Exhibit 99.2
------------------------------
CONVERSION APPRAISAL REPORT
PFS BANCORP, INC.
PROPOSED HOLDING COMPANY FOR
PEOPLES FEDERAL SAVINGS BANK
AURORA, INDIANA
DATED AS OF:
JUNE 8, 2001
------------------------------
PREPARED BY:
RP FINANCIAL, LC.
1700 NORTH MOORE STREET
SUITE 2210
ARLINGTON, VIRGINIA 22209
June 8, 2001
Board of Directors
Peoples Federal Savings Bank
Second and Bridgeway Streets
Aurora, Indiana 47001
Gentlemen:
At your request, we have completed and hereby provide an independent
appraisal ("Appraisal") of the estimated pro forma market value of the common
stock which is to be issued in connection with the mutual-to-stock conversion of
Peoples Federal Savings Bank, Aurora, Indiana ("Peoples Federal" or the "Bank").
The common stock issued in connection with the Bank's conversion will
simultaneously be acquired by a holding company, PFS Bancorp, Inc. ("PFS
Bancorp" or the "Holding Company"). Pursuant to the Plan of Conversion, the
common stock will be offered to depositors of the Bank, the Bank's employee
stock ownership plan (the "ESOP") directors, officers and employees of the Bank,
members of the local community and the public at large (the Subscription and
Community Offerings).
This Appraisal is furnished pursuant to the conversion regulations
promulgated by the Office of Thrift Supervision ("OTS"). This Appraisal has been
prepared in accordance with the written valuation guidelines promulgated by the
OTS, most recently updated as of October 21, 1994. Specifically, this Appraisal
has been prepared in accordance with the "Guidelines for Appraisal Reports for
the Valuation of Savings and Loan Associations Converting from Mutual to Stock
Form of Organization" of the OTS, dated as of October 21, 1994; and applicable
regulatory interpretations thereof.
DESCRIPTION OF REORGANIZATION
The Board of Directors of the Bank has adopted a plan of conversion
pursuant to which the Bank will convert from a federally chartered mutual
savings bank to a federally chartered stock savings bank and issue all of its
outstanding shares to the Holding Company. PFS Bancorp will sell in the
Subscription and Community Offerings, Holding Company common stock in the amount
equal to the appraised value of the Bank. In addition, Peoples Federal intends
to establish the PFS Community Foundation (the "Foundation") as part of the
conversion and will fund the Foundation with a contribution of PFS Bancorp
common stock. The contribution to the Foundation is estimated to equal 2.0
percent of the value of the shares issued in the offering. Immediately following
the conversion, the only significant assets of the Holding Company will be the
capital stock of the Bank and the net conversion proceeds remaining after
purchase of the Bank's common stock by the Holding Company. PFS Bancorp will use
50 percent of the net conversion proceeds to purchase the Bank's common stock. A
portion of the net conversion proceeds retained by the Holding Company will be
loaned to the ESOP to fund the ESOP's stock purchases in the offering, and the
remainder will be reinvested into investment securities.
Board of Directors
June 8, 2001
Page 2
RP FINANCIAL, LC.
RP Financial, LC. ("RP Financial") is a financial consulting firm
serving the financial services industry nationwide that, among other things,
specializes in financial valuations and analyses of business enterprises and
securities, including the pro forma valuation for savings institutions
converting from mutual-to-stock form. The background and experience of RP
Financial is detailed in Exhibit V-1. We believe that, except for the fee we
will receive for our appraisal and assisting in the preparation of related
business plans, we are independent of the Bank and the other parties engaged by
Peoples Federal to assist in the corporate reorganization and stock issuance
process.
VALUATION METHODOLOGY
In preparing our appraisal, we have reviewed Peoples Federal's
application for Approval of Conversion, including the Proxy Statement, as filed
with the OTS, and the Holding Company's Form SB-2 registration statement as
filed with the Securities and Exchange Commission ("SEC"). We have conducted a
financial analysis of the Bank that has included due diligence related
discussions with Peoples Federal's management; Grant Thornton LLP, the Bank's
independent auditor; Elias, Matz, Tiernan & Herrick L.L.P., Peoples Federal's
conversion counsel; and Prestige Financial Center, Inc., which has been retained
as the financial and marketing advisor in connection with the Holding Company's
stock offering. All conclusions set forth in the Appraisal were reached
independently from such discussions. In addition, where appropriate, we have
considered information based on other available published sources that we
believe are reliable. While we believe the information and data gathered from
all these sources are reliable, we cannot guarantee the accuracy and
completeness of such information.
We have investigated the competitive environment within which People
Federal operates and have assessed the Bank's relative strengths and weaknesses.
We have kept abreast of the changing regulatory and legislative environment and
analyzed the potential impact on Peoples Federal and the industry as a whole. We
have analyzed the potential effects of conversion on the Bank's operating
characteristics and financial performance as they relate to the pro forma market
value of PFS Bancorp. We have reviewed the economy in the Bank's primary market
area and have compared Peoples Federal's financial performance and condition
with selected publicly-traded thrift institutions with similar characteristics
as the Bank, as well as all publicly-traded thrifts. We have reviewed conditions
in the securities markets in general and in the market for thrift stocks in
particular, including the market for existing thrift issues and the market for
initial public offerings by thrifts.
Our Appraisal is based on Peoples Federal's representation that the
information contained in the regulatory applications and additional information
furnished to us by the Bank and its independent auditors are truthful, accurate
and complete. We did not independently verify the financial statements and other
information provided by the Bank and its independent auditors, nor did we
independently value the assets or liabilities, on or off balance sheet, of the
Bank. The
Board of Directors
June 8, 2001
Page 3
valuation considers Peoples Federal only as a going concern and should not be
considered as an indication of the liquidation value of the Bank.
Our appraised value is predicated on a continuation of the current
operating environment for Peoples Federal and for all thrifts. Changes in the
local, state and national economy, the legislative and regulatory environment,
the stock market, interest rates, and other external forces (such as natural
disasters or significant world events) may occur from time to time, often with
great unpredictability and may materially impact the value of thrift stocks as a
whole or the Bank's value alone. It is our understanding that Peoples Federal
intends to remain an independent institution and there are no current plans for
selling control of the Bank as a converted institution. To the extent that such
factors can be foreseen, they have been factored into our analysis.
Pro forma market value is defined as the price at which PFS Bancorp's
stock, immediately upon completion of the conversion offering, would change
hands between a willing buyer and a willing seller, neither being under any
compulsion to buy or sell and both having reasonable knowledge of relevant
facts.
VALUATION CONCLUSION
It is our opinion that, as of June 8, 2001, the aggregate pro forma
market value of the Holding Company's common stock, including the contribution
to the Foundation immediately following the offering, is $11,730,000 at the
midpoint, equal to 1,173,000 shares offered at a per share value of $10.00. The
resulting range of value pursuant to regulatory guidelines and the corresponding
number of shares based on the Board determined $10.00 per share offering price
is set forth below.
OFFERING FOUNDATION TOTAL SHARES AGGREGATE
VALUATION RANGE AMOUNT CONTRIBUTION ISSUED MARKET VALUE
--------------- ------ ------------ ------ ------------
(Shares) (Shares) (Shares) ($)
Minimum 977,500 19,550 997,050 $9,970,500
Midpoint 1,150,000 23,000 1,173,000 11,730,000
Maximum 1,322,500 26,450 1,348,950 13,489,500
Supermaximum 1,520,875 30,418 1,551,293 15,512,930
LIMITING FACTORS AND CONSIDERATIONS
Our valuation is not intended, and must not be construed, as a
recommendation of any kind as to the advisability of purchasing shares of the
common stock. Moreover, because such valuation is necessarily based upon
estimates and projections of a number of matters, all of which are subject to
change from time to time, no assurance can be given that persons who
Board of Directors
June 8, 2001
Page 4
purchase shares of common stock in the conversion will thereafter be able to buy
or sell such shares at prices related to the foregoing valuation of the pro
forma market value thereof.
RP Financial's valuation was determined based on the financial
condition and operations of Peoples Federal as of March 31, 2001, the date of
the financial data included in the regulatory applications and prospectus.
RP Financial is not a seller of securities within the meaning of any
federal and state securities laws and any report prepared by RP Financial shall
not be used as an offer or solicitation with respect to the purchase or sale of
any securities. RP Financial maintains a policy which prohibits the company, its
principals or employees from purchasing stock of its client institutions.
The valuation will be updated as provided for in the conversion
regulations and guidelines. These updates will consider, among other things, any
developments or changes in the Bank's financial performance and condition,
management policies, and current conditions in the equity markets for thrift
shares. These updates may also consider changes in other external factors which
impact value including, but not limited to: various changes in the legislative
and regulatory environment, the stock market and the market for thrift stocks,
and interest rates. Should any such new developments or changes be material, in
our opinion, to the valuation of the shares, appropriate adjustments to the
estimated pro forma market value will be made. The reasons for any such
adjustments will be explained in the update at the date of the release of the
update.
Respectfully submitted,
RP FINANCIAL, LC.
/s/ William E. Pommerening
William E. Pommerening
Chief Executive Officer
/s/ Gregory E. Dunn
Gregory E. Dunn
Senior Vice President
RP Financial LC.
TABLE OF CONTENTS
PEOPLES FEDERAL SAVINGS BANK
AURORA, INDIANA
PAGE
DESCRIPTION NUMBER
----------- ------
CHAPTER ONE OVERVIEW AND FINANCIAL ANALYSIS
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Introduction 1.1
Strategic Overview 1.2
Balance Sheet Trends 1.6
Income and Expense Trends 1.9
Interest Rate Risk Management 1.13
Lending Activities and Strategy 1.14
Asset Quality 1.17
Funding Composition and Strategy 1.18
Legal Proceedings 1.19
CHAPTER TWO MARKET AREA
-----------
Introduction 2.1
Market Area Demographics 2.1
National Economic Factors 2.4
Local Economy 2.6
Market Area Deposit Characteristics and Competition 2.7
CHAPTER THREE PEER GROUP ANALYSIS
-------------
Peer Group Selection 3.1
Financial Condition 3.5
Income and Expense Components 3.9
Loan Composition 3.12
Interest Rate Risk 3.14
Credit Risk 3.16
Summary 3.16
RP Financial LC.
TABLE OF CONTENTS
PEOPLES FEDERAL SAVINGS BANK
AURORA, INDIANA
(CONTINUED)
PAGE
DESCRIPTION NUMBER
----------- ------
CHAPTER FOUR VALUATION ANALYSIS
------------
Introduction 4.1
Appraisal Guidelines 4.1
RP Financial Approach to the Valuation 4.1
Valuation Analysis 4.2
1. Financial Condition 4.3
2. Profitability, Growth and Viability of Earnings 4.4
3. Asset Growth 4.7
4. Primary Market Area 4.7
5. Dividends 4.9
6. Liquidity of the Shares 4.9
7. Marketing of the Issue 4.10
A. The Public Market 4.10
B. The New Issue Market 4.16
C. The Acquisition Market 4.18
8. Management 4.20
9. Effect of Government Regulation and Regulatory Reform 4.21
Summary of Adjustments 4.21
Valuation Approaches 4.21
1. Price-to-Earnings ("P/E") 4.23
2. Price-to-Book ("P/B") 4.26
3. Price-to-Assets ("P/A") 4.26
Comparison to Recent Conversions 4.26
Valuation Conclusion 4.27
RP Financial LC.
LIST OF TABLES
PEOPLES FEDERAL SAVINGS BANK
AURORA, INDIANA
TABLE
NUMBER DESCRIPTION PAGE
------ ----------- ----
1.1 Historical Balance Sheets 1.7
1.2 Historical Income Statements 1.10
2.1 Summary Demographic Information 2.3
2.2 Unemployment Trends 2.7
2.3 Deposit Summary 2.9
3.1 Peer Group of Publicly-Traded Thrifts 3.3
3.2 Balance Sheet Composition and Growth Rates 3.6
3.3 Income as a Percent of Average Assets and Yields, Costs, Spreads 3.10
3.4 Loan Portfolio Composition Comparative Analysis 3.13
3.5 Interest Rate Risk Measures and Net Interest Income Volatility 3.15
3.6 Credit Risk Measures and Related Information 3.17
4.1 Market Area Unemployment Rates 4.8
4.2 Recent Conversion Pricing Characteristics 4.17
4.3 Market Pricing Comparatives 4.19
4.4 Public Market Pricing 4.24
RP Financial LC.
Page 1.1
I. OVERVIEW AND FINANCIAL ANALYSIS
INTRODUCTION
Peoples Federal Savings Bank ("Peoples Federal" or the "Bank"),
organized in 1887, is a federally chartered mutual savings bank headquartered in
Aurora, Indiana. In addition to its main office, which includes a full service
branch, the Bank maintains two other full service branches in the Southeastern
Indiana towns of Rising Sun and Vevay. The main office is located in Dearborn
County, while the Rising Sun and Vevay branches are located in Ohio and
Switzerland Counties, respectively. A map of the Bank's office locations is
provided in Exhibit I-1. Peoples Federal is a member of the Federal Home Loan
Bank ("FHLB") system, and its deposits are insured up to the regulatory maximums
by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit
Insurance Corporation ("FDIC"). At March 31, 2001, Peoples Federal had $113.4
million in assets, $95.8 million in deposits and total equity of $13.6 million
or 12.0 percent of total assets.
On May 11, 2001, the Board of Directors of the Bank adopted a plan of
conversion, incorporated herein by reference, in which the Bank will convert
from mutual to stock form. PFS Bancorp, Inc. ("PFS Bancorp" or the "Holding
Company"), an Indiana corporation, was recently organized to facilitate the
conversion of Peoples Federal. In the course of the conversion, the Holding
Company will acquire all of the capital stock that the Bank will issue upon its
conversion from the mutual to stock form of ownership. Going forward, PFS
Bancorp will own 100 percent of the Bank's stock, and the Bank will be PFS
Bancorp's sole subsidiary. A portion of the net proceeds received from the sale
of common stock will be used to purchase all of the then to be issued and
outstanding capital stock of the Bank, with the balance of the proceeds being
retained by the Holding Company.
At this time, no other activities are contemplated for the Holding
Company other than the ownership of the Bank, a loan to the newly-formed
employee stock ownership plan ("ESOP") and reinvestment of the proceeds retained
by the Holding Company. In the future, PFS Bancorp may acquire or organize other
operating subsidiaries, diversify into other banking-related activities or
repurchase its stock, although there are no specific plans to undertake such
activities at the present time.
RP Financial LC.
Page 1.2
In order to enhance the Bank's existing historically strong service and
reinvestment activities in the local community, the plan of conversion provides
for the establishment of the PFS Community Foundation (the "Foundation") in
connection with the stock offering. The Bank and the Holding Company will create
the Foundation and fund it with authorized but unissued shares of common stock
contributed by the Holding Company in an amount equal to 2.0 percent of the
shares sold in the public stock offering. The Foundation is intended to
complement the Bank's existing community reinvestment activities and will be
dedicated to the promotion of charitable purposes, with an emphasis on
educational activities within the communities served by the Bank. Funding the
Foundation with shares of common stock of the Holding Company will enable the
local community served to share in the growth and profitability of the Holding
Company over the long term through dividends and price appreciation. As such,
the Bank believes the Foundation will create a high level of community goodwill
toward the Holding Company and the Bank, increase the Bank's local visibility
and further enhance the Bank's reputation for community service, thereby
strengthening its community banking franchise.
STRATEGIC OVERVIEW
Peoples Federal maintains a local community banking emphasis, with a
primary strategic objective of meeting the borrowing and savings needs of its
local customer base. Historically, Peoples Federal's operating strategy has been
fairly reflective of a traditional thrift operating strategy in which 1-4 family
residential mortgage loans and retail deposits have constituted the principal
components of the Bank's assets and liabilities, respectively. Beyond 1-4 family
permanent mortgage loans, the Bank's loan portfolio includes diversification in
construction, land, commercial real estate, multi-family, consumer and
commercial business loans. Pursuant to the Bank's current strategic plan,
Peoples Federal will remain primary a 1-4 family lending, but will also continue
to pursuer greater diversification into non-residential lending as well as
commercial business and consumer types of lending.
Peoples Federal's' greater emphasis on lending diversification should
serve to enhance the overall yield earned on the loan portfolio, while also
increase the credit risk associated with the loan portfolio. The Bank has sought
to limit the credit risk exposure associated with higher risk types of loans,
through emphasizing origination of such loans in local and familiar markets.
RP Financial LC.
