Item 1. Business
General
Peoples Bancorp (the "Company") is an Indiana corporation organized in October 1990 to become the thrift holding company for Peoples Federal Savings Bank of DeKalb County (the "Bank" or "Peoples Federal"). The Company is the sole shareholder of Peoples Federal. The Bank conducts business from its main office in Auburn and its seven full-service offices located in Avilla, Columbia City, Garrett, Kendallville, LaGrange, and Waterloo, Indiana. Peoples Federal offers a full range of retail deposit services and lending services to northeastern Indiana. The Company has no other business activity other than being the holding company for Peoples Federal.
The Bank was founded in 1925 and chartered by the Federal Home Loan Bank Board ("FHLBB"), now the Office of Thrift Supervision ("OTS"), in 1937. Since that time, the Bank has been a member of the Federal Home Loan Bank System ("FHLB System") and the Federal Home Loan Bank of Indianapolis ("FHLB of Indianapolis"), and its savings accounts are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF"), as administered by the Federal Deposit Insurance Corporation (the "FDIC").
The Company is a unitary savings and loan holding company subject to regulation by the OTS. The Company's securities are registered with the Securities and Exchange Commission ("SEC") pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act"). As such, the Company is subject to the information, proxy solicitation, insider trading, and other restrictions and requirements of the Exchange Act.
In May 1997, the Board authorized a stock repurchase program. Purchases of up to 240,000 shares may be made in open market or in privately negotiated transactions. As of September 30, 1999, the Company had repurchased 233,925 shares.
On a yearly basis, Peoples Federal updates its long-term strategic plan. This plan includes, among other things, Peoples Federal's commitment to maintaining a strong capital base and continuing to improve the organization's return on assets through asset growth and controlling operating expenses. Continued careful monitoring of Peoples Federal's interest rate risk is also cited as an important goal. As a result, continued origination of short-term consumer and installment loans, prime plus equity loans, adjustable rate mortgage loans, and fixed-rate real estate loans with original terms of 15 years or less will be emphasized.
The Bank offers a wide range of consumer and commercial financial services. These services include: consumer demand deposit accounts; NOW accounts; regular and term savings accounts and savings certificates; residential and commercial real estate loans; and secured and unsecured consumer loans. During 1999, the Bank added agricultural and commercial lending officers to its staff. Since these loans typically yield higher returns than traditional mortgage lending and are for shorter terms, it is expected that these loans will assist the Bank in managing its interest rate risk, and increase overall profitability. The Bank provides these services through a branch network comprised of eight full-service banking offices. It also provides credit card services, as well as enhancements to its loan and deposit products designed to provide customers with added conveniences. The Bank has historically concentrated its business activities in northeastern Indiana. The Bank's current strategy is to maintain its branch office network as well as remain alert to new opportunities.
Over the years, the Bank has broadened its product line and enhanced its operations in order to accommodate its growth and to meet the vigorous competition from various financial institutions and other companies or firms that engage in similar activities.
The Thrift Industry
Thrift institutions are financial intermediaries which historically have accepted savings deposits from the general public and, to a lesser extent, borrowed funds from outside sources and invested those deposits and funds
primarily in loans secured by first mortgage liens on residential and other types of real estate. Such institutions may also invest their funds in various types of short- and long-term securities. The deposits of thrift institutions are insured by the SAIF as administered by the FDIC, and these institutions are subject to extensive regulations. These regulations govern, among other things, the lending and other investment powers of thrift institutions, including the terms of mortgage instruments these institutions are permitted to utilize, the types of deposits they are permitted to accept, and reserve requirements.
The operations of thrift institutions, including those of the Bank, are significantly affected by general economic conditions and by related monetary and fiscal policies of the federal government and regulations and policies of financial institution regulatory authorities, including the Board of Governors of the Federal Reserve System and the OTS. Lending activities are influenced by a number of factors including the demand for housing, conditions in the construction industry, and availability of funds. Sources of funds for lending activities include savings deposits, loan principal payments, proceeds from sales of loans, and borrowings from the Federal Home Loan Banks and other sources. Savings flows at thrift institutions are influenced by a number of factors including interest rates on competing investments and levels of personal income.
Earnings
The Bank's earnings depend primarily on the difference between income from interest-earning assets such as loans and investments, and interest paid on interest-bearing liabilities such as deposits and borrowings. The Bank typically engages in long-term mortgage lending at fixed rates of interest, generally for periods of up to 30 years, while accepting deposits for considerably shorter periods.
Generally, rapidly rising interest rates cause the cost of interest-bearing liabilities to increase more rapidly than yields on interest-earning assets, thereby adversely affecting the earnings of many thrift institutions. While the industry has received expanded lending and borrowing powers in recent years permitting different types of investments and mortgage loans, including those with floating or adjustable rates and those with shorter terms, earnings and operations are still highly influenced by levels of interest rates and financial market conditions and by substantial investments in long-term mortgage loans.
Competition
The Bank experiences strong competition both in making real estate loans and in attracting savings deposits. The Bank competes for real estate loans with commercial banks, mortgage banking companies, insurance companies, and other institutional lenders. The most direct competition for savings comes from other thrift institutions, mutual savings banks, commercial banks and credit unions. During periods of generally high interest rates, additional significant competition for savings accounts comes from corporate and government securities as well as money market mutual funds. The principal methods generally used by the Bank to attract deposit accounts include: competitive interest rates, advertising, providing a variety of financial services, convenient office locations, flexible hours for the public, and promotions for opening or adding to deposit accounts.
Net Interest Income
Net interest income increases during periods when the spread is widened between the Bank's weighted average rate at which new loans are originated and the weighted average cost of interest-bearing liabilities. The Bank's ability to originate loans is affected by market factors such as interest rates, competition, consumer preferences, the supply of and demand for housing, and the availability of funds.
The Bank has supplemented its interest income through purchases of investments when appropriate. This activity generates positive interest rate spreads on large principal balances with minimal administrative expense.
Interest Rate and Volume of Interest-Related Assets and Liabilities
Both changes in rate and changes in the composition of the Bank's interest-earning assets and interest-bearing liabilities can have a significant effect on net interest income.
For information regarding the total dollar amount of interest income from interest-earning assets, the average yields, the amount of interest expense from interest-bearing liabilities and the average rate, net interest income, interest rate spread, and the net yield on interest-earning assets, refer to page 12 of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 1999 Annual Report, incorporated herein by reference.
For information regarding the combined weighted average effective interest rate earned by the Bank on its loan portfolio and investments, the combined weighted average effective cost of the Bank's deposits and borrowings, the interest rate spread of the Bank, and the net yield on combined monthly weighted average interest-earning assets of the Bank on its loan portfolio and investments for the fiscal years ending September 30, 1999, 1998, and 1997 refer to page 9 of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 1999 Annual Report incorporated herein by reference.
For information concerning the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected the Bank's interest income and expense during the fiscal years ending September 30, 1999, 1998, and 1997 refer to page 13 of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 1999 Annual Report incorporated herein by reference.
Market Area
The Bank's market area in northeastern Indiana spans the counties of DeKalb, Whitley, Noble, and LaGrange. This market area has a population of approximately 145,000 and consists of a diversified industrial economic base with an emphasis on the production sector that includes major manufacturers of international scope. Moreover, the distribution sector, primarily in the wholesale and retail trades, constitutes a substantial portion of the area's economy, both in terms of product mix, sales receipts, and employment. The most rapid growth has occurred in the manufacturing sector, especially in the production of automotive and electronics products, and in the service sector with respect to packaging, warehousing, and distribution services.
