FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission file number 0-16772
PEOPLES BANCORP INC.
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(Exact name of Registrant as specified in its charter)
Ohio
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(State or other jurisdiction of incorporation or organization)
31-0987416
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(I.R.S. Employer Identification No.)
138 Putnam Street, P. O. Box 738, Marietta, Ohio 45750
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (740) 373-3155
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Not Applicable
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
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 X No
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
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Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, at August 7, 2003: 10,164,001.
Exhibit Index Appears on Page 35
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
The following Condensed Consolidated Balance Sheets, Condensed Consolidated
Statements of Income, Consolidated Statements of Stockholders' Equity, and
Consolidated Statements of Cash Flows of Peoples Bancorp Inc. and subsidiaries
("Peoples"), reflect all adjustments (which include normal recurring accruals)
necessary to present fairly such information for the periods and dates
indicated. Since the following condensed unaudited financial statements have
been prepared in accordance with instructions to Form 10-Q, they do not contain
all information and footnotes necessary for a fair presentation of financial
position in conformity with accounting principles generally accepted in the
United States. Results of operation for the six months ended June 30, 2003, are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2003. The balance sheet at December 31, 2002, contained
herein has been derived from the audited balance sheet included in Peoples
Bancorp Inc.'s Annual Report on Form 10-K for the year ended December 31, 2002
("2002 Form 10-K"). Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States have been omitted. These
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the 2002 Form 10-K.
The consolidated financial statements include the accounts of Peoples Bancorp
Inc. and its wholly-owned subsidiaries. Material intercompany accounts and
transactions have been eliminated.
PEOPLES BANCORP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
June 30, December 31,
ASSETS 2003 2002
Cash and cash equivalents:
Cash and due from banks $ 45,979 $ 34,034
Interest-bearing deposits in other banks 761 1,016
Federal funds sold 93,500 20,500
Other short-term investments 14,994 -
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Total cash and cash equivalents 155,234 55,550
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Available-for-sale investment securities, at estimated fair value (amortized
cost of $671,815 and $402,048 at June 30, 2003, and
December 31, 2002, respectively) 689,680 412,100
Loans, net of unearned interest 916,603 850,891
Allowance for loan losses (14,151) (13,086)
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Net loans 902,452 837,805
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Bank premises and equipment, net 22,102 18,058
Goodwill 40,771 25,504
Other intangible assets 8,032 5,234
Other assets 41,819 40,110
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Total assets $ 1,860,090 $ 1,394,361
=====================================================================================================================
LIABILITIES
Deposits:
Non-interest bearing $ 196,576 $ 115,907
Interest bearing 946,843 839,970
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Total deposits 1,143,419 955,877
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Short-term borrowings:
Federal funds purchased and securities sold under repurchase agreements 20,326 31,183
Federal Home Loan Bank term advances 22,500 -
Other short-term borrowings - 17,000
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Total short-term borrowings 42,826 48,183
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Long-term borrowings 456,129 203,829
Accrued expenses and other liabilities 10,259 10,199
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Total liabilities 1,652,633 1,218,088
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Guaranteed preferred beneficial interests in junior subordinated debentures 29,133 29,090
STOCKHOLDERS' EQUITY
Common stock, no par value, 24,000,000 shares authorized - 10,218,955 shares
issued at June 30, 2003, and 9,421,222 issued
at December 31, 2002, including shares in treasury 147,905 129,173
Accumulated comprehensive income, net of deferred income taxes 11,523 6,446
Retained earnings 20,022 12,650
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179,450 148,269
Treasury stock, at cost, 60,970 shares at June 30, 2003, and
59,351 shares at December 31, 2002 (1,126) (1,086)
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Total stockholders' equity 178,324 147,183
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Total liabilities, beneficial interests and stockholders' equity $ 1,860,090 $ 1,394,361
=====================================================================================================================
See notes to the consolidated unaudited financial statements
PEOPLES BANCORP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data) Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
Interest income:
Interest and fees on loans $ 15,678 $ 15,171 $ 31,017 $ 30,315
Interest on taxable investment securities 7,035 4,417 13,723 8,967
Interest on tax-exempt investment securities 721 716 1,445 1,327
Other interest income 58 8 84 18
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Total interest income 23,492 20,312 46,269 40,627
Interest expense:
Interest on deposits 4,903 5,160 10,107 10,699
Interest on short-term borrowings 138 229 242 520
Interest on long-term borrowings 4,290 2,412 8,116 4,738
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Total interest expense 9,331 7,801 18,465 15,957
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Net interest income 14,161 12,511 27,804 24,670
Provision for loan losses 935 980 1,766 1,841
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Net interest income after provision for loan losses 13,226 11,531 26,038 22,829
Other income:
Service charges on deposits 2,052 1,675 3,777 3,041
Fiduciary revenues 858 640 1,444 1,256
Electronic banking revenues 529 414 983 782
Business owned life insurance 353 376 718 701
Mortgage banking income 337 - 567 -
Insurance and investment commissions 320 462 762 986
(Loss) gain on securities transactions (29) - (27) 51
Loss on asset disposals (236) (7) (238) (14)
Gain on early debt extinguishment - - - 631
Other non-interest income 98 66 231 150
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Total other income 4,282 3,626 8,217 7,584
Other expenses:
Salaries and benefits 4,827 4,346 9,551 8,830
Occupancy and equipment 1,108 940 2,206 1,866
Trust Preferred Securities expense 606 623 1,213 1,184
Professional fees 499 582 941 883
Marketing 379 150 655 536
Data processing and software 320 294 650 617
Franchise taxes 272 178 529 360
Amortization of intangible assets 271 112 472 223
Other non-interest expense 1,760 1,324 3,529 2,728
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Total other expenses 10,042 8,549 19,746 17,227
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Income before income taxes 7,466 6,608 14,509 13,186
Income taxes 2,027 1,845 4,056 3,730
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Net income $ 5,439 $ 4,763 $ 10,453 $ 9,456
=================================================================================================================================
Earnings per share:
Basic $ 0.55 $ 0.60 $ 1.07 $ 1.20
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Diluted $ 0.54 $ 0.59 $ 1.05 $ 1.18
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Weighted average common shares outstanding:
Basic 9,905,403 7,873,795 9,742,471 7,857,062
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Diluted 10,094,114 8,102,047 9,931,638 8,045,609
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Cash dividends declared $ 1,634 $ 1,202 $ 3,081 $ 2,279
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Cash dividend per share $ 0.16 $ 0.15 $ 0.31 $ 0.29
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See notes to the consolidated unaudited financial statements
PEOPLES BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Dollars in thousands) Accumulated
Other
Common Stock Comprehensive Retained Treasury
Shares Amount Income Earnings Stock Total
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Balance, December 31, 2002 9,421,222 $ 129,173 $ 6,446 $ 12,650 $ (1,086) $ 147,183
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Net income 10,453 10,453
Unrealized gain on available-for-sale investment
securities, net of reclassification adjustment 5,077 5,077
Exercise of common stock options (20,972 shares -
reissued 10,307 treasury shares) 10,665 47 223 270
Tax benefit from exercise of stock options 49 49
Distribution of treasury stock for deferred
compensation plan (reissued 304 treasury 6 6
shares)
Cash dividends declared (3,081) (3,081)
Issuance of common shares 216,000 4,794 4,794
Common stock issued under dividend
reinvestment plan 8,113 194 194
Purchase of treasury shares, 41,923 shares (928) (928)
Issuance of common shares to purchase
Kentucky Bancshares Incorporated (issued
592,648 shares - reissued 29,693 treasury 562,955 13,648 659 14,307
shares)
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Balance, June 30, 2003 10,218,955 $ 147,905 $ 11,523 $ 20,022 $ (1,126) $ 178,324
====================================================================================================================================
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Dollars in thousands) Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
Net income $ 5,439 $ 4,763 $ 10,453 $ 9,456
Other comprehensive income, net of tax:
Unrealized gain on available-for-sale investment securities
arising
during the period 3,356 4,651 5,059 3,315
Less: reclassification adjustment for securities (loss) gains
included
in net income, net of tax (19) - (18) 33
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Net unrealized gain (loss) on available-for-sale arising 3,375 4,651 5,077 3,282
during the period
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Total comprehensive income $ 8,814 $ 9,414 15,530 12,738
========================================================================================================================
See notes to the consolidated unaudited financial statements
PEOPLES BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) Six Months Ended
June 30,
2003 2002
Cash flows from operating activities:
Net income $ 10,453 $ 9,456
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation, amortization, and accretion, net 2,986 1,399
Provision for loan losses 1,766 1,841
Business owned life insurance income (718) (701)
Loss (gain) on securities transactions 27 (51)
Gain on early debt extinguishment - (631)
Increase in interest receivable (1,250) (646)
Increase in interest payable 1,075 138
Deferred income tax expense 889 131
Deferral of loan origination fees and costs 127 (69)
Other, net (3,830) (1,174)
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Net cash provided by operating activities 11,525 9,693
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Cash flows from investing activities:
Purchases of available-for-sale securities (430,251) (95,659)
Proceeds from sales of available-for-sale securities 49,509 32,793
Proceeds from maturities and calls of available-for-sale securities 132,754 37,043
Net decrease (increase) in loans 8,044 (24,557)
Expenditures for premises and equipment (1,011) (828)
Proceeds from sale of other real estate owned 446 206
Expenditures for other real estate owned (1,307) -
Acquisitions, net of cash received 12,015 12,718
Investment in tax credit funds (993) (1,315)
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Net cash used in investing activities (230,794) (39,599)
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Cash flows from financing activities:
Net increase in non-interest bearing deposits 62,110 2,304
Net increase in interest-bearing deposits 11,273 20,227
Net (decrease) increase in short-term borrowings (5,357) 1,961
Proceeds from long-term borrowings 258,018 7,000
Payments on long-term borrowings (8,776) (4,025)
Cash dividends paid (2,451) (1,985)
Purchase of treasury stock (928) (174)
Repurchase of Trust Preferred Securities - (6,150)
Proceeds from issuance of Trust Preferred Securities - 7,000
Proceeds from issuance of common shares 5,064 727
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Net cash provided by financing activities 318,953 26,885
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Net increase (decrease) in cash and cash equivalents 99,684 (3,021)
Cash and cash equivalents at beginning of period 55,550 32,838
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Cash and cash equivalents at end of period $ 155,234 $ 29,817
==================================================================================================================
Supplemental cash flow information:
Interest paid $ 17,266 $ 15,789
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Income taxes paid $ 2,339 $ 2,825
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See notes to the consolidated unaudited financial statements
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
Basis of Presentation
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The accounting and reporting policies of Peoples Bancorp Inc. and Subsidiaries
("Peoples") conform to accounting principles generally accepted in the United
States and to general practices within the financial services industry. Peoples
considers all of its principal activities to be financial services related. The
consolidated financial statements include all accounts of Peoples' parent
company and its wholly-owned subsidiaries. The preparation of the financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect
the amounts reported in the financial statements and accompanying notes. Actual
results could differ from those estimates. Certain reclassifications have been
made to prior period amounts, which had no impact on net income or stockholders'
equity, to conform to 2003 presentation. All significant intercompany accounts
and transactions have been eliminated.
1. Mergers and Acquisitions:
On May 9, 2003, Peoples Bancorp completed the acquisition of Kentucky
Bancshares Incorporated ("Kentucky Bancshares"), the holding company of
Kentucky Bank & Trust, for total consideration of $29.1 million ($14.8
million in cash and $14.3 million in Peoples Bancorp's common shares).
The acquisition of Kentucky Bancshares included the merger of Kentucky Bank
& Trust into Peoples Bank, National Association ("Peoples Bank"). As a
result, the five former Kentucky Bank & Trust offices in northeastern
Kentucky communities of Ashland, Russell, Flatwoods, Greenup and South Shore
now operate as full-service financial service offices of Peoples Bank. In
this transaction, Peoples acquired loans of $75 million, deposits of $113
million, and trust assets under management of $181 million, as well as three
ATMs.
Peoples accounted for the transaction under the purchase method of
accounting. The balances and operations of the acquisition are included in
Peoples' consolidated financial statements from the date of the acquisition,
and do not materially impact Peoples' financial position, results of
operations or cash flows for any period presented. As part of the purchase
price allocation, Peoples recorded goodwill of $13.0 million, core deposit
intangible of $3.5 million and trust relationship intangible of $1.0
million.
Management expects this acquisition to positively impact Peoples' earnings,
from combined cost savings and enhanced efficiencies resulting from the
closure of Peoples Bank's office at 404 Ferry Street in Russell, Kentucky
concurrent with the acquisition and the planned closure of Peoples Bank's
Catlettsburg, Kentucky office in October 2003. These office closings are due
to the proximity of the newly acquired offices in Russell and Ashland,
Kentucky that will continue to serve these markets.
2. New Accounting Pronouncements:
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Financial Interpretation No. 46, "Consolidation of Variable Interest
Entities" ("FIN 46"). The objective of FIN 46 is to provide guidance on how
to identify a variable interest entity and determine when assets,
liabilities, noncontrolling interests and results of operations of a
variable interest entity need to be included in a company's consolidated
financial statements. FIN 46 applies immediately to variable interest
entities created after January 31, 2003, and in the first fiscal year or
interim period beginning after June 15, 2003, to variable interest entities
in which an enterprise holds an interest that is acquired before February 1,
2003. With respect to interests in entities subject to FIN 46, including low
income housing investments, the adoption of FIN 46 will not have a material
impact on Peoples' financial position. Peoples has determined that the
provisions of FIN 46 may require de-consolidation of the subsidiary grantor
trusts, which issue mandatorily redeemable preferred securities of the
grantor trusts. At adoption of FIN 46, the grantor trusts may be
de-consolidated and the junior subordinated debentures of Peoples owned by
the grantor trusts would be disclosed. The Trust Preferred Securities
currently qualify as tier 1 capital of Peoples for regulatory capital
purposes. The banking regulatory agencies have not issued any guidance which
would change the capital treatment for Trust Preferred Securities based on
the impact of the adoption of FIN 46.
On May 15, 2003, FASB issued Statement of Financial Accounting Standards No.
150, "Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity" ("SFAS 150"). SFAS 150 modifies the accounting
for certain financial instruments that issuers could account for as equity.
