator which does not reflect various repricing characteristics and may not indicate the sensitivity of net interest income in a changing interest rate environment, particularly during periods when the interest yield curve is flattening or steepening. The following repricing methodologies should be noted:

1. Public or government fund MMDA and NOW accounts are considered fully repriced within 60 days. Higher yielding retail and non-governmental money market and NOW deposit accounts are considered fully repriced within 90 days. Rewards Checking NOW accounts and other money market deposit accounts are considered fully repriced within one year. Other NOW and savings accounts are considered “core” deposits as they are generally insensitive to interest rate changes. These core deposits are generally considered to reprice beyond five years.

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2. Nonaccrual loans are considered to reprice beyond 5 years.

3. Assets and liabilities with contractual calls or prepayment options are repriced according to the likelihood of the call or prepayment being exercised in the current interest rate environment.

4. Measurements taking into account the impact of rising or falling interest rates are based on a parallel yield curve change that is fully implemented within a 12-month time horizon.

5. Bank owned life insurance is considered to reprice beyond 5 years.

The gap analysis reflects a liability sensitive gap position during the next year, with a cumulative negative one-year gap ratio at March 31, 2013 of 82.9% compared to a negative gap of 93.7% at December 31, 2012. The one-year gap ratio declined since December 31, 2012 due to a significant reduction in cash and cash equivalents during the March 2013 quarter, which reduced the amount of assets repricing during the next year compared to December 31, 2013. In general, a current negative gap would be favorable in a falling interest rate environment but unfavorable in a rising rate environment. However, net interest income is impacted not only by the timing of product repricing, but the extent of the change in pricing which could be severely limited from local competitive pressures. The existence of our significant “in the money” floating rate loan floors could also lessen the impact of an asset sensitive gap position in a rising interest rate environment. These factors can result in change to net interest income from changing interest rates different than expected from review of the gap table.

Table 5: Interest Rate Sensitivity Gap Analysis

	March 31, 2013
(dollars in thousands)		0-90 Days		91-180 days		181-365 days			1-2 yrs.			2-5 yrs.		Beyond 5 yrs.		Total

Earning assets:
Loans		$	161,335	$	42,656	$	53,737		$	84,812		$	112,258	$	45,224	$	500,022
Securities			17,103		5,371		11,095			18,668			44,279		44,049		140,565
FHLB stock															2,906		2,906
CSV bank-owned life insurance															11,911		11,911
Other earning assets			4,732		248		245			500			1,736				7,461

Total		$	183,170	$	48,275	$	65,077		$	103,980		$	158,273	$	104,090	$	662,865
Cumulative rate sensitive assets		$	183,170	$	231,445	$	296,522		$	400,502		$	558,775	$	662,865

Interest-bearing liabilities
Interest-bearing deposits		$	101,021	$	17,393	$	193,728		$	26,406		$	35,934	$	82,139	$	456,621
FHLB advances			23,000				12,909			22,215							58,124
Other borrowings			9,629							8,000			5,500				23,129
Senior subordinated notes													4,000				4,000
Junior subordinated debentures													7,732				7,732

Total		$	133,650	$	17,393	$	206,637		$	56,621		$	53,166	$	82,139	$	549,606
Cumulative interest
sensitive liabilities		$	133,650	$	151,043	$	357,680		$	414,301		$	467,467	$	549,606

Interest sensitivity gap for
the individual period		$	49,520	$	30,882	$	(141,560	)	$	47,359		$	105,107	$	21,951
Ratio of rate sensitive assets to
rate sensitive liabilities for
the individual period			137.1%		277.6%		31.5%			183.6%			297.7%		126.7%

Cumulative interest
sensitivity gap		$	49,520	$	80,402	$	(61,158	)	$	(13,799	)	$	91,308	$	113,259
Cumulative ratio of rate sensitive
assets to rate sensitive liabilities			137.1%		153.2%		82.9%			96.7%			119.5%		120.6%

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We use financial modeling techniques that measure interest rate risk. These policies are intended to limit exposure of earnings to risk. A formal liquidity contingency plan exists that directs management to the least expensive liquidity sources to fund sudden and unanticipated liquidity needs. We also use various policy measures to assess interest rate risk as described below.

We balance the need for liquidity with the opportunity for increased net interest income available from longer term loans held for investment and securities. To measure the impact on net interest income from interest rate changes, we model interest rate simulations on a quarterly basis. Our policy is that projected net interest income over the next 12 months will not be reduced by more than 15% given a change in interest rates of up to 200 basis points. The following table presents the projected impact to net interest income by certain rate change scenarios and the change to the one year cumulative ratio of rate sensitive assets to rate sensitive liabilities.

Table 6: Net Interest Margin Rate Simulation Impacts

Period Ended:	March 2013		December 2012		March 2012

Cumulative 1 year gap ratio
Base		83%		94%		103%
Up 200		80%		89%		99%
Down 100		85%		95%		104%

Change in Net Interest Income – Year 1
Up 200 during the year		-2.9%		-1.4%		-2.7%
Down 100 during the year		0.2%		0.4%		-0.3%

Change in Net Interest Income – Year 2
No rate change (base case)		-0.7%		-2.5%		-3.5%
Following up 200 in year 1		-3.4%		-2.8%		-3.7%
Following down 100 in year 1		-2.4%		-3.8%		-6.5%

Note: Simulations after March 2008 reflect net interest income changes from a down 100 basis point scenario, rather than a down 200 basis point scenario as dictated by internal policy due to the currently low level of relative short-term rates.

To assess whether interest rate sensitivity beyond one year helps mitigate or exacerbate the short-term rate sensitive position, a quarterly measure of core funding utilization is made. Core funding is defined as liabilities with a maturity in excess of 60 months and stockholders’ equity capital. Core deposits including DDA, lower yielding NOW, and non-maturity savings accounts (not including high yield NOW such as Rewards Checking deposits and money market accounts) are also considered core long-term funding sources. The core funding utilization ratio is defined as assets that reprice in excess of 60 months divided by core funding. Our target for the core funding utilization ratio is to remain at 80% or below given the same 200 basis point changes in rates that apply to the guidelines for interest rate risk limits exposure described previously. Our core funding utilization ratio after a projected 200 basis point increase in rates was 64.0% at March 31, 2013 compared to 60.5%% at December 31, 2012.

At March 31, 2013, internal interest rate simulations that project interest rate changes that maintain the current shape of the yield curve (often referred to as “parallel yield curve shifts”) and those which assume a flattening of the yield curve all point to decreased net interest income from a static balance sheet compared to the March 31, 2013 “base case.” If market rates decline, net interest income is negatively impacted by falling asset yields while funding costs currently near 0% have little room to decline. If market rates increase, net interest income is negatively impacted by existing interest rate floors on floating rate loans. As funding costs rise, these floating rate loans could remain at the same yield for several periods, reducing net interest margin and net interest income. During a period of rising interest rates, net interest income is also negatively impacted by a flattening yield curve. When the yield curve flattens, repriced short-term funding cost, such as for terms of 1 year or less increases, while maturing fixed rate balloon loans, such as with terms from 3 to 5 years, increase much less. During flattening periods, assets and liabilities may reprice at the same time but to a much different extent.

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The table below summarizes the percentage change to current “base case” net interest income as a result of certain interest simulations:

Table 7: Projected Changes to Net Interest Income Under Alternative Rate Simulations

	During next 12M		During next 24M		Delayed (24M)
	Down 100 bp		Parallel up 400 bp		Flat up 500 bp

Year 1		0.2%		-2.7%		0.0%
Year 2		-1.7%		-11.0%		0.0%
Year 3		-3.7%		-13.1%		-12.8%
Year 4		-6.9%		7.2%		-19.9%
Year 5		-8.7%		24.5%		-1.7%

While it would be possible to experience another 100 basis point reduction in market rates, this is is considered unlikely due to current rates being very low. We also expect a low interest rate scenario, similar to today, to continue during the next 24 months. Current indications by the Board of Governors of the Federal Reserve call for the existing very low rate environment to continue into 2015. We regularly monitor our asset-liability position in light of this potential long-term risk to net interest income levels from such a protracted low interest rate environment.

Noninterest Income

Quarter ended March 31, 2013 compared to March 31, 2012

Total noninterest income for the quarter ended March 31, 2013 was $1,415, compared to $1,242 earned during the March 2012, an increase of $173, or 13.9%. Investment sales and management commissions from Peoples Wealth Management increased $149, or 108%, to $287 during March 2013 compared to $138 during March 2012. Investment commissions can be dependent on completed sales and such income can be volatile quarter to quarter. However, PSB expects commission income of approximately $200 per quarter during the remainder of 2013 compared to the $184 quarterly average seen during calendar 2012.

