U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q


		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended June 30, 2006


o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number: 000-24601

PSB BANCORP, INC.

(Exact name of registrant as specified in its charter)


Pennsylvania		23-2930740
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

1835 Market Street
Philadelphia, PA 19103
(Address of principal executive offices)
(215) 979-7900
Registrant’s telephone number, including area code:

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 5,142,526 shares of Common Stock, at no par value, outstanding on August 15, 2006.

PSB BANCORP, INC.
FORM 10-Q
FOR THE SECOND QUARTER ENDED JUNE 30, 2006

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION			3

Item 1. Financial Statements			3
Consolidated Statements of Financial Condition as of June 30, 2006, (unaudited) and December 31, 2005			3
Consolidated Statements of Operations (unaudited) for the Three and Six Month Periods Ended June 30, 2006, and 2005			4
Consolidated Statements of Cash Flows (unaudited) for the Six Month Period Ended June 30, 2006, and 2005			5
Consolidated Statements of Comprehensive Loss (unaudited) for the Three and Six Month Periods Ended June 30, 2006, and 2005			6
Notes to Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			11
Item 3. Quantitative and Qualitative Disclosures about Market Risk			19
Item 4. Controls and Procedures			19

PART II. OTHER INFORMATION			19

Item 1. Legal Proceedings			19
Item 1A. Risk Factors			21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			22
Item 3. Defaults Upon Senior Securities			22
Item 4. Submission of Matters to a Vote of Security Holders			22
Item 5. Other Information			22
Item 6. Exhibits			22
Certification of Anthony DiSandro pursuant to Section 312
Certification of John Carrozza pursuant to Section 312
Certification Pursuant to 18 U.S.C. Section 1350

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

PSB BANCORP, INC. AND SUBSIDIARIES

STATEMENTS OF FINANCIAL CONDITION

(In thousands except per share data)


	June 30,			December 31,
	2006			2005
	(Unaudited)			(Audited)
Assets
Cash and due from banks	$	5,541		$	$6,454
Interest-earning deposits with banks		8,007			29,762
Federal funds sold		1,632			1,581

Total cash and cash equivalents		15,180			37,797

Loans held-for-sale		1,593			3,280
Investment securities available-for-sale, at fair value		112,697			123,994
Investment securities held to maturity (fair value $1,506 and $1,544)		1,139			1,325
Federal Home Loan Bank stock – at cost		1,290			1,061
Federal Reserve Bank stock – at cost		1,216			1,216

Loans		403,274			369,834
Less allowance for possible loans losses		(3,537	)		(3,300	)

Net loans		399,737			366,534

Accrued interest receivable		2,924			2,908
Premises and equipment, net		2,087			2,416
Bank-owned life insurance		13,455			13,181
Other assets		11,053			6,970


Total assets	$	562,371		$	560,682


Liabilities
Deposits
Non-interest bearing		41,664			40,695
Interest bearing		467,219			460,416


Total deposits		508,883			501,111


Securities sold under agreements to repurchase		1,138			1,127
Advances from borrowers for taxes and insurance		2,417			2,460
Other liabilities		3,060			2,763


Total liabilities		515,498			507,461


Shareholders’ equity
Common stock authorized, 15,000,000 shares no par value, 5,142,526 and 5,140,685 shares issued and outstanding on June 30, 2006 and December 31, 2005, respectively		46,658			46,292
Retained earnings		3,685			10,124
Accumulated other comprehensive loss		(1,954	)		(1,672	)
Employee stock ownership plan		(1,051	)		(1,093	)
Treasury stock, at cost, 81,001 and 78,252 shares at June 30, 2006, and December 31, 2005, respectively		(465	)		(430	)


Total shareholders’ equity		46,873			53,221


Total liabilities and shareholders’ equity	$	562,371		$	560,682

The accompanying notes are an integral part of these financial statements

PSB BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(In thousands, except per share data)


	Three months ended
	June 30,
	2006			2005
	(Unaudited)
Interest income
Loans, including fees	$	7,033		$	6,226
Investment securities		1,163			846
Deposits with banks		67			347

Total interest income		8,263			7,419


Interest expense
Interest on deposits		3,763			2,700
Interest on borrowings		9			6

Total interest expense		3,772			2,706


Net interest income		4,491			4,713

Provision for loan losses		135			90


Net interest income after provision for loan losses		4,356			4,623

Non-interest operating income		581			585


Non-interest expenses:

Salaries and employee benefits		2,589			2,536
Occupancy and equipment		621			627
Other operating		2,594			1,731

Total non-interest expenses		5,804			4,894


(Loss) income before income (taxes) benefit		(867	)		314

Income tax benefit (expense)		243			(111	)


Net (loss) income	$	(624	)	$	203


Earnings (loss) per share:
Basic	$	(0.13	)	$	0.04
Diluted	$	(0.13	)	$	0.04

The accompanying notes are an integral part of these financial statements

PSB BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(In thousands, except per share data)


	Six months ended
	June 30,
	2006			2005
	(Unaudited)
Interest income
Loans, including fees	$	14,104		$	12,271
Investment securities		2,369			1,680
Deposits with banks		254			656

Total interest income		16,727			14,607


Interest expense
Interest on deposits		7,290			5,189
Interest on borrowings		16			12