Lending Activities
General
The Bank has attempted to emphasize investments in adjustable-rate residential mortgages and consumer loans in its market area. In order to lessen its risk from interest rate fluctuations, the Bank emphasizes the origination of interest rate sensitive loan products, such as one-year adjustable-rate mortgage loans, and prime plus equity loans. However, during the recent low interest rate market, customers preferred fixed rate products. The Bank reacted to this trend by offering a new mortgage product of a seven-year fixed rate loan, which converts to a one-year adjustable product at the end of the seventh year. In this way, the Bank offered a fixed rate product to satisfy the customer demand, but is not locked into low interest rates for a long period of time. These loans show on the various charts in this 10-K as fixed rate product, since according to regulatory treatment, they are considered fixed rate until the repricing period is below five years. Since this was a new product last year, none of these loans is currently considered adjustable rate for regulatory reporting purposes.
Residential Mortgage Loans
A substantial portion of the Bank's lending activity involves the origination of loans secured by residential real estate, consisting of single-family dwelling units. The Bank also lends on the security of mid-size multifamily dwelling units. The residential mortgage loans included in the Bank's portfolio are primarily conventional fixed-rate loans with a maturity of up to 30 years.
The Bank also offers adjustable-rate mortgage loans. Currently, these loans generally have interest rates that adjust (up or down) every year. Generally, these loans provide for a maximum adjustment of 6% over the life of the loans with a maximum adjustment of 2% during any given year. Adjustments are based upon an index established at the time the commitment is issued by the Bank. The index used for most loans is tied to the applicable United States Treasury security index. While adjustable-rate mortgage loans assist the Bank in maintaining a positive spread during periods of high interest rates, it is not expected that adjustments in interest rates on adjustable-rate mortgages will match precisely changes in the Bank's cost of funds. The majority of the adjustable rate mortgages originated by the Bank have limitations on the amount (generally 6%) and frequency of interest rate changes.
During the fiscal year ended September 30, 1999, the Bank originated $127,435,000 of residential loans of which $79,917,000 was five- to 30-year fixed-rate mortgages and $47,518,000 was adjustable-rate loans. The rates offered on the Bank's adjustable-rate residential mortgage loans are generally competitive with the rates offered by other thrift institutions in the Bank's market area and are based upon the Bank's cost of funds and the rate of return the Bank can receive on comparable investments. Fixed-rate loans are originated only under terms and conditions and using documentation which would permit their sale in the secondary market and at rates which are generally competitive with rates offered by other financial institutions in the Bank's market area.
Set forth below is the amounts and percentages of fixed-rate and adjustable-rate loans (which include consumer loans) in the Bank's portfolio at September 30, 1999, 1998, and 1997 (Dollars in thousands).
September 30, ------------------------------------------------------------ 1999 1998 1997 -------------------- ------------------- ------------------- Fixed Adjustable Fixed Adjustable Fixed Adjustable -------- ----------- -------- ---------- -------- ---------- $259,133 $42,443 $225,270 $46,740 $180,631 $59,025 85.9% 14.1% 82.8% 17.2% 75.4% 24.6%
The terms of the residential loans originated by the Bank range from one to 30 years. Experience during recent years reveals that as a result of prepayments in connection with refinancings and sales of the underlying properties, residential loans generally remain outstanding for periods substantially shorter than maturity of the loan contracts. At September 30, 1999, the average contractual maturity of the Bank's portfolio of fixed-rate loans was 10 years and 3 months, and 15 years and 3 months with respect to its portfolio of adjustable-rate loans.
Substantially all of the Bank's residential mortgages include so-called "due on sale" clauses, which are provisions giving the Bank the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property subject to the mortgage, and the loan is not repaid.
Generally, the Bank will not lend more than 80% of the appraised value of a residential property which is owner occupied unless the borrower obtains private mortgage insurance reducing the uninsured portion of the loan to 72% of the appraised value. If private mortgage insurance is obtained, the Bank's policy is to lend up to 90% of the appraised value of the property securing the loan. The Bank applies the same standards to residential loans purchased in the secondary market.
Commercial Real Estate Loans
The Bank also originates commercial real estate loans. From September 30, 1998, to September 30, 1999, commercial real estate loans increased from $10,411,049 to $13,167,996, with the percentage of commercial real estate loans to total loans increasing from 3.80% to 4.30%. These loans consisted of construction and permanent loans secured by mortgages on mid-size commercial real estate. The terms of commercial real estate loans vary from loan to loan but are usually five-year adjustable-rate loans with terms of 20 to 25 years. The loan-to-value ratio of commercial real estate loans is generally 75% or less.
Generally, commercial real estate loans involve greater risk to the Bank than do residential loans but usually provide for a higher rate of interest and increased fee income than do residential loans. Commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of the related project and thus may be subject to a great extent to adverse conditions in the real estate market or in the economy generally.
Construction Loans
The Bank offers residential construction loans both to owner-occupants and to persons building residential property. Construction loans are usually offered with fixed rates of interest during construction. Generally, construction loans have terms ranging from six to 12 months at fixed rates over the construction period. Practically all residential construction loans are written so as to become permanent loans at the end of the construction period.
Construction loans involve greater underwriting and default risks to the Bank than do loans secured by mortgages on existing properties. Loan funds are advanced upon the security of the project under construction, which is more difficult to value prior to the completion of construction. Moreover, because of the uncertainties inherent in estimating construction costs, it is relatively difficult to evaluate accurately the total loan funds required to complete a project and the related loan-to-value ratios. Should a default occur which results in foreclosure, the Bank could be negatively impacted in that it would have to take control of the project and attempt either to arrange for completion of construction or dispose of the unfinished project.
The Bank's underwriting criteria are designed to evaluate and minimize the risks of each construction loan. The Bank carefully considers a wide variety of factors before originating a construction loan, including the availability of permanent financing or a takeout commitment to the borrower (which may be provided by the Bank at market rates); the reputation of the borrower and the contractor; independent valuations and reviews of cost estimates; pre-construction sale information; and cash flow projections of the borrower. Inspections of construction sites are made by the Bank on a timely basis to verify progress made to date as a further reinforcement of its conservative lending policy. To reduce the risks inherent in construction lending, the Bank limits the number of properties that can be constructed on a "speculative" or unsold basis by a developer at any one time and generally requires the borrower or its principals to personally guarantee repayment of the loan.
Consumer and Other Loans
Federal laws and regulations permit a federally-chartered savings institution to make secured and unsecured consumer loans including home equity loans (loans secured by the equity in the borrower's residence, but not necessarily for the purpose of improvement), home improvement loans (loans secured by a residential second mortgage), loans secured by deposit accounts, educational loans (insured by the State Student Loan Commission of Indiana), and credit card loans (unsecured). The Bank offers all of these types of loans and is currently emphasizing home equity loans to take advantage of the adjustable interest rate feature of this loan versus the mortgage product. These loans also carry a higher rate of interest than conventional mortgages, thereby increasing the profit potential while reducing the interest rate risk.
Loan Portfolio Cash Flows
The following table sets forth the estimated maturity of the Bank's loan portfolio by type of loan at September 30, 1999. The estimated maturity reflects contractual terms at September 30, 1999. Contractual principal repayments of loans do not necessarily reflect the actual term of the Bank's loan portfolio. The average life of mortgage loans is substantially less than their contractual terms because of loan prepayments and because of enforcement of "due on sale" clauses. The average life of mortgage loans tends to increase, however, when current mortgage loan rates substantially exceed rates on existing mortgage loans.
