PSB (PSBX) 10-Q 2012 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

 For the quarterly period ended December 31, 2011

o 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   0-50970

PSB Holdings, Inc.

(Exact name of registrant as specified in its charter)

United States	42-1597948
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

40 Main Street, Putnam, Connecticut  06260

(Address of principal executive offices)

(Zip Code)

(860) 928-6501

(Issuer’s telephone number)

N/A

(Former name, former address and former fiscal year, if changed since last report)

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 such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x YES o NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x YES o NO

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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer       o                                            Accelerated filer                        o

Non-accelerated filer         o                                            Smaller reporting company      x

(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) o YES x NO

As of January 31, 2012, there were 6,528,863 shares of the registrant’s common stock outstanding.

PSB Holdings, Inc.

Table of Contents

Part I.	FINANCIAL INFORMATION
		Page No.
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets at December 31, 2011 and June 30, 2011	1
	Condensed Consolidated Statements of Income for the Three and Six Months Ended December 31, 2011 and 2010	2
	Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended December 31, 2011 and 2010	3
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2011 and 2010	4
	Notes to Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42
Item 4.	Controls and Procedures	42
Part II.	OTHER INFORMATION
Item 1.	Legal Proceedings	43
Item 1A.	Risk Factors	43
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 3.	Defaults Upon Senior Securities	43
Item 4.	[Removed and Reserved]	43
Item 5.	Other Information	43
Item 6.	Exhibits	43
SIGNATURES		44

Part I.  FINANCIAL INFORMATION

Item 1.  Financial Statements (unaudited)

PSB Holdings, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

	December 31,			June 30,
	2011			2011
	(in thousands except share data)
ASSETS
Cash and due from depository institutions	$	15,427		$	7,915
Interest-bearing demand deposits with other banks		35			358
Total cash and cash equivalents		15,462			8,273
Securities available for sale, at fair value		50,793			58,009
Securities held-to-maturity (fair value of $111,062 as of
December 31, 2011 and $115,962 as of June 30, 2011)		108,688			114,741
Federal Home Loan Bank stock, at cost		8,056			8,056
Loans held for sale		566			1,567
Loans		257,713			256,297
Allowance for loan losses		(3,081	)		(3,072	)
Net loans		254,632			253,225
Premises and equipment		4,685			4,849
Accrued interest receivable		1,279			1,528
Other real estate owned		2,153			1,074
Goodwill		6,912			6,912
Other intangible assets		263			324
Bank owned life insurance		8,595			6,431
Other assets		7,596			7,510
Total assets	$	469,680		$	472,499
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits
Noninterest-bearing	$	39,371		$	36,814
Interest-bearing		295,072			296,959
Total deposits		334,443			333,773
Mortgagors’ escrow accounts		1,862			1,766
Federal Home Loan Bank advances		81,500			83,500
Securities sold under agreements to repurchase		3,929			4,244
Other liabilities		2,403			2,469
Total liabilities		424,137			425,752
Stockholders’ Equity
Preferred stock, $0.10 par value, 1,000,000 shares authorized,		-			-
no shares issued and outstanding
Common stock, $0.10 par value, 12,000,000 shares authorized,
6,943,125 shares issued, 6,528,863 shares outstanding
at December 31, 2011 and June 30, 2011		694			694
Additional paid-in capital		30,565			30,594
Retained earnings		23,464			22,648
Accumulated other comprehensive loss		(3,332	)		(1,267	)
Unearned ESOP shares		(1,629	)		(1,693	)
Unearned stock awards		(6	)		(16	)
Treasury stock, at cost (414,262 shares at
December 31, 2011 and June 30, 2011)		(4,213	)		(4,213	)
Total stockholders’ equity		45,543			46,747
Total liabilities and stockholders’ equity	$	469,680		$	472,499

See notes to condensed consolidated financial statements.

1

PSB Holdings, Inc.

Condensed Consolidated Statements of Income

(Unaudited)

	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2011			2010			2011			2010
	(in thousands, except per share data)
Interest and dividend income:
Interest on loans	$	3,243		$	3,434		$	6,617		$	6,937
Interest and dividends on investments		1,227			1,519			2,519			3,165
Total interest and dividend income		4,470			4,953			9,136			10,102
Interest expense:
Deposits and escrow		1,015			1,225			2,097			2,483
Borrowed funds		807			936			1,631			1,902
Total interest expense		1,822			2,161			3,728			4,385
Net interest and dividend income		2,648			2,792			5,408			5,717
Provision for loan losses		211			241			602			442
Net interest and dividend income after provision
for loan losses		2,437			2,551			4,806			5,275
Non-interest income:
Fees for services		459			531			977			1,063
Mortgage banking activities		22			64			31			113
Net commissions from brokerage service		19			38			65			76
Income from bank owned life insurance		89			70			164			140
Total other-than-temporary impairment losses on debt securities		(1,331	)		(1,332	)		(2,376	)		(2,090	)
Portion of losses recognized in other comprehensive loss/income		1,117			978			1,364			1,563
Net impairment losses recognized in earnings		(214	)		(354	)		(1,012	)		(527	)
Gain on sales of available-for-sale securities, net		-			-			235			254
Income from legal settlement		-			-			1,452			-
Other income		42			43			71			79
Total non-interest income		417			392			1,983			1,198
Non-interest expense:
Compensation and benefits		1,519			1,447			3,034			2,936
Occupancy and equipment		315			305			621			607
Data processing		233			209			493			405
Advertising and marketing		89			60			150			121
OCC/OTS assessment		46			47			91			93
FDIC deposit insurance		156			203			294			408
Other real estate owned expense		19			29			66			50
Write-down of other real estate owned		-			95			15			95
Other non-interest expense		507			484			965			909
Total non-interest expense		2,884			2,879			5,729			5,624
(Loss) income before income tax expense		(30	)		64			1,060			849
Income tax (benefit) expense		(41	)		(35	)		244			180
NET INCOME	$	11		$	99		$	816		$	669
Earnings per common share
Basic	$	0.00		$	0.02		$	0.13		$	0.11
Diluted	$	0.00		$	0.02		$	0.13		$	0.11

See notes to condensed consolidated financial statements.

2

PSB Holdings, Inc.

Condensed Consolidated Statements of Changes in Stockholders’ Equity

For the Six Months Ended December 30, 2011 and 2010

(Unaudited)

	Common Stock		Additional Paid-in Capital			Retained Earnings		Accumulated Other Comprehensive Loss			Unearned ESOP Shares			Unearned Stock Awards			Treasury Stock			Total Stockholders’ Equity
(in thousands)
Balances at June 30, 2010	$	694	$	30,633		$	21,550	$	(2,776	)	$	(1,821	)	$	(212	)	$	(4,213	)	$	43,855
Comprehensive income:
Net income		-		-			669		-			-			-			-			669
Net change in unrealized holding losses on available-for-sale securities, net of reclassification adjustments and tax effects		-		-			-		1,063			-			-			-			1,063
Comprehensive income																					1,732
Stock-based compensation		-		33			-		-			-			176			-			209
Balances at December 31, 2010	$	694	$	30,666		$	22,219	$	(1,713	)	$	(1,821	)	$	(36	)	$	(4,213	)	$	45,796
Balances at June 30, 2011	$	694	$	30,594		$	22,648	$	(1,267	)	$	(1,693	)	$	(16	)	$	(4,213	)	$	46,747
Comprehensive loss:
Net income		-		-			816		-			-			-			-			816
Net change in unrealized holding losses on available-for-sale securities, net of reclassification adjustments and tax effects		-		-			-		(2,065	)		-			-			-			(2,065	)
Comprehensive loss																					(1,249	)
Common stock held by ESOP committed to be released (6,390 shares)		-		(34	)		-		-			64			-			-			30
Stock-based compensation		-		5			-		-			-			10			-			15
Balances at December 31, 2011	$	694	$	30,565		$	23,464	$	(3,332	)	$	(1,629	)	$	(6	)	$	(4,213	)	$	45,543

See notes to condensed consolidated financial statements.

3

PSB Holdings, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	For the Six Months
	Ended December 31,
	2011			2010
	(in thousands)
Cash flows from operating activities
Net income	$	816		$	669
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of securities, net		714			545
Gain on sales of available-for-sale securities, net		(235	)		(254	)
Impairment losses on securities		1,012			527
Net decrease in loans held-for-sale		1,001			1,272
Amortization of deferred loan (fees) costs, net		(145	)		60
Provision for loan losses		602			442
Gain on sale of other real esate owned		(17	)		(40	)
Write-down of other real esate owned		15			95
Loss on sale of premises and equipment		5			-
Depreciation and amortization		209			234
Amortization of core deposit intangible		61			74
Decrease in accrued interest receivable and other assets		1,248			196
Increase in cash surrender value of bank owned life insurance		(164	)		(140	)
Decrease in other liabilities		(66	)		(291	)
Amortization of ESOP expense		30			-
Stock-based compensation		15			209
Net cash provided by operating activities		5,101			3,598
Cash flows from investing activities
Purchase of available-for-sale securities		(3,500	)		-
Proceeds from sales and maturities of available-for-sale securities		6,790			20,733
Purchase of held-to-maturity securities		(16,189	)		(62,955	)
Proceeds from maturities of held-to-maturity securities		21,548			33,301
Loan repayments net of originations		(3,537	)		(670	)
Purchase of bank owned life insurance		(2,000	)		-
Recoveries of loans previously charged off		19			21
Proceeds from sale of other real estate owned		577			177
Capital expenditures - premises and equipment		(71	)		(26	)
Net cash provided by (used in) investing activities		3,637			(9,419	)
Cash flows from financing activities
Net increase (decrease) in savings, demand deposits and NOW accounts		4,131			(4,080	)
Net decrease in time deposit accounts		(3,461	)		(641	)
Net increase in mortgagors’ escrow accounts		96			32
Proceeds from Federal Home Loan Bank advances		2,000			10,000
Repayments of Federal Home Loans Bank advances		(4,000	)		(15,000	)
Net decrease in securities sold under agreement to repurchase		(315	)		(381	)
Net cash used in financing activities		(1,549	)		(10,070	)
Increase (decrease)  in cash and cash equivalents		7,189			(15,891	)
Cash and cash equivalents at beginning of year		8,273			23,291
Cash and cash equivalents at end of period	$	15,462		$	7,400
Supplemental disclosures
Cash paid during the period for:
Interest	$	3,721		$	4,399
Income taxes (refunded) paid		(433	)		805
Loans transferred to other real estate owned		1,654			144

See notes to condensed consolidated financial statements.

4

PSB Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1 – Organization

PSB Holdings, Inc. (Company) is a federally chartered holding company formed on May 27, 2003 for the purpose of acquiring all of the common stock of Putnam Bank (Bank) concurrent with the Bank’s reorganization from a mutual savings institution to the mutual holding company form of organization.  No shares were offered to the public as part of this reorganization.

On October 4, 2004, the Company issued 6,943,125 shares of common stock, 3,729,846 shares (53.7%) of which were issued to Putnam Bancorp, MHC and 3,089,691 shares (44.5%) of which were sold to eligible depositors of the Bank and others at $10.00 per share. In addition, the Company issued 123,588 shares (1.8%) to a charitable foundation established by the Bank.

