PSB BANCORP INC
RISK FACTORS.            Changes in interest rates could reduce our income, cash     flows and asset values.         Our income and cash flows and the value of our assets depend to a great extent on the difference between the interest rates we earn on interest-earning assets, such as loans and investment securities, and the interest rates we pay on interest-bearing liabilities such as deposits and borrowings. These rates are highly sensitive to many factors which are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, will influence not only the interest we receive on our loans and investment securities and the amount of interest we pay on deposits and borrowings but will also affect our ability to originate loans and obtain deposits and the value of our investment portfolio. If the rate of interest we pay on our deposits and other borrowings increases more than the rate of interest we earn on our loans and other investments, our net interest income, and therefore our earnings, could be adversely affected. Our earnings also could be adversely affected if the rates on our loans and other investments fall more quickly than those on our deposits and other borrowings.           Economic conditions either nationally or locally in areas     in which our operations are concentrated may adversely affect     our business.         Deterioration in local, regional, national or global economic conditions could cause us to experience a reduction in deposits and new loans, an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, all of which could adversely affect our performance and financial condition. Unlike larger banks that are more geographically diversified, we provide banking and financial services locally. Therefore, we are particularly vulnerable to adverse local economic conditions.           Our financial condition and results of operations would be     adversely affected if our allowance for loan losses is not     sufficient to absorb actual losses or if we are required to     increase our allowance.         Despite our underwriting criteria, we may experience loan delinquencies and losses. In order to absorb losses associated with nonperforming loans, we maintain an allowance for loan losses based on, among other things, historical experience, an evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality. Determination of the allowance inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. At any time there are likely to be loans in our portfolio that will result in losses but that have not been identified as nonperforming or potential problem credits. We cannot be sure that we will be able to identify deteriorating credits before they become nonperforming assets or that we will be able to limit losses on those loans that are identified. We may be required to increase our allowance for loan losses for any of several reasons. State and federal regulators, in reviewing our loan portfolio as part of a regulatory examination, may request that we increase our allowance for loan losses. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in our allowance. In addition, if charge-offs in future periods exceed our allowance for loan losses, we will need additional increases in our allowance for loan losses. Any increase in our allowance for loan losses will result in a decrease in our net income and, possibly, our capital, and may materially affect our results of operations in the period in which the allowance is increased.           Competition may decrease our growth or profits.         We face substantial competition in all phases of our operations from a variety of different competitors, including commercial banks, savings and loan associations, mutual savings banks, credit unions, consumer finance companies, factoring companies, leasing companies, insurance companies and money market mutual funds. There is very strong competition among financial services providers in our principal service  6    Table of Contents  area. Our competitors may have greater resources, higher lending limits or larger branch systems than we do. Accordingly, they may be able to offer a broader range of products and services as well as better pricing for those products and services than we can. In addition, some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on federally insured financial institutions. As a result, those non bank competitors may be able to access funding and provide various services more easily or at less cost than we can, adversely affecting our ability to compete effectively.           We may be adversely affected by government     regulation.         The banking industry is heavily regulated. Banking regulations are primarily intended to protect the federal deposit insurance funds and depositors, not shareholders. Changes in the laws, regulations, and regulatory practices affecting the banking industry may increase our costs of doing business or otherwise adversely affect us and create competitive advantages for others. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of these changes, which could have a material adverse effect on our profitability or financial condition.           We rely on our management and other key personnel, and the     loss of any of them may adversely affect our operations.         We are and will continue to be dependent upon the services of our executive management team. In addition, we will continue to depend on our ability to retain and recruit key commercial loan officers. The unexpected loss of services of any key management personnel or commercial loan officers could have an adverse effect on our business and financial condition because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.           Environmental liability associated with lending activities     could result in losses.         In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances were discovered on any of these properties, we could be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.           Failure to implement new technologies in our operations     may adversely affect our growth or profits.         The market for financial services, including banking services and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking and telebanking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able properly or timely to anticipate or implement such technologies or properly train our staff to use such technologies. Any failure to adapt to new technologies could adversely affect our business, financial condition or operating results.           An investment in our common stock is not an insured     deposit.         Our common stock is not a bank deposit and, therefore, is not insured against loss by the Federal Deposit Insurance Corporation, commonly referred to as the FDIC, any other deposit insurance fund or by  7    Table of Contents  any other public or private entity. Investment in our common stock is subject to the same market forces that affect the price of common stock in any company.           Federal and state banking laws, our articles of     incorporation and our by-laws may have an anti-takeover     effect.         Federal law imposes restrictions, including regulatory approval requirements, on persons seeking to acquire control over us. Pennsylvania law also has provisions that may have an anti-takeover effect. In addition, our articles of incorporation and bylaws permit our board of directors to issue, without shareholder approval, preferred stock and additional shares of common stock that could adversely affect the voting power and other rights of existing common shareholders. These provisions may serve to entrench management or discourage a takeover attempt that shareholders consider to be in their best interest or in which they would receive a substantial premium over the current market price.           Our legal lending limits are relatively low and restrict     our ability to compete for larger customers.         At December 31, 2005, our lending limit per borrower was approximately $6.6 million, or approximately 15% of our capital. Accordingly, the size of loans that we can offer to potential borrowers (without participation by other lenders) is less than the size of loans that many of our competitors with larger capitalization are able to offer. Our legal lending limit also impacts the efficiency of our lending operation because it tends to lower our average loan size, which means we have to generate a higher number of transactions to achieve the same portfolio volume. We may engage in loan participations with other banks for loans in excess of our legal lending limits. However, there can be no assurance that such participations will be available at all or on terms which are favorable to us and our customers.           The market price for our common stock may be     volatile.         The market price for our common stock has fluctuated, ranging between $11.07 and $15.94 per share during the twelve months ended December 31, 2005. The overall market and the price of our common stock may continue to be volatile. There may be a significant impact on the market price for our common stock due to, among other things, developments in our business, variations in our anticipated or actual operating results, changes in investors’ perceptions of the risks and conditions of our business and the size of the public float of our common stock. The average daily trading volume for our common stock as reported on NASDAQ was 6,742 shares during the twelve months ended December 31, 2005, with daily volume ranging from a low of 100 shares to a high of 123,401. We do not expect that a more active or consistent trading market in our common stock will develop. As a result, relatively small trades will have a significant impact on the price of our common stock.           A court decision in favor of the purported option-holders     could have an effect on our stock price.         First Penn Bank merged with First Bank of Philadelphia in 1999. PSB cancelled 1,371,200 of the options issued pursuant to the merger to certain First Bank of Philadelphia shareholders. PSB is subject to numerous lawsuits related to the cancellation of the 1,371,200 options. PSB has included 895,240 of the disputed options in its prior period computation of diluted earnings per share that were the subject of an action that resulted in 895,240 shares being deposited into an escrow account (See Item 3-Legal Proceedings, Paragraph H). If a court were to find that the additional 475,960 options cancelled by PSB (the “Additional Options”) were validly issued, the fully diluted earnings per share of PSB would be reduced by an additional 5%. PSB cannot predict the outcome of this ongoing litigation. This additional dilution could have an adverse affect on the share price of PSB’s common stock. See Item 3-Legal Proceedings.  8   Table of Contents          A court decision in favor of the shareholders with respect     to the shareholder derivative suit could have an effect on our     stock price.         On December 2, 2004, a number of the shareholders involved in the option litigation delivered a demand letter to PSB’s Board of Directors that demanded that the Board take a number of actions, including seeking to have the 2001 PSB Stock Incentive Plan (the “Plan”) and certain options granted pursuant to the Plan declared null and void. On March 17, 2005, a number of purported shareholders sued derivatively in the name and right of PSB (the “Derivative Suit”) with respect to claims in the demand letter relating to the Plan. As part of the Board of Director’s response to the shareholder demand letter, a special committee was appointed to investigate numerous allegations including those contained in the Derivative Suit. The special committee retained special counsel to investigate and prepare a report on its findings. Based on the report from special counsel, the Board of Directors has concluded that no corrective action is necessary and that the Derivative Suit should be terminated. Pennsylvania law provides that if the process used by the Board of Directors in deciding to terminate the Derivative Suit was valid, then the court should dismiss the Derivative Suit prior to litigation on the merits. PSB is unable to predict the eventual outcome of this action or the effect on the share price of PSB’s common stock. See Item 3-Legal Proceedings.
UNRESOLVED STAFF COMMENTS.         NONE           ITEM 2.  PROPERTIES         As of December 31, 2005, the Bank conducted its business through an executive/administrative office and 13 full-service branch offices. The aggregate net book value of the Bank’s office premises and equipment was $2.4 million as of December 31, 2005. Seven of the branches are owned and six are leased. The Bank is leasing its center city Philadelphia, Pennsylvania full-service office and executive office for a term of 11 years, its 1632 Walnut Street, Philadelphia, Pennsylvania office for ten years, its Media, Pennsylvania office for a term of four years, its Chesterbrook, Pennsylvania office for a term of one year, the Chinatown office for a term of 5 years and its 23rd Street, Philadelphia, Pennsylvania office, on a month to month basis.           ITEM 3.  LEGAL PROCEEDINGS         Following is a summary of the various claims and lawsuits involving PSB Bancorp, Inc. (“PSB”) other than the usual ordinary course of business claims to enforce liens, foreclosure proceedings on properties in which PSB holds security interests, claims involving the making and servicing of real property loans, and other issues incident to PSB’s business.        In October 1999, in connection with the acquisition of First Bank of Philadelphia (“FBP”), each outstanding share of FBP was exchanged for .857 shares of PSB common stock. In addition, under the terms of the merger agreement, options to acquire 1,612,500 shares of FBP were to be converted into options to acquire 1,381,912 shares of PSB common stock. In the fourth quarter of 2001, PSB declared 1,371,200 options previously issued by FBP and converted to PSB options in the merger to be void because PSB believed, among other reasons, that these options were unlawfully and improperly granted. The following actions are either related to the voiding of such options or were initiated by plaintiffs involved directly or indirectly in the option litigation or counsel for such plaintiffs.        A. On March 6, 2002, Carl Lingle, Raymond Silverstein as Trustee under an Irrevocable Trust, Conwell Ltd. Partnership, Gerald Lehrfeld, Joan Lehrfeld, Jay Roseman, and Lynn Roseman, purported option holders, brought an action in the United States District Court for the Eastern District of Pennsylvania (the “Court”) to have 895,240 of the options previously voided by PSB declared valid and enforceable.  9    Table of Contents       On September 30, 2004, the Court granted the plaintiffs’ motion for summary judgment. PSB appealed the Court’s decision to the United States Court of Appeals for the Third Circuit (the “Appeals Court”). Subsequently, on February 15, 2005, the Appeals Court upheld the grant of summary judgment for the plaintiffs. On February 28, 2005, PSB filed a petition for rehearing with the Appeals Court in which PSB averred that, based on recently discovered information, the court lacked jurisdiction because at least one of the plaintiffs was a Pennsylvania resident and therefore diversity of citizenship was absent.        On April 1, 2005, the Appeals Court granted PSB’s petition for rehearing, vacated its prior ruling, dismissed the case for lack of subject matter jurisdiction and remanded the case to the Court with instructions to dismiss the underlying case for lack of subject matter. On April 26, 2005, the Court dismissed the original case with prejudice for lack of subject matter jurisdiction (the “Dismissal”).        B. On September 7, 2004, Conwell Ltd. Partnership, a purported option holder filed an action in the United States District Court for the Eastern District of Pennsylvania seeking among other actions a declaratory judgment that 133,160 of the options previously declared invalid by PSB are valid and enforceable. The plaintiff filed a motion for summary judgment that was denied. On February 28, 2005, PSB filed a motion to dismiss for lack of subject matter jurisdiction. In response, the plaintiff filed a motion to be allowed to transfer the purported options to Lynn Roseman. Oral argument was held on March 30, 2005. On July 5, 2005, the Court denied plaintiff’s motion and granted PSB’s motion to dismiss the case for lack of subject matter jurisdiction. Plaintiffs subsequently filed an appeal with the U.S. Court of Appeals for the Third Circuit. PSB intends to defend vigorously the action. However, there can be no assurance regarding the eventual outcome of this litigation.        C. On September 17, 2004, Hal Shaffer, a purported option holder filed an action in the United States District Court for the Eastern District of Pennsylvania seeking among other actions a declaratory judgment that 342,800 of the options previously declared invalid by PSB were valid and enforceable. On February 28, 2005, PSB filed a motion to dismiss which was subsequently denied by the Court. On April 25, 2005, PSB filed a motion for reconsideration. On November 9, 2005, the Court denied PSB’s motion for reconsideration. PSB intends to defend vigorously the action. However, there can be no assurance regarding the eventual outcome of this litigation.        D. On December 29, 2004, PSB received a shareholder demand letter (the “Demand Letter”) on behalf of several purported shareholders alleging that certain of PSB’s officers, directors and employees engaged in a pattern and practice of acts of waste of corporate assets and failed to make certain required public disclosures. The purported acts related to failure to disclose certain information in PSB’s Securities Exchange Act of 1934 reports filed with the SEC, incomplete or inaccurate financial reporting, certain actions taken by directors related to the merger of PSB and Jade Financial Corp., and issues related to PSB’s decision to void the FBP options. On January 20, 2005, the board of directors of PSB appointed a special committee composed of three independent directors. The independent directors appointed to the special committee are Dennis Wesley, James W. Eastwood, and James Kenney. On September 15, 2005, Edward J. Reitmeyer was a appointed as an additional member of the special committee. The special committee was charged with (i) investigating the allegations in the Demand Letter, (ii) preparing and presenting a report to the full board of directors of the results of their investigation, and (iii) making a recommendation to the full board of directors as to whether or not to proceed with a shareholder derivative action. The special committee has engaged separate legal counsel to assist it in the preparation of its report.        E. On March 17, 2005, Raymond Silverstein, as Trustee under an Irrevocable Trust dated April 1, 1993, and Carl Lingle, as shareholders suing derivatively in the name and right of PSB, filed an action in the United States District Court for the Eastern District of Pennsylvania against PSB and each individual member of the board of directors seeking among other things a judgment declaring the 2001 PSB Stock Incentive Plan (the “Plan”) and certain options granted pursuant to the Plan to be null and void. The plaintiffs contend that PSB’s board of directors breached their fiduciary duty and engaged in self-dealing by knowingly disavowing 1,317,200 options granted in the acquisition of First Bank of Philadelphia which they knew were valid and subsequently soliciting and obtaining the approval of PSB’s shareholders for the Plan to allow for the granting of new options to PSB’s board of directors and executive management. On  10    Table of Contents  April 29, 2005, PSB filed a motion to dismiss the cases. On June 23, 2005, the Court denied PSB’s motion to dismiss. The special committee’s counsel, appointed as a result of the shareholder demand described in Paragraph D above, submitted its report and the Board of Directors concluded that no corrective action was necessary and that the derivative suit should be terminated. PSB unequivocally denies the allegations contained in the action and intends to defend vigorously the action. However, there can be no assurance regarding the eventual outcome of this litigation.        F. On April 8, 2005, PSB filed a declaratory judgment action in the Court of Common Pleas of Philadelphia County against the various purported option holders seeking an order declaring the disputed options void and invalid. This action is in the discovery phase.        G. On April 15, 2005, in response to the Dismissal, Carl Lingle, Raymond Silverstein, as Trustee under an Irrevocable Trust, Gerald Lehrfeld, Joan Lehrfeld, Jay Roseman and Lynn Roseman, purported option holders, filed an action in the United States District Court for the Eastern District of Pennsylvania seeking among other actions a declaratory judgment that 854,858 options previously declared invalid by PSB are valid and enforceable or in the alternative an award of money damages estimated to be not less than $11 million. On May 16, 2005, PSB filed a motion to dismiss that was denied on June 23, 2005. PSB intends to defend vigorously the action. However, there can be no assurance regarding the eventual outcome of this litigation.        H. In May 2005, PSB filed an action in the Philadelphia Court of Common Pleas against Conwell Ltd. Partnership, et al. (“Conwell”) in order to terminate a June, 2004 escrow agreement entered into as part of the original option case. PSB had issued certain stock certificates in the names of the plaintiffs and the plaintiffs paid the option exercise price. The stock certificates and the money were put into escrow pending the outcome of PSB’s appeal. As referenced in Paragraph A above, the action was dismissed, and PSB contends that the escrow should be voided. In response to PSB’s action, Conwell filed an interpleader action in the U.S. District Court for the Eastern District of Pennsylvania. As a result of that action, the escrow agent deposited into federal court the stock certificates that had been held in escrow. On July 6, 2005, the district court denied PSB’s motion to dismiss. On November 4, 2005, the district court entered an order staying the case.        There are no additional material developments to report regarding the above actions at the time of the filing of this annual report on Form 10-K.           ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITIES     HOLDERS         On July 1, 2005, PSB held its annual meeting of shareholders to elect directors and vote on a shareholder proposal. Following are the results of the votes cast:   Matter No. 1 — Election of Class I Directors                             Election Results           Nominees   For   Withheld                     Anthony DiSandro, President & CEO of PSB      4,494,681       352,259           Rosanne Pauciello, PSB Corporate Secretary      4,495,801       351,139       Continuing Directors   Class II directors                 Name/Position                     James W. Eastwood, Director                  Edward J. Reitmeyer, Director*                  Dennis P. Wesley, Director                        *       Appointed to fill a vacancy on the Board of Directors created by     the death of a director   11   Table of Contents  Class III directors                 Name/Position                     Vincent J. Fumo, Chairman of the Board                  James F. Kenney, Director              Matter No. 2 — Shareholder Proposal        RESOLVED, it is recommended that the Board of Directors of PSB Bancorp, Inc. (the “Company”) take the steps necessary to remove any provisions in the Company’s Articles of Incorporation and Bylaws that segregate the Board of Directors into separate classes with staggered terms of office.   Voting Results:                             For   Against   Abstain                 923,316       2,302,502       15,933         PART II           ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED     STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY     SECURITIES         Not Applicable           ITEM 6.  SELECTED FINANCIAL DATA         The selected financial and operating information set forth below should be read in conjunction with “Management’s Discussion and Analysis of the Financial Condition and Results of Operations” of PSB and the financial statements of PSB included elsewhere herein (Dollars in thousands, except for per share data.)                                                     As for the Years Ended December 31,               2005   2004   2003   2002   2001                                 BALANCE SHEET DATA                                                  Total assets    $ 560,682     $ 533,077     $ 470,330     $ 496,780     $ 467,644           Cash and cash equivalents      37,797       54,650       52,408       110,269       54,756           Loans receivable, net      366,534       352,985       237,383       288,630       297,180           Loans held-for-sale      3,280       3,792       51,859       18,855       17,142           Investment securities available for sale      123,994       94,112       102,882       49,730       69,934           Investment securities held to maturity      1,325       1,533       775       6,468       2,310           Deposits      501,111       475,280       416,160       442,224       404,560           Shareholders’ equity      53,221       52,157       47,123       46,167       41,415           Book value per share    $ 10.35     $ 10.83     $ 10.39     $ 9.81     $ 9.13      12    Table of Contents                                                      As for the Years Ended December 31,               2005   2004   2003   2002   2001                                 SUMMARY STATEMENT OF OPERATIONS                                                  Interest income    $ 30,489     $ 27,989     $ 28,327     $ 31,698     $ 26,928           Interest expense      11,922       8,481       9,575       13,252       14,011                                             Net interest income      18,567       19,508       18,752       18,446       12,917           Provision for loan losses      405       235       45       1,437       270                                             Net interest income after provision for loan losses      18,162       19,273       18,707       17,009       12,647           Non-interest income      2,819       2,117       2,168       3,081       1,554           Non-interest expense      19,144       18,282       17,846       17,052       10,240           Loss on investment in Iron Bridge Holdings, Inc.(1)      —       —       —       32       154                                             Income before income taxes      1,837       3,108       3,029       3,006       3,807           Income tax provision      702       1,038       1,024       1,189       755                                             Income before cumulative effect of accounting change      1,135       2,070       2,005       1,817       3,052           Cumulative effect of accounting change      —       —       —       1,329       —                                             Net income    $ 1,135     $ 2,070     $ 2,005     $ 3,146     $ 3,052                                             PER SHARE DATA                                                  Income before cumulative effect of accounting change                                                    Basic    $ 0.24     $ 0.47     $ 0.47     $ 0.43     $ 0.73                                             Income before cumulative effect of accounting change —     diluted    $ 0.20     $ 0.40     $ 0.46     $ 0.42     $ 0.72                                             Cumulative effect of accounting change — basic    $ —     $ —     $ —     $ 0.32     $ —                                             Cumulative effect of accounting change — diluted    $ —     $ —     $ —     $ 0.32     $ —                                             Net income — basic    $ 0.24     $ 0.47     $ 0.47     $ 0.75     $ 0.73                                             Net income — diluted    $ 0.20     $ 0.40     $ 0.46     $ 0.74     $ 0.72                                             PERFORMANCE DATA                                                  Return on average assets      0.21 %     0.43 %     0.41 %     0.65 %     0.73 %         Return on average equity      2.15 %     4.42 %     4.28 %     7.07 %     7.75 %         Equity to assets      9.49 %     9.78 %     9.66 %     9.14 %     9.36 %         Interest rate spread      3.25 %     3.78 %     3.83 %     3.80 %     2.80 %               (1)       The financial results of Iron Bridge Holdings were consolidated     with PSB’s financial results effective January 1, 2004.            ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL     CONDITION AND RESULTS OF OPERATIONS         The following discussion and analysis of the financial condition and results of operations of PSB should be read in conjunction with the consolidated financial statements of PSB, including the related notes thereto, included elsewhere herein.        Certain statements in this document may be considered to be “forward-looking statements” as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that  13    Table of Contents  include the words “may”, “believes”, “expect”, “estimate”, “project”, “anticipate”, “should”, “would”, “intend”, “probability”, “risk”, “target”, “objective” and similar expressions or variations on such expressions. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For example, risks and uncertainties can arise with changes in: general economic conditions, including their impact on capital expenditures; business conditions in the financial services industry; the regulatory environment, including evolving banking industry standards; rapidly changing technology and competition with community, regional and national financial institutions; new service and product offerings by competitors, price pressures; and similar items. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. PSB undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risk factors described in other documents PSB files from time to time with the Securities and Exchange Commission, including PSB’s Annual Report on Form 10-K for the year ended December 31, 2005, Quarterly Reports on Form 10-Q filed by PSB in 2005 and any Current Reports on Form 8-K filed by the Company, as well as similar filings in 2005.   GENERAL        PSB’s results of operations depend primarily on the Bank’s net interest income, which is the difference between interest income on interest-earning assets, and interest expense on its interest-bearing liabilities. Its interest-earning assets consist primarily of loans receivable, investment securities, and interest earning deposits while its interest-bearing liabilities consist primarily of deposits. The Bank’s net income is also affected by its provision for loan losses and its level of non-interest income as well as by its non-interest expense, such as salary and employee benefits, occupancy costs, and charges relating to non-performing and other classified assets.   IMPACT OF INFLATION        The financial statements and related financial data presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on the operation of the Bank is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services.   CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES        The accounting and reporting policies of the Bank and its subsidiaries conform with accounting principles generally accepted in the United States of America (US GAAP) applicable to the financial services industry. All significant inter-company transactions are eliminated in consolidation and certain reclassifications are made when necessary to conform the previous year’s financial statements to the current year’s presentation. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods presented. Therefore, actual results could differ significantly from those estimates.        Allowance For Credit Losses — PSB uses the reserve method of accounting for credit losses. The balance in the allowance for loan losses is determined based on management’s review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including management’s assumptions as to future delinquencies, recoveries and losses. Increases to the allowance for loan and lease losses are made by charges to the provision for loan losses. Credit exposures deemed to be uncollectible are charged  14   Table of Contents  against the allowance for loan losses. Recoveries of previously charged-off amounts are credited to the allowance for loan losses. While management considers the allowance for loan and lease losses to be adequate based on information currently available, future additions to the allowance may be necessary due to changes in economic conditions or management’s assumptions as to future delinquencies, recoveries and losses and management’s intent with regard to the disposition of loans and leases. In addition, the regulators, as an integral part of their examination process, periodically review PSB’s allowance for loan losses. The regulators may require the Bank to recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examination.        Income Taxes — Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. Based upon the review of all components of the deferred tax assets and liabilities, future taxable income of PSB and regulatory guidelines, management has determined that no allowance is deemed necessary at December 31, 2005. However, circumstances could arise that would require management to revisit the need for such an allowance.   PERFORMANCE OVERVIEW           Results of Operations         Net income for 2005 was $1.1 million or $0.20 per diluted share compared to $2.1 million or $0.40 per diluted share for 2004 and $2.0 million or $0.46 per diluted share for 2003. These decreases are a result of declining net interest margins and increases in non-interest expenses. Detail regarding changes in each of these areas follows.           Net Interest Income         Net interest income is a primary source of revenue for the Bank. This income results from the difference between the interest and fees earned on loans and investments and the interest paid on deposits to customers and other non-deposit sources of funds, such as repurchase agreements. Net interest margin is the difference between the interest income on earning assets and the interest expense on interest bearing funds as a percentage of earning assets. During 2005, 2004, and 2003, the Bank had no tax-exempt sources of revenue. All discussion of net interest margin is on a fully taxable equivalent basis.        Net interest income for 2005 was $18.6 million, a 4.62% decrease over the $19.5 million of net interest income in 2004, which was a 3.72% increase over the $18.8 million of net interest income in 2003. Average earning assets increased by $38.2 million or 7.88% from 2004 to 2005. The net interest margin decreased to 3.55% in 2005 from 4.02% in 2004. Net interest margin decreased during 2005 generally because of the flatter yield curve that existed in 2005 and specifically because of an increase in time deposit average balances and an increase in the interest rate percentage paid on these time deposits. The average rate paid on deposits increased to 2.58% for 2005 from 1.99% in 2004. The primary growth in earning assets for 2005 was in average loans and investment securities. Average investment securities portfolio increased by 12.93% in 2005 and 29.28% in 2004. Average loans outstanding increased by 11.57% in 2005 and 11.68% in 2004.        