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, 2004
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 31-0987416
- ------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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 6, 2004: 10,555,919.
Exhibit Index Appears on Page 37
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
The following Condensed Consolidated Balance Sheets, Condensed Consolidated
Statements of Income, Consolidated Statement of Stockholders' Equity, and
Condensed 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, 2004, are not necessarily indicative of the results that may be
expected for the year ending December 31, 2004. The balance sheet at December
31, 2003, contained herein has been derived from the audited balance sheet
included in Peoples Bancorp Inc.'s Annual Report on Form 10-K for the fiscal
year ended December 31, 2003 ("2003 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 2003
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 2004 2003
Cash and cash equivalents:
Cash and due from banks $ 47,609 $ 28,349
Interest-bearing deposits in other banks 1,610 1,077
Federal funds sold 6,100 44,000
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Total cash and cash equivalents 55,319 73,426
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Available-for-sale investment securities,
at estimated fair value (amortized
cost of $641,269 at June 30, 2004 and
$634,801 at December 31, 2003) 639,190 641,464
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Loans, net of deferred fees and costs 935,556 914,998
Allowance for loan losses (14,693) (14,575)
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Net loans 920,863 900,423
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Loans held for sale 807 2,847
Business owned life insurance 44,277 23,355
Bank premises and equipment, net 21,720 22,155
Goodwill 53,770 41,407
Other intangible assets 11,504 7,298
Other assets 26,811 23,729
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Total assets $ 1,774,261 $ 1,736,104
================================================================================
Liabilities
Deposits:
Non-interest-bearing $ 137,335 $ 133,709
Interest-bearing 875,989 894,821
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Total deposits 1,013,324 1,028,530
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Short-term borrowings:
Federal funds purchased and securities
sold under agreements to repurchase 14,253 16,468
Federal Home Loan Bank advances 99,700 92,300
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Total short-term borrowings 113,953 108,768
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Long-term borrowings 434,126 388,647
Junior subordinated notes held by subsidiary trusts 29,220 29,177
Accrued expenses and other liabilities 13,836 10,102
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Total liabilities 1,604,459 1,565,224
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Stockholders' Equity
Common stock, no par value, 24,000,000 shares
authorized, 10,841,020 shares issued
at June 30, 2004 and 10,704,938 shares
issued at December 31, 2003, including
shares in treasury 162,535 161,005
Retained earnings 14,363 7,781
Accumulated comprehensive (loss) income, net
of deferred income taxes (1,436) 4,255
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175,462 173,041
Treasury stock, at cost, 238,521 shares at
June 30, 2004 and 101,146 shares
at December 31, 2003 (5,660) (2,161)
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Total stockholders' equity 169,802 170,880
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Total liabilities and stockholders' equity $ 1,774,261 $ 1,736,104
================================================================================
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) For the Three Months For the Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
Interest Income:
Interest and fees on loans $ 14,603 $ 15,678 $ 29,247 $ 31,017
Interest on taxable investment securities 5,833 7,035 12,004 13,723
Interest on tax-exempt investment securities 699 721 1,410 1,445
Other interest income 10 58 70 84
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Total interest income 21,145 23,492 42,731 46,269
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Interest Expense:
Interest on deposits 4,159 4,903 7,959 10,107
Interest on short-term borrowings 191 138 468 242
Interest on long-term borrowings 3,517 4,290 6,895 8,116
Interest on junior subordinated notes held by subsidiary
trusts 581 584 1,164 1,169
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Total interest expense 8,448 9,915 16,486 19,634
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Net interest income 12,697 13,577 26,245 26,635
Provision for loan losses 616 935 1,410 1,766
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Net interest income after provision for loan losses 12,081 12,642 24,835 24,869
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Other Income:
Service charges on deposit accounts 2,459 2,052 4,712 3,777
Investment and insurance commissions 1,428 320 1,727 762
Income from fiduciary activities 812 858 1,586 1,444
Electronic banking income 623 529 1,146 983
Business owned life insurance 506 353 922 718
Mortgage banking income 283 337 482 567
Gain (loss) on securities transactions 5 (29) 37 (27)
Gain (loss) on asset disposals 17 (236) 47 (238)
Other 134 98 495 231
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Total other income 6,267 4,282 11,154 8,217
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Other Expenses:
Salaries and employee benefits 5,819 4,827 11,208 9,551
Net occupancy and equipment 1,289 1,108 2,510 2,206
Amortization of other intangible assets 526 271 927 472
Data processing and software 441 320 913 650
Professional fees 411 520 867 984
Marketing 402 379 510 655
Bankcard costs 378 276 702 581
Franchise tax 371 272 712 529
Other 1,894 1,485 3,472 2,949
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Total other expenses 11,531 9,458 21,821 18,577
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Income before income taxes 6,817 7,466 14,168 14,509
Income taxes 1,764 2,027 3,749 4,056
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Net income $ 5,053 $ 5,439 $ 10,419 $ 10,453
=================================================================================================================================
Earnings per share:
Basic $ 0.48 $ 0.52 $ 0.98 $ 1.02
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Diluted $ 0.47 $ 0.51 $ 0.97 $ 1.00
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Weighted-average number of shares outstanding:
Basic 10,603,510 10,400,673 10,581,879 10,229,595
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Diluted 10,766,289 10,598,820 10,787,867 10,428,220
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Cash dividends declared $ 1,937 $ 1,634 $ 3,837 $ 3,081
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Cash dividends per share $ 0.18 $ 0.15 $ 0.36 $ 0.30
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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, except Per Share Data) Accumulated
Common Stock Retained Comprehensive Treasury
Shares Amount Earnings (Loss) Income Stock Total
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Balance, December 31, 2003 10,704,938 $ 161,005 $ 7,781 $ 4,255 $ (2,161) $ 170,880
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Net income 10,419 10,419
Unrealized gains on available-for-sale
securities,
net of reclassification adjustment (5,691) (5,691)
Purchase of treasury stock, 291,141 shares (7,857) (7,857)
Distribution of treasury stock for deferred
compensation plan (reissued 8,450 shares) 153 153
Exercise of common stock options (reissued
78,734
treasury shares) (1,731) 2,293 562
Tax benefit from exercise of stock options 110 110
Issuance of common stock under dividend
reinvestment plan 8,636 249 249
Cash dividends declared (3,837) (3,837)
Issuance of common stock to purchase Putnam
Agency, Inc. (reissued 66,582 treasury (327) 1,912 1,585
shares)
Issuance of common stock to purchase Barengo
Insurance Agency, Inc. 127,446 3,229 3,229
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Balance, June 30, 2004 10,841,020 $ 162,535 $ 14,363 $ (1,436) $ (5,660) $ 169,802
====================================================================================================================================
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Dollars in thousands) For the Three Months For the Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
Net income $ 5,053 $ 5,439 $ 10,419 $ 10,453
Other comprehensive (loss) income, net of tax:
Unrealized (loss) gain on available-for-sale investment
securities arising during the period (10,815) 3,356 (5,667) 5,059
Less: reclassification adjustment for securities gain (loss)
included in net income, net of tax 3 (19) 24 (18)
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Net unrealized (loss) gain on available-for-sale
arising during the period (10,818) 3,375 (5,691) 5,077
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Total comprehensive (loss) income $ (5,765) $ 8,814 $ 4,728 $ 15,530
====================================================================================================================================
See notes to the consolidated unaudited financial statements
PEOPLES BANCORP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands) For the Six Months
Ended June 30,
2004 2003
Net cash provided by operating activities $ 18,142 $ 11,525
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Cash flows from investing activities:
Purchases of available-for-sale securities (87,978) (430,251)
Proceeds from sales of available-for-sale securities 2,065 49,509
Proceeds from maturities of available-for-sale securities 78,109 132,754
Net (increase) decrease in loans (22,099) 8,044
Net expenditures for premises and equipment (1,797) (1,011)
Net proceeds (expenditures) from sales of other real estate owned 11 (861)
Business acquisitions, net of cash received (6,948) 12,015
Investment in business owned life insurance (20,000) -
Investment in limited partnership and tax credit funds (2,672) (993)
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Net cash used in investing activities (61,309) (230,794)
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Cash flows from financing activities:
Net increase in non-interest-bearing deposits 3,626 62,110
Net (decrease) increase in interest-bearing deposits (18,372) 11,273
Net increase (decrease) in short-term borrowings 5,185 (5,357)
Proceeds from long-term borrowings 52,500 258,018
Payments on long-term borrowings (7,021) (8,776)
Cash dividends paid (3,563) (2,451)
Purchase of treasury stock (7,857) (928)
Proceeds from issuance of common stock 562 5,064
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Net cash provided by financing activities 25,060 318,953
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Net (decrease) increase in cash and cash equivalents (18,107) 99,684
Cash and cash equivalents at beginning of period 73,426 55,550
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Cash and cash equivalents at end of period $ 55,319 $ 155,234
=====================================================================================================================
Supplemental cash flow information:
Interest paid $ 16,325 $ 17,266
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Income taxes paid $ - $ 2,339
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See notes to the consolidated unaudited financial statements
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
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 Bancorp Inc.
("Peoples Bancorp") 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 the 2004 presentation. All significant
intercompany accounts and transactions have been eliminated.
1. MERGERS AND ACQUISITIONS
At the close of business on May 28, 2004, Peoples completed the acquisition
of Barengo Insurance Agency, Inc., ("Barengo"), based in Marietta, Ohio, for
initial consideration of $6.0 million ($2.9 million in cash and $3.1 million
in Peoples Bancorp's common shares). The agreement also provides for
additional consideration of up to $2.7 million ($1.3 million in cash and
$1.4 million in Peoples Bancorp's common shares) to be paid by Peoples over
the next three years, contingent on Barengo achieving certain revenue growth
goals.
Peoples accounted for this transaction under the purchase method of
accounting. While Peoples has not finalized the purchase price allocation,
subject to the final valuation of the acquired tangible and intangible
assets, Peoples prepared a preliminary purchase price allocation, which is
included as a part of these financial statements, including goodwill of $4.9
million and customer relationship intangible of $1.9 million. Such estimates
and allocations are subject to change when additional information regarding
the valuation is finalized.
At the close of business on April 30, 2004, Peoples completed the
acquisition of substantially all of the assets of Putnam Agency, Inc.
("Putnam Agency"), with offices in Ashland, Kentucky and Huntington, West
Virginia, for initial consideration of $8.6 million ($7.0 million in cash
and $1.6 million in Peoples Bancorp's common shares). The agreement also
provides for additional consideration of up to $3 million in cash to be paid
by Peoples over the next three years, contingent on the Putnam Agency
achieving certain revenue growth goals. Peoples accounted for this
transaction under the purchase method of accounting. As part of the
preliminary purchase price allocation, Peoples recorded goodwill of $6.7
million and customer relationship intangible of $3.2 million. The
preliminary purchase price allocation is subject to change.
Both Barengo and the Putnam Agency are full-service insurance agencies that
offer a wide range of insurance products to both commercial and individual
clients. Peoples operates the former agencies as divisions of Peoples
Insurance Agency, using the "Barengo Insurance Agency" and "Putnam Agency"
trade names. Peoples has retained all key producers and managers, with the
exception of one producer with the Putnam Agency who has retired.
The balances and operations of the acquisitions 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.