NOTE  2 – Basis of Presentation

The accompanying unaudited condensed consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements and the instructions to Form 10-Q, and accordingly do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments necessary, consisting of only normal recurring accruals and the elimination of all significant intercompany accounts, to present fairly the financial position, results of operations and cash flows of the Company for the periods presented.  The interim results of operations are not necessarily indicative of the operating results to be expected for future periods, including the year ending June 30, 2012.  These financial statements should be read in conjunction with the 2011 consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on September 26, 2011.

NOTE 3 – Recent Accounting Pronouncements

In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-02, Receivables (Topic 310), “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” This ASU provides additional guidance or clarification to help creditors determine whether a restructuring constitutes a troubled debt restructuring. For public entities, the amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption.  As a result of applying these amendments, an entity may identify receivables that are newly considered impaired, and should measure impairment on those receivables prospectively for the first interim or annual period beginning on or after June 15, 2011.  Additional disclosures are also required under this ASU.  This ASU was adopted in the first quarter of fiscal year 2012 and did not have a significant impact on the Company’s condensed consolidated financial statements.

In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing (Topic 860), “Reconsideration of Effective Control for Repurchase Agreements.”  The objective of this ASU is to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.  This ASU prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repurchase agreements.  The guidance in this ASU is effective for the first interim or annual period beginning on or after December 15, 2011.  Early adoption is not permitted.  This amendment is effective for the Company on January 1, 2012 and is not expected to have a significant impact on the Company’s condensed consolidated financial statements.

5

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220), “Presentation of Comprehensive Income.”  This ASU amends the disclosure requirements for the presentation of comprehensive income.  The amended guidance eliminates the option to present components of other comprehensive income (OCI) as part of the statement of changes in stockholders’ equity.  Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or two separate but consecutive financial statements.  The changes are effective for fiscal years, and interim periods within those years, ending after December 15, 2011, with retrospective application required.  Early application is permitted.  This amendment is not expected to have a significant impact on the Company’s condensed consolidated financial results as the amendments relate only to changes in financial statement presentation.

In September 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other (Topic 350), “Testing Goodwill for Impairment.”  This ASU is intended to reduce the complexity and cost of performing an evaluation of impairment of goodwill.  Under the new guidance, an entity will have the option of first assessing qualitative factors (events and circumstances) to determine whether it is more likely than not (meaning a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount.  If, after considering all relevant events and circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test will be unnecessary.  The amendments will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  Early adoption is permitted.  This amendment is not expected to have a significant impact on the Company’s condensed consolidated financial statements.

In December 2011, the Financial Accounting Standards Board issued Accounting Standards Update No. 2011-12, Comprehensive Income (Topic 220), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. This Update defers the changes in Update 2011-05 that relate to the presentation of reclassification adjustments.  The amendments are being made to allow the FASB Board time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the FASB Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. This amendment is not expected to have a significant impact on the Company’s condensed consolidated financial results as the amendments relate only to changes in financial statement presentation.

Critical Accounting Policies

Critical accounting policies are those that involve significant judgments and assumptions by management that have, or could have, a material impact on our income or the carrying value of our assets.  Our critical accounting policies are those related to our loans, allowance for loan losses, income taxes, goodwill and the impairment of securities.

Loans.  The Company’s loan portfolio includes residential real estate, commercial real estate, construction, commercial and consumer/other segments. Residential real estate loans include classes for one-to four-family owner occupied, second mortgages and equity lines of credit.  Consumer/other loans include personal loans.  Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

6

The accrual of interest on all loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual if collection of principal or interest is considered doubtful.  All interest accrued but not collected for loans that are placed on nonaccrual is reversed against interest income.  The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

           Allowance for Loan Losses.  The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.

The allowance for loan losses is evaluated on a quarterly basis by management.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of general, specific and unallocated components, as further described below.

General component

The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate, commercial real estate, construction, commercial and consumer/other.  Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment.  This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; loan rating migration and national and local economic trends and conditions. There have been no material changes in the Company’s policies or methodology pertaining to the general component of the allowance for loan losses during 2011.

The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:

Residential real estate - The Company generally does not originate loans with a loan-to-value ratio greater than 80% and does not originate subprime loans.  All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower.  The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.

Commercial real estate - Loans in this segment are primarily income-producing properties throughout New England.  The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on the credit quality in this segment.  Management obtains rent rolls annually and continually monitors the cash flows of these loans.

Construction loans – Loans in this segment primarily include speculative real estate development loans for which payment is derived from sale of the property.  Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.

Commercial loans – Loans in this segment are made to businesses and are generally secured by assets of the business.  Repayment is expected from the cash flows of the business.  A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.

Consumer/other loans - Loans in this segment are generally unsecured and repayment is dependent on the credit quality of the individual borrower.

Specific component

The specific component relates to loans that are classified as impaired.  Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent or foreclosure is probable.  An allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan.  Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring agreement.

7

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

The Company periodically may agree to modify the contractual terms of loans.  When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring (TDR). All TDR’s are initially classified as impaired.

Unallocated component

An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general reserves in the portfolio.

           Goodwill.  The Company’s goodwill was recorded as a result of business acquisitions and combinations.  The Company’s goodwill (the amount paid in excess of fair value of acquired net assets) is reviewed at least annually to ensure that there have been no events or circumstances resulting in an impairment of the recorded amount of excess purchase price.  Adverse changes in the economic environment, operations of acquired business units, or other factors could result in a decline in projected fair values.  If the estimated fair value is less than the carrying amount, a loss would be recognized to reduce the carrying amount to implied fair value.

Other-Than-Temporary Impairment of Securities.  Management periodically reviews all investment securities with significant declines in fair value for potential other-than-temporary impairment pursuant to the guidance provided by ASC 320-10 “Investments-Debt and Equity Securities”.  The guidance addresses the determination as to when an investment is considered impaired, whether the impairment is other-than-temporary, and the measurement of an impairment loss.  It also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments.  Management evaluates the Company’s investment portfolio on an ongoing basis and recorded $214,000 and $354,000 of other-than-temporary impairment charges through income during the three months ended December 31, 2011 and 2010, respectively and $1.0 million and $527,000 of other-than-temporary impairment charges through income during the six months ended December 31, 2011 and 2010, respectively.

Income Taxes.  The Company recognizes income taxes under the asset and liability method.  Under this method, deferred tax assets and liabilities are established for the temporary differences between the accounting basis and the tax basis of the Company’s assets and liabilities at enacted rates expected to be in effect when the amounts related to such temporary differences are realized or settled.

Management has discussed the development and selection of these critical accounting policies with the Audit Committee.

 

8

NOTE 4 – Earnings Per Share (EPS)

As presented below, basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period.  Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. For purposes of computing diluted EPS, the treasury stock method is used.

The following information was used in the computation of EPS on both a basic and diluted basis for the three and six months ended December 31, 2011 and  2010:

	Three Months Ended		Three Months Ended		Six Months Ended		Six Months Ended
	December 31, 2011		December 31, 2010		December 31, 2011		December 31, 2010
Net income	$	11,000	$	99,000	$	816,000	$	669,000
Average basic common shares		6,362,765		6,339,910		6,361,167		6,333,350
Dilutive effect of stock options (1)		0		0		0		0
Average diluted common shares		6,362,765		6,339,910		6,361,167		6,333,350
Basic EPS:	$	0.00	$	0.02	$	0.13	$	0.11
Diluted EPS:	$	0.00	$	0.02	$	0.13	$	0.11

(1)Options to purchase 222,921 shares for the three and six months ended December 31, 2011 and 2010 were outstanding but not included in the computation of earnings per share because they were anti-dilutive, meaning the exercise price of such options exceeded the market value of the Company’s common stock.

9

NOTE 5 – Investment Securities

The carrying value and estimated market values of investment securities by maturity are as follows:

	Amortized		Gross Unrealized					Fair
	Cost Basis		Gain		(Loss)			Value
	(in thousands)
December 31, 2011
Available-for-sale:
Debt securities:
U.S. government and agency securities
Due in one year or less	$	543	$	29	$	-		$	572
From one through five years		3,500		10		-			3,510
		4,043		39		-			4,082
Corporate bonds and other securities
After ten years		5,999		-		(1,789	)		4,210
U.S. Government sponsored and guaranteed
mortgage-backed securities
From one through five years		634		31		-			665
From five through ten years		3,337		213		-			3,550
After ten years		19,778		1,239		(1	)		21,016
		23,749		1,483		(1	)		25,231
Non-agency mortgage-backed securities
After ten years		12,050		-		(2,615	)		9,435
Total debt securities		45,841		1,522		(4,405	)		42,958
Equity securities:
Auction rate preferred stock		10,000		-		(2,165	)		7,835
Total available-for-sale securities	$	55,841	$	1,522	$	(6,570	)	$	50,793
Held-to-maturity:
U.S. government and agency securities
Due in one year or less	$	8,283	$	33	$	(34	)	$	8,282
From one through five years		6,500		15		-			6,515
From five through ten years		929		127		-			1,056
		15,712		175		(34	)		15,853
U.S. Government sponsored and guaranteed
mortgage-backed securities
From five through ten years		7,788		99		-			7,887
After ten years		85,188		2,134		-			87,322
		92,976		2,233		-			95,209
Total held-to-maturity securities	$	108,688	$	2,408	$	(34	)	$	111,062

10

	Amortized		Gross Unrealized					Fair
	Cost Basis		Gain		(Loss)			Value
	(in thousands)
June 30, 2011:
Available-for-sale:
Debt securities:
US government and agency obligations:
From one through five years	$	630	$	36	$	-		$	666
Corporate bonds and other obligations:
After ten years		5,998		-		(1,093	)		4,905
Mortgage-backed securities		43,253		1,673		(2,888	)		42,038
Equity securities:
Auction rate preferred stock		10,047		682		(329	)		10,400
Total available-for-sale securities	$	59,928	$	2,391	$	(4,310	)	$	58,009
June 30, 2011:
Held-to-maturity:
US government and agency obligations:
From one through five years		2,000		34		-			2,034
From five through ten years		11,234		51		(26	)		11,259
After ten years		2,851		-		(15	)		2,836
		16,085		85		(41	)		16,129
Mortgage-backed securities
After ten years		98,656		1,221		(44	)		99,833
Total held to maturity securities	$	114,741	$	1,306	$	(85	)	$	115,962

There were no gross gains or losses realized on sales of available-for-sale securities for the three months ended December 31, 2011 and 2010.  Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.  There were other-than-temporary impairment charges on available-for-sale securities of $214,000 and $354,000 during the three months ended December 31, 2011 and 2010, respectively.  The loss on write-downs of securities included total other-than-temporary impairment losses of $1.3 million and $1.3 million, net of $1.1 million and $978,000 recognized in other comprehensive income/loss for the three months ended December 31, 2011 and 2010, respectively, before taxes.  There were gross gains of $235,000 and no gross losses realized on sales of available-for-sale securities for the six months ended December 31, 2011 and $254,000 of gross gains and no gross losses for the six months ended December 31, 2010.  There was an other-than-temporary impairment charge on available-for-sale securities of $1.0 million during the six months ended December 31, 2011 and $527,000 during the six months ended December 31, 2010.  The loss on write-downs of securities included total other-than-temporary impairment losses of $2.4 million and $2.1 million, net of $1.4 million and $1.6 million recognized in other comprehensive income/loss for the six months ended December 31, 2011 and 2010, respectively, before taxes.  See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Overview.”