Average interest-bearing deposits increased by 8.51% in 2005 and 3.76% in 2004 while average borrowings increased by 1.27% in 2005 and increased by 1.28% in 2004. The yield on interest-earning assets decreased by six basis points from 2004 to 2005, and the cost of interest-bearing liabilities increased by 59 basis points during the same time period. These increases reflect the flatter yield curve in which shorter term rates generally paid on deposits increased more than the increase in longer term rates generally earned on loans.  15   Table of Contents          Average Balances, Rates and Net Yield         The following table sets forth the average daily balances of major categories of interest earning assets and interest bearing liabilities, the average rate paid thereon, and the net interest margin for each of the periods indicated.                                                                                         Year Ended December 31,               2005   2004   2003                       Average       Yield/   Average       Yield/   Average       Yield/       Balance   Interest   Rate   Balance   Interest   Rate   Balance   Interest   Rate                                               (Dollars in thousands)         ASSETS                                                                                  Interest-earning assets:                                                                                    Interest-earning deposits    $ 54,067     $ 1,436       2.65 %   $ 65,664     $ 812       1.24 %   $ 94,454     $ 990       1.05 %           Investment securities      74,705       2,617       3.50 %     50,583       1,442       2.85 %     39,127       1,270       3.25 %           Mortgage-backed securities      33,574       1,366       4.07 %     45,296       1,928       4.26 %     36,620       2,082       5.69 %           Loans(1)      360,949       25,070       6.95 %     323,523       23,807       7.36 %     289,690       23,985       8.28 %                                                                     Total interest-earning assets      523,295     $ 30,489       5.83 %   $ 485,066     $ 27,989       5.77 %   $ 459,891     $ 28,327       6.16 %           Noninterest-earning assets      27,785                       32,519                       24,736                                                                                         Total assets    $ 551,080                     $ 517,585                     $ 484,627                                                                                         LIABILITIES                                                                                  Interest-bearing liabilities:                                                                                    Now checking accounts    $ 25,024     $ 124       0.50 %   $ 25,946     $ 132       0.51 %   $ 22,680     $ 191       0.84 %           Money market accounts      50,379       695       1.38 %     67,759       720       1.06 %     72,356       1,083       1.50 %           Savings deposits      81,526       981       1.20 %     90,592       1,097       1.21 %     93,453       1,345       1.44 %           Certificates      304,531       10,097       3.32 %     240,968       6,509       2.70 %     221,377       6,929       3.13 %                                                                     Total deposits      461,460       11,897       2.58 %   $ 425,265     $ 8,458       1.99 %   $ 409,866     $ 9,548       2.33 %           Borrowed money      1,120       25       2.23 %     1,106       23       2.08 %     1,092       27       2.47 %                                                                     Total interest-bearing liabilities      462,580       11,922       2.58 %   $ 426,371       8,481       1.99 %   $ 410,958       9,575       2.30 %           Noninterest-bearing liabilities      35,734                       41,245                       26,843                                                                                         Total liabilities      498,314                       467,616                       437,801                           Shareholders’ equity      52,766                       49,969                       46,826                                                                                     Total liabilities and shareholders’ equity    $ 551,080                     $ 517,585                     $ 484,627                                                                                     Net interest income            $ 18,567                     $ 19,508                     $ 18,752                   Interest rate spread                      3.25 %                     3.78 %                     3.83 %         Net yield on interest-earning assets                      3.55 %                     4.02 %                     4.08 %         Ratio of interest-earning assets to interest-bearing liabilities                      1.13 x                     1.14 x                     1.09 x               (1)       Includes Loans Held for Sale   16   Table of Contents          Changes in Interest Income and Interest Expense         The following table sets forth certain information regarding changes in interest income and interest expense of the Bank for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (1) changes in volume (changes in volume multiplied by old rate), and (2) changes in rate (changes in rate multiplied by average volume).           Analysis of Changes in Interest Income                                                              2005 Versus 2004   2004 Versus 2003                   Increase (Decrease)   Increase (Decrease)                   Volume   Rate   Net Change   Volume   Rate   Net Change                                     Interest Income:                                                          Interest bearing deposits with banks    $ (307 )   $ 925     $ 618     $ (356 )   $ 180     $ (176 )         Investment securities      844       329       1,173       327       (156 )     171           Mortgage-backed securities      (477 )     (86 )     (563 )     370       (523 )     (153 )         Loans      2,601       (1,327 )     1,274       2,490       (2,665 )     (175 )                                                 Total interest income      2,661       (159 )     2,502       2,831       (3,164 )     (333 )         Interest Expense:                                                          Now checking accounts      (5 )     (3 )     (8 )     17       (75 )     (58 )         Money market accounts      (240 )     217       (23 )     (49 )     (318 )     (367 )         Savings accounts      (109 )     (9 )     (118 )     (35 )     (215 )     (250 )         Certificates of deposit      2,111       1,494       3,605       529       (952 )     (423 )         Borrowings      0       2       2       0       4       4                                                   Total interest expense      1,757       1,701       3,458       462       (1,556 )     (1,094 )                                                 Net change in net interest income    $ 904     $ (1,860 )   $ (956 )   $ 2,369     $ (1,608 )   $ 761                                                       Other Income         The following table provides a summary of non-interest income, by category of income, for the three years ended December 31, 2005, 2004, and 2003 (in thousands):                                     Year Ended December 31,               2005   2004   2003                         Service fees on deposit accounts    $ 1,185     $ 1,004     $ 1,105           Loss on write down of equity investment      —       (51 )     (37 )         Loss on sale of real estate owned      (49 )     (48 )     (14 )         Bank owned life insurance      485       433       504           Gain on sales of investments securities      440       —       —           Other      758       779       610                                 Total    $ 2,819     $ 2,117     $ 2,168                                  The major source of non-interest income is income from bank owned life insurance and service fees on deposit accounts. Non-interest income increased $702,000 or 33.33% from $2.1 million in 2004 to $2.8 million in 2005. This increase is primarily due to an increase in service fees on deposit accounts related to the institution of an overdraft protection fee, increased income from bank-owned life insurance, and PSA Service Corp., the Bank’s wholly-owned subsidiary had a gain on the sale of investment securities during 2005.  17   Table of Contents          Other Expenses         The following table provides a summary of non-interest expense, by category of expense, for the three years ended December 31, 2005, 2004, and 2003 (in thousands):                                     Year Ended December 31,               2005   2004   2003                         Salaries and employee benefits    $ 10,074     $ 9,795     $ 9,543           Occupancy and equipment expense      2,569       2,380       2,086           Professional services      1,698       918       1,046           General insurance      289       306       256           Advertising      233       296       309           Data processing      768       792       640           Director fees      133       338       447           Other operating expense      3,380       3,457       3,519                                 Total    $ 19,144     $ 18,282     $ 17,846                                  The largest increase in non-interest expense incurred by the Bank is for professional services which totaled $1.7 million in 2005 compared to $918,000 in 2004 and $1.0 million in 2003. The increase in professional services expense for 2005 was primarily the result of the legal expenses related to the option and shareholder derivative suits (see “Item 3 — Legal Proceedings”).        Salaries and employee benefit expense increased $279,000, or 2.85% in 2005, after increasing $252,000 or 2.64% in 2004 as compared to 2003. Full-time equivalent (FTE) employees for the Bank were 154, 150, and 160 for the years ended December 31, 2005, 2004, and 2003, respectively.        Total occupancy and equipment expense increased by 8.33% in 2005 to $2.6 million, from $2.4 million in 2004 and increased by 14.29% in 2004 from $2.1 million in 2003. The occupancy increase in 2005 was primarily the result of the addition of a new branch location in the Chinatown section of Philadelphia.        Advertising expenses were $233,000 in 2005, $296,000 in 2004 and $309,000 in 2003, a decrease of 21.29% and 4.21% in 2005 and 2004, respectively, this reduction was made in an effort to reduce non-interest expense.           Income Taxes         PSB accounts for income taxes under the liability method specified by SFAS No. 109, “Accounting for Income Taxes.” Under SFAS No. 109, deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The principal types of accounts resulting in differences between assets and liabilities for financial statement and tax return purposes are the allowance for loan losses, leased assets, deferred loan fees and compensation. PSB had an income tax provision of $702,000, $1.0 million and $1.0 million for the years ended December 31, 2005, 2004 and 2003, respectively. PSB had an effective tax rate of 35.09%, 34.00%, and 33.81% for the years ended December 31, 2005, 2004, and 2003.           Financial Condition         The Bank’s total assets increased to $560.7 million at December 31, 2005, representing a growth rate of 5.18% from $533.1 million at December 31, 2004.  18    Table of Contents          Cash and Investment Securities Portfolio         Cash and cash equivalents decreased to $37.8 million at December 31, 2005 from $54.7 million at December 31, 2004 as management moved investable funds into higher yielding investment securities.        The investment securities portfolio increased 31.07% to $125.3 million at December 31, 2005, from $95.6 million at December 31, 2004. Investment securities are used to supplement loan growth as necessary, to generate interest and dividend income, to manage interest rate risk, and to provide liquidity. To accomplish these ends, most of the purchases in the portfolio during 2005 were of mortgage backed securities and bonds issued by US Government agencies.        At December 31, 2005, the investment securities portfolio balance included a net unrealized loss on available for sale securities of $2.4 million versus a net unrealized loss of $652,000 at December 31, 2004. The increase in interest rates during 2005 was primarily responsible for the depreciation in the fair market value of the investment securities.           Carrying Value and Fair Value of Investment     Securities         The following table sets forth carrying values, and current market values for the Bank’s investment securities portfolio. Adjustable-rate, mortgage-backed securities are included in the period in which interest rates are next scheduled to adjust (in thousands except for yields).                                     At December 31,               2005   2004   2003                       Amortized   Amortized   Amortized       Cost   Cost   Cost                       (In thousands)         INVESTMENT SECURITIES AVAILABLE-FOR-SALE:                                  Mutual funds    $ 2,354     $ 2,354     $ 2,354           State and municipal obligations      —       500       2,506           U.S. Government and agency securities      94,662       54,984       49,991           Mortgage-backed securities:                                  FNMA Certificates      16,220       22,716       25,995           GNMA Certificates      940       1,921       3,791           FHLMC Certificates      12,183       12,300       18,595                                 Total investment securities available-for-sale      126,359       94,775       103,232           INVESTMENT SECURITIES HELD TO MATURITY:                                  Mortgage-backed securities:                                  GNMA Certificates      482       562       775           FHLMC Certificates      843       971       —                                 Total investment securities held-to-maturity      1,325       1,533       775                               $ 127,684     $ 96,308     $ 104,007                            19    Table of Contents                                    At December 31,               2005   2004   2003                       Fair   Fair   Fair       Value   Value   Value                       (In thousands)         INVESTMENT SECURITIES AVAILABLE-FOR-SALE:                                  Mutual funds:    $ 2,288     $ 2,323     $ 2,341           State and municipal obligations      —       502       2,570           U.S. Government and agency securities      92,976       54,225       49,061           Mortgage-backed securities:                                  FNMA Certificates      15,865       22,787       26,420           GNMA Certificates      965       2,004       3,908           FHLMC Certificates      11,900       12,271       18,582                                 Total investment securities available-for-sale    $ 123,994     $ 94,112     $ 102,882           INVESTMENT SECURITIES HELD TO MATURITY:                                  Mortgage-backed securities:                                  GNMA      484       573       790           FHLMC Certificates      826       971       —                                 Total investment securities held-to-maturity      1,310       1,544       790                               $ 125,304     $ 95,656     $ 103,672                                     Loans         Loans increased to $369.8 million at December 31, 2005 from $356.1 million at December 31, 2004, an increase of $13.7 million or 3.85%. Management has targeted the loan portfolio as a key to the Bank’s continuing growth. Specifically, the Bank has shifted its lending focus to higher yielding commercial loans made to small and medium sized businesses in its market area. In order to facilitate growth in commercial lending, the bank assessed its loan staff and made significant personnel changes in senior management positions to assure its continued success in the development of this lending group. Management has also implemented changes within the credit administration division of the commercial lending group to ensure continued high quality underwriting standards are maintained. Additionally, the Bank has committed to an increase of at least two new experienced loan officers during the next twelve months servicing this area. A significant increase in the volume of commercial and construction loans during 2005 underscores that focus as the commercial portfolio increased to $220.0 million at December 31, 2005, from $211.0 million at December 31, 2004, an increase of $9.0 million or 4.27%.        Loans secured by residential real estate decreased to $80.0 million at December 31, 2005, from $90.7 million as of December 31, 2004, a decrease of $10.7 million or 11.80%, due to the declining interest rate environment which caused an increase in loan principal prepayments for these loans and net affect of $3.3 million of portfolio mortgage loans originated and sold in the 12 months ended December 31, 2005.        These sales of residential real estate loans in the secondary market reflect the Bank’s strategy of de-emphasizing the retention of long-term, fixed rate loans in the portfolio, generating fees, improving interest-rate risk and funding growth in higher yielding assets.  20   Table of Contents       The following table summarizes the loan portfolio of the Bank by loan category and amount at December 31 for the past five years, including data regarding the portion of the Bank’s loans that bear fixed and adjustable interest rates, respectively. The loan categories correspond to the Bank’s general classifications (in thousands, except for percentage):                                                                                             At December 31,               2005   2004   2003   2002   2001                               Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent                                                     Commercial loans    $ 171,555       46.43 %   $ 189,181       53.11 %   $ 148,761       61.78 %   $ 143,685       49.11 %   $ 53,260       17.72 %         Construction loans      48,309       13.08 %     21,763       6.11 %     17,278       7.17 %     29,709       10.15 %     21,651       7.20 %         Mortgage loans      79,856       21.61 %     90,654       25.45 %     26,676       11.08 %     60,099       20.54 %     150,358       50.02 %         Consumer loans      69,736       18.88 %     54,624       15.33 %     48,096       19.97 %     59,063       20.19 %     75,334       25.06 %                                                                       $ 369,456       100.00 %   $ 356,222       100.00 %   $ 240,811       100.00 %   $ 292,556       100.00 %   $ 300,603       100..00 %                                                                         Unearned fees and discounts    $ 378             $ (80 )           $ (359 )           $ (323 )           $ (552 )                 Allowance for loan losses      (3,300 )             (3,157 )             (3,069 )             (3,603 )             (2,871 )                                                                                 Net loans    $ 366,534             $ 352,985             $ 237,383             $ 288,630             $ 297,180                                                                                    Loan balances segregated in terms of sensitivity to changes in interest rates at December 31, 2005, are summarized below (In thousands):                               Less Than One Year to           Five Years   After Five Years                     Predetermined interest rate    $ 143,892     $ 141,992           Floating interest rate      79,482       4,090                             Total    $ 223,374     $ 146,082                               Loan Maturities         The following table sets forth the maturity or period of re-pricing of the Bank’s loan portfolio at December 31, 2005. Demand loans and loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. Adjustable and floating-rate loans are included in the period in which interest rates are next scheduled to adjust rather than the period in which they contractually mature, and fixed-rate loans are included in the period in which the final contractual repayment is due (in thousands).                                                     Amounts at December 31, 2005               Commercial   Residential   Construction   Consumer   Total Loans                                 Amounts due                                                  Non-accrual loans    $ 1,512     $ 773     $ 225     $ —     $ 2,510           Within one year      37,848       30       25,425       6,451       69,754                                             Total due within one year      39,360       803       25,650       6,451       72,264           After one year:                                                  1-3 years      32,740       804       22,659       7,973       64,176           3-5 years      65,538       94       —       10,856       76,488           Over 5 years      33,917       78,155       —       44,456       156,528                                             Total due after one year      132,195       79,053       22,659       63,285       297,192                                             Total amounts due    $ 171,555     $ 79,856     $ 48,309     $ 69,736     $ 369,456                                        21    Table of Contents          Provision and Allowance for Loan Losses         The provision for loan losses for 2005 was $405,000 compared to $235,000 in 2004 and $45,000 in 2003. The Bank performs a review of the credit quality of its loan portfolio on a quarterly basis to determine the adequacy of the allowance for possible loan losses. The allowance for loan losses at December 31, 2005, was $3.3 million, or 0.9% of outstanding loans, compared to $3.2 million or 0.9% of outstanding loans at December 31, 2004.        The allowance for loan losses is an amount that management believes to be adequate to absorb potential losses in the loan portfolio. Additions to the allowance are charged through the provision for loan losses. Management regularly assesses the adequacy of the allowance by performing an ongoing evaluation of the loan portfolio, including such factors as charge-off history, the level of delinquent loans, the current financial condition of specific borrowers, value of any collateral, risk characteristics in the loan portfolio, and local and national economic conditions. Significant loans are individually analyzed, while other smaller balance loans are evaluated by loan category. Based upon the results of such reviews, management believes that the allowance for loan losses at December 31, 2005, was adequate to absorb credit losses inherent in the portfolio as of that date.        The following table sets forth an allocation for the allowance for loan losses by category. The specific allocations in any particular category may be reallocated in the future to reflect then current conditions. Accordingly, management considers the entire allowance available to absorb losses in any category. (Dollars in thousands)                                                                                             Year Ended December 31,               2005   2004   2003   2002   2001                                   Percent       Percent       Percent       Percent       Percent       Amount   of Loans   Amount   of Loans   Amount   of Loans   Amout   of Loans   Amout   of Loans                                                     Real estate    $ 571       20.23 %   $ 947       34.29 %   $ 661       80.93 %   $ 510       82.77 %   $ 400       70.45 %         Commercial real estate      1,894       67.12 %     1,775       64.26 %     2,089       9.08 %     2,088       5.72 %     2,325       11.26 %         Consumer      357       12.65 %     40       1.45 %     120       9.99 %     179       11.51 %     146       18.29 %         Unallocated      478       —       395       —       199       —       826       —       —       —                                                                           Totals    $ 3,300       100 %   $ 3,157       100 %   $ 3,069       100 %   $ 3,603       100 %   $ 2,871       100 %                                                                    22   Table of Contents      The following table summarizes the changes in the Bank’s allowance for loan losses for each of the past five years (Dollars in thousands):                                                     2005   2004   2003   2002   2001                                 Balance at beginning of year    $ 3,157     $ 3,069     $ 3,603     $ 2,871     $ 1,349           Acquisition of Jade’s allowance for loan losses      —       —       —       —       1,874           Charge-offs:                                                  Real Estate: one-to four-family      93       17       93       474       262           Commercial      41       —       13       —       —           Consumer      284       345       656       382       526                                             Total charge-offs      418       362       762       856       788           Recoveries:                                                  Consumer      156       215       183       151       166                                             Total recoveries      156       215       183       151       166                                             Net charge-offs      262       147       579       705       622           Provision charged to operations      405       235       45       1,437       270                                             Allowance, end of period    $ 3,300     $ 3,157     $ 3,069     $ 3,603     $ 2,871                                             Allowance for loan losses to total loans      0.89 %     0.90 %     1.28 %     1.23 %     0.95 %         Allowance for loan losses to non accrual loans      131.47 %     86.90 %     58.99 %     80.42 %     69.52 %         Net charge-offs as a percentage of total loans      0.11 %     0.04 %     0.24 %     0.24 %     0.21 %             Non-Performing Assets         In 2005, the Bank’s level of non-performing assets decreased $436,000 or 10.75% to $3.6 million compared to a decrease of $1.5 million to $4.1 million at December 31, 2004 from $5.6 million at December 31, 2003. Non-accrual interest for 2005 and 2004 was $813,000 and $1.0 million, respectively.        As a matter of policy, the accrual of loan interest is discontinued if management believes that, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of interest becomes doubtful. This is normally done when a loan reaches 90 days delinquent. At this time, all accrued but unpaid interest is reversed out of interest income. There are occasional exceptions if the loans are well secured and in the process of collection. The Bank did not have any material restructured loans within the meaning of SFAS No. 15 in 2005.  23   Table of Contents       The following table sets forth information regarding loans 90 or more days delinquent and still accruing interest, non-accrual loans, and real estate owned held by the Bank at the dates indicated (Dollars in thousands):                                                     At December 31, 2005               2005   2004   2003   2002   2001                                 Loans past due 90 days or more as to interest or principal     and still accruing interest    $ —     $ —     $ —     $ —     $ —           Nonaccrual loans      2,510       3,633       5,203       4,480       4,130                                             Total nonperforming loans      2,510       3,633       5,203       4,480       4,130           Real estate owned (REO)      1,109       422       374       382       548                                             Total nonperforming assets    $ 3,619     $ 4,055     $ 5,577     $ 4,862     $ 4,678                                             Nonperforming loans to total loans      0.68 %     1.02 %     2.16 %     1.53 %     1.37 %         Nonperforming assets to total assets      0.65 %     0.76 %     1.19 %     0.98 %     1.00 %         Allowance for loan losses to total loans      0.89 %     0.90 %     1.28 %     1.23 %     0.95 %         Allowance for loan losses to nonperforming loans      131.47 %     86.90 %     58.99 %     80.42 %     69.52 %         Allowance for loan losses to nonperforming assets      91.19 %     77.85 %     55.03 %     74.11 %     61.37 %         Net charge-offs as a percentage of total loans      0.11 %     0.04 %     0.24 %     0.24 %     0.21 %          At December 31, 2005, the Company’s impaired loans consisted of 15 commercial real estate loans with a total recorded balance of approximately $1.3 million for which specific allowances of approximately $300,000 have been established. At December 31, 2004, the Company’s impaired loans consisted of 21 commercial real estate loans with a total recorded balance of approximately $3.2 million for which specific allowances of approximately $363,000 have been established. The average investment in impaired loans for the years ended December 31, 2005, 2004 and 2003 was approximately $2.5 million, $2.7 million, and $3.7 million respectively.           Deposits         The following tables present the average balances and rates paid on deposits for each of the years ended December 31, 2005, 2004 and 2003 (Dollars in thousands):                                                             Year Ended December 31,               2005   2004   2003                       Average   Average   Average   Average   Average   Average       Balance   Rate   Balance   Rate   Balance   Rate                                     Demand deposits    $ 32,889       —     $ 37,827       —     $ 24,843       —           Now checking accounts      25,024       0.50 %     25,946       0.51 %     22,680       0.84 %         Money market accounts      50,379       1.38 %     67,759       1.06 %     72,356       1.50 %         Savings accounts      81,526       1.20 %     90,592       1.21 %     93,453       1.44 %         Certificates of deposit      304,531       3.32 %     240,968       2.70 %     221,377       3.13 %                                                 Total deposits    $ 494,349       2.58 %   $ 463,092       1.99 %   $ 434,709       2.20 %                                                  Total deposits increased by $25.8 million or 5.43%, growing to $501.1 million at December 31, 2005 from $475.3 million at December 31, 2004.        Non-interest bearing deposits increased to $40.7 million at December 31, 2005, from $30.8 million at December 31, 2004, an increase of $9.9 million or 32.14%. Management continues to promote growth in these types of deposits, which include a free personal checking product, as a method to help reduce the overall cost of the Bank’s funds. Interest bearing deposits increased by $15.9 million or 3.58%, growing from $444.5 million at December 31, 2004 to $460.4 million at December 31, 2005.  24    Table of Contents          Maturity of Certificates of Deposit of $100,000 or     More         The following is a breakdown by contractual maturity, of the Company’s time certificates of deposit issued in denominations of $100,000 or more as of December 31, 2005.                         Certificates of Deposit       2005               (Dollars in thousands)         Maturing in:                    Three months or less    $ 14,175             Over three months through six months      9,741             Over six months through twelve months      42,560             Over twelve months      15,540                         Total    $ 82,016                      The following is a breakdown, by contractual maturities of the Company’s time certificates of deposit for the years 2006 through 2010 and beyond:                                                                     2006   2007   2008   2009   2010   Thereafter   Totals                                       (Dollars in thousands)         Time certificates of deposit    $ 261,961     $ 42,313     $ 7,414     $ 2,335     $ 6,052     $ 155     $ 320,230                                                          The Bank’s certificates of deposit in excess of $100,000, which totaled $82.0. million at December 31, 2005, mature as follows: $14.2 million within three months, $9.7 million between three and six months; $42.6 million between six and twelve months and $15.5 million after twelve months.        The ability of the Bank to attract and maintain deposits and the Bank’s cost of funds on these deposit accounts have been, and will continue to be, significantly affected by economic and competitive conditions.           Borrowed Funds         The Bank is a member of the Federal Home Loan Bank System (“FHLB”). The FHLB provide a central credit facility primarily for member institutions. The Bank, as a member of the FHLB of Pittsburgh, is required to hold shares of common stock in that FHLB in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans, home purchase contracts, and similar obligations at the beginning of each year, or 5% of its advances (borrowings) from the FHLB of Pittsburgh, whichever is greater. The Bank had a $1.1 million investment in the stock of the FHLB at December 31, 2005, which was in compliance with this requirement. At December 31, 2005 and 2004, the Bank had no outstanding borrowings from the FHLB of Pittsburgh. The Bank has a line of credit available in the amount of $207 million as of December 31, 2005.        Borrowed funds from various sources are generally used to supplement deposit growth. Securities sold under agreements to repurchase were $1.1 million at December 31, 2005, and $1.1 million at December 31, 2004.        Additionally, the Bank had securities sold under repurchase agreements are as follows:                                     Year Ended December 31,               2005   2004   2003                       (Dollars in thousands,       except percentages)         Balance at year-end    $ 1,127     $ 1,105     $ 1,099           Average during the year      1,120       1,109       1,092           Maximum month-end balance      1,127       1,111       1,099           Weighted average rate during the year      2.12 %     1.92 %     2.47 %         Rate at December 31      2.44 %     2.14 %     1.88 %    25    Table of Contents          Shareholders’ Equity         Total shareholders’ equity at December 31, 2005 and 2004 increased by $1.0 million and $5.1 million, respectively to $53.2 million and $52.2 million includes accumulated other comprehensive income, which includes an adjustment for the fair value of the Bank’s securities portfolio. This amount attempts to identify the impact to equity in the unlikely event that the Bank’s entire securities portfolio would be liquidated under current economic conditions. The amounts and types of securities held by the Bank at the end of 2005, combined with current interest rates, resulted in a decrease in equity, net of taxes, of $1.7 million. This compares with an decrease in equity, net of taxes, of $440,000 at the end of 2004. Retained earnings accounted for an increase in shareholders’ equity of $1.1 million and $2.1 million during 2005 and 2004, respectively.           