2. STOCK-BASED COMPENSATION:
Peoples accounts for stock-based compensation using the intrinsic value
method. 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,
2004 2003 2004 2003
Net Income, as reported $ 5,053 $ 5,439 $ 10,419 $ 10,453
Deduct: stock-based compensation expense determined
under fair value based method, net of tax 116 141 250 227
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Pro forma net income $ 4,937 $ 5,298 $ 10,169 $ 10,226
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Basic Earnings Per Share:
As reported $ 0.48 $ 0.52 $ 0.98 $ 1.02
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Pro forma $ 0.47 $ 0.51 $ 0.96 $ 1.00
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Diluted Earnings Per Share:
As reported $ 0.47 $ 0.51 $ 0.97 $ 1.00
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Pro forma $ 0.46 $ 0.50 $ 0.94 $ 0.98
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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
2004 and 2003:
2004 2003
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Risk-free interest rate 4.39% 5.50%
Dividend yield 2.83% 2.51%
Volatility factor of the market price of parent stock 29.5% 30.8%
Weighted-average expected life of options 7 years 7 years
3. EMPLOYEE BENEFIT PLANS:
Components of Net Periodic Benefit Costs
----------------------------------------
Peoples sponsors a noncontributory defined benefit pension plan and a
contributory postretirement benefit plan. The following table details the
components of the net periodic benefit cost for both plans:
Pension Benefits:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
(Dollars in Thousands) 2004 2003 2004 2003
Service cost $ 239 $ 163 $ 451 $ 326
Interest cost 201 168 386 337
Expected return on plan assets (259) (200) (486) (401)
Amortization of transition asset - - - -
Amortization of prior service cost 1 (1) 2 (2)
Amortization of net loss 60 17 104 34
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Net periodic benefit cost $ 242 $ 147 $ 457 $ 294
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Postretirement Benefits:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
(Dollars in Thousands) 2004 2003 2004 2003
Service cost $ - $ - $ - $ -
Interest cost 9 10 18 20
Expected return on plan assets - - - -
Amortization of transition asset - - - -
Amortization of prior service cost 3 3 6 6
Amortization of net loss - 1 - 2
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Net periodic benefit cost $ 12 $ 14 $ 24 $ 28
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Employer Contributions
----------------------
Through June 30, 2004, Peoples had made contributions totaling $1.1 million
to its defined benefit pension plan for the current year, as recommended by
the Retirement Plan Committee and authorized by the Board of Directors of
Peoples Bancorp.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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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,
2004 2003 2004 2003
SIGNIFICANT RATIOS
Return on average equity 11.83 % 12.92 % 12.17 % 12.95 %
Return on average assets 1.17 % 1.25 % 1.21 % 1.26 %
Net interest margin (a) 3.39 % 3.48 % 3.48 % 3.58 %
Non-interest income leverage ratio (b) 56.75 % 49.49 % 51.98 % 46.96 %
Efficiency ratio (c) 56.87 % 49.55 % 55.09 % 50.37 %
Average stockholders' equity to average assets 9.92 % 9.67 % 9.95 % 9.73 %
Average loans to average deposits 89.39 % 86.70 % 88.97 % 88.01 %
Cash dividends to net income 38.33 % 30.04 % 36.83 % 29.47 %
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ASSET QUALITY RATIOS (end of period)
Nonperforming loans as a percent of total loans (d) 0.62 % 0.62 % 0.62 % 0.62 %
Nonperforming assets as a percent of total assets (e) 0.35 % 0.35 % 0.35 % 0.35 %
Allowance for loan losses to loans net of unearned interest 1.57 % 1.55 % 1.57 % 1.55 %
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CAPITAL RATIOS (end of period)
Tier I capital ratio 12.27 % 13.87 % 12.27 % 13.87 %
Risk-based capital ratio 13.58 % 15.34 % 13.58 % 15.34 %
Leverage ratio 8.17 % 8.80 % 8.17 % 8.80 %
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PER SHARE DATA (f)
Net income per share - basic $ 0.48 $ 0.52 $ 0.98 $ 1.02
Net income per share - diluted 0.47 0.51 0.97 1.00
Cash dividends per share 0.18 0.15 0.36 0.30
Book value per share (end of period) 16.01 16.72 16.01 16.72
Tangible book value per share (end of period) (g) $ 9.86 $ 12.14 $ 9.86 $ 12.14
Weighted average shares outstanding - Basic 10,603,510 10,400,673 10,581,879 10,229,595
Weighted average shares outstanding - Diluted 10,766,289 10,598,820 10,787,867 10,428,220
Common shares outstanding at end of period 10,602,767 10,665,884 10,602,767 10,665,884
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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).
(c) Non-interest expense (less intangible amortization) as a percentage of
fully-tax equivalent net interest income plus non-interest income.
(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) Adjusted for stock dividends.
(g) Tangible book value per share reflects capital calculated for banking
regulatory requirements and excludes balance sheet impact of intangible
assets acquired through acquisitions accounted for using the purchase
method accounting.
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 Bancorp's primary
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"), PBNA L.L.C.
and Peoples Loan Services, Inc. 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 financial products and services through 51
financial service locations and 33 ATMs in Ohio, West Virginia and Kentucky.
Peoples Bank's internet-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 traditional 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, Inc., member NASD/SIPC and an independent
broker/dealer, located at Peoples Bank offices. Peoples Bank also offers a full
range of life, health, property and casualty insurance products to customers in
Peoples markets through Peoples Insurance Agency, Inc.
Peoples Investment Company and Peoples Capital Corporation were formed in 2001
to better deploy investable funds and provide new investment opportunities,
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, 2003, and
notes thereto, as well as the ratios, statistics and discussions contained
elsewhere in this Form 10-Q. All share and per share information has been
adjusted for stock dividends.
References will be found in this Form 10-Q to the following significant
transactions that have impacted or are expected to impact Peoples' results of
operations:
o As discussed in Note 1 of Notes to the Consolidated Unaudited Financial
Statements, Peoples completed the acquisition of Putnam Agency, Inc.
("Putnam") on April 30, 2004 and Barengo Insurance Agency, Inc.
("Barengo") on May 28, 2004, (collectively, the "Insurance Agency
Acquisitions").
o On May 9, 2003, Peoples completed its acquisition of Kentucky
Bancshares Incorporated ("Kentucky Bancshares"), the holding company of
Kentucky Bank & Trust. In this transaction, Peoples acquired loans of
$75 million, deposits of $113 million, and trust assets under
management of $182 million, as well as three ATMs and five full-service
financial service offices in northeastern Kentucky. In addition,
Peoples Bank closed an office at 404 Ferry Street in Russell, Kentucky,
concurrent with this acquisition. Peoples Bank also closed its
Catlettsburg, Kentucky, office on October 17, 2003, due to the
proximity of the acquired Ashland, Kentucky, office.
o In December 2003, Peoples Bank sold its existing credit card portfolio
to InfiCorp Holdings, Inc. ("InfiCorp"). In addition to the sale,
Peoples Bank and InfiCorp entered into a joint marketing agreement to
serve the credit card needs of Peoples' customers and prospective
customers.
o In December 2003, Peoples sold $55 million of mortgage-backed
investment securities due to the high rate of prepayments on those
securities and the corresponding downward pressure on yields from
accelerated amortization of bond premiums. Peoples reinvested the
proceeds from the sales into other mortgage-backed securities that are
anticipated to produce a higher yield with estimated lives similar to
those of the securities that were sold (collectively, the "Investment
Portfolio Restructuring"). Approximately $27 million of the
reinvestment settled in late December 2003 and the remaining
reinvestment of approximately $26 million settled in late January 2004.
o On December 16, 2003, Peoples prepaid $63 million of long-term,
convertible rate borrowings from the Federal Home Loan Bank ("FHLB")
and reborrowed the funds using a short-term, repurchase agreement
advance (collectively, the "Long-Term Debt Restructuring"). Peoples
incurred prepayment penalties totaling $6.8 million as part of this
transaction. The prepaid borrowings had a weighted-average rate of
5.14% and weighted-average remaining maturity of 5.4 years. The new
short-term advance has a significantly lower initial interest rate, yet
has somewhat similar interest rate sensitivity characteristics in a
rising interest rate environment.
o On December 17, 2003, Peoples announced the authorization to
repurchase up to 425,000, or approximately 4%, of Peoples Bancorp's
outstanding common shares in 2004 from time to time in open market or
privately negotiated transactions ("2004 Stock Repurchase Program").
The repurchases are eligible to be used for projected exercises of
stock options granted under Peoples' stock option plans, projected
purchases of common shares for Peoples Bancorp's deferred compensation
plans, and other general corporate purposes. The timing of the
purchases and the actual number of common shares purchased are
dependent on market conditions and limitations imposed by applicable
federal securities laws. The 2004 Stock Repurchase Program expires
December 31, 2004, and will not exceed an aggregate purchase price of
$13 million. Through August 6, 2004, Peoples Bancorp had repurchased
375,535 common shares (or 88% of the total authorized) under the 2004
Stock Repurchase Program, at an average price of $26.68.
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 financial services 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 conforming to US GAAP that include
general accounting practices within the financial services industry. Interest
income on loans and investment securities is recognized by methods that result
in level rates of return on principal amounts outstanding, including yield
adjustments resulting from the amortization of loan costs and premiums on
investment securities and accretion of loan fees and discounts on investment
securities. Since mortgage-backed securities comprise a sizable portion of
Peoples' investment portfolio, a significant increase in principal payments on
those securities negatively impacts interest income due to the corresponding
acceleration of bond premium amortization.
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 considered doubtful.
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 could increase or decrease each
quarter based upon the results of management's formal analysis.
The amount of the allowance for loan losses 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 for individual loan reviews are based
upon past loss experience, known 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, 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
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 the allowance for loan losses will be adequate to
cover all losses, but management believes the allowance for loan losses of $14.7
million at June 30, 2004, 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 such, adverse changes in economic activity could reduce
cash flows for both commercial and individual borrowers, which would likely
cause Peoples to experience increases in problem assets, delinquencies and
losses on loans.
Investment Securities
- ---------------------
Investment securities are initially 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 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 reported
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 other considerations. Available-for-sale securities are reported at
estimated 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.
While temporary changes in the market value of available-for-sale securities are
not recognized in earnings, a decline in fair value below amortized cost deemed
to be "other-than-temporary" results in an adjustment to the cost basis of the
investment, with a corresponding loss charged against earnings. Management
systematically evaluates Peoples' investment securities for other-than-temporary
declines in estimated fair value on a quarterly basis. This analysis requires
management to consider various factors in order to determine if a decline in
estimated fair value is temporary or other-than-temporary. These factors include
duration and magnitude of the decline in value, the financial condition of the
issuer, and Peoples' ability and intent to continue holding the investment for a
period of time sufficient to allow for any anticipated recovery in market value.
At June 30, 2004, there were no investment securities identified by management
to be other-than-temporarily impaired. If investments decline in fair value due
to adverse changes in the financial markets, charges to income could occur in
future periods.
Goodwill and Other Intangible Assets
- ------------------------------------
Over the past several years, Peoples has grown through mergers and acquisitions
accounted for under the purchase method of accounting. Under the purchase
method, Peoples is required to allocate the cost of an acquired company to the
assets acquired, including identified intangible assets, and liabilities assumed
based on their estimated fair values at the date of acquisition. At June 30,
2004, Peoples had $10.9 million of core deposit and customer relationship
intangible assets acquired in acquisitions, subject to amortization, and $53.8
million of goodwill, not subject to periodic amortization.
The determination of fair value and subsequent allocation of the cost of an
acquired company generally involves management making estimates based on third
party valuations, such as appraisals, or internal valuations based on discounted
cash flow analyses or other valuation techniques. In addition, the valuation and
amortization of intangible assets representing the present value of future net
income to be earned from customers (commonly referred to as "customer
relationship intangibles" or "core deposit intangibles") requires significant
judgment and the use of estimates by management. While management feels the
assumptions and variables used to value recent acquisitions were reasonable, the
use of different, but still reasonable, assumptions could produce materially
different results.