11

The following is a summary of the estimated fair value and related unrealized losses segregated by category and length of time that individual securities have been in a continuous unrealized loss position at:

December 31, 2011:	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(in thousands)	Value		Losses			Value		Losses			Value		Losses
Available-for-sale:
Debt securities:
Corporate bonds and other securities	$	-	$	-		$	4,210	$	(1,789	)	$	4,210	$	(1,789	)
U.S. Government sponsored and guaranteed
mortgage-backed securities		337		(1	)		-		-			337		(1	)
Equity securities:
Auction rate preferred stock		2,559		(441	)		5,276		(1,724	)		7,835		(2,165	)
Total temporarily impaired available-for-sale		2,896		(442	)		9,486		(3,513	)		12,382		(3,955	)
Held-to-maturity:
U.S. Government and agency securities		5,253		(34	)		-		-			5,253		(34	)
Other-than-temporarily impaired debt
securities (1)
Non-agency mortgage-backed securities		3,555		(467	)		5,880		(2,148	)		9,435		(2,615	)
Total temporarily-impaired and other-
than-temporarily impaired securities	$	11,704	$	(943	)	$	15,366	$	(5,661	)	$	27,070	$	(6,604	)
June 30, 2011:	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(in thousands)	Value		Losses			Value		Losses			Value		Losses
U.S. Government and agency securities	$	3,810	$	(41	)	$	-	$	-		$	3,810	$	(41	)
Corporate bonds and other obligations		-		-			4,905		(1,093	)		4,905		(1,093	)
Mortgage-backed securities		10,323		(44	)		-		-			10,323		(44	)
Equity securities		-		-			6,671		(329	)		6,671		(329	)
Total temporarily impaired securities		14,133		(85	)		11,576		(1,422	)		25,709		(1,507	)
Other-than-temporarily impaired debt
securities (1)
Mortgage-backed securities		4,567		(537	)		7,155		(2,351	)		11,722		(2,888	)
Total temporarily-impaired and other-
than-temporarily impaired securities	$	18,700	$	(622	)	$	18,731	$	(3,773	)	$	37,431	$	(4,395	)

(1)  Includes other-than-temporary impaired available-for-sale debt securities in which a portion of the other-than-temporary impairment loss remains in accumulated other comprehensive loss.

Management evaluates securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.

At December 31, 2011 and June 30, 2011, there were 28 and 32 individual investment securities, respectively, with declines in fair value below the amortized cost basis of the security.  Management has the intent and ability to hold these securities until cost recovery occurs and considers these declines to be temporary.

12

The unrealized losses on the Company’s investment in U.S. Government-sponsored agency bonds and U.S. government guaranteed and government-sponsored residential mortgage-backed securities were primarily caused by interest rate fluctuations.  These investments are guaranteed or sponsored by the U.S. government or an agency thereof.  Accordingly, it is expected that the securities would not be settled at a price less than the par value of the investment.  Because the decline in market value is attributable to changes in interest rates and not to credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2011.

The Company’s unrealized losses on investments in corporate bonds and other securities relate to investments in companies within the financial services sector.  The unrealized losses are primarily caused by (a) interest rate fluctuations, (b) recent decreases in profitability and near-term profit forecasts by industry analysts and (c) recent downgrades by several industry analysts.  The contractual terms of these investments do not permit the companies to settle the security at a price less than the par value of investment.  While the companies’ credit ratings have decreased, the Company currently does not believe it is probable that it will be unable to collect all amounts due according to the contractual terms of the investments.  Therefore, it is expected that the bonds would not be settled at a price less than the par value of the investment.  Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2011.

For the quarter ended December 31, 2011, securities with other-than-temporary impairment losses related to credit loss that were recognized in earnings consisted of non-agency mortgage-backed securities.  For these debt securities, the Company estimated the portion of loss attributable to credit loss using a discounted cash flow model.  Significant inputs for the non-agency mortgage-backed securities included the estimated cash flows of the underlying collateral based on key assumptions, such as default rate, loss severity and prepayment rate.  Assumptions used can vary widely from security to security, and are influenced by such factors as loan interest rate, geographical location of the borrower, borrower characteristics and collateral type.  The present value of the expected cash flows were compared to the Company’s amortized cost basis to determine the credit-related impairment loss.  Based on the expected cash flows derived from the model, the Company expects to recover the remaining unrealized losses on non-agency mortgage-backed securities.

The following table represents a roll-forward of the amount of credit losses on debt securities for which a portion of an other-than-temporary impairment was recognized in other comprehensive income (in thousands):

Balance as of June 30, 2010	$	12,241
Credit losses on securities for which other-than-temporary impairment
was not previously recorded		-
Additional credit losses on securities for which an other-than-temporary
impairment charge was previously recorded		1,065
Reductions for securities sold during the period		-
Balance as of June 30, 2011		13,306
Credit losses on securities for which other-than-temporary impairment
was not previously recorded		-
Additional credit losses on securities for which an other-than-temporary
impairment charge was previously recorded		1,012
Reductions for securities sold during the period		-
Balance as of December 31, 2011	$	14,318

13

Auction-rate trust preferred securities. At December 31, 2011, our auction-rate trust preferred securities (ARP) portfolio totaled $7.8 million, all of which were classified as available-for-sale.    Auction-rate trust preferred securities are a floating rate preferred stock, on which the dividend rate generally resets every 90 days based on an auction process to reflect the yield demand for the instruments by potential purchasers.  At December 31, 2011, our investments in auction-rate trust preferred securities consisted of investments in three corporate issuers.  These securities were originally purchased by the Company because they represented highly liquid, tax-preferred investments secured, in most cases, by preferred stock issued by high quality, investment grade companies (generally other financial institutions) (“collateral preferred shares”).  The ARP shares, or certificates, purchased by the Company are Class A certificates, which, among other rights, entitle the holder to priority claim on dividends paid into the Trust holding the preferred shares.

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

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

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

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

On September 7, 2008, the U. S. Department of the Treasury placed Fannie Mae and Freddie Mac under conservatorship and assumed an equity position in these entities, which takes priority over both common and preferred stocks.  Putnam Bank owned $4,000,000 in Freddie Mac auction-rate preferred securities and recorded an other-than-temporary impairment loss totaling $3.95 million during the quarters ended September 30, 2008 and December 31, 2008.   On August 24, 2011, the Bank redeemed the Freddie Mac auction-rate preferred securities and took custody of the 160,000 shares of Freddie Mac preferred stock that collateralized these ARPs.  On September 13, 2011, the Bank sold all of these preferred shares for $282,000.

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

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

The Company adopted the guidance in ASC 820-10, “Fair Value Measurements and Disclosures,” in the second quarter of 2009.  The Company concluded that the market value of the underlying collateral preferred shares did not represent orderly transactions and adopted the use of a discounted cash flow model to determine if there was any other-than-temporary impairment of its investments in the ARPs.  The resulting discounted cash flow for each of ARP classified as Level 3 showed no impairment in the fair value of the securities.

14

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

The chart below includes information as of December 31, 2011 on the various issuers of Auction Rate Preferred securities owned by the Company:

Issuer	Goldman Sachs	Merrill Lynch	Bank of America
Par amount	$3,000,000	$5,000,000	$2,000,000
Book Value	$3,000,000	$5,000,000	$2,000,000
Purchase Date	12-12-07	09-04-07	11-20-07
Maturity Date	08-23-26	05-28-27	08-17-47
Next Reset Date	02-21-12	02-27-12	02-16-12
Reset Frequency	Quarterly	Quarterly	Quarterly
Failed Auction	Yes	Yes	Yes
Receiving Default Rates	Yes	Yes	Yes
Current Rate	4.590%	4.659%	4.677%
Dividends Current:	Yes	Yes	Yes

NOTE 6 – Loans

The following table sets forth the composition of our loan portfolio at December 31, 2011 and June 30, 2011:

	December 31,			June 30,
	2011			2011
	(in thousands)
Mortgage Loans:
Residential (1)	$	197,670		$	193,084
Commercial real estate		52,183			53,248
Residential construction		1,606			2,824
Commercial		6,784			7,356
Consumer and other		946			1,070
Total loans		259,189			257,582
Unadvanced construction loans		(1,812	)		(1,476	)
		257,377			256,106
Net deferred loan costs		336			191
Allowance for loan losses		(3,081	)		(3,072	)
Loans, net	$	254,632		$	253,225

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

Credit Quality Information

The Company utilizes a nine grade internal loan rating system as follows:

Loans rated 1 -5:  Loans in these categories are considered “pass” rated loans with low to average risk.

Loans rated 6:  Loans in this category are considered “special mention.”  These loans are starting to show signs of potential weakness and are being closely monitored by management.

15

Loans rated 7:  Loans in this category are considered “substandard.”  Generally, a loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged.  There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.

Loans rated 8:  Loans in this category are considered “doubtful.”  Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.

Loans rated 9:  Loans in this category are considered uncollectible (“loss”) and of such little value that their continuance as loans is not warranted.

On an annual basis, or more often if needed, the Company formally reviews the ratings on all commercial real estate, construction and commercial loans.  Annually, the Company engages an independent third-party to review a significant portion of loans within these segments.  Management uses the results of these reviews as part of its annual review process.

The following table presents the Company’s loan segments by internally assigned grades at December 31, 2011:

	Residential		Commercial		Residential
December 31, 2011	Real Estate		Real Estate		Construction		Commercial		Consumer		Total
(in thousands)
Grade:
Pass	$	195,625	$	35,489	$	757	$	5,482	$	946	$	238,299
Special Mention		22		5,790		-		1,302		-		7,114
Substandard		2,023		9,513		-		-		-		11,536
Doubtful		-		428		-		-		-		428
Loss		-		-		-		-		-		-
Total	$	197,670	$	51,220	$	757	$	6,784	$	946	$	257,377

The following table represents modifications that were deemed to be troubled debt restructures for the six months ended December 31, 2011:

			Pre-Modification		Post-Modification
	Number of		Outstanding Recorded		Outstanding Recorded
	Contracts		Investment		Investment
(Dollars in thousands)
Troubled Debt Restructurings
Real Estate:
Residential		6	$	634	$	635
Commercial		11		1,193		1,227
		17		1,827		1,862

The modification on one commercial loan provided a reduced rate for five years and the capitalization of real estate taxes.  A tax escrow account has also been established.  The other commercial modifications relate to one loan relationship that was modified to provide a reduced rate for one year.  Management performs a discounted cash flow calculation to determine the valuation allowance required for each troubled debt restructure.  Residential loan modifications included restructurings that provided a reduced rate for five years, an extended amortization period with no change in rate, six months of interest-only payments along with a reduction in rate, an interest-only period of one year and a reduction in rate, substitution of collateral on a second mortgage, and the conversion a line of credit to an amortizing  fixed rate home equity loan.  Any reserve required is recorded through the provision for loan losses.

