UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
For Annual and Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended September 30, 2003
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ______ to ______
Commission File Number 0-18991
PEOPLES BANCORP
(Exact name of registrant as specified in its charter)
INDIANA 35-1811284
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
212 West 7th Street, Auburn, Indiana 46706
- ------------------------------------ --------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (260) 925-2500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act
Common Stock, par value $1.00 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
Aggregate market value of voting stock held by non-affiliates of the registrant,
as of December 18, 2003: $73,373,413.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of December 18, 2003:
3,397,973 shares of Common Stock, par value $1.00 per share
Documents Incorporated by Reference:
Portions of the definitive Proxy Statement/Prospectus (Part III) and the
Annual Report to Stockholders for the year ended September 30, 2003 (Parts II
and IV).
PART I
Peoples Bancorp (the "Company") may from time to time make written or oral
"forward-looking statements", including statements contained in the Company's
filings with the Securities and Exchange Commission (including this annual
report on Form 10-K and the exhibits thereto), in its reports to stockholders
and in other communications by the Company, which are made in good faith by the
Company pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995.
These forward-looking statements involve risks and uncertainties, such as
statements of the Company's plans, objectives, expectations, estimates and
intentions that are subject to change based on various important factors (some
of which are beyond the Company's control). The following factors, among others,
could cause the Company's financial performance to differ materially from the
plans, objectives, expectations, estimates and intentions expressed in such
forward-looking statements: the strength of the United States economy in general
and the strength of the local economies in which the Company conducts
operations; the effects of, and changes in, trade, monetary and fiscal policies
and laws, including interest rate policies of the board of governors of the
federal reserve system, inflation, interest rates, market and monetary
fluctuations; the timely development of and acceptance of new products and
services of the Company and the perceived overall value of these products and
services by users, including the features, pricing and quality compared to
competitors' products and services; the willingness of users to substitute
competitors' products and services for the Company's products and services; the
success of the Company in gaining regulatory approval of its products and
services, when required; the impact of changes in financial services laws and
regulations (including laws concerning taxes, banking, securities and
insurance); technological changes; acquisitions; changes in consumer spending
and saving habits; and the success of the Company in managing the risks
resulting from these factors.
The Company cautions that the listed factors are not exclusive. The Company
does not undertake to update any forward-looking statement, whether written or
oral, that may be made from time to time or on behalf of the Company.
Item 1. Business
General
The Company is an Indiana corporation organized in October 1990 to become
the thrift holding company for Peoples Federal Savings Bank of DeKalb County
("Peoples Federal"). The Company is the sole shareholder of Peoples Federal.
Peoples Federal conducts business from its main office in Auburn and its eight
full-service offices located in Avilla, Columbia City, Garrett, Kendallville,
LaGrange, Topeka and Waterloo, Indiana. Peoples Federal offers a full range of
retail deposit services and lending services to northeastern Indiana.
Peoples Federal was founded in 1925 and chartered by the Federal Home
Loan Bank Board ("FHLBB"), now the Office of Thrift Supervision ("OTS"), in
1937. Since that time, it has been a member of the Federal Home Loan Bank System
("FHLB System") and the Federal Home Loan Bank of Indianapolis ("FHLB of
Indianapolis"). Its savings accounts are insured up to applicable limits by the
Savings Association Insurance Fund ("SAIF"), as administered by the Federal
Deposit Insurance Corporation (the "FDIC").
On February 29, 2000 a merger was completed with Three Rivers Financial
Corp. and its subsidiary First Savings Bank ("First Savings") of Three Rivers,
Michigan. The Company became the sole shareholder of First Savings. First
Savings conducts business from its main office in Three Rivers, Michigan, and
its five full service offices in Union and Schoolcraft, Michigan, and Howe and
Middlebury, Indiana.
The Company has no other business activity other than being the holding
company for Peoples Federal and First Savings (collectively the "Banks") and is
subject to regulation by the OTS. The Company's securities are registered with
the Securities and Exchange Commission ("SEC") pursuant to the Securities
2
Exchange Act of 1934, as amended (the "Exchange Act"). As such, the Company is
subject to the information, proxy solicitation, insider trading, and other
restrictions and requirements of the Exchange Act.
In December 2002, the Board authorized a stock repurchase program.
Purchases of up to 300,000 shares of the Company's common stock may be made in
open market or in privately negotiated transactions. As of September 30, 2003,
the Company had repurchased 24,907 shares.
The Board of Directors approved the Stock repurchase program because, in
their opinion, the stock price was below the current value of the Company. The
Board and Management feel that the stock repurchase program enhances shareholder
value by decreasing the number of shares outstanding and by providing another
source to liquidate shares. Most shares are purchased at or below market value
and the company retires any shares repurchased, this also reduces the amount of
dividends paid. The repurchase plan also allows the company to efficiently
deploy excess capital.
On a yearly basis, the Company updates its long-term strategic plan. This
plan includes, among other things, the Company's commitment to maintaining a
strong capital base and continuing to improve the organization's return on
assets through asset growth and controlling operating expenses. Continued
careful monitoring of the Banks' interest rate risk is also cited as an
important goal. As a result, continued origination of short-term consumer and
installment loans, prime plus equity loans, adjustable rate mortgage loans, and
fixed-rate real estate loans with original terms of 15 years or less will be
emphasized.
The Banks offer a wide range of consumer and commercial financial services.
These services include: consumer demand deposit accounts; NOW accounts; regular
and term savings accounts and savings certificates; residential and commercial
real estate loans; and secured and unsecured consumer loans. During 1999,
Peoples Federal added agricultural and commercial lending officers to its staff.
Since these types of loans pose a higher credit risk than traditional mortgage
lending, they typically offer higher yields and are for shorter terms. It is
expected that these loans will assist Peoples Federal in managing its interest
rate risk, and increase its overall profitability. The Banks provide these
services through a branch network comprised of fourteen full-service banking
offices. They also provide credit card services, as well as enhancements to its
loan and deposit products designed to provide customers with added conveniences.
The Company has historically concentrated its business activities in
northeastern Indiana. The purchase of First Savings has extended this area to
southern Michigan. The Company's current strategy is to maintain its branch
office network as well as remain alert to new opportunities.
Over the years, the Company has broadened its product line and enhanced its
operations in order to accommodate its growth and to meet the vigorous
competition from various financial institutions and other companies or firms
that engage in similar activities.
The Thrift Industry
Thrift institutions are financial intermediaries which historically have
accepted savings deposits from the general public and, to a lesser extent,
borrowed funds from outside sources and invested those deposits and funds
primarily in loans secured by first mortgage liens on residential and other
types of real estate. Such institutions may also invest their funds in various
types of short and long-term securities. The deposits of thrift institutions are
insured by the SAIF as administered by the FDIC, and these institutions are
subject to extensive regulations. These regulations govern, among other things,
the lending and other investment powers of thrift institutions, including the
terms of mortgage instruments these institutions are permitted to utilize, the
types of deposits they are permitted to accept, and reserve requirements.
The operations of thrift institutions, including those of the Banks, are
significantly affected by general economic conditions and by related monetary
and fiscal policies of the federal government and regulations and policies of
financial institution regulatory authorities, including the Board of Governors
of the Federal Reserve System and the OTS. Lending activities are influenced by
a number of factors including the demand for housing, conditions in the
construction industry, and availability of funds. Sources of funds for lending
activities include savings deposits, loan principal payments, proceeds from
sales of loans, and borrowings from the Federal Home Loan Banks and other
3
sources. Savings flows at thrift institutions such as the Banks are influenced
by a number of factors including interest rates on competing investments and
levels of personal income.
Earnings
The Banks' earnings depend primarily on the difference between income from
interest-earning assets such as loans and investments, and interest paid on
interest-bearing liabilities such as deposits and borrowings. The Banks
typically engage in long-term mortgage lending at fixed rates of interest,
generally for periods of up to 30 years, while accepting deposits for
considerably shorter periods.
Generally, rapidly rising interest rates cause the cost of interest-bearing
liabilities to increase more rapidly than yields on interest-earning assets,
thereby adversely affecting the earnings of many thrift institutions. While the
industry has received expanded lending and borrowing powers in recent years
permitting different types of investments and mortgage loans, including those
with floating or adjustable rates and those with shorter terms, earnings and
operations are still highly influenced by levels of interest rates and financial
market conditions and by substantial investments in long-term mortgage loans.
Competition
The Banks experience strong competition both in making real estate loans
and in attracting savings deposits. The Banks compete for real estate loans with
commercial banks, mortgage banking companies, insurance companies, and other
institutional lenders. The most direct competition for savings comes from other
thrift institutions, mutual savings banks, commercial banks and credit unions.
During periods of generally high interest rates, additional significant
competition for savings accounts comes from corporate and government securities
as well as money market mutual funds. The principal methods generally used by
the Banks to attract deposit accounts include: competitive interest rates,
advertising, providing a variety of financial services, convenient office
locations, flexible hours for the public, and promotions for opening or adding
to deposit accounts.
Net Interest Income
Net interest income increases during periods when the spread is widened
between the Banks' weighted average rate at which new loans are originated and
the weighted average cost of interest-bearing liabilities. The Banks' ability to
originate loans is affected by market factors such as interest rates,
competition, consumer preferences, the supply of and demand for housing, and the
availability of funds.
The Banks have supplemented their interest income through purchases of
investments when appropriate. This activity generates positive interest rate
spreads on large principal balances with minimal administrative expense.
Interest Rate and Volume of Interest-Related Assets and Liabilities
Both changes in interest rates and changes in the composition of the Banks'
interest-earning assets and interest-bearing liabilities can have a significant
effect on net interest income.
For information regarding the total dollar amount of interest income from
interest-earning assets, the average yields, the amount of interest expense from
interest-bearing liabilities and the average rate, net interest income, interest
rate spread, and the net yield on interest-earning assets, refer to page eight
of Management's Discussion and Analysis of Financial Condition and Results of
Operations in the Company's 2003 Annual Report to Stockholders incorporated
herein by reference.
For information regarding the combined weighted average effective interest
rate earned by the Banks on their loan portfolios and investments, the combined
weighted average effective cost of the Banks' deposits and borrowings, the
interest rate spread of the Banks, and the net yield on combined monthly
weighted average interest-earning assets of the Banks on their loan portfolios
and investments for the fiscal years ending September 30, 2003, 2002, and 2001
refer to page five of Management's Discussion and Analysis of Financial
Condition and Results of Operations in the Company's 2003 Annual Report
incorporated herein by reference.