Customer relationship intangibles are required to be amortized over their
expected useful life. The method of amortization should reflect the pattern in
which the economic benefits of the intangible assets are consumed or otherwise
used up. Since Peoples' acquired customer relationships are subject to routine
customer attrition, the relationships are more likely to produce greater
benefits in the near-term than in the long-term, which typically necessitates
the use of an accelerated method of amortization for the related intangible
assets. Management is required to evaluate the useful life of customer
relationship intangibles to determine if events or circumstances warrant a
change in the estimated life. Should management determine in future periods the
estimated life of any intangible asset is shorter than originally estimated,
Peoples would adjust the amortization of that asset, which could increase future
amortization expense.
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 businesses acquired 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.
Peoples has reviewed its recorded goodwill and concluded that the recorded value
of goodwill was not impaired as of June 30, 2004. 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 that impairment
indicators exist and re-evaluate goodwill. If such re-evaluation indicated
impairment, Peoples would recognize the loss, if any. Any resulting impairment
loss could have a material, adverse impact on Peoples' financial condition and
results of operations.
RESULTS OF OPERATIONS
OVERVIEW OF THE INCOME STATEMENT
- --------------------------------
For the three months ended June 30, 2004, net income totaled $5,053,000, or
$0.47 per diluted share, down from $5,439,000, or $0.51 per diluted share,
during the same period a year ago. On a year-to-date basis through June 30,
2004, net income totaled $10,419,000 compared to $10,453,000 through six months
of 2003, while earnings per diluted share were $0.97 versus $1.00 for the same
periods, respectively.
Peoples' lower second quarter net earnings were attributable to reduced levels
of net interest income and additional operating expenses as a result of
acquisitions, which offset increases in non-interest revenues. Earnings per
share were also negatively impacted by additional common shares outstanding
resulting from Peoples Bancorp issuing over 800,000 common shares in connection
with acquisitions in the last year. Due to the Insurance Agency Acquisitions and
related securities regulations prohibiting management from repurchasing shares
during pricing periods, the majority of the 147,435 treasury share purchases
occurred late in the second quarter and had little impact on weighted-average
shares outstanding.
Net interest income totaled $12,697,000 for the second quarter of 2004, compared
to $13,548,000 last quarter and $13,577,000 for 2003's second quarter. Peoples'
reduced net interest income is largely the result of lower average earning
assets, coupled with lower asset yields due to the sustained low interest rate
environment. Net interest margin dropped to 3.39% in the second quarter of 2004,
versus 3.56% for the prior quarter and 3.48% for the second quarter of 2003. For
the six months ended June 30, 2004, net interest income totaled $26,245,000 and
net interest margin was 3.48%, versus $26,635,000 and 3.58% for the same period
in 2003.
For the quarter ended June 30, 2004, other income was $6,267,000, up 46% from
$4,282,000 for 2003's second quarter. This increase is primarily the result of
the Insurance Agency Acquisitions, which accounted for $1 million of the revenue
growth. Increased deposit account service charge income was also a contributing
factor. On a year-to-date basis through June 30, 2004, other income totaled
$11,154,000 compared to $8,217,000 for the first six months of 2003, a 36%
increase. In addition to the increased insurance revenues, revenues from the
offices added in the Kentucky Bancshares acquisition accounted for much of the
revenue growth.
Other expense was $11,531,000 in the second quarter of 2004, up 22% compared to
$9,458,000 for the same quarter in 2003, with $1.2 million of the increase
attributable to additional operating expenses due to the Insurance Agency
Acquisitions and a full-quarter impact of the May 2003 acquisition of Kentucky
Bancshares. For the six months ended June 30, 2004, other expense totaled
$21,821,000, up 17% versus $18,577,000 for the same period in 2003.
INTEREST INCOME AND EXPENSE
- ---------------------------
Peoples earns interest income from loans, investment securities and short-term
investments 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, as well as the rates
earned or paid on those 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 or extended periods of unusually low or high interest rates 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.
Net interest income totaled $12,697,000 in the second quarter of 2004, down from
$13,577,000 a year ago. Interest income totaled $21,145,000 for the three months
ended June 30, 2004, down $2,347,000 (or 10%) compared to the same period last
year. This decrease was due mainly to assets repricing downward in the low rate
environment, coupled with a modest reduction in earning assets, as management
opted to apply some of the principal runoff from the investment portfolio to
repay short-term borrowings during the quarter rather than reinvest those funds
in anticipation of higher yielding investment opportunities once rates increase.
Interest expense totaled $8,448,000 in the second quarter of 2004 versus
$9,915,000 in 2003's second quarter, down 15%, reflecting the lower cost of
funds and a reduction in interest-bearing liabilities.
Compared to the first quarter of 2004, net interest income was down $851,000 (or
6%), from $13,548,000. Interest income decreased 2% compared to $21,586,000,
reflecting the reduction in earning assets from the first quarter of 2004.
Interest expense increased by 5% from $8,038,000, attributable to management
shifting to longer-term debt to lock in the current low rates.
On a year-to-date basis, net interest income was $26,245,000 through June 30,
2004, compared to $26,635,000 for the first half of 2003. Interest income
dropped 8% to $42,731,000 due to declining yields as assets continue to reprice
downward. Interest expense was down $3,148,000 (or 16%), from $19,634,000,
reflecting the impact of the Long-Term Debt Restructuring in late 2003 and
overall reduction in Peoples' cost of funds in the low rate environment.
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%. The following
table details the calculation of FTE net interest income:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
(Dollars in Thousands) 2004 2003 2004 2003
Net interest income, as reported $ 12,697 $ 13,577 $ 26,245 $ 26,635
Taxable equivalent adjustments to net interest income 409 416 824 826
- ------------------------------------------------------------------------------------------------------------------
Fully-tax equivalent net interest income 13,106 13,993 27,069 27,461
==================================================================================================================
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 2004, net interest margin
was 3.39% versus 3.56% last quarter and 3.48% a year ago. On a year-to-date
basis, net interest margin compressed to 3.48% in 2004, from 3.58% for the first
six months of 2003. The sustained low interest rate environment has challenged
Peoples' generation of net interest income due to declining asset yields with
limited opportunities for similar reduction in Peoples' cost of funds.
Additionally, net interest margin was impacted by management's efforts to secure
longer-term funding coupled with a reduction in earning assets.
Earning assets averaged $1.55 billion, down $56.0 million compared to $1.61
billion a year ago. Net loans comprise the largest portion of Peoples' earning
assets, averaging $905.7 million in the second quarter of 2004, up from $881.6
million in the same quarter of 2003 due to loans acquired in the Kentucky
Bancshares acquisition and internally generated loans. The FTE yield on net
loans was 6.48% for the three months ended June 30, 2004, versus 6.57% and 7.14%
for the first quarter of 2004 and second quarter of 2003, respectively. The
combination of customers refinancing higher rate loans and significant volumes
of prime based commercial loan originations were key factors in the lower yield,
while the sale of the credit card portfolio contributed to the reduction in
yield from a year ago. Investment securities averaged $639.7 million in the
second quarter of 2004 compared to $703.6 million a year ago, with FTE yields of
4.32% and 4.63%, respectively. The decrease in the average balance is largely
attributable to management delaying the reinvestment of a portion of the
principal runoff until yields improved late in the second quarter.
For the six months ended June 30, 2004, average earning assets totaled $1.56
billion versus $1.53 billion a year ago, due to an increase in average loans
attributable to the Kentucky Bancshares acquisition. The average yield on
earning assets was 5.59% in the first half of 2004, down 58 basis points from
6.17% for the first six months of 2003. Average investment securities decreased
$10.9 million to $645.2 million, while average loans grew $41.8 million to
$901.5 million. The average FTE yield on investments and loans were both down
from a year ago due to the current rate environment and related investment of
funds at significantly lower rates.
Peoples' interest-bearing liabilities averaged $1.41 billion in the second
quarter of 2004, down from $1.44 billion a year ago. Traditional deposits
comprise the majority of Peoples' interest-bearing liabilities, averaging $887.2
million for the quarter ended June 30, 2004 compared to $906.9 million in 2003's
second quarter. This decrease was largely attributable to lower level of money
market account balances, due to intense competition for these deposits. For the
quarter ended June 30, 2004, the cost of funds from interest-bearing deposits
was 1.88%, down from 2.17% a year ago, a result of market rates remaining at low
levels. However, the impact of the low market rates was partially offset by
higher rates paid on longer-term certificates of deposit throughout 2003 and
first half of 2004 as part of a strategy to shift to longer-term funding.
Comparing the six months ended June 30, 2004, to the first six months of 2003,
interest-bearing liabilities increased $41.4 million, to $1.41 billion, while
the average cost dropped to 2.34% from 2.87%.
Peoples also utilizes a variety of borrowings as complementary funding sources
to traditional deposits. For the three months ended June 30, 2004, total
borrowed funds averaged $518.8 million compared to $529.0 million a year ago.
The decrease is the result of management reducing the amount of short-term
borrowing during the second quarter of 2004. Peoples' overall cost of borrowed
funds dropped to 3.29% from 3.79% in the second quarter of 2003, due in part to
the Long-Term Debt Restructuring. Compared to the first quarter of 2004, average
borrowed funds dropped $1.3 million, while the average cost increased 4 basis
points, from 3.25%.
Peoples' main source of borrowed funds is short- and long-term advances from the
FHLB. Short-term FHLB borrowings averaged $63.3 million in the second quarter of
2004 compared to $23.0 million a year ago, with an average cost of 1.03% and
1.59% for the same periods, respectively. The increased balance was attributable
to Peoples shifting $63 million of long-term advances to short-term as part of
the Long-Term Debt Restructuring. This shift also resulted in a $52.7 million
(or 24%) decline in long-term FHLB borrowings, which averaged $170.3 million
versus $223.0 million, and a reduction in the average cost of long-term FHLB
borrowings from 4.64% a year ago, to 4.23% for the second quarter of 2004.
Compared to the first quarter of 2004, average short-term FHLB borrowings
dropped $23.2 million and long-term FHLB borrowings increased $16.1 million, as
management shifted $25 million of short-term debt to long-term, fixed rate
advances to lock in rates. Management intends to continue using a variety of
FHLB borrowings to fund asset growth and manage interest rate sensitivity, as
deemed appropriate. Additional information regarding Peoples' advances from the
FHLB can be found later in this Discussion under the caption "Funding Sources".
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. In the second quarter of 2004, wholesale
market term repurchase agreements averaged $223.5 million compared to $216.3
million for both the prior quarter and second quarter of 2003. The average cost
of wholesale repurchase agreements was 2.85% in the second quarter of 2004,
virtually unchanged from prior periods.
As is the case with many financial institutions, net interest margin compression
continued in the second quarter of 2004 as a result of declining asset yields
with limited flexibility for a corresponding decrease in rates paid on
interest-bearing liabilities, due in large part to market competition. The
balance sheet restructuring in the fourth quarter of 2003 has had some positive
impact on net interest income and margin in the first half of 2004. In addition,
the action by the Federal Reserve to raise interest rates near the end of the
second quarter, coupled with an increase in earning assets, should ease some of
the net interest income pressures. However, management's efforts to secure
long-term, fixed rate funding to lock in rates could offset any short-term
improvement in asset yields. Additional interest rate increases in the second
half of 2004 could cause net interest income to increase modestly based on
Peoples' interest rate risk position and asset-liability simulations at June 30,
2004. Even though management continues to focus on minimizing the impact of
future rate changes on earnings, Peoples' net interest margin and income remain
difficult to predict, and to manage, since changes in market interest rates and
the timing of these changes remain uncertain.