Due in One Year Due After One Year Through Five or Less Five Years Years Total --------- ---------- ---------- ---------- (In thousands) Type of Loan: Construction loans -- residential real estate $ 6,998 $ - $ - $ 6,998 Real estate loans: Mortgage-residential 34,294 56,385 169,917 260,596 Commercial 866 9,256 3,046 13,168 Installment loans -- consumer 11,343 5,376 744 17,463 commercial 1,424 1,825 102 3,351 --------- ---------- ---------- ---------- Total $54,925 $72,842 $173,809 $301,576 ========= ========== ========== ==========
The following table sets forth the total amount of loans due after one year from September 30, 1999, which have a fixed rate or an adjustable rate. (Dollars in thousands)
Loans Due October 1, 2000 and thereafter - -------------------------------------- Fixed Adjustable Total at September 30, 1999 - ------------- ----------------------- ----------------------------------------- $162,474 $84,177 $246,651
Loan Portfolio Composition
The following table sets forth the composition of the Bank's loan portfolio by type of loan at the dates indicated. The table includes a reconciliation of total net loans receivable, after consideration of undisbursed Portion of loans, deferred loan fees and discounts, and allowance for losses on loans.
Origination, Purchase and Sale of Loans and Loan Concentrations
The Bank originates residential loans in conformity with standard underwriting criteria to assure maximum eligibility for possible resale in the secondary market. Although the Bank has authority to lend anywhere in the United States, it has confined its loan origination activities primarily in the Bank's service area.
Loan originations are developed from a number of sources, primarily from referrals from real estate brokers, builders, and existing and walk-in customers. The Bank also utilizes the services of a loan broker located in Fort Wayne, Indiana, who is paid on a commission basis (generally 1% of the loan amount) to originate loans for the Bank.
The Bank's mortgage loan approval process is intended to assess the borrower's ability to repay the loan, the viability of the loan, and the adequacy of the value of the property that will secure the loan. The loan committee of the Bank can approve residential and commercial loans ranging up to $200,000. The Bank's Board of Directors must approve loans exceeding $200,000. The Bank utilizes independent qualified appraisers approved by the Board of Directors to appraise the properties securing its loans and requires title insurance or title opinions so as to insure that the Bank has a valid lien on the mortgaged real estate. The Bank requires borrowers to maintain fire and casualty insurance on its secured properties.
The procedure for approval of construction loans is the same as for residential mortgage loans, except that the appraiser evaluates the building plans, construction specifications, and estimates of construction costs. The Bank also evaluates the feasibility of the proposed construction project and the experience and track record of the developer. In addition, all construction
loans generally require a commitment from a third-party lender or from the Bank for a permanent long-term loan to replace the construction loan upon completion of construction.
Consumer loans are underwritten on the basis of the borrower's credit history and an analysis of the borrower's income and expenses, ability to repay the loan, and the value of the collateral, if any. A consumer loan officer must approve consumer loans. Consumer loan originations currently are being generated primarily through advertising.
Currently, it is the Bank's policy to originate both fixed-rate and adjustable-rate loans, providing all such loans are eligible for sale in the secondary market. It is the Bank's intention to hold all originated and purchased loans in its portfolio and not for sale. Generally, the Bank is not active in the secondary market.
The following table shows mortgage and other loan origination, purchase, and repayment activity for the Bank during the periods indicated:
Years Ended September 30 ----------------------------- 1999 1998 1997 --------- --------- --------- (Dollars in thousands) Mortgage loans originated for the purpose of: Construction-commercial $ - $ 1,425 - Construction-residential 10,080 8,386 9,120 Purchase/refinance-commercial 2,325 2,324 618 Purchase/refinance-residential 92,772 82,553 53,374 Consumer and other loans originated 22,258 14,463 9,462 --------- --------- --------- Total loans originated 127,435 109,151 72,574 --------- --------- --------- Loans purchased - - - --------- --------- --------- 127,435 109,151 72,574 --------- --------- --------- Loan credits: Principal repayments 97,440 77,980 60,368 --------- --------- --------- Other: Provision for losses on loans 89 75 50 Amortization of loan fees (426) (380) (271) Loan foreclosures, net 121 73 183 --------- --------- --------- (216 (232) (38) --------- --------- ---------
Total credits, net 97,224 77,748 60,330 --------- --------- --------- Net increases in mortgage and other loans receivable, net $ 30,211 $ 31,403 $ 12,244 ========= ========= =========
Interest Rates, Points and Fees
The Bank realizes interest, point, and fee income from its lending activities. The Bank also realizes income from commitment fees for making commitments to originate loans, from prepayment and late charges, loan fees, application fees, and fees for other miscellaneous services.
The Bank accounts for loan origination fees in accordance with the Statement of Financial Accounting Standards on Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans ("SFAS No. 91") issued by the Financial Accounting Standards Board (the "FASB"). SFAS No. 91 prohibits the immediate recognition of loan origination fees as revenues and requires that such income (net of certain direct loan origination costs) for each loan be
amortized, generally by the interest method, over the estimated life of the loan as an adjustment of yield.
Nonperforming Assets
Loans are reviewed on a regular basis and are generally placed on nonaccrual status when the loans become past due 90 days or more, or when, in the judgment of management, the probability of collection is deemed to be insufficient to warrant further accrual. When a loan is placed on a nonaccrual status, previously accrued but unpaid interest is deducted from interest income. When the Bank is unable to resolve a delinquency satisfactorily within 45 days after the loan is past due, it will undertake foreclosure or other proceedings, as necessary, to minimize any potential loss.
Real estate acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as "real estate owned" until it is sold. When property is so acquired, it is recorded at the lower of loan balance or fair market value at the date of acquisition. Periodically, real estate owned is reviewed to ensure that net realizable value is not less than carrying value, and any allowance resulting there from is charged to operations as a provision for loss on real estate owned. All costs incurred in maintaining the property from the date of acquisition are expensed.
The following table reflects the amount of loans in delinquent status as of the dates indicated:
Loans Delinquent For --------------------------------------------------------------------- 30-59 Days 60-89 Days 90 Days and Over ------------------------ ---------------------- --------------------- Percent Percent Percent of Loan of Loan of Loan Number Amount Category Number Amount Category Number Amount Category ------- ------ -------- ------ ------ -------- ------ ------ -------- Real estate: (Dollars in thousands) One to four 15 $587 0.22% 2 $ 75 0.03% 23 $454 0.17% family Consumer 6 21 0.10% 5 28 0.13% 5 27 0.13% ------- ------ ------ ------ ----- ------- Total 21 $608 0.20% 7 $103 0.03% 28 $481 0.16% ======= ====== ====== ====== ===== =======
The following table sets forth the Bank's nonperforming assets at the dates indicated:
At September 30, ----------------------------------- 1999 1998 1997 1996 1995 ------ ------ ------ ------- ------ (Dollars in thousands) Nonaccrual loans $474 $729 $658 $ 814 $765 Loans past due 90 days and still accruing 64 23 64 88 99 ------ ------ ------ -------- ------ 538 752 722 902 864 Real estate owned, net of allowance - - - 110 47 ------ ------ ------ -------- ------ Total nonperforming assets $538 $752 $722 $1,012 $911 ====== ====== ====== ======== ======
Consumer loans are placed on n generally when the loan exceeds 90 days delinquent or if, in the opinion of management, the possibility of collecting the loan becomes questionable. Mortgage loans are placed on
nonaccrual generally when the loan exceeds 90 days delinquent; however, if the loan is below a 25% loan-to-value, management may at their option decide to accrue interest on the loan, since collection of the loan appears highly likely.
Interest income that would have been recognized for the year ended September 30, 1999, if nonaccrual loans had been current in accordance with their original terms, approximated $39,000. Interest income recognized on such loans for the year ended September 30, 1999, approximated $23,000. At September 30, 1999, the Bank had no loans that were deemed impaired in accordance with Statement of Financial Accounting Standards No. 114.