Interest Rate Sensitivity         Through the years, the banking industry has adapted to an environment in which interest rates have fluctuated dramatically and in which depositors have been provided with liquid, rate sensitive investment options. The industry utilizes a process known as asset/liability management as a means of managing this adaptation.        Asset/liability management is intended to provide for adequate liquidity and interest rate sensitivity by matching interest rate sensitive assets and liabilities and coordinating maturities and repricing characteristics on assets and liabilities.        Interest rate risk management involves managing the extent to which interest-sensitive assets and interest-sensitive liabilities are matched. Interest rate sensitivity is the relationship between market interest rates and earnings volatility due to the repricing characteristics of assets and liabilities. The Bank’s net interest income is affected by changes in the level of market interest rates. In order to maintain consistent earnings performance, the Bank seeks to manage, to the extent possible, the repricing characteristics of its assets and liabilities.        One major objective of the Bank when managing the rate sensitivity of its assets and liabilities is to stabilize net interest income. The management of and authority to assume interest rate risk is the responsibility of the Bank’s Asset/ Liability Committee (“ALCO”), which is comprised of senior management and Board members. The ALCO meets quarterly to monitor the ratio of interest sensitive assets to interest sensitive liabilities. The process to review interest rate risk management is a regular part of management of the Bank. In addition, there is an annual process to review the interest rate risk policy with the Board of Directors which includes limits on the impact to earnings from shifts in interest rates.        To manage the interest rate sensitivity position, an asset/liability model called “gap analysis” is used to monitor the difference in the volume of the Bank’s interest sensitive assets and liabilities that mature or reprice within given periods. A positive gap (asset sensitive) indicates that more assets reprice during a given period compared to liabilities, while a negative gap (liability sensitive) has the opposite effect.        At December 31, 2005, the Bank maintained a positive one to five year cumulative gap.  26   Table of Contents  Interest Sensitivity Gap at December 31, 2005                                                             0-3   4-12       More Than   No Stated   Balance at   Gap Table at December 31, 2005   Months   Months   1-5 Yrs.   5 Yrs.   Maturity   12/31/05                                     Cash due and from banks       —        —        —        —       6,454       6,454           Interest bearing deposits with banks      29,762        —        —        —        —       29,762           Fed Funds Sold      1,581        —        —        —        —       1,581           Investment securities      573       48,345       74,104       2,297               125,319           Loans held for sale      3,280        —        —        —        —       3,280           Mortgage loans      1,420       13,874       35,820       28,742       378       80,234           Commercial loans      35,239       50,963       64,327       21,026        —       171,555           Consumer loans      11,583       12,689       39,453       6,011        —       69,736           Construction loans      742       28,306       19,099       162        —       48,309           Allowance for loan losses       —        —        —        —       (3,300 )     (3,300 )         Other assets       —        —        —        —       27,752       27,752                                                   Total assets    $ 84,180     $ 154,177       232,803     $ 58,238     $ 31,284     $ 560,682                                                   Noninterest bearing deposits       —        —        —        —       42,136       42,136           NOW accounts      24,444        —        —        —        —       24,444           Money market accounts      41,835        —        —        —        —       41,835           Savings accounts      74,924        —        —        —        —       74,924           Time deposits      14,484       247,726       58,020                —       320,230           Borrowed funds      233       673       222        —        —       1,128           Other liabilities       —        —        —        —       2,764       2,764                                                   Total liabilities      155,920       248,399       58,242        —       44,900       507,461                                                   Shareholders’ equity                                      53,221       53,221                                                   Total liabilities and shareholders’ equity    $ 155,920     $ 248,399     $ 58,242     $ —     $ 98,121     $ 560,682                                                   GAP      (71,740 )     (94,222 )     174,561       58,238       (66,837 )      —           Gap Ratio      0.54       0.62       4.00       582.38       0.32       1.00           Cumulative Gap      (71,740 )     (165,962 )     8,599       66,837        —        —           Cumulative Gap Ratio      0.54       0.59       1.02       1.14       1.00       1.00            Certain shortcomings are inherent in the method of analysis presented in the above table. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the table. The ability of many borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase.        Management also simulates possible economic conditions and interest rate scenarios in order to quantify the impact on interest income. The effect that changing interest rates have on PSB’s net interest income is simulated by increasing and decreasing interest rates. This simulation is known as rate shocking. The report below forecasts changes in PSB’s market value of equity under alternative interest rate  27   Table of Contents  environments. The market value of equity is defined as the net present value of PSB’s existing assets and liabilities.                                     Market Value   Change in Market   Percentage       of Equity   Value of Equity   Change                         +300 Basis Points      66,260       2,914       4.60 %         +200 Basis Points      65,610       2,264       3.57 %         +100 Basis Points      64,649       1,303       2.06 %         Flat Rate      63,346       —       —           -300 Basis Points      56,267       (7,079 )     (11.18 )%         -200 Basis Points      59,505       (3,841 )     (6.06 )%         -100 Basis Points      61,840       (1,506 )     (2.38 )%             Capital         Federal bank regulatory agencies have established certain capital-related criteria that must be met by banks and bank holding companies. The measurements which incorporate the varying degrees of risk contained within the balance sheet and exposure to off-balance sheet commitments were established to provide a framework for comparing different institutions.        The Bank is not aware of any pending recommendations by regulatory authorities that would have a material impact on the Bank’s capital, resources, or liquidity if they were implemented, nor is the Bank under any agreements with any regulatory authorities.        The adequacy of the Bank’s capital is reviewed on an ongoing basis with regard to size, composition and quality of the Bank’s resources. An adequate capital base is important for continued growth and expansion in addition to providing an added protection against unexpected losses.        As required by the federal banking regulatory authorities, guidelines have been adopted to measure capital adequacy. Under the guidelines, certain minimum ratios are required for core capital and total capital as a percentage of risk-weighted assets and other off-balance sheet instruments. For the Bank, Tier I capital consists of common shareholders’ equity less intangible assets, and Tier II capital includes the allowable portion of the allowance for loan losses, currently limited to 1.25% of risk-weighted assets. By regulatory guidelines, the separate component of equity for unrealized appreciation or depreciation on available for sale securities is excluded from Tier I Capital. For 2005 and 2004, all applicable ratios were above minimum regulatory guidelines.        The following table sets forth PSB and the Bank’s capital ratios.                                                                               To be Well-                   Capitalized Under           For Capital   Prompt Corrective       Actual   Adequacy Purposes   Action Provisions                       Amount   Ratio   Amount   Ratio   Amount   Ratio                                   (Dollars in thousands)         As of December 31, 2005:                                                          Total capital (to risk-weighted assets)                                                            Company    $ 56,737       14.88 %   $ 30,500       ³8.00 %     N/A       N/A             Bank    $ 45,185       11.96 %   $ 30,221       ³8.00 %   $ 37,776       ³10.00 %         Tier I capital (to risk-weighted assets) Company    $ 53,437       14.02 %   $ 15,250       ³4.00 %     N/A       N/A             Bank    $ 41,885       11.09 %   $ 15,110       ³4.00 %   $ 22,666       ³6.00 %         Tier I capital (to average assets)                                                            Company    $ 53,437       9.53 %   $ 22,426       ³4.00 %     N/A       N/A             Bank    $ 41,885       7.50 %   $ 22,327       ³4.00 %   $ 27,908       ³5.00 %    28   Table of Contents                                                                              To be Well-                   Capitalized Under           For Capital   Prompt Corrective       Actual   Adequacy Purposes   Action Provisions                       Amount   Ratio   Amount   Ratio   Amount   Ratio                                   (Dollars in thousands)         As of December 31, 2004:                                                          Total capital (to risk-weighted assets)                                                            Company    $ 54,364       15.49 %   $ 28,082       ³8.00 %     N/A       N/A             Bank    $ 43,095       12.34 %   $ 27,930       ³8.00 %   $ 34,912       ³10.00 %         Tier I capital (to risk-weighted assets)                                                            Company    $ 51,207       14.59 %   $ 14,041       ³4.00 %     N/A       N/A             Bank    $ 39,938       11.44 %   $ 13,965       ³4.00 %   $ 20,947       ³6.00 %         Tier I capital (to average assets) Company    $ 51,207       9.53 %   $ 21,489       ³4.00 %     N/A       N/A             Bank    $ 39,938       7.48 %   $ 21,361       ³4.00 %   $ 26,701       ³5.00 %          The Bank is well-capitalized under the current regulatory guidelines for Tier I and total risk-based capital.           Liquidity and Funds Management         Liquidity management ensures that adequate funds will be available to meet anticipated and unanticipated deposit withdrawals, debt servicing payments, investment securities purchase commitments, commercial and consumer loan demand and ongoing operating expenses. Funding sources include principal repayments on loans and investment securities, sales of loans, growth in core deposits, short and long-term borrowings and repurchase agreements. Regular loan payments are a dependable source of funds, while the sale of loans and investment securities, deposit flows, and loan prepayments are significantly influenced by general economic conditions and level of interest rates.        At December 31, 2005, the Bank maintained $37.8 million in cash and cash equivalents primarily consisting of cash and due from banks. In addition, the Bank had $124.0 million in securities available for sale. The combined total of $161.8 million represented 28.9% of total assets at December 31, 2005.        The Bank considers its primary source of liquidity to be its core deposit base, which includes non-interest-bearing and interest-bearing demand, and savings deposits. This funding source consists of deposits from customers throughout the branch network. The Bank will continue to promote the growth of deposits through its branch offices. At December 31, 2005, approximately 32.3% of the Bank’s assets were funded by core deposits acquired within its market area.        The Bank’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments. Unused commitments, at December 31, 2005 totaled $84.2 million. This consisted of $23.9 million in commercial real estate and construction loans, $49.8 million in home equity lines of credit, $3.5 million in standby letters of credit and $7.0 million in other unused commitments. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Bank. Any amounts actually drawn upon, management believes, can be funded in the normal course of operations. The Bank has no investment in or financial relationship with any unconsolidated entities that are reasonably likely to have a material effect on liquidity or the availability of capital resources.  29   Table of Contents          Contractual Obligations and Other Commitments         The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2005:                                                       2010   2009   2008   2007   2006                               (Dollars in thousands)         Minimum annual rentals on non cancelable operating leases    $ 233     $ 363     $ 387     $ 586     $ 874           Remaining Contractual maturities of time deposits      6,202       2,335       7,414       42,313       261,961             Loan commitments                                      80,628           Standby letter of credit                                      3,539                                             Total    $ 6,435     $ 2,698     $ 7,801     $ 42,899     $ 347,002                                         RECENT ACCOUNTING PRONOUNCEMENTS        FASB Statement No. 123 (revised 2004), Share-Based Payment. Statement 123(R) addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. Statement 123(R) requires an entity to recognize the grant-date fair-value of stock options and other equity-based compensation issued to employees in the income statement. The revised Statement generally requires that an entity account for those transactions using the fair-value-based method; and eliminates an entity’s ability to account for share-based compensation transactions using the intrinsic value method of accounting in APB Opinion No. 25, Accounting for Stock Issued to Employees, which was permitted under Statement 123, as originally issued. The revised Statement requires entities to disclose information about the nature of the share-based payment transactions and the effects of those transactions on the financial statements. Statement 123(R) is effective for the Company beginning January 1, 2006. The Company anticipates using the modified prospective transition method with the adoption of this standard. The Company is assessing the impact of adopting the new pronouncement and is currently unable to estimate its impact on its consolidated financial statements.        In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”), which provides guidance on the interaction between Statement 123(R) and certain SEC rules and regulations. SAB 107 was issued to assist issuers in their initial implementation of Statement 123(R) and to enhance the information received by investors and other users of the financial statements.        In March 2005 the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47). FIN 47 requires an entity to recognize a liability for the fair value of a legal obligation to perform asset-retirement activities that are conditional on a future event if the amount can be reasonably estimated. The Interpretation provides guidance to evaluate whether fair value is reasonably estimable. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. FIN 47 is not expected to have a material impact on the Company’s financial position or results of operations.        In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which replaces APB Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle and to changes required by an accounting pronouncement when the pronouncement does not include specific transition provisions. SFAS No. 154 requires retrospective application of changes in accounting principle to prior periods’ financial statements unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including the cumulative effect of the change in net  30   Table of Contents  income for the period of the change in accounting principle. SFAS No. 154 carries forward without change the guidance contained in APB Opinion No. 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. SFAS No. 154 also carries forward the guidance in APB Opinion No. 20 requiring justification of a change in accounting principle on the basis of preferability. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, with early adoption permitted. Our adoption of SFAS No. 154 will not have an impact on our financial condition or results of operations.        In November 2005, the FASB issued FASB Staff Position (FSP) FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This FSP provides guidance on determining if an investment is considered to be impaired, if 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. The guidance in this FSP amends Statement 115, Accounting for Certain Investments in Debt and Equity Securities, and is effective for reporting periods beginning after December 15, 2005. The Company is currently accounting for investments in accordance with this guidance, and therefore, the adoption of this FSP will not have a material impact on the Company’s results of operations or financial position.        In July 2005, the FASB issued an Exposure Draft of a proposed Interpretation, “Accounting for Uncertain Tax Positions”. The proposed Interpretation clarifies the accounting for uncertain tax positions in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. The proposed Interpretation requires that a tax position meet a “probable recognition threshold” for the benefit of the uncertain tax position to be recognized in the financial statements. A tax position that fails to meet the probable recognition threshold will result in either a reduction of a current or deferred tax asset or receivable, or recording a current or deferred tax liability. The proposed Interpretation also provides guidance on measurement, de-recognition of tax benefits, classification, interim period accounting disclosure, and transition requirements in accounting for uncertain tax positions. The proposed Interpretation has a 60-day comment period and is scheduled to be effective for all companies as of the first fiscal year ending after December 15, 2005. The Company is assessing the impact of adopting the new pronouncement and is currently unable to estimate its impact on its consolidated financial statements.           ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET     RISK.         The discussion concerning the effects of interest rate changes on the Bank’s estimated net interest income for the year ending December 31, 2005, set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Interest Rate Sensitivity” in Item 7 hereof, is incorporated herein by reference.           ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA         The audited consolidated financial statement of PSB Bancorp, Inc., including the report of Grant Thornton LLP as of December 31, 2005 and 2004 and for each of the three years in the period ended December 31, 2005 which are included as Exhibit 99.1 to this Annual Report on Form 10-K, are incorporated herein by reference.           ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON     ACCOUNTING AND FINANCIAL DISCLOSURE         None           ITEM 9A.  CONTROLS AND PROCEDURES         Within the 90 days prior to the date of this Annual Report on Form 10-K, our Chief Executive Officer and our Chief Financial Officer evaluated the effectiveness of PSB’s disclosure controls and  31   Table of Contents  procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that PSB’s current disclosure controls and procedures are adequate and effective to ensure that information required to be disclosed in the reports PSB files under the Exchange Act is recorded, processed, summarized and reported on a timely basis. There were no significant changes to PSB’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
Other Information         None     PART III           ITEM 10.  Directors and Executive Officers of the Registrant         The following table sets forth information, as of December 31, 2005, with respect to the current directors of PSB.           Class I directors (Term expiring 2008).                                            Year First               Elected       Name/Position   Age   Director   Principal Occupation During Past Five Years                         Anthony DiSandro,      59       1997     President, Chief Executive Officer of PSB          Director, President and Chief                     Bancorp,            Executive Officer Inc.                                  Rosanne Pauciello,      62       1997     Corporate Secretary of PSB Bancorp, Inc;          Director and Corporate Secretary                   Pennsylvania State Senate Office Administrator             Class II directors (Term expiring 2006).                                        Year First               Elected       Name/Position   Age   Director   Principal Occupation During Past Five Years                         James W. Eastwood,      60       1997          President of Granary Associates, Inc.          Director                        (architectural design and consulting firm)         Edward J. Reitmeyer,      42       2005          Managing Member, Wynnewood          Director*                        Financial Partners, LLC, Consulting Firm for Real Estate     Developers and Investors; Former Partner, Drucker &     Scaccetti, CPA and Consulting Firm         Dennis P. Wesley,      53       2003          Manager, Business Processes,          Director                        PECO Energy             Class III directors (Term expiring 2007).                                        Year First               Elected       Name/Position   Age   Director   Principal Occupation During Past Five Years                         Vincent J. Fumo,      62       1997          Chairman of the Board of PSB          Chairman of the Board                        Bancorp, Inc. and Pennsylvania State Senator         James F. Kenney,      47       2003          Councilman-at-Large for the City of          Director                        Philadelphia, Pennsylvania; Director of Business Development,     Vitetta Architects and Engineers    32    Table of Contents  Executive Officers Who Are Not Directors                               During Past Five Years   Name/Position   Age   Principal Occupation                     Frank V. Borrelli,      62          Founder and CEO of B Systems Development Corp. Chief          Chief Operating Officer of                Operating Officer of First Penn Bank.          First Penn Bank                     Gary Polimeno,      53          Vice President and Treasurer of PSB Bancorp, Inc. and          Vice President and Treasurer                Corporate Vice President & Treasurer of First Penn          of PSB Bancorp, Inc. and Corporate Vice President &     Treasurer of First Penn                           *       Appointed to fill a vacancy on the Board of Directors due to the     death of a director.    AUDIT COMMITTEE FINANCIAL EXPERT        PSB’s board of directors has determined that Dennis Wesley, an independent director and member of the audit committee, qualifies as an audit committee financial expert.   AUDIT COMMITTEE        The Audit Committee as of December 31, 2005, was comprised of directors Eastwood (Chair), Reitmeyer, and Wesley, each of whom in the judgment of the Board is “independent” as that term is defined in Rule 4200(a)(15) of the National Association of Securities Dealers listing standards. The Audit Committee is responsible for the appointment, compensation, oversight, and termination of PSB’s independent auditors. The Audit Committee is required to pre-approve audit and certain non-audit services performed by the independent auditors. The Audit Committee is charged by the Board with providing oversight with respect to the integrity of PSB’s financial statements, PSB’s compliance with applicable legal and regulatory requirements and the performance of PSB’s internal audit function. The Audit Committee also is responsible for, among other things, reporting to PSB’s Board on the results of the annual audit and reviewing the financial statements and related financial and non-financial disclosures included in PSB’s annual report on Form 10-K and quarterly reports on Form 10-Q. The Audit Committee is expected to evaluate the independent auditors’ independence from PSB and PSB’s management, including approving consulting and other legally permitted, non-audit services provided by PSB’s auditors and the potential impact of the services on the auditors’ independence. The Audit Committee meets periodically with PSB’s independent auditors and PSB’s internal auditors outside of the presence of PSB’s management and possesses the authority to retain professionals to assist it in meeting its responsibilities without consulting with management. The Audit Committee also is expected to (i) review and discuss with management PSB’s earnings releases, including the use of pro forma information, (ii) address with management and the independent auditors the effect of accounting initiatives and off-balance sheet transactions, and (iii) receive and retain complaints and concerns relating to accounting and auditing matters.   SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE        Based upon a review of the information provided to PSB for the twelve month period ended December 31, 2005, no director, officer, or beneficial owner of more than ten percent of Common Stock, has failed to file a required Form 3, 4, or 5, in a timely fashion.   CODE OF ETHICS        The board of directors of PSB has adopted a Code of Ethics applicable to the chief executive officer and principal accounting officer. A copy of PSB’s Code of Ethics is available on the Company’s website under Investor Relations at www.firstpennbank.com and any shareholder may obtain a printed copy of  33    Table of Contents  these documents by writing to Investor Relations, PSB Bancorp, Inc., 1835 Market Street, Philadelphia, Pennsylvania 19103 or by calling Investor Relations at (215) 979-7963.           ITEM 11.  EXECUTIVE COMPENSATION         The following table sets forth for the years ended December 31, 2005, 2004, and 2003 certain information as to the total compensation paid by PSB to executive officers and officers who received salary and bonuses in excess of $100,000 during such fiscal year.                                                                           Restricted   Securities                       Stock   Underlying   All Other   Name and Principal Position   Year   Salary(1)   Bonus(2)   Awards(3)   Options   Compensation(4)                                     Vincent J. Fumo,      2005     $ 270,000     $ 100,000                     $ 39,804            Chairman of the Board     2004     $ 240,000     $ 450,000                     $ 39,804             2003     $ 223,000     $ 0     $ 1,000,000       500,000     $ 22,800           Anthony DiSandro,      2005     $ 290,000     $ 100,000                     $ 52,961            President and Chief     2004     $ 265,000     $ 375,000                     $ 52,961            Executive Officer     2003     $ 247,000     $ 0     $ 1,000,000       300,000     $ 50,357           Gary Polimeno,      2005     $ 126,450     $ 15,000                     $ 10,272            Vice President and     2004     $ 120,428     $ 30,000                     $ 10,272            Treasurer     2003     $ 116,920     $ 30,000                     $ 10,272           Frank Borrelli,      2005     $ 190,000     $ 9,427                     $ 0            Chief Operating     2004     $ 190,000     $ 18,853                     $ 0            Officer*     2003     $ 0     $ 0                     $ 0           Stephen Gaulberti,      2005     $ 127,900     $ 20,000                     $ 0            Vice-President of     2004     $ 106,640     $ 10,000                     $ 0            Construction Lending     2003     $ 100,538     $ 3,000                     $ 0                    *      Hired in 2004 as Chief Operating Officer of the Bank          (1)       Includes the portion of salary deferred by the executive     pursuant to the 401(k) Plan.       (2)       Pending resolution of the Bank’s Memorandum of     Understanding, at the direction of the Board, bonuses accrued     for Messrs. Fumo and DiSandro in 2003 were not paid until     2004. As a result the table reflects no 2003 bonus and the     payment of two bonuses in 2004.       (3)       Restricted stock award consisted of 100,000 shares of     common stock at a price of $10.00 per share vesting over a     five year period, which were granted on June 17, 2004. On     December 31, 2005, the market value of each 100,000 award     was $1,150,000.       (4)       Includes directors fees of $39,804, $39,804, and $4,800 paid to     Mr. Fumo, Mr. DiSandro and Mr. Polimeno,     respectively, for the year ended December 31, 2005.     Includes directors fees of $39,804, $39,804, and $4,800 paid to     Mr. Fumo, Mr. DiSandro and Mr. Polimeno     respectively, for the year ended December 31, 2004.     Includes directors fees of $22,800, $37,200, and $4,800 paid to     Mr. Fumo, Mr. DiSandro and Mr. Polimeno     respectively, for the year ended December 31, 2003.         There were no option grants made to the named executive officers for the year ended December 31, 2005.  34   Table of Contents  Aggregated Option/SAR Exercises in Last Fiscal Year   and FY-End Option/SAR Values                                                     Number of   Value of               Securities   Unexercised               Underlying   In-the-Money       Shares Acquired       Unexercised   Options/SARs   Name   on Exercise   Value Realized   Options/SARs   at FY-End                             Vincent J. Fumo     Chairman of the Board      0     $ 0       485,720     $ 758,580           Anthony DiSandro     President and Chief Executive Officer      0     $ 0       260,000     $ 390,000           Gary Polimeno     Vice President & Treasurer      0     $ 0       6,876       48,132       COMPENSATION OF OFFICERS THROUGH DEFINED BENEFIT PLANS        First Penn Bank (the “Bank”) has maintained a non-contributory defined benefit retirement plan (“Retirement Plan”). The Retirement Plan was “frozen” as of September 30, 1994 and benefits no longer accrue thereunder. Under the terms of the Retirement Plan, all employees age 21 or older who had worked at the Bank for a period of one year and had been credited with 1,000 or more hours of employment with the Bank during the year were eligible to accrue benefits under the Retirement Plan. The Bank would annually contribute an amount to the Retirement Plan necessary to satisfy the actuarially determined minimum funding requirements in accordance with the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). Employee contributions were not permitted under the Retirement Plan. The Retirement Plan is fully funded, under the Internal Revenue Code of 1986, as amended (the “Code”). Because the Retirement Plan is fully funded, the Bank will generally not be required to make any additional contributions unless asset depreciation occurs. Participants will continue to vest in accordance with the provisions of the Retirement Plan. No new employees will be eligible for participation. The Plan, however, remains subject to all other requirements of the Code.        The following table indicates the annual retirement benefit that would be payable under the Retirement Plan upon retirement at age 65 in calendar year 2005, expressed in the form of a single life annuity for the final average salary and benefit service classifications specified below.   Years of Service and Benefits Payable at Retirement                                                         Final Average Compensation   15   20   25   30   35   40                                     $ 50,000    $ 13,000     $ 17,400     $ 21,700     $ 26,000     $ 26,000     $ 26,000           $ 75,000    $ 20,900     $ 27,900     $ 34,800     $ 41,800     $ 41,800     $ 41,800           $100,000    $ 28,800     $ 38,400     $ 47,900     $ 57,500     $ 57,500     $ 57,500           $125,000    $ 36,600     $ 48,900     $ 61,100     $ 73,300     $ 73,300     $ 73,300           $150,000*    $ 44,500     $ 44,500     $ 74,200     $ 89,000     $ 89,000     $ 89,000                 *       Effective for retirements on or after January 1, 1994,     annual compensation for Bank Plan purposes could not exceed     $150,000 plus any increases indexed to cost of living     adjustments. Employees with compensation exceeding $150,000 in     years before 1994 may have larger “preserved     benefits.” Due to the Economic Growth and Tax Relief     Reconciliation Act of 2001, the annual compensation limit     increased to $200,000 plus any increases indexed to cost of     living adjustments.         As of December 31, 2005, Mr. Fumo, Mr. DiSandro, and Mr. Polimeno had 16, 15, and 18 years and 6 months of credited service (i.e. benefit service), respectively.  35    Table of Contents          Director Compensation         For the year ended December 31, 2005, with the exception of Messrs. Kenney and Wesley, both of whom were paid $1,459 per board meeting attended (due to additional committee responsibilities), the other directors of PSB were paid $1,250 per board meeting attended. The directors of PSB were paid no additional remuneration for committee meetings. For the year ended December 31, 2005, the directors of the Bank were paid $1,667 per board meeting attended; there was no additional remuneration paid for committee meetings. Directors of the Bank’s subsidiaries and affiliates, PSA Service Corp. and Transnational Mortgage Corp., were paid $150 and $250, respectively, per board meeting attended.           Employment Agreements         PSB and the Bank have entered into employment agreements (the “Employment Agreements”) with Vincent J. Fumo, Chairman and Chief Executive Officer of PSB, Anthony DiSandro, President of PSB, and Frank Borelli, Chief Operating Officer of the Bank. Under the terms of his Employment Agreement, Mr. Fumo serves as Chairman of PSB and the Bank at a base salary of $270,000. Under the terms of his Employment Agreement, Mr. DiSandro serves as President and Chief Executive Officer of PSB and the Bank at a base salary of $290,000 and Mr. Borelli serves as the Chief Operating Officer of the Bank at a base salary of $190,000. Each Employment Agreement provides for an initial term of three years, which will thereafter be automatically renewed for an additional year on each anniversary date unless terminated pursuant to its terms by the respective parties.        