PROVISION FOR LOAN LOSSES
- -------------------------
In the second quarter of 2004, Peoples' provision for loan losses was $616,000,
down from $794,000 in the prior quarter and $935,000 a year ago. The lower
overall provision was largely the result of Peoples' continued strong asset
quality and lower level of loan delinquencies. On a year-to-date basis through
June 30, Peoples provision for loan losses totaled $1,410,000 in 2004, compared
to $1,766,000 in 2003. When expressed as a percentage of average loans, the
provision was 0.07% in the second quarter of 2004 compared to 0.09% in the first
quarter of 2004 and 0.10% in the second quarter of 2003. The provision is
directionally consistent with the results of management's quarterly evaluation
and Peoples' loan quality. Future provisions will continue to be based on
management's quarterly procedural discipline described in the "Critical
Accounting Policies" section of this Discussion.
NON-INTEREST INCOME
- -------------------
Peoples generates non-interest income from six primary sources: deposit account
service charges, fiduciary activities, investment and insurance commissions,
electronic banking ("e-banking"), mortgage banking and business owned life
insurance ("BOLI"). In the second quarter of 2004, non-interest income was
$6,267,000, up $1,985,000 (or 46%) from $4,282,000 a year ago. Increased
insurance and investment commissions of $1,108,000, due largely to the Insurance
Agency Acquisitions, was the primary reason for the increase in non-interest
income, while additional deposit service charge income of $407,000 and BOLI
revenues of $153,000 also contributed to the improvement. Compared to the first
quarter of 2004, non-interest income grew $1,380,000 (or 28%) in the second
quarter, with 82% of the increase due to higher insurance and investment
commissions. For the six months ended June 30, 2004, non-interest income was
$11,154,000, up $2,937,000 (or 36%) from $8,217,000 for the same period in 2003,
with insurance and investment commissions and deposit account services charges
accounting for $965,000 and $935,000 of the increase, respectively.
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. For the quarter ended June 30, 2004, deposit
account service charges totaled $2,459,000, up 20% from $2,052,000 for 2003's
second quarter. On a year-to-date basis, deposit account service charges totaled
$4,712,000 in 2004, versus $3,777,000 in 2003, a 25% increase. These increases
were the result of higher volumes of overdraft and non-sufficient funds ("NSF")
fees, combined with an overall increase in the number of checking accounts
primarily due to acquisitions. Additionally, Peoples increased certain cost
recovery fees, including overdraft and NSF fees, effective January 1, 2004.
Management periodically evaluates its cost recovery fees to ensure the fees are
reasonable based on operational costs, as well as similar to fees charged in
Peoples' markets. Deposit account service charges were up $206,000 (or 9%) in
the second quarter versus $2,253,000 for the first quarter of 2004. The
following table details Peoples' deposit account service charges:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in Thousands) 2004 2003 2004 2003
Overdraft fees $ 1,657 $ 1,319 $ 3,037 $ 2,399
Non-sufficient funds fees 482 364 878 651
Other fees and charges 320 369 797 727
- ------------------------------------------------------------------------------
Total $ 2,459 $ 2,052 $ 4,712 $ 3,777
==============================================================================
As a result of the Insurance Agency Acquisitions, insurance and investment
commissions increased significantly in the second quarter compared to prior
periods, totaling $1,428,000 versus $299,000 and $320,000 for the first quarter
of 2004 and second quarter of 2003, respectively. For the six months ended June
30, 2004, insurance and investment commissions were $1,727,000, up 127% from a
year ago. The Putnam and Barengo divisions produced $1 million of revenue, with
the majority of these revenues derived from sales of commercial property and
casualty insurance, representing most of the revenue growth. Management expects
additional insurance and investment commissions during the third quarter of 2004
due to a full quarter's impact of the Insurance Agency Acquisitions. The
following table details Peoples' insurance and investment commissions:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in Thousands) 2004 2003 2004 2003
Property and casualty insurance $ 1,116 $ 112 $ 1,224 $ 203
Brokerage 115 50 216 94
Life and health insurance 78 42 105 101
Credit life and A&H insurance 64 39 71 70
Fixed annuities 55 77 111 294
- ---------------------------------------------------------------------------------------------------
Total $ 1,428 $ 320 $ 1,727 $ 762
===================================================================================================
Peoples offers various e-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 $623,000 for second quarter of
2004 compared to $529,000 a year ago, an increase of $94,000 (or 18%). Compared
to the first quarter of 2004, e-banking revenues were up $100,000 (or 19%)
during the second quarter of 2004. On a year-to-date basis through June 30,
2004, e-banking income was up 17% to $1,146,000, from $983,000 for the first
half of 2003. During the second quarter of 2004, Peoples' alliance with
InfiBank, formed as part of the credit card sale, generated income of $23,000
based on the net revenue of the portfolio and servicing income of $20,000, which
is intended to partially offset processing costs that Peoples continued to incur
through May 2004.
Since August 1, 2003, Peoples, as well as other financial services companies,
have experienced a reduction in fees earned on certain debit card transactions
as a result of the VISA and MasterCard litigation settlement. Despite the
reduced fee structure, Peoples' e-banking revenues remained strong in the
remainder of 2003 and first half of 2004. Management currently does not plan to
implement new fees for customers using its debit cards to offset any decline in
revenues but rather, plans to partially offset the reduced income stream by
continuing to grow core deposits, issuing more debit cards, and encouraging
customers to use their debit cards as a convenient way to do their banking. At
June 30, 2004, Peoples had 61,270 cards issued, with 48% of all eligible deposit
accounts issued a debit card, compared to 44,640 cards and a 42% penetration
rate a year ago. Peoples' customers used their debit cards to complete $30
million of transactions in the second quarter of 2004, up 42% from a year ago
and 9% from the first quarter of 2004, and $58 million of transactions through
six months of 2004, up 40% from $42 million in the first half of 2003.
Peoples' mortgage banking involves the origination and selling of long-term,
fixed-rate real estate loans into the secondary market. In the second quarter of
2004, mortgage banking produced revenues of $283,000 compared to $337,000 a year
ago and $199,000 in the first quarter of 2004. On a year-to-date basis through
June 30, mortgage banking income was $482,000 in 2004 versus $567,000 in 2003.
The reduction in mortgage banking income from last year reflects the decline in
real estate loan refinancing activity in response to higher long-term rates plus
seasonality. The following table details Peoples' mortgage banking activity:
(Dollars in Thousands) Mortgage
Banking Mortgage Number of
Income Loans Sold Mortgages Sold
Second quarter of 2004 $ 283 $ 10,978 141
First quarter of 2004 199 10,480 117
Fourth quarter of 2003 385 13,161 159
Third quarter of 2003 400 24,983 305
Second quarter of 2003 337 19,300 211
First quarter of 2003 230 9,999 103
Fourth quarter of 2002 135 6,091 60
While it appears the real estate loan refinancing activity will remain light
compared to 2003 activity, mortgage banking is a key part of Peoples' long-term
business strategy. Further information regarding Peoples' mortgage banking
activities can be found later in this discussion under "Loans."
Peoples' fiduciary revenues totaled $812,000 in the second quarter of 2004,
compared to $858,000 a year ago and $774,000 for the first quarter of 2004. On a
year-to-date basis, fiduciary revenues were $1,586,000 through June 30, 2004, up
from $1,444,000 for the same period in 2003. As part of the Kentucky Bancshares
acquisition, Peoples added trust assets of about $182 million, which accounted
for the largest portion of the increase in revenues. Since the relative
performance of equity markets is the basis for a significant portion of
fiduciary fees, changes in market value will continue to influence Peoples'
fiduciary revenues.
Peoples' BOLI investment enhances operating efficiency by offsetting rising
employee benefit costs. For the quarter ended June 30, 2004, BOLI income totaled
$506,000 compared to $353,000 a year ago and $416,000 last quarter. For the
first half of 2004, BOLI income was $922,000, up 28% from $718,000 for the first
six months of 2003. In early 2004, Peoples invested an additional $20 million in
BOLI, which was the key driver of the increased BOLI income from a year ago.
Management believes BOLI should continue to provide a better vehicle for funding
future benefit costs than alternative investment opportunities with similar risk
characteristics.
NON-INTEREST EXPENSE
- --------------------
For the quarter ended June 30, 2004, non-interest expense totaled $11,531,000,
up $2,073,000 (or 22%) from $9,458,000 a year ago. Compared to the second
quarter of 2003, the combination of the Insurance Agency Acquisitions and a full
quarter's impact of the Kentucky Bancshares acquisition resulted in Peoples
incurring additional operating expenses of $1.2 million in the second quarter of
2004, from primarily salaries and benefits expense, occupancy and equipment
costs and intangible amortization. Compared to the first quarter of 2004,
non-interest expense grew $1,241,000 (or 12%), from $10,290,000, with 74% of the
increase due to acquisitions. Non-interest expense totaled $21,821,000 through
six months of 2004 versus $18,577,000 a year ago, a 17% increase largely
attributable to recent acquisitions and Peoples' continued investment in
technology designed to improve customer service capabilities.
Salaries and benefits remain Peoples' largest operating expense, which is
inherent in a service-based industry such as financial services. For the three
months ended June 30, 2004, salaries and benefits totaled $5,819,000, compared
to $5,389,000 last quarter and $4,827,000 for 2003's second quarter. On a
year-to-date basis through June 30, 2004, salaries and benefits increased
$1,657,000, totaling $11,208,000 versus $9,551,000. These increases were largely
the result of adding approximately 80 associates in conjunction with recent
acquisitions, while annual salary adjustments necessary to retain key associates
was also a contributing factor. Management continues to explore ways, such as
the BOLI investment, to offset the rising salaries and benefit costs in order to
provide a reasonable level of benefits to associates and remain competitive in
order to attract and hire talented professionals.
In the second quarter of 2004, net occupancy and equipment expenses were
$1,289,000, up 6% from $1,221,000 the prior quarter and 16% from $1,108,000 for
the second quarter of 2003. Through six months of 2004, occupancy and equipment
expenses grew 14% compared to a year ago, totaling $2,510,000 versus $2,206,000.
These increases were a result of recent acquisitions and investments in
technology, which produced additional occupancy and equipment expenses,
particularly depreciation expense. Management believes the continued investment
in technology enhances Peoples' ability to serve clients and satisfy their
financial needs, while acquisitions have allowed Peoples to expand its customer
base for economies of scale. Management continues to monitor capital
expenditures to ensure the resources deployed either improve efficiencies or
generate additional revenues.
Acquisitions also caused an increase in amortization expense of customer
relationship intangible assets. In the second quarter of 2004, intangible
amortization was $526,000, nearly double last year's second quarter expense and
up $125,000 from the prior quarter. Management projects total intangible
amortization to be $100,000 higher in the third quarter due to the full
quarter's amortization of the customer relationship intangibles acquired in the
Insurance Agency Acquisitions, with slight reductions in the fourth quarter of
2004 and future quarters since Peoples uses an accelerated method of
amortization for these intangibles. On a year-to-date basis, intangible
amortization totaled $927,000 through June 30, 2004, compared to $472,000 for
the same period in 2003.