Page 1.3
Credit risk associated with the loan portfolio has also been limited by the
strength of the local economy and implementation of what are believed by
management to be conservative underwriting guidelines. Economic growth has been
supported by expansion of the national economy, which has spurred an increase in
demand for the products and services produced in the Bank's regional economy. In
general, the primary market area has experienced a decline in unemployment and
an increase in real estate values, which has increased demand for new
construction of both residential and commercial properties.
Investments serve as a supplement to the Bank's lending activities and
the investment portfolio is considered to be indicative of a low risk investment
philosophy. The investment portfolio is comprised primarily of cash and cash
equivalents ($13.3 million), with the balance of the investment portfolio
consisting of Freddie Mac stock ($1.3 million), municipal bonds ($169,000) and
FHLB stock ($694,000). The Freddie Mac stock is classified as available for sale
and at March 31, 2001, the Bank's retained earnings reflected a net unrealized
gain of approximately $873,000 attributable to its investment in Freddie Mac
stock.
Retail deposits have consistently served as the primary
interest-bearing funding source for the Bank. Deposit growth has generally been
adequate enough to fund most of the Bank's asset growth, with such growth
consisting of a mixture of CDs and transaction and savings accounts. CDs account
for the largest portion of the Bank's deposit composition, although in recent
years the concentration of CDs comprising total deposits has declined and
transaction and savings accounts have become a more significant component of
Peoples Federal's deposit composition. On a limited basis, the Bank has utilized
borrowings as an alternative funding source, with such borrowings consisting of
short-term FHLB advances. Retail deposits are expected to be the primary source
to fund the Bank's future growth; however, to the extent additional borrowings
are required, FHLB advances would likely continue to be the principal source of
borrowings utilized by the Bank.
Peoples Federal's earnings base is largely dependent upon net interest
income and operating expense levels, reflecting the Bank's emphasis on a
traditional thrift operating strategy. The Bank has maintained a relatively
healthy and stable net interest margin, reflecting Peoples Federal's favorable
interest-earning assets to interest-bearing liabilities ("IEA/IBL") ratio and
the
RP Financial LC.
Page 1.4
high concentration of loans that comprise the Bank's interest-earning asset
composition. Stability of the net margin has been facilitated by the Bank's
emphasis on originating adjustable rate and short-term loans, maintaining most
of the investment portfolio in short-term liquid funds and maintaining a strong
capital position that serves to reduce the level of interest rate sensitive
liabilities funding assets. Operating expenses represent the other major
component of the Bank's earnings and have been maintained at a relatively low
level, although, in recent years, operating expenses have increased as a percent
of average assets. The upward trend in the operating expense ratio reflects that
impact of opening a third branch facility in fiscal 2000, in which the costs of
maintaining and operating the branch have yet to be fully leveraged.
Additionally, compensation expenses increased sharply during the most recent
twelve month period, which was mostly attributable to a one-time expense
associated with establishing a deferred compensation plan for the Bank's
directors and senior officers. In general, the Bank's relatively low operating
expense ratio has been supported by an operating strategy which is not highly
diversified and its philosophy of retaining all loan originations for
investment. Accordingly, the Bank's does not have any off-balance sheet expenses
associated with servicing loans sold on a servicing retained basis. The Bank's
strategy of retaining all loan originations and increased capital position
following the infusion of conversion proceeds is expected to facilitate
leveraging of the operating expense ratio. At the same time, Peoples Federal
will incur additional operating expenses following the conversion, including
expenses associated with the stock benefit plans and, thus, leveraging of the
operating expense ratio is not expected to be significant following the
conversion.
The post-conversion business plan of the Bank is expected to continue
to focus on products and services which have facilitated growth of the Bank to
date. Specifically, Peoples Federal will continue to be an independent
community-oriented financial institution with a commitment to local real estate
and non-mortgage financing with operations funded by retail deposits,
borrowings, equity capital and internal cash flows. In addition, the Bank will
emphasize increasing its diversification into commercial real estate and
non-mortgage loans, as well as expansion and diversification of other products
and services.
The Bank's Board of Directors has elected to convert to the stock form
of ownership to improve the competitive position of Peoples Federal. The
additional capital realized from
RP Financial LC.
Page 1.5
conversion proceeds will increase liquidity to support funding of future loan
growth and other interest-earning assets. Peoples Federal's higher capital
position resulting from the infusion of conversion proceeds will also serve
to reduce interest rate risk, through enhancing the Bank's
interest-earning-assets-to-interest-bearing-liabilities ("IEA/IBL") ratio.
The additional funds realized from the stock offering will provide an
alternative funding source to deposits and borrowings in meeting the Bank's
future funding needs, which may facilitate a reduction in Peoples Federal's
funding costs. Additionally, Peoples Federal's higher equity-to-assets ratio
will also better position the Bank to take advantage of expansion
opportunities as they arise. Such expansion would most likely occur through
acquiring branches or other financial institutions in markets that would
provide for further penetration in the markets currently served by the Bank
or nearby surrounding markets. At this time, the Bank has no specific plans
for expansion other than internal growth. The Bank's projected internal use
of proceeds are highlighted below.
o PFS BANCORP. The Holding Company is expected to retain up to
50 percent of the net conversion proceeds. At present, funds
at the Holding Company level, net of the loan to the ESOP, are
expected to be primarily invested initially into short-term
investment grade securities. Over time, the funds may be
utilized for various corporate purposes, possibly including
acquisitions, infusing additional equity into the Bank,
repurchases of common stock, and the payment of regular and/or
special cash dividends.
o PEOPLES FEDERAL. Approximately 50 percent of the net
conversion proceeds will be infused into the Bank in exchange
for all of the Bank's newly issued stock. The increase in
capital will be less, as the amount to be borrowed by the ESOP
to fund an 8.0 percent stock purchase will be deducted from
capital. Cash proceeds (i.e., net proceeds less deposits
withdrawn to fund stock purchases) infused into the Bank are
anticipated to become part of general operating funds, and are
expected to be primarily utilized to fund loan growth.
Overall, it is the Bank's objective to pursue growth that will serve to
increase returns, while, at the same time, growth will not be pursued that could
potentially compromise the overall risk associated with Peoples Federal's
operations. The Bank has acknowledged that it intends to operate with excess
capital in the near term, operating with a below market return on equity, until
such time as the new capital can be leveraged in a safe and sound manner over an
extended period of time.
RP Financial LC.
Page 1.6
BALANCE SHEET TRENDS
From June 30, 1996 through March 31, 2001, Peoples Federal exhibited
annual asset growth of positive 4.2 percent (see Table 1.1). During this period,
the Bank's interest-earning asset composition exhibited a shift towards cash and
investments, as the loans receivable balance declined from 91.1 percent of
assets at fiscal year end 1996 to 84.8 percent of assets at March 31, 2001. The
decline in the concentration of loans maintained as a percent of assets resulted
from comparatively strong growth in cash and investments, as loan growth was
also sustained throughout the past four and three-quarter fiscal years. Asset
growth has been funded primarily by deposits and, to a lesser degree, borrowings
and retained earnings. A summary of Peoples Federal's key operating ratios for
the past three and three-quarter fiscal years are presented in Exhibit I-3.
Peoples Federal's loans receivable portfolio increased at a 2.7 percent
annual rate from fiscal year end 1996 through March 31, 2001, with the portfolio
exhibiting positive growth throughout the period. The most notable loan growth
occurred during fiscal 1999, with net loan growth approximating $3.6 million.
Loan growth has been sustained by the Bank's philosophy of retaining all loan
originations for investment and has consisted primarily of non-residential
mortgage loans and non-mortgage loans.
Peoples Federal's historical emphasis on 1-4 family lending is
reflected in its loan portfolio composition, as 73.3 percent of total loans
receivable consisted of 1-4 family mortgage loans at March 31, 2001. However,
recent growth trends in the Bank's loan portfolio show increased lending
diversification by the Bank into higher risk and higher yielding types of loans.
Specifically, commercial real estate and multi-family loans increased from 13.6
percent of total loans receivable at June 30, 1999 to 17.1 percent of total
loans receivable at March 31, 2001. As the result of the stronger growth of the
commercial real estate and multi-family loan portfolio, the Bank's 1-4 family
loans declined from 77.4 percent to 73.3 percent of total loans outstanding at
June 30, 1999 and March 31, 2001, respectively. Over the same time period, the
balance of consumer and other non-mortgage loans remained fairly consistent,
equaling 9.0 percent and 9.6 percent of total loans outstanding at June 30, 1999
and March 31, 2001, respectively.
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Page 1.7
RP Financial LC.
Page 1.8
The intent of the Bank's Company's investment policy is to provide
adequate liquidity and to generate a favorable return within the context of
supporting Peoples Federal's overall credit and interest rate risk objectives.
It is anticipated that proceeds retained at the holding company level will
primarily be invested into investments with short-term maturities. Over the past
five and three-quarter years, the Bank's level of cash and investment securities
(inclusive of FHLB stock) ranged from a low of 7.3 percent of assets at fiscal
year end 1996 to a high of 13.6 percent of assets at March 31, 2001. The
investment portfolio is comprised primary of cash and cash equivalents ($13.3
million), with the balance of the investment portfolio consisting of Freddie Mac
stock ($1.3 million), municipal bonds ($169,000) and FHLB stock ($694,000). The
Freddie Mac stock is classified as available for sale and at March 31, 2001, the
Bank's retained earnings reflected a net unrealized gain of approximately
$873,000 attributable to its investment in Freddie Mac stock. Exhibit I-4
provides detail of the Bank's investment portfolio.
Mortgage-backed securities comprise the balance of the Bank's
interest-earning assets composition, serving as an investment alternative to
deploy excess liquidity. In recent years, the Bank's loan growth has been
adequate enough to limit the need to invest in mortgage-backed securities.
Accordingly, over the past five and three-quarter fiscal years, the Bank's
investment in mortgage-backed securities balance has been very limited and, as
of March 31, 2001, the Bank did not hold any mortgage-backed securities.
Over the past five and three-quarter years, Peoples Federal's funding
needs have been substantially met through retail deposits, internal cash flows,
borrowings and retained earnings. From fiscal year end 1996 through March 31,
2001, the Bank's deposits increased at an annual rate of 3.8 percent. Positive
deposit growth was sustained throughout the period covered in Table 1.1, except
during fiscal 1998 when the Bank experienced a slight decline in deposits.
Growth in lower costing savings and transaction accounts has outpaced CD growth
in recent years, thereby facilitating a shift in the Bank's deposit composition
towards a higher concentration of transaction and savings accounts. As of March
31, 2001, CDs and transaction and savings accounts represented 71.9 percent and
28.1 percent of the Bank's total deposits, respectively. Comparatively, as of
June 30, 1996, CDs and transaction and savings accounts represented 76.6 percent
and 23.4 percent of the Bank's total deposits, respectively. Most of Peoples
Federal's transaction and savings account growth has been realized in demand and
RP Financial LC.
Page 1.9
NOW deposit accounts. As of March 31, 2001, money market and savings accounts
equaled 15.4 percent of total deposits, while NOW and demand accounts equaled
12.7 percent of total deposits.
Borrowings serve as an alternative funding source for the Bank to
address funding needs for loan growth and to support control of deposit costs.
In general, the Bank's use of borrowings has been limited, and, as of March 31,
2001, borrowings held by Peoples Federal totaled $3.0 million. All of the
borrowings held by Peoples Federal at March 31, 2001 consisted of short-term
FHLB advances. Anticipated deposit growth, the offering proceeds, and internal
cash flows are expected to adequately address most of the Bank's funding needs
in the foreseeable future. To the extent additional borrowings may be utilized
by the Bank, such borrowings would likely consist of FHLB advances.
Since fiscal year end 1996, positive earnings and an increase in the
unrealized gain maintained on securities designated as available translated into
an annual capital growth rate of 8.4 percent for the Bank. Capital growth
outpaced the Bank's asset growth rate, as Peoples Federal's equity-to-assets
ratio increased from 9.9 percent at fiscal year end 1996 to 12.0 percent at
March 31, 2001. All of the Bank's capital is tangible capital, and the Bank
maintained capital surpluses relative to all of its regulatory capital
requirements at March 31, 2001. The addition of conversion proceeds will serve
to strengthen Peoples Federal's capital position and competitive posture within
its primary market area, as well as possibly support expansion into other nearby
markets if favorable growth opportunities are presented. At the same time, as
the result of the Bank's relatively high pro forma capital position, Peoples
Federal's ROE can be expected to be below industry averages following its
conversion.
INCOME AND EXPENSE TRENDS
Table 1.2 shows the Bank's historical income statements from fiscal
year 1996 through the twelve months ended March 31, 2001. The Bank reported
positive earnings over the past five years and for the most recent twelve month
period, ranging from a low of 0.69 percent of average assets during fiscal 1997
to a high of 1.07 percent of average assets during fiscal 1998. For the twelve
months ended March 31, 2001, the Bank reported net income of $767,000 or 0.70
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Page 1.11
percent of average assets. Consistent with the Bank's traditional thrift
operating strategy, net interest income and operating expenses have been the
dominant factors in Peoples Federal's earnings. Non-interest operating income
derived from Peoples Federal's retail banking activities has been a limited
contributor to the Bank's earnings, while loan loss provisions have also been a
minor factor in the Bank's earnings over the past five and three-quarter years.
Gains resulting from the sale of loans and investment securities have generally
not been a factor in the Bank's earnings, with the exception of the most recent
twelve month period.
Peoples Federal maintained a healthy net interest margin throughout the
period shown in Table 1.2, which has been supported by the Bank's maintenance of
a relatively high concentration of loans and strong capital position. Over the
past five and three-quarter fiscal years, the Bank's net interest income to
average assets ratio has ranged from a low of 3.09 percent during fiscal 1996 to
a high of 3.40 percent during fiscal years 1997 and 1998. For the twelve months
ended March 31, 2001, the Bank's net interest income to average assets ratio
equaled 3.14 percent. The most recent twelve month period reflected increases in
both the interest income and interest expense ratios, which provided for a
slight decline in the net margin compared to fiscal 2000. Overall, the Bank's
net interest margin has exhibited relatively limited fluctuation, as Peoples
Federal's management of interest rate risk through emphasizing interest rate
sensitive types of lending, maintaining an investment portfolio with short-term
maturities and maintaining a strong capital position has supported maintenance
of a relatively stable interest rate spread. The Bank's historical net interest
rate spreads and yields and costs are set forth in Exhibits I-3 and I-5.
Consistent with the Bank's adherence to a traditional thrift operating
philosophy and resultant limited diversification, sources of non-interest
operating income have been a somewhat modest contributor to the Bank's earnings.
Throughout the period shown in Table 1.2, sources of non-interest operating
income have ranged from a low of 0.18 percent of average assets in fiscal 1996
to a high of 0.30 percent of average assets for the twelve months ended March
31, 2001. Sources of non-interest operating income consist substantially of fees
and service charges generated from the Bank's retail banking activities, with
the recent upward trend in the non-interest operating income ratio supported by
growth of fees earned on checking accounts and ATM transactions. Overall, beyond
Peoples Federal's limited diversification in general, the
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Page 1.12
absence of a loans serviced for others portfolio has been a limiting factor in
the amount of non-interest operating income generated by the Bank. At this time,
the Bank has no plans to further diversify into activities that would generate
additional non-interest operating income and, thus, Peoples Federal's earnings
can be expected to remain highly dependent upon the net interest margin.
Operating expenses represent the other major component of the Bank's
earnings, ranging from a low of 1.83 percent of average assets in fiscal 1998 to
a high of 2.40 percent of average assets in fiscal 1997. For the twelve months
ended March 31, 2001, the Bank's ratio of operating expenses to average assets
equaled 2.39 percent. The peak operating expense ratio posted in fiscal 1997 was
the result of a one-time assessment to recapitalize the SAIF, which equaled
$515,000. Likewise, the relatively high operating expense ratio posted for the
most recent twelve month period was largely attributable to a one-time expense,
which was incurred for establishing a deferred compensation plan for the Bank's
senior management and directors. The expense associated with the establishment
of the plan amounted to $611,000. Going forward, the annual expense related to
the deferred compensation plan will approximate $45,000. Higher operating
expenses have also resulted from opening a third branch in fiscal 2000, in which
the expenses associated with opening and operating the new branch facility have
yet to be fully leveraged. Upward pressure will be placed on the Bank's
operating expense ratio following the stock offering, due to expenses associated
with operating as a publicly-traded company, including expenses related to the
stock benefit plans. At the same, the increase in capital realized from the
stock offering will increase the Bank capacity to leverage operating expenses
through pursuing a more aggressive growth strategy.