16

The following is a summary of troubled debt restructurings that have subsequently defaulted within one year of modification:

	Six months ended
	December 31, 2011
	Number of	Recorded
	Contracts	Investment
(Dollars in thousands)
Troubled Debt Restructurings
That Subsequently Defaulted:
Real Estate:
Residential	2	$	209
Commercial	1		226
Total	3	$	435

The defaults on the commercial and residential troubled debt restructures were the result of the borrower’s delinquent loan payments during the period.  As of December 31, 2011 the commercial loan was greater than 90 days past due and on non-accrual.  One residential loan was 60 days past due and the other residential loan was current but on non-accrual due to past delinquency issues.  The Company evaluates the levels/trends in delinquencies and non-accruals as part of the qualitative factors within the allowance for loan loss framework

NOTE 7 – Non-performing Assets

The table below sets forth the amounts and categories of non-performing assets at the dates indicated:

	At December 31,			At June 30,
	2011			2011
	(Dollars in thousands)
Non-accrual loans:
Residential	$	2,021		$	1,752
Commercial real estate		5,374			4,635
Residential construction		-			-
Commercial		-			-
Consumer and other		-			-
Total non-accrual loans		7,395			6,387
Accruing loans past due 90 days or more:
Residential		-			32
Commercial real estate		-			-
Residential construction		-			-
Commercial		-			-
Consumer and other		-			-
Total		-			32
Total non-performing loans		7,395			6,419
Other real estate owned		2,153			1,074
Other non-performing assets		-			46
Total non-performing assets	$	9,548		$	7,539
Total non-performing loans to total loans		2.87	%		2.51	%
Total non-performing assets to total assets		2.03			1.60

17

Total non-performing assets increased $2.0 million to $9.5 million at December 31, 2011 from $7.5 million at June 30, 2011. Non-performing assets as of December 31, 2011 consisted of $2.2 million in other real estate owned carried at fair value less costs to sell.  Also included in non-performing assets at December 31, 2011 was $7.4 million in non-performing loans.  These loans consisted of 10 residential loans totaling $2.0 million and 14 commercial real estate loans totaling $5.4 million.  Non-performing assets as of June 30, 2011 consisted of $1.1 million in other real estate owned carried at fair value less costs to sell.  Also included in non-performing assets at June 30, 2011 is$46,000 in Freddie Mac auction-rate trust preferred securities, which were sold during the six months ended December 31, 2011, and $6.4 million in non-performing loans.

The balance in non-performing loans is a direct correlation to the deteriorating real estate climate.  Management is focused on working with borrowers and guarantors to resolve these trends by restructuring or liquidating assets when prudent. Many of our commercial relationships are secured by development loans, in particular condominiums which have experienced a significant reduction in demand. The Bank reviews the strength of the guarantors; requires face to face discussions and offers restructuring suggestions that provide the borrowers with short term relief and exit strategies. Overall, we expect to see improvement as solutions are identified and executed. The Bank obtains a current appraisal on all real estate secured loans that are 180 days or more past due if the appraisal on file is older than one year. If the determination is made that there is the potential for collateral shortfall, an allocated reserve will be assigned to the loan for the expected deficiency. It is the policy of the Bank to charge off or write down loans or other assets when, in the opinion of the Credit Committee and Loan Review, the ultimate amount recoverable is less than the book value, or the collection of the amount is expected to be unduly prolonged.  The level of non-performing assets is expected to fluctuate in response to changing economic and market conditions, and the relative sizes of the respective loan portfolios, along with management’s degree of success in resolving problem assets. Management takes a proactive approach with respect to the identification and resolution of problem loans.  In addition, in connection with a regularly scheduled Office of Thrift Supervision (“OTS”) examination, the Holding Company and Bank agreed to develop and implement a plan to reduce classified assets.  This plan has been implemented.  See Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following table sets forth information regarding past due loans at December 31, 2011 and June 30, 2011:

	30–59 Days		60–89 Days		90 days		Total
At December 31, 2011	Past Due		Past Due		or greater		Past Due
(in thousands)
Real Estate:
Residential	$	1,256	$	28	$	1,071	$	2,355
Commercial		-		-		2,379		2,379
Residential Construction		-		-		-		-
Commercial		-		-		-		-
Consumer		-		-		-		-
Other		-		-		-		-
Total	$	1,256	$	28	$	3,450	$	4,734
At June 30, 2011
(in thousands)
Real Estate:
Residential	$	92	$	247	$	1,126	$	1,465
Commercial		629		488		3,324		4,441
Residential Construction		-		-		-		-
Commercial		150		-		-		150
Consumer		-		-		-		-
Other		-		-		-		-
Total	$	871	$	735	$	4,450	$	6,056

18

The following is a summary of information pertaining to impaired loans at December 31, 2011 and June 30, 2011.

	At December 31, 2011						At June 30, 2011
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
	Investment		Balance		Allowance		Investment		Balance		Allowance
Impaired loans without a valuation allowance:	(in thousands)
Real Estate:
Residential	$	301	$	299	$	-	$	395	$	393	$	-
Commercial		2,384		2,382		-		2,625		2,623		-
Residential Construction		-		-		-		-		-		-
Commercial		-		-		-		-		-		-
Consumer		53		53		-		51		51		-
Total impaired with no related allowance		2,738		2,734		-		3,071		3,067		-
Impaired loans with a valuation allowance:
Real Estate:
Residential		2,510		2,505		324		2,025		2,022		236
Commercial		5,882		5,881		650		5,472		5,470		686
Residential Construction		-		-		-		-		-		-
Commercial		-		-		-		-		-		-
Consumer		-		-		-		6		6		6
Total impaired with an allowance recorded		8,392		8,386		974		7,503		7,498		928
Total Impaired Loans:
Real Estate:
Residential		2,811		2,804		324		2,420		2,415		236
Commercial		8,266		8,263		650		8,097		8,093		686
Residential Construction		-		-		-		-		-		-
Commercial		-		-		-		-		-		-
Consumer		53		53		-		57		57		6
Total impaired loans	$	11,130	$	11,120	$	974	$	10,574	$	10,565	$	928

19

The following is a summary of additional information pertaining to impaired loans:

	Three months ended						Three months ended
	December 31, 2011						December 31, 2010
	Average		Interest		Interest Income		Average		Interest		Interest Income
	Recorded		Income		Recognized		Recorded		Income		Recognized
	Investment		Recognized		on Cash Basis		Investment		Recognized		on Cash Basis
(in thousands)
Real Estate:
Residential	$	2,504		-	$	3	$	2,695	$	16	$	4
Commercial		7,364		41		23		6,296		16		-
Residential Construction		-		-		-		-		-		-
Commercial		-		-		-		-		-		-
Consumer		54		1		-		33		1		-
Total impaired loans	$	9,922	$	42	$	26	$	9,024	$	33	$	4
	Six months ended						Six months ended
	December 31, 2011						December 31, 2010
	Average		Interest		Interest Income		Average		Interest		Interest Income
	Recorded		Income		Recognized		Recorded		Income		Recognized
	Investment		Recognized		on Cash Basis		Investment		Recognized		on Cash Basis
(in thousands)
Real Estate:
Residential	$	2,471	$	17	$	9	$	2,380	$	33	$	9
Commercial		7,608		104		44		5,585		19		-
Residential Construction		-		-		-		-		-		-
Commercial		-		4		4		71		-		-
Consumer		55		2		-		33		1		-
Total impaired loans	$	10,134	$	127	$	57	$	8,069	$	53	$	9

20

NOTE 8 – Allowance for Loan Losses

An analysis of the allowance for loan losses for the three months ended December 31, 2011 and 2010 is as follows:

Three months ended
December 31, 2011	Residential			Commercial			Residential
	Real Estate			Real Estate			Construction			Commercial			Consumer			Other			Unallocated			Total
Allowance for credit losses:	(in thousands)
Beginning balance	$	1,533		$	1,241		$	21		$	86		$	8		$	2		$	21		$	2,912
Charge-offs		(39	)		-			-			-			(3	)		(11	)		-			(53	)
Recoveries		1			-			-			4			1			5			-			11
Provision		138			12			(4	)		(8	)		(4	)		10			67			211
Ending Balance	$	1,633		$	1,253		$	17		$	82		$	2		$	6		$	88		$	3,081
Three months ended
December 31, 2010	Residential			Commercial			Residential
	Real Estate			Real Estate			Construction			Commercial			Consumer			Other			Unallocated			Total
Allowance for credit losses:	(in thousands)
Beginning balance	$	1,419		$	1,027		$	8		$	78		$	35		$	6		$	7		$	2,580
Charge-offs		(162	)		(62	)		-			-			(1	)		(19	)		-			(244	)
Recoveries		2			-			-			-			-			7			-			9
Provision		112			56			-			9			-			10			55			242
Ending Balance	$	1,371		$	1,021		$	8		$	87		$	34		$	4		$	62		$	2,587
An analysis of the allowance for loan losses for the six months ended December 31, 2011 and 2010 is as follows:
Six months ended
December 31, 2011	Residential			Commercial			Residential
	Real Estate			Real Estate			Construction			Commercial			Consumer			Other			Unallocated			Total
Allowance for credit losses:	(in thousands)
Beginning balance	$	1,520		$	1,286		$	28		$	140		$	8		$	3		$	87		$	3,072
Charge-offs		(106	)		(476	)		-			-			(3	)		(27	)		-			(612	)
Recoveries		3			-			-			6			1			9			-			19
Provision		216			443			(11	)		(64	)		(4	)		21			1			602
Ending Balance	$	1,633		$	1,253		$	17		$	82		$	2		$	6		$	88		$	3,081
Six months ended
December 31, 2010	Residential			Commercial			Residential
	Real Estate			Real Estate			Construction			Commercial			Consumer			Other			Unallocated			Total
Allowance for credit losses:	(in thousands)
Beginning balance	$	1,332		$	901		$	10		$	297		$	37		$	6		$	68		$	2,651
Charge-offs		(208	)		(62	)		-			(212	)		(2	)		(43	)		-			(527	)
Recoveries		2			-			-			-			1			18			-			21
Provision		245			182			(2	)		2			(2	)		23			(6	)		442
Ending Balance	$	1,371		$	1,021		$	8		$	87		$	34		$	4		$	62		$	2,587

21

Further information pertaining to the allowance for loan losses at December 31, 2011 and June 30, 2011 is as follows:

