10-K 1 sept0310k.txt FORM 10-K FOR PERIOD ENDED SEPTEMBER 30, 2003 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K For Annual and Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended September 30, 2003 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______ to ______ Commission File Number 0-18991 PEOPLES BANCORP (Exact name of registrant as specified in its charter) INDIANA 35-1811284 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 212 West 7th Street, Auburn, Indiana 46706 ------------------------------------ -------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (260) 925-2500 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act Common Stock, par value $1.00 per share (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X] Aggregate market value of voting stock held by non-affiliates of the registrant, as of December 18, 2003: $73,373,413. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of December 18, 2003: 3,397,973 shares of Common Stock, par value $1.00 per share Documents Incorporated by Reference: Portions of the definitive Proxy Statement/Prospectus (Part III) and the Annual Report to Stockholders for the year ended September 30, 2003 (Parts II and IV). PART I Peoples Bancorp (the "Company") may from time to time make written or oral "forward-looking statements", including statements contained in the Company's filings with the Securities and Exchange Commission (including this annual report on Form 10-K and the exhibits thereto), in its reports to stockholders and in other communications by the Company, which are made in good faith by the Company pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties, such as statements of the Company's plans, objectives, expectations, estimates and intentions that are subject to change based on various important factors (some of which are beyond the Company's control). The following factors, among others, could cause the Company's financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the board of governors of the federal reserve system, inflation, interest rates, market and monetary fluctuations; the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors' products and services; the willingness of users to substitute competitors' products and services for the Company's products and services; the success of the Company in gaining regulatory approval of its products and services, when required; the impact of changes in financial services laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes; acquisitions; changes in consumer spending and saving habits; and the success of the Company in managing the risks resulting from these factors. The Company cautions that the listed factors are not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time or on behalf of the Company. Item 1. Business General The Company is an Indiana corporation organized in October 1990 to become the thrift holding company for Peoples Federal Savings Bank of DeKalb County ("Peoples Federal"). The Company is the sole shareholder of Peoples Federal. Peoples Federal conducts business from its main office in Auburn and its eight full-service offices located in Avilla, Columbia City, Garrett, Kendallville, LaGrange, Topeka and Waterloo, Indiana. Peoples Federal offers a full range of retail deposit services and lending services to northeastern Indiana. Peoples Federal 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, it has been a member of the Federal Home Loan Bank System ("FHLB System") and the Federal Home Loan Bank of Indianapolis ("FHLB of Indianapolis"). 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"). On February 29, 2000 a merger was completed with Three Rivers Financial Corp. and its subsidiary First Savings Bank ("First Savings") of Three Rivers, Michigan. The Company became the sole shareholder of First Savings. First Savings conducts business from its main office in Three Rivers, Michigan, and its five full service offices in Union and Schoolcraft, Michigan, and Howe and Middlebury, Indiana. The Company has no other business activity other than being the holding company for Peoples Federal and First Savings (collectively the "Banks") and is subject to regulation by the OTS. The Company's securities are registered with the Securities and Exchange Commission ("SEC") pursuant to the Securities 2 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 December 2002, the Board authorized a stock repurchase program. Purchases of up to 300,000 shares of the Company's common stock may be made in open market or in privately negotiated transactions. As of September 30, 2003, the Company had repurchased 24,907 shares. The Board of Directors approved the Stock repurchase program because, in their opinion, the stock price was below the current value of the Company. The Board and Management feel that the stock repurchase program enhances shareholder value by decreasing the number of shares outstanding and by providing another source to liquidate shares. Most shares are purchased at or below market value and the company retires any shares repurchased, this also reduces the amount of dividends paid. The repurchase plan also allows the company to efficiently deploy excess capital. On a yearly basis, the Company updates its long-term strategic plan. This plan includes, among other things, the Company'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 the Banks' 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 Banks offer 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, Peoples Federal added agricultural and commercial lending officers to its staff. Since these types of loans pose a higher credit risk than traditional mortgage lending, they typically offer higher yields and are for shorter terms. It is expected that these loans will assist Peoples Federal in managing its interest rate risk, and increase its overall profitability. The Banks provide these services through a branch network comprised of fourteen full-service banking offices. They also provide credit card services, as well as enhancements to its loan and deposit products designed to provide customers with added conveniences. The Company has historically concentrated its business activities in northeastern Indiana. The purchase of First Savings has extended this area to southern Michigan. The Company's current strategy is to maintain its branch office network as well as remain alert to new opportunities. Over the years, the Company 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 Banks, 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 3 sources. Savings flows at thrift institutions such as the Banks are influenced by a number of factors including interest rates on competing investments and levels of personal income. Earnings The Banks' 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 Banks typically engage 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 Banks experience strong competition both in making real estate loans and in attracting savings deposits. The Banks compete 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 Banks 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 Banks' weighted average rate at which new loans are originated and the weighted average cost of interest-bearing liabilities. The Banks' 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 Banks have supplemented their 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 interest rates and changes in the composition of the Banks' 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 eight of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 2003 Annual Report to Stockholders incorporated herein by reference. For information regarding the combined weighted average effective interest rate earned by the Banks on their loan portfolios and investments, the combined weighted average effective cost of the Banks' deposits and borrowings, the interest rate spread of the Banks, and the net yield on combined monthly weighted average interest-earning assets of the Banks on their loan portfolios and investments for the fiscal years ending September 30, 2003, 2002, and 2001 refer to page five of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 2003 Annual Report incorporated herein by reference. 