UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K/A
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission file number 0-16772
PEOPLES BANCORP INC.
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(Exact name of Registrant as specified in its charter)
Ohio 31-0987416
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
138 Putnam Street, P. O. Box 738, Marietta, Ohio 45750
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (740) 373-3155
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Shares, No Par Value (5,733,617 outstanding at March 4, 1999)
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
Based upon the closing price of the Common Shares of the Registrant on The
NASDAQ National Market as of March 4, 1999, the aggregate market value of
the Common Shares of the Registrant held by nonaffiliates on that date was
$123,520,116. For this purpose, certain executive officers and directors
are considered affiliates.
Documents Incorporated by Reference:
1) Portions of Registrant's Annual Report to Shareholders for the
fiscal year ended December 31, 1998, are incorporated by reference
into Parts I and II of this Annual Report on Form 10-K.
2) Portions of Registrant's definitive Proxy Statement relating to
the Annual Meeting to be held April 15, 1999, are incorporated by
reference into Part III of this Annual Report on Form 10-K.
PART I
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ITEM 1. BUSINESS.
Introduction
Peoples Bancorp Inc. ("Peoples Delaware") was incorporated under the laws of
the State of Delaware on April 1, 1980. Effective April 6, 1993, Peoples
Delaware was merged into Peoples Bancorp Inc., an Ohio corporation (the
"Company"), for the purpose of changing the Company's state of incorporation
from Delaware to Ohio. The Company's principal business is to act as a
multi-bank holding company. Its wholly-owned subsidiaries are The Peoples
Banking and Trust Company ("Peoples Bank"), The First National Bank of
Southeastern Ohio ("First National Bank"), Peoples Bank FSB and The Northwest
Territory Life Insurance Company, an Arizona corporation ("Northwest
Territory").
The Company's banking subsidiaries provide an array of financial products
and services to their customers, including traditional banking products such
as deposit accounts, lending products, credit and debit cards, corporate and
personal trust services, and safe deposit rental facilities. The Company's
insurance agency subsidiaries also offer investment and insurance products.
The Company's banking subsidiaries provide services through ordinary walk-in
offices, automated teller machines, and automobile drive-in facilities,
banking by phone, and also provide limited cash management services through
computer banking.
The Company's banking subsidiaries operate 34 sales offices in the states of
Ohio, West Virginia, and Kentucky. At December 31, 1998, the Company had
total assets of $880.3 million, total loans of $567.9 million, total deposits
of $714.2 million, and total stockholders' equity of $86.0 million. For the
year ended December 31, 1998, the Company's return on average assets was
1.20% and return on average stockholders' equity was 12.21%.
At December 31, 1998, the Company and its subsidiaries had 362 full-time
equivalent employees (including 27 full-time equivalent employees at the
parent company level). The principal executive office of the Company is
located at 138 Putnam Street, Marietta, Ohio 45750, and its telephone
number is (740) 374-6136.
Over the past several years, the Company has experienced significant growth
in assets and stockholders' equity, primarily through acquisitions as well
as banking center purchases. For the five-year period ended December 31,
1998, the Company's assets grew at a 12.1% compound annual growth rate,
while stockholders' equity grew at a compound annual growth rate of 13.5%.
The Company has also had a history of consistent earnings growth, as net
income per share grew at a compound rate of 9.9% for the five-year period
ended December 31, 1998. Over that same period, the Company's annual return
on average assets and stockholders' equity averaged 1.23% and 13.24%,
respectively.
The Company routinely explores opportunities for additional growth and
expansion of its core financial service businesses, including the
acquisition of companies engaged in similar activities. Management also
focuses on internal growth as a method for reaching performance goals and
reviews key performance indicators on a regular basis to measure the
Company's success. There can be no assurance, however, that the Company
will be able to grow, or if it does, that any such growth or expansions will
result in an increase in the Company's earnings, dividends, book value, or
market value of its common stock.
The Peoples Banking and Trust Company
General
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Peoples Bank, a full-service commercial bank, was chartered as an Ohio
banking corporation under its present name in Marietta, Ohio, in 1902. It
provides the following products to its customers: checking accounts; NOW and
Super NOW accounts; money market deposit accounts; savings accounts; time
certificates of deposit; commercial, installment, and commercial and
residential real estate mortgage loans; credit and debit cards; lease
financing; corporate and personal trust services; and safe deposit rental
facilities. Peoples Bank also sells travelers checks, money orders and
cashier's checks. Peoples Bank provides services through ordinary walk-in
offices, automated teller machines ("ATMs"), automobile drive-in facilities
called "Motor Banks," and banking by phone, and provides limited cash
management services through computer banking.
With offices located in Ohio and West Virginia, Peoples Bank serves
principally Washington, Athens, Meigs, Fairfield, and Gallia Counties in
Ohio and Wood, Wetzel, and Mason Counties in West Virginia, together with
portions of Hocking, Perry, Lawrence, Licking, and Vinton Counties in Ohio
and Tyler, Pleasants, and Jackson Counties in West Virginia. At December 31,
1998, Peoples Bank had assets of $694.0 million, deposits of $582.3 million,
net loans of $455.7 million and 279 full-time equivalent employees. Also at
December 31, 1998, the Investment and Trust Division of Peoples Bank held
approximately $551 million of assets (market value) in trust and custodial
accounts apart from the assets of the Bank.
Recent Acquisitions and Additions
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Effective at the close of business on June 26, 1998, Peoples Bank completed
the purchase of four full-service banking offices located in the communities
of Point Pleasant (two offices), New Martinsville, and Steelton, West
Virginia, from an unaffiliated financial institution. In the transaction,
Peoples Bank assumed approximately $121.0 million in deposits and purchased
$8.3 million in loans. The Point Pleasant offices, located in Mason County,
and the New Martinsville office, located in Wetzel County, currently operate
full-service banking offices and Motor Banks while the Steelton office, also
located in Wetzel County, operates a full-service banking office, Motor Bank,
and an ATM.
On August 17, 1998, a new banking facility was opened at 2107 Pike Street in
Parkersburg, West Virginia. The facility, located in the South Gate Shopping
Center, is a full-service office with an attached Motor Bank, and offers
loan, insurance, investment, and trust services along with traditional
deposit products.
In addition, Peoples Bank will operate a new ATM on leased property in
Nelsonville, Ohio. The lease expires four years from the ATM's delivery
date, which is expected to be in late March, 1999.
Banking Facilities
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Peoples Bank provides services to its customers through the various banking
facilities and ATMs throughout Ohio. In Marietta, Peoples Bank has four
facilities and ATMs: its principal banking office and ATM in downtown
Marietta; a full-service office, Motor Bank and ATM located at the Frontier
Shopping Center and at Second and Scammel Streets; and a full-service office
and ATM located inside a grocery store at Pike and Acme Streets. In Belpre,
Peoples Bank operates a full-service office, two Motor Banks and an ATM.
Other offices in Washington County include full-service offices with Motor
Banks located in Lowell and Reno. Peoples Bank provides services to its
Athens County customers through a full-service office and ATM located at One
North Court Street in downtown Athens, Ohio; a full-service office, Motor
Bank and ATM located at the Athens Mall on East State Street and at the HDL
Center on West Union Street in Athens; three ATMs located on the campus of
Ohio University, also in Athens; and a full service office with a Motor Bank
in Nelsonville, Ohio. In Meigs County, a full-service office and separate
Motor Bank are located in downtown Pomeroy, together with an ATM located
outside a local convenience store; and full-service offices located at
Middleport, and Rutland, Ohio. A full-service office and Motor Bank in
Gallipolis, Ohio, serve customers in neighboring Gallia County. A
full-service office in Baltimore, Ohio, complements a loan production office
in Granville, Ohio, both serving parts of Licking and Fairfield Counties.
Future Sales Offices
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In January 1999, Peoples Bank announced its intention to open three sales
offices in Wal-Mart stores located in the communities of New Martinsville,
Vienna, and Parkersburg, West Virginia. These sales offices will be located
in the front of each Wal-Mart store near the customer service area and will
offer new deposit accounts, loans, insurance products, investment services,
Internet access, ATM access, and more. Peoples Bank anticipates opening its
New Martinsville Wal-Mart sales office on April 1, 1999. The Vienna Wal-Mart
and Parkersburg (south) Wal-Mart sales offices are scheduled to open in the
third quarter and late fourth quarter of 1999, respectively, coinciding with
the grand opening of each store.
The First National Bank of Southeastern Ohio
General
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First National Bank is a national banking association chartered in 1900.
It provides banking services and products that are substantially the same as
those of Peoples Bank. First National Bank's market area is comprised of
Caldwell, Chesterhill, McConnelsville and the surrounding area in Noble and
Morgan Counties, Ohio. At December 31, 1998, it had assets of $87.8
million, deposits of $65.4 million, net loans of $58.0 million and 27
full-time equivalent employees.
First National Bank also owns through its subsidiary Northwest Territory
Insurance Agencies, Inc., two insurance agency subsidiaries, Northwest
Territory Life Insurance Agency, Inc. and Northwest Territory Property and
Casualty Insurance Agency, Inc. (the "Agencies"). The Agencies were created
in compliance with federal regulations allowing insurance powers to national
banks in communities with populations of 5,000 people or less. On December
22, 1995, each Agency received a Certificate of Qualification (license) to
operate the Agency from the Ohio Department of Insurance, thereby allowing
the Agencies to engage in the insurance agency business, subject to the
regulations of the Ohio Department of Insurance and the Comptroller of the
Currency. These were the first insurance agencies in Ohio associated with a
financial institution to receive licenses to conduct a broad-based insurance
business. In August 1998, these agencies were licensed by Ohio-based
Motorists Mutual Insurance Company, MICO Insurance Company and Motorists
Life Insurance Company ("Motorists"). The Agencies offer a complete line of
life and property and casualty products through Motorists. At December 31,
1998, the Agencies had 8 full-time employees.
In addition, a full line of investment products are offered at the Company
through Marketing One Securities, Inc., a unaffiliated registered broker
dealer, member NASD and SIPC. The Company has 16 registered representatives
and one registered principal.
Banking Facilities
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First National Bank operates a full-service office and Motor Bank at one
location at 415 Main Street, Caldwell, Ohio. It also operates a full-service
office and Motor Bank on Marion Street in Chesterhill, Ohio, as well as a
full-service office on Kennebec Street, McConnelsville, Ohio.
The Agencies' principal office is located within the First National Bank
office at 415 Main Street in Caldwell, Ohio. The Agencies also use office
space within the various offices of Peoples Bank and First National Bank as
necessary to serve their customers.
Peoples Bank FSB
General
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On January 1, 1997, the Company acquired Russell Federal Savings Bank
("Russell Federal"), and continued its operation as a federal savings bank.
Russell Federal was originally chartered as a mutual association in 1914,
but later converted to a stock corporation on October 6, 1994.
On December 12, 1997, the Company acquired Gateway Bancorp, Inc. ("Gateway")
and its subsidiary, Catlettsburg Federal Savings Bank ("Catlettsburg
Federal"). Catlettsburg Federal was originally chartered as a mutual savings
and loan association in 1935, and converted to a federally-chartered stock
savings bank in 1994 with Gateway as its sole shareholder.
On January 1, 1998, Russell Federal became a subsidiary of Gateway to begin
the process of aligning the Company's business units in northeast Kentucky.
Effective January 1, 1999, the Company merged Russell Federal and
Catlettsburg Federal to form a single thrift and renamed it "Peoples Bank
FSB". In addition, the Company dissolved Gateway. These actions were
designed to align the Company's Kentucky operations and optimize its focus
on sales and service in its markets. At January 1, 1999, Peoples Bank FSB
had total assets of $97.5 million, deposits of $66.8 million, net loans of
$44.7 million and 20 full-time equivalent employees.
Peoples Bank FSB's principal products include savings accounts, time
certificates of deposit and commercial and residential real estate loans.
Peoples Bank FSB's primary market area consists of Catlettsburg, Ashland,
Grayson, Russell and the contiguous areas of Greenup, Carter, and Boyd
Counties in Kentucky.
Recent Additions
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In 1998, Peoples Bank FSB expanded its products and services to include
non-interest bearing transaction accounts; NOW and Super NOW accounts;
commercial and consumer loans; debit cards; and ATM services. It also
completed the renovation of a new walk-in office and attached Motor Bank
located in Boyd County at 1410 Eagle Drive in Ashland, Kentucky in March,
1998. Peoples Bank FSB added its first ATM as part of the renovation.
Banking Facilities
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In addition to the Ashland office, Peoples Bank FSB serves the financial
needs of customers through a walk-in office located at 2717 Louisa Street
in Catlettsburg, Kentucky. Peoples Bank FSB also has a full-service, walk-in
office and adjacent Motor Bank at 380 South Carol Malone Boulevard in
Grayson, Kentucky and a full-service, walk-in office and Motor Bank on Ferry
Street in Russell, Kentucky.
The Northwest Territory Life Insurance Company
Northwest Territory was organized under Arizona law in 1983 and was issued a
Certificate of Authority to act as a reinsurance company by the State of
Arizona on February 8, 1984. Northwest Territory reinsures credit life and
disability insurance issued to customers of banking subsidiaries of the
Company by the issuing insurance company. At fiscal year end November 30,
1998, Northwest Territory had total assets of $1.5 million and had gross
premium income of $208,000 in 1998, $217,000 in 1997 and $186,000 in 1996.
Northwest Territory reinsures risks (currently not exceeding $15,000 per
insured on a present value basis) within limits established by governmental
regulations and management policy. Northwest Territory has no employees.
Customers and Markets
The Company's service area has a diverse economic structure. Principal
industries in the area include metals, plastics and petrochemical
manufacturing; oil, gas and coal production; and related support industries.
In addition, tourism, education and other service-related industries are
important and growing industries. Consequently, the Company is not
dependent upon any one industry segment for its business opportunities.
Each of the Company's banking subsidiaries originates various types of loans,
including commercial and commercial real estate loans, residential real
estate loans, home equity lines of credit, real estate construction loans,
and consumer loans (including loans to individuals, credit card loans, and
indirect loans). In general, the Company retains most of its originated
loans and, therefore, secondary market activity has been minimal. The loans
of each of the Company's subsidiaries are spread over a broad range of
industrial classifications. The Company believes that its subsidiaries
have no significant concentrations of loans to borrowers engaged in the
same or similar industries and its subsidiaries have no loans to foreign
entities. The lending market areas served by the Company's subsidiaries
are primarily concentrated in southeastern Ohio and neighboring areas of
Kentucky and West Virginia. In addition, a loan production office in
central Ohio provides opportunities to serve customers in that economic
region.
Commercial Loans
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At December 31, 1998, the Company's subsidiaries had outstanding
approximately $212.5 million in commercial loans (including commercial,
financial and agricultural loans), representing approximately 37.4% of the
total aggregate loan portfolio as of that date.
Legal Lending Limit. At December 31, 1998, none of the Company's
subsidiaries had extended credit to any one borrower in excess of its
respective legal lending limit (approximately $10.4 million, $1.2 million
and $1.4 million for Peoples Bank, First National and Peoples Bank FSB,
respectively) at the time the loan was closed.
