FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____ to ____ Commission file number 0-16772 PEOPLES BANCORP INC. ---------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) Ohio ---------------------------------------------------------------- (State or other jurisdiction of incorporation or organization) 31-0987416 ---------------------------------------------- (I.R.S. Employer Identification No.) 138 Putnam Street, P. O. Box 738, Marietta, Ohio 45750 - ------------------------------------------------ ---------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (740) 373-3155 ------------------- Not Applicable ------------------------------------------------------------------------ (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------------- ------------------ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No ------------- ------------------ Indicate the number of shares outstanding of each of the issuer's classes of common stock, at May 5, 2005: 10,405,462 common shares, without par value. Exhibit Index Appears on Page 33 PART I - FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS PEOPLES BANCORP INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in thousands) March 31, December 31, 2005 2004 Assets Cash and cash equivalents: Cash and due from banks $ 30,556 $ 30,670 Interest-bearing deposits in other banks 1,189 779 Federal funds sold 2,600 - - ------------------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 34,345 31,449 - ------------------------------------------------------------------------------------------------------------------------------- Available-for-sale investment securities, at estimated fair value (amortized cost of $591,313 at March 31, 2005 and $594,457 at December 31, 2004) 592,692 602,364 - ------------------------------------------------------------------------------------------------------------------------------- Loans, net of deferred fees and costs 1,013,000 1,023,058 Allowance for loan losses (15,202) (14,760) - ------------------------------------------------------------------------------------------------------------------------------- Net loans 997,798 1,008,298 - ------------------------------------------------------------------------------------------------------------------------------- Loans held for sale 1,147 612 Bank premises and equipment, net 22,126 22,640 Business owned life insurance 45,707 45,253 Goodwill 58,886 59,096 Other intangible assets 11,446 12,022 Other assets 27,482 27,352 - ------------------------------------------------------------------------------------------------------------------------------- Total assets $ 1,791,629 $ 1,809,086 =============================================================================================================================== Liabilities Deposits: Non-interest-bearing $ 157,087 $ 152,979 Interest-bearing 946,046 916,442 - ------------------------------------------------------------------------------------------------------------------------------- Total deposits 1,103,133 1,069,421 - ------------------------------------------------------------------------------------------------------------------------------- Short-term borrowings 83,724 51,895 Long-term borrowings 386,641 464,864 Junior subordinated notes held by subsidiary trusts 29,285 29,263 Accrued expenses and other liabilities 16,208 18,225 - ------------------------------------------------------------------------------------------------------------------------------- Total liabilities 1,618,991 1,633,668 - ------------------------------------------------------------------------------------------------------------------------------- Stockholders' Equity Common stock, no par value, 24,000,000 shares authorized, 10,855,010 shares issued at March 31, 2005 and 10,850,641 shares issued at December 31, 2004, including shares in treasury 162,277 162,284 Retained earnings 21,145 18,442 Accumulated comprehensive income, net of deferred income taxes 734 4,958 - ------------------------------------------------------------------------------------------------------------------------------- 184,156 185,684 Treasury stock, at cost, 461,131 shares at March 31, 2005 and 415,539 shares at December 31, 2004 (11,518) (10,266) - ------------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 172,638 175,418 - ------------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 1,791,629 $ 1,809,086 =============================================================================================================================== See notes to the consolidated unaudited financial statements PEOPLES BANCORP INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share data) For the Three Months Ended March 31, 2005 2004 Interest Income: Interest on taxable investment securities 5,659 6,171 Interest on tax-exempt investment securities 676 711 Other interest income 12 60 - ---------------------------------------------------------------------------------------------------------------------------- Total interest income 22,643 21,586 - ---------------------------------------------------------------------------------------------------------------------------- Interest Expense: Interest on deposits 5,105 3,800 Interest on short-term borrowings 546 277 Interest on long-term borrowings 3,682 3,378 Interest on junior subordinated notes held by subsidiary trusts 598 583 - ---------------------------------------------------------------------------------------------------------------------------- Total interest expense 9,931 8,038 - ---------------------------------------------------------------------------------------------------------------------------- Net interest income 12,712 13,548 Provision for loan losses 941 794 - ---------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 11,771 12,754 - ---------------------------------------------------------------------------------------------------------------------------- Other Income: Investment and insurance commissions 2,654 299 Service charges on deposit accounts 2,274 2,253 Income from fiduciary activities 757 774 Electronic banking income 647 523 Business owned life insurance 454 416 Gain on securities transactions 233 32 Mortgage banking income 117 199 Other 232 391 - ---------------------------------------------------------------------------------------------------------------------------- Total other income 7,368 4,887 - ---------------------------------------------------------------------------------------------------------------------------- Other Expenses: Salaries and employee benefits 6,686 5,389 Net occupancy and equipment 1,289 1,221 Amortization of other intangible assets 688 401 Professional fees 665 456 Data processing and software 461 472 Franchise tax 411 341 Marketing 381 108 Other 2,166 1,902 - ---------------------------------------------------------------------------------------------------------------------------- Total other expenses 12,747 10,290 - ---------------------------------------------------------------------------------------------------------------------------- Income before income taxes 6,392 7,351 Income taxes 1,700 1,985 - ---------------------------------------------------------------------------------------------------------------------------- Net income $ 4,692 $ 5,366 ============================================================================================================================ Earnings per share: Basic $ 0.45 $ 0.51 - ---------------------------------------------------------------------------------------------------------------------------- Diluted $ 0.44 $ 0.50 - ---------------------------------------------------------------------------------------------------------------------------- Weighted-average number of shares outstanding: Basic 10,419,189 10,560,241 - ---------------------------------------------------------------------------------------------------------------------------- Diluted 10,558,003 10,808,007 - ---------------------------------------------------------------------------------------------------------------------------- Cash dividends declared $ 1,989 $ 1,900 - ---------------------------------------------------------------------------------------------------------------------------- Cash dividends declared per share $ 0.19 $ 0.18 - ---------------------------------------------------------------------------------------------------------------------------- See notes to the consolidated unaudited financial statements PEOPLES BANCORP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Dollars in Thousands, except Per Share Data) Accumulated Common Stock Retained Comprehensive Treasury Shares Amount Earnings Income Stock Total - ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2004 10,850,641 $ 162,284 $ 18,442 $ 4,958 $ (10,266) $ 175,418 =================================================================================================================================== Net income 4,692 4,692 Other comprehensive income, net of tax (4,224) (4,224) Cash dividends declared of $0.19 per share (1,989) (1,989) Purchase of treasury stock, 61,404 shares (1,644) (1,644) Exercise of common stock options (reissued 15,812 treasury shares) (200) 392 192 Tax benefit from exercise of stock options 73 73 Issuance of common stock under dividend reinvestment plan 4,369 120 120 - ----------------------------------------------------------------------------------------------------------------------------------- Balance, March 31, 2005 10,855,010 $ 162,277 $ 21,145 $ 734 $ (11,518) $ 172,638 =================================================================================================================================== CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in thousands) For the Three Months Ended March 31, 2005 2004 Net income $ 4,692 $ 5,366 Other comprehensive income (loss): Unrealized (loss) gain on available-for-sale securities arising in the period (6,295) 7,220 Less: reclassification adjustment for net securities gains included in net income 233 32 Unrealized gain on cash flow hedge derivatives arising in the period 30 4 - ------------------------------------------------------------------------------------------------------------------------ Total other comprehensive (loss) income (6,498) 7,192 Income tax benefit (expense) 2,274 (2,517) - ------------------------------------------------------------------------------------------------------------------------ Total other comprehensive (loss) income, net of tax (4,224) 4,675 - ------------------------------------------------------------------------------------------------------------------------ Total comprehensive income $ 468 $ 10,041 - ------------------------------------------------------------------------------------------------------------------------ See notes to the consolidated unaudited financial statements PEOPLES BANCORP INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands) For the Three Months Ended March 31, 2005 2004 Net cash provided by operating activities $ 19,372 $ 8,053 Cash flows from investing activities: Purchases of available-for-sale securities (25,840) (41,330) Proceeds from sales of available-for-sale securities 593 2,065 Proceeds from maturities of available-for-sale securities 28,281 29,859 Net (increase) decrease in loans (1,980) 3,530 Net expenditures for premises and equipment (550) (580) Net proceeds (expenditures) from sales of other real estate owned 266 (74) Investment in business owned life insurance - (20,000) Investment in limited partnership and tax credit funds (1,519) (760) - --------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (749) (27,290) Cash flows from financing activities: Net increase in non-interest-bearing deposits 4,108 575 Net decrease in interest-bearing deposits 29,780 919 Net increase (decrease) in short-term borrowings 31,829 (21,439) Proceeds from long-term borrowings - 5,000 Payments on long-term borrowings (78,222) (2,650) Cash dividends paid (1,770) (1,797) Purchase of treasury stock (1,644) (4,146) Proceeds from issuance of common stock 192 209 - --------------------------------------------------------------------------------------------------------------------- Net cash used in financing activities (15,727) (23,329) - --------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 2,896 (42,566) Cash and cash equivalents at beginning of period 31,449 73,426 - --------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 34,345 $ 30,860 ===================================================================================================================== Supplemental cash flow information: Interest paid $ 10,043 $ 7,982 - --------------------------------------------------------------------------------------------------------------------- See notes to the consolidated unaudited financial statements NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS 1. Basis of Presentation --------------------- The accounting and reporting policies of Peoples Bancorp Inc. ("Peoples Bancorp") and Subsidiaries (collectively, "Peoples") conform to accounting principles generally accepted in the United States and to general practices within the financial services industry. Peoples considers all of its principal activities to be financial services related. The accompanying unaudited consolidated financial statements of Peoples reflect all adjustments (which include normal recurring adjustments) necessary to present fairly such information for the periods and dates indicated. The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. To conform to the 2005 presentation, certain reclassifications have been made to prior period amounts, which had no impact on net income or stockholders' equity. Results of operation for the three months ended March 31, 2005, are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. Certain information and footnotes typically included in financial statements prepared in conformity with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The balance sheet at December 31, 2004 contained herein has been derived from the audited balance sheet included in Peoples Bancorp's Annual Report on Form 10-K for the fiscal year ended December 31, 2004 ("2004 Form 10-K"). These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the 2004 Form 10-K. The consolidated financial statements include the accounts of Peoples Bancorp and its consolidated subsidiaries, Peoples Bank, National Association ("Peoples Bank") and Peoples Investment Company, along with their wholly-owned subsidiaries. Peoples Bancorp has two statutory business trusts that are variable interest entities for which Peoples Bancorp is not the primary beneficiary. As a result, the accounts of these trusts are not included in Peoples' consolidated financial statements. All significant intercompany accounts and transactions have been eliminated. 2. New Accounting Pronouncements: ------------------------------ On December 16, 2004, the FASB issued a revision of Statement No. 123, "Share-Based Payment" ("SFAS 123(R)"). SFAS 123(R) requires the compensation cost relating to share-based payment transactions to be recognized in financial statements based on the fair value of the equity or liability instruments issued. SFAS 123(R) replaces SFAS 123 and supercedes APB 25. SFAS 123 (R) was originally effective for public companies that do not file as small business issuers as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. On April 15, 2005, the Securities and Exchange Commission ("SEC") adopted a new rule that amends the compliance date for SFAS 123 (R) to allow public companies that do not file as small business issuers to implement SFAS 123 (R) at the beginning of their next fiscal year that begins after June 15, 2005. For Peoples, SFAS 123(R) now becomes effective for the year beginning January 1, 2006. 