Customer residential mortgage loan refinance activity also led mortgage banking activity higher by $84, or 26.9% more than seen during the March 2012 quarter. During the March 2013 quarter, a provision for serviced mortgage loan recourse liability of $203 was partially offset by a $123 reduction in the mortgage servicing right valuation allowance. A recourse loss of $125 was charged against the liability during March 2013 due to foreclosure losses on a mortgage sold to the FHLB that was determined to have been improperly underwritten. Loans originated by this former employee were reviewed and the situation is believed to be isolated, although a $78 recourse liability continued to be maintained at March 31, 2013. PSB expects mortgage banking income to decline moderately during the remainder of 2013 as most qualifying borrowers will have completed a refinance into the current rate levels. Lower mortgage banking fees will have a negative impact on net income in 2013 compared to 2012.

Noninterest Expense

Quarter ended March 31, 2013 compared to March 31, 2012

Noninterest expenses totaled $4,082 during the March 2013 quarter compared to $4,119 during the March 2012 quarter, down $37. Excluding the loss on foreclosed assets for both periods and $117 of March 2012 quarter professional fees associated with the Marathon purchase, March 2013 quarterly expenses would have been $4,076, and March 2012 quarterly expenses would have been $3,769, an increase of $307, or 8.1%.

During March 2013, salaries and employee benefits increased $135, or 6.2%, from inflationary wage increases effective January 1, 2013 and the additional cost of Marathon employees. In addition, occupancy and facilities expense increased $91, or 22.4% from operating and refurbishing costs of Marathon’s branch location retained following the purchase. Lastly, data processing and office operations expense increased $73, or 18.1%, from the addition of Marathon customer accounts and mailing costs associated with Marathon customer communication and account changes.

The March 2013 provision for income taxes was reduced $73 for the tax benefit realized on amendment of Marathon’s previously filed 2009 through 2011 income tax returns primarily to correct the treatment of tax-exempt interest on municipal loans. Before this tax reduction, the March 2013 effective income tax rate would have been 30.5%. Excluding $117 in nondeductible Marathon purchase professional fees, the March 2012 effective income tax rate would have been 31.6%. The effective tax rate decreased during 2013 from acquisition of Marathon’s tax exempt municipal securities portfolio. During the March 2013 quarter, tax exempt securities represented 7.9% of average interest earning assets compared to 5.3% of average interest earning assets during March 2012, prior to the purchase of Marathon.

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CREDIT QUALITY AND PROVISION FOR LOAN LOSSES

The loan portfolio is our primary asset subject to credit risk. Our process for monitoring credit risk includes quarterly analysis of loan quality, delinquencies, nonperforming assets, and potential problem loans. Loans are placed on a nonaccrual status when they become contractually past due 90 days or more as to interest or principal payments. All interest accrued but not collected for loans (including applicable impaired loans) that are placed on nonaccrual status or charged off is reversed against interest income. Nonaccrual loans and restructured loans maintained on accrual status remain classified as nonperforming loans until the uncertainty surrounding the credit is eliminated. In general, uncertainty surrounding the credit is eliminated when the borrower has displayed a history of regular loan payments using a market interest rate that is expected to continue as if a typical performing loan. Some borrowers continue to make loan payments while maintained on non-accrual status. We apply all payments received on nonaccrual loans to principal until the loan is returned to accrual status or repaid. Total nonperforming assets as a percentage of total tangible common equity including the allowance for loan losses was 19.33%, 20.54%, and 32.44% at March 31, 2013, December 31, 2012, and March 31, 2012, respectively (refer to Table 24). For the purpose of this measurement, tangible common equity is equal to total common stockholders’ equity less mortgage servicing right assets.

Nonperforming assets include: (1) loans that are either contractually past due 90 days or more as to interest or principal payments, on a nonaccrual status, or the terms of which have been renegotiated to provide a reduction or deferral of interest or principal (restructured loans), (2) investment securities in default as to principal or interest, and (3) foreclosed assets.

Table 8: Nonperforming Assets

	March 31,				December 31,
(dollars in thousands)	2013		2012		2012

Nonaccrual loans (excluding restructured loans)	$	6,162	$	5,828	$	6,491
Nonaccrual restructured loans		1,187		2,241		1,224
Restructured loans not on nonaccrual		2,755		6,923		2,965
Accruing loans past due 90 days or more		—		—		—

Total nonperforming loans		10,104		14,992		10,680
Nonaccrual trust preferred investment security		—		750		—
Foreclosed assets		1,822		3,108		1,774

Total nonperforming assets	$	11,926	$	18,850	$	12,454

Nonperforming loans as a % of gross loans receivable		2.02%		3.38%		2.20%
Total nonperforming assets as a % of total assets		1.74%		3.11%		1.75%
Allowance for loan losses as a % of nonperforming loans		73.57%		51.73%		69.58%

Total nonperforming assets decreased $528, or 4.2%, since December 31, 2012, and decreased $6,924, or 36.7%, since March 31, 2012. During the past year, the improvement in nonperforming assets was due to a $4,168 reduction in accruing restructured loans repaid on certain borrowers’ sale of collateral, and a $1,286 reduction in foreclosed assets from sale of our largest foreclosed property, held since 2009. At March 31, 2013, the allowance for loan losses was $7,434, or 1.49% of total loans (74% of nonperforming loans), compared to $7,431, or 1.53% of total loans (70% of nonperforming loans) at December 31, 2012, and $7,755, or 1.75% of total loans (52% of nonperforming loans) at March 31, 2012. At March 31, 2013, 70% of restructured loan principal shown in the table above remained on accrual status compared to 71% at December 31, 2012.

While the general credit quality of our loan portfolio and identified problem loans has improved, the economic recovery in central and northern Wisconsin is very slow, and during 2012, large local employers in the paper manufacturing, window manufacturing, and insurance claim processing industries announced plant closures, job reductions, or loss of key customer contracts. We expect these conditions to continue the slow pace of economic recovery as some borrowers continue to manage fragile cash flows and debt servicing ability. The longer significant recovery is delayed, the more difficult it will be for some borrowers to continue scheduled debt payments as previously unencumbered collateral is pledged for new working capital and balance sheet equity is drawn down, potentially increasing future provisions for loan losses. In light of these conditions, we could see an increase in borrowers requiring restructured loan terms which would increase our level of nonperforming loans. A continued slow local economy impacts the value of collateral and foreclosed assets, potentially increasing losses on foreclosed borrowers and properties during the coming quarters.

The majority of our customers live and work in Marathon, Oneida, and Vilas Counties, Wisconsin, in which we have branch locations. The unemployment rate (not seasonally adjusted) in the Wausau-Marathon County, Wisconsin MSA was 7.8% at March 31, 2013 compared to 8.0% at March 31, 2012. The unemployment rate in Oneida County, Wisconsin was 11.5% at March 31, 2013 compared to 11.4% at March 31, 2012. The unemployment rate in Vilas County, Wisconsin was 13.3% at both March 31, 2013 and 2012.

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At March 31, 2013, all nonperforming assets aggregating to $500 or more measured by gross principal outstanding per credit relationship are summarized in the following table and represented 12% of all nonperforming assets compared to 11% of nonperforming assets at December 31, 2012. In the table, loans presented as “Accrual TDR” represent troubled debt restructured loans maintained on accrual status. No new large nonperforming assets in excess of $500 were identified during the quarter ended March 31, 2013.

Table 9: Largest Nonperforming Assets at March 31, 2013 ($000s)

		Gross		Specific
Collateral Description	Asset Type	Principal		Reserves

Owner occupied cabinetry contractor real estate and equipment	Accrual TDR		749		84
Owner occupied multi use, multi-tenant real estate	Accrual TDR		655		184

Total listed nonperforming assets		$	1,404	$	268
Total bank wide nonperforming assets		$	11,926	$	2,266
Listed assets as a percent of total nonperforming assets			12%		12%

Table 10: Largest Nonperforming Assets at December 31, 2012 ($000s)

Collateral Description	Asset Type	Gross Principal		Specific Reserves

Owner occupied cabinetry contractor real estate and equipment	Accrual TDR	$	752	$	87
Owner occupied multi use, multi-tenant real estate	Accrual TDR		664		182

Total listed nonperforming assets		$	1,416	$	269
Total bank wide nonperforming assets		$	12,454	$	2,207
Listed assets as a percent of total nonperforming assets			11%		12%

In addition to nonperforming loans, we have classified certain performing loans as impaired loans under accounting standards due to heightened risk of nonperformance within the next year or other factors. In general, loans not classified as nonaccrual or restructured may be classified as impaired due to elevated potential credit risk but still be considered performing. At March 31, 2013, all impaired but performing loans aggregating to $500 or more measured by gross principal outstanding per credit relationship are summarized in the following table. No new large performing, but impaired loans were identified during the quarter ended March 31, 2013.

