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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
Annual Report Pursuant to Section 10 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, 1996
[ ] 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: (219) 925-2500
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. [ ]
Aggregate market value of voting stock held by non-affiliates of the
registrant, as of December 23, 1996: $40,127,665.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of December 23, 1996:
2,307,973 shares of Common Stock, par value $1.00 per share
Documents Incorporated by Reference:
Portions of the definitive Proxy Statement for the 1997 Annual Meeting of
Stockholders (Part III) and the Annual Report to Stockholders for the year ended
September 30, 1996 (Parts II and IV).
Exhibit Index Appears on Page 34
PART I
ITEM 1. BUSINESS
GENERAL
Peoples Bancorp (the "Company") is an Indiana corporation organized in
October, 1990 to become the thrift holding company for Peoples Federal Savings
Bank (the "Bank" or "Peoples Federal"). The Company is the sole shareholder of
Peoples Federal. The Bank conducts business from its main office in Auburn and
in its five full-service offices located in Avilla, Columbia City, Garrett,
Kendallville, and LaGrange, Indiana. Peoples Federal offers a full range of
retail deposit services and lending services to northeastern Indiana. The
Company has no other business activity other than being the holding company for
Peoples Federal.
The Bank 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, the Bank has been a member of the Federal Home Loan Bank System
("FHLB System") and the Federal Home Loan Bank of Indianapolis ("FHLB of
Indianapolis"), and its savings accounts are insured up to applicable limits by
the Federal Deposit Insurance Corporation (the "FDIC").
The Company is classified as a unitary savings and loan holding company
subject to regulation by the Securities and Exchange Commission of the United
States (the "SEC"), and the OTS.
In May, 1995, the Board authorized a stock repurchase program. Purchases of
up to 100,000 shares may be made in open market or in privately negotiated
transactions. As of September 30, 1996, the Company had repurchased 44,970
shares.
On a yearly basis, Peoples Federal updates its long-term strategic plan.
This plan includes, among other things, Peoples Federal'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 Peoples Federal's 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 Bank offers 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. The Bank provides
these services through a branch network comprised of six full-service banking
offices. It also provides credit card services, as well as enhancements to its
loan and deposit products designed to provide customers with added conveniences.
The Bank has historically concentrated its business activities in northeastern
Indiana. The Bank's current strategy is to maintain its branch office network as
well as remain alert to new opportunities.
Over the years, the Bank 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 FDIC through the Savings Association Insurance Fund ("SAIF"),
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 Bank, 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
sources. Savings flows at thrift institutions are influenced by a number of
factors including interest rates on competing investments and levels of personal
income.
EARNINGS
The Bank's earnings depend primarily on the spread between income from
lending activities and, to a lesser extent, investment activities, and the cost
of money, that is the difference between interest earned on loans and
investments, and interest paid on deposits and borrowings. The Bank typically
engages 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 deposit accounts
and borrowings to increase more rapidly than yields on mortgage loans, 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 Bank experiences strong competition both in making real estate loans
and in attracting savings deposits. In the past, thrift institutions generally
competed for real estate loans with commercial banks, mortgage banking
companies, insurance companies, and other institutional lenders. Recent
legislative and regulatory actions have increased competition between thrift
institutions and other financial institutions, such as commercial banks, by
expanding the range of services that may be offered such as demand deposits,
trust services, and consumer and commercial lending. The most direct competition
for savings has historically come 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 and, more recently, money market mutual
funds. The principal methods generally used by thrift institutions 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 Bank's weighted average rate at which new loans are originated and
the weighted average cost of interest-bearing liabilities. The Bank's 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 Bank has supplemented its 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 rate and changes in the composition of the Bank's 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 8 of
Management's Discussion and Analysis of Financial Condition and Results of
Operations in the Company's 1996 Annual Report, incorporated herein by
reference.
For information regarding the combined weighted average effective interest
rate earned by the Bank on its loan portfolio and investments, the combined
weighted average effective cost of the Bank's deposits and borrowings, the
interest rate spread of the Bank, and the net yield on combined monthly weighted
average interest-earning assets of the Bank on its loan portfolio and
investments for the fiscal years ending September 30, 1996, 1995, and 1994 refer
to page 6 of Management's Discussion and Analysis of Financial Condition and
Results of Operations in the Company's 1996 Annual Report incorporated herein by
reference.
For information concerning the extent to which changes in interest rates
and changes in volume of interest-related assets and liabilities have affected
the Bank's interest income and expense during the fiscal years ending September
30, 1996, 1995, and 1994 refer to page 9 of Management's Discussion and Analysis
of Financial Condition and Results of Operations in the Company's 1996 Annual
Report incorporated herein by reference.
MARKET AREA
The Bank's market area in northeastern Indiana spans the counties of
DeKalb, Whitley, Noble, and LaGrange. This market area has a population of
approximately 130,000 and consists of 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.
LENDING ACTIVITIES
GENERAL
The Bank, like most other thrift institutions, had traditionally
concentrated its lending activities on the origination of long-term fixed-rate
loans secured by mortgages on residential real estate. However, in response to a
number of factors, including a changing economic and regulatory environment, the
Bank since 1984 has attempted to emphasize investments in adjustable-rate
residential mortgages and consumer loans in its market area. In order to lessen
its risk from interest rate fluctuations, the Bank emphasizes the origination of
interest rate sensitive loan products, such as one year adjustable-rate mortgage
loans, and prime plus equity loans.
RESIDENTIAL MORTGAGE LOANS
A substantial portion of the Bank's lending activity involves the
origination of loans secured by residential real estate, consisting of
single-family dwelling units. The Bank also lends on the security of mid-size
multifamily dwelling units. The residential mortgage loans included in the
Bank's portfolio are primarily conventional loans.
In 1984, the Bank began offering adjustable-rate mortgage loans. Currently,
these loans generally have interest rates which adjust (up or down) every year.
Currently in effect is a maximum adjustment of 6% over the life of these loans
with a maximum adjustment of 2% during any given year. Adjustments are based
upon an index established at the time the commitment is issued by the Bank. The
index used for most loans is tied to the applicable United States Treasury
security index. While the addition of adjustable-rate mortgage loans will better
enable the Bank to maintain a positive spread during periods of high interest
rates, it is not expected that adjustments in interest rates on adjustable-rate
mortgages will match precisely changes in the Bank's cost of funds. The majority
of the adjustable rate mortgages originated by the Bank have limitations on the
amount (generally 6%) and frequency of interest rate changes.
During the fiscal year ended September 30, 1996, the Bank originated
$58,508,000 of residential loans of which $51,312,000 were five- to 30-year
fixed-rate mortgages and $7,196,000 were adjustable-rate loans. The rates
offered on the Bank's adjustable-rate residential mortgage loans are generally
competitive with the rates offered by other thrift institutions in the Bank's
market area and are based upon the Bank's cost of funds and the rate of return
the Bank 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 Bank's market area.
Set forth below are the amounts and percentages of fixed-rate and
adjustable-rate loans (which include consumer loans and mortgage-backed
securities) in the Bank's portfolio at September 30, 1996, 1995, and 1994 (in
thousands).
September 30,
- --------------------------------------------------------------------------------
1996 1995 1994
- ------------------------- --------------------------- ------------------------
Fixed Adjustable Fixed Adjustable Fixed Adjustable
- --------- ------------ ---------- ------------- ----------- ------------
$155,046 $73,159 $134,302 $89,221 $127,870 $86,414
67.9% 32.1% 60.1% 39.9% 59.7% 40.3%
The terms of the residential loans originated by the Bank 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, 1996, the average
contractual maturity of the Bank's portfolio of fixed-rate loans was 11 years
and 4 months, and 19 years and 1 months with respect to its portfolio of
adjustable-rate loans.
Substantially all of the Bank's residential mortgages include so-called
"due on sale" clauses, which are provisions giving the Bank 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 Bank 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 Bank's policy is
to lend up to 90% of the appraised value of the property securing the loan. The
Bank applies the same standards to residential loans purchased in the secondary
market.
COMMERCIAL REAL ESTATE LOANS
Federal laws and regulations permit a federally-chartered savings
institution to make commercial real estate loans. From September 30, 1995, to
September 30, 1996, commercial real estate loans increased from $6,271,832 to
$7,476,884, increasing the percentage of commercial real estate loans to total
loans from 2.82 to 3.30%. These loans consisted of construction and permanent
loans secured by mortgages on mid-size commercial 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 Bank
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.
CONSTRUCTION LOANS
The Bank offers 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
Bank 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 Bank could be negatively impacted in that it would
have to take control of the project and attempt either to arrange for completion
of construction or dispose of the unfinished project.