Each Employment Agreement provides for the payment of certain severance benefits in the event of the executive’s resignation for specified reasons or as a result of his termination by PSB or the Bank without “Cause” (as defined in each Employment Agreement). The executive would be entitled to severance payments if: (1) he terminates employment following any breach of the Employment Agreement by the Bank or PSB, loss of title, office or significant authority, reduction in annual compensation or benefits, or relocation of the executive’s principal place of employment by more than a specified number of miles from PSB or the Bank, or (2) if the Bank or PSB terminates his employment, other than for Cause.        If either Mr. Fumo or Mr. DiSandro becomes entitled to receive severance payments under his Employment Agreement, he would receive, over a period of 36 months, a cash payment equal to three times his average annual compensation during the five-year period preceding termination of employment. Payments would be made in equal monthly installments. In addition to the severance payments, the executive would be entitled to continue to receive life, medical, dental and other insurance coverages (or a dollar amount equal to the cost of obtaining each such coverage) for a period of up to 36 months from the date of termination. Payments under the Employment Agreements are limited, however, to the extent that they would not be permitted under the Federal Deposit Insurance Act. If Mr. Borelli becomes entitled to severance payments under his Employment Agreement, he would receive payments equal to his base salary for the remaining term of the agreement and would be entitled to continue to receive life, medical, dental and other insurance coverages for the for the remaining term of his Employment Agreement.           Supplemental Retirement Plan         PSB maintains a nonqualified Supplemental Retirement Plan for the benefit of certain executive officers and directors. The Supplemental Retirement Plan (“SRP”) has been adopted by the Company to provide supplemental retirement benefits to Messrs. Fumo and DiSandro. The SRP provides a defined benefit payable in 240 monthly installments of an amount based on a percentage of the executive’s highest base salary and bonus during the year of retirement or the four years prior to retirement. The participants under the SRP are Messrs. Fumo and DiSandro. The SRP provides that payments begin after termination of employment and attainment of age 65. The SRP provides for an early start for payment of the installments in the event of disability and that upon death prior to retirement, payment will be made in a lump sum as of the date the participant would have attained age 65. Benefits under the SRP are increased and are subject to acceleration upon a change in control.  36   Table of Contents          Compensation Committee Interlocks and Insider     Participation         None of our executive officers serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our Board of Directors or compensation committee.           Compensation Committee Report on Executive     Compensation.         Under rules established by the Securities and Exchange Commission (“SEC”), PSB is required to provide certain information regarding the compensation and benefits provided to PSB’s Chief Executive Officer and other executive officers of PSB. The disclosure requirements for the Chief Executive Officer and other executive officers include the use of tables and a report explaining the rationale and considerations that led to the fundamental compensation decisions affecting those individuals. In fulfillment of this requirement, the Compensation Committee, at the direction of the Board, has prepared the following report for inclusion in this proxy statement:        The Compensation Committee policy for executive compensation is designed to: (i) provide compensation opportunities that are consistent with those available to executives in other financial services companies; (ii) support PSB’s goal setting and strategic planning process; (iii) motivate the executive management of PSB to achieve profit and other key goals of the institution, including but not limited to PSB’s commitment to the communities it serves, to its employees, customers, and investors; and (iv) motivate the executive management to operate PSB and First Penn Bank in a safe and sound manner and in compliance with all relevant governmental and regulatory requirements.        The Compensation Committee utilized SNL Financial data, the BAI Compensation Survey, and America’s Community Banker’s Annual Compensation Survey as independent third-party sources of comparative data for similarly sized financial services companies as a baseline in setting the executive compensation salary levels.        During the course of 2005, the Compensation Committee took into account both objective and subjective criteria in evaluating the performance of the executive management of PSB. The Compensation Committee also assessed the various challenges facing PSB and the significant competitive pressures within PSB’s market area. The specific performance objectives were: (i) the financial performance of the Bank in a period of increasing interest rates and a flattening yield curve, and the effect of non-discretionary costs attributable to the ongoing option litigation; (ii) the initiation of a review of the strategic alternatives of PSB and the related time commitment required of management; and (iii) the completion of a strategic personnel and compensation structure review of senior and middle management.        Additionally, the Compensation Committee utilized a number of subjective elements as part of the decision-making process regarding executive compensation. The long tenure of the two senior executives and the individual skills and talents of the executive managers of PSB, including their leadership ability, planning and organizational skills, administrative talent, and vision for the future, and work ethic were given consideration in establishing executive compensation.        Mr. Vincent J. Fumo was the Chairman of the Board of PSB and First Penn Bank and Mr. Anthony DiSandro was the President and Chief Executive Officer of PSB and First Penn Bank in 2005. Messrs. Fumo’s and DiSandro’s compensation for 2005 were determined by the Compensation Committee after consideration of the factors discussed above. Specific additional elements of the compensation of Messrs. Fumo and DiSandro are discussed below:            •       The Compensation Committee recommended no stock based     compensation for Mr. Fumo or Mr. DiSandro for 2005.         •       The Compensation Committee recommended that the bonus amounts     paid to executive management be reduced by 56% and 50% from 2004     levels for Mr. Fumo and Mr. DiSandro, respectively.     This recommendation was made based upon the Committee’s     opinion that until the   37    Table of Contents                Bank reestablished satisfactory earning levels, bonus amounts     should be reduced for all levels of management.         •       The Compensation Committee recommended an immediate salary     freeze for senior management (includes all Vice Presidents and     above) until such time that earning levels are satisfactorily     reestablished.                 Respectfully submitted,              James W. Eastwood, Chairman of Compensation          Committee          James F. Kenney          Edward J. Reitmeyer   38   Table of Contents    Performance Graph        The following graph shows a comparison of total shareholder return on the common stock of PSB, based on the market price of the common stock, with the cumulative total return of companies on The Nasdaq Stock Market (U.S.) Index (“CCMP”) and The Nasdaq Banking Index (U.S.) (“CBNK”) for the period beginning on January 1, 2000, through December 31, 2005.   Total Return Performance                                                                                                                                12/31/2000     12/31/2001     12/31/2002     12/31/2003     12/31/2004     12/31/2005                                                            PSBI        100         147.88         180.86         256.98         334.54         269.74                                                                    CCMP        100         79.18         54.44         82.09         89.57         91.48                                                                    CBNK        100         112.54         120.36         160.13         181.94         178.41                                                               Notes:               A.       The lines represent annual index levels derived from compounded     daily returns that include all dividends.            B.       The indexes are reweighed daily, using the market capitalization     on the previous trading day.            C.       If the fiscal year-end is not a trading day, the preceding     trading day is used.            D.       The index level for all the series was set to 100.00 on     December 31, 2000.   39    Table of Contents          ITEM 12.  Security Ownership of Certain Beneficial Owners and     Management            Equity Compensation Plans.         The following chart presents summary information with respect to all of PSB’s and First Penn Bank’s equity compensation plans in effect as of the date of this proxy statement.   Equity Compensation Plan Information                                             Number of Securities       Number of Securities   Wtd Avg Exercise   Remaining Available for       to be Issued Upon   Price of o/s   Future Issuance Under       Exercise of o/s   Options,   Equity Compensation       Options, Warrants &   Warrants &   Plan (Excluding Sec in   Plan Category   Rights   Rights   Column(a)                         Equity compensation plans approved by security holders      909,739     $ 9.92       246,384           Equity compensation plans not approved by security holders      8,571     $ 4.75       0                                 Total      918,310     $ 9.87       246,384                                  The 1999 Director Stock Option Plan included in this chart is the only equity compensation plan adopted without shareholder approval.           Security Ownership of Management/ Certain Beneficial     Owners         The following table sets forth certain information furnished to PSB as of March 15, 2006 with respect to the beneficial ownership of common stock by: (i) each shareholder known to PSB to be the beneficial owner of five percent (5%) or more of the outstanding shares of common stock; (ii) each director of PSB; (iii) the executive officers named in the Summary Compensation Table on page 33 herein; and (iv) all current executive officers and directors as a group. Except as indicated in the footnotes to the table, the persons and entities named have sole voting and investment power with respect to all shares of common stock of which they are the respective beneficial owners.                               Amount and           Nature of   Percent of       Beneficial   Outstanding Shares   Name of Beneficial Owner   Ownership   of Common Stock                 5% Shareholders                          American Bank Incorporated                            4029 West Tilghman Street,                            Allentown, Pennsylvania 18104      347,643       6.8 %     Directors                          Vincent J. Fumo      982,938 (1)     17.5 %         Rosanne Pauciello      42,799 (2)     *           Anthony DiSandro      455,752 (3)     8.4 %         James W. Eastwood      58,805       1.1 %         James F. Kenney      30,404 (2)     *           Edward J. Reitmeyer      0       *           Dennis P. Wesley      40,000 (2)     *       Named Executive Officers                          Frank V. Borrelli      0                   Gary Polimeno      51,362       *           Stephen Gaulberti      0       *           All executive officers and directors as a group (10 persons)      1,662,060       27.8 %    40    Table of Contents            *       Ownership percentage is less than 1%.          (1)       Amount includes 73,284 shares held through the First Penn     Bank 401(k) Plan, 399,827 shares directly held by     Mr. Fumo, 24,107 shares held in the ESOP, and     485,720 shares subject to immediately exercisable options.     Amount does not include all shares held by the ESOP.     Mr. Fumo is a trustee of the ESOP and as such votes shares     held by the ESOP. The ESOP voting provisions require the holders     of allocated shares to direct the trustee as to how to vote     their shares on all matters presented to the shareholders of     PSB. The trustee is required to vote the unallocated shares in     proportion to the direction received from the holders of the     allocated shares.       (2)       Rosanne Pauciello, Dennis Wesley and James Kenney, hold     immediately exercisable options to acquire 25,000, 40,000 and     27,857 shares, respectively.       (3)       Amount includes 76,426 shares held indirectly through the     First Penn Bank 401(k) Plan, 94,583 shares directly held by     Mr. DiSandro, 24,743 shares held in the First Penn     Bank Employee Stock Ownership Plan (“ESOP”), and     260,000 shares subject to immediately exercisable options.     Amount does not include all shares held by the ESOP.     Mr. DiSandro is a trustee of the ESOP and as such     votes shares held by the ESOP. The ESOP voting provisions     require the holders of allocated shares to direct the trustee as     to how to vote their shares on all matters presented to the     shareholders of PSB. The trustee is required to vote the     unallocated shares in proportion to the direction received from     the holders of the allocated shares.            ITEM 13.  Certain Relationships and Related Transactions            Transactions with Management & Others.         Certain directors and executive officers of PSB, and associates of such persons (including corporations of which such persons are officers or 10% beneficial owners), were customers of and had transactions with PSB and its subsidiaries in the ordinary course of business during 2005. All loans made to such persons were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collectibility or present other unfavorable features. It is expected that any other transactions with directors and officers and their associates in the future will be conducted on the same basis.           ITEM 14.  Principal Accounting Fees & Services            Independent Registered Public Accounting Firm         The firm of Grant Thornton LLP performed certain accounting services for PSB, including the audit of the annual financial statements and the reviews of the unaudited financial statements included in PSB’s quarterly reports for the years ended December 31, 2005 and 2004.        The following tables set forth the aggregate fees to PSB for the fiscal years ended December 31, 2005 and 2004 by Grant Thornton LLP.                             2005   2004                     Audit Fees    $ 176,105     $ 128,655           Audit-Related Fees    $ 6,373       23,655           Tax Fees    $ 26,865       37,230           All other fees    $ 44,403       45,339                           Total    $ 253,746     $ 234,879                            Audit fees included the audit of PSB’s annual financial statements, reviews of the Company’s quarterly financial statements and comfort letters, statutory and regulatory audits, consents and other services related to Securities and Exchange Commission (“SEC”) matters.  41   Table of Contents       Audit-related fees principally included audits of employee benefit plans and certain internal audit services, which were allowable by law at the time the services were provided.        Tax fees included tax compliance services rendered based upon facts already in existence or transactions that have already occurred to document, compute, and obtain government approval for amounts to be included in tax filings and consisted of federal, state and local income tax return assistance and assistance with tax audits and appeals.        The Audit Committee may, from time to time, grant pre-approval to those permissible non-audit services classified as “all other services” that it believes are routine and recurring services, and would not impair the independence of the auditor. The Audit Committee has not currently pre-approved any such services.           Audit Committee Pre-Approval of Audit and Permissible     Non-Audit Services by Independent Auditors         The Audit Committee pre-approves all audit and non-prohibited, non-audit services provided by the independent auditors. These services may include audit services, audit-related services, tax services and other services. The Audit Committee has adopted a policy for the pre-approval of services provided by the independent auditors. The Audit Committee may delegate pre-approval authority to one or more of its members. This member must report any decisions to the Audit Committee at the next scheduled meeting. There were no waivers by the Audit Committee of the pre-approval requirement for permissible non-audit services in 2005.     PART IV           ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON     FORM 8-K         The consolidated financial statements listed below are from Exhibit 99.1 to the Registrant’s 2005 Form 10-K.        PSB Bancorp, Inc. and Subsidiaries Consolidated Balance Sheet Consolidated Statement of Income, Consolidated Statement of Cash Flow, and Notes to Consolidated Statements Reports of Independent Registered Public Accounting Firm.        (a) The following reports on Form 8-K were filed in the last quarter of 2005:            •      On October 26, 2005, PSB filed a     form 8-K     announcing the appointment of Edward J. Reitmeyer to the Board     of Directors.         (b) EXHIBITS: The exhibits listed below are filed herewith or incorporated by reference to other filings.                 Exhibit       No.   Document             2 .1        Agreement and Plan of Reorganization, dated as of March 19,     1999, between PSB Bancorp, Inc. and First Bank of Philadelphia     (incorporated herein by reference to Exhibit 2.1 of the     S-4 Registration Statement of PSB Bancorp, Inc. filed     June 25, 1999)         2 .2        Agreement and Plan of Reorganization, dated as of     November 2, 2000, between PSB Bancorp, Inc., PSB Merger     Sub, Inc. and Jade Financial Corp. (incorporated herein by     reference to Registration Statement of PSB Bancorp, Inc. filed     on January 16, 2001)         3 .1        Articles of Incorporation of PSB Bancorp, Inc. (incorporated     herein by reference to Exhibit 3.1 of the SB-2 Registration     Statement of PSB Bancorp, Inc. filed October 9, 1997)         3 .2        Bylaws of PSB Bancorp, Inc. (incorporated herein by reference to     Exhibit 3.2 of the SB-2 Registration Statement of PSB     Bancorp, Inc. filed October 9, 1997)    42    Table of Contents                Exhibit       No.   Document                 10 .1*        First Penn Bank’s Retirement Plan (incorporated herein by     reference to Exhibit 10.1 of the SB-2 Registration     Statement of PSB Bancorp, Inc. filed October 9, 1997)         10 .2*        First Penn Bank’s Cash or Deferred Profit Sharing Plan     (incorporated herein by reference to Exhibit 10.2 of the     SB-2 Registration Statement of PSB Bancorp, Inc. filed     October 9, 1997)         10 .3*        First Penn Bank’s Profit Sharing Plan (incorporated herein     by reference to Exhibit 10.3 of the SB-2 Registration     Statement of PSB Bancorp, Inc filed October 9, 1997)         10 .4*        Employment Agreement with Vincent J. Fumo (incorporated herein     by reference to Exhibit 7.1 of the SB-2 Registration     Statement of PSB Bancorp, Inc. filed October 9, 1997.)         10 .5*        Employment Agreement with Anthony DiSandro (incorporated herein     by reference to Exhibit 7.1 of the SB-2 Registration     Statement of PSB Bancorp, Inc. filed October 9, 1997.)         10 .6*        First Penn Bank’s Employee Stock Ownership Plan     (incorporated herein by reference to Exhibit 10.4 of the     SB-2 Registration Statement of PSB Bancorp, Inc. filed on     October 9, 1997)         10 .7        Lease Agreement between Eleven Colonial Penn Plaza Associates     and First Penn Bank, dated as of October 10, 1995     (incorporated herein by reference to Exhibit 10.7 of     Form S-1, Amendment No. 3 of PSB Bancorp, Inc. filed     May 5, 1998)         10 .8        Lease Agreement between Eleven Colonial Penn Plaza Associates     and First Penn Bank, dated as of October 12, 1995     (incorporated herein by reference to Exhibit 10.8 of     Form S-1, Amendment No. 3 of PSB Bancorp, Inc. filed     on May 5, 1998)         10 .9*        First Penn Bank’s Stock Option Plan (incorporated herein by     reference to Exhibit 10.9 of the S-4 Registration Statement     of PSB Bancorp, Inc. filed June 25, 1999)         10 .10*        First Penn Bank’s Management Recognition Plan (incorporated     herein by reference to Exhibit 10.10 of the S-4     Registration Statement of PSB Bancorp, Inc. filed June 25,     1999)         10 .11*        PSB Bancorp, Inc. 2001 Stock Incentive Plan (incorporated herein     by reference to Exhibit 10.13 of PSB’s Annual Report     on Form 10-K filed on April 1, 2002)         10 .12*        Employment Agreement for Frank Borrelli (incorporated by     reference to Exhibit 10.12 of PSB’s Annual Report on     Form 10-K filed on March 31, 2005)         10 .13        Supplemental Employee Retirement Plan — Mr. Fumo     (incorporated by reference to Exhibit 10.1 of PSB’s     Quarterly Report on Form 10-Q filed on November 15,     2004         10 .14        Supplemental Employee Retirement Plan —     Mr. DiSandro (incorporated by reference to     Exhibit 10.1 of PSB’s Quarterly Report on     Form 10-Q filed on November 15, 2004         14          Code of Ethics (incorporated by reference to Exhibit 14 of     PSB’s Annual Report on Form 10-K filed on     April 5, 2004)     21          Schedule of Subsidiaries. (filed herewith)         31 .1        Certification of Report by Chief Executive Officer. (filed     herewith)         31 .2        Certification of Report by Chief Financial Officer. (filed     herewith)         32          Certification of Report by Chief Executive Officer and Chief     Financial Officer. (filed herewith)         99 .1        2005 Financial Statements (filed herewith)               *       Denotes a management contract or compensatory plan or     arrangement.   43   Table of Contents  SIGNATURES        Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.                PSB BANCORP, INC.             By       /s/ Anthony DiSandro                            Anthony DiSandro      President and Chief Executive Officer    March 28, 2006        In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.                     Signature   Title   Date                        /s/ Vincent J. Fumo  Vincent J. Fumo        Chairman, Director        March 28, 2006            /s/ Anthony DiSandro  Anthony DiSandro        President, Chief Executive Officer, Director        March 28, 2006            /s/ John Carrozza  John Carrozza        Chief Financial Officer (Principal Accounting and Financial     Officer)        March 28, 2006            /s/ James W. Eastwood  James W. Eastwood        Director        March 28, 2006            /s/ Rosanne Pauciello  Rosanne Pauciello        Corporate Secretary and Director        March 28, 2006            /s/ Edward Reitmeyer  Edward Reitmeyer        Director        March 28, 2006            /s/ Dennis Wesley  Dennis Wesley        Director        March 28, 2006            /s/ James Kenney  James Kenney        Director        March 28, 2006    44   Table of Contents    EXHIBIT INDEX                 Exhibit       No.   Document             2 .1        Agreement and Plan of Reorganization, dated as of March 19,     1999, between PSB Bancorp, Inc. and First Bank of Philadelphia     (incorporated herein by reference to Exhibit 2.1 of the S-4     Registration Statement of PSB Bancorp, Inc. filed June 25,     1999)         2 .2        Agreement and Plan of Reorganization, dated as of     November 2, 2000, between PSB Bancorp, Inc., PSB Merger     Sub, Inc. and Jade Financial Corp. (incorporated herein by     reference to Registration Statement of PSB Bancorp, Inc. filed     on January 16, 2001)         3 .1        Articles of Incorporation of PSB Bancorp, Inc. (incorporated     herein by reference to Exhibit 3.1 of the SB-2 Registration     Statement of PSB Bancorp, Inc. filed October 9, 1997)         3 .2        Bylaws of PSB Bancorp, Inc. (incorporated herein by reference to     Exhibit 3.2 of the SB-2 Registration Statement of PSB     Bancorp, Inc. filed October 9, 1997)         10 .1*        First Penn Bank’s Retirement Plan (incorporated herein by     reference to Exhibit 10.1 of the SB-2 Registration     Statement of PSB Bancorp, Inc. filed October 9, 1997)         10 .2*        First Penn Bank’s Cash or Deferred Profit Sharing Plan     (incorporated herein by reference to Exhibit 10.2 of the     SB-2 Registration Statement of PSB Bancorp, Inc. filed     October 9, 1997)         10 .3*        First Penn Bank’s Profit Sharing Plan (incorporated herein     by reference to Exhibit 10.3 of the SB-2 Registration     Statement of PSB Bancorp, Inc filed October 9, 1997)         10 .4*        Employment Agreement with Vincent J. Fumo (incorporated herein     by reference to Exhibit 7.1 of the SB-2 Registration     Statement of PSB Bancorp, Inc. filed October 9, 1997.)         10 .5*        Employment Agreement with Anthony DiSandro (incorporated herein     by reference to Exhibit 7.1 of the SB-2 Registration     Statement of PSB Bancorp, Inc. filed October 9, 1997.)         10 .6*        First Penn Bank’s Employee Stock Ownership Plan     (incorporated herein by reference to Exhibit 10.4 of the     SB-2 Registration Statement of PSB Bancorp, Inc. filed on     October 9, 1997)         10 .7        Lease Agreement between Eleven Colonial Penn Plaza Associates     and First Penn Bank, dated as of October 10, 1995     (incorporated herein by reference to Exhibit 10.7 of     Form S-1, Amendment No. 3 of PSB Bancorp, Inc. filed     May 5, 1998)         10 .8        Lease Agreement between Eleven Colonial Penn Plaza Associates     and First Penn Bank, dated as of October 12, 1995     (incorporated herein by reference to Exhibit 10.8 of     Form S-1, Amendment No. 3 of PSB Bancorp, Inc. filed     on May 5, 1998)         10 .9*        First Penn Bank’s Stock Option Plan (incorporated herein by     reference to Exhibit 10.9 of the S-4 Registration Statement     of PSB Bancorp, Inc. filed June 25, 1999)         10 .10*        First Penn Bank’s Management Recognition Plan (incorporated     herein by reference to Exhibit 10.10 of the S-4     Registration Statement of PSB Bancorp, Inc. filed June 25,     1999)         10 .11*        PSB Bancorp, Inc. 2001 Stock Incentive Plan (incorporated herein     by reference to Exhibit 10.13 of PSB’s Annual Report     on Form 10-K filed on April 1, 2002)         10 .12*        Employment Agreement for Frank Borrelli (incorporated by     reference to Exhibit 10.12 of PSB’s Annual Report on     Form 10-K filed on March 31, 2005)         10 .13        Supplemental Employee Retirement Plan — Mr. Fumo     (incorporated by reference to Exhibit 10.1 of PSB’s     Quarterly Report on Form 10-Q filed on November 15,     2004         10 .14        Supplemental Employee Retirement Plan —     Mr. DiSandro (incorporated by reference to     Exhibit 10.1 of PSB’s Quarterly Report on     Form 10-Q filed on November 15, 2004         14          Code of Ethics (incorporated by reference to Exhibit 14 of     PSB’s Annual Report on Form 10-K filed on     April 5, 2004)     21          Schedule of Subsidiaries. (filed herewith)         31 .1        Certification of Report by Chief Executive Officer. (filed     herewith)         31 .2        Certification of Report by Chief Financial Officer. (filed     herewith)         32          Certification of Report by Chief Executive Officer and Chief     Financial Officer. (filed herewith)         99 .1        2005 Financial Statements (filed herewith)               *       Denotes a management contract or compensatory plan or     arrangement.   45      EX-21 2 w19032exv21.txt SCHEDULE OF SUBSIDIARIES                                                                                  .                                                                                .                                                                                .                                                                        EXHIBIT 21                              SCHEDULE OF SUBSIDIARIES    NAME                                                                                        STATE OF INCORPORATION   First Penn Bank                                                                                  Pennsylvania  Jade Abstract Company                                                                            Pennsylvania  Jade Insurance Company                                                                           Pennsylvania  Transnational Mortgage Company                                                                   Pennsylvania  PSA Service Corp.                                                                                Pennsylvania  PSA Financial Corp.                                                                              Pennsylvania  PSA Consumer Discount Company (inactive)                                                         Pennsylvania     EX-31.1 3 w19032exv31w1.txt CERTIFICATION OF REPORT BY CHIEF EXECUTIVE OFFICER                                                                        EXHIBIT 31.1  I, Anthony DiSandro, Chief Executive Officer of PSB Bancorp, Inc., certify that:        1. I have reviewed this annual report on Form 10-K of PSB Bancorp, Inc.;        2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;        3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;        4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:              (a) designed such disclosure controls and procedures to ensure that       material information relating to the registrant, including its       consolidated subsidiaries, is made known to us by others within those       entities, particularly during the period in which this quarterly report is       being prepared;              (b) evaluated the effectiveness of the registrant's disclosure       controls and procedures as of a date within 90 days prior to the filing       date of this quarterly report (the "Evaluation Date"); and              (c) presented in this quarterly report our conclusions about the       effectiveness of the disclosure controls and procedures based on our       evaluation as of the Evaluation Date;        5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):              (a) all significant deficiencies in the design or operation of       internal controls which could adversely affect the registrant's ability to       record, process, summarize and report financial data and have identified       for the registrant's auditors any material weaknesses in internal       controls; and              (b) any fraud, whether or not material, that involves management or       other employees who have a significant role in the registrant's internal       controls; and        6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.  Date: March 28, 2006                                                           /s/ ANTHONY DISANDRO                                                          -----------------------                                                          Anthony DiSandro                                                          Chief Executive Officer     EX-31.2 4 w19032exv31w2.txt CERTIFICATION OF REPORT BY CHIEF FINANCIAL OFFICER                                                                        EXHIBIT 31.2  I, John Carrozza, Chief Financial Officer of PSB Bancorp, Inc., certify that:        1. I have reviewed this annual report on Form 10-K of PSB Bancorp, Inc.;        2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;        3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;        4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:              (a) designed such disclosure controls and procedures to ensure that       material information relating to the registrant, including its       consolidated subsidiaries, is made known to us by others within those       entities, particularly during the period in which this quarterly report is       being prepared;              (b) evaluated the effectiveness of the registrant's disclosure       controls and procedures as of a date within 90 days prior to the filing       date of this quarterly report (the "Evaluation Date"); and              (c) presented in this quarterly report our conclusions about the       effectiveness of the disclosure controls and procedures based on our       evaluation as of the Evaluation Date;        5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):              (a) all significant deficiencies in the design or operation of       internal controls which could adversely affect the registrant's ability to       record, process, summarize and report financial data and have identified       for the registrant's auditors any material weaknesses in internal       controls; and              (b) any fraud, whether or not material, that involves management or       other employees who have a significant role in the registrant's internal       controls; and        6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.  Date: March 28, 2006                                                           /s/ JOHN CARROZZA                                                          -----------------------                                                          John Carrozza                                                          Chief Financial Officer     EX-32 5 w19032exv32.txt CERTIFICATION OF REPORT BY CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER                                                                          EXHIBIT 32                              CERTIFICATION PURSUANT TO                              18 U.S.C. SECTION 1350                              AS ADOPTED PURSUANT TO                   SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002        In connection with the Annual Report of PSB Bancorp, Inc. (the "Company") on Form 10-K for the period ended December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of the undersigned, in the capacities and on the dates indicated below, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to his knowledge:        1.    The Report fully complies with the requirements of Section 13(a) or             15(d) of the Securities Exchange Act of 1934; and        2.    The information contained in the Report fairly presents, in all             material respects, the financial condition and results of operation             of PSB.  /s/ ANTHONY DISANDRO, - ------------------------------------------------- President and Chief Executive Officer  /s/ JOHN CARROZZA, - ------------------------------------------------- Senior Vice President and Chief Financial Officer  Dated: March 28, 2006    EX-99.1 6 w19032exv99w1.txt 2005 FINANCIAL STATEMENTS                                                                        EXHIBIT 99.1  FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM                         PSB BANCORP, INC. AND SUBSIDIARIES                          DECEMBER 31, 2005, 2004 AND 2003                                      CONTENTS                                                                              PAGE                                                                           ----   REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM................     3 FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS.......................     4   CONSOLIDATED STATEMENTS OF INCOME....................................     