Table 11: Largest Performing, but Impaired Loans at March 31, 2013 ($000s)

		Gross		Specific
Collateral Description	Asset Type	Principal		Reserves

Owner occupied cabinetry contractor real estate and equipment	Impaired		682		—

Total listed performing, but impaired loans		$	682	$	—
Total performing, but impaired loans		$	1,898	$	260
Listed assets as a percent of total performing, but impaired loans			36%		0%

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Table 12: Largest Performing, but Impaired Loans at December 31, 2012 ($000s)

Collateral Description	Asset Type	Gross Principal		Specific Reserves

Owner occupied cabinetry contractor real estate and equipment	Impaired	$	686	$	25

Total listed performing, but impaired loans		$	686	$	25
Total performing, but impaired loans		$	1,969	$	227
Listed assets as a % of total performing, but impaired loans			35%		11%

Provision for Loan Losses and Loss of Foreclosed Assets

We determine the adequacy of the provision for loan losses based on past loan loss experience, current economic conditions, and composition of the loan portfolio. Accordingly, the amount charged to expense is based on management’s evaluation of the loan portfolio. It is our policy that when available information confirms that specific loans, or portions thereof, including impaired loans, are uncollectible, these amounts are promptly charged off against the allowance.

We recorded a $323 provision for loan losses during the March 2013 quarter compared to $160 recorded in March 2012. Despite lower levels of nonperforming assets during the March 2013 quarter compared to March 2012, the 2013 provision increased to fund reserves associated with increased net loan growth. Net loans receivable grew $14,597 during the March 2013 quarter, but net loans declined $2,076 during the March 2012 quarter. Loss on foreclosed assets was $6 during March 2013 compared to $233 in March 2012, which included $189 of partial write-downs to fair value on certain foreclosed assets. Taken together, March 2013 quarterly credit costs were $329 compared to $393 during 2012, a decline of $64, or 16%. Assuming the current trend in lower nonperforming assets, we expect total credit costs in the coming quarters to be similar to those seen during the March 2013 quarter. Average quarterly credit costs were $340 during the year ended December 31, 2012, and any reduction in 2013 credit costs is not expected to be a significant driver of increased 2013 earnings as it was during 2012. However, future provisions will be impacted by the actual amount of impaired and other problem loans identified by internal procedures or regulatory agencies.

Table 13: Allowance for Loan Losses

	Three months ended
	March 31,
(dollars in thousands)	2013			2012

Allowance for loan losses at beginning	$	7,431		$	7,941

Provision for loan losses		323			160
Recoveries on loans previously charged-off		8			1
Loans charged off		(328	)		(347	)

Allowance for loan losses at end	$	7,434		$	7,755

Net charge-offs of loan principal were $320 during the quarter ended March 31, 2013. Two unrelated credit relationships including a commercial loan and non-owner occupied single family residential mortgage loans totaling $229 were charged off during March 2013, representing 72% of all quarterly charge-offs. Net charge-offs of loan principal were $346 during the quarter ended March 31, 2012 led by a charge-off totaling $125 associated with inventory and equipment financing with an implement dealer upon liquidation. Annualized net loan charge-offs declined slightly and were 0.26% and 0.31% of total loans during the quarters ended March 31, 2013, and 2012, respectively.

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ASSET GROWTH AND LIQUIDITY

Balance Sheet Changes and Analysis

Total assets were $685,421 at March 31, 2013, down $26,545 (3.7%) since December 31, 2012, but up $78,633 (13.0%) since March 31, 2012. Assets since March 2012 increased on the purchase of Marathon State Bank during June 2012. Marathon held $107,364 of assets on the purchase date including cash equivalents and short-term investments totaling $32,105. Since the purchase, a portion of Marathon’s cash and securities have been used to reduce wholesale funding (including brokered certificates of deposit, Federal Home Loan Bank advances, and wholesale repurchase agreements) which declined to $124,345 at March 31, 2013 compared to $132,502 at March 31, 2012, down 6.2%.

Total assets declined since December 31, 2012 as $35,995 in short-term cash and cash equivalents were used to support $32,533 in local deposit withdrawals including seasonal deposits totaling $24,431 from commercial and municipal depositors. An $8,000 increase in FHLB borrowings and $4,644 of maturing investment security cash flow was used to fund $8,934 in residential real estate mortgage net loan growth and $5,003 in commercial related net loan growth. During the quarter ended March 31, 2013, Marathon branch deposits (excluding short-term seasonable deposits) declined $2,285, or 2.5%, led by a $2,393 decline in certificates of deposit.

Changes in assets during the three months March 31, 2013 are described in Table 14 below.

Table 14: Change in Balance Sheet Assets Composition

	Three months ended
Increase (decrease) in assets ($000s)	March 31, 2013
	$			%

Residential real estate mortgage and home equity loans	$	8,934			6.4%
Commercial real estate mortgage loans		8,763			4.2%
Other assets (various categories)		157			0.4%
Commercial, industrial and agricultural loans		(3,760	)		-2.8%
Investment securities		(4,644	)		-3.2%
Cash and cash equivalents		(35,995	)		-73.7%

Total decrease in assets	$	(26,545	)		-3.7%

Changes in net assets during the three months ended March 31, 2013, impacted funding sources as shown in Table 15 below.

Table 15: Change in Balance Sheet Liabilities and Equity Composition

	Three months ended
Increase (decrease) in liabilities and equity ($000s)	March 31, 2013
	$			%

FHLB advances	$	8,000			16.0%
Other borrowings		2,401			11.6%
Stockholders’ equity		1,259			2.3%
Other liabilities and debt (various categories)		(936	)		-6.6%
Wholesale and national deposits		(1,736	)		-3.2%
Retail certificates of deposit > $100		(2,241	)		-4.6%
Senior subordinated notes		(3,000	)		-42.9%
Core deposits (including MMDA)		(30,292	)		-6.6%

Total decrease in liabilities and stockholders' equity	$	(26,545	)		-3.7%

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Loans Receivable

Table 16: Period-End Loan Composition

	March 31,				March 31,				December 31, 2012
	Dollars		Dollars		Percentage of total						Percentage
(dollars in thousands)	2013		2012		2013		2012		Dollars		of total

Commercial, industrial and agricultural	$	128,873	$	130,553		25.8%		29.4%	$	132,633		27.3%
Commercial real estate mortgage		218,172		196,160		43.7%		44.1%		209,409		43.0%
Residential real estate mortgage		127,748		89,754		25.5%		20.2%		116,909		24.0%
Residential real estate loans held for sale		—		852		0.0%		0.2%		884		0.2%
Consumer home equity		20,735		23,380		4.1%		5.3%		21,756		4.5%
Consumer and installment		4,494		3,389		0.9%		0.8%		4,715		1.0%

Totals	$	500,022	$	444,088		100.0%		100.0%	$	486,306		100.0%

Loans held for investment continue to consist primarily of commercial related loans, including commercial and industrial and commercial real estate loans, representing 69% of total loans at March 31, 2013 and 70% of total loans at December 31, 2012. Refer to Note 4 of the Notes to Consolidated Financial Statements for more information on the composition of loans at period-end.

Loans for the purpose of construction, land development, and other land loans (including residential construction and development) were $43,169 at March 31, 2013, and $43,729 at December 31, 2012 (including loan principal not yet disbursed) and represented 8.5% of total gross loans at March 31, 2013 compared to 8.9% at December 31, 2012. Commercial real estate loans, including disbursed commercial construction and land development loans, were equal to 392% of total common stockholders’ equity compared to 385% of total common stockholders’ equity at December 31, 2012, and similar to the quarterly average of 381% of common equity seen during the year ended December 31, 2012. In addition, our commercial real estate concentration has declined steadily during the past several years and averaged 406%, 441%, and 477% of common stockholder equity during 2011, 2010, and 2009, respectively. We consider commercial real estate lending to be a core product and expect to maintain a concentration similar to March 2013 throughout the year. Our experience in such lending allows us to minimize credit risk with annual net charge-offs on commercial real estate lending ranging from 0.0% to 0.48% of the average commercial real estate portfolio during the five years ended December 31, 2012.