Federal regulations require savings associations to review their assets on a regular basis and to classify them as: special mention; substandard; doubtful and loss. Loans classified as special mention, are loans which currently do not expose the Bank to an unusual risk of loss but based on information available require the attention of management. This classification usually includes loans secured by unusual collateral, loans with documentary items that are being addressed by counsel, and relatively large loans where the borrower has had a history of delinquent payments and the collateral has a cashflow shortfall, however, the borrower has continued to service the debt.
Loans classified as substandard or doubtful generally represent balances where the borrower has made several late payments and is unable to bring the loan current. Substandard loans generally represent situations where the borrower is attempting to resolve the delinquency in the normal course of business (i.e., sale of the property or infusion of additional capital). Loans classified as doubtful represent situations where the borrower has been unsuccessful in attempts to resolve the delinquency in the normal course of business. Doubtful loans involve a greater degree of uncertainty regarding estimate of loss.
Loans classified as loss represent situations where the loan is severely delinquent. These loans typically involve extensive bankruptcy proceedings or other unusual circumstances where the debtor contests foreclosure.
Loans classified as special mention; substandard or doubtful do not necessarily require specific reserves. Individual loan balances may be classified in one or more categories based on management's analysis and estimate of the risk underlying each individual situation.
In accordance with the federal regulations, Management continually reviews the mix and delinquency status of its loan portfolio and classifies those loans, which it deems appropriate.
As of September 30, 1999, loan balances were classified by the Bank as follows:
Loss $ 26,140 Doubtful -0- Substandard 939,705 Special Mention 590,433
Allowance for Losses on Loans and Real Estate Owned
The allowances for loan and real estate owned losses represent amounts available to absorb inherent losses in the loan portfolio. Such allowances are based on management's continuing review of the portfolios, historical charge-offs, current economic conditions, and such other factors, which in management's judgment deserve recognition in estimating possible losses. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require additions to the allowances based on their judgment about the information available to them at the time of their examination. Provisions for losses are charged to earnings to bring the allowances to levels considered necessary by management. Losses are charged to the allowances when considered probable. As of September 30, 1999, the allowances for losses on loans and real estate owned were $1,005,119 and $-0- respectively. Management believes that the allowances are adequate to absorb known and inherent losses in the portfolio. No assurance can be given, however, that economic conditions which may adversely affect the Bank's markets or other circumstances will not result in additions to the allowance for loan losses.
The following table presents an allocation of the Bank's allowance for loan losses at the dates indicated and the percentage of loans in each category to total loans.
The following table is a summary of activity in the Bank's allowance for loan losses for the periods indicated.
Summary of Loan Loss Experience Years ended September 30, ------------------------------------- (Dollars in Thousands) 1999 1998 1997 1996 1995 ------- ------ ------ ------ -------- Balance of loan loss allowance at beginning of year $ 947 $886 $887 $912 $1,034 Charge-offs Residential - - - - 153 Commercial real estate - - - - - Commercial - - - - - Consumer 53 47 84 55 47 ------- ------ ------ ------ ------- Total Charge-offs 53 47 84 55 200 ------- ------ ------ ------ ------- Recoveries Residential - - - - - Consumer 22 33 33 21 28 ------- ------ ------ ------ ------- Total Recoveries 22 33 33 21 28 ------- ------ ------ ------ ------- Net Charge-offs (Recoveries) 31 14 51 34 172 Provision for loan losses 89 75 50 9 50 ------- ------ ------ ------ ------- Balance of loan loss allowance at end of year $1,005 $947 $886 $887 $ 912 ======= ====== ====== ====== ======= Ratio of net charge-offs to average loans outstanding 0.01% 0.01% 0.02% 0.02% 0.08%
Investment Activities
Federal thrift institutions have authority to invest in various types of liquid assets, including United States Treasury obligations and securities of various federal agencies, certificates of deposit at insured banks, bankers' acceptances and federal funds. As a member of the FHLB System, the Bank must maintain minimum levels of liquid assets specified by the OTS, which vary from time to time. Subject to various regulatory restrictions, federal thrift institutions may also invest a portion of their assets in certain commercial paper, corporate debt securities and mutual funds whose assets conform to the investments that a federal thrift institution is authorized to make directly. At September 30, 1999, the Bank's ratio of liquid assets to total assets was 6.0%, which exceeds the regulatory requirement.
The carrying values of the Bank's investment securities, including its liquid assets, as of the dates indicated are presented in the following table.
At September 30, ---------------------------------- 1999 1998 1997 --------- ---------- ----------- Interest-bearing deposits and (Dollars in thousands) certificates of deposit (1) $ 834 $ 718 $ 8,715 U.S. government and federal agency securities Held to maturity - 4,000 8,000 Available for sale 7,139 11,287 19,822 Mortgage backed securities Held to Maturity 258 372 499 Stock in FHLB of Indianapolis 2,474 2,218 2,062 Other Held to maturity 610 696 758 Available for sale(2) 9,793 10,591 8,646 --------- --------- --------- Total investments $21,108 $29,882 $48,502 ========= ========= ========= - ------------------------------------------------ (1) In FHLB of Indianapolis at September 30, 1999; In insured certificates of deposit at September 30, 1998; In FHLB of Indianpolis ($7,739) and insured certificates of deposit ($976) at September 30, 1997; (2) Van Kampen Prime Income Fund $3,677, Van Kampen Senior Income Trust $1,617, State and Municipal obligations $4,500 at September 30, 1999; Van Kampen Prime Income Fund $3,784, Van Kampen Senior Income Trust $1,677, State and Municipal obligations $5,130 at September 30, 1998; Van Kampen Prime Income Fund $2,564, State and Municipal obligations $6,082 at September 30, 1997.
The following table sets forth information regarding the maturity distribution of investment securities at September 30, 1999, and the weighted average yield on those securities.
Sources of Funds
General
Deposits have traditionally been the primary source of funds of the Bank for use in lending and investment activities. In addition to deposits, the Bank derives funds from loan prepayments and income on earning assets. While income on earning assets is a relatively stable source of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, money market conditions, and levels of competition.
Deposits
Deposits are attracted principally from within the Bank's primary market area through the offering of a variety of deposit instruments, including passbook and statement accounts and certificates of deposit ranging in terms from three months to five years. Deposit account terms vary, principally on the basis of the minimum balance required, the time periods the funds must remain on deposit and the interest rate. The Bank also offers individual retirement accounts ("IRA's").
The Bank's policies are designed primarily to attract deposits from local residents rather than to solicit deposits from areas outside its primary market. The Bank does not accept deposits from brokers due to the volatility and rate sensitivity of such deposits. Interest rates paid, maturity terms, service fees and withdrawal penalties are established by the Bank on a periodic basis. Determination of rates and terms are predicated upon funds acquisition and liquidity requirements, rates paid by competitors, growth goals and federal regulations.
A major determinant of the Bank's average cost of funds is the distribution of the Bank's accounts by interest rate paid. An important indicator of the Bank's stability of lendable funds is the distribution of the Bank's accounts by maturity.
For information on the various interest rate categories, the amounts of certificate accounts at September 30, 1999, maturing during the next five years and thereafter see the Notes to Consolidated Financial Statements in the Company's 1999 Annual Report.
The following table lists maturities of certificates of deposits where the balance of the certificate exceeds $100,000 for the periods indicated. None of these certificates were brokered deposits.