Overall, the general trends in the Bank's net interest margin and
operating expense ratio since 1996 reflect stability in the Bank's core
earnings, as indicated by the Bank's expense coverage ratio (net interest income
divided by operating expenses). Peoples Federal's expense coverage ratio equaled
1.59 times in fiscal 1996, versus a comparable ratio of 1.31 times during the
twelve months ended March 31, 2001. However, after adjusting the Bank's
operating expenses to exclude the non-recurring expense related to establishing
the deferred compensation plan, Peoples Federal's expense coverage ratio
improved to 1.68 time for the most recent twelve month period. Similarly,
Peoples Federal's efficiency ratio (operating expenses, net of
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Page 1.13
amortization of intangibles, as a percent of the sum of net interest income and
other operating income) of 69.5 percent for twelve months ended March 31, 2001
was less favorable than the 59.3 percent efficiency ratio maintained in fiscal
1996. However, after adjusting for the non-recurring expense of the deferred
compensation plan, the Bank's efficiency ratio improved to 54.4 percent for the
most recent twelve month period.
Loan loss provisions have had a limited impact on the Bank's earnings
over the past five and three-quarter years, reflecting Peoples Federal's
maintenance of favorable credit quality measures and generally positive trends
in the local real estate market. Loan loss provisions established by the Bank
ranged from a low of 0.07 percent of average assets in fiscal 1996 to a high of
0.14 percent of average assets for the twelve months ended March 31, 2001. The
higher level of loss provisions established during the most recent twelve month
period was largely attributable to growth of the loan portfolio, including
growth of higher credit risk types of loans such as commercial real estate
loans. As of March 31, 2001, the Bank maintained allowance for loan losses of
$677,000, equal to 163.9 percent of non-performing assets and accruing loans
more than 90 days past due and 0.70 percent of net loans receivable. Exhibit I-6
sets forth the Bank's allowance for loan loss activity during the past two and
three-quarter years.
Gains resulting from the sale of loans, investments, real estate owned
and other assets typically have not been a material factor in the Bank's
earnings. However, during the twelve months ended March 31, 2001, the Bank
recorded a gain from the sale of Freddie Mac stock amounting to 0.31 percent of
average assets. The Bank sold a portion of its Freddie Mac stock for purposes of
funding the expense of establishing the deferred compensation plan. Overall, the
gains that have been recorded by the Bank are not considered to be part of its
recurring or core earnings.
INTEREST RATE RISK MANAGEMENT
The Bank's balance sheet is liability-sensitive in the short-term (less
than one year) and, thus, the net interest margin will typically be adversely
affected during periods of rising and higher interest rates. As of March 31,
2001, the Net Portfolio Value ("NPV") analysis provided
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Page 1.14
by the OTS indicated that a 2.0 percent instantaneous and sustained increase in
interest rates would result in a 5.0 percent decline in the Bank's NPV (see
Exhibit I-7).
The Bank primarily manages interest rate risk from the asset side of
the balance sheet, through emphasizing investment in short-term funds,
emphasizing the origination of adjustable rate 1-4 family permanent mortgage
loans and diversifying into interest rate sensitive types of lending. As of
March 31, 2001, of the total loans due after March 31, 2001, ARM loans comprised
75.0 percent of those loans (see Exhibit I-8). On the liability and equity side
of the balance sheet, management of interest rate risk has been pursued through
maintaining a strong capital position and through emphasizing the build-up of
less interest rate sensitive and lower costing transaction and savings accounts.
The infusion of stock proceeds will serve to further limit the Bank's
interest rate risk exposure, as most of the net proceeds will be redeployed into
interest-earning assets and the increase to capital will lessen the proportion
of interest rate sensitive liabilities funding assets.
LENDING ACTIVITIES AND STRATEGY
Peoples Federal's lending activities have traditionally emphasized 1-4
family permanent mortgage loans and one-to-four family permanent mortgage loans
continue to comprise the largest concentration of the loan portfolio. Beyond 1-4
family loans, lending diversification by the Bank includes loans secured by
commercial real estate and multi-family residential real estate, construction
loans, land loans, consumer loans and commercial business loans. Exhibit I-9
provides historical detail of Peoples Federal's loan portfolio composition over
the past two and three-quarter years and Exhibit I-10 provides the contractual
maturity of the Bank's loan portfolio by loan type as of March 31, 2001.
Peoples Federal originates both fixed rate and adjustable rate 1-4
family permanent mortgage loans, retaining all loan originations for portfolio.
Fixed rate loan originations are generally underwritten to secondary market
standards that would allow for the sale of such loans if such a strategy becomes
warranted for purposes of managing interest rate risk and the Bank's liquidity.
Standard fixed rate loans offered by the Bank have terms of up to 30 years, with
a 10-year balloon provision. Most of the Bank's 1-4 family lending volume
consists of ARM loans.
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Page 1.15
ARM loans offered by the Bank consist of loans that reprice every year, which
are indexed to the equivalent of the one-year U.S. Treasury rate. Initial rates
on ARM loans are typically discounted from the fully-indexed rate, with
repricing terms providing for caps of 1.0 percent annually and 3.0 percent or
4.0 percent over the life of the loan. The Bank typically requires a
loan-to-value ("LTV") ratio of 80.0 percent or less for 1-4 family loans, but in
some cases may lend up to a 90.0 percent LTV. As of March 31, 2001, the Bank's
1-4 family permanent mortgage loan portfolio totaled $71.3 million or 73.3
percent of total loans outstanding.
Included in the 1-4 family loan balance were 1-4 family construction
loans that totaled $1.6 million at March 31, 2001. The Bank's construction
lending activities are typically for the construction of pre-sold homes. In
addition, the Bank makes construction loans to home builders on a speculative
basis. Construction loans are six-month fixed rates loans and require payment of
interest only during the construction period. Peoples Federal will originate
construction loans up to a LTV ratio of 80.0 percent. The construction loan
portfolio also includes a $1.3 million participation loan with another Indiana
institution for the construction of a multi-family property, which is included
with the multi-family loan balance of $1.6 million as of March 31, 2001. Except
for the participation loan, which is secured by a property in the Bank's normal
lending territory, the Bank's construction lending activities have generally
been limited to 1-4 family properties.
The balance of the mortgage loan portfolio consists of commercial real
estate and multi-family loans, which are collateralized by properties in the
Bank's normal lending territory. Commercial real estate and multi-family loans
are originated up to a maximum LTV ratio of 75.0 percent. Loan terms typically
provide for amortization periods of 15 to 25-years and are floating rate loans
tied to the Prime rate. Properties securing the commercial real estate and
multi-family loan portfolio consist primarily of storefronts, churches,
apartments, and warehouses. At March 31, 2001, the average balance of the Bank's
commercial real estate and multi-family loans equaled $82,000. As of March 31,
2001, the Bank's commercial real estate and multi-family loan portfolio totaled
$16.6 million or 17.1 percent of total loans outstanding. Commercial real estate
lending is expected to be an area of gradual lending growth for the Bank, as
Peoples Federal has been effective in establishing a lending niche to serve
borrowers with loan needs that
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Page 1.16
are viewed as being too small for the larger commercial banks to effectively
service.
Included in the balance of commercial real estate and multi-family
loans were land loans, which totaled $4.9 million at March 31, 2001. Land loans
serve as a complement to the Bank's 1-4 family lending activities, as such loans
are primarily secured by single-family lot loans or land that will be used for
residential development. Terms of land loans offered by the Bank generally
require a LTV ratio of 75.0 percent or less and are indexed to the Prime rate.
Land loans are interest only loans and are renewed annually. Peoples Federal's
largest non-residential loan at March 31, 2001 was secured by land and had an
outstanding balance of $527,000. The loan was current at March 31, 2001.
Diversification into non-mortgage lending consists of consumer loans,
as well as commercial business loans. The consumer loan portfolio consists
primarily of home equity lines of credit and automobile loans. Other types of
consumer loans held by the Bank include loans secured by deposit accounts,
mobile home loans and other secured installment loans. Peoples Federal is no
longer active in originating mobile home loans and the balance of mobile home
loans currently held by the Bank is minimal. Home equity lines of credit are
floating rate loans tied to the Prime rate and are limited to a maximum LTV
ratio of 80.0 percent of the combined balance of the home equity line of credit
and the first lien (up to an 85.0 percent LTV ratio if the Bank has the first
mortgage on the property). Auto loans consist of direct loans for both new and
used cars. Auto loans are offered for terms of up to 60 months, with higher
rates and shorter terms being required for used cars. As of March 31, 2001,
Peoples Federal's outstanding balance of consumer loans totaled $6.4 million or
6.6 percent of total loans outstanding.
The balance of the loan portfolio consists of commercial business
loans, which totaled $2.8 million or 2.9 percent of total loans outstanding at
March 31, 2001. Commercial business loans held by the Bank consist mostly of
secured loans that are extended to local businesses for purposes of working
capital. Loan terms for commercial business loans provide for floating rate
lines of credit that are tied to the Prime rate and are renewable annually.
Commercial business lending is a desired growth area for the Bank, in which
Peoples Federal will be targeting small- and mid-size companies in the local
market area as the primary source of commercial loan growth.
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Page 1.17
Exhibit I-11 provides a summary of the Bank's lending activities over
the past two and three-quarter years. During the past two and three-quarter
fiscal years, originations of 1-4 family permanent mortgage loans accounted for
$56.2 million, or 56.4 percent of the Bank's total lending volume. Originations
of 1-4 family loans were notably higher during fiscal 1999 compared to fiscal
2000 ($27.2 million versus $15.1 million), which was supported by a higher
demand for loans to be refinanced. The stronger demand for loan refinancings
also translated in higher repayments during fiscal 1999 and, thus, net loan
growth of $3.6 million during fiscal 1999 was not significantly above the $2.7
million growth posted during fiscal 2000. Consumer and commercial business loan
originations constituted the Bank's second most active area of lending during
the past two and three-quarter fiscal years, with such originations increasing
from $12.4 million during fiscal 1999 to $15.0 million during fiscal 2000. For
the nine months ended March 31, 2001, the Bank originated $5.9 million of
consumer and commercial business loans compared to $8.6 million of originations
for the year ago period. Consistent with the Bank's generally lending
philosophy, no loans were sold or purchased by the Bank during the past two and
three-quarter fiscal years.
ASSET QUALITY
The Bank's 1-4 family lending emphasis has generally supported
favorable credit quality measures. Over the past two and three-quarter years,
Peoples Federal's balance of non-performing assets and accruing loans that are
more than 90 days past due, ranged from a high of 0.74 percent of assets at
fiscal year end 1999 to a low of 0.36 percent of assets at March 31, 2001.
Non-accruing loans accounted for the largest portion of the Bank's
non-performing assets over the past two and three-quarter years. As shown in
Exhibit I-12, the Bank's balance of problem assets at March 31, 2001 consisted
of $311,000 of non-accruing loans and $102,000 of real estate owned. The largest
portion of the Bank's non-performing loans at March 31, 2001 consisted of 1-4
family loans.
The Bank reviews and classifies assets on a monthly basis and
establishes loan loss provisions based on the overall quality, size and
composition of the loan portfolio, as well other factors such as historical loss
experience, industry trends and local real estate market and
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Page 1.18
economic conditions. The Bank maintained valuation allowances of $677,000 at
March 31, 2001, equal to 0.70 percent of net loans receivable and 163.9 percent
of non-performing assets and accruing loans more than 90 days past due.
FUNDING COMPOSITION AND STRATEGY
Deposits have consistently accounted for the Bank's primary source of
funds and at March 31, 2001 deposits equaled 97.0 percent of Peoples Federal's
interest-bearing funding composition. Exhibit I-13 sets forth the Bank's deposit
composition for the past two and three-quarter fiscal years and Exhibit I-14
provides the interest rate and maturity composition of the CD portfolio at March
31, 2001. CDs represent the largest component of the Bank's deposit composition,
with Peoples Federal's current CD composition reflecting a higher concentration
of short-term CDs (maturities of one year or less). As of March 31, 2001, the CD
portfolio totaled $68.9 million or 71.9 percent of total deposits and 66.3
percent of the CDs were scheduled to mature in one year or less. As of March 31,
2001, jumbo CDs (CD accounts with balances of $100,000 or more) amounted to
$26.1 million or 37.9 percent of total CDs. Peoples Federal does not maintain
any brokered CDs. Deposit rates offered by the Bank are generally in the
middle-to-upper end of the range of rates offered by local competitors.
Lower cost savings and transaction accounts comprise the balance of the
Bank's deposit composition, with such deposits amounting to $26.9 million or
28.1 percent of total deposits at March 31, 2001. Over the past two and
three-quarter fiscal years, the Bank's concentration of transaction and savings
accounts comprising total deposits has increased slightly, as transaction and
savings account deposits equaled 27.0 percent of Peoples Federal's total
deposits at fiscal year end 1999. The increase in the concentration of core
deposits comprising total deposits was realized through growth of checking
accounts, which was partially offset by a decline in savings and money market
accounts.
Borrowings have been utilized to a limited degree by the Bank in recent
years, to support control of deposits costs and as a source of liquidity. The
Bank maintained $3.0 million of borrowings at March 31, 2001, versus a peak
balance of $5.0 million at fiscal year end 1998.
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Borrowings held by the Bank at March 31, 2001 consisted entirely of short-term
FHLB advances. Exhibit I-15 provides further detail of Peoples Federal's
borrowing activities during the past two and three-quarter fiscal years. Peoples
Federal's deposit growth, internal funding and stock proceeds are expected to be
adequate enough to fund the substantial portion of the Bank's lending and
investment activities for the intermediate-term. To the extent additional
borrowings are utilized by the Bank, such borrowings would most likely consist
of FHLB advances.
LEGAL PROCEEDINGS
Peoples Federal is involved in routine legal proceedings occurring in
the ordinary course of business which, in the aggregate, are believed by
management to be immaterial to the financial condition of the Bank.
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PAGE 2.1
II. MARKET AREA
INTRODUCTION
Peoples Federal serves Southeastern Indiana through three full service
branch offices, which are located in the towns of Aurora (Dearborn County),
Rising Sun (Ohio County) and Vevay (Switzerland County). The major portion of
Peoples Federal's activities are conducted within markets served by the retail
branches and surrounding contiguous markets. Markets served by Peoples Federal
include nearby markets in Ohio and Kentucky, as the Southeastern Indiana markets
served by the Bank's branches are located where those three states converge.
Exhibit II-1 provides information on the Bank's office facilities.
The Bank's primary market is viewed as suburban and rural in nature, as
indicated by low population density. Dearborn County, which is included in the
Cincinnati MSA is the most populous of the markets that is served by Peoples
Federal. Dearborn County has benefited from the outward expansion of the
Cincinnati metropolitan area, as indicated by strong population growth and
growth in household income. The primary market area economy is fairly
diversified, with services, wholesale/retail trade, manufacturing and government
constituting the basis of the primary market area economy. Competition for
financial services in the primary market area is considered to be significant,
particularly given the size of the population base served in each of the
counties.
Future business and growth opportunities will be partially influenced
by economic and demographic characteristics of the markets served by the Bank,
particularly the future growth and stability of the regional economy,
demographic growth trends, and the nature and intensity of the competitive
environment for financial institutions. These factors have been examined to help
determine the growth potential that exists for the Bank and the relative
economic health of the Bank's market area.
MARKET AREA DEMOGRAPHICS
Demographic growth in the Bank's market area has been measured by
changes in
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PAGE 2.2
population, number of households and median household income, with trends in
those areas summarized by the data presented in Table 2.1. In the 1990s, the
primary market area served by the Bank experienced positive growth as measured
by population and household growth. All three counties where Peoples Federal
maintains a branch presence recorded an increase in population during the 1990s,
with Dearborn County posting the strongest growth rate. Dearborn County's 2.4
percent annual growth rate was supported by its proximity to Cincinnati and the
growth that has occurred in suburban markets that are nearby to the Cincinnati
metropolitan area. Expansion of the local economy has contributed to Dearborn
County's population growth as well, most notably with respect to the economic
activity that was generated by the opening of two riverboat gambling casinos in
the late-1990s. Dearborn County is the most populous market served by the Bank,
with a 2000 population of 49,000. Population growth rates for both Dearborn and
Switzerland Counties exceeded the U.S. and Indiana growth rates, while Ohio
County's population increased modestly during the 1990s. Overall, the generally
rural nature of the primary market area is implied by the low population density
of the individual counties, as both Ohio and Switzerland Counties maintained
2000 populations of less than 10,000. Projected population growth for the
primary market area counties is not expected to vary materially from recent
historical trends; although, consistent with the projected growth rates for the
U.S. and Indiana, the population growth rates for Dearborn and Ohio Counties are
projected to be lower over the next five years. Comparatively, the population
growth rate for Switzerland County is projected to be slightly higher over the
next five years. Growth in households generally paralleled the population growth
rates, with Dearborn County posting the highest household growth rate among the
primary market area counties.