The Bank's underwriting criteria are designed to evaluate and minimize the
risks of each construction loan. The Bank carefully considers 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 Bank 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 Bank 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 Bank
limits the number of properties which can be constructed on a "speculative" or
unsold basis by a developer at any one time and generally requires the borrower
or its principals to guarantee personally 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,
educational loans (insured by the State Student Loan Commission of Indiana), and
credit card loans (unsecured). The Bank offers all of these types of loans and
is currently emphasizing home equity loans to take advantage of the recent
changes in the tax laws. These loans are often at adjustable interest rates that
generally are higher than the rates offered on mortgage loans.
LOAN PORTFOLIO CASH FLOWS
The following table sets forth the estimated cash flows (in thousands) of
the Bank's loan portfolio by type of loan at September 30, 1996 The estimated
cash flows reflect contractual terms at September 30, 1996 Contractual principal
repayments of loans do not necessarily reflect the actual term of the Bank's
loan portfolio. 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.
Cash Flows of Loans
Years Ended September 30
-------------------------------------------
1998- 2002 and
1997 2001 thereafter Total
-------- -------- ---------- ---------
Type of Loan:
Construction loans --
residential real estate $ 5,197 $ - $ - $ 5,197
Real estate loans:
Mortgage-residential 69,747 42,171 91,849 203,767
Commercial 3,324 2,601 850 6,775
Installment loans --
consumer 8,363 2,240 1,233 11,836
--------- -------- --------- ----------
Total $86,631 $47,012 $93,932 $227,575
========= ======== ========= ==========
The following table sets forth the estimated cash flows of the Bank's loan
portfolio (in thousands) after one year from September 30, 1996, in the
categories of fixed rate and adjustable rate.
Cash Flows of Loans
October 1, 1997 and thereafter
- ----------------------------------
Fixed Adjustable Total at September 30, 1996
- ----------- ----------------- ------------------------------
$99,930 $41,014 $140,944
LOAN PORTFOLIO COMPOSITION
The following table, sets forth the composition of the Bank's loan
portfolio by type of security 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 (dollars in thousands).
1996 1995 1994 1993 1992
---------------- ---------------- ----------------- ----------------- -----------------
TYPE OF SECURITY AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
--------- ------ --------- ------ --------- ------- --------- ------- ---------/ ------
Residential:
Single family units $207,028 91.0% $203,211 91.2% $195,525 91.7% $188,135 91.9% $186,317 92.3%
2-4 family units 1,234 0.5% 1,008 0.5% 1,006 0.5% 654 0.3% 568 0.3%
Over 4 family units 2,769 1.2% 1,738 0.8% 1,835 0.9% 1,751 0.9% 1,507 0.7%
Commercial real estate 4,006 1.8% 3,696 1.7% 2,729 1.3% 2,344 1.1% 2,108 1.0%
Land acquisition and
development 702 0.3% 838 0.4% 438 0.2% 560 0.3% 366 0.2%
Consumer and other loans 10,959 4.8% 11,337 5.1% 10,931 5.1% 10,441 5.1% 10,121 5.0%
Loans on deposits 877 0.4% 901 0.4% 860 0.4% 888 0.4% 883 0.4%
--------- ------ --------- ------ --------- ------ -------- ------- ---------- ------
227,575 100.0% 222,729 100.0% 213,324 100.0% 204,773 100.0% 201,870 100.0%
--------- ------ --------- ------ --------- ------ -------- ------- ---------- ------
Less:
Undisbursed portion
of loans 2,717 2,237 1,971 1,763 1,390
Deferred loan fees and
discounts 959 916 988 893 779
--------- --------- --------- --------- ---------
3,676 3,153 2,959 2,656 2,169
--------- --------- --------- --------- ---------
Total loans receivable 223,899 219,576 210,365 202,117 199,701
Allowance for losses
on loans 888 912 1,035 1,025 896
--------- --------- --------- --------- ---------
Net loans $223,011 $218,664 $209,330 $201,092 $198,805
========= ========= ========= ========= =========
ORIGINATION, PURCHASE AND SALE OF LOANS AND LOAN CONCENTRATIONS
The Bank originates residential loans in conformity with standard
underwriting criteria to assure maximum eligibility for possible resale in the
secondary market. Although the Bank has authority to lend anywhere in the United
States, it has confined its loan origination activities primarily in the Bank's
service area.
Loan originations are developed from a number of sources, primarily from
referrals from real estate brokers, builders, and existing and walk-in
customers. The Bank 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 the Bank.
The Bank's 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. Residential and
commercial loans ranging up to $200,000 can be approved by the loan committee of
the Bank. Loans exceeding $200,000 must be approved by the Bank's Board of
Directors. The Bank utilizes independent qualified appraisers approved by the
Board of Directors to appraise the properties securing its loans and requires
title insurance or title opinions so as to insure that the Bank has a valid lien
on the mortgaged real estate. The Bank requires 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
Bank also evaluates 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 Bank
for a permanent long-term loan to replace the construction loan upon completion
of construction.
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. Consumer loans must be
approved by a consumer loan officer. Consumer loan originations currently are
being generated primarily through advertising.
Currently, it is the Bank's policy to originate both fixed-rate and
adjustable-rate loans, providing all such loans are eligible for sale in the
secondary market. It is the Bank's intention to hold all originated and
purchased loans in its portfolio and not for sale. Generally, the Bank is not
active in the secondary market.
The following table shows mortgage and other loan origination, purchase, and
repayment activity for the Bank during the periods indicated:
Years Ended September 30
-------------------------------------------
1996 1995 1994
------------- -------------- --------------
Mortgage loans originated
for the purpose of:
Construction-commercial $ 995,000 $ - $ -
Construction-residential 6,582,000 7,069,000 3,120,000
Purchase/refinance-commercial 1,905,000 1,910,000 1,078,000
Purchase/refinance-residential 51,926,000 41,376,000 52,074,124
Consumer and other loans originated 6,837,000 9,160,000 7,803,000
------------ ------------- -------------
Total loans originated 68,245,000 59,515,000 64,075,124
------------ ------------- -------------
Loans purchased - - -
------------ ------------- -------------
68,245,000 59,515,000 64,075,124
------------ ------------- -------------
Loan credits:
Principal repayments 64,146,215 50,315,657 56,189,605
------------ ------------- -------------
Other:
Provision for losses on loans 8,824 50,058 23,746
Amortization of loan fees (368,362) (412,144) (525,064)
Loan foreclosures, net 111,000 228,000 149,000
------------ ------------- -------------
(248,538) (134,086) (352,318)
------------ ------------- -------------
Total credits, net 63,897,677 50,181,571 55,837,287
------------ ------------- -------------
Net increases in mortgage and other
loans receivable, net $ 4,347,323 $ 9,333,429 $ 8,237,837
============ ============= =============
INTEREST RATES, POINTS AND FEES
The Bank realizes interest, point, and fee income from its lending
activities. The Bank also realizes 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 Bank accounts 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
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.
NONPERFORMING ASSETS
Loans are reviewed on a regular basis and are placed on nonaccrual status
when the loans become past due 90 days or more, 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 Bank is unable to resolve a delinquency satisfactorily within 45 days after
the loan is past due, it will undertake foreclosure or other proceedings, as
necessary, to minimize any potential loss.
Real estate acquired by the Bank 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 therefrom 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 as of
the dates indicated (dollars in thousands)::
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:
One to four 29 $ 861 0.41% 10 $293 0.14% 27 $801 0.33%
family
Consumer 22 193 1.69% 10 39 0.34% 25 101 0.89%
------ ------ -------- ------ ------ -------- ------ ------ --------
Total 51 $1,054 0.46% 20 $332 0.15% 52 $902 0.35%
====== ====== ======== ====== ====== ======== ====== ===== ========
The following table sets forth the Bank's nonperforming assets at
the dates indicated (in thousands)::
At September 30,
-----------------------------------------------------
1996 1995 1994 1993 1992
---------- -------- ---------- ---------- -----------
Nonaccrual loans $ 814,000 $765,000 $1,020,000 $ 866,000 $1,748,000
Loans past due 90 days and
still accruing 88,000 99,000 49,000 87,000 48,000
---------- ------- ---------- ---------- ----------
902,000 864,000 1,069,000 953,000 1,796,000
Real estate owned, net
of allowance 110,297 46,596 25,316 105,825 277,844
---------- ------- ---------- --------- -----------
Total nonperforming
assets $1,012,297 $910,596 $1,094,316 $1,058,825 $2,073,844
========== ======== ========== ========== ==========
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.
Interest income that would have been recognized for the year ended September
1996, if nonaccrual loans had been current in accordance with their original
terms approximated $40,000. Interest income recognized on such loans for the
year ended September 30, 1996, approximated $99,000.
The 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 Bank 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 which
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.
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). 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.