At September 30, ---------------- ------------ 3 months or less $ 4,321 3-6 months 5,871 6-12 months 4,849 over 12 months 5,779 ---------- Total $20,820 ==========
Borrowings
As a member of the FHLB System and the FHLB of Indianapolis, the Bank is eligible to arrange borrowings or advances for various purposes and on various terms. As of September 30, 1999 and 1998 the Bank had outstanding advances to the FHLB of Indianapolis of $7,200,000 and $5,000,000. The Bank had no outstanding advances as of September 30, 1997. Of the $7,200,000 outstanding at September 30, 1999, $5,000,000 was long-term debt. See page 25 of the annual report to stockholders for the maturity breakdown of these long-term instruments.
Reverse repurchase agreements, another source of borrowing for the Bank, are retail obligations of the Bank with a maturity of 90 days or less, and are generally secured with specific investment securities owned by the Bank.
The following tables set forth certain information as to the Bank's short-term borrowings consisting of FHLB of Indianapolis advances and reverse repurchase agreements for the periods and at the dates indicated. Average balances and average interest rates are based on month-end balances.
Years Ended September 30 ------------------------- 1999 1998 1997 ------- ------- --------- (Dollars in thousands) Average balance of short-term borrowings $3,533 $4,166 $2,412 Highest month-end balance of total borrowings 4,417 5,088 3,293 Weighted average interest rate of total borrowings 5.28% 5.21% 4.85%
At September 30 ------------------------- 1999 1998 1997 Federal Home Loan Bank advances $2,200 $ - $ - Reverse Repurchase agreements 3,040 4,203 3,162 ------- ------- -------- Total short-term borrowings $5,240 $4,203 $3,162 ======= ======= =========
Weighted average interest rate 6.33% 5.22% 5.31%
Trust Department and Discount Brokerage Services
In October 1984, the FHLB of Indianapolis granted full trust powers to the Bank, one of the first savings institutions in Indiana to be granted such powers. As of September 30, 1999, the Bank's trust department assets totaled approximately $44,372,000 including self-directed Individual Retirement Accounts ("IRA's"), and it was offering a variety of trust services including estate planning. As of that date, the trust department was administering approximately 690 trust accounts, including estates, guardianships, revocable and irrevocable trusts, testamentary trusts, and self-directed IRA accounts. The trust department also offers and administers self-directed IRA's and Simplified Employee Pension IRA's for small businesses.
Non-Bank Subsidiary
Peoples Financial Services, Inc. ("PFSI") was organized in 1977 under the laws of the State of Indiana. It is wholly owned by the Bank and conducts a general insurance business within the State of Indiana under the name of Peoples Insurance Agency. During fiscal years ended September 30, 1999 and 1998, PFSI recorded total income of $90,515 and $97,493, respectively, with net income for such periods amounting to $24,327 and $50,227, respectively.
Since 1985, the Bank also has offered discount brokerage services to its customers. In 1996, this service was moved to the service corporation and was offered through U.S. Clearing Corp. Prior to 1996, another vendor was used. This service also reduces the expenses of securities transactions for the various trust accounts administered by the trust department and provides customers with a convenient and inexpensive means of conducting brokerage transactions.
Employees
As of September 30, 1999, the Bank employed 89 persons on a full-time basis and 11 persons on a part-time basis. The Bank's employees are not represented by any collective bargaining group, and management considers its relations with its employees to be excellent.
REGULATION
General
The Company, as a savings and loan holding company, and the Bank, as a federally chartered savings association, are subject to extensive regulation by the OTS and the FDIC. The lending activities and other investments of the Bank must comply with various federal regulatory requirements, and the OTS periodically examines the Bank for compliance with various regulatory requirements and for safe and sound operations. The FDIC also has the authority to conduct examinations. The Bank must file reports with the OTS describing its activities and financial condition and is also subject to certain reserve requirements promulgated by the Board of Governors of the Federal Reserve System. This supervision and regulation is intended primarily for the protection of depositors and the deposit insurance funds and not for the protection of stockholders of the Company. Certain of these regulatory requirements are referred to below or appear elsewhere herein.
Recent Legislation
Financial Services Modernization Legislation. On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999 (the "Financial Services Modernization Act"). The Financial Services Modernization Act repeals the two affiliation provisions of the Glass-Steagall Act: Section 20, which restricted the affiliation of Federal Reserve Member Banks with firms "engaged principally" in specified securities activities; and Section 32, which restricts officer, director, or employee interlocks between a member bank and any company or person "primarily engaged" in specified securities activities. In addition, the Financial Services Modernization Act also contains provisions that expressly preempt any state law restricting the establishment of financial affiliations, primarily related to insurance. The general effect of the law is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the Bank Holding Company Act framework to permit a holding company system to engage in a full range of financial activities through a new entity known as a "Financial Holding Company." "Financial activities" is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.
The Financial Services Modernization Act provides that no company may acquire control of an insured savings association after May 4, 1999, unless that company engages, and continues to engage, only in the financial activities permissible for a Financial Holding Company, unless grandfathered as a unitary savings and loan holding company. The Financial Institution Modernization Act grandfathers any company that was a unitary savings and loan holding company on May 4, 1999 (or becomes a unitary savings and loan holding company pursuant to an application pending on that date). Such a company may continue to operate under present law as long as the company continues to meet the two tests: it can control only one savings institution, excluding supervisory acquisitions, and each such institution must meet the QTL test. It further requires that a grandfathered unitary savings and loan holding company must continue to control at least one savings association, or a successor institution, that is controlled on May 4, 1999.
The Financial Services Modernization Act also permits national banks to engage in expanded activities through the formation of financial subsidiaries. A national bank may have a subsidiary engaged in any activity authorized for national banks directly or any financial activity, except for insurance underwriting, insurance investments, real estate investment or development, or merchant banking, which may only be conducted through a subsidiary of a Financial Holding Company. Financial activities include all activities permitted under new sections of the Bank Holding Company Act of 1956 ("BHCA") or permitted by regulation.
The Company and the Bank do not believe that the Financial Services Modernization Act will have a material adverse effect on the operations of the Company and the Bank in the near-term. However, to the extent that the act permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. The Financial Services Modernization Act is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis and which unitary savings and loan holding companies already possess. Nevertheless, this act may have the result of increasing the amount of competition that the Company and the Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources that the Company and the Bank. In addition, because the Company may only be acquired by other unitary savings and loan holding companies or Financial Holding Companies, the legislation may have an anti-takeover effect by limiting the number of potential acquirors or by increasing the costs of an acquisition transaction by a bank holding company that has not made the election to be a Financial Holding Company under the new legislation.
Regulation of the Company
General. The Company is a unitary savings and loan holding company as defined by the HOLA. As such, the Company is registered with the OTS and is subject to OTS regulation, examination, supervision and reporting requirements. As a subsidiary of a savings and loan holding company, the Bank is subject to certain restrictions in its dealings with the Company and affiliates thereof. The Company also is required to file certain reports with, and otherwise comply with, the rules and regulations of the SEC under the federal securities laws.
Activities Restrictions. There are generally no restrictions on the activities of a unitary savings and loan holding company. The broad latitude to engage in activities under current law can be restricted if the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings institution, the OTS may impose such restrictions as deemed necessary to address such risk including limiting: (i) payment of dividends by the savings institution; (ii) transactions between the savings institution and its affiliates; and (iii) any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. Notwithstanding the above rules as to permissible business activities of unitary savings and loan holding companies, if the savings institution subsidiary of such a holding company fails to meet the QTL test, then such unitary holding company shall also become subject to the activities restrictions applicable to multiple holding companies and, unless the savings institution requalifies as a QTL within one year thereafter, register as, and become subject to, the restrictions applicable to a bank holding company. See "Regulation of the Bank--Qualified Thrift Lender."