Total interest expense		7,306			5,201


Net interest income		9,421			9,406

Provision for loan losses		270			225


Net interest income after provision for loan losses		9,151			9,181

Non-interest operating income		1,149			1,550


Non-interest expenses:

Salaries and employee benefits		5,164			5,024
Occupancy and equipment		1,223			1,275
Legal settlement expense		9,650			—
Other operating		3,960			3,301

Total non-interest expenses		19,997			9,600


(Loss) income before income (taxes) benefit		(9,697	)		1,131

Income tax benefit (expense)		3,258			(357	)


Net (loss) income	$	(6,439	)	$	774


Earnings (loss) per share:
Basic	$	(1.31	)	$	0.17
Diluted	$	(1.31	)	$	0.14

The accompanying notes are an integral part of these financial statements

PSB BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, except per share data)


	Six months Ended
	June 30,
	2006			2005
	(Unaudited)
CASH FLOW FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash
Net income (loss)	$	(6,439	)	$	774
Adjustments used in operating activities:
Provision for loan losses		270			225
Depreciation and amortization		453			499
Amortization of discounts and accretion of premiums on investment securities		68			140
Restricted stock. expense		200			200
ESOP expense		166			196
Loss (gain) on sale of real estate		(7	)		43
Proceeds from sale and amortization of loans held-for-sale		5,630			18,674
Originations of loans held-for-sale		(7,317	)		(19,201	)
Change in assets and liabilities:
(Increase) in accrued interest receivable		(16	)		(102	)
(Increase) decrease in other assets		(1,006	)		305
Increase in other liabilities		299			954

Total adjustments		(1,260	)		1,933


Net cash ( used in) provided by operating activities		(7,699	)		2,707


CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment securities, available-for-sale		—			(10,092	)
Proceeds from sales of investment securities		—			2,135
Proceeds from maturities and calls of investment securities		11,086			5,378
(Purchase)redemption of Federal Home Loan Bank and Federal Reserve Bank stock		(229	)		252
Net decrease (increase) in loans		(33,393	)		2,212
Proceeds from sale of real estate owned		—			165
Purchase of premises and equipment		(125	)		(817	)


Net cash used in investing activities		(22,661	)		(767	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		7,772			8,179
Increase in securities sold under agreements to repurchase		11			14
Change in treasury stock		(35	)		—
Exercise of stock options		38
(Decrease) in advances for borrowers’ taxes and insurance		(43	)		(340	)

Net cash provided by financing activities		7,743			7,853

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(22,617	)		9,793


Cash and cash equivalents, beginning of period		37,797			54,650


CASH AND CASH EQUIVALENTS, END OF PERIOD	$	15,180		$	64,443

The accompanying notes are an integral part of these financial statements

PSB BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
(In thousands)


	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2006			2005		2006			2005
	(Unaudited)
Net (loss) income	$	(624	)	$	203	$	(6,439	)	$	774

Other comprehensive income (loss), net of tax:

Accumulated comprehensive gain (loss), investments available for sale		(250	)		543		(282	)		(471	)


Comprehensive (loss ) income	$	(874	)	$	746	$	(6,721	)	$	303

The accompanying notes are an integral part of these financial statements

PSB BANCORP, INC.

NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2006
(Unaudited)

1. Basis of Presentation

This quarterly report presents the consolidated financial statements of PSB Bancorp, Inc. (“PSB”) and its subsidiaries.

PSB’s financial statements reflect all adjustments and disclosures that management believes are necessary for a fair presentation of interim results. The results of operations for the quarter presented does not necessarily indicate the results that PSB will achieve for all of 2006. You should read these interim financial statements in conjunction with the consolidated financial statements and accompanying notes that are presented in the PSB Bancorp, Inc. Annual Report on Form 10-K for the year ended December 31, 2005.

The financial information in this quarterly report has been prepared in accordance with PSB’s customary accounting practices; these financial statements have not been audited. Certain information and footnote disclosures required under generally accepted accounting principles have been condensed or omitted, as permitted by rules and regulations of the Securities and Exchange Commission.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods presented. Actual results could differ from those estimates.

2. Earnings Per Share (EPS)

Basic earnings per share exclude dilution and are computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period. Diluted earnings per share take into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. All weighted average, actual shares and per share information in these financial statements have been adjusted retroactively for the effect of stock dividends.

The computation of dilutive earnings per share for the three and six month periods ended June 30, 2005 presented in the tables below 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 (see Part II, Item 1 — Legal Proceedings, herein). At June 30, 2005, these shares were considered contingently issuable shares and were required to be included in the calculation of diluted EPS and excluded from the calculation of basic EPS.

Legal claims associated with options to purchase the 895,240 shares previously included in the dilutive earnings per share calculation were settled on May 9, 2006. Therefore, the computation of dilutive earnings per share for the three and six month periods ended June 30, 2006, does not include any additional shares related to those proceedings.


