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 September 30, 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.
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(Exact name of Registrant as specified in its charter)
Ohio
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(State or other jurisdiction of incorporation or organization)
31-0987416
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(I.R.S. Employer Identification No.)
138 Putnam Street, P. O. Box 738, Marietta, Ohio 45750-0738
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (740) 373-3155
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Not Applicable
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(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
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Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock, at November 3, 2005: 10,493,097 common shares, without par value.
Exhibit Index Appears on Page 36
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
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PEOPLES BANCORP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30, December 31,
ASSETS 2005 2004
Cash and cash equivalents:
Cash and due from banks $ 33,898 $ 30,670
Interest-bearing deposits in other banks 1,033 779
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Total cash and cash equivalents 34,931 31,449
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Available-for-sale investment securities, at estimated fair value (amortized
cost of $604,008 at September 30, 2005 and $594,457 at December 31, 2004) 604,480 602,364
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Loans, net of deferred fees and costs 1,060,556 1,023,058
Allowance for loan losses (14,708) (14,760)
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Net loans 1,045,848 1,008,298
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Loans held for sale 492 612
Bank premises and equipment, net 23,952 22,640
Business owned life insurance 46,568 45,253
Goodwill 59,757 59,096
Other intangible assets 10,168 12,022
Other assets 30,191 27,352
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Total assets $ 1,856,387 $ 1,809,086
===============================================================================================================================
LIABILITIES
Deposits:
Non-interest-bearing $ 158,892 $ 152,979
Interest-bearing 938,010 916,442
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Total deposits 1,096,902 1,069,421
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Short-term borrowings 165,844 51,895
Long-term borrowings 366,309 464,864
Junior subordinated notes held by subsidiary trusts 29,328 29,263
Accrued expenses and other liabilities 17,549 18,225
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Total liabilities 1,675,932 1,633,668
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STOCKHOLDERS' EQUITY
Common stock, no par value, 24,000,000 shares authorized,
10,864,787 shares issued at September 30, 2005 and 10,850,641 shares issued
at December 31, 2004, including shares in treasury 161,998 162,284
Retained earnings 27,614 18,442
Accumulated comprehensive income, net of deferred income taxes 302 4,958
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189,914 185,684
Treasury stock, at cost, 377,035 shares at September 30, 2005 and 415,539 shares
at December 31, 2004 (9,459) (10,266)
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Total stockholders' equity 180,455 175,418
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Total liabilities and stockholders' equity $ 1,856,387 $ 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 For the Nine Months
Ended September 30, Ended September 30,
2005 2004 2005 2004
Interest Income:
Interest and fees on loans $ 17,607 $ 14,891 $ 50,580 $ 44,138
Interest on taxable investment securities 5,997 6,225 17,667 18,229
Interest on tax-exempt investment securities 730 688 2,097 2,098
Other interest income 21 46 51 116
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Total interest income 24,355 21,850 70,395 64,581
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Interest Expense:
Interest on deposits 5,770 4,371 16,464 12,330
Interest on short-term borrowings 1,301 361 2,573 829
Interest on long-term borrowings 3,511 3,641 10,745 10,536
Interest on junior subordinated notes held by subsidiary 623 586 1,835 1,750
trusts
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Total interest expense 11,205 8,959 31,617 25,445
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Net interest income 13,150 12,891 38,778 39,136
Provision for loan losses 485 605 1,466 2,015
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Net interest income after provision for loan losses 12,665 12,286 37,312 37,121
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Other Income:
Service charges on deposit accounts 2,533 2,510 7,279 7,222
Investment and insurance commissions 2,266 2,272 7,186 3,999
Income from fiduciary activities 794 988 2,466 2,574
Electronic banking income 706 608 2,087 1,754
Business owned life insurance 423 494 1,314 1,416
Mortgage banking income 275 227 656 709
Net (loss) gain on securities transactions - (7) 236 30
Net (loss) gain on asset disposals (9) (25) 112 22
Other 130 149 468 644
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Total other income 7,118 7,216 21,804 18,370
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Other Expenses:
Salaries and employee benefits 6,608 6,688 19,952 17,896
Net occupancy and equipment 1,215 1,350 3,842 3,860
Amortization of other intangible assets 661 635 2,023 1,562
Data processing and software 487 431 1,411 1,344
Professional fees 454 452 1,669 1,319
Franchise tax 425 374 1,254 1,086
Marketing 299 315 1,088 825
Bankcard costs 284 404 871 1,106
Other 2,103 1,895 6,035 5,367
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Total other expenses 12,536 12,544 38,145 34,365
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Income before income taxes 7,247 6,958 20,971 21,126
Income taxes 1,979 1,820 5,712 5,569
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Net income $ 5,268 $ 5,138 $ 15,259 $ 15,557
==============================================================================================================================
Earnings per share:
Basic $ 0.50 $ 0.49 $ 1.46 $ 1.47
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Diluted $ 0.50 $ 0.48 $ 1.44 $ 1.45
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Weighted-average number of shares outstanding:
Basic 10,451,578 10,524,304 10,425,704 10,562,547
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Diluted 10,591,470 10,669,798 10,563,753 10,748,064
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Cash dividends declared $ 2,108 $ 1,888 $ 6,087 $ 5,725
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Cash dividends declared per share $ 0.20 $ 0.18 $ 0.58 $ 0.54
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See notes to the consolidated unaudited financial statements
PEOPLES BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Dollars in Thousands, except Per Share Data) Accumulated
Common Stock Retained Comprehensive Treasury
Shares Amount Earnings Income Stock Total
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Balance, December 31, 2004 10,850,641 $ 162,284 $ 18,442 $ 4,958 $ (10,266) $ 175,418
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Net income 15,259 15,259
Other comprehensive loss, net of tax (4,656) (4,656)
Cash dividends declared of $0.58 per share (6,087) (6,087)
Purchase of treasury stock, 64,162 shares (1,721) (1,721)
Exercise of common stock options (reissued
79,466 treasury shares) (788) 2,036 1,248
Tax benefit from exercise of stock options 114 114
Issuance of common stock under dividend
reinvestment plan 14,146 378 378
Distribution of treasury stock for deferred
compensation plan (reissued 14,860 treasury
shares) 284 284
Issuance of common stock related to
acquisitions:
Putnam Agency, Inc. (reissued 4,662 treasury
shares) 3 116 119
Barengo Insurance Agency, Inc. (reissued 3,678
treasury shares) 7 92 99
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Balance, September 30, 2005 10,864,787 $ 161,998 $ 27,614 $ 302 $ (9,459) $ 180,455
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands) For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2005 2004 2005 2004
Net income $ 5,268 $ 5,138 $ 15,259 $ 15,557
Other comprehensive income (loss):
Unrealized (loss) gain on available-for-sale securities arising in the period (5,749) 8,024 (7,199) (716)
Less: reclassification adjustment for net securities (loss) gain included in - (7) 236 30
net income
Unrealized gain (loss) on cash flow hedge derivatives arising in the period 44 (97) 22 (76)
Less: reclassification adjustment for derivative losses included in net (250) - (250) -
income
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Total other comprehensive (loss) income (5,455) 7,934 (7,163) (822)
Income tax benefit (expense) 1,909 (2,777) 2,507 288
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Total other comprehensive (loss) income, net of tax (3,546) 5,157 (4,656) (534)
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Total comprehensive income $ 1,722 $ 10,295 $ 10,603 $ 15,023
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See notes to the consolidated unaudited financial statements
PEOPLES BANCORP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands) For the Nine Months
Ended September 30,
2005 2004
Net cash provided by operating activities $ 35,358 $ 26,838
Cash flows from investing activities:
Purchases of available-for-sale securities (96,676) (118,761)
Proceeds from sales of available-for-sale securities 596 2,065
Proceeds from maturities of available-for-sale securities 86,268 111,035
Net increase in loans (52,913) (45,081)
Net expenditures for premises and equipment (3,292) (1,797)
Net proceeds from sales of other real estate owned 1,426 94
Business acquisitions, net of cash received (1,157) (6,948)
Investment in business owned life insurance - (20,000)
Investment in limited partnership and tax credit funds (3,519) (2,672)
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Net cash used in investing activities (69,267) (82,065)
Cash flows from financing activities:
Net increase in non-interest-bearing deposits 5,913 9,438
Net increase (decrease) in interest-bearing deposits 22,048 (9,766)
Net increase (decrease) in short-term borrowings 113,949 (16,966)
Proceeds from long-term borrowings - 68,300
Payments on long-term borrowings (98,555) (9,859)
Cash dividends paid (5,491) (5,381)
Purchase of treasury stock (1,721) (13,373)
Proceeds from issuance of common stock 1,248 895
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Net cash provided by financing activities 37,391 23,288
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Net increase (decrease) in cash and cash equivalents 3,482 (31,939)
Cash and cash equivalents at beginning of period 31,449 73,426
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Cash and cash equivalents at end of period $ 34,931 $ 41,487
=====================================================================================================================
Supplemental cash flow information:
Interest paid $ 31,100 $ 25,442
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Income taxes paid $ 1,610 $ 115
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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 its subsidiaries (collectively, "Peoples") conform to
accounting principles generally accepted in the United States ("US GAAP")
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 US
GAAP 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 operations for the nine months ended September 30, 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 US GAAP have been condensed or omitted pursuant
to the rules and regulations of the Securities and Exchange Commission
("SEC"). 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 June 1, 2005, the Financial Accounting Standards Board ("FASB ") issued
Statement of Financial Accounting Standards No. 154, "Accounting Changes and
Error Corrections" ("SFAS 154"). SFAS 154 replaces APB Opinion No. 20,
"Accounting Changes", and FASB Statement No. 3, "Reporting Accounting
Changes in Interim Financial Statements", and changes the requirements for
the accounting for and reporting of a change in accounting principle. SFAS
154 applies to all voluntary changes in accounting principle, as well as
changes required by an accounting pronouncement in the unusual instance that
the pronouncement does not include specific transition provisions. SFAS 154
is effective for accounting changes and corrections of errors made in fiscal
years beginning after December 15, 2005. Earlier application is permitted
for accounting changes and corrections of errors made in fiscal years
beginning after June 1, 2005. The adoption of this standard is not expected
to have a material impact on financial condition, results of operations or
liquidity.