Median household and per capita income measures for the primary market
area counties indicate that the larger and faster growing Dearborn County market
is also a more affluent market area, reflecting the impact of population growth
among white-collar professionals who work in the Cincinnati metropolitan area.
Median household income measures for Dearborn and Ohio Counties exceeded the
median household income for Indiana and the U.S., although the per capita income
measures for all of the primary market area counties were lower than the per
capita income measures for Indiana and the U.S. Median household income
increased in all three of the primary market area counties during the 1990s,
with annual growth rates ranging
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PAGE 2.3
from a low of 5.8 percent in Dearborn County to a high of 8.4 percent in
Switzerland County.
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PAGE 2.4
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PAGE 2.5
Consistent with trends reflected during the 1990s, household income growth is
projected to be the strongest in Switzerland County over the next five years
(4.8 percent annual growth), followed by Dearborn County (3.5 percent annual
growth). Household income distribution measures further imply that Dearborn
and Ohio Counties are relatively affluent market areas, based on the higher
percentage of households with incomes of $100,000 or more in both of those
counties. Based on these demographic trends, the markets served by the Bank
are viewed as being conducive for supporting lending and deposit growth
opportunities over the next five years. The strongest growth opportunities
are expected to be realized in Dearborn County.
NATIONAL ECONOMIC FACTORS
Trends in the national economy have generally reflected a slowing pace
of growth since mid-2000. Reflecting positive factors, inflation remains
relatively low, and there has been significant job creation and low unemployment
rates by historical standards. The Federal government continues to operate with
a budget surplus, and expectations are for a rising surplus in the next five
years, which has reduced the demand for dollars in the capital markets.
Unemployment rates remained below 5.0 percent throughout 2000 and declined to a
30-year low of 3.9 percent most recently in October 2000. The economy during the
last six months of 2000 showed increasing signs of a slowdown, which included
lowered expectations of future earnings by a number of bellwether stocks in a
wide range of industrial sectors and declines in several key economic indicators
regarding production and consumer demand. The decline in the stock market during
2000, in particular the technology and Internet weighted NASDAQ market has also
contributed to the perception of a slowing domestic economy. The NASDAQ and the
DJIA were down by 39 and 6 percent, respectively, for 2000.
Signs of slower economic growth became more pronounced in the first
quarter of 2001, as a number of companies initiated lay-offs to offset profit
erosion caused by slackening demand for products and services in general.
Manufacturing activity in January 2001 plunged to a level that generally
indicates the economy is in a recession, while the unemployment rate for January
2001 increased to 4.2 percent. The economic slow down and the general decline in
the stock market combined to erode consumer confidence as well.
Stronger-than-expected job growth in
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PAGE 2.6
February and a steady unemployment rate provided signs that the economy may have
stabilized short of a recession. However, March data suggested the economy was
continuing to slow, as the unemployment rate edged up to 4.3 percent in March
and retail sales for March came in sharply below expectations.
Initial claims for unemployment insurance reached a five-year high in
early-April 2001, which raised concerns that consumer spending could weaken
markedly in the coming months. The April unemployment rate rose to 4.5 percent,
which was the highest level in two and one-half years and the loss of jobs
experienced in April was the most in any month since February 1991. While April
retail sales beat expectations and consumer confidence climbed in April, other
economic indicators generally suggested that the economy was continuing to
struggle. The manufacturing slump continued in April, new home sales fell in
April and profit margins continued to decline in the first quarter. A downward
revision in the first quarter GDP, from 2.0 percent to 1.3 percent, a decline in
April durable goods orders and a rising in office vacancy rates in the first
quarter further undercut expectations of a rapid recovery in the economy.
Economic data for May 2001 suggested that, outside of the manufacturing sector,
economic conditions may have leveled off. The loss of jobs in May was modest and
the unemployment rate in May declined to 4.4 percent, although the manufacturing
sector continued to experience a sharp reduction in jobs.
Interest rate trends have been varied over the past year. The strong
economic growth in 1999 and the first three quarters of 2000 prompted the
Federal Reserve to increase rates six times, resulting in a total rate increase
of 1.75 percent from mid-1999 to late-2000. Higher short-term rates resulted in
an inverted yield curve during most of 2000, as longer term interest rates did
not match the increase exhibited in short-term rates. The lower yields
maintained on the longer term Treasurys were in part due to the Treasury
Department's debt buy back program that involved purchases of approximately $30
billion of long-term Treasurys during fiscal 2000 and plans to continue the buy
back program into the future. Short- and long-term interest rates declined in
the fourth quarter of 2000, which was attributable to a number of factors
including the slow down in the economy, volatility in the stock market and
uncertainty over the outcome of the Presidential election.
Concerns of a slumping economy prompted the Federal Reserve to reduce
the overnight
RP FINANCIAL, LC.
PAGE 2.7
Fed funds rate by 50 basis points in early-January 2001, which was followed with
another 50 basis point rate cut at the end of January. The two interest rate
cuts and expectations of further rate cuts facilitated the reversion to a more
normalized yield curve in the one-to-thirty year range. Short-term interest
rates continued to decline through the end of the first quarter, as the Federal
Reserve cut short-term interest rates by another 50 basis point in late-March.
The third rate-cut in 2001 provider for a steeper yield curve, as long-term
interest rates edged higher at the end of the first quarter. The steepening of
yield curve continued at the beginning of the second quarter, particularly
following the surprise inter-meeting rate cut that was implemented by the
Federal Reserve in mid-April. The Federal Reserve cited slowing business
investment and falling profits in its decision to lower rates by 50 basis points
a month ahead of its regularly scheduled meeting. Lower short-term yields and
higher long-term yields both contributed to the steepening slop of the yield
curve, as investors sold longer-term U.S. Treasurys in anticipation of more rate
cuts by the Federal Reserve. The Federal Reserve cut short-term rates by a half
a point at its mid-May meeting, citing concerns that a recession remains the
greatest danger for the U.S. economy. As of June 8, 2001, one- and thirty-year
U.S. government bonds were yielding 3.56 percent and 5.74 percent, respectively,
versus comparable year ago rates of 6.22 percent and 5.89 percent. Exhibit II-2
provides historical interest rate trends from 1991 through June 8, 2001
LOCAL ECONOMY
The Bank's primary market area has a fairly diversified local economy,
with employment in services, wholesale/retail trade, government and
manufacturing serving as the basis of the local economy. Service jobs represent
the largest employer in all three of the primary market counties, with jobs in
wholesale/retail trade accounting for the second largest employment sector in
Dearborn County. Government and manufacturing were the second largest employers
in Ohio and Switzerland Counties, respectively. Demographic growth has
facilitated job growth in most sectors of the local economy, with employment in
services, wholesale/retail trade, financial services and construction all
increasing during recent years. Dearborn County also posted an increase in
manufacturing jobs, which tend to be relatively high paying jobs and, thus, are
viewed as being particularly beneficial to the local economy. Major employers in
primary
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PAGE 2.8
market area include Joseph E. Seagrams and Sons, Argosy Hotel and Casino, Grand
Victoria Casino, Anchor Glass Container Corp., PRI Pak, Dearborn County
Hospital, Lawrenceburg Community School Corp., American Electric Power, South
Dearborn School Corporation, Ohio County School Corporation and Switzerland
School Corporation.
Comparative unemployment rates for the primary market area counties, as
well as for the U.S. and Indiana, are shown in Table 2.2. The unemployment data
for the market area further implies a healthy local economy that should
facilitate growth opportunities for the Bank. Recent unemployment rates for
Dearborn and Ohio Counties were lower than the national and Indiana measures.
The relatively high unemployment rate in Switzerland County could in part be
attributed to the somewhat rural nature of that market area and resulting
seasonal fluctuations in employment. Similar to Indiana, the most recent
unemployment rates for the primary market area counties were lower from the
comparable year ago rates. Comparatively, the U.S. unemployment rate increased
slightly from March 2000 to March 2001.
Table 2.2
Peoples Federal Savings Bank
Unemployment Trends(1)
MARCH 2000 MARCH 2001
REGION UNEMPLOYMENT UNEMPLOYMENT
------ ------------ ------------
United States 4.3% 4.6%
Indiana 3.9 3.5
Dearborn County 3.6 2.7
Ohio County 4.1 3.0
Switzerland County 12.8 5.4
(1) Unemployment rates have not been seasonally adjusted.
Source: U.S. Bureau of Labor Statistics.
MARKET AREA DEPOSIT CHARACTERISTICS AND COMPETITION
Competition among financial institutions in the Bank's market area is
significant, and, as larger institutions compete for market share to achieve
economies of scale, the market
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PAGE 2.9
environment for the Bank's products and services is expected to become
increasingly competitive in the future. Among the Bank's competitors are much
larger and more diversified institutions, which have greater resources than
maintained by Peoples Federal. Financial institution competitors in the Bank's
primary market area include other locally-based thrifts and banks, as well as
regional and super regional banks. From a competitive standpoint, Peoples
Federal has sought to emphasize its community-orientation in the markets served
by its branches.
The Bank's retail deposit base is closely tied to the economic fortunes
of Southeastern Indiana and, in particular, the areas of the region that are
nearby to one of Peoples Federal's three branches. Table 2.3 displays deposit
market trends from June 30, 1998 through June 30, 2000 for the branches that
were maintained by the Bank during that period. Additional data is also
presented for the State of Indiana. The data indicates that deposit growth in
the Bank's primary market area has been positive and stronger than the overall
deposit growth rate posted by all Indiana banks and thrifts. Consistent with the
State of Indiana, commercial banks maintained a larger market share of deposits
than savings institutions in Ohio and Switzerland Counties, while savings
institutions maintained a slightly larger deposit market share than banks in
Dearborn County. Savings institutions gained deposit market share in all three
of the primary market area counties. Peoples Federal is the only savings
institution with branch locations in Ohio and Switzerland Counties.
Peoples Federal's largest balance of deposits is maintained in Dearborn
County, where the Bank is headquartered. The Bank's $74.8 million of deposits at
the Dearborn County branch represented a 12.3 percent market share of thrift and
bank deposits at June 30, 2000. As of June 30, 2000, the Bank's largest market
share of deposits was in Ohio County, based on a 30.4 percent market share of
total bank and thrift deposits. Peoples Federal recorded positive deposit growth
at all three branches from 1998 to 2000, with the strongest growth recorded at
the Ohio County branch. The Switzerland County branch was opened in August 1999
and maintained only $1.8 million of deposits at June 30, 2000. Peoples Federal
gained deposit market share in Ohio and Switzerland Counties for the two-year
period covered in Table 2.3, while experienced a slight decline in deposit
market share at its Dearborn County branch.
Future deposit growth may be enhanced by the infusion of the conversion
proceeds, as the additional capital will improve Peoples Federal's competitive
position and leverage capacity.
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PAGE 2.10
The Bank should also continue to benefit from its favorable image as a
locally-owned and community-oriented institution. However, given the competition
faced by Peoples Federal, it
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PAGE 2.11
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PAGE 2.12
will be difficult for the Bank to realize notable gains in deposit market
share without paying above market rates for deposits or further expanding the
Bank's branch network. At this time, the Bank has no definitive plans to
establish or acquire additional branches.
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PAGE 3.1
III. PEER GROUP ANALYSIS
This chapter presents an analysis of Peoples Federal's operations
versus a group of comparable savings institutions (the "Peer Group") selected
from the universe of all publicly-traded savings institutions in a manner
consistent with the regulatory valuation guidelines. The basis of the pro forma
market valuation of Peoples Federal is derived from the pricing ratios of the
Peer Group institutions, incorporating valuation adjustments for key differences
in relation to the Peer Group. Since no Peer Group can be exactly comparable to
Peoples Federal, key areas examined for differences are: financial condition;
profitability, growth and viability of earnings; asset growth; primary market
area; dividends; liquidity of the shares; marketing of the issue; management;
and effect of government regulations and regulatory reform.
PEER GROUP SELECTION
The Peer Group selection process is governed by the general parameters
set forth in the regulatory valuation guidelines. Accordingly, the Peer Group is
comprised of only those publicly-traded savings institutions whose common stock
is either listed on a national exchange (NYSE or AMEX), or is NASDAQ listed,
since their stock trading activity is regularly reported and generally more
frequent than non-publicly traded and closely-held institutions. Non-listed
institutions are inappropriate since the trading activity for thinly-traded or
closely-held stocks is typically highly irregular in terms of frequency and
price and thus may not be a reliable indicator of market value. We have also
excluded from the Peer Group those companies under acquisition or subject to
rumored acquisition, mutual holding companies and recent conversions, since
their pricing ratios are subject to unusual distortion and/or have limited
trading history. A recent listing of the universe of all publicly-traded savings
institutions is included as Exhibit III-1.
Ideally, the Peer Group, which must have at least 10 members to comply
with the regulatory valuation guidelines, should be comprised of locally or
regionally-based institutions with comparable resources, strategies and
financial characteristics. There are approximately 306 publicly-traded
institutions nationally and, thus, it is typically the case that the Peer Group
will be comprised of institutions with relatively comparable characteristics. To
the extent that
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PAGE 3.2
differences exist between the converting institution and the
Peer Group, valuation adjustments will be applied to account for the
differences. Since PFS Bancorp will be a full public company upon completion of
the offering, we considered only full public companies to be viable candidates
for inclusion in the Peer Group. From the universe of publicly-traded thrifts,
we selected eleven institutions with characteristics similar to those of Peoples
Federal. In the selection process, we applied one "screen" to the universe of
all public companies:
o SCREEN #1. INDIANA INSTITUTIONS WITH ASSETS BETWEEN $100
MILLION AND $450 MILLION, EQUITY-TO-ASSETS RATIOS OF AT LEAST
8.0 PERCENT, AND POSITIVE CORE RETURN ON EQUITY RATIOS OF LESS
THAN 10.0 PERCENT. Eleven companies met the criteria for
Screen #1 and all were included in the Peer Group: FFW
Corporation, First Bancorp of Indiana, First Capital, Inc.,
Logansport Financial Corp., MFB Corp., Montgomery Financial
Corp., Northeast Indiana Bancorp, River Valley Bancorp,
Security Financial Bancorp, Sobieski Bancorp and Union
Community Bancorp. Exhibit III-2 provides financial and public
market pricing characteristics of all publicly-traded thrifts
in Indiana.
Table 3.1 shows the general characteristics of each of the eleven Peer
Group companies and Exhibit III-3 provides summary demographic and deposit
market share data for the primary market areas served by each of the Peer Group
companies. While there are expectedly some differences between the Peer Group
companies and Peoples Federal, we believe that the Peer Group companies, on
average, provide a good basis for valuation subject to valuation adjustments.
The following sections present a comparison of Peoples Federal's financial
condition, income and expense trends, loan composition, interest rate and credit
risk versus the Peer Group as of the most recent publicly available date.
A summary description of the key characteristics of each of the Peer
Group companies is detailed below.
o FFW Corporation of Wabash IN. Selected due to Indiana market area,
traditional thrift operating strategy, comparable size of branch
network, comparable return on average assets, comparable net interest
margin and favorable credit quality measures.
o First Bancorp of IN. Selected due to Indiana market area, traditional
thrift operating strategy, comparable size of branch network, high
level of capital, comparable net interest margin and favorable credit
quality measures.
o First Capital, Inc. of IN. Selected due to Indiana market area,
traditional thrift operating strategy, comparable level of operating
expenses, similar degree of lending diversification into higher risk
types of loans, and favorable credit quality measures.
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PAGE 3.3
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PAGE 3.4
o Logansport Financial Corp. of IN. Selected due to Indiana market area,
traditional thrift operating strategy, comparable asset size, similar
interest-earning asset composition, similar capital position,
comparable net interest margin, and favorable credit quality measures.
o MFB Corp. of Mishawaka IN. Selected due to Indiana market area,
traditional thrift operating strategy, similar interest-earning asset
composition, comparable net interest margin, similar earnings
contribution from sources of non-interest operating income, and
favorable credit quality measures.
o Montgomery Financial Corp. of IN. Selected due to Indiana market area,
traditional thrift operating strategy, similar interest-earning asset
composition and strong emphasis on 1-4 family lending.
o Northeast Indiana Bancorp of IN. Selected due to Indiana market area,
traditional thrift operating strategy, same size of branch network,
similar interest-earning asset composition, and similar earnings
contribution from sources of non-interest operating income.
o River Valley Bancorp of IN. Selected due to Indiana market area,
traditional thrift operating strategy, similar interest-earning asset
composition, similar funding composition and comparable level of
operating expenses.
o Security Financial Bancorp of IN. Selected due to Indiana market area,
traditional thrift operating strategy, high level of capital,
comparable return on assets, similar earnings contribution from sources
of non-interest operating income, comparable degree of lending
diversification into higher risk types of loans, and favorable credit
quality measures.
o Sobieski Bancorp of IN. Selected due to Indiana market area,
traditional thrift operating strategy, comparable asset size, same size
of branch network, strong emphasis on 1-4 family lending, and favorable
credit quality measures.
o Union Community Bancorp of IN. Selected due to Indiana market area,
traditional thrift operating strategy, comparable asset size, high
level of capital, similar interest-earning asset composition, strong
emphasis on 1-4 family lending, comparable degree of lending
diversification into higher risk types of loans, and favorable credit
quality measures.