Lending Practices. Commercial lending entails significant additional risks
as compared with consumer lending (i.e., single-family residential mortgage
lending, installment lending, credit card loans and indirect lending). In
addition, the payment experience on commercial loans typically depends on
adequate cash flow of a business and thus may be subject to a greater
extent, to adverse conditions in the general economy or in a specific
industry. Loan terms include amortization schedules commensurate with the
purpose of each loan, the source of repayment and the risk involved. Approval
is required from each respective banking subsidiary's Board of Directors for
loans to borrowers whose aggregate total debt, including the principal
amount of the proposed loan, exceeds $2 million, $275,000 and $1 million for
Peoples Bank, First National and Peoples Bank FSB, respectively. However,
the Company's Loan Committee approval is required for loans by Peoples Bank
FSB to borrowers whose aggregate total debt exceeds $300,000. The primary
analysis technique used in determining whether to grant a commercial loan is
the review of a schedule of cash flows to evaluate whether anticipated
future cash flows will be adequate to service both interest and principal
due. In addition, collateral is reviewed to determine its value in relation
to the loan.
Peoples Bank periodically evaluates all new commercial loans greater in
amount than $250,000 and on an annual basis, all loans greater in amount
than $500,000. First National and Peoples Bank FSB periodically evaluate
all commercial loans greater in amount than $100,000. If deterioration has
occurred, the lender subsidiary takes effective and prompt action designed
to assure repayment of the loan. Upon detection of the reduced ability of a
borrower to meet cash flow obligations, the loan is considered an impaired
loan and reviewed for possible downgrading or placement on non-accrual status.
Consumer Loans
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At December 31, 1998, the Company's subsidiaries had outstanding consumer
loans (including indirect loans and credit cards) in an aggregate amount of
approximately $111.5 million (approximately 19.6% of the aggregate total
loan portfolio).
Lending Practices. Consumer loans generally involve more risk as to
collectibility than mortgage loans because of the type and nature of the
collateral and, in certain instances, the absence of collateral. As a
result, consumer lending collections are dependent upon the borrower's
continued financial stability, and thus are more likely to be adversely
affected by employment loss, personal bankruptcy, or adverse economic
conditions. Credit approval for consumer loans requires demonstration of
sufficiency of income to repay principal and interest due, stability of
employment, a positive credit record and sufficient collateral for secured
loans. It is the policy of each of the Company's subsidiaries to review its
consumer loan portfolio monthly and to charge off loans that do not meet
that subsidiary's standards and to adhere strictly to all laws and
regulations governing consumer lending. A qualified compliance officer is
responsible for monitoring the Company's performance in this area and for
advising and updating loan personnel.
The Company's subsidiaries make credit life insurance and health and
accident insurance available to all qualified buyers, thus reducing their
risk of loss when a borrower's income is terminated or interrupted. Each
subsidiary also offers its customers credit card access through the consumer
lending department of Peoples Bank.
Real Estate Loans
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At December 31, 1998, there were approximately $243.9 million ($213.3
million, $20.3 million, and $10.3 million, respectively) in residential real
estate, home equity lines of credit and construction mortgages outstanding,
representing 43.0% of total loans outstanding.
Lending Practices. The Company's subsidiaries require that the residential
real estate loan amount be no more than 90% of the purchase price or the
appraisal value of the real estate securing the loan, unless private
mortgage insurance is obtained by the borrower with respect to the percentage
exceeding such 90%. On occasion, the subsidiaries may lend up to 100% of
the appraised value of the real estate. The risk conditions of these loans
are considered during underwriting for the purposes of establishing an
interest rate compatible with the risks inherent in such home equity loans.
Loans made for each subsidiary's portfolio in this lending category are
generally one to five year adjustable rate, fully amortized mortgages. The
subsidiaries also generate fixed rate real estate loans and generally retain
these loans. All real estate loans are secured by first mortgages with
evidence of title in favor of the subsidiary in the form of an attorney's
opinion of the title or a title insurance policy. The subsidiaries also
require proof of hazard insurance with the subsidiary named as the mortgagee
and as the loss payee. Licensed appraisals are required in the case of
loans in excess of $250,000 for Peoples Banks and $75,000 for First National
and Peoples Bank FSB.
Home Equity Loans. Home equity lines of credit are generally made as second
mortgages by the Company's subsidiaries. The maximum amount of a home equity
line of credit is generally limited to 80% of the appraised value of the
property less the balance of the first mortgage. The Company's subsidiaries
will lend up to 100% of the appraised value to the property at higher
interest rates which are considered compatible with the additional risk
assumed in these types of equilines. The home equity lines of credit are
written with ten-year terms but are subject to review upon request for
renewal. For the past two years, the Company's subsidiaries have generally
charged a fixed rate on their home equity loans for the first five years.
At the end of the five-year period, the equiline reverts to a variable
interest rate product.
Construction Loans. Construction financing is generally considered to
involve a higher degree of risk of loss than long-term financing on improved,
occupied real estate. Risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value at
completion of construction and the estimated cost (including interest) of
construction. If the estimate of construction cost proves to be inaccurate,
the subsidiary making the loan may be required to advance funds beyond the
amount originally committed to permit completion of the project.
Competition
The banking subsidiaries of the Company experience significant competition
in attracting depositors and borrowers. Competition in lending activities
comes principally from other commercial banks, savings associations,
insurance companies, governmental agencies, credit unions, brokerage firms
and pension funds. The primary factors in competing for loans are interest
rate and overall lending services. Competition for deposits comes from other
commercial banks, savings associations, money market funds and credit unions
as well as from insurance companies and brokerage firms. The primary factors
in competing for deposits are interest rates paid on deposits, account
liquidity, convenience of office location and overall financial condition.
The Company believes that its size provides flexibility, which enables the
Company to offer an array of banking products and services. The Company's
financial condition also contributes to a favorable competitive position in
the markets it serves.
Northwest Territory operates in the highly competitive industry of credit
life and disability insurance. The principal methods of competition in the
credit life and disability insurance industry are the availability of
coverages and premium rates. The Company believes Northwest Territory has a
competitive advantage due to the fact that the business of Northwest
Territory is limited to the accepting of life and disability reinsurance
ceded in part to Northwest Territory from the credit life and disability
insurance purchased by loan customers of primarily Peoples Bank and First
National Bank.
The Agencies operate in the extremely competitive life insurance and
property and casualty insurance industries, due mostly to the large number
of companies and agents located within the Company's markets. The Agencies
provide several insurance product options to consumers including traditional
life insurance as well as property and casualty insurance products. The
Agencies' future competitive advantage will be based on their ability to
provide products to consumers efficiently with sensitivity to customer
service and cost price issues.
The Company primarily focuses on non-major metropolitan markets in which to
provide products and services. Management believes the Company has developed
a niche and certain level of expertise in serving these communities.
The Company historically has operated under a "needs-based" selling approach
that management believes has proven successful in serving the financial
needs of many customers. Management anticipates that in future periods, the
Company will increase its investment in sales training and education to
assist in the development of the Company's associates and their
identification of customer service opportunities.
It is not the Company's strategy to compete solely on the basis of interest
rate. Management believes that a focus on customer relationships and
incentives that promote customers' continued use of the Company's financial
products and services will lead to enhanced revenue opportunities.
Management believes the integration of traditional financial products with
the recent entry into insurance product offerings will lead to enhanced
revenues through complementary product offerings that satisfy customer
demands for high quality, "one-stop shopping".
Supervision and Regulation
The following is a summary of certain statutes and regulations affecting the
Company and its subsidiaries and is qualified in its entirety by reference
to such statutes and regulations:
General
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Bank Holding Company. The Company is a bank holding company under the Bank
Holding Company Act of 1956, which restricts the activities of the Company
and the acquisition by the Company of voting stock or assets of any bank,
savings association or other company. The Company is also subject to the
reporting requirements of, and examination and regulation by, the Federal
Reserve Board. The Company's subsidiary banks are subject to restrictions
imposed by the Federal Reserve Act on transactions with affiliates, including
any loans or extensions of credit to the Company or its subsidiaries,
investments in the stock or other securities thereof and the taking of such
stock or securities as collateral for loans to any borrower; the issuance of
guarantees, acceptances or letters of credit on behalf of the Company and
its subsidiaries; purchases or sales of securities or other assets; and the
payment of money or furnishing of services to the Company and other
subsidiaries. The Company is prohibited from acquiring direct or indirect
control of more than 5% of any class of voting stock or substantially all of
the assets of any bank holding company without the prior approval of the
Federal Reserve Board. The Company and its subsidiaries are prohibited from
engaging in certain tying arrangements in connection with extensions of
credit and/or the provision of other property or services to a customer by
the Company or its subsidiaries. In addition, any savings association
acquired by the Company must conform its activities to those permissible for
a bank holding company under the Bank Holding Company Act.
Savings and Loan Holding Company. The Company is also a savings and loan
holding company due to its ownership of Peoples Bank FSB. However, since
the Company is a bank holding company regulated by the Federal Reserve Board,
it is not subject to any separate regulation as a savings and loan holding
company. Transactions between a savings association subsidiary of a savings
and loan holding company and an affiliate thereof are subject to the same
restrictions imposed by the Federal Reserve Act on subsidiary banks of a
bank holding company.
Congress is considering legislation to eliminate the federal savings and
loan charter and the separate federal regulations of savings associations.
Pursuant to this legislation, Congress may eliminate the Office of Thrift
Supervision (the "OTS") and Peoples Bank FSB may be regulated under federal
law as a bank or be required to change its charter. Such change in
regulation or charter would likely change the range of activities in which
Peoples Bank FSB may engage and would probably subject Peoples Bank FSB to
more regulation by the Federal Deposit Insurance Corporation ("FDIC"). At
this time, the Company cannot predict when or whether Congress may actually
pass legislation regarding the Company's and Peoples Bank FSB's regulatory
requirements or charter. Although such legislation, if enacted, may change
the activities in which Peoples Bank FSB may engage, it is not anticipated
that the current activities of either the Company or Peoples Bank FSB will
be materially affected by those activity limits.
Banking Subsidiaries. Peoples Bank is an Ohio state-chartered bank
supervised and regulated by the Ohio Division of Financial Institutions and
the FDIC. First National Bank is a national bank, supervised and regulated
by the Comptroller of the Currency. Peoples Bank FSB is a federally-
chartered savings bank subject to regulation, supervision, and examination
by the OTS and as a member of the Federal Home Loan Bank ("FHLB") of
Cincinnati subject to limited regulation by the Federal Reserve Board.
Insurance Subsidiaries. Northwest Territory is chartered by the State of
Arizona and is subject to regulation, supervision and examination by the
Arizona Department of Insurance. The powers of regulation and supervision
of the Arizona Department of Insurance relate generally to such matters as
minimum capitalization, the grant and revocation of certificates of authority
to transact business, the nature of and limitations on investments, the
maintenance of reserves, the form and content of required financial
statements, reporting requirements and other matters pertaining to life and
disability insurance companies. The Agencies are incorporated in the State
of Ohio and licensed by the Ohio Department of Insurance, which regulates,
supervises and has authority to examine the Agencies.
Federal Deposit Insurance Corporation
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The FDIC insures the deposits of Peoples Bank, First National Bank, and
Peoples Bank FSB and those entities are subject to the applicable provisions
of the Federal Deposit Insurance Act. A subsidiary of a bank holding company
or savings and loan holding company can be liable to reimburse the FDIC if
the FDIC incurs or anticipates a loss because of a default of another
FDIC-insured subsidiary of the bank holding company or savings and loan
holding company or in connection with FDIC assistance provided to the
subsidiary in danger of default. In addition, the holding company of any
insured financial institution that submits a capital plan under the federal
banking agencies' regulations on prompt corrective action is required to
guarantee a portion of the institution's capital shortfall.
The FDIC is authorized to establish separate annual assessment rates for
deposit insurance for members of the Bank Insurance Fund ("BIF") and of the
Savings Association Insurance Fund ("SAIF"). Peoples Bank and First National
Bank are BIF members. Peoples Bank FSB is a SAIF member. Insurance premiums
for BIF and SAIF members are determined during each semi-annual assessment
period based upon the members' respective categorization as (1) well
capitalized, (2) adequately capitalized or (3) under capitalized. An
institution is also assigned by the FDIC to one of these supervisory
subgroups within each capital group. The supervisory subgroup to which an
institution is assigned is based on a supervisory evaluation provided to the
FDIC be the institution's primary federal regulator and information which
the FDIC determines to be relevant to the institution's financial condition
and the risk posed to the deposit insurance funds (which may include, if
applicable, information provided by the institution's state supervisor).
An institution's assessment rate depends on the capital category and
supervisory category to which it is assigned.
Office of Thrift Supervision
- ----------------------------
Peoples Bank FSB must file periodic reports with the OTS concerning its
activities and financial condition. Examinations are conducted periodically
by the OTS to determine whether Peoples Bank FSB is in compliance with
various regulatory requirements and is operating in a safe and sound manner.
The enforcement authority of the OTS includes, among other things, the
ability to assess civil money penalties, to issue cease-and-desist or removal
orders and to initiate injunctive actions. In general, these enforcement
actions may be initiated for violations of laws and regulations and unsafe
or unsound practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed with the
OTS. Except under specific circumstances, public disclosure of final
enforcement actions by the OTS is required.
Federal Home Loan Bank
- ----------------------
The FHLBs provide credit to their members in the form of advances. As a
member of the FHLB of Cincinnati, Peoples Bank FSB must maintain an
investment in the capital stock of that FHLB in an amount equal to the
greater of 1.0% of the aggregate outstanding principal amount of its
respective residential mortgage loans, home purchase contracts and similar
obligations at the beginning of each year, or 5% of its advances from the
FHLB. Peoples Bank FSB is in compliance with this requirement with an
investment in stock of the FHLB of Cincinnati of $1.4 million at December
31, 1998. In addition, Peoples Bank and First National Bank also hold an
investment in FHLB of Cincinnati stock of $6.7 million and $0.6 million,
respectively, at December 31, 1998.
Capital Requirements
- --------------------
Federal Reserve Board. The Federal Reserve Board has adopted risk-based
capital guidelines for bank holding companies and for state member banks.
The risk-based capital guidelines include both a definition of capital and a
framework for calculating weighted-risk assets by assigning assets and
off-balance sheet items to broad risk categories. The minimum ratio of
total capital to weighted-risk assets (including off-balance sheet items,
such as standby letters of credit) is 8%. At least 4% must be comprised of
common stockholders' equity (including retained earnings but excluding
treasury stock), qualifying noncumulative perpetual preferred stock, a
limited amount of qualifying cumulative perpetual preferred stock, and
minority interests in equity accounts of consolidated subsidiaries, less
goodwill and certain other intangible assets ("Tier 1 capital"). The
remainder ("Tier 2 capital") may consist of mandatory convertible debt
securities, a limited amount of subordinated debt, other preferred stock
and a limited amount of allowance for loan and lease losses. The Federal
Reserve Board also imposes a minimum leverage ratio (Tier 1 capital to total
assets) of 3% for bank holding companies and state member banks that meet
specified conditions, including no operational, financial or supervisory
deficiencies, and having the highest regulatory rating. The minimum leverage
ratio is 4% to 5% for other bank holding companies and state member banks
based on their particular circumstances and risk profiles and those
experiencing or anticipating significant growth.