On December 16, 2004, the FASB issued a revision of Statement of Financial
Accounting Standards 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 Opinion 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 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 fiscal year beginning
January 1, 2006. Management has not yet determined which method of
transition it will utilize to adopt Statement 123(R). The impact of adopting
Statement 123(R) on Peoples' financial statements will depend on the method
of adoption, the level of stock-based compensation awards and the valuation
method selected by management.
In March 2004, the FASB Emerging Issues Task Force ("EITF") released Issue
03-01, "Meaning of Other-Than-Temporary Impairment" ("Issue 03-01"), which
addressed other-than-temporary impairment for certain debt and equity
investments. The recognition and measurement requirements of Issue 03-01,
and other disclosure requirements not already implemented, were effective
for periods beginning after June 15, 2004. In September 2004, the FASB staff
issued FASB Staff Position ("FSP") EITF 03-1-1, which delayed the effective
date for certain measurement and recognition guidance contained in Issue
03-01. On June 29, 2005, the FASB staff issued FSP FAS 115-1, "The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain
Investments", which replaces the guidance on the meaning of
other-than-temporary impairment in Issue 03-01 with reference to existing
guidance. Under FSP FAS 115-1, an impairment loss should be recognized no
later than when the impairment is deemed other-than-temporary, even if a
decision to sell has not been made. FSP FAS 115-1 is effective for
other-than-temporary impairment analysis conducted for periods beginning
after September 15, 2005. Management does not anticipate the adoption of FSP
FAS 115-1 will have a material impact on financial condition, the results of
operations or liquidity.
3. Stock-Based Compensation:
-------------------------
Peoples accounts for stock-based compensation using the intrinsic value
method. Under the provisions of Peoples Bancorp's 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 Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
Net Income, as reported $ 5,268 $ 5,138 $ 15,259 $ 15,557
Deduct: stock-based compensation expense determined
under fair value based method, net of tax 99 141 359 391
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Pro forma net income $ 5,169 $ 4,997 $ 14,900 $ 15,166
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Basic Earnings Per Share:
As reported $ 0.50 $ 0.49 $ 1.46 $ 1.47
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Pro forma $ 0.49 $ 0.47 $ 1.43 $ 1.44
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Diluted Earnings Per Share:
As reported $ 0.50 $ 0.48 $ 1.44 $ 1.45
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Pro forma $ 0.49 $ 0.47 $ 1.41 $ 1.41
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The fair value was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions:
2005 2004
Risk-free interest rate 4.19% 3.93%
Dividend yield 2.72% 2.59%
Volatility factor of the market price of parent stock 26.6% 29.4%
Weighted-average expected life of options 6.4 years 7 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:
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in Thousands) 2005 2004 2005 2004
Service cost $ 227 $ 226 $ 682 $ 677
Interest cost 204 193 612 579
Expected return on plan assets (296) (243) (887) (729)
Amortization of transition asset - - - -
Amortization of prior service cost 1 - 2 2
Amortization of net loss 59 52 176 156
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Net periodic benefit cost $ 195 $ 228 $ 585 $ 685
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Postretirement Benefits:
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in Thousands) 2005 2004 2005 2004
Service cost $ - $ - $ - $ -
Interest cost 8 8 24 26
Expected return on plan assets - - - -
Amortization of transition asset - - - -
Amortization of prior service cost 3 4 8 9
Amortization of net (gain) loss - - - -
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Net periodic benefit cost $ 11 $ 12 $ 33 $ 35
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EMPLOYER CONTRIBUTIONS
----------------------
Through September 30, 2005, Peoples made contributions totaling $1.5 million
to its defined benefit pension plan for the current year, as recommended by
the Retirement Plan Committee and authorized by the Board of Directors of
Peoples Bancorp.
5. Goodwill:
---------
At the close of business on May 28, 2004, Peoples completed the acquisition
of Barengo Insurance Agency, Inc., ("Barengo"), based in Marietta, Ohio, for
initial consideration of $6.2 million ($3.0 million in cash and $3.2 million
in Peoples Bancorp's common shares). The agreement also provides for
additional consideration of up to $2.7 million ($1.3 million in cash and
$1.4 million in Peoples Bancorp's common shares) to be paid by Peoples over
the subsequent three years, contingent on Barengo achieving certain revenue
growth goals during those three years.
At the close of business on April 30, 2004, Peoples completed the
acquisition of substantially all of the assets of Putnam Agency, Inc.
("Putnam Agency"), with offices in Ashland, Kentucky and Huntington, West
Virginia, for initial consideration of $8.6 million ($6.6 million in cash
and $2.0 million in Peoples Bancorp's common shares), of which $1.5 million
is being paid out in three annual installments beginning April 30, 2005. The
agreement also provides for additional consideration of up to $4.4 million
in cash to be paid by Peoples over the subsequent three years, contingent on
the Putnam Agency achieving certain revenue growth goals during those three
years.
In 2005, Peoples paid additional consideration with respect to the
acquisition of both Barengo and Putnam Agency in accordance with the
respective agreements. The following details the changes in the carrying
amount of goodwill:
(Dollars in Thousands)
Balance at January 1, 2005 $ 59,096
Contingent consideration earned with respect to the
acquisition of:
Barengo 194
Putnam Agency 668
Reductions resulting from valuation adjustments in final
purchase price allocations (201)
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Balance at September 30, 2005 $ 59,757
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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- -----------------------------------------------------------------------
SELECTED FINANCIAL DATA
The following data should be read in conjunction with the unaudited consolidated
financial statements and the management discussion and analysis that follows:
At or For the Three At or For the Nine
Months Ended September 30, Months Ended September 30,
SIGNIFICANT RATIOS 2005 2004 2005 2004
Return on average equity (a) 11.59 % 11.95 % 11.50 % 12.10 %
Return on average assets (a) 1.13 % 1.15 % 1.12 % 1.19 %
Net interest margin (b) 3.32 % 3.34 % 3.30 % 3.44 %
Non-interest income leverage ratio (c) 60.02 % 60.86 % 59.40 % 55.20 %
Efficiency ratio (d) 57.37 % 57.97 % 58.78 % 56.10 %
Average stockholders' equity to average assets 9.79 % 9.59 % 9.75 % 9.82 %
Average loans to average deposits 95.22 % 91.84 % 94.09 % 89.93 %
Cash dividends to net income 40.02 % 36.75 % 39.89 % 36.80 %
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ASSET QUALITY RATIOS
Nonperforming loans as a percent of total loans (e) 0.56 % 0.53 % 0.56 % 0.53 %
Nonperforming assets as a percent of total assets (f) 0.44 % 0.30 % 0.44 % 0.30 %
Allowance for loan losses to total loans 1.39 % 1.55 % 1.39 % 1.55 %
Allowance for loan losses to nonperforming loans (e) 248.1 % 293.5 % 248.1 % 293.5 %
Provision for loan losses to average loans 0.05 % 0.06 % 0.14 % 0.22 %
Net charge-offs as a percentage of average loans (a) 0.19 % 0.21 % 0.20 % 0.26 %
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CAPITAL RATIOS (end of period)
Tier 1 capital ratio 11.34 % 11.97 % 11.34 % 11.97 %
Total risk-based capital ratio 12.65 % 13.29 % 12.65 % 13.29 %
Leverage ratio 7.92 % 7.85 % 7.92 % 7.85 %
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PER SHARE DATA
Earnings per share - basic $ 0.50 $ 0.49 $ 1.46 $ 1.47
Earnings per share - diluted 0.50 0.48 1.44 1.45
Cash dividends declared per share 0.20 0.18 0.58 0.54
Book value per share (end of period) 17.21 16.61 17.21 16.61
Tangible book value per share (end of period) (g) $ 10.54 $ 10.41 $ 10.54 $ 10.41
Weighted average shares outstanding - Basic 10,451,578 10,524,304 10,425,704 10,562,547
Weighted average shares outstanding - Diluted 10,591,470 10,669,798 10,563,753 10,748,064
Common shares outstanding at end of period 10,487,752 10,426,380 10,487,752 10,426,380
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<FN>
(a) Presented on an annualized basis.
(b) Calculated using fully-tax equivalent net interest income as a percentage
of average earning assets.
(c) Non-interest income (less securities and asset disposal gains and/or
losses) as a percentage of non-interest expense (less intangible
amortization).
(d) Non-interest expense (less intangible amortization) as a percentage of
fully-tax equivalent net interest income plus non-interest income.
(e) Nonperforming loans include loans 90 days past due and accruing,
renegotiated loans and nonaccrual loans. (f) Nonperforming assets include
nonperforming loans and other real estate owned. (g) Tangible book value
per share reflects capital calculated for banking regulatory requirements
and excludes balance sheet impact of intangible assets acquired through
acquisitions accounted for using the purchase method 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 Bancorp is a financial holding company subject to the reporting
requirements of, and examination and regulation by, the Federal Reserve Board.
As a financial holding company, the activities of Peoples Bancorp and its
subsidiaries are limited to those deemed financial in nature by the Federal
Reserve Board and complementary to financial activities, including securities
and insurance activities, sponsoring mutual funds and investment companies, and
merchant banking. In addition, the Federal Reserve Board has adopted risk-based
capital guidelines for financial holding companies and their banking
subsidiaries. Failure to maintain the "well-capitalized" standard or the other
criteria for a financial holding company or its banking subsidiaries may result
in requirements to correct the deficiency or limit activities to those generally
allowed bank holding companies.
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 49
financial service locations and 34 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.
References will be found in this Form 10-Q to the following significant events
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")
through a merger effective 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 then 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 are held as treasury shares
and are to be used for future exercises of 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 September 30, 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 events, 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 loan 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 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, the
allowance relating to the Overdraft Privilege program is 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 $14.7
million at September 30, 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 September 30, 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, charges to income could
occur in future periods.
GOODWILL AND OTHER INTANGIBLE ASSETS ACQUIRED
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 September
30, 2005, Peoples had $9.3 million of identifiable intangible assets acquired in
acquisitions, subject to amortization, and $59.8 million of goodwill, not
subject to periodic amortization.