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, Management continually reviews
the mix and delinquency status of its loan portfolio and classifies those loans
which it deems appropriate.
As of September 30, 1996 loan balances were classified by the Bank as
follows.
Loss $ 19,273
Doubtful -0-
Substandard 773,562
Special Mention 266,348
ALLOWANCE FOR LOSSES ON LOANS AND REAL ESTATE OWNED
The allowances for loan and real estate owned losses represent amounts
available to absorb future losses. Such allowances are 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
allowances 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 allowances to levels considered necessary by management. Losses are
charged to the allowances when considered probable. As of September 30, 1996,
the allowances for losses on loans and real estate owned were $887,478 and $-0-
respectively. Management believes that the allowances are adequate to absorb
known and inherent losses in the portfolio. No assurance can be given, however,
that economic conditions which may adversely affect the Bank's markets or other
circumstances will not result in future losses in the portfolio.
The following table presents an allocation of the Bank's allowance for loan
losses at the dates indicated and the percentage of loans in each category to
total loans (dollars in thousands).
September 30,
---------------------------------------------------------------------
1996 1995 1994 1993 1992
------------ ------------ ------------ ---------------- -------------
Amount % Amount % Amount % Amount % Amount %
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Balance at end of
period applicable to:
Residential Mortgage Loans $ 19 91.8% $ 42 92.2% $ 20 92.6% $ 177 92.4% $284 92.3%
Commercial Real Estate Loans - 3.0% - 2.0% 140 1.3% 140 1.1% 149 1.0%
Consumer Loans - 5.2% 30 5.8% 42 6.1% 15 6.5% 39 6.7%
Unallocated 868 840 832 693 423
----- ------ ---- ------ ------ ------ ------ ------ ----- -------
Total $887 100.0% $912 100.0% $1,034 100.0% $1,025 100.0% $895 100.0%
----- ------ ---- ------ ------ ------ ------ ------ ----- -------
The following table is a summary of activity in the Bank's allowance for
loan losses for the periods indicated.
Summary of Loan Loss Experience Years ended September 30,
---------------------------------------
(Dollars in Thousands) 1996 1995 1994 1993 1992
------ ------ ------- ------- -------
Balance of loan loss allowance at
beginning of year $912 $1,034 $1,025 $ 895 $708
Charge-offs
Residential - 153 5 1 1
Commercial real estate - - - - -
Commercial - - - - -
Consumer 55 47 30 45 46
------- ------- ------- ------- ------
Total Charge-offs 55 200 35 46 47
------- ------- ------- ------- ------
Recoveries
Residential - - - - -
Consumer 21 28 21 22 22
------ ------- ------- ------- ------
Total Recoveries 21 28 21 22 22
------ ------- ------- ------- ------
Net Charge-offs (Recoveries) 34 172 14 24 25
Provision for loan losses 9 50 23 154 212
------ ------- ------- ------- ------
Balance of loan loss allowance at
end of year $887 $ 912 $1,034 $1,025 $895
====== ======= ======= ======= ======
Ratio of net charge-offs to average
loans outstanding 0.02% 0.08% 0.01% 0.02% 0.01%
INVESTMENT ACTIVITIES
Federal thrift institutions 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 Bank 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. At
September 30, 1996, the Bank's ratio of liquid assets to total assets was 15.7%,
which exceeds the regulatory requirement.
The carrying values of the Bank's investment securities, including its
liquid assets, as of the dates indicated are presented on the following table.
At September 30,
----------------------------------------
1996 1995 1994
------------ ------------ ------------
Interest-bearing deposits and
certificates of deposit (1) $ 7,823,900 $ 8,190,942 $ -
U.S. government and federal
agency securities
Held to maturity 13,175,118 26,987,247 27,983,373
Available for sale 20,590,450 6,966,562 10,802,600
Mortgage backed securities
Held to Maturity 630,503 794,328 959,619
Stock in FHLB of Indianapolis 2,004,400 1,941,100 1,871,200
Other
Held to maturity 455,414 1,158,980 1,012,514
Available for sale 5,295,565 4,103,300 3,953,220
------------ ------------ ------------
Total investments $49,975,350 $50,142,459 $46,582,526
============ ============ ============
- ----------------------------------
(1) In FHLB of Indianapolis at September 30, 1996; In FHLB of Indianapolis
($7,800,686) and insured certificates of deposit ($390,256) at September
30, 1995.
The following table sets forth information regarding the maturity
distribution of investment securities at September 30, 1996 and the weighted
average yield on those securities.
1996
----------------------------------------------------------------
Available for Sale Held to Maturity
------------------------------ ---------------------------------
Approximate Approximate
Amortized Fair Amortized Fair
Maturity Distribution at September 30: Cost Yield Value Cost Yield Value
------------ ------ ----------- ------------- ----- ------------
Due in one year or less $ 2,932,475 5.09% $ 2,931,213 $ 5,209,172 4.79% $ 5,203,994
Due after one through five years 18,455,266 6.17% 18,295,759 8,130,946 5.42% 7,979,686
Due after five through ten years 4,328,731 7.17% 4,320,827 290,414 6.96% 302,624
Due after ten years 340,752 7.79% 338,216 - -
------------ ------------ ------------- ------------
26,057,224 25,886,015 13,630,532 13,486,304
Mortgage-backed securities - - 630,503 8.07% 662,833
$26,057,224 $25,886,015 $14,261,035 $14,149,137
============ ============= ============ ============
SOURCES OF FUNDS
GENERAL
Deposits have traditionally been the primary source of funds of the Bank
for use in lending and investment activities. In addition to deposits, the Bank
derives 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 Bank's primary market
area 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 Bank also offers individual retirement
accounts ("IRAs").
The Bank's policies are designed primarily to attract deposits from local
residents rather than to solicit deposits from areas outside its primary market.
The Bank does 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 Bank 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.
The following table reflects the make-up of the Bank's deposit portfolio by
type and weighted average rate paid:
Weighted
Average
Balance Rate Paid
------------- -----------
Transaction accounts $ 24,506,429 1.99%
Savings and money market accounts 43,805,904 3.17%
Certificates of deposit less than $100,000 16,664,414 5.37%
Certificates of deposit over $100,000 149,828,480 5.64%
-------------
234,805,227
Interest payable 276,213
-------------
$235,081,440
=============
A major determinant of the Bank's average cost of funds is the distribution of
the Bank's accounts by interest rate paid. An important indicator of the Bank's
stability of lendable funds is the distribution of the Bank's accounts by
maturity.
For information on the various interest rate categories, the amounts of
certificate accounts at September 30, 1996 maturing during the next five years
and thereafter see the Notes to Consolidated Financial Statements in the
Company's 1996 Annual Report.
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.
1996 1995 1994
------------ ------------ ------------
3 months or less $ 4,717,331 $ 2,199,413 $ 2,197,628
3-6 months 2,116,471 1,677,336 2,234,938
6-12 months 2,904,430 4,336,291 2,628,356
over 12 months 6,926,182 5,795,043 5,421,300
------------ ------------ ------------
Total $16,664,414 $14,008,083 $12,482,222
============ ============ ============
The following table sets forth certain information as to the Bank's deposit
flows at the dates and for the periods indicated:
Years Ended September 30,
--------------------------------------------
1996 1995 1994
------------- ------------- -------------
Beginning balance $232,747,018 $226,851,009 $213,590,085
------------- ------------- -------------
New accounts and
additional deposits,
net of withdrawals, (8,854,488) (4,706,433) 4,439,931
Interest credited 11,188,910 10,602,442 8,820,993
------------- ------------- -------------
Net increase 2,334,422 5,896,009 13,260,924
------------- ------------- -------------
Ending balance $235,081,440 $232,747,018 $226,851,009
============= ============= =============
BORROWINGS
As a member of the FHLB System and the FHLB of Indianapolis, the Bank is
eligible to arrange borrowings or advances for various purposes and on various
terms. The Bank had no advances at September 30, 1996. As of September 30, 1994,
and 1995 the Bank had outstanding advances to the FHLB of Indianapolis of $-0-
and $1,000,000 respectively.
Reverse repurchase agreements, another source of borrowing for the Bank, are
retail obligations of the Bank with a maturity of 90 days or less, and are
generally secured with specific investment securities owned by the Bank.