4 For information concerning the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected the Banks' interest income and expense during the fiscal years ending September 30, 2003, 2002, and 2001 refer to page nine of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 2003 Annual Report incorporated herein by reference. Market Area Peoples Federal's market area in northeastern Indiana spans the counties of DeKalb, Whitley, Noble, and LaGrange. This market area has a population of approximately 154,000 and has 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. With the addition of First Savings Bank to the Company, the market area has expanded into southern Michigan and additional towns of Howe and Middlebury in northeastern Indiana. First Savings serves St. Joseph, southern Kalamazoo, and Cass counties in Michigan and LaGrange and eastern Elkhart counties in Indiana. This expanded market area is contiguous to the Peoples Federal market area and is a natural expansion. This aggregate market area has a population estimate of 566,700 and consists of a diversified economic base that includes manufacturing, wholesale and retail trades, small farming, and service industries. The general area serviced by First Savings would be classified as rural. Lending Activities General The Banks have attempted to emphasize investments in adjustable-rate residential mortgages and consumer loans in their market areas. In order to lessen their risk from interest rate fluctuations, the Banks emphasize 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 Banks 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 Banks offered a fixed rate product to satisfy the customer demand, but are not locked into low interest rates for a long period of time. For regulatory reporting purposes, these loans are shown as fixed rate product until the period remaining to the next repricing is under five years. Seven year/one year loans originated during the initial implementation of this product are now shown in this Form 10-K as adjustable rate product. More recent originations of these types of loans are shown as fixed rate mortgages. First Savings sells any loans it originates for longer than seven year fixed rate terms on the secondary market. Residential Mortgage Loans A substantial portion of the Banks' lending activity involves the origination of loans secured by residential real estate, consisting of single-family dwelling units. The Banks also lend on the security of mid-size multifamily dwelling units. The residential mortgage loans included in the Banks' portfolio are primarily conventional fixed-rate loans with a maturity of up to 30 years. The Banks also offer 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 commitments are issued by the Banks. The index used for most loans is tied to the applicable United States Treasury security index. While adjustable-rate mortgage loans assist the Banks 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 5 match precisely changes in the Banks' cost of funds. The majority of the adjustable rate mortgages originated by the Banks have limitations on the amount (generally 6%) and frequency of interest rate changes. During the fiscal year ended September 30, 2003, the Banks originated $127,326,968 of residential loans of which $65,303,524 were five- to 30-year fixed-rate mortgages and $62,023,444 was adjustable-rate loans. The rates offered on the Banks' adjustable-rate residential mortgage loans are generally competitive with the rates offered by other thrift institutions in the Banks' market areas and are based upon the Banks' cost of funds and the rate of return the Banks 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 Banks' market areas. Set forth below is the amounts and percentages of fixed-rate and adjustable-rate loans (which include consumer loans) in the Banks' portfolios at September 30, 2003, 2002, and 2001 (Dollars in thousands). September 30, ---------------------------------------------------------------------------- 2003 2002 2001 ----------------------- ------------------------ ------------------------ Adjustable Fixed Adjustable Fixed Adjustable Fixed ----------- ----------- ----------- ------------ ----------- ----------- $231,122 $133,032 $239,265 $153,346 $267,681 $144,600 63.5% 36.5% 60.9% 39.1% 64.9% 35.1% The terms of the residential loans originated by the Banks 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, 2003, the average contractual maturity of the Banks' portfolios of fixed-rate loans was 8 years and 11 months, and 22 years and 1 month with respect to its portfolio of adjustable-rate loans. Substantially all of the Banks' residential mortgages include so-called "due on sale" clauses, which are provisions giving the Banks 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 Banks 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 Banks' policy is to lend up to 90% of the appraised value of the property securing the loan. The Banks apply the same standards to residential loans purchased in the secondary market. Commercial Real Estate Loans The Banks also originate commercial real estate loans. From September 30, 2002, to September 30, 2003, commercial real estate loans decreased from $20,870,000 to $16,969,000, with the percentage of commercial real estate loans to total loans decreasing from 5.30% to 4.70%. These loans consisted of construction and permanent loans secured by mortgages on mid-size commercial real estate and farms. Of these loans, approximately $9.1 million are secured by agricultural 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 Banks 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. 6 Construction Loans The Banks offer 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 Banks 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 Banks could be negatively impacted in that they would have to take control of the project and attempt either to arrange for completion of construction or dispose of the unfinished project. The Banks' underwriting criteria are designed to evaluate and minimize the risks of each construction loan. The Banks carefully consider 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 Banks 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 Banks 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 Banks limit the number of properties that can be constructed on a "speculative" or unsold basis by a developer at any one time and generally require 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, and credit card loans (unsecured). The Banks offer all of these types of loans and are currently emphasizing home equity loans to take advantage of the adjustable interest rate feature of this type of 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 Banks' loan portfolios by type of loan at September 30, 2003. The estimated maturity reflects contractual terms at September 30, 2003. Contractual principal repayments of loans do not necessarily reflect the actual term of the Banks' loan portfolios. 