The determination of fair value and subsequent allocation of the cost of an
acquired company generally requires management to make 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 are 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
shorten the amortization period 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 existed as of September 30, 2005. However, future events could cause
management to conclude that impairment indicators exist and re-evaluate
goodwill. If such re-evaluation indicates 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.
INCOME TAXES
Peoples is subject to the income tax laws of the U.S, its states and other
jurisdictions where it conducts business. Income taxes are provided based on the
liability method of accounting. Deferred taxes are recorded to reflect the tax
benefit and consequences of future years' differences between the tax basis of
assets and liabilities and their financial reporting basis.
The calculation of tax liabilities involves dealing with uncertainties in the
application of complex tax laws and is subject to different interpretations by
Peoples and the various tax authorities. These interpretations are subject to
challenge by the tax authorities upon audit or to reinterpretation based on
management's ongoing assessment of facts and evolving case law.
In the ordinary course of business, Peoples is involved in inquiries and reviews
by tax authorities, which normally require management to provide supplemental
information to support certain interpretations and positions taken by Peoples in
its tax returns. Peoples is currently undergoing an examination by the Ohio
Department of Taxation of its 2002 Ohio Corporation Franchise Tax Reports.
Management has agreed to a one-year extension of the statue of limitations for
the 2002 year. However, the administrative process is not yet complete and
Peoples has not received a notice of any proposed adjustment. Due to the fact
the Ohio Department of Taxation is in the early stages of its administrative
process, management cannot accurately make an estimate of potential exposure, if
any.
Although the ultimate outcome of any tax review cannot be predicted with
certainty, management believes that it has taken appropriate positions on its
tax returns. To the extent management determines additional taxes may be due,
Peoples recognizes liabilities for such tax exposures when losses associated
with the claims are judged to be probable and the loss can be reasonably
estimated. Management periodically assesses ongoing tax reviews based on the
most recent information available, and adjusts the liability for tax exposures
as deemed prudent and necessary. No assurance can be given that the final
outcome of these matters will not be different than what is reflected in the
current and historical financial statements.
RESULTS OF OPERATIONS
OVERVIEW OF THE INCOME STATEMENT
- --------------------------------
Net income for the quarter ended September 30, 2005, was $5,268,000, up 3%
compared to $5,138,000 earned in the third quarter a year ago. Diluted earnings
per share were $0.50 for the third quarter of 2005 compared to $0.48 for the
third quarter of 2004, a 4% increase. Peoples' increased earnings were
attributable to improved net interest income from a higher level of earning
assets and lower levels of operating expense. For the first nine months of 2005,
net income totaled $15,259,000, or $1.44 per diluted share, versus $15,557,000,
or $1.45 per diluted share, earned in the corresponding prior-year period.
Net interest income grew 2% to $13,150,000 in the third quarter of 2005, from
$12,891,000 a year ago, as average earning assets increased more than average
interest-bearing liabilities. Third quarter 2005 net interest margin was 3.32%,
down slightly from 3.34% for the third quarter a year ago, due to competition
for loans and deposits and the current slope of the interest rate yield curve.
Compared to the second quarter of 2005, net interest income was up 2% while net
interest margin was unchanged. Through nine months in 2005, net interest income
was $38,778,000 and net interest margin was 3.30%, compared to $39,136,000 and
3.44%, respectively, for the first nine months of 2004.
Other income was $7,118,000 for the third quarter of 2005, down 1% from
$7,216,000 for the same period a year ago. This decline was attributable to
$210,000 of one-time fiduciary fees earned during the third quarter last year
and lower business owned life insurance ("BOLI") revenues of $71,000, which were
partially offset by increased electronic and mortgage banking revenues. On a
year-to-date basis through September 30, 2005, other income was $21,804,000
versus $18,370,000 in 2004, a 19% increase. Revenues attributable to the
Insurance Agency Acquisitions accounted for nearly all of this increase.
In the third quarter of 2005, other expense was $12,536,000 versus $12,544,000
in 2004's third quarter. Other expense was also down 3% compared to the prior
quarter total of $12,862,000. These reductions were the result of lower
occupancy and equipment costs and bankcard processing fees. Through nine months
of 2005, other expense was $38,145,000 versus $34,365,000 a year ago, with
operating costs associated with the Insurance Agency Acquisitions accounting for
much of the increase.
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 that are within its
control, as well as the expected rates to be 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, the market driven slope of the
interest rate yield curve and Peoples' competitors, may negate any adjustments
management is able to make. Consequently, a volatile rate environment or
extended periods of abnormal interest rates, as reflected in the current yield
curve, can make it extremely difficult to manage net interest margin and income
in the short-term, much less be effective at repositioning the balance sheet to
mitigate any impact of future rate changes.
For the quarter ended September 30, 2005, net interest income totaled
$13,150,000, up 2% from $12,891,000 a year ago and $12,916,000 for the second
quarter of 2005. This improvement resulted from increased interest income due
largely to additional earning assets that more than offset increased interest
expense associated with higher levels of interest-bearing liabilities. Through
nine months of 2005, net interest income was $38,778,000 versus $39,136,000 for
the first nine months of 2004.
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:
For the Three Months Ended For the Nine months Ended
September 30, June 30, September 30, September 30,
(Dollars in Thousands) 2005 2005 2004 2005 2004
Net interest income, as reported $ 13,150 $ 12,916 $ 12,891 $ 38,778 $ 39,136
Taxable equivalent adjustments 422 401 405 1,217 1,229
- ----------------------------------------------------------------------------------------------------------------------------
Fully-tax equivalent net interest income $ 13,572 $ 13,317 $ 13,296 $ 39,995 $ 40,365
- ----------------------------------------------------------------------------------------------------------------------------
Average earning assets $ 1,639,189 $ 1,610,024 $ 1,591,511 $ 1,620,175 $ 1,572,405
- ----------------------------------------------------------------------------------------------------------------------------
Net interest margin 3.32% 3.32% 3.34% 3.30% 3.44%
- ----------------------------------------------------------------------------------------------------------------------------
Short-term interest rates continue to increase while longer-term rates have
increased only a modest amount. This flattening of the yield curve during the
last year, coupled with intense competition for loans and deposits, has
compressed net interest margin for many financial institutions, including
Peoples, due to the cost of funds rising at a faster pace than the yield on
earnings assets. These factors resulted in lower net interest margin versus the
same periods in 2004. Peoples' net interest margin was unchanged in the third
quarter from the second quarter of 2005, as improved asset yields were tempered
by increasing costs of interest-bearing liabilities. In the third quarter of
2005, the FTE yield on earning assets was 6.02%, compared to 5.92% in the prior
quarter and 5.57% in 2004's third quarter, while Peoples' cost of funds was
2.98%, 2.87% and 2.44% for the same periods, respectively.
Net loans comprise the largest portion of Peoples' earning assets, averaging
$1.03 billion in the third quarter of 2005, compared to $1.01 billion the prior
quarter and $929.8 million in the third quarter of 2004. Through nine months of
2005, net loans averaged $1.02 billion, up from $911.0 million for the same
period in 2004. The increased loan volume in 2005 is largely the result of
commercial loan originations and loans acquired in the Ashland Banking
Acquisition. For the three months ended September 30, 2005, the FTE yield on net
loans was 6.81%, versus 6.63% and 6.39% for the second quarter of 2005 and third
quarter of 2004, respectively. On a year-to-date basis, net loan yields improved
to 6.66% in 2005 from 6.48% in 2004. Loan yields have increased in 2005 due to
new loans being originated at higher rates, coupled with some repricing of prime
based loans as a result of the Federal Reserve's action to increase interest
rates, although competition for commercial loans and repayment of higher rate
loans have tempered these improvements.
Investment securities averaged $606.5 million in the third quarter of 2005, up
from $597.6 million last quarter but down from $651.1 million a year ago, with
FTE yields of 4.70%, 4.73% and 4.48%, respectively. For the nine months ended
September 30, 2005, average investment securities were $601.2 million, with a
FTE yield of 4.63% versus $647.2 million and 4.42% for the same period in 2004.
The decrease in average balances 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.
Peoples' interest-bearing liabilities averaged $1.49 billion in the third
quarter of 2005, up from $1.46 billion last quarter and $1.45 billion for the
third quarter of 2004. Traditional deposits comprise the majority of Peoples'
interest-bearing liabilities, averaging $939.1 million for the quarter ended
September 30, 2005, compared to $946.6 million in the second quarter of 2005 and
$882.3 million in 2004's third quarter. The higher volume of deposits from a
year ago was due primarily to deposits acquired in the Ashland Banking
Acquisition and additional brokered deposits, while lower savings and retail
time deposits accounted for the decline from the prior quarter. For the quarter
ended September 30, 2005, the average cost of interest-bearing deposits was
2.44%, up from 2.37% and 1.97% for the prior quarter and third quarter of 2004,
respectively.
Peoples also utilizes a variety of borrowings as complementary funding sources
to traditional deposits. For the three months ended September 30, 2005, total
borrowed funds averaged $546.8 million compared to $512.9 million for the second
quarter of 2005 and $570.8 million a year ago. The lower volume of borrowed
funds compared to last year was due to brokered deposit growth, which allowed
Peoples to reduce borrowings. Peoples' overall cost of borrowed funds increased
to 3.91% from 3.80% last quarter and 3.16% in the third quarter of 2004, due to
higher short-term rates resulting from the Federal Reserve's actions to increase
the Federal Funds rate.
Advances from the FHLB, both short-term and long-term, remain a key source of
funding for asset growth, as well as a means of managing Peoples interest rate
risk. Peoples also accesses wholesale repurchase agreements and other borrowings
from unrelated institutions to diversify funding sources. While included in
borrowed funds, Peoples' retail repurchase agreements are marketed and managed
as a cash management tool for commercial customers with higher balances.