For the three months ended June 30, 2004, data processing and software costs
were $441,000, up 38% from $320,000 a year ago and down 7% from $472,000 last
quarter. On a year-to-date basis, data processing and software costs totaled
$913,000 through June 30, 2004, compared to $650,000 a year ago. The higher
level of data processing and software costs was attributable to an increase in
software licensing fees in response to additional office locations and users of
key software packages, as well amortization of Peoples' $1.8 million investment
in Customer Relationship Management ("CRM") and profitability systems, the
majority of which was software related costs. While the CRM/profitability
investment will add future expense, these new systems and processes will be a
strategic part of Peoples' sales and marketing efforts for many years and are
consistent with management's long-term focus to build the best process to grow
revenues and develop profitable customer relationships.
Professional fees, which include fees for accounting, legal and other
professional services, totaled $411,000 for the second quarter of 2004, down 21%
from a year ago and down 10% from the first quarter of 2004. Through six months
of 2004, professional fees were $867,000 compared to $984,000 in the first half
of 2003, a 12% decrease. For the last two years, Peoples has paid consulting
fees to the firm that assisted with the implementation of the Overdraft
Privilege program, which were based on a percentage of the net improvement in
overdraft fee income. The consulting contract terminated at the end of the first
quarter of 2004, which reduced professional fees due to the elimination of the
consulting expense. Management believes professional fees could increase
slightly in the second half of 2004 as Peoples works to comply with new
reporting requirements mandated by the Sarbanes-Oxley Act, which apply to all
public companies.
Peoples' bankcard costs, which consist primarily of debit card and ATM
processing fees, were $378,000 in the second quarter of 2004, up from $276,000 a
year ago and $324,000 last quarter. For the six months ended June 30, 2004,
bankcard costs were totaled $702,000 compared to $581,000 for the first half of
2003. These increases were largely the result of Peoples' customers using the
ATM and debit cards to complete more of their transactions and additional cards
issued due in part to the Kentucky Bancshares acquisition.
Peoples is subject to various state franchise taxes, which are based largely on
Peoples Bank's equity at year-end. For the second quarter of 2004, franchise
taxes totaled $371,000 compared to $272,000 for 2003's second quarter. This
increase was primarily attributable to additional equity at Peoples Bank
resulting from the Kentucky Bancshares acquisition and a $16 million capital
contribution from Peoples Bancorp in early 2003. Despite the increased franchise
taxes, management believes Peoples Bank's stronger capital level positions
Peoples for strategic growth. In addition, management regularly evaluates the
capital position of Peoples' other direct and indirect subsidiaries and seeks to
maximize Peoples' consolidated capital position through appropriate capital
allocation designed to enhance profitability and shareholder value.
The non-interest leverage ratio serves as a measurement of Peoples' efficiency
for management and key performance indicator for Peoples' incentive compensation
plan for senior management and certain other associates. The non-interest ratio
is defined as non-interest income as a percentage of operating expenses,
excluding gains and losses on securities transactions, asset disposals, early
debt extinguishment and sale of the credit card portfolio, as well as intangible
asset amortization. The followings details the components of the non-interest
leverage ratio calculation:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
(Dollars in Thousands) 2004 2003 2004 2003
Total other income, as reported $ 6,267 $ 4,282 $ 11,154 $ 8,217
Add: Loss on asset disposals - 236 - 238
Loss on securities transactions - 29 - 27
Deduct: Gain on securities transactions 5 - 37 -
Gain on asset disposal 17 - 47 -
Recovery of loss on sale of other real estate owned - - 210 -
-----------------------------------------------------------------------------------------------------------------------------
Adjusted total other income 6,245 4,547 10,860 8,482
-----------------------------------------------------------------------------------------------------------------------------
Total other expense, as reported 11,531 9,458 21,821 18,577
Deduct: Amortization of other intangible assets 526 271 927 472
Loss on early debt extinguishment - - - 41
-----------------------------------------------------------------------------------------------------------------------------
Adjusted total other expense 11,005 9,187 20,894 18,064
-----------------------------------------------------------------------------------------------------------------------------
Non-interest leverage ratio 56.8% 49.5% 52.0% 47.0%
=============================================================================================================================
For the six months ended June 30, 2004, the non-interest leverage ratio was
52.0% compared to 47.0% a year ago. This improvement reflects Peoples' ability
to increase non-interest revenues without a corresponding increase in operating
expenses. Management's strategic goals include maintaining a non-interest
leverage ratio greater than 50% as a means of reducing Peoples' reliance on net
interest income.
RETURN ON EQUITY
- ----------------
In the second quarter of 2004, Peoples' return on equity ("ROE") was 11.83%
versus 12.92% for the same quarter last year. The lower ROE is primarily the
result of an increase in average equity, attributable to equity generated by the
Kentucky Bancshares acquisition and net earnings. Average equity was $171.8
million in the second quarter of 2004, up compared to $168.4 million for the
second quarter of 2003. For the six months ended June 30, ROE was 12.17% in 2004
compared to 12.95% a year ago, due mainly to a 7% increase in average equity.
Management uses ROE to evaluate Peoples' long-term performance. However,
management believes earnings per share ("EPS") serves as a more meaningful
measurement of short-term performance due to the volatility that can occur in
equity from changes in the estimated fair values of Peoples' investment
portfolio.
RETURN ON ASSETS
- ----------------
Return on assets ("ROA") was 1.17% in the second quarter of 2004 compared to
1.25% a year ago, while on a year-to-date basis, ROA was 1.21% and 1.26% in 2004
and 2003, respectively. 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 continues to make tax-advantaged investments in order to manage its
effective tax rate and overall tax burden. At June 30, 2004, the amount of
tax-advantaged investments totaled $53.3 million compared to $30.5 million at
December 31, 2003 and $29.8 million at June 30, 2003. The additional benefits
derived from this increase in tax-advantaged investments resulted in a reduction
in Peoples' effective tax rate. For the six months ended June 30, 2004, Peoples'
effective tax rate was 26.5%, down from 28.0% a year ago. 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, 2004, total assets were $1.77 billion compared to $1.74 billion at
year-end 2003, an increase of $38.2 million which is attributable to loan
growth, as well as additional BOLI and intangible assets associated with the
Insurance Agency Acquisitions. Since December 31, 2004, investment securities
have declined $2.3 million to $639.2 million at June 30, 2004, due to a decrease
in market value of the portfolio and management's decision to pay down debt
rather than reinvest all of the cash flows from the investment securities. At
June 30, 2004, gross loans were $935.6 million, up $20.6 million from $915.0
million at December 31, 2003.
Total liabilities were $1.60 billion at June 30, 2004, compared to $1.57 billion
at year-end 2003, an increase of $39.2 million. At June 30, 2004, deposits
totaled $1.01 billion, down $15.2 million from the prior year-end, while
borrowed funds used to fund asset growth and offset deposit runoff totaled
$577.3 million, up $50.7 million from $526.6 million at December 31, 2003.
Stockholders' equity totaled $169.8 million at June 30, 2004, versus $170.9
million at December 31, 2003, a decrease of $1.1 million. The lower level of
stockholders' equity is attributable to the change in market value of
available-for-sale securities and Peoples' treasury stock purchases, net of
shares reissued, which reduced equity by $5.7 million and $3.5 million,
respectively.
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 customer
activity and Peoples' liquidity needs. At June 30, 2004, cash and cash
equivalents totaled $55.3 million, down $18.1 million (or 25%) from $73.4
million at December 31, 2003. This decrease is attributable to a $37.9 million
reduction in Federal funds sold since year-end 2003. A portion of the decrease
in Federal funds sold was due to the $20 million BOLI investment in early 2004.
Cash and balances due from banks comprised the largest portion of Peoples' cash
and cash equivalents at June 30, 2004, totaling $47.6 million. Since year-end,
the amount of cash and balances due from banks grew $19.3 million (or 68%), due
to normal daily changes in the amount of items in process of collection and cash
on hand.
Management believes the current balance of cash and cash equivalents, along with
the availability of other funding sources, will allow Peoples to meet cash
obligations, special needs and off-balance sheet commitments, such as 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, 2004, the amortized cost of Peoples' investment securities totaled
$641.3 million compared to $634.8 million at year-end 2003, while the market
value of the investment portfolio was $639.2 million at June 30, 2004, down
slightly from $641.5 million at December 31, 2003. The increase in amortized
cost was primarily the result of Peoples completing the reinvestment of funds
from the Investment Portfolio Restructuring initiated in December 2003.
The difference in amortized cost and market value at June 30, 2004, resulted in
unrealized depreciation in the investment portfolio of $2.1 million and a
corresponding decrease in Peoples' equity of $1.4 million, net of deferred
taxes. In comparison, the difference in amortized cost and market value at
December 31, 2003, resulted in unrealized appreciation of $6.7 million and an
increase in equity of $4.3 million, net of deferred taxes.
The following table details Peoples' investment portfolio, at estimated fair
value:
(Dollars in Thousands) June 30, March 31, December 31, June 30,
2004 2004 2003 2003
US Treasury securities and obligations of
US government agencies and corporations $ 55,440 $ 63,277 $ 65,441 $ 66,714
Obligations of states and political subdivisions 62,926 65,726 66,288 68,841
Mortgage-backed securities 459,918 466,858 447,341 493,556
Other securities 60,906 61,439 62,394 60,569
- ------------------------------------------------------------------------------------------------------------
Total available-for-sale securities $ 639,190 $ 657,300 $ 641,464 $ 689,680
============================================================================================================
Overall, the composition of Peoples' investment portfolio at June 30, 2004, was
very comparable to recent periods. Since June 30, 2003, Peoples' investment in
mortgage-backed securities has fluctuated due to the timing of Peoples
reinvesting the principal runoff. In addition, management has used a portion of
the runoff to fund loan growth and other corporate purposes, when deemed
appropriate, which has impacted the balance of mortgage-backed securities.
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, provides guidance for
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 and consumer
loans, focusing primarily on lending opportunities in central and southeastern
Ohio, northwestern West Virginia, and northeastern Kentucky markets. At June 30,
2004, gross loans totaled $935.6 million, up $20.6 million since year-end 2003.
Peoples continues to experience strong internal originations of commercial and
residential real estate loans, which has offset volume declines experienced in
consumer loans. The following table details total outstanding loans:
(Dollars in Thousands) June 30, March 31, 2004 December 31, June 30,
2004 2003 2003
Commercial, mortgage $ 428,580 $ 413,167 $ 380,372 $ 353,767
Commercial, other 110,208 102,918 131,697 121,833
Real estate, construction 22,853 20,196 21,056 10,339
Real estate, mortgage 304,328 299,967 301,726 327,423
Consumer 69,587 74,545 79,926 94,549
Credit cards - - 221 6,407
- ---------------------------------------------------------------------------------------------------
Total loans $ 935,556 $ 910,793 $ 914,998 $ 914,318
===================================================================================================
Commercial loan balances, including loans secured by commercial real estate,
totaled $538.8 million at June 30, 2004, up $26.7 million from $512.1 million at
year-end 2003. This increase is the result of lending opportunities within
Peoples' existing markets. Commercial loans continued to represent the largest
portion of Peoples' total loan portfolio, comprising 57.6% and 56.0% of total
loans at June 30, 2004 and December 31, 2003, respectively. 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 considerations. In addition to in-market
opportunities, Peoples will continue to lend selectively to creditworthy
customers outside its primary markets.
While commercial loans comprise the largest portion of Peoples' loan portfolio,
residential real estate loans remain a major focus of Peoples' lending efforts,
whether the loans are ultimately sold into the secondary market or retained on
Peoples' balance sheet, that provides opportunities to sell additional products
and services to these consumers. At June 30, 2004, real estate loans, which
include construction loans but exclude loans secured by commercial real estate,
totaled $327.2 million compared to $322.8 million at December 31, 2003, an
increase of $4.4 million. Real estate loans comprised 35.0% of Peoples' total
loan portfolio at June 30, 2004, versus 35.3% at year-end 2003. Included in real
estate loans are home equity credit line balances of $31.2 million at June 30,
2004, up from $28.3 million at December 31, 2003.