Restrictions on Acquisitions. Savings and loan holding companies are prohibited from acquiring, without prior approval of the OTS, (i) control of any other savings institution or savings and loan holding company or substantially all the assets thereof or (ii) more than 5% of the voting shares of a savings institution or holding company thereof which is not a subsidiary. Under certain circumstances, a registered savings and loan holding company is permitted to acquire, with the approval of the OTS, up to 15% of the voting shares of an undercapitalized savings institution pursuant to a "qualified stock issuance" without that savings institution being deemed controlled by the holding company. In order for the shares acquired to constitute a "qualified stock issuance," the shares must consist of previously unissued stock or treasury shares, the shares must be acquired for cash, the saving and loan holding company's other subsidiaries must have tangible capital of at least 6-1/2% of total assets, there must not be more than one common director or officer between the savings and loan holding company and the issuing savings institution, and transactions
between the savings institution and the savings and loan holding company and any of its affiliates must conform to Sections 23A and 23B of the Federal Reserve Act. Except with the prior approval of the OTS, no director or officer of a savings and loan holding company or person owning by proxy or otherwise more than 25% of such company's stock, may also acquire control of any savings institution, other than a subsidiary savings institution, or of any other savings and loan holding company.
Regulation of the Bank
Federal Home Loan Bank System. The Bank is a member of the FHLB System, which consists of 12 district Federal Home Loan Banks subject to supervision and regulation by the Federal Housing Finance Board ("FHFB"). The Federal Home Loan Banks provide a central credit facility primarily for member institutions. As a member of the FHLB of Indianapolis, the Bank is required to acquire and hold shares of capital stock in the FHLB of Indianapolis in an amount at least equal to 1% of the aggregate unpaid principal of its home mortgage loans, home purchase contracts, and similar obligations at the beginning of each year, or 1/20 of its advances (i.e., borrowings) from the FHLB of Indianapolis, whichever is greater. The Bank was in compliance with this requirement with an investment in FHLB of Indianapolis stock at September 30, 1999, of $2,473,500.
The FHLB of Indianapolis serves as a reserve or central bank for its member institutions within its assigned district. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes advances to members secured by certain prescribed collateral in accordance with policies and procedures established by the FHFB and the Board of Directors of the FHLB of Indianapolis. Long-term advances may only be made for the purpose of providing funds for residential housing finance. Members must meet standards of community investment or service established by the FHLB of Indianapolis in order to maintain continued access to long-term advances. As of September 30, 1999, the Bank had advances totaling $7,200,000 outstanding. See "Business of the Company--Deposit Activity and Other Sources of Funds" and "--Borrowings."
Liquidity Requirements. Under OTS regulations, a savings association is required to maintain an average daily balance of liquid assets (including cash, certain time deposits and savings accounts, bankers' acceptances, certain government obligations, and certain other investments) in each calendar quarter of not less than 4% of either (1) its liquidity base (consisting of certain net withdrawable accounts plus short-term borrowings) as of the end of the preceding calendar quarter, or (2) the average daily balance of its liquidity base during the preceding quarter. The OTS may change this liquidity requirement from time to time to any amount from 4.0% to 10.0%, depending upon certain factors, including economic conditions and savings flows of all savings associations. The Bank maintains liquid assets in compliance with these regulations. Monetary penalties may be imposed upon an institution for violations of liquidity requirements.
Qualified Thrift Lender Test. Savings institutions must meet a qualified thrift lender ("QTL") test, which test may be met either by maintaining a specified level of assets in qualified thrift investments as specified in HOLA or by meeting the definition of a "domestic building and loan association" in section 7701 of the Internal Revenue Code of 1986, as amended (the "Code"). If the Bank maintains an appropriate level of certain specified investments (primarily residential mortgages and related investments, including certain mortgage-related securities) and otherwise qualifies as a QTL or a domestic building and loan association, it will continue to enjoy full borrowing privileges from the FHLB. The required percentage of investments under HOLA is 65% of assets while the Code requires investments of 60% of assets. An association must be in compliance with the QTL test or definition of domestic building and loan association on a monthly basis in nine out of every 12 months. Associations that fail to meet the QTL test will generally be prohibited from engaging in any activity not permitted for both a national bank and a savings association. As of September 30, 1999, the Bank was in compliance with its QTL requirement and met the definition of a domestic building and loan association.
Regulatory Capital Requirements. Under OTS capital regulations, savings institutions must maintain "tangible" capital equal to 1.5% of adjusted total assets, "core" capital equal to 3% of adjusted total assets and "total" capital
(a combination of core and "supplementary" capital) equal to 8% of risk-weighted assets. In addition, OTS regulations which impose certain restrictions on savings associations that have a total risk-based capital ratio that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less than 4.0% (or 3.0% if the institution is rated Composite 1 under the OTS examination rating system).
The OTS has adopted an amendment to its risk-based capital requirements that requires savings institutions with more than a "normal" level of interest rate risk to maintain additional total capital (the OTS is delaying implementation of this requirement). A savings institution's interest rate risk will be measured in terms of the sensitivity of its "net portfolio value" to changes in interest rates. Net portfolio value is defined, generally, as the present value of expected cash inflows from existing assets and off-balance sheet contracts less the present value of expected cash outflows from existing liabilities. A savings institution will be considered to have a "normal" level of interest rate risk exposure if the decline in its net portfolio value after an immediate 200 basis point increase or decrease in market interest rates (whichever results in the greater decline) is less than 2% of the current estimated economic value of its assets. A savings institution with a greater than normal interest rate risk will be required to deduct from total capital, for purposes of calculating its risk-based capital requirement, an amount (the "interest rate risk component") equal to one-half the difference between the institution's measured interest rate risk and the normal level of interest rate risk, multiplied by the economic value of its total assets.
The OTS will calculate the sensitivity of a savings institution's net portfolio value based on data submitted by the institution in a schedule to its quarterly Thrift Financial Report and using the interest rate risk measurement model adopted by the OTS. The amount of the interest rate risk component, if any, to be deducted from a savings institution's total capital will be based on the institution's Thrift Financial Report filed two quarters earlier. In general, savings institutions with less than $300 million in assets and a risk-based capital ratio above 12% are exempt from this interest rate risk component unless the OTS terminates such exemption. Although the Bank qualifies for the exemption, management believes that based on current financial data, the Bank would not be deemed to have more than a normal level of interest rate risk.
In addition to generally applicable capital standards for savings institutions, the Director of the OTS is authorized to establish the minimum level of capital for a savings institution at such amount or at such ratio of capital-to-assets as the Director determines to be necessary or appropriate for such institution in light of the particular circumstances of the institution. The Director of the OTS may treat the failure of any savings institution to maintain capital at or above such level as an unsafe or unsound practice and may issue a directive requiring any savings institution which fails to maintain capital at or above the minimum level required by the Director to submit and adhere to a plan for increasing capital. Such a directive may be enforced in the same manner as an order issued by the OTS.
At September 30, 1999, the Bank exceeded all regulatory minimum capital requirements as indicated in the table below. (Dollars in thousands)
-------------------------------------------- Required for Adequate To Be Well Actual Capital Capitalized -------------------------------------------- September 30 Amount Ratio Amount Ratio Amount Ratio - -------------------------------------------------------------------------------- Total risk-based capital (1)(to $36,705 20.5% $14,335 8.0% $17,918 10.0% risk-weighted assets) Tier 1 risk-based capital (1) (to $35,726 19.9% $14,335 8.0% $17,918 10.0% risk-weighted assets) Core Capital (1) (to adjusted $35,726 11.1% $12,904 4.0% $19,355 6.0% tangible assets) Core Capital (1) (to adjusted $35,726 11.1% $12,904 4.0% $16,129 5.0% total assets) (1) As defined by regulatory agencies
Insurance of Deposit Accounts. The Bank's deposit accounts are insured by the SAIF to the maximum amount permitted by law. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC or the institution's primary regulator.