4
For information concerning the extent to which changes in interest rates
and changes in volume of interest-related assets and liabilities have affected
the Banks' interest income and expense during the fiscal years ending September
30, 2003, 2002, and 2001 refer to page nine of Management's Discussion and
Analysis of Financial Condition and Results of Operations in the Company's 2003
Annual Report incorporated herein by reference.
Market Area
Peoples Federal's market area in northeastern Indiana spans the counties of
DeKalb, Whitley, Noble, and LaGrange. This market area has a population of
approximately 154,000 and has a diversified industrial economic base with an
emphasis on the production sector that includes major manufacturers of
international scope. Moreover, the distribution sector, primarily in the
wholesale and retail trades, constitutes a substantial portion of the area's
economy, both in terms of product mix, sales receipts, and employment. The most
rapid growth has occurred in the manufacturing sector, especially in the
production of automotive and electronics products, and in the service sector
with respect to packaging, warehousing, and distribution services.
With the addition of First Savings Bank to the Company, the market area has
expanded into southern Michigan and additional towns of Howe and Middlebury in
northeastern Indiana. First Savings serves St. Joseph, southern Kalamazoo, and
Cass counties in Michigan and LaGrange and eastern Elkhart counties in Indiana.
This expanded market area is contiguous to the Peoples Federal market area and
is a natural expansion. This aggregate market area has a population estimate of
566,700 and consists of a diversified economic base that includes manufacturing,
wholesale and retail trades, small farming, and service industries. The general
area serviced by First Savings would be classified as rural.
Lending Activities
General
The Banks have attempted to emphasize investments in adjustable-rate
residential mortgages and consumer loans in their market areas. In order to
lessen their risk from interest rate fluctuations, the Banks emphasize the
origination of interest rate sensitive loan products, such as one-year
adjustable-rate mortgage loans, and prime plus equity loans. However, during the
recent low interest rate market, customers preferred fixed rate products. The
Banks reacted to this trend by offering a new mortgage product of a seven-year
fixed rate loan, which converts to a one-year adjustable product at the end of
the seventh year. In this way, the Banks offered a fixed rate product to satisfy
the customer demand, but are not locked into low interest rates for a long
period of time. For regulatory reporting purposes, these loans are shown as
fixed rate product until the period remaining to the next repricing is under
five years. Seven year/one year loans originated during the initial
implementation of this product are now shown in this Form 10-K as adjustable
rate product. More recent originations of these types of loans are shown as
fixed rate mortgages. First Savings sells any loans it originates for longer
than seven year fixed rate terms on the secondary market.
Residential Mortgage Loans
A substantial portion of the Banks' lending activity involves the
origination of loans secured by residential real estate, consisting of
single-family dwelling units. The Banks also lend on the security of mid-size
multifamily dwelling units. The residential mortgage loans included in the
Banks' portfolio are primarily conventional fixed-rate loans with a maturity of
up to 30 years.
The Banks also offer adjustable-rate mortgage loans. Currently, these loans
generally have interest rates that adjust (up or down) every year. Generally,
these loans provide for a maximum adjustment of 6% over the life of the loans
with a maximum adjustment of 2% during any given year. Adjustments are based
upon an index established at the time the commitments are issued by the Banks.
The index used for most loans is tied to the applicable United States Treasury
security index. While adjustable-rate mortgage loans assist the Banks in
maintaining a positive spread during periods of high interest rates, it is not
expected that adjustments in interest rates on adjustable-rate mortgages will
5
match precisely changes in the Banks' cost of funds. The majority of the
adjustable rate mortgages originated by the Banks have limitations on the amount
(generally 6%) and frequency of interest rate changes.
During the fiscal year ended September 30, 2003, the Banks originated
$127,326,968 of residential loans of which $65,303,524 were five- to 30-year
fixed-rate mortgages and $62,023,444 was adjustable-rate loans. The rates
offered on the Banks' adjustable-rate residential mortgage loans are generally
competitive with the rates offered by other thrift institutions in the Banks'
market areas and are based upon the Banks' cost of funds and the rate of return
the Banks can receive on comparable investments. Fixed-rate loans are originated
only under terms and conditions and using documentation which would permit their
sale in the secondary market and at rates which are generally competitive with
rates offered by other financial institutions in the Banks' market areas.
Set forth below is the amounts and percentages of fixed-rate and
adjustable-rate loans (which include consumer loans) in the Banks' portfolios at
September 30, 2003, 2002, and 2001 (Dollars in thousands).
September 30,
----------------------------------------------------------------------------
2003 2002 2001
----------------------- ------------------------ ------------------------
Adjustable Fixed Adjustable Fixed Adjustable Fixed
----------- ----------- ----------- ------------ ----------- -----------
$231,122 $133,032 $239,265 $153,346 $267,681 $144,600
63.5% 36.5% 60.9% 39.1% 64.9% 35.1%
The terms of the residential loans originated by the Banks range from one
to 30 years. Experience during recent years reveals that as a result of
prepayments in connection with refinancings and sales of the underlying
properties, residential loans generally remain outstanding for periods
substantially shorter than maturity of the loan contracts. At September 30,
2003, the average contractual maturity of the Banks' portfolios of fixed-rate
loans was 8 years and 11 months, and 22 years and 1 month with respect to its
portfolio of adjustable-rate loans.
Substantially all of the Banks' residential mortgages include so-called
"due on sale" clauses, which are provisions giving the Banks the right to
declare a loan immediately due and payable in the event that, among other
things, the borrower sells or otherwise disposes of the real property subject to
the mortgage, and the loan is not repaid.
Generally, the Banks will not lend more than 80% of the appraised value of
a residential property which is owner occupied unless the borrower obtains
private mortgage insurance reducing the uninsured portion of the loan to 72% of
the appraised value. If private mortgage insurance is obtained, the Banks'
policy is to lend up to 90% of the appraised value of the property securing the
loan. The Banks apply the same standards to residential loans purchased in the
secondary market.
Commercial Real Estate Loans
The Banks also originate commercial real estate loans. From September 30,
2002, to September 30, 2003, commercial real estate loans decreased from
$20,870,000 to $16,969,000, with the percentage of commercial real estate loans
to total loans decreasing from 5.30% to 4.70%. These loans consisted of
construction and permanent loans secured by mortgages on mid-size commercial
real estate and farms. Of these loans, approximately $9.1 million are secured by
agricultural real estate. The terms of commercial real estate loans vary from
loan to loan but are usually five-year adjustable-rate loans with terms of 20 to
25 years. The loan-to-value ratio of commercial real estate loans is generally
75% or less.
Generally, commercial real estate loans involve greater risk to the Banks
than do residential loans but usually provide for a higher rate of interest and
increased fee income than do residential loans. Commercial real estate loans
typically involve large loan balances to single borrowers or groups of related
borrowers. In addition, the payment experience on loans secured by income
producing properties is typically dependent on the successful operation of the
related project and thus may be subject to a great extent to adverse conditions
in the real estate market or in the economy generally.
6
Construction Loans
The Banks offer residential construction loans both to owner-occupants and
to persons building residential property. Construction loans are usually offered
with fixed rates of interest during construction. Generally, construction loans
have terms ranging from six to 12 months at fixed rates over the construction
period. Practically all residential construction loans are written so as to
become permanent loans at the end of the construction period.
Construction loans involve greater underwriting and default risks to the
Banks than do loans secured by mortgages on existing properties. Loan funds are
advanced upon the security of the project under construction, which is more
difficult to value prior to the completion of construction. Moreover, because of
the uncertainties inherent in estimating construction costs, it is relatively
difficult to evaluate accurately the total loan funds required to complete a
project and the related loan-to-value ratios. Should a default occur which
results in foreclosure, the Banks could be negatively impacted in that they
would have to take control of the project and attempt either to arrange for
completion of construction or dispose of the unfinished project.
The Banks' underwriting criteria are designed to evaluate and minimize the
risks of each construction loan. The Banks carefully consider a wide variety of
factors before originating a construction loan, including the availability of
permanent financing or a takeout commitment to the borrower (which may be
provided by the Banks at market rates); the reputation of the borrower and the
contractor; independent valuations and reviews of cost estimates;
pre-construction sale information; and cash flow projections of the borrower.
Inspections of construction sites are made by the Banks on a timely basis to
verify progress made to date as a further reinforcement of its conservative
lending policy. To reduce the risks inherent in construction lending, the Banks
limit the number of properties that can be constructed on a "speculative" or
unsold basis by a developer at any one time and generally require the borrower
or its principals to personally guarantee repayment of the loan.
Consumer and Other Loans
Federal laws and regulations permit a federally-chartered savings
institution to make secured and unsecured consumer loans including home equity
loans (loans secured by the equity in the borrower's residence, but not
necessarily for the purpose of improvement), home improvement loans (loans
secured by a residential second mortgage), loans secured by deposit accounts,
and credit card loans (unsecured). The Banks offer all of these types of loans
and are currently emphasizing home equity loans to take advantage of the
adjustable interest rate feature of this type of loan versus the mortgage
product. These loans also carry a higher rate of interest than conventional
mortgages, thereby increasing the profit potential while reducing the interest
rate risk.
Loan Portfolio Cash Flows
The following table sets forth the estimated maturity of the Banks' loan
portfolios by type of loan at September 30, 2003. The estimated maturity
reflects contractual terms at September 30, 2003. Contractual principal
repayments of loans do not necessarily reflect the actual term of the Banks'
loan portfolios. The average life of mortgage loans is substantially less than
their contractual terms because of loan prepayments and because of enforcement
of "due on sale" clauses. The average life of mortgage loans tends to increase,
however, when current mortgage loan rates substantially exceed rates on existing
mortgage loans.
7
The following table sets forth the total amount of loans due after one year
from September 30, 2003, which have a fixed rate or an adjustable rate. (Dollars
in thousands)
Due in One Year Due After
One Year Through Five
or Less Five Years Years Total
--------- ------------- --------- ---------
(In thousands)
Type of Loan:
Construction loans --
Residential real estate $ 6,126 $ - $ - $ 6,126
Commercial -
Real estate loans:
Mortgage-residential 5,222 10,584 281,130 296,936
Commercial - 775 18,048 18,823
Installment loans --
Consumer 3,162 9,538 18,420 31,120
Commercial 7,082 2,786 1,281 11,149
--------- ----------- ---------- ----------
Total $ 21,592 $ 23,683 $318,879 $364,154
========= =========== ========== ==========
Loans Due
October 1, 2004 and thereafter
- -----------------------------------------
Fixed Adjustable Total at September 30, 2003
- ------------------ --------------------- ---------------------------------
$121,424 $221,138 $342,562
Loan Portfolio Composition
The following table sets forth the composition of the Banks' loan
portfolios by type of loan at the dates indicated. The table includes a
reconciliation of total net loans receivable, after consideration of undisbursed
portion of loans, deferred loan fees and discounts, and allowance for losses on
loans.