	Six months ended June 30, 2006
				Weighted
	Income			average shares		Per share
	(numerator)			(denominator)		amount
	(In thousands, except per share data)
Basic earnings per share

Loss available to common stockholders	$	(6,439	)		4,921	$	(1.31	)

Effect of dilutive stock options		—			N/A		—


Diluted earnings per share
Loss available to common stockholders plus effect of dilutive securities	$	(6,439	)		4,921	$	(1.31	)

All options were dilutive at June 30, 2006


	Three months ended June 30, 2006
				Weighted
	Income			average shares		Per share
	(numerator)			(denominator)		amount
	(In thousands, except per share data)
Basic earnings per share

Loss available to common stockholders	$	(624	)		4,923	$	(0.13	)

Effect of dilutive stock options		—			N/A		—

Diluted earnings per share
Loss available to common stockholders plus effect of dilutive securities	$	(624	)		5,066	$	(0.13	)

All options were dilutive at June 30, 2006


	Six months ended June 30, 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	$	774		4,659	$	0.17

Effect of dilutive stock options		—		985		(0.03	)


Diluted earnings per share
Income available to common stockholders plus effect of dilutive securities	$	774		5,644	$	0.14

All options were dilutive at June 30, 2005.


	Three months ended June 30, 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	$	203		4,655	$	0.04

Effect of dilutive stock options		—		967		—


Diluted earnings per share
Income available to common stockholders plus effect of dilutive securities	$	203		5,622	$	0.04

All options were dilutive at June 30, 2005.

3. New Accounting Pronouncements

RECENT ACCOUNTING PRONOUNCEMENTS

In March 2006, the FASB issued SFAS No. 156, “Amending Accounting for Separately Recognized Servicing Assets and Servicing Liabilities,” to simplify accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” to require an entity to 1) separately recognize financial assets as servicing assets or servicing liabilities, each time it undertakes an obligation to service a financial asset by entering into certain kinds of servicing contracts, 2) initially measure all separately recognized servicing assets and servicing liabilities at fair value, if practicable and 3) separately present servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. Additionally, SFAS No. 156 permits an entity to choose either the amortization method or the fair value measurement method for measuring each class of separately recognized servicing assets and servicing liabilities. SFAS No. 156 also permits a servicer that uses derivative financial instruments to offset risks on servicing to use fair value measurement when reporting both the derivative financial instrument and related servicing asset or liability. SFAS 156 applies to all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006, although early adoption is permitted. PSB is in the process of assessing the impact of the adoption of this statement on PSB’s financial results.

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 PSB’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 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. PSB is currently accounting for investments in accordance with this guidance, and therefore, the adoption of this FSP will not have a material impact on PSB’s results of operations or financial position.

On July 13, 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. Only tax positions that meet a “more-likely-than-not” recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative

effect of applying the provisions of FIN 48 are to be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that fiscal year. The new interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. The Company is currently assessing what the impact of this interpretation will be on the Company’s financial position or results of operations.

4. Stock Based Compensation

PSB adopted SFAS No. 123(R), “Share-Based Payments” on January 1, 2006 using a modified method of prospective application. Under SFAS No.123(R), all forms of shared-based payments to employees, including employee stock options, are treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award would generally be measured at fair value at the grant date. SFAS No.123(R) eliminates the ability to account for share-based compensation transactions using APB Opinion No.25. All options were fully vested as of December 31, 2005. PSB granted no options in the first quarter of 2006. Because all of PSB’s stock options are fully vested, there was no impact on income from continuing operations, income before taxes, net income or basic and diluted earnings per share from adopting SFAS No.123(R). Results for 2005 have not been restated. At June 30, 2006 there were 9,019 options exercised and PSB had 909,291 fully vested options outstanding with a weighted average exercise price of $9.47 and an aggregate intrinsic value of approximately $1,436,681. There were no grants or forfeitures during the six months ended June 30, 2006.

Prior to the adoption of Statement 123(R), PSB presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Statement of Cash Flows. Statement 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. However, during second quarter of 2006.

There is no table presented for the pro forma net income (loss) for the three and six month periods ended June 30, 2005, because there were no options that vested during the three and six month periods ended June 30, 2005.

5. 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”) and formed two new subsidiaries, one adopting the MPS name and the other, Avanti Capital, Inc, a registered investment advisory company. During the year ended December 31, 2001, 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 314,350 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 resulted in PSB recording goodwill of $1,381,363 and minority interest of $308,699. 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 tested for impairment, 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.

6. Legal Settlement

As previously disclosed in Part I, Item 1A, Risk Factors in PSB’s annual report on Form 10-K for the year ended December 31, 2005, PSB was a party to litigation regarding the validity of certain options. In the second quarter of 2006, management decided to settle the litigation for a cash payment of $9.65 million (the “Options Settlement”). Management concluded that this course of action was in the best interest of the shareholders. In accordance with the terms of the Options Settlement, plaintiffs terminated and waived or stipulated to dismissal with prejudice, all related claims against PSB. The plaintiffs, PSB, and its directors have executed mutual releases and covenants not to sue. The net of tax charge to earnings of $6.4 million was recorded in the first quarter and is included in the financial statements as of and for the six months ended June 30, 2006.

7. Reclassifications

Certain 2005 amounts have been reclassified to conform to the 2006 presentation.