The FDIC charges an annual assessment for the insurance of deposits based on the risk a particular institution poses to its deposit insurance fund. Under this system as of September 30, 1999, SAIF members paid within a range of 0 cents to 23 cents per $100 of domestic deposits, depending upon the institution's risk classification. This risk classification is based on an institution's capital group and supervisory subgroup assignment. Pursuant to the Economic Growth and Paperwork Reduction Act of 1996 (the "Act"), the Bank pays, in addition to its normal deposit insurance premium as a member of the SAIF an amount equal to approximately 6.4 basis points toward the retirement of the Financing Corporation bonds ("Fico Bonds") issued in the 1980s to assist in the recovery of the savings and loan industry. Members of the Bank Insurance Fund ("BIF"), by contrast, pay, in addition to their normal deposit insurance premium, approximately 1.3 basis points. Under the Act, the FDIC also is not permitted to establish SAIF assessment rates that are lower than comparable BIF assessment rates. Effective January 1, 2000, the rate paid to retire the Fico Bonds will be equal for members of the BIF and the SAIF. The Act also provided for the merging of the BIF and the SAIF by January 1, 1999, provided there were no financial institutions still chartered as savings associations at that time. Although legislation to eliminate the savings association charter had been proposed at January 1, 1999, financial institutions such as the Bank were still chartered as Savings associations.
Federal Reserve System. Pursuant to regulations of the Federal Reserve Board, a savings institution must maintain average daily reserves equal to 3% on the first $54.0 million of transaction accounts, plus 10% on the remainder. This percentage is subject to adjustment by the Federal Reserve Board. Because required reserves must be maintained in the form of vault cash or in a non-interest bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution's interest-earning assets. As of September 30, 1999, the Bank met its reserve requirements.
Dividend Restrictions. Under OTS regulations, the Bank is not permitted to pay dividends on its capital stock if its regulatory capital would thereby be reduced below the remaining balance of the liquidation account established for the benefit of certain depositors in connection with the conversion of the Bank from the mutual to stock form of organization. In addition, the Bank is required by OTS regulations to give the OTS 30 days' prior notice of any proposed declaration of dividends to the Company.
OTS regulations impose additional limitations on the payment of dividends and other capital distributions (including stock repurchases and cash mergers) by the Bank. Under these regulations, a savings institution that, immediately prior to, and on a pro forma basis after giving effect to, a proposed capital distribution, has total capital (as defined by OTS regulation) that is equal to or greater than the amount of its fully phased-in capital requirements (a "Tier 1 Association") is generally permitted, after notice, to make capital distributions during a calendar year in the amount equal to the greater of: (a) 75% of its net income for the previous four quarters; or (b) up to 100% of its net income to date during the calendar year plus an amount that would reduce by 50% its surplus capital ratio at the beginning of the calendar year. A savings institution with total capital in excess of current minimum capital ratio requirements but not in excess of the fully phased-in requirements (a "Tier 2 Association") is permitted, after notice, to make capital distributions without OTS approval of up to 75% of its net income for the previous four quarters, less dividends already paid for such period. A savings institution that fails to meet current minimum capital requirements (a "Tier 3 Association") is prohibited from making any capital distributions without the prior approval of the OTS. A Tier 1 Association that has been notified by the OTS that it is in need of more than normal supervision will be treated as either a Tier 2 or Tier 3 Association. Except under limited circumstances and with OTS approval, no capital distributions would be permitted if they would cause the
institution to become undercapitalized. As of September 30, 1999, the Bank was considered a Tier 1 Association under OTS regulations.
Despite the above authority, the OTS may prohibit any savings institution from making a capital distribution that would otherwise be permitted by the regulation, if the OTS were to determine that the distribution constituted an unsafe or unsound practice. Furthermore, under the OTS prompt corrective action regulations, the Bank would be prohibited from making any capital distributions if, after making the distribution, it would have: (i) a total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%. See "--Prompt Corrective Regulatory Action."
Affiliate Restrictions. Transactions between a savings association and its "affiliates" are subject to quantitative and qualitative restrictions under Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings association include, among other entities, the savings association's holding company and companies that are under common control with the savings association.
In general, Sections 23A and 23B and OTS regulations issued in connection therewith limit the extent to which a savings association or its subsidiaries may engage in certain "covered transactions" with affiliates to an amount equal to 10% of the association's capital and surplus, in the case of covered transactions with any one affiliate, and to an amount equal to 20% of such capital and surplus, in the case of covered transactions with all affiliates. In addition, a savings association and its subsidiaries may engage in covered transactions and certain other transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the savings association or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A "covered transaction" is defined to include a loan or extension of credit to an affiliate; a purchase of investment securities issued by an affiliate; a purchase of assets from an affiliate, with certain exceptions; the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; or the issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate.
In addition, under the OTS regulations, a savings association may not make a loan or extension of credit to an affiliate unless the affiliate is engaged only in activities permissible for bank holding companies; a savings association may not purchase or invest in securities of an affiliate other than shares of a subsidiary; a savings association and its subsidiaries may not purchase a low-quality asset from an affiliate; and covered transactions and certain other transactions between a savings association or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices. With certain exceptions, each loan or extension of credit by a savings association to an affiliate must be secured by collateral with a market value ranging from 100% to 130% (depending on the type of collateral) of the amount of the loan or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings association subsidiaries of savings associations from treatment as affiliates, except to the extent that the OTS or the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") decides to treat such subsidiaries as affiliates. The regulation also requires savings associations to make and retain records that reflect affiliate transactions in reasonable detail, and provides that certain classes of savings associations may be required to give the OTS prior notice of affiliate transactions.
Prompt Corrective Action. The prompt corrective action regulation of the OTS requires certain mandatory actions and authorizes certain other discretionary actions to be taken by the OTS against a savings bank that falls within certain undercapitalized capital categories specified in the regulation.
The regulation establishes five categories of capital classification: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." Under the regulation, the risk-based capital, leverage capital, and tangible capital ratios are used to determine an institution's capital classification. At September 30, 1999, the Bank met the capital requirements of a "well capitalized" institution under applicable OTS regulations.
In general, the prompt corrective action regulation prohibits an insured depository institution from declaring any dividends, making any other capital distribution, or paying a management fee to a controlling person if, following the distribution or payment, the institution would be within any of the three undercapitalized categories. In addition, adequately capitalized institutions may accept Brokered Deposits only with a waiver from the FDIC and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew, or roll-over Brokered Deposits.
If the OTS determines that an institution is in an unsafe or unsound condition, or if the institution is deemed to be engaging in an unsafe and unsound practice, the OTS may, if the institution is well capitalized, reclassify it as adequately capitalized; if the institution is adequately capitalized but not well capitalized, require it to comply with restrictions applicable to undercapitalized institutions; and, if the institution is undercapitalized, require it to comply with certain restrictions applicable to significantly undercapitalized institutions.
Community Reinvestment Act and Fair Lending Developments. The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act ("CRA") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low- and moderate-income neighborhoods. A savings association may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws. The federal banking agencies may take compliance with such laws and CRA obligations into account when regulating and supervising other activities.
A savings association's compliance with its CRA obligations is based on a performance-based evaluation system that bases CRA ratings on an institution's lending service and investment performance. When a holding company applies for approval to acquire another financial institution or financial institution holding company, the OTS will review the assessment of each subsidiary savings association of the applicant; and such records may be the basis for denying the application. In February 1997, the OTS rated the Bank "satisfactory" in complying with its CRA obligations.