Real estate loan balances have declined in recent periods in response to
customer demand for long-term, fixed-rate mortgages, which Peoples generally
sells in the secondary market with servicing rights retained. In the second
quarter of 2004, Peoples originated 141 long-term, fixed-rate mortgage loans,
with total loan amounts of $11 million, compared to 87 loans, with total loan
amounts of $8 million, in the first quarter of 2004 and 220 loans, with total
loan amounts of $20 million, in the second quarter of 2003. At June 30, 2004,
Peoples was servicing $95 million of real estate loans previously sold into the
secondary market. In addition, Peoples had $807,000 of fixed-rate real estate
loans held for sale into the secondary market at June 30, 2004. Management
anticipates selling these loans during the third quarter.
At June 30, 2004, consumer loan balances were $69.6 million, down $10.3 million
since year-end 2003. The indirect lending area represented a significant portion
of Peoples' consumer loans, with balances of $29.9 million and $38.4 million at
June 30, 2004 and December 31, 2003, respectively. Strong competition for loans,
particularly automobile loans, as well as availability of alternative credit
products, such as home equity credit lines, have challenged the performance and
growth of Peoples' consumer loan portfolio. Regardless of management's desire to
maintain, or even grow, consumer loan balances, Peoples' commitment to sound
underwriting practices and appropriate loan pricing discipline that produces
quality loans remains the paramount objective.
LOAN CONCENTRATION
- ------------------
Peoples' largest concentration of commercial loans is credits to lodging and
lodging-related companies, which comprised approximately 12.0% of Peoples'
outstanding commercial loans at quarter-end, compared to 12.7% at December 31,
2003. Loans to assisted living facilities and nursing homes also represented a
significant portion of Peoples' commercial loans, comprising 10.8% of Peoples'
outstanding commercial loans at June 30, 2004, versus 11.3% at year-end 2003.
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 lodging and lodging-related companies, as well as loans to assisted
living facilities and nursing homes, 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, which includes an evaluation of the
financial strength, market expertise and experience of the borrowers and
principals in these business relationships. In addition, a sizeable portion of
the loans to lodging and lodging-related companies is spread over various
geographic areas and is guaranteed by principals with substantial net worth.
ALLOWANCE FOR LOAN LOSSES
- -------------------------
Peoples' allowance for loan losses totaled $14.7 million, or 1.57% of total
loans, at June 30, 2004, compared to $14.6 million, or 1.59%, at year-end 2003.
The following table presents changes in Peoples' allowance for loan losses:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in Thousands) 2004 2003 2004 2003
Balance, beginning of period $ 14,774 $ 13,363 $ 14,575 $ 13,086
Chargeoffs (980) (955) (2,210) (1,740)
Recoveries 283 235 918 466
- -----------------------------------------------------------------------------------------------------
Net chargeoffs (697) (720) (1,292) (1,274)
Provision for loan losses 616 935 1,410 1,766
Allowance for loan losses acquired - 573 - 573
- -----------------------------------------------------------------------------------------------------
Balance, end of period $ 14,693 $ 14,151 $ 14,693 $ 14,151
=====================================================================================================
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,
2004 2003 2003
Commercial $ 11,858 $ 11,232 $ 10,387
Consumer 1,350 1,594 1,820
Real estate 1,032 1,234 1,482
Overdrafts 347 283 206
Credit cards 106 232 256
- --------------------------------------------------------------------------------
Total allowance for loan losses $ 14,693 $ 14,575 $ 14,151
================================================================================
The allowance allocated to commercial loans, which includes loans secured by
commercial real estate, has increased in recent periods, reflecting the credit
risk associated with this type of lending and continued growth in this
portfolio. The allowance allocated to the real estate and consumer loan
portfolios is based upon Peoples' allowance methodology for homogeneous pools of
loans, which includes a consideration of changes in total balances in those
portfolios. Management continues to maintain an allowance for loan losses for
credit cards since Peoples sold its business accounts with recourse.
In the second quarter of 2004, net loan chargeoffs were $697,000, down from
$720,000 a year ago but up from $595,000 in the first quarter of 2004.
Commercial loans and overdrafts continue to comprise a significant portion of
Peoples' net chargeoffs. The following table details Peoples' net chargeoffs:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in Thousands) 2004 2003 2004 2003
Commercial $ 475 $ 210 $ 374 $ 396
Overdrafts 211 150 346 267
Real estate 47 128 202 136
Consumer (32) 189 244 389
Credit card (4) 43 126 86
- -----------------------------------------------------------------------------------------------------
Total $ 697 $ 720 $ 1,292 $ 1,274
- -----------------------------------------------------------------------------------------------------
As a percent of average loans (a) 0.30% 0.32% 0.28% 0.29%
- -----------------------------------------------------------------------------------------------------
(a) Presented on an annualized basis
Asset quality remains a key focus, as management continues to stress
underwriting quality loans more than loan growth. Since December 31, 2003,
Peoples' asset quality ratios have improved slightly due to a modest decrease in
the level of nonperforming loans. The following table details Peoples'
nonperforming assets:
(Dollars in Thousands) June 30, March 31, December 31, June 30,
2004 2004 2003 2003
Loans 90+ days past due and accruing $ 374 $ 235 $ 188 $ 569
Renegotiated loans - - - 685
Nonaccrual loans 5,465 6,656 6,556 4,389
- --------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 5,839 6,891 6,744 5,643
Other real estate owned 392 470 392 960
- --------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 6,231 $ 7,361 $ 7,136 $ 6,603
- --------------------------------------------------------------------------------------------------------------------
Nonperforming loans as a percent of total loans 0.62% 0.76% 0.73% 0.62%
- --------------------------------------------------------------------------------------------------------------------
Nonperforming assets as a percent of total assets 0.35% 0.43% 0.41% 0.35%
- --------------------------------------------------------------------------------------------------------------------
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, if any, is
measured based on the fair value of the collateral.
At June 30, 2004, the recorded investment in loans that were considered to be
impaired was $24.0 million, of which $21.4 million were accruing interest and
$2.6 million were nonaccrual loans. Included in this amount were $8.3 million of
impaired loans for which the related allowance for loan losses was $2.2 million.
The remaining impaired loan balances do not have a related allocation of the
allowance for loan losses because the loans have either previously been
written-down, are well secured or possess characteristics indicative of the
ability to repay the loan. For the six months ended June 30, 2004, Peoples'
average recorded investment in impaired loans was approximately $21.7 million
and interest income of $416,000 was recognized on impaired loans during the
period, representing 1.0% 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 $1.01 billion, or 64% of
total borrowed funds, at June 30, 2004.
Non-interest-bearing deposits serve as a core funding source. At June 30, 2004,
non-interest-bearing deposit balances totaled $137.3 million, up $3.6 million
compared to the prior year-end. Since customer activity can result in temporary
changes in deposit balances at end of periods, 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 2004,
non-interest-bearing deposits averaged $142.9 million versus $135.5 in the first
quarter of 2004, reflecting Peoples' efforts to increase non-interest-bearing
deposits. Peoples' strategies include continued emphasis on core deposit growth
in products such as non-interest-bearing checking accounts.
Interest-bearing deposits totaled $876.0 million at June 30, 2004 compared to
$894.8 million at December 31, 2003. This decrease is due in part to
management's strategy to reduce Peoples' reliance on high-costing funds, such as
certificates of deposit ("CDs"), and shifting to lower-costing core deposits. In
addition, Peoples continues to experience highly competitive pricing of CDs,
which has contributed to the decline in balances. The following details Peoples'
interest-bearing deposits:
(Dollars in Thousands) June 30, March 31, December 31, June 30,
2004 2004 2003 2003
Certificates of deposit $ 443,447 $ 456,069 $ 461,904 $ 479,068
Savings accounts 178,651 173,013 171,488 181,408
Interest-bearing transaction accounts 158,025 167,091 157,410 167,846
Money market deposit accounts 95,866 99,107 104,019 118,521
------------------------------------------------------------------------------------------------------
Total interest-bearing deposits $ 875,989 $ 895,280 $ 894,821 $ 946,843
------------------------------------------------------------------------------------------------------
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 FHLB advances, a loan from an unrelated
financial institution and term repurchase agreements. At June 30, 2004, borrowed
funds totaled $577.3 million, up $50.7 million (or 10%) from $526.6 million at
year-end 2003, as a result of an increase in long-term borrowings.
Advances from the FHLB comprise a significant portion of Peoples' borrowed
funds. Short-term FHLB advances are typically variable rate cash management
advances used to manage Peoples' daily liquidity needs and may be repaid, in
whole or part, at anytime without a penalty. Peoples also utilizes short-term,
repo advances ranging in terms from overnight to one-year to manage its cost of
funds and temporary cash needs. Peoples' long-term FHLB advances are primarily
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 are subject to conversion, at the discretion
of the FHLB, to a LIBOR based, variable rate product. Peoples has the option to
prepay, without penalty, any advance that has been converted or allow the
borrowing to reprice. In addition to these convertible rate advances, Peoples
utilizes fixed-rate, long-term FHLB advances, both amortizing and
non-amortizing, to help manage its interest rate sensitivity and liquidity.
Further information regarding Peoples' management of interest rate sensitivity
can be found later in this discussion under "Interest Rate Sensitivity and
Liquidity."
In addition to FHLB advances, Peoples accesses national market repurchase
agreements to diversify its funding sources. At June 30, 2004, wholesale
repurchase agreements totaled $259.1 million, up $25.8 million from year-end
2003. This increase is due to Peoples using wholesale repurchase agreements to
fund investment securities purchases during the second quarter. Peoples' current
wholesale repurchase agreements range in original terms of two to five years.
The repurchase agreements may not be repaid prior to maturity and must remain
sufficiently collateralized during the entire term. As a result, a decline in
the market value of the investment securities associated with these agreements
would require Peoples to allocate additional investment securities to these
repurchase agreements.
CAPITAL/STOCKHOLDERS' EQUITY
- ----------------------------
At June 30, 2004, stockholders' equity was $169.8 million versus $170.9 million
at December 31, 2003, a decrease of $1.1 million (or 1%). The change in market
value of available-for-sale securities and Peoples' treasury stock purchases,
net of shares reissued, reduced equity by $5.7 million and $3.5 million,
respectively. These decreases were partially offset by Peoples' earnings, net of
dividends paid, of $6.6 million.
For the six months ended June 30, 2004, Peoples paid dividends of $3.8 million,
representing a dividend payout ratio of 36.8% of earnings, compared to a payout
ratio of 29.5% a year ago. While management anticipates Peoples continuing its
38-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.
Unrealized holding gains and losses on available-for-sale securities, net of
deferred income taxes, impacts Peoples' total equity. At June 30, 2004, net
unrealized holding losses totaled $1.4 million versus $4.3 million of net
unrealized holding gains at December 31, 2003. 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, 2004, Peoples had treasury stock totaling $5.7 million, up $3.5
million from year-end 2003. During the first half of 2004, Peoples Bancorp
repurchased 288,635 common shares (or 68% of the total authorized), at an
average price of $26.99 per share, under the 2004 Stock Repurchase Program and
2,506 common shares, at an average price of $26.71, in conjunction with the
deferred compensation plan for directors of Peoples Bancorp and its
subsidiaries. Peoples reissued 145,316 treasury shares due to stock option
exercises and acquisitions during the first six months of 2004. Peoples Bancorp
anticipates repurchasing additional common shares as authorized in the 2004
Stock Repurchase Program and in accordance with applicable Federal securities
laws.