Under SFAS 150, those instruments with characteristics of both liabilities
and equity must be classified as liabilities in statements of financial
position, with the corresponding payments to holders of the instruments
recognized as interest expense.
The reporting requirements of SFAS 150 are effective July 1, 2003. As a
result of this new standard, Peoples will reclassify its Trust Preferred
Securities, presented on the balance sheet as "Guaranteed preferred
beneficial interest in junior subordinated debentures", to liabilities and
recognize the related expense within the income statement as interest
expense versus Trust Preferred Securities expense. Accordingly, the adoption
of this standard had no impact on the results of operations or the financial
position of Peoples but will require the restatement of certain financial
ratios for all periods presented such as net interest margin, non-interest
income leverage and efficiency ratios, beginning in the third quarter of
2003.
3. Stock-Based Compensation:
Peoples accounts for stock-based compensation using the intrinsic value
method in accordance with Accounting Principles Board (APB) Opinion 25,
"Accounting for Stock Issued to Employees". No stock-based employee
compensation cost is reflected in net income, since all options granted
under those plans had an exercise price equal to the market value of the
underlying common shares on the date of grant. The following table
illustrates the effect on net income and earnings per share if Peoples had
applied the fair value recognition provisions of FASB Statement No. 123,
"Accounting for Stock-Based Compensation," to stock-based employee
compensation.
(Dollars in Thousands, except Per Share Data) Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
Net Income, as reported $ 5,439 $ 4,763 $ 10,453 $ 9,456
Deduct: stock-based compensation expense determined
under fair value based method, net of tax 141 90 227 150
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Pro forma net income $ 5,298 $ 4,673 $ 10,226 $ 9,306
=========================================================================================================================
Basic Earnings Per Share:
As reported $ 0.55 $ 0.60 $ 1.07 $ 1.20
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Pro forma $ 0.53 $ 0.59 $ 1.05 $ 1.18
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Diluted Earnings Per Share:
As reported $ 0.54 $ 0.59 $ 1.05 $ 1.18
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Pro forma $ 0.52 $ 0.58 $ 1.03 $ 1.16
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The fair value was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for
2003 and 2002:
2003 2002
Risk-free interest rate 5.50% 5.50%
Dividend yield 2.51% 2.51%
Volatility factor of the market price of parent stock 31% 31%
Weighted average expected life of options 7 years 7 years
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
\OF OPERATIONS
SELECTED FINANCIAL DATA
The following data should be read in conjunction with the unaudited consolidated
financial statements and the management discussion and analysis that follows:
At or For the Three At or For the Six
Months Ended June 30, Months Ended June 30,
SIGNIFICANT RATIOS 2003 2002 2003 2002
Return on average equity 12.92 % 18.85 % 12.95 % 19.10 %
Return on average assets 1.25 % 1.54 % 1.26 % 1.55 %
Net interest margin (a) 3.64 % 4.54 % 3.74 % 4.53 %
Non-interest income leverage ratio (b) 46.54 % 43.06 % 44.01 % 40.68 %
Efficiency ratio (c) 51.10 % 50.97 % 51.93 % 52.57 %
Average stockholders' equity to average assets 9.67 % 8.16 % 9.73 % 8.11 %
Average loans to average deposits 86.70 % 93.40 % 88.01 % 94.17 %
Cash dividends to net income 30.04 % 25.24 % 29.47 % 24.10 %
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ASSET QUALITY RATIOS (end of period)
Nonperforming loans as a percent of total loans (d) 0.62 % 0.87 % 0.62 % 0.87 %
Nonperforming assets as a percent of total assets (e) 0.35 % 0.57 % 0.35 % 0.57 %
Allowance for loan losses to loans net of unearned 1.54 % 1.44 % 1.54 % 1.44 %
interest
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CAPITAL RATIOS (end of period)
Tier I capital ratio 13.87 % 11.26 % 13.87 % 11.26 %
Risk-based capital ratio 15.34 % 12.62 % 15.34 % 12.62 %
Leverage ratio 8.80 % 8.42 % 8.80 % 8.42 %
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PER SHARE DATA
Net income per share - basic $ 0.55 $ 0.60 $ 1.07 $ 1.20
Net income per share - diluted 0.54 0.59 1.05 1.18
Cash dividends per share 0.16 0.15 0.31 0.29
Book value per share (end of period) 17.56 13.30 17.56 13.30
Tangible book value per share (end of period) (f) $ 12.75 $ 9.71 $ 12.75 $ 9.71
Weighted average shares outstanding - Basic 9,905,403 7,873,795 9,742,471 7,857,062
Weighted average shares outstanding - Diluted 10,094,114 8,102,047 9,931,638 8,045,609
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(a) Calculated using fully-tax equivalent net interest income as a percentage
of average earning assets.
(b) Non-interest income (less securities and asset disposal gains and/or
losses) as a percentage of non-interest expense (less intangible
amortization). The ratio for the six months ended June 30, 2002, excludes
gain on early debt extinguishment of $631,000.
(c) Non-interest expense (less intangible amortization) as a percentage of
fully tax equivalent net interest income plus non-interest income. The
ratio for the six months ended June 30, 2002, excludes gain on early debt
extinguishment of $631,000.
(d) Nonperforming loans include loans 90 days past due and accruing,
renegotiated loans and nonaccrual loans.
(e) Nonperforming assets include nonperforming loans and other real estate
owned. (f) Tangible book value per share reflects capital calculated for
banking regulatory requirements and excludes balance sheet impact of
intangible assets acquired through purchase accounting for acquisitions.
Introduction
- ------------
The following discussion and analysis of the Consolidated Financial Statements
of Peoples is presented to provide insight into management's assessment of the
financial condition and results of operations. Peoples' subsidiaries are Peoples
Bank, National Association ("Peoples Bank"), Peoples Investment Company, PEBO
Capital Trust I and PEBO Capital Trust II. Peoples Bank also operates Peoples
Insurance Agency, Inc. ("Peoples Insurance"), which offers a full range of life,
property, and casualty insurance products to customers in Peoples' markets, and
Peoples Loan Services, Inc., which invests in certain loans originated in
Peoples' markets. Peoples Investment Company also owns Peoples Capital
Corporation.
Peoples Bank is a member of the Federal Reserve System and subject to
regulation, supervision, and examination by the Office of the Comptroller of the
Currency. Peoples Bank offers complete financial products and services through
50 financial service locations and 33 ATMs in Ohio, West Virginia, and Kentucky.
Peoples Bank's e-banking service, Peoples OnLine Connection, can be found on the
Internet at www.peoplesbancorp.com (this uniform resource locator (URL) is an
inactive, textual reference only). Peoples Bank provides an array of financial
products and services to customers that include traditional banking products
such as deposit accounts, lending products, credit and debit cards, corporate
and personal trust services, and safe deposit rental facilities. Peoples
provides services through ordinary walk-in offices and automobile drive-in
facilities, automated teller machines, banking by phone, and the Internet.
Peoples Bank also makes available other financial services through Peoples
Financial Advisors, which provides customer-tailored services for fiduciary
needs, investment alternatives, financial planning, retirement plans, and other
asset management needs. Brokerage services are offered exclusively through
Raymond James Financial Services, member NASD/SIPC and an independent
broker/dealer, located at Peoples Bank offices.
Peoples Investment Company and Peoples Capital Corporation were formed in 2001
to allow management to better deploy investable funds and provide new
opportunities to make investments, including, but not limited to, low-income
housing tax credit funds, that are either limited or restricted at the bank
level.
This discussion and analysis should be read in conjunction with the audited
Consolidated Financial Statements for the year ended December 31, 2002, and
notes thereto, as well as the ratios, statistics and discussions contained
elsewhere in this Form 10-Q.
References will be found in this Form 10-Q to the following significant
transactions that have impacted or will impact Peoples' results of operations:
o As discussed in Note 1 of Notes to the Consolidated Unaudited Financial
Statements, on May 9, 2003, Peoples Bancorp completed its acquisition of
Kentucky Bancshares Incorporated ("Kentucky Bancshares"), the holding
company of Kentucky Bank & Trust. In addition, Peoples Bank closed an
office at 404 Ferry Street in Russell, Kentucky concurrent with this
acquisition. Peoples Bank also plans to close its Catlettsburg, Kentucky
office in October 2003 due to the proximity of the acquired Ashland,
Kentucky office.
o On March 13, 2003, Peoples announced the authorization to repurchase up
to 300,000, or approximately 3%, of Peoples' outstanding common shares
from time to time in open market or privately negotiated transactions
("2003 Stock Repurchase Program"). The common shares repurchased will be
used for projected stock option exercises granted under Peoples' stock
option plans, a portion of the consideration to be paid in acquisitions,
and other general corporate purposes. The timing of the purchases and
the actual number of common shares purchased will depend on market
conditions and limitations imposed by applicable federal securities
laws. The 2003 Stock Repurchase Program will expire on December 31,
2003.
o On December 19, 2002, Peoples Bancorp Inc. completed the sale of
1,440,000 common shares through a firm commitment underwritten offering
and on January 3, 2003, sold an additional 216,000 common shares in
conjunction with the option granted to the underwriters to cover
over-allotments (collectively, the "Common Stock Offering"). The Common
Stock Offering generated new capital totaling $36.9 million after
offering expenses. In January 2003, Peoples Bancorp used $16 million of
the net proceeds to increase Peoples Bank's capital position. Peoples
intends to use the remaining net proceeds for general corporate
purposes, which may include the repayment of outstanding indebtedness,
mergers and acquisitions, such as the Kentucky Bancshares acquisition,
or other strategic investments.
o In December 2002, Peoples initiated an investment growth strategy to
offset the dilutive impact of the Common Stock Offering, thereby
leveraging Peoples' increased capital levels ("Investment Growth
Strategy"). As a result of this Investment Growth Strategy, total
earning assets, particularly mortgage-backed investment securities,
increased by $260 million in January 2003 compared to the year-end 2002
balance. Peoples funded the investment purchases using $187 million of
wholesale market repurchase agreements at an average cost of 2.92%, $58
million of FHLB advances at an average cost of 2.15% and $15 million
from the Common Stock Offering. In March 2003, Peoples purchased an
additional $20 of million mortgage-backed investment securities as part
of this strategy. This purchase was funded using an $18.6 million
wholesale market repurchase agreement at a rate of 2.09%, with the
remainder from available corporate funds.
o On April 10, 2002, Peoples issued $7.0 million of LIBOR based floating
rate trust preferred securities through a newly-formed subsidiary, PEBO
Capital Trust II, which participated in a pooled offering. PEBO Capital
Trust II used the proceeds from the issuance to purchase floating rate
junior subordinated debt securities due April 22, 2032 (the
"Debentures"). Peoples has used the net proceeds from the sale of the
Debentures for general corporate purposes and management of corporate
liquidity.
The impact of these transactions, where significant, is discussed in the
applicable sections of this management's discussion and analysis.
Critical Accounting Policies
- ----------------------------
The accounting and reporting policies of Peoples conform to accounting
principles generally accepted in the United States ("US GAAP") and to general
practices within the banking industry. The preparation of the financial
statements in conformity with US GAAP requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates. Management
has identified the accounting policies described below as those that, due to the
judgments, estimates and assumptions inherent in those policies, are critical to
an understanding of Peoples' consolidated financial statements and management's
discussion and analysis.
Income Recognition
- ------------------
Peoples recognizes interest income by methods that conform to US GAAP that
include general accounting practices within the banking industry. In the event
management believes collection of all or a portion of contractual interest on a
loan has become doubtful, which generally occurs after the loan is 90 days past
due, Peoples discontinues the accrual of interest. In addition, previously
accrued interest deemed uncollectible that was recognized in income in the
current year is reversed, while amounts recognized in income in the prior year
are charged against the allowance for loan losses. Interest received on
nonaccrual loans is included in income only if principal recovery is reasonably
assured. A nonaccrual loan is restored to accrual status when it is brought
current or has performed in accordance with contractual terms for a reasonable
period of time, and the collectibility of the total contractual principal and
interest is no longer in doubt.
Allowance for Loan Losses
- -------------------------
In general, determining the amount of the allowance for loan losses requires
significant judgment and the use of estimates by management. Peoples maintains
an allowance for loan losses to absorb probable losses in the loan portfolio
based on a quarterly analysis of the portfolio. This formal analysis determines
an appropriate level and allocation of the allowance for loan losses among loan
types and resulting provision for loan losses by considering factors affecting
loan losses, including specific losses, levels and trends in impaired and
nonperforming loans, historical loan loss experience, current national and local
economic conditions, volume, growth and composition of the portfolio, regulatory
guidance and other relevant factors. Management continually monitors the loan
portfolio through its Loan Review Department and Loan Loss Committee to evaluate
the adequacy of the allowance. The provision expense could increase or decrease
each quarter based upon the results of management's formal analysis.
The amount of the allowance for the various loan types represents management's
estimate of expected losses from existing loans based upon specific allocations
for individual lending relationships and historical loss experience for each
category of homogeneous loans. The allowance for loan losses related to impaired
loans is based on discounted cash flows using the loan's initial effective
interest rate or the fair value of the collateral for certain collateral
dependent loans. This evaluation requires management to make estimates of the
amounts and timing of future cash flows on impaired loans, which consists
primarily of nonaccrual and restructured loans. While allocations are made to
specific loans and pools of loans, the allowance is available for all loan
losses.
Individual loan reviews are based upon specific quantitative and qualitative
criteria, including the size of the loan, loan quality ratings, value of
collateral, repayment ability of borrowers, and historical experience factors.
The historical experience factors utilized are based upon past loss experience,
trends in losses and delinquencies, the growth of loans in particular markets
and industries, and known changes in economic conditions in the particular
lending markets. Allowances for homogeneous loans (such as residential mortgage
loans, credit cards, personal loans, etc.) are evaluated based upon historical
loss experience, trends in losses and delinquencies, growth of loans in
particular markets, and known changes in economic conditions in each particular
lending market. Consistent with the evaluation of allowances for homogenous
loans, allowances relating to the Overdraft Privilege program are based upon
management's monthly analysis of accounts in the program. This analysis
considers factors that could affect future losses on existing accounts,
including historical loss experience and length of overdraft.