Additional information regarding Peoples' borrowed funds can be found later in
this Discussion under the caption "FINANCIAL CONDITION-Funding Sources". The
following details the average balance and rate of Peoples' borrowed funds:
For the Three Months Ended
----------------------------------------------------------------
September 30, 2005 June 30, 2005 September 30, 2004
------------------- ------------------- -------------------
Average Rate Average Rate Average Rate
Balance Balance Balance
Short-term borrowings:
FHLB advances $ 124,671 3.55% $ 85,135 2.94% $ 82,747 1.50%
Retail repurchase agreements 23,471 2.81% 16,252 2.25% 16,755 1.03%
- ---------------------------------------------------------------------------------------------------------
Total short-term borrowings $ 148,142 3.48% $ 101,387 2.87% $ 99,502 1.44%
- ---------------------------------------------------------------------------------------------------------
Long-term borrowings:
FHLB advances $ 197,854 4.12% $ 204,845 4.11% $ 183,136 3.76%
Wholesale repurchase agreements 157,850 3.17% 162,452 3.12% 243,593 2.87%
Other long-term borrowings 42,918 7.29% 44,260 7.06% 44,531 6.22%
- ---------------------------------------------------------------------------------------------------------
Total long-term borrowings $ 398,622 4.15% $ 411,557 4.05% $ 471,260 3.59%
- ---------------------------------------------------------------------------------------------------------
For the Nine Months Ended
September 30,
----------------------------------------------
2005 2004
-------------------- --------------------
Average Average
Balance Rate Balance Rate
Short-term borrowings:
FHLB advances $ 95,595 3.09% $ 77,532 1.23%
Retail repurchase agreements 18,435 2.36% 16,510 0.82%
- ---------------------------------------------------------------------------------------
Total short-term borrowings $ 114,030 3.02% $ 94,042 1.18%
- ---------------------------------------------------------------------------------------
Long-term borrowings:
FHLB advances $ 203,682 4.11% $ 169,236 4.13%
Wholesale repurchase agreements 168,823 3.11% 227,840 2.86%
Other long-term borrowings 43,911 7.04% 45,534 6.07%
- ---------------------------------------------------------------------------------------
Total long-term borrowings $ 416,416 4.04% $ 442,610 3.71%
- ---------------------------------------------------------------------------------------
The higher level of short-term FHLB advances compared to last year is partially
attributable to Peoples repaying other, longer-term borrowings using short-term
advances. Management has also match-funded selected three- and five-year
adjustable rate commercial loans using long-term FHLB advances with similar
amortization and repricing characteristics. The average cost of Peoples'
borrowed funds has steadily increased since mid-2004 in response to the Federal
Reserve's action to increase rates 275 basis points during that period.
Management may make adjustments to the mix of borrowed funds in the future, as
deemed desirable, to manage liquidity and position the balance sheet for
potential changes in interest rates.
Even with the challenges of the current interest rate environment and intense
competition for loans and deposits, Peoples has experienced some improvement in
asset yields in the third quarter of 2005 due to repricing of variable rate
loans and reinvestments of investment portfolio cash flows into higher yielding
securities. Management continues its efforts to position Peoples' balance sheet
for the expected increases in rates during the second half of 2005. At September
30, 2005, Peoples' interest rate risk position and asset-liability simulations
indicate additional interest rate increases would cause net interest income to
increase modestly. However, management believes any projected improvement could
be mitigated by the slope of the yield curve, as well as the impact of continued
competition and other factors affecting interest rates in Peoples' markets that
are difficult to include in interest rate simulations. Consequently, Peoples'
net interest margin and income remain difficult to predict and manage.
PROVISION FOR LOAN LOSSES
- -------------------------
In the third quarter of 2005, Peoples' provision for loan losses was $485,000,
compared to $605,000 a year ago. For the nine months ended September 30, 2005,
the provision for loan losses was $1,466,000 versus $2,015,000 for the first
nine months of 2004. The lower provisions were based on management's quarterly
evaluation of loss factors and are reflective of Peoples' recent loss experience
and recoveries of previously charged-off loans during the third quarter.
When expressed as a percentage of average loans, the provision for loan losses
was 0.14% through nine months of 2005 compared to 0.22% for the same period in
2004. Future provisions will continue to be based on management's quarterly
analysis 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, investment and insurance commissions, fiduciary activities,
electronic banking ("e-banking"), mortgage banking and business owned life
insurance ("BOLI"). Non-interest income also excludes gains and losses on
securities and other assets. In the third quarter of 2005, non-interest income
totaled $7,127,000 compared to $7,202,000 last quarter and $7,248,000 a year
ago, with the timing of some special fiduciary fees in prior periods accounting
for most of the declines. Non-interest income was $21,456,000 and $18,318,000
for first nine months of 2005 and 2004, respectively. This 17% increase was
mainly due to enhanced insurance commissions as a result of the Insurance Agency
Acquisitions in mid-2004.
Service charges and other fees on deposit accounts, which are based on the
recovery of costs associated with services provided, comprised the largest
source of non-interest revenue in the third quarter of 2005, totaling $2,533,000
versus $2,510,000 in 2004's third quarter. Deposit account service charges were
$7,279,000 on a year-to-date basis, compared to $7,222,000 last year. The
following table details Peoples' deposit account service charges:
For the Three Months Ended For the Nine Months
September 30, June 30, September 30, Ended September 30,
(Dollars in Thousands) 2005 2005 2004 2005 2004
Overdraft fees $ 1,738 $ 1,722 $ 1,708 $ 4,890 $ 4,745
Non-sufficient funds fees 506 464 484 1,364 1,362
Other fees and charges 289 286 318 1,025 1,115
-----------------------------------------------------------------------------------------------------------------------
Total $ 2,533 $ 2,472 $ 2,510 $ 7,279 $ 7,222
-----------------------------------------------------------------------------------------------------------------------
Insurance and investment commissions continue to represent a significant portion
of non-interest income. Through nine months of 2005, total revenues are up 80%,
reflecting a full year's impact of the Insurance Agency Acquisitions in
mid-2004. The following table details Peoples' insurance and investment
commissions:
For the Three Months Ended For the Nine Months
September 30, June 30, September 30, Ended September 30,
(Dollars in Thousands) 2005 2005 2004 2005 2004
Property and casualty insurance $ 1,904 $ 1,891 $ 1,936 $ 6,126 $ 3,160
Life and health insurance 154 127 146 422 251
Brokerage 143 104 78 341 294
Fixed annuities 27 104 75 189 186
Credit life and A&H insurance 38 40 37 108 108
----------------------------------------------------------------------------------------------------------------------
Total $ 2,266 $ 2,266 $ 2,272 $ 7,186 $ 3,999
----------------------------------------------------------------------------------------------------------------------
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. For the quarter
ended September 30, 2005, e-banking income was $706,000, up 16% from $608,000 in
2004's third quarter, but down 4% from $734,000 in the second quarter of 2005.
On a year-to-date basis, e-banking income was $2,087,000 and $1,754,000 through
September 30, 2005 and 2004, respectively, a 19% increase. The combination of
Peoples issuing more debit cards to customers and higher volumes of debit card
activity was the primary factor for the increased revenue compared to last year.
At September 30, 2005, Peoples had 82,847 cards issued, with 50% of all eligible
deposit accounts having a debit card, compared to 65,319 cards and a 47%
penetration rate a year ago. Peoples' customers used their debit cards to
complete $116 million of transactions in through nine months of 2005, up 30%
from $89 million a year ago.
In the third quarter of 2005, Peoples' fiduciary revenues decreased $194,000
compared to a year ago, totaling $794,000 and $988,000, respectively. On a
year-to-date basis, fiduciary revenues were $2,466,000 in 2005 versus $2,574,000
in 2004. These declines are attributable to the recognition of a special,
one-time fee, totaling $210,000, earned last year. Fiduciary revenues were also
down 13% compared to 2005's second quarter total of $915,000, with $80,000 due
to the recognition of an annual fee in the second quarter and $26,000 due to
special, one-time fees earned last quarter.
Peoples' mortgage banking involves the origination and selling of long-term,
fixed-rate real estate loans into the secondary market, with servicing rights
retained on most loans sold. The amount of associated revenue recognized is
dependent largely on customer demand for long-term fixed-rate mortgage loans. In
the third quarter of 2005, mortgage banking produced revenues of $275,000
compared to $264,000 in the prior quarter and $227,000 in the third quarter of
2004. Through nine months of 2005, mortgage banking income totaled $656,000
versus $709,000 for the first nine months of 2004. The decline through nine
months is attributable to Peoples' selling $11.6 million of fixed-rate loans,
acquired in the Ashland Banking Acquisition, at a net loss of $187,000 in the
first quarter of 2005, due to their associated interest rate risk.
Peoples' BOLI investment enhances operating efficiency by offsetting rising
employee benefit costs. Throughout 2005, BOLI has produced modestly lower income
due to the impact of a flatter yield curve on the associated investment funds.
Still, management believes BOLI continues 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 September 30, 2005, non-interest expense totaled
$12,536,000 versus $12,544,000 in the same quarter a year ago. Non-interest
expense was down 3% from $12,862,000 for the second quarter of 2005, the result
of lower occupancy and equipment costs and bankcard processing fees. Through
nine months of 2005, non-interest expense was $38,145,000 versus $34,365,000 a
year ago, with operating costs associated with the Insurance Agency Acquisitions
accounting for much of the increase.
Salaries and benefits remain Peoples' largest operating expense, which is
inherent in a service-based industry such as financial services. In the third
quarter of 2005, salaries and benefits were $6,608,000 compared to $6,658,000
last quarter and $6,688,000 for the three months ended September 30, 2004.
Through nine months of 2005, salaries and benefits totaled $19,952,000 versus
$17,896,000 in the prior-year period. A full year impact of the Insurance Agency
Acquisitions accounted for 70% of the increase in salaries and benefits, while
the remaining increase was due almost entirely to higher performance based
incentive cost. Peoples had 537 full-time equivalent employees at both September
30, 2005, and December 31, 2004, compared to 547 a year ago.
In the third quarter of 2005, net occupancy and equipment expenses were
$1,215,000, down 10% from $1,350,000 for the same period a year ago, with the
decline largely attributable to flood-related costs of $100,000 incurred in
2004's third quarter. Compared to the second quarter of 2005, net occupancy and
equipment expense were down 9%, due to reduced depreciation expense of $102,000.