5   CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY............     6   CONSOLIDATED STATEMENTS OF CASH FLOWS................................     7   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS...........................     8                 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM  Board of Directors PSB Bancorp, Inc.        We have audited the accompanying consolidated balance sheets of PSB Bancorp, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.        In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of PSB Bancorp, Inc. as of December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for the each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.  /s/ GRANT THORNTON LLP  Philadelphia, Pennsylvania  March 3, 2006                                         2                          PSB BANCORP, INC. AND SUBSIDIARIES                             CONSOLIDATED BALANCE SHEETS                  (DOLLARS IN THOUSANDS, EXCEPT SHARE INFORMATION)                                                                                           DECEMBER 31,                                                                                   ----------------------                                                                                     2005         2004                                                                                   ---------    ---------    Assets    Cash and due from banks.....................................................   $   6,454    $   4,355    Interest-earning deposits with banks........................................      29,762       49,964    Federal funds sold..........................................................       1,581          331                                                                                   ---------    ---------         Total cash and cash equivalents........................................      37,797       54,650     Loans held-for-sale.........................................................       3,280        3,792    Investment securities available-for-sale, at fair value.....................     123,994       94,112    Investment securities held to maturity (fair value $1,310 and $1,544).......       1,325        1,533    Federal Home Loan Bank stock - at cost......................................       1,061        1,308    Federal Reserve Bank stock - at cost........................................       1,216        1,139     Loans.......................................................................     369,834      356,142    Less allowance for loans losses.............................................      (3,300)      (3,157)                                                                                   ---------    ---------      Net loans.................................................................     366,534      352,985                                                                                   ---------    ---------    Accrued interest receivable.................................................       2,908        2,071    Premises and equipment, net.................................................       2,416        2,470    Bank-owned life insurance...................................................      13,181       12,696    Other assets................................................................       6,970        6,321                                                                                   ---------    ---------          Total assets...........................................................   $ 560,682    $ 533,077                                                                                   =========    =========  Liabilities     Deposits....................................................................      Non-interest bearing......................................................      40,695       30,786      Interest bearing..........................................................     460,416      444,494                                                                                   ---------    ---------          Total deposits.........................................................     501,111      475,280                                                                                   ---------    ---------     Securities sold under agreements to repurchase..............................       1,127        1,105    Advances from borrowers for taxes and insurance.............................       2,460        3,114                                           3         Other liabilities...........................................................       2,763        1,421                                                                                   ---------    ---------          Total liabilities......................................................     507,461      480,920                                                                                   ---------    ---------  Shareholders' equity  Common stock: authorized, 15,000,000 shares no par value, 5,140,685 and    4,893,609 shares issued and outstanding on  December 31, 2005 and 2004,    respectively................................................................      46,292       45,270 Retained earnings..............................................................      10,124        8,989 Accumulated other comprehensive loss...........................................      (1,672)        (440) Employee stock ownership plan..................................................      (1,093)      (1,232) Treasury stock, at cost, 78,252 and 78,187 on December 31, 2005 and 2004,    respectively................................................................        (430)        (430)                                                                                   ---------    ---------          Total shareholders' equity.............................................      53,221       52,157                                                                                   ---------    ---------          Total liabilities and shareholders' equity.............................   $ 560,682    $ 533,077                                                                                   =========    =========           The accompanying notes are an integral part of these statements.                                          4                          PSB BANCORP, INC. AND SUBSIDIARIES                         CONSOLIDATED STATEMENTS OF INCOME                               (DOLLARS IN THOUSANDS)                                                                                            DECEMBER 31,                                                                               --------------------------------                                                                                 2005        2004        2003                                                                               --------    --------    --------                                                                                     (DOLLARS IN THOUSANDS)     INTEREST INCOME   Loans, including fees ...................................................   $ 25,070    $ 23,807    $ 23,985   Investment securities ...................................................      3,983       3,370       3,352   Deposits in banks .......................................................      1,436         812         990                                                                               --------    --------    --------     Total interest income .................................................     30,489      27,989      28,327                                                                               --------    --------    -------- INTEREST EXPENSE   Deposits ................................................................     11,897       8,458       9,548   Borrowings ..............................................................         25          23          27                                                                               --------    --------    --------     Total interest expense ................................................     11,922       8,481       9,575                                                                               --------    --------    --------     Net interest income ...................................................     18,567      19,508      18,752 PROVISION FOR LOAN LOSSES .................................................        405         235          45                                                                               --------    --------    --------     Net interest income after provision for loan losses ...................     18,162      19,273      18,707                                                                               --------    --------    -------- NON-INTEREST INCOME   Service charges on deposit accounts .....................................      1,185       1,004       1,105   Loss on sale of loans and real estate owned .............................        (49)        (51)        (14)   Loss on write down of equity investment .................................         --         (48)        (37)   Bank-owned life insurance ...............................................        485         433         504   Gains on sales of investments securities ................................        440          --          --   Other ...................................................................        758         779         610                                                                               --------    --------    --------     Total non-interest income .............................................      2,819       2,117       2,168                                                                               --------    --------    -------- NON-INTEREST EXPENSE   Salaries and employee benefits ..........................................     10,074       9,795       9,543   Occupancy and equipment .................................................      2,569       2,380       2,086   Professional services ...................................................      1,698         918       1,046   General insurance expense ...............................................        289         306         256   Advertising .............................................................        233         296         309   Data processing .........................................................        768         792         640   Directors' fees .........................................................        133         338         447                                          5         Other operating expenses ................................................      3,380       3,457       3,519                                                                               --------    --------    --------     Total non-interest expense ............................................     19,144      18,282      17,846                                                                               --------    --------    --------     Income before income tax expense ......................................      1,837       3,108       3,029 INCOME TAX EXPENSE ........................................................        702       1,038       1,024                                                                               --------    --------    --------     NET INCOME ............................................................   $  1,135    $  2,070    $  2,005                                                                               ========    ========    ======== PER SHARE DATA    Net income -- basic .....................................................   $   0.24    $   0.47    $   0.47                                                                               ========    ========    ========   Net income -- diluted ...................................................   $   0.20    $   0.40    $   0.46                                                                               ========    ========    ========           The accompanying notes are an integral part of these statements.                                         6                          PSB BANCORP, INC. AND SUBSIDIARIES             CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY                    YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003                               (DOLLARS IN THOUSANDS)                                                                             ACCUMULATED                                                                             OTHER                                                                          COMPREHENSIVE   UNALLOCATED                                                    COMMON     RETAINED      INCOME          ESOP       TREASURY                                                    STOCK      EARNINGS      (LOSS)         SHARES        STOCK      TOTAL                                                   --------    --------   -------------   -----------   --------   --------        Balance at January 1, 2003 ....................   $ 41,985       4,914        1,277         (1,631)       (378)     46,167 Allocation of ESOP shares .....................        194          --           --            262          --         456 Comprehensive income ..........................                                                            (29)        (29)   Net income ..................................         --       2,005           --             --          --       2,005   Change in net unrealized loss on securities     available-for-sale, net of tax effect .....         --          --       (1,476)            --          --      (1,476)                                                   --------    --------   ----------      ---------     -------    --------     Total comprehensive income ................                                                                        529                                                                                                                   -------- Balance at December 31, 2003 ..................     42,179       6,919         (199)        (1,369)       (407)     47,123 Allocation of ESOP shares .....................        183          --           --            137          --         320 Restricted stock ..............................        236          --           --             --          --         236 Purchase of Treasury Stock ....................         --          --           --             --         (23)        (23) Exercise of stock options .....................      2,672          --           --             --          --       2,672  Comprehensive income   Net Income ..................................         --       2,070           --             --          --       2,070   Change in net unrealized gain on securities     available-for-sale, net of tax effect .....         --          --         (241)            --          --        (241)                                                                                                                   --------     Total comprehensive income ................                                                                      1,829                                                   --------    --------   ----------      ---------     -------    -------- Balance at December 31, 2004 ..................     45,270       8,989         (440)        (1,232)       (430)     52,157 Allocation of ESOP shares .....................        244          --           --            139          --         383 Restricted stock ..............................        364          --           --             --          --         364                                          7          Exercise of stock options .....................        414          --           --             --          --         414 Comprehensive income   Net Income ..................................         --       1,135           --             --          --       1,135   Change in net unrealized loss on securities     available-for-sale, net of tax effect .....         --          --       (1,232)            --          --      (1,232)                                                                                                                   --------     Total comprehensive income ...............         --          --           --             --          --          (97)                                                   --------    --------     --------      ---------     -------    -------- Balance at December 31, 2005 ..................   $ 46,292    $ 10,124     ($ 1,672)     ( $ 1,093)    ($  430)   $ 53,221                                                   ========    ========     ========      =========     =======    ========           The accompanying notes are an integral part of these statements.                                         8                          PSB BANCORP, INC. AND SUBSIDIARIES                       CONSOLIDATED STATEMENTS OF CASH FLOWS                               (DOLLARS IN THOUSANDS)                                                                                      YEAR ENDED DECEMBER 31,                                                                             -----------------------------------                                                                                2005         2004         2003                                                                             ---------    ---------    ---------                                                                                    (DOLLARS IN THOUSANDS)     Cash flows from operating activities   Net income ............................................................   $   1,135    $   2,070    $   2,005   Adjustments to reconcile net income to net cash   provided by (used in) operating activities     Provision for possible loan losses ..................................         405          235           45     Depreciation and amortization .......................................         996          859          928     Amortization of (discounts) and accretion of premiums on investment       securities ........................................................         232          169         (537)     Write-down of real estate owned .....................................          --           17           24     (Gain)loss on sale of real estate owned .............................          49          (27)          --     Gain on sale of investment securities ...............................        (440)          --           --     Proceeds from sale and amortization of loans held-for-sale ..........      28,353       17,159       34,289     Origination of loans held-for-sale ..................................     (27,997)     (43,750)     (67,293)     Deferred income taxes ...............................................          --           --           --     ESOP expense ........................................................         386          320          456     Restricted Stock Expense ............................................         364          236           --     (Increase) decrease in accrued interest receivable ..................        (837)         154          233     (Increase) decrease in other assets .................................         124         (873)      (1,524)     Increase (decrease) change in accrued expenses ......................       1,342       (1,783)        (713)                                                                             ---------    ---------    ---------       Net cash provided by (used in) operating activities ...............       4,112      (25,214)     (32,087)                                                                             ---------    ---------    --------- Cash flows from investing activities   Purchase of investment securities, available-for-sale .................     (45,095)     (25,845)    (100,304)   Proceeds from maturities and calls of investment securities ...........      13,407       33,382       51,011   Redemption (purchase) of Federal Home Loan Bank Stock .................         171       (1,106)        (149)   Net decrease (increase) in loans ......................................     (14,317)     (40,816)      51,094   Proceeds from sale of real estate owned ...............................         199          170           92   Purchase of premises and equipment ....................................        (942)        (474)        (796)                                                                             ---------    ---------    ---------                                          9             Net cash (used in) provided by investing activities ...............     (46,577)     (34,689)         948                                                                             ---------    ---------    --------- Cash flows from financing activities   Net increase in deposits ..............................................      25,831       59,120      (26,064)   Net increase in securities sold under agreements to repurchase ........          22            6           24   Treasury stock acquired ...............................................                      (23)         (29)   Exercise of Stock options .............................................         414        2,672           --   Increase in advances for borrowers' taxes and insurance ...............        (655)         370         (653)                                                                             ---------    ---------    ---------       Net cash provided by (used in) financing activities ..............       25,612       62,145      (26,722)                                                                             ---------    ---------    ---------       Net (decrease) increase in cash and cash equivalents .............      (16,853)       2,242      (57,861)   Cash and cash equivalents at beginning of year ........................      54,650       52,408      110,269                                                                             ---------    ---------    ---------   Cash and cash equivalents at end of year ..............................   $  37,797    $  54,650    $  52,408                                                                             =========    =========    =========   The accompanying notes are an integral part of these statements                                         10                          PSB BANCORP, INC. AND SUBSIDIARIES                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                          DECEMBER 31, 2005, 2004 AND 2003  NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES        PSB Bancorp, Inc. (the Company), primarily through its subsidiary, First Penn Bank (the Bank) operates thirteen branch offices, makes residential, construction, commercial, student and consumer loans to customers and provides community-banking services to individuals and corporate customers principally within Southeastern Pennsylvania and Southern New Jersey. The Company's principal business is the ownership of the Bank.        The Bank also conducts activities through its subsidiaries; Transnational Mortgage Company (TNMC), a wholly owned subsidiary, which originates residential loans. PSA Financial Corp. (PSA), a wholly owned subsidiary, which formerly originated residential and commercial loans. PSA Service Corp. (PSC), a wholly owned subsidiary, processes all loans for the Bank and the other subsidiaries. Jade Abstract Company, a wholly owned subsidiary, issuing title insurance for residential properties, and Jade Insurance Company, a wholly owned subsidiary, which sells insurance products in an agency status. First Penn Bank Revocable Trust, a wholly owned trust, is the owner and beneficiary of life insurance policies purchased by the trust on a certain group of employees        The Bank competes with other banking and financial institutions in its primary market communities, including financial institutions with resources substantially greater than its own. Commercial banks, savings banks, savings and loan associations, and credit unions actively compete for savings and time deposits, and for types of loans. Such institutions, as well as consumer finance, insurance, and brokerage firms, may be considered competitors of the Bank with respect to one or more of the services it provides.        The Bank is subject to regulations of certain state and federal agencies and, accordingly, is periodically examined by those regulatory authorities. As a consequence of the extensive regulation of commercial banking activities, the Bank's business is particularly susceptible to being affected by state and federal legislation and regulations.        1.    Basis of Financial Statement Presentation        The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (US GAAP) and predominant practices within the banking industry. The accompanying consolidated financial statements include the accounts of the Company, and all its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.                                         11          In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the balance sheets and the reported amounts of revenues and expenses during the reporting periods. Therefore, actual results could differ significantly from those estimates.        The principal estimates that are particularly susceptible to significant change in the near term relates to the allowance for loan losses and the valuation of goodwill impairment. The evaluation of the adequacy of the allowance for loan losses includes an analysis of the individual loans and overall risk characteristics and size of the different loan portfolios, and takes into consideration current economic and market conditions, the capability of specific borrowers to pay specific loan obligations, as well as current loan collateral values. However, actual losses on specific loans, which also are encompassed in the analysis, may vary from estimated losses.        SFAS No. 131, Segment Reporting, establishes standards for public business enterprises to report information about operating segments in their annual financial statements and requires that those enterprises report selected information about operating segments in subsequent interim financial reports issued to shareholders. It also established standards for related disclosure about products and services, geographic areas, and major customers. Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision-maker in deciding how to allocate and assess resources and performance. PSB's chief operating decision-maker is the President and Chief Executive Officer. PSB has applied the aggregation criteria set for the in SFAS No. 131 for its operating segments to create one reportable segment, "Community Banking".        PSB's community banking segment consists of commercial, construction, mortgage banking, and consumer lending. The community banking segment is managed as a single strategic unit, which generates revenue from a variety of products and services provided by PSB. For example, construction and commercial lending is dependent upon the ability of PSB to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for residential real estate lending and consumer lending.        2.    Cash and Cash Equivalents        Cash and cash equivalents include cash on hand, demand deposits maintained in depository institutions, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.       Cash paid during the year for interest and income taxes are as follows (in thousands):                                                                     YEAR ENDED DECEMBER 31,                                                                ----------------------------                                                                  2005      2004       2003                                                                --------   -------   -------     Interest ...................................................   $ 11,922   $ 8,481   $ 9,575 Income taxes ...............................................   $    702   $ 1,038   $ 1,024                                          12         3.    Investment and Mortgage-Backed Securities        Investment and mortgage-backed securities are classified in one of three categories: held-to-maturity, trading, or available-for-sale. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and are reported at amortized cost. As the Company does not engage in security trading, the balance of its debt securities and any equity securities are classified as available-for-sale. Net unrealized gains and losses for such securities, net of tax, are required to be recognized as a separate component of shareholders' equity and excluded from the determination of net income. Gains or losses on the sales of securities available-for-sale are recognized upon realization utilizing the specific identification method.        SFAS No. 133, as amended by SFAS No. 138, "Accounting for Certain Derivative Financial Instruments and Certain Hedging Activities," established accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the Statement of Financial Position and measure those instruments at fair value. The Company adopted SFAS No. 138 as amended, and the adoption did not have a material impact on its financial position or results of operations.        The Bank adopted Emerging Issues Task Force (EITF) 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, as of December 31, 2003. EITF 03-1 includes certain disclosures regarding quantitative and qualitative disclosures for investment securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, that are impaired at the balance sheet date, but an other-than-temporary impairment has not been recognized. In March 2004, the EITF issued a Consensus on Issue 03-1 requiring that the provisions of EITF 03-1 be applied for reporting periods beginning after June 15, 2004 to investments accounted for under SFAS No. 115 and 124. EITF 03-1 establishes a three-step approach for determining whether an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. In September 2004, the FASB issued a proposed Staff Position, EITF Issue 03-1-a, Implementation Guidance for the Application of Paragraph 16 of EITF 03-1 (EITF 03-1-a). EITF 03-1-a would provide implementation guidance with respect to debt securities that are impaired solely due to interest rates and/or sector spreads and analyzed for other-than-temporary impairment under paragraph 16 of EITF 03-1. In September 2004, the FASB issued a Staff Position, EITF Issue 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1 (EITF 03-1-1). FSP EITF Issue No. 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, delays the effective date of certain provisions of EITF Issue 03-1, including steps two and three of the Issue's three-step approach for determining whether an investment is other-than-temporarily impaired. However, step one of that approach must still be initially applied for impairment evaluations in reporting periods beginning after June 15, 2004. The delay of the effective date for paragraphs 10-20 of EITF Issue 03-1                                         13   will be superseded with the final issuance of proposed FSP EITF Issue 03-1-a, Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The disclosures under EITF 03-1 are required for financial statements for years ending after December 15, 2003 and are included in these financial statements.        4.    Variable Interest Entity        In January 29, 1999, PSB purchased 1,600,000 shares of Series A Convertible Preferred Stock, $.01 par value per share, (the "Preferred Stock") of McGuire Performance Solutions, Inc. ("MPS"). PSB purchased the shares for $.78125 per share for a total cost of $1,250,000. In 2000, MPS changed its name to Iron Bridge Holdings, Inc. ("Iron Bridge"). During the year ended December 31, 2001, and 2000, PSB purchased an additional 375,000 shares and 500,000 shares, respectively, of the Preferred Stock for $1.00 per share for a total cost $875,000. On December 27, 2002, the founding shareholders of Iron Bridge purchased from PSB 304,350 shares of preferred stock for $0.88 per share, which was the average cost per share paid by PSB for these shares. PSB currently owns 87.7% of the Preferred Stock, which represents a 49.9% fully diluted ownership interest in Iron Bridge. The Iron Bridge subsidiary, MPS, is a nationally recognized firm delivering cost-effective solutions for high performance total balance sheet management to banks, thrifts, credit unions and other financial institutions.        In the first quarter of 2004 PSB adopted FASB interpretation No. 46(R) Consolidation of Variable Interest Entities ("FIN 46(R)"). In applying FIN 46(R), it was determined that PSB, as the largest shareholder and virtually Iron Bridge's only financial resource, would absorb a majority of Iron Bridge's expected losses. Therefore, it was PSB's conclusion that in accordance with FIN 46(R), Iron Bridge is a variable interest entity and thus PSB was required to consolidate the financial results of Iron Bridge during the first quarter of 2004.        The consolidation of Iron Bridge as of September 30, 2005, resulted in PSB recording goodwill of $1,421,561 and minority interest of $254,767. PSB accounts for goodwill in accordance with SFAS 142, "Goodwill and Other Intangible Assets." Goodwill is now subject to impairment testing at least annually to determine whether write-downs of the recorded balances are necessary. PSB tests for impairment based on the goodwill maintained at each defined reporting unit. A fair value is determined for each reporting unit based on at least one of three various market valuation methodologies. If the fair value of the reporting unit exceeds its then book value, no write-down of recorded goodwill is necessary. If the fair value of a reporting unit is less, an expense may be required on PSB's books to write down the related goodwill to the proper carrying value. As of December 31, 2005, PSB completed its transitional testing, and determined that no impairment write-off was necessary. No assurance can be given that future goodwill impairment tests will not result in a charge to earnings.        5.    Loans and Allowance for Loan Losses                                         14         Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal adjusted for any charge-offs, the allowance for loans losses and any deferred fees or costs on originated loans. Interest on loans is accrued and credited to operations based upon the principal amounts outstanding.        Loan fees and certain direct loan origination costs are deferred and the net fee or cost is recognized as an adjustment of the loan yield over the contractual life of the loan using the interest method. When a loan is sold, unamortized net fees (costs) are recognized as income (expense). Other loan fees and charges representing service costs for the prepayment of loans, for delinquent payments or for miscellaneous loan services are recognized when collected. Commitment fees and costs relating to commitments whose likelihood of exercise is remote are recognized over the commitment period on a straight-line basis. If the commitment is subsequently exercised during the commitment period, the remaining unamortized commitment fee at the time of exercise is recognized over the life of the loan as an adjustment of yield.        