Office of the Comptroller of Currency. National bank subsidiaries, such as
First National Bank, are subject to similar capital requirements adopted by
the Comptroller of the Currency.
Office of Thrift Supervision. The OTS has established capital standards,
including a tangible capital requirement, a leverage ratio (or core capital)
requirement and a risk-based capital requirement applicable to savings
associations such as Peoples Bank FSB. The framework provided by the OTS to
define capital and calculate risk-weighted assets is much the same as the
framework provided by the Federal Reserve Board for bank holding companies
and for state member banks. These capital requirements must be generally as
stringent as the comparable capital requirements for national banks. The
capital regulations require tangible capital of at least 1.5% of adjusted
total assets (as defined by regulation). Tangible capital is defined in
OTS regulations as core capital minus any intangible assets. The capital
standards also require core capital of at least 3% of adjusted total assets.
Core capital generally consists of tangible capital plus certain intangible
assets, including a limited amount of purchased credit card relationships.
The OTS risk-based requirement requires saving associations to have total
capital of at least 8% of risk-weighted assets. Total capital consists of
core capital and supplementary capital. Supplementary capital consists of
certain permanent and maturing capital instruments that do not qualify as
core capital and general valuation loan and lease loss allowances up to a
maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital.
The OTS is also authorized to require a savings association to maintain an
additional amount of total capital to account for concentration of credit
risk and the risk of non-traditional activities.
The OTS has adopted an interest rate risk component to the risk-based capital
requirement, though the implementation of that component has been delayed.
Pursuant to that requirement, a savings association would have to measure
the effect of an immediate 200 basis point change in interest rates on the
value of its portfolio, as determined under the methodology established by
the OTS. If the measured interest rate risk is above the level deemed normal
under the regulation, the association will be required to deduct one-half of
that excess exposure from its total capital when determining its level of
risk-based capital. In general, an association with less than $300 million
in assets and a risk-based capital ratio of greater than 12% will not be
subject to the interest rate risk component. (Peoples Bank FSB currently
qualifies for such exemption.) Pending implementation of the interest rate
risk component, the OTS has the authority to impose a higher individualized
capital requirement on any savings association it deems to have excess
interest rate risk. The OTS also may adjust the risk-based capital
requirement on an individual basis for any association to take into account
risks due to concentrations of credit and nontraditional activities.
Compliance. The Company and its subsidiaries currently satisfy all capital
requirements. Failure to meet applicable capital guidelines could subject a
banking institution to a variety of enforcement remedies available to federal
and state regulatory authorities, including the termination of deposit
insurance by the FDIC. Federal regulations require prompt corrective action
to resolve capital deficient banks and savings associations. Under these
regulations, institutions which become undercapitalized become subject to
mandatory regulatory scrutiny and limitations, which increase as capital
continues to decrease. Such institutions are also required to file capital
plans with their primary federal regulator, and their holding companies must
guarantee the capital shortfall up to 5% of the assets of the capital
deficient institution at the time it becomes undercapitalized. As of
December 31, 1998, the most recent notification from the banking regulatory
agencies categorized the Company and each of its banking subsidiaries as
well capitalized under the regulatory framework for prompt corrective action.
The Company's ability to obtain funds for the payment of dividends and for
other cash requirements largely depends on the amount of dividends declared
by its subsidiary banks and other subsidiaries. However, the Federal
Reserve Board expects the Company to serve as a source of strength to its
subsidiary banks. The Federal Reserve Board may require the Company to
retain capital for further investment in its subsidiaries, rather than for
dividends for shareholders. Peoples Bank, First National Bank, and Peoples
Bank FSB may not pay dividends to the Company if, after paying such
dividends, they would fail to meet the required minimum levels under the
risk-based capital guidelines and the minimum leverage ratio requirements.
Peoples Bank and First National Bank must have the approval of their
respective regulatory authorities if a dividend in any year would cause the
total dividends for that year to exceed the sum of the current year's net
earnings and the retained earnings for the preceding two years, less
required transfers to surplus. Peoples Bank FSB may make capital
distributions during any calendar year equal to the greater of 100% of net
income for the year-to-date plus 50% of the amount by which the lesser of
its tangible, core or risk-based capital exceeds its capital requirement for
such capital component, as measured at the beginning of the calendar year,
or 75% of its net income for the most recent four-quarter period. If the
current minimum capital requirements following a proposed capital
distribution are not met, Peoples Bank FSB must obtain prior approval from
the OTS. Payment of dividends by a banking subsidiary may be restricted at
any time at the discretion of the appropriate regulator if it deems the
payment to constitute an unsafe and/or unsound banking practice or necessary
to maintain adequate capital. These provisions could limit the Company's
ability to pay dividends on its outstanding common shares.
Federal and State Laws
- ----------------------
Various requirements and restrictions under the laws of the United States
and the States of Ohio, West Virginia and Kentucky affect the operations of
Peoples Bank, First National Bank and Peoples Bank FSB. Included are
requirements to maintain reserves against deposits, restrictions on the
nature and amount of loans made and the interest charged thereon,
restrictions relating to investments and other activities, limitations on
credit exposure to correspondent banks, limitations on activities based on
capital and surplus, limitations on payment of dividends, and limitations on
branching. Since June 1997, pursuant to federal legislation, First National
Bank and Peoples Bank have been authorized to branch across state lines.
Peoples Bank, as an Ohio chartered banking corporation, has done so in West
Virginia, operating branches in that State under West Virginia consumer
banking law. Peoples Bank FSB has had unlimited branching authority across
state lines for some time but has not chosen, as yet, to do so.
The Company's financial institution subsidiaries are subject to regulatory
oversight under various consumer protection and fair lending laws. These
laws govern, among other things, truth-in-lending disclosure, equal credit
opportunity, fair credit reporting and community reinvestment. Failure to
abide by federal laws and regulations governing community reinvestment could
limit the ability of a financial institution to open a new branch or engage
in a merger transaction. Community reinvestment regulations evaluate how
well and to what extent an institution lends and invests in its designated
service area, with particular emphasis on low-to-moderate income communities
and borrowers in such areas. First National has received a "satisfactory"
examination rating under those regulations while Peoples Bank has received
an "outstanding" examination rating. Peoples Bank FSB has not received a
rating since its creation in January; however, Catlettsburg Federal and
Russell Federal both had "satisfactory" ratings prior to merging.
Prior to the enactment of the Small Business Jobs Protection Act (the "1996
Act") which was signed into law on August 21, 1996, earnings appropriated to
bad debt reserves and deducted for federal income tax purposes could not be
used by Peoples Bank FSB to pay cash dividends to the Company without the
payment of federal income taxes by the Company at the then current income
tax rate on the amount deemed distributed, which would include the amount of
any federal income taxes attributable to the distribution. The Company does
not contemplate any distribution by Peoples Bank FSB in a manner which would
create the above-mentioned federal tax liabilities.
Monetary Policy and Economic Conditions
The business of commercial banks and savings associations is affected not
only by general economic conditions, but also by the policies of various
governmental regulatory agencies, including the Federal Reserve Board. The
Federal Reserve Board regulates money and credit conditions and interest
rates in order to influence general economic conditions primarily through
open market operations in U.S. Government securities, changes in the
discount rate on bank borrowings, and changes in the reserve requirements
against bank and savings association deposits. These policies and
regulations significantly affect the overall growth and distribution of bank
and savings association loans, investments and deposits, and the interest
rates charged on loans, as well as the interest rates paid on deposits and
accounts.
The monetary policies of the Federal Reserve Board have had a significant
effect on the operating results of commercial banks and savings associations
in the past and are expected to continue to have significant effects in the
future. In view of the changing conditions in the economy and the money
markets and the activities of monetary and fiscal authorities, the Company
can make no definitive predictions as to future changes in interest rates,
credit availability or deposit levels.
Statistical Financial Information Regarding the Company
The following listing of statistical financial information, which is included
in the Company's Annual Report to Shareholders for the fiscal year ended
December 31, 1998, (the "Company's 1998 Annual Report") and incorporated
herein by reference (except the Average Balances and Analysis of Net Interest
Income and Maturity Schedule of Large Certificates of Deposit tables which
are included below), provides comparative data for the Company over the past
three and five years, as appropriate. These tables should be read in
conjunction with Item 7 of this Form 10-K/A ("Management's Discussion and
Analysis of Financial Condition and Results of Operation") and the
Consolidated Financial Statements of the Company and its subsidiaries found
at pages 12 through 33 of the Company's 1998 Annual Report.
Average Balances and Analysis of Net Interest Income:
(Dollars in Thousands)
1998 1997 1996
Average Average Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
Securities (1):
- ---------------
Taxable $183,372 $11,671 6.36% $126,632 $ 8,636 6.82% $127,815 $ 8,655 6.77%
Nontaxable (2) 34,653 2,677 7.72% 22,271 1,819 8.17% 22,621 1,906 8.42%
Total 218,025 14,348 6.58% 148,903 10,455 7.02% 150,436 10,561 7.02%
Loans (3) (4):
Commercial 186,746 17,156 9.19% 145,971 13,939 9.55% 125,138 11,944 9.54%
Real estate 234,141 20,176 8.62% 209,330 17,863 8.53% 172,367 14,322 8.31%
Consumer 111,824 11,684 10.45% 112,928 11,739 10.40% 102,759 10,949 10.66%
Valuation reserve (9,134) (7,521) (6,799)
- --------------------------------------------------------------------------------------------------------------------------
Total 523,577 49,016 9.20% 460,708 43,541 9.30% 393,465 37,215 9.30%
- --------------------------------------------------------------------------------------------------------------------------
Short-term Investments:
- -----------------------
Interest-bearing deposits 3,967 222 5.60% 1,713 93 5.41% 622 29 4.64%
Federal funds sold 20,671 1,104 5.34% 7,915 437 5.52% 5,900 315 5.35%
- --------------------------------------------------------------------------------------------------------------------------
Total 24,638 1,326 5.38% 9,628 530 5.50% 6,522 344 5.28%
- --------------------------------------------------------------------------------------------------------------------------
Total earning assets 766,240 64,690 8.45% 619,239 54,526 8.81% 550,423 48,120 8.74%
Other assets 65,056 48,260 42,021
-------- -------- --------
Total assets $831,296 $667,499 $592,444
-------- -------- --------
Deposits:
- ---------
Savings $ 97,262 $ 2,764 2.84% $ 83,342 $ 2,552 3.06% $ 75,805 $ 2,302 3.04%
Interest-bearing demand 168,035 6,002 3.57% 126,462 4,372 3.46% 111,376 3,656 3.28%
Time 321,920 17,284 5.37% 277,559 15,358 5.53% 234,550 12,922 5.51%
- --------------------------------------------------------------------------------------------------------------------------
Total 587,217 26,050 4.44% 487,363 22,282 4.57% 421,731 18,880 4.48%
- --------------------------------------------------------------------------------------------------------------------------
Borrowed Funds:
- ---------------
Short-term 44,959 2,242 4.99% 22,463 1,023 4.55% 29,965 1,449 4.84%
Long-term 38,885 2,205 5.67% 30,495 1,911 6.27% 26,692 1,637 6.13%
- --------------------------------------------------------------------------------------------------------------------------
Total 83,844 4,447 5.30% 52,958 2,934 5.54% 56,657 3,086 5.45%
- --------------------------------------------------------------------------------------------------------------------------
Total interest-
bearing liabilities 671,061 30,497 4.54% 540,321 25,216 4.67% 478,388 21,966 4.59%
- --------------------------------------------------------------------------------------------------------------------------
Noninterest-bearing
demand deposits 70,064 59,860 54,923
Other liabilities 7,904 7,248 6,114
------- ------- -------
Total liabilities 749,029 607,429 539,425
Stockholders' equity 82,267 60,070 53,019
------- ------- -------
Total liabilities and
stockholders' equity $831,296 $667,499 $592,444
------- ------- -------
Interest rate spread $34,193 3.91% $29,310 4.14% $26,154 4.15%
------- ----- ------- ----- ------- -----
Interest income/earning assets 8.45% 8.81% 8.74%
Interest expense/earning assets 3.98% 4.07% 3.99%
----- ----- -----
Net yield on earning assets
(net interest margin) 4.47% 4.74% 4.75%
===== ===== =====
<FN>
(F1) Average balances of investment securities based on carrying value.
(F2) Computed on a fully tax equivalent basis using a tax rate of 35% in 1998
and 1997 and 34% in 1996. Interest income was increased by $1,045,000,
$690,000 and $723,000 for 1998, 1997, and 1996, respectively.
(F3) Nonaccrual and impaired loans are included in the average balances
listed. Related interest income on nonaccrual loans prior to
the loan being put on nonaccrual is included in loan interest income.
(F4) Loan fees included in interest income for 1998, 1997 and 1996 were
$551,000, $542,000 and $532,000, respectively.
</FN>
Rate Volume Analysis:
Please refer to page 35 of the Company's 1998 Annual Report.
Loan Maturities:
Please refer to page 35 of the Company's 1998 Annual Report.
Average Deposits:
Please refer to page 34 of the Company's 1998 Annual Report.
Maturities Schedule of Large Certificates of Deposit:
1998 1997 1996 1995
Under 3 months $ 19,121 $ 13,302 $ 16,437 $ 18,662
3 to 6 months 14,335 24,069 8,279 9,319
6 to 12 months 9,189 9,520 10,309 5,140
Over 12 months 9,262 10,698 8,356 8,266
- ------------------------------------------------------------------
Total $ 51,907 $ 57,589 $ 43,381 $ 41,387
==================================================================
Loan Portfolio Analysis:
Please refer to pages 36 and 37 of the Company's 1998 Annual Report.
Securities Analysis:
Please refer to pages 19 and 20 and page 51 and 52 of the Company's
1998 Annual Report.
Return Ratios:
Please refer to page 9 of the Company's 1998 Annual Report.
Effect of Environmental Regulation
Compliance with federal, state and local provisions regulating the discharge
of materials into the environment, or otherwise relating to the protection
of the environment, has not had a material effect upon the capital
expenditures, earnings or competitive position of the Company and its
subsidiaries. The Company believes that the nature of the operations of its
subsidiaries has little, if any, environmental impact. The Company,
therefore, anticipates no material capital expenditures for environmental
control facilities for its current fiscal year or for the foreseeable future.
The Company's subsidiaries may be required to make capital expenditures for
environmental control facilities related to properties they acquire in the
future through foreclosure proceedings; however, the amount of such capital
expenditures, if any, is not currently determinable.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION.
Introduction
The following discussion and analysis of the consolidated financial
statements is presented to provide insight into management's assessment of
the financial results of Peoples Bancorp Inc. (the "Company"). It also
recaps the significant events that led to the results. The Company's
business activities are currently confined to one operating segment which is
community banking. The Company's subsidiaries, The Peoples Banking and
Trust Company ("Peoples Bank"), The First National Bank of Southeastern Ohio
("First National"), Peoples Bank FSB, and The Northwest Territory Life
Insurance Company, provide financial services to individuals and businesses
within the Company's market area.