8
2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------
TYPE OF LOAN AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
---------- -------- ---------- ------- --------- ------ ---------- ------- ---------- -------
Residential: (Dollars in thousands)
Single family unit $301,265 82.8% $312,509 79.5% $336,586 81.6% $332,847 83.4% $265,992 88.3%
2-4 family units 1,797 0.5% 2,954 0.8% 3,243 0.8% 3,263 0.8% 1,603 0.5%
Over 4 family units 2,593 0.7% 3,485 0.9% 1,452 0.4% 3,018 0.8% 2,525 0.8%
Commercial real estate 14,750 4.1% 20,870 5.3% 21,906 5.3% 16,665 4.2% 9,392 3.1%
Land acquisition and
development 1,480 0.4% 1,516 0.4% 1,938 0.5% 1,926 0.5% 1,251 0.4%
Consumer and other loans 41,748 11.5% 50,233 12.8% 46,177 11.2% 39,657 10.0% 19,861 6.6%
Loans on deposits 521 0.1% 1,044 0.3% 979 0.2% 1,052 0.3% 952 0.3%
---------- -------- ---------- ------- --------- ------ ---------- ------- ---------- -------
364,154 100.0% 392,611 100.0% 412,281 100.0% 398,428 100.0% 301,576 100.0%
---------- -------- ---------- ------- --------- ------ ---------- ------- ---------- -------
Less:
Undisbursed portion
of loans 3,467 3,821 5,262 4,341 2,307
Deferred loan fees and
discounts 1,623 1,653 1,829 2,002 1,394
---------- ---------- --------- ---------- ----------
5,090 5,474 7,091 6,343 3,701
---------- ---------- --------- ---------- ----------
Total loans receivable 359,064 387,137 405,190 392,085 297,875
Allowance for losses
on loans 2,111 2,117 1,895 1,650 1,005
---------- ---------- --------- ---------- ----------
Net loans $356,953 $385,020 $403,295 $390,435 $296,870
========== ========== ========= ========== ==========
Origination, Purchase and Sale of Loans and Loan Concentrations
The Banks originate residential loans in conformity with standard
underwriting criteria to assure maximum eligibility for possible resale in the
secondary market. Although the Banks have authority to lend anywhere in the
United States, they have confined their loan origination activities primarily in
the Banks' service areas.
Loan originations are developed from a number of sources, primarily from
referrals from real estate brokers, builders, and existing and walk-in
customers. Peoples Federal also utilizes the services of a loan broker located
in Fort Wayne, Indiana, who is paid on a commission basis (generally 1% of the
loan amount) to originate loans for Peoples Federal.
The Banks' mortgage loan approval process is intended to assess the
borrower's ability to repay the loan, the viability of the loan, and the
adequacy of the value of the property that will secure the loan. The loan
committees of the Banks can approve residential and commercial loans ranging up
to $500,000. The Banks' Boards of Directors must approve loans exceeding
$500,000. The Banks utilize independent qualified appraisers approved by the
Board of Directors to appraise the properties securing their loans and require
title insurance or title opinions so as to insure that the Banks have a valid
lien on the mortgaged real estate. The Banks require borrowers to maintain fire
and casualty insurance on its secured properties.
The procedure for approval of construction loans is the same as for
residential mortgage loans, except that the appraiser evaluates the building
plans, construction specifications, and estimates of construction costs. The
Banks also evaluate the feasibility of the proposed construction project and the
experience and track record of the developer. In addition, all construction
loans generally require a commitment from a third-party lender or from the Banks
for a permanent long-term loan to replace the construction loan upon completion
of construction.
9
Consumer loans are underwritten on the basis of the borrower's credit
history and an analysis of the borrower's income and expenses, ability to repay
the loan, and the value of the collateral, if any. A consumer loan officer must
approve consumer loans. Consumer loan originations currently are being generated
primarily through advertising.
Currently, it is the Banks' policy to originate both fixed-rate and
adjustable-rate loans, providing all such loans are eligible for sale in the
secondary market. It is Peoples Federal's intention to hold all originated and
purchased loans in its portfolio and not for sale. First Savings is currently
active in the secondary market and sells the majority of its fixed rate loan
products.
The following table shows mortgage and other loan origination, purchase,
and repayment activity for the Banks during the periods indicated:
Years Ended September 30
--------------------------------
2003 2002 2001
---------- ---------- ----------
(Dollars in thousands)
Mortgage loans originated
for the purpose of:
Construction-commercial $ - $ 365 $ -
Construction-residential 10,321 10,715 28,003
Purchase/refinance-commercial 3,349 3,884 2,938
Purchase/refinance-residential 123,978 109,247 87,517
Consumer and other loans originated 29,805 30,329 39,199
---------- ---------- ----------
Total loans originated 167,453 154,540 157,657
---------- ---------- ----------
Loan credits:
Loans sold
Principal repayments 195,406 172,416 144,191
---------- ---------- ----------
Other:
Provision for losses on loans 537 348 354
Amortization of loan fees (759) (680) (557)
Loan foreclosures, net 336 731 476
---------- ---------- ----------
114 399 273
---------- ---------- ----------
Total credits, net 195,520 172,815 144,464
---------- ---------- ----------
Net increases (decreases) in mortgage and
other loans receivable, net $(28,067) $(18,275) $ 13,193
========== ========== ==========
Interest Rates, Points and Fees
The Banks realize interest, point, and fee income from their lending
activities. The Banks also realize income from commitment fees for making
commitments to originate loans, from prepayment and late charges, loan fees,
application fees, and fees for other miscellaneous services.
The Banks account for loan origination fees in accordance with the
Statement of Financial Accounting Standards on Accounting for Nonrefundable Fees
and Costs Associated with Originating or Acquiring Loans ("SFAS No. 91") issued
by the Financial Accounting Standards Board (the "FASB"). SFAS No. 91 prohibits
the immediate recognition of loan origination fees as revenues and requires that
10
such income (net of certain direct loan origination costs) for each loan be
amortized, generally by the interest method, over the estimated life of the loan
as an adjustment of yield.
First Savings also realizes income from gains on sales of loans, and
servicing fees for loans sold with servicing retained.
Nonperforming Assets
Loans are reviewed on a regular basis and are generally placed on
nonaccrual status when the loans become 90 days or more past due, or when, in
the judgment of management, the probability of collection is deemed to be
insufficient to warrant further accrual. When a loan is placed on a nonaccrual
status, previously accrued but unpaid interest is deducted from interest income.
When the Banks are unable to resolve a delinquency satisfactorily within 45 days
after the loan is past due, they will undertake foreclosure or other
proceedings, as necessary, to minimize any potential loss.
Real estate acquired by the Banks as a result of foreclosure or by deed in
lieu of foreclosure is classified as "real estate owned" until it is sold. When
property is so acquired, it is recorded at the lower of loan balance or fair
market value at the date of acquisition. Periodically, real estate owned is
reviewed to ensure that net realizable value is not less than carrying value,
and any allowance resulting there from is charged to operations as a provision
for loss on real estate owned. All costs incurred in maintaining the property
from the date of acquisition are expensed.
The following table reflects the amount of loans in delinquent status at
September 30, 2003:
Loans Delinquent For
--------------------------------------------------------------------
30-59 Days 60-89 Days 90 Days and Over
--------------------------------------------------------------------
Percent Percent Percent
of Loan of Loan of Loan
Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------- ------ -------- ------ ------ -------
Real estate: (Dollars in thousands)
One to four 18 $1,197 0.40% 6 $325 0.11% 15 $ 976 0.32%
family
Other 1 149 0.71% 1 43 0.20% - - 0.51%
Consumer 16 139 0.32% 10 93 0.21% 26 241 0.55%
------ ------ ----- -------- ------- ------
Total 35 $1,485 0.41% 17 $461 0.13% 41 $1,217 0.33%
====== ====== ===== ======== ======= ======
The following table sets forth the Banks' nonperforming assets at the dates
indicated:
11
At September 30,
----------------------------
2003 2002 2001 2000 1999
------ ------ ---- ---- ----
(Dollars in thousands)
Nonaccrual loans $1,127 $ 801 $676 $587 $474
Loans past due 90 days and
still accruing 90 106 52 7 64
------ ------ ---- ---- ----
1,217 907 728 594 538
Real estate owned, net
of allowance 854 489 117 165 -
------ ------ ---- ---- ----
Total nonperforming
assets $2,071 $1,396 $845 $759 $538
====== ====== ==== ==== ====
Consumer loans are placed on nonaccrual generally when the loan exceeds 90
days delinquent or if, in the opinion of management, the possibility of
collecting the loan becomes questionable. Mortgage loans are placed on
nonaccrual generally when the loan exceeds 90 days delinquent; however, if the
loan is below a 25% loan-to-value, management may at their option decide to
accrue interest on the loan, since collection of the loan appears highly likely.
The increase in non-accrual loans since September 30, 2002 is primarily
from the 1 to 4 family portion of the loan portfolio, and management believes
the increase has been appropriately considered in determining the adequacy of
the allowance for loan and REO losses at September 30, 2003. Management believes
this increase is generally attributable to current economic conditions. The
local economy in the areas in which the Company operates is somewhat dependent
upon the automobile industry, which has not fully recovered from the recession,
and this has trickled down to several other aspects of the local economy. There
have been no significant changes in potential problem loans since September 30,
2002. Net charge-offs for the years ended September 30, 2003 and 2002 were
$543,635 and $125,249, respectively. Net charge-offs were slightly above average
this year due to the aforementioned economic conditions. This was combined with
a large loss on one commercial loan to make up the net charge-off increase for
this year.
Interest income that would have been recognized for the year ended
September 30, 2003, if nonaccrual loans had been current in accordance with
their original terms, approximated $22,000. Interest income recognized on such
loans for the year ended September 30, 2003, approximated $7,000. At September
30, 2003 the Banks had no loans that were deemed impaired in accordance with
Statement of Financial Accounting Standards No. 114.