In aggregate, the Peer Group companies maintain a higher level of
capital than the industry average (13.85 percent of assets versus 10.57 percent
for all public companies), generate comparable earnings as a percent of average
assets (0.74 percent core ROAA versus 0.72 percent for all public companies),
and generate a lower ROE (5.52 percent core ROE versus 7.56 percent for all
public companies). Overall, the Peer Group's average P/B ratio and average core
P/E multiple were below and similar to the respective averages for all
publicly-traded thrifts.
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PAGE 3.5
ALL
PUBLICLY-TRADED PEER GROUP
--------------- ----------
FINANCIAL CHARACTERISTICS (AVERAGES)
Assets ($Mil) $2,054 $202
Market capitalization ($Mil) $253 $22
Equity/assets (%) 10.57% 13.85%
Core return on assets (%) 0.72% 0.74%
Core return on equity (%) 7.56% 5.52%
PRICING RATIOS (AVERAGES)(1)
Core price/earnings (x)(2) 15.38x 15.13x
Price/book (%) 111.52% 83.68%
Price/assets (%) 11.50% 11.68%
(1) Based on market prices as of June 8, 2001.
Ideally, the Peer Group companies would be comparable to Peoples
Federal in terms of all of the selection criteria, but the universe of
publicly-traded thrifts does not provide for an appropriate number of such
companies. However, in general, the companies selected for the Peer Group were
fairly comparable to Peoples Federal, as will be highlighted in the following
comparative analysis.
FINANCIAL CONDITION
Table 3.2 shows comparative balance sheet measures for Peoples Federal
and the Peer Group, reflecting the expected similarities and some differences
given the selection procedures outlined above. The Bank's and the Peer Group's
ratios reflect balances as of March 31, 2001, unless indicated otherwise for the
Peer Group companies. Peoples Federal's equity-to-assets ratio of 12.0 percent
was below the Peer Group's average net worth ratio of 13.9 percent. However, the
Bank's pro forma capital position will increase with the addition of stock
proceeds and will likely exceed the Peer Group's ratio following the conversion.
All of the Bank's capital consisted of tangible capital, while the Peer Group's
capital included a nominal amount of intangibles (0.2 percent of assets). The
increase in Peoples Federal's pro forma capital position will be favorable from
a risk perspective and in terms of future earnings potential that could be
realized through leverage and lower funding costs. At the same time, the Bank's
higher pro
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PAGE 3.6
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PAGE 3.7
forma capitalization will also result in a relatively low return on equity. Both
the Bank's and the Peer Group's capital ratios reflected healthy capital
surpluses with respect to the regulatory capital requirements. On a pro forma
basis, the higher surpluses currently maintained by the Bank will become more
significant.
The interest-earning asset compositions for the Bank and the Peer Group
were somewhat similar, with loans constituting the bulk of interest-earning
assets for Peoples Federal and the Peer Group. Peoples Federal maintained a
higher concentration of loans as a percent of assets than the Peer Group (84.8
percent versus 73.5 percent for the Peer Group), while the Bank's cash and
investments-to-assets ratio was lower than the comparable ratio for the Peer
Group (13.6 percent versus 22.5 percent for the Peer Group). Overall, Peoples
Federal's interest-earning assets amounted to 98.4 percent of assets, which was
slightly above the comparable Peer Group ratio of 96.0 percent.
Peoples Federal's funding liabilities reflected some differences
relative to that of the Peer Group's funding composition. The Bank's deposits
equaled 84.4 percent of assets, which was above the Peer Group average of 67.8
percent. Borrowings, inclusive of subordinated debt, accounted for a lower
portion of the Bank's interest-bearing funding composition, as reflected by
borrowings-to-assets ratios of 2.6 percent and 17.2 percent for Peoples Federal
and the Peer Group, respectively. Accordingly, Peoples Federal was considered to
have greater borrowing capacity than the Peer Group, although both the Bank and
the Peer Group were considered to have ample borrowing capacities. Total
interest-bearing liabilities maintained as a percent of assets equaled 87.0
percent and 85.0 percent for Peoples Federal and the Peer Group, respectively,
with the Peer Group's lower ratio being supported by maintenance of a higher
capital position.
A key measure of balance sheet strength for a thrift institution is its
interest-earning assets to interest-bearing liabilities ("IEA/IBL") ratio.
Presently, the Bank's IEA/IBL ratio is comparable to the Peer Group's ratio,
based on respective ratios of 113.1 percent and 113.4 percent. The additional
capital realized from stock proceeds should provide Peoples Federal with a
higher IEA/IBL ratio than maintained by the Peer Group, as the capital realized
from Peoples Federal's stock offering will be primarily deployed into
interest-earning assets.
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PAGE 3.8
The growth rate section of Table 3.2 shows annual growth rates for key
balance sheet items. Peoples Federal's growth rates are based on annualized
growth for the nine months ended March 31, 2001, while the Peer Group's growth
rates are based on annual growth for the twelve months ended March 31, 2001.
Asset growth rates of positive 6.7 percent and positive 10.6 percent were posted
by the Bank and the Peer Group, respectively. The Peer Group's stronger growth
was in part supported by acquisition related growth, which, in part, contributed
to First Bancorp's asset growth rate of 45.7 percent. Peoples Federal's asset
growth was primarily realized through an increase in cash and investments,
while, to a lesser extent, loan growth also contributed to the Bank's asset
growth. Comparatively, asset growth for the Peer Group was more balanced between
loans and cash and investments, with a higher growth rate reflected for the Peer
Group's lower balance of cash and investments. Overall, the Peer Group's asset
growth measures would tend to support greater earnings growth relative to the
Bank's measures. However, following the conversion, Peoples Federal's leverage
capacity will be greater than the Peer Group's.
Deposit growth funded most of the Bank's asset growth, as well as a
reduction in borrowings. Asset growth for the Peer Group was funded by a
combination of deposits and borrowings. Deposit growth of 7.2 percent posted by
the Bank was not as strong as the Peer Group's deposit growth rate of 11.1
percent. As noted above, the Peer Group's deposit growth was in part supported
by acquisition related growth. Comparatively, the Bank's deposit growth was
achieved only through internal growth. The 2.1 percent borrowings growth rate
shown for the Peer Group average was understated by the Peer Group companies
which recorded borrowing growth rates in excess of 100 percent. For the period
shown in Table 3.2, all four of the "NM" borrowing growth rates shown for the
Peer Group companies in Table 3.2 were attributable to companies recording
borrowing growth rates in excess of 100 percent.
Capital growth rates posted by the Bank and the Peer Group equaled
positive 7.3 percent and positive 4.2 percent, respectively. The Peer Group's
lower capital growth rate was attributable to its higher level of capital,
dividend payments and stock repurchases, which more than offset the higher
return on average assets posted by the Peer Group. Following the increase in
capital realized from conversion proceeds, the Bank's capital growth rate will
be depressed by
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PAGE 3.9
its higher pro forma capital position, as well as by possible dividend payments
and stock repurchases.
INCOME AND EXPENSE COMPONENTS
Peoples Federal and the Peer Group reported net income to average
assets ratios of 0.70 percent and 0.79 percent, respectively (see Table 3.3),
based on earnings for the twelve months ended March 31, 2001, unless indicated
otherwise for the Peer Group companies. A higher net interest margin, a lower
level of operating expenses, a higher level of non-interest operating income and
a lower effective tax rate accounted for the Peer Group's higher profitability,
which was partially offset by the Bank's lower loss provisions and higher net
gains.
The Peer Group's stronger net interest margin resulted from a lower
interest expense ratio, which was partially offset by the Bank's higher interest
income ratio. The Bank's higher interest income ratio was realized through
maintaining a slightly higher yield on interest-earning assets (7.81 percent
versus 7.79 for the Peer Group) and a higher lever of interest-earning assets as
a percent of total assets (98.4 percent versus 96.0 percent for the Peer Group).
The lower interest expense ratio posted by the Peer Group was supported by the
Peer Group's slightly lower cost of funds (5.07 percent versus 5.12 percent for
the Bank) and maintenance of a lower level of interest-bearing liabilities as a
percent of assets (85.0 percent versus 87.0 percent for the Bank). Overall,
Peoples Federal and the Peer Group reported net interest income to average
assets ratios of 3.14 percent and 3.21 percent, respectively.
In another key area of core earnings, the Bank maintained a higher
level of operating expenses than the Peer Group. For the period covered in Table
3.3, the Bank and the Peer Group recorded operating expense to average assets
ratios of 2.39 percent and 2.24 percent, respectively. Peoples Federal's higher
operating expense ratio was the result of the expense related to the
establishment of the deferred compensation plan. After factoring out the
non-recurring portion of the deferred compensation plan expense, Peoples
Federal's operating expense to average assets ratio equaled 1.87 percent.
Peoples Federal's lower recurring operating expense ratio was achieved despite
maintaining a higher number of employees for its asset size. Assets per full
time equivalent employee equaled $3.2 million for the Bank, versus a
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PAGE 3.10
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PAGE 3.11
comparable measure of $4.2 million for the Peer Group. The Bank's higher
staffing requirements can in part be attributed to opening of a third branch
less than two years ago, in which the staffing levels of the recently opened
branch have not been fully leveraged. Additionally, higher staffing costs would
tend to be associated with the Banks interest-bearing funding composition in
comparison to the Peer Group's funding composition, given the higher cost of
servicing deposits relative to borrowings. On a post-offering basis, the Bank's
operating expenses can be expected to increase with the addition of the stock
benefit plans, with such expenses already impacting the Peer Group's operating
expenses. At the same time, Peoples Federal's capacity to leverage operating
expenses will be greater following the increase in capital realized from the
infusion of net conversion proceeds.
When viewed together, net interest income and operating expenses
provide considerable insight into a thrift's earnings strength, since those
sources of income and expenses are typically the most prominent components of
earnings and are generally more predictable than losses and gains realized from
the sale of assets or other non-recurring activities. In this regard, as
measured by their expense coverage ratios (net interest income divided by
operating expenses), the Bank's earnings strength was less favorable than the
Peer Group's. Expense coverage ratios posted by Peoples Federal and the Peer
Group equaled 1.31x and 1.43x, respectively. However, after factoring out the
non-recurring expense of the deferred compensation plan, the Bank's expense
coverage ratio of 1.68x was more favorable than the Peer Group's ratio. An
expense coverage ratio of greater than 1.0x indicates that an institution is
able to sustain pre-tax profitability without having to rely on non-interest
sources of income.
Sources of non-interest operating income provided a slightly larger
contribution to the Peer Group's earnings, with such income amounting to 0.37
percent and 0.30 percent of the Peer Group's and Peoples Federal's average
assets, respectively. The relatively minor portion of the Bank's and the Peer
Group's earnings realized from non-interest operating income is indicative of
their traditional thrift operating strategies, in which diversification into
areas that generate revenues from non-interest sources is typically limited.
Taking non-interest operating income into account in comparing the Bank's and
the Peer Group's earnings, Peoples Federal's efficiency ratio (operating
expenses, net of amortization of intangibles, as a percent of the sum of
non-interest operating income and net interest income) of 69.5 percent was less
favorable than
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PAGE 3.12
the Peer Group's efficiency ratio of 62.3 percent. After factoring the
non-recurring expense of the deferred compensation plan, the Bank's efficiency
ratio improved to 54.4 percent.
Loan loss provisions had a larger impact on the Peer Group's earnings,
amounting to 0.30 percent and 0.14 percent of the Peer Group's and Peoples
Federal's average assets, respectively. In comparison to the Bank, the higher
loss provisions established by the Peer Group was consistent with its greater
degree of diversification into higher risk types of lending and maintenance of a
higher non-performing assets-to-assets ratio.
Net gains made a larger contribution to the Bank's earnings, with such
gains amounting to 0.32 percent and 0.08 percent of average assets for Peoples
Federal and the Peer Group, respectively. Given the less predictable and more
non-recurring nature of gains and losses resulting from the sale of loans and
investments, as well as other assets, the net gains reflected in the Bank's and
the Peer Group's earnings will be discounted in evaluating the relative
strengths and weaknesses of their respective earnings. Extraordinary items were
not a factor in either the Bank's or the Peer Group's earnings.
Taxes were a more significant factor in the Bank's earnings, as Peoples
Federal and the Peer Group posted effective tax rates of 43.31 percent and 29.49
percent, respectively.
LOAN COMPOSITION
Table 3.4 presents data related to the loan composition of Peoples
Federal and the Peer Group. In comparison to the Peer Group, the Bank's loan
portfolio composition reflected a higher concentration in the aggregate of 1-4
family residential mortgage loans and mortgage-backed securities (61.4 percent
versus 52.9 percent for the Peer Group). A higher concentration of 1-4 family
loans accounted for the Bank's higher ratio, as Peoples Federal did not hold any
mortgage-backed securities as of March 31, 2001. Given the Bank's philosophy of
retaining all loan originations for investment, loans serviced for others
necessarily represented a more significant off-balance sheet item for the Peer
Group. However, the Peer Group's average balance of loans serviced for others of
$9.4 million implies that the Peer Group companies have also emphasized
originating loans for investment. The Peer Group's low balance of loans
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PAGE 3.13
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PAGE 3.14
serviced for others translated into a modest balance of servicing intangibles,
as servicing assets equaled 0.04 percent of the Peer Group's assets.
Diversification into higher risk types of lending was more significant
for the Peer Group companies on average. Commercial real estate/multi-family
loans represented the most significant area of diversification for the Peer
Group (10.1 percent of assets), followed by commercial business loans (6.5
percent of assets). The Bank's lending diversification consisted primarily of
commercial real estate/multi-family loans and construction/land loans, with
those portfolios equaling 9.2 percent and 6.6 percent of assets, respectively.
Construction and land loans accounted for the only lending area where the Bank
maintained a greater degree of lending diversification than the Peer Group,
although lending diversification into consumer loans was fairly comparable for
the Bank and the Peer Group. Notwithstanding, the Peer Group's greater
diversification into higher risk types of lending, the Bank maintained a
slightly higher risk-weighted assets-to-assets ratio compared to the Peer Group
(62.30 percent versus 59.86 percent for the Peer Group). More than offsetting
the Bank's more limited degree of lending diversification was its higher
concentration of total loans comprising assets.
INTEREST RATE RISK
Table 3.5 reflects various key ratios highlighting the relative
interest rate risk exposure of the Bank versus the Peer Group. In terms of
balance sheet composition, Peoples Federal's interest rate risk characteristics
were considered to be slightly less favorable than the Peer Group, as implied by
the Peer Group's higher equity-to-assets and IEA/IBL ratios. However, a lower
level of non-interest earning assets represented an advantage for the Bank with
respect to limiting interest rate risk associated with the balance sheet. On a
pro forma basis, the infusion of stock proceeds should serve to provide the Bank
with equity-to-assets and IEA/IBL ratios that are stronger than the comparable
Peer Group ratios.
To analyze interest rate risk associated with the net interest margin,
we reviewed quarterly changes in net interest income as a percent of average
assets for Peoples Federal and the Peer Group. In general, the relative
fluctuations in both the Bank's and the Peer Group's net interest income to
average assets ratios were considered to be fairly limited and, thus, based on
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PAGE 3.15
RP FINANCIAL, LC.
PAGE 3.16
the interest rate environment that prevailed during the period covered in Table
3.5, neither Peoples Federal or the Peer Group were viewed as having significant
interest rate risk exposure in their respective net interest margins. The
stability of the Bank's net interest margin should be enhanced by the infusion
of stock proceeds, as interest rate sensitive liabilities will be funding a
lower portion of Peoples Federal's assets.