3. Stock-Based Compensation: ------------------------- Peoples accounts for stock-based compensation using the intrinsic value method. Under the provisions of the stock option plans, the option price per share granted cannot be less than the fair market value of the underlying common shares on the date of grant. As a result, Peoples does not recognize any stock-based employee compensation expense in net income. The following table illustrates the effect on net income and earnings per share had Peoples applied fair value recognition to stock-based employee compensation, assuming the estimated fair value of the options as of the grant date is amortized to expense over the vesting period: (Dollars in Thousands, except Per Share Data) Three Months Ended March 31, 2005 2004 Net income, as reported $ 4,692 $ 5,366 Deduct: stock-based compensation expense determined under fair value based method, net of tax 145 134 ------------------------------------------------------------------------------- Pro forma net income $ 4,547 $ 5,232 ------------------------------------------------------------------------------- Basic Earnings Per Share: As reported $ 0.45 $ 0.51 ------------------------------------------------------------------------------- Pro forma $ 0.44 $ 0.50 ------------------------------------------------------------------------------- Diluted Earnings Per Share: As reported $ 0.44 $ 0.50 ------------------------------------------------------------------------------- Pro forma $ 0.43 $ 0.48 ------------------------------------------------------------------------------- The fair value was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: 2005 2004 Risk-free interest rate 4.44% 3.65% Dividend yield 2.75% 2.47% Volatility factor of the market price of parent stock 27.8% 29.8% Weighted-average expected life of options 7.4 years 7.0 years 4. Employee Benefit Plans: ----------------------- Components of Net Periodic Benefit Costs ---------------------------------------- Peoples Bancorp sponsors a noncontributory defined benefit pension plan and a contributory postretirement benefit plan. The following table details the components of the net periodic benefit cost for both plans: Pension Benefits Postretirement Benefits ------------------------ ------------------------- Three Months Ended Three Months Ended March 31, March 31, (Dollars in Thousands) 2005 2004 2005 2004 Service cost $ 232 $ 212 $ - $ - Interest cost 207 185 9 9 Expected return on plan assets (279) (227) - - Amortization of transition asset - - - - Amortization of prior service cost 1 1 3 3 Amortization of net loss 62 44 3 - ---------------------------------------------------------------------------------------- Net periodic benefit cost $ 223 $ 215 $ 15 $ 12 ======================================================================================== Employer Contributions ---------------------- Through March 31, 2005, Peoples Bancorp had not made any contributions to its defined benefit pension plan for the current year. Peoples anticipates contributing $1.5 million to its pension plan in 2005; however, actual contributions are made at the discretion of the Retirement Plan Committee and Peoples Bancorp's Board of Directors. ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SELECTED FINANCIAL DATA The following data should be read in conjunction with the unaudited consolidated financial statements and the management discussion and analysis that follows: At or For the Three Months Ended March 31, SIGNIFICANT RATIOS 2005 2004 Return on average equity 10.85 % 12.50 % Return on average assets 1.05 % 1.25 % Net interest margin (a) 3.27 % 3.56 % Non-interest income leverage ratio (b) 59.10 % 46.67 % Efficiency ratio (c) 59.60 % 53.24 % Average stockholders' equity to average assets 9.69 % 9.97 % Average loans to average deposits 94.34 % 88.54 % Cash dividends to net income 42.39 % 35.41 % - ----------------------------------------------------------------------------------------------------------------- ASSET QUALITY RATIOS (end of period) Nonperforming loans as a percent of total loans (d) 0.72 % 0.76 % Nonperforming assets as a percent of total assets (e) 0.46 % 0.43 % Allowance for loan losses to loans net of unearned interest 1.50 % 1.62 % - ----------------------------------------------------------------------------------------------------------------- CAPITAL RATIOS (end of period) Tier I capital ratio 11.16 % 13.79 % Risk-based capital ratio 12.52 % 15.19 % Leverage ratio 7.60 % 8.80 % - ----------------------------------------------------------------------------------------------------------------- PER SHARE DATA Earnings per share - basic 0.45 0.51 Earnings per share - diluted 0.44 0.50 Cash dividends declared per share 0.19 0.18 Book value per share (end of period) 16.61 16.70 Tangible book value per share (end of period) (f) 9.84 12.05 Weighted average shares outstanding - Basic 10,419,189 10,560,241 Weighted average shares outstanding - Diluted 10,558,003 10,808,007 Common shares outstanding at end of period 10,393,879 10,500,409 - ----------------------------------------------------------------------------------------------------------------- <FN> (a) Calculated using fully-tax equivalent net interest income as a percentage of average earning assets. (b) Non-interest income (less securities and asset disposal gains and/or losses) as a percentage of non-interest expense (less intangible amortization). (c) Non-interest expense (less intangible amortization) as a percentage of fully-tax equivalent net interest income plus non-interest income. (d) Nonperforming loans include loans 90 days past due and accruing, renegotiated loans and nonaccrual loans. (e) Nonperforming assets include nonperforming loans and other real estate owned. (f) Tangible book value per share reflects capital calculated for banking regulatory requirements and excludes balance sheet impact of intangible assets acquired through acquisitions accounted for using the purchase method of accounting. </FN> Introduction - ------------ The following discussion and analysis of the unaudited consolidated financial statements of Peoples is presented to provide insight into management's assessment of the financial condition and results of operations. Peoples Bancorp's primary subsidiaries are Peoples Bank, National Association ("Peoples Bank"), Peoples Investment Company, PEBO Capital Trust I and PEBO Capital Trust II. Peoples Bank also operates Peoples Insurance Agency, Inc. ("Peoples Insurance"), PBNA L.L.C. and Peoples Loan Services, Inc. Peoples Investment Company also owns Peoples Capital Corporation. Peoples Bank is a member of the Federal Reserve System and subject to regulation, supervision and examination by the Office of the Comptroller of the Currency. Peoples Bank offers financial products and services through 51 financial service locations and 33 ATMs in Ohio, West Virginia and Kentucky. Peoples Bank's internet-banking service, Peoples OnLine Connection, can be found on the Internet at www.peoplesbancorp.com (this uniform resource locator (URL) is an inactive, textual reference only). Peoples Bank provides an array of financial products and services to customers that include traditional banking products such as deposit accounts, lending products, credit and debit cards, corporate and personal trust services, and safe deposit rental facilities. Peoples provides services through traditional walk-in offices and automobile drive-in facilities, automated teller machines, banking by phone, and the Internet. Peoples Bank also makes available other financial services through Peoples Financial Advisors, which provides customer-tailored services for fiduciary needs, investment alternatives, financial planning, retirement plans and other asset management needs. Brokerage services are offered exclusively through Raymond James Financial Services, Inc., member NASD/SIPC and an independent broker/dealer, located at Peoples Bank offices. Peoples Bank also offers a full range of life, health, property and casualty insurance products to customers in Peoples markets through Peoples Insurance Agency, Inc. Peoples Investment Company and Peoples Capital Corporation were formed in 2001 to better deploy investable funds and provide new investment opportunities, including, but not limited to, low-income housing tax credit funds, that are either limited or restricted at the bank level. This discussion and analysis should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2004, and notes thereto, as well as the ratios, statistics and discussions contained elsewhere in this Form 10-Q. All share and per share information has been adjusted for stock dividends. References will be found in this Form 10-Q to the following significant transactions that have impacted or are expected to impact Peoples' results of operations: o Peoples completed the acquisition of certain assets of, and assumed certain liabilities from, Putnam Agency, Inc. ("Putnam") on April 30, 2004 and the acquisition of Barengo Insurance Agency, Inc. ("Barengo") on May 28, 2004, (collectively, the "Insurance Agency Acquisitions"). In addition, Peoples Bank acquired two full-service banking offices in the Ashland, Kentucky area at the close of business on December 3, 2004 (the "Ashland Banking Acquisition"). In conjunction with the Ashland Banking Acquisition, Peoples Bank consolidated two of its existing offices in the Ashland area market into other Peoples Bank offices and closed one of the acquired offices. o On December 10, 2004, Peoples Bancorp announced the authorization to repurchase up to 525,000, or approximately 5%, of Peoples Bancorp's outstanding common shares in 2005 from time to time in open market or privately negotiated transactions (the "2005 Stock Repurchase Program"). Any repurchased common shares will be held as treasury shares and are anticipated to be used for future exercises of stock options granted under Peoples Bancorp's stock option plans, future issuances of common shares in connection with Peoples Bancorp's deferred compensation plans, and other general corporate purposes. Through March 31, 2005, Peoples Bancorp had repurchased a total of 59,700 common shares (or 11% of the total authorized) under the 2005 Stock Repurchase Program, at an average price of $26.78 per share. The impact of these transactions, where significant, is discussed in the applicable sections of this management's discussion and analysis. Critical Accounting Policies - ---------------------------- The accounting and reporting policies of Peoples conform to generally accepted accounting principles in the United States ("US GAAP") and to general practices within the financial services industry. The preparation of the financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could materially differ from those estimates. Management has identified the accounting policies described below as those that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of Peoples' consolidated financial statements and management's discussion and analysis. Income Recognition - ------------------ Interest income on loans and investment securities is recognized by methods that result in level rates of return on principal amounts outstanding, including yield adjustments resulting from the amortization of loan costs and premiums on investment securities and accretion of loan fees and discounts on investment securities. Since mortgage-backed securities comprise a sizable portion of Peoples' investment portfolio, a significant increase in principal payments on those securities could negatively impact interest income due to the corresponding acceleration of premium amortization. In the event management believes collection of all or a portion of contractual interest on a loan has become doubtful, which generally occurs after the loan is 90 days past due, Peoples discontinues the accrual of interest. In addition, previously accrued interest deemed uncollectible that was recognized in income in the current year is reversed, while amounts recognized in income in the prior year are charged against the allowance for loan losses. Interest received on nonaccrual loans is included in income only if principal recovery is reasonably assured. A nonaccrual loan is restored to accrual status after appropriate review by lending and/or loan review personnel indicates the collectibility of the total contractual principal and interest is no longer considered doubtful. Allowance for Loan Losses - ------------------------- In general, determining the amount of the allowance for loan losses requires significant judgment and the use of estimates by management. Peoples maintains an allowance for loan losses to absorb probable losses based on a quarterly analysis of the portfolio. This formal analysis determines an appropriate level and allocation of the allowance for loan losses among loan types and resulting provision for loan losses by considering factors affecting losses, including specific losses, levels and trends in impaired and nonperforming loans, historical loan loss experience, current national and local economic conditions, volume, growth and composition of the portfolio, regulatory guidance and other relevant factors. Management continually monitors the loan portfolio through its Loan Review Department and Loan Loss Committee to evaluate the adequacy of the allowance. The provision could increase or decrease each quarter based upon the results of management's formal analysis. The amount of the allowance for loan losses for the various loan types represents management's estimate of expected losses from existing loans based upon specific allocations for individual lending relationships and historical loss experience for each category of homogeneous loans. The allowance for loan losses related to impaired loans is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation requires management to make estimates of the amounts and timing of future cash flows on impaired loans, which consists primarily of nonaccrual and restructured loans. While allocations are made to specific loans and pools of loans, the allowance is available for all loan losses. Individual loan reviews are based upon specific quantitative and qualitative criteria, including the size of the loan, loan quality ratings, value of collateral, repayment ability of borrowers, and historical experience factors. The historical experience factors utilized for individual loan reviews are based upon past loss experience, known trends in losses and delinquencies, the growth of loans in particular markets and industries, and known changes in economic conditions in the particular lending markets. Allowances for homogeneous loans (such as residential mortgage loans, personal loans, etc.) are evaluated based upon historical loss experience, trends in losses and delinquencies, growth of loans in particular markets, and known changes in economic conditions in each lending market. Consistent with the evaluation of allowances for homogenous loans, allowances relating to the Overdraft Privilege program are based upon management's monthly analysis of accounts in the program. This analysis considers factors that could affect losses on existing accounts, including historical loss experience and length of overdraft. There can be no assurance the allowance for loan losses will be adequate to cover all losses, but management believes the allowance for loan losses of $15.2 million at March 31, 2005, is adequate to provide for probable losses from existing loans based on information currently available. While management uses available information to provide for loan losses, the ultimate collectibility of a substantial portion of the loan portfolio, and the need for future additions to the allowance, will be based on changes in economic conditions and other relevant factors. As such, adverse changes in economic activity could reduce cash flows for both commercial and individual borrowers, which would likely cause Peoples to experience increases in problem assets, delinquencies and losses on loans. Investment Securities - --------------------- Investment securities are initially recorded at cost, which includes premiums and discounts if purchased at other than par or face value. Peoples amortizes premiums and accretes discounts as an adjustment to interest income over the