Federal regulations require savings associations to review their assets on
a regular basis and to classify them as: special mention; substandard; doubtful
and loss. Loans classified as special mention, are loans which currently do not
expose the Banks to an unusual risk of loss but based on information available
require the attention of management. This classification usually includes loans
secured by unusual collateral, loans with documentary items that are being
addressed by counsel, and relatively large loans where the borrower has had a
history of delinquent payments and the collateral has a cashflow shortfall,
however, the borrower has continued to service the debt. It is the Company's
policy to reserve 5% of the loan balance for loans classified as special
mention.
Loans classified as substandard or doubtful generally represent balances
where the borrower has made several late payments and is unable to bring the
loan current. Substandard loans generally represent situations where the
borrower is attempting to resolve the delinquency in the normal course of
business (i.e., sale of the property or infusion of additional capital).
Substandard loans are reserved at 20% of the loan balance. Loans classified as
doubtful represent situations where the borrower has been unsuccessful in
attempts to resolve the delinquency in the normal course of business. Doubtful
loans involve a greater degree of uncertainty regarding estimate of loss, and
the company reserves 50% of the loan balance.
12
Loans classified as loss represent situations where the loan is severely
delinquent. These loans typically involve extensive bankruptcy proceedings or
other unusual circumstances where the debtor contests foreclosure.
Loans classified as special mention; substandard or doubtful do not
necessarily require specific reserves. Individual loan balances may be
classified in one or more categories based on management's analysis and estimate
of the risk underlying each individual situation.
In accordance with the federal regulations, the Banks' management
continually reviews the mix and delinquency status of its loan portfolio and
classifies those loans, which it deems appropriate.
As of September 30, 2003, loan balances were classified by the Banks as
follows:
Loss $ -
Doubtful -
Substandard 2,528,000
Special Mention 1,800,000
Allowance for Losses on Loans
The allowances for loan losses represent amounts available to absorb
inherent losses in the loan portfolios. The allowance is based on management's
continuing review of the portfolios, historical charge-offs, current economic
conditions, and such other factors, which in management's judgment deserve
recognition in estimating possible losses. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the allowance for loan losses. Such agencies may require additions to the
allowance based on their judgment about the information available to them at the
time of their examination. Provisions for losses are charged to earnings to
bring the allowance to levels considered necessary by management. Losses are
charged to the allowance when considered probable. As of September 30, 2003
allowance for losses on loans was $2,110,946. Overall, the general composition
of the loan portfolio has remained similar to the prior year with no significant
shift of risk between components of the loan portfolio that would impact the
calculation of the allowance for loan losses. The Banks' management believes
that the allowance is adequate to absorb known and inherent losses in the
portfolios. No assurance can be given, however, that economic conditions which
may adversely affect the Banks' markets or other circumstances will not result
in additions to the allowance for loan and real estate owned losses.
The following table presents an allocation of the Banks' allowance for loan
losses at the dates indicated and the percentage of loans in each category to
total loans.
September 30,
2003 2002 2001 2000 1999
--------------- ------------- ------------ ------------ --------------
Amount % Amount % Amount % Amount % Amount %
-------- ------ ------- ----- ------ ------ ------ ----- ------- ------
Balance at end of (Dollars in thousands)
period applicable to:
Residential Mortgage Loans $1,420 82.1% $1,361 81.2% $ 910 82.4% $1,122 84.2% $ 869 88.7%
Commercial Real Estate Loans 166 5.8% 404 5.7% 527 6.2% 101 5.5% 76 4.4%
Consumer Loans 311 12.1% 294 13.1% 342 11.4% 196 10.3% 60 6.9%
Unallocated 214 58 116 231 -
------ ------- ------- ------ ------ ------ ------ ------ ------ --------
Total $2,111 100.0% $2,117 100.0% $1,895 100.0% $1,650 100.0% $1,005 100.0%
====== ======= ======= ====== ====== ====== ====== ====== ====== ========
The following table is a summary of activity in the Banks' allowance for
loan losses for the periods indicated.
13
Summary of Loan Loss Experience Years ended September 30,
---------------------------------------
2003 2002 2001 2000 1999
------ ------- ------- ------- --------
Balance of loan loss allowance at (Dollars in Thousands)
beginning of year $2,117 $1,895 $1,650 $1,005 $ 947
Allowance acquired in merger - - - 562 -
Charge-offs
Residential 25 36 4 - -
Commercial real estate - - - - -
Commercial 395 - - - -
Consumer 138 118 139 118 53
------ -------- ------- ------- -------
Total Charge-offs 558 154 143 118 53
------ -------- ------- ------- -------
Recoveries
Residential - - - - -
Consumer 15 28 34 41 22
------ -------- ------- ------- -------
Total Recoveries 15 28 34 41 22
------ -------- ------- ------- -------
Net Charge-offs (Recoveries) 543 126 109 77 31
Provision for loan losses 537 348 354 160 89
------ -------- ------- ------- -------
Balance of loan loss allowance at
end of year $2,111 $2,117 $1,895 $1,650 $1,005
====== ======== ======= ======= =======
Ratio of net charge-offs to average
loans outstanding 0.14% 0.03% 0.02% 0.01% 0.01%
Investment Activities
Federal thrift institutions, such as the Banks, have authority to invest in
various types of liquid assets, including United States Treasury obligations and
securities of various federal agencies, certificates of deposit at insured
banks, bankers' acceptances and federal funds. As a member of the FHLB System,
the Banks must maintain minimum levels of liquid assets specified by the OTS,
which vary from time to time. Subject to various regulatory restrictions,
federal thrift institutions may also invest a portion of their assets in certain
commercial paper, corporate debt securities and mutual funds whose assets
conform to the investments that a federal thrift institution is authorized to
make directly.
The carrying values of the Banks' investment securities, including its
liquid assets, as of the dates indicated are presented in the following table.
14
At September 30,
-----------------------------------
2003 2002 2001
---------- ---------- ---------
Interest-bearing deposits and (Dollars in thousands)
certificates of deposit (1) $ 29,965 $30,995 $13,029
U.S. government and federal
agency securities
Held to maturity - - 500
Available for sale 61,352 36,713 13,346
Mortgage backed securities
Held to Maturity 2,117 6,848 5,139
Available for sale 13,953 13,504 10,354
Stock in FHLB of Indianapolis 4,519 4,405 4,392
Other
Held to maturity - 295 635
Available for sale(2) 10,199 4,679 5,912
---------- --------- ---------
Total investments $122,105 $97,439 $53,307
========== ========= =========
- --------------------------------------------
(1) In Interest-bearing accounts at FHLB of Indianapolis $26,694, In Insured
certificates of deposit $3,270 at September 30, 2003; In Interest-bearing
accounts at FHLB of Indianapolis $27,175, In Insured certificates of
deposit $3,820 at September 30, 2002; In Interest-bearing accounts at FHLB
of Indianapolis $9,574, In Insured certificates of deposit $3,456 at
September 30, 2001;
(2) Van Kampen Prime Income Fund $2,298, Van Kampen Senior Income Trust $1,397,
State and Municipal obligations $6,504 at September 30, 2003; Van Kampen
Prime Income Fund $2,146, Van Kampen Senior Income Trust $1,160, State and
Municipal obligations $1,668 at September 30, 2002; Van Kampen Prime Income
Fund $2,409, Van Kampen Senior Income Trust $1,269, State and Municipal
obligations $2,869 at September 30, 2001;
The following table sets forth information regarding the maturity
distribution of investment securities at September 30, 2002, and the weighted
average yield on those securities.
At September 30, 2003
----------------------------------------------------------------
Available for Sale Held to Maturity
------------------------------ ---------------------------------
Weighted Approximate Weighted Approximate
Amortized Average Fair Amortized Average Fair
Maturity Distribution at September 30: Cost Yield Value Cost Yield Value
--------- -------- ----------- --------- ---------- ------------
(Dollars in thousands)
Due in one year or less $ 357 5.40% $ 365 $ - $ -
Due after one through five years 45,811 3.19% 46,373 - -
Due after five through ten years 18,872 3.42% 18,925 - -
Due after ten years 2,282 3.73% 2,194 - -
-------- --------- ---------- ------------
67,322 67,857 - -
Mortgage-backed securities 13,990 4.52% 13,953 2,117 4.88% 2,218
Marketable equity securities 4,453 3,695 - -
-------- --------- --------- ------------
Total $85,765 $85,505 $2,117 $2,218
======== ========= ========= ============
15
Sources of Funds
General
Deposits have traditionally been the primary source of funds of the Banks
for use in lending and investment activities. In addition to deposits, the Banks
derive funds from loan prepayments and income on earning assets. While income on
earning assets is a relatively stable source of funds, deposit inflows and
outflows can vary widely and are influenced by prevailing interest rates, money
market conditions, and levels of competition.
Deposits
Deposits are attracted principally from within the Banks' primary market
areas through the offering of a variety of deposit instruments, including
passbook and statement accounts and certificates of deposit ranging in terms
from three months to five years. Deposit account terms vary, principally on the
basis of the minimum balance required, the time periods the funds must remain on
deposit and the interest rate. The Banks also offer individual retirement
accounts ("IRA's").
The Banks' policies are designed primarily to attract deposits from local
residents rather than to solicit deposits from areas outside their primary
markets. The Banks do not accept deposits from brokers due to the volatility and
rate sensitivity of such deposits. Interest rates paid, maturity terms, service
fees and withdrawal penalties are established by the Banks on a periodic basis.
Determination of rates and terms are predicated upon funds acquisition and
liquidity requirements, rates paid by competitors, growth goals and federal
regulations.
A major determinant of the Banks' average cost of funds is the distribution
of the Banks' accounts by interest rate paid. An important indicator of the
Banks' stability of lendable funds is the distribution of the Banks' accounts by
maturity.
For information on the amounts of certificate accounts at September 30,
2003, maturing during the next five years and thereafter see Note 6 of Notes to
Consolidated Financial Statements on page 24 of the Company's 2003 Annual Report
to Stockholders.
The following table lists maturities of certificates of deposits where the
balance of the certificate exceeds $100,000 for the periods indicated. None of
these certificates were brokered deposits.
At September 30,
------------------------
2003
------------
(Dollars In thousands)
3 months or less $ 500
3-6 months 700
6-12 months 800
over 12 months 34,343
------------
Total $ 36,343
============
Borrowings
As members of the FHLB System and the FHLB of Indianapolis, the Banks are
eligible to arrange borrowings or advances for various purposes and on various
terms. As of September 30, 2003, 2002 and 2001 the Banks had outstanding
advances to the FHLB of Indianapolis of $54,100,000, $59,100,000, and
$45,092,965, respectively. See page 25 of the Company's 2003 Annual Report to
Stockholders for the maturity breakdown of these long-term instruments.