The allowance for loan losses is established through a provision for loan losses charged to expenses. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb loan losses on existing loans that may become uncollectible based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrower's ability to pay.        Accrual of interest is discontinued on a loan when principal and interest become 90 days or more past due and when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful. Once a loan is placed on non-accrual status, interest previously accrued and uncollected is charged to operations and interest is included in income thereafter only to the extent actually received in cash. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions or any of the other factors used in management's determination. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for losses on loans. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.        The Company accounts for its impaired loans in accordance with SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No 118, "Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures." This standard requires that a creditor measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that, as a practical expedient, a creditor may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is                                         15   collateral dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable.        In November 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 45 ("FIN No. 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." On January 1, 2003 the Company adopted the disclosure provisions of FIN No. 45 for guarantees issued or modified after December 31, 2002, and adopted the initial recognition and measurement provisions on January 1, 2003. Adoption of the initial recognition and measurement provisions did not affect the Company's financial condition or results of operations. While certain guarantees are only subject to the disclosure provisions of this interpretation, others are subject to both the disclosure and initial recognition and measurement provisions. For guarantees that fall within the scope of the initial recognition and measurement provisions, FIN No. 45 requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. Under the previous accounting rules, the Company did not record a liability when guaranteeing obligations unless it became probable that the Company would have to perform under the guarantee. The adoption of FIN No. 45 did not have a material impact on the consolidated financial statements or results operation.        In October 2003, the AICPA issued SOP No. 03-3 "Accounting for Loans or Certain Debt Securities Acquired in a Transfer". SOP No. 03-3 applies to a loan with the evidence of deterioration of credit quality since origination acquired by completion of a transfer for which it is probable at acquisition, that the Company will be unable to collect all contractually required payments receivable. SOP No. 03-3 requires that the Company recognize the excess of all cash flows expected at acquisition over the investor's initial investment in the loan as interest income on a level-yield basis over the life of the loan as the accretable yield. The loan's contractual required payments receivable in excess of the amount of its cash flows excepted at acquisition (nonaccretable difference) should not be recognized as an adjustment to yield, a loss accrual or a valuation allowance for credit risk. SOP No. 03-3 is effective for loans acquired in fiscal years beginning after December 31, 2004. Early adoption is permitted. Management is currently evaluating the provisions of SOP No. 03-3.        On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105, "Application of Accounting Principles to Loan Commitments" ("SAB 105"). SAB 105 clarifies existing accounting practices relating to the valuation of issued loan commitments, including interest rate lock commitments ("IRLC"), subject to SFAS No. 149 and Derivative Implementation Group Issue C13, "Scope Exceptions: When a Loan Commitment is included in the Scope of Statement 133." Furthermore, SAB 105 disallows the inclusion of the values of a servicing component and other internally developed intangible assets in the initial and subsequent IRLC valuation. The provisions of SAB 105 were effective for loan commitments entered into after March 31, 2004. The Company has adopted the provisions of SAB 105 which did not have a material effect on either the Company's consolidated financial position or consolidated results of operations.                                         16         6.    Loans Held-for-Sale        Loans held-for-sale are carried at the lower of cost or fair value. Management has determined, using an aggregate asset basis, that the cost of loans held for sale approximate fair value at December 31, 2005 and 2004. Accordingly, no loss has been recognized on loans held-for-sale. At December 31, 2005 and 2004, The Company serviced $47,426,000 and $36,982,000 loans, respectively for others. The capitalized servicing asset was $229,000 and $161,000 at December 31, 2005 and 2004, respectively.        The Company accounts for its transfers and servicing assets in accordance with SFAS No. 140, "Accounting for Transfers of Financial Assets and Extinguishments of Liabilities," which revised the accounting and reporting for transfers and servicing of financial assets and extinguishments of liabilities.        Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value. Gains and losses on the sales of loans are also accounted for in accordance with SFAS No. 134, "Accounting for Mortgage Securities Retained after the Securitizations of Mortgage Loans Held-for-Sale by a Mortgage Banking Enterprise." This statement requires that an entity engaged in mortgage banking activities classify the retained mortgage-backed security or other interest, which resulted from the securitizations of a mortgage loan held-for-sale based upon its ability and intent to sell or hold these investments.        In April 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 149 "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. All provisions of this Statement shall be applied prospectively. Based on the Company's current business operations, the adoption of the provisions of SFAS No. 149 did not materially impact the Company's financial condition, results of operations, or disclosures.        7.    Other Real Estate Owned        Real estate acquired by the Bank as a result of foreclosure is classified as other real estate owned ("REO") until it is sold. The REO is initially recorded at the lower of the related loan balance or fair value of the property at the date acquired. If the value of the property is less than the loan, less any related specific loan loss provisions, the difference is charged against the allowance for loan losses. Any subsequent write-down of REO is charged against earnings. The Bank had $1,109,000 and $442,000 of property acquired as a result of foreclosure at December 31, 2005 and 2004 and are included in other assets on the consolidated balance sheet.        8.    Bank-Owned Life Insurance (BOLI)                                         17         BOLI involves the purchasing of life insurance by the Company's wholly owned trust First Penn Bank Revocable Trust on a chosen group of employees. The Company is the owner and beneficiary of the policies. This pool of insurance, due to tax advantages to the Banks, is profitable to the Company. Bank deposits fund BOLI and the earnings from BOLI are recognized as non-interest income.        9.    Premises and Equipment        Premises and equipment are stated at cost less accumulated depreciation. Depreciation is charged to operations on a straight-line basis over the estimated useful lives of the assets.        On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," was issued. SFAS No. 144 retains the existing requirements to recognize and measure the impairment of long-lived assets to be held and used or to be disposed of by sale. SFAS No. 144 also changes the requirements relating to reporting the effects of a disposal or discontinuation of a segment of a business. The adoption of this statement did not have an impact on the financial condition or results of operations of the Company.        10.   Income Taxes        Under the liability method deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities.        The Company and its subsidiaries file a consolidated federal income tax return and the amount of income tax expense or benefit is computed and allocated on a separate return basis.        11.   Earnings Per Share        The Company follows the provisions of SFAS No. 128, "Earnings Per Share." Basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. Diluted EPS takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. EPS is computed based on the weighted-average number of shares of common stock outstanding.        In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 150 "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS No. 150"). SFAS No. 150 is generally effective for financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. Based on the                                         18   Company's current business operations, the provisions of SFAS No. 150 did not impact the Company's financial condition, results of operations, or disclosures        12.   Advertising Costs        The Company expenses advertising costs as incurred.        13.   Accounting for Stock-Based Compensation        The Company follows SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, which allows an entity to use a fair value-based method for valuing stock-based compensation, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, the statement permits entities to elect accounting for employee stock options and similar instruments under Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." The Company's Stock Option Plans (Option Plans) are accounted for under APB Opinion No. 25. Entities that continue to account for stock options using APB Opinion No. 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied.        At December 31, 2002, the Company's four Option Plans provide for the grant of (i) options to purchase Common Stock intended to qualify as incentive stock options (Incentive Stock Option) under Section No. 422 of the Code, and (ii) options that do not so qualify (Nonqualified Stock Options). Pursuant to the Option Plans, 1,653,315 shares of Common Stock (subject to adjustment) are reserved for issuance by the Company upon exercise of stock options to be granted to certain officers and employees of the Company from time to time under the Option Plans. As of December 31, 2003, 308,315 options were granted. The purpose of the Option Plans is to give certain officers and employees an opportunity to acquire common stock and thereby help the Company attract, retain and motivate key employees and officers. As of December 31, 2003, 2,143 options in connection with the First Bank acquisition remain outstanding.        In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment" (SFAS 123R). This statement is a revision of SFAS No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The provisions of this statement are effective for interim or annual periods beginning after January 1, 2006. The Company is currently evaluating the provisions of this revision to determine the impact on its consolidated financial statements. It is, however, expected to have a negative effect on consolidated net income.                                         19   The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation:                                                                                 YEAR ENDED DECEMBER 31,                                                                           ----------------------------                                                                            2005      2004       2003                                                                           ------   --------    -------     Net income   As reported.........................................................    $1,135   $ 2,070     $2,005   Less stock-based compensation costs determined under the fair     value-based method for all awards.................................        --    (2,334)       (65)                                                                           ------   -------     ------   Pro forma...........................................................    $1,135   $  (264)    $1,940                                                                           ======   =======     ====== Basic earnings per share   As reported.........................................................    $ 0.24   $  0.47     $ 0.47   Pro forma...........................................................    $ 0.24   $ (0.06)    $ 0.46 Diluted earnings per share   As reported.........................................................    $ 0.20   $  0.40     $ 0.46   Pro forma...........................................................    $ 0.20   $ (0.05)    $ 0.45         14. Employee Benefit Plans        The Company has certain employee benefit plans covering substantially all employees. The Company accrues such costs as incurred.        The Company follows the disclosure provisions of SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which was revised in December 2003. SFAS No. 132, as revised, requires additional employers' disclosures about pension and other postretirement benefit plans as of December 31, 2004. Certain disclosures related to estimated future benefit payments are effective for fiscal years ending after June 14, 2004. Net pension expense consists of service cost, interest cost, return on pension assets and amortization of unrecognized initial net assets. The Company accrues its post retirement benefit costs and other benefit plan costs as incurred.        15. Comprehensive Income        The Company reports comprehensive income, which includes net income, as well as certain other items, which result in a change to equity during the period. The income tax effects allocated to comprehensive income are as follows:                                         20                                                                           DECEMBER 31, 2005                                                               -----------------------------------                                                                               TAX                                                               BEFORE TAX   (EXPENSE)   NET OF TAX                                                                 AMOUNT      BENEFIT      AMOUNT                                                               ----------   ---------   ----------                                                                          (IN THOUSANDS)     Unrealized loss on securities   Unrealized holding losses arising during period.........     $(2,252)      $ 720      $(1,532)    Gains recognized in income statement                            440        (140)         300                                                                -------       -----      ------- Other comprehensive loss, net.............................     $(1,812)      $ 580      $(1,232)                                                                =======       =====      =======                                                                          DECEMBER 31, 2004                                                             ------------------------------------                                                             BEFORE TAX       TAX      NET OF TAX                                                               AMOUNT       BENEFIT      AMOUNT                                                             ----------     -------    ----------                                                                         (IN THOUSANDS)     Unrealized loss on securities   Unrealized holding gains arising during period..........    $(313)        $  72       $ (241)                                                               -----         -----       ------ Other comprehensive loss, net.............................    $(313)        $  72       $ (241)                                                               =====         =====       ======                                                                         DECEMBER 31, 2003                                                             -----------------------------------                                                             BEFORE TAX      TAX      NET OF TAX                                                               AMOUNT      BENEFIT      AMOUNT                                                             ----------    -------    ----------                                                                        (IN THOUSANDS)     Unrealized gains on securities   Unrealized holding gains arising during period..........   $(2,285)      $ 809      $(1,476)                                                              -------       -----      ------- Other comprehensive income, net...........................   $(2,285)      $ 809      $(1,476)                                                              =======       =====      =======         16. Reclassifications        Certain 2005 amounts have been reclassified to conform to the 2004 presentation.  NOTE B--INVESTMENT SECURITIES        The following tables present the amortized cost, gross unrealized gains and losses and fair values of the Company's investment securities available-for-sale and held-to-maturity as of December 31, 2005 and 2004 (in thousands):                                         21                                                                           DECEMBER 31, 2005                                                         ----------------------------------------------                                                                        GROSS       GROSS                                                         AMORTIZED   UNREALIZED   UNREALIZED     FAIR                                                           COST         GAINS       LOSSES       VALUE                                                         ---------   ----------   ----------   --------      Investment securities available-for-sale   Mutual funds.....................................     $   2,354         --           66     $  2,288   FHLB Notes.......................................        94,662         --        1,686       92,976                                                         ---------     ------      -------     --------                                                            97,016         --        1,752       95,264  Mortgage-backed securities available-for-sale   FNMA certificates................................        16,220        151          506       15,865   GNMA certificates................................           940         26            1          965   FHLMC Certificates...............................        12,183         24          307       11,900                                                         ---------     ------      -------     --------                                                            29,343        201          814       28,730                                                         ---------     ------      -------     --------                                                         $ 126,359     $  201      $ 2,566     $123,994                                                         ---------     ------      -------     --------  Mortgage-backed-securities held-to-maturity   FHLMC Certificates                                          844         --           18          826   GNMA Certificates................................           481         12            9          484                                                         ---------     ------      -------     --------                                                             1,325         12           27        1,310                                                         ---------     ------      -------     --------                                                         $ 127,684     $  213      $ 2,593     $125,304                                                         =========     ======      =======     ========                                                                           DECEMBER 31, 2004                                                         ----------------------------------------------                                                                        GROSS       GROSS                                                         AMORTIZED   UNREALIZED   UNREALIZED     FAIR                                                           COST         GAINS       LOSSES       VALUE                                                         ---------   ----------   ----------   --------      Investment securities available-for-sale   Mutual funds....................................      $  2,354          --          31     $  2,323   State and municipal obligations.................           500           2          --          502   FHLB Notes......................................        54,984          --         759       54,225                                                         --------        -----     ------     --------                                                           57,838            2        790       57,050  Mortgage-backed securities available-for-sale   FNMA certificates...............................        22,716          324        253       22,787   GNMA certificates...............................         1,921           83         --        2,004   FHLMC Certificates..............................        12,300           98        127       12,271                                                         --------        -----     ------     --------                                                           36,937          505        380       37,062                                                         --------        -----     ------     --------                                                         $ 94,775        $ 507     $1,170     $ 94,112                                                         --------        -----     ------     --------  Mortgage-backed-securities held-to-maturity   FHLMC Certificates..............................           971           --         --          971   GNMA Certificates...............................           562           20          9          573                                                         --------        -----     ------     --------                                                            1,533           20          9        1,544                                                         --------        -----     ------     --------                                                         $ 96,308        $ 527     $1,179     $ 95,656                                                         ========         =====    ======     ========                                          22                              The amortized cost and fair value of the Company's investment securities at December 31, 2005, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands).                                                       AVAILABLE-FOR-SALE          HELD-TO-MATURITY                                                   ---------------------      --------------------                                                   AMORTIZED      FAIR        AMORTIZED     FAIR                                                      COST        VALUE          COST       VALUE                                                   ---------    --------      ---------    -------      Due in one year or less.......................    $  44,852    $ 44,547       $    --     $    -- Due after one year through five years.........       52,164      50,720            --          -- Due after five years through ten years........           --          --            --          --                                                   ---------    --------       -------     -------                                                      97,016      95,267            --          -- Due after ten years                                      --          --            --          -- Mortgage-backed securities....................       29,343      28,727         1,325       1,310                                                   ---------    --------       -------     -------                                                   $ 126,359    $123,994       $ 1,325     $ 1,310                                                   =========    ========       =======     =======         No investment securities were pledged to secure public funds at December 31, 2005. The table below indicates the length of time individual securities have been in a continuous unrealized loss position at December 31, 2005 and 2004. (in thousands):                                         23   DECEMBER 31, 2005                                                                                  12 MONTHS OR                                                  LESS THAN 12 MONTHS             LONGER                  TOTAL                                     NUMBER       --------------------     --------------------   ---------------------         DESCRIPTION                   OF           FAIR    UNREALIZED     FAIR      UNREALIZED     FAIR     UNREALIZED        OF SECURITIES              SECURITIES      VALUE      LOSSES       VALUE       LOSSES       VALUE      LOSSES - ------------------------------    ----------     -------   ----------    -------    ----------   --------   ----------                                                                      (IN THOUSANDS)         U.S.  FHLB notes..............        14         $42,254     $(245)      $50,721     $(1,442)    $ 92,975    $(1,687) Mortgage- backed securities...        10           2,288       (66)       23,200        (813)      25,488       (879)                                       --         -------     -----       -------     -------     --------    ------- Total temporarily impaired   investment securities.......        24         $44,542     $(311)      $73,921     $(2,255)    $118,463    $(2,566)                                       ==         =======     =====       =======     =======     ========    =======   DECEMBER 31, 2004                                                                                   12 MONTHS OR                                                   LESS THAN 12 MONTHS             LONGER                  TOTAL                                      NUMBER      ----------------------   ---------------------   --------------------         DESCRIPTION                    OF         FAIR       UNREALIZED    FAIR      UNREALIZED    FAIR     UNREALIZED        OF SECURITIES               SECURITIES     VALUE         LOSSES     VALUE       LOSSES      VALUE      LOSSES - ------------------------------     ----------    ------      ----------   -------    ----------   -------   ----------                                                                        (IN THOUSANDS)         U.S.  FHLB notes..............          4        $   --       $    --     $39,437    $    (759)   $39,437   $    (759) Mortgage- backed securities...          9         4,582          (112)     23,963         (300)    28,545        (412)                                        --        ------       -------     -------    ---------    -------   --------- Total temporarily impaired   investment securities.......         13        $4,582       $  (112)    $63,400    $  (1,059)   $67,982   $  (1,171)                                        ==        ======       =======     =======    =========    =======   =========                                          24         In management's opinion, the unrealized losses reflect changes in interest rates subsequent to the acquisition of specific securities. There were nine securities in the less than twelve months category. The Company has the ability to hold these securities until maturity or market price recovery. Management believes that the unrealized losses represent temporary impairments of the securities.  NOTE C--LOANS        Loans are as follows:                                                                         DECEMBER 31,                                                                 --------------------                                                                   2005        2004                                                                 --------    --------                                                                    (IN THOUSANDS)      Commercial loans..........................................    $171,555    $189,181   Construction loans........................................      48,309      21,763   Mortgage Loans............................................      79,856      90,654   Consumer loans............................................      69,736      54,624                                                                 --------    --------                                                                  369,456     356,222  Unearned fees and discounts.................................         378         (80) Allowance for loan losses...................................      (3,300)     (3,157)                                                                 --------    --------   Loans.....................................................    $366,534    $352,985                                                                 ========    ========         In the ordinary course of business, the Company has granted loans to shareholders, officers, directors, and their affiliates. All loan transactions entered into between the Company and such related parties were made on the same terms and conditions as transactions with all other parties. In management's opinion, such loans are consistent with sound banking practices and are within applicable regulatory lending limitations. The aggregate approximate amount of these loans outstanding at December 31, 2005 and 2004 was $1.8 million and $2.9 million, respectively. In 2005, there was one new loan of $26,000, repayments of $247,000 and reclassification of $972,000 of a former director loan.        Non-performing assets include nonaccrual loans past due 90 days or more, impaired loans and other real estate owned. The aggregate amount of these assets at December 31, 2005 and 2004 were approximately $2.5 million, $0, $1.1 million and $3.6 million, 0 and $422,000 respectively.        As of December 31, 2005, 2004 and 2003, interest accrued on nonaccrual loans totaled $0, $0 and $324,000, respectively.                                         25        At December 31, 2005, the Company's classified loans consisted of 15 commercial real estate loans with a total recorded balance of approximately $1.9 million for which specific allowances of approximately $300,000 have been established. At December 31, 2004, the Company's classified loans consisted of 21 commercial real estate loans with a total recorded balance of approximately $3.2 million for which specific allowances of approximately $363,000 have been established. The average investment in classified loans for the years ended December 31, 2005, 2004 and 2003 was approximately $2.5 million, $2.7 million, and $3.7 million respectively.        Changes in the allowance for loan losses were as follows:                                                                                YEAR ENDED                                                                            DECEMBER 31,                                                                     -------------------------                                                                      2005      2004     2003                                                                     ------    ------   ------                                                                           (IN THOUSANDS)     Balance at the beginning of the year............................    $3,157    $3,069   $3,603 Provision for loan loss.........................................       405       235       45 Recoveries of loans previously charged off......................       156       215      183 Charged off.....................................................      (418)     (362)    (762)                                                                     ------    ------   ------ Balance at end of year..........................................    $3,300    $3,157   $3,069                                                                     ======    ======   ======   NOTE D --PREMISES AND EQUIPMENT        Premises and equipment are as follows:                                                                               DECEMBER 31,                                                          ESTIMATED     -------------------                                                         USEFUL LIVES     2005        2004                                                         ------------   -------     -------                                                                           (IN THOUSANDS)     Land...............................................      Indefinite    $    10     $    10 Buildings and improvements.........................           25-50      2,868       2,222 Furniture, fixtures and equipment..................            3-10      6,594       6,297                                                                        -------     -------                                                                        $ 9,472       8,529                                                                        -------     ------- Less accumulated depreciation......................                     (7,056)     (6,059)                                                                        -------     -------                                                                        $ 2,416     $ 2,470                                                                        =======     =======                                          26   NOTE E--VARIABLE INTEREST ENTITY        In January 29, 1999, PSB purchased 1,600,000 shares of Series A Convertible Preferred Stock, $.01 par value per share, (the "Preferred Stock") of McGuire Performance Solutions, Inc. ("MPS"). PSB purchased the shares for $.78125 per share for a total cost of $1,250,000. In 2000, MPS changed its name to Iron Bridge Holdings, Inc. ("Iron Bridge"). During the year ended December 31, 2001, and 2000, PSB purchased an additional 375,000 shares and 500,000 shares, respectively, of the Preferred Stock for $1.00 per share for a total cost $875,000. On December 27, 2002, the founding shareholders of Iron Bridge purchased from PSB 304,350 shares of preferred stock for $0.88 per share, which was the average cost per share paid by PSB for these shares. PSB currently owns 87.7% of the Preferred Stock, which represents a 49.9% fully diluted ownership interest in Iron Bridge. The Iron Bridge subsidiary, MPS, is a nationally recognized firm delivering cost-effective solutions for high performance total balance sheet management to banks, thrifts, credit unions and other financial institutions.        