At December 31, 2011	Residential		Commercial		Residential
	Real Estate		Real Estate		Construction		Commercial		Consumer		Other		Unallocated		Total
(in thousands)
Amount of allowance for loan losses for loans deemed to be impaired	$	324	$	650	$	-	$	-	$	-	$	-	$	-	$	974
Amount of allowance for loan losses for loans
collectively evaluated for impairment	$	1,309	$	603	$	17	$	82	$	2	$	6	$	88	$	2,107
Loans:
Total loans	$	197,670	$	51,220	$	757	$	6,784	$	911	$	35	$	-	$	257,377
Loans deemed to be impaired	$	2,804	$	8,263	$	-	$	-	$	53	$	-	$	-	$	11,120
Loans collectively evaluated for impairment	$	194,866	$	42,957	$	757	$	6,784	$	858	$	35	$	-	$	246,257
At June 30, 2011	Residential		Commercial		Residential
	Real Estate		Real Estate		Construction		Commercial		Consumer		Other		Unallocated		Total
(in thousands)
Amount of allowance for loan losses for loans deemed to be impaired	$	236	$	686	$	-	$	-	$	6	$	-	$	-	$	928
Amount of allowance for loan losses for loans
collectively evaluated for impairment	$	1,284	$	600	$	28	$	140	$	2	$	3	$	87	$	2,144
Loans:
Total loans	$	193,084	$	52,686	$	1,910	$	7,356	$	965	$	105	$	-	$	256,106
Loans deemed to be impaired	$	2,415	$	8,093	$	-	$	-	$	57	$	-	$	-	$	10,565
Loans collectively evaluated for impairment	$	190,669	$	44,593	$	1,910	$	7,356	$	908	$	105	$	-	$	245,541

22

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

NOTE 9 – Goodwill and Other Intangibles

Intangible assets include goodwill and a core deposit intangible associated with the Bank’s purchase of three branches from another financial institution in October 2005.  The goodwill is evaluated for impairment on an annual basis and the core deposit intangible is amortized on an accelerated basis over a ten-year period.  Goodwill was not considered impaired at December 31, 2011 or June 30, 2011.  The amortization expense related to the core deposit intangible for the three months ended December 31, 2011 and 2010 was $30,000 and $37,000, respectively.   The amortization expense related to the core deposit intangible for the six months ended December 31, 2011 and 2010 was $61,000 and $75,000, respectively.

	December 31,		June 30,
	2011		2011
	(in thousands)
Balances not subject to amortization:
Goodwill	$	6,912	$	6,912
Balances subject to amortization:
Core Deposit Intangible		263		324
Total intangible assets	$	7,175	$	7,236

NOTE 10 – Comprehensive Income (Loss)

Comprehensive income (loss) includes net income and any changes in equity from non-owner sources that are not recorded in the income statement (such as changes in the net unrealized gains (losses) on securities).  The Company’s only component of other comprehensive income (loss) is the net unrealized gain (loss) on securities and is presented below with related tax effects.

	Six Months Ended
	December 31,
	2011			2010
	(in thousands)
Net Income	$	816		$	669
Other comprehensive income (loss)
Net unrealized holding (losses) gains on
available-for-sale securities		(2,542	)		2,901
Reclassification adjustment for losses
realized in income on available-for-sale securities		777			273
Non credit portion of other-than-temporary gains (losses) on available-for-sale securities		(1,364	)		(1,563	)
Other comprehensive income (loss) before tax		(3,129	)		1,611
Income tax (expense) benefit related to items of other
comprehensive income		1,064			(548	)
Other comprehensive income (loss) net of tax		(2,065	)		1,063
Total comprehensive income (loss)	$	(1,249	)	$	1,732

23

NOTE 11 – FAIR VALUE MEASUREMENTS

In accordance with ASC 820, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value as follows:

Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuations for assets and liabilities traded in less active dealer or broker markets.  Valuations are obtained from third party pricing services for identical or comparable assets or liabilities.

Level 3 – Valuations for assets and liabilities that are derived from other methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions.  Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets and liabilities.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.  These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities carried at fair value for December 31, 2011.

The Company’s investment and mortgage-backed securities and other debt securities available for sale are generally classified within Level 2 of the fair value hierarchy.  For these securities, we obtain fair value measurements from independent pricing services.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U. S. treasury yield curve, trading levels, market consensus prepayment speeds, credit information and the instrument’s terms and conditions.

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence.  In the absence of such evidence, management’s best estimate is used.  Subsequent to inception, management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalization and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.

The Company’s impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral.  Collateral values are estimated using Level 2 inputs based upon appraisals of similar properties obtained from a third party.

The Company did not have any significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy during the six months ended December 31, 2011.

24

The following summarizes assets measured at fair value on a recurring basis at December 31, 2011 and June 30, 2011:

			Quoted Prices in		Significant		Significant
			Active Markets for		Other Observable		Unobservable
At December 31, 2011	Total Fair		Identical Assets		Inputs		Inputs
(in thousands)	Value		Level 1		Level 2		Level 3
Securities available for sale:
U.S. government and agency securities	$	4,082	$	-	$	4,082	$	-
Corporate bonds and other securities		4,210		-		4,210		-
U.S. Government agency sponsored/guaranteed
mortgage-backed securities		25,231		-		25,231		-
Non-agency mortgage-backed securities		9,435		-		9,435		-
Equity securities		7,835		-		-		7,835
Total	$	50,793	$	-	$	42,958	$	7,835
			Quoted Prices in		Significant		Significant
			Active Markets for		Other Observable		Unobservable
At June 30, 2011	Total Fair		Identical Assets		Inputs		Inputs
(in thousands)	Value		Level 1		Level 2		Level 3
Securities available-for-sale:
U.S. government and agency securities	$	666	$	-	$	666	$	-
Corporate securities		4,905		-		4,905		-
Mortgage-backed securities insured or guaranteed by
U. S. Government enterprises		30,316		-		30,316		-
Non-agency mortgage-backed securities		11,722		-		11,722		-
Equity securities		10,400		-		-		10,400
Total	$	58,009	$	-	$	47,609	$	10,400

The table below represents the changes in level 3 assets measured at fair value for the six months ended December 31, 2011.

(in thousands)
Beginning balance, July 1, 2011	$	10,400
Total unrealized losses included in other comprehensive loss		(2,165	)
Total realized losses included in net income		(400	)
Ending balance, December 31, 2011	$	7,835

25

The following summarizes assets measured at fair value on a non-recurring basis and the adjustments to the carrying value at and for the six months ended December 31, 2011 and 2010.

			Quoted Prices in		Significant Other		Significant		Total Losses
			Active Markets for		Observable Inputs		Unobservable Inputs		for the three
At December 31, 2011	Total Fair		Identical Assets						months ended
(in thousands)	Value		Level 1		Level 2		Level 3		December 31, 2011
Impaired loans	$	1,736	$	-	$	-	$	1,736	$	(108	)
Other real estate owned		363		-		-		363		(39	)
Totals	$	2,099	$	-	$	-	$	2,099	$	(147	)
			Quoted Prices in		Significant Other		Significant		Total Losses
			Active Markets for		Observable Inputs		Unobservable Inputs		for the three
At December 31, 2010	Total Fair		Identical Assets						months ended
(in thousands)	Value		Level 1		Level 2		Level 3		December 31, 2010
Impaired loans	$	374	$	-	$	-	$	374	$	(179	)
Other real estate owned		289		-		-		289		-
Totals	$	663	$	-	$	-	$	663	$	(179	)

The amount of loans represents the carrying value of impaired loans net of related write-downs and valuation allowances for which adjustments are based on the estimated fair value of the underlying collateral. The other real estate owned amount represents the carrying value for which adjustments are also based on the estimated fair value of the property.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because a market may not readily exist for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

There were no liabilities measured at fair value on a recurring or non-recurring basis at December 31, 2011 and 2010 or June 30, 2011.

26

The following methods and assumptions were used by the Company in estimating fair values of its financial instruments:

Cash and Cash Equivalents.  The carrying amounts of cash and cash equivalents approximate fair values based on the short-term nature of the assets.

Investment Securities and FHLBB Stock.  The fair value of securities to be held to maturity and securities available for sale is estimated based on quoted market prices, where available.  If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.  Ownership of Federal Home Loan Bank of Boston (“FHLBB”) stock is restricted to member banks; therefore, the stock is not traded.  The estimated fair value of FHLBB stock is equal to its carrying value, which represents the price at which the FHLBB is obligated to redeem its stock.

Loans.  For valuation purposes, the loan portfolio was segregated into its significant categories, which are residential, commercial real estate, residential construction, commercial and consumer and other loans. These categories were further segregated, where appropriate, into components based on significant financial characteristics such as type of interest rate (fixed or adjustable). Fair values were estimated for each component using assumptions developed by management and a valuation model provided by a third party specialist.

The fair values of residential, commercial real estate, residential construction, commercial and consumer and other loans were estimated by discounting the anticipated cash flows from the respective portfolios. Estimates of the timing and amount of these cash flows considered factors such as future loan prepayments. The discount rates reflected current market rates for loans with similar terms to borrowers of similar credit quality. The fair value of home equity lines of credit was based on the outstanding loan balances.  Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

            Loans held for sale: Loans held for sale are accounted for at the lower of cost or market and the fair value of loans held for sale based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted as required for changes in loan characteristics.

Deposits and Mortgagor’s Escrow.  The fair value of deposits with no stated maturity, such as demand deposits, NOW, regular savings, and money market deposit accounts, is equal to the amount payable on demand.  The fair value estimates do not include the benefit that results from the generally lower cost of funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.  The fair value estimate of time deposits is based on the discounted value of contractual cash flows.  The discount rate is estimated using the rates currently offered for deposits having similar remaining maturities.

Federal Home Loan Bank Advances.  The fair values of the Company’s long-term debt are estimated using discounted cash flow analyses based on the current incremental borrowing rates in the market for similar types of borrowing arrangements.

Securities Sold Under Agreements to Repurchase.  The Company enters into overnight repurchase agreements with its customers. Since these agreements are short-term instruments, the fair value of these agreements approximates their recorded balance. The Company also secures term repurchase agreements through other financial institutions. The fair value of these agreements are determined by discounting the anticipated future cash payments using rates currently available to the Bank for debt with similar terms and remaining maturities.

Off-Balance Sheet Instruments.  The fair value of off-balance-sheet mortgage lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.  In the case of the commitments discussed in Note 14, the fair value equals the carrying amounts which are not significant.

Summary of Fair Values of Financial Instruments.  The estimated fair values, and related carrying  amounts, of the Company’s financial instruments are as follows. Certain financial instruments and all nonfinancial instruments are exempt from disclosure requirements. Accordingly, the aggregate fair value amounts presented herein do not represent the underlying fair value of the Company.

27

The estimated fair values of the Company’s financial instruments, all of which are held or issued for purposes other than trading, are as of December 31, 2011 and June 30, 2011:

	December 31, 2011				June 30, 2011
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(in thousands)
Financial assets:
Cash and cash equivalents	$	15,462	$	15,462	$	8,273	$	8,273
Available-for-sale securities		50,793		50,793		58,009		58,009
Held-to-maturity securities		108,688		111,062		114,741		115,962
Federal Home Loan Bank Stock		8,056		8,056		8,056		8,056
Loans held for sale		566		578		1,567		1,583
Loans, net		254,632		261,190		253,225		253,835
Accrued interest receivable		1,279		1,279		1,528		1,528
Financial liabilities:
Deposits		334,443		337,892		333,773		331,132
Mortgagors’ escrow accounts		1,862		1,862		1,766		1,766
Federal Home Loan Bank advances		81,500		85,966		83,500		87,339
Securities sold under agreements to repurchase		3,929		3,929		4,244		4,244

NOTE 12 – Stock-Based Incentive Plan

At the annual meeting of stockholders on October 21, 2005, stockholders of the Company approved the PSB Holdings, Inc. 2005 Stock-Based Incentive Plan (the “Incentive Plan”).  Under the Incentive Plan, the Company may grant up to 340,213 stock options and 136,085 shares of restricted stock to its employees, officers and directors for an aggregate amount of up to 476,298 shares of the Company’s common stock for issuance upon the grant or exercise of awards.  Both incentive stock options and non-statutory stock options may be granted under the Incentive Plan.