estimated life of the security. The cost of investment securities sold, and any resulting gain or loss, is based on the specific identification method. Management determines the appropriate classification of investment securities at the time of purchase. Held-to-maturity securities are those securities that Peoples has the positive intent and ability to hold to maturity and are reported at amortized cost. Available-for-sale securities are those securities that would be available to be sold in the future in response to Peoples' liquidity needs, changes in market interest rates, and asset-liability management strategies, among other considerations. Available-for-sale securities are reported at estimated fair value, with unrealized holding gains and losses reported in stockholders' equity as a separate component of other comprehensive income, net of applicable deferred income taxes. Trading securities are those securities bought and held principally for the purpose of selling in the near term. Trading securities are reported at fair value, with holding gains and losses recognized in earnings. Presently, Peoples classifies its entire investment portfolio as available-for-sale. As a result, both the investment and equity sections of Peoples' balance sheet are more sensitive to changes in the overall market value of the investment portfolio, due to changes in market interest rates, investor confidence and other factors affecting market values, than if the investment portfolio was classified as held-to-maturity. While temporary changes in the market value of available-for-sale securities are not recognized in earnings, a decline in fair value below amortized cost deemed to be "other-than-temporary" results in an adjustment to the cost basis of the investment, with a corresponding loss charged against earnings. Management systematically evaluates Peoples' investment securities for other-than-temporary declines in estimated fair value on a quarterly basis. This analysis requires management to consider various factors in order to determine if a decline in estimated fair value is temporary or other-than-temporary. These factors include duration and magnitude of the decline in value, the financial condition of the issuer, and Peoples' ability and intent to continue holding the investment for a period of time sufficient to allow for any anticipated recovery in market value. At March 31, 2005, there were no investment securities identified by management to be other-than-temporarily impaired. If investments decline in fair value due to adverse changes in the financial markets, additional charges to income could occur in future periods. Goodwill and Other Intangible Assets - ------------------------------------ Over the past several years, Peoples has grown through mergers and acquisitions accounted for under the purchase method of accounting. Under the purchase method, Peoples is required to allocate the cost of an acquired company to the assets acquired, including identified intangible assets, and liabilities assumed based on their estimated fair values at the date of acquisition. At March 31, 2005, Peoples had $10.7 million of identifiable intangible assets acquired in acquisitions, subject to amortization, and $58.9 million of goodwill, not subject to periodic amortization. The determination of fair value and subsequent allocation of the cost of an acquired company generally involves management making estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. In addition, the valuation and amortization of intangible assets representing the present value of future net income to be earned from customers (commonly referred to as "customer relationship intangibles" or "core deposit intangibles") requires significant judgment and the use of estimates by management. While management feels the assumptions and variables used to value recent acquisitions were reasonable, the use of different, but still reasonable, assumptions could produce materially different results. Customer relationship intangibles are required to be amortized over their estimated useful lives. The method of amortization should reflect the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up. Since Peoples' acquired customer relationships are subject to routine customer attrition, the relationships are more likely to produce greater benefits in the near-term than in the long-term, which typically supports the use of an accelerated method of amortization for the related intangible assets. Management is required to evaluate the useful life of customer relationship intangibles to determine if events or circumstances warrant a change in the estimated life. Should management determine in future periods the estimated life of any intangible asset is shorter than originally estimated, Peoples would adjust the amortization of that asset, which could increase future amortization expense. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible elements in the business acquired. Goodwill recorded by Peoples in connection with its acquisitions relates to the inherent value in the businesses acquired and this value is dependent upon Peoples' ability to provide quality, cost effective services in a competitive market place. As such, goodwill value is supported ultimately by revenue that is driven by the volume of business transacted. A decline in earnings as a result of a lack of growth or the inability to deliver cost effective services over sustained periods can lead to impairment of goodwill that could adversely impact earnings in future periods. Peoples has reviewed its recorded goodwill and concluded that no indicators of impairment exist as of March 31, 2005. However, future events could cause management to conclude that impairment indicators exist and re-evaluate goodwill. If such re-evaluation indicated impairment, Peoples would recognize the loss, if any. Any resulting impairment loss could have a material, adverse impact on Peoples' financial condition and results of operations. RESULTS OF OPERATIONS Overview of the Income Statement - -------------------------------- Net income totaled $4,692,000, or $0.44 per diluted share, in the first quarter of 2005, compared to $5,366,000, or $0.50 per diluted share, a year ago. Peoples' lower earnings were primarily attributable to reduced levels of net interest income, which offset increases in net revenues generated by acquisitions completed during 2004. Additionally, Peoples recorded increased provision for loan losses of $147,000 in the first quarter of 2005 compared to the same period in 2004, which contributed to the reduction in net income. Earnings in the first quarter of 2005 included the impact of some significant asset transactions, which resulted in a net pre-tax gain of $54,000. Peoples recognized a net gain on securities transactions and asset disposals of $241,000 ($157,000 after-tax), with nearly all of the gain resulting from the sale of an investment security due to the merger of the issuer with an unrelated company. This gain was largely offset by a net loss of $187,000 ($122,000 after-tax) on the sale of $11.6 million of long-term fixed-rated mortgage loans, acquired during the fourth quarter of 2004 as part of the Ashland Banking Acquisition. These loans were sold due to their associated interest rate risk in the current rate environment. For the quarter ended March 31, 2005, net interest income totaled $12.7 million, down 6% compared to $13.5 million a year ago and unchanged from $12.7 million for the fourth quarter of 2004. The decline from 2004's first quarter was largely attributable to interest-bearing liabilities and their associated rates increasing more rapidly than earning asset balances and the yields earned on those assets due in part to conversion of earning assets to fund the purchase of business owned life insurance in early 2004, increased borrowings to support other non-earning assets and acquisitions and the impact of the flattening yield curve on new loan pricing and yields on securities reinvestments. Peoples' strategy to match fund selected long-term, adjustable rate commercial loans using borrowings with a similar interest rate risk profile also caused net interest margin to be less when compared to the first quarter of 2004. The combined effect of these factors caused net interest margin to compress to 3.27% in the first quarter of 2005, from 3.29% the prior quarter and 3.56% in the first quarter of 2004. Other income was $7.4 million for the first quarter of 2005, up 51% from $4.9 million for the same period a year ago. This increase was primarily the result of the Insurance Agency Acquisitions, which accounted for $2.3 million of the increase. For the first three months of 2005, other expense totaled $12.7 million versus $10.3 million in 2004's first quarter, with operating expenses relating to the acquired insurance agencies accounting for $1.5 million, or 60%, of the increase. Other increased costs in the first quarter included salaries and benefits, professional fees and marketing costs. Compared to the fourth quarter of 2004, non-interest expense was down slightly in the first quarter of 2005. Interest Income and Expense - --------------------------- Peoples earns interest income from loans, investment securities and short-term investments and incurs interest expense on interest-bearing deposits and borrowed funds. Net interest income, the amount by which interest income exceeds interest expense, remains Peoples' largest source of revenue. Management periodically adjusts the mix of assets and liabilities, as well as the rates earned or paid on those assets and liabilities, in an attempt to manage and improve net interest income. However, factors that influence market interest rates, such as interest rate changes by the Federal Reserve Open Market Committee and Peoples' competitors, may have a greater impact on net interest income than adjustments made by management. Consequently, a volatile rate environment or extended periods of unusually low or high interest rates can make it extremely difficult to manage net interest margin and income in the short-term, much less anticipate and position the balance sheet for future changes. Net interest income totaled $12,712,000 in the first quarter of 2005, down from $13,548,000 a year ago. Interest income totaled $22,643,000 for the three months ended March 31, 2005, up 5% compared to the same period last year primarily as a result of a modest increase in earning assets and a 16 basis point improvement in the yield on earning assets. The slight improvement in interest income was more than offset by increased interest expense during the first three months of 2005. Interest expense totaled $9,931,000 in the first quarter of 2005 versus $8,038,000 in 2004's first quarter, up 24%, reflecting higher deposit balances due to the Ashland Banking Acquisition and increased borrowings to support non-earning assets, coupled with an overall increase in Peoples' cost of funds. Compared to the fourth quarter of 2004, net interest income was virtually unchanged from $12,734,000, as increased interest expense was largely offset by higher levels of interest income. Peoples derives a portion of its interest income from loans to and investments issued by states and political subdivisions. Since these revenues generally are not subject to income taxes, management believes it is more meaningful to analyze net interest income on a fully-tax equivalent ("FTE") basis, which adjusts interest income by converting tax-exempt income to the pre-tax equivalent of taxable income using an effective tax rate of 35%. Net interest margin, calculated by dividing FTE net interest income by average interest-earning assets, serves as an important measurement of the net revenue stream generated by the mix and pricing of Peoples' earning assets and interest-bearing liabilities. The following table details the calculation of FTE net interest income and margin: Three Months Ended March 31, December 31, March 31, (Dollars in thousands) 2005 2004 2004 Net interest income, as reported $ 12,712 $ 12,734 $ 13,548 Taxable equivalent adjustments 394 401 414 --------------------------------------------------------------------------------------- Fully-tax equivalent net interest income $ 13,106 $ 13,135 $ 13,962 --------------------------------------------------------------------------------------- Average earning assets $ 1,611,015 $ 1,601,388 $ 1,575,126 --------------------------------------------------------------------------------------- Net interest margin 3.27% 3.29% 3.56% --------------------------------------------------------------------------------------- In recent periods, short-term interest rates have increased substantially while longer-term rates have risen only minimally. This flattening of the yield curve, coupled with intense competition for loans and deposits, has compressed net interest margin for most financial institutions, including Peoples, due to the cost of funds rising at a faster pace than the yield on earnings assets. In the first quarter of 2005, the FTE yield on earning assets was 5.76%, compared to 5.69% in the prior quarter and 5.60% in 2004's first quarter, while Peoples' cost of funds was 2.75%, 2.66% and 2.28% for the same periods, respectively. Net loans comprise the largest portion of Peoples' earning assets, averaging $1.0 billion in the first quarter of 2005, up from $977.8 million in the prior quarter and $897.2 million in the first quarter of 2004. The FTE yield on net loans was 6.53% for the three months ended March 31, 2005, versus 6.43% and 6.57% for the fourth and first quarters of 2004, respectively. The Federal Reserve's action to increase interest rates has allowed loan yields to stabilize, although competition for commercial loans and prepayments of higher rate loans, primarily commercial loans, have tempered any improvement in loan yields due to these rate pressures. Investment securities averaged $599.5 million in the first quarter of 2005, down from $619.0 million last quarter and $650.7 million a year ago, with FTE yields of 4.47%, 4.56% and 4.47%, respectively. The decrease in the average balance from a year ago is largely attributable to management using a portion of the principal runoff to manage liquidity, fund loan growth and for other corporate purposes. Management anticipates maintaining, or slightly growing, the investment portfolio in the remaining nine months of 2005, depending on loan growth and other corporate liquidity needs. Peoples' interest-bearing liabilities averaged $1.46 billion in the first quarter of 2005 compared to $1.45 billion last quarter and $1.41 billion a year ago. Traditional deposits comprise the majority of Peoples' interest-bearing liabilities, averaging $929.7 million for the quarter ended March 31, 2005, compared to $890.6 million in the fourth quarter of 2004 and $894.8 million in 2004's first quarter. The higher volume of deposits was due primarily to deposits acquired in the Ashland Banking Acquisition and additional brokered deposits. For the quarter ended March 31, 2005, the cost of funds from interest-bearing deposits was 2.23%, up from 2.08% and 1.71% for the prior quarter and first quarter of 2004, respectively. Peoples also utilizes a variety of borrowings as complementary funding sources to traditional deposits. For the three months ended March 31, 2005, total borrowed funds averaged $531.5 million compared to $557.7 million for the fourth quarter of 2004 and $520.0 million a year ago. The increase from 2004's first quarter average was the result of management using various borrowings to fund asset growth, while the decline from the prior quarter was due to an increase in funds, primarily from deposit growth, which allowed Peoples to reduce borrowings. Peoples' overall cost of borrowed funds increased to 3.66% from 3.57% last quarter and 3.25% in the first quarter of 2004. Peoples' main source of borrowed funds is short- and long-term advances from the FHLB. Short-term FHLB borrowings averaged $76.5 million in the first quarter of 2005 compared to $86.5 million a year ago, with