In the first quarter of 2004 PSB adopted FASB interpretation No. 46(R) Consolidation of Variable Interest Entities ("FIN 46(R)"). In applying FIN 46(R), it was determined that PSB, as the largest shareholder and virtually Iron Bridge's only financial resource, would absorb a majority of Iron Bridge's expected losses. Therefore, it was PSB's conclusion that in accordance with FIN 46(R), Iron Bridge is a variable interest entity and thus PSB was required to consolidate the financial results of Iron Bridge beginning the first quarter of 2004.        The consolidation of Iron Bridge as of December 31, 2005, resulted in PSB recording goodwill of $1,421,561 and minority interest of $254,767. PSB accounts for goodwill in accordance with SFAS 142, "Goodwill and Other Intangible Assets." Goodwill is now subject to impairment testing at least annually to determine whether write-downs of the recorded balances are necessary. PSB tests for impairment based on the goodwill maintained at each defined reporting unit. A fair value is determined for each reporting unit based on at least one of three various market valuation methodologies. If the fair value of the reporting unit exceeds its then book value, no write-down of recorded goodwill is necessary. If the fair value of a reporting unit is less, an expense may be required on PSB's books to write down the related goodwill to the proper carrying value. As of December 31, 2005, PSB completed its annual testing, and determined that no impairment write-off was necessary. No assurance can be given that future goodwill impairment tests will not result in a charge to earnings.  NOTE F--DEPOSITS        Deposits are summarized as follows:                                         27                                                                        DECEMBER 31,                                                                 --------------------                                                                   2005        2004                                                                 --------    --------                                                                    (IN THOUSANDS)    Demand......................................................    $ 40,695    $ 30,786 NOW.........................................................      24,444      27,040 Money Market and Statement Savings..........................      89,857     111,838 Passbook savings............................................      25,885      30,369 Certificates of deposit.....................................     320,230     275,247                                                                 --------    --------                                                                 $501,111    $475,280                                                                 ========    ========         At December 31, 2005, scheduled maturities of certificates of deposit are as follows (in thousands):     2006....................................................      $261,961 2007....................................................        42,313 2008....................................................         7,414 2009....................................................         2,335 2010....................................................         6,052 Thereafter..............................................           155                                                               --------                                                               $320,230                                                               ========   NOTE G--BORROWING        1.    Federal Home Loan Bank Advances        Under an agreement with the Federal Home Loan Bank of Pittsburgh (FHLB), the Company has a line of credit available in the amount of approximately $206,937,000. As of December 31, 2005 and 2004, there was no amount outstanding throughout the year on this line of credit, respectively. All FHLB advances are collateralized by a security agreement covering qualifying mortgage loans and unpledged treasury, agency and mortgage-backed securities which at December 31, 2005, had a combined carrying value of approximately $315,631,000. In addition, all FHLB advances are secured by the FHLB stock owned by the Company.        2.    Securities sold under agreements to repurchase              Securities sold under repurchase agreements are as follows:                                         28                                                                      YEAR ENDED DECEMBER 31,                                                                  -------------------------                                                                   2005     2004      2003                                                                  ------   ------    ------                                                                    (DOLLARS IN THOUSANDS,                                                                             EXCEPT                                                                          PERCENTAGES)     Balance at year-end..........................................    $1,127   $1,105    $1,099 Average during the year......................................     1,120    1,109     1,092 Maximum month-end balance....................................     1,127    1,111     1,099 Weighted average rate during the year........................      2.12%    1.92%     2.47% Rate at December 31..........................................      2.44%    2.14%     1.88%   NOTE H--INCOME TAXES        The components of the provision for income taxes are as follows (in thousands):        The components of the provision for income taxes are as follows (in thousands):                                                                   YEAR ENDED DECEMBER 31,                                                              ---------------------------                                                               2005       2004      2003                                                              ------     ------    ------     Current   Federal................................................    $  394     $  860    $  695   State .................................................       167        155       113                                                              ------     ------    ------                                                                 561      1,015       808                                                              ------     ------    ------  Deferred   Federal................................................       141        178       216   State .................................................        --         --        --                                                              ------     ------    ------                                                                 141        178       216                                                              ------     ------    ------   Total income tax expense...............................    $  702     $1,193    $1,024                                                              ======     ======    ======                                          29         A reconciliation between the reported income tax expense and the amount computed by multiplying income before income tax by the Federal statutory income tax rate is as follows (in thousands):                                                                                                YEAR ENDED                                                                                            DECEMBER 31,                                                                                     -------------------------                                                                                      2005     2004      2003                                                                                     ------   ------    ------     Expected statutory income tax expense..........................................     $  641   $1,109    $1,068 Increase (decrease) in taxes resulting from:   State and local taxes on income..............................................        110      102        76   Non-taxable income...........................................................       (175)     (38)     (222)   Non-deductible expenses......................................................        110       20       102   Other........................................................................         16       --        --                                                                                     ------   ------    ------ Total income tax expense.......................................................     $  702   $1,193    $1,024                                                                                     ======   ======    ======                                          30         Net deferred tax assets consist of the following (in thousands):                                                                                DECEMBER 31,                                                                           ----------------                                                                            2005      2004                                                                           ------    ------    Deferred tax assets   Allowance for loan losses............................................   $1,114    $  959   Non-accrual interest.................................................      311       390   Depreciation.........................................................      579       617   Net operating loss carry forwards....................................      136       321   Unrealized losses on investment securities available-for-sale........      806       223   Other................................................................        9        13                                                                           ------    ------   Net deferred tax asset, included in other assets                        $2,955    $2,523                                                                           ------    ------   The Bank is not required to recapture approximately $2.5 million of its tax bad debt reserve, attributable to bad debt deductions taken by it prior to 1988, as long as the Bank continues to operate as a bank under federal tax law and does not use the reserve for any other purpose. In accordance with SFAS No. 109, the Bank has not recorded any deferred tax liability on this portion of its tax bad debt reserve. The tax that would be paid were the Bank ultimately required to recapture that portion of the reserve, would amount to approximately $800,000. At December 31, 2005, the Bank has net operating loss carryover of about $838,000 million expiring in 2020.  NOTE I--EARNINGS PER SHARE  The following table illustrates the required disclosure of the numerators and denominators of the basic and diluted EPS computation. The computation of dilutive earnings per share in 2005 includes 895,240 shares of the 1,371,200 options which were issued in connection with the 1999 First Bank of Philadelphia acquisition and were originally deemed invalid by management. These shares are considered to be contingently issuable shares and are required to be included in the calculation of diluted EPS and excluded from the calculation of basic EPS for the year ended December 31, 2005 and 2004, because they currently are held in escrow. All or part of the stock options may be returned pending the outcome of an appeal of the court ruling which rendered the options valid. Prior to December 31, 2004, these shares were not held in escrow and accordingly were excluded from the calculation of basic and diluted EPS for the year ended December 31, 2003.                                         31                                                                       YEAR ENDED DECEMBER 31, 2005                                                             ------------------------------------------                                                                              WEIGHTED                                                              INCOME       AVERAGE SHARES     PER SHARE                                                             (NUMERATOR)    (DENOMINATOR)       AMOUNT                                                             -----------    -------------     ---------                                                               (IN THOUSANDS, EXCEPT PER SHARE DATA)     Basic earnings per share   Income available to common stockholders................   $ 1,135           4,785          $  0.24 Effect of dilutive securities   Stock options..........................................        --             952            (0.04)                                                             -------           -----          ------- Diluted earnings per share   Income available to common stockholders plus effect     of dilutive securities...............................   $ 1,135           5,737          $  0.20                                                             =======           =====          =======         All options to purchase shares were dilutive for the year ended December 31, 2005.                                                                       YEAR ENDED DECEMBER 31, 2004                                                            ------------------------------------------                                                                              WEIGHTED                                                              INCOME       AVERAGE SHARES    PER SHARE                                                            (NUMERATOR)     (DENOMINATOR)      AMOUNT                                                            -----------    --------------    ---------                                                               (IN THOUSANDS, EXCEPT PER SHARE DATA)     Basic earnings per share   Income available to common stockholders...............    $  2,070           4,425         $ 0.47 Effect of dilutive securities   Stock options.........................................          --             791          (0.07)                                                             --------           -----         ------ Diluted earnings per share   Income available to common stockholders plus effect     of dilutive securities..............................    $  2,070           5,216         $ 0.40                                                             ========           =====         ======         All options to purchase shares were dilutive for the year ended December 31, 2004.                                         32                                                                                   YEAR ENDED DECEMBER 31, 2003                                                                         -----------------------------------------                                                                                          WEIGHTED                                                                           INCOME      AVERAGE SHARES    PER SHARE                                                                         (NUMERATOR)    (DENOMINATOR)      AMOUNT                                                                         -----------   --------------    ---------                                                                           (IN THOUSANDS, EXCEPT PER SHARE DATA)     Basic earnings per share   Income available to common stockholders..........................       $ 2,005          4,250         $ 0.47 Effect of dilutive securities   Stock options....................................................            --            100          (0.01)                                                                           -------          -----         ------ Diluted earnings per share   Income available to common stockholders   Plus effect of dilutive securities...............................       $ 2,005          4,350         $ 0.46                                                                           =======          =====         ======   All options to purchase shares were dilutive for the year ended December 31, 2003.  NOTE J--FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK        The Company is a 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 and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Company's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.              The Company had the following off-balance-sheet financial instruments whose approximate contract amounts represent credit risk at the dates indicated:                                                                     DECEMBER 31,                                                               -----------------                                                                2005      2004                                                               -------   -------                                                                 (IN THOUSANDS)    Commitments to extend credit..............................    $38,346   $27,980 Unused lines of credit....................................     42,282    34,525 Standby letters of credit.................................      3,539     3,286                                                               -------   -------                                                               $84,167   $65,791                                                               =======   =======         Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the                                         33   Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include Small Business Administration guarantees, deposit accounts at the Company, marketable securities, personal or commercial real estate, accounts receivable, inventory, and equipment.        Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support contracts entered into by customers. Most guarantees extend for one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds collateral to support these commitments.        The Company issues financial and performance standby letters of credit, both of which are subject to the disclosure and initial recognition and measurement provisions of FIN No. 45. Financial and performance standby letters of credit are conditional commitments issued by the Company to assure the financial and performance obligations of a customer to a third party. At December 31, 2005, and 2004, the Company was contingently liable on financial and performance standby letters of credit totaling $3.5 million and $3.3 million, respectively, $885,000 of which were originated during 2005. The Company's commitments under standby letters of credit expire at various dates through 2008. Amounts due under these letters of credit would be reduced by any proceeds that the Company would be able to obtain in liquidating the collateral for the loans, which varies depending on the customer. The Company generally holds collateral and/or obtains personal guarantees supporting these commitments. Collateral held for these commitments at December 31, 2005 varied from 0 to 100% and averaged 98.0%.        The Bank grants mortgage, consumer and construction loans primarily to customers in Southeastern Pennsylvania and Southern New Jersey. Although the Bank has a diversified loan portfolio, a substantial portion of its customers' ability to honor their contracts is dependent upon the local economy. The Bank's net investment in loans is subject to a significant concentration of credit risk given that the investment is primarily within a specific geographic area.                                         34   NOTE K -- COMMITMENTS AND CONTINGENCIES        1.    Lease obligations              The Company has entered into several non-cancelable operating lease agreements for its facilities. Additionally, the Company is responsible for pro rata operating expense escalations. The approximate minimum annual rental payments at December 31, 2005, under these leases are as follows:                                   (IN THOUSANDS)     2006..........................................................      $  874 2007..........................................................         586 2008..........................................................         387 2009..........................................................         363 2010..........................................................         233 Thereafter....................................................         569                                                                     ------                                                                     $3,012                                                                     ======         Lease expense was approximately $950,000, $905,000, and $887,000 for the years ended December 31, 2005, 2004 and 2003, respectively.        2.    Litigation        In the fourth quarter of 2001, PSB declared 1,371,200 options previously issued by First Bank of Philadelphia to be void because PSB believes, among other reasons, that these options were unlawfully and improperly granted.        On March 6, 2002, certain of the purported option holders brought an action in United States District Court for the Eastern District of Pennsylvania (the "Court") to have the voided options declared valid and enforceable, or, alternatively, seeking aggregate damages of not less than $4.3 million.        On April 1, 2004, the Court granted the plaintiffs' motion for summary judgment in an action in which the plaintiffs sought to have certain stock options, previously voided by PSB Bancorp, Inc., to be declared enforceable. On April 5, 2004, PSB appealed the court's decision to the United States Court of Appeals for the Third Circuit (the "Appeals Court"). Pending the outcome of the appeal, PSB agreed to allow the purported option holders to exercise the options with the resulting shares and exercise consideration being placed in escrow. Subsequently, on February 15, 2005, the Appeals Court upheld the grant of summary judgment for the plaintiffs. On February 28, 2005, PSB filed a                                         35   motion for rehearing with the Appeals Court in which PSB avers that, based on recently discovered information, the court lacks jurisdiction because at least one of the plaintiffs is a Pennsylvania resident and therefore diversity of citizenship is absent.        On June 17, 2004 and September 7, 2004, the purported holders of the additional 475,960 voided options not subject to the initial suit filed separate actions in the Court to have the voided options declared valid and enforceable. These actions only effect 475,960 of the 1,371,200 options previously declared void by PSB. PSB has filed a motion to dismiss both actions for lack of jurisdiction arising from a lack of diversity.        On December 29, 2004, PSB received a shareholder demand letter (the "Demand Letter") from Mr. David C. Berger, Esq., of Robinson Brog Leinwand Greene Genovese & Cluck P.C., counsel for the purported holders of the voided options ("Option Counsel"), and counsel for Wellington Limited Partnership, a purported shareholder of PSB, requesting that the board of directors prosecute certain actions or take certain corrective measures. A shareholder derivative action is an action brought by a shareholder in the name of the corporation to recover alleged damages incurred by the corporation as a result of the actions of its directors, officers or third parties. Under Pennsylvania law, initially a committee of independent directors must determine whether to proceed with any action. On January 20, 2005, the board of directors of PSB appointed a special committee composed of three independent directors. The independent directors appointed to the special committee are Dennis Wesley, James W. Eastwood, and James Kenney. The special committee was charged with (i) investigating the allegations in the Demand Letter, (ii) preparing and presenting a report to the full board of directors of the results of their investigation, and (iii) making a recommendation to the full board of directors as to whether or not to proceed with a shareholder derivative action. The special committee has engaged separate legal counsel to assist it in the preparation of its report. If any action is recommended by the special committee, any recovery would be for the benefit of PSB. Option Counsel was informed of the formation of the special committee.        On March 17, 2005, prior to the conclusion of the formal review by the special committee, Option Counsel brought a shareholder derivative action on behalf of two of the purported option holders in the Court against the members of PSB's board of directors for breach of fiduciary duty and self dealing relating to the purported fraudulent solicitation of shareholder approval of PSB's 2001 Stock Incentive Plan (the "SIP"). This is one of the items contained in the Demand Letter. Plaintiffs are seeking a judgment declaring the SIP null and void and an injunction preventing the issuance or exercise of any additional options under the SIP. This matter will also be reviewed by the special committee formed in response to the Demand Letter. PSB unequivocally denies the allegations and intends to vigorously defend the action. However, there can be no assurance regarding the eventual outcome of this litigation.        April 29, 2005, PSB filed a motion to dismiss the cases. On June 23, 2005, the Court denied PSB's motion to dismiss. The special committee's counsel, appointed as a result of the shareholder demand described in Paragraph D above, submitted its report and the Board of Directors concluded that no corrective action was necessary and that the derivative suit should be terminated. PSB unequivocally denies the allegations contained in the action and intends to defend vigorously the action. However, there can be no assurance regarding the eventual outcome of this litigation.        On April 8, 2005, PSB filed a declaratory judgment action in the Court of Common Pleas of Philadelphia County against the various purported option holders seeking an order declaring the disputed options void and invalid. This action is in the discovery phase.        On April 15, 2005, in response to the Dismissal, Carl Lingle, Raymond Silverstein, as Trustee under an Irrevocable Trust, Gerald Lehrfeld, Joan Lehrfeld, Jay Roseman and Lynn Roseman, purported option holders, filed an action in the United States District Court for the Eastern District of Pennsylvania seeking among other actions a declaratory judgment that 854,858 options previously declared invalid by PSB are valid and enforceable or in the alternative an award of money damages estimated to be not less than $11 million. On May 16, 2005, PSB filed a motion to dismiss that was denied on June 23, 2005. PSB intends to defend vigorously the action. However, there can be no assurance regarding the eventual outcome of this litigation.        In May 2005, PSB filed an action in the Philadelphia Court of Common Pleas against Conwell Ltd. Partnership, et al. ("Conwell") in order to terminate a June, 2004 escrow agreement entered into as part of the original option case. PSB had issued certain stock certificates in the names of the plaintiffs and the plaintiffs paid the option exercise price. The stock certificates and the money were put into escrow pending the outcome of PSB's appeal. As referenced in Paragraph A above, the action was dismissed, and PSB contends that the escrow should be voided. In response to PSB's action, Conwell filed an interpleader action in the U.S. District Court for the Eastern District of Pennsylvania. As a result of that action, the escrow agent deposited into federal court the stock certificates that had been held in escrow. On July 6, 2005, the district court denied PSB's motion to dismiss. On November 4, 2005, the district court entered an order staying the case.        Periodically, there have been various claims and lawsuits involving PSB, such as claims to enforce liens, condemnation proceedings on properties in which PSB holds security interests, claims involving the making and servicing of real property loans, and other issues incident to PSB's business. At this time, there are no such claims or proceedings that are material to the operations of PSB.                                         36   NOTE L -- FAIR VALUE OF FINANCIAL INSTRUMENTS        SFAS No. 107 requires disclosure of the estimated fair value of an entity's assets and liabilities considered to be financial instruments. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in SFAS No. 107. However, many such instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Therefore, the Company had to use significant estimations and present value calculations to prepare this disclosure, as required by SFAS No. 107. Accordingly, the information presented below does not purport to represent the aggregate net fair value of the Company.        Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.        Estimated fair values have been determined by the Company using the best available data and an estimation methodology suitable for each category of financial institutions. The estimation methodologies used, the estimated fair values, and recorded book balances at December 31, 2005 and 2004, respectively, are outlined below.        For cash and due from banks, federal funds sold, and interest earning deposits with banks, the recorded book value of $37,797,000 and $54,650,000 approximates fair value at December 31, 2005 and 2004, respectively. The estimated fair values of investment securities are based on quoted market prices, if available. Estimated fair values are based on quoted market prices of comparable instruments if quoted market prices are not available.        The fair value of loans held-for-sale with recorded book values of approximately $3,280,000 and $3,792,000 at December 31, 2005 and 2004 are determined using an aggregate asset basis method and are carried at fair value.        The fair values of loans that management intends to hold for the foreseeable future are estimated based on a discounted cash flow analysis using interest rates currently offered for loans with similar terms to borrowers of similar credit quality. The carrying value of accrued interest approximates fair value.        The estimated fair values of demand deposits (i.e., interest and non-interest bearing checking accounts, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair value of variable rate certificates of deposit approximate their carrying amounts at the reporting date. The fair values of fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of                                         37   aggregated expected monthly time deposit maturities. The carrying amount of accrued interest payable approximates its fair value.                                         38                                                                                    2005                    2004                                                                         --------------------    --------------------                                                                           FAIR      CARRYING      FAIR      CARRYING                                                                           VALUE      AMOUNT       VALUE      AMOUNT                                                                         --------    --------    --------    --------                                                                                      (IN THOUSANDS)      Financial assets   Investment securities held-to-maturity............................    $  1,310    $  1,325    $  1,533    $  1,544   Investment securities available-for sale..........................     123,994     126,359      94,112      94,775   Loans.............................................................     368,020     369,814     348,778     356,142 Financial liabilities   Deposits with no stated maturities................................     155,494     180,881     200,003     212,635   Deposits with stated maturities...................................     321,437     320,230     275,247     275,242         The fair values of securities under agreements to repurchase totaling approximately $1,127,000 and $1,105,000 are estimated to approximate their recorded book balances at December 31, 2005 and 2004, respectively.        The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated costs to terminate the letters of credit. Fair values of unrecognized financial instruments including commitments to extend credit and the fair value of letters of credit are considered immaterial.  NOTE M -- STOCK-BASED COMPENSATION              A summary of the status of the Company's fixed stock option plan for the years ended December 31, 2005, 2004 and 2003, and changes during the years ending on those dates is presented below:              The summary of stock options for all periods presented excludes 1,371,200 options issued in connection with the 1999 First Bank acquisition, which have been deemed invalid by management.                                         39                                                               2005                     2004                     2003                                                    --------------------    ----------------------    --------------------                                                               WEIGHTED-                 WEIGHTED-               WEIGHTED-                                                                AVERAGE                   AVERAGE                 AVERAGE                                                    NUMBER      EXERCISE      NUMBER      EXERCISE     NUMBER     EXERCISE                                                      OF       PRICE PER       OF        PRICE PER      OF       PRICE PER                                                    SHARES       SHARE        SHARES       SHARE       SHARES      SHARE                                                    -------    ---------    ---------    ---------    -------    ---------        Outstanding at beginning of year.............      961,167     $7.12         310,458     $ 5.40      280,458     $ 5.05 Options granted..............................            0        --       1,020,000      10.00       30,000       8.61 Options exercised............................      (42,857)     9.65        (369,291)      6.16           --         -- Options forfeited............................           --        --              --         --           --         --                                                     -------                 ---------                 ------- Outstanding at end of year...................      918,310      9.87         961,167       7.12      310,458     $ 5.40                                                    =======                 =========                 =======               The following table summarizes information concerning options outstanding at December 31, 2005:                                    OPTIONS OUTSTANDING           OPTIONS EXERCISABLE                     --------------------------------------  -----------------------                                      WEIGHTED-                NUMBER                         NUMBER        AVERAGE    WEIGHTED-  EXERCISABLE   WEIGHTED-     RANGE OF        OUTSTANDING AT   REMAINING    AVERAGE        AT        AVERAGE     EXERCISE         DECEMBER 31,   CONTRACTUAL  EXERCISE   DECEMBER 31,  EXERCISE      PRICES             2005        LIFE (YEARS)   PRICE        2004        PRICE - ------------------  --------------  -----------  ---------  -----------   ---------       $3.36 to $8.61....       