On November 7, 2005, the Company awarded 319,800 options to purchase the Company’s common stock and 129,281 shares of restricted stock.  Stock option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of grant ($10.60) with a maximum term of ten years.

On June 7, 2006, the Company awarded 18,000 options to purchase the Company’s common stock and 6,000 shares of restricted stock.  Stock option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of grant ($10.78) with a maximum term of ten years.

On May 25, 2007, the Company awarded 29,000 options to purchase the Company’s common stock and 9,500 shares of restricted stock.  Stock option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of grant ($10.70) with a maximum term of ten years.

Both stock option and restricted stock awards granted to date vest at 20% per year beginning on the first anniversary of the date of the grant.

Stock options and restricted stock awards are considered common stock equivalents for the purpose of computing earnings per share on a diluted basis.

28

The Company has recorded share-based compensation expense related to outstanding stock option and restricted stock awards based upon the fair value at the date of grant over the vesting period of such awards on a straight-line basis.  The fair value of each restricted stock allocation, based on the market price at the date of grant, is recorded to unearned stock awards.  Compensation expense related to unearned restricted shares is amortized to compensation and benefits expense over the vesting period of the restricted stock awards.   The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing method which includes several assumptions such as volatility, expected dividends, expected term and risk-free rate for each stock option award.

NOTE 13 – Dividends

The Company did not declare a dividend during the six months ended December 31, 2011 and 2010.

NOTE 14 – Commitments to Extend Credit

The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the Condensed Consolidated Balance Sheets.

The contractual amounts of outstanding commitments were as follows:

	December 31,		June 30,
	2011		2011
	(in thousands)
Commitments to extend credit:
Loan commitments	$	4,124	$	2,966
Unadvanced construction loans		1,812		1,476
Unadvanced lines of credit		13,304		12,737
Standby letters of credit		852		782
Outstanding commitments	$	20,092	$	17,961

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

The following analysis discusses changes in the financial condition at December 31, 2011 and June 30, 2011 and results of operations for the three and six months ended December 31, 2011 and 2010, and should be read in conjunction with the Company’s Condensed Consolidated Financial Statements and the notes thereto, appearing in Part I, Item 1 of this quarterly report.  These financial statements should be read in conjunction with the 2011 Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K filed with the SEC on September 26, 2011.

Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions.  Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions.  The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain.  Factors which could have a material adverse effect on the operations of the Company and its subsidiary include, but are not limited to, changes in: interest rates, general economic conditions, legislation and regulations, real estate values, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area and accounting principles and guidelines.  These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.  Further information concerning the Company and its business, including additional factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission.

29

Except as required by applicable law and regulation, the Company does not undertake – and specifically disclaims any obligation – to publicly release the results of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

Financial Regulatory Reform Legislation

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ( the “Dodd-Frank Act”).  The Dodd-Frank Act  has a broad impact on the financial services industry, including significant regulatory and compliance changes including, among other things, (i) enhanced resolution authority of troubled and failing banks and their holding companies; (ii) increased capital and liquidity requirements; (iii) increased regulatory examination fees; (iv) changes to assessments to be paid to the FDIC for federal deposit insurance; and (v) numerous other provisions designed to improve supervision and oversight of, and strengthening safety and soundness for, the financial services sector.  Additionally, the Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve, the Office of the Comptroller of the Currency, and the FDIC.

Effective July 21, 2011, the Dodd-Frank Act provided for the elimination of the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest-bearing checking accounts.  Depending on competitive responses, this significant change to existing law could have an adverse impact on our net interest margin by potentially increasing our interest expense.

The Dodd-Frank Act also changes the base for FDIC deposit insurance assessments.  Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution, rather than on deposits.  The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per account, retroactive to January 1, 2008, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2013.  The legislation also increases the required minimum reserve ratio for the Deposit Insurance Fund, from 1.15% to 1.35% of insured deposits, and directs the FDIC to offset the effects of increased assessments on depository institutions with less than $10 billion in assets.

The Dodd-Frank Act requires publicly traded companies, like the Bank, to give their stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments.  It also provides that the listing standards of the national securities exchanges shall require listed companies to implement and disclose “clawback” policies mandating the recovery of incentive compensation paid to executive officers in connection with accounting restatements.  The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.

The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices.  The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.  The Dodd-Frank Act requires minimum leverage (Tier 1) and risk based capital requirements for bank and savings and loan holding companies that are no less than those applicable to banks.

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It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks.  However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.

Overview

The Company’s results of operation depend primarily on net interest and dividend income, which is the difference between the interest and dividend income earned on its interest-earning assets, such as loans and securities, and the interest expense on its interest-bearing liabilities, such as deposits and borrowings. The Company also generates noninterest income, primarily from fees and service charges.  Gains on sales of loans and securities and bank-owned life insurance income are added sources of noninterest income.  The Company’s noninterest expense primarily consists of employee compensation and benefits, occupancy and equipment expense, advertising, data processing, professional fees and other operating expenses.

During the quarters ended December 31, 2011 and 2010, the Company recorded non-cash OTTI charges of $214,000 and $354,000, respectively.  Both of these OTTI charges were taken on non-agency mortgage-backed securities.  The net interest margin decreased from 2.47% for the quarter ended December 31, 2010 to 2.42% for the quarter ended December 31, 2011, as we experienced a $144,000 decrease in net interest and dividend income over the periods.  In addition, noninterest expense increased $5,000 during the quarter ended December 31, 2011 compared to the quarter ended December 31, 2010.  The provision for loan losses decreased $30,000 during the quarter ended December 31, 2011 as compared to the quarter ended December 31, 2010.

During the six months ended December 31, 2011 and 2010, the Company recorded non-cash OTTI charges of $1.0 million and $527,000, respectively.  Both of these OTTI charges were taken on non-agency mortgage-backed securities.  The Company also received $1.5 million in a legal settlement reflected in the Company’s results of operation during the six months ended December 31, 2011.  The net interest margin decreased from 2.52% for the quarter ended December 31, 2010 to 2.44% for the six months ended December 31, 2011, as we experienced a $309,000 decrease in net interest and dividend income over the periods.  In addition, noninterest expense increased $105,000 during the six months ended December 31, 2011 compared to the same period in the prior year.  The provision for loan losses increased $160,000 during the six months ended December 31, 2011 as compared to the six months ended December 31, 2010.

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Comparison of Financial Condition at December 31, 2011 and June 30, 2011

Assets

Total assets decreased to $469.7 million at December 31, 2011 from $472.5 million at June 30, 2011.  Cash and cash equivalents increased $7.2 million and totaled $15.5 million or 3.3% of total assets.  Investments in available-for-sale securities decreased $7.2 million and totaled $50.8 million or 10.8% of total assets at December 31, 2011.  Investments in held-to-maturity securities decreased $6.1 million and totaled $108.7 million or 23.1% of total assets at December 31, 2011.  Net loans increased $1.4 million and totaled $254.6 million or 54.2% of total assets at December 31, 2011.  Included in other assets as of December 31, 2011 was $1.3 million in prepaid FDIC assessments.  Bank owned life insurance increased $2.2 million due to purchases of additional policies and totaled $8.6 million at December 31, 2011.

Allowance for Loan Losses

The table below indicates the relationships between the allowance for loan losses, total loans outstanding and nonperforming loans at December 31, 2011 and June 30, 2011.  For additional information, see “Comparison of Operating Results for the Three and Six Months Ended December 31, 2011 and 2010 – Provision for loan losses.”

	December 31,			June 30,
	2011			2011
	(Dollars in thousands)
Allowance for loan losses	$	3,081		$	3,072
Gross loans outstanding		257,713			256,297
Nonperforming loans		7,395			6,419
Allowance/gross loans outstanding		1.20	%		1.20	%
Allowance/nonperforming loans		41.7	%		47.9	%

Liabilities

Total liabilities decreased to $424.1 million at December 31, 2011 from $425.8 million at June 30, 2011.  Total deposits increased to $334.4 million at December 31, 2011 from $333.8 million at June 30, 2011, an increase of $670,000 or 0.2%.  Federal Home Loan Bank advances decreased to $81.5 million at December 31, 2011 from $83.5 million at June 30, 2011, a decrease of $2.0 million or 2.4%.  Securities sold under agreements to repurchase decreased to $3.9 million at December 31, 2011 from $4.2 million at June 30, 2011, a decrease of $315,000 or 7.4%.

Stockholders’ Equity

Stockholders’ equity decreased to $45.5 million at December 31, 2011 from $46.7 million at June 30, 2011, primarily due to a $2.1 million increase in unrealized losses on available-for-sale securities net of tax recorded in accumulated other comprehensive loss offset by net income of $816,000 for the six months ended December 31, 2011.

Comparison of Operating Results for the Three and Six Months Ended December 31, 2011 and 2010

Net Income

Net income amounted to $11,000 or $.00 per basic and diluted share for the quarter ended December 31, 2011 compared to net income of $99,000 or $.02 per basic and diluted share for the quarter ended December 31, 2010. The decrease in net income was primarily due to a decrease in net interest income of $144,000 to $2.6 million for the quarter ended December 31, 2011 compared to $2.8 million for the quarter ended December 31, 2010.  Other-than-temporarily impaired investment write-downs decreased by $140,000 to $214,000 for the quarter ended December 31, 2011 compared to $354,000 for the quarter ended December 31, 2010.  Loan loss provision decreased by $30,000 to $211,000 for the quarter ended December 31, 2011 compared to $241,000 for the quarter ended December 31, 2010.  Total noninterest expense remained unchanged at $2.9 million for the quarters ended December 31, 2011 and 2010.

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Net income amounted to $816,000 or $.13 per basic and diluted share for the six months ended December 31, 2011 compared to net income of $669,000 or $.11 per basic and diluted share for the six months ended December 31, 2010. The increase in net income was primarily due to $1.5 million received in a partial legal settlement regarding prior security losses during the six months ended December 31, 2011.  Other-than-temporarily impaired investment write-downs increased by $485,000 to $1.0 million for the six months ended December 31, 2011 compared to $527,000 for the six months ended December 31, 2010.  Loan loss provision increased by $160,000 to $602,000 for the six months ended December 31, 2011 compared to $442,000 for the six months ended December 31, 2010.  Net interest income decreased by $309,000 to $5.4 million for the six months ended December 31, 2011 compared to $5.7 million for the six months ended December 31, 2010.  Income tax expense increased by $64,000 to $244,000 for the six months ended December 31, 2011 compared to $180,000 for the six months ended December 31, 2010.  Noninterest expense increased $105,000 to $5.7 million for the six months ended December 31, 2011 compared to $5.6 million for the six months ended December 31, 2010.