There can be no assurance that the allowance for loan losses will be adequate to
cover all losses, but management believes the allowance for loan losses of $14.2
million at June 30, 2003, was adequate to provide for probable losses from
existing loans based on information currently available. While management uses
available information to provide for loan losses, the ultimate collectibility of
a substantial portion of the loan portfolio and the need for future additions to
the allowance will be based on changes in economic conditions and other relevant
factors. As a result of a slowdown in economic activity that could adversely
affect cash flows for both commercial and individual borrowers, Peoples could
experience increases in problem assets, delinquencies and losses on loans.
Investment Securities
- ---------------------
Investment securities are recorded at cost, which includes premiums and
discounts if purchased at other than par or face value. Peoples amortizes
premiums and accretes discounts as an adjustment to interest income using the
effective interest method over the estimated life of the security. The cost of
investment securities sold, and any resulting gain or loss, is based on the
specific identification method.
Management determines the appropriate classification of investment securities at
the time of purchase. Held-to-maturity securities are those securities that
Peoples has the positive intent and ability to hold to maturity and are recorded
at amortized cost. Available-for-sale securities are those securities that would
be available to be sold in the future in response to Peoples' liquidity needs,
changes in market interest rates, and asset-liability management strategies,
among others. Available-for-sale securities are reported at fair value, with
unrealized holding gains and losses reported in stockholders' equity as a
separate component of other comprehensive income, net of applicable deferred
income taxes.
Presently, Peoples classifies its entire investment portfolio as
available-for-sale. As a result, both the investment and equity sections of
Peoples' balance sheet are more sensitive to changes in the overall market value
of the investment portfolio, due to changes in market interest rates, investor
confidence and other factors affecting market values, than if the investment
portfolio was classified as held-to-maturity.
Management systematically evaluates investment securities for
other-than-temporary declines in fair value on a quarterly basis. Declines in
fair value of individual investment securities below their amortized cost that
are deemed to be other-than-temporary will be written down to current market
value and included in earnings as realized losses. There were no investment
securities identified by management to be other-than-temporarily impaired for
the six months ended June 30, 2003. If the financial markets experience
deterioration and investments decline in fair value, charges to income could
occur in future periods.
Goodwill and Other Intangible Assets
- ------------------------------------
Statement of Financial Accounting Standards No. 142, "Accounting for Goodwill
and Other Intangible Assets" ("SFAS 142"), establishes standards for the
amortization of acquired intangible assets and the non-amortization and
impairment assessment of goodwill. In addition, Statement of Financial
Accounting Standards No. 147, "Acquisitions of Certain Financial Institutions"
("SFAS 147"), establishes standards for unidentifiable intangible assets
acquired specifically in branch purchases that qualify as business combinations.
At June 30, 2003, Peoples had $7.8 million of core deposit and trust relation
intangible assets, subject to amortization, and $40.8 million of goodwill, not
subject to periodic amortization.
Goodwill arising from business combinations represents the value attributable to
unidentifiable intangible elements in the business acquired. Goodwill recorded
by Peoples in connection with its acquisitions relates to the value inherent in
the banking business and the value is dependent upon Peoples' ability to provide
quality, cost effective services in a competitive market place. As such,
goodwill value is supported ultimately by revenue that is driven by the volume
of business transacted. A decline in earnings as a result of a lack of growth or
the inability to deliver cost effective services over sustained periods can lead
to impairment of goodwill that could adversely impact earnings in future
periods.
Under US GAAP in effect through December 31, 2001, Peoples amortized goodwill on
a straight-line basis over periods ranging from ten to fifteen years. Effective
January 1, 2002, Peoples was no longer required to amortize previously recorded
goodwill as a result of adopting SFAS 142 and SFAS 147.
Peoples has reviewed its goodwill assets and has concluded the recorded value of
goodwill was not impaired as of June 30, 2003. There are many assumptions and
estimates underlying the determination of impairment and using different, but
still reasonable, assumptions could produce a significantly different result.
Additionally, future events could cause management to conclude impairment
indicators exist and Peoples' goodwill is impaired, which would result in
Peoples' recording an impairment loss. Any resulting impairment loss could have
a material, adverse impact on Peoples' financial condition and results of
operations.
Overview of the Income Statement
- --------------------------------
In the second quarter of 2003, net income totaled $5,439,000, up 14% from
$4,763,000 a year ago and up 8% from $5,014,000 for the first quarter of 2003.
Diluted earnings per share were $0.54 for the second quarter of 2003 versus
$0.59 for the same period last year and $0.51 the first quarter of 2003. For the
six months ended June 30, 2003, net income totaled $10,453,000, representing an
11% increase over the $9,456,000 earned a year ago. Earnings per diluted share
were $1.05 for the six months ended June 30, 2003, versus $1.18 for the first
six months of 2002.
Peoples' increased net income in 2003 is due in large part to additional net
interest income resulting from the Investment Growth Strategy implemented in the
first quarter of 2003 and an overall increase in net revenues attributable to
the Kentucky Bancshares acquisitions. The lower earnings per share is
attributable to higher average common shares outstanding, due to the issuance of
approximately 593,000 common shares in the second quarter of 2003 as partial
consideration in the Kentucky Bancshares acquisition and 1.7 million shares in
the Common Stock Offering. However, the Investment Growth Strategy offset most
of the dilutive effect of the Common Stock Offering. Peoples also recognized
merger-related costs of approximately $215,000 after-tax (or $0.02 per share)
relating to the Kentucky Bancshares acquisition.
Net interest income grew to $14,161,000 for the three months ended June 30,
2003, from $13,643,000 last quarter and $12,511,000 a year ago. Net interest
margin was 3.64% in the second quarter of 2003 versus 3.87% and 4.54% for the
first quarter of 2003 and second quarter of 2002, respectively. For the six
months ended June 30, 2003, net interest income totaled $27,804,000 and net
interest margin was 3.74% compared to $24,670,000 and 4.53% for the same period
in 2002. The Investment Growth Strategy accounted for a significant portion of
the increase in net interest income in 2003, but also contributed to compression
of net interest margin.
For the quarter ended June 30, 2003, non-interest income was $4,282,000,
compared to $3,626,000 for the same period last year. On a year-to-date basis,
non-interest income totaled $8,217,000 through June 30, 2003, compared to
$7,584,000 last year. Peoples' enhanced non-interest income was primarily the
result of higher deposit service charge income, with revenues from Peoples'
e-banking services, mortgage banking income and fiduciary activities also
contributing to the increase. Non-interest expense was $10,042,000 in the second
quarter of 2003, up 17% compared to $8,549,000 for the same period in 2002. On a
year-to-date basis, non-interest expense totaled $19,746,000 and $17,227,000
through June 30, 2003 and 2002, respectively. These increases are largely the
result of acquisitions and strategic initiatives, which caused Peoples to incur
additional expenses in 2003.
Interest Income and Expense
- ---------------------------
Peoples derives a majority of its interest income from loans and investment
securities and incurs interest expense on interest-bearing deposits and borrowed
funds. Net interest income, the amount by which interest income exceeds interest
expense, remains Peoples' largest source of revenue. Management periodically
adjusts the mix of assets and liabilities in an attempt to manage and improve
net interest income; however, factors that influence market interest rates, such
as interest rate changes by the Federal Reserve Open Market Committee and
Peoples' competitors, may have a greater impact on net interest income than
adjustments made by management. Consequently, a volatile rate environment can
make it extremely difficult to manage net interest margin and income in the
short term, much less anticipate and position the balance sheet for future
changes.
In the second quarter of 2003, net interest income totaled $14,161,000, up 13%
compared to $12,511,000 for 2002's second quarter. Interest income increased
$3,180,000 (or 16%) from last year, totaling $23,492,000 in the second quarter
of 2003, while interest expense was up $1,530,000 (or 20%), totaling $9,331,000
for the three months ended June 30, 2003. Compared to the first quarter of 2003,
net interest income grew 4% in the second quarter of 2003. On a year-to-date
basis through June 30, 2003, net interest income totaled $27,804,000 compared to
$24,670,000, an increase of $3,134,000 (or 13%). For the same period, total
interest income grew 14% to $46,269,000, while interest expense was up 16% to
$18,465,000. These increases are primarily the result of the Investment Growth
Strategy, while acquisitions also fueled some of the growth.
Peoples derives a portion of its interest income from loans to and investments
issued by states and political subdivisions. Since these revenues generally are
not subject to income taxes, management believes it is more meaningful to
analyze net interest income on a fully-tax equivalent ("FTE") basis, which
adjusts interest income by converting tax-exempt income to the pre-tax
equivalent of taxable income using an effective tax rate of 35%. For the three
months ended June 30, 2003, interest income was increased by $416,000 for the
impact of the tax-equivalent adjustment, resulting in FTE net interest income of
$14,577,000, up $1,657,000 (or 13%) from $12,920,000 for the same period in
2002, and up $524,000 (or 4%) from $14,053,000 for the first quarter of 2003.
The FTE yield on Peoples' earning assets was 5.96% for quarter ended June 30,
2003, versus 6.41% and 7.29% for the first quarter of 2003 and second quarter of
2002, respectively, while the cost of interest-bearing liabilities was 2.65%,
2.91% and 3.12% for the same periods, respectively. On a year-to-date basis, FTE
net interest income was $28,630,000 through June 30, 2003, compared to
$25,430,000 for the first half of 2002, an increase of $3,200,000 (or 13%). For
the six months ended June 30, 2003, the FTE yield on earning assets was 6.17%
and cost of interest-bearing liabilities was 2.77% versus 7.39% and 3.24%,
respectively, for the same period last year.
Net interest margin, calculated by dividing FTE net interest income by average
interest-earning assets, serves as an important measurement of the net revenue
stream generated by the mix and pricing of Peoples' earning assets and
interest-bearing liabilities. In the second quarter of 2003, net interest margin
was 3.64% versus 3.87% last quarter and 4.54% a year ago. For the six months
ended June 30, 2003, net interest margin was 3.74%, down from 4.53% for the
first six months of 2002. The lower net interest margin in 2003 is largely the
result of high volumes of prepayments in both the loan and investment
portfolios, which were reinvested at significantly lower rates due to the
current interest rate environment. In addition, a full quarter's impact of the
Investment Growth Strategy contributed to compression of net interest margin.
Earning assets averaged $1.61 billion in the second quarter of 2003, up $151.1
million (or 10%) compared to $1.46 billion last quarter, and up $467.9 million
(or 41%) from $1.14 billion for the second quarter of 2002. Net loans accounted
for the largest portion of earning assets, averaging $881.6 million for three
months ended June 30, 2003, compared to average net loans of $837.6 million and
$784.3 million for the first quarter of 2003 and second quarter of 2002,
respectively. Loans acquired in acquisitions accounted for a majority of the
loan growth. Investment securities averaged $703.6 million for the second
quarter of 2003 compared to $608.0 million for the prior quarter and $351.9 for
2002's second quarter, with the increases largely attributable to the Investment
Growth Strategy. The FTE yield on net loans was 7.14% for the quarter ended June
30, 2003, versus 7.40% for the first quarter of 2003 and 7.76% for the three
months of June 30, 2002, while the FTE yield on investments was 4.63%, 5.13% and
6.27% for the same periods, respectively. Declining yields on both loans and
investment securities were a result of lower market interest rates.
On a year-to-date basis, average earning assets were $1.53 billion in 2003
compared to $1.12 million in 2002. Net loan balances increased $84.7 million (or
11%), averaging $859.7 million for the six months ended June 30, 2003, versus
$775.0 million a year ago. Through six months in 2003, the FTE yield on loans
dropped 62 basis points from 7.88% to 7.26%. Average investment securities
totaled $656.1 million in the first half of 2003 versus $347.4 million for the
first six months of 2002, while the FTE yield on investments was 4.86% and 6.34%
for the same periods, respectively. Both the higher average balance and lower
yield were principally the result of the Investment Growth Strategy implemented
during the first quarter of 2003.
In the second quarter of 2003, Peoples' average interest-bearing liabilities
totaled $1.41 billion, up from $1.27 billion in the first quarter of 2003 and
$1.00 billion a year ago. For the six months ended June 30, 2003, average
interest-bearing liabilities were $1.34 billion, up from $992.1 million a year
ago. Traditional deposits comprise the majority of Peoples' interest-bearing
liabilities, averaging $906.9 million for the three months ended June 30, 2003
compared to $843.2 million and $755.5 million for the first quarter of 2003 and
second quarter of 2002, respectively. Through six months of 2003, traditional
deposits averaged $875.2 million compared to $740.6 million last year, an
increase of $134.6 million (or 18%). These increases were due largely to
deposits acquired as part of acquisitions. In the second quarter of 2003, cost
of funds from interest-bearing deposits was 2.17%, down from 2.50% in the prior
quarter and 2.74% in second quarter of 2002. The cost of funds from
interest-bearing deposits was 2.33% for the first half of 2003, down 58 basis
points from 2.91% for the same period in 2002. The lower rates paid on
interest-bearing deposit accounts were a result of market rates remaining at low
levels. However, management continues to price Peoples' longer-term certificates
of deposit competitively as part of a strategy to shift to longer-term funding.
Peoples also utilizes a variety of borrowings as complementary funding sources
to traditional deposits. Total borrowed funds averaged $499.9 million for the
three months ended June 30, 2003, up from $429.2 million in the first quarter of
2003 and up from $246.8 million a year ago. The majority of these increases are
attributable to borrowed funds used in the Investment Growth Strategy. The
interest cost of Peoples' borrowed funds was 3.53% in second quarter of 2003,
down from 3.70% last quarter and 4.29% for the same period in 2002. For the six
months ended June 30, 2003, borrowed funds averaged $464.7 million compared to
$251.6 million for the first half of 2002, while the average cost was 3.61% and
4.21% for the same periods, respectively.
Peoples' main sources of borrowed funds are short- and long-term advances from
the FHLB. Short-term FHLB advances are primarily variable rate, LIBOR based
advances that are used to balance Peoples' daily liquidity needs and may be
repaid at any time without a penalty. The long-term FHLB advances consist
largely of 10-year borrowings requiring monthly interest payments, with
principal due at maturity. The rate on these advances are fixed for initial
periods ranging from two to four years, depending on the specific advance. After
the initial fixed rate period, the FHLB has the option to convert each advance
to a LIBOR based, variable rate advance; however, Peoples may repay the advance,
without a penalty, if the FHLB exercises its option.