16
Reverse repurchase agreements, another source of borrowing for Peoples
Federal, are retail obligations of Peoples Federal with a maturity of 90 days or
less, and are generally secured with specific investment securities owned by
Peoples Federal.
The following tables set forth certain information as to the Banks'
short-term borrowings consisting of reverse repurchase agreements for the
periods and at the dates indicated. Average balances and average interest rates
are based on month-end balances.
Years Ended September 30
-------------------------
2003 2002 2001
------ -------- -------
(Dollars in thousands)
Average balance of short-term borrowings $4,294 $2,885 $1,068
Highest month-end balance of total
short-term borrowings 7,136 5,131 4,384
Weighted average interest rate of total
short-term borrowings 1.53% 2.39% 3.45%
At September 30
----------------------
2003 2002 2001
------ ------- -------
Reverse Repurchase agreements 2,650 3,193 4,384
------ ------- -------
Total short-term borrowings $2,650 $3,193 $4,384
====== ======= ========
Weighted average interest rate 1.49% 1.98% 3.45%
Trust Department
In October 1984, the FHLB of Indianapolis granted full trust powers to
Peoples Federal, one of the first savings institutions in Indiana to be granted
such powers. As of September 30, 2003, Peoples Federal's trust department assets
totaled approximately $99,773,000 including self-directed Individual Retirement
Accounts ("IRA's"), and it was offering a variety of trust services including
estate planning. As of that date, the trust department was administering
approximately 790 trust accounts, including estates, guardianships, revocable
and irrevocable trusts, testamentary trusts, and self-directed IRA accounts. The
trust department also offers and administers self-directed IRA's and Simplified
Employee Pension IRA's for small businesses. The trust department provides a
needed service to the communities served by Peoples Federal, as well as
generating fee income which is largely unaffected by interest rate fluctuations.
The large increase in trust assets administered (from less than $58 million
to almost $100 million) was due to the purchase by Peoples Federal of the trust
assets of First Federal Savings Bank of Huntington, IN. The purchase was
affected using a revenue sharing agreement, rather than an up-front cash
payment. While the merger still needed final regulatory approval at September
30, the assets had been combined in Peoples Federal's accounting system, and
Peoples had taken over the administration of these accounts. Final regulatory
approval is expected at any time.
Non-Bank Subsidiary
Peoples Financial Services, Inc. ("PFSI") was organized in 1977 under the
laws of the State of Indiana. It is wholly owned by Peoples Federal and conducts
a general insurance business within the State of Indiana under the name of
Peoples Insurance Agency. During fiscal years ended September 30, 2003 and 2002,
PFSI recorded total income of $54,326 and 57,255, respectively, with net income
for such periods amounting to $5,686 and $8,322, respectively.
Alpha Financial was organized under the laws of the state of Michigan in
1975 as a wholly owned subsidiary of First Savings. First Savings' investment in
Alpha Financial was $221,495 at September 30, 2003. The assets of Alpha
17
Financial consist of cash and stock in MIMLIC Life Insurance Company, which
reinsures credit life insurance policies written on the lives of borrowers of
various financial institutions.
Discount Brokerage Services
Since 1985, Peoples Federal has offered discount brokerage services to its
customers. In 1996, this service was moved to the service corporation and was
offered through U.S. Clearing Corp. Prior to 1996, another vendor was used. This
service also reduces the expenses of securities transactions for the various
trust accounts administered by the trust department and provides customers with
a convenient and inexpensive means of conducting brokerage transactions. During
2002, this service was discontinued.
Employees
As of September 30, 2003, the Banks employed 151 persons on a full-time
basis and 20 persons on a part-time basis. The Banks' employees are not
represented by any collective bargaining group, and management considers its
relations with its employees to be excellent. The holding company has no
employees.
REGULATION
General
The Company, as a savings and loan holding company, and the Banks, as
federally chartered savings associations, are subject to extensive regulation by
the OTS and the FDIC. The lending activities and other investments of the Banks
must comply with various federal regulatory requirements, and the OTS
periodically examines the Banks for compliance with various regulatory
requirements and for safe and sound operations. The FDIC also has the authority
to conduct examinations. The Banks must file reports with the OTS describing
their activities and financial condition and are also subject to certain reserve
requirements promulgated by the Board of Governors of the Federal Reserve
System. This supervision and regulation is intended primarily for the protection
of depositors and the deposit insurance funds and not for the protection of
stockholders of the Company. Certain of these regulatory requirements are
referred to below or appear elsewhere herein.
Recent Legislation
Sarbanes-Oxley. The Sarbanes-Oxley Act requires audit committees to be
directly responsible for the appointment, compensation and oversight of the
Company's public accounting firm, including the resolution of disagreements
between management and the auditor regarding financial reporting. The auditors
are required to report directly to the audit committee, and members of the audit
committee must be truly independent unless the SEC grants an exemption. If the
audit committee does not include a financial expert, the absence of such expert
must be disclosed. Audit committees are required to adopt written procedures to
receive and address complaints regarding accounting, internal controls and
auditing issues, including procedures to maintain the confidentiality of whistle
blowers.
USA Patriot Act of 2001. On October 26, 2001, President Bush signed the USA
Patriot Act of 2001. The Patriot Act is intended is to strengthen the U.S law
enforcement and the intelligence communities' abilities to work cohesively to
combat terrorism on a variety of fronts. The potential impact of the Patriot Act
on financial institutions of all kinds is significant and wide ranging. The
Patriot Act contains sweeping anti-money laundering and financial transparency
laws and requires various regulations, including:
o due diligence requirements for financial institutions that administer,
maintain, or manage private banks accounts or correspondent accounts for
non-US persons;
o standards for verifying customer identification at account opening;
18
o rules to promote cooperation among financial institutions, regulators, and
law enforcement entities in identifying parties that may be involved in
terrorism or money laundering; and
o reports by non-financial trades and businesses filed with the Treasury
Department's Financial Crimes Enforcement Network for transactions
exceeding $10,000, and filing of suspicious activities reports securities
by brokers and dealers if they believe a customer may be violating U.S.
laws and regulations.
On July 23, 2002, the U.S. Treasury proposed regulations requiring
institutions to incorporate into their written money laundering plans a board
approved customer identification program implementing reasonable procedures for:
o verifying the identity of any person seeking to open an account, to the extent
reasonable and practicable;
o maintaining records of the information used to verify the person's
identity; and
o determining whether the person appears on any list of known or suspected
terrorists or terrorist organizations.
Account is defined as a formal banking or business relationship established to
provide ongoing services, dealings, or other financial transactions. We do not
expect the proposed regulations will have a material impact on our operations.
Financial Services Modernization Legislation. The Gramm-Leach-Bliley Act
(the "Financial Services Modernization Act") became effective March 11, 2000.
The Financial Services Modernization Act repeals the two affiliation provisions
of the Glass-Steagall Act: Section 20, which restricted the affiliation of
Federal Reserve Member Banks with firms "engaged principally" in specified
securities activities; and Section 32, which restricts officer, director, or
employee interlocks between a member bank and any company or person "primarily
engaged" in specified securities activities. In addition, the Financial Services
Modernization Act also contains provisions that expressly preempt any state law
restricting the establishment of financial affiliations, primarily related to
insurance. The general effect of the law is to establish a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms, and other financial service providers by revising and
expanding the Bank Holding Company Act framework to permit a holding company
system to engage in a full range of financial activities through a new entity
known as a "Financial Holding Company." "Financial activities" is broadly
defined to include not only banking, insurance, and securities activities, but
also merchant banking and additional activities that the Federal Reserve Board,
in consultation with the Secretary of the Treasury, determines to be financial
in nature, incidental to such financial activities, or complementary activities
that do not pose a substantial risk to the safety and soundness of depository
institutions or the financial system generally.
The Financial Services Modernization Act provides that no company may
acquire control of an insured savings association, unless that company engages,
and continues to engage, only in the financial activities permissible for a
Financial Holding Company, unless grandfathered as a unitary savings and loan
holding company. The Financial Institution Modernization Act grandfathers any
company that was a unitary savings and loan holding company on May 4, 1999 (or
becomes a unitary savings and loan holding company pursuant to an application
pending on that date). Such a company may continue to operate under laws prior
to the Financial Services Modernization Act as long as the company continues to
meet the two tests: it can control only one savings institution, excluding
supervisory acquisitions, and each such institution must meet the QTL test. It
further requires that a grandfathered unitary savings and loan holding company
must continue to control at least one savings association, or a successor
institution, that is controlled on May 4, 1999.
The Financial Services Modernization Act also permits national banks to
engage in expanded activities through the formation of financial subsidiaries. A
national bank may have a subsidiary engaged in any activity authorized for
national banks directly or any financial activity, except for insurance
underwriting, insurance investments, real estate investment or development, or
merchant banking, which may only be conducted through a subsidiary of a
Financial Holding Company. Financial activities include all activities permitted
under new sections of the Bank Holding Company Act of 1956 ("BHCA") or permitted
by regulation.
19
The Company and the Banks do not believe that the Financial Services
Modernization Act will have a material adverse effect on the operations of the
Company and the Banks in the near-term. However, to the extent that the act
permits banks, securities firms, and insurance companies to affiliate, the
financial services industry may experience further consolidation. The Financial
Services Modernization Act is intended to grant to community banks certain
powers as a matter of right that larger institutions have accumulated on an ad
hoc basis and which unitary savings and loan holding companies already possess.
Nevertheless, this act may have the result of increasing the amount of
competition that the Company and the Bank face from larger institutions and
other types of companies offering financial products, many of which may have
substantially more financial resources that the Company and the Bank. In
addition, because the Company may only be acquired by other unitary savings and
loan holding companies or Financial Holding Companies, the legislation may have
an anti-takeover effect by limiting the number of potential acquirers or by
increasing the costs of an acquisition transaction by a bank holding company
that has not made the election to be a Financial Holding Company under the new
legislation.
Regulation of the Company
General. The Company is a savings and loan holding company as defined by
the Home Owners' Loan Act, as amended (the "HOLA"). As such, the Company is
registered with the OTS and is subject to OTS regulation, examination,
supervision and reporting requirements. As a subsidiary of a savings and loan
holding company, the Banks are subject to certain restrictions in their dealings
with the Company and affiliates thereof. The Company also is required to file
certain reports with, and otherwise comply with, the rules and regulations of
the SEC under the federal securities laws.