Our markets have traditionally supplied opportunities for loan growth. Purchased loan participations held were $20,381 and $20,601 at March 31, 2013 and December 31, 2012, respectively. The majority of our purchased loan participations are arrangements with other community banks in Wisconsin that work together to meet the credit needs of each other’s largest credit customers. These loans are underwritten in the same manner as loans originated solely for our own portfolio. At March 31, 2013, only $516 of loan participations were purchased from sources other than traditional banks with substantial operations in Wisconsin.

Commercial real estate loans increased $8,763 during the quarter ended March 31, 2013 primarily from two new loans secured by nonowner occupied multi-family residential dwellings totaling $4,995, or 57% of the total increase. These loans were with unrelated existing borrowers with whom we have longstanding relationships who successfully operate in the rental housing business. Competition from larger banks in our markets is strong as such banks with higher capital levels and substantial excess deposits look to lending for higher yielding assets as investment security returns remain very low. Banks including BMO Harris Bank (having the largest deposit market share in our markets), U.S. Bank, Associated Bank, and Chase Bank aggressively pursue high credit quality borrowers and have lowered lending interest rate spreads in an effort to aggressively increase their loan market share. We expect strong competition to continue during the next several quarters which could impact the pace of future loan growth and could negatively impact net interest margin and net interest income. To support local loan growth, we may increase purchased loan participations from other banks in Wisconsin during 2013.

During 2012, to support loan growth and invest low yielding liquid cash and cash equivalents, we maintained a program to originate 15-year fully amortizing fixed rate residential first mortgage loans and retain those loans on our balance sheet rather than selling them to secondary market investors as is our normal practice. The loans were fully underwritten with the majority of loans conforming to secondary market standards. However, if the property was located in a rural area in which an adequate number of recent comparable sales were not available, some of the mortgages may not have been underwritten with a qualifying secondary market appraisal, although a current appraisal was obtained on each loan. We do not intend to securitize these loans for sale on the secondary market. The program originated approximately $26.1 million in residential mortgage loans at a 2.92% weighted average interest rate during the year ended December 31, 2012. We continued this program during the quarter ended March 31, 2013 and originated approximately $9.2 million in residential mortgage loans at a 2.64% weighted average interest rate. At March 31, 2013, $33.9 million of total principal under this program remained on the balance sheet at a 2.84% weighted average interest rate. This in-house fixed rate mortgage program contributed to the net increase in residential mortgage loans in Table 16 above. We expect to curtail this program during 2013 as excess liquidity declines and loan growth is supplemented by traditional commercial related loan growth. Retaining residential mortgage loans on the balance sheet, instead of selling them to the secondary market, increases potential interest rate risk in a rising rate environment and adds credit risk from potential problem loan defaults. However, we believe both interest rate and credit risk are mitigated by limiting the program to conforming borrowers able to support the significantly faster 15 year principal amortization compared to a traditional 30 year amortizing loan.

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Deposits and Wholesale Funding Sources

Liquidity refers to the ability to generate adequate amounts of cash to meet our need for cash at a reasonable cost. We manage our liquidity to provide adequate funds to support borrowing needs and deposit flow of our customers. We also view liquidity as the ability to raise cash at a reasonable cost or with a minimum of loss and as a measure of balance sheet flexibility to react to marketplace, regulatory, and competitive changes. Retail and local deposits and repurchase agreements are the primary source of funding. Retail and local deposits and repurchase agreements were 70.7% of total assets at March 31, 2013, compared to 72.8% of total assets at December 31, 2012 and 66.4% of total assets at March 31, 2012.

Table 17: Period-end Deposit Composition

	March 31,								December 31,
(dollars in thousands)	2013				2012				2012
	$		%		$		%		$		%

Non-interest bearing demand	$	74,552		14.0%	$	62,452		13.4%	$	89,819		15.9%
Interest-bearing demand and savings		177,714		33.5%		134,092		28.7%		185,203		32.8%
Money market deposits		119,010		22.4%		110,788		23.7%		124,501		22.0%
Retail and local time deposits less than $100		60,711		11.4%		44,177		9.5%		62,756		11.1%

Total core deposits		431,987		81.3%		351,509		75.3%		462,279		81.8%
Retail and local time deposits $100 and over		46,465		8.8%		46,119		9.9%		48,706		8.6%
Broker and national time deposits less than $100		740		0.1%		736		0.2%		739		0.1%
Broker and national time deposits $100 and over		51,981		9.8%		68,142		14.6%		53,718		9.5%

Totals	$	531,173		100.0%	$	466,506		100.0%	$	565,442		100.0%

We continue to experience ongoing retail time deposit quarterly declines that began during the March 2009 quarter as wholesale funding rates for various funding types began to be lower than local retail certificates of deposit. During the March 2013 quarter, local certificates of deposit declined $4,286, of which $2,393, or 56%, was from our Marathon branch location. The primary deposit acquisition strategy employed by Marathon State Bank as an independent bank prior to our June 2012 purchase was to offer higher than market yields paid on certificates of 1 year term or shorter. Due to the weighted average remaining term of Marathon’s certificates at the June 2012 purchase, we expect the pace of Marathon certificate withdrawals to slow during the coming quarters.

Certificate balances have also been replaced by higher interest bearing demand account balances and money market accounts as customers have moved certificate funds into liquid, short-term deposit vehicles as certificate rates locally have moved to very low levels relative to certain non-maturity deposit accounts. This was also seen in deposit movements by Marathon customers since the purchase. Since the June 2012 purchase, Marathon certificates of deposit have declined $7,858, or 18.6%. However, all other Marathon deposits have increased $5,273, or 9.0% since the purchase date. In a rising environment, balances in non-maturity accounts may shift back into higher yielding time deposits, increasing interest expense and negatively impacting net interest income.

Consistent with the past seven years going back to the March 2006 quarter, elevated December 31 commercial demand and municipal tax deposits withdrawn early in the new year resulted in a net deposit decline when comparing March 31 to the prior December 31 local deposits. During March 2013, local deposits declined $30,292, which included $24,431 of net withdrawals from commercial demand deposits and seasonal municipal tax deposits during the quarter.

We originate retail certificates of deposit with local depositors under the CDARS program, in which our customer deposits (with participation of other banks in the CDARS network) are able to obtain levels of FDIC deposit insurance coverage in amounts greater than traditional limits. For purposes of the Period-end Deposit Composition Table above, these certificates are included in retail time deposits $100 and over and totaled $8,624 at March 31, 2013 compared to $8,825 at December 31, 2012. Although classified as retail time deposits $100 and over in the table above, we are required to report these balances as broker deposits on our quarterly regulatory call reports. We also originate certificates of deposit obtained through a national rate listing service and held $5,941 and $3,931 of such deposits at March 31, 2013 and December 31, 2012, respectively. These national certificates are classified with broker deposits in the table above.

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Wholesale funding often carries higher interest rates than local core deposit funding, so loan growth supported by wholesale funds can generate lower net interest spreads than loan growth supported by local funds. However, wholesale funds provide us the ability to quickly raise large funding blocks and to match loan terms to minimize interest rate risk and avoid the higher incremental cost to existing deposits from simply increasing retail rates to raise local deposits. Rates paid on local deposits are significantly impacted by competitor interest rates and the local economy’s ability to grow in a way that supports the deposit needs of all local financial institutions. Current brokered certificate of deposit rates available to us are less costly than equivalent local deposits due to very low rates of return available on the most conservative fixed income investments and as national wholesale funds place a premium on FDIC insurance available on their large deposit when placed with brokers in amounts less than current FDIC insurance limits. Due to large demand through brokers for these types of deposits, brokered deposit rates for well performing banks are historically low. In addition, declines in profitability and capital at some banks and regulatory pressure to reduce wholesale funding levels have reduced their access to wholesale funding or otherwise increased its cost. In many cases, these institutions with reduced wholesale funding access have increased their retail interest rates to gather funds through local depositors. Consequently, local certificate of deposit rates in many markets are priced higher than equivalent wholesale brokered deposits due to a limited supply of retail deposits. We expect this difference in pricing between wholesale and local certificates of deposit to be removed by the wholesale funding market as the banking industry is considered to be well capitalized and regains consistent profits. An improving national economy will likely increase wholesale rates relative to local core deposit rates which could increase the volatility of our interest expense due to a significant portion of our funding coming from wholesale sources.

Our internal policy is to limit broker and national time deposits (not including CDARS) to 20% of total assets. Broker and national deposits as a percentage of total assets were 7.7%, 7.6%, and 11.4% at March 31, 2013, December 31, 2012, and March 31, 2012, respectively. During the remainder of 2013, we expect to increase use of brokered deposits as needed to fund loan growth to the extent local deposit growth does not meet this need. Beyond the use of brokered and national time deposits, secondary wholesale sources also include FHLB advances, Federal Reserve Discount Window advances, and pledging of investment securities against wholesale repurchase agreements.