The decline in depreciation expense was attributable to existing assets becoming
fully depreciated, coupled with fewer shorter-term assets, such as computers and
other office equipment, being placed in service. On a year-to-date basis, net
occupancy and equipment expenses were essentially unchanged, totaling $3,842,000
in 2005 and $3,860,000 in 2004, respectively.
Peoples' bankcard costs, which consist primarily of debit card and ATM
processing fees, were $284,000 for the three months ended September 30, 2005,
versus $404,000 for the prior-year quarter, a 30% reduction. Compared to the
second quarter of 2005, bankcard costs were also down 7%, from $305,000. While
ATM and debit card activity continues to show modest growth, the expected impact
of this increased activity on bankcard expense has been offset by a reduction in
various transaction-based charges beginning in early 2005 as the result of a new
processing contract for ATM and debit card operations with Peoples' existing
provider.
Intangible amortization expense increased 4% to $661,000 in the third quarter of
2005, from $635,000 a year ago, due to the amortization of customer relationship
intangible assets from last year's acquisitions. Since Peoples uses an
accelerated method of amortization for existing intangible assets, amortization
expense in the third quarter of 2005 dropped 2% compared to last quarter.
Management expects additional reductions in intangible amortization in future
quarters based on the intangible assets included on Peoples' balance sheet at
September 30, 2005.
For the quarter ended September 30, 2005, professional fees, which include
accounting, legal and other professional expenses, were $454,000 compared to
$452,000 for the third quarter of 2004. Professional fees were $1,669,000
through nine months of 2005, compared to $1,319,000 through the same period a
year ago. Higher audit fees associated with the new regulatory reporting
environment under Sarbanes-Oxley was the primary factor driving the increased
professional fees.
Peoples is subject to various state franchise taxes, which are based largely on
Peoples Bank's equity at year-end. As a result of additional equity at Peoples
Bank from the Insurance Agency Acquisitions, franchise taxes have increased in
2005, totaling $425,000 in the third quarter, versus $418,000 in the second
quarter of 2005 and $374,000 in 2004's third quarter. On a year-to-date basis,
franchise taxes were up 15% through September 30, 2005, when compared to the
same period in 2004. Management believes Peoples Bank's stronger capital level
positions can provide the foundation 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 an allocation of capital which is intended to enhance
profitability and shareholder value.
Other non-interest expense for the third quarter of 2005 includes a $250,000
loss on an interest rate hedging instrument. During the third quarter,
management determined the loss, previously reflected in Peoples' equity as a
component of accumulated comprehensive income, should be charged to earnings.
This decision was based on management's review of the documentation of the
accounting for the hedging instrument. Future changes in the market value of
this interest rate hedge will be recorded in accumulated comprehensive income,
net of deferred taxes, and, as such, are not expect to have any impact on
earnings.
The non-interest income leverage ratio measures the percentage of Peoples'
normal non-interest expense that is offset by 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 income leverage ratio
is defined as non-interest income as a percentage of operating expenses,
excluding gains and losses on securities transactions, asset disposals and early
debt extinguishment, as well as intangible asset amortization. The following
details the components of the non-interest income leverage ratio calculation:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
(Dollars in Thousands) 2005 2004 2005 2004
Total other income, as reported $ 7,118 $ 7,216 $ 21,804 $ 18,370
Add: Loss on securities transactions - 7 - -
Loss on asset disposal 9 25 - -
Deduct: Gain on securities transactions - - 236 30
Gain on asset disposal - - 112 22
Recovery of loss on sale of other real estate owned - - - 210
-----------------------------------------------------------------------------------------------------------------------------
Adjusted total other income 7,127 7,248 21,456 18,108
-----------------------------------------------------------------------------------------------------------------------------
Total other expense, as reported 12,536 12,544 38,145 34,365
Deduct: Amortization of other intangible assets 661 635 2,023 1,562
-----------------------------------------------------------------------------------------------------------------------------
Adjusted total other expense 11,875 11,909 36,122 32,803
-----------------------------------------------------------------------------------------------------------------------------
Non-interest income leverage ratio 60.02% 60.86% 59.40% 55.20%
-----------------------------------------------------------------------------------------------------------------------------
RETURN ON EQUITY
- ----------------
In the third quarter of 2005, Peoples' return on equity ("ROE") was 11.59%
versus 12.04% last quarter and 11.95% for the third quarter a year ago. ROE was
11.50% for the nine months ended September 30, 2005, compared to 12.10% for the
same period in 2004. Peoples' lower ROE is largely attributable to modest
increases in average equity. Management uses ROE to evaluate Peoples' long-term
performance, but 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 1.13% in the third quarter of 2005 compared to
1.15% for 2004's third quarter. On a year-to-date basis, ROA was 1.12% through
September 30, 2005 versus 1.19% for the first nine months of 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 the effectiveness of
Peoples' asset utilization.
INCOME TAX EXPENSE
- ------------------
For the nine months ended September 30, 2005, Peoples' effective tax rate was
27.2%, up from 26.4% a year ago. Peoples continues to make tax-advantaged
investments in order to manage its effective tax rate and overall tax burden. At
September 30, 2005, the amount of tax-advantaged investments totaled $56.8
million compared to $53.4 million at December 31, 2004 and $53.4 million at
September 30, 2004. 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
- -------------------------
Total assets were $1.86 billion at September 30, 2005, compared to $1.81 billion
at year-end 2004 and $1.83 billion at June 30, 2005. Strong internal loan
production accounted for the majority of the increase in total assets. At
September 30, 2005, gross loans were $1.06 billion, up $26.5 million from $1.03
billion at June 30, 2005, and up $37.5 million from $1.02 billion at December
31, 2004. Investment securities at September 30, 2005, were virtually flat
compared to prior periods, as increases due to purchases were largely offset by
a modest decline in overall market value of the portfolio.
Total liabilities grew 2% in the third quarter to $1.68 billion at September 30,
2005, from $1.65 billion at the prior quarter-end, and grew 3% from $1.63
billion at year-end 2004. At September 30, 2005, deposits totaled $1.10 billion
and borrowed funds were $561.5 million, up $27.5 million and $15.5 million from
their respective December 31, 2004 balances. Compared to the prior quarter-end,
total deposits were essentially flat, while borrowed funds increased $26.1
million.
At September 30, 2005, stockholders' equity was $180.5 million, up $5.1 million
versus $175.4 million at December 31, 2004. This increase was primarily the
result of Peoples' earnings, net of dividends declared, of $9.2 million, which
was partially offset by a $4.7 million reduction in accumulated comprehensive
income largely attributable to a change in the market value of the investment
portfolio.
CASH AND CASH EQUIVALENTS
- -------------------------
Peoples' cash and cash equivalents include 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 September 30, 2005, cash and cash equivalents totaled $34.9
million, up 11% from $31.4 million at December 31, 2004. Cash and balances due
from banks comprised the largest portion of Peoples' cash and cash equivalents
at September 30, 2005, totaling $33.9 million, up $3.2 million from $30.7
million at December 31, 2004. This increase is due largely to additional items
in the process of collection at September 30, 2005.
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
productively, 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 September 30, 2005, the amortized cost of Peoples' investment securities
totaled $604.0 million compared to $597.5 million at June 30, 2005 and $594.5
million at year-end 2004, while the market value of the investment portfolio was
$604.5 million, $603.7 million and $602.4 million for the same periods,
respectively. The difference in amortized cost and market value at September 30,
2005, resulted in unrealized appreciation in the investment portfolio of $0.5
million and a corresponding increase in Peoples' equity of $0.3 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) September 30, June 30, December 31, 2004 September 30,
2005 2005 2004
US Treasury securities and obligations of
US government agencies and corporations $ 104,908 $ 94,925 $ 62,770 $ 76,173
Obligations of states and political subdivisions 70,896 67,856 62,234 63,976
Mortgage-backed securities 370,537 382,849 418,094 444,884
Other securities 58,139 58,101 59,266 59,439
- ----------------------------------------------------------------------------------------------------------------------------
Total available-for-sale securities $ 604,480 $ 603,731 $ 602,364 $ 644,472
- ----------------------------------------------------------------------------------------------------------------------------
Since September 30, 2004, Peoples' investment in mortgage-backed securities has
declined due to management using a portion of the principal runoff to fund loan
growth and for other corporate purposes. Management has also reinvested some of
the cash flows from mortgage-backed securities into U.S. agency and municipal
securities to improve the diversification and overall performance of the
investment portfolio in a rising rate environment. Management anticipates
maintaining, or slightly growing, the investment portfolio during 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
September 30, 2005, gross loans totaled $1.06 billion, up $37.5 million since
year-end 2004. This increase was the result of commercial loan growth of $52.8
million, which was partially offset by the first quarter sale of $11.6 million
of fixed-rate mortgage loans, acquired in the Ashland Banking Acquisition. The
following table details total outstanding loans:
(Dollars in Thousands) September 30, June 30, December 31, September 30,
2005 2005 2004 2004
Commercial, mortgage $ 493,954 $ 474,344 $ 450,270 $ 430,513
Commercial, other 135,568 133,537 126,473 116,621
Real estate, construction 45,299 35,950 35,423 37,847
Real estate, mortgage 322,975 330,881 349,965 307,648
Consumer 62,760 59,365 60,927 65,235
- ----------------------------------------------------------------------------------------------------
Total loans $ 1,060,556 $ 1,034,077 $ 1,023,058 $ 957,864
- ----------------------------------------------------------------------------------------------------
Commercial loan balances, including loans secured by commercial real estate,
totaled $629.5 million at September 30, 2005, up 9% from $576.7 million at
year-end 2004, with $21.6 million, or 40%, of the growth occurring in the third
quarter alone. This increase is the result of strong loan production in Peoples'
new central Ohio loan production office and lending opportunities within
Peoples' existing markets. Commercial loans continued to represent the largest
portion of Peoples' total loan portfolio, comprising 59.4% and 56.4% of total
loans at September 30, 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 Peoples' customary 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 September 30, 2005, real estate
loans, which include construction loans but exclude loans secured by commercial
real estate, totaled $368.3 million compared to $385.4 million at December 31,
2004, a decrease of $17.1 million. Real estate loans comprised 34.7% of Peoples'
total loan portfolio at September 30, 2005, versus 37.7% at year-end 2004.