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

RESULTS OF OPERATIONS

General

PSB’s results of operations depend primarily on First Penn Bank’s (the “Bank”) net interest income, which is the difference between interest income on its interest-earning assets, and interest expense on its interest-bearing liabilities. The Bank’s interest-earning assets consist primarily of loans receivable and investment securities, while its interest-bearing liabilities consist primarily of deposits and borrowings. 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, 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 that 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 PSB 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 Loan Losses

PSB uses the reserve method of accounting for loan 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 losses are made by charges to the provision for loan losses. Recoveries of previously charged-off amounts are credited to the allowance for loan losses.

While management considers the allowance for loan 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. In addition, the regulators, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. The banking 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.

Performance Overview

PSB’s net loss for the second quarter of 2006 was $624,000 or $(0.13) and $(0.13) on a basic and diluted per share basis. PSB’s net income for the second quarter of 2006 would have been $220,000 or $0.05 and $0.05 on a basic and diluted per share basis, if not for a non-recurring increase in the other expense related to the purchase of the rights to certain contested options as described in PSB’s report on Form 8-K filed with the SEC on June 20, 2006 (“Rights Purchase”). This compares to net income of $203,000 or $0.04 and $0.04 on a basic and diluted per share basis for the same quarter of 2005. The results for the second quarter of 2006 were primarily affected by a significant increase in interest expense and the expense of the Rights Purchase.

For the three months ended June 30, 2006, the Bank’s net interest margin decreased 32 basis points to 3.40% from 3.72% for the same period in 2005.

The Bank’s net interest margin decreased by 16 basis points from 3.71% for the six months ended June 30, 2005 to 3.55% for the same period in 2006.

Net Income (Loss)

PSB’s net loss for the three month period that ended June 30, 2006, was $624,000. or $(0.13) and $(0.13) on a basic and diluted per share basis compared to $203,000 or $0.04 and $0.04 on a basic and diluted per share basis for the three month period ended June 30, 2005. The non-recurring increase in other expenses related to the Rights Purchase had the effect of reducing both basic and diluted earnings per share by $(0.18).

PSB’s net loss for the six month period that ended June 30, 2006, was $6.4 million or $(1.31) and $(1.31) on a basic and diluted per share basis compared to $0.17 and $0.14 on a basic and diluted per share basis for the six month period that ended June 30, 2005. The significant decrease in earnings is attributable to a settlement related to outstanding litigation as reported in PSB’s Form 8-K filed with the SEC on May 9, 2006 (the “Option Settlement”) and the expense attributable to the Rights Purchase.

Although PSB has a diversified loan portfolio, the Bank continues to experience a decreasing net interest margin, due to the rapid and continuing increase in the cost of funds related to the continued increase in market interest rates generally. The Bank continues to increase its origination of commercial real estate loans, commercial business loans, and construction loans. The commercial real estate and construction loan departments are aggressively pursuing a marketing effort to increase their share of these market segments while maintaining an acceptable level of credit risk. Management also continues to pursue lending strategies to increase consumer home equity, and home equity lines of credit balances.

Net Interest Income and Average Balances

Net interest income is a key component of PSB’s profitability and is managed in coordination with PSB’s interest rate sensitivity position. Net interest income for the second quarter of 2006 decreased 4.3% from $4.7 million in the second quarter of 2005 compared to $4.5 million for the second quarter of 2006. Net interest income for the six month period ended June 30, 2006, was $9.4 million, the same as the six month period in 2005.

Overall, average total interest-earning assets provided a yield of 6.26% for the three months ended June 30, 2006, compared to 5.86% for the same period in 2005. Average total loans were $395.6 million for the three months ended June 30, 2006, and provided a yield of 7.11% for the period, compared to average total loans of $356.5 million for the three months ended June 30, 2005, which provided a yield of 6.99% for the period.

Overall, average total interest-earning assets provided a yield of 6.30% for the six months ended June 30, 2006, compared to 5.76% for the same period in 2005. Average total loans were $382.6 million for the six months ended June 30, 2006, and provided a yield of 7.37% for the period, compared to average total loans of $356.2 million for the six months ended June 30, 2005, which provided a yield of 6.89%.

Average total interest-bearing liabilities increased from $445.0 million to $467.8 million or 5.12% for the three months ended June 30, 2006, compared to the three-month period ended June 30, 2005. The average rate on total interest-bearing liabilities increased 80 basis points from 2.43% for the three months ended June 30, 2005, to 3.23% for the three months ended June 30, 2006. The increase in interest-bearing liabilities resulted from increases in certificates of deposit. The increase in the overall rate paid on interest-bearing liabilities was due to PSB’s decision to increase deposits by offering more competitive interest rates on its certificates of deposit.

Average total interest-bearing liabilities increased from $445.0 million to $465.8 million or 4.67% for the six months ended June 30, 2006, compared to the six month period ended June 30, 2005. The average rate on total interest-bearing liabilities increased 80 basis points from 2.34% for the six months ended June 30, 2005, to 3.14% for the six months ended June 30, 2006.

The increased funding costs resulting from higher rates resulted in a 16 basis point compression of our net interest margin for the period ended June 30, 2006, compared to the six month period ended June 30, 2005, and a 32 basis point compression for the three month period ended June 30, 2006, compared to the three month period ended June 30, 2005.