Short-term FHLB borrowings averaged $23.0 million for the quarter ended June 30,
2003, compared to $12.9 million a year ago, with an average cost of 1.59% and
1.83% for the same periods, respectively. This increase was attributable to
short-term advances used in the Investment Growth Strategy. Average long-term
FHLB borrowings were up $27.0 million (or 14%) compared to the second quarter of
2002, totaling $223.0 million for the three months ended June 30, 2003, while
the average cost dropped to 4.64% from 4.85%. The increase in long-term FHLB
advances was mainly due to management's efforts to secure longer-term funding
during this period of low rates. A portion of the new long-term FHLB advances
are fixed rate advances that require monthly principal and interest payments and
may not be repaid prior to maturity without a penalty. Management intends to
continue using a variety of FHLB borrowings to fund asset growth and manage
interest rate sensitivity, as deemed appropriate. For the six months ended June
30, 2002, short-term FHLB borrowings averaged $19.5 million versus $22.7 million
a year ago, while the average cost was 1.53% and 1.82% for the same periods,
respectively. Average long-term FHLB borrowings were $223.5 million through six
months of 2003, at an average cost of 4.67%, versus $194.4 million and average
cost of 4.86% a year ago.
In addition to FHLB borrowings, Peoples also accesses national market repurchase
agreements to diversify funding sources. Typically, these repurchase agreements
are for terms of 90 days or less. However, Peoples utilized repurchase
agreements with terms ranging from 2 to 5 years as part of the Investment Growth
Strategy in an effort to match the term of the funding sources with the initial
estimated life of the investments. As a result, wholesale market term repurchase
agreements averaged $216.3 million at an average cost of 2.91%, up from $150.5
million and average cost of 2.96% in the prior quarter and $9.1 million and
average cost of 3.69% a year ago. On a year-to-date basis, wholesale market
repurchase agreements averaged $183.5 million, at an average cost of 2.93%,
through June 30, 2003, compared to $7.7 million and average cost of 3.65% a year
ago.
Peoples offers cash management services to its business customers, which also
provide short-term funding in the form of overnight repurchase agreements. For
the three months ended June 30, 2003, overnight repurchase agreements, excluding
balances of wholesale market term repurchase agreements, averaged $20.7 million,
down from $21.6 million last quarter and $23.8 million a year ago. The average
rate paid on overnight repurchase agreements was 0.87% in second quarter of
2003, compared to 0.86% in the prior quarter and 1.40% in the second quarter of
2002. Average overnight repurchase agreements totaled $21.1 for the six months
ended June 30, 2003, compared to $23.3 million a year ago, while the average
cost dropped 60 basis points from 1.46% to 0.86%.
Late in the second quarter of 2003, management initiated a plan to improve the
performance of Peoples' investment securities portfolio in response to the high
rate of prepayments on mortgage-backed securities and the corresponding downward
pressure on yields due to accelerated amortization of bond premiums. As part of
this plan, Peoples sold $48.6 million of lower yielding mortgage-backed
securities resulting in a net loss of $37,000. Management sold additional lower
yielding securities experiencing increased prepayment speeds subsequent to
quarter end and reinvested the proceeds into higher yielding instruments.
Peoples expects the repositioning to improve both the yields and the timing of
cash flows from these securities.
On July 1, 2003, Peoples adopted the reporting requirements of SFAS 150, as
required. This adoption resulted in Peoples reclassifying its Trust Preferred
Securities, presented on the balance sheet as "Guaranteed preferred beneficial
interest in junior subordinated debentures", to the liabilities section of the
balance sheet. In addition, Peoples will recognize approximately $1.2 million of
interest expense on its Trust Preferred Securities in the final six months of
2003 that would have otherwise been recognized as non-interest expense had SFAS
150 not been in effect. Had SFAS 150 been in effect for the first six months of
2003, net interest margin would have been 3.59% versus the 3.74% reported.
As is the case with most financial institutions, Peoples continues to experience
net interest margin compression due to interest rates remaining at historically
low levels. Significant volumes of assets continue to reprice downward with
limited flexibility for a corresponding decrease in rates paid on
interest-bearing liabilities. In addition, a weak economy and other factors are
suppressing loan growth. While these conditions challenge Peoples' ability to
enhance net interest income and margin in the short-term, current
asset-liability simulations indicate a sustained increase in interest rates
could cause net interest income to increase modestly based on Peoples' interest
rate risk position at June 30, 2003. Even though management continues to focus
on minimizing the impact of future rate changes on Peoples' earnings, Peoples'
net interest margin and income remain difficult to predict, and to manage, since
changes in market interest rates remain uncertain.
Provision for Loan Losses
- -------------------------
In the second quarter of 2003, Peoples' provision for loan losses was $935,000,
up from $831,000 in the prior quarter and down from $980,000 a year ago. The
changes in the quarterly provision amounts reflected the changes in the
provision related to the Overdraft Privilege program, which totaled $185,000,
$81,000 and $230,000 for the same periods, respectively. On a year-to-date basis
through June 30, 2003, the provision for loan losses was $1,766,000 versus
$1,841,000 in 2002, of which $266,000 and $391,000, respectively, related to the
Overdraft Privilege program.
When expressed as a percentage of average loans, the provision was 0.10% in both
the first and second quarters of 2003 and 0.12% in the second quarter of 2002.
For the six months ended June 30, the provision was 0.20% of average loans in
2003 versus 0.23% in 2002. Management believes the provisions were appropriate
for the overall quality, inherent risk and volume concentrations of Peoples'
loan portfolio.
Gains and/or Losses on Securities Transactions
- ----------------------------------------------
Peoples recognized net losses on securities transactions of $29,000 for the
quarter ended June 30, 2003, versus no gains or losses in 2002's second quarter.
The net losses on securities transactions in 2003 were largely the result of
Peoples selling $48.6 million as part of the plan to improve the performance of
Peoples' investment securities portfolio. In the first half of 2003, Peoples
recognized net losses of $27,000, versus net gains of $51,000 a year ago.
Non-Interest Income
- -------------------
Peoples generates non-interest income from six primary sources: deposit account
service charges, fiduciary activities, investment and insurance commissions,
electronic banking, mortgage banking and business owned life insurance ("BOLI").
For the quarter ended June 30, 2003, non-interest income was $4,282,000, up
$656,000 (or 18%) from $3,626,000 for the same period last year. On a
year-to-date basis, non-interest income totaled $8,217,000 through June 30,
2003, compared to $7,584,000 last year, an increase of $633,000 (or 8%).
Peoples' enhanced non-interest income was primarily the result of higher deposit
service charge income, with revenues from Peoples' e-banking services, mortgage
banking and fiduciary activities also contributing to the increase. Compared to
the first quarter of 2003, non-interest income grew $347,000 (or 9%) in the
second quarter of 2003.
Peoples largest source of non-interest revenue remains service charges and other
fees on deposit accounts, which are based on the recovery of costs associated
with services provided. In the second quarter of 2003, deposit account service
charges grew $377,000 (or 23%) to $2,052,000, from $1,675,000 in 2002's second
quarter. This increase was primarily the result of higher volumes of overdraft
and non-sufficient funds fees, which were up $256,000 (or 24%) and $98,000 (or
37%), respectively. An increased number of checking accounts from acquisitions
and Peoples' Free Checking campaign also contributed to the increase. For the
six months ended June 30, 2003, deposit account service charges totaled
$3,777,000 versus $3,041,000 for the same period last year, an increase of
$736,000 (or 24%), as overdraft and non-sufficient funds fees grew $504,000 (or
27%) and $201,000 (or 45%), respectively. Due in part to the Kentucky Bancshares
acquisition, deposit account service charges were up $327,000 (or 19%) in the
second quarter of 2003 compared to $1,725,000 in the first three months of 2003.
Peoples utilizes various electronic banking services, including ATM and debit
cards, direct deposit services and Internet banking, as alternative delivery
channels to traditional sales offices for providing services to clients.
Peoples' electronic banking services generated revenues of $529,000 for the
quarter ended June 30, 2003, up $115,000 (or 28%) from $414,000 a year ago and
up $75,000 (or 17%) from $454,000 in the first quarter of 2003. These increased
revenues were the result of customers using Peoples' debit cards to complete
more of their payment transactions. In the second quarter of 2003, Peoples'
customers used their debit cards to complete over $14 million of transactions,
up from $12 million last quarter and $10 million in 2002's second quarter. For
the six months ended June 30, 2003, e-banking revenues totaled $983,000, an
increase of $201,000 (or 26%) compared to $782,000 in 2002, as debit card
transactions exceeded $26 million in 2003 versus $19 million a year ago. Further
information regarding Peoples' anticipated future electronic banking revenues
can be found later in this discussion under "Future Outlook."
Starting in the second half of 2002, Peoples began selling long-term, fixed rate
real estate loans into the secondary market. As a result of continuing this
program during the current year, Peoples recognized mortgage banking income of
$337,000 for quarter ended June 30, 2003, up from $230,000 in the prior quarter.
Through six months of 2003, mortgage banking produced revenue of $567,000 versus
no income in the same period last year. Prior to the third quarter of 2002,
Peoples primarily originated one- to five-year adjustable rate, fully amortizing
real estate loans rather than long-term, fixed rate loans due to the associated
interest rate risk and, as a result, did not recognize any mortgage banking
income in first six months of 2002.
Peoples' fiduciary fees totaled $858,000 in the second quarter of 2003, compared
to $586,000 in the prior quarter and $640,000 in the second quarter of 2002. On
a year-to-date basis, fiduciary revenues grew $188,000 (or 15%) to $1,444,000,
from $1,256,000 in 2002. While the sluggish equity markets, upon which a
significant portion of fiduciary fees are based, continue to challenge Peoples'
fiduciary revenues, the addition of trust assets through the Kentucky Bancshares
acquisition accounted for the majority of the increased revenue in the second
quarter.
Insurance and investment commissions totaled $320,000 in the second quarter of
2003 compared to $462,000 a year ago, a decrease of $142,000 (or 31%). Compared
to the first quarter of 2003, insurance and investment commissions were down
$122,000 (or 28%) in the second quarter, from $442,000. For the six months ended
June 30, insurance and investment commissions were $762,000 in 2003 versus
$986,000 in 2002, a decline of $224,000 (or 23%). The lower level of insurance
and investment income is largely attributable to lower volumes of fixed annuity
sales and related commission income. The following table details Peoples'
insurance and investment commissions for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 2003 2002 2003 2002
Property and casualty insurance $112 $93 $203 $178
Fixed annuities 77 222 294 502
Brokerage 50 61 94 128
Life and health insurance 42 30 101 83
Credit life and A&H insurance 39 56 70 95
- ----------------------------------------------------------------------------
Total $320 $462 $762 $986
============================================================================
Peoples' BOLI investment enhances operating efficiency by offsetting rising
employee benefit costs. In the second quarter of 2003, BOLI income totaled
$353,000 versus $365,000 last quarter and $376,000 a year ago. For the six
months ended June 30, 2003, BOLI produced income of $718,000 compared to
$701,000 for the same period in 2002.
Non-Interest Expense
- --------------------
In the second quarter of 2003, non-interest expense totaled $10,042,000, up
$1,493,000 (or 17%) from $8,549,000 a year ago, due largely to acquisitions and
strategic investments in technology. Compared to the first quarter of 2003,
non-interest expense increased $338,000 (or 3%) in the second quarter, from
$9,704,000. The majority of this increase was due to higher levels of salaries
and benefits and marketing costs, which were both up $103,000.
Salaries and benefits remain Peoples' largest non-interest expense, which is
inherent in a service-based industry such as financial services. For the quarter
ended June 30, 2003, salaries and benefits totaled $4,827,000 compared to
$4,346,000 the prior year and $4,724,000 for the first quarter of 2003,
increases of $481,000 (or 11%) and $103,000 (or 2%), respectively. In the first
half of 2003, salaries and benefits grew $721,000 (or 8%) to $9,551,000, from
$8,830,000 for the first six months of 2002. The majority of these increases
were due to the addition of new associates in conjunction with acquisitions. At
June 30, 2003, Peoples had 486 full-time equivalent associates, up from 451 at
March 31, 2003 and 447 a year ago. Management will continue to leverage Peoples'
resources in an effort to optimize customer service and produce additional
future revenue streams.
Net occupancy and equipment expenses increased $168,000 (or 18%) in the second
quarter of 2003, totaling $1,108,000 versus $940,000 last year. For the six
months ended June 30, 2003, net occupancy and equipment expenses totaled
$2,206,000, up $340,000 (or 18%) from $1,866,000 a year ago. Recent investments
in technology and acquisitions produced additional expenses, including
depreciation expense. The continued investment in technology has enhanced
Peoples' ability to serve clients and satisfy their financial needs, while
acquisitions have allowed Peoples to expand its customer base. Compared to the
first quarter of 2003, net occupancy and equipment expense was virtually
unchanged.
Professional fees, which include fees for accounting, legal and other
professional services, totaled $499,000 in the second quarter of 2003, down
$83,000 (or 14%) compared to last year but up $57,000 (or 13%) from $442,000
last quarter. In the second quarter of 2003, Peoples incurred additional legal
expenses, due in part to management implementing various provisions of the
Sarbanes-Oxley Act of 2002. These additional costs were offset by a reduction in
the consulting fees Peoples paid during the quarter for the implementation of
the Overdraft Privilege program. These fees, which are based on the net
improvement in overdraft fees, were $112,000 in the second quarter of 2003
versus $155,000 in the second quarter of 2002 and $152,000 in the first quarter
of 2003, as the percentage paid was reduced beginning in March 2003. Through six
months of 2003, professional fees were $941,000 compared to $883,000 for the
first half of 2002, an increase of $58,000 (or 7%).
Marketing expense was $379,000 for the three months ended June 30, 2003,
compared to $150,000 for the same period in 2002, an increase of $229,000 (or
153%). Compared to the first quarter of 2003, marketing expense grew $103,000
(or 37%) in the second quarter, from $276,000. In the first half of 2003,
Peoples advertised its newly created Peoples Financial Advisors division and
Freedom Checking product. While these initiatives resulted in higher marketing
expenses, management believes they will allow Peoples to attract many new
clients and, as a result, improve revenues.