Included in real estate loans are home equity credit line balances of $47.0
million at September 30, 2005, up 7% from $43.7 million at December 31, 2004.
Peoples' real estate loan portfolio continues to be affected by customer demand
for long-term, fixed-rate mortgages, which Peoples generally sells to the
secondary market with servicing rights retained. In the third quarter of 2005,
Peoples originated 142 long-term, fixed-rate mortgage loans, with total loan
amounts of $12 million, compared to 139 loans, with total loan amounts of $12
million, in the second quarter of 2005 and 149 loans, with total loan amounts of
$13 million, in the third quarter of 2004. At September 30, 2005, Peoples was
servicing $140.6 million of real estate loans previously sold to the secondary
market compared to $106.4 million at year-end 2004. In addition, Peoples had
$492,000 of fixed-rate real estate loans held for sale to the secondary market
at September 30, 2005 compared to $612,000 at December 31, 2004.
At September 30, 2005, consumer loan balances, including overdrafts, were $62.8
million, up $1.8 million since year-end 2004. Excluding overdrafts, consumer
loans grew $2.5 million during the third quarter to $60.5 million, from $58.0
million at June 30, 2005. The indirect lending area represented a significant
portion of Peoples' consumer loans and the third quarter growth, with balances
of $26.1 million at September 30, 2005, up $3.1 million since June 30, 2005, and
up $2.5 million compared to December 31, 2004. Peoples' ability to maintain, or
even grow, consumer loans in future quarters continues to be impacted by strong
competition for various types of consumer loans, especially automobile loans, as
well as availability of alternative credit products, such as home equity credit
lines. Additionally, Peoples' commitment to originate quality loans based on
sound underwriting practices and appropriate loan pricing discipline remains the
paramount objective and could limit any future growth.
LOAN CONCENTRATION
Peoples' largest concentration of commercial loans is credits to lodging and
lodging-related companies, which comprised approximately 9.6% 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 8.6% of Peoples'
outstanding commercial loans at September 30, 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 $14.7 million, or 1.39% of loans, at
September 30, 2005, compared to $14.8 million, or 1.44%, at year-end 2004. The
following table presents changes in Peoples' allowance for loan losses:
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in Thousands) 2005 2004 2005 2004
Balance, beginning of period $ 14,728 $ 14,693 $ 14,760 $ 14,575
Chargeoffs (918) (712) (3,090) (2,921)
Recoveries 413 220 1,572 1,137
- -----------------------------------------------------------------------------------------------------
Net chargeoffs (505) (492) (1,518) (1,784)
Provision for loan losses 485 605 1,466 2,015
- -----------------------------------------------------------------------------------------------------
Balance, end of period $ 14,708 $ 14,806 $ 14,708 $ 14,806
- -----------------------------------------------------------------------------------------------------
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) September 30, June 30, December 31, September 30,
2005 2005 2004 2004
Commercial $ 11,884 $ 11,884 $ 11,751 $ 11,751
Real estate 1,400 1,400 1,175 1,645
Consumer 1,149 1,149 1,394 926
Overdrafts 275 295 327 373
Credit cards - - 113 111
- ------------------------------------------------------------------------------------------------------------
Total allowance for loan losses $ 14,708 $ 14,728 $ 14,760 $ 14,806
- ------------------------------------------------------------------------------------------------------------
The significant allocation to commercial loans in recent periods reflects the
higher credit risk associated with this type of lending and continued growth of
commercial loans. In prior periods, Peoples had maintained an allowance for
credit cards that reflected an estimate of the loss from the retained recourse
on the business cards included in the credit card portfolio sale. This recourse
arrangement expired during the second quarter of 2005, eliminating the need for
an allocation for credit cards. While allocations are made to specific loans and
pools of loans, the entire allowance is available for all loan losses existing
as of September 30, 2005.
In the third quarter of 2005, net loan chargeoffs were $505,000, up from
$492,000 a year ago, but down from $514,000 in the second quarter of 2005.
Peoples continues to experience an increased level of recoveries in 2005, which
has had a positive impact on net chargeoffs. The following table details
Peoples' net chargeoffs:
For the Three Months Ended For the Nine Months Ended
September 30, June 30, September 30, September 30,
(Dollars in Thousands) 2005 2005 2004 2005 2004
Commercial $ 203 $ 201 $ 42 $ 447 $ 416
Overdrafts 195 156 243 439 589
Consumer 60 45 106 166 349
Real estate 49 126 106 490 309
Credit card (2) (14) (5) (24) 121
- ----------------------------------------------------------------------------------------------------------------------------
Total $ 505 $ 514 $ 492 $ 1,518 $ 1,784
- ----------------------------------------------------------------------------------------------------------------------------
As a percent of average loans (a) 0.19% 0.20% 0.21% 0.20% 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. At September 30, 2005, the amount of
nonperforming loans was down $1.7 million from the prior quarter-end, due
largely to Peoples reclassifying $2 million of nonaccrual commercial loans to
other real estate owned ("OREO"), as anticipated. As a result of this
reclassification, nonperforming assets as a percent of total assets were
unchanged from 0.44% at June 30, 2005. Additionally, the allowance for loan
losses improved to 248.1% of nonperforming loans during the quarter, from
192.6%. Management believes the property transferred to OREO to be marketable
and anticipates selling the property in the next three to six months, with no
significant gain or loss expected. The following table details Peoples'
nonperforming assets:
September 30, June 30, December 31, September 30,
(Dollars in Thousands) 2005 2005 2004 2004
Loans 90+ days past due and accruing $ 137 $ 475 $ 285 $ 298
Renegotiated loans - - 1,128 -
Nonaccrual loans 5,791 7,173 5,130 4,747
- ----------------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 5,928 7,648 6,543 5,045
Other real estate owned 2,259 353 1,163 301
- ----------------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 8,187 $ 8,001 $ 7,706 $ 5,346
- ----------------------------------------------------------------------------------------------------------------------------
Nonperforming loans as a percent of total loans 0.56% 0.74% 0.64% 0.53%
- ----------------------------------------------------------------------------------------------------------------------------
Nonperforming assets as a percent of total assets 0.44% 0.44% 0.43% 0.30%
- ----------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses as a percent of 248.1% 192.6% 225.6% 293.5%
nonperforming loans
- ----------------------------------------------------------------------------------------------------------------------------
A loan is considered impaired when, based on current information and events, it
is probable that Peoples will be unable to collect the scheduled payments of
principal or interest according to the contractual terms of the loan agreement.
The measurement of potential impaired loan losses is generally based on the
present value of expected future cash flows discounted at the loan's historical
effective interest rate, or the fair value of the collateral if the loan is
collateral dependent. If foreclosure is probable, impairment loss, if any, is
based on the fair value of the collateral.
At September 30, 2005, the recorded investment in loans that were considered
impaired was $9.3 million, of which $6.1 million were accruing interest and $3.2
million were nonaccrual loans. Included in this amount were $3.6 million of
impaired loans for which the related allowance for loan losses was $1.5 million.
The remaining impaired loan balances do not have a related allocation of the
allowance for loan losses because the loans have previously been written-down,
are well secured or possess characteristics indicative of the ability to repay
the loan. For the nine months ended September 30, 2005, Peoples' average
recorded investment in impaired loans was approximately $10.5 million and
interest income of $305,000 was recognized on impaired loans during the period,
representing 0.4% of Peoples' total interest income. This compares to average
impaired loans of approximately $19.5 million and interest income of $508,000,
or 0.8% of Peoples' total interest income, for the nine months ended September
30, 2004.
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
September 30, 2005, compared to $1.07 billion at December 31, 2004.
Non-interest-bearing deposits serve as a core funding source. At September 30,
2005, non-interest-bearing deposit balances totaled $158.9 million, up $5.9
million compared to the prior year-end. Since customer activity can cause
significant, temporary changes in deposit balances from one period to another,
management believes a comparison of average balances to be a more meaningful
reflection of the trend in non-interest-bearing deposits. In the third quarter
of 2005, non-interest-bearing deposits averaged $158.0 million versus $158.8 in
the second quarter of 2005 and $146.5 million in the third quarter of 2004,
reflecting Peoples' efforts to increase non-interest-bearing deposits. Through
nine months of 2005, non-interest-bearing deposits averaged $157.5 million, up
from $141.6 million a year ago. Peoples remains committed to core deposit growth
in products such as non-interest-bearing checking accounts.
Interest-bearing deposits totaled $938.0 million at September 30, 2005, compared
to $916.4 million at December 31, 2004, with additional brokered deposits of
$14.9 million comprising a significant portion of the increase. The following
details Peoples' interest-bearing deposits:
(Dollars in Thousands) September 30, June 30, December 31, September 30,
2005 2005 2004 2004
Retail certificates of deposit $ 446,308 $ 451,522 $ 456,850 $ 429,159
Interest-bearing transaction accounts 195,503 184,308 165,144 166,467
Savings accounts 136,979 145,806 157,145 168,095
Money market deposit accounts 114,366 115,666 107,394 96,876
Brokered certificates of deposits 44,854 44,850 29,909 23,998
- --------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits $ 938,010 $ 942,152 $ 916,442 $ 884,595
- --------------------------------------------------------------------------------------------------------------------
Peoples continues to experience highly competitive pricing of certificates of
deposit, which makes it difficult to maintain these balances at reasonable
rates. In the first quarter of 2005, Peoples introduced a new interest-bearing
checking product that pays a rate comparable to money market products offered by
Peoples' competitors. While this account has attracted some new customers with
higher balances, it has also resulted in some migration of existing savings and
money market account balances to this new product.