Provision for Loan Losses

The provision for loan losses represents the charge against earnings that is required to fund the allowance for loan losses. PSB determines the level of the allowance for loan losses through a regular review of the loan portfolio. Management’s evaluation of the adequacy of the allowance for loan losses is based upon an examination of the portfolio as well as such factors as declining trends, the volume of loan concentrations, adverse situations that may affect the borrower’s ability to pay, prior loss experience within the portfolio, current economic conditions and the results of the most recent regulatory examinations. PSB made a provision of $270,000 for loan losses during the six months ended June 30, 2006, and a $225,000 provision for the six months ended June 30, 2005. Additionally, PSB had charge-offs against the allowance for loan losses of $79,000 and $268,000 and recoveries of $46,000 and $80,000 during the six month periods ended June 30, 2006, and 2005, respectively.

Average Balance Sheets and Rate/Yield Analysis

Net interest income is affected by changes in both average interest rates and average volumes of interest-earning assets and interest-bearing liabilities. The following tables present the average daily balances of assets, liabilities, and shareholders’ equity and the respective interest earned or paid on interest-earning assets and interest-bearing liabilities, as well as average rates for the period indicated:


	Three months Ended June 30,
	2006							2005
	Average				Yield/			Average				Yield/
	Balance		Interest		Rate			Balance		Interest		Rate
					(Dollars in thousands)
ASSETS
Interest-earning assets:
Interest-earning deposits	$	11,516	$	67		2.33	%	$	54,554	$	347		2.54	%
Investment securities		92,801		884		3.81			61,702		505		3.27
Mortgage-backed securities		27,674		279		4.03			34,064		341		4.00
Loans		395,611		7,033		7.11			356,461		6,226		6.99

Total interest-earning assets		527,602	$	8,263		6.26	%		506,781	$	7,419		5.86	%

Noninterest-earning assets		30,778							33,318

Total assets	$	558,380						$	540,099


LIABILITIES
Interest-bearing liabilities:
Now checking accounts	$	24,695	$	22		0.36	%	$	25,297	$	32		0.51	%
Money market accounts		50,702		299		2.36			50,720		193		1.52
Savings deposits		70,347		220		1.25			83,963		251		1.20
Certificates		320,943		3,222		4.02			283,866		2,224		3.13

Total deposits		466,687		3,763		1.61	%		443,846		2,700		1.22
Borrowed money		1,136		9		3.17			1,118		6		2.15

Total interest-bearing liabilities		467,823	$	3,772		3.23	%		444,964	$	2,706		2.43	%

Non-interest-bearing liabilities		43,317							42,745

Total liabilities		511,140							487,709
Shareholders’ equity		47,240							52,390

Total liabilities and shareholders’ equity	$	558,380						$	540,099

Net interest income			$	4,491						$	4,713

Interest rate spread						3.04	%						3.42	%
Net yield on interest-earning assets						3.40	%						3.72	%

Ratio of interest-earning assets to interest-bearing liabilities						1.13	x						1.14	x


	Six months Ended June 30,
	2006							2005
	Average				Yield/			Average				Yield/
	Balance		Interest		Rate			Balance		Interest		Rate
					(Dollars in thousands)
ASSETS
Interest-earning assets:
Interest-earning deposits	$	23,023	$	254		2.21	%	$	56,514	$	656		2.32	%
Investment securities		95,538		1,785		3.74			59,981		971		3.24
Mortgage-backed securities		29,500		584		3.96			34,478		709		4.11
Loans		382,592		14,104		7.37			356,242		12,271		6.89

Total interest-earning assets		530,653	$	16,727		6.30	%		507,215	$	14,607		5.76	%

Noninterest-earning assets		28,494							30,543

Total assets	$	559,147						$	537,758


LIABILITIES
Interest-bearing liabilities:
Now checking accounts	$	24,560	$	54		0.44	%	$	25,599	$	66		0.52	%
Money market accounts		48,400		616		2.55			50,219		355		1.41
Savings deposits		73,158		481		1.31			85,218		490		1.15
Certificates		318,504		6,139		3.85			282,918		4,278		3.02

Total deposits		464,622		7,290		3.14	%		443,954		5,189		2.34
Borrowed money		1,131		16		2.83			1,117		12		2.15

Total interest-bearing liabilities		465,753	$	7,306		3.14	%		445,071	$	5,201		2.34	%

Non-interest-bearing liabilities		44,160							40,375

Total liabilities		509,913							485,446
Shareholders’ equity		49,234							52,312

Total liabilities and shareholders’ equity	$	559,147						$	537,758

Net interest income			$	9,421						$	9,406

Interest rate spread						3.17	%						3.42	%
Net yield on interest-earning assets						3.55	%						3.71	%

Ratio of interest-earning assets to interest-bearing liabilities						1.14	x						1.14	x

Non-interest Income

Non-interest income consists of service charges, rental income, other income, and gain on the sale of loans and securities. Non-interest income for the six month period ended June 30, 2006, decreased $401,000 or 25.87% compared to the same period in 2005. The significant decrease in non-interest income in the six months ended June 30, 2006, was primarily attributable to a one-time gain on the sale of investment securities held by PSA Service Corp. occurring during the six month period ending June 30, 2005, which resulted in a higher than normal amount of non-interest income for that period. PSB’s non-interest income for the second quarter of 2006, decreased by $4,000 or 6.8% from $585,000 to $581,000 at June 30, 2006.