32,590         2.94        6.38       35,447        5.07 $10.00............      885,720         8.50       10.00      925,720       10.00                         -------         ----       -----      -------       -----                         918,310         5.72        9.87      961,167        9.62                         =======         ====       =====      =======       =====                                          40   NOTE N -- EMPLOYEE BENEFIT PLANS        1.    Defined Benefit Pension Plan        The Company maintains a non-contributory defined benefit plan (the Pension Plan) covering all employees, as defined under the pension plan document. The Pension Plan calls for benefits to be paid to eligible employees at retirement based upon years of service with the Bank and compensation rates near retirement. Contributions to the Pension Plan reflect benefits attributed to employees' service. Pension Plan assets consist of common stock, investment grade corporate bonds and U.S. Government obligations. The Pension Plan was "frozen" in 1994 and benefits no longer accrue. No Pension Plan contributions were made in 2004, 2003, and 2002. No new employees will be eligible for participation.        The following table sets forth the plans' required disclosures:                                                                                                         DECEMBER 31,                                                                                               -------------------------                                                                                                  2005           2004                                                                                               ----------     ----------    Change in benefit obligation   Benefit obligation at beginning of year..............................................       $1,007,278     $  914,292   Interest cost........................................................................           59,623         63,771   Actual (loss) gain...................................................................           (1,244)        21,784   Benefits paid........................................................................          (24,984)       (94,552)   Increase due to the decrease in the discount rate....................................           56,645        101,983                                                                                               ----------     ----------   Benefits obligation at end of year...................................................       $1,097,318     $1,007,278                                                                                               ==========     ==========  Change in plan assets   Fair value of plan assets at beginning of year.......................................       $  818,094     $  823,171   Actual return on plan assets.........................................................           18,306         68,610   Employer Contributions...............................................................           12,962         20,865   Benefits paid........................................................................          (24,984)       (94,552)                                                                                               ----------     ----------   Fair value of plan assets at end of year.............................................       $  824,378     $  818,094                                                                                               ==========     ==========   Funded status........................................................................         (272,940)     $(189,184)   Unrecognized actuarial gain..........................................................          204,756        111,555   Unrecognized transition obligation...................................................           55,555         61,729                                                                                               ----------     ---------- Accrued pension cost at end of year....................................................       $  (12,629)    $  (15,900)                                                                                               ==========     ==========                                          41                                                                                             2005        2004     2003                                                                                        --------    -------   -------     WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31,  DISCOUNT RATE                                                                              5.50%      6.00%     7.00% EXPECTED RETURN ON PLAN ASSETS                                                             7.00%      7.00%     7.00%  Components of net periodic benefit cost (benefit)   Interest cost.....................................................................   $ 59,623    $63,771   $61,548   Expected return on plan assets....................................................    (56,853)   (58,294)  (50,867)   Amortization of transition amount.................................................      6,174      6,174     6,174   Amortization of gain..............................................................        747                   --                                                                                        --------    -------   -------   Net periodic benefit cost (benefit)...............................................   $  9,691    $11,651   $16,855                                                                                        ========    =======   =======         The asset allocation for the Bank's pension plans at the end of 2005 and 2004 and the larger allocation for 2006, by asset category, follows. The fair value of plan assets for those plans is $824,378 and $818,044 million at the end of 2005 and 2004, respectively.                                                                                                2005     2004      2003                                                                                            -----    -----     -----     Asset Category   Cash-money markets..................................................................      9.00%    1.00%     1.00%   Equity securities...................................................................     31.00%   99.00%    99.00%   Short term bonds....................................................................     60.00%      --        --                                                                                            -----    -----     -----     Total.............................................................................       100%     100%      100%                                                                                            =====    =====     =====         The Bank's pension plan assets are managed by Trustees of the Retirement Plan of the Bank. Assets are rebalanced at the end of each quarter. The Bank's investment strategy with respect to pension assets is to maximize return while protecting principal. The Trustees have the flexibility to adjust the asset allocation and move funds to the asset class that offers the most opportunity for investment returns.        The accumulated benefit obligation at December 31, 2005 and 2004 was $1,097,318 and $1,007,728 respectively.        Employer contributions and benefits paid in the above table include only those amounts contributed directly to, or paid directly from, plan assets. The expected employer contribution for 2006 is $35,000        The long-term rate of return on assets was developed through analysis of historical market returns, current market conditions and the fund's past experience. Estimates of future market returns by asset category are lower than actual long-term historical returns in order to reflect current market conditions.                                         42         Estimated future benefits payments are as follows:                                                                                        (IN THOUSANDS)   2006........................................................................           $ 32,882 2007........................................................................             37,381 2008........................................................................             67,181 2009........................................................................             71,008 2010........................................................................             76,738 2011-2015...................................................................            463,430         2.    Cash (Deferred) Profit-Sharing Plan        The Company has a profit-sharing plan (the 401(k) Plan) covering all employees, as defined under the plan document. Employees may contribute up to 15% of compensation, as defined under the plan document. In 2002, the 401(k) Plan was amended to include the Company matching employee contributions up to 3% of compensation. Prior to 2002, the Company made discretionary contributions. The Company contributed approximately $137,749, $109,000, and $104,000 for the years ended December 31, 2005, 2004 and 2003, respectively.        3.    Profit-Sharing Plan        The Company has a profit-sharing plan (the Profit Sharing Plan) covering all employees, as defined under the plan document. Discretionary contributions to the profit sharing plan are determined annually by the Board of Trustees based upon net income, as defined under the plan document. Allocation of the contributions to employees is based upon annual compensation. The Company made no contributions to the profit sharing plan in 2005, 2004 and 2003.        4.    Employee Stock Ownership Plan        The Company has an Employee Stock Ownership Plan (ESOP) covering all employees, as defined under the plan document. The ESOP is a tax-qualified plan subject to the requirements of ERISA and the Code. The ESOP borrowed funds from an unrelated third party lender and used the funds to purchase 42,780 shares of the Company common stock, which was later converted into 110,046 shares of Company common stock. The ESOP borrowed $1,288,540 from the Company to purchase an additional 128,854 shares of Company common stock.        The Company acquired 145,000 ESOP shares through the acquisition of Jade Financial Corp. and its wholly-owned subsidiary, IGA Federal Savings Bank. These shares were converted into 398,025 ESOP shares in which 79,605 shares were already allocated prior to the acquisition. As of the acquisition date 8,126.50 IGA ESOP shares converted to 22,307 shares were cashed out. As of December 31, 2003, 30,128 ESOP shares were paid out or rolled                                         43   over to employees who are no longer with the Company. Of the 30,123 shares, the Company purchased 3,671 shares during 2003 and transferred them to treasury stock.        Benefits under the ESOP generally become 100% vested after the third year of service or upon normal retirement (as defined in the ESOP), disability or death of the participant. If a participant terminates employment for any other reason prior to full vesting, his nonvested account balance will be forfeited. Forfeitures will be reallocated among remaining participating employees in the same proportion as contributions. Benefits may be payable upon death, retirement, early retirement disability or separation from service. The Company accounts for it ESOP in accordance with SOP 93-6. As shares are released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the allocated shares are included in outstanding shares for EPS purposes. The Bank's contributions to the ESOP recorded as compensation expense or (benefit) for the years ended December 31, 2005, 2004 and 2003 were approximately $386,000, $ 320,000, and $456,000, respectively.        In October 2004, the ESOP refinanced its outstanding loan at a lower interest rate.        Information with respect to the ESOP at December 31, 2005 are as follows:                                                                                           2005           2004                                                                                     ----------     ----------    Allocated shares..............................................................         203,838        198,122 Unreleased shares.............................................................         225,612        254,094                                                                                     ----------     ---------- Total ESOP shares.............................................................         429,450        452,216                                                                                     ==========     ========== Fair value of unreleased shares...............................................      $2,594,538     $3,507,000                                                                                     ==========     ==========         5.    Supplemental Executive Retirement Plan        In the third quarter of 2004 First Penn Bank established a nonqualified, noncontributory Supplemental Executive Retirement Plan (the "Executive Plan") for certain executives that provide for payments upon retirement, death or disability. The annual benefit is based on annual salary and bonuses (as defined in the Executive Plan) plus interest. Expense related to the Executive Plan included in the consolidated statements of income is approximately $621,000 for the year ended December 31, 2005.        Net expense for the year ended December 31, 2005 included the following components (in thousands):                                         44                                                                                                      2005                                                                                                 --------   Service cost...............................................................................      587,000 Interest cost..............................................................................       34,000                                                                                                 -------- Benefit expense............................................................................     $621,000                                                                                                 ========         We expect to contribute approximately $621,000 to the Executive Plan with respect to 2005. The Executive Plan is an unsecured untouched liability of the Company.        6.    Restricted Stock Awards        During the year ended December 31, 2004, PSB issued 200,000 shares of restricted stock. The shares vest at a rate of 20% on each of five annual vesting dates, with an initial vesting date of June 17, 2005. The market price of PSB's Common Stock on the date of grant was $10.00 per share.        Shares issued upon vesting may be either authorized but unissued shares or reacquired shares held by the Company as treasury shares. Expense is recognized for shares awarded over the vesting period at the fair market value of the shares on the date they were awarded. Compensation expense attributable to the restricted stock awards amounted to $364,000 for the year ended December 31, 2005.        7.    Management Recognition Plan        The 1995 and 1998 Management Recognition Plans (the MRP Plans) provide certain senior executive officers of the Company with a propriety interest in the Company. Benefits may be granted at the sole discretion of the Compensation Committee of the Company's Board of Trustees. The MRP Plans are managed by trustees who are directors of the Company and who have responsibility to invest all funds contributed by the Company to the trust created for the MRP Plans. The Company contributed approximately $254,000 to the 1995 MRP, which enabled the 1995 MRP to purchase 21,390 shares of the Company common stock in 1996 that were later converted into 55,023 shares of Company common stock. Under the 1998 MRP, the Company, contributed $322,500 to enable the MRP to purchase up to 181,384 shares of the Company common stock. Unless the Compensation Committee of the Board specifies otherwise, shares granted to MRP Plan participants will be in the form of restricted stock that vest over a five-year period at the rate of 20% of such shares per year. Compensation expense in the amount of the fair market value of the common stock at the date of grant to the employee will be recognized pro rata over the five years during which the shares vest. At December 31, 2005, all shares under the MRP have been allocated. The Company recorded                                         45   compensation expense of approximately $0, $64,500, and $64,500 for the years ended December 31, 2005, 2004 and 2003, respectively, for the MRP.  NOTE O -- REGULATORY MATTERS        State banking statutes restrict the amount of dividends on capital stock. Accordingly, no dividends shall be paid by the Company on its capital stock unless following the payment of such dividends, the capital stock of the Company will be unimpaired, and (1) the Company will have a surplus of not less than 50% of its capital, or, if not, (2) the payment of such dividend will not reduce the surplus of the Company.        The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory -- and possibly additional discretionary -- actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.        Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of December 31, 2005, management believes that the Company meets all capital adequacy requirements to which it is subject.       As of September 30, 2005, the most recent notification from the Federal Reserve Bank of Philadelphia categorized the Bank adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category.        The Company's and Bank's actual capital amounts and ratios are as follows:                                         46         The Company's and Bank's actual capital amounts and ratios are as follows:                                                                                                                TO BE WELL-                                                                                                         CAPITALIZED UNDER                                                                                   FOR CAPITAL           PROMPT CORRECTIVE                                                                ACTUAL          ADEQUACY PURPOSES        ACTION PROVISIONS                                                         -----------------      -----------------      --------------------                                                          AMOUNT     RATIO       AMOUNT     RATIO       AMOUNT        RATIO                                                         -------     -----      -------     -----      -------       ------                                                                            (DOLLARS IN THOUSANDS)        As of December 31, 2005:      Total capital (to risk-weighted assets)      Company........................................     $56,737     14.88%     $30,500   >or=8.00%         N/A          N/A      Bank...........................................     $45,185     11.96%     $30,221   >or=8.00%     $37,776    >or=10.00%  Tier I capital (to risk-weighted assets)      Company........................................     $53,437     14.02%     $15,250   >or=4.00%         N/A          N/A      Bank...........................................     $41,885     11.09%     $15,110   >or=4.00%     $22,666     >or=6.00%  Tier I capital (to average assets)      Company........................................     $53,437      9.53%     $22,426   >or=4.00%         N/A          N/A      Bank...........................................     $41,885      7.50%     $22,327   >or=4.00%     $27,908     >or=5.00%                                                                                                              TO BE WELL-                                                                                                        CAPITALIZED UNDER                                                                                   FOR CAPITAL          PROMPT CORRECTIVE                                                                ACTUAL          ADEQUACY PURPOSES       ACTION PROVISIONS                                                         -----------------      -----------------      ------------------                                                          AMOUNT     RATIO       AMOUNT     RATIO       AMOUNT      RATIO                                                         -------     -----      -------     -----      -------     ------                                                                            (DOLLARS IN THOUSANDS)        As of December 31, 2004:    Total capital (to risk-weighted assets)    Company..........................................     $54,364     15.49%     $28,082   >or=8.00%         N/A       N/A    Bank.............................................     $43,095     12.34%     $27,930   >or=8.00%     $34,912   >or=8.00%  Tier I capital (to risk-weighted assets)    Company..........................................     $51,207     14.59%     $14,041   >or=4.00%         N/A       N/A    Bank.............................................     $39,938     11.44%     $13,965   >or=4.00%     $20,947   >or=8.00%  Tier I capital (to average assets)    Company..........................................     $51,207      9.53%     $21,489   >or=4.00%         N/A       N/A    Bank.............................................     $39,938      7.48%     $21,361   >or=4.00%     $26,701   >or=8.00%                                          47   NOTE Q -- SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)                                                                                         THREE MONTHS ENDED                                                                        -----------------------------------------------                                                                        DEC. 31,    SEPT. 30,    JUNE 30,     MARCH 31,                                                                          2005         2005        2005         2005                                                                        --------    ---------    --------     ---------                                                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)      Interest income...................................................      $8,038      $ 7,844      $7,419       $7,188 Interest expense..................................................       3,398        3,323       2,706        2,495                                                                         ------      -------      ------       ------ Net interest income...............................................       4,640        4,521       4,713        4,693 Provision for loan losses.........................................         135           45          90          135 Non-interest income...............................................         694          573         585          967 Non-interest expenses.............................................       4,344        5,198       4,894        4,708                                                                         ------      -------      ------       ------ Income (loss)  before income tax expense..........................         855         (149)        314          817 Income tax (expense) benefit......................................        (374)          29        (111)        (246)                                                                         ------      -------      ------       ------ Net income (loss).................................................      $  481      $  (120)     $  203       $  571                                                                         ======      =======      ======       ====== Earnings (loss) per share     Basic.........................................................      $ 0.11      $ (0.03)     $ 0.04       $ 0.12     Diluted.......................................................      $ 0.09      $ (0.03)     $ 0.04       $ 0.10                                                                                        THREE MONTHS ENDED                                                                        -----------------------------------------------                                                                        DEC. 31,    SEPT. 30,    JUNE 30,     MARCH 31,                                                                          2004         2004        2004         2004                                                                        --------    ---------    --------     ---------                                                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)      Interest income...................................................      $8,084      $ 6,742      $6,929       $6,234 Interest expense..................................................       2,444        2,292       1,942        1,803                                                                         ------      -------      ------       ------ Net interest income...............................................       5,640        4,450       4,987        4,431 Provision for loan losses.........................................         145           90                        0 Non-interest income...............................................         567          532         538          480 Non-interest expenses.............................................       4,943        4,498       4,776        4,065                                                                         ------      -------      ------       ------ Income before income tax expense..................................       1,119          394         749          846 Income tax expense................................................         441          134         225          238                                                                         ------      -------      ------       ------ Net income........................................................      $  678      $   260      $  524       $  608                                                                         ------      -------      ------       ------ Earnings per share                                          48          Basic...........................................................      $ 0.15      $  0.06      $ 0.12       $ 0.14   Diluted.........................................................      $ 0.11      $  0.05      $ 0.10       $ 0.14                                          49   NOTE R -- CONDENSED FINANCIAL INFORMATION -- PARENT COMPANY ONLY        Condensed financial information for PSB Bancorp, Inc. (parent company only) follows:                              CONDENSED BALANCE SHEET                                                                                                             DECEMBER 31,                                                                                                      ------------------                                                                                                        2005       2004                                                                                                      -------    -------                                                                                                         (IN THOUSANDS)                                              ASSETS    Cash............................................................................................     $ 8,761    $ 8,463 Investment in subsidiaries......................................................................      41,409     40,737 Other assets....................................................................................       3,131      3,105                                                                                                      -------    -------     Total assets................................................................................     $53,301    $52,305                                                                                                      =======    =======                               LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities   Other liabilities.............................................................................     $    80    $   148 Shareholders' equity............................................................................      53,221     52,157                                                                                                      -------    -------     Total liabilities and stockholders' equity..................................................     $53,301    $52,305                                                                                                      =======    =======                           CONDENSED STATEMENT OF EARNINGS                                         50                                                                                                      YEAR ENDED DECEMBER 31,                                                                                                ---------------------------                                                                                                 2005       2004      2003                                                                                                ------     ------    ------                                                                                                     (IN THOUSANDS)     INCOME    Dividend income from subsidiaries........................................................    $   --     $   --    $  136   Interest income..........................................................................        88         70        74   Other income.............................................................................        --         --        --                                                                                                ------     ------    ------     Total income...........................................................................        88         70       210                                                                                                ------     ------    ------ EXPENSES   Other....................................................................................       891        728       649                                                                                                ------     ------    ------     Total expenses.........................................................................       891        728       649                                                                                                ------     ------    ------     Loss before undistributed earnings of subsidiaries.....................................      (803)      (658)     (439) Undistributed earnings of subsidiaries.....................................................     1,938      2,728     2,444                                                                                                ------     ------    ------       NET INCOME...........................................................................    $1,135     $2,070    $2,005                                                                                                ======     ======    ======                                          51                          CONDENSED STATEMENT OF CASH FLOWS                                                                                                 YEAR ENDED DECEMBER 31,                                                                                           --------------------------                                                                                            2005       2004     2003                                                                                           ------     ------   ------                                                                                               (IN THOUSANDS)     Cash flows from operating activities   Net income..........................................................................    $1,135     $2,070   $2,005   Adjustments to reconcile net income to net cash used in operating activities     Undistributed earnings from subsidiaries..........................................    (1,938)    (2,728)  (2,444)     Net change in other assets and liabilities........................................       687        519      359                                                                                           ------     ------   ------     Net cash used in operating activities.............................................      (116)      (139)     (80)                                                                                           ------     ------   ------ Cash flows from financing activities   Exercise of stock options...........................................................       414      2,397       --   Treasury stock acquired.............................................................        --        (23)     (29)                                                                                           ------     ------   ------       Net cash (used in) provided by financing activities.............................       414      2,374      (29)                                                                                           ------     ------   ------       NET (DECREASE) INCREASE IN CASH.................................................       298      2,235     (109) Cash at beginning of year.............................................................     8,463      6,228    6,337                                                                                           ------     ------   ------ Cash at end of year...................................................................    $8,761     $8,463   $6,228                                                                                           ======     ======   ======                                          52    GRAPHIC 7 w19032w1903201.gif GRAPHIC  begin 644 w19032w1903201.gif M1TE&.#EA4`+^`,0?`,O+RV%A8):6E?/S\\K*RK"PL.7EY3DY.+Z^O7M[>]C8 MV)65E:.CHT9&1HF)B&YNE144V!@8/'Q\7M[>M?7UU-34J*BHN3DY$9&1;V] MO*^OKVUM;8B(ARPL*________R'Y!`$``!\`+`````!0`OX```7_X">.9&F> M:*JN;.N^<"S/=&W?>*[O?.__P*!P2"P:C\BD$PNF\]HXR`!2`1&@3A"]!@,'NF\?L_O^_^`)PHC!R(%!B0%`B("!8&/ MD)&2DY25)`"+'PT=#X,?"7,?"`F6I::GJ*FJ-@4-#%L(`0>#`0`B`&\G';N\ MO;Z_P,'"P\3%QL0'<+CV(5'=@P= MMB,/I+6WN28=%@3U]O?X^?K[_/W^_P#W36@@H*#!@P@3*ES(L*'#AQ`C2IQ( ML:+%BQ@S:MS(L:/'CQ,;+$F0"=ZG=6U0_W0@X*&ERY!YI=,G!!T6,'.EBF;.ITZ=0H>X$2K6JU4!"A6@9L$C!JP\"OM2Y MDV)EU+-HTSZ=>K6MV[=AL@8Q(`"!)ZX%UL'R4I:IVK^``;.%2[BP82%RTY@- MS+CQVL2'(Z-Z9E0R#LAG%CO>S%GF8,N@3ZW$9P%S:!:FRVCNS)KSY].P)76( M22!U[!.VQZQNS3OPZ]O`_CO:W\>=HAK\L#AWU'^7,LSMU M7KU[&.DNJ7M'@?R[W^W!SC<%"!8!$^Z*(.!CRP"VT-;/*`7@:V",6$-E4(TX5G:=C2`@=X$($%_S&U MV`(1#-GD@#J^**4,7'70`(+`O!%+!^_D>!V&TPFTX8_TY!.?34)^B($'&LP# MTV(3W.C`/`1-L((&3==[I:0X`0-"!`U^\`(",#2A5G:!-\%B3CXB"B5.:Q&%P MP*:6LB3!!BO.^:1:!'XJ[`HQH2D%'1VM+_HA(< M@&2N"II%)Y3#ANO"``Y8B6,-R5H95K-?1K6`H_A4(.M-UGXX[;:+:7"KKYV* MZ^\)#.C))XP"Z+GN;U,&D3@\,,.G_D4`1A`^E(%2%)0@0026-`!?0VS MI/$!**85[+^?`K`)J4!PI:<#QX:6L!(+:_>2!!<0('%O)Z,\I0$!5=Q%[\\WSX7]? 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