Peoples Bank is chartered by the State of Ohio and subject to regulation,
supervision, and examination by the Federal Deposit Insurance Corporation
("FDIC") and the Ohio Division of Banks. First National 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
FSB is a member of the Federal Home Loan Bank, and is subject to regulation,
supervision, and examination by the Office of Thrift Supervision, and is
also subject to limited regulation by the Board of Governors of the Federal
Reserve System.
This discussion and analysis should be read in conjunction with the audited
consolidated financial statements and footnotes and the ratios, statistics,
and discussions contained elsewhere in this Annual Report.
The following text will include references to several acquisition
transactions that have affected or will affect the Company's results of
operations. On December 12, 1997, the Company completed the purchase of
Gateway Bancorp, Inc. and its subsidiary, Catlettsburg Federal Savings Bank
("Catlettsburg Federal"), of Catlettsburg, Kentucky, for approximately
$21.6 million in a combination of cash of $6.2 million and 548,208 shares of
Company stock ("Gateway Bancorp Acquisition"). Catlettsburg Federal had
total assets of $64.3 million and deposits of $43.8 million at December 12,
1997. Management operated Catlettsburg Federal as a federal savings bank
subsidiary of the Company until December 31, 1998, when it merged
Catlettsburg Federal and Russell Federal Savings Bank ("Russell Federal")
into a single thrift and renamed the company "Peoples Bank FSB".
On June 26, 1998, Peoples Bank completed the purchase of four full-service
banking offices located in the communities of Point Pleasant (two offices),
New Martinsville, and Steelton, West Virginia ("West Virginia Banking Center
Acquisition") from an unaffiliated institution. In the transaction, Peoples
Bank assumed approximately $121.0 million of deposits and purchased $8.3
million in loans.
Overview of the Income Statement
The Company had increased net income of $1,440,000 or 16.7%, to $10,045,000
in 1998 from $8,605,000 in 1997. On a diluted basis, earnings per share
reached $1.70 in 1998, up $0.10 (or 6.3%) compared to the previous year.
The Company's core earnings increased due to stronger earnings in existing
business units and additional revenue streams associated with recent
acquisitions. Return on average equity in 1998 totaled 12.21% compared to
14.33% in 1997. Return on average assets was 1.20% in 1998 compared to
1.29% the previous year.
Due primarily to earning asset growth, net interest income in 1998 increased
$4,528,000 (or 15.8%) to $33,148,000. The provision for loan losses in 1998
was comparable to the 1997 amount and reflective of the quality of the
portfolio and management of the inherent credit risks therein. Bolstered by
strong fourth quarter performance, non-interest income increased $854,000
(or 14.3%) to $6,820,000. In 1998, the Company reported net gains on
securities transactions of $418,000 compared to nominal losses in 1997.
Non-interest expense increased $4,011,000 (or 20.8%) to $23,276,000 due to a
combination of costs related to market expansion and acquisition, as well
as expenses related to refinancing of long-term debt. After considering
one-time charges, the Company's efficiency ratio improved to 50.38% for the
year ended December 31, 1998, compared to 51.06% in 1997.
The Company continues to grow through purchase acquisitions. While
acquisitions using stock are continually evaluated, management is cognizant
of not diluting shareholder ownership merely for the sake of growth.
Management believes a comparative approach to financial reporting should
include the discussion of "cash earnings", which removes the after-tax
impact of the amortization of intangibles on the Company's results of
operations and facilitates comparison of the Company with competitors making
acquisitions using pooling of interests accounting. The Company has
supplemented and will continue to supplement the discussion of its results
of operations with an analysis of cash earnings. Management uses cash
earnings as one of several ways to evaluate the impact of acquisitions on
profitability and the Company's return on its investment. Recent
acquisitions have increased and will modestly increase the Company's
amortization expense related to goodwill and other intangibles and as a
result, the purchase method of accounting has affected earnings per share
and other ratios.
In 1998, intangible amortization expense totaled $2,093,000 ($1,360,000
after taxes) compared to $1,138,000 ($740,000 after taxes) last year. After
adjusting for the after-tax effect of the amortization of intangibles,
diluted cash earnings per share for the year ended December 31, 1998 was
$1.95, up $0.21 (or 12.1%) from $1.74 in diluted cash earnings per share in
1997. Return on tangible assets was 1.41% in 1998 compared to 1.42% in 1997.
Return on tangible equity dropped to 17.82% in 1998 compared to 18.00% last
year.
Interest Income and Expense
Net interest income is the amount by which interest income on earning assets
exceeds interest paid on interest-bearing liabilities. Interest earning
assets include loans and investment securities. Interest-bearing liabilities
include interest-bearing deposits and borrowed funds such as Federal Home
Loan Bank ("FHLB") borrowings. Net interest income remains the primary
source of revenue for the Company. Changes in market interest rates, as
well as adjustments in the mix of interest-earning assets and interest-
bearing liabilities, impact net interest income.
When compared to the previous year, increased operating earnings in 1998 can
be attributed primarily to growth of the Company's net interest income.
The West Virginia Banking Center Acquisition and the Gateway Bancorp
Acquisition provided increased funding sources for the Company to grow its
earning asset base, generating incremental interest income streams.
As a result, net interest income grew significantly in 1998, up $4,528,000
(or 15.8%) to $33,148,000 compared to 1997. Total interest income reached
$63,645,000 while interest expense totaled $30,497,000. Included in
interest income is $1,967,000 of tax-exempt income from investments issued
by and loans made to states and political subdivisions. Since these revenues
are not taxed, it is more meaningful to analyze net interest income on a
fully-tax equivalent ("FTE") basis.
Net interest margin is calculated by dividing FTE net interest income by
average interest-earning assets and serves as a measurement of the net
revenue stream generated by the Company's balance sheet. In 1998, net
interest margin was 4.47% compared to 1997's ratio of 4.74%. The FTE yield
on earning assets was 8.45% in 1998, compared to 8.81% in 1997. The cost of
earning assets decreased 9 basis points to 3.98% in 1998.
In late 1998, the Federal Reserve Board modestly decreased the discount rate
and, as a result, the national prime rate decreased 25 basis points. The
Company adjusted its loan and deposit rates downward to reflect the decrease
in the national prime rate. This rate adjustment, combined with the "flat"
yield curve (i.e. little or no difference in short-term and long-term
interest rates) in effect for interest rates in general, combined to produce
decreased net interest margins for the Company in 1998.
Several other factors also contributed to net interest margin compression.
The deposits acquired in the West Virginia Banking Center Acquisition
significantly increased the Company's earning asset base in comparatively
lower-yielding assets such as federal funds sold. In 1998, average balances
in federal funds sold were $20.7 million, up $12.8 million compared to 1997.
By the end of 1998, the Company had redeployed recently acquired funds to an
earning asset mix that had a more appropriate balance of profitability, risk,
and characteristics similar in nature to the Company's allocation before the
West Virginia Banking Center Acquisition.
Net interest margin also decreased due to competitive pressures for loans
and deposits in the Company's markets. In addition, the recent thrift
acquisitions modestly changed the Company's earning asset mix and lowered
margins, due to the fact the Company's thrifts have primarily invested in
real estate loans, which typically do not generate return on investment like
other loan products such as commercial and personal loans.
In late 1998, the Company initiated actions designed to enhance net interest
income, margin and other performance ratios. The Company prepaid $20.3
million of its long-term FHLB borrowings at a one time cost of $402,000
($261,000 after tax). The average rate on these advances was 6.13% with a
weighted average maturity of approximately 7 years. The Company replaced
these borrowings with $20 million of FHLB advances with a one year weighted
average cost of 4.28%. At the FHLB's option, the product may reprice to a
LIBOR-based ("London Interbank Offer Rate") rate. Management estimates
that, absent other changes, the one time cost of refinancing will be
recovered in approximately two years. Recent declines in interest rates
decreased yields on the Company's variable rate assets such as federal
funds sold, as well as the rates on deposit products offered by the Company.
The prepayment of certain long-term FHLB borrowings should partially offset
the recent decreases in discount rates being paid by the Federal Reserve.
Average loans grew $62.8 million (or 13.7%) in 1998 and comprise the largest
earning asset component on the Company's balance sheet. Due to recent
acquisitions and resulting increases in funding sources, the Company's
average balances of investment securities increased $69.1 million from
$148.9 million in 1997 to $218.0 million in 1998. Management is
continuously evaluating alternative investment and loan products to maximize
return at an appropriate level of risk.
Yield on earning assets totaled 8.45% in 1998, compared to 8.81% the prior
year. Loan yields decreased to 9.21% in 1998 compared to 9.30% in 1997.
Net interest margin was negatively impacted by decreases in the Company's
investment portfolio yield, which dropped 44 basis points to 6.58% in 1998,
reflecting the reinvestment of higher-yielding, maturing investments into
lower-yielding instruments.
Compared to 1997, cost of interest-bearing liabilities decreased 13 basis
points to 4.54% in 1998. Deposit costs decreased due to a combination of
lowering time deposit rates, the acquisition of lower interest cost funding
sources from the West Virginia Banking Center Acquisition, and the
implementation of regional pricing in selected markets served by the Company.
Interest costs on the Company's array of traditional interest-bearing
deposit products decreased 13 basis points to 4.44% in 1998 compared to the
previous year. The most significant component of interest expense in 1998
was interest paid on time deposits (i.e. Certificates of Deposits and
Individual Retirement Accounts). In 1998, the Company paid interest of
$17,285,000, or 5.37%, on average time deposit balances of $321.9 million.
In 1997, the average rate paid was 5.53% on average time deposit balances of
$277.6 million. Growth in this type of funding source was generated
primarily from acquisitions. This combination increased interest expense
costs by $1,926,000. Management expects deposit pricing to be increasingly
competitive in 1999 and will continue to focus its efforts to increase
balances in non-interest bearing demand deposits, which grew $10.2 million
to $70.1 million in average balances in 1998.
In 1998, the Company continued to use a combination of short-term and
long-term borrowings as a funding source. The Company's cash management
services (offered to a variety of business customers) have provided
short-term funding, specifically overnight repurchase agreements. In 1998,
the Company's average balances of overnight repurchase agreements increased
$11.4 million to $31.4 million, due primarily to growth in balances from
existing customers and increased market penetration. Due to product
redesign of the Company's overnight repurchase agreements, the average rate
paid in 1998 on overnight repurchase agreements totaled 4.70%, up 29 basis
points from the prior year's average rate of 4.40%.
In 1998, the Company used short-term FHLB advances as a funding source for
a pre-investment strategy related to the West Virginia Banking Center
Acquisition. As a direct result, average short-term FHLB balances increased
to $12.5 million in 1998, compared to $2.0 million in 1997, causing interest
costs to increase to $712,000 (up from $117,000 last year). In 1998, the
average interest rate on short-term FHLB advances was 5.68% compared to
5.78% in 1997. Management plans to maintain access to short-term FHLB
borrowings as an appropriate funding source.
Long-term borrowing costs decreased compared to last year due to flattening
of the yield curve. The rate paid on average long-term borrowings totaled
5.67% in 1998, down 60 basis points compared to 6.27% in 1997. The majority
of the Company's long-term borrowings are fixed rate FHLB borrowings.
The growth of the Company's earning asset base through recent acquisitions
will continue to impact net interest margin in 1999. Although net interest
margin compression has recently stabilized, management expects interest rate
pressures will continue to challenge the Company in 1999 as financial
institutions and other competitors continue to search for new methods and
products to satisfy increasing customer demand for higher yielding
interest-bearing deposits. Management will continue to monitor the effects
of net interest margin on the performance of the Company. Please refer to
the "Consolidated Average Balance Sheet and Analysis of Net Interest Income"
table included in Item 1 of this Form 10-K/A for a complete quantitative
evaluation of the Company's net interest margin.
Provision for Loan Losses
In 1998, the Company recorded a provision for loan losses of $2,325,000,
compared to 1997's expense of $2,589,000. The provision is based upon
management's continuing evaluation of the adequacy of the allowance for loan
losses and is reflective of the quality of the portfolio and overall
management of the inherit credit risk. Management expects modest internal
loan growth in 1999 and believes that 1999's provision expense will remain
approximately level with the 1998 provision. The duration of current
provision levels will be dependent on loan delinquencies, portfolio risk,
overall loan growth, and general economic conditions in the Company's markets.
Non-Interest Income
The Company's non-interest income is generated from four primary sources:
cost-recovery fees related to deposit accounts, income derived from
fiduciary activities, electronic banking revenues, and insurance commissions.
Non-interest income (excluding securities transactions) from operations
reached record levels in 1998, totaling $6,820,000, an increase of 14.3%
compared to 1997. All non-interest income categories had strong growth
compared to last year. Management continues to focus on non-interest income
as a primary source of cost-recovery.
In 1998, account service charge income related to deposits increased
$351,000 (or 15.9%) to $2,553,000. Several factors contributed to this
growth, including the West Virginia Banking Center Acquisition and its
associated $121 million in deposits, which provided the base for increased
fee income in the last six months of 1998. Approximately $255,000 (or 72.6%)
of the Company's increase can be directly attributed to the deposits acquired
in the West Virginia Banking Center Acquisition. The Company's fee income
generated from deposits is based on the cost associated with relevant
services provided.
The fee structure for investment and fiduciary activities is based primarily
on the market value of assets being managed, which totaled approximately
$551 million at year-end 1998, up approximately $30 million from the
previous year-end. Income from fiduciary activities totaled $2,325,000,
an increase of 6.8% compared to 1997. The Company continues to build on
its leadership position in its markets and investment and fiduciary services
will be a significant contributor to the Company's non-interest income
streams.
Electronic banking, including ATM cards, direct deposit services, and debit
card services, is one of the many product lines offered by the Company.
The recovery of costs through fees associated with these products and
services is beginning to significantly impact the Company's non-interest
income. For the year ended December 31, 1998, total fees related to
electronic banking reached $596,000, up $120,000 (or 25.3%) compared to the
same period last year. These increases are primarily due to revenues
related to the Company's growing debit card program as well as non-customer
activity in the Company's network of ATM's, which has caused a corresponding
increase in ATM-related revenues.
In addition to traditional sources of non-interest income, the Company also
has the capability to provide customer service through a complete line of
insurance products. The Company's insurance subsidiaries, Northwest
Territory Life Insurance Agency, Inc. and Northwest Territory Property and
Casualty Insurance Agency, Inc. (the "Agencies"), which are part of First
National Bank, provide full life and property insurance product lines to
consumers in Ohio. In August 1998, these agencies were licensed by Ohio-
based Motorists Mutual Insurance Company, MICO Insurance Company, and
Motorists Life Insurance Company ("Motorists"). The Agencies offer a
complete line of life and property and casualty products through Motorists,
as well as investment products through Marketing One Securities, Inc.
Commissions on insurance and securities operations generated revenues of
$430,000 in 1998, up $91,000 (or 27.0%) compared to 1997, representing the
Company's largest percentage non-interest income increase.
Management will continue to explore new methods of enhancing non-interest
income in the future. Both traditional and nontraditional financial service
products are being analyzed for inclusion in the product mix currently
being offered by the Company.