Management uses the tangible equity ratio as one measure of the adequacy of
Peoples' equity. The ratio, defined as tangible equity as a percentage of
tangible assets, excludes the balance sheet impact of intangible assets acquired
through acquisitions accounted for using the purchase method of accounting. At
June 30, 2004, Peoples tangible equity ratio was 6.12% compared to 7.24% at
December 31, 2003 and 7.15% at June 30, 2003. The lower ratio compared to the
prior periods was primarily the result of an increase in intangible assets due
to the Insurance Agency Acquisitions.
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. Under the risk-based capital framework, a bank's balance sheet assets
and credit equivalent amounts of off-balance sheet items are typically assigned
to one of four broad risk categories: 0% (lowest risk), 20%, 50% or 100%
(highest risk). The sum of the resulting weighted values from each of the four
risk categories is used in calculating key capital ratios. At June 30, 2004,
Peoples' Total Capital, Tier 1 and Leverage ratios were 13.58%, 12.27% and
8.17%, 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, 2004.
INTEREST RATE SENSITIVITY AND LIQUIDITY
- ---------------------------------------
While Peoples is exposed to various business risks, the risks relating to
interest rate sensitivity and liquidity are typically the most complex and
dynamic and could materially impact 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 through management of the mix of assets and liabilities. Ultimately,
the ALM function is intended to guide management in the acquisition and
disposition of earning assets and selection of 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, as well as the diversity of its own investment
portfolio and borrowed funds. 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
due primarily 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 commitments and hedging transactions related to
the management of IRR. The ALCO consists of Peoples' Chief Financial Officer,
Chief Executive Officer, President and Chief Lending Officer, as well as other
members of senior management. It is the ALCO's responsibility to focus 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 adherence to
sound fundamentals of banking while allowing sufficient flexibility to exercise
the creativity and innovation 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 repricing of 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 the 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 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 periods focusing on a one-year
cumulative gap. 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 at the date of measurement. Results that are outside of any of
these limits will prompt a discussion by the ALCO of appropriate actions, if
any, that should be taken.
At June 30, 2004, Peoples' one-year cumulative gap amount was negative 11.6% of
earning assets, which represented $187.6 million more in liabilities than assets
that could reprice or mature during that period. However, management believes a
portion of interest-bearing liabilities are not likely to reprice at their first
opportunity, based on current rates and management's control over the pricing of
most deposits. Excluding those liabilities, Peoples' adjusted one-year
cumulative gap amount at quarter-end was positive 8.3% of earning assets, which
represented $134.2 million more in assets than liabilities that mature or may
reprice during the next twelve months.
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, 2004
(dollars in thousands):
Immediate Estimated
Interest Rate Decrease) Increase Estimated
Increase (Decrease) in in (Decrease) Increase in
Basis Points Net Interest Income Economic Value of Equity
- --------------------------- ----------------------- --------------------------
300 $ (330) (0.7)% $ (583) (0.3)%
200 48 0.1 2,375 1.3
100 75 0.2 2,617 1.4
(50) $ (102) (0.2)% $ (6,785) (3.6)%
The interest rate risk analysis shows Peoples is slightly 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, based on the assumptions used. However, the variability of
cash flows from the investment and loan portfolios continue to have a
significant influence on future net interest income and earnings, especially
during periods of changing interest rates. In general, the amount of principal
runoff from these portfolios tends to decrease as interest rates increase due to
fewer prepayments, limiting the amount of funds which can be reinvested at
higher rates, while declining interest rates tend to result in a higher level of
funds that must be reinvested at lower rates, due to an increase in prepayments.
The interest rate table 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
IRR 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, 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 wholesale funding and 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 net income from loans and investment securities.
Through six months of 2004, cash provided by financing activities totaled $25.1
million compared to $319.0 million a year ago. This decrease is largely
attributable to an increase in long-term borrowings in the first quarter of 2003
in connection with an investment growth strategy, as well as a net reduction in
total deposits in 2004 compared to significant deposit growth in 2003. Cash used
in investing activities totaled $61.3 million versus $230.8 million last year,
primarily due to lower level of investment securities purchases in 2004.
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, 2004, Peoples had available borrowing capacity of
approximately $73 million through these external sources and unpledged
securities in the investment portfolio of approximately $188 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, 2004,
Peoples' net liquidity position was $192.7 million, or 10.9% of total assets,
compared to $260.1 million, or 15.0% of total assets, at December 31, 2003. The
decrease in liquidity position was primarily the result of a lower level of
liquid assets, due in large part to the reduction in Federal funds sold. The
liquidity position as of June 30, 2004, was within Peoples' policy limit of
negative 10% of total assets. At June 30, 2004, total wholesale funding
comprised 29.8% of total assets and brokered funds were 0.6% 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 tax
credit 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:
June 30, March 31, December 31, June 30,
(Dollars in Thousands) 2004 2004 2003 2003
Loan commitments $ 140,882 $ 112,779 $ 115,685 $ 119,316
Standby letters of credit 23,274 22,478 20,928 9,606
Unused credit card limits - - - 22,469
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, 2004, Peoples held interest rate
contracts with notional amounts totaling $27 million and fair values totaling
$305,000. 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, 2004, 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 credit 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, 2004, these commitments approximated $6.3 million, with approximately $2.5
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. Many 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 a period of transition, as management
continues to work to position Peoples for long-term earnings growth, especially
as interest rates continue to rise. While non-interest revenue growth remains
strong, net interest income and margin continue to be challenged by rates
remaining at low levels. In the meantime, Peoples' strong capital position,
coupled with management's commitment to sound underwriting discipline and asset
quality, serves as a foundation of strength in the current business environment,
which continues to challenge Peoples' operating performance.
One of Peoples' primary strategies is to grow loans in a disciplined manner that
produces quality loans. While competition for loans, particularly consumer
loans, remains strong, management anticipates improving economic conditions
should allow Peoples to produce modest commercial loan growth in the final half
of 2004. As lenders work to meet the loan demand in Peoples' markets, management
will continue to emphasize loan quality as part of its long-term focus. In
addition, Peoples continues to devote resources and make investments in
technology that will allow Peoples' Home Loan Specialists to serve customers
more efficiently and shorten the time between application and closing, which
should result in additional residential real estate lending origination
opportunities whether the loans are sold into the secondary market or retained
by Peoples.
Peoples' business strategy also includes a focus on growing core deposits and
adjusting the mix of customer funding sources. In early 2004, Peoples
re-launched its Freedom checking campaign as part of its efforts to grow
non-interest-bearing deposits and reduce its reliance on high cost funding, such
as certificates of deposit. While the efforts have produced an overall lower
cost of funds in the first half of 2004, Peoples continues to experience ongoing
competitive pricing of CDs in its markets, which is likely to offset any
benefits derived from further growth of low-cost deposits. Management believes
the combination of an expanding branch network and extended hours in some
offices, plus technology, such as Internet banking and free online billpay, will
allow Peoples to successfully compete for core deposits and enhance future
operating results.
Cost control is a constant theme even as recent acquisitions and investments in
technology have resulted in additional operating expense. In the second half of
2004, management plans to evaluate staffing levels in Peoples' retail offices to
ensure offices have proper sales and service personnel in position, as well as
review the compensation structure of Peoples' fee-based revenues, with the
expectation of shifting to a more commission-based compensation arrangement for
portions of the sales group. These actions, coupled with the possible
consolidation of certain administrative activities of the Putnam and Barengo
agencies over the next several quarters, should enhance operating efficiencies.
However, rising medical and health insurance costs could increase expenses in
the latter half of 2004, especially considering the growth in associates due to
recent acquisitions.
The second quarter acquisitions of the Putnam and Barengo agencies are a step
towards meeting Peoples' goal of revenue diversification and continued expansion
of its business. Based on preliminary projections, management expects the
combined agencies to be slightly accretive to Peoples' 2004 EPS, assuming
revenue growth targets are achieved. In addition to new revenue streams, these
divisions provide additional access to insurance carriers and key producers and
managers, which should allow Peoples to retain most of the customer bases of
each former agency. In the second half of 2004, management will continue its
efforts to integrate the agencies into Peoples' culture and general operations
and to establish long-term relationships with the newly added customers.
With strong regulatory capital ratios and a comfortable level of tangible equity
to total assets, management believes mergers and acquisitions remain a viable
means of expanding Peoples' operations and customer base. While Peoples has
completed several traditional banking and branch acquisitions in recent years,
management's evaluation of future acquisitions will also include insurance
agency and professional investment services firms. Ultimately, the assessment of
potential acquisitions will emphasize opportunities to complement Peoples' core
competencies and strategic intent more than geographic location, size or nature
of business.
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 investment services. In the second
half of 2004, management expects earnings catalysts to include loan growth,
enhanced revenues from the Insurance Agency Acquisitions, controlled operating
expenses and possible improvement in net interest margin due to rate increases.
FORWARD-LOOKING STATEMENTS
- --------------------------
Certain 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. Words such as
"expects," "believes", "plans", "will", "would", "should", "could" and similar
expressions are intended to identify these forward-looking statements but are
not the exclusive means of identifying such statements. Forward-looking
statements are subject to risks and uncertainties that may cause actual results
to differ materially. Factors that might cause such a difference include, but
are not limited to: (1) competitive pressures among depository institutions
increase significantly; (2) changes in the interest rate environment that impact
interest margins; (3) prepayment speeds, loan sale volumes, chargeoffs and loan
loss provisions are less favorable than expected; (4) the business of Putnam and
Barengo may not be successfully integrated with Peoples Insurance or the
integration may take longer to accomplish than expected; (5) the expected
synergies from the Insurance Agency Acquisitions may make it difficult to
maintain relationships with clients, associates or suppliers; (7) general
economic conditions are less favorable than expected; (8) political
developments, wars or other hostilities may disrupt or increase volatility in
securities markets or other economic conditions; (9) legislative or regulatory
changes or actions adversely affect Peoples' business; (10) changes and trends
in the securities markets; (11) a delayed or incomplete resolution of regulatory
issues that could arise; (12) the impact of reputational risk created by these
developments on such matters as business generation and retention, funding and
liquidity; (13) the outcome of regulatory and legal proceedings and (11) other
risk factors relating to the banking industry or Peoples as detailed from time
to time in Peoples' reports filed with the Securities and Exchange Commission
("SEC").
All forward-looking statements speak only as of the execution date of this Form
10-Q and 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. Additionally, Peoples
undertakes no obligation to release revisions to these forward-looking
statements to reflect events or circumstances after the date of this Form 10-Q.
Copies of documents filed with the SEC are available free of charge at the SEC
website at http://www.sec.gov and/or from Peoples' website.