CREDIT RISK
The Bank's credit risk exposure appears to be somewhat lower than the
Peer Group's, on average, based on the Bank's lower ratio of non-performing
assets and higher reserves as a percent of non-performing assets. As shown in
Table 3.6, the Bank's ratio of non-performing assets and accruing loans that are
more than 90 days past due equaled 0.36 percent of assets, which was below the
comparable Peer Group ratio of 0.89 percent. Likewise, Peoples Federal
maintained a lower non-performing loans/loans ratio than the Peer Group, based
on comparable ratios of 0.32 percent and 0.94 percent, respectively. The Bank
maintained a higher level of loss reserves as a percent of non-performing assets
and accruing loans that are more than 90 days past due (163.9 percent versus
121.8 percent for the Peer Group). Comparatively, the Peer Group maintained a
slightly higher level of reserves as a percent of loans (0.94 percent versus
0.70 percent for the Bank). Net loan charge-offs were a comparable factor for
the Bank and the Peer Group, equaling 0.10 percent and 0.13 percent of loans for
the Bank and the Peer Group, respectively. Overall, both the Bank's and the Peer
Group's credit quality measures were considered to be representative of fairly
limited credit risk exposure.
SUMMARY
Based on the above analysis and the criteria employed in the selection
of the companies for the Peer Group, RP Financial concluded that the Peer Group
forms a reasonable basis for determining the pro forma market value of Peoples
Federal. Such general characteristics as asset size, capital position,
interest-earning asset composition, funding composition, core earnings measures,
loan composition, credit quality and exposure to interest rate risk all tend to
support
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PAGE 3.17
RP FINANCIAL, LC.
PAGE 3.18
the reasonability of the Peer Group from a financial standpoint. Those areas
where differences exist will be addressed in the form of valuation adjustments
to the extent necessary.
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PAGE 4.1
IV. VALUATION ANALYSIS
INTRODUCTION
This chapter presents the valuation analysis and methodology used to
determine Peoples Federal's estimated pro forma market value of the common stock
to be issued in conjunction with the conversion transaction. The valuation
incorporates the appraisal methodology promulgated by the OTS, particularly
regarding selection of the Peer Group, fundamental analysis on both the Bank and
the Peer Group, and determination of the Bank's pro forma market value utilizing
the market value approach.
APPRAISAL GUIDELINES
The OTS written appraisal guidelines, originally released in October
1983 and updated in late-1994, specify the market value methodology for
estimating the pro forma market value of an institution pursuant to a
mutual-to-stock conversion. The valuation methodology provides for: (1) the
selection of a peer group of comparable publicly-traded institutions, excluding
from consideration institutions which have recently converted, subject to
acquisition or in MHC form; (2) a financial and operational comparison of the
subject company to the selected peer group, identifying key differences and
similarities; and (3) a valuation analysis in which the pro forma market value
of the subject company is determined based on the market pricing of the peer
group as of the date of valuation, incorporating valuation adjustments for key
differences. In addition, the pricing characteristics of recent conversions,
both at conversion and in the aftermarket, must be considered.
RP FINANCIAL APPROACH TO THE VALUATION
The valuation analysis herein complies with such regulatory approval
guidelines. Accordingly, the valuation incorporates a detailed analysis based on
the Peer Group, discussed in Chapter III, which constitutes "fundamental
analysis" techniques. Additionally, the valuation incorporates a "technical
analysis" of recently completed stock conversions, including closing
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PAGE 4.2
pricing and aftermarket trading of such offerings. It should be noted that such
analyses cannot possibly fully account for all the market forces which impact
trading activity and pricing characteristics of a stock on a given day.
The pro forma market value determined herein is a preliminary value for
the Bank's to-be-issued stock. Throughout the conversion process, RP Financial
will: (1) review changes in the Bank's operations and financial condition; (2)
monitor the Bank's operations and financial condition relative to the Peer Group
to identify any fundamental changes; (3) monitor the external factors affecting
value including, but not limited to, local and national economic conditions,
interest rates, and the stock market environment, including the market for
thrift stocks; and (4) monitor pending conversion offerings (including those in
the offering phase) both regionally and nationally. If material changes should
occur prior to closing the offering, RP Financial will evaluate if updated
valuation reports should be prepared reflecting such changes and their related
impact on value, if any. RP Financial will also prepare a final valuation update
at the closing of the offering to determine if the prepared valuation analysis
and resulting range of value continues to be appropriate.
The appraised value determined herein is based on the current market
and operating environment for the Bank and for all thrifts. Subsequent changes
in the local and national economy, the legislative and regulatory environment,
the stock market, interest rates, and other external forces (such as natural
disasters or major world events), which may occur from time to time (often with
great unpredictability) may materially impact the market value of all thrift
stocks, including Peoples Federal's value, or Peoples Federal's value alone. To
the extent a change in factors impacting the Bank's value can be reasonably
anticipated and/or quantified, RP Financial has incorporated the estimated
impact into its analysis.
VALUATION ANALYSIS
A fundamental analysis discussing similarities and differences relative
to the Peer Group was presented in Chapter III. The following sections summarize
the key differences between the Bank and the Peer Group and how those
differences affect the pro forma valuation. Emphasis is
RP FINANCIAL, LC.
PAGE 4.3
placed on the specific strengths and weaknesses of the Bank relative to the Peer
Group in such key areas as financial condition, profitability, growth and
viability of earnings, asset growth, primary market area, dividends, liquidity
of the shares, marketing of the issue, management, and the effect of government
regulations and/or regulatory reform. We have also considered the market for
thrift stocks, in particular new issues, to assess the impact on value of
Peoples Federal coming to market at this time.
1. FINANCIAL CONDITION
The financial condition of an institution is an important determinant
in pro forma market value, because investors typically look to such factors as
liquidity, capital, asset composition and quality, and funding sources in
assessing investment attractiveness. The similarities and differences in the
Bank's and the Peer Group's financial strength are noted as follows:
o OVERALL A/L COMPOSITION. Loans funded by retail deposits were
the primary components of both Peoples Federal's and the Peer
Group's balance sheets. The Bank's interest-earning asset
composition exhibited a higher concentration of loans, while
the Peer Group's loan portfolio composition exhibited a
greater degree of diversification into higher risk and higher
yielding types of loans. Overall, the Bank's asset composition
provided for a slightly higher risk weighted assets-to-assets
ratio than maintained by the Peer Group. Peoples Federal's
funding composition reflected a higher level of deposits and a
lower level of borrowings than the comparable Peer Group
ratios. Overall, as a percent of assets, the Bank maintained
slightly higher levels of interest-earning assets and
interest-bearing liabilities, which provided for comparable
IEA/IBL ratios for the Bank and the Peer Group and indicated
the interest rate risk characteristics associated with their
respective balance sheets were comparable. For valuation
purposes, RP Financial concluded that no adjustment was
warranted for the Bank's overall asset/liability composition.
o CREDIT QUALITY. Both the Bank's and the Peer Group's credit
quality measures were indicative of fairly limited credit risk
exposure. However, in general, the Bank's credit quality
measures were considered to be more favorable than the Peer
Group's. The Bank maintained a lower non-performing
assets-to-assets ratio and a lower non-performing
loans-to-loan ratio than the comparable Peer Group ratios.
Loss reserves as a percent of non-performing assets were
stronger for the Bank, while the Peer Group maintained a
slightly stronger reserve coverage ratio as a percent of
loans. Overall, in comparison to the Peer Group, the Bank's
measures tended to imply a more limited degree of credit
exposure and, thus, RP
RP FINANCIAL, LC.
PAGE 4.4
Financial concluded that a slight upward adjustment was
warranted for the Bank's credit quality.
o BALANCE SHEET LIQUIDITY. The Peer Group operated with a higher
level of cash and investment securities relative to the Bank
(22.5 percent of assets versus 13.6 percent for the Bank).
Following the infusion of stock proceeds, the Bank's cash and
investments ratio is expected to increase as the proceeds
retained at the holding company level will be initially
deployed into investments. Peoples Federal's future borrowing
capacity was considered to be greater than the Peer Group's,
in light of the higher level of borrowings currently
maintained by the Peer Group. However, both the Bank and the
Peer Group were considered to have ample borrowing capacities.
Overall, balance sheet liquidity for the Bank was considered
to be comparable to the Peer Group and, thus, RP Financial
concluded that no adjustment was warranted for the Bank's
balance sheet liquidity.
o FUNDING LIABILITIES. Retail deposits served as the primary
interest-bearing source of funds for the Bank and the Peer
Group, with borrowings being utilized to a greater degree by
the Peer Group. The Bank's overall funding composition
provided for a similar cost of funds as maintained by the Peer
Group. In total, the Bank maintained a slightly higher level
of interest-bearing liabilities than the Peer Group, which was
attributable to Peoples Federal's lower capital position.
Following the stock offering, the increase in the Bank's
capital position should provide Peoples Federal with a
comparable or lower level of interest-bearing liabilities than
maintained by the Peer Group. Overall, RP Financial concluded
that no adjustment was warranted for Peoples Federal's funding
composition.
O CAPITAL. The Peer Group operates with a slightly higher
pre-conversion capital ratio than the Peer Group, 13.9 percent
and 12.0 percent of assets, respectively. However, following
the mutual-to-stock conversion, Peoples Federal's pro forma
capital position will likely exceed the Peer Group's
equity-to-assets ratio. The Bank's higher pro forma capital
position will result in greater leverage potential and reduce
the level of interest-bearing liabilities utilized to fund
assets. At the same time, the Bank's more significant capital
surplus will likely result in a depressed ROE. Overall, RP
Financial concluded that a slight upward adjustment was
warranted for the Bank's capital position.
On balance, Peoples Federal's balance sheet strength was considered to
be more favorable than Peer Group's, as implied by the more favorable credit
quality and capital characteristics of the Bank's pro forma balance sheet.
Accordingly, we concluded that a slight upward valuation adjustment was
warranted for the Bank's financial strength.
2. PROFITABILITY, GROWTH AND VIABILITY OF EARNINGS
RP FINANCIAL, LC.
PAGE 4.5
Earnings are a key factor in determining pro forma market value, as the
level and risk characteristics of an institution's earnings stream and the
prospects and ability to generate future earnings heavily influence the multiple
the investment community will pay for earnings. The major factors considered in
the valuation are described below.
o REPORTED EARNINGS. The Bank recorded lower earnings on a ROAA
basis (0.70 percent of average assets versus 0.79 percent for
the Peer Group). A stronger net interest margin and a lower
level of operating expenses largely accounted for the Peer
Group's more favorable reported earnings. A lower effective
tax rate and a slightly higher level of non-interest operating
income were also factors that supported the Peer Group's
higher return. Lower loss provisions and higher net gains
represented earnings advantages for the Bank. Reinvestment of
stock proceeds into interest-earning assets will serve to
increase the Bank's earnings, with the benefit of reinvesting
proceeds expected to be somewhat offset by higher operating
expenses associated with operating as a publicly-traded
company and the implementation of stock benefit plans.
Overall, the differences between the Bank's and the Peer
Group's reported earnings were considered to be representative
of the Peer Group's superior earnings strength and, thus,
Peoples Federal's lower reported earnings warranted a moderate
downward adjustment for valuation purposes.
o CORE EARNINGS. Both the Bank's and the Peer Group's earnings
were derived largely from recurring sources, including net
interest income, operating expenses, and non-interest
operating income. In these measures, the Bank operated with a
lower net interest margin, a higher operating expense ratio
and a lower level of non-interest operating income. The Bank's
lower net interest margin and higher level of operating
expenses translated into a lower expense coverage ratio (1.31x
versus 1.43x for the Peer Group). However, net of the
non-recurring expense related to the establishment of the
deferred compensation plan, the Bank's expense coverage ratio
of 1.68 times was more favorable than the Peer Group's ratio.
Likewise, due to the Bank's lower net interest margin, higher
operating expenses, as well as lower level of non-interest
operating income, the Peer Group's efficiency ratio was more
favorable than the Bank's (62.3 percent versus 69.5 percent
for the Bank). After factoring the non-recurring expense of
the deferred compensation plan, the Bank's efficiency ratio
improved to 54.4 percent. Loss provisions had a larger impact
on the Peer Group's earnings, which was consistent with the
Peer Group's higher level of non-performing assets and greater
diversification into higher risk types of lending. Overall,
these measures, as well as the expected earnings benefits the
Bank should realize from the redeployment of stock proceeds
into interest-earning assets, indicated that Peoples Federal's
core earnings were slightly stronger than the Peer Group's and
a slight upward adjustment was warranted for the Bank's core
earnings.
RP FINANCIAL, LC.
PAGE 4.6
o INTEREST RATE RISK. Quarterly changes in the Bank's and the
Peer Group's net interest income to average assets ratios
indicated a similar degree of interest rate risk exposure in
their respective net interest margins, as the Bank's and the
Peer Group's net interest margins exhibited fairly limited
quarterly fluctuations during the period analyzed. Other
measures of interest rate risk, such as capital ratios,
IEA/IBL ratios, and the level of non-interest earning
assets-to-total assets were fairly comparable for the Bank and
the Peer Group, thereby indicating a similar dependence on the
yield-cost spread to sustain net interest income. On a pro
forma basis, the infusion of stock proceeds can be expected to
provide the Bank with a stronger capital position and IEA/ILB
ratio than maintained by Peer Group, as well as enhance the
stability of the Bank's net interest margin through the
reinvestment of stock proceeds into interest-earning assets.
Accordingly, RP Financial concluded that the Bank's interest
rate risk exposure on a pro forma basis was less than the Peer
Group's and a slight upward adjustment was warranted for
valuation purposes.
o CREDIT RISK. Loan loss provisions were a larger factor in the
Peer Group's earnings, but were not considered to be
significant for either the Bank or the Peer Group. In terms of
future exposure to credit quality related losses, lending
diversification into higher risk types of loans was greater
for the Peer Group. The Bank's and the Peer Group's credit
quality measures indicated the Bank maintained a lower level
of non-performing assets and a higher level of reserves as a
percent of non-performing assets. Overall, RP Financial
concluded that a slight upward adjustment was warranted for
the credit risk exposure associated with the Bank's earnings.
o EARNINGS GROWTH POTENTIAL. Several factors were considered in
assessing earnings growth potential. First, the Peer Group's
historical growth was stronger than the Bank's. Second, the
infusion of stock proceeds will increase the Bank's earnings
growth potential with respect to leverage capacity, as the
Bank's pro forma leverage capacity should be slightly greater
than the Peer Group's. Lastly, opportunities for lending and
deposit growth in the Bank's market area are considered to be
slightly more favorable than the primary market areas served
by the Peer Group companies in general, as indicated by the
stronger population growth that is projected to continue in
the Bank's primary market area (see Exhibit III-3). Overall,
the Bank's earnings growth potential appears to be comparable
to the Peer Group's, and, thus, we concluded that no
adjustment was warranted for this factor.
o RETURN ON EQUITY. The Bank's return on equity will be below
the comparable averages for the Peer Group and all
publicly-traded thrifts. In view of the lower capital growth
rate that will be imposed by Peoples Federal's lower ROE, we
concluded that a moderate downward adjustment was warranted
for the Bank's ROE.
RP FINANCIAL, LC.
PAGE 4.7
On balance, the more favorable core earnings, interest rate risk and
credit risk characteristics indicated for the Bank's earnings were more than
offset by the Peer Group's more favorable reported earnings and higher return on
equity. Accordingly, RP Financial concluded that a slight downward valuation
adjustment was warranted for the Bank's profitability, growth and viability of
earnings.
RP FINANCIAL, LC.
PAGE 4.8
3. ASSET GROWTH
Peoples Federal's asset growth was lower than the Peer Group's, during
the periods covered in our comparative analysis (positive 6.7 percent versus
positive 10.6 percent for the Peer Group). This characteristic would normally be
considered as a negative, but was somewhat offset by the potential asset growth
that the Bank will be able to realize following the infusion of stock proceeds.
Additionally, the Peer Group's stronger growth rate was in part attributable to
acquisition related growth, as opposed to internal growth. On a pro forma basis,
the Bank's equity-to-assets ratio will be higher than the Peer Group's,
resulting in greater leverage capacity for Peoples Federal. Since the Bank
operates in a faster growing market than the Peer Group companies on average,
opportunities to grow the balance sheet through retail growth were viewed as
somewhat more favorable for the Bank. On balance, we believe no adjustment was
warranted for this factor, as the Bank's less favorable historical growth was
viewed as being offset by its greater capacity to leverage the balance sheet on
a pro forma basis.
4. PRIMARY MARKET AREA
The general condition of an institution's market area has an impact on
value, as future success is in part dependent upon opportunities for profitable
activities in the local market served. Peoples Federal's primary market area for
deposits and loans is considered to be Dearborn, Ohio and Switzerland Counties,
where the Bank's branches are located. A diversified and growing economy has
translated into favorable demographic growth for the Bank's primary market area,
as measured by growth in population and households during the 1990s. Growth has
been most notable in Dearborn County, where Peoples Federal is headquartered and
maintains its largest customer base. Overall, the demographic and economic
characteristics of the local market area are considered to be favorable with
respect to limiting credit risk exposure and supporting growth opportunities. At
the same time, given the desirable features of the market area, Peoples Federal
faces notable competition from numerous other financial institutions, including
many which are significantly larger than the Bank.