Activities Restrictions. There are generally no restrictions on the
activities of a savings and loan holding company. The broad latitude to engage
in activities under current law can be restricted if the OTS determines that
there is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings institution, the OTS
may impose such restrictions as deemed necessary to address such risk including
limiting: (i) payment of dividends by the savings institution; (ii) transactions
between the savings institution and its affiliates; and (iii) any activities of
the savings institution that might create a serious risk that the liabilities of
the holding company and its affiliates may be imposed on the savings
institution. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
institution subsidiary of such a holding company fails to meet the QTL test,
then such unitary holding company shall also become subject to the activities
restrictions applicable to multiple holding companies and, unless the savings
institution requalifies as a QTL within one year thereafter, register as, and
become subject to, the restrictions applicable to a bank holding company. See
"Regulation of the Bank--Qualified Thrift Lender."
Restrictions on Acquisitions. Savings and loan holding companies are
prohibited from acquiring, without prior approval of the OTS, (i) control of any
other savings institution or savings and loan holding company or substantially
all the assets thereof or (ii) more than 5% of the voting shares of a savings
institution or holding company thereof which is not a subsidiary. Under certain
circumstances, a registered savings and loan holding company is permitted to
acquire, with the approval of the OTS, up to 15% of the voting shares of an
undercapitalized savings institution pursuant to a "qualified stock issuance"
without that savings institution being deemed controlled by the holding company.
In order for the shares acquired to constitute a "qualified stock issuance," the
shares must consist of previously unissued stock or treasury shares, the shares
must be acquired for cash, the saving and loan holding company's other
subsidiaries must have tangible capital of at least 6-1/2% of total assets,
there must not be more than one common director or officer between the savings
and loan holding company and the issuing savings institution, and transactions
between the savings institution and the savings and loan holding company and any
of its affiliates must conform to Sections 23A and 23B of the Federal Reserve
Act. Except with the prior approval of the OTS, no director or officer of a
savings and loan holding company or person owning by proxy or otherwise more
than 25% of such company's stock, may also acquire control of any savings
institution, other than a subsidiary savings institution, or of any other
savings and loan holding company.
20
Regulation of the Banks
Federal Home Loan Bank System. The Banks are members of the FHLB System,
which consists of 12 district Federal Home Loan Banks subject to supervision and
regulation by the Federal Housing Finance Board ("FHFB"). The Federal Home Loan
Banks provide a central credit facility primarily for member institutions. As
members of the FHLB of Indianapolis, the Banks are required to acquire and hold
shares of capital stock in the FHLB of Indianapolis in an amount at least equal
to 1% of the aggregate unpaid principal of its home mortgage loans, home
purchase contracts, and similar obligations at the beginning of each year, or
1/20 of its advances (i.e., borrowings) from the FHLB of Indianapolis, whichever
is greater. The Banks were in compliance with this requirement with an
investment in FHLB of Indianapolis stock at September 30, 2003, of $4,518,700.
The FHLB of Indianapolis serves as a reserve or central bank for its member
institutions within its assigned district. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It makes
advances to members secured by certain prescribed collateral in accordance with
policies and procedures established by the FHFB and the Board of Directors of
the FHLB of Indianapolis. Long-term advances may only be made for the purpose of
providing funds for residential housing finance. Members must meet standards of
community investment or service established by the FHLB of Indianapolis in order
to maintain continued access to long-term advances. As of September 30, 2003,
the Banks had advances totaling $54,100,000 outstanding. See "Business of the
Company--Deposit Activity and Other Sources of Funds" and "--Borrowings."
Liquidity Requirements. Under OTS regulations, a savings association is
required to maintain an average daily balance of liquid assets (including cash,
certain time deposits and savings accounts, bankers' acceptances, certain
government obligations, and certain other investments) in each calendar quarter
sufficient to ensure its safe and sound operation. The Banks maintain liquid
assets in compliance with these regulations. Monetary penalties may be imposed
upon an institution for violations of liquidity requirements.
Qualified Thrift Lender Test. Savings institutions must meet a qualified
thrift lender ("QTL") test, which test may be met either by maintaining a
specified level of assets in qualified thrift investments as specified in HOLA
or by meeting the definition of a "domestic building and loan association" in
section 7701 of the Internal Revenue Code of 1986, as amended (the "Code"). If
the Banks maintain an appropriate level of certain specified investments
(primarily residential mortgages and related investments, including certain
mortgage-related securities) and otherwise qualify as QTL's or a domestic
building and loan association, they will continue to enjoy full borrowing
privileges from the FHLB. The required percentage of investments under HOLA is
65% of assets while the Code requires investments of 60% of assets. An
association must be in compliance with the QTL test or definition of domestic
building and loan association on a monthly basis in nine out of every 12 months.
Associations that fail to meet the QTL test will generally be prohibited from
engaging in any activity not permitted for both a national bank and a savings
association. As of September 30, 2003, the Banks were in compliance with their
QTL requirements and met the definition of a domestic building and loan
association.
Branching. Subject to certain limitations, the HOLA and the OTS regulations
currently permit federally chartered savings institutions such as the Banks to
establish branches in any state of the United States. Federal savings
associations with branches in more than one state must satisfy either the QTL or
the DBLA test on a state-by-state basis. The authority for a federal savings
institution to establish an interstate branch network would facilitate a
geographic diversification of the institution's activities. This authority under
the HOLA and the OTS regulations preempts any state law purporting to regulate
branching by federal savings institutions.
Regulatory Capital Requirements. Under OTS capital regulations, savings
institutions must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3% of adjusted total assets and "total" capital
(a combination of core and "supplementary" capital) equal to 8% of risk-weighted
assets. In addition, OTS regulations impose certain restrictions on savings
associations that have a total risk-based capital ratio that is less than 8.0%,
a ratio of Tier 1 capital to risk-weighted assets of less than 4.0% or a ratio
of Tier 1 capital to adjusted total assets of less than 4.0% (or 3.0% if the
institution is rated Composite 1 under the OTS examination rating system).
The OTS has adopted an amendment to its risk-based capital requirements
that requires savings institutions with more than a "normal" level of interest
rate risk to maintain additional total capital (the OTS is delaying
21
implementation of this requirement). A savings institution's interest rate risk
will be measured in terms of the sensitivity of its "net portfolio value" to
changes in interest rates. Net portfolio value is defined, generally, as the
present value of expected cash inflows from existing assets and off-balance
sheet contracts less the present value of expected cash outflows from existing
liabilities. A savings institution will be considered to have a "normal" level
of interest rate risk exposure if the decline in its net portfolio value after
an immediate 200 basis point increase or decrease in market interest rates
(whichever results in the greater decline) is less than 2% of the current
estimated economic value of its assets. A savings institution with a greater
than normal interest rate risk will be required to deduct from total capital,
for purposes of calculating its risk-based capital requirement, an amount (the
"interest rate risk component") equal to one-half the difference between the
institution's measured interest rate risk and the normal level of interest rate
risk, multiplied by the economic value of its total assets.
On December 1, 1998, the OTS issued Thrift Bulletin 13a ("TB 13a"), which
replaced previous thrift bulletins and certain other guidance on interest rate
risk to assist institutions in interpreting the rules governing interest rate
risk. TB 13a sets forth a definition and sources of interest rate risk and
directs the Board of Directors of a savings association to set interest rate
risk limits for the savings association and to adopt a system for measuring
interest rate risk. TB 13a also describes certain due diligence management
should undertake before taking a position in investment securities or financial
derivatives, requires certain record-keeping of such investments, and states
that the savings association's activities in this area will be subject to
assessment by examiners. TB 13a discusses the two elements to an examiner's
assessment of interest rate risk; the level of market risk as measured by a net
portfolio value model, and the quality of the savings association's practices
for managing interest rate risk. In the event the OTS believes supervisory
action is required to address interest rate risk at a savings association, TB
13a outlines the range of agency responses, from written plans from the board to
reduce risk to formal enforcement action, including supervisory agreements or
cease and desist orders.
The OTS will calculate the sensitivity of a savings institution's net
portfolio value based on data submitted by the institution in a schedule to its
quarterly Thrift Financial Report and using the interest rate risk measurement
model adopted by the OTS. The amount of the interest rate risk component, if
any, to be deducted from a savings institution's total capital will be based on
the institution's Thrift Financial Report filed two quarters earlier. In
general, savings institutions with less than $300 million in assets and a
risk-based capital ratio above 12% are exempt from this interest rate risk
component unless the OTS terminates such exemption. Although the Bank qualifies
for the exemption, management believes that based on current financial data, the
Bank would not be deemed to have more than a normal level of interest rate risk.
In addition to generally applicable capital standards for savings
institutions, the Director of the OTS is authorized to establish the minimum
level of capital for a savings institution at such amount or at such ratio of
capital-to-assets as the Director determines to be necessary or appropriate for
such institution in light of the particular circumstances of the institution.
The Director of the OTS may treat the failure of any savings institution to
maintain capital at or above such level as an unsafe or unsound practice and may
issue a directive requiring any savings institution which fails to maintain
capital at or above the minimum level required by the Director to submit and
adhere to a plan for increasing capital. Such a directive may be enforced in the
same manner as an order issued by the OTS.
At September 30, 2003, the Banks exceeded all regulatory minimum capital
requirements as indicated in Note 16, page 31 of the Company's Annual Report to
Stockholders.
Insurance of Deposit Accounts. The Banks' deposit accounts are insured by
the SAIF to the maximum amount permitted by law. Insurance of deposits may be
terminated by the FDIC upon a finding that the institution has engaged in unsafe
or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order, or
condition imposed by the FDIC or the institution's primary regulator.
The FDIC charges an annual assessment for the insurance of deposits based
on the risk a particular institution poses to its deposit insurance fund. Under
this system as of September 30, 2002, SAIF members paid within a range of 0
cents to 23 cents per $100 of domestic deposits, depending upon the
22
institution's risk classification. This risk classification is based on an
institution's capital group and supervisory subgroup assignment. Pursuant to the
Economic Growth and Paperwork Reduction Act of 1996 (the "Act"), the Bank pays,
in addition to its normal deposit insurance premium as a member of the SAIF an
amount equal to approximately 6.4 basis points toward the retirement of the
Financing Corporation bonds ("Fico Bonds") issued in the 1980s to assist in the
recovery of the savings and loan industry. Members of the Bank Insurance Fund
("BIF"), by contrast, pay, in addition to their normal deposit insurance
premium, approximately 1.3 basis points. Under the Act, the FDIC also is not
permitted to establish SAIF assessment rates that are lower than comparable BIF
assessment rates. Effective January 1, 2000, the rate paid to retire the Fico
Bonds will be equal for members of the BIF and the SAIF. The Act also provided
for the merging of the BIF and the SAIF by January 1, 1999, provided there were
no financial institutions still chartered as savings associations at that time.