Table 18: Summary of Balance by Significant Deposit Source

	March 31,				December 31,
(dollars in thousands)	2013		2012		2012

Total time deposits $100 and over	$	98,446	$	114,261	$	102,424
Total broker and national deposits		52,721		68,878		54,457
Total retail and local time deposits		107,176		90,296		111,462
Core deposits, including money market deposits		431,987		351,509		462,279

Table 19: March 31, 2013 Change in Deposit Balance since Period Ended:

	March 31, 2013					December 31, 2012
(dollars in thousands)	$			%		$			%

Total time deposits $100 and over	$	(15,815	)		-13.8%	$	(3,978	)		-3.9%
Total broker and national deposits		(16,157	)		-23.5%		(1,736	)		-3.2%
Total retail and local time deposits		16,880			18.7%		(4,286	)		-3.8%
Core deposits, including money market deposits		80,478			22.9%		(30,292	)		-6.6%

As a supplement to local deposits, we use short-term and long-term funding sources other than retail deposits including federal funds purchased from other correspondent banks, advances from the FHLB, use of wholesale and national time deposits, advances taken from the Federal Reserve’s Discount Window, and repurchase agreements from security pledging. Table 21 below outlines the available and unused portion of these funding sources (based on collateral and/or company policy limitations) as of March 31, 2013 and December 31, 2012. Currently unused but available funding sources at March 31, 2013 are considered sufficient to fund anticipated asset growth and meet contingency funding needs during the next several quarters. We also maintain formal policies to address liquidity contingency needs and to manage a liquidity crisis. The following Table 20 provides a summary of how the wholesale funding sources normally available to us would be impacted by various operating conditions.

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Table 20: Environmental Impacts on Availability of Wholesale Funding Sources:

	Normal	Moderately	Highly
	Operating	Stressed	Stressed
	Environment	Environment	Environment

Repurchase Agreements	Yes	Likely*	Not Likely
FHLB (primary 1-4 REM collateral)	Yes	Yes*	Less Likely*
FHLB (secondary loan collateral)	Yes	Likely*	Not Likely
Brokered CDs	Yes	Likely*	Not Likely
National CDs	Yes	Likely*	Not Likely
Federal Funds Lines	Yes	Less Likely*	Not Likely
FRB (Borrow-In-Custody)	Yes	Yes	Less Likely*
FRB (Discount Window securities)	Yes	Yes	Yes
Holding Company line of credit	Yes	Yes	Less Likely*

* May be available but subject to restrictions

Table 21 summarizes the availability of various wholesale funding sources at March 31, 2013, and December 31, 2012.

Table 21: Available but Unused Funding Sources other than Retail Deposits

	March 31, 2013				December 31, 2012
	Unused, but		Amount		Unused, but		Amount
(dollars in thousands)	Available		Used		Available		Used

Overnight federal funds purchased	$	26,578	$	1,422	$	28,000	$	—
Federal Reserve discount window advances		67,905		—		70,141		—
FHLB advances under blanket mortgage lien		37,978		58,124		38,797		50,124
Repurchase agreements and other FHLB advances		41,661		21,707		44,634		20,728
Wholesale and national deposits		84,363		52,721		87,936		54,457
Holding company secured line of credit		3,000		—		3,000		—

Totals	$	261,485	$	133,974	$	272,508	$	125,309

Funding as a percent of total assets		38.1%		19.5%		38.3%		17.6%
Percentage of gross available funding used at period-end				33.9%				31.5%

The following discussion examines each of the available but unused funding sources listed in the table above and the factors that may directly or indirectly influence the timing or the amount ultimately available to us.

March 31, 2013 compared to December 31, 2012

Overnight federal funds purchased

Our consolidated federal funds purchase availability totals $28,000 from three correspondent banks. The most significant portion of the total is $15,000 from our primary correspondent bank, Bankers’ Bank located in Madison, Wisconsin. We make regular use of the Bankers’ Bank line as part of our normal daily cash settlement procedures, but rarely have used the lines offered by the other two correspondent banks. Federal funds must be repaid each day and borrowings may be renewed for up to 14 consecutive business days. The annualized interest rate applicable to federal funds purchased from Bankers’ Bank is approximately .65%. To unilaterally draw on the existing federal funds line, we need to maintain a “composite ratio” as defined by Bankers’ Bank of 40% or less. Bankers’ Bank defines the composite ratio to be nonaccrual loans and foreclosed assets divided by tangible capital including the allowance for loan losses calculated at our subsidiary bank level. Due to existence of the composite ratio, an increase in nonaccrual loans or foreclosed assets could impact availability of the line or subject us to further review. In addition, a rising composite ratio could cause our other two correspondent banks to reconsider their federal funds line with us since they do not also serve as our primary correspondent bank. Our subsidiary bank’s composite ratio was approximately 12% at March 31, 2013, and 13% at December 31, 2012, and less than the 40% benchmark used by Bankers’ Bank.

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Federal Reserve discount window advances

We have a $100,000 line of credit with the Federal Reserve Discount Window supported by both commercial and commercial real estate collateral provided to the Federal Reserve under their Borrower in Custody (“BIC”) program. Since 2011, the annualized interest rate applicable to Discount Window advances is .75%. Under the BIC program, we provide a monthly listing of detailed loan information on the loans provided as collateral. We are subject to annual review and certification by the Federal Reserve to retain participation in the program. The Discount Window represents the primary source of liquidity on a daily basis following our federal funds purchased lines of credit discussed above. We were limited to a maximum advance of $67,905 and $70,141 at March 31, 2013 and December 31, 2012, respectively, based on the BIC loan collateral pledged. Discount Window advances must be repaid or renewed each day. No Discount Window advances were used during the quarters ended March 31, 2013 or 2012.

Only performing loans are permitted as collateral under the BIC and each individual loan is subject to a haircut to collateral value based on the Federal Reserve’s review of the listing each month. In general, approximately 75% of the loan principal offered as collateral is able to support Discount Window advances. Similar to the federal funds purchased lines of credit, an increase in nonperforming loans would decrease the amount of collateral available for Discount Window advances.

Federal Home Loan Bank (FHLB) advances under blanket mortgage lien and other FHLB advances

We maintain an available line of credit with the FHLB of Chicago based on a pledge of 1 to 4 family mortgage loan collateral, both first and secondary lien positions. We may borrow on the line to the lesser of the blanket mortgage lien collateral provided, or 20 times our existing FHLB capital stock investment. Based on our existing $2,906 capital stock investment, total FHLB advances in excess of $58,120 require us to purchase additional FHLB stock equal to 5% of the advance amount. At March 31, 2013 and December 31, 2012, no additional FHLB advances were available without the purchase of additional FHLB capital stock. Further advances of the remaining $37,978 available at March 31, 2013 would have required us to purchase additional FHLB stock totaling $1,899. FHLB stock currently pays an annualized dividend of .30% with expectations of continuing this dividend level. Therefore, additional FHLB advances carry additional cost relative to other wholesale borrowing alternatives due to the requirement to hold relatively low yielding FHLB stock.

Similar to the Discount Window, only performing residential mortgage loans may be pledged to the FHLB under the blanket lien. In addition, we are subject to a haircut of approximately 36% on first mortgage collateral and 60% on secondary lien collateral at March 31, 2013 and December 31, 2012. The FHLB also conducts periodic audits of collateral identification and submission procedures and adjusts the collateral haircuts higher in response to negative exam findings. The FHLB also assigns a credit risk grade to each member based on a quarterly review of the member’s regulatory CALL report. Our current credit risk is within the normal range for a healthy member bank. Negative financial performance trends such as reduced capital levels, increased nonperforming assets, net operating losses, and other factors can increase a member’s credit risk grade. Higher risk grades can require a member to provide detailed loan collateral listings (rather than a blanket lien), physical collateral, and other restrictions on the maximum line usage. FHLB advances are available on a daily basis and along with Discount Window advances represent a primary source of liquidity following our federal funds purchased lines of credit.

FHLB advances carry substantial penalties for early prepayment that are generally not recovered from the lower interest rates in refinancing. The amount of early prepayment penalty is a function of the difference between the current borrowing rate, and the rate currently available for refinancing. Under the collateral and pledging agreement we maintain with the FHLB effective April 12, 2011, we are also permitted to pledge commercial related collateral for advances. However, we did not pledge any commercial loan collateral to the FHLB at March 31, 2013 or December 31, 2012.