Interest and Dividend Income

Interest and dividend income amounted to $4.5 million for the quarter ended December 31, 2011 compared to $5.0 million for the quarter ended December 31, 2010, a decrease of $483,000 or 9.8%.  This was primarily due to a decrease in yield on earning assets of 30 basis points to 4.08% for the quarter ended December 31, 2011 compared to 4.38% for the quarter ended December 31, 2010.  Average investment securities decreased $17.4 million to $172.2 million for the quarter ended December 31, 2011 compared to $189.6 million for the quarter ended December 31, 2010.  The yield on investment securities decreased 36 basis points to 2.82% for the quarter ended December 31, 2011 compared to 3.18% for the quarter ended December 31, 2010.  Average loans increased by $341,000 to $256.6 million for the quarter ended December 31, 2011 compared to $256.3 million for the quarter ended December 31, 2010.  The yield on loans decreased 31 basis points to 5.01% for the quarter ended December 31, 2011 compared to 5.32% for the quarter ended December 31, 2010.

Interest and dividend income amounted to $9.1 million for the six months ended December 31, 2011  compared to $10.1 million for the six months ended December 31, 2010, a decrease of $966,000 or 9.6%.  This was primarily due to a decrease in yield on earning assets of 32 basis points to 4.13% for the six months ended December 31, 2011 compared to 4.45% for the six months ended December 31, 2010.  Average investment securities decreased $10.9 million to $175.6 million for the six months ended December 31, 2011 compared to $186.5 million for the six months ended December 31, 2010.  The yield on investment securities decreased 52 basis points to 2.84% for the six months ended December 31, 2011 compared to 3.36% for the six months ended December 31, 2010.  Average loans decreased by $284,000 to $256.4 million for the six months ended December 31, 2011 compared to $256.7 million for the six months ended December 31, 2010.  The yield on loans decreased 24 basis points to 5.12% for the six months ended December 31, 2011 compared to 5.36% for the six months ended December 31, 2010.

Interest Expense

Interest expense amounted to $1.8 million for the quarter ended December 31, 2011 compared to $2.2 million for the quarter ended December 31, 2010, a decrease of $339,000 or 15.7%.  The decrease was primarily due to changes in rates of interest-bearing liabilities.  The cost of average interest-bearing liabilities decreased 26 basis points to 1.89% for the quarter ended December 31, 2011 from 2.15% for the quarter ended December 31, 2010.  The average rate on interest-bearing deposits decreased by 28 basis points to 1.37% for the quarter ended December 31, 2011 compared to 1.65% for the quarter ended December 31, 2010.  The average rate on borrowed money increased by seven basis points to 3.66% for the quarter ended December 31, 2011 compared to 3.59% for the quarter ended December 31, 2010.

Interest expense amounted to $3.7 million for the six months ended December 31, 2011 compared to $4.4 million for the quarter ended December 31, 2010, a decrease of $657,000 or 15.0%.  The decrease was primarily due to changes in rates of interest-bearing liabilities.  The cost of average interest-bearing liabilities decreased 25 basis points to 1.92% for the six months ended December 31, 2011 from 2.17% for the six months ended December 31, 2010.  The average rate on interest-bearing deposits decreased by 26 basis points to 1.41% for the six months ended December 31, 2011 compared to 1.67% for the six months ended December 31, 2010.  The average rate on borrowed money increased by two basis points to 3.58% for the six months ended December 31, 2011 compared to 3.56% for the six months ended December 31, 2010.

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Net Interest and Dividend Income

Net interest and dividend income amounted to $2.6 million for the quarter ended December 31, 2011  compared to $2.8 million for the quarter ended December 31, 2010, a decrease of $144,000 or 5.2%.  Net interest spread decreased by four basis points to 2.19% for the quarter ended December 31, 2011 from 2.23% for the quarter ended December 31, 2010.  Net interest margin decreased five basis points to 2.42% from 2.47% when comparing the quarters ended December 31, 2011 and 2010, respectively.  Net interest-earning assets increased $2.9 million to $53.6 million for the quarter ended December 31, 2011 compared to $50.7 million for the quarter ended December 31, 2010.

Net interest and dividend income amounted to $5.4 million for the six months ended December 31, 2011  compared to $5.7 million for the six months ended December 31, 2010, a decrease of $309,000 or 5.4%.  Net interest spread decreased by six basis points to 2.21% for the six months ended December 31, 2011 from 2.27% for the six months ended December 31, 2010.  Net interest margin decreased eight basis points to 2.44% from 2.52% when comparing the six months ended December 31, 2011 and 2010, respectively.  Net interest-earning assets increased $3.4 million to $53.8 million for the six months ended December 31, 2011 compared to $50.4 million for the six months ended December 31, 2010.

Due to the large portion of fixed rate loans and securities in the Company’s asset portfolio, interest rate risk is a concern and the Company continues to monitor and adjust the asset and liability mix as much as possible to take advantage of the benefits and reduce the risks or potential negative effects of a rising rate environment.  Management attempts to mitigate the interest rate risk through balance sheet composition.  See “Market Risk, Liquidity and Capital Resources – Market Risk.”

Provision for Loan Losses

The provision for loan losses amounted to $211,000 for the quarter ended December 31, 2011 compared to $241,000 for the quarter ended December 31, 2010, a decrease of $30,000 or 12.4%.  The allowance for loan losses is based on management’s estimate of the probable losses inherent in the portfolio, considering the impact of certain internal and external factors.  Among the factors management may consider are prior loss experience, current economic conditions and their effects on borrowers, the character and size of the portfolio, trends in nonperforming loans and delinquency rates and the performance of individual loans in relation to contractual terms.  The provision for loan losses reflects adjustments to the allowance based on management’s review of the portfolio in light of those conditions. The ratio of the allowance to gross loans outstanding was 1.20% as of December 31, 2011 and June 30, 2011.  Net charge-offs were $42,000 for the quarter ended December 31, 2011 compared to net charge-offs of $235,000 for the quarter ended December 31, 2010.

The provision for loan losses amounted to $602,000 for the six months ended December 31, 2011 compared to $442,000 for the six months ended December 31, 2010, an increase of $160,000 or 36.2%. This is primarily due to increased allocations during the six months ended December 31, 2011 for certain impaired loans.   Net charge-offs were $593,000 for the six months ended December 31, 2011 compared to net charge-offs of $506,000 for the six months ended December 31, 2010.  The ratio of the allowance to nonperforming loans was 41.7% at December 31, 2011 compared to 47.9% at June 30, 2011.

Non-interest Income

Non-interest income totaled $417,000 for the quarter ended December 31, 2011 compared to $392,000 for the quarter ended December 31, 2010, an increase of $25,000 or 6.4%.  The increase was primarily due to a reduction in other-than-temporary impairment charges on available-for-sale securities of $140,000 to $214,000 for the quarter ended December 31, 2011 compared to $354,000 for the quarter ended December 31, 2010.  The impairment charges for the three months ended December 31, 2011 and December 31, 2010 were the result of credit losses on non-agency mortgage-backed securities.  This was partially offset by decreases in service fees of $72,000 or 13.6% and mortgage banking activities of $42,000 or 65.6% during the quarter ended December 31, 2011.

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Non-interest income totaled $2.0 million for the six months ended December 31, 2011 compared to $1.2 million for the six months ended December 31, 2010, an increase of $785,000 or 65.5%.  The increase was primarily due to a $1.5 million legal settlement during the six months ended December 31, 2011.  This was partially offset by an increase in other-than-temporary impairment charges on available-for-sale securities of $485,000 to $1.0 million for the six months ended December 31, 2011 compared to $527,000 for the six months ended December 31, 2010.  The impairment charges for the six months ended December 31, 2011 and December 31, 2010 were the result of credit losses on non-agency mortgage-backed securities.  Service fees decreased $86,000 or 8.1% to $977,000 for the six months ended December 31, 2011 compared to $1.1 million for the six months ended December 31, 2010.

Non-interest Expense

Non-interest expense amounted to $2.9 million for the quarter ended December 31, 2011 compared to $2.9 million for the quarter ended December 31, 2010, an increase of $5,000 or 0.2%.  Compensation and benefits expense increased $72,000 or 5.0%.  Occupancy and equipment expense increased $10,000 or 3.3%.  Other non-interest expenses decreased $77,000 or 6.8% to $1.0 million for the quarter ended December 31, 2011 compared to $1.1 million for the quarter ended December 31, 2010.

Non-interest expense amounted to $5.7 million for the six months ended December 31, 2011 as compared to $5.6 million for the six months ended December 31, 2010, an increase of $105,000 or 1.9%.  Compensation and benefits expense increased $98,000 or 3.3%.  Occupancy and equipment expense increased $14,000 or 2.3%.  Other non-interest expenses decreased $7,000 or 0.3%.

Provision for Income Taxes

Income tax benefit amounted to $41,000 for the quarter ended December 31, 2011 compared to $35,000 for the quarter ended December 31, 2010.  Income tax expense amounted to $244,000 for the six months ended December 31, 2011 compared to $180,000 for the six months ended December 31, 2010.

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Average Balances and Yields

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated.  No tax-equivalent yield adjustments were made, as the effect thereof was not material.  All average balances are daily average balances.  Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield.  The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.  Yields and costs are annualized.

	For the Three Months Ended December 31,
	2011							2010
	(Dollars in thousands)
	Average		Interest		Yield/			Average		Interest		Yield/
Interest-earning assets:	Balance		Income/Expense		Cost			Balance		Income/Expense		Cost
Investment securities	$	172,225	$	1,224		2.82	%	$	189,635	$	1,518		3.18	%
Loans		256,607		3,243		5.01	%		256,266		3,434		5.32	%
Other earning assets		5,991		3		0.20	%		2,780		1		0.14	%
Total interest-earnings assets		434,823		4,470		4.08	%		448,681		4,953		4.38	%
Non-interest-earning assets		35,248							35,403
Total assets	$	470,071						$	484,084
Interest-bearing liabilities:
NOW accounts	$	90,653	$	190		0.83	%	$	88,742	$	244		1.09	%
Savings accounts		49,701		44		0.35	%		47,349		42		0.35	%
Money market accounts		14,956		26		0.69	%		13,578		31		0.91	%
Time deposits		138,395		755		2.16	%		144,797		908		2.49	%
Borrowed money		87,483		807		3.66	%		103,527		936		3.59	%
Total interest-bearing liabilities		381,188		1,822		1.89	%		397,993		2,161		2.15	%
Non-interest-bearing demand deposits		38,565							36,043
Other non-interest-bearing liabilities		4,563							4,207
Capital accounts		45,755							45,841
Total liabilities and capital accounts	$	470,071						$	484,084
Net interest income			$	2,648						$	2,792
Interest rate spread						2.19	%						2.23	%
Net interest-earning assets	$	53,635						$	50,688
Net interest margin						2.42	%						2.47	%
Average earning assets to
average interest-bearing liabilities						114.07	%						112.74	%