Peoples also accesses other funding sources, including short-term and long-term
borrowings, to fund asset growth and satisfy liquidity needs. Advances from the
FHLB comprise a sizeable portion of Peoples' borrowed funds. Typically,
short-term FHLB advances, consisting of overnight repo advances or variable cash
management advances, are used to manage Peoples' daily liquidity needs since
they may be repaid, in whole or part, at anytime without a penalty. Peoples also
utilizes a combination of long-term FHLB advances to help manage its interest
rate sensitivity and liquidity. In most cases, the early repayment of long-term
FHLB advances requires Peoples to incur a prepayment penalty. In addition to
FHLB advances, Peoples accesses national market repurchase agreements to
diversify its funding sources. 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. The following details
Peoples' short-term and long-term borrowings:
(Dollars in Thousands) September 30, June 30, December 31, September 30,
2005 2005 2004 2004
Short-term borrowings:
FHLB advances $ 142,000 $ 111,000 $ 37,400 $ 77,300
Retail repurchase agreements 23,844 20,030 14,495 14,502
- ---------------------------------------------------------------------------------------------------------------------------
Total short-term borrowings 165,844 131,030 51,895 91,802
Long-term borrowings:
FHLB advances $ 194,859 $ 203,624 $ 210,814 $ 188,638
National market repurchase agreements 157,850 157,850 238,750 243,150
Term note payable 13,600 13,600 15,300 15,300
- ---------------------------------------------------------------------------------------------------------------------------
Total long-term borrowings 366,309 375,074 464,864 447,088
- ---------------------------------------------------------------------------------------------------------------------------
Subordinated notes held by subsidiary trusts 29,328 29,307 29,263 29,242
- ---------------------------------------------------------------------------------------------------------------------------
Total borrowed funds $ 561,481 $ 535,411 $ 546,022 $ 568,132
- ---------------------------------------------------------------------------------------------------------------------------
At September 30, 2005, total borrowed funds were up compared to both June 30,
2005 and December 31, 2004, due largely to asset growth. In the third quarter of
2005, short-term borrowings increased $34.8 million primarily as a result of
asset growth that exceeded deposit growth. In addition, Peoples repaid a $5
million convertible, fixed-rate FHLB advance using short-term advances rather
than allowing the advance to convert to a variable-rate advance at higher LIBOR
rates.
CAPITAL/STOCKHOLDERS' EQUITY
- ----------------------------
Stockholders' equity totaled $180.5 million at September 30, 2005, compared to
$175.4 million at December 31, 2004. Peoples' earnings, net of dividends
declared, increased total equity by $9.2 million, which was partially offset by
a $4.7 million reduction in accumulated comprehensive income largely
attributable to a change in the market value of the investment portfolio.
For the nine months ended September 30, 2005, Peoples Bancorp declared dividends
of $6.1 million, representing a dividend payout ratio of 39.9% of earnings,
compared to $5.7 million and payout ratio of 36.8% a year ago. While management
anticipates Peoples Bancorp continuing its 39-year history of consistent
dividend growth, 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.
One component of Peoples' stockholders' equity is accumulated comprehensive
income, net of deferred taxes, which consists of the adjustment for the net
unrealized holding gains on available-for-sale securities and a cash flow
hedging instrument. At September 30, 2005, accumulated comprehensive income
totaled $0.3 million versus $5.0 million at December 31, 2004, a decrease of
$4.7 million, due largely to a change in market value of People's investment
portfolio. The change in accumulated comprehensive income also reflects the
impact of reclassifying a $163,000 after-tax loss on derivative instruments to
earnings. 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 September 30, 2005, Peoples had treasury stock totaling $9.5 million, down
$0.8 million from year-end 2004. Through nine months 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 4,462
common shares, at an average price of $27.42, in conjunction with the deferred
compensation plan for directors of Peoples Bancorp and its subsidiaries. During
the same period, Peoples reissued 102,666 treasury shares in connection with
stock option exercises, distribution from the deferred compensation plan and the
Insurance Agency Acquisitions.
Management uses the tangible capital 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
September 30, 2005, Peoples' tangible equity ratio was 6.19% compared to 6.00%
at December 31, 2004 and 6.31% at September 30, 2004.
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 September 30,
2005, Peoples' Total Capital, Tier 1 and Leverage ratios were 12.65%, 11.34% and
7.92%, 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
September 30, 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 risks that can materially impact future results of operations 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 its management of the mix of assets and
liabilities, their related cash flows and the rates earned and paid on those
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, off-balance sheet commitments and hedging transactions related to the
management of IRR. The ALCO consists of Peoples' Chief Financial Officer,
President and Chief Executive Officer, and Chief Lending Officer, as well as
other members of senior management. It is the ALCO's responsibility to focus on
the future net interest income stream 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 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 streams and to monitor the
sensitivity of the net present estimated fair value of equity and the
difference, or "gap", between maturing or repricing 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 composition 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 projected fair 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 applied to the base case 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 or necessary,
are prepared using different interest rate scenarios than those used with the
base case simulation and/or possible changes in balance sheet composition. 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 time periods 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, which should be taken.
At September 30, 2005, Peoples' one-year cumulative gap amount was positive
10.5% of earning assets, which represented $174.6 million more in assets than
liabilities that are contractually scheduled to 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 13.3% of earning assets, which represented $221.3 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 in the one-year horizon of Peoples, on a pre-tax basis,
at September 30, 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
- --------------------------- ----------------------------- --------------------------------
200 $ 1,872 3.5 % $ (4,840) (2.1) %
100 1,069 2.0 (552) (0.2)
(100) (3,427) (6.5) (8,444) (3.6)
(200) $ (7,471) (14.1) % $ (25,779) (10.9) %
The interest rate risk analysis shows that Peoples is asset sensitive, which
means that increasing interest rates should favorably impact Peoples' net
interest income while downward moving interest rates should negatively impact
net interest income, based on the assumptions used. However, the variability of
cash flows from the investment and loan portfolios continues 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 a hedge position 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
opportunities, 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 changing rate environment.
LIQUIDITY
In addition to IRR management, a primary objective of the ALCO is to maintain 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 by cash generated from earning assets such as maturities,
calls, principal payments and net income from loans and investment securities.
Through nine months of 2005, cash provided by financing activities totaled $37.4
million compared to $23.3 million a year ago, due to higher treasury stock
purchases in 2004. Cash used in investing activities totaled $69.3 million
through nine months of 2005 versus $82.1 million for the first nine months of
2004. The higher cash used for investing activities last year was primarily due
to the additional $20 million BOLI investment and Insurance Agency Acquisitions
in 2004.
When appropriate, Peoples takes advantage of external sources of funds, such as
advances from the FHLB, national market repurchase agreements and brokered
deposits. These external sources often provide attractive interest rates and
flexible maturity dates that enable Peoples to match-fund the payment,
amortization and pricing characteristics of corresponding earning assets. At
September 30, 2005, Peoples had available borrowing capacity of approximately
$107 million through these external sources, along with unpledged securities in
the investment portfolio of approximately $147 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 of short-term deposits
and a variable-rate loan from an unrelated institution, while liquid assets
includes short-term investments and unpledged available-for-sale securities. At
September 30, 2005, Peoples' net liquidity position was $134.6 million, or 7.2%
of total assets, compared to $141.4 million, or 7.8% of total assets, at
December 31, 2004. The liquidity position as of September 30, 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:
September 30, June 30, December 31, September 30,
(Dollars in Thousands) 2005 2005 2004 2004
Loan commitments $ 154,893 $ 153,536 $ 139,731 $ 145,737
Standby letters of credit 31,697 31,832 31,612 21,882
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 September 30, 2005, Peoples held an interest rate
contract with a notional amount of $17 million and fair value of $92,000.
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 September 30,
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 to
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
September 30, 2005, these commitments approximated $2.5 million, with
approximately $0.7 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 or 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 affect 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' third quarter 2005 results reflect continued growth and positive trends
in key areas, including strong loan production, modest improvement in net
interest income and stable levels of non-interest expense. Management expects
interest rate challenges will persist, due to continued competition for both
loans and deposits and the relatively flat yield curve.
Peoples' capital position remains at levels management believes affords
opportunities to grow the balance sheet, while maintaining the long-standing
commitment to sound underwriting practices that have consistently produced solid
asset quality. While recognizing the need to generate short-term results,
management believes its disciplined, long-term approach to improving earnings
through Peoples' diverse revenue base will allow Peoples' to build value for its
shareholders.
Competition for traditional banking relationships and services has limited the
growth in core deposit balances and improvement in total revenues. In late
October 2005, Peoples implemented a marketing strategy designed to attract new
customers and increase non-interest-bearing deposits. As part of this strategy,
Peoples has partnered with a national consulting firm to create a target
marketing campaign that identifies and provides potential customers within
Peoples' existing market areas a direct mail offer of a promotional gift for
opening a new account. Since Peoples has never utilized a targeted direct
marketing program such as this in the past, it is difficult to predict the
impact of this new strategy. However, management expects this program to be well
received and cause growth in non-interest-bearing deposits and related revenues
in the fourth quarter.
Another key focus of management in the fourth quarter includes growing other
deposit balances, in addition to non-interest-bearing balances, to help manage
Peoples' overall cost of funds and interest rate risk. In early 2005, Peoples'
introduced a new interest-bearing checking product, Ultimate Freedom, that has
been successful in attracting new customers, as well as retaining existing
customers. In the fourth quarter, Peoples plans to aggressively price certain
interest-bearing deposits, including short-term certificates of deposit,
compared to its competitors, which is expected to cause an increase in total
deposit balances. While these actions could cause a modest increase in interest
expense, management believes the growth of deposit balance will reduce Peoples'
reliance on FHLB advances and other higher cost borrowings to fund asset growth.
In recent periods, management has taken steps to improve Peoples' operating
efficiency by streamlining operations in various areas, which are having some
positive impact on expenses. As part of this ongoing process, Peoples closed its
loan production office located in Granville, Ohio, during the third quarter.
Despite this closure, Peoples successfully continues to serve commercial
customers in that area through existing operations. Management continues to
evaluate its delivery channels and retail office structure, with the goal of
either reducing operating costs or enhancing revenues.