Gains (Losses) on Securities Transactions
In 1998, the Company recognized net gains on securities activity of $418,000
($272,000 after taxes, or $0.05 per share), compared to a net loss on
securities transactions of $28,000 a year earlier. For the year ended
December 31, 1998, the Company had gains of $523,000, of which $516,000
related to an equity investment in a company that was acquired in a merger
transaction. The Company reported losses on sales of securities of $105,000
from repositioning of the investment portfolio. Management does not expect
similar gains or losses in 1999.
Non-Interest Expense
Several categories within non-interest expense were directly impacted by
recent acquisitions and the related growth of non-interest expenses such
as salaries and benefits, depreciation expense, intangible amortization,
etc. Maintaining acceptable levels of non-interest expense and operating
efficiency are key performance indicators for the Company in its strategic
initiatives. For the year ended December 31, 1998, non-interest expense
totaled $23,276,000, up $4,011,000 (or 20.8%) compared to 1997.
When comparing 1998 non-interest expense to 1997, it is important to
consider the non-interest expense related to recent acquisitions.
Acquisitions, and the related salaries and employee benefits and increased
depreciation expense, comprise the majority of the increase in non-interest
expense in 1998. Non-operational items also contributed to the increase in
non-interest expense. In particular, amortization of intangibles totaled
$2,093,000 (up $955,000) compared to $1,138,000 in 1997. This increase is
due to completion in 1998 of the West Virginia Banking Center Acquisition as
well as amortization expense related to December 1997's Gateway Bancorp
Acquisition. The Company considers the impact of intangible amortization
when evaluating potential acquisitions.
The Company's recent acquisitions also impacted non-interest expense in
other areas, as the Company continues to expand its services and geographic
areas served. Compared to 1997, salaries and benefits expense increased
$957,000 (or 11.4%) to $9,315,000 in 1998. Recent acquisitions have
increased the number of Company employees, primarily customer service
associates in the acquired offices. At December 31, 1998, the Company had
362 full-time equivalent employees, compared to 314 full-time equivalent
employees at year-end 1997. While salaries and benefit expense has
increased on a gross comparison basis due to the many customer service
associates retained in the West Virginia Banking Center acquisition and
other recent acquisitions, management believes the human resources obtained
in recent acquisitions will enable the Company to further penetrate its new
markets, thereby optimizing customer service and return to shareholders.
Net occupancy expense, depreciation in particular, was impacted by recent
acquisitions. In 1998, furniture and equipment expenses totaled $1,728,000,
up $227,000 (or 15.1%) compared to 1997. Net occupancy expense totaled
$1,597,000 in 1998, an increase of $300,000 (or 23.1%) compared to the
previous year. These increases can be attributed primarily to the
depreciation of the assets purchased in recent acquisitions (in particular
the West Virginia Banking Center Acquisition), and completion of construction
projects to full-service offices in Athens and Caldwell, Ohio; Ashland,
Kentucky; and Parkersburg, West Virginia. Management believes the
increased investment in these offices enhances customer service capabilities
in those markets, and will provide additional opportunities for increased
market penetration. Increases are also due to growth in depreciation of
additional expenditures on technology. The Company's increased investment
in technology and other customer-service enhancements will also impact
depreciation expense in the future.
Included in non-interest expense for year ended December 31, 1998, were one
time expenses that management excludes from its assessment of operational
efficiency. In late 1998, the Company prepaid approximately $20.3 million
of FHLB borrowings to enhance net interest income, margin and other
performance ratios, at a cost of $402,000 ($261,000 after taxes). In
addition, the Company incurred $169,000 ($110,000 after taxes) of one time
expense related to the conversion of the West Virginia Banking Centers.
Expenses included purchase of new checks for the customers assumed in the
West Virginia Banking Center Acquisitions, education of new associates,
operational costs related to clearing items, telecommunications expense,
etc. Also included in the $169,000 of nonrecurring expense were one-time
costs related to market expansion in Parkersburg, West Virginia.
The Company and financial services industry use the efficiency ratio
(total non-interest expense less amortization of intangibles and
nonrecurring items as a percentage of the aggregate of fully-tax equivalent
net interest income and non-interest income) as a key indicator of
performance. Gains and losses on sales of investment securities and other
nonrecurring and/or one-time charges are not included in the calculation of
the Company's efficiency ratio. In 1998, the Company reported an efficiency
ratio of 50.38%, an improvement of 68 basis points compared to 1997's
51.06%. Management expects the efficiency ratio to continue to improve
modestly in 1999 due to recent strategic initiatives to leverage non-
interest expense associated with market expansion.
Return on Assets
For the year ended December 31, 1998, return on average assets ("ROA") was
1.20%, compared to 1.29% in 1997. Increased income streams from recent
acquisitions were offset by amortization of intangibles assumed in such
purchases, resulting in lower ROA levels compared to previous periods. The
Company's recent thrift acquisitions also affected ROA. In general, the
thrift industry has historically performed at lower ROA levels than
commercial banks.
The Company's ROA was challenged in 1998 due to the West Virginia Banking
Center Acquisition and the Gateway Bancorp Acquisition, and its corresponding
impact to the Company's balance sheet. Due primarily to recent acquisitions,
the Company's average assets grew approximately $164 million to over $830
million for the year ended December 31, 1998, while net income did not
proportionately increase.
In late 1998, the Company successfully employed recently acquired funds to
an asset mix similar to the Company's mix before the West Virginia Banking
Center Acquisition, in a manner consistent with acceptable return on
investment. Management anticipates ROA will stabilize in 1999 and could be
enhanced as the Company continues to shift the acquired funds into higher-
yielding assets such as loans.
Return on Equity
The Company's return on average stockholders' equity ("ROE") was 12.21% in
1998 compared to 14.33% in 1997. ROE decreased in 1998 primarily due to
issuance of approximately $15.35 million of capital stock (548,208 shares)
for the purchase of Gateway Bancorp, Inc. in December, 1997. As a result,
the increase in total equity had a significant impact on ROE for the year
ended December 31, 1998. Management expects ROE in 1999 to improve as the
Company continues to leverage the additional capital issued in the Gateway
Bancorp Acquisition.
The Company and its banking subsidiaries are considered well-capitalized
under regulatory and industry standards of risk-based capital (as discussed
in Note 12 of the Notes to the Company's Consolidated Financial Statements)
and has experienced growth through retention of increased earnings over the
last several quarters.
Income Tax Expense
Federal income taxes increased from $4,099,000 in 1997 to $4,740,000 in
1998. The Company's effective tax rate for 1998 was 32.1%, compared to
32.3% in 1997. The modest decrease can be attributed to increases in
tax-exempt income compared to the prior year. Management continues to
explore new methods of reducing the Company's overall tax burden and has
finalized an investment that should help manage the Company's tax burden.
Overview of the Balance Sheet
Total assets reached $880.3 million at December 31, 1998, up $122.1 million
compared to year-end 1997. Asset growth can be attributed primarily to the
assets and liabilities acquired in the West Virginia Banking Center
Acquisition. Net cash received in the West Virginia Banking Center
Acquisition was redeployed primarily into investment securities, which
increased $61.3 million (or 35.2%) from year-end 1997 to $235.6 million at
December 31, 1998. Loan demand in the Company's established markets, loans
acquired through the West Virginia Banking Center Acquisition, and loans
purchased from external sources combined to increase loan balances $45.2
million (or 8.8%) to $558.4 million at year-end 1998. Loan growth occurred
primarily in the commercial loan area.
Total liabilities increased $114.9 million (or 16.9%) to $794.3 million at
December 31, 1998. The majority of this growth occurred in the Company's
total deposits, which increased $103.1 million (or 16.9%) to $714.2 million
at December 31, 1998. Growth of the Company's funding sources occurred
primarily due to funds acquired in the West Virginia Banking Center
Acquisition. Increases in deposits for the Company occurred primarily in
interest-bearing deposits, while non-interest bearing deposit balances grew
$16.7 million (or 25.9%) to $80.9 million. Short-term borrowings totaled
$32.5 million at December 31, 1998, a modest decrease from the previous
year-end. Long-term borrowings, comprised primarily of FHLB borrowings
with maturities greater than one year, increased $12.1 million (or 42.3%)
to $40.7 million at December 31, 1998, due to strategic initiatives designed
to leverage Peoples Bank FSB's strong equity position.
Stockholders' equity increased $7.2 million (or 9.1%) to $86.0 million at
December 31, 1998. Equity growth occurred primarily through retention of
earnings, as well as increases in the Company's net unrealized gain on
available for sale securities. At December 31, 1998, the Company had a
treasury stock balance of 52,031 shares, or $1.8 million, due to purchases
in 1998 and the adoption of a deferred compensation plan that permits the
Company's directors to purchase the Company's stock through an established
trust. At December 31, 1997, the Company had no treasury shares.
Stockholders' equity as a percent of total assets was 9.77% at year-end
1998, down from 10.40% at December 31, 1997, as the Company leveraged its
capital base through the West Virginia Banking Center Acquisition. Please
see the Consolidated Statements of Stockholders' Equity found on page 14 in
this Report for additional information regarding the changes in stockholders'
equity.
Cash and Cash Equivalents
The Company's cash and cash equivalents totaled $40.1 million at December
31, 1998, an increase of $1.3 million compared to year-end 1997. The
Company's balances of cash and cash equivalents, particularly federal funds
sold, were higher than normal during the last six months of 1998 due to
excess funds acquired in the West Virginia Banking Center Acquisition. By
year-end 1998, the Company had successfully employed those excess funds
into higher-yielding assets such as loans and investments.
Management believes the current balance of cash and cash equivalents
adequately serves the Company's liquidity and performance needs. Total
cash and cash equivalents fluctuate on a daily basis due to transactions
in process and other liquidity needs. Management believes the liquidity
needs of the Company are satisfied by the current balance of cash and cash
equivalents, readily available access to traditional and non-traditional
funding sources, and the portions of the investment and loan portfolios that
mature within one year. These sources of funds should enable the Company
to meet cash obligations and off-balance sheet commitments as they come due.
Investment Securities
Investment securities totaled $235.6 million at year-end 1998, up $61.3
million (or 35.2%) compared to December 31, 1997. Growth was funded in 1998
primarily by the deposits acquired in the West Virginia Banking Center
Acquisition.
All of the Company's investment securities are classified as
available-for-sale. Management believes the available-for-sale
classification provides flexibility for the Company in terms of selling
securities as well as interest rate risk management opportunities. At
December 31, 1998, the amortized cost of the Company's investment securities
totaled $230.0 million, resulting in unrealized appreciation in the
investment portfolio of $5.5 million and a corresponding increase in the
Company's equity of $3.6 million.
As a direct result of growth in funding sources in recent periods, several
categories of investments within the portfolio have experienced significant
growth. Investments in mortgage-backed securities increased $28.4 million
(or 37.1%) to $104.8 million at December 31, 1998. Due primarily to
investments in trust preferred securities with attractive yields,
investments in corporate and other securities totaled $35.0 million, up
$14.8 million (or 73.4%) since December 31, 1997. Investments in
obligations of states and political subdivisions totaled $45.5 million at
year-end 1998, an increase of $19.8 million (or 77.1%) since year-end 1997.
The Company's balances in US Treasury securities and obligations of US
government agencies and corporations remained relatively unchanged since
year-end 1997. Management expects current balances of investment securities
to modestly shrink in 1999 due to anticipated loan demand and the shifting
of maturing investments to higher-yielding assets.
Management monitors the earnings performance and liquidity of the investment
portfolio on a regular basis through Asset/Liability Committee (" ALCO")
meetings. The group also monitors net interest income, sets pricing
guidelines, and manages interest rate risk for the Company. Through active
balance sheet management and analysis of the investment securities
portfolio, the Company maintains sufficient liquidity to satisfy depositor
requirements and the various credit needs of its customers. Management
believes the risk characteristics inherent in the investment portfolio are
acceptable based on these parameters.
Loans
The Company's lending is primarily focused in central and southeastern Ohio,
northern West Virginia, and northeastern Kentucky markets, and consists
principally of retail lending, which includes single-family residential
mortgages and other consumer lending.
Loans totaled $567.9 million at December 31, 1998, an increase of $46.3
million (or 8.9%) compared to year-end 1997. Growth occurred internally
in the Company's existing markets and also from other sources, such as $8.3
million of loans purchased in the West Virginia Banking Center Acquisition
and $11.8 million of commercial loans purchased from an unrelated financial
institution in the fourth quarter of 1998.
Real estate loans to the Company's retail customers continue to be the
largest portion of the loan portfolio, comprising 41.1% of the Company's
total loan portfolio. Real estate mortgage loans totaled $233.6 million at
December 31, 1998, up $4.9 million (or 2.1%) since year-end 1997. As the
Company blends its recent acquisitions into its core operations, certain
changes in loan mix will naturally occur. The Company experienced growth
in the home equity credit lines ("Equilines"). At December 31, 1998,
Equiline balances totaled $20.3 million, up $3.2 million (or 18.7%) since
year-end 1997. The Company's Equiline growth was due primarily to special
fixed Equiline rate offers in its markets. Management believes the Equiline
product is a competitive product with an acceptable return on investment,
after risk considerations. Residential real estate lending continues to
represent a significant focus of the lending activities due to the lower
risk factors associated with these types of loans and the opportunity to
provide additional products and services to these consumers at attractive
combined returns.
Lending activity in the Company's northeastern Kentucky markets has
historically centered on real estate loans. Management expects to continue
to penetrate those local markets in 1999, seeking opportunities to sell
additional lending and deposit products. Mortgage lending will remain a
vital part of the Company's lending operation due to the programs offered to
customers, who continue to seek quality real estate loan products in a
competitive environment.
The largest loan growth category for the Company in 1998 was commercial,
financial, and agricultural loans ("commercial loans"), which increased
$53.5 million (or 33.6%) to $212.5 million. Economic conditions in the
Company's markets have provided quality credit opportunities, in particular,
southeastern Ohio and central Ohio. Management will continue to focus on
the enhancement and growth of the commercial loan portfolio while
maintaining appropriate underwriting standards. Management expects
commercial loan demand to continue to be strong in several of the Company's
markets throughout 1999.
In an effort to redeploy acquired funding sources and reallocate the
Company's mix of earning assets to an allocation similar to previous
reporting periods, the Company purchased $11.8 million of commercial loans
in the fourth quarter of 1998. The majority of these loans are
collateralized by real estate and are outside of the Company's geographic
markets.
Consumer lending also continues to be a vital part of the core lending of
the Company. In 1998, consumer loan balances decreased $2.8 million
(or 2.5%) to $111.5 million. The majority of the Company's consumer loans
are indirect loans to consumers who purchase vehicles and similar items at
sales locations in the Company's market areas. At December 31, 1998, the
Company had indirect loan balances of $65.3 million, a decrease of $5.0
million since year-end 1997, as pressures to grow this segment of the
business continue to increase in the highly competitive market for indirect
lending. Management is pleased with the recent performance of the Company's
indirect loan portfolio, which can be attributed to the Company's commitment
to quality customer service and a tiered pricing system that enables the
Company to apply interest rates based on the corresponding risk associated
with the indirect loan. Although consumer debt delinquency is increasing in
the financial services industry (due mostly to credit card debt),
management's recent actions to reinforce the Company's pricing system and
underwriting criteria have tempered delinquencies and caused a modest
decrease in new indirect loan generation. Management plans to continue its
focus on usage of this tiered system combined with controlled growth of the
indirect lending portfolio in 1999.