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	For the Six Months Ended December 31,
	2011							2010
	(Dollars in thousands)
	Average		Interest/		Yield/			Average		Interest/		Yield/
Interest-earning assets:	Balance		Dividends		Cost			Balance		Dividends		Cost
Investment securities	$	175,641	$	2,515		2.84	%	$	186,516	$	3,162		3.36	%
Loans		256,380		6,617		5.12	%		256,664		6,937		5.36	%
Other earning assets		6,767		4		0.12	%		7,643		3		0.08	%
Total interest-earnings assets		438,788		9,136		4.13	%		450,823		10,102		4.45	%
Non-interest-earning assets		32,057							32,961
Total assets	$	470,845						$	483,784
Interest-bearing liabilities:
NOW accounts	$	90,981	$	391		0.85	%	$	88,951	$	505		1.13	%
Savings accounts		49,454		87		0.35	%		47,206		85		0.36	%
Money market accounts		14,758		51		0.69	%		13,236		60		0.90	%
Time deposits		139,444		1,568		2.23	%		144,849		1,833		2.51	%
Borrowed money		90,324		1,631		3.58	%		106,123		1,902		3.56	%
Total interest-bearing liabilities		384,961		3,728		1.92	%		400,365		4,385		2.17	%
Non-interest-bearing demand deposits		37,474							36,143
Other non-interest-bearing liabilities		2,268							2,004
Capital accounts		46,142							45,272
Total liabilities and capital accounts	$	470,845						$	483,784
Net interest income			$	5,408						$	5,717
Interest rate spread						2.21	%						2.27	%
Net interest-earning assets	$	53,827						$	50,458
Net interest margin						2.44	%						2.52	%
Average earning assets to
average interest-bearing liabilities						113.98	%						112.60	%

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The following tables set forth the effects of changing rates and volumes on our net interest income for the periods indicated.  The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume).  The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate).  The net column represents the sum of the prior columns.  For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

	For the Three Months Ended December 31, 2011
	Compared to the Three Months Ended December 31, 2010
	Increase (Decrease) Due to
	(In thousands)
INTEREST INCOME	Rate			Volume			Net
Investment securities	$	(162	)	$	(132	)	$	(294	)
Loans		(222	)		31			(191	)
Other interest-earning assets		1			1			2
TOTAL INTEREST INCOME		(383	)		(100	)		(483	)
INTEREST EXPENSE:
NOW accounts		(88	)		34			(54	)
Savings accounts		(1	)		3			2
Money Market accounts		(21	)		16			(5	)
Time deposits		(114	)		(39	)		(153	)
Borrowed money		118			(247	)		(129	)
TOTAL INTEREST EXPENSE		(106	)		(233	)		(339	)
CHANGE IN NET INTEREST INCOME	$	(277	)	$	133		$	(144	)

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	For the Six Months Ended December 31, 2011 Compared to the Six Months Ended December 31, 2010
	Increase (Decrease) Due to
	(In thousands)
INTEREST INCOME	Rate			Volume			Net
Investment securities	$	(470	)	$	(177	)	$	(647	)
Loans		(312	)		(8	)		(320	)
Other interest-earning assets		2			(1	)		1
TOTAL INTEREST INCOME		(780	)		(186	)		(966	)
INTEREST EXPENSE:
NOW accounts		(146	)		32			(114	)
Savings accounts		(5	)		7			2
Money Market accounts		(25	)		16			(9	)
Time deposits		(199	)		(66	)		(265	)
Borrowed money		41			(312	)		(271	)
TOTAL INTEREST EXPENSE		(334	)		(323	)		(657	)
CHANGE IN NET INTEREST INCOME	$	(446	)	$	137		$	(309	)

Market Risk, Liquidity and Capital Resources

Market Risk

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

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

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Net interest income at-risk measures the risk of a decline in earnings due to potential short-term and long- term changes in interest rates.  The table below represents an analysis of our IRR as measured by the estimated changes in NII, resulting from an instantaneous and sustained parallel shift in the yield curve (+100 and +200 basis points) at December 31, 2011 and June 30, 2011.

Net Interest Income At-Risk
	Estimated Increase (Decrease)	Estimated Increase (Decrease)
Change in Interest Rates	in NII	in NII
(Basis Points)	December 31, 2011	June 30, 2011
Stable
+ 100	-1.81%	-1.25%
+ 200	-6.79%	-3.99%

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

Net Portfolio Value Simulation Analysis.  The Office of Thrift Supervision previously required the computation of amounts by which the net present value of an institution’s cash flow from assets, liabilities and off-balance sheet items (the institution’s net portfolio value or “NPV”) would change in the event of a range of assumed changes in market interest rates.  The Office of Thrift Supervision provided all institutions that file a Consolidated Maturity/Rate Schedule as a part of their quarterly Thrift Financial Report an interest rate sensitivity report of net portfolio value.  The Office of Thrift Supervision simulation model used a discounted cash flow analysis and an option-based pricing approach to measuring the interest rate sensitivity of net portfolio value.  Historically, the Office of Thrift Supervision model estimated the economic value of each type of asset, liability and off-balance sheet contract under the assumption that the United States Treasury yield curve increases or decreases instantaneously by 100 to 300 basis point increments.  However, given the current low level of market interest rates, we did not prepare a net portfolio value calculation for an interest rate decrease of greater than 100 basis points.  A basis point equals one-hundredth of one percent, and 200 basis points equals two percent, an increase in interest rates from 3% to 5% would mean, for example, a 200 basis point increase in the “Change in Interest Rates” column below.  The Office of Thrift Supervision provided us the results of the interest rate sensitivity model, which is based on information we provided to the Office of Thrift Supervision (and, after July 21, 2011, the Office of the Comptroller of the Currency) to estimate the sensitivity of our net portfolio value.  For periods after December 31, 2011, the Office of the Comptroller of the Currency will no longer provide NPV information to federal savings banks.

The tables below set forth, at September 30, 2011, the estimated changes in our net portfolio value that would result from the designated instantaneous changes in the United States Treasury yield curve.  Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.  This data is for Putnam Bank only and does not include any yield curve changes in the assets of PSB Holdings, Inc.  We do not believe that there has been a material change in our NPV position between September 30, 2011 and December 31, 2011.

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									NPV as a Percentage of Present
									Value of Assets (3)
			Estimated Increase (Decrease) in
Change in			NPV									Increase
Interest Rates	Estimated											(Decrease)
(basis points) (1)	NPV (2)		Amount			Percent			NPV Ratio (4)			(basis points)
(Dollars in thousands)
+300	$	36,702	$	(8,835	)		-19	%		7.91	%		-150
+200	$	42,188	$	(3,349	)		-7	%		8.92	%		-49
+100	$	44,735	$	(802	)		-2	%		9.34	%		-7
0	$	45,537	$	-			0	%		9.41	%		0
-100	$	43,878	$	(1,659	)		-4	%		9.04	%		-37

(1)   Assumes an instantaneous uniform change in interest rates at all maturities.

(2)   NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.

(3)   Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.

(4)   NPV ratio represents NPV divided by the present value of assets.

Liquidity

The term liquidity refers to the ability of the Company and the Bank to meet current and future short-term financial obligations.  The Company and the Bank further define liquidity as the ability to generate adequate amounts of cash to fund loan originations, deposit withdrawals and operating expenses.  Liquidity management is both a daily and long-term function of business management. The Bank’s primary sources of liquidity are deposits, scheduled amortization and prepayments of loan principal and mortgage-related securities, and Federal Home Loan Bank of Boston borrowings.  The Bank can borrow funds from the Federal Home Loan Bank of Boston based on eligible collateral of loans and securities.  The Bank had Federal Home Loan Bank of Boston borrowings as of December 31, 2011 of $81.5 million with unused borrowing capacity of $46.3 million.  The Bank has an internal limit of wholesale borrowings to total assets ratio of 30.0%.  As of December 31, 2011, the ratio of wholesale borrowings to total assets was 17.4%.

The Bank’s primary investing activities are the origination of loans and the purchase of investment securities.  During the six months ended December 31, 2011 and 2010, the Bank’s principal collections net of loan originations were $3.5 million and $670,000, respectively. Purchases of securities totaled $19.7 million and $63.0 million, for the six months ended December 31, 2011 and 2010, respectively.

Loan repayments and maturing investment securities are a relatively predictable source of funds.  However, deposit flows, calls of investment securities and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and economic conditions and competition in the marketplace.  These factors reduce the predictability of the timing of these sources of funds.  Deposit flows are affected by the level of interest rates, by the interest rates and products offered by competitors and by other factors.  The Bank monitors its liquidity position frequently and anticipates that it will have sufficient funds to meet its current funding commitments.

Certificates of deposits totaled $137.2 million at December 31, 2011. The Bank relies on competitive rates, customer service and long-standing relationships with customers to retain deposits.  Based on the Bank’s experience with deposit retention and current retention strategies, management believes that, although it is not possible to predict with certainty future terms and conditions upon renewal, a significant portion of such deposits will remain with the Bank.

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The Bank was well capitalized at December 31, 2011 and exceeded each of the applicable regulatory capital requirements at such date.

	Required		Actual
Ratio of Tier 1 Capital to total assets	4	%	8.16	%
Ratio of Total Risk Based Capital to risk-weighted assets	8	%	16.63	%
Ratio of Tier 1 Risk Based Capital to risk-weighted assets	4	%	15.38	%

Management is not aware of any known trends, events or uncertainties that will have or are reasonably likely to have a material effect on the Company’s or the Bank’s liquidity, capital or operations, nor is management aware of any current recommendations by regulatory authorities which, if implemented, would have a material effect on the Company’s or the Bank’s liquidity, capital or operations.

Off-Balance Sheet Arrangements

In addition to the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements.  These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk.  Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, lines of credit, and letters of credit.

For the six months ended December 31, 2011, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Not applicable to smaller reporting companies

Item 4.  Controls and Procedures

Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15(d)-15(e) under the Exchange Act) as of the end of the period covered by this report.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and in timely altering them to material information relating to the Company (or its consolidated subsidiaries) required to be filed in its periodic SEC filings.

There has been no change in the Company’s internal control over financial reporting in connection with the quarterly evaluation that occurred during the Company’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II. – OTHER INFORMATION

Item 1.     Legal Proceedings – Not applicable

Item 1A.  Risk Factors – Not applicable

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

a) Not applicable

b) Not applicable

c) Not applicable

Item 3.      Defaults Upon Senior Securities – Not applicable

Item 4.      [Removed and Reserved]

Item 5.      Other Information

a.   Not applicable.

Item 6.      Exhibits

Exhibits

31.1      Chief Executive Officer Certification pursuant to 17 CFR 240.13a-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2      Chief Financial Officer Certification pursuant to 17 CFR 240.13a-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1      Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350.

32.2      Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350.

                 101 The following materials from the Company’s Quarterly Report on Form 10-Q for the three and six months ended December 31, 2011, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Changes in Stockholders’ Equity, (iv) the Condensed Consolidated Statements of Cash Flows and (v) the Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		PSB HOLDINGS, INC. (Registrant)
Date	February 14, 2012		/s/  Thomas A. Borner
			Thomas A. Borner Chief Executive Officer

Date	February 14, 2012	/s/  Robert J. Halloran, Jr.
		Robert J. Halloran, Jr. President, Chief Financial Officer and Treasurer

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