Repurchase agreements and FHLB advances collateralized by investment securities

Wholesale repurchase agreements may be available from a correspondent bank counterparty for both overnight and longer terms. Such arrangements typically call for the agreement to be collateralized by us at 110% of the repurchase principal. In the current market, repurchase counterparty providers are extremely limited and would likely require a minimum $10 million transaction. Repurchase agreements could require up to several business days to receive funding. Due to the lack of availability of counterparties offering the product, wholesale repurchase agreements are not a reliable source of liquidity. At March 31, 2013, $13,500 of our repurchase agreements include a wholesale agreements with a correspondent bank and $6,207 are overnight repurchase agreements with local customers using our treasury management services. At December 31, 2012, $13,500 of our repurchase agreements include a wholesale agreement with a correspondent bank and $7,228 were overnight repurchase agreements with local customers.

In addition to availability of FHLB advances under the blanket mortgage lien, we also have the ability to pledge investment securities as collateral against FHLB advances. Advances secured by investments are also subject to the FHLB stock ownership requirement as described previously. Due to the need to purchase additional FHLB member stock, FHLB advances secured by investments are not considered a primary source of liquidity. At March 31, 2013, $41,661 of additional FHLB advances were available based on pledging of securities if an additional $2,083 of member capital stock were purchased. At December 31, 2012, $44,634 of additional FHLB advances were available based on pledging of securities if an additional $2,232 of member capital stock were purchased.

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Wholesale market deposits

Due to the strength of our capital position, balance sheet, and consistent earnings, we enjoy the lowest possible costs when purchasing wholesale certificates of deposit on the brokered market. We have an internal policy that limits use of brokered deposits to 20% of total assets, which gave availability of $84,363 at March 31, 2013 and $87,936 at December 31, 2012. Brokered and national certificates were 7.7% and 7.6% of assets at March 31, 2013 and December 31, 2012, respectively. Due to a limited number of providers of repurchase agreement funding as well as our desire to retain unencumbered securities for liquidity purposes and adverse impacts from holding additional FHLB capital stock, loan growth in past years was often funded with brokered certificate of deposit funding. Brokered and national certificates were 11.4% of assets at March 31, 2012 but were regularly paid down upon maturity using funds acquired in our Marathon State Bank during the past several quarters. However, we expect to increase our usage of brokered certificates of deposit in coming quarters to fund new loan growth to the extent this growth is not supported by local deposits.

Participants in the brokered certificate market must be considered “well capitalized” under current regulatory capital standards to acquire brokered deposits without approval of their primary federal regulator. We regularly acquire brokered deposits from three market providers and maintain relationships with other providers to obtain required funds at the lowest possible cost. Ten business days are typically required between the request for brokered funding and settlement. Therefore, brokered deposits are a reliable, but not daily, source of liquidity. Brokered deposits represent our largest source of wholesale funding and we would see significant negative impacts if capital levels or earnings were to decline to levels not considered to be well capitalized. In addition to the requirement to be considered well-capitalized, banks under regulatory consent orders are not permitted to participate in the brokered deposit market without approval of their primary federal regulator even if they maintain a well-capitalized capital classification.

Holding company unsecured line of credit

We maintained a $3,000 line of credit with Bankers’ Bank in Madison, Wisconsin as a contingency liquidity source at March 31, 2013 and December 31, 2012. No amounts were drawn on the line at March 31, 2013 or December 31, 2012. Although our bank subsidiary has in the past provided the holding company’s liquidity needs through semi-annual upstream cash dividend of profits, bank losses or other negative performance trends could prevent the bank from providing these dividends as cash flow. Because our bank holding company current has approximately $1,547 of financing principal and interest payments due per year as well as approximately $150 of other expenses (before tax benefits), the holding company line of credit is a critical source of potential liquidity.

We were subject to financial covenants associated with the line which require our bank subsidiary to:

Maintain Tier 1 leverage, Tier 1 risk based capital, and Tier 2 risk based capital ratios above 8%, 10%, and 12%, respectively.

Maintain nonperforming assets (excluding accruing troubled debt restructured loans) as a percentage of tangible equity plus the allowance for loan losses to less than 20%.

Maintain an allowance for loan losses no less than 70% of nonperforming assets (excluding accruing troubled debt restructured loans).

At March 31, 2013 and December 31, 2012, we were not in violation of any of the line of credit covenants. A violation of any covenant could prevent us from utilizing the unused balance of the line of credit. The line of credit expires during December 2013.

If liquidity needs persist after exhausting all available funds from the sources described above, we would consider more drastic methods to raise funds including, but not limited to, sale of investment securities at a loss, cessation of lending to new or existing customers, sale of branch real estate in a sale-leaseback transaction, surrender of bank owned life insurance to obtain the cash surrender value net of taxes and penalties due, packaging and sale of qualified residential mortgage loan pools held in our portfolio, sale of foreclosed assets at a loss, and sale of mortgage servicing rights. Such actions could generate undesirable sale losses or income tax impacts while providing liquidity. While sale of additional common stock or issuance of other types of capital could provide additional liquidity, the ability to find significant buyers of such capital issues during a liquidity crisis would be difficult making such a source of funding unlikely or unreliable if the liquidity crisis was caused by our deteriorating financial condition.

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Liquidity Measurements and Contingency Plan

Our liquidity management and contingency plan calls for quarterly measurement of key funding, capital, problem loan, and liquidity contingency ratios at our banking subsidiary level. The measurements are compared to various risk levels that direct management to further responses to declining liquidity measurements as outlined below:

Risk Level 1 is defined as circumstances that create the potential for elevated liquidity risk, thus requiring an assessment of possible funding deficiencies. Normal business operations, plans and strategies are not anticipated to be immediately impacted.

Risk Level 2 is defined as circumstances that point to an increased potential for disruptions in the Bank’s funding plans, needs and/or resources. Assessment of the probability of a liquidity crisis is more urgent, and identification and prioritization of pre-emptive alternatives and actions may be both warranted and time sensitive.

Risk Level 3 is defined as circumstances that create a likely funding problem, or are symptomatic of circumstances that are highly correlated with impending funding problems; and, therefore, are expected to require some level of immediate action depending upon the situation.

These risk parameters and other qualitative and environmental factors are considered to determine whether a “Stress Level” response is required. Identification of a risk trigger does not automatically call for a stress level response. The following summarizes our response plans to various degrees of liquidity stress:

Stress Level A – Management provides a written summary evaluating the warning indicators and why it is deemed unlikely that there will be a resulting liquidity challenge.

Stress Level B – Management provides an assessment of the probability of a liquidity crisis and completes a sources and uses of funds report to estimate the impact on pro forma liquidity. Liquidity stress tests will be reviewed to ensure the scenarios being simulated are sufficiently robust and that there is adequate funding to satisfy potential demands for cash. Various pre-emptive actions will be considered and acted on as needed.

Stress Level C – Management has determined a funding crisis is likely and documents detailed assessments of the current liquidity situation and future liquidity needs. The Board approved action plan is carried out with vigor and may call for one or all of the following steps, among others, to mitigate the liquidity concern: sale of loans, intensify local deposit gathering programs, transferring unencumbered securities and loans to the Federal Reserve for Discount Window borrowings, curtail all lending except for specifically approved loans, reduce or suspend stock dividends, and investigate opportunities to raise new capital.

A Risk Level 2 trigger was exceeded at March 31, 2013 due to a quarterly funding gap in excess of 5%. Funding gap is defined as net quarterly loan growth less net deposit growth divided by total assets. During the March 2013 quarter, net loans increased while net deposits declined, resulting in a calculated quarterly funding gap of 6.6% compared to 2.5% at March 31, 2012. The decline in deposits was due to seasonal deposit activity as discussed previously, and net loan growth was greater than expected during the quarter. We expect the June 2013 funding gap to be less than 2.5% and no liquidity stress level was considered to exist at March 31, 2013 or 2012.

As part of our formal quarterly asset-liability management projections, we also measure basic surplus as the amount of existing net liquid assets (after deducting short-term liabilities and coverage for anticipated deposit funding outflows during the next 30 days) divided by total assets. The basic surplus calculation does not consider unused but available correspondent bank federal funds purchased, as those funds are subject to availability based on the correspondent bank’s own liquidity needs and therefore are not guaranteed contractual funds. However, basic surplus does include unused but available FHLB advances under the open line of credit supported by a blanket lien on mortgage collateral. Basic surplus does not include available brokered certificate of deposit funding as those funds generally may not be obtained within one business day following the request for funding. Our policy is to maintain a basic surplus of at least 5%. Basic surplus was 10.8% and 14.4% at March 31, 2013 and December 31, 2012, respectively. Basic surplus decreased significantly during the March 2013 quarter as excess cash and cash equivalent funds, including municipal and commercial customer seasonal funds held at December 31, 2012, were withdrawn while we continued to repay brokered certificates of deposit. We do not expect to see such a significant decline in the basic surplus ratio during the June 2013 quarter compared to March 31, 2013.