Year 2000 Compliance. In May 1997, the Federal Financial Institutions Examination Council issued an interagency statement to the chief executive officers of all federally supervised financial institutions regarding year 2000 project management awareness. It is expected that unless financial institutions address the technology issues relating to the coming of the year 2000, there will be major disruptions in the operations of financial institutions. The statement provides guidance to financial institutions, providers of data services, and all examining personnel of the federal banking agencies regarding the year 2000 problem. The federal banking agencies intend to conduct year 2000 compliance examinations, and the failure to implement a year 2000 program may be seen by the federal banking agencies as an unsafe and unsound banking practice. The OTS has recently established an examination procedure, which contains three categories of ratings: "Satisfactory," "Needs Improvement," and "Unsatisfactory." Institutions that receive a year 2000 rating of Unsatisfactory may be subject to formal enforcement action, supervisory agreements, and cease and desist orders, civil money penalties, or the appointment of a conservator. In addition, federal banking agencies will be taking into account year 2000 compliance programs when analyzing applications and may deny an application based on year 2000 related issues. The Company is currently addressing the year 2000 issue, as more fully discussed in the Company's Annual Report to Stockholders for the Year Ended September 30, 1998 under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations-Year 2000."
Item 2.
Item 2. Properties
The Bank owns eight full-service banking offices located in Avilla, Auburn, Columbia City, Garrett, Kendallville, LaGrange and Waterloo, Indiana.
The following table provides certain information with respect to the Bank's full-service offices at September 30, 1999.
Full Service Net Book Offices Date Opened Value(1) ------------ ----------- -------- Main Office, Auburn 1973 $149,283 Avilla 1980 120,858 Garrett 1972 54,096 Columbia City-Downtown 1971 136,284 Columbia City-North 1998 554,965 Kendallville 1941 472,883 LaGrange 1972 171,010 Waterloo 1999 -- (2) - --------------------- (1) Of real estate at September 30, 1999. (2) Waterloo is a temporary leased office and so has no real estate cost.
The Bank owns data processing equipment including computers, terminals and communications equipment for record keeping purposes. The estimated costs to make this equipment year 2000 compliant are not expected to be material.
The total net book value of the Bank's premises and equipment at September 30, 1999, was $2,285,889.
Item 3.
Item 3. Legal Proceedings
There are no material pending legal proceedings to which the Company, the Bank or any subsidiary is a party or to which any of their property is subject.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Reference is made to page 1 of the Company's Annual Report to Stockholders, for the year ended September 30, 1999 for the information required by this Item, which is hereby incorporated by reference.
Item 6.
Item 6. Selected Financial Data
Reference is made to page 16 of the Company's Annual Report to Stockholders for the year ended September 30, 1999, for the information required by this Item, which is hereby incorporated by reference.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Reference is made to pages 9 to 15 of the Company's Annual Report to Stockholders for the year ended September 30, 1999, for the information required by this Item, which is hereby incorporated by reference.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Reference is made to pages 10 and 11 of the Company's Annual Report to Stockholders for the year ended September 30, 1999, for the information required by this item, which is hereby incorporated by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
Reference is made to pages 17 to 32 of the Company's Annual Report to Stockholders for the year ended September 30, 1999 for the information required by this Item, which is hereby incorporated by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Reference is made to the section captioned "The Peoples Bancorp Annual Meeting-Election of Directors" in the Company's definitive Proxy Statement/Prospectus for the information required by this Item, which is hereby incorporated by reference.
Item 11.
Item 11. Executive Compensation
Reference is made to the section captioned "The Peoples Bancorp Annual Meeting-Executive Officer Compensation" in the Company's definitive Proxy Statement/Prospectus for the information required by this Item, which is hereby incorporated by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Reference is made to the section captioned "The Peoples Bancorp Annual Meeting-Securities Ownership of Certain Beneficial Owners in the Company's definitive Proxy Statement/Prospectus for the information required by this Item which is hereby incorporated by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
Reference is made to the section captioned "The Peoples Bancorp Annual Meeting-Transactions with Certain Related Persons" in the Company's definitive Proxy Statement/Prospectus for the information required by this Item, which is hereby incorporated by reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K
(a) The following consolidated financial statements of Peoples Bancorp and Its Wholly-owned Subsidiary, included in the Annual Report to Stockholders of the registrant for the year ended September 30, 1999 are filed as part of this report:
1. Financial Statements
o REPORT OF OLIVE LLP, INDEPENDENT AUDITORS. o CONSOLIDATED STATEMENT OF FINANCIAL CONDITION - AS OF SEPTEMBER 30, 1999 AND 1998. o CONSOLIDATED STATEMENT OF INCOME FOR THE YEARS ENDED SEPTEMBER 30, 1999, 1998, AND 1997. o CONSOLIDATED STATEMENT OF CHANGE IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 1999, 1998, AND 1997.
o CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER 30, 1999, 1998, AND 1997 o NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
2. Financial Statement Schedules
All schedules are omitted because they are not applicable, or the required information is shown in the consolidated financial statements and notes.
3. Exhibits
Exhibit No. Description of Exhibit
3.1 Articles of Incorporation of Peoples Bancorp (1)
3.2 Bylaws of Peoples Bancorp (1)
10.4 Amended and Restated Stock Option and Stock Grant Plan (2)
10.5 Employee Stock Ownership Plan (1)
10.5(a) First Amendment to Employee Stock Ownership Plan (3)
10.5(b) Second Amendment to Employee Stock Ownership Plan (3)
10.5(c) Third Amendment to Employee Stock Ownership Plan (3)
10.6 Expense and Tax Sharing Agreement between Peoples Bancorp, Peoples Federal Savings Bank of DeKalb County and Peoples Financial Services, Inc., dated May 28, 1992 (3)
10.7 New option plan
13 Annual Report to Stockholders
22 Subsidiaries of the Registrant
23 Consent of Auditors
- --------------------------------- (1) Incorporated by reference to Exhibit bearing the same number in the Company's Registration Statement of Form S-4 (33-37343) filed with the Securities and Exchange Commission on October 17, 1990.
(2) Incorporated by reference to Exhibit bearing the same number in the Company's Annual Report on form 10-K for the year ended September 30, 1991.
(3) Incorporated by reference to Exhibit bearing the same number in the Company's Annual Report on form 10-K for the year ended September 30, 1992.
(b) Reports on Form 8-K-On September 23, 1999, the Company filed a report on form 8-K reporting pursuant to Item 5, that the Company had entered into a definitive agreement to merge with Three Rivers Financial Corporation.
The Securities and Exchange Commission maintains a Web sit that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission including the Company. That address is http://www.sec.gov.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PEOPLES BANCORP
December 29, 1999 Roger J. Wertenberger Chairman of the Board, and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
December 29, 1999 Roger J. Wertenberger, Chairman of the Board, and Director
December 29, 1999 Maurice F. Winkler III, President, Chief Executive Officer and Director
December 29, 1999 Deborah K. Stanger Vice President-Chief Financial Officer
December 29, 1999 Robert D. Ball, Director
December 29, 1999 Bruce S. Holwerda, Director
December 29, 1999 John C. Harvey, Director
December 29, 1999 Douglas D. Marsh, Director
December 29, 1999 Lawrence R. Bowmar, Director
December 29, 1999 John C. Thrapp, Director
EXHIBIT 22
SUBSIDIARIES OF THE REGISTRANT
Name of Subsidiary State of Incorporation - ------------------------------- -------------------------- Peoples Federal Savings Bank of DeKalb County United States of America
and its subsidiary
Peoples Financial Services Inc. Indiana