The following tables set forth certain information as to the Bank's
borrowings consisting of FHLB of Indianapolis advances and 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
------------------------------
1996 1995 1994
---------- ---------- --------
Average balance of total borrowings $ 723,000 $ 279,000 $176,787
Highest month-end balance of total borrowings 1,000,000 1,000,000 546,960
Weighted average interest rate of total borrowings 5.83% 5.83% 3.95%
At September 30
------------------------------
1996 1995 1994
---------- ---------- --------
Advances from FHLB of Indianapolis $ - $1,000,000 $ -
Reverse Repurchase agreements - - -
---------- ---------- --------
Total borrowings $ $ - $1,000,000 $ -
========== ========== ========
Weighted average interest rate - 5.83% -
TRUST DEPARTMENT AND DISCOUNT BROKERAGE SERVICES
In October 1984, the FHLB of Indianapolis granted full trust powers to the
Bank, one of the first savings institutions in Indiana to be granted such
powers. As of September 30, 1996, the Bank's trust department assets totaled
approximately $39,700,000 including self-directed IRA accounts, and it was
offering a variety of trust services including estate planning. As of that date,
the trust department was administering approximately 750 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 Individual Retirement Accounts ("IRA's") and
Simplified Employee Pension IRA's for small businesses.
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 the Bank and conducts a
general insurance business within the State of Indiana under the name of Peoples
Insurance Agency. During fiscal years ended September 30, 1996 and 1995 PFSI
recorded total income of $36,851 and $32,809, respectively, with net income for
such periods amounting to $22,411 and $18,190, respectively.
Since 1985, the Bank also 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.
EMPLOYEES
As of September 30, 1996 the Bank employed 75 persons on a full time basis
and 10 persons on a part time basis. A comprehensive employee benefits program
is maintained which provides hospitalization and major medical insurance,
retirement income, life insurance and disability insurance which is provided
under the Bank's pension program. The Bank also maintains an Employee Stock
Ownership Plan for the benefit of its employees which provides for distributions
of an employee's vested portions upon retirement, disability, death or
termination of employment. The Bank's employees are not represented by any
collective bargaining group, and management considers its relations with its
employees to be excellent.
REGULATION
GENERAL
The Company, as a savings and loan holding company, and the Bank, as a
federally chartered savings association, are subject to extensive regulation by
the OTS. The lending activities and other investments of the Bank must comply
with various federal regulatory requirements, and the OTS periodically examines
the Bank for compliance with various regulatory requirements and for safe and
sound operations. The FDIC also has the authority to conduct examinations. The
Bank must file reports with the OTS describing its activities and financial
condition and is also subject to certain reserve requirements promulgated by the
Federal Reserve Board. This supervision and regulation is intended primarily for
the protection of depositors and the deposit insurance funds. Certain of these
regulatory requirements are referred to below or appear elsewhere herein.
REGULATION OF THE BANK
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member 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 a member of the FHLB of
Indianapolis, the Bank is 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 Bank
was in compliance with this requirement with an investment in FHLB of
Indianapolis stock at September 30, 1996 of $2,004,400.
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, 1996,
the Bank had no advances outstanding. See "Business of the Company--Deposit
Activity and Other Sources of Funds" and "--Borrowings."
LIQUIDITY REQUIREMENTS
The Bank is required to maintain average daily balances of liquid assets
(cash, certain time deposits, bankers' acceptances, highly rated corporate debt
and commercial paper, securities of certain mutual funds, and specified United
States government, state or federal agency obligations) equal to the monthly
average of not less than 5% of its net withdrawable savings deposits plus
short-term borrowings. Savings institutions are also required to maintain
average daily balances of short-term liquid assets of 1% of the total of their
net withdrawable savings accounts and borrowings payable in one year or less.
Monetary penalties may be imposed for failure to meet liquidity requirements.
QUALIFIED THRIFT LENDER TEST
The Home Owners' Loan Act (the "HOLA") and OTS regulations require savings
institutions to meet a qualified thrift lender ("QTL") test or the definition of
a domestic building and loan association in the Internal Revenue Service Code of
1986, as amended. A savings institution that does not meet this requirement must
either convert to a bank charter or comply with the following restrictions on
its operations: (i) the institution may not engage in any new activity or make
any new investment, directly or indirectly, unless such activity or investment
is permissible for a national bank; (ii) the branching powers of the institution
shall be restricted to those of a national bank; (iii) the institution shall not
be eligible to obtain any advances from its FHLB; and (iv) payment of dividends
by the institution shall be subject to the rules regarding payment of dividends
by a national bank. Upon the expiration of three years from the date the
institution ceases to meet these requirements, it must cease any activity and
not retain any investment not permissible for a national bank and immediately
repay any outstanding FHLB advances (subject to safety and soundness
considerations).
To meet the QTL test, an institution's "Qualified Thrift Investments" must
total at least 65% of "portfolio assets." Under OTS regulations, portfolio
assets are defined as total assets less intangibles, property used by a savings
institution in its business and liquidity investments in an amount not exceeding
20% of assets. Qualified Thrift Investments consist of, among other things, (i)
loans, equity positions or securities related to domestic, residential real
estate or manufactured housing, (ii) 50% of the dollar amount of residential
mortgage loans subject to sale under certain conditions, and (iii) stock in an
FHLB or the FHLMC or FNMA. In addition, savings institutions are able to treat
as Qualified Thrift Investments 200% of their investments in loans to finance
"starter homes" and loans for construction, development or improvement of
housing and community service facilities or for financing small businesses in
"credit-needy" areas. In order to maintain QTL status, the savings institution
must maintain a weekly average percentage of Qualified Thrift Investments to
portfolio assets equal to 65% on a monthly average basis in nine out of 12
months. A savings institution that fails to maintain QTL status will be
permitted to requalify once, and if it fails the QTL test a second time, it will
become immediately subject to all penalties as if all time limits on such
penalties had expired.
At September 30, 1996, approximately 81.8% of the Bank's portfolio assets
were invested in Qualified Thrift Investments, which was in excess of the
percentage required to qualify the Company under the QTL test.
UNIFORM LENDING STANDARDS
Under OTS regulations, 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 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 and approval and reporting
requirements. The real estate lending policies must reflect consideration of the
Interagency Guidelines for Real Estate Lending Policies (the "Interagency
Guidelines") that have been adopted by the federal bank regulators.
The Interagency Guidelines, among other things, call upon depository
institutions to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits: (i) for loans
secured by raw land, the supervisory loan-to-value limit is 65% of the value of
the collateral; (ii) for land development loans (i.e., loans for the purpose of
improving unimproved property prior to the erection of structures), the
supervisory limit is 75%, (iii) for loans for the construction of commercial,
multifamily or other nonresidential property, the supervisory limit is 80%; (iv)
for loans for the construction of one- to-four family properties, the
supervisory limit is 85%; and (v) for loans secured by other improved property
(e.g., farmland, completed commercial property and other income-producing
property including nonowner-occupied, one- to-four family property), the limit
is 85%. Although no supervisory loan-to-value limit has been established for
owner occupied, one- to-four family and home equity loans, the Interagency
Guidelines state that for any such loan with a loan-to-value ratio that equals
or exceeds 90% at origination, an institution should require appropriate credit
enhancement in the form of either mortgage insurance or readily marketable
collateral.
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, based on the support provided by other credit
factors. The aggregate amount of loans in excess of the supervisory
loan-to-value limits, however, should not exceed 100% of total capital and the
total of such loans secured by commercial, agricultural, multifamily and other
non-one- to-four family residential properties should not exceed 30% of total
capital. The supervisory loan-to-value limits do not apply to certain categories
of loans including loans insured or guaranteed by the U.S. government and its
agencies or by financially capable state, local or municipal governments or
agencies, loans backed by the full faith and credit of a state government, loans
that are to be sold promptly after origination without recourse to a financially
responsible party, loans that are renewed, refinanced or restructured without
the advancement of new funds, loans that are renewed, refinanced or restructured
in connection with a workout, loans to facilitate sales of real estate acquired
by the institution in the ordinary course of collecting a debt previously
contracted and loans where the real estate is not the primary collateral.
Management believes that the Bank's current lending policies conform to the
Interagency Guidelines and that the Interagency Guidelines will have no
material effect on its lending activities.
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, the
OTS has recently adopted regulations which 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). For purposes of these regulations, Tier 1 capital has the same
definition as core capital. See "Prompt Corrective Regulatory Action." The OTS
capital regulations define core capital as common stockholders' equity
(including retained earnings), noncumulative perpetual preferred stock and
related surplus, minority interests in the equity accounts of fully consolidated
subsidiaries, certain nonwithdrawable accounts and pledged deposits and
"qualifying supervisory goodwill," less intangible assets other than certain
qualifying supervisory goodwill and certain purchased mortgage servicing rights.
Tangible capital is the same as core capital, except that it does not include
qualifying supervisory goodwill and is reduced by the amount of all the savings
institution's intangible assets other than certain purchased mortgage servicing
rights.
The OTS capital rule requires that core and tangible capital be reduced by
an amount equal to a savings institution's debt and equity investments in
subsidiaries engaged in activities not permissible for national banks, other
than subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities and subsidiary depository institutions or their
holding companies ("non-includable subsidiaries"). As of September 30, 1996, the
Bank had no material investments in or extensions of credit to non-includable
subsidiaries.