Overall, the markets served by the Peer Group companies were viewed as
having favorable growth characteristics. The primary markets served by the Peer
Group companies
RP FINANCIAL, LC.
PAGE 4.9
have on average experienced an increase in population during the 1990s and, on
average, population growth in those markets is projected to continue over the
next five years. The Peer Group companies serve less populous and slower growing
markets than the primary market area served by the Bank. The median deposit
market share maintained by the Peer Group companies was slightly higher than the
Bank's market share of deposits in Dearborn County. In general, the degree of
competition faced by the Peer Group companies was viewed as less than
experienced in the Bank's primary market area, particularly with respect to the
Dearborn County market area, while the growth potential of the markets served by
the Peer Group companies was also viewed as somewhat less compared to Peoples
Federal's primary market area. Summary demographic and deposit market share data
for the Bank and the Peer Group companies is provided in Exhibit III-3. As shown
in Table 4.1, March 2001 unemployment rates for the markets served by the Peer
Group companies generally were slightly higher or comparable to the unemployment
rates reflected in the Bank's primary market area counties. On balance, we
concluded that a slight upward adjustment was appropriate for the Bank's market
area.
Table 4.1
Market Area Unemployment Rates
Peoples Federal and the Peer Group Companies (1)
MARCH 2001
COUNTY UNEMPLOYMENT
------ ------------
Peoples Federal - IN Dearborn 2.7%
Ohio 3.0
Switzerland 5.4
THE PEER GROUP
FFW Corporation of Wabash - IN Wabash 4.6%
First Bancorp - IN Vanderburgh 3.0
First Capital, Inc. - IN Harrison 2.7
Logansport Fin. Corp. - IN Cass 5.0
MFB Corp. of Mishawaka - IN St. Joseph 3.6
Montgomery Fin. Corp. - IN Montgomery 3.1
Northeast Indiana Bancorp - IN Huntington 4.2
River Valley Bancorp - IN Jefferson 3.7
Security Financial Bancorp - IN Lake 4.5
Sobieski Bancorp of S. Bend - IN St. Joseph 3.6
Union Community Bancorp - IN Montgomery 3.1
RP FINANCIAL, LC.
PAGE 4.10
(1) Unemployment rates are not seasonally adjusted.
Source: U.S. Bureau of Labor Statistics.
5. DIVIDENDS
The Bank has indicated its intention to pay an annual cash dividend of
$0.20 per share, which would provide for a yield of 2.0 percent based on the
$10.00 per share initial offering price. However, future declarations of
dividends by the Board of Directors will depend upon a number of factors,
including investment opportunities, growth objectives, financial condition,
profitability, tax considerations, minimum capital requirements, regulatory
limitations, stock market characteristics and general economic conditions.
Ten out of the eleven Peer Group companies pay regular cash dividends,
with implied dividend yields ranging from 1.48 percent to 4.40 percent. The
average dividend yield on the stocks of the Peer Group institutions was 2.70
percent as of June 8, 2001, representing an average earnings payout ratio of
44.45 percent. As of June 8, 2001, approximately 86 percent of all
publicly-traded thrifts (non-MHC institutions) had adopted cash dividend
policies (see Exhibit IV-1) exhibiting an average yield of 2.61 percent and an
average payout ratio of 34.77 percent. The dividend paying thrifts generally
maintain higher than average profitability ratios, facilitating their ability to
pay cash dividends.
The Bank's indicated dividend provides for a yield that is within the
Peer Group range of dividend yields and not materially different from the Peer
Group average. Likewise, based on earnings and capital, the Bank's dividend
capacity is considered to be comparable to the Peer Group's. On balance, we
concluded that no adjustment was warranted for purposes of dividends relative to
the Peer Group.
6. LIQUIDITY OF THE SHARES
The Peer Group is by definition composed of companies that are traded
in the public markets, and all of the Peer Group members trade on the NASDAQ
system. Typically, the number of shares outstanding and market capitalization
provides an indication of how much
RP FINANCIAL, LC.
PAGE 4.11
liquidity there will be in a particular stock. The market capitalization of the
Peer Group companies ranged from $9.7 million to $32.5 million as of June 8,
2001, with an average market value of $21.9 million. The shares issued and
outstanding to the public shareholders of the Peer Group members ranged from
approximately 678,000 to 2.5 million, with average shares outstanding of
approximately 1.6 million. The Bank's conversion stock offering is expected to
result in shares outstanding and market capitalization that will be lower than
the comparable Peer Group averages. Consistent with all of the Peer Group
companies, it is anticipated that the Bank's stock will be quoted on the NASDAQ
National Market System. Overall, we anticipate that the liquidity in the Bank's
stock will be less than the Peer Group companies on average and, therefore,
concluded a slight downward adjustment was necessary for this factor.
7. MARKETING OF THE ISSUE
We believe that three separate markets need to be considered for thrift
stocks such as Peoples Federal coming to market: (1) the after-market for public
companies, in which trading activity is regular and investment decisions are
made based upon financial condition, earnings, capital, ROE, dividends and
future prospects; (2) the new issue market in which converting thrifts are
evaluated on the basis of the same factors, but on a pro forma basis without the
benefit of prior operations as a publicly-held company and stock trading
history; and (3) the thrift acquisition market for thrift franchises in Indiana.
All of these markets were considered in the valuation of the Bank's to-be-issued
stock.
A. THE PUBLIC MARKET
The value of publicly-traded thrift stocks is easily
measurable, and is tracked by most investment houses and related organizations.
Exhibit IV-1 provides pricing and financial data on all publicly-traded thrifts.
In general, thrift stock values react to market stimuli such as interest rates,
inflation, perceived industry health, projected rates of economic growth,
regulatory issues and stock market conditions in general. Exhibit IV-2 displays
historical stock market
RP FINANCIAL, LC.
PAGE 4.12
trends for various indices and includes historical stock price index values for
thrifts and commercial banks. Exhibit IV-3 displays historical stock price
indices for thrifts only.
In terms of assessing general stock market conditions, the
performance of the overall stock market has been mixed over the past year.
Stocks generally advanced during the first half of June 2000, particularly
technology stocks, as indications of a slowing economy provided for a more
optimistic outlook for interest rates. Expectations of favorable second quarter
earnings and the more favorable outlook for interest rates provided for
additional gains in the stock market during the first half of July 2000,
particularly Old Economy stocks. Volatility was evident in the stock market
during the second half of July, as the market reacted to various earnings
announcements and forecasts of profitability for the balance of the year.
Technology stocks declined sharply at the end of July, primarily on news of less
favorable earnings prospects in the telecommunications sector. Signs of a
slowing economy generally supported advances in the stock market during most of
August, as easing inflation worries lessened expectations of further rate
increases by the Federal Reserve. Stocks continued to edge higher following the
Federal Reserve's decision to hold rates steady at its late-August meeting.
Blue chip stocks traded in a narrow range during the first
half of September 2000, while technology stocks generally declined on lower
earnings expectations by some of the industry leaders. Financial stocks
benefited from a renewal of merger activity, including Citigroup's announced
acquisition of Associates First Capital and Chase Manhattan's agreement to buy
J.P. Morgan. Soaring oil prices pulled market averages lower in mid-September,
as oil prices moved to a new post-Gulf War high. Volatility was evident in the
market in late-September, with lower oil prices and more attractive pricing
fueling gains in both Old Economy and technology stocks. However, the gains were
quickly erased by more profit warnings and an unexpected decline in the
September unemployment rate to 3.9 percent.
The sell-off in stocks intensified in mid-October 2000, as
stocks tumbled broadly on concerns of weak corporate earnings, surging oil
prices and escalating violence in the Mideast. High technology issues paced a
rebound in the market following a week of significant losses, as
better-than-expected earnings and more attractive fundamentals provided for a
7.9 percent increase in the NASDAQ and a 158 point gain in the Dow Jones
Industrial Average
RP FINANCIAL, LC.
PAGE 4.13
("DJIA") on October 13, 2000. The sell-off in the broader market resumed the
week of October 16th, as disappointing third quarter earnings and inflation
worries triggered further declines in the DJIA and the NASDAQ. A flight to
safety provided for a rebound in blue chip stocks in late-October, as investors
dumped technology stocks in favor of financial and consumer stocks.
Technology stocks rebounded strongly during the first week of
November 2000, reflecting more attractive fundamentals and bullish comments made
by Intel. However, following the election, stocks generally declined through the
end of November, largely as the result of earnings worries and uncertainty over
the outcome of the election. Selling pressure was most significant in the
technology sector, with the NASDAQ posting several new yearly lows at the end of
November. The resolution of the presidential election provided little relief for
the equities market, as stocks generally trended lower in early-December. The
sharpest declines continued to be in the technology, with the NASDAQ plunging to
an 18-month low on worries of slowing profit growth throughout the technology
sector. Disappointment that the Federal Reserve did not cut rates at its
December meeting also contributed to the decline in the market averages in
mid-December. Bargain hunting provided for a rebound in stocks prior to the
holidays, although the NASDAQ was still expected to experience its worst
performance year ever. Blue chip and defensive stocks staged a mild rally at the
close of 2000, reflecting growing expectations that the slowing economy would
produce an interest rate cut by the Federal Reserve. Comparatively, gains in
technology stocks were limited by concerns of weaker earnings that may result
from the economic slow down.
Volatility was evident in the stock market at the beginning of
2001. Weak manufacturing data for December sent stocks plunging on the first day
of trading of the New Year, as manufacturing activity in December fell to its
weakest level in almost ten years. However, stocks moved sharply higher the next
day, as the Federal Reserve cut the federal funds rate by 50 basis points in a
rare decision to move interest rates between formal meetings of the Federal
Reserve Board. For the balance of January, stocks generally settled into a more
narrow trading range, as investors reacted to the release of various fourth
quarter earnings reports. Anticipation of another interest rate cut by the
Federal Reserve supported a rally in stocks at the end of January. Overall, for
the month of January, the Dow Jones Industrial Average ("DJIA")
RP FINANCIAL, LC.
PAGE 4.14
and the NASDAQ Composite Index ("NASDAQ") increased by 0.9 percent and 12.2
percent, respectively.
At the beginning of February 2001, stocks reacted mildly to
the widely anticipated 50 basis interest rate cut implemented by the Federal
Reserve at the end of January. Further signs of a slow down in the national
economy, including an increase in the January unemployment rate and a decline in
January manufacturing activity to a level that generally indicates the economy
is in a recession, pushed stocks lower into mid-February. Technology stocks
generally experienced more significant declines than the broader market, as a
number of bellwether technology issues warned of slower revenue growth and
reduced profitability for the first half of 2001. The broader market staged a
modest recovery in late-February, which was supported by bargain hunting and
growing investor expectations of further interest rate cuts by the Federal
Reserve. However, diminished prospects for another interest rate cut before the
next Federal Reserve meeting prompted a general decline in the stock market at
the end of February.
More attractive valuations provided a boost to stocks in
early-March 2001, but the rally stalled on more earnings warnings and a sell-off
in the Tokyo stock market. The bleak outlook for first quarter earnings by a
number of the bellwether technology stocks spurred a two-day sell-off in the
NASDAQ of more than 11 percent and the S&P 500 fell 4.3 percent on March 12th,
which put that index into "bear-market" territory as well. Disappointment of
only a 0.50 percent rate cut by the Federal Reserve at its March 20th meeting
prompted a new wave of selling, particularly in technology stocks. Signs of a
stronger economy supported a late-March rally, which was again cut short by more
earnings warnings in the technology sector. The first quarter of 2001 concluded
as the worst first quarter ever for the NASDAQ and the worst first quarter for
the Dow Jones Industrial Average ("DJIA") in 23 years. On March 30, 2001, the
DJIA closed at 9878.78, a decline of 8.4 percent since year end 2000.
Comparatively, the NADAQ declined 25.5 percent in the first quarter.
Stocks continued to slide in early-April 2001, amid fears that
first quarter earnings would contain more bad surprises and generally fall short
of reduced expectations. However, favorable earnings reports by Dell Computer
Corporation and Alcoa served as a
RP FINANCIAL, LC.
PAGE 4.15
catalyst to one of the largest one-day gains in stock market history on April
5th, with the DJIA and NASDAQ posting gains of 4.2 percent and 8.9 percent,
respectively. The upward momentum in stocks was sustained into mid-April, as
investors gained confidence that the economy would improve in the second half of
the year. Stocks raced higher following a surprise inter-meeting rate cut by the
Federal Reserve on April 18th. The Federal Reserve cited slowing business
investment and falling profits in its decision to lower rates by 50 basis points
a month ahead of its regularly scheduled meeting. Following some profit taking
on the heels of the rate cut, stocks moved higher at the end of April. Favorable
economic data, including stronger than expected GDP growth for the first
quarter, served as the basis for the general increase in stocks.
The positive trend in stocks did not extend into May 2001, as
concerns over the business outlook generally pulled stocks lower through
mid-May. Implementation of a fifth rate cut by the Federal Reserve at its
mid-May meeting served to the reverse the downward trend in stock, as NASDAQ
posted a six-day winning streak following the rate cut. However, profit taking
and second quarter earnings jitters served to end the rally in late-May. In
early-June, the performance of the broader market was mixed, reflecting
uncertainty over the prospects for a recovery in the economy and stronger
corporate earnings. As an indication of the general trends in the nation's stock
markets over the past year, as of June 8, 2001, the DJIA closed at 10977.00 an
increase of 3.4 percent from one year earlier, while the NASDAQ Composite Index
stood at 2215.10, a decline of 42.8 percent over the same time period. The
Standard & Poors 500 Index closed at 1264.96 on June 8, 2001, a decline of 13.2
percent from a year ago.
The market for thrift stocks has been mixed during the past
twelve months. Indications of slower economic growth supported an advance in
thrift prices during late-May and early-June 2000, although the rally stalled on
profit taking and continued uncertainty about further rate increases by the
Federal Reserve. Thrift stocks generally declined during the second half of June
2000, reflecting growing concerns that some thrifts were experiencing a decline
in credit quality. The Federal Reserve's decision to leave interest rates
unchanged at its late-June meeting, along with expectations that the slowing
economy would deter further interest rate increases by the Federal Reserve,
supported a recovery in thrift prices during the first half of July. Thrift
stocks traded in a narrow range through the end of July, as second quarter
earnings
RP FINANCIAL, LC.
PAGE 4.16
generally met expectations. Lower interest rates lifted thrift stocks higher
during the first half of August, as bond yields approached their lowest level in
more than a year. Thrift stocks stabilized in late-August, as the Federal
Reserve's decision to leave rates unchanged was widely anticipated. Signs of
slower economic growth with tame inflation propelled thrift stocks higher
through most of September, as interest rate sensitive stocks benefited from
lower interest rates and the reversion to a normal yield curve for the first
time since mid-January. Larger cap financial stocks also generally moved higher
on news of Chase Manhattan's agreement to acquire J.P. Morgan, which was
announced on September 13, 2000 and FleetBoston's proposed acquisition of Summit
of New Jersey, which was announced on October 2, 2000.
Financial stocks declined with the broader market following the release
of the September 2000 employment data, which showed the unemployment rate
matching a 30-year low first reached in April 2000. The sharp sell-off in stocks
during mid-October included thrift stocks, reflecting growing concerns of credit
quality deterioration and higher interest rates negatively impacting the
earnings of financial stocks. Comparatively, thrift stocks posted solid gains
during the second half of October, as investors sold technology stocks and moved
into financial and other Old Economy stocks.
Thrift stocks eased lower through most of November 2000, as financial
stocks in general experienced selling pressures from growing credit quality
concerns and the Federal Reserve's decision not to cut rates at its mid-November
meeting. More attractive fundamentals and favorable comments from a thrift
analyst provided for a rebound in thrift prices at the end of November. Thrift
stocks fared better than the broader market through most of December, as the
slowing economy and declining interest rates attracted investors to interest
rate sensitive issues in general. Despite the surprise interest rate cut by the
Federal Reserve in early-January 2001, thrift stocks trended lower during the
first half of January. Profit taking following the year-end rally and concerns
that the slowing economy would lead to an increase credit quality problems for
lenders, particularly commercial lenders, were factors that contributed to the
decline in thrift prices. Thrift stocks rebound during late-January and the
first half of February, as the second interest rate cut by the Federal Reserve
and expectations of further interest rate cuts served to rekindle interest in
thrift issues.