an average cost of 2.49% and 1.12% for the same periods, respectively. Long-term FHLB borrowings averaged $208.5 million in the first quarter of 2005, up from $154.1 million a year ago, with an average cost of 4.10% and 4.44% for the same periods, respectively. These changes in average balance and cost reflect management's continued use of FHLB borrowings, as deemed appropriate, to fund asset growth and manage interest rate sensitivity. Additionally, management in the second half of 2004 match-funded selected three- and five-year adjustable rate commercial loans using long-term FHLB advances with similar amortization and repricing characteristics. Compared to the fourth quarter of 2004, average short-term FHLB borrowings grew $27.9 million, due in part to Peoples using short-term advances to reduce other borrowings during the first quarter, while long-term FHLB borrowings increased $2.5 million. Management intends to use longer-term borrowings, as appropriate, to lock in rates to hedge against rising interest rates. Additional information regarding Peoples' advances from the FHLB can be found later in this Discussion under the caption "Funding Sources". In addition to FHLB borrowings, Peoples also accesses national market repurchase agreements to diversify funding sources. In the first quarter of 2005, wholesale market term repurchase agreements averaged $186.5 million compared to $241.0 million for the prior quarter and $216.3 million for the first quarter of 2004. The decrease in the first quarter of 2005 was attributable to Peoples repaying matured agreements using short-term FHLB advances, with rates similar to the matured agreements, rather than extending the terms of the agreements. The average cost of wholesale repurchase agreements was 3.04% in the first quarter of 2005, up from 2.87% and 2.86% for the fourth and first quarters of 2004, respectively. As is the case with many financial institutions, the flattening yield curve in the first quarter of 2005 impacted new loan pricing and yields on securities reinvestments thereby limiting any improvement from the Federal Reserve's actions to raise interest rates. Management continues its efforts to position Peoples balance sheet for the expected increases in rates during the remaining nine months of 2005. Based on Peoples' interest rate risk position and asset-liability simulations at March 31, 2005, management believes additional interest rate increases could cause net interest income to increase modestly; however, certain actions, such as the match-funding of longer-term loan commitments, could mitigate any projected improvement. Peoples' net interest margin and income remain difficult to predict, and to manage, since changes in market interest rates and the timing of these changes remain uncertain and fierce competition for loans and deposits puts pricing pressure on both sides of the balance sheet. Provision for Loan Losses - ------------------------- In the first quarter of 2005, Peoples' provision for loan losses was $941,000, up from $531,000 in the prior quarter and $794,000 a year ago. The higher provision was based on management's quarterly analysis of the adequacy of the allowance for loan losses and a specific provision of $500,000 for a group of loans that are part of a single commercial relationship management determined was impaired. As Peoples Bancorp reported on its Current Report on Form 8-K filed May 3, 2005, the specific provision relates to a group of loans, with an aggregate principal balance of approximately $2.7 million, to two commonly controlled commercial borrowers. Management believes there is a reasonable likelihood the borrowers will be unable to meet the repayment terms of the loans, based in part on the fact the guarantors of the loans recently filed for personal bankruptcy. The level of the provision made in connection with these loans reflects the amount necessary to maintain the allowance for loan losses at an adequate level, based upon management's analysis of projected losses in its loan portfolio, with respect to loans held at March 31, 2005. Since this impairment was discovered in late April 2005, management is continuing to evaluate the financial condition of the borrowers and guarantors and the value of the collateral. Additional information regarding this relationship and its potential impact on Peoples' provision for loan losses can be found later in this discussion under the caption "Future Outlook". When expressed as a percentage of average loans, the provision was 0.09% in the first quarter of 2005 compared to 0.05% in the fourth quarter of 2004 and 0.09% in the first quarter of 2004. Future provisions will continue to be based on management's quarterly procedural discipline described in the "Critical Accounting Policies" section of this discussion. Non-Interest Income - ------------------- Peoples generates non-interest income from six primary sources: deposit account service charges, fiduciary activities, investment and insurance commissions, electronic banking ("e-banking"), mortgage banking and business owned life insurance ("BOLI"). In the first quarter of 2005, non-interest income was $7,368,000, up $2,481,000 (or 51%) from $4,887,000 a year ago. The Putnam and Barengo divisions generated revenue of $2,322,000 in the first quarter of 2005, comprising most of the increase. Compared to the fourth quarter of 2004, non-interest income nearly doubled in the first quarter of 2005, due in large part to a net loss of $3,211,000 on securities transactions and asset disposals last quarter versus a net gain of $241,000 for the quarter ended March 31, 2005. Insurance and investment commissions comprised the largest portion of non-interest income in the first quarter of 2005, due in part to Peoples' recognition of annual contingency income. For the three months ended March 31, 2005, insurance and investment commissions totaled $2,654,000, up from $2,153,000 and $299,000 in 2004's fourth and first quarters, respectively. The increase from a year ago was the result of the Insurance Agency Acquisitions in mid-2004, while contingency income accounted for $481,000 of the increase from the prior quarter. The following table details Peoples' insurance and investment commissions: Three Months Ended March 31, December 31, March 31, (Dollars in thousands) 2005 2004 2004 Property and casualty insurance $ 2,331 $ 1,769 $ 108 Life and health insurance 141 153 27 Brokerage 94 108 101 Fixed annuities 58 91 56 Credit life and A&H insurance 30 32 7 -------------------------------------------------------------------- Total $ 2,654 $ 2,153 $ 299 -------------------------------------------------------------------- Service charges and other fees on deposit accounts, which are based on the recovery of costs associated with services provided, remain a significant source of non-interest revenue. For the quarter ended March 31, 2005, deposit account service charges totaled $2,274,000, up 1% from $2,253,000 a year ago and down 6% compared to $2,414,000 for the fourth quarter of 2004. The decrease from the prior quarter was the result of lower volumes of overdraft and non-sufficient funds fees due to seasonality. The following table details Peoples' deposit account service charges: Three Months Ended March 31, December 31, March 31, (Dollars in thousands) 2005 2004 2004 Overdraft fees $ 1,430 $ 1,621 $ 1,380 Non-sufficient funds fees 394 482 396 Other fees and charges 450 311 477 -------------------------------------------------------------------- Total $ 2,274 $ 2,414 $ 2,253 -------------------------------------------------------------------- Peoples offers various e-banking services, including ATM and debit cards, direct deposit services and Internet banking, as alternative delivery channels to traditional sales offices, for providing services to clients. Peoples' electronic banking services generated revenues of $647,000 for the first quarter of 2005 compared to $523,000 a year ago, an increase of $124,000 (or 24%). Peoples' e-banking revenues have remained strong due in large part to an increase in the number of debit cards issued to customers and higher volumes of debit card activity. At March 31, 2005, Peoples had 73,922 cards issued, with 48% of all eligible deposit accounts having a debit card, compared to 56,723 cards and a 43% penetration rate a year ago. Peoples' customers used their debit cards to complete $37 million of transactions in 2004, up 32% from $28 million a year ago. Peoples' mortgage banking involves the origination and selling of long-term, fixed-rate real estate loans into the secondary market. In the first quarter of 2005, mortgage banking produced revenues of $117,000 compared to $222,000 in the prior quarter and $199,000 in the first quarter of 2004. The decline in mortgage banking income is attributable to Peoples' selling $11.6 million of fixed-rate loans, acquired in the Ashland Banking Acquisition, at net loss of $187,000. While future mortgage banking revenues will be largely dependent on customer demand for long-term fixed-rate mortgage loans, mortgage banking is a key part of Peoples' long-term business strategy. Peoples' fiduciary revenues totaled $757,000 in the first quarter of 2005, compared to $774,000 a year ago and $897,000 for the fourth quarter of 2004. The lower fiduciary income in the first quarter of 2005 is attributable to slower growth in assets under management and the timing recognition of certain fee income, due in part to a change in the fee structure of certain account types in 2004. Peoples' future fiduciary revenues will be influenced by the relative performance of equity markets since a significant portion of fiduciary fees is based on the market value of assets managed. Peoples' BOLI investment enhances operating efficiency by offsetting rising employee benefit costs. For the quarter ended March 31, 2005, BOLI income totaled $454,000 compared to $416,000 a year ago and $483,000 last quarter. In early 2004, Peoples invested an additional $20 million in BOLI, which was the key driver of the increased BOLI income from a year ago. Management believes BOLI will continue to provide a better vehicle for funding future benefit costs than alternative investment opportunities with similar risk characteristics. Non-Interest Expense - -------------------- For the quarter ended March 31, 2005, non-interest expense totaled $12,747,000, up $2,457,000 (or 24%) from $10,290,000 a year ago. Operating expenses relating to the Insurance Agency Acquisitions, primarily salaries and benefits expense, occupancy and equipment costs and intangible amortization, accounted for $1.5 million of the increase in non-interest expense. Other increased costs in the first quarter included salaries and benefits, professional fees and marketing costs. Compared to the fourth quarter of 2004, non-interest expense was down $86,000 in the first quarter of 2005. Salaries and benefits remain Peoples' largest operating expense, which is inherent in a service-based industry such as financial services, totaling $6,686,000 in the first quarter of 2005, compared to $5,389,000 for the three months ended March 31, 2004. The Insurance Agency Acquisitions accounted for $935,000 (or 70%) of this increase, with higher incentive accruals based on Peoples' performance also a significant factor. Compared to the fourth quarter of 2004, salaries and benefits were virtually unchanged from $6,678,000. In the first quarter of 2005, net occupancy and equipment expenses were $1,289,000, up 6% from $1,221,000 for the same period a year ago. This increase was a result of recent acquisitions, which produced additional occupancy and equipment expenses, particularly depreciation expense. Net occupancy and equipment expenses were up slightly in the first quarter compared to $1,274,000 in the fourth quarter of 2004. Last year's acquisitions also caused an increase in amortization expense of customer relationship intangible assets. In the first quarter of 2005, intangible amortization was $688,000 compared to $657,000 last quarter and $401,000 in the first quarter of 2004. Management expects slight reductions in intangible amortization in future quarters based on the intangible assets at March 31, 2005, since Peoples uses an accelerated method of amortization for these intangibles. Professional fees, which include fees for accounting, legal and other professional services, totaled $665,000 for the first quarter of 2005, compared to $456,000 for the first quarter of 2004, a 46% increase. Higher exam and audit fees associated with the new regulatory reporting environment under Sarbanes-Oxley was the primary factor of the increased professional fees. Compared to the fourth quarter of 2004, professional fees dropped 6% in the first quarter of 2005, from $711,000, as Peoples' incurred higher costs to comply with new Sarbanes-Oxley reporting requirements during the fourth quarter of 2004. In the first quarter of 2005, marketing costs were $381,000 compared to $303,000 the prior quarter and $108,000 in the first quarter of 2004. Peoples' efforts to promote new deposit products and increase brand awareness in various markets during the first quarter of 2005 were a key reason for the higher marketing costs. Peoples is subject to various state franchise taxes, which are based largely on Peoples Bank's equity at year-end. For the first quarter of 2005, franchise taxes totaled $411,000 compared to $341,000 for 2004's first quarter. These increases were primarily attributable to additional equity at Peoples Bank resulting from the Insurance Agency Acquisitions. Management believes Peoples Bank's stronger capital level positions Peoples for strategic growth. In addition, management regularly evaluates the capital position of Peoples' other direct and indirect subsidiaries and seeks to maximize Peoples' consolidated capital position through allocation of capital which is intended to enhance profitability and shareholder value. The non-interest leverage ratio serves as a measurement of Peoples' ability to offset non-interest expense with non-interest income and is one of the performance indicators for Peoples' incentive compensation plan for senior management and certain other associates. The non-interest leverage ratio is defined as non-interest income as a percentage of operating expenses, excluding gains and losses on securities transactions, asset disposals, early debt extinguishment and sale of the credit card portfolio, as well as intangible asset amortization. The followings details the components of the non-interest leverage ratio calculation: For the Three Months Ended March 31, (Dollars in Thousands) 2005 2004 Total other income, as reported $ 7,368 $ 4,887 Deduct: Gain on securities transactions 233 32 Gain on asset disposal 8 30 Recovery of loss on sale of other real estate owned - 210 -------------------------------------------------------------------------------------------- Adjusted total other income $ 7,127 $ 4,615 ============================================================================================ Total other expense, as reported $ 12,747 $ 10,290 Deduct: Amortization of other intangible assets 688 401 -------------------------------------------------------------------------------------------- Adjusted total other expense $ 12,059 $ 9,889 =========================================================================================== Non-interest leverage ratio 59.1% 46.7% =========================================================================================== Return on Equity - ---------------- In the first quarter of 2005, Peoples' return on equity ("ROE") was 10.85% versus 12.50% for the same quarter last year. The lower ROE was attributable to a $2.8 million increase in average equity, coupled with lower earnings. Management uses ROE to evaluate Peoples' long-term performance. However, management believes earnings per share ("EPS") serves as a more meaningful measurement of short-term performance due to the volatility that can occur in equity from changes in the estimated fair values of Peoples' investment portfolio. Return