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. 7 The following table sets forth the total amount of loans due after one year from September 30, 2003, which have a fixed rate or an adjustable rate. (Dollars in thousands) 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 $ 6,126 $ - $ - $ 6,126 Commercial - Real estate loans: Mortgage-residential 5,222 10,584 281,130 296,936 Commercial - 775 18,048 18,823 Installment loans -- Consumer 3,162 9,538 18,420 31,120 Commercial 7,082 2,786 1,281 11,149 --------- ----------- ---------- ---------- Total $ 21,592 $ 23,683 $318,879 $364,154 ========= =========== ========== ========== Loans Due October 1, 2004 and thereafter ----------------------------------------- Fixed Adjustable Total at September 30, 2003 ------------------ --------------------- --------------------------------- $121,424 $221,138 $342,562 Loan Portfolio Composition The following table sets forth the composition of the Banks' loan portfolios 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. 8 2003 2002 2001 2000 1999 ---------------------------------------------------------------------------------------------- TYPE OF LOAN AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT % ---------- -------- ---------- ------- --------- ------ ---------- ------- ---------- ------- Residential: (Dollars in thousands) Single family unit $301,265 82.8% $312,509 79.5% $336,586 81.6% $332,847 83.4% $265,992 88.3% 2-4 family units 1,797 0.5% 2,954 0.8% 3,243 0.8% 3,263 0.8% 1,603 0.5% Over 4 family units 2,593 0.7% 3,485 0.9% 1,452 0.4% 3,018 0.8% 2,525 0.8% Commercial real estate 14,750 4.1% 20,870 5.3% 21,906 5.3% 16,665 4.2% 9,392 3.1% Land acquisition and development 1,480 0.4% 1,516 0.4% 1,938 0.5% 1,926 0.5% 1,251 0.4% Consumer and other loans 41,748 11.5% 50,233 12.8% 46,177 11.2% 39,657 10.0% 19,861 6.6% Loans on deposits 521 0.1% 1,044 0.3% 979 0.2% 1,052 0.3% 952 0.3% ---------- -------- ---------- ------- --------- ------ ---------- ------- ---------- ------- 364,154 100.0% 392,611 100.0% 412,281 100.0% 398,428 100.0% 301,576 100.0% ---------- -------- ---------- ------- --------- ------ ---------- ------- ---------- ------- Less: Undisbursed portion of loans 3,467 3,821 5,262 4,341 2,307 Deferred loan fees and discounts 1,623 1,653 1,829 2,002 1,394 ---------- ---------- --------- ---------- ---------- 5,090 5,474 7,091 6,343 3,701 ---------- ---------- --------- ---------- ---------- Total loans receivable 359,064 387,137 405,190 392,085 297,875 Allowance for losses on loans 2,111 2,117 1,895 1,650 1,005 ---------- ---------- --------- ---------- ---------- Net loans $356,953 $385,020 $403,295 $390,435 $296,870 ========== ========== ========= ========== ==========
Origination, Purchase and Sale of Loans and Loan Concentrations The Banks originate residential loans in conformity with standard underwriting criteria to assure maximum eligibility for possible resale in the secondary market. Although the Banks have authority to lend anywhere in the United States, they have confined their loan origination activities primarily in the Banks' service areas. Loan originations are developed from a number of sources, primarily from referrals from real estate brokers, builders, and existing and walk-in customers. Peoples Federal 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 Peoples Federal. The Banks' 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 committees of the Banks can approve residential and commercial loans ranging up to $500,000. The Banks' Boards of Directors must approve loans exceeding $500,000. The Banks utilize independent qualified appraisers approved by the Board of Directors to appraise the properties securing their loans and require title insurance or title opinions so as to insure that the Banks have a valid lien on the mortgaged real estate. The Banks require 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 Banks also evaluate 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 Banks for a permanent long-term loan to replace the construction loan upon completion of construction. 9 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 Banks' policy to originate both fixed-rate and adjustable-rate loans, providing all such loans are eligible for sale in the secondary market. It is Peoples Federal's intention to hold all originated and purchased loans in its portfolio and not for sale. First Savings is currently active in the secondary market and sells the majority of its fixed rate loan products. The following table shows mortgage and other loan origination, purchase, and repayment activity for the Banks during the periods indicated: Years Ended September 30 -------------------------------- 2003 2002 2001 ---------- ---------- ---------- (Dollars in thousands) Mortgage loans originated for the purpose of: Construction-commercial $ - $ 365 $ - Construction-residential 10,321 10,715 28,003 Purchase/refinance-commercial 3,349 3,884 2,938 Purchase/refinance-residential 123,978 109,247 87,517 Consumer and other loans originated 29,805 30,329 39,199 ---------- ---------- ---------- Total loans originated 167,453 154,540 157,657 ---------- ---------- ---------- Loan credits: Loans sold Principal repayments 195,406 172,416 144,191 ---------- ---------- ---------- Other: Provision for losses on loans 537 348 354 Amortization of loan fees (759) (680) (557) Loan foreclosures, net 336 731 476 ---------- ---------- ---------- 114 399 273 ---------- ---------- ---------- Total credits, net 195,520 172,815 144,464 ---------- ---------- ---------- Net increases (decreases) in mortgage and other loans receivable, net $(28,067) $(18,275) $ 13,193 ========== ========== ========== Interest Rates, Points and Fees The Banks realize interest, point, and fee income from their lending activities. The Banks also realize 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 Banks account 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 10 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. First Savings also realizes income from gains on sales of loans, and servicing fees for loans sold with servicing retained. Nonperforming Assets Loans are reviewed on a regular basis and are generally placed on nonaccrual status when the loans become 90 days or more past due, 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 Banks are unable to resolve a delinquency satisfactorily within 45 days after the loan is past due, they will undertake foreclosure or other proceedings, as necessary, to minimize any potential loss. Real estate acquired by the Banks 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 at September 30, 2003: 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 18 $1,197 0.40% 6 $325 0.11% 15 $ 976 0.32% family Other 1 149 0.71% 1 43 0.20% - - 0.51% Consumer 16 139 0.32% 10 93 0.21% 26 241 0.55% ------ ------ ----- -------- ------- ------ Total 35 $1,485 0.41% 17 $461 0.13% 41 $1,217 0.33% ====== ====== ===== ======== ======= ====== The following table sets forth the Banks' nonperforming assets at the dates indicated: 11 At September 30, ---------------------------- 2003 2002 2001 2000 1999 ------ ------ ---- ---- ---- (Dollars in thousands) Nonaccrual loans $1,127 $ 801 $676 $587 $474 Loans past due 90 days and still accruing 90 106 52 7 64 ------ ------ ---- ---- ---- 1,217 907 728 594 538 Real estate owned, net of allowance 854 489 117 165 - ------ ------ ---- ---- ---- Total nonperforming assets $2,071 $1,396 $845 $759 $538 ====== ====== ==== ==== ==== Consumer loans are placed on nonaccrual 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. The increase in