In the second quarter of 2003, intangible amortization expense was up $159,000
(or 142%) to $271,000, from $112,000 last year. Compared to the prior quarter,
intangible amortization was up $70,000 (or 35%) from $201,000. For the six
months ended June 30, intangible amortization was $472,000 in 2003 versus
$223,000 in 2002. These increases were due to recent acquisitions. Intangible
amortization expense for the three and six months ended June 30, 2002, also
reflects the adoption of SFAS 147 and restatement of goodwill relating to
qualifying branch acquisitions.
State franchise taxes totaled $272,000 in the second quarter of 2003, up $94,000
(or 53%) from $178,000 a year ago. On a year-to-date basis, franchise taxes
increased $169,000 (or 47%) in 2003, totaling $529,000 versus $360,000 in first
half of 2002. These increases were a result of additional equity at Peoples
Bank, the primary basis for these taxes.
Management uses the non-interest income leverage ratio as a measurement of
non-interest expense leverage. The ratio, defined as non-interest income as a
percentage of operating expenses, excludes gains and losses on securities
transactions and asset disposals, as well as intangible asset amortization. For
the six months ended June 30, 2003, the non-interest income leverage ratio was
44.0% compared to 40.7% a year ago. In the second quarter of 2003, the
non-interest income leverage ratio improved to 46.5% from 41.4% for the prior
quarter and 43.1% for 2002's second quarter. Peoples' sales associates will
strive to generate new revenues and leverage operating expenses through a
needs-based selling approach in order to achieve a long-term target non-interest
income leverage ratio of 50%.
As a result of Peoples adopting the reporting requirements of SFAS 150 on July
1, 2003, as required, Peoples will recognize approximately $1.2 million of
interest expense on its Trust Preferred Securities in the final six months of
2003 that would have otherwise been recognized as non-interest expense had SFAS
150 not been in effect. Had SFAS 150 been in effect for the first six months of
2003, Peoples' non-interest leverage and efficiency ratios would have been 46.9%
and 50.4%, respectively, versus 44.0% and 51.9% actually reported.
Return on Equity
- ----------------
In the second quarter of 2003, Peoples' return on equity ("ROE") was 12.92%
versus 13.00% last quarter and 18.85% a year ago. On a year-to-date basis, ROE
was 12.95% in 2003, down from 19.10% in the first half of 2002. The lower ROE is
primarily the result of higher average equity generated by the Common Stock
Offering, the Kentucky Bancshares acquisition, increased earnings and
improvements in the net unrealized value of Peoples' available-for-sale
investment securities portfolio. While ROE remains a key part of the evaluation
of Peoples' long-term performance, management believes earnings per share
("EPS") serves as a more meaningful measurement of short-term performance due to
the impact of changing market valuations in the investment portfolio.
Return on Assets
- ----------------
Return on assets ("ROA") was 1.25% for the quarter ended June 30, 2003, compared
to 1.27% and 1.54% for the first quarter of 2003 and second quarter of 2002,
respectively. Through six months of 2003, ROA was 1.26% versus 1.55% for the
same period in 2002. The reduction in ROA is due to the increase in total
average assets resulting from the Investment Growth Strategy and acquisitions.
In recent years, Peoples' primary focus has shifted to EPS enhancement and ROE
while reducing the emphasis on ROA as a key performance indicator. However,
management continues to monitor ROA and considers it a measurement of Peoples'
asset utilization.
Income Tax Expense
- ------------------
Peoples' effective tax rate was 28.0% for the six months ended June 30, 2003,
compared to 28.3% for the same period in 2002. Peoples continues to make
tax-advantaged investments in order to manage its effective tax rate and overall
tax burden. At June 30, 2003, the amount of tax-advantaged investments included
in Other Assets totaled $29.8 million compared to $28.5 million at June 30,
2002. Depending on economic and regulatory conditions, Peoples may make
additional investments in various tax credit pools and other tax-advantaged
assets.
FINANCIAL CONDITION
Overview of Balance Sheet
- -------------------------
At June 30, 2003, total assets were $1.86 billion compared to $1.39 billion at
year-end 2002, an increase of $465.7 million (or 34%). During the second quarter
of 2003, total assets grew $191.4 million (or 11%), due primarily to the
Kentucky Bancshares acquisition. The Investment Growth Strategy contributed to
the increase in assets since the prior year-end, as investment securities
totaled $689.7 million at June 30, 2003, up $277.6 million (or 67%) since
December 31, 2002. Gross loans were $916.6 million June 30, 2003, up $65.7
million (or 8%) since December 31, 2002.
Total liabilities were $1.65 billion at June 30, 2003, compared to $1.22 billion
at year-end 2002, an increase of $434.5 million (or 36%). At June 30, 2003,
deposits totaled $1.14 billion versus $955.9 million at year-end, an increase of
$187.5 million (or 20%). This increase was primarily the result of deposits
acquired in the Kentucky Bancshares acquisition. Borrowed funds totaled $499.0
million at June 30, 2003, up from $252.0 million at December 31, 2002 due to
additional borrowings which funded the Investment Growth Strategy.
Stockholders' equity totaled $178.3 million at June 30, 2003, versus $147.2
million at December 31, 2002, an increase of $31.1 million (or 21%). The
majority of this increase is due to common shares issued in conjunction with the
Kentucky Bancshares acquisition and Common Stock Offering, which increased
equity by $19.1 million, while Peoples' earnings, net of dividends paid, was
also a significant contributor.
Cash and Cash Equivalents
- -------------------------
Peoples considers cash and cash equivalents to consist of Federal funds sold,
cash and balances due from banks, interest-bearing balances in other
institutions and other short-term investments that are readily liquid. The
amount of cash and cash equivalents fluctuates on a daily basis due to client
activity and Peoples' liquidity needs. At June 30, 2003, cash and cash
equivalents totaled $155.2 million, up $99.6 million (or 179%) compared to $55.6
million at December 31, 2002, attributable to a higher level of Federal funds
sold. At June 30, 2003, Peoples had Federal funds sold of $93.5 million,
compared to $20.5 million at December 31, 2002, an increase of $73.0 million.
This increase was the result of Peoples holding $60 million of funds at
quarter-end relating to the liquidation of a trust relationship associated with
the Kentucky Bancshares acquisition. In early July, these funds were transferred
to another fiduciary by the customer, resulting in cash and cash equivalents to
return to normal levels. A further discussion of this transaction can be found
later in this discussion under "Funding Sources."
Management believes the current balance of cash and cash equivalents, along with
the availability of other funding sources, should allow Peoples to meet cash
obligations, special needs and off-balance sheet commitments, specifically
undrawn lines of credit, construction loans and letters of credit, as they come
due. Peoples will actively manage the principal runoff from the investment and
loan portfolios and seek to reinvest those funds appropriately, based on loan
demand and investment opportunities, while maintaining adequate liquidity.
Further information regarding Peoples' liquidity can be found later in this
discussion under "Interest Rate Sensitivity and Liquidity."
Investment Securities
- ---------------------
At June 30, 2003, the amortized cost of Peoples' investment securities totaled
$671.8 million compared to $402.0 million at year-end 2002, while the market
value of the investment portfolio was $689.7 million at June 30, 2003, up from
$412.1 million at December 31, 2002. These increases were primarily the result
of the Investment Growth Strategy initiated in December 2002 and implemented in
the first quarter of 2003.
The difference in amortized cost and market value at June 30, 2003, resulted in
unrealized appreciation in the investment portfolio of $17.9 million and a
corresponding increase in Peoples' equity of $11.5 million, net of deferred
taxes. In comparison, the difference in amortized cost and market value at
December 31, 2002, resulted in unrealized appreciation of $10.1 million and an
increase in equity of $6.4 million, net of deferred taxes.
Since December 31, 2002, Peoples' investment in US treasury securities and
obligations of US government agencies and corporations has grown $38.1 million
(or 133%), as management reinvested a portion of the runoff from the investment
portfolio to maintain diversity within the portfolio. In addition, Peoples'
investment in mortgage-backed securities has grown significantly compared to
year-end 2002 due to the Investment Growth Strategy. The following table details
Peoples' investment portfolio, at estimated fair value:
(Dollars in thousands) June 30, March 31, December 31, June 30,
2003 2003 2002 2002
US Treasury securities and obligations of
US government agencies and corporations $ 66,714 $ 41,638 $ 28,647 $ 33,528
Obligations of states and political subdivisions 68,841 67,088 67,806 67,281
Mortgage-backed securities 493,556 522,469 259,811 214,748
Other securities 60,569 57,155 55,836 51,849
- ----------------------------------------------------------------------------------------------------
Total available-for-sale securities $ 689,680 $ 688,350 $ 412,100 $ 367,406
====================================================================================================
Management monitors the earnings performance and liquidity of the investment
portfolio on a regular basis through Asset/Liability Committee ("ALCO")
meetings. The ALCO also monitors net interest income, sets deposit pricing and
maturity guidelines, and manages Peoples' interest rate risk. Through active
management of the balance sheet and investment portfolio, Peoples seeks to
maintain sufficient liquidity to satisfy depositor demand, other company
liquidity requirements and various credit needs of its customers.
Loans
- -----
Peoples Bank originates various types of loans, including commercial, financial
and agricultural loans ("commercial loans"), real estate loans (both commercial
and residential) and consumer loans, focusing primarily on lending opportunities
in central and southeastern Ohio, northwestern West Virginia, and northeastern
Kentucky markets. At June 30, 2003, gross loans totaled $916.6 million, up $65.7
million since year-end 2002. While this increase is primarily attributable to
loans acquired in the Kentucky Bancshares acquisition, Peoples also experienced
internally generated commercial loan growth, which partially offset declines in
real estate and consumer loan balances. The following table details total
outstanding loans:
(Dollars in thousands) June 30, March 31, December 31, June 30,
2003 2003 2002 2002
Commercial, financial, and agricultural $ 475,600 $ 422,782 $ 392,528 $ 379,243
Real estate, construction 10,339 10,523 16,231 15,782
Real estate, mortgage 329,708 324,877 331,948 345,795
Consumer 94,549 96,857 103,635 115,398
Credit cards 6,407 6,065 6,549 6,159
- -----------------------------------------------------------------------------------------------
Total loans $ 916,603 $ 861,104 $ 850,891 $ 862,377
===============================================================================================
Commercial loan balances, including loans secured by commercial real estate,
totaled $475.6 million at June 30, 2003, up $83.1 million (or 21%) from $392.5
million at year-end 2002. While the majority of the increase in commercial loans
is attributable to acquiring $49 million of loans in the Kentucky Bancshares
acquisition, Peoples also experienced internally generated growth from lending
opportunities within Peoples' existing markets. Commercial loans continued to
represent the largest portion of Peoples' total loan portfolio, comprising 51.9%
and 46.1% of total loans at June 30, 2003 and December 31, 2002, respectively.
The portion of commercial loan balances secured by commercial real estate,
excluding construction loans, was $353.8 million at June 30, 2003, up from
$289.6 million at December 31, 2002. Future commercial lending activities will
be dependent on economic and related conditions, such as general demand for
loans in Peoples' primary markets, interest rates offered by Peoples and normal
underwriting requirements. In addition to in-market opportunities, Peoples will
continue to selectively lend to creditworthy customers outside its primary
markets.
Real estate loans, which include construction loans but exclude loans secured by
commercial real estate, totaled $340.0 million at the end of the second quarter
of 2003 compared to $348.2 million at December 31, 2002, a decrease of $8.2
million (or 2%). Real estate loan balances have declined in response to customer
demand for long-term, fixed-rate mortgages, which are sold in the secondary
market with servicing rights retained. Peoples acquired $21 million of real
estate loans in the Kentucky Bancshares acquisition, partially offsetting the
decline resulting from Peoples' increased secondary market activity. Real estate
loans comprised 37.1% of Peoples' total loan portfolio at June 30, 2003, versus
40.9% at year-end 2002. Included in real estate loans are home equity credit
line ("Equiline") balances of $29.1 million at June 30, 2003, up from $28.5
million at December 31, 2002. Management believes Equiline loans are a
relationship product with an acceptable return on investment after risk
considerations. Residential real estate loans continued to represent a major
focus of Peoples' lending due to the lower risk factors associated with this
type of loan, and the opportunity to provide additional products and services to
these consumers.
Excluding credit card balances, consumer loans decreased $9.1 million (or 9%)
since year-end 2002, totaling $94.5 million at June 30, 2003. Excluding loans
acquired as part of the Kentucky Bancshares acquisition, consumer loan balances
were down $13.8 million (or 13%) since December 31, 2002. The indirect lending
area represented the majority of Peoples' consumer loans, with balances of $46.9
million and $56.2 million at June 30, 2003 and December 31, 2002, respectively.
While sluggish economic conditions and strong competition for loans,
particularly automobile loans, have challenged the performance and growth of
Peoples' consumer loan portfolio, management remains committed to sound lending
practices and continues to emphasize appropriate discipline in loan pricing and
loan underwriting practices more than loan growth.
At June 30, 2003, Peoples' credit card balances totaled $6.4 million, down
slightly since December 31, 2002. Peoples' ability to grow credit card balances
is impacted by fierce competition for customers. Since management does not
intend to subject Peoples to additional and/or unnecessary risk merely for such
growth, Peoples continues to market its credit card as a complementary product
offering for client relationships.
Loan Concentration
- ------------------
Peoples' largest concentration of commercial loans are credits to assisted
living facilities and nursing homes, which comprised 12.2% of Peoples'
outstanding commercial loans at June 30, 2003, versus 13.4% at year-end 2002.
Loans to lodging and lodging-related companies also represented a significant
portion of Peoples' commercial loans comprising approximately 11.8% of Peoples'
outstanding commercial loans at quarter-end, compared to 11.2% at December 31,
2002.