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CAPITAL RESOURCES

During the quarter ended March 31, 2013, stockholders’ equity increased $1,259 primarily from $1,609 in retained net income, less $238 paid to buyback common stock on the open market. Net book value per share at March 31, 2013 was $33.71 compared to $32.93 at December 31, 2012. The stockholders’ equity ratio increased at March 31, 2013 to 8.13% compared to 7.65% at December 31, 2012 from retained earnings and a 3.7% decrease in total assets. We expect the stockholders’ equity ratio to continue near the March 31, 2013 level based on estimated earnings, projected organic asset growth, and shareholder cash dividends during the remainder of 2013.

We declared a 5% stock dividend to shareholders on June 19, 2012 to celebrate the 50 ^th anniversary of our subsidiary Peoples State Bank, which was paid in additional shares of our common stock on July 30, 2012 to shareholders of record on July 16, 2012. All references to per share information in this Quarterly Report on Form 10-Q to 2012 per share amounts have been updated to reflect the 5% stock dividend.

For regulatory purposes, the $7.7 million junior subordinated debentures maturing September 2035 reflected as debt on the Consolidated Balance Sheet are reclassified as Tier 1 regulatory equity capital. The floating rate payments required by the junior subordinated debentures have been hedged with a fixed rate interest rate swap resulting in a total interest cost of 4.42% through September 2017. The adequacy of our capital is regularly reviewed to ensure sufficient capital is available for current and future needs and is in compliance with regulatory guidelines. As of March 31, 2013 and December 31, 2012, the Bank’s Tier 1 risk-weighted capital ratio, total risk-weighted capital, and Tier 1 leverage ratio were in excess of regulatory minimums and were classified as “well-capitalized.” Refer to Table 22 for specific regulatory capital ratios at period-end. Failure to remain well-capitalized could prevent us from obtaining future whole sale brokered time deposits which are an important source of funding.

During the quarter ended March 31, 2013, we repaid $1,000 of our existing 8% senior subordinated notes and refinanced the remaining $6,000 of notes with new debt. Refer to Note 8 of the Notes to Consolidated Financial Statements for details on this refinancing transaction. Although the new $6 million debt no longer qualifies as Tier 2 regulatory capital (as did the prior 8% senior subordinated notes), the refinance generates significant ongoing interest expense savings and we continue to meet a regulatory capital minimums to be considered well capitalized under current and proposed regulatory capital rules.

Unrealized gains on securities available for sale, net of tax, reflected as accumulated other comprehensive income represented approximately $.98, or 2.9% of total net book value per share at March 31, 2013 compared to $1.10, or 3.3% of total net book value per share at December 31, 2012. The decline in market interest rates since September 30, 2008 originally increased the fair value of the fixed rate debt securities held in our investment portfolio and classified as available for sale, which is recorded as an increase to equity. During 2013, we expect the unrealized gain on securities to decline as maturing security proceeds are reinvested into currently low market rates. In addition, if market rates were to increase in the future, existing unrealized gains on our fixed rate investment portfolio would decline, negatively impacting net book value per share.

During the March 2013 quarter, we issued 8,076 shares of restricted stock having a grant date value of $210, or $26 per share, to certain key employees as a retention tool and to align employee performance with shareholder interests. The shares vest over the service period using a straight-line method and unvested shares are forfeited if, prior to vesting, the employee is no longer employed with the Bank. Refer to Note 12 of the Notes to Consolidated Financial Statements for more information on the restricted shares.

We purchased 8,930 shares of our common stock on the open market at a price of $26.62 per share during the quarter ended March 31, 2013 compared to a purchase of 200 shares at a price of $23.25 per share during the quarter ended March 31, 2012. Industry wide, the cost of capital remains very high, particularly related to issue of new common stock as our current stock price is valued at less than our net book value per share. In addition, many sources of previously low cost capital such as pooled trust preferred offerings are no longer available. As the banking industry awaits finalized new regulatory capital standards that will increase regulatory capital minimums, we continue to place a premium on capital and we expect to refrain from significant treasury stock repurchases during the remainder of 2013.

As discussed earlier in the Executive Summary section of this Quarterly Report on Form 10-Q, banking regulators recently issued two proposals that would substantially change how regulatory capital is calculated and the minimum capital to be retained. While we do not expect to be required to raise common stock capital solely to meet these new requirements, the new rules would increase the likelihood we would need capital through the issuance of new common stock if we continued merger and acquisition activity for growth. Because the market price of our stock currently trades at less than our book value, issuance of new common stock shares, such as for an acquisition, could dilute the book value per share of existing shareholders.

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Table 22: Capital Ratios – PSB Holdings, Inc. – Consolidated

	March 31,						December 31,
(dollars in thousands)	2013			2012			2012

Stockholders’ equity	$	55,706		$	51,502		$	54,447
Junior subordinated debentures, net		7,500			7,500			7,500
Disallowed mortgage servicing right assets		(144	)		(115	)		(123	)
Accumulated other comprehensive (income) loss		(1,227	)		(1,880	)		(1,394	)

Tier 1 regulatory capital		61,835			57,007			60,430
Senior subordinated notes		—			7,000			7,000
Allowance for loan losses		6,243			5,676			6,206

Total regulatory capital	$	68,078		$	69,683		$	73,636

Quarterly average tangible assets (as defined by current regulations)	$	686,711		$	605,909		$	689,974

Risk-weighted assets (as defined by current regulations)	$	498,229		$	451,982		$	495,287

Tier 1 capital to average tangible assets (leverage ratio)		9.00%			9.41%			8.76%
Tier 1 capital to risk-weighted assets		12.41%			12.61%			12.20%
Total capital to risk-weighted assets		13.66%			15.42%			14.87%

Table 23: Capital Ratios – Peoples State Bank – Subsidiary

Tier 1 capital to average tangible assets (leverage ratio)	9.70%	10.17%	9.35%
Tier 1 capital to risk-weighted assets	13.39%	13.62%	13.11%
Total capital to risk-weighted assets	14.64%	14.88%	14.36%

As a measurement of the adequacy of a bank’s capital base related to its level of nonperforming assets, many investors use a “non-GAAP” measure commonly referred to as the “Texas Ratio.” We also track changes in our Texas Ratio against our internal capital and liquidity risk parameters to highlight negative capital trends that could impact our ability for future growth, payment of dividends to shareholders, or other factors. As noted previously, correspondent bank providers of our daily federal funds purchased line of credit and the holding company operating line of credit use similar measures that impact our ability to continued use of those lines of credit if our level of nonperforming assets to capital were to rise above prescribed levels. The following Table 24 presents the calculation of our Texas Ratio.

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Table: 24: Calculation of “Texas Ratio” (a non-GAAP measure)

	As of Quarter End
		March 31,			December 31,			September 30,			June 30,			March 31,
(dollars in thousands)		2013			2012			2012			2012			2012

Total nonperforming assets		$	11,926		$	12,454		$	17,191		$	17,360		$	18,850

Total stockholders’ equity		$	55,706		$	54,447		$	53,795		$	52,632		$	51,502
Less: Mortgage servicing rights, net (intangible assets)			(1,443	)		(1,233	)		(1,091	)		(1,110	)		(1,151	)
Add: Allowance for loan losses			7,434			7,431			7,431			7,648			7,755

Total tangible common stockholders’ equity and reserves		$	61,697		$	60,645		$	60,135		$	59,170		$	58,106

Total nonperforming assets as a percentage of
total tangible common stockholders’ equity and reserves			19.33%			20.54%			28.59%			29.34%			32.44%

OFF BALANCE-SHEET COMMITMENTS AND CONTRACTUAL OBLIGATIONS

Off Balance Sheet Arrangements

We service residential mortgage loans originated by our lenders and sold to the FHLB and FNMA. As a FHLB Mortgage Partnership Finance (“MPF”) loan servicer, we provide a credit enhancement guarantee to reimburse the FHLB for foreclosure losses in excess of 1% of the original loan principal sold to the FHLB prior to November 2008. This impacts $33,164, or 12%, of serviced loans at March 31, 2013 compared to $36,023, or 13%, at December 31, 2012. These first mortgage loans are underwritten using standardized criteria we consider to be conservative on residential properties in our local communities. We believe loans serviced for the FHLB will realize minimal foreclosure losses in the future and that we will experience no loan losses related to charge-offs in excess of the FHLB 1% First Loss Account. The north central Wisconsin residential real estate market is experiencing similar home value declines as the state of Wisconsin as a whole, which are moderate when compared to other states in the country. The average residential first mortgage originated by us under the FHLB program which required a credit enhancement was approximately $154 in 2008 and $140 during 2007, the last two years of the program.