non-accrual loans since September 30, 2002 is primarily from the 1 to 4 family portion of the loan portfolio, and management believes the increase has been appropriately considered in determining the adequacy of the allowance for loan and REO losses at September 30, 2003. Management believes this increase is generally attributable to current economic conditions. The local economy in the areas in which the Company operates is somewhat dependent upon the automobile industry, which has not fully recovered from the recession, and this has trickled down to several other aspects of the local economy. There have been no significant changes in potential problem loans since September 30, 2002. Net charge-offs for the years ended September 30, 2003 and 2002 were $543,635 and $125,249, respectively. Net charge-offs were slightly above average this year due to the aforementioned economic conditions. This was combined with a large loss on one commercial loan to make up the net charge-off increase for this year. Interest income that would have been recognized for the year ended September 30, 2003, if nonaccrual loans had been current in accordance with their original terms, approximated $22,000. Interest income recognized on such loans for the year ended September 30, 2003, approximated $7,000. At September 30, 2003 the Banks 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 Banks 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. It is the Company's policy to reserve 5% of the loan balance for loans classified as special mention. 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). Substandard loans are reserved at 20% of the loan balance. 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, and the company reserves 50% of the loan balance. 12 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, the Banks' management continually reviews the mix and delinquency status of its loan portfolio and classifies those loans, which it deems appropriate. As of September 30, 2003, loan balances were classified by the Banks as follows: Loss $ - Doubtful - Substandard 2,528,000 Special Mention 1,800,000 Allowance for Losses on Loans The allowances for loan losses represent amounts available to absorb inherent losses in the loan portfolios. The allowance is 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 allowance 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 allowance to levels considered necessary by management. Losses are charged to the allowance when considered probable. As of September 30, 2003 allowance for losses on loans was $2,110,946. Overall, the general composition of the loan portfolio has remained similar to the prior year with no significant shift of risk between components of the loan portfolio that would impact the calculation of the allowance for loan losses. The Banks' management believes that the allowance is adequate to absorb known and inherent losses in the portfolios. No assurance can be given, however, that economic conditions which may adversely affect the Banks' markets or other circumstances will not result in additions to the allowance for loan and real estate owned losses. The following table presents an allocation of the Banks' allowance for loan losses at the dates indicated and the percentage of loans in each category to total loans. September 30, 2003 2002 2001 2000 1999 --------------- ------------- ------------ ------------ -------------- Amount % Amount % Amount % Amount % Amount % -------- ------ ------- ----- ------ ------ ------ ----- ------- ------ Balance at end of (Dollars in thousands) period applicable to: Residential Mortgage Loans $1,420 82.1% $1,361 81.2% $ 910 82.4% $1,122 84.2% $ 869 88.7% Commercial Real Estate Loans 166 5.8% 404 5.7% 527 6.2% 101 5.5% 76 4.4% Consumer Loans 311 12.1% 294 13.1% 342 11.4% 196 10.3% 60 6.9% Unallocated 214 58 116 231 - ------ ------- ------- ------ ------ ------ ------ ------ ------ -------- Total $2,111 100.0% $2,117 100.0% $1,895 100.0% $1,650 100.0% $1,005 100.0% ====== ======= ======= ====== ====== ====== ====== ====== ====== ========
The following table is a summary of activity in the Banks' allowance for loan losses for the periods indicated. 13 Summary of Loan Loss Experience Years ended September 30, --------------------------------------- 2003 2002 2001 2000 1999 ------ ------- ------- ------- -------- Balance of loan loss allowance at (Dollars in Thousands) beginning of year $2,117 $1,895 $1,650 $1,005 $ 947 Allowance acquired in merger - - - 562 - Charge-offs Residential 25 36 4 - - Commercial real estate - - - - - Commercial 395 - - - - Consumer 138 118 139 118 53 ------ -------- ------- ------- ------- Total Charge-offs 558 154 143 118 53 ------ -------- ------- ------- ------- Recoveries Residential - - - - - Consumer 15 28 34 41 22 ------ -------- ------- ------- ------- Total Recoveries 15 28 34 41 22 ------ -------- ------- ------- ------- Net Charge-offs (Recoveries) 543 126 109 77 31 Provision for loan losses 537 348 354 160 89 ------ -------- ------- ------- ------- Balance of loan loss allowance at end of year $2,111 $2,117 $1,895 $1,650 $1,005 ====== ======== ======= ======= ======= Ratio of net charge-offs to average loans outstanding 0.14% 0.03% 0.02% 0.01% 0.01% Investment Activities Federal thrift institutions, such as the Banks, 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 Banks 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. The carrying values of the Banks' investment securities, including its liquid assets, as of the dates indicated are presented in the following table. 14 At September 30, ----------------------------------- 2003 2002 2001 ---------- ---------- --------- Interest-bearing deposits and (Dollars in thousands) certificates of deposit (1) $ 29,965 $30,995 $13,029 U.S. government and federal agency securities Held to maturity - - 500 Available for sale 61,352 36,713 13,346 Mortgage backed securities Held to Maturity 2,117 6,848 5,139 Available for sale 13,953 13,504 10,354 Stock in FHLB of Indianapolis 4,519 4,405 4,392 Other Held to maturity - 295 635 Available for sale(2) 10,199 4,679 5,912 ---------- --------- --------- Total investments $122,105 $97,439 $53,307 ========== ========= ========= -------------------------------------------- (1) In Interest-bearing accounts at FHLB of Indianapolis $26,694, In Insured certificates of deposit $3,270 at September 30, 2003; In Interest-bearing accounts at FHLB of Indianapolis $27,175, In Insured certificates of deposit $3,820 at September 30, 2002; In Interest-bearing accounts at FHLB of Indianapolis $9,574, In Insured certificates of deposit $3,456 at September 30, 2001; (2) Van Kampen Prime Income Fund $2,298, Van Kampen Senior Income Trust $1,397, State and Municipal obligations $6,504 at September 30, 2003; Van Kampen Prime Income Fund $2,146, Van Kampen Senior Income Trust $1,160, State and Municipal obligations $1,668 at September 30, 2002; Van Kampen Prime Income Fund $2,409, Van Kampen Senior Income Trust $1,269, State and Municipal obligations $2,869 at September 30, 2001; The following table sets forth information regarding the maturity distribution of investment securities at September 30, 2002, and the weighted average yield on those securities. At September 30, 2003 ---------------------------------------------------------------- Available for Sale Held to Maturity ------------------------------ --------------------------------- Weighted Approximate Weighted Approximate Amortized Average Fair Amortized Average Fair Maturity Distribution at September 30: Cost Yield Value Cost Yield Value --------- -------- ----------- --------- ---------- ------------ (Dollars in thousands) Due in one year or less $ 357 5.40% $ 365 $ - $ - Due after one through five years 45,811 3.19% 46,373 - - Due after five through ten years 18,872 3.42% 18,925 - - Due after ten years 2,282 3.73% 2,194 - - -------- --------- ---------- ------------ 67,322 67,857 - - Mortgage-backed securities 13,990 4.52% 13,953 2,117 4.88% 2,218 Marketable equity securities 4,453 3,695 - - -------- --------- --------- ------------ Total $85,765 $85,505 $2,117 $2,218 ======== ========= ========= ============