on Assets - ---------------- Return on assets ("ROA") was 1.05% in the first quarter of 2005 compared to 1.25% a year ago, reflecting the $78 million increase in average assets, primarily from the Ashland Banking Acquisition and loan growth in 2004. In recent years, Peoples' primary focus has shifted to EPS enhancement and ROE while reducing the emphasis on ROA as a key performance indicator. However, management continues to monitor ROA and considers it a measurement of Peoples' asset utilization. Income Tax Expense - ------------------ Peoples continues to make tax-advantaged investments in order to manage its effective tax rate and overall tax burden. At March 31, 2005, the amount of tax-advantaged investments totaled $54.9 million compared to $53.4 million at December 31, 2004 and $51.4 million at March 31, 2004. The additional benefits derived from this modest increase in tax-advantaged investments resulted in a reduction in Peoples' effective tax rate. For the three months ended March 31, 2005, Peoples' effective tax rate was 26.6%, down from 27.0% a year ago. Depending on economic and regulatory conditions, Peoples may make additional investments in various tax credit pools and other tax-advantaged assets. FINANCIAL CONDITION Overview of Balance Sheet - ------------------------- At March 31, 2005, total assets were $1.79 billion compared to $1.81 billion at year-end 2004, a decrease of $17.0 million largely the result of lower loan and investment portfolio balances. Gross loans dropped $10.1 million to $1.01 billion at March 31, 2005, from $1.02 billion at December 31, 2004, as a result of Peoples selling $11.6 million of fixed-rate loans, acquired in the Ashland Banking Acquisition, in the first quarter of 2005. Investment securities totaled $592.7 million at March 31, 2005 versus $602.4 million at year-end 2004. Total liabilities were $1.62 billion at March 31, 2005, compared to $1.63 billion at year-end 2004, a decrease of $14.7 million. At March 31, 2005, deposits totaled $1.10 billion, up $33.7 million from the prior year-end, while borrowed funds declined $46.4 million to $499.6 million, from $546.0 million at December 31, 2004. Stockholders' equity totaled $172.6 million at March 31, 2005, down $2.8 million versus $175.4 million at December 31, 2004. This decrease was the result of a $4.3 million decline in accumulated comprehensive income and treasury stock purchases, net of shares reissued, of $1.5 million during the first quarter of 2005, which were partially offset by Peoples' earnings, net of dividends paid, of $2.7 million. Cash and Cash Equivalents - ------------------------- Peoples' cash and cash equivalents are composed of Federal funds sold, cash and balances due from banks, interest-bearing balances in other institutions and other short-term investments that are readily liquid. The amount of cash and cash equivalents fluctuates on a daily basis due to customer activity and Peoples' liquidity needs. At March 31, 2005, cash and cash equivalents totaled $34.3 million, up $2.9 million (or 9%) from $31.4 million at December 31, 2004. This increase was attributable to a $2.6 million increase in Federal funds sold since year-end 2004. Cash and balances due from banks comprised the largest portion of Peoples' cash and cash equivalents at March 31, 2005, totaling $30.6 million, virtually unchanged from $30.7 million at December 31, 2004. Management believes the current balance of cash and cash equivalents, along with the availability of other funding sources, will allow Peoples to meet cash obligations, special needs and off-balance sheet commitments, such as unfunded loan commitments, undrawn lines of credit, construction loans and letters of credit, as they come due. Peoples will actively manage the principal runoff from the investment and loan portfolios and seek to reinvest those funds appropriately, based on loan demand and investment opportunities, while maintaining adequate liquidity. Further information regarding Peoples' liquidity can be found later in this discussion under "Interest Rate Sensitivity and Liquidity." Investment Securities - --------------------- At March 31, 2005, the amortized cost of Peoples' investment securities totaled $591.3 million compared to $594.5 million at year-end 2004, while the market value of the investment portfolio was $592.7 million at March 31, 2005, down from $602.4 million at December 31, 2004. The difference in amortized cost and market value at March 31, 2005, resulted in unrealized appreciation in the investment portfolio of $1.4 million and a corresponding increase in Peoples' equity of $0.9 million, net of deferred taxes. In comparison, the difference in amortized cost and market value at December 31, 2004, resulted in unrealized appreciation of $7.9 million and an increase in equity of $5.1 million, net of deferred taxes. The following table details Peoples' investment portfolio, at estimated fair value: (Dollars in Thousands) March 31, December 31, 2004 March 31, 2005 2004 2004 US Treasury securities and obligations of US government agencies and corporations $ 69,722 $ 62,770 $ 63,277 Obligations of states and political subdivisions 62,081 62,234 65,726 Mortgage-backed securities 401,872 418,094 466,858 Other securities 59,017 59,266 61,439 --------------------------------------------------------------------------------------------- Total available-for-sale securities $ 592,692 $ 602,364 $ 657,300 ============================================================================================= Overall, the composition of Peoples' investment portfolio at March 31, 2005, was comparable to recent periods. Since March 31, 2004, Peoples' investment in mortgage-backed securities has declined due to management using a portion of the principal runoff to fund loan growth and other corporate purposes, when deemed appropriate. Management anticipates maintaining, or slightly growing, the investment portfolio in the remainder of 2005 depending on loan growth and other corporate liquidity needs. Management monitors the earnings performance and liquidity of the investment portfolio on a regular basis through Asset/Liability Committee ("ALCO") meetings. The ALCO also monitors net interest income, provides recommendations for deposit pricing and maturity guidelines and manages Peoples' interest rate risk. Through active management of the balance sheet and investment portfolio, Peoples seeks to maintain sufficient liquidity to satisfy depositor demand, other company liquidity requirements and various credit needs of its customers. Loans - ----- Peoples Bank originates various types of loans, including commercial, financial and agricultural loans ("commercial loans"), real estate loans and consumer loans, focusing primarily on lending opportunities in central and southeastern Ohio, northwestern West Virginia, and northeastern Kentucky markets. At March 31, 2005, gross loans totaled $1.01 billion, down $10.1 million since year-end 2004. This decrease was the result of Peoples selling $11.6 million of fixed-rate mortgage loans, acquired in the Ashland Banking Acquisition, due to their associated interest rate risk. The following table details total outstanding loans: (Dollars in Thousands) March 31, December 31, March 31, 2005 2004 2004 Commercial, mortgage $ 457,667 $ 450,270 $ 413,167 Commercial, other 128,898 126,473 102,918 Real estate, construction 32,120 35,423 20,196 Real estate, mortgage 334,681 349,965 299,967 Consumer 59,634 60,927 74,545 ---------------------------------------------------------------------------------- Total loans $ 1,013,000 $ 1,023,058 $ 910,793 ================================================================================== Commercial loan balances, including loans secured by commercial real estate, totaled $586.6 million at March 31, 2005, up $9.8 million from $576.7 million at year-end 2004. This increase is the result of lending opportunities within Peoples' existing markets. Commercial loans continued to represent the largest portion of Peoples' total loan portfolio, comprising 57.9% and 56.4% of total loans at March 31, 2005 and December 31, 2004, respectively. Future commercial lending activities will be dependent on economic and related conditions, such as general demand for loans in Peoples' primary markets, interest rates offered by Peoples and normal underwriting considerations. In addition to in-market opportunities, Peoples will continue to lend selectively to creditworthy customers outside its primary markets. While commercial loans comprise the largest portion of Peoples' loan portfolio, residential real estate loans (whether the loans are ultimately sold into the secondary market or retained on Peoples' balance sheet) remain a major focus of Peoples' lending efforts, due in part to the opportunity to sell additional products and services to these consumers. At March 31, 2005, real estate loans, which include construction loans but exclude loans secured by commercial real estate, totaled $366.8 million compared to $385.4 million at December 31, 2004, a decrease of $18.6 million. Real estate loans comprised 36.2% of Peoples' total loan portfolio at March 31, 2005, versus 37.7% at year-end 2004. Included in real estate loans are home equity credit line balances of $45.1 million at March 31, 2005, up 3% from $43.7 million at December 31, 2004. Real estate loan balances have declined in recent periods in response to customer demand for long-term, fixed-rate mortgages, which Peoples generally sells to the secondary market with servicing rights retained. In the first quarter of 2005, Peoples originated 110 long-term, fixed-rate mortgage loans, with total loan amounts of $9 million, compared to 91 loans, with total loan amounts of $8 million, in the fourth quarter of 2004 and 87 loans, with total loan amounts of $8 million, in the first quarter of 2004. At March 31, 2005, Peoples was servicing $124.1 million of real estate loans previously sold to the secondary market compared to $106.4 million at year-end 2004. In addition, Peoples had $1.1 million of fixed-rate real estate loans held for sale to the secondary market at March 31, 2005. Management anticipates selling these loans during the second quarter. At March 31, 2005, consumer loan balances were $59.6 million, down $1.3 million since year-end 2004. The indirect lending area represented a significant portion of Peoples' consumer loans, with balances of $21.3 million and $23.6 million at March 31, 2005 and December 31, 2004, respectively. Strong competition for loans, particularly automobile loans, as well as availability of alternative credit products, such as home equity credit lines, have challenged the performance and growth of Peoples' consumer loan portfolio. Regardless of management's desire to maintain, or even grow, consumer loan balances, Peoples' commitment to quality loan origination based on sound underwriting practices and appropriate loan pricing discipline remains the paramount objective. Loan Concentration Peoples' largest concentration of commercial loans is credits to lodging and lodging-related companies, which comprised approximately 10.6% of Peoples' outstanding commercial loans at quarter-end, compared to 11.4% at December 31, 2004. Loans to assisted living facilities and nursing homes also represented a significant portion of Peoples' commercial loans, comprising 9.0% of Peoples' outstanding commercial loans at March 31, 2005, versus 10.2% at year-end 2004. These lending opportunities have arisen due to the growth of these industries in markets served by Peoples or in contiguous areas, and also from sales associates' efforts to develop these lending relationships. Management believes Peoples' loans to lodging and lodging-related companies, as well as loans to assisted living facilities and nursing homes, do not pose abnormal risk when compared to risk assumed in other types of lending since these credits have been subjected to Peoples' normal underwriting standards, which includes an evaluation of the financial strength, market expertise and experience of the borrowers and principals in these business relationships. In addition, a sizeable portion of the loans to lodging and lodging-related companies is spread over various geographic areas and is guaranteed by principals with substantial net worth. Allowance for Loan Losses - ------------------------- Peoples' allowance for loan losses totaled $15.2 million, or 1.50% of total loans, at March 31, 2005, compared to $14.8 million, or 1.62%, at March 31, 2004 and $14.8 million, or 1.44%, at year-end 2004. The following table presents changes in Peoples' allowance for loan losses: Three Months Ended March 31, (Dollars in Thousands) 2005 2004 Balance, beginning of period $ 14,760 $ 14,575 Chargeoffs (1,068) (1,230) Recoveries 569 635 -------------------------------------------------------------------------- Net chargeoffs (499) (595) Provision for loan losses 941 794 -------------------------------------------------------------------------- Balance, end of period $ 15,202 $ 14,774 ========================================================================== The allowance is allocated among the loan categories based upon the consistent, quarterly procedural discipline described in the "Critical Accounting Policies" section of this discussion. However, the entire allowance for loan losses is available to absorb future loan losses in any loan category. The following details the allocation of the allowance for loan losses: (Dollars in thousands) March 31, December 31, March 31, 2005 2004 2004 Commercial $ 12,251 $ 11,751 $ 11,993 Consumer 1,386 1,394 1,319 Real estate 1,175 1,175 1,079 Overdrafts 269 327 281 Credit cards 121 113 102 -------------------------------------------------------------------------------- Total allowance for loan losses $ 15,202 $ 14,760 $ 14,774 -------------------------------------------------------------------------------- The allowance for credit cards reflects an estimate of the loss from the retained recourse on the business cards included in the credit card portfolio sale. This credit card recourse expires in the second quarter of 2005. While allocations are made to specific loans and pools of loans, the allowance is available for all loan losses. In the first quarter of 2005, net loan chargeoffs were $499,000, down 16% from $595,000 a year ago and 14% from $577,000 in the fourth quarter of 2004. Real estate loans comprised the largest portion of net chargeoffs in 2005's first quarter, totaling $315,000 versus $155,000 a year ago, while consumer loans accounted for $61,000 of 2005's first quarter net chargeoffs, compared to $275,000 in the first quarter of 2004. The following table details Peoples' net chargeoffs: Three Months Ended March 31, December 31, March 31, (Dollars in Thousands) 2005 2004 2004 Real estate $ 315 $ 183 $ 155 Overdrafts 88 232 135 Consumer 61 107 275 Commercial 43 57 (100) Credit card (8) (2) 130 ------------------------------------------------------------------------------------- Total $ 499 $ 577 $ 595 ------------------------------------------------------------------------------------- As a percent of average loans (a) 0.20% 0.23% 0.26% ------------------------------------------------------------------------------------- <FN> (a) Presented on an annualized basis. </FN> Asset quality remains a key focus, as management continues to stress loan underwriting quality more than loan growth. Since December 31, 2004, the level of nonperforming loans has risen slightly due to additional nonaccrual loans. Even with this increase, management believes Peoples' asset quality remains good. In the second quarter of 2005, Peoples' nonperforming loans could increase modestly due to the recently identified impaired commercial loan relationship, with principal balances totaling $2.7 million. Peoples' collection efforts and continued focus on loan quality and other factors affecting loan delinquencies could mitigate the impact of this impairment. The following table details Peoples' nonperforming assets: (Dollars in Thousands) March 31, December 31, March 