Adjusted total assets for purposes of the core and tangible capital
requirements are a savings institution's total assets as determined under
generally accepted accounting principles, increased by certain goodwill amounts
and by a prorated portion of the assets of subsidiaries in which the savings
institution holds a minority interest and which are not engaged in activities
for which the capital rules require the savings institution to net its debt and
equity investments in such subsidiaries against capital, as well as a prorated
portion of the assets of other subsidiaries for which netting is not fully
required under phase-in rules. Adjusted total assets are reduced by the amount
of assets that have been deducted from capital, the portion of a savings
institution's investments in subsidiaries that must be netted against capital
under the capital rules and, for purposes of the core capital requirement,
qualifying supervisory goodwill. At September 30, 1996, the Bank's adjusted
total assets for purposes of the core and tangible capital requirements were
$275 million.
In determining compliance with the risk-based capital requirement, a
savings institution is allowed to include both core capital and supplementary
capital in its total capital, provided the amount of supplementary capital
included does not exceed the savings institution's core capital. Supplementary
capital is defined to include certain preferred stock issues, nonwithdrawable
accounts and pledged deposits that do not qualify as core capital, certain
approved subordinated debt, certain other capital instruments and a portion of
the savings institution's general loan and lease loss allowances.
The risk-based capital requirement is measured against risk-weighted
assets, which equal the sum of each on-balance-sheet asset and the
credit-equivalent amount of each off-balance-sheet item after being multiplied
by an assigned risk weight. Under the OTS risk-weighting system, cash and
securities backed by the full faith and credit of the U.S. government are given
a 0% risk weight. Mortgage-backed securities that qualify under the Secondary
Mortgage Market Enhancement Act, including those issued, or fully guaranteed as
to principal and interest, by the FNMA or FHLMC, are assigned a 20% risk weight.
Single-family first mortgages not more than 90 days past due with loan-to-value
ratios under 80%, multi-family mortgages (maximum 36 dwelling units) with
loan-to-value ratios under 80% and average annual occupancy rates over 80%, and
certain qualifying loans for the construction of one- to four-family residences
presold to home purchasers are assigned a risk weight of 50%. Consumer loans,
non-qualifying residential construction loans and commercial real estate loans,
repossessed assets and assets more than 90 days past due, as well as all other
assets not specifically categorized, are assigned a risk weight of 100%. The
portion of equity investments not deducted from core or supplementary capital is
assigned a 100% risk-weight. OTS capital regulations require savings
institutions to maintain minimum total capital, consisting of core capital plus
supplemental capital, equal to 8.0% of risk-weighted assets.
The OTS has recently 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
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.
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 April 1991, the OTS proposed to amend its core capital requirement to
establish a 3% core capital ratio for savings institutions in the strongest
financial and managerial condition. For all other savings institutions, the
minimum core capital ratio would be 3% plus at least an additional 1 to 2%,
determined on a case-by-case basis by the OTS after assessing both the quality
of risk management systems and the level of overall risk in each individual
savings institution. [The Company does not expect that it will be materially
affected by this regulation if adopted in its current form.] In addition to the
proposed rule, the OTS has adopted a prompt corrective action rule under which a
savings institution that has a core capital ratio of less than 4% would be
deemed to be "undercapitalized" and may be subject to certain sanctions. See
"--Prompt Corrective Regulatory Action."
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, 1996, the Bank exceeded all regulatory minimum capital
requirements as indicated in the table below.
Dollars in Thousands
Actual Required Excess
Amount % Amount % Amount %
Tangible capital $33,186 12.09% $4,118 1.5% $29,068 10.59%
Core capital 33,186 12.09 8,236 3.0 24,950 9.09
Risk-based capital 34,054 25.63 10,630 8.0 23,424 17.63
Insurance of Deposit Accounts and Special Assessment. The Bank's deposit
accounts are insured by the Savings Association Insurance Fund ("SAIF") to a
maximum of $100,000 for each insured member (as defined by law and regulation).
If an institution has no tangible capital, the FDIC has the authority, should it
initiate proceedings to terminate an institution's deposit insurance, to suspend
the insurance of any such institution. However, if a savings association has
positive capital when it includes qualifying intangible assets, the FDIC cannot
suspend deposit insurance unless capital declines materially, the institution
fails to enter into and remain in compliance with an approved capital plan, or
the institution is operating in an unsafe or unsound manner.
Regardless of an institution's capital level, 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
may also prohibit an insured depository institution from engaging in any
activity the FDIC determines to pose a serious threat to the SAIF. The
management of the Bank is unaware of any practice, condition, or violation that
might lead to termination of its deposit insurance.
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, a savings association pays premiums, depending upon the
institution's risk classification. This risk classification is based on an
institution's capital group and supervisory subgroup assignment. In addition,
the FDIC is authorized to increase such deposit insurance rates on a semi-annual
basis if it determines that such action is necessary to cause the balance in the
SAIF to reach or maintain the designated reserve ratio of 1.25% of SAIF-insured
deposits. The SAIF was substantially underfunded at June 30, 1996. In addition,
the FDIC may impose special assessments on SAIF members to repay amounts
borrowed from the U.S. Treasury or for any other reason deemed necessary by the
FDIC. The Bank's federal deposit insurance premium expense for the year ended
September 30, 1996 amounted to approximately $2,000,000, of which $1,500,000 was
the special assessment on savings institutions to recapitalize the SAIF,
discussed below. By comparison, at September 30, 1996, members of the Bank
Insurance Fund ("BIF") were required to pay substantially lower, or virtually
no, federal deposit insurance premiums.
Effective September 30, 1996, federal law was revised to mandate a one-time
special assessment on SAIF members such as the Bank of approximately 65.7 basis
points per $100 of deposits held on March 31, 1995. The Bank recorded a
$1,500,871 pre-tax expense for this assessment at September 30, 1996, and such
assessment was payable on November 27, 1996. Beginning January 1, 1997, deposit
insurance assessments for SAIF members are expected to be reduced to
approximately 6.4 basis points per $100 of deposits on an annual basis through
the end of 1999. During this same period, BIF members are expected to be
assessed approximately 1.3 basis points per $100 of deposits. Thereafter,
assessments for BIF and SAIF members should be the same and the SAIF and BIF may
be merged. It is expected that these continuing assessments for both SAIF and
BIF members will be used to repay outstanding Financing Corporation bond
obligations. As a result of these changes, beginning January 1, 1997, the rate
of deposit insurance assessed the Bank will decline by approximately 72%.
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, 1996,
the Bank met its reserve requirements.
DIVIDEND RESTRICTIONS
Under OTS regulations, the Bank is not permitted to pay dividends on its
capital stock if its regulatory capital would thereby be reduced below the
remaining balance of the liquidation account established for the benefit of
certain depositors in connection with the Conversion. In addition, the Bank is
required by OTS regulations to give the OTS 30 days' prior notice of any
proposed declaration of dividends to the Company.
OTS regulations impose additional limitations on the payment of dividends
and other capital distributions (including stock repurchases and cash mergers)
by the Bank. Under these regulations, a savings institution that, immediately
prior to, and on a pro forma basis after giving effect to, a proposed capital
distribution, has total capital (as defined by OTS regulation) that is equal to
or greater than the amount of its fully phased-in capital requirements (a "Tier
1 Association") is generally permitted, after notice, to make capital
distributions during a calendar year in the amount equal to the greater of: (a)
75% of its net income for the previous four quarters; or (b) up to 100% of its
net income to date during the calendar year plus an amount that would reduce by
50% its surplus capital ratio at the beginning of the calendar year. A savings
institution with total capital in excess of current minimum capital ratio
requirements but not in excess of the fully phased-in requirements (a "Tier 2
Association") is permitted, after notice, to make capital distributions without
OTS approval of up to 75% of its net income for the previous four quarters, less
dividends already paid for such period. A savings institution that fails to meet
current minimum capital requirements (a "Tier 3 Association") is prohibited from
making any capital distributions without the prior approval of the OTS. A Tier 1
Association that has been notified by the OTS that it is in need of more than
normal supervision will be treated as either a Tier 2 or Tier 3 Association. In
December 1994, the OTS issued a proposal to amend the capital distribution
limits. Under that proposal, an institution not owned by a holding company with
one of the two highest examination ratings could make a capital distribution
without notice to the OTS, if it remains adequately capitalized, as described
above, after the distribution is made. Any other institution seeking to make a
capital distribution that would not cause the institution to fall below the
capital levels to qualify as adequately capitalized, would have to provide
notice to the OTS. Except under limited circumstances and with OTS approval, no
capital distributions would be permitted if they would cause the institution to
become undercapitalized. As of September 30, 1996, the Bank was considered a
Tier 1 Association under OTS regulations.