These lending opportunities have arisen due to the growth of these industries in
markets served by Peoples or contiguous areas, as well as sales associates'
efforts to develop these lending relationships. Management believes Peoples'
loans to assisted living facilities and nursing homes, as well as loans to
lodging and lodging-related companies, do not pose abnormal risk when compared
to risk assumed in other types of lending since these credits have been
subjected to Peoples' normal underwriting standards. In addition, a sizeable
portion of the loans to lodging and lodging-related companies are spread over
various geographic areas and are guaranteed by principals with substantial net
worth. Peoples also requires the owners in these business relationships to
possess market expertise and experience.
Allowance for Loan Losses
- -------------------------
Peoples' allowance for loan losses totaled $14.2 million, or 1.54% of total
loans, at June 30, 2003, compared to $13.1 million, or 1.54%, at year-end 2002.
The following table presents changes in Peoples' allowance for loan losses:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 2003 2002 2003 2002
Balance, beginning of period $ 13,363 $ 12,426 $ 13,086 $ 12,357
Chargeoffs (955) (1,147) (1,740) (2,100)
Recoveries 235 164 466 325
- -----------------------------------------------------------------------------------------------------
Net chargeoffs (720) (983) (1,274) (1,775)
Provision for loan losses 935 980 1,766 1,841
Allowance for loan losses acquired 573 - 573 -
- -----------------------------------------------------------------------------------------------------
Balance, end of period $ 14,151 $ 12,423 $ 14,151 $ 12,423
=====================================================================================================
The allowance is allocated among the loan categories based upon the consistent,
quarterly procedural discipline described in the "Critical Accounting Policies"
section of this discussion. However, the entire allowance for loan losses is
available to absorb future loan losses in any loan category. The following
details the allocation of the allowance for loan losses:
(Dollars in thousands) June 30, December 31, June 30,
2003 2002 2002
Commercial $ 10,387 $ 8,846 $ 7,557
Consumer 1,820 2,075 2,508
Real estate 1,482 1,617 1,752
Credit cards 256 342 432
Overdrafts 206 206 174
- ----------------------------------------------------------------------------------------------------
Total allowance for loan losses $ 14,151 $ 13,086 $ 12,423
====================================================================================================
The allowance allocated to commercial loans has increased in recent periods,
reflecting the higher credit risk associated with this type of lending and the
continued growth in this portfolio. The allowance allocated to the real estate
and consumer loan portfolios is based upon Peoples' allowance methodology for
homogeneous loans, which includes a consideration of changes in total balances
in those portfolios.
In the second quarter of 2003, net loan chargeoffs were $720,000 compared to
$983,000 a year ago and $554,000 in the first quarter of 2003. While commercial
and consumer loans, including overdraft chargeoffs, comprise the largest portion
of net chargeoffs, the lower level of chargeoffs in the second quarter of 2003
is attributable to fewer troubled commercial loans. In addition, commercial loan
chargeoffs were impacted by Peoples charging down a group of loans in single
client relationship totaling $697,000 and $341,000 in the second and first
quarters of 2002, respectively. The following table details Peoples' net
chargeoffs:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 2003 2002 2003 2002
Commercial $ 210 $ 690 $ 396 $ 1,139
Consumer 189 68 389 234
Overdrafts 150 147 267 251
Real estate 128 41 136 75
Credit card 43 37 86 76
- -----------------------------------------------------------------------------------------------------
Total 720 983 1,274 1,775
=====================================================================================================
As a percent of average loans $ 0.08% $ 0.12% $ 0.15% $ 0.23%
=====================================================================================================
Asset quality remains a key focus, as management continues to stress quality
rather than growth. Since December 31, 2002, Peoples' asset quality has improved
due to the combination of a lower level of nonperforming loans and an increase
in assets. The following table details Peoples' nonperforming assets:
(Dollars in thousands) June 30, March 31, December 31, June 30,
2003 2003 2002 2002
Loans 90+ days past due and accruing $ 569 $ 337 $ 407 $ 227
Renegotiated loans 685 685 2,439 2,864
Nonaccrual loans 4,389 3,741 4,617 4,425
- --------------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 5,643 4,763 7,463 7,516
Other real estate owned 960 924 148 124
- --------------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 6,603 $ 5,687 $ 7,611 $ 7,640
==========================================================================================================================
Nonperforming loans as a percent of total loans 0.62% 0.55% 0.88% 0.87%
==========================================================================================================================
Nonperforming assets as a percent of total assets 0.35% 0.34% 0.55% 0.57%
==========================================================================================================================
In the first half of 2003, the balance of nonperforming loans declined as a
large commercial loan, comprising the entire amount of renegotiated loans at
December 31, 2002, moved to performing status. In addition, a large commercial
loan on nonaccrual status moved into other real estate owned ("OREO") in the
first quarter of 2003, which also accounted for the majority of the increase in
OREO. Nonperforming assets comprise a smaller percentage of total assets at June
30, 2003, as a result of an increase in assets largely attributable to the
completion of the Investment Growth Strategy and the Kentucky Bancshares
acquisition. While the increase in nonperforming loans in the second quarter of
2003 was due mainly to loans acquired in the Kentucky Bancshares acquisition,
Peoples has recorded valuation reserves to absorb any probable losses from these
acquired loans.
A loan is considered impaired when, based on current information and events, it
is probable that Peoples will be unable to collect the scheduled payments of
principal or interest according to the contractual terms of the loan agreement.
The measurement of potential impaired loan losses is generally based on the
present value of expected future cash flows discounted at the loan's historical
effective interest rate, or the fair value of the collateral if the loan is
collateral dependent. If foreclosure is probable, impairment loss is measured
based on the fair value of the collateral.
At June 30, 2003, the recorded investment in loans that were considered to be
impaired was $12.9 million, of which $10.1 million were accruing interest, and
$2.8 million were nonaccrual loans. Included in this amount were $2.3 million of
impaired loans for which the related allowance for loan losses was $794,000. The
remaining impaired loan balances do not have a related allocation of the
allowance for loan losses because the loans have been previously written-down,
are well secured, or possess characteristics indicative of the ability to repay
the loan. For the six months ended June 30, 2003, Peoples' average recorded
investment in impaired loans was approximately $11.1 million and interest income
of $332,000 was recognized on impaired loans during the period, representing
0.7% of Peoples' total interest income.
Funding Sources
- ---------------
Peoples considers a number of sources when evaluating funding needs, including
but not limited to deposits, short-term borrowings, and long-term borrowings.
Deposits, both interest-bearing and non-interest bearing, continue to be the
most significant source of funds for Peoples, totaling $1.14 billion, or 70% of
total funding sources, at June 30, 2003.
Non-interest bearing deposits serve as a core funding source. At June 30, 2003,
non-interest bearing deposit balances totaled $196.6 million, up $80.7 million
(or 70%) compared to the prior year-end, with the Kentucky Bancshares
acquisition accounting for $19 million of the increase. In addition, Peoples
also acquired a trust relationship in this merger that was in the process of
being transferred to a successor fiduciary at the direction of the client. The
timing of the liquidation resulted in Peoples holding $60 million of
non-interest bearing deposits on June 30, 2003. On July 1, non-interest bearing
deposits returned to normal levels as these trust funds were transferred to the
new fiduciary. Since this transaction caused a temporary increase in balances at
June 30, 2003, management believes a comparison of average balances to be a more
meaningful reflection of the trend in non-interest bearing deposits. In the
second quarter of 2003, non-interest bearing deposits averaged $125.9 million
versus $108.3 million in the first quarter of 2003, an increase of $17.6 million
(or 16%).
Interest-bearing deposits totaled $946.8 million at June 30, 2003, an increase
of $106.8 million (or 13%) compared to $840.0 million at December 31, 2002. In
the second quarter, Peoples acquired interest-bearing deposits of $95 million as
part of the Kentucky Bancshares acquisition. The following details Peoples'
interest-bearing deposits:
(Dollars in thousands) June 30, March 31, December 31, 2002 June 30,
2003 2003 2002
Certificates of deposit $ 479,068 $ 420,817 $ 422,715 $ 414,502
Savings accounts 181,408 169,120 143,594 123,442
Interest-bearing transaction accounts 167,846 143,656 139,609 138,439
Money market deposit accounts 118,521 122,578 134,052 149,352
- -------------------------------------------------------------------------------------------------------------------
Total loans $ 946,843 $ 856,171 $ 839,970 $ 825,735
- -------------------------------------------------------------------------------------------------------------------
Peoples also accesses other funding sources, including short-term and long-term
borrowings, to fund asset growth and satisfy liquidity needs. Peoples'
short-term borrowings include overnight repurchase agreements and FHLB advances,
while long-term borrowings include 10-year FHLB advances, a loan from an
unrelated financial institution and term repurchase agreements. The majority of
the long-term FHLB advances are convertible rate advances, with the initial rate
fixed for periods ranging from two to four years, depending on the specific
advance. After the initial fixed rate period, these advances have the
opportunity, at the discretion of the FHLB, to convert to a LIBOR based,
variable rate product. Peoples has the option to prepay any converted advance
without penalty or allow the borrowing to reprice. In addition to these
convertible rate advances, recent long-term FHLB advances have included fixed
rate, amortizing advances, which have helped Peoples manage its interest rate
sensitivity. Further information regarding Peoples' management of interest rate
sensitivity can be found later in this discussion under "Interest Rate
Sensitivity and Liquidity."
At June 30, 2003, long-term borrowings totaled $456.1 million, up $252.3 million
(or 124%) from $203.8 million at December 31, 2002, with this increase largely
the result of the Investment Growth Strategy. In addition, Peoples converted a
$17 million short-term loan utilized to fund an acquisition in 2002 to a
long-term loan with the same unaffiliated financial institution. As a result,
short-term borrowings decreased $5.4 million to $42.8 million, compared to $48.2
million at year-end 2002.
Capital/Stockholders' Equity
- ----------------------------
At June 30, 2003, stockholders' equity was $178.3 million, versus $147.2 million
at December 31, 2002, an increase of $31.1 million (or 21%). The majority of
this increase is due to common shares issued in conjunction with the Kentucky
Bancshares acquisition and Peoples' earnings, net of dividends paid, which
accounted for $14.3 million and $7.4 million of the increase, respectively.
For the six months ended June 30, 2003, Peoples paid dividends of $3.1 million,
representing a dividend payout ratio of 29.5% of earnings, compared to a ratio
of 24.1% a year ago. While management anticipates Peoples continuing its 37-year
history of consistent dividend growth in future periods, Peoples Bancorp's
ability to pay dividends on its common shares is largely dependent upon
dividends from Peoples Bank. Additionally, Peoples Bancorp has established two
trust subsidiaries to issue preferred securities. If Peoples Bancorp suspends
interest payments relating to the trust preferred securities issued by either of
the two trust subsidiaries, Peoples will be prohibited from paying dividends on
its common shares. Peoples Bancorp or Peoples Bank may decide to limit the
payment of dividends, even when the legal ability to pay them exists, in order
to retain earnings for other strategic purposes.
The adjustment for the net unrealized holding gains on available-for-sale
securities, net of deferred income taxes, impacts Peoples' total equity. At June
30, 2003, net unrealized holding gains totaled $11.5 million versus $6.4 million
at December 31, 2002, a change of $5.1 million. Since all the investment
securities in Peoples' portfolio are classified as available-for-sale, both the
investment and equity sections of Peoples' consolidated balance sheet are more
sensitive to the changing market values of investments than if the investment
portfolio was classified as held-to-maturity.
At June 30, 2003, Peoples had treasury stock totaling $1.1 million, unchanged
from year-end 2002. In the first half of 2003, Peoples repurchased 40,000 common
shares (or 13% of the total authorized), at an average price of $22.04 per
share, under the 2003 Stock Repurchase Program and 1,923 common shares, at an
average price of $23.94, as part of the deferred compensation plan for directors
of Peoples Bancorp and Peoples Bank. The shares purchased under the 2003 Stock
Repurchased Program were reissued in the Kentucky Bancshares acquisition and
stock option exercises. Peoples anticipates repurchasing additional common
shares under the 2003 Stock Repurchase Program and for the deferred compensation
plan.
In addition to monitoring performance through traditional capital measurements
(i.e., dividend payout ratios and ROE), Peoples has also complied with the
capital adequacy standards mandated by the banking industry. Bank regulators
have established "risk-based" capital requirements designed to measure capital
adequacy. Risk-based capital ratios reflect the relative risks of various assets
banks hold in their portfolios. A risk-weight category of 0% (lowest risk
assets), 20%, 50% or 100% (highest risk assets) is assigned to each asset on the
balance sheet. At June 30, 2003, Peoples' Total Capital, Tier 1 and Leverage
ratios were 15.34%, 13.87% and 8.80%, respectively, exceeding the
well-capitalized standards of 10%, 6% and 5%, respectively. In addition, all
three risk-based capital ratios for Peoples Bank were also well above the
minimum standards for a well-capitalized institution at June 30, 2003.
Interest Rate Sensitivity and Liquidity
- ---------------------------------------
While Peoples is exposed to various business risks, the risks relating to
interest rate sensitivity and liquidity could materially impact its future
results of operation and financial condition. The objective of Peoples'
asset/liability management ("ALM") function is to measure and manage these risks
in order to optimize net interest income within the constraints of prudent
capital adequacy, liquidity and safety. This objective requires Peoples to focus
on interest rate risk exposure and adequate liquidity as it manages the mix of
assets and liabilities. Ultimately, the ALM function is intended to guide
management in the acquisition of earning assets and selection of the appropriate
funding sources.
Interest Rate Risk
- ------------------
Interest rate risk ("IRR") is one of the most significant risks for Peoples, and
the entire financial services industry, primarily arising in the normal course
of business of offering a wide array of financial products to its customers,
including loans and deposits. IRR is the potential for economic loss due to
future interest rate changes that can impact both the earnings stream as well as
market values of financial assets and liabilities. Peoples' exposure to IRR is
primarily due to differences in the maturity, or repricing, of earning assets
and interest-bearing liabilities. In addition, other factors, such as
prepayments of loans and investment securities or early withdrawal of deposits,
can expose Peoples to IRR and increase interest costs or reduce revenue streams.