31, 2005 2004 2004 Loans 90+ days past due and accruing $ 84 $ 285 $ 235 Renegotiated loans 1,116 1,128 - Nonaccrual loans 6,105 5,130 6,656 ----------------------------------------------------------------------------------------------------------- Total nonperforming loans 7,305 6,543 6,891 Other real estate owned 873 1,163 470 ----------------------------------------------------------------------------------------------------------- Total nonperforming assets $ 8,178 $ 7,706 $ 7,361 =========================================================================================================== Nonperforming loans as a percent of total loans 0.72% 0.64% 0.76% =========================================================================================================== Nonperforming assets as a percent of total assets 0.46% 0.43% 0.43% =========================================================================================================== A loan is considered impaired when, based on current information and events, it is probable that Peoples will be unable to collect the scheduled payments of principal or interest according to the contractual terms of the loan agreement. The measurement of potential impaired loan losses is generally based on the present value of expected future cash flows discounted at the loan's historical effective interest rate, or the fair value of the collateral if the loan is collateral dependent. If foreclosure is probable, impairment loss, if any, is measured based on the fair value of the collateral. At March 31, 2005, the recorded investment in loans that were considered to be impaired was $13.0 million, of which $9.8 million were accruing interest and $3.2 million were nonaccrual loans. Included in this amount were $6.9 million of impaired loans for which the related allowance for loan losses was $2.2 million. The remaining impaired loan balances do not have a related allocation of the allowance for loan losses because the loans have either previously been written-down, are well secured or possess characteristics indicative of the ability to repay the loan. For the three months ended March 31, 2005, Peoples' average recorded investment in impaired loans was approximately $10.4 million and interest income of $115,000 was recognized on impaired loans during the period, representing 0.5% of Peoples' total interest income. Funding Sources - --------------- Peoples considers a number of sources when evaluating funding needs, including but not limited to deposits, short-term borrowings, and long-term borrowings. Deposits, both interest-bearing and non-interest-bearing, continue to be the most significant source of funds for Peoples, totaling $1.10 billion at March 31, 2005, compared to $1.07 billion at December 31, 2004. Non-interest-bearing deposits serve as a core funding source. At March 31, 2005, non-interest-bearing deposit balances totaled $157.1 million, up $4.1 million (or 3%) compared to the prior year-end. Since customer activity can result in temporary changes in deposit balances at end of periods, management believes a comparison of average balances to be a more meaningful reflection of the trend in non-interest-bearing deposits. In the first quarter of 2005, non-interest-bearing deposits averaged $155.6 million versus $153.3 in the fourth quarter of 2004 and $135.5 million in the first quarter of 2004, reflecting Peoples' efforts to increase non-interest-bearing deposits. Peoples' strategies include continued emphasis on core deposit growth in products such as non-interest-bearing checking accounts. Interest-bearing deposits totaled $946.0 million at March 31, 2005 compared to $916.4 million at December 31, 2004. This increase is largely the result of a seasonal increase in public fund balances of $21.8 million and additional brokered deposits of $14.9 million. The following details Peoples' interest-bearing deposits: (Dollars in Thousands) March 31, December 31, March 31, 2005 2004 2004 Retail certificates of deposit $ 451,359 $ 456,850 $ 446,179 Interest-bearing transaction accounts 187,034 165,144 167,091 Savings accounts 151,592 157,145 173,013 Money market deposit accounts 111,224 107,394 99,107 Brokered certificates of deposits 44,837 29,909 9,890 ------------------------------------------------------------------------------------------------ Total interest-bearing deposits $ 946,046 $ 916,442 $ 895,280 ------------------------------------------------------------------------------------------------ Peoples continues to experience highly competitive pricing of CDs, which makes it difficult to maintain these balances. In the first quarter of 2005, Peoples introduced its new Ultimate Freedom Checking, an interest-bearing checking product that pays a rate comparable to money market products offered by Peoples' competitors, which is designed to attract customers with higher balances. As expected, Peoples experienced a slight decline in savings balances as customers look for better returns in this rising rate environment. Peoples also accesses other funding sources, including short-term and long-term borrowings, to fund asset growth and satisfy liquidity needs. At March 31, 2005, borrowed funds totaled $499.6 million, down $46.4 million (or 8%) from $546.0 million at year-end 2004, as a result of a decrease in long-term borrowings. The following details Peoples' short-term and long-term borrowings: (Dollars in Thousands) March 31, December 31, March 31, 2005 2004 2004 Short-term borrowings: FHLB advances $ 68,300 $ 37,400 $ 72,200 Retail repurchase agreements 18,424 14,495 15,129 ------------------------------------------------------------------------------------------- Total short-term borrowings $ 83,724 $ 51,895 $ 87,329 Long-term borrowings: FHLB advances $ 207,241 $ 210,814 $ 157,748 National market repurchase agreements 164,100 238,750 216,250 Term note payable 15,300 15,300 17,000 ------------------------------------------------------------------------------------------- Total long-term borrowings $ 386,641 $ 464,864 $ 390,998 ------------------------------------------------------------------------------------------- Subordinated notes held by subsidiary trusts $ 29,285 $ 29,263 $ 29,198 ------------------------------------------------------------------------------------------- Total borrowed funds $ 499,650 $ 546,022 $ 507,525 ------------------------------------------------------------------------------------------- Peoples' short-term borrowings include overnight repurchase agreements and FHLB advances, while long-term borrowings include FHLB advances, a loan from an unrelated financial institution and term repurchase agreements. Advances from the FHLB comprise a significant portion of Peoples' borrowed funds. Short-term FHLB advances are typically variable rate cash management advances used to manage Peoples' daily liquidity needs and may be repaid, in whole or part, at anytime without a penalty. Peoples also utilizes short-term, repo advances ranging in terms from overnight to one year to manage its cost of funds and temporary cash needs. Peoples' long-term FHLB advances are primarily convertible rate advances, with the initial rate fixed for periods ranging from two to four years, depending on the specific advance. After the initial fixed-rate period, these advances are subject to conversion, at the discretion of the FHLB, to a LIBOR based, variable rate product. Peoples has the option to prepay, without penalty, any advance that has been converted or allow the borrowing to reprice. In addition to these convertible rate advances, Peoples utilizes fixed-rate, long-term FHLB advances, both amortizing and non-amortizing, to help manage its interest rate sensitivity and liquidity. Further information regarding Peoples' management of interest rate sensitivity can be found later in this discussion under "Interest Rate Sensitivity and Liquidity." In addition to FHLB advances, Peoples accesses national market repurchase agreements to diversify its funding sources. At March 31, 2005, wholesale repurchase agreements totaled $164.1 million, down $74.7 million from $238.8 million at year-end 2004, as management chose to replace maturing repurchase agreements with short-term FHLB advances and $14.9 million of brokered deposits, which Peoples occasionally uses as an alternative funding sources to wholesale repurchase agreements. Peoples' current wholesale repurchase agreements, based on their original terms, range from two to five years. The repurchase agreements may not be repaid prior to maturity and must remain sufficiently collateralized during the entire term. As a result, a decline in the market value of the investment securities associated with these agreements would require Peoples to allocate additional investment securities to these repurchase agreements. Capital/Stockholders' Equity - ---------------------------- At March 31, 2005, stockholders' equity was $172.6 million versus $175.4 million at December 31, 2004, a decrease of $2.8 million (or 1%) as Peoples' earnings, net of dividends paid, of $2.7 million was offset by treasury stock purchases, net of treasury shares reissued, of $1.5 million and a decline in accumulated comprehensive income of $4.3 million. For the quarter ended March 31, 2005, Peoples Bancorp declared dividends of $2.0 million, representing a dividend payout ratio of 42.4% of earnings, compared to $1.9 million and payout ratio of 35.4% a year ago. While management anticipates Peoples continuing its 39-year history of consistent dividend growth in future periods, Peoples Bancorp's ability to pay dividends on its common shares is largely dependent upon dividends from Peoples Bank. Additionally, Peoples Bancorp has established two trust subsidiaries which have issued preferred securities. If Peoples Bancorp suspends interest payments relating to the trust preferred securities issued by either of the two trust subsidiaries, Peoples will be prohibited from paying dividends on its common shares. Peoples Bancorp or Peoples Bank may decide to limit the payment of dividends, even when the legal ability to pay them exists, in order to retain earnings for other strategic purposes. Included in Peoples' equity is accumulated comprehensive income, net of deferred taxes, which consists primarily of the adjustment for the net unrealized holding gains on available-for-sale securities. At March 31, 2005, accumulated comprehensive income totaled $0.7 million versus $5.0 million at December 31, 2004, a decrease of $4.3 million. Since all the investment securities in Peoples' portfolio are classified as available-for-sale, both the investment and equity sections of Peoples' consolidated balance sheet are more sensitive to the changing market values of investments than if the investment portfolio was classified as held-to-maturity. At March 31, 2005, Peoples had treasury stock totaling $11.5 million, up $1.3 million from year-end 2004. During the first quarter of 2005, Peoples Bancorp repurchased 59,700 common shares (or 11% of the total authorized), at an average price of $26.78 per share, under the 2005 Stock Repurchase Program and 1,704 common shares, at an average price of $26.81, in conjunction with the deferred compensation plan for directors of Peoples Bancorp and its subsidiaries. During the same period, Peoples reissued 15,812 treasury shares due to stock option exercises. Peoples Bancorp anticipates repurchasing additional common shares as authorized under the 2005 Stock Repurchase Program and in compliance with applicable Federal securities laws. Management uses the tangible equity ratio as one measure of the adequacy of Peoples' equity. The ratio, defined as tangible equity as a percentage of tangible assets, excludes the balance sheet impact of intangible assets acquired through acquisitions accounted for using the purchase method of accounting. At March 31, 2005, Peoples tangible equity ratio was 5.94% compared to 6.00% at December 31, 2004 and 7.56% at March 31, 2004. The lower ratio compared to a year ago was primarily the result of an increase in intangible assets due to acquisitions. In addition to monitoring performance through traditional capital measurements (i.e., dividend payout ratios and ROE), Peoples has also complied with the capital adequacy standards mandated by the banking industry. Bank regulators have established "risk-based" capital requirements designed to measure capital adequacy. Under the risk-based capital framework, a bank's balance sheet assets and credit equivalent amounts of off-balance sheet items are typically assigned to one of four broad risk categories: 0% (lowest risk), 20%, 50% or 100% (highest risk). The sum of the resulting weighted values from each of the four risk categories is used in calculating key capital ratios. At March 31, 2005, Peoples' Total Capital, Tier 1 and Leverage ratios were 12.52%, 11.16% and 7.60%, respectively, exceeding the well-capitalized standards of 10%, 6% and 5%, respectively. In addition, all three risk-based capital ratios for Peoples Bank were also well above the minimum standards for a well-capitalized institution at March 31, 2005. Interest Rate Sensitivity and Liquidity - --------------------------------------- While Peoples is exposed to various business risks, the risks relating to interest rate sensitivity and liquidity are typically the most complex and dynamic and could materially impact future results of operation and financial condition. The objective of Peoples' asset/liability management ("ALM") function is to measure and manage these risks in order to optimize net interest income within the constraints of prudent capital adequacy, liquidity and safety. This objective requires Peoples to focus on interest rate risk exposure and adequate liquidity through management of the mix of assets and liabilities. Ultimately, the ALM function is intended to guide management in the acquisition and disposition of earning assets and selection of appropriate funding sources. Interest Rate Risk - ------------------ Interest rate risk ("IRR") is one of the most significant risks for Peoples, and the entire financial services industry, primarily arising in the normal course of business of offering a wide array of financial products to its customers, including loans and deposits, as well as the diversity of its own investment portfolio and borrowed funds. IRR is the potential for economic loss due to future interest rate changes that can impact both the earnings stream as well as market values of financial assets and liabilities. Peoples' exposure to IRR is due primarily to differences in the maturity, or repricing, of earning assets and interest-bearing liabilities. In addition, other factors, such as prepayments of loans and investment securities or early withdrawal of deposits, can expose Peoples to IRR and increase interest costs or reduce revenue streams. Peoples has charged the ALCO with the overall management of Peoples' balance sheet mix and off-balance sheet commitments and hedging transactions related to the management of IRR. The ALCO consists of Peoples' Chief Financial Officer, Chief Executive Officer, President and Chief Lending Officer, as well as other members of senior management. It is the ALCO's responsibility to focus on the future by evaluating trends and potential future events, researching alternatives, then recommending and authorizing an appropriate course of action. To this end, the ALCO has established an IRR management policy that sets the minimum requirements and guidelines for monitoring and managing the level and amount of IRR. The objective of the IRR policy is to encourage adherence to sound fundamentals of banking while allowing sufficient flexibility to exercise the creativity and innovation necessary to meet the challenges and opportunities of changing markets. The ultimate goal of these policies is to optimize net interest income within the constraints of prudent capital adequacy, liquidity and safety. Peoples' ALCO relies on different methods of assessing IRR, including simulations, to project future net interest income and to monitor the