Despite the above authority, the OTS may prohibit any savings institution
from making a capital distribution that would otherwise be permitted by the
regulation, if the OTS were to determine that the distribution constituted an
unsafe or unsound practice. Furthermore, under the OTS prompt corrective action
regulations, the Bank would be prohibited from making any capital distributions
if, after making the distribution, it would have: (1) a total risk-based capital
ratio of less than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than
4.0%; or (iii) a leverage ratio of less than 4.0%. See "--Prompt Corrective
Regulatory Action."
ENFORCEMENT
Under the Federal Deposit Insurance Act (the "FDI Act"), the OTS has
primary enforcement responsibility over savings institutions and has the
authority to bring enforcement action against all "institution-related parties,"
including stockholders, and any attorneys, appraisers and accountants who
knowingly or recklessly participate in wrongful action likely to have an adverse
effect on a savings institution. Civil penalties cover a wide range of
violations and actions and range up to $25,000 per day unless a finding of
reckless disregard is made, in which case penalties may be as high as $1.0
million per day. Criminal penalties for most financial institution crimes
include fines of up to $1.0 million and imprisonment for up to 30 years. In
addition, regulators have substantial discretion to take enforcement action
against an institution that fails to comply with its regulatory requirements,
particularly with respect to the capital requirements. Possible enforcement
actions range from the imposition of a capital plan and capital directive to
receivership or conservatorship. Under the FDI Act, the FDIC has the authority
to recommend to the Director of the OTS enforcement action to be taken with
respect to a particular savings institution. If action is not taken by the
Director, the FDIC has authority to take such action under certain
circumstances. The FDIC may also take action to terminate deposit insurance.
TRANSACTIONS WITH RELATED PARTIES
Transactions between savings institutions and any affiliate are governed by
Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings
institution is any company or entity which controls, is controlled by or is
under common control with the savings institution. In a holding company context,
the parent holding company of a savings institution (such as the Company) and
any companies which are controlled by such parent holding company are affiliates
of the savings institution. Generally, Sections 23A and 23B (i) limit the extent
to which the savings institution or its subsidiaries may engage in "covered
transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, and contain an aggregate limit on all
such transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus and (ii) require that all such transactions be on terms
substantially the same, or at least as favorable, to the institution or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
similar transactions. In addition to the restrictions imposed by Sections 23A
and 23B, no savings institution may (i) loan or otherwise extend credit to an
affiliate, except for any affiliate which engages only in activities which are
permissible for bank holding companies, or (ii) purchase or invest in any
stocks, bonds, debentures, notes or similar obligations of any affiliate, except
for affiliates which are subsidiaries of the savings institution.
Further, savings institutions are subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act and the Federal Reserve Board's
Regulation O thereunder on loans to executive officers and principal
stockholders. Under Section 22(h), loans to a director, executive officer and a
greater than 10% stockholder of a savings institution and certain affiliated
interests of such persons, may not exceed, together with all other outstanding
loans to such person and affiliated interests, the institution's lending limit.
Section 22(h) also prohibits the making of loans above amounts prescribed by the
appropriate federal banking agency, to directors, executive officers and greater
than 10% stockholders of a savings institution, and their respective affiliates,
unless such loan is approved in advance by a majority of the board of directors
of the institution with any "interested" director not participating in the
voting. Regulation O prescribes the loan amount (which includes all other
outstanding loans to such person) as to which such prior board of director
approval is required as being the greater of $25,000 or 5% of capital and
surplus (up to $500,000). Further, Section 22(h) requires that loans to
directors, executive officers and principal stockholders be made on terms
substantially the same as offered in comparable transactions to other persons.
Section 22(h) also generally prohibits a depository institution from paying the
overdrafts of any of its executive officers or directors.
Savings institutions are also subject to the requirements and restrictions
of Section 22(g) of the Federal Reserve Act and Regulation O on loans to
executive officers and the restrictions of 12 U.S.C. ss. 1972 on certain tying
arrangements and extensions of credit by correspondent banks. Section 22(g) of
the Federal Reserve Act requires approval by the board of directors of a
depository institution for extension of credit to executive officers of the
institution, and imposes reporting requirements for and additional restrictions
on the type, amount and terms of credits to such officers. Section 1972 (i)
prohibits a depository institution from extending credit to or offering any
other services, or fixing or varying the consideration for such extension of
credit or service, on the condition that the customer obtain some additional
service from the institution or certain of its affiliates or not obtain services
of a competitor of the institution, subject to certain exceptions, and (ii)
prohibits extensions of credit to executive officers, directors and greater than
10% stockholders of a depository institution by any other institution which has
a correspondent banking relationship with the institution, unless such extension
of credit is on substantially the same terms as those prevailing at the time for
comparable transactions with other persons and does not involve more than the
normal risk of repayment or present other unfavorable features.
PROMPT CORRECTIVE REGULATORY ACTION
The federal banking regulators are required to take prompt corrective
action if an institution fails to satisfy certain minimum capital requirements,
including a leverage limit, a risk-based capital requirement, and any other
measure deemed appropriate by the federal banking regulators for measuring the
capital adequacy of an insured depository institution. All institutions,
regardless of their capital levels, are restricted from making any capital
distribution or paying any management fees that would cause the institution to
become undercapitalized. An institution that fails to meet the minimum level for
any relevant capital measure (an "undercapitalized institution") generally is:
(i) subject to increased monitoring by the appropriate federal banking
regulator; (ii) required to submit an acceptable capital restoration plan within
45 days; (iii) subject to asset growth limits; and (iv) required to obtain prior
regulatory approval for acquisitions, branching and new lines of businesses. The
capital restoration plan must include a guarantee by the institution's holding
company that the institution will comply with the plan until it has been
adequately capitalized on average for four consecutive quarters, under which the
holding company would be liable up to the lesser of 5% of the institution's
total assets or the amount necessary to bring the institution into capital
compliance as of the date it failed to comply with its capital restoration plan.
A significantly undercapitalized institution, as well as any undercapitalized
institution that does not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution. Any company controlling the
institution may also be required to divest the institution. The senior executive
officers of such an institution may not receive bonuses or increases in
compensation without prior regulatory approval and the institution is prohibited
from making payments of principal or interest on its subordinated debt, with
certain exceptions. If an institution's ratio of tangible capital to total
assets falls below the "critical capital level" established by the appropriate
federal banking regulator, the institution is subject to conservatorship or
receivership within 90 days unless periodic determinations are made that
forbearance from such action would better protect the deposit insurance fund.
Unless appropriate findings and certifications are made by the appropriate
federal bank regulatory agencies, a critically undercapitalized institution must
be placed in receivership if it remains critically undercapitalized on average
during the calendar quarter beginning 270 days after the date it became
critically undercapitalized.
The OTS has adopted regulations implementing the prompt corrective action
requirements. Under those regulations, the OTS measures a saving institution's
capital adequacy on the basis of its total risk-based capital ratio (the ratio
of its total capital to risk-weighted assets), Tier 1 risk-based capital ratio
(the ratio of its core capital to risk-weighted assets) and leverage ratio (the
ratio of its core capital to adjusted total assets). A savings institution that
is not subject to an order or written directive to meet or maintain a specific
capital level is deemed "well-capitalized" if it also has: (i) a total
risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital
ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or greater. An
"adequately capitalized" savings institution is a savings institution that does
not meet the definition of well-capitalized and has: (i) a total risk-based
capital ratio of 8.0% or greater; (ii) a Tier 1 risk-based capital ratio of 4.0%
or greater; and (iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if
the savings institution has a composite 1 MACRO rating). An "undercapitalized
institution" is a savings institution that has (i) a total risk-based capital
ratio less than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than
4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if the institution is
rated a Composite 1 under the OTS examination rating system). A "significantly
undercapitalized" institution is defined as a savings institution that has: (i)
a total risk-based capital ratio of less than 6.0%; or (ii) a Tier 1 risk-based
capital ratio of less than 3.0%; or (iii) a leverage ratio of less than 3.0%. A
"critically undercapitalized" savings institution is defined as a savings
institution that has a ratio of core capital to total assets of less than 2.0%.
The OTS may reclassify a well-capitalized savings institution as adequately
capitalized and may require an adequately capitalized or undercapitalized
institution to comply with the supervisory actions applicable to institutions in
the next lower capital category if the OTS determines, after notice and an
opportunity for a hearing, that the savings institution is in an unsafe or
unsound condition or that the institution has received and not corrected a
less-than-satisfactory rating for any examination rating category. The Bank is
classified as "well-capitalized" under the OTS regulations.