Peoples has charged the ALCO with the overall management of Peoples' balance
sheet mix and off-balance sheet hedging transactions related to the management
of IRR. It is the ALCO's responsibility to keep Peoples focused on the future by
evaluating trends and potential future events, researching alternatives, then
recommending and authorizing an appropriate course of action. To this end, the
ALCO has established an IRR management policy that sets the minimum requirements
and guidelines for monitoring and managing the level and amount of IRR. The
objective of the IRR policy is to encourage management to adhere to sound
fundamentals of banking while allowing sufficient flexibility to exercise the
creativity and innovations necessary to meet the challenges and opportunities of
changing markets. The ultimate goal of these policies is to optimize net
interest income within the constraints of prudent capital adequacy, liquidity,
and safety.
Peoples' ALCO relies on different methods of assessing IRR, including
simulations to project future net interest income and to monitor the sensitivity
of the net present market value of equity and the difference, or "gap", between
maturing or rate-sensitive assets and liabilities over various time periods.
Peoples uses these methods to monitor IRR for both the short- and long-term. The
ALCO places emphasis on simulation modeling as the most beneficial measurement
of IRR because it is a dynamic measure. By employing a simulation process that
estimates the impact of potential changes in interest rates and balance sheet
structures and by establishing limits on these estimated changes to net income
and net market value, the ALCO is better able to evaluate interest rate risks
and their potential impact to earnings and market value of equity.
The modeling process starts with a base case simulation using the current
balance sheet and current interest rates held constant for the next twelve
months. At least two alternative interest rate scenarios, one with higher
interest rates and one with lower interest rates, assuming parallel, immediate
and sustained changes are also prepared using the same balance sheet structure
as the base scenario. Comparisons produced from the simulation data, showing the
earnings variance from the base interest rate scenario, illustrate the risks
associated with the current balance sheet structure. Additional simulations,
when deemed appropriate, are prepared using different interest rate scenarios
than those used with the base case simulation and/or possible changes in balance
sheet structure. The additional simulations are used to better evaluate risks
and highlight opportunities inherent in the modeled balance sheet. Comparisons
showing the earnings and equity value variance from the base case are provided
to the ALCO for review and discussion. The results from these model simulations
are evaluated for indications of effectiveness of current IRR management
strategies.
As part of the evaluation of IRR, the ALCO has established limits on changes in
net interest income and the net value of the balance sheet. The ALCO limits the
decrease in net interest income of Peoples Bank to 10% or less from base case
for each 100 basis point shift in interest rates measured over a twelve-month
period assuming a static balance sheet. The ALCO limits the negative impact on
net equity value to 40% or less given an immediate and sustained 200 basis
points shift in interest rates also assuming a static balance sheet. The ALCO
also reviews static gap measures for specific time periods focusing on a
one-year cumulative gap. At June 30, 2003, Peoples' one-year cumulative gap
amount was positive 13.6% of earning assets, which represented $231.3 million
more in assets than liabilities that may reprice during that period. Based on
historical trends and performance, the ALCO has determined the ratio of the
one-year cumulative gap should be within +/-15% of earning assets. Results that
are greater than any of these limits will prompt a discussion by the ALCO of
appropriate actions, if any, that should be taken.
The following table is provided to illustrate the estimated earnings at risk and
value at risk positions of Peoples, on a pre-tax basis, at June 30, 2003
(dollars in thousands):
Immediate
Interest Rate Estimated Estimated
Increase (Decrease) in (Decrease) Increase (Decrease) Increase in
Basis Points In Net Interest Income Economic Value of Equity
- ---------------------- --------------------------- --------------------------
300 $ (433) (0.8) % $ 12,929 5.4 %
200 748 1.4 (22,207) (9.2)
100 1,438 2.6 (44,659) (18.5)
(50) $ 2,012 3.7 % $ (66,567) (27.6) %
The interest rate risk analysis shows that Peoples is asset sensitive, which
means that increasing interest rates should favorably impact Peoples' net
interest income while downward moving interest rates should negatively impact
net interest income. Peoples' asset sensitivity increased in the second quarter
of 2003 due to the Kentucky Bancshares acquisition; however, the ALCO believes
it is to the long-term benefit of Peoples to maintain an asset sensitive
position. The interest rate analysis also shows Peoples is within the
established IRR policy limits for all simulations and all scenarios for the
current period.
The ALCO has implemented hedge positions to help protect Peoples' net interest
income streams in the event of rising rates which will complement the current
slightly asset sensitive position. Peoples has a hedge position on a $17 million
long-term, fixed-rate borrowing from the FHLB that may convert to a variable
rate, at the FHLB's discretion. In addition, the ALCO may consider additional
hedging options for Peoples' variable rate liabilities, including, but not
limited to, the purchase of other interest rate hedge positions, as available
and appropriate, that would provide net interest income protection in a rising
rate environment.
Liquidity
- ---------
In addition to IRR management, a primary objective of the ALCO is the
maintenance of a sufficient level of liquidity. The ALCO defines liquidity as
the ability to meet anticipated and unanticipated operating cash needs, loan
demand, and deposit withdrawals, without incurring a sustained negative impact
on profitability. The ALCO's liquidity management policy sets limits on the net
liquidity position of Peoples and the concentration of non-core funding sources,
both total wholesale funding and reliance on brokered deposits.
Typically, the main source of liquidity for Peoples is deposit growth. Liquidity
is also provided from cash generated from earning assets such as maturities,
calls, principal payments and income from loans and investment securities. In
the first half of 2003, cash provided by financing activities totaled $319.0
million compared to $26.9 million a year ago, due largely to increased long-term
borrowings used for the Investment Growth Strategy. Cash used in investing
activities totaled $230.8 million versus $39.6 million last year, primarily due
to increased investment securities purchases, net of maturities and sales.
When appropriate, Peoples takes advantage of external sources of funds, such as
advances from the FHLB, national market repurchase agreements, and brokered
funds. These external sources often provide attractive interest rates and
flexible maturity dates that better enable Peoples to match funding dates and
pricing characteristics with contractual maturity dates and pricing parameters
of earning assets. At June 30, 2003, Peoples had available borrowing capacity of
approximately $92 million through these external sources and unpledged
securities in the investment portfolio of approximately $306 million that can be
utilized as an additional source of liquidity.
The net liquidity position of Peoples is calculated by subtracting volatile
funds from liquid assets. Peoples' volatile funds consist primarily of
short-term growth in deposits, while liquid assets includes short-term
investments and unpledged available-for-sale securities. At June 30, 2003,
Peoples' net liquidity position was $298.2 million, or 16.0% of total assets,
compared to $189.7 million, or 13.6% of total assets, at December 31, 2002. The
increase in liquidity position as a percent of total assets was primarily the
result of additional liquid assets from the higher level of cash and cash
equivalents at quarter end. The liquidity position as of June 30, 2003, was
within Peoples' policy limit of negative 10% of total assets. At June 30, 2003,
total wholesale funding comprised 25.4% of total assets and brokered funds were
0.5% of total assets, which was within Peoples' policy limits of 30% and 10%,
respectively.
Off-Balance Sheet Activities and Contractual Obligations
- --------------------------------------------------------
Peoples routinely engages in activities that involve, to varying degrees,
elements of risk that are not reflected in whole or in part in the consolidated
financial statements. These activities are part of Peoples' normal course of
business and include traditional off-balance sheet credit-related financial
instruments, interest rate contracts, operating leases, long-term debt and
commitments to make additional capital contributions in low-income housing
project investments.
Traditional off-balance sheet credit-related financial instruments are primarily
commitments to extend credit, and standby letters of credit. These activities
could require Peoples to make cash payments to third parties in the event
certain specified future events occur. The contractual amounts represent the
extent of Peoples' exposure in these off-balance sheet activities. However,
since certain off-balance sheet commitments, particularly standby letters of
credit, are expected to expire or be only partially used, the total amount of
commitments does not necessarily represent future cash requirements. These
activities are necessary to meet the financing needs of customers. The following
table details the total contractual amount of loan commitments and standby
letters of credit:
(Dollars in thousands) June 30, March 31, December 31, June 30,
2003 2003 2002 2002
Loan commitments $ 119,316 $ 114,342 $ 103,462 $ 93,355
Standby letters of credit 9,606 7,799 7,632 7,570
Unused credit card limits 22,469 22,447 21,216 21,338
Peoples also enters into interest rate contracts where Peoples is required to
either receive cash from or pay cash to counter parties depending on changes in
interest rates. Peoples utilizes interest rate contracts to help manage the risk
of changing interest rates.
At June 30, 2003, Peoples held interest rate contracts with notional amounts
totaling $37 million and fair values totaling $288,000. Interest rate contracts
are carried at fair value on the consolidated balance sheet, with the fair value
representing the net present value of expected future cash receipts or payments
based on market interest rates as of the balance sheet date. As a result, the
amounts recorded on the balance sheet at June 30, 2003, do not represent the
amounts that may ultimately be paid or received under these contracts.
Peoples also has commitments to make additional capital contributions in
low-income housing tax funds, consisting of a pool of low-income housing
projects. As a limited partner in these funds, Peoples receives Federal income
tax benefits which assists Peoples in managing its overall tax burden. At June
30, 2003, these commitments approximated $9.7 million, with approximately $2.1
million expected to be paid over the next twelve months. Management may make
additional investments in various tax credit funds.
Management does not anticipate Peoples' current off-balance sheet activities
will have a material impact on future results of operations and financial
condition.
Peoples continues to lease certain banking facilities and equipment under
noncancelable operating leases with terms providing for fixed monthly payments
over periods ranging from two to fifteen years. The majority of Peoples' leased
banking facilities are inside retail shopping centers and, as a result, are not
available for purchase. Management believes these leased facilities increase
Peoples' visibility within its markets and afford sales associates additional
access to current and potential clients.
Effects of Inflation on Financial Statements
- --------------------------------------------
Substantially all of Peoples' assets relate to banking and are monetary in
nature. As a result, inflation does not impact Peoples to the same degree as
companies in capital-intensive industries in a replacement cost environment.
During a period of rising prices, a net monetary asset position results in a
loss in purchasing power and conversely a net monetary liability position
results in an increase in purchasing power. The opposite would be true during a
period of decreasing prices. In the banking industry, typically monetary assets
exceed monetary liabilities. The current monetary policy targeting low levels of
inflation has resulted in relatively stable price levels. Therefore, inflation
has had little impact on Peoples' net assets.
Future Outlook
- --------------
Peoples' second quarter results reflect some earnings improvement from the first
quarter despite the sustained low interest rate environment and uncertain
economic conditions. In the final six months of 2003, management will focus to
overcome short-term earnings challenges by enhancing revenues and controlling
operating expenses. Peoples' overall focus remains long-term, and Peoples'
current asset-liability position should minimize the impact of any future
changes in interest rates on earnings. Management's commitment to sound
underwriting discipline has produced asset quality that compares favorably to
peer levels.
The expansion of Peoples' mortgage banking activities is an integral part of
short-term earnings growth and is a key part of Peoples' long-term business
strategy. In the first half of 2003, management took steps to improve Peoples'
real estate lending operations to better satisfy the needs of customers. The
refocusing of several Peoples Bank lenders to "Home Loan Specialists" has
allowed mortgage banking income to become a major source of revenue in a
relatively short period of time. Management believes the current interest rate
environment provides opportunities for additional growth in the second half of
2003. Since real estate loans, as well as a basic checking account, are anchor
products to successful long-term financial relationships with customers,
management expects mortgage banking to remain a valuable part of Peoples'
business even after rates start to increase.
While cost control remains a focus during this time of economic uncertainty,
Peoples' continues to make strategic investments that are expected to provide
long-term benefits for all stakeholders. For several months, management has been
working to improve the integration of Peoples' customer data to allow associates
to manage customer relationships more efficiently and effectively through the
implementation of Customer Relationship Management ("CRM") and profitability
systems. This $1.6 million investment will provide Peoples' associates with a
comprehensive view of every customer, as well as allow them to offer an
integrated sales package to potential customers. Beginning in the third quarter,
Peoples will begin to implement these new systems, as well as amortize the
project costs. Since the majority of the costs will be amortized over the
expected useful life, management does not expect the CRM and profitability
project to materially impact short-term earnings.
Management continues to review and rationalize Peoples' delivery channels,
particularly its sales offices. As a result of the Kentucky Bancshares
acquisition, Peoples' has had opportunities to improve operating efficiencies in
the Kentucky markets. Concurrent with this acquisition, Peoples Bank
consolidated its office at 404 Ferry Street in Russell, Kentucky with the newly
acquired Russell office on Diederich Boulevard. In addition, Peoples Bank plans
to close its existing Catlettsburg, Kentucky office and redirect customers to
the nearby Ashland office acquired in the merger. Management believes these
office consolidations allow Peoples to serve customers in these markets more
efficiently and provide conveniences, such as drive-thru banking and ATMs needed
in today's banking environment.
While the development and implementation of the Overdraft Privilege program has
increased non-interest revenue, Peoples is obligated to pay professional fees to
the consultant that assisted in the implementation of the process, based on
revenue parameters, with that amount totaling approximately $115,000 in the
second quarter of 2003 and $265,000 for the first half of 2003. Additional net
revenues from Overdraft Privilege (i.e. after provision for bad debt) have more
than offset the professional expenses associated with the new product. In March
2003, the percentage of revenues paid to the consultant decreased in accordance
with the contract, which will have a positive impact on total professional fees
in the final six months of 2003. In addition, the contract expires in February
2004, which should further enhance net revenues going forward, assuming Peoples
maintains and/or grows total retail core deposits and volumes remain stable.
Mergers and acquisitions, such as the Kentucky Bancshares acquisition, have been
an integral part of Peoples' efforts to expand its operations and scope of
client services, while continuing to build client relationships and implement
new products and services to enhance Peoples' earnings potential. Peoples'
stronger regulatory capital ratios, as a result of the Common Stock Offering,
afford management additional growth opportunities through mergers and
acquisitions and market expansion. With a higher level of tangible equity to
total assets, management believes Peoples is positioned to continue its
disciplined acquisition strategy of the past decade and plans to dedicate more
resources to develop and realize acquisition opportunities in and around
Peoples' markets. However, the evaluation of future acquisitions will focus more
on opportunities that complement Peoples' core competencies and strategic intent
rather than geographic location or proximity to current markets.