The Company's credit card balances at year-end 1998 were $6.8 million, a
decrease of $0.4 million compared to December 31, 1997. The credit card
industry is highly competitive, which has caused modest declines in the
Company's credit card balances. Management will continue to evaluate new
opportunities to serve our credit card customers, but will not assume
additional unnecessary risk for the sake of growth.
The offices acquired in the West Virginia Banking Center have generated
nearly $6 million in additional loan balances since the end of the second
quarter of 1998. Management is pleased with the loan growth momentum in
these new offices and expects loan activity to continue to be strong in
those markets in 1999.
Loan Concentration
The Company does not have a concentration of its loan portfolio in any one
industry. Real estate lending (both mortgage and construction loans)
continues to be the largest component of the loan portfolio, representing
$243.9 million (or 42.9%) of total loans, compared to $248.2 million at
year-end 1997. At December 31, 1998, commercial, financial, and agricultural
loans totaled $212.5 million (or 37.4%) of outstanding loans, up from
$159.0 million (or 30.5% of loans) at year-end 1997.
The Company's lending is primarily focused in the local southeastern Ohio
market and contiguous mid-Ohio valley areas. The Company's loan mix
principally consists of retail lending, which includes single-family
residential mortgages and other consumer loan products.
The Company's largest concentration of commercial loans are credits to
lodging and lodging related companies, which comprise approximately 10% of
the Company's outstanding commercial loans at December 31, 1998 and 8% at
December 31, 1997. These lending opportunities have arisen because of the
recent growth in the lodging industry and the need for additional travel
related services in certain areas in or contiguous to the Company's markets,
as well as the Company's ability to respond to the needs of customers in
this segment of the economy. The credits have been subjected to the
Company's normal commercial loan underwriting standards and do not present
more than the normal amount of risk assumed in other types of lending.
In addition to loans to lodging and lodging related companies, one of the
Company's largest groups of commercial loans consists of automobile dealer
floor plans, which totaled 7% of the Company's outstanding commercial loans
at December 31, 1998 and 12% at December 31, 1997.
Allowance for Loan Losses
The loan portfolio analysis on pages 36 and 37 presents in detail an
analysis of the Company's loan portfolio, the allowance for loan losses,
loan chargeoffs and recoveries by type of loan, and an allocation of the
allowance for loan losses by major loan type.
Management continually monitors the loan portfolio through its Loan Review
Department and Loan Loss Committee to determine the adequacy of the
allowance for loan losses. This formal analysis determines the appropriate
level of the allowance for loan losses, allocation of the allowance among
loan types and the adequacy of the unallocated component of the allowance.
The portion of the allowance allocated among the various loan types
represents management's estimate of expected losses based upon specific
allocations for individual lending relationships and historical loss
experience for each category of loans. The individual loan reviews are
based upon specific qualitative and quantitative criteria, including the
size of the loan and loan grades below a predetermined level. The historical
experience factor is based upon historical loss experience, trends in losses
and delinquencies, the growth of loans in particular markets and industries,
and known changes in economic conditions in the particular lending markets.
Allowances for homogeneous loans (such as residential mortgage loans, credit
cards, personal loans, etc.) are collectively evaluated upon historical loss
experience, trends in losses and delinquencies, the growth of loans in
particular markets, and known changes in economic conditions in the
particular lending markets.
The unallocated portion of the allowance is based upon management's
assessment of qualitative risk factors that may not be evident in the
Company's historical experience, such as, but not limited to, changes in
specific markets in both competition for loans and local economies. This
assessment involves a high degree of management judgment as well as higher
amounts of uncertainty. Assessment of the adequacy of the allowance is a
dynamic process that requires management to continually refine the process
as markets, economic conditions, and the Company change. Differences
between actual loss experiences and estimated events are compared on a
quarterly basis, allowing management to regularly modify loss provisions as
deemed appropriate based on market conditions and other factors previously
described.
The results of this analysis at December 31, 1998 indicate allocations to
specific lending categories that are not significantly different from the
prior year. The increase in the amount allocated to the commercial category
results from recent increases in the Company's commercial loans outstanding.
The amount allocated to the remaining categories and the unallocated portion
reflect the growth in the portfolios and changes in economic conditions.
Management expects 1999's quarterly loan loss provision to be consistent
with recent quarters.
The Company's consumer loan chargeoffs decreased $0.2 million (or 1.5%)
to $1.6 million in 1998 due to decreased credit card chargeoffs and direct
personal loan chargeoffs. Management will continue to monitor the
performance of the consumer loan portfolio and focus efforts on improving
experience and reducing losses. Real estate and commercial loan net
chargeoffs were insignificant in 1998, demonstrating the quality of the
portfolios.
Nonperforming loans (those loans classified as nonaccrual, 90 days or more
past due, and other real estate owned) as a percentage of outstanding loans
were 0.28% at December 31, 1998, compared to 0.33% at December 31, 1997.
Nonaccrual loans and those loans 90 days past due totaled $687,000 and
$495,000, respectively, at year-end 1998, compared to $1,220,000 and
$462,000, respectively, at year-end 1997. Other real estate owned totaled
$396,000 at year-end 1998 compared to $19,000 at December 31, 1997.
Management believes the current level of nonperforming loans is below peer
group levels and is a reflection of the overall quality of the Company's
loan portfolio.
A loan is considered impaired when, based on current information and events,
it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due 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 is measured based on the fair value of the
collateral. At December 31, 1998, the Company had an insignificant amount of
loans that were considered impaired. Management will continue to monitor
the status of impaired loans, including performing and non-performing loans.
The allowance for loan losses is deemed to be adequate to absorb losses
inherent in the portfolio at December 31, 1998.
Funding Sources
The Company considers deposits, short-term borrowings, and long-term
borrowings when evaluating funding sources. Traditional deposits continue
to be the most significant source of funds for the Company and the expansion
of the deposit base through acquisition in 1998 sustained the asset growth
of the Company. In 1998, total deposits grew $103.1 million (or 16.9%) to
$714.2 million, with the majority of the growth occurring in interest-bearing
deposits. The West Virginia Banking Center Acquisition provided the Company
with additional funding sources of $121.0 million ($11.3 million in
non-interest bearing demand deposit balances) and experienced minimal runoff
of those deposit balances following the completion of the acquisition.
In 1998, the Company implemented regional pricing among its Peoples Bank
banking centers, which permitted management to maintain interest cost
structures in the markets entered via the West Virginia Banking Center
Acquisition. Management believes regional pricing has provided the
opportunity to maintain and improve results of operations.
In 1998, the Company's average time deposit balances increased $44.4 million
(or 16.0%) to $321.9 million. The Company continues to offer time deposit
"specials" to customers in its established markets. In 1998, a 7-month time
deposit special was offered to retain maturing short-term time deposits as
well as provide a competitive product in the Company's markets. In late
1998 and early 1999, the Company began offering a 15-month time deposit
special. Management expects CD's to continue to be a vital funding source
for the Company in the future.
On a percentage basis, the largest growth component for the Company in 1998
occurred in interest-bearing transaction accounts, which increased $41.6
million (or 32.9%) to $168.0 million. The Company continues to offer
special "relationship accounts" (both non-interest bearing and
interest-bearing) based on deposits in other products such as CD's or IRA's.
Management believes that the deposit base remains the most significant
funding source for the Company and will continue to concentrate on
non-interest bearing deposit growth and maintaining adequate net interest
margin to meet the Company's strategic goals.
In addition to traditional deposits, the Company accesses both short-term
and long-term borrowings to fund its operations and investments. The
Company's short-term borrowings consist of federal funds purchased,
corporate deposits held in overnight repurchase agreements, and various
FHLB borrowings. Short-term borrowings at December 31, 1998, totaled $32.5
million compared to $32.6 million at year-end 1997. The largest component
of short term borrowings at year-end 1998 was balances in corporate deposits
in repurchase agreements, which totaled $31.7 million compared to $30.7
million at year-end 1997.
At December 31, 1998, the Company had a balance of $0.7 million in
short-term FHLB borrowings, down $1.0 million compared to prior year-end.
In general, the Company accesses this funding source at various times to
meet liquidity needs as they arise, and will continue to access short-term
FHLB borrowings as necessary in the future.
In addition to traditional deposits and short-term borrowings, the Company
continues to maintain long-term borrowings from the FHLB. This allows the
Company to obtain reliable funds at fixed and indexed rates for longer
periods of time than other traditional deposit products, creating the
opportunity to match longer term fixed rate mortgages and other
extended-maturity asset commitments against a similar funding source.
Total long-term FHLB advances were $38.0 million at year-end 1998, a net
increase of $12.4 million (or 48.4%) since year-end 1997. The increase in
funds was used primarily to fund growth strategies designed to leverage the
strong capital position of Peoples Bank FSB. In the second half of 1998,
the Company prepaid $20.3 million of its long-term FHLB borrowings, of which
$18.8 million were subject to prepayment penalties. The Company replaced
$20 million of the prepaid FHLB advances with borrowings designed to enhance
future performance. Management plans to maintain access to long-term FHLB
borrowings as an appropriate funding source.
The Company also has a long-term borrowing with an unaffiliated financial
institution. The original borrowing was $3.0 million and was used to
finance an acquisition in early 1997. At December 31, 1998, the balance was
$2.7 million. Principal payments began in 1998 and continue semi-annually
over the next three years.
Capital/Stockholders' Equity
During the year-ended December 31, 1998, the capital position of the Company
grew approximately $7.2 million (or 9.1%) to $86.0 million. In 1998, the
Company had net income of $10.0 million and paid dividends of $3.1 million,
a dividend payout ratio of 30.38% of earnings, compared to a ratio of 30.53%
in 1997. Management believes recent dividends represent an acceptable
payout ratio for the Company and anticipates similar payout ratios in future
periods through quarterly dividends.
Equity growth was affected in 1998 by the adjustment for the net unrealized
holding gain on available-for-sale securities which increased $1.2 million,
net of deferred income taxes, (or 51.5%) to a net gain of $3.6 million at
year-end 1998. Recent decreases in interest rates, combined with increased
purchases of investment securities in early 1998, have combined to cause the
gap to grow between the amortized cost and estimated fair value of the
Company's investment portfolio, resulting in a corresponding increase to the
Company's equity. Since all of the investment securities in the Company's
portfolio are classified as available-for-sale, both the investment and
equity sections of the Company's balance sheet are more sensitive to the
changing market values of investments.
The Company has also complied with the standards of capital adequacy
mandated by the banking industry. Bank regulators have established
"risk-based" capital requirements designed to measure capital adequacy.
Risk-based capital ratios reflect the relative risks of various assets banks
hold in their portfolios. A weight category of either 0% (lowest risk
assets), 20%, 50%, or 100% (highest risk assets) is assigned to each asset
on the balance sheet. Detailed information concerning the Company's
risk-based capital ratios can be found in Note 12 of the Notes to the
Consolidated Financial Statements. At December 31, 1998, the Company's and
each of its banking subsidiaries' risk-based capital ratios were above the
minimum standards for a well-capitalized institution. The Company's
risk-based capital ratio of 11.95% at December 31, 1998, is well above the
well-capitalized standard of 10%. The Company's Tier 1 capital ratio of
10.54% also exceeded the well-capitalized minimum of 6%. The Leverage ratio
at year-end 1998 was 7.08% and was also above the well-capitalized standard
of 5%.
In 1998, the Company's risk-based capital ratios dipped slightly due to
strategic leveraging of the Company's equity base, which increased
significantly in late 1997 related to the Gateway Bancorp Acquisition. The
Company's capital ratios provide quantitative data demonstrating the strength
and future opportunities for use of the Company's capital base. Management
continues to evaluate risk-based capital ratios and the capital position of
the Company and each of its banking subsidiaries as part of its strategic
decision process.
In June, 1998, the Company implemented a formal plan to purchase treasury
shares for use in its stock option plans. The announcement superseded a
previously announced stock repurchase plan and serves as the basis for
treasury purchases in anticipation of the Company's projected stock option
exercises.
The stock repurchase plan is based upon specific criteria related to market
prices and the number of shares expected to be issued under the Company's
stock option plans. In each of the second, third, and fourth quarters of
1998, the Company purchased 15,000 treasury shares at an average price of
$29.50 per share. Purchases totaled $1.3 million in 1998.
Management expects to purchase similar share amounts in future quarters for
use in its stock option plans. Future changes, if any, to the Company's
systematic share repurchase program may be necessary to respond to the
number of shares expected to be reissued for the Company's stock option
plans. The Company intends to fund future treasury share purchases with
internally generated sources in the short-term or external borrowings as
needed.
In early 1998, the Company initiated the Peoples Bancorp Inc. Deferred
Compensation Plan ("DCP") for the directors of the Company and its
subsidiaries, which is designed to recognize the value to the Company of the
past and present service of its directors and encourage their continued
service through implementation of a deferred compensation plan. The DCP
allows directors to defer the fees earned for their service as Company and
subsidiary directors into deferred accounts which are either invested in the
Company's common stock or a time deposit, at the specific director's
discretion at the time of entering the DCP. As a result and in accordance
with accounting regulations, the balances invested in Company stock in such
accounts are reported as treasury stock in the Company's financial
statements. At December 31, 1998, the Company owned $0.7 million of
Company stock related to the DCP, which reduces the equity balance of the
Company. Management does not expect the DCP to have a material impact on
future financial statements or results of operations for the Company.
As a result of treasury stock purchases net of reissuances, as well as
DCP activity, the Company had a treasury stock balance of $1.8 million at
year-end 1998. At December 31, 1997, the Company owned no treasury shares.
Primarily due to DCP activity, management expects the Company's treasury
stock balance to continue to modestly increase in the future.
Liquidity and Interest Rate Sensitivity
The objective of the Company's Asset/Liability Management function is to
maintain consistent growth in net interest income within the Company's
policy guidelines. This objective is accomplished through management of the
Company's balance sheet liquidity and interest rate risk exposure based on
changes in economic conditions, interest rate levels, and customer
preferences.
The goal of liquidity management is to provide adequate funds to meet
changes in loan demand, normal deposit balance fluctuations, or any
potential unexpected deposit withdrawals. This goal is accomplished
primarily by maintaining sufficient liquid assets in the form of investment
securities along with consistent core deposit growth, and the availability
of unused capacity to purchase funds in the national money markets. At
December 31, 1998, the Company had $45 million in securities and other
short-term investments maturing within one year compared to $57 million at
year-end 1997. Additional asset liquidity is provided by the remainder of
the securities portfolio and securitizable loan assets. Cash provided by
operating activities of $13.3 million during the year ended December 31,
1998 was offset by outflows from net investing activity of $2.2 million and
from financing activity of $9.8 million. The Company employs a practice of
maintaining core deposits as the primary means of funding interest-earning
assets. This emphasis results in the majority of interest earning assets
being funded by core deposit liabilities. As a matter of strategy rather
than policy, the Company prefers to maintain a position of excess funds to
sell in the open market.