15 Sources of Funds General Deposits have traditionally been the primary source of funds of the Banks for use in lending and investment activities. In addition to deposits, the Banks derive 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 Banks' primary market areas 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 Banks also offer individual retirement accounts ("IRA's"). The Banks' policies are designed primarily to attract deposits from local residents rather than to solicit deposits from areas outside their primary markets. The Banks do 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 Banks 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 Banks' average cost of funds is the distribution of the Banks' accounts by interest rate paid. An important indicator of the Banks' stability of lendable funds is the distribution of the Banks' accounts by maturity. For information on the amounts of certificate accounts at September 30, 2003, maturing during the next five years and thereafter see Note 6 of Notes to Consolidated Financial Statements on page 24 of the Company's 2003 Annual Report to Stockholders. 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, ------------------------ 2003 ------------ (Dollars In thousands) 3 months or less $ 500 3-6 months 700 6-12 months 800 over 12 months 34,343 ------------ Total $ 36,343 ============ Borrowings As members of the FHLB System and the FHLB of Indianapolis, the Banks are eligible to arrange borrowings or advances for various purposes and on various terms. As of September 30, 2003, 2002 and 2001 the Banks had outstanding advances to the FHLB of Indianapolis of $54,100,000, $59,100,000, and $45,092,965, respectively. See page 25 of the Company's 2003 Annual Report to Stockholders for the maturity breakdown of these long-term instruments. 16 Reverse repurchase agreements, another source of borrowing for Peoples Federal, are retail obligations of Peoples Federal with a maturity of 90 days or less, and are generally secured with specific investment securities owned by Peoples Federal. The following tables set forth certain information as to the Banks' short-term borrowings consisting of 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 ------------------------- 2003 2002 2001 ------ -------- ------- (Dollars in thousands) Average balance of short-term borrowings $4,294 $2,885 $1,068 Highest month-end balance of total short-term borrowings 7,136 5,131 4,384 Weighted average interest rate of total short-term borrowings 1.53% 2.39% 3.45% At September 30 ---------------------- 2003 2002 2001 ------ ------- ------- Reverse Repurchase agreements 2,650 3,193 4,384 ------ ------- ------- Total short-term borrowings $2,650 $3,193 $4,384 ====== ======= ======== Weighted average interest rate 1.49% 1.98% 3.45% Trust Department In October 1984, the FHLB of Indianapolis granted full trust powers to Peoples Federal, one of the first savings institutions in Indiana to be granted such powers. As of September 30, 2003, Peoples Federal's trust department assets totaled approximately $99,773,000 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 790 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. The trust department provides a needed service to the communities served by Peoples Federal, as well as generating fee income which is largely unaffected by interest rate fluctuations. The large increase in trust assets administered (from less than $58 million to almost $100 million) was due to the purchase by Peoples Federal of the trust assets of First Federal Savings Bank of Huntington, IN. The purchase was affected using a revenue sharing agreement, rather than an up-front cash payment. While the merger still needed final regulatory approval at September 30, the assets had been combined in Peoples Federal's accounting system, and Peoples had taken over the administration of these accounts. Final regulatory approval is expected at any time. 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 Peoples Federal and conducts a general insurance business within the State of Indiana under the name of Peoples Insurance Agency. During fiscal years ended September 30, 2003 and 2002, PFSI recorded total income of $54,326 and 57,255, respectively, with net income for such periods amounting to $5,686 and $8,322, respectively. Alpha Financial was organized under the laws of the state of Michigan in 1975 as a wholly owned subsidiary of First Savings. First Savings' investment in Alpha Financial was $221,495 at September 30, 2003. The assets of Alpha 17 Financial consist of cash and stock in MIMLIC Life Insurance Company, which reinsures credit life insurance policies written on the lives of borrowers of various financial institutions. Discount Brokerage Services Since 1985, Peoples Federal 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. During 2002, this service was discontinued. Employees As of September 30, 2003, the Banks employed 151 persons on a full-time basis and 20 persons on a part-time basis. The Banks' employees are not represented by any collective bargaining group, and management considers its relations with its employees to be excellent. The holding company has no employees. REGULATION General The Company, as a savings and loan holding company, and the Banks, as federally chartered savings associations, are subject to extensive regulation by the OTS and the FDIC. The lending activities and other investments of the Banks must comply with various federal regulatory requirements, and the OTS periodically examines the Banks for compliance with various regulatory requirements and for safe and sound operations. The FDIC also has the authority to conduct examinations. The Banks must file reports with the OTS describing their activities and financial condition and are 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 Sarbanes-Oxley. The Sarbanes-Oxley Act requires audit committees to be directly responsible for the appointment, compensation and oversight of the Company's public accounting firm, including the resolution of disagreements between management and the auditor regarding financial reporting. The auditors are required to report directly to the audit committee, and members of the audit committee must be truly independent unless the SEC grants an exemption. If the audit committee does not include a financial expert, the absence of such expert must be disclosed. Audit committees are required to adopt written procedures to receive and address complaints regarding accounting, internal controls and auditing issues, including procedures to maintain the confidentiality of whistle blowers. USA Patriot Act of 2001. On October 26, 2001, President Bush signed the USA Patriot Act of 2001. The Patriot Act is intended is to strengthen the U.S law enforcement and the intelligence communities' abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including: o due diligence requirements for financial institutions that administer, maintain, or manage private banks accounts or correspondent accounts for non-US persons; o standards for verifying