Growing loans remains a key focus of Peoples' strategic goals. The recent
addition of loan production offices in the central Ohio market has resulted in
significant loan growth through nine months of 2005. Management believes many
opportunities to generate loans exist in the more vibrant central Ohio and is
actively investigating locations in Lancaster, Ohio, for a full-service retail
office. This new office will include an ATM and will allow Peoples to serve
customers in that region better. Management anticipates the office being a
leased facility and expects the office to open in the first half of 2006.
Management is also evaluating opportunities to expand its presence in
Huntington, West Virginia, and other key markets, whether through the addition
of de novo full-service offices or loan production offices.
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 fourth
quarter 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 which may increase
significantly;
(2) changes in the interest rate environment which may adversely impact
interest margins;
(3) prepayment speeds, loan originations and sale volumes, chargeoffs and loan
loss provisions may be less favorable than expected;
(4) the expected synergies from the Insurance Agency Acquisitions and Ashland
Banking Acquisition may make it difficult to maintain relationships with
clients, associates or suppliers;
(5) general economic conditions may be less favorable than expected;
(6) political developments, wars or other hostilities may disrupt or increase
volatility in securities markets or other economic conditions;
(7) legislative or regulatory changes or actions may adversely affect Peoples'
business;
(8) changes and trends in the securities markets;
(9) a delayed or incomplete resolution of regulatory issues that could arise;
(10) the impact of reputational risk created by these developments on such
matters as business generation and retention, funding and liquidity;
(11) 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
(12) 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 September 30,
2005 2004
------------------------------------ -----------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
ASSETS
Securities:
Taxable $ 536,790 $ 5,997 4.43% $ 588,276 $ 6,225 4.20%
Tax-exempt (1) 69,707 1,124 6.45% 62,844 1,060 6.69%
- --------------------------------------------------------------------------------------------------------------------
Total securities 606,497 7,121 4.70% 651,120 7,285 4.48%
Loans (2):
Commercial (1) 648,586 10,915 6.68% 565,142 8,396 5.89%
Real estate (3) 334,463 5,389 6.39% 312,116 5,004 6.36%
Consumer 61,619 1,331 8.57% 67,524 1,525 8.96%
- --------------------------------------------------------------------------------------------------------------------
Total loans $ 1,044,668 17,635 6.75% 944,782 14,925 6.32%
Less: Allowance for loan loss (14,717) (14,939)
- --------------------------------------------------------------------------------------------------------------------
Net loans $ 1,029,951 17,635 6.81% 929,843 14,925 6.39%
Interest-bearing deposits with banks 2,201 16 2.81% 2,501 6 0.87%
Federal funds sold 540 5 3.31% 8,047 40 1.99%
- --------------------------------------------------------------------------------------------------------------------
Total earning assets $ 1,639,189 $ 24,777 6.02% 1,591,511 $ 22,256 5.57%
Other assets 202,586 191,802
- --------------------------------------------------------------------------------------------------------------------
Total assets $ 1,841,775 $ 1,783,313
- --------------------------------------------------------------------------------------------------------------------
LIABILITIES AND EQUITY
Interest-bearing deposits:
Savings 140,133 $ 235 0.67% $ 172,686 $ 321 0.74%
Interest-bearing demand deposits 308,782 1,472 1.89% 258,608 596 0.91%
Time 490,213 4,063 3.29% 450,957 3,454 3.04%
- --------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 939,128 5,770 2.44% 882,251 4,371 1.97%
Borrowed funds:
Short-term 148,142 1,301 3.48% 99,502 361 1.44%
Long-term 398,622 4,134 4.15% 471,260 4,227 3.59%
- --------------------------------------------------------------------------------------------------------------------
Total borrowed funds 546,764 5,435 3.91% 570,762 4,588 3.16%
- --------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 1,485,892 $ 11,205 2.98% 1,453,013 $ 8,959 2.44%
Non-interest-bearing deposits 158,028 146,478
Other liabilities 17,479 12,801
- --------------------------------------------------------------------------------------------------------------------
Total liabilities $ 1,661,399 1,612,292
Stockholders' equity 180,376 171,021
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' $ 1,841,775 $ 1,783,313
equity
Interest spread $ 13,572 3.04% $ 13,297 3.13%
Interest income to earning assets 6.02% 5.57%
Interest expense to earning assets 2.70% 2.23%
- --------------------------------------------------------------------------------------------------------------------
Net interest margin 3.32% 3.34%
- --------------------------------------------------------------------------------------------------------------------
<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 $123 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>
For the Nine Months Ended September 30,
2005 2004
------------------------------------- -----------------------------------
(dollars in thousands) Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
ASSETS
Securities:
Taxable $ 535,602 $ 17,667 4.41% $ 583,365 $ 18,229 4.17%
Tax-exempt (1) 65,620 3,226 6.57% 63,815 3,227 6.75%
- --------------------------------------------------------------------------------------------------------------------
Total securities 601,222 20,893 4.63% 647,180 21,456 4.42%
Loans (2):
Commercial (1) 629,342 30,572 6.49% 544,970 24,177 5.93%
Real estate (3) 342,208 16,174 6.32% 309,007 15,157 6.55%
Consumer 59,622 3,922 8.79% 72,039 4,903 9.09%
- --------------------------------------------------------------------------------------------------------------------
Total loans 1,031,172 50,668 6.55% 926,016 44,237 6.37%
Less: Allowance for loan loss (15,004) (15,011)
- --------------------------------------------------------------------------------------------------------------------
Net loans 1,016,168 50,668 6.66% 911,005 44,237 6.48%
Interest-bearing deposits with banks 2,335 40 2.29% 2,503 11 0.59%
Federal funds sold 450 11 3.27% 11,717 105 1.20%
- --------------------------------------------------------------------------------------------------------------------
Total earning assets 1,620,175 $ 71,612 5.90% 1,572,405 $ 65,809 5.59%
Other assets 200,426 176,394
- --------------------------------------------------------------------------------------------------------------------
Total assets $ 1,820,601 $ 1,748,799
- --------------------------------------------------------------------------------------------------------------------
LIABILITIES AND EQUITY
Interest-bearing deposits:
Savings $ 147,535 $ 790 0.72% $ 174,184 $ 809 0.62%
Interest-bearing demand deposits 296,942 3,844 1.73% 259,711 1,588 0.82%
Time 494,010 11,830 3.20% 454,165 9,933 2.92%
- --------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 938,487 16,464 2.35% 888,060 12,330 1.85%
Borrowed funds:
Short-term 114,030 2,573 3.02% 94,042 829 1.18%
Long-term 416,416 12,580 4.04% 442,610 12,286 3.71%
- --------------------------------------------------------------------------------------------------------------------
Total borrowed funds 530,446 15,153 3.79% 536,652 13,115 3.23%
- --------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 1,468,933 $ 31,617 2.87% 1,424,712 $ 25,445 2.38%
Non-interest-bearing deposits 157,473 141,647
Other liabilities 16,721 10,631
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 1,643,127 1,576,990
Stockholders' equity 177,474 171,809
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' $ 1,820,601 $ 1,748,799
equity
- --------------------------------------------------------------------------------------------------------------------
Interest spread $ 39,995 3.03% $ 40,364 3.21%
Interest income to earning assets 5.90% 5.59%
Interest expense to earning assets 2.60% 2.15%
- --------------------------------------------------------------------------------------------------------------------
Net interest margin 3.30% 3.44%
- --------------------------------------------------------------------------------------------------------------------
<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 $365 and $364 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 President and Chief Executive Officer and the
Chief Financial Officer and Treasurer of Peoples Bancorp Inc. ("Peoples
Bancorp"), Peoples Bancorp's management has evaluated the effectiveness of
Peoples Bancorp's 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 Bancorp's President and Chief Executive
Officer and Chief Financial Officer and Treasurer have concluded that:
(a) information required to be disclosed by Peoples Bancorp in this Quarterly
Report on Form 10-Q and the other reports which Peoples Bancorp files or
submits under the Exchange Act would be accumulated and communicated to
Peoples Bancorp's management, including its President and Chief Executive
Officer and Chief Financial Officer and Treasurer, as appropriate to allow
timely decisions regarding required disclosure;
(b) information required to be disclosed by Peoples Bancorp in this Quarterly
Report on Form 10-Q and the other reports which Peoples Bancorp 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 Bancorp's 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 Bancorp 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 Bancorp's internal control over financial
reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred
during Peoples Bancorp's fiscal quarter ended September 30, 2005, that have
materially affected, or are reasonably likely to materially affect, Peoples
Bancorp's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS.
- ---------------------------
There are no pending legal proceedings to which Peoples Bancorp 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 Bancorp's 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 September 30, 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
Period Purchased Paid per Share Plans or Programs (1) or Programs (1)(2)
July 1 - 31, 2005 737(3) $28.67(3) - 465,300
August 1 - 31, 2005 1,113(4) $29.06(4) - 465,300
September 1 - 30, 2005 481(4) $28.01(4) - 465,300
- ------------------------------------------------------------------------------------------------------
Total 2,331 $28.72 - 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) Information includes an aggregate of 40 common shares purchased in open
market transactions at an average price of $29.21 by Peoples Bank under the
Rabbi Trust Agreement establishing a rabbi trust holding assets to provide
payment of the benefits under the Peoples Bancorp Inc. Deferred
Compensation Plan for Directors of Peoples Bancorp Inc. and Subsidiaries
(the "Rabbi Trust") and an aggregate of 697 common shares acquired at an
average price of $28.64 in connection with the exercise of stock options
granted under Peoples' stock option plans.
(4) Information reflects solely common shares purchased 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.
- -------------------------------------------------------------
None.
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
[President and Chief Executive Officer]
31(b) Certification Pursuant to Rule 13a-14(a)/15d-14(a) Filed herewith
[Chief Financial Officer and Treasurer]
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: November 4, 2005 By: /s/ MARK F. BRADLEY
-------------------------------------
Mark F. Bradley
President and Chief Executive Officer
Date: November 4, 2005 By: /s/ JOHN W. CONLON
-------------------------------------
John W. Conlon
Chief Financial Officer and Treasurer
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
[President and Chief Executive Officer]
31(b) Certification Pursuant to Rule 13a-14(a)/15d-14(a) Filed herewith
[Chief Financial Officer and Treasurer]
32 Section 1350 Certifications Filed herewith