sensitivity of the net present market value of equity and the difference, or "gap", between maturing or repricing of rate-sensitive assets and liabilities over various time periods. Peoples uses these methods to monitor IRR for both the short- and long-term. The ALCO places emphasis on simulation modeling as the most beneficial measurement of IRR because it is a dynamic measure. By employing a simulation process that estimates the impact of potential changes in interest rates and balance sheet structures and by establishing limits on these estimated changes to net income and net market value, the ALCO is better able to evaluate interest rate risks and their potential impact to earnings and the market value of equity. The modeling process starts with a base case simulation using the current balance sheet and current interest rates held constant for the next twelve months. At least two alternative interest rate scenarios, one with higher interest rates and one with lower interest rates, assuming parallel, immediate and sustained changes are also prepared using the same balance sheet structure as the base scenario. Comparisons produced from the simulation data, showing the earnings variance from the base interest rate scenario, illustrate the risks associated with the current balance sheet structure. Additional simulations, when deemed appropriate, are prepared using different interest rate scenarios than those used with the base case simulation and/or possible changes in balance sheet structure. The additional simulations are used to better evaluate risks and highlight opportunities inherent in the modeled balance sheet. Comparisons showing the earnings and equity value variance from the base case are provided to the ALCO for review and discussion. The results from these model simulations are evaluated for indications of effectiveness of current IRR management strategies. As part of the evaluation of IRR, the ALCO has established limits on changes in net interest income and the net value of the balance sheet. The ALCO limits the decrease in net interest income of Peoples Bank to 15% or less from base case for each 200 basis point shift in interest rates measured over a twelve- and twenty-four-month period. The ALCO limits the negative impact on net equity to 30% or less given an immediate and sustained 200 basis points shift in interest rates, also assuming a static balance sheet. The difference between rate sensitive assets and rate sensitive liabilities for specified periods of time is known as the gap. The ALCO also reviews static gap measures for specific periods focusing on a one-year cumulative gap. Based on historical trends and performance, the ALCO has determined the ratio of the one-year cumulative gap should be within +/-15% of earning assets at the date of measurement. Results that are outside of any of these limits will prompt a discussion by the ALCO of appropriate actions, if any, that should be taken. At March 31, 2005, Peoples' one-year cumulative gap amount was positive 5.1% of earning assets, which represented $81.3 million more in assets than liabilities that could reprice or mature during that period. Management believes a portion of interest-bearing liabilities are not likely to reprice at their first opportunity, based on current rates and management's control over the pricing of most deposits. Excluding those liabilities, Peoples' adjusted one-year cumulative gap amount at quarter-end was positive 13.6% of earning assets, which represented $218.6 million more in assets than liabilities that mature or may reprice during the next twelve months. The following table is provided to illustrate the estimated earnings at risk and value at risk positions of Peoples, on a pre-tax basis, at March 31, 2005 (dollars in thousands): Immediate Interest Rate Estimated Estimated Increase (Decrease) in Increase (Decrease) Decrease in Basis Points In Net Interest Income Economic Value of Equity - --------------------------- ----------------------------- -------------------------------- 300 $ 3,250 6.3 % $ (14,562) (6.5) % 200 2,598 5.0 (8,482) (3.8) 100 1,443 2.8 (2,987) (1.3) (100) $ (3,045) (5.9) % $ (7,731) (3.5) % The interest rate risk analysis shows Peoples is asset sensitive, which means that increasing interest rates should favorably impact Peoples' net interest income while downward moving interest rates should negatively impact net interest income, based on the assumptions used. However, the variability of cash flows from the investment and loan portfolios continue to have a significant influence on future net interest income and earnings, especially during periods of changing interest rates. In general, the amount of principal runoff from these portfolios tends to decrease as interest rates increase due to fewer prepayments, limiting the amount of funds which can be reinvested at higher rates, while declining interest rates tend to result in a higher level of funds that must be reinvested at lower rates, due to an increase in prepayments. The interest rate table also shows Peoples is within the established IRR policy limits for all simulations and all scenarios for the current period. The ALCO has implemented hedge positions to help protect Peoples' net interest income streams in the event of rising rates which will complement the current IRR position. Peoples has a hedge position on a $17 million long-term, fixed-rate borrowing from the FHLB that may convert to a variable rate, at the FHLB's discretion. In addition, the ALCO may consider additional hedging options, including, but not limited to, the purchase of other interest rate hedge positions, as available and appropriate, that would provide net interest income protection in a rising rate environment. Liquidity - --------- In addition to IRR management, a primary objective of the ALCO is the maintenance of a sufficient level of liquidity. The ALCO defines liquidity as the ability to meet anticipated and unanticipated operating cash needs, loan demand and deposit withdrawals, without incurring a sustained negative impact on profitability. The ALCO's liquidity management policy sets limits on the net liquidity position of Peoples and the concentration of non-core funding sources, both wholesale funding and brokered deposits. Typically, the main source of liquidity for Peoples is deposit growth. Liquidity is also provided from cash generated from earning assets such as maturities, calls, principal payments and net income from loans and investment securities. Through three months of 2005, cash used in financing activities totaled $15.7 million compared to $23.3 million a year ago. This decrease is largely attributable to an increase in deposit balances in the first quarter of 2005. Cash used in investing activities totaled $0.7 million through three months of 2005 versus $27.3 million last year, primarily due to the additional $20 million BOLI investment in the first quarter of 2004. When appropriate, Peoples takes advantage of external sources of funds, such as advances from the FHLB, national market repurchase agreements, and brokered funds. These external sources often provide attractive interest rates and flexible maturity dates that better enable Peoples to match funding dates and pricing characteristics with contractual maturity dates and pricing parameters of earning assets. At March 31, 2005, Peoples had available borrowing capacity of approximately $146 million through these external sources and unpledged securities in the investment portfolio of approximately $171 million that can be utilized as an additional source of liquidity. The net liquidity position of Peoples is calculated by subtracting volatile funds from liquid assets. Peoples' volatile funds consist primarily of short-term growth in deposits, while liquid assets includes short-term investments and unpledged available-for-sale securities. At March 31, 2005, Peoples' net liquidity position was $143.8 million, or 8.0% of total assets, compared to $141.4 million, or 7.8% of total assets, at December 31, 2004. The liquidity position as of March 31, 2005, was within Peoples' policy limit of negative 10% of total assets. Off-Balance Sheet Activities and Contractual Obligations - -------------------------------------------------------- Peoples routinely engages in activities that involve, to varying degrees, elements of risk that are not reflected in whole or in part in the consolidated financial statements. These activities are part of Peoples' normal course of business and include traditional off-balance sheet credit-related financial instruments, interest rate contracts, operating leases, long-term debt and commitments to make additional capital contributions in low-income housing tax credit investments. Traditional off-balance sheet credit-related financial instruments are primarily commitments to extend credit, and standby letters of credit. These activities could require Peoples to make cash payments to third parties in the event certain specified future events occur. The contractual amounts represent the extent of Peoples' exposure in these off-balance sheet activities. However, since certain off-balance sheet commitments, particularly standby letters of credit, are expected to expire or be only partially used, the total amount of commitments does not necessarily represent future cash requirements. These activities are necessary to meet the financing needs of customers. The following table details the total contractual amount of loan commitments and standby letters of credit: March 31, December 31, March 31, (Dollars in Thousands) 2005 2004 2004 Loan commitments $ 148,276 $ 139,731 $ 112,779 Standby letters of credit 32,483 31,612 22,478 Peoples also enters into interest rate contracts where Peoples is required to either receive cash from or pay cash to counter parties depending on changes in interest rates. Peoples utilizes interest rate contracts to help manage the risk of changing interest rates. At March 31, 2005, Peoples held interest rate contracts with notional amounts totaling $17 million and fair values totaling $142,000. Interest rate contracts are carried at fair value on the consolidated balance sheet, with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. As a result, the amounts recorded on the balance sheet at March 31, 2005, do not represent the amounts that may ultimately be paid or received under these contracts. Peoples also has commitments to make additional capital contributions in low-income housing tax credit funds, consisting of a pool of low-income housing projects. As a limited partner in these funds, Peoples receives Federal income tax benefits, which assists Peoples in managing its overall tax burden. At March 31, 2005, these commitments approximated $4.7 million, with approximately $2.0 million expected to be paid over the next twelve months. Management may make additional investments in various tax credit funds. Management does not anticipate Peoples' current off-balance sheet activities will have a material impact on future results of operations and financial condition. Peoples continues to lease certain banking facilities and equipment under noncancelable operating leases with terms providing for fixed monthly payments over periods ranging from two to fifteen years. Many of Peoples' leased banking facilities are inside retail shopping centers and, as a result, are not available for purchase. Management believes these leased facilities increase Peoples' visibility within its markets and afford sales associates additional access to current and potential clients. Effects of Inflation on Financial Statements - -------------------------------------------- Substantially all of Peoples' assets relate to banking and are monetary in nature. As a result, inflation does not impact Peoples to the same degree as companies in capital-intensive industries in a replacement cost environment. During a period of rising prices, a net monetary asset position results in a loss in purchasing power and conversely a net monetary liability position results in an increase in purchasing power. The opposite would be true during a period of decreasing prices. In the banking industry, typically monetary assets exceed monetary liabilities. The current monetary policy targeting low levels of inflation has resulted in relatively stable price levels. Therefore, inflation has had little impact on Peoples' net assets. Future Outlook - -------------- Peoples' first quarter results reflect the positive impact of revenue diversification and good production from the Insurance Agency Acquisitions. While prospects for loan growth remain good and a full-year's impact of acquisitions could enhance earnings, the flattening yield curve continues to cause some concern and emphasizes the need to enhance non-interest income through increased cross-sales. Peoples' capital position, coupled with management's commitment to sound underwriting discipline and Peoples' solid asset quality, serves as a foundation of strength in the current business environment. Management continues its efforts to position Peoples for long-term earnings growth in anticipation of a rising interest rate environment, which will pose additional challenges as competition for loans and deposits intensifies. Cost control remains a key to improving Peoples' earnings, especially during recent periods of net interest margin compression. The cost and effort required to produce financial statements in the Sarbanes-Oxley reporting environment remains higher than prior years even though the first quarter's professional fee expense was below the 2004 fourth quarter total due to the implementation of new requirements in 2004. A full-year's impact of acquisitions completed in 2004 will also cause an increase in certain operating expenses. However, management will continue to monitor expenses and explore opportunities to enhance Peoples' operating efficiency by limiting the overall increase in expenses. In the second half of 2005, Peoples' earnings will benefit from the recent action by the SEC to defer implementation of new accounting rules requiring companies to expense stock options. As a result of this deferral, Peoples will not record the $400,000 to $500,000 of expense, or approximately $0.03 per diluted share after-tax, management projected at year-end 2004. Alternatively, Peoples will implement the new rules beginning January 1, 2006, as required, which should result in Peoples recording stock option expense similar to the pro forma costs estimated in Note 3 of the Notes to the Consolidated Unaudited Financial Statements. Loan growth is a key factor in achieving Peoples' 2005 operating goals, even though the sale of the acquired fixed-rate loans reduced overall loan balances in the first quarter. In the second quarter of 2005, management anticipates loan growth of $10 to $15 million, assuming no significant loan payoffs occur, which is difficult to predict. The recent addition of a loan production office in Westerville, Ohio, has already produced good loan originations, and Peoples' commercial lenders continue to focus on penetrating the central Ohio and the Ashland, Kentucky/Huntington, West Virginia, market areas. Peoples has also increased its marketing of its mortgage loan products, which should improve originations, whether the loans are retained or sold in the secondary market. As Peoples works to grow loans, management continues its efforts to attract core deposits and adjust the mix of funding sources as a way to manage Peoples' overall cost of funds and improve profitability. The flattening yield curve, coupled with intense competition for interest-bearing deposits in this rising rate environment, challenges deposit growth. Public funds were a significant driver of the deposit growth in the first quarter of 2005. Management expects these balances to drop in the second quarter, as the municipalities use these funds for summer projects and other normal operating purposes. In the first quarter of 2005, Peoples' provision for loan losses included a specific provision of $500,000 due to an impairment of