customer identification at account opening; 18 o rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; and o reports by non-financial trades and businesses filed with the Treasury Department's Financial Crimes Enforcement Network for transactions exceeding $10,000, and filing of suspicious activities reports securities by brokers and dealers if they believe a customer may be violating U.S. laws and regulations. On July 23, 2002, the U.S. Treasury proposed regulations requiring institutions to incorporate into their written money laundering plans a board approved customer identification program implementing reasonable procedures for: o verifying the identity of any person seeking to open an account, to the extent reasonable and practicable; o maintaining records of the information used to verify the person's identity; and o determining whether the person appears on any list of known or suspected terrorists or terrorist organizations. Account is defined as a formal banking or business relationship established to provide ongoing services, dealings, or other financial transactions. We do not expect the proposed regulations will have a material impact on our operations. Financial Services Modernization Legislation. The Gramm-Leach-Bliley Act (the "Financial Services Modernization Act") became effective March 11, 2000. 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, 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 laws prior to the Financial Services Modernization Act 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. 19 The Company and the Banks do not believe that the Financial Services Modernization Act will have a material adverse effect on the operations of the Company and the Banks 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 acquirers 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 savings and loan holding company as defined by the Home Owners' Loan Act, as amended (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 Banks are subject to certain restrictions in their 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 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. 20 Regulation of the Banks Federal Home Loan Bank System. The Banks are members 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 members of the FHLB of Indianapolis, the Banks are 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 Banks were in compliance with this requirement with an investment in FHLB of Indianapolis stock at September 30, 2003, of $4,518,700. 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, 2003, the Banks had advances totaling $54,100,000 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 sufficient to ensure its safe and sound operation. The Banks maintain 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 Banks maintain an appropriate level of certain specified investments (primarily residential mortgages and related investments, including certain mortgage-related securities) and otherwise qualify as QTL's or a domestic building and loan association, they 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, 2003, the Banks were in compliance with their QTL requirements and met the definition of a domestic building and loan association. Branching. Subject to certain limitations, the HOLA and the OTS regulations currently permit federally chartered savings institutions such as the Banks to establish branches in any state of the United States. Federal savings associations with branches in more than one state must satisfy either the QTL or the DBLA test on a state-by-state basis. The authority for a federal savings institution to establish an interstate branch network would facilitate a geographic diversification of the institution's activities. This authority under the HOLA and the OTS regulations preempts any state law purporting to regulate branching by federal savings institutions. 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 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 21 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. On December 1, 1998, the OTS issued Thrift Bulletin 13a ("TB 13a"), which replaced previous thrift bulletins and certain other guidance on interest rate risk to assist institutions in interpreting the rules governing interest rate risk. TB 13a sets forth a definition and sources of interest rate risk and directs the Board of Directors of a savings association to set interest rate risk limits for the savings association and to adopt a system for measuring interest rate risk. TB 13a also describes certain due diligence management should undertake before taking a position in investment securities or financial derivatives, requires certain record-keeping of such investments, and states that the savings association's activities in this area will be subject to assessment by examiners. TB 13a discusses the two elements to an examiner's assessment of interest rate risk; the level of market risk as measured by a net portfolio value model, and the quality of the savings association's practices for managing interest rate risk. In the event the OTS believes supervisory action is required to address interest rate risk at a savings association, TB 13a outlines the range of agency responses, from written plans from the board to reduce risk to formal enforcement action, including supervisory agreements or cease and desist orders. 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, 2003, the Banks exceeded all regulatory minimum capital requirements as indicated in Note 16, page 31 of the Company's Annual Report to Stockholders. Insurance of Deposit Accounts. The Banks' 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, 2002, SAIF members paid within a range of 0 cents to 23 cents per $100 of domestic deposits, depending upon the 22 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 Banks 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, 2003, the Banks met their reserve requirements. Dividend and Other Capital Distribution Limitations. The OTS imposes various restrictions or requirements on the ability of savings institutions to make capital distributions, including cash dividends. A savings institution that is a subsidiary of a savings and loan holding company, such as the Bank, must file an application or a notice with the OTS at least 30 days before making a capital distribution. Savings institutions are not required to file an application for permission to make a capital distribution and need only file a notice if the following conditions are met: (1) they are eligible for expedited treatment under OTS regulations, (2) they would remain adequately capitalized after the distribution, (3) the annual amount of capital distribution does not exceed net income for that year to date added to retained net income for the two preceding years, and (4) the capital distribution would not violate any agreements between the OTS and the savings institution or any OTS regulations. Any other situation would require an application to the OTS. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that the distribution would constitute an unsafe or unsound practice. A federal savings institution is prohibited from making a capital distribution if, after making the distribution, the savings institution would be unable to meet any one of its minimum regulatory capital requirements. Savings institutions cannot distribute regulatory capital that is needed for its liquidation account. 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. 