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,
2004 2003
------------------------------------ -----------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
ASSETS
Securities:
Taxable $ 576,319 $ 5,833 4.05% $ 636,503 $ 7,035 4.42%
Tax-exempt (1) 63,408 1,075 6.78% 67,107 1,109 6.61%
- -----------------------------------------------------------------------------------------------------------------
Total securities 639,727 6,908 4.32% 703,610 8,144 4.63%
Loans (2):
Commercial (1) 541,684 7,975 5.89% 463,951 7,315 6.31%
Real estate (3) 307,476 5,044 6.56% 330,322 5,934 7.19%
Consumer 71,658 1,617 9.03% 101,265 2,457 9.71%
- -----------------------------------------------------------------------------------------------------------------
Total loans 920,818 14,636 6.36% 895,538 15,706 7.02%
Less: Allowance for loan loss (15,079) (13,967)
- -----------------------------------------------------------------------------------------------------------------
Net loans 905,739 14,636 6.48% 881,571 15,706 7.14%
Interest-bearing deposits with banks 2,456 3 0.46% 2,399 4 0.73%
Federal funds sold 2,448 7 1.14% 18,759 54 1.15%
- -----------------------------------------------------------------------------------------------------------------
Total earning assets 1,550,370 21,554 5.57% 1,606,339 23,908 5.96%
Other assets 180,803 135,812
- -----------------------------------------------------------------------------------------------------------------
Total assets $ 1,731,173 $ 1,742,151
=================================================================================================================
LIABILITIES AND EQUITY
Interest-bearing deposits:
Savings $ 178,938 $ 254 0.57% $ 175,957 $ 529 1.20%
Interest-bearing demand deposits 257,677 495 0.77% 276,920 676 0.98%
Time 450,615 3,410 3.03% 454,069 3,698 3.26%
- -----------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 887,230 4,159 1.88% 906,946 4,903 2.17%
Borrowed funds:
Short-term 79,104 191 0.97% 43,637 138 1.26%
Long-term 439,668 4,098 3.73% 485,365 4,874 4.02%
- -----------------------------------------------------------------------------------------------------------------
Total borrowed funds 518,772 4,289 3.29% 529,002 5,012 3.79%
- -----------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 1,406,002 8,448 2.40% 1,435,948 9,915 2.76%
Non-interest-bearing deposits 142,901 125,922
Other liabilities 10,502 11,872
- -----------------------------------------------------------------------------------------------------------------
Total liabilities 1,559,405 1,573,742
Stockholders' equity 171,768 168,409
- -----------------------------------------------------------------------------------------------------------------
Total liabilities and equity $ 1,731,173 $ 1,742,151
=================================================================================================================
Interest spread $ 13,106 3.17% $ 13,993 3.20%
Interest income to earning assets 5.57% 5.96%
Interest expense to earning assets 2.18% 2.48%
- -----------------------------------------------------------------------------------------------------------------
Net interest margin 3.39% 3.48%
=================================================================================================================
(1) Interest income and yields are 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 $121 and $207 for the periods
presented in 2004 and 2003, respectively.
(3) Loans held for sale are included in the average balance listed.
Related interest income on loans originated for sale prior to the
loan being sold is included in loan interest income.
For the Six Months Ended June 30,
2004 2003
------------------------------------ -----------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
ASSETS
Securities:
Taxable $ 580,882 $ 12,004 4.13% $ 589,389 $ 13,723 4.66%
Tax-exempt (1) 64,306 2,168 6.74% 66,668 2,223 6.67%
- -----------------------------------------------------------------------------------------------------------------
Total securities 645,188 14,172 4.39% 656,057 15,946 4.86%
Loans (2):
Commercial (1) 534,774 15,781 5.90% 439,082 14,063 6.41%
Real estate (3) 307,435 10,154 6.61% 330,537 11,984 7.25%
Consumer 74,321 3,378 9.09% 103,756 5,018 9.67%
- -----------------------------------------------------------------------------------------------------------------
Total loans 916,530 29,313 6.40% 873,375 31,065 7.11%
Less: Allowance for loan loss (15,047) (13,683)
- -----------------------------------------------------------------------------------------------------------------
Net loans 901,483 29,313 6.53% 859,692 31,065 7.26%
Interest-bearing deposits with banks 2,504 6 0.48% 1,977 7 0.71%
Federal funds sold 13,573 64 0.94% 13,466 77 1.14%
- -----------------------------------------------------------------------------------------------------------------
Total earning assets 1,562,748 43,555 5.59% 1,531,192 47,095 6.17%
Other assets 168,604 128,180
- -----------------------------------------------------------------------------------------------------------------
Total assets $ 1,731,352 $ 1,659,372
=================================================================================================================
LIABILITIES AND EQUITY
Interest-bearing deposits:
Savings $ 174,941 $ 487 0.56% $ 163,134 $ 1,025 1.26%
Interest-bearing demand deposits 260,270 992 0.76% 273,894 1,543 1.13%
Time 455,786 6,480 2.84% 438,202 7,539 3.44%
- -----------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 890,997 7,959 1.80% 875,230 10,107 2.33%
Borrowed funds:
Short-term 91,283 468 1.03% 40,637 242 1.19%
Long-term 428,126 8,059 3.76% 453,189 9,285 4.10%
- -----------------------------------------------------------------------------------------------------------------
Total borrowed funds 519,409 8,527 3.27% 493,826 9,527 3.86%
- -----------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 1,410,406 16,486 2.34% 1,369,056 19,634 2.87%
Non-interest-bearing deposits 139,205 117,167
Other liabilities 9,533 11,755
- -----------------------------------------------------------------------------------------------------------------
Total liabilities 1,559,144 1,497,978
Stockholders' equity 172,208 161,394
- -----------------------------------------------------------------------------------------------------------------
Total liabilities and equity $ 1,731,352 $ 1,659,372
=================================================================================================================
Interest spread $ 27,069 3.25% $ 27,461 3.30%
Interest income to earning assets 5.59% 6.17%
Interest expense to earning assets 2.11% 2.59%
- -----------------------------------------------------------------------------------------------------------------
Net interest margin 3.48% 3.58%
=================================================================================================================
(1) Interest income and yields are 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 $241 and $378 for the periods
presented in 2004 and 2003, respectively.
(3) Loans held for sale are included in the average balance listed.
Related interest income on loans originated for sale prior to the loan
being sold is included in loan interest income.
ITEM 4: CONTROLS AND PROCEDURES
- -------------------------------
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
- ------------------------------------------------
With the participation of the Chief Executive Officer and the Chief Financial
Officer of Peoples Bancorp Inc. ("Peoples"), Peoples' management has evaluated
the effectiveness of Peoples' disclosure controls and procedures, as defined in
Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), as of the end of the period covered by this Quarterly Report on
Form 10-Q. Based on that evaluation, Peoples' Chief Executive Officer and Chief
Financial Officer have concluded that:
(a) information required to be disclosed by Peoples in this Quarterly
Report on Form 10-Q would be accumulated and communicated to Peoples'
management, including its Chief Executive Officer and Chief Financial
Officer, as appropriate to allow timely decisions regarding required
disclosure;
(b) information required to be disclosed by Peoples in this Quarterly
Report on Form 10-Q would be recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and
forms; and
(c) Peoples' disclosure controls and procedures are effective as of the end
of the quarterly period covered by this Quarterly Report on Form 10-Q
to ensure that material information relating to Peoples and its
consolidated subsidiaries is made know to them, particularly during the
period in which Peoples' periodic reports, including this Quarterly
Report on Form 10-Q, are being prepared.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
- ----------------------------------------------------
There were no changes in Peoples' internal control over financial reporting (as
defined in Rule 13a-15(f) under the Exchange Act) that occurred during Peoples'
fiscal quarter ended June 30, 2004, 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, USE OF PROCEEDS AND ISSUER PURCHASES
OF EQUITY SECURITIES.
The following table details Peoples' repurchases and purchases by "affiliated
purchasers" as defined in Rule 10b-18(a)(3) of Peoples' common shares during the
three months ended June 30, 2004:
(d)
(c) Maximum Number
Total Number of of Common Shares
Common Shares that May Be
(a) (b) Purchased as Part of Purchased Under
Total Number of Average price Publicly Announced the Plans or
Period Shares Purchased Paid per Share Plans or Programs (1) Programs (1)(2)
April 1 - 30, 2004 7,910(3) $24.32(3) - 283,800
May 1 - 31, 2004 - - - 283,800
June 1 - 30, 2004 147,703(4) $24.94(4) 147,435 136,365
- ----------------------------------------------------------------------------------------------------------------
Total 148,875 $24.93 147,435 136,365
================================================================================================================
(1) Information reflects solely the 2004 Stock Repurchase Program announced on
December 17, 2003, which authorized the repurchase of 425,000 common shares,
with an aggregate purchase price of not more than $13.0 million. The 2004
Stock Repurchase Program expires on December 31, 2004.
(2) Information reflects maximum number of common shares that may be purchased
at the end of the period indicated.
(3) Information reflects 1,172 common shares purchased in open market
transactions at an average price of $24.45 by Peoples Bank under the Rabbi
Trust Agreement establishing a rabbi trust holding assets to provide payment
of the benefits under the Peoples Bancorp Inc. Deferred Compensation Plan
for Directors of Peoples Bancorp Inc. and Subsidiaries (the "Rabbi Trust")
and 6,738 common shares acquired at an average price of $24.30 in connection
with the exercise of stock options under Peoples' stock option plans.
(4) Includes an aggregate of 268 common shares purchased in open market
transactions at an average price of $25.74 by Peoples Bank under the Rabbi
Trust.
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
- ------------ --------------------------------------------- ----------------
11 Computation of Earnings Per Share Filed herewith
12 Computation of Ratios Filed herewith
31(a) CEO Certification Pursuant to Rule Filed herewith
13a-14(a)/15d-14(a)
31(b) CFO Certification Pursuant to Rule Filed herewith
13a-14(a)/15d-14(a)
31(c) President/COO Certification Pursuant to Rule Filed herewith
13a-14(a)/15d-14(a)
32 Section 1350 Certifications Filed herewith
b) Reports on Form 8-K:
Peoples filed the following reports on Form 8-K during the three
months ended June 30, 2004:
1) Filed April 8, 2004 - Reporting, under Item 5, the issuance of a
news release on April 8, 2004, announcing the signing of a
definitive agreement by Peoples Insurance Agency, Inc. to
acquire Putnam Agency, Inc.
2) Filed April 13, 2004 - Reporting, under Item 5, the issuance of
a news release on April 13, 2004, announcing the retirement of
director from and re-election of four directors to the Board of
Directors of Peoples Bancorp Inc.
3) Filed May 14, 2004, as amended July 27, 2004 - Reporting, under
Item 5, the issuance of a news release announcing the
declaration of a cash dividend of $0.18 per share by the Board
of Directors of Peoples Bancorp Inc. on May 13, 2004.
4) Filed June 1, 2004 - Reporting, under Item 5, the issuance of
a news release on June 1, 2004, announcing the acquisition of
the Barengo Insurance Agency by Peoples Insurance Agency, Inc.
5) Filed June 14, 2004 - Reporting, under Item 5, the issuance of
a news release on June 10, 2004, announcing the appointment of
Mark F. Bradley as President and Chief Operating Officer of
Peoples Bancorp Inc. by the Board of Directors.
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 9, 2004 By:/s/ROBERT E. EVANS
-------------------------------------
Robert E. Evans
Chairman of the Board and
Chief Executive Officer
Date: August 9, 2004 By:/s/MARK F. BRADLEY
-------------------------------------
Mark F. Bradley
President and Chief Operating Officer
Date: August 9, 2004 By:/s/JOHN W. CONLON
-------------------------------------
John W. Conlon
Chief Financial Officer and Treasurer
EXHIBIT INDEX
PEOPLES BANCORP INC. QUARTERLY REPORT ON FORM 10-Q
FOR QUARTERLY PERIOD ENDED JUNE 30, 2004
Exhibit
Number Description Exhibit Location
- ------------ --------------------------------------------- ------------------
11 Computation of Earnings Per Share Filed herewith
12 Computation of Ratios Filed herewith
CEO Certification Pursuant to Rule Filed herewith
31(a) 13a-14(a)/15d-14(a)
CFO Certification Pursuant to Rule Filed herewith
31(b) 13a-14(a)/15d-14(a)
President/COO Certification Pursuant to Rule Filed herewith
31(c) 13a-14(a)/15d-14(a)
32 Section 1350 Certifications Filed herewith