Although legislation to eliminate the savings association charter had been
proposed at January 1, 1999, financial institutions such as the Banks were still
chartered as savings associations.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, a savings institution must maintain average daily reserves equal to 3% on
the first $54.0 million of transaction accounts, plus 10% on the remainder. This
percentage is subject to adjustment by the Federal Reserve Board. Because
required reserves must be maintained in the form of vault cash or in a
non-interest bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's
interest-earning assets. As of September 30, 2003, the Banks met their reserve
requirements.
Dividend and Other Capital Distribution Limitations. The OTS imposes
various restrictions or requirements on the ability of savings institutions to
make capital distributions, including cash dividends. A savings institution that
is a subsidiary of a savings and loan holding company, such as the Bank, must
file an application or a notice with the OTS at least 30 days before making a
capital distribution. Savings institutions are not required to file an
application for permission to make a capital distribution and need only file a
notice if the following conditions are met: (1) they are eligible for expedited
treatment under OTS regulations, (2) they would remain adequately capitalized
after the distribution, (3) the annual amount of capital distribution does not
exceed net income for that year to date added to retained net income for the two
preceding years, and (4) the capital distribution would not violate any
agreements between the OTS and the savings institution or any OTS regulations.
Any other situation would require an application to the OTS.
In addition, the OTS could prohibit a proposed capital distribution by any
institution, which would otherwise be permitted by the regulation, if the OTS
determines that the distribution would constitute an unsafe or unsound practice.
A federal savings institution is prohibited from making a capital distribution
if, after making the distribution, the savings institution would be unable to
meet any one of its minimum regulatory capital requirements. Savings
institutions cannot distribute regulatory capital that is needed for its
liquidation account.
Affiliate Restrictions. Transactions between a savings association and its
"affiliates" are subject to quantitative and qualitative restrictions under
Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings
association include, among other entities, the savings association's holding
company and companies that are under common control with the savings
association.
In general, Sections 23A and 23B and OTS regulations issued in connection
therewith limit the extent to which a savings association or its subsidiaries
may engage in certain "covered transactions" with affiliates to an amount equal
to 10% of the association's capital and surplus, in the case of covered
transactions with any one affiliate, and to an amount equal to 20% of such
capital and surplus, in the case of covered transactions with all affiliates. In
addition, a savings association and its subsidiaries may engage in covered
transactions and certain other transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction" is
defined to include a loan or extension of credit to an affiliate; a purchase of
investment securities issued by an affiliate; a purchase of assets from an
affiliate, with certain exceptions; the acceptance of securities issued by an
affiliate as collateral for a loan or extension of credit to any party; or the
issuance of a guarantee, acceptance, or letter of credit on behalf of an
affiliate.
23
In addition, under the OTS regulations, a savings association may not make
a loan or extension of credit to an affiliate unless the affiliate is engaged
only in activities permissible for bank holding companies; a savings association
may not purchase or invest in securities of an affiliate other than shares of a
subsidiary; a savings association and its subsidiaries may not purchase a
low-quality asset from an affiliate; and covered transactions and certain other
transactions between a savings association or its subsidiaries and an affiliate
must be on terms and conditions that are consistent with safe and sound banking
practices. With certain exceptions, each loan or extension of credit by a
savings association to an affiliate must be secured by collateral with a market
value ranging from 100% to 130% (depending on the type of collateral) of the
amount of the loan or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Board of Governors of the Federal
Reserve System (the "Federal Reserve Board") decides to treat such subsidiaries
as affiliates. The regulation also requires savings associations to make and
retain records that reflect affiliate transactions in reasonable detail, and
provides that certain classes of savings associations may be required to give
the OTS prior notice of affiliate transactions.
The Federal Reserve Board issued for public comment, in October 2002,
proposed amended regulations applicable to transactions between affiliates. The
Company does not believe that these proposed regulations, if adopted by the
Federal Reserve Board, will have any material effect upon the business or
operations of the Company.
Standards for Safety and Soundness. Under applicable regulatory
requirements, the Banks are required to prescribe standards, by regulation or
guideline, relating to internal controls, information systems and internal audit
systems, loan documentation, credit underwriting, interest rate risk exposure,
asset growth, asset quality, operational and managerial standards as the
agencies deem appropriate. The OTS and the federal bank regulatory agencies
adopted, effective August 9, 1995, a set of guidelines prescribing safety and
soundness standards pursuant to the statute. The safety and soundness guidelines
establish general standards relating to internal controls and information
systems, internal audit systems, loan documentation, credit underwriting,
interest rate risk exposure, asset growth, and compensation, fees and benefits.
In general, the guidelines require, among other things, appropriate systems and
practices to identify and manage the risks associated with each aspect of an
institution's operations. The guidelines also prohibit excessive compensation as
an unsafe and unsound practice and describe compensation as excessive when the
amounts paid are unreasonable or disproportionate to the services performed by
an executive officer, employee, director or principal stockholder.
In addition, on August 27, 1996, the OTS and the federal bank regulatory
agencies added guidelines for asset quality and earnings standards. Under the
standards, a savings institution would be required to maintain systems,
commensurate with its size and the nature and scope of its operations, to
identify problem assets and prevent deterioration in those assets as well as to
evaluate and monitor earnings and ensure that earnings are sufficient to
maintain adequate capital and reserves.
Prompt Corrective Action. The prompt corrective action regulation of the
OTS requires certain mandatory actions and authorizes certain other
discretionary actions to be taken by the OTS against a savings bank that falls
within certain undercapitalized capital categories specified in the regulation.
The regulation establishes five categories of capital classification: "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized." Under the regulation, the
risk-based capital, leverage capital, and tangible capital ratios are used to
determine an institution's capital classification. At September 30, 2000, the
Banks met the capital requirements of "well capitalized" institutions under
applicable OTS regulations.
In general, the prompt corrective action regulation prohibits an insured
depository institution from declaring any dividends, making any other capital
distribution, or paying a management fee to a controlling person if, following
the distribution or payment, the institution would be within any of the three
undercapitalized categories. In addition, adequately capitalized institutions
24
may accept Brokered Deposits only with a waiver from the FDIC and are subject to
restrictions on the interest rates that can be paid on such deposits.
Undercapitalized institutions may not accept, renew, or roll-over Brokered
Deposits.
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions.
Real Estate Lending Standards. Under joint regulations of the federal
banking agencies, including the OTS, savings institutions must adopt and
maintain written policies that establish appropriate limits and standards for
extensions of credit that are secured by liens or interests in real estate or
extensions of credit that are secured by liens or interests in real estate or
are made for the purpose of financing permanent improvements to real estate.
These policies must establish loan portfolio diversification standards, prudent
underwriting standards, including loan-to value limits that are clear and
measurable, loan administration procedures and documentation, approval and
reporting requirements. An institution's real estate lending policy must reflect
consideration of the Interagency Guidelines for Real Estate Lending Policies
(the "Interagency Guidelines") that have been adopted by the federal banking
agencies. The Interagency Guidelines, among other things, call upon depository
institutions to establish internal loan-to-value limits specified in the
Interagency Guidelines for the various types of real estate loans. The
Interagency Guidelines state that it may be appropriate in individual cases to
originate or purchase loans with loan-to-value ratios in excess of the
supervisory loan-to-value limits not exceeding those specified, but require that
the aggregate amount of loans with torn-to-value ratios in excess of certain
specified levels may not exceed the amount of the savings association's total
capital. (Amounts in excess of core capital must be deducted on a
dollar-for-dollar basis from this capital.)
Federal Consumer Credit and Non-Discrimination Legislation. The Banks'
mortgage lending activities arc subject to the provisions of various federal and
state statutes, including, among others, the Truth in Lending Act, the Equal
Credit Opportunity Act, the Real Estate Settlement Procedures Act, the Fair
Housing Act and the regulations promulgated thereunder. These statutes and
regulations, among other things, prohibit discrimination on the basis of race,
gender or other designated characteristics, prohibit unfair and deceptive trade
practices, require the disclosure of certain basic information to mortgage
borrowers concerning credit terms and settlement costs, and otherwise regulate
terms and conditions of credit and the procedures by which credit is offered and
administered. Each of the foregoing statutes provides for various
administrative, civil and, in limited circumstances, criminal enforcement
procedures, and violations thereof may also lead to class actions seeking actual
and/or punitive damages.
Community Reinvestment Act and Fair Lending Developments. The Banks are
subject to certain fair lending requirements and reporting obligations involving
home mortgage lending operations and Community Reinvestment Act ("CRA")
activities. The CRA generally requires the federal banking agencies to evaluate
the record of a financial institution in meeting the credit needs of its local
communities, including low- and moderate-income neighborhoods. A savings
association may be subject to substantial penalties and corrective measures for
a violation of certain fair lending laws. The federal banking agencies may take
compliance with such laws and CRA obligations into account when regulating and
supervising other activities.
A savings association's compliance with its CRA obligations is based on a
performance-based evaluation system that bases CRA ratings on an institution's
lending service and investment performance. When a holding company applies for
approval to acquire another financial institution or financial institution
holding company, the OTS will review the assessment of each subsidiary savings
association of the applicant; and such records may be the basis for denying the
application. As of the latest CRA Examinations, the Banks each received a rating
of "satisfactory" in complying with its CRA obligations.
25
Item 2. Properties
Peoples Federal owns nine full-service banking offices located in Avilla,
Auburn, Columbia City, Garrett, Kendallville, LaGrange, Topeka, and Waterloo,
Indiana.
The following table provides certain information with respect to Peoples
Federal's full-service offices at September 30, 2003:
Full Service Date Net Book
Offices Opened Value (1)
- ------------------------------------------------------------
(Dollars in thousands)
Main Office, Auburn 1973 $ 245
Avilla 1980 98
Garrett 1972 53
Columbia City-Downtown 1971 100
Columbia City-North 1998 491
Kendallville 1941 389
LaGrange 1972 230
Waterloo 2000 935
Topeka 2002 501
(1) Of real estate at September 30, 2003.
The total net book value of Peoples Federal's premises and equipment at
September 30, 2003, was $3.9 million.
First Savings Bank owns six full-service banking offices located in Three
Rivers, Union, and Schoolcraft, Michigan and Howe and Middlebury, Indiana.
The following table provides certain information with respect to First
Saving's full service offices at September 30, 2003.