STANDARDS FOR SAFETY AND SOUNDNESS
In July 1995, the federal banking agencies adopted final guidelines
establishing standards for safety and soundness. The guidelines set forth
operational and managerial standards relating to internal controls, information
systems and internal audit systems, loan documentation, credit underwriting,
interest rate exposure, asset growth and compensation, fees and benefits. In
August 1996, guidelines for asset quality and earnings standards were issued.
The guidelines establish the safety and soundness standards that the agencies
will use to identify and address problems at insured depository institutions
before capital becomes impaired. If an institution fails to comply with a safety
and soundness standard, the appropriate federal banking agency may require the
institution to submit a compliance plan. Failure to submit a compliance plan or
to implement an accepted plan may result in enforcement action.
INTERSTATE BANKING AND BRANCHING
In September 1994, the Riegel-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Act") became law. Under the Interstate
Act, beginning one year after the date of enactment, a bank holding company that
is adequately capitalized and managed may obtain approval to acquire an existing
bank located in another state without regard to state law. A bank holding
company would not be permitted to make such an acquisition if, upon
consummation, it would control (a) more than 10% of the total amount of deposits
of insured depository institutions in the United States or (b) 30% or more of
the deposits in the state in which the bank is located. A state may limit the
percentage of total deposits that may be held in that state by any one bank or
bank holding company if application of such limitation does not discriminate
against out-of-state banks. An out-of-state bank holding company may not acquire
a state bank in existence for less than a minimum length of time that may be
prescribed by state law except that a state may not impose more than a five year
existence requirement.
The Interstate Act also permits, beginning June 1, 1997, mergers of insured
banks located in different states and conversion of the branches of the acquired
bank into branches of the resulting bank. Each state may permit such
combinations earlier than June 1, 1997, and may adopt legislation to prohibit
interstate mergers after that date in that state or in other states by that
state's banks. The same concentration limits discussed in the preceding
paragraph apply. The Interstate Act also permits a national or state bank to
establish branches in a state other than its home state if permitted by the laws
of that state, subject to the same requirements and conditions as for a merger
transaction.
The Interstate Act is likely to increase competition in the Bank's market
areas especially from larger financial institutions and their holding companies.
It is difficult to assess the impact such likely increased competition will have
on the Bank's operations.
COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS
The Bank is 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 their local communities, including low and moderate income
neighborhoods. In addition to substantial penalties and corrective measures that
may be required for a violation of certain fair lending laws, the federal
banking agencies may take compliance with such laws and CRA into account when
regulating and supervising other activities. The OTS has rated the Bank
"satisfactory" in complying with its CRA obligations.
In May 1995, the federal banking agencies issued final regulations which
change the manner in which they measure a bank's compliance with its CRA
obligations. The final regulations adopt a performance-based evaluation system
which bases CRA ratings on an institution's actual lending service and
investment performance rather than the extent to which the institution conducts
needs assessments, documents community outreach or complies with other
procedural requirements. In March 1994, the federal Interagency Task Force on
Fair Lending issued a policy statement on discrimination in lending. The policy
statement describes the three methods that federal agencies will use to prove
discrimination: overt evidence of discrimination, evidence of disparate
treatment and evidence of disparate impact.
REGULATION OF THE COMPANY
GENERAL
The Company is a unitary savings and loan holding company as defined by 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 Bank is subject to certain
restrictions in its 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 unitary 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."
Savings and loan holding companies are the only financial institution
holding companies which may engage in any commercial securities and insurance
activities. However, congressional legislative proposals that have been
introduced or are under consideration would either limit unitary savings and
loan holding companies to the same activities as other financial institution
holding companies or would permit certain bank holding companies to engage in
commercial activities and expanded securities and insurance activities. The
Company cannot predict if and in what form these proposals might become law.
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution shall commence
or continue for a limited period of time after becoming a multiple savings and
loan holding company or subsidiary thereof, any business activity, upon prior
notice to, and no objection by, the OTS, other than: (i) furnishing or
performing management services for a subsidiary savings institution; (ii)
conducting an insurance agency or escrow business; (iii) holding, managing or
liquidating assets owned by or acquired from a subsidiary savings institution;
(iv) holding or managing properties used or occupied by a subsidiary savings
institution; (v) acting as trustee under deeds of trust; (vi) those activities
authorized by regulation as of March 5, 1987 to be engaged in by multiple
holding companies; or (vii) unless the OTS by regulation prohibits or limits
such activities for savings and loan holding companies, those activities
authorized by the Federal Reserve Board as permissible for bank holding
companies. Those activities described in (vii) above must also be approved by
the OTS prior to being engaged in by a multiple holding company.
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.
The OTS may only approve acquisitions resulting in the formation of a
multiple savings and loan holding company which controls savings institutions in
more than one state if: (i) the multiple savings and loan holding company
involved controls a savings institution which operated a home or branch office
in the state of the institution to be acquired as of March 5, 1987; (ii) the
acquiror is authorized to acquire control of the savings institution pursuant to
the emergency acquisition provisions of the FDI Act; or (iii) the statutes of
the state in which the institution to be acquired is located specifically permit
institutions to be acquired by state-chartered institutions or savings and loan
holding companies located in the state where the acquiring entity is located (or
by a holding company that controls such state-chartered savings institutions).
Under the Bank Holding Company Act of 1956, bank holding companies are
specifically authorized to acquire control of any savings association. Pursuant
to rules promulgated by the Federal Reserve Board, owning, controlling or
operating a savings institution is a permissible activity for bank holding
companies, if the savings institution engages only in deposit-taking activities
and lending and other activities that are permissible for bank holding
companies. A bank holding company that controls a savings institution may merge
or consolidate the assets and liabilities of the savings institution with, or
transfer assets and liabilities to, any subsidiary bank which is a member of the
BIF with the approval of the appropriate federal banking agency and the Federal
Reserve Board. The resulting bank will be required to continue to pay
assessments to the SAIF at the rates prescribed for SAIF members on the deposits
attributable to the merged savings institution plus an annual growth increment.
In addition, the transaction must comply with the restrictions on interstate
acquisitions of commercial banks under the Bank Holding Company Act of 1956.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
For federal income tax purposes, the Company reports its income and
expenses using the accrual method of accounting and files its federal income tax
returns on the basis of a fiscal year ending September 30. The Company and Bank
file consolidated federal income tax returns.
The Company is subject to those rules of federal income taxation generally
applicable to corporations. Under present provisions of the Internal Revenue
Code ("Code"), however, mutual and stock savings institutions which meet certain
definitional tests primarily relating to their assets and the nature of their
businesses are permitted to establish a reserve for bad debts and to make annual
additions thereto. Such institutions may deduct such additions, within specified
formula limits, in arriving at their taxable income.
A thrift institution must meet an asset test in order to qualify for the bad
debt reserve tax rules described below. At least 60% of the amount of the total
assets of the institution (at the close of the taxable year in question) must
consist of certain assets specified in Section 7701(a)(19) of Code. A thrift
institution that ceases to meet the 60% test in a tax year may not deduct any
addition to a bad debt reserve under the special rules applicable to thrifts
and, if the institution is a "large bank" as defined in Section 585(c)(2) of the
Code, generally must include existing reserves in income over a four-year
period. At September 30, 1996, in excess of 97% of the Bank's assets qualified
under Section 7701(a)(19). Therefore, the Bank was allowed an addition to its
tax bad debt reserve. The Bank also is not a "large bank" under Section
585(c)(2) of the Code.
For purposes of computing the deductible addition to its bad debt reserve,
the Bank's loans are separated into "qualifying real property loans" (generally
those loans secured by interests in real property) and "nonqualifying loans"
(all other loans). The deduction with respect to nonqualifying loans must be
computed under the experience method, which allows a deduction for the Bank's
actual charge-offs.
The Bank has generally computed its annual bad debt deductions with respect
to qualifying real property loans under the percentage of taxable income method,
except for years where the Bank incurred operating losses at which time the
experience method was utilized. Under the percentage of taxable income method
("percentage method"), the bad debt deduction for qualifying loans is computed
as a percentage of the Bank's taxable income before such deduction, as adjusted
for certain items. Thrift institutions are allowed a percentage of taxable
income bad debt deduction of 8% of such taxable income. To the extent the 8%
deduction exceeds an amount computed on the basis of actual loss experience,
such amount will constitute a preference item for purposes of the corporate
minimum tax discussed elsewhere herein.