The following table provides a summary of non-interest income, for the six months ended June 30, 2006, and 2005:


	Six months ended
	June 30,
	2006			2005
	(In thousands)
Service fees on deposit accounts	$	690		$	611
(Loss) on sale of real estate owned		(7	)		(43	)
Banked owned life insurance		264			233
Gain on sale of investment securities		—			423
Other		202			326

Total	$	1,149		$	1,550

Non-interest Expense

Non-interest expense for the Bank increased $10.4 million or 108.28%, to $20.0 million for the six months ended June 30, 2006, from $9.6 million for the same period in the prior year. The increase in non-interest expense that affected earnings in the six month period ended June 30, 2006, is attributable to the expense related to the Options Settlement and the Rights Purchase. On May 9, 2006, PSB Bancorp, Inc. settled the litigation concerning the validity of options to acquire 1,199,800 shares of PSB Bancorp, Inc. common stock, in exchange for a payment to the plaintiffs of $9.65 million. This payment resulted in a one time after-tax earnings charge of $6.4 million and was recorded as an expense during the first quarter of 2006. On June 20, 2006, PSB purchased all rights, if any, to 342,800 contested options (the “Rights”) to acquire PSB common stock in a secured creditor sale from “The Bank”, a New Jersey financial institution. The contested options were purportedly originally issued to Hal Shaffer, a former employee/director of a predecessor institution, and are the subject of on-going litigation regarding the validity of such options. This non-recurring increase in other expense had the effect of reducing earnings by $792,000 net of a tax benefit of $408,000. The gross charge of $ 1.2 million is included in other operating expense in the table below.

The following table provides a summary of non-interest expense, by category of expense, for the six months ended June 30, 2006, and 2005:


	Six months ended
	June 30,
	2006		2005
	(In thousands)
Salaries and employment benefits	$	5,164	$	5,024
Rent and occupancy expense		1,223		1,275
Professional fees		678		753
FDIC insurance expense		61		61
General insurance		151		159
Advertising		111		135
Data processing fees		371		181
Director fees		128		136
Legal settlement expense		9,650		—
Other operating expense		2,460		1,876

Total	$	19,997	$	9,600

Provision for Income Taxes

Income tax benefit and (provision) for the six month periods ended June 30, 2006, and 2005 were $3.3 million and $(357,000), respectively.

Liquidity

The maintenance of adequate liquidity and the mitigation of interest rate risk are integral to the management of PSB’s balance sheet. Liquidity represents the ability to meet potential cash outflows resulting from deposit customers who need to withdraw funds or borrowers who need available credit. PSB’s liquidity is quantified through the use of a standard liquidity ratio of liquid assets (cash and cash equivalents, investment securities available-for-sale, mortgage-backed securities available-for-sale and Federal Home Loan Bank stock) to short-term borrowings plus deposits.

PSB’s asset/liability management committee monitors the level of short-term assets and liabilities to maintain an appropriate balance between liquidity, risk, and return. Liquidity is derived from various sources which include increases in core deposits, sales of certificates of deposits, the amortization, and prepayment of loans and mortgage-backed securities, and maturities of investment securities and other short-term investments. The liquidity position of PSB is also strengthened by a $220.3 million credit facility with the Federal Home Loan Bank (“FHLB”). Advances are secured by FHLB stock and qualifying mortgage loans. PSB had no outstanding borrowings from the FHLB as of June 30, 2006.

Maximizing cash flow over time is crucial to the maintenance of adequate liquidity. PSB’s total cash flow is a product of its operating activities, investing activities and financing activities. During the six months ended June 30, 2006, net cash used in operating activities was $7.7 million, compared to net cash provided by operating activities of $2.7 million for the same period of 2005. During the six months ended June 30, 2006, net cash used in investing activities was $22.6 million, compared to net cash used in investing activities of $767,000 for the same period of 2005. Financing activities provided net cash of $7.7 million during the six months ended June 30, 2006, compared to $7.9 million in net cash provided by financing activities for the same period of 2005. The net result of these items was a $22.6 million decrease in cash and cash equivalents for the six months ended June 30, 2006 compared to December 31, 2005.

Interest Rate Sensitivity

Interest rate sensitivity focuses on the impact of fluctuating interest rates and the re-pricing characteristics of rate sensitive assets and liabilities on net interest income. Interest rate sensitivity is closely related to liquidity since each is directly affected by the maturity of assets and liabilities. Rate sensitivity also deals with exposure to fluctuations in interest rates and its effect on net interest income. The primary function of PSB’s interest rate sensitivity management is to reduce exposure to interest rate risk through an appropriate balance between interest-earning assets and interest-bearing liabilities. The goal is to minimize fluctuations in the net interest margin of PSB due to general changes in interest rates.

The blending of fixed and floating-rate loans and investments to match the re-pricing and maturity characteristics of the various funding sources is a continuous process in an attempt to minimize any significant fluctuations in net interest income. The composition of the balance sheet is designed to minimize any significant fluctuation in net interest income and to maximize liquidity. Management believes that the accessibility to FHLB borrowings will provide the flexibility to assist in keeping fluctuations in net interest income under control and to maintain an adequate liquidity position.