Due to historical strength of mortgage borrowers in our markets and relative stability of collateral home values, and the original 1% of principal First Loss Account provided by the FHLB, we believe the possibility of losses under guarantees to the FHLB to be remote. Since inception of our pools containing guarantees to the FHLB in 2000, only $0.4 million of $425 million of loans originated with guarantees have incurred a principal loss, all of which has been borne by the FHLB within their First Loss Account. Accordingly, no provision for a recourse liability has been made for this recourse obligation on loans currently serviced by us. Loans originated and sold to the FHLB under their XTRA program do not require credit enhancement and we have no risk of principal loss on such loans properly underwritten and sold. Under the MPF 100 and MPF 125 credit enhancement programs, the FHLB is reimbursed for any incurred principal losses in its First Loss Account by withholding the monthly credit enhancement fee (.07% to .10% of outstanding serviced principal) normally paid to us until their principal loss is recovered. Our credit enhancement fee is not a significant source of income.

Ten years after the original pool master commitment date, the FHLB First Loss Account and our Credit Enhancement Guarantee are reset to current levels based on loans remaining in the pool. The impact of the reset could increase the risk of incurring a credit enhancement loss above the FHLB First Loss Account. These factors are further reset every subsequent five years until the pool is repaid. The next First Loss Account reset date for any individual master commitment containing our Credit Enhancement Guarantee is scheduled for August 18, 2013.

Under bank regulatory capital rules, this FHLB recourse obligation to the FHLB is risk-weighted for the purposes of the total capital to risk-weighted assets capital calculation. Total risk-based capital required to be held for the recourse obligations under the FHLB MPF programs for capital adequacy purposes was $1,859 at March, 2013 and December 31, 2012. During October 2008, we ceased origination and sale of loans to the FHLB that required a credit enhancement and no additional risk-based capital will be required to support such loans. More information on all loans serviced for other investors, including FHLB and FNMA, is outlined in Table 25.

We also offer a commercial lending product that allows certain adjustable rate commercial loan customers to fix their interest rate with an interest rate swap. Refer to Note 9 of the Notes to Consolidated Financial Statements for details on the program. There were $14,816 and $14,979 in interest rate swaps with customers outstanding under the program at March 31, 2013 and December 31, 2012, respectively.

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Residential Mortgage Loan Servicing

We service $269,609 and $269,554 of residential real estate loans which have been sold to the FHLB and FNMA at March 31, 2013 and December 31, 2012, respectively. Loans sold to FHLB and FNMA are not reflected on our Consolidated Balance Sheets. An annualized servicing fee equal to .25% of outstanding principal is retained from payments collected from the customer as compensation for servicing the loan for the FHLB and FNMA. We recognize a mortgage servicing right asset due to the substantial volume of loans serviced for the FHLB and FNMA.

All loans sold to FHLB or FNMA in which we retain the loan servicing are subject to underwriting representations and warranties made by us as the originator and we are subject to annual underwriting audits from both entities. Our representations and warranties would allow FHLB or FNMA to require us to repurchase inadequately underwritten loans for any number of underwriting violations. We incurred losses due to underwriting violations totaling $28 and $38 during the years ended December 31, 2012 and 2011, respectively, due to failure to obtain private mortgage insurance when required. During the March 2013 quarter, we recorded a provision for serviced mortgage loan recourse liability of $203 which decreased mortgage banking income during the quarter. A recourse loss of $125 was charged against the liability during March 2013 due to foreclosure losses on a mortgage sold to the FHLB that was determined to have been improperly underwritten. Loans originated by this former employee were reviewed and the situation is believed to be isolated, although a $78 recourse liability continued to be maintained at March 31, 2013.

The following tables summarize loan principal serviced for the FHLB under various MPF programs and for FNMA as of March 31, 2013 and December 31, 2012.

Table 25: Residential Mortgage Loans Serviced for Others as of March 31, 2013 ($000s)

					Weighted		Average Monthly		PSB Credit		Agency		Mortgage
Agency	Principal		Loan		Average		Payment		Enhancement		Funded First		Servicing Right, net
Program	Serviced		Count		Coupon Rate		Seasoning		Guarantee		Loss Account		$		%

FHLB MPF 100	$	10,754		225		5.38%		119	$	94	$	291	$	18		0.17%
FHLB MPF 125		22,410		262		5.75%		75		1,851		1,474		65		0.29%
FHLB XTRA		192,607		1,504		3.88%		22		n/a		n/a		1,058		0.55%
FNMA		43,838		306		3.38%		14		n/a		n/a		302		0.69%

Totals	$	269,609		2,297		4.01%		29	$	1,945	$	1,765	$	1,443		0.54%

Table 26: Residential Mortgage Loans Serviced for Others as of December 31, 2012 ($000s)

					Weighted		Average Monthly		PSB Credit		Agency		Mortgage
Agency	Principal		Loan		Average		Payment		Enhancement		Funded First		Servicing Right, net
Program	Serviced		Count		Coupon Rate		Seasoning		Guarantee		Loss Account		$		%

FHLB MPF 100	$	12,328		247		5.38%		116	$	94	$	291	$	21		0.17%
FHLB MPF 125		23,695		272		5.75%		74		1,851		1,474		66		0.28%
FHLB XTRA		194,710		1,507		3.88%		21		n/a		n/a		909		0.47%
FNMA		38,821		274		3.44%		13		n/a		n/a		237		0.61%

Totals	$	269,554		2,300		4.05%		29	$	1,945	$	1,765	$	1,233		0.46%

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

There has been no material change in the information provided in response to Item 7A of our Form 10-K for the year ended December 31, 2012.

Item 4. Controls and Procedures

As of the end of the period covered by this report, management, under the supervision, and with the participation, of our President and Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) pursuant to Exchange Act Rule 13a 15. Based upon, and as of the date of such evaluation, the President and Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective.

PART II – OTHER INFORMATION

Item 1A. Risk Factors

In addition to the other information set forth in this report, this report should be considered in light of the risk factors referenced in Part I of PSB’s Annual Report on Form 10-K for the year ended December 31, 2012, under the caption “Forward-Looking Statements.” These and other risk factors could materially affect PSB’s business, financial condition, or future results of operations. The risks referenced in PSB’s Annual Report on Form 10-K are not the only risks facing PSB. Additional risks and uncertainties not currently known to PSB or that it currently deems to be immaterial also may materially adversely affect PSB’s business, financial condition, and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Purchases of Equity Securities

Maximum number

Total number

(or approximate

of shares (or

dollar value) of

Total number

units) purchased

shares (or units)

of shares

Average price

as part of publicly

that may yet be

(or units)

paid per share

announced plans

purchased under the

purchased

(or unit)

or programs

plans or programs

Period

(a)

(b)

(c)

(d)

January 2013

5,000

25.75

–

February 2013

1,500

26.85

–

March 2013

2,430

28.25

–

Quarterly totals

8,930

26.62

–

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Item 6. Exhibits

Exhibits required by Item 601 of Regulation S-K.

Exhibit
Number	Description

31.1	Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002
31.2	Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002
32.1	Certifications under Section 906 of Sarbanes-Oxley Act of 2002
101.INS*	XBRL Instance Document
101.SCH*	XBRL Taxonomy Extension Schema Document
101.CAL*	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*	XBRL Taxonomy Definition Linkbase Document
101.LAB*	XBRL Taxonomy Extension Label Linkbase Document
101.PRE*	XBRL Taxonomy Extension Presentation Linkbase Document

XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	PSB HOLDINGS, INC.


May 15, 2013	SCOTT M. CATTANACH
	Scott M. Cattanach
	Treasurer

	(On behalf of the Registrant and as Principal Financial Officer)

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EXHIBIT INDEX

FORM 10-Q

PSB HOLDINGS, INC.

for the quarterly period ended March 31, 2013

Pursuant to Section 102(d) of Regulation S-T

(17 C.F.R. §232.102(d))

The following exhibits are filed as part this report:

31.1	Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002
31.2	Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002
32.1	Certifications under Section 906 of Sarbanes-Oxley Act of 2002
101.INS*	XBRL Instance Document
101.SCH*	XBRL Taxonomy Extension Schema Document
101.CAL*	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*	XBRL Taxonomy Definition Linkbase Document
101.LAB*	XBRL Taxonomy Extension Label Linkbase Document
101.PRE*	XBRL Taxonomy Extension Presentation Linkbase Document