Under the Code which affects the 1996 fiscal year, the bad debt deduction
for qualifying real property loans computed under the percentage method may not
exceed the amount necessary to increase the balance in the bad debt reserve
accumulated for such loans to an amount equal to 6% of such loans outstanding at
the end of the taxable year. On September 30, 1996, the balance of such reserves
at the Bank as a percentage of such loans was approximately 4.5%. In addition,
the total bad debt deduction for any taxable year with respect to both
qualifying real property and nonqualifying loans may not exceed the greater of
(a) the deduction that would be permitted under the experience method, or (b)
the amount by which 12% of total deposits at year end exceed the sum of the
Bank's surplus, undivided profits, and reserves, as defined for federal income
tax purposes, at the beginning of the year. On September 30, 1996, this
limitation did not restrict the bad debt reserve deduction of the Bank. The
Bank's total bad debt reserve for tax purposes was approximately $9.6 million at
September 30, 1996. Based upon 1996 tax law changes, the above criteria will not
be of concern in future years.
To the extent earnings appropriated to a thrift institution's bad debt
reserves for qualifying real property loans and deducted for federal income tax
purposes exceed the allowable amount of such reserves computed under the
experience method ("Excess"), and to the extent of the institution's
supplemental reserves for losses on loans, such Excess and the supplemental
reserve may not, without adverse tax consequences, be utilized for payment of
dividends or certain other distributions to a shareholder (including
distributions in redemption, dissolution, or liquidation) or for any other
purpose (except to absorb bad debt losses). Distribution of a dividend by a
thrift institution to a shareholder is treated as made: first out of the
institution's current and post-1951 accumulated earnings and profits; second out
of the Excess; third out of the supplemental reserve for losses on loans to the
extent thereof; and fourth out of such other accounts as may be proper. In the
case of distributions in redemption, dissolution or liquidation, the
distribution is deemed to be first out of the Excess, second out of the
supplemental reserve for losses on loans, to the extent thereof, then out of
earnings and profits, and finally out of other proper accounts. To the extent a
distribution by the Bank is deemed paid out of its Excess or supplemental
reserve, under these rules, the Excess or supplemental reserve would be reduced
and the Bank's gross income for tax purposes would be increased by the amount
which, when reduced by the income tax, if any, attributable to the inclusion of
such amount in its gross income, equals the amount deemed paid out of the Excess
or supplemental reserve. As of September 30, 1996, the Bank's Excess for tax
purposes totaled approximately $9,600,000.
The Company is subject to an alternative minimum tax. This tax is
imposed at a rate of 20% on alternative minimum taxable income, which is the sum
of a corporation's regular taxable income (with certain adjustments), plus tax
preference items, less any available exemption. For alternative minimum tax
purposes, special adjustments apply to the NOL deduction, and such NOLs can
offset no more than 90% of alternative minimum taxable income. The alternative
minimum tax is imposed to the extent it exceeds a corporation's regular income
tax. The Company has been paying the regular income tax in recent years instead
of the alternative minimum tax.
For taxable years beginning after 1986, corporations, including the Company,
are also subject to an environmental tax equal to 0.12% of the excess of
alternative minimum taxable income for the taxable year (determined without
regard to alternative tax NOLs or the deduction for the environmental tax) over
$2 million. The Company incurred approximately $5,000 of this tax for its
taxable year ended September 30, 1996.
Thrifts have generally not established a liability for deferred taxes on the
bad debt reserves on their balance sheet. Therefore, if a thrift has to
recapture its bad debt reserves because of failure to qualify as a bank, the
effect on financial statements, apart from the cash outflow, could be material.
The Company has recorded a liability for increases in its tax bad debt reserves
from a base year of 1987.
Due to changes made by the 1996 tax law, the Bank must recapture into
taxable income the amount of the tax bad debt reserve in excess of the base year
reserve. This additional tax is to be paid over a six year period, with up to a
two year deferral if certain tests are met. The Bank has the expected liability
currently recorded in its financial statements.
STATE TAXATION
Effective for fiscal year 1991, the State of Indiana imposed an 8.5%
franchise tax on the net income of financial (including thrift) institutions,
exempting them from the prior gross income, supplemental net income, and
intangibles taxes. Net income for franchise tax purposes constitutes federal
taxable income before net operating loss deductions and special deductions,
adjusted for certain items, including bad debts.
Prior to 1991, the State of Indiana imposed a 1.2% gross income tax on
thrift institutions. The state also imposed an intangibles tax on thrift
institutions located in Indiana. The intangibles tax was based upon the Bank's
capital and deposits. The rate was .14%; however, the intangibles tax liability
for federally chartered savings institutions was reduced by the gross income and
personal property taxes paid. Other applicable state taxes include sales tax,
use tax, property tax, and a supplemental net income tax of 4.5% on the
difference, generally, between taxable income as defined in the Code and the
amount of gross income tax paid.
The Company's tax returns have not been audited by federal or state
authorities in the past ten years.
ITEM 2. PROPERTIES
The Bank owns six full-service banking offices located in Avilla, Auburn,
Columbia City, Garrett, Kendallville and LaGrange, Indiana.
The following table provides certain information with respect to the Bank's
full-service offices at September 30, 1996.
Full Service Net Book
Offices Date Opened Value(1)
------------------- ----------- --------
Main Office, Auburn 1973 $208,012
Avilla 1980 143,066
Garrett 1972 64,873
Columbia City 1971 144,087
Kendallville 1941 512,579
LaGrange 1972 191,638
(1) Of real estate at September 30, 1996.
The Bank owns data processing equipment including computers, terminals and
communications equipment for record keeping purposes.
The total net book value of the Bank's premises and equipment at September
30, 1996, was $1,467,764.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company, the
Bank or any subsidiary is a party or to which any of their property is subject.
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 2 of the Company's Annual Report to Stockholders,
for the year ended September 30, 1996, for the information required by this
Item, which is hereby incorporated by reference.
ITEM 6. SELECTED FINANCIAL DATA
Reference is made to page 13 of the Company's Annual Report to Stockholders
for the year ended September 30, 1996, 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 6 to 12 of the Company's Annual Report to
Stockholders for the year ended September 30, 1996, 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 27 of the Company's Annual Report to
Stockholders for the year ended September 30, 1996, 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.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to pages 2 - 4 of the Company's definitive Proxy Statement
for the 1996 Annual Meeting of Stockholders for the information required by this
Item which is hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
Reference is made to pages 6 - 10 of the Company's definitive Proxy
Statement for the 1996 Annual Meeting of Stockholders for the information
required by this Item which is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is made to pages 2 and 5 of the Company's definitive Proxy
Statement for the 1996 Annual Meeting of Stockholders for the information
required by this Item which is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is made to pages 5 and 6 of the Company's definitive Proxy
Statement for the 1996 Annual Meeting of Stockholders for the information
required by this Item which is hereby incorporated by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following consolidated financial statements of Peoples Bancorp and
Its Wholly-owned Subsidiary, included in the Annual Report to Stockholders of
the registrant for the year ended September 30, 1996, are filed as part of this
report:
1. Financial Statements
o REPORT OF GEO. S. OLIVE & CO. LLC, INDEPENDENT AUDITORS.
o CONSOLIDATED STATEMENT OF FINANCIAL CONDITION - AS OF SEPTEMBER 30,
1996 AND 1995.
o CONSOLIDATED STATEMENT OF INCOME FOR THE YEARS ENDED SEPTEMBER 30,
1996, 1995, AND 1994.
o CONSOLIDATED STATEMENT OF CHANGE IN STOCKHOLDERS' EQUITY FOR THE
YEARS ENDED SEPTEMBER 30, 1996, 1995, AND 1994.
o CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER
30, 1996, 1995, AND 1994.
o NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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)
10.2 Employment Agreement of Roger J. Wertenberger (1)
10.2(a) Amendment No.1 to Employment Agreement of Roger J. Wertenberger(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)
Exhibit No. Description of Exhibit
- ----------- ----------------------
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)
13 Annual Report to Stockholders
22 Subsidiaries of the Registrant
28 Definitive Proxy Statement for 1996 Annual Meeting
(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.
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 24, 1996 Roger J. Wertenberger
Chairman of the Board,
Principal Executive Officer,
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 24, 1996 Roger J. Wertenberger,
Chairman of the Board,
Principal Executive Officer,
and Director
December 24, 1996 Maurice F. Winkler III,
President, and Director
December 24, 1996 Robert D. Ball, Director
December 24, 1996 Jack L. Buttermore, Director
December 24, 1996 John C. Harvey, Director
December 24, 1996 Douglas D. Marsh, Director
December 24, 1996 Lawrence R. Bowmar, Director
December 24, 1996 John C. Thrapp, Director
EXHIBIT INDEX
Exhibit No. Description of Exhibit
- ----------- ----------------------
3.1 Articles of Incorporation of Peoples Bancorp (1)
3.2 Bylaws of Peoples Bancorp (1)
10.2 Employment Agreement of Roger J. Wertenberger (1)
10.2(a) Amendment No. 1 to Employment Agreement of Roger J. Wertenberger(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)
11 Statement Concerning Computation of Per Share Net Income
13 Annual Report to Stockholders
22 Subsidiaries of the Registrant
(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.
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