a $2.7 million commercial loan relationship. During the second quarter of 2005, management will continue to gather information and analyze the relationship's ability to repay the loan amount. Currently, management expects to place the loans on nonaccrual status, although the business is still a going concern, the loans are current and performing to original terms and the guarantors are working with Peoples to resolve the situation. In the early part of the second quarter of 2005, Peoples has experienced better than normal loan loss recoveries, with recoveries exceeding chargeoffs, and, therefore, the provision for loan losses may be lower in the second quarter of 2005 compared to the first quarter of 2005. However, future provisions will continue to be based on management's quarterly procedural discipline described in the "Critical Accounting Policies" section of this Discussion. Peoples remains a service-oriented company with a sales focus that strives to satisfy clients through a relationship sales process. Through this process, sales associates work to anticipate, uncover, and solve their clients' every financial need, from insurance to banking to investment services. In the remainder of 2005, management expects earnings catalysts to include loan growth, a full-year's impact of recent acquisitions, controlled operating expenses and possible improvement in net interest revenue due to interest rate increases. Forward-Looking Statements - -------------------------- Certain statements in this Form 10-Q which are not historical fact are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. Words such as "expects," "believes", "plans", "will", "would", "should", "could" and similar expressions are intended to identify these forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially. Factors that might cause such a difference include, but are not limited to: (1) competitive pressures among depository institutions increase significantly; (2) changes in the interest rate environment reduce interest margins; (3) prepayment speeds, loan originations and sale volumes, chargeoffs and loan loss provisions are less favorable than expected; (4) the businesses of Putnam and Barengo may not be successfully integrated with Peoples Insurance or the integration may take longer to accomplish than expected; (5) the expected synergies from the Insurance Agency Acquisitions and Ashland Banking Acquisition may make it difficult to maintain relationships with clients, associates or suppliers; (6) general economic conditions may be less favorable than expected; (7) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (8) legislative or regulatory changes or actions may adversely affect Peoples' business; (9) changes and trends in the securities markets; (10) a delayed or incomplete resolution of regulatory issues that could arise; (11) the impact of reputational risk created by these developments on such matters as business generation and retention, funding and liquidity; (12) the costs and effects of regulatory and legal developments, including the outcome of regulatory or other governmental inquiries and legal proceedings and results of regulatory examinations; and (13) other risk factors relating to the banking industry or Peoples as detailed from time to time in Peoples Bancorp's reports filed with the Securities and Exchange Commission ("SEC"). All forward-looking statements speak only as of the execution date of this Form 10-Q and are expressly qualified in their entirety by the cautionary statements. Although management believes the expectations in these forward-looking statements are based on reasonable assumptions within the bounds of management's knowledge of Peoples' business and operations, it is possible that actual results may differ materially from these projections. Additionally, Peoples undertakes no obligation to release revisions to these forward-looking statements to reflect events or circumstances after the date of this Form 10-Q. Copies of documents filed with the SEC are available free of charge at the SEC website at http://www.sec.gov and/or from Peoples' website. ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information called for by this item is provided under the caption "Interest Rate Sensitivity and Liquidity" under Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-Q, and is incorporated herein by reference. CONSOLIDATED AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME For the Three Months Ended March 31, 2005 2004 ------------------------------------ ----------------------------------- (dollars in thousands) Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate ASSETS Securities: Taxable $ 537,014 $ 5,659 4.27% $ 585,446 $ 6,171 4.22% Tax-exempt (1) 62,453 1,039 6.75% 65,204 1,094 6.71% - ----------------------------------------------------------------------------------------------------------------- Total securities 599,467 6,698 4.47% 650,650 7,265 4.47% Loans (2): Commercial (1) 611,085 9,587 6.36% 527,864 7,806 5.95% Real estate (3) 353,769 5,435 6.23% 307,394 5,108 6.57% Consumer 58,971 1,305 8.97% 76,984 1,761 9.20% - ----------------------------------------------------------------------------------------------------------------- Total loans 1,023,825 16,327 6.47% 912,242 14,675 6.43% Less: Allowance for loan loss (14,850) (15,016) - ----------------------------------------------------------------------------------------------------------------- Net loans 1,008,975 16,327 6.53% 897,226 14,675 6.57% Interest-bearing deposits with banks 2,311 10 1.74% 2,553 3 0.46% Federal funds sold 256 2 2.38% 24,697 57 0.91% - ----------------------------------------------------------------------------------------------------------------- Total earning assets 1,611,019 $ 23,037 5.76% 1,575,126 22,000 5.60% Other assets 198,360 156,402 - ----------------------------------------------------------------------------------------------------------------- Total assets $ 1,809,369 $ 1,731,528 $ ================================================================================================================= LIABILITIES AND EQUITY Interest-bearing deposits: Savings $ 154,344 $ 290 0.76% $ 170,945 $ 233 0.55% Interest-bearing demand deposits 279,319 1,007 1.46% 262,864 497 0.76% Time 495,992 3,808 3.11% 460,956 3,070 2.68% - ----------------------------------------------------------------------------------------------------------------- Total interest-bearing deposits 929,655 5,105 2.23% 894,765 3,800 1.71% Borrowed funds: Short-term 91,945 546 2.41% 103,462 277 1.07% Long-term 439,523 4,280 3.90% 416,585 3,961 3.80% - ----------------------------------------------------------------------------------------------------------------- Total borrowed funds 531,468 4,826 3.66% 520,047 4,238 3.25% - ----------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 1,461,123 $ 9,931 2.75% 1,414,812 8,038 2.28% Non-interest-bearing deposits 155,607 135,505 Other liabilities 17,235 8,564 - ----------------------------------------------------------------------------------------------------------------- Total liabilities 1,633,965 1,558,881 Stockholders' equity 175,404 172,647 - ----------------------------------------------------------------------------------------------------------------- Total liabilities and equity $ 1,809,369 $ 1,731,528 $ ================================================================================================================= Interest spread $ 13,106 3.01% $ 13,962 3.32% Interest income to earning assets 5.76% 5.60% Interest expense to earning assets 2.49% 2.04% - ----------------------------------------------------------------------------------------------------------------- Net interest margin 3.27% 3.56% - ----------------------------------------------------------------------------------------------------------------- <FN> (1) Interest income and yields are presented on a fully tax-equivalent basis using a 35% tax rate. (2) Nonaccrual and impaired loans are included in the average balances. Related interest income on nonaccrual loans prior to the loan being placed on nonaccrual is included in loan interest income. Loan fees included in interest income totaled $124 and $120 for the periods presented in 2005 and 2004, respectively. (3) Loans held for sale are included in the average balance listed. Related interest income on loans originated for sale prior to the loan being sold is included in loan interest income. </FN> ITEM 4: CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures - ------------------------------------------------ With the participation of the Chairman of the Board and Chief Executive Officer, the President and Chief Operating Officer and the Chief Financial Officer and Treasurer of Peoples Bancorp Inc. ("Peoples"), Peoples' management has evaluated the effectiveness of Peoples' disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, Peoples' Chairman of the Board and Chief Executive Officer, President and Chief Operating Officer and Chief Financial Officer and Treasurer have concluded that: (a) information required to be disclosed by Peoples in this Quarterly Report on Form 10-Q and the other reports which Peoples files or submits under the Exchange Act would be accumulated and communicated to Peoples' management, including its Chairman of the Board and Chief Executive Officer, President and Chief Operating Officer and Chief Financial Officer and Treasurer, as appropriate to allow timely decisions regarding required disclosure; (b) information required to be disclosed by Peoples in this Quarterly Report on Form 10-Q and the other reports which Peoples files or submits under the Exchange Act would be recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms; and (c) Peoples' disclosure controls and procedures are effective as of the end of the quarterly period covered by this Quarterly Report on Form 10-Q to ensure that material information relating to Peoples and its consolidated subsidiaries is made know to them, particularly during the period in which this Quarterly Report on Form 10-Q is being prepared. Changes in Internal Control Over Financial Reporting - ---------------------------------------------------- There were no changes in Peoples' internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during Peoples' fiscal quarter ended March 31, 2005, that have materially affected, or are reasonably likely to materially affect, Peoples' internal control over financial reporting. PART II - OTHER INFORMATION ITEM 1: Legal Proceedings. - --------------------------- There are no pending legal proceedings to which Peoples or any of its subsidiaries is a party or to which any of their property is subject other than ordinary routine litigation to which Peoples' subsidiaries are parties incidental to their respective businesses. Peoples considers none of such proceedings to be material. ITEM 2: Unregistered Sales of Equity Securities and Use of Proceeds. - --------------------------------------------------------------------- The following table details repurchases by Peoples Bancorp and purchases by "affiliated purchasers" as defined in Rule 10b-18(a)(3) of Peoples Bancorp's common shares during the three months ended March 31, 2005: (d) (c) Maximum Number Total Number of of Common Shares (a) Common Shares that May Yet Be Total Number of (b) Purchased as Part of Purchased Under Common Shares Average Price Publicly Announced the Plans or Period Purchased Paid per Share Plans or Programs (1) Programs (1)(2) January 1 - 31, 2005 5,821 (3) $26.19(3) 4,700 520,300 February 1 - 28, 2005 49,100 $26.93 49,100 471,200 March 1 - 31, 2005 6,483 (4) $26.20(4) 5,900 465,300 - -------------------------------------------------------------------------------------------------------------------- Total 61,404 $26.79 59,700 465,300 ==================================================================================================================== <FN> (1) Information reflects solely the 2005 Stock Repurchase Program originally announced on December 10, 2004, which authorized the repurchase of 525,000 common shares, with an aggregate purchase price of not more than $17.0 million. The 2005 Stock Repurchase Program expires on December 31, 2005. (2) Information reflects maximum number of common shares that may be purchased at the end of the period indicated. (3) Includes an aggregate of 1,121 common shares purchased in open market transactions at an average price of $27.00 by Peoples Bank under the Rabbi Trust Agreement establishing a rabbi trust holding assets to provide payment of the benefits under the Peoples Bancorp Inc. Deferred Compensation Plan for Directors of Peoples Bancorp Inc. and Subsidiaries (the "Rabbi Trust"). (4) Includes an aggregate of 583 common shares purchased in open market transactions at an average price of $26.45 by Peoples Bank for the Rabbi Trust. </FN> ITEM 3: Defaults upon Senior Securities. - ----------------------------------------- None. ITEM 4: Submission of Matters to a Vote of Security Holders. - ------------------------------------------------------------- On April 14, 2005, Peoples Bancorp Inc. held its Annual Meeting of Shareholders in the Ball Room at the Holiday Inn in Marietta, Ohio, with 86% of the outstanding common shares represented by proxy. No votes were placed in person. Four Directors of Peoples Bancorp were re-elected to serve terms of three years each (expiring in 2008): Mark F. Bradley, Frank L. Christy, Theodore P. Sauber and Joseph H. Wesel (Vice Chairman and Leadership Director). Other Directors of Peoples Bancorp who continue to serve after the 2005 Annual Meeting include Carl L. Baker, Jr., George W. Broughton, Wilford D. Dimit, Robert E. Evans (Chairman of the Board), Richard Ferguson, Robert W. Price, Paul T. Theisen and Thomas J. Wolf. The following is a summary of voting results: Abstentions and Broker Nominee For Withheld Non-Votes - --------------------------- -------------- -------------- -------------- Mark F. Bradley 9,013,106 46,615 n/a Frank L. Christy 9,035,089 24,632 n/a Theodore P. Sauber 8,989,008 70,713 n/a Joseph H. Wesel 9,035,018 24,703 n/a ITEM 5: Other Information. - --------------------------- None. ITEM 6: Exhibits. - ------------------ EXHIBIT INDEX Exhibit Number Description Exhibit Location - ------------ ----------------------------------------------------- ----------------- 11 Computation of Earnings Per Share Filed herewith 12 Computation of Ratios Filed herewith 31(a) Certification Pursuant to Rule 13a-14(a)/15d-14(a) Filed herewith [Chairman of the Board and Chief Executive Officer] 31(b) Certification Pursuant to Rule 13a-14(a)/15d-14(a) Filed herewith [Chief Financial Officer and Treasurer] 31(c) Certification Pursuant to Rule 13a-14(a)/15d-14(a) Filed herewith [President and Chief Operating Officer] 32 Section 1350 Certifications Filed herewith SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PEOPLES BANCORP INC. Date: May 9, 2005 By:/s/ ROBERT E. EVANS ------------------------------------------------- Robert E. Evans Chairman of the Board and Chief Executive Officer Date: May 9, 2005 By:/s/ JOHN W. CONLON ------------------------------------------------- John W. Conlon Chief Financial Officer and Treasurer Date: May 9, 2005 By:/s/ MARK F. BRADLEY ------------------------------------------------- Mark F. Bradley President and Chief Operating Officer EXHIBIT INDEX PEOPLES BANCORP INC. QUARTERLY REPORT ON FORM 10-Q FOR QUARTERLY PERIOD ENDED MARCH 31, 2005 EXHIBIT INDEX Exhibit Number Description Exhibit Location - ------------ ----------------------------------------------------- ----------------- 11 Computation of Earnings Per Share Filed herewith 12 Computation of Ratios Filed herewith 31(a) Certification Pursuant to Rule 13a-14(a)/15d-14(a) Filed herewith [Chairman of the Board and Chief Executive Officer] 31(b) Certification Pursuant to Rule 13a-14(a)/15d-14(a) Filed herewith [Chief Financial Officer and Treasurer] 31(c) Certification Pursuant to Rule 13a-14(a)/15d-14(a) Filed herewith [President and Chief Operating Officer] 32 Section 1350 Certifications Filed herewith