In addition to mergers and acquisitions, Peoples routinely explores and
evaluates opportunities to grow within existing markets. One such opportunity is
the expansion of Peoples' operations in central Ohio by converting Peoples' loan
production office in Lancaster, Ohio to a full-service business banking
facility. The primary focus of the expanded office will remain business clients.
However, the office will ultimately offer Peoples' complete line of products and
services, including mortgage baking, insurance and investment services. The new
office is planned to be completed in October 2003 and will offer deposit
products for business clients in Ohio's Fairfield County and surrounding
markets.
In recent years, Peoples' debit card, the Connect Card, has provided various
benefits to customers while also generating fee income for Peoples based on a
percentage of the transactions processed, known as interchange fees. However,
MasterCard International and Visa USA have implemented new rules and changed
business practices as part of agreements to settle claims brought against them
in connection with the card associations' rules and fees relating to merchant
acceptance of their branded cards. These changes are estimated to reduce
Peoples' debit card revenues by about $70,000 before tax per quarter beginning
in the third quarter of 2003, based on current volumes of debit card
transactions. Management plans to partially offset this reduced income stream by
continuing to grow core deposits, issuing additional debit cards, and
encouraging Peoples' customers to use their debit cards as a convenient way to
do their banking.
Peoples remains a service-oriented company with a sales focus that strives to
satisfy clients through a relationship sales process. Through this process,
sales associates work to anticipate, uncover, and solve their clients' every
financial need, from insurance to banking to investments. In the third quarter
of 2003, earnings catalysts include mortgage banking revenue growth, a full
quarter of the Kentucky Bancshares acquisition and improved operating
efficiencies. Management remains stakeholder-focused with four key long-term
objectives: 7% to 10% EPS growth per year, ROE improvement, consistent dividend
growth and revenue diversification.
Forward-Looking Statements
- --------------------------
The statements in this Form 10-Q which are not historical fact are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as
amended, and the Private Securities Litigation Reform Act of 1995. Although
management believes Peoples' plans, intentions and expectations reflected in or
suggested by these forward-looking statements are reasonable, Peoples cannot
give any assurance that those plans, intentions or expectations will be
achieved. The forward-looking statements involve a number of risks and
uncertainties, including, but not limited to, the effect of changes in interest
rates, the effect of federal and state banking and tax regulations, the effect
of technological changes, the effect of economic conditions, the effect of
competitive products and pricing, and other risks detailed in Peoples'
Securities and Exchange Commission filings. All forward-looking statements are
expressly qualified in their entirety by the cautionary statements. Although
management believes the expectations in these forward-looking statements are
based on reasonable assumptions within the bounds of management's knowledge of
Peoples' business and operations, it is possible that actual results may differ
materially from these projections.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by this item is provided under the caption "Interest
Rate Sensitivity and Liquidity" under Item 2 - Management's Discussion and
Analysis of Financial Condition and Results of Operations in this Form 10-Q, and
is incorporated herein by reference.
CONSOLIDATED AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME
For the Three Months Ended June 30,
2003 2002
------------------------------------ -----------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
ASSETS
Securities:
Taxable $ 636,503 $ 7,035 4.42% $ 288,413 $ 4,417 6.13%
Tax-exempt (1) 67,107 1,109 6.61% 63,526 1,102 6.94%
- -----------------------------------------------------------------------------------------------------------------
Total securities 703,610 8,144 4.63% 351,939 5,519 6.27%
Loans (2):
Commercial (1) 463,951 7,315 6.31% 375,911 6,449 6.86%
Real estate 330,322 5,934 7.19% 306,451 5,865 7.66%
Consumer 101,265 2,457 9.71% 114,436 2,880 10.07%
- -----------------------------------------------------------------------------------------------------------------
Total loans 895,538 15,706 7.02% 796,798 15,194 7.63%
Less: Allowance for loan loss (13,967) (12,536)
- -----------------------------------------------------------------------------------------------------------------
Net loans 881,571 15,706 7.14% 784,262 15,194 7.76%
Interest-bearing deposits 2,399 4 0.73% 2,191 7 1.37%
Federal funds sold 18,759 54 1.15% 43 1 1.86%
- -----------------------------------------------------------------------------------------------------------------
Total earning assets 1,606,339 23,908 5.96% $ 1,138,435 20,721 7.29%
Other assets 135,812 99,653
- -----------------------------------------------------------------------------------------------------------------
Total assets $ 1,742,151 $ $ 1,238,088 $
=================================================================================================================
LIABILITIES AND EQUITY
Interest-bearing deposits:
Savings $ 175,957 $ 529 1.20% $ 108,583 $ 413 1.52%
Interest-bearing demand deposits 276,920 676 0.98% 273,519 1,106 1.62%
Time 454,069 3,698 3.26% 373,394 3,641 3.90%
- -----------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 906,946 4,903 2.17% 755,496 5,160 2.74%
Borrowed funds:
Short-term 43,637 138 1.26% 45,766 229 2.00%
Long-term 456,242 4,290 3.76% 201,044 2,412 4.80%
- -----------------------------------------------------------------------------------------------------------------
Total borrowed funds 499,879 4,428 3.53% 246,810 2,641 4.29%
- -----------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 1,406,825 9,331 2.65% 1,002,306 7,801 3.12%
Non-interest bearing deposits 125,922 97,594
Other liabilities 40,995 37,120
- -----------------------------------------------------------------------------------------------------------------
Total liabilities 1,573,742 1,137,020
Stockholders' equity 168,409 101,068
- -----------------------------------------------------------------------------------------------------------------
Total liabilities and equity $ 1,742,151 1,238,088 $
=================================================================================================================
Interest spread 14,577 3.31% 12,920 4.17%
Interest income to earning assets 5.96% 7.29%
Interest expense to earning assets 2.32% 2.75%
- -----------------------------------------------------------------------------------------------------------------
Net interest margin 3.64% 4.54%
=================================================================================================================
(1) Interest income and yields presented on a fully tax-equivalent basis
using a 35% tax rate.
(2) Nonaccrual and impaired loans are included in the average balances.
Related interest income on nonaccrual loans prior to the loan being
placed on nonaccrual is included in loan interest income. Loan fees
included in interest income totaled $207 and $170 for the periods
presented in 2003 and 2002, respectively.
For the Six Months Ended June 30,
2003 2002
------------------------------------ ----------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
ASSETS
Securities:
Taxable $ 589,389 $ 13,723 4.66% $ 288,774 $ 8,967 6.21%
Tax-exempt (1) 66,668 2,223 6.67% 58,622 2,041 6.96%
- -----------------------------------------------------------------------------------------------------------------
Total securities 656,057 15,946 4.86% 347,396 11,008 6.34%
Loans (2):
Commercial (1) 439,082 14,063 6.41% 370,579 12,827 6.92%
Real estate 330,537 11,984 7.25% 301,838 11,703 7.75%
Consumer 103,756 5,018 9.67% 115,146 5,831 10.13%
- -----------------------------------------------------------------------------------------------------------------
Total loans 873,375 31,065 7.11% 787,563 30,361 7.71%
Less: Allowance for loan loss (13,683) (12,579)
- -----------------------------------------------------------------------------------------------------------------
Net loans 859,692 31,065 7.26% 774,984 30,361 7.88%
Interest-bearing deposits 1,977 7 0.71% 2,552 17 1.44%
Federal funds sold 13,466 77 1.14% 26 1 1.54%
- -----------------------------------------------------------------------------------------------------------------
Total earning assets 1,531,192 47,095 6.17% 1,124,958 41,387 7.39%
Other assets 128,180 97,088
- -----------------------------------------------------------------------------------------------------------------
Total assets $ 1,659,372 $ $ 1,222,046 $
=================================================================================================================
LIABILITIES AND EQUITY
Interest-bearing deposits:
Savings $ 163,134 $ 1,025 1.26% $ 96,756 $ 696 1.44%
Interest-bearing demand deposits 273,894 1,543 1.13% 275,104 2,222 1.62%
Time 438,202 7,539 3.44% 368,702 7,781 4.22%
- -----------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 875,230 10,107 2.33% 740,562 10,699 2.91%
Borrowed funds:
Short-term 40,637 242 1.19% 53,828 520 1.93%
Long-term 424,077 8,116 3.83% 197,752 4,738 4.79%
- -----------------------------------------------------------------------------------------------------------------
Total borrowed funds 464,714 8,358 3.61% 251,580 5,258 4.21%
- -----------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 1,339,944 18,465 2.77% 992,142 15,957 3.24%
Non-interest bearing deposits 117,167 95,788
Other liabilities 40,867 35,064
- -----------------------------------------------------------------------------------------------------------------
Total liabilities 1,497,978 1,122,994
Stockholders' equity 161,394 99,052
- -----------------------------------------------------------------------------------------------------------------
Total liabilities and equity $ 1,659,372 $ $ 1,222,046 $
=================================================================================================================
Interest spread 28,630 3.40% 25,430 4.15%
Interest income to earning assets 6.17% 7.39%
Interest expense to earning assets 2.43% 2.86%
- -----------------------------------------------------------------------------------------------------------------
Net interest margin 3.74% 4.53%
=================================================================================================================
(1) Interest income and yields presented on a fully tax-equivalent basis
using a 35% tax rate.
(2) Nonaccrual and impaired loans are included in the average balances.
Related interest income on nonaccrual loans prior to the loan being
placed on nonaccrual is included in loan interest income. Loan fees
included in interest income totaled $378 and $356 for the periods
presented in 2003 and 2002, respectively.
ITEM 4: CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
- ------------------------------------------------
With the participation of Peoples' management, including Peoples' principal
executive officer and principal financial officer, Peoples has evaluated the
effectiveness of its disclosure controls and procedures (as defined in Rules
13a-15 and 15d-15 of the Securities Exchange Act of 1934 (the "Exchange Act"))
as of the end of the period covered by this report. Based upon that evaluation,
Peoples' principal executive officer and principal financial officer have
concluded that such disclosure controls and procedures are effective as of the
end of the period covered by this report to ensure that material information
relating to Peoples and its consolidated subsidiaries is made known to them,
particularly during the period for which Peoples' periodic reports, including
this report, are being prepared.
Changes in Internal Controls
- ----------------------------
There were no significant changes during the period covered by this report in
Peoples' internal control over financial reporting (as defined in Rules 13a-15
and 15d-15 of the Exchange Act) that have materially affected, or are reasonably
likely to materially affect, Peoples' internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1: Legal Proceedings.
None.
ITEM 2: Changes in Securities and Use of Proceeds.
None.
ITEM 3: Defaults upon Senior Securities.
None.
ITEM 4: Submission of Matters to a Vote of Security Holders.
None.
ITEM 5: Other Information.
None.
ITEM 6: Exhibits and Reports on Form 8-K.
a) Exhibits:
EXHIBIT INDEX
Exhibit
Number Description Exhibit Location
- ------------ ----------------------------------------------------- ----------------------------------
10(a) Loan Agreement dated as of June 12, 2003, by and Filed herewith
between Peoples Bancorp Inc. and First Tennessee
Bank National Association.
10(b) Promissory note executed by Peoples Bancorp Inc., Filed herewith
as Maker in the principal amount of $17,000,000 dated
June 12, 2003.
10(c) Commercial Pledge Agreement dated as of June 12, Filed herewith
2003, by and between Peoples Bancorp Inc. and First
Tennessee Bank National Association.
11 Computation of Earnings Per Share. Filed herewith
12 Computation of Ratios. Filed herewith
31(a) CEO Certification Pursuant to Rule 13a-14(A)/15d-14(A) Filed herewith
31(b) CFO Certification Pursuant to Rule 13a-14(A)/15d-14(A) Filed herewith
32 Certification Pursuant To Title 18, United States Filed herewith
Code, Section 1350, As Adopted Pursuant To Section
906 Of The Sarbanes-Oxley Act Of 2002
b) Reports on Form 8-K:
Peoples filed the following reports on Form 8-K during the three months
ended June 30, 2003:
1) Filed April 1, 2003 - News release announcing the opening of a loan
production office in Delaware, Ohio.
2) Filed April 11, 2003 - Transcript of Peoples Bancorp Inc.'s Annual
Meeting of Shareholders held on April 10, 2003.
3) Filed April 15, 2003 - News release announcing earnings for
the quarter ended March 31, 2003.
4) Filed April 17, 2003 - Transcript of the conference call to discuss
first quarter of 2003 results held on on April 16, 2003.
5) Filed May 9, 2003 - News release announcing the Board of Directors of
Peoples Bancorp Inc. declared a quarterly dividend of $0.16 per share.
6) Filed May 12, 2003 - News release announcing Peoples Bancorp Inc.
completed its acquisition of Kentucky Bancshares Incorporated.
7) Filed June 19, 2003 - News release announcing the appointment of
Robert E. Evans as Chairman of the Board of Peoples Bancorp Inc. and
appointment of Mark F. Bradley as Chief Operating Officer of Peoples
Bancorp Inc.
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.
PEOPLES BANCORP INC.
Date: August 11, 2003 By: /s/ ROBERT E. EVANS
-----------------------------------------------
Robert E. Evans
Chairman, President and Chief Executive Officer
Date: August 11, 2003 By: /s/ JOHN W. CONLON
-----------------------------------------------
John W. Conlon
Chief Financial Officer
EXHIBIT INDEX
Exhibit
Number Description Exhibit Location
- ------------ ----------------------------------------------------- ----------------------------------
10(a) Loan Agreement dated as of June 12, 2003, by and Filed herewith
between Peoples Bancorp Inc. and First Tennessee
Bank National Association.
10(b) Promissory note executed by Peoples Bancorp Inc., Filed herewith
as Maker in the principal amount of $17,000,000 dated
June 12, 2003.
10(c) Commercial Pledge Agreement dated as of June 12, Filed herewith
2003, by and between Peoples Bancorp Inc. and First
Tennessee Bank National Association.
11 Computation of Earnings Per Share. Filed herewith
12 Computation of Ratios. Filed herewith
31(a) CEO Certification Pursuant to Rule 13a-14(A)/15d-14(A) Filed herewith
31(b) CFO Certification Pursuant to Rule 13a-14(A)/15d-14(A) Filed herewith
32 Certification Pursuant To Title 18, United States Filed herewith
Code, Section 1350, As Adopted Pursuant To Section
906 Of The Sarbanes-Oxley Act Of 2002