23 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. The Federal Reserve Board issued for public comment, in October 2002, proposed amended regulations applicable to transactions between affiliates. The Company does not believe that these proposed regulations, if adopted by the Federal Reserve Board, will have any material effect upon the business or operations of the Company. Standards for Safety and Soundness. Under applicable regulatory requirements, the Banks are required to prescribe standards, by regulation or guideline, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, operational and managerial standards as the agencies deem appropriate. The OTS and the federal bank regulatory agencies adopted, effective August 9, 1995, a set of guidelines prescribing safety and soundness standards pursuant to the statute. The safety and soundness guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks associated with each aspect of an institution's operations. The guidelines also prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder. In addition, on August 27, 1996, the OTS and the federal bank regulatory agencies added guidelines for asset quality and earnings standards. Under the standards, a savings institution would be required to maintain systems, commensurate with its size and the nature and scope of its operations, to identify problem assets and prevent deterioration in those assets as well as to evaluate and monitor earnings and ensure that earnings are sufficient to maintain adequate capital and reserves. 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, 2000, the Banks met the capital requirements of "well capitalized" institutions 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 24 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. Real Estate Lending Standards. Under joint regulations of the federal banking agencies, including the OTS, savings institutions must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or extensions of credit that are secured by liens or interests in real estate or are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification standards, prudent underwriting standards, including loan-to value limits that are clear and measurable, loan administration procedures and documentation, approval and reporting requirements. An institution's real estate lending policy must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies (the "Interagency Guidelines") that have been adopted by the federal banking agencies. The Interagency Guidelines, among other things, call upon depository institutions to establish internal loan-to-value limits specified in the Interagency Guidelines for the various types of real estate loans. The Interagency Guidelines state that it may be appropriate in individual cases to originate or purchase loans with loan-to-value ratios in excess of the supervisory loan-to-value limits not exceeding those specified, but require that the aggregate amount of loans with torn-to-value ratios in excess of certain specified levels may not exceed the amount of the savings association's total capital. (Amounts in excess of core capital must be deducted on a dollar-for-dollar basis from this capital.) Federal Consumer Credit and Non-Discrimination Legislation. The Banks' mortgage lending activities arc subject to the provisions of various federal and state statutes, including, among others, the Truth in Lending Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, the Fair Housing Act and the regulations promulgated thereunder. These statutes and regulations, among other things, prohibit discrimination on the basis of race, gender or other designated characteristics, prohibit unfair and deceptive trade practices, require the disclosure of certain basic information to mortgage borrowers concerning credit terms and settlement costs, and otherwise regulate terms and conditions of credit and the procedures by which credit is offered and administered. Each of the foregoing statutes provides for various administrative, civil and, in limited circumstances, criminal enforcement procedures, and violations thereof may also lead to class actions seeking actual and/or punitive damages. Community Reinvestment Act and Fair Lending Developments. The Banks are 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. As of the latest CRA Examinations, the Banks each received a rating of "satisfactory" in complying with its CRA obligations. 25 Item 2. Properties Peoples Federal owns nine full-service banking offices located in Avilla, Auburn, Columbia City, Garrett, Kendallville, LaGrange, Topeka, and Waterloo, Indiana. The following table provides certain information with respect to Peoples Federal's full-service offices at September 30, 2003: Full Service Date Net Book Offices Opened Value (1) ------------------------------------------------------------ (Dollars in thousands) Main Office, Auburn 1973 $ 245 Avilla 1980 98 Garrett 1972 53 Columbia City-Downtown 1971 100 Columbia City-North 1998 491 Kendallville 1941 389 LaGrange 1972 230 Waterloo 2000 935 Topeka 2002 501 (1) Of real estate at September 30, 2003. The total net book value of Peoples Federal's premises and equipment at September 30, 2003, was $3.9 million. First Savings Bank owns six full-service banking offices located in Three Rivers, Union, and Schoolcraft, Michigan and Howe and Middlebury, Indiana. The following table provides certain information with respect to First Saving's full service offices at September 30, 2003. Full Service Date Net Book Offices Opened Value (1) ------------------------------------------------------------ (Dollars in thousands) Main Office, Three Rivers 1981 628 Schoolcraft 1971 64 Union 1988 191 Three Rivers, branch 1988 298 Howe 1998 340 Middlebury 1998 620 (1) Of real estate at September 30, 2003. The total net book value of First Savings' premises and equipment at September 30, 2003 was $2.5 million. Item 3. Legal Proceedings There are no material pending legal proceedings to which the Company, the Banks or any subsidiary is a party or to which any of their property is subject. 26 Item 4. Submission of Matters to a Vote of Security Holders Not Applicable. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Reference is made to page 3 of the Company's Annual Report to Stockholders, for the year ended September 30, 2003 for the information required by this Item, which is hereby incorporated by reference. Reference is also made to Item 11 under Part III of this form 10-K for the Equity Compensation Plan Table required by Regulation S-K. Item 6. Selected Financial Data Reference is made to page 3 of the Company's Annual Report to Stockholders for the year ended September 30, 2003, for the information required by this Item, which is hereby incorporated by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Reference is made to pages 4 to 11 of the Company's Annual Report to Stockholders for the year ended September 30, 2003, for the information required by this Item, which is hereby incorporated by reference. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Reference is made to page 6 of the Company's Annual Report to Stockholders for the year ended September 30, 2003, for the information required by this item, which is hereby incorporated by reference. Item 8. Financial Statements and Supplementary Data Reference is made to pages 14 to 39 of the Company's Annual Report to Stockholders for the year ended September 30, 2003 for the information required by this Item, which is hereby incorporated by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures None. Item 9A. Controls and Procedures The Chief Executive Officer and the Chief Financial Officer of the Company (its principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation as of a date within 90 days prior to the date of the filing of this Report, that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company's management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. The Company's management, including the CEO and CFO, does not expect that its disclosure controls or its internal controls and procedures for financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls 27 can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of such evaluation. PART III 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 Proxy Statement dated December 8, 2003 for the information required by this Item, which is hereby incorporated by reference. Code of Ethics. The company has adopted an ethics policy that applies to Financial Managers of the Company and its subsidiaries. A copy of the Ethics Policy is attached on exhibit 14 to this annual report. Item 11. Executive Compensation Reference is made to the section captioned "The Peoples Bancorp Annual Meeting-Compensation of Executive Officers" in the Company's Proxy Statement dated December 8, 2003 for the information required by this Item, which is hereby incorporated by reference. (a) (b) (c) Number of securities remaining Number of Weighted available for securities to be -average future issuance issued upon exercise price of under equity exercise of outstanding compensation outstanding options, plans (excluding Plan Category options, warrants warrants and securities reflected and rights rights in column (a) ------------------------------ Equity compensation plans approved 110,249(1) $14.43 89,751 by security holders........... Equity compensation plans not -0- -0- approved by security holders.. Total......................... 110,249 $14.43 89,751 (1) 80,249 shares were assumed in connection with the acquisition of Three Rivers Financial Corp at a weighted average exercise price of $11.78. 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 Proxy Statement dated December 8, 2003 for the information required by this Item which is hereby incorporated by reference. 28 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 Proxy Statement dated December 8, 2003 for the information required by this Item, which is hereby incorporated by reference. Item 14. Principal Accounting Fees and Services Reference is made to the section captioned "Accountant's Fees" in the Company's Proxy Statement dated December 8, 2003 for the information required by this Item, which is hereby incorporated by reference. Item 15. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K (a) The following consolidated financial statements of Peoples Bancorp and Its Wholly-owned Subsidiaries, included in the Annual Report to Stockholders of the registrant for the year ended September 30, 2003 are filed as part of this report: 1. Financial Statements o REPORT OF BKD LLP, INDEPENDENT ACCOUNTANTS PAGE 13. o CONSOLIDATED BALANCE SHEETS - AS OF SEPTEMBER 30, 2003, AND 2002 PAGE 14. o CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002, AND 2001 PAGE 15. o CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002, AND 2001 PAGE 16. o CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002, AND 2001 PAGE 17. o NOTES TO CONSOLIDATED FINANCIAL STATEMENTS PAGES 18-39. 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) 29 10.7 New option plan 13 Annual Report to Stockholders 14 Code of Ethical Conduct for Financial Managers 22 Subsidiaries of the Registrant 99.1 Officer Certification 99.2 Officer Certification --------------------------------- (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) A report on Form 8-K was filed on July 25, 2003 reporting earnings for the period ended June 30, 2003. The Securities and Exchange Commission maintains a Web site 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. 30 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 18, 2003 /s/ 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 18, 2003 /s/Roger J. Wertenberger, Chairman of the Board, and Director December 18, 2003 /s/Maurice F. Winkler III, President, Chief Executive Officer and Director December 18, 2003 /s/Deborah K. Stanger Vice President-Chief Financial Officer December 18, 2003 /s/G. Richard Gatton, Director December 18, 2003 /s/Bruce S. Holwerda, Director December 18, 2003 /s/Erica D. Dekko, Director December 18, 2003 /s/Douglas D. Marsh, Director December 18, 2003 /s/Stephen R. Olson, Director December 18, 2003 /s/John C. Thrapp, Director 31 Exhibit 14 Code of Ethical Conduct for Financial Managers In my role as a finance manager of the Peoples Bancorp Corporation, I recognize that financial managers hold an important and elevated role in corporate governance. I am uniquely capable and empowered to ensure that stakeholders' interests are appropriately balanced, protected and preserved. Accordingly, this Code provides principles to which financial managers are expected to adhere and advocate. The Code embodies rules regarding individual and peer responsibilities, as well as responsibilities to the company, the public and other stakeholders. I certify to you that I adhere to and advocate the following principles and responsibilities governing my professional and ethical conduct. To the best of my knowledge and ability: 1. I act with honesty and integrity, avoiding actual or apparent conflicts of interest in personal and professional relationships. 2. I provide constituents with information that is accurate, complete, objective, relevant, timely and understandable. 3. I comply with rules and regulations of federal, state, provincial and local governments, and other appropriate private and public regulatory agencies. 4. I act in good faith, responsibly, with due care, competence and diligence, without misrepresenting material facts or allowing my independent judgment to be subordinated. 5. I respect the confidentiality of information acquired in the course of my work except when authorized or otherwise legally obligated to disclose. Confidential information acquired in the course of my work is not used for personal advantage. 6. I share knowledge and maintain skills important and relevant to my constituents' needs. 7. I proactively promote ethical behavior as a responsible partner among peers in my work environment and community. 8. I achieve responsible use of and control over all assets and resources employed or entrusted to me. 32 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 First Savings Bank Federal Savings Bank United States of America And its subsidiary Alpha Financial Michigan 33 Exhibit 99.1 CERTIFICATION I, Maurice F. Winkler III, President-Chief Executive Officer, certify that: 1. I have reviewed this annual report on Form 10-K of Peoples Bancorp, Incorporated; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 18, 2003 /s/Maurice F. Winkler III President-Chief Executive Officer 34 Exhibit 99.1 CERTIFICATION I Deborah K. Stanger, Vice President-Chief Financial Officer, certify that: 1. I have reviewed this annual report on Form 10-K of Peoples Bancorp, Incorporated; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 18, 2003 /s/Deborah K. Stanger Vice President-Chief Financial Officer 35 Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code), each of the undersigned officers of Peoples Bancorp (the "Company") does hereby certify with respect to the annual report on Form 10-K for the period ended September 30, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: December 18, 2003 /s/Maurice F. Winkler III Chief Executive Officer Date: December 18, 2003 /s/Deborah K. Stanger Chief Financial Officer 36