As a supplement to deposit funding, the Company has access to a variety of
other short-term and long-term funding sources. The Company utilizes the
Federal Home Loan Bank as a funding source, taking advantage of the
attractive funding alternatives offered when appropriate. The Company
maintains relationships with other correspondent institutions that can serve
as a funding source as well.
The Company has a strategic plan to address the contingency for extraordinary
demands on liquidity due to the Year 2000 ("Y2K") phenomena. The essence of
the plan will be to ensure the adequacy and availability of a variety of
sources of liquidity. Securing the availability of the Federal Reserve Bank
Discount Borrowings for the subsidiaries of the Company will be a primary
part of the plan. Also, the Company plans, as much as is reasonably
possible, to accumulate cash and near cash assets to meet or exceed the
potential need of additional liquidity. Additionally, the Company intends
to review current correspondent relationships, as well as seek additional
such relationships to provide diverse sources of liquidity. A proactive
campaign to allay concerns customers may have for potential problems arising
from the century date change will complement the Y2K liquidity contingency
plan.
The Company manages interest rate risk to minimize the impact of fluctuating
interest rates on earnings. The Company uses simulation techniques which
attempt to measure the volatility of changes in the level of interest rates,
basic banking interest rate spreads, the shape of the yield curve, and the
impact of changing product growth patterns. The primary method of measuring
the sensitivity of earnings to changing market interest rates is to simulate
expected cash flows using varying assumed interest rates while also
adjusting the timing and magnitude of non-contractual deposit repricing to
more accurately reflect anticipated pricing behavior. These simulations
include adjustments for the lag in prime loan repricing and the spread and
volume elasticity of interest-bearing deposit accounts, regular savings, and
money market deposit accounts. The principal function of interest rate risk
management is to maintain an appropriate relationship between those assets
and liabilities that are sensitive to changing market interest rates. The
Company closely monitors the sensitivity of its assets and liabilities on
an on-going basis and projects the effect of various interest rate changes
on its net interest margin. Interest sensitive assets and liabilities are
defined as those assets or liabilities that mature or reprice within a
designated time-frame. The difference between rate sensitive assets and
rate sensitive liabilities for a specified period of time is known as "gap".
To aid in interest rate management, the Company uses FHLB advances as a low
risk means of matching maturities of earning assets with interest bearing
funds to achieve a desired interest rate spread over the life of the earning
assets. Additionally, the Company considers the use of certain off-balance
sheet instruments such as interest rate caps, floors, and swaps, to further
aid interest rate risk management. As shown in the table, the Company
currently has two such off-balance sheet instruments. These instruments,
known as interest rate floors, will provide income to the Company should a
selected market interest rate decline below a preset level specified in the
transaction agreement. The intent of this type of instrument is to provide
additional income stability to the Company should there be a dramatic
decline in interest rate. Off-balance sheet instruments are an important
tool for effective interest rate risk management. The Company continuously
evaluates the current off-balance sheet positions and the need for
additional interest rate management tools. As demonstrated in the past, the
Company will use these instruments whenever appropriate.
In addition to gap analysis, management also analyzes the impact of maturing
assets and liabilities relative to the interest rates on those products.
The following table provides information about the Company's derivative
financial instruments and other financial instruments that are sensitive to
changes in interest rates. For loans, investment securities, and liabilities
with contractual maturities, the table presents principal cash flows and
related weighted average interest rates by contractual maturities as well as
estimated prepayments of residential mortgages and mortgage-backed
securities. For core deposits (non-interest bearing demand deposits,
interest-bearing checking accounts, and savings accounts) that have no
contractual maturity, the following table presents principal cash flows,
and, as applicable, related weighted average interest rates based on the
Company's historical experience and statistical analysis. For interest rate
floors, the table presents notional amounts (as described in previous
sections) and weighted average interest rates by contractual maturity date.
A fundamental difference between the following table and traditional
"static gap" analysis is that the following table presents the financial
instruments based on the date of expected cash flows while a static gap
analysis only focuses on the repricing characteristics of the financial
instruments.
Principal/Notional Amount Maturities at December 31, 1998:
Fair
(Dollars in Thousands) There- Value
1999 2000 2001 2002 2003 after Total 12/31/98
Rate sensitive assets:
- ----------------------
Fixed interest rate loans $ 71,030 $ 49,379 $ 32,824 $ 20,529 $ 13,119 $ 53,647 $240,528 $247,431
Average interest rate 9.66% 9.64% 9.45% 9.99% 9.92% 9.26% 9.58%
Variable interest rate loans $ 96,747 $ 35,737 $ 30,532 $ 25,379 $ 22,876 $116,118 $327,389 $327,389
Average interest rate 9.03% 8.07% 8.10% 8.13% 8.15% 8.11% 8.38%
Total loans $567,917
Fixed interest rate securities $ 28,446 $ 12,893 $ 14,211 $ 16,248 $ 13,847 $121,538 $207,183 $207,183
Average interest rate 6.04% 6.07% 5.90% 6.05% 6.01% 5.95% 5.98%
Variable interest rate securities $ 2,937 $ 5,478 $ 3,890 $ 370 $ 1,198 $ 14,513 $ 28,386 $ 28,386
Average interest rate 6.34% 6.06% 6.68% 7.04% 6.73% 7.08% 6.74%
Total securities $235,569
Other interest-bearing assets $ 14,050 $ 14,050 $ 14,050
Average interest rate 3.83% 3.83%
- -----------------------------------------------------------------------------------------------------------------------
Rate sensitive liabilities:
- ---------------------------
Non-interest bearing checking $ 22,648 $ 12,941 $ 9,706 $ 3,235 $ 8,655 $ 23,699 $ 80,884 $ 80,884
Average interest rate
Savings $ 15,847 $ 7,924 $ 7,924 $ 11,885 $ 5,943 $ 49,521 $ 99,044 $ 99,044
Average interest rate 2.42% 2.42% 2.42% 2.42% 2.42% 2.42% 2.42%
Interest bearing checking $ 24,049 $ 51,960 $ 24,050 $ 8,017 $ 19,641 $ 72,702 $200,419 $200,419
Average interest rate 3.45% 4.22% 3.45% 3.45% 3.45% 3.45% 3.65%
Time deposits $265,487 $ 44,962 $ 14,331 $ 3,923 $ 3,881 $ 1,237 $333,821 $334,803
Average interest rate 5.26% 5.29% 5.51% 5.49% 5.23% 4.51% 5.27%
Total deposits
$714,168
Fixed interest rate borrowings $ 159 $ 27 $ 28 $ 29 $ 31 $ 37,821 $ 38,095 $ 36,686
Average interest rate 4.70% 4.06% 4.06% 4.06% 4.06% 4.86% 4.86%
Variable interest rate borrowings $ 35,083 $ 35,083 $ 35,083
Average interest rate 4.77% 4.77%
Total borrowings $ 73,178
- -----------------------------------------------------------------------------------------------------------------------
Rate sensitivity liabilities:
- -----------------------------
Interest rate floors purchased $ 10,000 $ 10,000 $ 20,000 $ 104
Average strike rate 5.50% 5.25%
Forward rate 5.06% 5.06%
========================================================================================================================
Principal/Notional Amount Maturities at December 31, 1997:
Fair
There- Value
(Dollars in Thousands) 1998 1999 2000 2001 2002 after Total 12/31/97
Rate sensitive assets:
- ----------------------
Fixed interest rate loans $ 68,336 $ 39,449 $ 27,989 $ 18,117 $ 11,045 $ 41,245 $206,181 $208,504
Average interest rate 9.35% 9.78% 9.49% 9.87% 9.76% 9.23% 9.48%
Variable interest rate loans $104,969 $ 31,063 $ 25,710 $ 21,797 $ 18,660 $113,190 $315,389 $315,389
Average interest rate 10.11% 8.43% 8.39% 8.44% 8.39% 8.59% 9.04%
Total loans $521,570
Fixed interest rate securities $ 39,252 $ 13,407 $ 14,471 $ 6,292 $ 12,213 $ 74,683 $160,318 $160,318
Average interest rate 6.12% 6.61% 6.28% 6.30% 6.56% 6.62% 6.45%
Variable interest rate securities $ 202 $ 2,412 $ 590 $ 5,861 $ 505 $ 4,403 $ 13,973 $ 13,973
Average interest rate 6.31% 7.65% 7.76% 6.94% 7.34% 7.07% 7.14%
Total securities $174,291
Other interest-bearing assets $ 17,358 $ 17,358 $ 17,358
Average interest rate 6.50% 6.50%
- -----------------------------------------------------------------------------------------------------------------------
Rate sensitive liabilities:
- ---------------------------
Non-interest bearing checking $ 17,984 $ 10,277 $ 7,707 $ 7,129 $ 5,010 $ 16,122 $ 64,229 $ 64,229
Average interest rate
Savings $14,489 $7,244 $7,244 $ 7,878 $ 6,339 $ 47,360 $ 90,554 $ 90,554
Average interest rate 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10%
Interest bearing checking $ 15,829 $ 37,395 $ 15,829 $ 12,003 $ 10,684 $ 40,166 $131,906 $131,906
Average interest rate 3.38% 4.29% 3.38% 3.38% 3.38% 3.38% 3.54%
Time deposits $224,715 $ 78,199 $ 10,638 $ 6,496 $ 3,740 $ 630 $324,418 $325,086
Average interest rate 5.49% 5.81% 5.62% 6.00% 5.46% 4.60% 5.58%
Total deposits $611,107
Fixed interest rate borrowings $ 9,886 $ 3,681 $ 3,752 $ 2,837 $ 2,818 $ 4,185 $ 27,159 $ 27,259
Average interest rate 6.04% 6.14% 6.17% 6.05% 6.05% 6.46% 6.14%
Variable interest rate borrowings $ 33,979 $ 33,979 $ 33,979
Average interest rate 5.05% 5.05%
Total borrowings $ 61,138
- -----------------------------------------------------------------------------------------------------------------------
Rate sensitive derivative financial instruments:
- ------------------------------------------------
Interest rate floors purchased $ 20,000 $ 10,000 $ 10,000 $40,000 $101
Average strike rate 7.00% 5.50% 5.25%
Forward rate 5.81% 5.81% 5.81%
=======================================================================================================================
The preceding tables represent the Company's best estimates of future cash
flows from rate sensitive assets and liabilities. While this table
represents several significant changes in cash flow estimates for assets and
liabilities in maturity periods exceeding five years, the increases in fixed
rate loan and fixed rate investment securities maturing in 2004 and beyond
reflect investment decisions that were driven by simulation modeling which
indicated an asset sensitive balance sheet. Consequently, additional
emphasis was placed on adding fixed rate assets, which also resulted in
extended cash flow cycles to reduce the potential earnings impact of a
declining rate environment. In addition, several fixed rate liability
categories also reflect increases in extended cash flow characteristics.
While the underlying instruments have longer contractual maturities, certain
repricing options, if exercised by the creditor, would result in a
corresponding option to the Company to repay the borrowing. Management
intends to actively manage the corresponding impact of these extended cash
flow characteristics as a part of the regular review and actions of the ALCO.
The Company employs a variety of measurement techniques to identify and
manage its interest rate risk exposure. Evaluation and review of the
techniques, tools, and assumptions used in assessing the Company's interest
rate risk is an ongoing process.
Effects of Inflation on Financial Statements
Substantially all of the Company's assets relate to banking and are monetary
in nature. Therefore, they are not impacted by inflation in the same manner
as companies in capital intensive industries. During a period of rising
prices, a net monetary asset position results in loss in purchasing power
and conversely a net monetary liability position results in an increase in
purchasing power. In banks, monetary assets typically exceed monetary
liabilities and therefore, as prices have increased over the past year,
financial institutions experienced a modest decline in the purchasing power
of their assets.
Outlook for 1999
Recent financial data reflects enhanced operational results achieved through
a combination of external growth and optimization of core competencies of
customer service and community presence. In addition, management has
identified and will continue to analyze key performance areas which
quantitatively measure the relative performance of the Company compared to
prior year results.
Management is pleased with the recent conversion of the offices acquired in
the West Virginia Banking Center Acquisition. The successful transition of
these offices bolstered loan activity with minimal loss of deposits. The
new offices are a natural extension of the Company's presence in the
mid-Ohio Valley and leverage the Company's equity position for 1999 and
beyond. The Company expects to continue its investment in the new
geographic markets through loans and other community reinvestment activities.
Future loan growth is also anticipated as the Company continues to expand
its relationship with selected customers outside traditional geographic
markets.
Management plans to continue recent momentum of non-interest income growth
from various sources. The retention of the deposits acquired in the West
Virginia Banking Center Acquisition represents an additional opportunity to
provide superior customer service and strengthen the Company's position in
those markets. One of the Company's priorities in 1999 will be the
management and direction of the West Virginia Banking Center Acquisition
offices with existing full-service banking centers to create a united
financial service provider for the customers of Mason and Wetzel Counties in
West Virginia and surrounding areas of West Virginia and Ohio. Management
expects to enhance non-interest income streams in 1999 related to the
acquired deposits and associated cost-recovery fees of those deposits.
In January 1999, Peoples Bank announced intentions to open three sales
offices in Wal-Mart stores located in West Virginia (in the communities of
New Martinsville, Vienna, and Parkersburg). The Peoples Bank sales offices
will be located in the front of each Wal-Mart store near the customer
service area and will offer new deposit accounts, loans, insurance products,
investment services, Internet access, ATM access, and more. Peoples Bank
will open its New Martinsville Wal-Mart sales office in April, 1999; the
Vienna (near Parkersburg) Wal-Mart is scheduled to open in the third quarter
of 1999; and the south Parkersburg Wal-Mart is scheduled to be completed
near the end of 1999. It is anticipated that the Peoples Bank sales office
openings in the Vienna and Parkersburg Wal-Marts will coincide with the
grand opening of each store.
The three new offices will increase Peoples Bank's visibility in its West
Virginia markets and give the Company's team of personal bankers better
access to an increased number of shoppers compared to a traditional banking
center. The new Wal-Mart locations will complement the Company's existing
full-service banking centers in New Martinsville and Parkersburg, as well as
provide additional locations to Peoples Bank's customers in the greater
Parkersburg area, particularly through the Vienna store. Management
believes these new sales centers will be catalysts for 1999's sales and
customer service efforts and a focal point for future banking centers.
Rather than traditional banking offices, the Wal-Mart locations will be
full-service 'electronic' sales centers, with an emphasis on selling
products that meet the customers' financial needs combined with electronic
transaction capabilities and access to customer accounts.
Mergers and acquisitions remain a viable strategic option for the continued
growth of the Company's operations and scope of customer service. Future
acquisitions, if they occur, may not be limited to specific geographic
location or proximity to current markets. Management will focus its
energies on review and research of possible mergers, consolidations, or
banking center purchases as a means of acquiring sales centers that
complement existing Peoples Bancorp locations and sales strategies.
Ultimately, acquisitions will depend upon financial service opportunities
that complement the Company's core competencies and strategic intent.
Management considers mergers and acquisitions to be a viable method of
enhancing the Company's earnings potential and will continue to pursue
appropriate business opportunities as they develop.