Capital Adequacy

PSB is required to maintain minimum ratios of Tier I and total capital to total “risk weighted” assets and a minimum Tier I leverage ratio, as defined by the banking regulators. At June 30, 2006, PSB was required to have a minimum Tier I and total capital ratios of 6.0% and 10.0%, respectively, and a minimum Tier I leverage ratio of 5.0%. PSB’s actual Tier I and total capital ratios at June 30, 2006, were 11.83% and 12.71%, respectively, and PSB’s Tier I leverage ratio was 8.51%. These ratios exceed the requirements for classification as a “well capitalized” institution, the industry’s highest capital category.

On June 30, 2006, PSB was in compliance with regulatory capital requirements as shown in the following table:


	Well
	Capitalized			At June 30, 2006						At December 31, 2005
	Ratios			PSB			Bank			PSB			Bank
	(Dollars in thousands)
Tier I Capital				$	47,386		$	40,993		$	53,437		$	41,885
Tier II Capital					3,537			3,537			3,300			3,300

Total Qualifying Capital				$	50,923		$	44,530		$	56,737		$	45,185

Risk Adjusted Total Assets				$	400,565		$	394,958		$	381,254		$	377,761

Tier I Risk Based Capital Ratio		6.00	%		11.83	%		10.38	%		14.02	%		11.09	%
Total Risk Based Capital Ratio		10.00	%		12.71	%		11.27	%		14.88	%		11.96	%
Leverage Ratio		5.00	%		8.51	%		7.43	%		9.53	%		7.50	%

Average Assets				$	556,995		$	551,651		$	560,650		$	558,167

FINANCIAL CONDITION

General

PSB’s total assets increased $1.7 million from $560.7 at December 31, 2005, to $562.4 million as of June 30, 2006. Net loans outstanding increased by $33.2 million, or 9.06%, At June 30, 2006, PSB’s net loan portfolio totaled $399.7 million compared to $366.5 million at December 31, 2005 and cash and cash equivalents decreased by 59.79% to $15.2 million during the first six months of 2006, primarily as a result of increased loan demand during 2006. Total deposits equaled $508.9 million, an increase of $7.8 million or 1.56%, during the first six months of 2006. The increase in deposits was primarily as a result of increases in higher-cost certificates of deposit.

The following tables summarize the loan portfolio of PSB by loan category and amount at June 30, 2006, compared to December 31, 2005, respectively. Loans increased to $402.4 million at June 30, 2006 from $369.5 million at December 31, 2005, an increase of $33.0 million or 8.90%. 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 and construction loans made to small and medium sized businesses in its market area. A significant increase in the volume of commercial loans during the first six months of 2006 underscores that focus as the commercial portfolio increased to $192.3 million at June 30, 2006, from $171.6 million at December 31, 2005, an increase of $20.7 million or 12.06%.

The loan categories correspond to PSB’s general classifications (Dollars in thousands):


	At June 30,					At December 31,
	2006					2005
	Amount		Percent			Amount		Percent			Variance		% Change
Commercial loans	$	192,276		47.78	%	$	171,555		46.43	%	$	20,721		12.08	%
Construction loans		51,202		12.72	%		48,309		13.08	%		2,893		5.99	%
Mortgage loans(1)		81,345		20.21	%		79,856		21.61	%		1,489		1.86	%
Consumer loans		77,598		19.29	%		69,736		18.88	%		7,862		11.27	%

Total loans	$	402,421		100.00	%	$	369,456		100.00	%	$	32,965		8.92	%


	At June 30,				At December 31,
	2006				2005
	Amount			Percent	Amount			Percent	Variance	% Change
Unearned fees and discounts	$	853			$	378
Allowance for loan losses		(3,537	)			(3,300	)

Net Loans	$	399,737			$	366,534


(1)		Does not include loans held for sale.

The following table summarizes the loan portfolio of PSB by loan interest rate type and amount at June 30, 2006, and December 31, 2005.


	At June 30					At December 31,
	2006					2005
	Amount		Percent			Amount		Percent
Fixed rates	$	307,398		76.39	%	$	285,884		77.38	%
Adjustable rate		95,023		23.61	%		83,572		22.62	%

Total loans	$	402,421		100.00	%	$	369,456		100.00	%

Asset Quality

Non-Performing Assets

PSB’s non-performing assets decreased $630,000 or 16.67%, to $3.0 million at June 30, 2006, from $3.6 million at December 31, 2005. 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. There are occasional exceptions if the loans are in the process of collection and the loan is fully secured.

The following table sets forth non-performing assets as of June 30, 2006, and December 31, 2005:


	At June			At December 31,
	2006			2005
	(Dollars in thousands)
Loans past due 90 days or more as to interest or principal and accruing interest	$	—		$	—
Nonaccrual loans		1,880			2,510

Total nonperforming loans		1,880			2,510
Real estate owned (REO)		1,109			1,109

Total nonperforming assets	$	2,989		$	3,619

Nonperforming loans to total loans		0.47	%		0.68	%
Nonperforming assets to total assets		0.53	%		0.65	%
Allowance for loan losses to total loans		0.88	%		0.89	%
Allowance for loan losses to nonperforming loans		188.14	%		131.47	%
Allowance for loan losses to nonperforming assets		118.33	%		91.19	%
Net charge-offs as a percentage of total loans		0.02	%		0.11	%

Note: Total loans do not include loans held for sale

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses charged to expense. A charge is made against the allowance for possible 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. These estimates are particularly susceptible to changes that may result in a material adjustment to the allowance for loan losses. As adjustments become identified, they are reported in earnings for the period in which they become known. Management believes that it makes an informed judgment based upon available information.