Full Service Date Net Book
Offices Opened Value (1)
- ------------------------------------------------------------
(Dollars in thousands)
Main Office, Three Rivers 1981 628
Schoolcraft 1971 64
Union 1988 191
Three Rivers, branch 1988 298
Howe 1998 340
Middlebury 1998 620
(1) Of real estate at September 30, 2003.
The total net book value of First Savings' premises and equipment at
September 30, 2003 was $2.5 million.
Item 3. Legal Proceedings
There are no material pending legal proceedings to which the Company, the
Banks or any subsidiary is a party or to which any of their property is subject.
26
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Reference is made to page 3 of the Company's Annual Report to Stockholders,
for the year ended September 30, 2003 for the information required by this Item,
which is hereby incorporated by reference. Reference is also made to Item 11
under Part III of this form 10-K for the Equity Compensation Plan Table required
by Regulation S-K.
Item 6. Selected Financial Data
Reference is made to page 3 of the Company's Annual Report to Stockholders
for the year ended September 30, 2003, for the information required by this
Item, which is hereby incorporated by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Reference is made to pages 4 to 11 of the Company's Annual Report to
Stockholders for the year ended September 30, 2003, for the information required
by this Item, which is hereby incorporated by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Reference is made to page 6 of the Company's Annual Report to Stockholders
for the year ended September 30, 2003, for the information required by this
item, which is hereby incorporated by reference.
Item 8. Financial Statements and Supplementary Data
Reference is made to pages 14 to 39 of the Company's Annual Report to
Stockholders for the year ended September 30, 2003 for the information required
by this Item, which is hereby incorporated by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
None.
Item 9A. Controls and Procedures
The Chief Executive Officer and the Chief Financial Officer of the Company
(its principal executive officer and principal financial officer, respectively)
have concluded, based on their evaluation as of a date within 90 days prior to
the date of the filing of this Report, that the Company's disclosure controls
and procedures are effective to ensure that information required to be disclosed
by the Company in the reports filed or submitted by it under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms, and
include controls and procedures designed to ensure that information required to
be disclosed by the Company in such reports is accumulated and communicated to
the Company's management, including the Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure.
The Company's management, including the CEO and CFO, does not expect that
its disclosure controls or its internal controls and procedures for financial
reporting will prevent all error and all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the design
of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within the Company have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
27
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions;
over time, control may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of such evaluation.
PART III
Item 10. Directors and Executive Officers of the Registrant
Reference is made to the section captioned "The Peoples Bancorp Annual
Meeting-Election of Directors" in the Company's Proxy Statement dated December
8, 2003 for the information required by this Item, which is hereby incorporated
by reference.
Code of Ethics. The company has adopted an ethics policy that applies to
Financial Managers of the Company and its subsidiaries. A copy of the Ethics
Policy is attached on exhibit 14 to this annual report.
Item 11. Executive Compensation
Reference is made to the section captioned "The Peoples Bancorp Annual
Meeting-Compensation of Executive Officers" in the Company's Proxy Statement
dated December 8, 2003 for the information required by this Item, which is
hereby incorporated by reference.
(a) (b) (c)
Number of
securities
remaining
Number of Weighted available for
securities to be -average future issuance
issued upon exercise price of under equity
exercise of outstanding compensation
outstanding options, plans (excluding
Plan Category options, warrants warrants and securities reflected
and rights rights in column (a)
- ------------------------------
Equity compensation
plans approved 110,249(1) $14.43 89,751
by security holders...........
Equity compensation plans not -0- -0-
approved by security holders..
Total......................... 110,249 $14.43 89,751
(1) 80,249 shares were assumed in connection with the acquisition of Three
Rivers Financial Corp at a weighted average exercise price of $11.78.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Reference is made to the section captioned "The Peoples Bancorp Annual
Meeting-Securities Ownership of Certain Beneficial Owners in the Company's Proxy
Statement dated December 8, 2003 for the information required by this Item which
is hereby incorporated by reference.
28
Item 13. Certain Relationships and Related Transactions
Reference is made to the section captioned "The Peoples Bancorp Annual
Meeting-Transactions with Certain Related Persons" in the Company's Proxy
Statement dated December 8, 2003 for the information required by this Item,
which is hereby incorporated by reference.
Item 14. Principal Accounting Fees and Services
Reference is made to the section captioned "Accountant's Fees" in the
Company's Proxy Statement dated December 8, 2003 for the information required by
this Item, which is hereby incorporated by reference.
Item 15. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K
(a) The following consolidated financial statements of Peoples Bancorp and
Its Wholly-owned Subsidiaries, included in the Annual Report to Stockholders of
the registrant for the year ended September 30, 2003 are filed as part of this
report:
1. Financial Statements
o REPORT OF BKD LLP, INDEPENDENT ACCOUNTANTS PAGE 13.
o CONSOLIDATED BALANCE SHEETS - AS OF SEPTEMBER 30, 2003, AND 2002 PAGE 14.
o CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED SEPTEMBER 30, 2003,
2002, AND 2001 PAGE 15.
o CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED
SEPTEMBER 30, 2003, 2002, AND 2001 PAGE 16.
o CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER 30,
2003, 2002, AND 2001 PAGE 17.
o NOTES TO CONSOLIDATED FINANCIAL STATEMENTS PAGES 18-39.
2. Financial Statement Schedules
All schedules are omitted because they are not applicable, or the required
information is shown in the consolidated financial statements and notes.
3. Exhibits
Exhibit No. Description of Exhibit
3.1 Articles of Incorporation of Peoples Bancorp (1)
3.2 Bylaws of Peoples Bancorp (1)
10.4 Amended and Restated Stock Option and Stock Grant Plan (2)
10.5 Employee Stock Ownership Plan (1)
10.5(a) First Amendment to Employee Stock Ownership Plan (3)
10.5(b) Second Amendment to Employee Stock Ownership Plan (3)
10.5(c) Third Amendment to Employee Stock Ownership Plan (3)
10.6 Expense and Tax Sharing Agreement between Peoples Bancorp,
Peoples Federal Savings Bank of DeKalb County and Peoples
Financial Services, Inc., dated May 28, 1992 (3)
29
10.7 New option plan
13 Annual Report to Stockholders
14 Code of Ethical Conduct for Financial Managers
22 Subsidiaries of the Registrant
99.1 Officer Certification
99.2 Officer Certification
- ---------------------------------
(1) Incorporated by reference to Exhibit bearing the same number in the
Company's Registration Statement of Form S-4 (33-37343) filed with the
Securities and Exchange Commission on October 17, 1990.
(2) Incorporated by reference to Exhibit bearing the same number in the
Company's Annual Report on form 10-K for the year ended September 30, 1991.
(3) Incorporated by reference to Exhibit bearing the same number in the
Company's Annual Report on form 10-K for the year ended September 30, 1992.
(b) A report on Form 8-K was filed on July 25, 2003 reporting earnings for
the period ended June 30, 2003.
The Securities and Exchange Commission maintains a Web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Commission including the Company.
That address is http://www.sec.gov.
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
December 18, 2003 /s/ Roger J. Wertenberger
Chairman of the Board,
and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
December 18, 2003 /s/Roger J. Wertenberger,
Chairman of the Board,
and Director
December 18, 2003 /s/Maurice F. Winkler III,
President, Chief Executive Officer
and Director
December 18, 2003 /s/Deborah K. Stanger
Vice President-Chief Financial Officer
December 18, 2003 /s/G. Richard Gatton, Director
December 18, 2003 /s/Bruce S. Holwerda, Director
December 18, 2003 /s/Erica D. Dekko, Director
December 18, 2003 /s/Douglas D. Marsh, Director
December 18, 2003 /s/Stephen R. Olson, Director
December 18, 2003 /s/John C. Thrapp, Director
31
Exhibit 14
Code of Ethical Conduct for Financial Managers
In my role as a finance manager of the Peoples Bancorp Corporation,
I recognize that financial managers hold an important and elevated role in
corporate governance. I am uniquely capable and empowered to ensure that
stakeholders' interests are appropriately balanced, protected and preserved.
Accordingly, this Code provides principles to which financial managers are
expected to adhere and advocate. The Code embodies rules regarding individual
and peer responsibilities, as well as responsibilities to the company, the
public and other stakeholders.
I certify to you that I adhere to and advocate the following principles and
responsibilities governing my professional and ethical conduct.
To the best of my knowledge and ability:
1. I act with honesty and integrity, avoiding actual or apparent conflicts of
interest in personal and professional relationships.
2. I provide constituents with information that is accurate, complete,
objective, relevant, timely and understandable.
3. I comply with rules and regulations of federal, state, provincial and local
governments, and other appropriate private and public regulatory agencies.
4. I act in good faith, responsibly, with due care, competence and diligence,
without misrepresenting material facts or allowing my independent judgment
to be subordinated.
5. I respect the confidentiality of information acquired in the course of my
work except when authorized or otherwise legally obligated to disclose.
Confidential information acquired in the course of my work is not used for
personal advantage.
6. I share knowledge and maintain skills important and relevant to my
constituents' needs.
7. I proactively promote ethical behavior as a responsible partner among peers
in my work environment and community.
8. I achieve responsible use of and control over all assets and resources
employed or entrusted to me.
32
Exhibit 22
SUBSIDIARIES OF THE REGISTRANT
Name of Subsidiary State of Incorporation
- ------------------------------------ --------------------------
Peoples Federal Savings
Bank of DeKalb County United States of America
and its subsidiary
Peoples Financial Services Inc. Indiana
First Savings Bank
Federal Savings Bank United States of America
And its subsidiary
Alpha Financial Michigan
33
Exhibit 99.1
CERTIFICATION
I, Maurice F. Winkler III, President-Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Peoples Bancorp,
Incorporated;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 18, 2003 /s/Maurice F. Winkler III
President-Chief Executive Officer
34
Exhibit 99.1
CERTIFICATION
I Deborah K. Stanger, Vice President-Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Peoples Bancorp,
Incorporated;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 18, 2003 /s/Deborah K. Stanger
Vice President-Chief Financial Officer
35
Exhibit 99.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of
Chapter 63 of Title 18 of the United States Code), each of the undersigned
officers of Peoples Bancorp (the "Company") does hereby certify with respect to
the annual report on Form 10-K for the period ended September 30, 2003, as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
that:
1. The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: December 18, 2003 /s/Maurice F. Winkler III
Chief Executive Officer
Date: December 18, 2003 /s/Deborah K. Stanger
Chief Financial Officer
36