RP FINANCIAL, LC.
PAGE 4.17
After trading in a narrow range through mid-March 2001, a sell-off in
large U.S. banks rippled through the thrift sector as well. Most of the sell-off
was attributable to concerns over U.S. bank exposure to troubled Japanese banks,
which would only indirectly impact the thrift sector to the extent such problems
would impact the U.S. economy. The Federal Reserve's implementation of a third
rate cut at its March meeting had little impact on thrift stocks, as thrift
stocks followed the broader market lower following the rate cut. However, aided
by the decline in short-term interest rates that provided for a steeper yield
curve, thrift stocks moved higher at the end of the first quarter. After
following the broader market lower in early-April, thrifts stock recovered
slightly in mid-April and generally outperformed bank stocks. The more favorable
performance by thrifts was supported by their lower exposure to the downturn in
the commercial credit cycle and the more positive effect that the rate cuts
would have on their margins. While the announced merger between First Union and
Wachovia had little impact on the overall market for thrift and bank stocks,
financial stocks gained on news of the surprise rate cut by the Federal Reserve
in mid-April. The largest gains in the thrift sector tended to be in the
large-cap stocks. Thrift prices generally stabilized in late-April, as first
quarter earnings generally met expectations.
Lower short-term interest rates and a steeper yield curve continued to
benefit thrift issues in May 2001, particularly following the 0.50 percent rate
cut by the Federal Reserve in mid-May. Thrift issues traded in a narrow range in
late-May, as interest rates stabilized. Expectations of further rate cutes by
the Federal Reserve and stronger second quarter earnings translated into
slightly higher thrift prices in early-June. On June 8, 2001, the SNL Index for
all publicly-traded thrifts closed at 931.3, an increase of 56.2 percent from
one year ago.
B. THE NEW ISSUE MARKET
In addition to thrift stock market conditions in general, the
new issue market for converting thrifts is also an important consideration in
determining the Bank's pro forma market value. The new issue market is separate
and distinct from the market for seasoned stock thrifts in that the pricing
ratios for converting issues are computed on a pro forma basis, specifically:
(1) the numerator and denominator are both impacted by the conversion offering
amount, unlike
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PAGE 4.18
existing stock issues in which price change affects only the numerator; and (2)
the pro forma pricing ratio incorporates assumptions regarding source and use of
proceeds, effective tax rates, stock plan purchases, etc. which impact pro forma
financials, whereas pricing for existing issues are based on reported
financials. The distinction between pricing of converting and existing issues is
perhaps no clearer than in the case of the price/tangible book ("P/TB") ratio in
that the P/TB ratio of a converting thrift will typically result in a discount
to tangible book value whereas in the current market for existing thrifts the
P/TB ratio often reflects a premium to tangible book value. Therefore, it is
appropriate to also consider the market for new issues, both at the time of the
conversion and in the aftermarket.
The market for converting thrifts has shown some signs of
strengthening in recent months, although conversion activity has remained
somewhat limited. As shown in Table 4.2,
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PAGE 4.19
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PAGE 4.20
only three standard conversion offerings have been completed during the past
three months. Two out of the three offerings were closed at the top of the super
range and one was closed between the minimum and the midpoint. All three of the
recent conversions traded higher in initial trading activity and the average one
week change in price for standard conversion offerings completed during the past
three months equaled positive 30.8 percent. The average pro forma price/tangible
book and core price/earnings ratios of the recent standard conversions at
closing equaled 54.1 percent and 13.0 times, respectively.
In examining the current pricing characteristics of the conversion
offerings completed during the last three months (see Table 4.3), we note there
exists a considerable difference in pricing ratios compared to the universe of
all publicly-traded thrifts. Specifically, the current average P/B ratio of the
full conversions completed in the most recent three month period of 96.08
percent reflects a discount of 13.8 percent from the average P/B ratio of all
publicly-traded thrifts (equal to 111.52 percent). The equity-to-assets ratio of
the recent conversion was above the average for all publicly-traded thrifts
(14.73 percent versus 10.57 percent for all publicly-traded thrifts), which
primarily accounted for the lower core return on equity maintained by the recent
conversions (4.54 percent versus 7.56 percent for all publicly-traded thrifts).
Accordingly, the discount reflected in the P/B ratio of the recent conversion
suggests that the investment community has determined to discount their stocks
on a book basis until the return on equity improves through redeployment and
leveraging of the proceeds over the longer term and implementation of other
capital management strategies. One of the recent conversions in Table 4.3,
Fidelity Bankshares, was a second-step conversion and such offerings tend to be
priced at a higher P/B ratio than standard conversion offerings. The current
average P/B ratio of the two standard conversion offerings equaled 79.32 percent
and reflected a discount of 28.9 percent from the average P/B ratio for all
publicly-traded thrifts.
C. THE ACQUISITION MARKET
Also considered in the valuation was the potential impact on
Peoples Federal's stock price of recently completed and pending acquisitions of
other savings institutions operating in Indiana. As shown in Exhibit IV-4, there
were seven Indiana thrift acquisitions completed
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PAGE 4.21
between the beginning of 1998 through year-to-date 2001, and there are no
acquisitions currently
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PAGE 4.23
pending of Indiana savings institutions. The recent acquisition activity
involving Indiana thrifts may imply a certain degree of acquisition
speculation for the Bank's stock. To the extent that acquisition speculation
may impact the Bank's offering, we have largely taken this into account in
selecting Indiana-based companies which operate in markets that have
experienced a comparable level of acquisition activity as the Bank's market
and, thus, are subject to the same type of acquisition speculation that may
influence Peoples Federal's trading price.
* * * * * * * * * * *
In determining our valuation adjustment for marketing of the
issue, we considered market conditions in general and trends in the overall
thrift market, including the new issue market and the acquisition market for
Indiana thrifts. Taking these factors and trends into account, RP Financial
concluded that a slight downward adjustment was appropriate in the valuation
analysis for purposes of marketing of the issue.
8. MANAGEMENT
Peoples Federal's management team appears to have experience and
expertise in all of the key areas of the Bank's operations. Exhibit IV-5
provides summary resumes of Peoples Federal's Board of Directors. While the Bank
does not have the resources to develop a great deal of management depth, given
its asset size and the impact it would have on operating expenses, management
and the Board have been effective in implementing an operating strategy that can
be well managed by the Bank's present organizational structure as indicated by
the financial characteristics of the Bank. Peoples Federal currently does not
have any executive management positions that are vacant.
Similarly, the returns, capital positions, and other operating measures
of the Peer Group companies are indicative of well-managed financial
institutions, which have Boards and management teams that have been effective in
implementing competitive operating strategies. Therefore, on balance, we
concluded no valuation adjustment relative to the Peer Group was appropriate for
this factor.
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PAGE 4.24
9. EFFECT OF GOVERNMENT REGULATION AND REGULATORY REFORM
In summary, as a fully-converted SAIF-insured institution, Peoples
Federal will operate in substantially the same regulatory environment as the
Peer Group members -- all of whom are adequately capitalized institutions and
are operating with no apparent restrictions. Exhibit IV-6 reflects the Bank's
pro forma regulatory capital ratios. On balance, no adjustment has been applied
for the effect of government regulation and regulatory reform.
SUMMARY OF ADJUSTMENTS
Overall, based on the factors discussed above, we concluded that the
Bank's pro forma market value should be discounted relative to the Peer Group as
follows:
KEY VALUATION PARAMETERS: VALUATION ADJUSTMENT
------------------------ --------------------
Financial Condition Slight Upward
Profitability, Growth and Viability of Earnings Slight Downward
Asset Growth No Adjustment
Primary Market Area Slight Upward
Dividends No Adjustment
Liquidity of the Shares Slight Downward
Marketing of the Issue Slight Downward
Management No Adjustment
Effect of Government Regulations and Regulatory Reform No Adjustment
VALUATION APPROACHES
In applying the accepted valuation methodology promulgated by the OTS
and adopted by the FDIC, i.e., the pro forma market value approach, we
considered the three key pricing ratios in valuing Peoples Federal's
to-be-issued stock -- price/earnings ("P/E"), price/book ("P/B"), and
price/assets ("P/A") approaches -- all performed on a pro forma basis including
the effects of the conversion proceeds. In computing the pro forma impact of the
conversion and the related pricing ratios, we have incorporated the valuation
parameters disclosed in Peoples Federal's prospectus for reinvestment rate, the
effective tax rate, offering expenses and stock benefit plan
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PAGE 4.25
assumptions (summarized in Exhibits IV-7 and IV-8). In our estimate of value, we
assessed the relationship of the pro forma pricing ratios relative to the Peer
Group and the recent conversions.
RP Financial's valuation placed an emphasis on the following:
o P/E APPROACH. The P/E approach is generally the best indicator
of long-term value for a stock. Given the similarities between
the Bank's and the Peer Group's earnings composition and
overall financial condition, the P/E approach was carefully
considered in this valuation. At the same time, since reported
earnings for both the Bank and the Peer Group included certain
non-recurring items, we also made adjustments to earnings to
arrive at core earnings estimates for the Bank and the Peer
Group and resulting price/core earnings ratios.
o P/B APPROACH. P/B ratios have generally served as a useful
benchmark in the valuation of thrift stocks, particularly in
the context of an initial public offering, as the earnings
approach involves assumptions regarding the use of proceeds.
RP Financial considered the P/B approach to be a valuable
indicator of pro forma value taking into account the pricing
ratios under the P/E and P/A approaches. We have also modified
the P/B approach to exclude the impact of intangible assets
(i.e., price/tangible book value or "P/TB"), in that the
investment community frequently makes this adjustment in its
evaluation of this pricing approach.
o P/A APPROACH. P/A ratios are generally a less reliable
indicator of market value, as investors typically assign less
weight to assets and attribute greater weight to book value
and earnings - we have also given less weight to the assets
approach. Furthermore, this approach as set forth in the
regulatory valuation guidelines does not take into account the
amount of stock purchases funded by deposit withdrawals, thus
understating the pro forma P/A ratio. At the same time, the
P/A ratio is an indicator of franchise value, and, in the case
of highly capitalized institutions, high P/A ratios may limit
the investment community's willingness to pay market multiples
for earnings or book value when ROE is expected to be low.
The Bank will adopt Statement of Position ("SOP") 93-6, which will
cause earnings per share computations to be based on shares issued and
outstanding excluding unreleased ESOP shares. For purposes of preparing the pro
forma pricing analyses, we have reflected all shares issued in the offering,
including all ESOP shares, to capture the full dilutive impact, particularly
since the ESOP shares are economically dilutive, receive dividends and can be
voted. However, we did consider the impact of the adoption of SOP 93-6 in the
valuation.
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PAGE 4.26
Based on the application of the three valuation approaches, taking into
consideration the valuation adjustments discussed above, RP Financial concluded
that, as of June 8, 2001, the pro forma market value of Peoples Federal's
conversion stock, including the stock issued to the Foundation, was $11,730,000
at the midpoint, equal to 1,173,000 shares at $10.00 per share.
1. PRICE-TO-EARNINGS ("P/E"). The application of the P/E valuation
method requires calculating the Bank's pro forma market value by applying a
valuation P/E multiple to the pro forma earnings base. In applying this
technique, we considered both reported earnings and a recurring earnings base,
that is, earnings adjusted to exclude any one-time non-operating items, plus the
estimated after-tax earnings benefit of the reinvestment of the net proceeds.
The Bank's reported earnings equaled $767,000 for the twelve months ended March
31, 2001. In deriving Peoples Federal's core earnings, the only adjustments made
to reported earnings were to eliminate gains on the sale of investment
securities and real estate owned and the non-recurring expense related to the
establishment of the deferred compensation plan. The gains totaled $349,000,
while the expense of the deferred compensation plan less the ongoing expense of
maintaining the plan equaled $566,000 ($611,000 net of the $45,000 ongoing
expense of the plan). As shown below, on a tax effected basis, assuming an
effective marginal tax rate of 40.0 percent for the gains and non-recurring
expense eliminated, the Bank's core earnings were determined to equal $898,000
for the twelve months ended March 31, 2001. (Note: see Exhibit IV-9 for the
adjustments applied to the Peer Group's earnings in the calculation of core
earnings).
AMOUNT
------
($000)
Net income $767
Non-recurring compensation expense(1) 340
Gain on sale of investments and REO(1) (209)
-----
Core earnings estimate $898
(1) Tax effected at 40.0 percent.
Based on the Bank's reported and estimated core earnings, and
incorporating the impact of the pro forma assumptions discussed previously, the
Bank's pro forma reported and core P/E
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PAGE 4.27
multiples at the $11.7 million midpoint value equaled 13.07 times and 11.41
times, respectively, which provided for discounts of 15.3 percent and 24.6
percent relative to the Peer Group's average reported and core earnings
multiples of 15.44 times and 15.13 times, respectively (see Table 4.4). The
discounted earnings multiples are consistent with the previously indicated
valuation adjustments.
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PAGE 4.28
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PAGE 4.29
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PAGE 4.30
2. PRICE-TO-BOOK ("P/B"). The application of the P/B valuation method
requires calculating the Bank's pro forma market value by applying a valuation
P/B ratio to Peoples Federal's pro forma book value. The pre-conversion reported
book value for Peoples Federal equaled $13.6 million and consisted entirely of
tangible capital. Based on the $11.7 million midpoint valuation, Peoples
Federal's pro forma P/B and P/TB ratios both equaled 50.34 percent. In
comparison to the average P/B and P/TB ratios for the Peer Group of 83.68
percent and 84.70 percent, respectively, the Bank's ratios reflected a discount
of 39.8 percent on a P/B basis and a discount of 40.6 percent on a P/TB basis.
RP Financial considered the discounts under the P/B approach to be reasonable in
light of the valuation adjustments referenced earlier and the Bank's resulting
P/E and core P/E multiples.
3. PRICE-TO-ASSETS ("P/A"). The P/A valuation methodology determines
market value by applying a valuation P/A ratio to the Bank's pro forma asset
base, conservatively assuming no deposit withdrawals are made to fund stock
purchases. In all likelihood there will be deposit withdrawals, which results in
understating the pro forma P/A ratio which is computed herein. At the midpoint
of the valuation range, Peoples Federal's value equaled 9.53 percent of pro
forma assets. Comparatively, the Peer Group companies exhibited an average P/A
ratio of 11.68 percent, which implies an 18.4 percent discount has been applied
to the Bank's pro forma P/A ratio.
COMPARISON TO RECENT CONVERSIONS
As indicated at the beginning of this chapter, RP Financial's analysis
of recent conversion pricing characteristics at closing and in the aftermarket
has been limited to a "technical" analysis and, thus, the pricing
characteristics of recent standard conversions are not the primary determinate
of value herein. Particular focus was placed on the P/TB approach in this
analysis, since the P/E multiples do not reflect the actual impact of
reinvestment and the source of the stock proceeds (i.e., external funds vs.
deposit withdrawals). The recent standard conversions on average closed at a
price/tangible book ratio of 54.1 percent (see Table 4.2). In comparison, the
Bank's P/TB ratio at the appraised midpoint value reflects a discount of 17.0
percent relative to
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PAGE 4.31
the average closing P/TB ratio of the recent standard conversion offerings. In
comparison to the average current aftermarket P/TB ratio of the recent standard
conversions (79.32 percent), the Bank's P/TB ratio at the appraised midpoint
value reflects a discount of 36.5 percent.
VALUATION CONCLUSION
Based on the foregoing, it is our opinion that, as of June 8, 2001, the
estimated aggregate pro forma market value of the shares to be issued
immediately following the conversion, including the 2.0 percent of the shares to
be issued to the Foundation was $11,730,000 at the midpoint. Pursuant to
conversion guidelines, the 15 percent offering range indicates a minimum value
of $9,970,500 and a maximum value of $13,489,500. Based on the $10.00 per share
offering price, this valuation range equates to an offering of 997,050 at the
minimum and 1,348,950 at the maximum. In the event the appraised value is
subject to an increase, the offering range may be increased up to a super
maximum value of $15,512,930 without requiring a resolicitation.
Based on this valuation range, the offering range is as follows:
$9,775,000 at the minimum, $11,500,000 at the midpoint, $13,225,000 at the
maximum and $15,208,750 at the top of the super maximum. Based on a $10.00 per
share offering price, the number of offering shares is as follows: 977,500 at
the minimum, 1,150,000 at the midpoint, 1,322,500 at the maximum and 1,520,875
at the top of the super maximum. The comparative pro forma valuation
calculations relative to the Peer Group are shown in Table 4.4 and are detailed
in Exhibit IV-7 and Exhibit IV-8.