It is the objective of PSB’s evaluation process to establish the following components of the allowance for loan losses: a specific allocation for certain identified loans, a general allocation for identified pools of loans based on risk rating, and a general allocation for inherent loan portfolio losses. Management performs current evaluations of its criticized and classified loan portfolios and assigns specific reserves that reflect the current risk to PSB. A general reserve allocation is applied for pools of loans based on risk rating for all loans not specifically reserved for as described previously. The methodology used to calculate the provision is consistent with the guidance provided in SEC Staff Accounting Bulletin No. 102. Management reviews the adequacy of its allowance on an ongoing basis and will provide, as management may deem necessary, for additional provisions in future periods.

PSB 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 flow 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 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There has been no material change in PSB’s assessment of its sensitivity to market risk since its presentation in the 2005 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

Item 4. Controls And Procedures

(a) Disclosure Controls and Procedures. PSB’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of PSB’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, PSB’s disclosure controls and procedures are effective.

(b) Internal Control Over Financial Reporting. There have not been any changes in PSB’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, PSB’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. 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 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. The options related to this action are subject to various interest claims based on Mr. Shaffer’s assignment or pledge of the options to various parties. As part of the settlement referenced in Paragraph I, one of the parties settled its claims to 171,400 options included as part of this action. PSB intends to defend vigorously the action. However, there can be no assurance regarding the eventual outcome of this litigation.

B. On May 9, 2006, PSB announced the settlement of outstanding litigation concerning the validity of options to acquire 1,199,800 shares of PSB Bancorp, Inc. common stock. In exchange for a payment to the plaintiffs of $9.65 million, plaintiffs have terminated and waived, or stipulated to dismissal with prejudice, all related claims against PSB Bancorp. This payment resulted in a one time after-tax earnings charge of $6.4 million and a corresponding reduction in capital recorded in the first quarter of 2006.

After the foregoing payments, both PSB and First Penn Bank are well-capitalized under FDIC guidelines. The plaintiffs, PSB and its directors have executed mutual releases and covenants not to sue.

There are no additional material developments to report regarding the above actions at the time of the filing of this quarterly report on Form 10-Q. Additional information related to these actions is contained in PSB’s previously filed reports on Forms 10-K, 10-Q and 8-K.

Item 1A . Risk Factors.

The risk factor related to a court decision in favor of the purported option-holders previously disclosed in response to Item 1A to Part 1 of PSB’s Form 10-K for the year ended December 31, 2005 has changed as follows:

A court decision in favor of the purported option-holders could have an effect on our stock price

On June 20, 2006, PSB purchased the rights to 342,800 contested options to acquire the PSB’s common stock in a secured creditor sale from “The Bank”, a New Jersey financial institution. The contested options were purportedly originally issued to Hal Shaffer, a former employee/director of a predecessor institution, and are the subject of on-going litigation regarding the validity of such options by the PSB’s. This non-recurring increase in other expense had the effect of reducing earnings by $792,000 net of a tax benefit of $408,000.

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

The following table sets forth information regarding PSB’s repurchases of its common stock during the quarter ended June 30, 2006.

Total

Maximum

Number of

Number (or

Shares (or Units)

Approximate Dollar

Total

Average

Purchased

Value) of Shares (or

Number of

Price Paid

as Part of Publicly

Units) that May Yet

Shares (or Units)

per Share

Announced Plans

Be Purchased Under

Period

Purchased

(or Unit)

or Programs

the Plans or Programs

April 1 to June 30, 2006

5,031

12.00

N/A

Total

5,031

12.00


(1)		During the second quarter of 2006, PSB repurchased 5,031 of ESOP shares from three former employees of the bank

Item 3. Defaults upon Senior Securities.

Not Applicable

Item 4. Submission of Matters to a Vote of Security Holders.

None

Item 5. Other Information.

None

Item 6. Exhibits.

(a) Exhibits.


31.1		Certification of Anthony DiSandro pursuant to Section 312 of the Sarbanes Oxley Act of 2002.

31.2		Certification of John Carrozza pursuant to Section 312 of the Sarbanes-Oxley Act of 2002.

32		Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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 dully authorized.


	PSB BANCORP, INC.

	By:	/s/ Anthony DiSandro

		Anthony DiSandro,
		President, Chief Executive Officer, and Director

	By:	/s/ John Carrozza

		John Carrozza,
		Chief Financial Officer (Principal Financial Officer and
		Chief Accounting Officer)
August 14, 2006

EXHIBIT INDEX


Exhibit No.		Document

31.1		Certification of Anthony DiSandro pursuant to Section 312 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of John Carrozza pursuant to Section 312 of the Sarbanes-Oxley Act of 2002.

32		Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
		Sarbanes-Oxley Act of 2002.

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PSB BANCORP INC 10-Q