In conjunction with recent acquisitions and market expansion, management
continues to focus on operational efficiency as a method of increasing
shareholder value. As a means of increasing the Company's operating
efficiency and leverage available resources, the Company merged its federal
savings banks into a single unit effective January 1, 1999. The merger
provided an opportunity to unite the Company's Kentucky operations and
optimize the operating efficiency, profit potential, and capital positions
of the resulting entity. In 1999, management will continue to focus efforts
to enhance profitability of its southernmost operations through increased
product offerings, commitment to development of a non-interest bearing
deposit base, and other customer service possibilities.
In addition to operating efficiency, management focuses on increasing future
non-interest revenue streams to lessen the Company's dependency on net
interest income as the primary driver of future net income. In 1998, net
interest income increased as a percentage of total revenues due to the West
Virginia Banking Center Acquisition. In future periods, management will
focus on methods to enhance earnings potential through optimization of
customer relationships through an integrated sales process.
Integration of the Company's many sales processes, products, and services
will be the cornerstone of 1999's focus. Management will concentrate on a
marketing program based on establishing brand awareness of the Company in
its markets. The Company's insurance capabilities are an integral part of
future earnings streams and should reach break-even levels in 2000, and
gradually increase profitability thereafter. Management will continue to
research alternative methods of enhancing non-interest income streams, such
as electronic banking revenues, low income housing tax credits, and other
investments.
Management concentrates on several key performance indicators to measure and
direct the performance of the Company. While past results are not an
indication of future earnings, management believes the Company is positioned
to capitalize on its recent growth and enhance future performance levels
through integrated sales techniques and commitment to strategic initiatives
designed to increase shareholder value.
Impact of the Year 2000 Issue
The Company intends this information to constitute notice under the Year
2000 Information and Readiness Disclosure Act as a "Year 2000 Readiness
Disclosure".
Many companies across various industries have dedicated efforts to analyze
the much-publicized "Year 2000" issue (or "Y2K"), which is the result of
computer programs written using two digits rather than four to define the
applicable year. Computer programs or hardware which have date-sensitive
software or embedded chips may recognize a date of "00" as the year 1900
rather than the year 2000. This could result in system failure or
miscalculations causing disruptions of operations, including, among other
things, the inability to process transactions or engage in similar normal
business activities.
As discussed further below and based on assessments completed by the
Company, portions of the Company's software and hardware systems have been
modified, updated, or replaced so that those systems will properly utilize
dates beyond December 31, 1999. Management believes its assessment and
resulting remediation measures have mitigated the Y2K issue and ensured Y2K
compliance in regards to mission-critical applications, including customer
service related hardware and software systems (except certain ATM's, which
are to be updated in April, 1999).
Management has implemented plans to address Y2K issues and the impact to the
Company's business, operations, and relationships with customers, suppliers,
and other third parties. The Company primarily relies on third party
vendors for all critical processing systems software. Based on management's
assessments, the Company replaced certain portions of its software and
worked with software vendors so that those systems would properly utilize
dates beyond December 31, 1999. Management presently believes with these
recent modifications, combined with replacement of certain existing ATM
hardware and software, the Y2K issue will be mitigated.
Since the Company offers fiduciary services, management has conducted a
review of these services to identify potential liabilities. Management
continues to take appropriate action to manage identified exposure in order
to fulfill its responsibilities to fiduciary clients and to observe the
standards of prudence set forth in applicable laws and regulations.
Management plans to resolve the Y2K issue in five phases as follows:
awareness, assessment, renovation, validation, and implementation. To date,
the Company has completed its assessment of all material systems which could
be affected by the Y2K issue and addressed the extent to which its operations
are vulnerable should its software fail to be Y2K compliant. The completed
assessment indicates most of the Company's significant information technology
systems could be affected. Banking regulators have issued guidelines and
deadlines detailing what they expect financial institutions to do in order
to insure Y2K preparedness. The Company is following these guidelines and
expects to meet the deadlines defined by the regulators. As a part of this
process, the Company is also developing contingency plans for all
mission-critical systems, which it will implement in the event any of these
systems fail to function. Contingency plans for both information technology
systems ("IT") and non-information technology systems ("non-IT") include a
combination of manual processes and utilization of systems (which have
already been Y2K validated and implemented) that are completely independent
from the Company's core information systems.
The Company continues to assess the credit, liquidity and counterparty
trading risks which may be posed by customers who encounter Year 2000-related
problems. These problems may result from the failure of a customer to
properly remediate its own systems and from Y2K problems that are not
addressed by the customer's suppliers and clients. The Company has amended
credit policies to include an assessment of Year 2000-related risks for
material new customers. The initial assessment of customer-related risks
for material customers has been completed and management does not anticipate
material losses or a significant negative impact to the Company's future
results of operations or financial position. The Company will continue to
monitor these risks.
The Company's assessment process included IT and non-IT systems. The IT
systems identified included personal computers, mainframes, local area
networks and servers, wide area network, automated teller machines ("ATM's"),
printers, copy machines, facsimile machines, telephones, and the operating
systems and softwares for these systems. Based on the results of its
assessment process, management considers these IT systems to be compliant
with Y2K, except approximately half of the Company's ATM's require hardware
and/or software upgrades which will be completed in the second quarter of
1999. The remaining ATM's have been certified compliant by the vendors.
Non-IT systems identified included heating, air conditioning, vault controls,
alarm systems, surveillance systems, and postage meters. Contact has been
made with all outside servicers and major vendors to determine their
individual levels of Y2K compliance. Based on vendor responses and/or
certification of Y2K compliance, the Company has determined that it should
not be significantly impacted by Y2K from these systems.
As of February 12, 1999, the following chart shows the current and projected
status of the Company's Y2K compliance efforts relative to IT systems:
Nov. 13 Dec. 31 Feb. 12 March 31 June 30
PHASE 1998 1998 1999 1999 1999
Awareness 100% --- --- --- ---
Assessment 100% --- --- --- ---
Renovation 80% 80% 100% --- ---
Validation 20% 70% 75% 80% 100%
Implementation 20% 70% 75% 80% 100%
Management estimates that half of its potential Y2K issues originate in the
Company's core banking system (software provided by a third-party vendor).
The Company's core banking system supports approximately 50% of the
information processing for the Company. This single system software
provides accounting for the Company, as well as loan and deposit products.
This core banking system has been certified as Y2K compliant by the vendor
and the Information Technology Association of America. This software has
essentially been Y2K compliant for several years, as it was designed with a
four digit year field, and supports calculations beyond the year 2000. The
Company has completed 100% of its due diligence review of the proxy testing
of the core banking system. Additionally, the Company has conducted testing
in its own environment and plans to complete the validation of the proxy
tests through testing of mission critical interfaces into its core banking
system. Approximately 25% of the interface testing has been successfully
completed and the Company plans to complete the testing of the remaining
critical interfaces by the end of the first quarter of 1999.
The Company has replaced the central processing unit (hardware) that
supports the accounting system for Investment and Trust. The Company has
also upgraded the accounting system software, which has been certified
compliant by its vendor. These replacements and upgrades enabled the
Company to test the software and the related network and computer hardware,
in its own environment. This testing has been completed and management
believes the results were successful.
The ATM network software has also been certified compliant by its vendor and
has been tested in the Company's environment. The remaining mission critical
IT system, the Company's document processing and retrieval system, is
expected to be fully validated and implemented by June 30, 1999. The vendor
has supplied its Y2K certified version of its software and it has been
installed in the Company's current environment. Management is working
closely with the Company's third party vendors to ensure Y2K compliance in a
timely manner.
As planned, management replaced the Company's internal operating systems
(on existing hardware) during the second half of 1998. The internal
operating system for the mainframe computer has been successfully tested and
proven to be Y2K compliant. The Company has also completed the renovation
phase for all internally developed software applications. Management does
not consider internal software systems to be significant to the overall
operations of the Company.
All mission critical applications that were not Y2K compliant have been
upgraded. All reprogramming of internal software was completed in the third
quarter of 1998.
After completing the replacement of certain systems in January, 1999, the
Company's plans include testing and implementing its information technology
systems. As of February 12, 1999, the Company approximates it has completed
75% of its testing and has implemented all of the renovated systems that
have been tested. Completion of the testing phase is expected by the end of
the first quarter of 1999, with all renovated systems fully implemented by
June 30, 1999.
The Company has queried, through written and verbal communication, its
important suppliers (such as utility companies) which do not involve system
interface. To date, the Company is not aware of any problems which would
materially impact operations, although the Company has no means of ensuring
that these organizations will be Y2K ready. The inability of these parties
to complete their Year 2000 resolution process could materially impact the
Company, as well as other businesses and consumers.
The Company expenses Y2K project costs as incurred. The total out-of-pocket
cost of the Y2K compliance project is not expected to be greater than
$200,000 and, therefore, is immaterial to the Company's results of operations
or financial position. As of February 12, 1999, management estimates that
60% of the Company's costs have been incurred. Included in the cost estimate
is internal human resource expense which is estimated to approximate between
$100,000 to $150,000. Actual out-of-pocket expenses have been less than
anticipated, however, management has increased the amount of internal human
resource expected to be consumed by this project, offsetting the costs saved
relative to purchases of hardware, software, and/or consulting fees. In
addition, the Company has no pending material legal proceedings related to
Y2K.
Due to the positive progress of the Company relative to remediation of the
Y2K issue, management recently launched a comprehensive marketing program to
its customers designed to communicate the Company's preparedness regarding
Y2K. Throughout 1999, the Company plans to increase its efforts to
communicate its preparedness in the market area it serves.
The foregoing discussion of the Company's plans to complete the Y2K
modifications contains forward-looking statements for purposes of the
Private Securities Litigation Reform Act of 1995 and is based on
management's best estimates, which were derived utilizing assumptions of
future events including the continued availability of certain resources,
and other factors. Estimates on the status of completion and the expected
completion dates are based on costs incurred to date compared to total
expected costs. However, there can be no guarantee that these estimates
will be achieved and actual results could differ materially from those plans.
Specific factors which might cause such material differences include, but
are not limited to, the availability and cost of personnel trained in the
specialized area of Y2K compliance, the ability of vendors to deliver Y2K
compliant software as planned, the ability to locate and correct all
relevant computer codes, and similar uncertainties.
Comparison of 1997 to 1996
The Company reported an increase in net income of 12.5%, to $8,605,000 in
1997 from $7,651,000 in 1996. This increase in earnings provided basic and
diluted earnings per share of $1.65 and $1.60, respectively, for the year
ended December 31, 1997, compared to $1.48 and $1.46 in 1996. Strong
internal loan growth and loans acquired in the Russell Federal acquisition,
coupled with enhanced operational efficiencies, were the driving forces
behind the increase in net income.
For the year ended December 31, 1997, return on average assets was unchanged
from 1996's ratio of 1.29%. In 1997, return on stockholders' equity
declined slightly to 14.33% compared to 14.43% in 1996, a decline of 10
basis points. Asset growth also contributed to incremental increases in net
income in 1997 compared to 1996. In 1997, the Company grew its balance
sheet through a combination of acquisition and internal growth. Total assets
increased $141.5 million (or 23.0%) to $758.2 million at year-end 1997. For
the year ended December 31, 1997, the Company's asset growth primarily
occurred in earning assets such as loans and investments securities. Loans
grew $99.2 million (or 23.5%) to $521.6 million and investment securities
grew $26.5 million (or 17.9%) to $174.3 million.
The Company recorded net interest income of $28,620,000 in 1997, an increase
of 12.5% compared to 1996, as total interest income reached $53,836,000 and
interest expense totaled $25,216,000. Net interest margin modestly decreased
in 1997 to 4.74% from 4.75% in 1996. The interest cost on the Company's
array of traditional interest-bearing deposit products (demand and time
deposit accounts) increased nine basis points, with the most significant
cost being interest paid on time deposits (CDs and IRAs). The largest rate
increase occurred in average interest-bearing demand deposits, which
increased 18 basis points to 3.46% on average deposit balances of $126.5
million. The increases in interest expense were offset by increased interest
income, as the Company experienced average loan growth in 1997 of
approximately $67 million compared to the prior year, which produced an
additional incremental interest income of over $6 million.
Loans continued to be the largest earning asset component for the Company.
Loans averaged 84.0% of deposits in 1997, up from 82.3% at year-end 1996.
The fully-tax equivalent (FTE) yield on earnings assets increased slightly,
from 8.74% in 1996 to 8.81% in 1997. Interest costs as a percentage of
earning assets increased 8 basis points to 4.07% in 1997 due primarily to
the competitive rates paid on interest bearing deposits and minimal growth
in non-interest bearing deposits.
The Company's loan loss provision totaled $2,589,000 in 1997, up $624,000
compared to 1996, an increase of 31.8%. The growth was due primarily to
loan growth and a rise in loan delinquencies in 1997. At December 31, 1997,
the Company's allowance for loan losses as a percentage of total loans was
1.60%, compared to a year-end 1996 ratio of 1.63%.
Non-interest income (excluding securities transactions) continued its
positive growth trend in 1997, reaching $5,966,000, an increase of 16.3%
compared to 1996. Several categories had strong growth compared to 1996,
including income from fiduciary activities, which reported $2,176,000 in
revenues in 1997, an increase of 14.7% compared to 1996. Income related to
account service charges increased $265,000 (or 13.7%) to $2,202,000 in 1997,
due primarily to the full-year impact of increased deposit base acquired in
the acquisition of the Pomeroy, Rutland and Gallipolis offices in April,
1996. In 1997, electronic banking fee income increased $357,000 (or 33.4%)
compared to prior year due to increased revenues from the Company's growing
debit card program.
In 1997, non-interest expense totaled $19,265,000, an increase of 9.9% over
the prior year, due primarily to the Company's 1996 acquisitions and the
associated increased levels of non-interest expense such as salaries and
benefits, depreciation expense, and intangible amortization. Even though
salaries and employee benefits continued to be the largest source of
non-interest expense for the Company, totaling $8,358,000 in 1997, an
increase of $844,000 (or 11.2%) from 1996, increase in expense for
non-operational items also caused 1997's non-interest expense levels to
rise. Amortization of intangibles totaled $1,138,000 in 1997 compared to
$625,000 for the same period in the prior year, an increase of $513,000
(or 82.1%). Despite significant increases in major non-interest expense
areas, the Company leveraged its increased operational expenses due to
market share growth and enhanced revenue streams, causing the Company's
efficiency ratio to improve to 51.06% in 1997 compared to 53.76% in 1996.
"Safe Harbor" Statement under the Private Securities Litigation Reform Act
of 1995
The statements in this Annual Report which are not historical fact are
forward looking statements that involve risks and uncertainties, including,
but not limited to, the interest rate environment, the effect of federal and
state banking and tax regulations, the effect of economic conditions, the
Company's ability to execute its plan to address the Y2K issue and the
ability of third parties to effectively address their Y2K issues, the impact
of competitive products and pricing, and other risks detailed in the
Company's Securities and Exchange Commission filings.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
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Please refer to pages 24 through 27 in Item 7 of this Form 10-K/A.
SIGNATURES
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Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report on Form
10-K/A to be signed on its behalf by the undersigned, thereunto duly
authorized.
PEOPLES BANCORP INC.
Date: April 8, 1999 By: /s/ ROBERT E. EVANS
Robert E. Evans
President and Chief Executive Officer